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Subjects /Indian Economy / Financial System of India

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Introduction
25 Feb 2021

Indian Financial System is epicentre to the economic growth of the country. The prime function of Indian financial system is to mobilise savings and make them available for investments and capital formation to accelerate the economic growth in the country.

Financial system in a country comprises of various intermediaries who play crucial role in sourcing out the funds from the surplus segment and deploying such funds to needy segment.

These intermediaries include banks, financial institutions, mutual funds etc.

Financial System

Money Market

Capital Market

  • Short term transaction
  • Less than 1 year
  • Long term transaction
  • Greater than 1 year

Money Market

Money Market is mainly concerned with supply and demand of investible funds. It is also called a reservoir of short-term funds.

Indian Money Market

Organised

Sub-Market

Unorganised

Call Money Market

Bill Market

Commercial Bills

Treasury Bills






Money Market is a market for short-term financial assets that are close substitutes of money.

Liquidity is high in money market.

Call Money Market

It is the market for very short term where transactions are made on overnight basis.

Notice Money Market

Funds are transacted for a period between 2 to 14 days.

Term Money Market

Funds are transacted for a period between 15 to 365 days.

Money Market Instruments

Commercial papers

  • It is an unsecured money market instrument issued in form of a promissory note.
  • It was introduced in 1990, to enable the high rated corporate borrowers to diversify their sources of short-term borrowings and to provide an additional instrument to the borrowers.
  • Companies, primary dealers and All India Financial Institutions can raise short term resources through Commercial papers.

 

Certificate of Deposits

  • It is a negotiable money market instrument and issued in de-materialised form. Against funds deposited at a bank or other eligible financial institution for a specified time period.
  • Certificate of Deposits are issued by scheduled commercial banks and select All India Financial Institutions that have been permitted by RBI to raise short-term resources within the umbrella limit fixed by RBI.
  • Minimum amount of CD should be Rs. 1 lakh, and in multiples of Rs. 1 lakh thereafter.

Capital Market

Capital Market

Security Market

DFIs

(Development Financial Institutions)

 

Government Security Market

 

Gilt Edged Market

Corporate Security Market

Primary Market

(IPOs)

Secondary Market

(Stock Exchange)

Equity Share

Bonds/Debentures






Government Security Markets

Treasury Bills

These are short-term securities, issued by Government, for a different period of time as per the requirement like – for 91 days, 182 days and 364 days.

Gilt-Edged Market

  • It is the market of Government securities, gilt edge means most secured or having less risk, generally, it happens in case of Government securities.
  • It acknowledges the government’s debt obligation.
  • These can be short term or long term.


Types of Government Bonds

  • Fixed Rate Bonds
    • These are bonds on which the coupon rate is fixed for the entire life i.e. till maturity of the bond.
  • Floating Rate Bonds
    • These securities do not have a fixed coupon rate.
  • Zero Coupon Bonds
    • These bonds have no coupon payments. It is a specific kind of bond in which no interest is given, but it is available at high discount, so it is also known as Deep Discount Bonds.
    • The difference of purchase value and printed value is the benefit of investor because it is redeemed at printed value.
    • In India these are not allowed for private company and first such bond was issued by IDBI in 1994.
  • Capital Indexed Bonds
    • In these bonds, the principal is linked to an accepted index of inflation with a view to protect the principal amount of the investors from inflation.
  • Inflation Indexed Bonds (IIB)
    • In these bonds both coupon flows and principal amounts are protected against inflation. The inflation index used in IIBs may be Whole Sale Price Index (WPI) or Consumer Price Index (CPI).
  • Sovereign Gold Bond
    • In these bonds, the prices are linked to commodity price of Gold. These denominated in multiples of grams of gold with a basic unit of 1 gram. The tenor of the SGB is for a period of 8 years with exit option from 5th year to be exercised on the interest payment dates.


Security Market

The security market includes the following:

Primary Market

In primary market, issues of shares of a company are classified into public, rights or preferential issues.

The public issues are classified into Initial Public Offerings (IPOs) and Follow-on Public Offerings (FPO)

  • Initial Public Offerings: When a company makes either a fresh issue of shares or an offer for sale of its existing shares of both for the first time to the public.
  • Follow-on Public Offerings: When a company which is already a listed company, either makes a fresh issue of securities to the public or an offer for sale to the public through an offer document, then it is FPO.

Rights Issue: When a listed company proposes to issue fresh securities to its existing shareholders as on a record date.

Private Placement: When an issue of shares or convertible securities by a company is made to a select group of persons under the provisions of Section 81 of Indian Companies Act, 1956, which s neither a public issue nor a right issue.


Secondary Market

It is the market of old and existing share and securities, where transactions are made through stock exchanges.

Capital Market Instruments

Equity

The ownership interest in a company of holders of its common and preferred stock.

Cumulative Preference Shares

A type of preference shares on which dividend accumulates if remains unpaid.

Bonds/Debentures

These are long term securities or debt instruments on behalf of which companies raise funds from Capital Market.

  • The holders of such bonds are entitled to get certain interest, as long as they will hold the bond, irrespective of profit and loss of the company.
  • Generally, Bonds are issued by the Government, Semi-Government Institutions.
  • Debentures are issued by Private Company.

NOTE: In shares, there is no guarantee of Money.