Financial Markets Class 12 Business Studies: Stock Exchange, SEBI and Board Answers

What Financial Markets is about

Weightage: This chapter shares 15 of the 80 theory marks with Financial Management.Source: CBSE Business Studies (054) syllabus 2026-27, course structure (marks are printed once per group of units)

In real board papers: asked in 2 of the 2 board papers we hold (2026 to 2026), on average 6 marks per paper. See the questions

Key concepts

Financial market: concept and functions

A financial market brings together those who have surplus funds and those who need funds, and allocates savings efficiently.

Functions:
1. Mobilisation of savings and channelling them into the most productive uses (allocative function): savings are transferred from savers to investors who can use them best.
2. Facilitating price discovery: the price of a financial asset is set by the demand of investors and supply by firms.
3. Providing liquidity to financial assets: assets can be bought and sold easily, so they can be turned into cash.
4. Reducing the cost of transactions: the market gives information on securities and a common platform, saving time, effort and money for buyers and sellers.

Financial markets are classified by the maturity of the assets: money market (short term, up to one year) and capital market (medium and long term).

Worked example

The allocative function of a financial market helps in:
(a) fixing the price of goods (b) channelling savings into the most productive uses (c) printing currency (d) collecting taxes (1 mark)

Try it first, then show the solutionSolution

1. Allocation means moving savings from savers to their most productive use.

Answer: (b) channelling savings into the most productive uses

Money market (concept)

The money market is the market for short-term funds with a maturity of up to one year. Its instruments are highly liquid and safe, but the expected return is lower. Major participants are the Reserve Bank of India, commercial banks, financial institutions, mutual funds and large companies; individuals take little direct part because each deal involves large sums.

Common instruments (named to recognise them): treasury bills (short-term government borrowing), commercial paper (short-term unsecured promissory notes of large companies), call money (very short loans between banks), certificates of deposit and commercial bills. The syllabus asks for the concept only.

Worked example

Assertion (A): Money market instruments are more liquid than capital market securities.
Reason (R): Money market instruments are traded on stock exchanges.
(a) Both true, R explains A (b) Both true, R does not explain A (c) A true, R false (d) A false, R true. (1 mark)

Try it first, then show the solutionSolution

1. A is true: short maturity makes them highly liquid.
2. R is false: money market instruments are not traded on stock exchanges; they are dealt in by banks and institutions.

Answer: (c) A is true but R is false.

Capital market: primary and secondary

The capital market consists of the facilities and institutional arrangements through which long-term funds, both debt and equity, are raised and invested. Its instruments are shares, debentures, bonds and the like.

Primary market (new issues market): new securities are sold by a company directly to investors (or through an intermediary) for the first time. It directly promotes capital formation. Methods include an offer through prospectus, offer for sale, private placement, rights issue and e-IPO.

Secondary market (stock exchange): existing securities are bought and sold among investors. It gives liquidity and marketability to securities, and only indirectly promotes capital formation.

Basis	Primary market	Secondary market
Securities	New securities	Existing securities
Transfer	Company to investor	Investor to investor
Capital formation	Directly	Indirectly
Price	Fixed by the company	Set by demand and supply
Place	No fixed place	Stock exchange

Worked example

Suppose the finance manager of 'Elle Pharma Ltd.' wants to raise Rs 2 crore of long-term funds through shares or debentures from a regulated market. In which market will he raise the funds, and in which segment of it?

Try it first, then show the solutionSolution

1. Long-term funds through shares or debentures: the capital market. (1)
2. New securities are being issued for the first time: the primary market. (1)

Answer: Capital market, primary segment.

Capital market versus money market

Basis	Capital market	Money market
Participants	Financial institutions, banks, companies, foreign investors, ordinary retail investors	RBI, banks, financial institutions, large companies; individuals rarely
Instruments	Equity shares, debentures, bonds, preference shares	Treasury bills, commercial paper, call money, certificates of deposit, commercial bills
Investment outlay	Small: securities of low value, so ordinary people can invest	Large: each instrument involves huge sums
Duration	Medium and long term (more than one year)	Short term (up to one year)
Liquidity	Liquid through the stock exchange, but less than the money market	Highly liquid
Safety	Riskier in return and principal	Safer: short maturity and strong issuers
Expected return	Higher (dividends and capital gains)	Lower

Worked example

Differentiate between capital market and money market on the basis of (i) investment outlay (ii) liquidity (iii) safety. (3 marks)

Try it first, then show the solutionSolution

1. Investment outlay: capital market needs small amounts (low-value securities); money market involves huge sums. (1)
2. Liquidity: capital market securities are liquid through the stock exchange but less so; money market instruments are highly liquid. (1)
3. Safety: capital market is riskier; money market is safer. (1)

Answer: Outlay small vs large; liquidity lower vs higher; safety lower vs higher.

Stock exchange: meaning and functions

A stock exchange is an institution which provides a platform for buying and selling existing securities. The Securities Contracts (Regulation) Act, 1956 describes it as an association, organisation or body of individuals, incorporated or not, set up to assist, regulate and control business in buying, selling and dealing in securities.

Functions:
1. Providing liquidity and marketability to existing securities: investors can disinvest and reinvest at any time.
2. Pricing of securities: prices are set by demand and supply, giving an instant valuation.
3. Safety of transactions: membership is well regulated and dealings follow the legal framework, so investors get a safe and fair deal.
4. Contributes to economic growth: savings are channelled into the most productive investments through repeated buying and selling (disinvestment and reinvestment).
5. Spreading of equity cult: wider share ownership through investor education and regulation of new issues.
6. Providing scope for speculation: limited, controlled speculation is allowed, which ensures demand and supply and so liquidity.

Worked example

Suppose a friend tells an investor: 'Membership of the exchange is well regulated and all trading follows the law, so you get a fair deal.' Which function of a stock exchange is described? (1 mark)

Try it first, then show the solutionSolution

1. A regulated, legal framework protects investors.

Answer: Safety of transactions.

Trading procedure, depository and demat account

Trading on Indian stock exchanges is screen-based (online, through computer terminals), replacing the old open-outcry system.

Steps:
1. Selection of a broker: only registered brokers (members of the exchange) can trade; the investor fills a client form and gives proof of identity and PAN.
2. Opening a demat account with a depository participant (DP), plus a bank account for payments.
3. Placing the order with the broker (what to buy or sell, quantity, price).
4. Executing the order: the broker places it on the exchange's system; once matched, the trade is done.
5. Issue of a contract note by the broker, recording the details of the trade.
6. Pay-in: the investor delivers shares (seller) or pays money (buyer) to the broker.
7. Settlement / pay-out: the exchange settles the trade within the settlement cycle fixed by SEBI; shares are credited to the buyer's demat account and money to the seller.

Depository: an institution that holds securities in electronic form (like a bank holds money) and transfers them on instructions. India has two: NSDL and CDSL. Investors deal with them through a depository participant (a bank or broker registered with a depository).

Dematerialisation: converting physical share certificates into electronic holdings, held in a demat account. Benefits: no risk of theft, loss or forgery of certificates, quick transfer, lower paperwork and cost. (Converting electronic holdings back into physical certificates is rematerialisation.)

Worked example

State the first three steps of screen-based trading for buying and selling securities. (3 marks)

Try it first, then show the solutionSolution

1. Selection of a registered broker, with client form, proof of identity and PAN. (1)
2. Opening a demat account with a depository participant (and a bank account). (1)
3. Placing the order with the broker, stating the security, quantity and price. (1)

Answer: Select a broker; open a demat account; place the order.

SEBI: objectives and functions

The Securities and Exchange Board of India (SEBI) was set up by the Government of India on 12 April 1988 as an interim administrative body and given statutory status in 1992. It regulates the securities market and protects investors.

Objectives:
1. To regulate stock exchanges and the securities industry to promote their orderly functioning.
2. To protect the rights and interests of investors, especially individual investors, and to guide and educate them.
3. To prevent trading malpractices and achieve a balance between self-regulation by the industry and statutory regulation.
4. To regulate and develop a code of conduct and fair practices for intermediaries such as brokers and merchant bankers.

Functions:

• Protective: prohibiting fraudulent and unfair trade practices (misleading statements); controlling insider trading; prohibiting price rigging; promoting fair practices and a code of conduct; investor education.
• Developmental: training of intermediaries; conducting research and publishing information; a flexible, adaptable approach (e.g. permitting internet trading, making underwriting optional).
• Regulatory: framing rules and regulations for intermediaries; registration of brokers, sub-brokers, merchant bankers and mutual funds; levying fees; conducting inquiries and audits of stock exchanges; regulating takeovers of companies.

Worked example

Suppose SEBI calls for information from a stock exchange, issues a show-cause notice to its officials and conducts an audit. Which type of SEBI function is this? (1 mark)

Try it first, then show the solutionSolution

1. Inquiries and audits of stock exchanges are part of SEBI's regulatory role.

Answer: Regulatory function.

Financial Markets in real life

Each concept, met in an everyday situation. Read the situation, answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Topics in this chapter

• Money Market and Capital Market
• Stock Exchange: Functions and Trading Procedure
• SEBI: Objectives and Functions

Financial Markets: key facts

Financial market functions (4)

Mobilisation and allocation of savings; Price discovery; Liquidity; Lower transaction cost

The allocative function = channelling savings to productive uses.

Money vs capital market

Duration	money up to 1 year, capital over 1 year
Outlay	money large, capital small
Liquidity	money high, capital less
Safety	money safe, capital riskier
Return	money low, capital higher

Money market: concept only in the syllabus.

Primary vs secondary

1. 1.Primary: new securities, company
2. 2.investor, direct capital formation; Secondary: existing securities, investor
3. 3.investor, indirect

The stock exchange is the secondary market.

Stock exchange functions (6)

Liquidity and marketability, Pricing, Safety, Economic growth, Equity cult, Scope for speculation

Mnemonic 'LPSEES'.

Trading steps

1. 1.Broker
2. 2.Demat account
3. 3.Order
4. 4.Execution
5. 5.Contract note
6. 6.Pay-in
7. 7.Settlement

Depository: NSDL, CDSL; via a depository participant.

SEBI functions

Protective (investors), Developmental (market), Regulatory (intermediaries and exchanges)

Set up 1988; statutory status 1992.

How the board asks Financial Markets

The question patterns to expect, and the method that works for each.

Tricks to remember Financial Markets

Short memory aids. Say each one aloud once, then use it on a question the same day.

• Stock exchange functions: 'LP SEES'

  Liquidity, Pricing, Safety, Economic growth, Equity cult, Speculation.

  Use it when: Six functions.

• SEBI: 'Police, Teacher, Registrar'

  Protective like a police officer (stops insider trading, price rigging, fraud); Developmental like a teacher (trains intermediaries, publishes research, adopts a flexible approach); Regulatory like a registrar (registers brokers, audits exchanges, frames rules).

  Use it when: Sorting SEBI's functions.

• Money market: 'Short, Safe, Small return, Big cheque'

  Up to one year, safe, low return, large investment outlay.

  Use it when: Money vs capital market.

Financial Markets: board-level solved questions

Ordered from board level to HOTS. Cover the solution, write your own, then compare step by step.

Case-study practice (Section E style)

Read the situation, then answer every part. In the board paper this is a 4-mark question split into 1 + 1 + 2 marks.

Where the marks are

How a typical answer is split into step marks. Show every step: a right final answer alone rarely earns full marks.

Where students lose marks in Financial Markets

The slips examiners see most often, and what to write instead.

• ✗Mistake: Saying the secondary market directly promotes capital formation

  Trading looks like raising money.

  ✓Do this: Only the primary market directly raises new capital; the secondary market helps indirectly by giving liquidity.

  Usually costs: 1 mark in a statement-based MCQ.

• ✗Mistake: Calling the conversion of electronic holdings into paper 'dematerialisation'

  Direction is mixed up.

  ✓Do this: Dematerialisation = paper to electronic; rematerialisation = electronic to paper.

  Usually costs: 1 mark.

• ✗Mistake: Writing that money market instruments trade on stock exchanges

  ✓Do this: Money market deals happen among the RBI, banks and institutions; stock exchanges deal in capital market securities.

  Usually costs: 1 mark.

• ✗Mistake: Putting insider trading control under regulatory functions

  It sounds like regulation.

  ✓Do this: In the CBSE classification, prohibiting insider trading, price rigging and fraudulent practices are protective functions.

  Usually costs: 1 mark per function.

• ✗Mistake: Studying money market instruments in depth

  Old guides have long notes on each instrument.

  ✓Do this: The 2026-27 syllabus asks for the money market concept only; know the names and the features that distinguish it from the capital market.

  Usually costs: Time.

NCERT exercise guide: Financial Markets

What each exercise in the NCERT chapter tests, how to approach it, and a question of the same kind solved step by step. Questions here are written in our own words.

Financial Markets: previous year questions

• Asked in 2 of the 2 board papers we hold (2026 to 2026), on average 6 marks per paper; 6 questions in all, counting OR alternatives. In 4 of 4 sample papers.

Counted from the real papers on our previous year papers page, not estimated. Average marks are over every board paper we hold, with an OR pair counted once. Chapter tags are ours.

Solved board questions from Financial Markets

Real questions from recent papers. Try each one first, then open our step-by-step solution with marks per step.

Every Financial Markets question, by year

Practice questions on Financial Markets

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

1. Q1 · 1 mark · MCQBoard level

   Which of the following is a money market instrument?
   (a) Equity share (b) Debenture (c) Treasury bill (d) Preference share

   Hint

   Short-term government paper.

   Answer

   (c) Treasury bill

2. Q2 · 1 mark · Very short answerBoard level

   Name the two depositories in India.

   Hint

   N and C.

   Answer

   NSDL (National Securities Depository Ltd.) and CDSL (Central Depository Services (India) Ltd.).

3. Q3 · 1 mark · Assertion-reasonHarder board level

   Assertion (A): The investing public gets a safe and fair deal on a stock exchange.
   Reason (R): Membership of a stock exchange is well regulated and its dealings are defined by the legal framework.
   (a) Both true, R explains A (b) Both true, R does not explain A (c) A true, R false (d) A false, R true

   Hint

   Regulation gives safety.

   Answer

   (a)

4. Q4 · 3 marks · Short answerBoard level

   State any three development functions of SEBI. (3 marks)

   Hint

   Teacher role.

   Answer

   Training of intermediaries of the securities market; conducting research and publishing information useful to all market participants; undertaking measures to develop the capital market by adopting a flexible, adaptable approach (e.g. permitting internet trading, making underwriting optional).

5. Q5 · 3 marks · Case-basedHarder board level

   Suppose a company director buys his company's shares just before a confidential announcement of a big order, using information not yet public. Which malpractice is this, why is it unfair, and which SEBI function deals with it? (3 marks)

   Hint

   Inside information.

   Answer

   Insider trading (1). It is unfair because the director profits from price-sensitive information that ordinary investors do not have (1). SEBI controls it as part of its protective functions (1).

6. Q6 · 4 marks · Short answerBoard level

   State the objectives of SEBI. (4 marks)

   Hint

   Four.

   Answer

   To regulate stock exchanges and the securities industry for orderly functioning; to protect the rights and interests of investors, especially individuals, and guide and educate them; to prevent trading malpractices and balance self-regulation with statutory regulation; to regulate and develop a code of conduct and fair practices for intermediaries such as brokers and merchant bankers.

7. Q7 · 4 marks · Case-basedHOTS / competency

   Suppose an investor wants safety and quick access to funds for six months, while another wants higher returns over ten years and can bear risk. Which market suits each? Give two reasons for each choice. (4 marks)

   Hint

   Duration, safety, return.

   Answer

   First investor: money market, because it deals in short-term instruments (up to one year) that are highly liquid and safe (2). Second investor: capital market, because it deals in long-term securities such as shares that offer higher expected returns, though with more risk (2). (Note: individuals usually reach money market instruments through mutual funds, as direct deals involve large sums.)

8. Q8 · 3 marks · Short answerHarder board level

   Explain the steps of screen-based trading after the order is executed. (3 marks)

   Hint

   Note, pay-in, settlement.

   Answer

   Issue of a contract note by the broker recording the trade details (1); pay-in, where the seller delivers shares and the buyer pays money to the broker (1); settlement (pay-out) by the exchange within the SEBI settlement cycle, crediting shares to the buyer's demat account and money to the seller (1).

9. Q9 · 6 marks · Long answerHOTS / competency

   'The stock exchange is the barometer of the economy and a channel for savings.' Explain how it contributes to economic growth and the spread of the equity cult, and how it differs from the primary market. (6 marks)

   Hint

   Disinvestment and reinvestment.

   Answer

   Economic growth: through continuous disinvestment and reinvestment, savings flow to the most productive investment opportunities, supporting capital formation (2). Equity cult: by regulating new issues, better trading practices and educating the public, it spreads share ownership among more people (2). Difference: the primary market issues new securities from company to investor and directly forms capital; the stock exchange is the secondary market where existing securities trade among investors, helping capital formation only indirectly by providing liquidity (2).

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1. 1.Define a financial market.Show answer

   A market for the creation and exchange of financial assets.

2. 2.Four functions of a financial market?Show answer

   Mobilising and allocating savings, price discovery, liquidity, lower transaction costs.

3. 3.Money market maturity?Show answer

   Up to one year.

4. 4.Two types of capital market?Show answer

   Primary (new issues) and secondary (stock exchange).

5. 5.Which market directly promotes capital formation?Show answer

   The primary market.

6. 6.Six functions of a stock exchange?Show answer

   Liquidity and marketability, pricing, safety, economic growth, equity cult, scope for speculation.

7. 7.What is a depository participant?Show answer

   An agent (bank or broker) registered with a depository through which investors open demat accounts.

8. 8.What is dematerialisation?Show answer

   Converting physical share certificates into electronic holdings.

9. 9.When was SEBI set up and when did it get statutory status?Show answer

   12 April 1988; statutory status in 1992.

10. 10.Three groups of SEBI functions?Show answer

    Protective, developmental, regulatory.

11. 11.Is Financial Markets in the NCERT book?Show answer

    No; NCERT dropped it in 2022, but CBSE still assesses it.

Quick revision checklist

The night before the exam: can you do each of these without looking?

• ☐Can you define a financial market and give its four functions?
• ☐Can you explain the money market in two lines?
• ☐Can you compare capital and money markets on seven bases?
• ☐Can you distinguish primary and secondary markets?
• ☐Can you list six functions of a stock exchange and spot them in a case?
• ☐Can you write the steps of screen-based trading?
• ☐Can you explain depository, depository participant and dematerialisation?
• ☐Can you write SEBI's objectives and three groups of functions?

Financial Markets: frequently asked questions