UNIT 1

Structure of Indian Financial System.

1. Explain the types of Financial Markets in India.

Answer: Types of Financial Markets in India

Stock Markets – In this kind of market, an organization makes a listing of its shares which traders &
investors buy and sell. Stock marketing, though the usage of IPO, allows companies to increase their
capital.

Over The counter Market: It is a kind of decentralized Market, without fixed geographical locations.
Here, the trade is directly done between two parties instead of an agent/broker. Most stock trading
is done through exchanges

Bond Markets- The kind of securities that allow investors to borrow money from the lender for a
certain period of time, with a fixed interest rate is known as bonds. Bonds are issued to aid financial
projects by different state and central government bodies, municipal corporations, etc. Bonds are
usually issued as bills and notes.

Money Markets- This kind of Market trades in holdings with higher liquidities and is relatively safer.
In addition, the interest return is also cheaper. The capacity of trading between organizations and
traders is quite huge if viewed on the wholesale level.

Derivative Markets- This is a kind of Market where a contract is signed between two or more parties
depending upon the financial securities or assets. The worth of the derivatives is derived from the
primary source of security to which it is linked, thus making it “secondary security”.

Forex Market- Foreign Exchange Market, also called the Forex Market, is the kind of Market that
basically deals with currencies. As cash is the most liquid asset, Forex Market has the highest
liquidity of all Markets around the globe. Banks, commercial organizations, and investment
management firms comprise the majority of the Forex Market.

2. Mention the functions of Indian financial system.

Answer: Functions of Financial Systems

A financial system allows its participants to prosper and reap the benefits. It also helps in borrowing and
lending when needed. In simpler words, it will circulate the funds to different parts of an economy. Here are
some of the financial system functions:

1. Payment System – An efficient payment system allows businesses and merchants to collect money in
exchange for their products or services. Payments can be made with cash, checks, credit cards, and
even cryptocurrency in certain instances.
2. Savings – Public savings allow individuals and businesses to invest in a range of investments and see
them grow over time. Borrowers can use them to fund new projects and increase future cash flow,
and investors get a return on investment in return.
3. Liquidity – The financial markets give investors the ability to reduce the systemic risk by
providing liquidity. It thus allows for easy buying and selling of assets when needed.
 4. Risk Management – It protects investors from various financial risks through insurances and other
types of contracts.
5. Government Policy – Governments attempt to stabilize or regulate an economy by implementing
specific policies to deal with inflation, unemployment, and interest rates.

3. Discuss in brief securities traded in financial markets.

Answer: A security is a financial instrument that can be traded in a financial market.

There are four main types of security: debt securities, equity securities, derivative securities, and hybrid
securities, which are a combination of debt and equity.

Debt Securities

Debt securities, or fixed-income securities, represent money that is borrowed and must be repaid with terms
outlining the amount of the borrowed funds, interest rate, and maturity date. In other words, debt securities
are debt instruments, such as bonds (e.g., a government or municipal bond) or a certificate of deposit (CD)
that can be traded between parties.

Equity Securities

Equity securities represent ownership interest held by shareholders in a company. In other words, it is an
investment in an organization’s equity stock to become a shareholder of the organization.

Derivative Securities

Derivative securities are financial instruments whose value depends on basic variables. The variables can be
assets, such as stocks, bonds, currencies, interest rates, market indices, and goods.

The main purpose of using derivatives is to consider and minimize risk. It is achieved by insuring against price
movements, creating favorable conditions for speculations and getting access to hard-to-reach assets or
markets.

There are four main types of derivative securities:

1. Futures

Futures, also called futures contracts, are an agreement between two parties for the purchase and delivery of
an asset at an agreed-upon price at a future date. Futures are traded on an exchange, with the contracts
already standardized. In a futures transaction, the parties involved must buy or sell the underlying asset.

2. Forwards

Forwards, or forward contracts, are similar to futures, but do not trade on an exchange, only retailing. When
creating a forward contract, the buyer and seller must determine the terms, size, and settlement process for
the derivative.

Another difference from futures is the risk for both sellers and buyers. The risks arise when one party becomes
bankrupt, and the other party may not able to protect its rights and, as a result, loses the value of its position.

3. Options
Options, or options contracts, are similar to a futures contract, as it involves the purchase or sale of an asset
between two parties at a predetermined date in the future for a specific price. The key difference between the
two types of contracts is that, with an option, the buyer is not required to complete the action of buying or
selling.

4. Swaps

Swaps involve the exchange of one kind of cash flow with another. For example, an interest rate swap enables
a trader to switch to a variable interest rate loan from a fixed interest rate loan, or vice versa.

Hybrid Securities

Hybrid security, as the name suggests, is a type of security that combines characteristics of both debt and
equity securities. Many banks and organizations turn to hybrid securities to borrow money from investors.

Examples of hybrid securities are preferred stocks that enable the holder to receive dividends prior to the
holders of common stock, convertible bonds that can be converted into a known amount of equity stocks
during the life of the bond or at maturity date, depending on the terms of the contract, etc.

4. Write a note on RBI & its Functions.

Answer: RBI
Establishment
The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve
Bank of India Act, 1934.

The Central Office of the Reserve Bank was initially established in Kolkata but was permanently moved to
Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated.

Though originally privately owned, since nationalisation in 1949, the Reserve Bank is fully owned by the
Government of India.
Functions of RBI
1. Formulate monetary policy
2. To issue currency
3. To manage foreign exchange reserve
4. To act as a bankers of all banks
5. To act as a banker to the government
6. To act as lenders of last resort
7. To regulate the Indian banking system
8. To perform development functions
5. Write a note on SEBI.

Answer: SEBI stands for Securities and Exchange Board of India. It is a statutory regulatory body that was
established by the Government of India in 1992 for protecting the interests of investors investing in securities
along with regulating the securities market. SEBI also regulates how the stock market and mutual funds
function.

Objectives of SEBI
Following are some of the objectives of the SEBI:
1. Investor Protection: This is one of the most important objectives of setting up SEBI. It involves protecting the
interests of investors by providing guidance and ensuring that the investment done is safe.
2. Preventing the fraudulent practices and malpractices which are related to trading and regulation of the
activities of the stock exchange
3. To develop a code of conduct for the financial intermediaries such as underwriters, brokers, etc.
4. To maintain a balance between statutory regulations and self regulation.

Functions of SEBI
SEBI has the following functions
1. Protective Function
2. Regulatory Function
3. Development Function
The following functions will be discussed in detail
Protective Function: The protective function implies the role that SEBI plays in protecting the investor interest
and also that of other financial participants. The protective function includes the following activities.
a. Prohibits insider trading: Insider trading is the act of buying or selling of the securities by the insiders of a
company, which includes the directors, employees and promoters. To prevent such trading SEBI has barred the
companies to purchase their own shares from the secondary market.
b. Check price rigging: Price rigging is the act of causing unnatural fluctuations in the price of securities by
either increasing or decreasing the market price of the stocks that leads to unexpected losses for the investors.
SEBI maintains strict watch in order to prevent such malpractices.
c. Promoting fair practices: SEBI promotes fair trade practice and works towards prohibiting fraudulent
activities related to trading of securities.
d. Financial education provider: SEBI educates the investors by conducting online and offline sessions that
provide information related to market insights and also on money management.
Regulatory Function: Regulatory functions involve establishment of rules and regulations for the financial
intermediaries along with corporates that helps in efficient management of the market.
The following are some of the regulatory functions.
a. SEBI has defined the rules and regulations and formed guidelines and code of conduct that should be
followed by the corporates as well as the financial intermediaries.
b. Regulating the process of taking over of a company.
c. Conducting inquiries and audit of stock exchanges.
d. Regulates the working of stock brokers, merchant brokers.
Developmental Function: Developmental function refers to the steps taken by SEBI in order to provide the
investors with a knowledge of the trading and market function. The following activities are included as part of
developmental function.
1. Training of intermediaries who are a part of the security market.
2. Introduction of trading through electronic means or through the internet by the help of registered stock
brokers.

3. By making the underwriting an optional system in order to reduce cost of issue.

6. Explain global financial markets in detail.

Answer: Globalization of Financial Markets

 International trade activities have increased at great pace which augmented the importance of global finance
market. Global finance market mainly focuses on lending and borrowing in foreign currencies to finance the
foreign trade transactions. Global finance market operate outside the domain, directive and legislature
framework of a country. The numerous components of global finance market include euro currency market,
export credit facility, International bond market, and institutional finance. Global finance market is dominated
by issues and investors in bond. The choice of currency has important role in the area of global finance market.
The most chosen currencies for global finance market is US dollars, pond, sterling, Japanese yen. The
contributors in global finance market are multinationals, corporate enterprises, and government.

Factors responsible for global finance market are:

1. Deregulation
2. Science and technology: Technological advancement for monitoring world market, executing orders and
analysing financial opportunities.
3. Institutionalization: Shift from retailing to increase institutionalization of investors in financial market.
4. Competition: There is global competitions which force government to deregulate various aspects of
international financial market.
5. Information flow: There is a free and unlimited flow of market information around the world owing to
advancement in telecommunication.
The benefits of Global finance market are flexibility and wide dispersal. Global finance market also witnesses
some innovative instruments such as swaps which are of two types, namely, interest swaps and currency
swaps. There is debt equity swap also which is popular in Global finance market

7. Explain the structure of Indian financial system

Answer:

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

Let’s discuss each component of the system in detail.

1. Financial Institutions
The Financial Institutions act as a mediator between the investor and the borrower. The investor’s savings are
mobilised either directly or indirectly via the Financial Markets.
The main functions of the Financial Institutions are as follows:

• A short term liability can be converted into a long term investment

• It helps in conversion of a risky investment into a risk-free investment
• Also acts as a medium of convenience denomination, which means, it can match a small deposit with
large loans and a large deposit with small loans
The best example of a Financial Institution is a Bank. People with surplus amounts of money make savings in
their accounts, and people in dire need of money take loans. The bank acts as an intermediate between the
two.
The financial institutions can further be divided into two types:

• Banking Institutions or Depository Institutions – This includes banks and other credit unions which
collect money from the public against interest provided on the deposits made and lend that money to
the ones in need
• Non-Banking Institutions or Non-Depository Institutions – Insurance, mutual funds and brokerage
companies fall under this category. They cannot ask for monetary deposits but sell financial products
to their customers.
Further, Financial Institutions can be classified into three categories:

• Regulatory – Institutes that regulate the financial markets like RBI, IRDA, SEBI, etc.
• Intermediates – Commercial banks which provide loans and other financial assistance such as SBI,
BOB, PNB, etc.
• Non Intermediates – Institutions that provide financial aid to corporate customers. It includes
NABARD, SIBDI, etc.

2. Financial Markets
The marketplace where buyers and sellers interact with each other and participate in the trading of money,
bonds, shares and other assets is called a financial market.
The financial market can be further divided into four types:

• Capital Market – Designed to finance the long term investment, the Capital market deals with
transactions which are taking place in the market for over a year. The capital market can further be
divided into three types:
(a)Corporate Securities Market
(b)Government Securities Market
(c)Long Term Loan Market
 • Money Market – Mostly dominated by Government, Banks and other Large Institutions, the type of
market is authorised for small-term investments only. It is a wholesale debt market which works on
low-risk and highly liquid instruments. The money market can further be divided into two types:
(a) Organised Money Market
(b) Unorganised Money Market

• Foreign exchange Market – One of the most developed markets across the world, the Foreign
exchange market, deals with the requirements related to multi-currency. The transfer of funds in this
market takes place based on the foreign currency rate.
• Credit Market – A market where short-term and long-term loans are granted to individuals or
Organisations by various banks and Financial and Non-Financial Institutions is called Credit Market.
3. Financial Instruments/ Assets/ Securities
The products which are traded in the Financial Markets are called Financial Assets. Based on the different
requirements and needs of the credit seeker, the securities in the market also differ from each other.
Some important Financial Assets have been discussed briefly below:

• Call Money – When a loan is granted for one day and is repaid on the second day, it is called call
money. No collateral securities are required for this kind of transaction.
• Notice Money – When a loan is granted for more than a day and for less than 14 days, it is called
notice money. No collateral securities are required for this kind of transaction.
• Term Money – When the maturity period of a deposit is beyond 14 days, it is called term money.
• Treasury Bills – Also known as T-Bills, these are Government bonds or debt securities with maturity of
less than a year. Buying a T-Bill means lending money to the Government.
• Certificate of Deposits – It is a dematerialised form (Electronically generated) for funds deposited in
the bank for a specific period of time.
• Commercial Paper – It is an unsecured short-term debt instrument issued by corporations.

4. Financial Services
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.
The financial services in India include:

• Banking Services – Any small or big service provided by banks like granting a loan, depositing money,
issuing debit/credit cards, opening accounts, etc.
• Insurance Services – Services like issuing of insurance, selling policies, insurance undertaking and
brokerages, etc. are all a part of the Insurance services
• Investment Services – It mostly includes asset management
• Foreign Exchange Services – Exchange of currency, foreign exchange, etc. are a part of the Foreign
exchange services
The main aim of the financial services is to assist a person with selling, borrowing or purchasing securities,
allowing payments and settlements and lending and investing.

8. What are the features of Indian financial System?

Answer: The various types of services that are provided by financial institutions like banks, insurance
companies, pensions, fund etc. to the people of the country makes a financial system.
FEATURES OF INDIAN FINANCIAL SYSTEM:
➢ It plays a vital role in economic development of a country
➢ It encourages both savings and investment.
➢ It links savers and investors.
➢ It helps in capital formation
➢ It helps in allocation of risk.
It facilitates expansion of financial markets