Money, Banking And Share Market

Question 0

What is Bearish stock market?

Answer 0

Description of a stock market, where collective sentiment about the current and future performance of firms and the economy is negative, and results in falling stock prices.

Question 1

What is Bank run?

Answer 1

A panic situation where deposit holders queue up en messe at banks to withdraw cash from their accounts due to a fear that the banks may not have sufficient funds

Question 2

What is Bullish stock market?

Answer 2

Description of a stock market, where the collective sentiment about the current and future performance of firms and the economy is positive, and result in rising stock prices.

Question 3

What is CRR in banking parlance?

Answer 3

• Cash Reserve Ratio. A minimum percentage of net demand and time liabilities that banks are mandated by RBI to maintain in the form of cash.
• It varies from 20% to 3% of the deposit liabilities of banks.
• It is one of the measures to safeguard the depositors from issues like run on the bank

Question 4

What is Double coincidence of wants?

Answer 4

The matching of mutual demands for two goods for a successful BARTER EXCHANGE.

Question 5

What is Money?

Answer 5

A unit of measuring value, a medium of exchange, and a store of value.

Question 6

What is Money Supply (M1)

Answer 6

• Currency with the public + chequable demand deposits with banks, + other deposits with RBI.
• It is also called as ‘Narrow Money’.
• Its one of the type in which RBI categories money supply in the economy.

Question 7

What is Money Supply (M3)?

Answer 7

• M1+ time deposits with banks.
• Also known as ‘Broad Money’
• It is one of the types RBI categorises money supply in the economy.

Question 8

What is Mutual fund?

Answer 8

A financial instrument whereby specialist managers diversify risk by parking investors funds into different stocks, hoping to offer reasonable returns to the investors.

Question 9

NIFTY

Answer 9

Acronym for NATIONAL FIFTY, an index based on fifty shares traded on the National Stock Exchange of India which covers twenty-one different sectors of the Indian economy.

Question 10

SENSEX

Answer 10

A share price index of thirty sensitive and actively traded shares on the Bombay Stock Exchange.

Question 11

Shares

Answer 11

The stock of a firm divided into smaller denominations, such as, ₹ 100, and traded on the stock market for a price that reflects the firms current and future prospects and profitability.

Question 12

What is SLR in banking parlance?

Answer 12

• Statutory Liquidity Ratio. A minimum percentage of net demand and time liabilities that banks are mandated by RBI to maintain in the form of government securities, cash in hand gold.
• This is to safeguard the depositors and banks interest against issues like bad loans or Non Performing Assets (NPAs)

Question 13

What is ‘Stock’ in a share market parlance?

Answer 13

The capital investment in a firm by its owners.

Question 14

Explain the deposit insurance mechanism in India.

Answer 14

• loan defaults and consequent bank failures tend to spread panic among the deposit holders, resulting in a bank run. This can lead to complete collapse of banking mechanism.
• To counter such panic situations, government generally support a deposit insurance mechanism for the banks. This initiative began in the aftermath of the Great Depression of 1930s.
• In India, deposit holders bank accounts are insured up to a maximum of ₹ 1,00,000 each, per insured bank by the “ Deposit Insurance and Credit Guarantee Corporation (DICGC).

Question 15

What is the difference between ‘government securities’ and ‘debentures’?

Answer 15

1. Government Securities:
   - As the name suggest, govt securities are a form of loan by the public to the government.
   - They are considered almost risk free assets, for the government is not expected to default on the periodic payment of interest or repayment of borrowed funds on maturity.
2. Debentures:
   - are also a form of loan by the public, but, given to private firms.
   - the risk associated with the debentures is somewhat higher but interest earned on debentures is also higher than on government securities.
   - debenture holders receive interest irrespective of whether firm makes higher or lower profits, or makes profits at all.

Question 16

What is the difference between government securities or debentures and shares of firms?

Answer 16

1. The owners of the shares of a firm are also the owners of the firm.
   - Owners or shareholders of the firm are residual claimants of the profits made by the firms. This residual amount received by the shareholders is called dividend.
   - If firm makes huge profit shareholders earns large dividends, much larger than the interest that lenders earn by giving credit to the firm.
2. Those who invest in government securities or debentures of the firm are actually lenders to the firm; they are not owners of the firm.
   - Therefore, irrespective of whether or not firm makes profit, lenders have the first claim for receiving interest on or repayment of their financial investment.

Question 17

What is Open Market Operations (OMOs)

Answer 17

The selling (or buying) of government securities by the central bank of the country to (and from) commercial banks, financial institutions, and/or others in the financial market.

Question 18

What is Repo rate?

Answer 18

The rate at which commercial banks borrow short-term funds from the Reserve Bank of India.

Question 19

Explain “arms length principle”

Answer 19

The arm’s length principle (ALP) is the condition or the fact that the parties to a transaction are independent and on an equal footing. Such a transaction is known as an “arm’s-length transaction”.

It is used specifically in contract law to arrange an equitable agreement that will stand up to legal scrutiny, even though the parties may have shared interests (e.g., employer-employee) or are too closely related to be seen as completely independent (e.g., the parties have familial ties).

A transaction in which the buyers and sellers of a product act independently and have no relationship to each other. The concept of an arm’s length transaction is to ensure that both parties in the deal are acting in their own self interest and are not subject to any pressure or duress from the other party.

Examples

> A simple example of not at arm’s length is the sale of real property from parents to children.

The parents might wish to sell the property to their children at a price below market value, but such a transaction might later be classified by a court as a gift rather than a bona fide sale, which could have tax and other legal consequences.

To avoid such a classification, the parties need to show that the transaction was conducted no differently from how it would have been for an arbitrary third party.

This could be done, for example, by hiring a disinterested third party, such as an appraiser or broker, who could offer a professional opinion that the sale price is appropriate and reflects the true value of the property.

The principle is often invoked to avoid undue government influence over other bodies, such as the legal system, the press, or the arts.

For example, in the United Kingdom Arts Councils operate “at arm’s length” in allocating the funds they receive from the government.

> > The Organisation for Economic Co-operation and Development (OECD) has adopted the principle in Article 9 of the OECD Model Tax Convention, to ensure that transfer prices between companies of multinational enterprises are established on a market value basis.

In this context, the principle means that prices should be the same as they would have been, had the parties to the transaction not been related to each other.

This is often seen as being aimed at preventing profits being systematically deviated to lowest tax countries, although most countries are also concerned about prices that fail to meet the arm’s length test due to inattention rather than by design and that shifts profits to any other country (whether it has low or high tax rates).

It provides the legal framework for governments to have their fair share of taxes, and for enterprises to avoid double taxation on their profits.

Question 20

Explain “transfer pricing” in context of corporate tax avoidance/ Base Erosion & Profit Shifting (BEPS)

Answer 20

Transfer pricing is the setting of the price for goods and services sold between controlled (or related) legal entities within an enterprise.

For example, if a subsidiary company sells goods to a parent company, the cost of those goods is the transfer price.

Legal entities considered under the control of a single corporation include branches and companies that are wholly or majority owned ultimately by the parent corporation.

Certain jurisdictions consider entities to be under common control if they share family members on their boards of directors.

It can be used as a profit allocation method to attribute a multinational corporation’s net profit (or loss) before tax to countries where it does business.

Transfer pricing results in the setting of prices among divisions within an enterprise.

In principle a transfer price should match either what the seller would charge an independent, arm’s length customer, or what the buyer would pay an independent, arm’s length supplier.

> > While unrealistic transfer prices do not affect the overall enterprise directly, they become a concern when they are misused to lower profits in a division of an enterprise that is located in a country that levies high taxes and raise profits in a country that is a tax haven that levies no or low taxes.

Transfer pricing is the major tool for corporate tax avoidance also referred to as Base Erosion and Profit Shifting (BEPS).

Question 21

What are negative interest rates? Why do banks impose negative interest rates? Does it work? Are we going to see more of it?

Answer 21

Normally borrowers pay lenders a rate, typically as an annual percentage, on the amount borrowed.

So, for example, when people deposit money in a bank, they normally expect to get back some form of interest on the account.

However, when interest rates are negative, this relationship is reversed, and lenders have to pay to lend money or to invest.

The general idea of imposing negative rates is to discourage people or organisations from certain investments.

In short, for different reasons, but usually to try to stabilise the economy in some way.

The Swiss National Bank brought in a negative rate to try to lower the value of the Swiss franc, which has been rising as people look for safer investments.

Factors such as a sharp drop in the value of the Russian rouble and steeply falling oil prices have spooked investors.

Switzerland normally sees money flowing into its coffers in difficult economic times.

However, if the currency is too strong, this can hit exports, as products become more expensive.

In June, the European Central Bank (ECB) imposed a negative interest rate, but for different reasons.

It wanted to try to stop banks from depositing money with it, and instead lend to eurozone businesses.

Does it work?
How effective negative rates are depends on many different variables.

In the case of Switzerland, the immediate impact was a temporary fall in the franc against the euro, but the currency was trading slightly higher by late morning.

Its longer-term impact remains to be seen.

The ECB’s negative interest rate was announced as part of a raft of measures designed to stimulate the eurozone economy, which continues to stagnate.

Are we going to see more of it?

It very much depends on what banks want to achieve, and whether they think it’s going to work.

Negative interest rates are rarely brought in, and are seen as quite a radical measure.

While negative interest rates are normally aimed at institutional investors, in the long term they can have a detrimental effect on savers, if investors decide to recoup the costs of the rate by levying charges on consumers.

Besides, central banks have a range of other measures available to them to stimulate the economy.

For example, since the global financial crisis, both the Bank of England and the Federal Reserve have used so-called “quantitative easing” - buying assets to boost the supply of money - as an economic stimulus.

The Bank of England considered imposing a negative bank rate in February 2013, but decided against it in May of that year.

However, it’ll remain as an option to tackle contingencies as an instrument to stabilise national economies in fragile world economy.

Question 22

Explain, Economic spread.

Answer 22

DEFINITION OF ‘ECONOMIC SPREAD’
1. A performance metric that is equal to the difference between a company’s weighted average cost of capital (WACC) and its return on invested capital (ROIC).

2. The difference between the real rate of return on an investment and the rate of inflation in the economy.

INVESTOPEDIA EXPLAINS ‘ECONOMIC SPREAD’
1. Economic spread is a measure of a company’s ability to make money on its investments. If the cost of capital exceeds the return on invested capital, the company is losing money: what the company is doing with the capital is not providing enough to cover the cost of borrowing or using it.

2. Economic spread is important for evaluating the returns of a pension plan. The value of its invested funds may be increasing at what seems to be a acceptable level, but if the invested capital is not growing at a rate above inflation, the investment is actually losing its value on an annual basis. This nominal loss results from the fact that the invested capital will not be able to buy as much for the investor in the future as it can in the present time.

Question 23

Explain “Payment Bank” in Indian context.

Answer 23

Payments Bank would be permitted to undertake only certain restricted activities permitted to banks under the Banking Regulation Act, 1949, as given below:

NO LENDING activities.

ACCEPTANCE OF DEMAND DEPOSITS, i.e., current deposits, and savings bank deposits. [The eligible deposits mobilised by the Payments Bank would be covered under the deposit insurance scheme of the Deposit Insurance and Credit Guarantee Corporation of India (DICGC)]

PRIMARY ROLE is to provide PAYMENTS and REMITTANCES services and DEMAND DEPOSITS PRODUCTS to small businesses and low-income households.

Initially be restricted to holding a maximum balance of Rs. 100,000 per customer. [After the performance of the Payments Bank is gauged by the RBI, the maximum balance can be raised]

If the transactions in the accounts conform to the “small accounts”1 transactions, simplified KYC/AML/CFT norms will be applicable to such accounts as defined under the Rules framed under the Prevention of Money-laundering Act, 2002.

INTERNET BANKING - The RBI is also open to applicants transacting primarily using the Internet.[Should follow RBI instructions on information security, electronic banking, technology risk management and cyber frauds]

Functioning as BUSINESS CORRESPONDENT (BC) of other banks – A Payments Bank may choose to become a BC of another bank for credit and other services which it cannot offer.[***GRAVE POTENTIAL FOR CONCEALMENT/MONEY LAUNDERING ACTIVITIES]

The Payments Bank CANNOT SETUP SUBSIDIARIES to undertake non-banking financial services activities.

The Payments Bank will be required to use the word “Payments” in its name in order to differentiate it from other banks.

Question 24

Explain Equity Capital.

Answer 24

Invested money that, in contrast to debt capital, is not repaid to the investors in the normal course of business. It represents the risk capital staked by the owners through purchase of a company’s common stock (ordinary shares).

The value of equity capital is computed by estimating the current market value of everything owned by the company from which the total of all liabilities is subtracted.

On the balance sheet of the company, equity capital is listed as stockholders’ equity or owners’ equity. Also called equity financing or share capital.

Question 25

Explain “Soft Loans”.

Answer 25

A soft loan is a loan with a BELOW MARKET RATE OF INTEREST. This is also known as soft financing.

Sometimes soft loans provide other concessions to borrowers, such as LONG REPAYMENT PERIODS or INTEREST HOLIDAYS.

Soft loans are USUALLY provided BY GOVERNMENTS to projects they think are worthwhile. THE WORLD BANK and OTHET DEVELOPMENT INSTITUTIONS provide soft loans TO DEVELOPING COUNTRIES.

^This contrasts with a hard loan, which has to be paid back in an agreed hard currency, usually of a country with a stable robust economy.

Examples:

Soft loan is China’s Export-Import Bank, who gave a $2 billion soft loan to Angola in October 2004 to help build infrastructure. In return, the Angolan government gave China a stake in oil exploration off the coast.

Another example is the interest free soft loan of Rs. 20 billion given by the Asian Development Bank (ADB) to the government of West Bengal (India) on the condition that it be used for health, education and developing infrastructure and that the government would implement 16 economic reforms.

The field of Natural Finance uses the term Soft Loan as an enforced ability-based repayment loan where the softness is not based on below market interest, but rather on terms that don’t include fixed dates for repayment, but do mandate repayment when borrower is able to.[citation needed]

Question 26

REPO, REVERSE REPO, BANK RATE, CALL RATE, CRR & SLR DEFINITIONS

Answer 26

Repo (Repurchase) Rate

Repo rate is the rate at which banks borrow funds from the RBI to meet the gap between the demand they are facing for money (loans) and how much they have on hand to lend.

If the RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate.

Reverse Repo Rate

This is the exact opposite of repo rate.

The rate at which RBI borrows money from the banks (or banks lend money to the RBI) is termed the reverse repo rate. The RBI uses this tool when it feels there is too much money floating in the banking system

If the reverse repo rate is increased, it means the RBI will borrow money from the bank and offer them a lucrative rate of interest. As a result, banks would prefer to keep their money with the RBI (which is absolutely risk free) instead of lending it out (this option comes with a certain amount of risk)

Consequently, banks would have lesser funds to lend to their customers. This helps stem the flow of excess money into the economy

Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks, while repo signifies the rate at which liquidity is injected.

Bank Rate

This is the rate at which RBI lends money to other banks (or financial institutions .

The bank rate signals the central bank’s long-term outlook on interest rates. If the bank rate moves up, long-term interest rates also tend to move up, and vice-versa.

Banks make a profit by borrowing at a lower rate and lending the same funds at a higher rate of interest. If the RBI hikes the bank rate (this is currently 6 per cent), the interest that a bank pays for borrowing money (banks borrow money either from each other or from the RBI) increases. It, in turn, hikes its own lending rates to ensure it continues to make a profit.

Call Rate

Call rate is the interest rate paid by the banks for lending and borrowing for daily fund requirement. Si nce banks need funds on a daily basis, they lend to and borrow from other banks according to their daily or short-term requirements on a regular basis.

CRR

Also called the cash reserve ratio, refers to a portion of deposits (as cash) which banks have to keep/maintain with the RBI. This serves two purposes. It ensures that a portion of bank deposits is totally risk-free and secondly it enables that RBI control liquidity in the system, and thereby, inflation by tying their hands in lending money

SLR

Besides the CRR, banks are required to invest a portion of their deposits in government securities as a part of their statutory liquidity ratio (SLR) requirements. What SLR does is again restrict the bank’s leverage in pumping more money into the economy.