GFGC SIRSI CHAPTER - 3. FINANCIAL SERVICES.

CLS:BBA 4th sem

Meaning : Financial services can be defned as the products and services ofered bb insttutons like
banks of various kinds for the facilitaton of various fnancial transactons and other related actvites in
the world of fnance like loans, insurance, credit cards, investment opportunites and moneb
management as well as providing informaton on the stock market and other issues like market trends

Functions of financial services

1. Facilitatng transactons eechange of goods and services) in the economb.

2. Mobilizing savings for which the outlets would otherwise be much more limited).

3. Allocatng capital funds notablb to fnance productve investment).

4. Monitoring managers so that the funds allocated will be spent as envisaged).

5.Transforming risk reducing it through aggregaton and enabling it to be carried bb those more willing
to bear it).

Objectives of financial services

1) Fund Raising:The required funds can be raised bb the help of fnancial services from the host of
investors, individuals, insttutons and corporate. There are various instruments of fnance being used
for raising funds. These kinds of funds are required bb the corporate houses, individuals, etc.

2) Funds Deplobment:There are various kinds of fnancial services present in the fnancial markets which
help the companb in proper deplobment of funds. It also helps in decision-making of fnancial mie. The
fnancial service provide various tbpes of services like bill discountng, factoring of debtors, shiting of
short-term funds in the moneb market, credit ratng, e- commerce and securitsaton of debts for
efectve funds management.

3) Specialized Services :The various specialized services are being provided bb fnancial service eecept
banking and insurance like credit ratng, venture capital fnancing, lease fnancing, factoring, mutual
funds, merchant banking, stock lending, depositorb, credit cards, housing fnance, book- building, etc.
These services are provided bb various kinds of insttutons and agencies like stock eechanges,
specialized and general fnancial insttutons and non- banking fnance companies, subsidiaries of
fnancial insttutons, banks and insurance companies. etc.

4) Regulaton:There are various kinds of regulatorb bodies present in India like Securites and Eechange
Board of India SEBI), Reserve Bank of India RBI) and the Department of Banking and Insurance of the
Government of India which have diferent tbpes of legislatonns and also help in providing various kinds
of functons of fnancial services insttutons.
5) Economic Growth:The fnancial services help in increasing the economic growth and development of
countrb. It is done bb the help of mobilizing the saving of the public bb investng in productve
investments. Due to this reason, the various developed and developing countries which are engaged in
the efectve fnancial market has increased the savings and investments.

Characteristics or Nature of Financial Services

1. Intangibilitb: Financial services are intangible. Therefore, theb cannot be standardized orreproduced
in the same form. The insttutons supplbing the fnancial services should have a beter image and
confdence of the customers. therwise, theb mab not succeed. Theb have to focus on qualitb and
innovaton of their services. Then onlb theb can build credibilitb and gain the trust of the customers.

2. Inseparabilitb: Both producton and supplb of fnancial services have to be performed simultaneouslb.
Hence, there should be perfect understanding between the fnancial service insttutons and its
customers.

3. Perishabilitb: Like other services, fnancial services also require a match between demand and supplb.
Services cannot be stored. Theb have to be supplied when customers need them.4. Variabilitb: In order
to cater a varietb of fnancial and related needs of diferent customers in diferent areas, fnancial
service organisatons have to ofer a wide range of products and services. This means the fnancial
services have to be tailor-made to the requirements of customers. The service insttutons diferentate
their services to develop their individual identtb.

5. Dominance of human element: Financial services are dominated bb human element. Thus, fnancial
services are labour intensive. It requires competent and skilled personnel to market the qualitb fnancial
products.

LEASING

Meaning of leasing

Leasing is a process bb which a frm can obtain the use of a certain feed assets for which it must pab a
series of contractual, periodic, tae deductble pabments. The lessee is the receiver of the services or the
assets under the lease contract and the lessor is the owner of the assets. The relatonship between the
tenant and the landlord is called a tenancb, and can be for a feed or an indefnite period of tme called
the term of the lease). The consideraton for the lease is called rent.

Lease can be defined as the following ways:

1. A contract bb which one partb lessor) gives to another lessee) the use and possession of equipment
for a specifed tme and for feed pabments.

2. The document in which this contract is writen.

3. A great wab companies can conserve capital.

4. An easb wab vendors can increase sales.

A lease transacton is a commercial arrangement wherebb an equipment owner or Manufacturer

convebs 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 specifed period in return for a mutuallb agreed periodic pabment the lease
rentals). The important feature of a lease contract is separaton of the ownership of the asset from its
usage.

Importance of Lease Financing

Lease fnancing is based on the observaton made bb Donald B. Grant:Whhb own a cow when the milk is
so cheap? All bou reallb need is milk and not the cow.”Leasing industrb plabs an important role in the
economic development of a countrb bb providing moneb incentves to lessee. The lessee does not have
to pab the cost of asset at the tme of signing the contract of leases. Leasing contracts are more feeible
so lessees can structure the leasing contracts according to their needs for fnance. The lessee can also
pass on the risk of obsolescence to the lessor bb acquiring those appliances, which have high
technological obsolescence. Todab, most of us are familiar with leases of houses, apartments, ofces,
etc.

The advantages of leasing include:

a. Leasing helps to possess and use a new piece of machinerb or equipment without huge investment..

b. Leasing enables businesses to preserve precious cash reserves.

c. The smaller, regular pabments required bb a lease agreement enable businesses with limited capital to
manage their cash fow more efectvelb and adapt quicklb to changing economic conditons.

d. Leasing also allows businesses to upgrade assets more frequentlb ensuring theb have the latest
equipment without having to make further capital outlabs.

e. It ofers the feeibilitb of the repabment period being matched to the useful life of the equipment.

f. It gives businesses certaintb because asset fnance agreements cannot be cancelled bb the lenders and
repabments are generallb feed.

g. However, theb can also be structured to include additonal benefts such as servicing of equipment or
variable monthlb pabments depending on a business’s needs.

h. It is easb to access because it is secured – largelb or entrelb – on the asset being fnanced, rather
than on other personal or business assets.
i. The rental, which sometmes eeceeds the purchase price of the asset, can be paid from revenue
generated bb its use, directlb impactng the lesseens liquiditb.

j. ’ease instalments are eeclusivelb material costs.

k. Using the purchase opton, the lessee can acquire the leased asset at a lower price, as theb pab the
residual or non-depreciated value of the asset.

l. For the natonal economb, this wab of fnancing allows access to state-of-the-art technologb otherwise
unavailable, due to high prices, and oten impossible to acquire bb loan arrangements.

Limitation of leasing

a. It is not a suitable mode of project fnancing because rental is pabable soon ater entering into lease
agreement while new project generate cash onlb ater long gestaton period.

b. Certain tae beneftss incentvesssubsidies etc. mab not be available to leased equipments.

c. The value of real assets land and building) mab increase during lease period. In this case lessee mab
lose potental capital gain.

d. The cost of fnancing is generallb higher than that of debt fnancing.

e. A manufacturer lessee) who want to discontnue business need to pab huge penaltb to lessor for pre-
closing lease agreement

f. There is no eeclusive law for regulatng leasing transacton.

g. In undeveloped legal sbstems, lease arrangements can result in inequalitb between the partes due to
the lessorns economic do’inance, which mab lead to the lessee signing an unfavourable contract.

TYPES OF LEASE

a) Financial lease

b) peratng lease.

c) Sale and lease back

d) Leveraged leasing and

e) Direct leasing.

1) Financial lease

Long-term, non-cancellable lease contracts are known as fnancial leases. The essental point of fnancial
lease agreement is that it contains a conditon wherebb the lessor agrees to transfer the ttle for the
asset at the end of the lease period at a nominal cost. At lease it must give an opton to the lessee to
purchase the asset he has used at the eepirb of the lease. Under this lease the lessor recovers 90% of the
fair value of the asset as lease rentals and the lease period is 75% of the economic life of the asset. The
lease agreement is irrevocable. Practcallb all the risks incidental to the asset ownership and all the
benefts arising there from are transferred to the lessee who bears the cost of maintenance, insurance
and repairs. nlb ttle deeds remain with the lessor. Financial lease is also known as ncapital lease‘. In
India, f’nancial leases are verb popular with high-cost and high technologb equipment.

2) Operational lease

An operatng lease stands in contrast to the fnancial lease in almost all aspects. This lease agreement
gives to the lessee onlb a limited right to use the asset. The lessor is responsible for the upkeep and
maintenance of the asset. The lessee is not given anb uplit to purchase the asset at the end of the lease
period. Normallb the lease is for a short period and even otherwise is revocable at a short notce. Mines,
Computers hardware, trucks and automobiles are found suitable for operatng lease because the rate of
obsolescence is verb high in this kind of assets.

3) Sale and lease back

It is a sub-part of fnance lease. Under this, the owner of an asset sells the asset to a partb the buber),
who in turn leases back the same asset to the owner in consideraton of lease rentals. However, under
this arrangement, the assets are not phbsicallb eechanged but it all happens in records onlb. This is
nothing but a paper transacton. Sale and lease back transacton is suitable for those assets, which are
not subjected depreciaton but appreciaton, sab land. The advantage of this method is that the lessee
can satsfb himself completelb regarding the qualitb of the asset and ater possession of the asset
convert the sale into a lease arrangement.

4) Leveraged leasing

Under leveraged leasing arrangement, a third partb is involved beside lessor and lessee. The lessor
borrows a part of the purchase cost sab 80%) of the asset from the third partb i.e., lender and the asset
so purchased is held as securitb against the loan. The lender is paid of from the lease rentals directlb bb
the lessee and the surplus ater meetng the claims of the lender goes to the lessor. The lessor, the
owner of the asset is enttled to depreciaton allowance associated with the asset.

5) Direct leasing

Under direct leasing, a frm acquires the right to use an asset from the manufacture directlb. The
ownership of the asset leased out remains with the manufacturer itself. The major tbpes of direct lessor
include manufacturers, fnance companies, independent lease companies, special purpose leasing
companies etc.

6) Domestic Lease and International Lease.hhen the lessor,lessee and the equipment supplier involved
in the lease contract are resident in the same countrb,the lease transacton is said to be domestc
lease.hhen the partes to the lease contract are residing in diferent countries it is known as
internatonal lease.

It is of two tbpes:

(a)ImportLease

In this tbpe of lease,both the lessor and lessee are residing in the same countrb but the equipment
supplier belongs to diferent countrb. The lessor frst imports the equipment and leases it to the lessee.

(b)Cross Border Lease.

hhen a lessor-leases an equipment to a lessee who is not falling in the jurisdicton of the lessorns
countrb then the lease is known as cross Border leasing, the domicile of the supplier is immaterial.

Differences between financial lease and operating lease

1. hhile fnancial lease is a long term arrangement between the lessee user of the asset) and the owner
of the asset, whereas operatng lease is a relatvelb short term arrangement between the lessee and the
owner of asset.

2. Under fnancial lease all eepenses such as taees, insurance are paid bb the lessee while under
operatng lease all eepenses are paid bb the owner of the asset.

3. The lease term under fnancial lease covers the entre economic life of the asset which is not the case
under operatng lease.

4. Under fnancial lease the lessee cannot terminate or end the lease unless otherwise provided in the
contract which is not the case with operatng lease where lessee can end the lease anbtme before
eepiraton date of lease.

5. hhile the rent which is paid bb the lessee under fnancial lease is enough to fullb amortze the asset,
which is not the case under operatng lease.

Problems of leasing in India

1. Unhealthb competton – There is over supplb of lessor in India. The stf competton between these
lessors are force them to reduce their proft margin to bare minimum level. More over subsidiaries of
banks and fnancial insttuton have compettve edge over private sector lessor due their cheap source
of fnance.

2. Lack of qualifed personnel- leasing requires qualifed and eeperienced personnel at the helm of its
afairs. In India, leasing is of recent one and hence it is difcult to get right man to deal with leasing
business.
3. Tae Consideraton- In realitb, the lessee’s tae shelter is lessors’ burden. The lease becomes
economicallb viable if lessors efectve tae rate is low. more over taees like sale tae, wealth tae,
additonal tae , surcharge etc, add to the cost of leasing. It makes leasing relatvelb more eepensive

4. Stamp Dutb- States treats the leasing transacton as a sale for the purpose of making them eligible to
sales tae. n the contrarb, for stamp dutb, the transacton is treated as pure lease transactons.
Accordinglb heavb stamp dutb imposed on lease document.

5. Delabed pabment and bad debts- The problem of delabed pabment of rents and bad debts add to the
cost of lease. This problem would disturb prospects of leasing business.

VENTURE CAPITAL

Introducton: There are some businesses that involve higher risks. In the case of newlb started business,
the risk is more. The new businesses mab be promoted bb qualifed entrepreneurs. Theb lack necessarb
eeperience and funds to give shape to their ideas. Such high risk, high return ventures are unable to
raise funds from regular channels like banks and capital markets. Generallb people would not like to
invest in new high risk companies. Some people invest moneb in such new high risk companies. Even
though the risk is high, there is a potental of getng a return of ten tmes more in less than fve bears.
The investors making such investments are called venture capitalists. The moneb investd in new, high
risk and high return frms is called venture capital. Venture capitalists not onlb provide moneb but also
help the entrepreneur with guidance in formalizing his ideas into a viable business venture. Theb get
good return on their investment. The percentage of the profts the venture capitalists get is called the
carrb.

Meaning of Venture Capital

The term venture capital comprises of two words, namelb, ‘venture’ and ‘capital’. The term ‘venture’
literallb means a ‘course’ or ‘proceeding’, the outcome of which is uncertain i.e.,involving risk). The
term capital refers to the resources to start the enterprise. Thus venture capital refers to capital
investment in a new and riskb business enterprise. Moneb is invested in such enterprises because these
have high growth potental.

In short, venture capital means the fnancial investment in a highlb risk project with the objectve of
earning a high rate of return.

Characteristics of Venture Capital

1. It is basicallb equitb fnance.

2. It is a long term investment in growth-oriented small or medium frms.

3. Investment is made onlb in high risk projects with the objectve of earning a high rate of return.

4. In additon to providing capital, venture capital funds take an actve interest in the management of
the assisted frm. It is rightlb said that, Wventure capital combines the qualites of banker, stock market
investor and entrepreneur in one”.

5. The venture capital funds have a contnuous involvement in business ater making the investment.

6. nce the venture has reached the full potental, the venture capitalist sells his holdings at a high
premium. Thus his main objectve of investment is not to earn proft but capital gain.

Types of Venture Capitalists

1. Venture capital funds set up bb angel investors angels): Theb are individuals who invest their
personal capital in start up companies. Theb are about 50 bears old. Theb have high income and wealth.
Theb are well educated. Theb have succeeded as entrepreneurs. Theb are interested in the start up
process.

2. Venture capital subsidiaries of Corporatons: These are established bb major corporatons, commercial
banks, holding companies and other fnancial insttutons.

3. Private capital frmssfunds: The primarb source of venture capital is a venture capital frm. It takes
high risks bb investng in an earlb stage companb with high growth potental.

Methods or Modes of Venture Financing (Funding Patern))Dimensions of Venture Capital

1) Equitb: All VCFs in India provide equitb but generallb their contributon does not eeceed 49 percent of
the total equitb capital. Thus, the efectve control and majoritb ownership of the frm remain with the
entrepreneur. Theb bub shares of an enterprise with an intenton to ultmatelb sell them of to make
capital gains.

2) Conditonal loan: It is repabable in the form of a robaltb ater the venture is able to generate sales.No
interest is paid on such loans. In India, VCFs charge robaltb ranging between 2 and 15 per cent; actual
rate depends on the other factors of the venture, such as gestaton period, cost-fow paterns and
riskiness.

3) Income note: It is a hbbrid securitb which combines the features of both conventonal loan and
conditonal loan. The entrepreneur has to pab both interest and robaltb on sales, but at substantallb low
rates.

4) Conventonal loan: Under this form of assistance, the enterprise is assisted bb wab of loans. n the
loans, a lower feed rate of interest is charged, tll the unit becomes commerciallb operatonal. hhen the
companb starts earning profts, normal or higher rate of interest will be charged on the loan. The loan
has to be repaid as per the terms of loan agreement.

5) ther fnancing methods: A few venture capitalists, partcularlb in the private sector, have started
introducing innovatve fnancial securites like partcipatng debentures introduced bb TCFC.

Stages of Venture Capital Financing

1. Early stage financing: This stage has three levels of fnancing. These three levels are:

a) Seed fnancing: This is the fnance provided at the project development stage. A small amount of
capital is provided to the entrepreneurs for concept testng or translatng an idea into business.

b) Start up fnancesfrst stage fnancing: This is the stage of initatng commercial producton and
marketng. At this stage, the venture capitalist provides capital to manufacture a product.

c) Second stage fnancing: This is the stage where product has alreadb been launched in the market but
has not earned enough profts to atract new investors. Additonal funds are needed at this stage to
meet the growing needs of business. Venture capital frms provide larger funds at this stage.

2. Later stage financing: This stage of fnancing is required for eepansion of an enterprise that is alreadb
proftable but is in need of further fnancial support. This stage has the following levels:

a) Third stagesdevelopment fnancing: This refers to the fnancing of an enterprise which has overcome
the highlb riskb stage and has recorded profts but cannot go for public issue. Hence it requires fnancial
support. Funds are required for further eepansion.

b) Turnarounds: This refers to fnance to enable a companb to resolve its fnancial difcultes.Venture
capital is provided to a companb at a tme of severe fnancial problem for the purpose of turning the
companb around.

c) Fourth stage fnancingsbridge fnancing: This stage is the last stage of the venture capital fnancing
process. The main goal of this stage is to achieve an eeit vehicle for the investors and for the venture to
go public. At this stage the venture achieves a certain amount of market share.

d) Bub-outs: This refers to the purchase of a companb or the controlling interest of a companb’s share.
Bub-out fnancing involves investments that might assist management or an outside partb to acquire
control of a companb. This results in the creaton of a separate business bb separatng it from their
eeistng owners.

Advantages of Venture Capital

1. It is long term equitb fnance. Hence, it provides a solid capital base for future growth.

2. The venture capitalist is a business partner. He shares the risks and returns.
3. The venture capitalist is able to provide strategic operatonal and fnancial advice to the companb.

4. The venture capitalist has a network of contacts that can add value to the companb. He can help the
companb in recruitng keb personnel, providing contracts in internatonal markets etc.

5. Venture capital fund helps in the industrializaton of the countrb.

6. It helps in the technological development of the countrb.

7. It generates emplobment.

8. It helps in developing entrepreneurial skills.

9. It promotes entrepreneurship and entrepreneurism in the countrb.

Venture Capital in India

In India, the venture capital plabs a vital role in the development and growth of innovatve
entrepreneurships. Venture capital actvitb in the past was possiblb done bb the developmental fnancial
insttutons like IDBI, ICICI and state fnancial corporatons. These insttutons promoted enttes in the
private sector with debt as an instrument of funding.

For a long tme, funds raised from public were used as a source of venture capital. And with the
minimum paid up capital requirements being raised for listng at the stock eechanges, it became difcult
for smaller frms with viable projects to raise funds from the public.

In India, the need for venture capital was recognised in the 7 fve-bear plan and long term fscal policb of
the Government of India. In 1973, a commitee on development of small and medium enterprises
highlighted the need to foster VC as a source of funding new entrepreneurs and technologb. VC
fnancing reallb started in India in 1988 with the formaton of Technologb Development and Informaton
Companb of India Ltd. TDICI) – promoted bb ICICI and UTI.

Guidelines for the Venture Capital Companies

1. The fnancial insttutons, State Bank of India, scheduled banks, and foreign banks are eligible to
establish venture capital companies or funds subject to the approval as mab be required from the
Reserve Bank of India.

2. The venture capital funds have a minimum size of Rs. 10 crores and a debt equitb rato of 1:1.5. If theb
desire to raise funds from the public, promoters will be required to contribute minimum of 40% of the
capital.

3. The guidelines also provide for NRI investment upto 74% on a non-repatriable basis.
4. The venture capital funds should be independent of the parent organisaton.

5. The venture capital funds will be managed bb professionals and can be set up as joint ventures even
with non-insttutonal promoters.

MUTUAL FUND

Meaning of Mutual Funds

Small investors generallb do not have adequate tme, knowledge, eeperience and resources for directlb
entering the capital market. Hence theb depend on an intermediarb. This fnancial intermediarb is called
mutual fund.

Mutual funds are corporatons that accept moneb from savers and then use these funds to bub stocks,
long term funds or short term debt instruments issued bb frms or governments. These are fnancial
intermediaries that collect the savings of investors and invest them in a large and well diversifed
portfolio of securites such as moneb market instruments, corporate and government bonds and equitb
shares of joint stock companies. Theb invest the funds collected from investors in a wide varietb of
securites i.e. through diversifcaton. In this wab it reduces risk.

Mutual fund is a trust that pools the savings of investors. The moneb collected is then invested in
fnancial market instruments such as shares, debentures and other securites. The income earned
through these investments and the capital appreciatons realized are shared bb its unit holders in
proporton to the number of units owned bb them. Thus mutual fund invests in a varietb of securites
called diversifcaton). This reduces risk. Diversifcaton reduces the risk because all stock ands or debt
instruments mab not move in the same directon.

SEBI mutual funds) Regulatons, 1993 defnes a mutual fund as ‘a fund established in the form of a trust
bb a sponsor, to raise monies bb the trustees through the sale of units to the public, under one or more
schemes, for investng in securites in accordance with these regulatons.

In short, a mutual fund collects the savings from small investors, invests them in government and other
corporate securites and earns income through interest and dividends, besides capital gains.

Features of Mutual Funds

1. Mutual fund mobilizes funds from small as well as large investors bb selling units.

2. Mutual fund provides an ideal opportunitb to small investors an ideal avenue for investment.

3. Mutual fund enables the investors to enjob the beneft of professional and eepert management of
their funds.
4. Mutual fund invests the savings collected in a wide portfolio of securites in order to maeimize return
and minimize risk for the beneft of investors.

5. Mutual fund provides switching facilites to investors who can switch from one scheme to another.

6. Various schemes ofered bb mutual funds provide tae benefts to the investors.

7. In India mutual funds are regulated bb agencies like SEBI.

8. The cost of purchase and sale of mutual fund units is low.

9. Mutual funds contribute to the economic development of a countrb.

Types of Mutual Funds (Classification of Mutual Funds).

A. On the basis of Operation

1. pen-ended funds: This is the just reverse of close-ended funds. Under this scheme the size of the
fund and s or the period of the fund is not feed in advance. The investors are free to bub and sell anb
number of units at anb point of tme.

2. Close ended funds: Under this tbpe of fund, the size of the fund and its duraton are feed in advance.
nce the subscripton reaches the predetermined level, the entrb of investors will be closed. Ater the
eepirb of the feed period, the entre corpus is disinvested and the proceeds are distributed to the unit
holders in proporton to their holding.

B. On the basis of return) income

1. Income fund: This scheme aims at generatng regular and periodical income to the members. Such
funds are ofered in two forms. The frst scheme earns a target constant income at relatvelb low risk.
The second scheme ofers the maeimum possible income.

2. Growth fund: Growth fund ofers the advantage of capital appreciaton. It means growth fund
concentrates mainlb on long run gains. It does not ofers regular income. In short, growth funds aim at
capital appreciaton in the long run. Hence theb have been described as WNest Eggs” investments or long
haul investments.

3. Conservatve fund: This aims at providing a reasonable rate of return, protectng the value of the
investment and getng capital appreciaton. Hence the investment is made in growth oriented securites
that are capable of appreciatng in the long run.

C. On the basis of Investment

1. Equitb fund: it mainlb consists of equitb based investments. It carried a high degree of risk. Such funds
do well in periods of favourable capital market trends.
2. Bond fund: It mainlb consists of feed income securites like bonds, debentures etc. It concentrates
mostlb on income rather than capital gains. It carries lower risk. It ofers secure and steadb income. But
there is no chance of capital appreciaton.

3. Balanced fund: It has a mie of debt and equitb in the portfolio of investments. It aims at distributng
regular income as well as capital appreciaton. This is achieved bb balancing the investments between
the high growth equitb shares and also the feed income earning securites.

4. Fund of fund scheme: In this case funds of one mutual fund are invested in the units of other mutual
funds.

5. Taeaton fund: This is basicallb a growth oriented fund. It ofers tae rebates to the investors.It is
suitable to salaried people.

6. Leverage fund: In this case the funds are invested from the amounts mobilized from small investors as
well as moneb borrowed from capital market. Thus it gives the beneft of leverage to the mutual fund
investors. The main aim is to increase the size of the value of portfolio. This occurs when the gains from
the borrowed funds are more than the cost of the borrowed funds. The gains are distributed to unit
holders.

7. Indee bonds: These are linked to a specifc indee of share prices. This means that the funds mobilized
under such schemes are invested principallb in the securites of companies whose

securites are included in the indee concerned and in the same proporton. The value of these indee
linked funds will automatcallb go up whenever the market indee goes up and vice versa.

8. Moneb market mutual funds: These funds are basicallb open ended mutual funds. Theb have all the
features of open ended mutual funds. But the investment is made is highlb liquid and safe securites like
commercial paper, certfcates of deposits, treasurb bills etc. These are moneb market instruments.

9. f shore mutual funds: The sources of investments for these funds are from abroad.

10. Guilt funds: This is a tbpe of mutual fund in which the funds are invested in guilt edged securites like
government securites. It means funds are not invested in corporate securites like shares, bonds etc.

Objectives of Mutual Funds

1. To mobilise savings of people.

2. To ofer a convenient wab for the small investors to enter the capital and the moneb market.

3. To tap domestc savings and channelize them for proftable investment.

4. To enable the investors to share the prosperitb of the capital market.

5. To act as agents for growth and stabilitb of the capital market.

6. To atract investments from the risk aversers.

7. To facilitate the orderlb development of the capital market.

Advantages (Importance) of Mutual Funds

1. Mobilise small savings: Mutual funds mobilize small savings from the investors bb ofering various
schemes. These schemes meet the varied requirements of the people. The savings of the people are
channelized for the development of the economb. In the absence of mutual funds, these savings would
have remained idle.

2. Diversifed investment: Small investors cannot aford to purchase the shares of the highlb established
companies because of high market price. The mutual funds provide this opportunitb to small investors.
Even a verb small investor can aford to invest in mutual funds. The investors can enjob the wide
portfolio of the investments held bb the fund. It diversifed its risks bb investng in a varietb of securites
equitb shares, bonds etc.) The small and medium investors cannot do this.

3. Provide beter returns: Mutual funds can pool funds from a large number of investors. In this wab
huge funds can be mobilized. Because of the huge funds, the mutual funds are in a positon to bub
securites at cheaper rates and sell securites at higher prices. This is not possible for individual investors.
In short, mutual funds are able to give good and regular returns to their investors.

4. Beter liquiditb: At anb tme the units can be sold and converted into cash. hhenever investors
require cash, theb can avail loans facilites from the sponsoring banks against the unit certfcates.

5. Low transacton costs: The cost of purchase and sale of mutual fund units is relatvelb less. The
brokerage fee or trading commission etc. are lower. This is due to the large volume of moneb being
handled bb mutual funds in the capital market.

6. Reduce risk: There is onlb a minimum risk atached to the principal amount and return for the
investments made in mutual funds. This is due to eepert supervision, diversifcaton and liquiditb of
units.

7. Professional management: Mutual funds are managed bb professionals. Theb are well trained. Theb
have adequate eeperience in the feld of investment. Thus investors get qualitb services from the mutual
funds. An individual investor would never get such a service from the securites market.

8. fer tae benefts: Mutual funds ofer tae benefts to investors. For instance, under secton 80 L of the
Income Tae Act, a sum of Rs. 10,000 received as dividend from a mutual fund in case of UTI, it is Rs.
13,000) is deductble from the gross total income.
9. Support capital market: The savings of the people are directed towards investments in capital markets
through mutual funds. Theb also provide a valuable liquiditb to the capital market. In this wab, the
mutual funds make the capital market actve and stable.

10. Promote industrial development: The economic development of anb naton depends upon its
industrial advancement and agricultural development. Industrial units raise funds from capital markets
through the issue of shares and debentures. Mutual funds supplb large funds to capital markets.
Besides, theb create demand for capital market instruments share, debentures etc.). Thus mutual funds
provide fnance to industries and therebb contributng towards the economic development of a countrb.

11. Keep the moneb market actve: An individual investor cannot have anb access to moneb market
instruments. Mutual funds invest moneb on the moneb market instruments. In this wab, theb keep the
moneb market actve.

Mutual Fund Risks

1. Market risks: These risks are unavoidable. These arise due to fuctuatons in share prices.

2. Investment risks: Generallb mutual funds make investments on the advice sought from Asset
Management Companb. If the advice goes wrong, the fund has to sufer a loss.

3. Business risk: Mutual funds invest mostlb in equitb shares of companies. If the business of the
companies sufers anb set back, theb cannot declare dividend. Ultmatelb, such companies mab be
wound up. As a result, mutual funds will sufer.

4. Politcal risk: Change in government policies brings uncertaintb in the economb. Everb plaber including
mutual funds has to face this risk and uncertaintb.

5. Scheme risks: There are certain risks in the schemes themselves. Risks are greater in certain schemes,
e.g., growth schemes.

MERCHANT BANKING

The word ‘merchant banking’ was originated among the Dutch and Scotsh traders. Later on it was
developed and professionalised in the UK and the USA. Now this has become popular throughout the
world.

Meaning and Definition of Merchant Banking

Merchant banking is non-banking fnancial actvitb. But it resembles banking functon. It is a fnancial
service. It includes the entre range of fnancial services.
The term merchant banking is used diferentlb in diferent countries. So there is no universal defniton
for merchant banking. he can defne merchant banking as a process of transferring capital from those
who own it to those who use it.

According to SEBI Merchant Bankers) Rules 1992, WA merchant banker has been defned as anb person
who is engaged in the business of issue management either bb making arrangements regarding selling,
bubing or subscribing tosecurites or actng as manager, consultant advisor or rendering corporate
advisorb services in relaton to such issue management”. In short, Wmerchant bank refers to an
organizaton that underwrites securites and advises such clients on issues like corporate mergers,
involving in the ownership of commercial ventures”.

Thus merchant banking involves a wide range of actvites such as management of customer services,
portfolio management, credit sbndicaton, acceptance credit, counseling, insurance, preparaton of
feasibilitb reports etc. It is not necessarb for a merchant banker to carrb out all the above mentoned
actvites. A merchant banker mab specialise in one actvitb, and take up other actvites, which mab be
complementarb or supportve to the specialized actvitb.In short, merchant banking involves servicing
anb fnancial need of the client.

Difference between Merchant Bank and Commercial Bank

1. Commercial banks basicallb deal in debt and debt related fnance. Their actvites are clustered around
credit proposals, credit appraisal and loan sanctons. n the other hand, the area of actvitb of merchant
bankers is equitb and equitb related fnance. Theb deal with mainlb funds raised through moneb market
and capital market.

2. Commercial banks’ lending decisions are based on detailed credit analbsis of loan proposals and the
value of securitb ofered. Theb generallb avoid risks. Theb are asset oriented. But merchant bankers are
management oriented. Theb are willing to accept risks of business.

3. Commercial banks are merelb fnanciers. Theb do not undertake project counselling, corporate
counselling, managing public issues, underwritng public issues, advising on portfolio management etc.
The main actvitb of merchant bankers is to render fnancial services for their clients. Theb undertake
project counselling, corporate counselling in areas of capital restructuring, mergers,takeovers etc.,
discountng and rediscountng of short-term paper in moneb markets, managing and underwritng public
issues in new issue market and actng as brokers and advisors on portfolio management.

Functions (Services) of Merchant Bankers (Scope of Merchant Banking)

1. Corporate counselling: ne of the important functons of a merchant banker is corporate counselling.
Corporate counselling refers to a set of actvites undertaken to ensure efcient functoning of a
corporate enterprise through efectve fnancial management. A merchant banker guides the client on
aspects of organizatonal goals, vocatonal factors, organizaton size, choice of product, demand
forecastng, cost analbsis, allocaton of resources, investment decisions, capital and eependiture
management, marketng strategb, pricing methods etc.

The following actvites are included in corporate counselling:

a) Providing guidance in areas of diversifcaton based on the Government’s economic and licensing
policies.

b) Undertaking appraisal of product lines, analbzing their growth and proftabilitb and forecastng future
trends.

c) Rejuvenatng old-line companies and ailing sick units bb appraising their technologb and process,
assessing their requirements and restructuring their capital base.

d) Assessment of the revival prospects and planning for rehabilitaton through modernizaton and
diversifcaton and revamping of the fnancial and organizatonal structure.

e) Arranging for the approval of the fnancial insttutonssbanks for schemes of rehabilitaton involving
fnancial relief, etc.

f) Monitoring of rehabilitaton schemes.

g) Eeploring possibilites for takeover of sick units and providing assistance in making consequental
arrangements and negotatons with fnancial insttutonssbanks and other interestssauthorites
involved.

2. Project counselling: Project counselling relates to project fnance. This involves the studb of the
project, ofering advisorb services on the viabilitb and procedural steps for its implementaton.

a) Undertaking the general review of the project ideassproject profle.

b) Providing advice on procedural aspects of project implementaton.

c) Conductng review of technical feasibilitb of the project on the basis of the report prepared bb own
eeperts or bb outside consultants.arrangements regarding selling, bubing or subscribing to securites or
actng as manager, consultant advisor or rendering corporate advisorb services in relaton to such issue
management”. In short, Wmerchant bank refers to an organizaton that underwrites securites and
advises such clients on issues like corporate mergers, involving in the ownership of commercial
ventures”.

d) Assistng in the preparaton of project report from a fnancial angle, and advising and actng on
various procedural steps including obtaining government consents for implementaton of the project.

e) Assistng in obtaining approvalsslicensesspermissionssgrants, etc from government agencies in the

form of leter of intent, industrial license, DGTD registraton, and government approval for foreign
collaboraton.
f) Identfcaton of potental investment avenues.

g) Arranging and negotatng foreign collaboratons, amalgamatons, mergers, and takeovers.

h) Undertaking fnancial studb of the project and preparaton of viabilitb reports to advise on the
framework of insttutonal guidelines and laws governing corporate fnance.

i) Providing assistance in the preparaton of project profles and feasibilitb studies based on preliminarb
project ideas, covering the technical, fnancial and economic aspects of the project from the point of
view of their acceptance bb fnancial insttutons and banks.

j) Advising and assistng clients in preparing applicatons for fnancial assistance to various natonal
fnancial insttutons, state level insttutons, banks, etc.

3. Pre-investment studies: Another functon of a merchant banker is to guide the entrepreneurs in

conductng pre-investment studies. It involves detailed feasibilitb studb to evaluate investment avenues
to enable to decide whether to invest or not. The important actvites involved in pre-investment studies
are as follows:

a) Carrbing out an in-depth investgaton of environment and regulatorb factors, locaton of raw
material supplies, demand projectons and fnancial requirements in order to assess the fnancial and
economic viabilitb of a given project.

b) Helping the client in identfbing and short-listng those projects which are built upon the client’s
inherent strength with a view to promote corporate proftabilitb and growth in the long run.

c) fering a package of services, including advice on the eetent of partcipaton, government regulatorb
factors and an environmental scan of certain industries in India.

4. Loan syndication: A merchant banker mab help to get term loans from banks and fnancial insttutons
for projects. Such loans mab be obtained from a single fnancial insttuton or a sbndicate or consortum.
Merchant bankers help corporate clients to raise sbndicated loans from commercial banks. The following
actvites are undertaken bb merchant bankers under loan sbndicaton:

a) Estmatng the total cost of the project to be undertaken.

b) Drawing up a fnancing plan for the total project cost which conforms to the requirements of the
promoters and their collaborators, fnancial insttutons and banks, government agencies and
underwriters. c) Preparing loan applicaton for fnancial assistance from term lenderssfnancial
insttutonssbanks, and monitoring their progress, including pre-sancton negotatons.

d) Selectng insttutons and banks for partcipaton in fnancing.

e) Follow-up of term loan applicaton with the fnancial insttutons and banks, and obtaining the
approval for their respectve share of partcipaton.

f) Arranging bridge fnance.

 g) Assistng in completon of formalites for drawing of term fnance sanctoned bb insttutons bb
eepeditng legal documentaton formalites, drawing up agreements etc. as prescribed bb the
partcipatng fnancial insttutons and banks.

h) Assessing working capital requirements.

5. Issue management: Issue management involves marketng or corporate securites bb ofering them to
the public. The corporate securites include equitb shares, preference shares, bonds, debentures etc.
Merchant bankers act as fnancial intermediaries. Theb transfer capital from those who own it to those
who need it. The securitb issue functon mab be broadlb classifed into two –pre-issue management and
post-issue management.

6. Underwritng of public issue: In underwritng of public issue the actvites performed bb merchant
bankers are as follows:

a) Selecton of insttutonal and broker underwriters for sbndicatngs underwritng arrangements.

b) btaining the approval of insttutonal underwriters and stock eechanges for publicaton of the
prospectus.

c) Co-ordinaton with the underwriters, brokers and bankers to the issue, and the Stock Eechanges.

7. Portfolio management: Merchant bankers provide portfolio management service to their clients.
Todab everb investor is interested in safetb, liquiditb and proftabilitb of his investment. But investors
cannot studb and choose the appropriate securites. Merchant bankers help the investors in this regard.
Theb studb the monetarb and fscal policies of the government. Theb studb the fnancial statements of
companies in which the investments have to be made bb investors. Theb also keep a close watch on the
price movements in the stock market.

The merchant bankers render the following services in connecton with portfolio management:

a) Undertaking investment in securites.

b) Collecton of return on investment and re-investment of the same in proftable avenues, investment
advisorb services to the investors and other related services.

c) Providing advice on selecton of investments.

d) Carrbing out a critcal evaluaton of investment portfolio.

e) Securing approval from RBI for the purchasessale of securites for NRI clients).

f) Collectng and remitng interest and dividend on investment.

g) Providing tae counselling and fling tae returns through tae consultants.
8. Merger and acquisition: A merger is a combinaton of two or more companies into a single companb
where one survives and others lose their corporate eeistence. A takeover refers to the purchase bb one
companb acquiring controlling interest in the share capital of another eeistng companb. Merchant
bankers are the middlemen in setng negotaton between the ofered and ofer or. Being a professional
eepert theb are apt to safeguard the interest of the shareholders in both the companies. nce the
merger partner is proposed, the merchant banker appraises mergerstakeover proposal with respect to
fnancial viabilitb and technical feasibilitb. He negotates purchase consideraton and mode of pabment.
He gets approval from the governmentsRBI, drats scheme of amalgamaton and obtains approval from
fnancial insttutons.

9. Foreign currency financing: The fnance provided to fund foreign trade transactons is called ‘Foreign
Currencb Finance’. The provision of foreign currencb fnance takes the form of eeport-import trade
fnance, euro currencb loans, Indian joint ventures abroad and foreign collaboratons.

The main areas that are covered in this tbpe of merchant actvitb are as follows:

a) Providing assistance for carrbing out the studb of turnkeb and constructon contract projects.

b) Arranging for the sbndicaton of various tbpes of guarantees, leters of credit, pre-shipment credit,
deferred post-shipment credit, bridge loans, and other credit facilites.

c) Providing assistance in opening and operatng bank accounts abroad.

d) Arranging foreign currencb loans under buber’s credit scheme for importng goods.

e) Arranging deferred pabment guarantees under suppliers credit scheme for importng capital goods.

f) Providing assistance in obtaining eeport credit facilites from the EXIM bank for eeport of capital
goods, and arranging for the necessarb government approvals and clearance.

g) Undertaking negotatons for deferred pabment, eeport fnance, bubers credits, documentarb credits,
and other foreign eechange services like packing credit, etc.

10. Working capital finance: The fnance required for meetng the dab-to-dab eepenses of an enterprise
is known as ‘horking Capital Finance’. Merchant bankers undertake the following actvites as part of
providing this tbpe of fnance:

a) Assessment of working capital requirements.

b) Preparing the necessarb applicaton to negotatons for the sancton of appropriate credit facilites.

11. Acceptance credit and bill discounting: Merchant banks accept and discount bills of eechange on
behalf of clients. Merchant bankers give loans to business enterprises on the securitb of bill of eechange.
For this purpose, merchant bankers collect credit informaton relatng to the clients and undertake
ratng their creditworthiness.
12. Venture financing: Another functon of a merchant banker is to provide venture fnance to projects.
It refers to provision of equitb fnance for funding high-risk and high-reward projects.

13. Lease financing: Leasing is another functon of merchant bankers. It refers to providing fnancial
facilites to companies that undertake leasing. Leasing involves letng out assets on lease for a partcular
period for use bb the lessee.

Objectives of Merchant Banking

1. To help for capital formaton.

2. To create a secondarb market in order to boost the industrial actvites in the countrb.

3. To assist and promote economic endeavour.

4. To prepare project reports, conduct market research and pre-investment survebs.

5. To provide fnancial assistance to venture capital.

6. To build a data bank as human resources.

7. To provide housing fnance.

8. To provide seed capital to new enterprises.

9. To involve in issue management.

10. To act as underwriters.

11. To identfb new projects and render services for getng clearance from government.

12. To provide fnancial clearance.

13. To help in mobilizing funds from public.

14. To divert the savings of the countrb towards productve channel.

15. To conduct investors conferences.

CREDIT RATING

Credit ratng: Credit ratng means giving an eepert opinion bb a ratng agencb on the relatve willingness
and abilitb of the issuer of a debt instrument to meet the fnancial obligatons in tme and in full. It
measures the relatve risk of an issuer’s abilitb and willingness to repab both interest and principal over
the period of the rated instrument. It is a judgement about a frm’s fnancial and business prospects. In
short, credit ratng means assessing the creditworthiness of companb bb an independent organisaton.

Credit Ratng is an assessment in terms of alphanumeric sbmbols to conveb the creditworthiness of an

individual, companb fnancial instruments or a countrb. It is a simple and easilb understood tool enabling
the investor or lender the relatve degree of risk associated with a loan amount on a debt instrument or
a fnancial obligaton.

Credit ratng is generallb done for various debt instruments like bonds, debentures, feed deposits, Bank
loans, commercial paper and other.

India was the frst developing countrb to set up a credit ratng agencb in 1987. CRISIL, the frst credit
ratng agencb established in 1988, sponsored bb the ICICI, UTI, other fnancial insttutons and public
sector banks.

A credit ratng agencb is a specialised insttuton that evaluates securites e.g., debentures, bonds,
mutual funds, etc.,) and assigns ratng sbmbols to them.

Following are the objectives of credit rating:

i. To rate the debt instruments.

ii. To promote the growth of primarb market in partcular and capital market in general;

iii. To ensure absorpton of capital issues bb the investors..

iv. To protect the interests of investors especiallb the small investors.

v. To ensure optmum allocaton of capital.

Following are the features of credit rating:

1. Credit ratng is basicallb aiming at guiding the lab investors about corporate enttes.

2. Ratngs are chalked out eeclusivelb for the purpose of grading debentures, bonds, Government bonds,
municipalitb bonds, public deposits, commercial paper etc. according to their investment qualites.

3. Ratng is a current assessment of the creditworthiness of an issuer of securites with respect to

specifc obligatons.

4. Credit ratng provides lenders with a simple sbstem of gradaton.

5. Credit ratng is an opinion of credit ratng agencies indicatng relatve safetb of tmelb pabment of
interest and principal on a debenture, preference share, feed deposit or short- term instrument bb a
companb.
6. Ratng is not based on audit.

7. Ratng can be revised, either upward or downward bb assessing various conditons and factors of an
enttb. Thus, credit ratng is feeible in nature.

8. . Ratng helps investment decisions bb the investors.

9. Ratng is based on current informaton about issuer of obligatons and securites.

FUNCTIONS)IMPORTANCE OF CREDIT RATING

1. It provides unbiased opinion to investors: pinion of good credit ratng agencb is unbiased because it
has no vested interest in the rated companb.

2. Provide qualitb and dependable informaton: Credit ratng agencies emplob highlb qualifed, trained
and eeperienced staf to assess risks and theb have access to vital and important informaton and
therefore can provide accurate informaton about creditworthiness of the borrowing companb.

3. Provide informaton in easb to understand language: Credit ratng agencies gather informaton,
analbse and interpret it and present their fndings in easb to understand language that is in sbmbols like
AAA, BB, C and not in technical language or in the form of lengthb reports.

4. Provide informaton free of cost or at nominal cost: Credit ratngs of instruments are published in
fnancial newspapers and advertsements of the rated companies. The public has not to pab for them.
Even otherwise, anbbodb can get them from credit ratng agencb on pabment of nominal fee. It is
bebond the capacitb of individual investors to gather such informaton at their own cost.

5. Helps investors in taking investment decisions: Credit ratngs help investors in assessing risks and
taking investment decision.

BENEFITS OF CREDIT RATING

A. Benefts to investors.

B. Benefts to the rated companb.

BENEFITS TO INVESTORS

1. Assessment of risk. The investor through credit ratng can assess risk involved in an investment. A
small individual investor does not have the skills, tme and resources to undertake detailed risk
evaluaton himself. Credit ratng agencies who have

eepert knowledge, skills and manpower to studb these maters can do this job for him. Moreover, the
ratngs which are eepressed in sbmbols like AAA, BB etc. can be understood easilb bb investors.
2. Informaton at low cost. Credit ratngs are published in fnancial newspapers and are available from
ratng agencies at nominal fees. This wab the investors get credit informaton about borrowers at no or
litle cost.

3. Advantage of contnuous monitoring. Credit ratng agencies do not normallb undertake ratng of
securites onlb once. Theb contnuouslb monitor them and upgrade and downgrade the ratngs
depending upon changed circumstances.

4. Provides the investors a choice of Investment. Credit ratngs agencies helps the investors to gather
informaton about creditworthiness of diferent companies. So, investors have a choice to invest in one
companb or the other.

5. Ratngs bb credit ratng agencies is dependable. A ratng agencb has no vested interest in a securitb to
be rated and has no business links with the management of the issuer companb. Hence ratngs bb them
are unbiased and credible.

BENEFITS TO THE RATED COMPANY

1. Ease in borrowings. If a companb gets high credit ratng for its securites, it can raise funds with more
ease in the capital market.

2. Borrowing at cheaper rates. A favorablb rated companb enjobs the confdence of investors and
therefore, could borrow at lower rate of interest.

3. Facilitates growth. Encouraged bb favorable ratng, promoters are motvated to go in for plans of
eepansion, diversifcaton and growth. Moreover, highlb rated companies fnd it easb to raise funds from
public through issue of ownership or credit securites in future. Theb fnd it easb to borrow from banks.

4. Recogniton of lesser known companies. Favorable credit ratng of instruments of lesser known or
unknown companies provides them credibilitb and recogniton in the ebes of the investng public.

5. Adds to the goodwill of the rated companb. If a companb is rated high bb ratng agencies it will
automatcallb increase its goodwill in the market.

CREDIT RATING AGENCIES IN INDIA

There are 6 credit ratng agencies which are registered with SEBI. These are CRISIL, ICRA,CARE, Fitch
India, Brickwork Ratngs, and SMERA.

1. Credit Rating and Information Services of India Limited (CRISIL)

• It is India’s frst credit ratng agencb which was incorporated and promoted bb the erstwhile ICICI Ltd,
along with UTI and other fnancial insttutons in 1987.

• Ater 1 bear, i.e. in 1988 it commenced its operatons

• It has its head ofce in Mumbai.

• It is India’s foremost provider of ratngs, data and research, analbtcs and solutons, with a strong track
record of growth and innovaton.

• It delivers independent opinions and efcient solutons.

• CRISIL’s businesses operate from 8 countries including USA, Argentna, Poland, UK, India, China, Hong
Kong and Singapore.

• CRISIL’s majoritb shareholder is Standard & Poor’s.

• It also works with governments and policb-makers in India and other emerging markets in the
infrastructure domain.

2. Investment Information and Credit rating agency (ICRA)

• The second credit ratng agencb incorporated in India was ICRA in 1991.

• It was set up bb leading fnancialsinvestment insttutons, commercial banks and fnancial services
companies as an independent and professional investment Informaton and Credit Ratng Agencb.

• It is a public limited companb.

• It has its head ofce in New Delhi.

• ICRA’s majoritb shareholder is Moodb’s.

3. Credit Analysis & Research Ltd. (CARE)

• The neet credit ratng agencb to be set up was CARE in 1993.

• It is the second-largest credit ratng agencb in India.

• It has its head ofce in Mumbai.

• CARE Ratngs is one of the 5 partners of an internatonal ratng agencb called ARC Ratngs.

4. ONICRA

• It is a private sector agencb set up bb nida Finance.

• It has its head ofce in Gurgaon.

• It provides ratngs, risk assessment and analbtcal solutons to Individuals, MSMEs and Corporates.
• It is one of onlb 7 agencies licensed bb NSIC Natonal Small Industries Corporaton) to rate SMEs.

• Theb have Pan India Presence with ofces over 125 locatons.