1st PUC Business Studies Question Bank Chapter 8 Sources of Business Finance

Karnataka 1st PUC Business Studies Question Bank Chapter 8 Sources of Business Finance

One Mark Questions

Question 1.
What is business finance?
Answer:
An activity of business concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objective of the business.

Question 2.
For which purpose fixed capital is needed?
Answer:
Fixed capital is needed for the acquisition of fixed assets to the firm.

Question 3.
For which purpose working capital is needed?
Answer:
Working capital is needed to meet the day-to-day expenses of the firm.

Question 4.
Name a source of funds classified under the long term.
Answer:
Equity shares.

Question 5.
Name a source of funds classified under the short term.
Answer:
Trade credit.

Question 6.
Name any one source under the owner’s funds.
Answer:
Equity shares.

Question 7.
Name any one fund classified under borrowed funds.
Answer:
Debentures.

Question 8.
Give an example for internal sources of business enhance.
Answer:
Retained earnings.

Question 9.
Give an example for external sources of business finance
Answer:
Financial institutions.

Question 10.
Which source of finance is more economical, an internal source or an external source?
Answer:
Internal source.

Question 11.
Name any one method of factoring.
Answer:

1. Recourse method
2. Non-recourse method.

Question 12.
State one financial service ren&red by a factor
Answer:
Discounting of the bill.

Question 13.
Name one party In a lease contract
Answer:
Lessee.

Question 14.
What Is the tenure (period) of commercial papers?
Answer:
90 days to 364 days.

Question 15.
Name one type of shares issued by the companies.
Answer:
Equity shares.

Question 16.
State any one type of preference shares.
Answer:
Cumulative preference share.

Question 17.
State any one type of debentures.
Answer:
Coin enables debenture.

Question 18.
What type of shareholders enjoys voting right in a company?
Answer:
Equity shareholders.

Question 19.
Write one preferential right enjoyed by preference shareholders.
Answer:
Repayments of capital.

Question 20.
Name any one international source of finance where Indian companies can generate funds.
Answer:
Global depository receipts.

Question 21.
Name one financial instrument used to generate funds from the international capital] market.
Answer:
Global depository receipts.

Question 22.
Expand lECI.
Answer:
IFCI-Industrial Finance Corporation of India.

Question 23.
Expand SEC.
Answer:
SFC – State Financial Corporation.

Question 24.
Expand ICICI.
Answer:
ICICI-Industrial Credit and Investment Corporation of India.

Question 25.
Expand IDBI.
Answer:
IDBI – Industrial Development Bank of India.

Question 26.
Expand UTI.
Answer:
UTI – Unit Trust of India.

Question 27.
Expand LIC.
Answer:
LIC – Life Insurance Corporation.

Question 28.
Expand GDRs.
Answer:
Global Depository Receipt.

Question 29.
Expand ADRs.
Answer:
American Depository Receipt.

Question 30.
Name any one source of funds classified under the short term.
Answer:
Commercial paper.

Question 31.
State any one type of funds classified on the basis of ownership.
Answer:
Borrowed funds.

Question 32.
Write anyone merit of retained earnings as a source of business finance.
Answer:
It is a permanent free of funds, available to an organization.

Question 33.
Write anyone limitation of retained earnings as a source of business finance.
Answer:
It is an uncertain source of funds, as profits are fluctuating.

Question 34.
Write anyone merit of trade credit as a source of business finance.
Answer:
It is a convenient and continuous source of funds.

Question 35.
Write anyone limitation of trade credit as a source of business finance.
Answer:
Only a limited amount of funds can be generated.

Question 36.
Write anyone merit of factoring as a source of business finance.
Answer:
It doesn’t create any charge on the assets of fine.

Question 37.
Write anyone limitation of factoring as a source of business finance.
Answer:
It is expensive when the invoices are numerous and smaller in amount.

Question 38.
Write one merit of debentures as a source of business finance.
Answer:
It is preferred by investors who want fixed income at lesser risk.

Question 39.
Write one limitation of debentures as a source of business finance.
Answer:
They put a permanent burden on the earning of a company.

Question 40.
Write one merit of commercial banks as a source of business finance.
Answer:
Banks provide timely assistance to businesses by providing funds as and when needed by.

Question 41.
Write one limitation of commercial banks as a source of business finance.
Answer:
Funds are available for short periods and its extension on a renewal is uncertain.

Question 42.
What is a lease?
Answer:
A lease is a contractual agreement whereby one party i.e. the owner of an asset grants the other party the right to use the asset for a periodic payment.

Question 43.
Who is a lessor?
Answer:
The owner of the assets is called a lessor.

Question 44.
Who is a lessee?
Answer:
The party who uses the assets is known as the lessee.

Question 45.
Which type of asset lease financing is more prevalent?
Answer:
Electronic equipment.

Question 46.
How Public deposits are beneficial to depositors?
Answer:
Depositor gets a higher interest rate than Hank’s.

Question 47.
How Public deposits are beneficial to organizations?
Answer:
The cost of deposits to the company is less than the cost of borrowings from the bank.

Question 48.
Write one merit of Public deposits as a source of business finance.
Answer:
The procedure of obtaining funds is simple.

Question 49.
Write one limitation of Public deposits as a source of business finance.
Answer:
New companies generally find it difficult to raise funds through public deposits.

Question 50.
Write one merit of commercial papers as a source of business finance.
Answer:
It is a light liquid.

Question 51.
Write one limitation of commercial papers as a source of business finance.
Answer:
It is an impersonal method of financing.

Question 52.
Write one merit of equity shares as a source of business finance.
Answer:
They have voting rights in the company.

Question 53.
Write one limitation of equity shares as a source of business finance.
Answer:
It has more procedures and formalities to be followed.

Question 54.
Write one merit of preference shares as a source of business finance.
Answer:
It is useful for those investors who want a fixed rate of return with low risk.

Question 55.
Write one limitation of preference shares as a source of business finance.
Answer:
It dilutes the claims of equity shareholders over the assets of the company.

Question 56.
Write one merit of financial institutions as a source of business finance.
Answer:
It provides long-term finance which isn’t provided by commercial banks.

Question 57.
Write one limitation of financial institutions as a source of business.
Answer:
Financial institutions follow rigid criteria for the grant of loans.

Question 58.
Expand FCCBs.
Answer:
Foreign Currency Convertable Bonds.

Question 59.
Name any one factor that affects the choice of source of finance.
Answer:
Cost.

Question 60.
What are the two types of funds classified on the basis of ownership?
Answer:
(a) Owners funds
(b) Borrowed funds.

Two Mark Questions

Question 1.
What is business finance?
Answer:
An activity of business concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objective of the business.

Question 2.
What does yen mean by the fixed capital requirement of business?
Answer:
The funds required to purchase fixed assets like land and building, plant and machinery, etc. in order to start a business.

Question 3.
What do you mean by the working capital requirement of business?
Answer:
The funds are required by the company to meet its day-to-day expenses or to invest in current assets.

Question 4.
Name any two sources of funds classified under the long term.
Answer:
(a) Equity shares
(b) Debentures.

Question 5.
Name any two sources of funds classified under the short term. (March-S-2019)
Answer:
(a) Trade credit
(b) Banks.

Question 6.
Name any two sources of funds classified under the medium term.
Answer:
(a) Factoring
(b) Commercial paper.

Question 7.
Name any two owner’s fields.
Answer:
(a) Equity shares
(b) Retained earnings.

Question 8.
Name any two borrowed funds.
Answer:
(a) Debentures
(b) Loan from the bank.

Question 9.
Name any two internal sources of. business finance. (March-N-2018)
Answer:
(a) Equity shares
(b) Retained earnings

Question 10.
Name any two external sources of business finance.
Answer:
(a) Loan from banks
(b) Trade credit.

Question 11.
Which source of finance is more economical, an internal source or an external source? Why?
Answer:
Internal sources of finance are more economical because of less cost

Question 12.
Write the meaning of retained earnings.
Answer:
A company generally doesn’t distribute all its earnings amongst the shareholder as dividends. A portion of the net earnings may be retained by the business for use in the future.

Question 13.
What is trade credit’
Answer:
Trade credit is the credit extended by one trader to another for the purchase of goods and services. It facilitates the purchase of supplies without immediate payments.

Question 14.
State the methods of factoring.
Answer:
(a) Recourse method.
(b) Non-recourse method.

Question 15.
What are debentures?
Answer:
The companies can raise long-term funds by issuing documents that carry an assured rate of return for investors is called a debenture.

Question 16.
State any two types of debentures.
Answer:
Convertable debenture and non-convertable debenture.

Question 17.
Mention any two ways of extending loans by commercial banks.
Answer:
Cash credits and overdrafts.

Question 18.
Why financial institutions are called Development Banks?
Answer:
As these institutions aim at promoting the industrial development of a country, they are also called “Development banks”.

Question 19.
What is lease financing?
Answer:
A lease is a contractual agreement whereby one party, i.e. the owner of an asset grants the other party the right to use the asset in return for a periodic payment.

Question 20.
Who are the parties in a lease contract?
Answer:
Lessor and Lesser.

Question 21.
Give the meaning of public deposits.
Answer:
The companies can raise funds by inviting their shareholders, employees, and the general public to deposit their sayings with the company.

Question 22.
Public deposits are beneficial to both depositors as well as to organizations. How?
Answer:
The depositors get a higher interest rate than the offered by banks, the cost of deposits to the company is less than the cost of borrowings from banks.

Question 23.
What are commercial papers?
Answer:
Commercial paper is an unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days.

Question 24.
Give the meaning of shares. (March-S-2018)
Answer:
Share is the smallest unit into which the total capital of the company is the dividend.

Question 25.
Name the types of shares generally issued by companies.
Answer:
Equity shares: Preference shares.

Question 26.
What are equity shares?
Answer:
Equity share is shared that does not enjoy any preferential right in the matter of the claim of dividend or repayment of capital.

Question 27.
What are preference shares?
Answer:
Preference shares are those shares that carry preferential rights in respect of dividends and return of capital.

Question 28.
State any two- types of preference shares.
Answer:
(a) Cumulative preference shares.
(b) Non-cumulative preference shares.

Question 29.
Mention two preferential rights enjoyed by preference shareholders over equity shareholders.
Answer:
Payment of dividend and repayment of capital.

Question 30.
Name two international sources of finance from where Indian companies can generate funds.
Answer:
(a) Commercial banks.
(b) International capital markets.

Question 31.
Name any two prominent financial instruments used to generate funds from the international capital market? (March-N-2019)
Answer:
(a) Global depository receipts.
(b) American depository receipts.

Question 32.
What are Global Depository Receipts?
Answer:
Global depository receipts or certificates created by the overseas bank outside India dominated in dollars and issued to non-resident investors against the issue of ordinary shares of issuing companies.

Question 33.
What are American Depository Receipts?
Answer:
The depository receipts which are issued by a United States of America Bank for trading only in American stock markets are known as American depository receipts.

Question 34.
What are Foreign Currency Convertible Bonds?
Answer:
Foreign currency convertible bonds are equity-linked debt securities that are to be converted into equity or depository receipts after a specific period.

Question 35.
Name any two factors that affect the choice of source of finance.
Answer:
(a) Form of organization and legal status.
(b) Risk profile.

Question 36.
Write any two merits of retained earnings as a source of business finance.
Answer:
(a) It is a permanent source of funds available to an organization.
(b) It doesn’t involve any explicit cost in the form of dividends or interest.

Question 37.
Write any two limitations of retained earnings as a source of business finance.
Answer:
(a) It is an uncertain source of funds as profits are fluctuating.
(b) Excessive plowing back may cause dissatisfaction amongst the shareholder.

Question 38.
Write any two merits of trade credit as a source of business finance.
Answer:
(a) It is a convenient and continuous source of funds.
(b) It needs to promote the sales of an organization.

Question 39.
Wr1te any two limitations of trade credit as a source of business finance.
Answer:
(a) Only a limited amount of funds can be generated.
(b) It is a generally costly source of funds.

Question 40.
What is factoring as a source of business finance?
Answer:
Factoring is a financial service under which the factor renders various services.

Question 41.
Write any two merits of factoring as a source of business finance.
Answer:
(a) Obtaining funds through factoring is cheaper.
(b) It doesn’t create any charge on the assets of the firm.

Question 42.
Write any two limitations of factoring as a source of business finance.
Answer:
(a) This source is expensive when the invoices are numerous and smaller in amount.
(b) The factor is a third party to the customer who may not feel comfortable while dealing with it.

Question 43.
State the financial services rendered by a factor. ,
Answer:
(a) Discounting of bills.
(b) Providing information about the creditworthiness of clients.

Question 44.
Write any two merits of debentures as a source of business finance.
Answer:
(a) It is preferred by investors who want fixed income at lower risk.
(b) The issue of debentures, the capacity of a company to further borrow funds reduces.

Question 45.
Write any two limitations of debentures as a source of business nance.
Answer:
(a) As a fixed change instrument, debentures put a permanent burden on the earnings of a company.
(b) Each company has a certain borrowing capacity with the issue of debentures, the capacity of a company to further borrow funds reduce.

Question 46.
Write any two merits of commercial banks as a source of business finance.
Answer:
(a) Banks provide timely assistance to businesses by providing funds as and when needed by it.
(b) Secrecy of business can be maintained as the information supplied to the bank by the borrowers is kept confidential.

Question 47.
Write any two limitations of commercial banks as a source of business finance.
Answer:
(a) Funds are generally available for short periods and their extension and renewal are uncertain and difficult.
(b) In some cases, difficult terms and conditions are imposed by banks for the grant of a loan.

Question 48.
Write any two merits of lease financing as a source of business finance.
Answer:
(a) It enables the lesser to acquire thè asset with a lower investment.
(b) Simple documentation makes it easier to finance assets.

Question 49.
Write any two limitations of lease financing as a source of business finance.
Answer:
(a) The normal business operations may be affected in case the lease is not renewed.
(b) It depriver him of the residual value of the asset.

Question 50.
Write any two merits of public deposits as a source of business finance
Answer:
(a) Cost of public deposits is generally lower than the cost of borrowing from banks and financial institutions.
(b) As the depositors don’t have voting rights the control of the company is not diluted.

Question 51.
Write any two limitations of Public deposits as a source of business finance.
Answer:
(a) New companies generally find it difficult to raise funds through public deposits.
(b) It is an unreliable source of finance as the public may not respond when the company needs money.

Question 52.
Write any two merits of commercial papers as a source of business finance.
Answer:
(a) A commercial paper is an unsecured promissory note sold on an unsecured basis and doesn’t contain any restrictive conditions.
(b) As it is a freely transferable instrument, it has high liquidity.

Question 53.
Write any two limitations of commercial, papers as a source of business finance.
Answer:
(a) Only financially sound and highly rated firms can raise money through commercial papers.
(b) It is an impersonal method of financing.

Question 54.
Write any two merits Of equity shares as a source of business finance.
Answer:
(a) The equity shareholders are the owner of the company.
(b) it is suitable for those who want to take risks for a higher return.

Question 55.
Write any two limitations of equity shares as a source of business finance.
Answer:
(a) More procedures and formalities are required.
(b) issue of fresh shares reduces the earnings of existing shareholders.

Question 56.
Write any two merits of preference shares as a source of business finance.
Answer:
(a) It provides reasonably steady income in the form of a fixed rate of return.
(b) It does not affect the control of equity shareholders over the management.

Question 57.
Write any two limitations of preference shares as a source of business finance.
Answer:
(a) Preference capital dilutes the claims of equity shareholders over assets of the company.
(b) The rate of dividend on preference shares is generally higher than the rate of interest on debenture.

Question 58.
Write two merits of financial institutions as a source of business finance.
Answer:
(a) It provides long-term finance, which is not provided by commercial banks.
(b) The funds are made available even during periods of depression when other sources of finance are not available.

Question 59.
Write two limitations of financial institutions as a source of business.
Answer:
(a) Financial institutions follow rigid criteria for grant of loans.
(b) Certain restrictions such as restrictions on dividend payment is imposed on the powers of the borrowing company.

Four Mark Questions

Question 1.
Explain the financial needs of a business. (March-S-2018) (March-S-2019)
Answer:
(a) To purchase fixed assets: Every type of business needs some fixed assets like land and building, furniture, machinery, etc. A large amount of money is required for the purchase of these assets.
(b) To meet day-to-day expenses: After the establishment of a business, funds are needed to carry out day-to-day operations.
(c) To fund business growth: Growth of business may include expansion of the existing line of business as well as adding new lines. To finance such, growth, one needs more funds.
(d) To bridge the time gap between production and sales: The amount spent on production is realized only when sales are made. Normally, there is a time gap between production and sales and also between sales and realization of cash. Hence during this interval, expenses continue to be incurred, for which funds are required.
(e) To meet contingencies: Funds are always required to meet the ups and downs of business and for some unforeseen problems.

Question 2.
List out the sources of raising finance on the basis of ownership.
Answer:
On the basis of ownership, the sources can be classified into:
(a) Owner’s funds: It means funds that are provided by the owners of an enterprise, which may be a sole trader or partners or shareholders of a company. Issue of equity shares and retained earnings are the two important sources from where the owner’s funds can be obtained.

(b) Borrowed funds: It refers to the funds raised through loans or borrowings. The sources for raising borrowed funds include loans from commercial banks, loans from financial institutions, issues of debentures, public deposits, and trade credit. Such sources provide funds for a specified period, on certain terms and conditions and have to be repaid after the expiry of that period. A fixed-rate of interest is paid by the borrowers on such funds.

Question 3.
Write a note on (a) Owned funds (b) Borrowed funds.
Answer:
(a) Owner’s funds: It means funds that are provided by th6 owners of an enterprise, which may be a sole trader or partners or shareholders of a company. Issue of equity shares and retained earnings are the two important sources from where owner’s funds can be obtained,

(b) Borrowed funds: It refers to the funds raised through loans or borrowings. The sources for raising borrowed funds include loans from commercial banks, loans from financial institutions, issues of debentures, public deposits, and trade credit. Such sources provide funds for a specified period, on certain terms and conditions, and have to be repaid, after the expiry of that period. A fixed-rate of interest is paid by the borrowers on such funds.

Question 4.
Write a note on (a) Public deposit (b) Commercial papers.
Answer:
Public Deposits: The deposits that are raised by organizations directly from the public are known as public deposits. The rate of interest offered on public deposits are usually higher than that offered on bank deposits. Any person who is interested in depositing money in an organization can do so by filling up a prescribed form. The organization in return issues a deposit receipt as an acknowledgment of the debt. The depositors get a higher interest rate than that offered by banks; the cost of deposits to the company is less than the cost of borrowings from banks. Companies generally invite public deposits for a period of up to three years.

Commercial Papers (CP): Commercial Paper emerged as a source of short-term finance in our country in the early nineties. Commercial paper is an unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days. It is issued by one firm

to other business firms, insurance companies, pension funds, and banks. The amount raised by CP is generally very large. As the debt is totally unsecured, the firms having good credit ratings can issue the CP. Its regulation comes under the purview of the Reserve Bank of India.

Question 5.
Write a note on (a) equity shares (b) preference shares.
Answer:
Equity Shares:
(a) Equity shares represent the ownership of a company and thus the capital raised by the issue of such shares is known as ownership capital or Owner’s funds.
(b) Equity shares are shares, which do not enjoy any preferential right in the matter of the claim of dividend or repayment of capital.
(c) Equity shareholders are regarded as the owners of the company who exercise their authority through the voting rights they enjoy.

Preference Shares:
(a) The capital raised by the issue of preference shares is called preference share capital.

(b) The preference shareholders enjoy a preferential position over equity shareholders in two ways:

1. Receiving a fixed rate of dividend, out of the net profits of the company, before any
   the dividend is declared for equity shareholders.
2. Receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation.

(c) In other words, as compared to the equity shareholders, the preference shareholders have a preferential claim over dividend and repayment of capital. Preference shares resemble debentures as they bear a fixed rate of return. Also as the dividend is payable only at the discretion o,f the directors and* only out of profit after tax, to that extent, these resemble equity shares.

(d) Thus, preference shares have some characteristics of both equity shares and debentures. Preference shareholders generally do not enjoy any voting rights.

Question 6.
Write any four merits of raising funds through a financial institution.
Answer:
(a) Financial institutions provide long-term finance, which are not provided by commercial banks.
(b) Besides providing funds, many of these institutions provide financial, managerial, and technical advice and consultancy to business firms.
(c) Obtaining loan from financial institutions increases the goodwill of the borrowing company in the capital market. Consequently, such a company can raise funds easily from other sources as well.
(d) As repayment of loans can be made in easy installments, it does not prove to be much of a burden on the business.
(e) The funds are made available even during periods of depression when other sources of finance are not available.

Question 7.
Describe different avenues for organizations to raise funds internationally.
Answer:
(a) Commercial Banks: Commercial banks all over the world extend foreign currency loans for business purposes. They are an important source of financing non-trade international operations. The types of loans and services provided by banks vary from country to country.

(b) International Agencies and Development Banks: A number of international agencies and development banks have emerged over the years to finance international trade and business. These bodies provide long and medium-term loans and grants to promote the development of economically backward areas in the world. These bodies were set up by the Governments of developed countries of the world at national, regional, and international levels for funding various projects. The more notable among them include International Finance Corporation (IFC), EXIM Bank, and Asian Development Bank.

(c) International Capital Markets: Modem organizations including multinational companies depend upon sizeable borrowings in rupees as well as in foreign currency.

Prominent financial instruments used for this purpose are:
1. Global Depository Receipts (GDR’s)

• Global depository receipts or certificates created by the overseas bank outside India dominated in dollars and issued to non-resident investors against the issue of ordinary shares of issuing company.
• The depository receipts are marketed in Europe and the United States of America or both.

2. American Depository Receipts (ADR’s)

• The depository receipts which are issued by a United States of America Bank for trading only in American Stock markets are known as American Depository Receipts.
• Securities of a non-U.S. company that traded in the U.S. financial markets.

3. Foreign Currency Convertible Bonds (FCCB’s)

• Foreign currency convertible bonds are equity-linked debt securities that are to be converted into equity or depository receipts after a specific period. Thus, a holder of FCCB has the option of either converting them into equity shares at a predetermined price or exchange rate or retaining the bonds.
• The FCCB’s are issued in a foreign currency and carry a fixed interest rate which is lower than the rate of any other similar nonconvertible debt instrument. FCCB’s are listed and traded in foreign stock exchanges.

Question 8.
List out the sources of raising medium-term and short-term finance.
Answer:
Medium-term finance:
(a) Loan from banks
(b) Loan from the financial institution
(c) Public deposit
(d) Lease financing

Short term finance:
(a) Trade credit
(b) Banks
(c) Commercial paper
(d) Factoring

Question 9.
Write a note on (a) Retained Earnings (b) Trade Credit
Answer:
Retained Earnings: A company generally does not distribute all its earnings amongst the shareholders as dividends but a portion of the net earnings may be retained in the business for use in the future this is known as retained earnings. It is a source of internal financing or self-financing or ‘plowing back of profits ’. The profit available for plowing back in an organization depends on many factors like net profits, dividend policy, and age of the organization.

Trade Credit: It is the credit extended by one trader to another for the purchase of goods and services. Trade credit facilitates the purchase of supplies without immediate payment. Trade credit is commonly used by business organizations as a source of short-term financing. It is granted to those customers who have a reasonable amount of financial standing and goodwill.

The volume and period of credit extended depend on factors such as the reputation of the purchasing firm, the financial position of the seller, volume of purchases, past record of payment, and degree of competition in the market. Terms of trade credit may vary from one industry to another and from one person to another. A firm may also offer different credit terms to different customers.

Question 10.
Explain any four types of debentures.
Answer:
Secured and Unsecured: Secured debentures are such which create a charge on the assets of the company, thereby mortgaging the assets of the company, in the assets of the company. Registered and Bearer: Registered debentures are those which are duly recorded in the register of debenture holders maintained by the company. These can be transferred only through a regular instrument of transfer. In contrast, the debentures which are transferable by mere delivery are called bearer debentures.

Convertible and non-convertible: Convertible debentures are those debentures that can be converted into equity shares after the expiry of a specified period. On the other hand, non¬convertible debentures are those such cannot be converted into equity shares.

First and second: Debentures that are repaid before other debentures are could are known as first debentures. The second debentures are those which are paid after the first debenture have been paid back

Question 11.
Write short notes on ADRs and GDRs.
Answer:
American Depository Receipts (ADRs): The depository receipts issued by a company in the USA are known as American Depository Receipts. ADRs are bought and sold in American markets like regular stocks. It is similar to a GDR except that it can be issued only to American citizens and can be listed and traded on a stock exchange of the USA.

Global Depository Receipts (GDRs):
(a) The local currency shares of a company are delivered to the depository bank. The depository bank issues depository receipts against these shares. Such depository receipts denominated in US dollars are known as Global Depository Receipts (GDRs).

(b) GDR is a negotiable instrument and can be traded freely like any other security. In the Indian context, a 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.

(c) A holder of GDR can at any time convert it into the number of shares it represents. The holders of GDRs do not carry any voting rights but only dividends and capital appreciation. Many Indian companies such as Infosys, Reliance, Wipro, and ICICI have raised money through the issue of GDRs.

Eight Mark Questions

Question 1.
What are retained earnings? Explain its merits and demerits.
Answer:
The company generally does not distribute all its earnings amongst the shareholders as dividends. A portion of the net earnings may be retained in the business for use in the future. This is known as retained earnings.

Merits:
(a) Retained earnings are a permanent source of funds available to an organization.
(b) It does not involve any explicit cost in the form of interest, dividend, or floatation cost.
(c) As the funds are generated internally, there is a greater degree of operational freedom and flexibility.
(d) It enhances the capacity of the business to absorb unexpected losses.
(e) It may lead to an increase in the market price of the equity shares of a company.

Demerits:
(a) Excessive plowing back may cause dissatisfaction amongst the shareholders as they would get lower dividends.
(b) It is an uncertain source of funds as the profits of the business are fluctuating.
(c) The opportunity cost associated with these funds is not recognized by many firms. This may lead to sub-optimal use of the funds.

Question 2.
What is trade credit? Explain its merits and demerits as a source of business finance.
Answer:
Trade credit is the credit extended by one trader to another for the purchase of goods and services. Trade credit facilitates the purchase of supplies without immediate payment.

Merits:
(a) Trade credit is a convenient and continuous source of funds.
(b) Trade credit may be readily available in case the creditworthiness of the customers is known to the seller.
(c) Trade credit needs to promote the sales of an organization.
(d) If an organization wants to increase its inventory level in order to meet the expected rise in the sales volume in the near future, it may use trade credit to, finance the same.
(e) It does not create any charge on the assets of the firm while providing funds.

Demerits:
(a) Availability of easy and flexible trade credit facilities may induce a firm to indulge in overtrading, which may add to the risks of the firm.
(b) Only a limited amount of funds can be generated through trade credit.
(c) It is generally a costly source of funds as compared to most other sources of raising money.

Question 3.
Describe the merits and demerits of factoring.
Answer:
Merits:
(a) This source is expensive when the invoices are numerous and smaller in amount.
(b) The advance finance provided by the factoring firm is generally available at a higher interest cost than the usual rate of interest.
(c) The factor is a third party to the customer who may not feel comfortable while dealing with it.
(d) Obtaining funds through factoring is cheaper than financing through other means such as bank credit.
(e) With cash flow accelerated by factoring, the client is able to meet his/her liabilities promptly as and when these arise.

Demerits:
(a) Factoring as a source of funds is flexible and ensures a definite pattern of cash inflows from credit sales. It provides security for a debt that a firm might otherwise be unable to obtain.
(b) It does not create any charge on the assets of the firm.
(c) The client can concentrate on other functional areas of business as the responsibility of credit control is shouldered by the factor.

Question 4.
What is lease financing? What are the merits and limitations of lease financing? (March-S-2018)(.March-S-2019)
Answer:
A lease is a contractual agreement whereby one party i.e., the owner of an asset grants the other party the right to use the asset in return for a periodic payment. The owner of the assets is called the ‘lessor’ while the party that uses the assets is known as the ‘lessee’.

The lessee pays a fixed periodic amount called lease rental to the lessor for the use of the asset. The terms and conditions regulating the lease arrangements are given in the lease contract. At the end of the lease period, the asset goes back to the lessor.

Lease financing is more prevalent in the acquisition of such assets as computers and electronic equipment which become obsolete quicker because of the fast-changing technological developments. While making the leasing decision, the cost of leasing an asset must be compared with the cost of owning the same.

Merits of lease financing
(a) A lease arrangement may impose certain restrictions on the use of assets. For example, it may not allow the lessee to make any alteration or modification in the asset.
(b) The normal business operations may be affected in case the lease is not renewed.
(c) It may result in higher payout obligation in case the equipment is not found useful and the lessee opts for premature termination of the lease agreement.
(d) The lessee never becomes the owner of the asset. It deprives him of the residual value of the asset.

Limitations
(a) It enables the lessee to acquire the asset with a lower investment.
(b) Simple documentation makes it easier to finance assets.
(c) Lease rentals paid by the lessee are deductible for computing taxable profits.
(d) It provides finance without diluting the ownership or control of the business.
(e) The lease agreement does not affect the debt-raising capacity of an enterprise.
(f) The risk of obsolescence is borne by the lesser. This allows greater flexibility for the lessee to replace the asset.

Question 5.
What is a public deposit? Explain its merits and demerits as a source of business finance. (March-S-2018) (March-S-2019)
Answer:
Merits:
(a) The deposits that are raised by organizations directly from the public are known as public deposits.
(b) The procedure of obtaining deposits is simple and does not contain restrictive conditions as are generally there in a loan agreement.
(c) Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions.
(d) Public deposits do not usually create any charge on the assets of the company. The assets can be used as security for raising loans from other sources.
(e) As the depositors do not have voting rights, the control of the company is not diluted.

Demerits:
(a) New companies generally find it difficult to raise funds through public deposits.
(b) It is an unreliable source of finance as the public may not respond when the company needs money.
(c) Collection of public deposits may prove difficult, particularly when the size of deposits required is large.

Question 6.
What arc commercial papers? Explain the merits and demerits of commercial papers.
Answer:
Commercial paper is an unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days.

Merits of commercial papers:
(a) A commercial paper is sold on an unsecured basis and does not contain any restrictive conditions.
(b) As it is a freely transferable instrument, it has high liquidity.
(c) It provides more funds compared to other sources. Generally, the cost of CP to the issuing firm is lower than the cost of commercial bank loans.
(d) A commercial paper provides a continuous source of funds. This is because their maturity can be tailored to suit the requirements of the issuing firm. Further, maturing commercial paper can be repaid by selling new commercial paper.
(e) Companies can park their excess funds in commercial paper thereby earning some good return on the same.

Limitations of commercial papers:
(a) Only financially sound and highly rated firms can raise money through commercial papers. New and moderately rated firms are not in a position to raise funds by this method.
(b) The size of money that can be raised through commercial paper is limited to the excess liquidity available with the suppliers of funds at a particular time.
(c) Commercial paper is an impersonal method of financing. As such if a firm is not in a position to redeem its paper due to financial difficulties, extending the maturity of a CP is not possible.

Question 7.
Explain the merits and demerits of equity shares as a source of business finance. (March-N-2018)
Answer:
Merits
From Shareholders Point of View:
(a) The equity shareholders are the owners of the company.
(b) It is suitable for those who want to take risks for higher returns.
(c) The value of equity shares goes up in the stock market with the increase in profits of the concern.
(d) Equity shares can be easily sold in the stock market.
(e) The liability is limited to the nominal value of shares.
(f) Equity shareholders have a say in the management of a company as they are conferred voting rights.

From Management Point of View:
(a) A company can raise capital by issuing equity shares without creating any charge on its fixed assets.
(b) The capital raised by issuing equity shares is not required to be paid back during the lifetime of the company. It will be paid back only when the company is winding up.
(c) There is not binding on the company to pay dividends on equity shares. The company may declare dividends only if there are enough profits.
(d) If a company raises more capital by issuing equity shares, it leads to greater confidence among the creditors.

Demerits
(a) As equity capital cannot be redeemed, there is a danger of overcapitalization.
(b) The dividend which a shareholder receives is neither fixed nor controllable by him. The management of the company decides how much dividend should be given.
(c) Equity share investment is a risky share compared to any other investment.
(d) Equity shareholders get dividends only if there remains any profit after paying debenture interest, tax, and preference dividend. Thus, getting dividends on equity shares is uncertain every year.
(e) Issue of fresh shares reduces the earnings of existing shareholders.
(f) Cost of equity is high when compared to other sources of finance.

Question 8.
Explain the merits and demerits of preference shares as a source of business finance. (March-N-2018)
Answer:
Merits:
(a) Preference shares provide reasonably steady income in the form of fixed rate of return and safety of the investment.
(b) Preference shares are useful for those investors who want a fixed rate of return with comparatively low risk.
(c) It does not affect the control of equity shareholders over the management as preference shareholders don’t have voting rights.
(d) Payment of fixed rate of dividend to preference shares may enable a company to declare higher rates of dividend for the equity shareholders in good times.
(e) Preference shareholders have a preferential right of repayment over equity shareholders in the event of liquidation of a company.

Demerits:
(a) Preference shares are not suitable for those investors who are willing to take risks and are interested in higher returns.
(b) Preference capital dilutes the claims of equity shareholders over assets of the company.
(c) The rate of dividend on preference shares is generally higher than the rate of interest on debentures.
(d) As the dividend on these shares is to be paid only when the company earns profit, there is no assured return for the investors. Thus, these shares may not be very attractive to investors.
(e) The dividend paid is not deductible from profits as an expense. Thus, there is no tax saving as in the case of interest on loans.

Question 9.
Explain the merits and limitations of debentures as a source of finance.
Answer:
Merits:
(a) It is preferred by investors who want fixed income at lesser risk.
(b) Debentures are fixed charge funds and do not participate in the profits of the company.
(c) The issue of debentures is suitable in the situation when the sales and earnings are relatively stable.
(d) As debentures do not carry voting rights, financing through debentures does not dilute control of equity shareholders on management.
(e) Financing through debentures is less costly as compared to the cost of preference or equity capital as the interest payment on debentures is tax-deductible.

Demerits:
(a) As fixed charge instruments, debentures put a permanent burden on the earnings of a company. There is a greater risk when the earnings of the company fluctuate.
(b) In the case of redeemable debentures, the company has to make provisions for repayment on the specified date, even during periods of financial difficulty.
(c) Each company has a certain borrowing capacity. With the issue of debentures,, the capacity of a company to further borrow funds reduces.

Question 10.
Explain the merits and limitations of commercial banks as a source of finance.
Answer:
Merits of commercial papers
(a) A commercial paper is sold on an unsecured basis and does not contain any restrictive conditions.
(b) As it is a freely transferable instrument, it has high liquidity.
(c) It provides more funds compared to other sources. Generally, the cost of CP to the issuing firm is lower than the cost of commercial bank loans.
(d) A commercial paper provides a continuous source of funds. This is because their maturity can be tailored to suit the requirements of the issuing firm. Further, maturing commercial paper can be repaid by selling new commercial paper.
(e) Companies can park their excess funds in commercial paper thereby earning some good return on the same.

Limitations of commercial papers
(a) Only financially sound and highly rated firms can raise money through commercial papers. New and moderately rated firms are not in a position to raise funds by this method.
(b) The size of money that can be raised through commercial paper is limited to the excess liquidity available with the suppliers of funds at a particular time.
(c) Commercial paper is an impersonal method of financing. As such if a firm is not in a position to redeem its paper due to financial difficulties, extending the maturity of a CP is not possible.

Question 11.
Discuss the factors that affect while making the decision for the choice of an appropriate source of funds by the business organization. (March-S-20l8) (March-S-2019) (March-S-2019)
Answer:
(a) Cost: There are two types of cost viz., the cost of procurement of funds and cost of utilizing the funds. Both these costs should be taken into account while deciding about the source of funds that will be used by an organization.

(b) Financial strength and stability of operations: The financial strength of a business is also a key determinant. In the choice of source of funds, the business should be in a sound financial position so as to be able to repay the principal amount and interest on the borrowed amount.

(c) Form of organization and legal status: The form of business organization and status influences the choice of a source for raising money.

(d) Purpose and time period: Business should plan according to the time period for which the funds are required. A short-term need for example can be met through borrowing funds at a low rate of interest through trade credit, commercial paper, etc. For long-term finance, sources such as the issue of shares and debentures are more appropriate.

(e) Risk profile: Businesses should evaluate each of the sources of finance in terms of the risk involved. For example, there is the least risk inequity as the share capital has to be repaid only at the time of winding up and dividends need not be paid if no profits are available.

(f) Control: A particular source of funds may affect the control and power of the owners on the management of a firm. Issue of equity shares may mean dilution of the control.

(g) Effect on creditworthiness: The dependence of a business on certain sources may affect its creditworthiness in the market.

(h) Flexibility and ease: Another aspect affecting the choice of a source of finance is the flexibility and ease of obtaining funds. Restrictive provisions, detailed investigation, and documentation in case of borrowings from banks and financial institutions.

(i) Tax benefits: Various sources may also be weighed in terms of their tax benefits. For example, while the dividend on preference shares is not tax-deductible, interest paid on debentures and loans is tax-deductible and may, therefore, be preferred by organizations seeking tax advantage.

Question 12.
Distinguish between equity shares and preference shares by taking any four points. (March-N-2019)
Answer:
im-2

1st PUC Business Studies Sources of Business Finance Textbook Questions and Answers

Multiple Choices One Mark Questions

Question 1.
Equity shareholders are called (March-S-2019)
(a) Owners of the company
(b) Partners of the company
(c) Executives of the company
(d) Guardians of the company
Answer:
(a) Owners of the company

Question 2.
The term ‘redeemable’ is used for
(a) Preference shares
(c) Equity shares
Answer:
(a) Preference shares

Question 3.
Funds required for purchasing current assets is an example for
(a) Fixed capital requirement
(b) Ploughing back of profits
(c) Working capital requirements
(d) Lease financing
Answer:
(c) Working capital requirements

Question 4.
ADRs are issued in
(a) Canada
(b) China
(c) India
(d) the USA
Answer:
(d) the USA

Question 5.
Public deposits are the deposits that are raised directly from
(a) The public
(b) The directors
(c) The auditors
(d) The owners
Answer:
(a) The public

Question 6.
Under the lease agreement, the lessee gets the right to
(a) Share profits earned by the lessor
(b) Participate in the management of the organization
(c) Use the asset for a specified period
(d) Sell the assets.
Answer:
(c) Use the asset for a specified period

Question 7.
Debentures represent
(a) Additional capital of the company
(b) Permanent capital of the company
(c) Fluctuating cãpital of the company
(d) Loan capital of the company
Answer:
(d) Loan capital of the company

Question 8.
Under the factoring arrangement the factor
(a) Produces and distributes the goods and services
(b) Makes the payment on behalf of the client
(c) Collects the client’s debt or account receivables
(d) Transfer the goods from one place to another
Answer:
(c) Collects the client’s debt or account receivables

Question 9.
The maturity period of a commerci1 pap usually ranges from
(a) 20 days to 40 days
(b) 60 days to 90 days
(c) 120 days to 365 days
(d) 90 days to 364 days
Answer:
90 days to 364 days

Question 10.
Internal sources of capital are those that are
(a) Generated through outsiders such as suppliers
(b) Generated through loans from commercial banks
(c) Generated through the issue of shares
(d) Generated within the business
Answer:
(d) Generated within the business

Short Answers Questions

Question 1.
What is business finance? Why do businesses need funds? Explain.
Answer:
An activity of business concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objective of the business.
(a) To purchase fixed assets: Every type of business needs some fixed assets like land and building, furniture, machinery, etc. A large amount of money is required for the purchase of these assets.

(b) To meet day-to-day expenses: After the establishment of a business, funds are needed to carry out day-to-day operations.

(c) To fund business growth: Growth of business may include expansion of the existing line of business as well as adding new lines. To finance such growth, one needs more funds.

(d) To bridge the time gap between production and sales: The amount spent on production is realized only when sales are made. Normally, there is a time gap between production and sales and also between sales and realization of cash. Hence during this interval, expenses continue to be incurred, for which funds are required.

(e) To meet contingencies: Funds are always required to meet the ups and downs of business and for some unforeseen problems.

Question 2.
List the sources of raising long-term and short-term finance.
Answer:
Sources of Long Term Finance:
(a) Equity shares
(b) Retained earnings
(c) Preference shares
(d) Debenture
(e) Loans from banks and other financial institutions.

Sources of Medium Term Finance:
(a) Lease financing
(b) Public deposits
(c) Loans from banks and other financial institutions.

Sources of Short Term Finance:
(a) Trade credit
(b) Factoring
(c) Commercial papers
(d) Short-term loans from banks.

Question 3.
What is the difference between internal and external sources of raising funds? Explain.
Answer:

Internal Sources of Finance	External Sources of Finance
1. Internal sources of funds are those that are generated within the business.	1. External sources of funds include those sources that lie outside an organization, such as suppliers, lenders, and investors.
2. Examples are accelerating the collection of receivables, disposing of surplus inventories, and plowing back of profit.	2. Examples are issues of debentures, borrowing from commercial banks and financial institutions, and accepting public deposits.
3. The internal sources of funds can fulfill only limited needs of the business. The cost of internal funds is low.	3. a large amount of money can be raised through external sources. External funds are more costly.
4. Business is not required to provide security while obtaining funds from internal sources.	4. Business is required to mortgage its assets as security while obtaining funds from external sources.

Question 4.
What preferential rights are enjoyed by preference shareholders? Explain.
Answer:
The following preferential rights are enjoyed by preference shareholders:
(a) Receiving a fixed rate of dividend, out of the net profits of the company, before any dividend is declared for equity shareholders.
(b) Preference over equity shareholders in receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation.
(c) In case of dissolution of the company, preference share capital is refunded prior to the refund of equity share capital.

Question 5.
Name any three special financial institutions and state their objectives.
Answer:
Industrial Finance Corporation of India (IFCI):

• It was established in July 1948 as a statutory corporation under the Industrial Finance Corporation Act, 1948.
• Its objectives include assistance towards balanced regional development and encouraging new entrepreneurs to enter into the priority sectors of the economy.

State Financial Corporations (SFC):

• The State Financial Corporations Act, 1951 empowered the State Governments to establish State Financial Corporations.
• Its objective providing medium and short-term finance to industries of the states.
• SFCs are helpful in ensuring balanced regional development, higher investment, more employment generation, and broad ownership of industries.

Industrial Credit and Investment Corporation of India (ICICI)

• This was established in 1955 as a public limited company under the Companies Act.
• Its objective is to assists the creation, expansion, and modernization of industrial enterprises exclusively in the private sector.

Long Answer Questions

Question 1.
Explain trade credit and bank credit as sources of short-term finance for business enterprises.
Answer:
Trade Credit:
(a) Trade credit is the credit extended by one trader to another for the purchase of goods and services. It facilitates the purchase of supplies without immediate payment and is commonly used by business organizations as a source of short-term financing.

(b) Trade credit appears in the records of the buyer of goods as ‘sundry creditors’ or ‘accounts payable’. It is granted prudently to those customers who have a reasonable amount of financial standing and goodwill.

(c) The volume and period of credit extended depend on factors such as the reputation of the purchasing firm, the financial position of the seller, the volume of purchases, past record of payment, and degree of competition in the market.

(d) Terms of trade credit may vary from industry to industry and from person to person. As we know, trade is the purchase and sale of goods on the profit motive. So, trade credit strictly refers to routine business activity.

Bank Credit:
(a) Commercial banks provide funds for different purposes and for different time periods to firms of all sizes by way of cash credits, overdrafts, term loans, purchase/discounting of bills, and the issue of letters of credit.

(b) The rate of interest charged by banks depends on various factors such as the characteristics of the firm and the level of interest rates in the economy. The loan is- repaid either in a lump sum or in installments.

(c) Bank credit is not a permanent source of funds and is generally used for medium to short periods. The borrower is required to provide some security or create a charge on the assets of the firm before a loan is sanctioned by a commercial bank.

Question 2.
Discuss the sources from which a large industrial enterprise can raise capital for financing modernization and expansion. (March-S-2018)
Answer:
Financial institutions established by the central as well as state governments all over the country to provide finance to business organizations are considered the most suitable source of financing when large funds for a longer duration are required for expansion, reorganization, and modernization of an enterprise.

These institutions provide both owned capital and loan capital for long and medium-term requirements and supplement the traditional financial agencies like commercial banks. In addition to providing financial assistance, these institutions also conduct market surveys and provide technical assistance and managerial services to people who run the enterprises.

The various Special Financial Institutions in India are as under:
Industrial Finance Corporation of India (IFCI)

• It was established in July 1948 as a statutory corporation under the Industrial Finance Corporation Act, 1948.
• Its objectives include assistance towards balanced regional development and encouraging new entrepreneurs to enter into the priority sectors of the economy.

State Financial Corporations (SFC)

• The State Financial Corporations Act, 1951 empowered the State Governments to establish State Financial Corporations.
• Its objective providing medium and short-term finance to industries of the states.
• SFCs are helpful in ensuring balanced regional development, higher investment, more employment generation, and broad ownership of industries.

Industrial Credit and Investment Corporation of India (ICICI)

• This was established in 1955 as a public limited company under the Companies Act.
• Its objective is to assists the creation, expansion, and modernization of industrial enterprises exclusively in the private sector.

Industrial Development Bank of India (IDBI)

• It was established in 1964 under the Industrial Development Bank of India Act, 1964.
• Its objective to coordinate the activities of other financial institutions including commercial banks.

Unit Trust of India (UTI)

• It was established by the Government of India in 1964 under the Unit Trust of India Act, 1963.
• The basic objective of UTI is to mobilize the community’s savings and channelize them into productive ventures.

Life Insurance Corporation of India (LIC)

• LIC was set up in 1956 under the LIC Act, 1956.
• It mobilizes the community’s savings in the form of insurance premiums and makes it available to industrial concerns, both public as well as private.

Question 3.
What advantages does the issue of debentures provide over the issue of equity shares?
Answer:
The companies can raise long-term funds by issuing documents that carry an assured rate of return (interest) for investors is called a debenture. In short, it is a written acknowledgment of a debt by the company. It is known as debt capital or borrowed capital of the company.

Merits of Debentures over Equity Shares:
(a) Debentures are preferred by investors who want fixed income at lesser risk.
(b) Debentures are fixed charge funds and do not participate in the profits of the company.
(c) The issue of debentures is suitable in the situation when the sales and earnings are relatively stable.
(d) Financing through debentures does not dilute control of shareholders on management as debentures do not carry voting rights.
(e) Financing through debentures is less costly as compared to the cost of equity capital as the interest payment on debentures is tax-deductible.

Question 4.
State the merits and demerits of public deposits and retained earnings as methods of business finance.
Answer:
The companies can raise funds by inviting their shareholders, employees, and the general public to deposit their savings with the company. To attract the public, the company usually offers a higher rate of interest than the interest on bank deposits.

The merits of public deposits are:
(a) The procedure of obtaining deposits is simple and does not contain restrictive conditions as are generally there in a loan agreement.
(b) Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions.
(c) Public deposits do not usually create any charge on the assets of the company. The assets can be used as security for raising loans from other sources.
(d) As the depositors do not have voting rights, the control of the company is not diluted.

The major limitation of public deposits is as follows:
(a) New companies generally find it difficult to raise funds through public deposits.
(b) It is an unreliable source of finance as the public may not respond when the company needs money.
(c) Collection of public deposits may prove difficult, particularly when the size of deposits required is large.
The company generally does not distribute all its earnings amongst the shareholders as dividends. A portion of the net earnings may be retained in the business for use in the future. This is known as retained earnings.

The merits of retained earnings as a source of finance are as follows:
(a) Retained earnings are a permanent source of funds available to an organization.
(b) It does not involve any explicit cost in the form of interest, dividend, or floatation cost.
(c) As the funds are generated internally, there is a greater degree of operational freedom and flexibility.
(d) It enhances the capacity of the business to absorb unexpected losses.
(e) It may lead to an increase in the market price of the equity shares of a company.

Retained earnings as a source of funds have the following limitations:
(a) Excessive plowing back may cause dissatisfaction amongst the shareholders as they would get lower dividends.
(b) It is an uncertain source of funds as the profits of the business are fluctuating.
(c) The opportunity cost associated with these funds is not recognized by many firms. This may lead to sub-optimal use of the funds.

Question 5.
What are commercial papers? Explain the merits and demerits of commercial papers.
Answer:
Commercial paper is an unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days.

Merits of commercial papers
(a) A commercial paper is sold on an unsecured basis and does not contain any restrictive conditions.
(b) As it is a freely transferable instrument, it has high liquidity.
(c) It provides more funds compared to other sources. Generally, the cost of CP to the issuing firm is lower than the cost of commercial bank loans.
(d) A commercial paper provides a continuous source of funds. This is because their maturity can be tailored to suit the requirements of the issuing firm. Further, maturing commercial paper can be repaid by selling new commercial paper.
(e) Companies can park their excess funds in commercial paper thereby earning some good return on the same.

Limitations of commercial papers
(a) Only financially sound and highly rated firms can raise money through commercial papers. New and moderately rated firms are not in a position to raise funds by this method.
(b) The size of money that can be raised through commercial paper is limited to the excess liquidity available with the suppliers of funds at a particular time.
(c) Commercial paper is an impersonal method of financing. As such if a firm is not in a
position to redeem its paper due to financial difficulties, extending the maturity of a CP is not possible.

1st PUC Business Studies Question Bank with Answers