Q. 1. Explain the classification of sources of funds on the basis of period.
Ans. The sources of funds on the basis of period can be classified into three parts:
(i) Long-term sources: It includes those sources which are required by the business firms for a period exceeding 5 years. For example, shares, debentures.
(ii) Medium-term sources: It includes those sources which are required for a period of more than a year but less than 5 years. For example, public deposits, borrowings from Commercial Banks.
(iii) Short-term sources: It includes those sources which are required by business firms for a period of less than 1 year. For example, trade credit, commercial papers.
Q. 2. Why is adequate finance necessary to start the business?
Ans. Adequate finance is necessary to start the business to buy not only the fixed assets like plant, machinery, fixture and furniture but also to meet the working capital requirement to meet day-to-day operations of the business.
Q. 3. Write any three points of differences between owners’ fund and borrowed funds.
Ans. (i) Owners’ fund is the internal source of finance whereas borrowed fund is the external source of finance.
(ii) Owners’ fund remain invested in the business till the business exist and is not required to be refunded but borrowed fund is to be paid back to the lenders on the maturity period.
(iii) Owners’ fund does not create any change on the assets of the business whereas the borrowed funds may create change on the assets of the company.
Q. 4. What preferences are available to preference shareholders?
Ans. Following preferences are available to preference shareholders:
(i) Receiving a fixed rate of dividend out of the net profits of company before any dividend is declared for equity shareholders.
(ii) Receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation.
Q. 5. Discuss any three limitations of retained earnings as a source of Finance.
Ans. Limitations of retained earnings are as follows:
(i) There is imbalanced growth as undistributed profits remain in same industry.
(ii) Since the profits of business are fluctuating therefore it is an uncertain source of funds.
(iii) Excessive retaining of earnings causes dissatisfaction amongst the shareholders as this reduces the amount of the dividend receivable by them.
Q. 6. Define preference shares. State the merits of raising funds through the issue of preference shares.
OR
Mention any three advantages of preference shares from a company’s point of view.
Ans. Preference shares are those shares that enjoy certain priorities regarding the payment of dividend at a fixed rate and return of investment (capital).
Merits:
(i) They do not create any charge on the assets of the company.
(ii) They have the preferential right to repayment of capital over equity shareholders at the time of winding up of the company.
(iii) Since the dividend payable to preference shareholders is fixed, a company is in a position to declare high rates of dividend for equity shareholders during favourable times.
(iv) They provide steady income in the form of fixed rate of return and safety of investment from profitable business.
Q. 7. Explain any two merits and two demerits of raising funds through preference shares.
Ans. Merits:
(i) Preference share capital cannot be redeemed during the lifespan of the company. Hence, these are the sources of permanent capital.
(ii) The cost of issuing preference shares is economical.
Demerits:
(i) The dividend paid to the preference shareholders is not a deductible expense while computing the tax liability of the company.
(ii) Investors willing to take risk and earn higher profit do not prefer preference shares.
Q. 8. Write the types of preference shares.
Ans. The types of preference shares are as follows:
(i) Participating and non-participating preference shares: Participating preference shares are those shares which provide the holder a right to participate in the surplus of the company after a certain rate of dividend has been paid to equity shareholders. Preference shares that do not enjoy such right of participation provided to the holder in the profits of the company are known as nonparticipating preference shares.
(ii) Cumulative and non-cumulative preference shares: The preference shares whose dividend, if not paid during a year, gets accumulated are known as cumulative preference shares, while the preference shares which do not enjoy such right are known as non-cumulative preference shares.
(iii) Convertible and non-convertible preference shares: Convertible preference shares are those which can be converted into equity shares after a specified period of time while the preference shares which cannot be converted into equity shares are known as non-convertible preference shares.
Q. 9. Give the classification of funds on the basis of ownership.
Ans. On the basis of ownership, the sources of finance can be classified into two parts:
(i) Owner’s funds.
(ii) Borrowed funds.
Owner’s funds:
(a) The funds provided by the owner of an enterprise are known as owner’s funds.
(b) These funds remain invested in the business for a longer period of time and are not refunded during the lifetime of the business.
(c) The owners have control over the working of the company and are paid dividend after the payment of dividend to preference shares.
(d) For example, equity shares, retained earnings, etc.
Borrowed funds:
(i) The funds raised through loans or borrowings are known as borrowed funds.
(ii) It is a combination of funds that are raised either by the way of credit or loan.
(iii) They are permitted to fixed amount of interest.
(iv) Borrowed funds are generally raised by issuing debentures through credit or loans. It is also termed as debt financing.
Q. 10. State the limitations of equity shares.
Ans. (i) The voting power and earnings of existing equity shareholders is affected by issue of additional equity shares.
(ii) Raising funds through issue of equity shares involves a lot of formalities and a lengthy procedure.
(iii) Since the dividend payable to equity shareholders keeps on fluctuating, investors who want steady income do not prefer them.
(iv) The cost of raising funds through equity shares is generally more as compared to other sources.
Q. 11. Equity shares are the best investment avenue for adventurous investors. Justify the statement giving your views.
Ans. Following points justify equity investment as the best investment:
(i) Equity shareholders do not get fixed rate of dividend as in the case of preference shares but they enjoy higher dividends during large profits to the companies. Higher dividends appreciates the market value of equity shares in the market, maximising the shareholders wealth.
(ii) It is a source of long-term investment as the equity capital is not redeemable during the lifetime of the company.
(iii) Equity shares provide the voting rights to the shareholders through which they can exercise control over management
(iv) Marketability of equity share on the stock exchanges make them lucrative source of investment.
Q.12.Raman the finance manager of ‘Anjali Food Ltd’, has decided to ‘plough back the profits’ for expanding his business. Identify the source mentioned here and write any three advantages of this source.
Ans. The source of finance mentioned here is ‘Retained Earnings. Following are the advantages of Retained earnings’.
(i) Company does not have to pay any cost to obtain it.
(ii) This source is readily available and considered as permanent source of funds.
(iii) Retained earning eliminate the fear of ownership dilution and loss of control by equity shareholders.
Q. 13.Many organisations are using various financial instruments to raise funds in capital market. Discuss any two financial instruments used for this purpose.
Ans. Two financial instruments used for raising money in international capital market are:
(i) Global Depository Receipt: GDR is a negotiable financial instrument that represents underlying shares of a company issued in foreign countries and in foreign currencies. GDR holders carry benefits of equity shareholders for getting dividends, bonus, shares etc. However, they do not have voting rights. These are traded in those stock exchanges where these are listed. GDRs involve two way fungibility.
(ii) American Depository Receipt: ADR is a negotiable instrument containing underlying equity shares of non -US companies and is traded in US stock exchanges. They are issued in US financial market only and not throughout the world like GDRs. Face value of ADR is expressed only in US dollar. They are listed for trading only in US stock exchanges.
Q. 14. State the benefits of IDR.
Ans. IDRs offer following benefit:
(i) The Indian investors get an additional opportunity for foreign portfolio investment.
(ii) Indian stock market receives a new financial instrument for trading purpose.
(iii) Indian investors face less risk as only sound foreign companies are allowed to issue IDR.
(iv) Foreign companies can broaden their shareholders.
Q. 15. Give the basic differences between GDRs and ADRs.
Ans. (i) ADRs are listed in an American Stock Exchange. GDRs are listed in stock exchanges other than American Stock Exchanges.
(ii) ADRs can be issued only to American citizens whereas GDRs can be issued to non-American citizens also.
(iii) ADR is mainly an institutional market with higher liquidity whereas GDRs are less liquid.
(iv) ADR enhances shareholders value more than GDR.
Q. 16. Explain the issuing process of GDRs ?
Ans. (i) First of all, the company issuing GDRs handover its shares to some Domestic Custodian Bank (DCB).
(ii) Then DCB requests some Overseas Depository bank (ODB) situated in foreign country for issuing the shares as GDRs.
(iii) The ODB converts the shares into GDRs denominated in US dollars.
(iv) At the end, ODB issues them to the intending investors.
Q. 17. Enumerate the advantages of GDRs.
Ans. (i) GDR issues enhances the image of issuing company in international market.
(ii) Raising funds through GDRs from international market is less costly due to less formalities as compared to domestic issues.
(iii) GDR issues shareholders base and helps in tapping international capital for domestic users.
(iv) The market of GDR is more liquid and reduces foreign exchange risk as GDR is generally denominated in US dollars.
Q. 18. Why do Indian companies go for depository routes?
Ans. Indian companies are prohibited by law from listing rupee denominated shares directly on foreign stock markets. Therefore they issue such shares to a Domestic Custodian Bank which has an office within India. The DCBs request some Overseas Depository Bank (ODB) situated in some foreign countries for issuing shares in form of dollar denominated CDRs.
Q. 19. Briefly explain three advantages of issuing debentures.
Ans. Three advantages of issuing debentures are:
(i) The issue of debentures is suitable in the situation when the sales and earnings are relatively stable.
(ii) As debentures do not carry voting rights financing through debentures does not dilute control of equity share holders on management.
(iii) Debentures are fixed charged funds and do not participate in profits of the company.
Q. 20. Discuss any three characteristics of debentures.
Ans. Three characteristics of debentures:
(i) Debentures are part of borrowed fund capital and debenture holders are considered as the creditors of the company.
(ii) A fixed rate of interest (decided in annual general meeting of the company) is paid to debenture holders irrespective of profit earning capacity of company.
(iii) Debentures are aways redeemed or paid back on expiry of a fixed period of time.
(iv) No voting rights are given to debenture holders.
Q. 21. Explain three merits of public deposits.
OR
Explain public deposits. State the merits and demerits of public deposits.
Ans. Public deposits are raised by business organisations directly from the public. These deposits usually offer a high rate of interest. This source fulfils the medium as well as short-term finance requirements of the business.
Merits:
(i) The procedure of obtaining deposits is simple and does not contain restrictive conditions as in case of a loan agreement.
(ii) Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions.
(iii) Public deposits do not usually create any charge on the assets of the company. The asset can be used as security for raising loans from other sources.
Demerits:
(i) New companies generally find it difficult to raise funds through public deposits.
(ii) It is an unreliable source of finance as the public may not respond when the company needs funds.
(iii) Collection of public deposits may prove difficult, particularly when the size of deposits required is large.
Q. 22. List any three advantages of borrowed funds?
Ans. The advantages of borrowed funds are as follows:
(i) The interest paid on borrowed capital is a tax deductible expense.
(ii) Borrowed funds do not lead to the dilution of control as they do not provide voting rights.
(iii) Borrowed funds provide flexibility in the capital structure of the company as they can be redeemed when required.
Q. 23. What are debentures ? Discuss their merits and limitations.
Ans. Debentures are an important instrument for raising long-term debt capital. A debenture can be defined as an acknowledgement that the company has borrowed a certain amount of money which it promises to repay at a future date. Debenture holders are the creditors of the company and are paid fixed rate of interest at specified interval.
Merits:
(i) Investors who want fixed income at low risk prefer debentures.
(ii) Debenture holders do not carry voting rights. Therefore, they do not affect the control of equity shareholders on management.
Limitations:
(i) The issue of debenture reduces the borrowing capacity of the business.
(ii) Being fixed charge funds, they are a burden on the earnings of the company.
Q. 24. What do you understand by financial institutions ? Write their merits and limitations.
Ans. Financial institutions have been established all over the country to provide financial assistance to business organisations. These institutions have been established by the central as well as state governments to fulfil the medium as well as long term requirements of the business. Besides providing financial assistance, these institutions also conduct market surveys and provide technical assistance and managerial services to their clients.
Merits:
(i) They provide long-term finance, not provided by commercial banks.
(ii) They provide funds during periods of depression when other sources are not available.
Limitations:
(i) The procedure for obtaining loan from these institutions is time consuming and expensive. Moreover, it involves many formalities.
(ii) They impose many restrictions on the power of borrowing of the company.
Q. 25. Who issues bonds? How are they different from debentures?
Ans. Bonds are issued as long-term financial instruments by the Central Government, State Government or any specialised financial institution.
These are some fine differences between debentures and bonds:
(i) A debenture may be issued by creating charge on the company’s assets or without this charge. A bond can be issued only by creating charge on the assets.
(ii) A debenture may be redeemed in instalments while a bond is redeemed in lump sum.
Q. 26. Explain any four merits of trade credit.
Ans. The merits of trade credit are as follows:
(i) Simplicity: The operation of trade credit method is very simple. It requires just an understanding of the seller of items required by a buyer who wants to avail trade credit.
(ii) No charge on assets: Trade credit facility is available without creating any charge on the assets of the company. Thus, it increases credit worthiness.
(iii) No extra financial burden: Trade credit is available without any interest. Interest is charged only in the case of delay in payment of trade credit.
(iv) Flexibility: It is a flexible source of finance. The amount of trade credit may be adjusted according to the need of the buyer.
Q. 27. Mention the special features of Inter-corporate deposits.
Ans. The main features of inter-corporate deposits are as follows:
(i) Period of deposit: Minimum period for which ICD is deposited is 90 days and maximum period is 180 days. However, after the expiry of this period, the deposit may be renewed if both the parties agree.
(ii) Amount of deposit: Minimum deposit amount which can be raised is 1 lakh and there is no limit on the maximum amount.
(iii) Interest rate: Interest rate varies from 12 to 17% per annum.
Q. 28. Define debentures? Explain its three merits.
Ans. Debentures are the acknowledgement of debt taken by a company from the public for a fixed period of time at a given rate of interest.
Debentures give following benefits/merits:
(i) Low cost: The cost of raising debentures is less than the cost of raising preference shares or equity shares. It is a cheaper source of finance.
(ii) No dilution of control: Debenture holders do not get any voting rights. They are not allowed to participate in decision making. Thus do not dilute the control of equity shareholders.
(iii) Tax benefit for the company: The interest paid to debenture holders is considered as an expense of the company so the liability of tax reduces and the company gets tax benefits by issuing debentures.
Q. 29. What is business finance? Why do businesses need funds? Explain.
Ans. Business is concerned with the production and distribution of goods and services for the satisfaction of needs of the society. For carrying out various activities, business requires money. Finance, therefore, is called the life blood of any business. The requirements of funds by a business to carry out its various activities are called business finance. A business needs funds for the purchase of plant and machinery, furniture, and other fixed assets. Similarly, some funds are needed for day- to-day operations, say to purchase raw materials, pay salaries to employees, etc.
Q. 30. List Sources of raising long terms and short term finance.
Ans. Long term finance sources
(i) Equity shares
(ii) Preference shares
(iii) Debentures
(iv) Loan from Banks
(v) Retained Earnings
Short term finance sources
(i) Trade credit
(ii) Factoring
(iii) Short term overdraft by bank
(iv) Commercial papers
Q. 31. What is the difference between internal and external sources of raising funds? Explain.
Ans. Internal sources include all those sources which are generated from within the business. For example, retained earnings, collection of receivables or debts, etc. External sources of funds are those sources that exist outside the business. External sources include debentures, public deposits, borrowing from Commercial Banks and financial institutions, etc.
Q. 32. What preferential rights are enjoyed by preference shareholders? Explain.
Ans. Preferential rights that are enjoyed by preference shareholders are as follows:
(i) Receiving a fixed rate of dividend out of the net profits of the company before any dividend is declared for equity shareholders.
(ii) Receiving their capital after the claims of the company’s creditors have been settled at the time of liquidation.
Q. 33. Name three special financial institutions and state their objectives.
Ans. The three special financial institutions are as following:
(i) Industrial Finance Corporation of India (IFCI): Its objectives include promoting balanced regional development and encouraging new entrepreneurs to enter into the priority sectors of the country.
(ii) Unit Trust of India (UTI): The basic objective of UTI is to mobilise the community’s savings and channelise them into productive ventures.
(iii) Industrial Development Bank of India (IDBI): It was established in 1964 with an objective to co-ordinate the activities of other financial institutions, including Commercial Banks.
