New Financial Products and Services

Prof. Sarbesh Mishra Finance Area.

Preface

Structural change in international capital market has led to the emergence of new products and innovative techniques of operation in capital market. Financial intermediaries including banks have already started expanding their activities in the financial services sector by offering a variety of new products.
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Merchant Banking

It’s a financial intermediary who helps to transfer capital from those who possess it to those need it. Merchant banking includes wide range of activities i.e. management of customers securities, portfolio management, project counseling and appraisal, underwriting of shares and debentures, acting as banker for refund orders, handling interest and dividend warrants etc. Merchant banker renders a host of services to corporate and promotes industrial growth.
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Loan Syndication

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Loan arranged by a bank called lead manager for a borrower who is usually a large corporate customer or a government department. The other banks who are willing to lend can participate in the loan by contributing an amount suitable to their own lending policies. Since single bank can’t provide huge sum of loan, a number of banks join together and form a syndicate. It also enables the members of the syndicate to share the credit risk associated with a particular loan among themselves. This is otherwise referred as “Consortium Financing”.
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Mutual Funds

This refers to fund raised by a financial service company by pooling the savings of the public. It is invested in a diversified portfolio with view to spreading and minimizing risk. The fund provides investment avenue for small investors who can’t participate in the equities of big companies. It ensures low risk, steady returns, high liquidity and better capital appreciation in long run.
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Factoring
It refers to managing the process of sales ledger by financial service company.  It’s an arrangement under which financial intermediary assumes credit risk in the collection of book debts for its clients.  A factor provides credit information, collects debts, monitors sales ledgers, and provides finance against debts.

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Forfaiting

It’s a technique by which forfaitor (Financing Agency) discounts an export bill and pay ready cash to the exporter who can concentrate on the export front without bothering about the collection of export bills. The exporter is protected against the risk of non-payment of debts by the importers.

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Securitisation
It’s a process by which a financial company converts its ill-liquid, non-negotiable and high value financial assets into securities of small value which are made tradable and transferable.  It is best suited for housing finance companies whose loans are always long-term in nature and their money is locked up for a considerable period.  In such cases, securitisation would help the financial institution to raise cash against such assets by means of issuing securities of small values to the public.

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Derivative Security
It’s a security whose value depends on the value of other basic variables backing the security.  A derivative security is basically used as risk management tool and it is resorted to cover the risks due to price fluctuations by the investments manager.  It helps to break the risks into various components such as credit risk, interest rates risk, exchange rates risk and so on.  In India some forms of derivatives are in operation namely forwards in forex market

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Letter of Credit (LOC)
An innovative funding mechanism for the import of goods and services on deferred payment terms.  LOC is an arrangement of a financing institution / bank of one country with another institution / bank / agent to support the export of goods and services so as to enable the importers to import on deferred payment terms.  This is backed by a guarantee furnished by the institution / bank in the importing country.  This helps the exporter to get payment immediately as soon as the goods are shipped.

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Infrastructure Bond
 

 

It is a kind of debt instrument issued with a view to giving tax shelter to investors. The resources raised through this bond will be used for promoting investment in the field of certain infrastructure industries. Tax concessions are available under sec. 88, sec. 54 EA and sec. 54 EB of Income Tax Act. HUDCO has issued for the first time such bonds. It’s face value was Rs. 1000 each carrying an interest rate of 15% per annum payable semiannually.
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Miscellaneous

Yankee Bonds – If bonds are raised in USA, they are called as Yankee Bonds and if they raised in Japan they are called as Samurai Bond. Floating Rate Notes (FRNs) – These are debt instrument which facilitate the periodic interest rate adjustment. Loyalty Coupons – These are entitlements to the holder of debt for two to three years to exchange into equity shares at discount prices. Global Depository Receipt – It’s a dollar denominated instrument traded in a stock exchange in Europe or the USA.
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New Products in the FOREX Market
Forward Contract – In a forward transaction the delivery of foreign currency takes place at a specified future date for a specified price.  Obligation is there to honour this contract at any cost else penalty will be levied i.e. genuine business.  It is having a fixed or flexible maturity features i.e. 30th. Sept’08 or 1-30th. Sept’08.  These are traded over the counter (OTCEI) or simply be a signed contract between two parties.  Forwards transact only when purchased and on the settlement date.  In the case of physical delivery, the forward contract 09/22/08 Sarbesh Mishra 13 specifies to whom to make the delivery

Options
Buyer of the option has a right to buy or sell a fixed amount of currency against another currency at a fixed rate on a future date according to his option.  There is no obligation to buy or sell, but it is completely left to his option.  Options are of two types, namely 1. Call Options (Option to buy) 2. Put options (Option to sell)  Option trading leads to speculations and legal restrictions are imposed in India.

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Futures

It’s a legal contract where there is an agreement to buy or sell a stated quantity of foreign exchange at a future date at an agreed price on a stated stock exchange. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. Futures are rebalanced, or "marked to market," every day to the daily spot price of a forward with the same agreed-upon delivery price and underlying asset. The counterparty for delivery on a futures contract is chosen by the clearing house.
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SWAPS

Transaction wherein a financial intermediary buys and sells a specified foreign currency simultaneously for different maturity dates. It results into simultaneous buying and selling of same foreign currency of the same value for the different maturities to eliminate risk. It is also used to enter into arbitrage operations i.e. arbitrage is the practice of taking advantage of a price differential between two or more markets.

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