Indian Financial System

Module 1 (Introduction to Financial System and its components)

Finance refers to the funds or money needed by individuals, business houses and the
government to meet all their requirements in purchasing goods and services.

Finance is a science that describes the management, creation and study of money,
banking, credit, investments, assets and liabilities. Finance deals with the allocation
of assets and liabilities under the conditions of certainty and uncertainty.

System, on the other hand is an integrated set of components or entities that interact
to achieve a particular function or goal. So, the financial system is a complex, well-
integrated set of sub- systems of financial institutions, markets, instruments and the
services which facilitates the transfer and allocation of funds efficiently and
effectively in an economy.

So, financial system plays a crucial role in economic development through

mobilization of savings from surplus units to deficit units.

Q. “Financial system performs the coordination between savings and

investment”- comment.
The significant aspect of financial system is regarding savings and investment
activity. Mobilisation of savings from surplus units to deficit units and its utilisation
for individual investment stimulate capital formation. It also accelerates the process
of economic growth. Surplus spending units’ consumption and planned investment
are less than their income. The savings of the surplus spending is the difference
between income, consumption and planned investment.

saving = Total Income – (Consumption + Planned Investment)

The savings that are held by the surplus spending units in the form of cash balances
and financial assets. Generally, household, government sector and other sectors are
surplus spending economic units.
Deficit spending economic units are those whose consumption and planned
investments exceeds income. These units have negative savings. Borrowing of deficit-
spending units create a supply of financial assets or demand for loanable funds.
Corporate sector is a main deficit spending economic units.

Formal and Informal financial system

Formal and informal financial sectors co-exist in the financial system of the
developing countries of the world. This is referred as ‘financial dualism’.

Generally, the informal financial sector provides savings and credit facilities for
small farmers in rural areas and for lower income households and small-scale
enterprises in urban areas. The advantages of Informal sectors are- non- regulated,
low transaction costs, easy access to credit non-bureaucratic. As it is mostly non-
regulated, non-Institutional, information is widely diffused, less investment
opportunities and higher rates of interest prevailed in the informal sector.

The informal financial system of India consists of individual moneylenders, group of

persons operating as funds or associations, partnership firms consisting of local
agents, non-bank financial intermediaries and chit fund companies.

The formal financial sector is organised, regulated and based on financial institution
and markets. The sector caters the financial needs of industries, government and
individual also.

The formal financial system of India comes the jurisdiction and control of Ministry of
Finance, Reserve Bank of India, Securities and Exchange board of India, Insurance
Regulatory and Development Authority.
Importance or significance of financial system
The importance of a financial system lies in its role in fostering economic growth and
stability. Here’s how each component contributes:

1. Capital Formation: The financial system plays a crucial role in capital

formation by channelling savings into productive investments. This process
builds capital stock, enabling economic expansion and industrial growth,
which are essential for increasing productivity and income.

2. Mobilization of Savings: Financial institutions encourage and collect savings

from households and businesses. By mobilizing these savings, the financial
system ensures a steady flow of funds into the economy, making capital
available for investment and helping maintain economic stability.

3. Induced Investment: The financial system encourages investment by providing

the funds businesses need to expand and innovate. This leads to job creation,
increased production, and ultimately, higher economic growth, as funds are
allocated to areas with the most growth potential.

4. Barometer of Economic Development: Financial markets, such as the stock and

bond markets, reflect the overall health and growth potential of the economy.
When financial markets perform well, it indicates investor confidence and
economic growth, making them a barometer for economic development.

5. Providing Financial and Advisory Services: Financial institutions offer services

like investment advice, portfolio management, risk assessment, and wealth
management. These advisory services guide individuals and businesses in
making informed financial decisions, fostering responsible economic
behaviour and optimal resource allocation.

6. Financial Assistance: The financial system provides essential funding and

loans to individuals, businesses, and governments, enabling them to finance
projects, meet operational costs, or cover unexpected expenses. Financial
assistance supports entrepreneurial ventures and infrastructure development,
contributing to economic resilience and growth.
Together, these functions make the financial system fundamental to promoting
sustainable economic development, managing risk, and maintaining stability in an
economy.

Briefly discuss the role of financial system in the economic development of

a country
Economic development of a country depends on effective financial system. The more
improved and developed financial system ensures the more active capital
information. The contributions or role of financial system in economic development
are discussed below:

1. Increase of gross domestic product and per capita income: Effective financial
system helps to increase gross domestic product as well as per capita income of
a country. Different components of final financial system contribute positively
in this context.
2. Capital Formation: Economic development of a country depends on capital
formation. The creation of productive assets that expand an economic capacity
to produce goods and services is called capital formation. The financial system
of a country facilitates capital formation.
3. Mobilisation of financial resources: Mobilisation of financial resources is
necessary for economic development. Financial institution and markets help to
mobilise financial resources from surplus units to deficit units.
4. Increase savings: Savings and economic development are closely related to
each other. The mobilisation of domestic savings is crucial for raising the
economic growth and promoting development. Developed and well-regulated
financial system motivates common people or savers for more savings and
investment in financial market.
5. Economic development: A country should maintain continuous development
of different sectors like agriculture, industry and services in an economy.
Different components of financial system help to keep steady flow of sectoral
development of an economy.
Components of financial system

Financial institutions:
Financial institutions are financial enterprises that acts as mobilisers and depositors
of savings and perform brokering securities, managing funds or underwriting
securities. Financial institutions perform some important activities like exchange of
financial asset of people in financial markets, assist to transfer of financial asset in
the name of people, advice to decide to buy financial asset from the financial market.
So, in a word, a well-organised activities of financial institutions make financial
system well-controlled and stable.
Classification of financial institutions

Banking intermediary institution:

Among intermediary institutions, Banking institutions are an important institution.
Bank means an institution which collect deposits from people and creates credit and
sanctions loan and advances to different persons and business institutions. Bank
transformed money into deposits and again deposits into credit. It transferred money
of persons or business into the hands of other persons and businessmen.

Example of banking intermediary institutions are- (i)commercial banks, (ii) public

sector banks (State Bank of India, Bank of Baroda), (iii)private sector
banks.(iv)Foreign banks, (v)regional rural banks, (vi)cooperative banks

Different types of banks:

Commercial banks are financial institutions that provide a range of banking services
to individuals, businesses, and governments. Their primary functions include
accepting deposits, providing loans, and facilitating payment systems, which help
drive economic activity. Commercial banks are of two types schedule commercial
banks and non- schedule commercial banks.
Development banks are specialized financial institutions focused on promoting
economic development by providing long-term capital to sectors that are crucial for
national growth but may lack adequate funding from traditional commercial banks.
These sectors often include infrastructure, agriculture, industry, and small
businesses. Development banks aim to support projects that boost employment,
enhance productivity, and contribute to regional development.
Unlike commercial banks, development banks often provide funds at lower interest
rates and offer longer repayment periods, as their primary goal is economic growth
rather than profit. Examples of development banks include the Industrial
Development Bank of India (IDBI), National Bank for Agriculture and Rural
Development (NABARD) in India. Development banks are of 2 types, national level
development banks, state level development banks.
Cooperative banks are financial institutions that are owned, controlled, and operated
by their members. Cooperative banks are formed according to the cooperative
society's act. The banks sanction loan for development of agriculture and cooperative
activities at a low interest rate to their members.

Land Development Banks (LDBs) are banks, which sanctioned long-term loan to
farmers for permanent development of land, irrigation, digging of well, purchase of
costly agricultural machinery, purchase of new land for different objectives are
called land development banks.

Exchange banks are financial institutions that specialize in dealing with foreign
exchange and international trade. Their primary role is to facilitate currency
exchange, enabling businesses and individuals to convert one currency to another for
trade, investment, or travel purposes. Exchange banks provide crucial services such
as foreign currency loans, international payments, trade financing, and issuing
letters of credit, which help secure transactions between parties in different
countries.

They help importers and exporters manage foreign exchange risks by offering various
currency products and services. Prominent examples of exchange banks include
major international banks such as HSBC, CitiBank.

Central Bank is a national financial institution responsible for managing a country’s

monetary policy, regulating the money supply, and overseeing the financial system. It
plays a crucial role in maintaining economic stability, controlling inflation, and
fostering overall financial health within the economy. In India, the Reserve Bank of
India (RBI) functions as the central bank, while in the United States, the Federal
Reserve (Fed) serves this purpose. Central banks are vital to maintaining a balanced,
stable economy
Function of Banking Intermediary Institutions:
1. Acceptance of Deposit: Banks are important financial intermediaries between
savers and borrowers. Banks mobilise savings by accepting deposits. The amount
mobilised as deposits is then lent in the form of advances. The higher the amount of
deposits mobilised, the higher is the amount of funds lent. Banking institution pay
fixed rate of interest against deposits to depositors.

2. Providing Loans and Advances: To invest or provide loan, the money collected as
deposit or bank's own capital is the main function of banking institutions. Banking
institutions generally sanctions short-term, middle and long-term loans. In providing
of loans it demands interest at different rates from the borrowers.

3. Investment: Banking institutions invest long-term period by taking the

responsibility of selling shares and debentures of industries. It also sanctions short-
term and middle-term loan to industrial units

4. Act as an Agent: Banking institutions act as an agent of depositor and customers.

Functions performed by banking institutions as an agent are (i) transfer of
customers' money. (1) realisation of arrear money of customers, (iii) payment of
liabilities of depositors, (iv) collection of money, (v) act as guarantor, (vi) purchase
and sale of customers' shares and investment papers (vii) custodian of valuable
articles, (viii) advisor of income tax, (ix) agent of importer and exporter and (x) other
assistance.

5. Foreign Exchange Transactions: Commercial banks and foreign banks purchase

and sell foreign currencies with the permission of central bank. It results in
transaction of foreign trade.

6. Credit Creation: Sanctioning of loan and accepting of deposit create bank credit.
Depositors never withdraw the total amount deposited with the bank. Again, on the
other side though the bank can sanction the whole amount of loan to the borrower,
the total amount is not required at a time. In that case an account is opened in the
name of borrower. The borrower withdraws money from that account according to
his requirements. In this way, bank creates credit by sanctioning loan to the borrower
from the deposit amount of depositors in a serial process.

So, banking institutions not only perform various functions for the depositors, but
also play significant role to keep up the economic system of the country mobile.
Non-Banking intermediary institution:
Non-Banking Financial Intermediary Institutions (NBFIs) are financial institutions
that provide services similar to those of banks, but they do not have a full banking
license and cannot accept deposits from the public. These institutions play a vital
role in the financial system by offering a variety of financial services such as loans,
investments, asset management, and insurance, but they operate outside the
traditional banking structure.

Examples of non-banking intermediary institutions are-(i) Insurance Companies, (ii)

Mutual Funds, (iii) Leasing Companies, (iv) Hire-Purchase Companies, (v) Venture
Capital Firms, (vi)Housing Finance Corporation, (vii)Credit Rating Agencies,
(viii)Merchant Banking Organizations, (ix)Stock Broking Firms.

Mutual Fund (MF): A mutual fund is an investment vehicle that pools money from
multiple investors to create a large fund. This pooled capital is then managed by
professional fund managers, who invest in a diversified portfolio of assets like stocks,
bonds, money market instruments, or other securities based on the mutual fund’s
objectives. It allows individual investors to gain access to a diversified, professionally
managed portfolio of securities with a relatively small investment. The structure of
mutual funds, with roles like the sponsor, trustees, AMC, and custodian, ensures that
the fund operates securely, transparently, and in compliance with regulations.

Key Components of a Mutual Fund

1. Sponsor: The sponsor is the entity that establishes and promotes the mutual
fund, securing regulatory approvals, and setting up the necessary framework,
such as appointing trustees and forming the Asset Management Company
(AMC).

2. Trustees: Trustees are responsible for overseeing the mutual fund’s operations,
ensuring that the fund complies with regulations, and protecting investor
interests. They act as an intermediary between investors and the AMC.

3. Asset Management Company (AMC): The AMC is the company that manages
the fund’s investments. Professional fund managers at the AMC make decisions
about which assets to buy and sell based on the fund’s objectives, aiming to
generate returns for investors.
4. Custodian: The custodian is a financial institution responsible for holding and
safeguarding the fund’s assets. It also handles trade settlements, record-
keeping, and managing dividends or interest generated by the investments.

Benefits: Mutual funds offer a range of benefits, making them a popular investment
choice. By pooling money from many investors, mutual funds allow for diversified
investments across stocks, bonds, and other assets, which helps spread and reduce
risk. They are managed by professional fund managers, giving investors access to
expert strategies without needing to manage investments themselves. Additionally,
mutual funds offer liquidity, as open-ended funds allow easy redemption at the
current NAV. They’re accessible with low minimum investments, offer tax-saving
options in certain cases, and provide a convenient way to build wealth over time.

Insurance company is a financial institution that provides protection against

financial loss or risk through insurance policies. These policies allow individuals or
businesses to transfer the risk of specific losses (such as damage, illness, or death) to
the insurance company in exchange for regular premium payments. The insurance
company assesses the risk of insuring the policyholder, determines the terms of
coverage, and sets the premium amount. When a claim is made, the insurance
company evaluates the situation and compensates the policyholder according to the
policy’s conditions. The premiums collected are pooled together and invested,
ensuring the insurer has enough funds to cover claims while making a profit.

Function of Non-Banking Intermediary Institutions:

1. Intermediary Function: An important function of financial system is to invest
surplus money in deficit units from surplus units. Non-banking financial institution
acts as intermediary to reach the money of the savers to the ultimate investors.

2. Risk Reduction: It helps to reduce risks in the investment of savings of savers in

trade and commerce and industry. Institutions with expert and efficient investment
management can help to earn certain income from investment.

3. Creation of New Assets: These institutions create new financial assets. Money of
savers are invested in such a manner so that new assets are created.

4. Economic Growth: To manage savings toward production and form capital are the
important task perform these institutions in economic development.
5. Economy in Monetary Usage: These institutions reduce the expenditure in the use
of saver's money by giving them advice. Thus, it helps to investors of reduction of
transaction cost.

6. Sale of Securities: Non-banking financial institutions of India sell different types of

securities, bonds to the savers. These securities are tax saving bonds, insurance
certificates, loan and savings certificates.

7. Development of Capital Market: Non-banking financial institutions help to

organise and improve capital market of the country. Besides they assist to maintain
mobility of capital market.

It is not possible for commercial banks alone to collect savings from different sectors
and motivate towards production. Therefore, non-banking financial institutions
perform the subsidiary activities of bank and helps a lot in economic development
with capital formation.

Difference between Banking and Non-Banking Intermediary Institutions:

Financial Markets:
Financial markets are the centres or arrangements that provide facilities for buying
and selling of financial claims and services. Financial markets deal in financial assets
and instruments of various kinds such as currency, deposits, cheques, bills and bonds
etc. They play a crucial role in the economy by facilitating the flow of funds, enabling
individuals, companies, and governments to access capital

Financial markets may be classified into two broad categories – (i)Money market,
(ii)Capital market. Besides, foreign exchange market is an important segment of
financial market.

Money markets are a segment of the financial markets where short-term borrowing
and lending take place, typically in instruments with maturities of one year or less.
These markets deal with highly liquid, low-risk financial instruments, making them
an essential part of the financial system for managing short-term capital needs.

The money market consists of (1) unorganised sector, and (2) organised sectors. The
unorganised sector consists of indigenous bankers who pursue the banking business
on traditional lines and non- banking financial institutions. The organised sector
comprises the Reserve Bank of India, the State Bank of India and its associate banks,
the 20 nationalised banks and other private sector banks, both Indian and foreign.
The organised sectors of money markets are (a) call money market, (b) treasury bills
market, (c)commercial paper market, (d) certificate of deposits market (e)
commercial bill market, and (f) inter-bank call money market.

The capital market is a financial market where long-term debt and equity securities
are traded, providing a platform for raising capital to finance business expansion,
infrastructure projects, and other long-term investments.

The main objectives of capital market are: (i)To mobilize long-term savings to finance
long-term investments, (ii)To provide a market place for the purchase and sale of
securities, (iii)To provide liquidity with a mechanism enabling the investors to sell
financial assets, (iv)To discover new price of securities.

The capital market may be divided into two categories – (a) equity market, and (b)
debt market.

The equity market, also known as the stock market, is a segment of the financial
market where shares of publicly traded companies are bought and sold. It enables
companies to raise capital by issuing shares to the public, providing funds for growth
and expansion. For investors, the equity market offers an opportunity to own a
portion of a company and potentially earn returns through dividends and capital
appreciation. The equity market includes primary markets, where new shares are
issued (such as through IPOs), secondary markets, where existing shares are traded
among investors, and Derivatives market. This market plays a critical role in wealth
creation, economic development, and liquidity for investors.

The debt market is a financial market where debt instruments, such as bonds and
debentures, are traded. It enables governments, corporations, and other entities to
raise capital by issuing debt securities, promising to repay investors the principal
amount along with interest.

Debt instruments are generally less risky than equities, as they offer fixed returns
over a specified period and prioritize bondholders over shareholders in case of
liquidation. The debt market includes government bonds, corporate bonds,
municipal bonds. Debt market may be classified into – (a) government securities
market, (b)public sector bonds market, and (c)private sector bond market.
Financial Instruments/Assets:
Financial instruments, or financial assets, are contracts that represent monetary
value and can be traded or settled in financial markets. They include various forms of
investments like stocks, bonds, and derivatives, each serving different purposes such
as raising capital, managing risk, or generating returns.

Main Types of Financial Instruments:

1. Equity Instruments: Represent ownership in a company, like stocks or shares.

Investors in equity instruments can benefit from dividends and capital
appreciation if the company performs well.

2. Debt Instruments: Include bonds, debentures, and loans, which represent

borrowed funds that must be repaid with interest. These are generally lower
risk than equity instruments and are ideal for investors seeking fixed returns.

3. Derivatives: Financial contracts whose value depends on an underlying asset,

like commodities, currencies, or interest rates. Common derivatives include
options, futures, and swaps, often used for hedging or speculative purposes.

4. Hybrid Instruments: Combine features of both equity and debt, such as

convertible bonds, which can be converted into shares at a future date, offering
flexibility and additional potential for returns.

5. Money Market Instruments: Short-term debt instruments like Treasury bills,

certificates of deposit (CDs), and commercial paper, which are highly liquid
and used for short-term financing.

OR

1. Money Market Instruments: Money market instruments are short-term

instruments, the maturity period of which is less than one year. The development of
money market depends on the availability of variety of instruments to suit the
requirements of various types of borrowers and lenders in the money market.

Examples of money market instruments (a) money at call at short notice or call loans,
(b) treasury bills, (c) bills rediscounting scheme, (d) certificate of deposits, (e)
commercial paper, (f) repurchase options (repos), (g) financial futures, (h) forward
rate agreements, (i) money market mutual funds, etc.
2. Capital Market Instruments: Financial instruments that are used for raising capital
resources in the capital market are known as capital market instruments. Capital
market instruments are the source of long-term finance. Its maturity period is more
than one year.

Capital market instruments are divided into two broad categories (a) direct, (b)
derivative. In the direct category, the instruments are - (i) preference shares, (ii)
equity shares, (iii) company fixed deposits, (iv) debentures and bonds, and (v)
warrants.

Under the derivative category, the instruments are (i) forwards, (ii) futures, (iii)
options, and (iv) swaps

Financial Services:
Financial services refer to those services offered by banks, financial institutions,
insurance companies and other financial intermediaries. Financial services include
money management, portfolio management, stock broking and custodial services.

Financial services help to raise the required funds from a lot of investors, individuals,
institutions and corporates. Financial services assist in the decision-making
regarding the financing mix. It also helps not only in raising the required funds but
also in ensuring their efficient distribution. Financial services are provided by
specialised and general financial institutions, banks and insurance companies.

Financial services institutions are providing various activities. The important

activities are:

1. Supply of Alternative Capital: Financial services institutions do not supply capital

directly. It is not always possible for an organisation to collect the money necessary
for different types of machineries and technologies in the organisation. Financial
services institutions arrange to provide alternative capital to industrial units under
repayable in instalments.
2. Bill Rediscounting: These institutions perform rediscounting of different types of
commercial bills

3. To Encourage for New Venture: The institutions provide venture capital and make
advice to the new entrepreneurs for setting up business.

4. Financial Advice: Financial services institutions render advice regarding

management of finance, different types of financial instruments and preparation of
projects.

5. Merchant Banking Activities: Financial services perform the role of merchant

banking. This is really an important task in the competitive field of liberalised
economy and in financial management for the enterprises.

6. Channelisation: These institutions perform special role to organise money market

by keeping correlation with different institutions of financial system.

Financial services fall into two broad classes (1) fund or asset-based, and (2) fee or
advisory based.

Services offered by some financial institutions like providing finance, asset and
reduction of risk are called fund or asset-based financial services. Such services have
played the key role in innovating different types of financial instruments. shares,
debentures, bonds. Examples of fund-based services are

(i) underwriting or investment in of new issues;

(ii) participating in money market instruments;
(iii) involving in equipment leasing, hire purchase, venture capital, seed capital;
and
(iv) dealing in foreign exchange market activities.

Fund-based institutions are:

1. Lease Financing Institutions 2. Hire-Purchase Institutions

3. Factoring Institutions 4. Bill Discounting Institutions
5. Housing Finance Institutions 6. Insurance organization
7. Venture Capital Financing Institutions
Fee or advisory-based financial services are those services rendered by financial
institutions by taking fees instead of providing finance or fund. These include
(i) Managing the capital issues i.e., management of pre-issue and post-issue
activities.
(ii) Making arrangements for the placement of capital and debt instruments
with investments institutions.
(iii) Arrangement of funds from financial institutions.
(iv) Assisting in the process of getting all government and other clearances.
(v) Mergers and acquisitions activities.

Functions of the fee-based financial services institution are:

1. Share Issue Management
2. Issue of debenture and other Investment Management
3. Corporate Counselling
4. Mergers and acquisition
5. Merchant banking
6. Capital Reconstruction

The economic development of a country is largely dependent on the

financial system. Elucidate.
The economic development of a country is closely tied to the strength and efficiency
of its financial system, which includes institutions, markets, instruments, and
regulatory frameworks that facilitate the flow of funds. A well-functioning financial
system promotes economic growth by efficiently mobilizing savings, allocating
resources, managing risks, and providing liquidity, all of which are essential for a
robust economy.
Key Ways the Financial System Drives Economic Development:
1. Mobilization of Savings and Investment: The financial system channels savings
from households to businesses and government projects, enabling productive
investments. This flow of capital is crucial for funding infrastructure,
innovation, and industrial growth, which contribute to long-term economic
development.
2. Efficient Resource Allocation: Through financial markets, capital is allocated
to projects with the highest potential returns, supporting sectors that drive
economic growth. Banks, capital markets, and other financial institutions help
direct funds to sectors like manufacturing, technology, and services,
maximizing economic output.
3. Encouraging Entrepreneurship and Innovation: Access to finance from venture
capital, loans, and other sources supports entrepreneurs and startups. This
access fosters innovation, job creation, and competition, which are essential for
a dynamic and growing economy.
4. Risk Management: The financial system offers instruments like insurance and
derivatives that help manage risks associated with business operations and
investments. By mitigating risks, financial services encourage individuals and
companies to invest, increasing economic activity.
5. Financial Inclusion: A well-developed financial system includes provisions for
financial inclusion, enabling underserved populations to access banking,
credit, and other financial services. This inclusion supports poverty reduction,
small business growth, and improved standards of living, contributing to a
balanced economic development.
6. Market Stability and Investor Confidence: Regulatory bodies within the
financial system ensure transparency, protect investors, and promote stability,
fostering confidence in the economy. This stability encourages both domestic
and foreign investment, which is essential for sustained economic growth.
In essence, a strong financial system is the backbone of economic development,
supporting growth by efficiently managing and distributing financial resources,
promoting innovation, and enhancing stability across sectors.

How does the financial system enable mobilisation of savings?

The financial system enables the mobilization of savings by providing various
channels and instruments through which individuals, households, and businesses
can save and invest their funds. By converting idle savings into productive capital,
the financial system plays a crucial role in fostering economic growth.
Key Ways the Financial System Mobilizes Savings:
1. Banks and Financial Institutions: Banks and financial institutions accept
deposits from the public, offering safe and accessible options like savings
accounts, fixed deposits, and recurring deposits. These institutions then lend
these deposits to businesses and individuals, turning savings into productive
investments.
2. Capital Markets: The stock and bond markets allow individuals to invest their
savings in shares and bonds issued by companies and governments. This
access to a wide array of financial instruments encourages people to invest
their savings, helping to fund projects, expansion, and government spending.
3. Mutual Funds: Mutual funds pool small amounts of savings from many
investors and invest them in diversified portfolios of stocks, bonds, or money
market instruments. This pooling allows even small savers to benefit from
professional management and participate in larger, diversified investment
opportunities.
4. Insurance Companies: Insurance products, such as life insurance and pension
funds, act as long-term savings vehicles. Premiums paid by individuals are
invested by insurance companies, who then channel these funds into various
financial and infrastructure projects.
5. Pension and Provident Funds: Pension funds and provident funds collect
regular contributions from employees and employers. These funds are
invested to provide returns and security in retirement, effectively channelling
savings into long-term investments in the economy.
6. Non-Banking Financial Companies (NBFCs): NBFCs provide a wide range of
savings and investment products, especially to segments of the population that
may not have easy access to traditional banking. They offer loans, investment
products, and deposit schemes that mobilize savings from diverse sources.
7. Financial Instruments and Innovation: The financial system also offers
instruments like certificates of deposit, treasury bills, and bonds, which attract
savers looking for security and returns. Financial innovation continues to
create new savings products that appeal to different investor preferences,
boosting overall savings.
Overall Impact:
By offering multiple savings and investment options, the financial system encourages
people to move their money from cash or low-yield assets into productive
investments. This process helps pool capital for economic activities, driving growth,
infrastructure development, and wealth creation across the economy.
Give a diagrammatic representation to show how the various components
of the financial system are interred linked.

‘Financial assets are part of an investor’s wealth, but not a part of national
wealth”-explain
The statement “Financial assets are part of an investor’s wealth, but not a part of
national wealth” reflects the distinction between personal financial holdings and
tangible assets that directly contribute to a nation’s economic value. Financial assets,
such as stocks, bonds, or deposits, represent legal claims to future cash flows or
benefits but do not themselves create real goods or services. Here’s an explanation
incorporating the main points:
1. Nature of Financial Assets vs. Tangible Assets:
• Financial assets provide legal claims to future benefits, such as interest,
dividends, or repayments, but do not represent physical or productive assets
directly. For example, a treasury bill from the Reserve Bank of India or shares
of Tata Motors Ltd. gives investors a claim on future cash flows rather than
ownership of physical infrastructure, factories, or technology.
• National wealth, on the other hand, is made up of real, tangible assets like
infrastructure, factories, natural resources, and human capital, which directly
contribute to productive capabilities.
2. Investor vs. National Wealth:
• Financial assets are part of individual wealth. Investors holding financial
assets—like treasury bills or corporate shares—can claim future returns or sell
them in financial markets, realizing personal wealth.
• However, these assets do not constitute new wealth for a country. They are
essentially contracts between individuals or entities and do not create physical
goods or services that expand a country’s economic output.
3. Role of Financial Assets in Economic Development:
• Although financial assets are not directly counted as national wealth, they play
an indirect role by mobilizing savings into investments. When investors
purchase stocks or bonds, the issuing companies or governments channel
these funds into economic activities, such as industry expansion or
infrastructure projects. These investments contribute to creating tangible
assets and thus support national wealth.
4. Transferability and Ownership Rights:
• Financial assets provide investors with full ownership rights. They can be
traded in financial markets, pledged for loans, or sold to other investors. This
liquidity benefits individual investors, allowing them to manage their wealth.
• However, trading financial assets does not increase the real wealth of a nation;
it simply shifts ownership of existing claims without creating new value.
5. Risk Factors and Lack of National Guarantee:
• Financial assets come with various risks, such as purchasing power risk
(inflation risk), default risk (issuer fails to pay), and foreign exchange risk (for
assets in foreign currencies). These risks impact the value of investors’
financial assets but do not affect national wealth directly.
• Since the government does not guarantee individual returns on financial
assets, these assets remain part of individual wealth rather than national
wealth.
6. Key Differences: Wealth Transfer vs. Wealth Creation:
• Financial assets often facilitate the transfer of existing wealth (e.g., through
stock trading) rather than creating new wealth. For national wealth to grow,
tangible asset creation—like infrastructure, industrial output, or technology
development—is required.
• Only productive activities that increase a country’s physical and human
resources add to national wealth. Financial assets, being claims on existing
assets, don’t directly contribute to this.
In conclusion, while financial assets are valuable to individual investors as a source
of income, savings, and liquidity, they do not contribute directly to a nation’s tangible
resources. They are part of personal wealth, serving as a mechanism for capital
allocation rather than as creators of new economic value. The real growth of national
wealth depends on investments that result in tangible assets, which increase a
country’s production capabilities and overall economic output.
What is meant globalisation of financial markets?
Globalization of financial markets refers to the integration and interconnection of
financial systems across the world, allowing for the free flow of capital, investments,
and financial services across national borders. It enables investors, companies, and
governments to access global financial resources, diversify portfolios internationally,
and tap into new markets and investment opportunities.
Key Aspects of Globalization in Financial Markets
1. Cross-Border Capital Flows: Globalization has enabled the movement of
capital between countries, allowing investors to invest in foreign markets and
businesses to access funding from international sources. This includes foreign
direct investment (FDI), portfolio investments, and lending from international
banks.
2. Integration of Financial Institutions: Financial institutions, such as banks,
insurance companies, and investment funds, operate on a global scale,
providing services to clients across multiple countries. This has led to the
creation of multinational banks, global asset management firms, and
international insurance providers.
3. Global Financial Instruments: Financial products like stocks, bonds,
derivatives, and foreign exchange can be traded globally. This means investors
can buy and sell assets in different countries, which helps them diversify their
portfolios and manage risk across economies.
4. Advances in Technology: Technological advancements, especially in
communication and financial software, have accelerated globalization. Trading
systems, online platforms, and real-time data sharing allow for instant
transactions and monitoring of international financial markets.
5. Reduction of Trade and Investment Barriers: Many countries have reduced
regulations and trade barriers to attract foreign investment and allow the
exchange of financial services. Deregulation, such as loosening capital controls
and simplifying investment laws, has fostered a more open financial system.
6. Harmonization of Financial Standards: Global organizations, such as the
International Monetary Fund (IMF), World Bank, and Bank for International
Settlements (BIS), work toward harmonizing financial regulations and
standards. This alignment facilitates smoother cross-border transactions and
enhances financial stability.
Benefits of Globalization of Financial Markets
• Capital Accessibility: Businesses and governments can raise funds from a
larger pool of global investors.
• Risk Diversification: Investors can spread risk across countries and asset
classes.
• Efficient Allocation of Resources: Globalization directs funds to the most
productive uses, increasing global economic efficiency.
• Economic Growth: Access to international capital can support infrastructure
projects, innovation, and industrial expansion.
Risks of Globalization of Financial Markets
• Financial Contagion: Economic or financial crises can spread quickly across
countries, as seen during the 2008 global financial crisis.
• Exchange Rate Volatility: The movement of international capital can lead to
currency fluctuations, impacting trade balances and inflation rates.
• Regulatory Challenges: Differing national regulations can create complexities,
and regulatory gaps can lead to financial vulnerabilities.
In summary, globalization of financial markets fosters interconnectedness, allowing
for a more fluid movement of capital and financial services worldwide. While it
brings significant economic benefits, it also introduces risks that require careful
management to maintain financial stability across economies.

The factors that have led to the integration of financial markets are:
1. Deregulation of Financial Markets: Global competition has forced governments to
deregulate or liberalise various aspects of their financial markets so that their
financial Institutions can compete effectively around the world.
2. Technological Advancement: Technological advances in the last three decade have
increased the integration as well as efficiency of the financial markets. Many
investors can monitor global markets and simultaneously assess how this
information will impact the risk/return profile of their portfolios
3. Increased Institutionalisation: Institutional investors have been increasing and
they are willing to transfer funds across national borders to improve portfolio
diversification.
Globalisation as well as integration of financial markets leads to introduction of new
products such as repos (Repurchase options) and derivative products. The
movements in the Indian stock indices such as SENSEX and NIFTY are correlated
with the movements in the global stock indices.
Module 2 (Money Market)
The money market is a segment of the financial market where short-term funds are
borrowed and lent. It primarily deals with highly liquid and low-risk financial
instruments that have a maturity period of one year or less. The key purpose of the
money market is to provide an avenue for managing liquidity and short-term
financing needs for governments, financial institutions, and businesses.
In India it is Regulated by RBI. According to RBI, “Money market is a centre for
dealing mainly of short term in monetary assets”. It meets the short-term
requirement and providing liquidity of cash to lenders.

1) Why do you think money market plays an important role in the economy of a
country?
The money market is a segment of the financial market that deals with short-term
borrowing and lending of funds, typically involving instruments with maturities of
one year or less. It provides a platform for liquidity management and supports
economic stability by meeting the short-term financial needs of governments,
businesses, and financial institutions.
Importance of the Money Market
1. Ensures Liquidity Management: Provides short-term funds to banks, financial
institutions, and businesses for smooth day-to-day operations. Instruments
like Treasury Bills, Call Money, and Commercial Papers facilitate efficient
utilization of surplus funds.
2. Implements Monetary Policy: Central banks use money market tools like Repo
and Reverse Repo operations to regulate liquidity and interest rates. This helps
control inflation and ensures financial stability.
3. Promotes Financial Stability: By providing short-term funding solutions, the
money market helps avoid liquidity crises and supports the smooth
functioning of the financial system.
4. Efficient Allocation of Resources: Channels surplus funds from lenders to
borrowers, ensuring that idle money is productively used. This contributes to
overall economic productivity.
5. Supports Government Borrowing: Governments raise short-term funds
through Treasury Bills to meet fiscal needs without disrupting long-term
financing. For instance, the Indian government frequently issues Treasury Bills
to manage fiscal deficits.
6. Facilitates Investment Opportunities: Offers safe, low-risk investment options
such as Certificates of Deposit and Treasury Bills. Encourages saving and
investment, which boosts economic growth.
7. Stabilizes Interest Rates: Balances the demand and supply of short-term funds,
reducing fluctuations in interest rates and fostering a stable financial
environment.
8. Encourages Corporate Growth: Corporates can issue Commercial Papers to
meet their working capital needs, enabling them to focus on growth and
expansion without relying solely on bank loans.
The money market acts as the backbone of the financial system, ensuring liquidity,
stabilizing interest rates, and efficiently allocating resources. By meeting the short-
term financial needs of key players in the economy, it contributes significantly to
economic stability and growth, especially during challenging times like financial
crises or pandemics.

3) Do you think commercial paper and certificate of deposit are similar

instruments? Explain
While Commercial Paper (CP) and Certificate of Deposit (CD) are both short-term
financial instruments traded in the money market, they differ significantly in their
purpose, issuance, and features. Below is a comparison to highlight their similarities
and differences.
Similarities Between CP and CD
1. Short-Term Maturity: Both instruments have short-term maturities, generally
ranging from a few weeks to a year.
2. Tradability: Both CP and CD can be traded in the secondary market, providing
liquidity to investors.
3. Low Risk: These instruments are considered relatively low-risk compared to
other financial products, though the degree of risk depends on the issuer.
4. Purpose: Both are used to raise funds, either by corporates (CP) or banks (CD).
5. No Collateral Required: Both instruments are unsecured, meaning they do not
require collateral.
Minimum Investment ₹5 lakh and in multiples ₹1 lakh and in
thereof. multiples thereof.
Risk Level Higher risk due to Lower risk as
corporate default banks are more reliable
possibility. issuers.
4) Indian money market is Dichotomised. Elucidate.
The Indian money market is described as dichotomized because it consists of two
distinct segments: the organized sector and the unorganized sector. These segments
operate with minimal interaction and cater to different financial needs. Below is an
elucidation of this dichotomy:
1. Organized Sector
The organized sector is formal, regulated, and operates under the supervision of the
Reserve Bank of India (RBI). It is characterized by well-defined institutions and
instruments that cater to institutional and corporate financial requirements.
Key Features
• Regulated Operations: Governed by RBI guidelines.
• Formal Instruments: Includes Treasury Bills, Commercial Papers, Certificates
of Deposit, and Call Money.
• Participants: Banks, financial institutions, mutual funds, corporations, and the
government.
• Transparency: High due to formal regulations and standardized practices.
Examples
• Call Money Market: Facilitates short-term borrowing and lending among
banks.
• Treasury Bill Market: Used by the government to meet short-term funding
needs.
• Certificate of Deposit (CD): Time deposits issued by banks.

2. Unorganized Sector
The unorganized sector is informal, unregulated, and caters to the financial needs of
individuals and small businesses, especially in rural and semi-urban areas. It
operates independently of the formal system.
Key Features
• No Regulation: Operates outside the purview of the RBI.
• Non-standardized Instruments: Includes informal loans, promissory notes, and
chit funds.
• Participants: Indigenous bankers, moneylenders, chit funds, and pawnshops.
• Lack of Transparency: Transactions are often undocumented and less secure.
Examples
• Moneylenders: Provide high-interest loans without formal documentation.
• Chit Funds: Group-based savings and borrowing schemes popular in rural
areas.
• Indigenous Bankers: Offer credit to traders and small businesses.

Impact of Dichotomy
1. Dual Functioning: While the organized sector contributes to the formal
economy, the unorganized sector meets the financial needs of those excluded
from the formal banking system.
2. Challenges for Integration: The unorganized sector’s lack of regulation and
high costs hinder efforts to integrate it with the organized sector.
3. Development Efforts: The government and RBI have taken initiatives like
financial inclusion programs to reduce reliance on the unorganized sector by
promoting access to formal financial services.
The dichotomized nature of the Indian money market reflects the coexistence of a
regulated, formal system and an unregulated, informal one. While the organized
sector supports institutional and corporate finance, the unorganized sector
addresses the needs of underserved segments. Bridging this gap through financial
inclusion and regulation is essential for achieving a unified and efficient money
market.

Features of the Money Market

1. Short-Term Maturity: The money market exclusively deals with instruments
that have short-term maturities, ranging from 1 day to 1 year. This ensures that
the market is focused on addressing immediate financial needs rather than
long-term investments.
2. High Liquidity: Instruments traded in the money market, such as Treasury
Bills and Commercial Papers, are highly liquid. This allows institutions to
convert them into cash quickly without significant loss, making them ideal for
short-term financial adjustments.
3. Low Default Risk: The instruments are issued by creditworthy entities like the
government, commercial banks, and large corporations, which reduces the risk
of default and instils confidence among investors.
4. Wholesale Nature: The money market operates predominantly as a wholesale
market, involving large-scale transactions. Participants like banks, financial
institutions, and corporates deal in bulk, often in multiples of large
denominations.
5. Regulation by RBI: The Reserve Bank of India (RBI) plays a crucial role in
regulating the money market to ensure stability, transparency, and efficiency.
It monitors transactions and implements monetary policy measures through
instruments like Repo and Reverse Repo rates.
6. Fixed Returns: Most money market instruments offer pre-determined returns,
such as the discount on Treasury Bills or fixed interest on Certificates of
Deposit, ensuring predictability for investors.
7. Unsecured Nature: Instruments like Commercial Papers are unsecured,
meaning they are issued without requiring any collateral. This makes them
accessible to highly credible borrowers but slightly riskier for lenders.
8. Liquidity Management Tool: The money market plays a critical role in
managing short-term liquidity needs. Banks and corporations rely on it to
address temporary mismatches between inflows and outflows of funds.
9. Diverse Participants: The key players in the money market include the
government, RBI, commercial banks, financial institutions, mutual funds,
primary dealers, and corporates. This diversity ensures the smooth flow of
funds and efficient allocation of resources.
10. Market-Driven Interest Rates: The interest rates in the money market are
determined by the forces of demand and supply. Factors such as liquidity
conditions, monetary policy, and economic activities influence the rates.
The money market is a vital component of the financial system, characterized by
short-term transactions, high liquidity, low risk, and active regulation. It not only
supports liquidity management but also stabilizes interest rates and ensures the
efficient allocation of short-term funds.

Functions and Objectives of the Money Market:

1. Meeting Short-Term Financial Requirements of Firms: The money market provides
a platform for firms to borrow short-term funds to meet their working capital needs.
Instruments like Commercial Papers, Call Money, and Treasury Bills are used by
businesses to address temporary financial shortfalls, ensuring smooth operational
continuity.
2. Proper Duration of Liquid Assets: The money market ensures that financial
instruments are appropriately tailored to meet short-term liquidity needs. It
provides highly liquid assets with varying maturities, allowing participants to
manage their cash flow efficiently without locking funds in long-term investments.
3. Credit Creation: Banks and financial institutions in the money market play a dual
role:
o Credit Creation: By lending money, they inject liquidity into the market.
o Deposit Mobilization: By accepting deposits, they channel funds from
surplus units to deficit units.
This process of credit creation supports economic activities and facilitates financial
stability.
4. Supporting Commercial Transactions: The money market plays a vital role in
supporting commercial transactions, especially in international and foreign trade. It
facilitates the settlement of payments between buyers and sellers by offering
financial instruments like Bills of Exchange and Trade Credit, which are crucial for
cross-border trade. By ensuring smooth transactions, it reduces the financial barriers
in foreign trade.
5. Maintenance of Cash Flow: One of the core functions of the money market is to
maintain adequate cash flow in the economy. It ensures that surplus funds from one
segment of the economy (like individuals or institutions) are directed toward areas
that face temporary shortages. This efficient allocation of liquidity prevents
disruptions in financial activities and keeps the economy running smoothly.
Structure of Indian Money Market:

Reserve Bank of India (RBI)

The Reserve Bank of India (RBI) is the central bank of India and serves as the apex
institution for the country's monetary and financial system. Established on April 1,
1935, under the provisions of the Reserve Bank of India Act, 1934, the RBI plays a
pivotal role in regulating and stabilizing the Indian economy.
Functions of Reserve Bank of India
1. The issuer of currency: The objective is to maintain the currency and credit system
of the country to maintain the reserves. It has the sole authority in India to issue
currency. It also takes action to control the circulation of fake currency.
2. The issuer of Banking License: As per Sec 22 of Banking Regulation Act, every bank
has to obtain a Banking license from RBI to conduct banking business in India.
3. Banker to the Government: It acts as banker both to the central and the state
governments. It provides short-term credit. It manages all new issues of government
loans, servicing the government debt outstanding and nurturing the market for
government’s securities. It advises the government on banking and financial subjects.
4. Banker’s Bank: RBI is the bank of all banks in India as it provides the loan to
banks/bankers, accept the deposit of banks, and rediscount the bills of banks.
5. Lender of last resort: The banks can borrow from the RBI by keeping eligible
securities as collateral at the time of need or crisis.
6. Money supply and Controller of Credit: To control demand and supply of money in
Economy by Open Market Operations, Credit Ceiling, etc. RBI has to meet the credit
requirements of the rest of the banking system. It needs to maintain price stability
and a high rate of economic growth.
7. Manager of foreign exchange: It acts as a custodian of FOREX. It administers and
enforces the provision of Foreign Exchange Management Act (FEMA), 1999. RBI buys
and sells foreign currency to maintain the exchange rate of Indian rupee v/s foreign
currencies.
8. Regulator of Economy: It controls the money supply in the system, monitors
different key indicators like GDP, Inflation, etc.
12. Managing Government securities: RBI administers investments in institutions
when they invest specified minimum proportions of their total assets/liabilities in
government securities.
Monetary policy is a crucial tool used by the RBI to regulate the supply of money,
availability of credit, and interest rates in the economy. Through this, the RBI ensures
price stability, promotes economic growth, and maintains financial stability. The
monetary policy framework empowers the RBI to address inflationary pressures,
support liquidity needs, and manage economic fluctuations effectively.
1. Quantitative Tools
These tools control the overall money supply in the economy.
1. Repo Rate: The rate at which the RBI lends money to commercial banks against
government securities. Lowering the repo rate increases borrowing, boosting
liquidity, while raising it reduces money supply.
2. Reverse Repo Rate: The rate at which the RBI borrows money from commercial
banks. It is used to absorb excess liquidity from the banking system.
3. Cash Reserve Ratio (CRR): The percentage of a bank’s total deposits that must
be kept with the RBI as reserves. Increasing CRR reduces the funds available
for lending, thereby controlling money supply.
4. Statutory Liquidity Ratio (SLR): The percentage of a bank's net demand and
time liabilities (NDTL) that must be invested in specified liquid assets like
government securities. SLR influences the credit flow and liquidity in the
economy.
5. Open Market Operations (OMO): Buying or selling of government securities in
the open market by the RBI. Buying securities injects liquidity, while selling
absorbs liquidity.
6. Bank Rate: The rate at which the RBI lends money to commercial banks
without any collateral. It is a long-term tool used to influence credit and money
supply.

2. Qualitative Tools
These tools regulate specific sectors of the economy by controlling the flow of credit
selectively.
1. Moral Suasion: The RBI persuades banks to follow its directives to achieve
monetary policy goals, such as reducing lending to speculative sectors.
2. Selective Credit Control (SCC): The RBI imposes restrictions on lending to
certain sectors, especially speculative activities like trading in essential
commodities.
3. Credit Rationing: Imposing limits on the amount of credit that banks can lend
to specific sectors to prevent misuse or over-exposure.
4. Direct Action: The RBI can take direct action, such as penalizing banks or
restricting their operations if they fail to comply with its guidelines.

The Call Money Market is a key segment of the money market where banks and
financial institutions borrow and lend funds for very short durations, typically
overnight or up to 14 days. It is primarily used to manage immediate liquidity
requirements, such as meeting the Cash Reserve Ratio (CRR) and Statutory Liquidity
Ratio (SLR) obligations. Transactions in this market are unsecured as no collateral
securities are required, relying on the creditworthiness of participants. The interest
rate in the call money market, known as the call rate, is highly dynamic and serves as
a key indicator of liquidity in the banking system.
Regulated by the Reserve Bank of India (RBI), this market plays a vital role in
monetary policy implementation. The RBI uses tools like repo and reverse repo
operations to influence the call rate and manage liquidity. The market's participants
include commercial banks, financial institutions, mutual funds, and primary dealers,
where lenders with surplus funds meet borrowers facing temporary shortages. By
ensuring liquidity, facilitating interbank transactions, and acting as a benchmark for
short-term interest rates, the call money market supports the smooth functioning of
the financial system and promotes economic stability.

Difference Between Call Money and Short Notice Money

Aspect Call Money Short Notice Money
Definition Funds borrowed and lent for Funds borrowed and lent for a
an overnight period (1 day). short duration, typically 2 to 14
days.
Duration Maximum of 1 day (repayable Ranges from 2 days to 14 days.
on demand).
Purpose Primarily used for meeting Used for managing short-term
immediate liquidity needs. liquidity mismatches over
slightly longer periods.
Participants Mainly banks and financial Similar participants as call
institutions. money but may also include
corporates.
Interest Rate Highly volatile, as rates Less volatile compared to call
Volatility change daily based on money.
demand-supply.
Repayment No prior notice required; Requires advance notice for
Notice repayable on demand. repayment.
Nature of Predominantly overnight Slightly longer-term loans with a
Transactions loans. fixed tenure.

Treasury Bill (T-Bill):

Treasury Bills, or T-Bills, are short-term debt instruments issued by the Government
of India to meet its short-term borrowing requirements. These are zero-coupon
securities, meaning they are issued at a discount to their face value and redeemed at
face value on maturity, with the difference representing the investor's return.
T-Bills are among the safest investment options as they are backed by the
government and are risk-free from default. They are widely traded in the money
market and serve as a critical tool for managing liquidity in the economy.

Features of Treasury Bills

1. Short-Term Nature: T-Bills are issued with maturities of 91 days, 182 days, and
364 days.
2. Issued at a Discount: They are issued at a price lower than their face value and
redeemed at par, with the discount reflecting the investor's return.
3. Highly Liquid: Treasury bills are easily tradable in the secondary market,
making them highly liquid instruments.
4. Risk-Free Investment: Since they are issued by the government, there is no
default risk associated with T-Bills.
5. Zero-Coupon Instrument: They do not pay periodic interest; instead, the return
is the difference between the issue price and the redemption value.
6. Minimum Investment: The minimum amount of investment in Treasury Bills is
₹25,000, and multiples thereof.
7. Low transaction cost
8. They are negotiable securities

A commercial bill is a short-term, negotiable instrument used in trade financing to

meet the working capital needs of businesses. It is issued by a buyer (debtor) as a
promise to pay a seller (creditor) a specified amount at a future date. These bills are
commonly used in trade transactions and are payable either on-demand (demand
bills) or after a stipulated period (usance bills). Businesses can discount these bills
with banks or financial institutions to obtain immediate funds, making them a
crucial tool for liquidity management.
Commercial bills are easily transferable, enabling them to be traded in the money
market. Their pricing depends on the creditworthiness of the issuer and prevailing
market conditions. They play a significant role in ensuring smooth trade operations,
providing flexible and cost-effective short-term financing options. Bils can be Inland
or Foreign. Inland bills are drawn and payable in India or upon any person residing
in India. Whereas Foreign bills are drawn outside India.
Discounting of bills is a financial arrangement where a holder of a bill of exchange or
a promissory note sells it to a bank or financial institution before its maturity at a
discounted value. The discount represents the interest or fee charged by the bank for
advancing funds against the bill. This process provides immediate liquidity to the
holder while the bank assumes the responsibility of collecting the payment from the
issuer upon maturity.

Commercial Paper (CP) is a short-term, unsecured debt instrument issued by

corporations, financial institutions, and other entities to raise funds for their short-
term financial needs, such as working capital requirements. Typically issued at a
discount, CP is redeemed at its full-face value upon maturity, with the difference
representing the return to the investor. The maturity period of a CP typically ranges
from 7 days to 1 year, making it a convenient instrument for short-term financing.
CP is considered a highly liquid and negotiable instrument because it can be easily
traded in the secondary market, providing flexibility to investors. Since it is an
unsecured instrument, the creditworthiness of the issuing entity plays a crucial role
in its acceptance. Issuers must obtain a credit rating from authorized agencies,
ensuring that only entities with strong credit standings can issue CP. This makes it an
attractive financing option for high-rated companies. The minimum denomination
for CPs is ₹5 lakhs, which limits its use mainly to institutional investors. Commercial
papers serve as an efficient tool for managing short-term liquidity, offering an
alternative to traditional bank financing while providing a relatively low-risk option
for investors.

A Certificate of Deposit (CD) is a short-term, negotiable money market instrument

issued by banks and financial institutions to raise funds. It is a time deposit but offers
greater flexibility and liquidity than traditional fixed deposits, as it is transferable
and tradable in the secondary market. CDs are typically issued at a discount to their
face value and redeemed at maturity, with the difference representing the investor’s
return. The maturity period for CDs ranges from 7 days to 1 year for banks and up to 3
years for financial institutions.
CDs are issued in dematerialized form or as promissory notes and are available in
denominations of ₹1 lakh or more, catering primarily to institutional investors,
mutual funds, and high-net-worth individuals. As they are unsecured instruments,
their safety depends on the creditworthiness of the issuing bank or institution. The
Reserve Bank of India (RBI) regulates the issuance of CDs in India, ensuring that they
comply with guidelines on tenor, denomination, and interest rates.
The primary purpose of CDs is to help banks manage short-term liquidity needs
while offering investors a secure and low-risk investment option with better returns
compared to traditional savings accounts. They play a significant role in the money
market by enabling efficient fund mobilization and liquidity management.
Module 3 (Capital Market)
An equity share, also known as ordinary share, represents ownership in a company.
When an investor purchases equity shares, they acquire a portion of the company
and become a shareholder, entitled to a share of the company’s profits, typically in
the form of dividends. Equity shareholders also have voting rights, allowing them to
participate in the decision-making processes, such as electing board members and
influencing major corporate policies.
The value of equity shares fluctuates based on the company's performance and
market conditions, and they are traded on stock exchanges. Equity shareholders are
last in line to receive any payouts in the event of liquidation, making their investment
riskier compared to other stakeholders like bondholders. However, they have the
potential for higher returns if the company performs well, through both capital
appreciation (increase in share price) and dividends. Equity shares are a primary
means of raising capital for companies and a popular choice for long-term investors
seeking to benefit from a company’s growth.

A preference share is a type of equity security that offers certain preferential rights to
its holders, particularly in terms of dividends and claims on the company’s assets in
case of liquidation. Preference shareholders receive fixed dividends, which are paid
before any dividends are distributed to common shareholders. This makes them a
relatively safer investment compared to common shares, as they have a guaranteed
return on their investment. However, preference shareholders typically do not have
voting rights in the company, meaning they do not participate in corporate decision-
making. Additionally, in the event of liquidation, preference shareholders are paid
before common shareholders, but after debt holders. Some preference shares are
convertible, allowing shareholders to exchange their preference shares for common
shares at a later date, and others may be cumulative, meaning any unpaid dividends
accumulate and must be paid out in the future. Overall, preference shares provide a
balance between equity ownership and fixed income-like benefits, making them an
attractive option for investors seeking stability.

Debentures and bonds are both debt instruments issued by companies or

governments to raise capital. When an investor purchases a debenture or bond, they
are essentially lending money to the issuer in exchange for periodic interest
payments (known as the coupon) and the return of the principal amount at maturity.
Debentures are unsecured debt instruments, meaning they are not backed by any
specific asset as collateral. Instead, their repayment is based on the creditworthiness
of the issuer. Bonds, on the other hand, can be either secured or unsecured, but
typically secured bonds are backed by specific assets, providing an added layer of
security for investors.
Both debentures and bonds offer fixed or variable interest rates, but the key
difference is the level of security and the specific terms of repayment. Bonds tend to
be more common in the government sector, while debentures are often issued by
corporations. These instruments are popular among investors seeking steady income
with relatively lower risk compared to equity investments.

The primary market is the segment of the financial market where new securities are
issued and sold for the first time. It is in this market that companies, governments, or
other entities raise capital by issuing new stocks, bonds, or other financial
instruments to the public or institutional investors. The process of issuing these
securities is called an initial public offering (IPO) when it involves stocks, or a new
bond issue when it involves debt securities.
In the primary market, the issuer receives the proceeds from the sale of securities,
which can be used for various purposes such as business expansion, infrastructure
development, or paying off existing debts. Investors purchasing securities in the
primary market do so with the expectation of potential returns in the form of
dividends, interest, or capital gains. Once the securities are issued and sold, they are
then traded in the secondary market. The primary market plays a crucial role in
providing companies with access to capital, helping fuel economic growth and
development.
Features of the Primary Market
1. Initial Issuance: The primary market facilitates the issuance of securities for
the first time, enabling entities to raise fresh capital.
2. Direct Interaction with Issuers: Investors purchase securities directly from the
issuing company or government, unlike in the secondary market where trades
occur among investors.
3. Capital Formation: It plays a vital role in mobilizing savings and channeling
them into productive investments, contributing to economic development.
4. Methods of Issuance: Securities in the primary market are issued through
methods like Initial Public Offerings (IPOs), Follow-on Public Offerings
(FPOs), private placements, or rights issues.
5. Price Determination: The prices of securities are determined by the issuing
company, often based on valuation methods and market demand.
6. Regulatory Oversight: Transactions in the primary market are regulated by
financial authorities like SEBI (in India) to ensure transparency and protect
investor interests.