AHSEC - Class 12: Banking Notes | Financial Market for Feb' 2022 - 23 Exam

OBJECTIVE QUESTIONS (1 mark)

1. What is a financial market? Mention its components.                               2008, 2013

Ans: It refers to a market which creates and exchanges financial assets and credit instruments such as cheques, bills, bonds, deposits etc. It is divided into two parts: Money market and capital market.

2. What are financial assets?

Ans: It refers to the financial instruments or securities. For e.g. shares, debentures, treasury bills, commercial paper etc.

3. What is floatation cost?

Ans: The expenditure incurred in issuing the securities is called floatation cost.

4. What is a zero coupon bond?

Ans: It is a financial instrument for which no interest is paid but is issued at a discount redeemable at par.

5. State the components of capital market?

Ans: a) Primary market b) secondary market.

6. Name two buyers of Commercial paper.

Ans: a) Banks b) Insurance companies.

7. What is meant by “Near Money?”

Ans: All very short term securities are called near money for e.g. marketable securities.

8. What type of trade-off function is performed by the money market?

Ans: The money market establishes a balance between short term financial supply and short term financial demand.

9. Name the instruments that are traded in money market.                        2013

Ans: Call money, Commercial Papers, Certificates of deposits, Bills of exchange.

10. Name the instruments that are traded in capital market.

Ans: Stocks, Shares, Debentures, Bonds, GDR (Global Depository receipts)

11. Name the institutions operating in the money market.

Ans: Central Bank, Commercial banks, Non-bank financial institutions.

12. Name the institutions operating in the capital market.

Ans: IDBI, IFCI, ICICI, Stock exchanges.

13. In which year NSEI and BSE were established?                           2015

Ans: NSEI – In 1991 and BSE – In 1875. But, NSEI was recognized in 1992.

14. In which year OTCEI was established?

Ans: 1990

15. Write the full form of NSEI, BSE and OTCEI.                  2008

Ans: NSEI – National stock exchange of India (Nifty)-Nov, 1992

BSE – Bombay Stock Exchange (Sensex) – 1875 (Oldest Stock exchange of India)

OTCEI – Over the Counter Exchange of India – October, 1990

16. State two promoters of NSEI.

Ans: a) Industrial development bank of India (IDBI) b) Life insurance corporation of India (LIC)

17. How many stock exchanges are there in India?

Ans: There are 24 stock exchanges in India.

18. Name two advisory committees set up by SEBI.

Ans: a) Primary market Advisory committee. b) Secondary market advisory committee.

19. What is price rigging?

Ans: It refers to the manipulation of prices of the securities by agents/company for their own profits.

20. On what lines was OTCEI started?

Ans: It was started on the lines of NASDAQ (National Association of securities Dealers Automated Quotation)

21. Name the system where there is electronic book entry form of holding and transferring the securities.

Ans: Dematerialisation.

22. What is ‘Demutualisation of securities?’

Ans: It separates the ownership and control of stock exchanges from trading rights.

23. Name the Benchmark index of BSE.

Ans: SENSEX.

24. Stock exchange is called economic barometer.

Ans: True

25. State the segments of NSEI.

Ans: a) Wholesale debt market b) Capital market segment

26. State one development function of SEBI

Ans: to carry out research work.

27. Capital Market is the market for long term funds and money market is the market for short term funds? T/F

Ans: Given statement is true.                                     2010, 2012, 2013

28. Give some examples of Primary assets and secondary assets.

Ans: Primary assets include shares, debentures and bonds and secondary assets include mutual funds, bank deposit, insurance etc.

29. What are government securities or gilt edged securities market?

Ans: In this market, market issue gild edged securities such as TBs, Bonds and dated securities to raise money from public.

30. What is industrial securities market?

Ans: It refers to market for issue of securities for existing as well as new companies.

31. What is Sensex and Nifty?

Ans: Sensex: It is a Market Capitalisation Weighted index of 30 stocks representing a sample of large, well-established and financially sound companies. It is the oldest index in India.

Nifty: It is diversified weighted index of 50 stock from 23 sectors of the economy. It is used for benchmarking fund portfolios, index based derivatives and index funds.

LONG QUESTIONS (3/5/8 marks)

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Also Read:

1. HS 12 Banking Chapter wise Notes

2. AHSEC Class 12 Banking Question Papers From 2012 Till Date

3. AHSEC Class 12 Banking Solved Question Papers From 2012 Till Date

4. Banking Chapter wise MCQs

5. Class 12 Banking Important Questions and Question Bank

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Q.1. What is financial market? What are its components? Mention its functions.                             2015, 2019

Ans: Meaning of Financial Market: Financial market is simply a link between the savers and borrowers. It can be defined as an institution that facilitates exchange of financial instruments and credit instruments such as cheques, bills, deposits, loans, corporate stocks, government bonds, etc. The main participants of financial markets are financial institutions, agents, dealers, brokers, borrowers and savers.

According to Brigham "The place where people and organizations wanting to borrow money, are brought together, with those having surplus funds is called a financial market".

This definition makes it clear that a financial market is a place where those who need money and those who have surplus money are brought together. They may come together directly or indirectly through brokers and dealers.

Types of Financial Markets (sub-markets)                         2007, 2009, 2011, 2013, 2014

Every firms, individuals and institutions need finance for its expansion and day to day operating activities. Financial needs may be of two types – short term or long term. Based on these needs, financial markets are divided into two categories:

a) Money market – Market for short term funds (2012, 2017)

b) Capital market - Market for long term funds                (2013, 2016)

Role and Functions of financial market

a) Mobilisation of savings: Financial market encourages savings habits amongst the individuals. It mobilizes savings of savers into most appropriate uses.

b) Channelization of savings: It meets the various credit needs of the business houses by channelizing the savings of savers towards the entrepreneurs.

c) Liquidity: It provides liquidity of financial assets by providing ready market for buying and selling of securities.  Securities can be easily converted into cash in financial market.

c) Price discovery: It facilitates price discovery. Prices of securities in financial market are decided by the forces of demand and supply of financial assets in financial market.

e) Economic development: It assists in the process of economic development of a country. it helps in balanced regional and sectoral distribution of investible funds.

Q.2. What is money market (99, 02, 05, 10, 15,)? Explain its nature and functions.            2017, 2020

Ans: Money market is a place where money and short term financial assets which are close substitutes of money are traded. It mainly deals in cash or near money or liquid assets of short-term nature. It also deals in treasury bills (TBs), Commercial bills, Commercial paper (CP), ADRs, GDRs, Call and Short money market etc.

According to the RBI, "The money market is the centre for dealing mainly of short character, in monetary assets; it meets the short term requirements of borrowers and provides liquidity or cash to the lenders. It is a place where short term surplus investible funds at the disposal of financial and other institutions and individuals are bid by borrowers, again comprising institutions and individuals and also by the government."

From the above explanation, we can say that money market is a market for short term funds meant for use for a period of one year or less. The major participants of money market consist of the government, commercial banks, Life insurance companies, Mutual funds, Non-banking finance companies, stock exchange brokers etc.

Features of Money Market: The salient features of money market are as follows:  2020

a)      Flow of short-term funds: The money market brings together the lenders who have surplus funds for short-term and the borrowers who are in need of short-term funds.

b)      No fixed geographical location: There is no fix geographical location of money market. Different name is given to money market located in different areas.

c)       Participants: The major participants of money market consist of the government, commercial banks, Life insurance companies, Mutual funds, Non-banking finance companies, stock exchange brokers etc.

d)      Instruments:  It deals in money or instruments which are a close substitute of money such as treasury bills (TBs), Commercial bills, Commercial paper (CP), ADRs, GDRs, Call and Short money market etc.

e)      Sub-markets or components: Money market consists of many sub-markets such as call money market, collateral loan market, acceptance market, bill market, treasury bills market etc.

f)       Reasonable access: Money market provides reasonable access to users of short-term funds to meet their requirements on reasonable terms or rates of interest.

g)      Source of working capital: Money market constitutes a major source of working capital finance for borrowers.

Significance/Functions of Money Market

The major functions of money market are given below:

(a)    Economic Development: The money market helps in economic development of a country by providing short term funds to both public and private institutions without any discrimination.

(b)   Funds for government: Money market helps the government in borrowing short term funds at very low interest rate. This can be done by issuing treasury bills.

(c)    Return on idle funds: Money market helps the lenders to earn return on their idle or surplus funds for short period.

(d)   Implementation of Monetary Policy: Money market helps in implementing monetary policy of the central bank of any country.

(e)   Mobilisation of funds: The money market helps in transferring funds from one sector to another. The development of trade, commerce and industry depends on the mobilisation of financial resources.

(f)     Connecting link between various financial market: Money market acts as a connecting link between all the segments of financial market like capital market, foreign exchange market etc.

Q.3. Explain the various Money market instruments.  (Important for Business Studies exam only)

Ans: Money market is the short term security market. Following are the instruments dealt in money market.

a) Treasury bills: T-bills short term government security ranging from 14 days to 364 days issued by RBI on behalf of the government to meet its short-term financial needs. No fixed interest in payable on Treasury bills. Normally TBs are issued at the lowest interest rate agreed on competitive bidding. These bills are negotiable instruments and freely transferable.

b) Commercial Paper: Commercial papers are unsecured promissory notes issued by highly creditworthy companies to raise funds for short term. It usually has a maturity period of 15 days to one year. CPs are normally issued at a discount and redeemed at par.  The commercial banks and mutual funds are the main investors of commercial papers.

c) Call money and short notice money: Call money refers to money given for a very short period ranging from 1 day to 7 days. Surplus funds of the commercial banks and other institutions are usually given as call money. Banks are the borrowers as well as lenders for the call funds. If the loan is given for one day and can be called back on demand, it is called money at call but if the loan cannot be called back on demand and will require 3 days notice, it is called money at short notice. Money at short notice can be of maximum 14 days.

d) Certificate of deposit (CD): Certificate of deposit is a time deposit having a maturity period from 91 days to 12 months. CDs are issued only by a bank. It is a bearer certificate which is freely transferable and can be sold in secondary market. Banks are not allowed to discount these documents.

e) Commercial bills: These are the trade bills which are drawn at the time of credit sales by the Drawer (Supplier) and accepted by the Drawee (Debtor). It is an acknowledgment of debt normally having a maturity period of 90 days. It is a negotiable instrument and can also be endorsed from one person to another.  It can also be discounted with the bank before maturity.

Q.4. Write a brief note about the structure of Indian money market. What are its important constituents?

Ans: The Indian money market is composed of two categories of financial agencies:

a)      The Organised Sector: The sector contains will established financial instruments. The RBI at the apex is the lender of the money market and controls the banking sector. The scheduled and non-scheduled commercial banks in the private as well as public sector, foreign banks, post office savings bank and co-operative banks are parts of this sector.

b)      The Unorganised Sector: The unorganised sector contains agencies which have diverse policies, lack of uniformity and consistency in the lending business. It includes indigenous bankers, money lenders and chit funds. The indigenous bankers are known as shroffs, multanis, chettiars, etc. The unorganised sector lacks scientific organisation, being orthodox in approach, stagnant and ill-organised.

CONSTITUENTS/COMPOSITION OF INDIAN MONEY MARKET      2010, 2012, 2015, 2017, 2019

Following are the important components of the money market:

1.       Call Money Market: The call money market refers to the market for extremely short period, say one to seven days. These loans are repayable on demand or control. The borrowers are required to pay the loans as and when asked for. There is no demand for collateral securities on call money.

2.       Collateral loan market: Collateral loans are loans which are offered against collateral securities like stocks and bonds and the market is known as the collateral loan market. Collateral loan market is geographically most diversified.

3.       Acceptance market: Acceptance market refers to the market for banker’s acceptance involved in trade transactions. This market deals with banker’s acceptance which may be defined as a draft drawn by a business firm upon a bank and accepted by it. A banker is requiring to a certain sum of money to a particular party or to the bearer on a specific date both within India or abroad.

4.       Bill Market: It is a market in which short-term papers or bills are bought and sold. The most important types of short-term papers are the bills of exchange and the treasury bills. In bills of exchange market, trade bills and promissory note are traded and in treasury bills market, TBs issued by RBI on behalf of government are traded.

Q.5. What are the characteristics/Defects of Indian money market.                        2016

Ans: The distinguishing features of Indian money market are given below:           2007, 2009, 2011

1.       Existence of Unorganised Money Market: The Indian money market is dichotomized into organised and unorganised sectors. Existence of unorganised market is the major defect of Indian money market because such organised markets are not under the control of RBI.

2.       Lack of co-ordination: The Indian money market may be characterized as loose and unbalanced because there is no co-ordination between the organised and unorganised sectors.

3.       Disparity in interest rates: The rate of interest charged by the commercial banks, co-operative banks and financial institutions for the same kind of loan may be different. This was mainly due to lack of mobility of funds from one segment to another.

4.       Different lending policies: There is a wide divergence not only in the structure of interest rates, but also in the lending policies of the different financial institution.

5.       Inadequate control by the RBI: The RBI has inadequate control over the functioning of unorganised sector of the Indian money market.

6.       Instability and inelasticity: The instable and inelastic Indian money market acts as a great hindrance to the rapid economic development of the country.

7.       Lack of proper bill market: Indian traders prefer Hundies, rather than draw of bills of exchange. The reason for this is that there is no proper bill market or discount market for short term bills of exchange.

8.       No Banker’s acceptance: There is no development of banker’s acceptance or acceptance of credit by the banks in India.

9.       Banking gap: Banking facilities are inadequate in villages of India. Large commercial banks have a largely urban orientation in India.

10.   Seasonal diversity of Indian money market: Seasonal diversity is also a big problem of Indian money market. October to June is a very busy period for money market because of festive season and product of crops but the remaining period is not so busy.

Q.6. Discuss about the institutions participating in the Indian Money Market.   2012, 2013, 2015, 2017

Ans: Major Participants in the Indian Money Market is given below:

1) The Central Government: The Central Government is an issuer of Government of India Securities (G-Secs) and Treasury Bills (T-bills). These instruments are issued to finance the government as well as for managing the Government’s cash flow. T-bills and G-Secs are issued by RBI on behalf of the government to meet its short-term financial needs.

2) Commercial Banks: Commercial banks are major participants in money market. Certificate of deposits are issued by banks in money market. Then invest in government securities to maintain their statutory liquidity ratio. They also participate in call and term markets both as lenders and borrowers.

3) Life Insurance Companies: Life Insurance Companies (LICs) invest their funds in G-Sec, Bonds or short term money market instruments. They have certain pre-determined thresholds as to how much they can invest in each category of instruments.

4) Mutual Funds: Mutual funds also invest their funds in money market and debt instruments. The proportions of the funds which they can invest in any one instrument vary according to the approved investment pattern declared in each scheme.

5) Non-banking Finance Companies: Non-banking Finance Companies (NBFCs) invest their funds in debt instruments to fulfill certain regulatory requirements as well as to invest their surplus funds. NBFCs are required to invest 15% of their net worth in bonds which fulfill the SLR requirement.

Q.7. What is Capital Market? What are its components? Explain features and importance.         2014, 2016, 2020

Ans: Capital Market is generally understood as the market for long-term funds. This market supplies funds for financing the fixed capital requirement of trade and commerce as well as the long-term requirements of the Government. The long-term funds are made available through various instruments such as debentures, preference shares and equity shares. The capital market can be local, regional, national, or international. 99, 04, 08,09,11,14

The capital market is classified into two categories (Components), namely,

(i)      Primary market or new issue market, and

(ii)    Secondary market or stock exchange.

Features of Indian Capital Market                           2015, 2018

a)      Dealing in Securities: It deals in long-term marketable securities and non-marketable securities.

b)      Segments: It included both primary and secondary market. Primary market is meant for issue of fresh shares and secondary market facilitates buying and selling of second hand securities.

c)       Investors: It includes both individual investors and institutional investors such as Mutual funds, banks, Insurance companies etc. It also includes foreign institutional investors.

d)      Link between savers and investment opportunities: Capital market is a crucial link between saving and investment process. It facilitates flow of long term capital from those who have surplus capital to those who need capital.

e)      Intermediaries: It acts through intermediaries which includes bankers, brokers, underwriters etc.

f)       Government rules and regulations: The capital market operates freely but under the guidance of government policies. These market functions within the framework of government rules and regulations.

Functions and Importance of Capital Market

a)      Availability of funds: Capital market helps to raise long term funds from both domestic and as well as foreign institutional investors.

b)      Mobilization of savings: Capital market mobilizes the savings of individuals and institutions to productive channels. It facilitates flow of long term capital from those who have surplus capital to those who need capital.

c)      Industrial growth: it plays a significant role in the economic development of a country. It facilitates increase in production and productivity in the economy and hence enhances the economic welfare of the society.

d)     Stability in security prices: The Capital market tends to stabilize the values of stocks and securities and reduce the fluctuations in the price to the minimum. The process of stabilization is facilitated by providing capital to the borrowers at a lower interest rate and reducing the speculative and unproductive activities.

e)      Liquidity: It provides liquidity to investors in capital market. The securities issued through the primary market are traded in the secondary market which provides liquidity to the investors and also short-term as well as long-term yields on their investments.

f)       Promotion of economic growth: The capital market not only reflects the general conditions of the economy, but also smoothens and accelerates the process of economic growth. Various institutions of the capital market allocate the resources rationally in accordance with the development needs of the country.

g)      Balance between demand and supply: It bring about balance between demand and supply of capital by creating a link between those who demand capital and those who supply capital.

h)      Attracting foreign capital: Capital market helps in attracting foreign investments. The Indian capital market provides the channel through which foreign institutional investors and NRIs ca invest their funds in the securities of Indian companies.

Q.8. Distinguish between Capital market and Money market.    09, 12, 14, 15, 2016, 2019

Ans: Difference between capital market and money market

Q.9. What is primary and secondary market (Stock Exchange – 2015)? State four differences between primary market and secondary Market.

Ans: Primary market (2014,2016) which is also called new issue market represents a market where new securities i.e. shares, debentures and bonds that have never been previously issued are offered. It is a market of fresh capital. The main function of this market is to facilitate the transfer of funds from willing investors to the entrepreneurs who need funds. but with the changing time, the nature of primary market is also changing. There exist two types of primary market:

a)      Market where firms issue securities for the first time through Initial Public Offer (IPO).

b)      Market where firms which are already trading in secondary market raise additional capital through Seasoned Equity Offering (SEO).   

Secondary market also called stock exchange represents a market where existing securities i.e. shares and debentures are traded. Its main function is to create a link between the buyers and sellers of securities so that investments can change hands in the quickest and cheapest manner.

According to Securities Contract (Regulation) Act, 1956, the term stock exchange has been defined as, “an association, organisation or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities.”

Thus, a stock market is a market where dealings in the listed securities are made by the members of the exchange on their own behalf or on behalf of others.

From the above explanation it is clear that there are some differences between primary and secondary market which are given below:

Q.10. What is stock exchange? Mention its features. “Stock exchange is the barometer of the economy” In the light of the statement, discuss the functions of the stock exchange. 

Ans: STOCK EXCHANGE (2013): A stock exchange is highly organised financial market where the second hand securities can be bought and sold. Its main functions are to create a link between the buyers and sellers of securities so that investments can change hands in the quickest, cheapest and fairest manner. Under the Securities Contract (Regulation) Act, 1956, the term stock exchange has been defined as “as association, organisation or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities”.                                 2013,

FEATURES OF STOCK EXCHANGE

The important features of stock exchange are as follows –

a)      Stock exchange is a market where dealings take place in shares, debentures and bonds issued by the company’s corporations, government, etc.

b)      Only those securities could be traded that are included in the official list of stock exchange.

c)       It also deals in government securities.

d)      Stock exchange is organisation in the form of an association or a company or a body of individuals.

e)      It is a common meeting place of buyers and sellers of second hand securities.

f)       In stock exchanges, brokers serve as a link between the buyers and sellers.

g)      Stock exchanges frame their rules and regulations.

h)      The areas of operations of stock exchange or geographical jurisdiction is well defined.

i)        In India, stock exchanges operate as per guidelines issued by the Securities and Exchange Board of India.

Functions of stock exchange                      08, 09, 10, 12, 14, 2016, 2018, 2019

As the barometer measures the atmospheric pressure, the stock exchange measures the growth of the economy. It performs the following vital functions:

1.       Ready market and liquidity: Stock exchange provides a ready and continuous market where investors can convert their money into securities and securities into money easily and quickly. It provides a convenient meeting place for buyers and sellers of securities.

2.       Evaluation of securities: Stock exchange helps in determining the prices of various securities that reflect their real worth. The forces of demand and supply act freely in the stock exchange and help in the valuation of securities.

3.       Mobilisation of savings: Stock exchange helps in mobilising surplus funds of individuals and institutions for investment in securities. In the absence of facilities for quick and profitable disposal of securities, such funds may remain idle.

4.       Capital formation: Stock exchange not only mobilises the existing savings but also induces the public to save money. It provides avenue for investment in various securities which yield higher returns. It helps in allocation of available funds into the most productive channels.

5.       Regulation of corporate sector: Stock exchanges frame their rules and regulations. Every company which wants its securities to be dealt in at the stock exchange has to follow the rules framed by the stock exchange in this regard.

6.       Economic barometer: Stock exchange is very sensitive barometer of business conditions in the country. Booms, depressions and other important events affect prices of securities. Price trends on the stock exchange reflect the economic climate in the country. One can easily analyse the cause of change in the business climate by the ups and downs on the stock exchange.

7.       Encourages Industrialization: The stock exchange provides capital to industry and commerce. They provide finance to the Govt.

8.       Helps government in the Policy Formulation: All the government policies have their clear reflection on the national science through stock exchange whether they are economic policies or monetary or fiscal.

Q. 11. Mention various types of operators in stock exchange.

Ans: Types of operators in Stock Exchange

1. Brokers: A broker is a member of the stock exchange who buys and sells securities on behalf of investors. He charges brokerage or commission for his services.

2. Jobber: A jobber also known as Tarawaniwala is a member of the stock exchange who is specialised in one type of security and buys and sells securities on his own behalf.

3. Bulls: A bull is a speculator who buys securities expecting higher prices in future.

4. Bears: A bear is a speculator who sells securities expecting fall in prices in near future.

5. Stag: A stag is a speculator who applies for new securities in expectation that prices will rise by the time of allotment and he can sell them at premium.

Q.12. Write a brief note on foreign exchange market.   2011, 2012, 2016, 2020

Ans: Foreign Exchange Market: International transactions involve payments or receipts in currencies other than home currency of the trading countries. This results in the necessity for buying and selling of foreign exchange. The market in which currencies of different countries are bought and sold for one another is called the foreign exchange market. In other words, foreign exchange market is a market in which foreign exchange transactions take place. According to Kindle berger, “Foreign exchange market it a place where foreign money are bought and sold”. 08, 09, 12

Features of Foreign Exchange Market

a. Foreign exchange market has no geographical location.

b. It is electronically linked network.

c. The trading in the foreign exchange market is done usually 24 hours a day by telephone, display monitors, telex, fax machines and other means of communication.

d. The exchange dealers are bound by an informal code of moral conduct.

e. More transactions are based on oral communications to start with; the written documents follow later on.

TYPES OF FOREIGN EXCHANGE MARKET

There are two foreign exchange markets:

a)      Retail market: In this foreign exchange market, the individuals and firms who require foreign currency can buy it and those who have acquired foreign currency can sell it.

b)      Interbank market: In this foreign exchange market, banks who require foreign currency can buy it and those who have acquired foreign currency can sell it.

DEALERS/PARTICIPANTS IN FOREGIN EXCHANGE MARKET: Important dealers in the foreign exchange market are the following:

a)      Banks: The banks dealing in foreign exchange have branches (called exchange banks) in different countries and maintain substantial foreign currency balances in these branches. These branches discount and sell foreign bills of exchange, issue bank drafts, make telegraphic transfers etc.

b)      Brokers: Banks use the services of foreign exchange brokers. Brokers act as intermediaries between the buyers and sellers of foreign exchange among banks.

c)       Acceptance houses: Acceptance house accept bills on behalf of their customers and thus help in remittance of funds.

d)      Central Banks: Central banks are the most official participants in the foreign exchange market. They enter the market both as buyers and sellers to prevent excessive fluctuations in the exchange rates.

FUNCTIONS OF FOREIGN EXCHANGE MARKET: Following are the important functions performed by the foreign exchange market:

a)      Facilitates transfer: The basic function of the foreign exchange market is to transfer purchasing power between countries i.e. to provide a platform whereby currency of one country is converted into currency of another country at the prevailing exchange rate.

b)      Facilitates credit: Foreign bills of exchange used in the international payments normally have maturity period of three to six months. The foreign exchange market performs the function of providing credit to promote foreign trade. Credit is provided on the basis of such foreign bills of exchange.

c)       Facilitates hedging: In a situation of exchange risks, the foreign exchange market performs hedging function. Hedging is the act of equating one’s assets and liabilities in a foreign currency to avoid the risk resulting from future exchanges in the value of foreign currency.

d)      Facilitates trade and investment: International trade and investment would not have been possible without the arrangements or mechanism for buying and selling foreign currency. The foreign exchange market is required to undertake import/export transactions.

Q.13. What is NBFI’s? What are its components? Mention its importance. 09, 10, 11, 12,14, 15, 16, 17, 2019, 2020

Ans: Non-Banking Financial Institutions (NBFI’s): NBFI’s include such institution such as life-insurance companies, mutual savings bank, pension funds, building societies etc. which are doing diverse business. These financial institutions are thus a heterogeneous group of financial institutions other than commercial banks and co-operative societies. They include a wide variety of financial institutions, which raise funds from the public, directly or indirectly, to lend them to ultimate spenders. The growth of NBFI’s has been much faster than that of commercial banks. The main reason for this is that, in comparison to commercial banks, NBFI’s pay higher interest ratio to the depositors and change lower interest rate from the borrowers. Thus, they are competing with the commercial bank for public savings and as sources of Loanable funds.

Broadly NBFI’s in India are classified into two groups:

(i) Organised NBFI’s

(ii) Unorganised NBFI’s

(i) Organised NBFI’s: The organised NBFI’s include development banks and other specialised institutions. Development banks are further divided into Industrial Development banks and Agricultural Development banks:

Industrial Development banks are the following: (i) Industrial Development banks of India (IDBI). (ii) Industrial Credit and Investment Co-operations of India (ICICI). (iii) Industrial Development banks of India (IDBI). (iv) Life Insurance corporation (LIC). (v) Unit Trust of India (UTI). (vi) General Insurance Corporations (GIC).

Agricultural Development banks are the following: (i) National bank for agricultural and rural development (NABARD). (ii) Land Development Bank (LDB) (ii) Unorganised NBFI’s: A number of unorganised NBF does also operate in the country. They are known as loan companies; higher purchase finance companies, chit funds etc.

(ii) Unorganised NBFIs: The unorganised non-banking financial institutions include merchant banking companies, credit rating agencies, factoring companies, leasing companies etc.

Role of indigenous and non-banking financial institution (NBFI’S)

The role and importance of non-bank financial institution is very great in the economy of India. There are playing many functions and from this function we can understand their role as importance:

a)      They are financial intermediaries as they transfer funds from the savers to the investors. Financial intermediation is economical and less expensive to both small business and small savers.

b)      Non-bank financial intermediaries play an important role in promoting savings in the country. These institutions provide a wide range of financial assets as store of value and make available expert financial services to the savers.

c)       NBFI provides highly efficient mechanism for mobilising savings. These institutions mobilise small savings and provide high liquidity of funds. These institutions enter into contract with savers and provide them various types of benefit over the long periods.

d)      The objective of NBFI’s is to earn profit by investing the mobilised savings. The borrowers can meet bigger needs for funds. The role of interest charged by financial institutions is generally lower than that charged by other lenders.

e)      Financial intermediaries in general are of great importance to the economy as a whole because they not only promote economic development in the country, but also help in the implementation of national monetary policy.

Q.14. Mention the salient features of NBFI’s. Distinguish between commercial banks and NBFI’s.           2014, 2018

Ans: The distinguish features of NBFIs are listed below:

a)      NBFI accept deposits repayable on the expiry of specified time and certain NBFI receive funds from government.

b)      The liabilities of NBFI are not accepted as money as a means of payment of debt.

c)       NBFIs deal with medium and long-term funds in the capital market.

d)      NBFIs are heterogeneous group doing diverse business in the financial system of the economy.

e)      People invest their surplus fund with NBFI for earning income rather than safety and liquidity.

f)       NBFIs supply term finance for acquiring fixed assets.

g)      Mobilisation of savings by the NBFIs is highly affected by the interest rate. NBFI are regulated by their special statutes.

Difference between commercial bank and NBFI’s