Most households in India still prefer to invest on physical assets like land, buildings, gold, silver etc. But, studies have shown that investment in financial assets like equities in capital market fetches more return than investments on gold. It is imperative that one should have some basic knowledge about the rate of return on financial assets also.
The return on Government securities and bonds are comparatively less than on corporate securities due to lower risk involved therein. The Government and the RBI determine the interest rates on Government securities. Thus, the interest rates are administered and controlled. The peculiar feature of the interest rate structure is that the interest rates do not reflect the free market forces. They do not reflect the scarcity value of capital in the country also. Most of these rates are fixed on an adhoc basis depending upon the credit and monetary policy of the Government.
Generally the interest rate policy of the Government is designed to achieve the following:
(i) To enable the Government to borrow comparatively cheaply.
(ii) To ensure stability in the macro-economic system.
(iii) To support certain sectors through preferential lending rates.
(iv) To mobilize substantial savings in the economy.
The interest rate structure for bank deposits and bank credits is also determined by the RBI. Similarly the interest rate on preference shares is fixed by the Government at 14%. Normally, interest is a reward for risk undertaken through investment and at the same time it is a return for abstaining from consumption. The interest rate structure should allocate scarce capital between alternative uses. Unfortunately, in India the administered interest rate policy of the Government fails to perform the role of allocating scarce sources between alternative uses.
Recent Trends : With a view to bringing the interest rates nearer to the free market rates, the Government has taken the following steps:
(i) The interest rates on company deposits are freed.
(ii) The interest rates on 364 days Treasury Bills are determined by auctions and they are expected to reflect the free market rates.
(iii) The coupon rates on Government loans have been revised upwards so as to be market oriented.
(iv) The interest rates on debentures are allowed to be fixed by companies depending upon the market rates.
(v) The maximum rates of interest payable on bank deposits (fixed) are freed for deposits of above one year.
Thus, all attempts are being taken to adopt a realistic interest rate policy so as to give positive return in real terms adjusted for inflation. The proper functioning of any financial system requires a good interest rate structure.
Financial Instruments
Financial instruments refer to those documents which represent financial claims on assets. As discussed earlier, financial asset refers to a claim to the repayment of a certain sum of money at the end of a specified period together with interest or dividend. Examples are Bill of exchange, Promissory Note, Treasury Bill, Government Bond, Deposit Receipt, Share, Debenture, etc. Financial instruments can also be called financial securities. Financial securities can be classified into:
(i) Primary or direct securities.
(ii) Secondary or indirect securities.
Primary Securities : These are securities directly issued by the ultimate investors to the ultimate savers, e.g. shares and debentures issued directly to the public.
Secondary Securities : These are securities issued by some intermediaries called financial intermediaries to the ultimate savers, e.g. Unit Trust of India and mutual funds issue securities in the form of units to the public and the money pooled is invested in companies.
Again these securities may be classified on the basis of duration as follows :
(i) Short-term securities
(ii) Medium-term securities
(iii) Long-term securities
Short-term securities are those which mature within a period of one year. For example, Bill of Exchange, Treasury Bill, etc. Medium-term securities are those which have a maturity period ranging between one and five years like Debentures maturing within a period of 5 years. Long-term securities are those which have a maturity period of more than five years. For example, Government Bonds maturing after 10 years.
Characteristic Features of Financial Instruments
Generally speaking, financial instruments possess the following characteristic features:
(i) Most of the instruments can be easily transferred from one hand to another without many cumbersome formalities.
(ii) They have a ready market i.e., they can be bought and sold frequently and thus trading in these securities is made possible.
(iii) They possess liquidity, i.e., some instruments can be converted into cash readily. For instance, a bill of exchange can be converted into cash readily by means of discounting and re discounting.
(iv) Most of the securities possess security value, i.e., they can be given as security for the purpose of raising loans.
(v) Some securities enjoy tax status, i.e., investment in these securities are exempted from Income Tax, Wealth Tax, etc., subject to certain limits.
(vi) They carry risk in the sense that there is uncertainty with regard to payment of principal or interest or dividend as the case may be.
(vii) These instruments facilitate future trading so as to cover risks due to price fluctuations, interest rate fluctuations etc.
(viii) These instruments involve less handling costs since expenses involved in buying and selling these securities are generally much less.
(ix) The return on these instruments is directly in proportion to the risk undertaken.
(x) These instruments may be short-term or medium term or long-term depending upon the maturity period of these instruments.
The return on Government securities and bonds are comparatively less than on corporate securities due to lower risk involved therein. The Government and the RBI determine the interest rates on Government securities. Thus, the interest rates are administered and controlled. The peculiar feature of the interest rate structure is that the interest rates do not reflect the free market forces. They do not reflect the scarcity value of capital in the country also. Most of these rates are fixed on an adhoc basis depending upon the credit and monetary policy of the Government.
Generally the interest rate policy of the Government is designed to achieve the following:
(i) To enable the Government to borrow comparatively cheaply.
(ii) To ensure stability in the macro-economic system.
(iii) To support certain sectors through preferential lending rates.
(iv) To mobilize substantial savings in the economy.
The interest rate structure for bank deposits and bank credits is also determined by the RBI. Similarly the interest rate on preference shares is fixed by the Government at 14%. Normally, interest is a reward for risk undertaken through investment and at the same time it is a return for abstaining from consumption. The interest rate structure should allocate scarce capital between alternative uses. Unfortunately, in India the administered interest rate policy of the Government fails to perform the role of allocating scarce sources between alternative uses.
Recent Trends : With a view to bringing the interest rates nearer to the free market rates, the Government has taken the following steps:
(i) The interest rates on company deposits are freed.
(ii) The interest rates on 364 days Treasury Bills are determined by auctions and they are expected to reflect the free market rates.
(iii) The coupon rates on Government loans have been revised upwards so as to be market oriented.
(iv) The interest rates on debentures are allowed to be fixed by companies depending upon the market rates.
(v) The maximum rates of interest payable on bank deposits (fixed) are freed for deposits of above one year.
Thus, all attempts are being taken to adopt a realistic interest rate policy so as to give positive return in real terms adjusted for inflation. The proper functioning of any financial system requires a good interest rate structure.
Financial Instruments
Financial instruments refer to those documents which represent financial claims on assets. As discussed earlier, financial asset refers to a claim to the repayment of a certain sum of money at the end of a specified period together with interest or dividend. Examples are Bill of exchange, Promissory Note, Treasury Bill, Government Bond, Deposit Receipt, Share, Debenture, etc. Financial instruments can also be called financial securities. Financial securities can be classified into:
(i) Primary or direct securities.
(ii) Secondary or indirect securities.
Primary Securities : These are securities directly issued by the ultimate investors to the ultimate savers, e.g. shares and debentures issued directly to the public.
Secondary Securities : These are securities issued by some intermediaries called financial intermediaries to the ultimate savers, e.g. Unit Trust of India and mutual funds issue securities in the form of units to the public and the money pooled is invested in companies.
Again these securities may be classified on the basis of duration as follows :
(i) Short-term securities
(ii) Medium-term securities
(iii) Long-term securities
Short-term securities are those which mature within a period of one year. For example, Bill of Exchange, Treasury Bill, etc. Medium-term securities are those which have a maturity period ranging between one and five years like Debentures maturing within a period of 5 years. Long-term securities are those which have a maturity period of more than five years. For example, Government Bonds maturing after 10 years.
Characteristic Features of Financial Instruments
Generally speaking, financial instruments possess the following characteristic features:
(i) Most of the instruments can be easily transferred from one hand to another without many cumbersome formalities.
(ii) They have a ready market i.e., they can be bought and sold frequently and thus trading in these securities is made possible.
(iii) They possess liquidity, i.e., some instruments can be converted into cash readily. For instance, a bill of exchange can be converted into cash readily by means of discounting and re discounting.
(iv) Most of the securities possess security value, i.e., they can be given as security for the purpose of raising loans.
(v) Some securities enjoy tax status, i.e., investment in these securities are exempted from Income Tax, Wealth Tax, etc., subject to certain limits.
(vi) They carry risk in the sense that there is uncertainty with regard to payment of principal or interest or dividend as the case may be.
(vii) These instruments facilitate future trading so as to cover risks due to price fluctuations, interest rate fluctuations etc.
(viii) These instruments involve less handling costs since expenses involved in buying and selling these securities are generally much less.
(ix) The return on these instruments is directly in proportion to the risk undertaken.
(x) These instruments may be short-term or medium term or long-term depending upon the maturity period of these instruments.
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