UNIT 1

• INVESTMENT ENVIRONMENT IN INDIA

• OVERVIEW OF INDIAN FINANCIAL SYSTEM
• INVESTMENT ALTERNATIVES
 Overview of Indian Financial System

The financial system of a country is an important tool

for economic development of the country as it helps
in the creation of wealth by linking savings with
investments.
It facilitates the flow of funds from the households
(savers) to business firms (investors) to aid in wealth
creation and development of both the parties.
The institutional arrangements include all condition
and mechanism governing the production,
distribution, exchange and holding of financial assets
or instruments of all kinds.
Indian Financial System accelerates the rate and
volume of savings through provision of various
financial instruments and efficient mobilization of
savings.
It aids in increasing the national output of the country
by providing funds to corporate customers to expand
their respective business.
It helps in economic development and raising the
standard of living of people and promotes the
development of weaker section of the society through
rural development banks and co-operative societies. 
The financial system of a country
is concerned with
• Allocation and mobilization of savings
• Provision of funds
• Developing financial markets
• Facilitating the financial transactions
• Provision of legal financial framework
• Provision of financial and advisory services
According to Robinson the primary function
of financial system is
‘’to provide a link between the savings and
investment for creation of wealth and to
permit portfolio adjustment in the
composition of existing wealth’’.

A financial system consists of various financial

institutions, financial markets, financial
intermediaries, financial services, rules and
regulations etc.
 Features of financial system
• It plays a vital role in the economic
development of a country
• It encourages both savings and investment.
• It links savers and investors
• It helps in formation of capital
• It helps in allocation of risk.
• It facilitates expansion of financial markets.
 Functions of Indian financial system
• It bridges the gap between savings and investment
through efficient mobilization and allocation of surplus
funds
• It helps business in capital formation
• It helps in minimizing risk and allocating risk efficiently
• It helps a business to liquidate tied up funds
• It facilitates financial transactions through provision of
various financial instruments
• It facilitates trading of financial assets/instruments by
developing and regulating financial markets.
Importance of Indian financial system
• It accelerates the rate and volume of savings
through provision of various financial
instruments and efficient mobilization of
savings.
• It aids in increasing the national output of the
country by providing funds to corporate
customers to expand their respective business.
• It protects the interests of investors and
ensure smooth financial transactions through
regulatory bodies such as RBI, SEBI tec.
Importance of Indian financial system
• It helps economic development and raising
the standard of living of people.
• It helps to promote the development of
weaker section of the society through rural
development banks and cooperative
societies.
• It helps corporate customers to make better
financial decisions by providing effective
financial as well as advisory services.
• It aids in financial deepening and broadening
There are four main constituents
of the financial system as follows:
1. Financial Services 
2. Financial Assets/Instruments 
3. Financial Markets 
4. Financial Intermediaries/ institutions
 Financial Services
Financial Services are concerned with the design and delivery of financial instruments,
advisory services to individuals and businesses within the area of banking and related
institutions, personal financial planning, leasing, investment, assets, insurance etc. These
services includes

Banking Services: Includes all the operations provided by the banks including to the
simple deposit and withdrawal of money to the issue of loans, credit cards etc. 

Foreign Exchange services: Includes the currency exchange, foreign exchange banking or

the wire transfer. 

Investment Services: It generally includes the asset management, hedge fund

management and the custody services. 

Insurance Services: It deals with the selling of insurance policies, brokerages, insurance
underwriting or the reinsurance. 

Some of the other services include the advisory services, venture capital, angel
investment etc. 
 Financial Instruments/Assets
Financial asset represents a claim to the payment of a sum
of money in future and a periodic payment in the form of
interest or dividend.
Eg- govt bond, bank deposit, equity share etc
Financial securities are classified into primary (direct)and
secondary (indirect)securities.
primary securities are issued by ultimate investors directly
to the ultimate savers as ordinary shares and debentures
while secondary securities are issues by the financial
intermediaries to the ultimate savers as bank deposits,
insurance policies etc.
• Financial assets differ from each other in respect of their
features which are inter dependant and interrelated.
• Liquidity
• Marketability
• Transaction costs
• Risk
• maturity period
• Tax
• Rate of return etc.
 Financial Markets- classification
• Primary market- deals in the new financial
claims or new securities and are called as new
issues market
• Secondary market- deal in securities already
issued or existing or outstanding
• Primary market mobilize savings and supply
capital to business units and secondary market
provides liquidity to these claims
 Financial Markets- classification
• Money and capital markets
• Both perform the same function of transferring
resources to the producers.
• Money markets deals in short term claims ( with in a
period of maturity of one year or less)
• Capital markets does so in long term claims ( maturity
period above 1 yr)
• Money market eg-treasury bills market, call money
market, commercial bills market etc
• Capital market eg- equity market, debt market,
derivatives market
 Financial Markets
The financial markets are classified into two groups:
Capital Market: 
A capital market is an organised market which provides long-term finance for business.
Capital Market also refers to the facilities and institutional arrangements for borrowing
and lending long-term funds.
Capital Market is divided into three groups:
Corporate Securities Market: Corporate securities are equity and preference shares,
debentures and bonds of companies. The corporate security market is a very sensitive
and active market. It can be divided into two groups: primary and secondary. 

Government Securities Market: In this market government securities are bought and
sold. The securities are issued in the form of bonds and credit notes. The buyers of
such securities are Banks, Insurance Companies, Provident funds, RBI and Individuals. 

Long-Term Loans Market: Banks and Financial institutions that provide long-term

loans to firms for modernization, expansion and diversification of business. Long-Term
Loan Market can be divided into Term Loans Market, Mortgages Market and Financial
Guarantees Market. 
 Money Market
Money Market is the market for short-term funds.
The money market is divided into two types:
Unorganised and Organised Money Market.
Unorganized Market: It consists of Money lenders,
Indigenous Bankers, Chit Funds, etc. 
Organized Money Market: It consists of Treasury
Bills, Commercial Paper, Certificate Of Deposit, Call
Money Market and Commercial Bill Market.
Organised Markets work as per the rules and
regulations of RBI. RBI controls the Organized
Financial Market in India. 
 Financial Intermediaries 
A financial intermediary is an institution which
connects the deficit and surplus money. The
best example of an intermediary is a bank
which transforms the bank deposits to bank
loans. The role of the financial intermediary is
to distribute funds from people who have
extra inflow of money to those who don’t have
enough money to fulfil the needs.
 There can be two types of financial
intermediaries
• Banking institutions- it includes banks and
credit unions that collect money from public in
return for an interest on money deposits and
uses that money to advance loans to financial
customers
• Non banking institutions-these are brokerage
firms, insurance and mutual funds companies
that cannot collect money deposits but can sell
financial products to financial customers.
 financial institutions/intermediaries can be
classified into three categories
• Regulatory – SEBI, RBI, IRDA that regulates
financial markets and protect interests of small
investors.
• Intermediaries:-commercial banks such as SBI,
PNB that provides short term loans and other
financial services to individuals and corporate
customers.
• Non intermediaries-like NABARD, IDBI that
provides long term loans to corporate customers.
 Classification of financial institutions

• Banking institutions
• Non banking institutions
 Banking institutions
• they participate in the economy’s payments
mechanism ie; they provide transactions
services
• Their deposit liabilities constitute a major part
of the national supply
• They can, as a whole, create deposits or credit
which is money
Banking vs non banking financial institutions

• Banks, subject to legal reserve requirements

can advance credit by creating claims against
themselves, while other institutions can lend
only out of the resources put at their disposal
by the savers.
• Banks are creators of credit where as non
banking institutions are purveyors are credit.
• Examples of non banking financial institutions
are LIC, UTI, IDBI etc.
 Intermediaries and non intermediaries

• Financial institutions are also classified into

Intermediaries and non intermediaries
• Intermediaries intermediate between savers
and investors, they lend money as well as they
mobilise savings, their liabilities are towards
the ultimate savers, while their assets are
from investors or borrowers.
• Non intermediaries do the loan business but
their resources are not directly obtained from
the savers.
• All banking institutions are intermediaries.
• Non banking institutions also act as
intermediaries and when they do so they are
called as non banking financial institutions (NBFI)
• UTI, LIC,GIC are some of NBFI’s of India.
• GOI has set up IDBI,IFC,NABARD to provide
assistance ( credit needs) for specific
purposes, sectors and regions. They are called
as non banking statutory financial
organizations(NBSFO).
Functions of Financial Intermediary are are as follows:

Maturity transformation: Deals with the conversion of short-term liabilities to long

term assets. 

Risk transformation: Conversion of risky investments into relatively risk free ones. 

Convenience denomination: It is a way of matching small deposits with large loans

and large deposits with small loans.
 
Financial Intermediaries are divided into two types: 
Depository institutions: These are banks and credit unions that collect money
from the public and use that money to advance loans to financial customers.

Non-Depository institutions: These are brokerage firms, insurance and mutual

funds companies that cannot collect money deposits but can sell financial products
to financial customers.