B.Com 1st Sem Indian Financial System Question Paper Dec 2017
Time: 3 Hours
Max. Marks: 70
SECTION – A
I. Answer any five sub-questions. Each sub-question carries two marks. (5 x 2 = 10)
Question (a)
What is Financial Institution?
Answer:
Financial institutions, otherwise known as banking institutions, are corporations which provide services as intermediaries of financial markets. Broadly speaking, there are three major types of financial institutions.
- Depository institutions – deposit-taking institutions that accept and manage deposits and make loans, including banks, building societies, credit unions, trust companies, and mortgage loan companies
- Contractual institutions- insurance companies and pension funds
- Investment institutions-investment banks, underwriters, brokerage firms
Question (b)
What is Primary Market?
Question (c)
What is Overdraft?
Answer:
An overdraft is an extension of credit from a lending institution when an account reaches zero. An overdraft allows the individual to continue withdrawing money even if the ac-count has no funds in it or hot enough to cover the withdrawal. Basically, overdraft means that the bank allows customers to borrow a set amount of money.
Question (d)
What is Credit Control?
Answer:
Credit control is an important tool used by Reserve Bank of India, a major weapon of the monetary policy used to control the demand and supply of money (liquidity) in the economy. Credit control are of two.types namely quantitative and qualitative.
Question (e)
What is Letter of Credit?
Answer:
A letter of credit (LC), also known as a documentary credit, bankers commercial credit, is a payment mechanism used in international trade to perform the same economic function as a guarantee, by allocating risk undertaken by contracting parties.
Question (f)
What is lender of last resort?
Answer:
A lender of last resort is an institution, usually a country’s central bank, that offers loans to banks or other eligible institutions that are experiencing financial difficulty or are considered highly risky or near collapse.
Question (g)
Give the meaning of Open market.
Answer:
Open market operations (OMO) refer to the buying and selling of government securities in the open market in order to expand or contract the amount of money in the banking system. Securities’purchases inject money into the banking system and stimulate growth, while sales of securities do the opposite and contract the economy.
SECTION – B
II. Answer any three questions. Each question carries six marks. (3 x 6 = 18)
Question 2.
State the role of financial markets.
Answer:
Financial market gives strength to economy by making finance available at the right place.
(1) Mobilisation of Savings and their Channelization into more Productive Uses:
Financial market gives impetus to the savings of the people. This market takes the uselessly lying finance in the form of cash to places where it is really needed. Many financial instruments are made available for transferring finance from one side to the other side. The investors can invest in any of these instruments according to their wish.
(2) Facilitates Price Discovery:
The price of any goods or services is determined by the forces of demand and supply. Like goods and services, the investors also try to discover the price of their securities. The financial market is helpful to the investors in giving them proper price.
(3) Provides Liquidity to Financial Assets:
This is a market where the buyers and the sellers of all the securities are available all the times. This is the reason that it provides liquidity to securities. It means that the investors can invest their money, whenever they desire, in-securities through the medium of financial market. They can also convert their investment into money whenever they so desire.
(4) Reduces the Cost of Transactions:
Various types of information are needed while buying and selling securities. Much time and money is spent in obtaining the same. The financial market makes available every type of information without spending any money. In this way, the financial market reduces the cost of transactions.
Question 3.
Distinguish between Primary Market and Secondary Market.
Answer:
Purchasing Method or Primary and Secondary Market:
The primary market for financial instruments is a direct market where companies offer their shares to the members of the public for consideration. The buyers and sellers interact with one another offering the chance to negotiate for the shares on offer, especially in the auction markets where the highest bidder is assumed to have won the purchasing battle.
The secondary marker is an indirect financial platform where prospective buyers purchase shares from others investors. In the secondary market, the original owner of the shares (company) is not involved in the transfer of the units of ownership.
Financing/Beneficiary for Primary and Secondary Market:
The main purpose of the primary market is to provide finances to organizations so that they can expand their operations or boost their current activities. Companies offer their shares for a subscription to prospective buyers and investors in return for money, which is essential in funding the events of the company.
On the other hand, secondary market does not offer finances to the company. This is because the shares are traded between prospective investors who have speculative motives. The secondary market involves the exchange of shares from one investor to the other.
Parties Involved in Primary and Secondary Market:
The primary market involves direct contact between the company and the investor. The company offers shares to the investor who considers them for purchase concerning the associated profits and the cost of the shares. The secondary market involves different investors exchanging the financial instruments. The company is not involved because this is an indirect market, which involves investors only.
Price of Financial Instruments for Primary and Secondary Market:
In the primary market, the price of the financial instruments is usually fixed. Companies sell their shares in an open market where other members of the public are aware of the prevailing prices. Besides, the price of the shares in an initial public offer is communicated through the print and other media platforms.
However, the participants do not know the price of shares and other products. The price of the financial instruments keeps OR fluctuating and is mostly depends on demand and supply aspects. Therefore, the more the products, the lower the prices and the vice versa.
Organization:
The primary trade of financial instruments is usually not rooted in any specific place or geographical position. This means that buyers can buy their shares at any place, especially the organizational premises. The secondary market has physical existence, which means that this form of trade is rooted in a specific place. This explains why there is the existence of the stock exchange offices and halls where investors sell their units of ownership to other investors.
Agents/Intermediaries for Primary and Secondary Market: In the primary markets, underwriters are the intermediaries between the company and the investors who are willing to purchase units of ownership in the company. Some of the common underwriting agencies include banks and insurance companies among others. Brokers form the intermediaries in the secondary market. Brokers are responsible for assessing the risks and profits associated with a specific financial instrument after which they purchase the promising shares on behalf of the buyer.
Number of Transactions involved in Primary and Secondary Market:
In the primary market, a financial instrument is sold once. The enterprise is tasked with the obligation of selling the share to the investor for profit at a fixed rate upon which the investor possesses the full rights to the unit.
The investor is entitled to all the benefits associated with the ownership of the instrument including dividends and resale rights. On the other hand, a unit of ownership can be sold several times with each transaction involving the exchange of rights and benefits. This is because the secondary market consists of the sale of shares and other financial instruments between investors at a profit.
Question 4.
What are the objectives of Exim Banks?
Answer:
The Export-Import Bank of India was set up by the Government of India on January 1, 1982. Its main objects are:
- To ensure integrated and co-ordinated approach in solving the allied problems encountered by exporters in India
- To pay specific attention to the exports of capital goods
- Export projection
- To facilitate and encourage joint ventures and export of technical services and international and merchant banking
- To extend buyers’ credit and lines of credit
- To tap domestic and foreign markets for resources for undertaking development and financial activities in the export sector.
Question 5.
What are the indicators of liquidity of a commercial bank?
Answer:
Liquidity of the Indian commercial banks is measured through different ratios: Liquid assets to demand deposits, liquid assets to total assets, demand deposits to total deposits and advances to deposits. Liquid assets to demand deposits ratio is calculated by ratio of the assets matured within the time period of one year and the liabilities to be paid within the same period This proposed to capture the liquidity mismatch of assets and liabilities and provided an indication of the level to which bank could meet short term withdrawal of funds without facing liquidity problem.
Demand deposits to total deposits ratio specify the prerequisite of the bank to retain cash ready to pay the deposits payable on demand. Higher ratio enhances the ability of the bank to pay its liabilities as and when they are demanded.
Question 6.
What are the promotional functions of RBI?
Answer:
(a) Promotion of Banking Habit:
The Reserve Bank of India helps in mobilizing the savings of the people for investment. It expanded banking system throughout the nation by setting up of various institutions like UTI, IDBI, IRCI, N ABARD etc. Thereby it promoted banking habit among the people.
(b) Providing Refinance for Exports:
The Reserve Bank of India is providing refinance for export promotion. The Export Credit and Guarantee Corporation (ECGC) and Export Import Bank were established initially by the Reserve Bank of India to finance the foreign trade of India. They finance foreign trade in the form of insurance cover, long-term finance and foreign currency credit. However, they are now functioning separately.
(c) Providing Credit to Agriculture:
The Reserve Bank of India makes institutional arrangements for rural or agricultural finance. For example, the bank has set up special agricultural credit cells. It has promoted regional rural banks with the help of commercial banks. It has also promoted NABARD.
(d) Providing Credit to Small Scale Industrial Unit:
Commercial banks lend loans to small-scale industrial units as per the directives issued by the Reserve Bank of India time to time. The Reserve Bank of India encourages commercial banks to render guarantee services also to small-scale industrial sector. The Reserve Bank of India considers advances given to small-scale sector as priority sector advances. It also directed commercial banks to open specialized branches to provide adequate financial and technical assistance to small-scale industrial branches.
(e) Providing Indirect finance to Cooperative Sector:
The RBI has directed NABARD to give loans to State Cooperative Banks, which in turn lend loans to cooperative sector. Hence, the Reserve Bank of India provides indirect finance to cooperative sector in India.
(f) Exercising Control over Monetary and Banking system of the Country:
The Reserve Bank of India is vested with enormous and extensive powers regarding supervision and control over commercial banks, cooperative banks and also non-banking institutions receiving deposits. The Banking Regulation Act prescribes extensive requirements as minimum regarding the paid-up capital, reserves, cash reserves and liquid assets. The operation of the bank, the management, amalgamation, reconstruction and liquidation etc. are thoroughly supervised by the officials of the Reserve Bank of India. Every sched-uled bank is required to furnish to the Reserve Bank a weekly statement showing the principal items of its liabilities and assets in India.
(g) Making Industrial arrangement for Industrial Finance:
The Reserve Bank of India makes institutional arrangement for industrial finance. For instance, it has brought into existence several development banks such as the Industrial Finance Corporation of India, the Industrial Development Bank of India, which provide long-term finance to industries.
SECTION – C
III. Answer any three questions. Each question carries fourteen marks. (3 x 14 = 42)
Question 7.
Differentiate between Money Market and Capital Market.
Answer:
Money market is distinguished from capital market on the basis of the maturity period, credit instruments and the institutions:
(a) Maturity Period:
The money market deals in the lending and borrowing of short-term finance (i.e., for one year or less), while the capital market deals in the lending and borrowing of long-term finance (i.e., for more than one year).
(b) Credit Instruments:
The main credit instruments of the money market are call money, collateral loans, acceptances, bills of exchange. On the other hand, the main instruments used in the capital market are . stocks, shares, debentures, bonds, securities of the government.
(c) Nature of Credit:
Instruments: The credit instruments dealt with in the capital market are more heterogeneous than those in money market. Some homogeneity of credit instruments is needed for the operation of financial markets. Too much diversity creates problems for the investors.
(d) Institutions important institutions operating in the money market are central banks, commercial banks, acceptance houses, nonbank financial institutions, bill brokers, etc. Important institutions of the capital market are stock exchanges, commercial banks and nonbank institutions, such as insurance companies, mortgage banks, building societies, etc.
(e) Purpose of Loan: The money market meets the short-term credit needs of business; it provides working capital to the industrialists. The capital market, on the other hand, caters the long-term credit needs of the industrialists and provides fixed capital to buy land, machinery, etc.
(f) Risk:The degree of risk is small in the money market. The risk is much greater in capital market. The maturity of one year or less gives little time for a default to occur, so the risk is minimised. Risk varies both in degree and nature throughout the capital market.
(g) Basic Role:The basic role of money market is that of liquidity adjustment. The basic role of capital market is that of putting capital to work, preferably to long-term, secure and productive employment.
(h) Relation with Central Bank: The money market is closely and directly linked with central bank of the country. The capital market feels central bank’s influence, but mainly indirectly and through the money market.
(i) Market: Regulation: In the money market, commercial banks are closely regulated. In the capital market, the institutions are not much regulated.
Question 8.
Define Commercial Bank. Also discuss the functions of a Commercial Bank.
Answer:
Meaning of a Commercial Bank:
A commercial bank can be defined as the financial institution that offers banking services to the general public and to companies with the main aim of making profit. A commercial bank is a type of bank that provides services such as accepting deposits, making business loans, and offering basic investment products. Commercial banks accept deposits from customers with the aim of using such money to do business or serves as loan to other people with the aim of making profit. Commercial banks are limited liability companies.
Primary Functions of a Commercial Bank:
- Accepting Deposits
- Advancing Loan
(A) Accepting Deposits: This is perhaps the most important function of commercial banks. Commercial banks accept deposits from customers
The main kinds of deposits are:
(i) Current Account Deposits or Demand Deposits: These deposits refer to those deposits which are repayable by the banks on demand:
- Such deposits are generally maintained by businessmen with the intention of making transactions with such deposits.
- They can be drawn upon by a cheque without any re-striction.
- Banks do not pay any interest on these accounts. Rather, banks impose service charges for running these accounts.
(ii) Fixed Deposits or Time Deposits: Fixed deposits refer to those deposits, in which the amount is deposited with the bank for a fixed period of time.
- Such deposits do not enjoy cheque-able facility.
- These deposits carry a high rate of interest.
(iii) Saving Deposits: These deposits combine features of both current account deposits and fixed deposits:
- The depositors are given cheque facility to withdraw money from their account. But, some restrictions are imposed on number and amount of withdrawals, in order to discourage frequent use Of saving deposits.
- They carry a rate of interest which is less than interest rate on fixed deposits. It must be noted that Current Account deposits and saving deposits are chequable deposits, whereas, fixed deposit is a non-chequable deposit.
(B) Advancing of Loans: The deposits received by banks are not allowed to remain idle. So, after keeping certain cash reserves, the balance is given to needy borrowers and interest is charged from them, which is the main source of income for these banks.
Different types of loans and advances made by a Commercial Bank:
(i) Cash Credit:
Cash credit refers to a loan given to the borrower against his current assets like shares, stocks, bonds, etc. A credit limit is sanctioned and the amount is credited in his account. The borrower may withdraw any amount within his credit limit and interest is charged on the amount actually withdrawn.
(ii) Demand Loans:
Demand loans refer to those loans which can be recalled on demand by the bank at any time. The entire sum of demand loan is credited to the account and interest is payable on the entire sum.
(iii) Short-term Loans:
They are given as personal loans against some collateral security. The money is credited to the account of borrower and the borrower can withdraw money from his account and interest is payable on the entire sum of loan granted.
Secondary Functions of a Commercial Bank:
(a) Overdraft Facility:
It refers to a facility in which a customer is allowed to overdraw his current account upto an agreed limit. This facility is generally given to respectable and reliable customers for a short period. Customers have to pay interest to the bank on the amount overdrawn by them.
(b) Discounting Bills of Exchange:
It refers to a facility in which holder of a bill of exchange can get the bill discounted with bank before the maturity. After deducting the commission, bank pays the balance to the holder. On maturity, bank gets its payment from the party which had accepted the bill.
(c) Agency Functions of a Commercial Bank:
Commercial banks also perform certain agency functions for their customers. For these services, banks charge some commission from their clients.
Some of the agency functions are:
(i) Transfer of Funds: Banks provide the facility of economical and easy remittance of funds from place-to-place with the help of instruments like.demand drafts, mail transfers, etc.
(ii) Collection and Payment of Various Items: Commercial banks collect cheques, bills, interest, dividends, subscriptions, rents and other periodical receipts on behalf of their customers and also make payments of taxes, insurance premium, etc. on standing instructions of their clients.
(iii) Purchase and Sale of Foreign Exchange: Some commercial banks are authorized by the central bank to deal in foreign exchange. They buy and sell foreign exchange on behalf of their customers and help in promoting international trade.
(iv) Purchase and Sale of Securities: Commercial banks buy and sell stocks and shares of private companies as well as government securities on behalf of their customers.
(v) Income Tax Consultancy: They also give advice to their customers on matters relating to income tax and even prepare their income tax returns.
(vi) Trustee and Executor: Commercial banks preserve the wills of their customers as trustees and execute them after their death as executors.
(vii) Letters of Reference: They give information about the economic position of their customers to traders and provide the similar information about other traders to their customers.
General Utility Functions of a Commercial Bank – Commercial banks render some general utility services like:
(i) Locker Facility: Commercial banks provide facility of safety vaults or lockers to keep valuable articles of customers in safe custody.
(ii) Traveller’s Cheques: Commercial banks issue traveler’s cheques to their customers to avoid risk of taking cash during their journey.
(iii) Letter of Credit; They also issue letters of credit to their customers to certify their creditworthiness.
(iv) Underwriting Securities: Commercial banks also undertake the task of underwriting securities. As public has full faith in the creditworthiness of banks, public do not hesitate in buying the securities underwritten by banks.
(v) Collection of Statistics: Banks collect and publish statistics relating to trade, commerce and industry. Hence, they advise customers on financial matters. Commercial banks receive deposits from the public and use these deposits to give loans. However, loans offered are many times more than the deposits received by banks. This function of banks is known as Money Creation’.
Question 9.
Explain the functions of Reserve Bank of India.
Answer:
Functions of Reserve Bank:
(1) Issue of Notes:
The Reserve Bank has the monopoly for printing the currency notes in the country. It has the sole right to issue currency notes of various denominations except one rupee note (which is issued by the Ministry of Finance). The Reserve Bank has adopted the Minimum Reserve System for issuing/printing the currency notes. Since 1957, it maintains, gold and foreign exchange reserves of Rs. 200 Cr. of which at least Rs.115 cr. should be in gold and remaining in the foreign currencies.
(2) Banker to the Government:
The second important function of the Reserve Bank is to act as the Banker, Agent and Adviser to the Government of India and states. It performs all the banking functions of the State and Central Government and it also tenders useful advice to the government on matters related to economic and monetary policy. It also manages the public debt of the government.
(3) Banker’s Bank:
The Reserve Bank performs the same functions for the other commercial banks as the other banks ordinarily perform for their customers. RBI lends money to all the commercial banks of the country.
(4) Controller of the Credit:
The RBI- undertakes the responsibility of controlling credit created by the commercial banks. RBI uses two methods to control the extra flow of money in the economy. These methods are quantitative and qualitative techniques to control and regulate the credit flow in the country. When RBI observes that the economy has sufficient money supply and it may cause inflationary situation in the country then it squeezes the money supply through its tight monetary policy and vice versa.
(5) Custodian of Foreign Reserves:
For the purpose of keeping the foreign exchange rates stable, the Reserve Bank buys and sells the foreign currencies and also protects the country’s foreign exchange funds. RBI sells the foreign currency in the foreign exchange market when its supply decreases in the economy and vice-versa. Currently India has Foreign Exchange Reserve of around US$ 360bn.
(6) Other Functions:
The Reserve Bank performs a number of other developmental works. These works include the function of clearing house arranging credit for agriculture (which has been transferred to NABARD) collecting and publishing the economic data, buying and selling of Government securities (gilt edge, treasury bills etc)and trade bills, giving loans to the Government buying and selling of valuable commodities etc. It also acts as the representative of the Government in the International Monetary Fund (I.M.F.) and represents the membership of India.
Question 10.
Explain the Quantitative and Qualitative Credit Control of RBI.
Question 11.
Explain in detail the different types of financial services.