Class 11 Finance Chapter 1 Finance

AHSEC Class 11 Finance Chapter 1 Finance Solutions in English Medium to each chapter is provided in the list so that you can easily browse throughout different chapters AHSEC Class 11 Finance Chapter 1 Finance Question Answer and select needs one.

Class 11 Finance Chapter 1 Finance

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Also, you can read the SCERT book online in these sections Solutions by Expert Teachers as per SCERT (CBSE) Book guidelines. These solutions are part of SCERT All Subject Solutions. Here we have given AHSEC Board Class 11 Finance Chapter 1 Finance Notes for All Subject, You can practice these here.

Finance

Chapter : 1

A. Write the correct answer as directed: 

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

(i) RBI.

(ii) SEBI.

(iii) IRDA.

(iv) Ministry of Finance.

Ans: (i) RBI.

2. Development Financial Institutions are the main sources of short term funds for a business. (State whether the statement is true or false)

Ans: False. 

3. Commercial paper is a money market instrument. (State whether the statement is true or false).

Ans: True. 

4. Treasury bills are issued by ___________ (Fill up the gap). 

Ans: Government of India.

B. Give brief answer to the following questions: 

1. Define finance? 

Ans: Finance refers to the process of raising funds or capital for any kind of expenditure. Savers and investors accumulate funds in the form of savings deposits, insurance claims, provident fund, pension fund etc.

2. What is private finance?

Ans: Private finance is the study of income and expenditure, borrowings, etc. Of individuals, households and business firms. Personal finance deals with the process of optimising finances by individuals such as people, families and single consumers.   

3. What is public finance?

Ans: Public Finance is that part of economics which deals with the study of the state’s income and expenditure.

4. What is corporate finance?

Ans: Corporate finance is concerned with raising of funds and its judicious allocation for the different activities of a corporate house.

5. Write two sources of finance?

Ans: Long-Term Sources of Finance and Medium Term Sources of Finance. 

6. Give two examples of financial services. 

Ans: The two examples of financial services are: credit rating and mutual funds.

7. Name any two capital market instruments. 

Ans: The two capital market instruments are: Equity shares and Bonds.

8. What is the Money Market?

Ans: Money market is the sector of the financial market that includes financial instruments having a maturity or redemption period of one year or less at the time of issuance. It is mainly a wholesale market.

9. What is the Capital Market? 

Ans: Capital market is the sector of the financial market where long-term financial instruments issued by corporations and governments are traded. Here “long-term” refers to a financial instrument with an original maturity greater than one year and perpetual securities that are the securities with no maturity. 

C. Answer the following questions in about 200 words each: 

1. Explain briefly about the various functions of finance. 

Ans: The various functions of finance are discussed below:

(i) Acquisition, allocation and utilisation of funds: Finance is concerned with acquisition, allocation and utilisation of funds. For proper functioning of a business firm, uninterrupted flow of funds to all parts of the business must be ensured from the right sources at the right cost at the right time. 

(ii) Channelization of funds: Financial system is a critical element of any economy. The different components of the financial system like financial institutions, markets, instruments and services perform the essential function of channelling funds from people who have saved surplus funds by spending less than their income to people who have a shortage of investible funds.

(iii) Optimal mix of funds: Finance is concerned with the best optimal mix of funds in order to obtain the desired and determined results respectively. Primarily, funds are of two-owned funds (promoters’ contribution, equity shares, etc.) and borrowed funds (bank loan, bank overdraft, debentures, etc). A proper mix of the different sources ensures maximum profit for a business firm at minimum cost and risk. 

(iv) Creation of investment opportunities: Finance creates investment opportunities i.e. it ensures utilisation of fund for profit or returns. With available funds in hand, a person or institution can make investments by-  

(a) Creating physical assets such as development of land, acquiring commercial assets, etc.  

(b) Carrying on trading, manufacturing or other business activities.  

(c) Acquiring financial securities such as shares, bonds, units of mutual funds etc.

(v) Internal controls: Finance is concerned with internal controls maintained in the organisation or workplace. Internal financial controls include policies and procedures adopted by a firm for ensuring the orderly and efficient conduct of its business, including regulatory compliance and prevention and detection of frauds and errors.

(vi) Maximization of profit: Profit maximisation is the capability of a business or company to earn the maximum profit with low cost which is considered as one of the main objectives of any business. In realising this objective of a business, finance plays a very important role. Timely and adequate flow of finance helps a firm to take the advantages of business opportunities arising from time to time. 

(vii) Future decision making: Finance is concerned with the future decision of the organisation. From evaluating different types of loans, choosing whether to rent or buy, or deciding whether to invest in stock or bond, it’s important to understand the different aspects associated with finance. A sound knowledge on finance helps managers create budgets, understand public perception, track efficiency, analyse product performance, and develop short and long-term strategies.

(viii) Helps increase cash flow: Finance can help in increasing the cash flow in a firm. Keeping a track of the expenditures and spending patterns enables the firm to increase its cash flow. Tax planning, spending prudently, and careful budgeting ensure that the firm does not lose its hard earned money on unnecessary and unproductive expenses.

2. Write a short note on the different types of finance. 

Ans: Finance can be broken into four different sub-categories as under:

A. Classification on the basis of duration: 

(i) Short-term finance: The period of this type of finance is less than one year. Short Term finance is basically required to meet the working capital requirements of a firm – that is the expenditures connected with daily business activities such as paying wages to the staffs or getting raw materials. Cash credit, overdraft, bill discounting are some of the important sources of short term finance. Commercial banks are the main providers of short term finance. 

(ii) Medium-term finance: The period of this type of finance is one year to five years. Hire purchase finance, lease finance, Commercial banks and Development Finance Institutions are the main sources of medium term finance. A business firm requires medium term finance to purchase equipment, fixed assets and the like. 

(iii) Long-term finance: Finance required for a period of more than 5 years is called long term finance. This type of finance is mostly needed for buying plants, land, restructuring offices or buildings, etc for a business. Issue of bonds/debentures, issue of preference shares, issue of equity shares, long-term loans from government, financial institutions or investment banks, venture funding or funds from investors, are other examples of long-term finance.

B. Classification on the basis of users: 

(i) Public Finance: Public Finance is that part of economics which deals with the study of the state’s income and expenditure. It describes and analyses the expenditures of governments and the techniques used by governments to finance these expenditures. The scope of public finance includes the collection of funds and its allocation among different sectors of the state economy that are considered as essential functions or duties of the government. Public finance can be classified into three types– public expenditure, public revenues and public debt.

(ii) Corporate Finance: Corporate finance is concerned with raising of funds and its judicious allocation for the different activities of a corporate house. Corporate finance aims at studying the funding of assets from various sources like the market, the general public, or various financial institutions. The primary concern of corporate finance is the maximisation of shareholder value through short-term and long-term financial planning and different strategies’ implementation. 

(iii) Private Finance: Private finance is the study of income and expenditure, borrowings, etc. of individuals, households and business firms. Personal finance deals with the process of optimising finances by individuals such as people, families and single consumers. Business Finance involves the process of optimising finances by business organisations. It involves asset acquisition and proper allocation of funds in a way that maximises the achievement of set goals-maximising profit at minimum cost.

C. Classification on the basis of mode of delivery. On the basis of mode of delivery, finance could be of two types: 

(i) Direct Finance: Direct financing is done directly through a lender. In this case, the borrower directly borrows funds from the lender in the financial markets by selling them securities. An example is an individual who buys a newly issued government bond through the services of a broker, when the bond is sold by the broker in its original state. Another good example for direct finance is a business which directly buys newly issued commercial papers from another business entity. 

(ii) Indirect Finance: Indirect finance refers to a financing system where borrowers borrow funds from the financial market through indirect means, such as through a financial intermediary. In this case, the role of channelizing the funds from the savers to borrowers is done through financial intermediaries like commercial banks.

D. Classification on the basis of source. On the basis of source, finance can be divided as equity finance and debt finance:

(i) Equity finance: Owned capital brought in by the promoters or the businessman himself is referred to as equity finance. 

(ii) Debt finance: Debt finance refers to the borrowed fund. Debt reflects money owed by the company towards another person or entity. It is the money advanced by outside agencies like banks, financial institutions, etc. generally in the form of loans.

3. Differentiate between banks and non-bank financial institutions (NBFIs). 

Ans: The following are the main points of difference between banks and NBFIs.

4. State the functions of the financial system. 

Ans: Functions of Financial System: Various functions of Financial System are: 

(i) Establish linkage between savers and investors: One of the important functions of the financial system is to link the savers and investors. It helps in mobilising and allocating the savings effectively and efficiently. 

(ii) Promotion of liquidity: The major function of the financial system is to promote liquidity and safety of funds. 

(iii) Facilitating Payments: Financial System facilitates efficient payment mechanism for timely and smooth transfer of goods and services. 

(iv) Allocation of risk: It limits, pools, and trades the risks involved in mobilising savings and allocating credit. 

(v) Managing Information: The financial system makes available a lot of important information, which is important for the well-being of the economy as a whole. 

(vi) Efficient Middleman: The financial system plays the role of an efficient middleman. 

(vii) Helps in project selection: A financial system helps in selecting the right type of projects to be funded. 

(viii) Reduce cost of transaction and borrowing: A financial system helps in creation of financial structure that lowers the cost of transactions. 

(ix) Price discovery: The financial market performs the function of price discovery of the different financial instruments traded in the financial market.  

D. Answer the following questions in about 400 words each: 

1. Elaborately discuss the different sources of short term and long term finance for a business concern. 

Ans: (i) Long-Term Sources of Finance Long-term sources fulfil the financial requirements of a business for a period more than 5 years to 10, 15, 20 years or even more depending on other factors. Such financing is generally required for the procurement of fixed assets such as plant, equipment, machinery etc. Part of working capital which permanently stays with the business is also financed with long-term sources of funds. 

Long-term financing sources can be in the form of any of the following:  

(a) Equity share: These shares are issued to the general public and are non-redeemable in nature. Investors in such shares hold the right to vote, share profits and claim assets of a company.  

(b) Preference shares: Preference shares are those shares which get preferential rights to dividend announced by a company. This means that a company has to pay dividend to preference shareholders first and then to equity shareholders. In case a company is winding up, the final payment will be made to preference shareholders first and then equity shareholders. 

(c) Retained Earnings: Retained earnings are the portion of a company’s cumulative profit that is held or retained and saved for future use.  

(b) Debenture/ Bonds: A corporate house can raise funds from the capital market by issuing debentures and bonds. Debentures are unsecured debt instruments while bonds are secured by some form of collateral.

(e) Term Loans from financial institutions: Long term loans from financial institutions like IFCI, SFCs, commercial banks etc. is an important source of long term finance for commercial establishments.  

(f) Venture capital: Venture capital is a form of private equity and a type of financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential.  

(g) Asset Securitization: Asset securitization is the structured process whereby interests in loans and other receivables are packaged, underwritten, and sold in the form of “asset backed” securities.  

(h) International Financing: Finance can be raised from foreign market by way of Euro Issue, Foreign Currency Loans, ADR (American Depository Receipt), GDR (Global Depository Receipt) etc.

(ii) Short Term Sources of Finance: Funds which are required for a period not exceeding one year are called short-term sources. The need for short-term finance arises to finance the current assets of a business like an inventory of raw material and finished goods, debtors, minimum cash and bank balance etc. Short-term financing is also named as working capital financing. Main sources of short term finance are the following-  

(a) Trade Credit: Trade credit is a business-to-business agreement in which a customer can purchase goods without making immediate cash or cheque payments. Trade credit is a helpful tool for growing businesses.  

(b) Loan, Cash Credit and Overdraft: Short Term Loans, cash credit and overdraft facilities provided by Commercial Banks are the most popular sources of short term finance for the business community.  

(c) Advances received from customers: Customer advances may be defined as the part of payment made in advance by the customer to the enterprise for the procurement of goods and services in the future. This source of finance is free from interest burden. That means, the enterprise does not require paying any interest on advances received from customers.  

(d) Creditors: Trade credit facilitates the purchase of goods and services without making immediate payment and is commonly used by business organisations as a source of short-term financing.  

(e) Accounts Payables: Accounts Payable financing allows a company to pay its supplier immediately without having to use their own working capital. This type of financing gives the company a longer term to pay back the creditor or when they sell the inventory.  

(f) Factoring Services: Factoring is a financial service in which a business entity sells its bill receivables to a third party at a discount in order to raise funds. This is a type of business loan.  

(g) Bill Discounting: Bill Discounting is a trade-related activity in which a company’s unpaid invoices, which are due to be paid at a future date, are sold to a bank or other financial institution.

2. Discuss the various components of the financial system.

Ans: A financial system refers to a system which enables the transfer of money between investors and borrowers. In other words, the financial system facilitated the movement of funds from surplus areas to deficit areas. This movement of funds in a financial system is facilitated by a group of complex and closely linked institutions, agents, procedures, markets, transactions, claims and liabilities within an economy. These are known as the components of the financial system. 

The different components of a financial system are: 

(i) Financial Market: Financial market is one of the main components of a financial system which facilitates movement of funds from surplus areas to deficit areas. It is a market where funds and financial instruments of different durations are traded. It is a market in which individuals, government, semi government and corporate bodies can trade in funds, financial assets, commodities and other fungible items at prices determined by the demand and supply conditions. Financial markets can be divided under different categories. Broadly financial market can be divided as follows– 

(a) Money Market: Money market is the sector of the financial market that includes financial instruments having a maturity or redemption period of one year or less at the time of issuance. It is mainly a wholesale market. Money market has many submarkets like Call Money Market, Collateral loan Market, Commercial Bill Market, Treasury Bill Market etc. 

(b) Capital Market: Capital market is the sector of the financial market where long-term financial instruments issued by corporations and governments are traded. Here “long-term” refers to a financial instrument with an original maturity greater than one year and perpetual securities that is the securities with no maturity. There are two types of capital market securities viz. ownership securities and debt securities.

(ii) Financial Institutions: Any institution that accepts public savings and utilises it into assets such as stocks, bonds, bank deposits, or loans is considered a financial institution. Financial institutions facilitate smooth working of the financial system by providing a common platform to the investors and borrowers. They mobilise the savings of investors either directly or indirectly via financial markets. They offer services to individuals and organisations looking for advice on different problems including restructuring to diversification strategies.

Financial institutions can be divided into the following two broad categories: 

(a) Banking Institutions Bank is a financial institution that facilitates transfer of money from one person or business to another person or business. Basically, banking is a business activity which involves accepting money from public in the form of deposits and lending it as loans for earning profit. Banking institutions mainly serve two purposes viz. safeguarding public deposits and catering to their financial requirements by providing loan facilities. 

(b) Non-Banking Financial Institutions A non banking financial institution (NBFI) is a financial institution whose liabilities cannot be used as means for settlement of debt. Like the banking institutions, NBFIs can accept deposit from the public and provide loan. 

(iii) Financial Instruments: In a financial system the transfer of available funds takes place through the buying and selling of financial instruments. In other words, as a component of the financial system, financial instruments facilitate movement of funds from surplus areas to deficit areas. A financial instrument is a written legal obligation of one party to transfer something of value, usually money, to another party at some future date, under certain conditions. The term ‘instrument’ is used in a wider sense.

(iv) Financial services: Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organisations that deal with the management of money. Among these organisations are banks, credit card companies, insurance companies, consumer finance companies, stock brokerages, investment funds and some government sponsored enterprises. Financial service providers help to get the necessary funds and also make sure that they are efficiently deployed. 

(v) Regulatory Bodies: The task of control and regulation of the various participants in the financial system has been entrusted to some statutory authorities formed under different statutes of the parliament. Hence these statutory bodies are considered as an important component of the financial system. There are two most important regulatory bodies in the country viz. Reserve Bank of India and Securities and Exchange Board of India (SEBI). The Reserve Bank of India (RBI) regulates and supervises the major part of the financial system. 

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

Ans: The role of financial system in the economic development of a nation can be discussed under the following:

(i) Capital formation: Capital formation is the process by which a community’s savings are channelled into investments in capital goods such as plant, equipment, and machinery, which increases a country’s productive capacity and worker efficiency, ensuring a greater flow of goods and services in a country. The financial system mobilises excess funds or savings available in the hands of the citizens and thus helps in capital formation. 

(ii) Promoting investments: An important role of the financial system in economic development is that it encourages savings to flow into the various productive sectors of the economy. The level of investment determines the increase in output of goods and services, and incomes in the country. It is required to be noted that investment in productive segments are non-inflationary in nature which ultimately lead to the growth and development in the economy. 

(iii) Allocating savings on the basis of national priorities: The financial system allocates the savings in a more efficient manner so that the scarce capital may be more efficiently utilised among various priority sectors as per national policy. While investing funds, some preferences are always given to certain social and economic sectors on the basis of national priorities. 

(iv) Encouraging entrepreneurial talents: Financial system encourages the growth of entrepreneurial talents by promoting the spirit of enterprise and risk-taking capacity. Financial institutions like commercial and specialised banks act as the main driving force in the growth and development of entrepreneurship. They provide much needed financial resources to the entrepreneurs by different ways like overdraft, medium and long term loans, debt factoring, invoice discounting, asset finance including commercial mortgages and equity finance. 

(v) Financial deepening and broadening: A well –functioning financial system helps in promoting the process of financial deepening and broadening. Financial deepening refers to an increase of financial assets as a percentage of the gross domestic product. Financial broadening refers to building an increasing number and a variety of participants and instruments. 

(vi) Interest rates stabilisation: A well-developed financial system promotes healthy competition among the different participants both in the demand and supply side. This means that members have to compete with each other by lowering their costs. As a result, the benefits of lower interest rates are passed on to the consumers. Further, the existence of the financial system ensures uniform interest rate across the country. 

(vii) Growth of trade and commerce sector: By providing an efficient payment mechanism, financial system ensures timely and smooth transfer of goods and services and which in turn contributes to development of trade and commerce sector in an economy. An efficient payment system comprising of several institutions, like  banks, depository institutions, and private companies, minimize the credit risk in business. 

(viii) Employment generation: The financial system provides capital to entrepreneurs who want to start a business or expand their existing business. When these businesses come into existence, they, directly and indirectly, require the services of a wide variety of personnel. As a result, a lot of employment opportunities are generated in the economy. 

(ix) Expansion of international trade: Financial system plays a very important role in the international trade process. In international trade, all payments for exports and imports are routed through the banking institutions. By issuing letter of credit on behalf of importers, banks simplify the process of import of goods and services from exporting country. As a result, neither party has to rely on each other. 

(x) Aids in attracting foreign capital: Stable financial markets raise investor confidence. Investors from domestic as well as international markets start investing in the capital markets. As a result, more capital becomes available to domestic companies. They can then use this capital for the growth and expansion of their business, which makes them more competitive in the international market. 

(xi) Development of economic infrastructure: Financial markets play a vital role in the development of economic infrastructure in a country. Key sectors like power generation, oil, and gas, transport, telecommunication and railways receive a lot of funding at concessional rates. Development of these sectors contributes a lot to the economic development of a country. 

(xii) Assistance to Government: Financial markets also allow governments to raise large sums of money. This enables them to continue deficit spending. In the absence of financial markets, governments would not be able to continue deficit spending, which is important to fund infrastructure projects in the short run. 

(xiii) Developing backward areas: Development of economic infrastructure, expansion of trade, commerce and industries create a conducive atmosphere for the development of hitherto backward areas and thus, they contribute for the uniform development of all regions of the country.