Introduction to financial system:

A financial system is a network of financial institutions, financial markets, financial instruments and financial services to facilitate the transfer of funds. The system consists of savers, intermediaries, instruments and the ultimate user of funds. The level of economic growth largely depends upon and is facilitated by the state of financial system prevailing in the economy. Efficient financial system and sustainable economic growth are resulted. The financial system mobilizes the savings and channelizes them into the productive activity and thus influences the pace of economic development. Economic growth is hampered for want of effective financial system. Broadly speaking, financial system deals with three inter-related and interdependent variables, i.e., money, credit and finance. Or The processes and procedures used by an organization's management to exercise financial control and accountability. These measures include recording, verification, and timely reporting of transactions that affect revenues, expenditures, assets, and liabilities.

The functions of financial system can be enumerated as follows:

Financial system of a country has a significant role to play in the economy. Money supply, inflation, credit creation, foreign exchange reserves, flow of foreign capital and regulation of the banks and financial institutions are some of the key areas of control in a financial system. A well functioning financial system is essential for the growth of the economy. The financial system handles huge volume of money and securities and therefore needs proper checks and balances to ensure stability and public confidence. The basic functions of financial system are mechanism for mobilizing savings, mechanism for storing wealth, liquidity, credit mechanism, payment system, risk management, policy implementation and finally the information provider. All these comprise to be the functions. Financial system works as an effective conduit (passage) for optimum allocation of financial resources in an economy. I.e. transfer from Surplus. Promote savings. It helps in establishing a link between the savers and the investors. Financial system allows asset-liability transformation. Banks create claims (liabilities) against themselves when they accept deposits from customers but also create assets when they provide loans to clients. Economic resources (i.e., funds) are transferred from one party to another through financial system. The financial system ensures the efficient functioning of the payment mechanism in an economy. All transactions between the buyers and sellers of goods and services are effected smoothly because of financial system. Financial system helps in risk transformation by diversification, as in case of mutual funds. Financial system enhances liquidity of financial claims. Financial system helps price discovery of financial assets resulting from the interaction of buyers and sellers. For example, the prices of securities are determined by demand and supply forces in the capital market. Financial system helps reducing the cost of transactions.

Financial markets perform the essential economic function of channeling funds from households, firms, and governments that have saved surplus funds by spending less than their income to those that have a shortage or deficit of funds because they wish to spend more than their income. The principal lender-savers are households, but business enterprises and the government (particularly state and local government), as well as foreigners and their governments, sometimes also find themselves with excess funds and so lend them out. The most important borrower-spenders are businesses and the government (particularly the federal government), but households and foreigners also borrow to finance their purchases of cars, furniture, and houses. The arrows show that funds flow from lender-savers to borrower-spenders via two routes. In direct finance), borrowers borrow funds directly from lenders in financial markets by selling them securities (also called financial instruments), which are claims on the borrowers future income or assets. Securities are assets for

the person, who buys them, but they are liabilities for the individual or firm that sells (issues) them. For example, if General Motors needs to borrow funds to pay for a new factory to manufacture electric cars, it might borrow the funds from savers by selling them a bond, a debt security that promises to make payments periodically for a specified period

Surplus unit

Deficit unit

Financial instrument
A financial instrument is a tradable asset of any kind, either cash; evidence of an ownership interest in an entity; or a contractual right to receive, or deliver, cash or another financial instrument.

Categorization
Financial instruments can be categorized by form depending on whether they are cash instruments or derivative instruments: Cash instruments are financial instruments whose value is determined directly by markets. They can be divided into securities, which are readily transferable, and other cash instruments such as loans and deposits, where both borrower and lender have to agree on a transfer. Derivative instruments are financial instruments which derive their value from the value and characteristics of one or more underlying entities such as an asset, index, or interest rate. They can be divided into exchange-traded derivatives and over-the-counter (OTC) derivatives.

Alternatively, financial instruments can be categorized by "asset class" depending on whether they are equity based (reflecting ownership of the issuing entity) or debt based (reflecting a loan the investor has made to the issuing entity). If it is debt, it can be further categorized into short term (less than one year) or long term. Foreign Exchange instruments and transactions are neither debt nor equity based and belong in their own category.