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Ans.

1 Role of Financial system in economic development:

The functioning of an economy depends on the financial system of a country.


The financial system includes banks as a central entity along with other financial
services providers. The financial system of a country is deeply entrenched in the
society and provides employment to a large population. According to Baily and
Elliott, there are three major functions of the financial system.
1.Savings-investment relationship
The above three major functions are important for the running and development
activities of any economy. Apart from these functions, an economy’s growth is
boosted by the savings-investment relationship. When there are sufficient
savings, only then can there be sizeable investment and production activity.
2.Growth of capital markets
Another important work of finance is to boost growth of capital markets.
Businesses need two types of capital – fixed and working. Fixed capital refers to
the money needed to invest in infrastructure such as building, plant and
machinery. Working capital refers to the money needed to run the business on a
day-to-day basis.
3.Foreign exchange markets
In order to support the export and import businessmen, there are foreign
exchange markets whereby businesses can receive and transmit funds to other
countries and in other currencies. These foreign exchange markets also enable
banks and other financial institutions to borrow or lend sums in other currencies.
Moreover, financial institutions can invest and reap profits from their short- term
idle money by investing in foreign exchange markets.
4.Government securities
Governments use the financial system to raise funds for both short term and long
-term fund requirements. Governments issue bonds and bills at attractive interest
rates and also provide tax concessions. Budget gaps are taken care of by
government securities.
5.Infrastructure and growth
The economic growth depends on the growth of infrastructural facilities of the
country. Key industries such as power, coal, oil determine the growth of other
industries. These infrastructure industries are funded by the finance system of
the country. The capital requirement for infrastructure industries is huge.
6.Infrastructure and growth
The economic growth depends on the growth of infrastructural facilities of the
country. Key industries such as power, coal, oil determine the growth of other
industries. These infrastructure industries are funded by the finance system of
the country. The capital requirement for infrastructure industries is huge.

7.Employment growth
Financial system plays a key role in employment growth in an economy.
Businesses and industries are financed by the financial systems which lead to
growth in employment and in turn increases economic activity and domestic
trade.
8.Venture capital
Increase in venture capital or investment in ventures will boost growth in
economy. Currently, the extent of venture capital in India is less. It is difficult
for individual companies to invest in ventures directly due to the risk involved.
9.Balances economic growth
The growth of different sectors of an economy is balanced through the financial
system. There are primary, secondary and tertiary sector industries and all need
sufficient funds for growth.
Ans 2. Short Capital market and Money Market:
Capital Market:

Capital markets are venues where savings and investments are channelled
between the suppliers who have capital and those who are in need of capital.
The entities who have capital include retail and institutional investors while
those who seek capital are businesses, governments, and people.

Capital markets are composed of primary and secondary markets. The most
common capital markets are the stock market and the bond market.

Capital markets seek to improve transactional efficiencies. These markets bring


those who hold capital and those seeking capital together and provide a place
where entities can exchange securities.

KEY TAKEAWAYS

 Capital markets refer to the places where savings and investments are
moved between suppliers of capital and those who are in need of capital.
 Capital markets consist of the primary market, where new securities are
issued and sold, and the secondary market, where already-issued
securities are traded between investors.
 The most common capital markets are the stock market and the bond
market.

Money Market:

The money market is the trade in short-term debt investments. At the wholesale
level, it involves large-volume trades between institutions and traders. At the
retail level, it includes money market mutual funds bought by individual
investors and money market accounts opened by bank customers.

In any case, the money market is characterized by a high degree of safety and a
relatively low return in interest.

An individual may invest in the money market by buying money market funds,
short-term certificates of deposit (CDs), municipal notes or U.S. Treasury bills,
among other examples.

Traders and institutions are more commonly the buyers for other money market
products such as euro-dollar deposits, banker's acceptances, commercial paper,
federal funds, and repurchase agreements.
KEY TAKEAWAYS

 The wholesale money market involves the purchase and sale in large
volumes of short-term debt products.
 An individual may invest in the money market by purchasing a money
market mutual fund, buying a Treasury bill, or opening a money market
account at a bank.
 Money market investments are characterized by safety and liquidity.

Ans 3. The objectives, functions and powers of SEBI.

SEBI:
The Securities and Exchange Board of India was officially appointed as the
authority for regulating the financial markets in India on 12th April 1988. It was
initially established as a non-statutory body, i.e. it had no control over anything
but later in 1992, it was declared an autonomous body with statutory powers.
SEBI Plays important role in regulating the securities market of India. Thereby
it is important to know the purpose and objective of SEBI.

Objectives of SEBI

SEBI has following objectives-

1. Protection to the investors

The primary objective of SEBI is to protect the interest of people in the stock
market and provide a healthy environment for them.

2. Prevention of malpractices

This was the reason why SEBI was formed. Among the main objectives,
preventing malpractices is one of them.
3. Fair and proper functioning

SEBI is responsible for the orderly functioning of the capital markets and keeps
a close check over the activities of the financial intermediaries such as brokers,
sub-brokers, etc.

Functions of SEBI

SEBI primarily has three functions-

1. Protective Function
2. Regulatory Function
3. Development Function

Protective Functions

As the name suggests, these functions are performed by SEBI to protect the
interest of investors and other financial participants.

It includes-

 Checking price rigging


 Prevent insider trading
 Promote fair practices
 Create awareness among investors
 Prohibit fraudulent and unfair trade practices

Regulatory Functions

These functions are basically performed to keep a check on the functioning of the
business in the financial markets.

These functions include-

 Designing guidelines and code of conduct for the proper functioning of


financial intermediaries and corporate.
 Regulation of takeover of companies
 Conducting inquiries and audit of exchanges
 Registration of brokers, sub-brokers, merchant bankers etc.
 Levying of fees
 Performing and exercising powers
 Register and regulate credit rating agency

Development Functions

SEBI performs certain development functions also that include but they are not
limited to-

 Imparting training to intermediaries


 Promotion of fair trading and reduction of malpractices
 Carry out research work
 Encouraging self-regulating organizations
 Buy-sell mutual funds directly from AMC through a broker

Powers of SEBI

1. For the discharge of its functions efficiently, SEBI has been vested with the
following powers:
2. To approve by−laws of stock exchanges.
3. To require the stock exchange to amend their by−laws.
4. To inspect the books of accounts and call for periodical returns from
recognized stock exchanges.
5. To inspect the books of accounts of financial intermediaries.
6. To compel certain companies to list their shares in one or more stock
exchanges.
7. Registration of brokers.
Ans 4.

Merchant Banking:

Merchant banking can be defined as a skill-oriented professional service


provided by merchant banks to their clients, concerning their financial needs,
for adequate consideration, in the form of fee. Merchant banks are a specialist in
international trade and thus, excel in transacting with large enterprises. It offers
a range of financial and consultancy services, to the customers, which are
related to.

Role of Merchant Banking in Issue management.


 Preparation of prospectus

 Preparation of a budget

 Preparation of (Controller of Capital Issues) CCI application

 Selection of issue house

 Appointment of registrar, broker and bankers to issue

 Advertising and arranging publicity agency for post and pre-issue.

 Selection of institutional and broker under-writers.

 Compliance of listing requirements of stock exchange etc.


Ans 5.

Venture Capital:
It is a private or institutional investment made into early-stage / start-up
companies (new ventures). As defined, ventures involve risk (having uncertain
outcome) in the expectation of a sizeable gain. Venture Capital is money
invested in businesses that are small; or exist only as an initiative, but have huge
potential to grow. The people who invest this money are called venture
capitalists (VCs). The venture capital investment is made when a venture
capitalist buys shares of such a company and becomes a financial partner in the
business.
Venture Capital investment is also referred to risk capital or patient risk capital,
as it includes the risk of losing the money if the venture doesn’t succeed and
takes medium to long term period for the investments to fructify.
Venture Capital typically comes from institutional investors and high net worth
individuals and is pooled together by dedicated investment firms.
It is the money provided by an outside investor to finance a new, growing, or
troubled business. The venture capitalist provides the funding knowing that
there’s a significant risk associated with the company’s future profits and cash
flow. Capital is invested in exchange for an equity stake in the business rather
than given as a loan.

Factoring:

Factoring is a Financial transaction and a type of debtor finance in which a


business sells its accounts receivable (i.e., invoices) to a third party (called
a factor) at a discount. A business will sometimes factor its receivable assets to
meet its present and immediate cash needs. Forfaiting is a factoring arrangement
used in international trade finance by exporters who wish to sell
their receivables to a forfeiter. Factoring is commonly referred to as accounts
receivable factoring, invoice factoring, and sometimes accounts receivable
financing. Accounts receivable financing is a term more accurately used to
describe a form of assets-based lending against accounts receivable. The
Commercial Finance Association is the leading trade association of the asset-
based lending and factoring industries.
Ans 6.
Credit rating:

A credit rating is a quantified assessment of the creditworthiness of a borrower


in general terms or with respect to a particular debt or financial obligation. A
credit rating can be assigned to any entity that seeks to borrow money — an
individual, corporation, state or provincial authority, or sovereign government.

Individuals' credit is scored from by credit bureaus such as Experian and


TransUnion on a 3-digit numerical scale using a form of Fair Isaac (FICO)
credit scoring. Credit assessment and evaluation for companies and
governments is generally done by a credit rating agency such as Standard
&Poor’s (S&P), Moody’s, or Fitch. These rating agencies are paid by the entity
that is seeking a credit rating for itself or for one of its debt issues.

Merits of credit rating:

1.Safeguards against bankruptcy:


Credit rating of an instrument done by credit rating agency gives an idea to the
investors about degree of financial strength of the issuer company which
enables him to decide about the investment.

2.Recognition of risk:
Credit rating provides investors with rating symbols which carry information in
easily recognisable manner for the benefit of investors to perceive risk involved
in investment.

3.Credibility of issuer:
Rating gives a clue to the credibility of the issuer company. The rating agency is
quite independent of the issuer company and has no “Business connections or
otherwise any relationship with it or its Board of Directors, etc.
4.Saving of resources:
Investors rely upon credit rating. This relieves investors from the botheration of
knowing about the fundamentals of a company, its actual strength, financial
standing, management details, etc.

5.Choice of investments:
Several alternative credit rating instruments are available at a particular point of
time for making investment in the capital market and the investors can make
choice depending upon their own risk profile and diversification plan.

Demerits of Credit rating:

1.Biased rating and misrepresentations:


In the absence of quality rating, credit rating is a curse for the capital market
industry, carrying out detailed analysis of the company, should have no links
with the company or the persons interested in the company so that the reports
impartial and judicious recommendations for rating committee.

2.Static study:
Rating is done on the present and the past historic data of the company and this
is only a static study. Prediction of the company’s health through rating is
momentary and anything can happen after assignment of rating symbols to the
company.

3.Concealment of material information:


Rating Company might conceal material information from the investigating
team of the credit rating company. In such cases quality of rating suffers and
renders the rating unreliable.
4.Rating is no guarantee for soundness of company:
Rating is done for a particular instrument to assess the credit risk but it should
not be construed as a certificate for the matching quality of the company or its
management. Independent views should be formed by the user public in general
of the rating symbol.

5. Human bias:
Finding off the investigation team, at times, may suffer with human bias for
unavoidable personal weakness of the staff and might affect the rating.

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