Chapter - 11
Financial Markets
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Q.1 A) Select the correct answer from the options given below and rewrite the statements.
1. A financial market is a market in which people trade ................. and derivatives at low transaction costs.
a) Gold
b) Financial securities
c) Commodities
Ans: Financial Securities
2. When the trade bills are accepted by commercial banks it is known as .................
a) Treasury bills
b) Commercial bills
c) Commercial papers
Ans: Commercial Papers
3. Money market is a market for lending and borrowing of funds for ................. term.
a) short
b) medium
c) long
Ans: Short
4. Central Government is a borrower in the money market through the issue of .................
a) Commercial Papers
b) Trade Bills
c) Treasury Bills
Ans: Treasury Bills
5. ................. is the market for borrowing and lending long term capital required by business enterprises.
a) Money Market
b) Capital Market
c) Gold Market
Ans: Capital Market
B) Match the pairs.
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Group A
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Group B
|
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a) Financial
market
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1) Long term
fund
|
|
b) Money market
|
2) New issue
market
|
|
c) Primary
market
|
3) Trading of
commodities
|
|
d) Commercial
paper
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4) Short term
fund
|
|
|
5) Trading of
financial securities
|
|
|
6) Share market
|
|
|
7) Unsecured
promissory note
|
|
|
8) Secured
promissory note
|
Ans:
Group A | Group B |
a) Financial market | 5) Trading of financial securities |
b) Money market | 4) Short term fund |
c) Primary market | 2) New issue market |
d) Commercial paper | 7) Unsecured promissory note |
C) Write a word or a term or a phrase which can substitute each of the following statements.
1. A market where people trade financial securities and derivatives at low transaction cost.
Ans: Financial Market
2. A market which provide long term funds.
Ans: Capital Market
3. A market which provide short term funds.
Ans: Money Market
4. A money market instrument used by bank when one bank faces temporary shortage of cash.
Ans: Call Money / Notice Money
5. A bill which is issued by Reserve Bank of India on behalf of the Government of India.
Ans: Treasury Bills
6. A market which exclusively deals with the new issue of securities.
Ans: Primary Market / New issue Market
D) State whether the following statements are true or false.
1. A Financial Market is a market in which people trade financial securities and derivatives at high transaction costs.
Ans: False
2. Money market is the market for the long term funds.
Ans: False
3. Capital market is the market for the long term funds.
Ans: True
4. Primary market is also known as new issue market.
Ans: True
5. Secondary market is commonly known as stock market.
Ans: True
6. Commercial paper is a secured promissory note.
Ans: False
7. Treasury bills are issued by commercial banks.
Ans: False
E) Find the odd one.
1. Treasury Bills, Shares, Certificate of Deposit.
Ans: Share
2. FPO, Private Placement, Commercial paper.
Ans: Commercial Paper
3. New Issues Market, Call Money Market, Secondary Market.
Ans: Call money Market
F) Complete the sentences.
1. Funds borrowed and lent in money market are for ___________ term.
Ans: Short
2. When trade bills are accepted by commercial banks, it is known as _________.
Ans: Commercial Bills
3. Unsecured negotiable promissory notes issued by a commercial bank is called as _______.
Ans: Certificate of Depository
4. New shares, debentures, etc. are traded in ____________ market.
Ans: Primary/ New issues
5. In capital market the instruments traded have maturity period of more than ______ year.
Ans: One
G) Select the correct option from the bracket.
(Buying and selling of existing securities, Treasury Bills, Funds for long term, Fund for
short term)
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Group ‘A’
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Group ‘B’
|
|
a) Money
market
|
1) -----------
|
|
b) Zero
risk instrument
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2) -----------
|
|
c) ---------------
|
3) Capital
market
|
|
d) -----------
|
4) Secondary
market
|
Ans:
|
Group ‘A’
|
Group ‘B’
|
|
a) Money
market
|
1) Funds for short term
|
|
b) Zero
risk instrument
|
2) Treasury Bills
|
|
c) Funds for long term
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3) Capital
market
|
|
d) Buying and selling of existing securities
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4) Secondary
market
|
H) Answer in one sentence.
1. What is financial market ?
Ans: A Financial Market is a market where Financial assets i.e. Financial instruments are exchanged or bought and sold
2. What is call money market ?
Ans: Call money market means call money, funds are lent or borrowed for very short periods i.e. one day.
3. What is Certificate of Deposits ?
Ans: These are unsecured negotiable promissory notes usually issued by Commercial Banks and Financial Institutions.
4. What is Trade Bill ?
Ans: Bill of Exchange also called as Trade bills are negotiable instruments or bills drawn by a seller on the buyer for value of goods sold under credit sales.
5. What is new issue market ?
Ans: New issue market refers to a market where newly established companies sell their share, debentures, etc. for the first time to raise fresh capital.
I) Correct the underlined word/s and rewrite the following sentences.
1. In Primary market, already existing securities are traded.
Ans: In Secondary market, already existing securities are traded.
2. Companies sell fresh shares for the first time to the public in secondary market.
Ans: Companies sell fresh shares for the first time to the public in secondary market.
3. In Money market, the instruments traded have maturity period of more than one year.
Ans: In Capital market, the instruments traded have maturity period of more than one year.
4. Financial market can be classified as capital market and call money market.
Ans: Financial market can be classified as capital market and money market.
Q.2 Explain the following terms/concepts.
1. Financial market
Ans: A Financial Market is a market where Financial assets i.e. Financial instruments are exchanged or bought and sold.
2. Capital market
Ans: It is the market for borrowing and lending long term capital required by business enterprises. The financial assets dealt with in the capital market have long or indefinite maturity period. The capital market is a core of a country's financial system as it helps in mobilization of resources.
3. Money market
Ans: Money market is a market for lending and borrowing of funds for short term. It is a market wherein lending and borrowing of funds take place for a short period of time which varies from one day to a year.
4. Call money market
Ans: funds are lent or borrowed for very short periods i.e. one day
5. Treasury bills
Ans: Treasury Bills are short term securities issued by Reserve Bank of India on behalf of the Central Government of India to meet the government's short term funds requirement. Treasury Bills have three maturity periods - 91 days, 182 days and 364 days.
6. Commercial bills
Ans: Bill of Exchange also called as Trade bills are negotiable instruments or bills drawn by a seller on the buyer for value of goods sold under credit sales. When the trade bills are accepted by Commercial banks it is known as Commercial Bills.
7. Repurchase agreement
Ans: Repo is an agreement where the seller of a security, (i.e. one who needs money) agrees to buy it back from the lender at a higher price on a future date. Usually this agreement is made between RBI and commercial banks.
8. Primary market
Ans: The issue of new shares by the company is done in the primary market.
9. Secondary market
Ans: The securities issued earlier are traded in the secondary market
Q.3 Study the following case / situation and express your opinion.
(1) Joy ltd. Company is a newly incorporated company. It wants to raise capital for the first time by issuing equity shares.
a. Should it go to primary market or secondary market to issue its shares ?
Ans: Joy ltd. Should go to primary market to issue its shares as they issuing it for the first time.
b. Should it offer its shares through public offer or rights issue ?
Ans: Joy ltd. Should offer it share through a public offer to raise capital.
c. What will be the issue of Equity shares by Joy Ltd.Co. called as, IPO or FPO ?
Ans: The issue of Equity shares by Joy Ltd.Co. called as Initial Public Offer (IPO).
(2) Mr. X is the CFO ( Chief Financial Officer ) of PQR Co. Ltd. which is a reputed company in the field of construction business. Often Mr. X has to decide on investing surplus funds of the company for short durations. And at times, he also has to decide the sources from where he can raise funds for short durations.
a. Assume on behalf of the company Mr. X has Rs. 5 lakhs and wants to invest for a short period. Should he buy Equity shares or Certificate of Deposit ?
Ans: On behalf of the company MR. X should buy a Certificate of Deposit to invest Rs 5 Lakhs for short period.
b. The company has surplus funds and wants to invest it. However, he needs the money back in 4 months, so should he invest in Treasury Bills or Government Securities ?
Ans: On behalf of the company MR. X should invest surplus funds in treasury bills for a short period of 4 months.
c. Can the company issue Certificate of Deposit ?
Ans: No, the PQR Co ltd cannot issue a Certificate of Deposit. These are unsecured negotiable promissory notes usually issued by Commercial Banks and Financial Institutions.
Q.4 Distinguish between the following.
1. Primary market and Secondary market.
Ans:
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Point
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Primary market
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Secondary market.
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1) Meaning
|
The issue of
new shares by the company is done in the primary market.
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The
securities issued earlier are traded in the secondary market
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2) Mode of
Investment
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Direct
investment in the securities. Securities are acquired directly from the
company.
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Indirect
investment as the securities are acquired from other stakeholders.
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3) Parties in
action
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The parties
dealing in this market are company and investors.
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The parties
dealing in this market are only investors.
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4)
Intermediary
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The
underwriters are the intermediaries.
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The security
brokers are the intermediaries.
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5) Value of
security
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The price of
security in the primary market is fixed as it is decided by the company.
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The price of
security is fluctuating, depending on the demand and supply conditions in the
market.
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2. Money market and Capital market.
Ans:
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Point
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Money market
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Capital market
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1) Meaning
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It is a
component of the financial market where short-term borrowing takes place.
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It is a
component of financial market where long-term borrowings takes place.
|
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2) Time
period
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In money
market, the instruments traded have maturity period of one year or less than
one year.
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In capital
market, the instruments traded have maturity period of more than one year.
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3)
Instruments
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Certificate
of deposits, Commercial paper, Treasury bills, etc. are the instruments
traded in the money market.
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Shares,
Debentures, Bonds, Securities of the government are the instrument of capital
market
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4) Purpose of
borrowing
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Funds are
borrowed to meet working capital requirements or for small investments
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Long term
funds are required to establish new business, expand or diversify business or
purchase of fixed assets.
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5)
Institutions / Participants
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Participants
in the market are Central banks, Commercial banks, Non-bank financial
institution, etc.
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Stock
exchanges, Commercial banks and Non-bank institutions, financial
intermediaries, etc. are the participants in the market
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6) Risk
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In the money
market, risk factor is very less because maturity period of the instruments
is less than one year.
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In capital
market, the risk is more as compared to in the money market. The reason
behind this is the instruments have long maturity period.
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7) Return on
Investment
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Return on
investment in money market is less as they are highly liquid and safe.
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Return on
investment in capital market is comparatively high as they are more risky
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8) Role in
Economy
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This market
increases liquidity of funds in the economy.
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This market
helps in mobilization of savings in the economy.
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Q.5 Answer in brief.
1. State any four functions of financial market.
Ans: A Financial Market is a market where Financial assets i.e. Financial instruments are exchanged or bought and sold.
FUNCTIONS OF FINANCIAL MARKET
1. Transfer of Resources : Financial Market facilitates the transfer of real economic resources from lenders to ultimate users.
2. Productive usage : Financial Market allows productive use of the funds. In the hands of the investors their excess funds would have remained idle. Borrowers use these Funds for productive purposes.
3. Enhancing Income : Financial Market allows lenders to earn interest or dividend on their surplus funds, thus leading to the enhancement of the individual and the national income.
4. Capital Formation : Financial Market provides a channel through which savings flow to industrial and commercial organizations in the form of capital. This leads to capital formation.
5. Price determination : The financial instruments traded in a financial market get their prices from the mechanism of demand and supply. The investors are the suppliers of the funds and the corporates are the users. The interaction between the two and other market factors will help to determine the prices.
6. Sale Mechanism : Financial Market provides a mechanism for selling of a financial asset by an investor so as to offer the benefit of marketability and liquidity of such assets.
7. Mobilizing Funds : Idle funds in the hands of the investors can be productively used by corporates. Investors who have savings must be linked with corporates that require investment. So financial market enables the investors to invest their saving according to their choices and risk assessment. This will utilize idle funds and the economy will boom.
8. Liquidity : Financial market provides a mechanism for liquidating the financial instruments. This means at any given time, the investors can sell their financial instruments and convert them into cash. This is an important factor for investors who do not want to invest for
a long period.
9. Easy access : Both investors and industries need each other. The financial market provides a platform where both the buyers and sellers can find each other easily.
10. Industrial development : Financial market helps in transforming savings into capital. Corporates use the funds of investors to undertake productive or commercial activities thereby leading to economic development.
2. State any four features of money market.
Ans: Money market is a market for lending and borrowing of funds for short term. It is a market wherein lending and borrowing of funds take place for a short period of time which varies from one day to a year
Features of Money Market :
1) The funds borrowed and lent in money market are for short term. The maximum period for which the funds are traded in the market is one year.
2) It is a wholesale market for short term debt as the transaction volume is large.
3) Trading may take place over the telephone, after which written confirmation is done by way of e-mails.
4) Participants of money market include RBI, commercial banks, mutual funds, financial institutions, primary dealers and corporates.
5) There is an impersonal relationship between the participants of the money market.
6) Money market has no geographical area i.e. there is no fixed place for carrying out transactions.
7) The instruments of money market can be converted easily into cash or have very short maturity periods. Moreover, the returns on investment is also low.
8) Major segments of money market are :
a) Call money market
b) Certificate of Deposits market
c) Treasury Bill market
d) Commercial Bill market
e) Commercial papers market
3. State any four features of capital market.
Ans: Following are the main features of the capital market :
1) Link between investors and borrowers : The capital market links investors with the borrowers of funds. It routes money from savers to entrepreneurial borrowers.
2) Deals in medium and Long-term investment : Capital market is a market where medium and long term financial instruments are traded. Through this market, corporates, industrial organizations, financial institutions access long-term funds from both domestic and foreign markets.
3) Presence of Intermediaries : Capital market operates with the help of intermediaries like brokers, underwriters, merchant bankers, collection bankers etc. These intermediaries are important elements of a capital market.
4) Promotes capital formation : Capital market provides a platform for investors and borrowers of long term funds to trade. This leads to capital formation in an economy as it mobilizes funds.
Capital formation is the net addition to the existing stock of an economy's capital.
5) Regulated by government rules, regulations and policies : Capital market operates freely. However, it is regulated by government rules, regulations and policies. e.g. SEBI is the regulator of Capital markets.
6) Deals in marketable and non-marketable securities : Capital market trades in both marketable and non-marketable securities. Marketable securities are securities that can be transferred. e.g. Shares, Debentures etc. and non-marketable securities are those which cannot be transferred. e.g. Term Deposits, Loans and Advances.
7) Variety of Investors : Capital market has a wide variety of investors. It comprises both individuals like general public and institutional investors like Mutual Funds, Insurance companies, Financial Institutions, etc.
8) Risk : Risk is very high here as the instruments have long maturity periods. However,
the return on investments is very high.
Instruments in capital market :
1) Equity shares.
2) Preference shares.
3) Debentures.
4) Bonds.
5) Government securities
6) Public Deposits
4. Explain any 4 types of money market instruments.
Ans: Instruments of Money Market : In the money market, only those financial instruments are traded which are immediate substitute for money.
Some of these instruments are explained as follows :
1) Call money and Notice money : Call money and Notice money market is an important segment of the money market in India. Under Call money, funds are lent or borrowed for very short periods i.e. one day. Under Notice money, funds are lent or borrowed for periods between 2 days to 14 days. Funds have to be repaid within a specified time on the receipt of notice given by the lender. When one bank faces temporary shortage of cash, then another bank with surplus cash lends money to it. Hence Call/
Notice money market is also called as interbank Call money market.
2) Treasury Bills (T-Bills) : Treasury Bills are short term securities issued by Reserve Bank of India on behalf of the Central Government of India to meet the government's short term funds requirement. Treasury Bills have three maturity periods - 91 days, 182 days and 364 days. These bills are sold to banks and individuals, firms, institutions, etc. These bills are negotiable instruments and are freely transferable. The minimum value of T-bills is ` 25,000 or in multiples of ` 25000. These are issued at a discount and repaid at par and hence they are also called Zero Coupon Bonds.
3) Trade Bills/ Commercial Bills : Bill of Exchange also called as Trade bills are negotiable instruments or bills drawn by a seller on the buyer for value of goods sold under credit sales. These have short-term maturity period generally of 90 days and can be easily transferred. If the seller wants immediate cash, he can discount the trade bills with Commercial banks i.e. sell it to banks for cash. When the trade bills are accepted by Commercial banks it is known as Commercial Bills. Banks can
rediscount the bills any number of times till the maturity of the bill.
Q.6 Justify the following statements.
1. Financial markets acts as link between investor and borrower.
Ans:
a) Financial Market is a
market where financial assets i.e. Financial instruments are exchanged or
bought and sold.
b) In an economy individual, corporates, governments, etc. may have excess funds and may want to invest it. They are called investors.
c) On the other hand, there may be businessmen, corporates, Governments, etc. who may
need funds and are called as Borrowers.
d) The investors lend money to the Borrowers through a market called as Financial
Market.
e) financial market helps in the mobilization of savings and converts them into investments.
f) Thus, financial market acts as an intermediary between investors and borrowers.
2. Money market makes available short term finance through different instruments.
Ans:
a) Money market is a market
for lending and borrowing of funds for short term.
b) It is a market wherein lending and borrowing of funds take place for a short period of
time which varies from one day to a year.
c) Also the financial instruments traded in this market can be converted into cash easily without any loss of time and value.
d) It is an
important part of the financial system that helps in fulfilling the short-term and very short-term requirements of the companies, banks, financial institutions, government agencies, etc.
e) It is a market for financial assets which are close substitutes for money. An instrument like commercial paper, liquid and treasury bills, etc. are traded in the money market.
f) Hence, the Money market makes available short-term finance through different instruments.
3. Capital market is useful for corporate sector.
Ans:
a) Capital market is the market for borrowing
and lending long-term capital required by business enterprises.
b) The capital market links investors with the borrowers of funds. It routes money from savers to
entrepreneurial borrowers.
c) Through this market, corporates, industrial organizations, and financial institutions access
long-term funds from both domestic and foreign markets.
d) Primary or New Issues Market- here companies sell fresh shares, debentures, etc. for the first time
to the public.
e) Secondary Market – here already existing shares, debentures, etc. are traded through the Stock
Exchanges.
f) Hence, Capital market is useful for corporate sector.
4. There are many participants in money market.
Ans:
a) Money market is a market for lending and
borrowing of funds for short term. It is a market wherein lending and borrowing
of funds take place for a short period of time which varies from one day to a
year.
b) Reserve Bank of India: It is the most important participant in the money market. Through
the money market, RBI regulates the money supply and implements its monetary
policy.
c) Central and State Government: Central Government is a borrower in the Money Market, through the issue of Treasury Bills (T-Bills).
d) Public Sector Undertakings (PSU): Many listed government companies can issue commercial
paper in order to obtain its working capital.
e) Scheduled Commercial Banks: Scheduled commercial banks are very big borrowers and lenders in the money market.
f) Hence, There are many participants in money market.
Q.7 Answer the following questions.
1. Explain the functions of financial market.
Ans: FUNCTIONS OF FINANCIAL MARKET:
1. Transfer of Resources : Financial Market facilitates the transfer of real economic resources from lenders to ultimate users.
2. Productive usage : Financial Market allows productive use of the funds. In the hands of the investors their excess funds would have remained idle. Borrowers use these Funds for productive purposes.
3. Enhancing Income : Financial Market allows lenders to earn interest or dividend on their surplus funds, thus leading to the enhancement of the individual and the national income.
4. Capital Formation : Financial Market provides a channel through which savings flow to industrial and commercial organizations in the form of capital. This leads to capital formation.
5. Price determination : The financial instruments traded in a financial market get their prices from the mechanism of demand and supply. The investors are the suppliers of the funds and the corporates are the users. The interaction between the two and other market factors will help to determine the prices.
6. Sale Mechanism : Financial Market provides a mechanism for selling of a financial asset by an investor so as to offer the benefit of marketability and liquidity of such assets.
7. Mobilizing Funds : Idle funds in the hands of the investors can be productively used by corporates. Investors who have savings must be linked with corporates that require investment. So financial market enables the investors to invest their saving according to their choices and risk assessment. This will utilize idle funds and the economy will boom.
8. Liquidity : Financial market provides a mechanism for liquidating the financial instruments. This means at any given time, the investors can sell their financial instruments and convert them into cash. This is an important factor for investors who do not want to invest for a long period.
9. Easy access : Both investors and industries need each other. The financial market provides a platform where both the buyers and sellers can find each other easily.
10. Industrial development : Financial market helps in transforming savings into capital. Corporates use the funds of investors to undertake productive or commercial activities thereby leading to economic development.
2. State the instruments in money market.
Ans: Instruments of Money Market :
In the money market, only those financial instruments are traded which are immediate substitute for money.
Some of these instruments are explained as follows :
1) Call money and Notice money : Call money and Notice money market is an important segment of the money market in India. Under Call money, funds are lent or borrowed for very short periods i.e. one day. Under Notice money, funds are lent or borrowed for periods between 2 days to 14 days. Funds have to be repaid within a specified time on the receipt of notice given by the lender. When one bank faces temporary shortage of cash, then another bank with surplus cash lends money to it. Hence Call/
Notice money market is also called as interbank Call money market.
2) Treasury Bills (T-Bills) : Treasury Bills are short term securities issued by Reserve Bank of India on behalf of the Central Government of India to meet the government's short term funds requirement. Treasury Bills have three maturity periods - 91 days, 182 days and 364 days. These bills are sold to banks and individuals, firms, institutions, etc. These bills are negotiable instruments and are freely transferable. The minimum value of T-bills is ` 25,000 or in multiples of ` 25000. These are issued at a discount and repaid at par and hence they are also called Zero Coupon Bonds.
3) Trade Bills/ Commercial Bills : Bill of Exchange also called as Trade bills are negotiable instruments or bills drawn by a seller on the buyer for value of goods sold under credit sales. These have short-term maturity period generally of 90 days and can be easily transferred. If the seller wants immediate cash, he can discount the trade bills with Commercial banks i.e. sell it to banks for cash. When the trade bills are accepted by Commercial banks it is known as Commercial Bills. Banks can
rediscount the bills any number of times till the maturity of the bill.
3. State the features of capital market.
Ans: Following are the main features of the capital market :
1) Link between investors and borrowers : The capital market links investors with the borrowers of funds. It routes money from savers to entrepreneurial borrowers.
2) Deals in medium and Long-term investment : Capital market is a market where medium and long term financial instruments are traded. Through this market, corporates, industrial organizations, financial institutions access long-term funds from both domestic and foreign markets.
3) Presence of Intermediaries : Capital market operates with the help of intermediaries like brokers, underwriters, merchant bankers, collection bankers etc. These intermediaries are important elements of a capital market.
4) Promotes capital formation : Capital market provides a platform for investors and borrowers of long term funds to trade. This leads to capital formation in an economy as it mobilizes funds. Capital formation is the net addition to the existing stock of an economy's capital.
5) Regulated by government rules, regulations and policies : Capital market operates freely. However, it is regulated by government rules, regulations and policies. e.g. SEBI is the regulator of Capital markets.
6) Deals in marketable and non-marketable securities : Capital market trades in both marketable and non-marketable securities. Marketable securities are securities that can be transferred. e.g. Shares, Debentures etc. and non-marketable securities are those which cannot be transferred. e.g. Term Deposits, Loans and Advances.
7) Variety of Investors : Capital market has a wide variety of investors. It comprises both individuals like general public and institutional investors like Mutual Funds, Insurance companies, Financial Institutions, etc.
8) Risk : Risk is very high here as the instruments have long maturity periods. However, the return on investments is very high.
Instruments in capital market :
1) Equity shares.
2) Preference shares.
3) Debentures.
4) Bonds.
5) Government securities
6) Public Deposits
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