Financial Awareness E-Study Notes

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Sources of Financing
Introduction:
Business finance refers to funds required to operate business activities,
and expand in the future. Funds are specifically required for purchase
of various tangible assets such as furniture, machinery, buildings, land,
offices, factories, vehicles, stock, or intangible assets like patents,
technical expertise, and trademarks, franchises, copyrights, goodwill,
brands etc.
Apart from the assets mentioned above, other things that require in
funding are the day-to-day operational activities of a business. This
activity includes purchasing of raw materials, paying salaries, bills,
collecting money from clients, etc. It is essential to have sufficient
amount of money to survive and grow the business activites.
Features of Financing:-
1. Investment Opportunities
2. Allocation and Utilization of Funds
3. Diversify your Investment.
4. Financial Decision Making
5. Financial Management
Sources of financing can be classified in to 3 types

(1) Basis of time
(2) Basis of ownership and control
(3) Source of generation

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On basis of the period
(1) Long Term Sources:-These are the source of finance that fulfil the
financial requirements of the business for a longer period of more
than 5-10 years. It includes Debentures, Equity shares, Preference
shares, Ratined earnings, loans from financial institutions etc. This
finance is generally used for fixed assets like plant, machinery,
equipment etc. It is generally used for financing big projects,
funding operations, expansion plants etc. This source of finance
has a long term impact on the business.
(2) Medium Term Sources:-These are the sources that are required
for a period of more than one year but less than five to ten years.
Examples of these sources are loans from the bank, Public
deposits, loans from financial institutions etc.

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(3) Short Term Sources:-These are the sources of fund that is
required for less than a year.
Examples of these sources are Trade credit, Banks, Commercial
paper etc.
Based on Ownership
(1) OWNERS FUNDS– This fund is financed by the company owners,

also known as the owner’s capital. The capital is raised by issuing
preference shares, retained earnings, equity shares, etc. These are
for long term capital funds which form a base for owners to obtain
their right to control the firm’s management and operations.
(2) BORROWED FUNDS – These are the funds accumulated with the
help of borrowings or loans for a particular period. This source of
funds is the most common and popular amongst businesses. For
example, loans from commercial banks and other financial
institutions.
Based on Generation
* Internal Sources – The owners generated the funds within the
organization. The example for this reference includes selling off
assets and retained earnings, etc.

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* External Source – The fund is arranged from outside the business.
For instance, issuance of equity shares to the public, debentures,
commercial banks, loans etc
According to period
Sources of financing a business are classified based on the period for
which the money is required. The time is commonly classified into 3
following types
LONG TERM SOURCES MEDIUM-TERM SHORT TERM

OF FINANCING SOURCES OF SOURCES OF
FINANCING FINANCING
Equity Shares Preference Shares Trade Credit
Preference Shares Debenture Factoring Services
Retained Earnings Lease Finance Bill Discounting etc.
Debenture Hire Purchase Finance Advances received from
customers
Term Loans from Medium-Term Loans Short Term Loans like
Financial Institutes, from Financial Working Capital Loans
Government, and Institutes, Government, from Commercial Banks
Commercial Banks and Commercial Banks
Venture Funding - Fixed Deposits (<1 Year)
Long-Term Sources of Finance

Long term financing means capital requirements for more than 5 years
to 10, 15, 20 years or maybe more depending on other factors. Capital
expenditures in fixed assets like plant and machinery, land and
building, etc of business are funded using long-term sources of finance.
Part of working capital which permanently stays with the business is
also financed with long-term sources of funds. Long-term financing
sources can be in the form of any of them:

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* Equity share
* Preference share
* Retained Earnings
* Debentures
* Loans from Financial Institutes, Government, and Commercial
Banks
* Venture funding
* International Financing by way of Foreign Currency Loans, ADR,
GDR, etc.
Medium Term Sources of Finance

Medium-term financing means financing for a period of 3 to 5 years and
is used generally for two reasons. One, when long-term capital is not
available for the time being and second when deferred revenue
expenditures like advertisements are made which are to be written off
over 3 to 5 years. Medium-term financing sources can in the form of
one of them:
* Preference Capital or Preference Shares
* Debenture / Bonds
* Medium Term Loans from
* Financial Institutes
* Government, and
* Commercial Banks
* Lease finance
* Hire purchase finance
Short Term Sources of Finance

Short term financing means financing for less than 1 year. The need for
short-term finance arises to finance the current assets of a business like
an inventory of raw material and finished goods, debtors, minimum

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cash and bank balance etc. Short-term financing is also named working
capital financing. Short term finances are available in the form of:
* Trade credit
* Short Term Loans like working capital from Commercial Banks
* Fixed Deposits for 1 year or less>
* Advances received from customers
* Creditors
* Payables
* Factoring Services
* Bill discounting etc.
According to Ownership and Control:

Sources of finances are classified based on ownership and control over
the business. These two parameters are an important consideration
while selecting a source of funds for the business. Whenever we bring
in capital, there are two types of costs – one is the interest and another
is sharing ownership and control. Some entrepreneurs may not like to
dilute their ownership rights in the business and others may believe in
sharing the risk.
OWNED CAPITAL BORROWED CAPITAL

Equity Financial institutions,
Preference Commercial banks or
Retained Earnings The general public in case of
debentures.
Convertible Debentures
Venture Fund or Private
Equity

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Owned Capital
Owned capital also refers to equity. It is sourced from promoters of the
company or the general public by issuing new equity shares. Promoters
start the business by bringing in the required money for a startup.
Following are the sources of Owned Capital:
* Equity
* Preference
* Retained Earnings
* Convertible Debentures
* Venture Fund or Private Equity
Further, when the business grows and internal accruals like profits of
the company are not enough to satisfy financing requirements, the
promoters have a choice of selecting ownership capital or non-
ownership capital. This decision is up to the promoters. Still, to discuss,
certain advantages of equity capital are as follows:
* It is a long-term capital which means it stays permanently with the
business.
* There is no burden of paying interest or instalments like borrowed
capital. So, the risk of bankruptcy also reduces. Businesses in the
infancy stages prefer equity for this reason.
Borrowed Capital
Borrowed or debt capital is the finance arranged from outside sources.
These are the sources of debt financing that include the following:
* Financial institutions,
* Commercial banks or
* The general public in case of debentures
In this type of capital, the borrower has a charge on the assets of the
business which means the company will pay the borrower by selling
the assets in case of liquidation. Another feature of the borrowed fund
is a regular payment of fixed interest and repayment of capital.
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Certain advantages of borrowing are as follows:
* There is no dilution in ownership and control of the business.
* The cost of borrowed funds is low and it is a deductible expense
for taxation purposes which ends up saving on taxes for the
company.
* It gives the business benefit of investing borrowed money
ACCORDING TO SOURCE OF GENERATION:

Based on the source of generation, the following are the internal and
external sources of finance:
INTERNAL SOURCES EXTERNAL SOURCES
Retained profits Equity
Reduction or controlling of Debt or Debt from Banks
working capital
Sale of assets etc. All others except mentioned
in Internal Sources
Internal Sources
The internal source of financing is the one that is generated internally
by the business. These are as follows:
* Retained profits
* Reduction or controlling of working capital
* Sale of assets etc.
The internal source of funds has the same characteristics as owned
capital. The best part of the internal sourcing of capital is that the
business grows by itself and does not depend on outside parties.
Disadvantages of both equity and debt are not present in this form of
financing. Neither ownership dilutes nor fixed obligation/bankruptcy
risk arises.

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External Sources
An external source of financing is the capital generated from outside
the business. Apart from the internal sources of funds, all the sources
are external.
Deciding on the right source of funds is a crucial business decision
taken by top-level finance managers. The usage of the wrong source
increases the cost of funds which in turn would have a direct impact on
the feasibility of the project under concern. Improper match of the type
of capital with business requirements may go against the smooth
functioning of the business. For instance, if fixed assets, which derive
benefits after 2 years, are financed through short-term finances will
create a cash flow mismatch after one year and the manager will again
have to look for finances and pay the fees for raising capital again.

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Derivatives
Introduction:
A derivative is a contract between two or more parties whose value is
based on agreed-upon underlying financial assets like security or a set
of assets. Common underlying instruments include bonds, currencies,
commodities, interest rates, stocks and market indexes.
Derivatives can be used to either mitigate risk or assume risk with the
expectation of commensurate reward. Futures contracts, forward
contracts, options, swaps, and warrants are commonly used
derivatives.
In broad terms, there are two groups of derivative contracts, which are
distinguished by the way they are traded in the market:-
Types Of Derivatives:-

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(1) Over-the-counter derivatives

Over-the-counter (OTC) derivatives are contracts that are traded
(and privately negotiated) directly between two parties, without
going through an exchange or other intermediary. Products such
as swaps, forward rate agreements and exotic derivatives are
almost always traded in this way. The OTC derivative market being
the largest market for derivatives is mostly unregulated and
consists of disclosure of information between the parties. The OTC
market is made up of banks and other highly sophisticated parties,
such as hedge funds.
(2) Exchange-traded derivatives

Exchange-traded derivatives (ETD) are those derivatives
instruments that are traded with some special derivatives
exchanges or other exchanges. The world’s largest derivatives
exchange (by the number of transactions) are Korean Exchange
which lists KOSPI index options and futures, Euro and CME Group
a merger of the Chicago Mercantile Exchange, the Chicago Board
Of Trade and New York mercantile exchange. In exchange Traded
Derivatives Market, individual’s trade standardized contracts that
have been defined by the exchange.
(3) Inverse ETFs And Leveraged ETFs

Inverse Exchange Trade funds and Leveraged Exchange Trade
Funds are two types of special exchange-traded funds (ETFs)
which can be utilised by the common traders and investors on
major exchanges like the NYSE and Nasdaq. To maintain these
products net assets value, these funds administrators must
employ more financial engineering methods than what usually is
required for the maintenance of traditional ETFs. These
instruments must be regularly re-balanced and re-indexed every
day.
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(4) Common derivative contract

Following are the types of common derivatives contract
i Forwards:-A contract between two parties, where payment
takes place at a specific time in the future at today's pre-
determined price.
ii Futures:-These are the contracts to buy and sell assets on a
future date at a price specified on the date. The difference
between future and forward contract is that the futures
contract is a standardized contract written by a clearing
house.
Iii Options:- These are the contracts that give the owner the
right, but not the obligation (in the case of a call option) or sell
(in the case of a put option) The option contract also specifies
a maturity date. If the owner of the contract exercises this
right, the counter-party has to carry out the transaction.
Options can be classified into call option and put option.
A call option provides the owner the right to buy without an
obligation to buy and execute a contract when it is profitable.
A put option provides the buyer the right, but not the
obligation, to sell the underlying security at a specified price
before or at a predetermined expiration date.
iv Binary option:-These are the contracts that provide the
owner with all-or-nothing profit profile.
Apart from the commonly used short-dated options which
have a maximum maturity period of one year, there exist
certain long-dated options as well, known as warrants. These
are generally traded over the counter.
v Swaps:- These are contracts to exchange cash (flows) on or
before a specified future date based on the underlying value
of currencies exchange rates, bonds/interest rates,
commodities exchange, stocks and other assets.
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Swaps can be categorized into two types:-

(1) Interest rate swap:- These necessitate swapping only interest
associated cash flows in the same currency, between two parties.
(2) Currency swap:- In this kind of swapping the cash flow between
the two parties includes both principal and interest.
Examples of Derivatives:
Economic functions of the derivative market
(1) Prices in a structured derivative market not only replicate the

discernment of the market participants about the future but also
lead the prices of underlying to the professed future level.
Therefore, derivatives are essential tools to determine both
current and future prices.
(2) The derivatives market reallocates risk from the people who
prefer risk factors to the people who have a strong desire for risk.

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(3) The intrinsic nature of the derivatives market is associated with

the underlying spot market due to increased participation by
additional players who would not have otherwise participated due
to the absence of any procedure to transfer risk.
(4) The presence of an organized derivatives market, speculation can
be controlled, resulting in more great attention to the
environment.
(5) Third parties can use publicly available derivative prices as which
would help them for predicting uncertain future outcomes, for
example, the likelihood that a corporation will default on its debts.
Uses of Derivatives are as follows:-

(1) Hedge or mitigate risk in the underlying, by entering into a
derivative contract whose value has been moved in the opposite
direction to their underlying position.
(2) Create option ability is the value where the derivative is linked to
a specific condition or an event.
(E.g) the underlying reaching a specific price level.
(3) Provide leverage such that a small movement in the underlying
value can cause a large difference in the value of the derivative.
(4) Speculate and make a profit if the value of the underlying asset
moves the way they expect. (e.g. moves in a given direction, stays
in or out of a specified range, reaches a certain level)
(5) Switch assets allocations between different assets classes without
disturbing the underlying assets, as a part of transition
management.
(6) Avoid paying taxes. For example, an equity swap allows an
investor to receive steady payments, e.g. based on LIBOR rate
while avoiding paying capital gain taxes and keeping the stock.
(7) For the arbitraging purpose, allowing a riskless profit by
simultaneously entering into transactions into two or more
markets.
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Advantages of Derivatives:-
(1) Hedging risk:-
Derivative contracts are used for hedging risk springing up out in
price moves. The price of those contracts is dependent upon the
price of underlying property. Investors will buy the ones by-
product contracts whose cost moves contrary to the price of safety
the investor owns. Losses in underlying commodities may be
offset through earnings in contracts of derivatives.
(2) Determine Underlying Asset Price:-
Derivatives contracts is useful in ascertaining the price of
underlying property. An approximation of commodity charges is
thought through the spot fees of futures contracts.
(3) Provide Access To Unavailable Market Or Asset:-
An important advantage of the derivative is that it provides access
to unavailable markets and assets to people. Individuals can
acquire funds at a lower or favourable rate of interest as compared
to direct borrowings with the help of interest rate swaps.
(4) Enhance Market Efficiency:-
Derivatives play an green function in improving the financial
marketplace’s performance. These contracts are used for
replicating the belongings payoff. It permits in getting the fair and
correct economic price of an underlying commodity as these
contracts carry rate corrections thru arbitrage. This way market
will become rate efficient and equilibrium is attained.
(5) Low Transition Cost:-
Trading of these instruments entails low transaction expenses
that's beneficial for traders. This acts as a risk management tool
and safety in opposition to fee fluctuations. The price of trading in
derivatives is lower in comparison to different securities like
stocks or debentures.
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Disadvantages of Derivatives
(1) High Risk:-
Derivatives contracts are uncovered to a high degree of threat
because of the high volatile rate of underlying securities. Prices of
those underlying securities like shares or metals preserve on
changing hastily as derivatives are typically traded in an open
market. This entails a excessive diploma of threat.
(2) Counter Party Risk:-.
There is a opportunity of default at the part of the counter-
birthday party in case of derivatives traded over the counter
because of lack of due diligence process. OTC derivatives
compared to alternate derivatives lacks a benchmark for due
diligence.
(3) Speculative Features:-
Derivatives are an device that is used for speculation reason for
incomes earnings. Sometimes massive losses might also arise
because of unreasonable speculation as derivatives are of
unpredictable and excessive risky nature.
(4) Requires Expertise:-
This is one of the principal drawbacks of trading spinoff units.
Investors require high understanding and expertise for buying
and selling in those units compared to different securities like
stocks and metals.

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Risk management by banks

(Basel Norms and Bankruptcy code)
Introduction:-
Banking is a system of any nation’s economy. For an economy to remain
healthy and going, it is important that the banking system grows fast
and yet be stable.
Over a while, many several indicators have been developed the depth
and stability of the banking system. Examples can be the Capital
adequacy ratio (CAR), non-performing assets etc.
Basel norms:-
Basel norms are one of the international banking regulations which are
issued by the Basel Committee Banking Supervisions (BCBS)
A Basel norm is an effort to coordinate banking regulations worldwide,
to strengthen the international banking system.
The Basel Committee on Banking Supervision consists of
representatives from the central banks and regulatory authorities of 27
countries (including India). Its administrative office is located at the
bank of international settlements, headquartered in the city of Basel in
Switzerland. Hence the name is Basel norms. The Basel Committee has
three sets of regulations known as Basel-I, II, and III.
The Basel Norms-1
Basel norms were introduced in the year 1988. Basel 1 focuses on risk-
weighted assets and credit risk. This asset classifies according to the
level of risk associated with it. It requires the minimum capital ratio of
capital to risk-weighted assets for all banks to be 8%. Assets were
measured based on their risk
Tier 1 capital at 4%
Tier 2 capital at 4%

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Tier 1 Capital:-It refers to the capital of more permanent nature. It

should make up at least 50% of the banks total capital base. Tier 1
capital is the core measure of a bank's financial strength from a
regulator's point of view. It is composed of core capital, which consists
primarily of common stock and disclosed reserves, but may also
include non-redeemable non-cumulative preferred stock
Tier 2 Capital:-It refers to temporary or fluctuating in nature. Tier 2

capital is a component of the bank capital. It consists of the bank's
supplementary capital including undisclosed reserves, revaluation
reserves, and subordinate debt. Tier 2 capital is less secure than Tier 1
capital.
Benefits of Basel 1:-

* It has increased in Capital Adequacy Ratios of internationally active
banks
* Competition among internationally active banks
* Augmented management of capital
* A benchmark for financial evaluations and assessments for market
participants.
* Worldwide adoption.
* It has greater discipline in managing capital.
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The weakness of Basel 1 is as follows:-

Despite advantages positive effects, weakness of Basel 1 standard has
eventually become evident.
* Other kinds of capital adequacy risks depends on market risks,
operational risks, credit risks, liquidity risk etc.
* Emphasis is on book values of assets rather than the market value.
* Assessment of risks and effects of new financial instruments, as well
as risk mitigation techniques.
* In credit risk assessment there is no difference between debtors
and credit quality and ratings.
The Basel Norms 2:-

Basel 2 is the second set of international banking regulations which
was defined by the Basel Committee On Bank Supervision (BCBS) Basel
2 has expanded rules for minimum capital requirements which has
been established under Basel 1. The main difference between Basel 1
and Basel 2 is that it incorporates credit risks of assets that are held by
financial institutions. Basel 2 helped countries regulatory over national
capital requirements for banks. It provides guidelines for the
calculation of minimum regulatory capital ratios.
Basel 2 framework operates under three pillars:-

* Market discipline
* Capital adequacy requirements
* Supervisory review

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There are three pillars under Basel 2:-
Pillar 1:-Market Discipline:-

It helps to ensure market discipline by making it disclose relevant
market information. It helps the users to receive the relevant
information to make trading decisions and ensure market discipline.
The aim of Pillar 3 is to allow market discipline. It helps in requiring
institutions to disclose details on the scope of application, capital, risk
assessment processes, risk exposures and the capital adequacy of the
institution.
Pillar 2:-Capital adequacy requirements.
Pillar 2 helps to improve the policies of Basel I by taking into

consideration operational risks and credit risks associated with risk-
weighted assets (RWA). It requires banks to maintain a minimum

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capital adequacy requirement of 8% of their Risk-weighted assets. It

also provides banks with more approaches to calculating capital
requirements based on credit risks.
The two main characteristics that include are:-

(1) Standardized approach:-
The standardized approach is based on external credit ratings. It
helps to apply fixed risk-weighted assets based on commercial
banks, Corporates, retails etc. It doesn't require extensive
modelling. It helps to attract smaller banks with less experience. It
helps to use the credit ratings from external credit assessments
institutions.
(2) Internal rating approach:-

It is based on internal loss models. The internal ratings-based
approach is suitable for banks that are engaged in more complex
operations, with more developed risk management systems. It is
also called Foundation Internal Ratings Based Approach. Rating
Assignment and Rating Confirmation to be independent.
Pillar 3:-Supervisory review.

In Supervisory review, banks should have a process for assessing their
overall capital adequacy concerning their risk profile and a strategy for
maintaining their capital levels. The supervisor is responsible for
ascertaining whether the bank uses appropriate assessment
approaches and covers all risks associated with it. Supervisors are
obligated to review and evaluate the internal capital adequacy
assessments of banks, as well as their ability to monitor their
compliance with the regulatory capital ratios.

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The Basel Norms 3:-

Basel 3 is the regulatory norm for setting a common standard for banks
across different countries. The Basel 3 norms are to enhance the
supervision, regulation, risk management in the banking industry.
Basel 3 was introduced in the year 2009. Basel 3 norms have
introduced strong capital ratios by increasing the minimum Tier 1
capital from 4% to 6%, and minimum Common Equity Tier 1 capital
from 4% to 4.5%. Basel III norms are meant to make banks reduce the
risk of shocks from global banking issues.
Key principles of Basel 3 norms:-
(1) Minimum Capital requirements:-
Basel 3 have raised the minimum capital requirements for banks to
form 2% in Basel 2 to 4.5% of common equity, the highest form of
loss-absorbing capital, the minimum total capital requirement will
remain at the current 8% level, yet the required total capital will
increase to 10.5%.
(2) Leverage ratio:-

It was introduced a non-risk based leverage ratio to serve as risk-
based capital requirements. Banks are required to hold a leverage
ratio above 3%. The non-risk-based leverage ratio is calculated by
dividing Tier 1 capital by the average total assets of a bank.
(3) Liquidity requirements:-
It was introduced two liquidity ratios-The liquidity Ratio and Net
stable Funding Ratio. The standard requires that the ratio be no
lower than 100%. It is designed to ensure that a bank maintains an
adequate level of high-quality assets that can be converted into
cash. its liquidity needs for a 30-day time horizon under accurate
liquidity requirements.

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Impacts of Basel 3:-

* The requirement of the minimum capital amount that banks should
maintain is 7%.
* It helps to hold more required capital against assets, which will
reduce the size of their balance sheet.
* Banks will hold more liquid assets and increase the proportion of
long-term debts.
* Banks will also minimize business operations that are more subject
to liquidity risks.
* It requires a high capital charge for trade.
Implications of Basel 3 norms:-

* Increased quantity of capital.
* Increased quality of capital.
* Increased short term liquidity ratio.
* Increased stable long term balance sheet funding.
* Reduced leverage through the introduction of backstop leverage.
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Insolvency and Bankruptcy code:-

The Insolvency and Bankruptcy Code was introduced by the central
government in 2016 to resolve claims and involving insolvent
companies. The Insolvency and Bankruptcy Code has changed the
debtor and creditor relationship. This code aims to protect the interests
of small investors and make the process of doing business less. The IBC
has 11 schedules and 255 sections. IBC is one of the biggest insolvency
reforms in the economic history of India. It was enacted for
reorganization and insolvency resolution of partnership firms,
individuals and corporate persons for maximization of the value of
assets of such persons.
Meaning of bankruptcy code:-

It is a legal statement of an entity or a person where debt owned is to
the creditors which cannot be repaid is known as bankruptcy.
Bankruptcy is not synonymous with insolvency. A court order imposes
bankruptcy in most jurisdictions. It is mostly initiated by the debtor. It
is not the only legal status that could apply to an insolvent individual or
an entity. In countries like the UK, bankruptcy is exclusive to
individuals. Liquidation, administration and other such insolvency
proceedings apply to entities and companies.
Key features of Insolvency and Bankruptcy code:-

(1) Insolvency Resolution:-
The insolvency resolution processes for companies, individuals and
partnership firms. This process may be initiated by either debtor or
creditor. The insolvency and bankruptcy code had increased the
mandatory upper time limit of 330 days including time spent in the
legal process to complete the resolution process.

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(2) Insolvency Professionals:-

The insolvency process will be managed by licensed professionals.
These professionals will control the assets of the debtor during the
insolvency process.
(3) Insolvency Regulator:-
This code establishes to oversee the insolvency proceedings in the
country and regulating the companies which are registered under
it. The board will have 10 members including a representative from
the reserve bank of India and ministries of finance law.
(4) Bankruptcy and Insolvency Adjudicator:-
There are two separate tribunals to oversees the process of
insolvency resolution for individuals and companies (1) Debt
recovery for individuals and partnerships. (2) Limited liability
partnership firms and (3) National company law tribunals for
companies.

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Background of Bankruptcy and Insolvency code:-

* IBC has various laws relating to insolvency and bankruptcy which
had caused ineffective and inadequate results with undue delays.
* Reconstruction and securitization of financial assets and
enforcement of security interest act.
* The recovery of debts due to banks and financial institutions act and
for debt recovery by banks and financial institutions.
* Companies act for liquidation and winding up of the company.
Objectives of Insolvency and Bankruptcy code:-

* Maximization of the value of assets of corporate persons.
* To get promotion for entrepreneurship
* Consolidate all existing insolvency laws of India.
* Set up an Insolvency and Bankruptcy Board of India.
* Consolidate all existing insolvency laws of India.
* To receive the company in a time-bound manner.
Procedure to resolve insolvency bankruptcy code:-

Initiation:-
It is the resolution process that may be initiated by debtors or creditors.
The decision to resolve insolvency: A committee consisting of the
financial creditors will decide the future of the outstanding debt owed
to them. They may choose to revive the debt owed to them or sell
(liquidate) the assets of the debtor to repay the debts owed to them. If
a decision is not taken in 180 days, the debtor’s assets go into
liquidation.
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Liquidation:-
If the debtor goes into liquidation, an insolvency professional
administers the liquidation process. Proceeds from the sale of the
debtor’s assets are distributed in the already established order of
precedence.
New Insolvency and Bankruptcy Code Amendment 2020

* The Insolvency and Bankruptcy Code, 2018 to clarify those allotted
under a real estate project should be treated as financial creditors.
* The voting decision which is taken by the committee of creditors
has been reduced from 51% to 75%. This key decision has been
reduced to 66%
* It allows the withdrawal of a resolution application that is
submitted to the NCLT under the Code. This decision can be taken
with the approval of 90% of the committee of creditors.
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Advantages of bankruptcy code:-

(1) An automatic stay against creditors:-
Once you file, the court automatically issues this stay against any
debt collection activity. It does not cancel your debt, but it suspends
any debt collection proceedings until your bankruptcy case is
complete or the stay is lifted. This means
* Wage garnishments
* Letters or calls from debt collectors
* Home mortgage foreclosures
* Lawsuits on debts
(2) Allow you to maintain ownership of your property after
bankruptcy:-
If you can exempt an asset, this means you need not have to worry
about it being seized in bankruptcy. These exemptions play an
important role in bankruptcies. Some are exemptions that protect
up to a certain dollar amount of assets.
(3) Credit Score:-
Many debtors start improving their credit scores after they file for
bankruptcy. Once a person’s dischargeable debts are cancelled, this
allows them to move forward with a clean slate and begin
rebuilding their credit. Tanked credit ranking may delay in filing for
bankruptcy, and a bankruptcy filing remains a record of 7to 10
years.
Disadvantages of Insolvency Bankruptcy Code:-
(1) Loss of credit cards:-
Many credit card companies automatically cancel any cards you
hold when you file. These can help you to rebuild your credit, but
usually require annual high fees and interest rates. We can receive
many offers to apply for unsecured credit cards for filing.

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(2) Difficultly in obtaining mortgage or loan:-

A bankruptcy code filing can make it difficult to get another loan or
mortgage for many years.
(3) Denial of tax refunds:-
Federal tax refunds, local, state can be denied because of
bankruptcy.
(4) Non-Dischargeable debts:-
Non-dischargeable debts typically include alimony and student
loans, child support, fines and criminal restitution and any debts
which are acquired through fraud.
(5) Job and housing stigma:-
Some employers and landlords ask questions about any recently
filed bankruptcies and this can negatively affect your chances for
both.
(6) Loss of property and real estate:-
Sometimes not all real estate and personal property will fit under
an exemption. This means the bankruptcy court could seize some of
your property and sell it to pay your creditors.
Amendments of Insolvency and Bankruptcy code:-
These acts include:- promoters or management of the company if it has
outstanding and non-performing debt over a year, disqualified
directors, wilful defaulters etc.
* It gives the ability to home buyers and files insolvency to participate
in the resolution process.
* It helps to include a chapter on the cross-boundary insolvency and
resolution process.
* It helps to protect successful bidders from any risk of criminal
proceedings and which is committed by previous promoters of
companies.

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Corporate Governance
Introduction
Corporate governance refers to the way a corporation is governed. It is
the technique by which companies are directed and managed. It has the
attraction between various participants like the board of directors,
company’s management, shareholders etc.
The relationship between the owners and the managers in an
organization must be healthy and there should be no conflict between
any two.
Corporate governance deals with the manner providers of finance

guarantee themselves of getting a fair return on their investment. The
owners must see that individual’s actual performance is according to
standard performance. Corporate governance means carrying the
business as per the stakeholder's desire and it is conducted by the
board of directors and the concerned committees for the companies
stakeholders benefit. It is all about balancing social goals and
individuals as well as economic and social goals. Corporate governance
ensures strong and balanced economic development. It also ensures
the interests of all shareholders are safeguarded. Corporate
governance has a broad scope. It includes both social and institutional
aspects. Corporate governance encourages a moral, trustworthy and
ethical environment.

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Benefits of Corporate Governance:-

* It ensures corporate success and economic growth.
* Strong corporate governance maintains investors confidence as a
result of which the company can raise capital effectively and
efficiently.
* There is a positive impact on the share price.
* It helps in brand formation and development.
* It lowers the capital cost.
* Good corporate governance also minimizes risks, corruption,
wastage and mismanagement.
Seven characteristics of Corporate Governance are as follows:-

(1) Discipline:-
Corporate discipline is a commitment by a company’s senior
management to behaviour that is universally recognised and
accepted to be correct and proper. This encompasses a company’s
awareness of commitment to the underlying principles of good
governance, particularly at the senior management level.
(2) Transparency:-
Transparency is the ease with which an outsider can make a
meaningful analysis of a company's actions. This is a measure of
how good management is at making necessary information
available in accurate, candid and timely manner not only the audit
data but also the press releases and general reports.
(3) Accountability:-
These provide investors with the means to query and assess the
actions of the board of committees. Groups or Individuals in a
company, who make the decisions and take actions on specific
issues, needs to be accountable for their decisions and actions.
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(4) Independence:-
It is the extent to which mechanisms have been put in the place to
minimize or avoid potential conflicts of interest that may exist,
such as dominance by a large shareowner or by a chief executive.
(5) Responsibility:-
Responsibility pertains to behaviour that allows for corrective
action and for penalizing mismanagement. Responsible
management is when things are put in place to set the company on
the right path. It must act responsively to and with responsibility
towards all stakeholders of the company.
(6) Fairness:-
The system of the company must be balanced in taking into account
all those that have an interest in the company and its future. The
rights of various groups have to be respected and acknowledged.
(7) Social Responsibility:-

A well-managed company should be aware of and respond to social
issues placing a high priority on ethical standards. A good
corporate citizen is increasingly seen as one that is non-
exploitative,non-discriminatory and responsible about
environmental and human rights issues.
Types of Corporate Governance are as follows:-

(1) Internal Mechanism:-
The internal mechanism controls the progress and activities of the
organization and takes corrective actions when the business goes
off track. It helps in maintaining the corporations larger internal
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control and they serve the internal objectives of the corporation

and its internal stakeholders, including managers, owners and
employees. These objectives include smooth operations which
clearly defined reporting lines and performance measurement
systems. Internal mechanisms include oversight of independent,
internal audits, management, the structure of the board of
directors into the level of responsibility and segregation of control
and policy development.
(2) External Mechanism:-

External mechanisms are controlled by those outside an
organization and serve the objectives of entities such as trade
unions, regulators, governments and financial institutions. It is also
often imposed on organizations by external stakeholders in the
form of union regulatory guidelines or union contracts. External
organizations such as industrial associations may suggest
guidelines for best practices and businesses can choose to follow
these guidelines or ignore them. Therefore companies report the
status and compliance of external corporate governance
mechanisms to external stakeholders. External mechanisms
include adequate debt management and legal compliance.
(3) Independent Audit:-

An independent external audit of corporations financial statements
is part of the overall corporate governance structure. This exercise
gives a broad but limited view of organizations working
mechanisms and future outlooks. An audit of financial statements
serves external and internal stakeholders at the same time. An
audited financial statement and the accompanying auditor's
reports help employees, shareholders, investors and regulators
determine the financial performance of the corporation.
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(4) Small Business Relevance:-

Business owners make strategic decisions about how workers will
do their duties, and they monitor their performance this is an
internal control mechanism it is part of business governance. If a
business requests a loan from banks demands to comply with liens
and agreement terms an external control mechanism. Corporate
business has relevance in the small business world. If the business
is a partnership, a partner might demand an audit to place reliance
on the profit figured provided another form of external control.
Principles of corporate governance:-

(1) Sustainable development of all stakeholders:-
It helps to ensure the growth of all individuals associated with or
affected by the enterprise on a sustainable basis.
(2) Effective management and distribution of wealth:-

It helps to ensure that the enterprise creates maximum wealth and
judiciously uses the wealth created for providing maximum
benefits to all stakeholders.
(3) Discharge of social responsibility:-

It helps to ensure that the enterprise is acceptable to the society in
which it is functioning.
(4) Adherence to ethical standards:-

It helps to ensure independence, integrity, transparency and
accountability in dealings with all stakeholders.
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(5) Application of best management practice:-

It helps to ensure the functioning of the enterprise and optimum
creation of wealth on a sustainable basis.
Role of SEBI in Corporate governance:-

* The Government of India's securities watchdog, the Securities
Board of India, announced strict corporate governance norms for
publicly listed companies in India.
* The Indian Economy was liberalised in 1991. To achieve the full
potential of liberalisation and enable the Indian Stock Market to
attract huge investments from foreign institutional investors, it
was necessary to introduce a series of stock market reforms.
Corporate governance in India

* The Indian corporate scenario was more or less stagnant till the
early 90s.
* The position and goals of the Indian corporate sector have changed
a lot after the liberalisation of the 90s.
* India's economic reform programme made steady progress in
1994.
* India with its 20 million shareholders, is one of the largest
emerging markets in terms of market capitalization.
* The corporate governance of India has undergone a paradigm shift
since1990s, In 1996, the Confederation of Indian Industry (CHI),
took a special initiative on Corporate Governance.
* The objective was to develop and promote a code for corporate
governance to be adopted and followed by Indian companies, be
these in the Private Sector, the Public Sector, Banks or Financial
Institutions, all of which are corporate entities.
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* This initiative by Cll flowed from public concerns regarding the

protection of investor interest, especially the small investor, the
promotion of transparency within business and industry
Advantages of Corporate Governance:-

* It reduces the cost of energy.
* The share price has a positive effect.
* Good corporate governance also reduces corruption, reduces
waste, risk and maladministration.
* It helps to build and develop brands.
* It ensures market performance and economic development.
* Investor trust is maintained by sound corporate governance,
enabling a business to raise capital efficiently and effectively.
* It ensures that the organization is run in a way that fits the best
interests of all.
Disadvantages of Corporate Governance:-

(1) Separation of ownership and management:-
The executives and officials who oversee a company's internal
affairs and make the bulk of policies that are not necessarily
shareholders. In the absence of controlling shareholders and the
majority of shareholders vote by a company's assets shall be
managed by the board of directors and the officials. It leads to
interest between managements obligations to maximize
shareholders value and increase its revenue.
(2) Illegal Traders Training:-

The word corporates insiders apply to corporate executives. An
actioner is not directly associated with a company such as an
external auditor. A government regulator or a relative of a
corporate insider may also participate in unlawful insider trading.

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(3) Regulation Costs:-

The misuse of corporate governance has been lead to the adoption
of federal and state laws to discourage such abuses from repeating.
(4) Misleading Reports:-

There are many ways of presenting factually accurate financial
statements in a way that misleads investors.

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5. Capital Budgeting
Introduction
The responsibility of finance manager of a firm is to procure the
required quantum of funds from different sources and invest the raised
funds in various assets in the most profitable way.
There are number of decisions to be taken while investing funds that

are invested and benefits are expected over a long period.
The finance manager is to determine the composition of assets of the

firm. The assets of the firm are generally of two types i.e., fixed assets
and current assets. The aspect of taking the financial decision with
regard to fixed assets is called capital budgeting.
Meaning of Capital Budgeting

Capital budgeting means planning the capital expenditure in
acquisition of fixed (capital) assets such as land, building, plant &
machinery introducing new projects or replacing and modernising a
process and expansion of the business. It involves the preparation of
Detailed Project Report (DPR) and cost and revenue statements that
indicates the profitability. The project those gives the highest return on
investment is to be selected and then investment is to be made in such
a project as to maximise the profitability of the firm.
Definition of Capital Budgeting

The term capital budgeting is defined as follows:
(i) Charles T. Horngren: Capital budgeting is the long term planning
for making and financing proposed capital outlays.

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(ii) GC. Philoppatos: Capital budgeting is concerned with the

allocation of the firm's scarce financial resources among the
available market opportunities. The consideration of investment
opportunities involves the comparison of the expected future
streams of earnings from a project, with the immediate and
subsequent streams of expenditure for it.
Capital budgeting includes not only investment also marketing and

engineering investigation of these opportunities and financial analysis
as to their future profitability.
Features of capital budgeting

(i) Investments: Capital expenditure involves huge investment in
fixed assets.
(ii) Long-term: Capital expenditure, once approved, is represented
has long term investment that cannot be reversed or withdrawn
without sustaining a loss.
(iii) Forecasting: Capital budget plan Preparation involves forecasting
of several years profits in advance in order to judge the
profitability of projects.
(iv) Serious consequences: In order to invest large amount for a fairly
long period of time, any error in the evaluation of investment
projects may lead to serious consequences, financially and
otherwise and may adversely affect the other future plans of the
organisation.

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Objectives of Capital Budgeting

(1) Capital budget aims at deciding the most profitable among the
numerous investment proposals available.
(2) It decides the most suitable among different sources of finance on
the basis of capital market constraints.
(3) The growth and expansion of the firm and modernisation is done
via capital budgeting.
Need and significance of Capital Budgeting

(i) Substantial expenditure: The decisions generally involve
investment of substantial amount of funds. Therefore it is
necessary for a firm to make such decisions after a thoughtful
consideration otherwise it may result in loss.
(ii) Long term implications: The decisions regarding capital budgeting
has effects over a long period of time. These decisions not only
affect the future benefits and cost of the firm but also influence the
rate and direction of growth of the firm.
(iii) Irreversible decisions : The decisions regarding capital budgeting
are irreversible and the heavy amount invested cannot be taken
back without causing a substantial loss because it is very difficult
to find a market for the second hand capital goods and their
conversion into other uses may not be financially feasible.
(iv) Complexity: The decisions are based on forecasting of future
events and inflows. Quantification of future events involves
applications of statistical and probabilistic techniques, careful
judgement and application of mind is necessary.

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(v) Risk: The longer the time period of returns, greater is the
risk/uncertainty regarding cash flows. Therefore capital
budgeting decisions should be taken after a careful review of all
available information.
(vi) Surplus: Funds are to be raised by the firm at a certain cost (i.e.,
WACC). Even internally generated funds have an implicit cost.
Therefore, there is a need to obtain a surplus over and above the
cost of funds. Only then, the investment is justified.
Advantages of Capital Budgeting

(i) At every period of investment proposals Capital budgeting
evaluates them and ranks them as per merit. This enables
management to decide on implementing appropriate proposals.
(ii) The limited funds that are available can be most effectively
utilised.
(iii) The timing and actual execution of each project can be adjusted in
order with changes in capital market.
(iv) Different sources of finance can be considered and judicious
selection of sources can reduce overall cost of capital.
(v) Capital budgeting can take care of the proportion of debt and
equity in the capital structure and the resulting capital gearing.
(vi) In situations like tight money, capital rationing can be followed not
to waste scarce funds available.
Capital Budgeting Process

Capital investment decisions are regarded has the part of the capital
budgeting process, which is concerned with determining
(a) Which specific project a firm should accept,

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(b) The total amount of capital expenditure which the firm should
undertake,
(c) How the total amount of capital expenditure should be financed.
Evaluation of Capital Budgeting Proposals requires a sound
appraisal method in order to measure the economic worth of each
investment proposal.
The methods to evaluate and select an investment proposal can be

grouped into two categories as given below:
Traditional & Modern Methods.
I. Traditional (or) Non-discounting Methods
Under this methods do not discount cash flows to find out their
present worth. There are two such methods available i.e.,
(i) Pay back period method
(ii) The accounting or average rate of return method.
1. Pay back Period Method:

This method is also known has the payout or pay off or
replacement period method. It determines the length of time
required to recover the initial outlay of a project i.e., it is the period
within which the total cash inflows from the project equals the cost
of investment in the project. The lower the pay back period, the
better it is has initial investment is recouped faster
Example: Determine a project with an initial investment of Rs. 6
lakh, has a profit of Rs.1 lakh, after writing off depreciation of Rs.
25,000 per annum. Its payback period would be?
Pay Back period= Initial investment/ CFAT p.a
CFAT p.a. = Profit after tax + Depreciation
= 1,00,000+ 25,000
= Rs. 1,25,000
Pay back period= 6,00,000/1,25,000
= 4.8 years

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Procedure for computation of pay back period

(a) In case of uniform CFAT p.a.
Payback period = Initial investment/ CFAT p.a
(b) In case of differential CFAT for various years.
(i) Compute cumulative CFAT at the end of each year.
(ii) Find out the year in which cumulative CFAT exceeds initial
investment
(iii) Payback period = Time at which cumulative CFAT = Initial
investment (calculated on time proportion basis).
(iv) Accept if the pay back period is less than maximum or bench
mark period, else reject the project.
Merits of Payback Period Method

(i) This method is very easy to apply, calculate and interpret.
(ii) Payback period method is most useful when cost is not high and
the capital project is comples in a short period.
(iii) This method mainly focuses on early return heavily and ignores
distant returns. It, contains a built-in edge against economic
depreciation or obsolescens
(iv) It is useful in evaluating those projects that involve high
uncertainty.
(v) This method considers the liquidity as well as solvency of a firm as
a' principle' in the capital budgeting decisions.
(vi) It also gives an indication to a company facing shortage of funds in
projects with small payback period.

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Limitations of Payback Period Method

(i) Payback period method fails to take into account the time value of
money. All cash flows are treated and are weighed equally
regardless of the time period of their occurrence.
(ii) This method does not measure the profitability of a project and
ignores the cash inflows beyond the payback period. Thus it is a
biased indicator of economic value.
(iii) This method does not differentiate between projects requiring
different cash investments and thus it does not provide a
meaningful and comparable criterion.
(iv) It does not indicate any cut-off period regarding purpose of
investment decision.
(v) A slight change in operation cost will affect the cash inflows and as
such payback period shall also be affected.
(vi) There is Neither allowance made for taxation nor is any capital
allowance made.
Discounted Payback Period Method :

We can make changes to the original in payback period method
discussed above, taking into consideration the time value of money and
the firms required rate of return, thereby overcoming one of the
limitations of the undiscounted payback period method. When payback
period is calculated by taking into account the discount or interest
factor, it is called as discounted payback period.
Procedure for calculation of discounted payback period

(i) Ascertaining the initial investment (cash outflow)
(ii) Ascertaining CFAT (profit before depreciation and after tax) for
each year and commute discounted CFAT (CFAT X PV factor) for
each year.
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(iii) Ascertaining cumulative discounted CFAT at the end of each year.

(iv) Ascertaining the year in which cumulative discounted CFAT
exceeds initial investment.
(v) Calculating discounted payback period at the time at which
cumulative discounted CFAT = Initial investment.
(vi) Accept if discounted payback period is less than
maximum/benchmark period, else reject the project.
Post pay-back Profitability:

This method takes into consideration returns receivable beyond the
payback period.
The formula of post pay-back profitability index is as follows:

Post pay-back profitability index= (Post pay - back profit)/ Initial
investment *100
Pay back reciprocal:

It is known as the reciprocal of payback period. The reciprocal of the
payback shall be the close approximation of the internal rate of return
if the life of the project is atleast twice the payback period and the
project generates equal amount of the annual cash inflow. This tool is
regarded for quickly estimating the rate of return of the project
provided its life is atleast twice the payback period.
Payback Reciprocal = CFAT/Initial investment
(or) 1/Payback period.
2. Accounting or Average Rate of Return (ARR) Method

This method is the annualized net income earned on the average
funds invested in a project. It is a measured based on the
accounting profit i.e. profit after depreciation and tax rather than
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the cash flows and is also very similar to measure the rate of return
on capital employed, that is generally used to measure the overall
profitability of the firm.
The alternative formula for calculating the ARR is:

(a) Annual return on original investment method= (Annual average
net earnings/savings)/ Initial Investment * 100
where, Annual average net earnings = Average of the earnings
(savings) after depreciation and tax over the whole of the
economic life of the project.
Investment = Capital cost of the equipment minus salvage value of
the old equipment
(b) Annual return on average investment method

ARR= Annual average net earnings/ Average investment x100
The amount of 'Average investment' can be computed in any of the
following methods :
(i) Average investment= Initial investment/ 2
(ii) Average investment= Initial investment - Scrap value of the
asset/ 2
(iii) Average investment = Initial investment +Scrap value of the
asset/ 2
(iv) Average investment = [(Original investment- Scrap
value)/2]+ Additional net working capital + Scrap value
Procedures for computation of ARR

(i) Determine the average investment as given above.
(ii) Determine the profit after tax for each year: PAT=CFAT less
depreciation.
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(iii) Calculate the total PAT for N years, where N = project life.
(iv) Calculate average PAT per annum (Total PAT of all years /N years)
(v) ARR = Average PAT p.a/ Average investment
*100
Merits of ARR Method

(i) This method is very simple and easy to understand and to use.
(ii) ARR method takes into consideration the total earnings from the
project during its life time.
(iii) This method places emphasis on the profitability of the project,
rather than on liquidity as in the case of pay back period method.
(iv) ARR method can be calculated by using the accounting data
without another set of workings like cash flow etc.
Demerits of ARR Method

(i) This method ignores the time value of money and considers the
profit earned in the 1st year as equal to the profits earned in later
years and does not discount the future profits.
(ii) This method does not consider the length of project life
(iii) ARR ignores salvage value of the proposal. In real sense, the
salvage value is also a return from the proposal and should be
considered.
(iv) This method fails to recognise the size of investment required for
the project particularly, in case of mutually exclusive proposals,
the two projects having significantly different initial costs, may
have same ARR.

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II. Discounted Cash Flow (DCF) Methods (or) Time Adjusted

Methods (or) Present Value Methods
This method takes into consideration account time value of money

unlike the Traditional Methods. Both cash inflows and outflows
are discounted at a predetermined discounting rate in order to
ascertain their present value. Generally, the discounting rate is the
cost of capital rate of the firm. But it can also be another rate.
Discounting factors can be obtained from present value tables
This is calculated by following formula:

Discount (PV) factor= 1/(1+r)^n
where, r = Discount rate
n= No. of years
The second commendable feature of DCF methods is that they take into
consideration all benefits and costs during the entire life of the project.
Moreover, they use cash flows (i.e, CFAT) and not the accounting
concept of profit (i.e., PAT), discounted cash flow methods:
1. Net Present Value (NPV) Method
2. Internal Rate of Return (IRR) Method
3. Profitability Index (PI)
1. Net Present Value (NPV) Method:

It is also one of the DCF methods in which both future cash inflows
and outflows from a project are discounted at a cost of capital rate.
This method gives present value of cash inflows and outflows. The
difference between present value of cash inflows and outflows is
known has Net Present Value (NPV).
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Procedure for computation of NPV

(i) Ascertaining the total cash inflows of the project and the time
periods which they arise.
(ii) Calculation of the present value of cash inflows i.e., CFAT X PV
factor
(iii) Ascertaining the total cash outflows of the project and the time
periods in which they occur.
(iv) Calculation of the present value of cash outflows i.e., cash outflows
x PV factor
(v) Calculation of NPV = Present value of cash inflows - Present value
of cash outflows
(vi) Accepting projects if NPV is positive, else reject. If two projects are
mutually exclusive, the project with higher NPV should be
preferred.
Merits of NPV Method

(i) This method recognises the time value of money.
(ii) NPV method uses the discount rate which is the firm's cost of
capital.
(iii) This method considers all cash flows over the entire life of the
project.
(iv) NPV constitutes addition to the wealth of shareholders and thus
mainly focuses on the basic objective of financial management.
(v) Since all cash flows are converted into present value (current
rupees), different projects can be compared on NPV basis,
therefore, each project can be evaluated independent of others on
its own merit.

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Limitations of NPV Method

(i) NPV method assumes that the discount rate i.e., firm's cost of
capital is known. But the cost of capital is difficult to understand
and measure in practice.
(ii) This method may not give reliable answers while dealing with
alternative projects under the conditions of unequal lives of
projects.
(iii) Decisions are arrived and may not be satisfactory when projects
being compared involve different amounts of investment.
2. Internal Rate of Return (IRR) Method

IRR is referred to the rate of return at which the sum of discounted
cash inflows equal the sum of discounted cash outflows. IRR is the
rate at which the NPV of the investment is zero. It is also known as
internal rate because it depends majorly on the outlay and
proceeds associated with the project and not on any rate
determined outside the investment. This method is also called as
marginal rate of return method or time adjusted rate of return
method. IRR method is generally employed when cost of
investment and annual cash inflows are known, while the
unknown rate of return (i.e., rate of cost of capital) is to be
ascertained.
Procedure for computation of IRR

The calculation of IRR involves two methods on the basis tabular
values.
(a) When cash inflows are uniform for all the years : Under this case,
the IRR is determined with the help of annuity table showing the
present value of Re. = l received annually over 'n' years by taking
the following two steps :

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The factors to be located in the relevant annuity table is computed

by using the following simple equation: F = I/C
where, F = Factors to be located
I = Initial investment
C=Cash inflow per year
Step (ii) : This factor is located in annuity table by representing

number of year corresponding to the estimated useful life of the
assets and the relevant percentage of the discount which
represents IRR
(b) When cash inflows are not uniform: In this case, IRR is ascertained
by trial and error process. In this procedure, cash inflows are to be
discounted a number of trial rates.
Just to start, the average cash inflows of different years are to be
found. Original investment is to be divided by this average cash
inflow; this may be taken as present value factor. This rate is
ascertained from table for the factors and at this rate, the PV of
cash inflows of several years is calculated, then total PV of cash
inflows are compared with the original investment.
If calculated PV of cash inflows is less than the original investment,
the further interpolation be carried on at lower rate. On the other
hand, a higher rate should be tried if the PV of cash inflows is
higher than the original investment.
This procedure continues till the PV of cash inflows and the

original investment are equal or nearly equal. However, the exact
rate of return can be calculated with the help of the following
formula:
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IRR = Lower rate + (Positive NPV/ Difference in calculated present

values)* Difference in rate
Accept or Reject criterion
Accept the project if the IRR is higher than or equal to minimum
required rate of return. The minimum required rate of return is
also called as cut off rate or firm's cost of capital.
Merits of IRR Method

(i) All cash inflows regarding the project, is arising at a different
points of time are considered.
(ii) Time value of money is taken into account.
(iii) Capital Decisions are immediately taken by comparing IRR with
the cost of capital
(iv) This method also helps in achieving the basic objective of
maximisation of shareholders wealth.
Limitations of IRR Method

(i) Computation of IRR is too long and it is difficult to understand.
(ii) Both NPV and IRR assumes that cash inflows can be reinvested at
discounting rate in the new projects. However, reinvestment of
funds at the cut-off rate is more appropriate than at the IRR. Hence,
NPV method is more reliable than IRR for ranking two or more
projects.
(iii) This method may result in inconsistent with NPV method. This is
especially true in case of mutually exclusive projects i.e., projects
where acceptance of one would result in the rejection of the other.
Such conflict of results arises because of the following:
(a) Differences in cash outlays
(b) Unequal lives of projects
(c) Different pattern of cash flows
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3. Profitability Index (PI) Method

This method is a variant of the NPV method. It is also known as
benefit cost ratio or present value index. It is also based on the
basic concept of discounting the future cash flows and is
ascertained comparing the present value of cash inflows with the
present value of cash outflows. It is calculated dividing the former
by the latter.
PI =Present value of cash inflows/ Present value of cash outflows
Significance of PI
The PI represents the amount obtained at the end of the project life, for
every rupee invested in the project at the initial stage. The higher the
PI, the better it is, since the greater is the return for every rupee of
investment in the project.
Accept or Reject Criterion

Accept the project if its PI is more than 1 and reject the project if the PI
is less than 1. However if the PI is equal to 1, then the firm may be
indifferent because the present value of inflows is expected to be just
equal to the present value of the outflows.
Merits of PI Method
(i) It considers the time value of money.
(ii) It is a better project evaluation technique than NPV and helps in
ranking projects where NPV is positive.
(iii) It focuses on maximum return per rupee of investment and hence
is useful in case of investment in divisible projects, when funds are
not fully available.

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Illustration:
1. Assume a company is reviewing two projects. Management must
decide whether to move forward with one, both, or neither. Its cost
of capital is 10%. The cash flow patterns for each are as follows:
What is IRR for project A& B?
Project A
Initial Outlay = $ 5,000
Year one = $1,700
Year two = $1,900
Year three = $1,600
Year four = $1,500
Year five = $700
Project B
Initial Outlay = $2,000
Year one = $400
Year two = $700
Year three = $500
Year four = $400
Year five = $300
Sol: The company must calculate the IRR for each project. Initial outlay
(period = 0) will be negative. Solving for IRR is an iterative process
using the following equation: $0 = (initial outlay * −1) + CF1 ÷ (1 +
IRR)1 + CF2 ÷ (1 + IRR)2 + ... + CFX ÷ (1 + IRR)X
IRR Project A:
$0 = (−$5,000) + $1,700 ÷ (1 + IRR)1 + $1,900 ÷ (1 + IRR)2 +
$1,600 ÷ (1 + IRR)3 + $1,500 ÷ (1 + IRR)4 + $700 ÷ (1 + IRR)5
IRR Project A = 16.61 %
IRR Project B:

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$0 = (−$2,000) + $400 ÷ (1 + IRR)1 + $700 ÷ (1 + IRR)2 + $500 ÷

(1 + IRR)3 + $400 ÷ (1 + IRR)4 + $300 ÷ (1 + IRR)5
IRR Project B = 5.23 %
Given that the company’s cost of capital is 10%, management
should proceed with Project A and reject Project B.
2. Company xyz ltd wanted to know their net present value of cash
flow if they invest 100000 today. And their initial investment in
the project is 80000 for the 3 years of time, and they are expecting
the rate of return is 10 % yearly. From the above available
information, calculate the NPV.
Sol: NPV = Cash flows /(1- i)t – Initial investment
= 100000/(1-10)^3-80000
NPV = 57,174.21
3. If an initial investment is Rs 765000, the payback period is 4.5

years, then increase in future cash flow will be ?
Sol: 765000*4.5= Rs 3442500
4. Hasmukh Ltd wants to expand its business and so it is willing to

invest Rs 10,00,000. The investment is said to bring an inflow of
Rs. 1,00,000 in first year, 2,50,000 in the second year, 3,50,000 in
third year, 300,000 in fourth year and 4,15,000 in fifth year.
Assuming the discount rate to be 9%. What shall be its NPV?

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Sol: NPV= Rt/(1+i)^t
Year Flow Present value Computation

0 -1000,000 -10,00,000 –
1 1,00,000 91,743 1,00,000
2 2,50,000 2,10,419 (1.09)1
3 3,50,000 2,70,264 2,50,000
4 300000 212,464 /(1.09)2
5 4,15,000 3,50,000
2,69,721 /(1.09)3
415000 300000
/(1.09)5 /(1.09)4
The total sum of present value of cash inflows for all the 5 years is Rs.
10,54,611. The initial investment is Rs. 10,00,000. Hence, the NPV is Rs.
54,611
Since the NPV is positive the investment is profitable and hence

Hasmukh Ltd can go ahead with the expansion.

@Crossword2022

@Crossword2022
6. Basic concepts of Insurance

Insurance
Basic concepts of Insurance
Insurance is defined as a contract, which is called a policy, in which an
organization or individual receives financial protection and
reimbursement of damages from the insurer or the insurance company.
It is a form of protection from any kind of possible financial losses.
The basic principle of insurance is that an entity will choose to spend a
small periodic amount of money against the possibility of huge
unexpected losses. Therefore, all the policyholder pool their risks
together. Any loss that they suffer is going to be paid out of the
premiums which they pay.
Functions of Insurance Company:

1. Provides Reliability:
It helps to eliminate the uncertainty of an unexpected and sudden
loss. This is one of the most important worries of a business.
Instead of this uncertainty, it provides the knowledge of the
normal payment.
2. Protection:
Insurance doesn't reduce the danger of loss or damage that a
company may suffer. But it
Protects against such loss that a company may suffer. So a
minimum of the organisation doesn't suffer financial losses that
debilitate their daily functioning.

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3. Pooling of Risk:
In this type of insurance, all the policyholders pool their risks
together. They all pay their premiums and if one among them
suffers financial losses, then the pay-out come from this fund. So
the risk is shared between all of them.
4. Legal Requirements:
In a lot of cases getting some form of insurance is required by the
law of the land. For
Example when goods are in freight, or when you open a public
space getting fire insurance may have a mandatory requirement.
So an insurance firm will help us fulfil these requirements.
5. Capital Formation:
The pooled premiums of the policyholders help create capital for
the insurance firm. This
Capital can then be invested in productive purposes that generate
income for the company.
Principles of Insurance
Insurance is a form of contract. Hence certain principles are important
to make sure the validity of the contract. Both parties must accept these
principles.

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1. Utmost Good Faith:

A contract of insurance must be made based on utmost good faith.
It is important that the insured disclose all relevant facts to the
insurance company. Any facts that would increase his
Premium amount, or would cause any advisable insurer to
reconsider the policy must be Disclosed.
2. Insurable Interest:
This means that the insurer must have some pecuniary interest
within the material of the insurance. This suggests that the insurer
needn't necessarily be the owner of the insured property but he
must have some vested interest in it. If the property is broken the
insurer must suffer from some financial losses.
3. Indemnity:
Fire and marine insurance are contracts of indemnity. Here the
insurer undertakes the responsibility of compensating the insured
against any possible damage or loss that he may or might not
suffer. Life insurance isn't a contract of indemnity.
4. Subrogation:
This principle says that once the compensation has been paid, the
proper ownership of the property will shift from the insured to the
insurer. So the insured won't be ready to make a take advantage of
the damaged property or sell it.
5. Contribution:
This principle applies if there are quite on insurers. The insurer
can ask the other insurers to contribute their share of the
compensation. If the insured claims full insurance from one
insurer he loses his right to claim any amount from the other
insurers.
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6. Proximate Cause:
This principle states that the property is insured only against the
incidents that are mentioned in the policy. In case the loss is
thanks to quite one such peril, the one that's best in causing the
damage is that the cause to be considered.
Types of Insurance
There are 7 types of insurance policy such as,
* Life Insurance
* Property Insurance
* Marine Insurance
* Fire Insurance
* Liability Insurance
* Guarantee Insurance
* Social Insurance

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(1) Life Insurance:

Life insurance refers to a policy whereby the policyholder can
ensure financial freedom for his/her family members after death.
Though you are the sole earning member in your family,
supporting your spouse and children. Life insurance policies
secure that such a thing does not happen by providing financial
assistance to your family in the event of your passing.
(2) Property Insurance:

Under this property Insurance property of person/persons are
insured against a certain specified risk. This risk may be due to fire
or marine perils, theft of property or goods damage to property at
the accident.
(3) Marine Insurance:-

The marine perils are; collision with a rock or ship, attacks by
enemies, fire, and captured by pirates, etc. these perils cause
damage, destruction or disappearance of the ship and cargo and
non-payment of freight. So, marine insurance insures ships, freight
and cargo.
(4) Fire Insurance:

Fire insurance covers the risk of fire. With the assistance of fireside
insurance, the losses arising thanks to fire are compensated and
therefore the society isn't losing much. Fire insurance doesn't
protect only losses but it provides certain consequential losses
also war risk, turmoil, riots, etc. can be insured under this
insurance.

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(5) Liability Insurance:

General Insurance also includes liability insurance whereby the
insured is liable to pay the damage of property or to compensate
for the loss of injury, death etc.
(6) Social Insurance:

Social insurance is to protect the weaker sections of society who
are unable to pay the premium for adequate insurance. Disability
benefits, pension plans, sickness insurance, unemployment
benefits and industrial insurance are the varied sorts of social
welfare.
(7) Personal Insurance:

Personal insurance includes insurance of human life which can
suffer a loss thanks to death accident and disease. Personal
insurance is further sub-classified into life assurance, personal
accident insurance, and insurance.
(8) Guarantee Insurance:

The guarantee insurance covers the loss arising thanks to
dishonesty, disappearance, and disloyalty of the workers or
second party. The party must be a celebration of the contract. His
failure causes loss to the primary party. For example, in export
insurance, the insurer will compensate the loss at the failure of the
importers to pay the quantity of debt.
(9) Miscellaneous Insurance:

The property machine, goods, valuable articles, furniture,
automobiles etc can be insured against the damage due to accident
or disappearance due to theft. There are different sorts of
insurances for every sort of the said property whereby not only
property insurance exists but insurance and private injuries also
are the insurer.
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Insurance Regulatory and Development Authority (IRDA)

This was established in the year 1999 by the Indian Government, for
two significant reasons to safeguard the interest of the policyholders
and for the up-gradation of the entire insurance sector, right from the
approach adopted by the prevailing insurance companies towards
their shareholders to the eradication of the shortcomings of the
industry. The organisation was set up under the rules of the Insurance
Regulatory and Development Authority Act, 1999.
Scope of Insurance Regulatory and Development Authority.

IRDA has been authorised to register the new insurance companies in
India. The list of new insurance companies also includes the
collaborations of the renowned insurance companies overseas with the
existing Indian companies. The insurance companies in India are
required to approach the Insurance Regulatory and Development
Authority for renewal of the registration. The Insurance Regulatory and
Development Authority is allowed to withdraw the registration of the
businesses and even cancel the registration of a corporation if required.
It is also authorised to modify the registration procedure for a
company.
Functions of Insurance Regulatory and Development Authority

IRDA ensures and safeguards the interests of policyholders through
various ways such as
• Nomination by policyholders.
• Settlement of insurance claim.
• Practical training for insurance agents and other intermediaries.
• Insurable interest.
• Surrender value of policyholders.
• Code of conduct of insurance intermediaries. Guaranteed success
package General Studies paper.
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• Assistance in gaining correct information about policies.

• Creation of management information system.
• Promotion of self-regulation within the insurance sector.
Life Insurance Corporation of India (LIC)

LIC was established on 1st September 1956 which set the pace of
nationalisation of the
Insurance sector under the stewardship of CD Deshmukh. Its head
office in Mumbai and eight zonal offices, the most recent being at Patna.
LIC is additionally operating internationally through branch offices in
Fiji, Mauritius and UK and thru venture insurance companies in
Bahrain, Nepal, Sri Lanka, Kenya and Saudi Arabia.
General Insurance Corporation (GIC)

GIC was established on 1st January 1973 with its four subsidiaries, viz,
1. National Insurance Company Limited, Kolkata.
2. The New India Insurance Company Limited, Mumbai.
3. The Oriental Fire and General insurance firm Limited, New Delhi.
4. United India General Insurance Company Limited, Chennai GIC
Reinsurer (Re) has branch offices in Dubai and London and a
representative office in Moscow.
Advantages of insurance
(1) Providing security:
Insurance provides a cover against any sudden loss. In the case of
fire insurance and marine, the loss suffered by the insured is fully
compensated and he is restored to his earlier position. There is
always a fear of sudden loss. There may be a storm in the sea, fire
in the factory or loss of life.
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(2) Spreading of Risk:

The main principle of insurance is to spread risk among a huge
number of people. A large number of persons get insurance
policies and pay a premium to the insurer. Insurance covers the
loss of an individual but the social loss cannot be eliminated.
(3) Source for Collecting Funds:

Large funds are collected by way of premium. These funds can be
gainfully employed in `the industrial development of a country.
The premium is received regularly in instalments. The
employment opportunities are also increased by big investments
made by insurance companies. So, insurance has become an
important source of capital formation.
(4) Encourage Savings:

Life insurance provides a mode of investment. The amount of
policy is paid to the insured or ``to his nominees. In the case of
fixed time policies, the insured gets a lump-sum amount after the
maturity of the policy.
(5) Encourage International Trade:

International trade involves many risks in transporting goods
from one country to another. In the absence of insurance, the
traders will always be worried about the safe arrival of goods. The
quantum of trade will be limited because of uncertainties and risks
involved during transit.

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Disadvantages of Insurance:
(1) It doesn't compensate for all types of losses which are caused by
business to insured by an insurance company.
(2) Insurance encourages savings. It does not provide the facilities
that are provided by a bank.
(3) The total amount of premium may be higher than the policy
amount receivable on maturity.
(4) It leads to crimes in society as the beneficiaries of the policy may
be tempted to commit crimes to receive the insured amount.
(5) It takes time to provide financial compensation by lengthy legal
formalities.

@Crossword2022

@Crossword2022
7. Basic Concepts of Mutual Funds

Introduction:
Mutual Fund may be a trust that pools together the resources of
investors to form raid investments within the capital market thereby
making the investor be a neighbourhood owner of the assets of the
mutual fund. It is managed by a professional money manager who
invests the money collected from different investors in various bonds,
stocks or other securities according to specific investment objectives as
established by the fund. If the worth of the open-end fund investments
goes up, the return on them increases and the other way around. The
net income earned on the funds, alongside a capital appreciation of the
investment, is shared amongst the unit holders in proportion to the
units owned by them. In return for administering the fund and
managing its investment portfolio, the fund manager charges fees to
support the worth of the fund’s assets.

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Classification and types of mutual funds:-
Mutual Funds are classified into 3 types Equity Funds, Debt Funds and
Special Funds.
Equity funds invest primarily in stocks. A share of stock represents a
unit of ownership during a company. If an organization is successful,
shareholders can profit in two ways:
• It may increase in value, or
• The corporate can pass its profits to shareholders within the sort
of dividends.
If a corporation fails, a shareholder can lose the whole value of his
or her shares; however, a shareholder isn't responsible for the
debts of the corporate.
Equity Funds
Equity Funds are of the subsequent types,
(a) Growth Funds: They seek to supply future capital appreciation to
the investor and are best to future investors.
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(b) Aggressive Funds: They appear for super-normal returns that

investment is formed in start-ups, IPOs and speculative shares.
They are best for investors willing to require risks.
(c) Income Funds: They seek to maximise the present income of
investors by investing in safe stocks paying high cash dividends
and in high yield market instruments. They are best for investors
seeking current income.
Debt Funds
Debt Funds are of two types viz.
(a) Bond Funds: They invest in fixed income securities e.g.
government bonds, corporate debentures, convertible
debentures, market. Investors seeking tax-free income enter for
state bonds while those trying to find safe, steady income buy
government bonds or high-grade corporate bonds. Although there
are past exceptions, bond funds tend to be less volatile than stock
funds and sometimes produce regular income. For these reasons,
investors often use bond funds to diversify, provide a stream of
income, or invest for intermediate-term goals. However, like stock
funds, bond funds also have the following risks and can lose
money.
❖ Interest Rate Risk:
This risk relates to fluctuation in the market value of Bond
consequent upon the change in interest rate (YTM) as
discussed in the chapter on Security Valuation. There is an
inverse relationship between the market value of bonds and
interest rate. As the rate of interest goes the upmarket price
of Bond falls and the other way around.

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❖ Credit Risk:
This risk is similar to the risk of default in repayment of loans
or payment of interest or both by the borrowers of the funds.
Thus, this risk takes place when an open-end fund that
invested money within the Bonds of a corporation defaulted
within the payment of Interest or Principal. This risk is higher
just in the case of companies with lower Credit Ratings.
❖ Prepayment Risk:
This risk is related to the early refund of money by the issuer
of Bonds before the date of maturity. This generally happens
in case of falling interest rates when a company who already
issued Bond at higher interest rate issues fresh Bonds at a
lower rate of interest exercising its right of early redemption
of Callable Bonds and refunding the money raised out of the
fresh issue.
(b) Gilt Funds: They're mainly invested in Government securities.
Special Funds
Special Funds are of four types viz.
(a) Index Funds: Every stock exchange features a stock exchange
index that measures the upward and downward sentiment of the
stock market. Index Funds are low-cost funds and influence the
stock exchange. The investor will receive regardless of the market
delivers.
(b) International Funds: An open-end fund located in India to boost
money in India for investing globally.
(c) Offshore Funds: An open-end fund located in India to boost
money globally for investing in India.

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(d) Sector Funds: They invest their entire fund during a particular
industry e.g. utility fund for utility industry like power, gas, and
structure.
(e) Market Funds: These are predominantly debt-oriented schemes,
whose main objective is the preservation of capital, easy liquidity
and moderate-income. To achieve this objective, liquid funds
invest predominantly in safer short-term instruments like
Commercial Papers, Certificate of Deposits, Treasury Bills, G-Secs
etc.
(f) Fund of Funds: Fund of Funds (FoF) because the name suggests
are schemes that invest in other open-end fund schemes. The
concept is popular in markets where there are several open-end
fund offerings and selecting an appropriate scheme consistent
with one’s objective is hard. Just as an open-end fund scheme
invests during a portfolio of securities like equity, debt etc., the
underlying investments for a FoF is that the units of other mutual
fund schemes, either from the same fund family or from other fund
houses.
(g) Capital Protection Oriented Fund: The term ‘capital protection
oriented scheme’ means an open-end fund scheme that is
designated intrinsically and which endeavours to guard the capital
invested therein through suitable orientation of its portfolio
structure. The orientation towards the protection of capital
originates from the portfolio structure of the scheme and not from
any bank guarantee, insurance cover etc. SEBI stipulations require
these kinds of schemes to be close-ended in nature, listed on the
stock exchange and thus the intended portfolio structure would
wish to be mandatory rated by a credit rating agency. A typical
portfolio structure might be to line aside a major portion of the
assets for capital safety and will be invested in highly rated debt
instruments.

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Equity Diversified Funds

Diversified funds may be a fund that contains a good array of stocks. It
ensures a high level of diversification in its holdings, thereby reducing
the quantity of risk within the fund.
a. Multicap Fund: These are by definition, diversified funds. The
only difference is that, unlike a traditional diversified fund, the
offer document of a multi-cap/Flexi-cap fund generally spells out
the bounds for minimum and maximum exposure to every of the
market caps.
b. Contra fund: It invests in those companies that have unrecognised
value. It is ideally fitted to investors who want to take a position
during a fund that has the potential to perform altogether sorts of
market environments because it blends both growth and value
opportunities.
c. Index fund: It seeks to track the performance of a benchmark
market index like the Sensex, BSE or S&P CNX Nifty. Simply put,
the fund maintains the portfolio of all the securities within the
same proportion as stated within the benchmark index and earns
an equivalent return as earned by the market.
d. Dividend Yield fund: This fund invests in shares of companies
which is having high dividend yields. It is defined as a dividend per
share divided by the share’s market price. These funds invest in
stocks of companies having a dividend yield higher than the
dividend yield of a particular index, i.e., Sensex or Nifty.
These funds are considered to be a medium-risk proposition. However,
it's important to notice that dividend yield funds haven't always proved
resilient in short-term corrective phases.
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Two types of Dividend schemes are as follow:

• Dividend Pay-out Option: Dividends are paid bent the unit
holders under this feature. The units fall to the extent of the
dividend paid out and applicable statutory levels.
• Dividend Reinvestment Option: In this, the dividend that
accrues on units under the option is re-invested back into the
scheme at ex-dividend NAV. In this investors receive additional
units on their investments of dividends.
Sector Funds
Sector funds are highly focused on a particular industry. The basic
objective is to enable investors to require advantage of industry cycles.
Since sector funds ride on market cycles, they need the potential to
supply good returns if the timing is ideal. However, they're deprived of
downside risk protection as available in diversified funds.
Sector funds should constitute only a limited portion of one’s portfolio,

as they're much riskier than a diversified fund. Besides, only those that
have an existing portfolio should consider investing in these funds.
For example, land Mutual Funds invest in land properties and earn an
income within the sort of rentals, capital appreciation from developed
properties. Also, some a part of the fund corpus is invested in equity
shares or debentures of companies engaged in land assets or
developing land development projects.

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Thematic Funds
This fund focuses on trends that are likely to result in the ‘out -
performance’ by certain sectors or companies. It could vary from
international exposure, multi-sector, commodity exposure etc. Unlike a
sector fund, these funds have a broader outlook.
However, the downside is that the market may take an extended time
to acknowledge views of the fund house with regards to a specific
theme, which forms the idea of launching a fund.
Arbitrage Funds
These funds promise the safety of deposits, but tax benefits, better tax
and greater liquidity. Pru-ICICI is that the latest to hitch the list with its
equities and derivatives funds.
The open-ended equity scheme aims to get low volatility returns by

inverting during a mixture of cash equities, equity derivatives and debt
markets. The fund seeks to supply better returns than typical debt
instruments and lower volatility as compared to equity.
The other schemes within the arbitrage universe are Benchmark

Derivative, JM Equity and Derivatives, Prudential ICICI Balanced, UTI
Spread and Prudential ICICI Equity and Derivatives.
Hedge Fund
A Hedge Fund may be a lightly regulated investment fund that escapes
most regulations by being a kind of a personal investment vehicle being
offered to choose clients.

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The big difference between a hedge fund and an open-end fund is that
the previous doesn't reveal anything about its operations publicly and
charges a performance fee. Typically, if it outperforms a benchmark, it
takes a cut off the profits. Of course, this is a one-way street; any losses
are borne by the investors themselves.
Cash Fund
It is an open-ended liquid scheme that aims to get returns with lower
volatility and better liquidity through a portfolio of debt and market
instruments.
The fund will have retail institutional and super institutional plans.
Exchange Traded Funds

An Exchange Traded Fund (ETF) may be a hybrid product that mixes
the features of a mutual fund. The authorized participants act as market
makers for ETFs.
ETFs are often bought and sold like all other stock on an exchange.ETFs
are often bought or sold any time during the market hours at prices that
are expected to be closer to the NAV at the top of the day.
Advantages of mutual funds

(1) Low cost of management:
None of the mutual funds can increase the cost which is beyond
the prescribed limits of 2.5% maximum and any kind of extra cost
of management is to be borne by AMC.
(2) Professional Management:

Funds in these are managed by professional and skilled
experienced managers with some backup of a research team.
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(3) Diversification:
It offers diversification in a portfolio which reduces the risk.
(4) Liquidity:
The liquidity is provided by listing the units on the Stock Exchange.
Liquidity is provided by direct sales or repurchase by the mutual
funds in case of close-ended funds.
(5) Other benefits:

It provides regular withdrawal and systematic investment plans
according to the need of the investors.
Disadvantages of Mutual Funds:

(1) Cost factor:
Mutual funds carry price tags. Fund managers are the highest-paid
executive. Such costs reduce the return from the mutual fund. The
fees paid to the Asset Management Company are in no way related
to performance.
(2) Unethical Practices:

It doesn't play a fair game. Each scheme may sell some of the
holdings to its sister concerns for substantive notional gains and
posting NAVs in a formalized manner.
(3) Transfer difficulties:

This can be a major problem for investors. Liquidating a mutual
fund portfolio may increase risk, increase fees and commissions,
and create capital gains taxes.

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(4) Taxes:
When making decisions about your money, fund managers do not
consider your tax situation. For example, when a fund manager
sells a security, a capital gain tax is triggered, which affects how
profitable the individual is from the sale. It might have been more
profitable for the individual to defer the capital gain liability.
(5) Selection of proper fund:

For stocks, one can base his selection on the parameters of
economic, industry and company analysis. In the case of mutual
funds, past performance is the only criteria to fall back upon but
the past cannot predict the future.

@Crossword2022

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8. RBI Circular
1. Changes in Government Securities Auction Methodology
RBI has announced changes in benchmark securities of tenor 2-
year, 3-year, 5-year, 10-year, 14-year tenor and Floating Rate
Bonds
The changes in Benchmark securities is made due to the market
status, market borrowing program of the government.
From onwards there will be Uniform price auction method’ for
benchmark securities of tenor 2-year, 3-year, 5-year, 10-year, 14-
year tenor and FRBs.
Under the auction, successful bidders will have to pay for the
allotted quantity of securities at the same rate, which is the auction
cut-off rate, irrespective of the rate quoted by them.
For other benchmark securities i.e. 30-year and 40-year, the

auction will continue to be multiple price-based auctions. In this
the successful bidders will have to pay for the allotted quantity of
securities at the respective price/yield at which they have bid.
2. RBI Retail Direct’ Scheme

RBI has given a nod for Government Securities (G-Sec) to be
maintained by retail investors. The retail investors will be able to
open and maintain their glit securities account named as ‘ Retail
Direct Glit Account’ . They can open the Account via an online
portal where they will be able to access primary issuance of G-Sec
auctions and Negotiated Dealing System- Order Matching, for
buying and selling of G-Secs in the secondary market.
It includes GOI Treasury Bills , GOI dated securities, Sovereign Gold
Bonds, State Development Loans.

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Eligibility of retail investors to invest

1. They need to have a rupee saving bank account in India, PAN
details, Documents for KYC procedures, registered mobile number
and email id.
2. NRI individuals who are eligible to make investments in G-Secs
under Foreign Exchange Management Act 1999 are also eligible to
take benefit of the scheme.
3. There is no fee associated to open an RDG Account. In the process
of bidding, the participation and allotment of securities will be
based on non-competitive bidding scheme framed by RBI.
Investors for the payment of securities need to transfer funds to
payment for securities is done,RBI will credit the securities to their
RDG Accounts.
The investors are supposed to transfer funds to the designated
account of CCIL (Clearing corporation of NDS-OM) online, before
the start of trading hours or during the day and then the RBI will
credit the securities to investors Gilt Account.
3. RBI BI- Monthly Monetary policy

For the seventh consecutive time, MPC has maintained the same
rates.
Members of MPC: Shaktikanta Das (Chairperson of the
committee), Dr Michael Debabrata Patra, Dr Mridul K. Saggar, Prof.
Ashima Goyal, Dr Shashanka Bhide and Prof. Jayanth R Varma.
Current repo rate unchanged i.e. to 4%.
Reverse repo rate 3.35%.
Marginal Standing Facility Rate and Bank Rate 4.25%.
CRR is 4% and the SLR is 18%.
The unhanged policy rates will help to promote growth within the
framework of financial stability.
Inflation rate for FY22 is raised to 5.7%.
Two auctions of Rs 25,000 crore each shall be held under G-sec
Acquisition Programme.
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4. Financial Inclusion Index

Financial inclusion index shall be released by RBI in the month of
July every year, without any consideration of the base year for the
index.
It measures the extent of financial inclusion in activities like
banking, investments, insurance, postal and pension sector in
India.
The FI-Index value range between 0 to 100; where 0 indicates

complete financial exclusion while 100 indicates full financial
inclusion.
Parameters used for calculating FI are access, usage and quality.
The access carries a weightage of 35%, usage carries weightage of

45% and quality carries weightage of 20%.
The annual FI-Index for the period ending March 2021 is 53.9 as
against 43.4 for the period ending March 2017.
5. Regulated Entities for Integrated Supervision and Monitoring

(PRISM)’
RBI web-based end-to-end workflow automation system is named
as ‘Platform for Regulated Entities for Integrated Supervision and
Monitoring (PRISM)’.
It aims to enable the supervised entities to strengthen their

internal defenses and resilience by focusing on Root Cause
Analysis (RCA).
The PRISM will be having features like functionalities with respect

to inspection; compliance; incident functionality for
cybersecurity; complaints; and returns functionalities
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It shall also have remediation workflows, tracking of time, alerts,

and notifications.
It shall consist of MIS reports.
6. Recommendations on UCBs by RBI’s Expert Committee

The RBI committee was headed by former Deputy Governor of
RBI, N S Vishwanathan.
The committee was formed to give recommendations for
rehabilitation of UCBs and to review regulatory norms of UCB
under the Banking Regulation Act 1949
Committee Recommendations:
1. The committee suggested the 4-tier structure for UCBs on the
basis of UCB’s capital availability in order to ease the
regulatory process.
Tier 1: UCBs with deposits upto Rs 100 crore
Tier 2: UCBs with deposits between Rs 100 crore- Rs 1000
crore
Tier 3: UCBs with deposits between Rs 1000 crore- Rs 10,000
crore
Tier 4: UCBs with deposits more than Rs 10,000 crore
2. Minimum capital to risk-weighted asset ratio (CRAR) for Tier
1 UCBs will vary from 9% to 15%.
3. To set up an Umbrella Organisation (UO) with a minimum
capital of Rs 300 crore with CRAR and regulatory norms as
same as NBFCs. This will enable to raise funds from the
market or on-lend it to member UCBs.

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7. RBI raised Limit Under Indo-Nepal Remittance Facility

Scheme
RBI has raised the limit from Rs 50,000 per transaction to Rs 2 lakh
per transaction.
Also, the limit for remittance for 12 times in a year is removed.
For cash-based transfers under the same scheme, the per
transaction limit of Rs 50,000 will still be present with a maximum
number of transfers in a year allowed to be 12.
The limit has been increased to enhance the trade payments
between India and Nepal.
Indo-Nepal Remittance Facility Scheme:

The scheme beneficiaries will receive funds in Nepalese Rupees. The
funds are received into the bank account maintained with the
subsidiary of State Bank of India in Nepal, i.e. Nepal SBI Bank Ltd
(NSBL).
8. Large Exposure Framework for Banks

A bank’s exposures to its counterparties may result in
concentration of its assets to a single counterparty or a group of
connected counterparties. As a first step to address the
concentration risk, the Reserve Bank, in March 1989, fixed limits
on bank exposures to an individual business concern and to
business concerns of a group.
RBI’s prudential exposure norms have evolved since then and a
bank’s exposure to a single borrower and a borrower group is
currently restricted to 15 percent and 40 percent of capital funds
respectively.
In January 1991, the Basel Committee on Banking Supervision
(BCBS) issued supervisory guidance on large exposures, viz.,

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Measuring and Controlling Large Credit Exposures. Further, the

Core Principles for Effective Banking Supervision (Core Principle
19), published by BCBS of 2012 prescribed that local laws and
bank regulations set prudent limits on large exposures to a single
borrower or a closely related group of borrowers.
The exposures that will be exempted from the LEF are listed
below:
a. Exposures to the Government of India and State Governments
which are eligible for zero percent Risk Weight under the Basel III
– Capital Regulation framework of the Reserve Bank of India;
b. Exposures to Reserve Bank of India;
c. Exposures where the principal and interest are fully guaranteed
by the Government of India;
d. Exposures secured by financial instruments issued by the
Government of India, to the extent that the eligibility criteria for
recognition of the credit risk mitigation (CRM) are met in terms of
paragraph 7.III of this circular;
e. Intra-day interbank exposures;
f. Intra-group exposures4;
g. Borrowers, to whom limits are authorised by the Reserve Bank for
food credit;
h. Banks’ clearing activities related exposures to Qualifying Central
Counterparties (QCCPs)
9. Tokenisation – Card Transactions: Permitting Card-on-File

Tokenisation (CoFT)
Tokenisation refers to replacement of actual card details with an

unique alternate code called the “token”, which shall be unique for a
combination of card, token requestor and device.

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Conditions for Tokenisation – de-tokenisation service

i. Tokenisation and de-tokenisation shall be performed only by the
authorised card network and recovery of original Primary Account
Number (PAN) should be feasible for the authorised card network
only.
ii. Tokenisation and de-tokenisation requests should be logged by
the card network and available for retrieval, if required.
iii. Actual card data, token and other relevant details shall be stored
in a secure mode. Token requestors shall not store PAN or any
other card detail.
iv. Card network shall get the token requestor certified for (a) token
requestor’s systems, including hardware deployed for this
purpose, (b) security of token requestor’s application, (c) features
for ensuring authorised access to token requestor’s app on the
identified device, and, (d) other functions performed by the token
requestor, including customer on-boarding, token provisioning
and storage, data storage, transaction processing, etc.
v. Card networks shall get the card issuers / acquirers, their service
providers and any other entity involved in payment transaction
chain, certified in respect of changes done for processing
tokenised card transactions by them.
Registration by customer
Registration of card on token requestor’s app shall be done only with
explicit customer consent through Additional Factor of Authentication
(AFA), and not by way of a forced / default / automatic selection of
check box, radio button, etc.
AFA validation during card registration, as well as, for authenticating

any transaction, shall be as per extant Reserve Bank instructions for
authentication of card transactions.

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Suitable velocity checks (i.e., how many such transactions will be

allowed in a day / week / month) may be put in place by card issuers /
card network as considered appropriate, for tokenised card
transactions.
For performing any transaction, the customer shall be free to use any
of the cards registered with the token requestor app.
Before providing card tokenisation services, authorised card payment

networks shall put in place a mechanism for periodic system (including
security) audit at frequent intervals, at least annually, of all entities
involved in providing card tokenisation services to customers. This
system audit shall be undertaken by empanelled auditors of Indian
Computer Emergency Response Team (CERT-In). A copy of this audit
report shall be furnished to the Reserve Bank.
COFT
RBI has now permitted 'card-on-file tokenisation.' Under this model,
tokenisation will be done by multiple entities like merchant outlets,
payment aggregators, payment gateway providers, as well networks
like Visa and Mastercard. This will help in storing payment information
for recurring use like paying subscriptions.
In order to simplify recurring payments, Worldline has introduced an

innovative 'Subscription Payments Platform' focused on
comprehensive subscription life-cycle management and payment
processing services.
Conditions for COFT services

1. If card payment for a purchase transaction at a merchant is being
performed along with the registration for CoFT, then AFA
validation may be combined.

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2. The merchant shall give an option to the cardholder to de-register

the token. Further, a token requestor having direct relationship
with the cardholder shall list the merchants in respect of whom
the CoFT has been opted through it by the cardholder; and provide
an option to de-register any such token.
3. A facility shall also be given by the card issuer to the cardholder to
view the list of merchants in respect of whom the CoFT has been
opted by her / him, and to de-register any such token. This facility
shall be provided through one or more of the following channels –
mobile application, internet banking, Interactive Voice Response
(IVR) or at branches / offices.
4. Whenever a card is renewed or replaced, the card issuer shall seek
explicit consent of the cardholder for linking it with the merchants
with whom (s)he had earlier registered the card.
5. The TSP shall put in place a mechanism to ensure that the
transaction request has originated from the merchant and the
token requestor with whom the token is associated.

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Sources of Financing
Meaning
Cash Flow statement indicates the inflows (receipts) and outflows
(payments) of cash and its equivalents of an organization during a
particular period.
The cash receipts and payments are classified according to the firm's
Operating, Investing and Financing activities. It measures the net cash
inflow or net cash outflow for each activity and for the overall business
of the firm. It reports from where cash has come in and how it has been
utilized. It explains the causes for the change in the cash balance by
reconciling the opening balance of the period with the closing balance.
Objectives of Cash Flow Statement:

A basic objective of Financial Management is to match the inflows and
outflows of cash in such a way that the numerous demands for cash,
like payments for expenses, payment to suppliers, returns to investors
etc. are managed without excessive cash balance.
(1) To provide information about the cash flows of an enterprise to

users of Financial Statements this can be used as a basis to assess
the ability of the enterprise ananlyse cash and cash equivalents
and the needs of the enterprise to utilize those cash flows.
(2) To enable the users of Financial Statements to evaluate the
“Timing and certainty' of the generation of cash flows.
(3) To distinguish the cash flows on the basis of Operating, Investing
and Financing activities.

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Advantages or Benefits or Utility of Cash Flow Statement:

(1) Assessment of Firms ability to generate cash flows: Cash Flow
Statement is helpful in assessing the ability of the firm to generate
cash and cash equivalents and also the timing and certainty of such
cash flows.
(2) Classification of Cash flows: Cash flows are classified on the basis
of major activities i.e., Operating, Investing and Financing. It helps
to assess the effectiveness of the managements’ policies relating to
each of these major activities.
(3) Historical analysis as guide to forecasting: Cash flow statement
presents in detail the movements of cash in the recent past. This
can provide clear indications for the cash flows in the future
period, thus helping in forecasting the future commitments and
needs.
(4) Effective cash management: Cash flow statement can act as a guide
for coordinating the inflows and outflows of cash. The ‘Matching'
of the future cash receipts with payments results in effective cash
management.
(5) Formulation of financial policies: A clear insight into the cash flows
of the firm is the basis for financial policies like dividend policy,
cash discount, credit terms, etc.
(6) Preparation of cash budget: Cash flow statement is almost like the
'foundation' for cash budget. The cash flows in the recent past
indicate the quantum and direction of such flows and form the
basis for preparing monthly or quarterly budgets for cash or even
the annual cash budget for the ensuing year.
(7) Short term financial decisions: Short range financial decisions like
repayment of overdraft or loans, payment of bonus, advertising
campaigns, investments outside the firm, etc., may be taken on the
basis of the analysis provided by the cash flow statement.
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(8) Liquidity position: It reveals the liquidity position of the firm by

highlighting the various sources of cash and its uses.
(9) Revealations: It can reveal the causes for profitable firms
experiencing acute cash shortages. The reasons for any
mismanagement of cash resulting in such a position can be
analyzed and its recurrence can be avoided.
Limitations of cash flow analysis

1. Cash flow statement discloses inflows and outflows of cash alone.
Thus its scope is very limited compared to funds flow statement
which reveals the changes in working capital or the income
statement which displays the overall financial position.
2. Cash flow statements reveal the cash balance. But it can be easily
manipulated by. postponing payments for purchases or delaying
collection of receivables, etc.
3. Since non-cash items of expenses and incomes are excluded, it
cannot provide a comprehensive picture of a firm's financial
position. Inspite of the limitations, cash flow statement is
extensively used in practice along with ratio analysis to obtain
clear perception of the liquidity and financial position of a firm.
Differences between Funds Flow Analysis and Cash Flow Analysis:

(1) Basis of preparation: Funds flow analysis is based on the working
capital concept of 'funds'. Cash flow analysis is based on the cash
concept of 'funds'.
(2) Basis of accounting: Funds flow analysis is based on ‘Accrual
concept ‘or accrual basis of accounting. Cash flow analysis is based
on 'cash concept or cash basis of accounting.

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(3) Cash inflows and out flows are segregated into those from
operating, Investing and Financing activities.
(4) Changes shown: Funds flow analysis measures the various causes
for change in the working capital position over a period of time,
like between two balance sheet dates. Cash flow analysis measures
the causes for change in the cash position over the same
accounting period.
(5) Usefulness: Funds flow analysis is used for decision making in the
long run, while Cash flow analysis is useful for short term financial
decisions.
(6) Short term solvency: Cash flow analysis does not give accurate
short term solvency position of a firm because it considers only
cash and ignores all other current assets and liabilities, while
Funds flow analysis is better for short term solvency because it
considers all the current assets and liabilities and presents a more
comprehensive position.
(7) Inter Dependence: Working capital includes cash also. Thus,
improvement in cash position automatically improves working
capital also. But the reverse is not always true. Working capital
may increase even if cash decreases.
(8) Difference based on techniques of preparation of the statements:
(a) Cash flow statement begins with opening cash and bank balances
and ends with closing cash and bank balances. There are no
balances in the preparation of funds flow statement.
(b) Funds from operations are calculated in funds flow statement. The
funds from operations helps in adjusting cash from operating
acvities in cash flow statement.
(c) Increase in current assets and decrease in current liabilities
increases the working capital and decreases the cash and vice
versa.
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(9) Preparation of Budgets: When budgetary control system is in

operation, cash flow analysis helps in short term estimates of cash
for the preparation of cash budget. Funds flow analysis is an
important tool for the preparation of capital expenditure budget
particularly for the medium term.
CLASSIFICATION OF CASH FLOW ACTIVITIES

AS 3 provides explanation for changes in cash position of the business
entity. As per Accounting Standard 3, cash flows during the period are
classified as Operating; Investing and Financing activities.
OPERATING ACTIVITIES
1. Definition: It refers to revenue generating activities of the
enterprise. The amount of cash flows from operating activities
indicates Whether the firm has the capability
(a) Maintain the operating Expenses the enterprise;
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(b) Pay dividends, repay loans; and

(c) Make new investments without recourse to external
sources of financing.
Investing activities
1. Definition: It refers to the acquisition and disposal of long-term
assets and other investments not included in cash equivalents,
They are disclosed separately as to indicate expenditures made
for resources intended to generate future incomes and cash
flows.

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Financing activities
1. Definition: It indicates the changes in the size and composition of
the owner’s capital (including preference share capital) and
borrowings of the enterprise, they are disclosed separately so
that its helpful in predicting claims on future cash flows by
providers of funds (both capital and borrowings) to the
enterprise.
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Calculation of cash flow From OPERATING ACTIVITIES

1. Components: Cash flows from operating activities result from the
transactions and other events that enter into the determination
of net profit or loss.
2. Methods: An enterprise can determine cash flows from operating
activities using either:
(a) Direct Method: it considers gross cash receipts and gross cash
payments
(b) Indirect Method: In this, net profit or loss is adjusted for the
effects of transactions of a non-cash nature, deferrals or accruals
of past or future operating cash receipts or payments, and items
of income or expense associated with investing or financing
activities.
Direct Method
1. Information Required
(a) Gross receipts and gross cash payments are taken by
adjusting sales, cost of sales and other items in the profit
and loss accounts for:
• Changes during the period in stock and operating
receivables and payables;
• Other non-cash items such as depreciation on fixed
assets, goodwill written off, preliminary expenses
written off, loss or gain on sale of fixed assets etc.; and
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• Other items for which the cash effects are investing or

financing cash flows. Examples are interest received
and paid, dividend received and paid etc., which are
related to financing or investing activities and are
shown separately in the cash flow statement.
2. The direct method provides information which may be useful in

estimating future cash flows and which is not available under the
indirect method and is, therefore, considered more appropriate
than the indirect method.
Indirect Method
Under the indirect method, the net cash from operating activities is
calculated by adjusting net profit or loss instead of individual items
appearing in the profit and loss account. Net profit or loss is also
adjusted for the effect of:
(a) changes during the period in stock and operating receivables
and payables;
(b) non-cash items such as goodwill and
(c) all other items for which the cash effects are from financing or
investing cash flows.

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Proforma of ‘Cash Flow from Operating Activities’ by indirect

method
`
Net Profit for the year -
Add: Non-Cash and Non-Operating Expenses: -
Depreciation -
Loss on Sale of Assets -
Provision for taxation, etc. -
Less: Non-Cash and Non-Operating Incomes:
Profit on Sale of Assets -
Net Profit after Adjustment for Non-Cash Items (-)
Cash from = Net Profit (after adjustment for Non-

operation - cash Items) Increase in Current
+ Assets
+ Decrease in Current
- Assets Increase in
Current Liabilities
Decrease in Current Liabilities
CALCULATION OF CASH FLOWS FROM INVESTING ACTIVITIES

It calculates the acquisition and disposal of long-term assets, non-
operating current assets and investments which results in outflow of
cash and their sale results in inflow of cash.

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CALCULATION OF CASH FLOWS FROMFINANCING ACTIVITIES

It calculates the changes in capital and borrowing of the enterprise
which affect flow of cash such as Redemption of shares and
repayment of borrowings results in outflow of cash.
ILLUSTRATIONS
Illustration 1
Intelligent Ltd., a non-financial company has the following entries in
its Bank Account. It has sought your advice on the treatment of the
same for preparing Cash Flow Statement.
(i) Loans and Advances given to the following and interest earned
on them:
(1) to suppliers
(2) to employees
(3) to its subsidiaries companies
(ii) Investment made in subsidiary Smart Ltd. and dividend received
(iii) Dividend paid for the year
(iv) TDS on interest income earned on investments made
(v) TDS on interest earned on advance given to suppliers
(vi) Insurance claim received against loss of fixed asset
by fire Discuss in the context of AS 3 Cash Flow
Statement.
Solution
(i) Loans and advances given and interest earned
(1) to suppliers Operating Cash flow
(2) to employees Operating Cash flow
(3) to its subsidiary companies Investing Cash flow

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(ii) Investment made in subsidiary company and dividend received

Investing Cash flow
(iii) Dividend paid for the year Financing Cash Outflow
(iv) TDS on interest income earned on investments made
Investing Cash Outflow
(v) TDS on interest earned on advance given to suppliers
Operating Cash Outflow
(vi) Insurance claim received of amount loss of fixed asset by fire
Extraordinary item to be shown under a separate heading as
‘Cash inflow from investing activities’.
Illustration 2
Following are extracts of the Balance Sheets of Ajay Ltd.:
31.3.20X1 31.3.20X2
Particulars Notes
` `
Equity and Liabilities
Shareholder’s funds
(a) Share capital 1 5,00,000 5,00,000
(b) Reserve & surplus 2 50,000 90,000
Non-current liabilities
(a) Long-term borrowings 3 5,00,000 7,50,000
Current liabilities
(a) Other current liabilities 4 --- 5,000
Assets
Non-current assets
(a) Intangible assets 5 2,05,000 1,80,000
Notes to accounts

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31.3.20X1 31.3.20X2
` `
1 Share Capital
50,000 Equity Shares of `10 each 5,00,000 5,00,000
2 Reserve & surplus
Profit & Loss A/c 50,000 90,000
3 Long-term borrowings
10% Debentures 5,00,000 7,50,000
4 Other current liabilities
Unpaid interest --- 5,000
5 Intangible assets
Goodwill 2,05,000 1,80,000
You are required to show the related items in Cash Flow Statement.
Solution
An Extract of Cash Flow Statement for the year ending 31.3.20X2
`
Cash flows from operating activities:
Closing balance as per Profit & Loss A/c 90,000
Less: Opening balance as per Profit & Loss Alc (50,000)
Add: Goodwill amortisation 25,000
Add: Interest on Debentures (Refer Note 1) 75,000
Net Cash from Operating Activities 1,40,000
Note 1: Interest has been computed on the closing balance of

debentures as on 31.3.20X2 assuming that all the additions/ deletions
were made, if any, at the beginning of the year.

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Cash flows from financing activities:

Proceeds from debentures (Refer Working Note) 2,50,000
Interest paid on Debentures [less unpaid] (70,000)
Net Cash from Financing Activities 1,80,000
Working Note:
10% Debentures Account
Particulars ` Particular `
To Balance c/d 7,50,000 By Balance b/d 5,00,000
By Bank A/c (Bal. fig.) 2,50,000
7,50,000 7,50,000
Illustration 3
From the following information, calculate cash flow from operating
activities:
Summary of Cash Account
for the year ended March 31, 20X1
Particulars ` Particulars `
To Balance b/d 1,00,000By Cash Purchases 1,20,000
To Cash sales 1,40,000By Trade payables 1,57,000
To Trade receivables 1,75,000 By Office & Selling Expenses 75,000
To Trade Commission 50,000 By Income Tax 30,000
To Sale of Investment 30,000 By Investment 25,000
To Loan from Bank 1,00,000 By Repayment of Loan 75,000
To Interest & Dividend 1,000 By Interest on loan 10,000
By Balance c/d 1,04,000
5,96,000 5,96,000

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Solution
Cash Flow Statement of ……

for the year ended March 31, 20X1(Direct Method)
Particulars ` `
Operating Activities:
Cash received from sale of goods 1,40,000
Cash received from Trade receivables 1,75,000
Trade Commission received 50,000 3,65,000
Less: Payment for Cash Purchases 1,20,000
Payment to Trade payables 1,57,000
Office and Selling Expenses 75,000
Payment for Income Tax 30,000 (3,82,000)
Net Cash Flow used in Operating Activities (17,000)
Illustration 4
The following summary cash account has been extracted from the
company’s
accounting records:
Summary Cash Account

(` ’000)
Balance at 1.3.20X1 35
Receipts from customers 2,783
Issue of shares 300
Sale of fixed assets 128
Payments to suppliers 2,047 3,246

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Payments for property, plant & equipment 230

Payments for overheads 115
Wages and salaries 69
Taxation 243
Dividends 80 (3,034)
Repayments of bank loan 250
Balance at 31.3.20X2 212
Prepare Cash Flow Statement of this company Hills Ltd. for the year
ended 31st March, 20X2 in accordance with AS-3 (Revised).
The company does not have any cash equivalents.
Solution
Hills Ltd.
Cash Flow Statement for the year ended 31st March, 20X2
(Using direct method)
(` ’000)
Cash flows from operating activities
Cash receipts from customers 2,783
Cash payments to suppliers (2,047)
Cash paid to employees (69)
Other cash payments (for overheads) (115)
Cash generated from operations 552
Income taxes paid (243)
Net cash from operating activities 309
Cash flows from investing activities
Payments for purchase of fixed assets (230)

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Proceeds from sale of fixed assets 128

Net cash used in investing activities (102)
Cash flows from financing activities
Proceeds from issuance of share capital 300
Bank loan repaid (250)
Dividend paid (80)
Net cash used in financing activities (30)
Net increase in cash and cash equivalents 177
Cash and cash equivalents at beginning of 35
period
Cash and cash equivalents at end of period 212
Illustration 5
Prepare cash flow statement of M/s MNT Ltd. for the year ended 31
st March, 20X1 with the help of the following information:
(1) Company sold goods for cash only.

(2) Gross Profit Ratio was 30% for the year, gross profit amounts to
` 3,82,500.
(3) Opening inventory was lesser than closing inventory by ` 35,000.
(4) Wages paid during the year ` 4,92,500.
(5) Office and selling expenses paid during the year ` 75,000.
(6) Dividend paid during the year ` 30,000.
(7) Bank loan repaid during the year ` 2,15,000 (included interest `
15,000).
(8) Trade payables on 31st March, 20X0 exceed the balance on 31st
March, 20X1 by ` 25,000.
(9) Amount paid to trade payables during the year ` 4,60,000.

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(10) Tax paid during the year amounts to ` 65,000 (Provision for
taxation as on 31.03.20X1` 45,000).
(11) Investments of ` 7,00,000 sold during the year at a profit of `
20,000.
(12) Depreciation on fixed assets amounts to ` 85,000.
(13) Plant and machinery purchased on 15th November, 20X0 for `
2,50,000.
(14) Cash and Cash Equivalents on 31st March, 20X0` 2,00,000.
(15) Cash and Cash Equivalents on 31st March, 20X1` 6,07,500.
Solution
M/s MNT Ltd.
Particulars ` `
Cash flows from Operating Activities
Cash sales (` 3,82,500/.30) 12,75,000
Less: Cash payments for trade payables (4,60,000)
Wages Paid (4,92,500)
Office and selling expenses (75,000) (10,27,500)
Cash generated from operations before 2,47,500
taxes
Income tax paid (65,000)
Net cash generated from operating activities 1,82,500
(A)
Sale of investments (7,00,000 + 20,000) 7,20,000

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Payments for purchase of Plant & machinery (2,50,000)

Net cash used in investing activities (B) 4,70,000
Bank loan repayment (including interest) (2,15,000)
Dividend paid (30,000)
Net cash used in financing activities (C) (2,45,000)
Net increase in cash (A+B+C) 4,07,500
Cash and cash equivalents at beginning of 2,00,000
the period
Cash and cash equivalents at end of the 6,07,500
period
Illustration 6
Ms. Jyoti of Star Oils Limited has collected the following information for
the preparation of cash flow statement for the year ended 31st March,
20X1:
(` in lakhs)
Net Profit 25,000
Dividend paid 8,535
Provision for Income tax 5,000
Income tax paid during the year 4,248
Loss on sale of assets (net) 40
Book value of the assets sold 185
Depreciation charged to the Statement of Profit and 20,000
Loss
Profit on sale of Investments 100
Carrying amount of Investment sold 27,765
Interest income received on investments 2,506

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Interest expenses of the year 10,000

Interest paid during the year 10,520
Increase in Working Capital (excluding Cash & Bank 56,081
Balance)
Purchase of Fixed assets 14,560
Investment in joint venture 3,850
Expenditure on construction work in progress 34,740
Proceeds from calls in arrear 2
Receipt of grant for capital projects 12
proceeds from long-term borrowings 25,980
proceeds from short-term borrowings 20,575
Opening cash and bank balance 5,003
Closing cash and bank balance 6,988
Prepare the Cash Flow Statement for the year ended 31 March 20X1 in
accordance with AS 3. (Make necessary assumptions)
Solution
Star Oils Limited Cash Flow Statement
for the year ended 31st March, 20X1
(` in lakhs)
Net profit before taxation (25,000 + 5,000) 30,000
Adjustments for :
Depreciation 20,000
Loss on sale of assets (Net) 40
Profit on sale of investments (100)
Interest income on investments (2,506)

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Interest expenses 10,000

Operating profit before working capital changes 57,434
Changes in working capital (Excluding cash and(56,081)
bank balance)
Cash generated from operations 1,353
Income taxes paid (4,248)
Net cash used in operating activities (2,895)
Sale of assets (W.N.1) 145
Sale of investments (27,765 + 100) 27,865
Receipt of grant for capital projects 12
Interest income on investments 2,506
Purchase of fixed assets (14,560)
Investment in joint venture (3,850)
Expenditure on construction work-in progress (34,740)
Net cash used in investing activities (22,622)
Proceeds from calls in arrear 2
Proceeds from long-term borrowings 25,980
Proceed from short-term borrowings 20,575
Interest paid (10,520)
Dividend (including dividend tax) paid (8,535) 27,502
Net increase in cash and cash equivalents 1,985
Cash and cash equivalents at the beginning of the 5,003
period
Cash and cash equivalents at the end of the 6,988
period

@Crossword2022
Working note:
1. Book value of the assets sold 185
Less : Loss on sale of assets (40)
Proceeds on sale 145
Illustration 7
Prepare Cash flow for Gamma Ltd., for the year ending 31.3.20X1 from
the following information:
(1) Sales for the year amounted to `135 crores out of which 60% was
cash sales.
(2) Purchases for the year amounted to `55 crores out of which
credit purchase was 80%.
(3) Administrative and selling expenses amounted to `18 crores and
salary paid amounted to `22 crores.
(4) The Company redeemed debentures of `20 crores at a premium
of 10%. Debenture holders were issued equity shares of `15
crores towards redemption and the balance was paid in cash.
Debenture interest paid during the year wa` 1.5 crores.
(5) Dividend paid during the year amounted to `11.7 crores.
(6) Investment costing `12 crores were sold at a profit of `2.4 crores.
(7) `8 crores was paid towards income tax during the year.
(8) A new plant costing `21 crores was purchased in part exchange
of an old plant. The book value of the old plant was ` 2 crores
but the vendor took over the old plant at a value of `10 crores
only. The balance was paid in cash to the vendor.

@Crossword2022
(9) The following balances are also provided:
` in crores 1.4.20X0 ` in crores

31.3.20X1
Debtors 45 50
Creditors 21 23
Bank 6 18.2
Solution
Gamma Ltd.
Particulars ` in crores ` in crores

Cash sales (60% of 135) 81
Cash receipts from Debtors 49
[45+ (135x40%) - 50]
Cash purchases (20% of 55) (11)
Cash payments to suppliers (42)
[21+ (55x80%) – 23]
Cash paid to employees (22)
Cash payments for overheads (Adm. and (18)
selling)
Cash generated from operations 37
Income tax paid (8)
Net cash generated from operating activities 29

@Crossword2022
Sale of investments (12+ 2.40) 14.4

Payments for purchase of fixed assets (21 – (11)
10)
Net cash generated from investing activities 3.4
Redemption of debentures (22-15) (7)
Interest paid (1.5)
Dividend paid (11.7)
Net cash used in financing activities (20.2)
Net increase in cash 12.2
Cash at beginning of the period 6.0
Cash at end of the period 18.2

@Crossword2022

@Crossword2022
Finance Questions with Answers
Q1. Explain in detail the different methods of credit control in

India? (10 Marks)
Ans: The different methods of credit control in India is done by
Reserve Bank of India (RBI). It can be classified in two groups:
Quantitative controls and Qualitative controls. Quantitative
controls are used to control the total quantity of credit in the
economy. It includes bank rate, variable reserve ratios and open
market operations whereas Qualitative controls is selective
method used to channelize the cash and credit in the economy. It
controls certain sections whereas expands the other depending
upon the situation. It includes margin requirement, moral
suasion, direct action and credit rationing.
I. Quantitative methods:
i. Bank rate: The bank rate is the rate at which the RBI
provides the loan to commercial banks without keeping
any collateral for the longer period of time. It is also a
rediscounting rate at which commercial banks
rediscounts its bills of exchange or other commercial bills
eligible for purchase under RBI Act 1934. Currently bank
rate is 4.25%.
ii. Variable Reserve Ratios: Variable reserve ratios refers to
that proportion of bank deposits that the commercial
banks are required to keep in the form of cash or other
liquid assets to ensure liquidity of credit created by them.
RBI employs two types of variable ratios under this: Cash
Reserve Ratio and Statutory Liquidity Ratio. Cash Reserve
Ratio (CRR) is the ratio in which banks are required to
keep certain percentage of their NDTL (Net Demand and
@Crossword2022
Time Liabilities) in the form of cash with RBI. Statutory

Liquidity Ratio (SLR) is the ratio in which banks are
required to keep certain percentage of their NDTL in the
liquid form like gold, government securities and cash with
themselves. At present CRR is 3% and SLR is 18%.
iii. Open market Operations: It refers to buying and selling of
government securities in the open market to influence the
money supply. Buying of government securities lead to
decrease in cash reserves of the commercial banks which
further restricts the availability of credit in the economy
whereas selling of securities leads to increase in cash
reserves of the banks which further creates more credit in
the economy.
II. Qualitative methods:
i. Margin Requirement: it is the proportion of the loan
amount which is not financed by the bank. Margin against
a particular security is either reduced or increased in
order to encourage or discourage the flow of credit to a
particular sector.
ii. Moral Suasion: It is the request by RBI to commercial
banks to take certain measures as per trends of the
economy. It is a moral act of persuasion to influence or
change the behavior using verbal or theoretical
techniques.
iii. Direct Action: Under this method, RBI may refuse to
rediscount bank’s bills and securities, credit supply and
can even put ban on a particular bank if it works against
the objectives of monetary policy.
iv. Credit Rationing: under this method, RBI fix ceiling /
maximum amount of loans and advances for specific
categories of loans and advances.

@Crossword2022
Q2. What is the role of depositories? How many depositories are

there in India? (10 Marks)
Ans: A Depository is an organisation established under Depositories
Act, 1996, where the securities of a shareholder are held in the
electronic form at the request of shareholder through the
medium of a depository participant. The role of depositories can
be explained under following:
• A depository provides security and liquidity in the market.
• It facilitates dematerialization of shares; shares held in
electronic form
• It eliminates the risk of false or fake securities and bad
delivery.
• It facilitates share transfer from one Depository Participant
(DP) account to another on an immediate basis.
• It holds different securities such as debt, equity or
government securities in a single account.
• It provides an easy way of consolidation of accounts.
• It facilitates safekeeping of shares
• It acts as a safe keeper of securities of the shareholders.
• It eliminates the risk of holding a physical asset
In India, there are two depositories: a) National Securities
Depositories Limited (NSDL) b) Central Depositories Services
Limited (CSDL) that are registered with Securities Exchange
Board of India (SEBI). NSDL is the first and largest depository
established in 1996 promoted by National Stock Exchange (NSE).
CSDL is the second depository established in 1999, promoted by
Bombay Stock Exchange (BSE). Both the depositories hold the
financial securities like shares and bonds in dematerialized form
and facilitate trading in the stock exchange.

@Crossword2022
Q3. Describe Indian Capital Markets. What is the structure of

Indian capital market? (15 Marks)
Ans: The capital market is that branch within the financial system that
deals with long-term securities and facilitates its trading. It deals
with both the capital, debt and equity. In these markets
productive capital is raised and made available to corporates. In
short, the capital market structure provides structural
foundations for long-term capital flow in India.
With the pace of economic reforms followed in India, the
importance of capital market has grown in the last ten years. The
capital market scenario changed in 1948 with the establishment
of the Industrial Finance Corporation of India through which the
Government instituted facilities for providing long-term financial
assistance. With an emphasis on industrial development and
growth since 1956 and with the execution of the five-year plans,
there has been a steady growth of the capital market in India.
Features of capital market in India:
• The long-term redeemable types of investment such as
Government Promissory Notes, debentures, public deposits
and redeemable preference shares also constitute capital
market in India.
• Capital market links savers with borrowers of funds and
routes money from savers to entrepreneurial borrowers.
• Capital market is a market for long and medium term financial
instruments. It helps in raising long-term funds. Through this
market, Corporates, industrial organizations, financial
institutions get access to long-term funds from both domestic
and foreign markets.
• Capital market operates with the help of intermediaries like
brokers, underwriters, merchant bankers, sub-brokers,
collection bankers and so on. Theses intermediaries are the
important elements of capital market.
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• It is the determinant of the rate of capital formation in an

economy as it mobilizes the funds. As capital formation is the
net addition to the exciting stock of an economy’s capital.
• Capital markets in India are regulated by government rules,
policies and regulations. For example BSE and NSE are
regulated by Securities Exchange Board of India (SEBI), a
government body
• Capital markets in India deals in both marketable and non-
marketable securities. Marketable securities are those
securities which can be transferred e.g. shares, debentures
and so on. On the other hand non-marketable securities are
those securities which cannot be transferred like term
deposits, loans and advances
• Capital market in India has wide variety of investors. It
comprises both individual investors like general public and
institutional investors like mutual funds, LIC so on.
• The most important feature of Indian Capital markets is its
liquidity means investors can sell securities as and when
needed
• In Indian Capital market foreign investors, both individuals
and institutions and non-resident Indians can also invest in
Indian securities.
• The broad categories of tradable instruments of Indian capital
market structure are –Equities, Derivatives instruments and
Debt instruments.
However, Capital market structure of India is complex also, it
makes up the important part of a financial market Capital market
in India functions both in formal and informal way. The formal
capital market functions primarily through stock exchanges
while the informal capital market runs through “Dabba trading”
for secondary markets and “grey market “for primary markets.
Capital market in India is divided into primary markets and
secondary markets.
@Crossword2022
Primary markets is the markets for the issue of new securities

in the market. There are three main ways by which company can
raise capital- public issue, right issue and private placement.
Private companies, governments or public sector companies
participate in primary markets. Public issue can take two forms-
Initial Public Offering (IPO) when companies first time issue
securities in market before listing of company and other form is
Follow On Public Offer (FPO) when companies issues securities
in the market after listing in the stock exchanges. Right issue of
shares are those which are offered to the existing shareholders at
discounted prices whereas Private Placement of shares occurs
when securities are sold directly to the limited selected people
which cannot be more than 200. It includes preferential issue and
Qualifies Institutional Placement (QIP).
Secondary market or Stock Market is the market where actual
buying and selling of securities takes place through brokers and
intermediaries. Stock exchanges constitute an organized market
where securities issued by government, public bodies and joint
stock companies are traded. Indigenous banks, money lenders in
rural areas, and lending pawn brokers, private leasing and
finance companies, investment companies, chit funds form part
of unorganized market. Issue price in the market is decided by
market forces of demand and supply and prices are subjected to
fluctuations. There are major two stock exchanges in India:
Bombay Stock Exchange (BSE) established in 1875 is the Asia’s
oldest stock exchange under Securities Contract Regulation Act
1956 (SCRA). Sensex is the index of BSE representing companies
from 30 sectors and the other one is National Stock Exchange
(NSE) established in 1992 is the fully automated and electronic
trading system. Nifty is the index of NSE representing companies
from 50 sectors. Trading and settlement in stock exchanges
@Crossword2022
includes rolling settlement and intra-day settlement. Trading in

the stock market happens with the opening of Demat account
opened through a Depository Participant where shares are held
in electronic form.
Q4. What is inflation? What factors affect inflation? (10 Marks)

Ans: Inflation means rise in price of goods and services of daily or
common use, such as food, clothing, recreation, transport,
consumer staples etc. It occurs when demand exceeds the supply
for the goods and services. It leads to decline in purchasing power
of money and increase in purchasing power of people. As
currency loses value, price rises and it buys fewer goods and
services. This loss of purchasing power impacts the general cost
of living for the common public which leads to deceleration in
economic growth.
The factors affecting inflation are:
i. Increase in money supply: The higher the rate of the nominal
money supply, the higher is the rate of inflation.
ii. Increase in disposable income: When the disposable income
of the people rises, it raises their demands of goods and
services and further increases the rate of inflation.
iii. Cheap monetary policy: Cheap monetary policy or the
expansion of the credit leads to increase in money supply
which raises the demand of goods and services in the
economy. When credit expands, it increases the money
income of the borrowers which increases the aggregate
demand relative to supply, thereby leading to inflation.
iv. Deficit financing: In order to meet mounting expenses,
government intends to deficit financing by borrowing from
the public and even by printing more notes. This raises
aggregate demand relative to aggregate supply, thereby
leading to rise in price of goods and services.
@Crossword2022
v. Black money: The existence of black money due to

corruption, tax evasion etc. increases the aggregate demand
with respect to supply. This tends to raise the price level
further.
vi. Increase in exports: When demand for domestically
produced goods increases in foreign countries, this raises
the earnings of industries producing export commodities.
Thus creates more demand for goods and services which
raises the price level of the economy.
vii. Shortage of factors of production: One of the major factors
effecting inflation is the shortage of factors of production
such as labour, capital, raw material, power supply etc. this
leads to excess capacity and reduction in industrial
production, thereby raising general level of prices.
viii. Natural calamities: Natural calamities like floods,
earthquakes, drought adversely affects the supply of
agricultural products which creates the shortage of food
products and raw materials which affects the supply of the
products and increases the prices.
Q5. What are derivatives in simple terms? Explain the Over the
counter Derivative Contracts? (10 Marks)
Ans: A derivative is a contract between two parties which derives its
value from the underlying asset or commodity where settlement
is on future date and price and quantity decided in the present
time. This underlying asset can be shares, bonds, market indexes,
commodities, currency and interest rates. Derivatives can be over
the counter or exchange traded. These are usually leveraged
instruments which increases the potential risks and rewards.
Common derivatives include forwards, futures, swaps and
options.
@Crossword2022
Over the counter derivative contract is a financial contract

between two parties with minimal intermediation or regulation,
without going through an exchange or intermediaries. It can
involve equities, debt instruments, and derivatives which are
financial contracts that derive their value from an underlying
assets. It provides access to securities not available on standard
exchanges such as bonds, ADRs, and derivatives. These
derivatives offer more flexibility to the companies because unlike
“standardised” exchange traded derivative contracts they can be
customised according to the specific needs. Over the counter
derivatives can be broadly classified on the basis of underlying
assets through which the value is derived:
i. Interest rate Derivatives where underlying assets is an
interest rate. Example includes LIBOR, Swaps, US Treasury
Bills, and FRAs
ii. Commodity Derivatives where underlying assets is a wheat or
gold etc. Example includes forwards, options
iii. Forex Derivatives where underlying asset is foreign exchange
fluctuations
iv. Equity Derivatives where underlying assets are equity
securities.
v. Credit Derivatives where underlying assets are credit
instruments. Examples includes Credit default swaps, credit
linked notes
However there are some disadvantages of Over the Counter
Derivatives: lack of clearing house or exchange leads to credit or
default risk, lack of transparency, presence of systematic risk and
speculative nature of the transactions can cause market integrity
issues. Although Over the counter derivatives is a good tool for
corporates, it requires more education to attract investors.

@Crossword2022
Q6. Highlight the key prints in report of 15th Finance

Commission. (15 Marks)
Ans: The Finance Commission is a constitutional body formed by the
President of India to give suggestions on center-state financial
relations. The 15th Finance Commission chaired by Mr. N. K.
Singh was required to submit two reports. The first report,
consisting of recommendations for the financial year 2020-21
and the final report with recommendations for the 2021-26
period will be submitted by October 30, 2020.
Key recommendations in the first report (2020-21 period)
include:
• The share of states in the center’s taxes is recommended to be
decreased from 42% during the 2015-20 period to 41% for
2020-21. The 1% decrease is to provide for the newly formed
union territories of Jammu and Kashmir, and Ladakh from the
resources of the central government.
• States with lower per capita income would be given a higher
share to maintain equity among states. The income of a state
has been computed as average per capita GSDP during the
three-year period between 2015-16 and 2017-18.
• The Demographic Performance criterion has been introduced
to reward efforts made by states in controlling their
population. It will be computed by using the reciprocal of the
total fertility ratio of each state. States with a lower fertility
ratio will be scored higher.
• Forest and ecology criterion also introduced which has been
arrived at by calculating the share of dense forest of each state
in the aggregate dense forest of all the states.
• Tax effort has been used to reward states with higher tax
collection efficiency.
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• In 2020-21, the following grants will be provided to states:

 Revenue deficit grants: In 2020-21, 14 states are
estimated to have an aggregate revenue deficit of Rs
74,340 crore post-devolution.
 Special grants: The Commission has recommended
special grants to Karnataka, Mizoram, and Telangana
aggregating to Rs 6,764 crore.
 Sector-specific grants: Sector-specific grants for the
following sectors will be provided in the final report: (i)
nutrition, (ii) health, (iii) pre-primary education, (iv)
judiciary, (v) rural connectivity, (vi) railways, (vii) police
training, and (viii) housing.
 Performance-based grants: Guidelines for performance-
based grants include: (i) implementation of agricultural
reforms, (ii) development of aspirational districts and
blocks, (iii) power sector reforms, (iv) enhancing trade
including exports, (v) incentives for education, and (vi)
promotion of domestic and international tourism.
 Grants to local bodies: The total grants to local bodies for
2020-21 has been fixed at Rs 90,000 crore. The grants will
be divided between states based on population and area
in the ratio 90:10. The grants will be made available to all
three tiers of Panchayat- village, block, and district.
 The Commission recommended setting up National and
State Disaster Management Funds (NDMF and SDMF) for
the promotion of local-level mitigation activities.
 It recommended that both central and state governments
should focus on debt consolidation and comply with the
fiscal deficit and debt levels as per their respective Fiscal
Responsibility and Budget Management (FRBM) Acts.
 It recommended that both the central and state
governments should make full disclosure of extra-
budgetary borrowings.
@Crossword2022
 It observed that an overarching legal fiscal framework is

required which will provide for budgeting, accounting,
and audit standards to be followed at all levels of
government.
 The Commission recommended: (i) broadening the tax
base, (ii) streamlining tax rates, (iii) and increasing
capacity and expertise of tax administration in all tiers of
the government.
 The Commission highlighted some challenges with the
implementation of the Goods and Services Tax (GST).
These include: (i) large shortfall in collections, (ii) high
volatility in collections, (iii) accumulation of large
integrated GST credit, (iv) glitches in invoice and input tax
matching, and (v) delay in refunds.
Q7. What are the challenges faced by India for financial

inclusion? (15 Marks)
Ans: Financial Inclusion is an initiative which aims to provide
universal access to a wide range of financial services at a
reasonable cost. These include banking products as well as
financial services such as insurance equity products. It enables
sustainable economic and social development of the country and
helps in the empowerment of underprivileged and deprived
segments of society with the aim of making them self-sufficient
and well informed to facilitate better decisions.
It is generally accepted among financial experts that by giving
people access to banking services, can uplift the economic
welfare of their lives. However despite the various efforts for
financial inclusion and technological advancements that we have
achieved over the past years, since independence, the state of
Financial Inclusion has improved considerably over time.
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However, the financial inclusion hasn’t reached the poorest of the

poor and there are still many bottlenecks and challenges which
need immediate action. The main hurdles for policy and
authorities to achieve a higher rate of Financial Inclusion:
• Financial Literacy is a major barrier to financial inclusion in
India. Nearly 1/4th of the population in India is illiterate and
below the poverty line and ensuring deposits in Jan Dhan
accounts is a big challenge for such a group. By improving the
financial literacy rate among these individuals will lead to
better financial decisions and selection of the right products.
• One of the key challenges which prevent the unbanked from
getting access to such services is the lack of formal
identification documents
• There is also a lack of trust and confidence among people on
these newly established platforms
• Low income and the inability to provide collateral security
• Lack of sufficient bank branches in rural areas
• More reliance on informal lending
• A lot of hidden bank charges demotivate the poorest persons
from availing financial services
• Lack of low-cost and high-quality financial advice
• The rising level of NPAs of banks due to the large corporates
makes it difficult to improve the Financial Inclusion situation
in India
• Difficulty in adopting digital technology, non-availability of
suitable financial products, lack of skills among the
stakeholders to use digital services and some infrastructure
issues
• Non-universal access to bank accounts. According to a report
by the World Bank, about 190 million adults in India do not
have a bank account, making India the world’s second-largest
unbanked population nation, after China
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• Implementation deficit in various schemes launched by GOI

and other financial institutions. For instance, the Jan Dhan
Scheme has resulted in the opening of many accounts which
never saw actual transactions.
• Higher dependence on cash mode of transactions poses a
barrier to Digital Financial Inclusion.
• The gender gap is also one of the major challenges to Financial
Inclusion. According to 2017 Findex Survey, a sample of
110000 people in 99 countries, was found 8.3% Financial
Inclusion gap between men and women. Nearly about 83% of
males above 15 years of age in India held accounts as
compared to 77% of females. IFC research has shown that this
is largely due to lack of collateral, poor credit history which
leads to more women being denied credit by financial
institutions. Other barriers faced by women are lack of an ID
to prove identity, insufficient traditionally required collateral,
mobility constraints and little financial literacy
Q8. What is the importance of capital markets for the Indian

economy? (10 Marks)
Ans: Capital market is a market for investing in long term funds and
investments in the market through various instruments available
like shares, debentures, bonds etc. With the pace of economic
reforms followed in India, the importance of capital markets have
grown in the last ten years. Both public and private corporates
raise thousands of crores of rupees in these markets. Also the
government through Reserve Bank of India, as well as financial
institutions also raise lots of money from these markets. Capital
market plays an important role for the Indian economy:
• The capital market serves a very useful tool by pooling the
savings of individuals and making them available to the
business world.
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• It enhances efficient financial intermediation and increases

mobilization of savings and therefore improves efficiency and
volume of investments, economic growth and development.
• A well-developed capital market can solve the problem of
shortage of funds for the business enterprises and because of
their performance in capital markets they easily expand their
industries and also go in for diversification of business.
• It also act as a barometer of the economy by which it enables
the government to study the economic conditions of the
country and accordingly takes the suitable action.
• With the increased application of information technology, the
trading platforms of stock exchanges are accessible from
anywhere in the country through their trading terminals.
• It enables companies to raise permanent capital. The stock
exchange offers an opportunity to investors to buy or sell
their securities.
• Capital market is the central market through which resources
are transferred to the industrial sector of the economy. Thus
it stimulates industrial growth and economic development of
the country by mobilizing funds for investment in the
corporate securities.
• Capital market financial intermediaries offers advisory
services relating to the preparation of feasibility reports,
identifying growth potential and training entrepreneurs in
project management.
• It also serves as a reliable guide to the performance and
financial position of corporates.
• The financial institutions functioning in the capital market
provide a variety of services such as a grant of long-term and
medium-term loans to entrepreneurs, provision of
underwriting facilities, assistance in the promotion of
companies, participation in equity capital, giving expert
advice etc.
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• Capital Markets provide long-term funds for development

projects in backward and rural areas.
• It also generates foreign capital from overseas markets by
way of bonds and other securities.
• With the help of secondary market, investors can sell off their
holdings and convert them into liquid cash.
Q9. Write a short note on the following given topics: (15 Marks)
i. Depository
ii. Mutual funds
iii. Stock exchanges
Ans: i) Public Private Partnership: Public Private Partnership
(PPP) is a contract between a public sector and a private
sector for the purpose of delivering a project or service
traditionally provided by public sector. PPP can increase the
quality, the efficiency and the competitiveness of public
services. It completes the project much quicker than
traditional methods, increase the effectiveness of the
projects, reduces government budgets and budget deficits
and maintains high quality standards throughout the life cycle
of the project. Public-Private Partnerships are typically found
in transport infrastructure projects such as highways, roads,
airports, bridges, tunnels and railroads, municipal and
environmental infrastructure such as water and wastewater
facilities and public service accommodation facilities such as
schools buildings, dormitories, prisons and entertainment
facilities. Build Own Transfer (BOT), Operation &
Maintenance and Lease, Development, Operate & Maintain
are the different forms of Public Private Partnership.
ii) Mutual Funds: Mutual Fund is an openly managed
investment fund that pools money from different investors to
purchase securities like stocks, bonds, money market
instruments and other assets. These are operated by
@Crossword2022
professional managers who allocate the fund’s assets in vast

number of securities and attempt to produce income for
investors. Mutual Funds give small or individual investors
access to professionally managed portfolios of equities, bonds
and other securities, for this they charge some annual fees
collectively known as expense ratio. There are a number of
schemes of mutual funds and all of them have different
character and objective. Equity funds, Fixed-Income funds,
Index funds, balanced funds, Money Market funds, Income
funds, International funds and Exchange Traded Funds (ETF)
are among various types of mutual funds prevailing in India.
iii) Stock exchanges: According to section 4 of the Securities
contracts (Regulation) Act, 1956 defines stock exchange as an
association, organization or body of individuals, whether
incorporated or not, established for the purpose of assisting
and controlling the business of buying, selling and dealing in
securities. Stock exchanges constitute a market for trading in
the existing listed securities and also facilitates listing of new
securities for trading. They provide a reasonable degree of
safety and fair dealings to the investors. They are the part of
broader capital market ecosystem. Without an efficient stock
exchange, the savings of individuals would not be available
for the business community and this will hamper the
economic growth of the country. They play an important role
in creating liquidity of the financial securities. In India entire
stock exchanges are regulated by Securities Exchange Board
of India (SEBI) establishes as a statutory body in 1992. There
are mainly two stock exchanges namely National Stock
Exchange (NSE) and Bombay Stock Exchange (BSE).

@Crossword2022
Q10. What is credit rating? Discuss its benefits and limitations.

(10 Marks)
Ans: Credit rating is the quantified assessment of the creditworthiness
of the borrower and analysis of the credit risks associated with
the financial instrument or a financial entity. It is a rating given
to a particular entity based on the credentials and the extent to
which financial statements of the entity are sound, in terms of
borrowing and lending. Rating reflects the borrower
accountability, expected capability and inclination to pay interest
and principal in a timely manner. It is not a one-time assessment
of creditworthiness valid over the future life of the security
rather it is a continuous process. Credit rating is expressed in
terms of rating symbols which are easily comprehensible to lay
investors, there are distinct symbols for different instruments
and this differentiation is based on degree of safety. It is
extensively used for evaluating debt instruments like bonds,
debentures, commercial papers, fixed deposits, certificate of
deposits, preference shares. Equity shares are not rated. Credit
assessment and evaluation of companies and government is
generally done by a credit rating agency such as S&P, Global,
Moody or Fitch Ratings. In India there are presently four
companies, in the business of credit rating, they are CRISIL, ICRA,
CARE and Fitsch (international company)
There are certain benefits of credit rating:
i. It is useful in differentiating credit quality.
ii. It reflects the borrower’s reliability, capability and
accountability.
iii. It facilitates comparison of relative value between
competing securities.
iv. It helps in recognizing the risks involved in the investment.
v. It gives the opportunity to the company to reduce the cost of
borrowings by quoting less interest rates.
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vi. A rated company can approach a wider section of investors

for resource mobilization.
vii. It can also act as a marketing tool to create better image of
the company in dealing with its customers, lenders and
creditors
viii. It encourages the companies to come out with more
disclosures about their accounting system, financial
reporting and management pattern.
ix. It also provides access to small and not so well companies.
x. It helps financial intermediaries in pricing the debt.
xi. It also serves the objective of protecting the investors.
However, there are some limitations for the credit rating:
i. Credit rating is not the recommendation for the investors to
invest.
ii. They do not take into account other aspects which can
influence an investment decision.
iii. They do not evaluate the reasonableness of the issue price,
possibilities of capital gains or interest or exchange risks.
iv. It is just an opinion on the relative quality of the credit risk.
v. There can be biased rating or lead to misrepresentations
vi. This is only a static study as it is based on present and the
past historic data of the company
vii. Rating company might conceal material information from
the investigating team of the credit rating company.
viii. There is difference in rating of two agencies as the rating is
done by two different rating agencies for the same
instrument of the same issuer company. Such differences
many occur due to value judgment differences on qualitative
aspects of the analysis.

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Q11. Describe the trading and settlement procedure of stock

exchange. (10 Marks)
Ans: Before selling the securities through stock exchange, the
companies have to list their securities in the stock exchange. The
name of company is included in listed securities only when stock
exchange authorities feel satisfied with the financial soundness
and the other aspects of the company. Previously buying and
selling of securities was done in trading floor of stock exchange
but today it is traded through computer and it involves the
following steps:
i. Selection of broker: the buying and selling of securities can
only be done through SEBI registered brokers who are the
members of the stock exchange. The broker can be an
individual, partnership firm or corporate bodies.
ii. Opening Demat Account with the Depository: Demat
(Dematerialization) Account is the account which an Indian
citizen must open with the depository participant (banks and
stock brokers) to trade in listed securities in an electronic
form. The securities are held in electronic form with the
depository. At present there are two depositories in India:
NSDL and CDSL. There is no direct contact between
depository and investor. Depository interacts with investors
through depository participants only. Depository participant
will maintain securities account balances of investor and
intimate the investor about the status of their holdings from
time to time
iii. Placing the order: after opening the account, investor can
place the order. It can be placed either personally or through
phone, email etc. Investor must clearly state the range of price
at which securities can be bought or sold.
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iv. Executing the order: After the instructions by investor, broker

executes the order and prepares the contract note for the
order executed. The contract note contains the name and
price of the securities, name of parties, brokerage or
commission charged by him and it is signed by broker.
v. Settlement: It is the last stage in trading of securities which
means actual transfer of securities. The mode of settlement
depends upon the nature of contract. So once the buyer
receives the security and the seller receives the payment, the
transaction is settled. An equity spot market follows a T+2
rolling settlement. This means that any trade taking place on
Monday gets settled by Wednesday. Stock, exchange operates
from Monday to Friday between 9:55am and 3:30pm. Each
exchange has its own clearing house, which assumes all
settlement risk. There can be two types of settlement: On the
spot settlement means settlement done immediately and on
spot settlement follows T+2 rolling settlement. And the other
one is Forward settlement which means settlement will take
place on some future date. It can be T+5 or T+7.
Q12. “Investing in securities through mutual fund is a better

choice than direct investment.” Examine the statement.
(10 Marks)
Ans: Depending on the risk profile, one should look at investing some
part of the savings or earrings in the stock market. But direct
investing puts a person at great risk. So investing in securities
through mutual funds is better choice than direct investment.
Mutual Funds can be described as a trust that pools in the savings
and funds from a large number of investors who have a common
financial goal. Mutual funds issue units to investors, which
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represent equitable rights in the assets of mutual funds. It is

diversified in nature i.e. its assets are invested in many securities.
These are professionally managed on behalf of shareholders and
each investor holds pro-rata share of the portfolio entitled to any
profits when the securities are sold.
Advantages of mutual fund:
• Portfolio Diversification: normally mutual funds invest in
well-diversified portfolio. As each investor is a part of owner
of all fund’s assets, so he can invest in diversified portfolio
even with a small amount
• Professional Management : The investment management
skills along with the needed research into available
investment options ensure a much better return than what an
investor can manage on his own
• Reduction or Diversification of risk: Diversification reduces
risk of loss as compared to investing directly in one or two
shares or debentures or other instruments. When an investor
invests directly then the risk of loss is own. But if he invests
in well-diversified securities then loss is automatically shared
with the other investors.
• Reduction of transaction cost: A direct investor bears all the
costs of investing such as brokerage or custody of securities,
but if he goes through a fund he has the benefit of economies
of scale, less cost due to large volume
• Liquidity: An investor can liquidate the investment by selling
the units to the fund if open-ended or selling them in the
market if the fund is close-ended
• Convenience or Flexibility: In mutual funds, investor can
easily transfer his holdings from one scheme to the other.

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Q13. Define the term factoring and explain its mechanism.

(10 Marks)
Ans: Factoring may also be defined as a continuous relationship
between financial institution (the factor) and a business concern
(the client) selling goods and/or providing service to a trade
customer on an open account basis, whereby the factor
purchases the client’s book debts (account receivables) with or
without recourse to the client. In this way, the customer of the
client firm becomes the debtor of the factor and has to fulfil its
obligations towards the factor directly. It offers enterprises,
particularly small and medium ones, a means of financing their
needs for working capital but also an instrument of collection of
receivables and default risk hedging. Factoring provides finance
for the supplier, including loans and advance payments. Usually
the period for factoring is 90 to 150 days. It is considered to be a
less costly source of finance compared to other sources of short
term borrowings. There are different types of factoring
arrangements:
a) Recourse and Non-Recourse Factoring: in recourse factoring
the risk of bad debts is borne by the client while in non-
recourse factoring the risk or loss on account of non-payment
by the customers of the client is to be borne by the factor
b) Advance and Maturity Factoring: Under advance factoring
arrangement, certain percentage of receivables is paid in
advance to the client, while in maturity factoring no advance
is paid to the client and the payment is made to the client only
on collection of receivables
c) Domestic and Export Factoring: In domestic factoring three
parties are involved, namely, the selling firms (client), the
factor and the customer of the client (buyer) while in Export
factoring four parties are involved, namely, the exporter
(selling firm or client), the importer or the customer, the
export factor and the import factor.
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Mechanism of Factoring:
In a factoring arrangement, there are three parties directly
involved namely; the one who sells the invoice (client), the debtor
(customer of the seller), and the factor (financial organization).
• Seller of the product or service provider who originates the
invoice is called Client
• Debtors or customers of the client are the recipient of the
invoice for the goods or services rendered. They owe the
money for the value of goods and services bought from the
seller.
• Assignee (the factoring company) or factor is the service
provider who purchases the invoice and gives advance
payment to business firm.
Q14. Discuss the guidelines given by RBI with regard to

commercial paper and certificate of deposits. (10 Marks)
Ans: Commercial paper is an unsecured money market instrument
issued in the form of promissory note introduces in 1990 to
enable highly rated individuals to diversify their short term
borrowings for investors. Guidelines for issue of CP are presently
governed by various directives issued by the Reserve Bank of
India. The guidelines for issue of commercial papers are as
follows:
• Who can issue Commercial papers: Corporates, primary
dealers (PDs) and the all-India financial institutions (FIs) can
issue CPs. Corporates includes whose tangible net worth is at
least Rs 4 cr in previous year, there should be standard loans
only and there should be working capital loan.
• Rating Requirement: All eligible participants shall obtain the
credit rating for issuance of Commercial Paper from either the
Credit Rating Information Services of India Ltd. (CRISIL) or
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the Investment Information and Credit Rating Agency of India

Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE)
or the FITCH Ratings India Pvt. Ltd. or such other credit rating
agencies as may be specified by the Reserve Bank of India. The
minimum credit rating shall be P-2 of CRISIL.
• Maturity: CP can be issued for maturities between a minimum
of 7 days and a maximum up to one year from the date of
issue.
• Denominations: CP can be issued in denominations of Rs.5
lakh or multiples thereof.
• Mode of issuance: CP can be issued either in the form of a
promissory note or in a dematerialized form through any of
the depositories approved by and registered with SEBI. It will
be issued at a discount to face value as may be determined by
the issuer.
• Procedure of Issuance: Every issuer must appoint an Issuing
and Paying Agent (IPA) for issuance of CP. Only a scheduled
bank can act as an IPA for issuance of CP.
Certificate of Deposits is a money market instrument which gives
investors greater flexibility in deployment of their short term
surplus funds, introduced in India in 1989. Guidelines for issue of
CDs are presently governed by various directives issued by the
Reserve Bank of India. .The guidelines for issue of commercial
papers are as follows:
• Who can issue Certificate of Deposits: CDs can be issued by
scheduled commercial banks excluding Regional Rural Banks
(RRBs) and Local Area Banks (LABs); and all-India Financial
Institutions that have been permitted by RBI.
• Minimum issue size and denominations: Minimum amount of
a CD should be Rs.1 lakh i.e., the minimum deposit that could
be accepted from a single subscriber should not be less than
Rs. 1 lakh and in the multiples of Rs. 1 lakh thereafter.
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• Maturity: The maturity period of CDs issued by banks should

be not less than 15 days and not more than one year. The FIs
can issue CDs for a period not less than 1 year and not
exceeding 3 years from the date of issue.
• Discount or Coupon Rate: CDs may be issued at a discount on
face value. The issuing bank/FI is free to determine the
discount/coupon rate.
• Reserve requirements: Banks have to maintain the
appropriate reserve requirements, i.e., cash reserve ratio
(CRR) and statutory liquidity ratio (SLR), on the issue price of
the CDs.
• Transferability: Physical CDs are freely transferable by
endorsement and delivery. Dematted CDs can be transferred
as per the procedure applicable to other Demat securities.
There is no lock-in period for the CDs.
• Loans/Buy-backs: Banks/FIs cannot grant loans against CDs.
Q15. How did financial crisis of 2008 affect India? (15 Marks)
Ans: The financial crisis of 2007–2008, also known as the global
financial crisis (GFC), was a severe worldwide financial crisis. It
was a severe contraction of liquidity in global financial markets
that originated in the United States as a result of the U.S. housing
market. It caused the failure of several major investment and
commercial banks, mortgage lenders, insurance companies and
saving loans and associations and it caused the Great Recession
(2007-09), the worst economic downturn since the Great
Depression (1929-39). It was also followed by the European debt
crisis, in Greece in late 2009, and the Icelandic financial crisis in
2008–2011. It was among the five worst financial crisis the world
had experienced and led to a loss of more than $2 trillion from
the global economy. The crisis rapidly spread into a global
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economic shock, resulting in several bank failures. Economies

worldwide slowed during this period since credit tightened and
international trade declined. Housing markets suffered and
unemployment increased. Several businesses were also failed.
The U.S. unemployment rate peaked at 10% in October 2009, the
highest rate since 1983.
The impact of the financial crisis was also felt by the developing
economies like India. Indian economy began to slow down in
2007-08 after reaching a GDP growth of 9.8 per cent in the last
quarter of 2006-07. In early 2008-09, the huge rise in world
commodity prices pushed high inflation in India.
• The first impact of the global crisis on India was felt in the
stock market in January 2008. This came through the reversal
of inflows from foreign institutional investors (FIIs) into the
country.
• India had received about US$ 17.7 billion as net equity
investment inflows from FIIs during 2007. This turned into a
net disinvestment of US$ 13.3 billion during the period from
January 2008 to February 2009. The sudden withdrawal of
FIIs from the Indian stock market brought about a crash in the
market in January 2008.
• Capital inflows under external commercial borrowings,
short-term trade credit and external borrowing by banks
dropped sharply from April 2008.
• The crisis then moved to the foreign exchange market. The
rupee began to tumble from end-April 2008 to November
2008 by about 20 per cent.
• The Reserve Bank of India intervened the market by selling
dollars to smoothen the fall of the rupee. The heavy selling led
to a massive depletion of the stock of reserves from US$ 315
billion in May 2008 to US$ 246 billion in November 2008.
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• By mid-September 2008, the crisis gripped India’s money

market. The drying up of funds in the foreign credit markets
led to a virtual termination of external commercial borrowing
for India
• The collapse of stock market decreased the possibility of
companies raising funds from the domestic stock market.
Indian banks also lost access to funds from abroad, as inter-
bank borrowing seized up in the US and Europe. Instead,
banks had to send funds to their branches abroad in those
countries. All these put heavy pressure on domestic banks
leading to a liquidity crisis from mid-September to end-
October 2008 and this reflected in the inter-bank call money
markets where the call money rates rose to 20 per cent.
• The current account of India’s balance of payments had
shown strong growth in the first half of 2008-09:
merchandise exports grew by 35 per cent, imports by 45 per
cent software exports by 38 per cent, and private transfers by
41%. In the second half of 2008-09, these dramatically
changed: merchandise exports declined by 18 per cent,
imports by 11 per cent.
• In the financial sector, domestic banks responded to the
sudden loss of different avenues of funds for the Indian
commercial sector and increased their lending during the
period of “credit crunch”. In September and October 2008,
bank finance expanded more than the previous year. By
November 2008, the situation had fundamentally
transformed.
• The monetary policy also loosened and administered fiscal
stimulus packages. There were measures like relaxation of
external commercial borrowing rules, raising the cap of FII
investment in debt and permission given to India
Infrastructure Financing Company Limited (IIFCL) in floating
tax-free bonds for infrastructure funding, etc.
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• Monetary policy remained tightened till end-August 2009. In

mid-September the central bank started relaxing liquidity but
no decrease in policy rates.
• Inflation measured in terms of wholesale price index (WPI)
peaked at 12.9 per cent in early August 2008 and remained
high for some time.
• The RBI brought down cash reserve ratio (CRR) from 9 to 5
per cent, statutory liquidity ratio (SLR) from 25 to 24 per cent,
the repo rate from 9 to 4.75 per cent and reverse repo rate
from 6 to 3.25 per cent.
• The RBI opened a special window for banks to lend to mutual
funds, non-banking financial companies (NBFCs) and housing
finance companies.
• The central bank also opened refinance facilities for banks,
the Small Industrial Development Bank of India (SIDBI), the
National Housing Bank (NHB), and the EXIM Bank.
• The RBI also introduced a liquidity facility for NBFCs through
a special purpose vehicle (SPV), and increased export credit
refinance and also made dollar swap arrangements for
branches of Indian banks in the US.
• The growth in GDP moved down to 5.8 per cent (year-on-
year) during the second half of 2008-09 from 7.8 per cent in
the first half.
• The growth in fixed investment declined to 5.7 per cent in the
second half of 2008-09 from 10.9 per cent in the first half and
an average of 12.9 per cent in 2007-08.
• The government consumption growth rose steeply at 35.9
percent from just 0.9 per cent in the first half and 7.4 per cent
in 2007-08.

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Q16. Explain the need of corporate governance in banking sector.

(10 Marks)
Ans: Banks constitute the largest financial intermediaries around the
world and possess many powers of leverage. Unlike in the
corporate world, authorities like RBI and the government play a
direct role in bank governance through bank regulation and
supervision. Corporate governance of banks is an essential
element of a country’s governance architecture. In India, the
Reserve Bank of India (RBI) is the gatekeeper of Corporate
Governance. RBI is the central bank of India which regulates all
the major issues related to currency, foreign exchange reserves
etc. In the last 20 years, corporate governance in the Banking
sector has changed drastically. All over the world, many
committees were setting up to look into this aspect like the
Cadbury Committee, OECD Code, Combined Code of London
Stock Exchange, the Blue Ribbon Committee and Kumar
Mangalam Birla Committee in India. It builds and strengthens the
accountability, credibility, trust, transparency and integrity. If
there won’t be any regulatory watchdog which regulates the
governance of the banks then banks can decide things by their
own. Corporate governance in banking sector protects not just
economy of the country but also the shareholders, employees,
supervisors, customer and public at large. It can lead systemic
financial stability implications and shape the pattern of credit
distribution and overall supply of financial services. This is
required because of the need to ensure systemic stability,
financial stability and deposit insurance liability. While corporate
control will raise new barriers to effective corporate governance
as large investors may manipulate the firm contrary to the broad
interests of the bank and other stakeholders. Large shareholders
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may arrange loans for firms they own or conduct business

transactions for their profits at the expense of the bank and then
move the bank to higher risk in which they benefit, but the effect
comes on the bank as they bear the risk of failure. The current
trends in the market lay stronger emphasis on risk measurement
and management. Bank supervision helps shareholders and
make the boards accountable and assess the board effectiveness.
Banks are important stakeholders of corporations. Their actions
can affect corporate performance both positively and negatively.
Their influence as lenders should complement effective
shareholder monitoring. Banks and non-bank financial
intermediaries can also alter the risk composition of their assets
more quickly than most non-financial industries. Corporate
governance in the banking sector is not just a formality but a dire
need of society. Hence the necessity and importance of enforcing
effective corporate governance in the banking sector is important
for the proper functioning of banking sector in an economy.
However, too much pressure on the banks must not be imposed
on the banks in the name of corporate governance so that they
feel harassed in the name of governance and their efficiency
suffers leading to a slowdown of financial transactions.
Additionally, internal governance must be increased.
Q17. Explain the need of priority sector lending and why it is

important for Indian growth.
(10 Marks)
Ans: Priority sector lending is an important role given by RBI to the
banks for providing a specified portion of bank lending to few
specific sectors like agriculture and allied activities, micro, small
and medium enterprises, poor people for housing, students for
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education and other low income groups and weaker sections The
term ‘Priority sector’ indicates those activities which have
national importance and have been assigned priority for
development. Priority sector lending is needed because it focuses
on the idea of directing the lending of banks towards few specific
sectors and activities in the economy. It channelizes credit at
preferential rates at specifies sectors that may not get timely and
adequate credit in the absence of such special dispensation. For
the developing countries like India when the certain sector that
has not get timely and adequate credit and may be ignored due
to low income generating sectors but are important for the
progress of the country, these measures proved boon for the
development of the country. However, over the last four decades,
the Indian economy has not only undergone a structural
transformation but has also been increasingly integrated into the
global economy, resulting into a shift of national priorities from
lending to vulnerable sections to increase employability, create
basic infrastructure and create more employment opportunities.
Such regulatory binding on all banks to priority sector loans may
result in shortfall of Non-Performing Assets (NPAs) or bad loans
or both. Priority sector lending target for scheduled commercial
banks and foreign banks with 20 or more branches is 40 % of the
Adjusted Net Bank Credit (ANBC) to a priority sectors out of
which 18% should allocate to the agriculture sector. PSL target
for RRBs is 75% of the ANBC to a priority sectors out of which
18% should allocate to the agriculture sector. If any bank fails to
achieve above PSL practices then that bank have to deposit the
difference to the Rural Infrastructure Development Fund (RIDF)
with NABARD.

@Crossword2022
Q18. Derivative is the financial contract between 2 parties.

Differentiate between forward and future contracts.
(10 Marks)
Ans: A derivative is a contract between two parties which derives its
value from the underlying asset or commodity where settlement
is on future date and price and quantity decided in the present
time. This underlying asset can be shares, bonds, market indexes,
commodities, currency and interest rates. Derivatives can be over
the counter or exchange traded. Common derivatives include
forwards, futures, swaps and options.
The difference between forward and future contracts:
i. Forward contracts are customized/non-standardized
contracts while Future contracts are standardized contracts,
they are traded on the stock exchange.
ii. Forward contracts gives the high counterparty risks as it is
not regulated while Future contracts carries low
counterparty risk
iii. Forward contracts are negotiated directly by the seller and
the buyer while Future contracts are quoted and traded over
the stock exchanges and are government regulated.
iv. Forward contracts mature after the delivery of commodity
and this may not happen in Future contracts.
v. Forward contracts requires no initial payment as it is
customized according to customer needs while in future
contracts some nominal amount is required to keep s a part
of contract known as margin money which is usually 16% of
contract value.
vi. There is no guarantee of settlement until the date of
maturity in forward contracts while in future contracts the
value of the operation is marked to market rates with daily
settlement of profits and losses.
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vii. Forward contracts are used for hedging purposes while

Future contracts are used for speculation purposes
viii. Forward contracts have a relatively lower liquidity rate
while Future contracts offers high rate of liquidity.
Q19. Money market deals in short term securities. Explain the

various money market instruments. (10 Marks)
Ans: Money market is a market for overnight to short term funds.
Short term funds means those funds whose repayment period is
up to one year. The objectives of money markets are to provide a
reasonable access to the users of short-term funds to meet their
requirements at realistic cost and enables lenders to turn their
idle funds into an effective investment. The major participants in
money market are the commercial banks, other financial
intermediaries, large corporates and Reserve Bank of India. The
Reserve Bank of India (RBI) is the regulator of the money
markets. The depth of the money market depends on the number
of participants. This is a whole sale market, the volumes here are
very large and therefore there is need for professionals to
operate in this market. Trading conducts mainly on telephones,
followed by written communication from both the parties.
Various money markets instruments are as follows:
i. Call Money market: This market is used by banks, financial
institutions and mutual funds. Many banks borrow in these
markets for overnight liquidity. The call money rates are
determined by the demand supply situation prevailing on
almost day to day basis. There is no collateral required and
there is limit on borrowing and lending. The tenure extends
from 1 day to 1 year.
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ii. Treasury Bills: T-Bills are one of the safest money market
instruments. These are issued by central government when it
requires fund to meet its short term obligations. These are
issued for more than 91 days, 181 days and 364 days. These
are zero coupon securities means they are issued at discount
and redeemed at face value. Minimum value of T-Bills is Rs.
25000 or multiples thereof. Buying and selling of treasury
bills is done in electronic form on e-Kuber platform of RBI.
Since these are issued by central government, the default risk
is negligible.
iii. Commercial Bills: Commercial bills is a bills of exchange
accepted by bank. It is a negotiable instrument drawn by
seller on the buyer for the value of goods delivered to him.
These are also called trade bills and when these bills are
accepted by commercial banks these are called commercial
bills
iv. Certificate of Deposit: These are issued by scheduled
commercial banks excluding RRBs and Local Area Banks on
discount to face value method. Maturity period extends from
7 days to 1 year. These re issued in denomination like T-Bills.
Minimum value is Rs. lakh and multiples thereof. Participants
of certificate of deposits are individuals, corporates, Banks,
Financial Institutions, trusts, funds, and NRIs. Loan cannot be
granted against Certificate of Deposits
v. Commercial Paper: These instruments are issued by highly
rated corporates, Financial Institutions and Primary Dealers.
Highly rated corporates are those corporates whose tangible
net worth is at least Rs 4 cr in previous year, there should be
standard loans only and there should be working capital loan.
No collateral is kept here and these are issued at discount to
face value. These are issued in denominations of Rs 5 lakhs
and multiples thereof. Maturity period varies from 7 days to
1 year. Investors are banks, individuals, corporates, NRIs and
FIIs.
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vi. Repurchase Agreement (Repo): It is an agreement between a

seller and buyer stipulating the sale and later repurchase of
securities at a particular price and a date. It is usually a short
term loan to the seller with securities as collateral. This kind
of loan is repurchase loan and rate of interest paid to RBI is
called Repo rate.
Q20. Discuss the functions and importance of clearing house in

stock market. (10 Marks)
Ans: A clearing house acts as a mediator between any two entities or
parties that are engaged in a financial transaction. The clearing
house validates and finalizes the transaction, ensuring that both
the buyer and the seller honor their contractual obligations.
Every financial market has a designated clearing house to handle
this function. There are four parties assisting in clearing process
are: Depositories, Clearing banks, Clearing Members, and
Custodians.
Clearing Houses are important because it provides extra security
so that investors can trade freely without the chances of future
complaints. It also increases the efficiency of financial markets
and gives transparency to the market.
Functions of clearing house are as follows:
i. It ensures that transaction goes smoothly, with the buyer
receiving the tradable goods he intends to acquire and seller
receiving the amount.
ii. It ensures that parties involved respect the system and follow
the proper procedures for a successful transaction.
iii. It makes sure that the right goods are delivered to the buyer
in term of both quantity and quality, so at the end there is no
need left for complaints.
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iv. It improves the efficiency of the market and gives financial

stability to the financial system.
v. It helps in trade settlements for wholesale markets entities
like banks, insurance companies and mutual funds.
vi. It plays an active role in settlement of complex transactions at
predetermined future price and date.
vii. It also act as agent to Financial Benchmark India Private
Limited. The main role of FBI is to administer government
securities.
Q21. Explain the role of FDI in India. (10 Marks)

Ans: Foreign Direct Investment (FDI) is an investment by a foreign
individuals or companies into business, capital markets or
production in the host country. It plays a major role in the
economic development of the developing countries like India...
FDI covers various sectors such as Defence, Pharmaceuticals,
Asset Reconstruction Companies, Broadcasting, Trading, Civil
Aviation, Construction and Retail, etc.
In India FDI is regulated under Foreign Exchange Management
Act (FEMA) 2000 administered by Reserve Bank of India (RBI). It
is a major monetary source for the economic development in
India. There are two major routes by which India gets FDI: a)
Automatic Route: By this route FDI is allowed without prior
approval by Government or RBI. b) Government Route: Prior
approval by government is needed via this route. Today, India has
become one of the most attractive destinations for foreign direct
investments because of liberalized norms, easy policies and
subsidized rates. The Government of India has initiated various
steps to promote FDI as they set an investor friendly policy where

@Crossword2022
most of the sectors are open for FDI under the automatic route.
The FDI policy is reviewed on a continuous basis with the
purpose that India remains an investor-friendly and attractive
FDI destination. The capital inflow of foreign investors allowed
strengthening infrastructure, increasing productivity and
creating employment opportunities and also acts a medium to
acquire advanced technology and mobilize foreign exchange
resources. To boost manufacturing sector with a focus on ‘Make
in India’ initiative, the government has allowed manufacturers to
sell their products through the medium of wholesale and retail,
including e-commerce under the automatic route. Increase in
wages is also the major advantage of FDI in India as relatively
higher skilled jobs would receive higher wages. Entry of foreign
enterprises in domestic market creates a competitive
environment compelling national enterprises to compete with
the foreign enterprises operating in the domestic market which
increases the market penetration for the customers as they have
wider choices to explore in the market which further increased
their way of living. In February 2018, IKEA declared its plan to
invest approximately US$ 612 million in the Maharashtra to
establish multi-format stores and experience centers. During
2020, foreign direct investments (FDI) into the country increased
37 per cent in October-December to $26.16 billion, compared to
$19.09 billion of inflows in the corresponding period a year ago.
Despite the pandemic devastating economies, FDI inflows have
risen, indicating the confidence of global investors in India. Thus,
FDI plays an important role in the development of Indian
economy.

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Q22. Write a short note on: (15 Marks)

i. Lead Bank scheme
ii. Book Building
iii. Venture capital fund
Ans: i. Lead Bank Scheme: Lead Bank Scheme was introduces by RBI
in 1969 under the recommendation of both Gadgil Study
Group and Banker’s Committee (Nariman Committee), to
provide lead roles to both private and public sector banks for
the districts allotted to them. Here banks were gives a
specified area in which that bank had to play a lead role in
providing financial services to the people, making them
aware about the banks and various benefits of banks and also
generating trust among people so that they can avail the
banking services without being cheated or misguided. The
objectives of Lead Bank Scheme are: a) eradication of
unemployment and under employment, b) rise in standard of
living for the poor, c) availability of some basic needs of the
people to the poor sections of the society. This lead bank also
acts as a leader for coordination activities and services of all
financial institutions at that area. For this purpose Lead
Banking Officer now designated as Lead District Manager was
also appointed.
ii. Book Building: The concept of Book Building in India was
introduced in 1995, under the recommendation of
Y.H.Malegam Committee. Book building is the process by
which an underwriter which is usually an investment bank
attempts to determine the price at which Initial Public
Offering (IPO) will be offered. Here, underwriter builds a
book inviting institutional investors such as fund managers
and others to submit bid for the number of shares and the
price that they would be willing to pay for them and the issue
@Crossword2022
price is determined after the bid closure. It is the mechanism

by which companies price their IPOs and highly
recommended by all the major stock exchanges as the most
efficient way to price securities. The book should remain open
for minimum of five days and only electronically linked
transparent facility is allowed to be used in case of book
building.
iii. Venture Capital Fund: Venture Capital Fund is the type of
investment fund that invests in early-stage startup companies
and small as well as medium sized companies that offer a high
potential along with high degree of risk. The fund is managed
by venture capital firm and the investors are high net worth
individuals or institutions. It is somewhat similar to mutual
funds – these constitute funds collected from several types of
investors. Instead of Asset Management Companies these
funds are managed by venture capital firms. Generally there
are three types of venture capital funds: Early Stage Funding
which is invested to help a company to establish itself,
Expansion Funding which is invested to expand the company
operations, and Acquisition Funding which helps the firms to
acquire certain areas of businesses.

@Crossword2022

@Crossword2022
Finance Questions with Answers (Part-II)
Q23. What is bad bank? How it can resolve NPA misfortune?

(10 Marks)
Ans: A bad bank is the bank that buys the Non-Performing Assets
(NPAs) or bad loans of the lenders and other financial institutions
to help clear their balance sheets. NPAs are those loans or
advances for which the principal or interest payment remained
overdue for a period of 90 days. This concept of bad bank is
introduced to provide financial stability in the banking sector and
solve the ongoing NPA crisis of public sector banks especially
increased during COVID lockdown time due to economic slow-
down. Technically, Bad Bank is an Asset Reconstruction
Company or an Asset Management Company that takes over the
bad loans of the commercial banks, manages them and finally
recovers the money over the period of time. These are usually
created to maximize value from high-risk assets. A bad bank
makes profit by selling loan at a price higher than what it paid to
acquire the loan from a commercial bank. However, generating
profits is usually not the primary purpose of a bad bank, the
objective is to ease the burden on banks, holding a large pile of
stressed assets and to get them to lend more actively. Setting up
of Bad Banks will take off bad loans of troubled banks and give
bank the freedom to use the freed-up capital to extend more
loans to customers. It will hold the bad loans for public sector
banks which can be sold on to the investors at a reduced price.
The major advantage of bad banks is that it can help consolidate
all bad loans of banks under a single exclusive entity. The
creation of a bad bank also allows the segregation of a bank’s
good assets from its bad assets to allow investors to assess its
financial health with greater clarity and for banks to grow
financially.

@Crossword2022
Q24. Explain how derivatives can be used for risk management.

(10 Marks)
Ans: Risk management plays a key role in the financial industry. The
growth of the business and market expansion pose challenges for
managing the risk. The risks facing by firms might be interest
rate, foreign exchange, commodity, credit, liquidity, operational
and market risk etc. The risk could be controllable or
uncontrollable. As a result, financial instruments evolved to
manage the risks which are known as financial derivatives.
Derivatives are contracts where the yields of contracts depend
upon on underlying asset. The underlying asset can be an interest
rate, commodity, currency, bond, foreign exchange rate, and
stock. Derivatives trading help improve market liquidity, raises
skills and knowledge among market players. Derivatives trading
include Futures contract, Option Contract, Index Futures, Index
Options, Commodity Derivatives, and Swaps. It is a tool used by
the companies to manage the risk, it is used to hedge the risk
which is being faced by the company. There are two important
functions which are played by the financial derivatives: hedging
and speculation. Hedging is used to reduce the risk level attached
with the underlying transactions. It protects their assets or
liabilities from the adverse change by entering into derivative
contract whereas Speculation presumes the financial risk with
the prediction of gain from market fluctuations. Therefore,
financial derivative plays key role for managing risk. The efficient
use of financial derivatives reduces risk level and increases rate
of return. Thus, it is improving the financial health of business.
Financial derivatives are categorized into two forms over the
counter and exchange traded derivatives. Over the counter
derivatives are those financial instruments whose terms and
conditions are settled between two parties through negotiation,
on the other hand Exchange traded derivatives are those which
@Crossword2022
are traded through stock exchange. Therefore, whether the

activity is trade based or the over the counter, firms are in
mitigate their risk with the help of financial derivatives.
Q25. SIDBI offers wide range of finance schemes to the micro,

small and medium enterprises (MSME) industry. Explain the
role of SIDBI in MSME sector in India. (15 Marks)
Ans: MSMEs have been playing a crucial part in the upliftment of the
country’s socioeconomic area. The Government of India and the
State government have been pursuing a policy of protecting and
promoting small-scale industries for a longer time. Under the
special Act of the Parliament 1988, SIDBI (Small and Industrial
Development Bank of India) was established as a wholly owned
subsidiary of IDBI (Industrial Development Bank of India) which
became operational from April 2, 1990. It was set up as major
financial body for the marketing, financing, and development of
micro, small and medium-scale enterprises or MSMEs in India.
Besides focusing on the development of the Micro, Small and
Medium Enterprise sector, SIDBI also promotes cleaner
production and energy efficiency. The bank provides several
schemes and also offers financial services and products for
meeting the individual’s requirement of various businesses.
SIDBI (Small Industries Development Bank of India) offers the
following facilities to its customers:
1. Direct finance: It offers working capital assistance, term loan
assistance, foreign currency loan, support against receivables,
equity support, energy saving scheme for the MSME sector,
etc.
2. Indirect finance: It offers indirect assistance by providing
refinance to PLIs (Primary Lending Institutions) comprising
of banks, state level financial institutions, etc. The key
objective of the refinancing scheme is to raise the resource
position of primary lending institutions to enable the flow of
credit to the MSME sector.
@Crossword2022
3. Micro finance: It offers microfinance to small businessmen

and entrepreneurs for establishing their business.
Role of SIDBI (Small and Industrial Development Bank of India):
• It refinances loans that are extended by the PLIs to the small-
scale industrial units and also offers resources assistance to
them.
• It discounts and rediscounts bills.
• It also helps in expanding marketing channels for the
products of SSI (Small Scale Industries) sector both in the
domestic as well as international markets
• It offers services like factoring, leasing etc. to the industrial
concerns in the small-scale sector
• It promotes employment oriented industries particularly in
semi-urban areas for creating employment opportunities
• It also initiates steps for modernization and technological up-
gradation of current units
• It also enables the timely flow of credit for working capital as
well as term loans to Small Scale Industries in cooperation
with commercial banks
• It also co-promotes state level venture funds
• It acts as Nodal Agency for Indian Government MSME
schemes like Credit Linked Capital Subsidy Scheme or CLCSS,
Technology Up-gradation Fund Scheme or TUFS and others.
• It endorses other associated institutions like Asset
Reconstruction Company, Rating Agency, Venture Capital,
Credit Guarantee Fund and more.
• It also helps MSMEs in acquiring the funds to grow, market,
develop and commercialize their technologies and innovative
products.
• It promotes employment by offering multiple job
opportunities and up gradation of technology within the
sector.

@Crossword2022
Q26. Discuss the importance of financial intermediation in the

financial system. (10 Marks)
Ans: A financial intermediary is a firm or an institution that acts an
intermediary between a provider of service and the consumer. It
is the institution or individual that is in between two or more
parties. It channels savings into investments. Financial
intermediaries are an important source of external funding for
corporates. Unlike the capital markets where investors contract
directly with the corporates creating marketable securities,
financial intermediaries borrow from lenders or consumers and
lend to the companies that need investment. The main objective
of financial intermediaries is to establish a bridge between the
two parties, so that they are able to divide the risks and
proportionately manage their risks and returns to create a
beneficial impact for all three parties involved, the borrower, the
lender, as well as the financial intermediary involved. The
financial intermediaries are commercial banks, investment
banks, stock exchanges, insurance companies, etc.
Financial intermediation in the financial system is important in
the financial system because:
• It promotes high degree of value transformation which means
that borrowers can pool smaller deposits together in order to
lend this amount to those who are in need of larger funds.
• It manages liquidity preferences between the borrowers and
the lenders by establishing a middle ground.
• Financial Intermediaries are also important because they
significantly reduce the transaction costs that are associated
with the process.
• They share the risk by guaranteeing that in the case where a
borrower defaults on the loan, the lender will be paid back the
amount from the financial intermediary.
@Crossword2022
• It ensures that the market functionality is smooth and

normalized, without any misconceptions.
• It creates positive working style and leads to higher
transactions which contributes positively to the overall
economy.
• By the help of financial intermediaries individuals can get
fixed income at low cost in shorter time, as individual doesn’t
require to spend time and money to find good borrowers.
• Financial intermediaries transform primary securities into
secondary securities for the portfolio of ultimate lenders.
• They also increase the efficiency of resource allocation by
investing in different projects.
Q27. Discuss the main theme of Union Budget 2021-22.

(15 Marks)
Ans: The Union budget 2021-22, the first ever digital Union Budget,
presented by Union Minister of Finance and Corporate Affairs
Smt. Nirmala Sitharaman. The vision of the Union Budget 2021-
22 is to extend the goal of Atmanirbhar Bharat by increasing self-
reliance and India's ability to become a global manufacturing hub
across sectors. The 2022 Union Budget is based on the following
six pillars:
1. Health and Wellbeing
2. Physical and Financial Capital and Infrastructure
3. Inclusive development for Aspirational India
4. Reinvigorating Human Capital
5. Innovation and R&D
6. Minimum government and Maximum governance

@Crossword2022
Key highlights of the union budget 2021-22:

• Rs. 2,23,846 crore is allocated for health and wellbeing, an
increase of 137% against previous year’s budget
• Rs. 35,000 crore has been allotted for COVID-19 vaccine
• The Made-in-India Pneumococcal Vaccine is too rolled out
across the country, from present 5 states with an aim to avert
50,000 child deaths annually.
• Rs. 64,180 crore has been allotted for 6 years for PM
Atmanirbhar Swasth Bharat Yojana- a new centrally
sponsored scheme
• Mission Poshan 2.0 is to be launched merging Supplementary
Nutrition Programme and the Poshan Abhiyan
• Rs. 2,87,000 has been allotted under Jal Jeevan Mission
(Urban) over 5 years providing 2.86 crore household tap
connections
• Rs. 1, 41,678 crore has been allocated to Urban Swachh
Bharat Mission 2.0 over 5 years.
• Rs. 2,217 crore has been allocated for tackling air pollution
• Voluntary vehicle scrapping policy has been launched to
phase out old and unfit vehicles
• Rs. 1.97 lakh crore has been allocated for Production Linked
Incentive Scheme (PLI) in next 5 years in 13 sectors.
• 7 Textile parks has to be established over 3 years under Mega
Investment Textile Parks (MITRA) scheme
• Rs. 20,000 crore has been allocated to set up Development
Finance Institutions (DFI) for infrastructure financing.
• There has been 34.5% increase in capital expenditure from
last year budget amounting to Rs. 5.54 lakh crore
• Rs. 1,18,101 lakh crore has been allotted to Ministry of Road
Transport and Highways’.
@Crossword2022
• Rs. 5.35 lakh crore has been allotted for Bharatmala

Pariyojana
• Rs. 1,10,055 crore has been allotted to Railways of which
1,07,100 is for capital expenditure
• 100% electrification of Broad-Gauge routes to be completed
by December 2023
• National Hydrogen Energy Mission 2021-22 is to be launched
• Rs. 2,000 crore is to be offered in PPP mode for operation of
major ports
• Ujjwala scheme has been extended to 1 crore more
beneficiaries
• A new gas pipeline project has been launched in J&K
• A single Securities Market Code is to be evolved and system
of regulated Gold Exchanges to be set up under SEBI.
• There has been capital infusion of Rs. 1,000 crore to Solar
Energy Corporation of India and Rs. 1,500 crore to Indian
Renewable Energy Development Agency
• FDI limit in insurance sector has been increased from 49% to
74%
• Rs, 20,000 crore is to be infused to recapitalize the public
sector banks
• Non Resident Indians can now incorporate One Person
Companies (OPCs) in India and the residency limit for an
Indian citizen to set up an OPC has been reduced from 182
days to 120 days.
• Rs, 1,75,000 crore has been the estimated receipts from
disinvestment in 2021-22
• Other than IDBI Bank, two public sector banks and one
general insurance company has to be privatized and the IPO
of LIC in 2021-22
@Crossword2022
• Agriculture credit target has been enhanced to 16.5 lakh

crores in FY 22 and Operation Green Scheme has been
extended to 22 more perishable products
• 1,000 more mandis to be integrated with e-NAM market place
• Multipurpose Seaweed Park is to established in Tamil Nadu
to promote seaweed cultivation
• Rs, 15,700 crore has been allocated to MSME sector
• 15,000 schools to be strengthened, 100 new Sainik Schools
and 750 Eklavya model residential schools has been
proposed
• Central University in Leh, Ladakh is to be established
• Rs, 4,000 crore has been allocated to Deep Ocean Mission
• Rs. 300 crore has been granted to Goa for the diamond jubilee
celebrations of the state’s liberation from Portugese
• Gross borrowing from the market for the next year is to be
around 12 lakh crore
• Fiscal deficit has been pegged at 9.5% for 2020-21 and 6.8%
for 2021-22 and aims to decrease to less than 4.5% by 2025-
26
• Time-limit for re-opening cases reduced to 3 years from 6
years
• Exemption from filling tax returns for senior citizens over 75
years of age.
• Limit of turnover for tax audit increased to Rs. 10 crore from
Rs 5 crore for entities carrying out 95% transactions digitally
• Capital gains exemption for investment in start-ups has been
extended till 31st March 2022 and tax holidays for Affordable
Housing projects has also been extended till March 2022.

@Crossword2022
Q28. What is Fintech? How it has impacted banking? (15 Marks)

Ans: The term Fintech is derived by joining two words which are
financial services and digital technology. Fintech was introduced
as a technology that was used at the back-end systems of financial
institutions and banks. Fintech uses digital technology by
startups to come up with innovative products and services such
as mobile payments, alternative finance, online banking, big data,
and overall financial management. It refers to software and other
modern technologies used by businesses that provide automated
and improved financial services now it encompasses several
applications that are consumer based. By 2019, you can trade
stocks, manage funds, and pay for your insurance and food via
this technology. Fintech is much more than a financial
technology. It is often referred to as the innovative technology
that is used to improve the traditional financial methods and
develop effective solutions for financial services. Banking
software and mobile banking applications are classic examples of
development in financial technology. Among the many sections
of the financial sector; retail banking, fund transfers and
payments, insurance, brokerage services, insurance
intermediary, commercial banking, investment and wealth
management are impacted the most due to Fintech.
Like every other country, India has also experienced the benefits
of financial technology in the banking and finance sector.
• With a range of Fintech services and Fintech software, it has
changed the way the people carry out daily transactions and
handle their money.
• This dynamic transformation brought upon by the
association of technology and the financial sector has opened
a gateway for the Fintech ecosystem in India. In less than five
years, it has become one of the most buzzing sectors in India
with the investments and funding coming from the big
players like Google and WhatsApp. Additionally, indigenous
@Crossword2022
firms are playing a significant role in the development of this

massive industry include Paytm, Phonepe, Mobikwik, and
FreeCharge.
• It has transformed the way the banks operate and has opened
a huge new market for market-based lending.
• Fintech services has made the payments online using internet
or through smartphones. Money can be transferred directly
to the bank account, which reduces the chances of frauds and
transaction fees.
• Using the new financial technology, these companies aim to
provide customized solutions of managing their own wealth
and investments. Fintech software also helps in comparing
options in order to create the best investment plans for
personal finance.
• Acquiring insurance has also now become a less complex
procedure.
• Financial technology has also given rise to the new trend of
mobile banking. Various applications are developed using
new financial technology for smartphones which allows us to
perform various banking transactions.
• The collaboration of Artificial Intelligence with Fintech, using
a voice-operated assistant or next-generation chatbot has
changed the customer experience.
• Also the Block chain Technology is one of the greatest
revolutions of financial technology wherein technology is
used to create blocks and record transactions permanently. It
changed the traditional banking systems completely.
• It also enhanced opportunities for financial inclusion and
transformed KYC documentation process
• It introduced New banking models like neobanks, cloud
banking and more

@Crossword2022
Q29. What is disinvestment? How it can benefit the India

economy? (15 Marks)
Ans: Disinvestment means sale or liquidation of assets by the
government, usually central and state public sector enterprises,
projects, or other fixed assets. The government undertakes
disinvestment to reduce the fiscal burden or to raise money for
meeting specific needs, such as to bridge the revenue shortfall
from other regular sources. In some cases, disinvestment may be
done to privatize assets.
There is a separate department in India, under the Ministry of
Finance which handles all disinvestment-related works for the
government. During Budget 2021-22 the disinvestment target set
by Indian government is of Rs.1.75 lakh crores where two public
sector banks and one insurance company will be privatized. Main
objectives of disinvestment in India:
• To improve public finances
• To encourage private ownership
• To fund growth and development programmes
• To maintain and promoting competition in the market
• To reduce fiscal deficit
India benefits from disinvestment in several ways:
1. Disinvestment allows the transferring of the Indian
government’s enormous public debt of its PSU’s to the Indian
private sector which further reduces the financial debt of the
government.
2. It also eliminates the taxpayer’s exposure to the monetary
risk of PSU’s by transferring the exposure to the private sector
3. Disinvesting in PSU’s also enables the Indian government to
raise funds so that the government can invest in improving its
current physical and social infrastructure.
4. It allows the reallocation of PSU resources such as manpower,
real estate, technological, and operational infrastructure to
governmental sectors.
@Crossword2022
5. Disinvestment forces financially sick PSU companies, to either

become profitable enterprises or close down due to pressure
from competing companies in the private sector.
6. Disinvestment of PSU’s in India will bring more competition
into various private sectors and improves the quality of
service for the customer
7. Disinvestment helps to promote broader share ownership for
Indian citizens and also helps in the development of the
capital market in India.
8. Disinvestment allows government assets to allocate for
profit-making ventures instead be reallocated for use in
nonprofit activities or social causes thus helping to
strengthen both the nonprofit activities and social causes
9. It can brings about greater efficiencies for the economy and
markets as a whole
10. It can give greater opportunities and avenues for career
growth and can create further employment generation
11. It can be helpful in the long-term growth of the country
Q30. Discuss the role of NABARD in economic development.

(15 Marks)
Ans: The National Bank for Agriculture and Rural Development
(NABARD) is an apex development finance institution fully
owned by Government of India. It was established on the
recommendations of B.Sivaramman Committee on 12 July 1982
with the paid up capital of Rs. 100 cr under the National Bank for
Agriculture and Rural Development Act 1981. It replaced the
Agricultural Credit Department (ACD) and Rural Planning and
Credit Cell (RPCC) of Reserve Bank of India, and Agricultural
Refinance and Development Corporation (ARDC). It is one of the
premier agencies providing developmental credit in rural areas.
@Crossword2022
It is also required to support non-farm sector and other allied

economic activities in rural areas. It functions to promote
sustainable rural development for attaining prosperity of rural
areas in India.
It is an apex institution in rural credit structure for providing
credit for promotion of agriculture, small scale industries, cottage
and village industries, handicrafts etc. NABARD plays an
important role in economic development of the India:
• It takes measures towards institution building for improving
absorptive capacity of the credit delivery system, monitoring,
formulating rehabilitation schemes, restructuring of credit
institutions and training of personnel
• It monitors and evaluates projects refinanced by it
• It coordinates the rural financing activities of all institutions
engaged in developmental work at the field level
• It gives high priority to projects formed under Integrated
Rural Development Programme (IRDP) and arranges
refinance for IRDP accounts
• It gives guidelines for promotion of group activities under its
programs and provides 100% refinance support for them
• It sets linkages between Self-help Group (SHG) in rural areas.
• It completely refinances those projects which are operated
under the ‘National Watershed Development Programme
‘and the ‘National Mission of Wasteland Development‘.
• It also supports “Vikas Vahini” volunteer programs which
offer credit and development activities to poor farmers.
• It also inspects and supervises the cooperative banks and
RRBs and also recommends about licensing for RRBs and
Cooperative banks to RBI.
• NABARD gives assistance for the training and development of
the staff of various other credit institutions which are
engaged in credit distributions.
@Crossword2022
• It also runs programs for agriculture and rural development

in the whole country.
• It improves absorptive capacity of the credit delivery system
in India, including monitoring, formulation of rehabilitation
schemes, restructuring of credit institutions, and training of
personnel.
• It prepares annual rural credit plans for all districts in the
country.
• It also promotes research in rural banking, and the field of
agriculture and rural development.
• It co-ordinates the rural credit financing activities of all sorts
of institutions engaged in developmental work at the field
level
There are some development schemes offered by NABARD
including Kisan Credit Card schemes for farmers, RuPay Kisan
Cards, Dairy Entrepreneurship Development scheme, National
Livestock Mission, Interest Subvention Scheme and some
business initiatives including NABARD Infrastructure
Development Assistance (NIDA), Direct Refinance Assistance
(DRA) to Co-operative banks, Credit Facility for Federations
(CCF) and Dairy Processing and Infrastructure Development
Fund (DIDF).
Q31. What is NHB? Explain its role in housing finance.

(15 Marks)
Ans: National Housing Bank (NHB) is a government owned entity set
up on 9 July 1988 under National Housing Bank Act, 1987.
National Housing Bank operates under the control of its Board of
Directors and the Current Managing Director of National Housing
Bank is Mr. Sarada Kumar Hota along with various other
@Crossword2022
Directors. NHB is the apex financial institution for housing. It has

been established with an objective to operate as a principal
agency to promote housing finance institutions both at local and
regional levels. NHB registers and supervises Housing Finance
Companies (HFCs), keeps surveillance through On-site & Off-site
Mechanisms and co-ordinates with other Regulators. NHB plays
an important role in the growth of housing finance institutions in
India in many ways:
• National housing bank promotes, establishes and supports
housing finance institutions.
• NHB guarantees for the loan taken by housing finance
companies from the open market.
• NHB makes housing credit more affordable.
• NHB underwrites for the issue of securities of housing finance
institutions.
• National Housing Bank draws, accepts, discounts and re-
discounts bills of exchange for housing finance.
• NHB buys or sells or deals in mortgage of immovable
properties belonging to housing finance institutions.
• NHB may write off loans belonging to housing financing
companies
• It promotes mutual funds for undertaking housing finance.
• NHB undertakes house mortgage insurance and promote
mortgage banks or societies for providing housing finance.
• It undertakes research and survey on construction activities.
• It formulates various schemes for the extension of housing
credit.
• National housing bank plays an important role in formulating
housing schemes for EWS (economically weaker sections).
• National housing bank Co-ordinates with LIC, UTI, GIC and
other financial institutions.
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• Another important role National Housing Bank plays is that it

increases the number of housing units in the country.
• It ensures that Housing Finance Companies meet regulatory
Capital requirements as required by BASEL norms, have
proper risk management framework in place, good
governance practices, etc.
• NHB grants loans against pledge of jewels or mortgage of
properties and also advances against various assets.
• It deals with the bill of exchanges of the housing finance
companies.
• The purchase and sales, and mortgage of immovable
properties are also done by the NHB.
• It promotes a network of dedicated housing finance
institutions to adequately serve various regions and different
income groups.
Q32. “A good grievance redressal mechanism is an asset to the

economy.” Justify the statement with reference to banking
ombudsman scheme of India and also highlight its recent
changes. (15 Marks)
Ans: Banks operate in a competitive scenario where excellence in
customer service is the key to sustained business growth.
Customer complaints are inevitable and are a part of business
cycle for all corporate entities. Providing prompt and efficient
service to customers is important for attracting new customers
as well as retaining the old ones. To achieve this, banks have to
ensure that a proper service delivery and review mechanism is
for prompt redressal of customer complaints and grievances. A
good grievance redressal mechanism is important for the
functioning of the economy. Banks should ensure that a suitable
redressal mechanism should exist for receiving and addressing
complaints from its customers with specific emphasis on
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resolving such complaints fairly and expeditiously regardless of

source of the complaints. To redress the complaints of customers
on certain types of banking services provided by banks and to
facilitate the settlement of those complaints, RBI introduced
Banking Ombudsman Scheme in 1995 under section 35A of the
Banking Regulation Act, 1949. The scheme was introduced to
establish a system of expeditious and inexpensive resolution of
customer complaints. This scheme is administered through
twenty two Banking Ombudsman Offices. The scheme covers all
commercial banks, regional rural banks and scheduled primary
cooperative banks. Any person who has a grievance against a
bank may himself or through his authorized representative,
make a complaint to the Banking Ombudsman within whose
jurisdiction the branch or office of the bank complained against
is located. The complaint can be sent either in writing or sent
electronically. The Banking Ombudsman does not charge any fee
for filing and resolving customer’s complaints
A person can make a complaint to the Banking Ombudsman for
matters like:
• Delay in payment of inward remittances, collection of
cheques, drafts, bills etc
• Non-adherence to prescribed working hours
• Refusal to open deposit accounts without giving reasonable
reason
• Levying of charges without prior notice to customer
• Delay in providing banking facilities
• Delay in accepting payments towards taxes
• Delay in receipts of export proceeds, handling of export bills,
collection of bills etc
• Non acceptance of applications for loans without furnishing
valid reasons to the applicant

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There has been recent changes in Banking Ombudsman Scheme

in India:
• In 2006, RBI included deficiencies arising out of sale of
insurance, mutual funds or other third party investment
products by banks.
• In 2006, the scheme also included complaints against bank
regarding electronic banking or mobile banking services,
debit card or credit cards and appeal also has been awarded
for the rejected complaints closed under section 13 (C) of the
existing scheme.
• In 2017, compensation not exceeding Rs. 1 lakh can also be
awarded by ombudsman to the complainant for loss of time,
expenses, harassment and mental pain suffered by the
complainant
• In 2018, the scheme was extended to redressal of complaints
against Non-Banking Financial Companies registered with
RBI under section 45-IA of the RBI Act, 1934.
• In 2019, RBI introduced Banking Ombudsman Scheme for
digital transactions. This scheme is being implemented under
section 18 of Payment and Settlement Systems Act, 2007
• In 2021, the three ombudsman schemes namely banks, NBFCs
and digital transactions are being merged and integrated into
single scheme which will be effective from June 2021
Q33. Explain in brief the provisions of RBI act 1934. (15 Marks)
Ans: The Reserve Bank of India Act was passed on the 6th March, 1934
to establish Reserve Bank of India as the Central Bank of the
country. The Reserve Bank was established as a body corporate
under the Act and started the functioning from the 1st April,
1935. The RBI Act 1934 is applicable to the whole India. It
contains total 61 sections
@Crossword2022
The provisions of RBI Act 1934 has been explained further:

• Section 2(e) - Scheduled Bank means a bank whose name is
included in the Schedule II of the RBI Act, 1934.
• Section 3: Section 3 of the RBI act provides for establishment
of Reserve Bank of India for taking over the management of
the currency from Central Government and of carrying on the
business of banking.
• Section 4: Section 4 of the RBI Act defines the capital of RBI
which is Rs. five crore.
• Section 7: Section 7 of the RBI Act empowers the central
government to issue directions in public interest from time to
time to the bank in consultation with RBI Governor.
• Section 17: This section deals with the functioning of RBI. .
The RBI can accept deposits from the central and state
governments without interest. It can purchase and discount
bills of exchange from commercial banks. It can also purchase
foreign exchange from banks and sell it to them. It can provide
loans to banks and state financial corporations. It can provide
advances to the central government and state governments.
It can buy or sell government securities. It can deal in
derivative, repo and reverse repo.
• Section 18: This section describes emergency loans to banks.
• Section 21: This section assigns RBI as banker to the central
government and manage public debt.
• Section 22: This section grants power to RBI to issue bank
notes in India
• Section 24: This section states that highest denomination
note could be ฀10,000
• Section 28: This section empowers the RBI to form laws
concerning the exchange of damaged and imperfect notes
@Crossword2022
• Section 31: This section provides that in India RBI and central
government only can issue and accept promissory notes that
are due
• Section 40: This section states that Reserve Bank purchases
and sells foreign monetary standards and secures the nation’s
foreign exchange reserves.
• Section 42: This section provides that every scheduled bank
need to hold an average daily balance with the RBI which is
not more than three percent of the net demand and time
liabilities
• Section 43: This section states that banks shall to be published
each fortnight a consolidated statement showing aggregate
liabilities and assets of all scheduled banks.
• Section 49: This section determines the bank rate. It is the
standard rate at which RBI is ready to buy or rediscount bills
of exchange or commercial papers.
Q34. Explain the role of RBI in maintaining inflation in the

economy? (15 Marks)
Ans: Inflation is the increase in general price level of goods and
services and reduction of purchasing power per unit of money
and is certainly not good for the economy. Inflation is the
mismatch between total supply and total demand Inflation in
India is a major issue of concern which results in disparity
between rich and poor. The Reserve Bank of India plays the most
crucial role in managing the economy of India, keeping a stable
economic balance, and maintaining the cash and finance flows in
the country. The RBI adopts various policies through which it
decreases or increases certain rates to control inflation. These
measures reduce the money supply in the market thus reducing
demand which further decreases the prices. Here are some of the
measures adopted by RBI in controlling inflation:
@Crossword2022
1. Interest Rate
i. Repo rate: Repo rate is the rate at which Reserve Bank of
India lends money to commercial banks in the event of any
shortfall of funds. In order to control inflation RBI
increases Repo rate, this ultimately reduces the money
supply in the economy and thus helps in arresting
inflation. At present Repo rate is 4%
ii. Reverse repo rate: Reverse Repo rate is the rate when the
RBI borrows money from banks when there is excess
liquidity in the market. During high levels of inflation in
the economy, the RBI increases the reverse repo which
encourages the banks to park more funds with the RBI to
earn higher returns on excess funds, at present reverse
Repo rate is 3.35%.
iii. Bank Rate: Bank Rate is the interest rate at which a
nation's central bank lends money to domestic banks,
often in the form of very short-term loans. In order to
maintain inflation level in the economy, RBI increases the
bank rate which makes expensive for the commercial
banks to borrow money thus it decreases the liquidity in
the market.
2. Reserve Ratios
i. Cash Reserve Ratio (CRR): Cash Reserve Ratio is the
amount of funds that commercial banks are required to
keep with RBI in the form of cash or cash equivalents. In
order to maintain and control inflation RBI increases Cash
Reserve Ratio where banks are required to keep higher
percentage of their NDTL (Net Demand and Time
Liabilities) with RBI which will decrease the money
supply in the economy due to less availability of funds
with the banks. At present Cash Reserve Ratio is 3%.
@Crossword2022
ii. Statutory Liquidity Ratio (SLR): Statutory liquidity Ratio

is the amount of funds that commercial banks are
required to keep with themselves in the form of liquid
cash, gold or other government securities. To maintain
and control inflation in the economy RBI increases the SLR
rate so that there is reduction in the loan granting capacity
of the banks. At present SLR rate is 18%
3. Open Market Operations:
Open Market Operations is the buying and selling of
government securities by RBI in an open market. To control
inflation, the RBI sells the securities in the money market
which sucks out excess liquidity from the market. As the
amount of liquid cash decreases, demand goes down in the
market and inflation is maintained.
4. Selective Credit Control:
The RBI has been operating selective credit control policy to
maintain inflation of goods that are short in supply of goods
like food grains, vegetables, pulses, oilseeds, cotton, sugar,
gur, khansari, etc which are of mass consumption. The
selective credit control policy is used by RBI to discourage
advances given by banks against these essential commodities.
Q35. What is insider trading? Explain briefly the main elements of

the regulation relating to prohibition insider trading.
(10 Marks)
Ans: Insider trading is the buying and selling of a publicly traded
company’s stock by someone who has non-public, material
information about their stock. Insider trading is the buying,
selling or dealing in securities of a listed company by a director,
employee of the company, member of management, internal
auditor, advisor, consultant, etc who has knowledge of material
inside information which is not available to general public.
@Crossword2022
Material non-public information can be any information that

could substantially impact an investor’s decision to buy or sell the
security that has not been disclosed to the public. This sort of
insider trading can have harsh consequences, it can be lifetime
imprisonment.
Insider trading in India is an offence according to section 12A of
the Securities Exchange Board of India (SEBI) Act, 1992. The
penalty for insider trading under section 15 G is penalty of five
lakh rupees to 25 crore rupees or three times the profit made,
whichever is higher.
• In India Regulation 3 of SEBI Regulations seeks to prohibit
dealing, communication and counselling on matters related to
insider trading.
• Regulation 3 also provides that no insider shall on his own
behalf of any other person deal in securities of a company or
directly or indirectly communicate any unpolished price
sensitive information to any person
• Further Regulation 3 also prohibits any company from
dealing in the securities of another company or associate of
that company while in possession of any unpublished price
sensitive information
• SEBI trading rules 2002, covers temporary insiders like
lawyers, accountants, investment bankers, etc that are
deemed to be connected to insiders
• SEBI (Prohibition of Insider Trading) Regulations, 2015
prohibits all designated persons for exercise of Employee
Stock Option Plan (ESOPs) during the trading window closure
period and prohibition for exercising the ESOPs for six
months after the sale of shares
• The regulations, 2015 also prescribe that every employee
shall disclose to the company details of the trade within two
trading days of the transaction if the value of securities traded
in any calendar quarter exceeds Rs. 10 lakhs
@Crossword2022
• SEBI regulations, 2015 states that a designated person who

buys or sells any securities of the company shall not enter into
an opposite transaction during the next 6 months following
the prior transaction
• A new concept of trading plans have been introduced for an
insider under the regulations
• SEBI regulations, 2015 states that any designated person or
his/her immediate relatives trade in securities exceeding
market value of Rs. 42 lakhs during a calendar month, then
he/she should apply to Compliance Officer for pre-clearance.
• Regulations, 2015 also states that trading window shall be
closed when the Compliance Officer determines that a
designated persons is expected to have some unpublished
price-sensitive information
• In September 2020, SEBI had decided to implement system-
driven disclosures for members of promoters group,
directors, and designated persons of a listed company.
• In 2021, SEBI released new disclosure format under insider
trading rules where details of securities held upon becoming
the promoter group of a listed company and immediate
relatives of such persons need to be disclosed.
The smooth operation of the securities market and its healthy
growth and development depends on the integrity of the market.
Therefore preventing such transactions is an important
obligation for any capital market regulatory system, because
insider trading discourages investor’s confidence in the fairness
and integrity of the securities market.


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Sources of financing can be classified in to 3 types

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On basis of the period

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(1) OWNERS FUNDS– This fund is financed by the company owners,

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LONG TERM SOURCES MEDIUM-TERM SHORT TERM

Long-Term Sources of Finance

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Medium Term Sources of Finance

Short Term Sources of Finance

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According to Ownership and Control:

OWNED CAPITAL BORROWED CAPITAL

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ACCORDING TO SOURCE OF GENERATION:

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(1) Over-the-counter derivatives

(2) Exchange-traded derivatives

(3) Inverse ETFs And Leveraged ETFs

(4) Common derivative contract

Swaps can be categorized into two types:-

Economic functions of the derivative market

(1) Prices in a structured derivative market not only replicate the

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(3) The intrinsic nature of the derivatives market is associated with

Uses of Derivatives are as follows:-

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Risk management by banks

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Tier 1 Capital:-It refers to the capital of more permanent nature. It

Tier 2 Capital:-It refers to temporary or fluctuating in nature. Tier 2

Benefits of Basel 1:-

The weakness of Basel 1 is as follows:-

The Basel Norms 2:-

Basel 2 framework operates under three pillars:-

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There are three pillars under Basel 2:-

Pillar 1:-Market Discipline:-

Pillar 2:-Capital adequacy requirements.

Pillar 2 helps to improve the policies of Basel I by taking into

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capital adequacy requirement of 8% of their Risk-weighted assets. It

The two main characteristics that include are:-

(2) Internal rating approach:-

Pillar 3:-Supervisory review.

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The Basel Norms 3:-

(2) Leverage ratio:-

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Impacts of Basel 3:-

Implications of Basel 3 norms:-

Insolvency and Bankruptcy code:-

Meaning of bankruptcy code:-

Key features of Insolvency and Bankruptcy code:-

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(2) Insolvency Professionals:-

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Background of Bankruptcy and Insolvency code:-