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ASSIGNMENTS
PROGRAM: BFIA
SEMESTER-II
INSTRUCTIONS
Signature : _________________________
2
FINANCIAL MARKETS & REGULATIONS
Assignment A
Answer:
Money market: is a market for short-term, high liquid debt securities with
maturities of less than one year. It is a highly liquid market wherein
securities are bought and sold in large denominations to reduce
transaction costs. Call money market, certificates of deposit, commercial
paper, and treasury bills are the major instruments of the money market.
Money market Instruments are short-term, low risk, high liquid financial
instruments such as treasury bills, call money, notice money, certificates
of deposit, commercial paper etc.
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3) Inter-Bank Term Money: are deposits of maturity beyond 14 days.
The entry restrictions are the same as those for Call and Notice Money
except that, as per existing regulations, the specified entities are not
allowed to lend beyond 14 days.
4) Treasury Bills: is a document by which the Government borrows
money in the short term (up to one year). It is borrowing instruments of
the union Government. The Government promises to pay a stated sum
after expiry of the stated period from the date of issue (14/91/182/364
days i.e. less than one year). They are issued at a discount to the face
value, and on maturity the face value is paid to the holder. The rate of
discount and the corresponding issue price are determined at each
auction.
5) Certificate of Deposits (CDs): is a negotiable money market
instrument and issued in dematerialized form or as a usance Promissory
Note, for funds deposited at a bank or other eligible financial institution
for a specified time period. CDs are similar to traditional term deposits
but are negotiable and can be traded in the secondary market.
6) Commercial Paper (CP): is a note in evidence of the debt obligation
of the issuer. On issuing commercial paper the debt obligation is
transformed into an instrument. CP is thus an unsecured promissory
note privately placed with investors at a discount rate to face value
determined by market forces. CP is freely negotiable by endorsement and
delivery.
Answer:
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Depository participants are associates of a depository through whom the
investor will hold the beneficiary account of the investors to enable them to
trade in dematerialized shares.
Answer:
Answer:
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intended neither to create growth nor combat inflation, or tight if intended
to reduce inflation.
Within almost all modern nations, special institutions have the task of
executing the monetary policy such as the Bank of England, the
European Central Bank, Reserve Bank of India, and the Federal Reserve
System in the United States, the Bank of Japan, the Bank of Canada or
the Reserve Bank of Australia. In general, these institutions are called
central banks and often have other responsibilities such as supervising the
smooth operation of the financial system.
1) Price Stability.
2) Exchange Stability.
3) Increase in Capital Accumulation.
4) Higher Employment Level.
5) Increase in Rate of Economic Growth
All have the effect of contracting the money supply; and, if reversed,
expand the money supply. During inflation, the measures are taken to
decrease the supply of money in circulation and during deflation; the
supply of money is increased by adopting the above methods.
The primary tool of monetary policy is open market operations. This entails
managing the quantity of money in circulation through the buying and
selling of various credit instruments, foreign currencies or commodities. All
of these purchases or sales result in more or less base currency entering
or leaving market circulation.
A central bank can only operate a truly independent monetary policy when
the exchange rate is floating. If the exchange rate is pegged or managed in
any way, the central bank will have to purchase or sell foreign exchange.
These transactions in foreign exchange will have an effect on the monetary
base analogous to open market purchases and sales of government debt; if
the central bank buys foreign exchange, the monetary base expands, and
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vice versa. But even in the case of a pure floating exchange rate, central
banks and monetary authorities can at best "lean against the wind" in a
world where capital is mobile.
Answer:
There are many interest rates, and all are affected by certain underlying
economic conditions including supply of and demand for money. When
those conditions change, all rates change together. The equilibrium rate of
Interest is also determined by the forces of demand and supply in the
market.
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Economists have different theories in the forces assumed to be behind the
supply of and demand for money. Here are four of those theories: classical
theory, liquidity preference theory, loanable funds theory, and rational
expectations theory.
This theory is associated with the names of Ricardo, Hume, Fisher and
other classical economists. It is a static theory, and according to it the rate
of interest is a real phenomenon in the sense that it is determined by the
real factors. It is the supply of savings and the demand for investment that
determine the equilibrium rate of The Interest. The classical theory focused
on household savings as the primary source of the supply of money and
upon business investment as the primary demand. According to this
theory, households individuals and families change their level of
savings as interest rates change. This is because they view interest
earnings as a reward for deferring consumption. Households save more
when rates rise and save less as rates fall.
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risky securities. It arises or exists as a price or inducement for giving up
liquidity of holding money in favour of holding securities.
As interest rates rise, security prices will fall and investors will hold less
cash as they invest in the lower-priced securities. At very high interest
rates, investors will hold little cash. High interest rates are thus the
reward demanded by investors to surrender their liquidity.
Both the classical and liquidity preference theories have major limitations.
The classical theory is generally considered a long-run theory. It is not very
good at explaining short-run rate movements since it is based on savings
habits and investment productivity, factors that are believed to be slow in
changing. By contrast, liquidity preference is seen as a short-run theory,
unable to explain long-run interest rate trends, because it ignores
(implicitly holds as constant) important macroeconomic variables such as
income, investment, and price levels. In the 1960s and 1970s, a third
theory, the loanable funds theory, was developed to provide a more general
and comprehensive explanation of the base level of interest rates.
Once the dynamic assumptions are made regarding the creation of money
and credit, the following two positions of classical interest theory
necessarily need to be modified:
The aggregate supply of loanable funds is the sum of the quantity supplied
by the separate fund supplying sectors (e.g. households, business,
governments, foreign agents). Similarly, aggregate demand for loanable
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funds is the sum of the quantity demanded by the separate fund
demanding sectors.
Whenever the rate of interest is set higher than the equilibrium rate, the
financial system has a surplus of loanable funds. As a result, some
suppliers of funds will lower the interest rate at which they are willing to
lend and the demanders of funds will absorb the loanable funds surplus.
In contrast, when the rate of interest is lower than the equilibrium interest
rate, there is shortage of loanable funds in the financial system.
The rational expectations theory argues that the market for money
displays the same efficiency often ascribed to the market for securities.
Investors are rational in that they promptly and accurately assess the
meaning of any newly received information which bears upon interest
rates. Interest rates therefore reflect all publicly known information, are
always at equilibrium levels, and change promptly as new information
arrives.
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Assignment B
Answer:
Finance is the study and practice of how money is raised and used by
organizations. It is a discipline concerned with determining value and
making decisions. The finance function allocates resources, which includes
acquiring, investing, and managing resources.
Secondly, the word "system", in the term "financial system", implies a set
of complex and closely connected or interlined institutions, agents,
practices, markets, transactions, claims, and liabilities in the economy.
Christy has opined that 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
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consequence of price level changes or unnecessary interference with
individual desires."
From the above definitions, it may be said that the primary function of the
financial system is the mobilization of savings, their distribution for
industrial investment and stimulating capital formation to accelerate the
process of economic growth.
The use of a stable, widely accepted medium of exchange reduces the costs
of transactions. It facilitates trade and therefore, specialization in
production.
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Financial Markets are the mechanism enabling participants to deal in
financial claims. The markets also provide a facility in which their
demands and requirements interact to set a price for such claims. The
main organized financial markets are money market and capital market.
The first is market for short term securities while the second is a market
for long term securities with the maturity period of one year or more.
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Q: 2). What do you understand by capital market? Discuss
capital market instruments.
Answer:
The long term capital takes two forms: Equities or ordinary shares and
fixed interest capital like preference share capital or debentures.
Capital markets can be classified into primary and secondary markets. The
primary market is meant for new issues and the secondary market is a
market where outstanding issues are traded. In other words, the primary
market creates long-term instruments for borrowings, whereas the
secondary market provides liquidity through the marketability of these
instruments. The secondary market is also known as the stock market.
1) Stock Exchange.
2) Investment Trusts.
3) Insurance Companies.
4) Hire Purchase Companies.
5) Building Societies.
6) Pension Funds.
7) Commercial Banks.
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Q: 3). Discuss all the participants in a stock market.
Answer:
1) Investors
Once the formality of account opening is done, investors can put through
their transactions through their brokers terminal. The trades have to be
settled, i.e. securities delivered/received and funds paid out/received,
according to the settlement schedule (currently T+2) decided by the
exchange. Investors have to give instructions to the DP to transfer
securities from their account to that of the broker who is also a clearing
member. Or give standing instructions to receive securities if they have
bought shares. Similarly, they have to ensure that funds are available in
their bank account to settle for shares they have bought.
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2) Brokers
3) DPs
The DPs are responsible for executing the investors directions on delivery
and receipt of shares from their beneficiary account to settle the trades
done on the secondary markets.
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CASE STUDY
In April 1992, press reports indicated that there was a shortfall in the
Government Securities held by the State Bank of India. Investigations
uncovered the tip of an iceberg, later called the securities scam, involving
misappropriation of funds to the tune of over Rs. 3500 Crores8. The scam
engulfed top executives of large nationalized banks, foreign banks and
financial institutions, brokers, bureaucrats and politicians: The
functioning of the money market and the stock market was thrown in
disarray. The tainted shares were worthless as they could not be sold. This
created a panic among investors and brokers and led to a prolonged
closure of the stock exchanges along with a precipitous drop in the price of
shares. Soon after the discovery of the scam, the stock prices dropped by
over 40%, wiping out market value to the tune of Rs. 100,000 crores. TIle
normal settlement process in government securities was that the
transacting banks made payments and delivered the securities directly to
each other. The broker's only function was to bring the buyer and seller
together. During the scam, however, the banks or at least some banks
adopted an alternative settlement process similar to settlement of stock
market transactions. The deliveries of securities and payments were made
through the broker. That is, the seller handed' over the securities to the
broker who passed them on to the buyer, while the buyer gave the cheque
to the broker who then made the payment to the seller. There were two
important reasons why the broker intermediated settlement began to be
used in the government securities markets: The brokers instead of merely
bringing buyers and sellers together stfu1ed taking positions in the
market. They in a sense imparted greater liquidity to the markets.
When a bank wanted to conceal the fact. That it was doing a Ready
Forward deal, the broker came in handy. The broker provided contract
notes for this purpose with fictitious counterparties, but arranged for the
actual settlement to take place with the correct counterparty. This allowed
the broker to lay his hands on the cheque as it went from one bank to
another through him. The hurdle now was to find a way of crediting the
cheque to his account though it was drawn in favour of a bank and was
crossed account payee. It is purely a matter of banking custom that an
account payee cheque is paid only to the payee mentioned on the cheque.
In fact, privileged (Corporate) customers were routinely allowed to credit
account payee cheques in favour of a bank into their own accounts to
avoid clearing delays; thereby reducing the interest lost on the amount.
The brokers thus found a way of getting hold of the cheques as they went
from one bank to another and crediting the amounts to their accounts.
This effectively transformed an RF into a loan to a broker rather than to a
bank. But this, by itself, would not have led to the scam because the RF
after all is a secured. Loan and a secured loan to a broker is still secured.
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What was necessary now was to find a way of eliminating the security
itself.
Some banks (or rather their officials) were persuaded to part with
cheques without actually receiving securities in return. A simple
explanation of this is that the officials concerned were bribed and/or
negligent. Alternatively, as long as the scam lasted, the banks benefited
from such an arrangement. The management of banks might have been
sorely tempted to adopt this route to higher profitability.
The third method was simply to forge the securities themselves. In many
cases, PSU bonds were represented only by allotment letters rather than
certificates on security paper. However, it accounted for only a very small
part of the total funds misappropriated. During the scam, the brokers
perfected the art of using fake BRs to obtain unsecured loans from the
banking system. They persuaded some small and little known banks - the
Bank of Karad (BOK) and the Metropolitan Cooperative Bank (MCB) - to
issue BRs as and when required. These BRs could then be used to do RF
deals with other banks. The cheques in favour of BOK were, of course,
credited into the brokers' accounts. In effect, several large banks made
huge unsecured loans to the BOK/MCB which in turn made the money
available to the brokers.
Questions:
Answer:
Some of the flaws in the regulation that gave the scope of 1991 scam are
as following:
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c) Tainting of shares that were worthless(they could not sold)
d) Creation of panic among investors and brokers leading to a
prolonged closure of stock exchanges, along with a sudden drop in
the price of shares.
e) Banks adopting an alternative settlement process similar to
settlement of stock market transactions.
f) Deliveries of securities and payments were made through the
brokers
Regulation improvement
Answer:
Duty of Fair Dealing: This includes the duty to execute orders promptly,
disclosing material information (information that a brokers client would
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consider relevant as an investor), and charge prices that are in line with
competitors.
Customer Confirmation Rule: The broker must provide the investor with
certain information, at or before the execution of the order (i.e. date, time,
price, and number of shares, commission and other information).
Trading During Offerings: the Rule 101 prohibits the broker from buying
a stock that is being offered during the "quiet period" one to five days
before and up to the offering.
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Assignment C
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Q: 6). The Reserve Bank of India regulates the _______ and Securities
and Exchange Board of India (SEBI) regulates _________.
a) Money market, capital market ().
b) Capital market, Money market
c) Money market and debt market.
d) Money market and derivative market.
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d) All of the statements above are correct.
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Q: 17). Financial markets and institutions
a) Involve the movement of huge quantities of money.
b) Affect the profits of businesses.
c) Affect the types of goods and services produced in an economy.
d) Do all of the above ().
Q: 21). Three theories about the term structure of Interest rates are:-
a) The Expectations Theory, Default Premium Theory, Market
Segmentation Theory
b) Default Premium Theory, Liquidity Premium Theory, Market
Segmentation Theory
c) The Expectations Theory, Liquidity Premium Theory, Default
Premium Theory
d) The Expectations Theory, Liquidity Premium Theory,
Market Segmentation Theory ()
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IV. Serves as a banker to the government
V. Builds up and strengthens the country's financial
infrastructure
a) I, II, III, IV
b) II, III, IV, V
c) I to V ()
d) I, II, III, V
Q: 32). Bonds that allow the issuer to alter the tenor of a bond, by
redeeming it prior to the original maturity date, are called ________
bonds.
a) Callable ()
b) Puttable
c) Amortising
d) Step up
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Q: 33). An ________________ represents ownership in the shares of a
foreign company trading on US financial markets.
a) Global Depositary Receipt (or GDR)
b) Treasury Bills
c) Government Security( G-sec)
d) American Depositary Receipt (or ADR) ()
a) I, II, III, IV
b) II, III, IV, V
c) I to V ()
d) I, II, III, V
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Q: 38). Various economic variables impact the movement in exchange
rates such as:
I. Interest rates
II. Inflation figures
III. Balance of payment figures
IV. GDP( Gross domestic product)
a) I, II, III
b) I, II, III, IV ()
c) II, III, IV
d) I, III, IV
a) I, II
b) I, III
c) II, III
d) I, II, III ()
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