Financial_Institutions_and_Markets.pdf - M N Financial Institutions and Markets IM S Financial Institutions and Markets N M IM S Financial Institutions

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Unformatted text preview: M N Financial Institutions and Markets IM S Financial Institutions and Markets N M IM S Financial Institutions and Markets COURSE DESIGN COMMITTEE TOC Reviewer Content Reviewer Ms. Manisha Mishra Ms. Manisha Mishra Visiting Faculty, NMIMS Global Access School for Continuing Education Specialization: Wealth Management, Financial Accounting, Banking & Insurance and Business Communication Visiting Faculty, NMIMS Global Access School for Continuing Education Specialization: Wealth Management, Financial Accounting, Banking & Insurance and Business Communication Chief Academic Officer M IM S Dr. Sanjeev Chaturvedi NMIMS Global Access – School for Continuing Education N Author: Sanjive Saxena Reviewed By: Ms. Manisha Mishra Copyright: 2015 Publisher ISBN: 978-93-5119-867-3 Address: 4435/7, Ansari Road, Daryaganj, New Delhi–110002 Only for NMIMS Global Access - School for Continuing Education School Address V. L. Mehta Road, Vile Parle (W), Mumbai – 400 056, India. NMIMS Global Access - School for Continuing Education CONTENTS CHAPTER NAME PAGE NO. 1 Financial System: An Overview 1 2 Regulation in Indian Financial Market – Regulators and their Roles 25 3 Money Market 43 4 Capital Market 63 5 Primary, Secondary and Debt Market 85 Currency Market 109 Institutions in the Financial Market— Banking Institutions 131 Non-banking Financial Institutions (Nbfis) 147 8 9 M IM 7 N 6 S CHAPTER NO. Development Financial Institutions 163 10 Mutual Funds, Insurance and Venture 181 11 International Financial Institutions 205 12 Efficient Market and Market Anomalies 225 13 Risk Management in Financial Institutions 243 14 Case Studies 265 NMIMS Global Access - School for Continuing Education iv F i na nc i a l I ns t i t u t i o n s a n d M a r k e t s c u r r i c u l u m Financial System – An Overview: Introduction to Financial System, Indian Financial System and its Functions, Structure of Indian Financial System and its Segments, International Financial System, International Financial System vs. Indian Financial System, Impact of Liberalisation on Financial Institutions and Markets, Impact of New Initiatives in Indian Financial System M IM S Regulation in Indian Financial Market – Regulators and their Roles: Regulatory Theory, State Intervention in Financial Markets, Regulatory Institutions, Types of Regulatory Institutions (Regulatory, Funding and Mixed), Important Regulators in India and their Functions (RBI, SEBI, IRDA and FMC) Money Market: Money Markets, Indian Money Market, International Money Markets, Money Market Instruments, Treasury Bills, Bills of Exchange, Promissory Notes, Commercial Papers, Certificate of Deposits, Bill Market in India, Issues in Indian Money Market, Unorganised Money Market in India N Capital Market: Capital Market, Roles of Capital Market, Composition and Structure of Indian Capital Market, Scams and Reforms in the Indian Capital Market, Capital Market Instruments, Capital Market Regulation, Control of Capital Issues, Securities and Exchange Board of India, Securities Contracts (Regulation) Act, 1956, Monopolies and Restrictive Trade Practices (MRTP) Act, 1969, Foreign Exchange Regulation Act (FERA), 1973, Foreign Exchange Management Act (FEMA), 1999 Primary, Secondary and Debt Market: Primary Market, Functions of Primary Market, Listing of Securities—Methods of Floatation of New Issues, Operators in Primary Market, Problems of Primary Market, Secondary Market and the National Stock Market System, Trading Mechanism in the Secondary Market, National Stock Market System, Over-the-Counter (OTC) Markets, Depository System, Stock Holding Corporation of India Limited (SHCIL), Stock Exchanges and Their Functions, Stock Exchanges in India, Commodity Exchanges Currency Market: Roles of Foreign Exchange Market, Participants in Foreign Exchange Market, Balance of Trade (BOT) and Balance of Payments (BOP), Monetary Policy and Foreign Exchange, Interest Rate and Exchange Rate, Exchange Rate Dynamics NMIMS Global Access - School for Continuing Education v Institutions in the Financial Market—Banking Institutions: History and Evolution of Banking Institutions in India, Commercial Banking, Functions of Commercial Banking, Services Offered by Banks, Commercial Banking Principles, Concept of Central Banking and India’s Central Bank (RBI), Evolution of Central Banking, Functions of a Central Bank Non-banking Financial Institutions (NBFIs): NBFI– An Introduction, Types of NBFIs, Importance of Industrial Financial Institutions, Major NBFIs in India, Non-banking Financial Companies (NBFCs), Major NBFCs in India, Regulatory Norms of NBFCs M IM S Development Financial Institutions: History and Evolution of Development Financial Institution in India, Importance of DFI in Economy, Land Development: NABARD, Industrial Development: SIDBI, Export and Import Development: EXIM Bank, Housing Development: NHB, New Initiative of GOI: MUDRA Bank N Mutual Funds, Insurance and Venture: Concept and Origin of Mutual Funds, Mutual Funds in India, SEBI Requirements for AMC, Functions and Working of AMC, The Unit Trust of India, Regulatory Structure of Mutual Funds, Concept and Principles of Insurance, Reinsurance, General Insurance, Life Insurance, Concept of Venture Capital, Stages of Venture Capital Financing, Venture Capital in India, Deal Structure, Registration of Venture Capital Fund (VCF), Application for Venture Capital International Financial Institutions: IMF, World Bank, IBRD, IDA, IFC, MIGA, ICSID Efficient Market and Market Anomalies: Efficient Market, Historical Evolution of EMH, Characteristics of Efficient Market, Degree of Efficiency, Tests for Market Efficiency, Market Anomalies, Earnings Announcement, Price/Earnings Ratio, Firm Size Effect, January Effect, Monday Effect, Bubbles, St. Petersburg Paradox, Information Economics Risk Management in Financial Institutions: Risks in Financial Market, Systematic and Unsystematic Risks, Concept of Hedging, Hedging Techniques—Derivatives, Forwards, Futures, Options, Swaps, Basel Norms NMIMS Global Access - School for Continuing Education S M IM N Ch 1 a p t FINANCIAL SYSTEM: AN OVERVIEW S CONTENTS N M IM 1.1 Introduction 1.2 Introduction to Financial System Self Assessment Questions Activity 1.3 Indian Financial System and its Functions 1.3.1 Structure of Indian Financial System and its Segments Self Assessment Questions Activity 1.4 International Financial System Self Assessment Questions Activity 1.5 International Financial System vs. Indian Financial System Self Assessment Questions Activity 1.6 Impact of Liberalisation on Financial Institutions and Markets 1.6.1 Impact of New Initiatives in Indian Financial System Self Assessment Questions Activity 1.7 Summary 1.8 Descriptive Questions 1.9 Answers and Hints 1.10 Suggested Readings for Reference NMIMS Global Access - School for Continuing Education e r 2  Financial Institutions and Markets e Introductory Caselet s SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI) SEBI was established in 1988 as a regulator for the Indian securities market. Prior to this, the Indian economy faced several securities scams, which shook the confidence of Indian investors in the Indian financial framework. For getting that trust back, the Government of India (GOI) felt a need of establishing a statutory body with as intense power to regulate the securities market of India. SEBI performs a number of functions so that the financial system of India can contribute significantly to the growth of the country’s economy. It provides a healthy and amicable financial framework by ensuring the availability of accurate and correct information. This helps issuers to raise finance easily, investors to make right investment decisions and intermediaries to play their roles fairly in any transaction that takes place between issuers and investors. S t M IM o OBJECTIVES OF SEBI The prime objective of SEBI is to protect the interests of investors and promote the development of the stock exchange by regulating the activities of the stock market. The other objectives of SEBI are to: ‰‰ Regulate the functioning of the stock exchange ‰‰ Protect the rights of investors by ensuring safety against their investment N n ‰‰ Prevent fraudulent practices by implementing various rules and regulations ‰‰ Develop a code of conduct for various participants of the financial system that includes companies, brokers and underwriters NMIMS Global Access - School for Continuing Education FINANCIAL SYSTEM: AN OVERVIEW  3 n learning objectives After studying this chapter, you will be able to: Describe the concept of financial system Explain the Indian financial system and its functions Discuss the role of international financial system Distinguish between international financial system and Indian financial system State the impact of liberalisation on financial institutions and markets >> >> >> >> 1.1 INTRODUCTION S >> M IM Financial system refers to the financial framework of an economy that enables lenders and borrowers to exchange funds in a systematic manner. An effective financial system ensures the availability of sufficient funds for economic activities with comparatively low transaction costs. The enhancement of economic activities leads to increased production of goods and services, improved level of national income and enhanced living standards of individuals in a country. N The financial system of a country is divided into various segments such as financial institutions, financial markets, financial instruments and financial services. The efficiency of each segment adds to the efficiency of the whole financial system of an economy. In the globlised today, every economy needs to have an effective financial system in place to come out as an emerging economy. This requires adoption of a more liberalised approach towards the financial framework of an economy. A liberalised financial system helps in attracting international investors, which increases money supply in the domestic economy. The most prominent factor of ensuring the efficiency of the financial system is investors’ confidence that encourages them to spend their savings in financial markets. Such confidence can be fostered if a country has a well-established financial framework that is able to protect the interests of investors. At the same time, the financial framework has to be rigid enough to face all the challenges that could impact its smooth functioning. In this chapter, you learn about the concept of financial system. The chapter explains all the components of financial system in detail. The Indian financial system and international financial system are discussed in detail. In addition, all the major reforms that took place to smoothen the complexities of Indian financial framework are explained in detail. NMIMS Global Access - School for Continuing Education o t e s 4  Financial Institutions and Markets e s 1.2 INTRODUCTION TO FINANCIAL SYSTEM A financial system acts as an intermediary between borrowers and lenders of an economy. The concept of financial system can be defined at different levels, such as organisation-specific level, regional level and global level. At the organisational level, the financial system encompasses all financial activities of an organisation. The financial system at the regional level serves as a platform for exchanging funds between lenders and borrowers. The concept of financial system gets broader when it is discussed at the global level that encompasses financial activities between borrowers, lenders and various financial institutions such as International Monetary Fund (IMF), World Bank, central banks and other major banks of countries. The following are some definitions of financial system: S t In the words of Van Horne, Financial system allocates savings efficiently in an economy to ultimate users either for investment in real assets or for consumption. M IM o According to Prasanna Chandra, financial system consists of a variety of institutions, markets and instruments related in a systematic manner and provide the principal means by which savings are transformed into investments. The prime motive behind the functioning of a financial system is to move funds across the economy. Funds are moved from sectors having surplus funds to sectors having the shortage of funds. Thus, it can be said that a financial system acts like a gateway that channelises the flow of funds. The following points explain the importance of a financial system: N n ‰‰ A financial system creates a link between borrowers and lenders by mobilising funds from one sector (having surplus) to others (having a shortage). ‰‰ It acts as a tool to monitor the performance of an organisation. For instance, a company that is able to manage funds easily is certainly the one that gains the trust of investors. This further boosts the market image of that particular company. ‰‰ A financial system provides a platform that facilitates the investment process. Investors can put in their money by purchasing various kinds of securities such as shares, debentures and fixed deposit as per their convenience. From the discussion so far, it can be said that the financial system plays a crucial role in maintaining the health of an economy by facilitating the movement of funds. Apart from this, the following are some other functions of an economy: ‰‰ Reducing information cost: Rational investment decision making largely depends on accurate and timely information related to the financial system. NMIMS Global Access - School for Continuing Education FINANCIAL SYSTEM: AN OVERVIEW  5 n The financial system creates a platform where the various types of information related to different securities can be disseminated at a lower cost. High information cost may obstruct the smooth flow of funds to the most productive use. Without financial system, the investment-related information can be difficult to access at lower cost. For instance, in the absence of financial intermediaries, every investor needs to incur a huge cost to obtain information for evaluating the worth of an investment proposal. ‰‰ Lowering transaction cost: A large number of transactions take place in the financial system on a day-to-day basis. A certain cost is associated with each transaction for its processing. A large number of transactions by financial intermediaries help them to achieve economies of scale, thereby reducing transaction costs. trade activities: The financial system smoothens trade-related activities by ensuring the availability of adequate funds across the economy. and managing risk: There are a number of securities available in the financial system. An investor can diversify his/ her risk by investing in more than one security. ‰‰ Maintaining M IM ‰‰ Diversifying S ‰‰ Facilitating liquidity: The most important function of a financial system is to maintain enough money for the production of goods and services. A business firm needs adequate finance for long and short-term purposes. Finance raised by a firm for long term is called capital, while finance raised for short term is called working capital. The financial system ensures liquidity across business firms by providing them capital and working capital. financial framework: It is the duty of a financial system to regulate the functioning of the financial framework of an economy by introducing standardised rules and instruments (securities). N ‰‰ Regulating self assessment Questions 1. A financial system smoothens trade-related activities by ensuring the availability of adequate funds across the economy. (True/False) 2. A ________ provides a platform that facilitates the investment process. Investors can put in their money by purchasing various kinds of securities such as shares, debentures and fixed deposit as per their convenience. Activity With the help of the Internet, collect information on how the financial system helps in reducing the transaction and information costs. Prepare a report based on your findings. NMIMS Global Access - School for Continuing Education o t e s 6  Financial Institutions and Markets e s 1.3 INDIAN FINANCIAL SYSTEM AND ITS FUNCTIONS As already discussed, the prime function of a financial system is to mobilise the savings of individuals so that capital formation can take place in an economy. The Indian financial system works on the same principle and ensures the smooth flow of money across the Indian economy. In the post-liberalisation era (after 1991), India came out as an open economy as it allowed the flow of money across the country with comparatively lesser restrictions. This resulted in the enhanced flow of foreign capital into the Indian economy, which further increased various dynamics and complexities in the Indian financial market. Now, let us discuss the structure of the Indian financial system. 1.3.1 STRUCTURE OF INDIAN FINANCIAL SYSTEM AND ITS SEGMENTS S t The Indian financial system is considered to be a complex system as it involves a large number of participants dealing in various financial instruments and services. The structure of the Indian financial system is shown in Figure 1.1: M IM o N n Financial Institutions Indian Financial System Financial Markets Financial Instruments Financial Services Figure 1.1: Structure of the Financial System of India Let us discuss the structure and segments of the Indian financial system in the next sections. FINANCIAL INSTITUTIONS A financial institution refers to an intermediary that mobilises savings done by one section of an economy and allocates that to another section of the economy requiring funds for accomplishing economic activities. The following are some major financial institutions: ‰‰ Regulatory and promotional institutions: Like any other system, the financial system also needs regulatory authorities to make rules and guidelines for governing the financial framework of an economy. In India, there are many regulatory bodies that are responsible for managing the activities of financial institutions and markets and the issuing of financial instruments and services. NMIMS Global Access - School for Continuing Education FINANCIAL SYSTEM: AN OVERVIEW  7 n These bodies are the Ministry of Finance of India, Company Law Board, Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Insurance Regulatory and Development Authority (IRDA), Department of Economic Affairs, Department of Company Affairs, etc. Out of these bodies, two prime regulators of the Indian financial system are RBI and SEBI. They are responsible for administering, legislating, supervising, monitoring and controlling the financial system. All financial institutions in India are governed by RBI, whereas financial markets are under the control of SEBI. institutions: Banking institutions ensure the mobilisation of the savings of people. They accumulate the savings of one sector of an economy and provide credit to another section of the economy. The banking sector can be classified into three categories—commercial banks, co-operative banks and developmental banks. Banking institutions accumulate the savings of individuals and provide a wide range of financial services like bank accounts, loans, D-MAT accounts, mutual funds, etc. M IM S ‰‰ Banking It is a financial institution that is not regulated under any banking regulatory agency. Services provided by NBFIs include credit facilities, retirement planning, money markets, underwriting and merger activities. The examples of NBFIs include insurance firms, cashier’s check issuers and microloan organisations. The major NBFIs in India include Unit Trust of India (UTI), General Insurance Company of India (GIC) and Life Insurance Corporation (LIC). N ‰‰ Non-Banking Financial Institutions (NBFIs): FINANCIAL MARKETS The term market refers to a place where interaction between the buyers and sellers of a certain good or service takes place. A financial market is a place where people make transactions of financial se...
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