An overview of Indian Financial System

Financial instruments are tradable assets of any kind. They can be cash, evidence of an ownership interest in an entity, or a contractual right to receive or deliver cash or another financial instrument. It can also be classified generally as equity based, representing ownership of the asset, or debt based, representing a loan made by an investor to the owner of the asset.  Documents (such as a check, draft, bond, share, bill of exchange, futures or options contract) come under this category.

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.

Important Money Market Instruments are Briefed below:

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.

Inter-Bank Term Money: 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.

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.

Certificate of Deposits: Certificates of Deposit (CDs) is a negotiable money market instrument and issued in dematerialised 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 issuance 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. A Financial Institution (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.

Commercial Paper (CP): 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 discounted 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.

Capital Market Instruments: 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, convertible preference shares, non-convertible preference shares etc. and in the debt segment debentures, zero coupon bonds, deep discount bonds etc.

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

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