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

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

 TYBMS SEM 6

 Financial:

 Innovation Financial Service

(Q.P. November 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.

Q1 A) Multiple choice questions (Attempt any 8 out of 10):    (8)

1) The quality of financial service rendered changes from customer to customer. This characteristic of financial services is called ________.

(a) Perishability

(b) Variability

(c) Intangibility 

(d) Inseparability

2) The owner of the equipment in a lease contract is called,

(a) Lender 

(b) Lessor 

(c) Lessee 

(d) Buyer

3) The regulator of Housing Finance Companies is

(a) RBI 

(b) HUDCO 

(c) NHB 

(d) HDFC

4) A Clearing member who is not a Trading member is called

(a)Trading member 

(b) Trading cum self clearing member 

(c) Trading cum clearing member 

(d) Professional clearing member

5) To act as a underwriter, Certificate of Registration must be obtained from

(a) SEBI 

(b) RBI 

(c) Ministry of Finance 

(d) Ministry of Corporate Affairs

6) The order which if not traded will remain in the system till it is cancelled or the series expires, whichever is earlier is called as 

(a) Good for Day 

(b) Good till Cancelled 

(c) Good till date 

(d) Limit Order

7) is the process of converting illiquid, non-negotiable financial assets into securities of small value which are tradable.

(a) Consumer Finance

(b) Hire Purchase 

(c) Securitization 

(d) Credit Rating

8) Credit card facility is an excellent example of

(a) Cash credit 

(b) Revolving credit 

(c) Secured credit 

(d) Term loan

9) Venture capital involves _______level of risk.

(a) No 

(b) Low 

(c) Medium 

(d) High

10) The first credit rating agency in India is

(a) ICICI 

(b) CRISIL 

(c) CARE 

(d) ICRA

B) State whether the following statements are True or False (Attempt any 7):    (7)

1) Forfaiting is a non-fund based facility.

Ans: True

2) Venture capital helps to create entrepreneurs.

Ans: True

3) Factoring service is provided only for a specific bill of exchange.

Ans: False

4) Bills discounting is a without recourse transaction.

Ans: True

5) Merchant banking business is regulated by SEBI.

Ans: True

6) By selling off loans through securitization, banks are able to improve their capital adequacy ratio.

Ans: True

7) Debit card allows the customers to spend today and pay tomorrow.

Ans: False

8) Credit score shows the creditworthiness of a borrower.

Ans: True

9) The ALM process rests on three pillars ALM Information System, ALM organization and ALM Process. 

Ans: True

10) In Instalment Sale, the ownership of the asset is transferred to the buyer immediately at the time of sale.

Ans: False

Q2 A) What is forfaiting? Explain its benefits. 

Forfaiting is a trade finance technique used by exporters to obtain cash by selling their medium- to long-term foreign accounts receivable at a discount on a without-recourse basis. In simpler terms, it's a way for exporters to convert future payment obligations from foreign buyers into immediate cash, transferring the risk of non-payment to the forfaiter. The term "forfaiting" is derived from the French term "à forfait," which means "to forfeit" or "to surrender" rights.

How Forfaiting Works:

The forfaiting process typically involves the following steps:

1. Exporter and Importer Agreement: The exporter and importer agree on the terms of the export transaction, including the goods or services to be provided, the payment schedule (usually involving promissory notes or bills of exchange), and the interest rate.

2. Forfaiting Offer: The exporter approaches a forfaiter (usually a bank or specialized financial institution) and requests a quote for forfaiting the receivables. The forfaiter assesses the creditworthiness of the importer and the political and economic risks associated with the importer's country.

3. Discounting and Purchase: If the forfaiter finds the transaction acceptable, it provides a discount rate, which reflects the risk involved and the desired profit margin. The exporter then sells the receivables to the forfaiter at this discounted value. The exporter receives immediate cash, less the discount.

4. Without Recourse: The sale is made on a "without recourse" basis, meaning that the forfaiter assumes all the risks associated with the importer's non-payment. The exporter is relieved of any further liability.

5. Collection: The forfaiter becomes the new holder of the receivables and is responsible for collecting payment from the importer according to the agreed-upon schedule.

Key Players in Forfaiting:

• Exporter: The seller of goods or services who seeks to convert future receivables into immediate cash.

• Importer: The buyer of goods or services who issues payment obligations (e.g., promissory notes).

• Forfaiter: The financial institution that purchases the receivables from the exporter at a discount and assumes the risk of non-payment.

• Guarantor (Optional): A bank or other financial institution that provides a guarantee for the importer's payment obligations, reducing the risk for the forfaiter.

Benefits of Forfaiting:

Forfaiting offers several significant benefits to exporters, importers, and forfaiters:

Benefits for Exporters:

• Immediate Cash Flow: Forfaiting provides exporters with immediate cash, improving their liquidity and working capital. This allows them to reinvest in their business, finance new projects, and take advantage of growth opportunities.

• Risk Mitigation: Exporters are relieved of the risks associated with non-payment by the importer, including credit risk, political risk, and transfer risk. This allows them to focus on their core business activities without worrying about potential losses from bad debts.

• Simplified Export Process: Forfaiting simplifies the export process by eliminating the need for exporters to manage the collection of receivables from foreign buyers.

• Access to New Markets: Forfaiting can enable exporters to enter new and potentially riskier markets by mitigating the financial risks associated with those markets.

• Improved Competitiveness: By offering attractive payment terms to importers (e.g., medium- to long-term credit), exporters can enhance their competitiveness in the global marketplace.

• Off-Balance Sheet Financing: Forfaiting is often treated as an off-balance sheet transaction, which can improve the exporter's financial ratios and creditworthiness.

Benefits for Importers:

• Access to Financing: Forfaiting allows importers to access financing for their purchases, even if they have limited access to traditional bank loans.

• Extended Payment Terms: Importers can benefit from extended payment terms, allowing them to manage their cash flow more effectively.

• Simplified Payment Process: The payment process is simplified, as the importer only needs to make payments to the forfaiter according to the agreed-upon schedule.

Benefits for Forfaiters:

• Profit Opportunity: Forfaiters earn a profit by discounting the receivables and collecting the full amount from the importer.

• Diversification of Portfolio: Forfaiting allows forfaiters to diversify their portfolio by investing in a range of international trade transactions.

• Fee Income: Forfaiters may also earn fee income from providing advisory services to exporters and importers.

Q2 B) What is the registration process to be appointed. as Banker to the issue? Describe the roles and responsibilities of Banker to the issue. 

Becoming a Banker to the Issue (BTI) in India

The process for becoming a Banker to the Issue (BTI) in India is regulated by the Securities and Exchange Board of India (SEBI) through the Securities and Exchange Board of India (Bankers to an Issue) Regulations, 1994. Here's a breakdown of the registration process and the roles & responsibilities of a BTI:

Registration Process:

1. Application: The bank files an application for a certificate of registration as a BTI with SEBI in a prescribed format called Form A. This form details the bank's information and capabilities for handling securities issuance processes.

2. Supporting Documents: Along with the application, the bank submits various documents to establish its suitability, including:

   • Certified copies of the bank's Memorandum of Association (MoA)/Statute/ Bye-Laws demonstrating its authorization for BTI activities.
   • Appointment letters, latest payslips, and PAN cards of key personnel like the Compliance Officer.
   • Acknowledgement letter from the Financial Intelligence Unit (FIU) confirming the appointment of a Principal Officer for Anti-Money Laundering (AML) compliance.
   • PAN cards of the bank, its promoters, directors, and key management personnel.

3. Scrutiny and Approval: SEBI scrutinizes the application and documents to ensure the bank meets the "fit and proper person" criteria as outlined in the regulations. This involves assessing the bank's:

   • Financial stability
   • Experience in handling securities transactions
   • Infrastructure capabilities
   • Compliance record

4. Registration and Fees: Upon approval, SEBI issues a Certificate of Registration (Form B) to the bank. The bank needs to pay the prescribed fees as specified in the regulations.

5. Renewal: The registration certificate has a validity period. To continue functioning as a BTI, the bank needs to apply for renewal before the expiry.

• Roles and Responsibilities of a Banker to the Issue (BTI)

A BTI plays a critical role in facilitating the public issuance of securities by companies. Here are some of their key responsibilities:

• Account Collection: The BTI collects application money from investors during the issue process. This may involve handling Application Supported by Blocked Amount (ASBA) transactions, where funds are blocked in the investor's account until allotment.
• KYC Compliance: The BTI ensures adherence to Know Your Customer (KYC) norms by verifying investor identities and collecting necessary documentation.
• Account Management: The BTI manages investor accounts and facilitates the allotment of securities after the issue is finalized.
• Refunds: In case of partial or full allotment, the BTI processes refunds to investors for the unallocated amounts.
• Regulatory Compliance: The BTI ensures adherence to SEBI regulations and other relevant guidelines throughout the issuance process.
• Reporting: The BTI submits reports to SEBI and the issuer company with details about the subscription received, allotment, and refunds processed.
• Limited Due Diligence: The BTI may be involved in limited due diligence activities as per the issuer's instructions, but the primary responsibility lies with the lead manager.

OR

Q2 P) What are the limitations of credit rating?

Credit ratings, while a valuable tool, have several limitations to consider:

• Focus on Default Risk: Credit ratings primarily assess the likelihood of a borrower defaulting on a loan. They don't consider other investment risks like market volatility or interest rate fluctuations, which can impact the value of an investment.

• Opinion-Based: Credit ratings are essentially opinions by credit rating agencies on a borrower's creditworthiness. While based on analysis, they can be subjective and may not always be perfectly accurate.

• Backward-Looking: Credit ratings are based on past financial performance and may not fully capture future changes in a borrower's financial health or economic conditions.

• Time Lag: Credit ratings can be slow to react to changes in a borrower's financial situation. This means a highly-rated borrower could become risky before the rating is adjusted.

• Potential Conflicts of Interest: Credit rating agencies are paid by the issuers of the debt they rate. This can create a potential conflict of interest, as the agencies may be hesitant to downgrade an issuer's rating for fear of losing future business.

• Limited Scope: Ratings focus on credit risk and don't consider other factors like environmental, social, and governance (ESG) factors that can impact a company's long-term prospects.

Here's how you can mitigate these limitations:

• Use Credit Ratings Alongside Other Analysis: Don't rely solely on credit ratings. Conduct your own research, including financial statement analysis and market research.
• Understand the Rating Scale: Each rating agency has its own credit rating scale. Be familiar with the specific definitions and limitations of each rating level.
• Consider the Rating Agency: Different rating agencies may have slightly different methodologies and may not always agree on a particular borrower's creditworthiness.

Q2 Q) What is consumer finance? What are the sources of consumer finance?

Consumer finance refers to the various financial products and services that allow individuals to acquire goods and services they may not be able to afford with upfront cash. It essentially helps bridge the gap between a consumer's current financial resources and the desired purchase.

Here are some key characteristics of consumer finance:

• Financing Everyday Purchases: Consumer finance is typically used for financing everyday or mid-ticket items, rather than long-term assets like houses. Examples include furniture, appliances, electronics, or even vacations.
• Shorter Repayment Periods: Compared to mortgages or business loans, consumer credit typically comes with shorter repayment periods, ranging from a few months to several years.
• Focus on Borrowing Capacity: Loan approval for consumer finance products is based on the borrower's creditworthiness and ability to repay, as indicated by factors like credit score and income.

Sources of Consumer Finance:

There are several ways consumers can access financing for their purchases. Here are some common sources:

• Credit Cards: These offer revolving lines of credit, allowing you to borrow up to a certain limit and repay in minimum monthly installments. Interest rates on credit cards tend to be higher than other loan options.
• Retail Credit Cards: Some stores offer co-branded credit cards with specific benefits or rewards programs for purchases made at their stores.
• Store Financing: Many retailers provide in-house financing options for their products, often with promotional zero-interest rates for a limited period.
• Personal Loans: These are unsecured loans offered by banks, credit unions, or online lenders. They come with fixed interest rates and repayment terms.
• Buy Now, Pay Later (BNPL): This is a relatively new option that allows consumers to split their purchase into smaller installments, often interest-free, but with shorter repayment periods.

The choice of financing source depends on various factors like the purchase amount, creditworthiness, desired repayment terms, and interest rates offered.

Q3 A) On 1st April 2013. Tone Up Gym purchased a machine from Neil Ltd. on hire purchase basis. The cash price of the machine was Rs.2,00,000/-. The payment was to be made Rs.1,00,000/- on the date of agreement and the balance in two annual installments of Rs. 50,000/- plus interest at 12% per annum payable on 31st March each year. The first installment was payable on 31st March 2014.

Prepare Machine a/c and Neil Ltd. a/e in the books of ToneUp Gym for the financial years 2013-14 and 2014-15 assuming that the accounts are closed on 31st March every year and depreciation at 20% p.a. is charged on reducing balance method.                     08

Solution:

Working Notes

Cash price of machine: Rs. 2,00,000
Down payment (1.4.2013): Rs. 1,00,000
Balance: Rs. 1,00,000

Interest @12% p.a.

• Interest for 2013–14 on Rs. 1,00,000 = Rs. 12,000

• Interest for 2014–15 on Rs. 50,000 = Rs. 6,000

Installments

Year	Principle	Interest	Total
31-3-2014	50,000	12,000	62,000
31-3-2015	50,000	6,000	56,000

Depreciation @20% p.a. on WDV

• 2013–14: 20% of 2,00,000 = Rs. 40,000

• 2014–15: 20% of 1,60,000 = Rs. 32,000

Machine Account

(In the books of Tone Up Gym)

Date	Particulars	Amount (Rs.)	Date	Particulars	Amount (Rs.)
1-4-2013	To Neil Ltd.	2,00,000	31-3-2014	By Depreciation	40,000
			31-3-2014	By Balance c/d	1,60,000
Total		2,00,000	Total		2,00,000

2014–15

Date	Particulars	Amount (Rs.)	Date	Particulars	Amount (Rs.)
1-4-2014	To Balance b/d	1,60,000	31-3-2015	By Depreciation	32,000
			31-3-2015	By Balance c/d	1,28,000
Total		1,60,000	Total		1,60,000

Neil Ltd. Account
(In the books of Tone Up Gym)

Date	Particulars	Amount (Rs.)	Date	Particulars	Amount (Rs.)
1-4-2013	To Bank (Down payment)	1,00,000	1-4-2013	By Machine A/c	2,00,000
31-3-2014	To Bank (Installment + Interest)	62,000	31-3-2014	By Interest A/c	12,000
			31-3-2014	By Balance c/d	50,000
Total		1,62,000	Total		1,62,000

2014–15

Date	Particulars	Amount (Rs.)	Date	Particulars	Amount (Rs.)
1-4-2014	To Balance b/d	50,000	31-3-2015	By Interest A/c	6,000
31-3-2015	To Bank (Final installment)	56,000	31-3-2015	By Bank	56,000
Total		1,06,000	Total		1,06,000

Q3 B) What is a Futures contract? Explain its characteristics.

Meaning of Futures Contract

A futures contract is a legally binding agreement made on a recognized stock or commodity exchange to buy or sell a specified underlying asset at a predetermined price on a specified future date. The asset may be shares, stock indices, commodities, currencies, or interest rates. Both parties to the contract must fulfill the agreement on the settlement date, irrespective of the market price prevailing at that time.

Futures contracts are mainly used to manage price risk (hedging) and to earn profit from price fluctuations (speculation).

Characteristics of a Futures Contract

1. Standardized Agreement
   Futures contracts are fully standardized by the exchange. The quantity of the asset, quality, contract size, expiry date, and settlement procedure are predetermined. Because of this standardization, futures contracts can be easily bought and sold in the market.

2. Trading on Organized Exchange
   Futures contracts are traded only on recognized and regulated exchanges such as stock or commodity exchanges. This ensures transparency, safety, and proper regulation of trading activities.

3. Obligation to Perform the Contract
   In a futures contract, both the buyer and the seller are legally obligated to perform the contract on the maturity date. There is no option to cancel the contract. If a party does not want to continue, the position must be closed by entering into an opposite contract.

4. Margin System
   To enter into a futures contract, both parties must deposit an initial margin with the exchange. This margin acts as a security deposit and helps to reduce the risk of default. Additional margins may be demanded if market prices move adversely.

5. Marking to Market
   Futures contracts are settled on a daily basis. At the end of each trading day, gains or losses arising due to price changes are calculated and adjusted in the margin account of the trader. This process is known as marking to market.

6. Role of Clearing House
   The clearing house acts as an intermediary between the buyer and the seller. It becomes the counterparty to both sides and guarantees the settlement of the contract, thereby eliminating counterparty risk.

7. High Liquidity
   Futures contracts are highly liquid because they are standardized and traded on exchanges. Traders can easily enter and exit positions before the expiry date without much difficulty.

8. Low Risk of Default
   Due to the margin system, daily settlement, and clearing house guarantee, the risk of default in futures contracts is very low.

9. Leverage
   Futures contracts involve a high degree of leverage. A trader can control a large contract value by paying only a small margin amount. While this increases the potential for higher returns, it also increases the risk of losses.

10. Settlement of Contract
    Futures contracts can be settled either by actual delivery of the underlying asset or by cash settlement, depending on the type of contract and exchange rules. In practice, most futures contracts are settled before maturity.

OR

Q3 P) Explain the registration process for a stock broker.

 In India, registering as a stockbroker is a process regulated by the Securities and Exchange Board of India (SEBI). Here's a breakdown of the key steps involved:

Eligibility:

• Must be a minimum of 21 years old Indian citizen.
• Completed at least 10+2 or higher secondary education.
• Minimum experience of 2 years (can be as a partner, authorized assistant, authorized clerk, remisier, or apprentice to a Stock Broker).

Registration Process:

1. Application: Submit a Form A (Application for Registration as Stock Broker) to SEBI through the chosen stock exchange you wish to be a member of.

2. Supporting Documents: Along with the application, submit various documents including:

   • Certified copies of Memorandum of Association (MoA)/ Partnership Deed/ Articles of Association.
   • Audited/Un-audited Financial Statements.
   • Net-worth certificate.
   • KYC documents (PAN and Aadhar Card) of proprietors/ directors/ partners.
   • Educational qualification and experience certificates related to the securities market.
   • Details of sales personnel with relevant certification.
   • Memorandum of Understanding (MoU) with a clearing member if applicable.
   • Recommendation letter from the Stock Exchange (after initial approval by the exchange).

3. Scrutiny and Approval: SEBI scrutinizes the application and documents to ensure the applicant meets the "fit and proper person" criteria. This involves assessing the applicant's:

   • Financial stability
   • Experience in securities markets
   • Infrastructure and technological capabilities
   • Compliance history

4. Registration and Fees: Upon approval, SEBI issues a Certificate of Registration (Form B) to the applicant. The applicant needs to pay the prescribed registration fees.

5. Membership with Stock Exchange: After receiving the SEBI certificate, the applicant finalizes membership with the chosen stock exchange. This may involve additional processes and approvals by the exchange.

Q.3.Q. Distinguish between Finance Lease and Operating Lease.

	Finance Lease	Operating Lease
Meaning	A finance lease is a long-term lease in which substantially all the risks and rewards of ownership are transferred to the lessee.	An operating lease is a short-term lease in which the risks and rewards of ownership remain with the lessor.
Ownership of Asset	Ownership is effectively transferred to the lessee, though legal ownership may remain with the lessor.	Ownership remains with the lessor throughout the lease period.
Lease Period	Generally, covers a major part of the economic life of the asset.	Usually covers a shorter period than the economic life of the asset.
Risk and Rewards	Risks such as obsolescence and rewards from use of the asset are borne by the lessee.	Risks and rewards are borne by the lessor.
Maintenance and Insurance	Maintenance, repairs, and insurance are usually the responsibility of the lessee.	Maintenance, repairs, and insurance are generally the responsibility of the lessor.
Cancellation	Lease is non-cancellable or cancellable only with heavy penalty.	Lease is usually cancellable by giving notice.
Lease Rentals	Lease rentals are high and structured to recover the cost of the asset along with interest.	Lease rentals are relatively lower and treated as rent.
Accounting Treatment	Asset and corresponding liability appear in the lessee’s balance sheet.	Lease rent is treated as an expense and the asset appears in the lessor’s books.
Examples	Leasing of machinery, plant, heavy equipment.	Leasing of vehicles, computers, office equipment.

 

Q4 A) Katrina Factors Ltd. advances Rs.72 lakhs to Kareena Ltd., against agreement of providing advance payment of 80% of receivables and for guaranteed payment after 3 months. The rate of interest is 15% compounded quarterly and factoring commission is 1.5% of receivables, both collected upfront.

i) Compute amount actually made available to Kareena Ltd.

ii) Calculate effective cost of funds made available to Kareena Ltd. if both interest and commission are collected in advance.

iii) Assume interest is collected in arrears and commission in advance. What would be effective cost of funds?                                                                             08

Solution:

Given Information

• Advance given = Rs. 72 lakhs

• Advance is 80% of receivables

Total Receivables = 72 / 80% = Rs.90 lakhs

• Period = 3 months

• Rate of Interest = 15% p.a. compounded quarterly

• Factoring commission = 1.5% of receivables

Working Note 1: Factoring Commission

1.5% of 90 = Rs.1.35 lakhs

Working Note 2: Interest Calculation

Since interest is compounded quarterly, rate for 3 months = 15% ÷ 4 = 3.75%

$$\text{Interest }$$= 72 × 3.75% = Rs.2.70 lakhs

$$\text{(i) Amount Actually Made Available to Kareena Ltd.(Interest and commission collected upfront) Particulars Amount (Rs. lakhs) Advance sanctioned 72.00 Less: Interest (upfront) 2.70 Less: Factoring commission 1.35 Net amount available 67.95}$$

$$\text{Amount actually made available = Rs. 67.95 lakhs}$$

$$\text{(ii) Effective Cost of Funds (Interest \& Commission Collected in Advance) Cost incurred = Interest + Commission = 2.70 + 1.35 = Rs. 4.05 lakhs Funds actually received = Rs. 67.95 lakhs Period = 3 monthsEffective Cost = 4.05 / 67.95 × 12 / 3 ×100=23.85\% p.a. (approx)}$$

$$\text{Effective cost of funds = approx. 23.85\% p.a.}$$

$$\text{(iii) Interest Collected in Arrears \& Commission in Advance}$$

$$\text{Amount Available Initially}$$

Particulars	Amount (Rs. lakhs)
Advance sanctioned	72.00
Less: Commission (upfront)	1.35
Net funds available	70.65

Cost Incurred

Particular	Amount (Rs.)
Interest (after 3 months)	2.70
Commission	1.35
Total cost	4.05

$$\text{Effective Cost }=$$4.05 / 70.65​ × 12 / 3 ​×100

$$=22.93\%\text{ p.a. (approx)}$$

$$\text{Effective cost of funds = approx. 22.93\% p.a.}$$

Q.4.B What are the various disinvestment mechanisms for a venture capital firm?

Venture capital firms (VCs) invest in high-growth potential startups with the goal of achieving a return on their investment (ROI) through an eventual exit or "disinvestment." Here are some common disinvestment mechanisms used by VCs:

1. Initial Public Offering (IPO):

• The most sought-after exit strategy for VCs.
• The company goes public by issuing shares on a stock exchange, allowing investors to buy in and the VC to sell its stake to the public.
• A successful IPO can generate significant returns for the VC, but the process can be lengthy and complex.

2. Merger and Acquisition (M&A):

• The VC-backed company is acquired by a larger, established company.
• This can be a faster exit strategy than an IPO and can still yield a good return for the VC.
• The attractiveness of the acquisition offer depends on the acquiring company's valuation and strategic fit.

3. Secondary Sale:

• The VC sells its stake in the company to another investor, such as another VC firm, a private equity firm, or a strategic investor.
• This can be a good option if the company is not yet ready for an IPO or there's no suitable M&A opportunity.
• The VC's return depends on the price negotiated with the new investor.

4. Stock Repurchase (Buyback):

• The VC-backed company uses its own cash to repurchase the VC's shares.
• This is less common but can be an option if the company has strong financials and sees value in repurchasing its stock.
• The VC receives a return on its investment, but the company's future growth potential plays a role in determining its repurchase capability.

5. Employee Stock Ownership Plan (ESOP):

• The VC sells its stake to the company itself, which then offers the shares to employees through an ESOP.
• This can be a way to incentivize employees and align their interests with the company's success.
• The VC's return depends on the repurchase price offered by the company.

• Management Buyout (MBO): In some cases, the company's management team may buy back the VC's stake to take the company private.
• Liquidation: This is a last resort if the company fails and the VC is unable to recoup its investment.

Choosing the Right Exit Strategy:

The best disinvestment mechanism depends on various factors, including the VC's investment goals, the company's stage of development, market conditions, and the availability of suitable exit options.

OR

Q.4.P. Elaborate on the Sources of Funds for Housing Finance Companies.

Housing Finance Companies (HFCs) play a vital role in the Indian housing market by providing loans to individuals for purchasing homes. To meet this demand, they rely on a diversified mix of funding sources. Here's a detailed breakdown of the key sources of funds for HFCs:

Debt Sources:

• Banks: Banks are a significant source of funds for HFCs, particularly for short-term borrowings. They offer:

  • Term Loans: These loans have fixed repayment schedules and interest rates.
  • Line of Credit: This allows HFCs to borrow on an as-needed basis up to a pre-approved limit, providing flexibility.

• National Housing Bank (NHB): Established by the Government of India, NHB plays a critical role in supporting housing finance. It provides HFCs with:

  • Liquidity Support: NHB offers refinance facilities to HFCs, allowing them to repay existing borrowings and free up capital for fresh lending. This injects liquidity into the housing finance system.
  • Special Lines of Credit: NHB offers targeted credit lines for specific housing segments, such as affordable housing, to promote social objectives.

• Public Deposits: HFCs can accept deposits from the public, often offering competitive interest rates compared to traditional banks. This source provides a longer-term funding base compared to bank borrowings.

Capital Market Instruments:

• Securitization: HFCs can pool together a portfolio of housing loans and sell them as securities in the capital market. Investors purchase these securities, providing HFCs with fresh funds. This allows them to access a broader funding base and potentially lower costs compared to traditional bank loans.

• Bonds: Some HFCs with a strong track record can issue bonds to institutional investors like insurance companies and pension funds. Bonds offer a long-term source of funds with potentially lower interest rates compared to bank loans, depending on market conditions.

• External Commercial Borrowings (ECBs): HFCs with a strong financial position can access funds from foreign lenders by issuing ECBs. These borrowings are denominated in foreign currency, offering some flexibility but also introducing exchange rate risk.

Equity Capital:

• Equity Issuance: HFCs can raise funds by issuing equity shares to investors through public offerings or private placements. This increases the HFC's capital base, which acts as a buffer and allows for further lending activities.

Choosing the Right Mix:

The optimal mix of funding sources for an HFC depends on several factors:

• Maturity of Housing Loans: HFCs aim to match the maturity of their funding sources with the maturity of their loans to manage interest rate risk. Short-term borrowings should not be used to fund long-term loans.

• Regulatory Requirements: Regulatory bodies may impose restrictions on the sources and proportion of funds HFCs can access. This ensures financial stability and appropriate risk management.

• Market Conditions: HFCs will leverage the most cost-effective and readily available funding sources based on prevailing market interest rates and liquidity conditions. During periods of high-interest rates, securitization or bond issuance might be more attractive.

Importance of Diversification:

A diversified funding strategy is crucial for HFCs to ensure a steady flow of funds and support their lending activities in the housing finance market. By relying on a mix of debt and equity sources, they can manage their risk profile and meet the long-term funding needs for their loan portfolio.

Q.4.Q Describe the role of the various parties involved in securitization process.

Securitization is a complex financial process that transforms illiquid assets (like loans) into tradable securities. Here's a breakdown of the key players involved and their roles:

Originator:

• The entity that owns the pool of assets (e.g., a bank with a portfolio of mortgages).
• The Originator initiates the securitization process and benefits by freeing up capital for further lending activities.

Sponsor:

• Often an investment bank that structures the securitization transaction and acts as an intermediary between other parties.
• The Sponsor designs the legal and financial structure of the deal, selects assets for securitization, and arranges for the issuance of securities.

Special Purpose Entity (SPV):

• A legal entity created specifically for the securitization transaction.
• The SPV holds the pool of transferred assets and issues securities backed by those assets. The originator typically transfers ownership of the assets to the SPV.

Trustee:

• Acts as a neutral third party and holds the assets in trust for the benefit of the investors.
• The Trustee ensures proper administration of the assets, collects payments from obligors (borrowers), and distributes them to security holders according to the terms of the issuance.

Underwriter:

• A financial institution that helps sell the securities issued by the SPV to investors.
• The Underwriter assesses investor interest, prices the securities, and markets them to potential buyers.

Credit Rating Agencies (CRAs):

• These agencies assess the creditworthiness of the security issuance based on the underlying assets and the transaction structure.
• Higher credit ratings from CRAs generally attract more investors and allow for more favorable interest rates on the securities.

Investors:

• Institutional investors like banks, pension funds, and insurance companies purchase the issued securities.
• Investors seek attractive returns based on the interest payments generated by the underlying assets.

Servicer:

• The entity responsible for collecting payments from the obligors on the original loans.
• The Servicer may be the original loan servicer or a different company appointed for the securitization transaction.
• The Servicer handles loan administration tasks like collecting payments, managing defaults, and foreclosing on properties if necessary.

Additional Parties:

• Legal Counsel: Attorneys advise on the legal structure and documentation for the transaction.
• Accountants: They may be involved in auditing the financial aspects of the securitization process.

The interaction of these parties is crucial for a successful securitization transaction. Each party plays a specific role in ensuring the efficient transfer of risk, creation of tradable securities, and ultimately, facilitating access to capital in the financial system.

Q.5 A. Describe the advantages of credit cards.

Credit cards offer a variety of advantages that can make them a valuable financial tool if used responsibly. Here are some key benefits:

Convenience and Flexibility:

• Cashless Transactions: Credit cards allow for easy and secure cashless transactions at stores, online retailers, and restaurants. You don't need to carry large amounts of cash.
• Payment Flexibility: Payments for purchases are made at a later date, typically at the end of the billing cycle. This allows you to manage your cash flow better.
• Emergency Expenses: Credit cards can be a lifesaver for unexpected expenses like car repairs or medical bills.

Building Credit History:

• Responsible Use: Using your credit card responsibly and making payments on time can help you build a positive credit history. This is important for securing loans, renting an apartment, or getting better insurance rates in the future.

Rewards and Benefits:

• Reward Programs: Many credit cards offer reward programs that give you points, cash back, or miles for using your card. These rewards can be redeemed for travel, merchandise, or statement credits.
• Benefits: Some cards offer additional benefits like purchase protection, travel insurance, extended warranties, and airport lounge access.

Security and Fraud Protection:

• Chip and PIN Technology: Most credit cards today use chip and PIN technology, which makes them more secure than traditional swipe cards.
• Fraud Protection: Credit card companies offer fraud protection in case your card is lost or stolen. You are typically not liable for unauthorized charges.

Other Advantages:

• Budgeting Tool: Credit card statements can help you track your spending habits and create a budget.
• Building Financial Discipline: When used responsibly, credit cards can help you develop financial discipline by requiring on-time payments and encouraging you to stay within your credit limit.

It's important to remember that credit cards also come with potential drawbacks:

• High Interest Rates: Credit cards typically have high interest rates. If you don't pay your balance in full each month, you can accrue significant interest charges.
• Debt Trap: Overspending and minimum payment traps can lead to a cycle of debt. It's crucial to only spend what you can afford to repay.
• Annual Fees: Some credit cards have annual fees, which can negate the benefits if you don't use the card enough to redeem rewards or Consumer finance refers to the borrowing and lending arrangements made by individuals to pay for goods and services. These terms can vary depending on the specific loan or credit product, but here are some common elements you'll encounter:

Loan Amount: This is the total amount of money you borrow from the lender.

Interest Rate: This is the cost of borrowing the money, expressed as a percentage of the loan amount. It's typically an Annual Percentage Rate (APR) which reflects the total yearly interest including potential fees.

Loan Term: This is the duration of the loan, which determines the repayment schedule. It can range from a few months to several years.

Repayment Schedule: This outlines how often you'll make payments (e.g., monthly) and the minimum amount required per payment.

Down Payment: For some loans, like car loans or mortgages, you might be required to pay a down payment upfront before receiving the full loan amount. This reduces the lender's risk and lowers the total amount borrowed.

Origination Fee: This is a one-time fee charged by the lender to cover the processing costs of setting up the loan.

Prepayment Penalty: Some loans may have a prepayment penalty if you pay off the loan early. This discourages borrowers from repaying quickly, as the lender loses out on the expected interest income.

Collateral: For secured loans, the borrower pledges an asset (e.g., car, house) as collateral. If the borrower defaults (fails to repay), the lender can seize the collateral to recoup their losses.

Annual Percentage Rate (APR): As mentioned earlier, APR is a crucial term that reflects the total yearly cost of borrowing. It includes the interest rate and any associated fees like origination fees or annual fees. A higher APR signifies a more expensive loan.

Grace Period: Some lenders offer a grace period for making your first payment. This short window (usually 15-30 days) allows some leeway before late payment penalties kick in.

Default: This occurs when the borrower fails to make their loan payments as agreed. Defaulting on a loan can have severe consequences, including damage to your credit score, collection actions, and even legal action from the lender.

Variable vs. Fixed Interest Rate: Interest rates can be fixed (remain constant throughout the loan term) or variable (fluctuate based on market conditions). Fixed rates offer predictability, while variable rates can be lower initially but carry the risk of rising in the future.

OR

Q5 Write short notes on (Attempt any 3 out of 5):

a) Role of NBFCs

NBFCs, or Non-Banking Financial Companies, play a vital role in the Indian financial system by acting as intermediaries between those with surplus funds (savers) and those who need them (borrowers). Here's a breakdown of their key functions:

Financial Inclusion:

• Reach Underserved Markets: NBFCs are often more flexible than traditional banks and can cater to borrowers in rural and semi-urban areas or those with limited credit history. They offer a wider range of loan products tailored to the specific needs of these segments.

• Microfinance: NBFCs play a significant role in providing microfinance loans to small businesses and entrepreneurs, especially women entrepreneurs. These microloans help individuals start or grow their businesses, promoting financial inclusion and economic development.

Credit Availability:

• Faster Loan Approvals: NBFCs generally have less stringent loan approval processes compared to banks. This allows for quicker loan approvals, which can be crucial for individuals or businesses needing funds promptly.

• Variety of Loan Products: NBFCs offer a diverse range of loan products beyond traditional home loans and car loans. This includes personal loans, education loans, gold loans, two-wheeler loans, and loans for specific business needs.

Innovation:

• New Financial Products: NBFCs are more adaptable and can introduce innovative financial products to cater to the evolving needs of the market. This can include loans with flexible repayment options or products tailored to specific demographics.

• Technological Adoption: Many NBFCs are at the forefront of adopting new technologies like digital lending platforms and mobile applications. This allows for a more streamlined and user-friendly experience for borrowers.

Overall, NBFCs complement the traditional banking sector by:

• Bridging the gap between banks and unbanked or underserved segments of the population.
• Enhancing financial inclusion by providing access to credit for a wider range of borrowers.
• Promoting economic development by facilitating business growth and entrepreneurial ventures.
• Encouraging innovation in the financial services sector.

Here are some additional points to consider:

• While NBFCs offer many benefits, it's crucial to choose a reputable and regulated NBFC before entering into any financial agreements.
• Interest rates charged by NBFCs can sometimes be higher than those offered by banks.
• It's advisable to compare terms and conditions from different NBFCs and banks before making a borrowing decision.

NBFCs are a vital part of India's financial landscape, playing a crucial role in making financial products and services more accessible to a wider population.

b) Foreign brokers

Foreign brokers play a significant role in global financial markets by facilitating the buying and selling of securities across international borders. Here's a short note outlining their key characteristics and functions:

Foreign brokers are financial intermediaries or firms that operate in countries other than where their clients are based. They provide access to foreign markets for investors seeking to diversify their portfolios or capitalize on investment opportunities abroad. These brokers typically offer a range of services, including trading in stocks, bonds, currencies, commodities, and derivatives.

Key characteristics of foreign brokers include:

1. Market Access: Foreign brokers provide access to international markets that may otherwise be inaccessible to domestic investors. They enable clients to trade in foreign securities and access diverse investment opportunities.

2. Expertise in Foreign Markets: Foreign brokers possess expertise and knowledge about the regulations, market dynamics, and trading practices of the countries in which they operate. This expertise is invaluable for clients looking to navigate unfamiliar markets.

3. Execution Services: Foreign brokers execute trades on behalf of their clients in foreign markets. They ensure timely and efficient execution of orders, leveraging their technology infrastructure and market connectivity.

4. Research and Analysis: Many foreign brokers offer research reports, market analysis, and investment recommendations to help clients make informed decisions. This research covers a wide range of asset classes and provides insights into global market trends.

5. Compliance and Regulatory Support: Foreign brokers assist clients in complying with regulatory requirements and tax implications associated with cross-border investments. They ensure that trades adhere to relevant regulations in both the home and foreign jurisdictions.

6. Currency Conversion: Foreign brokers facilitate currency conversion for clients engaging in cross-border transactions. They offer competitive exchange rates and convenient conversion services to minimize currency-related risks.

c) Pass Through Certificate and Pay Through Certificate

A pass-through certificate is a type of security representing an ownership interest in a pool of assets, such as mortgages, auto loans, or credit card receivables. The cash flows generated by these underlying assets (principal and interest payments) are "passed through" to the certificate holders after deducting servicing and other fees.

Structure and Characteristics

• Direct Ownership: Investors in pass-through certificates directly own a fractional share of the underlying asset pool.

• Cash Flow Distribution: The cash flow from the underlying assets is distributed to certificate holders on a pro-rata basis, according to their ownership percentage.

• Servicer Role: A servicer manages the underlying asset pool, collecting payments from borrowers, handling delinquencies, and distributing cash flows to investors.

• Credit Enhancement: Pass-through certificates may incorporate credit enhancement mechanisms to mitigate the risk of default. These mechanisms can include:

  • Excess Spread: The difference between the interest rate on the underlying assets and the interest rate paid to certificate holders. This excess spread can absorb losses.

  • Reserve Funds: A dedicated fund set aside to cover potential losses.

  • Overcollateralization: The value of the underlying assets exceeds the value of the certificates issued.

  • Third-Party Guarantees: Guarantees from insurance companies or other financial institutions.

• Prepayment Risk: Investors in pass-through certificates are exposed to prepayment risk, which is the risk that borrowers will repay their loans earlier than expected. This can occur when interest rates decline, prompting borrowers to refinance. Prepayments can reduce the yield on the certificates and shorten their expected life.

• Examples: Mortgage-backed securities (MBS) issued by government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac are common examples of pass-through certificates.

Advantages

• Diversification: Investors gain exposure to a diversified pool of assets, reducing the risk compared to investing in individual loans.

• Liquidity: Pass-through certificates are generally liquid, meaning they can be easily bought and sold in the secondary market.

• Predictable Cash Flows: While subject to prepayment risk, the cash flows from pass-through certificates are generally more predictable than those from other types of securities.

Disadvantages

• Prepayment Risk: As mentioned earlier, prepayment risk can negatively impact the yield and expected life of the certificates.

• Servicing Fees: Servicing fees reduce the cash flow available to investors.

• Complexity: Understanding the structure and risks of pass-through certificates can be complex, requiring careful analysis of the underlying assets and credit enhancement mechanisms.

Pay-Through Certificates

A pay-through certificate is another type of asset-backed security where the cash flows from a pool of underlying assets are used to pay debt service (principal and interest) on the certificates. Unlike pass-through certificates, pay-through certificates are structured as debt obligations of the issuing entity.

Structure and Characteristics

• Debt Obligation: Pay-through certificates are structured as debt obligations of a special purpose entity (SPE) or trust. The SPE purchases the underlying assets and issues the certificates.

• Collateralized Debt: The underlying assets serve as collateral for the certificates.

• Cash Flow Distribution: The cash flow from the underlying assets is used to make scheduled payments of principal and interest to certificate holders.

• Overcollateralization: Pay-through certificates typically involve overcollateralization, where the value of the underlying assets exceeds the value of the certificates issued. This provides a cushion to protect investors against losses.

• Credit Enhancement: Similar to pass-through certificates, pay-through certificates may incorporate other credit enhancement mechanisms, such as reserve funds and third-party guarantees.

• Tranches: Pay-through certificates are often structured into multiple tranches, each with a different level of seniority and risk. Senior tranches have a higher priority for payment and are therefore less risky than junior tranches.

• Examples: Collateralized mortgage obligations (CMOs) and collateralized loan obligations (CLOs) are common examples of pay-through certificates.

Advantages

• Tailored Risk and Return: The tranche structure allows investors to choose certificates with different risk and return profiles.

• Reduced Prepayment Risk (for some tranches): The tranche structure can be designed to mitigate prepayment risk for certain tranches. For example, sequential pay tranches receive principal payments in a predetermined order, protecting senior tranches from early prepayments.

• Higher Potential Yield: Junior tranches offer the potential for higher yields to compensate for the increased risk.

Disadvantages

• Complexity: The tranche structure and complex cash flow rules can make pay-through certificates difficult to understand.

• Credit Risk: Junior tranches are exposed to significant credit risk, as they are the first to absorb losses from defaults on the underlying assets.

• Prepayment Risk (for some tranches): While some tranches may be protected from prepayment risk, others may be highly sensitive to changes in prepayment rates.

d) Regulatory Framework for Financial services

The regulatory framework for financial services refers to the system of laws, rules, institutions, and supervisory bodies that govern the functioning of financial markets and financial service providers. In India, this framework aims to ensure stability of the financial system, protect investors, promote fair practices, and encourage orderly growth of financial services.

1. Reserve Bank of India (RBI)

The Reserve Bank of India is the apex monetary authority of the country and plays a key role in regulating financial services.

Functions of RBI:

• Regulates banks, NBFCs, and housing finance companies

• Controls credit creation and money supply

• Frames monetary policy

• Supervises payment and settlement systems

• Ensures financial stability and liquidity in the system

RBI issues guidelines related to interest rates, capital adequacy, prudential norms, and risk management.

2. Securities and Exchange Board of India (SEBI)

SEBI is the regulator of the capital market and investment-related financial services.

Functions of SEBI:

• Regulates stock exchanges and securities markets

• Protects the interests of investors

• Regulates mutual funds, merchant bankers, portfolio managers, and brokers

• Prevents unfair trade practices such as insider trading and market manipulation

• Ensures disclosure and transparency in the securities market

SEBI plays a crucial role in maintaining investor confidence.

3. Insurance Regulatory and Development Authority of India (IRDAI)

IRDAI regulates the insurance sector in India.

Functions of IRDAI:

• Regulates insurance companies and intermediaries

• Protects policyholders’ interests

• Frames rules regarding insurance products and premiums

• Promotes orderly growth of the insurance industry

It ensures solvency and fair conduct in insurance services.

4. Pension Fund Regulatory and Development Authority (PFRDA)

PFRDA regulates pension and retirement-related financial services.

Functions of PFRDA:

• Regulates pension funds under the National Pension System (NPS)

• Protects the interests of pension subscribers

• Develops and promotes pension schemes

5. Ministry of Finance, Government of India

The Ministry of Finance provides overall policy direction to the financial system.

Functions:

• Formulates financial and fiscal policies

• Supervises regulatory authorities

• Enacts financial sector legislation

• Coordinates between different regulators

6. Other Regulatory and Support Institutions

• Stock Exchanges (BSE, NSE): Ensure fair trading and compliance by members

• Clearing Corporations: Ensure settlement and reduce counterparty risk

• Self-Regulatory Organizations (SROs): Assist regulators by framing codes of conduct

Importance of Regulatory Framework

• Ensures stability and safety of the financial system

• Protects investors and consumers

• Prevents frauds and malpractices

• Promotes transparency and confidence

• Encourages growth and development of financial services

e) Factoring Cost

Factoring cost refers to the total cost incurred by a firm when it raises funds by selling its receivables to a factor. It represents the price paid by the client for services such as financing, collection of debts, sales ledger administration, and protection against bad debts.

In simple words, factoring cost is the effective cost of funds obtained through a factoring arrangement.

Types of Factoring Fees

The primary cost associated with factoring is the factoring fee, also known as the discount fee. This fee is a percentage of the invoice value and is charged for the factor's service of advancing funds. The factoring fee is not a fixed rate and can vary significantly.

Here's a breakdown of common factoring fees:

• Discount Fee: This is the main fee charged by the factor. It's usually expressed as a percentage of the invoice amount and is deducted from the advance. The discount fee can be a flat rate or a variable rate that increases over time. For example, a factor might charge 1% for the first 30 days and an additional 0.5% for each subsequent 30-day period.

• Service Fee: Some factors charge a separate service fee to cover administrative costs, credit checks, and other services. This fee can be a flat monthly fee or a percentage of the invoice value.

• Reserve Account Fee: In some factoring arrangements, the factor holds a percentage of the invoice value in a reserve account to cover potential losses due to customer non-payment or disputes. The reserve account fee is the interest earned on this reserve account, which is typically lower than the discount fee. The remaining reserve is returned to the business once the invoice is paid.

• Due Diligence Fee: This is a one-time fee charged by the factor to assess the creditworthiness of the business and its customers. It covers the cost of performing credit checks, verifying invoices, and evaluating the overall risk of the factoring arrangement.

• Termination Fee: Some factoring agreements include a termination fee if the business decides to end the relationship before the agreed-upon term. This fee is intended to compensate the factor for the costs associated with setting up the account and the potential loss of future revenue.

• Other Fees: Depending on the factor and the specific agreement, there may be other fees, such as wire transfer fees, late payment fees, or fees for handling disputed invoices.

Factors Influencing Factoring Costs

Several factors can influence the overall cost of factoring:

• Invoice Volume: Factors often offer lower rates to businesses that factor a large volume of invoices regularly. This is because the factor can spread their costs over a larger base of transactions.

• Customer Creditworthiness: The creditworthiness of the business's customers is a major factor in determining the factoring fee. If the customers have a strong credit history and a low risk of default, the factor will typically charge a lower fee.

• Payment Terms: The length of the payment terms on the invoices also affects the factoring fee. Longer payment terms increase the risk for the factor, as they have to wait longer to receive payment. As a result, they may charge a higher fee.

• Industry: Some industries are considered riskier than others, and factors may charge higher fees to businesses in these industries. For example, industries with high rates of customer disputes or bankruptcies may be considered riskier.

• Type of Factoring: Recourse factoring, where the business is responsible for repurchasing unpaid invoices, typically has lower fees than non-recourse factoring, where the factor assumes the risk of non-payment.

• Advance Rate: The advance rate is the percentage of the invoice value that the factor advances to the business upfront. A higher advance rate may result in a higher factoring fee.

• Factor's Overhead: The factor's own operating costs and profit margins also influence the factoring fees they charge.