PU2: Business Studies Chapter 10 Solutions

Chapter 10

Financial Markets

Part - A

1. Expand IPO/BSE/NSEI/SEBI/NASDAQ/OTCEI/CSDL

Ans. IPO – Initial public Offer

BSE – Bombay Stock Exchange

NSEI – National Stock Exchange of India

SEBI – Securities and Exchange Board of India

NASDAQ - National Association of Security Dealers Automated Quotation (not in textbook)

OTCEI – Over the Counter Exchange of India

CDSL (not CSDL) – Central Depository Services Limited.

2. What is Money Market?

Ans. The money market is a market for short term funds which deals in monetary assets (like treasury bills, commercial paper, etc.) whose period of maturity is upto one year.

3. What is Stock Exchange?

Ans. 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.

4. What is the benchmark index of BSE?

Ans. The BSE SENSEX is the  benchmark index of BSE.

5. What is the benchmark index of NSE?

Ans. NIFTY (National Stock Exchange Fifty) is the benchmark index of NSE.

6. Name the first and the largest depository presently operational in India.

Ans. National Securities Depositories Limited (NSDL) is the first and largest depository presently operational in India.

7. What is meant by Depository?

Ans. Just like a bank keeps money in safe custody for customers, a depository keeps securities in electronic form on behalf of the investor. It is a technology driven electronic storage system.

In the depository a securities account can be opened, all shares can be deposited, they can be withdrawn/sold at any time and instructions to deliver or receive shares on behalf of the investor can be given.

8. Give the meaning of Dematerialisation.

Ans. The process of holding securities in an electronic form is called dematerialisation. In this process, 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 called demat account.

9. Primary and secondary markets

(a) Compete with each other

(b) Complement each other

(c) Function independently

(d) Control each other

Ans. (b) Complement each other

10. The settlement cycle in NSE is

(a) T+5

(b) T+3

(c) T+2

(d) T+1

Ans. (c) T+2

11. The National Stock Exchange of India was recognized as Stock Exchange in the year

(a) 1999

(b) 1993

(c) 1994

(d) 1995

Ans. (b) 1993

12. 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 the above

Ans. (a) An instrument to borrow short term funds

No Questions in Part - B

Part - C

13. Explain briefly the functions of a Financial Market.

Ans. Meaning 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.

Functions of a 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 channeling 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: 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 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.

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 would have to otherwise spend to try and find each other.

Thus, the financial market provides a common platform where buyers and sellers can meet for fulfillment of their individual needs.

14. Explain any four methods of floating new issues in the primary market.

Ans. Meaning of primary market - The primary market is also known as the new issues market. It deals with new securities being issued for the first time.

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. This involves inviting subscription from the public through issue of prospectus.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 issuing houses or stock brokers. In this case, a company sells securities enbloc 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 and at a lower cost than a public issue.

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.

Also

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).

15. Write any four advantages of ‘Electronic Trading System’ in Stock exchanges.

Ans. Under ‘Electronic Trading System’, all buying and selling of shares and debentures are done through a computer terminal.

Electronic trading systems or screen-based trading has following advantages:

1.It ensures transparency 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 increases efficiency of information being passed on, thus helping in fixing prices efficiently. 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.People from all over the country and even abroad who wish to participate in the stock market can buy or sell securities through brokers or members without knowing each other. That is, they can sit in the broker’s office, log on to the computer at the same time and buy or sell securities. This system has enabled a large number of participants to trade with each other, thereby improving the liquidity of the market.

Also

5.A single trading platform has been provided as 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 onto one trading platform, i.e., the stock exchange, on the computer.

16. Distinguish between primary market and secondary market (any four points).

Ans.

Primary Market (also called new issue market)	Secondary Market (also called stock exchange)
(i)There is sale of securities by new companies or further (new issues of securities by existing companies to investors).	(i) There is trading of existing shares only.
(ii) Securities are sold by the company to the investor directly (or through an intermediary).	(ii) Ownership of existing securities is exchanged between investors. The company is not involved at all.
(iii) The flow of funds is from savers to investors, i.e. the primary market directly promotes capital formation.	(iii) Enhances encashability (liquidity) of shares, i.e. the secondary market indirectly promotes capital formation.
(iv) Only buying of securities takes place in the primary market, securities cannot be sold there.	(iv) Both the buying and the selling of securities can take place on the stock exchange.
(v) Prices are determined and decided by the management of the company.	(v) Prices are determined by demand and supply for the security.
(vi) There is no fixed geographical location.	(vi) Located at specific places.

 

17. State the objectives of Securities and Exchange Board of India.

Ans. Meaning of SEBI - The Securities and Exchange Board of India was established by the Government of India on 12 April 1988 as an interim administrative body to promote orderly and healthy growth of securities market and for investor protection. It was later given statutory status, first by an ordinance and later by an Act of Parliament known as the Securities and Exchange Board of India Act, 1992.

The overall objective of SEBI is to protect the interests of investors and to promote the development of, and regulate the securities market. This may be elaborated 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. 

Part - D

18. Explain any four money market instruments.

Ans. Meaning of money market – Refer to Q2 of Part – A

Money market instruments -

1.Treasury bill: A Treasury bill is basically an instrument of short-term borrowing by the Government of India maturing in less than one year. They are also known as Zero Coupon Bonds issued by the reserve Bank of India on behalf of the Central Government to meet its short-term requirement of funds. Their main features are:

(i). Treasury bills are issued in the form of a promissory note.

(ii). They are highly liquid and have assured yield and negligible risk of default.

(iii). They are issued at a price which is lower than their face value and repaid at par. The difference between the price at which the treasury bills are issued and their redemption value is the interest receivable on them and is called discount. Example: Suppose an investor purchases a 91 days Treasury bill with a face value of Rs. 1,00,000 for Rs. 96,000. By holding the bill until the maturity date, the investor receives Rs. 1,00,000. The difference ofrs. 4,000 between the proceeds received at maturity and the amount paid to purchase the bill represents the interest received by him.

(iv). Treasury bills are available for a minimum amount of rs 25,000 and in multiples thereof.

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 creditworthy companies to raise short-term funds at lower rates of interest than market rates. Its main features are:

(i). It usually has a maturity period of 15 days to one year.

(ii). It is sold at a discount and redeemed at par.

(iii). The original purpose of commercial paper was to provide short-terms funds for seasonal and working capital needs. For example companies use this instrument for purposes such as bridge financing.

Example: Suppose a company needs long-term finance to buy some machinery. In order to raise the long term funds in the capital market the company will have to incur floatation costs (costs associated with floating of an issue are brokerage, commission, printing of applications and advertising etc.). Funds raised through commercial paper are used to meet the floatation costs. This is known as Bridge Financing.

3. Call Money: Call money is short term finance repayable on demand, with a maturity period of one day to fifteen days, used for inter-bank transactions. It is a method by which banks borrow from each other to be able to maintain the cash reserve ratio.

4. Certificate of Deposit: Certificates of deposit (CD) are unsecured, negotiable, short-term instruments in bearer form, issued by commercial banks and development 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.

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, 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.

19. What is Stock Exchange? Explain the functions of stock exchange.

Ans. Meaning of Stock Exchange – Refer to Q3

The following are some of the important functions of a stock exchange:

1. Providing Liquidity and Market-ability 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 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. 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 to economic growth: A stock exchange is a market in which existing securities are resold or traded. Through this process of disinvestment and reinvestment 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. It is generally accepted that a certain degree of healthy speculation is necessary to ensure liquidity and price continuity in the stock market.

20. Briefly explain the steps in the Screen based Trading and Settlement procedure in a Stock Exchange.

Ans. 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. He has to sign a broker-client agreement, a client registration form and provide other details to the broker like PAN no., date of birth, address, etc. 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’ (BO) 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 giving clear instructions 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. The broker will issue a trade confirmation slip to the investor.

6.After the trade has been executed, within 24 hours the broker issues a Contract Note. 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 is assigned to each transaction by the stock exchange and is printed on the contract note.

7.Now, the investor has to deliver the shares sold or pay cash for the shares bought. This should be done immediately after receiving the contract note or before the day when the broker shall make payment or delivery of shares to the exchange. 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.

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 since he has already received payment from the exchange.

10.The broker can make delivery of shares in demat form directly to the investor’s demat account.

21. How does the Demat System work? Explain.

Ans. Meaning of Dematerialisation – Refer to Q8

Working of the Demat System

1.A depository participant (DP), either a bank, broker, or financial services company, is identified.

2.An account opening form and documentation (PAN card details, photograph, power of attorney) is completed.

3.The physical certificate is to be given to the DP along with a dematerialisation request form.

4.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.

5.If shares are to be sold through a broker, the DP is to be instructed to debit the account with the number of shares.

6.The broker then gives instruction to his DP for delivery of the shares to the stock exchange.

7.The broker then receives payment and pays the person for the shares sold.

8.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.

22. Explain the functions of Securities and Exchange Board of India.

Ans. Meaning of Stock exchange – Refer to first part of Q17.

Functions of SEBI - SEBI is entrusted with the twin task of both regulation and development of the securities market. It also has certain protective functions.

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 any other securities market.

4. Regulation of takeover bids by companies.

5. Calling for information by under-taking 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, as may be delegated by the Government of India.

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 mis-leading 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