Financial Markets Question Answers: NCERT Class 12 Business Studies

A financial market is a platform where the trading of financial securities like bonds, stocks, currencies, and derivatives takes place. It helps in the efficient allocation of resources by linking surplus and deficit sectors of the economy.

The money market deals with short-term funds and instruments, typically for a period of one year or less (e.g., treasury bills, certificates of deposit), while the capital market handles long-term securities (e.g., equity shares, bonds) for a duration of more than one year.

A stock exchange is a regulated marketplace where stocks, bonds, and other securities are traded. It facilitates the buying and selling of financial instruments and plays a key role in maintaining liquidity in the financial system.

The financial market performs various critical functions:

• Facilitates Price Discovery: The forces of demand and supply in financial markets help in determining the prices of financial instruments.
• Liquidity Provision: It allows investors to buy and sell securities, providing liquidity to the assets.
• Reduces Transaction Costs: The availability of a well-functioning market reduces the cost involved in searching for buyers and sellers.
• Mobilizes Savings: It helps in channeling the surplus funds from savers to those needing capital for productive use.
• Risk Sharing: Financial markets provide instruments that help in diversifying and managing risk.

The NSE is India’s leading stock exchange, established in 1992. It provides a platform for investors to trade equities, derivatives, and other securities electronically. Some of its key roles include:

• Efficient and Transparent Trading: It ensures a transparent trading environment with real-time market data.
• Investor Protection: It has systems in place to protect investors through regulatory frameworks and automated systems.
• Wide Accessibility: NSE’s digital network allows traders from across the country to participate in the market.

The money market is characterized by:

• Short-Term Instruments: It deals with debt instruments that mature within one year.
• High Liquidity: The instruments in the money market are highly liquid, ensuring easy convertibility to cash.
• Safety: Due to the short-term nature and government backing of many instruments, they are considered safe investments.
• Low Returns: The returns are generally lower due to lower risk and shorter maturity.

The Securities and Exchange Board of India (SEBI) plays a pivotal role in the regulation and development of financial markets. Its primary functions include:

• Regulating Stock Exchanges: SEBI ensures the smooth functioning of stock exchanges by formulating and enforcing rules.
• Protecting Investors: SEBI protects the interests of investors by ensuring fair practices and punishing malpractices like insider trading and fraud.
• Promoting Healthy Growth: It fosters the development of financial markets by introducing new financial products and ensuring transparency.
• Educating Investors: SEBI works to increase investor awareness and understanding of the financial markets. SEBI has been instrumental in maintaining the integrity and efficiency of India’s financial markets through its regulatory, developmental, and protective functions.

The capital market is a major component of the financial system, dealing with long-term investments. It consists of two segments:

• Primary Market: This is where new securities are issued and sold to investors directly by companies (e.g., Initial Public Offerings or IPOs).
• Secondary Market: It provides a platform for the trading of previously issued securities. The stock exchange is the key player in the secondary market, allowing investors to buy and sell stocks. Key instruments in the capital market include:
• Equity Shares: Represent ownership in a company and provide dividends to shareholders.
• Debentures: Long-term bonds issued by companies to raise capital.
• Bonds: Debt securities issued by the government or companies that pay fixed interest to investors. The capital market helps in wealth creation, economic development, and efficient allocation of resources by linking savers and borrowers in the economy.

Trading on a stock exchange follows a systematic process:

• Placing an Order: Investors place orders through brokers to buy or sell securities.
• Order Matching: Orders are matched electronically in the stock exchange based on price and quantity.
• Settlement: Once the transaction is matched, the settlement process begins where the buyer pays for the securities and the seller delivers them. The importance of stock exchange trading includes:
• Liquidity: Stock exchanges provide liquidity, allowing investors to convert their securities into cash quickly.
• Transparency: Automated systems ensure transparency in the trading process with real-time price updates.
• Regulation: Exchanges are regulated by SEBI to prevent fraud and protect investors.
• Price Discovery: The stock exchange serves as a marketplace where the price of securities is determined through supply and demand.

Treasury Bill is an instrument of short-term debt, issued by the RBI on behalf of central Government to meet short-term requirement of funds.

• They are issued in the form of a promissory note, having maturity period of less than one year.
• They are highly liquid and have assured returns and with negligible risk of default.
• They are available for a minimum amount of ₹ 25,000, and in multiples thereof.
• They are also known as ‘Zero coupon bonds’ as they do not pay any interest, but since the issue price is less than the redemption value, this difference is the interest receivable on them.

The National Stock Exchange is the latest, most modern and technology driven exchange. It was incorporated in 1992 and was recognized as a stock exchange in April 1993. It provides trading in two main segments:

• Whole sale debt Market segment.
• Capital Market segment.

Investing public can expect a safe and fair deal in the stock market due to these two main reasons:

1. To protect the interest and right of investors, particularly by guiding and educating individual investors on the way to deal in stock exchange.
2. To develop and regulate fair practice and code of conduct by intermediaries like brokers, merchant banker etc.

The common name for beneficiary account is ‘Demat Account’. A beneficiary owner is an owner who enjoys the benefits of ownership even though the property is titled with the name of someone else. In also means that, any individual or groups of individuals who has the power to vote or influence the transaction decision such as company shares either directly or indirectly.

The two details that need to be provided by the investor to the broker while filling a client registration form are:

• Pan number. (This is mandatory)
• Date of birth and address.

Financial Market plays an important role in the allocation of scarce resources in an economy by performing four important functions:

1. Mobilization of saving 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.

2. 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.

3. 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.

4. 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.

Money market is a market where transactions are made in short-term securities or it is meant for those securities where the payment period is upto one year. Since, their maturity period is very short, they are also termed as near money. These securities include call money, treasury bills, commercial bills, certificate of deposit, commercial paper, etc. Short-term financial instruments satisfy the requirement of short-term or working capital needs of commercial establishments.

Features of Money Market are:

1. The volume of transaction in money market is large that is why it is also called Wholesale market.
2. The participants of money market are RBI, commercial banks, financial institutions and finance companies.
3. Impersonal relationship is established among the participants in a money market.
4. Money markets are highly liquid and have an arrangement for providing liquidity, which is provided by Discount and Finance Houses of India (DFHI).

Difference between capital market and money market:

Stock Exchange performs the following functions:

1. Provides Liquidity and Marketability to Existing Securities: It provides a ready and continuous market where securities are bought and sold. It gives investors the chance to disinvest or reinvest. Thus, regular dealing provides both liquidity and marketability to existing securities.

2. Pricing of Securities: It helps in determining the prices of various securities that reflect their real worth. It enables correct pricing of securities through the interplay of demand and supply. The stock market index like SENSEX, reflects the market direction and indicate day-to-day fluctuations in share prices.

3. Safety of Transactions: It is well regulated and its dealings are well-defined according to the existing legal framework. This ensures that the investing public gets a fair deal in the market.

4. Contributes to Economic Growth: In stock exchange, the process of disinvestment and reinvestment channelize the saving into productive investment avenues. This leads to capital formation and economic growth.

5. Spreading Equity Cult: It is an organised market, which takes various steps to guide and educate investors, publishes information about companies listed on the exchange and ensures better and safe trading practices. These practices have played a vital role in increasing the number of people investing in equity, thus leading to wider ownership of equity.

6. Providing Scope for Speculation: It is generally accepted that a certain degree of speculation is necessary to ensure liquidity and price continuity in the stock market. Thus, it provides sufficient scope for speculation in a restricted and controlled manner within the provisions of law.

The Securities and Exchange Board of India (SEBI) was established by the Government of India on 12th April, 1988 with an objective to protect the interest of investors and to promote the development of and regulate the securities market.

The SEBI has many objectives, some of them are discussed below:

1. To regulate stock exchange and 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. Top revent trading malpractices and achieve balance between self- regulation by the securities industry and its statutory regulation.
4. To regulate and develop a code of conduct for intermediaries with a view to make them competitive and professional.

The National Stock Exchange (NSE) is the latest, most modern and technology driven exchange. It was incorporated in 1992 and was recognised as a stock exchange in April 1993.

NSE was set up with the following objectives:

1. Establishing a nationwide trading facility for all types of securities.
2. Ensuring equal access to investors all over the country through an appropriate communication network.
3. Providing a fair, efficient and transparent securities market using electronic trading system.
4. Enablingshortersettlementcyclesandbookentrysettlements.
5. Meeting international benchmarks and standards.

Once 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. This is an important document as it is legally enforceable and helps to settle disputes/claims between the investors and the broker. A unique Order Code number is assigned to each transaction by the stock exchange and is printed on the contract note.

Various instruments available in the money market are:

1. Treasury Bills (T-Bills): It is a short-term borrowing instrument issued by the Government of India. RBI, issue it on behalf of Government of India.

• It is also known as zero coupon bonds.
• It has a maturity of less than one year.
• It is issued at discount and repaid at par.
• It is in the form of a promissory note.
• It is highly liquid and has negligible risk.
• It is available in denominations of ₹ 25000 and its multiples.

2. Commercial Paper: Commercial paper is issued by large creditworthy companies to raise short-term funds at lower rates of interest than the market rate.

• It is an unsecured promissory note, having a maturity of 15 days to one year.
• It is a negotiable instrument, transferable by endorsement and delivery.
• It is sold at discount and redeemed at par.
• It is an alternative to bank borrowing. The original purpose of commercial paper was to meet working capital needs of companies.
• It is used by companies for bridge financing, a method of financing used by companies before issuing shares or debentures, to cover the expenses associated with the issue of such securities, i.e. floatation costs.

3. Call Money: Call money is a method used by commercial banks to borrow funds from each other, in order to maintain the Cash Reserve Ratio (CRR). Cash Reserve Ratio is the minimum balance of cash to be maintained by banks, according to RBI guidelines.

• It is short-term finance repayable on demand.
• Maturity of call money is 1 day to 15 days.
• The interest paid on call money is called the call rate.
• Call rate is highly fluctuating, which varies from day-to-day or even from hour-to-hour.
• There is an inverse relationship between call rates and return on other short-term money market instruments. Increase in call rates make the demand for call money decrease, and increase in demand for other short-term instruments, as they become cheaper in relation to call money.

4. Certificate of Deposit: Certificate of deposits are 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.
• They help to mobilise large amounts of money in a short time period.

5. Commercial Bill: It is a bill of exchange used by business firms to meet their working capital needs.

• It is an unsecured, negotiable instrument in bearer form.
• When goods are sold on credit, the seller (drawer) draws a bill of exchange on the buyer (drawee), who accepts it. When he accepts the bill, it becomes a marketable instrument, which is called a trade bill. When the seller presents it to the bank for discounting it, to get the funds before the maturity of the bill and the bank accepts it, it is called a commercial bill.

Capital market is a market for medium and long-term funds. This market facilitates the institutional arrangements through which long-term funds, both debt and equity are raised and invested. The capital market consists of development banks, commercial banks and stock exchanges. An ideal capital market is one, where finance is available at a reasonable cost. The process of economic development is facilitated by the existence of a well functioning capital market. There are two types of capital market Primary Market and Secondary Market. Primary market facilitates capital formation in the economy by Channelising public saving into productive investments. And secondary market is also known as the stock market or stock exchange. In this market, securities are not directly issued by the company to investors but it is sold by existing investor to other investors. It provides liquidity and marketability to existing securities.

The history of stock market in India goes back to the end of the eighteenth century when long-term negotiable securities were first issued. In 1850 the Companies Act was introduced for the first time bringing with it the feature of limited liability and generating investor interest in corporate securities. The first stock-exchange in India was set-up in 1875 as The Native Share and Stock Brokers Association in Bombay. Today it is known as the Bombay Stock Exchange (BSE). This was followed by the development of exchanges in Ahmedabad (1894), Calcutta (1908) and Madras (1937). It is interesting to note that stock exchanges were first set up in major centers of trade and commerce.

Until the early 1990s, the Indian secondary market comprised regional stock exchanges with BSE heading the list. After the reforms of 1991, the Indian Secondary market acquired a three tier form. This consists of:

1. Regional Stock Exchange: There are 21 Regional Stock Exchange (RSE). The first Regional Stock Exchange was Ahmedabad Stock Exchange (ASE) that came into existence in 1894. Next the Calcutta Stock Exchange (CSE) came into existence in 1908. In early sixties, there were only few recognised RSEs that are Calcutta, Madras, Ahmedabad, Delhi, Hyderabad and Indore. The latest stock exchange is Coimbatore Stock Exchange and Meerut Stock Exchange.

2. National Stock Exchange: The National Stock Exchange is the latest, most modern and technology driven exchange. It was incorporated in 1992 and was recognised as a stock exchange in April 1993. It started operations in 1994, with trading on the wholesale debt market segment. The NSE was set up by leading financial institutions, banks, insurance companies and other financial intermediaries.

3. Over the Counter Exchange of India (OTCEI): Over The Counter Exchange of India (OTCEI) was incorporated in 1990 under the companies act 1956 and it was recognised as a stock exchange under the Securities Contracts Regulation Act, 1956. It started its operations in the year 1992 and it is modeled along the lines of NASDAQ, which is OTC Exchange in USA. And the objective of OTCEI was to provide easy access to the capital market to the small and medium companies. OTCEI is a fully computerized and single window exchange system.

The Securities and Exchange Board of India (SEBI) was established by the Government of India on 12th April, 1988 with an objective to protect the interest of investors and to promote the development of and regulate the securities market.

The SEBI has many objectives, some of them are discussed below:

1. To regulate stock exchange and 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. Top revent trading malpractices and achieve balance between self- regulation by the securities industry and its statutory regulation.
4. To regulate and develop a code of conduct for intermediaries with a view to make them competitive and professional.

Functions of SEBI are discussed below:

1. Regulatory Functions

• Registration of brokers, sub-brokers and other players in the market.
• Registration of collective investment schemes and mutual funds.
• Regulation of stock brokers, portfolio exchanges, underwriters and merchant bankers and the business in stock exchanges.
• Regulation of takeover bids by companies.
• Levying fee or other charges for carrying out the purposes of the Act.
• SEBI conducts inspections, enquiries and audits of stock exchanges.
• Perform and exercise such power under Securities Contracts (Regulation) Act 1965, as may be delegated by the Government of India.

2. Development Functions

• Training of intermediaries of the securities market.
• Conducting research and publishing information useful to all market participants.
• Undertaking measures to develop the capital markets by adopting a flexible approach.

3. Protective Functions

• Prohibition of fraudulent and unfair trade practices.
• Controlling insider trading and imposing penalties for such practices.
• Undertaking steps for investor protection.
• Promotion of fair practices and code of conduct in securities market.

a. Which market is being reflected in the above case?

Ans. The market that has been reflected in the above case is Primary Market. Primary Market is also known as the new issues market, as this market deals with the new securities issued for the first time.

b. State which method of floatation in the above identified market is being highlighted in the case?

Ans. The floatation method that has been highlighted in this case is Right 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. This right is called the ‘pre-emptive right’ of the existing shareholders.

c. Explain any two other methods of floatation.

Ans. Methods of flotation are:

1. Offer Through Prospectus: Under this method, a company invites public to subscribe for its shares through issue of prospectus, which makes a direct appeal to investors to invest in the company, through an advertisement in the newspapers and magazines.

• The contents of prospectus must be according to the provisions of Companies Act and SEBI guidelines.
• The issue must be listed on at least one stock exchange.
• The issue may be underwritten to save the company from under subscription.

2. Private Placement: Private placement is the allotment of securities by a company to institutional investors and some selected individuals. It is considered beneficial because:

• It helps to raise funds more quickly than a public issue.
• The cost of flotation, which is quite expensive in other alternatives, is saved.

Following are the steps 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. The investor has a sign a broker-client agreement and a client registration form before placing an order to buy or sell securities. He has also to provide certain other details and information. These details includes:
   
   a. PAN Number
   b. Date of birth and address
   c. Educational qualification and occupation
   d. Residential status (Indian/ NRI)
   e. Bank account details
   f. Depository account details
   g. Name of any other broker with whom registered
   h. Client code number in the client registration form
   
   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 participants (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. Clear instructions have to be given 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. This is an important document as it is legally enforceable and helps to settle disputes/claims between the investor and the broker. 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 as the deal has to be settled and finalized on the T+2 day. The settlement cycle is on T+2 day on a rolling settlement basis, w.e.f. 1 April 2003.

9. On the T+2 day, the exchange will deliver the share or make payment to the 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. The investor has to give details of his demat account and instruct his depository participant to take delivery of securities directly in his beneficial owner account.