Skip to content
Home » UPSC PYQ on Financial Instrument

UPSC PYQ on Financial Instrument

Financial Instrument important part of Economy and its syllabus. Previous Year Question (PYQ) papers are invaluable resources for aspirants preparing for competitive exams like the Union Public Service Commission (UPSC) examinations. In this article we present important PYQ on Financial Instrument.

PYQ on Financial Instrument

Q- “Rapid Financing Instrument” and “Rapid Credit Facility” are related to the provisions of lending by which of the following: (2022)

  1. Asian Development Bank
  2. International Monetary Fund
  3. United Nations Environment Programme Finance Initiative
  4. World Bank

Answer- Option B

EXPLANATION

The Rapid Financing Instrument (RFI) is a lending mechanism offered by the International Monetary Fund (IMF) designed to provide swift financial aid to member countries facing urgent balance of payments challenges. This facility was established as part of broader reforms aimed at enhancing the IMF’s financial support to cater to the varied needs of member nations. The RFI replaces the previous emergency assistance policy and can be utilized in a wide array of situations.

The Rapid Credit Facility (RCF) is a concessional program through which the IMF extends financial assistance to low-income countries (LICs) encountering immediate balance of payments difficulties. Introduced within the Poverty Reduction and Growth Trust (PRGT), the RCF offers more targeted support with broader coverage. It assists member LIC countries in coping with commodity price fluctuations, economic disruptions, or significant natural disasters. This policy is exclusively available to nations falling under the Poverty Reduction and Growth Trust (PRGT). Eligibility for RCF access is determined based on various factors such as economic strength, repayment capacity, macroeconomic policies, outstanding payments, current economic status, and poverty levels of nations.

Q- With reference to the expenditure made by an organisation or a company, which of the following statements is/are correct? (2022)

  1. Acquiring new technology is capital expenditure.
  2. Debt financing is considered capital expenditure, while equity financing is considered revenue expenditure.

Select the correct answer using the code given below:

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer- Option A

EXPLANATION

Capital expenditures (CapEx) represent funds utilized by a company to procure, enhance, and maintain physical assets like property, plants, buildings, technology, or equipment, often directed towards new projects or investments. Examples of CapEx include acquisitions of property, equipment, land, computers, furniture, and software, as mentioned in statement 1.

However, debt financing is not classified as a capital expenditure. Capital expenditures involve long-term investments in physical assets expected to yield future economic benefits. In contrast, debt financing is a liability used to fund asset purchases but doesn’t create new assets itself. For instance, borrowing money to construct a factory constitutes a capital expenditure, while the interest payments on the loan do not, as they don’t generate new assets, as explained in the example.

In the context of personal expenses like dental work, debt financing for such expenses isn’t considered a capital expenditure since dental work doesn’t produce future economic benefits for the individual. Debt financing, whether for working capital or capital expenditures, involves selling debt instruments to investors who become creditors, expecting repayment of principal and interest. Equity financing, another method of raising capital, involves issuing shares of stock. Both debt financing and equity financing are distinct from capital expenditures. Additionally, revenue expenditures are ongoing operational expenses for daily business operations, contrasting with capital expenditures. Hence, statement 2 is not accurate.

Q- With reference to the Indian economy, consider the following statements: (2022)

  1. A share of the household financial savings goes towards government borrowings.
  2. Dated securities issued at market-related rates in auctions form a large component of internal debt.

Which of the above statements is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer- Option C

EXPLANATION

Statement 1 accurately states that gross financial savings of households encompass various forms of savings, including bank deposits, provident funds, pension schemes, shares, insurance, and currency holdings. These savings serve as a crucial source of domestic finance for investments, which are essential for job creation and economic revival.

Deposits with banks represent the largest portion of households’ financial assets, followed by insurance funds, mutual funds, and currency. Any negative shifts in household savings can significantly impact banks, insurance companies, and mutual/provident funds, as they are major investors in government securities.

Statement 2 is also correct in noting that internal debt constitutes a substantial portion, over 93%, of the overall public debt. This internal debt comprises marketable and non-marketable debt, with sources including dated government securities (G-Secs), treasury bills, external assistance, and short-term borrowings.

Q- Consider the following statements: (2022)

  1. In India, credit rating agencies are regulated by Reserve Bank of India.
  2. The rating agency popularly known as ICRA is a public limited company.
  3. Brickwork Ratings is an Indian credit rating agency.

Which of the statements given above are correct?

(a) 1 and 2 only

(b) 2 and 3 only

(c) 1 and 3 only

(d) 1, 2 and 3

Answer- Option B

EXPLANATION

Statement 1 is inaccurate: Credit Rating Agencies play a crucial role in financial markets and are regulated by the Securities and Exchange Board of India (SEBI) rather than the Reserve Bank of India (RBI). SEBI regulates Credit Rating Agencies through the powers granted by the Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999.

Statement 2 is correct: ICRA Limited was established in 1991 by prominent financial and investment institutions, commercial banks, and financial services companies as an independent and professional investment information and credit rating agency. ICRA operates as a public limited company, with its shares listed on both the Bombay Stock Exchange and the National Stock Exchange.

Statement 3 is also accurate: Brickwork Ratings (BWR) is an Indian Credit Rating Agency registered with SEBI. Additionally, it has received accreditation from the Reserve Bank of India. BWR provides rating services for various financial instruments such as bank loans, non-convertible debentures (NCDs), commercial paper, fixed deposits, securitized paper, and security receipts.

Q- Convertible Bonds, consider the following statements: (2022)

  1. As there is an option to exchange the bond for equity, Convertible Bonds pay a lower rate of interest.
  2. The option to convert to equity affords the bondholder a degree of indexation to rising consumer prices.

Which of the statements given above is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer- Option C

EXPLANATION

Statement 1 accurately describes convertible bonds as debt securities with the added feature of the right or obligation to exchange the bond for a predetermined number of shares in the issuing company. These bonds typically offer a lower coupon rate compared to regular bonds due to the value of the conversion option. Investors are willing to accept a lower coupon rate in exchange for the potential upside from converting the bond into common stock. This feature allows issuers to save on interest expenses, particularly with large bond issues.

Statement 2 is also correct in highlighting that the option to convert to equity provides bondholders with a form of indexation to rising consumer prices. Equity prices can vary significantly from fixed interest payments, offering a potential hedge against inflation. Therefore, the conversion feature of convertible bonds can serve as a means of protection against inflationary pressures.

Q- With reference to Non-Fungible Tokens (NFTs), consider the following statements: (2022)

  1. They enable the digital representation of physical assets.
  2. They are unique cryptographic tokens that exist on a blockchain.
  3. They can be traded or exchanged at equivalency and therefore can be used as a medium transactions. of commercial

Which of the statements given above are correct?

(a) 1 and 2 only

(b) 2 and 3 only

c) 1 and 3 only

(d) 1, 2 and 3

Answer- Option A

EXPLANATION

Statement 1 accurately states that Non-Fungible Tokens (NFTs) allow for the digital representation of physical assets, such as art, music, in-game items, and videos.

Statement 2 correctly explains that NFTs are typically bought and sold online, often using cryptocurrency, and are encoded with the same underlying software as many cryptocurrencies. They are built using blockchain technology, which records transactions on a distributed public ledger.

However, Statement 3 is inaccurate. It incorrectly characterizes NFTs as being non-fungible due to their inability to be exchanged or equal in value to one another. In reality, NFTs are indeed non-fungible, but this is because each token has a unique digital signature, not because they cannot be exchanged for or are unequal to one another.

Q- With reference to India, consider the following statements: (2021)
1. Retail investors through Demat account can invest in Treasury Bills and Government of India Debt Bonds in the primary market
2. The “Negotiated Dealing System-Ordering Matching” is a government securities trading platform of the Reserve Bank of India.
3. The “Central Depository Services Ltd” is jointly promoted by the Reserve Bank of India and the Bombay Stock Exchange.
Which of the statements given above is/are correct?
a) 1 only
b) 1 and 2
c) 3 only
d) 2 and 3

Answer- Option B

EXPLANATION

Statement 1: In August 2005, RBI introduced an anonymous screen-based order matching module on NDS, called NDS-OM, operated by CCIL on behalf of the RBI. Direct access to NDS-OM is available only to select financial institutions like Commercial Banks, Primary Dealers, Insurance Companies, Mutual Funds, etc.
Statement 2: RBI has ownership with DICGC and some of the AIFIs.
Statement 3: CDSL is a depository set up by the Bombay Stock Exchange (BSE) with 54% shareholding owned by BSE and 46% owned by various banks.

Q- Indian Government Bond yields are influenced by which of the following? (2021)

1. Actions of the United States Federal Reserve
2. Actions of the Reserve Bank of India
3. Inflation and short-term interest rates.

Select the correct answer using the code given below
a) 1 and 2 only
b) 2 only
c) 3 only
d) 1, 2 and 3

Answer- Option D

EXPLANATION

Statement 1: Increase in interest rates by the United States Federal Reserve results in a shift of funds from equities to US treasury bonds and causes a capital outflow from emerging economies to the US, thus negatively affecting Indian Government Bond Yields.

Statement 2: The Reserve Bank of India (RBI) has multifaceted roles in the payment system, monetary policy formulation, financial stability policy, and coordination with the Treasury, empowering it to influence nominal yields on government bonds by adjusting short-term interest rates and employing other monetary policy tools as necessary.

Statement 3: Short-term interest rates and inflation levels are the primary factors determining interest rates on government bonds.

Q- Consider the following: (2021)

1. Foreign currency convertible bonds
2. Foreign institutional investment with certain conditions
3. Global depository receipts
4. Non-resident external deposits

Which of the above can be included in Foreign Direct Investments?

a) 1, 2 and 3
b) 3 only
c) 2 and 4
d) 1 and 4

Answer- Option A

EXPLANATION

Statement 1 correct: Foreign Currency Convertible Bonds (FCCBs) are bonds issued under the guidelines outlined in the Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depository Receipt Mechanism) Scheme, 1993, with amendments over time.

Statement 2 correct: Issuance of Foreign Currency Convertible Bonds (FCCBs) is permitted through the Automatic Route.

Statement 3 correct correct: Foreign Portfolio Investment (FPI) involves investments by non-residents in the capital instruments of Indian companies, with the distinction between direct and institutional investment based on the percentage of investment made.

Statement 4 incorrect: A Non-Resident External (NRE) account is a rupee-denominated account established by Non-Resident Indians (NRIs) to deposit their foreign currency earnings, but it is not categorized as Foreign Direct Investment (FDI).

Q- With reference to the Indian economy, consider the following statements : (2020)

(1) Commercial Paper is a short-term unsecured promissory note.

(2) Certificate of Deposit is a long-term Instrument issued by RBI to a corporation.

(3) ‘Call Money’ is short-term finance used for interbank transactions.

(4) “Zero-Coupon Bonds’ are the interest-bearing short-term bonds issued by the Scheduled Commercial Banks to corporations.

Which of the statements given above is/are correct?

(a) 1 and 2 only

(b) 4 only

(c) 1 and 3 only

(d) 2, 3 and 4 only

Answer- Option C

EXPLANATION

There are two main types of markets: the money market and the capital market. The money market deals with short-term monetary assets, meeting the short-term needs of borrowers and providing liquidity to lenders. Financial instruments in the money market have a maturity period of up to one year, including Call money, Treasury Bill, Commercial Paper, Deposit Certificates, and Trade bill. Therefore, statement 1 is true and 2 is false.

On the other hand, the capital market deals with medium and long-term funds, with financial assets having a maturity period of more than one year. Long-term financial instruments in the capital market include Equity, Debt, IPOs, and Commodity Markets. Additionally, there is a non-securit market encompassing Mutual Funds, Fixed Deposits, and Saving Deposits.

Regarding additional information, Call money addresses the day-to-day cash needs of banks and is a short-term financial instrument, involving participants such as banks and entities specified by the RBI. Notice money involves loans for 2-14 days to banks and is also a short-term financial instrument. Therefore, statement 3 is correct.

Q- In the context of the Indian economy, non-financial debt includes which of the following? (2020)

(1) Housing loans owed by households

(2) Amounts outstanding on credit cards

(3) Treasury bills

Select the correct answer using the code given below :

(a) 1 only

(b) 1 and 2 only

(c) 3 only

(d) 1, 2 and 3

Answer- Option D

EXPLANATION

Debt financing refers to the practice of borrowing money to be repaid at a future date, typically with interest. It encompasses two main categories of debts: public debt and non-financial debt.
Public debt represents the total amount borrowed by a government and can be further classified into internal public debt and external public debt. Internal public debt pertains to borrowing within the country, while external public debt involves borrowing from foreign entities.
Non-financial debt includes credit instruments issued by government entities, households, and businesses outside the financial sector. Examples of non-financial debts include housing loans, credit card balances, treasury bills, and outstanding credit card balances. Therefore, statements 1, 2, and 3 are all correct.

Q- Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly? (2019)

(a) Certificate of Deposit

(b) Commercial Paper

(c) Promissory Note

(d) Participatory Note

Answer- Option D

EXPLANATION

Participatory Notes (P-Notes) are derivative instruments based on Indian stocks, allowing foreign investors to trade on Indian exchanges without registration. Certificate of Deposit (CDs) are short-term instruments issued by banks and financial institutions, freely transferable and with maturities ranging from 91 days to one year. Commercial Paper (CP) is a short-term debt instrument for up to one year, issued by companies to raise funds. It’s an unsecured promissory note introduced in India in 1990.

Q- What was the purpose of the Inter Creditor Agreement signed by Indian banks and financial institutions recently? (2019)

(a) To lessen the Government of India’s perennial burden of fiscal deficit and current account deficit

(b) To support the infrastructure projects of Central and State Governments

(c) To act as independent regulator in case of applications for loans of Rs. 50 crore or more

(d) To aim at faster resolution of stressed assets of Rs. 50 crore or more which are-under consortium lending

Answer- Option D

EXPLANATION

The objective is to expedite the resolution process for distressed assets valued at Rs 50 crore or more that are part of consortium lending arrangements. The inter-creditor agreement seeks to facilitate the resolution of loan accounts exceeding ₹50 crores that involve multiple lenders.

Q- Which one of the following best describes the term “Merchant Discount Rate” sometimes seen in the news? (2019)

(a) The incentive given by a bank to a merchant for accepting payments through debit cards pertaining to that bank.

( b) The amount paid back by banks to their customers when they use debit cards for financial transactions for purchasing goods or services.

(c) The charge to a merchant by a bank for accepting payments from his customers through the bank’s debit cards.

(d) The incentive given by the Government, to merchants for promoting digital payments by their customers through Point of Sale (PoS) machines and debit cards.

Answer- Option C

EXPLANATION

The merchant discount rate is a charge that merchants need to factor in when managing their business expenses. Both local and online merchants usually have different fee structures and contractual terms.
In order to enable card payments, merchants need to establish this service and consent to the fee. Typically, merchants can anticipate paying a fee ranging from 1% to 3% for processing each transaction. Payment service providers have established systems and fee structures to accommodate various types of merchant transactions.

Q-Consider the following statements: (2018)

(1) The Reserve Bank of India manages and services Government of India Securities but not any State Government Securities.

(2) Treasury bills are issued by the Government of India and there are no treasury bills issued by the State Governments.

(3) Treasury bills offered are issued at a discount from the par value.

Which of the statements given above is/are correct?

(a) 1 and 2 only

(b) 3 Only

(c) 2 and 3 only

(d) 1, 2 and 3

Answer- Option C

EXPLANATION

Government securities (G-Secs) are tradable instruments representing the debt obligations of the central or state governments. The issuance of G-Secs is overseen by the Reserve Bank of India (RBI), which conducts regular auctions on behalf of the central government every Friday. Transactions involving state government securities are facilitated by the RBI as per agreements with the respective state governments.

Treasury bills, on the other hand, are short-term debt instruments exclusively issued by the central government. They play a crucial role in the government’s cash management strategy. As risk-free assets, their yields at various maturities serve as benchmarks for short-term interest rates, influencing the pricing of diverse floating-rate products in the market. Treasury bills are typically issued at a discount and redeemed at face value upon maturity.

Q- With reference to ‘Bitcoins’, sometimes seen in the news, which of the following statements is/are correct? (2013)

(1) Bitcoins are tracked by the Central Banks of the countries.

(2) Anyone with a Bitcoin address can send and receive Bitcoins from anyone else with a Bitcoin address.

(3) Online payments can be sent without either side knowing the identity of the other.

Select the correct answer using the code given below.

(a) 1 and 2 only

(b) 2 and 3 only

(c) 3 only

(d) 1, 2 and 3

Answer- Option B

EXPLANATION

The Bitcoin system operates on a peer-to-peer basis, facilitating transactions directly between users without the need for intermediaries. Contrary to statement 1, this decentralized nature means that transactions are trackable through the blockchain ledger, making it possible for anyone to trace them.
As stated in statement 2, Bitcoin transactions enable users to send funds globally without intermediaries, provided the sender possesses the recipient’s Bitcoin address. Additionally, as mentioned in statement 3, Bitcoin transactions can be conducted anonymously, without disclosing the identities of the parties involved.

Q- What is/are the purpose/purposes of the Government’s ‘Sovereign Gold Bond Scheme’ and ‘Gold Monetization Scheme’? (2016)

(1) To bring the idle gold lying with Indian households into the economy

(2) To promote FDI in the gold and jewellery sector

(3) To reduce India’s dependence on gold imports

Select the correct answer using the code given below.

(a) 1 only

(b) 2 and 3 only

(c) 1 and 3 only

(d) 1, 2 and 3

Answer- Option C

EXPLANATION

The Sovereign Gold Bond Scheme, which was introduced in November 2015 as part of the Gold Monetisation Scheme, offers government securities denominated in grams of gold and is issued by the RBI on behalf of the Government. The objective of the Gold Monetisation Scheme is to mobilize gold held by households and utilize it for productive purposes, aiming to reduce the country’s dependence on imported gold. Thus, statements 1 and 3 accurately reflect the purpose and structure of these schemes. However, it’s important to note that the schemes are not intended to attract Foreign Direct Investment (FDI) in the gold and jewellery sector, making statement 2 incorrect.

Q- With reference to `IFC Masala Bonds’, sometimes seen in the news, which of the statements given below is/are correct? (2016)

(1) The International Finance Corporation, which offers these bonds, is an arm of the World Bank.

(2) They are the rupee-denominated bonds and are a source of debt financing for the public and private sector.

Select the correct answer using the code given below.

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2

Answer- Option C

EXPLANATION

The World Bank Group (WBG) comprises five entities, namely the International Bank for Reconstruction and Development (IBRD), the International Development Association (IDA), the International Finance Corporation (IFC), the Multilateral Investment Guarantee Agency (MIGA), and the International Centre for Settlement of Investment Disputes (ICSID). This aligns with statement 1.

IFC initiated the issuance of Masala bonds in 2014 to fund infrastructure projects in India. These bonds are denominated in rupees and are offered to offshore investors, serving as a debt financing source for both public and private sectors. Therefore, statement 2 is also accurate.

Q- Recently, which one of the following currencies has been proposed to be added to the basket of the IMF’s SDR? (2016)

(a) Rouble

(b) Rand

(c) Indian Rupee

(d) Renminbi

Answer- Option D

EXPLANATION

The Special Drawing Right (SDR) is an international reserve asset introduced by the IMF in 1969 to bolster global liquidity. It serves as a supplementary reserve asset for IMF member countries and is not considered a currency or a direct claim on the IMF. The composition of the SDR basket includes currencies that are freely usable, widely used, and widely traded. Initially consisting of four currencies—the U.S. dollar, the euro, the British pound, and the Japanese yen—the SDR basket was expanded in 2016 to include the Chinese renminbi (RMB) following the IMF’s regular review. Currently, the SDR basket comprises five currencies—the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling.

Q- Which of the following best describes the term ‘import cover’, sometimes seen in the news? (2016)

(a) It is the ratio of value of imports to the Gross Domestic Product of a country

(b) It is the total value of imports of a country in a year

(c) It is the ratio between the value of exports and that of imports between two countries

(d) It is the number of months of imports that could be paid for by a country’s international reserves

Answer- Option D

EXPLANATION

Import cover is a metric used to gauge a country’s ability to pay for its imports using its international reserves over a certain period. This indicator is crucial for assessing currency stability, with a recommended minimum of eight to ten months of import cover considered essential. Maintaining adequate import cover helps prevent balance of payments (BoP) crises by enabling timely preventive measures.

Q- If the interest rate is decreased in an economy, it will (2014)

(a) decrease the consumption expenditure in the economy

(b) increase the tax collection of the Government

(c) increase the investment expenditure in the economy

(d) increase the total savings in the economy

Answer- Option 3

EXPLANATION

When interest rates decline, individuals may choose not to deposit their money in banks due to lower returns, thus eliminating option 4. Instead, they tend to inject cash into the economy by either investing in productive ventures or increasing day-to-day spending, eliminating option 1.
Therefore, when interest rates decrease in an economy, it typically stimulates investment expenditure as capital becomes more readily available for investments, validating option 3.
This relationship between interest rates and investment expenditure is depicted by the investment curve, which exhibits a downward slope indicating that a decrease in interest rates leads to an increase in investment spending.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.