Credit

Management

CREDIT MANAGEMENT

CreditManagement

CreditManagement

Project ON

MBA (Banking & Finance) 3rd Term, Session 2009-2011

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Class Roll NumberExam Roll Number

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Romana NargusA-1462

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Rida Farooq KhanB-3467

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Sehrish JabeenA-2452

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Asma Sadia GulB-4451

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We declare that this project report entitled “Financing Methodologies” is

original and bonafide work of our own in the partial fulfillment of the

requirements for the award of the Degree of MASTER OF BUSINESS

ADMINISTRATION (Banking & Finance) and submitted to the Department

of Business Administration, Gomal University Dera Ismail Khan,

Khyber.Pakhton.Khwa.

The data that has been collected by us is truly authentic and contains true and

complete information.

Romana NargusRida farooq KhanSehrish jabeenAsma Sadia Gull

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All praise to ALLAH, the most merciful, kind and beneficent, and the source of all knowledge, wisdom within and beyond our

comprehension. He is the only God, who can help us in every field of life. All respect and possible tributes goes to our Holy

Prophet Mohammad (SAW), who is forever guidance and knowledge for all human beings on this earth.

We are proud to say that we are very grateful to our families whose kind prayers and cooperation helped us at every step of our work. Special

thanks go to our formative Teacher’s for their cooperation for the sake of our knowledge.

Romana NargusRida FarooqSehrish JabeenSadia Gul M.B.A (B/F), 2009-2011

b r i e f

BRIEF c o n t e n t s

CONTENTSWhat is financing 2Why financing 2What is the financial system 2Flow of funds through financial

system

3

Classification of the financial system 3Financing methodologies 4Direct financing 4Debt and equity market 4Primary markets 5Secondary markets 5Money markets 5Capital markets 6Indirect financing 7Depository institution 7Commercial banks 7Saving & Loan Associations 8Mutual saving banks 8Credit unions 8Contractual saving institution 8Life Insuring companies 8Fire & casualty insurance companies 8Pensions funds, Govt retirements funds 8Investment intermediaries 8Financial Companies 8Mutual Funds 9Direct versus indirect financing 9References 9

WHAT IS FINANCING?

The act of providing funds for business activities, making purchases or investing. Financial

institutions and banks are in the business of financing as they provide capital to businesses,

consumers and investors to help them achieve their goals.

WHY FINANCING?

pg. 1

– Obvious? Not necessarily.

– Integral part of the plan for the business (and “Business Plan”).

– Varies by type of business.

WHAT IS THE FINANCIAL SYSTEM?

• “In finance, the financial system is the system that allows the transfer of money between

savers and borrowers. It comprises a set of complex and closely interconnected financial

institutions, markets, instruments, services, practices, and transactions.”

• The financial system consists of the group of institutions in the economy that helps to

match one person’s saving with another person’s investment.

• The financial system is made up of financial institutions that coordinate the actions of

savers and borrowers.

• Financial system refers to a set of activities, which facilitate transfer of resources from

savers to borrowers. This system provides for regular, smooth, efficient and cost effective

linkage between depositors and investors.

• The financial system allocates funds from surplus units to deficit units.

A Surplus Unit is any party whose income over a period exceeds its outlays.

A Deficit Unit is any party whose income over a period is less then its outlays.

FLOW OF FUNDS THROUGH FINANCIAL SYSTEM

pg. 2

CLASSIFICATION OF FINANCIAL SYSTEM

• Financial Market

• Financial Institutions

• Financial Instruments

pg. 3

FINANCING METHODOLOGIES

There are two types of financing…

1- DIRECT FINANCING

Raising funds from financial markets involve the issue of securities. Direct financing

mainly occur in capital markets

The borrower goes directly to the investor to borrow funds.

The direct exchange of money and financial claims between individuals with excess

funds and individuals with a shortage of funds.

The participant with a deficit issues a financial claim (a bond for example) purchased by

the participant with a surplus of funds.

Direct Financing

OR

DIRECT FINANCING

The borrower borrow funds directly from lenders in financial markets by selling them securities,

also called (financial instruments) which are claims on he borrowers future income or assets.

Securities are assets for the person who buys then but liabilities (IOU or debt) for the individual

or firm that sells (issues) them.

DEBT & EQUITY MARKET

The firm or an individual can obtain funds on financial markets in two ways. the most common

method is to issue a debt instruments, such as a bond, or a mortgage which is contractual

agreement by the borrower to pay the holder of the instrument fixed amount at regular intervals

(interest & principal payments) until a specified date (Maturity Date) when financial payment is

made that instruments expiration date.

pg. 4

Supply Funds

RepaymentObligation

Arranged By the BANKs BorrowersLeander’s

The debt instruments are short-term if maturity is less then a year and log-term if its maturity is

ten years or longer. Debt instruments with a maturity b/w one and 10 years are said to b

intermediate-term.

Second method of raising funds is by issuing equities, such as common stock, which are claims

to share in the net income (income after expenses & taxes) and the assets of the business.

Equity often make periodic payment (dividend)to their holders are consider long-term securities

because they have no maturity date, in addition owning stock mean that you own a portion of

the firm and they have a right to vote on issue important to the firm and to elect its director.

PRIMARY MARKETS

It is a financial market in which new issue of a security such as corporation or Government

agencies borrowing the funds. The primary markets is the investment bank it does this by

underwriting securities, it grantee a pries for a corporations securities and then sells them then to

the public.

SECONDARY MARKETS

It is a financial institutions in which securities that have been previously issued (and are thus

second hand) can be resold. The KSE is the best example of secondary market, Securities

brokers and dealers are crucial to well functioning secondary markets.

Broker is the agents of investor who match buyers with sellers of securities.

Dealer link buyers and seller by buying and selling securities at stated prices.

Secondary markets can be organized two ways….

One is organize exchange where buyers and seller of the securities (or their agents or

brokers) meet in one central location to conduct trades (Stock exchange for stock and the

commodities, wheat, corn, cotton, silver, and other raw material) are examples of

organized exchanges.

Second method of organizing secondary markets is to have an over-the-counter (OTC)

market, in which dealers at different location have inventory of securities and stand ready

to buy and sell securities “OTC” to any who comes to them and is willing to accept their

prices b/c OTC dealer are computer contact and know the prices set by one other it is

very competitive market.

MONEY MARKET

It is financial market in which only short-term debt instruments (original maturity of less then 1

year) are traded.

pg. 5

CAPITAL MARKET

It is the financial market in which long-term debts(original maturity of 1 year or grater) and

equity instruments are traded.

2- INDIRECT FINANCING

The alternative process to direct financing is intermediation. This occurs when financial

institution acts as the borrower to surplus units and the lender to deficit units. The process

creates two set of assets and liabilities. Intermediary’s deposits are both its liabilities and

the assets of the lenders.

An intermediary transforms assets acquired through the market into a more widely

preferred asset (which becomes their liability).

The intermediary is then holding a direct claim in terms of their assets. The participants

holding the claims issued by the intermediary are said to have an indirect claim.

EXAMPLES

• Commercial Bank: Accept Deposits and uses the cash to make loans to other participants

(both households and businesses)

• Mutual Fund Firm: Pooling Funds of individuals and uses them to buy a portfolio of

securities.

Indirect Financing

OR

pg. 6

Supply FundsSupply Funds

RepaymentObligation

RepaymentObligation

Financial Intermediary BorrowersLeander’s

INDIRECT FINANCING

Funds moves from lender to borrower by a second route called indirect financing because it

involves a financial intermediary that stands b/w the lender-sever and the borrower-spender and

help transfer funds one to the other. For example A bank might acquire funds by the issuing a

liability in the form of saving deposit (an assets for the public).it might then use the funds to

acquire on assets by making a loan to Toyota Motors or buying a TM bond in the financial

markets the ultimate result is that funds have been transferred from public (lender-sever) to TM

(the borrower-spender) with the help of financial intermediaries(bank).the process of indirect

financing using financial intermediaries called financial intermediaries.

Primary assets and Liabilities of Financial Intermediaries

Type of Intermediary Primary Liabilities (Sources of Funds)

Primary Assets (Uses of Funds)

1-Depository Institutions (Bank)Commercial banks Deposit Business & consumer loans,

mortgages PAK Govt: securities & municipal bonds

Saving & Loan Associations Deposit mortgagesMutual Saving banks Deposit mortgagesCredit Unions Deposit Consumer loans

2-Contractual Saving InstitutionsLife Insuring Companies Premiums from Policies Corporate bonds & mortgages Fire & Casualty insurance companies

Premiums from Policies Municipal Bonds, corporate bonds & Stock, Govt: Securities

Pensions funds, Govt retirements Funds

Employer & employee Contributions

Corporate bonds & Stock

3-Investment IntermediariesFinancial Companies Commercial Papers, Stocks, Consumer & Business LoansMutual Funds Shares Stocks, BondsMoney Market Shares Money Market Instruments

1- DEPOSITORY INSTITUTIONS (BANK)

Accept deposits from individual and institutions and make loans. These include commercial

banks, saving and loan association, mutual saving banks and credit unions.

Commercial Banks: These financial institution raise funds primarily by issuing checkable

deposit (which cheek can be written), saving deposits (deposit that are payable on demand but do

not allow their owner to write cheek) and time deposit (deposits with fixed terms to maturity)

pg. 7

Saving & loan association/Mutual saving banks: These depository institutions obtain funds

primary through saving deposits (shares) and times and checkable deposits.

Credit Unions: These depository institutions very small corporate any institutions organized

around a particular group, union members, employees of a particular firm.

2- CONTRACTUAL SAVING INSTITUTIONS

Such as financial insurance companies, and pension funds are financial intermediaries that

acquire funds at periodic intervals on a contractual basis. i.e they tend to invest their funds

primarily in long0term securities such as corporate bond, stock and mortgage.

Life insurance companies: It insure peoples against financial hazards following a death and sell

annuities (annual income payments upon retirement).the acquire funds from the premiums that

people pay to keep their polices in force and use them mainly to buy corporate bonds and

mortgage.

Types of Annuities

• Fixed annuity: A financial instrument, typically issued by an insurance company that

pays regular, constant installments to the owner beginning at a specific future date.

• Variable annuity: A financial instrument, typically issued by an insurance company, that

beginning on a specific future date pays the owner a stream of returns that depends on the

value of an underlying portfolio of assets.

Fire & Casualty insurance companies: The companies insure their polices holders against loss

from theft, fire and accidents, they are very much like life insurance companies, recovery funds

through premiums fir their policies, but they have a greater probability of loss of funds if major

disasters occurs.

Pensions funds, Govt retirements Funds: Pension funds and state and local government

retirement funds provide retirement income in the form of annuities to employees who are

covered by a pension plan. Funds are acquired by contributions from employees or from

employers, or either have automatically deducted from their paychecks or contribute voluntary.

3- INVESTMENT INTERMEDIARIES

This category of financial institution includes…

Financial Companies: They raised funds by selling commercial papers(short-term debt

instruments) and by issuing stock and bonds, the land those funds to consumer, who make

purchase of such items as furniture, automobiles, and home investment, and to small business,

some finance companies are organized by a prevent corporation to help sell its products. For

example Motor credit companies make loans to consumer also purchase automobiles.

pg. 8

Mutual Funds: The financial institutions acquires funds by selling shares to many individuals

and use the proceeds to purchase diversified portfolios of stock and bonds, mutual funds allow

pool their recourse so that they can take advantage of transaction costs where buying large

blokes of stock or bonds.

Money Market: These relatively new financial institutions have the depository institutions

because they offer deposit type events, like most of mutual funds, they sell shares to acquires

funds that are the used to buying money market instruments that are both safe and very liquid,

the interest ate theses assets is then paid out to the shareholder.

DIRECT VERSUS INDIRECT FINANCING

• Direct: Savers and borrowers link directly• Indirect: An intermediary channels funds from saves to borrowers.

Text References

∗ Financial Markets and Institutions 5th Edition by Frederic S.Mushkin,Stanley G.Eakins.

Web References

www.google.com

www.docstoc.com

pg. 9