2nd PUC Business Studies Question Bank Chapter 10 Financial Market

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Karnataka 2nd PUC Business Studies Question Bank Chapter 10 Financial Market

Question 1.
Give the meaning of financial market. ( 1 Mark )
Answer:
A financial market is a market for the creation and exchange of financial assets. Financial assets include shares, debentures and bonds.

[Note: The initial issue of shares and debentures by a public company results in the ‘creation’ of financial assets. Purchase and sale of existing shares, debentures and bonds results in ‘exchange’ of financial assets].

Question 2.
Explain briefly the functions of a financial market. ( 4 Marks )
Answer:
Functions of a financial market:

• Mobilisation of savings and channalising them into the most productive uses: A financial market facilitates the transfer of savings from savers to investors. Further, it helps to channalise surplus funds into the most productive use.
• Facilitating price discovery: The interaction between the suppliers of funds (i.e., household) and the receivers of funds (i.e., business firms) helps to establish a price for the financial asset (i.e., shares, debentures and bonds)
• Providing liquidity to financial assets: Financial markets facilitate easy purchase and sale of financial assets. Thus, they provide liquidity to financial assets (i.e., shares or debentures can be easily converted into cash).
• Reducing the cost of transactions: The financial market provides a common platform where buyers and sellers can meet for fulfillment of their individual needs. Thus, it helps both the buyers and sellers of financial assets to save their time, effort and money.

Question 3.
What is money market? ( 1 Mark )
Answer:
Money market is a market for short term funds. It deals in monetary assets whose period of maturity is less than one year.

[Note: It is a market where low risk, unsecured and short term debt instruments that are highly liquid are issued and actively traded every day. If enables the raising of short term funds for meeting the temporary shortages of cash. The major participants in the money market are the Reserve Bank of India (RBI), commercial banks, Non Banking Finance Companies, State Governments, Large Corporate Houses and Mutual Funds.]

Question 4.
Explain any four money market instruments. ( 8 Marks )
Answer:
Following are the important money market instruments.
(1) Treasury Bills: They are instruments of short term borrowing issued by the Reserve Bank of India (RBI) on behalf of the Government of India. Thus, they help the central govt, to meet its short term requirement of funds. Their maturity period is less than one year.

Treasury bills are issued in the form of promissory note. They are highly liquid and have assured yield and negligible risk. They are issued at a price lower than their face value and repaid at par. The price difference is interest (i.e., discount). Treasury bills are available for a minimum amount of Rs. 25,000 and in multiples thereof.

(2) Commercial paper: It is a short term, unsecured negotiable instrument issued by large and credit worthy companies, to raise short term funds at lower rate of interest. Usually it has a maturity period of 15 days to one year. It is sold at a discount and redeemed at par. Funds raised through commercial paper are used to meet the floatation costs.

(3) Call money: Call money is a method by which banks faced with temporary shortage of cash can borrow short term finance from other banks. The maturity period of call money is one day to 15 days. Usually commercial banks raise short term finance by this method to be able to maintain the cash reserve ratio prescribed by the RBI. The Interest rate paid on call money loans is known as call rate.

(4) Certificate of deposit (CD): Certificate of deposits are bearer documents issued by commercial banks against the deposits kept by individuals and companies. They are short term, unsecured, negotiable instruments. They carry fixed rate of interest. They help to mobilize a large amount of money for short periods.

(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 term negotiable instrument which is used to finance the credit sales of firms. 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.
(Explain any four points)

Question 5.
What are treasury bills? ( 1 Mark )
Answer:
A treasury bill is an instrument of short term borrowing issued by the Reserve Bank of India on behalf of the Govt of India.

Question 6.
What is capital market?
Answer:

• Capital market refers to facilities and institutional arrangements through which long term funds both debt and equity are raised and invested.
• In short, it is a market for long term funds.

[Note: Capital market consists of development banks, commercial banks and stock exchanges. It helps corporate undertakings and government to mobilize long term funds-and help the economic development of the country.]

Question 7.
State any four differences between capital market and money market. ( 4 Marks )
Answer:
Distinction between capital market and money market

Basis of difference	Capital market	Money market
Participants	Financial institutions, Banks, Corporate entities foreign investors and retail investors	The RBI, banks, financial institutions and finance companies.
Instruments	Equity shares, debentures, bonds and preference shares.	Treasury bills, trade bills, commercial paper and certificates of deposit.
Investment outlay	A huge amount of financial outlay is not required by an individual investor.	Huge sums of money is required.
Duration	It deals in medium and long term securities.	The duration of securities is upto one year.
Liquidity	Generally, securities enjoy liquidity.	Securities enjoy higher degree of liquidity.
Safety	Instruments are riskier in respect of the returns and principal repayment.	Instruments are much safer with a minimum risk of default.
Expected return	Rate of return is high.	Rate of return is low.

Question 8.
Explain any four methods of floating new issues in the primary market. ( 4 Marks )
Answer:
Varies methods of floating new issues in the primary market are:

(1) Offer through prospectus (or public issue): Offer through prospectus is the most popular method of raising funds by public companies in the primary market. This involves inviting subscription from the public through issue of prospectus in the form of newspaper advertisement.

(2) Offer for sale: Under this method, securities are offered for sale through intermediaries like issuing houses or stock brokers. In this case company sells securities at an agreed price to brokers who, in turn, resell them to the investing public.

(3) Private placement: Private placement is the allotment of securities by a company to institutional investors and some selected individuals. It helps to raise capital more quickly than a public issue.

(4) Rights issue: Under this method, the existing shareholders are offered the ‘right’ to buy new shares in proportion to the number of shares they already possess.

(5) e-IPOs: It is a method of raising capital under which a company proposing to issue shares to the public i.e., initial public offer (IPO) enters into an agreement with the stock exchange to sell its shares through the online system of the stock exchange. SEBI registered brokers have to be appointed for the purpose of accepting applications and placing orders with the company.
(Write any four points)

Question 9.
Expand IPO. ( 1 Mark )
Answer:
IPO = Initial Public Offer

Question 10.
Distinguish between primary market and secondary market (any four points) ( 4 Marks )
Answer:
Distinguish between primary market and secondary market
Primary Market (New issue market):

1. It involves issue (sale) of new securities by new or by existing companies.
2. Securities are sold by the company to the investor directly.
3. The flow of funds is from savers to investors.
4. It directly promotes capital formation.
5. Prices of securities are determined and decided by the management of the company.

Secondary Market (Stock exchange):

1. There is trading of already existing securities only.
2. Ownership of existing securities is exchanged between investors. The company is not involved at all.
3. Enhances encashability (i.e., liquidity) of shares.
4. It indirectly promotes capital formation.
5. Prices are determined by demand and supply relating to the security.

Question 11.
What is stock exchange? ( 1 Mark )
Answer:
A stock exchange is an institution which provides a platform for buying and selling of existing securities.

Question 12.
What is stock exchange? Explain the functions of stock exchange. ( 8 Marks )
Answer:
A stock exchange is an institution which provides a platform for buying and selling of existing securities.
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”.

Functions of Stock Exchange:
Following are some of the important 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 disinvest and reinvest. This provides both liquidity and easy marketability to already existing securities in the market.

(2) Pricing of securities: Share prices in 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. Such a valuation provides important 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 Jo economic growth: Stock exchange is a market in which existing securities are resold or traded. Through this process of disinvestment and reinvestment savings get channalised into the 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. It is generally adopted that a certain degree of healthy speculation is necessary to ensure liquidity and price continuity to the stock market.

Thus, efficient functioning of a stock exchange creates a positive environment among investors and leads to the growth of primary market for new issues.

Question 13.
Write any four advantages of “Electronic Trading System” in stock exchanges. ( 4 Marks )
Answer:
Advantages of Electronic Trading System (or screen based trading or online trading) in stock exchanges:

1. It ensures transparency in transactions as it allows participants to see the prices of all securities in the market while business is being transacted. They are able to see the full market during real time.
2. It helps in fixing security prices efficiently by increasing the efficiency of information being passed on. The computer screens display information on prices and also capital market developments that influence share prices.
3. It increases the efficiency of operations, since there is reduction in time, cost and risk of error.
4. This system has improved the liquidity of securities by enabling a large number of participants to trade with each other. People from all over the country and even abroad can buy or sell securities through brokers.
5. On-line trading system provides a single trading platform as the business is transacted at the same time in all the trading centres. Thus, all the trading centres spread all over the country have been brought into one trading platform on the computer.

Now, screen based trading or online trading is the only way available to buy or sell shares in the secondary market.
(Write any four points)

Question 14.
Briefly explain the steps in the screen based trading and settlement procedure in a stock exchange. ( 8 Marks )
Answer:
The steps in the screen based trading (or electronic trading or online trading) and settlement procedure in a stock exchange:

(1) If an investor wishes to buy or sell any security, first he has to approach a SEBI registered broker or sub-broker. After providing necessary information such as PAN, Bank account details, Depository account details, date of birth, address etc., the investor has to sign a broker – client agreement and a client registration form, (in which client code number is given). The broker then opens a trading account in the name of the investor.

(2) The investor has to open a ‘Demat’ account (or beneficial owner account) with a depository participant (DP) for holding and transferring securities in the demat form. He will also have to open a ‘Bank account’. With these preliminary steps, the other steps involved in online trading and settlement are:

(3) Placing an order with the broker to buy or sell shares. In the order, the investor should specify the type and number of shares and the price at which the shares should be brought or sold.

(4) The broker will then go online and connect to the main stock exchange and match the share and the best price available.

(5) The broker will then execute the order by actually buying or selling shares according to the instructions of the investor. The order will be executed electronically.

(6) After the trade has been executed, within 24 hours the broker issues a contract note to the investor. This note 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 given by the stock exchange is printed on the contract note).

(7) Now, the investor has to deliver the shares sold by giving proper delivery instruction slip or pay cash for the shares brought by issuing a cheque for the amount. This enables the broker to make payment or deliver the shares to the exchange.

(8) Cash is paid or securities are delivered to the stock exchange by the broker on the pay in day, which is before the T + 2 day.

(9) On the T + 2 day (i.e., payout day), the exchange will deliver the share or make payment to the other broker.

(10) The other broker then has to make payment to the investor who had sold shares within 24 hours of the payment day. Similarly, the broker makes delivery of shares in demat form directly to the demat account of the investor who made purchases.

Question 15.
Give the meaning of dematerialization. ( 1 Mark )
Answer:
The process of cancelling physical form of securities and holding them in an electronic form is called dematerialization.

Question 16.
What is demat account? ( 1 Mark )
Answer:
Demat account is an account opened and maintained with a Depository through Depository participant for holding and transferring securities in the demat (i.e., electronic) form.

Question 17.
How does the Demat system works? Explain. ( 8 Marks )
Answer:
The process of converting the securities from the physical or material form to electronic form is called dematerialization.

Working of the Demat System:

• A depository participant (DP) (either a bank, a broker or a financial services company) may be identified.
• An account opening form and documentation (PAN card details, photograph, power of attorney) may be completed.
• The physical (share) certificate is to be given to the DP along with a dematerialisation request form.
• If shares are applied in a public offer, simple details of DP and demat account are to be given and the shares on allotment would automatically be credited to the demat account.
• When the shares are sold through a broker,, the DP is to be instructed to debit the account with the number of shares sold.
• The broker then gives instruction to his DP for delivery of the shares to the stock exchange.
• The broker then receives payment and pay the person for the shares sold.
• All these transactions are to be completed within 2 days, i.e., delivery of shares and payment received from the buyer is on a T + 2 basis settlement period.

Question 18.
What is meant by depository? ( 1 Mark )
Answer:
A depository is like a bank and keeps securities in electronic form on behalf of the investor. (Note: there are two depositories.

1. National Securities Depository Limited (NSDL)
2. Central Depository (India) Limited (CDSL).

Question 19.
Name the first and the largest depository presently operational in India? ( 1 Mark )
Answer:
National Securities Depository Limited (NSDL)

Question 20.
Expand NSDL. ( 1 Mark )
Answer:
NSDL → National Securities Depository Limited.

Question 21.
Expand CDSL. ( 1 Mark )
Answer:
CDSL = Central Depository Services (India) Limited.
(OR)
Central depository Services Limited.

Question 22.
Who is a Depository Participant (DP)? ( 1 Mark )
Answer:
Depository participant is an intermediary between the investor and the depository e.g., Banks and stock brokers may be depository participants.

Question 23.
Expand NSEI (OR) NSE. ( 1 mark )
Answer:
NSEI = National Stock Exchange of India.
(OR)
National Stock Exchange.

Question 24.
What is the bench mark index of NSE? ( 1 Mark )
Answer:
NIFTY

Question 25.
Expand BSE. ( 1 Mark )
Answer:
BSE = Bombay Stock Exchange

Question 26.
What is the benchmark index of BSE? ( 1 Mark )
Answer:
SENSEX

Question 27.
Expand NASDAQ. ( 1 Mark )
Answer:
NASDAQ = National Association of Securities Dealers Automated Quotations. .
It is New York Stock Exchange Index.

(Note: This term may not be asked in the examination because its expanded form is not given in the NCERT Text Book)

Question 28.
Expand SEBI. ( 1 Mark )
Answer:
SEBI = Securities and Exchange Board of India.

Question 29.
State the objectives of Securities and Exchange Board of India. ( 4 Marks )
Answer:

• To regulate stock exchanges and the securities industry and to promote their orderly functioning.
• To protect the rights and interests of investors, particularly individual investors and to guide and educate 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 make them competitive and professional.

Thus, the overall objective of SEBI is to protect the interests of investors and to regulate and promote the
development of the securities market.

Question 30.
Explain the functions of securities and Exchange Board of India. ( 8 Marks )
Answer:
SEBI is entrusted with the twin task of both regulation and development of the securities market. It also has certain protective functions.

Regulatory functions:

• Registration of brokers and 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 bankers and the business in stock exchanges and any other securities market.
• Regulation of takeover bids by companies.
• Calling for information by undertaking inspection, conducting enquiries and audits 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.

Development Functions:

• Training of intermediaries of the securities market.
• Conducting research and publishing information useful to all market participants.
• Undertaking measures to develop the capital markets by adopting a flexible approach.

Protective Functions:

• Prohibition of fraudulent and unfair trade practices like making misleading statements, manipulations, price rigging etc.
• Controlling insider trading and imposing penalties for such practices.
• Undertaking steps for investor protection.
• Promotion of fair practices and code of conduct in securities market.

Some common stock market terms:

• Bourses is another word for the stock market.
• Bulls and Bears – The term does not refer to animals but to market sentiment of the investors. A Bullish phase refers to a period of optimism and a Bearish phase to a period of pessimism on the bourses.

I. Multiple choice questions (1 Mark each)

Question 1.
Primary and secondary markets:
(a) Compete with each other
(b) Complement each other
(c) Function independently
(d) Control each other
Answer:
(b) Complement each other

Question 2. The total number of Stock Exchanges in India is :
(a) 20
(b) 21
(c) 22
(d) 23
Answer:
(b) 21
Note: At present only NSE and BSE are the two active stock exchanges in our country.

Question 3.
The settlement cycle in NSE is :
(a) T + 5
(b) T + 3
(c) T + 2
(d) T + 1
Answer:
(c) T + 2

Question 4.
The National Stock Exchange of India was recognized as stock exchange in the year.
(a) 1992
(b) 1993
(c) 1994
(d) 1995
Answer:
(b) 1993

Question 5.
NSE commenced futures trading in the year:
(a) 1999
(b) 2000
(c) 2001
(d) 2002
Answer:
(b) 2000

Question 6.
Clearing and settlement operations of NSE are carried out by:
(a) NSDL
(b) NSCCL
(c) SBI
(d) CDSL
Answer:
(a) NSDL

Question 7.
A Treasury Bill is basically:
(a) An instrument to borrow short-term funds
(b) An instrument to borrow long-term funds
(c) An instrument of capital market
(d) None of above
Answer:
(a) An instrument to borrow short-term funds