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FINANCIAL SERVICES
UNIT-I
UNIT I: Introduction Financial Services - Concept - Objectives - Functions -
Characteristics - Financial Services Market - Concept - Constituents - Growth of
Financial Services in India - Financial Services Sector Problems - Financial Services
Environment - The Forces - Players in Financial Markets

INTRODUCTION
The Indian financial services industry has undergone a metamorphosis since1990.
Before its emergence the commercial banks and other financial institutions dominated the field
and they met the financial needs of the Indian industry. It was only after the economic
liberalisation that the financial service sector gained some prominence

MEANING OF FINANCIAL SERVICES

Financial services refer to services provided by the finance industry. The finance
industry consists of a broad range of organisations that deal with the management of money.
These organisations include banks, credit card companies, insurance companies, consumer
finance companies, stock brokers, investment funds and some government sponsored
enterprises.
Financial services can also be called financial intermediation. Financial
intermediation is a process by which funds are mobilised from a large number of savers and
make them available to all those who are in need of it and particularly to corporate
customers.
OBJECTIVES (OR) FUNCTIONS OF FINANCIAL SERVICES
Following are the objectives of Financial Services that are generally offered by banking
financial companies:-
1. Fund Raising: Financial Services help to raise the required funds from a host of investors,
individuals, institutions and corporate. For this purpose, various instruments of finance are
used. The funds are demanded by corporate houses, individuals, etc.

2. Funds Deployment: An array of financial services are available in the financial markets
which help the players to ensure a profitable deployment of the funds raised. Financial Services
assist in the decision making regarding the financing mix. Services such as bill discounting,
factoring of debtors, parking of short-term funds in the money market, credit rating, e-
commerce, and securitization of debts are provided by banking financial services firms in order
to ensure efficient management of funds.

3. Specialized Services : The financial services sector provides specialized services such as
credit rating, venture capital financing, lease financing, factoring, mutual funds, merchant
banking, stock lending, depository, credit cards, housing finance, book building, etc.

4. Regulation: There are agencies that are involved in the regulation of the financial services
activities. In India, agencies such as the Securities and Exchange Board of India (SEBI),
Reserve Bank of India (RBI) and the Department of Banking and Insurance, Government of
India, through a plethora of legislative measures, regulate the functioning of the financial
service institutions. The objective is to ensure an orderly functioning of the financial markets.

5. Economic Growth: Financial services contribute, in good measure, to speeding up the

process of economic growth and development. This takes place through the mobilization of the
savings of a cross section of people, for the purpose of channelling them into productive
investments
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CHARACTERISTICS OF FINANCIAL SERVICES:

1. Intangibility: The basic characteristics of financial services are that they are intangible in
nature. For financial services to be successfully created and marketed, the institutions providing
them must have a good image and enjoy the confidence of their clients.
2. Customer Orientation: The institutions providing financial services study the needs of the
4customers in detail. Based on the results of the study, they come out with innovative financial
strategies that give due regard to costs, liquidity, and maturity considerations for various
financial products and services. This way, financial services are customer oriented.
3. Inseparability: The functions of production and supply of financial services have to be
carried out simultaneously. This cause for a project understanding between the financial
services firms and their clients.
4. Perishability: Financial Services have to be created and delivered to the target clients
instantaneously. They cannot be started. They have to be supplied according to the
requirements of customers. Hence it is imperative that the providers of financial services ensure
a match between demand and supply.
5. 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.

IMPORTANCE OF FINANCIAL SERVICES:

It is the presence of financial services that enables a country to improve its economic
condition whereby there is more production in all the sectors leading to economic growth. The
benefit of economic growth is reflected on the people in the form of economic prosperity where
in the individual enjoys higher standard of living.
1. Promoting Investment: The presence of financial services creates more demand for
products and the producer, in order to meet the demand from the consumer goes for more
investment. At this stage, the Financial Services come to the rescue of the investor such as
merchant banker through the new issue market, enabling the producer to raise capital. The stock
market helps in mobilising more funds by the investor. Investments from abroad is attracted.
2. Promoting Savings: Financial Services such as mutual funds provide ample opportunity for
different types of saving. In fact, different types of investment options are made available for
the convenience of pensioners as well as aged people so that they can be assured of a reasonable
return without much risks for people interested in the growth of their savings, various
reinvestment opportunities are provided.
3. Minimising the risks: The risk of both financial services as well as producers are minimized
by the presence of insurance companies. Various types of risks are covered which not only
offer protection from the fluctuating business conditions but also from risks caused by natural
calamities. Insurance is not only a source of finance but also a source of a savings, besides
minimizing the risks.
4. Maximising the returns: The presence of financial services enables businessmen to
maximize their returns. This is possible due to the availability of credit at a reasonable rate.
Producers can avail various types of credit facilities for acquiring assets. In certain cases, they
can even go for leasing of certain assets of very high value. Factoring companies enable the
sources as well as producer to increase their turn over which also increases the profit.
5. Ensures greater yield: As seen already, there is a subtle difference between return and
yield. It is the yield which attracts more producers to enter the market and increase their
production to meet the demands of the consumer. The financial services enable the producer to
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not only earn more profits but also maximize their wealth. Financial Services enhance their
goodwill and induce them to go in for diversification. The stock market and the different types
of derivative market provide ample opportunities to get a higher yield for the investor.
6. Economic growth: The development of all the sectors is essential for the development of
the economy. The financial services ensure equal distribution of funds to all the three sectors
namely, primary, secondary and tertiary so that activities are spread over in a balanced manner
in all the three sectors.
7. Economic development: Financial Services enable the consumers to obtain different types
of products and services by which they can improve their standard of living. Purchase of car,
house and other essential as well as luxurious items are made possible through hire purchase,
leasing and housing finance companies.
8. Benefit to Government: The presence of financial services enables the government to raise
both short-term and long-term funds to meet both revenue and capital expenditure through the
money market, government raises short-term funds by the issue of Treasury Bills. There are
purchased by commercial banks from out of their depositor’s money. In addition to this, the
government is able to raise long-term funds by the sale of government securities in the
securities market which forms a part of financial market. Even foreign exchange requirements
of the government can be met in the foreign exchange market.
9. Expands activities of financial institutions: The presence of financial services enables
financial institutions to not only raise finance but also get an opportunity to disburse their funds
in the most profitable manner. Mutual funds, factoring, credit cards, hire purchase finance are
some of the services which get financed by financial institutions.
10. Capital Market: One of the barometers of any economy is the presence of a vibrant capital
market. If there is hectic activity in the capital market, then it is an indication of the presence
of a positive economic condition. The financial services ensure that all the companies are able
to acquire adequate funds to boost production and to reap more profits eventually.
11. Promotion of Domestic and Foreign Trade: Financial Services ensure promotion of
domestic as well as foreign trade. The presence of factoring and forfeiting companies ensures
increasing sale of goods in the domestic market and export of goods in the foreign market.
Banking and insurance services further contribute to step up such promotional activities.
12. Balanced Regional Development: The government monitors the growth of economy and
regions that remain backward economically are given fiscal and monetary benefits through tax
and cheaper credit by which more investment is promoted. This generates more production,
employment, income, demand and ultimately increase in prices.
TYPES / KINDS /CLASSIFICATIONS OF FINANCIAL SERVICES
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
1. 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.
2. 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 instalments. 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.
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3. 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.
4. 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.
5. 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, Ind
Bank Housing etc
6. 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.
7. 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.
8. 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
9. 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

1. Merchant banking: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”.
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2. 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.
3. 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.
4. 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.
5. 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.
6. Securitisation (of debt): Securitisation is defined as a process of transformation of illiquid
asset into security which may be traded later in the opening market. In short, securitization is
the transformation of illiquid, non- marketable assets into securities which are liquid and
marketable assets. It is a process of transformation of assets of a lending institution into
negotiable instruments.
CHALLENGES FACED BY THE FINANCIAL SERVICE SECTOR.
Financial service sector has to face lot of challenges in its way to fulfil the ever growing
financial demand of the economy. Some of the important challenges are listed below:
1. Lack of qualified personnel in the financial service sector.
2. Lack of investor awareness about the various financial services.
3. Lack of transparency in the disclosure requirements and accounting practices relating to
financial services.
4. Lack of specialisation in different financial services (specialisation only in one or two
services).
5. Lack of adequate data to take financial service related decisions.
6. Lack of efficient risk management system in the financial service sector.
The above challenges are likely to increase in number with the growing requirements of the
customers. However, the financial system in India at present is in a process of rapid
transformation, particularly after the introduction of new economic reforms.
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FINANCIAL SERVICES MARKET -CONCEPT

The market for the exchange of financial services products and instruments through a
wide variety of players, each one offerings a unique type of service, may be designated as the
‘financial services market’.

FINANCIAL SERVICES MARKET -CONSTITUENTS

The Financial Services Market comprises of four major constituents as stated
below:
1. Market Players: Financial Services are offered by a host of institutions and agencies that
understand and meet the requirements of a wide spectrum of customers. The players include
banks, financial institutions, mutual funds, merchant bankers, stock brokers, consultants,
underwriters, market makers, corporate bodies, FIIS, custodians, venture capital funds etc.
2. Instruments: Financial Instruments constitute an important part of the financial services
market. The instruments include equity instruments, debt instruments, hybrid and exotic
instruments. It is characteristic of a financial services market that a number of innovative
instruments, such as zero-coupons bonds, etc. are floated on a continuous basis. The purpose
is to keep the financial markets vibrant.
3. Specialized Institutions: A financial services market is characterized by the dynamic
presence of specialized institutions. These include acceptance house, discount houses, factors,
depositories, credit rating agencies, venture capital institutions, etc
4. Regulatory Bodies: The financial service market is regulated by a host of institutions and
agencies. The regulatory bodies include the department of banking and insurance of the Central
Government, Reserve Bank of India, Securities and the exchange board of India, board of
industrial and financial reconstruction, etc.

GROWTH OF FINANCIAL SERVICES IN INDIA

The growth of financial services in India has taken place under the various stages. It is
outlined below:
1. Merchant Banking Era: The period between 1960 and 1980 may be called the ‘Merchant
Banking Era’. During this period, financial queries such as merchant banking, insurance and
leasing services began to grow. During this period, merchant bankers carried out the following
functions.
(i) Identifying projects, preparing feasibility reports, and developing detailed project
reports.
(ii) Conducting marketing, managerial, financial and technical analysis on behalf of
their clients.
(iii) Assist in designing an appropriate capital structure.
(iv) Acting as a bridge between the capital market and fund-seeking institutions.
(v) Carrying out underwriting functions
2. Investment Companies Era: This era marked the setting up of a variety of investment
institutions and banks. The investment companies include the Unit Trust of India, which is the
largest public sector mutual fund in the world, the life insurance corporation of India that
initiated the life insurance business and the general insurance corporations.

3. Modern Services Era: This stage marked the launch of a variety financial products and
services during the eighties. These financial services included over-the-counter services. Share
transfers, pledging of shares, mutual funds, factoring, discounting, venture capital & credit
rating.
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4. Depository Era: In order to integrate the Indian financial sector with the global financial
services industry, depositories were setup. The depository system was introduced with a view
to promoting the concept of paperless trading through the dematerialization of shares and
bonds. The introduction and popularization of book-building was also another step forward in
the direction of building a strong financial services sector in India. Similarly the ‘On-line
Trading’ interface introduced by the Bombay Stock Exchange, the Delhi Stock Exchange and
the computerization of the National Stock Exchange, are all acting as the fulcrum for the
development of a strong financial services market in India.
5. Legislative Era: Several legislations were introduced in order to allow for broad based
development in the financial services sector. The FERA has been replaced by FEMA. Far-
reaching amendments were made in the Indian Companies Act, Income Tax Act, etc. to
facilitate safe and orderly trading, and settlement of transactions.
6. Foreign Institutional Investors (FIIS): This era marks the latest stage in the growth of the
Indian financial markets. The economic reform measures initiated by the Government
necessitated greater free play for various participants. As part of it, divestment guidelines have
been issued by the SEBI in recent times, where by FIIs are permitted to operate in the Indian
capital market.
FINANCIAL SERVICES SECTOR – PROBLEMS
A brief description of some of these problems is presented below:
1. Lack of expertise: To be able to understand and implement many of the financial services
schemes, experts are required. Despite the presence of a number of institutions and professional
bodies, there has been noticed a dearth of personnel with expert knowledge to manage the firms
engaged in financial services sector in India. The public sector financial services industry, for
instance, is constrained by restrictions imposed on salaries, etc., and the private sector firms
too cannot match the offers made by the foreign financial firms.
2. Inadequate accommodation. Financial services firms require accommodation at central
locations in order to be able to effectively cater to the needs of a wide variety of clients. Finding
a suitable place in the financial capital of India. Mumbai, has become a serious problem due to
skyrocketing real estate prices.
3. Inadequate technology: One of the basic problems faced by the Indian financial services
firms is that they lack adequate and time-tested technology to efficiently create and deliver the
financial products to the clients. For instance. Relative tardy growth of computer and
telecommunication technology has constrained the growth of the financial services industry in
India considerably in the initial period.
4. Inadequate quality service: Rendering financial service efficiently is the cornerstone of a
successful financial services market. In fact, the key to survival is to deliver quality services
and products at the right price, at the right place and at the right time. This calls for the
application of appropriate technology to process a large flow of information to their clients.
Indian financial services firms need to improve the quality of their services to the satisfaction
of their clients. Very often, there is complaint of high fees and poor quality service. The work
of credit rating agencies also comes under attack, as the grading furnished by them is often
unreliable.
5. Captive organizations: The practice in India is that most financial service institutions have
been set up as subsidiary organizations of large commercial banks and financial institutions.
The subsidiary institutions, thus, depend on their parent institutions for funds. This obligates
the parent firms to lend at rates of interest lower than that of the market rates, despite situations
where the parent institutions are hard-pressed to raise funds at a higher cost
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6. Restricted scope of operations: The scope of operations relating to financial services is

currently restricted to certain segments. For instance, the scope of venture capital operations in
India is restricted to providing finance for start-up, high-tech projects and to converting R&D
efforts into commercial production. Venture capital funds in India are shy of entering the
services sector.
7. Limited innovation: The growth and development of the financial system is measured in
terms of the width and depth of the range of products offered by it. There has been limited
innovation in the realm of financial services products. It is imperative therefore that the
financial services sector works to achieve growth and development, by innovating and
introducing a wide range of financial products tailor-made to suit the needs of varying
entrepreneurs

8. Lack of sound institutional mechanism: An immediate requirement for a healthy financial

services sector is the existence of a sound institutional mechanism. This is important for a broad
based and a strong financial system. Moreover, there must be a wide range of financial services,
available too. The establishment of a sound institutional mechanism, whereby the existing
financial institutions, banks and insurance companies are allowed to open full-fledged
subsidiaries, is therefore, called for.

FINANCIAL SERVICES ENVIRONMENT – THE FORCES

Financial Services Environmental (FSE) connotes forces that drive the contemporary
evolution in the structure of financial services and markets of a national economy. These
forces includes policies of money, growth, and financial markets etc., formulated by the
Government.
A brief description of the various forces that influence the dynamics of a financial
services market is presented below:
1. Employment and Unemployment
Full employment ensures better utilization of resources of a nation. It also enhances the
country's Gross National Product (GNP). Unemployment refers to involuntary idleness of
resources including manpower. Persistence of this problem leads to a situation where the actual
output GNP is less than the country's potential output.
2. Inflation and Deflation
Inflation represents a situation of constantly rising prices of commodities and factors of
production. Inflation, is the persistent upward movement in the general price level which results
in a decline in the purchasing power of the monetary unit. Inflation affects different segments
of people in different ways. Inflation brings about a change in the pattern of income
distribution. The situation of falling prices is called deflation. Both inflation and deflation are
fraught with consequences, good and bad. It therefore becomes the task of the Government to
mitigate the ill-effects of inflation and deflation.
3. Trade cycles
Trade cycles are periodic fluctuations in the levels of economic or business activity
which is reflected in the variation in GNP. The fluctuations occur on production and
employment fronts over time. Periods of good trade alternate with periods of bad trade. In other
words, boom periods of high output and high employment alternate with slump periods of low
employment rate. In periods of recession, unemployment is high and the rate of inflation is
moderate. The causes of business cycles are to be studied so as to undertake remedial measures.
4. Stagflation
Stagflation represents the coexistence of inflation and unemployment in a stagnant
economy. Most modern economies suffer from this malady.
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5. Economic Growth
The trend in the nation's total output over a certain period is known as economic growth.
It refers to an expansion of society's production capacity such as bringing new land under
cultivation or setting up new factories etc. Growth is measured by the annual rate of increase
in per capita income. There are three major sources of growth viz., labor force, capital
formation, and technological progress. A country seeks to achieve economic growth mainly for
improving the living standards of its people.

6. Exchange Rate and Balance Of Payments

The balance of payments is a systematic record of all economic transactions of a
country with the rest of the world in an accounting year. These transactions are largely
influenced by the exchange rate. The rate at which the currency of a country is exchanged for
the currency of another country is called rate of exchange.

7. Deregulatory measures
The need for joining the drive towards deregulation of domestic financial markets and
their eventual integration with the world financial markets also acts as a force for innovations
in the financial services market. The worldwide reduction of structural rigidities and other
barriers to competition stimulate a greater competitiveness between the national and financial
positions and assure an equality of competitive conditions between all financial intermediaries.
This helps decreased costs of intermediation thus making markets more efficient.

8. Technological changes
The worldwide revolution happening in the realm of information technology is another
fundamental force underlying change and innovation in financial markets. This revolution has
come about through the development of increasingly more sophisticated computers and their
widespread application for efficient hand ling of information. This has strongly influenced the
progress towards greater perfection in goods and financial markets alike and has led to much
higher trading activity.

9. Enhanced Competition
Growing competition in international financial markets is another factor which has
increased the pressure for innovation and structural change. Competition results from
technology changes and from shift in savings and investment patterns. The increased
competition happens between different national financial systems, and between banks and non-
bank financial institutions within a national financial system.

10. Global Portfolio Preferences

The shifting global portfolio preferences have a strong impact on the nature of
developments to take place in the realm of financial markets around the globe. For instance,
the 'second oil shock' shifted wealth from the oil-consuming back to Europe, Japan, and a few
small Asian countries.

PLAYERS IN FINANCIAL MARKETS

1. Households
Households are the people that include wage earners, individuals, housewives, and
others. The demand for funds arises for meeting the needs of investment in housing, education,
and consumer durables. The supply of funds arises as a result of savings, savings for a retired
life, savings for meeting precautionary motive, etc. The demand for and the supply of funds
from these players are largely influenced by demographic factors such as age, sex, income
level, marital status, personal taxes, etc.
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2. Business Firms
The demand for funds arises owing to their engagement in two types of investments,
viz., working capital and fixed capital investments. Firms meet their funding requirements
either though borrowings or though their own accumulated savings. The demand for and the
supply of funds depends upon such factors as the state of the economy, whether the economy
is in the state of boom, or recession, technological progress, taxes, etc.
3. Financial Firms
These are the institutions and agencies involved in the provision of financial services.
Financial firms include brokers, merchant bankers, underwriters, custodians, banks, financial
institution, investment bankers, etc.

4. Governments
Governments such as central, state, and local bodies take part in financial markets, both
as borrowers and as lenders of funds. Their primary role is confined to borrowing of funds. In
fact, one of the methods of Government financing is popularly called 'deficit financing'. Deficit
financing requires borrowing to bridge the deficit. Where surplus is yielded on account of
excess of revenue over the expenditure, Government becomes a lender. Hence, factors such
atax revenues and expenditures predominantly determine the demand for and the supply of
funds.

5. External Agencies
Apart from the domestic agencies such as households, Governments, and firms,
external agencies such as foreigners also cause demand and supply of funds. This is called
'international borrowing and lending'. Factors such as information, transaction costs, determine
the demand for and the supply of loanable funds. Foreign exchange market is concerned with
borrowing and lending of foreign currencies.

DISCUSS THE VARIOUS MACROECONOMIC AGGREGATES THAT AFFECT

THE FINANCIAL SECTOR POLICY INITIATIVES IN INDIA
1. Real Sector Policies: Real Sector Policies are guided by the objective of boosting domestic
investment demand by expanding the participation of private enterprise and by promoting
foreign investment.

2. Fiscal Policies: Fiscal Policies renew commitment to consolidation and rectitude alongsidea
six-pronged strategy to reinvigorate the economy and return to a growth path consistent with
its potential. Monetary policy aims at ensuring adequate liquidity to meet credit demand and
pursues the objective of softening of interest rates consistent with a vigil on price stability.

3. Agriculture Policy: Agriculture policy aims at initiating measures for the development of
the agriculture sector. A number of steps have been undertaken in this regard for instance
measures have been taken to reduce food grain stocks that are posing problems of storage and
disposal.

4. Policy on Manufacturing Infrastructure and Services: Policy initiatives are continued to

be taken under the gamut of ‘economic liberalization’ to support and promote manufacturing,
infrastructure and services sector. The plan outlay on power, roads and national highways and
railways in enhanced substantially to step up public investment in infrastructure.

5. Trade Policies: The Medium-Term Export Strategy (MTES) sets out a road map for the
export sector, which is coterminous with the tenth five-year plan period. The MTES aims at
increasing India’s share in world trade.
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6. Export and Import (EXIM) Policy: The five year Exim policy for the period 2002-2007
includes, inter alia, removal of all QRs on exports (except a new sensitive items reserved for
exports through state trading enterprises), a farm-to-port approach for exports of agricultural
products, special focus on cottage sector and handicrafts and Assistance to States for
Infrastructural Development for Exports (ASIDE).
7. Policies for external capital flows:
a. Foreign direct investment.
b. Portfolio investment
c. Non-resident deposits
d. Indian direct and portfolio investment overseas
e. External commercial borrowings and EEFC accounts.

INTEREST RATE DETERMINATION

MEANING
The rate of exchange between present and future resources is called ‘market interest
rate’. An interest rate refers to the price of a loan. Interest rate represents terms at which
short-term funds are loaned and borrowed.

FEATURES
1. Shifting Resources: Interest rate helps those who wish to shift present resource to future by
lending.
2. Future Expectation: The exchange of resources takes place through the mechanism of market
rate of interest. It tells participants as to how much money is to be expected in future for the
money lent now.
3. Rate Determination: The relative demand for and supply of funds determine the market rate
of interest.The market rate of interest is always positive because lenders have the alternative
of keeping the funds idle and therefore there is no question of getting anything lessin future
than what they give up now.
4. Different Rates: There are many market rates depending on the length of time and the extent
of risk of funds. The rate as applicable to a risky company will be higher than thatpaid by the
government because lenders are risk-average and require greater compensation in future
resources from risky borrowers.

DETERMINING THE RATE OF INTEREST

The rate of interest for funds is determined by the demand for and the supplyof funds
1. Demand for funds: Demand for funds is indicated by the “demand curve”. The
function of a demand curve is to show different rates of interest which borrowers would
be willing to borrow. Demand curve always slopes downwards. This is because, high
interest rate would result is less borrowing and vice versa. Further, higher rate of
interest funds the necessity for a promise of higher amount in future for a given amount
at present. This makes borrowings less attractive moreover, demand curverepresents the
behavior of borrowers.
2. Supply of funds: Supply of funds is indicated by the ‘Supply Curve’. The function of
a supply curve is to show the different rates of interest at which lender would be willing
to lend. Supply curve always slopes upwards. This is because; high interestrate would
result in more lending by lenders and vice versa. Supply curverepresents the behavior
of lenders.
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 12

FINANCIAL SERVICES
UNIT-II
UNIT II: Merchant Banking and Public Issue Management Definition - Functions -
Merchant Bankers Code of Conduct - Public Issue Management - Concept - Functions -
Categories of Securities Issue - Mechanics of Public Issue Management - Issue Manager
- Role of issue Manager - Marketing of Issue - New Issues Market Vs. Secondary Market.
MEANING
Merchant banks are institutions that provide loans and capital for business enterprises.
They may also provide consulting services, or help their clients structure large international
transactions. Merchant banks provide different services from both retail and investment banks.

DEFINITION
According to Charles’s.Kindleberges, “Merchant banking is the development of
banking from commerce which frequently encountered a prolonged intermediate stage known
in England originally as merchant banking.”

FUNCTIONS OF MERCHANT BANKING

1. CORPORATE COUNSELING:- Corporate Counselling refers to a set of activities under
taken to ensure efficient running of a corporate enterprise at its maximum potential through
effective management of finance. It aims at rejuvenating old-line companies and ailing units,
and guiding the existing units in locating areas/ activities of growth and diversification.
 Providing guidance in areas of diversification based on the government’s economic
and licensing policies.
 Arranging for the approval of the financial institutions banks for the schemes of
rehabilitation in involving financial relief, etc.
 Providing assistance in getting soft loans from financial institutions for capital
expenditure, and the requisite credit facilities from the bank.
2. PROJECT COUNSELLING
 Project counselling is a part of corporate counselling, and relates to project financing.
It broadly covers the study of the project.
 It offers advisory assistance on the viability and procedural steps for its implementation.
undertaking the general review of the project ideas projects profile.
 Providing advice on procedural aspects of project implementation.
 Conducting review of technical feasibility of the project on the basis of the report
prepared by own experts or by outside consultants.
 Arranging and negotiating foreign collaborations, amalgamations mergers, and take
over’s.
 Advising and assisting clients in preparing applications for financial assistance to
various national financial institutions, state level institutions, banks,etc.
3. PRE-INVESTMENT STUDIES
 Activities that are connected with making a detailed feasibility exploration to evaluate
alternative avenues of capital investment in terms of growth and profit prospectus are
called ‘Pre-investment Studies’.
 Carrying out an in-depth investigation of environment and regulatory factory, location
of raw material suppliers demands projections, and financial requirements in order to
assess the financial and economic viability of a project.
 Conducting each studies as many be required for foreign companies wishing to
participate in joint ventures in India.
 13

4.CAPITAL RESTRUCTURING SERVICES:- Activities that are carried out to assist

projects in achieving their maximum potential through effective capital structuring and to
suggest various strategies to widen and restructure the capital base, diversify operations and
implement schemes for amalgamations, merger or change in business states are collectively
known as “Capital Restructuring Services”
 Examining the capital structure of the client company to determine the extent of
capitalization required
 Preparing a memorandum covering valuation of shares and justifying the level of
premium applied for.
 Capital restructuring may cover mergers, take over’s and amalgamations, involving
modernization or diversification of the existing production systems and the units.
5.CREDIT SYNDICATION:- Activities connected with joint credit procurement and project
financing, aimed at raising Indian and foreign currency loans from banks and financial
institutions, are collectively known as ‘credit syndication’ Estimating the total cost of the
project to be undertaken.
6. ISSUE MANAGEMENT AND UNDERWRITING: - Issue management and
underwriting are the activities connected the management of the public issues of corporate
securities, viz, equity shares, preference shares, and debentures or bonds, and are aimed at
mobilization of money from the capital market.
 Preparation of an action plan
 Preparation of budget for the total expenses for the issue
 Drafting of prospectus
 Selection of issue houses and advertising agencies for undertaking pre and post- issue
publicity.
 Co-ordination with the underwriters, brokers and bankers the issue and the stock
exchange.
7. PORTFOLIO MANAGEMENT:
 Undertaking investment in securities
 Undertaking review of provident fund investment, trust investment, etc.
 Providing advice on selection of investment
 It involves making the right choice of investment, aimed at obtaining an optimum
investment mix, taking into account factors such as the objectives of the investment,
tax bracket of the investor, need for maximizing yield and capital appreciation, etc.
8. WORKING CAPITAL FINANCES: - The finance required for meeting the day -to -day

capital requirements
 Preparing the necessary application to negotiations for the sanction of appropriate credit
facilities. Advising on the issue of debentures for argument long –term requirements of
working capital.
9. ACCEPTANCE CREDIT AND BILL DISCOUNTING:- Activities relating to the
acceptance and the discounting of bills of exchange, besides the advancement of loans to
business concerns on the strength of such instruments, are collectively known as” Acceptance
Credit and Bill Discounting. It is the integral part of a developed money market.
10.MERGER AND ACQUISITION:- This is a specialized services provided by the merchant
banker who arranges for negotiating acquisitions and mergers by offering expert valuation regarding
the quantum and the nature of consideration, and other related matters.
 Examining the pros and cons of proposals and formulating schemes for financial
reconstruction, merger, and acquisition.
 14

 Obtaining approvals from shareholders, depositors, creditors, government and other

authorities.
 Monitoring the implementation of merger and amalgamation schemes.
 Identifying organizations with matching characteristics
11.VENTURE FINANCING:- A specially designed capital, as a form of equity financing for
funding high risk and high rewards projects, is known as ‘Venture capital’.
 In India, venture capital companies have largely contributed to the technological and
industrial revolution. A large number of Indian and international companies are
engaged in venture capital funding for high-risk projects.
 A number of leading national developments financial institutions such as IFCI, IDBI
and ICICI are engaged in venture capital financing, and have developed a number of
special schemes for this purpose.
12. LEASE FINANCING: - A merchant banking activity whereby financial facilities are
provided to companies that undertake leasing, is known as ‘Lease financing’. Leasing involves
letting out assets on lease for a particular times period for use by the lessee.
 Providing advice on the viability of leasing as an alternative source for financing capital
investment projects.
 Providing advice on the choice of a favourable rental structure.
 Providing assistance in establishing lines of lease for acquiring capital equipment,
including preparation of proposals, documentations etc.
13. FOREIGN CURRENCY FINANCING: - The finance provided to fund foreign trade
transactions is called ‘Foreign Currency Finance’. The provision of foreign currency finance
takes the form of export import trade finance, Euro currency loans, Indian joint ventures
abroad, and foreign collaborations.
 Providing assistance in opening and operating bank accounts abroad.
 Arranging foreign currency loans under buyer’s credit scheme for importing goods.
14. BROKERING FIXED DEPOSITS
 Computation of the amount that could be raised by a company in the form of deposits
from the public and loans from shareholders.
 Drafting of advertisement for inviting deposits.
 Filling a copy of advertisement with the resistor of company for registration
 Arranging for the issue of advertisement in newspapers, as required by the company
act.
 Drafting and printing of application forms.

Submission of periodical statements to companies concerned.
 Making arrangements for payment of interest amounts
 Helping the company to observe all the rules and regulation in this connection.
 Assisting in maintenance of records and registers for the purpose.
15.MUTUAL FUND:- Institutions and agencies that are engaged in the mobilization of the
savings of innumerable small investors for the purpose of channelling them into productive
investment of a wide variety of corporate and other securities, are called ‘mutual funds’. Some
of the services rendered by mutual funds are as follows:-
 Mopping up public savings, investing the funds in a diversified portfolio of shares and
debentures belonging to well- managed and growing companies.
 Making investment in any commercial paper floated by the central government, RBI,
any local authority, any foreign Government, foreign bank or any other authority
outside India and approved by RBI.
 15

16. RELIEF TO SICK INDUSTRIES

 Rejuvenating old- lives and ailing units by appraising their technology and process,
assessing their requirements, and restructuring their capital base.
 Evolving rehabilitation packages which are acceptable to financial institutions and
banks.
 Monitoring the implementation of rehabilitation schemed, mergers and or
amalgamations.
17. PROJECT APPRAISAL
 The evaluation of industrial projects in terms of alternative variants in technology, raw
materials, production capacity, and location of plant is known as ‘Project Appraisal’.
 The various components of project appraisal are financial appraisal, technical appraisal
and economic appraisal.

MERCHANT BANKERS' CODE OF CONDUCT

Merchant Bankers have to abide by the following Code of Conduct as prescribed by the SEBI:
1. Integrity Observance of high standards of integrity and fairness in all dealings with clients
and other merchant bankers.
2. Quality service Rendering high standards of service, exercising due diligence, ensuring
proper care and exercising independent professional judgment, disclosing to the clients,
wherever necessary, possible sources of conflict of duties and interests, while providing
unbiased services.
3. Fair practice: Refraining from making any statement or becoming privy to any act, practice
or unfair competition, which is likely to be harmful to the interests of other merchant bankers,
or is likely to place other merchant bankers in a disadvantageous position in relation to the
merchant banker, while competing for or executing any assignment.
4. Responsible statement: Not to indulge in making any exaggerated statement, oral or
written, to the client, either about the qualification or the capability to render certain services,
or achievements in regard to services rendered to other clients.
5. Best advice: Endeavouring to render the best possible advice to the clients keeping in mind
the client's needs, and the merchant banker's own professional skill in order to ensure that all
professional dealings are effected in a prompt, efficient, and cost effective manner.
6. Secrecy: Not to divulge to other clients, press or any other party, any confidential
information about the client and deal in the securities of any client without disclosing to the
Board, as required under the regulations.
7. Information: Making constant efforts to ensure that the investors are provided with true and
adequate information, without making any misguided or exaggerated claims, in order to make
them aware of the attendant risks before they undertake any investment decision.
8. Prospectus: Making available copies of the prospectus, memorandum and related literature
to investors.
9. Allotment: Initiating adequate steps to ensure the fair allotment of securities, and refund of
application money without delay.
10. True market: not to be a party to the creation of false market, price rigging or
manipulation, passing on price sensitive information to brokers, members of the stock
exchanges and other players in the capital market, or take any other action which is unethical
or unfair to the investors.
11. Compliance: Abiding by the provisions of the Act, rules and regulations which may be
applicable and relevant to the activities carried out by the merchant bankers.
 16

PUBLIC ISSUE MANAGEMENT

MEANING
The management of securities of the corporate sector offered to the public on a regular
basis, and existing shareholders on a rights basis, is known as 'public issue management'. Issue
management is an important function of merchant bankers and lead managers.
The function of capital issues management in India is carried out by merchant bankers
who have the requisite professional skill and competence. One of their major functions, in fact,
is issue management. Factors such as the tremendous growth in the number and size of public
listed companies, and the complexity arising due to the ever-increasing SEBI requirements
have all attributed to the increasingly significant role played by merchant bankers in the recent
past.

FUNCTIONS
 The general functions that form part of the capital issues management of merchant
bankers are as follows:
 Obtaining approval for the securities issue from SEBI.
 Arranging for underwriting of the proposed issue.
 Preparation of draft and finalization of the prospectus and obtaining its clearance from
the various agencies concerned.
 of draft and finalization of other documents such as application forms, newspaper
advertisements, and other statutory requirements.
 Making a choice regarding registrar to the issue, printing press, advertising agencies,
brokers and bankers to the issue, and finalization of the fees to be paid to them.
 Arranging for press conferences and the investors' conferences.
 Coordinating printing, publicity and other work in order to get everything ready at the
time of the public issue.
 Complying with SEBI guidelines after the issue is over by sending various reports as
required by the authorities.

CATEGORIES OF SECURITIES ISSUE

Corporate enterprises use several modes for raising funds from the capital market. Issue
of securities constitutes an important mode of raising such finances Security issue takes the
following forms:
1. Public Issue of Securities
When capital funds are raised through the issue of a prospectus, it is called 'public issue
of securities'. It is the most common method of raising funds in the capital market. A security
issue may take place either at par, or at a premium or at a discount. The prospectus issued for
this purpose, should disclose all the essential facts about the company to the prospective
purchasers of security.

2. Rights Issue
When shares are issued to the existing shareholders of a company on a privileged basis,
it is called 'Rights Issue'. The existing shareholders have a pre-emptive right to subscribe to the
new issue of shares. Right shares are offered as additional issue by corporates to mop up further
capital funds. Such shares are offered in proportion to the capital paid-up on the shares held by
them at the time of the offer.

It is to be noted that the shareholders, although privileged to be offered the issue, are
under no legal obligation to accept the offer. Right shares are usually offered on terms
advantageous to the shareholders. For instance, shares of market value Rs.150 may be offered
at par.
 17

3. Private Placement
When the issuing company sells securities directly to investors, especially the
institutional investors, it takes the form of private placement. In this case, no prospectus is
issued, since it is presumed that the investors have sufficient knowledge and experience and
are capable of evaluating the risks of the investment.
Private placement covers shares, preference shares and debentures. The role of the
financial intermediary, such as the merchant bankers and lead managers, assumes greater
significance in private placement. They involve themselves in the task of preparing an offer
memorandum and negotiating with investors.

MECHANICS OF PUBLIC ISSUE MANAGEMENT

 Decision to Raise Capital Funds
 Obtaining SEBI Approval
 Arranging Underwriting
 Preparation and Finalization of Prospectus
 Selection of Registrars, Brokers, Bankers, etc.
 Arranging Press and Investor Conference
 Printing and Publicity of Public Issue Documents
 SEBI Compliance
 Issue Launch

ISSUE MANAGER
Any financial institution/intermediary which carries out the activities connected with
issue management, is registered with SEBI, and follows its regulations and guidelines, is
capable of venturing into issue management. Issue management is an important activity for
merchant bankers.
Requirements
The Issue Manager needs to satisfy the following requirements before being allowed
by the SEBI to carry out various issue management activities:
1. Adequate and necessary infrastructure such as adequate office space, equipment and
manpower to effectively discharge activities.
2. Minimum number of two persons needed, who are professionally qualified in Law,
Finance or Business Management and have the experience to conduct the business of the
merchant banker.
3. Fulfilling the capital adequacy requirements, i.e., a minimum net worth of Rs.5 crores.
Categories of Issue Managers
SEBI has classified Issue Managers into four categories as follows:
1. Category I: Merchant banker who is authorized to act as issue manager, advisor, consultant,
underwriter and portfolio manager.
2. Category II: Merchant banker who is authorized to act only as advisor. Consultant,
underwriter and portfolio manager.
3. Category III: Merchant banker who is authorized to act as underwriter. Advisor and
consultant to an issue.

4. Category IV: Merchant banker who is authorized to act only as advisor or consultant to an
issue.
 18

ROLE OF ISSUE MANAGER

The merchant banker as an issue manager is helpful in the following ways:
1. Easy flotation: An issue manager acts as an indispensable pilot facilitating a public/rights
issue. This is made possible with the help of a repository of special skills possessed by him to
execute the management of issues.
2. 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.
3. Underwriting: An issue manager allows for underwriting the issues of securities made by
corporate enterprises. This ensures due subscription of the issue.
4. Market makers: Merchant bankers, as issue managers often act as the market makers for
the issues lead-managed by them. They invest. Continue to hold and provide, buy and sell
quotes for the listed scrips of the company.
5. 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.
6. Coordination: The issue manager is required to coordinate with a large number of
institutions and agencies while managing an issue in order to make it successful.
7. 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.

ACTIVITIES INVOLVED IN PUBLIC ISSUE MANAGEMENT

The various activities involved in raising funds from the capital markets are described
below:
1. PRE ISSUE ACTIVITIES
a. Signing of MoU: Signing of MoU between the client company and the merchant banker-
issue management activities, marks the award of the contract The role and responsibility of the
merchant banker as against the issuing company are clearly spelled out in the MOU.
b. Obtaining appraisal note: An appraisal note containing the details of the proposed capital
outlay of the project and the sources of funding is either prepared in-house or is obtained from
external appraising agencies, viz. financial institutions/banks, etc. A project may be funded
either by borrowing money from outside agencies or by injecting capital.
c. Optimum capital structure: The level of capital that would maximize the shareholders’
value and minimize the overall cost of capital has to be determined. This has to be done
considering the nature and size of the project Equity funding is preferable especially when the
project is capital intensive.
d. Convening meeting: A meeting of the Board of Directors of the issuing company is
convened. This is followed by an EGM of its members. The purpose of these meetings is to
decide the various aspects related to the issue of securities. An application to RBI, seeking its
permission is made, where capital issue of shares is to be offered to NRIS/OCBS or FIls.
e. Appointment of financial intermediary: Financial intermediaries such as Underwriters,
Registrars, etc., have to be appointed. Necessary contracts need to be made with the underwriter
to ensure due subscription to the offer. Similar contracts, when entered into with the Registrars
to an issue, will help in share allotment related work, appointment of bankers to an issue for
handling the collection of applications at various centres, printers for bulk printing of issue
related stationery, legal advisors, and advertising agency.
 19

f. Preparing documents: As part of the issue management procedure, the documents to be

prepared are 'initial listing application' for submission to those stock exchanges where the
issuing company intends to get its securities listed, 'MoU with the Registrar', bankers, advisors,
and co-managers to the issue, agreement for purchase of properties, etc. This will have to be
sent for inclusion in the prospectus.
g. Due diligence certificate: The lead manager issues a 'due diligence certificate' which
certifies that the company has scrupulously followed all legal requirements, has exercised
utmost care while preparing the offer document and has made a true, fair and adequate
disclosure in the draft offer document.
h. Submission of offer document: The draft offer document along with the due diligence
certificate is filed with SEBI The SEBI, in turn, makes necessary corrections in the offer
document and returns the same with relevant observations, if any, within 21 days from the
receipt of the offer document. i. Finalization of collection centres In order to collect the issue-
application
2. POST ISSUE ACTIVITIES
The major activities covered are:
a. Finalization of basis of allotment If the public issue is oversubscribed to the extent of
greater than five times, a SEBI-nominated public representative is required to participate in the
finalization of Basis of Allotment (BOA). In case of rights issue that is oversubscribed greater
than two times, a SEBI- nominated public representative is required to participate in the
finalization of BoA. If it is under-subscribed, information regarding accepted applications is
formalized, and Regional Stock Exchanges are approached for finalization of BoA.
b. Despatch of share certificates immediately after finalizing the BOA, share certificates are
despatched to the eligible allotters, and refund orders made to unsuccessful applicants. In
addition, a 78 days report is to be filed with SEBI Permission for listing of securities is also
obtained from the stock exchange
c. Advertisement An announcement in the newspaper has to be made regarding the basis of
allotment, the number of applications received and the date of despatch of share certificates
and refund orders, etc.

MARKETING OF ISSUE- Need

In the case of a public issue, the company is required to take certain steps by which the
potential investing community is appraised of the features of the forthcoming issue. The need
for marketing the public issue arises because of the highly competitive nature of the capital
market. Moreover, there is a plethora of companies, which knock at the doors of investors
seeking to sell their securities. Added to this, the media bombards the modern investors with
eye-catching advertisement to sell their concepts to prospective investors.
STEPS
Following are the steps involved in the marketing of the issue of securities to be
undertaken by the lead manager:
1. Identifying target market: The first step towards the successful marketing of securities is
the identification of a target market segment where the securities can be offered for sale. This
ensures smooth marketing of the issue. Further, it is possible to identify whether the market
comprises of retail investors, wholesale investors or institutional investors.
2. Estimating subscriptions: After having chosen the target market for selling the securities,
steps are taken to assess the maximum number of subscriptions that can be expected from the
market. It would work to the advantage of the company if it concentrates on the regions where
it is popular among prospective investors.
 20

3. Determining Price: After assessing market expectations, the kind and level of price to be
charged for the security is decided. Pricing of the issue also influences the design of capital
structure. The offer has to be made more attractive by including some unique features such as
safety net. Multiple options for conversion, attaching warrants, etc.
4. Mobilizing intermediaries: For successful marketing of public issues, it is important that
efforts are made to enter into contracts with financial intermediaries such as an underwriter,
broker/sub-broker, and fund arranger. etc.
5. Preparing offer document: Every effort is made to ensure that the offer document for issue
is educative and contains maximum relevant information. Institutional investors and high net
worth investors should also be provided with detailed research on the project, specifying its
uniqueness and its advantage over other existing or upcoming projects in a similar field.
6. Launching advertisement campaign In order to push the public issue, the lead manager
should undertake a high voltage advertisement campaign. The advertising agency must be
carefully selected for this purpose. The task of advertising the issue shall be entrusted to those
agencies that specialize in launching capital offerings. The theme of the advertisement should
be finalized keeping in view SEBI guidelines. An ideal mix of different advertisement vehicles
such as the press, the radio and the television, the hoarding, etc., should be used.
7. Holding brokers' and investors' conferences: As part of the issue campaign, the lead
manager should arrange for brokers' and investors' conferences in the metropolitan cities and
other important centres which have sufficient investor population. In order to make such
endeavours more successful, advance planning is required. It is important that conference
materials such as banners, brochures, application forms, posters, etc... reach the conference
venue in time. In addition, invitation to all the important people, underwriters, bankers at the
respective places, investors' associations should also be sent.
8. Determining timing of the issue A critical factor that could make or break the proposed
public issue is its timing. The market conditions should be favourable. Otherwise, even issues
from a company with an excellent track record, and whose shares are highly priced, might flop.
Similarly, the number and frequency of issues should also be kept to a minimum to ensure
success of the public issue.
NEW ISSUES MARKET (NIM)
INTRODUCTION
NIM also known as 'primary market' is a market, which is characterized by the presence
of a set of all institutions, structures, people, procedures, services, and practices involved in
raising of fresh capital funds by both new and existing companies.
NIM AND SECONDARY MARKETS-AN INTERFACE
Both the primary and secondary markets are closely interrelated. This is clear from the
following:
1. Securities trading For the purpose of securities to be traded in the secondary market, it is
important that they are first issued in the primary market.
2. Securities listing In order that a corporate entity makes a successful issue of security in the
primary market, it is incumbent that the terms of the issue carry a stipulation that the issues are
to be listed in a recognized stock exchange and that an application for this purpose has been
made already to the stock exchange concerned.
 21

3. Regulation The activities in the primary market such as the new issues, etc., are greatly
influenced by the regulatory norms prescribed by the SEBI and stock exchanges. The objective
is to bring about orderliness in the new issues market.
4. Marketability The advantage of marketability provided by the secondary market greatly
helps the subscribers in the primary market. For instance, the positive trends prevailing in the
secondary market immensely help the investors to off-load their existing holdings so as to
subscribe for fresh issues in the NIM. This liquidity advantage helps in expansion of the NIM.
5. Prevailing conditions The conditions prevailing in the secondary market affect to a very
great extent the successfulness or otherwise of the issue being made in the NIM. Accordingly,
where the conditions are so favourable in the secondary market that high market prices prevail,
the issues made in the primary market will turn out to be encouraging and successful. In such
a case issues would fetch good premium

SERVICES OF NIM
A brief description of the various services rendered by the new issues market is made below:
Transfer Function;
An important function rendered by NIM is to allow the transfer of resources from savers
to entrepreneurs who establish new companies. It is also called the function of 'origination'.
The transfer function is facilitated by specialist agencies that are engaged in the provision of
investigative and advisory services as specified below:
a. Investigative services: The merchant bankers and other agencies provide the investigative
services. These include technical analysis, economic analysis, financial analysis and analysis
of legal and environmental aspects of the proposed business. Merchant bankers provide the
above information to investors so as to enable the investors in making a choice as to the type,
quality and quantity of the issue.

b. Advisory services: Various advisory services are made available with a view to improving
the quality of capital issues. The relevant services include determining the tyre, the mix, the
price, the timing, the size, and the selling strategies, the methods of floatation, and the terms
and conditions of issue of securities.
c. Guarantee function: It is the function of 'underwriting'. Underwriting aims at guaranteeing
the subscription of public issue. Underwriters ensure successful subscription of the issue by
undertaking to take up the securities in the event of the public failing to subscribe the same. It
benefits the issuing company, the investing public and capital market in general. The function
of underwriting is undertaken for a fee.
d. Distribution function: The function that facilitates the sale of securities to ultimate
investors is called 'distribution'. The function of distribution is rendered by the specialized
agencies like brokers and dealers in securities. They maintain a constant and a close link with
the issuers and the ultimate investors on the one hand, and issuers and other agencies of capital
market on the other
 22

NIM VS SECONDARY MARKET

S.O FEATURE NIM SECONDARY MARKET

NIM deals only with new or fresh

issue of securities. Issues are
1 ISSUE OF considered fresh or new provided Deals in exsting securities.
SECURITIES such issues are made for the first
time either by the existing
company or by the new company
Needs a fixed place to house the
2 LOCATION No fixed geographical location secondary market
needed activities,viz,trading.
Securities are transferred from
TRANSFER Securities are created and one investor to another through
3 OF transferred from corporates to the stock exchange mechanism
SECURITIES investors for the first time
For the securities to enter the
portais of stock exchanges for
4 ENTRY All companies can enter NIM and the purpose of trading, listing is
make fresh issue of securities. mandatory.
Has a definite administrative
5 ADMINISTR Has no tangible from of set-up that facilitates trading in
ATION administrative set-up securities.
Subject to regulations mostly Subject to regulation both from
from outside the company— within and outside the stock
6 REGULATION SEBI , stock exchanges , exchange frame work.
companies act, etc..

METHODS OF MARKETING SECURITIES

Following are the various methods being adopted by corporate entities for marketing
the securities in the New Issues Market:
1. PURE PROSPECTUS METHOD
Meaning
A method of marketing securities whereby an existing corporate enterprise mops up
capital funds from the general public by means of an issue of a prospectus, is called 'Pure
Prospectus Method'. It is the most popular method of making public issue of securities by
corporate enterprises.
Features
1. Exclusive subscription under this method, the new issues of a company are offered for
exclusive subscription of the general public. According to the SEBI norms, a minimum of 49
per cent of the total issue at a time is to be offered to public.

2. Issue price Direct offer is made by the issuing company to the general public to subscribe
to the securities at a stated price. The securities may be issued either at par, of at a discount or
at a premium.
 23

3. Underwriting Public issue through the 'pure prospectus method' is usually underwritten.
This is to safeguard the interest of the issuer in the event of an unsatisfactory response from
the public.
4. Prospectus: A document that contains information relating to the various aspects of the
issuing company, besides other details of the issue is called a 'Prospectus'. The document is
circulated to the public

2. OFFER FOR SALE METHOD

Meaning
Where the marketing of securities takes place in bulk quality to intermediaries, such as
issue houses, stockbrokers and others, it is a case of 'Offer for Sale Method".
The essential steps involved in this method of marketing of securities are as follows
1. Order: Broker receives order from the client and places orders on behalf of the client with
the issuer.
2. Share allocation: The issuer finalizes share allocation and informs the broker regarding the
same.
3. The client: The broker advises the successful clients of the share allocation. Clients then
submit the application forms for shares and make payment to the issuer through the broker.
4. issue account: The issuer opens a separate escrow account (primary issue account) for the
primary market issue. The clearing house of the exchange debits the primary issue account of
the broker and credits the issuer's account
5. Certificates: Certificates are then delivered to investors. Otherwise depository account may
be credited.

3. PRIVATE PLACEMENT METHOD

Meaning
A method of marketing of securities whereby the issuer makes the offer of sale to
individuals and institutions privately without the issue of a prospectus is known as 'Private
Placement Method'. This is the most popular method gaining momentum in recent times among
the corporate enterprises.
Features
Under this method, securities are offered directly to large buyers with the help of share
brokers. This method works in a manner similar to the 'Offer for Sale Method' whereby
securities are first sold to intermediaries such as issues houses, etc. They are in turn placed at
higher prices to individuals and institutions. Institutional investors play a significant role in the
realm of private placing. The expenses relating to placement are borne by such investors.

4. INITIAL PUBLIC OFFER (IPO) METHOD

The public issue made by a corporate entity for the first time in its life is called Initial
Public Offer' (IPO). Under this method of marketing, securities are issued to successful
applicants on the basis of the orders placed by them. Through their brokers.
When a company whose stock is not publicly traded wants to offer that stock to the
general public, it takes the form of 'Initial Public Offer". The job of selling the stock is entrusted
to a popular intermediary, the underwriter. An underwriter is invariably an investment banking
company. He agrees to pay the issuer a certain price for a minimum number of shares, and then
resells those shares to buyers, who are often the clients of the underwriting firm. The
underwriters charge a fee for their services.

The essential steps involved in this method of marketing of securities are as follows
1. Order: Broker receives order from the client and places orders on behalf of the client with
the issuer.
 24

2. Share allocation: The issuer finalizes share allocation and informs the broker regarding the
same.
3. The client: The broker advises the successful clients of the share allocation. Clients then
submit the application forms for shares and make payment to the issuer through the broker.
4. Issue account: The issuer opens a separate escrow account (primary issue account) for the
primary market issue. The clearing house of the exchange debits the primary issue account of
the broker and credits the issuer's account
5. Certificates: Certificates are then delivered to investors. Otherwise depository account may be
credited.

5. RIGHTS ISSUE METHOD

Where the shares of an existing company are offered to its existing shareholders. it takes
the form of 'rights issue'. Under this method, the existing company issues shares to its existing
shareholders in proportion to the number of shares already held by them. The relevant
guidelines issued by the SEBI in this regard are as follows:
1. Rights Issue shall be issued only by listed companies.
2. Announcement regarding rights issue once made, shall not be withdrawn and where
withdrawn, no security shall be eligible for listing upto 12 months.
3. Underwriting as to rights issue is optional and appointment of Registrar is compulsory.
4. Appointment of category I Merchant Bankers holding a certificate of registration issued by
SEBI shall be compulsory.
5. Rights shares shall be issued only in respect of fully paid shares.
6. Letter of Offer shall contain disclosures as per SEBI requirements.

6. BONUS ISSUE METHOD

A method of marketing the securities of a company by converting its accumulated
reserves and surplus profits, it takes the form of 'bonus issue method".
Bonus issue merely implies capitalization of existing reserves and surplus of a
company. The issue of bonus shares is subject to certain rules and regulations. The issue does
not in any way affect the resources base of the enterprise. It saves the company enormously of
the hassles of capital issue.

RIGHTS ISSUE VS BONUS ISSUE

SI. FEATURE RIGHTS ISSUE BONUS ISSUE
NO.

1 Payment The issue is to be paid for The issue is free

2 Privilege Confers a privilege on the existing Not a privilege issue
members

3 Paid-up shares Shares may be partly paid-up also Shares are necessarily to be
fully-paid up

4 Minimum Subscription Minimum subscription is required Minimum subscription is not

required required

5 Separate Account Money is to be kept in a separate No such requirement

bank account

6 Regulation Regulated by the provisions of the Regulated by the provisions

Companies Act and SEBI of the company's Articles and
guidelines SEBI guidelines
 25

7. BOOK-BUILDING METHOD
A method of marketing the shares of a company whereby the quantum and the price of
the securities to be issued will be decided on the basis of the 'bids' received from the prospective
shareholders by the lead merchant bankers, is known as 'book-building method'.
Under the book-building method, share prices are determined on the basis of real
demand for the shares at various price levels in the market. For discovering the price at which
issue should be made, bids are invited from prospective investors from which the demand at
various price levels is noted. The merchant bankers undertake full responsibility for the issue.
8. BOUGHT-OUT DEALS - Meaning
A method of marketing of securities of a body corporate whereby the promoters of an
unlisted company make an outright sale of a chunk of equity shares to a single sponsor or the
lead sponsor, is known as 'bought-out deals'.
Features
1. Parties to the deal: There are three parties involved in the bought-out deals They are
promoters of the company, sponsors and cosponsors who are generally merchant bankers and
investors.
2. Outright sale: Under this arrangement, there is an outright sale of a chunk of equity shares
to a single sponsor or the lead sponsor.
#################################################################################

FINANCIAL SERICES
UNIT-III
UNIT III: Money Market and Stock Exchange Characteristics - Functions - Indian
Capital Market - Constituents of Indian Capital Market - New Financial Institutions and
Instruments - Investor Protection - Stock Exchange - Functions - Services - Features -
Role - Stock Exchange Traders -Regulations of Stock Exchanges - Depository - SEBI -
Functions and Working.
MONEY MARKET
According to the Reserve Bank of India, a money market is a "centre for dealings,
mainly of a short-term character, in monetary assets; it meets the short-term requirements of
the borrowers and provides liquidity or cash to lenders. It is the place where short-term surplus
investible funds at the disposal of the financial and other institutions, and individuals are bid
by borrowers, again comprising institutions and individuals and also by the Government'.

DISCUSS THE STRUCTURE (OR) COMPONENTS OF INDIAN MONEY MARKET.

The Indian money market consists of two segments, namely organized sector and
unorganized sector. The RBI is the most important constituents of Indian money market. The
organized sector is within the direct purview of RBI regulation. The unorganized sector
comprises of indigenous bankers, money lenders and unregulated non-banking financial
institutions

(A).ORGANIZED MONEY MARKET INSTRUMENTS

1. Call and Notice Money Market: Under call money market, funds are transacted on
overnight basis. Under notice money market funds are transacted for the period between 2 days
and 14 days. The funds lent in the notice money market do not have a specified repayment date
when the deal is made. The lender issues a notice to the borrower 2-3 days before the funds are
to be paid. On receipt of this notice, the borrower will have to repay the funds within the given
time. Generally, banks rely on the call money market where they raise funds for a single day.
 26

2. Treasury Bills (T-Bills): Treasury bills are short-term securities issued by RBI on behalf of
Government of India. They are the main instruments of short term borrowing by the
Government. They are useful in managing short-term liquidity. At present, the Government of
India issues three types of treasury bills through auctions, namely – 91 days, 182-day and 364-
day treasury bills. There are no treasury bills issued by state governments. With the
introduction of the auction system, interest rates on all types of TBs are being determined by
the market forces.

3. Commercial Bills: Commercial bill is a short-term, negotiable, and self-liquidating

instrument with low risk. They are negotiable instruments drawn by a seller on the buyer for
the value of goods delivered by him. Such bills are called trade bills. When trade bills are
accepted by commercial banks, they are called commercial bills. If the seller gives some time
for payment, the bill is payable at future date (i.e. usance bill). Generally the maturity period
is upto 90 days

4. Certificates of Deposits (CDs): CDs are unsecured, negotiable promissory notes issued at
a discount to the face value. They are issued by commercial banks and development financial
institutions. CDs are marketable receipts of funds deposited in a bank for a fixed period at a
specified rate of interest. CDs were introduced in India in June 1989.

5. Commercial Papers (CPs): Commercial Paper (CP) is an unsecured money market

instrument issued in the form of a promissory note with fixed maturity. They indicate the short-
term obligation of an issuer. They are quite safe and highly liquid. They are generally issued
by the leading, nationally reputed, highly rates and credit worthy large manufacturing and
finance companies is the public as well as private sector. CPs were introduced in India January
1990.

(B) UNORGANIZED SECTOR OF INDIAN MONEY MARKET

1. Indigenous Bankers: They are financial intermediaries which operate as banks, receive
deposits and give loans and deals in hundies. The hundi is a short term credit instrument. It is
the indigenous bill of exchange. The rate of interest differs from one market to another and
from one bank to another. They do not depend on deposits entirely, they may use their own
funds.
2. Money Lenders: They are those whose primary business is money lending. Money lenders
predominate in villages. However, they are also found in urban areas. Interest rates are
generally high. Large amount of loans are given for unproductive purposes. The borrowers are
generally agricultural labourers, marginal and small farmers, artisans, factory workers, small
traders, etc.
3. Unregulated non-bank Financial Intermediaries: The consist of Chit Funds, Nithis, Loan
companies and others.
(a) Chit Funds: They are saving institutions. The members make regular contribution to the
fund. The collected funds is given to some member based on previously agreed criterion (by
bids or by draws). Chit Fund is more famous in Kerala and Tamilnadu.
(b) Nidhis: They deal with members and act as mutual benefit funds. The deposits from the
members are the major source of funds and they make loans to members at reasonable rate of
interest for the purposes like house construction or repairs. They are highly localized and
peculiar to South India. Both chit funds and Nidhis are unregulated.
4. Finance Brokers: They are found in all major urban markets specially in cloth markets,
grain markets and commodity markets. They are middlemen between lenders and borrowers.
 27

EXAMINE THE DEFECTS OF MONEY MARKET IN INDIA.

1. Existence of Unorganized Money Market: This is one of the major defects of Indian
money market. It does not distinguish between short term and long term finance, and also
between the purposes of finance. Since it is outside the control and supervision of RBI, it limits
the RBI’s control of over money market.
2. Lack of Integration: The Indian money market is broadly divided into two sectors, the
organized money market and the unorganized market. The organized market constitutes several
institutions such as RBI, State Bank of India, commercial banks, cooperative banks and
financial institutions. RBI as an apex body regulates their working. The unregulated sector is
not homogenous in itself. It constitutes indigenous bankers, loan companies, money lenders,
etc. There is no uniformity in their practices and there is multiplicity of functionaries.

3. Multiplicity in Interest Rates: There exists too many rates of interest in the Indian money
market such as the borrowing rate of government, deposits and lending rates of cooperative
and commercial banks, lending rates of financial institutions, etc. This is due to lack of mobility
of funds from one section of the money market to another. The rates differ for funds of same
durations lent by different institutions.

4. Inadequate Funds: Generally there is shortage of funds in Indian money market on account
of various factors like inadequate banking facilities, low savings, lack of banking habits,
existence of parallel economy, etc. However, the banking development particularly branch
expansion, has improved the mobilization of funds to some extent in the recent years.

5. Seasonal Stringency of Money: The seasonal stringency of money and high rate of interest
during the busy season (November to June) is a striking feature of Indian money market. There
are wide fluctuations in the interest rates from one season to another. RBI has been taking
various measures to avoid such fluctuations in the money market by adding money into the
money market during the busy season and withdrawing the funds during the slack season.

6. Absence of Bill Market: A well-organized bill market is necessary for linking up various
credit agencies effectively to RBI. The bill market is not yet developed on account of many
factors such as the practice of banks keeping a large amount of cash for liquidity purposes,
preference for borrowing rather than discounting bills, dependence of indigenous bankers on
one another, widespread practice of using cash credit, high stamp duty on usance bill, etc.

7. Inadequate Credit Instruments: The Indian money market did not have adequate short
term paper instruments till 1985-86. There were only call money and bill markets. Moreover
there were no specialist dealers and brokers dealing in the money market. After 1985-86, RBI
has introduced new credit instruments such as 182-day treasury bills, 364-day treasury bills,
CDs and CPs. These instruments are still in underdeveloped state in India

CAPITAL MARKET
MEANING
Capital market may be defined as a market for borrowing and lending long-term capital
funds required by business enterprises. Capital market is the market for financial assets that
have long or indefinite maturity. Capital market offers an ideal source of external finance.
Capital market forms an important core of a country's financial systems too.
It refers to all the facilities and the institutional arrangements for borrowing and lending
medium-term and long-term funds. Like any market, the capital market is also composed of
those who demand funds (borrowers) and those who supply funds (lenders).
 28

CHARACTERISTICS- CAPITAL MARKET

Following are the characteristic features of a capital market:
1. Securities market The dealings in a capital market are done through the securities like
shares, debentures, etc. The capital market is thus called securities market.
2. Security prices The price of securities that are dealt with in the capital market is determined
through the general laws of demand and supply. The equilibrium in demand and supply of
securities is brought about by the prices. The price depends upon a large number of factors
such as the following:
a) Yield on securities
b) Extent of funds available from public savings
c) Level of demand for funds
d) Flow of funds from the banking system
e) Price situation in general
f) Attitude towards liquidity on the part of investors
3. Participants There are many players in the capital market. The participants constitute a
plethora of institutions, which provide a wide variety of services of access to capital. The
capital is either directly supplied or arranged through financial intermediaries. These
intermediaries form the basic edifice of a capital market. The participants in the capital
market include the following:
a)Block exchanges b) Brokers c) FIIs d) DII e) Portfolio manager f) Custodians g)
Depositories h) Merchant bankers i) Share transfer agent j) Underwriters k) Venture
capital funds L) Mutual funds m) Regulators, etc.
4. Location It is interesting to note that the capital market is not confined to certain specific
locations, although it is true that parts of the market are concentrated in certain well-known
centres known as Stock Exchanges. It exists all over the economy, wherever suppliers and users
of capital get together and do business.

FUNCTIONS OF CAPITAL MARKET

The functions performed by the capital market are detailed below:
1. Allocation Function: Capital market allows for the channelization of the savings of
innumerable investors into various productive avenues of investments. Accordingly, the
current savings for a period are allocated amongst the various users and uses.
The market attracts new investors who are willing to make new funds available to
business. It also allocates and rations funds by a system of incentives and penalties.
2: Liquidity Function: Capital market provides a means whereby buyers and sellers can
exchange securities at mutually satisfactory prices. This allows better liquidity for the securities
that are traded.
3. Other Functions: In addition to the functions of funds allocation and liquidity, capital
market also renders the following functions:
a) Indicative function A capital market acts as a barometer showing not only the
progress of a company, but also of the economy as a whole through share price movements..
b) Savings and Investment function Capital market provides a means of quickly
converting long-term investment into liquid funds, thereby generating confidence among
investors and speeding up the process of saving and investment.
c) Transfer function Capital market facilitates the transfer of existing assets-tangible
and intangible-among individual economic units or groups.
d) Merger function Capital market encourages voluntary or coercive take-over
mechanism to put the management of inefficient companies into more competent hands.
 29

INDIAN CAPITAL MARKET - EVOLUTION AND GROWTH

The evolution in the realm of capital market in India could be broadly discussed as follows:
1. Infrastructure Stage
The period between 1947 and 1973 mark the period of the development of infrastructure
for capital market. The stage saw the process of strengthening of capital market through the
establishment of a network of development financial institutions such as IFCI (1948), ICICI
(1955), IDBI and UTI (1964). SFCs (during the fifties and sixties) and SIDCs (during the
sixties and early seventies). A number of important enactments covering the functioning of
different segments of capital market were legislated during this period. These include: Capital
Issues (Control) Act, 1947, Securities Contracts (Regulation) Act, 1956 and Companies Act,
1956.
2. New Issues Stage
This stage heralded the enactment of the Foreign Exchange Regulation Act (FERA)
between the period 1973 and 1980. Under this Act, shareholding of foreign firms in joint
ventures was restricted to 40 per cent if the companies wanted to be recognized as Indian
companies. This period saw many well- managed multinational companies offering their
equities to the public at relatively low prices. This encouraged a large number of domestic
public limited companies to come out with the offer of new capital issues for public
subscription. All these culminated in the stock market exhibiting an upward trend with share
prices displaying a high level of buoyancy. This also created, for the first time, an awareness
among the common investors about the potential of equity investments as a hedge against
inflation and a source of higher earnings compared to the other forms of investments.
3. The SEBI Stage
This stage of development during the period between 1980 and 1992 brought about
rapid changes in the Indian capital market. This marked a period of change, signifying the
widening and deepening of the market. 'Debenture' emerged as a powerful instrument of
resource mobilization in the primary market. The public sector bonds, which came to be
introduced since 1985-86, imparted an additional dimension to the market. The impressive
growth witnessed in this stage was responsible for bringing into existence a number of stock
exchanges. phenomenal increase in the listed companies with a quantum jump in their paid-up
capital and market capitalization. This signified a momentous growth in the secondary market.
a) New financial services An important part of development under this stage was the
emergence of SEBI as an effective regulatory body to set right many ailments afflicting the
secondary and the primary markets so as to afford a measure of protection to small investors.
New financial services such as credit rating, etc., came to be introduced. Several credit rating
institutions such as CRISIL, CARE and ICRA were set up in order to help investors make a
right choice of investment.
b) Committees/Working groups An important part of growth during this period was the
constitution of a number of committees in order to suggest measures to revamp and restructure
the working of the secondary market and cause buoyancy in the primary market so as to instill
confidence in the investing community. These included the following:
i) A Committee on Organization and Management of Stock Exchange. 1986 under the
chairmanship of Mr. G.S. Patel.
ii) A Working group on the Development of the Capital Market, 1989 under the chairmanship
of Dr. Abid Hussain.
iii) A Study Group for Guidelines Relating to Valuation and New Instruments, 1991 under the
chairmanship of Mr. M.J. Pherwani. iv) A High Powered Study Group on Establishment of
New Stock Exchanges, 1991 under the chairmanship Mr. M.J. Pherwani.
v) A Committee on Trading in Public Sector Bonds and Units of Mutual Funds, 1992 under
the chairmanship of Mr. S.S. Nadkarni.
 30

CONSTITUENTS OF INDIAN CAPITAL MARKET

The Indian capital market is composed of the following:
1. The gilt-edged market
2. The industrial securities market
1. GILT-EDGED MARKET
'Gilt-edged Market' also known as 'Government Securities Market', is the market for
Government and semi-Government securities. An important feature of the securities traded in
this market is that they are stable in value and are much sought after by banks (as banks are
obligated under the Banking Regulations Act to maintain a proportion of total deposits in
Government securities as part of SLR requirements).
Some of the special features of the gilt-edged market are as follows:
1. Guaranteed return on investments.
2. No speculation in securities.
3. Institutional based investors which are compelled by law to invest a portion of their funds in
these securities.
4. Predominated by such institutions as LIC, GIC, the provident funds and the commercial
banks.
5. Heavy volume of transactions necessitating negotiation of each transaction.

2. INDUSTRIAL SECURITIES MARKET

The market for industrial securities is known as 'Industrial Securities Market'. It offers
an ideal market for corporate securities such as bonds and equities. Industrial securities
market comprises of the following segments:
1. Primary market
2. Secondary market
1. Primary Market- Meaning
Primary market also known as New Issues Market (NIM) is a market for raising fresh
capital in the form of shares and debentures. Corporate enterprises, which are desirous of
raising capital funds through the issue of securities, approach the primary market. Issuers
exchange financial securities for long-term funds. The primary market allows for the formation
of capital in the country and the accelerated industrial and economic development.
Modes of Raising Capital
Following are the popular ways by which capital funds are raised in the primary market:
1. Public issue: Where the securities are issued to the members of the general public, it takes
the form of 'public issue. It is the most popular method of raising long-term funds.
2. Rights issue: Where the issue of equity shares of a body corporate is made to the existing
shareholders as a pre-emptive right, it takes the form of 'rights issue. Under this method,
additional securities are offered for subscription to the existing shareholders.
3. Private placement: Where the shares of a body corporate are sold to a group of small
investors, it takes the form of 'private placement'.

2. Secondary Market- Meaning

A market, which deals in securities that have been already issued by companies, is known as
'the secondary market'. It is also called the stock exchange or the share market. The market
provides a platform for buying and selling of securities.
Importance
The importance of the secondary market springs from the fact that it is the base upon which
rests the edifice of the primary market. In other words, for the efficient growth of the primary
market, a sound secondary market is an essential requirement. This is because the secondary
market offers the important facility of trading of securities.
 31

Stock Exchanges
The activities of buying and selling of securities in a secondary market are carried out
through the mechanism of stock exchanges. Stock exchanges form an integral part of the
secondary market in India. There are at present 24 stock exchanges in India recognized by the
Government. They are located at Mumbai, Calcutta, Delhi, Chennai, Ahmedabad, Bangalore,
Hyderabad, Indore, Pune, Kanpur, Cochin, Ludhiana, Mangalore, Patna, Guwahati,
Bhuwaneshwar, Jaipur, Saurashtra, Surat, Baroda, Coimbatore, Rajkot and Meerut, and OTC
Exchange of India and NSE at Mumbai.

NEW FINANCIAL INSTITUTIONS

A number of institutions of finance have been established to cater to the credit requirements of
various segments of industry and needs. A brief outline of these institutions is presented below:
1. Venture Fund Institutions: An innovative financing scheme of providing funds for high
risk and high reward projects is called "Venture capital financing. It is a form of equity
financing designed especially for funding new and innovative project ideas. Venture capital
funds are instrumental in bringing into force the hi-technology projects by assisting the research
and development projects, which are eventually converted into commercial production.
2. Mutual Funds: Financial institutions that provide facilities for channelling savings of a vast
number of small investors into avenues of productive investments are called 'Mutual Funds'.
Mutual funds are essentially collective investment vehicles that invest the funds pooled from
numerous investors and thus gives them the benefit of diversified investment portfolio and a
reasonable return.
3. Factoring Institutions: Financial institutions that provide financial accommodation on the
basis of assignment/sale of accounts receivables are called 'factoring institutions. Under the
factoring arrangement, the factoring institution undertakes the task of collecting the book debts
for and on behalf clients. The concept of rendering financial services through factoring has
gained strong momentum in the advanced countries, like USA, UK, etc.
4. Credit Rating Institutions: There has been a long-felt need in India for those institutions
which would provide services of evaluating the credit-worthiness of traders and securities and
on the basis of which issue rating grades indicative of the quality and soundness of credit. The
main purpose of credit rating is to provide guidance to investors/creditors in determining the
credit risk associated with a debt instrument/credit obligation by an independent, professional
and impartial institution.
5. Over-The-Counter Exchange of India (OTCEI): The OTCEI was set up by a premier
financial institution to allow the trading of securities across the electronic counters throughout
the country. It addresses some specific problems of both investors and medium sized
companies. Some of the greatest strengths of OTCEI are transparency of transactions, quick
deals, faster settlements and better liquidity.
6. National Stock Exchange of India Limited (NSEI): NSEI was established under the
Companies Act, 1956 on November 27, 1992 to function as a model stock exchange. The
exchange aims at providing the advantage of nationwide electronic screen based "scripless"
and "floorless" trading system in securities. The institution allows for an efficient and
transparent system of securities trading.
7. National Clearance and Depository System (NCDS): Under the scripless trading system,
settlement of transactions relating to securities takes place through a book entry as against the
physical exchange of securities under the traditional system. The need for scripless trading was
 32

felt on account of the anticipated unprecedented growth on the stock market, contributing to a
steep rise in the number of investors and the growth of equity cult among the masses. Moreover,
the present system of physical transfer of securities and the registration is slowly becoming an
outdated practice. The entire scripless trading system comprises the following three segments:
8.National Securities Depositories Limited (NSDL): The NSDL was set up in the year 1996
for achieving a time bound dematerialization as well as dematerialization of shares in
accordance with the Depositories Act, 1996. The establishment of NSDL is expected to
alleviate the problems of post-trade transactions in the secondary market.

NEW FINANCIAL INSTRUMENTS

Indian capital market also witnessed a phenomenal growth in the launching of a variety
of new financial instruments. A brief description of some of the newly introduced financial
instruments is presented below:
1. Commercial Paper (CP): A form of usance promissory note, which is negotiable by
endorsement and delivery, is known as Commercial Paper.
2: Certificate of Deposit (CD): The CD is a document of title, similar to the deposit receipt
issued by a bank. There is no prescribed interest rate on such funds and therefore banks have
the freedom to issue it at a discount or at face value. Being a bearer document, it is readily
negotiable. It is beneficial both to the banker and the investor.
3: Secured Premium Notes (SPN) with Attached Warrant: These are the bonds issued with
a detachable warrant and are redeemable after a notified period, say, 4 to 7 years. In the case
of fully paid SPNs, the warrants attached to them facilitate the holder, the right to apply and
get allotted equity shares.
4. Non-Convertible Debenture (NCD) with Detachable Equity Warrants: The equity
warrants attached to this instrument allows its holder to buy a specific number of shares from
the company at a predetermined price within a definite framework. Warrants are issued where
full payment of NCDs value has been made. Where the option to apply for equities is not
exercised, the company will be at its liberty to dispose off the unapplied portion of shares.
5. Zero Coupon Bonds: These are the bonds which bear no interest. In order to compensate
the loss of interest, they are issued at substantial discount from their eventual maturity values.
6. Zero Interest Fully Convertible Debentures (FCD): These instruments carry no interest.
They are automatically and compulsorily converted into shares after the expiry of a specified
time period as may be notified in the terms of issue.
7. Deep Discount Bonds: The bonds that are issued by corporates at very high discount and
matured at par value are 'Deep Discount Bonds'.
8.Stock Invest: An arrangement whereby it is possible for an investor to apply for the shares
without having to pay for them and where the investor could make payment for shares when
allotted to him, through his banker, is known as 'stock invest'. Under this mechanism, there is
only a guarantee of subscription and a banker makes payment only on the allotment of shares.
9. Equity Shares with Detachable Warrants: The holders of these shares are eligible to apply
for a specified number of shares at a predetermined price in future. Detachable warrants are
separately registered with the stock exchanges and traded separately.
10.'Equipref' Shares: These instruments are issued in two parts, part A and part B. Part A is
convertible into equity shares automatically and compulsorily on the date of allotment without
any further act or application by the allottee. Part B will be redeemed at par/converted into
equity shares after a lock-in-period at the option of the investors
 33

MEASURES OF INVESTOR PROTECTION

The SEBI has initiated a number of measures in order to protect the interest of investors.
These include: computerization of stock exchanges, expanding the realm of
dematerialization of shares, prescribing the capital adequacy for brokers, application of
the circuit breaker in stock exchanges in case of wide fluctuations in prices, introducing
and fine tuning the format of quarterly results and other stringent measures. These
measures are expected to produce positive results in terms of transaction cost,
transparency, and investor confidence.
Towards enhancing and deepening the transparency of operations in the capital market,
SEBI has taken a host of measures. These included: introduction of net trading,
implementation of the recommendations of the Kumar Mangalam Birla report on
corporate governance, K.B.Chandrasekhar report on venture capital funds, etc.,
permitting high net worth foreign individuals and corporates to invest in stock markets
under the FII route, allowing domestic mutual funds to manage foreign portfolios and a new
framework for accounting standards so as to accomplish universal accounting practices.

SCRA
Stock exchanges are subject to Government supervision and control. The regulation of
the functions and working of stock exchanges in India have been brought under the purview of
the Securities Contracts (Regulation) Act, which was passed in 1956. The regulations require
that only those stock exchanges which have been recognized by the Central Government, are
permitted to function in any notified State or area.

STOCK EXCHANGE
HISTORY
The first organized stock exchange in India is the Bombay Stock Exchange (BSE),
which was established in 1875. But trading in securities used to take place much earlier in the
18th century, and share quotations were published in contemporary newspapers. However,
dealings were not regulated by any code of rules, nor any hours of business prescribed nor was
there any committee to supervise the conduct of members. Dealers congregated under some
tree in open fields for the purpose of transacting business.

MEANING
A market where securities are bought and sold, under a code of rules and
regulations, is known as a 'stock exchange'. Its chief aim is to facilitate the provision of
capital funds to trade, industry and commerce. In addition, it also provides finances to the
Government. It is considered to be the nerve center of national finances. It is the financial
barometer and structure that reflect the prosperity or adversity of an economy. It is the fulcrum
on which the whole financial structure of a stands.

DEFINITION
1. According to Hastings. "Stock exchange or securities market comprises all the places where
buyers and sellers of stocks and bonds or their representatives undertake transactions involving
the sale of securities"
2. According to Husband and Dockeray, "Securities or stock exchanges are privately
organized markets which are used to facilitate trading in securities".
 34

FUNCTIONS/SERVICES/FEATURES/ROLE
1. Common and trading platform: A stock exchange provides an ideal and convenient
meeting place and a common platform for sellers and buyers of securities. It is the nerve center
where open offers and bids are made under free competition.
2. Mobilization of savings: Stock exchanges help in the mobilization of savings and surplus
funds of individuals, firms and other institutions. In other words, the stock market provides
ample opportunity to all the investors, both individuals and institutions to invest their surplus
funds (amount saved after meeting the expenses from the earnings) into various financial
instruments, and thus, directs its flow towards deficit units (which are short of funds to meet
their productive requirements).
3. Safety to investors: One of the fundamental functions of a stock exchange is to provide
adequate safety to the genuine investors and save them from fraud and manipulation caused
due to activities of speculators, For this purpose, adequate rules and regulations have been
provided under the Securities Contract (Regulation) Act, 1956.
4. Distribution of new securities: Stock exchanges also help in the distribution of new
securities. Existing companies, which wish to raise additional capital, may sell securities
through stock exchange.
5. Ready market: An important function of a stock exchange is to provide a continuous, ready,
open and a broad-based market for securities. This way maximum liquidity, marketability and
price uniformity for securities is ensured. It is possible for the investors to sell their securities
at the best-quoted price and thus, convert their investments into cash, almost immediately and
without much effort.
6. Liquidity: Liquidity is an important indicator for judging the efficiency of an exchange as
it concerns with sale and purchase of securities, quickly, easily and at reasonable prices, which
is nearer to the previous one. In fact, liquidity is related with depth, breadth and resiliency of
the market Depth relates to buy and sell orders around the price at which a share is transacted.
7. Capital formation: As an essential adjunct of joint stock enterprise, stock exchanges allow
for quick capital formation to take place. This in turn contributes to the development and
promotion of the economy through accelerated industrial development. Stock exchanges
enable people to know the current market prices of securities. People could invest in those
securities that yield higher returns.
8. Speculative trading: An efficient functioning of stock market motivates investors to save
more and invest in high yielding securities, and thus, promotes those industrial units that show
best productive and financial performance. Speculation also plays a dominant role in
mobilization of savings in an economy.
9. Sound price setting Stock exchanges, through a plethora of measures of compliance, allow
for a sound and a fair price setting to take place. The prices usually reflect the real worth of
securities. Factors such as limitless and free competition in open market, enlightened scientific
trading based on accurate knowledge of present as well as future prospects of demand and
supply, free flow of information, etc., contribute for the better price which benefits the investors
ultimately.
10. Economic barometer Stock exchanges serve as a barometer of the economy. The price
movement of securities on a stock exchange indicates the state of health not only of industrial
companies but also of the economy of the nation as a whole
11. Dissemination of market data Stock exchanges serve as information hub of trade and
industry of an economy. They disseminate information about share prices, volume of trade,
industry-wise, scrip-wise, etc. In addition, information is also provided on the financial aspects
of the companies whose shares are traded widely in the stock market. The signals of impending
financial or business booms or distress are first indicated in advance by stock exchanges very
promptly.
 35

12. Perfect market conditions Perfect market conditions prevail in the stock exchanges. On
account of these reasons, the transaction and the carrying cost are the least. The activities are
much standardized. They are well. Regulated by institutions of Government. They facilitate a
free and limitless competition among the dealers and the brokers of securities.
13. Seasoning of securities Stock market players such as underwriters, dealers, brokers, and
speculators temporarily hold securities issued by new companies. This is called 'seasoning of
securities'. The securities are then released gradually at a time when the market is prepared to
absorb the new issue. This process ensures a better benchmarking and market for the securities.
14. Efficient channelling of savings The stock exchange mechanism enables judicious use of
national savings by allowing the flow of savings into the profitable and desirable areas of
investments. It allows corporates to mobilize capital in a free and equitable manner. For, only
those corporate enterprises that satisfy the market tests of efficiency and profitability could
possibly approach the market for capital funds.
15. Optimal resource allocation Stock exchange serves as an ideal tool of allocating the
national savings to promising issues and thereby, ensures most effective and optimum
allocation and utilization of scarce financial resources in industry and commerce for maximum
social advantage. This is made possible by the price mechanism under the free competition.
16. Platform for public debt By serving as an organized market Government securities, stock
exchanges allow for raising huge resources of finance required by the Government for
financing its development activities. Stock exchanges act as platforms for mopping up public
debt to execute the schemes of planned projects. It works as an over-the-counter market,
consisting of dealers and brokers in Government securities. Banks LIC, Provident Fund and
Pension Fund institutions are the chief buyers of Government securities.
17. Clearing house of business information: The business information supplied by corporate
enterprises is allowed to be exchanged between investors and the issuers by the stock exchange.
This allows a stock exchange to serve as a clearing house of business information. Besides, the
information provided by corporates by way of financial statements. Annual reports and other
reports, etc., helps ensure maximum publicity of corporate operations and working.
18. Evaluation of securities: Another important function of the stock exchange is to allow for
an opportunity to determine a reasonable and fair price of various scrips traded on its floor
through the market forces of demand and supply. The prices of the scrips quoted on the stock
exchange change continuously on the basis of their real (intrinsic) worth along with
fundamental and technical factors.
19. True market mechanism: The stock exchange provides liquidity and price continuity only
to listed securities. Securities that are listed and allowed to be traded on a particular stock
exchange are called listed securities. It is possible that a security may be listed at more than
one stock exchange for the purpose of trading
20. Investor education: An important function of a stock exchange is to widen the share
ownership base especially in developing countries. Stock exchanges play a significant role in
educating the mass through various communication media by providing information relating
to principles and advantages of investing in shares, debentures, bonds and other avenues. They
also educate the people in selecting the securities and designing their own portfolio. Stock
exchanges have a potential to play a significant role in the Indian economy where the saving
rate is the highest in the world. and the mass of population is uneducated and living in rural
and semi- urban areas.
21. Fair price determination The prices in the stock market are determined by the interplay
of the forces of supply and demand. The two-way auction trading taking place in the stock
exchange facilitates a fair price determination. There is free trading and free competition in the
stock market, which in turn facilitates better bargains so as to arrive at a fairly attractive price.
 36

STOCK EXCHANGE AND COMMODITY EXCHANGE DISTINGUISHED

The points difference that exist between a stock exchange and a commodity exchange are
furnished below:
S.no feature Stock exchange Commodity exchange
1. function Provides easy marketability. Offers hedging or price
insurance services and liquidity
to securities.
2. object Object is facilitating capital Object is facilitating goods flows
formation an making best use of through risk education.
capital resources.
3. participants Inventors and speculators. Producers, dealers, traders, and
body of speculators.
4. Period of Cash ready delivery and Instant cash dealings and a
dealings dealings for account for a settlement period of 2 or 3
fortnight. months for futures market
dealings.

5. Articles traded Industrial securities such as Only durable, graded and goods
stocks and bonds and having large volume of trade,
government securities such as price uncertainty and
public debt, etc uncontrolled supply.
6. speculation Speculation ensures saleability Speculation ensures assumption
of securities affording a broad, and absorption of price risk.
ready ,liquid and continuous
market of securities.
7. Forward Forward dealings are simplified Standards are to be fixed for
contract as securities are fully deliverable grades to facilitate
standardized. futures contract.

8. cornering As seller has to deliver the Cornering is difficult as the

agreed securities, cornering is seller has option to deliver
easy. standard or other deliverable
goods.
9. Price quotation As regards forward dealings, Cornering is difficult as the
only one quotation is possible. seller has option to deliver
standard or other deliverable
goods for futures dealings,
multiple quotations are possible.

STOCK EXCHANGE TRADERS

Only the registered members are permitted to carry out trading on the floor of a stock
exchange. However, for reasons of convenience some other persons are also permitted to enter
the premises and transact business on behalf of the members. They are:
1. Remisiers: The sub-brokers employed by a member (share-broker) to secure business are
called 'Remisiers'. As the share brokers are prohibited to get business by advertisement the role
of remisiers assumes importance. Remisiers are not permitted to enter the trading floor for
exchange dealings. Remisiers are engaged by the full-fledged members of the BSE in order to
secure business for them. They act as agents of the members. The members pay them
commission on the business procured by them and for this reason remisiers are best known as
"half commission men".
 37

2. Authorized Clerks: Authorized clerks are the people who assist a member in transacting
business. Especially at times where the volume is heavy. The employees of a member of a
stock exchange are called 'authorized clerks. These clerks or assistants are authorized to
transact business on behalf of their member-employer, but they make any bargain in their own
name. Such persons can sign on behalf of their employers where they are provided with the
power of attorney.
3. Brokers And Jobbers: In a stock exchange, the actions of brokers and jobbers are
interrelated. Both the broker and the jobber perform important functions. A broker acts as an
expert agent of the ordinary investors who is hardly competent to deal with skilled jobbers
directly. A jobber renders a useful service by executing orders without delay. The immediate
execution of orders helps make the price fluctuations smooth. He uses his experience and
specialized knowledge to name the price at which a security should pass from one investor to
another.
4. Tarawaniwalas: Tarawaniwalas are dealers in securities in the BSE who transact business
in their own name and on their own behalf as well. Such dealers usually specialize in one or
two securities only. They resemble the jobbers of the London Exchange in as far as the method
of transacting business is concerned.
5. Dealers: Dealers are market-makers. They are important intermediaries in the stock
exchange. Dealers buy and sell inventory of stocks. Through this process, they absorb
excessive buying or selling pressures, thereby providing liquidity and immediacy in the
exchange. Such intermediaries are not very common in the Indian capital market.

WEAKNESSES OF THE INDIAN STOCK EXCHANGES

Although rapid strides have been made in the Indian stock markets, there are many
irritants that continue to afflict the functioning of the stock exchanges. Following are the
principal weaknesses of the Indian stock exchanges:
1. Raging speculation: It is highly characteristic of the Indian stock exchanges that there
prevails a rampant speculative transaction. The continued spell of unprecedented booms and
crashes is a clear testimony for this phenomenon. The Indian stock market witnesses high
volatility taking the unwary investors for a ride as they do not reflect a very healthy state of
affairs. Over-speculative character and high volatility have made the Indian stock market crises
prone.
2. Insider trading menace: The possibility that the insiders in a stock exchange have an access
to price-sensitive information about the market movements of certain scrips breaks the Playing
field'. This way, equal opportunity of information access is denied to all the participants in the
market.
3. Neglect of small investors The Indian stock market is often highly dominated by large
financial institutions, big brokers, and operators. The oligopolistic structure does not leave any
advantage to the small investors. The small investor is often meted out a raw deal, despite the
much-proclaimed safeguards built into the various regulations issued by the SEBI from time to
time.
4. Restrictions on forward trading: The ban imposed on the 'forward trading' in India in
1969, had a deleterious effect on share prices. Further, the restrictions placed on dividend
payments by companies as part of the anti-inflationary measures adopted by the Government
aggravated the dealings in share market. The limited facility allowed for carrying forward the
delivery contract beyond 14 days in an informal manner.
5. Bad trading practice: There are many obsolete, inefficient and outdated share-trading
practices that are ruling roost in the Indian stock exchanges. Major problem areas are settlement
periods, margin system and carry forward (badla) system. The settlement period is 14 days in
most of the Indian stock exchanges, whereas most of the countries are moving towards a rolling
3 days settlement period.
 38

6. Lack of integration: In order that the services of a stock market are made use of by a wide
spectrum of investors across the country, close integration among the various stock exchanges
becomes an imperative necessity. Such an arrangement will also help enhance the cohesive
functioning of the stock exchanges with efficient sharing of information among them.
7. Lack of interface In India, the kind and the quality of developments taking place in the
realm of new issues market are not adequately matched by the developments in the secondary
markets. For instance, the recent upsurge of the primary market has created serious problems
of interfacing with the secondary market.
8. Ineffective banking system: The dilatory and inefficient working of the banking system
under which outstation cheques takes very long to be encashed, the difficulty in making
necessary payments in reply to calls or in connection with the subscription for issues also affect
the system.
9. Inadequacy of investor service As regards investor service, it is found to be much wanting
especially among the small stock exchanges. They make a limited contribution to the spread of
the equity cult in their region.
10. Inadequate infrastructure: The extent of facilities that are available in the stock
exchanges are far from satisfactory. This results in lower operational flexibility of stock
exchanges and brokers to handle sudden surges in volumes of trading.
REGULATION OF STOCK EXCHANGES
The authority, however, is regulated primarily through the Securities Contract
(Regulation) Act, 1956 (SCRA). Further, the Securities and Exchange Board of India (SEBI)
also regulates the stock exchanges in order to protect the interest of investors and to promote
the development of security markets in India. This constitutes the second-level authority. The
third-level of authority constitutes self-regulation whereby all stock exchanges have their own
separate rules, byelaws and regulations that are exercised through their Governing Board.
Regulatory Structure
a. The stock exchange division: The Stock Exchange Division of Ministry of Finance has its
Head Office at Delhi and Branch offices at Bombay and Calcutta. The essential functions of
the Division are as follows:
i) Providing linkage between Government and stock exchanges.
ii) Monitoring the operations of the stock exchanges.
iii) Providing advice to overcome the untoward developments and crises.
iv) Ensuring the compliance of listing provisions.
v) Ensuring smooth functioning of the stock exchanges.
vi) Issuing licenses to brokers and dealers in securities and also in areas beyond the
jurisdiction of recognized stock exchanges.
b. SEBI: An apex body called the Securities and Exchange Board of India (SEBI) has also
been constituted besides the above. A Chairman heads the SEBI. The first chairman of this
Board was Dr. S.A. Dave, former Executive Director of IDBI. Besides, the Central Government
is also empowered to nominate four members that comprise the top management team of the
SEBI The SEBI issues from time to time various rules, regulations and guidelines for
promoting the development and stabilization of the securities market in India. A few important
among them are as follows:
i) SEBI (Portfolio Managers) Rules and Regulations, 1992. SEBI (Stock Brokers and
Sub-brokers) Rules and Regulations, 1992.
iii) SEBI (Insider Trading) Regulations, 1992.
iv) SEBI (Merchant Bankers) Rules and Regulations, 1992.
 39

v) SEBI (Mutual Fund) Regulations, 1993.

vi) SEBI (Underwriters) Rules and Regulations, 1993. vii) SEBI (Registrars to Issue
and Share Transfer Agents) Rules and Regulations, 1993.
viii) SEBI (Debenture Trustee) Rules and Regulations, 1993.
ix) SEBI (Bankers to an Issue) Rules and Regulations, 1993.
Besides the above, SEBI has also issued guidelines regarding the following:
i) Free pricing of shares.
ii) Disclosures and Investors' protection.
iii) Registration of Foreign Institutional Investors (FII).
iv) Allotment of shares.
v) New financial instruments.
vi) Credit rating of fixed return bearing securities.
c. Departments The major departments of a typical stock exchange in Indiaare as follows:
1. Listing department: It is an important department of a stock exchange Its main function is
to list the securities of companies for trading purposes at the stock exchange.
2. Operations department: The basic objective of this department is to keep watch on the
daily trading and other operations of the stock exchange.
3. Computer and EDP department: The basic function of this department is to collect and
compile the various data relating to corporates, quotations of scrips and member-wise and
scrip-wise turnover.
4. Inspection and audit department: This department is concerned with carrying out routine
audit of the stock exchanges for checking the accuracy and validity of the accounting records,
balance sheet item, receipts and payments items, and other relevant registers.
5. Monitoring department :This department aims at supervising the activities of the members
in the trading ring. Besides, it also watches the price movements and the trading volume of the
members.
6. Investor service department: The basic objective of this department is to safeguard the
interests of investors by rendering expeditious service to them and by attending to their
complaints against broker-members and their authorized clerks and the listed companies

DEPOSITORY
Depository provides an answer to the kind of problems encountered as above by the
investors. Depository originated in the USA. Depository provides for an electronic transfer of
securities. This process completes transfer of ownership in a day. In fact, the international
practice is Delivery versus Payment, implying that once funds are available in the buyer's
account, he gets a clean delivery, with ownership transferred to him on the same day.
Depository provides for scripless transfer of ownership thus improving the efficiency of the
market and thereby eliminating the problems encountered in dealing with physical securities.
A wide range of related services would also be available. Some of the services that are rendered
by the depository are as follows:
1. Maintaining beneficial holdings on behalf of individual investors. 2. Providing facilities of
dematerialization and dematerialization of securities.
3. Effecting transfer and settlement of trades.
4. Extending pledge and hypothecation facilities and thereby regulating stock lending
operations.
5. Effecting inter-depository transfers in multi-depository environment.
 40

SEBI-FUNCTION AND WORKING

INTRODUCTION
Government of India set up the Securities and Exchange Board of India (SEBI) on April
12, 1988 on the basis of the recommendations of the high powered Committee on Stock
Exchange Reforms headed by G.S. Patel. SEBI was given a legal status by the Securities and
Exchange Board of India Ordinance, 1992. The members of the Board of Management of the
SEBI comprised those drawn from professional brokers, financial consultants, merchant
bankers, investors, stock exchange authorities, finance ministry, etc.

MANAGEMENT
Under Section 4 of the SEBI Act, the management of SEBI is entrusted with the Board
of Members. The Board consists of a Chairman, two members from amongst the officials
of the Ministries of the Central Government dealing with Finance and Law, one member
from amongst the officials of the Reserve Bank of India constituted under Section 3 of the
Reserve Bank of India Act, 1934 and two other members appointed by the Central Government
who are professionals having experience or special knowledge relating to securities market.
The Chairman and the other members of the Board are chosen from amongst the
persons of ability, integrity and standing who have shown capacity in dealing with problems
relating to securities market or have special knowledge or experience of law, finance,
economics, accountancy, administration or in any other discipline which, in the opinion of the
Central Government, shall be useful to the Board.

OBJECTIVES OF SEBI
1. Conducive environment SEBI aims at creating a proper and conducive environment
required for raising money from the capital market through the rules, regulations, trade
practices, customs and relations among institutions, brokers, investors and companies.
2. Investor education SEBI aims at educating investors so as to make them aware of their
rights in clear and specific terms by providing them with information.
3. Infrastructure SEBI aims at developing a proper infrastructure for facilitating automatic
expansion and growth of business of middlemen like brokers, jobbers, commercial banks,
merchant bankers, mutual funds, etc.
4. Others: In addition to the above mentioned objectives, SEBI would also make efforts to
bring about necessary enactments for regulating business of intermediaries such as mutual
funds, NBFCs and chit funds, etc.
POWERS AND FUNCTIONS
1. Under the SEBI Act
a. Stock exchange regulation SEBI is empowered to regulate the business in stock exchanges
and any other securities market. It works to prohibit fraudulent and unfair trade practices in
securities market.
b. Stock broker’s regulation SEBI is empowered to register and regulate the working of
stockbrokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds,
registrars to an issue etc.
 41

c. CIS regulation: SEBI works to regulate the working of Collective Investment Schemes
(CIS), including mutual funds. For this purpose it promotes and regulates self-regulatory
organizations.
d. Investor protection SEBI is empowered to initiate all the steps for promoting investor
education and training of intermediaries in securities market
2. Under the SCRA
In addition to the powers that have been granted to be exercised by the SEBI under its own
law, following are the powers granted to it under the Securities Contracts (Regulation) Act
(SCRA):
Stock exchange regulation SEBI commands the following powers as relating to the
regulation of stock exchanges:
a) Approval of byelaws of the exchange(s) for regulation and control of contracts.
b) Licensing of dealers in securities in certain areas.
c) Compel a public company to list its shares.
d) Amendment of rules relating to matters specified ir. Section 3(2) of the Act.
e) Furnishing of annual report by recognized stock exchanges.
f) Issuing directions to stock exchanges in general.
g) Superseding the governing body of a recognized stock exchange.
3. Registration of Intermediaries: All intermediaries dealing in securities are compulsorily
registered with the SEBI in accordance with the regulations made under the SEBI Act. The
certificate of registration contains the conditions/rules and regulations for conduct of business
by the security market intermediaries
4. Directions from Government: The Government of India can issue directions to the SEBI
on questions of policy in writing from time to time. It is bound to follow and observe such
directions in the exercise of its powers/the performance of its functions.
5. Power to Make Rules: The Government is authorized to make rules for carrying out the
purposes of the SEBI Act. The important matter for which rules may be framed, include, the
additional functions to be performed by it, its constitution, maintenance of its accounts, manner
of inquiry to impose penalty for defaults, constitution of the Securities Appellate Tribunal
(SAT).
6. Power to Make Regulations: To carry out its functions, the SEBI is empowered to make
regulations. Every regulation made by it must have the prior approval of the Government. All
such regulations must be published as notification in the official gazette. The matters for which
regulations may be framed include (a) the conditions for registration certificate, fee for
registration, cancellation/suspension of registration of intermediaries and (b) matters relating
to issue of capital, transfer of securities and so on.
7. Power to Adjudicate: The SEBI is empowered since 1995, to appoint any of its officers of
the rank of a division chief as the adjudicating officer, to hold an enquiry in the prescribed
manner for determining the amount of penalty on any intermediary. The quantum of penalty is
to be fixed with due regard to (a) the amount of disproportionate gain or unfair advantage made
as a result of the default, (b) the amount of loss caused to an investor/group of investors as a
result of the default and (c) the repetitive nature of the default.
$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$$
 42

FINANCIAL SERICES
UNIT-IV
UNIT IV: Leasing and Factoring and Securitisation Characteristics - Types -
Participants - Myths about Leasing - Hire Purchase – Lease Financing Vs Hire Purchase
Financing - Factoring - Mechanism - Functions of a Factor - Factoring - Players- Types
- Operational Profile of Indian Factoring - Operational Problems in Indian Factoring -
Factoring Vs bills Discounting - Securitisation of Debt- Parties involved- Steps of
securitisation - Types of securitisation- Advantages- Limitations – SARFAESI Act 2002-
Background- Purpose of the Act- Main provisions

LEASING:
 A financing arrangement that provides a firm with the advantages of using an asset
without owning it may be termed as leasing.
 According to the Institute of chartered accountants of India” as lease is an agreement
whereby the lesson conveys to the lessee, in return for rent, the right to use an asset for
an agreed period of time.
 Lessor is a person who conveys to another person the right to use an asset in
consideration of a payment of periodical rental under a lease agreement lessee is a
person who obtains forms the lessor the right to use the asset for a periodical rental
payment for an agreed period of time

CHARACTERISTICS OF LEASE:
1. Parties to lease agreement: There are two parties to lease agreement. They are lessor and
the lessee. Lessor is a person who conveys to another person the right to issue an asset
inconsideration of a periodical rental payment, under a lease agreement. Lessee is a person who
obtains, the right to use the asset form the lessor for periodical rental payment for a agreed
period of time.
2. Lease asset: Leasing is used for financing the use of fixed assets of high value. The asset is
the property to be leased out . It may include an automoblile,an aircraft, plant and machinery,
a building etc. However the ownership of asset is separated form the use of the asset. During
the period of the lease, the ownership of the asset rest with the lessor while the use is transferred
to the lease.
3. Lease term: The term of the lease is called the lease period. It is the period for which
agreement is in operation. It is illegal to have a lese without a specified term. Sometime the
lease period may be broken into primary lease period and secondary lease period. A primary
lease period is a period during which the lessor harts to get back in investment together with
interest. A secondary period comprises the later part of the lease period, where only nominal
rentals are charged in order to keep the lease agreement operational.
4. Lease rentals: Lease rental constitute the consideration payable by the lessees as specified
in the lease transaction. Rentals are determined to cover such costs as interest on the lessor’s
investment cost of any repairs and maintenance that are part of the lease package, depreciation
on the leased asset and any other service charge in connection with lease.

TYPES OF LEASE:
1. Financial lease: A financial lease also called capital lease, is a contract investing payment
over an obligatory period of specified sure sufficient in total to amortize the capital outlay
beside giving some profit to the lessor According to the international accounting standard (IAS)
no “a financial lease is a lease that transfers substantially also the risks and rewards incident to
ownership of an asset. TITLE may or may not eventually be transferred”.
 43

2. Operating lease: An operating lease is any other type of lease where by the asset is not
fully amortized during the non cancelable period of the lease, and where the lesson does not
rely on the lease rentals for profits. The lease is cancelable at short – notice by the lessee. The
lessee has the option of renewing the lease after the expiry of the lease period it is the
responsibility of the lessor to ensure maintenance, insurances of the asset, which is chargeable
by the lessor.
3. Leveraged lease: When a part or whole of the financial requirement involved in a lease are
arranged with the help of a financier. It takes the form of leveraged lease. This type of lease is
resorting to in cases where the value of the leased asset is very his In the type of lease, the
lessor who is also a financier. Involves one more financier, who may hold a charge over leased
asset, over and above part of the lease rentals.
4. Sale and lease back : Under this type of lease, the owner of an asset sells it to the lessor,
and gets the asset back under the lease agreement the owner ship of the asset changes hands
from the original owner to the lessor, who is turn lease out the asset, back to the original owner.
This paper exchange of title has the effect of providing immediate free finance to the selling
company the lessee.
5. Partial payout lease: It is a type of lease where by the lesson obtains full payment of the
lease is several lease. This broadly falls under the category of operating lease.
6. Consumer leasing: Leasing of consumer durable such as televisions, refrigerators, etc is
called consumer leasing. It has assumed popularity with the rapid increase in the quart urn of
consumer credit.
7. Close-end- leasing: A leasing arrangement whereby the asset leased out is reverted to the
lessor is known as close –end leasing. It is also called walk away lease.
8. Open-end leasing: A term commonly used in automobile leasing in the USA it means a
lease agreement where the lessee guarantees that the lessor will realize a minimum value from
the sale of the asset at the end of the lease period.
9. Swap leasing: In swap leasing the lessee is allowed to exchange equipment leased out
whenever the original asset has to be sent to the lessor for some repair or maintenance.
10. Import leasing: The leasing of imported capital goods is known as “import leasing”. It
is beneficial to the lessee because arranging any other source of funding may take a long time,
during which the prices of the importable items as also the rates of exchange may change.
Moreover lenders don’t usually finance the import duty, which forms a sizable part of the
acquisition of such items.
12. Wrap leasing: When the lessee further subleases the asset to the end user, retaining a fee
and a share of the residual value it is called wrap leasing. Normally the term of the first lease
is longer than the second, in order to maximize the firm lessor’s tax deduction. It is so called
because the firm lessee wraps the second lease.

13. Cross- border leasing: A type of lease where the lessor in one country lease out assets to
a lessee to another country it known as cross- border leasing. The jurisdictions of lessors and
lessses are in two different countries cross- border leasing originated in the 1970 in the US
Financial Institutions in the US leased out big assets, such as airplanes etc, to the lessess outside
USA.
14. International leasing:- When a leasing companies in different countries through its
branches it is a case if international leasing. International leasing is active countries such as
US,, japan and Hong Kong.
 44

FINANCIAL LEASE VS OPERATING LEASE

Financial Lease Operating Lease

Specificity
The asset leased out is use specific The asset leased out may be
for the lessee usedcommonly by a number
of users in
sequence.
Ownership risks
The lessee bears the risks and The risks and rewards
rewards associated with the use of associated with the use of the
the asset leased; the lessor is simply asset leased is borne by the
the legae owner of the asset lessor and the lesse is simply
provided with the use of the
asset for a certain period of time.
Obsolescence risk
The lessee bears the risks of The lessor bears the risks
obsolescence of
obsolescence
Cancel ability
The lease cannot be cancelled either The lease can be cancelled at
of the parties. The lessor rather theoption of the lessee and the
interested in rental and in the asset lessor does not have the
difficulty of
leasing the same asset to
willing lessees
Lease period
The lease period usually coincides Lease period is generally small
with the life of the asset, and may be as the lessor intends to lease the
broken into primary and secondary same asset several time to
period various users.

MYTHS ABOUT LEASING

Although leasing is believed to be the most beneficial form of financing, there are
several myths surrounding it. They are as follows:
1. 100 per cent financing A commonly held opinion is that leasing provides 100 per cent
financing, without having to borrow. Although it is true that leasing enables avoidance of
acquisition of the asset, there is an incursion of liability by way of a periodical payment of lease
rentals.
2. Off-balance sheet financing As against borrowing which gets shown as a liability with its
resultant effect on the debt-equity ratio, the leasing liability need not be shown in the balance
sheet. This is supposed to keep the debt-raising capacity of the firm intact, though this is not
quite true. The debt-raising ability of a firm is dependent upon its ability to service its debt, and
not on the balance sheet ratios and their interpretations.
3. Better financial performance: Another commonly held view is that leasing helps improve
the financial performance of a firm. This is because; it is possible to enhance the ROI with less
asset base. Such ratios, which are the result of accounting adjustments, are illusory in reality.
A lease transaction is capable of creating wealth for the firm, only if it yields a positive NPV.
 45

4. No evaluation needed It is believed that leasing does not require to be included in any
capital expenditure evaluation, since there are no capital investments involved. This argument
defies logic, because leasing, like a buying decision, needs to be examined carefully of cash
flow consequences in order to determine the possible advantages of it. In the absence of any
screening, the decision to accept leasing might expose the firm to business fluctuations, and
endanger its very survival.

PARTICIPANTS
There are a number of players present in the leasing industry. A brief discussion of
these players is presented below:
Lessors: There are different kinds of lessors. They are specialized leasing companies one-off
lessors, manufacturer-lessor, banks-sponsored leasing companies financial institutions, in-
house lessors, etc.
Lessees: The lessees constitute a wide range of companies, from blue chip companies to small
units, which avail the financial services from the lessor companies. The considerations for, and
the conditions under which, such companies operate vary. A characteristic of the Indian lessees
is that most of them belong to the private sector.
Lease Brokers: Lease brokers are the intermediaries between the lessors and lessees who help
find a suitable lessor for a prospective lessee and vice versa. Armed with information and
rapport, lease brokers help both lessors and lessees with financial advantage through tough
negotiations and by providing a wider choice.
Lease Financiers: Lease financiers are banking institutions which provide financial assistance
to lessors for the purpose of acquiring the assets that are to be leased. Such assistance is usually
secured by the hypothecation of the leased asset, and also by the assignment of lease rentals

ADVANTAGES OF LEASING
1. Advantages to lessor
 Stable business: - leasing mechanism provides for a continuous and stable
manufacturing business for the lessor.
 Tax benefits: - There is relative tax benefit for the receipts of lease rentals the lessor-
owner of the asset can also claim depreciation tax benefits on assets let out on lease.
 Absorbing obsolescence risks: - In the case of a no cancellable financial lease, the risk
of obsolescence arising from the usage of asset have to be borne by lessee. In the same
way, the cancellable nature of operating lease enables the lessor to cancel the lease and
acquire a new asset for further lease. In addition, the lessor charges a premium on the
lease rentals
 Easy finance: - The availability of easy and convenient finance has proved to be a great
stimulant for the increase in demands for capital equipment. This is turn boosts the
manufacture and sales of the leasing companies
2. Advantages to lessee: -
 Efficient use of funds: - Leasing arrangements allow the lessee to acquire the use of the
asset without having to own it. This dispenses with the need for capital investment. This
way, more funds are released for working capital purpose.
 Cheaper source: - Leasing as a mode of financing the use of capital assets is found to be
less expensive, as compared to other modes such as the buying options’
 Flexible source:- Leasing of equipment is highly flexible source of financing ass compared
to other methods. The flexible nature of the lease contract allows for promotion of the
mutual interest of the parties, especially of the lessee
 46

 Tax benefits:- The extent of benefit that would be derived by owing an asset, by way of
depreciation tax shield is less than the benefit to the lessee by way of lease rentals. This is
because depreciation tax shield is lease than lease rentals. Moreover, lease rental are fully
tax- deductible.
 Favorable terms:- The terms of financial arrangements with institutions are usually
restrictive and disadvantageous to loan lease arrangements allow the use of the asset on
favorable terms.

LIMITATIONS OF LEASING
1. Disguised debt financing: - Evidence has been gained through studies that lease financing
is another form of debt financing.
2. Costly option: - When the leasing company acts only as a financial intermediary , and
borrows from the market at prevailing or even higher interest rates, leasing may prove to be a
costlier exercise as compared with a straight borrowing.
3. Loss of tax shield:- If depression rates are higher and leasing is preferred over buying , it
may result in loss of deprecation tax shield of the lease.
4. Double sales tax:- Depending on the prevailing sales tax laws in various states there are
responsibilities of the lease rental revenues attracting sales tax twice. Once at the time of the
sale and again when the asset is leased out.
5. Loss of residual value:- there is a loss of residual value for the lessee, since the leased asset
has to be returned to the lessor at the end of the lease period.

HIRE PURCHASE FINANCING

MEANING
A transaction of finance whereby goods are bought and sold as per the terms and conditions
specified below is known as 'hire purchase finance'.
1. Payment of periodic instalments.
2. Immediate possession of goods by the buyer.
3. Ownership of goods remaining with the vendor until the payment of the last
instalment.
4. Vendor's right to repossess the goods in the event of default committed by the
buyer.
5. Treatment of each instalment as hire charge till the payment of the last instalment.
RIGHTS OF HIRER
The Hire Purchase Act of 1972, provides the following rights to the hirer:
Right of Protection: It is not possible for the hire vendor to terminate the hire purchase
agreement on account of default in payment of hire charges by the hirer, or due to unauthorized
act or breach of express conditions, unless the hire vendor gives notice in writing to the hirer
in this regard.
Right of Notice: When the hire charges are weekly, or for a period less than that, one week
notice is to be given, and in all other cases a two weeks’ notice is to be given.
Right of Repossession: The right of repossession is not available to the hire vendor, unless
sanctioned by the court in the following cases:
1. One half of the price has been paid where the hire purchase price is less than Rs.15.000
(Rs.5,000 in the case of motor vehicles).
2. Three fourth of the price has been paid where the hire purchase price is not less than Rs.
15,000 (Rs.5,000 in the case of motor vehicles).
3. Three fourth or such higher proportion, not exceeding nine-tenth, where the hire purchase
price is not less than Rs. 15,000.
 47

Right of Statement: The hirer has the right to obtain a statement on payment of Re. 1,
containing details such as the amount paid by the hirer, the amount and the date upon which
the instalment becomes due but has not been paid, the amount of instalment, which will become
payable, etc.

Right to Excess Amount: The hirer has the right to obtain any amount in excess of the value
of goods repossessed, over and above the amount of instalments payable by the hirer, in the
rent of a default.
LEASE FINANCING VS.HIRE PURCHASE FINANCING
SI.no Characteristics Lease Financing HP Financing
1. Ownership Ownership of the property lies Ownership of the property is
withthe finance company, the transferred to the hirer on the
lessor and paymentof the last instalment.
it is never transferred to the
lessee,the user
2. Depreciation Lessor, and not the lessee, The hirer (owner) is entitled to
isentitled to claim depreciation claimdepreciation tax shield
tax
shield
3. Capitalization Capitalization of the asset is Capitalization of the asset is
done inthe books of the lessor, done inthe books of the hirer
the leasing
company
4. Payment The entire lease payments are Only the hire-interest is eligible
eligible for tax computation in for taxcomputation in the books
the books of the lessee of the hirer
5. Salvage Value The lessor, and not the lessee, The hirer can claim benefit of
hasthe right to claim the salvagevalue as the prospective
benefit of owner of the
salvage value asset

FACTORING- MEANING
Factoring is a type of finance in which a business would sell its accounts receivable
(invoices) to a third party to meet its short-term liquidity needs. Under the transaction between
both parties, the factor would pay the amount due on the invoices minus its commission or fees.

FUNCTIONS OF FACTORS
1. Credit Cover: The factor takes over the risk burden of the client and thereby the client’s
credit is covered through advances.
2. Case advances: The factor makes cash advances to the client within 24 hours of receiving
the documents.
3. Sales ledgering: As many documents are exchanged, all details pertaining to the transaction
areautomatically computerized and stored.
4. 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 owninterest.
5. 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
countrybetter than the exporter clients.
 48

MECHANISM
Under the factoring arrangement, the seller does not maintain a credit or collection
department. The jobinstead is handed over to a specialized agency called the factor. After each
sale, a copy of the invoice and delivery challan, the agreement and other related papers are
handed over to the factor.

TYPES OF FACTORING
1. Domestic factoring: Factoring that arises from transactions relating to domestic sales
is known as Domestic factoring.
Domestic factoring may be of three types as described below.
a) Disclosed factoring: In the type of factoring, the payment has to be made the buyer
directly to the factor named in the invoice. The arrangement for factoring may take the form of
recourse. Where by the supplier may continueto bear the risk of nonpayment by the buyer
without passing it on to the factor. In the case of nonrecourse factoring, factor assumes the risk
of bad debt arising from nonpayment.
b) Undisclosed factoring: Under undisclosed factoring the name of the proposed factor
finds no mention on the invoice madeout by the seller of goods. At through the control of all
monies remains with the factor the entire realizationof the sales transaction is done in the name
of the seller. This type of factoring is quite popular in the U.K.
c) Discount factoring: Discount factoring is process where the factor discounts the
invoices of the seller at a pre- agreed credit limit with the institutions providing finance .book
debts and receivables serve as securities for obtaining financial accommodation.
2. Export factoring: When the claims of an exporter are assigned to banker or any financial
institution, and financial assistance is obtain on the strength of export documents and
guaranteed payments it is called export factoring.
3. Cross – border factoring: Cross border factoring involves the claims of an exporter which
are assigned to a banker or any financial institution in the importer’s country and financial
assistance is obtained on the strength of the export documents and guaranteed payments.
4. Full – service factoring: Full – service factoring also known as old – line factoring is a type
of factoring where’ by the factor has no recourse to the seller in the event of the failure of the
buyers to make prompt payment of their dues to the factor, which might result from financial
inability or insolvency of the buyer.
5. With Resource factoring: The factor has recourse to the client firm in the event of the book
debts purchased becoming irrecoverable. The factor assumes no credit risks associated with the
receivables. If the customer defaults in payment, the resulting bad debt loss shall be met by the
firm.
 49

6. Without Resource factoring: No right with the factor to have recourse to the client. The
factor bears the loss arising out of irrecoverable receivables. The factor charges higher
commission called “delcredere commission” as a compensation for the said loss. The factor
actively involves in the process of grant of credit and the extension of line of credit to the
customers of the client.
7. Advanced and Maturity factoring: The factor makes an advance payment in the range of
70 to 80 percent of the receivables factored and approved from the client the balance amount
being payable after collecting from customers. The factor collects interest on the advance
payment from the client.
8. Bank participation factoring: It is variation of advance and maturity factoring under this
system of factoring, the factor arranges a part of the advance to the clients through the banker.
The net factor advance will be calculated as follows. [ factor advance percent X Bank advance
percent ]
9. Collection / maturity factoring: Under this type of factoring, the factor makes no
advancement of finance to the client. The factor makes payment either on the guaranteed
payment date or on the date of collection, the guaranteed payment date being fixed after taking
into.

FACTORING-PLAYERS
Factoring starts with credit sales made by the seller, and is mainly concerned with the
realization of credit sales. Factoring starts where credit sales ends. Thus, the Factor works
between the seller and buyer, and sometimes together with seller's bank too.
The people who take part in factoring services include the following:
1. Buyer of the goods who has to pay for them on credit terms.
2. Seller of goods, who has to realize credit sales from buyer.
3. 'Factor', who acts as agent in realizing credit sales from buyer and passes on the
realized sum to the seller after deducting a commission.
The various activities undertaken by the above parties in a factoring transaction are as
follows:
The Buyer
1. Negotiating the terms of purchase of goods and services with the seller
2. Receiving delivery of goods with invoice, and instructions from the seller regarding making
payment to the Factor on due dates.
3. Making payments to the Factor in time, getting an extension, or in the case of default
subjecting to the legal process at the hands of Factor

The Seller
1. Entering into a Memorandum Of Understanding (MOU) with the buyer by setting out the
terms and conditions of factoring
2. Making a sale of goods to the buyer as per the MOU
3. Delivering copies of invoice, delivery challan, MOU and paymen instructions given to the
buyer, and to the factor.
4. Receiving payment in advance from the factor on the sale of receivables 5. Receiving balance
payment from the factor, after deduction of the Factor's services charges, etc.

The Factor
1. Entering into an agreement with the seller for rendering factoring services.
2. On receipt of copies of the sale documents, making advance payment on the strength of book
debts to the seller.
3. Receiving payment from buyers on the due date and making remittances of the same to seller
after deductions, thus relieving the client of the bother of collection work.
 50

OPERATIONAL PROFILE OF INDIAN FACTORING

Domestic Factoring
1. Factoring is of the recourse factoring type.
2. The Factor undertakes collection and credit services.
3. Factoring is not available for deferred credit transaction type of credit sales.
4. Factoring advance up to 80 per cent is available to the seller (client).
5. Factors also undertake maintenance of the sales ledger by using computerized systems,
monthly sales analysis and overdue invoice analysis.
6. Factors provide customers' payment reports to the clients.
7. Availability in cash is directly geared to sales once a line of credit is established.
8. Factors charge for factoring receivables by way of service charges/fee without
guarantee/security being insisted upon, etc.
Export Factoring
1. Approval by RBI of the scheme evolved by the Export Credit and Guarantee Corporation of
India (ECGC) for the exporters for the purpose of providing a non-fund based export-factoring
service.
2. ECGC providing non-fund based export factoring as an in-house service. 3. ECGC granting
100 per cent credit protection to bills drawn on approved overseas buyers through endorsement
to the policy

DIFFERENCE BETWEEN BILL DISCOUNTING AND FACTORING

BASIS BILL DISCOUNTING FACTORING

Bill discounting means to

Factoring means to sell its bool debt to the
Meaning trade bill before it becomes
financialtransaction to the factoring company
due for payment at par value.
at a discount.
Bill discounting comes
Existence There is no such specific law for factoring.
under theNegotiable
instrument act, 1881.
In bill discounting, the bill is In factoring, the financer gives a maximum
Settlement of
discounted and paid when the amount as anadvance when a transaction takes
finance
transaction takes place. place the remaining amount at the time of
settlement.

Parties In bill discounting there is a In factoring, there is a factoring company,

involved drawer,drawee, and a payee. debtor and acustomer.

A financer charges fees in Financer gets fees in the form of interest for the
Fees
the formof discounting financialservices and commission for extra
charges or interest. services facilitate.
Type Recourse only Recourse and Non-Recourse

Assignment of
No Yes
Debts
 51

OPERATIONAL PROBLEMS IN INDIAN FACTORING

 Lack of access to any authentic common source of information.
 Lack of experience and database to take on jobs such as credit evaluation of clients.
 Expensive system of multiple databases maintained by individual Factors.
 Lack of uniformity in the working of specialized credit information agency/bureau.
 High stamp duty on assignment of debt to Factors.
 High cost of operations and consequent erosion of profitability for the Factors.
 No fool-proof legal framework available which is capable of protecting the interest
of the Factor and other parties involved in factoring.
 Lack of access to wider funding sources on the same scales as available to other
finance companies.
 Too much dependence on equity funds, forcing them to have a non-viable funding
pattern.
 Reluctance on the part of banks in India to issue a disclaimer certificate enabling
the purchase of book debts by the Factor.
 Not much headway achieved in export factoring.

DEBT SECURITIZATION- MEANING

Debt securitization is the process of packaging debts from a number of sources into
a single security to be sold to investors. Many such securities are batches of home mortgage
loans that are sold by the banks that granted them. The buyer is typically a trust that converts
the loans into a marketable security.
DEBT SECURITIZATION-PARTIES INVOLVED
A securitisation transaction generally involves some or all of the following parties:
(i) the initial owner of the asset (the originator or sponsor) who has a loan agreement
with the borrowers (obligors);
(ii) the issuer of debt instruments who also is the SPV.

STEPS OF SECURITIZATION
Securitization can be best described as a two-step process:
Step 1: Packaging: The bank (or financial institution) combines multiple assets into a single
“compound asset.” The return offered by the compound asset is some weighted average of the
return offered by the individual assets that make up the “compound asset.”
Step 2: Sale: The bank (or financial institution) sells the “compound asset” to global capital
market investors.

TYPES OF SECURITIZATION
The different kinds of receivables determine the type of securitization it requires. Given
below are some of the most common types of securitization:
1. Asset-Backed Securities (ABS): The bonds which are supported by underlying financial
assets. The receivables which are converted into ABS include credit card debts, student loans,
home-equity loans, auto loans, etc.
2. Residential Mortgage-Backed Securities (MBS): These bonds comprise of various
mortgages like of property, land, house, jewellery and other valuables.
3. Commercial Mortgage-Backed Securities (CMBS): The bonds that are formed by
bundling different commercial assets mortgage such as office building, industrial land, plant,
factory, etc.
4. Collateralized Debt Obligations (CDO):The CDOs are the bonds designed by re-bundling
the personal debts, to be marketed in the secondary market for prospective investors.
 52

5. Future Flow Securitization: The Company issues these instruments over its debts
receivable in a future period. The company meets the principal and interest through its routine
business operations, though such obligations are secured against its future receivables.

ADVANTAGES OF SECURITIZATION
 Provides Liquidity: The illiquid assets, such as the receivables on loans sanctioned by the
bank, are converted into liquid assets.
 Lowers Funding Cost: With the help of securitization, even the BB grade companies can
benefit by availing AAA rates if it has an AAA-rated cash flow.
 Risk Management: The financial institution lending the funds can transfer the risk of bad
debts by securitizing its receivables.
 Diversified Portfolio: The investor can attain a well-diversified portfolio on including the
securitized bonds; since these are very different from other instruments.
 Benefit Small Investors: The investors having minimal capital for investment can also
make a profit out of securitized bonds

DISADVANTAGES OF SECURITIZATION
 Lack of Transparency: The SPV may not disclose the complete information about the
assets included in a securitized bond to the investors.
 Complex to Handle: The whole process of securitization is quite complicated involving
multiple parties; also, the assets need to be blended wisely.
 Quite Expensive: When compared to share flotation, the cost of a securitized bond is
usually high, including underwriting, legal, administration and rating charges.
 Investor Bears Risk: The non-repayment of debts by the borrower would ultimately end
up as a loss to the investors. Therefore, the investor is the sole risk-bearer in the process.

SARFAESI Act, 2002

The SARFAESI Act full form is – “Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest Act”. The SARFAESI Act allows banks and other financial
institutions for auctioning commercial or residential properties to recover a loan when a
borrower fails to repay the loan amount. Thus, the SARFAESI Act, 2002 enables banks to
reduce their non-performing assets through recovery methods and reconstruction.

OBJECTIVES OF SARFAESI Act

 Efficient or rapid recovery of non-performing assets (NPAs) of the banks and FIs.
 Allows banks and financial institutions to auction properties (say,
commercial/residential) when the borrower fails to repay their loans.

PURPOSE OF SARFAESI Act

 The SARFAESI Act allows banks and other financial institutions for auctioning
commercial or residential properties to recover a loan when a borrower fails to
repay the loan amount.
 Thus, the SARFAESI Act, 2002 enables banks to reduce their non-performing assets
through recovery methods and reconstruction.

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 53

FINANCIAL SERICES
UNIT-V
UNIT V: Venture Capital, credit rating and pension Fund Origin and Growth of Venture
Capital - Investment Nurturing Methods - Mutual Funds - Portfolio Management Process
in Mutual Funds - Credit Rating System - Growth Factors - Credit Rating Process -
Global and Domestic Credit Rating agencies - Pension Fund - Objectives - Functions -
Features - Types - Chilean Model - Pension Investment Policy - Pension Financing.
VENTURE CAPITAL- MEANING
Venture capital refers to an equity/equity-related investment in a growth- oriented
small/medium business to enable the investors to accomplish corporate objectives, in return for
monetary shareholding in the business or the irrevocable right to acquire it. Venture capital is
a typical "private equity investment'.
FEATURES
1. New ventures: Venture capital investment is generally made in new enterprises that use new
technology to produce new products, in expectation of high gains or sometimes, spectacular
returns.
2. Continuous involvement Venture capitalists continuously involve themselves with the
client's investments, either by providing loans or managerial skills or any other support.
3. Equity investment Venture capital is basically an equity financing method, the investment
being made in relatively new companies when it is too early to go to the capital market to raise
funds. In addition, financing also takes the form of loan finance/convertible debt to ensure a
running yield on the portfolio of the venture capitalists.
4. Objective The basic objective of a venture capitalist is to make a capital gain on equity
investment at the time of exit, and regular return on debt financing. It is a long-term investment
in growth-oriented small/medium firms. It is a long-term capital that is injected to enable the
business to grow at a rapid pace, mostly from the start-up stage.
5. High risk-return ventures: Venture capitalists finance high risk- return ventures. Some of
the ventures yield very high return in order to compensate for the heavy risks related to the
ventures. Venture capitalists usually make huge capital gains at the time of exit.

ORIGIN AND GROWTH OF VENTURE CAPITAL

The origin and the growth of venture capital funds the world over is presented below
briefly:
USA
The American Research and Development Corporation (ARDC) was formed as the first
venture capital organization, in the year 1946. The object was the promotion of new
technologies developed in institutions like Massachusetts Institute of Technology (MIT). The
other groups that subsequently formed venture capital funds included Draper, Gaither and
Anderson, and Davis and Rock. Thereafter, phenomenal growth was witnessed in the venture
capital financing.
UK
In the 1980s, several new independent funds like Equity Capital for Industry (ECI),
Public Utility Pension Funds, National Enterprise Board, and several semi-state venture capital
bodies like Scottish and Welsh Development Agencies were incorporated. The venture capital
funds that are active at present in the U.K. may be grouped under the following:
1. Clearing bank captive funds.
2. Funds sponsored by savings and investment institutions and merchant bankers.
 54

EUROPE
Venture capital financing became popular in continental Europe in the eighties
particularly in France, the Netherlands, Sweden and Belgium under the lead of UK. In 1983,
the European Venture Capital Association (EVCA) was formed with a membership of 40
funds, of which 11 are British, 10 French, 6 Dutch and 4 Belgium, 3 Irish, and 3 from Erstwhile
West Germany origins. The Fund was primarily aimed at assisting the growth of the small
business sector in the member countries of the European community.
INDIA
Venture capital that originated in India very late, is still in its infancy. It was the Bhatt
Committee (Committee on Development of Small and Medium Entrepreneurs) in the year
1972, which recommended the creation of venture capital. .A brief description of some of the
venture capital funds of India is as follows:
a. Risk capital foundation The Industrial Finance Corporation of India (IFCI) launched the
first venture capital fund in the year 1975. The fund, 'Risk Capital Foundation' (RCF) aimed at
supplementing 'promoters equity' with a view to encouraging technologists and professionals
to promote new industries.
b. Seed capital scheme This venture capital fund was launched by IDBI in 1976, with the same
objective in mind.
c. Venture capital scheme Venture capital funding obtained official patronage with the
announcement by the Central Government of the 'Technology Policy Statement' in 1983. It
prescribed guidelines for achieving technological self- reliance through commercialization and
exploitation of technologies. The ICICI, an all-India financial institution in the private sector
set up a Venture Capital Scheme in 1986, to encourage new technocrats in the private sector to
enter new fields of high technology with inherent high risk. The scheme aimed at allocating
funds for providing assistance in the form of venture capital to economic activities having risk,
but also high profit potential.

INVESTMENT NURTURING
Definition
The process, by which venture capital companies continue to involve themselves in the
operations of concerns assisted by them, is called "investment nurturing" There is an enduring
relationship of after-funding care between the venture capital companies and the units assisted
by them.
Objectives
Following are the objectives of investment nurturing undertaken by the venture capital
companies:
1. Ensuring proper utilization of assistance provided, any deviation from the
programme/appraisal should be with the prior approval of the VCI.
2. Ensuring the implementation of the project/venture within the time and cost/envisaged.
3. Assisting in finding additional/supplementary finance, in case of time and cost over-runs
beyond the control of the VCU.
4. Providing strategic inputs in technology, production, finance, marketing. personnel and so
on.
5. Anticipating likely problems and advise preventive/remedial actions.
6. Ensuring that the venture does not default in any statutory/other obligations.
7. Evaluating the performance of the project and suggesting measures for improvement, if
required.
 55

MUTUAL FUNDS- MEANING

`A trust that pools the savings of investors who share a common financial goal is known
as a 'Mutual Fund'. The money thus collected is then invested in financial market instruments
such as shares, debentures and other securities like Government paper, etc.

FEATURES/ROLE/BENEFITS
1. Mobilizing small savings Mutual funds mobilize funds by selling their own shares,
known as units. To an investor, a unit in mutual funds means ownership of a proportional share
of securities in the portfolio of a mutual fund.
2. Reduced risks: Mutual funds provide small investors the access to a reduced
investment risk resulting from diversification, economies of scale in transaction cost and
professional finance management.
3. Tax benefits An attractive benefit of mutual funds is that the various schemes offered
by them provide tax shelter to the investor. This benefit is available under the provisions of the
Income Tax Act.
4. Low transaction costs The cost of purchase and sale of mutual fund units is
relatively lower. This is due to the large volume of money being handled by mutual funds in
the capital market.
5. Convenience Mutual Fund units can be traded easily and with little or no
transaction costs. No brokerage is incurred.

PRODUCTS/SCHEMES OF MUTUAL FUNDS

1. Operational Classification

a. Open-ended scheme When a fund is accepted and liquidated on a continuous basis by a

mutual fund manager, it is called 'open-ended scheme'. The fund manager buys and sells units
constantly on demand by the investors.
b. Close-ended scheme When units of a scheme are liquidated (repurchased) only after the
expiry of a specified period, it is known as a close-ended scheme. Accordingly, such funds
have fixed capitalization and remain as a corpus with the mutual fund manager
2. Return-based Classification
a. Income fund scheme The scheme that is tailored to suit the needs of investors who are
particular about regular returns is known as 'income fund scheme. The scheme offers the
maximum current income, whereby the income earned by units is distributed periodically.
b. Growth fund scheme It is a mutual fund scheme that offers the advantage of capital
appreciation of the underlying investment. For such funds, investment is made in growth-
oriented securities that are capable of appreciating in the long run. Growth funds are also known
as nest eggs or long haul investments.
c. Conservative fund scheme A scheme that aims at providing a reasonable rate of return,
protecting the value of the investment and achieving capital appreciation, may be designated
as 'conservative fund scheme'. These are also known as middle-of-the-road funds, since such
funds offer a blend of all these features
3. Investment-based Classification
a. Equity fund scheme: A kind of mutual fund whose strength is derived from equity-based
investments is called 'equity fund scheme'. They carry a high degree of risk. Such funds do
well in periods of favorable capital market trends.
b. Bond fund scheme: It is a type of mutual fund whose strength is derived from bond-based
investments. The portfolio of such funds comprises bonds. Debentures, etc. This type of fund
carries the advantage of secure and steady income.
 56

c. Balanced fund scheme: A scheme of mutual fund that has a mix of debt and equity in the
portfolio of investments may be referred to as a 'balanced fund scheme'. The portfolio of such
funds will be often shifted between debt and equity, depending upon the prevailing market
trends
d. Sectoral fund schemes: When the managers of mutual funds invest the amount collected
from a wide variety of small investors directly in various specific sectors of the economy, such
funds are called sectoral mutual funds. The specialized sectors may include gold and silver,
real estate, specific industry such as oil and gas companies, offshore investments, etc.
e.Fund-of-fund scheme There can also be Funds of Funds, where funds of one mutual fund
are invested in the units of other mutual funds. There are a number of funds that direct
investment into a specified sector of the economy. This makes diversified and yet intensive
investment of funds possible.
f. Leverage-fund scheme:The funds that are created out of investments, with not only the
amount mobilized from small savers but also the fund managers who borrow money from the
capital market, are known as 'leveraged-fund scheme.
g. Gilt funds These funds seek to generate returns through investment in gilts. Under this
scheme, funds are invested only in Central and State Government securities and repos/reverse
repo in such securities, and not in equity or corporate debt securities. A portion of the corpus
may be invested in the call money market or RBI to meet liquidity requirement.
h. Index-funds These funds are also known as growth funds, but they are linked to a specific
index of share prices. It means that the funds mobilized under such scheme are invested
principally in the securities of companies whose securities are included in the index concerned
and in the same weightage.
i. Tax saving schemes: Certain mutual fund schemes offer tax rebate on investments made in
equity shares, under Section 88 of the Income Tax Act 1961. Income may also be periodically
distributed, depending upon surplus. Subscriptions made upto Rs. 10,000 in an assessment year
are eligible for tax rebate under Section 88.

PORTFOLIO MANAGEMENT PROCESS IN MUTUAL FUNDS

The Portfolio management process of a mutual fund involves the following four basic
steps:
1. Setting Investment Goal: The first and foremost task of managing the portfolio of a mutual
fund is to identify and set the goal for the proposed scheme. The goal is set keeping in mind
considerations such as the protection of investors, nature of the scheme, risk and return, market
conditions, regulatory norms, size of issue, etc.
2. Identifying Specific Securities: When once the goal to be, accomplished by the proposed
scheme has been identified, efforts are made to analyze and identify the right security where
funds are required to be invested. For this purpose, security analysis is carried out from the
viewpoint of the company, industry and the economy. For each security, risk and return
characteristics are evaluated in a broader perspective. For the purpose of analysis, the fund
manager considers the strengths and weaknesses of some of the sample securities.
3. Portfolio Designing: Portfolio designing involves making an ideal mix of debt and equity
securities of corporates, Government, etc. It is concerned with decisions regarding the type of
securities to be bought, the quantum and the timing of issue. Portfolio designing is carried out
on the basis of research and analysis of stock markets. Based on their results, the long-term and
short-term investment strategies are worked out.
4. Portfolio Revision: The build-up of portfolio needs to be periodically reviewed keeping in
mind the risk-return characteristics of all securities under the changing circumstances. The
revision of the portfolio has to be undertaken in the context of the dynamic investment world.
Further, the exercise is to be taken up to cash on the renewed market opportunities in order to
maximize the portfolio returns.
 57

CREDIT RATING- MEANING

A credit rating is a quantified assessment of the creditworthiness of a borrower in
general terms or with respect to a particular debt or financial obligation. A credit rating can be
assigned to any entity that seeks to borrow money—an individual, corporation, state or
provincial authority, or sovereign government.

CHARACTERISTICS OF CREDIT RATING

1. Assessment of issuer's capacity to repay. It assesses issuer's capacity to meet its financial
obligations i.e., its capacity to pay interest and repay the principal amount borrowed.
2. Based on data. A credit rating agency assesses financial strength of the borrower on the
financial data.
3. Expressed in symbols. Ratings are expressed in symbols e.g. AAA, BBB which can be
understood by a layman too.
4. Done by expert. Credit rating is done by expert of reputed, accredited institutions.
5. Guidance about investment-not recommendation. Credit rating is only a guidance to
investors and not recommendation to invest in any particular instrument.

CREDIT RATING PROCESS

In India credit rating is done mostly at the request of the borrowers or issuer companies.
The borrower or issuer company requests the credit rating agency for assigning a ranking to
the proposed instrument. The process followed by most of the credit rating agencies is as
follows:
1. Agreement. An agreement is entered into between the rating agency and the issuer company.
It covers details about terms and conditions for doing the rating.
2. Appointment of analytical team. The rating agency assigns the job to a team of experts.
The team usually comprises of two analysts who have expert knowledge in the relevant
business area and is responsible for carrying out rating.
3. Obtaining information. The analytical team obtains the required information from the
client company and studies company's financial position, cash flows, nature and basis of
competition, market share, operating efficiency arrangements, managements track cost
structure, selling and distribution record, power (electricity) and labour situation etc.
4. Meeting the officials. To obtain clarifications and understanding the client's business the
analytical team visits and interacts with the executives of the client.
5. Discussion about findings. After completion of study of facts and their analysis by the
analytical team the matter is placed before the internal committee (which comprises of senior
analysts) an opinion about the rating is taken.

CREDIT RATING SYSTEM-GROWTH FACTORS

1. Credibility and Independence: Ratings are considered valuable only as long as they are
credible. Credibility arises primarily from objectivity, which results from the rating agency
being independent of the issuer's business.
2. Capital Market Mechanism: A strong demand for investment related information is
generated due to the reliance on the capital market for resource allocation. Rating agencies
provide this information. Investors consider rating as an important input for their investment
decisions only when there is a perceived default risk.
3. Disclosure Requirements: Rating agencies have assumed importance on account of their
task of assigning grades to securities issued by companies. Moreover, it is becoming incumbent
for companies, due to regulatory guidelines, to have adequate corporate disclosure and to
publish all the essential information required by the investors. These guidelines require a
mandatory disclosure of ratings.
 58

4. Credit Education: Credit rating serves as an effective educator on the modalities of arriving
at valid judgments about investing in securities. It is to be noted that the information should
not only reach the investor, but it must also enable them to make meaningful interpretations.
The investor should also be aware of the limitations of credit rating and should realize that the
rating is not an insurance or guarantee against default risk.
5. Creation of Debt Market: Credit rating is considered as an essential input for guiding
investments in bonds. This assumes significance in the context of substantial risks involved in
their subscription. In fact, the continued growth and evolution of the credit rating business
depends on the size and growth of the debt market. An active primary and secondary debt
market is crucial for rating agencies to continue to provide their services.
GLOBAL CREDIT RATING AGENCIES
A brief note on the background of the major international rating agencies is as follows:
1. Moody’s Investors Service (Moody's)
John Moody founded this agency by the turn of the century. The agency offers rating coverage
for a wide range of debt related securities, both in U.S. and international markets. In 1919, it
assigned sovereign ratings to the debt of countries such as Britain, France, etc., and in 1950, it
rated international issuers such as Canada, World Bank, etc. It offered rating of Commercial
paper in 1970. By late 1970s this was extended to rating of Certificate of Deposit, both in the
U.S. and internationally. Other services include rating of mortgage and asset backed securities,
assessing the financial strength of insurance companies. Mutual Funds, U.S. and international
banks, Sovereign nations, public utilities and Municipal bonds. Ratings were internationalized
in the mid 1980s with a network of offices in other continents.
2. Standard and Poor's Corporation (S&P)
S & P is a premier international rating agency, which began its operations with a
publication containing financial information on U.S. industrial companies. S & P also offers
rating on a wide range of debt securities, both in the U.S. and overseas markets. It has issued
outstanding ratings on bonds and preferred stocks, and short-term ratings on U.S. corporates,
Municipalities and States. International ratings include Government debts, municipalities and
sovereign nations. It has also participated in other local rating agencies, such as joint ventures
in Australia, France, Sweden, and Thailand. As part of its information desk, it brings out a
publication with ratings of common stocks and mutual funds.
3. Duff and Phelps Credit Rating Co (DCR)
DCR is a major international source of credit information. It has been in existence for
over sixty years. It rates all major types of fixed-income securities, long-term and short-term
debt of corporations, sovereign nations and financial institutions. It also rates-structured
financing, mortgage-backed securities and insurance companies. It has established joint
ventures, largely in Latin American countries and since 1992, also in Asian countries such as
Pakistan and India.
4. Japan Credit Rating Agency (JCR)
It was established in 1985 and was promoted by financial institutions, banks and
insurance companies in Japan. It provides ratings to foreign and domestic debt issuers.
5. IBCA Limited
This is an independent and privately owned international credit rating agency based in
London. First of its kind, it was established with the objective of offering credit analysis on
banks in different countries. In 1988, it expanded its coverage to include industrial and
commercial corporates. At present, it provides credit analysis on banks and financial
institutions in more than 25 countries and large number of corporates in Europe.
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6. Thomson Bank Watch

This rating agency is based in Toronto, Canada. It is a subsidiary of the Thomson
Corporation. It is a rating agency exclusively offering grades of rating to financial institutions
including banks, securities firms and finance companies.

DOMESTIC CREDIT RATING AGENCIES

Credit rating business in India started only recently. It was in the late eighties (1987)
that the first rating agency, CRISIL, was established. At present, there are three rating agencies,
namely, CRISIL, ICRA Ltd and CARE. The fourth. rating agency is a joint venture between
Duff and Phelps, U.S. and Alliance Capital Limited, Calcutta.
CRISIL
CRISIL was jointly promoted by ICICI, nationalized and foreign banks, and insurance
companies in 1987. It went public in 1992, and is the only listed credit rating agency in India.
Since 1995, in strategic alliance with Standard & Poor's, it has extended its credit rating
services to borrowers from the overseas market. The services offered are broadly classified as
rating, information services, infrastructure services, and consultancy. Rating services cover the
rating of long, medium and short-term debt instruments, securitized assets and builders.
Information services include corporate research reports and the CRISIL 500 index. The
infrastructure and consultancy division provides assistance on specific sectors such as power,
telecom and infrastructure financing.
ICRA
ICRA was promoted in 1991, by IFCI and 21 other shareholders comprising of
nationalized and foreign banks and insurance companies. It is the second rating agency to be
established in India. The services offered can be broadly classified as rating services, advisory
services and investment information services.
The rating services comprise rating of debt instruments and credit assessment Advisory
services include strategic counseling, general assessment such as restructuring, and services
specific to sectors, such as for power, telecom, ports, municipal ratings, etc.
The information desk provides research reports on specific industries, sectors and
corporates. The information services also include equity related services, viz., Equity Grading
and Equity Assessment. In 1996, ICRA entered into a strategic alliance with Financial
Proforma Inc, a Moody's subsidiary. to offer services on Risk Management Training and
Software. Moody's and ICRA have entered into a Memorandum of Understanding to support
these efforts.
CARE
CARE was incorporated in 1992, with the combined efforts of IDBI, and several other
banks and insurance companies. The services cover rating of debt instruments and sector
specific industry reports.

CONCEPT OF PENSION
Retirement income contract between the employee and employer that represents the
benefit payable, either as a lump sum amount or in the form of annuities, by an employer to an
employee, for the service rendered by the latter, is known as 'pension. It is an important
constituent of the broader concept of social security.

PENSION FUND -MEANING

Pension funds are financial intermediaries which offer social insurance by
providing income to the insured persons following their retirement. Often they also provide
death and disability benefits.
 60

OBJECTIVES/FEATURES OF PENSION FUND

1. Insurance against Infirmness: Pension funds are designed to provide for poverty relief,
consumption smoothing and insurance in respect of longevity, etc. In the words of the Asian
Development Bank (ADB), 'old age pensions are designed to meet the requirements of an
individual when, due to ageing, his/her capacity for work declines to the point where he/she is
unable to be self-sufficient'.
2. Socio-economic Justification: A pension fund not merely affords compensation for the
loyal service rendered in the past, but in a broader significance, works as a measure of socio-
economic justice. It provides economic security in the fall of life when physical and mental
prowess of an individual is receding corresponding to ageing process. and, therefore, one is
required to fall back on savings. It is a social welfare measure rendering socio-economic justice
to those who in the heydays of their life have toiled ceaselessly for the employer on an
assurance that in their old age they would not be left in the lurch.
3. Employee’s Right: A pension is neither a bounty nor a matter of grace that depend upon the
sweet will of the employer. In fact, it creates a vested right on the part of the employee. Pension
is not an ex-gratia payment but is a payment for the past service rendered.
4. Balance of Interest: The design of a pension fund aims at obtaining a balance between
retirement benefit of the employees and the financial burden of the State Governments. Hence,
the pension arrangements take into consideration the needs of the employees in their old age
on the one hand and the financial burden of the State Governments on the other.

TYPES OF PENSION FUND

1. Defined Benefit (DB) pension fund: The contractual arrangement that sets out the rights
and obligations of all parties and where pensions are paid from a separate pool of assets, set
aside to provide collateral for the promised benefits, it is a case of 'Defined Benefit Pension
Fund'. The level of pension benefit is determined as a function of both years of service and
wage history.
2. Defined Contribution (DC) pension fund: A pension system that involves defined annual
contributions, whose benefits depend on the return on investments and the length of
contribution, is called 'defined contribution pension fund'
3. Notional Defined Contribution (NDC) pension fund NDC is a variant of defined
contribution pension. Under this type of pension system, a notional account is accumulated
during the working life of an employee based on contributions, both by the employee and the
employer.
4. PAYG pension fund Under the PAYG (Pay-As-You-Go) scheme, current pensioners are
paid through the contributions of taxes of the current generation of workers. Under this plan, a
direct transfer of resources takes place from the current workforce to those in receipt of
pensions.
5. Private Pension Fund: Where a sponsor is in the nature of a private business entity that acts
for its employees, it is a case of "private pension fund". It is also known as 'corporate pension
plan'. Pension programs that are operated by private agencies are called private pension funds.
6. Public Pension Fund: Pension funds that are sponsored by the Government, either for its
own workers or for the general population, are called 'public pension plans'. Where a sponsor
is in the nature of federal, state, and local entities that acts for their employees, it is a case of a
'public pension plan'.

FUNCTIONS/BENEFITS OF PENSION FUND

1. Peaceful Retired Living: Pension funds make it possible for a person to lead an unruffled
life after retirement. The savings mechanism built into the pension system allows for sufficient
accumulation of money in the early ages of the person so as to be used in the latter part of one's
 61

life. An individual would be able to achieve a higher level of economic well-being with the
help of pension funds.
2. Income Opportunity: Pension funds offer an opportunity for an individual to earn regular
income through a host of financial markets and institutions operating in the pension market.
Pension funds provide for the investment of surplus funds today for greater consumption and
a higher standard living of tomorrow.
3. Cushion Against Volatile Income: Acting as financial intermediaries, pension funds help
in bridging the gap between rising desired expenditures during the retirement period and the
abrupt decline in income at the cessation of the individual's work career. In fact, pension fund
managers have a fiduciary responsibility to deliver promised pension benefits. For this purpose,
they are usually subject to extensive Government regulations covering the quality of their
investments and the treatment of pension plan members.
4. Low Risk Option: By providing for a low-cost method for the employees of business firms
and Governments to accumulate a highly diversified portfolio of assets, pension funds carry
fairly low risk.
5 Tax Advantage: In order to sustain the pension and motivate employees to take part in the
pension system, it is essential that necessary tax incentives be extended to beneficiaries.
Further, providing tax relief to contributions constitutes an important incentive in creating an
environment for the acceptance of the scheme.

CHILEAN MODEL
Many types of models are available as to the management of pension funds
Popular among them is the 'Chilean Model'. The model is followed worldwide. The Indian
Government too is all set to adopt this model to undertake the much needed and long-awaited
pension reforms in the country. The system provides for collection and investment of the
employees provident fund. Similarly, the Chile's experience in this regard has interesting
lessons for India. Chile, which began its economic liberalization program 20 years ago, has
managed to maintain a sustained and impressive growth in its national savings, largely by
creating a safe and innovative institutional framework for attracting and investing the savings
of its huge middle class.
Some of the essential features of the Chilean Model of pension fund management
are as follows:
1. Capital market linkage: Chile's model of pension fund management lays emphasis on the
ability of the pension fund to link the massive corpus of employees' pension fund to the capital
market. The objective is to create a market driven fund by both domestic funds as well as by
the Foreign Institutional Investors (FIIs). The huge pension fund market in Chile has been
responsible for safeguarding the country against the shock waves sent out by the Mexican crisis
in that region.
2. Higher return: According to the Chilean model, management of pension funds by the
Government is inefficient which gave only a low rate of return to the investor. The Chilean
model advocates taking away the PFS (Pension Funds) completely from Government control
so that smaller fund managers could manage them privately but strictly working under the
control of the Government supervision.
3. Wide options: Under this model, the employee has the option to choose from the scores of
pension funds, which are run privately, but strictly monitored by Superintendence of Pension
Fund Administrators'. There is one administrator, who acts as a regulatory authority, for each
pension fund. The employees go for the fund, which charges the lowest fee with an indicative
return.
4. Portfolio composition: The portfolio composition of funds is highly regulated and
investments are made on the basis of a very conservative risk evaluation system. Most
importantly, the Government stands as a guarantor to compensate the employee in the event of
 62

occurrence of fraud. Besides, there are also specific measures, which limit the losses of the
pension saver.
5. Portfolio management: Pension fund administration companies invest in stocks, bonds and
Government debt. They also invest in safe instruments in the international market. This acts as
a cushion when there is a sudden dollar outflow when foreign institutional investors operating
in Chile book their profits by selling stocks.

PENSION INVESTMENT POLICY

A brief description of the investment policy generally adopted by pension fund managers is
presented below:
Investment Factors
The pension fund investment policies are influenced by a number of factors. These
include source of funding, incidence of taxation, quality of sponsoring firm's management, the
nature of fund obligations, limitations on the investment policy of a fund, etc. The relevant
factors are outlined below:
a. Funding source: One of the important factors that shape the amount of retirement benefit
is the source of funding chosen by the sponsor or the employee. It is imperative that the funding
source is stable. This emanates from the fact that contractual nature of contributions made by
employers and employees are highly stable in nature. This makes possible any prediction of
the expected future outflows in the form of pension.
b. Taxes: Taxes strongly influence the pension policy of an organization Taxes affect both the
mix of contributions by employers and employees, and the nature of fund investments. For
instance, the tax incentive available to an employer facilitates making contributions for
building a pension fund for the benefit of the employees. Further, as there are no taxes payable,
pension fund managers command the incentive of making investment of funds.
c. Management wish: An important factor that influences the investment policy of a pension
fund is that the management wish to achieve a high return on any funds placed with the pension
programme. The objective is to ensure payment of promised retirement benefits at minimum
cost to the sponsoring employer. This, in fact, helps the employer to promise adequate build-
up and payment of retirement income.
d. Funding obligations The nature of funding obligations promised to the pension
beneficiaries determine, to a great extent, the types of investments that will be made by pension
funds. The funding obligations are of two types. They are fixed annuity and the variable
annuity.

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