MANAGEMENT+OF+FINANCIAL+SERVICES

FM302-MANAGEMENT OF
FINANCIAL SERVICES


FINANCE SPECILIZATION
Mr.LALIT TANK
Asst. Professors, MBA Department,
Bhagawan Mahavir College of Management, Surat
Email id: [email protected]
COURSE CONTENTS
Module No.1
• Introduction to Indian Financial system
Reserve bank and financial system.
structure of banking and non-banking
companies.
Introduction to different markets- Capital,
Money, Primary, Secondary Markets.
Module No.2
• Asset/Fund based financial services
Leasing, hire purchase
Module No.3
Consumer credit, factoring and forfeiting , Bill
discounting, Housing finance, Insurance
services, venture capital financing, Mutual fund
services
Module No.4
Merchant banking services :
all services related to issue management
Module No.5
Credit rating, Stock broking, depositories,
custodial services and short selling and
securities lending and borrowing services,
Credit cards.

CHAPTER -1
INTRODUCTION TO INDIAN
FINANCIAL SYSTEM

INDIAN FINANCIAL SYSTEM

• The economic development of a nation is
reflected by the progress of the various economic
units, broadly classified into corporate sector,
government and household sector. While
performing their activities these units will be
placed in a surplus/deficit/balanced budgetary
situations.

Constituents of a Financial System

Financial System
• An institutional framework existing in a country to enable
financial transactions.
• Three main parts
– Financial assets (loans, deposits, bonds, equities, etc.)
– Financial institutions (banks, mutual funds, insurance
companies, etc.)
– Financial markets (money market, capital market, forex market,
etc.)
• Regulation is another aspect of the financial system (RBI,
SEBI, IRDA, FMC)

Financial assets/Instruments
• Enable channelizing funds from surplus units to deficit
units
• There are instruments for savers such as deposits,
equities, mutual fund units, etc.
• There are instruments for borrowers such as loans,
overdrafts, etc.
• Like businesses, governments too raise funds through
issuing of bonds, Treasury bills, etc.
• Instruments like PPF, KVP, etc. are available to savers who
wish to lend money to the government
Financial Institutions
• Includes institutions and mechanisms which
– Affect generation of savings by the community
– Mobilization of savings
– Effective distribution of savings
• Institutions are banks, insurance companies,
mutual funds- promote/ mobilize savings
• Individual investors, industrial and trading
companies- borrowers

Financial Markets
• Money Market- for short-term funds (less
than a year)
– Organised (Banks)
– Unorganised (money lenders, chit funds, etc.)

• Capital Market- for long-term funds
– Primary Issues Market
– Stock Market
– Bond Market


Function of the Financial System
• Prevision of liquidity
liquidity refers to cash or money and other assets
which can be converted into cash readily without loss
of value and time.

• Mobilization of savings




Weaknesses of India financial system
Lack of co-ordination between different
financial institutions.
Monopolistic market structures
-LIC in life insurance
-UTI in mutual fund
Dominance of development banks in industrial
financing
Inactive and erratic capital market
Imprudent financial practice

Reserve Bank of India
(RBI)
Establishment of RBI
The reserve bank of India was established
on April 1,1935 in accordance with the provisions of
the reserve bank of India Act, 1934.
The central office of the reserve bank was
initially in Calcutta but was permanently moved to
Mumbai in 1937. the central office is where the
governor sits and where policies are formulated.
Objectives of RBI
• To maintain the internal value of the nation’s
currency.
• To preserve the external value of the currency
• To secure reasonable price stability.
• To promote economic growth with rising
levels of employment, out and real income
Functions of a RBI
• Monetary policy functions
• Currency issue and management
• Maintaining value of currency
• Anchor economic growth expectation
• Monetary regulation and management
• Regulation of interest rates
• Financial sector regulation and supervision
• Exchange management and control
• Credit control
• Liquidity management
• Clearing and settlement
• Development of financial market
• Policy oriented research
• Collection of data and publication of reports
• Institution building
Role of the Reserve Bank of India
• Banker to the government
• Banker to the banks
• Bank’s supervision
• Monetary regulation and management
• Foreign exchange and management
• Promotional functions





Supervisory/regulatory function of RBI
• Licensing of banks
• Approval of capital, reserves and liquid assets of
banks
• Branch licensing policy
• Inspection of banks
• Control over management
• Audit
• Credit information service
• Deposit insurance
• Training and banking education


RBI –ORGANISATION STRUCTURE
Introduction to different
Markets
• Capital Market, Money Market,
• Primary Market, Secondary Market
Money Market
• The market for dealing with financial assets
and sec. which have a maturity period of up to
one year.
• RBI defines the money market as “A market
for short term financial assets that are close
substitutes for money, facilitates the exchange
of money for new financial claims in primary
market as also for financial claims, already
issued, in the secondary market”

Money Market Instruments
• Money market instruments are those which
have maturity period of less than one year.
• The most active part of the money market is
the market for overnight call and term money
between banks and institutions and repo
transactions
• Call money/repo are very short-term money
market products
Money Market Instruments
• Certificates of Deposit
• Commercial Paper
• Inter-bank participation certificates
• Inter-bank term money
• Treasury Bills
• Bill rediscounting
• Call/notice/term money
• CBLO (Collateralized Borrowing and Lending Obligation)
• Market Repo
Features of a money market
• Market purely for short –term funds or financial assets
• Its deals with financial assets having maturity period up
to one year.
• it deals with those assets which can be convert in to
cash readily without loss and mini transaction cost
• Transaction have to be conducted without the help of
brokers

Objectives of money market
• To provide a parking place to employ short-term
surplus
• To provide room for overcoming short-term
deficits.
• To enable the central bank to influence and
regulate liquidity in the economy through its
intervention in this market.
• To provide reasonable access to the users of
short-term funds to meet requirements.


Characteristics of a Developed
Money Market
• Highly organized banking system
• Presence of a central bank
• Availability of proper credit instrument
• Existence of sub-brokers
• Sufficient resources
• Existence of secondary markets
• Demand and supply of funds


Importance of Money Market
• Development of money market
• Development of capital market
• Smooth functioning of commercial banks
• Effective central bank control
• Formulation of suitable monetary policy
• Non-inflation source of finance to
government

Composition of Money Market
The money market consist of following sub market.

• Call money market
• Commercial bills market
• Acceptance market
• Treasury bill market

Call money market
The call money market refers to the market
for extremely short period loans, say one day
to fourteen days.
These loans are repayable on demand at
the option of either the lender or the
borrower.


Advantages of call money market
• High liquidity
• High profitability
• Maintenance of statutory reserve ration
(SRR)
• Safe and cheap
• Assistance to central bank operation

Drawbacks of call money market
• Uneven development

• Lack of integration

• Volatility in call money rates


Commercial bills market or discount
Market
• Definition
“An instrument in writing containing
an unconditional order, signed by the maker,
directing a certain person to pay a certain sum
of money only to ,or the order of certain
person or to the bearer of the instrument”.

Types of bills
Many types of bills are in circulation in a
bill market
• Demand bills are also called sight bills. these bills are
payable immediately as soon as they are presented
to the drawer no time of payment is specified and
hence they are payable at sight.
• Documentary bill
when bills have to be accompanied by
document of title to goods like railway receipt, lorry
receipt, bill of lading etc.the bills are called doc.bills.

• Inland and foreign bills
inland bills are those drawn upon a person
resident in India and are payable in India. foreign bills are
drawn outside India and they may be payable either in
India or outside India.
• Export bills and import bills
export bills are those drawn by Indian exporters on
imports outside India and importer bills are drawn on
Indian importers in India by exporters outside India.
• Indigenous bills
indigenous bills are those drawn and accepted
according to native custom or usage of trade.


Advantages of Commercial bills market
• Liquidity
• Self-liquidating and negotiable asset
• Certainty of payment
• Ideal investment
• Simple legal remedy
• High and quick yield
• Easy central bank control
Drawbacks of Commercial bills market
• Absence of bill culture
• Absence of rediscounting among banks
• Stamps duty
• Absence of secondary market
• Difficulty in ascertaining genuine trade bills
• Limited foreign trade
• Absence of acceptance service
• Attitude of banks


Treasury bill market
A treasury bill nothing but a promissory
note issued by the Govt. under discount for a specified
period stated therein. the govt.promises to pay the
specified amount mentioned therein to the bearer of
the instrument on the due date.

T.B are issued only by the RBI on behalf of the
govt. TB are issued for meeting temporary govt.
deficits.

Types of Treasury bill
• There are two types of TB
ordinary treasury bills are issued to the
public and other financial institution for
meeting the short term financial requirements
of the central govt.
ad hocs treasury are always issued in favor
of the RBI only.

Importance of TB
• Safety
• Liquidity
• Ideal short-term investment
• Ideal fund management
• Statutory liquidity
• Source of sort term funds
• Non-inflationary monetary tool
• Hedging facility
Defects of TB
 poor yield
 absence of competitive bids
 absence of active trading







Commercial papers (CP)
• A Cp Is an unsecured promissory note issued with a fixed
maturity by a company approved by RBI, negotiable by
endorsement and delivery, issued in bearer form and issued at
such discount on the face value as may be determined by the
issuing co.
• Short-term borrowings by corporate, financial institutions,
primary dealers from the money market
• Can be issued in the physical form (Usance Promissory Note) or
demat form
• Introduced in 1990
• When issued in physical form are negotiable by endorsement
and delivery and hence, highly flexible
• Issued subject to minimum of Rs. 5 lacs and in the multiple of
Rs. 5 lacs after that
• Maturity is 7 days to 1 year
• Unsecured and backed by credit rating of the issuing company
• Issued at discount to the face value

• Certificate of deposit
CD are short term deposits instruments issued
by bank and financial institutions t raise large sums
of money.
• Repo instrument.
Repurchase transaction the borrower parts
with securities to the lender with an agreement to
repurchase them at the end of the fixed period at a
specified price.
• At the end of the period the borrower will
repurchase the securities at the predetermined
price.


Capital Markets
• What is Capital Market
It is an organized market mechanism for effective and efficient
transfer of money capital or financial resources from the investing class
to the entrepreneur class in the private and public sector of the
economy.
•Capital market for long term funds.
•The capital market provides long term debt and equity finance for
govt. and corporate.
•Capital market facilitates the dispersion of business ownership and
reallocation of financial resources among corporate and industries.

Dimensions of capital market
• The capital market is directly responsible for the
following activities.
• Mobilization or concentration of national saving
for economic development.
• Mobilization and import of foreign capital and
foreign investment capital plus skill to fill up the
deficit in the required financial resources to
maintain the expected rate of economic growth.
• Productive utilization of resources
• Directing the flow to funds of high yields and also
strive for balanced and diversified
industrialization.

Capital market mechanism
•Individuals
•Institutions
•Government
Capital Market
•Stock exchange
•New issue market
•Finance and
investment corp.
•Individuals
•Institutions
•Government
Supply of
funds
•Investors
•Lenders
•Sellers of money
capital
• Entrepreneurs
•Borrowers
•Clearing house for
long term or
permanent finance
• Buyers of money
capital
Middlemen
Demand for
funds
Capital Market Structure
Marketable Securities
Non-Marketable Securities
Govt.
securities
Corporate
securities
PSUs Bonds
UTI Mutual
Funds
Bank
Deposits
Deposits
with
Companies
Loans and
advances of
banks and
FIs.
POC and
deposits
New Issues
Market
players –
original
Stock market
intermediaries
New Issues
Market
players –for
Issues
Special features of the Indian capital
market
• Greater reliance on debt instrument as against
equity and in particular borrowing from financial
institution.
• Issues of debenture, particularly convertible
debentures with automatic or compulsory from
conversion into equity without the normal option
given to investors.
• Avoidance of underwriting by some cos. Reduce.
• Fast growth of mutual funds and subsidiaries of
banks for financial services.
Capital market instruments
• Equity shares
• Preference shares
• Non-voting equity shares
• Cumulative convertible preference shares
• Company fixed deposits
• Debentures/ bonds
• Global depository receipts

Structure of Capital Markets
Primary Markets Secondary Markets
When companies need financial resources for
its expansion, they borrow money from
investors through issue of securities.
The place where such securities are traded by
these investors is known as the secondary
market.
Securities issued
a) Preference Shares
b) Equity Shares
c) Debentures
Securities like Preference Shares and
Debentures cannot be traded in the secondary
market.
Equity shares is issued by the under writers
and merchant bankers on behalf of the
company.
Equity shares are tradable through a private
broker or a brokerage house.
People who apply for these securities are:
a) High networth individual
b) Retail investors
c) Employees
d) Financial Institutions
e) Mutual Fund Houses
f) Banks
Securities that are traded are traded by the
retail investors.
One time activity by the company. Helps in mobilizing the funds for the investors
in the short run.
What is Commodity market
Commodity markets are markets where raw or
primary products are exchanged.

It covers physical product (food, metals,
electricity)markets but not the ways that
services, including those of governments, nor
investment nor debt, can be seen as a
commodity.

History of Commodity Market
Modern Commodity Market have their roots in the
trading of agricultural products.
Wheat and corn, cattle and pigs, were widely traded
using standard instruments in the 19th century in the
United States.
Historically, in ancient times Sumerian use of sheep
or goats, or other peoples using pigs, rare seashells, or
other items as commodity money, have traded
contracts in the delivery of such items, to render trade
itself more smooth and predictable.

Size of the Market
•The trading of commodities includes physical
trading of food items, Energy and Metals, etc. and
trading of derivatives.
•In the five years up to 2007, the value of global
physical exports of commodities increased by
17% while the notional value outstanding of
commodity
OTC derivatives increased more than 500% and
commodity derivative trading on exchanges more
than 200%.

• Agricultural contracts trading grew by 32% in
2007, energy 29% and industrial metals by
30%.
•Precious metals trading grew by 3%, with
higher volume in New York being partially
offset by declining volume in Tokyo.
• OTC trading accounts for the majority of
trading in gold and silver

List of Traded Commodity
Agricultural (Grains, and Food and Fiber)
•Livestock & Meat
•Energy
•Precious metals
•Industrial metals
• Precious Metal:- Gold, Platinum, Palladium, Silver.
•Industrial Metals:- Copper, Lead, Zinc, Tin,
Aluminium, Aluminium alloy, Nickel, Aluminium
alloy, Recycled steel.

Commodity Exchanges
• Abuja Securities and Commodities Exchange
•Bhatinda Om & Oil Exchange Bathinda
•Brazilian Mercantile and Futures Exchange
•Chicago Board of Trade
•Chicago Mercantile Exchange
•Commodity Exchange Bratislava, JSC
•Dalian Commodity Exchange
•Dubai Mercantile Exchange
•Intercontinental Exchange

Recent trends in Commodity Market
• The 2008 global boom in commodity prices - for
everything from coal to corn – was fueled by heated
demand from the likes of China and India.

•Speculation in forward markets.
•Farmers are expected to face a sharp drop in crop
prices as a result of bad rainfall.
•Other commodities, such as steel, are also expected to
fall due to lower demand

Assignment -1
• Q-1 Write in detail about Commodities market

• LAST DATE OF SUBMISSION :8/10/2010
LEASING
Meaning of Leasing
• Lease may be define as a contractual arrangement/
transaction in which a party owning an asset/equipment
provides the asset for use to another /transfer the right
to use the equipment to the user over certain/ for an
agreed period of time for consideration in form of /in
return for periodic payment (rental) with or without a
further payment (premium).

• Lease is a contract whereby the owner of an asset grants
to another party the exclusive right to use the asset
usually for an agreed period of time in return for the
payment of rent.
PARTIES IN LEASING
• Leasing essentially involves the divorce of
ownership from the economic use of an
asset/equipment.
• LESSOR: Lessor is the owner of the asset that
is being leased.
• LESSEE: Lessee is the receiver of the services
of the asset under a lease contact.
Essential elements of leasing
• Parties to the contract
• Asset : The asset, property or equipment to be
leased is the subject matter of a contract of leasing
finance.
• Ownership separated from user:
• Term of lease: lease term is the period for which the
lease agreement remains in operation.
• Lease rentals: lease rental is the consideration which
the lessee pays to the Lessor for the lease
transaction.
• Modes of terminating lease.
Classification of Lease
1. Financial lease and operating lease
2. Sales and lease back and direct lease
3. Single investor lease and leveraged lease
4. Domestic lease and international lease

1.Financial lease and operating lease
• In a finance lease the Lessor transfers to the lessee,
substantially all the risks and rewards incidental to the
ownership of the asset whether or not the title is eventually
transferred.
• In such leases, the lessor is only a financier and is usually not
interested in the assets.
• It is for this reason that the such lease are also called as ‘fully
payout leases’ as they enable a lessor to recover his
investment in the lease and derive a profit.
• Assets included under such lease, are ships, aircraft, railway
wagons, lands, building heavy machinery and so on.
Features of finance lease
• The lessee select the equipment according to his requirements, from
its manufacturer or dist.
• The lessee negotiates and settles with the manfuct.or dist, the price,
the delivery schedule, installation, term of warranties, maintenance
and payment and so on.
• The lessor purchases the equipment either directly from manfct. Or
dist. Or from the lessee after the equipment is delivered.
• The lessor then leases out the equipment to lessee. The lessor retains
the ownership while lessee is allowed to use the equipment.
• A finance lease provide a right or option, to purchase the equipment
at a future date. This practice is rarely found in India.
• The lease is originally for a non-cancellable period is called the
primary lease period. The lease is subject to renewal for the
secondary lease period.
• The lessee is entitled to exclusive and peaceful use of equipment.




Operating lease
• An operating lease is one which is not a
finance lease. In an operating lease, the lessor
does not transfer all the risks and rewards
incidental to the ownership of the asset and
the cost of the asset is not fully amortised
during the primary lease period.
• The lessor provides services attached to the
leased asset, such as repair and technical
advice. for this reason it called ‘service lease’
Features of operating lease
• An O.L is generally for a period significantly shorter
than the economic life of the leased asset.
• Lease period are shorter than expected life of the
asset, the lease rentals are not sufficient to totally
amortise the cost of the assets.
• The lessor does not rely on the single lessee for
recovery of his investment.
• O.L normally include maintenance clause requiring
the lessor to maintain the lease assets and provide
services such as insurance, support staff, fuel etc.
Examples of operating lease
• Providing mobile cranes with operators
• Chartering of aircraft and ships, including the
provision of crew, fuel, support service.
• Hiring of computers with operators
• Hiring a taxi for a particular travel, which
includes service of driver, provision for
maintenance, fuel, repairs.

2.Sale and lease back and direct
lease
• It is an indirect form of leasing
• The owner of an equipment/asset sells it to a leasing
co.(lessor) which leases it back to the owner(lessee).
• Example: this type of leasing is the sale and lease back of safe
deposits vaults by bank under which banks sell them in their
custody to a leasing co.at a market price substantially higher
than the book value. The leasing co. turn offers these lockers
on long term basis to the bank.
• The bank sub-lease the lockers to its customers.
• The lease back arrangement in sale and lease back type of
leasing can be in the form of finance lease or operating.

Direct lease
• In direct lease, the lessee, and the owner of the equipment are
two different entities. A direct lease can be two types.
• Bipartite:
1.Equipment supplier –cum lessor.
2. Lessee such a type of lease is typically structured as an operating
lease with in-built facilities. like upgradition of equipment
(upgrade lease).addition to the original equipment configuration.
• The lessor maintains the asset and if necessary, replace, it with a
similar equipment in working condition (swap lease).
• Tripartite: such type of lease involves 3 different parties in the
lease agreement: equipment, supplier, lessor, lessee.
• an innovative variant of tripartite lease is the sales-aid lease
under which the equipment supplier arranges for lease finance in
various form.
3.Single investor lease and
leveraged lease.
• Single investor lease there are only two
parties to the lease transaction, the lessor and
lessee. The leasing co.(lessor) funds the entire
investment by an appropriate mix of debt and
equity funds.
• The debts raised by the leasing co. to finance
the asset are without recourse to the lessee.
That is in the case of default in servicing the
debt by the leasing co. the lender is not
entitled to payment from the lessee.
Leveraged lease
• There are three parties to the transaction
1. Lessor (equity investor)
2. Lender (loan participant)
3. Lessee.
• A leveraged lease is a lease in which the lessor puts up some of the
money required to purchase the asset and borrows the rest from
a lender. The lender is given a senior secured interest on the asset and
an assignment of the lease and lease payments. The lessee makes
payments to the lessor, who makes payments to the lender.
• The term may also refer to a lease agreement wherein the lessor, by
borrowing funds from a lending institution, finances the purchase of
the asset being leased.
• The lessor pays the lending institution back by way of the lease
payments received from the lessee. Under the loan agreement,
the lender has rights to the asset and the lease payments if the lessor
defaults.



Domestic lease and international
lease
• Domestic lease : a lease transaction is
classified as domestic if all parties to the
agreement, namely, equipment supplier,
lessor and the lessee, are domiciled in the
same country.
• International lease: if the parties to the lease
transaction are domiciled in different
countries, it is knows as international lease.
• Import lease : In an import lease, the lessor
and the lessee are domiciled in different same
country but the equipment supplier is located
in a different country. The lessor imports the
asset and leases it to the lessee.
• Cross border lease: when the lessor and the
lessee are domiciled in different countries, the
lease is classified as cross-boarder lease. The
domicile of the supplier is immaterial.
• The domestic and international leases are
differentiated on the basis of risk.

Profile/structure of leasing
• Major players can be categorized into 6 groups
• Independent leasing cos.: a major part of their income is
derived from leasing. Some of them have financial/technical
collaboration with overseas partners. They offer their services
through direct advertisement, personal contacts, lease
brokers including foreign banks and merchant banks.
• Other finance cos:
• Manufacturer- lessors:
• Financial institutions:
• In-house lessors
• Commercial banks


Salient features of the lease
structures in India
• By and large, the structured lease fall in the
category of finance lease. operating lease is
not very popular primarily because of the
virtual non-existence of resale market for
most of the used equipments.
• The lease agreements do not provide for
transfer of ownership to the lessee as such
transactions are classified as hire purchase
from the tax angle.

• The lease rentals are structured so as to
recover the entire investment cost during the
primary period.
• The lease rentals are payable generally in
equated/level monthly instalments at the
beginning of every month.
• Sale and lease back type of transactions are
rare. Most of the are direct lease.
• By and large equipment leases are for capital
investment not exceeding Rs.100 lakh.


Advantages of leasing
• To the lessee.
1. Financing of capital goods.
2. Additional source of finance.
3. Less costly
4. Ownership preserved
5. Avoids conditionality
6. Flexibility in structuring of rentals
7. Simplicity
8. Tax benefits
9. Obsolescence risk is averted.

Advantages to the lessor
• Full security
• Tax benefit
• High profitability
• Trading on equity
• High growth potential
Limitations of leasing
• Restrictions on use of equipment
• Limitations of financial lease
• Loss of residual value
• Consequences of default
• Understatement of lessee’s asset
• Double sales-tax
Special provisions to leasing contract/transactions.
• Leasing as a bailment agreement
• Liabilities of lessee (Bailee-whom the goods are delivered)
-Reasonable care
-Not to make unauthorized use
-To return the goods
-Not to set up an adverse title
-To pay the lease rental
-To insure and repair the goods.
• Liabilities of lessor (bailor-who delivers the goods):
-Delivery of goods
-Peaceful possession
-Fitness of goods
-To disclose all defects

Remedies for Breach
• Remedies to the lessor:
-Forfeiture
-Damages
-Repossession
• Remedies to the lessee.
-Insurance of leased asset and claims necessity
-Risk insured
-Insurable interest
-claims (treatment of claim proceeds)
-sub-lease of leased asset right to sub lease
-effect of sub lease
-effect of termination of main lease

Lease documentation and
agreement
• Proposes and essential requirement
- The person executing the document should
have the legal capacity to do; the doc. Should
be in prescribed format; properly stamped,
witnessed, and duly executed and stamped
should be registered with appropriate
authorities.

Master lease and supplemental
lease agreements
• The lease agreement specifies the legal rights
and obligations of the lessor and lessee.
Usually a master lease agreement is signed
which stipulates all the conditions that govern
the lease. It specify the all the detail of –
equipment detail –credit limit –rental profile –
other details.

Clauses in lease agreement
• Nature of the lease
• Description of equipment
• Delivery and re-delivery
• Period
• Lease rentals
• Use
• Title : ownership of
equipment
•Repairs and maintenance
• Alteration
•Peaceful possession
•Charges
•Indemnity clause
•Inspection
•Prohibition of sub leasing
•Events of default and
remedies
•Applicable law