Financial Services Assignment

Q.A) Process of Credit Rating

Ans. Credit rating is the process of assigning standard scores which

summarize the probability of the issuer being able to meet its repayment
obligations for a particular debt instrument in a timely manner.

Steps involved in Credit Rating

 Request from issuer and analysis: The first step to credit rating is that
the enterprise applies to the rating agency for the rating of a particular
instrument. Thereafter, an expert team interacts with the firm’s those
charged with governance and acquires relevant data. Factors which are
considered includes:
o Historical performance
o Financial Policies
o Business Risk profile
o Competitive Position, etc.

 Rating Committee: Based on the information gathered and evaluation

performance, the presentation of the report is made by the expert’s
team to the Rating Committee, in which the issuer is not permitted to
take part.

 Communication to management and appeal: The decision of the

rating is shared with the issuer and if he/she does not agree with the
 decision, then an opportunity of being heard is given. The issuer is
required to provide material information, so as to appeal against the
decision. The decision is reviewed by the committee, but that does not
make any change in the ratings.

 Pronouncement of the rating: When the issuer agrees to the rating

decision, the agency make a public announcement, of the rating.

 Monitoring of the assigned rating: The agency which rates the issue,
overlooks the performance of the issuer and the business environment
in which it operates.

 Rating Watch: On the basis of continuous critical observation

undertaken by the rating agency, it may place a rated security on
Rating Watch.

 Rating Coverage: Credit Ratings are not confined to particular debt

instruments, but also covers public utilities, transport, infrastructure,
energy projects, Special Purpose Vehicles etc.

 Rating Scores: Rating scores are given by the credit rating agencies
like CRISIL, ICRA, CARE, FITCH.
Credit Rating is of great help, not just in investors protection but to the entire
industry, as it directly mobilizes savings of the individuals.

Q.B) Difference between factoring and forfaiting ?

Ans.

Definition of Factoring

Factoring is defined as a method of managing book debt, in which a business

receives advances against the accounts receivables, from a bank or financial
institution (called as a factor). There are three parties to factoring i.e. debtor
(buyer of goods), the client (seller of goods) and the factor (financier).
Factoring can be recourse or non-recourse, disclosed or undisclosed.

Definition of Forfaiting

Forfaiting is a mechanism, in which an exporter surrenders his rights to

receive payment against the goods delivered or services rendered to the
importer, in exchange for the instant cash payment from a forfaiter. In this
way, an exporter can easily turn a credit sale into cash sale, without recourse
to him or his forfaiter.

Comparison Chart
Basis for
Factoring Forfaiting
Comparison
Factoring is an arrangement that Forfaiting implies a
converts your receivables into transaction in which the
Meaning ready cash and you don't need to forfaiter purchases claims
wait for the payment of from the exporter in return
receivables at a future date. for cash payment.
Maturity of Involves account receivables of Involves account receivables
receivables short maturities. of medium to long term
 Basis for
Factoring Forfaiting
Comparison
maturities.
Trade receivables on ordinary Trade receivables on capital
Goods
goods. goods.
Finance up to 80-90% 100%
Type Recourse or Non-recourse Non-recourse
Cost of factoring borne by the Cost of Forfaiting borne by
Cost
seller (client). the overseas buyer.
Negotiable Does not deals in negotiable Involves dealing in
Instrument instrument. negotiable instrument.
Secondary
No Yes
market

Q.C) Legal aspect of leasing ?

Ans. Legal aspects of leasing

As there is no separate statue for equipment leasing in India, the provisions

relating to bailment in the Indian Contract Act govern equipment leasing
agreements as well section 148 of the Indian Contract Act defines bailment as:

“The delivery of goods by one person to another, for some purpose, upon a
contract that they shall, when the purpose is accomplished, be returned or
otherwise disposed off according to the directions of the person delivering
them. The person delivering the goods is called the ‘bailor’ and the person to
whom they are delivered is called the ‘bailee’.

Since an equipment lease transaction is regarded as a contract of bailment, the

obligations of the lessor and the lessee are similar to those of the bailor and
the bailee (other than those expressly specified in the least contract) as defined
by the provisions of sections 150 and 168 of the Indian Contract Act.
Essentially these provisions have the following implications for the lessor and
the lessee.
 1. The lessor has the duty to deliver the asset to the lessee, to legally
authorise the lessee to use the asset, and to leave the asset in peaceful
possession of the lessee during the currency of the agreement.
2. The lessor has the obligation to pay the lease rentals as specified in the
lease agreement, to protect the lessor’s title, to take reasonable care of the
asset, and to return the leased asset on the expiry of the lease period.
Contents of a lease agreement:
The lease agreement specifies the legal rights and obligations of the lessor and
the lessee. It typically contains terms relating to the following:

1. Description of the lessor, the lessee, and the equipment.

2. Amount, time and place of lease rentals payments.
3. Time and place of equipment delivery.
4. Lessee’s responsibility for taking delivery and possession of the leased
equipment.
5. Lessee’s responsibility for maintenance, repairs, registration, etc. and
the lessor’s right in case of default by the lessee.
6. Lessee’s right to enjoy the benefits of the warranties provided by the
equipment manufacturer/supplier.
7. Insurance to be taken by the lessee on behalf of the lessor.
8. Variation in lease rentals if there is a change in certain external factors
like bank interest rates, depreciation rates, and fiscal incentives.
9. Options of lease renewal for the lessee.
10. Return of equipment on expiry of the lease period.
11. Arbitration procedure in the event of dispute.

Q.D) Define 'fire' in a insurance policy ?

Ans. Definition: Fire and special perils policy is an insurance contract that
safeguards the insured against unforeseen contingency caused by accidental
fire, lightning, explosion or implosion, destruction or damage caused by aerial
devices, man made perils in the form of riots, strike etc, natural calamities like
storm, cyclone, flood etc, damage caused by impact by a rail or a road vehicle,
damage cased by landslide or subsidence, peril caused by pollution and
contamination, bursting and or overflowing of water tanks, apparatus and
pipes, missile testing operations, leakage from automatic sprinkler
installations and bush fire.

It is a contract wherein the insurer guarantees to pay for the loss and damage
happen to the property for the specified period of time (normally the fire
policy is a one year policy and renewable annually). The valuation of assets is
made according to the market value. The value factors in both the
depreciation as well as the appreciation of assets due to inflation.

How Fire Insurance Works

Fire insurance covers a policyholder against fire loss or damage from a

number of sources. Sources include fires brought about by electricity, such as
faulty wiring and explosion of gas, as well as those caused by lightning and
natural disasters. Bursting and overflowing of a water tank or pipes may also
be covered by the policy.

Most policies provide coverage regardless of whether the fire originates from
inside or outside of the home. The limit of coverage depends on the cause of
the fire. The policy will reimburse the policyholder on either a replacement-
cost basis or an actual cash value (ACV) basis for damages.

If the home is considered a total loss, the insurance company might reimburse
the owner for the house's current market value. Typically the insurance will
provide a market value compensation for lost possessions, with the total
payout capped based on the home's overall value.

For example, if a policy insures a house for $350,000, the contents are usually
covered for at least 50-70% of the policy value or a range of $175,000 to
$245,000. Many policies limit how much reimbursement covers luxury items
such as paintings, jewellery, gold, and fur coats.

Q.E) Venture capital services in India ?

Ans. Venture Capital refers to the finance provided by Venture Capitalists,

who invest in relatively new, high growth companies or start-ups that have a
potential to grow and develop into highly profitable ventures. It has high-risk
and high-return characteristics. Therefore, it acts as an important source of
finance for entrepreneurs with new ideas.

It is a private or institutional investment made to early start-up companies.

Venture Capital is money invested in businesses that are small; or exist only
as an initial stage but have huge potential to grow. The people who invest this
money are known as venture capitalists.

It is an investment made when a venture capitalist buys shares of a start-ups

company and become a financial partner in the business.

Venture Capital is also stated as a huge capital risk or patient risk capital
investment, as it involves the risk of losing the money if the venture doesn’t
succeed.

Some of active Venture Capital Firms in India.

1) Sequoia Capital :https://www.sequoiacap.com/india/

Founded: 1972

Sequoia Capital is a venture capital firm that invests in public and private
companies from all sectors. It specializes in incubation, seed stage, start-up
stage, early stage, and growth stage investments in private companies.
Sequoia is focused on energy, financial, enterprise, healthcare, internet, and
mobile start-ups.

2) IDG Ventures: http://www.idgvcindia.com/

Founded: 1996

IDG Ventures India is a leading India-focused technology venture capital

firm. The fund is part of IDG Ventures, a global network of technology
venture funds with more than US$ 4 billion under management, over 200
investor companies and 10 offices across Asia and North America. The fund’s
lead investor and the sponsor are the International Data Group (IDG), the
world’s largest IT media company.

3) Indian Angel Network: http://indianangelnetwork.com/

Founded: 2006

Indian Angel Network is a network of Angel investors keen to invest in early

stage businesses which have the potential to create inconsistent value. The
members of the Network are leaders in the Entrepreneurial Eco-System as
they have had strong operational experience as CEOs or a background of
creating new and successful ventures. They share a passion for creating scale
and value for startup ventures.

4) Accel Partners: http://www.accel.com/

Founded: 1983

Accel is a leading early and growth-stage venture capital firm, powering a

global community of entrepreneurs. Accel backs entrepreneurs who have
what it takes to build a world-class, category-defining business. Accel’s invest
in the companies that will be responsible for the growth of next-generation
industries.
5) 500 startups:http://500.co/

Founded: 2010

500 Start-ups is a global venture capital seed fund and start up accelerator
based in Silicon Valley with ~$200 million in assets under management. They
have invested in a wide variety of technology start-ups all over the world.

Q.F) Fund and Non- Fund based financial services ?

Ans. The five major areas of fund based activities. The areas are: 1. Leasing
2. Hire-Purchase 3. Bill Discounting 4. Factoring 5. Venture Capital.
Fund Based Activity: Area

1. Leasing:
Leasing is the most significant development as a method of procuring assets
which has taken place in the field of finance during the past five decades
although it was on real estate leasing at first During the past several years,
various firms are granting lease almost all types of fixed assets.

2. Hire-Purchase:
A line-put transaction is one when the seller owner of certain goods delivers
has goods to a person (known as hire-purchase) with a condition that he (hire-
purchaser) with repay the price of the goods which is inclusive of certain
amount of interest) by different specified periodical instalments and acquires
the property (goods) immediately but the same is transferred only when the
last instalment is paid.

3. Bill Discounting:
When the holder of a bill wants to get the money before the due date, he can
sell the bill to a bank against a small charge, known as discounting charges
i.e., a supplier or creditor of goods discounts the incomes for sale of goods.

Discounting charge is imposed by the bank at a fixed rate present p. a from

the date of discounting to the date of maturity. At present in our country,
through the discounting of bills of exchange a major part of lending of money
taken place by commercial banks.

4. Factoring:
A factor is a financial institution who takes the responsibility of financing and
collecting debts that may arise out of credit sales. It is done on a continuous
basis. Under the arrangement as soon as new bills receivables come in they
are taken by the factor and the proceeds are credited to the accounts of the
client correspondingly.

5. Venture Capital:
Venture capital implies the financial investment to high-tech growing
companies (i.e., higher risk based) as equity capital with the expectation of a
higher rate of return which is inclusive of initial as well as development
capital for a company.

Although the concept is very old, it is not widely accepted. Sometimes, this
capital is being introduced as a result of the product of any scientific
improvement and technology and to bring it into real world situation. It also
helps the new companies to issue shares who find it difficult.

Types of non-fund based activities in India.

1. Issue Management:
Like ordinary issue, the process of issue management is same. It is, however,
the duty of the Non-Banking Financial Company to supply a complete set of
services and must try to improve and develop the process of marking the
issues by which the net work of the promoters will be extended.

 2. Portfolio Management:

Portfolio management implies the investment of funds taken from
numbers/clients in various securities and an adequate return should be given
to them. In other words, it is a scheme by which the portfolio manager raise
funds from his clients/members with a commitment in order to operate the
securities market together with the information, in well explained terms
relating to the composition of portfolio, annual return, appropriation of
capital, the extent of risk etc.

3. Loan/Lease Syndication:
The practising Chartered Accountants who supply the liaison services to the
clients where they are in need of funds whether for the purpose of working
capital or for term loan purposes.

At present, it has been found that the Chartered Accountant firms are keen
interested to keep in touch with the large group of companies and are trying
to improve their contact with others with the help of such giant clients who
are doing quite successful business.

 4. Advising on Acquisition and Mergers:

NBFC should pay the proper attention in this field. In order to consolidate the
firm and to form a new one or to enjoy the benefits of economies of large
scale, many companies are interested to amalgamate. The matter is very clear
and simple if the management of both the companies is ready to do so.

To have these objectives, sometimes the promoters misuse their powers over
the various companies. For this purpose, the Government has laid down
certain guidelines prescribing the maximum limit of holding by the NRJs in
the Indian companies recently.

5. Advising on Capital Restructuring:

For the purpose of fresh issue, the companies have to present and prepare
their Balance Sheet in a healthy form but not with the product of window
dressing which produces an effective use and application of financial
management as a whole. It is not an easy task. It requires a lot a practical
exercise and experience. Sometimes, professional advice may also be
required.

case study
A) What are the reasons of financial crises?

Ans. In a financial crisis, asset prices see a steep decline in value, businesses

and consumers are unable to pay their debts, and financial institutions
experience liquidity shortages. A financial crisis is often associated with a
panic or a bank run during which investors sell off assets or withdraw money
from savings accounts because they fear that the value of those assets will
drop if they remain in a financial institution. Other situations that may be
labelled a financial crisis include the bursting of a speculative
financial bubble, a stock market crash, a sovereign default, or a currency
crisis. A financial crisis may be limited to banks or spread throughout a single
economy, the economy of a region, or economies worldwide.

Reasons of financial crises

1. Mark-to-market accounting. In the early 1990s, the Securities and Exchange

Commission and the Financial Accounting Standards Board started requiring
public companies to value their assets at market value as opposed to historical
cost -- a practice that had been discredited and abandoned during the Great
Depression. This pushed virtually every bank in the country into insolvency
from an accounting standpoint when the credit markets seized in 2008 and
2009, thereby making it impossible to value assets.

2. Ratings agencies. The financial crisis couldn't have happened if the three
ratings agencies -- Standard & Poor's, Fitch, and Moody's -- hadn't classified
sub prime securities as investment grade. Part of this was incompetence. Part
of it stemmed from a conflict of interest, as the ratings agencies were paid by
issuers to rate the securities.
3. Infighting among financial regulators. Since its inception in 1934, the
FDIC has been the most robust bank regulator in the country -- the others
have, at one time or another, included the Office of the Comptroller of the
Currency, the Federal Reserve, the Office of Thrift Supervision, the Securities
and Exchange Commission, the Federal Savings and Loan Insurance
Corporation, and an assortment of state regulatory agencies. But thanks to
infighting among regulators, the FDIC was effectively excluded from
examining savings and investment banks within the OTS's and SEC's primary
jurisdiction between 1993 and 2004. Not coincidentally, those were the firms
that ended up wreaking the most havoc.

4. Securitization of loans. Banks traditionally retained most of the loans that

they originated. Doing so gave lenders incentive, albeit imperfectly, to
underwrite loans that had only a small chance of defaulting. That approach
went by the wayside, however, with the introduction and proliferation of
securitization. Because the originating bank doesn't hold securitized loans,
there is less incentive to closely monitor the quality of underwriting
standards.

5. Fraud. While very few financiers have been prosecuted for their role in the
financial crisis, don't interpret that to mean that they didn't commit fraud.
Indeed, the evidence is overwhelming that firms up and down Wall Street
knowingly securitized and sold toxic mortgage-backed securities to
institutional investors, including insurance companies, pension funds,
university endowments, and sovereign wealth funds, among others.

6. Short-term investment horizons. In the lead-up to the crisis, analysts and

investors castigated well-run firms such as JPMorgan Chase and Wells
Fargo for not following their peers' lead into the riskiest types of sub prime
mortgages, securities, and derivatives. Meanwhile, the firms that succumbed
to the siren song of a quick profit -- Citigroup, for instance -- were the first to
fail when the house of cards came tumbling down.
7. Off-balance-sheet risk. Why did investors allow financial firms to assume
so much risk? The answer is that no one knew what they were up to because
most of the risky assets weren't reflected on their balance sheets. They had
been securitized and sold off to institutional investors, albeit with residual
liability stemming from warranties that accompanied the sales, or were
corralled in so-called special-purposes entities, which are independent trusts
that the banks established and administered. Suffice it to say that all of the
residual liability flooded back onto the banks' balance sheets only after the
you-know-what hit the fan.

8. Lehman Brothers' bankruptcy. Allowing Lehman Brothers to fail was a

mistake of epic proportions. History clearly demonstrates that the downfall of
a major money-center bank -- be it a commercial or investment bank -- almost
always triggers wide-scale financial panics. In 1873, it was Jay Cooke &
Company. In 1884, it was Grant & Ward. In 1907, it was the Knickerbocker
Trust Company. I could go on and on with examples. The point being, despite
the admittedly unsavoury thought of bailing out someone as aggressively
offensive as Dick Fuld, it would have been a small price to pay to avoid the
subsequent economic carnage.

9. Basel II bank capital rules. Any time an economy experiences a severe

financial shock, one of the biggest problems is that undercapitalized banks
will be rendered insolvent. That's true in part because of the absurd
application of mark-to-market accounting during periods of acute stress in the
credit markets, and in part because banks are highly leveraged, meaning that
they hold only a small slice of capital relative to their assets. The so-called
Basel II capital rules, which took effect in 2004, accentuated this reality. The
rules allowed banks to substitute subordinated debt and convertible preferred
stock in the place of tangible common equity. The net result was that tangible
common equity at certain major U.S. banks declined to less than 4% on the
eve of the crisis.
B) What is the role played by Indian government to stop such
financial crisis ?

Ans. Monetary Policy Measures:

Our response to the global financial turmoil has been both monetary and
fiscal. The RBI which for several months before has been increasing cash
reserve ratio and interest rates to fight against inflation reversed its monetary
policy from Oct. 2008.

The RBI took several steps to prevent fast depreciation of Indian rupee due to
massive capital outflow by FIIs by selling billions of dollars in the foreign
exchange market from its reserves. But for RBI intervention, the value of
rupee would have gone much below Rs. 52 for a US dollar.

The problem raised by global financial crisis was diagnosed as the lack of
liquidity in the money market which adversely affected the flow credit to
industries. Therefore, to increase liquidity of the banking system, RBI cut cash
reserve ratio (CRR) four times in 0ct.2008 to January 2009 by 400 basis points
(i.e. by 4 percentage points) from 9 per cent to 5 per cent. With this the RBI
infused liquidity of Rs. 1, 60,000 crores in the banking system.

Besides, RBI reduced statutory liquidity ratio (SLR) from 25 per cent to 24
which enabled banks to get Rs. 20,000 crores from RBI against Government
securities for lending to mutual funds. Besides, RBI released Rs. 25,000 crores
to the banks in connection with the farm waiver scheme of the Central
Government. It may be noted further that banks can also borrow from RBI
through repo window of liquidity adjustment facility (LAF) scheme of RBI.

Besides, unwinding of some market stabilisation scheme was also undertaken

to increase liquidity with the banks. In this way about Rs. 2,00,000 crores had
been infused into the domestic money market to alleviate the pressures
brought on by deterioration in global financial environment. With infusion of
this adequate liquidity in the system through various measures the banks
could provide credit to the industries for financing working capital and fixed
investment projects. This was expected to boost industrial growth which had
slackened in the last few months.

As a result of this various Indian banks (including SBI) reduced their prime
lending rate (PLR) to around 12 to 12.5 per cent. With this banks lower their
lending rates so that cost of borrowing from the banks fell and more credit
was created for investment by the companies and there was more demand for
durable consumer goods such as houses, cars etc.

Besides, RBI cut reverse repo rate, which is the overnight rate of interest at
which banks park their surplus funds with the RBI to 4 per cent. This was
meant to encourage banks to give credit to business enterprises for
investment and to consumers for buying houses, cars etc. rather than keeping
surplus liquid funds with RBI.

However, reports from banks (in March 2009) revealed that though liquidity
had eased in the system and banks had lowered their lending rates but credit
to industries did not pick up to the extent it was expected to happen. As a
result, most banks were sitting on surplus cash. This showed due to global
meltdown and its adverse effects on various sectors of the Indian economy
banks became risk averse and were not willing to lend for fear of defaults by
the borrowers.