Class XII – Financial Market – PYQs

Ans. Four main functions of financial market are

(i) Mobilisation of Savings and Channelising them into the most Productive Uses A financial market facilitates the transfer of savings from savers to investors. Thus, it helps in Channelising surplus funds into the most productive uses.

(ii) Facilitating Price Discovery: Households represent the supply of funds and the business firms represent the demand. The interaction between the demand and supply helps in the price discovery of financial asset, which is being traded in a particular market.

(iii) Providing Liquidity to Financial Assets: Financial market facilitates easy purchase and sale of financial assets. In doing so, they provide liquidity, which means that financial assets are easily converted into cash whenever required.

(iv) Reducing the Cost of Transactions: Financial markets provide a common platform where buyers and sellers meet. It helps in saving time, effort and money of the buyers and sellers at the time of trading in the market, by providing them valuable information.

Ans. (i) Certificate of Deposit It is issued by commercial banks or developmental financial institutions to individuals, institutions, corporations and companies. It is an unsecured, negotiable instrument in bearer form.

It is issued in periods of tight liquidity when the deposits by individuals and households are less, but the demand for credit is high. It helps to mobilise large amount of money in a short time period.

(ii) Commercial Bill It is a bill of exchange used by business firms to meet their working capital needs. It is a short-term self-liquidating, negotiable instrument, used for financing credit sales of a firm. When goods are sold on credit, the seller (drawer) draws a bill of exchange on the buyer (drawee), who accepts it.

Ans. (i) Commercial Paper It is issued as an unsecured promissory note by large and creditworthy companies for meeting their short-term needs of funds. It is a negotiable instrument, transferable by endorsement and delivery. This instrument is generally used for ‘bridge financing’, i.e. a method of financing used by companies to cover the floatation costs of issuing equity shares, preference shares, etc.

(ii) A firm can get funds for a duration of 15 days to one year.

(iii) Commercial paper can also be used for meeting working capital needs.

Ans. (i) 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 at a fixed price.

(ii) e-IPO It is a new method of issuing securities through online system of stock exchange. In this, company has to appoint registered brokers for the purpose of accepting applications and placing orders. The issuer company has to apply for listing of its securities and the leading manager coordinates all the activities of these issues through various intermediaries.

Ans. Primary market is a market which deals in new securities, being issued for the first time. The important function of a primary market is to facilitate the transfer of investible funds from savers to entrepreneurs, seeking to establish new enterprises or to expand existing ones through issue of securities. There are various methods of flotation of new issues in the primary market, two of which are as follows

(i) Offer through Prospectus: Under this method, a company invites subscription from the public through issue of prospectus. A prospectus makes a direct appeal to investors to raise capital through an advertisement in newspapers and magazines.

(ii) 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 the entire securities en-block at an agreed price to the intermediaries, who, in turn, resell them to the investing public.

Ans. Functions of stock exchange discussed are

(i) It provides a ready and continuous market where securities are bought and sold. It gives investors the chance to disinvest or reinvest. Line “It creates a continuous ……… re-invest.”

(ii) Stock exchange channelise the savings into productive investment avenues. This leads to capital formation and economic growth. Line “Through this process …… investment avenues.”

(iii) It is well regulated and its dealings are well defined according to the existing legal framework. Which ensures fair and safe deal in the market. Line “To ensure that ……… legal framework.”

(iv) It is an organised market, which takes various steps to guide and educate investors, publish information about companies listed on the exchange and ensures better and safe trading practices. Line “It also ensures ……… about investments.”

Ans. Trading procedure on a stock exchange involves the following steps

(i) Approach a registered broker and open a trading account.

(ii) Open a demat account with depository participant.

(iii) Place on order with the broker to buy or sell shares.

(iv) Execution of the order by the broker.

(v) Issue of a contract note containing details of number of shares sold, price, date and time of deal.

(vi) Delivery of shares sold or payment of cash for the shares bought on the pay-in day.

(vii) Settlement of the deal on the pay-out day, i.e. T + 2 day.

(viii) Delivery of shares and payment of cash by the broker to the investors.

Ans. The main objective of SEBI is to protect the interest of investors, promote the development of and regulate the securities market. Following are the other objectives of SEBI

(i) To regulate stock exchange and the securities market to promote their orderly functioning.

(ii) To protect the rights and interests of investors, particularly individual investors, and to guide and educate them.

(iii) To prevent fraudulent activities and malpractices by balancing between self-regulation of business and its statutory regulation.

(iv) To regulate and develop a code of conduct and fair practices by intermediates like brokers etc, so that they become competitive and professional.

Ans. (i) They should buy ‘capital market instruments’.

(ii) The investment in capital markets generally yield a higher return for investors than the money markets. The possibility of earnings is higher if the securities are held for a longer duration. First, there is the scope of earning capital gains in equity share. Second, in the long-run, the prosperity of a company is shared by shareholders by way of high dividends and bonus issues.

The capital market directs the savings of the public (investor) into their most productive investment plan, leading to growth and development of economy.

(iii) Capital market instruments are risker both with respect to returns and principal repayments. Issuing companies may fail to perform as pre projections and promoters may defraud investors. But the money market is generally much safer with a minimum risk of default. This is due to the shorter duration of investment and also due to financial soundness of the issuers, which primarily are the government banks and highly rated companies.

Ans. The two functions performed by SEBI in the above case are as follows

(i) SEBI conducts Inspections, Enquiries and Audit of Stock Exchanges It is one of the regulatory functions of SEBI. Lines from the above para which indicate that the above function was performed are Line “On regular inspection ………………….. was able to detect this irregularity.”

(ii) SEBI controls Insider Trading and imposes Penalty for such Practices It is one of the protective functions of SEBI. Lines from the above para which indicate that the above function was performed by SEBI are Line “SEBI imposed …………… on Vikas Mehra.”

Ans. Difference between primary and secondary market