Answer the following questions.
1. Explain the functions of financial market.
Ans: FUNCTIONS OF FINANCIAL MARKET ARE AS FOLLOWS:
1. Transfer of Resources : Financial Market facilitate the transfer of real economic resources from lenders to ultimate users.
2. Productive usage : Financial Market allows productive use of the funds. In the hands of the Investors their excess funds would have remained idle. Borrowers use these Funds for productive purposes.
3. Enhancing income : Financial Market allows lenders to earn Interest or dividend on their surplus funds, thus leading to the enhancement of the individual and the national Income.
4. Capital Formation : Financial Market provides a channel through which savings flow to Industrial and commercial organisations in the form of capital. This leads to capital formation.
5. Price determination : The financial instruments traded In a financial market get their prices from the mechanism of demand and supply. The Investors are the suppliers of the funds and the corporates are the users. The interaction between the two and other market factors will help to determine the prices.
6. Sale Mechanism : Financial Market provides a mechanism for selling of a financial asset by an investor so as to offer the benefit of marketability and liquidity of such assets.
7. Mobilizing Funds : Idle funds in the hands of the investors can be productively used by corporates. Investors that have savings must be linked with corporates that require investment. So financial market enables the investors to Invest their saving according to their choices and risk assessment. This will utilize Idle funds and the economy will boom.
8. Liquidity : Financial market provides a mechanism for liquidating the financial Instruments. This means at any given time, the Investor can sell their financial instruments and convert them Into cash. This is an important factor for investors who do not want to Invest for a long period.
9. Easy access : Both Investors and industries need each other. The financial market provides a platform where both the buyers and sellers can find each other easily. 10. Industrial development : Financial market helps in transforming savings Into capital. Corporates use the funds of Investors to undertake productive or commercial activities thereby leading to economic development.
2. State the instrument of money market.
Ans: Instrument of Money Market: In the money market, only those financial instruments are traded which are immediate substitute for money. Some of these instruments are as follows:
1) Call money and Notice money : Call money and Notice money market le an Important segment of the money market in India, Under Call money, funds are lent or borrowed for very short periods i.e. one day. Under Notice money, funds are lent or borrowed for periods between 2 days to 14 days. Funds have to be repaid within a specified time on the receipt of notice given by the lender. When one bank faces temporary shortage of cash, then another bank with surplus cash lends money to It. Hence Call/ Notice money market Is also called as interbank Call money market.
2) Treasury Bills (1-Bills): Treasury Bills are short term securities issued by Reserve Bank of India on behalf of the Central Government of India to meet the government’s short term funds requirement. Treasury Bills have three maturity periods – 91 days, 182 days and 364 days. These bills are sold to banks and individuals, firms, institutions, etc. These bills are negotiable Instruments and are freely transferable. The minimum value of T-bills is 25,000 or in multiples of 25000. These are Issued at a discount and repaid at par and hence they are also called Zero Coupon Bonds.
3) Trade Bills/ Commercial Bills: Bill of Exchange also called as Trade bills are negotiable Instruments or bills drawn by a seller on the buyer for value of goods sold under credit sales. These have short-term maturity period generally of 90 days and can be easily transferred. If the seller wants immediate cash, he can discount the trade bills with Commercial banks i.e. sell it to banks for cash. When the trade bills are accepted by Commercial banks it Is known as Commercial Bills. Banks can rediscount the bills any number of times till the maturity of the bill.
4) Commercial Papers (CPs): Commercial Paper is an unsecured promissory note Issued by highly rated companies, All India Financial Institutions, like SIDBI, Exim Bank etc, and Primary Dealers with a fixed maturity period which varies from 7 days to maximum 1 year. The minimum value of CP is 5 lakhs or in multiples of f 5 lakhs. It is issued at a discount to the face value and are highly liquid as It gives better returns than normal bank deposits. Individuals, Banks, Mutual funds, Companies, etc. Invest in Commercial Papers.
5) Certificate of Deposits (CDs): These are unsecured negotiable promissory notes usually Issued by Commercial Banks and Financial institutions, It Is a receipt of funds deposited in a bank for a fixed period at a specified rate of interest. It can be Issued for a minimum value of r 1 lakh or in multiples of T1 lakh, They can be issued at a discount to the face value. They have a maturity period of minimum 7 days and maximum 1 year. (Maximum maturity may be 3 years, If the CDs are issued by Financial institutions.) CDs can be bought by individuals, companies, etc.
6) Government Securities : The marketable debts issued by the government or by semi government bodies which represent claims on the government is known as government securities, These securities are issued by agencies such as Central Government, State Government, local self-government e,g. Municipalities etc. These securities are safe investment as payment of interest and repayment of principal amount are guaranteed by the government.
7) Repo or Repurchase Agreement : Repo is an agreement where the seller of a security, (le, one who needs money) agrees to buy It back from the lender at a higher price on a future date. Usually this agreement Is made between RBI and commercial banks. Repo rate Is the rate at which banks borrow from RBI and Reverse repo rate is the rate at which RBI borrows from banks. RBI uses the repurchase agreement to control the money supply In the economy. These agreements are the most liquid of all money market Investments having maturity ranging from 24 hours to several months.
8) Money Market Mutual Funds (MMMFS): A Mutual Fund which Invests In Money market Instruments Ilke Call Money, Repos, T-bills, CDs, etc. Is called as MMMFs. This type of Mutual Fund Invest in debt Instruments which mature In less than 1 year and have low risk. Individuals and corporates are allowed to invest In MMMFs,
3. State the features of capital market.
Ans: Features of Capital Market : Following are the main features of the capital market:
1) Link between Investors and borrowers : The capital market links investors with the borrowers of funds, It routes money from savers to entrepreneurial borrowers.
2) Deals In medium and Long-term investment : Capital market Is a market where medium and long term financial Instruments are traded. Through this market, corporates, Industrial organizations, financial institutions access long-term funds from both domestic and foreign markets.
3) Presence of Intermediaries : Capital market operates with the help of intermediaries like brokers, underwriters, merchant bankers, collection bankers etc. These intermediaries are important elements of a capital market.
4) Promotes capital formation : Capital market provides a platform for Investors and borrowers of long term funds to trade. This leads to capital formation in an economy as It mobilizes funds. Capital formation Is the net addition to the existing stock of an economy’s capital.
5) Regulated by government rules, regulations and policies : Capital market operates freely. However, it is regulated by government rules, regulations and policies. e.g. SEBI is the regulator of Capital markets.
6) Deals in marketable and non-marketable securities : Capital market trades in both marketable and non-marketable securities. Marketable securities are securities that can be transferred. e.g. Shares, Debentures etc. and non-marketable securities are those which cannot be transferred. e.g. Term Deposits, Loans and Advances.
7) Variety of investors : Capital market has a wide variety of investors. It comprises both individuals like general public and institutional investors like Mutual Funds, Insurance companies, Financial institutions, etc. 8) Risk: Risk is very high here as the instruments have long maturity periods. However, the return on investments is very high.