Financial Markets

A financial market is a market for the creation and exchange of financial assets, and it links savers and investors by channelling savings into productive uses. In this chapter you will study its four functions: mobilisation of savings, facilitating price discovery, providing liquidity to financial assets and reducing the cost of transactions. You will learn about the money market, which deals in short-term funds with a maturity of up to one year, and its instruments: Treasury Bills issued by the RBI on behalf of the government as zero coupon bonds, Commercial Paper, Call Money, Certificates of Deposit and Commercial Bills. The chapter then explains the capital market, its distinction from the money market, and its two parts: the primary market, where new securities are issued through a prospectus, offer for sale, private placement, rights issue and e-IPOs, and the secondary market or stock exchange. You will study the functions of a stock exchange, the trading and settlement procedure, dematerialisation and depositories such as NSDL and CDSL, and the role of SEBI.

Detailed Worksheet: Financial Markets Section A - Definitions (10 marks) 1. Define a financial market. State any two of its functions. (2 marks) 2. What is a Treasury Bill? Why is it called a zero coupon bond? (2 marks) 3. Distinguish between the primary market and the secondary market on two bases. (2 marks) 4. What is dematerialisation? Name the two depositories in India. (2 marks) 5. State the objectives of SEBI. (2 marks) Section B - Calculations and Applications (15 marks) 6. A 91-day Treasury Bill with a face value of Rs 1,00,000 is issued at Rs 98,250. Calculate the discount earned by the investor and the approximate annualised yield, using yield = (discount divided by issue price) x (365 divided by 91) x 100. (3 marks) 7. A company issues Commercial Paper of face value Rs 50 lakh for 180 days at a price of Rs 48 lakh. Calculate the cost to the company for 180 days as a percentage of the amount received, and the approximate annual cost. State two features of Commercial Paper. (3 marks) 8. A company makes a rights issue in the ratio of 1 new share for every 4 shares held, at Rs 80 per share. An investor holds 1,000 shares. Calculate the number of rights shares he is entitled to and the amount he must pay. If the market price is Rs 120, calculate the notional benefit. (3 marks) 9. An investor buys 200 shares at Rs 450 each and sells them later at Rs 520 each. Brokerage is 0.5% on each transaction. Calculate the brokerage paid on purchase and sale, and the net gain. Name the two depositories through which the shares are held in demat form. (3 marks) 10. Identify the method of floatation in each case: (i) shares offered to existing shareholders in proportion to their holdings (ii) shares sold to institutional investors and select individuals (iii) shares sold to an intermediary who resells them to the public (iv) a company issues shares through the online system of a stock exchange (v) a company issues a prospectus inviting the public. (3 marks) Section C - Diagrams (10 marks) 11. Draw a chart classifying financial markets into the money market and the capital market, showing the instruments of the money market and the primary and secondary parts of the capital market. (4 marks) 12. Draw a flowchart of the screen-based trading and settlement procedure on a stock exchange, from opening a demat and trading account to settlement. (3 marks) 13. Draw a chart showing the functions of SEBI under three heads: regulatory, development and protective, with two examples each. (3 marks) Section D - Analysis and Higher-order Thinking (15 marks) 14. Distinguish between the money market and the capital market on five bases. Analyse why a company would raise short-term funds through Commercial Paper and long-term funds through equity shares. (5 marks) 15. Explain the functions of a stock exchange. Analyse how a stock exchange contributes to economic growth and to the evaluation of companies' securities. (5 marks) 16. A company plans to raise Rs 200 crore. Evaluate the merits and limitations of an offer through prospectus, a rights issue and private placement for this purpose, and recommend the most suitable method for a well-established listed company. (5 marks) Instructions: Time allowed 2 hours. Attempt all sections. Show all calculations with formulae, and quote relevant lines from cases while identifying concepts.