Reserve Bank of India

Establishment

The Reserve Bank of India was established in 1935 under the provisions of the Reserve Bank
of India Act, 1934 in Calcutta, eventually moved permanently to Mumbai. Though originally
privately owned, was nationalized in 1949.

Organisation and Management

The Reserve Bank’s affairs are governed by a central board of directors. The board is appointed by
the Government of India for a period of four years, under the Reserve Bank of India Act.

(i) Full-time officials: Governor and not more than four Deputy Governors. Nominated by
Government: ten Directors from various fields and two governments Officials Others: four Directors
– one each from four local boards

Functions and promotional roles of Reserve Bank of India (RBI).

The Reserve Bank of India is performing various functions related to monetary management,
banking operations, foreign exchange, developmental works and research on problems of economy.
1. Note Issue: Being the Central Bank of the country, the RBI is entrusted with the sole authority to
issue currency notes after keeping certain minimum reserve consisting of gold reserve worth Rs. 115
crore and foreign exchange worth Rs. 85 crore. This provision was later amended and simplified.
2. Banker to the Government: The RBI is working as banker of the government and therefore all
funds of both Central and State Governments are kept with it. It acts as an agent of the government
and manages its public debt. RBI also offering “ways and means advance” to the government for
short periods.
3. Banker’s Bank: The RBI is also working as the banker of other banks working in the country. It
regulates the whole banking system of the country, keep certain percentage of their deposits as
minimum reserve, works as the lender of the last resort to its scheduled banks and operates clearing
houses for all other banks.
4. Credit Control: The RBI is entrusted with the sole authority to control credit created by the
commercial banks by applying both quantitative and qualitative credit control measures like variation
in bank rate, open market operation, selective credit controls etc.
5. Custodian of Foreign Exchange Reserves: The RBI is entrusted with sole authority to determine
the exchange rate between rupee and other foreign currencies and also to maintain the reserve of
foreign exchange earned by the Government. The RBI also maintains its relation with International
Monetary Fund (IMF).
6. Developmental Functions: The RBI is also working as a development agency by developing
various sister organisations like Agricultural Refinance Development Corporation. Industrial
Development Bank of India etc. for rendering agricultural credit and industrial credit in the country.
On July 12, 1986, NABARD was established and has taken over the entire responsibility of
ARDC. Half of the share capital of NABARD (Rs. 100 crore) has been provided by the Reserve
Bank of India. Thus, the Reserve Bank is performing a useful function for controlling and managing
the entire banking, monetary and financial system of the country.
Regulatory and promotional functions performed by the RBI:
1. Regulating the Volume of Currency: The RBI is performing the regulatory role in issuing and
controlling the entire volume of currency in the country through its Issue Department. While
regulating the volume of currency the RBI is giving priority on the demand for currency and the
stability of the economy equally.
2. Regulating Credit: The RBI is also performing the role to control the credit money created by the
commercial banks through its qualitative and quantitative methods of credit control and thereby
maintains a balance in the money supply of the country.
3. Control over Commercial Banks: Another regulatory role performed by the RBI is to have
control over the functioning of the commercial banks. It also enforces certain prudential norms and
rational banking principles to be followed by the commercial banks.
4. Determining the Monetary and Credit Policy: The RBI has been formulating the monetary and
credit policy of the country every year and thereby it controls the Statutory Liquidity Ratio (SLR),
Cash Reserve Ratio (CRR), bank rate, interest rate, credit to priority sectors etc.
5. Mobilizing Savings: The RBI is playing a vital promotional role to mobilize savings through its
member commercial banks and other financial institutions. RBI is also guiding the commercial banks
to extend their banking network in the unbanked rural and semi-urban areas and also to develop
banking habits among the people. All these have led to the attainment of greater degree of
monetization of the economy and has been able to reduce the activities of indigenous bankers and
private moneylenders.
6. Institutional Credit to Agriculture: The RBI has been trying to increase the flow of institutional
credit to agriculture from the very beginning. Keeping this objective in mind, the RBI set up ARDC
in 1963 for meeting the long term credit requirement of rural areas. Later on in July 1982, the RBI
set up NABARD and merged ARDC with it to look after its agricultural credit functions.
7. Specialized Financial Institutions: The RBI has also been playing an important promotional role
for setting specialized financial institutions for meeting the long term credit needs of large and small
scale industries and other sectors. Accordingly, the RBI has promoted the development of various
financial institutions like, WCI, 1DBI, ICICI, SIDBI, SFCs, Exim Bank etc. which are making a
significant contribution to industry and trade of the country.
8. Security to Depositors:In order to remove the major hindrance to the deposit mobilization arising
out of frequent bank failures, the RBI took major initiative to set up the Deposit Insurance
Corporation of India in 1962. The most important objective of this corporation is to provide security
to the depositors against such failures.
9. Advisory Functions;The RBI is also providing advisory functions to both the Central and State
Governments on both financial matters and also on general economic problems.
10. Policy Support:The RBI is also providing active policy support to the government through its
investigation research on serious economic problems and issues of the country and thereby helps the
Government to formulate its economic policies in a most rational manner. Thus, it is observed that
the RBI has been playing a dynamic role in the economic development process of the country
through its regulatory and promotional framework
Meaning of financial institutions
Financial institutions are entities that help individuals and businesses fulfill their monetary or
financial requirements, either by depositing money, investing it, or managing it. Some of the
institutions labeled under this category include – banks, investment firms, trusts, brokerage ventures,
insurance companies, etc.

Financial Institutions
1. Central Banks

These are the financial entities that monitor and oversee the procedures of the other financial
or banking institutions in the nation. They do not deal with individual customers directly. Instead,
they finance other retail banks. In short, these are banks for the banks. Every economy has a separate
central bank and is named differently. For example, in the United States, the Federal Reserve Bank is
the central bank.
2 . Commercial Banks
Retail and commercial banks are widely available to serve the financial needs of individuals and
businesses. From depositing money to borrowing amounts to buy property, these banks act as saviors
for people in need to secure their future financially. Some of the products that these banks offer
include savings accounts, personal loans, mortgage loans, certificates of deposits (CDs), credit cards,
etc.
3 . Non-Banking Institutions
Non-Banking Financial Companies (NBFCs) are entities that neither acquire a valid banking
license nor do they allow customers to deposit amounts. However, these entities can offer alternative
financial facilities to customers, including investment, consultation, brokerage, transmission, and risk
pooling services.
4 . Credit Unions
The institutions offer traditional banking services but are not publicly traded entities. They
are established and operated by the members, the ultimate shareholders. These associations use and
reinvest the money received as an interest to keep the costs low. As a result, they become the better
choices for members to fulfill their financial needs. These entities enjoy tax-exempt status as not-for-
profit organizations.
5. Investment Entities
The investment banks and brokerage firms fall under this non-depository category. The investment
firms help corporations, governments, and other entities build capital, raise funds, and gain financial
advice. These entities, as brokerage ventures, let customers acquire finances by investing in
securities, like stocks, mutual funds, bonds, and exchange-traded funds (ETFs). In addition, it acts as
a guide to startups or companies in conducting complex transactional processes. They also offer
advice for initiating fruitful mergers and acquisitions (M&A).
6 .Thrift Institutions
Also referred to as savings and loan associations, these entities allow up to 20% of total lending to
customers, who are also their owners. They help individuals enjoy opening accounts and acquiring
personal loans and home mortgages.
7 .Insurance Companies
These financial institutions allow individuals and businesses have policies against monthly
premiums, which they are subject to pay at regular intervals. In addition, these schemes offer
coverage or protection to assets against any financial risk they remain exposed to.
What is Securitisation?

When a bank combines several illiquid assets and converts them into a security that can be purchased
or sold in the financial markets, thus providing liquidity in the market and lower risk.

Process of Securitisation

Financial organisations first list out all the assets that they want to securitize and remove from their
associated balance sheets and then gather the details of these assets. All this information (called
reference portfolio) is then sold to the issuers who create tradable securities.

The investors can then buy these securities and these reference portfolios can also be divided into
smaller sections called tranches which categorise these assets on various factors like rate of interest,
maturity date, type of loan, etc. Thus, each branch has a different risk factor and rate of return, so the
investors can buy them as per their budget and requirements, thus reducing the liability of the
original creditor or lender.
The subprime mortgage crisis that began in 2007 has given the decades-old concept of securitization
a bad name. Securitization is the process in which certain types of assets are pooled so that they can
be repackaged into interest-bearing securities.

The interest and principal payments from the assets are passed through to the purchasers of the
securities. Securitization got its start in the 1970s, when home mortgages were pooled by U.S.
government-backed agencies. Starting in the 1980s, other income-producing assets began to be
securitized, and in recent years the market has grown dramatically. I

n some markets, such as those for securities backed by risky subprime mortgages in the United
States, the unexpected deterioration in the quality of some of the underlying assets undermined
investor confidence. Both the scale and persistence of the attendant credit crisis seem to suggest that
securitization—together with poor credit origination, inadequate valuation methods, and insufficient
regulatory oversight—could severely hurt financial stability. Increasing numbers of financial
institutions employ securitization to transfer the credit risk of the assets they originate from their
balance sheets to those of other financial institutions, such as banks, insurance companies, and hedge
funds.

They do it for a variety reasons. It is often cheaper to raise money through securitization, and
securitized assets were then less costly for banks to hold because financial regulators had different
standards for them than for the assets that underpinned them. In principle, this “originate and
distribute” approach brought broad economic benefits too—spreading out credit exposures, thereby
diffusing risk concentrations and reducing systemic vulnerabilities. Until the subprime crisis
unfolded, the impact of securitization appeared largely to be positive and benign.

But securitization also has been indicted by some for compromising the incentives for originators to
ensure minimum standards of prudent lending, risk management, and investment, at a time when low
returns on conventional debt products, default rates below the historical experience, and the wide
availability of hedging tools were encouraging investors to take more risk to achieve a higher yield.
Many of the loans were not kept on the balance sheets of those who securitized them, perhaps
encouraging originators to cut back on screening and monitoring borrowers, resulting possibly in a
systematic deterioration of lending and collateral standards.

The securitization process In its most basic form, the process involves two steps (see chart). In step
one, a company with loans or other income-producing assets—the originator—identifies the assets it
wants to remove from its balance sheet and pools them into what is called the reference portfolio. It
then sells this asset pool to an issuer, such as a special purpose vehicle (SPV)—an entity set up,
usually by a financial institution, specifically to purchase the assets and realize their off-balance-
sheet treatment for legal and accounting purposes. In step two, the issuer finances the acquisition of
the pooled assets by issuing tradable, interest-bearing securities that are sold to capital market
investors.

The investors receive fixed or floating rate payments from a trustee account funded by the cash flows
generated by the reference portfolio. In most cases, the originator services the loans in the portfolio,
collects payments from the original borrowers, and passes them on—less a servicing fee—directly to
the SPV or the trustee.

In essence, securitization represents an alternative and diversified source of finance based on the
transfer of credit risk (and possibly also interest rate and currency risk) from issuers to investors. In a
more recent refinement, the reference portfolio is divided into several slices, called tranches, each of
which has a different level of risk associated with it and is sold separately. Both investment return
(principal and interest repayment) and losses are allocated among the various tranches according to
their seniority. The least risky tranche, for example, has first call on the income generated by the
underlying assets, while the riskiest has last claim on that income.

The conventional securitization structure assumes a three-tier security design—junior, mezzanine,

and senior tranches. This structure concentrates expected portfolio losses in the junior, or first loss
position, which is usually the smallest of the tranches but the one that bears most of the credit
exposure and receives the highest return. There is little expectation of portfolio losses in senior
tranches, which, because investors often finance their purchase by borrowing, are very sensitive to
changes in underlying asset quality. It was this sensitivity that was the initial source of the problems
in the subprime mortgage market last year.

When repayment issues surfaced in the riskiest tranches, lack of confidence spread to holders of
more senior tranches— causing panic among investors and a flight into safer assets, resulting in a
fire sale of securitized debt. Securitization was initially used to finance simple, selfliquidating assets
such as mortgages. But any type of asset with a stable cash flow can in principle be structured into a
reference portfolio that supports securitized debt. Securities can be backed not only by mortgages but
by corporate and sovereign loans, consumer credit, project finance, lease/trade receivables, and
individualized lending agreements.

The generic name for such instruments is asset-backed securities (ABS), although securitization
transactions backed by mortgage loans (residential or commercial) are called mortgage-backed
securities. A variant is the collateralized debt obligation, which uses the same structuring technology
as an ABS but includes a wider and more diverse range of assets. The allure of securitizing
Securitization started as a way for financial institutions and corporations to find new sources of
funding—either by moving assets off their balance sheets or by borrowing against them to refinance
their origination at a fair market rate. It reduced their borrowing costs and, in the case of banks,
lowered regulatory minimum capital requirements.

For example, suppose a leasing company needed to raise cash. Under standard procedures, the
company would take out a loan or sell bonds. Its ability to do so, and the cost, would depend on its
overall financial health and credit rating. If it could find buyers, it could sell some of the leases
directly, effectively converting a future income stream to cash. The problem is that there is virtually
no secondary market for individual leases. But by pooling those leases, the company can raise cash
by selling the package to an issuer, which in turn converts the pool of leases into a tradable security.

Moreover, the assets are detached from the originator’s balance sheet (and its credit rating), allowing
issuers to raise funds to finance the purchase of assets more cheaply than would be possible on the
strength of the originator’s balance sheet alone. For instance, a company with an overall “B” rating
with “AAA”-rated assets on its books might be able to raise funds at an “AAA” rather than “B”
rating by securitizing those assets. Unlike conventional debt, securitization does not inflate a
company’s liabilities. Instead it produces funds for future investment without balance sheet growth.
Investors benefit from more than just a greater range of investible assets made available through
securitization.

The flexibility of securitization transactions also helps issuers tailor the risk-return properties of
tranches to the risk tolerance of investors. For instance, pension funds and other collective
investment schemes require a diverse range of highly rated long-term fixed-income investments
beyond what the public debt issuance by governments can provide. If securitized debt is traded,
investors can quickly adjust their individual exposure to credit-sensitive assets in response to
changes in personal risk sensitivity, market sentiment, and consumption preferences at low
transaction cost. Sometimes the originators do not sell the securities outright to the issuer (called
“true sale securitization”) but instead sell only the credit risk associated with the assets without the
transfer of legal title (“synthetic securitization”). Synthetic securitization helps issuers exploit price
differences between the acquired (and often illiquid) assets and the price investors are willing to pay
for them (if diversified in a greater pool of assets). Growth of securitization The landscape of
securitization has changed dramatically in the last decade.

No longer is it wed to traditional assets with specific terms such as mortgages, bank loans, or
consumer loans (called self-liquidating assets). Improved modeling and risk quantification as well as
greater data availability have encouraged issuers to consider a wider variety of asset types, including
home equity loans, lease receivables, and small business loans, to name a few. Although most
issuance is concentrated in mature markets, securitization has also registered significant growth in
emerging markets, where large and highly rated corporate entities and banks have used securitization
to turn future cash flow from hard-currency export receivables or remittances into current cash. In
the future, securitized products are likely to become simpler.

After years of posting virtually no capital reserves against highly rated securitized debt, issuers will
soon be faced with regulatory changes that will require higher capital charges and more
comprehensive valuation. Reviving securitization transactions and restoring investor confidence
might also require issuers to retain interest in the performance of securitized assets at each level of
seniority, not just the junior tranche.

NEW FINANCIAL SERVICES

FINANCIAL SERVICES

Efficiency of emerging financial system largely depends upon the quality and variety of financial
services provided by financial intermediaries. The term financial services can be defined as
“activities, benefits, and satisfactions, connected with the sale of money, that offer to users and
customers, financial related value. within the financial services industry the main sectors are banks,
financial institutions, and non-banking financial companies.
FACTORING
INTRODUCTION

Receivables constitute a significant portion of Current Assets of a firm. But for investment in
receivables, a firm has to incur certain costs such as Lusts financing receivables and costs of
collection from receivables. Further, there is a risk of had debts also, it is therefore, very essential to
have a proper control and management of receivables. In fact, maintaining of receivables poses to
types of problems; the problem of raising funds to finance the receivables, and (ii) the problems
relating to collection, delays and defaults of the receivables. A small firm may handle the problem of
receivables management of its own, but it may not be possible for a large firm to do so efficiently as
it may be exposed to the risk of more and more bad debts. In such a casts, a firm nay avail the
services of specialised institutions engaged in receivable management, called factoring firms.

MEANING & DEFINITION

Factoring may broadly be defined as the relationship, created by an agreement between the
seller of goods/ services and a financial institution called the factor, whereby the later purchases the
receivables of the former and also controls and administers the receivables of the former.

Factoring may also be defined as a continuous relationship between Financial institution (the factor)
and business concern selling goods and/ or providing service (the client) 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 , thereby controlling the credit extended to the customer and also
undertaking to administer the sales ledgers relevant to the transaction.
FUNCTIONS OF THE FACTOR
These are the functions of factor:

1. Administration of Sales Ledge The factor maintains sales ledger in respect of each client. When
the sales transaction action takes place an invoice is prepared in duplicate by the client one copy is
given to customer and second copy is sent to the factor. Entries are made in the ledger on open - item
method.

Each receipt is matched against the specific invoice. Periodic reports are sent by factor to the client
with respect to current status of receivables and amount received from customers. Depending upon
the volume of transactions, the periodicity of report is decided. Thus, the entire sales ledger
administration responsibility of the client gets transferred to the factor.
2. COLLECTION OF RECEIVABLES The main functions is to collect the receivables on behalf
of the client and to relieve him from all the botheration/ problems associated with the collection. This
way the client can concentrate on other major areas of his business on one hand and reduce the cost
of collection by way of savings in labour, time and efforts on the other hand.
3. PROVISION OF FINANCE Finance, which id the life blood of a business, is made available
easily by the factor to the client. A factor purchases the book debts of his client and debts are
assigned in favour of the factor. 75 % to 80 percent of assigned debts is given as an advance to the
client by the factor.
(i) Where an agreement is entered into between the client (seller) and the factor for the purchase of
receivables without recourse, the factor becomes responsible to the seller on the date of the invoice
whether ether or not the buyer makes the payment to the factor.
4. PROTECTION AGAINST RISK This service is provided where the debts are factored without
recourse. The factor fixes the credit limits (i.e. the limit up to which the client can sell goods to
customers) in respect of approved customers and factor collect that fixed trade debt.

The factor not only relieves the client from the collection work And also advises the client on the
creditworthiness of potential customers. The credit standing of the customer is assessed by the
factors on the basis of information collected from credit rating reports, bank reports, trade reference,
financial statement.

5. Advisory Services These services arise out of the close relationship between a factor and a client.
Since the factors are better knowledge and wide experience in field of finance, and possess extensive
credit Information about customer's standing, they provide various advisory services on the matters
relating to:
(i) Customer ' s preferences regarding the clients products,

(ii) Changes in marketing policies/ strategies of the competitors.

(iii) Suggest improvements in the procedures adopted for invoicing, delivery and sales return.

(iv) Helping the client for raising finance from banks/ financial institutions, etc.

TYPES OF FACTORING

A number of factoring arrangements are possible depending upon the agreement reached between the
selling firm and the factor. The most common feature of practically all the factoring transactions is
collection of receivables and administration of sale ledger. However, following are some of the
important types of factoring arrangements.

(i). Recourse and Non - recourse Factoring In a recourse factoring arrangement, the factor has
recourse to the client (selling firm) if the receivables purchased turn out to be bad, i.e. the risk of bad
debts is to be borne by the client and the factor does not assume credit risks associated with the
receivables. Thus the factor acts as an agent for collection of bills and does not cover the risk of
customer 's failure to pay debt or interest on it. The factor has a right to recover the funds from the
seller client in case of such defaults as the seller takes the risk of credit and creditworthiness of
buyer. The factor charges the selling firm for maintaining the sales ledger and debt collection
services and also charges interest on the amount drawn by client (selling firm) for the period.

Whereas, in case of 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 and he cannot claim this amount from the selling
firm. Since the factor bears the risk of non - payment, commission or fees charged for the services in
case of non - recourse factoring is higher than under the recourse factoring. The additional fee
charged by the factor for bearing the risk of bad debts/ non - payment on maturity is called Del
credere commission.

(ii) Maturity Factoring Under this type, the factor does not provide immediate cash payment to the
client at the time of assignment of debts. He undertakes to pay cash as and when collections are
made from the debtors. The entire amount collected less factoring fees is paid to the client
immediately. Hence it is also called collection Factoring '. In fact, under this type, no financing is
involved. But all other services are available.

(iii) Bulk Factoring Under this type, the factor provides finance after disclosing the fact of
assignment of debts to the debtors concerned. This type of factoring is resorted to when the factor is
not fully satisfied with the financial condition of the client. The work relating to sales ledger
administration, credit control, collection work etc., has to be done by the client himself. Since the
notification has been made, the factor simply collects the debts on behalf of the client. This is
otherwise called as " Disclosed Factoring " or " Notified Factoring "

(iv) Agency Factoring The word agency has no meaning as far as factoring is concerned, Under this
type, the factor and the client share the work between themselves as follows:

(i) The client has to look after the sales ledger administration and collection work and

(ii) The factor has to provide finance and assume the credit risk.

(v) International Factoring Under this type, the services of a factor in a domestic business are
simply extended to international business. Factoring is done purely the basis of the invoice prepared
by the exporter. Thus, the exporter able to get immediate cash to the extent of 80% of the export
invoice under international factoring. International factoring is facilitated with the help of export
factors and import factors.

(vi) Suppliers Guarantee Factoring This type of factoring is suitable for business establishments
which sell goods through middlemen Generally goods are sold through wholesalers, retailers or
through middlemen. In such cases, the factor guarantees the supplier of goods against invoices raised
by the supplier upon another supplier. The bills are assigned in favour of the factor who guarantees
payment of those bills. This enables the supplier to earn profits without much financial involvement.

(vii) Limited Factoring Under this type, the factor does not take up all the invoices of a client. He
discounts only selected invoices on merit basis and converts credit bills into cash in respect of those
bills only.

(viii) Buyer Based Factoring In most cases, the factor is acting as an agent of the seller. But under
this type, the buyer approaches a factor to discount his bills. Thus, the initiative for factoring comes
from the buyers ' end. The approved buyers of a company approach a factor for discounting their
bills to the company in question. In such cases, the claims on such buyers are paid by discounting the
bills without recourse to the seller and the seller also gets ready cash. This facility is available only to
reputed credit worthy buyers and hence it is also called selected Buyer Based Factoring,

(ix) Seller Based Factoring Under this type, the seller, instead of discounting his bills, sells all his
accounts receivables to the factor, after invoicing the customers. The seller ' s job is over as soon as
he prepares the invoices. Thereafter, all the documents connected with the sale are handed over to the
factor who takes over the remaining functions. This facility is extended to reputed and credit worthy
sellers and hence it is also called Selected Seller Based Factoring.
MUTUAL FUNDS AND VENTURE CAPITAL MUTUAL FUND

Mutual funds have become a hot favourite of millions of people all over the world. The
driving force of mutual funds is the ‘safety of the principal’ guaranteed, plus the added advantage of
capital appreciation together with the income earned in the form of interest or dividend. People
prefer mutual funds to bank deposits, life insurance and even bonds because with a little money, they
can get into the investment game.
What is Mutual Fund

To state in simple words, a mutual fund collects the savings from small investors, invest them in
Government and other corporate securities and earn income through interest and dividends, besides
capital gain.
IMPORTENCE OF MUTUAL FUNDS
(i) DIVERSIFICATION: A large number of investors have small savings with them. They can at
the most buy shares of one or two companies. When small savings are pooled and entrusted to
mutual funds then these can be used to buy shares of many different companies. Thus, investors can
participate in a large basket of shares of different companies.

(ii) Liquidity A peculiar advantage of a mutual fund is that investment made in its schemes Can be
converted back into cash promptly without heavy expenditure on brokerage, delays, etc. According
to the regulations of SEBI, a mutual fund in India is required to ensure liquidity. For open ended
schemes, the investor can always approach the Mutual Fund to repurchase units at declared het assets
value ' (NAV). In case of close can easily be sold in the stock market. ended schemes, units.

(iii) Reduced Risk. As mutual funds invest in large number of companies and are managed
professionally, the risk factor of the investor is reduced. A small investor, on the other hand, may not
be in a position to minimise such risks.

(iv) Tax advantage. There are certain schemes of mutual funds which provide lax advantage under
the Income Tax Act. Thus, the tax liability of an investor is also reduced when he invests in these
schemes of the mutual funds.

(v) Low Operating costs. Mutual funds have large investible funds at their disposal and thus can
avail economics of large scale. This reduces their operating costs by way of brokerage, fees,
commission etc. Thus, a small investor also gets the benefit of large scale economies and low
operating costs.

(vi) Flexibility. Mutual funds provide flexible investment plans to its subscribers such as, regular
investment plans, regular withdrawal plans and dividend reinvestment plans, etc. Thus, an investor
can invest or withdraw funds according to his own requirements,
(vii) Higher Returns. Mutual funds are expected to provide higher return to the investors as
compared to direct investment because of professional management, economies of scale, reduced
risk, etc.

(viii) Investor Protection. Mutual funds are regulated and monitored by the Securities and
Exchange Board of India (SEBI). The SEBI Mutual Funds) Regulations, 1996 which have replaced
the regulations of 1993, provide better protection to the investors, impart a greater degree of
flexibility and facilitate competition.
TYPES OF MUTUAL FUNDS
(A) Close - ended Funds

Under this scheme, the corpus of the fund and its duration are prefixed. In other words, the corpus of
the fund and the number of units are determined in advance. Once the subscription reaches the pre -
determined level, the entry of investors is closed. After the expiry of the fixed period, the entire
corpus is disinvested and the proceeds are distributed to the various unit holders in proportion to their
holding. Thus, the fund ceases to be a fund, after the final distribution.
Features: The main features of the close - ended funds are:
(i) The period and/ or the target amount of the fund is definite and fixed beforehand.

(ii) Once the period is over and/ or the target is reached, the door is closed for the investors. They
cannot purchase any more units.

(iii) These units are publicly traded through stock exchange and generally, there is no repurchase
facility by the fund.

(iv) The main objective of this fund is capital appreciation.

(B) Open - ended Funds

It is just the opposite of close - ended funds. Under this scheme, the size of the fund and/ or
the period of the fund is not pre - determined. The investors are free to buy and sell any number of
units at any point of time. Anybody can buy this unit at any time and sell it also at any time at his
discretion.
The Main Features of the Open - Ended Funds are:
(i) There is complete flexibility with regard to one’s investment or disinvestment. In other words,
there is free entry and exit of investors in an open - ended fund. There is no time limit. The investor
can join in and come out from the Fund as and when he desires.

(ii) These units are not publicly traded but, the Fund is ready to repurchase them and resell them at
any time.

(iii) The investor is offered instant liquidity in the sense that the units can be sold on any working
day to the Fund.
 (iv) The main objective of this fund is income generation. The investors get dividend, rights or
bonuses as rewards for their investment.
(v) Since the units are not listed on the stock market, their prices are linked to the Net Asset Value
(NAV) of the units. The NAV is determined by the Fund and it varies from time to time.

On the Basis of Income

A) Income Funds: As the very name suggests, this Fund aims at Generating and distributing regular
income to the members on a return is higher than periodical basis. It concentrates more on the
distribution that of income and it also sees that the average the income from bank deposits.
The main features of the Income Funds are
(i) The investor is assured of regular income at periodic intervals. say half - yearly or yearly and so
on.
(ii) The main objective of this type of Fund is to declare regular dividends and not capital
appreciation. (iii) The pattern of investment is oriented towards high and fixed income yielding
securities like debentures, bonds etc.
(iv) This is best suited to the old and retired people who may not have any regular income.
(v) Il concerns itself with short run gains only.
(B) Pure Growth Funds (Growth Oriented Funds).

Unlike the Income Funds, Growth Funds concentrate mainly on long run gains i.e. capital
appreciation. They do not offer regular income and they aim at capital appreciation in the long run.
Hence, they have been described as " Nest Eggs " investments. The Main features of the Growth
Funds are.

(i) The growth oriented Fund aims at meeting the investors ' need for capital appreciation.

(ii) The investment strategy therefore, conforms to the Fund objective by investing the funds
predominantly on equities with high growth potential.

(iii) The Fund tries to get capital appreciation by taking much risks and investing on risk bearing
equities and high growth equity shares.

(iv) The fund may declare dividend, but its principal objective is only capital appreciation.

(v) This is best suited to salaried and business people who have high risk bearing capacity and ability
to defer liquidity. They can accumulate wealth for future needs.

(C) Balanced Funds: This is otherwise called " income - cum - growth " fund/. It is nothing but a
combination of both income and growth funds. It aims at distributing regular income as well as
capital appreciation This is achieved by balancing the investments between the high growth equity
shares and also the fixed income earning securities.
(D) Specialised Funds: These funds invest in a particular type of securities, these funds may
specialise in securities of companies dealing in a particular product, firms in a particular industry or
of certain income producing securities. Ant investor wanting to invest in a particular security will
prefer a fund dealing in such securities.

(E) Money - Market Mutual Funds (MMMFs): These funds are basically open ended mutual
Funds and as such they have all the features of the Open ended Fund. But, they invest in highly
liquid and safe securities like commercial paper, banker ' s acceptances, certificates of deposits,
Treasury bills etc. These instruments are called money market instruments. They take the place of
shares, debentures and bonds in a capital market. They pay money market rates of interest.

(F) Taxation Funds: A taxation fund is basically a growth oriented fund. But, it offers tax rebates to
the investors either in the domestic or foreign capital market. It is suitable to salaried people who
want to enjoy tax rebates particularly during the month of February and March In India, at present
the law relating to tax rebates is covered under Sec. 88 of the Income Tax Act, 1961. An investor is
entitled to get 20 % rebate in Income Tax for investments made under this fund subject to a
maximum investment of Rs. 10, 000/ - per annum.

OTHER CLASSIFICATION

(G) Leveraged Funds: These funds are also called borrowed funds since they are used primarily to
increase the size of the value of portfolio of a mutual fund. When the value increases, the earning
capacity of the fund also increases. The gains are distributed to the unit holders, This is resorted to
only when the gains from the borrowed funds are more than the cost of borrowed funds.

(H) Dual Funds: This is a special kind of closed end fund. It provides a single investment
opportunity for two different types of investors. For this purpose, it sells two types of investment
stocks viz., income shares and capital shares. Those investors who seek current investment income
can purchase income shares. They receive all the interest and dividends earned from the entire
investment portfolio. However, they are guaranteed a minimum annual dividend payment. The
holders of capital shares receive all the capital gains earned on those shares and they are not entitled
to receive any dividend of any type. In this respect, the dual fund is different from a balanced fund.

(I) Index Funds: Index funds refer to those funds where the portfolios are designed in such a way
that they reflect the composition of some broad based market index. This is done by holding
securities in the same proportion as the index itself. The value of these index linked funds will
automatically go up whenever the market index goes up and vice versa. (J) Bond Funds: These funds
have portfolios consisting mainly of fixed income securities like bonds. The main thrust of these
funds is mostly on income rather than capital gains. They differ from income funds in the sense
income funds offer an average returns higher than that from bank deposits and also capital gains
lesser than in equity shares.

VENTURE CAPITAL
CONCEPT OF VENTURE CAPITAL

The term ' Venture Capital ' is understood in many ways. In a narrow sense, if refers to
investment in new and tried enterprises that that are lacking a stable record of growth.

In a broader sense, venture capital refers to the commitment of capital as shareholding, for
the formulation and setting up of small firm specialising in new ideas or new technologies. It is not
merely an injection of funds into a new firm, it is a simultaneous input of skill needed to set up the
firm, design its marketing strategy and organise and manage it. It is an association with successive
stages of firm ' s development with distinctive types of financing appropriate to each stage of
development.
Meaning of Venture Capital
Venture capital is long term risk capital to finance high technology projects which involve risk but at
the same time has strong potential for growth. Venture capitalist pool their resources including
managerial abilities to assist new entrepreneurs in the Early years of the project. Once the project
reaches the stage of profitability, they sell their equity holdings at high premium.
Definition of a Venture Capital Company

A venture capital company is defined as " a financing institution which joins an entrepreneur as a co
- promoter in a project and shares the risks and rewards of the enterprise. "
Features of Venture Capital
Some of the features of venture capital financing are as under: 1. Venture capital is usually in the
form of an equity participation. It may also take the form of convertible debt or long term loan.

2. Investment is made not only in high risk but also in high growth potential projects.

3. Venture capital is available only for commercialisation of new ideas or new technologies and not
for enterprises which are engaged in trading, booking, financial services, agency, liaison work or
research and development.

4. Venture capitalist joins the entrepreneur as a co - promoter in projects and share the risks and
rewards of the enterprise.

5. There is continuous involvement in business after making an investment by the investor.

6. Once the venture has reached the full potential the venture capitalist disinvests his holdings either
to the promoters or in the market. The basic objective of investment is not profit but capital
appreciation at the time of disinvestment.

SCOPE OF VENTURE CAPITAL/ STAGES/TYPES OF VENTURE CAPITAL

Venture capital may take various forms at different stages of the project. There are four
successive stages of development of a project viz.

Development of a project idea, Implementation of the idea, commercial production and

marketing and finally large scale investment to exploit the economics of scale and achieve stability.
Financial institutions and banks usually start financing the project only at the second and third stage
but rarely from the first stage. But venture capitalist provide finance even from the first stage of idea
formulation.
The various stages in the financing of Venture Capital are described below:

1. Development Of An Idea- Seed Finance In the initial stage venture capitalist provide seed
capital for translating an idea into business proposition. At this stage investigation is made indepth
which normally takes a year or more.

2. Implementation Stage - Start up Finance: When the firm is set up to manufacture a product or
provide a service, start up finance is provided by the venture capitalists. The first and second stage
capital is used for full scale manufacturing and further business growth.

3. Fledging Stage - Additional Finance: In the third stage firm has made some headway and
entered the stage of manufacturing product but faces teething problems. It may not be able to
generate adequate funds and so additional round of financing is provided to develop the marketing
infrastructure.

4. Establishment Stage. Establishment Finance: At this stage the firm is established in the market
and expected to expand at a rapid pace. It needs further financing for expansion and diversification
so that is can reap economics of scale and attain stability. At the end of the establishment stage, the
firm is listed on the stock exchange and at this point the venture capitalist disinvests their
shareholdings through available exist routes.
LEASING
INTRODUCTION. The main objective of a business is to maximise the owner ' s economic
welfare. The firm makes investments to maximise stockholder’s wealth. After identifying attractive
projects, the firm considers various methods of financing them. In addition to debt and equity
financing, leasing has emerged as a third important source of intermediate and long - term financing
of corporate enterprises during the recent few decades.
 It is widely used in western countries to finance investments. Prior to 1950, leasing was
primarily concerned with real estate, i. c. land and buildings. But today, almost all types of fixed
assets can be leased. In India, leasing is a recent development and equipment leasing was introduced
by First Leasing Company of India Limited in 1973 only. Since then, a number of medium to large -
sized companies, financial institutions like ICICI, IRCI, SICOM and CIC have also entered the field
of leasing.

MEANING

Leasing is an arrangement that provides a firm with the use and control over assets without
buying and owning the same. It is a form of renting assets. Lease is a contract between the owner of
the asset (lessor) and the user of the asset called the lesser, whereby the lessor gives the right to use
the asset to the lessee over an agreed period of time for a consideration called the lease rental. The
lease contract is regulated by the terms and conditions of the agreement. The lessee pays the lease
Tent periodically to the lessor as regular fixed payments over a period of time. The rentals may be
payable at the beginning or end of a monthly, quarter, half - year or year. The lease rentals can also
be agreed both in terms of amount and timing as per the profits and cash flow position of the lessee.
At the expiry of the lease period, the asset reverts back to the lessor who is the legal owner of the
asset.
ESSENTIAL ELEMENTS OF LEASING

1. No. of Parties to the Contract. There are always two parties to a contract of lease financing

(a) The user or the lessee (b) The owner or the lessor.

2. Asset. The subject matter of a lease financing contract may be an asset, property equipment e.g.
plant and machinery, land and building etc.

3. Consideration. The right to use an asset is given to lessee for a consideration called lease rental.
Lease rent is determined by the lessor taking into consideration the capital invested in the asset,
depreciation, interest on capital, repairs etc.

4. Lease Period. A contract of leasing is usually undertaken for a fixed period (no. of years). It may
sometimes spread over the entire economic/ useful life of the asset. At the expiry of the lease period,
the asset reverts back to the lesser who is the legal owner of the asset.

5. Use VIS. Ownership. During the term of lease, ownership of the asset remains with the lessor
where as the possession of asset lies with the lessee. He is allowed to use the asset during the tenure
of lease agreement.
Types of Leasing 1. Operating Leasing 2. Financial Leasing
OPERATING OR SERVICE LEASE

An operating lease is usually characterised by the following features:

(i) It is a short - term lease on a period to period basis. The lease period in such a contract is less than
the useful life of the asset.

(ii) The lease is usually cancellable at short - notice by the lessee.

(iii) As the period of an operating lease is less than the useful life of the asset, it does not necessarily
amortize the original cost of the asset. The lessor has to make further leases or sell the asset to
recover his cost of investment and expected rate of return.

(iv) The lessee usually has the option of renewing the lease after the expiry of lease period.

(v) The lessor is generally responsible for maintenance, insurance and taxes of the asset. He may also
provide other services to the lessee.

As it is a short - term cancellable lease, it implies higher risk to the lessor but higher lease rentals to
the lessee Operating or service leasing is common to the equipment which require expert technical
stat for maintenance and are exposed to technological developments, e.g. computers, vehicles

FINANCIAL LEASE

A lease is classified as financial lease if it ensures the term of the lessor for amortisation of the entire
cost of investment plus the expected return on capital outlay during the term of the lease. Such a
lease is usually for a longer period and non - cancellable. As a source of funds, the financial leases is
an alternative similar to debt financing. Most of the leases in India are financial leases that are
commonly used for leasing land, building, machinery and fixed equipment.

A financial lease is usually characterised by the following features: (1) The present value of the total
lease rentals payable during the period of the lease exceeds or is equal to substantially the whole of
the fair value of the leased asset. It implies that within the lease period, the lessor recovery his
investment in the asset along with an acceptable rate of return.

(2) As compared to operating lease, a financial lease is for a longer period of time.

(3) It is usually non - cancellable by the lessee prior to its expiration date.

(4) The lessee is generally responsible for the maintenance, insurance and service of the asset.
However, the terms of lease agreement, in some cases. may require the lessor to maintain and service
the asset. Such an arrangement is called ' Maintenance or gross lease’.
(5) A financial lease usually provides the lessee an option of renewing the lease for further period at
a nominal rent.
Forms of Financial Lease arrangements:

The following are the important forms of financial lease arrangements:

(i) Sale and Leaseback. A sale and leaseback arrangement involves the sale of an asset already
owned by a firm (vendor) and leasing of the same asset back to the vendor from the buyer.

This form of lease arrangement enables a firm to receive cash from the sale of asset and also
retain the economic use of the asset in consideration of periodic lease payments. A sale and
leaseback arrangement is generally preferred by firms facing shortage of working capital funds. The
lessors engaged in sale and lease back include insurance companies, pension funds, private finance
companies and financial institutions.

(ii) Direct Leasing. In contrast with sale and leaseback, under direct leasing a firm acquires the use
of an asset that it does not already man. A direct lease may be arranged either the manufacturer
supplier directly or through the leasing company.

In the first case, the manufacturer/ supplier himself acts as the lessor while in the second case the
lessee firm arranges the purchase of the asset for the leasing company (lessor) from the manufacturer
or the supplier and also enters into an agreement with the lessor for the lease of on the asset.

(iii) Leveraged Lease. A leveraged lease is an arrangement under which the lessor borrows funds for
purchasing the asset, from a third party called lender which is usually a bank, finance company. The
loan is usually secured by the mortgage of the asset and the lease rentals to be received from the
lessee. The loan is paid back out of the lease rentals, may be directly by the lessee by paying only the
excess amounts to the lessor. The lessor acts as the owner as well as the borrower and the lender is
usually a bank insurance company financial institution or a private financing company.

(iv)Straight Lease and Modified Lease. Straight lease requires the lessee firm to pay lease rentals
over the expected service life of the asset and does not provide for any modifications to the terms and
conditions of the basic lease. Modified lease, on the other hand, provides several options to the lessee
during the lease period. For example, the option of terminating the lease may be provided by either
purchasing the asset or returning the same.

(v) Primary and Secondary Lease (Front - ended and Back - ended Lease). Under primary and
secondary lease, the lease rentals are charged in such a manner that the lesser recovers the cost of the
asset and acceptable profit during the initial period of the lease and then a secondary lease is
provided at nominal rentals. In simple words, the rentals charged in the primary period are much
more than that of the secondary period. This form of lease arrangement is also known as front -
ended and back - ended lease.

Primary Market / New Issue Market

Primary market is a market for new issues or new financial claims. Hence, it is also called
New Issue market. The primary market deals with those securities which are issued to the public for
the first time.

In the primary market, borrowers exchange new financial securities for long term funds.
Thus, primary market facilitates capital formation. There are three ways by which a company may
raise capital in a primary market.

FEATURES OF PRIMARY MARKETS

(i) This is the market for new long term equity capital. The primary market is the market where the
securities are sold for the first time. Therefore it is also called the new issue market (NIM).

(ii) in a primary issue, the securities are issued by the company directly to investors.

(iii) The company receives the money and issues new security certificates to the investors

(iv) Primary issues are used by companies for the purpose of setting up new business or for
expanding or modernizing the existing business.

(v) The primary market performs the crucial function of facilitating capital formation in the
economy.

(vi) The new issue market does not include certain other sources of new long term external finance,
such as loans from financial institutions. Borrowers in the new issue market may be raising capital
for converting private capital into public capital, this is known as " going public. "

FUNCTIONS OF NEW ISSUE MARKET A three service functions: The main functions of a new
issue sue market can divided into new project.

1. Origination.

It refers to the work of investigation analysis and processing of new project proposals.. It
starts before an issue is actually floated in the market. This function is done by merchant bankers
who may be commercial banks, all India financial institutions or private firms. At present, financial
institutions and private firms also perform this service is highly important the success of the issue
depends, to a large extent on the efficiency of the market.
2. Underwriting.

It is an agreement whereby the underwriter promises to subscribe to specified number of

shares or debentures or a specified amount of stock in the event of public not subscribing to the
issue. If the issue is fully subscribed, then there is no liability for the underwriter. If a part of share
issues remains unsold, the underwriter will buy the shares. Thus, underwriting is a guarantee for
marketability of shares. There are two types of underwriters in India - Institutional (LIC, UTI, IDBI,
ICICI) and Non - institutional are brokers.

3. Distribution.

It is the function of sale of securities to ultimate investors. This service is performed by

specialized agencies like brokers and agents who maintain a regular direct contact with the ultimate
investors.

SECONDARY MARKET

Secondary market is a market for secondary sale of securities. In other words, securities
which have already passed through the new issue market are traded in this market. Generally, such
securities are quoted the Stock Exchange and it provides a continuous and regular market to buying
and selling of securities. This market consists of all stock exchanges recognised by the Government
of India. The stock exchanges in India are regulated under the Securities Contracts (Regulation) Act
1956. The Bombay Stock Exchange is the principal stock exchange in India which sets the tone of
the other stock markets.

FUNCTIONS OF STOCK EXCHANGE

The stock exchanges play an important role in the economic development of a country.

The importance of stock exchange will be clear from the functions they perform and discussed: as
follows: provide a place where shares and stock

1. Ensure Liquidity of Capital. The stock exchanges where buyers and sellers are converted into
cash. The exchanges provide a ready market. Had are always available and those who are in need of
hard cash can sell their holdings this not been possible then many persons would have feared for
blocking their savings in Securities as they can not again convert them into cash.

2. Continuous Market for Securities. The stock exchanges provide a ready market in securities.
The securities once listed continue to be traded at the exchanges irrespective the fact that owners go
on changing. The exchanges provide a regular market for trading in securities.
3. Mobilising Surplus Savings. The stock exchanges provide a ready market for various securities.
The investors do not have any difficulty in investing their savings by purchasing shares, bonds etc,
from the exchanges. If this facility is not there then many persons who want to invest their savings
will not find avenues to do so. In this way stock exchanges play an important role in mopping up
surplus funds of investors.

4. Helpful in Raising New Capital. The new and existing concerns need capital for their activities.
The new concerns raise capital for the first time and existing units increase their capital for
expansion and diversification purposes. The shares of new concerns are registered at stock exchanges
and existing companies also sell their shares through brokers etc, at exchanges. The exchanges are
helpful in raising capital both by nets old concerns.

5. Safety in Dealings. The dealings at stock exchanges are governed by well - defined rules and
regulations of Securities Contract (Regulation) Act, 1956. There is no scope manipulating
transactions. Every contact is done according to the procedure laid down and there is no fear in the
minds of contracting parties. The safety in dealings brings confidence in the minds of all concerned
parties and helps in increasing various dealings.

6. Listing of Securities. Only listed securities can be purchased at stock exchanges. Every company
desirous of listing its securities will apply to the exchange authorities. The listing is allowed only
after a critical examination of capital structure, management and prospects of the company. The
listing of securities gives privilege to the company. The investors can form their own views about the
securities because listing a security does not guarantee the financial stability of the company.

7. Smoothens the Price Movements. A stock exchange smoothens the price movements of stocks in
the market by ensuring a continuous flow of securities,

8. Investor Protection. The stock exchange renders safeguarding activities for investors in
securities. It provides a grievance redressal mechanism for investors. Stock exchanges also operate a
compensation fund for the protection of investors.