Indian Financial System

FINANCIAL MANAGEMENT ASSIGNMENT ON INDIAN FINANCIAL SYSTEM

The financial system in india refers to the system of borrowing and lending of funds or the demand for and the supply of funds of all individuals, institutions, companies and of the government.

Commonly the Indian financial system is classified into:

1. Industrial finance: funds required for the conduct of industry and trade
2. Agricultural finance: funds needed and supplied for the conduct of agriculture and allied activity
3. Development finance: funds needed for development; actually it includes both industrial finance and agricultural finance
4. Government finance: relates to the demand for a nd supply of funds to meet government expenditure

The mobilization of savings and the effective distribution of the savings among all those who demand the funds for investment purposes. The banking system, the insurance companies, mutual funds, investment funds and other institutions which promote savings among the public, collect their savings and transfer them to the actual investors

The investor in the country composed of individuals investors, industrial investors, industrial and trading companies and the government, these enters in the financial system as borrowers.

Functions Of Indian Financial System

The Indian financial system performs a crucial role in economic development of india through saving investment process also known as capital formation. Sometimes it is also calls financial market.

The purpose of financial market is to mobile savings efficiently and allocates the same efficiency among the ultimate users of funds, ie:

1. Increase in savings, that is resources that are would have been normally used for consumption purposes should be released for other purposes.
2. Mobilization of savings – domestic savings collected by banking and financial institutions and placed at disposal of actual investors; and
3. Investment proper, which is the production of capital goods.

Composition Of The Indian Financial System

The Indian money market is the market in which short term funds are borrowed and lent. The capital market in india on the other hand, is the market for medium- term and long term funds. Reserve bank of india Organized sector Sub Market Unorganized sector Public sector banks Private sector banks NBFC IDFC, GIC, LIC Call money T- Bills Certificate for Deposit Commercial Papers

Short Term And Long Term Funds Shares

Shares comes in the Long term funds. A share is a unit of capital of the company. It has a definite face value. It represents ownership rights of their holders. Buyers of shares are called shareholder and they are legal owners of the firm whose shares they hold.

Each shareholder invest their money in the shares of a company in exception of a return on their investment capital. The return of shareholder consists of dividend and capital gain. Share holder make capital gain or (loss) by selling their share. Each share carries a distinct number. Shares are transferable units. Shareholders are of two type Ordinary and Preference shareholders. Preference share: These shares have preference over the ordinary shares in terms of payment of dividend and repayment of capital if company is wound up. They may be issued with or without a maturity period.

Redeemable preference share are shares with maturity and irredeemable preference shares without any maturity. The holder of preference shares get dividend at a fixed rate. With regards to dividend, preference shares may be issued with or without cumulative features. In the case of cumulative preference shares unpaid dividends accumulate and are payable in the future. Dividends in arrears do not accumulate in the case of non cumulative preference shares. Features of preference share claim on income and assets: preference share is a senior security as compared to ordinary share.

It has a prior claim on the company’s income in the sense that the company must first pay preference share dividend before paying the ordinary dividend. Fixed dividend: The dividend rate are fixed in the case of preferences share, and preference dividend are not tax deductable. Cumulative dividend: that all past unpaid dividend be paid before the ordinary dividends are paid. Ordinary Shares: represents the ownership position in a company. The holders of ordinary shares called shareholders are the legal owners of the company. Ordinary shares are the sources of permanent capital since they do not have a maturity date.

However, the ordinay shareholders are entitled to receive dividends. The amount or rate of dividends are not fixed. An ordinary share is called variable income security. Being the owner the company, shareholders bear the risk of ownership; they are entitled to dividends after the income claims of others have been satisfied. Similarly, when the company is wound up, they can exercise their claim on assets after the claims of other suppliers of capital have been met. Features of Ordinary shares: Claims on income: Ordinary shareholders have a residual ownership claim.

They have a claim to the residual income, which is earnings available for ordinary shareholder after paying expenses, interest charges, taxes and preference dividend. Claim on asset: Ordinary shareholder have residual claim on company asset in case of liquidation. Voting rights: Ordinary shareholder are required to vote on a number of important matters. The most significant proposals include: election of directors and change in memorandum of association.

Rights Issue

When company distributes all earnings to shareholders, then, it can reacquire new capital from the same sources by issuing new shares called rights shares.

Bonds

A bond is a long term debt instrument or security. Bonds issued by the government do not have any risk of defaults. The private sector companies also issue bonds, which are called debentures. A company can issue secured and unsecured debenture. In case of bonds and debentures, the rate of interest is generally fixed and known to investors.

Features of Bonds

1. Face value is the par value. A bond is generally issued at a par value of Rs:100 or Rs:1000, and interest in paid on face value.
2. Interest rate is fixed and known to bondholders.
3. Interest paid on a bond is tax deductable.
4. Interest rate is called coupon rate.
5. Maturity bond is generally issued for a specified period of time. It is repaid on maturity.
6. Redemption value The value that a bondholder will get on maturity is called redemption or maturity value. A bond may be redeemed at par or at premium or at discount.
7. Market value A bond may be traded in a stock exchange. The price at which it is currently sold or bought is called the market value of the bond. Market value may be different from par value or redemption value.

Bonds may be classified into three (1) Bond with maturity (2) Pure discount bonds (3) Perpetual bonds Bond with maturity The companies issue bonds that specify the interest rate and the maturity period. Pure discount bonds These bonds do not carry an explicit rate of interest. It provides for the payment lump sum amount at a future date in exchange for the current price of bond. Perpetual bonds These bonds are also consols, has an indefinite life and therefore, it has no maturity value.

Types of Debentures

1. Convertible debenture (CD)
2. Non convertible debenture (NCD)
3. Fully convertible debenture (FCD)
4. Partly convertible debenture (PCD)

Warrants

A warrant entitles the purchaser to buy a fixed number of ordinary shares at a particular price during a specified time period. Warrants are generally issued along with debentures as sweeteners. Warrants are used in conjunction with ordinary or preference shares. Characteristics of Warrants Exercise price of a warrant is the price at which its holder can purchase the issuing firms ordinary shares. Exercise ratio states the number of ordinary shares that can be purchased at the exercise per warrants. Expiration date is the date when the option to buy ordinary shares in exchange of warrants expires.

It is the market for lending and borrowing short term surplus investible funds of banks and other financial institution are demanded by borrowers comprising individual companies and the government. The composition of Indian money market consist of Call money market One important submarket of the Indian money market is the Call money market, which is the market for very short term funds. This market is also known as money at call and short notice. This market has two segments (a) the call market or overnight market and (b) short notice market. The rate at which unds are borrowed and lent in this market is called the call money market. Call money rates are market determined by demand and supply of short term funds. The public sector banks account for about 80% for the demand and foreign banks and Indian private sector banks account for the balance of 20% of borrowings. NBFC’s like IDBI, GIC, LIC are call money market lenders. Bill market in India The bill market ir the discount market is the most important part of the money market where short bills normally up to 90days are bought and sold. The bill market is further subdivided into commercial bill market and treasury bill market.

The 91 day treasury bills are the most common ways the government of india raises funds for the short period. Government has also introduced the 182 day T-Bills and 364 day T-bills, In 1997 government introduced 14 day T-Bill. Dated government securities The government of india has also decided to sell dated securities on an auction basis. The purpose of this government decision is:

1. To develop dated securities as a monetary instrument with flexible yields
2. To provide financial instrument to suit investors expectation, and
3. To meet Government needs directly from the market.

Repo and reverse repos Repos are now a regular feature of RBI’s market operations, If the banking system experience liquidity shortage, then RBI comes to assist banking system by repurchasing government securities. When the government securities are repurchased from the market, payment is made by RBI to commercial banks and this adds to their liquidity and enables them to expand their credit to industry and trade. Reverse repo is to sell dated securities through auction at fixed cut off rate of interest.

The objective is to provide short term avenue to banks to park their surplus funds. Certificate of Deposits (CD) The CD’s are another important money market instrument. They were issued by banks in multiples of Rs:25 lakhs to expand the investor base of CD’s, the min: value was reduced and is presently Rs: 1 lakhs. The maturity is between 3 months and one year. CD ‘s are freely transferable after 45 days after the date of issue. CD’s became immediately popular with banks for raising resources at competitive rates of interest.