Meaning and definition of financial system:The financial system is possibly the most

important institutional and functional vehicle for economic transformation. Finance is a

bridge betweenthe present and the future and whether the mobilization of savings or
their efficient, effective and equitable allocation for investment, it the access with which
the financial system performs its functions that sets the pace for the achievement of
broadernational objectives.

Features of financial systemThe features of a financial system are as follows1.Financial

system provides an ideal linkage between depositors andinvestors, thus encouraging
both savings and investments.2.Financial system facilitates expansion of financial
markets over space and time.3.Financial system promotes efficient allocation of
financial resources for socially desirable and economically productive
purposes.4.Financial system influences both the quality and the pace of economic
development.

FunctionsofFinancialSystem:The financial system helps production, capital

accumulation, and growth by (i) encouraging savings, (ii) mobilising them, and (iii)
allocating them among alternative uses and users. Each of these functions is important
and the efficiency of a given financial system depends on how well it performs each of
these functions.(i)EncourageSavings:Financial system promotes savings by providing a
wide array of financial assets as stores of value aided by the services of financial
markets and intermediaries of various kinds. For wealth holders, all this offers ample
choice of portfolios with attractive combinations of income, safety and yield.With
financial progress and innovations in financial technology, the scope of portfolio choice
has also improved. Therefore, it is widely held that the savings-income ratio is directly
related to both financial assets and financial institutions. That is, financial progress
generally insures larger savings out of the same level of real income.

As stores of value, financial assets command certain advantages over tangible assets
(physical capital, inventories of goods, etc.) they are convenient to hold, or easily
storable, more liquid, that is more easily encashable, more easily divisible, and less
risky.(ii)MobilisationofSavings:Financial system is a highly efficient mechanism for
mobilising savings. In a fully-monetised economy this is done automatically when, in the
first instance, the public holds its savings in the form of money. However, this is not the
only way of instantaneous mobilisation of savings..(iii)AllocationofFunds:Another
important function of a financial system is to arrange smooth, efficient, and socially
equitable allocation of credit. With modem financial development and new financial
assets, institutions and markets have come to be organised, which are replaying an
increasingly important role in the provision of credit.
Merchant Banker

Merchant Banking is a combination of Banking and consultancy services. It provides consultancy to its
clients for financial, marketing, managerial and legal matters. Consultancy means to provide advice,
guidance and service for a fee. It helps a businessman to start a business. It helps to raise (collect)
finance. It helps to expand and modernize the business. It helps in restructuring of a business. It helps to
revive sick business units. It also helps companies to register, buy and sell shares at the stock exchange.

The functions of merchant banking are listed as follows:

1. Raising Finance for Clients : Merchant Banking helps its clients to raise finance through
issue of shares, debentures, bank loans, etc. It helps its clients to raise finance from the
domestic and international market. This finance is used for starting a new business or
project or for modernization or expansion of the business.
2. Broker in Stock Exchange : Merchant bankers act as brokers in the stock exchange. They
buy and sell shares on behalf of their clients. They conduct research on equity shares.
They also advise their clients about which shares to buy, when to buy, how much to buy
and when to sell. Large brokers, Mutual Funds, Venture capital companies and
Investment Banks offer merchant banking services.
3. Project Management : Merchant bankers help their clients in the many ways. For e.g.
Advising about location of a project, preparing a project report, conducting feasibility
studies, making a plan for financing the project, finding out sources of finance, advising
about concessions and incentives from the government.
4. Advice on Expansion and Modernization : Merchant bankers give advice for expansion
and modernization of the business units. They give expert advice on mergers and
amalgamations, acquisition and takeovers, diversification of business, foreign
collaborations and joint-ventures, technology up-gradation, etc.
5. Managing Public Issue of Companies : Merchant bank advice and manage the public
issue of companies. They provide following services:
i. Advise on the timing of the public issue.
ii. Advise on the size and price of the issue.
 iii. Acting as manager to the issue, and helping in accepting applications and
allotment of securities.
iv. Help in appointing underwriters and brokers to the issue.
v. Listing of shares on the stock exchange, etc.
6. Handling Government Consent for Industrial Projects : A businessman has to get
government permission for starting of the project. Similarly, a company requires
permission for expansion or modernization activities. For this, many formalities have to
be completed. Merchant banks do all this work for their clients.
7. Special Assistance to Small Companies and Entrepreneurs : Merchant banks advise small
companies about business opportunities, government policies, incentives and concessions
available. It also helps them to take advantage of these opportunities, concessions, etc.
8. Services to Public Sector Units : Merchant banks offer many services to public sector
units and public utilities. They help in raising long-term capital, marketing of securities,
foreign collaborations and arranging long-term finance from term lending institutions.
9. Revival of Sick Industrial Units : Merchant banks help to revive (cure) sick industrial
units. It negotiates with different agencies like banks, term lending institutions, and BIFR
(Board for Industrial and Financial Reconstruction). It also plans and executes the full
revival package.
10. Portfolio Management : A merchant bank manages the portfolios (investments) of its
clients. This makes investments safe, liquid and profitable for the client. It offers expert
guidance to its clients for taking investment decisions.

Significance of Financial Instruments

Types of Financial Instruments

Financial Instruments are intangible assets, which are expected to provide future benefits in the
form of a claim to future cash. It is a tradable asset representing a legal agreement or a
contractual right to evidence monetary value / ownership interest of an entity.

Under the subject of Finance Management, Financial Instrumentscan be classified as cash

instruments and derivative instruments. Financial Instruments are typically traded in financial
marketswhere price of a security is arrived at based on market forces.

Cash Instruments:

Cash Instruments are tradable and derive their value from financial markets. Cash Instruments
can be further classified into equity instruments and debt instruments.

Equity Instruments refer to instruments which represent ownership of the asset. Types of
Equity Instruments are as follows:

• Common Shares: Common (ordinary) shares represent partial ownership of the company and
provide their holders claims to future streams of income, paid out of company profits and
commonly referred to as dividends.
 • Preferred shares is a financial instrument, which represents an equity interest in a firm and
which usually does not allow for voting rights of its owners. Typically the investor into it is only
entitled to receive a fixed contractual amount of dividends and this make this instrument similar
to debt. Preferred shares can also be non-cumulative, redeemable, convertible, participating
etc.
• Private Equity: When companies are organized as partnerships and private limited companies,
their shares are not traded publicly. The form of equity investments, which is made through
private placements, is called private equity. The most important sources of private equity
investments come from venture capital funds, private equity funds and in the form of leveraged
buyouts.
• ADRs, GDRs: Investors may invest into foreign shares by purchasing shares directly, purchasing
American Depository Receipts (ADRs), Global Depository Receipts (GDRs).
• Exchange traded funds (ETFs) are passive funds, that track specific index. Thus investor can
invest into a specific index, representing a country’s (e.g. foreign) stock market.

Debt Instruments represent debt/ loan given by a financial investor to the owner of the asset.
The types of bonds issued in debt capital markets include Callable and Potable bonds,
Convertible bonds, Eurobonds, Floating rate notes, foreign bonds, Index linked bonds, Junk
bonds, Strips etc.

Derivative Instruments:

Investments based on some underlying assets are known as derivatives. In general derivatives
contracts promise to deliver underlying products at some time in the future or give the right to
buy or sell them in the future. Types of derivative instruments are as follows:

• Forward Contract: A forward contract gives the holder the obligation to buy or sell a certain
underlying instrument at a certain date in the future at a specified price.
• Futures Contract: Futures contracts are forward contracts traded on organized exchanges. A
futures contract is a legally binding commitment to buy or sell a standard quantity at a price
determined in the present (the futures price) on a specified future date.
• Swaps: A swap is an agreement whereby two parties (called counterparties) agree to exchange
periodic payments. The cash amount of the payments exchanged is based on some
predetermined principal amount.
• Options: An option is a contract in which the option seller grants the option buyer the right to
enter into a transaction with the seller to either buy or sell an underlying asset at a specified
price on or before a specified date.

Difference Between Primary Market vs Secondary Market

The primary market refers to the market where securities are created, while the secondary market is
one in which they are traded among investors. Various types of issues made by the corporation are a
Public issue, Offer for Sale, Right Issue, Bonus Issue, Issue of IDR, etc. The company that brings the IPO is
known as the issuer, and the process is regarded as a public issue. The process includes many
investment banks and underwriters through which the shares, debentures, and bonds can directly be
sold to the investors.

For example, company XYZ Inc. hires four underwriting firms to determine the financial details of its IPO.
The underwriters detail that the issue price of the stock will be $20. Investors can then buy the IPO at
this price directly from the issuing company. This is the first opportunity that investors have to
contribute capital to a company through the purchase of its stock. A company’s equity capital is
comprised of the funds generated by the sale of stock on the primary market.

Methods of Raising Funds

1] Offer through Prospectus

This is a method of public issue. It is also the most used method in the primary market to raise
funds. Here the company invites the investors (general members of the public) to invest in their
company via an advertisement also known as a prospectus.

After a prospectus is issued, the public subscribes to shares, debentures etc. As per the response,
shares are allotted to the public. If the subscriptions are very high, allotment will be done on
lottery or pro-rata basis.

The company can sell the shares directly to the public, but it generally hires brokers and
underwriters. Merchant banks are another option to help out with the process, especially Initial
Public Offerings.

2] Private Placement

Public offers are an expensive affair. The incidental costs of IPO’s tend to be very high. This is
why some companies prefer not to go down this route. They offer investment opportunities to a
select few individuals.

So the company will sell its shares to financial institutes, banks, insurance companies and some
select individuals. This will help them raise the funds efficiently, quickly and economically.
Such companies do not sell or offer their securities to the public at large.

3] Rights Issue

Generally, when a company is looking to expand or are in need of additional funds, they first
turn to their current investors. So the current shareholders are given an opportunity to further
invest in the company. They are given the “right” to buy new shares before the public is offered
the chance.

This allotment of new shares is done on pro-rata basis. If the shareholder chooses to execute his
right and buy the shares, he will be allotted the new shares. However, if the shareholder chooses
to let go of his rights issue, then these shares can be offered to the public.
4] e-IPO

It stands for Electronic Initial Public Offer. When a company wants to offer its shares to the
public it can now also do so online. An agreement is signed between the company and the
relevant stock exchange known as the e-IPO.

This system was introduced in India some three years ago by the SEBI. This makes the process
of the IPO speedy and efficient. The company will have to hire brokers to accept the applications
received. And a registrar to the issue must also be appointed.

Secondary Market

After the primary market is the secondary capital market. This is more commonly known as the
stock market or the stock exchange. Here the securities (shares, debentures, bonds, bills etc) are
bought and sold by the investors.

The main point of difference between the primary and the secondary market is that in the
primary market only new securities were issued, whereas in the secondary market the trading is
for already existing securities. There is no fresh issue in the secondary market.

The securities are traded in a highly regularised and legalized market within strict rules and
regulations. This ensures that the investors can trade without the fear of being cheated. In the last
decade or so due to the advancement of technology, the secondary capital market in India has
seen a great boom.

What is Book Building?

Book building is the process by which an underwriter attempts to determine the price at which an
initial public offering (IPO) will be offered. An underwriter, normally an investment bank, builds
a book by inviting institutional investors (fund managers et al.) to submit bids for the number of
shares and the price(s) they would be willing to pay for them.

Understanding Book Building

Book building has surpassed the 'fixed pricing' method, where the price is set prior to investor
participation, to become the de facto mechanism by which companies price their IPOs. The
process of price discovery involves generating and recording investor demand for shares before
arriving at an issue price that will satisfy both the company offering the IPO and the market. It is
highly recommended by all the major stock exchanges as the most efficient way to price
securities.

The book building process comprises of these steps:

1. The issuing company hires an investment bank to act as underwriter who is tasked with
determining the price range the security can be sold for and drafting a prospectus to send
out to the institutional investing community.
 2. Invite investors, normally large scale buyers and fund managers, to submit bids on the
number of shares that they are interested in buying and the prices that they would be
willing to pay.
3. The book is 'built' by listing and evaluating the aggregated demand for the issue from the
submitted bids. The underwriter analyzes the information then uses a weighted average to
arrive at the final price for the security, which is termed the 'cut off' price.
4. The underwriter has to, for the sake of transparency, publicize the details of all the bids
that were submitted.
5. Allocate the shares to the accepted bidders.

Even if the information collected during the book building suggests a particular price point is best, that
does not guarantee a large number of actual purchases once the IPO is open to buyers. Further, it is not
a requirement that the IPO be offered at that price suggested during the analysis.

How is the Price Fixed?

All the applications received till the last dates are analyzed and a final offer price, known as the
cutoff price is arrived at. The final price is the equilibrium price or the highest price at which all
the shares on offer can be sold smoothly. If the price quoted by an investor is less than the final
price, he will not get allotment.

If price quoted by an investor is higher than the final price, the amount in excess of the final price is
refunded if he gets allotment. If the allotment is not made, full money is refunded within 15 days after
the final allotment is made. If the investor does not get money or allotment in a month’s time, he can
demand interest at 15 per cent per annum on the money due.

Example:

In this method, the company doesn’t fix up a particular price for the shares, but instead gives a
price range, e.g., Rs. 80 to 100. When bidding for the shares, investors have to decide at which
price they would like to bid for the shares, e.g., Rs. 80, Rs. 90 or Rs. 100. They can bid for the
shares at any price within this range. Based on the demand and supply of the shares, the final
price is fixed.

The lowest price (Rs. 80) is known as the floor price and the highest price (Rs. 100) is known as
cap price. The price at which the shares are allotted is known as cut off price. The entire process
begins with the selection of the lead manager, an investment banker whose job is to bring the
issue to the public.

Both the lead manager and the issuing company fix the price range and the issue size. Next,
syndicate members are hired to obtain bids from the investors. Normally, the issue is kept open
for 5 days. Once the offer period is over, the lead manager and issuing company fix the price at
which the shares are sold to the investors.

If the issue price is less than the cap price, the investors who bid at the cap price will get a refund
and those who bid at the floor price will end up paying the additional money. For example, if the
cut off in the above example is fixed at Rs. 90, those who bid at Rs. 80, will have to pay Rs. 10
per share and those who bid at Rs. 100, will end up getting the refund of Rs. 10 per share. Once
each investor pays the actual issue price, the share are allotted.

Book Building vs. Reserve Book Building:

While book building is used to raise capital for the company’s business operations, reverse book
building is used for buyback of shares from the market. Reverse book building is also a price
discovery method, in which the bids are taken from the current investors and the final price is
decided on the last day of the offer. Normally the price fixed in reverse book building exceeds
the market price.

Private Placement & Bought out Deals | Meaning | Features | Merits & Demerits

Private placement method is a method of marketing of securities whereby the issuer makes the offer of
sale to individuals and institutions privately without the issue of the prospectus. Recently, private
placement has gained popularity among corporate enterprises.

Features of Private Placement of Securities

Under private placement 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 issue houses, etc. They are in turn, placed at
higher prices to individuals and institutions.

Institutional investors play a predominant role in private placing. The expenses relating to
placement are borne by such investors.

Advantages of Private Placement of Securities

1. Private placement of securities is less expensive. Various costs associated with the issue are
borne by the issue houses and other intermediaries.

2. Private placement of securities is not a cumbersome one. Stock exchange requirements

concerning contents of prospectus and its publicity etc., are not so much.

3. Small companies find private placement of securities convenient.

4. Private placement of securities is highly beneficial where the public response to the issue is
doubtful.

Disadvantages of Private placement

Private placement securities suffers from the following weaknesses.

1. securities are concentrated in a few hands

2. artificial scarcity is created for securities

3. common investors are deprived of their opportunities io subscribe to the issue.

MEANING OF BROUGHT-OUT DEALS

Under bought out deals, the issuer makes an outright sale of a chunk of equity shares to a single
sponsor or the lead sponsor.

Features of Brought-out deals

1. The parties to bought out sale are

promoters of the company

sponsors and

co-sponsors.

2. There is an outright sale of a chunk of equity shares to a single sponsor or the lead sponsor.

3. Sponsors form a syndicate with other merchant bankers for meeting the resource requirements
and for distributing the risk.

4. The sale of securities is influenced by factors such as project evaluation, promoter’s image and
reputation, current market sentiments, prospects of offloading these shares at a future date, etc.

5. Bought out deals are in the nature of fund based activity where the funds of the merchant
bankers get locked in for at least the prescribed minimum period.

6. Investor can realize price when shares get listed and higher prices prevail. Listing is done
when the performance of the company improves and the project generates larger cash inflows.

Benefits or Advantages of Bought-out deals

Following are the benefits of bought out deals.

1. Bought out deals ensure sedype sale of securities at low cost

2. Promoters have freedom to set a realistic price and convince the sponsor about the same.

3. Bought out deals facilitate better investors protection.

4. Bought out deals help enhance the quality of capital flotation and primary market offerings.
Limitations or disadvantages of bought-out deals

Bought out deals suffer from the following limitations.

1. Promoters of closely held companies apprehend that the sponsors may usurp control of the
company as they own large chunk of the shares of the company.

2. Where market conditions are unfavorable, off-loading the shares may result in losses to
sponsors.

3. Wrong appraisal of the project and over estimation of the potential price of the share may
cause loss to sponsors.

4. There is great scope for manipulation at the hands of the sponsor through insider trading and
rigging.

5. There are no adequate guidelines to regulate offerings by sponsors.

6. Sponsors earn windfall profits at the cost of small investors.

FACTORING

Factoring is a financial transaction and a type of debtor finance in which a business sells its
accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. A business will
sometimes factor its receivable assets to meet its present and immediate cash needs.

The mechanism of factoring is summed tip as below:

(i) An agreement is entered into between the selling firm and the factor firm. The agreement
provides the basis and the scope of the understanding reached between the two for rendering
factor services.

(ii) The sales documents should contain the instructions to make payments directly to the factor
who is assigned the job of collection of receivables.

(iii) When the payment is received by the factor, the account of the selling firm is credited by the
factor after deducting its fees, charges, interest etc. as agreed.

(iv) The factor may provide advance finance to the selling firm if the conditions of the agreement
so require.

The mechanism of factoring has been shown in the following figure:

Types of Factoring:

A number of factoring arrangements are possible depending upon the agreement reached
between the selling firm and the factor.

However, following are some of the important types of factoring arrangements:

1. Recourse and Non-Recourse Factoring:

In a recourse factoring arrangement, the factor has recourse to the client (selling firm) if the
receivables purchased turn out to be bad, i.e., the risk of bad debts is to be borne by the client and
the factor does not assume the risks of default associated with receivables. The difference
between recourse and non-recourse factoring is mainly on account of risk factor.

Whereas, in case of non-recourse factoring, the risk or loss on account of non-payment by the
customers of the client is to be borne by the factor and he cannot claim this amount from the
selling firm. Since the factor bears the risk of non-payment, commission or fees charged for the
services in case of non-recourse factoring is higher than under the recourse factoring.

The additional fee charged by the factor for bearing the risk of bad debts/non-payment on
maturity is called del credere commission.

2. Advance and Maturity Factoring:

Under advance factoring arrangement, certain percentage of receivables is paid in advance to the
client, the balance being paid on the guaranteed payment date.

But, in case of maturity factoring, no advance is paid to the client and the payment is made to the
client only on collection of receivables or the guaranteed payment date as may be agreed
between the parties. Thus, maturity factoring consists of the sale of accounts receivables to a
factor with no payment of advance funds at the time of sale.

3. Conventional or Full Factoring:

In conventional or full factoring, the factor performs almost all the services of factoring
including non-recourse and advance factoring. It is also known as old Line Factoring.

4. Domestic and Export Factoring:

The basic difference between the domestic and export factoring is on account of the number of
parties involved. In domestic factoring three parties are involved, namely, the selling firms
(client), the factor and the customer of the client (buyer).

In contrast, four parties are involved in case of export or cross-border factoring. Namely, the
exporter (selling firm or client), the importer or the customer, the export factor and the import
factor. Since, two factors are involved in the export factoring; it is also called two-factor system
of factoring.

Forfaiting:

The term forfaiting is similar to export factoring. It is a form of financing of export receivables.
Forfaiting in essence means the forfeiting of the right to future payments through discounting
future cash flows.

Thus the difference between forfaiting and factoring is that forfaiting provides hundred percent
finance in advance against receivables whereas, in factoring only certain (usually 75 to 85)
percentage of receivables is available as advance finance.

Moreover, forfaiting is purely financing arrangement whereas, factoring also includes other
services such as administration of credit sales, collection of receivables, maintenance of sales
ledger, etc.

Benefits of Factoring:

A firm that enters into factoring agreement is benefited in a number of ways as it is relieved from
the problem of collection management and it can concentrate on other important business
activities.

Some of the important benefits are outlined as under:

(a) It ensures a definite pattern of cash inflows from the credit sales.
(b) It serves as a source of short-term finance.

(c) It ensures better management of receivables as factor firm is a specialised agency for the
same.

(d) It enables the selling firms to transfer the risk of non-payments, defaults or bad debts to the
factoring firms in case of non-recourse factoring.

(e) It relieves the selling firms from the burden of credit management and enables them to
concentrate on other important business activities.

(f) It saves in cost as well as space as it is a substitute for in-house collection department.

(g) In provides better opportunities for working capital management.

(h) The selling firm is also benefited by advisory services rendered by a factor.

Limitations of Factoring:

In spite of May services offered by factoring, it suffers from certain limitations.

The most critical fall outs of factoring include:

(i) The high cost of factoring as compared to other sources of short-term finance,

(ii) The perception of financial weakness about the firm availing factoring services, and

(iii) adverse impact of tough stance taken by factor, against a defaulting buyer, upon the
borrower resulting into reduced future sales.

HOUSING FINANCE

Good housing is a pre-requisite for human development and welfare. It provides

shelter, security, amenitiesand privacy to the human beings for decent living.
Without good housing, people cannot realize theirfull potential and carry on the life
they want to lead.Good housing reflects the general welfare of the community,
whereas bad housing leads to serious consequences such as diseases, immorality,
and juvenile delinquency. Deprivation of a decent housing,in fact, becomes a threat
to social harmony and economic prosperity. Housing is also an investment activity
and provides impetus to economic growth.It has both forward and backward
linkages. Becauseof its forward and backward linkages, even a small initiative in
housing will propel multiplier effect in the economy through the generation of
employment and demand.
Problem of Housing Finance

In India, the demand for housing has increased rapidly due to population growth,
migration from rural areas to urban areas, the decay of the existing housing stock
and breakdown of traditional joint families. The information technology revolution
and rapid growth of knowledge based industries in recent years have also further
contributed to the already growing acute shortage of housing India particularly in
urban areas. Since housing requires huge investment, a critical constraint for the
development of housing is lack of finance.

With the entry of commercial banks into housing finance, the housing sector has
witnessed real boom during the last decade. The growing demand for housing
finance has contributed for rapid growth of banks' lending to housing sector. Housing
finance has now emerged as an important segment of the credit portfolio of banks.
Its rate of growth in the recent years is rapid enough to cause concern to the
regulator. During the year 2003 for example, the unprecedented interest evinced by
almost all banks in attracting new customers for their housing loans, has resulted in
an increase of 55 percent in housing finance. In its Annual Report 2002-03, the
Reserve Bank of India expressed its concern in a box item captioned as Housing
Finance: New Driver of Bank Credit. “The cause for potential worry” it revealed, “is
that by lowering the lending rates, banks are approaching the cost of funds”. It
cautioned, “Banks need to be alert against an unbridled growth of housing finance
and should take due precaution in the matter of interest rates, margin, rest period
and documentation.”It is also important to note that the on-going global financial
crisis was mainly caused by housing finance in US. With the real estate boom and
appreciating house prices, the housing finance spurred competition among financial
institutions to unprecedented levels. Large number of borrowers, brokers and
appraisers inflated house prices and borrowers income on loan applications. The
banks were confident that potential repayment problems could be mitigated by ever
increasing market prices for the collateral houses. With the fall in asset prices, the
housing finance by banks ultimately led to subprime lending crisis. From the housing
finance policy perspective, India has a lesson to draw from this housing finance
subprime crisis. Tarapore Committee has already drawn the attention of policy
makers on the growing subprime quality of housing finance in India.

Evolution of Housing Policy in India

Housing, literally, connotes a physical structure to provide shelter including basic

amenities such as supply of safe drinking water, sewerage system, electricity, and
other basic infrastructure required to lead a good quality life. In a broader sense,
housing means more than just a shelter. By virtue of its fixed location, it becomes an
integral part of a neighborhood and social, cultural and economic environment. It
defines a space of social reproduction that necessarily reflects gender, familial and
other types of social relations. It provides security against changing climatic
conditions and protects the belongings of the households. It can also function as a
place of contact, leisure, education and religious observance, of ordered social
interactions. The good housing, thus, reflects the general welfare of the community,
whereas the bad housing causes serious consequences such as health hazards,
juvenile delinquency and social disharmony and also becomes a threat to economic
prosperity. Housing, by definition, is not only a basic necessity for human living but
also an indicator of the progress of the nation in terms of human development and
welfare. Without good housing, people cannot realize their full potential and carry on
the life they want to lead. This chapter, therefore, focuses on the problem of housing
and an overview of the evolution of housing policy in India since independence as a
backdrop.

Insurance

Insurance is defined as a contract, which is called a policy, in which an individual or organisation

receives financial protection and reimbursement of damages from the insurer or the insurance
company. At a very basic level, it is some form of protection from any possible financial losses.

The basic principle of insurance is that an entity will choose to spend small periodic amounts of
money against a possibility of a huge unexpected loss. Basically, all the policyholder pool their
risks together. Any loss that they suffer will be paid out of their premiums which they pay.

Functions of an Insurance Company

1] Provides Reliability

The main function of insurance is that eliminates the uncertainty of an unexpected and sudden
financial loss. This is one of the biggest worries of a business. Instead of this uncertainty, it
provides the certainty of regular payment i.e. the premium to be paid.

2] Protection

Insurance does not reduce the risk of loss or damage that a company may suffer. But it provides
a protection against such loss that a company may suffer. So at least the organisation does not
suffer financial losses that debilitate their daily functioning.
3] Pooling of Risk

In insurance, all the policyholders pool their risks together. They all pay their premiums and if
one of them suffers financial losses, then the payout comes from this fund. So the risk is shared
between all of them.

4] Legal Requirements

In a lot of cases getting some form of insurance is actually required by the law of the land. Like
for example when goods are in freight, or when you open a public space getting fire insurance
may be a mandatory requirement. So an insurance company will help us fulfil these
requirements.

5] Capital Formation

The pooled premiums of the policyholders help create a capital for the insurance company. This
capital can then be invested in productive purposes that generate income for the company.

Principles of Insurance

As we discussed before, insurance is actually a form of contract. Hence there are certain
principles that are important to ensure the validity of the contract. Both parties must abide by
these principles.

1] Utmost Good Faith

A contract of insurance must be made based on utmost good faith ( a contract of

uberrimate fidei). It is important that the insured disclose all relevant facts to the insurance
company. Any facts that would increase his premium amount, or would cause any prudent
insurer to reconsider the policy must be disclosed.

If it is later discovered that some such fact was hidden by the insured, the insurer will be within
his rights to void the insurance policy.

2] Insurable Interest

This means that the insurer must have some pecuniary interest in the subject matter of the
insurance. This means that the insurer need not necessarily be the owner of the insured property
but he must have some vested interest in it. If the property is damaged the insurer must suffer
from some financial losses.

3] Indemnity

Insurances like fire and marine insurance are contracts of indemnity. Here the insurer undertakes
the responsibility of compensating the insured against any possible damage or loss that he may
or may not suffer. Life insurance is not a contract of indemnity.
4] Subrogation

This principle says that once the compensation has been paid, the right of ownership of the
property will shift from the insured to the insurer. So the insured will not be able to make a profit
from the damaged property or sell it.

5] Contribution

This principle applies if there are more than one insurers. In such a case, the insurer can ask the
other insurers to contribute their share of the compensation. If the insured claims full insurance
from one insurer he losses his right to claim any amount from the other insurers.

6] Proximate Cause

This principle states that the property is insured only against the incidents that are mentioned in
the policy. In case the loss is due to more than one such peril, the one that is most effective in
causing the damage is the cause to be considered.