MBA III

1st Day Thursday (03.10.2019)

Financial Markets & Institutions

*Definition of Financial Markets – Ex Stock Market/Share Market A financial market is a market in
which people trade financial securities and derivatives at low transaction costs. Securities include stocks
and bonds, derivatives, foreign exchange, commodities and precious metals. Financial markets are where
traders buy and sell assets

TERMINOLOGY

**Financial securities(A security, in a financial context, is a certificate or other financial instrument that has
monetary value and can be traded. Securities are generally classified as either equity securities, such as
stocks and debt securities, such as bonds and debentures{ an unsecured loan certificate issued by a
company})

** Derivatives (In finance, a derivative is a contract that derives its value from the performance of an
underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply
called the "underlying".)

** Stock exchange, securities exchange or bourse, is a facility where stock brokers and traders can buy
and sell securities, such as shares of stock and bonds and other financial instruments.

** stocks and bonds (stocks are shares in the ownership of a business, while bonds are a form of debt
that the issuing entity promises to repay at some point in the future. ... This means that stocks are a
riskier investment than bonds. Periodic payments.)

** Stock market- A stock market, equity market or share market is the aggregation of buyers and
sellers of stocks, which represent ownership claims on businesses; these may include securities listed on
a public stock exchange, as well as stock that is only traded privately.

** Foreign exchange (The foreign exchange market is a global decentralized or over-the-counter market
for the trading of currencies. This market determines foreign exchange rates for every currency. It
includes all aspects of buying, selling and exchanging currencies at current or determined prices.)

** Commodities(Grain, precious metals, electricity, oil, beef, orange juice, and natural gas are
traditional examples of commodities)

** Precious metals(gold, silver, platinum, and palladium).

** Assets(In financial accounting, An asset is anything of durable value, that is, anything that acts as a means
to store value over time. An asset is any resource owned by the business. Anything tangible or intangible that
can be owned or controlled to produce value and that is held by a company to produce positive economic value
is an asset. Simply stated, assets represent value of ownership that can be converted into cash..
**Real assets are assets in physical form (e.g., land, equipment, houses,...), including "human capital" assets
embodied in people (natural abilities, learned skills, knowledge,..).

**Financial assets are claims against real assets, either directly (e.g., stock share equity claims) or indirectly
(e.g., money holdings, or claims to future income streams that originate ultimately from real assets).

** Exchange is a marketplace where securities, commodities, derivatives and other financial

instruments are traded. The core function of an exchange is to ensure fair and orderly trading and
the efficient dissemination of price information for any securities trading on that exchange.

** Over-the-counter or off-exchange trading is done directly between two parties, without the supervision of
an exchange. It is contrasted with exchange trading, which occurs via exchanges. A stock exchange has the
benefit of facilitating liquidity, providing transparency, and maintaining the current market price.

**Securities are financial assets exchanged in auction and over-the-counter markets (see below) whose
distribution is subject to legal requirements and restrictions (e.g., information disclosure requirements).

**Lenders are people who have available funds in excess of their desired expenditures that they are
attempting to loan out.

**Borrowers are people who have a shortage of funds relative to their desired expenditures who are seeking to
obtain loans. Borrowers attempt to obtain funds from lenders by selling to lenders newly issued claims against
the borrowers' real assets, i.e., by selling the lenders newly issued financial assets.

A financial market is a market in which financial assets are traded. In addition to enabling exchange of
previously issued financial assets, financial markets facilitate borrowing and lending by facilitating the sale by
newly issued financial assets. Examples of financial markets include the New York Stock Exchange (resale of
previously issued stock shares), the U.S. government bond market (resale of previously issued bonds), and the
U.S. Treasury bills auction (sales of newly issued T-bills). A financial institution is an institution whose primary
source of profits is through financial asset transactions. Examples of such financial institutions include discount
brokers (e.g., Charles Schwab and Associates), banks, insurance companies, and complex multi-function
financial institutions such as Merrill Lynch.

Introduction to Financial Markets and Institutions:

Financial markets serve six basic functions. These functions are briefly listed below:

 Borrowing and Lending: Financial markets permit the transfer of funds (purchasing power) from one
agent to another for either investment or consumption purposes.

 Price Determination: Financial markets provide vehicles by which prices are set both for newly issued
financial assets and for the existing stock of financial assets.

 Information Aggregation and Coordination: Financial markets act as collectors and aggregators of
information about financial asset values and the flow of funds from lenders to borrowers.

 Risk Sharing: Financial markets allow a transfer of risk from those who undertake investments to those
who provide funds for those investments.

 Liquidity: Financial markets provide the holders of financial assets with a chance to resell or liquidate
these assets.

 Efficiency: Financial markets reduce transaction costs and information costs.

In attempting to characterize the way financial markets operate, one must consider both the various types of
financial institutions that participate in such markets and the various ways in which these markets are
structured.

Who are the Major Players in Financial Markets?

By definition, financial institutions are institutions that participate in financial markets, i.e., in the creation and/or
exchange of financial assets. At present in the United States, financial institutions can be roughly classified into
the following four categories: "brokers;" "dealers;" "investment bankers;" and "financial intermediaries."

Brokers:

A broker is a commissioned agent of a buyer (or seller) who facilitates trade by locating a seller (or buyer) to
complete the desired transaction. A broker does not take a position in the assets he or she trades -- that is, the
broker does not maintain inventories in these assets. The profits of brokers are determined by the commissions
they charge to the users of their services (either the buyers, the sellers, or both). Examples of brokers include
real estate brokers and stock brokers.

Diagrammatic Illustration of a Stock Broker:

Payment ----------------- Payment

------------>| |------------->

Stock | | Stock

Buyer | Stock Broker | Seller

<-------------|<----------------|<-------------

Stock | (Passed Thru) | Stock

Shares ----------------- Shares

Dealers:

Like brokers, dealers facilitate trade by matching buyers with sellers of assets; they do not engage in asset
transformation. Unlike brokers, however, a dealer can and does "take positions" (i.e., maintain inventories) in
the assets he or she trades that permit the dealer to sell out of inventory rather than always having to locate
sellers to match every offer to buy. Also, unlike brokers, dealers do not receive sales commissions. Rather,
dealers make profits by buying assets at relatively low prices and reselling them at relatively high prices (buy
low - sell high). The price at which a dealer offers to sell an asset (the "asked price") minus the price at which a
dealer offers to buy an asset (the "bid price") is called the bid-ask spread and represents the dealer's profit
margin on the asset exchange. Real-world examples of dealers include car dealers, dealers in U.S.
government bonds, and Nasdaq stock dealers.

Diagrammatic Illustration of a Bond Dealer:

 Payment ----------------- Payment

------------>| |------------->

Bond | Dealer | Bond

Buyer | | Seller

<-------------| Bond Inventory |<-------------

Bonds | | Bonds

-----------------

Investment Banks:

An investment bank assists in the initial sale of newly issued securities (i.e., in IPOs = Initial Public Offerings)
by engaging in a number of different activities:

 Advice: Advising corporations on whether they should issue bonds or stock, and, for bond issues, on
the particular types of payment schedules these securities should offer;

 Underwriting: Guaranteeing corporations a price on the securities they offer, either individually or by
having several different investment banks form a syndicate to underwrite the issue jointly;

 Sales Assistance: Assisting in the sale of these securities to the public.

Some of the best-known U.S. investment banking firms are Morgan Stanley, Merrill Lynch, Salomon Brothers,
First Boston Corporation, and Goldman Sachs.

Financial Intermediaries:

Unlike brokers, dealers, and investment banks, financial intermediaries are financial institutions that engage in
financial asset transformation. That is, financial intermediaries purchase one kind of financial asset from
borrowers -- generally some kind of long-term loan contract whose terms are adapted to the specific
circumstances of the borrower (e.g., a mortgage) -- and sell a different kind of financial asset to savers,
generally some kind of relatively liquid claim against the financial intermediary (e.g., a deposit account). In
addition, unlike brokers and dealers, financial intermediaries typically hold financial assets as part of an
investment portfolio rather than as an inventory for resale. In addition to making profits on their investment
portfolios, financial intermediaries make profits by charging relatively high interest rates to borrowers and
paying relatively low interest rates to savers.

Types of financial intermediaries include: Depository Institutions (commercial banks, savings and loan
associations, mutual savings banks, credit unions); Contractual Savings Institutions (life insurance companies,
fire and casualty insurance companies, pension funds, government retirement funds); and Investment
Intermediaries (finance companies, stock and bond mutual funds, money market mutual funds).

Diagrammatic Example of a Financial Intermediary: A Commercial Bank

Lending by B Borrowing by B
 deposited

------- funds ------- funds -------

| |<............. | | <............. | |

| F |.............> | B | ..............> | H |

------- loan ------- deposit -------

contracts accounts

Loan contracts Deposit accounts

issued by F to B issued by B to H

are liabilities of F are liabilities of B

and assets of B and assets of H

NOTE: F=Firms, B=Commercial Bank, and H=Households

Important Caution: These four types of financial institutions are simplified idealized classifications, and many
actual financial institutions in the fast-changing financial landscape today engage in activities that overlap two
or more of these classifications, or even to some extent fall outside these classifications. A prime example is
Merrill Lynch, which simultaneously acts as a broker, a dealer (taking positions in certain stocks and bonds it
sells), a financial intermediary (e.g., through its provision of mutual funds and CMA checkable deposit
accounts), and an investment banker.

What Types of Financial Market Structures Exist?

The costs of collecting and aggregating information determine, to a large extent, the types of financial market
structures that emerge. These structures take four basic forms:

 Auction markets conducted through brokers;

 Over-the-counter (OTC) markets conducted through dealers;

 Organized Exchanges, such as the New York Stock Exchange, which combine auction and OTC
market features. Specifically, organized exchanges permit buyers and sellers to trade with each other
in a centralized location, like an auction. However, securities are traded on the floor of the exchange
with the help of specialist traders who combine broker and dealer functions. The specialists broker
trades but also stand ready to buy and sell stocks from personal inventories if buy and sell orders do
not match up.
  Intermediation financial markets conducted through financial intermediaries;

Financial markets taking the first three forms are generally referred to as securities markets. Some financial
markets combine features from more than one of these categories, so the categories constitute only rough
guidelines.

Auction Markets:

An auction market is some form of centralized facility (or clearing house) by which buyers and sellers, through
their commissioned agents (brokers), execute trades in an open and competitive bidding process. The
"centralized facility" is not necessarily a place where buyers and sellers physically meet. Rather, it is any
institution that provides buyers and sellers with a centralized access to the bidding process. All of the needed
information about offers to buy (bid prices) and offers to sell (asked prices) is centralized in one location which
is readily accessible to all would-be buyers and sellers, e.g., through a computer network. No private
exchanges between individual buyers and sellers are made outside of the centralized facility.

An auction market is typically a public market in the sense that it open to all agents who wish to participate.
Auction markets can either be call markets -- such as art auctions -- for which bid and asked prices are all
posted at one time, or continuous markets -- such as stock exchanges and real estate markets -- for which bid
and asked prices can be posted at any time the market is open and exchanges take place on a continual basis.
Experimental economists have devoted a tremendous amount of attention in recent years to auction markets.

Many auction markets trade in relatively homogeneous assets (e.g., Treasury bills, notes, and bonds) to cut
down on information costs. Alternatively, some auction markets (e.g., in second-hand jewelry, furniture,
paintings etc.) allow would-be buyers to inspect the goods to be sold prior to the opening of the actual bidding
process. This inspection can take the form of a warehouse tour, a catalog issued with pictures and descriptions
of items to be sold, or (in televised auctions) a time during which assets are simply displayed one by one to
viewers prior to bidding.

Auction markets depend on participation for any one type of asset not being too "thin." The costs of collecting
information about any one type of asset are sunk costs independent of the volume of trading in that asset.
Consequently, auction markets depend on volume to spread these costs over a wide number of participants.

Over-the-Counter Markets:

An over-the-counter market has no centralized mechanism or facility for trading. Instead, the market is a public
market consisting of a number of dealers spread across a region, a country, or indeed the world, who make the
market in some type of asset. That is, the dealers themselves post bid and asked prices for this asset and then
stand ready to buy or sell units of this asset with anyone who chooses to trade at these posted prices. The
dealers provide customers more flexibility in trading than brokers, because dealers can offset imbalances in the
demand and supply of assets by trading out of their own accounts. Many well-known common stocks are
traded over-the-counter in the United States through NASDAQ (National Association of Securies Dealers'
Automated Quotation System).

Intermediation Financial Markets:

An intermediation financial market is a financial market in which financial intermediaries help transfer funds
from savers to borrowers by issuing certain types of financial assets to savers and receiving other types of
financial assets from borrowers. The financial assets issued to savers are claims against the financial
intermediaries, hence liabilities of the financial intermediaries, whereas the financial assets received from
borrowers are claims against the borrowers, hence assets of the financial intermediaries. (See the
diagrammatic illustration of a financial intermediary presented earlier in these notes.)
Additional Distinctions Among Securities Markets

Primary versus Secondary Markets:

Primary markets are securities markets in which newly issued securities are offered for sale to
buyers. Secondary markets are securities markets in which existing securities that have previously been issued
are resold. The initial issuer raises funds only through the primary market.

Debt Versus Equity Markets:

Debt instruments are particular types of securities that require the issuer (the borrower) to pay the holder (the
lender) certain fixed dollar amounts at regularly scheduled intervals until a specified time (the maturity date) is
reached, regardless of the success or failure of any investment projects for which the borrowed funds are used.
A debt instrument holder only participates in the management of the debt instrument issuer if the issuer goes
bankrupt. An example of a debt instrument is a 30-year mortgage.

In contrast, an equity is a security that confers on the holder an ownership interest in the issuer.

There are two general categories of equities: "preferred stock" and "common stock."

Common stock shares issued by a corporation are claims to a share of the assets of a corporation as well as to
a share of the corporation's net income -- i.e., the corporation's income after subtraction of taxes and other
expenses, including the payment of any debt obligations. This implies that the return that holders of common
stock receive depends on the economic performance of the issuing corporation.

Holders of a corporation's common stock typically participate in any upside performance of the corporation in
two ways: by receiving a share of net income in the form of dividends; and by enjoying an appreciation in the
price of their stock shares. However, the payment of dividends is not a contractual or legal requirement. Even if
net earnings are positive, a corporation is not obliged to distribute dividends to shareholders. For example, a
corporation might instead choose to keep its profits as retained earnings to be used for new capital investment
(self-financing of investment rather than debt or equity financing).

On the other hand, corporations cannot charge losses to their common stock shareholders. Consequently,
these shareholders at most risk losing the purchase price of their shares, a situation which arises if the market
price of their shares declines to zero for any reason. An example of a common stock share is a share of IBM.

In contrast, preferred stock shares are usually issued with a par value (e.g., $100) and pay a fixed dividend
expressed as a percentage of par value. Preferred stock is a claim against a corporation's cash flow that is
prior to the claims of its common stock holders but is generally subordinate to the claims of its debt holders. In
addition, like debt holders but unlike common stock holders, preferred stock holders generally do not participate
in the management of issuers through voting or other means unless the issuer is in extreme financial distress
(e.g., insolvency). Consequently, preferred stock combines some of the basic attributes of both debt and
common stock and is often referred to as a hybrid security.

Money versus Capital Markets:

The money market is the market for shorter-term securities, generally those with one year or less remaining to
maturity.

Examples: U.S. Treasury bills; negotiable bank certificates of deposit (CDs); commercial paper, Federal funds;
Eurodollars.

Remark: Although the maturity on certificates of deposit (CDs) -- i.e., on large time deposits at depository
institutions -- can run anywhere from 30 days to over 5 years, most CDs have a maturity of less than one year.
Those with a maturity of more than one year are referred to as term CDs. A CD that can be resold without
penalty in a secondary market prior to maturity is known as a negotiable CD.

The capital market is the market for longer-term securities, generally those with more than one year to maturity.

Examples: Corporate stocks; residential mortgages; U.S. government securities (marketable long-term); state
and local government bonds; bank commercial loans; consumer loans; commercial and farm mortgages.

Remark: Corporate stocks are conventionally considered to be long-term securities because they have no
maturity date.

Domestic Versus Global Financial Markets:

Eurocurrencies are currencies deposited in banks outside the country of issue. For example, eurodollars, a
major form of eurocurrency, are U.S. dollars deposited in foreign banks outside the U.S. or in foreign branches
of U.S. banks. That is, eurodollars are dollar-denominated bank deposits held in banks outside the U.S.

An international bond is a bond available for sale outside the country of its issuer.

Example of an International Bond: a bond issued by a U.S. firm that is available for sale both in the U.S. and
abroad.

A foreign bond is an international bond issued by a country that is denominated in a foreign currency and that is
for sale exclusively in the country of that foreign currency.

Example of a Foreign Bond: a bond issued by a U.S. firm that is denominated in Japanese yen and that is for
sale exclusively in Japan.

A Eurobond is an international bond denominated in a currency other than that of the country in which it is sold.
More precisely, it is issued by a borrower in one country, denominated in the borrower's currency, and sold
outside the borrower's country.

Example of a Eurobond: Bonds sold by the U.S. government to Japan that are denominated in U.S. dollars.
*Definition of Financial Institutions - Financial institutions, otherwise known as banking institutions, are
corporations that provide services as intermediaries(An intermediary is a third party that offers intermediation services
between two parties) of financial markets. The major categories of financial institutions include central
banks, retail and commercial banks, internet banks, credit unions, savings, and loans associations,
investment banks, investment companies, brokerage firms, insurance companies, and mortgage
companies.

List of Major Financial Institutions in India:

The Reserve Bank of India is the official Central Banking Authority for the smooth supervision of the
banking industry in India. RBI regulates the banking monetary policy in India. Banks are classified into 4
broad categories – Commercial Banks, Small Finance Banks, Payment Banks and Co-operative Banks.
Commercial Banks are further classified into Public sector banks and Private sector banks.

There are total of 91 commercial banks operating in India. Out of which, there are 20 Public Sector
Banks in India including SBI and 19 nationalized banks.

 Imperial Bank of India 1921

 Reserve Bank of India (RBI) April 1, 1935

 Industrial Finance Corporation of 1948
India (IFCI)

 State Bank of India July 1, 1955

 Industrial Credit and Investment 1955

Corporation India Ltd.(ICICI)

 Life insurance corporation of India Sept.1956

(LIC)

 Export Credit Guarantee Corporation 30 July 1957

of India (ECGC)

 Industrial Development Bank of India July,1964

(IDBI)

 General Insurance Corporation (GIC) Nov.1972

 Regional Rural Banks Oct. 2, 1975

 Housing development and finance 1977

Corporation Ltd (HDFC)

 EXIM Bank January 1,

1982

 IRBI( now it is called IIBIL since march March

1997) 20,1985

 Board for Industrial and Financial 1987

Reconstruction

 Securities and Exchange Board of April 12,

India (SEBI) 1988

 National Housing Bank July 1988

 Small Industries Development Bank 1990

 of India (SIDBI)

 Bharatiya Reserve Bank Note Mudran 1995

Private Limited

 Rural Infrastructure and Development April 1, 1995

Fund (RIDF)

 Infrastructure Development Finance Jan.31, 1997

Company (IDFC)

 Unit Trust of India Feb.1, 2003

 Bifurcation of UTI (UTI-i & UTI-ii) Feb. 2003

 Indian Infrastructure Finance April, 2006

Company (IIFCL)

 National Payments Corporation of Dec.2008

India

List of Banks in India

Allahabad Bank American Express Andhra Bank

Axis Bank Bandhan Bank Bank of Baroda

Bank of India Bank of Maharashtra Canara Bank

Catholic Syrian Bank Ltd. Central Bank of India Citibank

City Union Bank Corporation Bank DCB Bank

Dena Bank Deutsche Bank Dhanlaxmi Bank

DBS Bank Federal Bank HDFC Bank

HSBC Bank ICICI Bank IDBI Bank

IDFC Bank Indian Bank Indian Overseas Bank

IndusInd Bank J&K Bank Karnataka Bank

Karur Vysya Bank Kotak Mahindra Bank Lakshmi Vilas Bank

Nainital Bank Oriental Bank of Commerce Punjab & Sind Bank

Punjab National Bank RBL Bank South Indian Bank

Standard Chartered Bank State Bank of India Syndicate Bank

Tamilnad Mercantile Bank UCO Bank Union Bank of India

United Bank of India Vijaya Bank YES Bank

List of Financial Institutions in India

Bajaj Finserv Capital First Citicorp Finance (India) Limited

Credila DHFL India Infoline Finance Limited

Indiabulls LIC Housing Finance Limited Manappuram Finance

Muthoot Finance PNB Housing Tata Capital

Reliance Home Finance Shriram Housing Finance Sundaram Finance

Small Finance Banks

AU Small Finance Bank Capital Small Finance Bank ESAF Small Finance Bank

Equitas Small Finance Bank Fincare Small Finance Bank Jana Small Finance Bank

North East Small Finance Bank Suryoday Small Finance Bank Ujjivan Small Finance Bank

Utkarsh Small Finance Bank

Unit 1: Introduction

1.1 Nature, Structure and Role of Financial System

 What is Financial System - A 'financial system' is a system that allows the exchange of funds
between lenders, investors, and borrowers. Financial systems operates at national and global
levels.

Meaning of Financial System:

 A financial system is a system involving various components like the financial markets
(regulating different markets which perform the functions of facilitating financial
 transactions), financial intermediaries (financial institutions like banks and mutual funds),
suppliers and demanders of fund(any system would come into existence only when demand
and supply exist, facilitating the exchange process. There are suppliers and demanders of
funds. For eg. A company which requires money for investment in a new project would be a
demander of fund then the public would be investing in that company by providing funds and
taking their shares in exchange) (This is the main function of financial market involving the
various financial institutions) facilitating trade in financial assets regulated by governing
bodies(RBI SEBI all these governing bodies are keeping a track over the rules and regulations
of these systems to see if they are working well. This is where financial regulatories come into
existence for everyone to have equal opportunities)
 It enables lenders and borrowers to exchange funds.
 It serves as a network between all the financial institutions providing financial services to trade
in financial instruments in a way connecting demand with supply
___________________________________________________________________________
Structure of financial system:

Financial Market A financial market is market for creation and exchange of financial assets
involving various participants facilitating price discovery
1. Money Market -The market facilitating trade in short-term securities like t-bills(treasury bills),
commercial papers, certificate of deposits etc.
2. Capital Market - The market facilitating trade in long-term securities like shares, bonds and
debentures (In corporate finance, a debenture is a medium- to long-term debt instrument used by large companies to
borrow money, at a fixed rate of interest.)
____________________________________________________________________________
Financial Intermediaries
 Banks- A bank is a financial institution that accepts deposits from the public, creates credit and
provides various wealth management services. Ex- SBI, ICICI,HDFC etc
 Mutual Funds- An investment programme funded by various investors creating a pool of funds
to trade in financial assets. Ex- Aditya Birla Sun Life AMC Limited(Annual Maintenance Charges),
HDFC AMC Ltd. Etc
 NBFCs- A non-banking financial company is a financial institution that does not have a full
banking license but is registered under companies act performing various banking and financial
services. Ex- L&T Infotech, Bajaj Finserv, Muthoot Finance, Kotak Mahindra finance, ICICI
ventures etc (even though they do not have full banking services because they are registered
under the companies act but still they provided many financial services like leasing, finance,
higher purchasing finance, infrastructure finance, housing finance, venture capital finance,
investment and securities)
 Insurance Companies- Companies providing insurance services as a means of protection from
financial loss. Ex- LIC, Max Life Insurance, HDFC std. life insurance etc.
 NBFSCs- It stands for Non-Banking Financial Services Companies. This group of companies
consists of merchant banks, credit rating agencies, depositories(A depository is a facility such as
a building, office, or warehouse in which something is deposited for storage or safeguarding. It
 can refer to an organization, bank, or institution that holds securities and assists in the trading of
securities).
1. Merchant banks like Goldman Sachs Securities Pvt. Ltd., Morgan Stanley India Co. Pvt. Ltd.,
SBI Capital Markets ltd., ICICI Securities ltd.
2. Credit Rating Agencies like CRISIL(Credit Rating Information Services of India Ltd),
CARE(Credit Analysis and Research Ltd), ICRA (Investment Information and Credit Rating
Agency) (Is any company that assigns rating to debtors according to their ability to pay back
the debt. Basically Credit Score)
3. Depositories like NSDL ( National Securities Depository Ltd.), CSDL ( Central Securities
Depository Ltd.) They are institutions which dematerialize fiscal(tax) securities. These
depositories provide the transfer of ownership by electronic entries For eg. When exchanging
shares they would facilitate the transfer of ownership from one party to another

Financial Regulatory Bodies

 RBI- The Reserve Bank of India is India's central banking institution, which controls the issuance
and supply of the Indian rupee and serves as banker’s bank established in 1935
 SEBI- The Securities and Exchange Board of India has been entrusted with the responsibility of
dealing with various matters relating to capital market founded in 1992
 IRDA- The Insurance Regulatory and Development Authority of India is an autonomous,
statutory body tasked with regulating and promoting the insurance industries in India founded
in 1999
 PFRDA- The Pension Fund Regulatory and Development Authority, a statutory body, is the
pension regulator of India which was established by Government of India in 2003

__________________________________________________________________________________

Role/Functions of financial system

 It provides a payment system for the exchange of goods & services
 It generates information that helps in coordinating decision making
 It provides a way for managing uncertainity and controlling risk
 It enables the pooling of funds for undertaking large projects or setting up business
 It provides a mechanism for transfer of financial asset and helps in reducing the cost of
transaction
 It serves as a source of capital formation both for the individual as well as economy
_____________________________________________________________________________________

1.2 Equilibriumin Financial Markets (Equilibrium is the state in which market supply and demand balance
each other, and as a result, prices become stable. ... The balancing effect of supply and demand results in
a state of equilibrium.)

Infation Vs Deflation

*Inflation is the increase in the prices of goods and services over time. It's an economics
term that means you have to spend more to fill your gas tank, buy a gallon of milk, or get a
haircut. Inflation increases your cost of living. Inflation reduces the purchasing power of
each unit of currency.
There are two main causes of inflation: Demand-pull(occur when demand from consumers
pulls prices up.) and Cost-push(occurs when supply cost force prices higher.). Both are
responsible for a general rise in prices in an economy.
Demand-pull inflation is the most common cause of rising prices. It occurs when
consumer demand for goods and services increases so much that it outstrips supply.
Producers can't make enough to meet demand. They may not have time to build the
manufacturing needed to boost supply. They may not have enough skilled workers to make
it. Or the raw materials might be scarce.
If sellers don't raise the price, they will sell out. They soon realize they now have the luxury
of hiking up prices. If enough do this, they create inflation.

The second cause is cost-push inflation. It only occurs when there is a supply shortage
combined with enough demand to allow the producer to raise prices.
There are five contributors to inflation on the supply side. The first is wage
inflation that increases salaries. It rarely occurs without active labor unions.
A company with the ability to create a monopoly is a second contributor to cost-push
inflation. It controls the entire supply of a good or service. The Sherman Anti-Trust Act
outlawed monopolies in 1890.
Natural disasters create temporary cost-push inflation by damaging production facilities.
That's what happened to oil refineries after Hurricane Katrina. The depletion of natural
resources is a growing cause of cost-push inflation. For example, overfishing has reduced
the supply of seafood and drives up prices.

The Bottom Line

There are two major types of inflation: demand-pull and cost-push. Demand-pull inflation
occurs when consumers have greater disposable income. Having more money to spend
allows people to want more products and services. Expansionary fiscal and monetary
policies, consumer expectation of future price increases, and marketing or branding can
increase demand.
Cost-pull inflation happens when supply decreases, creating a shortage. Producers raise
prices to meet the increasing demand for their goods or services. Increase in wages,
monopoly pricing, natural disasters, government regulations, and currency exchange rates
often decrease supply vis-à-vis demand.
Deflation
*Deflation is a decrease in the general price level of goods and services. Deflation occurs
when the inflation rate falls below 0%. Inflation reduces the value of currency over time, but
deflation increases it. This allows more goods and services to be bought than before with
the same amount of currency.
A reduction in money supply or credit availability is the reason for deflation in most cases
when price decreases lead to lower production levels, which, in turn, leads to lower wages,
which leads to lower demand by businesses and consumers, which lead to further
decreases in prices.

*Which is better deflation or inflation?

Moderate inflation is also good because it increases national output, employment and income,
whereas deflation reduces national income and brings the economy backward to a state of
depression. Again inflation is better than deflation because when it occurs the economy is
already in a situation of full employment

Equilibrium is the state in which market supply and demand balance each other, and as a result,
prices become stable. Generally, an over-supply of goods or services causes prices to go down,
which results in higher demand. The balancing effect of supply and demand results in a state of
equilibrium.

Understanding Equilibrium
The equilibrium price is where the supply of goods matches demand. When a
major index experiences a period of consolidation or sideways momentum, it can be said that the
forces of supply and demand are relatively equal and that the market is in a state of equilibrium.
As proposed by New Keynesian economist and PhD, Huw Dixon, there are three properties to a state
of equilibrium: the behavior of agents is consistent, no agent has an incentive to change its
behavior, and that the equilibrium is the outcome of some dynamic process. Dr. Dixon names these
principles: equilibrium property 1, equilibrium property 2, and equilibrium property 3, or P1, P2, and
P3, respectively.
KEY TAKEAWAYS
 A market is said to have reached equilibrium price when the supply of goods matches demand.
 A market in equilibrium demonstrates three characteristics: behavior of agents is consistent,
there are no incentives for agents to change behavior, and a dynamic process governs
equilibrium outcome.
 Disequilibrium is the opposite of equilibrium and it is characterized by changes in conditions
that affect market equilibrium.
Notes on Equilibrium
Economists like Adam Smith believed that a free market would trend towards equilibrium. For
example, a dearth(scarcity/lack of something) of any one good would create a higher price
generally, which would reduce demand, leading to an increase in supply provided the right
incentive(motivation/stimulant). The same would occur in reverse order provided there was excess
in any one market.
Modern economists point out that cartels (A cartel is a grouping of producers that work together to
protect their interests. Cartels are created when a few large producers decide to co-operate with respect to
aspects of their market. Once formed, cartels can fix prices for members, so that competition on price is
avoided.) or monopolistic ( A market structure characterized by a single seller, selling a unique product in
the market. In a monopoly market, the seller faces no competition, as he is the sole seller of goods with
no close substitute. ... He enjoys the power of setting the price for his goods.) companies can artificially
hold prices higher and keep them there in order to reap higher profits. The diamond industry is a
classic example of a market where demand is high, but supply is made artificially scarce by
companies selling fewer diamonds in order to keep prices high. Another example would be Royal
Enfield in the past but now has opted for mass production and overly commercial with more color
options and variants.
Paul Samuelson argued in a 1983 paper Foundations of Economic Analysis published by Harvard
University that giving equilibrium markets what he described as a ‘normative meaning’ or a value
judgment was a misstep. Markets can be in equilibrium, but it may not mean that all is well. For
example, the food markets in Ireland were at equilibrium during the great potato famine in the mid
1800s. Higher profits from selling to the British made it so the Irish/British market was at equilibrium
price was higher than what farmers could pay, contributing to one of the many reasons people
starved.

Equilibrium vs. Disequilibrium

When markets aren't in a state of equilibrium, they are said to be in disequilibrium. Disequilibrium
either happens in a flash, or is a characteristic of a certain market. At times disequilibrium can
spillover from one market to another, for instance if there aren’t enough companies to ship coffee
internationally then the coffee supply for certain regions could be reduced, effecting the equilibrium
of coffee markets. Economists view many labor markets as being in disequilibrium due to how
legislation and public policy protect people and their jobs, or the amount they are compensated for
their labor.
Example of Equilibrium
A store manufactures 1,000 spinning tops and retails them at Rs700 per piece. But no one is willing
to buy them at that price. To pump up demand, the store reduces their price to Rs 500. There are
250 buyers at that price point. In response, the store further slashes the retail cost to Rs. 350 and
garners five hundred buyers in total. Upon further reduction of the price to Rs 150, one thousand
buyers of the spinning top materialize. At this price point, supply equals demand. Hence Rs 150 is
the equilibrium price for the spinning tops.