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FINANCIAL MANAGEMENT NOTES
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32 views25 pagesUnit 1 - Part 1
FINANCIAL MANAGEMENT NOTES
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© © All Rights Reserved
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/ 25
Financial Management and Indian Financial System (Unit 1)
FINANCIAL MANAGEMENT AND
INDIAN FINANCIAL SYSTEM
AL EVE EGE sian
1.1.1. Meaning and Definition of Finance
Finance is the soul of the business activities, ‘Without finance, the heart and brain of business cannot function
‘implying thereby its natural death. Right from conceiving the idea of birth of a business to its liquidation,
finance is required. Inputs are made available only with finance. Even managerial ability can be had with only
finance. So, finance is the pivot around which the whole business ‘operations cluster. Therefore, there is an
imperative need to efficiently manage the
finances of a company.
Finance may be defined as the provision of money at the time when it is required. Finance refers to the
management of flows of money through an organization. It concerns with the application of skills in the
‘manipulation, use and control of money. Different authorities have interpreted the term ‘finance’ differently.
According to F.W. Paish, “Finance may be defined as the position of money at the time it is wanted”.
According to John J. Hampton, “The term finance can be defined as the management ofthe flow of money
fhrouigh an organization, whether itis be a corporation, school, bank or government agency”.
According to Howard and Upton, “Finance may be defined as that administrative area or set of administrative
functions in an organization which-relates to the arrangement of cash and credit so that the organization may
have the means to carry out the objectives as satisfactorily as possible”.
11.2. Meaning and Definition of Financial Management
‘The term financial management consists of two words ‘financial’ and-‘managemerit’. ‘Financial
Procuring sources of money supply and allocation of these sources on the basis of forecasting
Fequitements of the business. The word ‘Management’ refers to planning, organization, co-ordination and
Sontrol of human activities and physical resources for achieving the objectives of an enterprise.
‘means
ial management refers to the management of finance. It is the effective & efficient utilization of financiat
‘RSoutces, It means creating a balance among financial planning, procurement of funds; profit ‘administration &
Sources of funds. The financial management is defined as follows:
a ording to Soloman, “Financial management is concemed with the efficient use of an important economic
Tesource, namely, Capital Funds”.
rding to J.F, Bradley; “Financial management is the area of business management devoted to the
+ Iudicious use of capital & careful selection of sources of capital in order to enable a spending unit to move in
the direction of reaching its goals”, ®
According to Howard & Upton, “Financial management is the application of the planning & control functions
of the finance functions”.
“Thus, financial management is mainly concemed with planning, organizing, directing and controlling the
‘Phancial activities such as procurement and utilization of funds of the enterprise.
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‘Thakur's MBA Second Semester (Financial Management) BB.U
1.1.3, Scope/Approaches of Financial Management :
Financial management has undergone significant changes, over the years in its scope and coverage. Financial
aienal na pproach measures the scope of the financial management in various fields, which include the
essential part of the finance. Broadly, it has two approaches:
Scope to Financial Management
Traditional Approach
— (Procurement of Funds)
113.1. Traditional Approach
The scope of finance was treated,
manager Was treated as just provi
administering resources was consi
manager had no role to play in d
‘Modem Approach.
(Effective Utilization of Funds)
in the narrow sense of procurement or arrangement of funds. The finance
ider of funds, when organization was in need of them. The utilization or
idered outside the purview of the finance function. It was felt that the finance
aoe Pl lecision-making for its utilization. Others used to take decisions regarding its
application iv the organization, without the involvement of finance personnel, Finance manager had been”
treated, in-fact, as an outsider with i imi i i to perform when the
need of finds was ele by incor 3 reese and limited function, supplier of funds, to perfc
AAS per this approach, the following aspects only were included inthe scope of financial management:
1) “Estimation of requirements of finan ‘
2) Arrangement of funds from financial institutions, :
3) Arrangement of funds through financial instruments such as shares, debentures, bonds and foans, and
4) Looking after the accounting and legal work connected with the raising of funds. 2
Limitations of Traditional Approach :
‘The traditional approach evolved during 1920 continued to dominate academic thinking during the forties and.
through the early fifties. However, is the latter fifties it started to be severally criticized and later abandoned on
account of following reasons: :
1) Outsider-Looking-In Approach: The approach equated finance function. with .the raising and
administering of funds. It, thus, treated the subject of finance from the viewpoint of suppliers of funds, i.e.
outsiders, bankers, investors, etc It followed on outsiderlooking-in approach arid not the insider-looking-
out approgch since it completely ignored the viewpoint of those who had to take intemal financing
decisions. ‘ eae :
Ignored Routine Problems: The approach gave undue emphasis to episodic of infrequent happenings in
the-life of an. enterprise..-The subject of-financial-management was-mainly-confined to the financial
problems arising ‘during, the course of incorporation, mergers, consolidation: and ‘re-organization of
corporate enterprises. As-a result, the subjects did not give any importance to day-to-day financial problems
of business undertakings. .
Ignored Non-Corporate Enterprises: The approach focused attention only on the financial problems of
corporate enterprises. Non-corporate industrial organizations remained outside its scope.
Ignored Working Capital Financing: The approach laid overemphasis on the problems of long-term
financing. The problems relating to financing short-term or working capital were ignored.
No Emphasis on Allocation’ of Funds: The approach confined financial management to issues involving
it of funds. It did not emphasize on allocation of funds. It ignored, as pointed-out by Solomon
the following central issues of financial management:
i) Should an enterprise commit capital funds to certain purposes?
ii) Do the expected returns meet financial standards of performance?
iii) How should these standards be set and what is the cost of capital funds to the enterprise?
iv) How does the cost vary with the mixture of financing methods used? Financial Management and Indian Financial System (Unit 1) B
1.13.2. Modern Approach
The modem approach views the term financial management in a broad sense and provides « conceptual and
analytical framework for financial decision-making. According to it, the finance function covers both
acquisitions of funds as well as their allocation. Thus, apart from the issues involved in acquiring external
funds, the main concem of financial management is the efficient and wise allocation of funds to various uses,
Defined in a broad sense, it is viewed as an integral part of over-all management.
Financial management, according to the new approach, is concemed with the solution of thrée major problems
relating to the financial operations of a firm, corresponding to the three questions, namely, investment,
financing and dividend decisions. Thus, financial management, in the riadern sense of the tern . an be broken
‘down into four major decisions as functions of finance, They are:
1) Investment decision,
2) Financing decision,
3) Liquidity decision, and
4) Dividend policy decision.
1.1.4. Functions of Financial Management
Following are the functions of financial management: :
1) Estimation of Capital Requirements: A finance manager has to make estimation with regards to capital
requirements of the company. This will depend upon expected costs and profits and future programmes and
Policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity
of enterprise,
2) Determination of Capital Composition: Once the estimation have been made, the capital structure have to
be decided. This involves short- term. and long- term debt equity analysis. This will depend upon. the
Proportion of equity capital a company is possessing and additional funds which have to be raised from
outside parties.
3) Choice of Sources of Funds: For additional funds to be procured, a company has many choices like-
i) Issue of shares and debentures.
i) Loans to be taken from banks and financial institutions,
Public deposits to be drawn like in form of bonds.
iv) Choice of factor will depend on relative merits and demerits of each source and period of financing.
Investment of Funds: The finance manager has to decide to allocate funds into profitable ventures so that
there is safety on investment and regular returns is possible.
5). Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in
two ways: e
i) Dividend Declaration: It includes identifying the rate of dividends and other benefits like bonus,
ii) Retained Profits: The volume has to be decided which will depend upon expansional, innovational,
diversification plans of the company.
6) Management of Cash: Finance manager has to niake decisions with regards to cash management. Cash is
required for many purposes like payment of wages and salaries, payment of electricity and water bills,
payment to creditors, meeting current liabilities, maintainance of enough stock, purchase of raw materials,
ete,
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7) Financial Controls: The finance manager has not only to plan, procure and utilize the funds but he also has
to exercise control over finances. This can be done through many techniques like ratio analysis, financial
forecasting, cost and profit control, etc.
1.1.5. Importance of Financial Management
Some of the importance of the financial management is as follows: vise
1) Financial Planning and Control: Finance is a base for all she business activities, Business activities
should be not only harmonized but also planning determination and implementation offer analysis of
finance. All activities revolve around the finance. So financial planning and control are important function.
, K ‘Thakur's MBA Second Semester (Financial Management) BU
2) Essence of Managerial Decision: Financial management provides a sound base to all managerial
decisions. Financial management is the focal point in the process of decision making such as production,
sale Employees, Research & Development decisions are based on financial management.
3) Improve Profitability: Profitability of the concem purely depends on the effectiveness and proper
Utilization of funds by the business concem. Financial management helps to improve the profitability
Position of the concem with the help of strong financial control devices such as budgetary control, ratio
analysis and cost volume profit analysis.
4) Financial Management is a Scientific & Analytical Analysis: In the process of decision making and
financial analysis modem mathematical techniques are used. It requires not only a feeling for the situation
& an analytical skill, but also a thorough knowledge of the techniques and tools of financial analysis & the
knowledge to apply them & interpret the results.
5) Continuous Administration Function: In older times financial management was used periodically and its
importance was limited to the procurement of funds but in modem times finance is a continuous
administrative function. Its relation is with the procurement of capital, sources of funds, capital budgeting
decisions etc,
6) Centralized Nature: All business activities are centrally administered & control. All financial decisions in
business are taken at a central point. Functional areas such as marketing & production are decentralized in
the modem industrial concer, but financial co-ordination and control are achieved through centralization.
7) Basis of a Managerial Process: Financial management is the basis of whole management process, such as
planning, co-ordination and control. According to sound financial planning all other plans are executed &
controlled.
8) Measure of Performance: Financial management deals with risk & uncertainty factors which are directly
hit by profitability & risk. Thus, financial management is needed for maintaining proper balance in risk &
., uneertainty. +
1.1.6. Objectives of Financial Management
Financial management is concemed with procurement and use of funds. Its main aim is to use business funds in
such a way that the earnings are maximized. There are various alternatives available for using business funds.
Each altemative course has to be evaluated in detail.
The pros and cons of various decisions have to bé looked into before making a final selection. The decisions
will have to take into consideration the commercial strategy of the business. Financial management provides a
framework for selecting. a proper course of action and deciding. a viable commercial strategy. The main
objective of a business is to maximize the owner’s economic welfare. There are two main goals of firiancial
management: .
Objectives of Financial Management
Profit Maximization
Wealth Maximization,
1.1.6.1. Profit Maximization
Profit earning is the main aim of every economic activity. A business being an economic institution must eam
profit to cover its costs and provide funds for growth. No business can survive without earning profit. Profit is a
measure of efficiency of a business enterprise,
Profits also serve as a protection against risks which cannot be ensured. The accumulated profits enable a
business to face risks like fall in prices, competition from other units, advertise government policies etc. Thus,
profit maximization is considered as the main objective of business. il
1.1.6.1.1. Features of Profit Maximization
aim of any kind of economic activity is earning profit. A business concem is also functioning main|
the purpose of earning profit. Profit is the measuring techniques to understand the business efficiency of Financial Management and Indian Financial System (Unit 1) . 4
concem. Profit maximization is also the traditional and narrow approach, which aims at, maximizing the profit
of the concer. Profit maximization consists of te following important features: ;
1) Profit maximization is also called as cashing per share maximization, It leads to maximize the business
‘operation for profit maximization,
2) Ultimate aim of the business concern is eaming profit; hence, it considers all the possible ways to increase
the profitability of the concem.
3) Profit is the parameter of measuring the efficiency of the business concern. So, it shows the entire position
of the business concern,
4) Profit maximization objectives help to reduce the risk of the business.
1.1.6.1.2. Arguments in Favour of Profit Maximization
The following arguments are advanced in favour of profit maximization asthe objective of business:
1) Profit is the Test of Economic Efficiency: It is a measuring rod by which the economic performance of
"« the company can be judged.
2) Efficient Allocation of Fund: Profit leads to efficient allocation of resources as resources tend to be
directed to uses which in terms of profitability are the most desirable,
3) Social Welfare: It ensures maxim social welfare, ie, maximum dividend to shareholders, timely
__ Payments to creditors, more and more wages and other benefits to employees, beter quality at cheaper rate
‘consumers, more employment to society, and maximization of capital to the owners.
) Internal Resources for Expansion: Retained profits can be used for expansion and modernization. Thus,
~ lot of botheration of borrowings can be avoided,
3) Reduction in Risk and Uncertainty: Once huge profits are availed the company develops the risk
bearing capacity. The gross present value of a course of action is found out by discounting or capital
Sating its benefits at a rate which reflects their timing and uncertainty. A financial action which hes
___ Positive net present value creates wealth ahd therefore, is desirable. The negative present value should be
Tejected.
More Competitive: More and more Profit enharices the competitive spirit thus, under such conditions firms
~ having more and more profits can survive. Therefore, Profit maximization should be the aim of every
business.
} Desire for Controls: More and more profits do not add new shareholders a3 intemal resources are used for
expansion and modemization. Urider such situation control of the ‘company remains jn the same hands. _
Basis of Decision-Making: In all businesses profit earning capacity is the Sound basis‘of decision-making,
11.613. Limitations of Profit Maximization ..-. - sien te
The profit maximization criterion is criticized onthe following grounds; |
+ Quality of Benefits: Profit maximization approach jgnores the quality aspects of benefits associated with a
© financial course of action. The quality means the degree of certainty with whi fits are expected.
2) Ambiguity-Vague: The term ‘profit’ is vague arid has differen interpretations. It means different things to
different people. It can be. pre-tax or post-tax profit. It is not clear whether it is short-term profit or long-
“fer profit. Does it mean operating profit or profit avilable for shareholders? The other equivalent term,
Often used, is ‘Retum’. Retum can be on total capital employed or total assets ‘or shareholders equity and so
en. a!
) ‘Timing and Value of Money-Ignored: The concept of Profit maximization does not help in making a
__ Choice between projects, giving different benefits, spread over a period of time, It ignores the difference in
ine in respect of benefits arising from the similar amount of investment.-The fact that a rupee received
"today is more valuable than the rupee received later is ignored in this concept.’ ‘
‘Change in Organization Structure: Principle of Profit maximization was, earlier, accepted when the
‘Structure of the business was sole proprietorship. In this type of structure, sole proprietor managed the
business, individually, and was the recipient of total profits. As total profit belonged to him, his wealth
_Taximized. This was the picture in 19th century, when the business was, totally, self managed,
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5) Social Welfare may be Ignored: Due to Profit maximization objective, business may produce goods and
services, which may not be necessary and beneficial to the society. So, it is, indeed, doubtful how far the
Profit maximization objective serves or promotes socal welfare, let alone optimizes social welfare.
d 6) Ignores Financing and Dividend Aspects: The Profit maximization concept concentrates on profitability
jes 2" tnd impact of financing and dividend decisions on the market value of shares ae, totaly,
| ia :
d Tass ae that Profit maximization should be the basic criteria for decision-making. The primary
9 Te ports Of financial manager isto sie judicious balance between return and rik in order to maximize
1.1.6.2. Wealth Maximization
i Ezra Solomon bas described a wealth maximization goal in these terms: “The gross present worth ofa course
gen, ation is equal to the capitalized value f the flow of future expected benefits, discounted (or capitalized) at a
rate which reflects the uncertainty or certainty. Wealth or net present worth is the difference between gross
present worth and the amount. of capital investment required to achieve the benefits.”
The wealth maximization (also known as value maximization or net present worth maximization) is also
universally accepted criterion for financial decision making. The Value of an asset should be viewed in terms of
‘benefits it can produce over the cost of capital investment.
i This is also known as net present worth maximization approach, i takes into consideration the time value of
I money. Its operational features satisfy all the three requirements of a suitable operational objective of financial
courses of action i.e. quality of benefits, timing of benefits and exactness.
‘The wealth maximization approach can be more explicitly defined in the following ways:
Ay Ay A, 2 Stay
Waa a AS 2
> (14K) (14K)? ” (1+) “GK
So
tat (1+ K)*
‘Aq= Streams of benefits expected/funure cash flows
cost of action/ cost of project
ert ee platon rate
1 W=Nét present worth
The objective of wealth maximization helps to resolve two most trouble some problems attached with the flow
"of benefits, There is consideration of time value of money. The problem is handled by selecting an appropriate
| rate of discount and using this rate of discount the expected flow of future benefits.
‘The wealth maximization objective is consistent with the objective of maximizing the owner’s economic
welfare. The wealth maximization principle implies that the fundamental objective of a firm should be to
maximize the market value of its shares.
1.1.62.1, Features of Wealth Maximization =
fe] Wealth maximization criterion is Widely aécepted because of the given important features:
“'7''1) The concept of wealth is clearly defined and easy to'understand,
2) It serves as a very useful guideliné for taking investment decisions. I
3) Itrepresents present value of benefits minus cost of the investment...
4) It is consistent with the objective of maximizing the economic welfite ofthe shareholders ofa company.
o 5) Itconsiders both the quantity and quality dimensions of benefits, c
- 6) Italso incorporates the time value of money and risk factors.
— financing short-term or current assets such as cash, receivables and inventories. It is essential to maintain
__ Proper level of these assets. Finance manager is required to determine the quantum of such assets.
Profit Planning and Control: Profit planning and control is an important responsibilty of the financial
‘manager. Profit maximization is, generally, considered being an important objective ofa business. Profit is
also used as a tool for evaluating the performance of management. Profit is determined by the volume of
Fevenue and expenditure. Reveaue may accrue from sales, investment in outside securities or income from
ther sources, The expenditure may include manufacturing costs, trading expenses, office and
administrative expenses selling and distribution expenses ad financial costs. The excess of revenue over
expenditure determines the amount of profit. Profit planning and control directly influence the declaration
o
-7.2. | Changing Role of FinanceManager
There has been a total attitudinal change among owners towards the finanée ianager, Finance manager is no
Frese ctered to as an accountant. Instead of being a commodity, the finance managet is now a part of the top
tanagement. The finance manager does not cover the routine duties of finance and accounting. As a member of
Pmasiagement he is also responsible for formulation and implenientation of policies and decision-making.
1a’ modern enterprise, the finance manager occupies a key position. the traditional role ofthe finance manager
stricted to raising the needed funds from a combination of the various’ aVailable sources. But the recent
Nelopments in econofnics and finance have placed the finance manager in a central position in the business
ie ; wie aiatoeon ;
Ss ompetitive times, survival depends largely on an organization’s capabilites to anticipate and prepare
‘change rather than just react to i. The role of the financial officer, thus, beeomes crucial to meet these
hnological, economic, and political changes.
oday’s ever-changing business environment, Financial Managers are exploring ways in which the financial
tion can bring greater value to their organizations. With the passage of time, the role of Finance Manager's
Se aaa LU =
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has been changed. Financ;
consider how Besta patna Mana
decisions, Financial Me
efficieney of their fj
an organization’
mel val depends largely c
rather than just react to it.
ing and control tools over the past twenty yea:
lager to a greater extent than any other officer to provide adequat
°F Corporate Executive in addition to tn v
id prepare for change
‘gement and its various plannis
mana;
ibility of dickens’ Stetion in a big firm may ap
Fansibility of discharging the fi i
ion though ne ete the finance finton is that of
‘Accounts Manager/
Controtter
7 ¥ ¥
— oo os
wn Aecting} Magra | ta
Figure 1.1: Organisation of Finance Function
The CFO of an organisation is involved in all crucial decisions of the firm: He is a member of the t
staagSement team and is a party to formulation of seater ee isi
ified i rOUpS:
1) Functions of CFO as a Controller, and
2) Functions of CFO as a Treasurer.
1.1.8.1. Functions of CFO as a Controller
Functions of |
account; direction of internal auditing and cost control,
2) Specific control activ
') Preparation and interpretation of regular financial reports and statements,
ii) Inventory control.
itl) General accounts — primary and subsidiary accounts, devising checks on the company's finances an
safeguarding its assets; checking invoices and accounts received controlling cash payments, receipt
payroll accounts, cost accountng activities of the various management functions
iv) Statisties.
¥) Interpretation of control data,
3) Budgeting and control of corporation and results,
4) Interpretation of control data.
5) Internal audits, ee ee em > cere Sr Spee
Se
| Financial Management and Indian Financial System (Unit 1) 2
1.1.82. Functions of CFO as a Treasurer
Functions of treasurer can be divided into four broad categories:
1) Cash Management Functions: These include:
i) Opening accounts and depositing funds in banks
if) Payment of company obligations through proper disbursement procedures.
iii) Maintaining records of cash transactions,
iv) Management of petty cash and bank balance,
2) Credit Management Functions: These includes:
i) Orderly handling of collections,
Handling cash discounts and terms of sale for prompt payment
© il) Collections.
_ jv) Determination of customers credit risks,
Financial Planning Functions: These includes:
i) Reporting financial results to the officers of the company.
Planning borrowing requirements.
i) Forecast of cash receipts and disbursement,
+i) Planning the company investment program.
<=) Advice on dividend payment.
4 Sessy Floatation Functions: These includes:
; a i) Recommendation of type of security most desirable for ‘company borrowing requirements and
-}.__ correlation ofthese with company's long term ability to pay.
) Provision for trustee: registration of transfer agent.
dictionary meani
of risk is the possibility of loss or injury, the degree or probability of such loss.
skis composed of the demand that bring in variations in return of income. The main forces contributing to
price and interest. All investments are risky, whether in stock or capital market or banking and financial
| Seor/ real-estate, bullion gold, étc. The degree of risk, however, varies on the basis of features of assets,
ijesiment instrument, mode of investment or issuer of security, ete,
ie:
‘According to Fischer and Jordon, risk is the, “Variability of return around the expected average is thus a
tative description of risk”. : See:
| Kisk is also influenced by external and internal condition. External risks are uncontrollable and broadly affect
inv t These external risks are called systematic risk. Risk due to internal environment of firm or that
ting a particular industry is referred to as unsystematic risk. .
definitions of risk include the term adverse deviation to express the negative dimension of the ‘expected or
for outcome. One. does not agree with this limitation, which implies that risk exists only with adverse
ions which must be negative and thus ae linked fo losses. Such a restriction would implicitly exclude any
connotations from the concept of risk. One believe that risk has two sides, which both have to be
nel uded in the definition, and that risk itself has to dimension, negative or positive,
s tisk is “Uncertainty of Outcome’, either from pursuing @ future positive opportunity, or an existing
tive threat in trying to achieve a current objective. a a
e -Thakr's MBA Second Semester (Financial Managemen) BhU
1.2.2, Causes of Risks
Following are the causes of risks:
1) Wrong Decision: Wrong decision of what to invest in.
2) Wrong Timing: Wrong timing of investments.
3) Nature of Instruments: Nature of instruments invested such as shares or
are highly risky than bank deposits or P.O. certificates, ete.
4) Creditworthiness of Issuer: Securities of government and semi-government bodies
than those issued by the corporate sector.
5) Maturity Period or Length of Investment: Longer the period, the more risky is the i
6) Amount of Investment: Higher the amount invested in any security the larger isthe risk.
7) Method of Investment: Method of investment, namely, secured by collateral or not.
8) Terms of Lending: Terms of lending such as periodicity of servicing, redemption periods, etc.
9) Nature of Industry: Nature of industry or business in which the company is operating.
10) National and International Factors: National and international factors, acts of god, etc.
bonds, chit funds, benefit funds
are more creditworthy
s the investment normally.
1.2.3. Types of Risk
| Following are the two broad types of risk: a
Syaematic Unsytematic
Ris Rise
. Ee aceepel
Market |[ tnterestRate | [Purchasing
Ris Risk Power Risk
fee 1
Business Financial
: Risk
¥ Internal External
Risk . Risk
Figure 1.2: Types of Risk
1.23.1, Systematic Risk
Systematic risk is also referred as uncontrollable risk, Systematic risk is non-diversifiable and is associated
with the securities market a8 well as economic, sociological, political and legal considerations of the prices of
all securities in the economy. The effect ofthese factor is to put pressure on all securities in such a way that the
ptices ofall stocks will move in the same direction. For example, during a boom period, prices of all securities
vill rise and indicate that the economy is moving towards prosperity.
Components of Systematic Risk :
Following are the components of systematic risk:
| 1) Market Risk: Market risk as that portion of total variability of retum caused by thé alternating forces of
bull and bear markets. When the security index moves upward haltingly for a significant period of time, itis
known as bull market. In the bull market, the index moves from a low level to the peak. Bear market is just
is a reverse to the bull market, the index declines haltingly from the peak to a market low point called.
trough for a significant period of time, During the bull and bear market more than 80 per cent of the
securities” prices rise or fall along with the stock market indices. 3
Interest Rate Risk: Interest rate risk is the variation inthe single period rates of return caused by the |
fluctuations in'the market interest rate. Most commonly interest rate risk affects the price of bonds,
"1 Financial Management and Indian Financial System (Unit 1) 2
debentures and stocks. The fluctuations in the interest rates are caused by the changes in the government
monetary policy and the changes that occur in the interest rates of treasury bills and the government
bonds. |
Likewise, if the stock market is in a depressed condition, investors would like to shift their money to the @@
ond market, to have an assured rate of retum. The rise of fall in the interest rate affects the cost of
borrowing. When the call money market rate changes, it affects the badla rate to.
Interest rates not only affect the security traders but also the corporate bodies who carry their business with
borrowed funds, The cost of borrowing would increase and a heavy outflow of profit would take place in
the form of interest to the capital borrowed. This would lead to a reduction in eamings per share and
consequent fallin the price of share,
3) Purchasing Power: Risk: Variations in the retums are-caused also by the loss of purchasing power of
currency. Inflation is the reason behind the loss of purchasing power. The level of inflation proceeds faster
than the increase in capital value, Purchasing power risk isthe probable loss in the purchasing power of the
retums to be received. The rise in price penalizes the retums to the investor, and every potential rise in price
is a risk to the investor. The inflation may be demand-pull or cost-push inflation.
“1,232. Unsystematic Risk
Unsystematic risk is also referred as controllable risk. Unsystematic risks stems from a managerial
‘inefficiency, technological-change in the production process, availability of raw material, changes in the
‘consumer preference, and labour problems. The nature and magnitude of the above mentioned factors differ
‘analyzed separately for each industry and
* ffoin industry to industry, and company to company. They have to be
firm. -
1) Bu
© environment of the business. Business ris!
competitive edge and the growth or stability of the earnings. Variation that occurs in the operating
environment is reflected on the operating income and expected dividends. The variation in the expected
{operating income indicates the business risk. Business risk can be divided into external business risk
}-and internal business risk:
2) Financial Risk: Financial risk in 2 company is associated with the method through which it plans its
financial structure. Ifthe capital structure of a company tends to make earnings unstable, the company may
fail financially. How a company raises funds to finance its needs and growth will have an impact on its
“future earings and consequently on the stability of earings. It is found that variation in retums for
shareholders in levered firms (borrowed funds company) is higher than in unlevered firms. The variance in
*retums is the financial risk. ;
~-Financial risk can be divided into:
6
ness Risk: Business risk is that portion of the unsystematic risk caused by the operating
c arises from the inability of a firm to maintain its
“7 2) Political Risk
b). Regulatory Risk
<__ ©) Economie Risk J
iv) Liquidity Risk =
Investors are aware that there is uncertainty in returns because there is risk associated with it. General
awareness of investors is not enough. Risk must be quantified. To quantify systematic and unsystematic risk
“separately is rather a diffieult ask because their effects are involved. An attempt is made to try and measure
er as a Single measure.
risk in such a way that all the qualitative factors are taken togeth
é
é
oS —
6
@)
1.2,4,*° Measurement of Risk
Risk refets to the possibility that the actual outcome of an investment will differ from the expected outcome.
Put differently, risk refers to variability or dispersion If an asset’s return has no variability, itis rsk-less. The
following methods are used to measure the risk: me :
a
Pa : = ee g _ a »
I rt tty mon wit amin
Eee earenenscta ee a ee
RTRs Sn RRS eT oe
etree nena ede ee
[rar] eae | oes |
= eS |e |
conceptually
the following
twits probability, eviation considers every possible event and assigns each event « weight equal
2) Standard deviation
=<)
=
~@
Mg 7 SEE ete emt ay ts a opt
>
2
a
rest espe Gn tress lon Ts ia cbc
bean akas Nesihility freee”, : Pel
deviation is bained ts the square roe of the fn of squared dierences multiplied by thei
probebilin This facilitates comparaon of fa asmemoed Gy unin deviate cod exposed rear
both are meaured inthe ame con Ths is wy sunderd devin i plan to variance asa mere of
Criticisms of Variance as a Measure of Risk 7
Pacey wed it inane, there are two ctciams ofthe use of variance a a measure of isk:
srance Considers all deviations, negative as well as positive. Investors, however, do not view postive
‘deviations unfavourably — in fact, they welcome it. He
jof Company-A and Company-B have identical expected average returns. But the spread is different.
‘in Company-A is from 8 to 12 and for Company-B it ranges between 9 to 11 only. The range does
greater risk. The spread or dispersion can be measured by standard deviation.
oa ace, add dn as pl
See
variance i calcula, except that considers aly negate deveios, Makowit However, chosen
Yerlnce because analytically canbe hadi ely Not haa long ee he veer we treed
Epmmerically, variance is simpy two times semirtance aad does oa make en dflercae whet
Veranc ls sed or semi-varane i
2) When the probability di ition is not symmetrical around its expected value, variance alone does not.
i Fast een cee armen Fu See ene fom at
Consider skewness in developing prtlo ther. Proponents ofthe Mahone mode uty te ve ot
‘variance on the grounds that the historical returns of stocks have been approximately symmetrical.
Yield to Maturity = AVera8e:
“Annual Coupon
*, P=Purchase of Price
Average Annual Return =90:
Average Invesment = MP
100
950”
Eaming Yield =
Eaming Yield = —_P2ming
Priceof Share 36
(or depreciation
like equity stocks, the capital return predominates.
‘Thus, the total return for any security (or for that matter any asset) is defined as: é
Capital retum
Measurement of Return
are following two categories for measuring the return on investments:
‘Traditional Methods: Computation of yield to measure a financial asset's return isthe simplest and oldest
"technique of measurement. Yield can be found out by following formula:
mated Yieta __ExPested Cash Income
Estimated Yield = E*Peeted Cash Income
Current Price of Assets
Amount Invested
particular period to find out the return on the amount that is invested,
._ Yield can be computed both for bonds and stocks.
Bonds: Bonds usually have a maturity period.
period or on maturity. While it is advisable to find out yield to maturity and it is also the common
Practice, yet the current yield on the bonds can also be found out,
sa bond in 1978 maturity in 1980 at 2900. It has a maturity value of 10
Yyears and par value of 21,000. It fetches £90 every year. Calculate yield
Current Yiela= Anaual Cash Price _ 90
PurchasePrice 900 10%
Annual Return
Average Investment
aturity of par value of bond
Number of years remaining to maturity
100
‘4 100
10
1000-4900 _
2
‘Yield to Maturity = —— =.105 =105%
eS EArRing
Price of Share
A stock that is selling for 236 and earns %3 annually has an E/P ratio of:
=3=0083=
Bi Siock or Share: The return on'stocks i méasured by finding out dividend yield, Dividend yields can i
) divided by the beginning price of the asset. For assets
The current return can be zero or postive, whereas the capital return can be negative, zero or positive.
‘Yield on them can be caiculated either for the current
=100
950
be estimated on expected yields as well as actual yields.
smaated Vicia _ Expected Cash dividend
Estimated Yield = EXpeeted Cash dividend
car starePris
Dividend Received
eld Dividend Reselved
Se Tricot chasin de Gogiai of spe
Another way of finding out return in stock is by finding out “earning yield”,
833% i
nee
}) Modern Methods: The modern m
wethods for measuring return are as follows:
') Holding Period Yield: The holding period yield is one ofthe modern techniques on measuring return.
Itserves two purposes:
a) It measures the total ret iginal it
8) Trough tis oc EE upc of the oigia investment
Tin piod yan te try ae sep fen si ci Sk
pin est and bonds can be cusped through this measure. The formula for the holding
Holding Period Yield =
Income payment received during the yearin rupees + Capital change for the periodin rupees
Pricein rupeesof in originalinvestmentat the beginnig of the period
ii) Bonds Holding Period Yields: The holding period yields for bonds are measured in the following way:
Bond Holding Period Yields = 1880me payment during Period t+ change in price during t
Price at the begining of the period of t
or BHpy= +P
R
Where, t= Holding petiod,
Bond ‘coupon interest during period t,
“= Bonds price atthe beginning of holding period,
P= Change in Bond Price over the period. s
Example 4: A company 9% bonds are bought at €1,000, retained for a holding period of 1 year and
Sold for %1,100. Find Holding Period Yields (1=9% of 1000). !
1+P _90+100_
PR 1000 .
ii) Return and Statistical Method: In this modem technique, return can be measured either through
Central Tendency or Dispersion.
a) Central Tendency: There are various methods of central tendency, ie., mean, median, and mode.
The mean is also called ‘arithmetic mean’ and is used to measure average returns. To find out
arithmetic mean, the values in the distribution are added and divided by the total number of
values.
Mean of any probability distribution is called its ‘expected value’. ‘Mean’ is the best measure t0
calculate retums. In Comparison with median and mode, its superiority is established as a technique
for calculating returns.
b) Measure of Dispersion: Dispersion method help to assert risk in receiving a return on investment. —
The greater the potential dispersion, the greater the risk. One of the simplest methods in calcalating
dispersion is range. The range, however, has limited importance. It is useful when there are small
samples it loses its effectiveness when the number of yalues in sample increases. The best and
most effective method to find out how the data scattered around a frequency distribution is to use
the standard deviation method, Variance is the square of standard deviation.
Solution: Bond Holding Period Yields = 19
1.2.9, Risk-Return Relationship
SSS The rate of tum required by a frm, toa great extent, depends upon the risk involved, Higher thers, greater
isthe retam expected bythe firm. The rate of tum required by the business consists of following components:
1). Return at Zero Risk: This refers tothe expected rate of return where a proest involves no risk whether
business or financial.
2) Premium for Business Risk: The term busines risk refers to the variability in operating profit (EBIT) due to
change in sales, Incase ofa project having more than the normal or average ris, the firm will expect a higher
tate of retum than the normal rate. Hence, the return expected by the business will go up. Similarly, if the
project involves a lower degree of rik than the normal level, the retum expected bythe firm will come down, Finance! Management and Indian Financial System (Unit 1)
1.2.10. Risk-Return Trade-off
‘The concept of a risk/retur trade-
sort of iskretur trade-off; the greater the risk, the
of the various rsk-retum tradeoffs available is part
13 depicts the rishretum trade-off (the risk-free
security such as a US, Treasury bill),
In the case of investment in stock, as an investor, demand
higher rtum from a speculative stock to compensate for the
higher level of isk. In the case of working, capita
management, the less. inventory keep, the higher the
expected retum (since less of cument asets are tied up)
however, there is increased risk of running out of stock and
thus losing potential revenue,
Risk and Retum Trade-off give the direct relationship
between risk and retum, investors are able to measure this
relationship and use that measurement to build a portolie
with the appropriate risk and retum trade-off profil. By
using what is called the Sharpe Ratio or simply-d
standard deviation (level of risk), are able to ascertain t
“of is integral to the subject of finance. All financial decisions involve some
Breater the retum expected. Proper assessment and balance
of creating a sound financial and investment plan. Figure
‘ate is the rate of retum commonly required on a risk-free
Risk Return Trade-off
Sale i
‘High Potential Retum
Return
Figure 13: Standard Deviation (or Risk)
ing the excess expected return of an asset class by its
the amount of excess expected retum per unit of risk for
an asset class. Doing so helps us to compare, contrast and select asset classes with dissimilar excess expected
returns and risk levels,
For example, suppose we have two asset classes, A and B, Asset clas A has a standard deviation of 6 per cent
and an exces expected retum of 8 percent over the proposed holding period,
‘Risk return trade off = Excess expected return/ Standard deviation
= 8/6=133
By dividing the excess expected retumn of 8 per cent by the standard deviation of 6 per cent, we find that asset
class A has a risk and return trade-off profile of 1.33,
Asset class B has astindard deviation of4 percent and an exces expected retum of 6 per cet,
Risk return trade off = Excess expected return/Standard deviation
=64=15
‘This translates into a risk and return trade-off profile of 1.5. can be understand that, although asset class A has
ite higher expected return, it clearly does not provide the highest level. of expected retum per unit of risk, as
does asset class B,
A common misconception is that
higher risk gives us the possibility of
feturns, it also means higher potential losses,
12.11,
Following are the different decision areas of risk and return:
higher retums, There are
Major Risk-Return Decision Areas
igher risk equals greater return. The risk/retur trade-off tells us that the
no guarantees, Just as tisk means higher potential
") Binancial Analysis and Control: This area is concemed with the Financial Statements, ie, Income
Statement, Balance Sheet, Funds Flow Statement, Cash Flow Statement, etc., which provide an overall view
of the financial position of the business.
oa) Budgeting and Profit P!
ing: This area is concemed with forecasting the future operating and financial
Performance of the firm. He is in a position to compare alternative choices of action and select one which
jum risk,
Bives him maximum profit with mi a ‘Thakur's MBA Second Semester (Financial Management) Bh.U
3) Capital Budgeting: This area is concerned with long-term planning for proposed capital outlays and their
financing. It includes both raising of long-term funds and their utilization.
4) Financial Planning: This area is concerned with estimating the amount of capital to be raised, determining
the form and proportionate amount of securities and laying down the policies as to the administration of the
financial plan,
5) Working Capital Management: This area is concerned with the problems that arise in attempting to
manage the current assets, current ies and the inter-relationship that exists between them.
6) Cost of Capital: This area is concemed with determination of the rate of return the firm requires from its
investments in order to maximize the value of the firm’s shares.
1.3. TIME VALUE OF MONEY (TVM)
1.3.1. Meaning of Time Value of Money
The concept of TVM refers to the fact that the money received today is different in its worth from the money
receivable at some other time in future. In other words, the same principle can be stated as that the money
receivable in future is less valuable than the money received today. For example, if an individual is given an
option to receive 1,000 today or to receive the same amount after one year, he will definitely choose to receive
the amount today (of course he is presumed to be a rational being). The obvious reason for this reference for
receiving the money today is that the rupee received today has a higher value than the rupee receivable in
future. This preference for current money as against future money is known as the time preference for money
or simply TM.
This concept of TVM is applicable in equal strength to individuals as well as to the business firms. In case of
most of the decision particularly those taken by a firm, the financial implications may occur over a period of
time and even up to ten years or more. Therefore, TVM becomes an important consideration for any financial
decision.
For example, a firm is selling a machine for £25,000. The buyer offers to pay € 25,000 either now or after one
year. The seller firm will naturally accept the first offer, ic., to receive %25,000 now. In this case, if the firm
Teinvests the amount of %25,000 in fixed deposit account for one year at 10% p.s. interest, then after one year
the firm will be having total money of €27,500 (25,000 + interest of €2,500). In the second option, the firm
will receive only 25,000 after one year. Therefore, in the first option the firm will be better off by %2,500.
On the other hand, if the buyer of the machine is ready to pay €27,500 instead of %25,000 after one year, then
the firm may be indifferent. In this situation, the firm will be having 27,500 after one year either:
1) By receiving €25,000 now and reinvesting to get interest of €2,500 or ‘
2) To get €27,500 from the buyer after one year. This interest amount of €2,500 is the TVM.
Thus, the TVM for the money is its rate of return which the firm can earn by reinvesting its present money. This
rate of return can also be expressed as a required rate of retum to make equal the worth of money of two
different time periods. In simpler terms, the value of a certain amount of money today is more valuable than its
value tomorrow. The difference in the value of money today and tomorrow is referred as time value of money.
1.3.2. Reasons for Time Value of Money i
Money has time value because of the following reasons:
1) Risk and Uncertainty: Future is always uncertain and risky. Outflow of cash is in our control as payments.
to parties are made by us. There is no certainty for future cash inflows. Cash inflow is dependent out,on our
creditor, bank, etc, As an individual or firm is not certain about future cash receipts, it prefers receiving
cash now.
2) Preference for Consumption: Most people have subjective preference for present consumption over future
consumption of goods and services either because of the urgency of their present wants or because of the) Financial Managemen and Indian Financial System (Unit 1)
may be caus:
risk of not being in a position to enjoy future consumption that may ”
7 squire most
because of inflation. As money is the means by which individuals ac
may prefer to have money now.
3) Investment Opportunities: An investor can profitably employ arupe received
value to be received tomorrow or after a certain period of time.
4) Inflationary Economy: In an inflationary economy, the money received today, has
than the money to be received in future. In other words, a rupee today represents
power than a rupee a year hence.
4.3.3. Simple Interest and Compound Interest
Simple interest is the interest that is calculated only on the original amount (pri
‘compounding of interest take place.
Compound interest isthe interest that is received on the original amount (principle) as v
cared but not withdrawn during earlier periods. Compounding is the process of finding th:
flows by applying the concept of compound interest.
In compound interest, each interest payment is reinvested to ear further interest in future
no interest is earned on interest, the investment earns ony simple interest. In such a case, th
as follows:
Future value = Present value (1 + Number of Years x Interest rate]
For example, if €1,000 is invested @ 12% simple interest, in 5 years it will become 1,00¢
1,600 .
‘The following table reveals how an investment of 71,200 grows over time under simple it
compound interest when the interest rate is 12 per cent. From this table, we can feel the pov
interest. Value of 81,000 invested at 10% simple and compound interest.
Year ‘Simple Interest ‘Compound Interest
‘Starting Balance + Interest = Ending Balance
T= ]'¥,000 + 100 1,100
5 | 1400+ 100= 1,500
10 | 1,900+ 100 =2,000
20 -| 2900+ 100=3,000
30 | 5,900+ 100 = 6,000
100 _ | 10,900+ 100 = 11,000
1,000 + 100 = 1,100
1464 + 146= 1,610
2,358 +236 =2,504
6116+ 612 = 6,728
1,06,718 + 106
134, Techniques of Time Value of Money
There aré tivo techniques for adjusting time value of money. They are:
a ‘Worth of money today that is receivable or payable at a future date is called Present Value. Sin
lueof money a a future date with given interest rate is called future value.
138. Present Value/Discounting Concept
— of discounting i the reverse of compounding technique and is known as the present v
toes FV of sums invested now, calelted as per the compounding techniques, there ae alo the
‘fa cash flow scheduled to occur in future. Present value is the current value of a future amot
at —
Financial Management na Indian Financial System (Unit 1) :
risk of not being in a position to enj i se Oy
‘being nioy future consumption that may be caused by i i
because of inflation. As money is th: ich indivi ire most goods and services, hey
rrr saan en se et
3) Investment Opportunities: An investor can profitably employ a rupee received today, (o give him a higher
Value tobe received tomorrow or after acertamn period oftime,
4) Inflationary Economy: In an inflationary ‘economy, the money received today, has more purchasing power
than the money to be received in future. In other words, a rupee today represents a greater real purchasing
power than a rupee a year hence. pagar AH a
133. Simple Interest and Compound Interest
Simple interest is the interest that is calculated only on the original amount (principle), and thus, 20
" tompounding of interest take place,
‘Compound interest is the interest that is received on the original amount (principle) as well as on any interest
ed but not withdrawn during earlier periods. Compounding isthe process of finding the furure value of cash
by applying the concept of compound interest.
Thcompound interest, each interest payment is reinvested to eam further interest in future periods. However, if
interest is eamed on interest, the investment eams only simple interest. In such a case, the investment grows
following table reveals how an investment of £1,200 grows over time under simple interest as well as
pound interest when the interest rate is 12 per cent. From this table, we can feel the power of compound
Value of 71,000 invested at 10% simple and compound interest. a
‘Simple Interest ‘Compound Interest
‘Starting Balance + Interest =Ending Balance _| Starting Balance + Interest = Ending Balance
000+ 100= 1,100 =e 1,000 + 100=1,100
1,400 + 100 = 1,500 ‘ 1,464 + 146 = 1,610
1,900 + 100 = 2,000 2,358 + 236 = 2,594
7} 2,900%+100=3,000 - 6,116 +612= 6,728
5,900 + 100 = 6,000 ‘ 1,06,718 + 10672 =11,7,390
10,900+100=11,000 1,25,27,829 + 12,52,783 = 1,37,80,612
Techniques of Time Value of Money
two techniques for adjusting time value of money. They are:
‘Techniques of Time Value of Money
Future Value or
‘Compounding Concept
‘of money today that is receivable or payable at future date is called Present Value. Similarly, the
pfmioney at a future date with a given interest rate is called future value, : ir
resent Value/Discounting Concept _ : :
Of discounting is the reverse of compounding technique and is known as the present value, As
Vs of sums invested now, calculated as per the compounding techniques, there are also the present
‘cash flow scheduled to occur in future, Present value is the current value of a future amount. It is ~>
SS
“4
Thakur’s MBA Second Semester (Financial Management) Bh |
1.4.1. Meanii as
The financial sate he eo aaition of Indian Financial System
Finance is a bridge between the paneer institutional and Functional vehicle for economic transformation
efficient, effective and equtatie sett a4 the future and whether itis the mobilization of savings or the
‘quitable allocation for investment, it is the success with which the financial system
performs its functions that sets the p
ace for the achievement of broader national objectives.
‘According to Chris i
q WY: the objective ofthe financial system isto “Supply funds to various sectors and activities
e
of the economy in we
ie cones ieee Promote the fullest possible utilization of resources without the destabilizing
‘cl changes or unnecessary interference with individual desires”.
According to Robi ,
iiecainent teenie ef Primary function of the system is “To provide a link between savings and
wealth”, new wealth and to permit portfolio adjustment in the composition of the existing
financial ;
oe eae weet Sector functions as an intermediary ‘and facilitates the flow of funds from the
practices, meney mani aie as ta {tis a composition of various institutions, markets, regulations and laws,
explained by figure LSgiven beloen ansstions and claims and Fails. The flow of financial service i
Sechersof funds | Flow of Funds Sevins) [Spies finds
‘mainly business ||
(mainly
firms and household
government) i
fF———___-.__|
Incomes and Financial Claims
Figure 1.5: Flow of Financial Services
The word “system”, in the term “financial system”, implies a set of complex and closely connected or interlined
institutions, agents, practices, markets, transactions, claims, and liabilities in the economy, The financial
system is concemed about money, credit and finance — the three terms are intimately related, yet are somewhat
different from each other. Indian finandial system consists of financial market, financial instruments, financial
intermediation and financial services.
8
1.4.2, Characteristics of Indian Financial Systemi
The characteristics of Indian financial system are as follows:
1) Financial system provides an ideal linkage between depositors and investors, thus encouraging both savings
and investments. :
2) Financial system facilitates expansion of financial markets over space and time.
3) Financial system promotes efficient allocation of financial resources for socially desirable and economically
productive purposes.
4) Financial system influences both the quality and the pace of economic development.
5) Financial system promotes the process of financial deepening and broadening.
6) Financial system offers portfolio adjustment facility.
7), Financial system lowers the cost of transactions.
8) Financial system disseminate price — related information.
1.4.3. Functions of Indian Financial System
A good Indian financial system serves in the following ways: ; :
1) Link between Savers and Investors: One of the important functions of a financial system is to link the
savers and investors and thereby help in mobilizing and allocating the savings efficiently and effectively
By acting as an efficient medium for allocation of resources, it permits continuous up gradation o
technologies for promoting growth on a sustained basis.
SS Financial Management and Indian Financial System (Unit 1) “s
Functions of
I System
Link between Savers and
bovesiors rH Helps in Projects Selection
Allocation of Risk
L{ Information Available
——
Minimizes Situations of
Asymmetric Information ||} Reduce Cost of Transaction
—— and Borrowing
Promotion of Liquidity
Financial Deepening and
Broadening
2) Helps in Projects Selection: A financial system not only helps in seletng projects tobe funded bt also inspires
the operators to monitor the performance ofthe investment. It provides a payment mechanism forthe exchange of
s0ods and services, and transfers economic rsoures through time and across geographic regions and industries,
3) Allocation of Risk: One of the most important functions of a financial system is to achieve optimum
allocation of risk bearing. It limits, pools, and trades the risks involved in mobilizing savings and allocating
credit. An efficient financial system aims at containing risk within acceptable limits and reducing the cost
of gathering and analyzing information to assist ‘operators in taking decisions carefully.
4) Information Available: It makes available price-related information which isa valuable assistance to those
Who need to take economic and financial decisions,
5), Minimizes Situations of Asymmetric Information: A financial system minimizes situations where the
information is asynmetric and likely to affect motivations among operators or when one party has the
information and the other party does not. It provides financial services such as insurance and pension and
offers portfolio adjustment facilities,
6) Reduce Cost of Transaction and Borrowing:’A financial system helps in the creation of a financial structure
that lowers the cost of transactions. This has a beneficial influence on the rate of retum to savers. It also
reduces the cost of borrowing, Thus, the system generates an impulse among the people to save more.
1) Promotion of Liquidity: The major function of the financial system is thie provision of money and monetary
assets for the production of goods and services, There should not be any shortage of money for productive
‘Ventures. In financial language, the money and monetary assets are referred to as liquidity. In other words, the
liquidity refers to cash or money and other assets which can be converted into cash easily without loss, Hence, all
activities in a financial system are related to liquidity — ether provision of liquidity o trading in liquidity.
8) Financial Deepening and Broadening: A well-functioning financial system helps in promoting the
rocess of financial deepening and broadening. Financial deepening refers to an increase of financial
assets as a percentage of the Gross Domestic Product (GDP). Financial broadening refers to building an
increasing number and a variety of participants and instruments,
144, Importance of Indian Financial System
‘The importance of Indian financial system is explained under following heads:
+ | Importance of Indian Fiuapicial System
: Taereaseike Ouputotthe |_|) [Accents he Volume and Ras
Economy of Savings
~ Makes Inovation Evaluating Assets Ineeasing
Liquidity, and Producing and
isk Management Series Spreading Information
Disciplining and Guiding the ‘eal ‘Stability and Resilience
‘Management Companies
Accelerates the Rae of
Economic Growth 2 Ins upto Eom: Th tein file li en
tnd pon The gov of anal sree peonitin wo eoomic Poth Int wee Mare
ication arenas ue Ge pre mverefceme pee ig nf coy ane
i sony nie re fderassac ap maton ea
‘scien olune ad at ngs png see ag of femal tae
Seve tah ert Tsetse aetind ee he le sek
lela roaster he ighecam itr Res gen seg ofa The wes
itredain oman ios oe seh
system makes innovation least oly and most proflable, thereby
‘counties whose financial systems encourage diverse financing
‘rangement are able to maintain interational competitiveness trough updating tet productive capacities.
4) Evaluating Assets, Increasing Liquidity, Producing and Spreading Information: In addition ‘0
affecting the rate a3 wel asthe nature of economic growth, a financial system is Useful in evaluating ase,
increasing liguidity, an producing and spreading information.
5) Risk Management Services: It happens often that a financial system develop in response to changing
fates of demand fy funds nthe 197 tere was 2 world inate in the demand fr move
‘management services. Maty financial systems met this demand by inreasing tading eetivty and by
evelopment of many new risk management products. Hence, economic growth can also stimulate growth
ofthe financial system.
©) Stability and Resilience: Financial markets represent the deep end of the nancial sytem; deeper the
‘system, greater its stability and apsilience. A well-developed money and govemment secures market helps
the Central bank to conduct monetary policy effectively with the use of market-based insirumente. Wel: