Money and Capital Market (Theory)

1st Mid Term Questions and Answers

1. (a) What do you mean by financial market? Classify financial market with appropriate example.
(b) Describe the role of financial market in the functioning of an economy.
2. (a) What is meant by money market? Discuss the features of a developed money market.
(b) What are the differences between a developed money market, such as that of the United States or
Europe, and the money market in Bangladesh in terms of the range of financial instruments traded,
market liquidity, and regulatory environment?

Answer to the Question No. 1(a)

A financial market is a marketplace where buyers and sellers trade financial assets such as stocks, bonds,
currencies, and commodities. Financial markets are essential for the functioning of modern economies, as
they provide a mechanism for individuals, companies, and governments to raise capital and manage risk.

There are several types of financial markets, including stock markets, bond markets, foreign exchange
markets, and commodity markets. Each market has its own unique characteristics, participants, and
regulations.
Classification of financial market:

Financial markets can be classified into the following categories:

1. Money Market: The money market in Bangladesh consists of the market for short-term financial
instruments such as treasury bills, commercial papers, and certificates of deposit. The central bank of
Bangladesh, Bangladesh Bank, conducts monetary policy operations in the money market to regulate
the country's money supply.

2. Capital Market: The capital market is responsible for raising long-term capital for businesses and
the government. It consists of the stock market, bond market, and other securities markets. The
Dhaka Stock Exchange (DSE) and the Chittagong Stock Exchange (CSE) are the two major stock
exchanges in Bangladesh.

Answer to the Question No. 1(b)

The financial market plays a critical role in the functioning of an economy in several ways:

1. Mobilizing Savings: Financial markets provide a platform for investors to channel their savings to
individuals, businesses, and governments that need capital. It enables these entities to borrow money
to finance their projects and investments.
2. Allocation of Capital: Financial markets help allocate capital to different sectors and industries in an
economy. They enable investors to choose from a variety of investment opportunities, based on their
preferences and risk appetite.

3. Price Discovery: Financial markets help in price discovery, which is the process of determining the
fair market value of financial assets. The prices of financial assets are determined by supply and
demand forces, reflecting the underlying economic fundamentals of the assets.

4. Risk Management: Financial markets provide a platform for investors to manage their risk exposure
by diversifying their portfolios across different asset classes, sectors, and geographic regions.
 5. Liquidity: Financial markets provide liquidity to investors by allowing them to buy and sell
financial assets quickly and easily. This facilitates efficient capital allocation and enhances the
overall efficiency of the economy.

Overall, financial markets play a crucial role in facilitating economic growth, by providing a mechanism for
capital formation and efficient allocation of resources.

Answer to the Question No. 2(a)

The money market refers to the global financial market where short-term financial instruments such as
treasury bills, certificates of deposit, commercial papers, and other highly liquid and low-risk securities are
traded.

The money market is a segment of the financial market where companies, governments, and financial
institutions can raise short-term funds. The primary purpose of the money market is to provide a source of
liquidity for borrowers and investors to meet their short-term cash needs. The market is considered to be
relatively safe and stable, with minimal risk of default.

The interest rates in the money market are determined by the supply and demand for these short-term
financial instruments. The interest rates in the money market have a significant impact on the overall
economy, as they affect the cost of borrowing for individuals and businesses, and also influence the value of
currencies.

A developed money market is characterized by a set of features that help it to function effectively and
efficiently. Here are some of the key features of a developed money market:

1. Depth and Liquidity: A developed money market should have sufficient depth and liquidity to
accommodate the needs of investors and borrowers. This means that there should be a wide range of
financial instruments available for trading, and the market should be able to absorb large transactions
without significant price fluctuations.

2. Diverse Range of Financial Instruments: A developed money market should offer a diverse range
of financial instruments, including short-term debt securities such as treasury bills, commercial
papers, certificates of deposit, and repurchase agreements. This provides investors with a variety of
investment options, and also helps to mitigate risk.
3. Efficient Trading Mechanisms: A developed money market should have efficient trading
mechanisms in place, such as electronic trading platforms and well-established settlement systems.
This helps to facilitate smooth and timely transactions, reducing operational and settlement risks.

4. Adequate Regulation and Supervision: A developed money market should have adequate
regulatory and supervisory frameworks in place to ensure the safety and stability of the market. This
includes setting standards for issuers and intermediaries, ensuring transparency and disclosure, and
monitoring market activities to detect and prevent misconduct.

5. Active Central Bank Participation: The central bank plays a critical role in a developed money
market by conducting monetary policy operations and providing liquidity to the market as needed.
Central bank participation helps to stabilize the market during times of stress, promoting confidence
and trust among market participants.

6. Openness to Foreign Participation: A developed money market should be open to foreign

participation, allowing foreign investors and institutions to access the market and contribute to its
development. This helps to increase the depth and liquidity of the market, and also encourages the
adoption of international best practices.
Overall, a developed money market is a key component of a healthy and dynamic financial system. It
provides an important source of short-term financing, supports economic growth, and helps to mitigate risk
in the wider financial system.

Answer to the Question No. 2(b)

A developed money market, such as that of the United States or Europe, typically offers a wider range of
financial instruments than the money market in Bangladesh. For example, in addition to treasury bills and
commercial papers, developed markets may also offer short-term bonds, repurchase agreements, and other
complex financial products. This is due to the greater diversity and sophistication of financial institutions in
developed economies.
Market liquidity is another key difference between developed money markets and the one in Bangladesh.
The money market in developed economies tends to be more liquid, which means that there is a higher
volume of trading activity and a greater number of market participants. This increased liquidity helps to
ensure that investors can buy and sell financial instruments quickly and efficiently, which is important for
managing short-term cash needs.

Finally, the regulatory environment is also an important difference between developed money markets and
the one in Bangladesh. Developed markets typically have more robust and stringent regulatory frameworks,
which helps to ensure that market participants adhere to high standards of transparency and disclosure. This
can help to increase investor confidence and reduce the risk of fraud or other financial malfeasance.

In contrast, the money market in Bangladesh is relatively less developed and offers a narrower range of
financial instruments. Market liquidity is also lower, and there are fewer market participants. However, the
Bangladeshi government has taken steps in recent years to develop the country's financial infrastructure and
improve its regulatory environment, which may help to stimulate greater growth and investment in the
money market over time.