Financial System Short Answer Type Questions
Question 1.
Distinguish between capital and money market.
Answer:
→ The subject matter of capital market comprises long-term financial instruments having maturity of more than one year, on the other hand, the thrust of money market is on short-term instruments only.
→ Money market is a wholesale market and the participants in money market are large institutional investors, commercial banks, mutual funds, and corporate bodies. However, in case of capital market even a small individual investor can deal by sale/purchase of shares, debentures or mutual fund units.
→ In capital market, the two common segments are primary market and secondary market. Both these segments are interrelated. Securities emerge in primary segment and their subsequent dealings take place in secondary market. However, in case of money market, there is no such sub-division in general. In efficient money market, secondary market transactions may also take place.
→ Total volume of trade occur per day in money market is many fold that of the volume per day taking place in capital market.
→ In capital market, the financial instruments being dealt with are shares (equity as well as preference),debentures (a large variety), public sector bonds and units of mutual funds. On the other hand, money market has different financial instruments such as treasury bills, commercial papers, call money, certificate of deposits, etc.
Question 2.
State the functions of financial system.
Answer:
Following are the functions of financial system:
- The main function of financial system is the channelization of the individuals saving and making it available for various borrowers. The borrowers are companies and industries which take loan in order to increase their overall growth of the economy
- It helps in liquidating one’s savings whenever required
- It help to pass financial information
- It Creates an environment for one to invest their funds which involves good return on investment
- It helps to select best investment based on the pre-determined risk and return.
- It acts as a regulatory body and monitors the action performed by financial institutions and financial market.
- It plays vital role to control risks and uncertainties
- It increases the habit of savings
- It helps in Mobilizing huge financial resources for the economic growth.
- It gives some innovative services like smart cards, debit cards, credit cards enable the user to make easy payment and transfer of money.
Question 3.
State the.features of primary market.
Answer:
The various features of primary markets are:
→ This is the market for new long term equity capital. The primary market is the market where the securities are sold for the first time. Therefore it is also called the new issue market (NIM).
→ In a primary issue, the securities are issued by the company directly to investors.
→ The company receives the money and issues new security certificates to the investors.
→ Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business.
→ The primary market performs the crucial function of facilitating capital formation in the economy.
→ The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be raising capital for converting private capital into public capital; this is known as “going public.”
Question 4.
Explain the components of financial system.
Answer:
The financial system consists four components. These are financial markets, financial services, financial instruments and financial institutions.
(a) Financial Institution:
Financial Institution can be classified as banking and nonbanking institutions. Banking Institutions are creators and purveyors of credit while non banking financial institutions are purveyors of credit.
(b) Financial Markets:
Financial Markets can be classified, as primary and secondary markets. A Primary Market deals with new issues and secondary markets is meant for trading in existing securities.
(c) Financial Instruments:
A financial instrument is a claim against an institution or a person for payment at a future date of a sum of money in the form of dividend.
(d) Financial Services:
Financial services are those , which help with borrowing and funding, buying and selling securities, lending and investing, making and enabling payments and settlements and managing risk exposures in financial markets.
Question 5.
Write a note on financial assets.
Answer:
A financial asset is an intangiable asset representing the monetary value of paper’ securities. It obtains its monetary value from a contractual agreement. Financial asset is a document that has no fundamental value in itself until it is converted into cash. Financial assets are usually more.liquid than tangible assets types of financial assets include certificates, bonds stocks and bank deposits. – Classification of financial assets:
(a) Stock asset:
Stock includes equity shares and preference shares. These stock assets are issued by companies to raise long term capital. Equity share holders are considered to be the owners of the company but preference share holders are not the owners of the company but they have preferential right over equity in receiving dividend and during the time of liquidation of the company.
(b) Debt Asset:
It is an instrument whereby the business enterprises will enter into a contractual agreement with the debenture holder for a predetermined period and during the period it promises to pay a fixed percentage of invest to investors.
(c) Bonds:
Bonds are sold by government and corporations to raise funds for short term projects bonds are legal documents contains how much interest is guaranteed to be returned to the investor along with the original loan amount
Question 6.
Explain the importance and functions of developed money market. Importance of a developed money market and its various functions are discussed below:
(i) Financing Trade:
Money Market plays crucial role in financing both internal as well as international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade.
(ii) Financing Industry:
Money market contributes to the growth of industries in two ways:
(a) Money market helps the industries in securing short-term loans to meet their working capital requirements through the system of finance bills, commercial papers, etc.
(b) Industries generally need long-term loans, which are provided in the capital market. However, capital market depends upon the nature of and the conditions in the money market. The short-term interest rates of the money market influence the long-term interest rates of the capital market. Thus, money market indirectly helps the industries through its link with and influence on long-term capital market.
(iii) Profitable Investment:
Money market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which are highly liquid and can be easily converted into cash. Thus, the commercial banks earn profits without losing liquidity.
(iv) Self-Sufficiency of Commercial Bank:
Developed money market helps the commercial banks to become self¬sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market.
(v) Help to Central Bank:
Though the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank.
Money market helps the central batik in two ways:
(a) The short-run interest rates of the money market serves as an indicator of the monetary and banking conditions in the country and, in this way, guide the central bank to adopt an appropriate banking policy.
(b) The sensitive and integrated money market helps the central bank to secure quick and widespread influence on the sub-markets, and thus achieve effective implementation of its policy.
Question 7.
Explain the functions of money market.
Answer:
- It facilitates economic development through provision of short term funds to industrial and other sectors
- It provides a mechanism to achieve equilibrium between demand and supply of short term funds
- It facilitates effective implementation of RBIs monetary policy
- It provides ample avenues for short term funds with fair returns to investors
- It instills financial discipline in commercial banks
- It provides funds to meet short term needs
- It helps in employment generation
- It provides funds to government to meet its deficit
- It helps to control inflation
Question 8.
What is financial system? Explain its features.
Answer:
Financial system is a set of inter – related activities or services working together to achieve some predetermined purpose or goal. It includes different markets, institutions, instruments and services and mechanism which influence the generation of savings investment capital formation and economic growth.
Features:
- It is a set of inter- related activities or services
- Services are working together to achieve pre-determined goals.
- It connects the link between savers and borrowers
- It includes financial institutions, markets, instruments services, practices and transactions
- Its main objective is to formulate capital investment and profit generation
- It provides services that are essential in a modern economy.
Question 9.
What is certificate of deposits? Explain the characteristics of certificate of deposits.
Certificate of deposits are those deposits which are issued by banks and it is like a promissory note. The term of a CD generally ranges from One month to five years. Following are the important features of certificate of deposits –
- Certificate of deposits is considered as risk-less because default risk in them is almost negligible and hence its safe bet for investors.
- Certificate of deposits is highly liquid and marketable and hence investors can buy or sell it whenever they desire to do so.
- They are transferable from one party to another which cannot be done with term deposits and hence it is an added advantage for investors who are willing to invest in it.
- It is a time deposit that restricts holders from withdrawing funds on demand, however if an investor wants to withdraw the money, this action will often incur a penalty.
- A certificate of deposits may be payable to the bearer or registered in the name of the investor. Most certificates of deposits are issued in bearer form because investors can resell bearer CD’s more easily than registered CD’s.
Question 10.
State the features of a developed money market.
Answer:
The features of developed money market are:
(i) Highly organised Banking System:
The commercial banks are the nerve centre of the whole money market. They are the principal suppliers of short-term funds. Their policies regarding loans
and advances have impact on the entire money market. The commercial banks serve as vital link between the central bank and various segments of the money market, consequently, a well developed money market and a highly organised banking system co-exist.
(ii) Presence of a Central Bank:
Central Bank acts as the banker’s bank. It keeps their cash Reserves and provides them financial accommodation in difficulties by discounting their eligible securities. In other words, it enables the commercial banks and other institutions to convert their assets into cash in times of financial crisis. Through its open market operations the central banks absorbs surplus cash during off¬season and provides additional liquidity in the busy seasons. Thus, the central bank is the leader, guide and controller of the money market.
(iii) Availibility of proper credit Instruments:
It is necessary for the existence of a developed money market a continuous availibility of readily acceptable negotiable securities such as bills of exchange, treasury bills etc., in the market. There should Tie a number of dealers in the money maket to transact in these securities. Availibility of negotiable securities and the presence of dealer and brokers in large numbers to transact in these securities are needed for the existence of a developed money market.
(iv) Existance of Sub-markets:
The number of sub-markets determines the development of a money market. The larger the number of sub- markets, the broader and more developed will be the structure of money market. The several sub -markets together make a Cohernt money market. In an underdeveloped money market, the various sub- markes particularly the bill market, are absent.
(v) Ample Resources;
There must be availibility of sufficient funds to finance transactions in the sub-markets. These funds may come from within the country and also from foriegn countries.
(vi) Existence of secondary market:
There should be an active secondary market in these instruments.
(vii) Demand and supply of funds:
There should be a large demand and supply of short-term funds. It presupposes the existance of a large domestic and foreign trade. Besides it should have adequate amount of liquidity in the form of large amounts maturing with in a short period.
(viii) Other factors:
Other factors also contribute to the development of a money market, Rapid industrial development leading to the emergence of stock exchanges, large volume of international trade leading to the system of bills of exchange, political stability, favourable conditions for foreign investment, price stabilisation etc.
Question 11.
Discuss the primary market for industrial securities.
Answer:
Primary market is a market for new issues or new financial claims. Hence, it is also called new issue market. The primary market deals with those securities which are issued to the public for the first time. In the primary market, borrowers exchange new financial securities for log term funds. Thus, primary market facilitates capital formation.
There are three ways by which a company may raise capital in a primary market. They are –
(i) Public Issue:
In this case, the securities are offered to the public. It means, capital is raised through the sale of securities to the public.
(ii) Rights Issue:
It is the sale of securities first to the existing shareholders on a priority basis.
(iii) Private placements:
It is the sale of securities privately to a small group of investors.
Question 12.
What are the objectives of financial system.
Answer:
Following are the objectives of financial system:
(a) To mobilize the savings:
The financial system mobilizes saving from the small saving community. It collects the fund by offering different schemes which attract the investor to invest their savings in different institutions, services securities etc.
(b) To distribute the savings for the industrial investment:
It collects the funds from small investors and invest the amount in different industries. There by it meets the fund requirement of industrial sector therefore it helps in the growth of industrial sector
(c) To stipulate capital formation:
This is also one of the main object of financial system financial system is supporting the industries by sanctioning the fund needed to them. It also makes the industries to formulate the capital out of their earnings for further capital requirement and industrial investment.
(d) To accelerate the process of economic growth:
The ultimate aim of financial institutions is to support the process of economic growth of a nation. Directing the saving fund to the industrial capital need motivating them for the capital formation support the acceleration of the process of economic growth.
Question 13.
What’s financial market? What are its importance?
Answer:
Financial markets are a the market for purchase and sale of stocks shares bonds bills of exchange commodities, futures and options, foreign currency etc. Financial markets are the market for exchange of credit and capital. It is on essential player in the economic development of a nation. It facilitates the organization in the savings and investment process.
Importance of financial market:
- It provides facilities for interaction between investors and borrowers
- It provides Information resulting from buyers and sellers interaction in the market
- It provides security to deal in financial assets
- It helps investor to sell their financial assets.
- It gives financial information to select best investment available among the various alternatives.
Question 14.
What is financial market? State its role.
Answer:
Financial market refers to as those centres and arrangements which facilitate ‘buying and selling of financial assets and claims.
(a) Helpful to Business: Financial markets helpful to the business developments and provide short term financial facilities to such business.
(b) Helpful to commercial banks: It not only provide financial facilities to business but also to commercial banks.
(c) Facilities effective implementation of monetary policy: It helps the central banks for effective implementation of monetary policy. So, central banks can achive its goals.
(d) Helpful to the development of capital market: Financial markets were also helpful to the development of capital markets.
(e) Helpful to the formulation of monetary policy ; It also helpful to the government to the formulation of monetary policy.
(f) Helpful to the government to mobilize finance: Finance markets helpful to the Government to mobilize finance. Finance markets provide funds to govt, in case of shortage of funds.
(g) Opportunity to exchange financial assets ; Financial markets provides an opporutunity to exchange financial assets.
Question 15.
Write a note on Treasury Bill or T- Bills.
Answer:
Treasury Bills are short term financial instruments issued by RBI on behalf of govt departments to over-come short term liquidity short falls. Treasury Bills are borrowing instruments of the Govt of India which enable investors to invest their funds in short term funds while reducing their market risks treasury bills are repaid at par on maturity
Features of Treasury Bills are:
- Treasury bills are negotiable securities
- These securities are highly liquid
- There is absence of default risk
- These securities have an assured yield on its investment
- Treasury bills are issued in the form of subsidiary general ledger (SGL) entries in the books of RBI to hold the securities on behalf of the holder
- Treasury bills are also issued under the market stabilization scheme (MSS)
- There are two types of treasury bills viz, (a) Regular treasury bills and (b) Adhoc treasury bills
- These bills are short term investment generally up to one.year.
- There is no tax deducted at sources
- Treasury bills are liquid money market instruments
Question 16.
Write a note on role of money market in economic development of the nation.
Answer:
The money market is integral part of a country’s economy will developed money market help in the economic development of a country. A developed money market enables the smooth functioning of the financial system in any economy in the following ways.
(a) Financing the industries: A well developed money market helps the industries to secure short term loans for meeting their working capital requirements.
(b) Financing the trade: Money market plays important role in financing the domestic as well as international trade. Traders can get short term finance from banks by discounting bills of exchange
(c) Development of capital market: The short term rates of interest and the conditions prevail in the money market influence the long term rates of interest as well as mobilization of resources in the capital market.
(d) Profitable investment: The money market helps the commercial banks to earn profit by investing their surplus funds in the purchase of treasury bills and bills of exchange etc. these instrument are sale highly liquid.
(e) Smooth functioning of commercial banks : The money market provides the facilities for temporarily employing their funds in easily realizable assets. Banks can get back the funds easily.
(f) Effective implementation of monetary policy: The well developed money market helps the central bank in shaping and controlling the flow of money in the country.
(g) Encourages economic growth
(h) Well organized money market safeguards the liquidity and safety of financial assets and this encourages for economic growth savings and investments.
(i) Proper allocation of resources: the saving of the community are converted into investment which leads to proper allocation of resources in the country.
Question 17.
What is capital market? Explain its functions.
Answer:
Capital market is a market dealing in medium and long term funds. It provides facilities for marketing and trading of securities. It constitutes all long term borrowings from banks and financial institutions borrowings from foreign markets and raising of capital by issuing various securities such as shares, debentures, bonds etc capital market includes primary market and secondary market.
Functions of capital market –
- It mobilizes savings and acceleration of capital formation
- It promotes industrial growth
- It raises long term capital
- It facilitates for proper channelization of funds
- It provides insurance against market risk
- It enables quick valuation of financial instruments.
- It provides operation efficiency like lowering settlement time lower transaction cost and simplified transaction procedure.
Question 18.
What are the objectives of capital market.
Answer:
Following are the objectives of capital market:
(a) To connect link between savers and investors: The main objective of capital market is to connect link between savers and investors. It plays an important role in mobilizing the savings and diverting them in productive investment. Therefore capital market plays an important role in transferring the financial resources from surplus areas to productive and deficit areas.
(b) To encourage savings: Capital market encourage people to save more in banking and non- banking financial institutions
(c) To encourage for investment: Capital market provides facilities to business and Govt by lending the money and there by it helps the banks and non banking institution to invest their amount in right investment areas.
(d) To promote economic growth: Capital market connects the link between savers and investors. There fore it facilities the growth of economic conditions of the country various institutions of capital market allocate the resources rationally in accordance with the development needs of the country.
(e) To stabilize security prices: The capital market tends to stabilize the values of stocks and securities and reduce the fluctuations in the prices to the minimum. The process of stabilization is facilitated by providing capital reducing the speculative and unproductive activities.
(f) To give benefits to investors: Capital market helps the investor to invest in long term financial assets
(g) To regulate the market ; Capital market implement policies laws and regulations related to the activities of securities.
(h) To reduce risk; Capital market gives protection to the activities of securities and stock and there by it reduces the risks and uncertainties
Question 19.
Write a note on Organizational structure of Indian capital market.
Answer:
(a) Government securities : It also knows as gilt edged market. This refers to the market for government and semi – government securities backed by Reserve Bank of India.
(b) Industrial securities Market: This is a market for industrial securities like shares and debentures of the existing and new corporate firms Industrial securities market helps for buying and selling of such financial instruments. This market is divided into two types. They are primary market for New issues of shares and debentures and secondary market for old and existing issue of shares and debentures. In primary market fresh capital is raised by the companies by issuing new shares bonds, mutual funds units and debentures and in secondary market old shares and debentures are traded.
(c) Development Financial Institutions (DFIs): It is another part of Indian capital market It includes various financial institutions like IFCI, ICICI, SFC, IDBI, IIBI, UIT etc. these financial institutions provide long term finance for the establishment of new industries.
(d) Financial intermediaries: It is last segment of Indian capital market this comprises various merchant banking institutions, mutual funds, leasing finance companies, venture, capital companies and other financial institutions.
Question 20.
Write the role of capital market in economic development?
Answer:
The role of capital market in economic growth of the nation is outlined as follows
- It increases long term savings for long term investment
- It enables large scale industries to establish its business without any problems by providing long term capital
- It enables corporations to raise capital to finance their investment in real assets
- Capital market helps to increase the productivity and employment
- It helps to connect link between banking system with industrial investment
- It Increases the domestic savings and investment ratio and that are essential for rapid industrialization
- It provides equity capital and infrastructure development capital for the socio economic benefits of the nations.
- It promotes public – private sector partnerships to encourage participation of private sector in productive investments
- It assist the public sector to close resourse gap and complement its efforts in financing essential socio-economic development through raising long term project based capital
- It also attracts foreign portfolio investors who are critical in supplementing the domestic savings level.