NCERT Business studies class 12 | Financial Markets chapter -10 cbse |

cbse class 12 business studies

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class 12 business studies

Chapter 10-Financial Markets

Class 12 business studies important question and answers

1.Explain the concept of financial market.

A financial market is a market for the creation and exchange of financial assets.Financial markets exist wherever a financial transaction occurs.
Financial transactions could be in the form of creation of financial assets such as the initial issue of shares and debentures by a firm or the purchase and sale of existing financial assets like equity shares, debentures and bonds.

2.Explain the functions of financial market.

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 the most productive uses:

A financial market facilitates the transfer of savings from savers to investors.
It gives savers the choice of different investments and thus helps to channelise surplus funds into the most productive use.

2. Facilitating price discovery:

The forces of demand and supply help to establish a price for a commodity or service in the market.
In the financial market, the households 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 traded in that particular market

3. Providing liquidity to financial assets:

Financial markets facilitate easy purchase and sale of financial assets.
They provide liquidity to financial assets, so that they can be easily converted into cash, by the holders of assets, whenever required.

4.Reducing the cost of transactions:

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 asset .
The financial market is thus, a common platform where buyers and sellers can meet for fulfilment of their individual needs.

3.Explain the concept of capital market and money market as types of financial markets

Financial markets are classified on the basis of the maturity of financial instruments traded in them.
Instruments with a maturity of less than one year are traded in the money 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.
Instruments with longer maturity are traded in the capital market.
The term capital market refers to facilities and institutional arrangements through which long-term funds ( debt and equity) are raised and invested.

4.Explain the concept of money 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. These assets are close substitutes for money.
It is a market where low risk, unsecured and short term debt instruments that are highly liquid are issued and actively traded everyday. It has no physical location, but is conducted over the phone and internet.
It enables the raising of short-term funds for meeting the temporary shortages of cash and obligations and the temporary deployment of excess funds for earning returns.
The major participants in the market are the Reserve Bank of India (RBI), Commercial Banks, Non Banking Finance Companies, State Governments, Large Corporate Houses and Mutual Funds.

5.Discuss the concept of capital market

The term capital market refers to facilities and institutional arrangements through which long-term funds ( debt and equity) are raised and invested.
It consists of a series of channels through which savings of the community are made available for industrial and commercial enterprises and for the public .
The capital market consists of development banks, commercial banks and stock exchanges.
An ideal capital market is one where finance is available at reasonable cost.
It is essential that financial institutions are developed and the market operations are free, fair, competitive and transparent.
The capital market should also be efficient in respect of the information that it delivers, minimise transaction costs and allocate capital most productively

6.Describe the various money market instruments.

Money Market Instruments

1. Treasury Bill:

Is an instrument of short-term borrowing by the Government of India
It matures in less than one year and are also known as Zero Coupon Bonds .
Treasury bills are issued in the form of a promissory note.
They have high liquidity and assured yield and negligible risk of default.
They are issued at a price which is lower than their face value and repaid at par.
Treasury bills are available for a minimum amount of `25,000 and in multiples thereof.

2. Commercial Paper:

It is a short-term unsecured promissory note, negotiable
It is transferable by endorsement and delivery with a fixed maturity period.
It is issued by large and creditworthy companies to raise short-term funds at lower rates of interest than market rates.
It usually has a maturity period of 15 days to one year.
Funds raised through commercial paper are used to meet the flotation costs. This is known as Bridge Financing.

3. Call Money:

It is a short term finance, repayable on demand,
The maturity period is one day to fifteen days,
It is used for inter-bank transactions.
Commercial banks have to maintain a minimum cash balance known as cash reserve ratio.
The Reserve Bank of India changes the cash reserve ratio from time to time . Call money is a method by which banks borrow from each other .
The interest rate paid on call money loans is known as the call rate,and is a highly volatile rate that varies from day-today and sometimes from hour-to hour.

4. Certificate of Deposit:

These are unsecured, negotiable, short-term instruments in bearer form
It is issued by commercial banks and development financial institutions.
They can be issued to individuals, corporations and companies
It is issued 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.

5. Commercial Bill:

It is a bill of exchange used to finance the working capital requirements of business firms.
It is a short-term, negotiable, self-liquidating instrument which is used to finance the credit sales of firms.
When goods are sold on credit, the buyer becomes liable to make payment on a specific date in future.
The seller could wait till the specified date or make use of a bill of exchange. The seller (drawer) of the goods draws the bill and the buyer (drawee) accepts it.
On being accepted, the bill becomes a marketable instrument and is called a trade bill.
These bills can be discounted with a bank if the seller needs funds before the bill matures.
When a trade bill is accepted by a commercial bank it is known as a commercial bill.

7.Explain primary and secondary markets as types of capital market

The Capital Market can be divided into two parts:

a. Primary Market

b. Secondary Market

The primary market

It is also known as the new issues market.
It deals with new securities being issued for the first time.
main function of a primary market is to facilitate the transfer of investible funds from savers to entrepreneurs seeking to establish new enterprises for the first time.
The investors are banks, financial institutions, insurance companies, mutual funds and individuals.
A company can raise capital through the primary market in the form of equity shares, preference shares, debentures, loans and deposits.
Funds raised may be for setting up new projects, expansion, diversification, etc.

The secondary market

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 dis-invest and fresh investors to enter the market.
It also provides liquidity and marketability to existing securities.
It contributes to economic growth by channelising funds towards the most productive investments through the process of disinvestment and reinvestment.
Securities are traded, cleared and settled within the regulatory framework prescribed by SEBI.
Advances in IT have made trading through stock exchanges accessible from anywhere

8.Differentiate between capital market and money market.

The major points of difference between the two markets are as follows:

Capital market

Money market

(i)Participants

financial institutions,banks,

corporate entities,

RBI, banks, financial

institutions

ii) Instruments

equity shares, debentures

bonds, preference shares etc

T-bills, trade bills reports,

commercial paper and

certificates of deposit.

iii) Investment

Outlay

does not necessarily require a

huge financial outlay.

The value of units of

securities is generally low

transactions entail huge

sums of money as the

instruments are quite

expensive.

(iv) Duration:

deals in medium

and long term securities

have a maximum tenure of

one year or for for a single

day.

(v)Liquidity:

are considered

liquid but a share may not be

actively traded

enjoy a higher degree of

liquidity

(vi) Safety

are riskier both with respect

to returns and principal

repayment.

much safer with a minimum

risk of default.

(vii)Expected return

yield a higher return

for investors

lesser return compared to

capital market

9.Discuss the methods of floating new issues in the primary market

There are various methods of floating new issues in the primary market :

1. Offer through Prospectus:

It is the most popular method of raising funds by public companies in the primary market.
It involves inviting subscription from the public through issue of prospectus.
It makes a direct appeal to investors to raise capital, through an advertisement in newspapers and magazines.
The issues may be underwritten and also are required to be listed on at least one stock exchange.
The contents of the prospectus have to be in accordance with the provisions of the Companies Act and SEBI disclosure and investor protection guidelines.

2. Offer for Sale:

Under this method securities are not issued directly to the public but are offered for sale through intermediaries like stock brokers.
In this case, a company sells securities en bloc (together and at same time) at an agreed price to brokers who, will resell them to the investing public.

3. Private Placement:

It is the allotment of securities by a company to institutional investors and selected individuals.
It helps to raise capital more quickly than a public issue.
Some companies, cannot afford a public issue and choose to use private placement.

4. Rights Issue:

This is a privilege given to existing shareholders to subscribe to a new issue of shares according to the terms and conditions of the company.
The shareholders are offered the ‘right’ to buy new shares in proportion to the number of shares they already possess.

5. e-IPOs:

A company proposing to issue capital to the public through the on-line system of the stock exchange has to enter into an agreement with the stock exchange. This is called an Initial Public Offer (IPO).
SEBI registered brokers have to be appointed for accepting applications and placing orders with the company.
The issuer company should also appoint a registrar to the issue having electronic connectivity with the exchange.
The issuer company can apply for listing of its securities on any exchange other than the exchange through which it has offered its securities.
The lead manager coordinates all the activities amongst intermediaries connected with the issue.

10.Distinguish between primary and secondary markets.

Primary Market

Secondary Market

There is sale of securities by new companies

or further (new issues of securities by

existing companies to investors

There is trading of existing shares only.

Securities are sold by the company to the

investor directly (or through an

intermediary).

Ownership of existing securities is

exchanged between investors. The company

is not involved at all.

The flow of funds is from savers to

investors, i.e. the primary market directly

promotes capital formation.

Enhances encashability (liquidity) of shares,

i.e. the secondary market indirectly

promotes capital formation.

Only buying of securities takes place in the

primary market, securities cannot be sold

there.

Both the buying and the selling of securities

can take place on the stock exchange.

Prices are determined and decided by the

management of the company

Prices are determined by demand and

supply

for

the security.

There is no fixed geographical location.

Located at specified places.

11.Give the meaning of a stock exchange.

According to Securities Contracts (Regulation) Act 1956, stock exchange means any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying and selling or dealing in securities.

12.Explain the functions of a stock exchange.

1. Providing Liquidity and Marketability to Existing Securities: The basic function of a stock exchange is the creation of a continuous market where securities are bought and sold. It gives investors the chance to dis-invest and reinvest. This provides both liquidity and easy marketability to already existing securities in the market.

2. Pricing of Securities: Share prices on a stock exchange are determined by the forces of demand and supply. A stock exchange is a mechanism of constant valuation through which the prices of securities are determined. This provides instant information to both buyers and sellers in the market.

3. Safety of Transaction: The membership of a stock exchange is well- regulated and its dealings are well defined according to the existing legal framework. This ensures that the investing public gets a safe and fair deal on the market.

4. Contributes to Economic Growth: A stock exchange is a market in which existing securities are resold or traded. Through this process savings get channelised into their most productive investment avenues. This leads to capital formation and economic growth.

5. Spreading of Equity Cult: The stock exchange can play a vital role in ensuring wider share ownership by regulating new issues, better trading practices and taking effective steps in educating the public about investments.

6. Providing Scope for Speculation: The stock exchange provides sufficient scope within the provisions of law for speculative activity in a restricted and controlled manner. A certain degree of healthy speculation is necessary to ensure liquidity and price continuity in the stock market.

13.Discuss the trading procedure in a stock exchange

The following steps are involved in the screen-based trading for buying and selling of securities:

1.If an investor wishes to buy or sell any security he has to first approach a registered broker or sub-broker and enter into an agreement with him.

The investor has to sign a broker-client agreement and a client registration form before placing an order to buy or sell securities.

He has also to provide certain other details and information.

These include:

PAN number (This is mandatory)•
Date of birth and address.
Educational qualification and occupation.
Residential status (Indian/ NRI).
Bank account details.
Depository account details.
Name of any other broker with whom registered.
Client code number in the client registration form.
The broker then opens a trading account in the name of the investor.

2.The investor has to open a ‘demat’ account with a depository participant (DP) for holding and transferring securities in the demat form. He will also have to open a bank account for cash transactions in the securities market.

3.The investor then places an order with the broker to buy or sell shares. Clear instructions have to be given about the number of shares and the price at which the shares should be bought or sold. The broker will then go ahead with the deal at the above mentioned price or the best price available. An order confirmation slip is issued to the investor by the broker.

4.The broker then will go on-line and connect to the main stock exchange and match the share and best price available.

5.When the shares can be bought or sold at the price mentioned, it will be communicated to the broker’s terminal and the order will be executed electronically.

6.After the trade has been executed, within 24 hours the broker issues a Contract Note. It contains details of the number of shares bought or sold, the price, the date and time of deal, and the brokerage charges. A Unique Order Code number assigned to each transaction is printed on contract note.

7.Now, the investor has to deliver the shares sold or pay cash for the shares bought immediately after receiving the contract note . This is called the pay-in day.

8.Cash is paid or securities are delivered on pay-in day, which is before the T+2 day as the deal has to be settled and finalised on the T+2 day.

9.On the T+2 day, the exchange will deliver the share or make payment to the other broker. This is called the pay-out day. The broker then has to make payment to the investor within 24 hours of the pay-out day.

10.The broker can make delivery of shares in demat form directly to the investor’s demat account. The investor has to give details of his demat account and instruct his depository participant to take delivery of securities directly in his beneficial owner account.

14.Give the meaning of depository services and demat account as used in the trading procedure of securities

All trading in securities are now computerised, and buying and selling of securities are settled through an electronic book entry form. This is done to eliminate problems like theft, fake transfers, transfer delays and paperwork associated with share certificates or debentures held in physical form.

This is a process where securities held by the investor in the physical form are cancelled and the investor is given an electronic entry or number so that she/he can hold it as an electronic balance in an account.
This 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 a depository.
All Initial Public Offers (IPOs) are issued in dematerialisation form .
The Securities and Exchange Board of India (SEBI) has made it mandatory for the settlement procedures to take place in demat form in certain select securities.
Holding shares in demat form is very convenient as it is just like a bank account. Physical shares can be converted into electronic form or electronic holdings can be reconverted into physical certificates (re-materialisation).
Dematerialisation enables shares to be transferred to some other account just like cash and ensures settlement of all trades through a single account in shares.

These demat securities can even be pledged to get loans.

A depository is like a bank and keeps securities in electronic form on behalf of the investor.
In the depository a securities account can be opened, all shares can be deposited, and can be withdrawn/ sold at any time

Instruction to deliver or receive shares on behalf of the investor can be given.
It has no paper work relating to share certificates, transfer, forms, etc.
All transactions of the investors are settled with greater speed, efficiency and use as all securities are entered in a book entry mode.
If the investor is buying and selling the securities through the broker or the bank or a non-banking finance corporation, it acts as a DP for the investor and complete the formalities.

15.State the objectives of SEBI.

The objective of SEBI is to protect the interests of investors and to promote the development of, and regulate the securities market. This can be explained as follows:

1.To regulate stock exchanges and the securities industry to promote their orderly functioning.

2.To protect the rights and interests of investors, particularly individual investors and to guide and educate them.

3.To prevent trading malpractices and achieve a balance between self regulation by the securities industry and its statutory regulation.

4.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.

16.Explain the functions of SEBI.

Regulatory Functions

1. Registration of brokers and sub brokers and other players in the market.

2. Registration of collective investment schemes and Mutual Funds.

3. Regulation of stock brokers, portfolio exchanges, underwriters and merchant bankers and the business in stock exchanges and other securities market.

4. Regulation of takeover bids by companies.

5. Calling for information by undertaking inspection, conducting enquiries and audits of stock exchanges and intermediaries.

6. Levying fee or other charges for carrying out the purposes of the Act.

7.Performing and exercising such power under Securities Contracts (Regulation) Act 1956.

Development Functions

1.Training of intermediaries of the securities market.

2.Conducting research and publishing information useful to all market participants.

3.Undertaking measures to develop the capital markets by adapting a flexible approach.

Protective Functions

1.Prohibition of fraudulent and unfair trade practices like making misleading statements, manipulations, price rigging etc.

2.Controlling insider trading and imposing penalties for such practices.

3.Undertaking steps for investor protection.

4.Promotion of fair practices and code of conduct in securities market.

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