lbs fs lecture 1-2

7/26/2019 LBS FS Lecture 1-2

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LBS FS Lecture 1-2

Course on Financial Systems


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Study Plan

Text Books Pathak V Bharati - The Indian Financial

System, 21!

"han # $ - Indian Financial System, 21%


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&i'hly (ecommended (eadin's Sharma, (uchir, )Breakout *ations+ In ursuit o the

next economic miracle., /llen Lane, 1st

0dition 212 /aila3le in the li3rary4

+ (eadin' the 3ook 5ill hel you tackle 'rou task *o2 3etter

/ &undred Small Stes+ (eort o the Committee on

Financial Sector (eorms+ 6oernment o India,Plannin' Commission, 27

+(eort aaila3le at+

htt+88

lannin'commission9nic9in8reorts8'enre8re:r8csr:all
http://planningcommission.nic.in/reports/genrep/rep_fr/cfsr_all.pdfhttp://planningcommission.nic.in/reports/genrep/rep_fr/cfsr_all.pdfhttp://planningcommission.nic.in/reports/genrep/rep_fr/cfsr_all.pdfhttp://planningcommission.nic.in/reports/genrep/rep_fr/cfsr_all.pdfhttp://planningcommission.nic.in/reports/genrep/rep_fr/cfsr_all.pdf


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Some #ore (ecommended (eadin's6oldman Sachs (esearch

B(ICS 6lo3al 0conomics Paer *o 77+ ;reamin' 5ith Brics

une 2A4

THE ABOVE HAS BEEN EMAILED TO YOU.EXPLORE THE SITE FOR A LOT MORE


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6rou Task 1

(eorts 1@ marks4 andresentations 1 marks4

onFinancial systems o Select

Countries


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6rou Presentations

;eadlines

/ll teams to email their resentations to meand the class res 3y @9% m on the 2!tho >anuary, 21?

Presentations 2 er class4 commence in

the 1st

class in the last 5eek o >anuary21?Toics Toics or arious 'rous are 'ien in the

next slideForm /ll mem3ers to ointly resent % minutes each 2@ min or resentation

@ min or D/8


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Ehat 5ill you coer in 'rou 5ork 1

0conomy

6oernment Central Bank

Stock exchan'e s4

Imortant industries


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6rou Task 2 @ marks4

$ou are 'oin' to 3e handed oer not really4 on the 1sto>anuary 21? or mana'in', a sum o J 1 3illion, 5hichcan 3e inested only in listed stocks in the selectedcountries not more than @ comanies er country49 Thetime horiKon o the inestment 5ill 3e a minimum o @years, say 21?-29

;ecide14the ercenta'e o inesti3le unds to 3e inested in thestock market o the country that you are analysin', and

24 % to @ comanies 5hich you Gnd 5orthy o inestment

()0mail the reort 3y 1thFe3 21? to me and one 'rou

mem3er 5ill make a 3rie @ min4 resentation in theclass, on a suita3le day ater the Grst round o 'rouresentations is oer9

()/ter all the 'rous hae made their resentations, the5hole house 5ill discuss the matter


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Financial system

Introduction


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A e! "6 u$ %!e7 "6 8nanial in!i!u!i"n97ar:e!9 in!ru7en! and ervie.In!er7edia!e #i!5 !5e ;"# "6 6und $e!#eenaver and $"rr"#er.Faili!a!e !ran6er and all"a!i"n "6 arere"ure e "6 Finanial

S%!e7


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F"r7al 8nanial %!e7? Or>ani1ed9 in!i!u!i"nal and re>ula!ed

In6"r7al financial system: Advan!a>e? L"# !rana!i"n "! Mini7u7 de6aul! ri: Tranparen% "6

pr"edure

Diadvan!a>e? @ide ran>e "6 in!ere!ra!e

Hi>5er ra!e "6 in!ere! Unre>ula!ed

T%pe "6 Finanial S%!e7


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Finanial In!i!u!i"nFinanial Mar:e!

Finanial In!ru7en!Finanial Servie

4"7p"nen! "6 !5e Finanial

S%!e7


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Tyes o Financial Institutions

Bankin' and *on MBankin' Bankin'+ creators and ureyors ocredit9 Tyes+ Commercial Banks

Cooeratie Banks *on-Bankin'+ureyors o credit Tyes+ ;eelomental Gnancial institutionsN #utual FundsN

Insurance comaniesN

*BFCs


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Functions o FinancialInstitutions

Proide three transormation serices+Lia3ility, asset and siKe transormation

#aturity transormation

(isk transormation


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Finanial Mar:e!Tyes+

#oney #arket M / market or short -term de3t

instruments.

Caital #arket - / market or lon'

-term euity and de3t instruments

Se'ments+

Primary #arket M / market or ne5 issues

Secondary #arket M / market or tradin' outstandin'

issues


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Link Bet5een Primary SecondaryCaital markets

/ 3uoyant secondary marketindisensa3le or the resence o a

i3rant rimary market Secondary market roides a 3asis

or the determination o rices o

ne5 issues ;eth o the secondary market

deends on the rimary market

Bunchin' o ne5 issues aOects


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Finanial In!ru7en!

Tyes+ Primary Secondary

;istinct Features+ #arketa3le Tradea3le Tailor-made


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Finanial Servie

#aor cate'ories+ Funds

Intermediation Payments

#echanism Proision o

liuidity (isk

#ana'ement Financial

0n'ineerin'


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Fun!i"n "6 Finanial %!e7

#o3ilise and allocate sain's

#onitor cororate erormance

Proide ayment and settlement systems


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+e% ele7en! "6 a #ell 6un!i"nin> 8nanial%!e7

/ stron' le'al and re'ulatory enironment

Sta3le money

Sound u3lic Gnances and u3lic de3t

mana'ement / central 3ank

Sound 3ankin' system

Inormation system Eell -unctionin' securities market


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Financial system desi'ns

Tyes + Bank M 3ased

#arket M 3ased


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#arket -3ased FinancialSystem

/danta'es+Proide attractie terms to 3oth inestors and 3orro5ers

Facilitate diersiGcation

/llo5 risk sharin'

/llo5 Gnancin' o ne5 technolo'ies

;ra53acks+Prone to insta3ility

0xosure to market risk

Free rider ro3lem


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Bank M3ased FinancialSystem

/danta'es+ Close relationshis 5ith arties

Proide tailor made contracts

0cient inter-temoral risk sharin'

*o ree rider ro3lem

;ra53acks+ (etards innoation and 'ro5th

Imedes cometition


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Functions o Financial#arkets

0na3lin' economic units to exercise their time reerence

Searation, distri3ution, diersiGcation and reduction o risk

0cient ayment mechanism

Proidin' inormation

0nhancin' liuidity Proidin' ortolio mana'ement serices9


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The main function of a financial system is thecollection of savings and their distribution for

investment, thereby stimulating capital formationand, to that extent, accelerating the process ofeconomic growth. The financial system is a linkbetween the savers (savings-surplus economic

units) and the investors (saving-deficit economicunits). It is made up of all those channelsthrough which savings become available forinvestment.

Functions

2?


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!inancial intermediaries (!Is) represent a significantchange in the whole process of a transfer of choice ofinvestment from an individual saver to an institutional

agent. They convert primary securities with a given set ofcharacteristics, into indirect securities with very differentfeatures. " primary security is a security issued by a non-financial economic unit. " security issued by a financialintermediary is an indirect security. The ability of !Is to

transform a primary security into an indirect securitymakes it more attractive to both the borrowers and thelenders. The pooling of funds by an !I leads to anumber

Finanial In!er7ediarie

2A


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of indirect and derived benefits that add greatly to theeffectiveness and efficiency of the savings-investment

process. The benefitsservices associated with thetailoring of financial assets according to the desires ofthe savers and investors are# (i) convenience in terms ofdenomination and li$uidity, (ii) lower risk due todiversification of the portfolio, (iii) expert management of

the portfolio and (iv) lower cost resulting from economiesof scale. " diversified structure of !Is in a matured andsophisticated financial system consists of banks, %&!'s,mutual funds, insurance organisations and so on. ith avariegated structure, these are able to mobilise savingsfrom the widest section of the investing public andchannelise them to a cross-section of economicindustrialenterprises.

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!inancial markets are a significant component ofthe financial system. They are not a source offunds, but they act as a facilitating organisationand link the savers and investors, both individualas well as institutional. "s facilitatingorganisations, financial markets provide a widevariety of specialist institutional facilities. &asedon the nature of funds which are their stock-in-trade, they are classified into# (i) money marketsand (ii) capitalsecurities markets.

Finanial Mar:e!

%


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oney market is a market for dealing inmonetaryfinancial assets of a short-term nature,generally less than one year. Its broad ob*ectives are toprovide (i) an e$uilibrating mechanism for evening outshort-term surpluses and deficiencies in the financial

system, (ii) a focal point of central bank (+&I) interventionfor influencing li$uidity in the economy through a varietyof instruments, and (iii) a reasonable access to theusers of short-term funds to meet their re$uirements atrealisticreasonable pricecost. The money market

organisation comprises of a number of interrelated sub-markets such as call market, T-bills market, commercialbills market, ' market, ' market, repo market, etc.

M"ne% Mar:e!

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'apitalsecurities market is a market for long-term funds.

It has two segments# primarynew issue market andsecondarystock exchangemarket. The primary marketdeals in new securities, offered to the investors for thefirst time. It performs a triple-service function, at thedifferent stages of the issue, namely, origination, that is,investigation, analysis and processing of new issueproposals underwriting and distribution of securitiesto the investors. The stock exchange is a market forexisting securities. It discharges three vital functions# it

acts as a nexus between savings and investment, itprovides li$uidity to investors by offering a place fortransaction in securities and it helps in continuous priceformation.

4api!al Mar:e!

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" financial assetinstrumentsecurity is a claim ona stream of income andor assets of anothereconomic unit and is held as a store of value and

for the expected return. There are three types offinancial assets#

primarydirect,

Indirect, and

derivatives.

Finanial

Ae!In!ru7en!

%%


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" primary security is a security issued by a non-financial economic unit, such as ordinary

preference shares, debenturesbonds andinnovative debt instruments includingparticipating, convertibles, warrants and so on.

Pri7ar% Seuri!%

%!


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"n indirect security is a security issued by an !Isuch as units of mutual funds. It is based on an

underlying primary security. The pooling of fundsby an !I and converting a primary security into anindirect security is associated with a number ofbenefits, namely, convenience, diversification,

expert management and lower cost.

Indire! Seuri!%

%@


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" derivative instrument includes# (i) a securityderived from a debt instrument, share, secured or

unsecured loan, risk instrument, contract fordifferences or any other form of security and (ii) acontract which derives its value from thepricesindex of prices of the underlying

securities. It is an instrument of riskmanagement. The most commonly usedderivative contracts are forwards, futures andoptions.

Deriva!ive In!ru7en!

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A forward contractis an agreement to exchange an

asset for cash, at a predetermined future datespecified today. "t the end of the contract, onecan enter into an offsetting transaction by payingin the difference in the price. It is settled by the

delivery of the asset on the expiration date.

%=


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!uture contracts are transferable specified

delivery forward contracts. They are agreementsbetween two counterparties to fix forward theterm of an exchangelock-in the price today, of anexchange that will take place between them at

some fixed future date, ranging between / to 01months. epending on the underlying asset,future contracts could be stock futures or indexfutures.

%A


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2ptions give the holder the right (but not the

obligation) to buy (call option) or sell (put option)securities at a predetermined price(strikeexercise price) withinat the end of aspecified period. In order to ac$uire the right of

option, the buyer pays to the seller, an optionpremium as the price for the right. 3e can lose nomore than the option premium paid but hispossible gain is unlimited. The sellers4 possible

loss is unlimited but his maximum gain isrestricted to the option premium charged by him.

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lbs fs lecture 1-2

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