Financial Markets Test - 1

The correct answer is Capital market

Key Points

• A capital Market is a planned market where both business organizations (corporations and pension funds) and individuals exchange and sell equity securities and debt.
• A capital market is expected to be for the distribution and exchanging of long-term securities.
• A long-term investment means its lock-in period is more than a year.
• SEBI is a statutory regulatory body established on the 12th of April, 1992.
• It monitors and regulates the Indian capital and securities market while ensuring to protect the interests of the investors, formulating regulations and guidelines.
• The Securities and Exchange Board of India (SEBI) is the regulatory authority and is the principal regulator for Stock Exchanges in India.
• SEBI's primary functions include protecting investor interests, and promoting and regulating the Indian securities markets.

Functions of Capital Market

• Change of savings to finance long-term investments
• Minimizing information cost and transaction
• Motivate proprietor of productive assets
• Provide insurance upon price and market risk, through secondary trading
• Expedite trading of securities
• Speedy evaluation of financial measures like debentures and shares
• Settlement of transaction on a particular given time or schedule

The correct answer is Primary Market

Key Points

• The primary market is the part of the capital market that deals with the issuance and sale of securities to purchasers directly by the issuer.
• A primary market means the market for new issues of securities, as distinguished from the secondary market, where previously issued securities are bought and sold.
• In the Primary market there is the sale of securities by new companies or further (new issues of securities by existing companies to investors).
• In the primary market Securities are sold by the company to the investor directly (or through an intermediary).
• In the primary market the flow of funds is from savers to investors, i.e. the primary market directly promotes capital formation.
• In the primary market only buying of securities takes place in the primary market, securities cannot be sold there.
• In the primary market prices are determined and decided by the management of the company.
• In the primary market there is no fixed geographical location.
• Types of primary market issues include an initial public offering (IPO), a private placement, a rights issue, and a preferred allotment.
• Stock exchanges instead represent secondary markets, where investors buy and sell from one another.

The correct answer is Treasury bill

Key Points

• The money market is a market for short-term funds that deal in monetary assets whose period of maturity is up to one year.
• These assets are close substitutes for money. It is a market where low-risk, unsecured, and short-term debt instruments that are highly liquid are issued and actively traded every day.
• It has no physical location but is an activity conducted over the telephone and through the internet.
• It enables the raising of short-term funds for meeting the temporary shortages of cash and obligations and the temporary deployment of excess funds for earning returns 
• The major participants in the market are the Reserve Bank of India Commercial Banks, Non-Banking Finance Companies, State Governments, Large Corporate Houses and Mutual Funds

Various instruments available in the money market are:

Treasury Bills (T-Bills):

• It is a short-term borrowing instrument issued by the Government of India. RBI issues 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.
• E.g. : A treasury bill of face value of Rs 1,00,000 will be sold at Rs 96,000 and at the time of maturity the investor will get Rs 1,00,000. Thus,, Rs 4,000 is the interest received by him.
• It is in the form of a promissory note.
• It is highly liquid and have negligible risk.
• It is available in denominations of Rs 25,000 and its multiples.

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 (e.g.: brokerage, commission, printing of applications, advertising, etc.)

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 makes the demand for call money decrease, an increase in demand for other short-term instruments, as they become cheaper in relation to call money.

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 is less, but the demand for credit is high.
• They help to mobilise large amounts of money in a short time period.

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. 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.

The correct answer is Secondary market

Key Points

• Capital Market is a planned market where both business organizations (corporations and pension funds) and individuals exchange and sell equity securities and debt. A capital market is expected to be for the distribution and exchanging of long-term securities. Here, a long term investment means whose lock-in period is more than a year.
• Sometimes, the government also engage in the capital market, particularly by the distribution of long-term bond. As the government are not allowed to issue shares and equity securities

Types of Capital Market

• The capital market is divided into two parts:
• Primary Market-
• Primary Market Also know as New Issue Market, it is the first time market trading of new securities and later available for institutions and individuals.
• It supports both private and public offerings.
• An organization provides securities to the public to accumulate funds and satisfy its long-term goals.
• In the primary market, the securities are issued by either an Initial Public Offer (IPO) or Further Public Offer (FPO). IPO is a process through which an organization can make a public offer to the investors for the first time to make an investment.
• This trade is between the investors and the original issuer in the primary market.
• Secondary Market –
• It is called secondary because the securities they have are old and already have been issued in the primary market for trade.
• This trade is between the investors and the original issuer in the primary market. The trade is between the buyer and seller and the stock exchange facility.

The correct answer is All of the Above

Key PointsMethods of Flotation
Initial Public Offering (IPO)

• One way to float a company is to issue an initial public offering (IPO), where a private company will go public by issuing shares for the first time.
• Floating a company using an IPO typically involves an investment bank that undertakes the underwriting process and determines the specific details of the IPO, such as the share price and the number of shares to be issued.
• Additionally, the investment bank will develop the investment prospectus required for the IPO and go on a roadshow to promote the new stock offering to potential investors.

Offer through Sale

• In addition to an IPO, a private company can pursue flotation by offering securities for sale using an intermediary, such as a stockbroker.
• The issuance of new shares is not available to the public. Usually, a company that pursues such a flotation method is in its early stages of operations, or it wants to mitigate from issuing shares to the public due to high flotation costs.

Rights Issue

• A company can also be floated by issuing new shares that are available only to a group of existing investors, who are given the opportunity to purchase new shares before the shares officially get offered to the public.

Private Placement

• A private placement is also another way to float a company. Under the private placement, an intermediary would purchase securities from a company at a predetermined price and sell these securities to certain individuals and institutional investors.
• Again, it helps a company avoid incurring high flotation costs and raise more capital quicker than pursuing an IPO.

The correct answer is stock exchange

Key Points

• A stock exchange is an important factor in the capital market.
• It is a secure place where trading is done in a systematic way.
• Here, the securities are bought and sold as per well-structured rules and regulations.
• Securities mentioned here includes debenture and share issued by a public company that is correctly listed at the stock exchange, debenture and bonds issued by the government bodies, municipal and public bodies.

Functions of Stock Exchange
Following are some of the most important functions that are performed by  stock exchange:

Role of an Economic Barometer: 

• Stock exchange serves as an economic barometer that is indicative of the state of the economy. It records all the major and minor changes in the share prices. It is rightly said to be the pulse of the economy, which reflects the state of the economy.

Valuation of Securities:

• Stock market helps in the valuation of securities based on the factors of supply and demand. The securities offered by companies that are profitable and growth-oriented tend to be valued higher. Valuation of securities helps creditors, investors and government in performing their respective functions.

Transactional Safety:

• Transactional safety is ensured as the securities that are traded in the stock exchange are listed, and the listing of securities is done after verifying the company’s position. All companies listed have to adhere to the rules and regulations as laid out by the governing body.

Contributor to Economic Growth:

• Stock exchange offers a platform for trading of securities of the various companies. This process of trading involves continuous disinvestment and reinvestment, which offers opportunities for capital formation and subsequently, growth of the economy.
• Making the public aware of equity investment: Stock exchange helps in providing information about investing in equity markets and by rolling out new issues to encourage people to invest in securities. 

Offers scope for speculation:

• By permitting healthy speculation of the traded securities, the stock exchange ensures demand and supply of securities and liquidity.

Facilitates liquidity:

• The most important role of the stock exchange is in ensuring a ready platform for the sale and purchase of securities. This gives investors the confidence that the existing investments can be converted into cash, or in other words, stock exchange offers liquidity in terms of investment.

Better Capital Allocation:

• Profit-making companies will have their shares traded actively, and so such companies are able to raise fresh capital from the equity market. Stock market helps in better allocation of capital for the investors so that maximum profit can be earned.

Encourages investment and savings:

• Stock market serves as an important source of investment in various securities which offer greater returns. Investing in the stock market makes for a better investment option than gold and silver

The correct answer is Call Money

Key Points

• ​The money market is a market for short-term funds that deal in monetary assets whose period of maturity is up to one year.
• These assets are close substitutes for money. It is a market where low-risk, unsecured, and short-term debt instruments that are highly liquid are issued and actively traded every day.
• It has no physical location but is an activity conducted over the telephone and through the internet.
• It enables the raising of short-term funds for meeting the temporary shortages of cash and obligations and the temporary deployment of excess funds for earning returns 
• The major participants in the market are the Reserve Bank of India Commercial Banks, Non-Banking Finance Companies, State Governments, Large Corporate Houses and Mutual Funds

Various instruments available in the money market are:

Treasury Bills (T-Bills):

• It is a short-term borrowing instrument issued by the Government of India.
• RBI issues 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.
• E.g. : A treasury bill of face value of Rs 1,00,000 will be sold at Rs 96,000 and at the time of maturity the investor will get Rs 1,00,000. Thus,, Rs 4,000 is the interest received by him.
• It is in the form of a promissory note.
• It is highly liquid and have negligible risk.
• It is available in denominations of Rs 25,000 and its multiples.

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 (e.g.: brokerage, commission, printing of applications, advertising, etc.)

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 makes the demand for call money decrease, an increase in demand for other short-term instruments, as they become cheaper in relation to call money.

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 is less, but the demand for credit is high.
• They help to mobilise large amounts of money in a short time period.

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. 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.

The correct answer is Commercial paper

Key Points.

• The money market is a market for short-term funds that deal in monetary assets whose period of maturity is up to one year.
• These assets are close substitutes for money. It is a market where low-risk, unsecured, and short-term debt instruments that are highly liquid are issued and actively traded every day.
• It has no physical location but is an activity conducted over the telephone and through the internet.
• It enables the raising of short-term funds for meeting the temporary shortages of cash and obligations and the temporary deployment of excess funds for earning returns 
• The major participants in the market are the Reserve Bank of India Commercial Banks, Non-Banking Finance Companies, State Governments, Large Corporate Houses and Mutual Funds

Various instruments available in the money market are:

Treasury Bills (T-Bills):

• It is a short-term borrowing instrument issued by the Government of India. RBI issues 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.
• E.g. : A treasury bill of face value of Rs 1,00,000 will be sold at Rs 96,000 and at the time of maturity the investor will get Rs 1,00,000. Thus,, Rs 4,000 is the interest received by him.
• It is in the form of a promissory note.
• It is highly liquid and have negligible risk.
• It is available in denominations of Rs 25,000 and its multiples.

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 (e.g.: brokerage, commission, printing of applications, advertising, etc.)

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 makes the demand for call money decrease, an increase in demand for other short-term instruments, as they become cheaper in relation to call money.

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 is less, but the demand for credit is high.
• They help to mobilise large amounts of money in a short time period.

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. 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.

The correct answer is Knowledge Processes Outsourcing (KPO)

Key Points

• A stock exchange is an important factor in the capital market.
• It is a secure place where trading is done in a systematic way. Here, the securities are bought and sold as per well-structured rules and regulations.
• Securities mentioned here includes debenture and share issued by a public company that is correctly listed at the stock exchange, debenture and bonds issued by the government bodies, municipal and public bodies.
• Typically bonds are traded Over-the-Counter (OTC), but a few corporate bonds are sold in a stock exchange.
• It can enforce rules and regulation on the brokers and firms that are enrolled with them.
• A stock exchange is a forum where securities like bonds and stocks are purchased and traded.
• This can be both an online trading platform and offline (physical location).
   

Additional InformationFunctions of Stock Exchange
Following are some of the most important functions that are performed by  stock exchange:

Role of an Economic Barometer: 

• Stock exchange serves as an economic barometer that is indicative of the state of the economy. It records all the major and minor changes in the share prices. It is rightly said to be the pulse of the economy, which reflects the state of the economy.

Valuation of Securities:

• Stock market helps in the valuation of securities based on the factors of supply and demand. The securities offered by companies that are profitable and growth-oriented tend to be valued higher. Valuation of securities helps creditors, investors and government in performing their respective functions.

Transactional Safety:

• Transactional safety is ensured as the securities that are traded in the stock exchange are listed, and the listing of securities is done after verifying the company’s position. All companies listed have to adhere to the rules and regulations as laid out by the governing body.

Contributor to Economic Growth:

• Stock exchange offers a platform for trading of securities of the various companies. This process of trading involves continuous disinvestment and reinvestment, which offers opportunities for capital formation and subsequently, growth of the economy.
• Making the public aware of equity investment: Stock exchange helps in providing information about investing in equity markets and by rolling out new issues to encourage people to invest in securities. 

Offers scope for speculation:

• By permitting healthy speculation of the traded securities, the stock exchange ensures demand and supply of securities and liquidity.

Facilitates liquidity:

• The most important role of the stock exchange is in ensuring a ready platform for the sale and purchase of securities. This gives investors the confidence that the existing investments can be converted into cash, or in other words, stock exchange offers liquidity in terms of investment.

Better Capital Allocation:

• Profit-making companies will have their shares traded actively, and so such companies are able to raise fresh capital from the equity market. Stock market helps in better allocation of capital for the investors so that maximum profit can be earned.

Encourages investment and savings:

• Stock market serves as an important source of investment in various securities which offer greater returns. Investing in the stock market makes for a better investment option than gold and silver.

The correct answer is Protective

Key Points

• SEBI stands for Securities and Exchange Board of India.
• It is a statutory regulatory body that was established by the Government of India in 1992 for protecting the interests of investors investing in securities along with regulating the securities market.
• SEBI also regulates how the stock market and mutual funds function.
   

Objectives of SEBI
Following are some of the objectives of the SEBI:

1. Investor Protection: This is one of the most important objectives of setting up SEBI.
2. It involves protecting the interests of investors by providing guidance and ensuring that the investment done is safe.
3. Preventing the fraudulent practices and malpractices which are related to trading and regulation of the activities of the stock exchange
4. To develop a code of conduct for the financial intermediaries such as underwriters, brokers, etc.
5. To maintain a balance between statutory regulations and self-regulation.
    

Functions of SEBI
SEBI has the following functions

1. Protective Function:

• The protective function implies the role that SEBI plays in protecting the investor interest and also that of other financial participants. The protective function includes the following activities.

1. Prohibits insider trading: Insider trading is the act of buying or selling of the securities by the insiders of a company, which includes the directors, employees and promoters. To prevent such trading SEBI has barred the companies to purchase their own shares from the secondary market.
2. Check price rigging: Price rigging is the act of causing unnatural fluctuations in the price of securities by either increasing or decreasing the market price of the stocks that leads to unexpected losses for the investors. SEBI maintains strict watch in order to prevent such malpractices.
3. Promoting fair practices: SEBI promotes fair trade practice and works towards prohibiting fraudulent activities related to trading of securities.
4. Financial education provider: SEBI educates the investors by conducting online and offline sessions that provide information related to market insights and also on money management.
    

2. Regulatory Function:

• Regulatory functions involve the establishment of rules and regulations for the financial intermediaries along with corporates that helps in efficient the management of the market.
• The following are some of the regulatory functions.

1. SEBI has defined the rules and regulations and formed guidelines and codes of conduct that should be followed by the corporates as well as the financial intermediaries.
2. Regulating the process of taking over a company.
3. Conducting inquiries and audits of stock exchanges.
4. Regulates the working of stock brokers, and merchant brokers.
    

3. Developmental Function:

• Developmental function refers to the steps taken by SEBI in order to provide the investors with knowledge of the trading and market function.
• The following activities are included as part of developmental function.

1. Training of intermediaries who are a part of the security market.
2. Introduction of trading through electronic means or through the internet by the help of registered stock brokers.
3. By making the underwriting an optional system in order to reduce cost of issue.