Q. 1. What do you mean by financial system? What are its different components?
Ans. A financial system can be defined as a set of complex, and inter-connected institutions, agents, practices, markets, transactions and claims and liabilities in the economy. It is concerned about credit, money and finance. It plays a significant role in economy’s development.
Its different components are:
(a) Financial Institutions
(b) Financial Markets
(c) Financial Instruments
(d) Financial Services
Q. 2. Define Financial Institutions. Distinguish between different types of financial institutions.
Ans. Financial Institutions are mediators between savers and demanders of credit. They mediate between mobilizations of savings and also act as providers of credit and loans. Financial institutions can be classified into:
(a) Banking institutions and Non-Banking Institutions.
(b) Intermediaries and Non-Intermediaries.
Banking Institutions and Non-Banking Institutions:
Banking institutions accept demand deposits i.e. they accept deposits that can be used for payments and transactions motive. Banking institutions are creators of credit.
Non-Banking institutions do not accept demand deposits i.e. they do not accept deposits that can be used for payments and transactions motive. Non-Banking institutions are purveyors of credit.
Intermediaries and Non-Intermediaries:
Intermediaries mediate between investors and savers. They lend money as well as mobilize savings. Their liabilities are towards the ultimate savers and their assets are from borrowers. All banking institutions are financial intermediaries.
Non-intermediaries do the loan business but their money is not directly received from savers. They only lend money. Their liabilities are not specifically known but their assets are investors. Non-Banking institutions may be intermediaries or non intermediaries. When they are non-intermediaries, they are called non-banking financial intermediaries.
Q. 3. What are financial markets? Distinguish between different types of markets.
Ans. It is a market in which people deal in financial securities like shares, debentures etc. Financial markets can be classified into:
(a) Primary and Secondary Markets
(b) Money Market and Capital Market
Primary Market and Secondary Market:
Primary Market deals in new financial claims or new securities. It mobilizes savings and savings supply fresh or additional capital to business units. Secondary Market deals in securities which are already issued or existing or outstanding. Secondary markets do not directly contribute to the supply of additional capital. Their role is to making primary markets liquid.
Money Market and Capital Market:
Money market is a short-term market for short-term securities with a maturity of less than one year. It provides funds for working capital.
Capital market is a market for long-term securities which have maturity period of one year or more. It provides funds for long-term.
Q. 4. Define Financial Instruments. Distinguish between primary securities and secondary securities.
Ans. A financial instrument is a claim against a person or an institution for the payment on a future date. Examples of financial instruments are shares, debentures, mutual funds etc.
Primary Securities and Secondary Securities:
Primary securities are directly issued by the ultimate borrowers of funds to ultimate user. These are also called direct securities. Secondary securities are securities issued by intermediaries. They are also called indirect securities.
Q. 5. What are financial services? Give some examples.
Ans. Those services that bridge the knowledge gap of investors are called financial services. Financial services have become quite relevant in increasing sophistication of financial instruments and markets. Examples of financial services include merchant banking leasing, hire purchase, credit rating etc.
Q. 6. Explain how does a weak financial system retards economic growth?
Ans. Weak financial system means low savings and thereby high cost of funds. It would imply low investments and low investment would lead to low rate of economic growth. It is explained with the help of following diagram:
Q. 7. Explain the significance of sound financial system in the process of Economic Development.
Ans. It is a must to have a sound financial system for a rapid economic growth. It can contribute to economic development in three ways:
(a) Technical progress which is endogenous requires higher savings and higher investments. It is provided by financial sector.
(b) No production can take place without capital. Financial system promotes the rate of capital formation.
(c) It expands the size of market over space and time. It improves efficiency of function of exchange and hence increases the rate of economic development.
Q. 8. Explain the functions that are performed by financial system in the process of economic growth.
Ans. Financial system acts as a link between savers and investors. In this way it improves efficiency in allocation of resources. An efficient financial system minimizes the risk of investment. It also helps reducing the cost of collecting information. It provides a mechanism where investors can monitor the performance of their investment. It provides updated information on price and returns that helps to take right decisions. It creates an impulse to save more. It reduces cost of transactions. It helps in increasing financial assets as a percentage of GDP. It reduces the instances of cheating and fraud. It provides insurance services, pension funds and portfolio adjustment facilities. It also increases variety of participants and instruments in the financial market.
Q. 9. What do you mean by flow-of-funds?
Ans. Flow-of-Funds refers to movement of funds from one sector to another. As the word suggests, flow means movement. Flow also implies it is measured over a period of time. These are financial counterparts of the national income accounts of the real sector of the economy. Funds flow from those who have surplus funds to those who need it either directly or through financial intermediaries.
Q. 10. Mention the uses of flow of funds accounting.
Ans. Uses of funds flow accounting are as follows:
- It helps in providing useful framework for classifying and measuring the sources.
- It gives statistics on uses of both internal and external funds.
- It reflects the relationship among different sectors of the economy.
- It provides statistics on relation on credit flows to total spending goods and services.
- It provides historical data that can be used to draw trend line and thereby helps in forecasting.
- It is used to test hypothesis concerning the portfolio behaviour of consumers and firms.
Q. 11. What does the flow-of-funds matrix of an economy show?
Ans. A flow-of-funds matrix is a matrix wherein the economy is classified into few sectors like households, firms, government and rest of the world. If we can handle complex matrix, these sectors may be given sub sectors. But too complex matrix will not be able to serve the purpose. The ideal number of group will depend on the purpose of the analysis and the degree of segregation necessary. We have given a hypothetical matrix below in table given below.
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