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Elective – I - 506 FINANCIAL MARKETS AND SERVICES (F)

COURSE OBJECTIVE : To explain the structure of Indian Financial System. To
understand leasing, hire purchase, Mutual funds.
UNIT - I : STRUCTURE OF INDIAN FINANCIAL SYSTEM : Indian Financial System
– Structure, Functions, Types of Financial Markets, Securities traded in Financial Markets,
Regulatory Institutions and their functions– RBI & SEBI, Global Financial Markets
UNIT - II : PRIMARY AND SECONDARY MARKET : Primary Market – Introduction,
Book Building, Free Pricing, Underwriting, On-Line IPOs, e-Prospectus; Secondary
Market – Organisation of Stock Exchanges, NSE, BSE and OTCEI, Listing of Securities,
Trading and Settlement, Internet Trading, New financial instruments.
UNIT - III : LEASING AND HIRE PURCHASE : Asset/ Fund Based Financial Services
– Leasing, Concept and classification, Advantages and Limitations, Hire Purchase –
Definition, mechanism, Differences between Leasing and Hire Purchase, Venture Capital –
Definition, Rationale, stages of financing.
UNIT - IV : NON FUND FINANCIAL SERVICES : Non- Fund Based Financial Services
– Credit Rating, Factoring and Forfaiting, Merchant Banking – Definition, Features,
Mechanism, Types.
UNIT - V : MUTUAL FUNDS : Mutual Funds – History, Definition, Classification,
Advantages and Disadvantages, Estimating the Net Asset Value, Mechanics of MF
Operations, Functions of AMC, Evaluating Mutual Funds.
SUGGESTED BOOKS : 1. Vasant Desai, Financial Markets and Financial Services,
Himalaya Publishing House 2. Madura,Financial Institutions and Markets, Cengage
Learning 3. M.Y. Khan, Financial Services, Mc Graw Hill 4. Dr. S.Guruswamy, Financial
Services and Markets, Thomson 5. L.M.Bhole and Jitendra Mahakud, Financial Institutions
and Markets, Mc Graw Hill
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FINANCIAL MARKETS AND SERVICES(F){5TH SEM}

UNIT-1 STRUCTURE OF INDIAN FINANCIAL SYSTEM:
 The financial system is possibly the most important institutional and functional
vehicle for economic transformation.
 Finance is a bridge between the present and the future and whether it be the
mobilisation of savings or their efficient, effective and equitable allocation for
investment, it is the success with which the financial system performs its functions
that sets the pace for the achievement of broader national objectives.
Significance and Definition
 The term financial system is a set of inter-related activities/services working together
to achieve some predetermined purpose or goal. It includes different markets, the
institutions, instruments, services and mechanisms which influence the generation
of savings, investment capital formation and growth.
 Van Horne defined the financial system as the purpose of financial markets to
allocate savings efficiently in an economy to ultimate users either for investment in
real assets or for consumption.
 Christy has opined that the objective of the financial system is to "supply funds to
various sectors and activities of the economy in ways that promote the fullest
possible utilization of resources without the destabilizing consequence of price level
changes or unnecessary interference with individual desires."
 According to Robinson, the primary function of the system is "to provide a link
between savings and investment for the creation of new wealth and to permit
portfolio adjustment in the composition of the existing wealth."
 It may be said that the primary function of the financial system is the mobilisation of
savings, their distribution for industrial investment and stimulating capital formation
to accelerate the process of economic growth.

FUNCTIONS :

1) Financial system works as an effective conduct for optimum allocation of

financial resources in an economy.
2) It helps in establishing a link between the savers and the investors.
Financial system allows ‘asset-liability transformation’. Banks create claims
(liabilities) against themselves when they accept deposits from customers but also
create assets when they provide loans to clients.
3) Economic resources (i.e., funds) are transferred from one party to another
through financial system.
4) The financial system ensures the efficient functioning of the payment
mechanism in an economy. All transactions between the buyers and sellers of
goods and services are effected smoothly because of financial system.
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5) Financial system helps in risk transformation by diversification, as in case of

mutual funds.
6) Financial system enhances liquidity of financial claims.
7) Financial system helps price discovery of financial assets resulting from the
interaction of buyers and sellers. For example, the prices of securities are
determined by demand and supply forces in the capital market.
8) Financial system helps reducing the cost of transactions.

STRUCTURE OF INDIAN FINANCIAL SYSTEM :

A) Financial Services
Financial Services are concerned with the design and delivery of financial instruments,
advisory services to individuals and businesses within the area of banking and related
institutions, personal financial planning, leasing, investment, assets, insurance etc. These
services includes
1. Banking Services: Includes all the operations provided by the banks including to the
simple deposit and withdrawal of money to the issue of loans, credit cards etc.
2. Foreign Exchange services: Includes the currency exchange, foreign exchange
banking or the wire transfer.
3. Investment Services: It generally includes the asset management, hedge fund
management and the custody services.
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4. Insurance Services: It deals with the selling of insurance policies, brokerages,

insurance underwriting or the reinsurance.
Some of the other services include the advisory services, venture capital, angel investment
etc.
B) Financial Instruments/Assets
Financial Instruments can be defined as a market for short-term money and financial assets
that is a substitute for money. The term short-term means generally a period of one year
substitutes for money is used to denote any financial asset which can be quickly converted
into money. Some of the important instruments are as follows:
1. Call /Notice-Money: Call/Notice money is the money borrowed on demand for a
very short period. When money is lent for a day it is known as Call Money.
Intervening holidays and Sunday are excluded for this purpose. Thus money
borrowed on a day and repaid on the next working day is Call Money. When the
money is borrowed or lent for more than a day up to 14 days it is called Notice
Money. No collateral security is required to cover these transactions.
2. Term Money: Deposits with maturity period beyond 14 days is referred as the term
money. The entry restrictions are the same as that of Call/Notice Money, the
specified entities not allowed to lend beyond 14 days.
3. Treasury Bills: Treasury Bills are short-term (up to one year) borrowing instruments
of the union government. It’s a promise by the Government to pay the stated sum
after the expiry of the stated period from the date of issue (less than one year). They
are issued at a discount off the face value and on maturity, the face value is paid to
the holder.
4. Certificate of Deposits: Certificates of Deposits is a money market instrument issued
in dematerialised form or as a Promissory Note for funds deposited at a bank, other
eligible financial institution for a specified period.
5. Commercial Paper: CP is a note in evidence of the debt obligation of the issuer. On
issuing commercial paper the debt is transformed into an instrument. CP is an
unsecured promissory note privately placed with investors at a discount rate of face
value determined by market forces.

C) Financial Markets
The financial markets are classified into two groups:
a) Capital Market: A capital market is an organised market which provides long-term
finance for business. Capital Market also refers to the facilities and institutional
arrangements for borrowing and lending long-term funds. Capital Market is divided
into three groups:
b) Corporate Securities Market: Corporate securities are equity and preference shares,
debentures and bonds of companies. The corporate security market is a very
sensitive and active market. It can be divided into two groups: primary and
secondary.
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c) Government Securities Market: In this market government securities are bought

and sold. The securities are issued in the form of bonds and credit notes. The buyers
of such securities are Banks, Insurance Companies, Provident funds, RBI and
Individuals.
d) Long-Term Loans Market: Banks and Financial institutions that provide long-term
loans to firms for modernization, expansion and diversification of business. Long-
Term Loan Market can be divided into Term Loans Market, Mortgages Market and
Financial Guarantees Market.
2) Money Market :Money Market is the market for short-term funds. The money market is
divided into two types: Unorganised and Organised Money Market.
a) Unorganized Market: It consists of Money lenders, Indigenous Bankers, Chit Funds,
etc.
b) Organized Money Market: It consists of Treasury Bills, Commercial Paper, Certificate
Of Deposit, Call Money Market and Commercial Bill Market. Organised Markets work
as per the rules and regulations of RBI. RBI controls the Organized Financial Market
in India.

D) Financial Intermediaries
A financial intermediary is an institution which connects the deficit and surplus money. The
best example of an intermediary is a bank which transforms the bank deposits to bank
loans. The role of the financial intermediary is to distribute funds from people who have
extra inflow of money to those who don’t have enough money to fulfil the needs. Functions
of Financial Intermediary are are as follows:
1. Maturity transformation: Deals with the conversion of short-term liabilities to long
term assets.
2. Risk transformation: Conversion of risky investments into relatively risk free ones.
3. Convenience denomination: It is a way of matching small deposits with large loans
and large deposits with small loans.
Financial Intermediaries are divided into two types:
Depository institutions: These are banks and credit unions that collect money from the
public and use that money to advance loans to financial customers.
Non-Depository institutions: These are brokerage firms, insurance and mutual funds
companies that cannot collect money deposits but can sell financial products to financial
customers.

TYPES OF FINANCIAL MARKETS:

 A 'financial market' is a market in which people trade financial securities and
derivatives such as futures and options at low transaction costs. Securities include
stocks and bonds, and precious metals.
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 The term "market" is sometimes used for what are more strictly exchanges,
organizations that facilitate the trade in financial securities, e.g., a stock exchange or
commodity exchange. This may be a physical location (like the NYSE, BSE, LSE, JSE) or
an electronic system (like NASDAQ).
 Much trading of stocks takes place on an exchange; still, corporate actions (merger,
spinoff) are outside an exchange, while any two companies or people, for whatever
reason, may agree to sell stock from the one to the other without using an exchange.
 Trading of currencies and bonds is largely on a bilateral basis, although some bonds
trade on a stock exchange, and people are building electronic systems for these as
well, similar to stock exchanges.
The financial markets are classified into two groups:
1) Capital Market: A capital market is an organised market which provides long-term
finance for business. Capital Market also refers to the facilities and institutional
arrangements for borrowing and lending long-term funds. Capital Market is divided
into three groups:
a) Corporate Securities Market: Corporate securities are equity and preference shares,
debentures and bonds of companies. The corporate security market is a very
sensitive and active market. It can be divided into two groups: primary and
secondary.
b) Government Securities Market: In this market government securities are bought
and sold. The securities are issued in the form of bonds and credit notes. The buyers
of such securities are Banks, Insurance Companies, Provident funds, RBI and
Individuals.
c) Long-Term Loans Market: Banks and Financial institutions that provide long-term
loans to firms for modernization, expansion and diversification of business. Long-
Term Loan Market can be divided into Term Loans Market, Mortgages Market and
Financial Guarantees Market.
2) Money Market :Money Market is the market for short-term funds. The money market is
divided into two types: Unorganised and Organised Money Market.
a) Unorganized Market: It consists of Money lenders, Indigenous Bankers, Chit Funds,
etc.
b) Organized Money Market: It consists of Treasury Bills, Commercial Paper, Certificate
Of Deposit, Call Money Market and Commercial Bill Market. Organised Markets work
as per the rules and regulations of RBI. RBI controls the Organized Financial Market
in India.
3) Derivatives markets: which provide instruments for the management of financial risk.
4) Futures markets: which provide standardized forward contracts for trading products at
some future date; see also forward market.
5) Foreign exchange markets: which facilitate the trading of foreign exchange.
6) Spot market
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FUNCTIONS OF FINANCIAL MARKETS:

Functions of financial markets
1) Transfer of resources: Financial markets facilitate the transfer of real economic
resources from lenders to ultimate borrowers.
2) Enhancing income: Financial markets allow lenders to earn interest or dividend on
their surplus invisible funds, thus contributing to the enhancement of the individual
and the national income.
3) Productive usage: Financial markets allow for the productive use of the funds
borrowed. The enhancing the income and the gross national production.
4) Capital formation: Financial markets provide a channel through which new savings
flow to aid capital formation of a country.
5) Price determination: Financial markets allow for the determination of price of the
traded financial assets through the interaction of buyers and sellers. They provide a
sign for the allocation of funds in the economy based on the demand and to the
supply through the mechanism called price discovery process.
6) Sale mechanism: Financial markets provide a mechanism for selling of a financial
asset by an investor so as to offer the benefit of marketability and liquidity of such
assets.
7) Information: The activities of the participants in the financial market result in the
generation and the consequent dissemination of information to the various
segments of the market. So as to reduce the cost of transaction of financial assets.

REGULATORY INSTITUTIONS AND THEIR FUNCTIONS :

 Regulatory agency (also regulatory authority, regulatory body or regulator) is a
public authority or government agency responsible for exercising autonomous
authority over some area of human activity in a regulatory or supervisory capacity.
 An independent regulatory agency is a regulatory agency that is independent from
other branches or arms of the government.
 Regulatory agencies deal in the areas of administrative law, regulatory law,
secondary legislation, and rulemaking (codifying and enforcing rules and regulations
and imposing supervision or oversight for the benefit of the public at large).
 The existence of independent regulatory agencies is justified by the complexity of
certain regulatory and supervisory tasks that require expertise, the need for rapid
implementation of public authority in certain sectors, and the drawbacks of political
interference.
 Some independent regulatory agencies perform investigations or audits, and other
may fine the relevant parties and order certain measures.
 Regulatory agencies are usually a part of the executive branch of the government,
and they have statutory authority to perform their functions with oversight from the
legislative branch. Their actions are generally open to legal review.
 Regulatory authorities are commonly set up to enforce standards and safety or to
oversee use of public goods and regulate commerce. Examples of regulatory
agencies are the Interstate Commerce Commission and the Food and Drug
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Administration in the United States, the Medicines and Healthcare Products

Regulatory Agency and Ofcom in the United Kingdom, and the Telecom Regulatory
Authority in India. See Internet regulation in Turkey for additional examples.
To ensure that it does fill its role, a regulatory agency uses mechanisms such as the
following
 Transparency of information and decision-making
 Procedures of consultation and participation
 Requirement that administrators give reasons explaining their actions
 Requirement that administrators follow principles that promote non-arbitrary and
responsive decisions
 Arrangements for review of administrative decisions by courts or other bodies

RESERVE BANK OF INDIA:

 The Reserve Bank of India (RBI) (IAST: Bhāratīya Rija़rva Baiṃka) is India's central
banking institution, which controls the monetary policy of the Indian rupee. It
commenced its operations on 1 April 1935 in accordance with the Reserve Bank of
India Act, 1934.
 The RBI plays an important part in the Development Strategy of the Government of
India. It is a member bank of the Asian Clearing Union.
 The general superintendence and direction of the RBI is entrusted with the 21-
member central board of directors: the governor; four deputy governors; two
finance ministry representatives (usually the Economic Affairs Secretary and the
Financial Services Secretary); ten government-nominated directors to represent
important elements of India's economy; and four directors to represent local boards
headquartered at Mumbai, Kolkata, Chennai and the capital New Delhi. Each of
these local boards consists of five members who represent regional interests, the
interests of co-operative and indigenous banks.
 The central bank was an independent apex monetary authority which regulates
banks and provides important financial services like storing of foreign exchange
reserves, control of inflation, monetary policy report till August 2016.
 A central bank is known by different names in different countries. The functions of a
central bank vary from country to country and are autonomous or quasi-
autonomous body and perform or through another agency vital monetary functions
in the country.
 A central bank is a vital financial apex institution of an economy and the key objects
of central banks may differ from country to country still they perform activities and
functions with the goal of maintaining economic stability and growth of an economy.
 The bank is also active in promoting financial inclusion policy and is a leading
member of the Alliance for Financial Inclusion (AFI). The bank is often referred to by
the name Mint Street. RBI is also known as banker's bank.
FUNCTIONS OF RBI:
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1) Financial Supervision: The primary objective of RBI is to undertake consolidated

supervision of the financial sector comprising commercial banks, financial
institutions and non-banking finance companies.
2) Regulator and supervisor of the financial system: The institution is also the
regulator and supervisor of the financial system and prescribes broad parameters
of banking operations within which the country's banking and financial system
functions. Its objectives are to maintain public confidence in the system, protect
depositors' interest and provide cost-effective banking services to the public.
3) Regulator and Supervisor of the Payment and Settlement Systems: Payment and
settlement systems play an important role in improving overall economic
efficiency. The Payment and Settlement Systems Act of 2007 (PSS Act)[gives the
Reserve Bank oversight authority, including regulation and supervision, for the
payment and settlement systems in the country. In this role, the RBI focuses on
the development and functioning of safe, secure and efficient payment and
settlement mechanisms.
4) Banker and Debt Manager to Government: Just like individuals need a bank to
carry out their financial transactions effectively & efficiently, Governments also
need a bank to carry out their financial transactions. RBI serves this purpose for
the Government of India (GoI). As a banker to the GoI, RBI maintains its accounts,
receive payments into & make payments out of these accounts. RBI also helps
GoI to raise money from public via issuing bonds and government approved
securities.
5) Managing foreign exchange:The central bank manages to reach different goals of
the Foreign Exchange Management Act, 1999. Their objective is to facilitate
external trade and payment and promote orderly development and maintenance
of foreign exchange market in India.
6) Issue of currency: Reserve bank of India is the sole body who is authorized to
issue currency in India. The bank also destroys the same when they are not fit for
circulation. All the money issued by the central bank is its monetary liability, i.e.,
the central bank is obliged to back the currency with assets of equal value, to
enhance public confidence in paper currency.
7) Banker's bank:Reserve Bank of India also works as a central bank where
commercial banks are account holders and can deposit money. RBI maintains
banking accounts of all scheduled banks.Commercial banks create credit. It is the
duty of the RBI to control the credit through the CRR, bank rate and open market
operations. As banker's bank, the RBI facilitates the clearing of cheques between
the commercial banks and helps the inter-bank transfer of funds. It can grant
financial accommodation to schedule banks.
8) Regulator of the Banking System: RBI has the responsibility of regulating the
nation's financial system. As a regulator and supervisor of the Indian banking
system it ensures financial stability & public confidence in the banking system.
RBI uses methods like On-site inspections, off-site surveillance, scrutiny &
periodic meetings to supervise new bank licenses, setting capital requirements
and regulating interest rates in specific areas.
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9) Custodian to foriegn exchange:The Reserve Bank has the custody of the country’s
reserves of international currency, and this enables the Reserve Bank to deal
with crisis connected with adverse balance of payments position.
10) Detection of fake currency:In order to curb the fake currency menace, RBI has
launched a website to raise awareness among masses about fake notes in the
market.

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI):

 Securities Exchange Board of India (SEBI) was set up in 1988 to regulate the functions
of securities market. SEBI promotes orderly and healthy development in the stock
market but initially SEBI was not able to exercise complete control over the stock
market transactions.
 It was left as a watch dog to observe the activities but was found ineffective in
regulating and controlling them. As a result in May 1992, SEBI was granted legal
status. SEBI is a body corporate having a separate legal existence and perpetual
succession.
Purpose and Role of SEBI:
SEBI was set up with the main purpose of keeping a check on malpractices and protect the
interest of investors. It was set up to meet the needs of three groups.
1. Issuers: For issuers it provides a market place in which they can raise finance fairly and
easily.
2. Investors: For investors it provides protection and supply of accurate and correct
information.
3. Intermediaries: For intermediaries it provides a competitive professional market.
Objectives of SEBI:
The overall objectives of SEBI are to protect the interest of investors and to promote the
development of stock exchange and to regulate the activities of stock market. The
objectives of SEBI are:
1. To regulate the activities of stock exchange.
2. To protect the rights of investors and ensuring safety to their investment.
3. To prevent fraudulent and malpractices by having balance between self regulation of
business and its statutory regulations.
4. To regulate and develop a code of conduct for intermediaries such as brokers,
underwriters, etc.

FUNCTIONS OF SEBI:
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The SEBI performs functions to meet its objectives. To meet three objectives SEBI has three
important functions. These are:
1. Protective functions
2. Developmental functions
3. Regulatory functions.
1. Protective Functions:
These functions are performed by SEBI to protect the interest of investor and provide safety
of investment.
a) It Checks Price Rigging.
b) It Prohibits Insider trading.
c) SEBI prohibits fraudulent and Unfair Trade Practices.
d) SEBI undertakes steps to educate investors so that they are able to evaluate
the securities of various companies and select the most profitable securities.
e) SEBI has issued guidelines to protect the interest of debenture-holders
wherein companies cannot change terms in midterm.
f) SEBI is empowered to investigate cases of insider trading and has provisions
for stiff fine and imprisonment.
2. Developmental Functions:
These functions are performed by the SEBI to promote and develop activities in stock
exchange and increase the business in stock exchange. Under developmental categories
following functions are performed by SEBI:
a) SEBI promotes training of intermediaries of the securities market.
b) SEBI tries to promote activities of stock exchange by adopting flexible and adoptable
approach in following way.
c) SEBI has permitted internet trading through registered stock brokers.
d) SEBI has made underwriting optional to reduce the cost of issue.
e) Even initial public offer of primary market is permitted through stock exchange.
3. Regulatory Functions:
These functions are performed by SEBI to regulate the business in stock exchange. To
regulate the activities of stock exchange following functions are performed:
a) SEBI has framed rules and regulations and a code of conduct to regulate the
intermediaries such as merchant bankers, brokers, underwriters, etc.
b) These intermediaries have been brought under the regulatory purview and private
placement has been made more restrictive.
c) SEBI registers and regulates the working of stock brokers, sub-brokers, share
transfer agents, trustees, merchant bankers and all those who are associated with
stock exchange in any manner.
d) SEBI registers and regulates the working of mutual funds etc.
e) SEBI regulates takeover of the companies.
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f) SEBI conducts inquiries and audit of stock exchanges.

GLOBAL FINANCIAL MARKETS:

 The global financial system is the worldwide framework of legal agreements,
institutions, and both formal and informal economic actors that together facilitate
international flows of financial capital for purposes of investment and trade
financing.
 Since emerging in the late 19th century during the first modern wave of economic
globalization, its evolution is marked by the establishment of central banks,
multilateral treaties, and intergovernmental organizations aimed at improving the
transparency, regulation, and effectiveness of international markets.
 In the late 1800s, world migration and communication technology facilitated
unprecedented growth in international trade and investment. At the onset of World
War I, trade contracted as foreign exchange markets became paralyzed by money
market illiquidity.
 Countries sought to defend against external shocks with protectionist policies and
trade virtually halted by 1933, worsening the effects of the global Great Depression
until a series of reciprocal trade agreements slowly reduced tariffs worldwide.
 Efforts to revamp the international monetary system after World War II improved
exchange rate stability, fostering record growth in global finance.
 A series of currency devaluations and oil crises in the 1970s led most countries to
float their currencies. The world economy became increasingly financially integrated
in the 1980s and 1990s due to capital account liberalization and financial
deregulation.
 A series of financial crises in Europe, Asia, and Latin America followed with
contagious effects due to greater exposure to volatile capital flows.
 The global financial crisis, which originated in the United States in 2007, quickly
propagated among other nations and is recognized as the catalyst for the worldwide
Great Recession.
 A market adjustment to Greece's noncompliance with its monetary union in 2009
ignited a sovereign debt crisis among European nations known as the Eurozone
crisis.
 A country's decision to operate an open economy and globalize its financial capital
carries monetary implications captured by the balance of payments.
 It also renders exposure to risks in international finance, such as political
deterioration, regulatory changes, foreign exchange controls, and legal uncertainties
for property rights and investments.
 Both individuals and groups may participate in the global financial system.
Consumers and international businesses undertake consumption, production, and
investment.
 Governments and intergovernmental bodies act as purveyors of international trade,
economic development, and crisis management. Regulatory bodies establish
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financial regulations and legal procedures, while independent bodies facilitate

industry supervision.
 Research institutes and other associations analyze data, publish reports and policy
briefs, and host public discourse on global financial affairs.
 While the global financial system is edging toward greater stability, governments
must deal with differing regional or national needs. Some nations are trying to
orderly discontinue unconventional monetary policies installed to cultivate recovery,
while others are expanding their scope and scale.