Class 11 Finance Unit-1: Introduction to Finance Important Questions Answers (ASSEB-AHSEC Division-I)

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Assam Board (ASSEB-AHSEC) Class 11 Finance Unit-01: Introduction to Finance Important Questions and Answers

AHSEC Class 11/H.S First Year Finance Notes 
Unit- 1: Introduction to Finance

UNIT-I: Finance

Finance: Meaning, features, functions, types and sources.

Financial System: Meaning and components. Role of financial system in economic development.


1. Explain the concept of 'Finance' and its features.

Ans: Finance is the lifeblood of business. Just as our body can become paralyzed without sufficient blood flow, a business can become ineffective without adequate finance. This shortage negatively impacts its operations, profitability and growth prospects. Finance is essential for forming new businesses, growth opportunities, creating jobs, increasing income and boosting investments in the economy. It also supports other businesses and contributes to government revenue.

Money, credit and finance are closely related but distinct concepts:

'Money' refers to the current medium of exchange or means of payment.

'Credit' or loan is a sum of money to be returned, normally with interest; it refers to a debt of economic unit.

'Finance' is monetary resources comprising debt and ownership funds of the State, company or person.

In a broader sense, finance is the process of raising funds or capital for various expenses. It involves accumulating funds from savers and investors, such as savings deposits, insurance claims, provident funds and pension funds. Finance then channels these funds through credit, loans, or investments to economic entities that require them for productive use.

Finance plays a critical role in supporting economic, social and administrative activities. It acts as a lifeline for businesses, individuals and governments, enabling them to pursue their objectives and manage their financial affairs effectively. For example, when someone borrows money to set up a new industry, it represents finance that fuels economic activity and growth.

Definitions:

According to the Oxford dictionary it says that, the word 'finance' indicates 'management of money.

"Business finance consists of the raising, providing, managing of all the money, capital or funds of any kind to be used in connection with the finance".- Bonneville and Deway

"Finance is that administrative area or set of administrative functions in an organisation which relate the arrangement of cash and credit so that the organisation may have the means to carry out its objectives as satisfactorily as possible".-Howard and Upton

In the business world, finance refers to the "process of raising money through the issuance and sale of debt and/or equity".

Scientific view explains, finance as "the science that describes the management, creation, and study of money, banking, credit, investments, assets, and liabilities".

FEATURES OF FINANCE

i. A Branch of Economics: Finance is a branch of economics that deals with managing, allocating, and acquiring resources.

ii. It is a Process: Finance involves the process of getting money for various expenses. It's about getting funds in the form of loans, investments, or credit to be used productively.

iii. Closely associated with Money: Finance is closely related to money. It provides money when it's needed.

iv. Complex Elements: Finance includes a wide range of institutions, markets, instruments and services that help move money from savers to those who need it. It's based on economic theories.

V. Flow of Funds: Money in finance flows from areas with extra funds to those with deficits, and the financial system helps facilitate this flow.

vi. Different Forms: Finance comes in various forms, like corporate finance, private finance, government finance, short-term finance and long-term finance.

vii.Multiple Sources: We can get finance from short-term, long-term, or medium-term sources, and it can be from internal or external sources.

viii. Purpose: Finance helps people save, manage, and raise money for different purposes.

ix. Exchange: Finance is an exchange of available resources. It's not just about money but also applies to barter systems.

X. Optimal Funding Mix(best mix of funds): Finance aims to find the best mix of funds to achieve desired results.

1. Discuss the different functions/role of finance.

Ans: The following are the different functions/role of finance

i. Acquisition, Allocation, and Utilization of Funds: Finance involves obtaining, distributing, and using funds efficiently in a business. This includes deciding how to raise money, allocating it to different projects, and ensuring effective utilization.

ii. Channelization of Funds: The financial system, comprising institutions, markets, instruments and services, channels funds from savers (those with surplus funds/units) to borrowers (those with deficit funds/units)

iii. Optimal Mix of Funds: Finance aims to find the best mix of owned funds (e.g., equity) and borrowed funds (e.g., loans/debts) to maximize profits while minimizing costs and risks.

iv. Creation of Investment Opportunities: Finance facilitates the use of funds for profitable purposes. It allows individuals and institutions to invest in physical assets, engage in business activities, or acquire financial securities.

v. Internal Controls: Finance involves policies and procedures to ensure efficient business operations, regulatory compliance, and prevention of fraud and errors.

vi.Profit Maximization: Finance plays a crucial role in helping businesses maximize profits by ensuring the timely flow of funds, enabling them to seize profitable opportunities..

vii. Future Decision Making: Finance is essential for making informed decisions about a company's future. It involves evaluating financial options, creating budgets, tracking performance, and developing short- and long-term strategies.

viii. Enhancing Cash Flow: Finance helps companies in managing their cash effectively through expense monitoring, smart spending and budgeting, ensuring money is used wisely for productive purposes.

2. Explain the different types of finance.

Ans: The different types/categories of finance are:

(a) Short-term Finance: It refers to finance with a duration of less than one year. It is used for daily operational expenses such as wages and raw materials. Some of its sources include cash credit, overdraft, and bill discounting, primarily provided by commercial banks.

(b) Medium-term Finance: This type of finance spans one to five years. It is employed for purchasing equipment and fixed assets. Sources include hire purchase finance, lease finance, commercial banks, and development finance institutions.

(c) Long-term Finance: Finance required for more than five years falls into the category of long-term finance. This kind of finance is typically needed for significant investments like buying land or restructuring buildings. Examples include bonds, debentures, preference shares, equity shares, long-term loans from government or financial institutions, venture funding and investor funds.

B. User-Based Classification:

(a) Public Finance: It deals with the government's income, expenditure and financing techniques. It encompasses public expenditure, public revenues and public debt.

(b) Corporate Finance: This field focuses on raising and allocating funds for corporate activities. Its primary objective is to maximize shareholder value through financial planning and the implementation of various strategies.

(c) Private Finance: It involves managing income, expenditure, and borrowing for individuals, households, and business firms. The goal is to optimize finances to achieve specific objectives, such as maximizing profit while minimizing costs.

C. Mode of Delivery-Based Classification:

(a) Direct Finance: In this case, borrowers directly obtain funds from lenders by selling securities in financial markets. For instance, individuals may buy government bonds, or businesses may purchase commercial papers.

(b) Indirect Finance: Borrowers access funds indirectly through financial intermediaries, such as commercial banks. These intermediaries channel funds from savers to borrowers.

D. Source-Based Classification:

(a) Equity Finance: This type of finance consists of owned capital brought in by promoters or business owners

(b) Debt Finance: Debt finance involves borrowed funds, representing money owed by the company to external entities like banks and financial institutions, often in the form of loans.

3. What are the different sources of Sources of finance and their different categories? Or Elaborately discuss about the different sources of short term and long term finance for a business concern.

Ans: Finance has sa broad meaning and so its sources can be divided under the following heads:

A. On the basis of duration:

1. Long-Term Sources of Finance:

i. Equity Share: It represents shares issued to the public, entailing voting rights and ownership

ii. Preference Share: These shares offer preferential rights to dividends and claims during liquidation

iii. Retained Earnings: It comprises accumulated profits saved for future use

iv. Debenture/Bonds: It involves borrowing from the capital market by issuing debentures or bonds, which can be secured or unsecured.

v. Term Loans from Financial Institutions: These are loans from institutions like IFCI, SFCs and commercia banks

vi. Venture Capital: It provides funding to startups with growth potential.

vii. Asset Securitization: This process involves packaging and selling interests in loans and receivables as "asset-backed" securities.

viii. International Financing: It refers to raising funds from foreign markets through methods like Euro Issue, Foreign Currency Loans, ADR and GDR

2. Medium-Term Sources of Finance:

i. Preference Share: It can be issued for medium-term capital needs

ii. Debenture/Bonds: They cater to medium term fund requirements

iii. Financial Institutions/DFIs; These institutions extend medium-term loans for new units or expansion

iv. Lease Finance: It allows firms to rent assets

v. Hire Purchase Finance: it involves buyers paying for an asset in insta Intents.


3. Short-Term Sources of Finance:

i. Trade Credit; It permits buying goods without immediate payment

ii. Loan, Cash Credit and Overdraft: These are popular short term sources provided by commercial banks

iii. Advances Received from Customers: These are prepayments for future goods or services

iv. Creditors it means delayed payments for goods and services

v.  Accounts Payables: It enables immediate payment to suppliers without using working capital

vi Factoring Services: It involves selling receivables at a discount

vii Bill Discounting: It means selling unpaid invoices to a bank or financial institution

B. Classification on the basis of Ownership and Control:

i. Owned Capital (Equity Capital); it is mobilized by issuing equity shares to promoters and the public It is preferred for its long term nature and absence of interest payments 

ii. Borrowed Capital (Debt Capital): It is raised externally through financial institutions, banks, bonds and debentures. It offers advantages like tax deductibility but comes with interest payments.


C. On the basis of source of generation:

1. Internal Sources: It means capital generated within the business, including retained profits and asset sales.

ii. External Sources: It means capital generated from outside the business, such as debt financing and equity issuance.

Thus, the choice of source depends on factors like the required amount, purpose, duration, business size, and current financial status. It impacts costs, profitability and project feasibility.

4. What is meant by Financial System? Give some definitions and explain its features and functions.

Ans: Financial System is the backbone of an economy, working to create a smooth and efficient relation between those who have money to spare (depositors/surplus unit) and those who need it for various purposes (investors/deficit unit). It is a network of financial institutions, markets, tools and services all working together.

The main goal of the financial system is to make sure funds move from where they are in surplus to where they are in need, all in an efficient and effective manner.

Thus, a financial system is the circulatory system of the economy which makes sure of the flows of money to where it's needed to keep the economic engine running smoothly.

In simple words, financial system facilitates transfer of funds from investors to borrowers. The term "system" in "Financial System" indicates a group of complex and closely linked institutions, agents, procedures, markets, transactions, claims and liabilities within an economy.

According to Christy, the financial system "supply funds to various sectors and activities of the economy in ways that promote the fullest possible utilization of resources without the destabilizing consequence of price level changes or unnecessary interference with individual desires."

According to Robinson, the primary function of the system is "to provide a link between savings and investment for the creation of new wealth and to permit portfolio adjustment in the composition of the existing wealth.

Features of Financial System:

i. Component of the National Economy: The financial system is a vital part of an economy, moving funds from surplus to deficit areas.

ii. Dichotomy: It consists of two main segments the formal and informal financial systems.

iii. Sub-Systems: It is a complex network of institutions, markets, instruments, and services, all aiding the transfer and allocation of funds.

iv. Establishing Linkage: It connects savers and investors, promoting both savings and investments.

V. Financial Assets: The core product of the financial system is financial assets used for production, consumption, or further investment.

Vi Liquidity: All financial system activities relate to liquidity, either providing or trading in it.

VII. Allocation of Financial Resources: It gathers funds from surplus areas and efficiently allocates them to various productive sectors.

Vill Contribution to Economic Development: The efficiency of the financial system significantly influences a nation's economic development

Functions of Financial System:

i. Linking Savers and Investors: It connects those who save with those who need funds for investments, enhancing economic productivity.

ii. Promoting Liquidity: It ensures there is enough money for productive ventures and maintains safety of funds

iii. Facilitating Payments: Efficient payment mechanisms ensure the smooth transfer of goods and services.

iv. Allocating Risk: It manages and limits risk in mobilizing savings and allocating credit.

V. Managing Information: Provides crucial information, especially price data, which guides economic decisions.

vi. Efficient Middleman: It acts as an efficient intermediary, directing savings towards productive activities with minimal transaction costs. 

vii. Project Selection: This assists in choosing the right projects for funding and monitors their performance.

5. Discuss the various components of financial system.

Ans: The financial system comprises various interrelated components that enable the transfer of funds between investors and borrowers, moving money from surplus to deficit areas. These key components are:

Financial System

A. Financial Market

B. Financial Institutions

C. Financial Services

D. Financial Instruments

E. Regulatory Bodies

A. FINANCIAL MARKET: The financial market is an important component of the financial system that enables the transfer of funds from surplus areas to deficit areas. It is a platform where various financial instruments and funds of different durations are traded, with prices determined by supply and demand. These markets deal with financial assets, securities, and other financial instruments representing future payments or periodic returns. Financial markets can be sub-divided into

(a) Money Market

(b)Capital Market

(a) Money Market: Money Market deals with short-term financial instruments with maturities of one year or less. It includes submarkets like Call Money Market, Collateral Loan Market and Treasury Bill Market etc.

(b) Capital Market: Capital Market involves long-term financial instruments issued by governments and corporations. It includes Government Securities Market, Industrial Securities Market and Long-Term Loan Market etc.

B. FINANCIAL INSTITUTIONS: Financial institutions are entities that accept public savings and utilize them in B.various assets like stocks, bonds, deposits, or loans. They play a crucial role in the financial system by providing a platform for investors and borrowers. They mobilize savings and offer a wide range of services, including advice on financial matters and managing financial assets such as deposits and securities. Figancial institutions sub-divided into two categories:

(a) Banking Institutions: Banks are financial institutions that facilitate money transfers between individuals and businesses. They accept deposits from the public and provide loans. They safeguard public deposits and fulfill financial requirements by offering loan facilities. Banking institutions include central banks, commercial banks, cooperative banks and foreign exchange banks.

The Banking Regulation Act, 1949 defines banking company as "a company which transacts the business of banking in India" and the word 'Banking' has been defined as 'accepting for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawal by cheque, draft, order or otherwise."

(b) Non-Banking Financial Institutions (NBFIs): NBFIs are financial institutions that do not issue liabilities for settling debts. NBFIs engage in various activities like loans, shares, stocks, bonds, leasing, hire-purchase, and insurance, among others. They can accept deposits and provide loans, but they have certain restrictions.

The RBI has imposed specific restrictions on the operations of Non-Banking Financial Institutions (NBFIs), which are:

1. NBFIs are prohibited from accepting demand deposits.

ii. NBFIs are not integrated into the payment and settlement system, and they are not authorized to issue self-drawn cheques.

Deposit insurance coverage provided by the Deposit Insurance and Credit Guarantee Corporation is not accessible to depositors of NBFIs, unlike in the case of banks.

C. Financial instruments: Financial instruments, as a crucial component of the financial system, facilitate the transfer of available funds through the buying and selling of various financial assets, such as stocks, bonds etc. These instruments play a vital role in moving funds from surplus areas to deficit areas within the financial system.

These include a wide range of tradable assets, including cash, ownership interests in entities, or contractual rights to receive or deliver cash or other financial assets. Notable examples include equity shares, debentures and bonds, among others.

Features of Financial Instruments

i. Enforceable Contracts: Financial instruments are legally binding contracts, offering protection to potential buyers.

ii. Transfer of Value: These instruments involve the transfer of value between parties, including banks, insurance companies, governments, firms, or individuals.

iii. Near-Money Assets: Financial instruments can function as near-money assets, serving as a means of payment or a store of value, but they come with varying levels of risk.

IV. Risk Transfer: Certain financial instruments allow for risk transfer, with buyers paying sellers to assume specific risks, as seen in insurance policies.

V. Standardization: Many financial instruments are standardized, featuring similar obligations and contracts for buyers

vi Easy Transferability: These instruments are typically easily transferable, facilitating straightforward transactions between parties.

vii. Ready Market: Financial instruments have a ready market, allowing for frequent buying and selling, ensuring liquidity.

viii. Possess Liquidity: These instruments often possess liquidity, with some readily convertible into cash, such as bills of exchange through discounting.

Classification of Financial Instruments

1. Classification Based on Determination of Value:

(a) Cash Instruments: These financial instruments have values directly determined by the market and include securities, loans and deposits.

(b) Derivative Instruments: Derivative instruments derive their value from underlying entities, such as assets, indices, or interest rates.

2. Classification Based on Asset Class:

(a) Equity Instruments: Equity instruments represent claims on a corporation's earnings and assets. While some equities offer periodic dividends, they aren't guaranteed. Equity securities have no maturity date, making them long-term investments.

(b) Debt Instruments: Debt instruments involve a promise by the issuer to make fixed payments to the buyer after a specified period. (Examples debentures and bonds.)

(c) Foreign Exchange Instruments: These are legally enforceable agreements related to foreign exchange payments.

3. Classification Based on Issuers:

(a) Government Securities: These fixed-income securities are issued by the government or on its behalf by institutions like the RBI. They carry minimal risk and lower interest rates compared to private financial investments. State governments and quasi-government bodies also issue such securities.

(b) Industrial Securities: These are issued by the corporate sector to meet long-term and working capital needs. Examples of industrial securities are equity shares, preference shares, debentures and commercial papers etc.

4. Classification Based on Maturity:

(a) Money Market Instruments: These are short-term instruments with maturities of up to one year, covering both government and industrial instruments. Examples Money Market Instruments are treasury bills, commercial bills, commercial papers and certificate of deposits.

(b) Capital Market Instruments: These include long-term debt instruments with maturities of one year or more, such as debentures, bonds, and government instruments like NSC and KVP.

5. Classification Based on Intermediaries Involved:

(a) Primary Instruments: Primary instruments are directly issued by the ultimate borrowers of funds to the ultimate savers. Examples of primary instruments include equity shares and debentures.

(b) Secondary Instruments: Secondary instruments are issued by financial intermediaries to the ultimate savers. These are also known as indirect securities. Examples of secondary instruments include units of mutual funds and insurance policies.

D. Financial Services: Financial services encompass a broad range of organizations involved in managing money, including banks, credit card companies, insurance firms, consumer finance companies, stock brokerages, investment funds, and government-sponsored enterprises.

i. Fund Management-Financial service providers assist in obtaining necessary funds and ensure their efficient utilization. They play a role in determining the financing mix and provide professional services up to the stage of servicing lenders. They are involved in activities such as borrowing, securities trading, lending, investment management, payment processing, settlement, and risk management in financial markets. Additionally, they offer services like credit rating, venture capital financing, mutual funds, merchant banking, depository services, and book building to corporate entities.

ii. Key Service Providers: Notable financial service providers include leasing companies, mutual fund houses, merchant bankers, portfolio managers, bill discounting and acceptance houses, among others.

E. Regulatory Bodies: The financial system is subject to control and regulation by statutory authorities established under various parliamentary statutes. These regulatory bodies play a crucial role in overseeing and maintaining the integrity of the financial system.

Key Regulatory Bodies:

Reserve Bank of India (RBI): The RBI is responsible for regulating and supervising a significant portion of the financial system. It exercises supervisory control over commercial banks, urban cooperative banks (UCBs), select financial institutions, and non-banking finance companies (NBFCs).

ii. Securities and Exchange Board of India (SEBI): SEBI regulates the capital market, mutual funds, and other capital market intermediaries, ensuring the integrity and transparency of these segments.

iii. National Bank for Agriculture and Rural Development (NABARD): NABARD supervises Regional Rural Banks and cooperative banks.

iv. National Housing Bank (NHB): NHB regulates housing finance companies.

v. Department of Company Affairs (DCA): DCA, under the Government of India, oversees deposit-taking activities of corporate entities, excluding NBFCs registered under the Companies Act.

vi. Insurance Regulatory and Development Authority (IRDA): IRDA is responsible for regulating the insurance sector.

vii. Pension Funds Regulatory and Development Authority (PFRDA): PFRDA regulates pension funds in India.


6. Distinguish between Banking and Non Banking Financial Institutions.

Ans: table distinguishing between Banking and Non-Banking Financial Institutions (NBFIs):

AHSEC Class 11 Finance Notes HS 1st Year Finance Important Question Answers

7. Discuss the role of financial system in the economic development of a country.

Ans: ROLE/FUNCTION OF FINANCIAL SYSTEM IN THE ECONOMIC DEVELOPMENT OF A COUNTRY


The financial system, composed of various institutions like banks and insurance companies, plays a crucial role in a economic development of country. It performs several crucial functions:


i. Capital Formation: Financial system mobilizes savings from individuals and channels them into investments in capital goods, such as machinery and equipment, promoting economic growth.


ii. Promoting Investments: The financial system encourages savings to flow into productive sectors, leading to increased output, income and employment opportunities.


iii. Allocation of Savings: It efficiently allocates savings according to national priorities, directing funds to key sectors.


iv. Entrepreneurship Support: Financial institutions provide necessary funding and non-fund-based services, fostering entrepreneurial talent and risk-taking.


V. Financial Deepening and Broadening: It enhances the depth and breadth of financial assets and participants in the economy.


vi. Interest Rate Stabilization: A well-developed financial system ensures competitive interest rates, benefiting consumers and maintaining uniform rates across the country.


vii. Trade and Commerce Growth: Efficient payment mechanisms facilitate smooth trade, coritributing to economic development.


viii. Employment Generation: Capital provision to businesses leads to job creation, boosting employment opportunities.


ix. International Trade Facilitation: It simplifies international trade by handling payments and reducing risk through mechanisms like letters of credit.


x. Attracting Foreign Capital: Stable financial markets attract both domestic and foreign investors, providing capital for business expansion.


xi. Economic Infrastructure Development: Financial markets fund critical sectors like power, transport and telecommunications, promoting infrastructure growth.


xii. Government Assistance: Financial markets enable governments to raise funds for infrastructure projects and deficit spending.


xiii. Development of Backward Areas: Economic infrastructure development and industrial growth benefit previously underserved regions, promoting balanced development.


In summary, we can say the role of financial system in economic development is pivotal (of great importance), as it mobilizes savings, directs investments, fosters entrepreneurship, and supports various sectors, ultimately contributing to overall prosperity and stability of a nation.


8. Write the correct answer as directed: (TEXUAL)

1) Which of the following regulates the money market in India?

i) RBI 

ii) SEBI

iil) IRDA

iv) Ministry of Finance

Answer: The Reserve Bank of India (RBI) regulates the money market in India.

2) Development Financial Institutions are the main sources of short-term fund for a business. (True/False)

Answer: False

3) Commercial paper is a money market instrument. (True/False)

Answer: True

4) Treasury bills are issued by

Answer: Treasury bills are issued by the Government of India.


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