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Amity CampusUttar PradeshIndia 201303
ASSIGNMENTSPROGRAM: BFIA
SEMESTER-II
Subject Name: MANAGEMENT OF FINANCIAL SERVICES
Study COUNTRY: SOMALIARoll Number (Reg. No.):
BFIA01512010-2013019
Student Name: MOHAMED ABDULLAHI KHALAF
INSTRUCTIONS
a) Students are required to submit all three assignment sets.ASSIGNMENT DETAILS MARKSAssignment A Five Subjective Questions 10Assignment B Three Subjective Questions + Case Study 10Assignment C Objective or one line Questions 10b) Total weight-age given to these assignments is 30%. OR 30 Marks
c) All assignments are to be completed as typed in word/pdf.
d) All questions are required to be attempted.
e) All the three assignments are to be completed by due dates and need to be submitted for evaluation by Amity University.
f) The students have to attach a scanned signature in the form.
Signature : _________________________
Date: 23 April, 2013
( √ ) Tick mark in front of the assignments submitted
Assignment A’ Ö Assignment ‘B’ Ö Assignment ‘C’ Ö
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Management of Financial Services
Assignment A
Q: 1).“Factoring provides resources to finance receivables and facilitates their collection.” Explain.
Answer:
Receivables constitute a significant portion of current assets of any firm. But, for investment in receivables, a firm has to incur certain costs such as costs of financing receivables and costs of collection from receivables. Furthermore, there is a risk of bad debts also. It is, therefore, very essential to have a proper control and management of receivables. In fact, maintaining of receivables poses two types of problems; (i) the problem of raising funds to finance the receivables, and (ii) the problems relating to collection, delays and defaults of the receivables. A small firm may handle the problem of receivables management of its own, but it may not be possible for a large firm to do as efficiently as it may be exposed to the risk of more and more bad debts. In such a case, a firm may avail the services of specialized institutions engaged in receivables management, called factoring firms.
Factoring may be defined as the relationship created by an agreement between the seller of goods/services and a financial institution called the factor, whereby the later purchases the receivables of the former and also controls and administers the receivables of the former. It is a continuous relationship between financial institution (the factor) and a business concern selling goods and/or providing service (the client) to a trade customer on an open account basis, whereby the factor purchases the client’s book debts (account receivables) with or without recourse to the client - thereby controlling the credit extended to the customer and also undertaking to administer the sales ledgers relevant to the transaction.
The term “factoring” has been defined in various countries in different ways due to non-availability of any uniform codified law. It can be defined as an arrangement in which receivables arising out of sale of goods/ services are sold to the factor as a result of which the title to the goods/services represented by the said receivables passes on to the factor. Hence the factor becomes responsible for all credit control, sales accounting and debt collection from the buyer (s).
“Factoring means arrangement between a factor and his client which includes at least two of the following services to be provided by the factor:
o Finance o Maintenance of accounts o Collection of debts o Protection against credit risks.
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Factoring provides resources to finance receivables as well as facilitates the collection of receivables. Factoring involves the outright sale of receivables at a discount to a factor to obtain funds. Factoring can broadly be defined as an agreement in which receivables arising out of sale of goods or services are sold by a firm to the 'factor' as a result of which the title of the goods or services represented by the said receivables passes on to the factor. From then on, the factor becomes responsible for all credit control, sales accounting and debt collection from the buyers. In other words, factoring paves the way by which receivables can be used for financing.
The factor helps the client in adopting better credit control policy. The main functions of a factor is to collect the receivables on behalf of the client and to relieve him from all the botherations/problems associated with the collection. This way the client can concentrate on other major areas of his business on one hand and reduce the cost of collection by way of savings in labor, time and efforts on the other hand. The factor possesses trained and experienced personnel, sophisticated infrastructure and improved technology which helps him to make timely demands on the debtors to make payments.
Functions of a Factor:
o Financing facility/trade debts: The main function of a factor is the purchase of accounts receivables from his client at a price. The receivables then are assigned to the factor and he grants advances based on the receivables. Where the debts are factored with recourse, the finance provided would become refundable by the client in case of non-payment of the buyer. However, where the debts are factored without recourse, the factor’s obligation to the seller becomes absolute on the date of the invoice whether or not the buyer makes the payment.o Maintenance and administration of sales ledger: Another function of a factor includes maintenance of the client’s sales ledger. Once a sale transaction is done, the invoice is sent to the buyer of the goods and a copy to the factor. Each receipt is matched with the specific invoice and thus on any date the ledger gives information about the specific invoices that are outstanding and the ones that are settled. Thus the ledger is maintained by the factor under the open item method. Periodically the factor also performs the function of sending reports to their customers regarding the status of the ledgers.
o Providing collection facility: The collection problems of the customers are solved due to the existence of the factor. The factor undertakes the collection responsibility and employs his manpower and time to collect the receivables payment. Thus he saves the valuable time of his customer who can concentrate more on his main work of sales. The factor uses sophisticated infrastructural back-up and this makes him efficient to collect the receivables in time and even for the payer, it is a credit issue for him if he fails to meet the settlement date.
o Control and restriction of credit and assumption of credit risk: One of the important functions of a factor is the assumption of credit risk, especially when the receivables are factored without recourse. The factor fixes the credit limit for the approved customers in consultation with his clients. He undertakes to purchase all the receivables of those customers within this fixed limit and he assumes the risk
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of default in payment by the customer. Thus the client of the factor is benefitted in two ways: factoring relieves the client of his collection work and he provides information on the credit worthiness of each individual customer of the client so that he can exercise better credit control hence forth.
o Providing Advisory Services: The factor provides a variety of incidental advisory services to their clients like:
a) What is the perception of the client's products?
b) What are the changes in the marketing strategies and what are the emerging trends?
c) Audit of the procedures followed for invoicing, delivery and dealing with sales returns.
d) Introduction to the credit department of a bank or subsidiaries of banks engaged in leasing, hire-purchase and merchant banking.
Q: 2).“Investment in Mutual fund is indirect in nature”. Examine it in the light of features of mutual funds.
Answer:
Investment in Mutual fund is indirect in nature, the term itself gives some hint about its nature. “Mutual” means combined and “Funds” means money. So, mutual funds are the collective investment contributed by many investors and managed by professional individual or company (your fund manager). The fund manager invests this combined money in stocks, bonds, short-term money market instruments, and/or other securities.
Unlike most other financial products like provident fund, insurance and post office schemes, Top Mutual Funds not only provides convenience while investing money, but it also offers a variety of features that benefit investors. A few of most common features and benefits of top mutual funds are highlighted.
Micro SIP/Chota SIP
Top Mutual Fund Companies offer its investors an option to invest extremely small amounts such as Rs 100/-, Rs 500/-, Rs 1000/- each month depending on individual’s capacity into many of its mutual fund schemes. This is for Daily Wage Workers, Rickshaw Taxi Drivers, Labourers who wish to invest into Mutual Funds.
Flexibility of Dates
Investor can invest in top Mutual Fund Scheme on their choice of dates. Many large Mutual Fund companies offer multiple dates for investing into its top performing mutual fund schemes. E.g few dates would be 1st, 5th, 10th, 15th, and 25th of each month. This makes regular investments on salary dates possible.
Timely Payments through ECS
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Investors in Mutual Funds need not worry about making timely payments each month through opting for ECS Payment Method. This ensures regular, hassle free, timely and correct monthly payments. This feature is useful for people who are busy or travel a lot, as he does not have time to keep track of his monthly payments.
Investing Through POA (Power of Attorney)
Investments in Mutual Funds can be done through Assignment of a Power of Attorney for effective financial planning. Army Personnel, Officers posted on-duty at far off places, owners/directors of limited companies, Non-Resident Indians, Resident Indian posted onsite/outside India can invest through the convenience of POA.
Top-up Facility for Mutual Funds
Apart from regular payments investors can also invest via top-up facility. The amount of SIP can be increased at fixed intervals. The Top-up amount has to be in multiples of Rs 500/- depending upon fund. The frequency is fixed at Yearly and Half-Yearly Basis.
Direct Credit of Dividend Payments
Asset Management Companies offer direct credit of dividend payment proceeds to investor’s bank accounts in order to ensure faster processing and timely credits of dividend amount.
Direct Credit of Redemption Payments
When a mutual fund is sold the money is directly credited to investor’s bank account to facilitate quick withdrawal of funds.
Trigger/SWP/AEP Plans
In case price of investment goes up, investors can set automatic triggers to sell or transfer the portion of the increased value. This is to ensure that the profits are booked from increased valuation on their Mutual Fund Investment. E.g Trigger can be set to Sell/Transfer if the NAV appreciates by 12%, 20%, 50% and 100%.
Register Multiple Bank Accounts
As a Mutual Fund investor you can register up to 5 different bank accounts in your portfolio. So in case if you have to close or transfer any one of the accounts the other can be utilized.
Q: 3).What do you mean by Merchant banking? Explain various services that comes under the ambit of merchant banking.
Answer:
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A merchant bank is a financial institution which provides capital to companies in the form of share ownership instead of loans. A merchant bank also provides advisory on corporate matters to the firms they lend to. In the United Kingdom, the term "merchant bank" refers to an investment bank.
A merchant banker is a financial intermediary who helps to transfer capital from those who possess it to those who need it. Merchant banking includes a wide range of activities such as management of customer securities, portfolio management, project counseling and appraisal, underwriting of shares and debentures, loan syndication, acting as banker for the refund orders, handling interest and dividend warrants etc. Thus, a merchant banker renders a host of services to corporate, and thus promote industrial development in the country.
Merchant banking may be defined as an institution which covers a wide range of activities such as underwriting of shares, portfolio management, project counseling, insurance etc. They render all these services for a fee.
The merchant bankers as sponsors of capital issues is reflected in their major services/functions such as, determining the composition of the capital structure (type of securities to be issued), draft of prospectus (offer documents) and application forms, compliance with procedural formalities, appointment of registrars to deal with the share application & transfers, listing of securities, arrangement of underwriting/sub-underwriting, placing of issues, selection of brokers & bankers to the issue, publicity & advertising agents, printers, and so on.
Registration
SEBI (Merchant Bankers) Regulation Act, 1992 defines a “Merchant Banker” as any person who is engaged in the business of issue management either by making agreements regarding selling, buying or subscribing to securities or acting as manager, consultant, advisor or rendering corporate advisory service in relation to such issue management.
At present no organization can act as a “Merchant Banker” without obtaining a certificate of registration from the SEBI. However, it must be noted that a person/organization has to get him registered under these regulations if he wants to carry on or undertake any of the authorized activities, i.e., issue management assignment as manager, consultant, advisor, underwriter or portfolio manager. To obtain the certificate of registration, one had to apply in the prescribed form and fulfill two sets of norms
a) Operational capabilities b) Capital adequacy norms
Compulsory Registration
Merchant bankers require compulsory registration with the SEBI to carry out their activities. Earlier they fell under four categories.
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Classification of Merchant Bankers
Category I Merchant Bankers. These merchant bankers can act as issue manager, advisor, consultant, underwriter & portfolio manager.
Category II merchant Bankers. Such merchant bankers can act as advisor, consultant, underwriter & portfolio manager. They cannot act as issue manager of their own but can act co-manager.
Category II Merchant Bankers. They are allowed to act as advisor, consultant & underwriter only. They can neither undertake issue management of their own nor do they act as co-manager. They cannot undertake the activities of portfolio management also.
Category IV Merchant Bankers. A category IV Merchant Banker can merely act as consultant or advisor to an issue of capital.
Q: 4).Elaborate the present Indian financial services sector with their role in economic development.
Answer:
The Indian financial services industry has undergone a metamorphosis since 1990. During the late seventies & eighties, the Indian financial services industry was dominated by commercial banks and other financial institution which cater to the requirements of the Indian industry. The economic liberalization has brought in a complete transformation in the Indian financial services industry.
The term “Financial Services” in a broad sense means “mobilizing and allocating savings”. Thus it includes all activities involved in the transformation of savings into investment. The ‘financial service’ can also be called ‘financial intermediation’. Financial intermediation is a process by which funds are mobilized from a large number of savers and make them available to all those who are in need of it and particularly to corporate customers. Thus, financial service sector is a key area and it is very vital for industrial developments. A well-developed financial services industry is absolutely necessary to mobilize the savings and to allocate them to various investable channels and thereby to promote industrial development in a country. Financial services, through network of elements such as financial institution, financial markets and financial instruments, serve the needs of individuals, institutions and corporate. It is through these elements that the functioning of the financial system is facilitated. Considering its nature and importance, financial services are regarded as the fourth element of the financial system.
FEATURES OF FINANCIAL SERVICE
Customer-Oriented: Like any other service industry financial service industry is also a customer-oriented one. That customer is the king and his requirements must be satisfied in full should be the basic tenant of any financial service industry.
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It calls for designing innovative financial products suitable to varied risk-return requirements of customer. Intangibility: Financial services are intangible and therefore, they cannot be standardized or reproduced in the same form. Hence, there is a need to have a track record of integrity, reputation, good corporate image and timely delivery of services. Simultaneous Performance: Yet another feature is that both production and supply of financial services have to be performed simultaneously. Therefore, both suppliers of services and consumers should have a good rapport, clear-cut perception and effective communication. Dominance of Human Element: Financial services are dominated by human element and thus, they are people-intensive. It calls for competent and skilled personnel to market the quality financial products. But, quality cannot be homogenized since it varies with time, place and customer to customer. Perishability: Financial services are immediately consumed and hence inventories cannot be created. There is a greater need for balancing demand and supply properly. In other words, marketing and operations should be closely inter-linked.
IMPORTANCE OF FINANCIAL SERVICES
Economic Growth: The financial service industry mobilizes the savings of the people and channels them into productive investment by providing various services to the people. In fact, the economic development of a nation depends upon these savings and investment. Promotion of Savings: The financial service industry promotes savings in the country by providing transformation services. It provides liability, asset and size transformation service by providing large loans on the basis of numerous small deposits. It also provides maturity transformation services by offering short-term claim to savers on their liquid deposit and providing long-term loans to borrowers. Capital Formation: The financial service industry facilitates capital formation by rendering various capital market intermediary services – capital formation in the very basis for economic growth. It is the principal mobilizer, of surplus funds to finance productive activities and thus it promotes capital accumulation. Provision of Liquidity: The financial service industry promotes liquidity in the system by allocating and reallocating savings and investment into various avenues of economic activity. It facilitates easy conversion of financial asset into liquid cash at the discretion of the holder of such assets. Financial Intermediation: The financial service industry facilitates the function of intermediation between savers and investors by providing a means and a medium of exchange and by undertaking innumerable services. Contribution to GNP: The contribution of financial services to GNP has been going on increasing year after year in almost all countries in recent times. Creation of Employment Opportunities: The financial service industry creates and provides employment opportunities to millions of people all over the world.
SOURCES OF REVENUE
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Accordingly, there are two categories of sources of income for a financial service company namely: fund based &fee- based. Fund-based income comes mainly from interest spread, lease rentals, income from investments in capital market and real estate. On the other hand, fee based income has its sources in merchant banking, advisory services, custodial services, loan syndication etc. income has its sources in merchant banking, advisory services, custodial services, loan syndication etc. A major part of income is earned through fund-based activities. At the same time, it involves a large share of expenditure in the form of interest & brokerage. It means that such companies should have to compromise the quality of its investment. On the other hand fee-based income does not involve much risk.
CLASSIFICATION OF FINANCIAL SERVICES
OBJECTIVES OF FINANCIAL SERVICES
Fund raising: Financial services help to raise the required funds from a host of investors, individuals, institution and corporate. For this purpose, various instruments of finance are used. Funds deployment: An array of financial services is available in the financial markets which help the players to ensure an effective deployment of funds raised. Services such as bill discounting, parking of short-term funds in the money market, credit rating &securitization of debts are provided by financial services firms in order to ensure efficient management of funds. Specialized services: The financial service sector provides specialized services such as credit rating, venture capital financing, lease financing, mutual funds, credit cards, housing finance, etc. besides banking and insurance. Institutions and agencies such as stock exchanges, non-banking finance companies, and subsidiaries of financial institutions, banks & insurance companies also provide these services.
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1 .Issue Management
2 .Portfolio Management
3 .Capital Restructuring
4 .Loan Syndication
5 .Merger & Acquisition
6 .Corporate Counseling
7 .Foreign Collaborations
Fund-based Activities Fee-based Activities
Regulation: There are agencies that are involved in the regulation of the financial services activities. In India, agencies such as the Securities and Exchange Board of India (SEBI), Reserve Bank of India (RBI) and the Department of Banking and Insurance of the Government of India, regulate the functioning of the financial service institutions. Economic growth: Financial services contribute, in good measure, to speeding up the process of economic growth & development.
CAUSES OF FINANCIAL INNOVATION
Financial intermediaries have to perform the task of financial innovation to meet the dynamically changing needs of the economy. There is a dire necessity for the financial intermediaries to go for innovation due to following reasons:
Low profitability: The profitability of the major financial intermediary, namely banks has been very much affected in recent times. There is a decline in the profitability of traditional banking products. So, they have compelled to seek out new products which may fetch high returns. Keen competition: The entry of many financial intermediaries in the financial sector market has led to severe competition among themselves. This keen competition has paved the way for the entry of varied nature of innovative financial products so as to meet the varied requirements of the investors. Economic liberalization: Reform of the financial sector constitutes the most important component of India’s programme towards economic liberalization. The recent economic liberalization measures have opened the door to foreign competitors to enter into our domestic market. Deregulation in the form of elimination of exchange controls and interest rate ceilings have made the market more competitive. Innovation has become a must for survival. Improved communication technology: The communication technology has become so advanced that even the world’s issuers can be linked with the investors in the global financial market without any difficulty by means of offering so many options and opportunities. Hence, innovative products are brought into the domestic market in no time. Customer service: Nowadays, the customer’s expectations are very great. They want newer products at lower cost or at lower credit risk to replace the existing ones. To meet this increased customer sophistication, the financial intermediaries are constantly undertaking research in order to invent a new product which may suit to the requirement of the investing public. Innovations thus help them in soliciting new business. Global impact: Many of the providers and users of capital have changed their roles all over the world. Financial intermediaries have come out of their traditional approach and they are ready to assume more credit risks. As a consequence, many innovations have taken place in the global financial sector which has its own impact on the domestic sector also. Investor awareness: With a growing awareness amongst the investing public, there has been a distinct shift from investing the savings in physical assets like gold, silver, land etc. to financial assets like shares, debentures, mutual funds etc. To meet the growing awareness of the public, innovation has become the need of the hour.
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PRESENT SCENARIO OF FINANCIAL SERVICES
Conservatism to dynamism: At present, the financial system in India is in a process of rapid transformation, particularly after the introduction of reforms in the financial sector. The main objective of the financial sector reforms is to promote an efficient, competitive and diversified financial system in the country. This is essential to raise the allocative efficiency of available savings and to promote the accelerated growth of the economy as a whole. The emergence of various financial institution and regulatory bodies has transformed the financial services sector from being a conservative industry to a very dynamic one. Emergence of Primary Equity Market: The capital markets have become a popular source of raising finance. The aggregate funds raised by the industries have gone from Rs. 5976 crore in 1991-92 to Rs. 32382 crore in 2006-07. Thus the primary market has emerged as an important vehicle to channelize the savings of the individuals and corporates for productive purposes and thus to promote the industrial & economic growth of our nation. Concept of Credit Rating: The investment decisions of the investors have been based on factors like name recognition of the company, reputation of promoters etc. now, grading from an independent agency would help the investor in his portfolio management and thus, equity grading is going to play a significant role in investment decision making.
Now it is mandatory for non-banking financial companies to get credit rating for their debt instruments. The major credit rating agencies functioning in India are:
i. Credit Rating Information Services of India Ltd.ii. Credit Analysis and Research Ltd.iii. Investment Information and Credit Rating Agency.iv. Duff Phelps Credit Rating Pvt. Ltd.
Process of Globalization: The process of globalization has paved the way for the entry of innovative financial products into our country. The government is very keen in removing all obstacles that stand in the way of inflow of foreign capital. India is likely to enter the full convertibility era soon. Hence, there is every possibility of introduction of more and more innovative financial services in our country. Process of Liberalization: The government of India has initiated many steps to reform the financial services industry. The Government has already switched over to free pricing of issues from pricing issues by the Controller of capital issues. The interest rates have been deregulated. The private sector has been permitted to participate in banking and mutual funds and the public sector undertakings are being privatized. The financial service industry in India has to play a positive and dynamic role in the years5 India has to play a positive and dynamic role in the years to come by offering many innovative products to suit to the varied requirements of the millions of prospective investors spread throughout the country.
Q: 5).Differentiate between factoring and forfeiting services & comment over emerging trends of other financial services.
Answer:
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Factoring and forfeiting are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers.
The differences between factoring and forfeiting include:
o Factoring is for transactions of short-term maturities not exceeding six months. It is more related to receivables against commodity sales while forfeiting is usually for international credit transactions of long-term maturity periods ranging between 90 days up to 5 years.
o Factoring can be with resource or without resource depending on the terms of transaction between the seller and the factor, but forfaiting is 100 per cent financing without resource to the exporter.
o The cost (charge) of factoring is usually borne by the seller, while in forfaiting the cost consists of three elements: discount rate, commitment fees and handling fees which are ultimately borne by the importer.
o In factoring, the factor handles the entire sales ledger at a predetermined price. Factoring requires the assignment of whole turnover with a buyer on a continuous basis. Factoring is a continuous and revolving facility. Under forfaiting, the complete sales ledger of the exporter is not handled by the forfaiter. Forfaiting, structuring, and costing is tailor-made and a case-to-case basis.
o The fundamental difference between factoring and forfaiting is the difference in the risk profiles of the receivables, which has implications for the cost of services.
o In international factoring, there is two factor systems: the export factor and the import factor with no bank involved in the transaction, while in forfaiting, there is a forfaiter and a bank involved in the transaction.
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Assignment B
Q: 1).“Venture Capital funds provide finance to venture capital undertakings through modes/instruments.” Describe these instruments in detail. What are the alternatives available to a venture capitalist to exit from an invested company? Discuss.
Answer:
Venture Capital has emerged as a new financial method of financing during the 20th century. Venture capital is the capital provided by firms of professionals who invest alongside management in young, rapidly growing or changing companies that have the potential for high growth. Venture capital is a form of equity financing especially designed for funding high risk and high reward projects.
The venture capital funds provide finance to venture capital undertakings through different modes/instruments which are traditionally divided into two types: (i) Equity and (ii) debt instruments. Investment is also made partly by way of equity and partly as debt. The venture capital funds select the instrument of finance taking into account the stage of financing, the degree of risk involved and the nature of finance required. These instruments are detailed below:
1) Equity Instruments: Equity instruments are ownership instruments and bestow the right of the owner on the investor/Venture Capital Funds. They are:
i) Ordinary Shares on which no dividend is assured. Non-Voting equity shares may also be issued, which carry a little higher dividend, but no voting rights are enjoyed by the investors. There may be different variants of equity shares also, e.g. deferred equity shares on which the ordinary shares rights are deferred till a certain period or happening of an event. Moreover, preferred ordinary shares carry an additional fixed income.ii) Preference Shares carry an assured dividend at a specified rate. Preference shares may be cumulative/non-cumulative, participating preference shares which provide for an additional dividend, after payment of dividend to equity shareholders. Convertible preference shares are exchangeable with the equity shares after a specified period of time.
Thus, the venture capital fund can select the instrument with flexibility.
2) Debt Instruments: Venture Capital Funds prefer debt instruments to ensure a return in the earlier years of financing when the equity shares do not give any return. The debt instruments are of various types, as explained below:
i) Conditional Loans: On conditional loans, no interest rate as lower rate of interest and no payment period is prescribed. The Venture Capital Funds recover their funds, along with the return thereon by way of share in the sales of the undertaking for a specified period of time. This preference is pre-
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determined by Venture Capital Funds. The recovery by the Venture Capital Funds depends upon the success of the business enterprise. Hence, such loans are termed as “Conditional Loans”.ii) Convertible Loans: Sometimes loans are provided with the stipulation that they may be converted into equity at a later stage at the option of the lender or as agreed upon between the two parties.iii)Conventional Loans: These loans are the usual term loans carrying a specified rate of interest and are repayable in instalments over a number of years.
Exit Routes
The venture capital company/fund after financing a venture capital undertaking nurtures it to make it a successful proposition, but it does not intent to retain its investment therein forever. As the venture capital undertaking starts its commercial operations and reaches the profit-earning stage, the venture capitalist endeavors to disinvest its investment in the company at the earliest. The primary aim of the venture capitalist happens to realize appreciation in the value of the shares held by him and thereafter to finance another venture capitals undertaking. This is called the “Exit Route”. There are several alternatives before venture capitalist to exit from an investee company, as stated below:
i) Initial Public Offering: When the shares of the investee company are listed on the stock exchange(s) and are quoted at premium, the venture capitalist offers his holdings for public sale through public issue.ii) Buy back of Shares by the Promoters: In terms of the agreement entered into with the investee company, promoters of the company are given the first opportunity to buy back the shares held by the venture capitalist, at the prevailing market price. In case they refuse to do so, other alternatives are restored to by the venture capitalist.
iii)Sale of Enterprise to another Company: Venture capitalist can recover his investments in the investee company by selling the holdings to outsider who is interested in buying the entire enterprise from the entrepreneur.
iv) Sale to New Venture Capitalist: A venture capitalist can sell his equity holdings in the enterprise to a new venture capital company, who might be interested in buying the ownership portion of the venture capital. Such sale may be distress sale by the venture capitalist to realize the investments and exit from the enterprise. Alternatively, such sale may be for inducting a willing venture capitalist who wishes to take the existing liability in the company to provide second round of funding.
v) Self-liquidating Process: In case of debt financing by the venture capitalist, the process is self-liquidating in nature, as the principal amount, along with interest is realized in instalments over a specified period of time.
vi) Liquidation of the Investee Company: If the investee company does not become profitable and successful and incurs loses, the venture capitalist resorts to recover his investment by negotiating or settlement with the
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entrepreneur. Failing which the recovery is restored to by means of winding up of the enterprise through the court.
Q: 2).Discuss the Credit rating methodology used by rating companies in India. Name different types of securities which need credit rating.
Answer:
Rating methodology used by the major Indian credit rating agencies is more or less the same. The rating methodology involves an analysis of all the factors affecting the creditworthiness of an issuer company e.g. business, financial and industry characteristics, operational efficiency, management quality, competitive position of the issuer and commitment to new projects etc. A detailed analysis of the past financial statements is made to assess the performance and to estimate the future earnings. The company’s ability to service the debt obligations over the tenure of the instrument being rated is also evaluated.
In fact, it is the relative comfort level of the issuer to service obligations that determine the rating. While assessing the instrument, the following are the main factors that are analyzed into detail by the credit rating agencies.
1) Business Risk Analysis2) Financial Analysis
3) Management Evaluation
4) Geographical Analysis
5) Regulatory and Competitive Environment
6) Fundamental Analysis
These are explained as under:
I. Business Risk Analysis
Business risk analysis aims at analyzing the industry risk, market position of the company, operating efficiency and legal position of the company. This includes an analysis of industry risk, market position of the company, operating efficiency of the company and legal position of the company.
a. Industry risk: The rating agencies evaluates the industry risk by taking into consideration various factors like strength of the industry prospect, nature and basis of competition, demand and supply position, structure of industry, pattern of business cycle etc. Industries compete with each other on the basis of price, product quality, distribution capabilities etc. Industries with stable growth in demand and flexibility in the timing of capital outlays are in a stronger position and therefore enjoy better credit rating.
b. Market position of the company: Rating agencies evaluate the market standing of a company taking into account:
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i. Percentage of market shareii. Marketing infrastructure
iii. Competitive advantages
iv. Selling and distribution channel
v. Diversity of products
vi. Customers base
vii. Research and development projects undertaken to identify obsolete products.
viii. Quality Improvement programs etc.
c. Operating efficiency: Favorable locational advantages, management and labor relationships, cost structure, availability of raw-material, labor, compliance to pollution control programs, level of capital employed and technological advantages etc. affect the operating efficiency of every issuer company and hence the credit rating.
d. Legal position: Legal position of a debt instrument is assessed by letter of offer containing terms of issue, trustees and their responsibilities, mode of payment of interest and principal in time, provision for protection against fraud etc.
e. Size of business: The size of business of a company is a relevant factor in the rating decision. Smaller companies are more prone to risk due to business cycle changes as compared to larger companies. Smaller companies operations are limited in terms of product, geographical area and number of customers. Whereas large companies enjoy the benefits of diversification owing to wide range of products, customers spread over larger geographical area.
Thus, business analysis covers all the important factors related to the business operations over an issuer company under credit assessment.
II. Financial Analysis
Financial analysis aims at determining the financial strength of the issuer company through ratio analysis, cash flow analysis and study of the existing capital structure. This includes an analysis of four important factors namely:
a) Accounting qualityb) Earnings potential/profitability
c) Cash flows analysis
d) Financial flexibility
Financial analysis aims at determining the financial strength of the issuer company through quantitative means such as ratio analysis. Both past and current performance is evaluated to comment the future performance of a company. The areas considered are explained as follows.
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a. Accounting quality: As credit rating agencies rely on the audited financial statements, the analysis of statements begins with the study of accounting quality. For the purpose, qualification of auditors, overstatement/ understatement of profits, methods adopted for recognizing income, valuation of stock and charging depreciation on fixed assets are studied.
b. Earnings potential/profitability: Profits indicate company’s ability to meet its fixed interest obligation in time. A business with stable earnings can withstand any adverse conditions and also generate capital resources internally. Profitability ratios like operating profit and net profit ratios to sales are calculated and compared with last 5 years figures or compared with the similar other companies carrying on same business. As a rating is a forward-looking exercise, more emphasis is laid on the future rather than the past earning capacity of the issuer.
c. Cash flow analysis: Cash flow analysis is undertaken in relation to debt and fixed and working capital requirements of the company. It indicates the usage of cash for different purposes and the extent of cash available for meeting fixed interest obligations. Cash flows analysis facilitates credit rating of a company as it better indicates the issuer’s debt servicing capability compared to reported earnings.
d. Financial flexibility: Existing Capital structure of a company is studied to find the debt/equity ratio, alternative means of financing used to raise funds, ability to raise funds, asset deployment potential etc. The future debt claims on the issuer’s as well as the issuer’s ability to raise capital is determined in order to find issuer’s financial flexibility.
III. Management Evaluation
Any company’s performance is significantly affected by the management goals, plans and strategies, capacity to overcome unfavorable conditions, staff’s own experience and skills, planning and control system etc. Rating of a debt instrument requires evaluation of the management strengths and weaknesses.
IV. Geographical Analysis
Geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company. An issuer company having its business spread over large geographical area enjoys the benefits of diversification and hence gets better credit rating.
A company located in backward area may enjoy subsidies from government thus enjoying the benefit of lower cost of operation. Thus geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company.
V. Regulatory and Competitive Environment
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Credit rating agencies evaluate structure and regulatory framework of the financial system in which it works. While assigning the rating symbols, CRAs evaluate the impact of regulation/deregulation on the issuer company.
VI. Fundamental Analysis
Fundamental analysis includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. This includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company.
1) Liquidity management involves study of capital structure, availability of liquid assets corresponding to financing commitments and maturing deposits, matching of assets and liabilities.
2) Asset quality covers factors like quality of company’s credit risk management, exposure to individual borrowers and management of problem credits etc.
3) Profitability and financial position covers aspects like past profits, funds deployment, revenues on non-fund based activities, addition to reserves.
4) Interest and tax sensitivity reflects sensitivity of company following the changes in interest rates and changes in tax law.
Fundamental analysis is undertaken for rating debt instruments of financial institutions, banks and non-banking finance companies.
Q: 3).What are the advantages that accrue from branding of financial services? Illustrate with the help of examples, some of the pitfalls associated with umbrella branding.
Answer:
Advantages that accrue from branding of financial services are
BUYER BENEFITS
o Product identificationo Shorthand cue of features and benefitso Distinguishes products of similar typeo Reduces buyer search timeo Increases buyer assuranceo Assists in quality evaluationo Psychological rewardo Brand association
SELLER BENEFITS
o Product awareness
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o Helps launch new producto Secures demando Facilitates repeat purchaseo Fosters brand loyaltyo Enables premium pricingo Provides equity valueo Offers proprietary brand assets
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CASE STUDY
The banking industry is transformed, global forces for change include technological innovation; the deregulation of financial services at the national level and opening-up to international competition and changes in corporate behavior, such as growing disintermediation and increased emphasis on shareholder value. Indian banking system and financial system has as a whole had to be strengthened so as to be able to compete. India has had more than decade of financial sector reforms during which there has been substantial transformation and liberalization of the whole financial system. It is an appropriate time to take stock and assess the efficacy of our approach. It is useful to evaluate how the financial system has performed in an objective quantitative manner.
There has been importance because India's path of reforms has been different from most other emerging market economies: it has been a measured, gradual, cautious, and steady process, devoid of many flourishes that could be observed in other countries. The Indian debt market ranks third in Asia, after Japan and South Korea, in terms of issued amount. Outstanding size of the debt floatation as a proportion of GDP, however, is not very high in India. Moreover, although in terms of the primary issues Indian debt market is quite large, the Government continues to be the large borrower, unlike in South Korea where the private sector is the main borrower. The corporate debt market in the country is still at nascent stage. Factors such as lack of good quality issuers, institutional investors, supporting infrastructure and high cost of issuance, market fragmentation, etc. have been identified as the reason for lack of depth of the corporate debt market in India.
Competition is sought to be fostered by permitting new private sector banks and liberal entry of branches of foreign bank. Competition is sought to be fostered in rural and semi-urban areas also by encouraging Local Area Banks. Some diversification of ownership in select public sector banks has helped the process of autonomy and thus some response to competitive pressures and competition induced by the new private sector banks has clearly re-energized the Indian banking sector as a whole: new technology is now the norm, new products are being introduced continuously, and new business practices have become common place.
The principles underlying these guidelines would also be applicable as appropriate to public sector. More important, this suggests that the competitive nature of the Indian banking system is not significantly different from banking system in other countries, particularly in view of the fact that nearly 75 percent of banking system assets is with state owned banks. The validation of monopolistic competition during the second sub-period suggests that the recent trends toward consolidation led to more rather than less competition in the banking sector.
The using Indian banking industry as one case study, there will propose and test hypotheses regarding the possibility of relationship between three elements of bank related reforms like, fiscal reforms, financial reforms and private investment liberalization and bank efficiency. Bank efficiency is measured using data envelopment analysis or DEA and the relationship between the measured efficiency
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and India bank specific characteristics and environmental factors associated with reform is examined using estimations. Negative relationship between the presence of foreign banks and bank efficiency is found, which we attribute to a short-run increase in costs due to the introduction of new banking technology by foreign banks.
Questions:
Q: 1).List the various factors behind Indian Banking Sector reforms and its impact.
Answer:
Factors behind Indian Banking Sector reforms include:
o Technological innovation; the deregulation of financial services at the national level and opening-up to international competition and changes in corporate behavior, such as growing disintermediation and increased emphasis on shareholder value.
o To be able to compete: Indian banking system and financial system has as a whole had to be strengthened so as to be able to compete.
o Ongoing Reforms: India has had more than decade of financial sector reforms during which there has been substantial transformation and liberalization of the whole financial system.
o Time: It is an appropriate time to take stock and assess the efficacy of our approach.
o Benefits: It is useful to evaluate how the financial system has performed in an objective quantitative manner.
Q: 2).As per the above case, what is negative relationship?
Answer:
Negative relationship between the presence of foreign banks and bank efficiency is found, which we attribute to a short-run increase in costs due to the introduction of new banking technology by foreign banks.
Q: 3).Comment over ‘presence of Foreign Banks in Indian market’.
Answer:
Foreign banks are those banks whose branch offices are in India but they are incorporated outside India, and have their head office in a foreign country. These banks were allowed to set up their subsidiaries in India from the year 2002. They have to operate their business by following all the rules and regulations laid down by the RBI - Reserve Bank of India. They have to pay more attention to the priority sector by giving them a special place in bank
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lending. These banks are expected to follow all the banking regulations, just like any other domestic banks. The foreign banks can operate in India only, if they have a sound financial status. They must have a minimum of 25 million US dollars in minimum 3 branches. The first branch and the second branch must have 10 million US dollars each. The third branch should have a minimum of 5 million US dollars. The foreign banks are permitted to open up more branches in the country, if the performance of the bank is more than satisfactory and it matches the criteria laid adopted by the domestic banks. There are 40 foreign banks from 21 different countries operating in India. The business is conducted with the help of more than 205 branches. These branches are located in more than 15 states which includes union territories. Apart from these banks there are representative branches operating in India from 12 different countries.
Foreign banks who wish to open up branches in India have to apply to the RBI. These banks should be able to satisfy the RBI regulations. The banks should also get permission from their home country to set up branches in India. Other factors that are considered while approving the application of setting up the presence of foreign banks in India are as follows:
Financial soundness of the foreign banks Economic and political relations between the home country of the foreign banks and India.
International ranking of the bank
Home country ranking of the bank
International presence of the bank
Rating given to the bank by international rating agencies
Foreign banks have played an important role in the Indian economy, especially in the priority sectors. Globalization has compelled the banking sector to reach out to more customers in order to expand their business. This meant opening banking businesses even in the foreign countries. Many of the private banks were interested in expanding their business all over the world. They opened up branches across the globe to serve large number of customers, and also improve service to the existing customers. This change was a blessing for India. Currently, the foreign banks are growing tremendously in India.
The services provided by these banks are very impressive. The presence of these banks in India brought a lot of technical development. Banks of all categories, be it a domestic bank or an international bank, started using the latest technologies to provide better service to the customers. The technological development saved a lot time of the customers as well as the bankers. They introduced innovative and unique banking practices in India.
The previous years witnessed cut throat competition in the banking sector with the presence of foreign banks. The competition has compelled banks to
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come up with something new that no other bank can provide to the customers. Banks are partially a part of the service industry. The main objective of all the banks was to provide a better service to a large number of customers and look after their financial requirements. Customer satisfaction was a priority for domestic banks as well as the foreign banks.
Here is a list of some foreign banks operating in India
HSBC - Hong Kong and Shanghai Banking Corporation ABN Amro Bank NV
Barclays Bank
Deutches Bank
Standard Charted Bank
National Australia Bank
Banca di Roma
Depfa Bank PLC
Banco Bibao Vizcaya Argentina SA
Citibank NA
BNP Paribas
American Express Bank Ltd.
Abu Dhabi Commercial Bank Ltd.
State Bank of Mauritius Ltd.
DBS Bank Ltd.
Bank of Ceylon
Scotia Bank
JP Morgan Chase Bank
Taib Bank
China Trust Commercial Bank
Arab Bangladesh Bank Ltd.
Bank of Muscat S.A.O.G
Bank of America NA
Oman International Bank S.A.O.G
Overseas Chinese Banking Corporation Ltd.
UFJ Bank Ltd. (The Sanwa Bank Ltd.)
The Siam Commercial Bank
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Assignment C
Q: 1).All of the following are financial intermediaries except
a) Insurance companies
b) Pension funds
c) Mutual funds
d) None of the above (Ö).
Q: 2).Lease which includes a third party (a lender) is known as:
a) Sale and leaseback
b) Direct lease
c) Inverse Lease
d) Leveraged Lease (Ö).
Q: 3).Financial instruments issued by government agencies or corporations that promise to pay certain amounts of money to the holder on specific future dates are called:
a) Venture Capital.
b) Preferred stock.
c) Equity Shares.
d) Bonds (Ö).
Q: 4).The purpose of financial markets is to:
a) Increase the price of common stocks.
b) Lower the yield on bonds.
c) Allocate savings efficiently (Ö).
d) Control inflation.
Q: 5).Financial intermediaries:
a) channel funds from savers to borrowers
b) greatly enhance economic efficiency
c) have been a source of many financial innovations
d) Have done all of the above (Ö).
Q: 6). __________ are the economies Central nervous system.
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a) Financial Instruments
b) Financial Markets (Ö).
c) Financial Institutions
d) Financial Companies
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Q: 7).Financial markets and institutions
a) Involve the movement of huge quantities of money.
b) Affect the profits of businesses.
c) Affect the types of goods and services produced in an economy.
d) Do all of the above (Ö).
Q: 8). All merchant bankers have to be registered with….
a) RBI.
b) SEBI (Ö).
c) AMFI
d) All of the above
Q: 9).A mutual fund can operate as a venture capital fund.
a) True (Ö).
b) False
c) Cannot say
d) None of the above
Q: 10). How are funds allocated efficiently in a market economy?
a) The most powerful economic unit receives the funds.
b) The economic unit that is willing to pay the highest expected return receives the funds (Ö).
c) The economic unit that considers itself most in need of funds receives them.
d) Receipt of the funds is rotated so that each economic unit can receive them in turn.
Q: 11). ……. Funds do not have a fixed date of redemption.
a) Open ended funds (Ö).b) Closed ended funds
c) Diversified funds
d) Both a & b
Q: 12). In lease system, interest rate is calculated on:
a) Cash down paymentb) Cash price Outstanding (Ö).
c) Hire purchase pricePage 27 of 35
d) None of the above
Q: 13). A short term lease which is of tern cancellable is known as:
a) Finance leaseb) Net lease
c) Operating lease (Ö).
d) Leveraging lease
Q: 14). Which of the following is not a usual type of lease arrangement?
a) Sale & leasebackb) Goods on Approval (Ö).
c) Leverage Lease
d) Direct lease
Q: 15). Under income-tax provisions, depreciation on lease asset is allowed to:
a) Lessor (Ö).
b) Lessee
c) Any of the two
d) None of the two
Q: 16). A lease which is generally not cancellable and covers full economic life of the asset is known as:
a) Sale & leaseback
b) Operating lease
c) Finance lease (Ö).
d) Economic lease
Q: 17). One difference between Operating & Finance lease is:
a) There is often an option to buy in operating lease
b) There is often a call option in financial lease
c) An operating lease is generally cancellable by lessee (Ö).
d) A financial lease in generally cancellable by lessee.
Q: 18). C.R.A. is banking parlance stands for
a) Credit Rating Association
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b) Credit Rating Agency
c) Credit Risk Assessment (Ö).
d) None of these
Q: 19). From the point of view of the lessee, a lease is a:
a) Working capital decisionb) Financial decision (Ö).
c) Buy or make decision
d) Investment decision
Q: 20). Which of the following is not true for a “Lease or Buy” decision for the lessee?
a) Helps in project selectionb) Helps in project financing
c) Helps in project location
d) All of the above (Ö).
Q: 21). Bad debt cost is not borne by factor in case of
a) Pure factoring
b) Without recourse
c) With recourse (Ö).
d) None of the above
Q: 22). If a company sells its receivable to another party to raise funds, it is known as
a) Securitization
b) Factoring (Ö).
c) Pledging
d) None of the above
Q: 23). For a lessor, a lease is a
a) Investment decision (Ö).
b) Financing Decision
c) Dividend Decision
d) None of the above
Q: 24). Which of the following is true for mutual funds in India?Page 29 of 35
a) Exit load is not allowed
b) Entry load is allowed
c) Entry load is not allowed (Ö).
d) Exit load allowed is some cases
Q: 25). Debt/Income funds invest in
a) Tax saving schemes
b) Money Market Instruments
c) High Rate fixed income bearing instruments
d) Both debt and equity (Ö).
Q: 26). Which one of the following is not a feature or characteristics of hire purchase?
a) A small initial outlay (deposit) is required
b) The user of the asset never becomes the owner (Ö).
c) The hirer can use the asset immediately (or within a few days) of agreement
d) Regular interest and capital payments (e.g. monthly) are made by the user to the hire purchase company
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Q: 27). Which of the following is not a service provided by factoring companies?
a) The provision of finance
b) Bond issuance facilities (Ö).
c) Sales ledger administration
d) Credit insurance
Q: 28). Which of the following is not regulated by SEBI
a) Foreign institutional investors
b) Foreign direct investment
c) Mutual funds
d) Depositories (Ö).
Q: 29). Which one of the following most accurately describes an operating lease?
a) A short term leasing contract in which the lessee conveys the right to the lessor to receive interest payments from an asset leased out to another firm.
b) A short-term leasing contract or a contract which can be terminated at short notice. The lessor conveys the right to use equipment in return for regular rental payments.
c) A lease agreement in which a firm sells equipment to a finance house, which then permits the firm to continue to use it in return for regular rental payments (Ö).
d) A lease agreement in which the finance provider expects to recover the full cost (or almost the full cost) of the equipment, plus interest, over the period of the lease
Q: 30). Mutual Funds provide the benefits of ________.
a) Portfolio management
b) Diversification
c) Investment Avenues
d) All of the above (Ö).
Q: 31). Mutual Funds investor can not earn following return
a) Dividend
b) Capital Gain
c) Increase in NAV
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d) Fixed interest earning (Ö).
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Q: 32). The major difference between hire purchase (HP) and leasing is:
a) With HP, the user of the equipment generally owns it eventually after a set number of payments, whereas with leasing the user never owns the equipment (Ö).
b) HP is easy to arrange at point of sale, whereas leasing involves a prolonged legal process.
c) The effective rate is much higher on HP than on leasing.
d) In HP the payments are made annually, whereas with leasing monthly payments are more common.
Q: 33). Mutual funds are valued with help of their
a) NAV’s (Ö).
b) NFO
c) IPO
d) None of the above
Q: 34). One of the following, what is not true in respect of factoring?
a) Continuous Arrangement between factor and seller
b) Sale of receivables to the factor
c) Factor provides cost free finance to seller (Ö).
d) None of the above
Q: 35). An asset management company is formed
a) To manage bank’s assets
b) To manage mutual funds’ investments (Ö).
c) To construct infrastructure projects
d) To run a stock exchange
Q: 36). Which of the following is not an advantage of Hire Purchase?
a) Hire purchase is often available when other sources of finance are not
b) Hire purchase agreements can be cancelled at short notice with no penalty (Ö).
c) Hire purchase is easy to arrange
d) Hire purchase usually represents a fixed rate form of finance
Q: 37). Balanced funds provide:
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a) Steady return (Ö).
b) High return
c) Increase volatility
d) None of the above
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Q: 38). Prime duty of merchant banker is:
a) Maintaining records of clients
b) Giving loans to clients
c) Working as a capital market intermediary (Ö).
d) None of the above
Q: 39). Basic objective of a money market mutual fund is:
a) Guaranteed rate of return
b) Investment in short – term securities
c) Both a & b (Ö).
d) None of a & b
Q: 40). Mutual funds that charge a sales commission when shares are purchases are called
a) No-load funds
b) Loaded funds (Ö).
c) Sinking funds
d) Sinking-charge funds
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