Class 12 Finance Chapter 4 Financial Services Question answer to each chapter is provided in the list so that you can easily browse throughout different chapters SCERT Class 12 Finance Chapter 4 Financial Services and select need one.
Class 12 Finance Chapter 4 Financial Services
Also, you can read the SCERT book online in these sections Solutions by Expert Teachers as per SCERT (CBSE) Book guidelines. Class 12 Banking Solutions These solutions are part of SCERT All Subject Solutions. Here we have given Assam Board/NCERT Class 12 Finance Chapter 4 Financial Services Solutions for All Subject, You can practice these here.
Financial Services
Chapter: 4
| (A) Very short type Questions Answers: |
1. Who introduced merchant banking in India and in which year?
Ans: Merchant Banking was introduced in India in 1967 by National Grindlays Bank.
2. Name the first Indian financial institution who setup merchant banking division.
Ans: State Bank of India.
3. Name two types of organisations providing merchant banking services in India.
Ans: (i) Foreign Banks: e.g.. Standard Chartered Bank, Citibank. etc.
(ii) Indian Bank: e.g.. State Bank of India, Canara Bank, Bank of Baroda etc.
4. Define Merchant Banker.
Ans: The notification of finance defines a merchant banker as “any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate services in relation to such issue management.”
5. What is Merchant Banking?
Ans: Merchant Banks are issue houses rendering such services to industrial projects or corporate units as flotation of new ventures and new companies, preparation, planning and execution of new projects, consultancy and advice in technical, financial, organizational and managerial fields. A major function of merchant banking is issue management. The issue can be public issue through prospectus, offer of sale or private placements.
6. What is a Mutual Fund?
Ans: Mutual fund is a financial instrument that pools money from different investors. The pooled money is then invested in securities like stocks of listed companies, government bonds, corporate bonds, and money market instruments. As an investor, you don’t directly own the company’s stocks that mutual funds purchases. However, you share the profit or loss equally with the other investors of the pool. This is how the word “mutual” is associated with a mutual fund. You get the advantage of the expertise of the fund manager and regulatory safety of the Securities Exchange and Board of India (SEBI). The professional fund manager ensures a maximum return to investors.
7. What Are Fee-Based Services?
Ans: The term fee-based services is a source of confusion. Usually, a fee-based service is offered by a financial advisor who charges an annual percentage of the client’s assets as a flat fee for all or most professional services. The average fee is 1% to 3% of the assets. This is not the same as a fee-based investment, which is a product that pays a commission to the advisor for selling it to clients.
8. What is Stocking?
Ans: Stockbroking is a service which gives retail and institutional investors the opportunity to buy and sell equities. Stockbrokers will trade shares both on exchange and over-the-counter, dependent on where they can find the best price and liquidity. Stock exchanges place strict regulations on who can trade shares directly on their books, which is why most individual investors hoping to trade shares will do so via a stockbroker. Typically, a stockbroking firm will charge commission on the trades it makes on a client’s behalf, or a fee for retaining its services.
9. Who is a Stock Broker?
Ans: A stockbroker, also known as a broker, is a financial market representative who operates in securities. Their primary job role dictates obtaining purchase and sale orders and execution of the same. Market participants or investors rely on their expertise and knowledge regarding market dynamics to invest in stocks and other investment options. Share brokers either work individually or as part of a brokerage firm.
10. What is Banking?
Ans: Banking is essentially an activity that is opted to be performed by not only individuals but also countless entities. The Banks in a country, state, or city safeguard the Money from their customers and then lend it to others. This creates a balance within the economy and makes sure that one of the individuals benefits from it.
11. What are the two broad categories of Financial Services?
Ans: Financial Services provided by various financial institutions commercial banks and merchant bankers can be broadly classified into two categories:
(a) Asset based/ Fund based services.
(b) Fee based / advisory services.
12. Name two Asset based and fee based services.
Ans: Two Asset or fund based services are:
(a) Hire Purchase and consumer credit.
(b) Housing Finance.
Two fee based or advisory services are:
(a) Credit Rating.
(b) Stock broking.
| (B) Short type Questions Answers: |
1. What do you mean by the term ‘Financial Services’?
Ans: The term financial services, in its broader sense, refer to mobilizing and allocation of savings. It is identified as all those activities involved in the process of converting savings into investment. The entities that provide those services are called financial intermediaries, such as Merchant Bankers, Venture Capitalists, Commercial Banks, Insurance Companies, etc.
In general all types of activities, which are of a financial nature would be brought under the term ‘financial services’. Thus, financial services sector is a key area and it is very vital for industrial developments. A well-developed financial service industry is absolutely necessary to mobilize the savings and to allocate them to various investible challenge and thereby to promote industrial development in a country.
2. What is E-banking? What are its features?
Ans: E-Banking or electronic banking is the latest wave in information technology. It can be defined as the services provided by the banks on the internet. It involves low transaction costs, adds value to the banking relationship and empowers customers. Electronic services offered by the bank are Electronic Funds Transfer (EFT), Automated Tekker Machines (ATM), Electronic Data Interchange (EDI), Credit cards, Debit cards, etc. These services help the customers to conduct banking transactions such as managing savings, applying for loans, checking accounts, paying bills, etc. over the internet a personal computer, mobile telephone, etc.
(i) It facilitates 24 hours of banking services to consumers.
(ii) It involves electronic services offered by the bank I.e. Electronic Funds Transfer
(iii) (EFT), Automated Teller Machines (ATM). Electronic Data Interchange (EDI) etc.
(iv) It provides greater security to the customers as they can avoid travelling with cash.
(v) It also offers unlimited access to the bank.
(vi) It keeps a record of each and even transaction.
3. What are the Features of Debit Card?
Ans: Debit card benefits and features that are most significant to a common user are:
(i) Convenience, cash withdrawal from ATM, or payment through a card, both in-person or online.
(ii) Allows spending within the capacity.
(iii) You know your spending limit.
(iv) Overdraft option, which helps you to spend even when your account has low cash.
(v) Rewards points add up.
(vi) These are secure cards.
4. Why ATM Card is Important?
Ans: The importance of ATM Card:
(i) With ATM cards, the sole function you can perform is withdrawing cash from the ATM. ATM cards use a 4-digit PIN or unique PIN which is linked to your bank account. Upon withdrawal, your bank account balance is reduced in real-time if you withdraw any cash.
(ii) While ATM cards do not charge any interest, the most inhibiting factor about them is that you cannot use them everywhere. They have a very limited utility. By this, we can understand that ATM cards are not accepted at all major retail and payment outlets.
(iii) Also, another factor to consider about ATM cards is that you might be charged high fees by your bank or by another bank in the name of ATM charges if you withdraw cash from the ATM of a different bank.
(iv) Also, you cannot utilise the overdraft facility on ATM cards in case of inadequate funds in your account.
5. Write the Difference Between an ATM card and a Debit card.
Ans: Usually, one card serves as an ATM-cum-debit card. But, an ATM card may not be necessarily a debit card, if the banks don’t allow it. If you have a card that can be functional only at ATMs, then you cannot use it for online payments. Similarly, you will also not be able to use it for swiping at EFTPOS (Electronic Fund Transfer at Point of Sale). While you can use debit cards at online payment gateways as well as with swiping machines. However, banks usually issue one card that serves both as a debit card and an ATM card. If it is only an ATM card, it may bear logos like Maestro, Cirrus, or Plus. In case, it is a debit card, it may be Visa, Rupay, Mastercard or so.
6. What are the Disadvantages of Mobile Banking?
Ans: Disadvantages of Mobile Banking:
(i) Mobile Banking is not available on all mobile phone. Sometimes, it requires you to install apps on your phone to use the Mobile Banking feature which is available on the high-end smartphone. If the customer does not have a smartphone than the use of Mobile Banking becomes limited.
(ii) A transaction like transfer of funds is only available on high-end phones.
(iii) Regular use of Mobile Banking may lead to extra charges levied by the bank for providing the service.
(iv) Mobile banking users are at risk of getting fake SMS messages and scams.
(v) The loss of a mobile customer device often means that criminals can gain access to your mobile banking PIN and other sensitive information.
7. What are the Mobile Banking Functions?
Ans: Mobile Banking Functions are:
(i) Obtaining account balances and lists of latest transactions.
(ii) Electronic bill payments.
(iii) Remote check deposits.
(iv) P2P payments.
(v) Funds transfers between a customer’s or another’s accounts.
8. What is a Lease?
Ans: Lease is an implied or written agreement specifying the conditions under which a lessor accepts to let out a property to be used by a lessee. The agreement promises the lessee use of the property for an agreed length of time while the owner is assured consistent payment over the agreed period. Both parties are bound by the terms of the contract, and there is a consequence if either fails to meet the contractual obligations.
Some features of lease are:
(i) A lease is a financial contract.
(ii) Two parties are – Lessor and Lessee.
(iii) Equipment is purchased by the lessor on the request of the lessee.
(iv) Lessee has the right to possess the equipment.
(v) It is for a specific period of time.
(vi) Lessee have to pay some lease rentals to the lessor.
(vii) Lessor takes some depreciation and income tax benefits.
9. Write the definition of lease financing.
Ans: A lease can be defined as a contractual agreement where the owner (lessor) of an equipment transfers the right to use the equipment to the user (lessee) for an agreed period of time for rental. At the end of the lease period the assets reverts to the lessor unless there is a provision for transfer of ownership to the lessee. The lessee usually bears the costs of insuring and maintaining the asset.
In the Indian context the fundamental difference between a lease transaction and other asset financing plans like hire purchase is that a lease contract cannot provide for a transfer of ownership from the lessor to the lessee whereas the other asset based financing plans carry this feature. Consequently the tax and accounting aspects of lease transactions are different from that of other financing plans.
10. What are the major features or elements of the leasing?
Ans: The major features or elements of the leasing are the following:
(i) The Contract: There are essentially two parties to a contract of lease financing, namely the owner and the user.
(ii) Assets: The assets, property to be leased are the subject matter lease financing contract.
(iii) Lease Period: The basic lease period during which the lease is non-cancelable.
(iv) Rental Payments: The lessee pays to the lessor for the lease transaction is the lease rental.
(v) Maintain: Provision for the payment of the costs of maintenance and repair, taxes, insurance, and other expenses appertaining to the asset leased.
(vi) Term of Lease: The term of the lease is the period for which the agreement of lease remains in operation.
11. What are the features of Operating lease.
Ans: Features of Operating lease are:
(i) Operating lease is a short term arrangement for the use of asset between the lessee and the owner of the asset.
(ii) Various costs related to that asset like maintenance, taxes etc. are paid by the owner of the asset.
(iii) The term of operating lease is always shorter than the economic life of that asset.
(iv) The lessee can cancel the operating lease prior to the end date of the operating lease.
(v) The terms related to an operating lease can vary significantly depending upon the agreement between the lessee and the owner of the asset.
(vi) The rent which is paid by the lessee for the duration of the operating lease is lower than the cost of asset.
12. Write the Contents of a lease agreement.
Ans: The lease agreement specifies the legal rights and obligations of the lessor and the lessee. It typically contains terms relating to the following:
(i) Description of the lessor, the lessee, and the equipment.
(ii) Amount, time and place of lease rentals payments.
(iii) Time and place of equipment delivery.
(iv) Lessee’s responsibility for taking delivery and possession of the leased equipment.
(v) Lessee’s responsibility for maintenance, repairs, registration, etc. and the lessor’s right in case of default by the lessee.
(vi) Lessee’s right to enjoy the benefits of the warranties provided by the equipment manufacturer/supplier.
(vii) Insurance to be taken by the lessee on behalf of the lessor.
(viii) Variation in lease rentals if there is a change in certain external factors like bank interest rates, depreciation rates, and fiscal incentives.
(ix) Options of lease renewal for the lessee.
(x) Return of equipment on expiry of the lease period.
(xi) Arbitration procedure in the event of dispute.
13. Discuss the functions of venture capital.
Ans: The key functions of Venture Capital are:
(i) Venture Capital provide finance as well as skills to new enterprises and new ventures of existing ones based on high technology innovations. It provides seed capital funds to finance innovation even in the pre-start stage.
(ii) Venture capitalist’s fills the gap in the owner’s funds in relation to the quantum of equity required to support the successful launching of a new business or the optimum scale of operations of an existing business.
(iii) Venture capitalist’s duty extends even as far as to see that the firm has proper and adequate commercial banking and receivable financing.
(iv) Venture capitalist assists the entrepreneurs in locating, interviewing and employing outstanding corporate achievers to professionalise the firm.
(v) Venture Capital assistance provided by the financial institution in the form of project, loans, equity, conditional loan (quasi-equity), a comprehensive techno-managerial support and guidance service including technology information service.
14. Write a note on Role and Importance of Stock Brokers.
Ans: Apart from buying and selling stocks for clients, the role of stock brokers has evolved in a big way over the last decade. They help investors wade through the whole investment process, provide research-based advice on stocks to facilitate decision making, offer assistance to invest in alternative investment assets, IPOs and mutual fund schemes. In the modern era of FinTech, stock brokers are striving to make stock market investments simple and easy by introducing new-age technologies. Like for example, today most stock brokers offer a mobile application that enables you to buy or sell shares in a single click within seconds, keep a track of your investments, create watch lists, interact with the community and do so much more. In fact, few brokers also extend financing facilities for investors to take leverage positions. We can say that today stock brokers have transformed themselves to become a one-stop investment solution provide.
15. What are the Types of Credit Rating.
Ans: The various credit agency agencies use similar alphabetical symbols to determine credit ratings. However, these ratings are also grouped into two types of grades – ‘investment grade’ and/or ‘speculative grade’.
(i) Investment grade: These ratings refer to the fact that the investment made is solid, and the borrower will most likely meet the repayment terms. Thus, they are often priced less.
(ii) Speculative grade: These ratings show that the investments are at a higher risk, and they often have higher interest rates.
| (C) Long type Questions Answers: |
1. What are the Characteristics or Nature of Financial Services? Explain.
Ans: From the following characteristics of financial services, we can understand their nature:
(a) Intangibility: Financial services are intangible. Therefore, they cannot be standardized or reproduced in the same form. The institutions supplying the financial services should have a better image and confidence of the customers. Otherwise, they may not succeed. They have to focus on quality and innovation of their services. Then only they can build credibility and gain the trust of the customers.
(b) Inseparability: Both production and supply of financial services have to be performed simultaneously. Hence, there should be perfect understanding between the financial service institutions and its customers.
(c) Perishability: Like other services, financial services also require a match between demand and supply. Services cannot be stored. They have to be supplied when customers need them.
(d) Variability: In order to cater a variety of financial and related needs of different customers in different areas, financial service organisations have to offer a wide range of products and services.
This means the financial services have to be tailor-made to the requirements of customers. The service institutions differentiate their services to develop their individual identity.
(e) Dominance of human element: Financial services are dominated by human element. Thus, financial services are labour intensive. It requires competent and skilled personnel to market the quality financial products.
(f) Information based: Financial service industry is an information based industry. It involves creation, dissemination and use of information. Information is an essential component in the production of financial services.
2. Briefly explain the Importance of Financial Services.
Ans: The importance of financial services may be understood from the following points:
(a) Economic growth: The financial service industry mobilises the savings of the people, and channels them into productive investments by providing various services to people in general and corporate enterprises in particular. In short, the economic growth of any country depends upon these savings and investments.
(b) Promotion of savings: The financial service industry mobilises the savings of the people by providing transformation services. It provides liability, asset and size transformation service by providing huge loan from small deposits collected from a large number of people. In this way financial service industry promotes savings.
(c) Capital formation: Financial service industry facilitates capital formation by rendering various capital market intermediary services. Capital formation is the very basis for economic growth.
(d) Creation of employment opportunities: The financial service industry creates and provides employment opportunities to millions of people all over the world.
(e) Contribution to GNP: Recently the contribution of financial services to GNP has been increasing year after year in almost countries.
(f) Provision of liquidity: The financial service industry promotes liquidity in the financial system by allocating and reallocating savings and investment into various avenues of economic activity. It facilitates easy conversion of financial assets into liquid cash.
3. What are the functions of Financial services?
Aps: Functions of financial services are:
(a) Facilitating transactions (exchange of goods and services) in the economy.
(b) Mobilizing savings (for which the outlets would otherwise be much more limited).
(c) Allocating capital funds (notably to finance productive investment).
(d) Monitoring managers (so that the funds allocated will be spent as envisaged).
(e) Transforming risk (reducing it through aggregation and enabling it to be carried by those more willing to bear it)
(i) These firms not only help to raise the required funds but also assure the efficient deployment of funds.
(ii) They assist in deciding the financing mix.
(iii) They extend their services upto the stage of servicing of lenders.
(iv) They provide services like bill discounting, factoring of debtors, acquisition of short-term funds in the money market, commerce, securitization of debts and so on to ensure an efficient management of funds.
4. Mention the scope and kinds of Financial Services.
Ans: The scope of financial services is very wide because financial services cover a wide range of services.
Supplies of financial services (financial intermediaries) include the following type of institutions:
(i) Banks and financial institutions.
(ii) Insurance companies.
(iii) Stock exchanges.
(iv) Unit Trusts.
(v) Investment Trust and Mutual Funds.
(vi) Finance Companies and so on.
Financial services provided by various financial institutions, commercial banks and merchant bankers can be broadly classified into two categories.
(i) Asset Based/ Fund Based:
The important fund based services include:
(a) Equipment leasing.
(b) Hire purchase and Consumer credit.
(c) Venture capital.
(d) Factoring etc.
(ii) Fee Based/ Advisory Services:
The fee based services include the following:
(a) Corporate counseling.
(b) Credit Rating.
(c) Merchant Banking.
(d) Stock Braking.
(e) Portfolio Management and so on.
5. What are the important Fund based and non fund based services are there?
Ans: The most important fund based and non-fund based services (or types of services) may be briefly discussed as below:
(a) Asset/Fund Based Services:
(i) Equipment leasing/Lease financing: A lease is an agreement under which a firm acquires a right to make use of a capital asset like machinery etc. on payment of an agreed fee called lease rentals. The person (or the company) which acquires the right is known as lessee. He does not get the ownership of the asset. He acquires only the right to use the asset. The person (or the company) who gives the right is known as lessor.
(ii) Hire purchase and consumer credit: Hire purchase is an alternative to leasing. Hire purchase is a transaction where goods are purchased and sold on the condition that payment is made in installments. The buyer gets only possession of goods. He does not get ownership. He gets ownership only after the payment of the last instalment. If the buyer fails to pay any instalment, the seller can repossess the goods. Each instalment includes interest also.
(iii) Bill discounting: Discounting of bill is an attractive fund based financial service provided by the finance companies. In the case of time bill (payable after a specified period), the holder need not wait till maturity or due date. If he is in need of money, he can discount the bill with his banker. After deducting a certain amount (discount), the banker credits the net amount in the customer’s account. Thus, the bank purchases the bill and credits the customer’s account with the amount of the bill less discount. On the due date, the drawee makes payment to the banker. If he fails to make payment, the banker will recover the amount from the customer who has discounted the bill. In short, discounting of bill means giving loans on the basis of the security of a bill of exchange.
(iv) Venture capital: Venture capital simply refers to capital which is available for financing the new business ventures. It involves lending finance to the growing companies. It is the investment in a highly risky project with the objective of earning a high rate of return. In short, venture capital means long term risk capital in the form of equity finance.
(v) Housing finance: Housing finance simply refers to providing finance for house building. It emerged as a fund based financial service in India with the establishment of National Housing Bank (NHB) by the RBI in 1988. It is an apex housing finance institution in the country. Till now, a number of specialised financial institutions/companies have entered in the filed of housing finance. Some of the institutions are HDFC, LIC Housing Finance, Citi Home, Indian Bank Housing etc.
(vi) Insurance services: Insurance is a contract between two parties. One party is the insured and the other party is the insurer. Insured is the person whose life or property is insured with the insurer. That is, the person whose risk is insured is called insured. Insurer is the insurance company to whom risk is transferred by the insured. That is, the person who insures the risk of insured is called insurer. Thus insurance is a contract between insurer and insured.
(vii) Factoring: Factoring is an arrangement under which the factor purchases the account receivables (arising out of credit sale of goods/ services) and makes immediate cash payment to the supplier or creditor. Thus, it is an arrangement in which the account receivables of a firm (client) are purchased by a financial institution or banker. Thus, the factor provides finance to the client (supplier) in respect of account receivables.
The factor undertakes the responsibility of collecting the account receivables. The financial institution (factor) undertakes the risk. For this type of service as well as for the interest, the factor charges a fee for the intervening period. This fee or charge is called factorage.
(viii) Forfaiting: Forfaiting is a form of financing of receivables relating to international trade. It is a non-recourse purchase by a banker or any other financial institution of receivables arising from export of goods and services. The exporter surrenders his right to the forfaiter to receive future payment from the buyer to whom goods have been supplied. Forfaiting is a technique that helps the exporter sells his goods on credit and yet receives the cash well before the due date. In short, forfaiting is a technique by which a forfaitor (financing agency) discounts an export bill and pay ready cash to the exporter. The exporter need not bother about collection of export bill. He can just concentrate on export trade.
(ix) Mutual fund: Mutual funds are financial intermediaries which mobilise savings from the people and invest them in a mix of corporate and government securities. The mutual fund operators actively manage this portfolio of securities and earn income through dividend, interest and capital gains. The incomes are eventually passed on to mutual fund shareholders.
(B) Non-Fund Based/Fee Based Financial Services:
(i) Merchant banking: Merchant banking is basically a service banking, concerned with providing non-fund based services of arranging funds rather than providing them. The merchant banker merely acts as an intermediary. Its main job is to transfer capital from those who own it to those who need it. Today, merchant banker acts as an institution which understands the requirements of the promoters on the one hand and financial institutions, banks, stock exchange and money markets on the other. SEBI (Merchant Bankers) Rule, 1992 has defined a merchant banker as, “any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, advisor, or rendering corporate advisory services in relation to such issue management”.
(ii) Credit rating: Credit rating means giving an expert opinion by a rating agency on the relative willingness and ability of the issuer of a debt instrument to meet the financial obligations in time and in full. It measures the relative risk of an issuer’s ability and willingness to repay both interest and principal over the period of the rated instrument. It is a judgement about a firm’s financial and business prospects. In short, credit rating means assessing the creditworthiness of a company by an independent organisation.
(iii) Stock broking: Now stock broking has emerged as a professional advisory service. Stock broker is a member of a recognized stock exchange. He buys, sells, or deals in shares/securities. It is compulsory for each stock broker to get himself/herself registered with SEBI in order to act as a broker. As a member of a stock exchange, he will have to abide by its rules, regulations and bylaws.
(iv) Custodial services: In simple words, the services provided by a custodian are known as custodial services (custodian services). Custodian is an institution or a person who is handed over securities by the security owners for safe custody. Custodian is a caretaker of a public property or securities. Custodians are intermediaries between companies and clients (i.e. security holders) and institutions (financial institutions and mutual funds). There is an arrangement and agreement between custodian and real owners of securities or properties to act as custodians of those who hand over it. The duty of a custodian is to keep the securities or documents under safe custody. The work of custodian is very risky and costly in nature. For rendering these services, he gets a remuneration called custodial charges.
Thus custodial service is the service of keeping the securities safe for and on behalf of somebody else for a remuneration called custodial charges.
(v) Loan syndication: Loan syndication is an arrangement where a group of banks participate to provide funds for a single loan. In a loan syndication, a group of banks comprising 10 to 30 banks participate to provide funds wherein one of the banks is the lead manager. This lead bank is decided by the corporate enterprises, depending on confidence in the lead manager.
A single bank cannot give a huge loan. Hence a number of banks join together and form a syndicate. This is known as loan syndication. Thus, loan syndication is very similar to consortium financing.
(vi) Securitisation (of debt): Loans given to customers are assets for the bank. They are called loan assets. Unlike investment assets, loan assets are not tradable and transferable. Thus loan assets are not liquid. The problem is how to make the loan of a bank liquid. This problem can be solved by transforming the loans into marketable securities. Now loans become liquid. They get the characteristic of marketability. This is done through the process of securitization. Securitisation is a financial innovation. It is conversion of existing or future cash flows into marketable securities that can be sold to investors. It is the process by which financial assets such as loan receivables, credit card balances, hire purchase debtors, lease receivables, trade debtors etc. are transformed into securities. Thus, any asset with predictable cash flows can be securitised.
6. Explain the features of E-banking.
Ans: Features of E-banking are:
(i) Check Account Balances & Statements: You can log into the internet banking account to check your account balance at any time. You can check for recent transactions or download statements from years ago.
(ii) 24×7 Fund Transfer: You can transfer money within the same or different banks through internet banking via facilities like RTGS, IMPS, NEFT, and UPI. You can also initiate overseas fund transfers.
(iii) Bill Payments & Recharge: You can pay various utility bills like electricity, landline, gas, property tax, etc., and set up standing instructions for automatic payments. You may also recharge your DTH and mobile phone connection, pay credit card bills and loan EMIs conveniently.
(iv) Order Cheque Books & Cards: Another feature of internet banking is the provision to place orders for new cheque books and bank cards. You can apply for primary and add-on debit cards and credit cards online and get swift delivery.
(v) Open deposit accounts: Banks also allow you to open fixed and recurring deposits through the internet banking platform. You can choose your preferred type of term deposit and tenure, and earn higher interest rates than those provided on your savings account.
(vi) Apply for Loans: You can apply for personal loans, home loans, and auto loans through the net banking portal. You can also access all the necessary information about the loan before sending your loan application.
7. Explain the importance or uses of e-banking to customer and banks.
Ans: Benefits of e-Banking to customers:
(i) e-banking covers digital payments, which have transparency.
(ii) It usually supports 24×7 access to banking services. So customers can avail services as per their time.
(iii) It is a very convenient and easy to use service for customers as they do not have to visit the bank branches every time.
(iv) It provides the best features, such as notification services which inform customers of anything and everything happening with their banking services.
(v) Financial discipline is inculcated as each and every transaction is recorded.
Benefits of e-Banking to banks:
(i) It reduces banks’ transaction costs. Operation cost per unit service decreases.
(ii) It is completely electronically managed, which reduces the chance of mistakes in the transaction.
(iii) Banks can easily attract customers for various offers via phone calls, emails and apps, as the customer doesn’t have to visit the branches anymore for any product specific information.
(iv) Banks have to hire less people and also it will reduce the branch size and area, which helps in overall revenue growth.
(v) It provides a competitive advantage to the banks.
(vi) With the help of e-banking, banks have a wider coverage area as banks are now not limited to the number of branches.
(vii) Loads of branches are reduced as a centralized database is present.
8. Give some common e-banking services.
Ans: Given below are a few common e-banking services:
(i) Electronic Fund Transfer (EFT): When a fund (money) is transferred from one bank to another bank electronically, it is called an electronic fund transfer. For example- Direct deposit/debit, Wire transfer, NEFT, RTGS, IMPS, etc.
(ii) POS-Point Of Sale: As the name suggests, Point Of Sale usually refers to a POINT(Retail Outlet) in terms of date, time, and place where a customer can make payment using plastic cards for the purchase of goods & services.
(iii) Credit Card: Credit cards are used for online and POS outlet payments, and it is issued by the banks to their customer at their request, after checking their credit scores. This provides the customers to borrow funds to a certain limit and make transactions. The cardholders are required to pay their debt within a time period with some charges.
(iv) Debit Card: A Debit Card is issued to customers in lieu of his money deposited in the bank. The customers can make immediate payment of goods purchased or services obtained on the basis of his debit card provided the terminal facility is available with the seller.
(v) ATM: ATM stands for Automated Teller Machine. It is one of the oldest and most common e-banking services. They provide 24×7 banking at all major locations. ATMs are not only used to withdraw cash whenever required, they can also be used to check your account statements, fund transfers, PIN and mobile number, etc.
(vi) Electronic Data Interchange (EDI): EDI is used in the banking industry to improve operational efficiency and reduce the cost of banking services. It also helps in efficient and faster process management.
(vii) TeleBanking: Under this facility, a customer can get information about the account balance or any other information about the latest transactions on the telephone.
(viii) Core Banking Solution Centralized Banking Solution: In this system customer by opening a bank account in one branch (which has CBS facility) can operate the same account in all CBS branches of the same bank anywhere across the country. It is immaterial with which branch of the bank the customer deals with when he/she is a CBS branch customer.
(ix) National Electronic Fund Transfer: NEFT refers to a nationwide system that facilitate individuals, firms and companies to electronically transfer funds from any branch to any individual, firm or company having an account with any other bank branch in the country. NEFT settles transactions in batches. The settlement takes place at a particular point of time for example, NEFT settlement takes place 6 times a day during the weekdays (9.30am, 10.30 am, 12.00 noon, 1.00 pm. 3.00 pm & 4.00pm) and 3 times during Saturday 9.30 am, 10.30 am and 12.00 noon) Any transaction initiated after a designated settlement time is settled on the next fixed settlement time.
(x) Real Time Gross Settlement: RTGS refers to a funds transfer system where transfer of funds takes place from one bank to another on a Real-time and on Gross basis. Settlement in Real-time means transactions are settled as soon as they are processed and are not subject to any waiting period. Gross settlement means the transaction is settled on one to one basis without bunching or netting with any other transaction. This is the fastest possible money transfer system through the banking channel. The RTGS service for customers is available from 9.00 am to 3.00 pm on weekdays and from 9.00 am to 12.00 noon on Saturdays. The basic difference between RTGS and NEFT is that while RTGS transactions are processed continuously, NEFT settles transactions in batches.
(xi) Internet Banking: Customers have access to a banking service that enables them to utilize the bank’s website or application to conduct various financial and non-financial transactions online. To process customer service requests automatically without requiring human involvement, a network service provider links a personal computer directly to a bank’s host computer system utilizing the Internet banking system and method. The system can distinguish between customer service requests that can be processed automatically and those that require a customer support representative. Customers who use remote banking can access the bank’s other automated services because the system is connected to the host computer system.
(x) Mobile banking: For mobile banking, almost all banks have developed smartphone applications that enable you to finish transactions at the touch of a button. All of the following are required: a smartphone, an active bank account, an internet connection, a mobile application, and mobile banking. It is the most recent electronic banking service that enables bank customers to do different financial transactions utilizing a mobile device. Since a mobile device needs to have a WAP browser loaded to provide access to information, mobile banking relies on WAP (Wireless Application Protocol) technology. Banks may be able to expand their traditional customer base through e-banking, offer new products and services, and improve their ability to compete in the payment services sector.
9. Discuss the Advantages and Disadvantages of E-banking.
Ans: Advantages of E-banking are:
(i) Convenience: E-banking provides great convenience to customers for performing various financial transactions. People can easily access their bank accounts anytime just sitting at their homes without visiting their bank.
(ii) Faster Service: It provides speedy service as peoples do no need to stand in queues for paying their bills or transferring funds. Funds get transferred instantly from one account to another in less time using online payment systems.
(iii) Higher Interest Rate: Online banking services provide higher interest rates to customers. It has reduced the operational cost of banks which helps them in providing better interest rates on deposits of customers.
(iv) Quality Service: Internet banking has improved the service quality to customers. It is efficient, safe and easy to do payments using online banking. Customers are able to monitor all transactions related to their accounts using e-banking apps.
(v) 24×7 Facility: E-banking services are available to customers at all times that are 24 hours a day and on all 7 days during a week. Customers can have access to banking products and services from anywhere at any joint of time.
(vi) Liquidity: It provides better liquidity of funds to customers. They can easily withdraw money from ATM machines at any time and from anywhere.
(vii) Discounts: Another important advantage of using online banking services is that it helps customers in availing various discounts. Peoples enjoy various discount schemes on retail outlets on usage on credit or debit cards.
Disadvantages of E-banking:
(i) Insecurity: E-banking services face various insecurity issues resulting from hacking done by online hackers. Customers may lose their credentials while doing payments and may cause huge financial loss.
(ii) High Start-up Cost: It requires huge expenditure for installing various hardware components, software, computers, modem, and internet network. Banking organizations need large expenditures for starting internet banking services.
(iii) Lack of Personal Contact between Customer and Banker: Online banking faces a barrier of direct interaction between clients and banks. Customers interacts with bank using their websites online. Sometimes customers are not able to resolve their issues by connecting with the bank virtually.
(iv) Transaction Problems: Many times banking servers are down thereby leading to transaction failure. Customers face difficulty in doing payments online which causes inconvenience.
(v) Training and Development: Banks need to provide training to their staff for providing better online service to their customers. It requires huge amount of investment for maintaining qualified and trained staff.
10. Explain the Advantages and Disadvantages of Credit Cards.
Ans: There are many advantages to using a credit card. Some of the benefits include:
(i) Convenience: Using a credit card lets you buy something today but put off the real cost until payday rolls around – so you don’t have to wait.
(ii) Spread out the costs: If you need to make a big purchase, a credit card lets you pay over several monthly installments. This can help with budgeting and, as long as you ensure you make your repayments, it won’t leave a huge hole in your finances.
(iii) Boost your credit: If you use a credit card responsibly, lenders will notice – and it can help to improve your credit score. If you have a low credit rating, you can get a credit builder credit card designed to help you build-up your score.
(iv) Purchase protection: Sometimes there could be a problem with your purchase – it might get lost or damaged, for example, or the company could even go bust. With credit cards, you have buyer protection for any purchases made on the card between £100 and £30,000. That means you can claim your money back from the card provider if there’s an issue with your goods or services.
(v) Go interest-free: Plenty of credit cards offer a 0% interest period. So you can borrow for free with no interest charged, so long as you make your minimum monthly repayments.
Disadvantages of Credit Cards:
(i) Overspending: Most often buyers can go overboard with their spending and can land in massive debt at the end of the month without even realising it.
(ii) Hidden Charges: No matter how many facilities and offers your credit card provides, there will always be hidden costs like cash advance fees and late payment fees that a lot of credit card customers do not know about.
(iii) High-interest Rates: If you fail to make your credit card payment on time, then the balance is carried over to another month and interest is charged on the outstanding balance. After your interest-free period is over, the bank can charge up to 3% for your outstanding payment.
(iv) Credit card fraud: Though not very common, there are chances you might be victim of credit card fraud. With advances in technology, it is possible to clone a card and gain access to confidential information through which another individual or entity can make purchases on your card.
(v) Limited use: Credit card providers might charge you extra for things that are free with a debit card, such as withdrawing cash from an ATM or buying things overseas.
11. What are the advantages and disadvantages of Debit card?
Ans: Advantages of Debit Card:
(i) Alternative to Cash: Debit cards allow cashless money transactions as a convenient mode for payment and transfer. It helps to avoid handling a large amount of cash. It can be used for the purchases of goods and receipt of services by direct deduction of funds from the payee’s bank account.
(ii) Prepaid Card: Debit card can be considered as a prepaid card for the cardholder’s bank account and permits transactions for any amount to the extent of the available balance in the holder’s bank account.
(iii) Nominal Fee: Banks charge a very nominal annual fee for issuing and maintaining debit cards. Such a fee gets automatically debited from the cardholder’s bank account on yearly basis.
(iv) Easy to obtain: Debit cards can be easily obtained from the bank and can be activated for use.
(v) Easy acceptability: Debit cards are accepted in a wide variety of merchant sites both within the country and abroad which makes it a convenient means of cashless transactions.
(vi) Immediate Transfer of Funds: Transaction with a debit card makes an immediate transfer of funds from the cardholder’s bank account at the time of purchases of goods and receipts of services. It avoids any manual intervention or involvement of cash and saves time.
(vii) Instant Withdrawal of Cash: The cash withdrawal from an ATM using a debit card hardly takes any time and allows withdrawal of money from any location without visiting the bank premises.
Disadvantages of Debit Card:
(i) Unprotected against identity: Debit cards are protected only by a number known as the PIN that can be used for the transfer of funds. Anyone carrying the card can access the account if the PIN is known. So there is less protection against identity theft.
(ii) Limit of transaction: In most cases, there is a limit on the maximum amount that can be withdrawn or transferred by the customer. So debit cards are not very useful in the transaction of high amounts.
(iii) Terminal Dependent: Merchants having an electronic device for card access can only allow transactions through debit cards. Again, a customer can access his account only from the place where the ATM facility is available Limit to fund access: Debit card has access to fund only available in the bank account, which can slow down business. Credit cards facilitate easy cash flow by allowing spending more money that can be replenished later. But with debit cards, you are not allowed to spend beyond what you have in your account.
(iv) Security threat: Debit cards may be subject to potential frauds if not handled properly. One has to be aware of the various provisions and mechanisms for fraud protection.
12. Briefly explain the features of ATM.
Ans: The following are the main features of ATMs:
(i) ATMs are versatile devices that have many functions. Though its main function is cash withdrawal, customers can make deposits, transfer money, and check accourt information using modern ATMs.
(ii) Banks charge a service charge on cash withdrawals, deposits, etc. An advantage of using the customer’s bank-operated ATM is that the fee will be lesser.
(iii) ATMs can also offer maximum security, at least more than internet banking which is subject to data threats, hacking, etc. Moreover, the adoption of newer technologies like biometric scanners, and one-time password (OTP) systems, keep customers safe.
(iv) They are user-friendly and can be used by anyone, despite being a sensitive process. It also operates in multiple languages, which helps everyone adopt the technology.
(v) ATMs restrict the withdrawal amount. For example, many ATMs limit the amount drawn in a single drawing and on a single day. This ensures sufficient cash for other customers.
(vi) They use credit or debit cards to authenticate the user. Using card systems to identify customers securely has helped ATMs flourish greatly.
(vii) OTP systems and biometric scanners are currently being used to secure the process further.
13. How to Use an ATM card?
Ans: Follow the below steps to know how to use an ATM card for various transactions-
(i) Go to the nearest Automated Teller Machine (ATM) irrespective of the bank. You can do transactions from any bank ATM even if you are not an account holder of the same.
(ii) Insert the ATM card in the card reader space provided in the ATM. A light usually blinks near the card reader when it is ready to take a new card. Generally, it is marked by an arrow.
(iii) Make sure you keep the front side of the ATM card on the top and place it clockwise. The display screen of the ATM indicates if you do not insert the card properly. This is because the ATM is unable to recognize the details.
(iv) The magnetic stripe on the back of the card has all information of the account holder. The ATM server automatically recognizes the data and then you can proceed with the transaction.
(iv) The screen displays the steps to perform a transaction which you can use as a guide. You can also select the language at your convenience Mostly there is a speaker in ATMs to give audio feedback and guide you through the process.
(v) The automated teller machine asks you to log in using your PIN (Personal Identification Number). Banks provide you with a temporary PIN when they issue the card. Then, you can change this 4-digit PIN and you must do so for security reasons. Remember your PIN while making transactions.
(vi) Once the transaction is complete, make sure you log out. Fraudsters may use this opportunity to transact money from your account if you miss logging out.
(vii) Do not share your PIN or CVV number with anyone.
14. Elaborate the Advantages of ATM.
Ans: Advantages ATM machines are:
(i) Access to hard Cash Anywhere at Anytime: The biggest advantage of ATM machines is that they allow access to cash at any time. In addition to having a limited amount of time to obtain cash, there was only one way of accessing it before 1967, through visiting the nearest bank. This meant that if you lived in remote areas you had to travel all the way to the nearest town. People only had access to withdrawing their cash until 3pm. Thanks to ATM machines, anyone can withdraw cash anywhere at any time of day and night, you can even access 2 ATM machines in Antarctica.
(ii) ATM Machines offer Financial Inclusion: ATM machines can be used to deliver banking services in low income countries where only a few people use banks. Interactive Automated Teller Machines, that can dispense and take deposits, help increase financial literacy and facilitate the access to formal financial services in remote areas. Two thirds of the world’s population depend on hard cash. Most of these people reside in developing countries where a large portion of them is unbanked. Therefore, the importance of ATM machines in financial inclusion cannot be underestimated. So offering financial inclusion is an advantage of ATM machines.
(iii) ATM Machines offer wide range of services: ATM’s nowadays offer a wide range of services such as cardless transactions, cash deposits, balance enquiry, person to person payment as well as cheque cashing. Wells Fargo, Bank of America and JP Morgan Chase have introduced card free transactions on their ATM machines as well. In some countries, ATM machines sell airline and movie tickets. ATM Machines have the big advantage of offering a wide range of services.
(iv) ATM machines are Cheaper to Maintain: Compared to brick and mortar, ATM machines are cheaper to build and maintain. Most of the services that can be obtained from a bank teller can be accessed on an Automated Teller Machine. This reduces a bank teller’s workload in addition to labour costs. Thus the other advantage of ATM Machines is that they are cheaper to maintain.
(v) ATM machines Serve an Important Function in times of Crisis: ATM machines are essential in times of crisis. The advantage of ATM machines is that they continue to operate when businesses close due to natural disasters, a health crisis or economic depression. Historically, the demand for hard cash increases during times of crisis. This is because people feel more secure when they have their wealth in their hands. The fact that Automated Teller Machines can be relied on during an emergency shows how they are vital in uncertain and normal times.
Disadvantages of ATM Machines:
(i) ATM machines can be targeted by criminals, robbers and hackers: One of the disadvantages of ATM machines is that they are both physically and electronically vulnerable. This makes them an easy target for criminals. Malware can be used to access people’s cash. Skimming devices and small cameras can be fitted onto Automated Teller Machines. Other criminals can physically destroy an ATM in order to access cash. People risk being robbed using ATM machines especially in isolated areas. This is a huge disadvantage of ATM Machines.
(ii) ATM Machines May Malfunction: An Automated Teller Machine like any other machine is bound to break down, although this is rare. Some machines may fail to recognise bank cards or can run out of cash. At other times the ATM system goes off-line. Also, there is a limit to the amount of cash one can withdraw from an ATM which can be an inconvenience if you require more funds. So the other disadvantage of Automated Teller Machines is that they may breakdown.
(iii) ATM machines Are Costly For The Users: Setting up ATM machines can be affordable for financial institutions, but it is not the same for the users. Banks and machine owners obtain a lot of revenue from ATM machines in the form of fees that users are charged for using them. The transaction costs are a huge disadvantage of ATM Machines.
(iv) Lack of Personal service: Lack of personal service is a disadvantage of ATM Machines. There are no bank assistants to help you or to ask questions to.
(v) Obsolescence: The other disadvantage of Automated Teller Machines is that they may become obsolete. ATM machines may slowly become obsolete due to the use of debit, credit cards, mobile money and internet banking. Transactions are becoming more digital and the use of physical cash is slowly declining. Also, the major reason people use ATM machines is to withdraw cash, these days, this can be done from any point of sale. Any point of sale (POS) vendor with enough funds can dispense cash quickly and conveniently just like an ATM. Thus, the use of ATM machines may decline in the near future.
15. What are the Features and Benefits of Mobile banking? Explain.
Ans: Following are the most prominent mobile banking features and benefits:
(i) 24×7 Access to Your Bank Account: The most prominent advantage of mobile banking is that it allows you to access your bank account from anywhere, any time. Whether you are at home, in your office, or on vacation in some remote corner of the world, you can keep a tab on your bank account 24×7. All you need is a stable and secure internet connection to view your account balances, check past transactions and download account statements.
(ii) Instant Money Transfer Facilities: Transferring funds using your mobile banking app is easier than ever through electronic fund transfer systems like NEFT, RTGS, IMPS and UPI. You can send money between bank accounts in India and overseas at the tap of a few buttons. Banks levy nominal fund transfer fees and even offer waivers on fund transfers.
(iii) Timely Payments of Bills & Loan EMIS: A critical mobile banking feature is that you can make all sorts of payments directly through your mobile banking apps. For instance, you can set up billers and pay all types of utility bills. Similarly, you can repay your loan EMIs, recharge your mobile and DTH devices, repay your credit card dues, etc. You can set up standing instructions for recurring payments and auto-enable bill payments before the due date.
(iv) Make Investments Securely: Most banks offer facilities to manage your investments through their mobile banking apps. You can invest in mutual funds, create a contingency fund for medical and financial emergencies, and open fixed and recurring term deposit accounts directly through the app.
(v) Quick Customer Service: Time-saving mobile banking benefits include access to customer support. You can launch the app to consult with bank representatives. The customer service department attempts to address your queries or grievances and resolve them quickly.
(vi) Multi-stage Security Features: Mobile banking apps are geared to ensure your account details are stored securely. Banks provide multistage security features such as login passcodes and biometric facilities to encrypt your app and safeguard your critical banking information. You cannot make fund transfers without OTPs, and you also get SMS alerts on initiating transactions or receiving payments.
16. Explain the Types of lease.
Ans: Types of lease are as follows:
(i) Financial Lease: Financial lease refers to the lease which is for long term duration, it means period takes place the same as the life of an asset. It covers the capital outlay plus required rate of return on funds at the period of lease, Here, lessor intends to cover the cost of capital of the asset and also wants to get some required rate of return. This financial lease cannot be canceled, the lessee has to make a series of payment for the use of an asset.
Lessee possess that asset without having any title. In other words, there is no transfer of title in the financial lease. Rest life of equipment is equal to the scrap value where lessor does a contract to sell his asset to the lessee at scrap value and transfer his title to the lessee. The Financial lease has taken place where lessee doesn’t have enough funds to purchase the equipment. So, he takes the equipment from lessor by paying lease rental payments. In case of housing, loan lessor becomes the bank and lessee is the one who purchases the house by taking a loan from the bank.
(ii) Operating Lease: Operating lease is somehow the same as financial lease. Operating lease for short term duration and power of lessor to control on the asset is more than lessee. When the lessor is a manufacturer, who wants to boost up his sales in short term, so he allows customers to possess the asset for a short period of time. In some cases, lessor takes the title of goods and lease his assets to the lessee for a specific time duration. So, it is the responsibility of the lessee to take care of the possessed goods. If any misuse of an asset has been taken place by the lessee then, penalty and press charges are charged to him by the lessor.
In an operating lease, the contract can be canceled before the expiry of duration. The payment of lease payments doesn’t mean that lessor wants to recover the cost of an asset. As it can be multiple leases, so lessor can recover his cost and earn his commission from the different lessee. This is a popular lease in many countries because people used to lease their equipment to find out the exact profit from their asset. This lease is preferred in the following conditions-
(a) When the life of an asset is uncertain.
(b) In case of rapid obsolescence of good.
(c) When we have to use the asset to recover its temporary problem.
(iii) Sales and Leaseback – In this lease, the first lessee purchases the equipment on his own and then he sells it to the lessor or to its firm. This operation can be used when the user of equipment holds his asset for a longer period of time and makes his lump sum cash and then makes some alternative use of it.
The main advantage of this type of lessee satisfy himself for the quality of the asset and after his possession, he can convert it into the sale. In this lease, lessor also can also claim tax for depreciation expenditure. This lease is popular because when the lessee facing any liquidity problems from an asset. Then, he can sell his equipment to the lessor and get it back from them. This will help lessee in sort out the liquidity issue without parting with it.
(iv) Leveraged Lease – In this form of contract, lessor takes only finance part of the money which is required to purchase the asset. There are generally three parties who get involved in this contract, the lessor, the lessee, and the financer. This type of lease agreement will help the lessor to expand his business with limited capital and keep it balanced.
(v) Sales Aid Leasing – In this leasing agreement, parties who involves are usually the manufacturer of the good where they get commission upon their sales and adding it to their profits.
17. Discuss the advantages and disadvantages of leasing from the point of view of the lessor and lessee.
Ans: Advantages of leasing may be discussed from the lessee’s point of view as well as from the lessor’s point of view.
(A) Advantages of leasing to the lessee:
Lease financing has the following advantages to the lessee:
(i) Financing of capital Goods: Lease financing enables the lessee to have finance for huge investments in land, building, plant, machinery, heavy equipment etc. up to 100 per cent without requiring any down payment. Thus, the lessee is able to commence his business virtually without making any initial investment (of course he may have to invest the minimum sum of working capital needs).
(ii) Additional source of finance: Leasing facilitates the acquisition of equipment, plant and machinery without the necessary capital investment and thus has a competitive advantage of mobilizing the scarce financial resources of business enterprise. It enhances the working capital position and makes available the internal accruals for business operations.
(iii) Less Costly: Leasing as method of financing is less costly than the other alternatives available.
(iv) Ownership preserved: Leasing provides finance without diluting the ownership or control of the promoters. As against it, other modes of long term finances, for example, equity or debentures normally dilute the ownership of the promoters.
(v) Avoids conditionality: Lease finance is considered preferable to institutional finance, as in the former case, there are no string attached. Lease financing is beneficial since it is free from restrictive covenants and conditionality, such as representation on the board, conversion of debt into equity, payment of dividend etc. which usually accompany institutional finance and term loans from bank.
(vi) Simplicity: Lease finance is simple to negotiate and free from cumbersome procedure with foster and simple documentation. As against it, institutional finance and terms loans require compliance of covenants and formalities and bulk of documentation causing procedural delays.
(B) Advantages of leasing to the lessor:
(i) Full security: The lessors interest is full secured since he is always the owner of the leased asset and can take repossession of the asset if the lessee fails to repay rentals. As against it, releasing an asset secured against a loan in more difficult and cumbersome.
(ii) Tax Benefit: The greatest advantage for the lessor is the tax relief by way of depreciation. If the lessor is in high tax bracket he can lease out assets with high depreciation rates and reduce his tax liability substantially.
(iii) High Profitability: The leasing business is highly profitable since the rate of return is more than what the lessor pays on his borrowings. Also the rate of return is more than in case of lending finance directly.
(iv) Highly Growth Potential: Lease financing enables the lessees to acquire equipment and machinery even during a period of depression, since they don’t have to invest any capital. Leasing thus, maintains the economic growth even during recessionary period.
(v) Trading on equity: Lessor usually carries out the operations with greater financial leverage, i.e, they have a very low equity capital and use a substantial amount of borrowed funds and deposits. Thus, the ultimate return equity is very high.
Limitations of leasing are as follows:
(a) Restriction on use of equipment: A lease arrangement may impose certain restrictions on use of the equipment, or requires compulsory insurance etc. Besides, the lessee is not free to make additions or alteration to the lease assets to suit his requirement.
(b) Limitations of financial lease: a financial lease may entail a higher payout obligation, if the equipment is found not useful and the lessee opts for premature termination of lease agreement.
(c) Loss of residual value: The lessee never becomes the owner of the lease asset. Thus, he is deprived of the residual value of the asset and is not even entitled to any improvements done by the lessee or caused by inflation or otherwise.
(d) Double Sales Tax: With the amendment of sales tax laws of various states, a lease financing transaction may be charged to sales tax twice, once when the lessor purchases the equipment and again when it is leased to the lessee.
18. What are the features of Financial lease?
Ans: Features of financial leases:
(i) 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.
(ii) 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.
(iii) The lease is non-cancelable, meaning the lessee cannot return the asset and not pay the whole of the lessor’s investment.
(iv) In this sense, they are full-payout, meaning the full repayment of the lessor’s investment is assured.
(v) 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.
(vi) 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.
(vii) In financial leases, the lessor’s rate of return is fixed: it is not dependant upon the asset-value, 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.
(viii) Financial leases are technically different but substantively similar to secured loans.
19. What are the advantages and disadvantages of Financial lease?
Ans: Advantages of Finance Lease:
(i) Finance lease allows business customers to use an asset without buying it.
(ii) Borrower (Lessee) pays installments of the cost of the asset rather than a large upfront investment.
(iii) In finance lease, the repayment structures are flexible and available. It can be tailored as per the need and capacity of the borrower.
(iv) The amount paid by the lessee is spread over the period of time in the form of fixed installments.
(v) Lessee is allowed to claim depreciation on the asset, which reduces taxable income.
Disadvantages of Finance Lease:
(i) Lessee has the responsibility to maintain and look after the asset hence, lessee incur some additional maintenance expenses.
(ii) All the risks associated with the asset is borne by the lessee. In finance lease, the risk is transferred to the lessee.
(iii) Finance lease involves a lot of documentation and other formalities.
(iv) In finance lease, lessee is creating excess debt in its balance sheet.
(v) In case of bankruptcy, protection is not granted to leased asset.
20. What are the advantages and disadvantages of Operating lease?
Ans: Advantages of Operating lease:
(i) No ownership: Not owning an asset can be beneficial because you won’t have to pay for repairs or maintenance.
(ii) Renting may be cheaper: Renting is generally much more affordable than purchasing, benefitting smaller or newer businesses that don’t yet have the financial strength to collect expensive assets.
(iii) Short-term: You’ll only need to lease the asset for as long as you need it, reducing the overall costs of purchasing, maintaining, and selling it if you no longer need it.
Disadvantages of Operating lease:
(i) No equity: When you lease, you don’t gain any equity.
(ii) Financing costs: You might incur financing costs with a lease, such as interest.
(iii) Might pay more than market value: Depending on how long an asset is leased, the total cost could be more than the market value at the time the lease originated.
(iv) Continuous terms renegotiation: Many leases are short-term. This means the lessor and lessee will renegotiate terms every time the lease expires. This provides the lessor an opportunity to raise rates or fees.
21. Explain the Key Differences Between Finance (Capital) Lease and Operating Lease.
Ans: The following are the major differences between finance (capital) lease and operating lease:
(i) The lease agreement in which the risk and rewards are transferred with the transfer of an asset is known as Finance Lease. The lease agreement in which the risk and rewards are not transferred with the transfer of the asset is known as Operating Lease.
(ii) Finance Lease is a sort of loan agreement in which the lessor plays the role of financier. As opposed to the Operating Lease, which is similarly like a rental agreement.
(iii) Finance Lease is for the long term as it covers the maximum part of the life of the asset. Unlike, Operating Lease, which is for a shorter period.
(iv) An Operating lease is more flexible as compared to the Finance Lease.
(v) In the finance lease, the ownership of the asset is transferred to the lessee at the end of the lease term, by paying a nominal amount which is equal to the fair market value of the asset. Conversely, in operating lease, there is no such kind of option.
(vi) In Finance Lease, the lessee bears the risk of obsolescence whereas in Operating Lease the lessor bears the risk for so.
22. What are the features of Hire Purchase System?
Ans: The main features of hire purchase finance are:
(i) The hire purchaser becomes the owner of the asset after paying the last installment.
(ii) Every installment is treated as hire charge for using the asset.
(iii) Hire purchaser can use the asset right after making the agreement with the hire vendor.
(iv) The hire vendor has the right to repossess the asset in case of difficulties in obtaining the payment of installment.
(v) Rental payments are paid in installments over the period of the agreement.
(vi) Each rental payment is considered as a charge for hiring the asset. This means that, if the hirer defaults on any payment, the seller has all the rights to take back the assets.
(vii) All the required terms and conditions between both the parties involved are documented in a contract called Hire-Purchase agreement.
(viii) The-frequency of the installments may be annual, half-yearly, quarterly, monthly, etc. according to the terms of the agreement.
(ix) Assets are instantly delivered to the hirer as soon as the agreement is signed.
23. Discuss the advantages of Hire purchase system.
Ans: Advantages of Hire purchase system.
(i) Facility of Buying: People with small income can buy expensive articles such as car, house, furniture etc. They can make payment in easy installments and thereby improve their standard of living. The buyer can return the goods, if he is not satisfied with their quality or is unable to pay further installments.
(ii) Thrift and savings: Hire purchase system encourages people to reduce expenses and save money to pay installments at regular intervals.
(iii) Higher Sales: Hire purchase system helps to widen market for costly goods. People who cannot buy such goods otherwise are tempted to purchase them on installments. The seller can take back the goods if buyer makes default in payment.
(iv) Boon to small producers: Small scale units and farmers can buy machinery and equipment and pay installments out of earnings.
24. Discuss the disadvantages of Hire Purchase System.
Ans: Disadvantages of Hire Purchase System.
(i) Extravagance: Hire purchase system induces middle class people to buy luxury goods which they cannot otherwise afford. They are tempted to pledge their future income. They may not be able to pay installments in time. They suffer heavy loss when the seller takes back the goods on default of payment.
(ii) Higher Prices: The buyer has to pay much higher prices than that payable on cash purchase. The seller adds a margin to cover interest and risk. The seller may pass on goods of doubtful quality by offering easy credit terms. The buyer does not get ownership of goods until last installment paid. He cannot sell the goods before the final payment.
(iii) Risk of bad Debts: When the buyer fails to pay installments, the seller may suffer loss. He may have to spend money and time to recover goods from the buyer. There is risk of loss of goods lying with the buyer.
(iv) Large Investment: The hire purchase seller has to invest considerable funds because payments are received from buyers over a long period of time.
25. What are the basic differences between Hire Purchase and Leasing?
Ans: Hire Purchase and Lease Financing mostly differ in the following respects:
(i) Ownership: The lessor is the owner and the lessee is entitled to the economic use of the leased asset/equipment only in case of lease financing. The ownership is never transferred to the user (lessee). In contrast, the ownership of the asset passes on to the user (hirer) in case of hire-purchase finance on the last instalment; before payment of the last instalment the ownership of the asset vests in the finance company/ intermediary (seller).
(ii) Depreciation: The depreciation on the asset is charged in the books of the lessor in case of leasing while the hirer is entitled to the depreciation shield on assets hired by him.
(iii) Magnitude: The magnitude of funds involved in Lease finance is very large, for example, for the purchase of aircrafts, ships, machinery and so on. The cost of acquisition in hire purchase is relatively low, that is, automobiles, office equipments and generators and so on are generally hire purchased.
(iv) Extent: Lease financing is invariably 100 per cent financing. No immediate cash down payment is required to be paid by the lessee. In a hire-purchase transaction typically a margin equal to 20-25 per cent of the cost of the equipment is required to be paid by the hirer.
(v) Maintenance: The cost of maintenance of hired asset is to be borne by the hirer himself. In case of finance lease only, the maintenance of the leased assets is the responsibility of the lessee. It is the lessor (seller) who has to bear the maintenance cost in an operating lease.
(vi) Tax benefits: The entire lease rental is tax deductible expense. Only the interest component of the HP instalment is tax deductible.
26. What are the RBI guidelines for HP business?
Ans: Under section 6(1)(0) of Banking Regulation Act-1949, the Govt. Of India has permitted banks to engage in HP business. Following are some of the important guidelines of RBI for HB business of banks.
(a) Banks shall not themselves undertake directly (departmentally) the business of hire purchases.
(b) Banks desirous of undertaking HP business through an existing companies or new subsidiaries will require prior approval of RBI.
(c) Banks investments in the shares of subsidiaries engaging in leasing and HP business shall not exceed 10% of the paid up share capital and reserves of the banks.
(d) Without prior approval of RBI, banks shall not act as promoters of other hire purchase companies.
(e) Prior clearance of RBI is required for the purpose of any application to the Controller of Capital issue in case of IPO of new subsidiary and FPO of existing subsidiaries of Banks.
(f) Bank shall furnish necessary information regarding its HP or equipment leasing subsidiaries, as and when RBI demands.
27. State the different types of mutual fund schemes.
Ans: The objectives of mutual funds are to provide continuous liquidity and higher yields with high degree of safety to investors. Based on these objectives, different types of mutual fund schemes have evolved.
(A) Functional Classification of Mutual Funds:
(i) Open Ended Schemes: In case of open ended schemes, the mutual fund continuously offers to sell and repurchase its units at net asset value (NAV) or NAV related prices. Open ended schemes do not have a fixed corpus. The corpus of fund increases or decreases, depending on the purchase or redemption of units by investors. The key feature to open-ended funds is liquidity. They increase liquidity of the investors as the units can be continuously bought and sold.
(ii) Close-ended schemes: Close-ended schemes have a fixed corpus and a stipulated maturity period ranging between 2 to 5 years. Investors can invest in the scheme when it is launched. The scheme remains open for a period not exceeding 45 days. If an investor sells units directly to the fund, he cannot enter the fund again, as units bought back by the fund cannot be reissued. The close ended scheme can be converted into an open-ended scheme.
(iii) Interval Scheme: Interval Scheme combines the features of open-ended and close-ended schemes. They are open for sale or redemption during pre determined intervals at NAV related prices.
(B) Portfolio Classification/ Classification on the basis on investment pattern.
(i) Income Funds: The aim of income funds is to provide safety of investments and regular income to investors. Such schemes invest predominantly in income bearing instruments like bonds, debentures, government securities and commercial paper. The return as well as the risk are lower in income funds.
(ii) Growth funds: The man objective of growth funds is capital appreciation over the medium to long term. They invest most of the corpus in equity shares with significant growth potential and they offer higher return to investors in the long term.
(iii) Balanced Funds: The aim of balanced scheme is to provide both capital appreciation and regular income. They divide their investment between equity shares and fixed nice-bearing instruments in such a proportion that the portfolio is balanced. This exposure to risk is moderate and they offer a reasonable rate of return.
(iv) Money Market Mutual funds: They specialise in investing in short term money market instruments like treasury bills and certificate of deposits. The objective of such funds is high liquidity with low rate of return.
(v) Pension Funds: Pension mutual funds are really long-term investments that offers regular returns after the investor retires. These funds split the investment between equity and debt instruments so that the equity component offers higher returns while the debt component balances the risk while providing low but steady returns. Investors can draw their returns as a lump sum amount or as a fixed pension, or in a combination of the two.
(C) Based on Risk: The mutual fund types based on risk are:
(i) Very Low-Risk Funds: Liquid funds and ultra-short-term funds (one month to one year) are known for its low risk, and understandably their returns are also low (6% at best). Investors choose this to fulfil their short-term financial goals and to keep their money safe through these funds.
(ii) Low-Risk Funds: In the event of rupee depreciation or unexpected national crisis, investors are unsure about investing in riskier funds. In such cases, fund managers recommend putting money in either one or a combination of liquid, ultra short-term or arbitrage funds. Returns could be 6-8%, but the investors are free to switch when valuations become more stable.
(iii) Medium-risk Funds: Here, the risk factor is of medium level as the fund manager invests a portion in debt and the rest in equity funds. The NAV is not that volatile, and the average returns could be 9-12%.
(iv) High-Risk Funds: Suitable for investors with no risk aversion and aiming for huge returns in the form of interest and dividends, high-risk mutual funds need active fund management. Regular performance reviews are mandatory as they are susceptible to market volatility. You can expect 15% returns, though most high-risk funds generally provide up to 20% returns.
(D) Based on Asset Class:
(i) Equity Funds: Equity funds are mutual funds which invest majorly in equity stocks of the company. Equity funds are considered to be risky but they tend to give higher returns in the long term.
(ii) Debt Funds: Debt funds are mutual funds which usually invest in the government securities, corporate bonds etc. Debt funds are more stable and less volatile to the market conditions.
(iii) Money Market Funds: A money market refers to the mutual funds that are highly liquid and where the money is invested in short-term investments like deposits certificates, treasury bills etc.. You can have your money invested in money market funds for a duration like a day.
(iv) Balanced or Hybrid Funds: Balance or hybrid funds are a mix of equity and debt funds. They tend in to invest an equal amount in equity and debt funds to keep the risk level balanced in the investment.
(E) Based on Specialty:
(i) Sector Funds: Sector funds are the funds that stick to one sector of the industry when investing. For example – Real Estate mutual funds will only invest in those companies which are in real estate business or sector. The returns of the investment also depend on the performance of the particular sector.
(ii) Index Funds: The index fund is a type of investment which is made to match the working of a market index like BSE. These funds provide broader exposure to the market, less operating cost and low portfolio turnover.
(iii) Global Funds: These are similar to international funds and invest their money in the companies located in all the parts of the world. The only difference from international funds is that investment can also be made in the same country of the mutual fund investment.
(iv) Real Estate Funds: As the name sounds, the real estate funds invest their money in real estate business. The investment in a real estate project can be made at any phase of the project.
(v) Asset Allocation Funds: These funds allow the portfolio manager to adjust the allocated assets to achieve results. The amount of investment gets divided into such funds to invest in different instruments like bonds and equity.
28. What are the benefits of investing in mutual funds?
Ans: Some of the benefits are mentioned below:
(a) Professional Management: An average investor lacks the knowledge of capital market operations and does not have large resources to reap the benefits of investment. Hence, he requires the help of an expert. Mutual funds are managed by professional managers who have the requisite skills and experience to analyse the performance and prospects of companies. They make possible an organised investment strategy, which a hardly possible for an individual investor.
(b) Portfolio diversification: An investor undertakes risk if he invest all his funds in a single scrip. Mutual funds invest in a number of companies across various industries and sectors. This diversification reduces the riskiness of the investments.
(c) Liquidity: Often, investors cannot sell the securities held easily, while in case of mutual funds, they can easily encash their investment by selling their units to the fund if it is an open-ended scheme or selling them on a stock exchange if it is a close – ended scheme.
(d) Tax benefits: Mutual fund investors now enjoy income-tax benefits. Dividends received from mutual fund’s debt schemes are tax exempt to the overall limit of Rs. 9,000 allowed under section 80L of the Income Tax Act.
(e) Transparency: Mutual funds transparently declare their portfolio every month. Thus an investor knows where his/her money is being deployed and in case they are not happy with the portfolio they can withdraw at a short notice.
(f) Stability to the stock market: Mutual funds have a large amount of funds which provide them economics of scale by which they can absorb any losses in the stock market and continue investing in the stock market. In addition, mutual funds increase liquidity in the money and capital market.
(g) Equity Research: Mutual funds can afford information and data required for investments as they have large amount of funds and equity research terms available with them.
(h) Reduction in transaction costs: Compared to direct investing in the capital market, investing through the funds is relatively less expensive as the benefit of economies of scale is passed on to the investors.
29. What are the Disadvantages of Mutual Funds in India? Explain.
Ans: Disadvantages of Mutual Funds in India:
(i) Fluctuating returns: Mutual funds do not offer fixed guaranteed returns in that you should always be prepared for any eventuality including depreciation in the value of your mutual fund. In other words, mutual funds entail a wide range of price fluctuations. Professional management of a fund by a team of experts does not insulate you from bad performance of your fund.
(ii) Diversification: Diversification is often cited as one of the main advantages of a mutual fund. However, there is always the risk of over diversification, which may increase the operating cost of a fund, demands greater due diligence and dilutes the relative advantages of diversification.
(iii) Lock-in Period: The lock-in period can sometimes prove to be a significant disadvantage as you cannot withdraw your money before the specified time. Hence, in case of emergencies, you cannot liquidate your invested amount.
(iv) Fluctuating Returns: Mutual fund returns are not guaranteed as they keep fluctuating according to the market conditions. Hence, investors must be aware of the risk profile of the fund before investing.
(v) Fund Evaluation: Many investors may find it difficult to extensively research and evaluate the value of different funds. A mutual fund’s net asset value (NAV) provides investors the value of a fund’s portfolio. However, investors have to study various parameters such as sharpe ratio and standard deviation among others to ascertain how one, fund has fared compared to another which can be complicated to some extent.
30. Briefly discuss the Association of Mutual Funds in India (AMFI).
Ans: The Association of Mutual Funds in India (AMFI) was established in 1993 when all the mutual funds, except UTI, came together realising the need for a common forum for addressing the issues that affect the mutual fund industry as a whole. The AMFI is dedicated to developing the Indian Mutual fund industry or professional, health, and ethical lines and to enhance and maintain standards in all areas with a view to protecting and promoting the interests of mutual funds and their unit – holders.
Objectives of AMFI:
(a) To define and maintain high professional and ethical standards in all areas of operation of mutual fund industry.
(b) To interact with the securities and Exchange Board of India (SEBI) and to represent to SEBI on all matters concerning the mutual fund industry.
(c) To represent to the Government, Reserve Bank of India and other bodies on all matters relating to the mutual fund industry.
(d) To undertake nationwide investor awareness programme so as to promote proper understanding of the concept and working of mutual funds.
(e) To disseminate information on mutual fund industry and to undertake studies and research directly and/ or in association with other bodies.
AMFI continues to play its role as a catalyst for setting new standards and refining existing ones in many areas, particularly in the sphere of valuation of securities. Based on the recommendation of the AMFI, detailed guidelines have been issued by SEBI for valuation unlisted equity shares. AMFI maintains a liaison with different regulators such as SEBI, IRDA and RBI to prevent any over-regulation that may hamper the growth of the industry.
31. State the growth of mutual funds in India.
Ans: The Indian Mutual fund industry has evolved over distinct stages.
The growth of the mutual fund industry in India can be divided into four phases:
(a) PHASE I: The mutual fund concept was introduced in India with the setting up of UTI in 1963. The Unit Trust of India (UTI) was the first mutual fund set up under the UTI Act, 1963, a special act of the parliament. It became operational in 1964 with a major objective of mobilizing savings through the sale of units and investing them in corporate securities for maximizing yield and capital appreciation. This phase commenced with the launch of Unit Scheme 1964 (US-64) the first open-ended and the most famous scheme. UTI maintained its monopoly and experienced a consistent growth till 1987.
(b) PHASE II: The second phase witnessed the entry of mutual fund companies sponsored by the nationalized the banks and the insurance companies. In 1987, SBI Mutual Fund and Canbank Mutual Fund were set up as trusts under the Indian Trust Act, 1882. The Indian Growth fund was another off shore fund, floated by UTI, which was listed on the New York Stock Exchange (NYSE). By 1990, the two nationalized insurance giants, LIC and GIC, and nationalized banks, namely Indian Bank, Bank of India, and Punjab National Bank had started operations of wholly owned mutual fund subsidiaries. In October 1989, the first regulatory guidelines were issued by the RBI but they were applicable only to the mutual funds sponsored by banks. Subsequently, the Govt. of India issued comprehensive guidelines in June 1990 covering all mutual funds.
(c) PHASE III: The year 1993 marked a turning point in the history of mutual funds in India. The Securities and Exchange Board of India (SEBI) issued by the Mutual Fund Regulations in January 1993. SEBI notified regulation bringing all mutual funds except UTI under a common regulatory framework. Private domestic and foreign players were allowed entry in the mutual fund industry. However the year 1995 was the beginning of the sluggish phase of the mutual fund industry. During 1995 and 1996, unit holders saw an erosion in the value of their investments due to a decline in the NAVs of the equity funds. Moreover, the service quality of mutual funds declined due to a rapid growth in the numbers of investor’s account, and the inadequacy of service infrastructure. Investor’s perception about mutual funds gradually turned negative.
(d) PHASE IV: During this phase, the flow of funds into the mutual funds sharply increased. This significant growth was aided by a more positive sentiment in the capital market, significant tax benefits and improvement in the quality of investor service. However in 2000-2001, the Indian Mutual fund industry has again stagnated.
32. Discuss the potentiality of Mutual Funds in India.
Ans: The first Mutual Fund launched in our country is by Unit Trust of India (UTI) in 1964 and thereafter a lot of mutual funds are launched in India over last 40 years like LIC Mutual Funds, ICICI Mutual Funds, Tata Mutual Funds, Birla Mutual Funds etc. with various schemes like Canpep 95, Master Share Magnum 93 etc. By the end of March 2000 apart from UTI there were 36 Mutual Fund operating, of which 9 are in public sector and 27 are in private sector. It is found that UTI have dominated the mutual fund market in India till 1994-95 and have accounted for about 76.5% of market share through enjoy various schemes. Until recently UTI used to enjoy the maximum public confidence so far as the mutual fund business is concerned.
With poor performance of different Mutual Funds in 1999-2000 and the tumbling of the flagship scheme of UTI, Unit 64, the mutual fund market became sluggish and failed to come up to full potential. It is due to the following reasons why mutual funds business in India is not blooming to the potential:
(a) Poor performance of most of the schemes.
(b) Poor show of stock Exchange.
(c) Inefficient Asset Management by the AMCS.
(d) Downfall of UTI.
(e) Uncertainty about the Mutual fund schemes.
(f) Lack of knowledge of the investors to choose the Mutual Fund schemes.
(g) Too much control by SEBI.
Now, with the opening up of economy and the constant growth of economy since 96-97 in India there is a huge scope for the Mutual Fund in India. The AMCs and the Mutual Fund should take care of the following in order to be successful and perform upto the potential to earn the confidence of unit holders:
(a) Professional Fund Managers should be engaged.
(b) Specific schemes for specific investors should be the target.
(c) Diversification of risk through systematic risk taking.
(d) Performing with honesty.
In India there is a variety of mutual fund schemes available like UTI Mastergain, Magnum 93, CANPEP, Birla Mutual etc which are either open-ended or close-ended or these may be long term or short term. The success of Mutual Fund schemes depends on their Net Asset Value (NAV). In India most of the Mutual Fund schemes show a below par NAV which discourages the investors to put money in the unit. So to perform up to the potential of the Mutual Fund Market in India, all the mutual Fund Schemes, AMCs and professional fund managers should aim at making the NAV healthier and as high as possible.
33. What are the Functions of Mutual Funds? Also discuss SEBI regulations relating to Mutual Funds.
Ans: Functions: The special function of Mutual Fund is that it provides investors of small and moderate means the opportunity that is enjoyed by large, rich investors wholly, to realise high and secure rate of return on their savings. This is sought to be ensured by diminishing the risk of investing in stocks by spreading or diversifying investments over a large number of different kinds of stocks. Unit Trust enables a small investor to hold a share in a large and diversified portfolio of assets which reduces the risks of investment. Similarly, it makes possible for small investors to have the benefit of professional management of portfolio which, in turn, helps them to earn a relatively higher rate of return them they otherwise would how earned if their small savings were invested independently or separately. In other words, the unit trust helps (small) investors to obtain “high return low risk “combination from their indirect holding of equities and other assets.
SEBI (Mutual Funds) REGULATIONS, 1996:
(a) All the schemes to be launched by the Asset Management Company (AMC) need to be approved by the trustees and copies of offer documents of such schemes are to be filed with SEBI.
(b) The offer documents shall contain adequate disclosures to enable the investors to made informed decisions.
(c) Advertisement in respect of schemes should be in conformity with the SEBI prescribed advertisement code, and disclose the method and periodicity of valuation of investment sales and repurchase in addition to the investment objectives.
(d) Units of a close-ended scheme can be opened for sale or redemption at a predetermined fixed interval if the minimum and maximum amount of sale, redemption, and periodicity is disclosed in the offer document.
(e) Units of a close-ended scheme can also be converted into an open-ended scheme with the consent of a majority of the unit-holders and disclosure is made in the offer document about the option and period of conversion.
(f) Units of a cost- ended scheme may be rolled over by passing a resolution by a majority of the shareholders.
(g) No schemes other than unit-linked scheme can be opened for subscription for more than 45 days.
(h) The listing of close-ended schemes is mandatory and every close-ended scheme should be listed or a recognised stock exchange within six months from the closure of subscription.
34. Write the Key Differences Between Open-ended and Closed- ended Funds.
Ans: The difference between open-ended and closed-ended funds can be drawn clearly on the following grounds:
(i) Open-ended funds refer to the mutual fund, in which the investor is allowed to buy shares anytime, even after the closure of the NFO, i.e. New Fund Offer. As opposed, the shares of closed-ended funds can be bought only during the New Fund Offer, i.e. after the NFO is over the investor is not allowed to invest.
(ii) The subscription of the open-ended mutual fund remains open on a regular basis, i.e. it accepts funds from the public by providing its units. Conversely, the subscription of closed-ended schemes is open for a short period only, i.e. from one to three months only.
(iii) In the open-ended mutual fund, there is no fixed maturity period, whereas there is a definite maturity period, in the case of closed-ended funds.
(iv) The liquidity is provided by the fund itself, in the open-ended scheme. As against this, in the closed-ended scheme, the stock market provides liquidity.
(v) In an open-ended fund, the corpus is variable because of continuous buying and redemption. On the other hand, the corpus is fixed because no new units are offered for sale, beyond the limit specified.
(vi) In open-ended scheme, the transactions are executed on daily basis, while in the closed-ended scheme the transactions are executed on real time basis.
(vii) In the open-ended fund, prices are determined by dividing NAV from shares outstanding. Unlike, in the closed-ended fund price per share is ascertained by supply and demand.
35. What is Venture Capital? Explain the Features of Venture capital.
Ans: It is a private or institutional investment made into early-stage/ start-up companies (new ventures). As defined, ventures involve risk (having uncertain outcome) in the expectation of a sizeable gain. Venture Capital is money invested in businesses that are small; or exist only as an initiative, but have huge potential to grow. The people who invest this money are called venture capitalists (VCs). The venture capital investment is made when a venture capitalist buys shares of such a company and becomes a financial partner in the business. Venture Capital investment is also referred to risk capital or patient risk capital, as it includes the risk of losing the money if the venture doesn’t succeed and takes medium to long term period for the investments to fructify.
The following are the features of venture capital:
(a) It is basically financing of new companies which are finding it difficult to go to the capital market at their early stage of existence.
(b) This finance can also be loan-based or in-convertible debentures so that they carry a fixed yield for the providers of venture capital.
(c) Those who provide venture capital aim at capital gain due to the success achieved by the concern that borrows.
(d) It is a long-term investment and made in companies which have high growth potential. The provision of venture capital will bring rapid growth for the business.
(e) The venture capital provider will also take part in the business of borrowing concern whereby, the venture capital financier not merely confines to finance, but also provide managerial skill.
(f) Not all the capitalists will experience high risk. But venture capital financing contains risks. But the risk is compensated with a higher return.
36. What are the Advantages of Venture Capital Funds?
Ans: The main advantages of venture capital funds for entrepreneurs and startups are the following:
(i) Access to financing that, sometimes, cannot be obtained through traditional banking and financial entities.
(ii) Eliminate the constant worry of facing a debt that you must pay regardless of the growth of your business.
(iii) Promote the development of your project with one of the most comprehensive types of investment since it not only contributes with resources but also with relationships, experience, professionalism, and advice in the administration of your business.
(iv) Earn a good reputation for your project and your brand with the participation of a venture capital company.
(v) Being at the forefront of technology, new business models, and learning. Many investors want to be in this sector to learn from diverse technologies or sectors.
Disadvantages of Venture Capital Funds:
(i) Depending on the % that they take, whether private equity or venture capital, venture capitalists can control the company and ultimately decide what should be done.
(ii) Venture capital funds often incorporate control clauses and vetoes that limit your independence as a company manager.
(iii) Certain decisions have to be communicated in an organization, and they need to take investors’ approval.
(iv) Venture capitalists also usually put economic clauses stressing that they will be the first to obtain investment returns or ensure minimum profitability.
(v) The funds have a specific period, from 3 to 5 years, in which they need to generate a divestment. This implies the possibility of generating pressure on the management/founding team of the company to grow or to find ways out for the venture capital funds.
37. Explain the Importance of Venture Capital Financing.
Ans: The following are the importance of venture capital financing:
(i) Promotes products: New products with modern technology become commercially feasible mainly due to the financial assistance of venture capital institutions.
(ii) Encourages customers: The financial institutions provide venture capital to their customers not as a mere financial assistance but more as a package deal which includes assistance in management, marketing technical and others.
(iii) Brings out latent talent: While funding entrepreneurs, the venture capital institutions give more thrust to potential talent of the borrower which helps in the growth of the borrowing concern.
(iv) Promotes exports: The Venture capital institution encourages export oriented units because of which there is more foreign exchange earnings of the country.
(v) As Catalyst: A venture capital institution acts as more as a catalyst in improving the financial and managerial talents of the borrowing concern. The borrowing concerns will be more keen to become self dependent and will take necessary measures to repay the loan.
(vi) Creates more employment opportunities: By promoting entrepreneurship, venture capital institutions are encouraging self employment and this will motivate more educated unemployed to take up new ventures which have not been attempted so far.
(vii) Helps sick companies: Many sick companies are able to turn around after getting proper nursing from the venture capital institutions.
38. Discuss in detail the classification of Venture Capital discuss the evaluation process by the venture capital Institution (VCI).
Or
Discuss the stages of Venture Capital Financing.
Ans: The first step in the Venture Capital Financing decision is the selection of investment. The starting point of the evaluation process by the Venture Capital Institution (VCI) is the business plan of the Venture Capital undertaking (promoter). The selection of investment by a VCI is closely related to the stages and type of investment.
The stages of financing, as differentiated in the venture Capital industry, broadly fell into to categories:
(a) early stage. and
(b) later stage.
(a) EARLY STAGE FINANCING: This stage includes
(i) seed capital/pre-start up.
(ii) start-up. and
(iii) second-round financing.
(i) Seed Capital: This stage is essentially an “applied research” phase where the concepts and ideas of the promoters constitute the basis of a pre-commercialization research project which may or may not lead to a business launch. The evaluation of the project by the VCIs has to ensure that the technology skills of the entrepreneur matches with market opportunities.
(ii) Start-up: This is the stage when commercial manufacturing has to commence. Venture Capital Financing here is provided for product development and initial marketing. The essence of this stage is that the product/service is being commercialized for the first time in association with the VCIS.
(iii) Second Round Financing: This represents the stage at which the product has already been launched in the market but the business has not, yet, become profitable enough for public offering to attract new investors. The VCI’s provide larger funds at this stage than at other early stage financing.
(b) LATER STAGE FINANCING: This stage of Venture capital financing involves establishment business, which require additional financial support but cannot take resource to public issues of capital. It includes development capital, bridge/expansion, buyouts and turnarounds.
(i) Development Capital: This financing of established which have overcome the extremely high-risk early stage, have recorded profits for a few years but are yet to reach a stage when they can go public and raise money from the capital market/conventional sources. The development finance stage has a time-frame of one to three years and falls in the medium risk category. It constitutes a significant part of the activities of many VCI’s.
(ii) Expansion/Bridge: This finance by VCI’s involves low risk perception and a time frame of one to three years. Venture Capital undertakings use such finance to expand business by way of growth of their own productive asset or by the acquisition of other firms/assets of other firms. In a way, it represents the last round of financing before a planned exit.
(iii) Buyouts: These refer to the transfer of management control. They fall into two categories:
(a)Management buy Outs (MBOS) and
(b) Management buy ins (MBIS).
(a) Management Buy Outs: In MBOS, VCIS provide funds to enable the current operating management/investors to acquire an existing product line/business. They represent an important part of the activity of VCIS.
(b) Management Buy Ins: MBIs are funds provided to enable an outside group [of manager(s)] to buy an ongoing company. They usually bring three elements together: a management team, a target company and an investor (VCI). MBIs are able to target only the weaker/under performing companies.
(iv) Turnarounds: These are a subset of buyouts and involve the buying the control of a sick company. Two kinds of inputs are required in a turnaround namely, money and management. The VCI’s have to identify good management and operations leadership. Such form of Venture Capital financing involves medicine to high risk and a time frame of three to five years. It is gaining widespread acceptance and increasingly becomes the focus of attention of VCIS.
39. Discuss the functions of venture capital.
Ans: The key functions of Venture Capital are:
(i) Venture Capital provide finance as well as skills to new enterprises and new ventures of existing ones based on high technology innovations. It provides seed capital funds to finance innovation even in the stage.
(ii) Venture capitalist’s fills the gap in the owner’s funds in relation to the quantum of equity required to support the successful launching of a new business or the optimum scale of operations of an existing business.
(iii) Venture capitalist’s duty extends even as far as to see that the firm has proper and adequate commercial banking and receivable financing.
(iv) Venture capitalist assists the entrepreneurs in locating, interviewing and employing outstanding corporate achievers to professionalise the firm.
(v) Venture Capital assistance provided by the financial institution in the form of project, loans, equity, conditional loan (quasi-equity), a comprehensive techno-managerial support and guidance service including technology information service.
40. What is the meaning of Factoring? What are its features?
Ans: Factoring is a financial service in which the business entity sells its bill receivables to a third party at a discount in order to raise funds. It differs from invoice discounting. The concept of invoice discounting involves, getting the invoice discounted at a certain rate to get the funds, whereas the concept of factoring is broader. Factoring involves the selling of all the accounts receivable to an outside agency. Such an agency is called a factor.
Salient features of factoring:
(i) Credit Cover: The factor takes over the risk burden of the client and thereby the client’s credit is covered through advances.
(ii) Case advances: The factor makes cash advances to the client within 24 hours of receiving the documents.
(iii) Sales ledgering: As many documents are exchanged, all details pertaining to the transaction are automatically computerized and stored.
(iv) Collection Service: The factor, buys the receivables from the client, they become the factor’s debts and the collection of cheques and other follow-up procedures are done by the factor in its own interest.
(v) Provide Valuable advice: The factors also provide valuable advice on country-wise and customer-wise risks. This is because the factor is in a position to know the companies of its country better than the exporter clients.
41. Explain the Functions of Factor.
Ans: A factor performs a number of functions for his client.
These functions are:
(i) Maintenance of Sales Ledger: A factor maintains sales ledger for his client firm. An invoice is sent by the client to the customer, a copy of which is marked to the factor. The client need not maintain individual sales ledgers for his customers.
(ii) Collection of Accounts Receivables: Under factoring arrangement, a factor undertakes the responsibility of collecting the receivables for his client. Thus, the client firm is relieved of the rigours of collecting debts and is thereby enabled to concentrate on improving the purchase, production, marketing and other managerial aspects of the business.
(iii) Credit Control and Credit Protection: Another useful service rendered by a factor is credit control and protection. As a factor maintains extensive information records (generally computerized) about the financial standing and credit rating of individual customers and their track record of payments, he is able to advise its client on whether to extend credit to a buyer or not and if it is to be extended the amount of the credit and the period there-for.
(iv) Advisory Functions: At times, factors render certain advisory services to their clients. Thus, as a credit specialist a factor undertakes comprehensive studies of economic conditions and trends and thus is in a position to advise its clients of impending developments in their respective industries.
42. Explain the types of Factoring.
Ans: The types of factoring are discussed below:
(i) Recourse Factoring: In Recourse factoring the credit risk remains with the client though the debt is assigned to the factor, i.e., the factor can have recourse to the client in the event of non-payment by the customer.
(ii) Non-Recourse Factoring: The Non-Recourse Factoring also called as ‘Old-line factoring’. It is an arrangement whereby he factor has no recourse to the client when the bill remains unpaid by the customer. Thus, the risk of bad debt is absorbed by the factor.
(iii) Advance Factoring: Where the payment is made by the factor immediately is called Advance Factoring Under this type of factoring, the factor provides financial accommodation apart from non-financial services rendered by him.
(iv) Confidential and Undisclosed Factoring: In confidential and undisclosed factoring the arrangement between the factor and the client are left un-notified to the customers and the client collects the bills from the customers without intimating them to the factoring arrangements.
(v) Maturity Factoring: In maturity factoring method, the factor may agree to pay an amount to the client for the bills purchased by him either immediately or on maturity. The later refers to a date agreed upon on which the factor pays the client.
(vi) Supplier Guarantee Factoring: Supplier Guarantee Factoring is also known as ‘drop shipment factoring’. This happens when the client is a mediator between supplier and customer. When the client is a distributor, the factor guarantees the supplier against the invoices raised by the supplier upon the client and the goods may be delivered to the customer. The client thereafter raises bills on the customer and assigns them to the factor. The factor thus enables the client to make a gross profit with no financial involvement at all.
(vii) Bank Participation Factoring: In bank participation factoring the bank takes a floating charge on the client’s equity i.e., the amount payable by the factor to the client in respect of his receivables. On this basis, the bank lends to the client and enables him to have double financing.
43. Briefly explain the Steps Involved in Factoring.
Or
Explain the mechanism of factoring.
Ans: Mechanics of Factoring shown in figure is explained below:
(a) Firstly, the customer places an order with the Client. (It may be noted that the client is the seller and customer is the buyer of goods).
(b) Then the client enters into Factoring arrangement with the Factor. The pre-payment limit, service charges, and discount charges and other terms and conditions of the arrangement are agreed upon. The Client has to obtain a “LETTER OF DIS-CLAIMER “from the bank holding charge on his receivable. This is required because in many cases the receivables may have been assigned to the bank for credit facility extended by it. After obtaining this letter, the Client executes the Factoring documentation.
(c) The client dispatches the goods or services to the customer on credit on open account basis and then sends the corresponding invoice to the customer directly. From then onwards, the client passes all credit sales invoices to the Factor. While the original invoice and document of title to goods like lorry receipt to the Customer, copies of these documents are handed over to Factor for Purchase.
(d) The original as well as copies of invoices sent to customer, contain a printed Notice of Assignment addressed to the customer, directing the customer to make all payments to the Factor.
(e) On receiving a copy of the invoice, the Factor purchases the invoice subject to the overall limit and the Customer limit. The Factor arrives at a sub-limit for each customer of the client within the overall limit.
(f) Periodical statements and MIS (Management Information System) reports are furnished to the Client and the Customer.
(g) If monthly installments are not paid within the due date, follow-up letters are sent.
(h) When the payment is cleared by the Customer to Factor, a notice is sent by the Factor to the Client.
(i) This is followed by the release of retention margin held by the Factor to the Client.
44. Briefly explain the Advantages and disadvantages of Factoring.
Ans: Following are advantages of factoring:
(i) It is help to improve the current ratio. Improvement in the current ratio is an indication of improved liquidity. Enables better working capital management. This will enable the unit to offer better credit terms to its customers and increase orders.
(ii) It is increase in the turnover of stocks. The turnover of stock into cash is speeded up and this results in larger turnover on the same investment.
(iii) It ensures prompt payment and reduction in debt.
(iv) It helps to reduce the risk. Present risk in bills financing like finance against accommodation bills can be reduced to minimum.
(v) It is help to avoid collection department. The client need not undertake any responsibility of collecting the dues from the buyers of the goods.
Limitations of Factoring:
(i) Factoring is a high risk area, and it may result in over dependence on factoring, mismanagement, over trading of even dishonesty on behalf of the clients.
(ii) It is uneconomical for small companies with less turnover.
(iii) The factoring is not suitable to the companies manufacturing and selling highly specialized items because the factor may not have sufficient expertise to asses the credit risk.
(iv) The developing countries such as India are not able to be well verse in factoring. The reason is lack of professionalism, non-acceptance of change and developed expertise.
45. Explain the Non-Fund Based/Fee Based Financial Services.
Ans: Non-Fund Based/Fee Based Financial Services are:
(a) Merchant banking: Merchant banking is basically a service banking, concerned with providing non-fund based services of arranging funds rather than providing them. The merchant banker merely acts as an intermediary. Its main job is to transfer capital from those who own it to those who need it. Today, merchant banker acts as an institution which understands the requirements of the promoters on the one hand and financial institutions, banks, stock exchange and money markets on the other. SEBI (Merchant Bankers) Rule, 1992 has defined a merchant banker as, “any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, advisor, or rendering corporate advisory services in relation to such issue management”.
(b) Credit rating: Credit rating means giving an expert opinion by a rating agency on the relative willingness and ability of the issuer of a debt instrument to meet the financial obligations in time and in full. It measures the relative risk of an issuer’s ability and willingness to repay both interest and principal over the period of the rated instrument. It is a judgement about a firm’s financial and business prospects. In short, credit rating means assessing the creditworthiness of a company by an independent organisation.
(c) Stock broking: Now stock broking has emerged as a professional advisory service. Stock broker is a member of a recognized stock exchange. He buys, sells, or deals in shares/securities. It is compulsory for each stock broker to get himself/herself registered with SEBI in order to act as a broker. As a member of a stock exchange, he will have to abide by its rules, regulations and bylaws.
(d) Custodial services: In simple words, the services provided by a custodian are known as custodial services (custodian services). Custodian is an institution or a person who is handed over securities by the security owners for safe custody. Custodian is a caretaker of a public property or securities. Custodians are intermediaries between companies and clients (i.e. security holders) and institutions (financial institutions and mutual funds). There is an arrangement and agreement between custodian and real owners of securities or properties to act as custodians of those who hand over it. The duty of a custodian is to keep the securities or documents under safe custody. The work of custodian is very risky and costly in nature. For rendering these services, he gets a remuneration called custodial charges.
Thus custodial service is the service of keeping the securities safe for and on behalf of somebody else for a remuneration called custodial charges.
(e) Loan syndication: Loan syndication is an arrangement where a group of banks participate to provide funds for a single loan. In a loan syndication, a group of banks comprising 10 to 30 banks participate to provide funds wherein one of the banks is the lead manager. This lead bank is decided by the corporate enterprises, depending on confidence in the lead manager.
A single bank cannot give a huge loan. Hence a number of banks join together and form a syndicate. This is known as loan syndication. Thus, loan syndication is very similar to consortium financing.
(f) Securitisation (of debt): Loans given to customers are assets for the bank. They are called loan assets. Unlike investment assets, loan assets are not tradable and transferable. Thus loan assets are not liquid. The problem is how to make the loan of a bank liquid. This problem can be solved by transforming the loans into marketable securities. Now loans become liquid. They get the characteristic of marketability. This is done through the process of securitization. Securitisation is a financial innovation.
It is conversion of existing or future cash flows into marketable securities that can be sold to investors. It is the process by which financial assets such as loan receivables, credit card balances, hire purchase debtors, lease receivables, trade debtors etc. are transformed into securities. Thus, any asset with predictable cash flows can be securitised.
46. What are the several different services a stockbroker provide?
Ans: There are several different services a stockbroker can provide:
(i) Stockbrokers give accurate advice on buying and selling stocks and other securities. Since they know the markets, they can advise a client on what stocks to buy and sell and when to buy or sell them. They thoroughly research securities before making such recommendations.
(ii) Stockbrokers buy and sell shares on behalf of their clients and handle the associated paperwork. They also act as a record keeper and keep records of all transactions, statements and so on.
(iii) Stockbrokers manage the client’s investment portfolio and provide regular updates to their clients about their portfolios.
(iv) They also answer investment questions that a client may have.
(v) Stockbrokers inform their client about any new investment opportunity in the stock market.
(vi) Stockbroker also helps a client to make changes in investment strategies depending on the market conditions.
47. Briefly write the functions of Stockbroker.
Ans: Functions of the Stockbroker:
(a) The selling stockbroker will use his best endeavours to sell the listed securities on the first trading day, following the receipt of instructions from his client.
(b) The selling stockbroker shall be responsible for ensuring that his client is the registered holder of the security. He must ascertain that there is enough available holdings to be sold, and that there is no charge registered against these holdings in the “Central Securities Depository”, or the “Register of Shares”. If it transpires that the holdings are not sufficient to meet the order, or that there is a charge against the holdings, the order will be rejected by BATS.
(c) The buying stockbroker shall use his best endeavours to buy the listed securities on the first trading day following the receipt of instructions from his clients.
(d) Both the selling and buying stockbrokers shall be responsible for supplying the Exchange with sufficient details of their clients, to enable the Exchange to produce the “Client Contract Notes” on behalf of the stock broking firms. This information must be supplied before the trade execution. In the event that sufficient details of the client are not available at the Exchange, the order will not be validated by BATS.
48. What are the types of stockbrokers?
Ans: The following are the various types of stockbrokers:
(a) Full-Service Stockbroker: A full-service stockbroker offers a variety of financial services to clients. Usually, clients are assigned individual licensed stockbrokers. The brokerage firms employ research departments providing analyst recommendations and access to initial public offerings (IPOs). Full-service stockbrokers also provide services like financial planning, business and personal home loans, banking services, and asset management. Clients can either contact their personal stockbroker for trading options or use mobile and online platforms.
(b) Discount Stockbroker: Discount stockbrokers provide financial products, access to mutual funds, banking products, and other services. A discount stockbroker offers many products and services that are similar to a full-service stockbroker, but with smaller commissions.
(c) Online Stockbroker: Also called a direct access stockbroker, an online stockbroker offers services to active day traders with the smallest commission – usually priced on a per-stock basis. Online stockbrokers offer direct access platforms with capabilities of routing and charting, and access to multiple exchanges, market makers, and electronic communication networks (ECN).
49. What do you mean by Credit Rating? What are the functions of a Credit Rating Agency? Also Highlight its Advantages and Disadvantages.
Ans: Credit Rating is the opinion of the rating agency on the relative ability and willingness of the issuer of a debt instrument to meet the debt service obligations as and when they arise. Symbols are simple and easily understood tool which help the investor to differentiate between debt instruments on the basis of their underlying credit quality. The credit Rating gives the investors an indication as to how safe is their money when put into the different instruments in relation to timely payment of interest an timely returns of capital.
Functions Of A Credit Rating Agency: A credit rating agency serves the following functions:
(i) Provides unbiased opinion: An independent credit rating agency is likely to provide an unbiased opinion as to relative capability of the company to service debt obligations because of the following reasons:
(a) It has no vested interest in an issue unlike brokers, financial intermediaries.
(b) Its own reputation is at stake.
(ii) Provides quality and dependable information: A credit rating agency is in a position to provide quality information a credit risk which is more authenticate and reliable because:
(a) It has highly trained and professional staff who has better ability to assess risk.
(b) It has access to a lot of information which may not be publically available.
(iii) Provide basis for investment: An investment rated by a credit rating enjoys higher confidence from investors. Investors can make an estimate of the risk and return associated with a particular rated issue while investing money in them.
(iv) Healthy discipline on corporate borrowers: Higher credit rating to any credit investment enhances corporate image an builds up goodwill and hence in induces a heathy discipline on corporates.
(v) Formation of Public Policy: Once the debt securities are rated professionally, it would be easier to formulate public policy guidelines as to the eligibility of securities to be included in different kinds of institutional portfolio.
Advantages of Credit Rating: Different benefits accrue from use of rated instruments to different class of investors or the company.
(a) Benefits to Investors:
(i) Safety of Investments: Credit rating gives an idea in advance to the investors about the degree of financial strength of the issuer company. Based on rating he decides about the investment. Highly rate issues given as assurance to the investors of safety of Investments and minimises his risk.
(ii) Recognition of risk and returns: Credit rating symbols indicate both the returns expected and the risk attached to a particular issue. It becomes easier for the investor to understand the worth of the issuer company just by looking at the symbol because the issue is backed by the financial strength of the company.
(iii) Advantages of continuous monitoring: Credit rating agencies not only assign rating symbols but also continuously monitor them. The rating agency downgrades or upgrades the rating symbols following the decline or improvement in the financial position respectively.
(a) Benefits to the Company:
(i) Reduced cost of public issues: A company with highly rated instruments has to make least effort’s in raising funds through public. It can reduce its expenditure on press and publicity. Rating facilities best pricing and timing of issues.
(ii) Rating facilitates growth: Rating motivates the promoters to undertake expansion of their operations or diversify their production activities thus leading to the growth of the company in future. Moreover highly rated companies find it easy to raise funds from public through new issues or through credit from banks ad financial institutions to finance their expansion activities.
(iii) Recognition to unknown companies: Credit rating provides recognition to relatively unknown companies going for public issues through wide investor base.
(c) Benefits to Intermediaries: Stock brokers have to make less efforts in persuading their clients to select an investment proposal of making investment in highly rated instruments Thus rating enables brokers and other financial intermediaries to save time, energy, cost and manpower in convincing their clients.
Disadvantages Of Credit Rating: Credit rating suffers from the following limitations:
(i) Non-disclosure of significant information: Firm being rated may not provide significant or material information, which is likely to affect the investor’s decision, as to investment, to the investigation team of the credit rating company. Thus any decision taken in the absence of such significant information may put investors at a loss.
(ii) Static study: Rating is a static study of present and past historic data of the company at one particular point of time. Number of factors including economic, political, environment and government policies have direct bearing on the working of a company. Any changes after the assignment of rating symbols may defeat the very purpose of risk indicativeness of rating.
(iii) Rating is no certificate of soundness: Rating grades by the rating agencies are only an opinion about the capability of the company to meet its interest obligation. They do not pinpoint towards quality of products or management or staff etc.
50. What are the steps involved in credit rating process? Explain.
Ans: The steps involved in credit rating process are explained below:
(i) Receipt of the Request: The credit rating process begins, with the receipt of a formal request for rating from a company desirous of having its issue obligations under proposed instrument rated by credit rating agencies. An agreement is entered into between the rating agency and the issuer company.
(ii) Assignment to Analytical Team: On receipt of the above request, the CRA assigns the job to an analytical team. The team usually comprises of two members/analysts who have expertise in the relevant business area and are responsible for carrying out the rating assignments.
(iii) Obtaining Information: The analytical team obtains the requisite information from the client company. Issuers are usually provided a list of information requirements and a broad framework for discussions. The requirements are derived from the experience of the issuers business and broadly confirm to all the aspects which have a bearing on the rating. The analytical team analyses the information relating to its financial statements, cash flow projections, and other relevant information.
(iv) Plant Visits and Meeting with Management: The obtain classification and a better understanding of the client’s operations, the team visits, and interests with the company’s executives.
Plants visits facilitate understanding of the production process, assess the state of equipment and main facilities, evaluate the quality of technical personnel and form an opinion on the key variables that influence level, quality, and cost of production.
Direct dialogue is maintained with the issuer company as this enables the CRA’s to incorporate non-public information in a rating decision and also enables the rating to be forward-looking.
(v) Presentation of Findings: After completing the analysis, the findings are discussed at length in the internal committee, comprising senior analysts of the credit rating agencies. All the issues having a bearing on the rating are identified. An opinion on the rating is also formed. The findings of the team are finally presented to the rating committee.
(vi) Rating Committee Meeting: This is the final authority for assigning ratings. The rating committee meeting is the only aspect of the process in which the issuer does not participate directly. The rating is arrived at after composite assessment of all the factors concerning the issuer, with the key issues fetting greater attention.
(vii) Communication of Decision: The assigned rating grade is communicated finally to the issuer along with reasons or rationale supporting the credit rating. The credit ratings which are not accepted are either rejected or reviewed in the light of additional facts provided by the issuer. The rejected credit ratings are not disclosed and complete confidentiality is maintained.
(viii) Dissemination of the Public: Once the issuer accepts the rating, the credit rating agencies disseminate it through printed reports to the public.
(ix) Monitoring for Possible Change: Once the company has decided to use the rating, CRAs are obliged to monitor the accepted ratings over the life of the instrument. The CRA constantly monitors all ratings with reference to new political, economic, and financial developments and industry trends. All this information is reviewed regularly to find companies for, major changes. Any changes in the rating are made public through published reports by CRAs.
51. What are the top factors that can impact your credit rating?
Ans: Below are some of the top factors that can impact your credit score:
(i) Credit Repayment History: It is the most important factor that impacts your credit score. It accounts for about 35% of your score and is used by lenders to evaluate your creditworthiness. If you have made any default in paying your credit card bills or loan EMIs, it will likely to be negatively impacting your score. And if you have paid all your outstanding dues on time, you will be rewarded with a better credit score.
(ii) Credit Utilization Limit: Credit Utilization Limit is the amount of your credit card balance compared to your credit limit. This factor accounts for 30% of your credit score. Typically, the lower your credit utilization ratio, the better it is. As it demonstrates that you can responsibly pay off your debts on time. Ideally, you should use 30% of the credit limit to maintain a good credit score.
(iii) Credit History Length: How long you have held credit accounts makes up 15% of your credit score. This includes the age of your oldest credit account, the age of your newest credit account and the average age of all your accounts. Generally, the longer your credit history, the higher your credit score.
(iv) Credit Mix: Another category that has an impact on your credit score is the different types of credit accounts you have open, including credit cards and loans. While calculating your credit score, credit bureaus consider the types of accounts and how many of each you have as an indication of how well you manage a wide range of credit products. Credit mix accounts for 10% of your credit score.
(v) New Credit: The number of credit accounts you’ve recently pened, as well as the number of hard inquiries lenders make when you apply for credit, accounts for 10% of your credit score. Opening too many accounts or creating inquiries indicates increased risk which can hurt your credit score.
(vi) Paying Only the Minimum Amount Due: A minimum amount due is a small portion of the principal amount that is outstanding every month. You will fall into a debt trap if you are in the habit of paying only the minimum amount due every month leads to the interest compounding on your outstanding balance. So, it is advised to pay your credit card bills in full and on time to avoid paying a late fee. It also reflects poor repayment behaviour.
52. What are the Major Problems or Disadvantages of Credit Rating?
Ans: The various problems of credit rating are as follows:
(a) The absence of accountability limits the process of credit rating. Lack of experienced and skilled staff may not do justice to their task and it may lead to inappropriate ratings.
(b) There is a huge scope of biased rating as there is no fixed mathematical formula for the calculation of rating.
(c) Rating does not guarantee any financial strength to the investors. It is changeable over the period of time.
(d) Ratings are based on the past and present performances of a company and it may get altered the future events of a company.
(e) Investors may get confused as different rating agencies provide different ratings for the same financial instrument of the same entity.
(f) The credit rating company charges a sizable fee from the companies to award ratings to their instruments. This may result in misleading or inflated ratings.
(g) The information for rating is always provided by the borrower or the issuer and this is subject to inaccuracy on the part of the company.
(h) The credit rating agencies have been facing a problem of absence of a widespread branch network which may lead to limited skills in rating.
53. What are the Credit Rating Agencies in India?
Ans: Credit ratings are evaluated by credit agencies. In India, credit rating agencies are regulated by the SEBI (Credit Rating Agencies) Regulations, 1999, part of the Securities and Exchange Board of India Act, 1992.
Some of the top credit rating agencies in India are:
(i) Credit Rating Information Services of India Limited (CRISIL): This was one of the first credit rating agencies in India, established in 1987. It rates companies, banks, and organizations using their strengths, market share, market reputation board, etc. The company also operates in the USA, UK, Hong Kong, Poland, Argentina and China and offers 8 types of credit ratings ranging from AAA – D. Investment Information and Credit Rating Agency of India (ICRA) Limited Established in 1991, ICRA offers comprehensive ratings to corporates for a variety of situations, such as bank loans, corporate debt, mutual funds, and more.
(ii) Credit Analysis and Research Limited (CARE): From April 1993, CARE has been offering a range of credit rating services. These include areas like debt, bank loans, corporate governance, recovery, financial sector and more. Their rating scale also includes two categories – long term debt instruments and short-term debt ratings.
(iii) India Rating and Research Private Limited: Known formerly as Fitch Ratings India Pvt. Ltd., this company offers credit ratings to evaluate the credibility of corporate issuers, financial institutions, project finance companies, managed funds, urban local bodies, etc.
(iv) Acute Ratings & Research: Formerly Small Medium Enterprises Rating Agency of India Limited or (SMERA Ratings Ltd.) this credit rating agency was established in 2011. It has two divisions – SME Ratings and Bond Ratings, and also offers 8 formats of credit rating ranging from AAA – D.
(v) Brickwork Ratings India Private Limited: This credit rating agency rates bank loans, municipal corporations, real estate investments, NGOs, capital market instruments, SMEs, etc.
54. What are the features of Merchant banking?
Ans: Features of Merchant Banking are:
(i) Merchant banking is a specialized form of banking that focuses on providing customized financial services and advice to corporations, governments, and high net-worth individuals.
(ii) Merchant bankers act as intermediaries between their clients and financial markets, helping clients to raise capital, manage risks, and invest wisely.
(iii) Merchant banking services include underwriting, syndication, mergers and acquisitions, portfolio management, corporate restructuring, and project financing.
(iv) Merchant bankers are skilled in analyzing financial data, assessing market trends, and identifying investment opportunities for their clients.
(v) Merchant banking requires a high level of expertise and experience in financial markets, as well as strong relationships with other financial institutions, regulators, and key stakeholders.
55. What are the benefits of Merchant banking?
Ans: Benefits of Merchant Banking are:
(i) Risk Management: Merchant banks can provide risk management services such as hedging, derivatives, and insurance solutions to protect clients from market fluctuations.
(ii) Expertise: Merchant banks have extensive knowledge of financial markets and industries, providing clients with strategic advice and guidance.
(iii) Networking: Merchant banks have vast networks of contacts, including investors, corporations, and financial institutions, which can help clients identify opportunities and connect with potential partners.
(iv) International Presence: Merchant banks often have a global presence, which can help clients expand their business internationally and access foreign markets.
(v) Customized Solutions: Merchant banks provide tailored solutions to meet the specific needs of clients, rather than offering off-the-shelf products and services.
(vi) Long-term Relationships: Merchant banks typically work closely with clients over the long term, building strong relationships and providing ongoing support and advice.
56. Explain the Functions of Merchant Banks In India.
Ans: Functions of Merchant Banks In India:
(i) Project Counselling: Merchant bankers assist their clients at every stage of the project-idea generation, report creation, budgeting, and financing. This is especially the case with new entrepreneurs.
(ii) Leasing Services: The banks extend leasing facilities-clients lease assets and equipment to generate rental income.
(iii) Issue Management: High net-worth individuals employ merchant banks to issue equity shares, preference shares, and debentures to the general public.
(iv) Underwriting: The banks also facilitate equity underwriting. They assess the price and risk involved in particular security and initiate public issue and distribution of stocks.
(v) Fund Raising: Through various facilities like underwriting and securities issuance, bankers help the private companies generate capital from international and domestic markets.
(vi) Portfolio Management: On behalf of clients, these bankers invest in different kinds of financial instruments.
(vii) Loan Syndication: They finance term loans to back projects that need funding.
(viii) Promotional Activities: Merchant banks are financial intermediaries that promote new enterprises.
57. What are the roles of merchant banking in India?
Ans: The role of the merchant banker as an issue manager can be studied from the following points:
(a) Easy fund raising: An issue manager acts as an indispensable pilot facilitating a public/ rights issue. This is made possible with the help of special skills possessed by him to execute the management of issues.
(b) Financial consultant: An issue manager essentially acts as a financial architect, by providing advice relating to capital structuring, capital gearing and financial planning for the company.
(c) Underwriting: An issue manager allows for underwriting the issues of securities made by corporate enterprises. This ensures due subscription of the issue.
(d) Due diligence: The issue manager has to comply with SEBI guidelines. The merchant banker will carry out activities with due diligence and furnish a Due Diligence Certificate to SEBI. The detailed diligence guidelines that are prescribed by the Association of Merchant Bankers of India (AMBI) have to be strictly observed. SEBI has also prescribed a code of conduct for merchant bankers.
(e) Co-ordination: The issue manger is required to co-ordinate with a large number of institutions and agencies while managing an issue in order to make it successful.
(f) Liaison with SEBI: The issue manager, as a part of merchant banking activities, should register with SEBI. While managing issues, constant interaction with the SEBI is required by way of filing of offer documents, etc. In addition, they should file a number of reports relating to the issues being managed.
58. Write a short note on Merchant Banking in India.
Ans: Prior to the enactment of Indian Companies Act, 1956, managing agents acted as merchant bankers. They acted as issue houses for securities, evaluated project reports, provided venture capital for new firms etc. Few share broking firms also functioned as merchant bankers. With the rapid growth in the number and size of the issues made in the primary market, the need for specialized merchant banking service was felt. Grindlays Bank (foreign bank) opened its merchant banking division in 1967, followed by Citibank in 1970. SBI started its merchant banking division in 1972 and it followed up by setting up a fully owned subsidiary in 1980, namely SBI Capital Markets Ltd. The other nationalized banks and financial institutions, like IDBI, IFCI, ICICI, Securities and Finance Company Ltd., Canara Bank (Can Bank Financial Services Ltd.), Bank of India (BOI Finance Ltd.) and private sector financial companies, like JM Financial and Investment Consultancy Services Ltd., DSP Financial Consultancy Ltd. have also set up their merchant banking divisions. With over 1,100 merchant bankers operating in the country, the primary market activity is picking up. Merchant banking services have assumed greater importance in the present capital market scenario. With the investor becoming more cautious and discerning, the role of merchant banker has gained more prominence. In India, apart from the overall control by the RBI, merchant bankers’ operations are closely supervised by the SEBI for their proper functioning and investor protection.
59. Write the Difference Between Commercial Bank and Merchant Bank.
Ans: The following are the important differences between merchant banks and commercial banks:
(a) Commercial banks basically deal in debt and debt related finance. Their activities are clustered around credit proposals, credit appraisal and loan sanctions. On the other hand, the area of activity of merchant bankers is equity and equity related finance. They deal with mainly funds raised through money market and capital market.
(b) Commercial banks’ lending decisions are based on detailed credit analysis of loan proposals and the value of security offered. They generally avoid risks. They are asset oriented. But merchant bankers are management oriented. They are willing to accept risks of business.
(c) The main business of the commercial bank is related to regular banking services, whereas merchant banks excel in providing consultancy and advisory services to the clients.
(d) Loan extended by the commercial bank is debt-related. Unlike equity related loans are granted by the merchant banks.
(e) Commercial banks are less prone to risk, while merchant banks are highly exposed to risk.
(f) The role of a commercial bank resembles a financier. On the contrary, the merchant banks act as a financial advisor.
