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Economy - Prelims Questions DPP – 26

1. Consider the following statements: How many of the above are the advantages of
1. A mutual fund is a company that collects Inflation-Induced Bonds (IIBs)?
and invests money on behalf of the (a) Only one (b) Only two
investors. (c) All three (d) None
2. The Net Asset Value (NAV) of the mutual
fund is the market value of the fund
4. With reference to Masala Bonds, consider the
determined on a per-unit basis.
following statements:
Which of the statements given above is/are
1. These are rupee-denominated bonds
correct?
issued outside India.
(a) 1 only (b) 2 only
2. The risk in these bonds is borne by the
(c) Both 1 and 2 (d) Neither 1 nor 2 issuer of these bonds.
3. Both the Government and Private entities
2. Consider the following statements: can issue these bonds.
1. A future contract in the stock market How many of the above statements are correct?
allows an investor to speculate on the (a) Only one (b) Only two
direction of a security, commodity, or
(c) All three (d) None
financial instrument.
2. A stock option makes it obligatory for an
5. What led to the decline in investments through
investor to buy or sell a stock at an agreed-
Participatory Notes (P-Notes) in the Indian
upon price and date.
stock market, prompting the introduction of
Which of the statements given above is/are
Know Your Customer (KYC) norms by the
correct?
Securities and Exchange Board of India
(a) 1 only (b) 2 only (SEBI)?
(c) Both 1 and 2 (d) Neither 1 nor 2 (a) P-Notes were predominantly used by
hedge funds.
3. With reference to the Indian economy, (b) P-Notes facilitated the easy routing of
Consider the following: black money into the Indian economy.
1. IIBs provide protection to investors from (c) The Reserve Bank of India (RBI) imposed
uncertainty regarding inflation. stringent regulations on P-Notes.
2. The interest received on IIBs is not (d) P-Notes were primarily issued by foreign
taxable. institutions.
3. The real coupon interest rate in the case of
IIBs is adjusted for inflation.
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Answer

1. (c) 4. (b)
2. (a) 5. (b)
3. (a)

Hints and Solutions
1. Option (c) is correct:
❖ Statement 1 is correct: A mutual fund is
a fund that is set up to help small
investors take or enjoy the benefits of the
stock market without exposing themselves
to market complications. Thus, mutual
funds pool small savings of lakhs of
investors and, based on their professional
expertise, invest in the stock market to
provide gains of the stock market growth
to small investors. A mutual fund is a
company that pools money from many
investors and invests the money in
securities such as stocks, bonds, and
short-term debt. The combined holdings
of the mutual fund are known as its
portfolio.
❖ Statement 2 is correct: The Net Asset
Value (NAV) of the mutual fund is the
market value of the fund determined on
a per-unit basis. It is calculated by
dividing the total value of all the assets
in a portfolio minus the liabilities. NAV is
determined at the end of every market
day.
2. Option (a) is correct:
❖ Statement 1 is correct: A futures contract
involves an agreement between two
parties to buy or sell an asset at a certain
price in the future. The fulfillment of the
contract is an obligation of the parties
involved. A futures contract allows an
investor to speculate on the direction of
a security, commodity, or financial
instrument.
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❖ Statement 2 is not correct: Under this,
the buyer has the right, but not the
obligation, to buy/sell a specific asset at
a price at the stated date. Thus, unlike
Future Contracts, the fulfillment of the
contract is not binding on the parties
involved.
3. Option (a) is correct:
❖ Statement 1 is correct: Inflation Index
Bonds (IIBs) are government securities
that aim at insulating the customer from
the impacts of inflation. Under these
bonds, the principal value is adjusted
for inflation while the interest rate is
fixed. Thus, it provides constant returns to
the investors irrespective of inflation
trends in the economy.
❖ Statement 2 is not correct: Tax
provisions are applicable on the interest
payment as well as the capital gains made
on selling Inflation Index Bonds (IIBs).
❖ Statement 3 is not correct: The real
coupon interest rate in the case of IIBs is
fixed, however, the nominal principal
value is adjusted for inflation, i.e., the
principal amount is indexed to inflation.
They are, thus, designed to cut down the
inflation risk of an investment and also
provide a 2% extra interest rate after
maturity.
4. Option (b) is correct:
❖ Statement 1 is correct: Masala bonds are
rupee-denominated bonds, issued by an
Indian entity in foreign markets to raise

money, in Indian currency. These are debt
instruments offered by Indian firms in
capital markets outside India and are
denominated in Indian rupees. They are
offered and settled in dollars to raise
Indian rupees from International
investors.
❖ Statement 2 is not correct: The risk in
these bonds is borne by the investor.
Thus, any fall in the exchange rate of the
rupee would have a negligible effect on
the issuer of these bonds.
❖ Statement 3 is correct: Both the
Government and Private entities can
issue these bonds. Any corporate or body
corporate is eligible to issue rupee-
denominated bonds. RBI has allowed
Indian banks to issue masala bonds. Banks
can participate as arrangers, underwriters,
market makers, and traders in rupee-
denominated bonds issued overseas.
5. Option (b) is correct:
About Participatory Notes (P-Notes):
❖ SEBI allowed Participatory Notes in
2000.
   
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❖ Participatory Notes (P-Notes) are
financial instruments that are issued by a
registered Foreign Institutional
Investor (FII) to an overseas investor
who wishes to invest in the Indian stock
market without having to register
themselves with the market regulator, the
Securities and Exchange Board of India
(SEBI).
❖ P Notes are mostly used by hedge funds,
overseas individual investors, and foreign
institutions to invest in the Indian stock
market.
❖ This provides an easy route for overseas
investors to invest in India.
❖ A large amount of money was invested in
India through the P-Notes route.
❖ It was subsequently found that P-Notes
became a medium to invest black money
in the economy. Thus, the Securities and
Exchange Board of India (SEBI) has
introduced Know Your Customer
(KYC) norms for P-Notes. This has made
the investment through P-Notes difficult
and hence a decline in investment through
this route.