Fundamentals of Stock Trading - Important Question/Answers for Examination

Fundamentals of Stock Trading 

Important Question/Answers for Examination

Question 1 

Explain the term investment and factors affecting investment decision. 

Answer: 

Meaning of Investment

Investment refers to the expenditure made on the purchase or creation of new capital assets such as machinery, buildings, tools, equipment, and inventories. It involves sacrificing current consumption to gain future benefits.
In economics, investment means addition to the capital stock of an economy.
In finance, it means allocating money to assets like shares, bonds, or real estate to earn returns in the future.
Thus, investment is a future-oriented activity undertaken with the expectation of earning income, profit, or growth.

Factors Affecting Investment Decisions

Investment decisions are influenced by a combination of economic, financial, and psychological factors. The major factors include:

1. Expected Rate of Return

Higher expected returns motivate investors to invest more. Investment increases when profitability is high and decreases when returns are low.

2. Rate of Interest

Interest rate represents the cost of borrowing funds.

• High interest rates discourage investment because borrowing becomes expensive.

• Low interest rates encourage investment by reducing the cost of capital.

3. Level of Income and Demand

When consumers’ incomes rise and market demand increases, firms expect higher sales in the future. This encourages businesses to invest in expansion.

4. Cost of Capital Assets

If machinery, equipment, and raw materials are expensive, investment becomes less attractive.
Lower cost of capital goods → higher investment
Higher cost → lower investment

5. Technological Advancement

Innovation and new technology encourage firms to replace old machinery and adopt advanced methods, leading to increased investment.

6. Government Policies

Tax incentives, subsidies, lower interest loans, and favourable industrial policies encourage investment.
However, high taxes, strict regulations, or policy uncertainty can reduce investment.

7. Business Expectations

Positive expectations about future economic conditions boost investment.
If businesses fear recession, political instability, or market uncertainty, they postpone investment.

8. Availability of Funds

Firms need internal savings or external finance to invest. Easy availability of credit and strong business profits increase investment.

9. Existing Capital Stock

If firms already have excess production capacity, they delay new investment.
If machinery is outdated or operating at full capacity, new investment becomes necessary.

10. Risk Factor

Investors consider the level of risk associated with each investment.
High risk discourages investment unless it is compensated by higher expected returns.

Conclusion

Investment is a crucial driver of economic growth as it increases productive capacity and generates employment. Investment decisions depend on returns, interest rates, demand, costs, technology, government support, and market expectations. Understanding these factors helps individuals and businesses make informed financial decisions.

Question 2

Explain the different types of investment avenues available to investor in the market

Answer: 

Investment avenues refer to the various options where an investor can allocate funds to earn returns. These avenues differ in terms of risk, return, liquidity, and investment horizon. They are broadly classified into Financial and Non-Financial investments.

A. FINANCIAL INVESTMENT AVENUES

1. Bank Deposits

Includes Fixed Deposits (FDs) and Recurring Deposits (RDs).
They offer fixed and safe returns, suitable for risk-averse investors.

2. Government Securities

Examples: Treasury Bills, Government Bonds, NSC.
Backed by the government, they involve very low risk.

3. Post Office Saving Schemes

Such as PPF, Kisan Vikas Patra, MIS, Senior Citizen Savings Scheme.
Provide secure returns with tax benefits.

4. Equity Shares

Represent ownership in a company.
High returns in the long run but high market risk.

5. Debentures and Corporate Bonds

Issued by companies; offer fixed interest.
Moderate return with moderate risk.

6. Mutual Funds

Professionally managed funds that invest in equities, debt, or both.
Types: Equity Funds, Debt Funds, Hybrid Funds, Index Funds.
Offer diversification and liquidity.

7. Exchange Traded Funds (ETFs)

Trade like shares on stock exchanges.
Low-cost investment option tracking indices or commodities.

8. Derivatives (Futures & Options)

Used for hedging and speculation.
High-risk and suitable for experienced investors.

9. Insurance-Based Investments

Includes ULIPs and traditional life insurance plans.
Offer long-term investment with insurance benefits.

10. Pension & Retirement Funds

Examples: NPS, EPF.
Provide long-term retirement savings with tax advantages.

B. NON-FINANCIAL INVESTMENT AVENUES

11. Real Estate

Investment in land, flats, shops, or commercial property.
High capital requirement; offers rental income and appreciation.

12. Gold & Precious Metals

Options: Physical Gold, Gold ETFs, Sovereign Gold Bonds.
Acts as a hedge against inflation and economic uncertainty.

13. Commodities

Trading in metals (silver, copper), crude oil, agricultural products.
Used for hedging and high-risk trading.

14. Collectibles

Artworks, antiques, rare coins, stamps, etc.
Low liquidity and high risk, suitable for niche investors.

C. DIGITAL / MODERN INVESTMENT AVENUES

15. Cryptocurrency

Digital assets like Bitcoin, Ethereum.
Highly volatile and risky; suitable for high-risk investors.

16. Peer-to-Peer (P2P) Lending

Online platforms connecting lenders and borrowers.
Higher returns but involves credit/default risk.

Conclusion

Investors have multiple avenues ranging from safe and stable options (PPF, FDs, Government Securities) to high-risk opportunities (Equity, Derivatives, Crypto).
A good investment strategy involves diversifying across different avenues based on risk appetite, financial goals, and time horizon.

Question 3

Stock Markets Play an important role in Indian Markets. Explain the statement. 

Answer:

Importance of Stock Markets in Indian Security Markets

The stock market is an essential part of the Indian financial system. It provides a platform for trading shares, debentures, bonds, and other financial instruments. Major Indian stock exchanges include the NSE (National Stock Exchange) and the BSE (Bombay Stock Exchange).
Stock markets play a crucial role in mobilizing savings, providing investment opportunities, and supporting the growth of the economy.

1. Mobilization of Savings

Stock markets encourage individuals and institutions to invest their savings in productive financial assets.
This leads to the efficient utilization of idle funds and promotes capital formation.

2. Facilitates Capital Formation

Companies raise long-term funds by issuing shares and debentures through the stock market.
This helps businesses expand operations, adopt new technologies, and grow, contributing to economic development.

3. Provides Liquidity

One of the most important functions of stock markets is to provide high liquidity.
Investors can buy or sell securities at any time, making investment flexible and attractive.

4. Fair Price Discovery

Share prices are determined through the forces of demand and supply.
This transparent mechanism helps investors know the true value of securities and make informed decisions.

5. Ensures Safety through Regulation

The stock market is regulated by SEBI (Securities and Exchange Board of India).
SEBI ensures:

• fair trading

• investor protection

• transparency

• prevention of fraud

This increases investor confidence in the market.

6. Offers Diversification

Stock exchanges offer a wide range of investment instruments such as:

• Equity shares

• Bonds

• ETFs

• Mutual funds

• Derivatives

This allows investors to spread their risk and earn balanced returns.

7. Indicator of Economic Health

Stock market movements reflect the overall performance of the economy.
A rising stock market shows economic growth and positive business sentiment, while a falling market indicates slowdown.
Thus, the stock market acts as an economic barometer.

8. Promotes Corporate Governance

Listed companies must follow strict disclosure and reporting standards.
This encourages:

• transparency

• accountability

• ethical management practices

Improved governance benefits both investors and the economy.

9. Wealth Creation & Economic Growth

Stock markets help create wealth for investors through capital appreciation and dividends.
A strong stock market attracts domestic and foreign investment, supporting economic growth and job creation.

Conclusion

Stock markets play a vital role in the Indian security market system. They mobilize savings, provide liquidity, ensure transparency, promote corporate growth, and act as an indicator of economic performance. A well-regulated and efficient stock market is essential for a stable and growing economy.

Question 4

Differentiate between Limit Order and Market order

Answer:

Difference Between Limit Order and Market Order

Basis	Limit Order	Market Order
Meaning	An order to buy or sell a security at a specific price or better.	An order to buy or sell a security immediately at the current market price.
Execution Price	Executed only at the price set by the investor (or better).	Executed at the best available price in the market.
Speed of Execution	Execution may take time; not guaranteed.	Executed instantly; guaranteed execution.
Price Control	Gives full control over the buying or selling price.	No control over the exact price; price may vary slightly.
Risk Level	Lower risk because price is predetermined.	Higher price risk because price may change during execution.
Use Case	Used when investors want a specific entry/exit price.	Used when the investor wants quick execution regardless of price.
Best For	Low-volatility strategies and patient investors.	High-speed trades and urgent transactions.

Question 5

Differentiate between Stop Loss Order and Stop Loss Market Order.

Answer:

Difference Between Stop-Loss Order and Stop-Loss Market Order

Basis	Stop-Loss Order (SL Order)	Stop-Loss Market Order (SL-M Order)
Meaning	A stop-loss order that becomes a limit order once the trigger price is hit.	A stop-loss order that becomes a market order once the trigger price is hit.
Execution Price	Executed only at the limit price or better set by the trader.	Executed at the current market price, whatever it may be, after the trigger is hit.
Price Control	Gives price control; execution may not happen if price moves away.	No price control; execution is certain once triggered.
Execution Guarantee	Not guaranteed—may remain pending if price doesn’t match the limit.	Guaranteed execution, but at any available market price.
Risk Level	Risk of non-execution (order may remain open).	Risk of slippage (executed at unfavourable price).
Use Case	Used when the trader wants protection and control over execution price.	Used when the trader wants to exit quickly at any price once trigger hits.

Question 6

Explain the term Indirect Investing. How is it different from Direct Investing?

Answer:

Indirect Investing

Indirect investing means investing in financial assets through an intermediary, such as mutual funds, pension funds, portfolio management services, or insurance-linked investment plans.
The investor does not directly buy shares or bonds. Instead, a professional fund manager invests on behalf of the investor.

Examples of Indirect Investing

• Mutual Funds

• Exchange Traded Funds (ETFs)

• Pension Funds (NPS)

• ULIPs

• Portfolio Management Schemes (PMS)

Difference Between Direct and Indirect Investing

Basis	Direct Investing	Indirect Investing
Decision Making	Investor makes all buy/sell decisions independently.	Fund managers make decisions for the investor.
Ownership	Direct ownership of shares or securities.	Indirect ownership through pooled funds.
Risk Level	Riskier due to lack of diversification.	Lower risk due to diversification.
Expertise Required	Requires good market knowledge and research.	Little or no expertise needed.
Cost	Lower ongoing charges (no fund management fees).	Higher fees like expense ratio, fund management charges.
Time Involvement	High—requires monitoring and analysis.	Low—professionals manage the investment.
Control	Full control over portfolio and timing.	Limited control; decisions made by intermediaries.

Conclusion

• Indirect Investing is suitable for investors who prefer convenience, diversification, and professional management.

• Direct Investing is suited for experienced investors who want full control, higher potential returns, and are willing to take higher risks.

Question 7

Differentiate between open ended and close ended mutual funds. 

Answer:

Difference Between Open-Ended and Close-Ended Mutual Funds

Basis	Open-Ended Mutual Funds	Close-Ended Mutual Funds
Meaning	Funds that allow investors to buy or sell units anytime.	Funds that allow buying only during the initial offer period.
Entry & Exit	Free entry and exit throughout the year.	Entry only at NFO; exit allowed only after maturity (except via stock exchange).
Maturity Period	No fixed maturity.	Have a fixed maturity (e.g., 3–7 years).
Liquidity	Highly liquid; units can be redeemed directly with the AMC.	Low liquidity; units can be sold only on the stock exchange (if listed).
Pricing	Price is based on NAV (Net Asset Value) declared daily.	Traded on exchange; price may differ from NAV.
Flexibility	Very flexible; suitable for regular investing (SIP).	Less flexible; suitable for long-term locked investments.
Fund Size	Keeps changing as investors buy/sell units anytime.	Fixed fund size since no new units are issued after NFO.
Who Should Invest?	Investors looking for liquidity and convenience.	Investors who want disciplined long-term investment.

Question 8

What are mutual funds. Explain the advantages of investing in mutual funds. 

Answer: 

What Are Mutual Funds?

A Mutual Fund is a financial investment vehicle that pools money from many investors and invests it in a diversified portfolio of securities such as shares, bonds, money market instruments, or other assets.
The fund is managed by professional fund managers who make investment decisions on behalf of investors.

Each investor in a mutual fund owns units of the fund, which represent their share in the overall pool of assets. The value of these units is known as the Net Asset Value (NAV).

Mutual funds are regulated by SEBI (Securities and Exchange Board of India) to ensure transparency and investor protection.

Advantages of Investing in Mutual Funds

1. Professional Management

• The fund is managed by qualified and experienced fund managers.

• Investors benefit from expert research, analysis, and decision-making.

2. Diversification

• Mutual funds invest in a wide range of securities.

• Diversification reduces the overall risk because losses in one investment may be offset by gains in another.

3. Liquidity

• Investors can buy or redeem units of open-ended mutual funds at any time.

• Easy entry and exit make mutual funds convenient.

4. Low Cost and Affordable Investment

• Investors can start with a small amount (e.g., ₹500–₹1000 via SIP).

• Total cost is lower due to shared expenses and economies of scale.

5. Transparency and Safety

• SEBI regulations ensure regular disclosures of portfolio, NAV, fees, and performance.

• Higher level of investor protection.

6. Variety of Schemes

• Equity funds, debt funds, hybrid funds, index funds, sectoral funds, tax-saving ELSS, etc.

• Investors can choose according to their risk level, goals, and time horizon.

7. Tax Benefits

• ELSS (Equity Linked Savings Scheme) offers tax deduction under Section 80C up to ₹1.5 lakh.

• Long-term capital gains are taxed at favourable rates.

8. Easy to Invest and Operate

• Investment can be made online, through SIP, or lumpsum.

• No need for expertise in stock markets.

9. Better Returns Compared to Traditional Investments

• Equity and hybrid funds can offer higher returns over the long term due to market-linked growth.

10. Regulated and Well-Structured

• Mutual funds operate under strict guidelines ensuring safe operations and fair practices.

Question 9 

Differentiate between Primary & Secondary markets. 

Answer: 

Difference Between Primary and Secondary Markets

Basis	Primary Market	Secondary Market
Meaning	Market where companies issue new securities to raise funds.	Market where existing securities are bought and sold among investors.
Purpose	To raise capital for business expansion or new projects.	To provide liquidity and enable investors to trade existing shares.
Participants	Issuing company, investors, underwriters.	Investors, brokers, trading members, stock exchanges.
Examples	Initial Public Offer (IPO), Follow-on Public Offer (FPO), Rights Issue.	Stock exchanges like NSE and BSE where shares are traded.
Price Determination	Price is fixed by the company or underwriter before issue.	Price is determined by demand and supply in the market.
Funds Flow	Money flows from investors to the company.	Money flows between investors; company does not receive funds.
Securities	Newly issued shares, debentures, bonds.	Already listed shares, bonds, ETFs, mutual fund units.
Regulation	SEBI regulates issue procedures and disclosure.	SEBI regulates trading, settlement, and transparency.
Liquidity	Less liquid initially; shares are locked until listing.	Highly liquid; investors can buy or sell anytime.

Question 10

What are the procedure followed to invest in stock market. 

Answer:

Procedure to Invest in the Stock Market in India

Investing in the stock market requires a few formalities and steps to ensure safe and legal trading. Here’s the process:

1. Open a Demat Account

• A Demat Account holds all your shares in electronic form.

• Required to buy and sell shares on stock exchanges.

• Opened with a Depository Participant (DP) like ICICI, HDFC, Zerodha, Upstox, etc.

• National Depositories: NSDL and CDSL.

Documents required: PAN card, Aadhaar, bank account details, and address proof.

2. Open a Trading Account

• A Trading Account is needed to place buy or sell orders on the stock exchange.

• Linked with your Demat and bank accounts.

• Can be opened with a broker or brokerage firm.

3. Complete KYC Formalities

• Submit Know Your Customer (KYC) documents.

• Includes PAN, Aadhaar, photographs, and bank account details.

• Mandatory for SEBI compliance.

4. Fund Your Trading Account

• Transfer money from your bank account to your trading account.

• This money will be used to buy shares or securities.

5. Research and Select Stocks

• Study companies’ financials, performance, and market trends.

• Analyze risk, expected returns, and investment horizon.

• Decide the quantity and price at which you want to buy shares.

6. Place Orders

• Log in to your trading account (online platform or broker).

• Types of orders:

  • Market Order: Buy/sell at the current market price.

  • Limit Order: Buy/sell at a specific price or better.

  • Stop Loss / Stop-Loss Market Orders: To limit losses.

• Orders are sent to the stock exchange electronically.

7. Order Execution

• Stock exchange matches buy and sell orders using an electronic order-matching system.

• Once matched, trade is executed and confirmed.

8. Settlement of Trade

• Clearing Corporation ensures delivery of shares to the buyer and payment to the seller.

• Settlement cycle is T+1 (trade date + 1 working day).

• Shares are credited to the Demat account, and money is debited from the bank account.

9. Monitor and Manage Investments

• Keep track of market trends and portfolio performance.

• Decide when to sell or buy more shares based on goals, risk, and market conditions.

10. Maintain Records and Pay Taxes

• Keep transaction records for capital gains tax calculation.

• Pay taxes as per Short-Term Capital Gains (STCG) or Long-Term Capital Gains (LTCG) rules.

Question 11

What do you mean by NAV of a Mutual Fund? How is it determined? 

Answer:

Net Asset Value (NAV) of a Mutual Fund

Meaning:
The Net Asset Value (NAV) of a mutual fund represents the per unit market value of the fund’s assets minus its liabilities. It is the price at which investors buy or redeem units of the mutual fund.

Formula to Calculate NAV

$$\text{NAV per unit} = \frac{\text{Total Assets of the Fund – Total Liabilities}}{\text{Number of Units Outstanding}}$$

Where:

• Total Assets = Market value of all securities held by the fund + cash + receivables

• Total Liabilities = Expenses, fees, or other obligations of the fund

• Units Outstanding = Total units issued to investors

Example

• Total Assets = ₹10 crore

• Total Liabilities = ₹50 lakh

• Units Outstanding = 50 lakh units

$$\text{NAV} = \frac{10,00,00,000 - 50,00,000}{50,00,000} = \frac{9,50,00,000}{50,00,000} = ₹19 \text{ per unit}$$

Key Points About NAV

1. NAV Changes Daily:
   It is calculated at the end of each trading day based on the closing market prices of the fund’s securities.

2. Not the Same as Market Price:

   • Open-ended funds: Units are bought/redeemed at NAV.

   • Close-ended funds: Units may trade at premium or discount to NAV on stock exchanges.

3. Reflects True Value of Fund:
   NAV shows the actual per-unit worth of the mutual fund’s portfolio.

4. Used for Buying and Redemption:
   Investors buy or redeem mutual fund units at the NAV declared on that day, after adding applicable loads (entry/exit fees).

Question 12

Write Short note on the following:

a) Ethical Fund                         b)  Rolling settlement        c) Depository Participants

d) Broad market Index            e) IPO

Answer:

a) Ethical Fund 

An Ethical Fund is a type of mutual fund that invests in companies and industries based on ethical, social, and environmental principles. These funds follow Socially Responsible Investing (SRI) or Environmental, Social, and Governance (ESG) criteria to ensure that investors’ money supports businesses that align with moral and ethical values.

Ethical funds avoid investing in sectors considered harmful or controversial, such as tobacco, alcohol, gambling, weapons, or environmentally damaging industries. Instead, they focus on companies involved in clean energy, sustainable practices, environmental protection, social welfare, fair trade, and good corporate governance.

Benefits include supporting responsible businesses, lower reputational risk, and long-term sustainable returns. However, they may offer limited diversification and sometimes lower short-term profits as certain high-earning sectors are excluded.

Overall, ethical funds allow investors to earn returns while contributing positively to society and the environment.

b) Rolling Settlement

Rolling settlement is a system in the securities market where trades are settled continuously at regular intervals, rather than on a specific single day. Under this mechanism, the settlement of a trade takes place a fixed number of days after the trade date (T day). For example, in India, the stock market follows a T+1 rolling settlement, meaning that if a trade is executed today (T), it is settled on the next working day.

In rolling settlement, buyers receive securities and sellers receive payment within the specified settlement cycle. This system improves liquidity, reduces risk, prevents trade accumulation, and ensures faster and more efficient settlement compared to earlier weekly settlement systems.

c) Depository Participants

A Depository Participant (DP) is an intermediary between the investor and the depository (such as NSDL or CDSL) in the securities market. Investors cannot directly access depositories, so DPs act as authorized agents who provide demat account services, enabling investors to hold securities in electronic form.

DPs include banks, brokers, financial institutions, and NBFCs registered with SEBI. Their main services include opening demat accounts, dematerialization and rematerialization of securities, transfer/settlement of shares, pledging of securities, and providing account statements.

Overall, Depository Participants make the process of holding and transferring securities safe, fast, and convenient for investors.

d) Broad Market Index

A Broad Market Index is a stock market index that represents the performance of a large and diverse segment of the market, covering companies across multiple sectors, sizes, and industries. It provides a wide view of the overall market trend rather than focusing on a specific sector or group.

Examples include Nifty 500, BSE 500, and Nifty Total Market Index, which track hundreds of companies. Because they cover a broad range of firms—large-cap, mid-cap, and small-cap—these indices are considered more comprehensive and reflective of the entire market’s movement.

Broad market indices are often used for benchmarking mutual fund performance, understanding market health, and designing index funds or ETFs.

e) IPO

An Initial Public Offering (IPO) is the process by which a private company offers its shares to the public for the first time and becomes a publicly listed company on a recognized stock exchange such as NSE or BSE. It marks the transition of a company from the private domain to the public domain.

An IPO enables a company to raise substantial capital for various purposes such as business expansion, setting up new projects, diversification, working capital needs, or repayment of existing loans. The company appoints merchant bankers (lead managers) who assist in drafting the Draft Red Herring Prospectus (DRHP), obtaining SEBI approval, deciding the price band, and managing the entire issue.

There are mainly two methods of pricing an IPO: fixed price issue and book-building issue. In book building, the final price is discovered based on investor bids. Once the issue is subscribed, shares are allotted to investors, and the company's stock is subsequently listed and traded on the stock exchange.

Overall, an IPO enhances a company’s public image, credibility, and access to capital markets, while providing investors an opportunity to participate in the company's future growth.

Question 13

What do you mean by ETF. What are its pros and cons. 

Answer:

An Exchange Traded Fund (ETF) is a type of investment fund that is traded on stock exchanges just like shares. It pools money from investors to invest in a basket of securities such as equities, bonds, commodities, or market indices. Most ETFs are passively managed, meaning they aim to replicate the performance of a specific index like Nifty 50, Sensex, Gold Index, or sectoral indices. Since they trade on exchanges throughout the day, their prices fluctuate in real time based on demand and supply.

ETFs combine features of both mutual funds and shares: like mutual funds, they offer diversification, and like shares, they can be bought and sold anytime during market hours. Investors must have a demat and trading account to invest in ETFs.

Advantages (Pros) of ETFs

1. Low Cost
   ETFs generally have lower expense ratios compared to actively managed mutual funds because they follow a passive strategy and do not require heavy fund management.

2. High Liquidity
   Since ETFs are traded on exchanges throughout the day, investors can buy or sell units at market prices anytime during trading hours.

3. Diversification
   A single ETF provides exposure to a broad range of securities, reducing risk compared to investing in individual stocks.

4. Transparency
   ETF portfolios are usually disclosed daily, allowing investors to clearly know where their money is invested.

5. Flexibility of Trading
   Investors can use trading strategies such as limit orders, stop-loss orders, intraday trading, margin trading (in some cases), etc.

6. Lower Tracking Error
   Since ETFs replicate an index, the difference between ETF returns and index returns (tracking error) is usually minimal.

Disadvantages (Cons) of ETFs

1. Demat and Trading Account Required
   Investors must have a demat and trading account, which may increase cost and limit accessibility for beginners.

2. Liquidity Issues in Some ETFs
   While major ETFs are liquid, many sectoral or thematic ETFs have low trading volumes, leading to price deviations and difficulty in buying/selling.

3. Market-Linked Fluctuations
   Since ETFs track indices or commodities, their prices are fully market-dependent and may decline during volatile periods.

4. Limited Outperformance Potential
   Because most ETFs are passive, they cannot beat the market—they only mirror the index. Hence, returns are capped at index-level performance.

5. Bid–Ask Spread Cost
   Investors may bear the bid-ask spread, which can reduce actual returns, especially in less liquid ETFs.

6. Tracking Error Risks
   Although usually low, factors like fund expenses, imperfect replication, and market conditions may cause ETFs to underperform the index slightly.

Conclusion

ETFs are an efficient, low-cost, and flexible investment option suitable for investors seeking diversified exposure with low management costs. However, they carry risks related to market volatility and liquidity. Understanding the type of ETF, its underlying index, and market conditions is essential before investing.

Question 14

 Distinguish between the following:

a) Money market and Capital market

b) Government and Non- Government securities

c) Futures and Forwards contracts

Answer:

a) Money market and Capital market

Basis	Money Market	Capital Market
1. Meaning	Deals in short-term financial instruments used for meeting temporary fund requirements.	Deals in long-term financial instruments used for raising permanent or long-term funds.
2. Duration / Maturity	Less than 1 year (short-term).	More than 1 year (long-term).
3. Instruments	Treasury bills, Commercial paper, Certificates of deposit, Call money, Repo, etc.	Shares, Debentures, Bonds, Preference shares, Government securities.
4. Purpose	To provide short-term liquidity to borrowers.	To provide long-term capital for investment and growth.
5. Risk Level	Low risk due to short-term and high-quality borrowers.	Higher risk due to long-term investment and market fluctuations.
6. Return	Lower but stable returns.	Higher returns but more volatile.
7. Participants	Banks, RBI, Financial institutions, Mutual funds, Corporates.	Retail investors, FIIs, insurance companies, banks, stock exchanges.
8. Market Structure	No formal exchange; operates over-the-counter (OTC).	Has formal exchanges like NSE, BSE for trading securities.
9. Regulator	Regulated mainly by the RBI.	Regulated by SEBI.
10. Nature of Investment	Highly liquid and safe short-term investments.	Long-term wealth creation and capital formation.

b) Government and Non- Government securities

Basis	Government Securities (G-Secs)	Non-Government Securities
1. Issuer	Issued by Central Government, State Governments, and sometimes government-backed bodies.	Issued by private companies, public limited companies, banks, financial institutions, and PSUs without sovereign guarantee.
2. Risk Level	Very low risk because they are backed by the government (sovereign guarantee).	Higher risk due to no sovereign backing; depends on creditworthiness of the issuer.
3. Return	Offer moderate and stable returns, usually through fixed coupon rates.	Returns can be higher but may fluctuate based on market conditions and issuer performance.
4. Examples	Treasury Bills, Government Bonds, State Development Loans (SDLs), Dated Securities.	Corporate Bonds, Debentures, Commercial Paper, Certificates of Deposit.
5. Maturity Period	Can range from short-term to very long-term (91 days to 40 years).	Generally short-term to medium/long-term, depending on the type of security.
6. Safety	Considered the safest investment in the market.	Safety varies—can be low, moderate, or high depending on credit rating.
7. Liquidity	Highly liquid; widely traded in government securities markets and RBI platforms.	Liquidity varies; some corporate securities may have low trading volumes.
8. Regulation	Managed and regulated by the RBI, with oversight from the Government of India.	Regulated by SEBI and governed by company law and listing regulations.
9. Purpose of Issue	To finance fiscal deficit, development projects, and government programs.	To raise funds for business expansion, working capital, projects, or general corporate purposes.
10. Suitability	Suitable for risk-averse investors seeking safety and stable income.	Suitable for investors willing to take higher risk for potentially higher returns.

c) Futures and Forwards contracts

Basis	Forward Contract	Futures Contract
1. Trading Platform	OTC (private agreement)	Traded on organised exchanges
2. Standardisation	Customised terms	Fully standardised contract size and date
3. Counter-party Risk	High (no clearing house)	Very low due to clearing house guarantee
4. Settlement	Settled on maturity date	Daily settlement through mark-to-market
5. Liquidity	Low, difficult to exit	High, easy to buy/sell anytime
6. Regulation	Not regulated by exchange	Highly regulated (SEBI in India)
7. Price Transparency	Low — terms not publicly known	High — prices publicly available
8. Speculation & Hedging Use	Mainly for hedgers	Used by both hedgers and speculators

Question 15

 How can the order be modified and cancelled in a stock market?

Answer:

In the stock market, investors place buy or sell orders through their brokers using an online trading platform. However, market conditions may change after placing an order, requiring the investor to modify or cancel the order before it gets executed. Stock exchanges such as NSE and BSE allow order modification and cancellation through their electronic trading systems, provided the order is still open and not yet executed.

Order Modification

Order modification means changing the details of an existing order before it is executed. Only open or pending orders can be modified. The investor can modify:

• Price (increase or decrease the limit price)

• Quantity (increase or reduce the number of shares)

• Order type (convert from limit to market or vice versa, if allowed)

• Validity (change from Day order to GTT, IOC, etc., depending on broker)

• Stop-loss trigger price

Process of Modifying an Order:

1. Log in to the trading platform (mobile app or web).

2. Go to the Order Book where all pending/open orders are shown.

3. Select the order that needs modification.

4. Click on “Modify Order”.

5. Update price, quantity, or other details.

6. Confirm the modification; the updated order is sent back to the exchange.

7. The exchange replaces the old order with a new timestamp, keeping the priority as per the time of modification.

Conditions for Modification:

• The order must be in open state (not executed, cancelled, or rejected).

• For partially executed orders, only the unexecuted portion can be modified.

• Market orders typically cannot be modified once placed.

Order Cancellation

Order cancellation means withdrawing or deleting an order placed earlier. An order can be cancelled at any time before it gets executed by the exchange.

Process of Cancelling an Order:

1. Open the Order Book on the trading platform.

2. Select the pending order.

3. Click on “Cancel Order”.

4. Confirm the cancellation request.

5. The system sends a cancellation request to the exchange.

6. If the order has not been executed yet, the exchange cancels it and marks it as Cancelled in the order book.

Conditions for Cancellation:

• Only pending or unexecuted orders can be cancelled.

• Market orders cannot be cancelled once execution has begun.

• Partially executed orders can be cancelled only for the remaining unexecuted quantity.

Why Investors Modify or Cancel Orders

• Change in market price

• Avoiding losses or revising stop-loss

• Change in trading strategy

• Wrong entry of price/quantity

• Volatile market conditions

• Desire to improve order execution priority

Conclusion

Order modification and cancellation are essential features of the modern electronic trading system. They give investors flexibility, control, and protection against unfavourable price movements. As long as the order is not executed, investors can adjust or withdraw it easily through their broker’s platform, ensuring efficient and safer trading.

Question 16

 Explain the concept of REITs. Explain its classifications. 

Answer:

Meaning and Concept of REITs

A Real Estate Investment Trust (REIT) is a company or trust that owns, operates, or finances income-generating real estate. REITs allow small investors to invest in large-scale real estate projects—such as commercial buildings, shopping malls, office spaces, warehouses, and hotels—without directly buying property.

They are similar to mutual funds, but instead of pooling money to invest in shares, REITs pool money to invest in real estate assets. Investors are allotted units (like mutual fund units), which are traded on stock exchanges such as NSE and BSE.

REITs generate income mainly through rent, lease payments, and capital appreciation, and distribute a significant portion of their earnings to unit holders. SEBI regulations require REITs to distribute at least 90% of their distributable surplus to investors, ensuring regular income.

REITs provide diversification, liquidity, transparency, and professional real estate management, making real estate investment accessible to retail investors.

Classifications of REITs

REITs can be classified on the basis of ownership, operation, and investment style. The main classifications are:

1. Equity REITs

These REITs own and operate income-producing real estate properties.

• Their primary income comes from rent and lease of properties.

• They invest in office buildings, malls, warehouses, hotels, hospitals, etc.

• Most REITs listed in India are equity REITs.
  They offer stable income and long-term capital appreciation.

2. Mortgage REITs (mREITs)

These REITs do not own real estate directly.

• Instead, they invest in mortgage loans or mortgage-backed securities (MBS).

• They earn income from interest on loans rather than rent.
  They are more sensitive to interest rate changes and have higher risk.

3. Hybrid REITs

Hybrid REITs combine features of equity REITs and mortgage REITs.

• They both own real estate and invest in mortgage loans.

• Provide a mix of rental income and interest income.
  They offer diversification across real assets and mortgage instruments.

4. Publicly Traded REITs

• Listed on stock exchanges and traded like shares.

• Highly liquid and regulated.
  Retail investors can easily invest in them.

5. Private REITs

• Not listed on exchanges and sold only to institutional or accredited investors.

• Less liquid and less regulated compared to public REITs.

6. Public Non-Traded REITs

• Registered with regulators but not traded on stock exchanges.

• Offer stable returns but low liquidity.

Conclusion

REITs play a vital role in enabling small investors to access large, income-creating real estate investments with ease. Their classifications—equity, mortgage, hybrid, public, and private—offer different risk-return profiles. REITs have emerged as an attractive investment option due to steady income, diversification, liquidity, and transparency, making them an important component of modern financial markets.

Question 17

 Explain the various money market instruments.

Answer:

The money market is a financial market for short-term funds with maturities of up to one year. It provides liquidity to the economy and enables governments, financial institutions, and corporations to meet their short-term financial requirements. The major money market instruments are:

1. Treasury Bills (T-Bills)

• Issued by the Government of India to meet short-term borrowing needs.

• They are issued at a discount and redeemed at face value.

• Maturities: 91-day, 182-day, and 364-day.

• Considered the safest money market instrument due to sovereign backing.

2. Commercial Paper (CP)

• A short-term unsecured promissory note issued by highly rated companies to raise funds for working capital.

• Maturity: 7 days to 1 year.

• Issued at a discount to face value.

• Offers higher returns than T-Bills but carries more risk.

3. Certificates of Deposit (CDs)

• Negotiable time deposits issued by commercial banks and financial institutions.

• Maturity: 7 days to 1 year for banks and 1 to 3 years for financial institutions.

• They offer fixed interest and are transferable.

• Useful for banks to raise short-term funds.

4. Call Money and Notice Money

• Call money: Borrowing/lending for 1 day.

• Notice money: Borrowing/lending for 2 to 14 days.

• Mainly used by banks for maintaining CRR requirements.

• Highly liquid; interest rates fluctuate sharply.

5. Repurchase Agreements (Repos) and Reverse Repos

• Repo: Borrower sells securities (usually government securities) with an agreement to repurchase them at a higher price on a future date.

• Reverse repo: Opposite of repo; the lender receives the securities.

• Used by RBI as a tool for monetary policy.

6. Commercial Bills (Bill of Exchange)

• Short-term negotiable instruments used in trade finance.

• Arise from credit sales of goods.

• Can be discounted with banks to obtain immediate funds.

• Provide liquidity to sellers and act as a secure payment mechanism.

Conclusion

Money market instruments provide high liquidity, low risk, and fulfil short-term funding needs of governments, banks, and corporations. They ensure the smooth functioning of the financial system by enabling efficient cash management and maintaining overall stability in the economy.

Question 18

 Discuss the various stages in the investment decision. 

Answer:

Investment decision-making is a systematic process through which an investor chooses the best investment option based on risk, return, and financial goals. The major stages are:

1. Identification of Financial Goals

The first step is to clearly define financial objectives—such as buying a house, funding education, retirement planning, or wealth creation. Goals may be short-term, medium-term, or long-term, and they guide the entire investment process.

2. Determining Risk Appetite and Return Expectations

Investors differ in their ability and willingness to take risk. Factors like age, income, financial stability, and knowledge influence risk tolerance. Setting appropriate return expectations based on risk capacity helps in selecting suitable investment instruments.

3. Gathering and Analyzing Information

This stage involves collecting information about available investment avenues such as stocks, bonds, mutual funds, real estate, gold, and deposits. The investor evaluates factors such as historical performance, market conditions, risk levels, liquidity, tax implications, and costs.

4. Evaluation of Investment Alternatives

After collecting data, various investment options are compared on the basis of:

• Expected return

• Risk involved

• Time horizon

• Market volatility

• Liquidity

• Alignment with financial goals

This helps in shortlisting the most suitable alternatives.

5. Selection of the Best Investment Option

Based on analysis and evaluation, the investor chooses the most appropriate investment or a diversified portfolio. This decision must balance risk and return while matching the investor’s financial objectives.

6. Executing the Investment Decision

Once the investment option is selected, the investor proceeds to implement it. This includes:

• Opening demat/trading accounts

• Completing KYC formalities

• Placing orders

• Investing through brokers, banks, or online platforms
  Proper execution ensures the investment is made correctly and timely.

7. Monitoring and Reviewing the Investment

Investment performance must be monitored regularly. Changing market conditions, inflation, interest rates, and personal financial situations may affect investments. Regular review helps to:

• Rebalance the portfolio

• Exit poorly performing assets

• Take advantage of better opportunities

8. Revision or Rebalancing

If investments deviate from financial goals or risk levels, adjustments must be made. Rebalancing involves reallocating funds to maintain the desired investment mix and ensure long-term financial stability.

Conclusion

Investment decision-making is a multi-stage process involving goal-setting, risk assessment, analysis, selection, execution, and continuous monitoring. Following these stages helps investors make informed and effective decisions, optimising returns while managing risk efficiently.