1.

Financial System

A financial system refers to the collection of institutions, markets, instruments, laws, and
regulations that facilitate the transfer of funds between savers and borrowers. It plays a critical
role in mobilizing savings, allocating capital, and facilitating economic development. The major
components of a financial system include financial institutions (banks, insurance companies),
financial markets (money market, capital market), financial instruments (shares, bonds,
derivatives), financial services (loans, mutual funds, insurance), and regulatory bodies like RBI,
SEBI, and IRDAI.

The primary functions of the financial system are to channel savings into investments, provide
liquidity, allocate risk, and maintain economic stability. For example, banks collect deposits
from the public and lend to businesses, enabling capital formation. The financial system also
supports monetary policy transmission and ensures an efficient payment mechanism through
digital and physical infrastructure. In India, the financial system is categorized into formal
(regulated by authorities) and informal sectors (moneylenders, chit funds), with increasing
digitalization strengthening the formal system.

2. Financial Services

Financial services are economic services provided by the finance industry that help individuals
and organizations manage, invest, grow, and protect their money. These services include banking
(loans, savings), insurance (life, health), asset management (mutual funds, portfolio
management), stockbroking, credit rating, and more. Financial services form the backbone of the
financial system as they connect investors, borrowers, and markets.

The key players in this sector include banks, NBFCs, insurance companies, mutual fund houses,
and fintech startups. Financial services enable wealth creation by helping people make informed
decisions and offering access to funds and credit. For businesses, they provide capital for
expansion, manage financial risk, and help with mergers and acquisitions. With technological
advancements, services like mobile banking, UPI, robo-advisors, and online trading platforms
have transformed the delivery of financial services in India.

3. Money Market & Its Instruments

The money market is a part of the financial market where short-term instruments with high
liquidity and short maturities (usually less than one year) are traded. It plays a vital role in the
economy by providing a platform for borrowing and lending funds for short durations,
maintaining liquidity, and enabling monetary policy implementation by central banks.

The key instruments in the Indian money market include:

  Treasury Bills (T-Bills): Issued by the government, short-term instruments with
maturities of 91, 182, or 364 days.
 Commercial Paper (CP): Unsecured promissory notes issued by corporations to meet
working capital needs.
 Certificates of Deposit (CD): Time deposits issued by banks to attract short-term funds.
 Call Money: Very short-term funds (overnight to 14 days) used by banks to maintain
liquidity.
 Repurchase Agreements (Repo): Agreements for selling securities with a commitment
to repurchase them at a later date.

The money market is crucial for stabilizing the banking system and supporting liquidity in the
economy.

4. Non-Banking Financial Companies (NBFCs)

NBFCs are financial institutions that provide banking services without meeting the legal
definition of a bank. They are registered under the Companies Act and regulated by the Reserve
Bank of India (RBI). Unlike banks, NBFCs cannot accept demand deposits or issue cheques
drawn on themselves, but they play a vital role in financial inclusion by reaching underserved
segments of the population.

NBFCs provide a wide range of services, including loans and credit facilities, leasing, hire-
purchase, investment in securities, asset management, and insurance. Major NBFCs in India
include Bajaj Finance, LIC Housing Finance, and Muthoot Finance. They serve sectors like
MSMEs, infrastructure, and real estate where traditional banks may hesitate to lend. NBFCs are
categorized into Investment Companies, Loan Companies, Infrastructure Finance Companies,
and Microfinance Institutions.

Their flexibility, faster processing, and targeted services make NBFCs key players in India's
financial ecosystem, although they face stricter regulatory scrutiny after incidents like the IL&FS
crisis.

5. Risk and Return Measurement

Risk and return are two core concepts in finance. Return is the profit or loss derived from an
investment over a certain period, usually expressed as a percentage of the initial investment. It
can be in the form of dividends, interest, or capital gains. Risk, on the other hand, is the
possibility that the actual returns will differ from expected returns. In finance, a higher risk is
generally associated with a potential for higher returns.

Return measurement is done through formulas like:

 Simple Return = (Final Value - Initial Value) / Initial Value × 100

 Annualized Return for comparing investments across different timeframes.
Risk measurement tools include:

 Standard Deviation: Measures total risk by showing variability in returns.

 Beta: Measures market risk or systematic risk relative to the market.
 Sharpe Ratio: Evaluates return per unit of risk (excess return over risk-free rate divided
by standard deviation).

These tools help investors choose investments matching their risk appetite and return
expectations, aiding in portfolio management and decision-making.

6. Depository and Depository Participant

A Depository is a financial institution that holds securities such as shares, bonds, and debentures
in electronic form, enabling seamless trading and transfer. In India, the two major depositories
are NSDL (National Securities Depository Ltd.) and CDSL (Central Depository Services
Ltd.). These institutions reduce the risks associated with physical securities, such as loss, theft,
or forgery.

A Depository Participant (DP) acts as an intermediary between the investor and the depository.
DPs can be banks, brokers, or financial institutions registered with SEBI. An investor opens a
Demat Account with a DP to hold securities electronically. For example, if you purchase shares
on the stock exchange, they are credited to your Demat account by your DP.

The depository system ensures transparency, safety, and efficiency in the Indian securities
market, making investing more accessible and secure.

7. Benchmark Indices

Benchmark indices are indicators that reflect the overall performance of a group of stocks,
representing a segment of the financial market. These indices are used to track market trends and
measure the performance of investment portfolios or mutual funds.

In India, the two main benchmark indices are:

 Sensex (by BSE): Tracks 30 major companies from various sectors.

 Nifty 50 (by NSE): Tracks 50 actively traded stocks from different sectors.

Other sectoral indices include Nifty Bank, Nifty IT, etc. Benchmark indices serve as a standard
for fund managers to compare the returns of their funds. If a fund underperforms the index, it
may be considered inefficient. For retail investors, these indices help gauge market sentiment
and make informed investment decisions.
8. Mutual Funds

A Mutual Fund (MF) is an investment vehicle that pools money from various investors and
invests it in diversified assets like equities, debt instruments, or a mix of both. These funds are
managed by professional fund managers who aim to generate returns aligned with the fund’s
objective.

Benefits of mutual funds include diversification (spreading risk), professional management,

liquidity, and affordability (low minimum investments). Mutual funds are ideal for investors who
lack the time or expertise to manage individual investments.

Types of mutual funds include:

 Equity Funds (invest in stocks)

 Debt Funds (invest in bonds)
 Hybrid Funds (mix of equity and debt)
 Index Funds (track an index)

They are regulated by SEBI to protect investor interests. Mutual funds are popular due to their
transparency, flexibility, and potential for consistent returns.

9. Open-Ended Mutual Funds

Open-ended mutual funds allow investors to enter or exit the fund at any time based on the Net
Asset Value (NAV) of the fund. These funds do not have a fixed maturity period and offer high
liquidity, which is beneficial for investors seeking flexibility.

The NAV of the fund is calculated daily and reflects the current market value of the fund’s
assets. Open-ended funds continuously issue and redeem units, depending on investor demand.

These are the most common types of mutual funds in India, available in various categories such
as large-cap, mid-cap, debt, or balanced funds. Investors can choose Systematic Investment
Plans (SIPs) to invest periodically.

Examples include HDFC Equity Fund, ICICI Prudential Bluechip Fund, etc. Their flexibility,
professional management, and accessibility make them a preferred choice for retail investors.

10. Thematic Mutual Funds

Thematic Mutual Funds invest in stocks based on a particular theme or trend rather than a
specific sector. Themes may include digital technology, ESG (Environmental, Social,
Governance), infrastructure, consumption, or rural development. Unlike sectoral funds that focus
on a single industry, thematic funds can span across sectors if they fit the theme.

These funds aim to capitalize on long-term macroeconomic or structural trends. For example, a
Green Energy Thematic Fund may invest in renewable energy, electric vehicles, and
sustainability-focused companies.

While these funds offer potential for high returns if the theme performs well, they are also risky
due to their concentrated investment strategy. Hence, thematic funds are suitable for
knowledgeable investors with a high-risk appetite and long-term investment horizon.

11. Share Buyback

Share buyback is a corporate action where a company repurchases its own shares from the
existing shareholders or from the open market. Companies undertake buybacks for several
reasons: to reduce the number of outstanding shares, improve earnings per share (EPS), return
surplus cash to shareholders, or signal that the stock is undervalued.

Buybacks can be conducted in two ways:

 Open Market Buyback – through stock exchanges.

 Tender Offer Buyback – shareholders offer shares at a fixed price.

The benefits include improved valuation metrics, better capital structure, and increased
shareholder value. However, excessive buybacks may also reduce future growth investment
opportunities. SEBI regulates buybacks in India to ensure transparency and protect shareholder
interests.

12. NAV for Mutual Funds

NAV (Net Asset Value) is the per-unit price of a mutual fund. It represents the market value of
all the assets held by the fund, minus its liabilities, divided by the total number of units
outstanding.

NAV=Total Assets – LiabilitiesNumber of Outstanding Units\text{NAV} = \frac{\text{Total

Assets – Liabilities}}{\text{Number of Outstanding
Units}}NAV=Number of Outstanding UnitsTotal Assets – Liabilities

NAV is calculated daily at the end of the trading day. For open-ended mutual funds, the NAV
determines the price at which investors buy or sell fund units. NAV helps track fund
performance, but it’s not the sole indicator of growth. It doesn’t reflect the stock market price
movements directly but adjusts based on changes in the fund’s holdings.

Investors should also consider other metrics like past returns, expense ratio, and fund manager
performance while evaluating a mutual fund.

13. Financial Regulators in India

India has several financial regulatory authorities to ensure stability, transparency, and investor
protection in the financial system. The key regulators include:

 Reserve Bank of India (RBI): Central bank that regulates monetary policy, banking, and
inflation control.
 Securities and Exchange Board of India (SEBI): Regulates stock markets, mutual
funds, and securities market participants.
 Insurance Regulatory and Development Authority of India (IRDAI): Oversees the
insurance sector.
 Pension Fund Regulatory and Development Authority (PFRDA): Regulates pension
and retirement schemes like NPS.
 NABARD: Supervises rural credit and agricultural finance.

These regulators ensure compliance, protect consumers, and develop infrastructure to foster a
strong financial ecosystem in India.

14. Greenshoe Option in IPO

The Greenshoe Option is a mechanism used during an IPO (Initial Public Offering) to stabilize
the stock price in the secondary market. It allows the underwriters to sell more shares (typically
15% more) than initially planned, in case of high demand.

If the stock price falls post-IPO, underwriters can buy back shares from the market to support the
price. If the price rises, they can use the extra shares allotted under the Greenshoe Option to meet
excess demand.

This mechanism reduces volatility and boosts investor confidence. In India, the Greenshoe
Option was used during major IPOs like Reliance Power and LIC.

15. Financial Scams

Financial scams are fraudulent schemes that mislead investors or institutions for financial gain.
India has witnessed several high-profile financial frauds, such as:

 Harshad Mehta Scam (1992): Misuse of banking loopholes to manipulate stock prices.
 Ketan Parekh Scam (2001): Insider trading and circular trading in stock markets.
 PNB-Nirav Modi Scam (2018): Fraudulent issuance of Letters of Undertaking (LoUs)
worth ₹13,000+ crore.

These scams exposed weaknesses in regulatory systems and prompted reforms. The aftermath
included stricter SEBI and RBI guidelines, mandatory audit disclosures, and digital surveillance
systems to detect fraud.

16. PE and VC

Private Equity (PE) and Venture Capital (VC) are forms of investment in private companies,
but they differ in focus and stage of investment:

 PE involves investing in mature, often underperforming companies to restructure or

expand them. The goal is high returns through management improvement or cost
reduction.
 VC focuses on early-stage startups with innovative ideas and high growth potential. It
involves higher risk and potential high reward.

Both provide not just capital but also strategic guidance, networking, and mentoring. They are
vital for business innovation, job creation, and economic growth.

17. Credit Rating

Credit rating is a formal assessment of the creditworthiness of an individual, company, or

government entity. It reflects the entity’s ability to repay debts on time. Credit rating agencies
like CRISIL, ICRA, and CARE assign ratings such as AAA (highest), AA, A, BBB, etc.

High-rated entities can borrow at lower interest rates. Ratings are based on financial statements,
debt levels, industry position, and management quality. While useful, ratings are not foolproof
and should be considered alongside other financial indicators.

18. Credit Scoring

Credit scoring is a numerical system used to evaluate the credit risk of an individual. In India,
agencies like CIBIL, Experian, and Equifax calculate credit scores ranging from 300 to 900. A
score above 750 is generally considered good.

Factors affecting credit score include:

 Repayment history
 Credit utilization ratio
 Credit mix
 Length of credit history

Credit scores are used by banks and NBFCs to approve or reject loan and credit card
applications. Maintaining a high credit score helps in getting better interest rates and higher loan
limits.

19. Types of Mutual Funds

Mutual funds are classified based on structure, asset class, and investment objective:

 By Structure:
o Open-Ended: No maturity, flexible entry/exit.
o Closed-Ended: Fixed maturity, listed on exchanges.
 By Asset Class:
o Equity Funds: Invest in stocks.
o Debt Funds: Invest in bonds.
o Hybrid Funds: Combination of equity and debt.
 By Objective:
o Index Funds: Track specific market indices.
o ELSS (Tax-saving): Offer tax benefits under Section 80C.
o Thematic/Sectoral Funds: Focus on themes or specific industries.

Each fund type has different risk-return profiles and is suited to different investor goals.

20. Banking System

The Banking System is the backbone of a country’s financial infrastructure. It is a network of institutions
that accept deposits from the public, provide loans, and offer various financial services. The Indian
banking system plays a crucial role in mobilizing savings, promoting investments, and facilitating
economic development.
Types of Banks in India:

1. Commercial Banks – These include both public and private sector banks that offer services like
savings and current accounts, personal and business loans, credit cards, etc.
o Examples: State Bank of India (Public), HDFC Bank (Private)
2. Cooperative Banks – Operate on a cooperative basis to provide credit facilities to rural and
semi-urban areas. They are categorized into Urban and Rural Cooperative Banks.
3. Regional Rural Banks (RRBs) – Established to provide banking services in rural areas, especially
to farmers and small businesses.
4. Development Banks – Provide long-term financing to industries and infrastructure projects.
o Example: NABARD, SIDBI
5. Payments Banks – These are niche banks offering limited services like deposits, payments, and
remittances. They cannot lend money.
o Example: Paytm Payments Bank
6. Small Finance Banks – Provide financial inclusion to underserved sections by offering loans and
accepting deposits.
o Example: AU Small Finance Bank

Structure of Indian Banking System:

 Reserve Bank of India (RBI): The apex body that regulates the banking system, controls
monetary policy, and ensures financial stability.
 Scheduled vs Non-Scheduled Banks: Scheduled banks are listed in the Second Schedule of the
RBI Act and fulfill specific criteria, while non-scheduled banks do not.

Functions of Banks:

 Accepting Deposits (savings, current, fixed)

 Lending Loans (home loans, personal loans, business loans)
 Facilitating Payments and Settlements (cheques, UPI, NEFT/RTGS)
 Offering Financial Services (insurance, mutual funds, forex)
 Promoting Digital Banking and Financial Inclusion

Recent Developments:

 Digital Banking: UPI, Mobile Banking, and Internet Banking have revolutionized the Indian
banking system.
 Consolidation: Several public sector banks have been merged to strengthen the system.
 Financial Inclusion: Through schemes like Jan Dhan Yojana, more people are brought into the
banking system.