Finance

The term "finance" in our simple understanding it is perceived as equivalent to 'Money'. We read about Money and banking in Economics, about Monetary Theory and Practice and about "Public Finance". But finance exactly is not money, it is the source of providing funds for a particular activity. Thus public finance does not mean the money with the Government, but it refers to sources of raising revenue for the activities and functions of a Government.

Indian Financial System

The Indian financial system comprises a set of financial institutions, financial markets and financial infrastructure. Moreover, the economic development of a nation is reflected by the progress of the various economic units, broadly classified into corporate sector, government and household sector. While performing their activities these units will be placed in a surplus/deficit/balanced budgetary situations. There are areas or people with surplus funds and there are those with a deficit. A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the areas of deficit. A Financial System is a composition of various institutions, markets, regulations and laws, practices, money manager, analysts, transactions and claims and liabilities.

Flow of Financial System

Financial System
The word "system", in the term "financial system", implies a set of complex and closely connected or interlined institutions, agents, practices, markets, transactions, claims, and liabilities in the economy. The financial system is concerned about money, credit and financethe three terms are intimately related yet are somewhat different from each other. The activities include production, distribution, exchange and holding of financial assets of different kinds by financial institutions, banks and other intermediaries of the market. In nutshell, financial market, financial assets, financial services and financial institutions constitute the financial system.

Structure of Financial System

Syste
Broadly, organizational structure of financial system includes of the following three components
Financial Markets Financial Institutions & Intermediaries Financial Products

Financial Markets
A Financial Market can be defined as the market in which financial assets are created or transferred. As against a real transaction that involves exchange of money for real goods or services, a financial transaction involves creation or transfer of a financial asset. Financial Assets or Financial Instruments represents a claim to the payment of a sum of money sometime in the future and /or periodic payment in the form of

Continued.
Money Market - The money market is a wholesale debt

market for low-risk, highly-liquid, short-term instrument. Funds are available in this market for periods ranging from a single day up to a year. This market is dominated mostly by government, banks and financial institutions. Capital Market - The capital market is designed to finance the long-term investments. The transactions taking place in this market will be for periods over a year. Forex Market - The Forex market deals with the multicurrency requirements, which are met by the exchange of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes place in this market. This is one of the most developed and integrated market across the globe. Credit Market - Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term loans to corporate and individuals.

Continued.
The Securities market has again classified into TWO interdependent and inseparable segments; they are
Primary Market: It is also termed as New Issue

Market, provides channel for sale of new securities.

Secondary Market: It is a platform for

purchase and sale of securities by investors. Securities previously issued are dealt in secondary market

Constituents of a Financial System

Financial Institutions & Intermediaries

Having designed the instrument, the issuer should then ensure that these financial assets reach the ultimate investor in order to garner the requisite amount. When the borrower of funds approaches the financial market to raise funds, mere issue of securities will not suffice. Adequate information of the issue, issuer and the security should be passed on to take place. There should be a proper channel within the financial system to ensure such transfer. To serve this purpose, Financial intermediaries

Continued.
This service was offered by banks, FIs, brokers, and dealers. However, as the financial system widened along with the developments taking place in the financial markets, the scope of its operations also widened. Some of the important intermediaries operating ink the financial markets include; investment bankers, underwriters, stock exchanges, registrars, depositories, custodians, portfolio managers, mutual funds, financial advertisers financial consultants, primary dealers, satellite dealers, self regulatory

Continued..
Financial Institutions are broadly classified into FOUR categories; they are
Development Financial Institutions:

National Level Banks - IDBI, IFCI, ICICI, SIDBI. Regional Level Banks SFC, SIDC.
Commercial Banks Public, Private & Foreign Non Banking Financial Companies Loans, Venture

Capital, Leasing, Hire purchase, Housing, M & A etc.

Insurance Organization LIC & GIC

GIC has four subsidiaries i.e. National Insurance, New India Assurance Co. Ltd. United India Assurance Company Limited & Oriental Insurance.

Financial Products
The Indian financial system witnessed a significant growth in new financial instruments. The attraction of the instruments for both the corporate sector and the investor lies in that on one hand investor gets a reasonable return and issuer gets credit on reasonable terms. A wide instruments are available in Indian financial markets.

Market Regulation
The legislative framework before SEBI came into being consisted of three major Acts governing the capital markets;
Capital Issues (Control) Act, 1947 Companies Act, 1956 Securities Contracts (Regulation) Act, 1956 Public Debt Act, 1942 Income Tax Act, 1961 Banking Regulation Act, 1949

Capital Issues (Control) Act 1947

Governments

approval is mandatory companies to tapping household savings

for

Modification in regulation from time to time for

raising capital for national resources.

Central Government determine the amount, types

and price of the issue.

Cancelled and Replaced by SEBI Act in 1992

Companies Act 1956

All aspects of Company from Formation to Winding Up Deals with New issue, Allotments and transfer of securities and various

aspects relating to Company management. Standard Disclosure to Public , Investors Community to avoid risk factor. Regulates Underwriters in Premium, Discount, Bonus Issue, Right Issue, Payment of Dividends, Supply of Annual Reports and other Information to Companies Drawbacks Split into various agencies and their provisions scattered into number of status Inefficiency in enforcement of Regulations. Not allocated the resources to the best possible investments, leads to low allocational Efficiency Informational Efficiency was low to investors to make their decision regarding details of prospectus, adequate and accurate information . Due to this SEBI framed regulations and guidelines to improve efficiency of markets, enhance transparency, check unfair trade practices and

Securities Contract (Regulation) Act 1956

Stock

Exchanges, through a process of recognition and continued supervision Contracts in Securities Listing of securities on Stock exchanges The Regulatory jurisdiction on stock exchanges was passed over to SEBI on enactment of SEBI Act in 1992 from Central Government by amending SC(R) Act.

 Practice of resource allocation among different

Securities Exchange Board of India

competing entities was discontinued. Secondary market overcame the geographical barriers by moving to screen-based trading. Traders enjoy counterparty guarantee. Physical security certificate have almost disappeared. Settlement period has shortened to two days. Some of the other following major principal reforms measures undertaken since 1992 and they are discussed below; they are

Continued.
Repeal of the Capital Issue (Control) Act 1947 was ceased

away in May 1992. Capital Issue (Control) Act was abolished and the market was allowed to allocate resources to competing uses & users Indian companies were allowed access to international capital market through issue of ADR, GDR. To ensure effective regulation, of the market SEBI Act was enacted as Statutory powers

Protecting the interest of investors Promoting the development of the Indian Securities market Regulating the securities market.

Regulatory jurisdiction extends over corporate in issue of

capital and extended to securities. SEBI can specify the matters to be disclosed and standard disclosed required for investors protection.

Continued.
SEBI has the full right to direct the intermediaries and

other persons associated with the securities market; they are

Development of securities market Conduct of any Inquiries Audits and Inspection of all concerned with arbitrate activities.

In short, it has given necessary autonomy and authority to regulate and develop an orderly securities market In the year Depository Act, 1996 is also administered by SEBI A high level committee on capital markets has

Guidelines for Disclosure & Investor Protection

High Standards of Integrity and fair dealing, comply with

all the requirements with due skill, diligence & Care and disclose the whole truth.
Fuller disclosure of relevant information about the issue

and nature of securities, so that investor can take informed decision.

SEBI has placed a responsibility on the lead managers to

give a due diligence certificate about the Pros & Cons of prospectus.
SEBI has raised standards of disclosures in public issue to

enhance the level of investors protection

Improved Disclosures by Listed Companies

Improved the availability of timely information. Information

technology helps to disseminate the information about listed companies and market intermediaries.

Equity Research & Credit rating has improved the

quality of information.
SEBI recently started a system for Electronic Data

Information Filing and Retrieval System (EDIFAR) to facilitate electronic filing of public domain information by companies

Functions of Good Financial System

Regulation of Currency Banking Functions Performance of agency services & Custody of Cash

Reserves Management of National Reserves of International Currency Credit Control Administering National, fiscal and Monetary Policy to ensure stability of the economy Supply and Deployment of funds for productive use Maintaining Liquidity

Long Term Growth of Financial Markets

Education of Investors Giving autonomy to Foreign Investors to become

efficient under competition

Consolidation through Mergers Facilitating entry of new institutions to add depth

to the market
Minimizing

Regulatory Measures and Market Segmentation

Financial System & Economic Development

Indian financial system is of critical importance for the

global economy and its financial markets. Instability of interest rates, currency values, and stock index prices represent great headaches for financial planners and forecasters. Central purpose of Indian financial system is to support healthy competition, capital formation, and new product development. Creating a wide collection of new savings instruments, Indian financial system encourage the mobilization of savings and provide a rich variety of risk repackaging services, increasing the flow of funds between savers and investors, and simulating the growth of financial intermediation services.

Financial Sector Reforms in India

November 1992 April 1993 June 1994 March 1995 April 1995

NSE came into Incorporation Recognition as a stock exchange Wholesale Debt Market segment goes live Establishment of Investor Grievance Cell Establishment of NSCCL, first Clearing Became largest stock exchange in the Commencement of clearing and settlement by Launch of S&P CNX Nifty Commencement of trading/settlement in DEMAT Launch of CNX Nifty Junior

Corporation October 1995 country April 1996 NSCCL April 1996 December 1996 A/c December 1996

Introduction to Derivatives
Derivatives is a product whose value is derived from the value of one or more basic variables, called bases in a contractual manner. All Derivatives are based on some Cash products. The underlying asset can be Equities. Commodities. Foreign Exchange and Bonds of Different types (Short & Long Term).

Derivatives Market in India

The first step towards introduction of derivatives trading in the Indian financial markets was the promulgation of the Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on options in securities. The market for derivatives, however, did not take off, as there was no regulatory framework to govern trading of derivatives. SEBI set up a 24 member committee under the chairmanship of Dr. L.C.Gupta on November 18, 1996 to develop appropriate regulatory framework for derivatives trading in India. The committee submitted its report on March 17, 1998 prescribing necessary pre-conditions for introduction of derivatives trading in India. The committee recommended that derivatives should be declared as securities so that regulatory framework applicable to trading of securities could also govern trading of securities. SEBI also set up a group in June 1998 under the Chairmanship of Prof. J. R. Varma, to recommend measures for risk containment in derivatives market in India. The report, which was submitted in October 1998, worked out the operational details of margining system, methodology for charging initial margins, broker net worth, deposit

Arguments for Derivatives

In India, derivatives were introduced mainly with a view to curb the increasing volatility of the asset prices in financial markets and to provide sophisticated risk management tools leading to higher returns by reducing risk and transaction costs as compared to individual financial assets. Derivative products serve the vitally important economic functions of price discovery and risk management. The transparency, which emerges from their trading mechanism, ensures the price discovery in the underlying market. Further, they serve as risk management tools by transmitting risk among market

Continued
Efficient Market Hypothesis argues that in an efficient

market new information that is arriving to the market are quickly processed and instantaneously reflect in the securities prices and hence it is not possible to make abnormal profit by formulating strategies based on information asymmetry. In reality, stock markets are not efficient and also there exist wide variations between futures market and the spot markets in terms of transacting cost, margin requirements, trading frequencies, regulations, etc. Moreover, it is quite often that one market leads the other for its efficiency to reflect new information.

Derivative Market Milestones

The trading in Index Options was commenced in June 2001 and the trading in

Options on individual securities commenced in July 2001. Futures contracts on individual stocks were launched in November 2001 Interest Rate Futures trading commenced in March 2003. NSE introduced trading in futures and option contracts for CNX - IT index and CNX Bank Nifty Index in 29th August, 2003 & 1st June, 2005 respectively. 1st June 2007 NSE launched its trading on futures and options was extended to the indices on CNX 100 and CNX Nifty Junior. Mini derivatives Contracts on Nifty was launched in January 2008. Long Term Option contracts on S & P CNX Nifty Index was launched in March 2008. Launch of Currency Derivatives and Interest Rate Futures in the month of August 2008 & 2009, respectively.