CHAPTER 9

FINANCIAL MANAGEMENT
Business finance: Money required for carrying out business activities is called business
finance. Almost all business activities require some finance. Finance is needed to
establish a business, to run it, to modernise it, to expand, or diversify it
Financial Management: Financial Management is concerned with optimal
procurement as well as usage of finance. For optimal procurement, different available
sources of finance are identified and compared in terms of their costs and associated
risks.
Role of Financial Management: The financial statements such as Balance Sheet and
Profit and Loss Account reflect a firm9s financial position and its financial health.
Almost all items in the financial statements of a business are affected directly or
indirectly through some financial management decisions.
(i) The size as well as the composition of Fixed Assets of the business
(ii) The quantum of Current Assets as well as its break-up into cash, inventories
and receivables:
(iii) The amount of long term and short -term financing to be used:
(iv) Break-up of long- term financing into debt, equity etc:
(v) All items in the Profit and Loss Account e.g., Interest, Expense, depreciation
Objectives of Financial Management :
Primary aim of financial management is to maximise shareholder9s wealth, which is
referred to as the wealth maximisation concept. The market price of a company9s shares
are linked to the three basic financial decisions Financial decision-making is concerned
with three broad decisions which are Investment Decision, Financing Decision,
Dividend Decision.

FINANCIAL DECISIONS:
Financial decision-making is concerned with three broad decisions:
A) Investment decision, B) Financing decision and, C) Dividend decision

A. Investment decision (Capital Budgeting Decision):- This decision relates to careful

selection of assets in which funds will be invested by the firms. Investment decision can
be long term or short-term. A long-term investment decision is also called a Capital
Budgeting decision. It involves committing the finance on a long-term basis. Short term
investment decisions (also called working capital decisions) are concerned with the
decisions about the levels of cash, inventories and debtors. These decisions affect the
day to day working of a business. These affect the liquidity as well as profitability of a
business.
Factors Affecting Investment/ Capital budgeting decision:3
1. Cash flows of the project:-Before considering an investment option, business must
carefully analyse the net cash flow expected from the investment during the life of the
investment. Investment should be made if net cash flow is more.
2. The rate of return:-Investment should be done in the projects which earn the higher
rate of return. It should be calculated on the basis of expected return of the projects.

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3. Investment criteria involved:-Before taking decision, each investment opportunity
must be compared by using the various capital budgeting techniques. These techniques
involve calculation of rate of return, cash flow during the life of investment, cost of
capital etc.

B. Financing decision:-It deals with determination of sources of finance i.e. amount to

be raised from each source. A firm needs to have a judicious mix of both debt and equity
in making financing decisions, which may be debt, equity, preference share capital and
retained earnings

Factors Affecting Financing decision:-

1. Cost of raising finance: - The cost of raising finance from various sources is different
and finance managers always prefer the source with minimum cost.
2. Risk involved:-The risk associated with each of the sources is different.
3. Flotation costs:- Higher the floatation cost, less attractive the source.
4. Cash flow position of the company: - A strong cash flow position may make debt
financing more viable than funding through equity.
5. Fixed Operating Costs: - If a company is having high fixed operating cost then they
must prefer owner8s fund because due to high fixed operational cost, the company may
not be able to pay interest on debt securities.
6. Control consideration: - If existing shareholders want to retain the complete control
of business then they prefer borrowed fund securities to raise further fund.
7. State of Capital Markets: During the period when stock market is rising, more
people are ready to invest in equity. However, depressed capital market makes it difficult
for any company.

C. Dividend decisions:- It refers decisions related to amount of profit/surplus to be

distributed among shareholders and how much amount of profit/surplus keep aside as
retained earnings.
Factors Affecting Dividend decisions:-
1. Amount of Earning: - Dividends are paid out of current and past earning.
2. Stability of earning: - Companies having stable or smooth earning prefer to give
high rate of dividend.
3. Stability of dividend: - Some companies follow a stable dividend policy as it has
better impact on shareholder and improves the reputation of company in the share
market.
4. Growth opportunities: - If companies have no investment or growth plans then it
would be better to distribute more in the form of dividend. Generally mature companies
declare more dividends whereas growing companies keep aside more retained earnings.
5. Cash Flow Position:-Paying dividend means outflow of cash. Companies declare
high rate of dividend only when they have surplus cash.
6. Taxation Policy: - If tax rate is higher, then company prefers to pay less in the form
of dividend whereas if tax rate is low then company may declare higher dividend.
7. Shareholders Preference: There are always some shareholders who depend upon a
regular income from their investments.
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8. Stock Market Reaction: The possible impact of dividend policy on the equity share
price is one of the important factors considered by the management while taking a
decision about it.
9. Access to Capital Market: Large and reputed companies generally have easy access
to the capital market and therefore may depend less on retained earnings to finance their
growth.
10. Legal Constraints: Certain provisions of the Company9s Act place restrictions on
payouts as dividend.
11. Contractual Constraints: While granting loans to a company, sometimes the lender
may impose certain restrictions on the payment of dividends in future.

Financial planning- It is the process of estimating the funds requirement, specifying

the sources of fund and utilizing them in an optimum manner. It is essentially preparation
of a financial blueprint of an organisation9s future operations.
Objectives of financial Planning-
(a) To ensure availability of funds whenever these are required.
(b) To see that firm does not raise resources unnecessarily.
Importance of financial Planning-
(a) Makes the firm better prepared to face the future.
(b) Helps in avoiding Business Shocks and Surprises.
(c) Coordinate various functions.
(d) Proper utilization of finance.
(e) Link present with future.
(f) Link between Investment and Financing Decisions.
(g) Financial planning reduce waste, duplication of efforts, and gaps in planning.
(h) It makes the evaluation of actual performance easier.

Capital Structure:- Refers to proportion of debt and equity used for financing the
operations of business.
Trading on Equity: Trading on Equity refers to the increase in profit earned by the
equity shareholders due to the presence of fixed financial charges like interest. It is
possible only when return on investment is more than rate of interest on debt.
Factors Affecting Capital Structure: 3
1. Cash flow positions: - A company employs more of debt securities in its capital
structure if company is sure generating enough cash inflow whereas if there is shortage
of cash then it must employ more of equity in its capital structure.
2. Interest coverage ratio (ICR):- High ICR means companies can have more of
borrowed fund securities whereas lower ICR means less borrowed fund securities.
3. Debt Service Coverage Ratio (DSCR): A higher DSCR indicates better ability to
meet cash commitments and consequently, the company9s potential to increase debt
component in its capital structure.
4. Return on investment: - If return on investment is more than rate of interest then
company must prefer debt in its capital structure otherwise equity.
5. Cost of Debts: - If firm can arrange borrowed fund at low rate of interest then it will
prefer more of debt as compared to equity.
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6. Tax rate: - High tax rate makes debt cheaper as interest paid to debt is subtracted
from income before calculating tax.
7. Cost of Equity: Stock owners expect a rate of return from the equity which is
commensurate with the risk they are assuming.
8. Floatation Costs: Process of raising resources also involves some cost.
9. Risk consideration: - If firm8s business risk is low then it can raise more capital by
issue of debt securities whereas at the time of high business risk it should depend upon
equity.
10. Flexibility: If a firm uses its debt potential to the full, it loses flexibility to issue
further debt.
11. Control: Debt normally does not cause a dilution of control. A public issue of equity
may reduce the management9s holding in the company and make it vulnerable to
takeover.
12. Regulatory Framework: Every company operates within a regulatory framework
provided by the law e.g., public issue of shares and debentures are made according to
the guidelines of the Indian Companies Act, 2013 and SEBI guidelines.
13. Stock Market Conditions: If the stock markets are bullish, equity shares are more
easily sold even at a higher price. However, during a bearish phase, a company, may
find raising of equity capital more difficult.
14. Capital Structure of other Companies: A useful guideline in the capital structure
planning is the debt equity ratios of other companies in the same industry.

Fixed Capital:3It refers to money invested in the fixed assets, which is to be used over
a long period of time. The management of fixed capital or investment or capital
budgeting decisions are important for the following reasons: (i) Long-term growth and
effects: (ii) Large amount of funds involved: (iii) Risk involved: (iv) Irreversible
decisions:
Factors Affecting Fixed Capital: 3
1) Nature of business: - A manufacturing company needs more fixed capital as
compared to a trading company.
2) Scale of operations:- A large scale company require more fixed capital as they need
more machineries and other assets.
3) Choice of technique:-Companies using capital-intensive technique require more
fixed capital whereas companies using labour intensive technique require les capital.
4) Technology upgradation:-Industries in which technology upgradation is fast need
more amount of fixed capital as when new technology is invented old machines become
obsolete.
5) Growth prospects: - Companies which are expanding and have higher growth plan
require more fixed capital as to expand their production capacity.
6) Diversification: - Companies which have plan to diversify their activities by
including more range of products require more fixed capital as to produce more
products.
7) Financing Alternatives: A developed financial market may provide leasing facilities
as an alternative to outright purchase.
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8) Level of Collaboration: At times, certain business organizations share each other9s
facilities which may lead to less fixed capital requirement.

Working Capital:- refers to the amount which is invested in current assets. It is required
for payment of daily expenses, payment of current liabilities etc. This investment
facilitates smooth business operations.
Factors affecting the requirement of working capital:-
1) Nature of business:- Manufacturing business requires more amount of working
capital because it takes lot of time in converting raw material into finished goods while
trading business requires less amount of working capital.
2) Scale of operation:-Business operating on larger scale requires more funds to
maintain the high quantum of inventory and debtors to meet day to day expenses as
compared to small scale business.
3) Business Cycle fluctuation: - In case of boom, there is increase in production and
sales leading to the increased requirement for working capital, whereas the requirements
for working capital reduce during depression.
4) Seasonal factors: - During peak season the level of activity is high, leading to
increased need of working capital as compared to the capital during lean period.
5) Production cycle: - working capital requirement is higher in firms with longer
processing cycle and lower in firms with shorter processing cycle
6) Credit Allowed: A liberal credit policy results in higher amount of debtors,
increasing the requirement of working capital.
7) Credit Availed: To the extent, it avails the credit on its purchases, the working capital
requirement is reduced.
8) Operating Efficiency: The firm having higher degree of operating efficiency requires
less amount of working capital.
9) Availability of Raw Material: If the raw materials and other required materials are
available freely and continuously, the firms can manage with less amount of working
capital.
10) Growth Prospects: If the growth potential of a concern is perceived to be higher,
it will require higher amount of working capital
11) Level of Competition: Higher level of competitiveness may necessitate higher
stocks increases the working capital requirement.
12) Inflation: - If there is increase or rise in price then the price of raw material and cost
of labour will rise, it will result in an increase in working capital requirement.

MULTIPLE CHOICE QUESTIONS

1. The board of directors of M Ltd decided to issue debentures worth Rs.40 lakhs in
order to finance a major research and development project. This would increase the debt
equity ratio from 1: 1 to 2: 1. However, at the same time it would increase the earnings
per share. The reason that will justify the above situation is
(a) Unfavourable financial leverage, as the financial risk will be higher.
(b) Unfavourable financial leverage, as return on investment is lower than the
cost of debt.
(c) Favourable financial leverage as debt is easily available.
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 (d) Favourable financial leverage, as return on investment is higher than cost
of debt
2. Which of the following is not a factor affecting capital structure of a company?
(a) Cost of Debt (b) Growth Opportunities
(c) Cash Flow Position (d) Interest Coverage Ratio
3……..... refers to the increase in profit earned by the equity shareholders due to the
presence of fixed financial charges like interest.
(a) Capital structure (b) Earning per share
(c) Trading on equity (d) Return on investment
4. Which of the following statement does not highlight the importance of financial
planning?
(a) Detailed plans of action prepared under financial planning increase waste,
duplication of efforts and gaps in planning.
(b) It helps in forecasting what may happen in future under different business
situations.
(c) It provides a link between investment and financing decisions on a continuous
basis.
(d) It helps in avoiding business shocks and surprises and helps the company in
preparing for the future.
5. During the Covid-19 pandemic, the restaurant industry faced many challenges. The
lockdown led to huge decrease in demand. From April 2022, the effect of Covid started
reducing. The economy stated pricking up and boom was noticed in the restaurant
industry. As a result, larger amount of working capital was required with increased
production and sales. The factor affecting the working capital requirement discussed
above is
(a) Seasonal factor (b) Production cycle (c) Operating efficiency (d) Business cycle

6. Match the factors affecting fixed capital requirements given in the Column I with
explanations given in Column II

Column I Column II
A. Nature of Business (i) A trading organisation needs lower
investments in fixed assets as compared
to a manufacturing organisation.
B. Technology upgradation (ii) A textile manufacturing company is
installing a cement manufacturing plant
and thus is investments in fixed assets is
increasing.

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 C. Diversification (iii) A capital-intensive organisation
requires higher investments in fixed
assets as compared to labour-intensive
organisation.
D. Choice of Techique (iv) Mobile phones became obsolete
faster or many other assets. Hence these
type of businesses require more fixed
capital.

(a) (i) A (iv)B (ii)C (iii)D (b) (ii)A (iii)B (iv)C (i)D
(c) (iii)A (ii)B (i)C (iv)D (d) (iv)A (i)B (iii)C (ii)D

7. 'Temptations' is a food joint in Imperial Mall in Bengaluru. It is becoming popular

among students and working people due to healthy, on-the-go dishes on its menu like
'Paneer Wrap', 'Chickpeas Salad', 'Grilled Sandwiches', etc. It has now decided to open
two new branches in other parts of Bengaluru. Which financial decision has been
discussed in the above case?
(a) Long-term investment decision (b) Short-term investment decision
(c) Dividend decision (d) Financing decision
8. A decision to acquire a new and modern plant to upgrade an old one is known as
(a) Financing decision (b) Working capital decision
(c) Investment decision (d) Dividend decision
9. ABC Ltd. has debt equity ratio of 3:1 whereas XYZ Ltd. has debt equity ratio of 1: 1.
Name the advantage ABC Ltd will have over XYZ Ltd, when the rate of interest is lower
than the rate of return on investment of the company.
(a) Trading on equity (b) Low risk
(c) Low cost of equity (d) Greater flexibility
10. Vikrant joins his father's business of Organic masalas near Kotgarh in Himachal
after completing his MBA. In order to capture a major share of the market, he by using
the latest packaging technology decided to sell the products in attractive packages. His
father suggested to hire financial consultants to estimate the amount of funds that would
be required for the purpose and timings when it would be required. The concept being
discussed by Vikran's father, links which financial decision with the investment
decision?

(a) Dividend decision (b) Financial planning

(c) Capital structure decision (d) Financing decision

11. Statement I : A company wants to establish a new unit in which a machinery of

worth Rs.50 lakh is involved. Here in the said case, investment decision is involved.

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 Statement II : Working capital involves the allocation of firm's capital to long-term
assets or projects.
Alternatives
(a) Statement I is correct and Statement II is incorrect
(b) Statement II is correct and Statement I is incorrect
(c) Both the statements are correct
(d) Both the statements are incorrect

12.
Statement I Business finance refers to the money required for carrying out business.
Statement II Financing decision involves careful selection of assets, in which funds are
to be invested.
Alternatives
(a) Statement I is correct and Statement II is incorrect
(b) Statement II is correct and Statement I is incorrect
(c) Both the statements are correct
(d) Both the statements are incorrect

13.
Assertion (A) Finance is the life blood of business.
Reason (R) Finance is very essential for the smooth running of the business.
Alternatives
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation
of Assertion (A)
(b) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the correct
explanation of Assertion (A)
(c) Assertion (A) is true, but Reason (R) is false
(d) Assertion (A) is false, but Reason (R) is true
14.
Assertion (A) Primary aim of financial management is to maximise shareholder's
wealth.
Reason (R) Company's funds belong to the shareholders and the return earned by them
determine their market value and price.
Alternatives
(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation
of Assertion (A)
(b) Both Assertion (A) and Reason (R) are true, but Reason (R) is not the correct
explanation of Assertion (A)
(c) Assertion (A) is true, but Reason (R) is false
(d) Assertion (A) is false, but Reason (R) is true

ANSWER KEY
1.d 2. b 3.c 4.a 5.d 6.a 7.a 8.c 9.a 10.b 11. a
12. a 13. a 14. a
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VERY SHORT ANSWER TYPE QUESTIONS
15. Organisations which choose to diversify their operations require ....................fixed
capital. (more/less)
16. "The size of assets, the profitability and competitiveness are affected by one of the
financial decisions' State the decision involved with reference to the given
statement. Name and state the decision.

17. In the paint industry, various raw materials are mixed in different proportions with
petroleum for manufacturing different kinds of paints. One specific raw material is not
readily and regularly available to the paint manufacturing companies. Bonler Paints
Company is also facing this problem and because of this there is a time lag between
placing the order and the actual receipt of the material. But, once it receives the raw
materials, it takes less time in converting it into finished goods. Identify the factor
affecting the working capital requirements of this industry.
18. VXL Ltd is a company dealing in dairy products. It procures these products from
Rajasthan and sells them to various parts of Delhi. A month before Marico Ltd., a
Haryana based company entered Delhi market with a similar range of products. State
the impact of entry of Haryana based 'Marico Ltd.' on the working capital requirements
of VXL Ltd. Also, name the factor affecting the working capital requirements of VXL
Ltd.

19. Name and state the aspect of financial management that enables to foresee the fund
requirements both in terms of 'the quantum' and 'the timings' Or Name and state the
aspect of financial management that provides a link between investment and financing
decisions
20. Radhika and Vani who young fashion designers are left their job with a famous
fashion designer chain to set-up a company 'Fashionate Pvt Ltd. 'They decided to run a
boutique during the day and coaching classes for entrance examination of National
Institute of Fashion Designing in the evening. For the coaching center they hired the first
floor of a nearby building. Their major expense was money spent on photocopying of
notes for their students. They thought of buying a photocopier knowing fully that their
scale of operations was not sufficient to make full use of the photocopier.
In the basement of the building of 'Fashionate Pvt Ltd'. Praveen and Ramesh were
carrying on a printing and stationery business in the name of 'Neo Prints Pvt Ltd'
Radhika approached Praveen with the proposal to buy a photocopier jointly which could
be used by both of them without making separate investment, Praveen agreed to this.
Identify the factor affecting fixed capital requirements of 'Fashionate Pvt. Ltd.'

21. 'Best Bulbs Pvt Ltd was manufacturing good quality LED bulbs and catering to local
market. The current production of the company is 800 bulbs a day. Sumit, the marketing
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manager of the company surveyed the market and decided to supply the bulbs to five-
star-hotels also. He anticipated the higher demand in future and decided to buy a
sophisticated machine to further improve the quality and quantity of the bulbs produced.
Identify the factor affecting fixed capital requirements of the company.

22. Rizul Bhattacharya after leaving his job wanted to start a Private Limited Company
with his son. His son was keen that the company may start manufacturing of mobile
phones with some unique features. Rizul Bhattacharya felt that the mobile phones are
prone to quick obsolescence and a heavy fixed capital investment would be required
regularly in this business. Therefore, he convinced his son to start a furniture business.
Identify the factor affecting fixed capital requirements which made Rizul Bhattacharya
to choose furniture business over mobile phones.

23. How does cost of debt affect the capital structure of a company? State.
ANSWER KEY
15. Ans. More 16. Ans. Capital budgeting decision
17. Ans. Availability of raw materials
18. Ans. With entry of "Marico Ltd., VXL Ltd. needs to increase its working capital.
The factor is level of competition'
19. Ans. Financial planning 20. Ans. Level of collaboration
21. Ans. Technology upgradation 22. Ans. Technology upgradation
23. Ans. When a firm is able to borrow at a lower rate, it increases the capacity to employ
higher debt and can increase the debt component in the capital structure.

SHORT ANSWER TYPE QUESTIONS

24. 'Geo Motors' is the manufacturer of sophisticated cranes. The Production Manager
of the company, reported to the Chief Executive Officer, Ashish Jain that one of the
machines used in manufacturing sophisticated cranes had to be replaced to compete in
the market, as other competitors were using automatic machines for manufacturing After
a detailed analysis, it was decided to purchase a new automatic machine having the latest
technology. It was also decided to finance this machine through long-term sources of
finance. Ashish Jain compared various machines and decided to invest in the machine
which would yield the maximum returns to its investors.
(i) Identify the financial decision taken by Ashish Jain.
(i) Explain any three factors affecting the decision identified in (i) above.

25. The Return on Investment (Rol) of a company ranges between 10-12% for the past
three years. To finance options for borrowing debt. its future fixed capital needs, it has
the following
Option 'A' : Rate of interest 9% Option 'B' : Rate of interest 13%
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Which source of debt, 'Option A' or 'Option B', is better?
Give reason in support of your answer. Also state the concept being used in taking the
decision.
26. Neelabh Sarin, the Finance Manager and Atul Chopra, the Managing Director of
Ghokerns Ltd. were discussing regarding the source of finance to be raised for
modernisation of their existing plant. Quoting that sensex has soared by 5078 points' in
the last three years, Neelabh Sarin suggests that equity should be preferred while Atul
Chopra wanted to opt for debt. Keeping in mind the high operating costs of the company,
suggest the source of finance that should be used for moderninsation of existing plant.
Also, explain the two factors highlighted above which should be kept in mind for taking
this decision.

27. Ramnath Ltd. is dealing in import of organic food items in bulk. The company sells
the items in smaller quantities in attractive packages. Performance of the company has
been up to the expectations in the past. Keeping up with the latest packaging technology,
the company decided to upgrade its machinery. For this, the Finance Manager of the
company, Mr. Vikrant Dhull, estimated the amount of funds required and the timings.
This will help the company in linking the investment and the financing decisions on a
continuous basis. Therefore, Mr Vikrant Dhull began with the preparation of a sales
forecast for the next four years. He also collected the relevant data about the profit
estimates in the coming years. By doing this, he wanted to be sure about the availability
of funds from the internal sources. For the remaining funds he is trying to find out
alternative sources. Identify the financial concept discussed in the above paragraph. Also
state any two points of importance of the financial concept, so identified.
28. 'X Ltd. issued 14% debentures of Rs. 4,00,000 and 10,000 equity shares of Rs.60
each. This investment resulted in a net profit of Rs.2,00,000 before interest and tax. The
tax rate was 50%.
i)Calculate the 'Return on Investment and Earning per Share of "X Ltd'.
(ii) State with reason whether the above example is that of favourable or unfavourable
leverage.

ANSWER KEY

24.Ans.
(i) Financial decision taken by Ashish Jain is Investment (Long-term/Capital budgeting)
decision. (ii) Factors affecting capital budgeting decision
25.Ans)
The company Should use Option A' as in this case the Return on Investment (10-12%)
will be more Than the Cost of Debt (9%).
The concept being used in the above case is 'trading on equity'.
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The use of debt along with equity increases Earnings Per Share (EPS). This use of fixed
financial charge, i.e. interest, increases the profit earned by shareholders. This concept
is known as trading on equity.
If the company opts for Option A, it will lead to favourable trading on equity as in this
case Rol > CoD, Where Rol - Return on Investment (10-12%) CoD - Cost of Debt (9%)
26.Ans.
The company should opt for equity as the source of finance to modernise the existing
plant. (1) Following factors were taken into consideration from the decision
(i) Stock market condition (ii) Cash flow positions
27.Ans.
The concept discussed in the above paragraph is 'financial planning'. (1) The two points
of importance of this concept are
(i) Helps in avoiding business shocks and surprises
(ii) ii) Helps in coordination (any two imp)

28.Ans)
EPS = 72000/10000=7.2
ROI = 200000/1000000*100=20%
(ii) Here, the rate of interest is 14%, which is less than 20% (R0I).
Thus, it is a favourable leverage.

LONG ANSWER TYPE QUESTIONS

29. Dhaval Acharya, after acquiring a bachelor's degree in Hotel Management joined his
father's chain of vegetarian restaurants in Ahmednagar. Being young and enterprising,
he suggested his father to add a new section of vegetarian bakery items which required
an investment of Rs.5 crores. His father Mr. Aariketh Acharya suggested him to take the
decision with caution and understood everything comprehensively as bad decision may
damage the financial fortune of business. Identify the decision suggested by Mr.
Aariketh Acharya. State by giving any three reasons as to why he must have advised his
son to take decision with caution.
30. Harish is working as a finance manager in 'Kozee Software Ltd'. He had been
awarded 'Best employee of the year Award' because of his foresightedness. He always
aims at smooth operations of all the financial activities by focusing on fund requirements
and their availability in the light of financial decisions. He takes into consideration the
growth, performance, investments and requirements of funds for a given period so that
financial resources and not left idle and don't unnecessarily add to the cost. By doing all
this Harish strives to achieve the two main objectives of an important concept of
financial management. Identify the concept and explain its three importance.

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31. Krish Limited is the business of manufacturing and exporting carpets and other home
decor products. It has a share capital of Rs.70 lacs at the face value of Rs.100 each.
Company is considering a major expansion of its production facilities and wants to raise
Rs. 50 lacs. The finance manager of the company Mr. Prabhakar has recommended that
the company can raise funds of the same amount by issuing 7% debentures. Given that
earning per share of the company after expansion is Rs.35 and tax rate is 30%, did Mr.
Prabhakar give a justified recommendation. Show the working.
32. Anurag Tiwari is a famous news reader. He has recently started a news company
'Axis Media Corporation Ltd'. The aim of this company is to launch a 24-hour Hindi
news channel to broadcast latest news from India and around the world. For this now
venture, the company will have to decide how to invest funds in different assets. The
purchase of few assets like equipment, computers, vehicles, etc. will involve committing
the finance on a long-term basis. It will affect earning capacity of the business in the
long run. Therefore the company need to take the decision to invest in such assets with
utmost care. (i) Identify and state the type of investment decision discussed in the above
paragraph. ii) State any four factors which affect the decision identified in (i) above.

33. 'Reliable Labs Ltd.' is a trusted name in diagnostic services with seven branches
spread across the city of Pune. The directors of this company have projected that with
the rise in health consciousness in the society and the rising burden of chronic diseases,
the demand for diagnostic tests is expected to grow in future. Considering this, they
decided to open branches of their diagnostic labs in Ahmedabad. It was estimated that it
will require Rs.100 crore of additional funds.
The directors have to take the decision about how much funds should be raised from
equity capital and how much from debt. It will affect the overall cost of capital and the
financial risk of the company.
(i) Identify the state the financial decision discussed in the above paragraph.
(ii) State any three factors that should be kept in mind by the Board of Directors of
Reliable Labs Ltd'. While taking the decision identified in (i) above.

34. Sahil is the Finance Manager of 'Knitwear Ltd'. The company is engaged in the
manufacturing of woollen clothes. The demand of the company's products is seasonal,
whereas the production continues throughout the year. Due to the quality of its products,
the company's business is spreading across the country. The company is operating at a
large scale having is regional offices in Northern, Southern, Eastern and Western India.
The performance of its each division is of a very high level. For uninterrupted
availability of raw materials, the company requires high stock levels. Not only has this,
to face the competition and to meet the urgent orders of the customers, the company also
needed enough stock of finished goods.
Considering the above discussion, state five factors affecting working capital
requirements of "Knitwear

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35. 'Abhishek Engineering Ltd.', a leading manufacturer of steel rods wants to enter into
the business of manufacturing trucks. For this, the Finance Manager has to ensure the
availability of funds whenever required and its possible sources. He has to see that the
company does not raise funds unnecessarily. In this way he has to match the funds
requirement and their availability. i Identify and give the meaning of the concept
discussed in the above para which will help the Finance Manager to achieve his
objectives. (ii) Also, state any three points of importance of the concept identified in i)
above.

36. Vansh Limited is a large and reputed company which manufactures ventilators. After
the outbreak of •Covid-19' in 2020 the company witnessed an increase in revenue by
40%. It has plans to further increase its production capacity and also start production of
PPE kits, sanitisers and masks in 2022. The Finance manager of the Company Mr. Rajiv
feels confident about the future of the company and its liquidity position. Discuss the
meaning of Dividend Decision and in the light of the above statement explain any three
factors which should be considered by 'Vansh Limited' while formulating the dividend
policy of the company.

37. Vedansh Limited has a share capital of Rs.10,00,000 divided into shares of Rs.100
each. For expansion purpose, the company requires additional funds of Rs.5,00,000. The
considering the following alternatives for raising funds.
Alternative 1 Issue of 5,000 equity shares of Rs.100 each
Alternative 2 Issue of 10% debentures of Rs.5,00,000
The company's present Earnings Before Interest and Tax(EBIT) is Rs.4,00,000 p.a.
Assuming that the rate of Return of Investment remains the same after expansion, which
alternatives should be used by company in order to maximise the returns to the equity
shareholders. The tax rate is 50%. Show the working.

38. Dheeraj wants to start a business of selling N-95 masks after the outbreak of the
global pandemic of Covid-19. Due to the uncertain market conditions he wants to make
a low investment in fixed capital. Suggest how the decisions related to the choice of
technique and financing alternatives can help Dheeraj in ensuring a low investment in
fixed capital requirements.

39. Sun Industries Ltd. is a leading company in India which manufactures steel. Its plants
are located in Jamshedpur and Bokaro. Currently it produces about three million tons of
saleable steel. As the demand for steel is growing, it is planning to expand the capacity
of the existing steel plants. It is estimated that it will require Rs 1,800 crore of fixed
capital and Rs 200 crore of working capital. To raise the funds, the company is
considering whether it should issue equity shares or 7% debentures of Rs 2,000 crore.
Presently the capital structure is comprising of equity only. The Finance Manager of the

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company suggested that since the stock markets are undergoing a bearish phase, it
should issue debentures.
i) Is it justified to raise funds by issuing debentures? Give reason in support of your
answer.
(ii) Explain the impact of issue of debentures on the risk faced by the company.
(iii) Explain the impact of 'cost of debt' and 'cost of equity' on the capital structure of the
company.

40. From last many years, in the move if November, due to sudden rise in the pollution
levels in Delhi and other parts of Northern India, there has been an increase in the
demand for air purifiers. Indraprastha Technologies Ltd., a manufacturer of air purifiers
wants to use this opportunity and wants to raise its investment in stock. It is expected
that this decision would increase the rate of profitability of the business. Due to this,
many competitors have recently entered in this industry. In order to increase the sales,
the company has started selling air purifiers on liberal credit terms. It is not affecting the
profits of the company since the production cycle of the product is short. Identify and
state any two factors that Indraprastha Technologies Ltd.' will keep in mind before
deciding its working capital requirements. Also state three other factors which should
be kept in mind while deciding the working capital requirements of a company.

41. 'Smart Stationery Ltd.' wants to raise funds of Rs.40,00,000 for its new project. The
management is considering the following mix of debt and equity to raise this amount
Capital Structure Alternative
I II III
Equity 40,00,000 30,00,000 10,00,000
Debt 0 10,00,000 30,00,000

Other details are as follows Interest Rate on Debt 9% Face Value of Equity Shares
Rs.100 each Tax Rate 30% Earnings Before Interest and Tax (EBIT) Rs.8,00,000
(i) Under which of the three alternatives will the company be able to take advantage of
Trading on Equity?
ii) Does Earning Per Share always rise with increase in debt?

42. Viyo Ltd, is a company manufacturing textiles. It has a share capital of Rs. 60 lakh.
The earning per share in the previous year was Rs.0.50. For diversification, the company
requires additional capital of Rs. 40 lakh. The company raised funds by issuing 10%
debentures for the same. During the current year the company earned a profit of Rs.8
lakh on capital employed. It paid tax @ 40%.
(i) State whether the shareholders gained or lost, in respect of earning per share on
diversification. show your calculations clearly. (ii) Also, state any three factors that
favour the issue of debentures by the company as part of its capital structure.
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43. 'Sarah Ltd.' is a company manufacturing cotton yarn. It has been consistently earning
good profits for many years. This year too, it has been able to generate enough profits.
There is availability of enough cash in the company and good prospects for growth in
future. It is a well -managed organisation and believes in quality, equal employment
opportunities and good remuneration practices. It has many shareholders who prefer to
receive a regular income from their investments. It has taken loan of 40 lakh from IDBI
and is bound by certain restrictions on the payment of dividend according to the terms
of loan agreement. The above discussion about the company leads to various factors
which decide how much of the profits should be retained and how much has to be
distributed by the company.
Quoting the lines from the above discussion identify and explain any four such factors.
ANSWER KEY

29.Ans. Mr Aariketh Acharya has suggested capital budgeting decision. Reasons why
he must have advised this decision are i) These decisions have bearing on the long-term
growth. (ii) These decisions result in large portion of funds being blocked in long-term
projects, these investments are planned after a detailed analysis. iii) These decisions
affect the returns of the firm, therefore influence the overall business risk complexion
of the firm. (iv) These decisions once taken, are not reversible without incurring heavy
losses. Abandoning a project after heavy investment is costly in terms of waste of funds.

30.Ans. The concept discussed in the above case is "Financial Planning" and any three
importance

31.Ans. Earning per share = Rs.35 Earning after tax = Rs.24,50,000 Interest = 50,00,000
× 7/100 = Rs.3,50,000 Earning before tax = Rs. 35,00,000 EBIT = Earning before tax +
Interest = 35,00,000 + 3,50,000 ＝Rs.38,50,000 Rol = EBIT/Total Investment x 100 =
38,50,000/1,20,00,000 × 100 = 32.08%

As Rol (32.08%) > Rate of interest (7%). The company can choose to use trading on
equity to increase its EPS. The finance manager was justified in making this
recommendation.

32.Ans. (1) Capital budgeting decision (ii) any three factors

33.Ans. i) Financing decision. Meaning ii) any three factors
34.Ans. Factors affecting working capital requirements
35.Ans. i) The concept discussed in the paragraph is financial planning and any three
importance
36.Ans. Dividend decision. Factors affecting dividend decision
37.Ans. Rate of Return of Investment is 4,00,000/10,00,000 × 100 = 40%. EBIT after
expansion - 40% × 15,00,000 = 6,00,000,EPS Plan I is 20 and Plan II is 27.5.The
company should use Plan 2 in order to increase the return to the equity shareholders.
38.Ans. Choice of technique and Financial alternatives
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39.Ans. (i) Yes, it is justified to raise funds by issuing debentures. Reason any one (a)
During a bearish phase in the capital market, a company may find raising of equity
capital more difficult and it may opt for debt (b) It will help to lower the overall cost of
capital. (1) (ii) The issue of debentures will increase the financial risk faced by the
company as the payment of interest and the return of principle is obligatory for the
business. Any default in meeting these commitments may force the business to go into
liquidation. (2) (iii) Impact of the following on capital structure of the company. (a) Cost
of debt More debt can be used in the capital structure if debt can be raised at a lower
rate. (b) Cost of equity When a company increases debt, the financial risk faced by the
equity shareholders increases. Consequently, their desired rate of return may increase
due to which cost of capital will increase.

40.Ans. Factors that "Indraprastha Technologies Ltd. will keep in mind before deciding
its working capital requirements (any two) i)Seasonal factor (ii) Level of competition
(iii) Credit allowed.

41.Ans.(i) The company will be available to take advantage of Trading on Equity in

Alternative (III). This is because of higher earning per share in Alternative III.

(ii) No, earning per shares only rises with increase in debt when the rate of interest on
debt is lower than the return on investment.

42.Ans.Since, Earning Per Share has fallen from 0.50 to 0.40, therefore the shareholders
stand to lose on diversification. Note: In the absence of any information, shares are
assumed to be of Rs.10 each. So, Number of Shares = Share Capital/ Face Value Per
Share = 60,00,000/10 = 6,00,000 shares . ii Three factors that favour issue of debentures
by the company as part of its capital structure are (a) Debenture interest payable is a
charge to the profits. Hence a company stands to gain in terms of tax-benefits. (b) Issue
of debentures help the shareholders of the company to gain through 'Trading on Equity'.
(c) Debenture is a cheaper source of finance as compared to equity.

43.Ans. The factors identified in the above lines are given below i) The line 'It has been
consistently earning goods profits for many years' indicated 'Stability of earnings'.
ii) The line 'This year too, it has been able to generate enough profits' indicates
'Earnings' as a factor affecting dividend decision. (iii) The line 'There is availability of
enough cash in the company and good prospects for growth in future' indicates 'Growth
opportunities'. (iv) The line= It has many shareholders who prefer to receive a regular
income from their investments= indicates 8Shareholders preference9

CASE BASED QUESTIONS

44.Mr. Bose is running a successful business. Mr. Bose is the owner of R. K. Cement
Ltd. Mr. Bose decided to expand his business by acquiring a Steel Factory. This required
an investment of Rs.60 crores. To seek advice in this matter, he called his financial
advisor Mr. T. Ghosh who advised him about the judicious mix of equity (40%) and
debt (60%). Employ more of cheaper debt may enhance the EPS. Mr. Ghosh also
suggested him to take loan from a financial institution as the cost of raising funds from
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financial institutions is low. Though this will increase the financial risk but will also
raise the return to equity shareholders. He also apprised him that issue of debt will not
dilute the control of equity shareholders. At the same time, the interest on loan is a tax
deductible expense for computation of tax liability. After due deliberations with Mr.
Ghosh, Mr. Bose decided to raise funds from a financial institution.

(i) Identify the concept of financial management as advised by Mr. Ghosh in the above
situation.
(a) Capital Budgeting (b) Capital Structure
(c) Dividend Decision (d) Working Capital Decision
Ans. (b) Capital Structure

(ii) In the above case Mr. Ghosh suggested to raise more funds from debt. Higher debt-
equity ratio results in
(a) Lower financial risk (b) Higher degree of operating risk
(c) Higher degree of financial risk (d) Higher earning of profit
Ans. (c) Higher degree of financial risk

(iii) "Mr. T. Ghosh who advised him about the judicious mix of equity (40%) and Debt
(60%)". . The proportion of debt in the overall capital is called -
(a) Working capital (b) Financial leverage (c) Total assets (d) None of these
Ans. (b) Financial leverage
(iv) Employ more of cheaper debt may enhance the EPS. Such practice is called
(a) Equity trading (b) Financial leverage
(c) Investment decision (d) Trading on equity

Ans. (d) Trading on equity

45.
Direction: Read the following text and answer the questions on the basis of the same
AVP is a renowned multiplex operator in India. It owns around 560 screens in 110
properties at 80 locations in the country. Considering the fact that there is more growing
trend among the people to spend more of their disposable income on entertainment,
company planned to add more screen at existing locations and start at new locations
also. Further, they plan to add food chain also at their locations. The company planned
to float equity shares in market to raise the desired capital. The issue was fully
subscribed and paid. Over the years, the sale and the profit of the company have
increased tremendously and it has been declaring higher dividend and the market price
of its share has increased manifolds.

i. Which financial decision is highlighted in the lines, "Considering the fact that there is
more growing trend among the people to spend more of their disposable income on
entertainment, company planned to add more screen at existing locations and start at
new locations also"?
(a) Investment decision (b) Financing decision
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(c) Dividend decision (d) None of the above

Ans (a) Investment decision

ii. Identify the decision involved in the lines, "The company planned to float equity
shares in market to raise the desired capital. The issue was fully subscribed and paid."
(a) Financing decision (b) Investment decision
(c) Dividend decision (d) None of these

Ans (c) Dividend decision

iii.The above case highlights the fulfilment of one of the prime objectives of financial
management by AVP company. Identify the objective.
(a) Profit maximisation (b) Increasing customer base
(c) Wealth maximisation of shareholders (d) None of the above

Ans (c) Wealth maximisation of shareholders

iv. "Over the years, the sale and the profit of the company have increased tremendously
and it has been declaring higher dividend and the market price of its share has increased
manifolds". The quoted lines highlight one of the factors affecting dividend decision.
Identify the factor.
(a) Taxation policy (b) Legal restrictions
(c) Stability of earnings (d) None of these

Ans (c) Stability of earnings

=======================================================

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 CHAPTER 10
FINANCIAL MARKET

FINANCIAL MARKET
Financial market serves as a link between savers (who have surplus money) and
borrowers (who have investment idea, but lacks money).

FUNCTIONS OF FINANCIAL MARKET

1. Mobilizing savings into investment: - financial market connects savers and
investors.
2. Price discovery: - financial markets helps in fixing the prices of financial assets.
Market forces (demand and supply) determine the price of securities.
3. Liquidity to financial assets: - through easy exchange process (buying and
selling), financial assets can easily be converted into cash.
4. Reduce cost of transaction: - With the help of financial market, investors and
companies can easily gather information regarding price, cost and availability of
various financial assets.

CLASSIFICATION OF FINACIAL MARKET

1. Capital Market: - it is a mechanism to raise medium term and long-term funds.
Capital market can be classified into
a. Primary Market- also known as New Issue Market. Here securities are issued
for the first time.
b. Secondary Market (Stock Exchange): - securities already issued in primary
market are bought and sold in secondary market.
2. Money Market: - money market is an arrangement to raise short-term funds. It
helps the players to meet their working capital needs.

CAPITAL MARKET:
It is an institutional arrangement through which long-term and medium-term funds are
raised and invested. Shares, debentures, bonds, public deposits etc. are the common
instruments used in capital market.

FEATURES OF CAPITAL MARKET

1. Acts as a link: - capital market connects savers and investors. It channelizes
funds from surplus unit to deficit unit.
2. Long-term investment: - capital market provides funds for long-term uses (for
more than one year)
3. Intermediaries: - capital market needs services of intermediaries. Different
intermediaries are brokers, depositories, underwriters etc.

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 4. Capital formation: - by connecting savers and investors, capital market enables
companies to raise capital for formation, expansion, innovation etc.
5. Government rules and regulations: - capital market functions under the
regulations of SEBI

TYPES OF CAPITAL MARKET

1. Primary Market: - otherwise known as New Issue Market. In this market,
securities are issued for the first time. Companies can issue shares, debentures,
deposits, loans etc. to raise capital from the primary market. The price of the
securities is determined by the company.
2. Secondary Market (Stock Exchange): - it is like a second-hand market. The
existing securities are bought and sold in the secondary market. The price of the
securities is determined by market forces (demand and supply).

CAPITAL MARKET V/S MONEY MARKET

S.No Basis Capital Market Money Market
1 Participants Public and Private Companies, Financial Institutions,
Financial institutions, Banks, Banks, Public and Private
Foreign Investors, Ordinary companies
Retail Investors from Public

2 Duration Deals in long-term and Deals with short-term

medium-term financial instruments having
securities. maximum duration of one
year
3 Instruments Shares, Debentures, Bonds and Commercial Paper,
other innovative securities Certificate of Deposits,
Treasury Bills, Trade Bills
etc.
4 Investment The value of investment is Money market instruments
Outlay generally low are expensive and huge
amount is required to invest
5 Liquidity Capital market securities are Money market instruments
not that much liquid when we are highly liquid and can
compare with money market easily be converted into cash
instruments
6 Safety Considering the factors related Money market instruments
to duration and expected return, enjoy high amount of safety
capital market instruments are due to short duration and
riskier reliability of issuers
7 Expected High Less due to short duration
return
8 Type of To meet long-term fixed capital To meet short-term working
Capital requirements capital requirements

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PRIMARY MARKET V/S SECONDARY MARKET
S.No Basis Primary Market Secondary Market
1 Type of Issue of new securities Mechanism for existing or
Securities Second-hand securities
2 Issued By Directly by companies Securities already issued in
Primary market is transferred
between investors only.
3 Capital Directly helps in capital Helps indirectly for capital
Formation formation formation
4 Entry All companies can enter by Only listed companies can trade
following the prevailing their securities
norms
5 Price Fixed by management of Fixed by free market forces
the companies (demand and supply)

STOCK EXCHANGE
<Stock exchange' means an association, organization, body of individuals,
whether incorporated or not, established for the purpose of assisting, regulating
and controlling the business of buying and selling or dealing in securities=.-
Securities Contract (Regulation) Act, 1956.
FUNCTIONS OF STOCK EXCHANGE
1. Providing liquidity and marketability to existing securities- investors can
easily disinvest and reinvest with the help of stock exchange. It creates a
continuous market for existing securities
2. Pricing of securities- stock exchanges value the securities on the basis of free
market forces, that is demand and supply.
3. Safety of transaction- the dealings of stock exchange are well regulated by SEBI
4. Contributes to economic growth- it helps indirectly in capital formation
5. Spreading of Equity Cult- stock exchanges educate people to invest in capital
market securities. It provides better trading practices
6. Providing scope for speculation- stock exchanges promote healthy speculation
of securities.

TRADING PROCEDURE IN A STOCK EXCHANGE

1. Selection of a Broker: - Broker is a member of the stock exchange who helps in
buying and selling of securities. Trading can only be done through SEBI
registered broker. So, the prime step is the selection of a broker.
2. Opening DEMAT account: - DEMAT account keeps securities in electronic
format. Prospective investors can open their demat account with Depository
Participant (Banks and Stock Brokers). Securities are held in electronic format by
a depository (NSDL and CDSL). Depository participants are the connecting link
between investors and depository.

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 3. Placing the order: - investor has to place an order to the broker personally or
through email, phone calls etc. The order should contain the quantity and price
range at which securities can be traded.
4. Match the share and best price: - broker goes online to see the best price
available.
5. Executing order: - When the shares can be bought or sold at the price mentioned,
it will be communicated to the broker9s terminal and the order will be executed
electronically. The broker will issue a trade confirmation slip to the investor.
6. Issue of contract note: - after execution, broker issues a contract note. It contains
details of price, quantity, date, time of deal and brokerage amount. It9s a legal
document. A unique order number is assigned to each transaction by stock
exchange and is printed on the contract note.
7. Delivery of share and making payment: - now investor has to deliver the shares
sold or make cash payment for the shares purchased. This should be done
immediately after receiving the contract note or before the day when the broker
shall make payment or delivery of shares to the exchange. This is called the pay-
in day.
8. Settlement cycle: - the deal has to be settled and finalized on the T+2 day.
9. On T+2 day, stock exchange will deliver the share or make payment to the other
broker. This is called Pay out day. The broker then has to make payment to
investors within 24 hours of the pay-out day since he/she already received
payment from the exchange.
10.Now the broker can make delivery of shares in demat form directly to the
investor9s demat account.
DEMATERIALISATION:
Conversion of physical securities into electronic form is called dematerialization.
For this investor has to open a demat account with an organization called depository.

The Depository- apex organization in this system. Depository is just like a bank
where the investor can deposit and withdraw his/her shares. They interact with the
investors through Depository Participants (DP). They facilitate electronic transfer of
securities and settlement of transactions.
The Depository Participants (DP)- they are the connecting link between depository
and investors. Financial institutions, share brokers, banks etc. can become depository
participants after registering with SEBI. Depository participant will maintain securities
account balances of investors.

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

- Was set up in 1988
- Was granted legal status in 1992
- To regulate stock market
- To protect investors
Role of SEBI
1. To protect the interest of investors
2. To provide a market for issuers in order to raise capital
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 3. To regulate the functioning of intermediaries
Objectives of SEBI
1. To regulate the functioning of stock exchanges
2. To protect the right of investors and provide safety to their investment
3. To prevent fraudulent activities like price rigging, insider trading etc.
4. To regulate the activities of intermediaries (brokers, sub-brokers, underwriters
etc.)
5. To develop a code of conduct for intermediaries
FUNCTIONS OF SEBI
1. REGULATORY FUNCTIONS
2. DEVELOPMENTAL FUNCTIONS
3. PROTECTIVE FUNCTIONS

1. Regulatory Functions
a. Registration of brokers, sub-brokers and other players in the security market
b. Registration of mutual funds
c. To regulate the activities of stock brokers, portfolio managers, merchant
bankers, underwriters etc.
d. To regulate the takeover bids by companies
e. To regulate stock exchanges and intermediaries by calling for information,
conducting inspections/enquiries, through auditing etc.
f. Levying fees and other chares

2. Developmental Functions
a. To provide training to intermediaries
b. Conducting research and publishing information; which can bring development
to stock market
c. Undertaking measures to develop the capital markets by adapting a flexible
approach.

3. Protective Functions
a. SEBI protects the interest of investors by performing following activities
b. Check Price Rigging: - Price rigging refers to the manipulation of security prices
with an intend to cheat the investors. SEBI prohibits such practice
c. Prohibits Insider Trading: - insider trading means buying or selling securities
based on non-public, material insider information. SEBI keeps a strict check
when insiders are trading company9s securities
d. SEBI prohibits misleading statements
e. SEBI undertakes steps for investor protection
f. Promotion of fair practices and code of conduct in stock market.

MULTIPLE CHOICE QUESTIONS

1. Surya Ltd immediately requires 1 crore rupees to buy certain raw materials for
next two months. Where they can approach?
a) Capital market b) Money Market c) Both a) and b) d) None of the above
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 2. ……. helps directly in capital formation
a) Primary Market b) Secondary market c) Both a and b d) None of the above

2. Ms. Bindu sure that her share certificate won9t get damaged or no one can steal.
What may be the reason?
a) Rematerialisation b) Dematerialisation c) Both a and b d) None of the above
4. Mr. Tilak wants to trade in stock exchange. If so, he must open a ………. Account
with the help of stock broker
a) Savings account b) Demat account c) Current account d) None of the above

5. SEBI was granted legal status in the year ………...

a) 1988 b) 1991 c) 1992 d) 1990
6. MATCH THE FOLLOWING
1 They are the link between investors (i) Insider Trading
and depository organization
2 Manipulating the price of securities to (ii) Demat
attract investors
3 It is an account which holds securities (iii) Stock Exchange
electronically
4 It provides a platform to trade second- (iv) Depository Participants
hand securities
5 Trading of securities by using non- (v) Price Rigging
public, material information

ASSERTION AND REASON TYPE:

Select the suitable option from the following to answer questions from 7 to 11
(a) Both Assertion (A) and Reason (R) are true.
(b) Both Assertion (A) and Reason (R) are false.
(c) Assertion (A) is true and Reason (R) is false.
(d) Assertion (A) is false and Reason(R) is true.

7 Assertion (A). Financial market mobilises savings into most productive uses.
Reason (R). Financial market provides choice of different investment avenues
to
savers, which helps them to mobilise surplus funds to most productive uses.
8 Assertion (A). Money market deals with instruments having maturity period
more than one year.
Reason (R). money market instruments can be used to meet working capital
requirements.
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 9 Assertion (A). Capital market facilitates the process of economic development.
Reason (R). Capital market directly helps in capital formation, which is vital for
the economic development.
10 Assertion (A). Stock exchange provides ready market for the trading of existing
securities.
Reason (R). The presence of ready market provides liquidity and marketability
to existing securities.
11 Assertion (A). The increase in investors population resulted in variety of trading
malpractices by companies, stock market intermediaries etc.
Reason (R). SEBI was established by Indian Government to prevent various
trading malpractices.

VERY SHORT ANSWER TYPE QUESTIONS

12 <SEBI is the watchdog of security market=. Comment on it
13 <Stock market promotes habits of savings and investments=. Explain.
14 Ankita is a company secretary in XYZ Ltd. From inside the company, she
came to know that the company is going to acquire the business of some other
companies. Ankita thinks that, due to the acquisition process, market price of
the share may rise. Considering this, Ankita bought large number of shares of
XYZ Ltd. This acquisition news was unknown to the public.
a) Identify the malpractice used by Ankita.
b) Name the body which regulates such malpractices
15 Rohit holds 1500 shares of ABC Ltd. He likes to sell 750 shares out of total.
a) Which market should be selected for selling those shares
b) How would the price be determined in the above market
16 Money market is essentially a market for working capital needs, discuss.
SHORT ANSWER TYPE QUESTIONS
17 PQR Ltd. Wants to expand their business. They are in need of 100 crore rupees
for this expansion process. Expansion project includes starting new product
lines, establishing branches in different states, purchase of sophisticated
technology etc. Management team is planning to raise the required amount
from financial market. You have to help the management by answering
following questions;
a) Identify the mentioned need. Whether it is working capital requirement
or long-term requirement?
b) Identify the market which can to meet the requirements of the
company.
c) Point out any of the two features of the identified market.

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 18 Financial market plays a vital role in the allocation of limited resources in an
economy by performing many significant functions. Explain three such
functions.
19 Financial market is a mechanism for creation and exchange of financial assets.
It connects the surplus (savers) unit of an economy with deficit unit (investors).
By connecting, financial market channelizes funds to most productive avenues.
Through stock exchanges, it also promotes easy trade of financial securities.
Apart from that, stock exchanges also educate investors and prospective
investors on many aspects related to capital market.
a) Identify two functions performed by financial market from the above passage
b) Explain two functions of stock exchange, other than those mentioned in the
above paragraph
20 Supriya9s grandmother who was unwell, called her and gave her a gift packet.
Supriya opened the packet and saw many crumpled share certificates inside.
Her grandmother told her that they had been left behind by her late
grandfather. As no trading is now done in physical form, Supriya wants to
know the process by adopting which she is in a position to deal with these
certificates.
A. Identify and state the process.
B. State two reasons due to which the share is not traded physically?

21 SEBI conducts workshop sessions to the intermediaries about the changes

happening in the stock market. SEBI always stands for the development of
various market participants. It conducts researches on <innovations happening
in the area of stock market=. They publish the findings of such researches
through journals. That helps market participants to gain useful information.
a) Identify the major function performed by SEBI
b) Point out the sub functions by quoting the lines

LONG ANSWER TYPE QUESTIONS

22 Anmol works as a sales executive in an Automobile company in Delhi. While
helping a customer in the sales process he overhears him at the table saying that
the he has made huge profits by investing in stock market. That made Anmol to
think about <channelising his surplus savings to stock market=. He is totally
unaware of the trading processes related to stock exchange.
Imagine that you are a stock market consultant and help Anmol to understand the
steps involved in the trading process of securities.

23 After doing a course in stock trading, Madhav downloaded one trading app from the
google play store and he started trading securities. That helped him to earn sufficient

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 profits. Adwaith, a friend of Madhav, having lot of money in his pocket is finding
difficulty in appreciating the money. Madhav suggested Adwaith to open a Demat
account with any of the stock broker. An Initial Public Offer (fresh issue of securities
for the first time) of a blue-chip company was on the way. Madhav wanted to invest
in that. As Adwaith was not that much confident, he decided to buy some existing
securities from the stock market. In the context above case:
(a) Identify the two different types of capital market being referred to by quoting
lines from the para.
(b) State any four differences between the two types of capital markets as
identified

24. JKL Ltd, a well-known steel manufacturing company has managed to capture major
market share in this sector. Recently, it was found out that the directors of the
company have tried to manipulate the price of its securities, in order to attract
investment from the general public. Through investigation, that fraud was
detected by SEBI. SEBI is considering action against these directors.
a) Name the malpractice done by the directors of this company.
b) Mention other functions of SEBI under same category.
25. Ms. Ananya had lost her physical share certificates of LKG Ltd while travelling in
a transport bus. After a long time, she was able to trace out her lost certificates. Now she
is facing difficulties in selling those shares. One of her friends suggested to convert those
physical certificates into electronic format. Friend had an opinion that <it would be easy
to convert electronic securities into cash=. On the basis of the above discussion, answer
the following questions;
a) Name the account which is opened to convert physical securities into electronic
form
b) With whom will she have to open this account?
c) Which are the two major organizations, in India, who keep securities in electronic
form?
26. STV Ltd issued prospectus for the subscription of its shares for Rs.1 crore in 2024.
The issue was oversubscribed by ten times. The company issued shares to all applicants
on pro-rata basis. During an inspection, SEBI found out that the company used some
misleading statement in its prospectus. SEBI imposed a penalty on STV Ltd. Also
banned three of the directors from dealing in security market for next five years. Identify
the major function performed by SEBI in this case.

ANSWER KEY
1. Money Market

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