CASE Studies INDIAN FINAICIAL SYSTEM PDF

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CASE STUDIES FOR INDIAN FINANCIAL SYSTEM IMPORTANT QUESTION BEFORE EXAM...

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CASE STUDIES Question 1. A very famous article was published in a finance magazine. A portion of that article is present here: Financial market is not a usual market where you buy commodities but a special place where one can have all the necessary information about the different securities traded in the market. The buyers on the one hand get to know about the securities and they get a place where securities are sold helping reduce the wastage of time, effort and money. The financial experts say otherwise the job of the people involved in the securities transactions would have been really difficult. Securities get a buyer on the one hand and the seller on the other hand on a common platform—this helps in easy conversion of securities into cash. In the economies where there is no stock exchange the funds remain blocked. The money trapped in the houses should come out and flow in the economy and when they are invested in the shares of a company they have the capability to attain the maximum value. People would always like to sell securities on their own conditions. No government intervention can predict the price of securities. The stock market is a place which runs on the forces of demand and supply thus giving a security its price depending upon its demand. One wonders how the economy of a company can grow without the existence of financial market. Identify explain the functions of financial market discussed in the above case. Answer: The various functions of financial market highlighted in the above case are: 1. Financial market reduces the cost of transactions. The buyers on the one hand get to know about the securities and they get a place where securities are sold helping reduce the wastage of time, effort and money. 2. Financial market provides liquidity to financial assets. Securities get a buyer on the one hand and the seller on the other hand on a common platform-this helps in easy conversion of securities into cash. 3. Financial market helps in mobilization of savings and channelises them to the most productive use. The money trapped in the houses should come out and flow in the economy and when they are invested in the shares of a company they have the capability to attain the maximum value. 4. Financial market helps in facilitating price discovery of financial assets. The stock market is a place which runs on the forces of demand and supply thus giving a security its price depending upon its demand. Question 2. A bank named ‘Dhan Sangraha Karta’ allows Kapoor family to deposit their money time and again in it. It gives a definite return to this family which is in the form of interest. To get this interest the money stored in the household of Kapoor family gets entry into this bank. Nearby there is a stock exchange, Mr. Raj an Kapoor, who is the head of the family, goes there and buys securities. He says that in this way more return in earned by him on his saved money though the risk is also there. 1. Identify the process in above case performed by the bank and the stock exchange. 2. What are the roles of the bank and the stock exchange with respect to each other?

3. Name a condition for the bank to perform its role in this process. 4. Name a condition for the stock market to perform its role in this process. Answer: 1. The process performed by the bank and the stock exchange is ‘Financial Intermediation. 2. The bank and the stock exchange are competing intermediaries in the financial system. The household is making a choice between the bank and the stock exchange and this choice is given by the financial system to them. 3. The bank should provide a higher rate of return to the household saving then what it would get by lying passive in the household itself. Since the money will only decrease in value there will be no return. 4. The stock exchange will help the household invest money in a company’s security. The chances of growth of money could be highest here as the money is generally invested in companies which show the chances of the best possible growth. Question 3. These days, the development of a country is also judged by its system of transferring finance from the sector where it is in surplus to the sector where it is needed the most. To give strength to the economy, SEBI is undertaking measures to develop the capital market. In addition to this, there is another market in which unsecured and short¬term debt instruments are actively traded every day. These markets together help the savers and investors in directing the available funds into their most productive investment opportunity. 1. Name the function being performed by the market in the above case. 2. Name the market segment other than the capital market segment in which unsecured and short-term debt instruments are traded. Also, give any three points of difference between the two. Answer: 1. Allocative function. 2. Money market. Difference between Capital and Money market:

Basis

Capital-market

Money-mark

The participants are financial institutions, The participants are RBI, fin (i) Participants

banks, corporates, foreign investors and institutions, banks and corp retail investors.

Instruments traded are Treas Instruments traded are Shares, Debentures Commercial papers, Certific

(ii) Instruments and Bonds.

deposit, Call money and Co

(iii) Investment Investment outlay is small.

Investment outlay is large.

Capital Market deals in medium term and

Money market deals in shor

long-term securities.

securities.

Outlay

(iv) Duration

Capital market securities are comparatively Money market securities are (v) Liquidity less liquid.

comparatively more liquide

3. Question 4. Ramesh buys a financial asset from the RBI. This financial asset is an instrument of short term borrowing. He has bought it because he doesn’t want to take risk and wants an assured return. This instrument is a promissory note. It is highly liquid. This instrument is also known as Zero Coupon Bond. On this instrument is written T-91. 1. 2. 3. 4. 5.

Which financial asset is indicated in the above case? On whose behalf does the RBI issue this instrument? Why is this instrument called as the Zero Coupon Bond? What does T-91 denote here? What is the minimum amount for which this instrument is available?

Answer: 1. The financial asset which is indicated in the above case is ‘Treasury Bill’. 2. The RBI issues this instrument on the behalf of the Government of India. 3. The instrument is called as Zero Coupon Bond because the interest rate given by the bank is not given openly. The interest in fact comes in the form of discount which is given on the face value. The instrument is redeemed at par (on the written face value). So the instrument is issued at discount. 4. T-91 here denotes the maturity period of the Treasury bill which is here 91 days.

5. The minimum amount for which T- Bills are available is ?25,000. For a higher value it is given in the multiples of ,?25,000. Question 5. A company uses a financial instrument for bridge financing. The instrument here is short term, low risk, unsecured and highly liquid. It needed to buy machinery for which it issued equity. This turned out to be expensive as this issue involved floatation costs. The company is a large and creditworthy and this method has come up as a great help to it. 1. 2. 3. 4. 5.

Which financial instrument is indicated in the above case? Which type of instrument is this? Name the types of floatation costs which are generally involved? How has this method helped the company? Name two money market instruments which are issued at discount and redeemed at Par.

Answer: 1. The financial instrument indicated in the above case is ‘Commercial Paper’. 2. This is a money market instrument. 3. The types of floatation costs involved here are: o Brokerage. o Publishing costs. o Advertising costs. o Underwriter’s commission. 4. This method has helped the company by providing short-term funds for its seasonal and working capital needs. 5. The two money market instruments which are issued at discount and redeemed at par are: o Treasury bill o Commercial paper. Question 6. ‘Ganesh Steel Ltd.’ is a large and creditworthy company manufacturing steel for the Indian market. It now wants to cater to the Asian market and decides to invest in new hi-tech machines. Since the investment is large, it requires long-term finance. It decides to raise funds by issuing equity shares. The issue of equity shares involves huge floatation cost. To meet the expenses of floatation cost the company decides to tap the money- market. 1. Name and explain the money-market instrument the company can use for the above purpose. 2. What is the duration for which the company can get funds through this instrument? 3. State any other purpose for which this instrument can be used. Answer:

1. The company can use Commercial Paper. Commercial paper. It is a short-term unsecured promissory note which is negotiable and transferable by endorsement and delivery having a fixed maturity period. It is an instrument issued by large and creditworthy companies to raise short term funds at lower interest rates. 2. The maturity period of commercial paper is from 15 days to one year. 3. It can be used to raise short term funds for seasonal needs or to finance working capital requirements of the business. Question 7. ‘Dhan Samudra’ is a bank, which needs immediate cash. This has been the situation since the RBI chose to increase the CRR (Cash Reserve Ratio). It is looking for other banks to meet its cash requirements by borrowing from other banks in the industry. However, it resorts to a very expensive source of fund. This source of fund has an inverse relationship with other sources of funds like commercial paper and certificates of deposit. 1. 2. 3. 4.

Which financial instrument is highlighted In the above case? How does increased CRR change the cash requirements by banks? Why this financial instrument considered an expensive source of finance? What type of inverse relationship exists between this instrument and commercial paper or certificates of deposit?

Answer: 1. The financial instrument highlighted in the above case is ‘Call Money’. 2. The increase in CRR (Cash Reserve Ratio) makes a bank keep a definite amount of cash. For example, if CRR is 5% then bank will have to keep 5% of its money as the cash reserve which it will not touch. Thus the ability of the bank to give loans is reduced thus reducing liquidity in the market. 3. Call Money is considered an expensive source of finance because it is made available to the banks at a very short notice. The interest paid by the banks seeking call money is call rate. The call rate is highly volatile and changes on an hourly basis. 4. The inverse relationship which exists between call money and these instruments is that with the rise in the call money rates these sources become cheaper. So the banks have the option of raising funds from these sources in a comparatively cheaper manner. Question 8. A developmental financial institute issues a money market instrument. It is issued by the financial institute during the time of tight liquidity. This helps the firm to mobilize large amount of funds in a short period of time. 1. Which money market instrument is highlighted in the above case? 2. What are the characteristics of a money market instrument? 3. Which other type of body can issue this money market instrument? When? Answer:

1. The money market instrument which is highlighted in the above case is ‘Certificate of Deposit’. 2. A money market instrument is short-term, highly liquid, unsecured and involves low risk. 3. The other type of body which can issue certificate of deposit is ‘Commercial Bank’. It issues certificate of deposit when the deposit growth is slow and the demand for credit is high. Question 9. A business firm issues a money market instrument to finance its working capital requirements. In order to finance the credit sales of the firm it issues this instrument. A textile firm which is taking goods on credit from this firm promises to buy on the 25th of the next month. The selling business firm makes use of this instrument when the’ date arrives. 1. Which money market instrument is highlighted in the above case? 2. What is the role of commercial bank in the above process? 3. Explain the above process in detail. Answer: 1. The money market instrument which is highlighted in the above case is ‘Commercial Bill’. 2. When the trade bill is accepted by a commercial bank it becomes a commercial bill. 3. When the goods are sold on credit the buyer has to make payment on a specific date in the future. The seller now has an option either to make payment on the specified date or make use of bill of exchange. Here the seller is known as the drawer (he draws the bill) . and the buyer is known as the drawee (he accepts the bill). As soon as the bill is accepted it becomes a trade bill. These bills can be given to a bank or these bill could be discounted with the bank which makes it a commercial bill as soon as it accepts it. Here onwards the bank takes the responsibility of taking money from the buyer. The seller gets a little less than the actual value. The bills receivable are handed over to the bank. Question 10. Identify the type of financial market in the following cases: 1. The value of securities issued by a company is low. It has not set up a huge financial outlay. Mr. Manuj has purchased 100 units of shares with the value of ?8G each. Though he has small savings yet he is able to invest money in this financial market. 2. A financial market deals only in short term securities. The securities in the market may even be issued for a single day. 3. A financial market deals in medium and long term securities such as equity shares and debentures. 4. The participants in this financial market are institutions like banks, corporations, large sized companies and members of the public. 5. The securities in this financial market yield low rate of return.

6. The securities return in this market is riskier in relation to both the returns as well as principal amount. The reason is the performance of the issuing companies. When these companies perform well there are chances of high return but when the other way round happens the returns may go down and result in loss of money to the investors. 7. In this financial market there is a higher degree of liquidity of the financial instruments available to the investors as there is an institute which takes guarantee of this action. The name of this institute is DFHI (Discount Finance House of India). 8. There is minimum risk of default in this financial market. There is shorter duration of investment and this provides financial stability to the investors. The issuing houses have a very good history of creditworthiness. Answer: The type of financial market in the above mentioned cases are: 1. 2. 3. 4. 5. 6. 7. 8.

Capital Market Money Market Capital Market Capital Market Money Market Capital Market Money Market Money Market

Question 11. In the above Question 10 find the ‘basis’ on which these distinctions between ‘Capital Market’ and ‘Money Market’ have been made. Answer: 1. 2. 3. 4. 5. 6. 7. 8.

Investment Outlay Duration Duration Participants Expected return Safety Liquidity Safety

Question 12. Ramesh the CEO of a company thinks of going with the most popular method of raising funds used by the public companies. He discussed this option with his immediate subordinates. After discussion he realises that since his company is a private company he should think of some other option. Then they think of issuing the securities through intermediaries like issuing houses or stock brokers. When his nephew comes to know about his decision, he decides to suggest his uncle another way. He advises him to involve institutional investors which will help him raise funds more quickly and reduce many mandatory and non-mandatory expenses. After a lot of discussion the option suggested by his nephew is chosen as final.

1. 2. 3. 4.

In the above case identify the various methods of floatation highlighted. Which method do you think will be applicable in the primary market? In which type of capital market trading of only existing shares is done? In which type of capital market only buying of securities is possible as securities can’t be sold here? 5. Which type of capital market doesn’t have fixed geographical location? Answer: 1. The various methods of floatation highlighted in the above case are: o Offer through prospectus. Ramesh the CEO of a company thinks of going with the most popular method of raising funds used by the public companies. o Offer for sale. Then they think of issuing the securities through intermediaries like issuing houses or stock brokers. o Private placement. He advises him to involve institutional investors which will help him raise funds more quickly and many mandatory and non-mandatory expenses could be avoided. 2. The method which will be applicable in the primary market will be ‘offer through prospectus’. 3. The type of capital market in which trading of only existing share is done is ‘Secondary Market (Stock Exchange)’. 4. Primary Market 5. Primary Market Question 13. Meca Ltd. a reputed automobile manufacturer needs Rupees ten crore as additional capital to expand its business. Atul Jaian, the CEO of the company wanted to raise funds through equity. On the other hand the Finance Manager, Nimi Sachdev said that the public issue may be expensive on account of various mandatory and non-mandatory expenses. Therefore, it was decided to allot the securities to institutional investors. Name the method through which the company decided to raise additional capital Answer: Private Placement. Question 14. Sika Ltd., a reputed industrial machines manufacturer, needs Rupees twenty crores as additional capital to expand the business. Mr. Amit Joshi, the Chief Executive Officer (CEO) of the company wants to raise funds through equity. The Finance Manager, Mr. Narinder Singh, suggested that the shares may be sold to investing public through intermediaries, as the same will be less expensive. Name the method through which the company decided to raise additional capital. Answer: Offer for Sale. Question 15. Raman who is a broker in a stock exchange has to face fchallenging questions from society. His own family sometimes asks him to think about his decision to become a broker. He however, has full faith in the stock exchange. He knows that the membership of a stock

exchange is properly regulated abiding the legal system and the public doing investment is safe in making deals. His children one day asked him the reason behind the ups and downs in the stock market. He clarified their doubt by telling them that forces of supply and demand decide the prices of securities in the secondary market. Off late he has decided to write a book on the functioning of stock exchange and its significance in the Indian economy. He is trying to highlight in his book how through the process of investment and disinvestment existing securities are sold and resold and savings are channelized into the most productive opportunities. Definitely Raman is justifying his presence in his job. 1. What is the meaning of Stock Exchange? 2. Identify and briefly explain the functions of Stock Exchange discussed in the above case. 3. What is an e-IPO? Answer: 1. Stock exchange is a collection of individuals, formed as a body or not, constituted for the objective of helping, controlling and regulating the dealings related to buying and selling of securities. 2. The different functions of Stock Exchange highlighted in the above case are: o Ensures safety of transaction. He knows that the membership of a stock exchange is properly regulated abiding the legal system and the public doing investment is safe in making deals. o Helps in deciding pricing of securities. He clarified their doubt by telling them that forces of supply and demand decide the prices ...