Andhra Pradesh BIEAP AP Inter 2nd Year Commerce Study Material 4th Lesson Financial Markets Textbook Questions and Answers.
AP Inter 2nd Year Commerce Study Material 4th Lesson Financial Markets
Essay Answer Questions
What is meant by financial market? Briefly explain its functions and classification.
A financial market is a broad term describing any market place where buyers and sellers participate in the trade of financial assets such as equities, bonds, currencies and derivatives. Investors have access to a large number of financial markets and exchanges representing a vast range of financial products. Some of these markets have always been open to private investors; Others remained the exclusive domain of major international banks and financial professionals until the very end of the twentieth century.
Specifically, financial markets play an important role in the allocation of scarce resources in an economy by performing the following four important functions.
1. Mobilisation of savings and channelling them into most productive uses :
A financial market facilitates the transfer of savings from savers to investors. It gives savers to choice different investments and thus helps to channelise surplus funds into most productive use.
2. Facilitating price discovery:
It is known that the forces of demand, supply help to establish a price for a commodity or service in the market. In the financial markets, house holds are suppliers of funds and business firms represent the demand. The interaction between them helps to establish a price for the financial asset which is being traded in that particular market.
3. Providing liquidity to financial assets :
Financial markets facilitate easy purchase and sale of financial assets. In doing so, they provide liquidity to financial assets, so that they can be easily converted into cash whenever required. Holders of assets can readily sell their financial assets through the mechanism of their financial market.
4. Reducing cost of transaction :
Financial markets provide valuable information about securities being, traded in the market. It helps to save time, effort and money that both buyers and sellers of a financial assets would have to otherwise spend to try and find each other. The financial market is thus, a common platform where buyers and sellers can meet for fulfilment of their individual needs.
Financial markets are basically classified, on the basis of the maturity of financial instruments traded.in them, into money market and capital market. The financial instruments with a maturity of less than one year are traded in the money market and with long maturity are traded in the capital market. Furthur, money market is classified primarily into call money market, acceptance market, bill market, collateral loan market, whereas capital market may include both primary market and secondary market.
What is capital market? What is its importance?
The term capital market refers to facilities and institutional arrangements through which long term funds, both debt and equity are raised and invested. It consists of series of channels through which savings of the community are made available for industrial and commercial enterprises. The capital market consists of development banks, commercial banks and stock exchanges. The process of economic development is facilitated by the existence of a well organised capital market. In fact, economic growth can be achieved through the development of the financial system. It is essential that financial institutions are sufficiently developed and that market operations are free,, fair, competitive and transparent.
Importance of capital market:
1. Act as a link between savers and investors :
Capital market plays an important role in mobilising the savings and diverting them into productive investment. In this way, it is transferring financial resources from surplus and wasteful areas to deficit and productive areas.
2. Encourage savings :
In the undeveloped countries, there are low savings and those can save often invest their savings in unproductive areas and conspicuous consumption in the absence of a capital market. With the development of a capital market, the financial institutions provide wide, range of instruments which encourages people to save.
3. Encouragement to investors :
Various financial assets like shares, bonds etc., encourage people to put their investment in the industry or lend to government. This can be facilitated by the existence of capital market.
4. Stability in prices :
The capital market tends to stabilise the value of stocks and securities. In the process of stabilisation, it is providing capital to the borrowers at a lower interest rate and discourage investment in speculative and unproductive areas.
5. Promotes economic growth :
The balanced economic growth is possible in any country with, the proper allocation of resources among the’ industries. The capital market not only reflects the general condition of the economy, but also smoothens and accelerate the process of economic growth.
Distinguish between capital and money market.
Distinction between capital market and money market.
|Points of distinction||Capital Market||Money Market|
|1. Participants||The participants in the capital market are development banks and investment companies.||The central bank and commercial banks are major participants.|
|2. Instruments||The main instruments traded in the capital market are equity shares, preference shares, bonds, debentures etc.||The main instruments are shortterm debt instruments such as treasury bills, trade bills, commercial paper and certificates of deposits.|
|3. Investment outlay||Investment in the capital market does not necessarily require a huge financial outlay. The value of units of securities is generally low.||In the money market, transaction entail huge sums of money as the instruments are quite expensive.|
|4. Period||It is a market for long term funds for more than one year.||It is a market for short term funds for a period not exceeding one year.|
|5. Liquidity outlay||Capital market securities are considered liquid investments because they are marketable in the stock exchanges.||Money market instruments, on the other hand, enjoy a higher degree of liquidity as there is formal agreement for this.|
|6. Safety||Capital market instruments are riskier both with respect to returns and principal repayment.||But the money market is generally much safer with a minimum risk of default. This is due to the shorter duration of investing and also to financial soundness of the issues.|
|7. Expected return||The investment in capital market generally yield higher returns for investors than the money market.||The returns in the money market investments are low when compared with capital markets.|
|8. Regulator||SEBI regulates the institutions and procedures.||Reserve Bank of India regulates the market.|
Define stock exchanges and explain its functions. [A.P. Mar. 17]
According to securities contracts Act 1956, a stock exchange is defined as “an association, organisation, or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities”. .
Functions of stock exchange :
1. Ready and continuous market: The stock exchange provides a ready and continuous market for securities. The exchange provides a regular market for trading securities.
2. Protection to investors :
The stock exchange protects the interest of the investors through the enforcement pf rules. The rules of the securities contracts (Regulation) Act, 1956 also govern the dealings on stock exchanges.
3. Provides the information to assers the real worth of the securities :
The value of securities is made properly on the stock exchange. This is made by taking into consideration various factors such as present and future competition in securities, financial and general economic conditions. The stock exchange publishes the quotation of different securities on the faith of these quotations every investor knows the worth of his holdings at any time.
4. Provides liquidity of investment:
The stock exchange is a market for existing securities. This market is continuously available for the conversion of securities into cash and vice-versa. Persons who are not in need of hard cash can dispose off their securities easily.
5. Helps in raising capital:
There is always demand for additional capital from the existing concerns. The demandis met through the issue of shares. Stock exchange provides a ready market for such shares.
6. Raising public debt:
The increasing government’s role in economic development has necessiated the raising of huge amounts and stock exchange provides a plat form for raising public debt.
7. Listing of securities :
The company which wants its shares to be traded on stock exchange should list their securities by applying to the stock exchange authorities giving all the details regarding capital structure, management etc.
8. Encourage savings habit:
Stock exchange creates the habit of saving and investing among the members in the public. It leads to investment of their funds in corporate and government securities. In this way it contributes to the capital formation.
9. Economic barometer:
The pulse of the market can be known by its stock indices. The prevailing economic conditions effect the share prices. So, stock exchanges can be called as economic barometer.
10. Improve the company’s performances :
In stock exchanges only those securities are traded which are listed. The stock exchanges exercises influence over the management of the company.
Explain the objectives and functions of SEBI.
The Securities Exchange .Board of India (SEBI) was established by the Government of India in April 1988 as interim administrative body to promote orderly and healthy growth of securities market and for investors protection. The SEBI was given a statutory status in 1992 Jan through an ordinance.
Objectives of SEBI:
The following are the objectives of SEBI.
- To regulate stock exchanges and the securities market to promote their orderly functioning.
- To protect the rights and interests of the investors, particularly individual investors by guiding and educating them.
- To prevent trading malpractices and achieve a balance between self regulation by the securities industry and its statutory regulation.
- To regulate and develop a code of conduct and fair practices by intermediaries like brokers, merchant bankers etc. with a view to making them competitive and professional.
Functions of SEBI:
SEBI was enturusted with the twin task of both regulation and development of the securities market. It has certain protective functions.
A. Regulatory functions:
- Registration of brokers, sub-brokers and other players in the market.
- Registration of collective investment schemes and mutual funds.
- Regulation of stock brokers, portfolio exchanges, underwriters and merchant bank¬ers and the business of stock exchange and any other securities market.
- Regulation of takeover bids by companies.
- Calling for information by undertaking inspection, conducting enquiries and au¬dits of stock exchanges and intermediaries.
- Levying fee or other charges for carrying out the purposes of the Act.
- Performing and exercising such power under securities contracts (Regulation) Act 1956, as may be delegated by the Government of India.
B. Development Functions :
- Training for intermediaries of the securities market.
- Conducting research and publishing information useful to all market participants.
- Under taking measures to develop the capital markets by adapting a flexible ap-proach.
C. Protective functions:
- Prohibition of fraudulent and unfair practices like making misleading statements, manipulations, price rigging etc.
- Controlling insider trading and imposing penalties for such practices.
Short Answer Questions
What are the different components of money market?
The following are the basic components of money market.
1. Call Money Market:
It is an important sub market of Indian money market. It is also known money at call and money at short notice. It is also called as Inter bank loan market. In this market money is demanded for extremely short period. The duration of such transaction is from few hours to 15 days. It is basically located in industrial and commercial locations such as Mumbai, Calcutta, Delhi etc. These transactions help stock brokers and dealers to fulfill theif financial requirements. The rate at which money is made available is called as a call rate. The rate is fixed by the market forces such as demand for and supply of money.
2. Acceptance market:
A market consisting primarily of short term instruments of credit typically used by exporters in getting paid more quickly for their exported goods.
3. Bill market:
Bill market is meant for short term bills. It includes commercial bills and treasury bills. It helps the government by marketing of treasury bills and helps other sectors also.
4. Collateral Load Market:
It is an important section of the money market, which takes the form of loans, O.D.S and Cash credits. These advances are covered by collaterates like government securities, gold, silver, stocks and merchandise etc.
Explain the various money market instruments. .
The following are some of the important money market instruments.
1. Treasury bills :
A treasury bill is basically an instrument of short term borrowings by the Government of India maturing is less than one year. They are also known as zero coupon bonds issued by RBI on behalf of Central Government to meet its short term requirements of funds. The purchase price is less than face value. At maturity the government will pay full face value.
2. Commercial paper:
Commercial paper is a short term unsecured promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is issued by large and credit worthy companies to raise short-term funds at lower rates of interest than market rates. It is usually has a maturity period of 15 days to one year. It is sold at discount and redeemable at par. The original purpose of commercial paper was to provide short term funds for seasonal and working capital needs. Companies use this instrument for the purpose such as brige financing.
3. Call money :
Call money is a short term finance repayable on demand, with a maturity period of one day to fifteen days, used for inter bank transactions. Commercial banks have to maintain a minimum cash balance known as cash reserve ratio. Call money is a method by which banks borrow from each other to be able to maintain the cash reserve ratio. The interest rate paid on call money loans is known as the call rate. It is highly volatile rate that varies from day-to-day and sometimes even from hour-to-hour also.
4. Certificate of deposit:
Certificate of deposit are unsecured, negotiable, short¬term instruments in bearer form, issued by commercial banks and developed financial institutions. They can be issued to individuals, corporations and companies during periods of tight liquidity when the deposit growth of banks is slow but the demand for credit is high. They help to mobilise a large amount of money for short periods. The return on the certificate is higher than the treasury bills because it assumes a higher level of risk.
5. Commercial bill:
A commercial bill is a bill of exchange used to finance the working capital requirements of business firms. It is a short, negotiable, self liquidating instrument which is used to finance the credit sales of firms. The seller draws a bill on the buyer.
When it is accepted, it is called trade bill and becomes marketable instrument. These bills can be discounted with a bank if the seller needs funds before the bill natures. When trade bill accepted by a commercial bank, it is known as commercial bill.
6. Collateral loan :
Commercial banks provides loans against the government securities and bonds.
Explain the capital market instruments.
The following are the capital market instruments.
1. Secured Premium Notes (SPN):
It is a secured debenture redeemable at premium issued along with a debenture warrant, redeemable after a notice period, say four to seven years. The warrants attached to SPN gives the’holder a right to apply and get allotted equity shares, provided the SPN is fully paid.
2. Deep discount bonds :
A bond that sells at a significant discount and redeemable at par at the time of maturity. They are designed to meet the long term funds requirements of the issuer and investors who are not looking for immediate return and can be sold with a long maturity of 25 – 30 years.
3. Equity shares with detachable warrants:
A warrant is issued by a company entitling the holder to buy a given number of shares at a stipulated price during a specified period. The warrants are separately registered with stock exchange and traded separately.
4. Fully convertible debentures with interest:
This is a debt instrument that is fully converted into equity shares over a specified period. The conversion can be in one or several phases. When the instrument is pure debt instrument, interest is paid to the investor. After conversion, interest payments peases on the portion that is converted.
5. Sweat equity shares :
These equity shares are issued by the company to employees or directors on favourable terms, in recognition of their services. Sweat equity usually takes the form of giving options to employees to buy the shares of the company, so they become part owners and participate in the profits, apart from earning salary.
6. Disaster bonds :
Also known as catastrophe or CAT bonds. Disaster bonds is a high yield debt instrument that is usually insurance linked and meant to raise money in case of a catastrophy. It has a special condition which states that if the issuer (Insurance or Reinsurance Company) suffers a loss from a particular pre-defined catastrophy, then issues obligation pay interest and/or repay the principle is either deferred or completely forgiven.
7. Foreign currency convertible bonds :
A convertible bond is a mix between a debt and equity instrument. It is bond having a regular coupon and principal payments and also take the advantage of any large price appreciation in stock, due to equity side of the bond.
A derivative is a financial instrument whose value and characteristics denend on characteristics and value of some underlying asset, typically commodity, bond,r, currency, index etc.
Distinction between Primary and Secondary market.
The following are the differences between primary market and secondary market.
|Primary Market (New issue market)||Secondary Market (Stock Exchange)|
|1. There is sale of securities to investors by new companies or new issues by existing companies.||1. There is trading of existing shares only.|
|2. Securities are sold by the company to the investor directly or through an in termediary.||2. Ownership of existing securities is exchanged between investors. The company is not involved at all.|
|3. The flow of funds is from savers to investors i.e. The primary market directly promotes capital formation.||3. Enhances encashment (liquidity) of shares i.e. The secondary market indirectly promotes capital formation.|
|4. Only buying of securities takes place in the primary market. Securities cannot be sold there.||4. Both the buying and selling of securities can take place on the stock exchange.|
|5. Prices of securities are determined and decided by the management of the company.||5. Prices are determined by demand and supply of the security.|
|6. There is no fixed geographical location.||6. Located at specified places.|
What do you know about BSE and NSE? [A.P. Mar. 17]
Bombay Stock Exchange :
The first stock exchange was established as ‘Native Share and Stock Brokers Association’ at Bombay in 1875, the predecessor of the present day Bombay Stock Exchange (BSE). BSE is located in Dalai street, Mumbai, which is Asia’s first stock exchange and one of India’s leading exchange groups. Over the past 140 years, BSE has facilitated the growth of Indian corporate sector by providing it an efficient capital raising platform. In 1956, the BSE became the first stock exchange to be recognised by the Indian Government under the securities contracts Regulation Act, 1956. It is 4th largest stock exchange in Asia and the 9th largest in the world. More than 5000 companies are listed in BSE making it World No. 1 exchange in terms of listed securities.
National Stock Exchange (NSE) :
The most important development in the Indian Stock market was the establishment of the National Stock Exchange (NSE). It is the latest and most modem technology driven exchange. It was incorporated on 27th November 1992 and was recognised as stock exchange in April 1993. It started operations in 1994, with trading on the whole sale debt market segment. It launched capital market segment in Nov. 1994 as trading plantform for equities and the futures and options segment in June 2000 for various derivative instruments. NSE has been able to take the stock market to the door step of the investors. It has provided a nation-wide screen based automated trading system with high degree of transparency and equal access to investors irrespective of geographical location.
Briefly explain about depository and dematerialisation.
Just like a bank keeps money in safe custody for customers, a depository is also like a bank and keeps all securities in electronic form on behalf of the investor. In the depository, a securities account can be opened, all shares can be deposited, they can be withdrawn / sold at any time and instruction to deliver or receive shares on behalf of investor can be given. It is a technology driven electronic storage system. It has no paper work relating to share certificates, transfer forms etc. All transactions of the investors and settled with greater speed, efficiency and all securities are entered in a book entry made.
All trading in securities is now done through computer terminals. Since all systems are computerised, buying and selling of securities are settled through an electronic book entry form. This is mainly done to eliminate problems like theft, fake / forged transfers, transfer delays and paper work associated with share certificates or debentures held in physical form.
In this process securities held by the investor in physical form are cancelled and the investor is given an electronic entry or number so that he can hold it as an electronic balance in an account. The process of holding securities in an electronic form is called dematerialisation. For this the investor has to open a demat account with an organisation called depository. In fact, now all initial public offers are issued in dematerialised form.
What is index? Explain any two popular indices in our country.
A stock market index is a barometer of market behaviour. It measures overall market sentiment through a set of stocks that are representative of the market. It reflects market direction and indicate day-to-day fluctuations in stock prices. An ideal index number must represent changes in the prices of securities and reflect price movement of typical shares for better market representation. If the index rises, it indicates that the market is doing well and Vice-Versa. In Indian market the BSE – SENSEX and NSE – Nifty are important indices.
SENSEX (Sensitive Index) :
SENSEX is the bench mark index of the BSE. The BSE sensex is also called the BSE-30. Scince the BSE has been the leading exchange of the Indian secondary market, the sensex has been an important indicator of the indian stock market. It is most frequently used indicator while reporting on the state of the market. The SENSEX, launched in 1986 is made up of 30 of the most actively traded stocks in the market. They represent 13 sectors of the economy and’are leaders in their respective industries. The index with a base year of 1978-79, the value base year was 100.
NIFTY is an index of NSE, which computed from performance of top stocks from different sectors listed in NSE. NIFTY stands for National Stock Exchanges Fifty. It consists of 50 companies from 24 different sectors. The companies which form index of nifty may vary from time to time based on many factors considered by NSE. The base year for index is 1995 – 96 with the base value as 1000.
Very Short Answer Questions
A financial market is a broad term describing any market place where buyers and sellers participate in the trade of financial assets such as equities, bonds, currencies and derivatives.
Classification of financial market.
Financial markets are basically classified on the basis of maturity of financial instruments traded in them, into money market and capital market. The financial instruments with a maturity of less than one year are traded in money market and with longer maturity are traded in the capital market.
The money market is a market for short term funds which deals in monetary assets whose period of maturity is up to one year. The market facilitates raising of short-term funds for meeting temporary shortage of cash and obligations and deployment of excess funds for earning returns.
The term capital market refers to facilities and institutional arrangements through which longterm funds, both debt and equity are raised and invested. It consists of series of channels. Through which savings of the community are made available for industrial and commercial purposes.
It is also known as the new issue market. It deals with new securities being issued for the first time. The essential function of primary market is to facilitate the transfer of investible funds from savers to entrepreneurs.
It is also known as the stock market or stock exchange. It is a market for the purchase and sale of existing securities. It helps existing investors to disinvest and fresh investors to enter into the market. It provides liquidity and marketability to existing securities.
A treasury bills is an instrument of short term borrowing by Government of India maturing in less than one year. These are issued by RBI on behalf of Goyemment to meet its short term requirements. The purchase price is-less than face value and at maturity govt, will pay full face value.
Commercial paper is a short-term unsecured promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is issued by large and credit worthy companies to raise short-term funds at lower rates of interest than market rates.
Certificate of Deposit.
Certificates of deposits are unsecured, negotiable short-term instruments in bearer form, issued by commercial banks and developed financial institutions. They can be issued to individuals, corporations during periods of tight liquidity when deposit growth of banks slow and demand for credit is high.
The Over The Counter Exchange of India (OTCEI) is a company incorporated under companies Act, to provide small and medium companies to access to the capital market for raising finance in a cost effective manner. It is also meant to provide investors with a convenient, transparent and efficient avenue for capital market investment.
Dematerialisation. [A.P. Mar. 17]
It is a process where securities held by investor in the physical form are cancelled and the investor is given an electronic entry so that he can hold it as an electronic balance in an account. This process of holding securities in an electronic form is called dematerialisation. ‘
Just like a bank keeps money is safe custody for customers, a depository keep securities in electronic form on behalf of investors. In the depository a securities account is opened and all shares deposited and sold at any time, an instruction to deliver and receive shares on behalf of investors given.
SENSEX. [A.P. Mar. 17]
BSE sensex is called BSE-30. Since BSE has been the leading exchange of the Indian secondary market, SENSEX is an important indicator of the Indian Stock Market. SENSEX which was launched in 1986 is madeup of 30 of the most actively traded stocks in the market.
NIFTY stands for National Stock exchange 50. It is an index computed from the performance of top stocks from different sector listed in NSE. NIFTY consists of 50 companies from 24 different sectors. The companies which form index of NIFTY may vary from time to time based on many factors Considered by NSE.