205 FIN : FINANCIAL MARKETS & BANKING OPERATIONS

Q1) Solve any five :

a) Define financial system.
A financial system refers to a network of institutions, markets, regulations, and
mechanisms that facilitate the flow of funds between lenders (savers) and borrowers
(investors) within an economy. It encompasses various components, including financial
institutions such as banks, credit unions, insurance companies, and investment firms, as
well as financial markets such as stock exchanges, bond markets, and money markets.

Key functions of a financial system include:

1. Intermediation: Financial institutions act as intermediaries between savers and

borrowers by accepting deposits from savers and providing loans or investment
opportunities to borrowers.
2. Facilitating Payments: The financial system provides mechanisms for making
payments, such as bank accounts, checks, electronic funds transfers, and payment cards,
which facilitate transactions between individuals, businesses, and governments.
3. Risk Management: Financial institutions and markets offer a range of products and
services to help manage financial risks, including insurance, hedging instruments, and
diversification strategies.
4. Resource Allocation: By channeling funds from savers to borrowers, the financial
system plays a crucial role in allocating resources efficiently across different sectors of
the economy, thereby promoting economic growth and development.
5. Price Discovery: Financial markets provide a platform for determining the prices of
financial assets, such as stocks, bonds, currencies, and commodities, based on supply
and demand dynamics and other market forces.
6. Policy Transmission: The financial system serves as a transmission mechanism for
monetary policy actions by central banks, which influence interest rates, credit
conditions, and overall economic activity.

b) State the difference between Money Market and Capital Market.

1. Instruments Traded:
 Money Market: The money market deals with short-term debt securities and financial
instruments with high liquidity and low risk. Examples include Treasury bills, commercial
paper, certificates of deposit (CDs), repurchase agreements (repos), and short-term
government bonds.
 Capital Market: The capital market, on the other hand, deals with long-term securities
and financial instruments used for raising long-term funds. This includes stocks (equity),
bonds with longer maturities (corporate bonds, municipal bonds, and government
bonds), and other long-term investments like real estate and derivatives.

2. Maturity of Instruments:

 Money Market: Instruments in the money market typically have short-term maturities,
usually ranging from overnight to one year. They are used for short-term financing
needs and cash management by institutions, corporations, and governments.
 Capital Market: Instruments in the capital market have longer-term maturities, extending
beyond one year and often lasting several years or even decades. They are used for
long-term investment and capital-raising purposes by businesses and governments.

3. Participants:

 Money Market: Participants in the money market include commercial banks, central
banks, corporations, financial institutions, and government entities. They use the money
market to manage liquidity, meet short-term funding needs, and invest excess cash.
 Capital Market: Participants in the capital market include investors, corporations,
governments, financial institutions, and investment banks. They engage in the capital
market to raise long-term capital for business expansion, infrastructure projects, or
government financing, and to invest in long-term assets for wealth accumulation and
retirement planning.

4. Risk and Return:

 Money Market: Generally, investments in the money market are considered low risk with
correspondingly lower returns. This is because money market instruments are typically
backed by strong issuers and have short maturities, leading to lower exposure to
interest rate and credit risk.
c) Define the term OMR.
OMR stands for Optical Mark Recognition. It is a technology used to detect and
interpret marks made by a human or machine on documents such as surveys,
questionnaires, and multiple-choice examination papers. OMR technology relies on
specialized scanners or imaging devices to capture images of these documents and
software algorithms to analyze the marks.

OMR systems are commonly used in various fields, including education (for grading
multiple-choice tests), market research (for collecting survey data), elections (for
processing ballot papers), and data collection in general. The marks made on the
documents are typically in the form of filled-in bubbles, checkboxes, or tick marks, which
are then interpreted by the OMR software to extract and tabulate the data.

OMR technology offers advantages such as speed, accuracy, and efficiency in processing
large volumes of paper-based forms. It eliminates the need for manual data entry and
reduces the potential for human error, making it a valuable tool for automating data
collection and analysis processes.

d) List the advantages of Commodity Future Market.

1. Price Discovery: Futures markets provide a platform where buyers and sellers can
discover the market-clearing price for commodities based on supply and demand
dynamics, as well as other factors such as weather conditions, geopolitical events, and
economic trends.
2. Risk Management: One of the primary advantages of commodity futures markets is
their role in hedging against price fluctuations. Producers and consumers can use
futures contracts to lock in prices for future delivery, thereby mitigating their exposure
to price volatility and uncertainty. This helps stabilize cash flows and protects against
adverse market movements.
3. Efficient Allocation of Resources: Futures markets facilitate the efficient allocation of
resources by allowing market participants to adjust their production and consumption
plans in response to changing market conditions. This helps ensure that resources are
allocated to their most productive uses, promoting economic efficiency and optimal
resource utilization.
4. Liquidity and Market Depth: Commodity futures markets are typically highly liquid,
with a large number of buyers and sellers actively participating in trading activities. This
liquidity ensures that market participants can enter and exit positions easily, without
significantly impacting market prices. It also promotes price stability and reduces the
cost of trading.
5. Arbitrage Opportunities: Futures markets provide opportunities for arbitrage, where
traders can exploit price differentials between futures contracts and the underlying
physical commodities or between different futures contracts with the same underlying
commodity. Arbitrage activities help align prices across different markets and ensure
efficient price discovery.
6. Speculation and Investment Opportunities: Commodity futures markets attract
speculators and investors seeking to profit from anticipated price movements.
Speculative activity adds liquidity to the market and enhances price discovery, while also
providing opportunities for investors to diversify their portfolios and potentially
generate returns that are uncorrelated with traditional asset classes.
7. Global Reach and Access: With the advancement of technology, commodity futures
markets have become increasingly accessible to participants around the world. This
globalization allows producers, consumers, traders, and investors to hedge their

e) Define GDR

GDR stands for Global Depository Receipt. It is a financial instrument issued by a

depository bank in one country, typically located outside the issuing company's home
country, representing ownership of a certain number of shares in the issuing company.
GDRs are commonly used by companies to raise capital in international markets and to
enable investors outside the company's home country to invest in its shares.
 Here's how the process typically works:

1. Issuance: A company seeking to raise capital in international markets engages a

depository bank to issue GDRs on its behalf. The depository bank purchases shares of
the issuing company in the local market and deposits them with a custodian bank in the
company's home country.
2. GDR Creation: The depository bank then issues GDRs, representing ownership of the
deposited shares, to investors in international markets. Each GDR typically represents a
certain number of underlying shares, with the ratio determined by the issuing company
and the depository bank.
3. Trading: GDRs are traded on international stock exchanges, allowing investors to buy
and sell them like regular shares. The prices of GDRs are influenced by various factors,
including the performance of the underlying company, market conditions, and investor
sentiment.
4. Dividends and Voting Rights: GDR holders are entitled to receive dividends and other
corporate actions, such as rights issues or bonus shares, equivalent to the underlying
shares they represent. However, GDR holders usually do not have voting rights in the
issuing company's shareholder meetings, as these rights remain with the custodian bank
or are held separately by the company's management.
5. Conversion: GDRs can typically be converted into underlying shares by submitting them
to the depository bank for redemption. Conversely, investors can also convert
underlying shares into GDRs by depositing them with the depository bank.

f) Define Central Bank

1. Monetary Policy: Central banks are responsible for formulating and implementing
monetary policy, which involves managing the money supply, interest rates, and credit
conditions in the economy to achieve macroeconomic objectives such as price stability,
full employment, and economic growth. This is often done through open market
operations, changes in interest rates, reserve requirements, and other policy tools.
2. Currency Issuance: Central banks have the authority to issue currency and regulate its
circulation within the economy. They are responsible for designing and distributing
banknotes and coins, ensuring their integrity and security, and maintaining public
confidence in the currency.
3. Banking Regulation and Supervision: Central banks typically have regulatory and
supervisory authority over commercial banks and other financial institutions operating
within their jurisdiction. They establish prudential regulations, conduct examinations and
audits, and oversee compliance with banking laws and regulations to promote financial
stability and protect depositors' interests.
4. Lender of Last Resort: Central banks serve as lenders of last resort to commercial banks
and other financial institutions facing liquidity shortages or financial distress. They
provide emergency liquidity assistance through various mechanisms, such as discount
window lending, to prevent systemic disruptions and maintain confidence in the
financial system.
5. Foreign Exchange Management: Central banks manage a country's foreign exchange
reserves and intervene in foreign exchange markets to influence the value of the
national currency relative to other currencies. They may engage in foreign exchange
operations to stabilize exchange rates, address imbalances in the balance of payments,
or build reserves to support monetary policy objectives.
6. Clearing and Settlement: Central banks often operate or oversee payment and
settlement systems that facilitate the efficient and secure transfer of funds between
financial institutions. These systems play a critical role in the functioning of the financial
markets and the broader economy by enabling the timely settlement of transactions
and reducing counterparty risks.

g) List out diffeent types of banking.

1. Retail Banks: These banks cater to individual consumers and provide a wide range of
basic banking services such as savings accounts, checking accounts, personal loans,
mortgages, and credit cards. They typically have a network of branches and ATMs for
customer convenience.
2. Commercial Banks: Commercial banks primarily serve businesses, offering a variety of
financial products and services tailored to their needs. These include business loans,
lines of credit, cash management services, merchant services, and business accounts.
3. Investment Banks: Investment banks specialize in providing financial advisory services,
underwriting securities issuance (such as stocks and bonds), facilitating mergers and
acquisitions, and managing corporate restructuring. They also engage in trading
activities and offer brokerage services to institutional clients and high-net-worth
individuals.
4. Private Banks: Private banks offer personalized wealth management and financial
services to high-net-worth individuals (HNWIs) and ultra-high-net-worth individuals
(UHNWIs). They provide customized investment advice, portfolio management, estate
planning, and other specialized services tailored to the unique needs of wealthy clients.
5. Community Banks: Community banks are locally owned and operated financial
institutions that focus on serving the banking needs of specific communities or regions.
They often have deep roots in their communities and offer personalized customer
service, community development lending, and support for local businesses and
organizations.
6. Online Banks: Online banks operate exclusively through digital channels, such as
websites and mobile apps, without physical branches. They typically offer higher interest
rates on savings accounts and lower fees compared to traditional brick-and-mortar
banks, appealing to customers seeking convenience and competitive rates.
7. Credit Unions: Credit unions are member-owned financial cooperatives that offer
banking services to their members, who typically share a common bond such as
employment, residence, or membership in a specific organization or community. Credit
unions provide savings accounts, loans, and other financial products with a focus on
serving the needs of their members and promoting financial inclusion.

h) Define option.
An option is a financial derivative contract that gives the holder (the buyer) the right, but
not the obligation, to buy or sell a specific underlying asset at a predetermined price
(the strike price) within a specified period of time (until the expiration date). The
underlying asset can be a stock, a bond, a commodity, a currency, or an index.

There are two main types of options:

1. Call Option: A call option gives the holder the right to buy the underlying asset at the
strike price on or before the expiration date. If the price of the underlying asset rises
above the strike price before expiration, the holder can exercise the option and buy the
asset at the lower strike price, potentially realizing a profit. If the price remains below
the strike price or falls, the holder may choose not to exercise the option, allowing it to
expire worthless.
2. Put Option: A put option gives the holder the right to sell the underlying asset at the
strike price on or before the expiration date. If the price of the underlying asset falls
below the strike price before expiration, the holder can exercise the option and sell the
asset at the higher strike price, potentially profiting from the price decline. If the price
 remains above the strike price or rises, the holder may choose not to exercise the
option, allowing it to expire worthless.

Options are commonly used for hedging, speculation, and generating income.

Q2) Solve any two :

a) Explain in detail on Bond Markets.

1. Participants:

 Issuers: Entities that issue bonds to raise funds, such as governments, municipalities,
corporations, and government-sponsored enterprises (GSEs).
 Investors: Individuals, institutional investors, and financial institutions that buy bonds as
investments. These include pension funds, mutual funds, insurance companies, banks,
hedge funds, and individual investors.
 Intermediaries: Brokerage firms, investment banks, bond dealers, and bond market
makers that facilitate bond trading by matching buyers and sellers, providing liquidity,
and offering advisory services.

2. Types of Bonds:
 Government Bonds: Issued by national governments to finance public spending and
manage government debt. Examples include U.S. Treasury bonds, German Bunds, and
Japanese Government Bonds (JGBs).
 Municipal Bonds: Issued by state and local governments to finance public infrastructure
projects, such as schools, roads, and utilities. Municipal bonds offer tax advantages for
investors.
 Corporate Bonds: Issued by corporations to raise capital for business operations,
expansion, or acquisitions. Corporate bonds vary in credit quality and risk, ranging from
investment-grade bonds issued by blue-chip companies to high-yield or junk bonds
issued by lower-rated companies.
 Agency Bonds: Issued by government-sponsored enterprises (GSEs) such as Fannie Mae,
Freddie Mac, and the Federal Home Loan Banks to support housing finance and other
public policy objectives.
 Asset-backed Securities (ABS): Backed by pools of underlying assets such as mortgages,
auto loans, credit card receivables, or student loans. ABS are structured products that
offer diversification and credit enhancement features.

3. Characteristics of Bonds:

 Maturity: The length of time until the bond's principal amount is repaid to the
bondholder. Bonds can be classified as short-term (typically less than one year),
medium-term (one to ten years), or long-term (more than ten years).
 Coupon Rate: The annual interest rate paid by the issuer to the bondholder, expressed
as a percentage of the bond's face value. Coupon payments are usually made
semiannually or annually.
 Face Value: The principal amount of the bond that will be repaid to the bondholder at
maturity. It is also known as the par value or nominal value of the bond.
 Credit Rating: An assessment of the issuer's creditworthiness and the likelihood of
default by credit rating agencies such as Standard & Poor's, Moody's, and Fitch. Bonds
are assigned credit ratings based on their risk of default, ranging from AAA (highest
credit quality) to D (default).
 Yield: The rate of return earned by the bondholder, calculated as the bond's annual
interest payments divided by its price. Yield can be expressed as current yield, yield to
maturity (YTM), or yield to call (YTC).

4. Functions of Bond Markets:

 Financing: Bond markets provide a source of long-term financing for governments,
municipalities, and corporations to fund capital expenditures, infrastructure projects,
and working capital needs.
 Investment: Bonds offer investors a fixed income stream through regular coupon
payments and the return of principal at maturity. They provide diversification benefits
and help investors manage risk in their investment portfolios.
 Risk Management: Bond markets facilitate the transfer and management of credit risk,
interest rate risk, and liquidity risk through various financial instruments such as credit
default swaps (CDS), interest rate swaps, and bond futures.
 Price Discovery: Bond markets determine market prices and interest rates based on
supply and demand dynamics, economic conditions, inflation expectations, and central
bank policies. Bond prices are inversely related to interest rates: when interest rates rise,
bond prices fall, and vice versa.
 Economic Indicators: Bond markets serve as leading indicators of economic conditions,
reflecting investors' expectations about future growth, inflation, and monetary policy.
Changes in bond yields and spreads can signal shifts in market sentiment and economic
fundamentals.

5. Trading Mechanisms:

b) Distinguish between Commercial Bank and Co-operative Bank.

c) Describe the concept of Electronic Clearing Service.