UNIT
– I: FINANCIAL SERVICES
1.
Classification of Financial
services:
Introduction:-
Financial services refers to
services provided by the banks and financial institution in a financial system.
All types of activities which are financial in nature are regarded as financial
services. In a broad sense financial service means mobilization and allocation
of savings. Thus, it involves all activities involved in the transformation of
savings into investment.
Now-a-days some companies issued
convertible debentures and convertible preference shares and right shares to
raise capital. Even some companies raise finance by obtaining financial
services like commercial papers, lease financing, venture capital, merchant
banking and mutual funds.
Meaning:-
The term financial services in a
broad sense means “mobilization and allocation of savings”. Thus, it includes
all the activities involved in the transformation of savings into investment.
Classification
of Financial Services:-
Financial
Services |
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Capital Market intermediaries:-
The capital market intermediaries
consist of term lending institutions and investment institutions which mainly
provide long term loans(funds)
Money Market intermediaries:-
Money market consist of commercial
banks, co-operative banks and other agencies which supply other short term
funds.
Scope of Financial Services:-
Financial services cover a wide
range of activities. They can be broadly classified into two namey
·
Traditional
activities
·
Modern
activities
Traditional Activities:-
Traditionally, the financial
intermediaries have been rendering a wide range of services encompassing both
capital and money market activities. They can be grouped into two heads namely
a)
Fund
based activities
b)
Non-Fund
based activities
Fund based activities:-
The traditional function which come
under fund based activities are as following:
(i)
Underwriting
of investments in shares, debentures, bonds etc.
(ii)
Dealing
in secondary market activities
(iii)
Participating
in money market instruments like commercial papers, certificate of deposits
etc.
(iv)
Dealing
in foreign exchange activities
Non-Fund Based activities:-
(i)
Managing
the capital issues i.e. managing of pre-issue and past issue activities
relating to capital issue in accordance with SEBI guidelines and thus enabling
promoters to market their issue.
(ii)
Making
arrangements for the placement of capital and debt instruments with investment
institutions.
(iii)
Arrangement
of funds from financial institutions for the clients project cost or his working
capital requirements.
(iv)
Assisting
in the process of getting all government and other clearances.
Modern activities:-
(i)
Rendering
project advisory services right from the preparation of project report till the
raising of funds for starting the project with necessary government approval.
(ii)
Planning
for mergers and acquisitions and assisting for smooth carry out.
(iii)
Guiding
corporate customers in capital restructing.
(iv)
Acting
as trustees to the debenture holders
(v)
Recommending
suitable changes in the management structure and management style with a view
to achieve big results.
(vi)
Structuring
the financial collaboration by identifying suitable joint ventures partners and
preparing joint venture agreements.
(vii)
Managing
the portfolio of large public sector corporations.
(viii)
Rehabitating
and reconstructing sick companies through appropriate and facilitating
implementation of the scheme.
(ix)
Hedging
of risks due to exchange rate risk, interest rate risk, economic risk and
political risk by using swaps and other derivative products.
(x)
Undertaking
risk management services like insurance services, buyback options etc.
(xi)
Advising
the clients on the question of selecting best source of taking funds into
consideration the quantum of funds raised, their cost, lending period etc.
(xii)
Guiding
the clients in minimization of the cost of debt and in the determination of
optimum debt-equity mix.
(xiii)
Undertaking
services related to capital market such as:
(a)
Clearing
services
(b)
Registration
and transfers.
(c)
Safe
custody of securities
(d)
Collection
of income on securities.
(xiv)
Promoting
credit rating agencies for the purpose of rating companies which want to go
public by the issue of debt instruments.
Financial
Products and Services:-
2. Explain
financial products and services
Introduction:-
As a result of innovations new
instruments and new products are emerging in the capital market. The capital
market and money market are getting widened and deeped. Many financial service
sector by offering a variety of products are expanding. Financial intermediaries
including banks have already started expanding. Their activities in their
financial service sector by offering a variety of new products. As a result
sophistication and innovations have been appeared in the arena of financial
intermediaries. Some of them are briefly discussed below.
1.
Merchant Banking:-
A merchant banker is a financial
intermediary who helps to transfer capital from those who posts to those who
need it. Merchant banking includes a wide range of activities such as a
management of customer securities portfolio management, project counseling and
appraisal, underwriting of shares and
debentures, dividend warrants etc.
2.
Loan
syndication:-
This is more or less similar to
“consortium” financing. But, this work is taken up by merchant banker as a lead
manager. It refers to loan arranged by a bank called lead manager or a borrower
who usually a large corporate enterprise or a government department. The other
banks who are willing to lead can participate in the loan by contributing an
amount suitable to their own lending policies.
3. Leasing:-
A lease is an agreement under
which a company or a firm, acquires a right to make use of capital asset like
machinery on payment of a prescribed fee called “rental charges”. In lease
cannot acquire the ownership of assets, but he can use it and have full control
over it. He is expected to pay for all maintenance charges, repairing and
operating costs. In countries like U.S.A, U.K and Japan equipment leasing is
very popular and 25% of the plant and equipment is being financed by leasing
companies.
4. Mutual
Funds:-
A mutual fund refers to fund
raised by a financial service company by pooling the savings of public. It is
invested in diversified portfolio with a view of spreading and minimizing risk.
The fund provide investment avenue for small investors who cannot participate
in the equities of big companies.
5. Factoring:-
Factoring refers to the process
of managing sales ledger of a client by a financial service company. In other
words , it is an arrangement, under which a financial intermediary assumes the
credit risk in the collection of book debts for its clients. The entire
responsibility of collection of book debts is passed on to the factor. His
services can be compared to a delcredre agent, who undertakes to collect debts.
6. Forfeiting:-
Forfeiting is a technique by
which a forfeitor(financial agency), discounts an export bill and pays ready
cash to the exporter who can concentrate on the export front without bothering
about the collection of export bill.
7. Venture
capital:-
A venture capital is another
method of financing in the form of equity participation. A venture capitalized
finances a project based on the potentials of new innovative project. It is in
contrast to the conventional security based financing.
8. Custodial
services:-
It is yet another line of
activity which has gained importance of late. Under, this financial services it
provides service to clients, particularly foreign investors for a prescribed
fee. Custodial services provide agency services like safe keeping of shares and
debentures, collection of interest and dividend and reporting of matters on corporate
development.
9. Corporate
Advisory services:-
Financial intermediaries,
particularly banks have to set up corporate advisory service branches to lender
services exclusively to their corporate customers. For instance, some banks
have extended computer terminals to their corporate consumers so that they can
transact some of their important banking transactions by citing in their own
office.
10. Derivative
Secutity:-
A derivative security is a
security whose value depends upon values of other basic variables backing the
security. In most cases, these variables are nothing but the prices of traded
securities.
11. New
products of foreign market:-
New products have also emerged in
the foreign markets of the developed countries. Some of these products are yet
to make full entry in the Indian markets. Among them following are important
ones:
a)
Forward Contracts:- A Forward transaction is one where the
delivery of a foreign currency takes place at a specified future data for a
specified price.
b)
Options:- It is a contract where in the
buyer of the option has a right to buy or sell a fixed amount of currency
against another currency at a fixed rate according to his option.
c)
Futures:- It is a contract where there is an agreement
to buy or sell a stated quantity of foreign currency at a future date at a
price agreed to between the parties on stated exchange. Unlike options, there
is an obligation to buy or sell foreign exchange on future date at a specific
rate.
d)
Swaps:- A swap refers to a transaction
where in a financial intermediary buys and sells a specified foreign currency
simultaneously for different maturity dates say for instance, purchase of spot
and sole of forward or vice versa with different maturities.
UNIT-II:
MERCHANT BANKING SERVICES
1. Explain
nature of merchant banking.
Introduction:-
Merchant banking is non banking financial
activity. But, it resembles banking function. It is financial service.
Dictionary of bank as an organization that underwrites securities for corporations,
advises such clients on mergers and is involved in the ownership of commercial
ventures.
Meaning:-
According to SEBI Rules 1992, “ A merchant
banker has been defined as any person who is engaged in the business of issue
management either by making arrangements regarding selling, buying or
subscribing to securities or acting as manager, consultant advisor or rendering
corporate advisory services in relation to such issue management.
Nature
of Merchant Banking:-
It is clear from the meaning of
merchant banking that it is a skill based activities and involves financial
need of every client. SEBI has made the quality of manpower as one of the
criteria for registration as merchant banker. These skills should not be
concentrated in issue management and underwriting alone which may have an
adverse impact on business.
Objective
of Merchant Banking:-
Merchant banking is non-banking
financial activities. The objectives of merchant banking in the prevailing
economy are as follows:
1)
To
help for capital formation.
2)
To
create secondary market in order is boost industrial activities in the country.
3)
To
assist and promote economic endeavour.
4)
To
prepare project reports, conduct market, research and pre – investment surveys.
5)
To
provide financial assistance to venture capital.
6)
To
build a data bank as human resources
7)
To
provide housing finance.
8)
To
provide seed capital to new enterprises
9)
To
involve in issue management.
10) To act as underwriters.
11) To identify new projects and
render services for getting clearance from government
12) To provide financial clearance.
2. Importance
of Merchant Banking services.
The key reason for the growth of
merchant banking is due to exerting excess demand on the source of funds
forever expanding industry and trade.
(i)
Corporate
sector had the only alternative to avail of the capital market services for
meeting their long term financial requirements through capital issues of equity
and debentures.
(ii)
With
the growing demand for funds there was pressure on capital market that enthused
the commercial banks, share brokers and financial consultancy firms to enter
into field of merchant banking.
(iii)
India
have opened merchant banking windows and are competing in this field and also
doing advisory functions as merchant bankers as well as managing public issues,
in syndication with other merchant bankers.
(iv)
Merchant
banks can play highly significant role in mobilizing funds of savers to
investible channels assuring promising return on investment activity.
(v)
With
the growth of merchant banking professionals corporate enterprise in both
public and private sector will be able to meet the growing requirements for the
funds for establishing new enterprise.
(vi)
Merchant
banks have been procuring impressive support for capital market for the
corporate sector financing their projects
(vii)
In
the view of multitude of enactments, rules and regulations, guidelines and off
shoot press release instructions brought out by the government from time to
time. Imposing statutory obligations up on corporate sector to comply with all
those requirements.
(viii)
Merchant
bankers advise the investors of the incentives available in the form of tax
reliefs, other statutory relaxations good return on investment and capital
appreciation in such investment to motivate them to invest their savings in
securities.
(ix)
Merchant
banking helps the industry and trade to raise funds and the investors to invest
their saved money in sound and healthy concerns with confidence safety and
organizations for high yield.
3. Explain
the stages and the process of obtaining venture capital.
Venture
Capital:-
Introduction:-
Venture capital is a growing business of
recent origin in area of industrial financing. The term venture capital is
understood in many ways. In a narrow sense it refers to investment in new and
tried enterprises that are lacking a stable record of growth. In a broader
sense, venture capital refers to the commitment of capital as shareholding, for
the formulation and setting up of small firms specializing in new ideas or new
simultaneous input of skill needed to set up the firm, design its marketing
strategy, organize and manage it.
Definition:-
A venture capital company is
defined as “ a financial institution which joins an entrepreneur as a
co-promote in a project and shares the risks and rewards of the enterprise.
Stages
of Venture Capital:
Venture capitalist finance both
early and late stage investments to maintain a balance between risk and
profitability. There are five distinct stages of venture capital funding, they
are:
 |
1) Seed or Early stage:-
The first stage of business is known as seed capital
stage. Venture capitalists are more often interested in providing seed finance
is making provision of very small amounts for finance needed to turn a
business.
2) Start – up Stage:-
Newly formed companies without operating history are
considered to be in the start – up stage. Most venture capital fund this stage
of a company’s development with their own funds as well as investment from
angel investors. Angels are wealthy individuals, friends, or family members
that personally invest in a company.
3) Second Round Financing:-
It refers to the stage when product has already been
launched in the market but has not earned enough profits to attract new
investors. Additional funds are needed at this stage to meet the growing needs
of business. Venture capital funds provide large funds at this stage than at other
early stage financing in the form of debt. The time scale of investment is
three to seven years.
4) Expansion Stage:-
Venture
capitalists perceive low risk in ventures requiring finance for expansion
purposes either by growth implying bigger factory, larger ware house, new
factories, new products or new markets or through purchase of existing
businesses. The time frame of investment is usually from one to three years. At
this stage, it may be necessary to finance additional working capital
requirement in view of expansion of business activities.
Process of
obtaining Venture Capital:-
Once
the company has decided to take the venture capital funding for your business.
The venture capital fund raising involves for the following steps:
1) Preparation of business plan:-
The process of
obtaining venture capital financing starts with finalization of business plan.
Normally, a venture capitalist in an innovative business that has a lots of
potential to grow in the future. Business plan includes at least the following
·
A description of the opportunity and market size
·
Profiles of the management team
·
A review of the competitive landscape and
solutions
·
Detailed financial projections
·
A capitalization table
·
An executive summary of business proposal along
with business plan
2) Identification of right venture
capitalist:
Once a detailed
business plan is ready, the next step is to identify a suitable venture capital
institute for funding, selection of venture capital firm depends upon ability
and experience of the venture capitalist to deal in the industry concerned.
3) Meeting the Venture Capitalist:-
The investment
banker approaches venture capitalists and start making presentations to them.
The purpose of these presentation is to bring the promoters of the company and
the investors face to face. In the follow – up meeting the company tries to
convince the investors about the investment.
4) Due diligence:-
This entails a
rigorous process that determines whether or not the venture capital fund or
other investors will invest in the company. The process involves asking and
answering a series of questions to evaluate the business and legal aspects of
the opportunity.
5) Signing the term sheet:-
The term sheet
as the name implies, covers the key terms of the investment. Two of the most
important terms in the TS are the valuation of the company and the transaction
structure. If the due diligence phase is satisfactory, the Venture capitalist
will offer a term sheet.
6) Execution with Venture Capital Support:-
Once the term
sheet is signed, the venture capitalist becomes actively involved in the
company’s activities. Venture capitalists normally do not make their entire
investment in a company at once, they do this only in rounds.
UNIT-III
LEASING AND HIRE-PURCHASE
Leasing
1) Explain essential elements of leasing
Introduction:-
Leasing
is a process in which a firm can obtain the use of certain fixed assets for
which it may pay a series of contractual, periodic, tax deductible payments.
The lessee is the receiver of the services or assets under lease contract and
the lessor is the owner of the assets. The relationship between the tenant and
the landlord is called a tenancy and can be for fixed or indefinite period of
time.
Definition:-
The
transfer of property Act defines a lease as a transaction in which a party
owing the asset provides the asset for use over a certain period of time to
another for consideration either in form of periodic rent or in the form of
down payment.
Essential elements of lease:-
1) Parties to the contract:-
There are essentially two parties to a contract of
lease financing called the lessor and lessee. Lessors as well as lessees may be
individuals, partnerships, joint stock companies, corporations or financial
institution.
2)
Asset:-
The asset, property or equipment to be leased is
subject matter of a contract of lease financing. The asset may be an
automobile, plant & machinery, equipment, land and building etc. The asset
must however be the lesee’s choice suitable for his business needs.
3) Ownership separated from user:-
The essence of a lease financing contract is that
during tenure, ownership of the asset vests with the lessor and its use is
allowed to lessee
4) Term of lease:-
The term of lease is the period for which the
agreement of lease remains in operation. Every lease should have definite
period otherwise it will be legally inoperative. The lease period may sometimes
stretch over the entire economic life of the asset or a period shorter than the
useful life of the asset.
5) Lease Rentals:-
The consideration which the lessee pays to the lessor
for the lease transaction in the lease rental. The lease rentals are so
structured as to compensate the lessor for the investment made in the asset,
the interest on investments etc.
6) Modes of Terminating lease:-
At the end of lease period, the lease is terminated and various courses
are possible
a)
The lease is renewed on a perpetual basis or for
a definite period
b)
The asset reverts to the lessor.
c)
The asset reverts to the lessor and the lessor
sells it to third party.
d)
The lessor sells the asset to the lessee.
The parties
may mutually agree to choose any of aforesaid alternatives at the beginning of
the lease nature.
Types of lease:-
Certain
variations in the elements of lease classifies lease into different types. Such
elements are as follows:
·
The degree of ownership risk and rewards
transferee.
·
No. of parties involved in the lease contract
·
Location of lessor, lessee and the equipment
supplier
1) Financial lease:-
Financial lease
also known as full payout lease is a type of lease wherein the lessor transfers
substantially all the risks and reward related to the asset to the lessee.
Generally the ownership is transferred to the lessee at the end of economic
life of the asset.
2)
Operational
Lease:-
All operating
lease stands in contrast to the financial lease in almost all aspects. The
lease agreement gives to the lessee only a limited right to use the asset. The
lessor is responsible for the unkeep and maintenance of the asset. The lessee
is not given any uplift to purchase the asset at the end of lease period.
3) Sale and lease back:-
It is a sub part
of finance lease. Under this the owner of an asset sells the asset to a party
who in turn leases back the same asset to the owner in consideration of lease
rentals. However under this arrangement the assets are not physically exchanged
but it all happens in record only.
4) Leveraged leasing:-
Under leveraged
leasing arrangement a third party is involved beside lessor and lessee. The
lessor borrows a part of purchase cost of the asset from third party i.e.
lender and the asset so purchased is held as security against the loan. The
lender is paid off from the lease rentals directly by the lessee and the surplus
after meeting the claims of lending goes to the lessor.
5) Direct leasing:-
Under direct
leasing a firm acquires the right to use an asset from the manufacturer
directly. The ownership of the asset leased out remains with the manufacturer
itself. The major types of direct lessor include manufacturers, financial
companies etc.
6) Single Investor lease:-
In single
investor lease, there are two parties – lessor and lessee. The lessor arrange
the money to finance the asset or equipment by way of equity or debt. The
lender is entitled to recover money from the lessor only and not from the
lessee in case of default by lessor.
7) Domestic and International lease:-
When all the
parties of the lease agreement reside in the same country, it is called called
domestic lease. When the lessor or lessee reside in the same country and
equipment supplier stays in different country, the lease arrangement is called
import lease. When the lessor and lessee are residing in two different
countries and no matter where the equipment supplier stays the lease is called
cross broader lease.
2) Explain features of Hire purchase and its
meaning
Hire purchase:-
Introduction:-
Hire
purchase is a type of installment credit under which the hire purchaser, called
the ‘hirer’ agrees to take the goods on hire at a stated rental, which is
inclusive of the repayment of principal as well as interest, with an option to
purchase. Under this transaction, the hire purchaser acquires the property
immediately on signing the hire purchase agreement but the ownership or title
of the same is transferred only when the last installment is paid.
The hire purchase system is
regulated by the Hire purchase Act 1972. The Act defines Hire purchase as
“An
agreement under which goods are let out on hire and under which the hirer has
an option to purchase them in accordance with the terms of the agreement and
includes an agreement under which
1)
The owner delivers possession of goods thereof
to a person on condition that such person pays agreed amount in periodic
installments.
2)
The property in the goods is to pass such person
on the payment of last and such installments
3)
Such persons has a right to terminate the
agreement at any time before the property so passes.
Features:-
1)
The person who has hire the goods will give
regular installment or rent to the owner of the goods which will include some
portion of principal amount and some portion of interest as agreed by both the
parties.
2)
The ownership of good passes only when the
person has paid the last installment of the goods which he or she has hired.
3)
In case of hire purchase the person who has
taken the good on hire cannot transfer the goods to a third party as he or she
does not have ownership of the goods.
4)
Every installment is treated as hire charge for
using the asset.
5)
The hire vendor has a right to reposses the
asset in case of difficulties in obtaining payment of installment.
6)
If the hire does not want to own the asset, he
can return the assets any time and is not required to pay any installment that
falls due after the return. However, once the hirer returns the assets he
cannot claim back any payments already paid as there are the charges towards
the hire and use of assets.
UNIT – IV
CREDIT RATING
1.
State the
objectives and factors affecting credit rating.
Introduction:-
Credit
rating involves analysis and assessment of companies and government that issues
securities for raising finance from various markets. The credit rating agencies
collects the data from various sources about the issuer of the securities. The
market in which issuer operates overall economy etc. and provides guidance to
the investors in matter of credit risk associated with the securities so that
investor can take informed decisions.
Factors
affecting credit rating:-
Credit
rating depends upon various factors as various agencies use different formulae
to calculate credit rating but most are based on following factors:
1) Payment history:-
Payment history indicates how company has managed
various payments in past. How timely payments are made to the lender, creditor
and other suppliers.
2) Public records:-
Public records about the events such as bankruptcies,
negative judgement from legal authorities can lower the credit rating of a
company.
3) Duration of credit history:-
Longer credit history is better for the company and it
results in better credit rating.
4) New accounts:-
In general opening a multiple new accounts in a short
period may lower credit rating of a company.
Objectives of
Credit Rating:-
·
It imposes a financial discipline on the
borrowers
·
It helps the financial intermediary in
discharging the functions relating to the debt issues.
·
It guides the investor regarding the commitment
towards the particular debt instrument for better returns.
·
It facilitates the promotion of public
guidelines on the institutional investment.
·
It may provide adequate funds for the high rated
companies at a low rate of interest.
·
It lends greater credibility to the financial
and other representatives.
·
It encourages transparency of information and better
accounting standard.
Types of Credit
Rating:-
This
type of rating constitutes the major business of a rating company. But with the
passage of time these agencies have started providing other types of rating
such as:
1) Equity Rating:-
Rating of equity
shares issued in company capital market is termed as equity rating. In such exertion
the opinion on the earnings prospects and list associated with such earning can
be arrived at through comprehensive information on acquisition, interaction
with the management of the corporate critical analysis and collective judgmental
process.
2) Mutual Fund Rating:-
Mutual funds
rating which are popular all over world are evaluated by rating agencies and is
known as mutual fund rating. It facilitates selection of right fund from the
available funds.
3) Individual Credit Rating:-
Consumer finance
is gaining popularity in developing countries. The success of consumer finance
depends on the credit worthiness of the consumer. Rating agencies may take up
rating of such individuals. Individual credit rating is own objective
assessment of the risk attached to the financial transaction.
4) Rating of banks and financial
companies:-
Banks and
financing companies are also issuers of debts like banks issue certificate of
deposits. The issuers internal affair is scanned by evaluation of their
background and history. Their relations with government and central bank are
studied.
5) Sovereign
Rating:-
It is primarily
rating of a country as to its credit worthiness and probability to risk etc. In
this process economic parameters and economic policies of a country are under
constant observation. Such ratings influences the availability of foreign aids
from agencies like World Bank.
6)
Rating Structured obligation:-
Structured obligation is a
negotiable instrument or security which is backed by some asset. The main role
of credit rating agency is analyzing an asset backed security or a structured
obligation is to assess the risk of default in meeting the contractual
obligations to the investor.
MUTUAL FUNDS
1. Explain types of mutual funds and its
features.
Introduction:-
Mutual
funds represent one of the most important institutional forces in the market.
They are institutional investors and play a major role in today’s financial
markets.
Meaning:-
Mutual
funds are corporations that accept money from sources and then use these funds
to buy stocks, long term funds or short term debt instruments issued by firms
or government.
Definition:-
SEBI
regulations, 1993 defines a mutual fund as a fund established in form of a
trust by a sponsor to raise money by the trustees through the sale of units to
the public, under one or more schemes for investing in securities accordance
with their regulations.
Features of Mutual funds:-
Mutual
funds possess the following features:
1)
Mutual funds mobilize funds from small as well
as large investors by selling units
2)
Mutual funds provide an ideal opportunity to
investors an ideal avenue for investment.
3)
Mutual fund enables the investors to enjoy the
benefit of professional and expert management of their funds.
4)
Mutual funds invest the savings collected in a
wide portfolio of securities in order to maximize return and minimize risk for
the benefit of investors.
5)
Various schemes offered by mutual funds provide
tax benefits
Classification of Mutual funds:-
Mutual
funds can be classified into many types:
A. On the basis of operation:-
1) Close Ended Funds:-
Under this type of fund, the size of fund and its duration
are fixed in advance. Once the subscription reaches the pre-determined level
the entry of investors will be closed. After the expiry of the fixed period,
the entire corpus is disinvested and proceeds are distributed to unit holders
in proportion to their land holding.
2) Open-ended Funds:-
This is the just reverse of close ended funds. Under
this scheme the size of the land or the period of fund is not fixed in advance.
The investors are free to buy and sell no of units at any point.
B. On the basis of return/income:
1) Income Fund:-
This scheme aims at generating regular and periodical
income to the members. Such funds are offered in two forms. The first funds are
target constant income at relatively low risk.
2) Growth Funds:-
Growth funds offer the advantage of capital
appreciation. It means growth funds concentrate mainly on long run gains. It
does not mainly on long run gains. It does not offer regular income. In short
growth funds aim at capital appreciation in the long run.
3) Conservation Fund:-
This aims at providing a reasonable rate of return
protecting the value of investment and getting capital appreciation.
C. On the basis of Investment:-
1) Equity fund:-
It mainly consists of equity based investments with high degree of risk.
2) Bond funds:-
It mainly consists of fixed income securities like bonds and concentrates
mostly on income rather than capital gains.
3) Balanced funds:-
It is mix of debt and equity in portfolio investment and distributing
regular income as capital appreciation.
4) Leverage fund:-
In this case the funds are invested from the amounts mobilized from small
investors as well as borrowed from capital market.
5) Index bonds:-
These are linked to a specific index of share prices. This means that the
funds mobilized funds mobilized under such scheme are invested principally in
the securities of companies whose securities are included in index.
UNIT – V
FACTORING AND FORFEITING
1. Explain factoring? What are its advantages
and disadvantages?
Factoring:-
Introduction:-
Factoring
may be defined as selling the receivables of a firm at a discount to a
financial organization. The cash from sale of receivables provides finance to
the selling company. Out of the difference between the face value of the
receivables and what the factor pays to the selling company it meets its
expenses.
Advantages
of Factoring:-
The
firm that enters into factoring agreement is benefited in no. of ways:
1) Improves efficiency:-
Factoring is an important tool for efficient receivables management.
Factors provide specialized services with regard to sales ledger administration
credit control etc.
2) Higher credit standing:-
Factoring generates cash for selling firm. It can use this cash for other
purposes with the advance payment made by a factor. It is possible for the
client to pay off his liabilities in time.
3) Reduces cost:-
The client need not have a special administrative setup to look after
credit control. Hence it can save manpower, time and effort. Since the
factoring facilities steady and reliable cash flows client can cut costs and
expenses
4) Additional service:-
Funds from a factor is an additional source of finance for the client.
Factoring releases the fund paid up in credit extended to customers and solve
problems relating to collection, delays and defaults of receivables.
5) Advisory Service:-
A factor firm is a specialized agency for better management of
receivables. The factor assesses the financial, operational and managerial
capabilities of customers.
6) Acceleration of production cycle:-
With cash available for credit sales, client firm’s liquidity will
improve. In this way its production cycle will be accelerated.
7) Adequate credit period for customers:-
Customers get adequate credit period for payment of assigned debts.
8) Competitive terms to offer:-
The client firm will be able to offer competitive terms to its buyers.
This will improve its sales and profits.
Limitations of factoring:-
The main limitations of
factoring are given below:
1)
Factoring may lead to over-confidence in the
behavior of client.
2)
There are chances of fraudulent acts on the part
of client, invoicing against non-existent goods duplicate invoicing etc.
3)
Lack of professionalism, competence, resistance
to change etc are some of the problems which made it unpopular.
4)
Factoring is not suitable for small companies
with lesser turnover, companies with speculative business, companies have large
no. of debtors for small amounts.
Types of
Factoring:-
There
are different types of factoring and can be briefly discussed as follows:
1) Recourse factoring:-
In this type of
factoring, the factor only manages the receivables without taking any risk like
bad debts.
2) Non-Recourse factoring:-
Here the firm
gets total credit protection because complete risk of total receivables is
borne by a factor. The client gets 100% cash against the invoices even if bad
debts occur.
3) Maturity factoring:-
In this type of
factoring the factor does not pay any cash in advance. The factor pays client
only when he receives funds from the customer or when the customers guarantee
full payment.
4) Advance factoring:-
Here the factor
makes advance payment of about 80% of the invoice value to client.
5) Invoice discounting:-
Under this
arrangements the factor gives advance to the client against receivables and
collects interest for the period extending from date of advance to the date of
collection.
6) Undisclosed factoring:-
The factor
performs all its usual factoring services in the name of the client or a sales
company to which the client sells its book debts. Through this the company
factor deals with customers.
7) Cross boarder factoring:-
It is similar to
domestic factoring except that there are four porters
a)
Exporter
b)
Export Factor
c)
Import Factor
d)
Importer
Exporter enters into factoring
arrangement with export factor in his country and assigns to him export
receivables. Export factor enters into arrangement with import factor and has
arrangements for credit evaluation and collection of payment for an agreed fee.
2. Explain forfeiting. Explain its advantages
and disadvantages.
Forfeiting:-
Introduction:-
The
concept of forfeiting was originally developed to help German exports to
Eastern bloc countries. The term “forfeit” is a French word. It means to surrender
something or to give up one’s right. Thus forfeiting means giving up the right
of experts to the forfeiter to receive payment in future from the importer.
It
is a method of trade financing that allows exporters to get immediate cash and
relieve from all risks by selling their receivables on a work resource basis.
Under forfeiting the exporter surrenders his right to a receivable due at a
future date in exchange for immediate cash payment at an agreed discount.
Characteristics
of forfeiting:-
The
main characteristics of forfeiting are
1)
It is 100% financing with resources to the
exporter.
2)
The importer’s obligation is normally supported
by a local bank guarantee.
3)
Receivables are usually evidenced by bills of
exchange, promissory note and letter of credit.
4)
Finance can be arranged on fixed or floating
rate basis
5)
Forfeiting is suitable for high value exports
such as capital goods, durables of necessary documents, shortly after shipment.
Advantages:-
1) Profitable and Liquid:-
From the forfeiter’s point of view, it is very
advantageous because he not only gets immediate income in form of discount
charges, but also can sell them in secondary market,
2) Simple and flexible:-
It is also beneficial to the exporter. All the
benefits that are available to a client under factoring are automatically
available under forfeiting also.
3) Avoids export credit risks:-
The exporter is completely free from many export
credit risk that may arise due to possibility of interest rate fluctuation or
exchange rate fluctuations that may affect collection of bills.
4) Avoids Export Credit Insurance:-
In the absence of forfeiting, the exporter has to go
for export credit insurance. It is very costly and it involves very cumbersome
procedures.
5) Confidential and speedy:-
International trade transactions can be carried out very
quickly through forfeitor. It does not involve much documentary procedures
Disadvantages:-
The
following are drawbacks of forfeiting:
Non- availability
for short & long periods:
Forfeiting
is highly suitable to only medium term deferred payments. Forfeiters do not
come forward to undertake forfeit financing for long periods since it involves
much credit risk.
1. What are forward contracts ?
Meaning:-
A
forward contract is an agreement between two counter parties: a buyer and
seller. The buyer agrees to buy an underlying asset from other party (seller).
The delivery of the asset occurs at a later time but the price is determined at
the date of purchase.
Features:-
·
Highly customized counterparties can determine
and define the terms and features to fit their specific needs including when
delivery will take place and the exact identify of the underlying asset.
·
All the parties are exposed to counterparty
default risk. This is the risk that made other party may not make the required
delivery or payment.
·
Transactions take place in large, private and
largely unregulated markets consisting of banks.
·
Underlying assets can be a stocks, bonds,
foreign currencies, commodities or some combination thereof. The underlying
asset could even be interest rates.
·
They tend to be held to maturity and have little
or no market liquidity.
·
Any commitment between two parties to trade an
asset in future is a forward contract.
2. State the characteristics and types of
option contracts.
Option contracts are of two
types. Call option and Put option.
Call option:- Call option is
made to buy an underlying asset.
Put option:- Put option is made
to sell an underlying asset.
Both
put and call options have three basic characteristics i.e. exercise date,
expiration date and time to expiration.
·
The buyer has the right to buy or sell the
asset.
·
To acquire the right of an option. The buyer of
the option must pay a price to the seller. This is called option price or the
premium.
·
The exercise price is also called the fixed
price, strike price or just the strike and is determined at the beginning of
the transaction. It is the fixed price at which the holder of the call or put
can buy or sell the underlying asset.
·
Exercising is using this right the option grants
you to buy or sell. The underlying asset the seller have a potential commitment
to buy or sell asset. If buyer exercises his right on option.
·
The expiration date is the final date that the
option holder has to exercise her right to buy or sell the underlying asset.
·
Default on options work the same way as they do
with forward contracts. Default on over the counter option transactions are
based on counterparties. While exchange traded houses use a clearing house.
Thank u madam
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