Assignment of FSM

On

Submitted to: Dr. Dheeraj Sharma

Submitted by: Arpandeep Kaur M.B.A. 2nd (c) Roll no: 6292

INTRODUCTION
Financial Services basically mean all those kinds of services provided in financial terms where the essential commodity is money. These services include: leasing, hire purchase, consumer credit, investment banking, commercial banking, venture capital, insurance, credit rating, bill discounting, and mutual funds , stock broking, housing finance, vehicle finance, mortgages and car loans, factoring among other things.

Various entities that provide these services are basically categorized into (a) Non Banking Finance Companies (b) Commercial Banks, and (c) Merchant Banks.

Financial Services in India is too vast and varied too have evolved at one place and at one time. One of the main entities that offer financial services in India is Non-Banking Finance Companies. These NBFCs registered with Reserve Bank of India mainly perform fund based services to the customer. Fund based services of NBFCs include: leasing, hire-purchase and other asset based services whereas fee based services of NBFCs include bill discounting, portfolio management and other advisory services.

LEASING
Leasing as financial service is a contractual agreement where the owner (lessor) of equipment transfers the right to use the equipment to the user (lessee) for an agreed period of time in return for a rental. At the end of the lease period the asset reverts back to the lessor unless there is a provision for the renewal of the contract or there is a provision for the transfers of ownership to the lessee. If there is any such provision for transfer of ownership, the deal is treated as hire purchase. Therefore, a lease could be generally defined as A contract where a party being the owner (lessor) of an asset (leased asset) provides the asset for use by the lessee at a consideration (rentals), either fixed or dependent on any

variables, for a certain period (lease period), either fixed or flexible, with an understanding that at the end of such period, the asset, subject to the embedded options of the lease, will be either returned to the lessor or disposed off as per the lessor's instructions.

Leasing was prevalent during the ancient Sumerian and Greek civilizations where leasing of land, agricultural implements, animals mines and ships took place. The practice of leasing came into being sometime in the later half of the 19th century where the rail road manufacturers in the U.S.A resorted to leasing of rail cars and locomotives. The equipment leasing industry came into being in 1973 when the first leasing company, appropriately named as First Leasing This industry however remained relegated to the background until the early eighties, because the need for these industry was not strongly felt in industry. The public sector financial institutions IDBI, IFCI, ICICI and the State Financial Corporations (SCFs) provided bulk of the term loans and the commercial banks provided working capital finance required by the manufacturing sector on relatively soft terms. Given the easy availability of funds at reasonable cost, there was obvious no need to look for alternative means of financing. The credit squeeze announced by the R.B.I coupled with the strict implantation of the Tandon & Chore committees norms on Maximum Permissible Bank Finance (MPBF) for working capital forced the manufacturing companies to divert a portion of their long term funds for their working capital.

HISTORY AND DEVELOPMENT OF LEASING

The history of leasing dates back to 200BC when Sumerians leased goods. Romans had developed a full body law relating to lease for movable and immovable property. However the modern concept of leasing appeared for the first time in 1877 when the Bell Telephone Company began renting telephones in USA. In 1832, Cottrell and Leonard leased academic caps, grown and hoods. Subsequently, during 1930s the Railway Industry used leasing service for its rolling stock needs. In the post war period, the American Air Lines leased their jet engines for most of the new air crafts. This development ignited immediate popularity for the lease and generated growth of leasing industry.

The concept of financial leasing was pioneered in India during 1973. The First Company was set up by the Chidambaram group in 1973 in Madras. The company undertook leasing of industrial equipment as its main activity. The Twentieth century Leasing Company Limited was established in 1979. By 1981, four finance companies joined the fray. The performance of First Leasing Company Limited and the Twentieth Century Leasing Company Limited motivated others to enter the leasing industry. In 1980s financial institutions made entry into leasing business. Industrial Credit and Investment Corporation was the first all India financial institution to offer leasing in 1983. Entry of commercial banks into leasing was facilitated by an amendment of Banking Regulation Act, 1949. State Bank of India was the first commercial bank to set up a leasing subsidiary, SBI capital market, in October 1986. Can Bank Financial Services Ltd., BOB Financial Service Ltd., and PNB Financial Services Limited followed suit. Industrial Finance Corporations Merchant Banking division started financing leasing companies as well as equipment leasing and financial services. There was thus virtual explosion in the number of leasing companies rising to about 400 companies in 1990.

In the subsequent years, the adverse trends in capital market and other factors led to a situation where apart from the institutional lessors, there were hardly 20 to 25 private leasing companies who were active in the field. The total volume of leasing business companies was Rs.5000 crores in 1993 and it is expected to cross Rs.10, 000 crores by March 1995.

ELEMENTS IN LEASE STRUCTURE

This is an explanation of the elements in a lease - the parties, asset, rentals, residual value, etc. This section would also elaborate the unique features of a lease as different from a regular financing transaction.

1. The transaction:
The transaction of lease of lease is generically an asset-renting transaction. What distinguishes a lease from a loan is that in the latter, what is lent out is money; in a lease, what is lent out is the asset.

2. Parties to a lease:
There are two parties to a lease: the owner and the user, called the lessor and the lessee. The lessor is the person who owns the asset and gives it on lease. The lessee takes the asset on lease and uses it for the period of the lease. Any one can be a lessor, and any one can be a lessee, subject to usual conditions as to competence to contract, or holding of properties. Technically, in order to be a lessor, one does not have to own the asset: one has to have the right to use the asset. Thus, a lessee can be a

lessor for a sub-lessee, unless the parent lessor has restricted the right to sub-lease.

3. The leased asset:

The subject of a lease is the asset, article or property to be leased. The asset may be anything - an automobile, or aircraft, or machine, or consumer durable, or land, or building, or a factory. Only tangible assets can be leased - one cannot contemplate the leasing of the intangible assets, since one of the essential elements of a lease is handing over of possession, along with the right to use. Hence, intangible assets are assigned, whereas tangible assets may be leased. The concept of leasing will have the following limitations: 1. What cannot be owned cannot be leased. Thus, human resources cannot be "leased". 2. While lease of movable properties can be affected by mere delivery, immovable property is incapable of deliveries in physical sense. Most countries have specific laws relating to transactions in immovable properties: if such law provides a particular procedure for a lease of immovable or real estate, such procedure should be complied with. For example, in Anglo-Saxon legal systems (UK, Australia, India, Pakistan, etc.), transactions in real estate are not valid unless they are effected by registered conveyance. This would apply to lease of land and buildings, and permanent attachments to land. 3. A lease is structurally a rental for the lease period: with the understanding that the asset will be returned to the lessor after the period. Thus, the asset must be capable of redelivery: it must be durable (at least during the lease period), identifiable and severable.

The existence of the leased asset is an essential element of a lease transaction - the asset must exist at the beginning of the lease, during the lease and at the end of the lease term. Nonexistence of the asset, for whatever reason, will be fatal to the lease.

4. Lease period:
The term of lease, or lease period, is the period for which the agreement of lease shall be in operation. As an essential element in a lease is redelivery of the asset by the lessee at the end of the lease period, it is necessary to have a certain period of lease. During this certain period, the lessee may be given a right of cancellation, and beyond this period, the lessee may be given a right of renewal, but essentially, a lease should not amount to a sale: that is, the asset being given permanently to the lessee. In financial leases, is common to differentiate between the primary lease period and the secondary lease period. The former would be the period over which the lessor intends recovering his investment; the latter intended to allow the lessee to exhaust a substantial part of the remaining asset value. The primary period is normally non-cancelable, and the secondary period is normally cancelable.

5. Lease rentals:
The lease rentals represent the consideration for the lease transaction. This is what the Lessee pays to the Lessor. If it is a financial lease transaction, the rentals will simply be the recovery of the lessor's principal, and a certain rate of return on outstanding principal. In other words, the rentals can be seen as bundled principal repayment and interest. If it is an operating lease transaction, the rentals might include several elements depending upon the costs and risks borne by the Lessor, such as:

Interest on the lessor's investment.

If the lessor is bearing any repairs, insurance, maintenance or operation costs, them charges for such cost.

Depreciation in the asset. Servicing charges or packaging charges for providing a package of the above service.

6. Residual value:
Put simply, "residual value" means the value of the leased equipment at the end of the lease term. If the lease contains a buy out option with the lessee, residual value would mostly mean the value at which a lessee will be allowed to buy the equipment. If there is no embedded purchase option, residual value might mean the value that the lessee or some one else assures will be the minimum value of the equipment at the end of the lease term. This is typical in case of financial leases where the lessor cannot grant a buyout option to the lessee; for the lessor to protect himself against asset-based risks, he would take an assured residual value commitment either from the lessee himself or from a third party, typically an insurance company. The residual value might also the value that the lessor assures to pay-back to the lessee in case the lessee returns the asset to the lessor: that is, it might be the value the lessor assures as the minimum value of the equipment. Such a lease, obviously an operating lease because the lessor is taking a risk on asset values, is a full payout lease, but the lessor agrees to refund the guaranteed value on the lessee returning the equipment at the end of the lease term.

7. End-of-term options:
The options allowed to the lessee at the end of the primary lease period are called end-of-term options. Essentially, one, or more, of the following options will be given to the lessee at the end of the lease term:

Option to buy (buyout option) at a bargain price or nominal value (typical in a hirepurchase transaction), called bargain buyout option

Option to buy at a fair market value or fixed, but substantial value Option to renew the lease at nominal rentals, called bargain renewal option Option to renew the lease at fair market rentals or substantial rentals Option to return the equipment

In any lease, which option will be suitable depends on the nature of the lease transaction, as also the applicable regulations. For example, in a full payout financial lease, the lessor would have recovered the whole or substantially the whole of his investment during the primary lease period. Therefore, it is quite natural that the lessee should be allowed to exhaust the whole of the remaining value of the equipment. Regulation permitting, the lessor provide the lessee a bargain purchase option to allow the lessee to complete the purchase of the equipment. However, in many jurisdictions, it is the existence of such buyout option that demarcates between lease and hire-purchase transaction. If the lessor is interested to structure the lease as a lease and not hire-purchase, he would be advised not to provide any buyout option, but instead, to allow the lessee to renew the lease to continue the use of the asset. In essence, a renewal option achieves the same purpose as a purchase, but the lessor retains his ownership as also his reversionary interest in the equipment. Fair market value options, either for purchase of equipment, or for renewal, are typical of operating leases, but are really speaking no more than assuring to the lessee a continued use of the equipment. If equipment has to be bought at its prevailing market value, it can be bought from the market rather than from the lessor - therefore, the fair market value option carries no value for the lessee.

8. Upfront payments:
Lessors may require one or more of the following upfront, that is, instant payments from a lessee:

Initial lease rental or initial hire or down payment Advance lease rental Security deposit Initial fees

The initial lease rent or initial hire (the word hire is more common in case of hire-purchase transactions) is a surrogate for a margin or borrower contribution in case of loan transactions.

Note that given the nature of a lease or hire-purchase as asset-renting transaction, it is not possible to expect a lessee's contribution to asset cost as such. Hence, the down payment or first lease rent serves the purpose of a margin. Between advance lease rent and initial lease rent - the difference is only technical. The whole of the initial lease rental is supposed to be appropriated to income on the date of its receipt, whereas advance rental is still an advance - normally an advance against the last few rentals. Therefore, the advance rental will remain as a deposit with the lessor to be adjusted against the last few rentals. The security deposit is a proper deposit to secure against the lessee's commitments under the contract - it is generally intended to be refunded at the end of the lease contract.

TYPES OF LEASING

FINANCE LEASE A lease is defined as finance lease if it transfers a substantial part of the risks and rewards associated with ownership from the lessor to the lessee. According to the International Accounting Standards Committee (IASC), there is a transfer of a substantial part of the ownership-related risks and rewards if: i. The lease transfers ownership of the asset to the lessee by the end of the lease term; (or) ii. The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than the fair market value at the date the option becomes exercisable and, at the inception of the lease, it is reasonably certain that the option will be exercised; (or) iii. The lease term is for a major part of the useful life of the asset. The title may or may not eventually be transferred; (or)

iv. The present value of the minimum lease payments (See Glossary) is greater than or substantially equal to the fair market value of the asset at the inception of the lease. The title may or may not eventually be transferred. The aforesaid criteria are largely based on the criteria evolved by the Financial Accounting Standards Board (FASS) of USA. The FASS has in fact defined certain cut-off points for criteria (iii) and (iv). According to the FASS definition of a finance lease, if the lease term exceeds 75 percent of the useful life of the asset or if the present value of the minimum lease payments exceeds 90 percent of the fair market value of the asset at the inception of the lease, the lease will be classified as a 'finance lease' Financial leases are "loan look-alike": However, financial leases, though being leases by structure, are financings by contrivance. To achieve the financing purpose, the leasing structure here tries to eliminate the substantive differences between leasing and plain financings As you might notice, in the above example, the lessee has been put virtually in the position of an asset owner - he has the right to use the asset for 5 years, with a power to extend the lease period for another 5 years. The first 5 years are called the primary lease period and the extended period is called the secondary lease period. The lease is non-cancelable during the primary lease period - that is, the lessee cannot return the asset and not pay balance of the lessor's rentals. For the secondary period, the lessee will have no incentive of returning the asset, as what the lessee has to pay is nominal, whereas the asset might still carry substantial value. Thus, the asset will be enjoyed by the lessee virtually for the whole of its economic life.

The lessor too has no significant risk/reward other than that of a virtual money-lender: he would continue getting the lease rentals for the primary period which will fully-payout the lessor's

investment in the lease as also give him his desired return on investment, irrespective of the state, value or utility of the asset. If the lessee performs as per agreement, the lessor would get no more, and no less, than such pre-fixed return on investment. Incidentally, in the present example, the lessor gets a return of 12.98% - this is equivalent to the rate of interest in case of loans. As this rate is not explicit, but implicit in the rate of rentals, the rate is implicit rate of return or IRR.

Features of financial leases:

The above discussion leads to the following features of financial leases: Financial leases allow the asset to be virtually exhausted by the same lessee. Financial leases put the lessee in the position of a virtual owner. The lessor takes no asset-based risks or asset-based rewards. He only takes financial risks and financial rewards, and that is why the name financial leases. The lease is non-cancelable, meaning the lessee cannot return the asset and not pay the whole of the lessor's investment. In this sense, they are full-payout, meaning the full repayment of the lessor's investment is assured. As the lessor generally would not take any position other than that of a financier, he would not provide any services relating to the asset. As such, the lease is net lease. The risk the lessor takes is not asset-based risk but lessee-based risk. The value of the asset is important only from the viewpoint of security of the lessor's investment. In financial leases, the lessor's payback period, viz., primary lease period is followed by an extended period to allow exhaustion of asset value by the lessee, called secondary lease period. As the renewal is at a token rental, this option is called bargain renewal option. Alternatively, if the regulations permit, the lessee may be given a purchase option at a nominal price, called bargain buyout or purchase option.

 In financial leases, the lessor's rate of return is fixed: it is not dependant upon the assetvalue, performance, or any other extraneous costs. The fixed lease rentals give rise to an ascertainable rate of return on investment, called implicit rate of return. Financial leases are technically different but substantively similar to secured loans.

Financial leases and Hire-purchase: In some countries, distinction is made between lease and hire-purchase transactions. A hirepurchase transaction is usually defined as one where the hirer (user) has, at the end of the fixed term of hire, an option to buy the asset at a token value. In other words, financial leases with a bargain buyout option at the end of the term can be called a hire-purchase transaction. Hire-purchase is decisively a financial lease transaction, but in some cases, it is necessary to provide the cancellation option in hire-purchase transactions by statute: that is, the hirer has to be provided with the option of returning the asset and walking out from the deal. If such an option is embedded, hire-purchase becomes significantly different from a financial lease: the risk of obsolescence gets shifted to the hire-vendor. If the asset were to become obsolete during the pendency of the hire term, the hirer may off-hire the asset and closes the contract, leaving the owner with less than a full-payout. Hire-purchase is of British origin - the device originated much before leases became popular, and spread to countries which were then British dominions. The device is still popular in Britain, Australia, New Zealand, India, Pakistan, etc. Most of these countries have enacted, in line with United Kingdom, specific laws dealing with hire-purchase transactions.

DIFFERENCE BETWEEN LEASE FINANCING AND HIRE PURCHASE

BASIS A

LEASE FINANCING Lease transaction is

HIRE PURCHASE a Hire purchase is type of

Meaning

commercial arrangement, whereby installment credit under an equipment owner or manufacturer which the hire purchaser conveys to the equipment user the agrees to take the goods right to use the equipment in return on hire at a stated rental, for a rental. which is inclusive of the repayment of principal as well as interest, with an option to purchase.

No option is provided to the lessee Option is provided to the

Option To User

(user) to purchase the goods.

hirer(user).

Lease rentals paid by the lesee are Only

interest in

element the hire

Nature Of Expenditure

entirely lessee.

revenue

expenditure

of included

purchase, installments is revenue expenditure by nature.

Lease rentals comprise of two Hire purchase installments

Components

elements (1) finance charge and (2) comprise capital recovery. elements

of (1)

three normal

trading profit (2) finance charge (3) recovery of cost of goods/assets.

Substance of financial lease:

If financial leases are substantively so close to secured financing transactions, the categorical issue is: why should they be treated as a lease at all? Why should they not be regulated, taxed and accounted for as plain loan transactions? This question may be significant from viewpoint of :

Regulation of financial leasing activity. Asset rights of the lessor. Taxation of the lessor/lessee. Accounting for the lease transaction.

In each case, treating the lease as a lease or, based on substance, a financing transaction, may lead to completely different implications.
o

From viewpoint of general regulation of financial leasing activity, if it is taken as

financing by another name, it should form a part of overall financial markets regulation most countries' central banks maintain some control on financial intermediaries.
o

The asset-rights of the lessor would also be similar to those of a secured lender, while in a

plain lease contract, the lessor is the sole owner of the asset and the lessee is merely its bailee.
o

If the lease is treated as a financing transaction, the lessor should not be allowed to claim

any asset-related benefit, such as depreciation. His income should be the implicit part of

rentals going towards return on investment. Likewise, the lessee, apparently a mere user of the asset, should be treated as a virtual owner and should be allowed all asset-based benefits.
o

From accounting viewpoint, if the lease is a mere financing arrangement, the asset should

feature on the Balance Sheet of the lessee rather than the lessor, along with a corresponding liability to pay fixed rentals to the lessor. Ideally, any system should be able to differentiate or integrate transactions based on their substance, and not nomenclature. So, if financial leasing is so close to lending, it should have been treated as such for every purpose, and the lessor should have been treated as a lender. However, such ideal is never achieved. There are two reasons to this - one, to an extent, laws, regulators and taxmen are conditioned by the legal fabric of a transaction. And two, lessors would emphasize upon on one or more structural differences between a lease and a loan, and be able to create a situation by which the substance rule fails. Therefore, financial leasing all over the World continues to live with, or rather thrive on, differing approaches to its character - it being treated at par with loans for some purposes, and distinguished from loans in for some others. Besides, the lease/loan treatment also depends upon the maturity of a country's regulatory system to appreciate the substance of a deal by exploding its form - understandably, doing so is not easy because it would mean going beyond the apparent form of a contract. Based on the 4 major areas listed above (general regulation, asset rights, taxation and accounting), there might be numerous combinations treating financial leases as loans on security for some purpose and true lease for some other purposes. Accountings standards are the first (perhaps because they are least dependent on a statute) to realize the indifference between leases and loans. Taxation, particularly, income-tax, moves close to accounting standards. General property laws are the last to do so, because often, for enforcement of a contract, the way the parties create their mutual rights apparently is more important than what could have been their intent behind such creation.

For the purpose of determining the present value, the discount rate to be used by the lessor will be the rate of interest implicit in the lease and the discount rate to be used by the lessee will be its incremental borrowing rate. Therefore, a lease is to be classified as a finance lease if one of the conditions (iii) or (IV) is satisfied.

In a finance lease, the lessee is responsible for repair, maintenance and insurance of the asset. The lessee also undertakes a "hell or high water" obligation to pay rental regardless of the condition or the suitability of the asset. A finance lease which operates over the entire economic life of the equipment is called a "full pay out lease".

OPERATING LEASE

The International Accounting Standards Committee defines an Operating Lease as "any lease other than a finance lease". An Operating Lease has the following characteristics:

a.. The lease term is significantly less than the economic life of the equipment. b. The lessee enjoys the right to terminate the lease at short notice without any significant penalty. c. The services equipment lessor and in usually provides the an the operating of lease the know-how, insuring is called suppliers, and a the related the An

undertakes which where

responsibility operating bears

maintaining 'wet lease'.

case the

operating lease

lessee

costs

of insuring and

maintaining

the leased equipment is called a 'dry lease'. From the features of an operating lease, it is evident that this form of a lease does not shift the equipment-related business and technological risks from the lessor to the lessee. The lessor structuring an operating lease transaction has to depend upon multiple leases or on the realization of a substantial resale value (on expiry of the first lease) to recover the investment cost plus a reasonable rate of return thereon. Therefore, specializing in operating leases calls for an in-depth knowledge of the equipments per se and the secondary (resale) market for such equipments. Of course the prerequisite is the existence of a resale market. Given the fact that the resale market for most of the used capital equipments in our count~ lacks breadth, operating leases are not in popular use. But then this form of lease ideally suits the requirements of firms operating in sun rise industries which are characterized by a high degree of technological risk. Following are illustrative situations where a lease will be regarded as an operating lease:

If the lease has a cancellable period, during which rentals forming more than 10% in present value terms of the fair value of the asset are received;

If part of the rentals are contingent or conditional, and such rentals form more than 10% in present value terms of the fair value of the asset;

If the lessor relies upon unguaranteed residual value, and such value forms more than 10% in present value terms of the fair value of the asset;

If the lessor relies upon guaranteed residual value, but such value is guaranteed by a third party, and such third-party-guaranteed residual value forms more than 10% in present value terms of the fair value of the asset - in this case, the lease will be regarded as a financial lease for the lessor but an operating lease for the lessee;

If the lessor's IRR and the lessee's incremental borrowing rate differ: the lease may be a financial lease for the lessor and an operating lease for the lessee

Differences between Finance and Operating Leases

Financial Lease

Operating Lease

Risks and rewards of ownership are transferred to, and borne by, the lessee. This includes the risks of accidental ruin or damage of the asset (although these risks may be insured or otherwise assigned). Thus damage that renders an asset unusable does not exempt the lessee from financial liabilities before the lessor.

Economic ownership with all corresponding rights and responsibilities are borne by the

lessor.The lessor buys insurance and undertake maintenance. The goal of the lessee is usage of the leased asset for a specific temporary need, and hence the operating lease contract covers only the short-term use of the asset. Further, the duration of an operating lease is usually much shorter than the useful life of the asset. It is not the lessees intention to acquire the asset, and lease payments are determined accordingly. In responsibility for

The goal of the lessee is either to acquire the asset or at least use the asset for most of its economic life. As such, the lessee will aim to cover all or most of the full cost of the asset during the lease term and therefore is likely to assume the title for the asset at the end of the lease term. The lessee may gain the title for the asset earlier, but not before the full cost of the asset has been paid off.

addition, an asset under an operating lease may subsequently be rented out. The present value of all lease payments is significantly less than the full asset price.

The lessor retains legal ownership for

the duration of the lease term, though the lessee may or may not buy out the leased asset at the end of the lease, with the lessor charging only a nominal fee for the transfer of asset to the lessee. The lessee chooses the supplier of the asset and applies to the lessor for funding. This is significant because the leasing company that funds the

transaction should not be liable for the asset quality, technical characteristics, and completeness, even though it retains the legal ownership of the asset. The lessee will also generally retain some rights with respect to the supplier, as if it had purchase asset directly.

SALE AND LEASEBACK In a sale and leaseback transaction, the owner of equipment sells it to a leasing company which in turn leases it back to the erstwhile owner (the lessee). The 'leaseback' arrangement in this transaction can be in the form of a 'finance lease' or an 'operating lease'. A classic example of this type of transaction is the sale and leaseback of safe deposit vaults resorted to by commercial banks is Under this arrangement the bank sells the safe sells the safe deposit vaults in its custody to a leasing company at a market price which is substantially higher than the book value.

SELLER

SALE TRANSACTION SALE VALUE

BUYER

LEASE TRANSACTION

LESSEE

LESSOR
LEASE RENTALS

Sales and Leaseback

The leasing company offers these lockers on a long-term lease to the bank. The advantages to the bank are: a. It is able to unlock its investment in a low income yielding asset. b. It is able to enjoy the uninterrupted use of the lockers (which can be leased to its customers). c. It can invest the sale proceeds (which are not subject to the reserve ratio requirements) in high income yielding commercial loans. In general, the 'sale and leaseback' arrangement is a readily available source of funds for financing the expansion and diversification programs of a firm. In case where capital investments in the past have been funded by high cost short-term debt, the sale and lease back transaction provides an opportunity to substitute the short-term debt by medium-term finance (assuming that the leaseback arrangement is a finance lease). From the leasing company's angle a sale and leaseback transaction poses certain problems. First, it is difficult to establish a fair market value of the asset being acquired because the secondary market for the asset may not exist; even if it exists, it may lack breadth. Second, the Income Tax Authorities can disallow the claim for depreciation on the fair market value if they perceive the fair market value as not being 'fair'.

DIRECT LEASE A direct lease can be defined as any lease transaction which is not a "sale and leaseback" transaction. In other words, in a direct lease, the lessee and the owner are two different entities. A direct lease can be of two types: Bipartite Lease and Tripartite Lease.

Bipartite Lease
In a bipartite lease, there are two parties to the transaction - the equipment supplier cum-lessor and the lessee. The bipartite lease is typically structured as an operating lease with in-built facilities like up gradation of the equipment (upgrade lease) or additions to the original equipment configuration. The lessor undertakes to maintain the equipment and even replaces the equipment that is in need of major repair with similar equipment in working condition (swap lease). Of course, all these add-ons to the basic lease arrangement are possible only if the lessor happens to be a manufacturer or a dealer in the class of equipments covered by the lease.

Tripartite Lease
A tripartite lease on the other hand is a transaction involving three different parties -the equipment supplier, the lessor, and the lessee. Most of the equipment lease transactions fall under this category. An innovative variant of the tripartite lease is the sales-aid lease where the equipment supplier catalyzes the lease transaction. In other words, he arranges for lease finance for a prospective customer who is short on liquidity. Sales-aid leasing can take one of the following forms: a.. The equipment supplier can provide a reference about the customer to the leasing company. b. The equipment supplier can negotiate the terms of the lease with the customer and complete the necessary paper work on behalf of the leasing company.

c. The supplier can write the lease on his own account and discount the lease receivables with
the designated leasing company. The effect of the transaction is that the leasing company owns the equipment and obtains an assignment of the lease rental. By and large, sales-aid lease is supported by recourse to the supplier in the event of default by the lessee. The recourse can be in the form of the supplier offering to buyback the equipment from the lessor in the event of default by the lessee or in the form of providing a guarantee on behalf of the lessee.

LEVERAGED LEASE In a leveraged lease transaction, the leasing company (called equity investor) invests in the equipments by borrowing a large chunk of the investment with full recourse to the lessee and without any recourse to it. The lender (also called the loan participant) Obtains the assignment of the lease and the rentals to be paid by the lessee, and a first mortgage on thee leased asset. The transaction is routed through a trustee who looks after the interests of the lender and the lessor. On receiving the rentals from the lessee, the trustee remits the debt- service component of the rental to the loan participant and the balance to the lessor. A schematic representation of transaction is represented in the figure:

Leveraged Lease

Sells Asset

Leases Assets

Manufacturer

Lessor

Lessee

Lender

Domestic Lease & International Lease

A lease transaction is classified as a domestic lease if all parties to the transaction to the equipment supplier, the lessor and the lessee are domiciled in the same country. On the other hand, if the parties are domiciled in different countries, the transaction is classified as an International Lease Transaction.

The distinction between a domestic lease transaction and an international lease transaction is important for two reasons. First, packaging an international lease transaction calls for, a. An understanding of the political and economic climate; and b. Knowledge of the tax and the regularity framework governing these transactions in the countries concerned. Second, as the payments to the supplier and the lease are denominated in different currencies, the economies of the transactions from the points of view of both the lessor and the lessee tend to be affected by the variations in the relevant exchange rates. In short, international lease transactions unlike domestic lease transactions are affected by two additional sources of risk country risk and currency risk.

LEASING TO LESEE AND LESSOR

Advantages of LEASING to LESSEE There are several extolled advantages of acquiring capital assets on lease:

(1)

Saving of capital:

Leasing covers the full cost of the equipment used in the business by providing 100% finance. The lessee is not to provide or pay any margin money as there is no down payment. In this way the saving in capital or financial resources can be used for other productive purposes e.g. purchase of inventories.

(2)

Flexibility And Convenience:

The lease agreement can be tailor- made in respect of lease period and lease rentals according to the convenience and requirements of all lessees.

(3)

Planning Cash Flows:

Leasing enables the lessee to plan its cash flows properly. The rentals can be paid out of the cash coming into the business from the use of the same assets.

(4)

Improvement In Liquidity:

Leasing enables the lessee to improve their liquidity position by adopting the sale and lease back technique.

(5)

Shifting of Risk of Obsolescence:

The lessee can shift the risk upon lessor by acquiring the use of asset rather than buying the asset.

(6)

Maintenance And Specialized Services:

In case of special kind of lease arrangement, Lessee can avail specialized services of lessor for maintenance of asset leased. Although lessor charges higher rentals for providing such services, lessees overall administrative and service costs are reduced because of specialized services of the lessor.

(7)

Off-The-Balance-Sheet-Financing:

Leasing provides "off balance sheet" financing for the lessee, in that the lease is recorded neither as an asset nor as a liability.

Disadvantages of LEASING to LESSEE

(1)

Higher Cost:

The lease rental include a margin for the lessor as also the cost of risk of obsolescene, it is, thus regarded as a form of financing at higher cost.

(2) up. (3)

Risk of being deprived the use of asset in case the leasing company winds

No Alteration In Asset:

Lessee cannot make changes in asset as per his requirement.

(4)

Penalties On Termination Of Lease:

The lessee has to pay penalties in case he has to terminate the lease before expiry o lease period.

Advantages of LEASING to LESSOR

(1)

Higher profits:

The lessor can get higher profits by leasing the asset.

(2)

Tax Benefits:

The lessor being owner of asset can claim various tax benefits such as depreciation.

(3)

Quick Returns:

By leasing the asset, the Lessor can get quick returns than investing in other projects of long gestation period.

Disadvantages of LEASING to LESSOR

(1)

High Risk of Obsolescence:

The lessor has to bear the risk of obsolescence as there are rapid technology changes.

(2)

Price Level Changes:

In case of inflation, the prices of asset rises but the lease rentals remain fixed.

(3)

Long term Investment:

Leasing requires the long term investment in purchase of an asset, and takes long time to cover the cost of that asset