Unit I - Financial services

I. Indian Financial System: The financial system is the main part of running the
economy smoothly. Financial system provides the flow of finance in the economy
which leads to the development of the country financial system show the strength of
the country.
Indian Financial System is a combination of financial institutions, financial markets,
financial instruments and financial services to facilitate the transfer of funds.
Financial system provides a payment mechanism for the exchange of goods and
services. It is a link between saver and investor.

Structure of Indian Financial System

The following are the four major components that comprise the Indian Financial
System:
 Financial Institutions
 Financial Markets
 Financial Instruments/Assets/Securities
 Financial Services.

Financial Institutions:
Financial institutions are the intermediaries who facilitate the smooth functioning of
the financial system by making investors and borrowers meet. They mobilize
savings of the surplus units and allocate them in productive activities promising a
better rate of return. Structure of Indian Financial System also provides services to
entities (individual, business, government) seeking advice on various issues ranging
from restructuring to diversification plans. They provide whole range of services to
the entities who want to raise funds from the markets or elsewhere. The financial
Institutions is very important for the function of a financial system.

Types of Financial Institutions

Financial institutions can be classified into two categories
 Banking Institutions
 Non-Banking Financial Institutions

Financial Markets
Financial markets may be broadly classified as negotiated loan markets and open
the negotiated loan market is a market in which the lender and the borrower
personally negotiate the terms of the loan agreement, e.g. a businessman borrowing
from a bank or from a small loan company. On the other hand, the open market is an
impersonal market in which standardized securities are treated in large volumes.
The stock market is an example of an open market. The financial markets, in a
nutshell, the credit markets catering to the various credit needs of the individuals,
links and institutions. Credit is supplied both on a short as well as a long.
On the basis of the credit requirement for short-term and long term purposes,
financial markets are divided into two categories

Types of the financial market

 Money Market
 Capital Market

Financial Instruments/ Assets/ Securities

This is an important component of the financial system. Financial instruments are
monetary contracts between parties. The products which are traded in a financial
market are financial assets, securities or other types of financial instruments. There is
a wide range of securities in the markets since the needs of investors and credit
seekers are different. Financial instruments can be real or virtual documents
representing a legal agreement involving any kind of monetary value. Equity-based
financial instruments represent ownership of an asset. Debt-based financial
instruments represent a loan made by an investor to the owner of the asset.

Types of Financial Instruments

 Cash Instruments
 Derivative Instrument
Financial Services
It consists of services provided by Asset Management and Liability
Management Companies. They help to get the required funds and also make sure
that they are efficiently invested. They assist to determine the financing combination
and extend their professional services up to the stage of servicing of lenders.

Types of Financial Services

 Banking
 Wealth Management
 Mutual Funds
 Insurance
The Structure of Indian Financial System is about A financial system is a system that
system which allows the exchange of funds between investors, lenders, and
borrowers. Indian Financial systems operate at national and global levels. They
consist of complex, closely related services, markets, and institutions intended to
provide an efficient and regular linkage between investors and depositors.

II. Financial Services:

Meaning: Financial services are the services which are offered by the financial
companies. The financial companies comprise of both Asset Management
Companies and Liability Management Companies. In Asset Management
Companies, there leasing are companies, mutual funds, merchant bankers and
issue/portfolio managers while Liability Management Companies has the bill
discounting and acceptance houses.

In other words, the financial service is referred to as the products and services which
are offered by the banks as they provide various kinds of facilities of financial
transactions and other financial activities loans, insurance, credit cards,
investment opportunities and money management and also give information on the
stock market and other issues like market ups and downs. The basic aim of this
sector is to act as intermediary between individual and institutional investors which
will help in financial transactions.

Definition: Financial services refer to services provided by the banks and financial
institutions in a financial system. In general, all types of activities which are of
financial nature may be regarded as financial services. In a broad sense, the term
financial services mean mobilisation and allocation of savings. Thus, it includes all
activities involved in the transformation of savings into investment.

The finance industry covers a broad range of organizations that deal with
management of inflow and outflows of funds in an economy. Among these
organizations are Asset Management Companies like leasing companies, merchant
bankers and Liability Management Companies like discounting houses and
acceptance houses, and further general financial institutions like banks, credit card
companies, insurance companies, consumer finance companies, stock exchanges,
and some government sponsored enterprises.

Concept of Financial Services: It is a key component of the financial system that

facilitates financial transactions in an economy. Financial services are an essential
tool for economic growth as it brings together the one who needs funds and those
who can supply funds. It enables peoples in raising their standards of livings by
providing them with a facility of purchasing various products on hire purchase.
Financial services acts as a barrier against risk arising from various unforeseen
activities through insuring people against losses. These services are consumer-
oriented as these are designed and provided in accordance with the needs of
customers.

Features/Characteristics of Financial Services:

 Customer-centric: Financial services are usually customer focused. Financial
Services are provided, depending on the need of customer for example, leasing
finance service may be needed by an industrial customer, while merchant
banker’s services may be needed by a company issuing new equity share in the
market. Financial services firms like other service firms continuously remain in
touch with their customers, so that they can design products which can cater to
the specific needs of their customers.

 Intangibility: Financial services are intangible in nature. In a highly competitive

global environment, brand image is very important. Unless the financial
institutions providing financial products and services have good image, enjoying
the confidence of their clients, they may not be successful.

 Concomitant: Production of financial services and delivery of these services have

to be concomitant. Both these functions i.e. production of new and innovative
financial services and supplying of these services are to be performed
simultaneously.

 Perishable in nature: Like other services, financial services also require a match
between demand and supply. Services cannot be stored. They have to be supplied
when customers need them.
 Dominance of human element: Financial services are dominated by human
element. Thus, financial services are labour intensive. It requires competent and
skilled personnel to market the quality financial products.

 Advisory: Financial services can be of three types i.e. a fund based or a fee-based
or both. In case of fee-based services, the advisory function is dominant. Issue
management, registrar of issue, merchant banking, pricing of securities etc. are
few examples of advisory financial services.

 Heterogeneity: Financial services are customized services. It cannot be uniform

for all clients. Financial services vary from one client to other. Institutional client
requirements differ from individual client. After analysing the needs of the
clients, financial institutions offer customised financial services to the clients.

 Information based: Financial service industry is an information based industry. It

involves creation, dissemination and use of information. Information is an
essential component in the production of financial services.

Importance of Financial Services:

Facilitates Transactions: Financial services facilitate the smooth functioning of
transactions in an economy. Various financial instruments such as debit cards, credit
cards, cheque, bill of exchanges and many more assist people in doing payments.

Ensures liquidity: These services ensure proper liquidity by facilitating free

movement of funds among people. Financial services enable people to easily acquire
the required funds through credit cards or loan facilities.

Mobilizes Savings: Mobilization of people’s savings is another important role

played by financial services. It brings together those who have excess ideal lying
resources and one who are in need of funds for investing into productive means.

Risk Minimization: Financial services reduce the effect of risk to customers through
diversification. Insurance policies offered by companies provide protection to people
against various losses.

Allocates Capital Funds: It enables people to allocate their fund into efficient
sources. Financial services provide various investment options to customers like
mutual funds, stocks, saving and fixed deposits which can generate income for them.

Generates Employment: Financial services helps in creating more employment

opportunities in a country. There are large numbers of people who are associated
with financial institutions selling these services. Such institutions via selling financial
services generate their income and pay remuneration to their employees.
Economic Growth: These services enable the overall development of all sectors of
the economy. Financial services provide sufficient funds to all key sectors that is a
primary sector, secondary sector and tertiary sector. It results in a balanced growth
of the whole economy.
Functions of Financial Services
Financial services, through the network of financial institutions, financial markets
and financial instruments serve the needs of individuals, institutions and corporate.
In essence, orderly functioning of the financial system depends to a great deal, on
the range and the quality of financial services extended by the financial
intermediaries.

Specifically financial services perform following functions for the orderly

development of an economy.
 Mobilization of funds: A financial service helps in mobilizing fund from
investors, individual, institutions and corporate entities. These funds are
mobilized through different financial instruments like equity shares, bonds,
mutual funds etc.

 Effective utilization of funds: These financial services also help in effective

utilization of mobilized funds. Financial services helps in this regard through
services like factoring, securitization, credit rating etc. Services of Credit Rating
Company enables investors to make wise and informed decisions related to
investment. Similarly merchant banking services helps companies in mergers and
acquisitions.

 Transforming risk: Financial services like insurance helps in reduction of risk by

transferring risk to those who are more willing to bear it.

 Enhancement of economic development: A financial service helps in economic

development of the country by mobilization and deployment of funds. Ideal
savings of individuals are channelized into productive investment through
financial services.

 Provision of liquidity: The financial service industry promotes liquidity in the

financial system by allocating and reallocating savings and investment into
various avenues of economic activity. It facilitates easy conversion of financial
assets into liquid cash.

 Creation of employment opportunities: The financial service industry creates

and provides employment opportunities to millions of people all over the world.
III. Types of Financial Services:
Financial service institutions render a wide variety of services to meet the
requirements of individual users. These services may be summarized as below:
1. Provision of funds: (a) Venture capital (b) Banking services (c) Asset financing (d)
Trade financing (e) Credit cards (f) Factoring and forfaiting.

2. Managing investible funds: (a) Portfolio management (b) Merchant banking (c)
Mutual and pension funds

3. Risk financing: (a) Project preparatory services (b) Insurance (c) Export credit
guarantee

4. Consultancy services: (a) Project preparatory services (b) Project report

preparation (c) Project appraisal (d) Rehabilitation of projects (e) Business advisory
services (f) Valuation of investments (g) Credit rating (h) Merger, acquisition and
reengineering

5. Market operations: (a) Stock market operations (b) Money market operations (c)
Asset management (d) Registrar and share transfer agencies (e) Trusteeship (f) Retail
market operation (g) Futures, options and derivatives

6. Research and development: (a) Equity and market research (b) Investor education
(c) Training of personnel. (d) Financial information services

Scope of Financial Services: The scope of financial services is very wide. This is
because it covers a wide range of services. The financial services can be broadly
classified into two: (a) fund based services and (b) non-fund services (or fee-based
services).
Fund based Services: The fund based or asset based services include the following:
1. Underwriting
2. Dealing in secondary market activities
3. Participating in money market instruments like CPs, CDs etc.
4. Equipment leasing or lease financing
5. Hire purchase
6. Venture capital
7. Bill discounting.
8. Insurance services
9. Factoring
10. Forfeiting
11. Housing finance
12. Mutual fund

Non-fund based Services: Today, customers are not satisfied with mere provision of
finance. They expect more from financial service companies. Hence, the financial
service companies or financial intermediaries provide services on the basis of non-
fund activities also. Such services are also known as fee based services.
These include the following:
1. Securitisation
2. Merchant banking
3. Credit rating
4. Loan syndication
5. Business opportunity related services
6. Project advisory services
7. Services to foreign companies and NRIs.
8. Portfolio management
9. Merger and acquisition
10. Capital restructuring.
11. Debenture trusteeship
12. Custodian services
13. Stock broking

The most important fund based and non-fund based services (or types of services)
may be briefly discussed as below:
A. Asset/Fund Based Services
1. Equipment leasing/Lease financing: A lease is an agreement under which a firm
acquires a right to make use of a capital asset like machinery etc. on payment of an
agreed fee called lease rentals. The person (or the company) which acquires the right
is known as lessee. He does not get the ownership of the asset. He acquires only the
right to use the asset. The person (or the company) who gives the right is known as
lessor.

2. Hire purchase and consumer credit: Hire purchase is an alternative to leasing.

Hire purchase is a transaction where goods are purchased and sold on the condition
that payment is made in instalments. The buyer gets only possession of goods. He
does not get ownership. He gets ownership only after the payment of the last
instalment. If the buyer fails to pay any instalment, the seller can repossess the
goods. Each instalment includes interest also.

3. Bill discounting: Discounting of bill is an attractive fund based financial service

provided by the finance companies. In the case of time bill (payable after a specified
period), the holder need not wait till maturity or due date. If he is in need of money,
he can discount the bill with his banker. After deducting a certain amount
(discount), the banker credits the net amount in the customer’s account. Thus, the
bank purchases the bill and credits the customer’s account with the amount of the
bill less discount. On the due date, the drawee makes payment to the banker. If he
fails to make payment, the banker will recover the amount from the customer who
has discounted the bill. In short, discounting of bill means giving loans on the basis
of the security of a bill of exchange.

4. Venture capital: Venture capital simply refers to capital which is available for
financing the new business ventures. It involves lending finance to the growing
companies. It is the investment in a highly risky project with the objective of earning
a high rate of return. In short, venture capital means long term risk capital in the
form of equity finance.

5. Housing finance: Housing finance simply refers to providing finance for house
building. It emerged as a fund based financial service in India with the establishment
of National Housing Bank (NHB) by the RBI in 1988. It is an apex housing finance
institution in the country. Till now, a number of specialised financial
institutions/companies have entered in the field of housing finance. Some of the
institutions are HDFC, LIC Housing Finance, Citi Home, Ind Bank Housing etc

6. Insurance services: Insurance is a contract between two parties. One party is the
insured and the other party is the insurer. Insured is the person whose life or
property is insured with the insurer. That is, the person whose risk is insured is
called insured. Insurer is the insurance company to whom risk is transferred by the
insured. That is, the person who insures the risk of insured is called insurer.

Thus insurance is a contract between insurer and insured. It is a contract in which

the insurance company undertakes to indemnify the insured on the happening of
certain event for a payment of consideration. It is a contract between the insurer and
insured under which the insurer undertakes to compensate the insured for the loss
arising from the risk insured against. According to Mc Gill, “Insurance is a process in
which uncertainties are made certain”.

In the words of Jon Megi, “Insurance is a plan wherein persons collectively share the
losses of risks”. Thus, insurance is a device by which a loss likely to be caused by
uncertain event is spread over a large number of persons who are exposed to it and
who voluntarily join themselves against such an event.
The document which contains all the terms and conditions of insurance (i.e. the
written contract) is called the ‘insurance policy’. The amount for which the insurance
policy is taken is called ‘sum assured’. The consideration in return for which the
insurer agrees to make good the loss is known as ‘insurance premium’. This
premium is to be paid regularly by the insured. It may be paid monthly, quarterly,
half yearly or yearly.

7. Factoring: Factoring is an arrangement under which the factor purchases the

account receivables (arising out of credit sale of goods/services) and makes
immediate cash payment to the supplier or creditor. Thus, it is an arrangement in
which the account receivables of a firm (client) are purchased by a financial
institution or banker. Thus, the factor provides finance to the client (supplier) in
respect of account receivables. The factor undertakes the responsibility of collecting
the account receivables. The financial institution (factor) undertakes the risk. For this
type of service as well as for the interest, the factor charges a fee for the intervening
period. This fee or charge is called factorage.

8. Mutual fund: Mutual funds are financial intermediaries which mobilise savings
from the people and invest them in a mix of corporate and government securities.
The mutual fund operators actively manage this portfolio of securities and earn
income through dividend, interest and capital gains. The incomes are eventually
passed on to mutual fund shareholders.

Non-Fund Based/Fee Based Financial Services:

1. Merchant banking: Merchant banking is basically a service banking, concerned
with providing non-fund based services of arranging funds rather than providing
them. The merchant banker merely acts as an intermediary. Its main job is to transfer
capital from those who own it to those who need it. Today, merchant banker acts as
an institution which understands the requirements of the promoters on the one hand
and financial institutions, banks, stock exchange and money markets on the other.
SEBI (Merchant Bankers) Rule, 1992 has defined a merchant banker as, “any person
who is engaged in the business of issue management either by making arrangements
regarding selling, buying or subscribing to securities or acting as manager,
consultant, advisor, or rendering corporate advisory services in relation to such issue
management”.

2. Credit rating: Credit rating means giving an expert opinion by a rating agency on
the relative willingness and ability of the issuer of a debt instrument to meet the
financial obligations in time and in full. It measures the relative risk of an issuer’s
ability and willingness to repay both interest and principal over the period of the
rated instrument. It is a judgement about a firm’s financial and business prospects.
In short, credit rating means assessing the creditworthiness of a company by an
independent organisation.

3. Stock broking: Now stock broking has emerged as a professional advisory

service. Stock broker is a member of a recognized stock exchange. He buys, sells, or
deals in shares/securities. It is compulsory for each stock broker to get
himself/herself registered with SEBI in order to act as a broker. As a member of a
stock exchange, he will have to abide by its rules, regulations and bylaws.

4. Custodial services: In simple words, the services provided by a custodian are

known as custodial services (custodian services). Custodian is an institution or a
person who is handed over securities by the security owners for safe custody.
Custodian is a caretaker of a public property or securities. Custodians are
intermediaries between companies and clients (i.e. security holders) and institutions
(financial institutions and mutual funds). There is an arrangement and agreement
between custodian and real owners of securities or properties to act as custodians of
those who hand over it. The duty of a custodian is to keep the securities or
documents under safe custody. The work of custodian is very risky and costly in
nature. For rendering these services, he gets a remuneration called custodial charges.
Thus custodial service is the service of keeping the securities safe for and on behalf
of somebody else for a remuneration called custodial charges.

5. Loan syndication: Loan syndication is an arrangement where a group of banks

participate to provide funds for a single loan. In a loan syndication, a group of banks
comprising 10 to 30 banks participate to provide funds wherein one of the banks is
the lead manager. This lead bank is decided by the corporate enterprises, depending
on confidence in the lead manager. A single bank cannot give a huge loan. Hence a
number of banks join together and form a syndicate. This is known as loan
syndication. Thus, loan syndication is very similar to consortium financing.

6. Securitisation (of debt): Loans given to customers are assets for the bank. They
are called loan assets. Unlike investment assets, loan assets are not tradable and
transferable. Thus loan assets are not liquid. The problem is how to make the loan of
a bank liquid. This problem can be solved by transforming the loans into marketable
securities. Now loans become liquid. They get the characteristic of marketability.
This is done through the process of securitization.

Securitisation is a financial innovation. It is conversion of existing or future cash

flows into marketable securities that can be sold to investors. It is the process by
which financial assets such as loan receivables, credit card balances, hire purchase
debtors, lease receivables, trade debtors etc. are transformed into securities. Thus,
any asset with predictable cash flows can be securitised.

Securitisation is defined as a process of transformation of illiquid asset into security

which may be traded later in the opening market. In short, securitization is the
transformation of illiquid, non- marketable assets into securities which are liquid
and marketable assets. It is a process of transformation of assets of a lending
institution into negotiable instruments. Securitisation is different from factoring.
Factoring involves transfer of debts without transforming debts into marketable
securities. But securitisation always involves transformation of illiquid assets into
liquid assets that can be sold to investors.

IV. Role of Financial Services in development of an Economy:

To explain the role of financial services in development of economy, we must
understand that this sector leads, manages and controls the flow of money in an
economy. Developed countries have always shown a strong financial services sector.

a. Help Businesses to Grow

Financial services help in the development of businesses by giving them the required
financial assistance, guaranteeing losses, etc. The loans issued by companies are used
for buying fixed assets and/or investing in other fundraising sources.

b. Capital growth
Both working and fixed capital growth are led by financial services system in an
economy by promoting the issue of debentures, shares, short-term loans, etc.

c. Promotes Entrepreneurship growth

Financial services are also available for entrepreneurs looking for funding and
investors for their business. Banks do not easily give loans to new entrepreneurs, but
other players in the market specialize in this field. Angel investors, Venture capitals,
loan services, counselling services, etc. assist play a key role in the growth of
entrepreneurship in India.

d. Infrastructure development
Investment in infrastructure companies will promote more involvement of private
sector companies in this sector.

e. Healthy competition
A vast and expanded financial service sector and market gives the choice of
investing their money in the investors’ hands. Better the services, more the
customers for a service and the company. This ensures competition among the firms
which benefits the investors—the public and businesses of a country.

f. Promote free and easy trade

Availability of choices to investors and the public ensures trade without barriers,
mediation by trusted banks and companies. It also helps in the development of
domestic and foreign trade of goods and services.

g. Networking of Finance
The financial service sector is not one single company or bank. Rather, it is a network
of companies working together for different matters of money. Consider a person
has surplus money. He saves some amount in a bank and invests the remaining in
the stocks market. He gets high returns on the stocks and earns a profit. He now
decides to buy a car and gets its insurance done.
In this situation, we saw how the person is connected to different segments of the
market. The companies he dealt with must be connected with other service
providers.
Moral of this story was that a vast interconnected network of financial services
ensures continuous flow of capital or what we call as liquidity in the market.

h. Easy Credit and Loan availability

Credits and loans are also the wheels of this financial system. Borrowing and
lending capital and repaying it with interest is an age-old method of capital trade.
But due to problems in less income, high demand for money in the market, there is a
huge imbalance between loans and their repayment. In India, many companies and
individuals are unable to pay back the loans and outstanding credit dues. This
causes the downfall of the economy and building up of leverages and debts. This
sector has to be regulated with more attention to the type of buyer.

i. Job creation
Another way the financial service sector plays an important role is in job creation.
This sector needs different kinds of the workforce based on their skills—
management, accounting, law, IT, and more.
This sector indeed needs skilled personnel. A study of India’s top 250 companies
revealed that almost 28% of total jobs are in the financial services sector. This is
important for both the workers and the community as it leads to more
understanding of how the financial market works among the common people.

j. Balance in the economy

Finally, the financial services system helps in diversification of capital market and
removes its monopoly from the government and central authorities. It encourages
more investment from private companies and an overall, innovative, facilitative
growth of the market.
This also saves the economy from shocks in case of any sudden losses. In this case,
both the government and private financial service companies are responsible for the
balance and smooth working of the economy.

V. Financial Assets: Financial assets are the intangible assets i.e., they cannot be
physically touched but are the liquid assets whose values are derived from the
contractual claims i.e., a contract is made between two parties where one entity that
invests its money will get some contractual right to receive returns in the form of
dividends, interests etc. from another entity in which the former invests its money
and the examples of financial assets are cash and cash equivalents, bonds,
marketable securities, mutual funds, etc.

Financial assets are basically the financial instruments that are more liquid in nature
as compared to the other assets of the business and are intangible in nature. These
financial Assets derive its values from the contractual claims and are usually there in
the form of receipts, legal document, certificate, etc. They are easily convertible into
real cash. In financial assets, two parties enter into a contract which gives one party
who invest the amount (investor) gets right to receive the financial benefit from the
other party in which the amount is invested. Some of the examples of financial assets
are bonds, derivatives, fixed deposit, equity shares, and insurance contracts, etc.

Types of Financial Assets

The various types of assets are as follows:
1. Cash and the Cash Equivalents
These are the financial assets that are highly liquid current assets of the business
such as the cash balance of the business, balance in the bank accounts of the
business, cheques received from the parties but are yet to be cleared by the bank, and
commercial paper, etc.

2. Fixed Deposits
Fixed deposits refer to the amount that the business deposit with some other entity
in the expectation of earning returns on such money deposited in the form of
interest. For example, a company Z Incorporation deposited $50,000 as a fixed
deposit for a period of 1 year in the bank and in return bank has promised to pay an
interest @ 10% per annum to Z Incorporation. So fixed deposit certificate is given by
the bank to the Investor so that certificate is the proof of the fixed deposit and will
work as a contractual agreement between Z Incorporation and Bank where a bank
will pay $55,000(dollar 50,000 amount of money deposited Plus 5,000 interest) after
the completion of 1 year period.

3. Equity Shares
Equity shares are the financial assets of the company when that company purchases
equity shares issued by another company. This will be the financial asset for the
company that purchased the equity shares and owners’ equity for the company that
issued such equity shares. This financial asset establishes the right to receive
dividend to the investor which is paid by the issuing company. For example, ABC
Incorporation purchases equity shares of PQR Incorporation worth $500. This
investment has given the right to ABC incorporation to receive the dividend from
PQR incorporation and the right to vote on the matters of PQR Incorporation.

4. Preference Shares
Just like equity shares, preference shares also give the right to the holders to receive
dividend but at a pre-determined rate on the amount of shares purchased by the
holder of the company who is issuing preference shares (issuing company) and in
the event of winding up of the issuing company, preference shareholders have the
right to receive the assets of the issuing company before the assets are allocated to
equity shareholder.

5. Debentures
Debentures are the financial assets that give the debenture holders the right to
receive the interest at a pre-determined rate and on the specified due dates on the
amount invested by them. Also at the time of maturity of debentures, the amount
invested is also repaid to the debenture holders and debenture holders have the
right to claim the assets of the issuing company before preference shareholders and
equity shareholders at the time of winding up of the issuing company.

6. Accounts Receivable
When the sales are made on a credit basis then the selling party has the right to
receive the payment from the party who purchases their product (known as Debtor).
So for the selling party, that debtor comes under the head accounts receivable. In
short, these are the assets that creates a right to receive money in return to the credit
sales made by the business within the credit period granted by it and also show the
right to receive interest if the payment is delayed that is if the payment is not
received within the allowable credit days period then the purchaser (Debtor) has to
repay the purchase amount plus the interest amount which is calculated at the rate
decided at the time of sale of goods.
7. Mutual Funds
A mutual fund is a fund governed by the asset management company where they
ask the small investors to give them money and in return, they provide them units of
the mutual fund. So after collecting money from such investors, the mutual fund
invests them in the financial market making a diversified portfolio of stocks. Later,
mutual funds provide investors returns in the form of capital appreciation and
dividends/interest.

8. Derivatives
Derivatives are the financial instruments or we can say it is a contract between two
parties deriving its values from the underlying assets where such underlying asset
can be index, commodities, stocks, interest rates, currencies, etc. The most commonly
used derivative instruments are options, futures, swaps, etc.

9. Insurance Contracts
Insurance contracts are another type of financial assets where one party (known as a
policy holder) pays a premium to the insurance companies to get the right of getting
compensation at the time of occurrence of an uncertain future event in the business
that results in the loss of the business. For example, in case, a policy holder has taken
a policy which gives the right to the policy holder to get compensation in case of fire
then if the fire occurs in the business then the insurance company will compensate
the business for the loss occurred due to such fire.

Conclusion – Financial Assets Types

Thus, financial assets are the most liquid assets of the company which fulfils the cash
need of the company. These financial assets cannot be touched physically but are
important for the business to yield income in the form of dividends, interest, or any
other asset. These can be in the form of a legal document, certificates such as share
certificate, invoices, etc. and the examples are equity shares, debentures, bonds,
preference shares, derivatives, accounts receivable, cash & cash equivalents, etc.

VI. Financial Markets:

Financial Markets include any place or system that provides buyers and sellers the
means to trade financial instruments, including bonds, equities, the various
international currencies, and derivatives. Financial markets facilitate the interaction
between those who need capital with those who have capital to invest. In addition to
making it possible to raise capital, financial markets allow participants to transfer
risk (generally through derivatives) and promote commerce.
Definition: Financial markets refer broadly to any marketplace where the trading of
securities occurs, including the stock market, bond market, forex market, and
derivatives market, among others. Financial markets are vital to the smooth
operation of capitalist economies.

Understanding the Financial Markets

Financial markets play a vital role in facilitating the smooth operation of capitalist
economies by allocating resources and creating liquidity for businesses and
entrepreneurs. The markets make it easy for buyers and sellers to trade their
financial holdings. Financial markets create securities products that provide a
return for those who have excess funds (Investors/lenders) and make these funds
available to those who need additional money (borrowers).

The stock market is just one type of financial market. Financial markets are made by
buying and selling numerous types of financial instruments including equities,
bonds, currencies, and derivatives. Financial markets rely heavily on informational
transparency to ensure that the markets set prices that are efficient and appropriate.
The market prices of securities may not be indicative of their intrinsic value because
of macroeconomic forces like taxes.

Some financial markets are small with little activity, and others, like the National
Stock Exchange. The equities (stock) market is a financial market that enables
investors to buy and sell shares of publicly traded companies. The primary stock
market is where new issues of stocks, called initial public offerings (IPOs), are sold.
Any subsequent trading of stocks occurs in the secondary market, where investors
buy and sell securities that they already own.

Types of Financial Markets:

Broadly speaking, the financial markets are classified as money market and capital
market. While the money market deals with short-term credit, the capital market
handles long-term credit. Let us have a brief idea about these two types of markets.

I. Money market refers to the whole network of financial institutions dealing in

short-term funds which provide an outlet to lenders and a source of supply for such
funds to borrowers. It may be noted that it does not deal in cash or money as such,
but handles the near money assets (short-term credit instruments) such as the bills of
exchange, promissory notes, commercial paper, treasury bills, etc. with the help of
which funds are borrowed for a short period by the business units, other
organisations and the government.
The Reserve Bank of India describes money market as "the centre for dealings,
mainly of short-term character. In monetary assets. It meets the short-term
requirements of borrowers and provides liquidity or cash to them by the lenders. It
is the place where short-term surplus investible funds at the disposal of the financial
and other institutions and individuals are bid by borrowers, again comprising
institutions and individuals, and also the government".

The demand for short-term funds comes primarily from the government, business
units and individual borrowers. The government probably has become the biggest
borrower everywhere, requiring short-term funds to meet its current details. The
firms need them for meeting their working capital requirements. The other
important borrowers include stock exchange brokers, dealers in government and
other securities, merchants, farmers, etc. The banks also need such funds at times
and borrow from the central bank or from each other. The supply of loanable funds
comes mostly from the central bank of the country, the commercial banks and other
financial institutions. The central bank is the primary source of credit to commercial
banks while the commercial banks constitute the most important source of short-
term credit for business houses and individual borrowers.

Indian money market:

Meaning: The Money Market is a market for lending and borrowing of short-term
funds. It deals in funds and financial instruments having a maturity period of one
day to one year. It covers money and financial assets that are close substitutes for
money. The instruments in the money market are of short term nature and highly
liquid.

The Indian money market consists of two segments, namely organized sector and
unorganized sector. The RBI is the most important constituents of Indian money
market. The organized sector is within the direct purview of RBI regulation. The
unorganized sector comprises of indigenous bankers, money lenders and
unregulated non-banking financial institutions.

The structure or components of Indian money market:

(A) Organized Money Market Instruments and Features:
1. Call and Notice Money Market: Under call money market, funds are transacted
on overnight basis. Under notice money market funds are transacted for the period
between 2 days and 14 days. The funds lent in the notice money market do not have
a specified repayment date when the deal is made. The lender issues a notice to the
borrower 2-3 days before the funds are to be paid. On receipt of this notice, the
borrower will have to repay the funds within the given time. Generally, banks rely
on the call money market where they raise funds for a single day. The main
participants in the call money market are commercial banks (excluding RRBs),
cooperative banks and primary dealers. Discount and Finance House of India
(DFHI), Non-banking financial institutions such as LIC, GIC, UTI, NABARD etc. are
allowed to participate in the call money market as lenders.

2. Treasury Bills (T-Bills): Treasury bills are short-term securities issued by RBI on
behalf of Government of India. They are the main instruments of short term
borrowing by the Government. They are useful in managing short-term liquidity. At
present, the Government of India issues three types of treasury bills through
auctions, namely – 91 days, 182-day and 364-day treasury bills. There are no treasury
bills issued by state governments. With the introduction of the auction system,
interest rates on all types of TBs are being determined by the market forces.

3. Commercial Bills: Commercial bill is a short-term, negotiable, and self-liquidating

instrument with low risk. They are negotiable instruments drawn by a seller on the
buyer for the value of goods delivered by him. Such bills are called trade bills. When
trade bills are accepted by commercial banks, they are called commercial bills. If the
seller gives some time for payment, the bill is payable at future date (i.e. usance bill).
Generally the maturity period is upto 90 days. During the usance period, if the seller
is in need of funds, he may approach his bank for discounting the bill. Commercial
banks can provide credit to customers by discounting commercial bills. The banks
can rediscount the commercial bills any number of times during the usance period of
bill and get money.

4. Certificates of Deposits (CDs): CDs are unsecured, negotiable promissory notes

issued at a discount to the face value. They are issued by commercial banks and
development financial institutions. CDs are marketable receipts of funds deposited
in a bank for a fixed period at a specified rate of interest. CDs were introduced in
India in June 1989. The main purpose of the scheme was to enable commercial banks
to raise funds from the market through CDs. According to the original scheme, CDs
were issued in multiples of Rs.25 lakh subject to minimum size of an issue being Rs.1
crore. They had the maturity period of 3 months to one year. They are freely
transferable but only after the lock in period of 45 days after the date of issue.

5. Commercial Papers (CPs): Commercial Paper (CP) is an unsecured money market

instrument issued in the form of a promissory note with fixed maturity. They
indicate the short-term obligation of an issuer. They are quite safe and highly liquid.
They are generally issued by the leading, nationally reputed, highly rates and credit
worthy large manufacturing and finance companies is the public as well as private
sector. CPs were introduced in India January 1990. CPs were launched in India with
a view to enable highly rated corporate borrowers to diversify their sources of short-
term borrowings and also to provide an additional instrument to investors. RBI has
modified its original scheme in order to widen the market for CPs. Corporates and
primary dealers (PDs) and the all India financial institutions can issue CPs.

A corporate can issue CPs provided they fulfil the following conditions: (a) The
tangible net worth of the company is not less than Rs.4 crore. (b) The company has
been sanctioned working capital limit by banks or all India financial institutions, and
(c) The borrowed account of the company is classified as a standard asset by the
financing institution or bank.

6. Repos: A repo or reverse repo is a transaction in which two parties agree to sell
and repurchase the same security. Under repo, the seller gets immediate funds by
selling specified securities with an agreement to repurchase the same at a mutually
decided future date and price. Similarly, the buyer purchases the securities with an
agreement to resell the same to the seller at an agreed date and price. The repos in
government securities were first introduced in India since December 1992. Since
November 1996, RBI has introduced “Reverse Repos”, i.e. to sell government
securities through auction.

7. Discount and Finance House of India (DFHI): It was set up by RBI in April 1988
with the objective of deepening and activating money market. It is jointly owned by
RBI, public sector banks and all India financial institutions which have contributed
to its paid up capital. The DFHI deals in treasury bills, commercial bills, CDs, CPs,
short-term deposits, call money market and government securities. The presence of
DFHI as an intermediary in the money market has helped the corporate entities,
banks, and financial institutions to invest their short-term surpluses in money
market instruments.

8. Money Market Mutual Funds (MMMFs): RBI introduced MMMFs in April 1992
to enable small investors to participate in the money market. MMMFs mobilizes
savings from small investors and invest them in short-term debt instruments or
money market instruments such as call money, repos, treasury bills, CDs and CPs.
These instruments are forms of debt that mature in less than a year.

(B) Unorganized Sector of Indian Money Market: The unorganized Indian money
market is largely made up of indigenous bankers, money lenders and unregulated
non-bank financial intermediaries. They do operate in urban centres but their
activities are largely confined to the rural sector. This market is unorganized because
its activities are not systematically coordinated by the RBI.

The main components of unorganized money market are:

1. Indigenous Bankers: They are financial intermediaries which operate as banks,
receive deposits and give loans and deals in hundies. The hundi is a short term
credit instrument. It is the indigenous bill of exchange. The rate of interest differs
from one market to another and from one bank to another. They do not depend on
deposits entirely, they may use their own funds.

2. Money Lenders: They are those whose primary business is money lending.
Money lenders predominate in villages. However, they are also found in urban
areas. Interest rates are generally high. Large amount of loans are given for
unproductive purposes. The borrowers are generally agricultural labourers,
marginal and small farmers, artisans, factory workers, small traders, etc.

3. Unregulated non-bank Financial Intermediaries: This consist of Chit Funds,

Nithis, Loan companies and others.
(a) Chit Funds: They are saving institutions. The members make regular contribution
to the fund. The collected funds is given to some member based on previously
agreed criterion (by bids or by draws). Chit Fund is more famous in Kerala and
Tamilnadu.
(b) Nidhis: They deal with members and act as mutual benefit funds. The deposits
from the members are the major source of funds and they make loans to members at
reasonable rate of interest for the purposes like house construction or repairs. They
are highly localized and peculiar to South India. Both chit funds and Nidhis are
unregulated.

4. Finance Brokers: They are found in all major urban markets especially in cloth
markets, grain markets and commodity markets. They are middlemen between
lenders and borrowers.

II. Capital Market: Capital market refers to an organisation and the mechanism
through which the companies, other institutions and the government raise long term
funds by issue of securities such as shares, debentures, bonds, etc. It signifies the
institutional arrangement for raising long-term funds and providing facilities for
marketing and trading of securities. It symbolizes a system through which the public
takes up long term securities directly or through intermediaries, and thus, helps in
mobilising savings of the community and make them available to business units and
others for long-term use.
The demand for long-term funds is made in most countries by individuals, business
corporations, public corporations, the central bank, and the state and local
governments. On the supply side of the market for such funds, there are four
categories of lenders in any capital market, viz., individual investors, institutional
investors, banks and special industrial financing institutions known as development
banks. It may be noted that the capital market consists of primary and secondary
markets. The primary market deals with new/fresh issue of securities and is,
therefore, known as new issue market. The secondary market, on the other hand,
provides a place for purchase and sale of existing securities and is often termed as
stock market or stock exchange.

Capital market in India:

Capital market is the market for medium and long term funds. It refers to all the
facilities and the institutional arrangements for borrowing and lending term funds
(medium-term and long-term funds). The demand for long-term funds comes
mainly from industry, trade, agriculture and government. The central and state
governments invest not only on economic overheads such as transport, irrigation,
and power supply but also a basic and consumer goods industries and hence require
large sums from capital market. The supply of funds comes largely from individual
savers, corporate savings, banks, insurance companies, specialized financial
institutions and government.

The Role/Significance of Capital Market in economic development:

Capital market has a crucial significance to capital formation. Adequate capital
formation is indispensable for a speedy economic development. The main function
of capital market is the collection of savings and their distribution for industrial
development. This stimulates capital formation and hence, accelerates the process of
economic development. A sound and efficient capital market facilitates the process
of capital formation and thus contributes to economic development.

The significance of capital market in economic development is explained below.

1. Mobilisation of Savings: Capital market is an organized institutional network of
financial organizations, which not only mobilizes savings through various
instruments but also channelizes them into productive avenues. By making available
various types of financial assets, the capital market encourages savings. By
providing liquidity to these financial assets through the secondary markets capital
market is able to mobilize large amount of savings from various sections of the
people such as individuals, families, and associations. Thus, capital market mobilizes
these savings and make the same available for meeting the large capital needs of
industry, trade and business.
2. Channelization of Funds into Investments: Capital market plays a crucial role in
the economic development by channelizing funds in accordance with development
priorities. The financial intermediaries in the capital market are better placed than
individuals to channel the funds into investments which are more favourable for
economic development.

3. Industrial Development: Capital market contributes to industrial development in

the following ways:
(a) It provides adequate, cheap and diversified finance to the industrial sector for
various purposes.
(b) It provides funds for diversified purposes such as for expansion, modernization,
up gradation of technology, establishment of new units etc.
(c) It provides a variety of services to entrepreneurs such as provision of
underwriting facilities, participating in equity capital, credit rating, consultancy
services, etc. This helps to stimulate industrial entrepreneurship.

4. Modernization and Rehabilitation of Industries: Capital market can contribute

towards modernization, rationalization and rehabilitation of industries. For example,
the setting up of development financial institutions in India such as IFCI, ICICI, IDBI
and so on has helped the existing industries in the country to adopt modernization
and replacement of obsolete machinery by providing adequate finance.

5. Technical Assistance: An important bottleneck faced by entrepreneurs in

developing countries is technical assistance. By offering advisory services relating to
the preparation of feasibility reports, identifying growth potential and training
entrepreneurs in project management, the financial intermediaries in the capital
market play an important role in stimulating industrial entrepreneurship. This helps
to stimulate industrial investment and thus promotes economic development.

6. Encourage Investors to invest in Industrial Securities: Secondary market in

securities encourage investors to invest in industrial securities by making them
liquid. It provides facilities for continuous, regular and ready buying and selling of
securities. Thus, industries are able to raise substantial amount of funds from
various segments of the economy.

7. Reliable Guide to Performance: The capital market serves as a reliable guide to

the performance and financial position of corporate, and thereby promotes
efficiency. It values companies accurately and toes up manager compensation to
stock values. This gives incentives to managers to maximize the value of companies.
This stimulates efficient resource allocation and growth.
Financial Markets in India: Like the money market, capital market in India is
dichotomised into organised and unorganised components.

The organised sector of the capital market comprises all the term-lending financial
institutions (or development banks or non-banking financial institutions, like 1DB1,
ICICI, etc.), banks with their medium-term and their merchant banking divisions or
subsidiaries, LIC, GIC, UTI and the stock exchanges (an essential component of the
capital market). The unorganised sector comprises low-lying indigenous bankers
and moneylenders in rural and urban areas, chit funds, nidhis, etc.

Fig 10.2 describes the structure of the securities market which is divided into
government securities and corporate securities. Since former type of securities issued
by the government are risk-free, they are called gilt-edged securities. In the gilt-
edged securities market, the RBI plays an all-important role. Corporate securities like
shares, or equities, bonds and debentures are issued by the corporate firms. It
consists of the primary market, called new issues, and the secondary market, called
old issues. These are the instruments through which long-term capital funds are
collected from the public.

The institution of stock exchange is an important component of the capital market

through which both new issues of securities are made and old issues of securities are
purchased and sold. The former is called the ‘new issues market’ and the latter is the
‘old issues market’.

The stock exchange is, thus, a specialist market place to facilitate the exchanges of
old securities. It is known as a ‘secondary market’ for securities. The stock exchange
dealings for ‘listed’ securities are made in an open auction market where buyers and
sellers from all over the country meet. There is a well-defined code of bye-laws
according to which these dealings take place and complete publicity is given to
every transaction.

As far as the primary market or new issues market is concerned, it is the public
limited companies instead of stock market that deals in ‘old issues’ that raises funds
through the issuance of shares, bonds, debentures, etc. However, to conduct this
business, the services of specialised institutions like underwriters and stockbrokers,
merchant banks are required.

Since the new issues are not ‘quoted’ or ‘listed’ or ‘approved’ in the register of the
stock exchange in the organised stock exchanges, these new securities (of small
companies whose prices are determined not through open bidding or auction but
through direct negotiation) are dealt in ‘over-the-counter market’ or the ‘auction
market’.

Government securities market for both ‘old’ and ‘new’ issues has been on ‘over-the-
counter market’ where securities of the Union Government and State Governments
are issued. State Governments’ securities are issued by government undertakings,
municipalities and corporations, etc. The gilt-edged market in India is of two types;
the Treasury bill market and the government bond market.

As the RBI manages entirely the public debt operations of both Central and State
Governments, it is responsible for the new issue of loans. Further, in this gilt-edged
market, financial institutions like commercial banks, the RBI itself, LIC, GIC, the
provident fund organisations are the statutory holders of such government
securities. This is what is called the ‘captive market’ for government securities.