MF0017 Merchant Banking and Financial Services
Q.1. Define merchant banking and explain its functions.
Ans. Merchant banking is an essential service provided by financial institutions that help in the growth of
corporate sector, which eventually reflects in the overall growth and economic development of the
State Bank of India was the first Indian bank to set up its Merchant Banking Division in 1972. From
1992, reform measures were introduced in the capital market. The reform measures included conferring of
statutory powers on the Securities and Exchange Board of India (SEBI) and the repeal of Capital Issues
Control Act. These measures brought about major improvement in the regulatory and functional
efficiency of the market. The measures also enabled the merchant bankers to take legal and moral
responsibility towards the investing public. It includes public sector, private sector and foreign players.
Some of the registered merchant banks in India are Kotak Mahindra Capital, HDFC Bank, ICICI Bank,
IDBI Bank, and so on.
The following are the main functions of merchant banking:
a) Issue management – A major function of merchant banking is issue management. The issue can be
through offer of sale or private placements, prospectus, and so on. The issue management includes the
following functions with respect to issue through prospectus:
To obtain approval for the issue from the SEBI and to arrange underwriting for the proposed issue.
To draft and finalize the prospectus and to obtain clearance from the stock exchange, auditors,
underwriters and registrar of companies. To select registrar of the issue, advertising agencies,
underwriters, bankers and brokers to the issue and finalize the charges to be paid to the registrar.
To arrange press conferences, and investors and brokers through advertising agency.
To finalize the terms of issue to make the issue more attractive.
b)Pre-investment studies of investors – The merchant bankers undertake the practicality surveys in
selected areas of client’s interest. Pre-investment study covers the study of the project and includes the
Developing or reviewing of project profile, preparing project reports after analyzing financial, market
and economic feasibility, estimating the cost of the project, studying the procedural aspects of project
implementation, determining the source of financing and deciding the capital structure, assisting in legal
formalities for implementing the project.
c) Corporate counselling – Corporate counselling refers to the activities undertaken to ensure effective
running of a corporate enterprise through efficient management of finance.
The following are the areas in which the corporate counselling is provided:
Area of diversification considering the Government’s licensing and economic policies. Market analysis
for growth, present and future demand, and profitability of each product produced by the corporate
enterprise. The analysis also helps to determine whether to continue the product or not.
d) Project counselling – Project counselling is a part of corporate counselling which is related to project
finance. A merchant banker provides the clients project counselling that involves providing advice on
procedural aspects of project implementation, conducting financial study of the project, providing
assistance in project profiles, providing assistance in seeking approvals from Government of India for
foreign technical and financial collaboration agreements.
e) Loan syndication – A merchant banker helps the clients to get loan for the project. They also help in
conducting appraisal and designing capital structure.
f) Portfolio management - Portfolio management refers to making decisions related to investment of cash
resources of a corporate enterprise in marketable securities by deciding the type of security to be
purchased. A merchant banker helps the clients in making the right choice of investment to obtain
optimum investment, undertaking investment in securities conducting critical evaluation of investment
portfolio, and so on.
g) Project finance – A merchant banker who undertakes a project scheme also assists in arranging a
comprehensive package for the project funding. The process involves the study of the pattern of financing
available from merchant banks and financial institutions.
h) Working capital – Merchant bankers assist in arranging finance for working capital particularly for
new ventures. For existing firms, the merchant bankers arrange the funds from non-traditional sources
such as through issue of debentures, and so on. For example, Central Bank of India (CBI) has started
working capital finance as one of the merchant banking service area.
i) Managerial and technical services – Merchant bankers provide services to deal with problems in
technical, financial and managerial fields.
Q.2. Explain the taxation aspect of hire purchase transaction.
Ans. The taxation aspects of hire purchase transaction can be divided into three parts
(a) Income Tax, (b) Sales Tax and (c) Interest Tax.
Income Tax Aspect
Hire purchase, as a financing alternative, offers tax benefits both to the hire vendor and the hirer. The
hirer is entitled to the tax shield on depreciation calculated with reference to the cash purchase price and
the tax shield on the finance charges. Even though the hirer is not the owner ,he gets the benefit of
depreciation on the cash price of the asset/equipment. If the agreement provides for the option of
purchasing the goods as any time or of returning the same before the total amount is paid, no deduction of
tax at source is to be made from the consideration of hire paid to the owner.
Income tax assessment of the Owner or financer: The consideration for hire/hire charges / income
received by the hire financer is liable to tax under the head profits and gains of business and profession
where hire purchase constitute the business of the assessee, otherwise as income from other sources. The
hire income from house property is generally taxed as income from house property. Normal deduction
(except depreciation) are allowed while computing the tax.
Sales Tax Aspect
The salient features of sales tax pertaining to hire purchase transactions after the Constitution (Forty Sixth
Amendment)Act, 1982, are as discussed as following:
Hire purchase as Sale: Hire purchase, though not sale in the true sense, is deemed to be sale. Such
transactions are liable to sales tax. Full tax is payable irrespective of whether the owner gets the full price
of the goods or not.
Delivery v/s Transfer of property: A hire purchase deal is regarded as a sale immediately the goods are
delivered and not on the transfer of the title to the goods. The quantum of sales tax is the sales price, thus
the sales tax is charged on the whole amount payable by the hirer to the owner. The sales tax on a hire
purchase sale is levied in the state where the hire purchase agreement is executed.
Rate of tax: The rate of sales tax on hire purchase deals vary from state to state. There is no uniformity
even regarding the goods to be taxed. If the rates undergo a change during the currency of a hire purchase
agreement, the rate in force on the date of the delivery of the goods to the hirer is applicable.
The hire purchase finance companies, like other finance companies, have to pay interest tax under the
Interest Tax Act, 1974. According to this Act, interest tax is payable on the total amount of interest earned
less bad debts in the previous year at a rate of 2 percent. The tax is treated as a tax deductible expense for
the purpose of computing the taxable income under the Income Tax.
Q3. Explain the concept of factoring. What are the characteristics of factoring?
Ans. Factoring is the financial service which involves conversion of credit sales into cash, and collection
of debts at a certain interest rate.
Factoring is an arrangement in which the factor buys the receivables on account of sale of goods at a
certain discount. Thus, the factor exercises control over the credit extended to customers, and administers
the sales ledger of the respective client.
Factoring is an arrangement between a financial institution (the factor), usually a bank and a business
concern, selling goods to the customer. In factoring, the factors buys the accounts receivable of a client
and then pays up to 80 percent of the amount immediately on agreement. The rest of the amount is paid to
the client when the customer pays the debt.
Factoring is broadly defined as a financial service in which receivables are acquired by the factor and
credit sales are converted to cash sales. As a result of this the factor becomes the bearer of the receivables.
Thus, the factor is responsible for all credit control, sales accounting and debt collection from the buyer.
In the case of factoring without recourse, the factor has to bear the losses if the debtor fails to pay the dues
The importance of factoring is well recognized in the industry. The following are the characteristics of
a) Invoices represent book debts assigned in favour of a factor.
b) It requires customer consent to make a repayment directly to the factor not to the client or buyer.
c) Factoring follows dual pricing structure consisting discount charges and service charges.
d) Money is collected from the seller or customer and after deducting customer’s own charges, the
remaining amount of the value of invoice is paid to the client.
e) The period of factoring normally lies between 90 to 150 days. In some cases, the factoring company
extends the period up to 150 days.
f) It is a method of off-balance sheet financing.
g) Bad debts are not considered for factoring.
h) Credit rating is not compulsory but still the factoring companies usually perform credit risk analysis
before entering into an agreement.
Q.4. Explain the different life insurance products.
Ans. Life insurance products or services are the managing tools. They manage the uncertain risks and
losses. Life insurance is a co-operative device for distributing equally the heavy financial losses on an
individual or his family, each bearing a nominal expenditure and feeling secure against physical or
Some of the different types of conventional life insurance products are discussed as below:
Whole life plans, Term assurance plans, Endowment plans and Annuities.
(a)Whole Life Plans: Whole life assurance policies lasts for the whole of the assured’s life, the benefits
being payable at the death only. It is a type of life insurance contract under which the policy holder is
covered for his entire life. Premiums on these policies may be paid in single premium plans, limited
premium plans and continuous premium plans. The main feature of whole life insurance policy is that his
nominees or other beneficiaries receive the policy money.
The different whole life policies are:
Ordinary whole life policies.
Limited payment whole life policies.
Single premium whole life policy.
Convertible whole life policies.
Special whole life policies.
Jeevan Anand plan is a combination of Endowment Assurance and Whole Life plans. It provides financial
protection against death throughout the lifetime of the life assured with the provision of payment of a
lump sum at the end of the selected term in case of his survival.
The benefits in case of death during the selected term is that the sum assured along with the vested
bonuses is payable on death in a lump sum.
(b)Term assurance plans: A term assurance plan is the oldest form of insurance. It provides life insurance
protection for a specified period only. If the policy holder dies during the selected period of 5, 10 or 20
years, the benefits are payable to the named beneficiary as named in the policy. However, if the insured
does not die during the specified period, the insurer pays nothing to the policy holder.
A variety of term forms are available to the purchaser:
Decreasing term Policy.
Renewable term Policy.
(c)Endowment plans: Endowment insurance is a type of life insurance contract which provides for the
sum assured to be paid either at death or after a fixed number of years, whichever comes first. The
number of years is selected by the assured when effecting a policy. The premium is higher in endowment
policies than that of whole life policies. Nowadays this is the most popular form of life insurance. The
endowment policy combines both investment and protection elements, therefore it can be usefully
employed for accumulating money for a variety of purposes.
These policies are of various types:
Ordinary Endowment Policy.
Pure Endowment Policy.
Optional Endowment Policy.
Double Endowment Policy.
The Anticipated Endowment Policy.
The Educational Endowment Policy.
Joint Life Endowment Policy.
(d)Annuities: Annuity has been defined as a contract whereby the insurer, in return for a certain sum of
money paid in a lump sum or by instalments agrees to pay the annuitant an annual amount either for a
specific period or for so long as the annuitant is alive, which is determined by the contract of annuity.
The person during whose life the annuity is paid, is called the annuitant while the amount charged for
benefits is called the purchase price. The annuity is the specific amount to be paid yearly to the designated
A life annuity can be compared to a pure endowment policy. In the case of pure endowment policy, the
entire sum assured becomes payable to the assured if he survives upto the stated age. In the case life
annuity, the payment of the sum is made every year so long as the life survives. Thus, a life annuity is
series of pure endowment.
There are various forms of annuity contracts to suit the diverse needs of the purchasers. The main among
Annuity for Life.
Cash Refund Annuity.
Single Life and Joint Life Annuity.
Q.5. Give an overview of Indian venture capital scenario.
Ans. Venture capital is a type of private equity capital typically provided by professional, outside
investors to new, growth businesses.
Venture capital financing was introduced in India in 1975 by the financial institutions with the
inauguration of Risk Capital Foundation(RCF) sponsored by IFCI with a view to encourage technologists
and professionals to promote new industries.The seed capital scheme was introduced by IDBI in 1976.
Till 1984, venture capital took the form of risk capital and seed capital.In 1986, ICICI launced a
venture capital scheme to encourage new technocrats in the private sector in emerging fields of high-risk
However, the concept of venture capital financing first time got statutory recognition in the fiscal budget
for the year 1986-87.Under the guidelines governing venture capital funds, only all India financial
institutions, all scheduled banks including foreign banks operating in India, and the subsidiaries of the
above were eligible to set up venture capital funds/companies.
Unit Trust of India sponsored venture capital unit schemes. State Bank of India has a venture capital
scheme operated through its subsidiary SBI Caps. A foreign bank set up a Venture Capital Fund in 1987.
In addition, other public sector banks have participated in the equity share capital of venture capital
companies or invested in schemes of venture capital funds.
Several venture capital firms are incorporated in India and they are promoted either by financial
institutions, such as IDBI, ICICI, IFCI, State-level financial institutions and public sector banks, or
promoted by foreign banks/private sector financial institutions.
The venture capital companies operating at present in India can be divided into four categories based on
their mode of promotion. The first category is promoted by All India Development Financial Institution
(IDFI).In India, the other category is promoted by State Level Financial Institutions. Venture capital
funds have been established by their corresponding commercial banks to undertake venture capital
financing activity. Several venture capital funds have been established to provide funding to various small
Q6.What is mutual fund? Illustrate the flow of funds in mutual fund.
Ans: Mutual fund is a type of financial intermediary that pools the funds of investors who seek the same
general investment objective and invest them in a number of different types of financial instruments.
Mutual funds are the associations who wish to make investments in the financial instruments for the
mutual benefit of its members. It serves as a key financial intermediary.
The mutual funds are governed by an investment company with the financial aim of generating high rate
of returns. These asset management or investment management companies invest in different stocks,
bonds and other money market instruments in a diversified manner with the money collected from the
investors. These companies carry out a detailed research and thorough analysis on the market conditions
and orientation of stock and bond prices before investing which help the fund managers to contemplate
properly in the right direction.
The transactions carried out are within the purview of the Securities and Exchange Board of India (SEBI).
This type of investment is popular because mutual funds are managed professionally, gives the investors a
wide range to choose from, and has high liquidity.
The flow of funds in a mutual fund are as follows:
a)Investors money is pooled.
b)Fund manager invests the money in the securities,
c)Securities generates the returns,
d)Returns given to the investors.