An ideal capital market is one where finance is available ________.

Answer & explanation

Correct answer: option 3

The correct answer is Option (3) → at reasonable cost

Option (1) with a minimum risk of default — Incorrect. A minimum risk of default marks the money market. Its instruments are short-term and their issuers are financially sound.

Option (2) with a higher degree of liquidity — Incorrect. A higher degree of liquidity is enjoyed by money market instruments, as there is a formal arrangement for it.

Option (3) at reasonable cost — Correct. An ideal capital market is one where finance is available at reasonable cost. Firms can then raise long-term funds without paying too much for them.

Option (4) at the prevailing call rate — Incorrect. The call rate is the interest rate on call money loans, which banks take from each other.

NCERT (Pre-rationalised Edition): “CAPITAL MARKET … An ideal capital market is one where finance is available at reasonable cost. The process of economic development is facilitated by the existence of a well functioning capital market. In fact, development of the financial system is seen as a necessary condition for economic growth. It is essential that financial institutions are sufficiently developed and that market operations are free, fair, competitive and transparent. The capital market should also be efficient in respect of the information that it delivers, minimise transaction costs and allocate capital most productively.”

“(v) Liquidity: Capital market securities are considered liquid investments because they are marketable on the stock exchanges. However, a share may not be actively traded, i.e. it may not easily find a buyer. Money market instruments on the other hand, enjoy a higher degree of liquidity as there is formal arrangement for this. The Discount Finance House of India (DFHI) has been established for the specific objective of providing a ready market for money market instruments.”

“(vi) Safety: Capital market instruments are riskier both with respect to returns and principal repayment. Issuing companies may fail to perform as per projections and promoters may defraud investors. But the money market is generally much safer with a minimum risk of default. This is due to the shorter duration of investing and also to financial soundness of the issuers, which primarily are the government, banks and highly rated companies.”