AHSEC - Class 12: Banking Notes | Financial Market for Feb' 2022 - 23 Exam (2023)


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

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

2. What are financial assets?

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

3. What is floatation cost?

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

4. What is a zero coupon bond?

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

5. State the components of capitalmarket?

Ans: a) Primary market b) secondary market.

6. Name two buyers of Commercialpaper.

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 isperformed by the money market?

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

9. Name the instruments that aretraded in money market. 2013

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

10. Name the instruments that aretraded in capital market.

Ans: Stocks, Shares, Debentures, Bonds, GDR (Global Depositoryreceipts)

11. Name the institutions operating inthe money market.

Ans: Central Bank, Commercial banks, Non-bank financialinstitutions.

12. Name the institutions operating inthe capital market.

Ans: IDBI, IFCI, ICICI, Stock exchanges.

13. In which year NSEI and BSE wereestablished? 2015

Ans: NSEI – In 1991 and BSE – In 1875. But, NSEI was recognized in1992.

14. In which year OTCEI wasestablished?

Ans: 1990

15. Write the full form of NSEI, BSEand OTCEI. 2008

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

BSE – Bombay Stock Exchange (Sensex) – 1875 (Oldest Stock exchangeof 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) Lifeinsurance corporation of India (LIC)

17. How many stock exchanges are therein India?

Ans: There are 24 stock exchanges in India.

18. Name two advisory committees setup by SEBI.

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

19. What is price rigging?

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

20. On what lines was OTCEI started?

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

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

Ans: Dematerialisation.

22. What is ‘Demutualisation ofsecurities?’

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

23. Name the Benchmark index of BSE.


24. Stock exchange is called economicbarometer.

Ans: True

25. State the segments of NSEI.

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

26. State one development function ofSEBI

Ans: to carry out research work.

27. Capital Market is the market forlong 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 Primaryassets and secondary assets.

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

29. What are governmentsecurities or gilt edged securities market?

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

30. What is industrialsecurities market?

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

31. What is Sensex and Nifty?

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

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

LONG QUESTIONS (3/5/8 marks)

Also Read:

1. HS 12 Banking Chapter wiseNotes

2. AHSEC Class 12 BankingQuestion PapersFrom 2012 Till Date

3. AHSEC Class 12Banking Solved Question PapersFrom 2012 Till Date

4. Banking Chapter wiseMCQs

5. Class 12 BankingImportant Questionsand Question Bank


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

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

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

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

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

Everyfirms, individuals and institutions need finance for its expansion and day today operating activities. Financial needs may be of two types – short term orlong term. Based on these needs, financial markets are divided into twocategories:

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 marketencourages savings habits amongst the individuals. It mobilizes savings ofsavers into most appropriate uses.

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

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

c) Price discovery: Itfacilitates price discovery. Prices of securities in financial market aredecided by the forces of demand and supply of financial assets in financialmarket.

e) Economic development:It assists in the process of economic development of a country. it helps inbalanced 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:Moneymarket is a place where money and short term financial assets which are closesubstitutes of money are traded. It mainly deals in cash or near money orliquid assets of short-term nature. It also deals in treasury bills (TBs),Commercial bills, Commercial paper (CP), ADRs, GDRs, Call and Short moneymarket etc.

Accordingto theRBI, "The money market is the centre for dealing mainly ofshort character, in monetary assets; it meets the short term requirements ofborrowers and provides liquidity or cash to the lenders. It is a place whereshort term surplus investible funds at the disposal of financial and otherinstitutions and individuals are bid by borrowers, again comprisinginstitutions and individuals and also by the government."

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

Featuresof Money Market: The salient features of money market are asfollows: 2020

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

b) No fixedgeographical 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, commercialbanks, Life insurance companies, Mutual funds, Non-banking finance companies,stock exchange brokers etc.

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

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

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

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

Significance/Functions of Money Market

The majorfunctions of money market are given below:

(a) EconomicDevelopment: The money market helps in economic development of a country byproviding short term funds to both public and private institutions without anydiscrimination.

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

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

(d) Implementationof Monetary Policy: Money market helps in implementing monetary policy of thecentral bank of any country.

(e) Mobilisationof funds: The money market helps in transferring funds from one sector toanother. The development of trade, commerce and industry depends on themobilisation of financial resources.

(f) Connectinglink between various financial market: Money market acts as a connecting linkbetween all the segments of financial market like capital market, foreignexchange market etc.

Q.3. Explain the various Money marketinstruments. (Important for BusinessStudies exam only)

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

a) Treasury bills: T-bills short termgovernment security ranging from 14 days to 364 days issued by RBI on behalf ofthe government to meet its short-term financial needs. No fixed interest inpayable on Treasury bills. Normally TBs are issued at the lowest interest rateagreed on competitive bidding. These bills are negotiable instruments andfreely transferable.

b) Commercial Paper: Commercial papers areunsecured promissory notes issued by highly creditworthy companies to raisefunds 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 themain investors of commercial papers.

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

d) Certificate of deposit (CD): Certificate ofdeposit 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 freelytransferable and can be sold in secondary market. Banks are not allowed todiscount these documents.

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

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

Ans: The Indianmoney market is composed of two categories of financial agencies:

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

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


Following are the important components of themoney market:

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

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

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

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

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

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

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

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

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

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

5.Inadequate control by the RBI: The RBI hasinadequate control over the functioning of unorganised sector of the Indianmoney market.

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

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

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

9.Banking gap: Banking facilities are inadequatein villages of India. Large commercial banks have a largely urban orientationin India.

10.Seasonal diversity of Indian money market:Seasonal diversity is also a big problem of Indian money market. October toJune is a very busy period for money market because of festive season andproduct 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 theIndian 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 thegovernment as well as for managing the Government’s cash flow. T-billsand G-Secs are issued by RBI on behalf of the government to meet its short-termfinancial needs.

2) Commercial Banks: Commercial banks aremajor participants in money market. Certificate of deposits are issued by banksin money market. Then invest in government securities to maintain theirstatutory liquidity ratio. They also participate in call and term markets bothas lenders and borrowers.

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

4) Mutual Funds: Mutualfunds also invest their funds in money market and debt instruments. Theproportions of the funds which they can invest in any one instrument varyaccording 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 tofulfill certain regulatory requirements as well as to invest their surplusfunds. NBFCs are required to invest 15% of their net worth in bonds whichfulfill the SLR requirement.

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

Ans: CapitalMarket is generally understood as the market for long-term funds. This marketsupplies funds for financing the fixed capital requirement of trade andcommerce as well as the long-term requirements of the Government. The long-termfunds 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 twocategories (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 inSecurities: It deals in long-term marketable securities and non-marketablesecurities.

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

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

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

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

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

Functions and Importanceof Capital Market

a)Availability of funds: Capital market helps toraise long term funds from both domestic and as well as foreign institutionalinvestors.

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

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

d)Stability in security prices: The Capitalmarket tends to stabilize the values of stocks and securities and reduce thefluctuations in the price to the minimum. The process of stabilization isfacilitated by providing capital to the borrowers at a lower interest rate andreducing the speculative and unproductive activities.

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

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

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

h)Attracting foreign capital: Capital markethelps in attracting foreign investments. The Indian capital market provides thechannel through which foreign institutional investors and NRIs ca invest theirfunds in the securities of Indian companies.

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

Ans: Difference between capital market and money market

Basis of Distinction

Capital Market

Money Market

1) Period

Capital market is a market for medium and long term funds.

Money market is a market for short term funds.

2) Constituents

These include new issue market, stock market, stock brokers and intermediaries.

These include call money market, bill market and discounting market.

3) Participants

Individual and institutional investors operate in the capital market.

Only the institutional investors operate in the money market.

4) Instruments

The instruments in the capital market include shares, debentures, bonds etc.

Trade bills, certificate of deposits, commercial papers etc. are the instruments of money market.

5) Liquidity

The instruments of capital market always take time to convert into cash.

The instruments of money market have very high degree of liquidity.

6) Safety

Investments are unsecured due to high volatility in market.

Investments are safe as compared to capital market.

7) Regulation

Capital market is primarily regulated by the Securities and Exchange Board of India (SEBI)

Money market is regulated by the Reserve Bank of India (RBI)

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

Ans: Primary market (2014,2016) which is also called new issuemarket represents a market where new securities i.e. shares, debentures andbonds that have never been previously issued are offered. It is a market offresh capital. The main function of this market is to facilitate the transferof funds from willing investors to the entrepreneurs who need funds. but withthe changing time, the nature of primary market is also changing. There existtwo types of primary market:

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

b) Marketwhere firms which are already trading in secondary market raise additionalcapital through Seasoned Equity Offering (SEO).

Secondary market also called stock exchangerepresents a market where existing securities i.e. shares and debentures aretraded. Its main function is to create a link between the buyers and sellers ofsecurities so that investments can change hands in the quickest and cheapestmanner.

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, establishedfor the purpose of assisting, regulating and controlling business in buying,selling and dealing in securities.”

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

From the above explanation it is clear thatthere are some differences between primary and secondary market which are givenbelow:


Primary Market

Secondary Market

1. Meaning

It is the market where the securities are issued for the first time. It is also referred as New issue market.

It is the market where the existing securities are traded. It is also called stock Exchange.

2. Price determination

The prices of the securities are determined by the company.

The prices of the securities are determined by the forces of demand and supply of the securities.

3. Buying and selling

Here, only buying of the securities take place.

Here, buying and selling of the securities, both take place.

4. Participants

Securities are sold by the company directly to the investors.

Securities are traded by the investors. Company is not involved in trading.

5. Purpose

Purpose of primary market is to provide capital for setting new business.

The main purpose of secondary market is to provide liquidity to the investors.

6. Capital formation

Primary market promotes capital formation directly.

Capital market promotes capital formation indirectly.

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

Ans: STOCK EXCHANGE (2013):A stock exchange is highly organised financial market where the second handsecurities can be bought and sold. Its main functions are to create a linkbetween the buyers and sellers of securities so that investments can changehands in the quickest, cheapest and fairest manner. Under the SecuritiesContract (Regulation) Act, 1956, the term stock exchange has been defined as“as association, organisation or body of individuals, whether incorporated ornot, established for the purpose of assisting, regulating and controllingbusiness in buying, selling and dealing in securities”. 2013,


The important features of stock exchange areas follows –

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

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

c)It also deals in government securities.

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

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

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

g)Stock exchanges frame their rules andregulations.

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

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

Functionsof stock exchange 08,09, 10, 12, 14, 2016, 2018, 2019

As the barometer measures the atmosphericpressure, the stock exchange measures the growth of the economy. It performsthe following vital functions:

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

2.Evaluation of securities: Stock exchange helpsin 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 inthe valuation of securities.

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

4.Capital formation: Stock exchange not onlymobilises the existing savings but also induces the public to save money. Itprovides avenue for investment in various securities which yield higherreturns. It helps in allocation of available funds into the most productivechannels.

5.Regulation of corporate sector: Stockexchanges frame their rules and regulations. Every company which wants itssecurities to be dealt in at the stock exchange has to follow the rules framedby the stock exchange in this regard.

6.Economic barometer: Stock exchange is verysensitive barometer of business conditions in the country. Booms, depressionsand other important events affect prices of securities. Price trends on thestock exchange reflect the economic climate in the country. One can easilyanalyse the cause of change in the business climate by the ups and downs on thestock exchange.

7.Encourages Industrialization: The stockexchange provides capital to industry and commerce. They provide finance to theGovt.

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

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

Ans: Typesof operators in Stock Exchange

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

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

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

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

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

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

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

Featuresof Foreign Exchange Market

a. Foreign exchange market has no geographicallocation.

b. It is electronically linked network.

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

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

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


There are two foreign exchange markets:

a) Retailmarket: In this foreign exchange market, the individuals and firms who requireforeign currency can buy it and those who have acquired foreign currency cansell it.

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

DEALERS/PARTICIPANTSIN FOREGIN EXCHANGE MARKET: Important dealers in the foreign exchangemarket are the following:

a) Banks: Thebanks dealing in foreign exchange have branches (called exchange banks) indifferent countries and maintain substantial foreign currency balances in thesebranches. These branches discount and sell foreign bills of exchange, issuebank drafts, make telegraphic transfers etc.

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

c) Acceptancehouses: Acceptance house accept bills on behalf of their customers and thushelp in remittance of funds.

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

FUNCTIONSOF FOREIGN EXCHANGE MARKET: Following are the important functionsperformed by the foreign exchange market:

a) Facilitatestransfer: The basic function of the foreign exchange market is to transferpurchasing power between countries i.e. to provide a platform whereby currencyof one country is converted into currency of another country at the prevailingexchange rate.

b) Facilitatescredit: Foreign bills of exchange used in the international payments normallyhave maturity period of three to six months. The foreign exchange marketperforms the function of providing credit to promote foreign trade. Credit isprovided on the basis of such foreign bills of exchange.

c) Facilitateshedging: In a situation of exchange risks, the foreign exchange market performshedging function. Hedging is the act of equating one’s assets and liabilitiesin a foreign currency to avoid the risk resulting from future exchanges in thevalue of foreign currency.

d) Facilitatestrade and investment: International trade and investment would not have beenpossible without the arrangements or mechanism for buying and selling foreigncurrency. The foreign exchange market is required to undertake import/exporttransactions.

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

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

Broadly NBFI’s in India are classified intotwo groups:

(i) Organised NBFI’s

(ii) Unorganised NBFI’s

(i) Organised NBFI’s: The organised NBFI’sinclude development banks and other specialised institutions. Development banksare further divided into Industrial Development banks and AgriculturalDevelopment banks:

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

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

(ii) Unorganised NBFIs: The unorganisednon-banking financial institutions include merchant banking companies, creditrating agencies, factoring companies, leasing companies etc.

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

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

a)They are financial intermediaries as theytransfer funds from the savers to the investors. Financial intermediation iseconomical and less expensive to both small business and small savers.

b)Non-bank financial intermediaries play animportant role in promoting savings in the country. These institutions providea wide range of financial assets as store of value and make available expertfinancial services to the savers.

c) NBFIprovides highly efficient mechanism for mobilising savings. These institutionsmobilise small savings and provide high liquidity of funds. These institutionsenter into contract with savers and provide them various types of benefit overthe long periods.

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

e) Financialintermediaries in general are of great importance to the economy as a wholebecause they not only promote economic development in the country, but alsohelp in the implementation of national monetary policy.

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

Ans: Thedistinguish features of NBFIs are listed below:

a) NBFIaccept deposits repayable on the expiry of specified time and certain NBFIreceive funds from government.

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

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

d) NBFIs areheterogeneous group doing diverse business in the financial system of theeconomy.

e) Peopleinvest their surplus fund with NBFI for earning income rather than safety andliquidity.

f) NBFIssupply term finance for acquiring fixed assets.

g) Mobilisationof savings by the NBFIs is highly affected by the interest rate. NBFI areregulated by their special statutes.

Differencebetween commercial bank and NBFI’s


Commercial Bank

Non-banking Financial Institution

1. Nature

Banks are homogenous group of institution doing only banking business.

NBFIs are heterogeneous group of institution doing diverse business.

2. Repayment of deposit

Commercial banks accepts deposits which are repayable on demand.

NBFIs accept deposits which are repayable on the expiry of fixed period of time.

3. Source of fund

The main sources of bank’s funds are deposits through different accounts.

NBFIs generally raise funds by selling securities and they do not provide deposit accounts facilities.

4. Cheque and ATM facility

Commercial banks provide ATM and Cheque facilities to the depositors.

NBFIs do not provide ATM and cheque facilities to the depositors

5. Period/Duration

Banks operate in the money market and deals with short term funds only.

NBFIs operate mainly in capital market and deals with medium and long-term fund.

6. Creation of money

Banks have the power to create money.

NBFIs cannot create money.

7. Debt payment

The bank deposits are accepted as a means to discharge its debt.

The liabilities of NBFIs or deposits are not accepted to discharge its debt.

8. Return

The return on bank deposits is generally lower as compared to NBFIs.

The NBFIs promise higher return to their investors to attract more funds.

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