Dibrugarh University b.Com 6th Sem: Indian Financial System Solved Papers (May' 2015)

1. Answer the following as directed:                                                                                       1x8=8

a) Rural Banking System: Rural banking in India started since the establishment of banking sector in India. Rural Banks in those days mainly focused upon the agro sector. Today, commercial banks and Regional Rural Banks in India are penetrating every corner of the country are extending a helping hand in the growth process of the rural sector in the country.

Rural banking institutions are playing a very important role for all round development of rural areas of the country. In order to support the rural banking sector in recent years. Regional Rural Banks have been set up all over the country with the objective of meeting the credit needs of the most under privileged sections of the society. These regional rural banks have been receiving a high degree of importance and attention in the rural credit system.

The regional banks where established in 1975 for supplementing the commercial banks and co-operative is supplying rural credit. The main objective of regional rural banks in India is to advance credit and other facilities especially to small and marginal farmers, agricultural labourers artisans and small entrepreneurs in order to develop agriculture, trade, commerce, industry and other productive activities in different rural areas of the country.

At the initial state, fine regional rural banks were established on October 2, 1975 under the sponsorship of the state Bank of India. The syndicate bank united commercial bank, Punjab National Bank and united Bank of India. The Regional Rural Banks are maintaining its special character as they are area of operation is very much limited to a definite region. They grant direct loan to rural people at a concessional rate subsidy and concessions from the Reserve Bank & Sponsoring bank. Regional Rural banks have made a commendable progress in advancing various types of loan to the weaker and under privileged sections of the rural society. In respect of credit operations, RDBS were successful in identifying the target groups and also in meeting their credit requirements.

b) Functions of New Issue Market: A primary market refers to any market where new shares of stock are sold. The primary market is the entry market for companies and investors, where a company or institution that requires initial or additional capital sells its shares or financial instrument to the investors. For example, Initial Public Offering (IPO), public offer, rights issue and bond issue are done on the primary market. The primary market is also unique that the initial buyer is the only person who can exchange the securities for funds. When companies are willing to go for publicly listed on the stock exchange and wants to collect funds from general investors, they first sell their financial instrument in the primary market. Primary market is the first place for trading financial instruments including stocks and bonds.

The main function of a primary market can be divided into three service functions. They are: origination, underwriting and distribution.

1. Origination: Origination refers to the work of investigation, analysis and processing of new project proposals. Origination begins before an issue is actually floated in the market. The function of origination is done by merchant bankers who may be commercial banks, all India financial institutions or private firms.

2. Underwriting: When a company issues shares to the public it is not sure that the whole shares will be subscribed by the public. Therefore, in order to ensure the full subscription of shares (or at least 90%) the company may underwrite its shares or debentures. The act of ensuring the sale of shares or debentures of a company even before offering to the public is called underwriting. It is a contract between a company and an underwriter (individual or firm of individuals) by which he agrees to undertake that part of shares or debentures which has not been subscribed by the public. The firms or persons who are engaged in underwriting are called underwriters.

3. Distribution: This is the function of sale of securities to ultimate investors. This service is performed by brokers and agents. They maintain a direct and regular contact with the ultimate investors.

c) Call Money Market: Call/Notice money is an amount borrowed or lent on demand for a very short period. If the period is more than one day and up to 14 days it is called 'Notice money' otherwise the amount is known as Call money' and market where these money are lent or borrowed are called call money market. No collateral security is required to cover these transactions.

Features of Call Money market:

d) Commercial Paper: Commercial papers (CPs) is negotiable short-term unsecured promissory notes with fixed maturities, issued by well rated companies generally sold on discount basis. Companies can issue CPs either directly to the investors or through banks / merchant banks (called dealers). These are basically instruments evidencing the liability of the issuer to pay the holder in due course a fixed amount (face value of the instrument) on the specified due date. These are issued for a fixed period of time at a discount to the face value and mature at par.

Types of Debt Funds

Types of Equity Funds

Types of Hybrid Funds

Ans: Meaning and definition of financial system:

The financial system is possibly the most important institutional and functional vehicle for economic transformation. Finance is a bridge between the present and the future and whether the mobilization of savings or their efficient, effective and equitable allocation for investment, it the access with which the financial system performs its functions that sets the pace for the achievement of broader national objectives.

According to Christy, the objective of the financial system is to “supply funds to various sectors and activities of the economy in ways that promote the fullest possible utilization of resources without the destabilizing consequence of price level changes or unnecessary interference with individual desires.”

According to Robinson, the primary function of the system is “to provide a link between savings and investment for the creation of new wealth and to permit portfolio adjustment in the composition of the existing wealth.

A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the deficit. It is a composition of various institutions, markets, regulations and laws, practices, money manager analyst, transactions and claims and liabilities.

Elements or Structure of Indian Financial System

The formal financial system comprises financial institutions, financial markets, financial instruments and financial services. These constituents or components of Indian financial system may be briefly discussed as below:

A. Financial Institutions: Financial institutions are the participants in a financial market. They are business organizations dealing in financial resources. They collect resources by accepting deposits from individuals and institutions and lend them to trade, industry and others. They buy and sell financial instruments. They generate financial instruments as well. They deal in financial assets. They accept deposits, grant loans and invest in securities.

On the basis of the nature of activities, financial institutions may be classified as: (a) Regulatory and promotional institutions, (b) Banking institutions, and (c) Non-banking institutions.

1. Regulatory and Promotional Institutions: Financial institutions, financial markets, financial instruments and financial services are all regulated by regulators like Ministry of Finance, the Company Law Board, RBI, SEBI, IRDA, Dept. of Economic Affairs, Department of Company Affairs etc. The two major Regulatory and Promotional Institutions in India are Reserve Bank of India (RBI) and Securities Exchange Board of India (SEBI). Both RBI and SEBI administer, legislate, supervise, monitor, control and discipline the entire financial system.

2. Banking Institutions: Banking institutions mobilise the savings of the people. They provide a mechanism for the smooth exchange of goods and services. They extend credit while lending money. They not only supply credit but also create credit. There are three basic categories of banking institutions. They are commercial banks, co-operative banks and developmental banks.

3. Non-banking Institutions: The non-banking financial institutions also mobilize financial resources directly or indirectly from the people. They lend the financial resources mobilized. They lend funds but do not create credit. Companies like LIC, GIC, UTI, Development Financial Institutions, Organisation of Pension and Provident Funds etc. fall in this category.

B. Financial Markets: Financial markets are another part or component of financial system. Efficient financial markets are essential for speedy economic development. It facilitates the flow of savings into investment. Financial markets bridge one set of financial intermediaries with another set of players. Financial markets are the backbone of the economy. This is because they provide monetary support for the growth of the economy.

Classification of Financial Markets: There are different ways of classifying financial markets. There are mainly five ways of classifying financial markets.

1. Classification on the basis of the type of financial claim: On this basis, financial markets may be classified into debt market and equity market.

Debt market: This is the financial market for fixed claims like debt instruments.

Equity market: This is the financial market for residual claims, i.e., equity instruments.

2. Classification on the basis of maturity of claims: On this basis, financial markets may be classified into money market and capital market.

Money market: A market where short term funds are borrowed and lend is called money market. It deals in short term monetary assets with a maturity period of one year or less. Liquid funds as well as highly liquid securities are traded in the money market. Examples of money market are Treasury bill market, call money market, commercial bill market etc.

Capital market: Capital market is the market for long term funds. This market deals in the long term claims, securities and stocks with a maturity period of more than one year.

3. Classification on the basis of seasoning of claim: On this basis, financial markets are classified into primary market and secondary market.

Primary market: Primary markets are those markets which deal in the new securities. Therefore, they are also known as new issue markets.

Secondary market: Secondary markets are those markets which deal in existing securities. Existing securities are those securities that have already been issued and are already outstanding. Secondary market consists of stock exchanges.

4. Classification on the basis of structure or arrangements: On this basis, financial markets can be classified into organised markets and unorganized markets.

Organised markets: These are financial markets in which financial transactions take place within the well established exchanges or in the systematic and orderly structure.

Unorganised markets: These are financial markets in which financial transactions take place outside the well established exchange or without systematic and orderly structure or arrangements.

5. Classification on the basis of timing of delivery: On this basis, financial markets may be classified into cash/spot market and forward / future market.

Cash / Spot market: This is the market where the buying and selling of commodities happens or stocks are sold for cash and delivered immediately after the purchase or sale of commodities or securities.

Forward/Future market: This is the market where participants buy and sell stocks/commodities, contracts and the delivery of commodities or securities occurs at a pre-determined time in future.

6. Other types of financial market: Apart from the above, there are some other types of financial markets. They are foreign exchange market and derivatives market.

Foreign exchange market: Foreign exchange market is simply defined as a market in which one country’s currency is traded for another country’s currency.

Derivatives market: It is a market for derivatives. The important types of derivatives are forwards, futures, options, swaps, etc.

C. Financial Instruments (Securities): Financial instruments are the financial assets, securities and claims. They may be viewed as financial assets and financial liabilities. Financial assets represent claims for the payment of a sum of money sometime in the future (repayment of principal) and/or a periodic payment in the form of interest or dividend. Financial liabilities are the counterparts of financial assets. They represent promise to pay some portion of prospective income and wealth to others. Financial assets and liabilities arise from the basic process of financing.

D. Financial Services: The development of a sophisticated and matured financial system in the country, especially after the early nineties, led to the emergence of a new sector. This new sector is known as financial services sector. Its objective is to intermediate and facilitate financial transactions of individuals and institutional investors. The financial institutions and financial markets help the financial system through financial instruments. The financial services include all activities connected with the transformation of savings into investment. Important financial services include lease financing, hire purchase, instalment payment systems, merchant banking, factoring, forfaiting etc.

Or

Ans:  Meaning and definition of financial system:

The financial system is possibly the most important institutional and functional vehicle for economic transformation. Finance is a bridge between the present and the future and whether the mobilization of savings or their efficient, effective and equitable allocation for investment, it the access with which the financial system performs its functions that sets the pace for the achievement of broader national objectives.

According to Christy, the objective of the financial system is to “supply funds to various sectors and activities of the economy in ways that promote the fullest possible utilization of resources without the destabilizing consequence of price level changes or unnecessary interference with individual desires.”

According to Robinson, the primary function of the system is “to provide a link between savings and investment for the creation of new wealth and to permit portfolio adjustment in the composition of the existing wealth.

A financial system or financial sector functions as an intermediary and facilitates the flow of funds from the areas of surplus to the deficit. It is a composition of various institutions, markets, regulations and laws, practices, money manager analyst, transactions and claims and liabilities.

The features of a financial system are as follows

1. Financial system provides an ideal linkage between depositors and investors, thus encouraging both savings and investments.

2. Financial system facilitates expansion of financial markets over space and time.

3. Financial system promotes efficient allocation of financial resources for socially desirable and economically productive purposes.

4. Financial system influences both the quality and the pace of economic development.

Even though Indian financial system is more developed today, it suffers from certain weaknesses. These may be briefly stated below:

1. Lack of co-ordination among financial institutions: There are a large number of financial intermediaries. Most of the financial institutions are owned by the government. At the same time, the government is also the controlling authority of these institutions. As there is multiplicity of institutions in the Indian financial system, there is lack of co-ordination in the working of these institutions.

2. Dominance of development banks in industrial finance: The industrial financing in India today is largely through the financial institutions set up by the government. They get most of their funds from their sponsors. They act as distributive agencies only. Hence, they fail to mobilise the savings of the public. This stands in the way of growth of an efficient financial system in the country.

3. Inactive and erratic capital market: In India, the corporate customers are able to raise finance through development banks. So, they need not go to capital market. Moreover, they do not resort to capital market because it is erratic and inactive. Investors too prefer investments in physical assets to investments in financial assets.

4. Unhealthy financial practices: The dominance of development banks has developed unhealthy financial practices among corporate customers. The development banks provide most of the funds in the form of term loans. So there is a predominance of debt in the financial structure of corporate enterprises. This predominance of debt capital has made the capital structure of the borrowing enterprises uneven and lopsided. When these enterprises face financial crisis, the financial institutions permit a greater use of debt than is warranted. This will make matters worse.

5. Monopolistic market structures: In India some financial institutions are so large that they have created a monopolistic market structures in the financial system. For instance, the entire life insurance business is in the hands of LIC. The weakness of this large structure is that it could lead to inefficiency in their working or mismanagement. Ultimately, it would retard the development of the financial system of the country itself.

6. Other factors: Apart from the above, there are some other factors which put obstacles to the growth of Indian financial system. Examples are:

a. Banks and Financial Institutions have high level of NPA.

b. Government burdened with high level of domestic debt.

c. Cooperative banks are labelled with scams.

d. Investors confidence reduced in the public sector undertaking etc.,

e. Financial illiteracy.

Ans: Sources of Funds for commercial bank

Whatever the funds raised by commercial banks should be properly channelized into investment earning asset because without such earnings bank cannot survive in the long run to compute in the challenging financial market. The uses of funds are as follows:

                Besides these securities, banks also invest in fixed deposits, units and capital of various financial institutions. However, amongst all these, a marked preference of the banker is noted in favour of government and semi-government securities. Investment by banks in these securities constitutes the “third line of defence” of the banks.

(i) Cash Credit: Cash Credit is a type of advance wherein a banker permits his customer to borrow money upto a particular limit by a bond of credit with one or more securities. The advantage associated with this system is that a customer can withdrawn money as and when required. The bank will charge interest only on the actual amount withdrawn by the customer. Many industrial concerns and business houses borrow money in this form.

(ii) Overdraft: An overdraft is an arrangement by which the customer is allowed to overdraw his account. It is granted against some collateral securities. The facility to overdraw is allowed through current account only. Interest is charged on the exact amount of overdrawn subject to the payment of minimum amount by way of interest.

(iii) Loan: Loan is an advance in lump sum amount the whole of which is withdrawn and is supported to be rapid generally wholly at one time. It is made with or without security. It is given for a fixed period at in agreed rate of interest. Repayments may be made in installments or at the expiry of a certain period.

(iv) Discounting Bill of Exchange: The bank also gives advances to their customers by discounting their bills. The net amount after deducting the amount of discount is credited to the account of customer. The bank may discount the bills with or without any security from the debtor in addition to the personal security of one or more person already liable on the bill.

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Ans:  The Indian Government has introduced many Economic Reforms in India since 1991. In 1990-91 India had to face grave economic problem. India was facing serious deficiency in her foreign trade balance and it was increasing. The foreign exchange stock was also decreasing. In 1990 and 1991 the government of India had to take huge amount of loan from the IMF as compensatory financial facility. At the same time, India was also suffering from inflation, the rate of which was 12% by 1991. To get relief from such a grave problem the government of India had only two ways before it. One was to take foreign debt and to create favorable conditions within the country for increasing the flow of foreign exchange and also to increase the volume of export. The other was to establish fiscal discipline within the country and to make structural adjustment for the purpose. For this purpose, the govt. of India adopted the LPG mode to revive economy from this financial crisis.

The role of banks in India has changed a lot since economic reforms of 1991. These changes came due to LPG, i.e. liberalization, privatization and globalization policy being followed by GOI. Since then most traditional and outdated concepts, practices, procedures and methods of banking have changed significantly. Today, banks in India have become more customer-focused and service-oriented than they were before 1991. They now also give a lot of importance to their rural customers. They are even willing ready to help them and serve regularly the banking needs of country-side India.

The changing role of banks in India can be glanced in points depicted below:

1. Better Customer Service: Before 1991, the overall service of banks in India was very poor. There were very long queues (lines) to receive payment for cheques and to deposit money. In those days, some bank staffs were very rude to their customers. However, all this changed remarkably after Indian economic reforms of 1991.

Banks in India have now become very customer and service focus. Their service has become quick, efficient and customer-friendly. This positive change is mostly due to rising competition from new private banks and initiation of Ombudsman Scheme by RBI.

2. Foreign Currency Exchange: Banks deal with foreign currencies. As the requirement of customers, banks exchange foreign currencies with local currencies, which is essential to settle down the dues in the international trade.

3. Consultancy: Modern commercial banks are large organizations. They can expand their function to consultancy business. In this function, banks hire financial, legal and market experts who provide advice to customers in regarding investment, industry, trade, income, tax etc.

4. Bank Guarantee: Customers are provided the facility of bank guarantee by modern commercial banks. When customers have to deposit certain fund in governmental offices or courts for a specific purpose, a bank can present itself as the guarantee for the customer, instead of depositing fund by customers.

5. Bank on Wheels: The 'Bank on Wheels' scheme was introduced in the North-East Region of India. Under this scheme, banking services are made accessible to people staying in the far-flung (remote) areas of India. This scheme is a generous attempt to serve banking needs of rural India.

6. Credit cards: A credit card is cards that allow their holders to make purchases of goods and services in exchange for the credit card’s provider immediately paying for the goods or service, and the card holder promising to pay back the amount of the purchase to the card provider over a period of time, and with interest.

7. ATMs Services: ATMs replace human bank tellers in performing basic banking functions such as deposits, withdrawals, account inquiries. Key advantages of ATMs include:

8. Debit cards: Debit cards are used to electronically withdraw funds directly from the cardholders’ accounts. Most debit cards require a Personal Identification Number (PIN) to be used to verify the transaction.

9. Home banking: Home banking is the process of completing the financial transaction from one’s own home as opposed to utilizing a branch of a bank. It includes actions such as making account inquiries, transferring money, paying bills, applying for loans, directing deposits.

10. Online banking: Online banking is a service offered by banks that allows account holders to access their account data via the internet. Online banking is also known as “Internet banking” or “Web banking.”

Online banking through traditional banks enable customers to perform all routine transactions, such as account transfers, balance inquiries, bill payments, and stop-payment requests, and some even offer online loan and credit card applications. Account information can be accessed anytime, day or night, and can be done from anywhere.

11. Mobile Banking: Mobile banking (also known as M-Banking) is a term used for performing balance checks, account transactions, payments, credit applications and other banking transactions through a mobile device such as a mobile phone or Personal Digital Assistant (PDA),

12. Accepting Deposit: Accepting deposit from savers or account holders is the primary function of a bank. Banks accept deposit from those who can save money but cannot utilize in profitable sectors. People prefer to deposit their savings in a bank because by doing so, they earn interest.

13. Priority banking: Priority banking can include a number of various services, but some of the popular ones include free checking, online bill pay, financial consultation, and information.

14. Private banking: Personalized financial and banking services that are traditionally offered to a bank’s rich, high net worth individuals (HNWIs). For wealth management purposes,

HNWIs have accrued far more wealth than the average person, and therefore have the means to access a larger variety of conventional and alternative investments. Private Banks aim to match such individuals with the most appropriate options.

Ans: The instruments used by the central Bank for controlling the supply of bank money are classified into two categories namely

When the central bank wants to bring about a reduction in bank credit, it raises the bank rate. The effect is that the commercial banks raise the market rate in order to retain their profit margin. Rise in the market rate brings about a reduction in the volume of bills offered by the customers to the commercial banks. If the volume of bills is less, the amount of money going out from the commercial banks to the people is less i.e.: the supply of money is less.

If the central bank wants to bring about an expansion of Bank credit it lowers the bank rate. The commercial banks can lower the market rate due to which the people offer more bills for discounting and the supply of money increases.

When it wants to bring about a reduction of credit, it increases the SLR. The commercial banks have to invest a larger part of their deposits in government bonds. To that extent they are left with less cash for advancing loans that puts a brake on their capacity to extend credit.

c)       Moral suasion: The central bank interacts with the commercial banks and urges them to adopt a particular credit policy. The commercial banks accept the policy suggested by the central bank because they have a respect for the central bank.

Moral suasion is better than direct action. It is preventive whereas direct action is curative. A frequent direct action taken by the central bank spoils the atmosphere between the central bank and the commercial banks. Hence as far as possible the central bank relies upon moral suasion.

d)      Consumer credit: The commercial banks advance loans to enable their customers to purchase durable costly consumer goods. The central bank can prescribe the rate of interest which they have to charge on these loans. It can also fix the installments in which the loans are to be recovered. If the rate of interest is raised and the number of installments is reduced it is difficult for the people to use them. The demand for the concerned consumer commodity falls.

e)      Publicity: The central bank of the country gives a wide publicity to its policy through its publications. The commercial banks accept that policy even when the central bank does not insist upon it. This method is also widely used by the central banks in developing countries.

Conclusion: In a developing country like India, the selective instruments are used more. They produce positive as well as negative effect. They directly bring about the desired change. They can be effective even if the country does not like a well organized money market and capital market.

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Ans: Banker’s Bank: The Reserve Bank of India serves as a banker to the scheduled commercial banks in India. It performs this function in three capacities:

Ans: Merchant bankers are body corporate who engaged in issue of securities. It acts as manager or advisor or consultant to issuing company. A merchant banker requires compulsory registration under the regulation 3 of SEBI (Merchant Bankers) Regulations, 1992. These activities mainly includes determining the composition of capital structure, compliance with procedural formalities , appointment of registration , listing of securities, arrangement of underwriting , selection of brokers and bankers, publicity and advertisement agent , private placement of securities, advisory services, etc.

Following other services are provided by merchant bankers.

1. Corporate counseling: Corporate counseling covers entire field of merchant banking viz project counseling, capital restructuring, project management, loan syndication, working capital, lease financing, portfolio management, underwriting etc. Such counseling is provided to corporate and client units to solve their problems.

2. Project Counseling: Which includes preparing project reports, finance for cost of project, appraising projects from the angle of technical, commercial and financial viability, Getting approval of project from bank/Govt and other agencies & Planning for public issue.

3. Loan Syndication: Arranging loan for big projects not only from one bank or financial institution but from more than one bank or financial institution as amount of loan is very large.

4. Underwriting of public issue: Underwriting is a guarantee given by the underwriter that in the event of under subscription, the amount would be provided by him to the extent of under subscription. All public issues are to be underwritten fully. Merchant banks provide such service of underwriting pubic issue subject to some limitations.

5. Managers, Consultants or advisors to the issue: Managers to the issue assist in drafting of prospectus, application forms and completion of formalities under companies act, appointment of Registrar for dealing with share applications, transfer and listing of shared with stock exchange.

6. Portfolio Management: It refers to investments in different kinds of securities such as shares, debentures, bonds issued by different companies and securities issued by the Govt. Merchant bankers advise about mix of investments a company should follow to ensure maximum return with minimum risk and for this purpose merchant makers have to make a careful study of Govt. policies, capital market as well as financial position of companies.

7. Corporate restructuring: Merchant bankers are also advising companies ;about corporate restructuring including merger, acquisition, takeovers etc.

8. Off-share financing: Merchant bankers are also arranging foreign currency, foreign loans, foreign collaborations, financing exports imports etc.

9. Technical assistance: Merchant bankers are also providing services on technical aspects such as technological up gradation, modernization of industries etc.

10. Revival package for sick units: Merchant bankers are also liaisoning with Board of Industrial and Financial Reconstruction (BIFR) and industrial Reconstruction Bank of India (IRBI) and such helping their clients in this regard also.

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Ans: Stock exchange is a specific place, where trading of the securities, is arranged in an organized method. In simple words, it is a place where shares, debentures and bonds (securities) are purchased and sold. The term securities include equity shares, preference shares, debentures, government bonds, etc. including mutual funds.

According to the Securities Contracts (Regulation) Act 1956, the term 'stock exchange' is defined as ''An association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling of business in buying, selling and dealing in securities."        

Husband and Dockerary have defined stock exchange as: "Stock exchanges are privately organized market which are used to facilitate trading in securities."

In simple Words, a stock exchange provides a platform or mechanism to, the investors - individuals or institutions to purchase or sell the securities of the companies, Government or semi Government institutions. It is like a commodity market where securities are bought and sold. It is an important constituent of capital market.

From the above discussion, we get the following important features of a stock exchange:

Presence and vibrant functioning of a stock exchange is necessary for a developing economy. It reflects healthy financial and investment conducive atmosphere in the economy. The Indian securities market is considered as one of the most promising emerging markets. It is one of the top eight markets of the world. The stock exchange plays a vital role in the process of raising resources for the development of corporate sector. In the absence of the stock exchange it would be impossible for private enterprises, industries and entrepreneurs to survive and grow. A stock exchange plays a significant role in a capital market which are mentioned below:

Ans: With the growth in the dealings of stock markets, lot of malpractices also started in stock markets such as price rigging, ‘unofficial premium on new issue, and delay in delivery of shares, violation of rules and regulations of stock exchange and listing requirements. Due to these malpractices the customers started losing confidence and faith in the stock exchange. So government of India decided to set up an agency or regulatory body known as Securities Exchange Board of India (SEBI).

It was left as a watch dog to observe the activities but was found ineffective in regulating and controlling them. As a result in May 1992, SEBI was granted legal status. SEBI is a body corporate having a separate legal existence and perpetual succession.

SEBI was set up with the main purpose of keeping a check on malpractices and protect the interest of investors. It was set up to meet the needs of three groups.

1. Issuers: For issuers it provides a market place in which they can raise finance fairly and easily.

2. Investors: For investors it provides protection and supply of accurate and correct information.

3. Intermediaries: For intermediaries it provides a competitive professional market.

Objectives of SEBI: The overall objectives of SEBI are to protect the interest of investors and to promote the development of stock exchange and to regulate the activities of stock market. The objectives of SEBI are:

1. To regulate the activities of stock exchange.

2. To protect the rights of investors and ensuring safety to their investment.

3. To prevent fraudulent and malpractices by having balance between self regulation of business and its statutory regulations.

4. To regulate and develop a code of conduct for intermediaries such as brokers, underwriters, etc.

The SEBI performs functions to meet its objectives. To meet three objectives SEBI has three important functions. These are:

i. Protective functions

ii. Developmental functions

iii. Regulatory functions.

1. Protective Functions: These functions are performed by SEBI to protect the interest of investor and provide safety of investment. As protective functions SEBI performs following functions:

(i) It Checks Price Rigging: Price rigging refers to manipulating the prices of securities with the main objective of inflating or depressing the market price of securities. SEBI prohibits such practice because this can defraud and cheat the investors.

(ii) It Prohibits Insider trading: Insider is any person connected with the company such as directors, promoters etc. These insiders have sensitive information which affects the prices of the securities. This information is not available to people at large but the insiders get this privileged information by working inside the company and if they use this information to make profit, then it is known as insider trading. SEBI keeps a strict check when insiders are buying securities of the company and takes strict action on insider trading.

(iii) SEBI prohibits fraudulent and Unfair Trade Practices: SEBI does not allow the companies to make misleading statements which are likely to induce the sale or purchase of securities by any other person.

(iv) SEBI undertakes steps to educate investors so that they are able to evaluate the securities of various companies and select the most profitable securities.

(v) SEBI promotes fair practices and code of conduct in security market by taking following steps:

(a) SEBI has issued guidelines to protect the interest of debenture-holders wherein companies cannot change terms in midterm.

(b) SEBI is empowered to investigate cases of insider trading and has provisions for stiff fine and imprisonment.

(c) SEBI has stopped the practice of making preferential allotment of shares unrelated to market prices.

2. Developmental Functions: These functions are performed by the SEBI to promote and develop activities in stock exchange and increase the business in stock exchange. Under developmental categories following functions are performed by SEBI:

(i) SEBI promotes training of intermediaries of the securities market.

(ii) SEBI tries to promote activities of stock exchange by adopting flexible and adoptable approach in following way:

(a) SEBI has permitted internet trading through registered stock brokers.

(b) SEBI has made underwriting optional to reduce the cost of issue.

(c) Even initial public offer of primary market is permitted through stock exchange.

3. Regulatory Functions: These functions are performed by SEBI to regulate the business in stock exchange. To regulate the activities of stock exchange following functions are performed:

(i) SEBI has framed rules and regulations and a code of conduct to regulate the intermediaries such as merchant bankers, brokers, underwriters, etc.

(ii) These intermediaries have been brought under the regulatory purview and private placement has been made more restrictive.

(iii) SEBI registers and regulates the working of stock brokers, sub-brokers, share transfer agents, trustees, merchant bankers and all those who are associated with stock exchange in any manner.

(iv) SEBI registers and regulates the working of mutual funds etc.

(v) SEBI regulates takeover of the companies.

(vi) SEBI conducts inquiries and audit of stock exchanges.

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Ans: A mutual fund is an institutional device through which the investors pool their funds to invest in a diversified portfolio of securities. The fund is termed as ‘mutual’ because all its return, minus its expenses are shared by the investors.

A mutual fund serves as a link between the investors and the securities market. It provides a gateway to the investors. Particularly small investors to enter into the securities market. It helps in diverting the savings of common man who have neither the time nor the money or expertise to undertake direct investment in securities market successfully, from bank deposits gold, etc to the stock market. Professionally managed mutual funds with their investment expertise helps in garnering savings of all sections of the society. They channelise these saving in corporate securities in such a way as to ensure steady return, capital appreciation and low risk.