FOFA-2

1. Financial Institutions and Market

Structure, Growth and Innovation

Nature and Role of Financial

System
Chapter1
 Probability
Mathematics
theory

Financial Statistical
accounting theory

Economics Finance Psychology

FINANCE IS . . .
analytical, using statistical, probability, and mathematics to solve
problems.
based on economic principles.
uses accounting information as inputs to decision-making.
global in perspective.
the study of how to raise money and invest it productively.
 Capital markets
and capital
market theory

Financial Investment
management management

Three areas are all intertwined, based on

a common set of theories and principles.
 Those who have money
Those who need money
• The economic development of any nation is reflected by the
progress of the various economic units, broadly classified into
corporate sector, government and household sector.
• There are units or people with surplus funds and there are
those with a deficit. People from the areas of surplus provide
funds to the areas of deficit.
IDEA SEEKS TO CAPITALISE ON MARKET MOMENTUM

With the explosive growth of their subscriber base, telecom companies are all looking at
capital markets to raise funds to fuel their expansion plan. Idea Cellular, the fifth largest
operator in the country and the flagship telecom venture of AV Birla Group, has decided to
enter the capital market to raise between Rs. 1,700 and Rs. 2,000 crore.

The company has appointed J.M. Morgan Stanley, Merrill Lynch among other as book-
runners for the proposed Initial Public Offer (IPO), which is expected to be ready by
January end.

Since, under SEBI norms, the minimum float size is 10 per cent, the company will divest
between 10 and 12 per cent, “The last private placement made by the promoters is
at a market capitalisation of Rs. 15,000 crore. The proposed float is expected to be at 10 to
20 per cent premium of the private placement price,” AV Birla Group recently divested 35
per cent stake in the company to a clutch of private equity firms.

However, this is a fresh issue of shares, where the proceeds will be utilised by Ideal Cellular
for capital expenditure. After the proposed issues, the promoters stake will come
down to around 58 per cent.
Source: www.hindustantimes.com
 Financial Institutions and Markets
LM Bhole and Jitendra Mahakud
1. Financial intermediation and Financial system
2. Banks
3. Non banking Institutions
4. Market Instruments
5. Futures
6. Foreign Exchange
7. Interest rates
Financial Institutions and Market
Structure, Growth and Innovation

Chapter 1

Nature and Role of Financial System

7
 Financial System
• Enhances
1. the rate of capital formation,
2. efficiency of the function of medium of
exchange
3. and facilitate allocation of resources across
space and time in an uncertain environment
 Structure of Financial System

• Financial System : Money, Credit , Finance

– Money: medium of exchange
– Credit: money to be returned with interest
– Finance: monetary resource: equity and debt
• The Structure of Financial system consists of :
• specialised & non-specialised financial institutions
• organised and unorganised financial markets
• financial instruments and services which facilitates
transfer of funds
 Financial assets and Instruments
• A financial asset is an intangible asset that
derives value because of a contractual claim.
– Examples include bank deposits, bonds, and stocks.
Financial assets are usually more liquid than tangible
assets, such as land or real estate, and are traded
on financial markets.
• A financial instrument is a tradable asset of any
kind; either cash, evidence of an ownership
interest in an entity, or a contractual right to
receive or deliver cash or another financial
instrument.
– it is defined as "any contract that gives rise to a
financial asset of one entity and a financial liability or
equity instrument of another entity"
 Characteristics of Financial assets
• Investment characteristics of Financial assets
• Liquidity • Maturity period
• Marketability • Tax status
• Reversibility • Buy-back options
• Transferability • Volatility of prices
• Transaction costs • Rate of return
• Risk of default
 Financial Institutions
• Banks, securities firms, and insurance companies are
examples of financial institutions.
• Securities Firm is a company that facilitates financial
market trades between buyers and sellers for a fee.
• Includes firms whose principal lines of business are in
securities brokerage, financial advisory services,
investment banking and/or securities trading.
Structure of Indian Financial System
 Functions of financial market
1. Mobilization of Savings and Channeling them
into the most Productive Uses
2. Provide Liquidity to Financial Assets
3. Reduce the Cost of Transactions
4. Facilitate Price Discovery
 Money market
• The money market is a market for short term funds
which deals in monetary assets whose period of
maturity is up to one year.
• These assets are close substitutes for money.
• It is a market where low risk, unsecured and short term
debt instruments that are highly liquid are issued and
actively traded everyday
• It enables the raising of short-term funds for meeting
the temporary shortages of cash and obligations and
the temporary deployment of excess funds for earning
returns.
• The major participants in the market are the Reserve
Bank of India
 Equilibrium in Financial Markets
• Equilibrium is established when the expected demand
for funds (credit) for short-term & long-term
investment matches with the planned supply of funds
generated out of savings and credit creation.
(Figure A,B &C )

• Interest rate can also be fixed irrespective of the equilibrium

rate of interest i.e. Administered Interest rate (Figure D) in
order to match/adjust supply and demand for funds as per
economic policy requirement
contd...
 Financial Sector & Economic Development

Theories on the impact of financial development on savings and

investment :

The classical prior voluntary

savings theory

 Forced saving or Inflationary

Financing theory

Financial Repression theory

Financial Liberalisation theory

18
 contd...

• The role of financial system in the growth

process : to reduce the cost of accumulating
capital.

 Policy makers should align private incentives with public

interest in such a way that the scrutiny of financial institutions by
supervisors is supported by supervision of market participants :
Market-aware regulation
 Fundamental Questions
 Whether institutions find the most productive investment?
 Do institutions revalue their assets & liabilities in response to
changed circumstances?
 Whether Institutions facilitate the management of risk?
 Whether financial institutions transparent in communication?
 How effective is the regulatory and supervisory system?
 Do investors and financial institutions learn from past
mistakes?
Concepts : Financial Development
 Efficiency a. Information Arbitrage
b. Fundamental Valuation Efficiency
c. Full Insurance Efficiency
d. Operational Efficiency
e. Allocation Efficiency

 Financial Innovations
 Financial Engineering
 Financial Revolution
 Diversification
 Financial Repression
 Financial Integration
 Securitisation
 Braod,Wide,Deep and shallow market