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( i1 ,,:'\ 1. J-,;.~Irnal 11·.\ 1-404
GURU HARKRISI-IAN INSTT. OF MANAGEMENT
MANAGEMENT OF FINANCIAL SERVICES (FM-404)
Ques 1 :- Explain the concept of financial system along with its development in India?
Ans- Financial systems one of the industries in an economy. It performs certain essential functions for the economy including maintenance of payment system. collection & allocation of the savings of society and creation of a variety of stores of wealth to suit the preferences of savers. Finance is the flowing blood in the body of financial system. It is a link between the saving & investments by providing the mechanism through which savings of savers are pooled and are put into the hands of those able & willing to invest by financial intermidateres. The role of financial system is thus, to promote savings and their channalisation in the economy through financial assets that are more productive than the physical assets. This means that the operations of financial system are vital to pace & structure of the growth of the economy. This system plays a significant role in access the rate of economic development which is to improving general standard of living & higher social welfare.
Development of Financial Systems in India
Some serious attention was paid to the development of a sound financial system in India .. Only after the launching of the planning era in the country. With the adoption of the theory of mined economy, the development of financial system took a different turn so as to fulfill the socio-economic & political objectives. The various stages under this are:-
(a) Nationalization of Financiallnstitutions:- RBI is the leader of the financial systems. It was nationalized in 1948. It was followed by the nationalization of Imperial Bank of India in 1956. In the same Year, 245 Life Insurance companies were brought under Govt. control by merging all of them into a single corporation called Life Insurance Corporation of India. Another significant development was the nationalization of 14 major commercial banks in 1969.
(b) Starting of Unit Trust of India:- VTI was established in 1964 as a public sector institution to collect the savings of the peoples and make them available for productive ventures. It is the oldest & largest mutual fund in India. However in 1994, the scheme of VTI have to the approved by SEBI. It has introduced a number of open ended & close-ended schemes. It has established the following subsidiaries.
(i) VTI Bank Ltd., in April 1994
(ii) VTllnvestors Service Ltd.
(iii) VTI Security Exchange Ltd.
(c) Establishment of Development Banks:- Many development banks were started not only to extent credit facilities to Fl's but also to render advisory services. These banks are multi purpose Institutions which provide medium & long-term credit to Industrial undertakings, discover investment projects, undertake the preparation of project reports provide technical advice to managerial services. IFCI was set up in 1948 with the project of "making medium & long term credit more easily available to Industrial concerns in India. It was followed by the establishment of ICICI in 1955 to develop large & medium industries in private sector. In lOBI was established in 1964 as a wholly owned subsidiary of the RBI. At the state level, Industrial level, industrial development corporations SIDCO were created to meet the financial requirements of the states & to promote regional development.
(d) Institutions for Financing Agriculture:- In 1963, the RBI set up the Agricultural refinance & Development corporation to provide refinance support to banks to finance major development projects such as minor irrigation, land development, daily development etc. However, In July 1982, the National Bank for Agriculture & Rural development was established.
(e) Institutions for Foreign Trade:- The export & Import Bank of India was set upon Jan1, 1982 to takeover the operations of International finance wing of the lOBI. Its main objective is to provide financial assistance to exporters and importers.
(f) Institutions for Housing Finance:- National Housing Bank has been set up on July 9, 1988 as an open Institution to mobilize resources for the housing sector and to promote housing finance Institutions both at regional and local levels. It also provides guarantee & underwriting facilities to housing finance Institutions.
(g) Stock holding corporation of India Ltd. (SHCIL):- SHCIl was set up to tone up the stock and capital markets in India. Its main objective is to provide quick share transfer facilities, clearing services, depository services, support services etc .. The SHCIl was set up by seven All India Financial Institution via lOBI, IFCI, ICICI, L1C, GIC, VTI and IRBI.
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(h) Mutual Fund Industry:- Mutual Funds refer to the funds raised but financial services companies b~~ pooling the savmgs of the public & investing them in a well diversified portfolio. These has been floated by some public sector banks, LlC, GIC and recently by private sector also e.g. SBI mutual fund, Bazaz Allianz, Mutual Funds, ICICI Prudental Mutual Fund etc.
(i) Legislative Support:-' Indian Financial System has been well supported by suitable legislative measures taken by the Govt. for its proper growth and smooth functioning, The Indian companies act was passed in 1956 with a view to regulating the function of companies from birth to death. It was a follow up to the Capital Issues control Act passed in 1947. Again, in 1956, the structures contracts (regulations) Act was passed to prevent undesirable transactions in securities, further to ensure the proper functioning of the economic system & to prevent concentration of economic proper functioning of the economic system & to prevent concentration of economic power in the hands of few. the monopolies and restructure Trade practices Act was passed in 1970. In 1973, the foreign exchange regulka6tion Act was exacted to regulate the foreign exchange dealings, Besides the above, the Indian contract Act, the negotiable Instruments Act, The Banking Regulation Act, deserve a special mention.
Ques 2:- Define Financial Service Industry & Critically analyze the present position of the financial service sector in India & State the Challenges it has to face in the Years to come>
Ans:- The term "Financial Services" in a broad sense means "mobilization and allocating savings". Thus, it includes all activities involved to the transformation of savings into investments. The financial service can also be called "financial intermediation". It is a process by which funds are mobilized from a large no. of savers and make them available to all those who are in need of it and particularly to corporate customers.
The Present Scenario of Financial Service Sector is:-
(1) Conservatism to Dynamism:- At present. the financial system in India is in a process of rapid transformation. particularly after the introduction of reforms in the financial sector, In this changed content. the role of financial services has assumed greater significance in our country. At present, numerous new financial Intermediaries have started functioning with a view to extending multi functional services to the investing public in the area of the financial services. The emergence of various financial institutions and regulatory bodies have transformed the financial services sector from being conservative industry to a very dynamic one.
(2) Emergence of Primary equity market:- The capital markets which were very sluggish, have become a popular source of raising financing. The number of stock exchanges in the country has gone up from 9 in 1980 to 24 in 2004. Thus the primary equity market has emerged as an important vehicle to channelise the savings of the individuals & corporat5es for productive purposes & thus to promote the industrial and economic growth of the nation.
(3) Concept of Credit Rating:- The concept of credit rating would playa significant role in identifying the rule level of the corporate entry in which the investor wants to take part. Now, it is mandatory for the NBFC to get credit rating for their debt. instruments. The three major credit rating agencies functioning in India are:-
(a) Credit rating Imp. Service of India Ltd. (RISIL) (b) Credit Analysis & Research Ltd. (CARE)
(c) Investment Information and Credit Rating Agency
(4) Process of Globalization:- Again. the process of globalization has paved a way for the entry of innovative and sophisticated financial products into our country. Since the Govt. is very keen in removing all obstacles that stand in the way of inflow of foreign capital. the potentialibilities for the introduction of innovative international financial products in India are very great.
(5) Process of liberalization:- Relating all these factors. the Govt. of India has imitated many steps to reform the financial services industry. The Govt. of India has already switched over to free pricing of issues from pricing issues. The interest rates have been deregulated, the private sector has been permitted to participate in banking and mutual funds and the public sector undertakings are being privatized. The securities exchange Board of India has liberalized many stringent conditions so as to boost the capital and money markets. In this changed context, the financial service industry in India has to playa very position and dynamic role in the years to come by offering many innovative products to suit to the varied req. nations of investors spread through out the country.
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,i,' Challenges facing the Financial Sector Are:-
(1) lack of qualified personnel:- The financial services sector is fully geared to the taste of "Financial Creativity" However, this sector has to face many challenges, In fact the dearth, of qualifies and trained personnel is an important implement in its growth. Hence, It is very vital that a proper and comprehensive training must be given to the various financial interrnidateres.
(2) lack of Investor Awareness:- The introduction of new financial products and instruments will be of no use unless the investor is aware of the advantages and uses of the new and innovative products & instruments, Hence. the financial intermidateres should educate the prospective users of the advantages of the instruments through literature, seminars, workshops etc.
(3) lacks of transparency:- The whole financial system is undergoing a phenomenal (change in accordance) with the recruitments of the national and global environments. Hence, this section should opt for better level of transparency.
(4) lack of specialization:- In the Indian Scene, each intermediary seems to deal in different financial service lines without specializing in one or two areas only. This helps them to achieve high levels of efficiency and excellence.
(5) lack of Recent Datar- Most of the intermediaries do not spend more on research. It is very vital that one should build up a proper data base on the basis of which one could embark upon "Financial creativity". Moreover, a proper data base would keep oneself aware of the recent development in other parts of the whole world & above all. It would enable the fund managers to take sound judicial decisions.
Ques 3:- What is Credit Card? Explain the advantages & limitations of Credit Card?
Ans:- Credit card are the innovative ones in the line of financial services offered by the commercial banks. A credit card is a card or mechanism which enables card holders to purchase goods, travel & dine in a hotel without making immediate payments. The holders can use the cards too get credit from banks upt 45 days. The credit card relieves the consumers from the botheration of carrying cash and ensures safety. Thus Credit card is a passport to ·Safety, Convenience, Prestige and credit.
There are three parties to a credit card, the cardholder, the issuer and the member establishments. - Issuer:- The banks or other card issuing organization.
Cdholders:- Individuals, corporate bodies and non-individual & non-corporate bodies such as firms.
Members Establishments:- Shops & Services organization enlisted by Credit Card issuer who accepts Credit Cards.
The Member establishments may be a business enterprise dealing in goods and services such as retail outlets, departmental stores, restaurant, hotels, hospitals, travel agencies etc.
Benefits of Credit Card:-
The benefit of credit cards to various parties are given below:(a) Card Holders:-
* Credit Card are simple to operate & easy to carry.
* It is a convenient method of payment for goods and services.
* Owing to resolving nature of credit, the costumer can take advantage of it as and when he pleases within the overall limit.
* Cash can be obtained at any branch of the issuer.
* Overdraft facility is given to cardholders who are entitled to spend more than their actual limit. * The purchasing power of the cardholder increased to the extend of credit limit given in the cad. * They also provide a certain degree of prestige to the holder.
Credit Card offer high profit for the banks. They get commission usually 2.5 % , on sale through credit cards, An interest charge of 1.5% is made on all outstanding.
* where the card is issued to non-account holders, it may help to get new costumers.
* A credit card system helps control bank cost as it reduces the number of cheques issued by the costumers. (C ) Member Establishment:-
* A Good cash flow is established because of the speedy settlement of bills by banks. * The acceptance of Card in lieu of cash reduces security risk.
* They are able to offer credit facility to their customers without setting up their own credit arrangements.
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? * The merchant has guarantee of payment & his account IS credited immediately on submitting the Chagnsint:::: his bank No bad debt arises in credit card transactions.
Demerit of Credit Cards:-
The credit card is not risk free and all players associated with it have to face an element of risk associated with it (a) Card Holders:-
• The cardholders are burdened with service charge. annual fee, membership fee etc A high rate of interest !.~ charged for delayed payment.
• Credit Cards tempt the holders for more purchases beyond their income & repaying capacity. Issues:-
The cost involved in the credit card business is high which includes cost of plastic car5d to be imported, cost '2" information. cost of placing and marketing cards and to carry out credit checks on applicants etc.
• The average utilization of credit car5d is only 20% to 30% in India. The under utilization of this facility erodes th~ profitability of banks.
( C ) Member Establishment:-
* The commission to be paid to the issuing banks or credit card organization is heavy.
* Some banks make delay in payment due to lack of adequate system and trained personnel, which affect the cash floe of the member establishment.
Ques 4:- Explain the role of SEBI in regulating the merchant banking operations in India.
,.. Ans:- SAEBl defines merchant bankers as "any person who is engaged in the business of issue management.. 3J
.~ either by making arrangement regarding selling, buying or subscribing to securities or acting as manager,
consultant, advisor or rendering corporate advisory services in relation to such issue management. Thus regulations are applicable only to limited activities undertaken by merchant banker. On the basis of regulations. banking activities can be cagorised as "authorized" and non-authorized activities. The merchant bankers required to get themselves registered under regulations only for authorized activities are undertaking issue management assignment, as manager, consultant, advisor underwriter portfolio manager.
Merchant Banking Activities not requiring SEBI's registration are:-
Project Counseling Corporate Counseling Factoring
Bill acceptance and discounting Loan syndication
Merger & amalgamation
Merchant Banking activities requiring SEBI's registration under different regulations but not under Merchant Banking regulations.
Venture Capital Mutual Funds Depositary
Portfolio Management Share Broking
Custodian Service Trusteeship or Debentures
Another angle from which authorized activities can be identified is the activities specified for each categories of
merchant bankers. . .
Categories of Merchant Bankers:-
The Merchant Banking regulations require that anybody seeking registration as merchant banker has to apply in one of the following four categories:-
Category I:-These merchant bankers can carry on any activity of the issue management which will inter-olio consist of preparations of prospectus & other information relating to the issue, determining financial structure and final allotment and refund of subscription . They can also act as adviser, consultant, manager, underwriter, and portfolio manager.
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/i;~::r Category II:~ Such Merchant Bankers can act as advisor, consultant, co-manager, underwriter and portfoli< manager. This means they cannot undertake issue management of their own.
Category 111:- These merchant bankers can neither undertaker issue management nor act as co-manager. Th Cannot conduct business of portfolio management. Thus the area of their operation restricts to act as underwritt . advisor and consultant to the issue.
Category IV:- Such merchant bankers do not undertake any activities requiring funds. They can act only advisor consultant to an issue.
Any agency to operate as merchant banker has to register itself under SEBI Regulations. Application is to I submitted in the prescribed format To get registration and certificate to operate as merchant banker, the agen has to fulfill two sets of criteria: -
(I) Operational Capabilities:- In this content SEBI before granting 'Certificate to Operate as mercha Banker' makes sure that concerned agency is competent on these parameters. To be more specit these are:
(a) It is necessary that to serve the clients and investors the merchant banker should have sufficie physical infrastructure.
(b) To ensure that services rendered are the best, SEBI desire the applicant have at least two persor who have the experience to conduct the business of the merchant banker.
(c) In order to avoid excessive registration SEBI makes sure that a person directly! Indirect connected with the applicant has not been already granted registration.
(d) The applicant or the Director should be man of integrity. SEBI is to make sure that such registratio should be in the interest of investors. Only those applicants who qualify on all these points ar granted registration.
(II) Capital Adequacy: -In the categories where in fund based activities are involved, SEBI desires ther to have sufficient capital. The concept of adequate capital is expressed in terms of 'net worth'. At th time of registration as well as subsequently following pattern of 'net worth' should be at leas maintained =
Category of Merchant Banker Minimum Net Worth
Category I Rs.5,OO,OO,OOO
Category II Rs. 50,00,000
Category III Rs. 20,00,000
Category IV NIL
Those applicants who qualify on both fronts are granted registration. The registered applicants are grantee certificate of registration in 'Form-B'. In which SEBI specifies for which category registration has been granted When certificate is finally granted the registered merchant bankers are to submit required fees. Registration ls granted for three years at one time. To keep the registration operative, merchant bankers are to pay registratior fee. The registration fee pattern is as under:-
Category Fee for 1st two Yrs. Third Yr.
Category I Rs. 2.5 Lakh Per Yr. Rs. 1 Lakh
Category II Rs. 1.5 Lakh per yr. Rs. 0.5 lakh
Category III Rs. 1 Lakh per yr. RS.0.25Iakh
Category IV Rs, 5,000 per year Rs.1000
Once the merchant bankers are registered to ensure that they, maintain high standard of services, regulations require them to adhere to a code of conduct specified in the schedule III of regulations. Some important provisions of code are as under:-
Maintain high standard of service, Maintain secrecy about client; do riot engage in unfair competition, Not to make llispresentation.
:lues 5:- What do you mean by risk management? Explain the different aspects of financial risk nanagement?
\ns:- Risk management can be defined as practices by which a firm optimize the manner in which it takes financial isk. It includes monitoring of risk taking activities, upholding relevant policies. And procedures and distributing risk elated reports.
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Further risk management IS not about ~ptlmizlng risk In some sense That IS the province of the board of dlrect~ and senior management. perhaps working with more tactical risk takers such as traders or portfolio managers. N risk management is about optimizing the manner in which risk is taken. Accordingly. risk management is not abo managing anything. It is really about facilitating.
Risk management is implemented in different ways There may be. within the bond of directors. a risk committe usually there is some sort of risk oversight committee. comprising senior managers. In practice. various names a given to these two committees. A senior manager called the head of risk management. reports to the risk oversig committee. This head of risk management may oversee a single department called the risk manageme department. Professionals working within that department, called risk managers. are responsible for facilitating tt taking of applicable financial risks-market risk. credit risks and operational risks- by other departments within it firm.
Functionally. there are four aspects of financial risk management. Success depends upon a positive corpora culture. actively observed policie & procedures, effective use of technology, independence of risk management professionals.
(a) Culture:- Corporate Culture plays a critical role in risk management because it defines the risk which c individual must persoOnally take if they are going to help managing organizational risks. A positive ris culture is one, which promotes individual responsibility and is supportive of risk taking. Corporate cultui defines what behaviour the members of an organization will condone- and what behaviour they will shu Characteristics include:-
.Individual Making decision:- group decision making can be ineffective if no one is personally accountable when a single person makes a decision-possibly with the help or approval of others-that individual is accountabl· .Questioning: -In a positive risk culture, people question everything. Not only does this identify better ways to ( things. It also ensures that people understand and appreciate procedures.
No risk culture is perfect. Fortunately, few are beyond repair. The challenge of risk management is to honest assess an organization's culture, and than work to improve it.
(8) Policies & Procedures:- These are powerful tools of risk management. Their purpose is to empower peopf They specify how people can accomplish what need to be done. The success of policies and procedures deper critically what people should do- and what they should not do- in a given situation. By reducing uncertain individual risk-they promote action.
(C) Technology:- The primary role technology plays in risk management is risk assessment and cornmunicatio. Technology is employed to qualify or otherwise summarize risk as they are being taken. It then communicates th information to decision-makers, as appropriate . For many Institutions, such as banks or securities firm technology is a critical component of risk management.
A good approach to implementing an enterprise risk management initiative is - initially allocate minimal funding f, the initiative, but ensure that board members, senior management or other supervisors are involved in tt process. Start by planning, a risk management strategy that involves no technology at all. This can be z empowering exercise. It focuses participants on the procedural and cultural issues of risk management. Ultimatel it is those which determine the success of an initiative.
(0) Independence:- For risk management to succeed risk, risk managers must be independent of risk takir functions within the organization. Holtane defines independence as comprising the following four criteria:-
• Risk Managers have reporting lines that are independent from those of risk taking functions. Except at tt highest levels, risk takers have no input on the performance reviews, compensations on promotion of ris managers, and conversely . Employees cannot switch from one role to the other. Those hired into ris management stay in risk management. Those hired as risk takers stay as risk takers .. Risk Managers do not ta~ risk on the firms behalf. They do not advise on which risk to take. They express no opinion about the desirability I any particularly risk. With risk manager not responsible for taking risks, there is little possibility of shifting blame 1 them when things go wrong.
QUES 6:- what is meant by Credit rating? Discuss the rating process followed by credit rating firms?
Ans: - Credit Rating is a symbolic indication of the current objective assessment by a rating agency of the relatlv capability and willingness of an issue of a debt programmes to service the debt obligations as per the terms of th contract. It may be referred as current opinion of a borrowers credit quality in terms of business & financial risk. only indicates representative characters of a particular security, which does not amount to any recommendation 1 purchase, sell or hold that security.
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,/' Any rating agency assigns a rating only when there is adequate information to available to form a credible opin« and only after extensive quantitative, qualitative and if appropriate legal analyses are performed. The process rating of broadly three-tier system:
(a) Information:- When the issuer approaches credit rating agency, it is to provide relevant information to ther The nature & source of Information required is presented in Chart I.
Source of Information
Outsider (Independent Source)
Specific During Plant Visit Interview
(Bankers, Auditors, Competitors Industry. experts, Dealers, and consumers)
(Business Profile) (Finance Profile)
(B) Analysis of Information:- The rating process of rating agencies is almost similar since the basic paramete to be observed to assess risks associated are same. Rating is a search of long term fundamentals and tt probabilities for changes in the fundamentals. These fundamentals are:-
(I) Financial Profile:- Financial profile, for which in depth study is made for Issuer, covers liquidi position, capital structure, financial flexibility, cash flow adequacy, profitability, leverage, intere coverage etc. The historical facts and future projections both are intensively used for these parameter Besides these, the rating agency also cr5itically evaluates accounting policies and practices wi particular reference to practices of providing for depreciation, income recognition, stock valuatio valuation of fixed assets etc.
(II) Business Profit:- There may be so many other factors which are not considered in financial analysi All such factors for convenience are grouped under the head business profile. The main facto considered here are:
(a) Issuer's industry:- The nature of industry to which issues belong has an i9mpact on rating of tt
instrument. The following questions need to be answered. - Is the Industry in a growth, stable or declining phase?
- What is the nature and Intensity of the competition in the Industry?
- What is the labour situation in the Industry?
- What is the statues and history of supply7 factor of key raw material?
(b) Issuer'S Competition:- After general evaluation of Industry, specific evaluation of issuer's position in tt industry need to studied. The main question is: -
- Does the company have a large enough portion of the market share to influence industry dynamics?
- Does the company have competitive advance through marketing and distribution strength?
- What is the financial strength of the company in content of the competitors?
(C ) Issuer's Management:- Management is tested on the related points important of which are as under:- What is the background and history of issuer?
- To what extend is the management professional?
- How effective is the control mechanism in the company?
- What is the report of past and present creditors of the company? 1::, >-'.I~l ~;:r
- How competent is the management to cope with short term charges? ~il\~f.
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." (c) Grading Rating Symbo!:- The process starts with the request of the prospective Issuer's formal requ
for rating The Issuer IS generally asked to submit required information in a set Performa of essen' items. Further the team may visit the premises to gather first hand information especially about qualitat. aspects. They may6 have assess to books of record. The data base of the rating agency about5 indus concerned is also extensively used .. Following this review and discussion. a recommendation is made the primary analyst and a rating committee meeting is convened The committee discusses t recommendations and the pertinent facts supporting the rating. The borrower is subsequently notified the rating and the major supporting considerations. Once a final rating is assigned, it will disseminated agencies subscriber clientele and publicity through the news media if the issuer accepts the rating.
At regular intervals company is supposed to submit the updated data and communicate major changes in pol matters. if any/. This surveillance system continues till the life of the concerned instrument. Under this system formal review is conduced annually6, new developments, i9ndustry trends and financial performance releases c reviewed regularly As a result rating may be changed or withdrawn.
Ques 7:- Discuss the principles of Insurance along with limitations of Insurance? Ans:- Insurance is a device for the transfer to an insurer come by the insured.
Insurance is a plan by which large number of people associate themselves and transfer to the shoulders of all, n that attach to individuals.
Principles of insurance:-
The following requirements along with all the essentials of a valid contract are most essential for a contract insurance to be valid: -
1. Good Faith:- A contract of Insurance is based on absolute good faith. It means that the insured rm disclose all material facts concerning the subject matter of the insurance. If a material fact is not dlsclos. or if there is mispresentation of frau, it shall render the contract void able at the option of the insurer. material fact is one, which the insurer shall take into account while considering whether to accept the ri or not to accept the risk.
2. .ndemnity:- A part from Life insurance other forms of Insurance (e.g. fire, marine) are contracts indemnity. The insurer i9n these cases promises to indemnity the insured person for what he actua losses on account of some misfortune. The contract of Insurance contained in a marine or fire policy, is contract of identity and of Identity only and that this contract mean that the assured in case of a 10 against which the policy has been made, shall be fully indemnified but shall never be more than fu Indemnified. The considerations of public interest also dictate that the insured must not get anything mo than the actual loss.
3. Subrogation:- According to the principle of subrogation, the insurer becomes entitled to all the rights the ensured as regards the subject matter of Insurance. The insured may have the rights against the thi party on account of negligence of the third party or on account of an agreement between the insured third party etc.
The following essential elements of the doctrine of subrogation deserve consideration:-+ Contracts of life &. Accident Insurance.
-+ Payment of the whole loss
-+ The Insured to surrender all his rights claims & remedies in favor of insurers.
-+ Insurer entitled to benefit only to the extent of his payment.
-+ The insurer entitled to only such rights as are available to the insured.
4. Insurable Interest:- For an Insurance contract to be valid, 'Insurance Interest' is the legal right to insur The legal right to insure is measured in terms of money and vests in a person to whom the law recognize as a person who is interested in the preservation of a thing. A contract of Insurance without an insurab interest is void.
Some of the instances where a person has an insurable interest in the life of another as follows:- A father may has insurable interest in the life of his son & vice-versa.
- A creditor has insurable interest in the life of debtor.
- A trustee has insurable interest with regard to the trust of which he is a trustee.
5. Cause Proximal:-It means that when the loss arises on account of more than one cause, then the neare cause is considered responsible for the loss. It is that cause which, in a natural and unbroken series (
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/.":.f" events. IS responsible for loss or damage. It is the cause closest to the result in order to effect. though not
, necessanly In time.
The principle of cause pronima stated that to ascertain whether the insurer is liable for the loss or not. the proximate and not the remote cause must be looked to. If there is only one cause of damage of loss. there is no difficulty in fixing the liability of the insurer.
Limitations of Insurance are:-
(a) All the risk cannot be insured. Only pure risk can be insured and speculative risks are not insurable. (b) Insurable interest on the subject matter.
(c) Impossibility of measurement of real loss.
(d) Not possible to insure the risk covered by a single individual or a small group due to higher cost involved. (e) Higher premium due to higher operating cost.
(f) Moral hazards = It becomes difficult to control moral hazards in insurance. There are certain people who mistulize the insurance plans for their self-interest by claiming false claims from insurance companies.
(g) Certain rights cannot be insured by private insurers like unemployment insurance. bankruptcy of bank insurance etc
6. Doctrine of subrogation:- The doctrine of contribution ensures equitable distribution of loss as between insurers. This states that insurers who has paid more than their proportionate shared to the insured shall have to right to recover the proportionate contribution from other insurers.
For ex.:- a person insures his house under two policies- with a for Rs. 20,000 and with B Rs. 18,000 the contribution shall be as follows:-
A shall pay 20,000 X 18000 = 12,857 28,000
B shall pay 8,000 X 18000 = 5,143
Thus doctrine of subrogation has the following features:-
~ The subject matter of insurance must be same to all the policies. , The same insured must be there in all policies.
» All the policies must be in force when loss occurs.
Ques 8:- Write short note on securitrisation of securities also discuss the various stages involved in the process secu ritisation?
a) Ans:- Securitisation of debt or asset refers to the process of liquidating the illiquid and long term assets like loan & receivable of financial institutions by issuing marketable securities against them. In other words, it is a technique by which a long term, non-negotiable high valued financial assets like hire purchase is converted into securities of small values which can be tradable in the market just like shares. Under securitisation, a financial institution pools its illiquid, non-negotiable and long term assets, creates securities against them, gets them rated and sell them to investors. It is an ongoing process in the sense that assets are converted into securities, securities into cash, cash into assets and assets into securities and so on.
1} Thus securitisation is nothing but liquefying assets comprising loans and receivables of an Institution through systematic issuance of financial instruments. Thus financial assets can be made liquid through securitisation that is through packaging loans and selling them in the market.
The various stages involved in the working of securitisation are as follows:-
a) Identification stage
b) Transfer Stage
c) Issue Stage
d) Redemption Stage
e) \Credit Rating Stage
a) Identification Stage:- The lending financial Institution either a bank or any other Institution for that matter which decides to go in for securitisation of its assets is called the 'Originator'. The originator has to pick up a pool of homogeneous nature, considering the maturities, interest rate involved, frequency of repayments and marketability. This process of selecting a pool of loans and receivables from the asset portfolio for securitisation is called 'Identification Process'.
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b) Transfer Process:- After the Identification process is over, the selected pool of asserts are the 'passed through" to another Institution which is ready to help the originator to convert those pool asserts Into securities. This institution is called the special purpose vehicle (SPV) or the trust. The pass through transaction between the originator and the SPV is either by the way of outright sale that is full transfer of assets in question for valuable consideration. This process of passing through the selected pool of assets by the originator to a SPV is called transfer process and once this process is over, assets are remove from the balance sheet of the originator.
c) Issue process:- After this transfer process is over, the SPV takes up the task of converting these assests of different maturities. It is on this basis, the SPV issues securities to investors, The SPV actually splits the package into individual securities of smaller values and they are sold to the investing public. The securities issued by the SPV are called by different names like pay through certificates, pass through certificates, interest only certficates.
d) Redemption Process:- The redemption and payments of interest on these securities are facilitated by the collections received by the SPV from the securities assests. The task of collection of dues is generally entrusted to the originator of a special servicing agent can be appointed for this purpose. This agency is paid a certain percentage of commission for the collection services rendered . Usually, the originator is appointed as the serviced, Thus under securitisation the role of the originator gets reduced to that of a collection agent on behalf of the SPV, in case he is appointed as a collection agent. A pass through certificate may be either 'with recourse to the originator or 'without recourse'. The usual practice is to make it 'without recourse'.
e) Credit Rating Process:- Since the pass through certificates have to be publicly issued, they require credit rating by a good credit rating agency so that they become more attractive and easily acceptable. Hence, these certificates are rated at least by one credit rating agency on the eve of the securitisation, The issue could also be guaranteed by eternal guarantor institutions like merchant bankers which would enhance the credit worthiness of the certificated and would be readily acceptable to investors.
Of course, this rating guarantee provides a sense of confidante to the investor with regard to the timely payment of principal & interest by the SPV.
~l Pass through certificates, like debentures, directly reflect new ownership rights in the assests
~ securities, their repayment schedule, interest rate etc. These certificates, be ore maturity, are tradable
• in a secondary market to ensure liquidity for the investors. They are negotiable securities and hence
1,'1 they can be easily tradable in the market.
• Ques 9:- Explain factoring along with its cost and benefits?
Ans:- Factoring is a method of financinq unheard by a company sells its trade debts at a discount to a final ~ institution. In other words, factoring is a continuous arrangement between a financial institution (I.E. factor) and a .. company, which sells goods and services to trade customers on credit. The client is immediately paid 80% of the 'j.', trade debs taken over and when the trade customers repay their dues, the factor will make remaining 20% payments.
Cost & Benefit of Factoring:.:i
The cost of factoring comprises of two aspects namely finance charges and service charges. Since the factor
~ provides 80% of the invoice as credit, he revives finance charges. Factoring is charge only on the amount actually ! provided to the client as repayment of his supplies. A part from this service charge is also levied. Generally, the factor changes a service fee on the total turnover of the bills. The benefits of factoring are saving in cost of credit administration and cost of bad-debt .
A business concern has to evaluate the cost and benefit to arrive are a decision before using the factoring service. Illustration: -
A manufacturing concern has a total sale of Rs. 16,00,000 and its average collection period is 90 days. The past experience indicates a bad-debt loss around 1.5% of credit sales. The company spends Rs. 25,000 on credit Administration and collection. A factor is prepared to buy the firms receivables by charging 2% commission. The factor will pay advance receivable at an interest of 18% after withholding 10% as reserve. Calculate the cost and benefit to the company and also effective rate of annual cost of factoring cost & benefit-
Credit Sales: = Rs. 16,00,000
Avg. Collection Period = 90 Days
= Rs. 3,52,000
==....::c=__;_c'--'-=--~-=-=- __ = Rs. 15,840
= Rs. 13.79/-
Benefits of Factoring:-
1. Financial service:- The greatest advantage is that factoring assumes immediate cash flow. When the cash position improves, the client is able to make his purchase on cash basis and thus, he can avail of cash discount facilities also. Another benefit is that the client will be able to come their trade debts into cash up to 80% immediately as soon as the credit sales are over.
2. Collection Service:- Collection of debts is another problematic area for many concerns, delay in the collection process often leads to delay in production and suppliers. Ultimately, it affects, the profitability of the company. Now, this collection work is completely taken up by the factoring organization, leaving the client to concentrate on production alone. This is an important service rendered by a factor to his client.
3. Credit Risk Service:- In the absence of a factor, the entire credit risk has to be borne by the client himself. But, once the factoring relationship is established, the client need not bother about the loss due to bad debts. Even, if the costumer fails to pay the debt, it becomes the responsibility of the factor to pay that amount to the client.
4. Consultancy Service:- Factors are professionals in offering management servicelistic consultancy. They collect information regarding the credit worthiness of the customers, ascertain their track record, quality of portfolio t6urnover & pass on the same to their clients.
Ques 10:- Write short notes on:- : .: : :~.~r
(a) Banking. (b) Leasing & Hire Purchase ... Co•• ;.' ~.~, ~j '1 ...
Ans.:- Bankmg:- A bank collects money from those who have it to spare or who are saving it out of their incomes, and it lends this money those who require it.
Banking means the accepting for the purpose of Indian companies lending or investment, of deposits of mosney from the public, repayable on demand of money from the public,. repayable on demand and withdrawable by cheques, drafts or otherwise.
Types of Banks:- Banks can be classified as:-
(a) On the basis of Reserve Bank Schedule (b) On the basis of ownership
(c) On the basis of domicile.
(d) On the basis of functions.
(a)On the basis of Reserve Bank schedule banks can be classified as :-
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. (I)Schedule Banks:- All those banks which are included In the list of schedule second of the Reserve bank of ".
I ndia are called Scheduled Bank. ' (II) Non-Scheduled-8ank:- The banks which are not included in the second scheduled of RBI Act, 1934 are called non-scheduled banks.
(b) On the basis of ownership banks are:-
(I) Public Sector 8anks:- These are those banks which are owned or controlled by the government. In 1955. the first public sector bank was established by passing a special Act of parliament, which is known as SB!.
(II) Private Sector 8ank:- These are those banks which are owned and controlled by the private sector that is a private individuals and corporations. In 1951. there were in all 566 private sector banks of which 92 banks were scheduled and remaining 474 were non-scheduled banks.
(III) Co-operative 8anks:- These are special types of banks doing ordinary6 banking business in which the members cooperate with each other for the promoter of their common economic interests.
(C ) On the basis domicile banks are:-
(I) Domestic Banks :- Those banks which are incorporated and registered in India.
(II) Foreign 8anks:- These are those banks which are set up in a foreign country with their control and management on the hands of head office in their country 09f origin but having business branches in India.
(d) On the basis of function banks are:-
(I) Commercial Banks:- These are those banks which perform all kinds of banking business and functions like accepting deposits, advancing loans, credit creation and agency functions.
(II) Industrial Banks:- These are those banks which provide medium & long-term finance to the industries for the purchase of loan & other , plant & machinery and other industrial equipment.
(III) Exchange Banks:- These are those banks which are on foreign exchange and specialized in financing the foreign trade.
(B) Leasing & Hire Purchase:- Leasing, as a financial concept, is an assignment between two parties, the leasing company or lesser and the user or lesser, whereby the former arranges to but capital equipment for the use of the latter for an agreed period of time in return for the payment of rent. The rentals are predetermined and payable at fixed intervals of time, according to the mutual convenience of both the parties.
Conceptually, a lease may be defined as a contractual agreement in which a party owing an asset (Lesser) provides the asset for use to another (Lessee) over a certain period of time for consideration in the form of periodic payments. At the end of the period of contract, the assets revert back to the lesser unless there is a provision for the renewal of the contact, The lessee is free to choose the asset according to his requirement and the lesser does not take recourse to the equipment as long as the rentals are regularly paid to him.
Hire Purchase:- It is a method of selling goods, In a hire purchase transaction the goods are let out on hire by a finance company (Creditor) to the hire purchase customers(hirer). The buyer is required to pay an agreed amount in periodically installments during a given period. The ownership of the property remains with creditor and passes on to hirer on the payment of last installment.
Features of Hire Purchase Agreement:-
- Under this agreement, the buyer takes possession of goods immediately and agrees to pay the total hire purchase price in installment.
- each installment is treated as hire charge
- The owner ship of the goods passes on the hirer on the payment of last installment.
- In case the buyer makes any default in the payment of any installment the seller has right to repossess the goods
from the buyer and forfeit the amount already received treating it as hire change.
- The hirer has the right to terminate the agreement any time before the4 property passes. He has the option to return the goods in which case he need not pay installments falling due thereafter.