Capital Market – AHSEC Class 12 Finance Chapter 9

Here is a comprehensive study note for the AHSEC Class 12 Finance textbook, focusing on Chapter 9: Capital Market.

Chapter 9: Capital Market

Summary Note

This chapter introduces the Capital Market, which is a crucial component of a country’s financial system, dealing with long-term funds.

• Meaning of Capital Market:
  • The capital market is a financial market for the borrowing and lending of long-term funds, typically for a period of more than one year.
  • It deals with long-term securities like shares, debentures, and bonds.
  • It acts as the financial pillar of an industrialized economy by facilitating the transfer of savings from those who have surplus funds (savers/investors) to those who need them for long-term investment (corporations, governments).
  • Demand Side: The main borrowers are corporations, central and state governments, and local bodies that need long-term funds for development and expansion.
  • Supply Side: The main suppliers of funds are individual investors, companies, mutual funds, insurance companies, and other financial institutions.
• Features of the Capital Market:
  1. Long-Term Funds: It deals with funds for periods exceeding one year.
  2. Long-Term Instruments: It trades in instruments like shares, debentures, and bonds.
  3. Finances Fixed Capital: It provides funds for financing the fixed capital requirements of businesses (e.g., purchasing machinery, constructing buildings).
  4. Key Institutions: The main institutions are stock exchanges, development banks, commercial banks, and insurance companies.
  5. Higher Risk: Compared to the money market, the capital market involves a higher degree of risk.
• Functions of the Capital Market:
  1. Link between Savers & Investors: It mobilizes savings from the public and channels them into productive investments in the corporate and government sectors.
  2. Encourage People to Save: By offering attractive investment opportunities and returns, it encourages people to save more.
  3. Transformation of Savings into Investments: It provides the mechanism to convert savings into long-term investments.
  4. Promotion of Economic Growth: By allocating resources efficiently to development projects, it helps in the expansion of trade and industry, leading to balanced economic growth.
  5. Stability: It helps to stabilize the prices of securities in the stock market by providing a continuous market for them.
  6. Benefits to Investors: It provides investors with opportunities to invest in long-term financial instruments, track their investments through published prices, and safeguards their interests through regulatory mechanisms.
• Divisions of the Capital Market: The capital market is divided into two main segments:
  1. Primary Market (or New Issue Market – NIM): This is the market where new securities (shares, debentures) are issued for the first time by companies to raise capital.
  2. Secondary Market (or Stock Exchange): This is the market where existing, previously issued securities are bought and sold among investors.

Complete Textual Question Answers

Here are the answers to all the questions given at the end of Chapter 9.

A. Very Short Answer Questions (1 Mark each)

1. Who are the main suppliers of funds in the capital market?
   Ans: The main suppliers of funds in the capital market are individuals (savers). Besides them, companies, mutual funds, and financial institutions also supply funds.

B. Short Answer Questions (2 Marks each)

1. What is capital market?
   Ans: The capital market is a market for dealing with the long-term borrowing and lending of funds. It deals with long-term securities like shares, debentures, and bonds which have a maturity period of more than one year.
2. Who need fund from the capital market?
   Ans: Corporations, Central and State governments, and local bodies need funds from the capital market to meet their long-term requirements for development and business activities.
3. Who are the suppliers of funds in the capital market?
   Ans: The main suppliers of funds are individuals. Besides them, companies, mutual funds, NBFCs, and other financial institutions also supply funds to the capital market.
4. Write two features of capital market.
   Ans: Two features of the capital market are:
   i. It provides long-term funds for a period exceeding one year.
   ii. It deals in long-term credit instruments such as shares, debentures, and bonds.
5. Write two functions of capital market.
   Ans: Two functions of the capital market are:
   i. Link between Savers & Investors: It acts as a link to mobilize savings and divert them into productive investments.
   ii. Promotion of Economic Growth: It helps in the promotion of balanced economic growth by allocating resources according to the development needs of the country.
6. How capital market helps the investors to invest in long-term financial instruments?
   Ans: The capital market helps investors by providing a platform (like stock exchanges) where they can buy and sell long-term securities. It also safeguards their interests and allows them to track the value of their investments through published security prices, making long-term investment more secure and attractive.

C. Long Answer Questions (Type-I) (5 Marks each)

1. Explain five functions of capital market.
   Ans: Five important functions of the capital market are:
   • Link between Savers & Investors: It acts as a crucial intermediary, mobilizing the scattered savings of individuals and channeling them to corporations and governments that need them for productive purposes.
   • Encourage people to save: By offering a variety of financial instruments with the potential for attractive returns (like dividends and capital appreciation), it motivates people to save rather than consume their surplus income.
   • Promotion of Economic Growth: It facilitates the allocation of capital to the most productive projects. This efficient allocation of resources leads to the expansion of trade and industry, thereby promoting balanced economic growth.
   • Stability: It helps to stabilize the prices of securities by providing a continuous and ready market (the stock exchange). This liquidity ensures that prices do not fluctuate wildly and reflect the true worth of the securities.
   • Benefits to investors: It provides a platform for investors to invest in long-term assets, helps them keep track of their investments through published prices, and safeguards their interests from fraud through regulatory bodies.
2. What is capital market? State the features of capital market.
   Ans: The capital market is a financial market where long-term funds (for a period of more than one year) are raised and invested. It deals with long-term securities like shares, debentures, and bonds, facilitating the flow of capital from savers to borrowers like corporations and governments.
   The main features of the capital market are:
   • Long-Term Funds: It is a market for funds with a maturity period exceeding one year.
   • Long-Term Instruments: It trades in securities like shares, debentures, and government bonds.
   • Finances Fixed Capital: It provides the necessary funds for businesses to finance their fixed capital requirements, such as machinery and buildings.
   • Key Institutions: Its main institutions include stock exchanges, development banks, commercial banks, and insurance companies.
   • Higher Risk: The investments in the capital market are generally associated with a higher level of risk compared to the money market.

D. Long Answer Questions (Type-2) (8 Marks each)

1. What is capital market? State the functions of capital market.
   Ans: (This is a comprehensive question. First, provide a detailed definition of the capital market as explained in B.1. Explain the demand and supply sides of the market. Then, discuss the functions of the capital market in detail, as covered in C.1. Elaborate on each function, explaining how it contributes to the overall economy. Include points like linking savers and investors, encouraging savings, promoting economic growth, ensuring stability, and providing benefits to investors.)

Previous Year AHSEC Question Answers (2015-2025)

Short Questions (1-2 Marks)

• What is Capital Market? (AHSEC 2015, 2019)
  Ans: The capital market is a market for dealing with the long-term borrowing and lending of funds (for a period of more than one year) through instruments like shares, bonds, and debentures.
• Mention two features of Capital Market. (AHSEC 2017)
  Ans: Two features of the capital market are: (i) It deals in long-term funds for a period exceeding one year, and (ii) It provides funds for financing the fixed capital requirements of trade and commerce.
• Mention two functions of Capital Market. (AHSEC 2018, 2022)
  Ans: Two functions of the capital market are: (i) It acts as a link between savers and investors, and (ii) It promotes economic growth by channeling savings into productive investments.
• Name the two components of Capital Market. (AHSEC 2020)
  Ans: The two components of the Capital Market are (i) the Primary Market (or New Issue Market) and (ii) the Secondary Market (or Stock Exchange).

Long Questions (5-8 Marks)

• Discuss the functions of the Capital Market. (AHSEC 2016, 2021)
  Ans: (This answer is the same as the textual Long Answer Question C.1. Please refer to that answer above).
• What is Capital Market? Explain its features. (AHSEC 2018)
  Ans: (This answer is the same as the textual Long Answer Question C.2. Please refer to that answer above).

10 Most Important Questions Answer

1. What is the primary difference between the money market and the capital market?
   Ans: The primary difference is the maturity period of the funds; the money market deals with short-term funds (less than one year), while the capital market deals with long-term funds (more than one year).
2. Who are the main borrowers in the capital market?
   Ans: The main borrowers are corporations (business firms), the Central and State governments, and local bodies who need long-term funds for investment and development projects.
3. What are the two main segments of the capital market?
   Ans: The two main segments are the Primary Market (New Issue Market) and the Secondary Market (Stock Exchange).
4. How does the capital market promote economic growth?
   Ans: The capital market promotes economic growth by mobilizing savings from the public and allocating these resources to productive investments in industry and infrastructure, which leads to increased production and expansion of the economy.
5. What kind of instruments are traded in the capital market? Give two examples.
   Ans: Long-term credit instruments are traded in the capital market. Two examples are shares and debentures.
6. Why is the risk in the capital market considered higher than in the money market?
   Ans: The risk is higher because the investments are for a longer duration, and the value of instruments like shares can fluctuate significantly, potentially leading to a loss of principal. Money market instruments are generally safer and have a shorter maturity.
7. What is the role of stock exchanges in the capital market?
   Ans: Stock exchanges are the main institutions of the secondary capital market. They provide a platform for the buying and selling of existing securities, ensuring liquidity and price stability for investors.
8. How does the capital market encourage people to save?
   Ans: It encourages people to save by providing various financial instruments (like shares, bonds, mutual funds) that offer the potential for higher returns (dividends, interest, capital gains) compared to keeping money idle.
9. Who are the main suppliers of funds to the capital market?
   Ans: The main suppliers of funds are individual savers. Other suppliers include companies with surplus funds, banks, insurance companies, and mutual funds.
10. Explain the function of “Transformation of savings into investments”.
    Ans: This function means that the capital market provides the necessary channels and institutions to collect the small and scattered savings from individuals and transform them into large pools of capital that can be lent to the government and corporate sector for long-term investment.