FINANCIAL MARKET• A financial market is a market in which people and entities can trade financial

securities, commodities, and other items of value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and

bonds, and commodities include precious metals or agricultural goods.• Financial markets facilitate:• The raising of capital (in the capital markets)

• The transfer of risk (in the derivatives markets)

• Price discovery

• Global transactions with integration of financial markets

• The transfer of liquidity (in the money markets)

• International trade (in the currency markets)

Types of financial markets• Capital markets which consist of:

– Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.

– Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.

• Commodity markets, which facilitate the trading of commodities.• Money markets, which provide short term debt financing and

investment.• Derivatives markets, which provide instruments for the

management of financial risk.• Futures markets, which provide standardized forward contracts for

trading products at some future date; see also forward market.• Insurance markets, which facilitate the redistribution of various

risks.• Foreign exchange markets, which facilitate the trading of foreign

exchange.

CONSTITUENTS OF A FINANCIAL SYSTEM

FINANCIAL INSTRUMENTS

Money Market Instruments

• The money market can be defined as a market for short-term money and financial assets that are near substitutes for money. The term short-term means generally a period up to one year and near substitutes to money is used to denote any financial asset which can be quickly converted into money with minimum transaction cost.Some of the important money market instruments are briefly discussed below; 1. Call/Notice Money2. Treasury Bills3. Term Money4. Certificate of Deposit5. Commercial Papers

Call /Notice-Money Market

• Call/Notice money is the money borrowed or lent on demand for a very short period. When money is borrowed or lent for a day, it is known as Call (Overnight) Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus money, borrowed on a day and repaid on the next working day, (irrespective of the number of intervening holidays) is "Call Money". When money is borrowed or lent for more than a day and up to 14 days, it is "Notice Money". No collateral security is required to cover these transactions.

Treasury Bills.

• Treasury Bills are short term (up to one year) borrowing instruments of the union government. It is an IOU of the Government. It is a promise by the Government to pay a stated sum after expiry of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder. The rate of discount and the corresponding issue price are determined at each auction.

• Inter-bank market for deposits of maturity beyond 14 days is referred to as the term money market. The entry restrictions are the same as those for Call/Notice Money except that, as per existing regulations, the specified entities are not allowed to lend beyond 14 days.

• Certificates of Deposit (CDs) is a negotiable money market instrument and issued in dematerialized form or as a Usance Promissory Note, for funds deposited at a bank or other eligible financial institution for a specified time period. Guidelines for issue of CDs are presently governed by various directives issued by the Reserve Bank of India, as amended from time to time.

• CDs can be issued by • (i) scheduled commercial banks excluding Regional Rural Banks (RRBs)

and Local Area Banks (LABs); and • (ii) select all-India Financial Institutions that have been permitted by

RBI to raise short-term resources within the umbrella limit fixed by RBI. Banks have the freedom to issue CDs depending on their requirements. An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue of CD together with other instruments viz., term money, term deposits, commercial papers and inter corporate deposits should not exceed 100 per cent of its net owned funds, as per the latest audited balance sheet.

• CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper the debt obligation is transformed into an instrument. CP is thus an unsecured promissory note privately placed with investors at a discount rate to face value determined by market forces. CP is freely negotiable by endorsement and delivery.

• A company shall be eligible to issue CP provided - (a) the tangible net worth of the company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the working capital (fund-based) limit of the company from the banking system is not less than Rs.4 crore and (c) the borrowal account of the company is classified as a Standard Asset by the financing bank/s.

• The minimum maturity period of CP is 7 days. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies.

• The capital market generally consists of the following long term period i.e., more than one year period, financial instruments;

In the equity segment:• Equity shares &preference shares: Equity shares are those shares which are ordinary in the

course of company's business. They are also called as ordinary shares.

• Convertible preference shares,

• non-convertible preference shares etc

and in the debt segment

• debentures,

• zero coupon bonds,

• deep discount bonds etc.

• Hybrid instruments have both the features of equity and debenture. This kind of instruments is called as hybrid instruments. Examples are convertible debentures, warrants etc.

Reserve Bank of India (RBI) is the central bank of India. It monitors, formulates and implements India’s monetary policy. Established in the year 1935, RBI was nationalized in the year 1949. Owned fully by the Government of India, Reserve Bank has 22 regional offices in various state capitals of India with its headquarters located in Mumbai. It has a majority stake in the State Bank of India.

Banker to the Government - RBI acts as banker, both to the central government and state governments. It manages all the banking transactions of the government involving the receipt and payment of money. In addition, RBI remits exchange and performs other banking operations. RBI provides short-term credit to the central government. RBI also manages all new issues of government loans, servicing the government debt outstanding, and nurturing the market for governments securities.

Managing Government Securities - Various financial institutions such as commercial banks are required by law to invest specified minimum proportions of their total assets/liabilities in government securities. RBI administers these investments of institutions. The other responsibilities of RBI regarding these securities are to ensure -

Smooth functioning of the marketReadily available to potential buyersEasily available in large numbersUndisturbed maturity-structure of interest rates because of excess or deficit supplyNot subject to quick and huge fluctuationsReasonable liquidity of investmentsGood reception of the new issues of government loans.

Banker to Other BanksThe role of RBI as a banker to other banks is as follows: Holds some of the cash reserves of banksLends funds for short periodProvides centralized clearing and quick remittance facilitiesRBI has the authority to statutorily ensure that the scheduled commercial banks deposit a stipulated ratio of their total net liabilities. This ratio is known as cash reserve ratio [CRR]. However, banks can use these deposits to meet their temporary requirements for interbank clearing as the maintenance of CRR is calculated based on the average balance over a period.

Controller of Money Supply and Credit - In a planned economy, the central bank plays an important role in controlling the paper currency system and inflationary tendency. RBI has to regulate the claims of competing banks on money supply and credit. RBI also needs to meet the credit requirements of the rest of the banking system. RBI needs to ensure promotion of maximum output, and maintain price stability and a high rate of economic growth. To perform these functions effectively, RBI uses several control instruments such as -

Open Market OperationsChanges in statutory reserve requirements for banksLending policies towards banksControl over interest rate structureStatutory liquidity ration of banks.

Exchange Manager and Controller - RBI manages exchange control, and represents India as a member of the international Monetary Fund [IMF]. Exchange control was first imposed on India in September 1939 when World War II started and continues till date. Exchange control was imposed on both receipts and payments of foreign exchange.

Publisher of Monetary Data and Other Data - RBI maintains and provides all essential banking and other economic data, formulating and critically evaluating the economic policies in India. In order to perform this function, RBI collects, collates and publishes data regularly. Users can avail this data in the weekly statements, the RBI monthly bulletin, annual report on currency and finance, and other periodic publications.

Promotional Role of RBI - Promotion of commercial banking Promotion of cooperative banking Promotion of industrial finance Promotion of export finance Promotion of credit to weaker sections Promotion of credit guarantees Promotion of differential rate of interest scheme Promotion of credit to priority sections including rural & agricultural sector.

MONETARY POLICYMonetary policy is the process by which monetary authority of a country, generally a

central bank controls the supply of money in the economy by exercising its control over interest rates in order to maintain price stability and achieve high economic growth. In

india, the central monetary authority is the reserve bank of india (rbi). Is so designed as to maintain the price stability in the economy.

Monetary operations involve monetary techniques which operate on monetary magnitudes such as money supply, interest rates and availability of credit aimed to maintain price stability, stable exchange rate, healthy balance of payment, financial

stability, economic growth. RBI, the apex institute of India which monitors and regulates the monetary policy of the country stabilizes the price by controlling inflation. RBI takes into account the following

monetary policies:Open market operations

Cash reserve ratioStatutory liquidity ratio

Bank rate policyCredit ceiling

Open Market OperationsAn open market operation is an instrument of monetary policy which involves buying or selling of government securities from or to the public and banks. This mechanism influences the reserve position of the banks, yield on government securities and cost of bank credit. The RBI sells government securities to contract the flow of credit and buys government securities to increase credit flow. Open market operation makes bank rate policy effective and maintains stability in government securities market.

Cash Reserve RatioCash Reserve Ratio is a certain percentage of bank deposits which banks are required to keep with RBI in the form of reserves or balances .Higher the CRR with the RBI lower will be the liquidity in the system and vice-versa.RBI is empowered to vary CRR between 15 percent and 3 percent. But as per the suggestion by the Narshimam committee Report the CRR was reduced from 15% in the 1990 to 5 percent in 2002. As of 30 th Jan 2013, the CRR is 4.0 percent.

Statutory Liquidity RatioStatutory Liquidity Ratio Every financial institution has to maintain a certain quantity of liquid assets with the RBI for time and demand liabilities. These assets can be cash, precious metals, approved securities like bonds etc. The ratio of the liquid assets to time and demand liabilities is termed as the Statutory liquidity ratio. There was a reduction of SLR from 38.5% to 25% because of the suggestion by Narshimam Committee. The current SLR is 23%.

Bank Rate PolicyBank rate is the rate of interest charged by the RBI for providing funds or loans to the banking system. This banking system involves commercial and co-operative banks, Industrial Development Bank of India, IFC, EXIM Bank, and other approved financial institutes. Funds are provided either through lending directly or rediscounting or buying money market instruments like commercial bills and treasury bills. Increase in Bank Rate increases the cost of borrowing by commercial banks which results into the reduction in credit volume to the banks and hence declines the supply of money. Increase in the bank rate is the symbol of tightening of RBI monetary policy. Bank rate is also known as Discount rate. The current Bank rate is 8.75%

Credit CeilingIn this operation RBI issues prior information or direction that loans to the commercial banks will be given up to a certain limit. In this case commercial bank will be tight in advancing loans to the public. They will allocate loans to limited sectors. Few example of ceiling are agriculture sector advances, priority sector lending.

Fiscal PolicyThe fiscal policy is concerned with the raising of government revenue and

incurring of government expenditure. To generate revenue and to incur expenditure, the government frames a policy called budgetary policy or fiscal

policy. So, the fiscal policy is concerned with government expenditure and government revenue.

It is prime duty of Government to make fiscal policy . By making this policy , Govt. collects money from his different resources and utilize it in different

expenditure . Thus fiscal policy is related to development policy . All welfare projects are completed under this policy

Objectives of Fiscal Policy

There are following objectives of fiscal policy :-

1. Development of Country :-For development of Country , every country has to make fiscal policy . With this policy , all work work is done govt. planning and proper use of fund for development functions . If govt. does not make fiscal policy , then it may happen that revenue may be  misused  without targeted expenditure of govt.

2. Employment :-

• Getting the full employment is also objective of fiscal policy . Govt. can take many action for increase employment. Government can fix certain amount which can be utilized for creation of new employment for unemployed peoples .

3. Inequality :-

• In developing country like India , we can see the difference one basis of earning . 10% of people are earning more than Rs. 100000 per day and other are earning less than Rs .100 per day . By making a good fiscal policy , govt. can reduce this difference . If govt. makes it as his target .

4. Fixation of Govt. Responsibility :-

• It is the duty of Govt. to effective use of resources and by making of fiscal policy different minister's accountability can be checked .

Techniques of Fiscal Policy 1. Taxation Policy 

Taxation policy is relating to new amendments in direct tax and indirect tax . Govt. of India passes finance bill every year . In this policy govt. determines the rate of taxes . Govt. can increase or decrease these tax rates and amend previous rules of taxation .Govt.'s earning's main source is taxation . But more tax on public will adverse effect on the development of economy.→ If Govt. will increase taxes , more burden will be on the public and it will reduce production and purchasing power of public .→ If Govt. will decrease taxes , then public's purchasing power will increase and it will increase the inflation.Govt. analyzes  both the situation and will make his taxation policy more progressive .

2. Govt. Expenditure Policy There are large number of public expenditure like opening of govt schools , colleges and universities , making of bridges , roads and new railway tracks . In all above projects govt has paid large amount for purchasing  and paying wages and salaries all these expenditure are paid after making govt. expenditure policy . Govt. can increase or decrease the amount of public expenditure by changing govt. budget . So , govt. expenditure is technique of fiscal policy by using this , govt. use his fund  first on very necessary sector and other will be done after this .

3. Deficit Financing Policy If Govt.'s expenditures are more than his revenue , then govt. should have to collect this amount . This amount is deficit and it can be fulfilled by issuing new currency by central bank of country . But , it will reduce the purchasing power of currency . More new currency will increase inflation and after inflation value of currency will  decrease . So, deficit financing is very serious issue in the front of govt. Govt. should use it , if there is no other source of govt. earning .

4. Public Debt Policy

If Govt. thinks that deficit financing is not sufficient for fulfilling the public expenditure or if govt. does not use deficit financing , then govt. can take loan from  world bank , or take loan from public by issuing govt. securities and bonds . But it will also increase the cost of debt in the form of interest which govt. has to pay on  the amount of loan . So, govt. has to make solid budget for this and after this amount is fixed which is taken as debt. This policy  can also use as the technique of fiscal policy for increase the treasure of govt.

OVERVIEW OF FOREIGN EXCHANGE MARKET

What is Foreign Exchange?Foreign exchange consists of trading one type of currency for another. Unlike other financial markets, the FX market has no physical location and no central exchange. It operates "over the counter" through a global network of banks, corporations and individuals trading one currency for another. The FX market is the world's largest financial market, operating 24 hours a day with enormous amounts of money traded on a daily basis.

'Foreign Exchange Market'The market in which participants are able to buy, sell, exchange and speculate on

currencies. Foreign exchange markets are made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors. The forex market is considered to be the largest financial market in the world.

A Short History of the Foreign Exchange Trading MarketForeign exchange markets originally developed to facilitate cross border trade conducted in different currencies by governments, companies and individuals. While these markets primarily existed to provide for the international movement of money and capital, even the earliest markets had speculators.Today, an enormous proportion of FX market activity is being driven by speculation, arbitrage and professional dealing, in which currencies are traded like any other commodity.

Advantages of Forex markets:1. Minimal or no commissions - There are no clearing fees, no exchange fees, no government fees and no brokerage fees. 2. Easy access – if you compare the money you need on the market in comparison with the amount needed for entering the stock, options or futures market, it’s a huge difference. The amount of capital is very low and it allows numerous types of people to easily enter the foreign exchange market. 3. No middlemen – spot currency trading is decentralized and eliminates middlemen, allowing you to trade directly. 4. Time and location flexibility – the market is open 24 hours each day, so you don’t have to match your schedule with the one of the market. It doesn’t require a full-time engagement and you can choose the hours that suit your best. 6. Low transaction costs – the transaction cost, determined by the bid/ask spread, is usually less than 0.1%, and it can go even lower in the case of large dealers. 7. A high liquidity market – the market is huge, so is extremely liquid. Around 4 trillion dollars are exchanged every day, according to the latest figures released by the Bank of International Settlements (BIS). That becomes an advantage, as you don’t have to struggle so much until you will find someone who wants to buy your currency or sell you one

DIFFERENT TYPES OF TRANSACTIONS IN THE FOREIGN EXCHANGE MARKET

Spot Market:The term spot exchange refers to the class of foreign exchange transaction which requires the immediate delivery or exchange of currencies on the spot. In practice the settlement takes place within two days in most markets. The rate of exchange effective for the spot transaction is known as the spot rate and the market for such transactions is known as the spot market.

Forward Market:The forward transactions is an agreement between two parties, requiring the delivery at some specified future date of a specified amount of foreign currency by one of the parties, against payment in domestic currency be the other party, at the price agreed upon in the contract. The rate of exchange applicable to the forward contract is called the forward exchange rate and the market for forward transactions is known as the forward market.Futures While a focus contract is similar to a forward contract, there are several differences between them. While a forward contract is tailor made for the client be his international bank, a future contract has standardized features the contract size and maturity dates are standardized. Futures cab traded only on an organized exchange and they are traded competitively.

Options While the forward or futures contract protects the purchaser of the contract fro m the adverse exchange rate movements, it eliminates the possibility of gaining a windfall profit from favorable exchange rate movement. An option is a contract or financial instrument that gives holder the right, but not the obligation, to sell or buy a given quantity of an asset as a specified price at a specified future date. An option to buy the underlying asset is known as a call option and an option to sell the underlying asset is known as a put option.

OVERVIEW OF FINANCAL SERVICES

Brief OverviewIndian financial markets, broadly comprising of segments like asset management, banking, insurance, foreign direct investments (FDI) and foreign institutional investors (FII), effectively promote the savings of the economy by directing them towards suitable investment options. The Indian financial sector is well developed, competitive and integrated to face all traumas (like the recent financial turmoil).

World Economic Forum’s latest report ‘Financial Development Report 2012’ has named India as the world's top-ranked country in terms of life insurance density. Life insurance density is the ratio of direct domestic premiums for life insurance to per capita gross domestic product (GDP) of a country. India has been ranked 40th in terms of overall financial development of a country, but is much ahead of larger economies like the US, UK, Japan and China for life insurance density.

Scope of Financial Services Services•Financial services cover a wide range Financial services cover a wide range of activities. They can be broadly of activities. They can be broadly classified into two, namely :classified into two, namely :•i Traditional. Activities. •ii. Modern activities.

Traditional Activities

• Traditionally, the financial Traditionally, the financial intermediaries have been rendering intermediaries have been rendering a wide range of services a wide range of services encompassing both capital and encompassing both capital and money market activities. They can be money market activities. They can be grouped under two heads, viz. grouped under two heads, viz.

A. Fund based activities and B. Non-fund based activities.

Fund based activities : The traditional services which come under fund based activities are the under fund based activities are the following:- •i. Underwriting or investment in shares, debentures, bonds, etc. of new issues (primary market activities)ii. Dealing in secondary market activities.iii. Participating in money market instruments like commercial papers, certificate of deposits, treasury bills, discounting of bills etc iv. Involving in equipment leasing, hire purchase, venture capital, v. Dealing in foreign exchange market activities.

Non fund based activities.Financial intermediaries provide services on the basis of non-fund activities also. This can be called 'fee based' activity. Today customers, whether individual or corporate, customers, are not satisfied with mere provisions of are not satisfied with mere provisions of finance. They expect more from financial services companies. Hence a wide variety of services, are being provided under this head. services, are being provided under this head. They include : They include :1.Managing the capital issue — i.e. management of pre-issue and post-issue activities relating to the capital issue in activities relating to the capital issue in accordance with the SEBI guidelines and thus enabling the promoters to market their issue. enabling the promoters to market their issue.•ii. Making arrangements for the placement2. Making arrangements for the placement of capital and debt instruments with of capital and debt instruments with investment institutions.3. Arrangement of funds from financial institutions for the clients' project cost or his working capital requirements4.Assisting in the process of getting all Government and other clearances.

Modern Activities

•Beside the above traditional services, the financial intermediaries render innumerable services in recent times. Most of them are in the nature of non-fund based activity. In view of the importance, these activities have been brief under the head 'New financial in brief under the head 'New financial products and services'. However, some of the modern services provided by them are given in brief here under.1.Rendering project advisory services right from the right from the preparation of the project report till the raising of funds for starting the project with necessary Government approvals.2.Planning for M&A and assisting for smooth carry out.3.Guiding corporate customers in capital restructuring.4. Acting as trustees to the debenture holders.5.Recommending suitable changes in the management structure and management style with a to achieving better results.

UNIT- 2

MANAGEMENT OF COMMERCIAL BANKS