NCERT Solutions for Class 12

Business Studies

Chapter 10 – Financial Markets

Multiple Choice Questions:

1. Primary and secondary markets

(a) Compete with each other

(b) Complement each other

(c) Function independently
(d) Control each other
Ans: The primary and secondary markets are mutually beneficial. The primary
market is concerned with the new securities. It is related to when a company for the
very first time issues securities which is called an IPO, meaning the company is
offering securities to the general public for subscription), they are traded in the
Primary Market with the assistance of issuing houses, dealing/brokerage firms,
investment bankers, and or underwriters. That is, a company raises capital directly
from borrowers through the primary market and if we talk about the secondary
market, it deals with the purchase and sale of existing securities. In other words, after
the securities are issued in the primary market, they are traded in the secondary
market. In this way, the two markets complement one another.

2. The total number of Stock Exchange in India is

(a) 20

(b) 21
(c) 22
(d) 23

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Ans: In India, there are a total of 23 stock exchanges. However, according to the
most recent SEBI updates, India has 25 stock exchanges.

3. The settlement cycle in NSE is

(a) T+5

(b) T+3

(c) T+2

(d) T+1
Ans: The settlement cycle is the time period during which actual settlement between
buyers and sellers of shares occurs. In other words, it is called as the time span
between when the seller of the shares receives the money and when the buyer of the
share acquires ownership of the share. The NSE operates on a T + 2 settlement cycle.
T + 2 indicates that transactions completed on the trading day will be settled by the
exchange of money and securities on the following business day (excluding
Saturdays, Sundays, Bank and exchange trade holidays). The transaction date is
denoted by the letter T. As a result, T + 2 implies that NSE transactions are used to
settle within 2 days of the date of transaction.

4. The National Stock Exchange of India was recognized as stock exchange in

the year

(a) 1992

(b) 1993

(c) 1994

(d) 1995
Ans: The National Stock Exchange of India was founded in 1992 as a public limited
company by financial institutions. However, under the Securities Contracts
(Regulation) Act of 1956, it was recognized as a stock exchange in April, 1993. It
began operations in the capital market in 1994, and operations in the derivatives
market began in 2000.

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5. NSE commenced futures trading in the year
(a) 1999

(b) 2000

(c) 2001

(d) 2002
Ans: The National Stock Exchange began operations in 1994. On June 12, '2000,' it
began trading in the futures and options markets.

6. Clearing and settlement operations of NSE are carried out by

(a) NSDL

(b) NSCCL
(c) SBI

(d) CDSL
Ans: NSCCL handles the clearing and settlement operations for the NSE. NSCCL
(National Securities Clearing Corporation Ltd.) was founded in August 1995 and
began clearing for the NSE in April 1996.

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 the above

Ans: (a) Treasury Bills are a short-term borrowing instrument. These are generally
issued by the central bank i.e Reserve Bank of India and that too on the behalf of
the Union Government i.e Government of India.

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Short Answer Type:
1. What are the functions of a financial market?
Ans: A financial market is a market for the creation and exchange of financial assets
such as shares and debentures. A financial market performs the following functions.

i) Savings mobilization and channeling into the most productive uses. A

financial market serves as a conduit between savers and investors. It serves as a
channel for the transfer of savings from households to investors. It provides savers
with a variety of investment options, assisting in the allocation of surplus funds to
the most productive use.
ii) Make Price Discovery Easier. The price of a financial asset, like a commodity,
and generally determined by the forces of demand and supply for funds. The
financial market serves as a platform for the interaction of fund demand (represented
by business firms) and fund supply (represented by the households). As a result, it
aids in determining the price of the traded asset.
iii) Gives Financial Assets Liquidity. In a financial market, an asset or security can
be easily bought and sold. This gives the assets liquidity. That is, assets can be easily
converted into cash or cash equivalents through financial market trading.

iv) Reduce Transaction Costs. Financial markets provide useful information about
the securities that are traded on the market. It saves time, effort, and money that both
buyers and sellers of a financial asset would otherwise have to spend trying to find
each other. As a result, the financial market serves as a common platform where
buyers and sellers can meet to meet their individual needs.

2. ''Money Market is essentially a Market for short term funds''. Discuss.

Ans: The money market is a market for trading short-term securities and funds.
Money market securities have a very short maturity period ranging from one day to
one year. These assets can be used as a close substitute for cash or money. These are
also called as 'Near Money instruments' due to their short maturity period. These
instruments are considered as an vital source of financing for working capital needs.
They have a high level of liquidity. DFHI offers a discount on money market
securities and a ready market for them. Furthermore, securities traded in the money
market are safe and secure because transactions are made in instruments issued by
financially strong financial institutions and companies. Treasury bills, commercial

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paper, call money, certificates of deposit, and other common instruments traded in
the money market include treasury bills, commercial paper, call money, certificates
of deposit, and so on.

3. What is a Treasury Bill?

Ans: The Reserve Bank of India issues Treasury Bills on behalf of the Central
Government of India. They are issued to meet the Government of India's short-term
funding needs. Treasury Bills have maturities ranging from 14 to 364 days. These
bills are typically introduced by commercial banks, LICs, UTIs, non-banking
financial institutions, and so on. They're also known as Zero-Coupon Bonds.
Treasury bills are highly liquid instruments because the RBI is always willing to
purchase them. Furthermore, because they are issued by the RBI, they are regarded
as the safest instrument. They are available for a minimum of Rs 25,000 and in
multiples of that amount. Treasury Bills are issued at a discount, that is, at a lower
price than the face value, and are redeemed at par. The interest received during
redemption is denoted by the discount (the difference between the issue price and
the redemption value). The purpose of issuing T-Bills is to meet the government's
short-term money borrowing needs. T-bills have several advantages over other bills,
including:
1. They have a zero risk weighting because of issuance by the government, and on
the other hand sovereign papers carry no risk.

2. High liquidity because the maturities are 91 and 364 days, respectively.
3. Accountability.
4. Because T-Bills have a very active secondary market, they have a higher degree
of tradability.

4. Distinguish between Capital Market and Money Market.

Ans: The following points highlight the difference between Capital Market and
Money Market:

Basis of difference Capital Market Money Market

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 Time Span of Securities The capital market is
primarily concerned with
the trading of medium and
long-term securities with
maturities of more than
one year.
Liquidity Capital market securities
are liquid in the sense that
they can be traded on
stock exchanges, but they
are less liquid than money
market securities.
Return expected Because of the possibility Because of the shorter
of long-term and regular duration, expected returns
dividends or bonuses, are lower.
expected returns are
higher.
Instruments Equity shares, preference
shares, debentures, bonds,
and other long-term
securities are among the
instruments traded in the
capital market.
Risk In terms of principal
repayment, capital market
securities carry a higher
level of risk.
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This Market is usually
concerned with the short-
term trading of securities
with maturities ranging
from one day to a
maximum of one year.
The traded securities are
extremely liquid. DFHI
offers a discount on
money market securities
and a ready market for
them.
Treasury bills,
commercial bills,
certificates of deposit,
and other short-term
securities are among the
instruments traded in the
money market.
The securities here are
less risky due to the short
time period and the
issuers' strong financial
position.
6
5. What are the functions of a Stock Exchange?
Ans: The term "stock exchange" refers to a market where existing securities are
bought and sold. The primary functions of a stock exchange are as follows.

(i) Provides Liquidity and Marketability: The stock exchange provides a ready-
to-trade platform for existing securities. In another way we can say, it provides a
continuous market for the sale and purchase of securities. Securities can be easily
converted into cash via stock exchange whenever needed. Furthermore, long-term
securities can be converted to medium-term and short-term securities via stock
exchange.

(ii) Determination of Prices: A stock exchange aids in determining the value of the
monetary assets traded in that market. It provides a platform for interaction between
buyers and sellers of securities, assisting in the determination of securities prices
through the forces of demand and supply.

(iii) Fair and Safe Market: As a legal and well-regulated market, the stock
exchange. It operates within the boundaries of the defined and existing legal
framework. As a result, it ensures transactional safety and fairness.
(iv) Facilitates Economic Growth: Securities are constantly bought and sold on a
stock exchange. This ongoing process of disinvestment and reinvestment aids in
directing savings and investments to the most productive uses. This boosts capital
formation as well as economic growth.

(v) Spreading Equity Cult: A stock exchange can help educate people about
investing by regulating issues and improving trading practices. It encourages and
promotes people to invest in ownership securities.
(vi) Acts as an Economic Barometer: A stock exchange reflects changes in
economic conditions through changes in share prices. For example, the rise (or fall)
in share prices reflects a boom (or recession).

(vii) Scope for Speculation: It is widely assumed that some degree of speculation
is required for improved liquidity and the maintenance of demand and supply for
securities. Within the confines of the law, the stock exchange allows for a reasonable
and controlled scope of speculation.

6. What are the objectives of the SEBI?

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Ans: The Securities and Exchange Board of India (SEBI) was formed to promote
the orderly and healthy growth of India's securities market. The following points
highlight SEBI's overall goals:

1.To regulate the stock exchanges market as well as the securities industry in order
to ensure their smooth operation.
2. To protect and guide individual investors' rights and interests, as well as to educate
and guide them.

3. To prevent trading malpractices and strike a balance between the securities

industry's self-regulation and statutory regulation.
4. Regulating as well as developing a code of conduct and fair practices for
intermediaries such as brokers, merchant bankers, and so on. , in order to make them
more competitive and professional.

7. State the objectives of the NSE.

Ans: The National Stock Exchange of India was established in 1992. It was
established as a stock exchange in 1993 and began operations in 1994. It was
founded by major banks, financial institutions, insurance firms, and financial
intermediaries. NSE was founded with the following goals in mind.
(i)The NSE aimed to establish a single nationwide trading system to provide trading
in all types of securities. This type of system boosts investor confidence.

(ii) It ensured that all investors throughout the country have easy and equal access
to a suitable communication network. It improves the security's liquidity. In the
transaction, the people involved were limited under the regional stock exchange
system. In contrast, the NSE incorporates transactions from all over the country,
increasing the liquidity of the securities.

(iii) The NSE aims to provide a fair, efficient, and transparent securities market by
utilizing an electronic trading system. Anyone can obtain information about the
trading of various securities from the NSE's local terminals. As a result, it aids in the
reduction of trading fraud.

(iv) One of the NSE's goals is to enable shorter settlement cycles and book entry
settlements.

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(v) The NSE aimed to meet international stock exchange standards and benchmarks.

Long Answer Type:

1. Explain the various Money Market Instruments.

Ans: The money market is a market where short-term funds are traded. In this
context, short term funds are monetary assets with a maximum maturity period of
one year. Some of the most common money market instruments are as follows.

(i) Treasury Bill I (T-Bills) A Treasury Bill is a promissory note used by the
government for short-term borrowing. They are the most widely used financial
instrument. The Reserve Bank of India auctions and issues them on behalf of the
Central Government. T-bills can be purchased for as little as Rs 25,000 and in
multiples of that amount. T- Bills are issued at a lower price than their face value,
and when redeemed, the investor receives the face value. The interest earned on them
is the difference between the value at which they are issued and the redemption
value. For example, suppose an investor pays Rs 50,000 for a 182-day treasury bill
with a face value of Rs 56,000. The investor will receive Rs 56,000 when the
investment matures. Thus, the difference of Rs 6,000 (56,000 - 50,000) represents
the bill's interest receivable. T-Bills are also referred to as ZeroCoupon Bonds. T-
bills are highly liquid bonds with a guaranteed yield and a low risk of default.
(ii) Make a phone call. Call money is a type of short-term finance that is repayable
on demand and has a maturity period ranging from one day to fifteen days. It is used
for inter-bank transactions. Commercial banks are required to keep a minimum cash
balance, known as the cash reserve ratio. The Reserve Bank of India modifies the
cash reserve ratio on a regular basis, which affects the amount of funds available for
lending by commercial banks. Call money is a method for banks to borrow from one
another in order to maintain a cash reserve ratio. The call rate is regarded as the
interest rate paid on call money loans. It is a highly volatile rate that fluctuates from
day to day, and sometimes even hour to hour. Call rates have an inverse relationship
with other short-term money market instruments such as certificates of deposit and
commercial paper. That is, as the call rate rises, other money market instruments
become less expensive and their demand rises.

(iii) (CPs) Commercial paper is a short-term unsecured money market instrument. It

is a negotiable instrument as well as transferable promissory note whose maturity
period ranges between 15 days to one year. They first appeared in India in 1990.

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Large and creditworthy companies typically issue CPs to raise short-term funds.
Commercial Papers are viewed by large corporations as an alternative to bank
borrowings and capital market borrowings. Commercial Papers bear interest at a
lower rate than the market rate. Commercial Papers are commonly used for bridge
financing by businesses. That is, to raise the funds needed to cover the floatation
cost on long-term capital market borrowings. For example, If a company wants to
raise capital from the capital market to buy land; It will have to incur floating costs
for this, such as brokerage, commission, advertising, and so on. The company can
issue Commercial Paper to finance such floatation costs.

(iv) (CDs) Certificates of Deposit are unsecured time deposits that are negotiable.
They are bearer instruments for a limited time period ranging from one month to
more than five years. CDs are a type of secured investment that is issued by
commercial banks and development financial institutions to individuals,
corporations, and businesses. They are issued to meet credit demand during times of
limited liquidity. For example, when a person purchases a CD by depositing a
specific amount, he receives a certificate stating the term of the deposit, the
applicable interest rate, and the maturity date. On the maturity date, the individual is
entitled to the principal amount as well as the interest earned on it.

(v) Bill of Sale A commercial bill, also known as a bank bill or a bill of exchange,
is an instrument used to finance a company's working capital needs. It is a short-term
negotiable instrument. Commercial Bills are used by businesses to finance credit
sales. When an individual makes credit sales, for example, the buyer becomes
obligated to make the payment on a specified future date. In this case, the seller
creates a bill of exchange and gives it to the buyer, indicating a specific maturity
date. When the buyer accepts the bill, it becomes a marketable instrument that can
be discounted with a bank.

2. What are the methods of floatation in the Primary Market?

Ans: The following are the various methods for floating new issues.

(i) Make an offer through a prospectus The prospectus offer is the most common
method for raising funds in the primary market. It entails soliciting subscriptions
from the general public through the distribution of a prospectus. A prospectus is
advertised in newspapers, magazines, and other publications. It includes information
such as the fund's purpose, the company's history and future prospects, past financial
performance, and so on. Such information informs the public and investors about the

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company, as well as the potential risks and earnings. Such issues must be listed on
one of the stock exchanges and must adhere to the guidelines and rules outlined in
the Companies Act and SEBI disclosure.

(ii) Make an offer through a sale.

The securities are not issued by the company directly to the public under the offer
through sale method, but rather through intermediaries such as brokers, issuing
houses, and so on. That is, securities are issued in two steps under offer through sale:
first, the company sells its securities to intermediaries at face value, and then the
intermediaries resell the securities to the investing public.

(iii) Personal Placement The securities are sold to a select group of individuals and
large institutional investors rather than to the general public under this method.
Companies either issue the securities themselves or sell them to intermediaries, who
then sell them to specific clients. This method saves the company money on a variety
of mandatory and non-mandatory expenses such as manager fees, commissions,
underwriter fees, and so on. As a result, companies that cannot afford the high costs
associated with a public offering frequently opt for a private placement.
(iv) The Issue of Rights This is a privilege granted to existing shareholders to
subscribe to a new issue of shares in accordance with the company's terms and
conditions. The shareholders are given the 'right' to purchase additional shares in
proportion to the number of shares they already own.

(v) electronic initial public offerings (e-IPOs) It is a system for issuing securities via
the internet. If a company decides to sell its securities via an online system, it must
enter into an agreement with the stock exchange. This is known as an Initial Public
Offering (IPO) (IPO). Brokers are appointed by the company to accept applications
and place orders. A company can apply to be listed in any stock exchange except the
one where it has previously offered securities.

3. Explain the recent Capital Market reforms in India.

Ans: In 1988, the Securities and Exchange Board of India (SEBI) was established.
It was granted legal status in 1992. SEBI was established primarily to regulate the
activities of merchant banks, to control the operations of mutual funds, to act as a
promoter of stock exchange activities, and to act as a regulatory authority of
company new issue activities. The SEBI was established with the primary goal of

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"protecting the interests of investors in the securities market and for matters
connected with or incidental thereto."

The main functions of SEBI are:-

• To oversee the operation of the stock market and other securities markets.
• promoting and regulating self-regulatory organizations To outlaw deceptive and
unfair trade practices in the securities market.

• Raising investor awareness and training intermediaries about market safety.

• Prohibiting insider trading in the securities market; and

• Regulating large acquisitions of shares and corporate takeovers.

● Establishment of Creditors Rating Agencies: The Credit Rating

Information Services of India Limited (CRISIL - 1988), the Investment
Information and Credit Rating Agency of India Limited (ICRA - 1991), and
Credit Analysis and Research Limited (CARE) were established to evaluate
the financial health of various financial institutions and agencies involved in
stock market activities. It also act as a guide for investors in assessing the risk
of their investments. Increased Merchant Banking Activity In recent years,
many Indian and foreign commercial banks have established merchant
banking divisions. These divisions offer financial services such as
underwriting, issue organization, and consulting. It has proven to be beneficial
to factors related to the capital market.
● Candid Performance of Indian Economy: In recent years, the Indian
economy has grown at a rapid pace. It has attracted a good amount of Foreign
Institutional Investment (FII). In recent times, the massive entry of FIIs into
the Indian capital market has resulted in a positive appreciation for Indian
investors.

● Increased Electronic Transactions: Because of technological advancements

in recent years. The physical transaction is reduced, as is the amount of
paperwork. Paperless transactions are now increasing at an alarming rate. It
saves investors' money, time, and energy. As a result, it has made investing

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 more secure and convenient, encouraging more people to participate in the
capital market.

● Growing Mutual Fund Industry: The expansion of mutual funds in India

has undoubtedly aided the growth of the capital market. Many new funds have
been launched by public sector banks, foreign banks, financial institutions,
and joint mutual funds between Indian and foreign firms. Mutual funds in
India have undergone significant diversification in terms of schemes,
maturity, and so on. It has made it easier for ordinary investors to enter the
capital market.

● Growing Stock Exchanges: The number of different stock exchanges in

India is growing. Initially, the BSE was the primary exchange, but since the
establishment of the NSE, stock exchanges have spread throughout the
country. A new stock exchange in India, the Interconnected Stock Exchange
of India, has recently joined the existing stock exchanges.
● Investors Protection: In 2001, the Central Government of India established
the Investors Education and Protection Fund (IEPF) under the auspices of the
SEBI. It is effective in educating and guiding investors. It used to protect the
small investors interests from capital market frauds and malpractices.

● Growth of Derivative Transactions: The NSE has allowed derivatives

trading in equities since June 2000. It also introduced futures and options
transactions in November 2001. These innovative products have increased the
variety of investment options, resulting in the expansion of the capital market.
● Insurance Sector Reforms: In the last few years, the Indian insurance sector
has also seen massive reforms. In the year 2000, the Insurance Regulatory and
Development Authority (IRDA) was established. It paved the way for private
insurance companies to enter India. It has grown in size as more insurance
companies invest their money in the capital market.

● Commodity Trading: Commodity trading has recently been encouraged, in

addition to the trading of ordinary securities. The Multi Commodity Exchange
(MCX) has been established. The volume of such transactions is rapidly
increasing. Apart from these reforms, the establishment of the Clearing
Corporation of India Limited (CCIL), Venture Funds, and so on has resulted
in the phenomenal growth of the Indian capital market.

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4. Explain the objectives and functions of the SEBI.
Ans: The Securities and Exchange Board of India (SEBI) was established in 1988
to promote the orderly and healthy growth of the Indian securities market. SEBI was
established with the overarching goal of protecting investors and promoting the
development and regulation of securities market functions.

Objectives of SEBI:

SEBI's overarching goal is to protect investors' interests while also promoting the
development and regulation of the securities market. This can be expanded as
follows:

1. To promote the orderly operation of stock exchanges and the securities industry
by regulating them.
2. To protect the rights as well as interests of the investors, basically individual
investors, as well as to guide and educate them

3. To prevent trading malpractices and strike a balance between the securities

industry's self-regulation and statutory regulation.

4. To regulate as well as develop a code of conduct & fair practices for intermediaries
such as brokers and merchant bankers in order to make them more competitive and
professional.

Functions of SEBI:
Given the nascent nature of India's securities market, SEBI was entrusted with the
dual task of securities market regulation and development.

Regulatory Functions:
1. Registration of brokers, sub brokers, and other market participants.

2. Collective investment schemes and mutual funds must be registered.

3. Stock bankers, portfolio exchanges, and merchant bankers are regulated.

4. Prohibition of deceptive and unfair business practices.

5. Controlling insider trading and takeover bids, as well as imposing penalties for
such behavior.

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6. Inquiring for information through inspections, inquiries, and audits of stock
exchanges and intermediaries.

7. Imposing fees or other charges in order to carry out the Act's purposes.

8. Carrying out and exercising such powers as may be delegated by the Government
under the Securities Contracts (Regulation) Act 1956.

Development Functions:
1. Educating investors

2. Intermediary training

3. Advocating for fair practices and a code of conduct for all SROs.
4. Conducting research and disseminating information that is beneficial to all market
participants.

5. Explain the various segments of the NSE.

Ans: The National Stock Exchange, founded in 1992, is a technology-driven stock
exchange. It was designated as a stock exchange in 1993 and began operations in
1994. The NSE trades in two major segments: Wholesale Debt Market Segment and
Capital Market Segment.

(i) Wholesale Debt Market Segment This segment provides a trading platform for
fixed income securities like state development loans, bonds issued by public sector
undertakings, corporate debentures, commercial paper, mutual funds, central
government securities, zero coupon bonds, treasury bills, and so on. In June 1994,
the NSE began operations in the WholeSale Debt Market. It is the first system for
trading in the debt market that is entirely based on screens. That is, it is the first
trading system based on a computer. Trading in the debt market involves two parties:
trading members (who are NSE-registered brokers) and participants (i.e. the buyers
and sellers of securities). Transactions between participants are settled by members.
For example, a member may place an order for the seller of a security, which is then
suitably matched by another member for the buyer of a security who wishes to
purchase that security. An order is kept in the system until it is properly matched.
This NSE segment is also known as NEAT (National Exchange for Automated
trading).

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(ii) Capital Market Segment The NSE trades equity shares, preference shares,
debentures, exchange traded funds, and retail government securities in this segment.
It offers a reliable and transparent platform for a fair trading system. The capital
market segment began operations in November 1995. The NSE Capital Market
trading system is also known as the National Exchange for Automated Trading -
Capital Market (NEAT- CM). The Capital Market segment's trading operations
remain the same as in the Wholesale Debt market system.

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