Investing in Stock Markets 2019 Solved Question Papers | Gauhati University | B.Com 1st Sem

Gauhati University Solved Question Papers

Investing in stock markets’ 2019 (Honours Generic)

Paper: COM-GE-1046 (B)

Table of Contents

1. Answer the following as directed:       1×10=10

(a) “The basic objective of investor is to minimize the risk and maximize the return on investment.” Write whether the statement is true of false.

(b) In India, Mutual fund scheme was started in:

  1. 1964
  2. 1987
  3. 1992
  4. None of the above    (Choose the correct alternative)

(c) Which of the following is not associated with the open-ended mutual fund?

  1. It has a fixed maturity period.
  2. The investors can subscribe their fund at any time.
  3. It provides prompt liquidity to investors.
  4. The investors have an option to redeem their holding at any time.     (Choose the correct alternative)

(d) Which of the following is the oldest stock exchange of India?

  1. Calcutta stock exchange
  2. Ahmadabad stock exchange
  3. Bombay stock exchange
  4. Gauhati stock exchange          (Choose the correct alternative)

(e) Who is the regulatory authority of Indian Stock Market?

Ans: SEBI is the regulator authority Indian Stock Market.

(f) Which of the following is related in case of market order of investor?

  1. To buy shares at lowest possible price.
  2. To sale shares at highest possible price.
  3. Both i) and ii)
  4. None of the above    (Choose the correct alternative) (Market order is an order to buy or sale securities immediately at the current market price available)

(g) Write the full form of CRISIL.

Ans: Credit Rating Information Services of India Limited

(h) Which of the following is the feature of derivative?

  1. It is an instrument whose value depends upon the value of some underlying assets.
  2. It arises out of contract between two parties.
  3. It may be financial or commodity derivatives.
  4. All of the above       (Choose the correct alternative)

(i) Security market is a market for equity, debts and derivatives.” This statement is:

  1. True
  2. False

(j) Liquidity ratio of a company basically consists of:

  1. Current ratio
  2. Liquid ratio
  3. Both i) and ii)
  4. None of the above    (Choose the correct alternative)

2. Answer the following questions in about 50 words each: 2×5=10

(a) Give the meaning of investment.

Ans: Investment is the employment of funds with the aim of getting return on it. In general terms, investment means the use of money in the hope of making more money. In finance, investment means the purchase of a financial product or other item of value with an expectation of favorable future returns.

(b) What is online trading of stock?

Ans: Online trading of stocks means trading in securities in stock market with the help of internet and computers or mobile. Users can search different stocks online and make investment in the stock of their interest at a convenience of home. They need not took the help of any stock broker.

(c) Define NAV.

Ans: Net Asset Value (NAV) refers to the value of each unit of a mutual fund scheme which is equivalent to:

Unit-holders’ Funds in the Scheme ÷ No. of Units

It can also be calculated as:

(Total Assets minus Liabilities other than to Unit holders) ÷ No. of Units

(d) What is a commodity derivative?

The term ‘commodity Derivative’ stands for a contract whose price is derived from or is dependent upon an underlying commodity. The underlying commodity could be metals such as gold, silver, steel aluminum, gas, agriculture products and minerals.

(e) Give an idea of primary market.

Ans: Primary market which is also called new issue market represents a market where new securities i.e. shares, debentures and bonds that have never been previously issued are offered. It is a market of fresh capital. The main function of this market is to facilitate the transfer of funds from willing investors to the entrepreneurs who need funds.

3. Answer any four questions of the following in about 150 words each: 5×4=20

a) Explain the procedure of buying and selling of securities in the stock market.

Ans: Procedure of buying and selling of securities in the stock market:

1) Selecting a broker: First step in buying and selling securities in the stock market is to select a stock broker because transactions in stock market can be done only through SEBI registered stock broker. Some of the popular broking houses are: Zerodha, Sharekhan, Angel Broking, SMC global.

2) Demat account: Second step in trading in securities is to open a demat account with selected broker. Demat account is an account in which all the securities bought are deposited in digital form. Now a days, demat account can be opened at a convenience of home using various mobile application promoted by broking house. All the demat accounts are opened with depository participants. At present there are two depository participants in India – CDSL and NSDL.

3) Placing order: After opening demat account, investors can place order to buy or sale securities using mobile application of their stock brokers. Also order can be place through email or phone. Orders placed to buy or sale securities may be market order, limit order or stop loss order.

4) Execution of the order: After placing order, the order gets executed as per the instructions of account holder. After orders are executed, a contract note is prepared and signed by the stock brokers and emailed to the account holder. The contract note contains the name, quantity, price of the stock bought or sold, and also brokerage charged and STT and other taxes levied.

5) Settlement: The last stage in the procedure of buying and selling of securities is the transfer of securities from seller’s demat account to the buyer’s demat account which is called settlement. Settlements of securities are done on T+2 basis. Here “T” means Trading day T+2 means 3rd day from the date of trading.

b) Mention the four ratios generally used by investors to evaluate the performance of a company.

Ans: The accounting ratios used by the investors to evaluate the performance of a company:

a) Liquidity Ratios: These ratios show relationship between current assets and current liabilities of the business enterprise. Example: Current Ratio, Liquid Ratio.

b) Leverage Ratios: These ratios show relationship between proprietor’s fund and debts used in financing the assets of the business organization. Example: Capital gearing ratio, debt-equity ratio, and proprietary ratio. This ratio measures the relationship between proprietors fund and borrowed funds.

c) Efficiency/Activity Ratio: This ratio is also known as turnover ratio or productivity ratio or efficiency and performance ratio. These ratios show relationship between the sales and the assets. These are designed to indicate the effectiveness of the firm in using funds, degree of efficiency, and its standard of performance of the organization. Example : Stock Turnover Ratio, Debtors’ Turnover Ratio, Turnover Assets Ratio, Stock working capital Ratio, working capital Turnover Ratio, Fixed Assets Turnover Ratio.

d) Profitability Ratio: These ratios show relationship between profits and sales and profit & investments. It reflects overall efficiency of the organizations, its ability to earn reasonable return on capital employed and effectiveness of investment policies. Example : i) Profits and Sales : Operating Ratio, Gross Profit Ratio, Operating Net Profit Ratio, Expenses Ratio etc. ii) Profits and Investments : Return on Investments, Return on Equity Capital etc.

c) Write a short note on the history of mutual fund.

Ans: Mutual Funds History

In general term, a mutual fund is an investment vehicle for medium and long term investors where they can pool their funds for investing in a diversified portfolio with a view to earn decent return and appreciation in their value. The fund so collected is management by the professional fund managers so investors need not worry too much about their investment. Mutual fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. Through investment in a mutual fund, an investor can get access to equities, bonds, money market instruments and/or other securities that may otherwise be unavailable to them and avail of the professional fund management services offered by an asset management company.

Though the concept of mutual fund is a new concept in Indian securities market, but it is not new for international security market. Mutual funds first established in the Dutch Republic in the year 1772-73. Its main aim was to provide small investors an opportunity to diversify their investments. But mutual funds get popularity when they are introduced in United States in 1890s. That time mutual fund institutions deals only in closed ended funds. Since there is a lack of liquidity in closed ended fund, investors didn’t want to block their money in closed ended funds in the early phase. But with the introduction of open-ended funds on 21st Mar, 1924, investors started to invest more money in mutual funds.

The mutual fund industry in India started in 1963 with the formation of Unit Trust of India, at the initiative of the Government of India and Reserve Bank of India. The first mutual fund scheme was launched by UTI in 1964. Earlier private players are not allowed in mutual fund industry in India. But With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian investors a wider choice of fund families.

d) Describe the factors affecting the choice of mutual fund.

Ans: Factors affecting the choice of mutual funds:

1) Investment objective

This the most important factor in selecting any mutual fund. The fund so selected must fit into the investor’s overall investment objective. For example, if an investor want stable and regular dividend income then he must select regular dividend paying debt and equity funds not growth oriented funds.

2) Past risk-adjusted returns

Past performance of the mutual fund must be looked into before selection. If a mutual fund scheme giving a risk adjusted return of 15% to 20% in previous 3 to 5 years, then it can be considered for investment.

3) Experience and longevity of the Mutual fund management team

A stable fund management team will perform better over a longer period of time as compared to those whose management team changes frequently. The main reason for this is a stable fund management team develops consistency in investment strategy.

4) Expenses ratio

Expense ratio is a key consideration while selecting any mutual fund. At the time of buying mutual fund units there is no entry load, but if you exit from the fund before the stipulated period of time, exit load will be levied which may range from 1% to 2%. Also transaction cost such as operational costs, administrative costs, marketing costs etc. are debited from the NAV of the fund. These expense ratios must be compared with the return before selecting any mutual fund scheme.

5) Tax implications

Short term Capital gain Tax @ 15% levied if equity funds are sold before a period of 1 year or debt funds sold before a period of 3 years. Also LTCG exceeding Rs. 1,00,000 will be taxable @ 10% without the benefit of indexation. Tax implications must be taken into consideration before making any investment on mutual funds.

e) Briefly explain the participants of derivative market.

Ans: Click here for Detailed answer

f) Write an explanatory note on the following: Load and no-load mutual funds Or IPO and FPO

Ans: Load Mutual funds: A load mutual fund is one in which a charge is levied at the time of purchase or sale of mutual fund units. These charges are used by mutual fund companies in marketing and distribution.

Non load mutual funds: A no-load mutual fund is one in which no charge is levied at the time of entry or exit if units are hold for a specified period.

IPO – Initial Public Offer

Initial public offer (IPO) is the most popular method of raising capital by unlisted companies. An unlisted company (which is not listed in any stock exchange) announces IPO when it plans to raise capital through the sale of shares to the public for expansion or repayment of debt or for disinvestment. It is simply a process of selling securities for the first time by an unlisted company to the public in the primary market. To raise capital through an IPO, a public limited company issue prospectus containing information about the company and the terms of issue. The price at which IPO is made is decided by the company after taking into consideration the guidelines issued by the SEBI. Price of an IPO can be fixed or can be fixed through book building process. In book building process, a price range is fixed say 25 to 28, the lower level is called the floor price and upper limit is called cap price and final price is fixed on the basis of applications received from the public.

FPO – Follow-on Public Offer

Follow-on public offer (FPO) is a method of raising capital by companies which are already listed in stock exchange. Process of FPO starts after an IPO. FPO is a further issue of securities to the existing shareholders or public in general or some selected groups with a view to raise additional capital. FPOs are of two types – dilutive offering and non-dilutive offering. In dilutive offering the companies releases more shares to raise more funds. In non-dilutive FPOs, the companies release some of their shares to the public. Price of an FPO is normally near to the market price of the shares.

Investing in Stock Market Question Paper’ 2019 – Gauhati University

4. Answer the following questions in about 600 words each:   4×10=40

(a) What is meant by mutual fund? Explain its advantages and disadvantages.    2+8

Ans: Mutual Funds Meaning

In general term, a mutual fund is an investment vehicle for medium and long term investors where they can pool their funds for investing in a diversified portfolio with a view to earn decent return and appreciation in their value. The fund so collected is management by the professional fund managers so investors need not worry too much about their investment. Mutual fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. Through investment in a mutual fund, an investor can get access to equities, bonds, money market instruments and/or other securities that may otherwise be unavailable to them and avail of the professional fund management services offered by an asset management company.

Mutual Funds advantages and Disadvantages
Mutual Funds Advantages

A mutual fund is a special type of institution which acts as an investment intermediary and channelizes the savings of large number of people towards the corporate securities in such a way that investors get steady returns and capital appreciation at low risk. Mutual funds are gaining popularity now days due to the following advantages:

1. Professional Management: A small investor cannot be an expert in portfolio management so there is a chance of loss for small investors. Mutual funds offer investors the opportunity to earn an income or build their wealth through professional management of their investible funds. There are several aspects to such professional management viz. investing in line with the investment objective, investing based on adequate research, and ensuring that prudent investment processes are followed.

2. Diversification: It is not possible for small investors to invest in variety of sectors. They mainly invest in few selected securities and rely on them for good return. An investor in a mutual fund gets the advantage of being invested in the entire fund’s portfolio which is invested in a diversified sector. Thus, even a small investment of Rs 5,000 in a mutual fund scheme can give investors a diversified investment portfolio.

3. Economies of large Scale investment: The pooling of large sums of money from so many investors makes it possible for the mutual fund to engage professional managers to manage the investment. Individual investors with small amounts to invest cannot, by themselves, afford to engage such professional management.

4. Liquidity: The most peculiar advantage of a mutual fund is that investments made in its schemes can be converted into cash promptly with incurring any heavy expenditure. As per the regulations of SEBI, is becomes necessary for every mutual funds institutions is to ensure liquidity for its investors.

5. Tax Benefits: Mutual funds are not liable to pay tax on the income they earn. If the same income were to be earned by the investor directly, then tax may have to be paid in the same financial year. Specific schemes of mutual funds (Equity Linked Savings Schemes) give investors the benefit of deduction of the amount invested, from their income that is liable to tax. This reduces their taxable income, and therefore the tax liability.

Mutual Funds Disadvantages

In spite of various advantages, mutual funds suffer from various disadvantages some of which are listed below:

1. Lack of portfolio customization: Mutual fund unit-holder is just one of several thousand investors in a scheme. Once a unit-holder has bought into the scheme, investment management is left to the fund manager. Thus, the unit-holder cannot influence what securities or investments the scheme would buy.

2. Liquidity crisis: Mutual funds in India face liquidity problems. Investors are not able to draw back from some of the schemes due to lack of no easy exit route. Recently, we saw that Franklin Templeton has defaulted in redemption of mutual funds during lock down period.

3. Choice overload: Over 1,200 mutual fund schemes offered by 38 mutual funds – and multiple options within those schemes – make it difficult for investors to choose between them.

4. No control over costs: All the investor’s moneys are pooled together in a scheme. Costs incurred for managing the scheme are shared by all the Unit holders in proportion to their holding of Units in the scheme. Therefore, an individual investor has no control over the costs in a scheme.

5. High Management Fee: The Management Fees charged by the fund reduces the return available to the investors.

Or

Explain four types of instruments that are used in investment of fund.                  10

Ans: Click here for detailed answer

(b) Discuss in detail the functions of capital market.                         10

Ans: Meaning of Capital Market

Capital Market is generally understood as the market for long-term funds. This market supplies funds for financing the fixed capital requirement of trade and commerce as well as the long-term requirements of the Government. The long-term funds are made available through various instruments such as debentures, preference shares, and common shares. The capital market can be local, regional, national, or international. The capital market is classified into two categories, namely,

  • Primary market or new issue market, and
  • Secondary market or stock exchange.

Primary Market (New Issue Market): A primary market refers to any market where new shares of stock are sold. The primary market is the entry market for companies and investors, where a company or institution that requires initial or additional capital sells its shares or financial instrument to the investors. For example, Initial Public Offering (IPO), public offer, rights issue and bond issue are done on the primary market. The primary market is also unique that the initial buyer is the only person who can exchange the securities for funds. When companies are willing to go for publicly listed on the stock exchange and wants to collect funds from general investors, they first sell their financial instrument in the primary market. Primary market is the first place for trading financial instruments including stocks and bonds.

Functions of Primary Market

The main function of a primary market can be divided into three service functions. They are: origination, underwriting and distribution.

  1. Origination: Origination refers to the work of investigation, analysis and processing of new project proposals. Origination begins before an issue is actually floated in the market. The function of origination is done by merchant bankers who may be commercial banks, all India financial institutions or private firms.
  2. Underwriting: When a company issues shares to the public it is not sure that the whole shares will be subscribed by the public. Therefore, in order to ensure the full subscription of shares (or at least 90%) the company may underwrite its shares or debentures. The act of ensuring the sale of shares or debentures of a company even before offering to the public is called underwriting. It is a contract between a company and an underwriter (individual or firm of individuals) by which he agrees to undertake that part of shares or debentures which has not been subscribed by the public. The firms or persons who are engaged in underwriting are called underwriters.
  3. Distribution: This is the function of sale of securities to ultimate investors. This service is performed by brokers and agents. They maintain a direct and regular contact with the ultimate investors.

Secondary market or stock exchange: Stock exchange is a specific place, where trading of the securities, is arranged in an organized method. In simple words, it is a place where shares, debentures and bonds (securities) are purchased and sold. The term securities include equity shares, preference shares, debentures, government bonds, etc. including mutual funds.

Role/Functions of stock exchange in capital market

Presence and vibrant functioning of a stock exchange is necessary for a developing economy. It reflects healthy financial and investment conducive atmosphere in the economy. The Indian securities market is considered as one of the most promising emerging markets. It is one of the top eight markets of the world. The stock exchange plays a vital role in the process of raising resources for the development of corporate sector. In the absence of the stock exchange it would be impossible for private enterprises, industries and entrepreneurs to survive and grow. A stock exchange plays a significant role in a capital market which are mentioned below:

  1. Encourages capital formation: A common investor is attracted to capital market. Today investor prefers to divert his surplus and savings in the securities like shares, debentures, mutual funds etc. As a result new capital formation is speeded up.
  2. Resource Mobilsation: Due to continuous buying and selling of the securities the resources of the economy flow from one company to other company giving comparatively higher returns. This helps mobilisation of resources.
  3. Help in repaid economic development: The stock exchanges help in the process of rapid economic development by speeding up the process of capital formation and resource mobilization. It helps in raising the medium and long term capital for the development and expansion of the companies. New industries and commercial enterprises easily get capital funds through a stock exchange.
  4. Flexibility in investments: The stock exchanges provide liquidity to the investment made in the securities. As there are multiple options, investors can flexibly go on switching their investment where it is more beneficial?
  5. Value addition to the securities: Listing of shares on a stock exchange adds to the prestige and reputation to companies. With the advantage of listed shares it can raise loans from corporate sector.
  6. Protects investor’s interest: All the transactions in the stock exchanges are effected and controlled by the Securities Control (Regulation) Act 1956. The stock exchanges protect the interests of the investors through the strict enforcement of their rules and regulations. The malpractices of the brokers are punishable with heavy fine, suspension of their membership and even imprisonment.
  7. Motivation to Management: A stock exchange allows the trading of listed securities only. Listing procedure requires to comply with certain guidelines for protecting the interests of investors and obviously are under strict supervision of stock exchange. If companies do not comply with the rules and regulations of the exchange, the shares of a company can be delisted. To avoid such unfavorable and undesirable consequences every company manages its affairs more cautiously and effectively.

Or

Explain the various tools used for the analysis in the future prospect of a company.         10

Answer: Coming Soon

(c) In which year SEBI came into effect? Also point out the principal functions of SEBI.     2+8=10

Ans: Securities Exchange Board of India (SEBI) was set up in 1988 to regulate the functions of stock market but it was granted legal status in the year 1992. SEBI is a body corporate having a separate legal existence and perpetual succession.

Functions of SEBI: SEBI is considered to be watch dog of securities market. It plays a significant role in the regulations and development of stock market. Functions of SEBI are mainly divided into three (3) categories:

1. Protective Functions of SEBI: Protective functions are those which are performed by SEBI to protect the interest of investor and provide safety of investment. It plays a significant role in maintaining faith of investors in stock market. Protective functions of SEBI include:

(i) Prohibition and control Price Rigging: Price rigging refers to an act of manipulation of prices of securities by potential traders with the object of inflating or depressing the market price of securities. This is done to defraud and cheat the small investors. SEBI prohibits such practices and can take actions against those who are found involve in such activities.

(ii) Prohibition of Insider trading: Insider are those person which have connection with the company such as directors, promoters etc. These insiders have sensitive information which is not available to people at large. Such information can affects the price of securities and insiders can took the advantage of such information and if they use this information to make profit in stock market, then it is known as insider trading. SEBI keeps a close eye when insiders are buying securities of the company and takes strict action if anyone in found involved in insider trading.

(iii) Prohibitions of fraudulent and Unfair Trade Practices: Any statement by the company which induces their investors to buy or sale their shares is considered to a fraudulent and unfair trade practices. SEBI does not allow the companies to make misleading statements and can take strict action if companies are found involve in these acts.

(iv) Investor education: SEBI undertakes steps to educate the investors about the securities market so that they are able to evaluate the securities of various companies before investment and select the most profitable securities.

(v) SEBI promotes fair practices and code of conduct in security market by taking following steps:

– SEBI has issued guidelines to protect the interest of debenture-holders wherein companies cannot change terms in midterm.

– SEBI is empowered to investigate cases of insider trading and has provisions for stiff fine and imprisonment.

– SEBI has stopped the practice of making preferential allotment of shares unrelated to market prices.

2. Developmental Functions: Development functions are those which are performed by the SEBI to promote and develop activities in stock exchange and increase the trading and investment in stock exchange. SEBI perform the following development functions:

(i) SEBI conducts training of intermediaries of the securities market. SEBI also approved various courses for investors and intermediaries.

(ii) SEBI tries to promote activities of stock exchange by adopting flexible and adoptable approach in following way:

(a) Now internet based trading through registered stock brokers is permitted by SEBI. Now you can trade at the convenience of your home by simply downloading and registering mobile application of any registered broker.

(b) Underwriting is now made optional by SEBI which reduces the cost of issue of securities.

(c) SEBI now permitted the initial public offer through stock exchange. Previously companies were issuing IPO only in primary market.

3. Regulatory Functions: These functions are performed by SEBI to regulate the business in stock exchange. To regulate the activities of stock exchange following functions are performed:

(i) SEBI has framed rules and regulations and a code of conduct to which every intermediary of stock market such as merchant bankers, brokers, underwriters, etc must be adhered to.

(ii) All intermediaries of the stock market are brought under the regulatory purview of SEBI and more restrictions are imposed on private placement of shares.

(iii) SEBI registers and regulates the working of stock brokers, sub-brokers, share transfer agents, trustees, merchant bankers and all those who are associated with stock exchange in any manner.

(iv) Mutual funds institutions are also registered and regulated by SEBI.

(v) Takeover of the companies are also regulated by SEBI.

(vi) Inquiries and audit of stock exchanges are conducted by SEBI at regular intervals.

Or

Distinguish between:                     5+5=10

i) Open-ended mutual fund and closed-ended mutual fund

Ans: Open ended funds

Open ended funds are those funds which are open for investors to entry or exit at any time, even after the NFO. In such funds, maturity period is not specified and investors can enter or exit from the fund any time they with. The most important feature of this type of fund is that it offers liquidity to the investors. These funds are not listed on any stock exchange but investors can redeem their investors directly through the mutual funds institutions in which they have invested. Entry and exit price of the units of open ended mutual funds are calculated by dividing net assets under management of the fund with number of units outstanding.

Closed ended funds

Closed ended funds are those which have a fixed maturity period, normally three to five years. Investors can buy units of a closed-ended scheme from the fund only during its NFO. After the close of NFO, investors can buy or sale units of close-ended fund only through stock exchange where these funds are listed. These funds are listed on stock exchange where investors can sale their units of mutual funds at the prevailing market price. Prices of units of closed ended funds are determined by the forces of demand and supply in stock exchange. These funds are ideal for long term investors.

Difference between Open Ended and Closed Ended Funds

Basis Open Ended Funds Closed Ended Funds
Lock in period It has no lock in period and investors can enter or exit any time they wish. It has a lock in period of 3 to 5 years.
Listing These funds are not listed on any stock exchange. These funds are listed on stock exchanges.
Entry The investors can subscribe this fund at any time. The investors can enter into these funds only through NFO.
Redemption The investors have an option to redeem their holding at any time. Closed ended fund can be redeemed only through stock exchange or at the end of lock in period.
Investors perspective These funds are suitable for short term investors. These funds are suitable for long term investors.
ii) Limit order and Market order

Ans: Limit order:

A limit order is an order to buy or sell a security at the price we have set or better price. The main advantage of this order is that the trade will be executed at a price entered by us or better price.

For Example: If you place a limit order to buy Trident Shares at Rs. 40, you will get Trident Shares at Rs. 42 or lower if available. Again if you place a limit order to sale Tata Power Shares for Rs. 999, you will get Rs. 999 per share for sale or higher if buyers are available at this price.

Market Order:

A market order is an order to buy or sell a specific security at the best available price. These orders are executed as soon as it reaches the exchange. For a sell order, a market order generally will execute at or near to the current bid price and for a buy order, a market order generally executed at or near to the current ask price.

(d) What is meant by forward contract? Also point out the difference between forward contract and future contract. 4+6=10

Ans: Forward Contracts: A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like expiration date, price and quantity are negotiated bilaterally by the parties to the contract. On the expiration date, the contract has to be settled by delivery of the asset. The forward contracts are normally traded outside the exchanges.

The salient features of forward contracts are as given below:

  • They are bilateral contracts and hence exposed to counter-party risk.
  • Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality.
  • The contract price is generally not available in public domain.
  • On the expiration date, the contract has to be settled by delivery of the asset.
  • If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party, which often results in high prices being charged.

Future Contract: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered and a standard timing of such settlement. A futures contract can be setteled prior to maturity by entering into an equal and opposite transaction. The standardized items in a futures contract are:

  • Quantity of the underlying
  • Quality of the underlying
  • The date and the month of delivery
  • The units of price quotation and minimum price change
  • Location of settlement

Differentiate Between Forward and Future contracts

At a basic level, futures are also forwards but in a more organized and regulated form that are executed through exchange. The exchange acts a guarantee to any counter-party risk. To summarize, the main differences between forwards and futures are:

Basis Forward contracts Future contracts
Trading Forward contracts are traded over the counter. Futures contracts are traded in stock exchange.
Regulation Unlike futures, Forward contracts are self regulated. Future contracts are regulated by SEBI.
Negotiation Forward contracts can be negotiated between buyers and sellers. Future contracts are standardised where conditions relating to date, quantity and delivery are fixed. It cannot be negotiated between buyer and seller.
Settlement Forwards contracts are settled on  a maturity date. In futures the balance is settled everyday (also called mark to market settlement).
Transferability Forward contracts are contracts between two parties and hence not transferable to third parties. Future contracts are tradable and transferable.
Initial margin There is no need of initial margin in case of forward contracts. Initial margin is required in case of future contract.
Counter party risk Forwards are bilateral contract and hence counter party risk in case of forward contracts are very high. Counter party risk in case of future contracts are less.
Liquidity Forward contracts are less liquid and also there is a high chance of default by a party. Future contracts are more liquid because participants involved in future contracts are more.
Contract price Contract price of  a forward contract is not known to the public. Prices of various future contracts are available in stock exchanges.

Or

Write note on any two of the following:   5×2=10

i) Benefits of credit rating

Ans: Analysis of credit risk associated with the financial instruments of a business entity is called credit rating. Credit rating helps in the assessment of financial solvency of business entities. Credit rating are assigned on the basis of the past lending or borrowings and credit worthiness of the entity. Some of the popular credit rating agencies are CRISIL, ICRA, Standard and Poor’s, Moody’s Investor Service etc.

Benefits of credit rating:

a) Helpful in taking investment decision: Credit rating report helps the investor in selecting quality instruments. Highly rated instruments are considered safe for investment.

b) Continuous monitoring of financial instruments: Credit rating is a continuous approach and upgrade or downgrades of instruments are done by credit rating agencies regularly on the basis of market factors. So, it is helpful for investors in their investments decisions.

c) Help business entity to raise additional funds: Highly rated credit instruments helps companies in raising additional funds in case of need of funds for expansion or other commercial activities.

d) Improve Goodwill: Highly rated instruments have a significant impact on the image of the issuer. Investors feels safe when they invests in highly rated instruments and also they are always ready to give additional funds.

ii) Common mistakes while investing

Ans: Common mistakes while investing in stock market:

Stock market is place where one can make tremendous wealth is long period of time. But 90% investors fails to do so because of the some common mistakes which are listed below:

  1. Investing is not gambling: Majority of people in our country considered investing in stock market as gambling. They enter into market to become rich over the night. But one must understood that investing in stock market is a pure business.
  2. Avoid tips and recommendations: Instead of doing own research, people invest blindly in stock market on the tips and recommendation of other which can cause huge losses to the investors. Always do your own research while investing in stock market.
  3. Unrealistic expectations: Multiple time unrealistic return in a very short period is one of the causes of losses in stock market. One must understood that growth in share price depends on the profitability of the companies. If the profits are growing at the rate of 20% per annum, one must expect 200% return a particular stock.
  4. Beware of beast of stock market: One must not enter into such stock whose financial position is unsound and which can be easily operated by the operators.
  5. Avoid over trade: Over trade in stock market must be avoided. It can cause huge losses. Not making losses is also very important in stock market.
  6. Don’t fall in love with any stock: Investors must not fall in love with a particular stock.
  7. Last but not the least; use your own mind and knowledge while investing in stock market.

iii) The role of broker in stock market

Ans: An individual cannot buy or sell securities directly at stock exchange. He can do so only through a broker. So he has to select a broker through whom the purchase or sale is to be made. Brokers are commission agents who act as an intermediary between buyers and sellers of securities in the primary and secondary markets.

Role and duties of stock brokers:

The duties of a broker can be divided into three categories:

A) General Duties:

1. Integrity: A stock broker maintains high standards of integrity in the conduct of all his business activities.

2. Exercise of due care and diligence: A stock broker shall act with due care and diligence in the conduct of his business.

3. Manipulation: A stock broker shall not indulge in manipulations of securities or spreading rumours in stock market.

4. Malpractices: A stock broker shall not create false market or do not indulge in any act which is detrimental to the interest of the investors.

5. Compliance with statutory requirements: A stock broker along with its sub-brokers shall abide by the all the provisions of the Act and the rules, regulations issued by the Government and SEBI.

B) Duties to the Investors:

1. Execution of orders: A stock-broker shall faithfully execute the orders of buying and selling of securities at the best available market price and not to refuse to deal with a small investors.

2. Issue of contract note: A stock-broker shall issue contract note of all the transactions made by client immediately or on the date of the transactions.

3. Not to Breach the trust: A stock-broker must not share the details of its client with third party.

4. Avoid doing Business with defaulting client: A stock-broker shall not deal or transact business with a client who already defaulted in carrying out his commitments with another stock-broker.

5. Investment Advice: A stock broker shall not make a recommendation to any client who might be expected to rely thereon to acquire or dispose of any securities unless he has reasonable grounds for believing that the recommendation is suitable for such a client.

C) Duties towards its sub-brokers and other stock-brokers:

1. Conduct of dealings: A stock-broker shall co-operate with the other stock-brokers or sub-brokers contracting party in comparing unmatched transactions.

2. Protection of client interests: A stock-broker shall extend fullest co-operation to other stock-brokers or sub-brokers in protecting the interest of his clients regarding their rights to dividends, bonus etc.

3. Advertisement and publicity: A stock-broker shall not advertise his business publicly unless permitted by the stock exchange.

4. Inducement of clients: A stock-broker shall not resort to unfair means of inducing clients from other stock-brokers.

5. False or misleading returns: A stock-broker shall not neglect or fail to refuse to submit the required return and not make any false or misleading statement on any returns required to be submitted to the board and the stock exchange.

iv) Price earnings ratio

Ans: Price Earnings Ratio is the ratio of the current market price of a company’s share in relation to its earnings per share (EPS) which is calculated as:

P/E ratio = Current market price of company’s share/Earning per share (EPS).

Price earnings ratio of a company is of two types:

a) Forward P/E ratio which is calculated by diving CMP with future expected EPS. This ratio shows the future earning prospect of the company and it is effective in stock selection.

b) Trailing P/E ratio which is calculated by diving CMP with past 12 months EPS. This ratio only shows past performance of the company which may or may continue in future. This P/E ratio is less effective as compared to forward P/E ratio.

Price Earnings ratio is commonly used to investors to decide whether a particular stock is overvalued or undervalued. For effective use of P/E ratio one must compare company’s P/E ratio with it peers and also took into consideration forward P/E ratio of the company.

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