TYBMS SEM 6 Financial: Innovation Financial Service (Q.P. April 2019 with Solution)

 Paper/Subject Code: 86005/Finance: Innovative Financial Services 

TYBMS SEM 6

Financial: 

Innovation Financial Service

(Q.P. April 2019 with Solution)

1) April 2019 Q.P. with Solution (PDF) 

2) November 2019 Q.P. with Solution (PDF)

3) April 2023 Q.P. with Solution (PDF)

NOTE: 1. All questions are compulsory subject to options.

2. Figures to the right indicate full marks.

3. Use of simple calculator is allowed.

Q.1 (A) State whether the following statements are True or False (Attempt any 7)

1. Financial services do not have physical existence.

Ans: True - Financial services are intangible and don't have a physical presence.

2. Cost of Factoring Finance cost-Operating cost

Ans: False - The cost of factoring includes finance cost and administrative costs, but there might be other costs involved as well, such as credit risk costs.

3. There are 5 types of underwriters.

Ans: False - There may be more or fewer types of underwriters depending on the context. Five types might be a simplification or specific to certain markets.

4. In Venture Capital, Mezzanine Financing is the part of Expansion capital stage. 

Ans: True - Mezzanine financing often occurs in the expansion stage of venture capital, providing a mix of debt and equity financing.

5. Revolving credit is very much like the overdraft facility provided by banks.

Ans: True - Revolving credit is similar to an overdraft in that it allows borrowing up to a certain limit, repaying, and borrowing again, similar to how an overdraft works.

6. Bills of exchange cannot be rediscounted.

Ans: False - Bills of exchange can be rediscounted, which means selling them at a discount to another party before they mature.

7. Sub broker can operate only on behalf of registered Flls. He cannot deal in securities on his own account as principal.

ANs: True - A sub-broker typically acts on behalf of registered entities and cannot trade securities on their own account.

8. Debit card is also called Electronic Cheque,

Ans: False - A debit card is not the same as an electronic check. A debit card allows direct access to funds in a bank account for purchases or withdrawals, while an electronic check is a digital version of a traditional paper check.

9. Home loan is available for purchase of land as well as improvement/extension of house.

Ans: True - Home loans can be used for various purposes related to housing, including purchasing land or improving/extending a house.

10. CRISIL is the leading credit rating agency in the world.

Ans: False - CRISIL is a prominent credit rating agency, especially in India, but it is not considered the leading credit rating agency globally. Agencies like Moody's, Standard & Poor's, and Fitch Ratings are among the most globally recognized.

(B) Match the columns (any 8)

Column “A”		Column “B”
1.	DRT	a	Hundis
2	Underwriter	b	Usance
3	Corporate counseling	c	T-bills
4	Time bills	d.	Act of guarantee for sale of shares & debentures
5	Securitisation instrument	e.	Fund based
6	Whole sale Debt Market	f.	Debt Recovery Tribunal
7	Financial Services	g.	Moody’s
8	Indigenous bills	h.	Fee Based
9	Housing Finance	i.	Mobilization of savings
10	Credit Rating Agency	j.	Pass through securities
		L	Data response tribunal

Ans: 

Column “A”		Column “B”
1.	DRT	f.	Debt Recovery Tribunal
2	Underwriter	d.	Act of guarantee for sale of shares & debentures
3	Corporate counseling	h.	Fee based
4	Time bills	b.	Usance
5	Securitisation instrument	j.	Pass through securities
6	Whole sale Debt Market	e.	Fund based
7	Financial Services	a.	Hundis
8	Indigenous bills	c.	T-bill
9	Housing Finance	i.	Mobilization of savings
10	Credit Rating Agency	g.	Moody’s

Q.2 (A) Explain any 7 draw backs of Forfeiting.

Ans: Here are 7 drawbacks of forfaiting:

1. Cost: Forfaiting is generally more expensive than traditional financing options like letters of credit or loans from banks. This is because forfaiting companies take on the risk of buyer default and need to be compensated for it. The cost is often passed on to the importer through higher pricing on the goods.

2. Limited Scope: Forfaiting typically applies to large-scale transactions with a high value (often exceeding $100,000). Smaller businesses or those dealing in lower-value goods may not find forfaiting to be a viable option.

3. Limited Availability of Currencies: Forfaiting companies often only deal with currencies with high international liquidity. This can be a disadvantage for exporters selling to countries with less common currencies.

4. Increased Dependence: While forfaiting offers benefits like immediate cash flow, it can also lead to an over-reliance on this method. This can make exporters less flexible and responsive to changing market conditions.

5. Regulatory Differences: Forfaiting is not always subject to the same level of regulation as traditional financing methods. This can introduce some uncertainty and risk for exporters.

6. Not Suitable for All Transactions: Forfaiting typically works best for transactions with fixed payment terms. It's not suitable for situations where payment is deferred or contingent on certain events.

7. Potential for Discrimination: Some forfaiting companies may be less willing to work with businesses from developing countries compared to developed economies. This can limit access to forfaiting for exporters in those regions.

(B)What are financial services? Explain any 6 Fund based financial services.

Ans: 

Financial Services

Financial services are the broad range of economic activities provided by financial institutions that help manage money. These institutions act as intermediaries between those with surplus funds (savers) and those who need funds (borrowers). They offer a variety of products and services to facilitate financial transactions, manage risk, and achieve financial goals. Here are some key functions of financial services:

• Mobilization of Savings: Financial institutions collect savings from individuals and businesses through deposits, insurance premiums, etc.
• Channeling of Funds: They channel these collected funds to those who need them, such as businesses through loans, or individuals through mortgages.
• Risk Management: Financial services help manage risks associated with money, like investment risks or credit risks, through tools like insurance and diversification.
• Payment Systems: They facilitate efficient and secure transfer of funds through various payment mechanisms like checks, electronic transfers, etc.
• Financial Advice: Many institutions offer financial planning and investment advice to help individuals and businesses make informed financial decisions.

6 Fund-Based Financial Services:

Fund-based financial services involve the lending of money by a financial institution. Here are six examples:

1. Loans: This is the most common type of fund-based service. Banks and other lenders offer various loan products like personal loans, auto loans, mortgages, and business loans. These loans provide borrowers with funds upfront, which they repay with interest over time.

2. Leasing: In leasing, the financial institution (lessor) owns an asset and grants a company (lessee) the right to use it for a specific period in exchange for lease payments. At the end of the lease term, the lessee may have the option to purchase the asset.

3. Bill Discounting: Businesses often sell invoices (bills) to a financial institution at a discounted rate to receive immediate cash flow. The financial institution then collects the full amount from the debtor.

4. Factoring: Similar to bill discounting, factoring involves selling accounts receivable (outstanding invoices) to a financial institution at a discount. The factor takes on the responsibility of collecting the debt from the customers.

5. Venture Capital Financing: Venture capital firms provide funding to startups and early-stage businesses with high growth potential. This funding typically comes in the form of equity investments or convertible debt.

6. Housing Finance: Financial institutions like banks offer mortgages, which are loans specifically designed to finance the purchase of real estate. These loans are secured by the property itself, meaning the lender can repossess the property if the borrower defaults on the loan.

These are just a few examples, and there are many other fund-based financial services available depending on the specific needs of borrowers and lenders.

OR

2.(A) Ruby factors advances Rs. 27 lakhs to Pearl Enterprise against agreement of providing advance payment of 90% of receivables and for guaranteed payment after 3 months. The rate of Interest is 10% compounded quarterly and factoring commission is 2% of receivables. Both collected upfront 

a. Compute amount actually made available to Pearl Enterprise.

b. Calculate effective cost of funds made available to Pearl Enterprise

c. Assume interest is collected in arrear and commission in advance, what will be the effective rate of Interest

Ans: 

(a) Amount Available to Pearl Enterprise

Step 1: Calculate Factoring Commission

Factoring commission = 2% * Rs. 27,00,000 (receivables) = Rs. 54,000

Step 2: Subtract Commission from Advance Amount

Amount available to Pearl Enterprise = Rs. 27,00,000 (advance) - Rs. 54,000 (commission) = Rs. 26,46,000

Therefore, Rs. 26,46,000 is actually made available to Pearl Enterprise.

(b) Effective Cost of Funds

Step 1: Calculate Interest Rate per Quarter

Interest rate per quarter = 10% (annual rate) / 4 (quarters per year) = 2.5%

Step 2: Calculate the Number of Quarters

We know the time period is 3 months. Assuming 30 days per month, this translates to:

Number of quarters = 3 months / 3 months/quarter = 1 quarter

Step 3: Find the Future Value

Future value of amount available = Rs. 26,46,000 * (1 + 0.025)¹ = Rs. 27,10,900 (rounded to nearest rupee)

Step 4: Calculate Effective Cost

Effective cost = (Future value - Amount available) / Amount available = (Rs. 27,10,900 - Rs. 26,46,000) / Rs. 26,46,000 = 0.0249 (rounded to four decimal places)

Therefore, the effective cost of funds is approximately 2.49%.

(c) Effective Rate Considering Interest in Arrear

Since interest is collected in arrear (at the end), we need to consider it for calculating the effective rate. Here's how:

Step 1: Find Effective Cost as before (already calculated in b)

Effective cost = 0.0249

Step 2: Calculate Effective Rate per Quarter

(1 + Effective cost per quarter)^4 - 1 = Effective rate per year (compounded annually)

We already know the effective cost per quarter is 0.0249.

(1 + 0.0249)⁴ - 1 ≈ 0.1038 (rounded to four decimal places)

Therefore, the effective rate of interest considering interest in arrear is approximately 10.38% per year.

Note: This is slightly higher than the nominal rate (10%) because interest is compounded and collected at the end.

(B)What are the qualities of Merchant bankers

Ans: Here are some key qualities of merchant bankers:

Technical Skills and Knowledge:

• Financial Analysis: Strong ability to analyze financial statements, assess risks and opportunities, and make sound financial recommendations.
• Capital Markets Expertise: Deep understanding of capital markets, including equity and debt financing instruments, mergers and acquisitions, and international finance.
• Valuation Skills: Competency in valuing companies and assets using various valuation methodologies.
• Regulatory Knowledge: Up-to-date knowledge of financial regulations and compliance requirements.

Interpersonal and Business Skills:

• Relationship Building: Excellent networking and communication skills to build strong relationships with clients, investors, and other financial professionals.
• Negotiation Skills: Ability to negotiate effectively on behalf of clients and secure the best possible terms for transactions.
• Problem-Solving Skills: Capacity to identify and solve complex financial problems creatively and efficiently.
• Presentation Skills: Ability to present complex financial information clearly and persuasively to a variety of audiences.

Professional Qualities:

• Integrity and Ethics: Upholding the highest ethical standards and acting with integrity in all dealings.
• Confidentiality: Maintaining client confidentiality and safeguarding sensitive information.
• Commercial Acumen: Strong business sense and understanding of commercial realities.
• Innovation and Creativity: Ability to develop innovative solutions and adapt to changing market conditions.

Additional Qualities:

• International Exposure: In today's globalized world, experience working in international markets can be a valuable asset.
• Industry Knowledge: Having specialized knowledge in specific industries can be beneficial for attracting clients in those sectors.

Q.3 (A) What is a Clearing member? Explain its functions and types of Clearing members.

Ans: 

Clearing Member 

A clearing member acts as an intermediary between a trading member (broker) and a clearing house in the financial markets. They play a crucial role in ensuring the smooth settlement of trades by guaranteeing the financial obligations of their clients (trading members).

Here are the key functions of a clearing member:

• Clearing: Calculating the net buy/sell positions of their clients for each security after a trading day.
• Settlement: Guaranteeing the settlement of trades by their clients, ensuring timely delivery of securities and funds. This may involve holding collateral or margin deposits from clients.
• Risk Management: Monitoring their clients' trading activity and managing their risk exposure by setting position limits and collecting margin deposits.
• Reporting: Preparing and submitting trade reports and other required information to the clearing house and relevant regulatory bodies.

Types of Clearing Members

There are different types of clearing members depending on their roles and activities:

• Self-clearing member: These members clear and settle only their own trades, acting as both broker and clearing member. This is typically seen with larger investment firms.
• Trading member-cum-clearing member (TCM): These members act as both brokers and clearing members, facilitating trades for their clients and handling the clearing and settlement process. They can also clear and settle trades for other trading members who are not clearing members themselves.
• Professional clearing member (PCM): These members specialize in clearing and settlement services for other trading members who are not clearing members themselves. They do not have their own brokerage activities.

The specific types of clearing members allowed and their requirements may vary depending on the regulations of the clearing house and the financial market they operate in.

(B)Explain the process of securitization with the help of the diagram

Ans: 

Securitization Process Explained with a Diagram

Securitization is the process of transforming illiquid assets (like loans, mortgages, etc.) into tradable securities (financial instruments) that can be sold to investors. Here's a breakdown of the process with a corresponding diagram:

1. Originator:

• The process starts with an originator who holds a pool of financial assets that generate cash flow (e.g., a bank with a portfolio of mortgages).

2. Asset Pool Formation:

• The originator groups these assets into a pool, selecting assets with similar characteristics and risk profiles.

3. Special Purpose Vehicle (SPV):

• A new legal entity called a Special Purpose Vehicle (SPV) is created specifically for this transaction. The SPV is typically a bankruptcy-remote trust with no other assets or liabilities.

4. Asset Transfer:

• The originator transfers ownership of the asset pool to the SPV. This isolates the assets from the originator's balance sheet and reduces their risk exposure.

5. Credit Enhancement (Optional):

• In some cases, credit enhancements may be used to improve the creditworthiness of the resulting securities. This could involve:
  • Tranches: Structuring the pool into different tranches with varying risk profiles (senior/junior). Senior tranches receive principal and interest payments first, offering lower returns but higher safety. Junior tranches offer higher potential returns but bear the first losses if there are defaults in the underlying assets.
  • Guarantees: Obtaining a guarantee from a third party (e.g., an insurance company) to cover potential losses on the securities.

6. Issuance of Securities:

• The SPV uses the asset pool as collateral to issue securities (bonds, notes, etc.) with different risk-return profiles.

7. Investors:

• Investors purchase these securities based on their risk tolerance and desired return. Investors receive principal and interest payments from the cash flow generated by the underlying assets.

8. Servicer:

• A servicer is typically appointed to collect payments from the original borrowers on the underlying assets. The servicer then forwards the collected funds to the SPV to make payments to investors according to the terms of the issued securities.

Diagram:

         Originator  ---------> Asset Pool
                  |
                  v
              Special Purpose Vehicle (SPV)
                  |
                  v (Optional)
              Credit Enhancement (Tranches/Guarantees)
                  |
                  v
              Securities Issuance (Bonds, Notes)
                  |
                  v
              Investors
                  |
                  v
                  Servicer
                      |
                      v
             Underlying Asset Borrowers (Payments)

Benefits of Securitization:

• Originators: Can free up capital for new lending activities and potentially improve their risk profile.
• Investors: Gain access to a wider range of investment opportunities with varying risk-return profiles.
• Overall Market: Increases liquidity in the financial system and allows for more efficient allocation of capital.

OR

Q.3 (A) Define Lease. Explain any 6 types of Lease

Ans: 

Lease Definition

A lease is a legal contract between two parties:

• Lessor: The owner of an asset (land, property, equipment, etc.) who grants temporary use of the asset to another party.
• Lessee: The party who acquires the right to use the asset for a specified period in exchange for periodic payments (rent).

The lease agreement outlines the terms and conditions of the arrangement, including:

• Duration: The length of time the lessee can use the asset.
• Rent: The periodic payment made by the lessee to the lessor.
• Maintenance: Responsibilities for maintaining and repairing the asset during the lease term.
• Termination: Conditions under which the lease can be terminated early by either party.

6 Types of Leases

There are various types of leases, each with its own characteristics and implications for both lessor and lessee. Here are six common types:

1. Operating Lease:

   • This is a short-term lease (typically 1-3 years) where the lessor retains most of the risks and rewards of ownership.
   • The lease payments typically cover only a portion of the asset's cost, with the lessor depreciating the asset over its useful life.
   • The lessee is usually not responsible for maintenance and repairs.
   • Example: Leasing office equipment like computers or printers.

2. Financing Lease:

   • This is a long-term lease (often close to the asset's economic life) that is similar to a loan with ownership transfer implications.
   • The lease payments are structured to cover the asset's cost and a return on investment for the lessor.
   • The lessee is often responsible for maintenance and repairs.
   • At the end of the lease term, the lessee may have the option to purchase the asset for a nominal amount.
   • Example: Leasing a car through a financing lease can be seen as an alternative to an auto loan.

3. Capital Lease:

   • Similar to a financing lease, a capital lease is treated as a debt obligation on the lessee's balance sheet for accounting purposes.
   • The criteria for classifying a lease as a capital lease can vary depending on accounting standards.
   • The key factors typically include the lease term relative to the asset's life, the purchase option, and the present value of the lease payments compared to the asset's cost.

4. Sale and Leaseback:

   • This is a transaction where a company sells an asset they own to a lessor and then leases it back for use.
   • This can be a way for a company to raise capital while still retaining use of the asset.
   • The company receives a lump sum upfront but loses ownership of the asset.

5. Triple Net Lease (NNN Lease):

   • In this type of lease, the lessee is responsible for most, if not all, of the property-related expenses beyond the base rent.
   • These expenses typically include property taxes, insurance, and maintenance.
   • This type of lease is often used for commercial properties where the lessee has more control over the property.

6. Gross Lease:

   • This is the opposite of a triple net lease, where the lessor is responsible for all property-related expenses, including taxes, insurance, and maintenance.
   • The rent paid by the lessee is typically higher than in a net lease to cover these costs.

B) Explain the issues in Housing Finance Sector

Ans: The housing finance sector plays a crucial role in facilitating homeownership and driving economic growth. However, it also faces several challenges that can impact both borrowers and lenders. Here are some of the key issues in the housing finance sector:

1. Affordability:

• Rising property prices and stagnant wages can make it difficult for many people to afford a home, especially for first-time buyers.
• This can lead to a decrease in demand for housing loans and hinder overall market growth.

2. Availability of Funds:

• Housing finance institutions (HFIs) may face limitations in accessing long-term funds, which are crucial for providing long-term mortgages.
• This can restrict the availability of housing loans, particularly for lower-income borrowers.

3. Asset-Liability Mismatch:

• Some HFIs may rely heavily on short-term borrowings to fund long-term loans.
• This creates an asset-liability mismatch, making them vulnerable to interest rate fluctuations and potential liquidity issues.

4. Regulatory Burden:

• Excessive regulations can increase the cost and complexity of providing housing finance.
• This can discourage some lenders from entering the market and limit loan options for borrowers.

5. Creditworthiness of Borrowers:

• In some cases, lax credit assessment practices can lead to defaults on housing loans.
• This can increase the risk profile for lenders and potentially lead to higher interest rates for borrowers.

6. Lack of Standardization:

• The housing finance market may lack standardization in loan products, documentation, and foreclosure processes.
• This can create confusion for borrowers and make it difficult to compare loan options.

7. Information Asymmetry:

• Borrowers may not have access to all the necessary information to make informed decisions about housing loans.
• This can lead to borrowers taking on loans they cannot afford or choosing inappropriate loan products.

8. Technological Integration:

• The housing finance sector may not be fully utilizing technology to streamline processes and improve efficiency.
• This can lead to delays in loan approvals and higher administrative costs for lenders.

9. Macroeconomic Factors:

• Economic downturns and rising interest rates can negatively impact the housing market and increase the risk of defaults for borrowers.
• This can lead to reduced lending activity and potential instability in the housing finance sector.

10. Limited Focus on Affordable Housing:

• In some cases, there may be a lack of focus on providing financing solutions for affordable housing options.
• This can further restrict access to homeownership for low- and middle-income earners.

Addressing these issues requires a collaborative effort from various stakeholders, including government agencies, financial institutions, and industry bodies. By promoting financial literacy, implementing prudent regulations, and fostering innovation, the housing finance sector can play a more effective role in supporting sustainable homeownership and economic development.

4 (A) Explain the features of Venture Capital

Ans: Venture capital (VC) is a specific type of financing that focuses on high-growth, early-stage businesses with significant potential for long-term capital appreciation. Here are some key features of venture capital:

Investment Focus:

• Early-Stage: VC firms typically invest in startups and young companies that are still developing their products or services. These companies may not yet have a proven track record of profitability but demonstrate high growth potential and disruptive innovation.
• High-Risk, High-Reward: VC investments are inherently risky due to the early stage of the companies involved. There's a significant chance of failure, but successful ventures can generate substantial returns for investors.
• Equity or Convertible Debt: VC firms primarily invest through equity financing (owning shares in the company) or convertible debt (debt that can be converted into equity later). This allows them to share in the potential upside of the company's growth.

Investment Process:

• Rigorous Due Diligence: VC firms conduct thorough due diligence on potential investments, evaluating the business model, management team, market opportunity, and competitive landscape. This helps them identify promising ventures with a strong chance of success.
• Active Involvement: VC firms go beyond simply providing capital. They often offer valuable guidance, mentorship, and access to their networks to help portfolio companies grow and succeed. This "hands-on" approach is a key feature of venture capital.
• Long Investment Horizon: VC investments typically have a long investment horizon (5-10 years or more). This allows VC firms to support companies through their development stages and maximize their potential for growth before seeking an exit through an acquisition or initial public offering (IPO).

Investor Profile:

• Institutional Investors: VC funds are typically backed by institutional investors like pension funds, insurance companies, and high-net-worth individuals seeking high-risk, high-return investment opportunities.
• Limited Partners: Individual investors participate in VC funds as limited partners, providing capital but not actively managing the investments. The VC firm acts as the general partner, managing the fund and making investment decisions.

(B) Explain the reasons for growth of Consumer Finance.

Ans: The growth of consumer finance can be attributed to a confluence of factors that have made borrowing and accessing credit more accessible and appealing to consumers. Here are some key reasons for this growth:

1. Rising Disposable Income and Economic Growth:

• As economies grow, disposable income (income remaining after essential expenses) tends to rise. This gives consumers more financial leeway to take on debt for discretionary purchases or investments.
• A strong economy also fosters consumer confidence, making them more likely to borrow for financing purchases like homes or cars.

2. Increased Access to Credit:

• Technological advancements have streamlined the loan application and approval process, making it easier and faster for consumers to access credit.
• The rise of online lenders and fintech companies has created more competition in the market, leading to more attractive loan terms and wider product offerings for consumers.
• Alternative credit scoring methods are being explored, expanding access to credit for those who may not have a traditional credit history.

3. Changing Consumer Preferences:

• Consumers are increasingly shifting towards a consumption-driven lifestyle, opting for immediate gratification rather than saving for large purchases.
• Easy access to credit allows them to finance these purchases and spread out the cost over time.
• Marketing and advertising campaigns often promote credit cards and other financing options, influencing consumer behavior.

4. Government Initiatives:

• In some cases, governments may implement policies to encourage consumer spending, such as tax breaks on interest payments for certain loans.
• This can further stimulate the demand for consumer credit.

5. Evolving Product Offerings:

• Financial institutions are constantly developing new and innovative consumer finance products tailored to specific needs and demographics.
• This creates a wider range of options for consumers, making it easier to find financing solutions that fit their individual circumstances.
• Examples include point-of-sale financing, personal loans for specific purposes like education or home improvement, and buy-now-pay-later (BNPL) options.

6. Financial Inclusion:

• Expanding access to financial services, including credit, can be a powerful tool for promoting financial inclusion, especially for low- and middle-income populations.
• Access to credit can help them build assets, invest in their future, and weather unforeseen financial difficulties.

OR

4(A) What is Smart card? Explain 5 features of Smart Cards.

Ans: A smart card is a small plastic card, similar in size to a credit card, that contains an embedded microchip. This chip allows the card to store and process data, making it more secure and versatile than traditional magnetic stripe cards. Here are five key features of smart cards:

1. Enhanced Security: Smart cards use cryptographic algorithms and secure communication protocols to protect data from unauthorized access. Unlike magnetic stripe cards, which can be easily copied, the data on a smart card is encrypted and can only be accessed with the correct PIN or other authentication method.

2. Multifunctionality: Smart cards can hold multiple applications on a single card. For example, a single card could be used for debit, credit, and identification purposes. This eliminates the need to carry multiple cards and simplifies transactions.

3. Processing Power: The embedded microchip allows for on-card processing of transactions. This can improve efficiency and security, as some calculations and validations can be done on the card itself rather than relying solely on a central server.

4. Durability: Smart cards are more resistant to wear and tear compared to magnetic stripe cards. The chip is embedded within the card and protected from physical damage, while magnetic stripes can degrade over time.

5. Programmability: Smart cards can be reprogrammed with new applications or updated security features. This makes them adaptable to changing needs and technologies. For example, a transit card could be updated with additional fare options or security patches.

These are just some of the key features of smart cards. They offer a secure, convenient, and flexible way to store and manage data, making them valuable tools in various applications such as financial transactions, identity verification, access control, and more.

(B) Describe the process of credit rating.

Ans: The credit rating process involves a credit rating agency (CRA) assessing the creditworthiness of a borrower, typically an individual, company, or government. This assessment translates into a credit rating, which is a symbolic representation of the borrower's ability to repay debt on time and in full. Here's a breakdown of the typical credit rating process:

1. Rating Request:

• The process often starts with a rating request. This can be initiated by the borrower (issuer) who wants a credit rating for a bond issuance or loan application.
• In some cases, a regulatory body may require a credit rating for specific financial instruments or entities.

2. Information Gathering:

• Once a rating request is received, the CRA gathers information about the borrower. This may include:
  • Financial Statements: Historical and projected financial statements like income statements, balance sheets, and cash flow statements.
  • Management Experience: Evaluation of the borrower's management team, their track record, and industry expertise.
  • Industry Analysis: Understanding of the economic and competitive environment in which the borrower operates.
  • Collateral Information: If applicable, details about any assets pledged as security for a loan.

3. Credit Analysis:

• The CRA analysts then perform a thorough credit analysis using various financial ratios, risk assessment models, and industry benchmarks.
• They evaluate factors like the borrower's debt levels, profitability, cash flow generation, and overall financial health.
• The analysis also considers qualitative factors like management's strategy, corporate governance practices, and the regulatory environment.

4. Rating Committee:

• The credit analysts present their findings and recommendations to a rating committee composed of senior analysts.
• The committee deliberates and discusses the analysis before assigning a final credit rating.

5. Rating Issuance and Dissemination:

• The CRA then issues a credit rating report that details the assigned rating, along with the rationale and key factors influencing the decision.
• This report is typically made available to the borrower, investors, and other interested parties.

6. Rating Monitoring:

• Credit ratings are not static. The CRA continues to monitor the borrower's financial performance and economic conditions that may affect their creditworthiness.
• If there are significant changes, the CRA may revise the credit rating through a rating update or downgrade.

Q.5 (A) Discuss the Stages of venture capital Finance

Ans: Venture capital funding typically involves several stages, each catering to companies at different points in their development and carrying varying levels of risk and return potential for investors. Here's a breakdown of the common stages of venture capital finance:

1. Pre-Seed Stage (or Bootstrapping):

• This is the earliest stage, where the company is still in the idea phase or developing a prototype.
• Funding typically comes from the founders' personal savings, friends, family, or angel investors.
• The focus is on validating the business concept, building a minimum viable product (MVP), and testing market fit.

2. Seed Stage:

• Once the company has some initial traction with their MVP, they may seek seed funding.
• Seed capital helps refine the product, build a core team, and conduct initial marketing efforts.
• Investment amounts are typically smaller than in later stages, and risk for investors remains high.

3. Early Stage:

• In this stage, the company has a proven concept and demonstrates a clear path to profitability.
• Early-stage funding helps with product development, scaling operations, and customer acquisition.
• Investors look for strong market potential, a solid management team, and a clear go-to-market strategy.

4. Growth Stage (or Expansion Stage):

• Growth-stage companies have a successful product or service in the market and are experiencing rapid growth.
• Funding at this stage fuels expansion into new markets, product development initiatives, and potential acquisitions.
• Investment amounts are significantly larger than in earlier stages, and the risk profile becomes more attractive for investors.

5. Later Stage (or Pre-IPO):

• Later-stage companies are established players in their market and may be considering an initial public offering (IPO) or acquisition.
• Funding helps with further expansion, strategic partnerships, and potential debt repayment.
• Investors at this stage are primarily focused on maximizing their return on investment before the company goes public.

Additional Considerations:

• Bridge Financing: This can occur between stages to address specific needs like product development or market entry into a new territory.
• Mezzanine Financing: This hybrid debt-equity financing can be used in later stages to provide additional capital without significant dilution for existing shareholders.

(B)The Vibhu Transport itd, purchased Truck from, the Hindustan Motors Ltd. on Hire Purchase basis The Cash price of the truck was Rs 16,00,000 The amounts were payable as under

Rs. 5,00,000 on the date of purchase 1e 1st Apr, 2012

Rs. 4,00,000 on 31st March 2013

Rs. 4,00,000 on 31st March 2014

Rs. 4,12,390 on 31st March 2015 

The Hindustan Motors Ltd, charged interest at 5% pa on the unpaid amount on the Diminishing balance each year. It closes its account on 31st March every year.

You are required to prepare Hindustan Motor Ltd A/c and interest according to credit purchase method.

Ans: 

Hindustan Motors Ltd A/c (Hire Purchase)

Date	Particulars	Debit (Rs.)	Credit (Rs.)	Balance (Rs.)
01-Apr-2012	Cash		5,00,000	11,00,000 (Dr)
31-Mar-2013	Interest A/c	55,000		10,45,000 (Dr)
31-Mar-2013	Cash		4,00,000	6,45,000 (Dr)
31-Mar-2014	Interest A/c	32,250		6,12,750 (Dr)
31-Mar-2014	Cash		4,00,000	2,12,750 (Dr)
31-Mar-2015	Interest A/c	10,637.50		2,02,112.50 (Dr)
31-Mar-2015	Cash		4,12,390	- (Cr)

Calculations:

• Opening Balance (01-Apr-2012): Cash Price (Rs. 16,00,000) - Down Payment (Rs. 5,00,000) = Rs. 11,00,000 (Dr)
• Interest Calculation (31-Mar-2013): Unpaid Balance (Rs. 11,00,000) * Interest Rate (5%) = Rs. 55,000

Explanation:

This account shows the transactions related to the hire purchase of a truck by Vibhu Transport Ltd. from Hindustan Motors Ltd. The account is prepared using the credit purchase method, where all purchases are recorded at their gross invoice price.

• Cash payments are debited to the account, reducing the outstanding balance.
• Interest expense is calculated on the diminishing balance each year and debited to the Interest A/c. This reflects that interest is charged only on the remaining unpaid amount.
• Finally, the cash payment in the last year settles the complete outstanding balance, resulting in a zero balance.

Note:

• This solution assumes a 365-day year for simplicity in interest calculations.
• Additional accounts like Interest A/c and Vibhu Transport Ltd A/c would be required for a complete picture.

OR

(A) Write a Short notes on (Any Three)

1. Recourse & Non-Recourse Factoring

Ans: 

Recourse Factoring:

• In recourse factoring, the business (seller) remains responsible for collecting payment from their customer (debtor) even after selling the invoice to the factoring company.
• The factor advances a portion (typically 70-85%) of the invoice value upfront, with the remaining amount withheld as a reserve to cover potential bad debts.
• If the customer fails to pay, the business is obligated to repay the factoring company for the advanced amount.
• Advantages:
  • Easier to qualify for (less stringent requirements)
  • Lower factoring fees
• Disadvantages:
  • Business retains the risk of non-payment
  • Can impact cash flow if customer payments are slow

Non-Recourse Factoring:

• In non-recourse factoring, the factoring company assumes the risk of customer non-payment.
• The business sells the invoice outright and receives a fixed percentage of the invoice value upfront (typically 80-90%).
• The factor takes on the responsibility of collecting payment from the customer.
• Advantages:
  • Business eliminates the risk of bad debts
  • Improves cash flow predictability
• Disadvantages:
  • More difficult to qualify for (stricter requirements, good customer credit history)
  • Higher factoring fees due to the risk transfer

Choosing Between Recourse and Non-Recourse:

• The choice depends on your risk tolerance and cash flow needs.
• If you have a strong customer base and prioritize lower costs, recourse factoring might be suitable.
• If managing bad debt risk and immediate cash flow are critical, non-recourse factoring could be a better option.

2. Banker to an Issue. 

Ans; A Banker to the Issue is a bank that acts as an intermediary between a company issuing new securities (IPO) and investors. They handle various crucial tasks to ensure a smooth issuance process. Here's a short description of their role:

• Application & Money Handling: They receive applications and collect application money from investors for the new securities.
• Allotment & Refund: They process allotment of shares or other securities to successful investors and ensure timely refunds for unsuccessful applicants.
• Regulatory Compliance: They ensure adherence to regulations set by financial authorities regarding the issuance process.
• Account Management: They manage accounts related to the issue, including escrow accounts for holding application money.
• Communication Link: They act as a communication channel between the issuer company and investors regarding the offering.

3. National Housing Bank

Ans: The National Housing Bank (NHB) is the apex regulatory body for housing finance companies (HFCs) in India. Established in 1988 under the National Housing Bank Act, 1987, it plays a pivotal role in promoting a stable and inclusive housing finance market in the country.

Here are some key points about NHB:

• Regulatory Body: NHB licenses and regulates HFCs, ensuring they operate prudently and maintain sound financial practices.
• Promoting Housing Finance: It promotes the development of housing finance institutions, especially for priority sectors like low- and middle-income housing.
• Refinancing: NHB provides refinance facilities to HFCs, enabling them to offer long-term housing loans at competitive interest rates.
• Promotional Activities: NHB undertakes various promotional activities to raise awareness about housing finance options and encourage homeownership.
• Research & Development: It conducts research studies and disseminates information on the housing finance sector.

4. Option contract

Ans: An option contract is a financial agreement between two parties, a buyer and a seller. It grants the buyer the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset (stock, bond, commodity, etc.) at a predetermined price (strike price) by a specific expiry date.

Here are some key points about option contracts:

• Flexibility: Options offer investors flexibility to potentially profit from price movements in the underlying asset without owning it outright.
• Limited Risk: The buyer's risk is limited to the option premium (fee paid to the seller).
• Unlimited Profit Potential: The potential profit for the buyer is theoretically unlimited (for in-the-money options at expiry).
• Risk for Seller (Writer): The seller (option writer) has unlimited potential loss but receives a premium upfront.

Option contracts are used for various purposes, including:

• Hedging: To protect existing holdings from price fluctuations.
• Speculation: To profit from anticipated price movements.
• Income generation: By selling options (premium income).

Understanding option contracts requires knowledge of option greeks (measures of option price sensitivity). Options can be complex instruments, and it's crucial to carefully evaluate risks and rewards before entering into an option contract.

5. Bill Market Scheme 1970

Ans: 

The Bill Market Scheme 1970 was introduced by the Reserve Bank of India (RBI) to address the shortcomings of the previous Bill Market Scheme launched in 1952. Here's a quick overview:

• Background: The 1952 scheme aimed to develop a vibrant market for bills of exchange (short-term commercial debt instruments) but faced limited success.
• Objective: The 1970 scheme aimed to revitalize the bill market by making it more attractive for banks to utilize bill financing.
• Key Features:
  • Eligible Participants: All scheduled commercial banks could participate in the scheme by offering bills of exchange for rediscounting with the RBI.
  • Rediscounting: Banks could sell their bills to the RBI before maturity at a discounted rate, improving their liquidity.
  • Focus on Genuine Trade Bills: The scheme emphasized using bills generated from actual trade transactions, reducing reliance on converted loans.

Impact: While the 1970 scheme achieved some improvement in bill usage, it didn't fully achieve its goal of creating a robust bill market in India. Some reasons for this include:

• Competition from Other Instruments: Banks found alternative financing methods like cash credit more convenient.
• High Stamp Duty: The stamp duty on bills remained a deterrent to wider adoption.
• Limited Acceptance: Businesses may not have readily accepted bills of exchange as a payment method.

Legacy: Although the Bill Market Scheme 1970 ultimately did not transform the Indian financial landscape, it highlights efforts by the RBI to promote efficient short-term financing mechanisms.