Test: Resource Mobilization - 2 - CUET Commerce MCQ

Internal sources of finance are economical, while external sources of finance are expensive. Internal sources of finance do not require collateral for raising funds.
External sources can be costlier as compared to internal sources, as assets need to be mortgaged and the rate of interest can be high. Borrowed funds are generally provided on the security of some fixed assets also known as mortgage. A fixed rate of interest is paid by the borrowers on such funds. At times, it puts a lot of burden on the business as payment of interest is to be made even when the earnings are low or when loss is incurred. Generally, borrowed funds are provided on the security of some fixed assets. Hence, statements (a) and (c) are correct. Fixed charge instruments and debentures put a permanent burden on the earnings of a company. There is a greater risk when earnings of the company fluctuate. So, funds raised through debentures are not owner's funds. Hence statement (b) is incorrect.

The automatic sources of short-term funds arising in the normal course of business are spontaneous financing. Spontaneous financing flows with the volume of sales activity during normal business operation that requires no additional assistance from lenders or creditors.

Money market and capital market are parts of financial market. A financial market is a market that brings buyers and sellers together to trade in financial assets such as stocks, bonds, commodities, derivatives and currencies.

A venture capitalist (VC) is a private equity investor that provides capital to companies exhibiting high growth potential in exchange for an equity stake. This could be funding startup ventures or supporting small companies that wish to expand but do not have access to equities markets. Ultimately the aim of VC is to make huge profits. The yardstick is profit potential, not technology or high risk.

The Securities and Exchange Board of India (SEBI) is the regulatory authority established under the SEBI Act, 1992, and is the principal regulator for stock exchanges in India. SEBI's primary functions include protecting investor interests, and promoting and regulating the Indian securities markets. The capital market is regulated by SEBI.

Angel investors are the individuals who have an earned income that exceeds $20,000 annually. They can be found across industry sectors, but they usually work with entrepreneurs who are somewhere between their first-time financing and a venture capital effort.

The primary market is where securities are created. It's in this market that firms sell (float) new stocks and bonds to the public for the first time. An initial public offering, or IPO, is an example of a primary market. The primary market is the part of the capital market that deals with the issuance and sale of equity-backed securities to investors directly by the issuer. Investor buy securities that were never traded before.

a) Venture capital (VC) is a form of private equity financing that is provided by venture capital firms or funds to startups, early-stage, and emerging companies that have been deemed to have high growth potential or which have demonstrated high growth (in terms of the number of employees, annual revenue, the scale of operations, etc.). Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake. Venture capitalists take on the risk of financing risky start-ups in the hopes that some of the firms they support will become successful.
b) Venture Capital typically comes from institutional investors and high net worth individuals and is pooled together by dedicated investment firms. It is the money provided by an outside investor to finance a new, growing, or troubled business.
c) Venture capitalist finances innovation and ideas, which have the potential for high growth but are unproven. This makes it a high risk, high return investment. In addition to finance, venture capitalists also provide value-added services and business and managerial support for realizing the venture's net potential.
d) Start-up companies with the potential to grow to need a certain amount of investment. Wealthy investors like to invest their capital in such businesses with a long-term growth perspective. This capital is known as venture capital and the investors are called venture capitalists. Venture capital financing is a long term investment. It generally takes a long period to encash the investment in securities made by the venture capitalists.
Thus, options (a) and (b) are not true.

Equity shares capital is the prerequisite to the creation of a company. It represents the ownership of the company. Equity shareholders do not get a fixed rate of dividend, nor do they enjoy preferential position over preference shareholders. They are paid on the basis of the earnings of the company. They receive their contribution after settlement of all claims on company's income and assets. So, option 1 represents the right feature of equity share capital.

Statement 2 is not correct because equity shares are issued without any creation of charge on the assets of the company though charge is created if any other kind of secured loan is taken by the company. On the other hand, the other given statements are correct. Debentures put a permanent burden on the earnings of the company being fixed charge instrument. Preference shares are not suitable for those investors who are willing to take risk and are interested in higher returns. Higher risk and higher returns are suitable for equity shareholders.

A Global Depository Receipt (GDR) is an instrument issued abroad by an Indian company to raise funds in some foreign currency and is listed and traded on a foreign stock exchange. Shares of domestic company are delivered to the depository bank which in turns issue depository receipts denominated in US dollars, known as Global Depository Receipt. Holder of Global Depository Receipt can convert it into number of shares at any time. American Depository Receipt is like Global Depository Receipt but can only be issued to the American citizens. Indian Depository Receipt are the depository receipts denominated in Indian currency to enable foreign company to raise funds from Indian securities market.

Secured debentures are debentures secured by a charge on the fixed assets of the issuer company. For instance, mortgage debentures secured on land of the company. When the issuer company fails on payment of either the principal or interest amount, the assets of the company can be sold to repay the liability to the investors. Hence, statement (a) is correct.
Debentures are fixed charge funds i.e they are to be returned on a fixed interest and not as per the profits earned by the company. Hence they do not participate in the profit share of the company.
A convertible debenture is a type of long-term debt issued by a company that can be converted into shares of equity stock after a specified period. Convertible debentures are usually unsecured bonds or loans, often with no underlying collateral backing up the debt. Hence statement (c) is correct.

In order to choose the right source of funds, there are various factors to be considered such as cost, financial strength, purpose and time period, control, credit worthiness, risk and tax benefits, etc. For example, interest on debentures is tax deductible, but dividend on preference shares is not tax deductible. In case of risk, there is less risk associated with the equity because no fixed return is needed to be paid unlike in case of debentures. In case of credit worthiness, issue of secured debentures affects the interest of secured creditors and may adversely impact their willingness to extend further credit to the company. Therefore, all options are correct.

In case of loans from commercial banks, difficult terms and conditions may be imposed by the banks for granting of loans that may be in respect to sale of mortgaged goods, etc. In case of issue of shares or debentures, no such conditions are imposed by anyone. Funds are raised through these means by providing them merely on the basis of ownership powers or fixed rate of returns backed by secured assets. So, option 3 is correct.

The capital of a company is share capital. Total capital is divided into a number of small indivisible units of a fixed amount and each such unit is known as share. Hence, Statement (a) is correct.
Shares are units of equity ownership in a corporation. For some companies, shares exist as a financial asset providing for an equal distribution of any residual profits, if any are declared, in the form of dividends. Hence statement (b) is correct.
Common shareholders possess the right to share in the company's profitability and gains from its stock price appreciation. Shareholders may also share in a company's profits by receiving cash or stock payments from the company. It is profit shared not interest from the organisation. Hence, statement (c) is incorrect.