Financial Markets and Regulations-1


SKU: AMSEQ-094 Category:

Section – A

Q1: What do you mean by Money Market and Money Market instruments?



Q2: Explain role of depositories.



Q3: What do you mean by Primary Market? Explain its objectives.



Q4: What is Monetary Policy? Explain its objectives, tools and targets in detail.



Q5: Explain theories which decide level of interest rate in any economy.


Section – B

Q1: What do you mean by Financial System? Explain in detail.



Q2: What do you understand by capital market? Discuss capital market instruments.



Q3: Discuss all the participants in a stock market.






Security Scam In India-1991

In April 1992, press· reports indicated that there was a shortfall in the Government Securities held by the State Bank of India. Investigations uncovered the tip of an iceberg, later called the securities scam, involving misappropriation of funds to the tune of over Rs. 3500 Crores8. The scam engulfed top executives of large nationalized banks, foreign banks and financial institutions, brokers, bureaucrats and politicians: The functioning of the money market and the stock market was thrown in disarray. The tainted shares were worthless as they could not be sold. This created a panic among investors and brokers and led to a prolonged closure of the stock exchanges along with a precipitous drop in the price of shares. Soon after the discovery of the scam, the stock prices dropped by over 40%, wiping out market value to the tune of Rs. 100,000 crores. TIle normal settlement process in government securities was that the transacting banks made payments and delivered the securities directly to each other. The broker’s only function was to bring the buyer and seller together. During the scam, however, the banks or at least some banks adopted an alternative settlement process similar to settlement of stock market transactions. The deliveries of securities and payments were made through the broker. That is, the seller handed’ over the securities to the broker who passed them on to the buyer, while the buyer gave the cheque to the broker who then made the payment to the seller. There were two, important reasons why the broker intermediated settlement began to be used in the government securities markets: The brokers instead of merely bringing buyers and sellers together stfu1:ed taking positions in the market. They in a sense imparted greater liquidity to the markets.

• When a bank wanted to conceal the fact. that it was doing a Ready Forward deal, the· broker came in handy. The broker provided contract notes for this purpose with fictitious counterparties, but arranged for the actual settlement to take place with the correct counterparty. This allowed the broker to lay his hands on the cheque as it went from one bank to another through him. The hurdle now was to find a way of crediting the cheque to his account though it was· drawn in favour of a bank and was crossed account payee. It is purely a matter of banking custom that an account payee cheque is paid only to the payee mentioned on the cheque. In fact, privileged (Corporate) customers were routinely allowed to credit account payee cheques in favour of a bank into their own accounts to avoid clearing delays; thereby reducing the interest lost on the amount. The brokers thus found a way of getting hold of the cheques as they went from one bank to another and crediting the amounts to their accounts. This effectively transformed an RF into a loan to abroker rather than to a bank. But this, by itself, would nothave led to the scam because the RF after all is a secured . loan, and a secured loan to a broker is still secured. What was necessary now was to find a way of eliminating the security itself.

Three routes adopted for this purpose were:

• Some banks (or rather their officials) were persuaded to part with cheques without actually receiving securities in return. A simple explanation of this is that the officials concerned were bribed and/or negligent. Alternatively, as long as the scam lasted, the banks benefited from such an arrangement. The management of banks might have been sorely tempted to adopt this route to higher profitability.

• The second route was to replace the actual securities by a worthless piece of paper – a fake Bank Receipt (BR). A BR like an IOU has only the borrower’s assurance that the borrower has the securities which can/will be delivered if/when the need arises.

• The third method was simply to forge the securities themselves. In many cases, PSU bonds were represented only by allotment letters rather than certificates on security paper. However, it accounted for only a very small part of the total funds misappropriated. During the scam, the brokers perfected the art of using fake BRs to obtain unsecured loans from the banking system. They persuaded some small and little known banks – the Bank of Karad (BOK) and the Metropolitan Cooperative Bank (MCB) – to issue BRs as and when required. These BRs could then be used to do RF deals with other banks. The cheques in favour of BOK were, of course, credited into the brokers’ accounts. In effect, several large banks made huge unsecured loans to the BOK/MCB which in turn made the money available to the brokers.


1. Explain flaws in regulation which gives scope to scam-1991 and how that scam helps. in improvement of regulations.

2. Explain roles and responsibilities of brokers and how that was being violated in that scam and what actions should be taken by regulatory bodies to avoid these kinds of frauds.






Section – C


1. The organised financial system comprises the following sub-systems:

I. Banking system

II. Cooperative system

III. Development Banking system

IV. 4.Money markets

V. Financial companies/institutions.

a. I, II, and III above

b. I, II, III and IV above

c. I, III, IV and V above

d. I, II, III, IV, V


2. The formal financial system consists of segments:

a. Financial Institutions, Financial markets, financial instruments and financial services.

b. Financial Institutions, Financial markets and financial instruments.

c. Financial markets, financial instruments and financial services.

d. Financial markets, financial instruments, financial derivatives and financial services.


3. Financial institutions can be classified as banking and non banking financial institutions.

a. True

b. False


4. The main organised financial markets in a country are normally:

a. Money market and capital market.

b. Money market and debt market.

c. Money market and equity market.

d. Money market and derivative market.


5. Examples of primary or direct securities include _________ .

a. Mutual fund and Insurance policies

b. Insurance policies and Bank deposits

c. Bank deposits and Insurance policies

d. Equity shares and debentures


6. The Reserve Bank on India regulates the _______ and Securities and Exchange Board of India (SEBI) regulates _________.

a. Money market, capital market

b. Capital market, Money market

c. Money market and debt market.

d. Money market and derivative market.


7. Secondary securities are also referred to as indirect securities, as they are issued by financial intermediaries to the ultimate savers._______________ are secondary securities.

a. Mutual fund, equity shares and Insurance policies

b. Insurance policies, Bank deposits and Mutual fund

c. Bank deposits, equity shares and Insurance policies

d. Bank deposits, Mutual fund and debentures


8. Interest rates are typically determined by the supply of and demand for ___________in the economy.

a. Commodities

b. Money

c. Manpower

d. Technology



9. If the economic growth of an economy picks up momentum, then the demand for money tends to________, putting upward pressure on interest rates.

a. Go down

b. Stabilize

c. Go up

d. None of the above


10. Inflation is a ______ in the general price level of goods and services in an economy over a period of time.

a. Rise

b. Fall

c. Stabilization

d. None of the above


11. Which of the following are examples of a primary market transaction?

a. A company issues new common stock.
b. An investor asks his broker to purchase 1,000 shares of Microsoft common stock.
c. An investor sells his shares

d. All of the statements above are correct.

12. When the price of a bond is above face value:

  1. The yield to maturity is below the coupon rate.
  2. The yield to maturity will be above the coupon rate.
  3. The yield to maturity will equal the current yield.
  4. The yield to maturity will equal the coupon rate.


13. Which of the following statements is most true?

  1. Yield to maturity is equal to the coupon rate if the bond is held to maturity.
  2. Yield to maturity is the same as the coupon rate.
  3. Yield to maturity is the same as the coupon rate if the bond is purchased for face value.
  4. Yield to maturity is the same as the coupon rate if the bond is purchased for face value and held to maturity.


14. ___________, __________ or _________means the sum mentioned in the capital clause of Memorandum of Association.


a. Nominal, issued or registered capital

b. Nominal, authorised or paid up capital

c. Nominal, paid up or registered capital

d. Nominal, authorised or registered capital


15. _____________means that part of the issued capital at nominal or face value which has been subscribed or taken up by purchaser of shares in the company and which has been alloted.

a. Paid up capital

b. Issued capital

c. Subscribed Capital

d. Called Up Capital


16. Three theories about the determination of rate of Interest are:

i. The classical theory

ii. The loanable funds theory

iii. The Keynesian theory

iv. The Vogel’s theory



a i, ii, and iii

b ii, iii and iv

c I, iii and iv

d i, ii, iii, iv


17. Financial markets and institutions

a Involve the movement of huge quantities of money.

b Affect the profits of businesses.

c Affect the types of goods and services produced in an economy.

d Do all of the above.


18. The _____________ is the monetary authority of India, and also acts as the regulator and supervisor of commercial banks.


a. SEBI (Securities and exchange board of India)

b. RBI (Reserve Bank of India)

c. SBI (State bank of India)

d. CBI (Central Bank of India)


19. Based on how interest is computed, interest rates are classified into _____________ and ____________.

a. Fixed, floating

b. Short term , Long term

c. Simple, compound

d. Long term, short term, medium term


20. Three theories about the determination of rate of Interest are:-

a. The classical theory, The loanable funds theory, The Keynesian theory.

b. The modern theory, The loanable funds theory, The Keynesian theory.

c. The classical theory, The modern theory, The Keynesian theory.

d. The classical theory, The loanable funds theory, The modern theory.



21. Three theories about the term structure of Interest rates are:-

a. The Expectations Theory, Default Premium Theory, Market Segmentation Theory

b. Default Premium Theory, Liquidity Premium Theory, Market Segmentation Theory

c. The Expectations Theory, Liquidity Premium Theory, Default Premium Theory

d. The Expectations Theory, Liquidity Premium Theory, Market Segmentation Theory


22. the RBI performs a wide range of functions; particularly, it:-

i. Acts as the currency authority

ii. ?Controls money supply and credit

iii. ?Manages foreign exchange

iv. ?Serves as a banker to the government

v. ?Builds up and strengthens the country’s financial infrastructure


a. i, ii, iii, iv

b. ii, iii, iv, v

c. i to v

d. i,ii, iii, v

23. By increasing ____________ , the RBI can reduce the funds available with the banks for lending and thereby tighten liquidity in the system;

a) Statutory Liquidity Ratio

b) Current Ratio

c) Cash Reserve Ratio

d) Bank ratio


24. ________________ banks cater to the financing needs of agriculture, retail trade, small industry and self-employed businessmen in urban, semi-urban and rural areas.

a. Co-operative

b. Scheduled commercial

c. Foreign

d. Private


25. Monetary policy is referred to as either being a _________ policy, or a ____________policy.

a. Liberal, strict

b. Expansionary, contractionary

c. Inflationary, deflationary

d. Classical. Modern


26. Monetary policy is the process by which the central bank or monetary authority of a country controls the ________________.

a. Supply of money

b. Demand of money

c. Inflation

d. Deflation


27. A monetary policy is referred to as __________ if it reduces the size of the money supply or increases it only slowly, or if it raises the interest rate.

a. Expansionary

b. Contractionary

c. Inflationary

d. Deflationary


28. The ____________ is a system in which the price of the national currency is measured in units of gold bars and is kept constant by the daily buying and selling of base currency to other countries and nationals.

a. Stock trading

b. Gold standard

c. Discount window lending

d. Monetarism


29. Price level targeting is similar to ___________ except that CPI growth in one year is offset in subsequent years such that over time the price level on aggregate does not move.

a. Inflation targeting

b. Stock trading

c. Discount window lending

d. Monetarism



30. Money market is a very important segment of the financial system of a country. It is the market dealing in monetary assets of short term nature.

a. Long term nature

b. Medium term nature

c. Short term nature

d. All the above


31. Yield to maturity (YTM) is a popular and extensively used method for

computing the return on a _______ investment.

a. Share

b. Share & bond

c. Futures & options

d. Bond


32. Bonds that allow the issuer to alter the tenor of a bond, by

redeeming it prior to the original maturity date, are called ________


a. Callable

b. Puttable

c. Amortising

d. Step up


33. An ________________ represents ownership in the shares of a foreign company trading on US financial markets.

a. Global Depositary Receipt (or GDR)

b. Treasury Bills

c. Government Security( G-sec)

d. American Depositary Receipt (or ADR)


34. External Commercial Borrowings (ECB) include:

i. Commercial Bank Loans

ii. Buyer’s Credit

iii. Supplier’s Credit

iv. Securitized Instruments Such As Floating Rate Notes, Fixed Rate Bonds Etc.

v. Credit From Official Export Credit Agencies

a. i, ii, iii, iv

b. ii, iii, iv, v

c. i to v

d. i,ii, iii, v



35. The credit risk of a borrower is evaluated by ____________.

a. SEBI (Securities and exchange board of India)

b. Stock Exchange

c. RBI( Reserve Bank of India)

d. Credit rating agencies


36. _________ risk denotes the risk of the value of an investment denominated in some other country’s currency, coming down in terms of the domestic currency.

a. Currency

b. Country

c. Hedging

d. Speculation


37. A _________is an entity which provides “trading” facilities for stock brokers and traders, to trade stocks and other securities.

a. Stock exchange

b. Depository

c. Company

d. Credit rating agency




38. Various economic variables impact the movement in exchange rates such as:

i. Interest rates

ii. Inflation figures

iii. Balance of payment figures

iv. GDP( Gross domestic product)


a. i, ii, iii

b. i, ii, iii, iv

c. ii, iii, iv

d. i, iii, iv

39. Benefits of trading through a stock exchange:

i. Best price

ii. lack of any counter-party risk

iii. Access to investor grievance and redressal mechanism

a. i, ii

b. i, iii

c. ii, iii

d. i, ii, iii


40. In a ____________ exchange, the three functions of ownership, management and trading are concentrated into a single Group.

a. Mutual

b. Demutualised

c. Neither a nor b

d. Both a & b


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