Reviewing AP Inter 2nd Year Commerce Study Material Chapter 3 Financial Markets and Instruments Questions and Answers can help students prepare confidently for exams.
AP Inter 2nd Year Commerce 3rd Lesson Financial Markets and Instruments Questions and Answers
Very Short Answer Questions
Question 1.
What is the main difference between the money market and the capital market?
Answer:
Money Market: The Central Bank and Commercial Banks are the major participants.
It is a market for short-term funds for period not exceeding one year. Ex: T-bills, CD
Capital Market: The Development banks and Investment Companies are the major participants. It is a market for long-term funds for more than one year. Ex: Shares, Debentures.
Question 2.
Define the term derivative
Answer:
The derivatives market deals with financial contracts whose value is derived from underlying assets like stocks, bonds, commodities, or currencies. It is mainly used for hedging risk and speculation.
Question 3.
Explain what a ‘futures contract’ means.
Answer:
A future contract is an agreement to buy or sell an asset at a fixed price on a specific future date. These are traded on organized exchanges like the NSE.
Question 4.
Who regulates the capital market in India?
Answer:
The Securities and Exchange Board of India (SEBI) regulates the capital market and the Reserve Bank of India (RBI) regulates the money market.
Short Answer Questions
Question 1.
Describe the functions of the financial market
Answer:
Functions of Financial Market:
1. Mobilisation of Savings: A financial market facilitates the transfer of savings from savers to investors. It gives savers the choice of different investments.
2. Facilitating Price Discovery: It is known that the forces of demand and supply help to establish a price for a commodity or service in the market. In the financial market, the households are supplies of funds and business firms represent the demand.
3. Providing Liquidity to Financial Assets: Financial markets facilitate easy purchase and sale of financial assets. In doing so, they provide liquidity to financial assets, so that they can be easily converted into cash whenever required.
4. Reducing the cost of transactions: Financial markets provide valuable information about securities being traded in the market. It helps to save time, effort, and money that both buyers and sellers of a financial asset have to find each other.
Question 2.
Explain the major instruments of the money market
Answer:
Money Market Instruments:
1. Treasury Bill: It is basically an instrument of short-term borrowing by the Government of India maturing in less than one year. They are also known as Zero Coupon Bonds issued by the RBI on behalf of the Central Government to meet its short-term requirement of funds.
2. Commercial Paper: It is a short-term unsecured promissory note, negotiable and transferable by endorsement and delivery with a fixed maturity period. It is raised short-term funds at lower rates of interest than market rates. It has usually a maturity period of 15 days to one year.
3. Call Money: Call money is short-term finance repayable on demand, with a maturity period of one day to fifteen days, used for inter-bank transactions. The interest rate paid on call money loans is known as the call rate.
4. Certificate of Deposit: These are unsecured, negotiable, short-term instruments in bearer form, issued by commercial banks and developed financial institutions. The return on the certificate of deposit is higher than the Treasury Bills because it assumes a higher level of risk.
5. Commercial Bill: A commercial bill is a bill of exchange used to finance the working capital requirements of business firms. It is a short-term, negotiable, self-liquidating instrument.
6. Collateral Loan: It is a loan provided by commercial banks against security or collateral such as government securities, bonds, gold, or other valuable assets.
Question 3.
Differentiate between the Primary market and Secondary market.
Answer:
| Primary Market (New Issue Market) | Secondary Market (Stock Exchange) |
| 1. There is a sale of securities to investors by new companies or existing companies. | 1. There is trading of existing shares only. |
| 2. Securities are sold by the company to the investor directly or through an intermediary. | 2. Ownership of existing securities is exchanged between investors. The company is not involved at all. |
| 3. The flow of funds is from savers to investors, i.e. the primary market directly promotes capital formation. | 3. Enhances encashment (liquidity) of shares, i.e., the secondary market indirectly promotes capital formation. |
| 4. Only buying of securities takes place in the primary market, securities cannot be sold there. | 4. Both the buying and the selling of securities can take place on the stock exchange. |
| 5. Prices of securities are determined and decided by the management of the company. | 5. Prices are determined by demand and supply of the security. |
| 6. There is no fixed geographical location. | 6. Located at specified places. |
Question 4.
What are derivatives? Explain the four main types.
Answer:
The derivatives market deals with financial contracts whose value is derived from underlying assets like stocks, bonds, commodities, or currencies. It is mainly used for hedging risk and speculation.
- Forwards: A forward is a private agreement between two parties to buy or sell an asset at a future date for an agreed price. It is not traded on an exchange, so it carries more risk.
- Futures: A future is an agreement to buy or sell an asset at a fixed price on a specific future date. These are traded on organized exchanges like the NSE.
- Options: An option gives the right, but not the obligation, to buy or sell an asset at a fixed price within a set time. There are two types:
- Call Option: Right to buy.
- Put Option: Right to sell.
- 4) Swaps: A swap is an agreement between two parties to exchange financial obligations, such as interest rates or currencies.
Long Answer Questions
Question 1.
Discuss the Importance of capital market in economic growth.
Answer:
Capital Market: The term capital market refers to the institutional arrangements through which long-term funds; both debt and equity are raised and invested. It consists of a series of channels through which savings of the community are made available for industrial and commercial enterprises. The capital market consists of development banks, commercial banks and stock exchanges.
Importance of Capital Market:
1. Link between savers and investors: Capital market plays an important role in mobilizing the savings and diverting them into productive investment. In this way it is transferring financial resources from surplus and wasteful areas to deficit and productive areas.
2. Encouragement of Savings: In the un-developed countries, there are very less savings and those who save often invest their savings in unproductive areas and conspicuous consumption in the absence of a capital market. With the development of capital market, the financial institutions provide vast range of instruments which encourage people to save them.
3. Encouragement of Investments: Various financial assets like shares, bonds etc., encourage savers to lend to the government or ta invest in industry. Thus, the capital market facilitates lending to the businessmen and the government.
4. Stability in Prices: The capital market tends to stabilize the values of stocks and securities. In the process of stabilization it is facilitated by providing capital to the borrowers at a lower interest rate and reducing the speculative and unproductive areas.
5. Promotes Economic Growth: The balanced economic growth is possible in any country with the proper allocation of resources among the industries. The capital market not only reflects the general conditions of the economy, but also smoothens and accelerate the process of economic growth.
Question 2.
Distinguish between capital and money market.
Answer:
Differences between capital and money market:
| Basis of differences | Capital Market | Money Market |
| 1. Participants | Development banks and Investment Companies. Ex: Stock markets like NSE, BSE. | The Central Bank and Commercial Banks. Ex: RBI, SBI |
| 2. Instruments | Equity shares, preference shares, debentures, bonds etc. | T-bills, Trade bills, commercial paper and certificates of deposit. |
| 3. Investment Outlay | Investment in the capital market does not necessarily require a huge financial outlay. | In the money market, transactions entail huge sums of money as the instruments are quite expensive. |
| 4. Period | It is a market for long-term funds for more than one year. | It is a market for short-term funds for period not exceeding one year. |
| 5. Liquidity | Capital market securities are considered liquid investments. | Money market instruments enjoy a higher degree of liquidity. |
| 6. Safety | Capital market instruments (shares) are riskier both with respect to returns and principal repayment. | Money market is generally much safer with a minimum risk of default. |
| 7. Expected return | The investment in capital markets generally yield a higher return for investors than the money markets. | The returns in the money market investments are low when compared with capital markets. |
| 8. Regulator | SEBI regulates the institutions and procedures. | RBI regulates the market. |
Fill in the Blanks
Question 1.
The financial market is divided mainly into the _________ market and the capital market
Answer:
money
Question 2.
The money market deals with instruments having a maturity period of less than _________ year
Answer:
one
Question 3.
The capital market is used for raising _________-term funds
Answer:
long
Question 4.
The derivatives market derives its value from an underlying _________.
Answer:
assets
Question 5.
Futures, options, forwards, and swaps are examples of _________ instruments
Answer:
derivative