➢ Financial System

• Financial system plays a vital role in the economic growth of a country through capital formation

• Intermediates the flow of funds

• Facilitates the transfer and allocation of funds efficiently and effectively

➢ Definition

Financial system is a complex, well integrated set of sub-systems of financial institutions, markets, instruments and services which
facilitates the transfer and allocation of funds efficiently and effectively

➢ The participants in the financial system

are primarily individuals, firms, and governments. The three main functions of the financial system are to: • Help these participants
achieve their purposes in using the financial system. • Determine the returns that equate the total supply of savings with the total
demand for borrowing. • Allocate capital to its most efficient uses.

Flow of Funds

➢ Elements of a financial system

• Strong legal & regulatory environment • Sound public finances and public debt management • A central bank • Sound banking
system • Information system • Well functioning securities market.
 ➢ Structure of Indian Financial System

•Classified into the formal financial system and the informal financial system

•Formal financial system comes under the purview of the Ministry of Finance (MoF), the Reserve Bank of India(RBI), Securities
and Exchange Board of India(SEBI) and Insurance Regulatory and Development Authority of India (IRDAI) and the Pension Fund
Regulatory and Development Authority (PFRDA)

•Informal financial system consists of individual money lenders, group of persons, partnership firms.

(1) Financial Institutions

• Includes institutions and mechanisms which
• Affect generation of savings by the community
• Mobilisation of savings
• Effective distribution of savings
• Institutions are banks, insurance companies, mutual funds- promote/mobilise savings
• Individual investors, industrial and trading companies- borrowers
➢ Banking Institutions

• Banking institutions mobilise the savings of the people.

• provide a mechanism for the smooth exchange of goods and services.

• extend credit while lending money. They not only supply credit but also create credit

. • There are categories of banking institutions. They are commercial banks, co-operative banks, small finance banks, payment
banks.

➢ Non-banking institutions

• The non-banking financial institutions also mobilize financial resources directly or indirectly from the people. They lend funds
but do not create credit.

• Development financial institutions (DFIs), NBFCs, Housing Finance companies (HFCs)

• Specialised finance institutions such as the EXIM, NABARD, NHB etc

• Investment institutions like LIC, GIC

• State level financial institutions like SFCs, SIDCs owned by state government

(2) Financial Assets/Instruments

• Enable channelizing funds from surplus units to deficit units
• Types of financial instruments can be designed to suit the risk and return preferences of different classes of investors.
• Savings and investments are linked through a variety of complex financial instruments known as securities.
• Financial securities may be primary and secondary securities.
➢ Financial Instruments
 • Primary or direct securities are those that are directly issued by the ultimate borrowers of funds to the ultimate savers. Eg
equity shares, debentures
• Secondary or indirect securities are those that are issued by the financial intermediaries to the ultimate savers
• Differ in terms of liquidity, marketability, reversibility, return, risk and transaction cost
(3) Financial services
• Those that help with borrowing and funding, lending and investing, buying and selling securities, making and enabling
payments and settlements and managing risk exposures in financial market.
• Producers are financial intermediaries such as banks, insurance companies, mutual funds and stock exchanges
• Merchant banking, hire purchase, leasing, factoring, credit rating etc
• Bridge the gap between lack of knowledge on the part of investors and the increasing sophistication of financial
instruments and markets
• Vital for creation of firms, industrial expansion and economic growth
(4) Financial Markets
• Efficient financial markets are essential for speedy economic development.
• The vibrant financial market enhances the efficiency of capital formation
• The growth of the financial markets is the barometer of the growth of a country’s economy
• The participants in the financial markets are corporations, financial institutions, individuals and the government.
• These participants trade in financial products in these markets. They trade either directly or through brokers and dealer

➢ FINANCIAL SYSTEM & THE ECONOMY

• Production function is the link between finance and economic development
• An economy consists of two kinds of economic structures that encompasses the financial system – Savings structure and
Borrowing Structure Savings structure
• consists of savers or entities that save in the form of financial assets (deposits, life insurance, etc) or cash balances
. •Savings can be estimated as the remainder or surplus from incomes earned after expenditures (food, rent, home supplies,
etc).
•This surplus or savings can be directed in the form of financial assets or withheld as cash. Borrowing structure
• comprises of “borrowers” or entities that finance their needs through borrowing
• The borrowers include the government sector (central and state level) and private sector corporations.
• provide or supply financial assets to savers by issuing primary securities in financial markets, which in turn are reissued
by financial intermediaries as secondary securities (in financial markets) for the savers as investments.

➢ Capital Formation
 •The flow of money from savings to investments leads to formation of capital stock in the form of equipment, buildings,
intermediate goods and inventories.
•reflects the country’s capability of producing and distributing goods and services across different sectors and industries
thus leading to an increase in the country national incomes of economic growth
➢ Economic growth
• The savings and borrowing structure converge to build up capital in the country, which in turn leads to economic growth.
• The economic growth of an economy can be explained based on the association between household sector and the
private/government sector.

➢ Capital Market
Platform to raise long term funds for companies and government Capital Market is a place where money is exchanged
between people who have excess of it, to those who are in deficit. Capital is being traded Regulators: SEBI, RBI,
Government Ministries
➢ Importance of Capital Market
• Pool the capital resources
• Solve the problem of shortage of funds
• Mobilize the small and scattered savings
• Increase the availability of invest-able funds
• Provide a number of profitable investment opportunities for a small saver
Primary Market

It helps the industry to raise the funds by issuing different types of securities. It is that market in which shares, debentures and other
securities are sold for the first time for collecting long-term capital. This market is concerned with new issues. Therefore, the primary
market is also called NEW ISSUE MARKET.

Functions

The main function of new issue market is to facilitate transfer resources from savers to the users It plays an important role in
mobilizing the funds from the savers and transferring them to the borrowers. The main function of new issue market can be divided
into three service functions: origination, underwriting, distribution

Origination

It refers to the work of investigation, analysis and processing of new project proposals. Origination starts before an issue is actually
floated in the market. It includes a careful study of the technical, economic and financial viability to ensure the soundness of the
project and provides advisory services.

Underwriting

It is an agreement whereby the underwriter promises to subscribe to a specified number of shares or debentures in the event of public
not subscribing to the issue. Thus it is a guarantee for the marketability of shares Underwriters may be institutional and non-
institutional.

Distribution
It is the function of sale of securities to ultimate investors. Brokers and agents who maintain regular and direct contract with the
ultimate investors, perform this service. Initiated with a new prospectus issue.

Initial public offering (IPO)

The issuing company directly offers to the general public/institutions a fixed number of securities at a stated price or price band
through a document called prospectus. This is the most common method followed by companies to raise capital through issue of
the securities.

Two ways:

Fresh Issue: This refers to the issuance of new equity shares in the company and selling those newly issued shares to the investors.

Offer for Sale: Offer for sale means selling of shares by an existing promoter/investor of the company.

Follow-on Public offer Offering of either a fresh issue of securities or an offer for sale to the public by an already listed company
through an offer document Process by which a company already listed on an exchange, issues new shares to the investors or existing
shareholders

2) Right Issue When a listed company proposes to issue securities to its existing shareholders, whose names appear in the register
of members on record date, in the proportion to their existing holding, through an offer document, This mode of raising capital is
the best suited when the dilution of controlling interest is not intended

3) Bonus Issue also known as a scrip issue or a capitalization issue, Is an offer of free additional shares to existing shareholders. A
company may decide to distribute further shares as an alternative to increasing the dividend payout. For example, a company may
give one bonus share for every five shares held.

4) Private placement Direct sale of newly issued securities by the issuer to a selected set of investors Number of investors can go
only upto 49 Investors include financial institutions, corporates, banks, and HNWIs. Time, cost, flexibility, no much formalities.

Preferential Issue or allotment : An issue of equity by a listed company to selected investors at a price which may or may not be
related to the prevailing market price is referred to as preferential In India preferential allotment is given mainly to promoters or
friendly investors to ward off the threat of takeover. Group of persons in terms of provisions of Chapter XIII of SEBI(DIP)
Guidelines. Qualified Institutional Placement(QIP) the listed company issues equity shares or shares convertible into equity shares
to Qualified Institutional Buyers only as per Chapter XIIIA of SEBI (DIP) guidelines. "Qualified Institutional Buyer“(QIB) shall
mean – a. public financial institution; b. scheduled commercial banks; c. mutual funds; d. foreign institutional investor registered
with SEBI;

➢ Pricing of Issues
 The companies eligible to make public issue can freely price their equity shares or any security convertible at a later date
into equity shares as per SEBI guidelines 2000. The issuer can fix-up issue price in consultation with merchant bankers,
subject to giving disclosures of the parameters which have considered while deciding the issue price
➢ Factors influencing pre-IPO valuation

•The number of stocks being sold in an IPO

•The organizational set-up of the private company

•The current prices of the stocks of similar companies in the same sector

•Company’s growth potential

•Company’s business model financial effectiveness

•General overall market trend

•The demand from the potential customers for the company’s stock Sometimes, the company’s success story, the values they believe
in, products they offer may also affect pricing.

➢ Fixed Price Process

▪Price at which the securities are offered and would be allotted is made known in advance to the investors

▪Demand for the securities offered is known only after the closure of the issue.

▪Payment is made at the time of subscription whereas refund is given after allotment.

▪100 % Applications Supported by Blocked Amount (ASBA)

▪50 % of the shares offered are reserved for applications below Rs. 2 lakh and the balance for higher amount applications.

➢ Book-Building/Price Band

•process wherein the issue price of a security is determined by the demand and supply forces in the capital market

• The Price at which securities will be allotted is not known in advance to the investor.

• Only an indicative price range is known.

•A 20 % price band is offered by the issuer within which investors are allowed to bid and the final price is determined by the issuer
only after closure of the bidding.

•Demand for the securities offered , and at various prices, is available on a real time basis on the BSE website during the bidding
period.

•100 % Applications Supported by Blocked Amount.

•50 % of shares offered are reserved for QIBS, 35 % for Non Retail and 15% for Retail Investors On the basis of the demands
received at various price levels within the price band specified by the issuer, Book Running Lead Manager (BRLM) in close
consultation with the issuer arrives at a price at which the security offered by the issuer, can be issued.

➢ SEBI and IPO pricing

•seeking more disclosures on how the issue price has been arrived at, including looking at past transactions in the shares of such
companies
•The basis of issue price has been the subject of debate after new-age companies such as Paytm and Zomato slid sharply over their
issue price post listing.

•the company must disclose the reason for the price variation.

•the companies must inform them of the litigation about the key managerial personnel in the documentation

➢ Secondary Market

The secondary market is that market in which the buying and selling of the previously issued securities is done. Also known as
Stock Exchanges Trading on stock exchange provides liquidity and transparency to the investors

Some of the entities that are functional in a secondary market include – •Retail investors. •Advisory service providers and brokers
comprising commission brokers and security dealers •Financial intermediaries including non-banking financial companies,
insurance companies, banks and mutual funds.

➢ Instruments in the Secondary Market

• Fixed income instruments: a regular form of payment such as interests, and the principal is repaid on maturity.
Examples of fixed income securities are – debentures, bonds, and preference shares.
• Variable income instruments: Investment in variable income instruments generates an effective rate of return
to the investor, and various market factors determine the quantum of such return. expose investors to higher risks
as well as higher rewards. Examples – equity and derivatives.
• Hybrid instruments: Two or more different financial instruments are combined to form hybrid instruments.
Convertible debentures serve as an example of hybrid instruments.
➢ Functions of Secondary Market
•provides a platform to investors to enter into a trading transaction of bonds, shares, debentures and such other financial
instruments.
•Transactions can be entered into at any time, and the market allows for active trading
•a medium of determining the pricing of assets in a transaction consistent with the demand and supply •indicative of a
nation’s economy as well, and also serves as a link between savings and investment.
•great exit route for IPO investors
➢ Types of Secondary Market
Secondary markets are primarily of two types – Stock exchanges and over-the-counter markets.
 • Stock exchange: Stock exchanges are centralised platforms where securities trading take place, sans any contact
between the buyer and the seller. National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) are
examples of such platforms.
• Over-the-counter (OTC) market :Over-the-counter markets are decentralised, comprising participants
engaging in trading among themselves. FOREX is an example of an OTC market.
➢ Pros
▪Investors can ease their liquidity problems
▪indicates a benchmark for fair valuation of a particular company.
▪Price adjustments of securities in a secondary market takes place within a short span
▪Investor’s funds remain relatively safe due to heavy regulations
▪Mobilization of savings becomes easier as investors’ money is held in the form of securities.
➢ Cons
▪Prices of securities in a secondary market are subject to high volatility,
▪Before buying or selling in a secondary market, investors have to duly complete the procedures involved, which are usually
a time-consuming process.
▪Investors’ profit margin may experience a dent due to brokerage commissions levied
▪Investments in a secondary capital market are subject to high risk due to the influence of multiple external factors.

➢ MONEY MARKET

Market for overnight to short term funds and for short term money and financial assets that are close substitutes for money. Money
market instruments are those instruments, which have a maturity period of less than one year. Substitutes for money/Near money
asset : financial asset that can be converted into cash with minimum transaction cost & without loss of value

➢ CHARACTERISTICS
• a wholesale market for short term debt instruments.
• not a single market but a collection of markets for several instruments.
• facilitates effective implementation of monetary policy of a central bank of a country.
• a market for short term financial assets that are close substitutes of money.
• Basically an over the phone market
 • Transactions are made without the help of brokers

➢ MONEY MARKET PARTICIPANTS

▪Central Govt

▪State Govt

▪Mutual Funds

▪Large Corporates

▪Banks

▪PSUs

▪Insurance Companies

▪Non-Banking Financial Institutions

▪Discount & Finance House of India (DFHI)

➢ DISCOUNT AND FINANCE HOUSE OF INDIA(DFHI)

The DFHI was set up in April 1988 as a specialised money market institution. DFHI was given the specific task of widening and
deepening the money market. The DFHI was set up jointly by the RBI, public sector banks and financial institutions.

➢ MAIN OBJECTIVES OF DFHI

• To provide liquidity to money market instruments.

• To provide safe and risk-free short-term investment avenues to institutions.

• To facilitate money market transactions of small and medium sized institutions that are not regular participants in the market.

• To integrate the various segments of the money market.

• To develop a secondary market for money market instruments.

➢ FUNCTIONS OF MONEY MARKET

❖Helps in development of Commerce &Trade

❖Earn interest on short term funds

❖Removes necessity of borrowing from RBI

❖Helps govt to borrow short term funds

❖Implementation of Monetary Policy

❖Promotes Liquidity and safety

❖RBI control liquidity in the Economy

1. CALL/SHORT NOTICE MONEY

Market for short term funds repayable on demand and with maturity period varying between one day to a fortnight Banks borrow
money without collateral from other banks to maintain a minimum cash balance. Inter bank borrowing - to meet their CRR
requirements. An over-the-counter market without intermediation of brokers, non-bank participants act as lender only. Money lent
for a day is called as call money and that is lent for more than a day up to 14 days is called as short notice money. Interest rate paid
on call loans is known as the call rate.

➢ PARTICIPANTS

Participants or Players in the Call Money Market

1. Scheduled commercial banks and RBI

2. Non-Scheduled commercial banks

3. Co-operative banks

4. Foreign banks

5. Discount and Finance House of India

The above players are permitted to operate both as lenders

and borrowers.

(1) LIC (2) UTI (3) GIC (4) IDBI (5) NABARD (6)

Specific mutual funds, etc.

The above participants are permitted to operate as

Lenders

2. TREASURY BILLS MARKET

Short term (up to one year) borrowing instruments of the Government of India. Enable investors to park their short term surplus
funds while reducing their market risk. Issued at a discount to face value. The return to the investor is the difference between the
maturity value and issue price. RBI issues T-Bills for three different maturities: 91 days, 182

days and 364 days 91 days T bills auctioned every week on Wednesdays & others on every alternate week on Wednesdays
promissory notes or a kind of finance bill issued by the Govt. for a fixed period not extending beyond one year. Treasury bill is
used by the Govt. to raise short term funds for meeting temporary Govt. deficits. Treasury Bills are available for a minimum
amount of Rs.25,000 and in multiples of Rs.25,000 thereafter. Treasury Bills are eligible securities for SLR purposes. RBI quarterly
issues a calendar of T bill auctions which is available at bank’s website retail investors in India can buy T-bills by opening up a
‘Retail Direct Scheme Account’ with the (RBI).

3.COMMERCIAL BILLS MARKET

Commercial bill is a short term, negotiable, and self-liquidating instrument with low risk. Bills of exchange are negotiable
instruments drawn by the seller (drawer) on the buyer (drawee) or the value of the goods delivered to him. Such bills are called trade
bills When trade bills are accepted by commercial banks, they are called commercial bills. a market in which commercial bills (short
term) are bought and sold. It enhances the liability to make payment within a fixed date when goods are bought on credit. widely
used in both domestic and foreign trade to discharge the business obligations. Discounting is the main process in this market. Hence
commercial bill market is also known as discount market. The bank discount this bill by keeping a certain margin and credits the
proceeds. Banks can also get such bills rediscounted by financial institutions. The maturity period of the bills varies from 30 days,
60 days or 90 days, depending on the credit extended in the industry.

4. CERTIFICATES OF DEPOSITS MARKET

A CD is a time deposit, financial product commonly offered to consumers by banks. a promissory note issued by a bank in form of
a certificate entitling the bearer to receive interest. The certificate bears the maturity date, the fixed rate of interest and the value.
issued in any denomination. They are stamped and transferred by endorsement. restricts the holders to withdraw funds on demand.
However, on payment of certain penalty the money can be withdrawn on demand also.The returns on certificate of deposits are
higher than T-Bills because it assumes higher level of risk. Loans cannot be granted against CDs and Banks/FIs cannot buy back
their own CDs before maturity. (upto 270 days). CDs issued by banks should not have the maturity less than seven days and not
more than one year. Known as negotiable CDs or bearer instrument. CDs can be issued to individuals, corporations, trusts, funds
and associations. Loans cannot be granted against CDs and Banks/FIs cannot buy back their own CDs before maturity.

5. COMMERCIAL PAPER MARKET

Unsecured short term promissory notes issued by reputed, well established and big companies having high credit rating. These are
issued at a discount. Commercial papers can now be issued by primary dealers and all India financial institutions. They can be issued
to (or purchased by) individuals, banks, companies and other registered Indian corporate bodies. Issued with fixed maturity ranging
from15 days to 1 year

•CP should be issued to investors directly or through bankers.

• The CP issuing company must have a net worth of not less then Rs. 5crores.

•The issuing company’s shares must be listed in the stock exchange.

•The minimum amount of issue should be Rs. 1 crore and the minimum denomination of Rs. 5 lakhs

• The CPs issuing cost should not exceed 1% of the amount raised. • RBI is the sole authority to decide the size of issue and timing
of issue.

•The interest on CP shall be a market determined

. • The issuing companies should get certification of credit rating for every six months and ‘A’ grading enterprises may be permitted
to enter the market.

6. ACCEPTANCE MARKET

a market for banker’s acceptance. Banker’s Acceptance is a financial instrument that is guaranteed by the bank (instead of the
account holder) for the payments at a future date. means that the bank has accepted the liability to pay the third party in case the
account holders defaults. used in cross border trade for assuring exporters against counterparty default risk. acceptance market is a
market where the bankers’ acceptances are easily sold and discounted. The person drawing the bill must have a good credit rating
otherwise the Banker’s Acceptance will not be tradable. The most common term for these instruments is 90 days.

7. COLLATERAL LOAN MARKET

The collateral loan market is a market which deals with collateralized Borrowing and Lending Obligation (CBLO) Collateral means
anything pledged as security for repayment of a loan. Backed by gilts as collaterals The collateral loans are given for a few months.
The collateral security is returned to the borrower when the loan is repaid. The borrowers are generally the dealers in stocks and
shares. But even smaller commercial banks can borrow collateral loans from the bigger banks.

8. REPO MARKET

A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in
government securities. The dealer sells the underlying security to investors and, by agreement between the two parties, buys them
back shortly afterwards, usually the following day, at a slightly higher price.

MONEY MARKET MUTUAL FUNDS(MMMFS)

A money market fund is a mutual fund that invests solely in money market instruments. Introduced in April 1991 Money market
instruments are forms of debt that mature in less than one year and are very liquid. Treasury bills make up the bulk of the money
market instruments. Securities in the money market are relatively risk-free. Money market funds are generally the safest and most
secure of mutual fund investments. Minimum lock in period is 15 Days
FINANCIAL SERVICES

• India has a diversified financial sector undergoing rapid expansion, both in terms of growth of existing financial services firms
and new entities entering the market.

• The sector comprises commercial banks, insurance companies, non-banking financial companies, co-operatives, pension funds,
mutual funds and other smaller financial entities.

• The banking regulator has allowed new entities such as payments banks

• Financial services refer to services provided by the finance industry.

• Services that are financial in nature.

• The finance industry encompasses a broad range of organizations that deal with the management of money.

Introduction

Financial Services

Services required for mobilizing and channelizing savings to productive activities for producing final goods & services. Most
significant element of a financial system interlinking all other elements. Includes various services created and delivered by the
financial system-not only helps raise funds but ensure their efficient deployment

➢ Functions of Financial Services

• Mobilization of funds

• Effective Deployment of funds

• Provision of need based services

• Provision of regulated service

• Enhancement of Economic Development

➢ Nature /Features
• Customer Centric
• Intangibility
• Inseparability
• Heterogeneity
• Perishability
• People-based service
• Dynamic nature.

➢ Asset Management Companies

• Pool their client's funds and invest them in those securities that match their declared financial objectives,

• Greater diversification for individual investors is possible if they invest through a AMC

• Mutual funds, hedge funds and pension plans are AMCs Liability Management Companies

• Attract customer deposits and use them for the purpose of lending to achieve balanced growth

• Liability management is important in determining the profitability

• Commercial Banks and other financial institutions

 ➢ Liability Management Companies

• Attract customer deposits and use them for the purpose of lending to achieve balanced growth

• Liability management is important in determining the profitability

• Commercial Banks and other financial institutions

➢ Scope of Financial Services

• Financial services cover a wide range of activities relating to : Planning to raise funds, assisting in deciding the finance
mix, helping in the deployment of funds. They can be broadly classified into two, namely i. Traditional. Activities, ii.
Modern activities.

Traditional Activities : • Traditionally, the financial intermediaries have been rendering a wide range of services
encompassing both capital and money market activities. They can be grouped under two heads, viz. • a. Fund based
activities and • b. Non-fund based activities.

• Fund based activities : The traditional services which come under fund based activities are the following : • i.
Underwriting or investment in shares, debentures, bonds, etc. of new issues (primary market activities). ii. Dealing in
secondary market activities. iii. Participating in money market instruments like commercial papers, certificate of deposits,
treasury bills, discounting of bills etc . iv. Involving in equipment leasing, hire purchase, venture capital, seed capital, v.
Dealing in foreign exchange market activities.

Non fund-based activities • Financial intermediaries provide services on the basis of non-fund activities also. This can be
called 'fee based' activity.

• a wide variety of services, are being provided under this head. They include:

i. Managing the capital issue — i.e., management of pre-issue and post-issue activities relating to the capital issue
in accordance with the SEBI guidelines and thus enabling the promoters to market their issue.
ii. Making arrangements for the placement of capital and debt instruments with investment institutions.
iii. Arrangement of funds from financial institutions for the clients' project or his working capital requirements.
iv. Assisting in the process of getting all Government and other clearances.

➢ MODERN ACTIVITIES
Beside the above traditional services, the financial intermediaries render innumerable services in recent times. Most of them are in
the nature of non-fund based activity. In view of the importance, these activities have been in brief under the head 'New financial
products and services:

I. Rendering project advisory services right from the preparation of the project report rill the raising of funds for starting the
project with necessary Government approvals.
II. Planning for M&A and assisting for their smooth carry out.
III. Guiding corporate customers in capital restructuring
IV. Recommending suitable changes in the management structure and management style with a view to achieving better
results.
V. Structuring the financial collaborations / joint ventures by identifying suitable joint venture partners and preparing joint
venture agreements,
VI. Rehabilitating and restructuring sick companies through appropriate scheme of reconstruction and facilitating the
implementation of the scheme.
VII. Hedging of risks due to exchange rate risk, interest rate risk, economic risk, and political risk by using derivative products.
VIII. Undertaking risk management services like insurance services, buy-back options etc.

➢ TYPES OF FINANCIAL SERVICES

• Fund or asset based financial services

• Fee based financial services

1. FUND BASED SERVICES

• The firm raises funds through debt, equity, deposits and the bank invests the funds in securities or lends to those who are
in need of capital.
• The following are some of these fund-based services such as:

– Leasing and Hire Purchase

– Housing Finance

– Credit Cards

– Venture Capital

– Factoring

– Forfaiting

– Bill Discounting

– Insurance

(a) Leasing

• A lease transaction is a commercial arrangement whereby an equipment owner or Manufacturer conveys to the equipment
user the right to use the equipment in return for a rental.

• In other words, lease is a contract between the owner of an asset (the lessor) and its user (the lessee) for the right to use
the asset during a specified period in return for a mutually agreed periodic payment (the lease rentals).
(b) Consumer Credit

• Consumer credit is basically the amount of credit used by consumers to purchase non-investment goods or services that
are consumed and whose value depreciates quickly.

• This includes automobiles, education, loans but excludes debts taken out to purchase real estate

• For example, a mortgage for purchasing a house is not consumer credit. However, the 52 inch television you put on your
credit card is consumer credit.

(c) Hire Purchase

• A system by which a buyer pays for a thing in regular installments while enjoying the use of it. During the repayment
period, ownership (title) of the item does not pass to the buyer. Upon the full payment of the loan, the title passes to the
buyer.

• A method of buying an article by making regular payments for it over several months or years. The article only belongs
to the person who is buying it when all the payments have been made

(d) Factoring

• Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called
a factor) at a discount.

(e) Forfaiting

• It is a form of financing of receivables relating to international trade.

• It is a form of supplier credit in which an exporter surrenders possession of export receivables, which arr usually
guaranteed by a bank on the importer’s country.

(f) Bills Discounting

• While discounting , banks buy the bill before it is due and credit the value of the bill after a discount charge to the
customer's account.

• Housing finance is what allows for the production and consumption of housing.

• It refers to the money we use to build and maintain the nation’s housing stock.

• But it also refers to the money we need to pay for it, in the form of rents, mortgage loans and

repayments.”

(g) Housing Finance

Housing finance is what allows for the production and consumption of housing.

• It refers to the money we use to build and maintain the nation’s housing stock.

• But it also refers to the money we need to pay for it, in the form of rents, mortgage loans and repayments.”

(h) Venture Capital Financing

• It is a fund that is available for investment in an enterprise which offers the probability of profit along with the possibility
of loss.
• Venture is a course of proceeding associated with risk whose outcome is uncertain.

• Capital means the financial resources to start an enterprise.

2. FEE BASED SERVICES

• The services wherein financial institutions operate in specialized fields to earn a substantial income

in the form of fees or dividends or brokerage on operations.

• The major fee based financial services are as

follows:

– Issue Management

– Corporate Advisory Services

– Credit Rating

– Mutual Funds

– Asset Securitization

– Stock Broking Services

(a) Mutual Funds

• A mutual fund refers to a fund raised by a financial service company by pooling the savings

of the public.

• It is invested in a diversified portfolio with a view to spreading and minimizing the risk

• The fund provides investment avenues for small investors who cannot participate in the equities of

big companies.

• It ensures low-risk, steady returns, high liquidity and better capitalization in the long run.

(b) Stock Broking

• The process of investing in the share market, either individually or through a broker is

known as stock broking.

• This is primarily done by opening a Demat account.

• If done through a broker, he opens an account, helping to operate through online

stock broking facility.

(c) Credit Rating

• It is an opinion on the future ability and legal obligation of an issuer to make timely

payments of principal and interest on a specific fixed income security.

• As per credit rating agencies regulations 1999 rating means

– An opinion regarding securities

– Expressed in the form of standard symbols

– Assigned by a credit rating agency

– Used by an issuer of such securities

(d) Securitization

• Securitization is a technique whereby a financial company converts its ill-liquid, non-negotiable and high value financial
assets into securities of small value which are made tradable and transferable

MODULE 2 MERCHANT BANKING SERVICES

MERCHANT BANKING

➢ Introduction

• The term ‘merchant banking’ has been used differently in different parts of the world. While in UK, a merchant banking
refers to the ‘accepting and issuing houses’, in USA it is known as ‘investment banking’.

• Merchants used to attend to extending of loans and arranging finance for trade purposes;

• As the time passed the banking assumed more importance and the merchants switched over to banking activities, hence
the term merchant Banking

• Later these merchants formed an association which is now called ”Merchant Banking and Securities House Association”

➢ In India

• The Banking Commission in its Report in 1972 has indicated the necessity of merchant banking service in view of the
wide industrial base of the Indian economy

• Merchant banking services were started in 1967 by National Grindlays Bank followed by Citi Bank in 1970.

• The State Bank of India was the first Indian commercial bank having set up a separate merchant banking Division in
1972.

• Later, the ICICI set up its merchant banking division in 1973 followed by a number of other commercial banks like
Canara Bank, Bank of Broada, Bank of India, Syndicate Bank, Punjab National Bank, Central Bank of India, UCO Bank,
etc
Qualities of Merchant Banker

• Should have knowledge and information about the capital markets, trends in the stock exchange, psychology of the
investing public, and technological and economical changes in the country;
 • Ability to analyze and evaluate various technical, financial, and economical aspects concerning the formation of an
industrial project;
• Safeguard the interest of the investing public. Integrity and maintenance of high professional standards are necessary for
the success;
• Should realize the changing environment of capital market and keep cordial relationship with the investors
• They should develop innovative capital market instruments for satisfying the changing needs of investors
• Must restrict, concentrate and develop their strength to keep costs under control.

Functions/Services rendered

• Corporate counseling;
• Project Counseling;
• Pre-investment studies
• Loan syndication;
• Management of issues and underwriting
• Capital restructuring services
• Consultancy to sick industrial units;
• Corporate Advisory services;
• Portfolio management;
• Mutual Funds
➢ SEBI Guidelines for Merchant Banker
• MBs have to be corporate organizations and are allowed to undertake only those activities related to the securities market,
including issue management.
• They are prohibited from carrying on fund based activities other than those related exclusively to the capital market.
• It is mandatory for a merchant banker to register with the SEBI
• No person can act as merchant banker in India without holding a certificate of registration granted by SEBI
➢ SEBI (Merchant Bankers) Rules and regulations

I. Registration of Merchant Bankers Application for Grant of certificate - can be made in Form A. The application shall be
made for any of the following categories of merchant banker namely:

• Category I: It Will take up activities associated with issue management. Also act as of advisor, consultant, co-manager,
underwriter and portfolio manager
• Category II: Allowed to carry the roles of advisor, consultant, co-manager, underwriter and portfolio manager;
• Category III: Allowed to act as underwriter, advisor, and consultant; and
• Category IV: Only allowed to act as advisor or consultant.

2. Conformance to requirements

3.Furnishing of information

4. Consideration of Application - body corporate - primary dealer - necessary infrastructure - employ minimum of 2 persons who
have experience -is in the interest of investors - capital adequacy requirement.

5. Capital Adequacy Requirement

Type Min Net worth

• Category I : Rs. 5 crores
• Category II : Rs.50 lakhs
• Category III : Rs.20 lakhs
• Category IV : Nill

• Procedure for Registration – the applicant eligible shall grant a certificate in Form B. On the grant of certificate the applicant
shall be liable to pay the fees .
• Renewal of certificate – 3 months before expiry.
• Procedure where registration is not granted-apply within 30 days.
• Effect of refusal to grant certificate – cease to carry on any activity.
• Payment of fees – pay such fees within the period specified in Schedule II.

➢ General obligations
• Sole function – not to associate with any business other than that of securities market.
• Maintenance of books –shall keep and maintain books.
• Submission of Half yearly results.
• Preservation of books of account, records – for a minimum period of 5 years.
• Report on steps taken on auditor’s report – within 2 months.
• Appointment of Lead Merchant Bankers.
• Restriction on Appointment of lead managers.
• Responsibilities of lead managers.
• Underwriting obligations.
• Submission of due diligence certificate.
• Documents to be furnished to the board.
• Acquisition of shares prohibited.
• Information to the Board.
• Disclosures to the Board.
• Appointment of compliance officer.

➢ Issue Management
• Important and major function of merchant banker.
• The management of issues for raising funds through various types of instruments by companies is known as issue
management.
• Carried out by merchant bankers who have the requisite professional skill and competence.
• Factors such as tremendous growth in the number and size of public listed companies and the complexity arising due to
the ever increasing SEBI requirements have all attributed to the significant role played by merchant banker.
• Under SEBI Guidelines, each Public Issue and Rights Issue with size exceeding Rs. 50 lakhs is required to be managed by
a Merchant Banker, registered with SEBI
•

➢ SELECTING A PUBLIC ISSUE PROPOSAL

• Background of the Promoters/Management.
• Company Profile:
• Project Profile:
• Capital Market Position:
• Other Important Factors:outlook of the: investors generally towards other companies , Public Issues of similar companies,
Dividend payment schedule SEBI has issued compendium of circulars to merchant bankers from time to time and broadly
has divided these activities into two groups i.e., Pre-issue activities and Post-issue activities.

➢ Pre – issue Activities

1) Memorandum of Understanding: every merchant banker (lead manager) must invariably enter into a Memorandum of
Understanding (MoU) with the company making the issue (issuer) clearly setting out their mutual rights, liabilities and
obligations relating to the issue.

2) Obtaining Appraisal Note: is prepared either in-house or is obtained from outside appraising agencies viz., Financial
Institutions/ Banks etc. The appraisal note throws light on the proposed capital outlay on the project and the sources of funding
it. 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 Pre – issue Activities

3. Appointment of Other Intermediaries: ensure that the requisite intermediaries, who are appointed, are registered with SEBI.

4. Inter-se Allocation of Responsibilities Where an issue is managed by more than one lead manager, the responsibility of each
lead manager shall be clearly delineated,

5. Preparing Prospectus: The lead manager should, therefore, not only furnish adequate disclosures but also ensure due
compliance with the Guidelines for Disclosure and Investor Protection issued by SEBI which also specifies the contents of
prospectus as well as application form. Pre – issue Activities

6. Submission of Draft Offer Documents The Lead Manager shall hand over not less than 25 copies of the draft offer document
to SEBI and also to the Stock Exchange where the issue is proposed to be listed. Submit to SEBI the Draft Prospectus , Copies
of the Draft Prospectus will be made available by the Lead Managers/Stock Exchange to prospective investors. Prospectus or
letter of offer are in conformity with the SEBI Guidelines for Disclosure and Investor Protection. Due Diligence Certificate as
specified by SEBI accompanies each draft offer document submitted to SEBI. It is to be ensured that the format of prospectus
conforms to the format prescribed by the Department Company Affairs. Pre – issue Activities

7. Launching of a Public Issue the process of marketing the Issue starts. Lead Manager arrange for distribution of public issue
stationery to various collecting banks, brokers, investors, etc. Public Issue is launched formally by conducting Press Conference,
Brokers Meets, issuing advertisements in various newspapers and mobilizing Brokers and Sub Brokers. The announcement
regarding opening of Issue in the newspapers is also required to be made by advertising in newspapers 10 days before the Issue
opens. A certificate to the effect that the required contribution of the promoters has been raised before opening of the Issue
obtained from a Chartered Accountant is also required to be filed with SEBI. Another announcement through the newspapers
is also made regarding the closure of the Issue

➢ Post Issue Activities

• Activities undertaken immediately after the closure of the issue is known as post – issue activities.
• Lead manager manages the post issue activities.
• He is to ensure the submission of the post issue monitoring report as desired by SEBI.
• Major activities covered are: finalization of basis of allotment, dispatch of share certificates, advertisement Post Issue
Activities.
• Post issue lead Merchant banker shall ensure that in all issues, advertisement details relating to oversubscription, basis of
allotment, number, value arid percentage of applications received
• date of completion of dispatch of refund orders, date of dispatch of certificates and date of filing of listing application is
released within 10 days from the date of completion of the various activities.
• at least in an English National daily with wide circulation, one Hindi National Paper and a Regional language daily
circulated at the place where registered office of the issue company is situated.

➢ Issue Management

Intermediaries

• Merchant banker/Lead Managers

• Underwriters

• Bankers to an issue

• Brokers to the issue

• Registrars to an issue and share transfer agents

• Debenture trustees

• Portfolio Manager.

MODULE 3. MUTUAL FUNDS

MUTUAL FUND INTRODUCTION

• Mutual fund is one of the funds based financial services which provides the stock market benefits to small investors
• Special type of investment institution that acts as an investment conduit.
• Pools the savings particularly relatively small investors and invests them in a well diversified portfolio of sound
investment.
• Issue securities to the investors in accordance with the quantum of money invested by them.
• The profits or losses are shared by the investors in proportion to their investment

• the money pooled in by a large number of people (or investors) is what makes up a Mutual Fund. This fund is managed by
a professional fund manager.
• a trust that collects money from a number of investors who share a common investment objective.
• it invests the money in equities, bonds, money market instruments and/or other securities.
• Each investor owns units, which represent a portion of the holdings of the fund.
• The income/gains generated from this collective investment is distributed proportionately amongst the investors after
deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV

DEFINITION

A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds,
and short-term debt. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds.
Each share represents an investor’s part ownership in the fund and the income it generates. A trust that pools the savings of
investors who share a common financial goal is known as mutual fund,

➢ ORIGIN AND GROWTH

▪ In the year 1822 the concept of mutual funds was found in Belgium.

▪ In 1868, foreign colonial government trust was established in England to spread the risks in securities market

▪ Mutual funds concept was spread to USA and some of the mutual funds institutions were established.

▪ Unit Trust of India was established in 1964 as a public sector mutual funds institution by the central government. It is the first
mutual fund in India.
 ▪ First unit scheme offered was US-64

▪ Monopoly of UTI ended in 1987, SBI set up its first mutual fund followed by Canara Bank

▪ market was made open to private players in 1993

▪ first private sector fund to operate in India was Kothari Pioneer.

EVOLUTION OF MUTUAL FUND

• First Phase – 1964-87 -Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. . The first scheme
launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had Rs.6, 700 crores of assets under management.
• Second Phase – 1987-1993 (Entry of Public Sector Funds) -SBI Mutual Fund was the first non- UTI Mutual Fund
established in June 1987 followed by Canbank Mutual Fund (Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian
Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda Mutual Fund
• Third Phase – 1993-2003 (Entry of Private Sector Funds) Kothari Pioneer (now merged with Franklin Templeton) was
the first private sector mutual fund registered in July 1993. As at the end of January 2003, there were 33 mutual funds with
total assets of Rs. 1, 21,805 crores.
• Fourth Phase – since February 2003 -In February 2003, following the repeal of the Unit Trust of India Act 1963 UTI was
bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with assets under
management of Rs.29, 835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, • The
second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under
the Mutual Fund Regulation

➢ NEW FUND OFFER

• A new fund offer (NFO) refers to the initial sale of fund shares issued by an investment company to investors.
• Similar to an IPO in the stock market, NFOs are intended to raise capital for the fund and attract investors.
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➢ MANAGING MUTUAL FUNDS IN INDIA

Have a four-tier system of managing mutual funds in India:

▪ Sponsor ▪ Trustees ▪ Custodians ▪ Asset Management Companies (AMC)

SPONSOR

• Any corporate body which initiates the launching of a mutual fund.

• Sound track record and experience in the field of financial services for a minimum period of 5 years.
• Should have professional competence, financial soundness and general reputation for fairness and integrity in business
transactions.
• Minimum contribution : 40% of the net worth of the AMC ▪ Appoints trustees, AMC and custodians in compliance with
the regulations.

TRUSTEES

• Person who holds the property of the mutual fund in trust for the benefit of the unit holders.
• Look after the mutual fund.
• A company is appointed with prior approval from SEBI.
• A minimum of 75% of the trustees must be independent of the sponsors.
 • Functions include: keep in custody, furnish information, evolve an investment management agreement, observe and ensure
that AMC is managing in accordance with trust deed.
• Are paid compensation in form of trusteeship fee.
• Present annual report to the investors.

CUSTODIANS

• Agency that keep custody of the securities that are bought by the mutual fund managers.
• Ensure safe custody and ready availability of scrips.
• Cannot act as sponsor or trustee to any mutual fund.
• Supposed to act only for a single mutual fund.
• Functions: safe keeping of securities, collecting income/dividend, ensuring delivery of scrips, arranging for proper
registration or recording of securities

ASSET MANAGEMENT COMPANY

• Investment manager.
• Can act as AMC of only one mutual fund.
• Only activities in the nature of management and advisory services.
• Operate as an underwriter with the permission of SEBI.
• Track record; net worth of at least Rs 100 crores
• Reputation.
• Expertise.
• Operational autonomy.
• Contribution by sponsors

FUNCTIONS OF AMC

AMC carries out its functions through outside agencies that are appointed for that purpose.

(I) Registrars and transfer agents

(II) Fund Accountants
(III) Lead Managers
(IV) Investment advisors
(V) Legal advisors
(VI) Auditors
(VII) underwriters

MUTUAL FUND SCHEMES

(a) Based on fund scheme

1. Open end Scheme: fund manager buys and sells units constantly on demand by investors

2. Close end scheme : units of the scheme are repurchased only after the expiry of a specified period.

(b) based on asset invested

1. Equity or Growth Funds

• These invest predominantly in equities i.e. shares of companies.
• The primary objective is wealth creation or capital appreciation.
• They have the potential to generate higher return and are best for long term investments.
• On an average, equity funds have generated before-tax returns in the range of 10%-12%.
• Examples would be
• “Large Cap” funds which invest predominantly in companies that run large established business
• “Mid Cap” funds which invest in mid-sized companies.
• “Small Cap” funds that invest in small sized companies.
• “Multi Cap” funds that invest in a mix of large, mid and small sized companies.
• “Sector” funds that invest in companies that are related to one type of business. For e.g. Technology funds that
invest only in technology companies
• “Thematic” funds that invest in a common theme. For e.g. Infrastructure funds that invest in companies that will
benefit from the growth in the infrastructure segment.
• Tax-Saving Funds
2. Debt Fund / Fixed Income Funds
• These Funds invest predominantly in rated debt / fixed income securities like corporate bonds, debentures,
government securities, commercial papers and other money market instruments.
• They are best suited for the medium to long-term investors who are averse to risk and seeking regular and steady
income.
• Debt Funds are less risky when compared with equity funds.
• Short-term ranges from 3 months to 1 years, while medium term ranges from 3 years to 5 years.
3. Hybrid Funds
 • These invest in both Equities and Fixed Income, thus offering the best of both, Growth Potential as well as Income
Generation.
• Hybrid funds can be differentiated as per their asset allocation. Some types of hybrid funds have a higher equity
allocation while others allocate more to debt.
o Equity-oriented hybrid funds
o Debt-oriented balanced funds
o Balanced Funds
o Monthly Income Plans
• Examples would be Aggressive Balanced Funds, Conservative Balanced Funds, Pension Plans, Child Plans and
Monthly Income Plans, etc.
➢ JUDGING OPERATIONAL EFFICIENCY
• Net return: appreciation in value of investments and dividend or interest received
• Net Asset Value(NAV):dividing the total value of all the securities in its portfolio, less any liabilities, by the
number of fund shares outstanding.
Load: A mutual fund load is a fee charged for the purchase or sale of a mutual fund
• Disclosures: half yearly results, annual reports
• Investor’s Protection: unit certificates within 6 weeks, transfers within 30 days, dividend warrants within 42 days,
within 10 working days redemption proceeds must be dispatched, conduct inspections, defaulting AMCs are
prohibited.

➢ RISK PARAMETERS TO CHECK BETWEEN FUNDS

• Standard deviation measures the volatility of the returns from a mutual fund scheme over a particular period. It
tells you how much the fund's return can deviate from the historical mean return of the scheme.
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• Alpha is the excess return of a fund compared to its benchmark index.
• If a fund has an alpha of 11%, it means it has outperformed its benchmark by 11% during a specified period. Beta
which measures a fund's volatility compared to that of a benchmark. It tells you how much a fund's performance
would swing compared to a benchmark.
• A fund with a beta of 1 means, it will move as much as the benchmark. If a fund has a beta of 1.2, it means that
for every 10% upside or downside, the fund's NAV would be 12% up or down
➢ EVALUATING MUTUAL FUND
• Evaluation tools take into consideration the risks and uncertainty associated with the returns
• Some of the tools are Treynor’s Model and Sharpe Model.
• Sharpe ratio measures how well the fund has performed vis-a-vis the risk is taken by it. It is the excess return over risk-
free return (usually return from treasury bills or government securities) divided by the standard deviation.
• The higher the Sharpe Ratio, the better its risk-adjusted-performance.
• The Sharpe measure evaluates return relative to total risk.
• Appropriate for a well-diversified portfolio, but not for individual securities.
• The Treynor measure evaluates the return relative to beta, a measure of systematic risk.
• It ignores any unsystematic risk

➢ ASSOCIATION OF MUTUAL FUNDS IN INDIA

• Association of Mutual Funds in India (AMFI) was incorporated on 22nd August, 1995.
 • (AMFI) modeled on the lines of a Self Regulating Organization (SRO) with a view to 'promoting and protecting the interest
of mutual funds and their unit-holders, increasing public awareness of mutual funds, and serving the investor’s interest by
defining and maintaining high ethical and professional standards in the mutual funds industry'
• Association of Mutual Funds India has brought down the Indian mutual fund industry to a professional and healthy market
with ethical lines enhancing and maintaining standards.
• It follows the principle of both protecting and promoting the interests of mutual funds as well as their unit holders.
➢ OBJECTIVES OF AMFI
• AMFI interacts with SEBI and works according to SEBIs guidelines in the mutual fund industry
• To recommend and promote best business practices and code of conduct to be followed by members and others engaged
in the activities of mutual fund and asset management including agencies connected or involved in the field of capital
markets and financial services.
• To recommend and promote best business practices and code of conduct to be followed by members and others engaged
in the activities of mutual fund and asset management including agencies connected or involved in the field of capital
markets and financial services.
• It develops a team of well qualified and trained Agent distributors. It implements a programme of training and certification
for all intermediaries and other engaged in the mutual fund industry
• AMFI undertakes all India awareness programme for investors in order to promote proper understanding of the concept
and working of mutual funds.
• Association of mutual fund of India also disseminate information on Mutual Fund Industry and undertakes studies and
research either directly or in association with other bodies.

POLICY DEVELOPMENTS

▪ SEBI tightened the disclosure norms ▪ Laid down detailed investment and disclosure norms for employees of AMCs and
Trustee companies ▪ Invest in listed or unlisted or units of venture capital funds ▪ Detailed guidelines on disclosure and reporting
requirements for investment in foreign securities ▪ To improve professional standards, made it mandatory to appoint agents
who have obtained Association of Mutual Funds in India (AMFI) certification

MODULE 4 OTHER FINANCIAL SERVICES

➢ VENTURE CAPITAL
Venture capital is a type of private equity financing that is provided to early-stage and high-potential startups and
companies with innovative business ideas or technologies. Venture capital firms, also known as VC firms, typically invest
in these companies in exchange for an ownership stake, with the goal of generating significant returns on their investment.

Unlike traditional loans, venture capital investments are high-risk and high-reward, with the potential for substantial returns
but also the risk of total loss if the startup fails. Venture capital investors provide not only financial support, but also
strategic advice, guidance, and networks to help the startup grow and succeed.
➢ FEATURES
• High risk, high reward: Venture capital investments are typically made in high-risk, high-potential companies
that have yet to prove themselves in the marketplace. As a result, venture capitalists assume a significant amount
of risk in exchange for the potential for significant returns.
 • Long-term investments: Venture capital investments are often long-term in nature, as it can take several years
for an early-stage company to develop and mature. As a result, venture capitalists typically have a longer
investment horizon than traditional investors.

• Active involvement: Venture capitalists often take an active role in the management of the companies they invest
in, providing guidance, expertise, and resources to help the companies grow and succeed.

• Equity ownership: In exchange for their investment, venture capitalists typically receive an ownership stake in
the company in the form of equity. This allows them to participate in the company's success and potentially profit
from a future acquisition or initial public offering (IPO).

• Limited liquidity: Venture capital investments are often illiquid, meaning that it can be difficult for investors to
sell their ownership stake in the company before an exit event, such as an acquisition or IPO.

• Focus on innovation: Venture capital firms often focus on investing in companies that are developing innovative
products or services that have the potential to disrupt existing markets or create new ones. As a result, they are
often more willing to take risks on unproven ideas and technologies.
➢ DIMENSIONS

• Stage of Investment: Venture capital investments are typically divided into different stages, including seed, early-stage,
expansion, and later-stage investments. Seed investments are made in very early-stage companies, while early-stage
investments are made in companies that have already developed a product or service and have demonstrated some traction
in the market. Expansion and later-stage investments are made in companies that are more established and are looking to
scale their operations.
• Industry Focus: Venture capital investors tend to specialize in specific industries or sectors. Some investors may focus on
technology startups, while others may focus on healthcare or consumer products. The industry focus of a venture capital
firm can influence its investment strategy and the types of companies it invests in.
• Geographic Focus: Venture capital investors may also have a geographic focus. Some investors may focus on investing
in companies in a specific region, such as Silicon Valley or New York City. Other investors may have a more global focus
and invest in companies from around the world.
• Investment Size: Venture capital investments can vary widely in size, from small seed investments of a few hundred
thousand dollars to larger investments of tens of millions or even hundreds of millions of dollars. The investment size can
depend on the stage of the company, the industry, and the specific investment strategy of the venture capital firm.
• Investment Structure: Venture capital investments can take a variety of forms, including equity, convertible debt, or a
combination of both. The structure of the investment can depend on the specific needs and goals of the company
and the investor.

VENTURE CAPITAL INDUSTRY IN INDIA

India's venture capital industry has grown significantly in recent years and is considered one of the most dynamic and active startup
ecosystems in the world. In 2021, Indian startups raised a record $16.5 billion in funding, up from $9.5 billion in 2020.

Some of the top venture capital firms in India include Accel Partners, Sequoia Capital India, Nexus Venture Partners, and Kalaari
Capital, among others. These firms typically invest in startups that operate in various sectors such as e-commerce, healthcare,
fintech, edtech, and food tech.
The Indian government has also launched several initiatives to promote entrepreneurship and support startups, including the Startup
India initiative, which provides funding, mentorship, and other resources to early-stage companies. Additionally, the Reserve Bank
of India has relaxed rules to allow foreign investors to invest in Indian startups more easily.

However, the venture capital industry in India still faces challenges such as the lack of exit opportunities for investors, high
valuations, and a shortage of skilled talent. Nevertheless, the overall outlook for the Indian venture capital industry remains positive,
as the country continues to witness the emergence of innovative startups with significant growth potential.

➢ GUIDELINES FOR VENTURE CAPITAL COMPANIES IN INDIA

Venture capital companies in India typically operate within a regulatory framework governed by the Securities and Exchange Board
of India (SEBI), the Reserve Bank of India (RBI), and other relevant authorities. Here are some guidelines that venture capital
companies in India should keep in mind:

• Registration: Venture capital companies in India need to be registered with SEBI as Alternative Investment Fund (AIF)
Category I or Category II. The registration process involves submitting a detailed application form, along with supporting
documents and fees.
• Investment limits: SEBI has set limits on the amount that venture capital companies can invest in a single company or a
group of related companies. These limits vary depending on the stage of the company, sector, and other factors.
• Disclosure requirements: Venture capital companies in India are required to disclose information about their investment
activities, including the terms and conditions of their investments, the risks involved, and the fees they charge.
• Risk management: Venture capital companies need to have robust risk management policies in place to mitigate the risks
associated with their investments. They should also have a strong compliance culture to ensure that they comply with all
regulatory requirements.
• Investor protection: Venture capital companies should take steps to protect the interests of their investors, including
providing regular updates on their investments and ensuring that they have adequate risk management and compliance
systems in place.
• Exit strategy: Venture capital companies should have a clear exit strategy for their investments. This could include a sale
to a strategic investor, an IPO, or a merger and acquisition.
• Ethical conduct: Venture capital companies should adhere to high ethical standards in their investment activities. They
should avoid conflicts of interest and ensure that they act in the best interests of their investors.

➢ FACTORING

Factoring is a method by which a businessman can obtain cash for invoices he sends to his customers in respect of supply
of goods and services to them. Factoring is also termed as ‘Invoice discounting’. Factoring involves the sale of receivables
to a financial institution such as an old line factor—a commercial financial company or one of a few commercial banks.

The factor purchases accounts which are acceptable to him generally without resource; if the customer does not pay, the
factor takes the loss. The client no longer carries factored receivable on his balance sheet, in effect, having converted them
into cash. Firms owing the account receivable to client firms are notified that the account has been sold to the factor and
are asked to remit directly to the factor.

➢ Types of Factoring:

1. Full Factoring

2. Recourse Factoring
3. Maturity Factoring

4. Advance Factoring

5. Undisclosed Factoring

6. Invoice discounting

7. Buyer-based Factoring

9. Bill-discounting.

8. Seller-based Factoring

1. Full Factoring:

Under full factoring arrangement, a factor renders services of collection of receivables and maintains sales ledgers, credit control
and credit protection. On the basis of credit worthiness of the firm, a monetary limit is fixed up to which trade credit provided by
the client will be taken over by the factor without recourse to the client.The liability of the factor is limited only to the defaults
arising out of customer’s financial inability to pay. If the payment is withheld for reasons of dispute regarding inherent defect in
goods, quality, counter claim, etc. recourse will be available to the factor against the client.

2. Recourse Factoring:

In this type of factoring, the factor does not provide any protection to the client against a customer’s failure to pay debts. It may,
therefore, not be necessary for the factor to either approve the customer or fix a credit limit. If the customer does not pay the invoice
on maturity for any reason, the factor is entitled to recover from the client the amount paid in advance.

3. Maturity Factoring:

This type of factoring involves no financing abinitio and hence no drawing limit is made available to the client. But the factor
administers the client’s sales ledger and renders debt collection services. The amount of each invoice is made over the client at the
end of the credit period or on an agreed maturity date, less the factor’s charges.

The maturity date is decided upon at the commencement of the agreement by reference to the average- time taken by the client to
collect a debt. The maturity date bears no relation to the date on which the receivable is actually due for payment as it is an ‘estimated
date of collection.’

4. Advance Factoring:

In this kind of factoring, factor is prepared to pay for debts in advance of receiving the payment due from the customers. Th is is
only a prepayment and not an advance. A drawing limit is made available to the client as soon as the invoice is accounted for.

5. Undisclosed Factoring:

Unlike all other types of factoring, in undisclosed factoring customers are not informed about the arrangements between the factor
and the client. The factor maintains the sales ledger on the basis of the copy of the invoice. He provides the client with either debt
default cover or finance or both, as desired. Debt collection is done by the client who makes over payment of each invoice to the
factor.

The factor keeps a check on its risk by receiving from the client an age-wise analysis of debts at regular intervals. The types of
services which may be offered under an undisclosed arrangement are very flexible. This may be on non-recourse basis and/or
seasonal and/or selective basis.

6. Invoice Discounting:

Under this arrangement, the factor buys all or selected invoices of its client at a discount. The factor does not maintain sales ledger
for his client nor undertakes debt collection function. He only provides finance to his client.

7. Buyer-Based Factoring:

Buyer-based factoring involves factoring of all the buyer’s payables. Thus, the factor would maintain a list of ‘approved buyers’
and any claims on such buyers (by any seller) would be factored without recourse to the seller.

8. Seller-Based Factoring:

In this type of factoring, the factor takes over the credit function of the seller entirely. After invoicing his customer (who should be
previously cleared by the factor), the seller submits a copy of the invoice, the delivery challan, the buy-sell contract and related
papers like quality stipulations and text certificate to the factor who takes over the remaining operations like reminding the buyer
for payment, maintaining his account and collecting the amount.

➢ FUNCTIONS OF FACTOR:

A factor performs a number of functions for his client.

These functions are:

1. Maintenance of Sales Ledger: A factor maintains sales ledger for his client firm. An invoice is sent by the client to the
customer, a copy of which is marked to the factor. The client need not maintain individual sales ledgers for his customers.
On the basis of the sales ledger, the factor reports to the client about the current status of his receivables, as also receipt of
payments from the customers and as part of a package, may generate other useful information. With the help of these
reports, the client firm can review its credit and collection policies more effectively.
2. Collection of Accounts Receivables: Under factoring arrangement, a factor undertakes the responsibility of collecting
the receivables for his client. Thus, the client firm is relieved of the rigours of collecting debts and is thereby enabled to
concentrate on improving the purchase, production, marketing and other managerial aspects of the business. With the help
of trained manpower backed by infrastructural facilities a factor systematically undertakes follow up measure and makes
timely demand in the debtors to pay amounts. Normally, debtors are more responsive to demands or reminders from a
factor as they would not like to go down in the esteem of credit institution as a factor.

3. Credit Control and Credit Protection: Another useful service rendered by a factor is credit control and protection. As
a factor maintains extensive information records (generally computerized) about the financial standing and credit rating of
individual customers and their track record of payments, he is able to advise its client on whether to extend credit to a buyer
or not and if it is to be extended the amount of the credit and the period there-for
 4. Advisory Functions: At times, factors render certain advisory services to their clients. Thus, as a credit specialist a
factor undertakes comprehensive studies of economic conditions and trends and thus is in a position to advise its clients of
impending developments in their respective industries. Many factors employ individuals with extensive manufacturing
experience who can even advise on work load analysis, machinery replacement programmes and other technical aspects of
a client’s business.

➢ ADVANTAGES

• There are many factoring companies, so prices are usually competitive.

• It can be a cost-effective way of outsourcing your sales ledger while freeing up your time to manage the business.
• It assists smoother cashflow and financial planning.
• Some customers may respect factors and pay more quickly.
• Factors may give you useful information about the credit standing of your customers and they can help you to negotiate
better terms with your suppliers.
• Factors can prove an excellent strategic - as well as financial - resource when planning business growth.
• You will be protected from bad debts if you choose non-recourse factoring.
• Cash is released as soon as orders are invoiced and is available for capital investment and funding of your next orders.
• Factors will credit check your customers and can help your business trade with better quality customers.

➢ WHAT IS BILL DISCOUNTING?

Bill Discounting, also called Invoice Discounting, is a trading activity where a seller sells some goods or services to a buyer. The
buyer has to make the payment as per the agreed credit period. Now, if the buyer needs money before that, he can approach a bank
or some NBFC and ‘sell’ that invoice to them. The financial institution gets the invoice verified by the buyer and then makes
payment to the seller on their behalf. However, they make some deductions, called ‘discount’, as their commission.

So, in a way, the seller gets a discounted payment for their bill. This way, they can run their business operations, and buyers get an
extended credit period. On the due date, the seller makes the payment to the financial institution, which completes the cycle for that
particular invoice. Since the seller gets payment on a ‘discount’, this transaction is called Bill Discounting.

FEATURES OF BILL DISCOUNTING:

1. Evaluating the seller and buyer: Before approving the bill discounting, the bank or NBFC first checks the seller’s
reputation and the buyer’s creditworthiness. This is done to ensure that the buyer does not default on making the payment
to the bank.
2. Making instant cash available for the buyer: It is the most salient feature of bill discounting. The bank or NBFC
purchases the invoice and immediately pays after discounting the bill. This makes life easy for the seller. They get an
immediate payment and do not need to wait for the buyer to pay the bill.
3. Discount Charge: The difference margin between the face value of the invoice and the amount approved and disbursed
by the bank is called the discount. This discount is calculated on the maturity value at a certain percentage per annum.
4. Maturity: The maturity date of a bill means the date on which payment of the invoice is due. The average maturity period
is 30, 60, 90, or 120 days.

➢ BENEFITS OF BILL DISCOUNTING

 • Improves cash flow position: All businesses, big or small, depend on cash flow to survive and grow. Bill discounting
facility helps inject a quick cash flow into the business and help the businesses survive and flourish. The money received
quickly may be used to pay salaries, procure raw materials for the next order, or invest in some new asset.
• Provides instant access to cash: For a seller, a bill discounting facility is a quick and hassle-free way of getting payment
against their invoices. It helps them manage their working capital better and keep the working capital cycle short. Most
financial institutions like MYND offer funds within 24 to 72 hours.
• No collateral involved: Bill discounting, as a process, is very simple. It does not involve much documentation. Secondly,
the seller is not required to provide any collateral security to get the funds. The invoice itself is strong enough collateral to
get the funds.
• No debt incurred: Getting funds using a bill discounting facility does not put the buyer under any kind of debt. Here, the
buyers get money against the invoices, which is anyways due to them. It just helps them get the money. So, it does not
create any debt liability for them. Compared to traditional financing models, a bill discounting facility is safe from any
kind of loss or damage.
• No impact on business sheet: Bill discounting facility does not create any tax liability. It is more of an off-the-book
process. So, it has no impact on the balance sheet of the business.

BASIS FOR
BILL DISCOUNTING FACTORING
COMPARISON

Meaning Trading the bill before it becomes due for A financial transaction in which the business
payment at a price less than its face value organization sells its book debts to the financial
is known as Bill Discounting. institution at a discount is known as Factoring.

Arrangement The entire bill is discounted and paid, The factor gives maximum part of the amount
when the transaction takes place. as advance when the transaction takes place and
the remaining amount at the time of settlement.

Parties Drawer, Drawee and Payee Factor, Debtor and Client

Type Recourse only Recourse and Non Recourse

Governing statute The Negotiable Instrument Act, 1881 No such specific act.

Financier's Income Discounting Charges or interest Financier gets interest for financial services and
commission for other allied services.

Assignment of Debts No Yes

Leasing: Definitions, Types, Merits and Demerits!

A “lease” is defined as a contract between a lessor and a lessee for the hire of a specific asset for a specific period on payment of
specified rentals.

The maximum period of lease according to law is for 99 years. Previously land or real resate, mines and quarries were taken on
lease. But now a day’s plant and equipment, modem civil aircraft and ships are taken.

Definition:

(i) Lessor:

The party who is the owner of the equipment permitting the use of the same by the other party on payment of a periodical
amount002E

(ii) Lessee: The party who acquires the right to use equipment for which he pays periodically.

Lease Rentals: This refers to the consideration received by the lessor in respect of a transaction and includes:

(i) Interest on the lessor’s investment;

(ii) Charges borne by the lessor. Such as repairs, maintenance, insurance, etc;

(iii) Depreciation;

(iv) Servicing charges.

➢ TYPES OF LEASES:

1. Financial Lease:

This type of lease which is for a long period provides for the use of asset during the primary lease period which devotes almost the
entire life of the asset. The lessor assumes the role of a financier and hence services of repairs, maintenance etc., are not provided
by him. The legal title is retained by the lessor who has no option to terminate the lease agreement.

The principal and interest of the lessor is recouped by him during the desired playback period in the form of lease rentals. The
finance lease is also called capital lease is a loan in disguise. The lessor thus is typically a financial institution and does not render
specialized service in connection with the asset.

2. Operating Lease:

It is where the asset is not wholly amortized during the non-cancellable period, if any, of the lease and where the lessor does not
rely for is profit on the rentals in the non- cancellable period. In this type of lease, the lessor who bears the cost of insurance,
machinery, maintenance, repair costs, etc. is unable to realize the full cost of equipment and other incidental charges during the
initial period of lease.

The lessee uses the asset for a specified time. The lessor bears the risk of obsolescence and incidental risks. Either party to the lease
may termite the lease after giving due notice of the same since the asset may be leased out to other willing leases.

3. Sale and Lease Back Leasing:

To raise funds a company may-sell an asset which belongs to the lessor with whom the ownership vests from there on. Subsequently,
the lessor leases the same asset to the company (the lessee) who uses it. The asset thus remains with the lessee with the change in
title to the lessor thus enabling the company to procure the much needed finance.

4. Sales Aid Lease:

Under this arrangement the lessor agrees with the manufacturer to market his product through his leasing operations, in return for
which the manufacturer agrees to pay him a commission.

5. Specialized Service Lease:

In this type of agreement, the lessor provides specialized personal services in addition to providing its use.

6. Small Ticket and Big Ticket Leases:

The lease of assets in smaller value is generally called as small ticket leases and larger value assets are called big ticket leases.

7. Cross Border Lease:

Lease across the national frontiers is called cross broker leasing. The recent development in economic liberalisation, the cross-
border leasing is gaining greater importance in areas like aviation, shipping and other costly assets which base likely to become
absolute due to technological changes.

Merits of Leasing:
(i)The most important merit of leasing is flexibility. The leasing company modifies the arrangements to suit the leases requirements.

(ii) In the leasing deal less documentation is involved, when compared to term loans from financial institutions.

iii) It is an alternative source to obtain loan and other facilities from financial institutions. That is the reason why banking companies
and financial institutions are now entering into leasing business as this method of finance is more acceptable to manufacturing units.

(iv) The full amount (100%) financing for the cost of equipment may be made available by a leasing company. Whereas banks and
other financial institutions may not provide for the same.

(v) The ‘Sale and Lease Bank’ arrangement enables the lessees to borrow in case of any financial crisis.

(vi) The lessee can avail tax benefits depending upon his tax status.

Demerits of Leasing:
(i) In leasing the cost of interest is very high.

(ii) The asset reverts back to the owner on the termination of the lease period and the lesser loses his claim on the residual value.

(iii) Leasing is not useful in setting up new projects as the rentals become payable soon after the acquisition of assets.

(iv) The lessor generally leases out assets which are purchased by him with the help of bank credit. In the event of a default made
by the lessor in making the payment to the bank, the asset would be seized by the bank much to the disadvantage of the lessee.

PROBLEMS OF LEASING

1. Unhealthy Competition:

The market for leasing has not grown with the same pace as the number of lessors. As a result, there is over supply of lessors leading
to competitor. With the leasing business becoming more competitive, the margin of profit for lessors has dropped from four to five
percent to the present 2.5 to 3 percent. Bank subsidiaries and financial institutions have the competitive edge over the private sector
concerns because of cheap source of finance.

2. Lack of Qualified Personnel:

Leasing requires qualified and experienced people at the helm of its affairs. Leasing is a specialized business and persons constituting
its top management should have expertise in accounting, finance, legal and decision areas. In India, the concept of leasing business
is of recent one and hence it is difficult to get right man to deal with leasing business. On account of this, operations of leasing
business are bound to suffer.

3. Tax Considerations:

Most people believe that lessees prefer leasing because of the tax benefits it offers. In reality, it only transfers; the benefit i.e. the
lessee’s tax shelter is lessor’s burden. The lease becomes economically viable only when the transfer’s effective tax rate is low. In
addition, taxes like sales tax, wealth tax, additional tax, surcharge etc. add to the cost of leasing. Thus leasing becomes more
expensive form of financing than conventional mode of finance such as hire purchase.

4. Stamp Duty:

The states treat a leasing transaction as a sale for the purpose of making them eligible to sales tax. On the contrary, for stamp duty,
the transaction is treated as a pure lease transaction. Accordingly a heavy stamp duty is levied on lease documents. This adds to the
burden of leasing industry.

5. Delayed Payment and Bad Debts:

The problem of delayed payment of rents and bad debts add to the costs of lease. The lessor does not take into consideration this
aspect while fixing the rentals at the time of lease agreement. These problems would disturb prospects of leasing business.

Hire Purchase: Meaning, Features, Advantages and Disadvantages

Meaning:
Hire purchase is a method of financing of the fixed asset to be purchased on future date. Under this method of financing, the purchase
price is paid in installments. Ownership of the asset is transferred after the payment of the last installment.

Features of Hire Purchase:

The main features of hire purchase finance are:

• The hire purchaser becomes the owner of the asset after paying the last installment.
• Every installment is treated as hire charge for using the asset.
• Hire purchaser can use the asset right after making the agreement with the hire vendor.
• The hire vendor has the right to repossess the asset in case of difficulties in obtaining the payment of installment.
• Rental payments are paid in installments over the period of the agreement.
 • Each rental payment is considered as a charge for hiring the asset. This means that, if the hirer defaults on any payment,
the seller has all the rights to take back the assets.
• All the required terms and conditions between both the parties involved are documented in a contract called Hire-Purchase
agreement.
• The frequency of the installments may be annual, half-yearly, quarterly, monthly, etc. according to the terms of the
agreement.
Assets are instantly delivered to the hirer as soon as the agreement is signed.
• If the hirer uses the option to purchase, the assets are passed to him after the last installment is paid.
• If the hirer does not want to own the asset, he can return the assets any time and is not required to pay any installment that
falls due after the return.
• However, once the hirer returns the assets, he cannot claim back any payments already paid as they are the charges towards
the hire and use of the assets.
• The hirer cannot pledge, sell or mortgage the assets as he is not the owner of the assets till the last payment is made.
• The hirer, usually, pays a certain amount as an initial deposit / down payment while signing the agreement.
• Generally, the hirer can terminate the hire purchase agreement any time before the ownership rights pass to him.

Advantages of Hire Purchase:

Hire purchase as a source of finance has the following advantages:

• Financing of an asset through hire purchase is very easy.

• Hire purchaser becomes the owner of the asset in future.
• Hire purchaser gets the benefit of depreciation on asset hired by him/her.
• Hire purchasers also enjoy the tax benefit on the interest payable by them.
• Immediate use of assets without paying the entire amount.
• Expensive assets can be utilized as the payment is spread over a period of time.
• Fixed rental payments make budgeting easier as all the expenditures are known in advance.
• Easy accessibility as it is a secured financing.
• No need to worry about the asset depreciating quickly in value as there is no obligation to buy the asset.

Disadvantages of Hire Purchase:

Hire purchase financing suffers from following disadvantages:

• Ownership of asset is transferred only after the payment of the last installment.
• The magnitude of funds involved in hire purchase are very small and only small types of assets like office equipment’s,
automobiles, etc., are purchased through it.
• The cost of financing through hire purchase is very high.
• The addition of any covenants increases the cost.
• If the hired asset is no longer needed because of any change in the business strategy, there may be a resulting penalty.
• Total amount paid towards the asset could be much higher than the cost of the asset due to substantially high-interest rates.

Term Used in Hire Purchase agreement;

• Hire Purchaser: He is buyer in hire purchase agreement.

 • Hire Vendor: He is seller in a hire purchase agreement.
• Cash Price: It is the amount to be paid for outright purchase in cash.
• Down Payment: It is the of initial payment payable by the hire purchaser at the time of entering into a hire purchase
agreement.
• Hire Purchase Price: It is the total amount payable by the hire purchasers to the hire vendor of goods are purchased under
the hire purchase system.

BASIS FOR
HIRE PURCHASING LEASING
COMPARISON

Meaning The deal in which one party can use the Leasing is an agreement where one party buys
asset of the other party for the payment of the asset and allows the other party to use it by
equal monthly installments is known as Hire paying consideration over a specified period is
Purchasing. known as Leasing.

Governing No Specific Accounting Standard AS- 19

Accounting
Standard

Down Payment Required Not Required

Installments Principal plus interest Cost of using the asset

Asset type Car, trucks, lorries etc. Land and Building, Property.

Ownership Ownership of the asset is transferred to the Transfer of ownership depends on the type of
hire purchaser on the payment of the last lease.
installment.

Repairs & Responsibility of hire purchaser. Depends upon the type of lease
Maintenance

Consideration Initial payment plus installment. Lease Rentals

Duration Short Term Comparatively Long term

Concept of Securitization:
Securitization is a carefully structured process by which a pool of loans and other receivables are packaged and sold in the form of
asset-backed securities to the investors to raise the required funds from them. Through this process relatively illiquid assets are
converted into securities. Securitization falls under the broad category termed as structured finance transactions.

Structured finance refers to securities where the promise to repay the investors is backed by the value of the underlying financial
asset or the credit support of a third party to the transaction or some combination of the two. Thus, securitization is nothing but
liquefying assets comprising loans and receivables of an institution through systematic issuance of financial instruments.

In a securitized transaction, the burden of repayment on the bond shifts away from the issuer to a pool of assets or to a third party.
The cash flows from the pools of assets which have been securitized provide the funds for repayment to the bond.

Securitized transaction is termed as structured transaction because through specific choices relating to the type and amount of assets
in the pool and particular features of the transaction, these securities may be structured to achieve a desired level of risk and a desired
level of rating.

Mechanism of Securitization

(i) The process of securitization starts with identification by the company (the originator) the loans or bills receivable in its portfolio,
to prepare a basket or pool of assets to be securitized. The package usually forms an optimum mix so as to ensure fair marketability
of the instrument to be issued.

Further, the maturities are also so chosen that the package represents one homogeneous lot. The pool of receivables is backed by
the underlying securities held by the originator (in the form of mortgage, pledge, charge, etc.).

(ii) The pool of assets so identified is then sold to a specific purpose vehicle (SPV) or trust. Usually an investment banker performs
the task of an SPV, which is also called an issuer, as it ultimately issues the securities to investors.

iii) Once the assets are acquired by SPV, the same are split into individual shares/securities which are reimbursed by selling them
to investors. These securities are called ‘Pay or Pass Through Certificates’ (PTC) which are so structured as to synchronize for
redemption with the maturity of the securitized loans or bills.

A PTC thus represents a sale of an undivided interest to the extent of the face value of the PTC in the aggregate pool of assets
acquired by the SPV from the originator.

(iv) Repayments under the securitized loans or bills keep on being received by the originator and passed on to the SPV. To this end,
the contractual relationship between the originator an d the borrowers/obligates is allowed to subsist in terms of the pass through
transaction; alternatively a separate agency arrangement is made between the SPV (Principal) and the originator (agent).

(v) Although a PTC could be with recourse to its originator, the usual practice has been to make it without recourse. Accordingly, a
PTC holder takes recourse to the SPV and not the originator for payment to the principal and interest on the PTCs held by him.
However, a part of the credit risk, as perceived (and not interest risk), can be absorbed by the originator, by transferring the assets
at a discount, enabling the SPV to issue the PTCs at a discount to face value.

(vi) The debt to be securitized and the PTC issues are got rated by rating agencies on the eve of the securitization. The issues by the
SPV could also be guaranteed by external guarantor-institutions to enhance creditability of the issues. The PTCs, before maturity,
are tradable in a secondary market to ensure liquidity for the investors.

BENEFITS

1. Cheaper Financing
By using securitization techniques to separate a pool of underlying receivables, the originator may be able to generate a lower cost
of financing than it can through various forms of borrowing. This is because receivables are often a better credit quality than the
originator itself

2. Balance Sheet Benefits

Securitization accelerates cash receipts from the receivables while removing the accounts receivables from the originator’s balance
sheet. This reduces the originator’s debt/equity ratio so that it is better able to: (i) comply with financial covenants in respect of its
on-balance sheet borrowing; (ii) borrow more; and (iii) improve the return on capital.

3. Capital Adequacy

In most jurisdictions, financial institutions must hold a minimum capital requirement (essentially equity, reserves and various forms
of subordinated debt) against “risk-weighted” assets (that is, the value of assets taking into account a risk weighting which is based
on the likelihood of the asset value being realized). The requirement is expressed as a ratio that is set by the relevant regulatory
authority in a specific jurisdiction. The sale of receivables for cash effectively removes risk weighted assets from the regulated
institution’s balance sheet and reports additional cash instead. This balance sheet “exchange” of receivables for cash improves
regulated institution’s capital structure and reduces regulatory cost.

4. Alternative Source of Funding

Asset securitization provides the originator with additional source of funding or liquidity because this financing technique basically
converts an illiquid asset (e.g. receivable deriving from a consumer loan which itself cannot be sold) into (i) cash for the originator
and (ii) a security with greater marketability for investors. Further, the ability to sell these securities worldwide diversifies the
institution’s funding base, which reduces the institution’s dependence on local economies.

MODULE 5 CREDIT RATING

Credit rating is a numerical representation of the creditworthiness of an individual or a business. The credit rating is a key aspect
that makes or breaks a loan application. The credit rating/score acts as an indicator stating if the borrower has defaulted on loan
payments before and if he is worth trusting with the new loan.

There are several credit rating agencies in India, such as CRISIL Ltd, India Ratings and Research Pvt Ltd, ICRA Limited, CARE,
Brickwork Ratings India Pvt Ltd, SMERA Ratings Limited, and Infometrics Valuation and Rating Pvt Ltd.

What does credit rating mean?

A credit score is a 3-digit number that represents the creditworthiness of the borrower. Credit rating is the analysis of the possible
credit risks associated with granting a financial instrument to an individual or a company. Based on the credit score, a lender
determines whether the borrower can repay the loan amount or not.

The rating is provided based on the creditworthiness and the credentials of an individual or a company. The creditworthiness of an
individual or a company is decided based on the lending and borrowing transactions done in the past. Credit rating is determined
after weighing the statements of liabilities and assets, and their ability to meet the debt obligations.

It is recommended that you maintain a good credit rating if you would like to apply for a huge loan in the future.

You can maintain a good score given that you pay all your existing debts on time, check your credit report once in a while to stay
informed of your score and keep your credit utilisation ratio below 30%.
The credit score is determined based on the following factors.

Payment History: 35%

Credit Utilisation: 30%

Credit History Duration: 15%

Credit Mix: 10%

New Credit: 10%

Concept Of Credit Rating

Credit rating is the process of evaluating credit risk. It does not reflect market risk nor predict the prices or yields for credit
instruments. It provides an expert opinion about the relative ability and willingness to make timely payments on debtor-related
instruments.

It measures the likelihood of a borrower paying interest and principal on time. It gives a ranking of the credit quality of various debt
instruments.

Ratings are often expressed in either alphabetic or alphanumeric symbols. These ratings allow the investor to distinguish between
different debt instruments based on their credit quality. Credit rating is therefore a symbol of an investor's current opinion about the
issuer's ability to pay its debt obligations on time. Ratings are indicators of safety, liquidity, and profitability for debt instruments.

This function is performed by independent rating agencies. This is based on various factors like past performance, the market,
competitors, and the risk associated with the project.

Functions of Credit rating agencies:

1. Business Analysis

A credit rating company will analyze the business condition of the borrowing company not merely by the profits the borrowing
concern has made, but by the use of capital in a more productive purpose. The return on capital and the cost of capital will be
analyzed.

2. Evaluation of industrial risks

Every industry will have its risks which are due to natural or market conditions such as competition or due to the substitutes that
have arrived in the market. The extent of risks and measures to overcome them will be taken into account while judging the credit
rating of the company.

3. Market position of the company within the industry

What is the share of the market of the company seeking credit rating? A higher percentage of market share will involve more risks
as the company has to be vigilant to maintain its share. So, a credit rating agency will give due weightage for the market share of
the borrowing concern.

4. Operating efficiency

This is judged from the point of view of utilization of the capacity. When full capacity is utilized, the company has an advantage
over others. This may be possible due to location advantage or better labor relations. These will be looked into by the credit rating
agency.
5. Legal position in terms of prospectus

The statements made in the prospectus, should be true and factual. If tall claims are made, they will hamper the growth of the
company and the credit rating agency will not rely on the prospectus of the company. It may also be construed as a willful fraud for
attracting more funds. So, the contents of prospectus will also be a factor for credit rating considerations.

6. Financial analysis based on accounting quality

If accrued incomes are taken for making a window-dressing of balance sheet, it will not reflect well on the quality of accounting of
the borrowing concern. Companies relying on realized income, will be in a better position to provide a realistic balance sheet. So,
the true financial position of the company will be judged not merely on the books of accounts but also on their market conditions in
meeting their debt commitments.

7. Statement of profits

There may be over statement or under statement of profits depending upon the purpose for which the statement is prepared. Here,
again the credit rating agency has to scrutinize the realistic position of the company.

8. Earnings protection

To what extent, the earnings of the companies are consistent? Does it show any growth? What is the extent of profitability? All
these will be judged under this criteria.

9. Adequacy of cash flow

Is the cash flow sufficient to meet its current commitments as well as any other contingencies? This factor is taken into consideration
by the rating agencies.

10. Financial flexibility

How far the company is in a position to arrange for alternative financial plans for raising its funds, if its existing idea does not work
out successfully? Rating agencies adjudge the financial flexibility of companies.

➢ THE MERITS OF CREDIT RATING

Merits to Investors:

i. Security against Bankruptcy:

The rating of a credit instrument, performed by the Credit Rating Agency gives an indication to investors about the financial strength
of the company that issued the instrument. This helps him decide regarding the investment. Instruments that are highly rated by the
company assure investors of the security of the instruments and a low chance of bankruptcy.

ii. A Simple Understanding of Risk:

Credit rating offers investors rating symbols that convey information in a way that is easily recognized. It helps investors see the
potential risks associated with investing. It's easier for investors to gauge the worth of the company that is the issuer through
symbolism.

iii. Credibility of Issuers:

The symbol of a rating associated with an instrument of credit provides an indication of the reliability of the company that issues
the credit instrument. It is independent of the issuer and has no business or other connections with it. The lack of connections to
business between the rating agency and the company being rated gives credibility to the rating agency and draws investors.

iv. The Saving of Resources:

Investors depend on credit ratings. This eliminates the hassle of understanding the basic aspects of a business and its strength,
financial standing, management information and more. The credit score, which is provided by the experts from this credit rating
agency, gives the investor confidence to trust the credit rating to make the right investment decisions.

v. Capacity to Make Direct decisions:

Usually, investors need to get advice from financial intermediaries, merchant bankers, stock brokers and portfolio managers or
financial advisors about the best investment options. But investors do not have to trust the recommendations provided by these
brokers when it comes to assessed instruments because the rating symbol that is assigned to any instrument indicates the
creditworthiness of the instrument as well as the level of risk associated with it. Therefore, investors are able to make investment
decisions on their own.

vi. Choice of Investments:

Many alternative credit-rated instruments are readily available at a specific point in time for investing in the capital markets.
Investors can choose according to their risk profile and their diversification strategy.

vii. Rating Surveillance:

Investors can benefit from the ongoing monitoring by the credit rating agency of the instruments that are rated and rating by various
businesses. Credit Rating Agency downgrades the rating of any instrument when it is discovered that the strength of the business
decreases or if any other incident occurs that requires disclosure of information regarding its financial condition to investors.

Merits to Company:

i. Lower Cost of Borrowing:

A company that has an instrument with a high rating is able to cut costs of borrowing money from public sources by quoting lower
interest rates on fixed deposits, bonds or debentures. Investors typically prefer to invest in secure securities, even though they yield
less return.

ii. Extensive Borrowing:

A company that has an instrument that is highly rated could approach investors frequently to mobilize resources using the media.
Investors of all levels of society might be drawn to higher-rated instruments. Investors are aware of the level of confidence in the
timely payments of principal and interest on debt instruments with higher ratings.

iii. Rating as a Marketing Tool:

Businesses with rated instruments boost their image and take advantage of rating as an advertising tool that creates an image that is
more appealing when dealing with customers, lenders, creditors and constituents. Customers are confident about the utility products
made by companies that have high scores for credit products.

iv. The Self-Discipline of Companies:

Ratings encourage businesses to make more information regarding their accounting system as well as financial reporting,
management patterns and more. The company has the opportunity and incentive to enhance the practices it has in place to be
comparable to the standard of competitors and to maintain the high standard of rating it has earned or improve its rating.
v. Reduction of Costs in Public Problems:

A company that has a better rating is able to draw investors and raise funds with minimal effort. So, the company that is rated can
cut costs and reduce the cost of public matters by limiting the costs of conferences, coverage in the media and other publicity-related
events.

vi. Motivation to grow:

Ratings provide confidence to the company's growth because the individuals who promote the company are confident about their
efforts and are encouraged to pursue the expansion of their business or to develop new initiatives. With a more positive image by a
higher credit score, it is able to access money from public banks and institutions.

8 Big Problems with Credit Rating

The different problems that arise with credit rating can be described as the following:

1. Lack of accountability hinders the process of rating credit. The lack of skilled and experienced personnel may not be up to
their job and can result in an inaccurate rating.

2. There is a wide possibility of bias in rating since there is no standard mathematical formula to calculate the amount of
rating.

3. Ratings do not warrant any security for investors. It is subject to change over time.

4. Ratings are based upon the current and past performance of a business and can be affected by future events of a company.

5. Investors might be confused by the fact that different rating agencies give different ratings to the same financial instrument
of the same entity.

6. To give ratings to their instruments, the credit rating agency charges a substantial fee. This could lead to misleading or
exaggerated ratings.

7. Rating information is provided by the borrower/issuer and is subject to an error on the part of the company.

8. Credit rating agencies are facing the problem of not having a large branch network, which could lead to limited rating
skills.

Credit Rating: Top 5 Limitations

These are the limitations of credit rating:

i. Biased Ratings and Misrepresentations:

Credit rating is a curse in the capital market industry if it does not have a quality rating. The Rating Agency experts should not have
any connections with the company or persons who are interested in the company in order to avoid biased ratings. This will allow
them to make impartial and judicious recommendations to the rating committee. Rating committee members must be impartial and
judicious in making decisions.

ii. Static Study:

The company's past and present historical data are used to rate the company. This is not a static study. There may be many changes
in the political environment, economic situation, or government policy framework that directly impact the company's functioning.
Ratings will be useless in the future if there are such changes.

iii. Concealed Material Information:

Rating Companies may conceal information from the credit rating company's investigating team. It means that the company may
give only that information which goes in its favour. This can lead to a reduction in quality and render the rating unreliable. As is
said, "there are loopholes everywhere."

iv. There is no guarantee of the soundness of the company:

Ratings are done for specific instruments to assess credit risk, but they should not be taken as a guarantee of matching quality or
management. The rating symbol should not be used to form independent opinions. A good credit rating doesn't always indicate the
soundness of an organization.

v. Downgrade:

After a company is rated, if the company fails to perform well or has poor working results, the credit rating agency will review the
rating and downgrade it. The company's image will be affected. Therefore, it becomes important for companies to maintain a certain
standard throughout.

What is a credit rating agency?

A credit rating agency (CRA) evaluates and assesses an individual’s or a company’s creditworthiness. That is, these agencies
consider a debtor’s income and credit lines to analyse the debtor’s ability to repay the debt or if there is any credit risk associated.

Securities and Exchange Board of India (SEBI) reserves the right to authorise and regulate credit rating agencies according to SEBI
Regulations, 1999 of the SEBI Act, 1992.

How do credit rating agencies work?

Credit rating agencies analyse an organisation, individual, or entity and assign ratings to it. These agencies have the authority to rate
companies, state governments, non-profit organisations, countries, securities, local government bodies, and special purpose entities.

Many factors are considered while settling with a rating such as financial statements, type of debt, lending and borrowing history,
repayment capability, past credit repayment behaviour, and more. Each of these factors contributes to a specified share in computing
the end result, credit score.

The credit rating agency does not provide any decision to financial institutions on whether an entity should get a credit facility or
not; rather it provides the report and additional inputs making it easier for the lender to analyse and an informed decision.

List of registered credit rating agencies

According to SEBI, the following credit rating agencies are registered and authorised to compute and share credit score/report with
the financial institutions and applicants.

CRISIL Limited: Credit Rating Information Services of India Limited (CRISIL), one of the oldest credit rating agencies, was set
up in 1987. The agency stepped on to infrastructure rating in 2016. CRISIL has been operational in countries such as the USA, UK,
Poland, Hong Kong, China, and Argentina in addition to India.

India Ratings and Research Pvt Ltd: India Ratings and Research, a wholly-owned subsidiary of Fitch Group, provides accurate
and timely credit opinions on the country’s credit market. The firm covers corporate issuers, financial institutions, managed funds,
urban local bodies, project finance companies, and structured finance companies. The headquarters is in Mumbai and the other
branch offices are in Ahmedabad, Delhi, Chennai, Bengaluru, Hyderabad, Pune, and Kolkata.

ICRA Limited: The Investment Information and Credit Rating Agency (ICRA), a joint venture of Moody’s and Indian Financial
and Banking Service Organisation was established in 1991. The organisation is known for assigning corporate governance rating,
performance rating, mutual funds ranking, and more.
CARE: Credit Analysis and Research Limited (CARE) is a credit rating agency that is operational since April 1993. The agency
provides a credit rating that helps corporates to raise funds for their investment requirements. Investors can make decisions based
on credit risk and risk-return expectations. In addition to the head office in Mumbai, the firm has regional offices in New Delhi,
Pune, Kolkata, Chandigarh, Jaipur, Ahmedabad, Bengaluru, Chennai, Coimbatore, and Hyderabad.

Brickwork Ratings India Pvt Ltd: In addition to registering with SEBI, Brickwork Ratings (BWR) is accredited by RBI and
empanelled by NSIC, NCD, MSME ratings and grading services. It has received accreditation from NABARD for MFI and NGO
grading. Brickwork is also authorised to grade companies seeking credit facilities from IREDA, Renewable Energy Service
Providing Companies (RESCOs) and System Integrators (SIs). Canara Bank was the leading promoter and strategic planner for
Brickwork.

SMERA Ratings Limited: SMERA analyses and establishes the credibility of existing micro, small, and medium enterprises
(MSMEs). MSMEs can improve, grow, and avail cheaper/faster loans

Infometrics Valuation and Rating Pvt Ltd: This SEBI-registered, RBI-accredited credit rating agency was founded by finance
professionals, former bankers, and administrative services personnel. It evaluates entities such as banks, non-banking financial
companies, large corporates, and small and medium scale units (SMUs).

What is CRISIL Rating?

CRISIL, an acronym for Credit Rating Information Services of India Limited, is the first Credit Rating Agency established in India.
It’s a global analytical company whose main objective is to make financial markets function better. It provides ratings, research,
risk and advisory services to numerous companies and financial institutions.

It is majorly owned by Standard and Poor’s Global Inc. which provides transparent ratings, benchmarks, analytics across the world’s
financial markets.

The analysis, insights and solutions provided by CRISIL help institutions across the country in taking better financial decisions and
mitigating risks.

What is CRISIL Rating?

CRISIL rating refers to a rating which the company assigns to an entire range of debt instruments and financial entities. This credit
rating by CRISIL tells us about the creditworthiness of an instrument or an institution under consideration by using various analytical
tools and financial history.
These institutions can be manufacturing companies, banks, NBFCs, PSUs, financial institutions, state governments, urban local
bodies, and mutual funds.

CRISIL Rating helps issuers and borrowers in augmenting their access to funding, looking for various funding and investment
alternatives. The rating also helps in optimising the cost of funds for the financial entity.

Functions

• It has broad application in developing and providing comprehensive ratings.

• It believes in excellence, teamwork, integrity, and accountability to drive an ethical business of ratings.

• It serves business in eight countries: India, China, Hong Kong, Poland, Argentina, Singapore, the USA, and the UK.

• Currently, it serves 86 countries, having a customer base of 100,000.

• It reduces substantial levels of information asymmetry prevalent in the financial markets.

• Therefore, as a credit rating agency, it provides necessary support to the consulting business, financial services, commercial
and investment banks, insurance companies, asset management corporations, and private equity players.

• It offers independent insights and opinions, which becomes a constructive solution.

• It facilitates businesses to take up comprehensive and conclusive business and investment decisions.

• It additionally helps small lenders to take up the right lending calls and allow them to make correct business decisions.

• The agency performs extensive due diligence and financial analysis to arrive at a comprehensive rating.

• Due diligence may include gathering information from several research-based websites, followed by a meeting with the
top management.

CRISIL Rating

• The rating agency provides both long-term and short-term ratings.

• The rating starts from AAA and ends with SD.

• It provides credit ratings for long-term scale, short-term scale, structured finance, credit enhancement, fixed deposit scale,
corporate credit scale, etc.

• The agency’s rating rationale would focus on drivers that establish ratings, recent news, and developments and update
business performance, credit factors, and key performance indicators.

• To supplement the rationale, it provides financial commentary on the risk profile of a business.

• The AAA rating is the highest order, indicating that the borrowers make timely payments. It ensures that the issuer makes
timely payments.

• The AA rating is the rating that indicates the instrument issued of low risk, and it makes timely payments on its due
obligations.

• The A rating is the rating that indicates the instrument issued of low risk and it has adequate safety with minor lapses in
servicing obligations.

• The BB rating is the rating that indicates that the instrument issued is of very high risk and may default.
• The C rating is the rating wherein the instrument can be regarded as highly risky and has a high probability of default.

• This rating of D indicates that the issuer of the financial instrument has defaulted on its due obligations.

• SD rating also applies, indicating that the financial issuer has defaulted on the selective asset classes.

What is the full form of ICRA?

The full form of ICRA is Investment Information and Credit Rating Agency. ICRA Limited was previously called the
Investment Information and Credit Rating Agency. It was founded as an independent & competent investing information and
credit score company by leading banks, financial institutions and financial institutions in 1991.

Significant information about ICRA

• The ICRA consists of a group of Companies includes its subsidiaries.

• It is a limited public company and its shares are mentioned on the BSE (Bombay Stock Exchange) and the NSE (National
Stock Exchange) respectively.

• It is one of the nation’s most successful credit rating agencies currently.

• It rates rupee-denominated debt instruments provided by commercial banks, financial institutions, manufacturing firms,
undertakings of the government sector and much more.

• Also, it has a moody’s investor Service alliance. One of the main shareholders of ICRA is the international Credit Rating
Agency (Moody’s Investor Service).

Services from ICRA

• To offer institutional & individual creditors or investors with tips and guidance

• Improving the capacity of lenders/borrowers to access the financial markets to take advantage of a significant amount of
capital

• The assistance of regulatory authorities in the promotion of financial market clarity

• To include tools built for mediators to increase the efficacy of fund-raising systems