Financial Management: Working Capital Management and Cost of Capital, Lecture notes of Financial Management

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Financial Management

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Subject: FINANCIAL MANAGEMENT Credits: 4

SYLLABUS

Overview Introduction to Financial Management: Objectives of Financial Management, Functions of Financial Management; Financial Instruments: Equity Shares, Preference Shares, Right Issues; Debts: Debentures, Types of Debentures; Indian Financial System: Functions of Financial Market, Classification of Financial Markets, Efficiency of Financial System, Skeleton of the Financial System; Time Value of Money; Valuation of Bonds and Shares.

Financial Statements Comparative Statement: Importance of Financial Statement, Limitations, Constructing Comparative Statement; Common Size Statement: Advantages of Common Size Statement, Limitations of Common Size Statement, Constructing Common Size Statement; Trend Analysis: Advantages of Trend Percentages Analysis, Limitations of Trend Percentages Analysis, Method of Preparation of Trend Percentages, Precautions; Ratio Analysis: Importance, Limitations and Classification of Ratios.

Cash Flow Fund Flow Statement: Objectives of Funds Flow Statement, Limitations, Preparation of Funds Flow Statement; Cash Flow Statement: Direct and Indirect Methods of Cash Flow.

Fixed Capital Analysis Capital Budgeting: Features of Capital Budgeting, Importance of Capital Budgeting; Evaluations Techniques of Projects: Traditional Techniques: Pay Back Period, ARR,Time Adjusted Techniques: NPV, IRR, PI; Risk and Uncertainty in Capital Budgeting.

Capital Structure and Dividend Policy Leverage Analysis: Operating Leverage, Financial Leverage, Combined Leverage; Capital Structure: Factors Determining the Capital structure, Theories of Capital Structure; Cost of Capital: Significance of Cost of Capital, Computation of Cost of Capital, EPS, EBIT Analysis; Dividend Policy: Dividend decision and valuation of Firm, Determinants of Dividend Policy, Types of Dividends, Forms of Dividend, Bonus Issue.

Working Capital Analysis Working Capital: Operating Cycle/Working Capital Cycle, Factors Effecting Working Capital, Importance of Adequate Working Capital, Financing of Working Capital, Determining Working Capital Financing Mix, Working Capital Analysis, Estimation of Working Capital Requirements; Receivables Management: Costs of Maintaining Receivables, Meaning and Definition of Receivables Management , Dimensions of Receivables Management.

Inventory Management Inventory Management: Meaning of Inventory, Purpose of Holding Inventory, Inventory Management, Objectives of Inventory Management; Inventory Management Techniques.

Cash Management Analysis Cash Management: Motives for Holding Cash, Cash Management, Managing Cash Flows; Cash Management Models.

OVERVIEW

Structure

1.1 Introduction to Financial Management 1.1.1 Objectives of Financial Management 1.1.2 Functions of Financial Management

1.2 Financial Instruments: Equity Shares, Preference Shares; Right Issue

1.3 Debts: Debentures, Types of Debentures

1.4 Indian Financial System 1.4.1 Functions of Financial Markets 1.4.2 Classification of Financial Markets 1.4.3 Efficiency of Financial system 1.4.4 Skeleton of the Financial System

1.5 Time Value of Money

1.6 Valuation of Bonds and Shares.

1.7 Review Questions

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1.1 INTRODUCTION TO FINANCIAL MANAGEMENT

Finance is defined as the provision of money at the time when it is required. Every enterprise, whether big, medium, small, needs finance to carry on its operations and to achieve its target. In fact, finance is so indispensable today that it is rightly said to be the blood of an enterprise. Without adequate finance, no enterprise can possibly accomplish its objectives.

Meaning of Financial Management: Financial management refers to that part of the management activity, which is concerned with the planning, & controlling of firm’s financial resources. It deals with finding out various sources for raising funds for the firm. Financial management is practiced by many corporate firms and can be called Corporation finance or Business Finance.

According to Guthmann and Dougall: “ Business finance can be broadly defined as the activity concerned with the planning, raising controlling and administrating the funds used in the business. ”

According to Joseph & Massie: “ Financial Management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations”

Financial Management is the application of the general management principles in the area of financial decision-making, namely in the areas of investment of funds, financing various activities, and disposal of profits.

Financial management is the art of planning; organizing, directing and controlling of the procurement and utilization of the funds and safe disposal of profits to the end that individual, organizational and social objectives are accomplished.

Is concerned with

Analysis

Wealth Maximization

Figure: 1.1 Financial Management Interrelationships

1.1.1 Functions of Financial Management

A financial manager has to concentrate on the following areas of the finance function.

1. Estimating Financial Requirements: The first task of the financial manager is to estimate short term and long-term financial requirement of his business. For this purpose, he will prepare a financial plan for present as well as future. The amount required for purchasing fixed assets as well as the needs of funds for working capital has to be

Financial management

Financing decision Investment Decision Dividend Decision

Risk and Return Relationship

To achieve the goal of

Profit Maximization

c. Break even analysis d. Cost control e. Cost and internal audit.

7. The use of various control techniques: This will help the financial manager in evaluating the performance in various Areas and take corrective measures whenever needed.
8. Proper use of Surpluses: The utilization of profits or surpluses as also an important factor in financial management. A judicious use of surpluses is essential for the expansion and diversification plans and also protecting the interest of the shareholders. The ploughing back of profit is the best policy of further financing. A balance should be struck in using the funds for paying dividends and retaining earnings for financing expansion plans.

1.1.2 Objectives of the Financial Management

The main objective f a business is tom maximize the owner’s economic welfare. Financial management provides a framework for selecting a proper course of action and deciding a commercial strategy.

The objectives can be achieved by: (i) Profit maximization (ii) Wealth maximization

Profit Maximization: Profit earning is the main aim of every economic activity. A business being an economic institution must earn profit to cover its cists and provide funds for growth. No business ca survives without earning profit. Profit is a measure of efficiency of a business enterprise. Profit also serves as a protection against risks which cannot be ensured.

Arguments in favor of Profit Maximization

1. When profit earning is the aim of the business then the profit maximization should be the obvious objective.
2. Profitability is the barometer for measuring the efficiency and economic prosperity of a business enterprise, thus profit maximization is justified on the ground of the rationality.
3. Profits are the main source of finance for the growth of the business. So a business should aim at maximization of the profits for enabling its growth and development.
4. Profitability is essential for fulfilling the social goals also. A firm by pursuing the objectives of profits maximization also maximizes the socio economic welfare.
5. A business may be able to survive under unfavorable condition only if it had some past earnings to rely upon.

Arguments against of Profit Maximization

1. It is precisely defined. It means different things for different people. The term ‘Profit’ is vague and it cannot be precisely defined. It means different things for different people. Should we mean (i) Short term profit or long term profit? (ii) Total profit or earning per

share? (iii) Profit before tax or after tax? (iv) Operating profit or profit available for the shareholders?

2. It ignores the time value of money and does not consider the magnitude and the timing of earnings. It treats all the earnings as equal though they occur in different time periods. It ignores the fact that the cash received today is more important than the same amount if cash received after, say, three years.
3. It does not take into consideration the risk of the prospective earning stream. Some projects are more risky than others. Two firms may have same expected earnings per share, but if the earning stream in one is more risky the market share of its share will be comparatively less.
4. The effect of the dividend policy on the market price of the shares is also not considered in the objective of the profit maximization. In case, earnings per share is the only objective then the enterprise may not think of paying dividends at all because it retains profits in the business or investing them in the market may satisfy this aim.

Wealth Maximization: Financial theory asserts that the wealth maximization is the single substitute for a stake holder’s utility. When the firm maximizes the shareholder’s wealth, the individual stakeholders can use this wealth to maximize his individual utility. It means that by maximizing stakeholder’s wealth the firm is operating consistently toward maximizing stakeholder’s utility. A stake solder’s wealth in the firm is the product of the numbers of the shares owned, multiplied within the current stock price per share.

Stockholder’s current wealth in the firm = (No. Of shares owned) * (Current stock price per share )

Higher the stock price per share, the greater will be the shareholder’s wealth. Thus a firm should aim at maximizing its current stock price, which helps in increasing the value of shares in the market.

Refers to Refers to Refers to

Maximum Utility

Maximum stockholder’s wealth

Maximum current stock price per share

4. The objective of wealth maximization may also face difficulties when ownership and management are separated, as is the case in most of the corporate form of organizations. When managers act as the agents of the real owner, there is the possibility for a conflict of interest between shareholders and the managerial interests. ---------------------------------------------------------------------------------------------------------------------

1.2 FINANCIAL INSTRUMENTS: EQUITY SHARES, PREFERENCE

SHARES, RIGHT ISSUE

Why there is a need for Finance: Every business needs funds both for short term and long term. They may need working capital, or, fixed capital. The finance may be obtained from the varied sources and through various instruments. The various sources of finance include shareholders, financial instruments, and financial institutions and so on. The funds can be collected through various instruments such as equity shares, convertible bonds, non- convertible debentures, fixed deposits, loan agreements, and so on. The finance is needed at various stages and for various purposes like promoting a business, smooth conduct of business activities.

Methods of Raising Finance

1. Public Issue of Shares: The company can raise a substantial amount of fixed capital by issue of shares- equity and preference. In India, however, equity shares are more popular as compared to preference shares. The issue of shares requires a number of formalities to be completed such as approval of prospectus by S.E.B.I., appointment of underwriters, bankers, and registrars to the issue, filing of the prospectus with the registrar of companies, and so on.
2. Rights Issue of Shares: A Right issue is issue of shares to the existing shareholders of the company through a Letter of Offer made in first instance to the existing shareholders on pro data basis. The shareholders have a choice to forfeit this right partially or fully. The company, then issue this additional capital to public. This is an inexpensive method as underwriting commission, brokerage are very small. Rights issue prevents dilution of control but it may conflict with the broader objective of wider diffusion of share capital.
3. Private Placement of Shares: This is a method of raising funds from a group of financial institutions and others who are ready to invest in the company.
4. Issue of Debentures: There are companies who collect long term funds by issuing debentures- convertible, or, non convertible. Convertible debentures are very popular in the Indian market.
5. Long Term Loans: The company may also obtain long term loans from banks and financial institutions like I.D.B.I., I.C.I.C.I., and so on. The funding of term loans by financial institutions often acts as an inducement for the investors to sub- scribe for the shares of the company. This is, because, the financial institutions study the project report of the company before sanctioning loans. This creates confidence in the investors, and they too, lend money to the company in form of shares, debentures, fixed deposits, and so on.

6. Accumulated Earnings (Reserves): The Company often resorts to ploughing back of profits that, is, retaining a part of profits instead of distributing the entire amount to shareholders by way of dividend. Such accumulated earnings are very useful at the time of replacements, or, purchases of additional fixed assets.

We will discuss rights issue in detail.

Rights Issue: Rights issue is an invitation to the existing shareholders to subscribe for further shares to be issued by a company. A right simply means an option to buy certain securities at a certain privileged price within a certain specified period. The Company Act, 1956 lays down the manner in which further issue of shares, whether equity or preference, is to be made so as to ensure equitable distribution of shares without disturbing the established equilibrium of shareholding in the company. According to Section 81 of the Companies Act, whenever a public limited company proposes to increase its subscribed capital by the allotment of further shares, after the expiry of two years from the formation of the company or the expiry of one year from the first allotment of shares in the company, whichever is earlier, the following conditions or procedure must be followed:

1. Such shares must be offered to holders of equity shares in proportion, as nearly as circumstances admit, to the capital paid-up on those share.
2. The offer must be made by giving a notice specifying the number of shares offered.
3. The offer must be made to accept the shares within a period specified in the notice being not than 15 days.
4. Unless the articles of association of the company provide otherwise, the notice must also state that the shareholder has the right to renounce all or any of the shares offered to him in favor of his nominees.

Shares so offered to existing shareholders are called Right Shares as the existing equity shareholders of the public company have a first right of allotment of further shares. The offer of such shares to the existing equity shareholder is known as Privileged Subscription or Right Issue. The prior right of the shareholders is also known as pre-emptive right. After expiry of the time specified in the notice or on receipt of earlier information from the shareholder declining to accept the shares offered, the Board of Directors may dispose them off in such a manner as they think most beneficial to the company.

Advantages of Rights Issue

1. It ensures that the control of the company is preserved in the hands of the existing shareholders.
2. The expenses to be incurred, otherwise if shares are offered to the public, are avoided
3. There is more certainty of the shares being sold to the existing shareholders.
4. It betters the image of the company and stimulates enthusiastic response from shareholders and the investment market.
5. It ensures that the directors do not misuse the opportunity of issuing new shares to their relatives and friends at lower prices on the one hand and on the other get more controlling rights in the company.

of these shares have a preference for dividend and a first claim for return of capital; when the company is closed down. But, their dividend rate is fixed. Preference share can be of following types:

a) Cumulative Preference Shares: Such shareholders have a right to claim the dividend. If, dividend is not paid to them, then, such dividend gets accumulated, and, therefore, they are called as “Cumulative Preference shares”. b) Non- Cumulative Preference Shares : They are exactly opposite to cumulative preference shares. Their right to get dividend lapses if, they are not paid dividend and it does not get accumulated. Thus, their right to claim dividend for the past years will lapse and will not be accumulated. c) Participating Preference Shares: Such shareholders have a right to participate in the excess profits of the company, in addition to their usual dividend. Thus, if, there are excess profits and huge dividends, are declared in the equity shares, the holders of these all shares get a second round of dividend along with equity shareholders; after a dividend at a certain rate has been paid to equity shareholders. d) Non- Participating Preference Sh ares: Such shareholders do not have any right to share excess profits. They get only fixed dividend. e) Convertible Preference Shares : Such shares can be converted into equity shares, at the option of the company. f) Redeemable Preference Shares: Such shares are to be redeemed, or, paid back in cash to the holders after a period of time. g) Non- Redeemable Preference Shares: Such shares are not paid in cash during the life of the company.

Merits of Preference Shares

a) Fixed dividend. b) First claim on company assets. c) Cost of capital is low. d) No dilution over control. e) No dividend obligation. f) No redemption liability.

Demerits of Preference Shares:

a) Not a very high dividend rate. b) No voting rights. c) Dividends paid are not tax- deductible. d) Non payment of dividend affects firm.

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1.3 DEBTS: DEBENTURES, TYPES OF DEBENTURES

DEBENTURES: When borrowed capital is divided into equal parts, then, each part is called as a debenture. Debenture represents debt. For such debts, company pays interest at regular intervals. It represents borrowed capital and a debenture holder is the creditor of the company.

Debenture holder provides loan to the company and he has nothing to do with the management of the company.

Kinds of Debentures: A company can issue different kinds of debentures.

a) Registered and Bearer Debentures: This classification of debentures is made on the basis of transferability of debentures. Registered debentures are those in respect of which the names, addresses, and particulars of the holdings of debenture holders are entered in a register kept by the company. The transfer of ownership of such debentures is possible through a regular instrument of transfer which is duly signed by the transferee and the transferor. However, the transfers are freely allowed through the execution of a regular Transfer Deed. Only formal approval of the Board is necessary. Interest on such debentures is paid through interest warrants. Bearer debentures are transferable by mere delivery. They are freely negotiable instruments. The company keeps no records of the debenture- holders in the case of bearer debentures. Such debentures are similar to Share Warrants; the interest on them is paid by means of attached coupons which encashed by the holder are as and when cash falls due. On maturity, the principal sum of Bearer Debenture is paid back to the holder.

b) Secured and Unsecured Debentures: This classification is made on the basis of security offered to debenture-holders. Secured debentures are those which are secured by some safe charge on the property of the company. The charge or, mortgage may be “Fixed”, or, “Floating”, and thus, there may be “Fixed Mortgage Debentures”, or, “Floating Mortgage Debentures” depending upon the nature of charge under the category of Secured Debentures. Unsecured, or, Naked Debentures are those that, are secured by any charge on the assets of the company. The holders of such debentures are like ordinary creditors of the company. The general solvency of the company is the only security available to unsecured or, naked debentures.

c) Redeemable And Irredeemable Debentures: This classification is made on the basis of terms of repayment. Redeemable Debentures are for fixed period and they provide for payment of the principal sum on specified date, or, on demand, or, notice. Irredeemable Debentures are not issued for a fixed period. The issuing company does not fix any date by which the principal would be paid back. The holders of such debentures cannot demand payment from the company so long as it is a going concern. Such debentures are perpetual in nature as they are payable after a long time, or, on winding up of the company.

d) Convertible And Non- Convertible Debentures: This classification is made on the convertibility of the debentures. Convertible Debentures are those which are convertible into Equity Shares on maturity as per the terms of issue. Convertible Debentures are those which are convertible into equity shares on maturity as per the terms of issue. Convertible debentures are now popular in our India and many companies issue convertible debentures which are automatically converted into shares after a fixed period, or, date (usually, after three years). The rate of exchange of debentures into shares is also decided at the time of issue of debentures. Interest is paid on such debentures till

These institutions are all a part of the financial system. Sector-wise, government and business sectors are the major borrowers whose investment is always greater than savings. On the other hand, in India the household and foreign sectors are the net savers, with savings exceeding investment. The financial system provides the intermediation between investors and helps the process of specialization and sophistication in the financial infrastructure, leading to greater financial development that is prerequisite for faster economic development.

1.4.1 Functions of Financial Markets

The primary function of the financial markets is to facilitate the transfer of funds from surplus sectors (lenders) to deficit sectors (borrowers). Normally, households have excess of funds or savings, which they lend to borrowers in the corporate and public sectors whose requirement of funds, exceed their savings. A financial market consists of investors or buyers, ‘sellers, dealers and brokers and does not refer to a physical location. Formal trading rules and communication networks for originating and trading financial securities link the participants in the market. The primary market in which public issue of securities is made through a prospectus is a retail market and there is no physical location. The investors are reached by direct mailing. On the other hand, the secondary market or stock exchange where existing securities are traded is an auction market and may have a physical location such as the rotunda of the Bombay Stock Exchange or\the trading floor of Delhi, Ahmedabad and other exchanges where the exchange members meet to trade securities face-to-face. In the Over-The-Counter (OTCEI) market and National Stock Exchange, trading in securities is screen-based. The Bombay Stock Exchange (BOLT) now introduces on-line trading, and other exchanges are in the process of introducing the same that is screen-based.

Financial markets trade in money and their price is the rate of return the buyer expects the financial asset to yield. The value of financial assets changes with the investors’ expectations on earning or interest rates. Investors seek the highest return for a given level of risk (by paying the lowest price) and users of funds attempt to borrow at the lowest rate possible. The aggressive interaction, of investors and users of funds in a properly functioning capital market ensures the flow of capital to the best user. Investors receive the highest return and the users obtain funds at the lowest cost.

The three important functions of financial markets are:

a) Financial Markets Facilitate Price Discovery. Financial markets help in establishing the prices of financial assets. Well organized financial markets seem to be remarkably in the rate of return and other incentives, funds flow from less efficient in price discovery. That is why financial economists productive to more productive activities. The efficient functioning say: “If you want to know what is the value of a financial asset simply look at its price in the financial market”

b) Financial Markets Provide Liquidity to Financial Assets. Investors can readily sell their financial assets through the mechanism of financial markets. In the absence of financial markets, which provide such liquidity, the motivation of investors to hold financial assets will be considerably diminished. Thanks to negotiability and transferability of securities through the financial markets, it is possible for companies

(and other entities) to raise long-term funds from investors with short-term and medium- term horizons. While one investor is substituted by another when a security is transacted, the company is assured of long-term availability of funds.

c) Financial Markets Considerably Reduce the Cost of Transacting. The two major costs associated with transacting are search costs and information costs. Search costs comprise explicit costs such as the expenses incurred on advertising when one wants to buy or sell an asset and implicit costs such as the effort and time one has to put in to locate a customer. Information costs refer to costs incurred in evaluating the investment merits of financial assets.

1.4.2 Classification of Financial Markets

Financial markets can be classified in various types based on the different characteristics.

a) One way is to classify financial markets by the type of financial claim. The debt market is the financial market for fixed claims (debt instruments) and the equity market is the financial market for residual claims (equity instruments).

b) A second way is to classify financial markets by the maturity of claims. The market for short-term financial claims is referred to as the money market and the market for Long- term financial cli.1ims is called the capital market traditionally the cut-off between short- term and long-term financial claims has been one year-though this dividing line is arbitrary, it is widely accepted. Since short-term financial claims are almost invariably debt claims, the money market is the market for short-term debt instruments. The capital market is the market for long-term debt instruments and equity instruments.

c) A third way to classify financial markets is based on whether the claims represent new issues or outstanding issues. The market where issuers sell new claims is referred to as the primary market and the market where investors trade outstanding securities is called the secondary market

d) A fourth way to classify financial markets is by the timing of delivery. A cash or spot market is one where the delivery occurs immediately and a forward or futures market is one where the delivery occurs at a pre-determined time in future

e) A fifth way to classify financial markets is by the nature of its organisational structure. An exchange-traded market is characterised by a centralised organisation with standardised procedures. An over-the counter market is a decentralised market with customised procedures.

We will concentrate on classification as per seasoning of claims:

a) Primary market b) Secondary market

important part in the process. Their role regarding supply of capital is indirect. The secondary markets can in no circumstance supply additional funds since the company is not involved in the transaction. The stock exchanges have physical existence and located in particular geographical areas.

Functions of secondary markets: Stock exchanges discharge following three vital functions in the orderly growth of capital formation:

a) Nexus between savings and investments: First and foremost, they are the nexus between the savings and the investment of the community. The savings of the community are mobilized and channelled by stock exchanges for investment in to those sectors and units which are favored by the community at large, on the basis of such criteria as good return, appreciation of capital, and so on. It is the preference of investors for individual units a well as industry groups, which is reflected in the share price, that decides the mode of investment. Stock exchanges render this service by arranging for the preliminary distribution of new issues of capital, offered through prospectus, as also offers for sale of existing securities, in an orderly and systematic manner. They themselves administrator the same, by ensuring that the various requisites of listing are duly complied with Members of stock exchanges also assist in the flotation of new issues by acting (i) as brokers, in which capacity they, inter alia, try to procure subscription from investors spread all over the country, and (ii) as underwriters.

b) Market Place: They provide a market place for the purchase and sale of securities, thereby enabling their free transferability through several successive stages from the original subscriber to the never-ending stream of buyers, who may be buying them today to sell them at a later date for a variety of considerations like meeting their own needs of liquidity, shuffling their investment portfolios to gear up for the ever-changing market situations, and so on. Since the point of aggregate sale and purchase is centralised, with a multiplicity of buyers and sellers at any point of time, by and large, a seller has a ready purchaser and a purchaser has a ready seller at a price which can be said to be competitive. This guarantees sales ability to one who has already invested and surety of purchase to the other who desires to invest.

c) Continuous Price Formation: The third major function, discharged by the stock exchanges is the process of continuous price formation. The collective judgment of many people operating simultaneously in the market, resulting in the emergence of a large number of buyers and sellers at any point of time, has the effect of bringing about changes in the levels of security prices in small graduations, thereby evening out wide swings in prices. The ever-changing demand and supply conditions result in a continuous revaluation of assets, with today's prices being yesterday's prices, altered, corrected, and adjusted, and tomorrows values being again today's values altered, corrected and adjusted. The process is an unending one. Stock exchanges thus act as a barometer of the state of health of the nations economy, by constantly measuring its progress or otherwise. An investor can always have his eyes turned towards the stock exchanges to know, at any point of time, the value of the investments and plan his personal needs accordingly.

1.4.3 Efficiency of Financial System The real test of development of financial system is its efficiency in operations and functional roles. The operational efficiency is reflected in the costs of intermediation, quality of service and its width. The improved operational efficiency during the nineties is seen from significant reforms in the capital market and stock markets, lowering of costs of credit and greater flow of bank credit into these markets, lowering of costs raising funds from the capital market through the route of book building and private placement. The strengthening of the institutions evidences the Width of Services Structure and increasing the instruments of mobilizing funds, introduction of technological innovations in the Stock and Capital markets and in the banking system, deregulation, privatization and globalization of markets and freer flow of funds into and outside country etc. The reforms in general and increasing role of technology and competitive forces in particular have improved the quality of service. Any financial system can be assessed for its functional efficiency through following criteria in general:

1. Quantity of funds raised through saving for investment and pattern of allocation from less to more productive purposes.
2. Its contribution to economic growth and its impact on real economic variables, reflected in market capitalization as a proportion of GDP and the usual ratios, such as Finance ratio
   • ratio of total issues to national income; Financial interrelations ratio -ratio of total issues to net domestic capital, formation; and financial intermediation ratio -ratio of secondary issues raised by banks and financial institutions to primary issues in the market
3. Information absorption - whether all information a market and economy are fully reflected in the scrip prices.
4. Fundamental valuation efficiency - whether the company valuation are reflected in scrip prices.

1.4.4 Skeleton of the Financial System

A radical restructuring of the economic system consisting of industrial deregulation, liberalization of policies relating to foreign direct investment, public enterprise reforms, reforms of taxation system, trade liberalization and financial sector reforms have been initiated in 1992-

93. Financial sector reforms in the area of commercial banking, capital markets and non-banking finance companies have also been undertaken.

The focus of reforms in the financial markets has been on removing the structural weaknesses and developing the markets on sound lines. The money and foreign exchange market reforms have attempted to broaden and deepen them. Reforms in the government securities market sought to smoothen the maturity structure of debt, raising of debt at close-to-market rates and improving the liquidity of government securities by developing an active secondary market. In the capital market the focus of reforms has been on strengthening the disclosure standards, developing the market infrastructure and strengthening the risk management systems at stock exchanges to protect the integrity and safety of the market. Elements of the structural reforms in various market segments are introduction of free pricing of financial assets such as interest rate on government securities, pricing of capital issues and exchange rate, the enlargement of the number of participants and introduction of new instruments.