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An Introduction to Financial System

Stock market, GDP, Inflation etc are the different measures which reveal the situation that a country is in at the present time but have you ever wondered what are the different branches whose performance determines all of these. A financial market is the most important factor which makes or breaks the present of any economy let’s have a look at what is a financial market.

Financial Market

The market acts as a barometer to check the economic development. The whole system is divided into two types :

• Product Market: a market for products
• Factor Market: It is a market for factors of production
The financial market is a part of Factor market. Before starting with the topic let’s have a look at some of the terminologies;
• Asset
• Financial Asset
• Lender
• Borrower
• Retail Investor

Asset

It is any type of property or possession which can be exchanged for some value. It is again divided into two types Tangible (which has a physical form eg: plot, money, house etc) and Intangible (which does not have any physical form eg: shares in Demat account).

Financial Asset

These are intangible assets. The financial assets are represent a claim of the financial asset holder to the future cash flows. For example Mr. X purchases a new car and takes a loan from bank. The bank takes a collateral security before releasing the loan amount and if Mr. X has kept the home documents as collateral then the documents of the home is the financial asset.

Lender

A lender is one person or an organization which has excess or surplus money and is looking for a suitable investment.

Borrower

A borrower is one who borrows money from lender and pays the lender some money for time decided by them and at a particular rate of interest

Retail Investor

An individual investor is referred to as a Retail Investor. The main aim of the financial markets is to maintain the liquidity and it is done by transferring the money from a person (or lender) who has surplus money to those who need (borrower) surplus money to invest in a project or an asset and it done in financial market. A financial market provides for the exchange of the financial asset with the money or investment.

Types of Financial Markets

As shown in the above figure the financial markets are divided into Capital markets, Money Market & Forex market. Let’s have a look at these three types
• Capital Markets
• Money Market
• Forex Market

Capital Markets

One of the simplest ways to define the capital market is “where the money is raised for a long term (more than one year)”. It is a market where companies and governments raise capital for business and it is raised for long term. The Capital markets include Primary markets (new bonds & securities are issued) and secondary markets (issued bonds and securities are traded). These markets are regulated by SEBI (Security Exchange Board of India) in India, FSA (Financial Services Authority) in UK. The assets traded in the capital market are debts. Equity shares, Preference shares etc and these are traded in stock markets. There are many stock markets in India but the most prominent ones are National Stock Exchange (NSE) & Bombay Stock Exchange (BSE).

Advantages of Capital Markets
• Companies and government can raise the required capital very easily
• Huge capital that is required for a business can be raised.
• The markets are regulated in order to protect the interest of the investors. The SEBI is the regulatory authority of capital markets which was established after the Harshad Mehta’s Stock Market Scandal.
• The investors can diversify their portfolio & invest their money in the market according to their requirement.
• The capital markets have given a chance for retail (or Individual) investors to participate in the market.

Money Market

The money market provides the opportunity for the borrowers (companies and government) to raise capital for short term or for less than one year. Some of the instruments traded in the money market are;

Call money: Money lent for only one day Notice money: Money lent for more than one day Term money: lending money for 15 days or more

Some of other instruments are Certificate Deposit, Commercial Papers, Treasury bills etc. This market is efficiently used up by the banks that fund other banks and if necessary get funded. The main advantage in money market is that the instrument that is close substitute of money is liquid and can quickly be converted at lower cost. The money market is perceived to be a good place for investment for those investors who want quick returns and want to play safe but it cannot be said that the money market is 100% safe.

The money market in India is dependent on the interest rates that are inflation adjusted. In India money market is regulated by RBI (Reserve Bank of India) and SEBI.

Forex Market

Foreign Exchange Market is called as Forex Market. In this market banks and other financial institutions can buy and sell the currencies. The main aim is to increase international trading. It helps the business firms for example a company which is into exporting business to America gets the payment in dollars it can be exchanged for rupees in the forex market. The Indian Foreign exchange market consists of buyers, sellers, market mediators and the regulatory authority.

In India the forex market is regulated by FEMA (Foreign Exchange Management Act). Status Role of financial markets :
• If there were no financial markets then the first thing is that the borrowers would find it very difficult to raise money. Even in case they raised money from any lender then all the terms and conditions would have been put by the lender like (high interest rates, credit period etc)
• The financial markets provide for or interaction or discussion between the buyer and seller and it results in a process called as Price Discovery Process. It is nothing but the buyer and seller come to a conclusion about the required returns.
• The financial markets have helped the investor to diversify his portfolio this works out as the investor does not keep all the eggs in one basket.
• The financial market offers liquidity to the investor in the sense that the investor can sell the financial instruments at any time to get the money.
• The financial markets reduce the costs (Information cost and search costs). You may ask why a company needs to go to other countries when it can do the same thing in its own country some of the reasons are ;
• The economic situation may not be supportive in the resident country.
• One of the most important factors which make the companies to look for other countries financial markets is low interest rates. If the borrowing rates in another country is less than that of own financial market then the companies look for other country.
• The domestic market in the country of fund seeking company may not be fully developed. The global financial markets are divided into Internal and External market this is according to a country’s perspective.

Internal market is where a person or a company that is resident of a country trades in that market. The internal market is again divided into Domestic and foreign market.

The external market is also called as International market deals with a company conducting the market activities in other countries.

Financial Planning
Tax Planning
Investment Planning