Introduction

A financial system is a network of financial organizations that work together to trade and transfer
capital from one location to another, such as insurance firms, stock exchanges, and investment
banks. Investors obtain funds to develop initiatives and receive a return on their investments
through the financial system.

The financial system is divided into two types.

Banks oriented
Financial system
Market oriented
Banks oriented system

Under the bank oriented system the banks play a key role in mobilizing savings, allocating
money, regulating corporate managers' investment decisions, and also providing risk
management vehicles in bank-based systems that that the customer may not delay their time.

Market oriented system

Under the market oriented system the companies to form the capital they are more likely to issue
securities under a market-oriented system (shares, bonds, etc.). These securities are purchased
directly by savers through distribution networks or institutions so that will helps the business or
companies to run in the normal strength. They issue the bones and share so that will lead to gain
the various types of invertor to invest in the market.

Components of a Financial System

1. Financial services: Financial services are economic services offered by the finance sector,
which includes credit unions, banks, credit-card companies, insurance companies, accounting
firms, consumer-finance firms, stock brokerages, investment funds, and individual investors.

2. Financial instrument: A financial instrument is like an agreement between two or more

persons or parties that have monetary worth. They can be formed, exchanged, resolved, or
amended according to the needs of the parties concerned.

Examples: stocks, bonds, futures, etc.

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 3. Financial institutions: Commercial banks, investment banks, brokerage firms, insurance
firms, and asset management funds are among the most frequent forms of financial institutions.

4. Financial market: A marketplace where bonds, equities, foreign exchange, and

derivatives can be bought and sold. Firms and investors may use financial markets to raise funds
in order to expand their operations or generate more money.

Needs of the Financial System

 Financial systems act as a middleman between savers and investors, providing transparent and
accurate information on risks and potential rewards.

 it helps in monitoring the corporate performance of the different businesses.

 It aids the government in making monetary policy decisions to function in the economy.

 It lowers transaction costs and increases returns, which encourages consumers to save more.

Functions of Financial System

Payment System Savings Liquidity

Government Policy Risk Management

Payment System: An effective installment framework permits organizations and vendors to

gather cash in return for their items or administrations. Installments can be made with cash,
checks, Visas, and even digital money in specific occasions.

Savings: Public reserve funds permit people and organizations to put resources into a scope of
speculations and see them develop over the long run. Borrowers can utilize them to subsidize
new tasks and increment future income, and financial backers receive a profit from interest
consequently.
Liquidity: The monetary business sectors enable financial backers to decrease the foundational
hazard by giving liquidity. It consequently considers simple purchasing and selling of resources
when required.

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Risk Management: It shields financial backers from different monetary dangers through
protections and different sorts of agreements.
Government Policy: Governments endeavor to settle or control an economy by executing explicit
arrangements to manage swelling, joblessness, and loan costs
Allotment of Funds: One more significant capacity of a monetary framework is to orchestrate
smooth, productive, and socially impartial assignment of credit. Cash loan specialists and native
financiers have been giving money to their borrowers since long. In any case, their money
experiences a few imperfections.
With current monetary turn of events, new monetary foundations, resources and markets have
come to be coordinated, which are assuming an inexorably significant part in the arrangement of
credit.
Advancement of Trade: The monetary framework helps in the advancement of both homegrown
and unfamiliar exchange. The monetary establishments finance brokers and the monetary market
helps in limiting monetary instruments like bills. Unfamiliar exchange is elevated due to per-
shipment and post-shipment finance by business banks.
The most amazing aspect of the monetary framework is that the dealers or the purchasers don't
meet one another and the archives are haggled through the bank. As such, the monetary
framework assists the dealers with welling different monetary foundations.
Features of Financial System
1) It assumes an imperative part in monetary improvement of a country
2) It empowers both saving and ventures
3) It joins savers and financial backers
4) It helps in capital development
5) It helps in distribution of hazard
6) It works with extension of monetary business sectors
7) It helps with monetary extending and expanding
Financial Instruments
Financial instruments are contracts for the acquisition, sale, creation, modification, or settlement
of monetary assets.
For example, if someone pays cash for a bond, other person must deliver a financial instruments
so as for the transaction to be fully completed. One person is required to provide cash, while the
opposite is required to produce the bond.
Examples of financial instruments: securities, cheques, bonds

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 Types of Financial Instruments

Financial Instruments

Cash Instruments Derivative Instruments Foreign Exchange Instruments

1. Cash Instruments

Cash instruments are financial instruments whose values can be directly influenced by market
conditions. There are two types of cash instruments: securities and deposits and loans.

Securities: A security is a monetary-valued financial instrument that is traded on the stock

market.

Loans and Deposits: Deposits and loans are both classified as cash instruments because they
represent monetary assets that are subject to a contractual agreement.

2. Derivative Instruments

Derivative instruments are financial instruments whose values are based on underlying assets
such as commodities, currencies, bonds, stocks, and stock indexes.

The common example of derivative is;

Forward: A forward is a contract between two parties that includes customized derivatives and
involves an exchange at a predetermined price at the end of the contract.

Future: A future is a derivative transaction that allows you to exchange derivatives at a

predetermined exchange rate at a future date.

Option: A contract between two parties in which the seller grants the buyer the right to buy or
sell a specific number of derivatives at a predetermined price for a set period of time is known as
an option. 

Foreign Exchange Instruments

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Foreign exchange instruments are financial instruments that are traded on a remote exchange
market, primarily currency agreements and derivatives.
Asset Classes of Financial Instruments
Financial instruments can be divided into two asset classes in addition to the types of financial
instruments listed above , namely  

1. Debt-Based Financial Instruments

Debt-based financial instruments are a type of debt-based financial instrument that a company
can use to raise capital. Bonds, debentures, mortgages, credit cards are some examples. They are
an important part of the business environment because they allow businesses to increase profits
by increasing capital. 

2. Equity-Based Financial Instruments

Equity-based financial instruments are mechanisms that act as legal owners of a business.
Common stock, convertible debentures, preferred stock, and transferable subscription rights are
all examples of this type of security.

They help businesses grow capital over a longer period of time than debt-based financing, but
they have the advantage of not requiring the owner to repay any debt

Advantages of Financial System

A strong and stable financial system is an important contributor to a country's financial stability.
Growth of capital Market: Capital is required by businesses to fund their operations and
production. Working capital and fixed capital are the two types of capital required by businesses.
As a result, a variety of business entities rely on the financial system to raise funds for both
short- and long-term cash needs.

Foreign Exchange Markets: Exporters and importers can use the foreign exchange market to
raise and receive funds to complete transactions. It also allows banks to borrow money and
provide funds to a variety of customers in different foreign currencies. The market also allows
banks to earn profit from short-term idle funds by investing them in the market. Governments
will be benefited as well, as they are able to meet their foreign exchange requirements through
this market.

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Government Securities: The financial system helps the government to raise funds by allowing
them to borrow money at a lower interest rate. The state and the central government can use the
government securities market to raise short- and long-term funds to meet capital needs by issuing
bills and bonds. Treasury bills are another way for the government to borrow money from the
money market. These instruments have enticing interest rates. As a result, the money market,
capital market, and foreign exchange market all contribute to the development of trade, industry,
and commerce both within and outside India, ensuring economic growth.

Infrastructure and growth: Economic growth is strongly influenced by the financial

infrastructure. The financial infrastructure refers to the three main pillars of the economy:
financial assets, financial markets, and financial intermediaries. Financial services play a critical
role in infrastructure and industry development by providing funds. By acting as a link between
savers and investors and facilitating the transfer of resources between them, the financial market
provides a mechanism for trading financial assets through financial intermediaries.

Employment opportunities: A well-functioning financial system aids in the creation of more job
opportunities in the economy. The financial system aids in the provision of funds to expanding
businesses and industries, resulting in an increase in output. As a result, both the organized and
unorganized sectors benefit from increased employment opportunities. Increased business and
industrial activity creates a variety of job opportunities in areas such as sales, marketing, and
advertising. Startup funding assists in the creation of additional job opportunities.

Conclusion

To conclude, a financial system is a network of financial organizations that work together to

trade and transfer capital from one location to another. Financial system acts as a middleman
between savers and investors, helps in monitoring the corporate finance and aids in government
regarding decision making. Financial system uses various instruments like cash, derivative and
foreign exchanges. Additionally financial instruments can be divided into two assets namely
debt-based and equity based besides instruments mentioned above. Financial instrument can
facilitate the growth of capital market, foreign exchange, infrastructure and growth and
employment opportunity.

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 Reference

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