Financial System Overview

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Questions and Answers

What are the three main categories of financial institutions?

Lenders, Borrowers, Intermediaries

Commercial Banks, Investment Banks, Central Banks

Mutual Funds, Investment Banks, Insurance Companies

Monetary or Banking Financial institutions, Non-monetary or Non-banking institutions, Specialized Financial institutions (correct)

What is the primary role of financial institutions in an economy?

Financial institutions play a critical role in the transfer of resources from savers to borrowers. They also facilitate investment, facilitate economic development, and help create financial stability.

The money market exclusively trades long-term debt instruments.

False

Which of the following is NOT a characteristic of the Indian Money Market?

Highly integrated market with a uniform system of interest rates Signup and view all the answers

What is 'financial deepening'?

Financial deepening refers to increasing access to financial services and adequate credit, especially for vulnerable groups like low-income individuals, at affordable costs. Signup and view all the answers

What distinguishes a 'Call Money Market' from a 'Commercial Bills Market'?

The Call Money Market primarily deals in short-term loans with maturities ranging from one to fourteen days, while the Commercial Bills Market focuses on trading bills of exchange related to trade transactions, typically with maturities of 30 to 90 days. Signup and view all the answers

What is the main objective of a 'Repo' transaction?

To provide a short-term secured loan using securities as collateral. Signup and view all the answers

What is the primary function of a 'Financial Instrument'?

Financial instruments are documentary evidence of a claim against an individual, firm, or state for payment of principal and/or interest or dividend on a specified maturity date. They serve as a mechanism for channeling funds from lenders to borrowers. Signup and view all the answers

The Indian financial system has remained unchanged since Independence.

False Signup and view all the answers

What is the key role of the Reserve Bank of India (RBI) in the Indian Money Market?

The RBI plays a significant role in regulating and controlling the Indian Money Market. It influences interest rates, manages liquidity by adjusting the supply of money, and facilitates the flow of funds in the financial system. Signup and view all the answers

The term 'Financial Instrument' is used for a variety of ______ claims on money that are transferable from one person to another.

written legal Signup and view all the answers

The central bank is responsible for ______ the financial system.

regulating Signup and view all the answers

What is the difference between a 'primary market' and a 'secondary market'?

The 'primary market' is where newly issued securities are initially sold to investors, while the 'secondary market' is where previously issued securities are traded among investors. Signup and view all the answers

What are the key features of a 'Zero Coupon Bond'?

They are issued at a discount to their face value and pay no interest. Signup and view all the answers

Study Notes

Financial System

Refers to a set of activities facilitating resource transfer from savers to borrowers
An institutional framework in a country to enable financial transactions
Includes financial institutions, financial markets, financial instruments and financial services

Features of Financial System

Characterized by an integrated, organized and well-regulated financial market
Features innovative financial instruments, services and dynamic institutions
Meets short-term and long-term financial needs of individuals, government and corporate segments
Regulates transactions between various economic units (govt., industry and household)
Provides linkage between depositors and investors
Promotes efficient allocation and development of financial resources

Components of Financial System

Consists of financial markets, financial instruments, financial institutions and financial services
Indian financial system includes these components

Financial Markets

An institutional arrangement facilitating the exchange of financial assets (e.g., deposits, stocks, bonds, options, futures)
Can be organised or unorganised
Organised markets are recognised, formal markets with rules and regulations, controlled by regulators
Consists of money markets and capital markets
Money markets: Deal in short-term money & monetary assets (e.g., call money, treasury bills, bills of exchange)
Capital markets: Deal in long-term securities (e.g., equity, debentures, bonds)
Include Primary & Secondary markets
Primary market: Securities are issued for the first time
Secondary market: Securities are traded on exchanges (stock exchanges)

Financial Institutions

Organizations that mobilize savings and provide finance/credit to individuals/organizations
Act as intermediaries between lenders and borrowers
Can be classified into monetary (banking) and non-monetary (non-banking) institutions
Monetary: Central banks, commercial banks, regional rural banks, co-operative banks
Non-monetary: Non-banking finance companies (NBFCs), investment companies, leasing firms, venture capital firms, etc.
Specialized: Industrial development banks, state level financial institutions

Financial Instruments

Written legal claims on money, transferable between parties
Evidence of a claim for payment of principal/interest/dividend (specified maturity)
Issued by financial intermediaries in financial markets for channeling funds from lenders to borrowers
Classified as primary (direct) and secondary (indirect)
Primary: Issued directly by ultimate borrowers to ultimate savers (e.g., equity shares, debentures)
Secondary: Issued by financial intermediaries to ultimate savers (e.g., mutual fund units, insurance policies)

Financial Services

Activities/benefits connected with the sale of money or money's worth
Facilitate transactions for individuals & institutional investors
Cover a wide range of activities (insurance, banking, credit, merchant banking, mutual funds, venture capital, leasing, stock broking, hire purchase, etc.)
Can be categorized into Funds Intermediation, Payments Mechanism, Provision of Liquidity, Risk Management , and Financial Engineering

Development of Indian Financial System

Pre-independence: Unorganised and weak
Since independence: Mixed economic system, govt controls credit, establishment of development & term lending institutions, nationalized banks, strengthening of institutional infrastructure

Recent Developments in Indian Financial System

Increased foreign investment
New bank licenses issued
Reforms in regulatory structure
Digitalization and technology integration

Role of Financial Institutions

Facilitate capital mobilization and formation
Facilitate investment
Manage risk
Develop payment systems
Support financial inclusion/social impact
Stimulate innovation and technology integration
Promote global integration

Indian Money Market Instruments

Commercial Paper (CPs): Unsecured promissory notes issued by companies (short-term)
Certificate of Deposits (CDs): Negotiable instruments issued by banks (short-term)
Treasury Bills (T-Bills): Short-term debt instruments issued by the government
Commercial Bills(CBs): Arise from trade transactions (short-term)
Call Money: Very short-term loans between banks (typically overnight)
Repurchase Agreements (repos): Sale of securities, with an agreement to repurchase them at a future date (short-term)

Money Market Features

No geographical constraints
Wholesale market for short-term debt instruments
Not a single market, composed of sub-markets
Links RBI and banks for policy implementation

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Description

This quiz covers the fundamentals of the financial system, including its features, components, and the role it plays in facilitating resource transfers between savers and borrowers. Learn about the various financial institutions, markets, and instruments that make up this crucial system. Test your knowledge on how the financial system operates in India and its impact on the economy.