Unit 1 – Indian and Global Financial System

1. Introduction to the Financial System

A financial system refers to a structured framework that facilitates the exchange of funds among
individuals, businesses, and governments. It includes institutions, markets, instruments, and
regulatory bodies that ensure smooth capital flow.

Key Components of a Financial System:

• Financial Institutions (e.g., Banks, NBFCs, Insurance companies)
• Financial Markets (e.g., Capital Market, Money Market)
• Financial Instruments (e.g., Shares, Bonds, Derivatives)
• Regulatory Bodies (e.g., RBI, SEBI, IRDAI in India; SEC, Federal Reserve in the USA)
A well-developed financial system supports economic growth by efficiently allocating resources,
providing liquidity, and ensuring financial stability.

2. Functions of a Financial System:

• Mobilization of Savings: Encourages individuals and institutions to save money.
• Capital Formation: Converts savings into productive investments.
• Liquidity Management: Provides short-term and long-term funds.
• Risk Management: Diversifies and mitigates financial risks through insurance and hedging.
• Facilitates Trade & Commerce: Enables businesses to expand operations by providing necessary
funds.

3. Classification of Financial System

The financial system is broadly classified into the following categories:
A. Based on Structure
1. Formal Financial System – Regulated by authorities (e.g., Banks, Stock Exchanges, Insurance
companies).
2. Informal Financial System – Unregulated financial activities (e.g., Moneylenders, Pawnshops,
Hawala transactions).

B. Based on Nature of Markets

1. Money Market – Deals with short-term financial instruments (less than one year).
2. Capital Market – Deals with long-term financial instruments (more than one year).

C. Based on Geographical Scope

1. Domestic Financial System – Operates within a country (e.g., Indian Financial System).
2. Global Financial System – Includes international transactions (e.g., World Bank, IMF, Global
Stock Exchanges).

4. Financial Markets
A financial market is a marketplace where financial securities, commodities, and other assets are
traded. It connects buyers and sellers, allowing capital to flow efficiently.
Types of Financial Markets:
1. Capital Market – Deals with long-term securities like stocks and bonds.
2. Money Market – Deals with short-term financial instruments.
3. Foreign Exchange Market (Forex) – Facilitates currency trading.
4. Commodity Market – Trades in physical goods like gold, oil, and agricultural products.
5. Derivatives Market – Deals with futures and options based on underlying assets.

5. Capital Market
The Capital Market is a part of the financial system that provides long-term funding for businesses
and governments. It enables companies to raise capital by issuing shares and bonds.

Types of Capital Market:

1. Primary Market – Where new securities are issued (e.g., IPO – Initial Public Offering).
2. Secondary Market – Where existing securities are traded among investors (e.g., Stock
Exchanges).

Participants in the Capital Market:

• Investors (Retail & Institutional)
• Companies & Corporations
• Regulators (e.g., SEBI in India, SEC in the USA)
• Stock Exchanges (e.g., NSE, BSE, NYSE, NASDAQ)

Functions of the Capital Market:

• Facilitates long-term investment in stocks and bonds.
• Promotes economic growth by providing funds to businesses.
• Enhances wealth creation for investors.

6. Money Market
The Money Market deals with short-term financial instruments (maturity of less than one year). It
provides liquidity for businesses, governments, and financial institutions.

Features of the Money Market:

• Deals with highly liquid instruments.
• Low risk compared to capital markets.
• Instruments have short maturity periods.
• Involves wholesale transactions among banks and institutions.

Key Money Market Instruments:

1. Treasury Bills (T-Bills): Short-term government securities issued by the RBI.
2. Commercial Paper (CP): Unsecured short-term loans issued by companies.
3. Certificates of Deposit (CDs): Issued by banks to depositors for a fixed tenure.
4. Call Money Market: Short-term borrowing and lending between banks.
5. Repurchase Agreements (Repo): Short-term borrowing using government securities as collateral.

Functions of the Money Market:

• Provides short-term liquidity to financial institutions.
• Helps in the implementation of monetary policies by the central bank.
• Aids in controlling inflation and interest rates.

Unit 2 – Financial Institutions

1. Types of Financial Institutions

Financial institutions facilitate the movement of money in an economy by providing financial services
such as deposits, loans, investments, and insurance. These institutions are classified into Banking
Financial Institutions (BFIs) and Non-Banking Financial Institutions (NBFIs).

A. Banking Financial Institutions

These institutions accept deposits from the public and provide loans and financial services under
strict regulation.
Types of Banks:
1. Central Bank: Regulates the entire banking system (e.g., RBI in India, Federal Reserve in the USA).
2. Commercial Banks: Offer deposits, loans, and investment services (e.g., SBI, HDFC Bank).
3. Cooperative Banks: Serve rural areas and small businesses.
4. Regional Rural Banks (RRBs): Focus on rural development and agriculture.
5. Development Banks: Provide long-term financing for industrial and infrastructure projects (e.g.,
IDBI).
6. Payment Banks: Provide limited banking services like deposits and digital transactions.

B. Non-Banking Financial Institutions (NBFIs)

These institutions do not accept demand deposits like banks but offer financial services such as
loans, investment funds, insurance, and asset management.
Types of NBFIs:
1. Development Financial Institutions (DFIs): Provide funding for infrastructure and industries (e.g.,
IDBI, SIDCs).
2. Insurance Companies: Offer financial protection against risks (e.g., LIC).
3. Mutual Funds: Pool money from investors to invest in securities.
4. Hedge Funds: Invest in high-risk financial instruments for high returns.
5. EXIM Bank: Supports foreign trade financing.
6. State Financial Corporations (SFCs): Provide loans to small and medium enterprises (SMEs).

2. Constitution, Objectives, and Functions of Key Financial Institutions

A. Industrial Development Bank of India (IDBI)
Constitution:
• Established in 1964 as a subsidiary of the RBI.
• Became an independent financial institution in 1976.
• Converted into a full-fledged commercial bank in 2004.
Objectives:
• Provide long-term finance to industrial projects.
• Promote industrial growth in India.
• Support small and medium enterprises (SMEs).
• Assist in infrastructure development.
Functions:
• Provides project financing and industrial loans.
• Offers investment banking and advisory services.
• Supports entrepreneurial development programs.
• Funds infrastructure projects and modernization of industries.

B. Life Insurance Corporation of India (LIC)

Constitution:
• Established in 1956 under the LIC Act, 1956.
• Nationalized insurance sector by merging 245 private insurers.
Objectives:
• Provide life insurance and financial security.
• Mobilize public savings for national economic development.
• Offer social security schemes.
Functions:
• Offers life insurance policies and pension schemes.
• Invests funds in government securities and infrastructure.
• Provides financial aid to policyholders through loans.

C. Export-Import Bank of India (EXIM Bank)

Constitution:
• Established in 1982 under the Export-Import Bank of India Act, 1981.
• A government-owned institution to finance international trade.
Objectives:
• Promote Indian exports by providing financial assistance.
• Facilitate foreign trade and business expansion.
• Support exporters and importers with credit and advisory services.
Functions:
• Offers export credit and loans to Indian exporters.
• Provides financial guarantees and risk management.
• Supports overseas investment by Indian businesses.

D. Mutual Funds
Definition:
A mutual fund is a financial vehicle that pools money from multiple investors to invest in diversified
securities such as stocks, bonds, and other assets.
Objectives:
• Provide retail investors access to diversified portfolios.
• Offer professionally managed investment opportunities.
• Generate returns while minimizing risk.
Functions:
• Invests in stocks, bonds, and money market instruments.
• Allows small investors to participate in financial markets.
• Offers liquidity and diversification.
Types of Mutual Funds:
1. Equity Funds: Invest in stocks.
2. Debt Funds: Invest in fixed-income securities.
3. Hybrid Funds: Combination of equity and debt.
4. Index Funds: Track a market index (e.g., NIFTY 50).

E. Hedge Funds
Definition:
A hedge fund is a private investment fund that uses advanced strategies to generate high returns.
Objectives:
• Maximize investor returns using aggressive investment techniques.
• Hedge risks through derivatives and leverage.
• Outperform traditional investment vehicles.
Functions:
• Uses short selling, derivatives, and leverage for high returns.
• Invests in stocks, commodities, forex, and alternative assets.
• Targets high-net-worth individuals and institutional investors.

Key Differences Between Mutual Funds & Hedge Funds:

Feature Mutual Funds Hedge Funds
Regulation Highly regulated Less regulated
Investment Strategy Diversified, moderate risk Aggressive, high risk
Investor Type Retail & Institutional High-net-worth individuals
Liquidity High Limited
Fee Structure Fixed management fee Performance-based fee

Unit 3 – Commercial Banks

1. Introduction to Commercial Banks

Commercial banks are financial institutions that provide banking services such as deposits, loans,
and investment facilities to individuals, businesses, and governments. They play a crucial role in
economic development by mobilizing savings and facilitating credit flow.
Types of Commercial Banks:
1. Public Sector Banks – Government-owned (e.g., SBI, PNB).
2. Private Sector Banks – Privately owned (e.g., HDFC Bank, ICICI Bank).
3. Foreign Banks – Operate in multiple countries (e.g., Citibank, HSBC).
4. Regional Rural Banks (RRBs) – Provide rural banking services.
5. Cooperative Banks – Operate on a cooperative basis.

2. Role of Commercial Banks

Commercial banks contribute to economic growth and financial stability through various functions:
• Mobilizing Savings: Encourage public savings and channel them into investments.
• Credit Creation: Provide loans and advances to businesses and individuals.
• Monetary Policy Implementation: Act as intermediaries in the money supply as per central bank
regulations.
• Facilitating Trade and Commerce: Offer trade financing, foreign exchange services, and
remittance facilities.
• Infrastructure and Industrial Development: Provide funds for large-scale projects.

3. Functions of Commercial Banks

Commercial banks perform primary and secondary functions:
A. Primary Functions:
1. Accepting Deposits:
• Demand Deposits: Withdrawable on demand (e.g., current and savings accounts).
• Time Deposits: Fixed-term deposits with interest (e.g., fixed deposits).

2. Providing Loans and Advances:

• Short-Term Loans: Working capital loans, trade credit.
• Long-Term Loans: Housing loans, business expansion loans.
• Overdraft Facility: Allows account holders to withdraw beyond their balance.
• Cash Credit: Credit granted against security.

3. Credit Creation: Banks lend a portion of deposits to borrowers, creating new money in the
economy.

B. Secondary Functions:
1. Agency Functions: Acts as an agent for clients by collecting payments, paying bills, and handling
investments.
2. General Utility Services: Provides locker facilities, foreign exchange services, online banking,
and investment advisory.

4. Investment Policy of Commercial Banks

Commercial banks follow an investment policy that balances profitability, liquidity, and safety.
Key Principles of Investment Policy:
1. Liquidity: Banks must ensure that sufficient funds are available to meet withdrawals.
2. Safety: Investments should be in low-risk securities to avoid losses.
3. Profitability: Banks aim for maximum returns on their investments.
4. Diversity: Investments are spread across different asset classes to reduce risk.
Investment Areas:
• Government Securities: T-bills, bonds (low risk, stable returns).
• Corporate Bonds: Higher returns but moderate risk.
• Stock Market Investments: Limited exposure to equities.
• Real Estate: Investment in properties for capital appreciation.

5. Prudential & Exposure Norms Relating to Credit

Prudential norms are guidelines set by the Reserve Bank of India (RBI) to maintain financial
stability and reduce credit risk.
Key Norms:
1. Capital Adequacy Ratio (CAR):
• Banks must maintain minimum capital reserves based on their risk exposure.
• Basel III norms require banks to keep a minimum of 8% CAR.
2. Loan Exposure Norms: Limits on the amount of credit exposure to a single borrower or group.
3. Provisioning Norms: Banks must set aside a percentage of funds for Non-Performing Assets
(NPAs).
4. Risk Classification: Loans classified as Standard, Sub-standard, Doubtful, or Loss Assets
based on repayment history.

6. Asset-Liability Management (ALM)

Significance:
• Manages risks related to liquidity, interest rates, and market fluctuations.
• Ensures profitability and financial stability.
ALM Process:
1. Identification of Risks: Market risk, liquidity risk, credit risk.
2. Risk Measurement: Using various models (Gap Analysis, Value at Risk).
3. Mitigation Strategies: Adjusting interest rates, loan tenure, investment portfolio.

7. ALM Techniques
A. Gap Analysis:
• Measures interest rate risk by comparing assets and liabilities with different maturities.
B. Duration Analysis:
• Evaluates sensitivity of assets and liabilities to interest rate changes.
C. Simulation Models:
• Uses mathematical models to predict financial performance under different scenarios.
D. Value at Risk (VaR):
• Statistical method to assess the risk of investment losses.
E. Book Value vs. Market Value of Equity Perspective:
• Book Value of Equity (BVE): The net worth recorded in financial statements.
• Market Value of Equity (MVE): The value of a bank’s shares in the stock market.

8. Securitization
Definition:
Securitization is the process of converting loans into tradeable securities.
Process:
1. Pooling of Loans: Banks group multiple loans together.
2. Issuing Securities: These loan pools are converted into securities.
3. Selling to Investors: Investors buy these securities, providing liquidity to banks.
Benefits:
• Frees up capital for more lending.
• Transfers risk to investors.
9. Asset Reconstruction Companies (ARCs)
Definition:
ARCs buy Non-Performing Assets (NPAs) from banks and try to recover the money.
Functions of ARCs:
• Purchase bad loans from banks at a discount.
• Restructure and recover loans.
• Sell assets to recover debt.
Key ARCs in India:
• ARCIL (Asset Reconstruction Company of India Ltd.).
• Edelweiss ARC.
• Reliance ARC.

Unit 4 – Regulatory Institutions

1. Reserve Bank of India (RBI)

A. Organization of RBI
The Reserve Bank of India (RBI) is the central bank of India, established in 1935 under the RBI Act,
1934. Initially privately owned, it was nationalized in 1949 and is now fully owned by the
Government of India.
Structure of RBI:
1. Governor: Head of RBI, appointed by the Government of India.
2. Deputy Governors (4): Assist in different operational areas.
3. Central Board of Directors:
• Appointed by the Government of India.
• Includes Governor, Deputy Governors, and Non-Executive Directors.
4. Regional Offices: Present across major cities in India.

B. Objectives of RBI
The primary objective of RBI is to regulate the monetary and financial system to ensure economic
stability and growth. Its key objectives include:
1. Monetary Stability: Controlling inflation and ensuring price stability.
2. Financial Stability: Regulating banks and financial institutions.
3. Economic Growth: Supporting government policies for growth.
4. Currency Issuance: Managing money supply and circulation.
5. Foreign Exchange Control: Regulating forex markets.

C. Role and Functions of RBI

1. Monetary Policy Implementation
• Formulates and implements monetary policy to control inflation and growth.
• Uses tools like:
o Repo Rate & Reverse Repo Rate (Interest rates for lending/borrowing).
o Cash Reserve Ratio (CRR) & Statutory Liquidity Ratio (SLR) (Reserves banks must
maintain).
o Open Market Operations (OMO) (Buying/selling government securities).
2. Regulation and Supervision of Banks
• Issues banking licenses.
• Ensures financial stability by inspecting and monitoring banks.
• Manages Non-Performing Assets (NPAs) in banking.
3. Issuance of Currency
• RBI is the sole authority for issuing currency in India.
• Ensures adequate supply of money and prevents counterfeiting.
4. Regulation of Foreign Exchange (Forex)
• Manages India's foreign exchange reserves.
• Controls forex markets under the Foreign Exchange Management Act (FEMA), 1999.
5. Developmental Functions
• Promotes financial inclusion and rural banking.
• Develops payment systems (UPI, RTGS, NEFT, IMPS).
6. Government’s Banker
• RBI manages public debt and monetary transactions of the government.
7. Consumer Protection
• Protects depositors and borrowers through regulations.
• Handles banking disputes via Ombudsman schemes.

2. Securities and Exchange Board of India (SEBI)

A. Organization of SEBI
The Securities and Exchange Board of India (SEBI) was established in 1988 and given statutory
power in 1992 under the SEBI Act, 1992. It is responsible for regulating the securities market in
India.
Structure of SEBI:
1. Chairperson: Appointed by the Government of India.
2. Board Members: Includes representatives from RBI, Finance Ministry, and other financial
institutions.
3. Regional Offices: Located in Mumbai (Headquarters), Delhi, Kolkata, Chennai, Ahmedabad,
etc.

B. Objectives of SEBI
The main objective of SEBI is to protect investors and regulate the stock market. Its key objectives
include:
1. Investor Protection: Prevents fraudulent activities in the securities market.
2. Market Development: Promotes efficient and transparent trading.
3. Regulation of Market Participants: Ensures fair practices among brokers, mutual funds, and
investment banks.
4. Fair Pricing of Securities: Prevents insider trading and price manipulation.
5. Encouraging Foreign Investment: Facilitates Foreign Institutional Investors (FIIs) in the Indian
stock market.
 Unit 5 – Financial Services

1. Meaning and Definition of Financial Services

Financial services refer to economic services provided by the finance industry, which includes
banks, investment firms, insurance companies, and other financial institutions. These services help
individuals and businesses manage money, investments, and risk efficiently.
Definition:
Financial services are intangible economic activities that facilitate the mobilization and allocation
of funds in an economy, enabling efficient financial transactions and economic growth.
Examples:
• Banking
• Insurance
• Investment advisory
• Asset management
• Leasing and hire purchase
• Venture capital financing

2. Features of Financial Services

1. Intangibility: Financial services do not have a physical presence but provide value through money
management.
2. Customer-Oriented: Tailored to meet the specific needs of individuals and businesses.
3. Risk and Return: Financial services involve varying degrees of risk and return potential.
4. Perishability: Services must be utilized immediately (e.g., loans, insurance policies).
5. Regulated by Government: Controlled by RBI, SEBI, IRDAI, and other regulatory bodies.
6. Continuous Innovation: Includes new products like digital banking, cryptocurrency services, and
financial derivatives.

3. Importance of Financial Services

1. Economic Growth: Helps businesses and individuals access capital for investment and
expansion.
2. Wealth Creation: Provides investment options for saving and growing money.
3. Liquidity Support: Ensures a smooth flow of funds in the economy.
4. Employment Generation: Creates jobs in banking, insurance, investment, and fintech.
5. Financial Inclusion: Expands access to banking and credit for rural and underserved
populations.
6. Risk Management: Protects businesses and individuals from financial losses through insurance
and hedging services.

4. Types of Financial Services

A. Factoring
Factoring is a financial service where a business sells its accounts receivable (invoices) to a third
party (factor) at a discount to receive immediate cash.
Features of Factoring:
• Provides instant liquidity to businesses.
• The factor collects payments from customers on behalf of the business.
• Used by businesses with long credit cycles.
Types of Factoring:
1. Recourse Factoring: Seller is responsible for unpaid invoices.
2. Non-Recourse Factoring: The factor bears the risk of non-payment.
3. Domestic Factoring: Both parties are in the same country.
4. Export Factoring: Used for international trade.

B. Forfeiting
Forfeiting is the process of selling export receivables (future payments from foreign buyers) to a
forfeiter at a discount to get immediate cash.
Features of Forfeiting:
• Used in international trade.
• Provides 100% finance to exporters.
• Non-recourse financing, meaning the forfeiter assumes all risks.
• Helps exporters avoid credit and currency risks.

C. Leasing
Leasing is a financial service where a business or individual rents an asset from the owner (lessor)
for a fixed period instead of purchasing it outright.
Features of Leasing:
• Allows businesses to use assets without buying them.
• Regular lease payments instead of large upfront investments.
• Lease agreements are for fixed periods.

Types of Leasing:
1. Operating Lease: Short-term lease where ownership stays with the lessor.
2. Finance Lease: Long-term lease where the lessee bears the risks and rewards of ownership.
3. Sale and Leaseback: The owner sells the asset and leases it back from the buyer.

Examples of Leased Assets:

• Vehicles (cars, trucks, buses)
• Machinery and equipment
• Real estate (office space, buildings)

D. Hire Purchase
Hire Purchase is a financial arrangement where the buyer pays for goods in installments while using
them. Ownership is transferred after full payment is made.
Features of Hire Purchase:
• Ownership remains with the seller until full payment is completed.
• Buyer pays in fixed monthly or quarterly installments.
• Commonly used for automobiles, machinery, and household appliances.
Difference Between Leasing and Hire Purchase:
Feature Leasing Hire Purchase
Ownership Stays with lessor Transfers after final payment
Monthly Payments Rent-like payments Loan-like payments
Duration Usually shorter Longer repayment period
Asset Usage Returned after the lease Becomes buyer’s property

E. Venture Capital
Venture Capital (VC) is financing provided by investors to startups and small businesses with high
growth potential.
Features of Venture Capital:
• Provides funds to high-risk, high-potential startups.
• Investors get equity (ownership stake) in the company.
• Usually involves mentorship and strategic support from investors.
• Investors earn returns when the startup succeeds or is acquired.

Stages of Venture Capital Financing:

1. Seed Capital: Early-stage investment to develop ideas.
2. Startup Capital: Funding for product development and market entry.
3. Expansion Capital: Investment for scaling operations.
4. Bridge Financing: Short-term funding before IPO or acquisition.

Examples of Venture Capital Firms:

• Sequoia Capital
• Accel Partners
• Tiger Global
• SoftBank Vision Fund

Unit 6 – Capital Market Instruments

1. Capital Market Instruments

1.1 Introduction to Capital Market
The capital market is a financial market where long-term securities (stocks, bonds, debentures,
etc.) are bought and sold. It provides businesses and governments with funds for expansion,
infrastructure, and projects.
1.2 Functions of Capital Market
1. Mobilization of Savings: Converts household and institutional savings into productive
investments.
2. Liquidity: Provides a platform for buying and selling securities, ensuring liquidity for investors.
3. Price Determination: Helps in price discovery based on demand and supply.
4. Economic Growth: Provides capital for business expansion, leading to job creation and economic
development.
5. Risk Diversification: Investors can diversify their portfolio by investing in different securities.
6. Transparency & Regulation: Regulated by authorities like SEBI to ensure fair trading.
1.3 Significance of Capital Market
• Encourages Investments: Attracts domestic and foreign investments.
• Wealth Creation: Helps individuals and businesses grow their wealth.
• Stable Financial System: Ensures the efficient allocation of capital.
• Promotes Industrial Growth: Businesses raise funds for innovation and expansion.

1.4 Classification of Capital Market

The capital market is divided into two major segments:
A. Primary Market
The Primary Market is where companies issue new securities to raise capital from investors.
Features of Primary Market:
• Companies issue Initial Public Offerings (IPOs) and Follow-on Public Offerings (FPOs).
• Investors buy directly from the company.
• Helps businesses raise funds for expansion and new projects.
• Includes methods like public issues, rights issues, and private placements.

B. Secondary Market
The Secondary Market is where previously issued securities are bought and sold among investors.
Features of Secondary Market:
• Investors trade securities through stock exchanges (e.g., NSE, BSE, NYSE).
• Companies do not receive funds directly; money flows between investors.
• Helps determine market prices of securities based on supply and demand.
• Provides liquidity to investors by enabling easy buying and selling.

Differences Between Primary and Secondary Market

Feature Primary Market Secondary Market
Purpose Raise fresh capital Enable buying & selling of existing securities
Who gets the funds? Company issuing securities Previous security holders
Regulation SEBI, Stock Exchanges SEBI, Stock Exchanges
Examples IPOs, FPOs, Private Placement Stock exchanges (NSE, BSE, NASDAQ)

2. Foreign Direct Investment (FDI)

2.1 Introduction to FDI
Foreign Direct Investment (FDI) refers to investments made by foreign entities in the business
operations of another country. It involves direct control or ownership of a company or assets.

2.2 Origin of FDI

FDI gained momentum in the 20th century, as multinational companies (MNCs) expanded globally.
Countries liberalized their economies to attract foreign investments, leading to the rise of cross-
border investments.

2.3 Types of FDI

FDI is classified based on the degree of control and investment method:
A. Based on Investment Nature
1. Greenfield Investment: Foreign companies set up new facilities, factories, or offices from
scratch.
2. Brownfield Investment: Foreign investors acquire or merge with existing companies.
3. Joint Ventures: Foreign and domestic firms form partnerships for investment.

B. Based on Investment Strategy

1. Horizontal FDI: Investment in the same industry as the home country. (Example: Apple
setting up retail stores in India.)
2. Vertical FDI: Investment in a different part of the supply chain. (Example: A U.S. auto
company investing in an Indian tire manufacturing company.)
3. Conglomerate FDI: Investment in unrelated businesses. (Example: A U.K. telecom firm
investing in an Indian food company.)

2.4 Eligibility for FDI in India

India allows FDI under two routes:
1. Automatic Route: No government approval required. (Examples: Manufacturing, IT, Services.)
2. Government Route: Approval required from government authorities. (Examples: Defense, Media,
Telecom.)
Sector-wise FDI Limits in India:
• 100% FDI: IT, E-commerce, Construction, Renewable Energy.
• 74% FDI: Banking (automatic route).
• 49% FDI: Defense (automatic route, beyond this needs approval).
• 26% FDI: Print Media.

2.5 Conditions and Regulations for FDI

• Foreign investors must comply with RBI and SEBI guidelines.
• Investment must be in line with India’s FDI policy.
• Certain sectors are restricted, such as atomic energy, lottery businesses, and real estate trading.
• Mergers and acquisitions must get government clearance if they exceed a certain limit.

2.6 FDI Calculations and Reporting

1. Equity Capital Calculation: FDI Equity = Foreign Investor’s Contribution/Total Company Equity X
100
2. Remittance Process:
• Foreign investment is reported to RBI within 30 days.
• Funds are transferred through authorized banks as per FEMA guidelines.
3. Annual Reporting: Companies must submit Foreign Liabilities and Assets (FLA) Returns to the
RBI.

2.7 Violations of FDI Regulations

If a company violates FDI norms, it may face:
1. Monetary Penalties: Fines imposed by RBI or SEBI.
2. Legal Action: Cancellation of business licenses and legal proceedings.
3. Repatriation Restrictions: Government may restrict the repatriation of profits.
4. Blacklist from Future Investments: Companies violating FDI laws may be barred from future
investments in India.

Unit 7 – Stock Exchange Mechanism

1. Stock Exchange Mechanism

1.1 Introduction to Stock Exchange
A stock exchange is a regulated marketplace where stocks, bonds, and other securities are bought
and sold. Major stock exchanges include:
• National Stock Exchange (NSE)
• Bombay Stock Exchange (BSE)
• New York Stock Exchange (NYSE)
• NASDAQ
• London Stock Exchange (LSE)

1.2 Trading Mechanism on a Stock Exchange

Stock trading is conducted through electronic trading systems where buyers and sellers are
matched.
Steps in Trading Process:
1. Placing an Order – Investors place buy/sell orders through a broker.
2. Order Matching – The exchange’s system matches buy and sell orders based on price and time
priority.
3. Trade Execution – Once matched, the transaction is executed.
4. Confirmation – Both buyer and seller receive trade confirmation.
5. Settlement – The transaction is settled within a predefined period.

1.3 Settlement Process

Settlement refers to the transfer of securities and money after a trade.
Types of Settlement Cycles:
• T+1 Settlement (Trade Date + 1 day): Securities and funds are exchanged the next working day
after trade execution.
• Rolling Settlement: All trades are settled within a fixed number of days (e.g., T+1 or T+2).
• Derivatives Settlement: Cash-settled on the expiration date.

Settlement Agencies in India:

• Clearing Corporation of India Ltd (CCIL) – Ensures smooth trade settlements.
• National Securities Clearing Corporation Ltd (NSCCL) – Handles NSE settlements.
• Indian Clearing Corporation Ltd (ICCL) – Handles BSE settlements.

1.4 Risk Management in Stock Exchanges

Risk management ensures fair trading and prevents defaults in settlements.
Key Risk Management Measures:
1. Margin Requirements – Traders deposit an initial margin to cover potential losses.
2. Circuit Breakers – If stock prices move sharply (up or down), trading is temporarily halted.
3. Price Bands & Limits – Stocks have daily price fluctuation limits (e.g., 5%, 10%, 20%) to avoid
excessive volatility.
4. Monitoring of Market Manipulation – SEBI and stock exchanges track unusual trading patterns.

1.5 Investor Grievances and Protection

Investors may face issues like fraudulent trades, non-receipt of securities, or price manipulation.
Common Investor Grievances:
• Unauthorized Trading: Brokers execute trades without client consent.
• Delays in Settlement: Non-receipt of securities or funds.
• Price Manipulation: Artificially inflating or deflating stock prices.
• Fake IPOs & Scams: Fraudulent new offerings.

Investor Protection Measures:

• SEBI’s SCORES Portal: Investors can file complaints online.
• Investor Protection Fund (IPF): Compensation in case of broker default.
• Ombudsman for Stock Market Issues: Handles serious investor disputes.

1.6 Basics of Pricing Mechanism

The price of stocks is determined by supply and demand.
Factors Affecting Stock Prices:
1. Company Performance: Higher profits → Stock price increase.
2. Market Sentiment: Positive news increases demand; negative news reduces it.
3. Economic Factors: Inflation, interest rates, GDP growth.
4. Global Events: Political instability, war, or international policies affect prices.

1.7 Carry Forward & Badla System

These are old trading practices in India, replaced by modern settlement systems.

1.7.1 Carry Forward Trading

• Allows traders to carry forward their positions to the next settlement cycle.
• Now replaced by derivatives trading (Futures & Options).

1.7.2 Badla System (Now Banned)

• Badla was a deferred settlement system in India.
• Investors could buy stocks without paying the full amount immediately.
• It was abolished in 2001 due to risk and speculation concerns.

1.8 Automated Lending and Borrowing Mechanism (ALBM)

ALBM allows securities lending and borrowing among investors.
• Investors lend stocks to short-sellers for a fixed interest.
• Helps in market liquidity and allows traders to take short positions.
• Regulated by SEBI and conducted through stock exchanges.
2. Players on the Stock Exchange
Various participants influence stock market movements.
2.1 Investors
• Long-term players who invest based on fundamental analysis.
• They buy stocks and hold for years to generate returns.
• Examples: Retail investors, mutual funds, pension funds, foreign institutional investors (FIIs).

2.2 Speculators
• Traders who take short-term positions for quick profits.
• High-risk strategies; rely on market fluctuations.
• Types of speculators: Bulls, Bears, Stags.

2.3 Market Makers

• Financial institutions or individuals who provide liquidity by buying and selling stocks.
• They reduce price volatility by ensuring continuous buying and selling.
• Example: NSE-appointed market makers for small-cap stocks.

2.4 Bulls
• Optimistic traders who believe stock prices will rise.
• They buy stocks expecting a price increase.
• Their activity pushes stock prices higher (Bull Market).

2.5 Bears
• Pessimistic traders who expect prices to fall.
• They sell stocks or short-sell, expecting to buy back at a lower price.
• Their activity causes stock prices to decline (Bear Market).

2.6 Stags
• Investors who apply for IPOs hoping to sell at a profit on listing day.
• They do not hold stocks for long-term investment.
• Their activity affects IPO subscription levels.