Management of financial services

UNIT - I
Decision Support System : Overview, components and classification, steps in
constructing a dss, role in business, group decision support system.
UNIT - II
Information system for strategic advantage, strategic role for information system,
breaking business barriers, reengineering business process, improving business
qualities.
UNIT - III
Information system analysis and design, information SDLC, hardware and software
acquisition, system testing, documentation and its tools, conversion methods.
UNIT - IV
Marketing IS, Manufacturing IS,Accounting IS, Financial IS.
MBA–3rd SEMESTER, M.D.U., ROHTAK
SYLLABUS
External Marks : 70
Time : 3 hrs.
Internal Marks : 30
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MANAGEMENT OF FINANCIAL SERVICES
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UNIT – I
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FINANCE : SPECIALIZATION PAPERS
Q. Define Financial Services. Explain its nature and scope.
Ans. Introduction : Financial services are an important component of the financial system.
There are four components of financial system.
Diagram : Financial System
Meaning of Financial Services : The term financial services is broadly understood to
include banking, insurance, housing finance, stock broking and investment services. The
services include fund-based as well as fee-based services. Financial services cater to the
needs of financial institutions, financial markets and financial instruments geared to serve
individual and institutional investors.
Financial institutions and financial markets facilitate functioning of the financial system
through financial instruments. In order to fulfil the tasks assigned, they required a number of
services of financial nature. Financial services are, therefore regarded as the fourth element
of the financial system.An orderly functioning of the financial system depends to a great deal
on the range of financial services extended by the provider, and their efficiency and
effectiveness.
Financial services not only to help to raise the required funds but also ensure their efficient
deployment. They assist in deciding the financial mix and extend their services up to the
stage of servicing of lenders. In order to ensure an efficient management of funds, services
such as:
Financial
Services
Financial Institutions
Financial System
Financial Market
Financial
Instruments
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ØBill Discounting
ØFactoring of Debtors
ØParking of short term funds in the money market
ØSecuritisation of debts
Sources of Financial Services :
(i) Stock Exchanges
(ii) Specialised and General Institutions
(iii) Non-Banking Finance Companies
(iv) Subsidiaries of financial Institutions
(v) Bank Insurance Companies.
Nature of Financial Services :
Financial services differ in nature from other services. Some of the salient features of
financial services are discussed as follows:
(1) Customer-Oriented : Financial services are customer-oriented. The providers of
such services study the needs on the customers in detail to suggest financial
strategies which give due regard to costs, liquidity and maturity considerations. The
providers of financial services remain in constant touch with the market. They design
both universal and firm-specific projects. This is due to the fact that the present day
firms happen to be different in terms of:
ØSize
ØLevel of Output
ØProfits and Labour force.
(2) Intangibility : Financial services are intangible in nature. Unless the institutions
supplying them have a good image and confidence of the clients, they may not
succeed. Thus, they have to focus on quality and innovativeness of their services to
build their credibility and gain the trust of clients.
(3) Inseparability : the functions of producing and supplying financial services have to be
performed simultaneously. This needs a perfect understanding between the financial
services firms and their clients.
(4) Perishability : Financial services like any other services cannot be stored. They have
to be supplied as required by customers. The providers of financial services have to
ensure a match between demand and supply.
(5) People Based Service : Marketing of financial services is people-intensive and
therefore subject to variability of performance or quality of service. The personnel in
financial services organizations need to be selected on the basis of their suitability.
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(6) Dynamism : Financial services have to be constantly redefined on the basis of socio-
economic changes such as disposable income, standard of living and educational
changes related to the various classes of customers. Financial services institutions
while evolving new services could be proactive in visualizing in advance what the
markets want, or reactive to the needs and wants of customers.
Scope or Constituents of Financial Services : Financial services comprise four major
constituents:
(1) Instruments :These includes:
(i) Equity Instruments
(ii) Debt Instruments
(iii) Hybrid Instruments
(iv) Exotic Instruments.
(2) Market Players :These includes:
(i) Banks
(ii) Financing Institutions
(iii) Mutual Funds
(iv) Merchant Bankers
(v) Stock Brokers
(vi) Consultants
(vii) Underwriters
(viii) Market Makers etc.
(3) Specialised Institutions :These include:
(i) Discount Houses
(ii) Credit RatingAgencies
(iii) Venture Capital Institutions etc.
(4) Regulatory Bodies :These includes
(i) Department of Banking and Insurance of the Central Government.
(ii) Reserve Bank of India
(iii) Securities and the Exchange Board of India (SEBI)
(iv) Board for Industrial and Financial Reconstruction (BIFR)
Q. Explain the Regulatory Framework for Financial Services.
Ans. Meaning of Financial Services : Financial services cater to the needs of financial
institutions, financial markets and financial instruments geared to serve individual and
institutional investors.
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Financial institutions and financial markets facilitate functioning of the financial system
through financial instruments. In order to fulfil the tasks assigned, they required a number of
services of financial nature. Financial services are, therefore regarded as the fourth element
of the financial system.An orderly functioning of the financial system depends to a great deal
on the range of financial services extended by the provider, and their efficiency and
effectiveness.
Different Level of Regulation on Financial Services :
Level I Government of India
AppellateAuthority and Regulator in Certain Cases
Level II Legislation Passed in the Parliament
Banking RegulationAct,
InsuranceAct,
IndianTrustAct, etc.
Level III Institutions Under anAct of Parliament
UTIAct,
LICAct,
GICAct, etc.
Level IV Regulators
RBI
SEBI
IRA
Level V Regulations Given by the Regulators
RBI Directions to Commercial Banks
NBFC's Directions issued by the RBI
SEBI Regulations, Guidelines, Notifications, etc.
Level VI Self - Regulation
By-laws, Rules and Regulation and Code of Conduct
Issued by the various Financial Service Industry
Associations.
Regulatory Framework : For the purpose of studying regulatory framework which govern
the financial services, we can divide the financial services in four different categories:
(A) Banking and Financing Services
(B) Insurance Services
(C) Investment Services
(D) Merchant Banking and other services
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Regulations on all these services are :
(A) Regulations on BankingAnd Financing Services :
(1) Banking Institutions : In order to develop a sound banking system in the
country, the RBI regulates the commercial banking institutions in the following
ways:
(i) It is the licensing authority to sanction the establishment of new bank or
new branch.
(ii) It prescribe the
ØMinimum capital,
ØReserves and use of profits and reserves
ØDistribution of dividends
ØMaintenance of minimum cash reserve
ØOther liquid assets
(iii) It has the authority to inspect or conduct investigation on the working of the
banks; and
(iv) It has the power to control the appointment of Chairman and Chief
Executive Officer of the private Banks and nominate members in the
Board of Directors.
(2) Non-Banking Financial Companies (NBFCs) : The Banking Laws Act, 1963
was introduced to regulate the NBFCs.The RBI which derives powers under this
Act regulates the NBFCs as follows:
(i) It requires the NBFCs of certain categories to register with it and provide
periodical statements on their working.
(ii) It prescribes the types of companies which are eligible to raise funds from
public and its members.
(iii) It also prescribes the extent to which the funds could be raised and the
terms and condition thereof.
(iv) NBFCs are also required to invest certain percentage of the deposits in
the approved securities and maintain reserve fund.
(v) It also collects periodic reports and has the powers to collect information
on any aspect relating to the functioning of the NBFCs , conduct
inspection of the books of NBFCs and investigate on any aspects relating
to the activities of the NBFCs.
(vi) Finally, it has the powers to imposing penalties or suspending or canceling
the license or registration.
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Major Directions:
The RBI has issued three major directions to regulate different forms of Non-Banking
Financial Companies and other financial institutions.They are:
(i) Non-Banking Financial Companies Directions, 1977
(ii) Miscellaneous Non-Banking Financial Companies Directions, 1977
(iii) Residuary Non-Banking Financial Companies Directions, 1977
(B) Regulations on Insurance Services : With an objective of reforming the insurance
sector and allowing private entrants, the Government of India had set up an interim
Insurance Regulation Authority (IRA) in January, 1996 and introduced the Insurance
RegulatoryAuthority Bill, 1996 in December, 1996 to give statutory status. The duties,
powers and functions of the IRAas per theAct are:
(i) To regulate, promote and ensure orderly growth of the insurance business.
(ii) To protect the interest of the policyholders in matter concerning assigning of
policy nomination by policyholders, insurance interest, settlement of insurance
claims, surrender value of the policy and other terms and conditions of contract
insurance.
(iii) To promote efficiency in the conduct of insurance business
(iv) To call for information from, undertake inspection and conduct enquires and
investigation including audit of the insurers, insurance intermediaries and other
organization connected with the insurance business.
(v) To regulate investment of funds by insurance companies.
(vi) To adjudicate disputes between insurers and intermediaries.
(C) Regulations on Investment Services : Investment services are primarily fund based
activities. The mutual funds and venture capital funds are directly fall under the
investment services. SEBI is emerging as a powerful regulator of various financial
services.
Securities and Exchange Board of India (SEBI) : The SEBI Act, 1992 entrusts the
responsibility of protecting the interest of investors in securities.They are:
(i) Regulating the business of stock exchange and any other securities markets.
(ii) Registering and regulating the working of stock brokers.
(iii) Registering and regulating the working of collective investment schemes
including mutual funds.
(iv) Promoting investors education and training of intermediaries of securities
markets.
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(v) Calling for information from, undertaking inspection, conducting inquires and
audit of stock exchanges.
(vi) Conducting research for the above purpose
(vii) Performing some other functions as may be required.
(D) Merchant Banking and Other Services : There are several intermediaries
associated with management of public and rights issue of capital. While the merchant
bankers is the main intermediary others associated with the issue management are
Underwriters, Brokers, Advisors and Credit Rating Agencies. The SEBI has issued a
detailed guideline/regulation on many of these intermediaries.They are:
(i) SEBI ( Merchant Banker) Regulation, 1992
(ii) SEBI Rules for Underwriters
(iii) SEBI ( Brokers and Sub-brokers) Regulation 1992
(iv) SEBI Rules for Registrar to an Issue and ShareTransferAgents, 1993
(v) SEBI (DebenturesTrustees ) Regulations, 1993
Graphic Presentation of Regulation on Financial Services :
Regulation on Financial Services Financial Services
Banking and Insurance Investment and Merchant Bankers
Financing Services Fee-based Services and Other Services
Services
Banking Insurance Securities Contracts SEBI Regulations,
Regulation Act, 1938 Act, 1956 1992
Act, 1949 CompaniesAct, 1956
IndianTrustAct, 1882
Reserve Bank Insurance SEBI SEBI Rules for
of India Regulatory Registrar
Authority And Share
TransferAgents
Notification, Regulations, SEBI Regulations,
Rules, Guildelines etc. 1994
Directions, etc.
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Q. Explain the risk involved in Financial Services.
Ans. Meaning of Financial Services : The term financial services is broadly understood to
include banking, insurance, housing finance, stock broking and investment services.
Classification of Financial Services:- Financial services include fund-based as well as fee-
based services.
(i) Fund-based Services: In fund based services, the firm raises equity, debt and deposits
and invests in securities or lends to those who are in need of capital.
(ii) Fee-based Services: In fee-based services, the financial service firms enable other to
raise capital from the market.
The financial sector is also known for its dynamic character and within a short period, it has
introduced several new products and services. Though the sector is growing rapidly all over
the world, the financial markets have seen a number of bank and insurance companies
failure and market crashes. The industry is operating in an environment where the risk is
very high.
Trading in Risk :There are two types of risk involved in financial services:
(1) External Risk
(2) Internal Risk.
(1) External Risk : It could be due to changes in interest rate in the market that reduces
the value of existing financial claims.As these are events arising outside the company,
they can be grouped under external sources. The following are few external sources of
risk:
(i) Institutions Providing Direct Finance : There are different types of institutions
available in the financial market providing finance for various requirements.
There are many examples:
ØCommercial Banks normally provide finance for short term needs of the
firms.
ØTerm-lending institutions meet the long term funding needs of industries
which are commonly known as project financing.
ØHousing finance companies provide funds to individuals and some times
house-construction companies for acquisition of house property.
ØVenture capital provides funds in the form of equity to new projects which
involve some innovative ideas.
External Risk :
ØA bank may fail to honour the deposit claims of the deposit holders if the
non-performing assets of the bank are above its net worth.
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ØAnother important external reason for the failure of these institutions in the
business of lending is the quality of other assets in their total assets. If the
investment is made in high-risk debt or equity securities, any adverse
development in the capital market or the issuing company or agency will
reduce the value of the investments and in this process it may affect the
bank's ability to meet the liability.
(ii) Insurance Services : Insurance services take the risk associated with the
assets of their clients. The premium collected for this service in turn is either
invested in securities or led to outsiders who are in need of money.
External Risk :
ØAn insurance company may fail to honour its obligation if the investments
they have been made poor.
ØSimilarly, the quality of assets they have insured may also turn bad.
ØThere are two common problems in insurance services namely :
(a) Moral Hazard : Moral hazard is the tendency of an insured to take greater
risk because she/he is insured. For example, a machine owner may run
the machine continuously ignoring the normal shut-down requirement to
complete an order in less time. Without insurance, the owner may not turn
the unit ignoring the normal shut-down requirement.
(b) Adverse Selection : The adverse selection is the tendency of insuring
the low quality asset and not insuring high quality assets.
(iii) Stock Broking Services : Stock Brokers but and sell on behalf of their clients.
They collect the securities from the sellers and collect money from the buyer and
hand over the funds to seller after deducting the brokerage for the service
rendered.
External Risk : Though the activity looks relatively simple, the risk from external
sources are very high:
ØFirst, in situation where the trades are not guaranteed by the stock
exchanges.
ØThere is always a possibility that the client may fail to honour the
commitment but the broker has to make good the loss.
(iv) Leasing and Hire Purchase : Leasing and Hire Purchase service is very close
to the banking service. These companies also raise money from the market
through deposits and other means and lend to industries. Of course, the lending
is done not in the form of term loan or working capital loan, but in the form of
assets.
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External Risk : Leasing and hire purchase companies are also affected by the
frequent changes in the regulations. The recent Reserve Bank of India
regulation is expected to wipe out many of these companies from the market as
RBI has put rigid norms in raising deposits from the public.
(v) Institutions Offering Fee Based Services : Merchant Banking, Mutual Funds,
Credit Rating , Merger and Acquisition are few examples of fee based services
offered by the financial services companies.
External Risk :
ØThere are major changes in the regulation of merchant banking and
mutual funds which will effectively reduce the number of players in their
respective industry.
(2) Internal Risk : Financial Services Company often fails due to their own mistakes.
There are several internal factors that contribute to the failure of the firms in the
financial services industry. Some of these internal sources of risk for different financial
services companies are discussed below:
(i) Institutions Providing Direct Finance : Banks, term lending institutions and
other companies providing direct finance are exposed to several internal source
of risk.
Internal Risks :
ØFirst and foremost among them is the quality of evaluation of the loan
proposals. Often, the appraising officers fail to consider vital issues that
affect the outcome of the project.
ØThey are also affected by the asset-liability mismatch and excessive
dealing in the security market.
ØAnother important source of internal risk is the policy of the institution in
using derivatives in managing their risk. If the bank fails to use the
derivatives products in hedging the risk, its performance may be affected if
the market moves against the position the bank is holding.
(ii) Insurance Services : As in case of financial services companies which are in
the business of direct lending, insurance companies are also affected by the
efficiency in assessing the insurance proposal.
Internal Risk : Unless, the internal system of evaluating the insurance proposal
is efficient, the company will end up in insuring bad assets.
(iii) Stock Broking Service : Though the stock broking is a fee based service, there
are many sources of risk attributable to internal factors. Stock broking activity
typically involves
ØReceipt of the order from the clients
ØExecution of the order in the exchange
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ØReceipt of documents or cash from the clients and delivery of cash or
documents to the clients.
Internal Risk :
ØThere are many fake documents in the market
ØEven if the stocks delivered are good and genuine, there is no guarantee
that they are good for delivery.
ØMany Indian stock brokers have also trade on their account and their
proximity with the trading system does not guarantee profit. On several
occasions, many big brokers have incurred huge losses on their trading.
(iv) Leasing and Hire Purchase : The business of leasing and hire purchase is
highly competitive with too many players in the market.
Internal Risk :
ØFirst the credit rating information in India is relatively weak and published
accounts are not reliable to assess the credit worthiness of the borrowers.
ØSecondly, the competition in the industry allows very little time to take
decision on sanctioning the proposals, otherwise, the competitors will
take away your clients.
ØAnother internal problem is on the asset-liability mismatch.
(v) Institutions Offering Fee Based Services : Institutions offering specialized
services are exposed to several internal risks.
Internal Risk :
ØThe performance of mutual funds directly depends on the ability of the
fund managers in reading the market and making investments
accordingly.
ØOn the other hands, if they freely use the information to their own benefit, it
hurts the performance of the funds.
Types of Risk : In the previous section, the different source of risk for various financial
services firms have discussed. They could now broadly be classified under the following six
heads:
1. Credit Risk : Many of the financial services firms like banking, credit cards, lease and
hire purchase are also involved in fund based business. The credit risk affects the fund
based activities of the financial services. The risk arises in evaluating the proposals for
lending. While credit rating, either by credit rating institutions or internally helps to
quantify the risk, the percentage of non-performing assets measurers the impact of
credit risks in the firms.
2. Asset-Liability Gap Risk : This risk also applies to firms doing fund based services.
Since funds raised from external sources play a major role in the fund based activities,
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the duration of the liability is an important variable which needs to be considered while
lending. For example, if a firm gives a five year loan against a deposit for two years,
there is a mismatch between the liability and asset.
3. Due-Diligence Risk : Merchant banking companies and other financial services firms
which are offering fee based services like merger and acquisition have to exercise due
diligence in their operations. This due diligence may have to be provided to the
regulatory agencies or to their clients. For example, the SEBI regulation on Merchant
Banking requires the lead manager to provide a due diligence certificate in the
prescribed form before the public or rights issue opens for subscriptions. In the event
of any lapse or mistake noticed in the due diligence subsequently, it will affect the
financial services firm which has provided the due-diligence certificate in different
ways.
4. Interest Rate Risk : This risk affects the firms which are in fund based activities. The
interest rate risk arises when there are frequent changes in the interest rates in the
market.
5. Market Risk : Financial services firms which are in the investment business or
investing a part of the funds in securities are exposed to the market risk. This risk
arises on account of changes in the economy and all securities are affected.
6. Currency Risk : Firms which are dealing in foreign exchange currencies are exposed
to this source of risk. Bank, financial institutions and money changers are few financial
services firms which are normally affected by this source of risk. This risk arises
because of changes in the currency values which in turn was determined by the
fundamental economic strength of the two countries and short run demand and supply
gap. These firms are affected by currency risk when they hold currencies or liabilities
in the form of either forward contract or interest/principal payment.
(i) When the Rupee depreciates, it affects those who are holding foreign currency
liabilities.
(ii) When the Rupee appreciates, if affects those who are holding foreign currency.
Q. Explain how you can manage the risk involved in Financial Services.
Ans. Introduction : It may not be feasible to start any venture without taking risk. Risk is an
integral part of any business and the reward or profit is directly proportional to the risk
undertaken. In the case of financial services industry, the firms deals with financial claims
which are by nature risk products. We will now discuss different strategies available to
manage these risks:
Management of Risk :
(1) Managing Credit Risk : The first step in the process of managing the credit risk is the
quantification of credit risk the firm is exposed. The quantification is done through
credit rating. The firm can adopt the following strategy in managing the credit risk. The
steps involved in this strategy are:
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(i) Desirable Loan Portfolio : The starting point could be to develop a desirable
loan mix which consists of different categories of the borrowers.
(ii) Continuous Monitoring : This is more important in managing the credit risk.
This continuous monitoring requires flow of information from the borrowers and
also from the market and the firm has to develop necessary mechanism to
collect such information from the borrowers and the market intelligence system.
Since the performance of the borrowers deteriorate over a period, the
monitoring system in force should give early warning and thus assumes a
crucial role in the credit risk management.
(iii) Action on Doubtful and Bad Debts : The moment the monitoring system
raises some doubts about the loan account, action need to be initiated to
recover the loans.The steps are:
ØFirst things that need to be done is to check the assets, movable or
immovable, that are given as a security to avail the loan.
ØIf the asset value is found is to be inadequate, then demand is to be made
for additional security. Along with this process, it is also useful to offer a
good discount to motivate the borrowers to prepay the loan.
(2) Managing Asset-Liability Gap Risk : This risk also applies to firms doing fund based
services. Since funds raised from external sources play a major role in the fund based
activities, the duration of the liability is an important variable which needs to be
considered while lending. For example, if a firm gives a five year loan against a
deposit for two years, there is a mismatch between the liability and asset. The
techniques of management are:
Gap Management: The first job in the ALM is to measure gap. There are two
ways in which the gap can be measured. If the gap is measured at a macro level,
it has limited use. It given an idea about the level of risk involved in the firm. The
second method which is useful in ALM is to get a detailed break up of 'Gap'. The
gap has to be necessarily closed or managed.
(3) Managing Due-Diligence Risk : The professional efficiency and ethics followed by
the firm determine this source of risk. Since the financial services firm is giving a
certification to either the regulating agencies or its client on the completion of required
formalities, they are expected to perform efficiently with thigh ethical standards. This
risk could be managed by bringing in more professional an creating right environment
within the organization.
(4) Managing Interest Rate Risk : Interest rates in the economy play a major role in the
financial markets. For managing interest rate risk interest rate swap is adopted.
Interest Rate Swap : Interest rate swap involves the exchange of interest payments.
It usually occurs when a person or a firm needs fixed rate funds but is only able to get
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floating rate funds. It finds another party who needs any floating rate loan but is able to
get fixed rate funds. The two, known as counter parties, exchange the interest
payments and the loans according to their own choice. It is the swap dealer, usually a
bank, that brings together the two counter-parties for the swap.
(5) Managing Market Risk : This is the minimum risk that investors in the market are
exposed. Firms which are investing in the securities have to manage the market risk.
There are several ways through which the market risk is managed. Some firms take a
view on the market and switch over the funds from one market to another in order to
minimize the risk.
(6) Managing Currency Risk : Firms dealing in foreign exchange are exposed to
currency risk. Non-banking entities, such as traders, that use the foreign exchange
market for the purpose of hedging their foreign exchange exposure on account of
changes in the exchange rate.They are known as hedgers.
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UNIT – II
Q. Explain the Operations of Indian Stock Market.
Ans. Meaning of Stock Exchange : Stock exchange means an organized market where
securities issued by companies, government organizations and semi-organizations are sold
and purchased. Securities include:
(i) Shares
(ii) Debentures
(iii) Bonds etc.
Definition of Stock Exchange :
According to Pyle :
“Stock Exchange are market places where securities that have been listed thereon,
may be bought and sold for either investment or speculation.”
Features of Stock Exchange : The main features of stock exchange are as follows:
(1) Organised Market : Stock Exchange is an organized market. Every stock exchange
has a management committee, which has all the rights related to management and
control of exchange. All the transactions taking place in the stock exchange are done
as per the prescribed procedure under the guidance of management committee.
(2) Dealing in Securities issued by various concerns : Only those securities are
traded in the stock exchanges which are listed there. After fulfilling certain terms and
conditions, a company gets it security listed on stock exchange.
(3) Dealing only through Authorized Members : Investors can sale and purchase
securities in stock exchange only through authorized members. Stock exchange is a
specified market place where only the authorized members can go. Investor has to
take their help to sale and purchase.
(4) Necessary to obey the Rules and Bye-Laws : While transacting in stock exchange,
it is necessary to obey the rules and bye-laws determined by stock exchange.
Functions of Stock Exchange : The main functions performed b stock exchange are as
follows:
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(1) Providing Liquidity and Marketability to existing securities : Stock exchange is a
market place where previously issued securities are traded. Various types of
securities are traded here on regular basis. Whenever required, investor can invest his
money through this market into securities and can reconvert this investment into cash.
(2) Pricing of Securities : A stock exchange provides platform to deal in securities. The
forces of demand and supply work freely in the stock exchange. In this way, prices of
securities are determined.
(3) Safety of Transactions : Stock exchanges are organized markets. The fully protect
the interest of investors. Each stock exchange has its own laws and be-laws. Each
member of stock exchange has to follow them and any member found violating them,
his membership is cancelled.
(4) Contributes to Economic Growth : Stock exchange provides liquidity to securities.
This gives the investor a double benefit-first, the benefit of the change in the market
price of securities and secondly, n case of need for money they can be sold at the
existing market price at any time.
(5) Spreading Equity Cult : Share market collects every types of information in respect
of the listed companies. Generally this information is published or otherwise n case of
need anybody can get it from the stock exchange free of any cost. In this way, the stock
exchange guides the investors by providing various types of information.]
(6) Providing Scope for Speculation : When securities are purchased with a view to
getting profit as a result of change in their market price, it s called speculation. It is
allowed or permitted under the provisions of the relevant Act. It is accepted that in
order to provide liquidity to securities, some scope for speculation must be allowed.
The share market provides this facility.
Stock Exchange in India : There are 24 stock exchanges functioning currently in India. The
names are given below:
1. Mumbai Stock Exchange OR 12. Bhubaneswar Stock Exchange
Bombay Stock Exchange-BSE 13. Cochin Stock Exchange
2 National Stock Exchange (NSE) 14. Coimbatore Stock Exchange
3. Over the Counter Exchange o 15. Guwahati Stock Exchange
India (OTCEI) 16. Jaipur Stock Exchange
4. Calcutta Stock Exchange(CSE) 17. Kanpur Stock Exchange
5. Delhi Stock Exchange (DSE) 18. Ludhiana Stock Exchange
6. Chennai Stock Exchange 19. Mangalore Stock Exchange
7. Ahmedabad Stock Exchange 20. Meerut Stock Exchange
8. Hyderabad Stock Exchange 21. Patna Stock Exchange
9. Bangalore Stock Exchange 22. Pune Stock Exchange
10. Indore Stock Exchange 23. Rajkot Stock Exchange
11. Baroda Stock Exchange 24. Capital Stock Exchange Kerala Ltd.
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Q. What are the main features of NSEI? Explain the trading process of NSEI
Ans. National Stock Exchange of India (NSEI) : The NSEI has been established in the
form of a traditional competitor stock exchange. It is an exchange where business is carried
on in the securities of the medium & large-sized companies & the government securities.
This stock exchange is fully computerized.
The NSEI was established in the form of a public limited company in Nov., 1992. Its
promoters are like this:
(i) The Industrial Development Bank of India (IDBI).
(ii) The Industrial Finance Corporation of India (IFCI).
(iii) The Industrial Credit & Investment Corporation of India (ICICI).
(iv) The Life Insurance Corporation of India (LIC).
(v) The General Insurance Corporation of India (GIC).
(vi) The SBI Capital Market Limited.
(vii) The Stock Holding Corporation of India Ltd.
(viii) The Infrastructure Leasing & Financial Services Ltd.
Features or Nature of NSEI : The Chief features of the NSEI are following:
1) Model Exchange : The NSEI is the first stock exchange of its kind. The system of
transaction of securities is very efficient and transparent. It is, therefore called a model
exchange.
2) Floorless : In the NSEI there is no special importance of trading. The terminals of the
NSEI have been established almost throughout the country.
3) Two Segments : On the basis of the transactions of securities done on the NSEI, it
can be divided into two parts:
(i) Wholesale Debt Market (WDM): This can be called money market segment. It
mai9nly concerns the government securities, bonds of public sector
undertakings, treasury bills, commercial papers, certificates of deposits, etc.
(ii) Capital Market Segment: Its concern is with the shares and debentures of
companies.
4) Easy Access : It being a special floorless stock exchange, every big and small
investor can easily approach it.
5) Transparency in Transactions : Anybody can visit the local terminal of the NSEI
and have a look at various transactions of the securities. Therefore is no possibility of
any fraud in transactions.
6) Competition : The NSEI has removed the shortcomings of the traditional share
markets and it has attempted to provide better facilities to the investors. That’s why the
remaining share markets are nervous at its success. Now, they are also trying to
provide good facilitate to the investors. In this way, there is a competition between two
kinds of share markets.The investors are getting the benefits of this competition.
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7) Same Price : Under the traditional system, the shares of a company could have
different rates in different share markets but at the NSEI all the shares have the same
value in all the towns.
8) Listing of other Stock Exchange : The securities of those companies which have not
been listed on other share markets can be traded on the NSEI.
9) Undisclosed Identity of Participants : Information about any individual trading on
any terminal of the NSEI cannot be passed on to any other person. In this way, the
secrecy about the identity of the investors is maintained.
10) Order Driven System : The NSEI is a stock exchange based on the order driven
system. It means that the sellers and buyers first place the order about the type of
security, its number, rate and time when they are ready to buy or sell them. On the
receipt of this order on the computer, the process of order matching starts. The
moment a good matching takes place, its information appears on the computer
screen.
Purposes of NSEI :
The chief aims of the establishment of the NSEI are the following:
1) Single Stock Exchange at National Level : It was decided by a Shri M.J. Pherwani
that there should be a single stock exchange at the National level so that the
confidence of the investors in the capital market increases.
2) Increasing Numbers of Transactions : For the last few decades, there has been an
increase in the numbers of investors while the stock exchange system continues to be
old. In such a situation the transactions cannot be settled easily. The purpose of the
establishment of the NSEI is to solve this problem.
3) Increasing Transaction Costs : The transaction costs increase because of the
distance between the stock exchange and the investors. Through the medium of
NSEI, an effort bas been made to reduce these costs.
4) Decreasing Liquidity : There is a decline in the liquidity of the securities under the
system of local stock exchange because the people doing transaction on a single
stock exchange are limited in number. On the contrary, through the medium of NSEI
the investors from the entire country can trade simultaneously at a single stock
exchange. This increase the liquidity of securities. Therefore, the purpose of the NSEI
is to check the decreasing liquidity of securities.
5) Developing a Debt Market : The purpose of the NSEI is to develop a debt Market. In
the traditional share market, transactions are mostly in shares and no attention is paid
to Debentures. Now the NSEI has divided the market in two parts-Debt market and
capital Market.Therefore, this division is helpful in the development of debt market.
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6) Conforming to International Standard : Many modern share markets are being
established at the International Level. In India also, there is a dire need of establishing
a stock exchange of international level. The NSEI is a modern stock exchange based
on the international standards.
7) Outdated Settlement System : In the traditional share markets, the system of
settlement of transactions had become old. It was getting difficult to control the ever
increasing number of transactions under this system. Under the NSEI, provision has
been made to settle the transaction very quickly.
Trading Process on NSEI : The selling and buying process of securities on the NSEI is as
under:
1) Placing the Order : First of all the person buying or selling securities places an order.
In this order, he tells the name of the company whose security he is ready to buy or sell
at what price, in what quantity and for what period of time.
2) Conveying the Message to Computer : The moment the terminal operator receives
the order from the customer, he feeds it in the computer.
3) Starting of Matching Process : The moment the computer receives orders, it starts
the process of matching. During the process of matching orders, the best matching of
the selling or buying order is sought to be found out.
4) Accepting the Order : As soon as the best matching of the buying and selling orders
is established during the process of matching orders, its list is immediately obtained on
the computer screen. This information tells us at what rate, time.All the terminals of the
NSEI established throughout the country go on feeding their computers continent with
what party your order has been transacted.
5) Delivery and Payment : After the transaction has been settled, the delivery and
payment are made according to the rules of the NSEI.
Q. What are the main features of OTCEI? Explain the trading process of OTCEI.
Ans. Over the Counter Exchange of India (OTCEI) : The OTCEI is a completely
computerized and special ringless stock exchange which is different from the traditional
stock exchange and on which the buying and selling of securities is absolutely transparent
and moves at a great speed. Its counters are spread all over the country where transactions
are made with the help of telephone.
The OTCEI was established under section 25 of the CompaniesAct, 1956 in October, 1990.
The promoters of the OTCEI are the following financial and other institutions:
(i) The UnitTrust of India
(ii) The Industrial Credit and Investment Corporation of India.
(iii) The Industrial Development Bank of India
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(iv) The Industrial Finance Corporation of India
(v) The Life Insurance Corporation of India
(vi) The General Insurance Corporation of India
(vii) The SBI Capital Market Limited
(viii) The Canbank Financial Services Limited.
Features or Nature of OTCEI :The main features of the OTCEI are the following:
(1) Ringless Trading : There s no particular place for transacting business in securities
under the OTCEI. This exchange has its counters/offices throughout the country. Any
buyer or seller of securities can go the counter/officer and have transaction through
the medium of the operator.
(2) Nation Network : The OTCEI has its network all over the country.All the counters are
linked with the central terminal through the medium of computers. Therefore, the
facility of nationwide listing is available here. In other words by listing on one
exchange, one can have transactions with all the counters in the whole country.
(3) Exclusive List of Companies : On the OTCEI only those companies are listed whose
issued capital is 30 lakhs or more. In the old share markets this amount used to be ten
crores on the BSE and three crores on the other exchanges and hence, listing was not
possible in case the issued capital was less than three crores. Those companies
which have been listed on the old share markets cannot be listed on the OTCEI.
(4) Fully Computerized : This exchange is fully computerized. It means that all the
transactions done on this exchange are done through the medium of computers.
(5) Sponsorship : In order to get listed on the OTCEI, a company has to find a member to
sponsor it. The main job of a sponsor is market making. T means a sponsor has to be
read to buy or sell the shares of that company at least for a period of 18 months. In this
way, a sponsor creates liquidity in securities.
(6) Investor’s Registration : All the investors doing transactions on the OTCEI have got
to register themselves compulsorily. Registration can be got done b giving an
application at an counter. The registration is called the INVESTOTC CARD. On the
basis of this card, one can do transactions of securities at any counter throughout the
country.
(7) Greater Liquidity : There is greater liquidity in securities because of the sponsor’s job
of market making.
(8) Transparency in Transactions : All the transactions are done in the presence of the
investor. The rates of buying and selling can be seen on the computer screen. The
operator cannot do any fraud or mischief with the transactions.
(9) Faster Delivery and Payment : On the OTCEI, delivery in case of buying and
payment in case of selling are both very fast. The work of delivery and payment in case
of listed securities and permitted securities is completed within seven days and 15
days respectively.
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(10) Two ways of Public Offer : A company listed on the OTCEI can issue security in two
ways. Firstly, the company can go directly to the public. This is called Direct Offer
System. Secondly, the company sells its securities to the sponsor at a particular price.
Then the sponsor sells them to the public.This is called Indirect Offer System.
(11) Easy Access : In the big cities the counters of the OTCEI can be seen like ordinary
shops.Any body can go the counter and do buying and selling of securities.
Trading Process : One can trade in securities b going to any counter of the OTCEI. All the
counters are linked with the central computer at the OTCEI headquarter. This office is in
Mumbai.There can be three types of trading on the OTCEI:
(1) Initial Allotment : When an investor is allotted shares through the medium of OTCEI,
he is given a receipt which is called counter receipt-CR. This receipt is just like the
share certificate. Selling and buying can be done through the medium of this receipt.
(2) Buying in the Secondary Market : For the purpose of buying shares listed on the
OTCEI, a person has to get himself registered (if he is not already registered). After
this, he informs the counter operator about the number of the shares to be purchased.
The counter operator displays the rates on the screen. After getting himself satisfied
with the rate, the investor hands over the cheque to the operator. On the encashment
of the cheque, the CR is handed over to the investor. This procedure takes about a
week.
(3) Selling in the Secondary Market : An investor who has purchased shares from the
OTCEI can sell his shares at any counter of the OTCEI. After getting himself satisfied
with the rate displayed on the screen, the investor hands over the Counter Receipt and
the Transfer Deed to the Operator. The operator prepares the Sales Confirmation Slip
(SCS) and a copy of it is handed over to the seller. The operator sends the CR, TD and
SCS to the Registrar for confirmation.After confirming every detail the Registrar sends
them back to the counter operator. In the end the operator issues a cheque to the seller
and receives back the SCS from the seller.
Purposes of OTCEI : The objects of the establishment of the OTCEI may be described as
under:
(1) Liquidity : The first object for the establishment of the OTCEI is o maintain liquidity in
the securities of the small companies. The sponsor has got to do the job of market
making.
(2) Transparency : The second aim of this share market is to maintain transparency of
transactions. Here all the transactions are made on the computer screen. This
eliminates any chance of fraud.
(3) Investor’s Grievances : An important aim of the establishment of the OTCEI is the
speed solution of the problems of the investors.
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(4) Quick Settlement : In the traditional share markets both the delivery and payment
take time.This problem has been overcome with the help of the OTCEI.
(5) Listing of Small Companies : Small companies remain deprived of being listed
because they are unable to fulfil the conditions laid down by the old share markets.
(6) Access : This stock exchange is of the ringless type and therefore, has its counters all
over the country.
Q. Write brief notes on the concept of mutual funds. Also explain the
organizational functions of mutual funds.
Ans. Meaning of Mutual Fund : A mutual fund is essentially a mechanism of pooling
together the savings of a large number of small investors for collective investment, with an
avowed objective of attractive yields and capital appreciation, holding the safety and liquidity
as prime parameters.
Amutual fund is a trust that pools the savings of a number of investors who share a common
financial goal.The money, thus, collected is then invested in capital market instruments such
as shares, debentures and other securities. The income earned through these investments
and the capital appreciation realized are share by its unit holders in proportion to the number
of units owned by them.
Working of a Mutual Fund : The flow chart below describes broadly the working of a
mutual fund :
Returns
Passed back to
Generates
Investors
Pool their
money with
Fund
Manager
Invest in
Securities
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Mutual Fund – Organisation : There are many entities involved and the diagram below
illustrates the organization set up of a mutual fund:
Organisation of a Mutual Fund
A mutual fund can be constituted either as a corporate entity or as a trust. In India, UTI was
set up as a corporation under an Act of parliament in 1964. Indian banks when permitted to
operate mutual funds, were asked to create trusts to run these funds. A trust has to work on
behalf of its trustees. Indian banks operating mutual funds had made a convincing plea
before the government to allow their mutual funds to constitute them as ‘Asset Management
Companies’. The department of Company Affairs, Ministry of Law, Justice and Company
Affairs has issued guidelines in respect of registration of Assets Management Companies
(AMCs) in consultation with SEBI, as follows:
(1) Approval of AMC by SEBI : As per guidelines, AMC shall be authorized for business
by SEBI on the basis of certain criteria and the Memorandum and Articles of
Association of theAMC would have to be approved by SEBI.
(2) Authorised Capital of AMC : The primary objective of setting up of an AMC is to
manage the assets of the mutual funds and other activities, which it can carry out, such
as, financial services consultancy, which do not conflict with the fund management
activity and are only secondary and incidental. Many players who help in running a
mutual fund are as follows:
SEBI
Unit Holders
Sponsors
Trustees
The Mutual Fund
Custodian
AMC
Transer Agent
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(i) Registers and TransferAgents :The major responsibilities are:
ØReceiving and processing the application form of a mutual fund
ØIssuing of unit/share certificate on behalf of mutual fund
ØMaintain detailed records of unit holders transactions
ØPurchasing, selling, transferring and redeeming the Unit/Share certificate
ØIssuing of income /dividend, broker cheques etc.
(ii) Advertiser : Major responsibilities of an adviser include:
ØHelping mutual funds organizers to prepare a media plan for marketing
the fund.
ØIssuing/buying the space in newspapers and other electronic media for
advertising the various features of a fund.
ØArranging or hoardings at public places.
(iii) Advisor/ Manager : It is generally a corporate entity that does the following
jobs:
ØProfessional advice on the fund’s investments
ØAdvice on asset management services.
(iv) Trustees : Trustees provide the overall management services and charge
management fee.
(v) Custodian : A custodian is again a corporate body that carries out the following
functions:
ØHolds Securities
ØReceives and delivers securities
ØCollects income/interest/dividends on the securities
ØHolds and processes cash
(vi) Other Players : Besides the above, other players are as under:
ØFundAdministrator
ØFundAccounting Services
ØLegalAdvisors.
ØFund Officers
ØUnderwriters/Distributors
Q. What are the advantages of investing in mutual funds? Also explain the
drawbacks of mutual funds.
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Advantages of Investing in Mutual Funds : The advantages of investing in mutual funds
are:
(1) Professional Management : Most mutual funds pay top-flight professionals to
manage their investments. These managers decide what securities the fund will buy
and sell.
(2) Regulatory Oversight : Mutual funds are subject to many government regulations
that protect investors from fraud.
(3) Liquidity : It’s easy to get your money out of a mutual fund. Write a cheques, make a
call and you’ve got the cash.
(4) Convenience : You can usually buy mutual fund shares by mail, phone or over the
Internet.
(5) Low Cost : Mutual fund expenses are often no more 1.5 % of your investment.
(6) Investment variety and spread in different industries.
(7) CapitalAppreciation
(8) No impulsive decision-making regarding purchase or sale of share/securities, since
the funds are managed by expert, professional fund managers who have access to
the latest detailed information regarding the stock market.
(9) Even the smallest dividend or capital gain gets reinvested, thus enhancing the
effective return.
(10) Freedom from paperwork.
(11) Transparency
(12) Flexibility
(13) Choice of Schemes
(14) Tax benefits on invested amounts/returns/capital gains
(15) Well regulated
Drawbacks of Mutual Fund : Mutual funds have their drawbacks:
(1) No Guarantees : No investment is risk-free. If the entire stock market declines in
value, the value of mutual fund shares will go down as well.
(2) Fees and Commissions : All funds charge administrative fees to cover their day-to-
day expenses. Some funds also charge sales commissions or ‘loads’ to compensate
brokers, financial consultants, or financial planners.
(3) Taxes : During a typical year, most actively managed mutual funds sell anywhere from
20 to 70% of the securities in their portfolios. If your fund makes a profit on its sales,
you will pay taxes on the income you receive, even if you reinvest the money you
made.
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(4) Management Risk : When you invest in a mutual fund, you depend on the fund’s
manager to make the right decisions regarding the fund’s portfolio. If the manager
does not perform as well as you had hoped, you might not make as much money on
your investment as you expected.
Q. What are the different types of mutual funds schemes?Also explain the types of
mutual fund schemes in India.
Types of Mutual Fund Schemes : A wide variety of mutual fund schemes exists to cater to
the needs such as financial position, risk tolerance and return expectations etc.
Types of Mutual Fund Schemes
By Structure By Investment Other Schemes
Objectives
Open-ended Funds Growth Funds Tax Saving Funds
Close-ended Funds Income Funds Special Funds
Balanced Funds
Area Funds
(A) By Structure : On the basis of structure, there are two types of mutual fund schemes:
(1) Open-ended Funds : In open-ended funds, there is not limit to the size of funds.
Investors can invest as and when they like.
(2) Close-ended funds : These funds are fixed in size as regards the corpus of the
fund and the number of shares. In close-ended funds, no fresh units are created
after the original officer of the scheme expires.
(B) By Investment Objectives : On the basis of investment objectives there are four
types of mutual funds schemes:
(1) Growth Funds : These funds do not offer fixed regular returns but provide
substantial capital appreciation in the long run. The pattern of investment in
general is oriented towards shares of high growth companies.
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(2) Income Funds : These funds offer a return much higher than the bank deposits
but with less capital appreciation. The emphasis being on regular returns, the
pattern of investment in general is oriented towards fixed income-yielding
securities like non-convertible debentures of consistently good dividend paying
companies etc.
(3) Balance Schemes or Income and Growth-Oriented Funds : These offer a
blend of immediate average returns and reasonable capital appreciation in the
long run.
(4) Area Funds : These are funds that are raised on other countries for providing
access to foreign investors. The India Growth Fund and the India Fund raised in
the US and UK respectively are examples of area funds.
(C) Other Schemes :
(1) Tax Saving Funds : These funds are raised for providing tax relief to those
investors whose income comes under taxable limits.
(2) Special Funds : These funds are invested in a particular industry like cement,
steel, jute, power or textile etc. These funds carry high risks with them as the
entire fund is exposed to a particular industry.
Types of Mutual Fund Schemes in India :
(1) Growth Funds :There are the following features:
(i) Objective : Generating substantial capital appreciation
(ii) Investment Pattern : Nearly all in equity shares
(iii) Duration : SevenYears
(iv) Investment Risk : High risk in reinvestment schemes
(v) Returns : No assured return but high returns are expected
(vi) Liquidity : No repurchase facility except at the end of the scheme
(vii) Transfer of units is allowed
Some Examples of Growth Schemes : Schemes issued by
(a) Master Share, Master share plus, Master Gain, UGS-200 UnitTrust of India
(b) Magnum Express, Magnum Multiplier SBI Mutual Fund
(C) Canshare, Canstar Cap, Cangrowth, Canbonus Canbank Mutual Fund
(d) Ind Ratna, Ind Sagar, Ind Moti Indbank Mutual Fund
(2) Income Funds :The Income funds are the following features:
(i) Objective :Assured minimum income and safety of capital
(ii) Duration : 5-7 years
(iii) Investment Pattern : Bulk of funds invested in fixed income securities like
government bonds, company debentures, etc. and rest in equity shares.
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(iv) Investment Risk :Absolute Safety
(v) Return : 14.75% p.a. upwards-payable monthly or quarterly plus mid scheme
bonus and end of the scheme appreciation.
(vi) Liquidity : No listing on stock exchange and units are not transferable.
Some examples of Income Funds:
(a) Units Scheme of 1964, Growing Income Unit Scheme of 1987 Unit trust of India
(b) Magnum Monthly Income Schemes SBI Mutual Fund
(c) Rising Monthly Income Schemes BOI Mutual Fund
(3) Balance Funds :The main features are:
(i) Objective : Income and growth with reasonable safety
(ii) Duration : SevenYears
(iii) Investment pattern :About 50% in equity and the rest in debenture etc.
(iv) Returns : No assured returns, but steady income due to annual contribution of
minimum of 80% of theTrust’income by way of dividends, interest etc.
(v) Liquidity : Repurchase facility after initial lock-in period of three years
(vi) No listing of stock exchange
(vii) Transfer of units permitted
(viii) Units can be pledged to banks for loans
(4) Tax Planning Schemes : The investment made under these schemes are deductible
from the taxable income up to certain limits, thus providing substantial tax relief to the
investors.
Examples of tax planning schemes:
(a) Can 80CC and Canstar 80Lof Canbank Mutual Fund
(b) Ind 88Aof Indbank Mutual Fund
(5) Other Schemes : These include schemes of 10-15 years duration, which offer
multiple benefits. For example:
Sr. No. Scheme Benefits
1. Unit Linked Insurance (i) Contribution eligible for tax deduction of
Plan of UTI ITAct
(ii) Insurance cover up to target amount
(iii) Reasonable income by way of dividend
(iv) Liquidity
(v) Safety Of Capital
2. Dhanaraksha, These offer some or all of the following
Dhansahyog, benefits :
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Dhanavridhi (i) Life Insurance cover
(ii) Accident Insurance Cover
Schemes of LIC (iii) Reinvestment of annual dividends of
Mutual Fund reasonable dividend
(iv) Safety of capital
(v) Reasonable capital appreciation
(vi) Liquidity
(vii) Units are not transferable, but bank
loan facility is available
(viii) Tax exemption on dividend
Q. Explain the Merchant Banking Services.
Ans. Merchant Bankers : Amerchant banker is 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/advisors or rendering corporate
advisory service in relation to such issue management. Issues mean an offer for
sale/purchase of securities by any body corporate/other person or group of persons through
a merchant banker. The importance of merchant bankers as sponsors of capital issues is
reflected in their major services such as, determining the composition of capital structure,
draft of prospects and application forms, listing of securities and so on. In view of the
importance of merchant bankers in the process of capital issues, it is now mandatory that all
public issues should be managed by merchant bankers functioning as the lead managers. In
the case of right issues not exceeding Rs. 50 lakh, such as appointments may not be
necessary.
Services provided by the Merchant Bankers :
(1) Project Management : Right from planning to commissioning of project, project
counseling and preparation of project reports, feasibility reports, preparation of loan
application form, government clearances for the project from various agencies,
foreign collaboration, etc.
(2) Issue Management :
(i) The evaluation of the client’s fund requirements and evolution of a suitable
finance package.
(ii) The design of instrument such as equity, convertible debentures, non-
convertible debentures etc.
(iii) Applications covering consents from institutions/banks and audited certificates,
etc.
(iv) Appointment of agencies such as printers, advertising agencies, registrars,
underwriters, and brokers to the issue.
(v) Preparation of prospectus
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(3) Portfolio Management Services : Portfolio management schemes are promoted by
merchant bankers and other finance companies to handle funds of investors at a fee.
(4) Counselling : Corporate counseling basically means the advice a merchant banker
gives to a corporate unit to ensure better performance in terms of growth and survival.
(5) Loan Syndication : Loan syndication refers to the services rendered by merchant
banker in arranging and procuring credit from financial institutions, banks and other
lending institutions.
Q. What is Issue Management. Explain various types of issues.
Ans. Issue Management : Issue management refers to management of securities
offerings of the corporate sector to public and existing shareholders on rights basis. Issue
managers in capital market are known as Merchant Banker or Lead Managers.Although the
term merchant banking, in generic terms, covers a wide range of services, but issue
management constitutes perhaps the most important function within it.
Under SEBI Guidelines, each public issue and rights issue of more than Rs. 50 lacs is
required to be managed by merchant banker, registered with SEBI.
Types of Issues : Existing as well as new companies raise funds through various sources
for implementing projects:
(1) Public Issue : The most common method of raising funds through issues is through
prospectus. Public issue is made by a company through prospectus for a fixed number
of shares at a stated price which may be at par or premium and any person can apply
for the shares of the company.
(2) Rights Issue : Right issues are issues of new shares in which existing shareholders
are given preemptive rights to subscribe to new issue of shares. Such further shares
are offered in proportion to the capital paid-up on the shares help by them at the date of
such offer. The shareholders to whom the offer is made are not under any legal
obligation to accept the offer.
(3) Private Placement : The direct sale of securities by a company to investors is called
private placement. In private placement, no prospectus is issued. Private placement
covers shares, preference, shares and debentures.
Q. Discuss briefly the pre-issue and post-issue obligations of merchant bankers.
Ans. Introduction : raising money from the capital market needs planning the activities and
chalking out a marketing strategy. It is, therefore, essential to make an nalaytical study of
various sources, the quantum, the appropriate time, the cost of raising capital and the
possible impact of such resources on the overall capital structure besides the low governing
the issue. There are various activities required for raising funds from the capital markets.
These can be broadly divided into pre-issue and post-issue activities.
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(A) Pre-issueActivities :
(1) Signing of MoU : Issue management activities begin with the signing of
Memorandum of Understanding between the client company and the Merchant
banker. The MoU clearly specifies the role and responsibility of the Merchant banker,
vis-à-vis, that of the Issuing Company.
(2) Obtaining Appraisal Note : After the contract is awarded, an appraisal note is
prepared either-in-house or is obtained from outside appraising agencies viz.,
financial institutions/banks etc. The appraisal not thus prepared throws light on the
proposed capital outlay on the project and the sources of funding it.
(3) Determination of Optimum Capital Structure : Optimum capital structure is
determined considering the nature and size of the project. If the project is capital
intensive, funding is generally biased in favour of equity funding.
(4) Appointment of Underwriters, Registrars etc. : For ensuring subscription to the
offer, underwriting arrangement are also made with various functionaries. This is
followed by appointment of registrars to an issue for handling share allotment related
work, appointment of Bankers to an issue for handling collection of application at
various centres, printers for bulk printing of issue related stationery, legal advisors and
advertising agency.
(5) Preparation of Documents : Thereafter, initial application are submitted to those
stock exchange where the listing company intends to get its securities listed. Lead
managers also prepares the list of material documents viz., MoU with Registrar, with
bankers to an issue, with advisor to the issue, co-managers to issue, agreement for
purchase of properties, etc., to be sent for inclusion of prospectus.
(6) Due Diligence : The lead manager while preparing the offer document is required to
exercise utmost due diligence and to ensure that the disclosures made in the draft
offer document are true, fair and adequate.
(7) Submission of Offer Document to SEBI : The draft document thus prepared is filed
with SEBI along with a due diligence certificate to obtain their observations. SEBI is
required to give its observations on the offer document within 21 days from the receipt
of the offer document.
(8) Finalisation of Collection Centres : Lead Manager finalises collection centres at
various places for collection of issue application from the prospective investors.
(9) Filing with RoC : After incorporating SEBI observations in the offer document, the
complete document is filed with Registrar of Companies to obtain their
acknowledgment.
(10) Launching of a Public Issue : The observation letter issued by SEBI is valid for a
period of 365 days from the date of its issuance within which the issue can open for
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subscription. Once the legal formalities and statutory permission for issue of capital
are complete, the process of marketing the issue starts. Lead manager has to arrange
for distribution of public issue stationery to various collecting banks, brokers, investor ,
etc. The announcement regarding opening of issue in the newspapers is alos required
to be made by advertising in newspapers 10 days before of the issue opens.
(11) Promoter’s Contribution : A certificate to this effect that the required contribution of
the promoter’s has been raised before opening of the issue obtained from a chartered
accountant is also required to be filed with SEBI.
(12) Closing of the Issue : During the currency of the issue, collection figures are also
obtained on daily basis from Bankers to the issue. These figures are to be filed in a 3
days report with SEBI. Another announcement through the newspapers is also made
regarding the closure of the issue.
(B) Post-Issue Activities : After the closures of the issue, lead manager has to manage
the post-issue activities pertaining to the issue. Certificate of 90% subscription from
Registrar as well as final collection certificate from Bankers are obtained.
(1) Finalisation of Basis of Allotment : In case of a public offering, if the issue is
subscribed more than five times, association of SEBI nominated public representative
is required to participate in the finalization of Basis of allotment (BoA).
(2) Despatch of Share Certificate : Then follows dispatch of share certificates to the
successful allotees and refund order to unsuccessful applicants.
(3) Issue of Advertisement in Newspapers : An announcement in the newspaper is
also made regarding BoA, no. of applications received and the date of despatch of
share certificates and refund orders etc.
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UNIT – III
Q. Define Leasing. What are its essential elements? Discuss briefly the
significance and limitations of leasing.
Ans. Meaning of Leasing : Conceptually, a lease may be defined as a contractual
arrangement in which a party owing an asset (lessor) provides the asset for use to another
(lessee) over a certain/for an agreed period of time for consideration in form of periodic
payment. At the end of the period of contract, the asset reverts back to the lessor unless
there is a provision for the renewal of the contract. Leasing is a process by which a firm
obtain the use of a certain fixed asset for which it must make a series of contractual periodic
tax-deductible payments (lease rentals).
Essential Elements :The essential elements of leasing are:
(1) Parties to the Contract : There are essentially two parties to a contract of lease
financing, namely:
(i) The Owner called the lessor
(ii) The User called the lessee
Lessors as well as lessees may be individuals, partnerships, joint stock companies,
corporations or financial institutions. Sometime there may be jointly lessors or joint
lessees. Besides, there may be a lease-broker who acts as an intermediary in
arranging lease deals. They charge certain percentage of fees for their services,
ranging between 0.5 to 1 percent.
(2) Asset : The asset, property or equipment to be leased is the subject matter of a
contract of lease financing. The asset may be an automobile, plant & machinery
equipment, land & building and so on. The asset must, however, be of the lessee's
choice suitable for his business needs.
(3) Ownership separated from User : The essence of a lease financing contract is that
during the lease-tenure, ownership of the asset vests with the lessor and its use is
allowed to the lessee. On the expiry of the lease tenure, the asset reverts to the lessor.
(4) Term of Lease : the term of lease is the period for which the agreement of lease
remains in operation. Each lease should have a definite period otherwise it will be
legally inoperative.
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(5) Lease Rentals : The consideration which the lessee pays to the lessor for the lease
transaction is the lease rental.
(6) Modes of Terminating Lease : The lease is terminated at the end of the lease period
and various courses are possible, namely,
(i) The lease is renewed on a perpetual basis for a definite period, or
(ii) The asset reverts to the lessor, or
(iii) The asset reverts to the lessor and the lessor sells it to a third party, or
(iv) The lessor sells the asset to the lessee.
Advantage/Significance of Leasing :The advantages are:
(A) Advantage to the Lessee : Lease financing has following advantage to the lessee:
(1) Financing of Capital Goods : Lease financing enables the lessee to have finance for
huge investments in land, building, plant, machinery, heavy equipments and so on,
upto 100 percent, without requiring any immediate down payment.
(2) Additional Source of Finance : leasing facilitates the acquisition of equipment, plant
& machinery without necessary capital outlay, and thus, has a competitive advantage
of mobilizing the scare financial resources of the business enterprise.
(3) Less Costly : Leasing, as a method of financing, is less costly than other alternatives
available.
(4) Ownership Preserved : Leasing provides finance without diluting the ownership or
control of the promoters.
(5) Flexibility in Structuring of Rentals : The lease rentals can be structured to
accommodate the cash flow position of the lessee, making the payment of rentals
convenient to him.
(6) Simplicity : A lease finance arrangement is simple to negotiate and free from
cumbersome procedure with faster and simple documentation.
(7) Tax Benefits : By suitable structuring of lease rentals, a lot of tax advantage can be
derived. If the lessee is in a tax paying position, the rental may be increased to lower
his taxable income. If the lessor is in tax paying position, the rentals may be lowered to
pass on a part of the tax benefit to the lessee. Thus, the rentals can be adjusted
suitably for postponement of taxes.
(8) Obsolescence Risk is averted : In a lease arrangement, the lessor being the owner
bears the risk of obsolescence and the lessee is always free to replace the asset with
latest technology.
(B) Advantage to the Lessor :Alessor has the following advantage:
(1) Full Security : The lessor's interest is fully secured since he is always the owner of the
leased asset and can take repossession of the asset if the lessee defaults.
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(2) Tax Benefit : The greatest advantage for the lessor is the tax relief by way of
depreciation. If the lessor is in high tax bracket, he can assets high depreciation rates
and , thus reduce his tax liability substantially.
(3) High Profitability : The leasing business is highly profitable since the rate of return is
more than what the lessor pays on his borrowings.
(4) High Growth Potential : The leasing industry has a high growth potential. Lease
financing enables the lessees to acquire equipment and machinery even during a
period of depression, since they do not have to invest any capital. Leasing, thus,
maintains the economic growth even during recessionary period.
Limitations of Leasing : Lease financing suffers from certain limitations too:
(1) Restrictions on Use of Equipment : A lease arrangement may impose certain
restrictions on use of the equipment, or require compulsory insurance, and so on.
Besides, the lessee is not free to make additions or alterations t the leased asset to suit
his requirement.
(2) Loss of Residual Value : The lessee never becomes the owner of the leased asset.
Thus, he is deprived of the residual value of the asset and is not even entitled to any
improvement done by the lessee or caused by inflation or otherwise, such as
appreciation in value of leasehold land.
(3) Consequences of Default : If the lessee defaults are complying with any terms and
conditions of the lease contract, the lessor may terminate the lease and take over the
possession of the leased asset.
(4) Understatement of Lessee's Asset : Since the leased assets do not form part of
lessee's assets, there is an effective understatement of his assets.
(5) Double Sales-tax : With the amendment of sale-tax law of various states, a lease
financing transaction may be charged to sales-tax twice- once when the lessor
purchases the equipment and again when it is leaded to the lessee.
Q. Define Lease. Give the Classification of Lease.
Ans : Meaning of Leasing : Conceptually, a lease may be defined as a contractual
arrangement in which a party owing an asset (lessor) provides the asset for use to another
(lessee) over a certain/for an agreed period of time for consideration in form of periodic
payment. At the end of the period of contract, the asset reverts back to the lessor unless
there is a provision for the renewal of the contract. Leasing is a process by which a firm
obtain the use of a certain fixed asset for which it must make a series of contractual periodic
tax-deductible payments (lease rentals).
Classification of Lease : Leasing can be classified into the following types:
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(A) Finance Lease and Operating Lease :
(1) Finance Lease :According to InternationalAccounting Standards (IAS-17), in finance
lease the lessor transfers to the lessee, substantially all the risks and rewards
incidental to the ownership of the asset. It involves payment of rentals over an
obligatory non-cancellable lease period, sufficient in total to amortise the capital outlay
of the lessor and leave some profit. In such leases, the lessor is only a financier and is
usually not interested in the assets. Types of assets included, under such lease, are
ships, lands, buildings, heavy machinery diesel generating sets and so on.
(2) Operating Lease : According to the IAS-17, an operating lease is one which is not a
finance lease. In an operating lease, the lessor does not transfer all the risks and
rewards incidental to the ownership of the asset and the cost of the asset is not fully
amortised during primary lease period. The lessor provides services attached to the
leased asset, such as maintenance, repair and technical advice. Operating lease is
generally used for computers, office equipments, automobiles, trucks, some other
equipments, and so on.
(B) Sale and Lease Back and Direct Lease :
(1) Sale and Lease Back : In a way, it is an indirect form of leasing. The owner of an asset
sells it to a leasing company (lessor) which leases it back to the owner (lessee).
(2) Direct Lease : In direct lease, the lessee, and the owner of the asset are two different
entities.Adirect lease can be of two types:
ØBipartite Lease :There are two parties in the lease transaction, namely (i)Asset
Supplier-cum-lessor and (ii) Lessee
ØTripartite Lease : Such type of lease involves three different parties in the lease
agreement: supplier, lessor and lessee.
(C) Single Investor Lease and Leveraged Lease :
(1) Single Investor Lease : There are only two parties to the lease transaction- the lessor
and the lessee. The leasing company (lessor) funds the entire investment by an
appropriate mix of debt and equity funds.
(2) Leveraged Lease : There are three parties to the transaction- (i) Lessor, (ii) Lender
(iii) Lessee. In such type of lease, the leasing company buys the asset through
substantial borrowing.
(D) Domestic Lease and International Lease :
(1) Domestic Lease : A lease transaction is classified as domestic if all parties to the
agreement, namely, equipment supplier, lessor and the lessee, are domiciled in the
same country.
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(2) International Lease : If the parties to the lease transaction are domiciled in different
countries, it is known as international lease. This type of lease if further sub-classified
into
ØImport Lease : In an import lease, the lessor and the lessee are domiciled in the
same country but the equipment supplier is located in a different country. The
lessor imports the asset and leases it to the lessee.
ØCross-border Lease : When the lessor and the lessee are domiciled in different
countries, the lease is classified as cross-border lease. The domicile of the
supplier is immaterial.
Q. What are the regulations and directions for lease?
Ans. RBI NBFCs Directions : With a view to coordinate, regulate and control the
functioning of all non-banking financial companies, the RBI issues directions from time to
time under the RBIAct.They apply to leasing and hire-purchase companies as well.
(1) OtherActs /Laws :The other acts/laws applicable to the NBFCs are:
(i) Motor Vehicles Act : the lessor is regarded as a dealer and although the legal
ownership vests in the lessor, the lessee is regarded as the owner for purposes
of registration of the vehicle under theAct and so on. In case of vehicle financed
under lease, the lessor is treated as a financier.
(ii) Indian Stamp Act : The Act requires payment of stamp duty on all
instruments/documents creating a right/liability in monetary terms. The
contracts for equipment leasing are subject to stamp duty which varies from
state to state.
(2) Lease Documentation and Agreement : Lease transactions involve a number of
formalities and various documents. The lease agreements have to be properly
documented to formalize the deal between the parties concerned and to bind them.
The purposes and essential requirements of lease documentations are:
(i) The documentation of lease agreements is significant as it provides evidence
availability and enforceability of security, brings to sharp focus the terms and
conditions agreed between the borrower and the lenders and enables the
leasing company to take appropriate legal action in case of default.
(ii) The essential requirements of documentation of lease agreements are that the
persons:
ØExecuting the document should have the legal capacity to do
ØThe documents should be in the prescribed format, should be properly
stamped, witnessed, and the duly executed and stamped documents
should be registered where necessary, with appropriate authorities.
(iii) Clauses in LeaseAgreement : There is no standardized lease agreement. The
contents differ from case to case. A typical lease agreement has the following
clauses:
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ØNature of the Lease : This clause specifies whether the lease is an
operating lease, a financing lease or a leveraged lease.
ØDescription : The clause specifies the detailed description of equipment,
its actual condition, size, components, estimated useful life, and so on.
ØDelivery and Re-Delivery : The clause specifies when and how the
equipment would be delivered to the lessee and re-delivered to the lessor
or expiry of the lease contract.
ØPeriod : This clause specifies that the lessee has to take the equipment
for his use on lease on the terms specified in the schedule to the
agreement. It also includes an option clause to the lessee to renew the
lease of the equipment.
ØLease Rentals : This clause specifies the procedure for paying lease
rentals by the lessee to the lessor at the rates specified in the schedule to
the agreement.
ØUse : This clause enjoins upon the lessee the responsibility for proper and
lawful usage.
ØTitle : identification and ownership of equipment.
ØRepairs and Maintenance: This clause specifies the responsibility for
repairs and maintenance, insurance and so on.
ØAlteration : It specifies that no alteration to the leased equipment may be
made without the written consent of the lessor.
ØCharges : This clause specifies clearly which party to the agreement
would bear the delivery, re-delivery, customs, income tax, sales tax and
clearance charges.
ØInspection : It gives the lessor or his representative a right to enter the
lessee's premises for the purpose of confirming the existence, condition
and proper maintenance of the equipment.
ØProhibition of Sub-leasing : This clause prohibits the lessee from the
sub-leasing or selling the equipment to third parties.
ØEvents of default and remedies : This clause specifies the
consequences of defaults by the lessee and recourse available to the
lessor.This clause may also specify other remedies, if any.
ØApplicable Law : This clause specifies the country whose laws would
prevail in case of a dispute.
Q. Explain the accounting treatment for finance and operating leases by a lessor
and by a lessee and their disclosures in financial statements.
Ans. Accounting Treatment for Leasing :Accounting treatment for leasing is divided into
two parts:
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(A) Accounting for Leases by a Lessee
(B) Accounting for Leases by a Lessor
(A) Accounting for Leases by a Lessee : Accounting for finance and operating leases
by a lessee and disclosures in their financial statements are given below:
(1) Finance Lease : A finance lease should be reflected in the balance sheet of a lessee
by recording an asset and a liability at amount equal at the inception of the lease to the
fair value of the leased assets net of grants and tax credits receivable by the lessor; if
lower, at the present value of the minimum lease payments. In calculating the present
value of the minimum lease payments the lease factor is the interest implicit in the
lease, if this is practicable to determine.
A finance lease gives rise to a depreciation charge for the asset as well as finance
charge for each accounting period. The depreciation policy for leased assets should
be consistent with that for depreciable assets which are owned and the depreciation
charge should be calculated on the basis set out in the 'IAS-4:Depreciation
Accounting'.
(2) Operating Lease : The charge to income under an operating lease should be the
rental expenses for the accounting period, recognized on a systematic basis that is
representative of the time pattern of the user's benefit.
Disclosure in Financial Statements of Lessees: Disclosure should be made of the
amount of the assets that are subject to finance lease at each balance sheet date.
Liabilities related to these leased assets should be shown separately from other
liabilities, differentiating between the current and the long-term portions.
(B) Accounting for Leases by Lessors : Accounting for finance, and operating leases
by lessors and disclosure in their financial statements are given below:
(1) Finance Lease : An asset held under a finance lease should be recorded in the
balance sheet not as property, plant & equipment but as a receivable, at an anount
equal to the net investment in the lease.
(2) Operating Lease : Assets held for operating leases should be recorded as property,
plant & equipment in the balance sheet of the lessor.
The depreciation of leased assets should be on a basis consistent with the lessor's
normal depreciation policy for similar assets and the depreciation charge should be
calculated on the basis set out in IAS-4: DepreciationAccounting.
Disclosure in the Financial Statements of Lessors: Disclosures should be made at
each balance sheet date of the gross investment in leases reported as finance leases,
and the related unearned finance income and unguaranteed residual values of the
leased assets.
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Q. Explain the Tax aspects of Leasing.
Ans. Tax Aspects of Leasing : The tax aspects of leasing pertain to both income-tax and
sales tax.
(A) IncomeTaxAspects
(B) SalesTaxAspects
(A) Income Tax Aspects : Leasing , as a finance device, has tax implications for, and
offers tax benefits both to, the lessor and the lessee.
(1) For Lessor : The main attraction of leasing device to the lessor is the deduction of
depreciation from his taxable income. The relevant provisions applicable to the
computation of the lessor's income, the tax rates and so on are summarized as
follows:
(i) Taxability of Lease Rentals : the computation of taxable income of an
assessee under the provisions of the Income Tax Act, 1961 involves
computation under various heads of income which are aggregated and then
reduced by certain deductions. Calculation of Computation of Income are:
Computation of Total Income :
ØIncome from Salary ----------
ØIncome from House Property ----------
ØIncome from Business or Profession ----------
ØIncome from Capital Gain ----------
ØIncome from Other Sources ----------
____________
GrossTotal Income -----------
Less: Deductions ----------
_____________
Taxable Income ------------
Where leasing constitutes the business/main activity of the assessee (lessor), income from
lease rental is taxable under the head Income from Business or Profession. In other cases,
the income from lease is taxed as Income from Other Sources.
(ii) Deductibility of Expenses : While computing the income of lessor from
leasing, certain expenses are allowed as a deduction to determine the taxable
income.These include:
ØDepreciation
ØRent, taxes, repairs and insurance of the leased asset where such
expenditure is borne by the lessor.
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ØAmortisation of certain preliminary expenses, such as expenditure for
preparation of project report, market survey and so on.
ØInterest on borrowed Capital
ØBad Debts
ØEntertainment expenses subject to prescribed limits.
ØTravel Expenses as per approved norms.
Among the allowable deductions, depreciation and interest are the most important
expenses for the lessor in the computation of his taxable income.
(2) For Lessee :The income tax considerations for the lessee are:
(i) Allowability of Lease Rentals : Lease rentals are allowed by the Income Tax
Act as a normal business expenditure of the lessee for assessment purpose
provided the expense is not
ØOf Capital Nature
ØAPersonal Expense.
(ii) Deductibility of Incidental Expenses : The lessee is normally required to bear
expenses associated with the leased asset such as repairs and maintenance,
finance charge and so on. These incidental expenses to the lease are allowed
as a deduction by the IncomeTaxAct from taxable income of the lessee.
(B) Sales Tax Aspects : The legislative framework governing levy of sales tax consists of
the :
ØCentral Sales TaxAct, 1957(CST): The CST deals with the levy and collection of
sales tax on the inter-state sale of goods only.
ØSales Tax Acts: The tax on sale of goods within a state (Intra-state sale) is
governed by the provisions of the respective STAs.
Alease normally has three important elements from the viewpoint of sales tax:
(i) Purchase of Equipment : When purchase of an equipment by a lesser involves inter-
state sale, the transactions attracts the provisions of the CST according to which the
normal rate of sales tax (10 per cent) or the appropriate rate applicable to intra-state
purchase/sale of goods in the respective state, whichever is higher, is imposed.
(ii) Lease Rentals : Before 1982, there was no sales tax on lease rentals. The incidence
of sales tax on them was introduced by the ConstitutionAct, 1982.The provisions are:
ØSales tax is payable on the annual taxable turnover (aggregate lease rentals) of
the lessor. The rates of tax vary between a minimum and maximum; they also
vary from state to state.
ØIn addition, in several states, surcharge, additional surcharge, additional sales
tax on turnover exceeding a specified limit/turnover tax are also levied on the
lease rentals.
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(iii) Sale of Asset : Second sale exemptions available for the normal second sale
transaction within the state are usually not available for lease transaction. For
example, a leasing company buys and equipment from a supplier and lease it to a
lessee, both within the same state. The transaction between the leasing company and
the equipment supplier is called the first sale; it will attract local sales tax. The
transaction between the lessor and the lessee being a deemed sale is called second
sale. Normally second sale of some specified goods is exempted from levy of sales
tax. But thie exemption is usually not available in lease transactions.
Q. Define Debt Securitization. Explain its process.
Ans. Meaning of Debt Securitization : Securitization is the process of pooling and
repackaging of homogeneous illiquid financial assets into marketable securities that can be
sold to investors. In other words, securitization is the process of transforming assets into
securities. The process leads to the creation of financial instruments that represent
ownership interest in, or are secured by a segregated income producing asset or pool, of
assets. The pool of assets collateralizes securities. These assets are generally secured by
personal or real property such as automobiles, real estate, or equipment loans but in some
case are unsecured for example, credit card debt and consumer loans.
Securitization Process :The securitization process is listed below:
(1) Asset are originated through receivables, leases, housing loans or any other form of
debt by a company and funded on its balance sheet. The company is normally referred
to as the "originator".
(2) Once a suitably large portfolio of assets has been originated, the assets are analysed
as a portfolio and then sold or assigned to a third party, which is normally a special
purpose vehicle company ("SPV") formed for the specific purpose of funding the
assets. It issues debt and purchases receivables from the originator.
(3) The administration of the asset is then subcontracted back to the originator by the
SPV. It is responsible for collecting interest and principal payments on the loans in the
underlying poolt of assets and transfer to the SPV.
(4) The SPV issues tradable securities to fund the purchase of assets. The performance
of these securities is directly linked to the performance of the assets and there is no
resource back to the originator.
(5) The investors purchase the securities because they are satisfied that the securities
would be paid in full and on time from the cash flows available in the asset pool. The
proceeds from the sale of securities are used to pay the originator.
(6) The SPV agrees to pay any surpluses which, may arise during its funding of the
assets, back to the originator. Thus, the originator, for all practical purposes, retains its
existing relationship with the borrowers and all of the economies of funding the assets.
(7) As cash flow arise on the assets, these are used by the SPV to repay funds to the
investors in the securities.
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Graphic Presentation of Securitization Process :
Parties to a Securitization Transaction :
(1) Originator : This is the entity on whose books the assets to be securitized exist. It sells
the assets on its books and receives the funds generated from such sale.
(2) SPV : An issuer, also known as the SPV, is the entity, which would typically buy the
assets to be securitized from the originator.
(3) Investors : The investors may be in the form of individuals or institutional investors,
and so on. They buy a participating interest in the total pool of receivables and receive
their payment in the form of interest and principal as per agreed pattern.
(4) Obligors : the obligors are the original debtors. The amount outstanding from an
obligor is the asset that is transferred to an SPV.
(5) Rating Agency : Since the investors take on the risk of the asset pool rather than the
originator, an external credit rating plays an important role. The rating process would
assess the strength of the cash flow and the mechanism designed to ensure full and
timely payment by the process of selection of loans of appropriate credit quality, the
extent of credit and liquidity support provided and the strength of the legal framework.
(6) Administrator or Servicer : It collects the payment due from the obligors and passes
it to the SPV, follows up with delinquent borrowers and pursues legal remedies
available against the defaulting borrowers. Since it receives the installment and pays it
to the SPV, it is also called the Receiving and PayingAgent.
(7) Structure : Normally, an investment banker is responsible as structure for bringing
together the originator, the credit enhancers, the investors and other partners to a
securitization deal. It also works with the originator and helps in structuring deals.
Interest and Principal
Ancillary Service
Provider
Special Vehicle
Creit Rating
of Securities
Rating Agency
Structure
Issue of Securities
Investors
Subscription of
Securities
Obligor
Originator
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Q. Explain the System and Organisation of Housing Finance in India.
Ans. Introduction : Housing is one of the basic human need of the society. It is closely
linked with the process of overall socio-economic development of a country. India, being a
highly populated country there is a great need and scope for the development of Housing
Sector. Unfortunately, for some reasons or the other, the housing sector in India has
remained underdeveloped in the past, however, it is hoped that there would be improvement
in the near future.
Organisation or Structure of Housing Finance in India :
The setting up of the National Housing Bank marked the new era in housing finance as a new
fund-based financial service in the country. A large number of financial
institutions/companies in the public, private and joint sector entered in this field. For
example, Life Insurance Corporation of India and General Insurance Corporation came with
various schemes for finance the housing units. In 1970, Housing and Urban Development
Corporation (HUDCO) a wholly government owned enterprise, was set up with the objective
of housing and urban development as well as infrastructure development. The structure of
housing finance industry is presented in the following figure:
STRUCTURE OF HOUSE FINANCING INDUSTRY
Formal Sector Informal Sector
Household Savings
Disposal of Existing Properties
Borrowings from friends, relatives
and money lenders, Etc.
Government
Central Govt.
State Govt.
Public Authorities
Banking
Commercial Banks
Cooperative Banks
Other Banks
Non-Banking
Non-Banking Finance Companies (NBFCs)
Housing Finance Companies (HFCs)
Non-Banking Housing Finance Companies (NBHFCs)
Insurance LIC/GIC
Specialised Institutions HDFC
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Q. Explain the Housing Finance Schemes in India.
Ans. Housing Finance Schemes : Various institutions provide financial assistance to the
needy persons. For this, they have come out with various financing schemes with different
features for meeting the diversified needs of this sector. The various housing finance
schemes are :
(A) Home Loan Account Scheme of NHB : Home Loan Account Scheme initiated by
National Housing Bank (NHB) with an objective of encouraging individual to save
specifically for housing.The basic features of this scheme are:
(i) Eligibility : Any Indian citizen who is not owing exclusively in his or her name, a
house/flat/apartment any where in India may open an account under this
scheme.
(ii) Contribution : The individual under this scheme is required to start a saving of a
minimum of Rs. 30 per month. The minimum period for which the savings must
be accumulated is five years to become eligible for loan under this scheme.
There is no upper limit on the amount to be saved under the scheme.
(iii) Interest on Deposit : The contribution under this scheme is entitled for interest
at the rate of 10 per cent per annum.
(iv) Default : If the contributor fails to deposit for a continuous period for 12 calendar
months, the original date of opening the home loan account is shifted forward by
the period of default.
(v) Withdrawals : Under this scheme the amount can be withdrawn only for
construction/buying a house or a flat only after the expiry of 5 years. The amount
can be withdrawn even if he/she does not avail of loan facility.
(vi) Eligibility of Loan : An account holder is eligible for housing loan on the
completion of the saving period.The quantum of the loan is based upon the built-
up area which is as under:
Built-upArea Quantum of loan in multiples of
accumulated savings
Upto 430 square feet 4 times
Upto 860 square feet 3 times
Above 860 square feet 2 times
(vii) Interest on Loan
LoanAmount Interest per annum (%)
Up to 50,000 10.5
50,001-1,00,000 12.0
1,00,001-2,00,000 13.5
Above 2,00,000 14.5
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Management of financial services

Management of financial services

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