01. Financial Markets, Instruments Introduction.pdf

Financial Markets & Instruments introduction Capital Markets Sem 5 SOE  Session 1 Financial System – Functions formal & informal sectors Financial Markets – Primary /secondary – Money Markets & Capital Markets – Debt Markets, Equity Markets, Fex Markets,...

Financial Markets & Instruments introduction Capital Markets Sem 5 SOE  Session 1 Financial System – Functions formal & informal sectors Financial Markets – Primary /secondary – Money Markets & Capital Markets – Debt Markets, Equity Markets, Fex Markets, Derivatives & Commodity Markets- OTC & Exchange traded Markets – Financial Intermediation Financial Services Financial Intermediaries  Financial Institutions Financial institutions facilitate smooth working of the financial system by making investors and borrowers meet. They mobilize the savings of investors either directly or indirectly via financial markets, by making use of different financial instruments as well as in the process using the services of numerous financial services providers.  Introduction – Financial System Financial system", implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy”. is the system that allows the transfer of money between savers (and investors) and borrowers. is the set of Financial Intermediaries, Financial Markets and Financial Assets.  Introduction – Financial System Helps in the formation of capital. Meets the short term and long term capital needs of households, corporate houses, Govt. and foreigners. its responsibility is to mobilize the savings in the form of money and invest them in the productive manner.  What is a financial System? A financial system is a complex, well- integrated set of sub-systems of financial institutions, Financial markets, Financial instruments, and services which facilitates the transfer and allocation of funds, efficiently and effectively.  1000 thousand 1000,000 million 1000,000,000 billion 1000,000,000 trillion Spot market or cash market Forward market (contract)  Equity Market (SEBI) Debt Market – Bond market- Govt securitites Currency Markets (OTC Market) Commodity Markets Derivatives Markets (Futures & options) Money Market (Short term) Financial System Consists of Functions of Financial System Formal and Informal Financial Sectors The financial systems of most developing countries are characterised by coexistence and cooperation between the formal and informal financial sectors. This coexistence of these two sectors is commonly referred to as ‘financial dualism.’ Formal and Informal Financial Sectors formal financial sector informal financial sector  Formal Sectors The formal financial sector is characterised by the presence of an organised, institutional, and regulated system which caters to the financial needs of the modern spheres of economy; Formal and Informal Financial Sectors The informal financial sector is an unorganised, non-institutional, and non- regulated system dealing with the traditional and rural spheres of the economy Formal and Informal Financial Sectors The informal financial sector has emerged as a result of the intrinsic dualism of economic and social structures in developing countries, and financial repression which inhibits the certain deprived sections of society from accessing funds.  The Indian Financial System The Indian financial system can also be broadly classified into the formal (organised) financial system and the informal (unorganised) financial system.  The Indian Financial System The formal financial system comes under the purview of 1.The Ministry of Finance (MoF), 2.The Reserve Bank of India (RBI), 3.The Securities and Exchange Board of India (SEBI), and 4.other regulatory bodies.  The informal financial system The informal financial system consists of: Individual moneylenders such as neighbours, relatives, landlords, traders, and storeowners. Groups of persons operating as ‘funds’ or ‘associations etc  Informal Financial System Advantages Low transaction costs Minimum default risk Transparency of procedures Disadvantages Wide range of interest rates Higher rates of interest Unregulated  COMPONENTS OF THE FORMAL FINANCIAL SYSTEM The formal financial system consists of four segments or components. These are: 1.financial institutions, 2.financial markets, 3.financial instruments, and 4.financial services Financial Institutions  Financial Institutions They could be categorized into Regulatory, Intermediaries, Non-intermediaries and Others. They offer services to organizations looking for advises on different problems including restructuring to diversification strategies. They offer complete array of services to the organizations who want to raise funds from the markets and take care of financial assets for example deposits, securities, loans, etc. Classification of Financial Institutions Banking and non-banking Term finance Specialised Sectoral Investment State-level  Financial Institutions These are intermediaries that mobilise savings and facilitate the allocation of funds in an efficient manner. Financial institutions can be classified as banking and non-banking financial institutions. Banking institutions are creators and purveyors of credit while non-banking financial institutions are purveyors of credit.  Financial Institutions While the liabilities of banks are part of the money supply, this may not be true of non- banking financial institutions. In India, non-banking financial institutions, namely, the developmental financial institutions (DFIs), and non-banking financial companies (NBFCs) as well as housing finance companies (HFCs) are the major institutional purveyors of credit.  Financial Institutions Financial institutions can also be classified as term-finance institutions such as the Industrial Development Bank of India (IDBI), the Industrial Credit and Investment Corporation of India (ICICI), the Industrial Financial Corporation of India (IFCI), the Small Industries Development Bank of India (SIDBI), and the Industrial Investment Bank of India (IIBI).  Financial institutions Financial institutions can be specialised finance institutions like the Export Import Bank of India (EXIM), the Tourism Finance Corporation of India (TFCI), ICICI Venture, the Infrastructure Development Finance Company (IDFC), and sectoral financial institutions such as the National Bank for Agricultural and Rural Development (NABARD) and the National Housing Bank (NHB).  Financial Institutions Investment institutions in the business of mutual funds Unit Trust of India (UTI), public sector and private sector mutual funds and insurance activity of Life Insurance Corporation (LIC), General Insurance Corporation (GIC) and its subsidiaries are classified as financial institutions Banking and Non-Banking Institutions Bank’s Characteristics: Characteristics of the banking business as defined in Section 5(b) of the Banking Regulation Act are as follows. Acceptance of deposits from the public For the purpose of lending or investment Repayable on demand or otherwise Withdrawable by means of any instrument whether a cheque or otherwise  Banks are creators of credit Banks are a special type of financial intermediaries which not only accept and deploy large amounts of uncollateralised deposits in a fiduciary capacity, but also leverage such funds through credit creation The creation of credit is an important function of a bank and this function distinguishes banks from the non-banking institutions  Ancillary Functions of Banks Banks provide a range of ancillary services, including transfer of funds, collection, foreign exchange, safe deposit locker, gift cheques, and merchant banking. Thus, banks provide a wide variety of banking and ancillary services.  Market Size – Banks in India The Indian banking system consists of 12 public sector banks 22 private sector banks, 44 foreign banks, 56 regional rural banks, 1,589 urban cooperative banks and 93,550 rural cooperative banks  Broad Sectors for Priority Sector Lending Agriculture Small Enterprises Retail Trade Micro Trade Education Loans Housing Loans  RBI – Reserve Banks of India : SEBI – Securities and Exchange Board of India IRDA – Insurance Regulatory and Development Authority PFRDA – Pension Fund Regulatory and Development Authority Financial FMC – Forward Markets Commission Regulatory Bodies in India  Financial Markets Financial markets are a mechanism enabling participants to deal in financial claims. The markets also provide a facility in which their demands and requirements interact to set a price for such claims  Financial Markets The main organised financial markets in India are the money market and the capital market. The first is a market for short-term securities while the second is a market for long-term securities, i.e., securities having a maturity period of one year or more.  Financial Markets A financial market is the place where financial assets are created or transferred. It can be broadly categorized into money markets and capital markets. Money market handles short-term financial assets (less than a year) whereas capital markets take care of those financial assets that have maturity period of more than a year. Money versus Capital Market Maturities  Financial Markets One more classification is possible: primary markets and secondary markets. Primary markets handles new issue of securities in contrast secondary markets take care of securities that are presently available in the stock market.  Types of Financial Securities Types Money market Capital market Segments Primary market Secondary market Distinct Features Marketable Tradeable Tailor-made  Financial Markets Financial markets can also be classified as primary and secondary markets. While the primary market deals with new issues, the secondary market is meant for trading in outstanding or existing securities. There are two components of the secondary market: Over-the-counter (OTC) market and the exchange traded market.  Financial Markets The key functions are: 1. Assist in creation and allocation of credit and liquidity. 2. Serve as intermediaries for mobilization of savings. 3. Help achieve balanced economic growth. 4. Offer financial convenience.  Financial Markets The government securities market is an OTC market. In an OTC market, spot trades are negotiated and traded for immediate delivery and payment while in the exchange-traded market, trading takes place over a trading cycle in stock exchanges. Derivatives Market (Futures and Options) operate through Exchanges  Nature of Financial Markets Financial markets create liquidity that allows businesses to grow and entrepreneurs to raise money for their ventures. They reduce risk by having information publicly available to investors and traders. These markets calm the economy by instilling confidence in investors. Investor confidence stabilizes the economy.  Financial Instruments A financial instrument is a claim against a person or an institution for payment, at a future date, of a sum of money and/or a periodic payment in the form of interest or dividend. The term ‘and/or’ implies that either of the payments will be sufficient but both of them may be promised.  Financial Instruments Financial instruments represent paper wealth shares, debentures, like bonds and notes. Many financial instruments are marketable as they are denominated in small amounts and traded in organised markets. This distinct feature of financial instruments has enabled people to hold a portfolio of different financial assets which, in turn, helps in reducing risk. Different types of financial instruments can be designed to suit the risk and return preferences of different classes of investors  Financial Instruments This is an important component of financial system. The products which are traded in a financial market are financial assets, securities or other type 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 They indicate a claim on the settlement of principal down the road or payment of a regular amount by means of interest or dividend. Equity shares, debentures, bonds, etc are some examples.  Financial instruments Financial instruments differ in terms of marketability, liquidity, reversibility, type of options, return, risk, and transaction costs. Financial instruments help financial markets and financial intermediaries to perform the important role of channelising funds from lenders to borrowers. Availability of different varieties of financial instruments helps financial intermediaries to improve their own risk management  Financial securities Financial securities are financial instruments that are negotiable and tradeable. Financial securities may be primary or secondary securities. Primary securities are also termed as direct securities as they are directly issued by the ultimate borrowers of funds to the ultimate savers. Examples of primary or direct securities include equity shares and debentures. Secondary securities are also referred to as indirect securities, as they are issued by the financial intermediaries to the ultimate savers. Bank deposits, mutual fund units, and insurance policies are secondary securities.  What are Financial Assets? Financial assets refer to assets that arise from contractual agreements on future cash flows or from owning equity instruments of another entity. Eg : Debt instruments - Bonds Financial instruments refer to a contract that generates a financial asset to one of the parties involved, and an equity instrument or financial liability to the other entity.  Need of Financial Services Borrowing and funding Lending and investing Buying and selling securities Making and enabling Payments and settlements Managing risk  Concept of intermediation Intermediation involves the "matching" of lenders with savings to borrowers who need money by an agent or third party, such as a bank.  Financial intermediaries an important source of external funding for corporates. Unlike the capital markets where investors contract directly with the corporates creating marketable securities, financial intermediaries borrow from lenders or consumers and lend to the companies that need investment.  Financial Intermediaries Come in between the ultimate borrowers and ultimate lenders provide key financial services such as merchant banking, leasing, credit rating, factoring etc. Services provided by them are: – Convenience ( maturity and divisibility), – Lower Risk(diversification), – Expert Management and – Economies of Scale. Types of Financial Intermediaries  Financial Services Financial services consist of services provided by Asset Management and Liability Management Companies. They help to get the necessary funds and also make sure that they are efficiently deployed. They assist to determine the financing combination and extend their professional services upto the stage of servicing of lenders.  Financial Services They help with borrowing, selling and purchasing securities, lending and investing, making and allowing payments and settlements and taking care of risk exposures in financial markets. These range from the leasing companies, mutual fund houses, merchant bankers, portfolio managers, bill discounting and acceptance houses.  Financial Services The financial services sector offers a number of professional services like credit rating, venture capital financing, mutual funds, merchant banking, depository services, book building, etc. Financial institutions and financial markets help in the working of the financial system by means of financial instruments. To be able to carry out the jobs given, they need several services of financial nature. Therefore, Financial services are considered as the major component of the financial system.