BU Material

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Before you talk, listen. Before you react, think. Before you criticize, wait. Before you pray,

forgive. Before you quit, try

MODULE -1

Finance is abranch ofeconomics concerned with resource allocation as well as resource

management,acquisition and investment. Simply, finance deals with matters related to money

and the markets.

It consist of 3 decisions viz :

1. financing decisions

2. investment decision

3. dividend decision

INDIAN FINANCIAL SYSTEM

The economic development of a nation is reflected by the progress of the various economic

units, broadly classified into corporate sector, government and household sector. While

performing their activities these units will be placed in a surplus/ deficit/ balanced budgetary

situations.

There are areas or people with surplus funds and there are those with a deficit. A financial

system or financial sector functions as an intermediary and facilitates the flow of funds from the

areas of surplus to the areas of deficit. A Financial System is a composition of variousinstitutions, markets, regulations and laws, practices, money manager, analysts, transactions and

claims and liabilities.

Financial System;

The word "system", in the term "financial system", implies a set of complex and closely

connected or interlinked institutions, agents, practices, markets, transactions, claims, and

liabilities in the economy. The financial system is concerned about money, credit and finance-

the three terms are intimately related yet are somewhat different from each other. Indian
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financial system consists of financial market, financial instruments and financial intermediation

and financial services.

STRUCTURE OF FINANCIAL SYSTEM:

RBI

RBI(Reserve Bank of India) is the central Bank of the country. It is the centre of Indian financial

and Monetary system. As the Apex institution, it is guiding, monitoring, regulating, controlling

and promoting the Indian financial system.

Financial

Instrume

nts

Short term, medium

term, long term

Eg: Securities,

debentures, warrants,

bonds, treasury bills,

CDs, CPs, Call/Notice

Money

Financial

Services

Custodian, merchant

banking, depository,

investment banking ,Underwriting and financial

consultancy

Financial

Intermediar

ies

Bankin

g

Non

Banking

LIC, GIC, NABARD,

Venture capital

Financial

Markets

Primary

Market

Secondary

Market

Capital

market

Money

market

Fee

Based

Fund

basedUnderwriting, leasing,

factoring, forfaiting,

venture capitalist, housing

finance, bills discounting


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RBI started functioning from 1st April, 1935 on the terms of the RBI ACT, 1934.It was a private

share holders institution till January 1949, after which it became a State-owned institution Under

the Reserve Bank (Transfer to Public Ownership) of India Act, 1948.

Organisation and Management:

The Bank is managed by

a. Central Board of directors (The governor, 4 Deputy governors and 15 Directors

nominated by central Govt.)

b. Four local board of directors

c. Committee of Central board of directors

The functions of the Local Board of directors is to advice the Central Board of

directors

The local board of directors are also required to perform the required duties

The final control vests in the Central Board.

In order to perform various functions, the bank has been divided and sub-divided into a large no.

of departments. Apart from banking and issue departments, there are 20 departments and three

training establishments at the central office of the bank.

Functions of RBI:

1. To maintain monetary stability (Controlling of liquidity and inflation)

2. To maintain financial stability (Controlling the variation of rupee)

3. To maintain Balance of payment

4. To promote the financial infrastructure of the market and financial system

5. To ensure the proper credit allocation throughout the system

6. To regulate the overall volume of money and credit in the economy

Roles of RBI:

1. Note Issuing Authority:

RBI is the sole authority for issuing of currency except for minting of coins. The bank

can issue notes against the security of gold coins and gold bullion, foreign securities,

government securities.

2. Banker to the Government:


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The RBI is the banker to the Central and state Governments. It provides to the

Government all banking services such as acceptance of deposits, withdrawal of funds by

cheques, making payment as well as collections on behalf of government, transfer of

funds and management of public debts.

3. Bankers Bank:

RBI is considered as the Banks bank. It has the authority to regulate all the commercial,

co-operative banks and financial institutions. RBI lends funds to the Banks In times of

shortage and the banks can park their excess funds with RBI. RBI is also called as the

lender of last resort.

4. Supervising Authority:

The RBI has the vast powers to control the Commercial and Co-operative banks with a

view to develop adequate and sound banking system. Hence,

a. It issues licenses for the establishment of new banks

b. It issues licenses for setting up of new branches

c. It prescribes minimum requirement for paid up capital, reserves, maintenance of cash

reserves etc.

d. It inspect and investigate working of banks

5. Exchange control authority:

RBI to maintain the stability of the external value of the rupee, follows the following

dimensions:

a. To administer the foreign exchange control

b. To manage and fix the exchange rate between Rupee and other currencies

c. To manage exchange reserves

d. To interact and negotiate with monetary authorities.

Monetary policy of RBI:

1. To accelerate economic development in an environment of reasonable price stability

2. To develop appropriate institutional set up

3. Controlled expansion of bank credit and money supply

4. To stabilize the Inflationary pressures

5. To maintain price stability.


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The RBI uses following techniques to control the monetary pressures and policies

a. Bank rate

b. Statutory liquidity ratio(SLR)

c. Cash reserve ratio (CRR)d. Open market operations

e. Credit planning

f. Liquidity Adjustment facility (LAF)

The recent developments in the Indian Monetary Policy are:

1. Reducing the rigidities

2. Introducing flexibility

3. encouraging diversification

4. Promoting more competitive environment

5. Imparting greater discipline and prudence in the operations of the financial system

Banking Operations/Special roles of the Commercial Banks

1. Balancing Profitability with Liquidity Management:

Commercial Banks provide various financial services to customers in return for payment

in the form of interest, discounts, fees, commission and so on. When compared to other

business concerns, banks have to give more attention to balancing profitability with

liquidity. The maintenance of liquidity is very important because of the nature of

liabilities. Banks deal with other peoples money, a substantial part of which is repayable

on demand.

2. Management of reserves:

The banks are expected to hold voluntarily a party of their deposits in the form of cash

reserves; and the ratio of cash reserves to deposits is known as the cash reserve ratio.

Central bank in every country is empowered to prescribe their reserve ratio that all banksmust maintain.

3. Creation of credit:

Another distinguishing feature of banks is, they can create as well as transfer money.

Banks are said to create deposits or credit or money, or it can be said that every loan

given by banks creates a deposit. This has given rise to the important concept of Deposit


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multiplier or money multiplier or money multiplier, i.e they add to the money supply in

the economy.

4. Basis and process of credit creation:

Apart from the currency issued by the government and the central bank, the demand orcurrent or checkable deposits with the banks are accepted as by public as money as they

are most liquid form of money.

SEBI

SEBI (Securities and Exchange board of India) is a regulatory authority established on April 12,

1988, later became a statutory and powerful body on 21st February, 1992.

Constitution and Organisation:

The SEBI is a body of 6 members comprising of:

a. The Chairmanb. 2 members from among the officials of the ministries of Central Government dealing

with finance and Lawc. 2 members who are professionals and have experience or special knowledge relating to

securities marketd. One member from RBI

All members except RBI member is appointed by the government, who also lays down their

terms of office, tenure and conditions of service.

The work of SEBI has been organised into 5 operational departments each of which is headed by

an executive director who reports to the chairman:

a. Primary Market Operations and regulatory Departmentb. Secondary market operations and insider trading departmentc. Issue management and intermediaries departmentd. Secondary market exchange administration, inspection and non member intermediaries

departmente. Institutional investment department

Other than these departments, there are Legal and Investigation department also.

Objectives:

The overall objectives as per the Preamble of the SEBI Act, 1992 are:

a. To protect the interest of the Investors


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b. To promote and develop the securities market in Indiac. To regulate the securities market and the matters concerned withd. To prevent trading malpracticese. To facilitate the efficient mobilization and allocation of resources throughout the

securities market.

f. To maintain transparency and to provide information to investors

Powers:

SEBI has the powers to regulate

a. Depository participantsb. Custodiansc. Debenture trustees and trust deedsd. FIIse. Insider Trading

f. Merchant Bankersg. Mutual Fundsh. Portfolio Managers and Investment Advisorsi. Registrars to the issue and share transfer agentsj. Stock brokers and sub-brokersk. Underwritersl. Venture capital fundsm. Banker to the issue

Guidelines:

SEBI can issue guidelines in respect of

a. Information disclosureb. Operational transparency and investor protectionc. Development of financial institutionsd. Pricing of issuese. Bonus issuef. Preferential issues

g. Financial instrumentsh. Firm allotment and transfer of shares among promoters

Terminologies:

1. Insider Trading: It refers to the trading of a corporation's stockor othersecurities (e.g.bonds orstock options) by individuals with potential access to non-public informationabout the company.
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SEBI GUIDELINES

PRE- ISSUE GUDIELINES

1. The lead merchant banker shall exercise due diligence. The standard of due diligence shall

be such that the merchant banker shall satisfy himself about all the aspects of offering,veracity and adequacy of disclosure in the offer documents.

2. The liability of the merchant banker shall continue even after the completion of issue process.

3. The lead merchant banker shall pay requisite fee in accordance with regulation

4. The lead merchant banker shall ensure that facility of Applications Supported by BlockedAmount is provided in all book built public issues which provide for not more than onepayment option to the retail individual investors

5. No company shall make an issue of security through a public or rights issue unless aMemorandum of Understanding has been entered into between a lead merchant banker andthe issuer company specifying their mutual rights, liabilities and obligations relating to theissue.

6. In case of a fast track issue, the lead merchant banker shall furnish a due diligence certificateto the Board as per the format specified

7. In case a public or rights issue is managed by more than one Merchant. Banker the rights,

obligations and responsibilities of each merchant banker shall be demarcated

POST ISSUE GUIDELINES

1. Irrespective of the level of subscription, the post-issue Lead Merchant. Banker shall

ensure the submission of the post-issue monitoring reports as per formats specified in

Schedule

2. These reports shall be submitted within 3 working days from the due Dates

3. Lead Merchant Banker responsible for post issue obligations (post issue Lead Merchant

Banker) shall ensure that a public representative nominated by the Board is associated inthe process of finalization of basis of allotment in following cases:

a) Par issues with over subscription level of more than 5 times

b) Premium issues with over subscription level of more than 2 times.


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4. The Post - Issue Lead Merchant Banker shall actively associate himself with post-issueactivities namely, allotment, refund, dispatch and giving instructions to Self CertifiedSyndicate Banks and shall regularly monitor redressal of investor grievances arisingthere from

5. If the issue is proposed to be closed at the earliest closing date, the lead Merchant Bankershall satisfy himself that the issue is fully subscribed before announcing closure of theissue.

6. In case, there is no definite information about subscription figures, the issue shall be keptopen for the required number of days to take care of the underwriters' interests and toavoid any dispute, at a later date, by the underwriters in respect of their liability.

7. In case of undersubscribed issues, the lead merchant banker shall furnish information inrespect of underwriters who have failed to meet their underwriting devolvements to the

Board in the format specified

GUIDE LINES FOR PUBLIC ISSUE:

The due dates for submitting post issue monitoring report in case of

Public issues:

a. 3-Day Post Issue Monitoring Report:

The due date for this report shall be the 3rd day from the date of closure of subscriptionof the issue.

b. 78-Day Post Issue Monitoring Report:The due date for this report shall be the 78th day from the date of closure of subscription

of the issue."

c. Final post issue monitoring report for all issues:The due date for this report shall be the 3rd day from the date of listing or 78 days from

the date of closure of the subscription of the issue, whichever is earlier

d. In case a public or rights issue is managed by more than one MerchantBanker the rights, obligations and responsibilities of each merchant banker shall be

demarcated

Public Issue by Unlisted Companies :

An unlisted company shall make a public issue of any equity shares or any security

convertible into equity shares at a later date subject to the following: -


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It has a pre-issue networth of not less than Rs.1 crore in three (3) out of precedingfive (5) years, with a minimum networth to be met during immediately precedingtwo (2) years; and

It has a track record of distributable profits in terms of section 205 of the CompaniesAct, 1956, for at least three (3) out of immediately preceding five (5) years.

An unlisted company can make a public issue of equity shares or any security convertibleinto equity shares at a later date, only through the book-building process if ,

it does not comply with the conditions specified in clause above, or,

its proposed issue size exceeds five times its pre-issue networth as per the lastavailable audited accounts either at the time of filing draft offer document with theBoard or at the time of opening of the issue

Provided that sixty percent (60%) of the issue size shall be allotted to the Qualified

Institutional Buyers (QIBs), failing which the full subscription monies shall be

refunded.

Public Issue by Listed Companies :

A listed company shall be eligible to make a public issue of equity shares or any security

convertible at later date into equity share.

Provided that the issue size (i.e. offer through offer document + firm allotment +promoters contribution through the offer document) does not exceed five (5) timesits pre-issue networth as per the last available audited accounts either at the time offiling draft offer document with the Board or at the time of opening of the issue.

A listed company which does not fulfil the condition given in the proviso to clauseabove, shall be eligible to make a public issue only through the book building

process.

Provided that sixty percent (60%) of the issue size shall be allotted to the Qualified

Institutional Buyers (QIBs), failing which the full subscription monies shall be

refunded.

GUIDELINES FOR RIGHTS ISSUE:

The due dates for submitting post issue monitoring report in case of

Rights issues:

a. 3-Day Post-Issue Monitoring Report:The due date for this report shall be the 3rd day from the date of closure of subscription of

the issue.

b. 50-Day Post - Issue Monitoring Report:The due date for this report shall be the 50th day from the date of closure of subscription of

the issue.


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c. Due diligence certificate to be submitted with final post issue monitoring report

d. In case a public or rights issue is managed by more than one MerchantBanker the rights, obligations and responsibilities of each merchant banker shall be

demarcated

GUIDELINES ON BOOK BUILDING

An issuer company proposing to issue capital through book building shall comply with the

following:

A. 75% Book Building Process

In an issue of securities to the public through a prospectus the option for 75% book

building shall be available to the issuer company subject to the following:

a. The option of book-building shall be available to all body corporatewhich are otherwise eligible to make an issue of capital to the public.

b. The book-building facility shall be available as an alternative to, and tothe extent of the percentage of the issue which can be reserved for firm allotment, as per

these Guidelines.

c. The issuer company shall have an option of either reserving thesecurities for firm allotment or issuing the securities through bookbuilding process.

d. The issue of securities through book-building process shall beseparately identified / indicated as 'placement portion category', in the prospectus.

e. In case the book-building option is availed of, underwriting shall bemandatory to the extent of the net offer to the public.

GUIDELINES FOR ISSUE OF CONVERTIBLE DEBT INSTRUMENTS

1. Requirement of credit rating:

No company shall make a public issue or rights issue of (Convertible Debt Instrument),

unless credit rating is obtained from at least one credit rating agency registered with theBoard and disclosed in the offer document.

Where ratings are obtained from more than one credit rating agencies, all the ratings,

including the unaccepted ratings, shall be disclosed in the offer document.


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2. Requirement in respect of Debenture Trustee:

a. No company shall issue a prospectus or a letter of offer to the public for subscription ofits debentures, unless the company has appointed one or more debenture trustees forsuch debentures in accordance with the provisions of the Companies Act, 1956. Thenames of the debenture trustees shall be stated in the Offer Documents and also in all thesubsequent periodical communications sent to the debenture holders

b. A trust deed shall be executed by the issuer company in favour of thedebenture trustees within three months of the closure of the issue.

c. The merchant banker shall also ensure that the security created isadequate to ensure 100% asset cover for the debentures.

d. Trustees shall obtain a certificate from the company's auditors:

i. in respect of utilisation of funds during the implementation period of projects.

ii. Creation of Debenture Redemption Reserve (DRR) For the redemption of the

debentures issued, the company shall create debenture redemption reserve in

accordance with the provisions of the Companies Act, 1956.

3. Distribution of Dividends:

a. In case of the companies which have defaulted in payment of interest on debentures orredemption of debentures or in creation of security as per the terms of issue of thedebentures, any distribution of dividend shall require approval of the Debenture Trustees andthe Lead Institution, if any

b. In the case of existing companies, prior permission of the lead institutionfor declaring dividend exceeding 20% or as per the loan covenants is

necessary if the company does not comply with institutional condition

regarding interest and debt service coverage ratio.

c. Dividends may be distributed out of profit of particular years only aftertransfer of requisite amount in DRR.

d. If residual profits after transfer to DRR are inadequate to distributereasonable dividends, company may distribute dividend out of general

reserve.

4. Redemption:The issuer company shall redeem the debentures as per the offer document.

5. Creation of charge:


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The offer document shall specifically state the assets on which security shall be created andshall also state the ranking of the charge/s. In case of second or residual charge orsubordinated obligation, the offer document shall clearly state the risks associated with suchsubsequent charge. The relevant consent for creation of security such as consent of thelessor of the land in case of leasehold land etc. shall be obtained and submitted to thedebenture trustee before opening of issue of debenture

GUIDELINES FOR MERCHANT BANKER:

1. An application should be submitted to SEBI in Form A of the SEBI (Merchant

Bankers) Regulations, 1992. SEBI shall consider the application and on beingsatisfied issue a certificate of registration in Form B of the SEBI (Merchant Bankers)Regulations, 1992 and Rs. 5 lakhs should be paid within 15 days before the grant ofcertificate.

2. Without holding a certificate of registration granted by the Securities and ExchangeBoard of India, no person can act as a merchant banker.

3. The validity of the certificate is three years

4. Three months before the expiry period, an application should be submitted to SEBI inForm A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider theapplication and on being satisfied renew certificate of registration for a further periodof 3 years with a renewal fees of 2.5 lakhs.

5. Only a body corporate other than a non-banking financial company shall be eligibleto get registration as merchant banker.


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6. The categories for which registration may be granted are given below:

Category I to carry on the activity of issue management and to act as adviser, consultant,

manager, underwriter, portfolio manager.

Category II - to act as adviser, consultant, co-manager, underwriter, portfolio manager.

Category III - to act as underwriter, adviser or consultant to an issue

Category IV to act only as adviser or consultant to an issue

7. The capital requirement depends upon the category. The minimum net worthrequirement for acting as merchant banker is given below:

Category I Rs. 5 croresCategory II Rs, 50 lakhs

Category III Rs. 20 lakhsCategory IV Nil

SEBI GUIDELINES FOR DEPOSITORIES:

1. An application for the grant of a certificate of registration as a depository shall be made tothe Board by the sponsor in Form A, shall be accompanied by the fee specified

2. The certificate of registration issued under regulation 20, or renewed under regulation 22

shall be valid for a period of five years from the date of its issue or renewal, as the case maybe.

3. The minimum net worth stipulated by SEBI for a depository is Rs.100 crore.

4. The account opening form must be supported by copies of any one of the approveddocuments to serve as proof of identity (POI) and proof of address (POA) as specified bySEBI. Besides, production of PAN card in original at the time of opening of account hasbeen made mandatory

5. SEBI has rationalised the cost structure for dematerialisation by removing account openingcharges, transaction charges for credit of securities, and custody charges

6. Every depository shall maintain the following records and documents, namely: -

(a) records of securities dematerialised and rematerialised;

(b) the names of the transferor, transferee, and the dates of transfer of securities;

(c) a register and an index of beneficial owners


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MODULE 2

NBFCs

EXIM

The EXIM bank was set up in January 1982 as a statutory corporation wholly owned by the

central government. It grants direct loans in India and outside for the purpose of exports and

imports, refinances loans of banks and other notified financial institutions for purposes of

international trade, rediscounts usance export bills for banks, provides overseas investment

finance for Indian companies towards their equity participations in joint ventures abroad

The products and services of EXIM banks include:

a. Post shipment term finance

b. Preshipment credit

c. Term loans for export oriented units

d. Overseas investment finance

e. Finance for export marketing

f. Relending facilities to banks abroad

g. Rediscounting of export bills

h. Refinance of export credit

i. Bulk import finance

j. Research, analysis, advisory and informational services

National Bank for Agriculture and Rural Development

(NABARD):


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The NABARD was set up on july 12, 1982 under an act of parliament as a central or apex

institution for financing agriculatural and rural sectors. Its paid up capital of Rs 100 crore

subscribed by government and RBI in equal amounts.

Nabard provides:

a. Long term refinance for minor irrigation, plantation, horticulture, land development, farm

mechanization, animal husbandry, fisheries etc.

b. Short term loan assistance for financing of seasonal agricultural operations, marketing of

crops, purchase/procurement/distribution of agricultural inputs etc.

c. Medium-term loan facilities for approved agricultural purposes

d. Working capital refinance for handloom weavers

e. Refinance for financing government-sponsored programmes such as IRDP, Rozgar

yogna

Small Industries Development Bank of India (SIDBI):

The SIDBI was set up in October 1989 under the Act of Parliament as a wholly-owned

subsidiary of the IDBI.The authorized capital is 250 Crore with an enabling provision to increase

it to Rs. 1000 crore.

The Objectives are:

a. To initiate steps for technological up gradation and modernization of existing units

b. To expand channels for marketing of SSI sector products in India and abroad

c. To promote employment-oriented industries In semi urban areas and to check migration

of population to big cities.

The functions are:

a. SIDBI refinances the SFCs and commercial banks for modernization of projects

b. SIDBI refinances ceiling of Rs.50 lakhs fr single window scheme of SFCs etc

c. It participates in venture capital funds set up by public as well as public limited

companies.

d. It provides refinance to lending institutions which are now permitted to lend SSI units

Industrial Financial Corporation of India(IFCI)


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This is the first term financing institution set up in july, 1948 by Government of India under IFCI

Act, 1948.

It provides direct rupee and foreign currency loans for setting up new industrial projects

and for expansion, diversification, renovation and modernization of existing units.

It also underwrites and directly subscribes to industrial securities, provides financial

guarantees, merchant banking services and lease finance.

Its resources are in the form of:

a. Loan from RBI

b. Share capital

c. Retained earnings

d. Repayment of loans

e. Issue of bonds

f. Loans from the government

g. Lines of credit from foreign lending agencies

h. Commercial borrowings in international capital markets.

Coperative Bank:

Co-operative banks are organized and managed on eh principals of Co-operation, self help

and mutual help. They function with the principle of one member one vote. Well being of

all the members is their motto and not profit.

The perform all the activities of banks such as deposit mobilization, supply of credit and

provision of remittance facilities..

The sources of funds for co-operative:

a. Central and state governments

b. The RBI and NABARD

c. Co-operative institutions

d. Ownership funds

e. Deposits

SMALL SAVINGS


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Small Savings are mainly of two types:

a. Post office deposits b

b. Saving certificates and bonds

These in turn consists of small savings bank account with co-operative banks, Recurring

Deposits (RD), Cumulative Term Deposits (CTD) etc.

The main Characteristics of these are:

1. These assets represent medium and long term investment opportunities

2. They are the good substitute for liquidity, maturity and safety

3. Most of them will be in the for of reinvestment plans

4. POSB (Post office savings bank) are as liquid as bank deposits and constitute the moneysulpply in the economy

5. Unit linked insurance plans, RD and CTD provide insurance cover to the investor

6. Tax benefits can also be availed through some of the investments

Types of instruments in small savings media:

1. Post Office Savings Bank Deposits

2. Post office Cumulative Time Deposits(POCTD)

3. Post Office Time Deposits (POTD)

4. Post Office Recurring Deposits (PORD)

5. National Savings Certificate(NSC)

6. Indira Vikas Patra(IVP)

7. Kisan Vikas Patra (KVP)

8. National Savings Scheme (NSC)

9. Post Office Monthly Income Scheme (POMIS)

PROVIDENT FUNDS

This is the way of savings mostly by people who earn their income in salaries. However, with

the starting of the Public Provident Fund Schemes, it is possible even for non salaried earners

also to save in this form.


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Savings in the form of Provident Fund is a contractual obligation and the main motto is to

provide for old age and for the family after ones death. Profit making or capital appreciation on

investment is not of much important aspect in these funds.

The various PF schemes operating in India are:

a. Provident funds for Exempted Industrial Establishments

b. Central and State Government Employee Provident Fund

c. Coal Mines Provident Fund

d. Assam Tea Plantations Provident Fund

e. Public Provident Fund

Factors promoting growth of PPF:

1. The adoption of statutory measures to make provident fund compulsory for industrial and

other establishments

2. The increase in the number of establishments covered under the statutory provisions

3. The expansion of industry and service sector mad consequent increase in no. of salary

earners

4. Introduction of good schemes

5. Provision of tax benefits

6. Increase in Minimum and Maximum rates of contribution by the employees and

employers

7. Attractive interest rates

8. Provision of loan facilities based on provident funds

Pension Funds:

Pension Plans (PP) is an arrangement to provide income to participants in the plan when they

retire. PPs are generally sponsored by private employers, government as an employer and labour

unions.

Classification of Pension Plans:

The financial intermediary, or an organization, or and institution or a trust that manages the

assets and pays the benefits to the old and retirees is called a Pension Fund (PF). Some pension

plans are said to be insured i.e in such cases, the sponsor pays premiums to a life insurance

company in exchange for a group annuity that would pay retirement benefits to the participants.


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Another type of classification is

a. Defined Benefits pension Plan (DBPP)

b. Defined Contribution Pension Plan (DCPP) or Money Purchase Pension Plan (MPPP)

c. Pay as-you-go Pension plan (PAYGPP)

Defined Benefits pension Plan (DBPP): under DBPP, the final pension is pre-defined based on

the final salary and the period of service. Most of the pension plans offered by public sector

enterprises and the government as employer in India are of DBPP variety. This type ensures a

predictable amount of pension to the employees for all the years after their retirement and it is

guaranteed by the state.

Defined Contribution Pension Plan (DCPP): DCPPs popular in US, do not guarantee the

amount of final benefit which the employees would get after they retire. In DCPP, The employee

and employer make a predetermined contribution each year, and these funds are invested over

the period of time till the retirement of employee. What ever the value of these investments at the

time of retirement, the employee will get the certain amount which he would use to purchase an

annuity.

Pay as-you-go Pension plan (PAYGPP): In most European Countries, including France and

Germany, Pensions are paid through PAYGPP, under which the current employees pay a

percentage of their income to provide for the old, and this, along with the contribution of the

state, goes as a pension that sustains the older generation.

Some of the Pension schemes available in India are:

1. Government Employees pension scheme

2. Bank Employees Pension Scheme and Insurance Employees Pension Scheme

(BEPS/IEPS)

3. Privately Administered Superannuation fund

INSURANCE:

The concept of Life Insurance came to India fro UK in 1818. Then the Life Insurance Companies

Act, 1912 was taken as the first measure to regulate the life insurance business. The Life

Insurance Corporation of India came into existence in September 1956 by LIC Act passed by the

Indian Parliament.


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The General Insurance Business started in India in 1850 with the establishment of Triton

Insurance Company Ltd. Later, Insurance act was passed in 1961 for the establishment of

General Insurance Company. The general insurance business was nationalized in India with

effect from 1st January, 1973 and all the Indian and Foreign players were amalgamated into four

operating companies under General Insurance Corporation viz

National Insurance Company Limited

New India Assurance company Limited

Oriental Insurance Company Limited

United India Insurance Company Limited

Insurance is a protection against the financial loss arising against the unforeseen contingences or

unexpected happenings. It gives the reimbursement or financial protection against the possible

future contingent losses or damages.

Insurance is a contract between two parties insurer and the insured. The insured pays a premium

to the insurer for indemnifying against the risk.

Definition:

Insurance is a contract between two parties whereby one party agrees to undertake the risk of

another in exchange for consideration known as premium and promises to pay a fixed sum of

money to the other party on happening of an uncertain event(death) or after the expiry of certain

period in case of life insurance or to indemnify the other party on happening of an uncertain

event in case of general insurance.

Lets take some examples to understand how insurance actually works:

Example 1 Example 2

SUPPOSE

Houses in a village = 1000

Value of 1 House = Rs. 40,000/-

Houses burning in a yr = 5

Total annual loss due to fire = Rs.

2,00,000/-

Contribution of each house owner = Rs.

300/-

SUPPOSE

Number of Persons = 5000

Age and Physical condition = 50 years &

Healthy

Number of persons dying in a yr = 50

Economic value of loss suffered by family

of each dying person = Rs. 1,00,000/-

Total annual loss due to deaths = Rs.

50,00,000/-

Contribution per person = Rs. 1,200/-

UNDERLYING ASSUMPTION

All 1000 house owners are exposed to a commonrisk, i.e. fire

UNDERLYING ASSUMPTION

All 5000 persons are exposed to common risk, i.e.death


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PROCEDURE

All owners contribute Rs. 300/- each as premium to the

pool of funds

Total value of the fund = Rs. 3,00,000 (i.e. 1000 houses *

Rs. 300)

5 houses get burnt during the year

Insurance company pays Rs. 40,000/- out of the pool to

all 5 house owners whose house got burnt

PROCEDURE

Everybody contributes Rs. 1200/- each as premium to the

pool of funds

Total value of the fund = Rs. 60,00,000 (i.e. 5000 persons

* Rs. 1,200)

50 persons die in a year on an average

Insurance company pays Rs. 1,00,000/- out of the pool to

the family members of all 50 persons dying in a year

EFFECT OF INSURANCERisk of 5 house owners is spread over 1000 houseowners in the village, thus reducing the burden onany one of the owners.

EFFECT OF INSURANCERisk of 50 persons is spread over 5000 people,thus reducing the burden on any one person.

The benefits of insurance are:

Safeguard oneself and ones family for future requirements

Peace of mind in case of financial loss

Encourages savings

Get tab rebates and benefits

Protection from claims made by creditors

Security against the various assets

Provides a protection cover

Life Insurance:

The insurance that guarantees a specific sum of money to a designated beneficiary upon the

death of the insured or to the insured if he or she lives beyond a certain age is known as Life

Insurance.

In general, life insurance is a type of coverage that pays benefits upon a person's death ordisability. In exchange for relatively small premiums paid in the present, the policy holderreceives the assurance that a larger amount of money will be available in the future to help his orher beneficiaries pay debts and funeral expenses. Some forms of life insurance can also be usedas a tax-deferred investment to provide funds during a person's lifetime for retirement oreveryday living expenses.


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LIFE INSURANCE:

Life insurance or life assurance is a contract between the policy owner and the insurer, where the

insurer agrees to pay a sum of money upon the occurrence of the insured individual's or

individuals' death or other event, such as terminal illness or critical illness. In return, the policy

owner agrees to pay a stipulated amount called a premium at regular intervals or in lump sums.There may be designs in some countries where bills and death expenses plus catering for after

funeral expenses should be included in Policy Premium. In the United States, the predominant

form simply specifies a lump sum to be paid on the insured's demise.

Parties to the Contract:

There is a difference between the insured and the policy owner (policy holder), although the

owner and the insured are often the same person. For example, if Joe buys a policy on his own

life, he is both the owner and the insured. But if Jane, his wife, buys a policy on Joe's life, she is

the owner and he is the insured. The policy owner is the guarantee and he or she will be theperson who will pay for the policy. The insured is a participant in the contract, but not

necessarily a party to it.

The beneficiary receives policy proceeds upon the insured's death. The owner designates thebeneficiary, but the beneficiary is not a party to the policy.

Types of Life Insurance Policies:

1. Whole Life Assurance: In this kind of policy, the insurance company collectspremium from the insured for whole life or till the time of his retirement and pays

claim to the family of the insured only after his death.

2. Endowment Assurance: In case of endowment assurance, the term of policy isdefined for a specified period say 15, 20, 25 or 30 years. The insurance companypays the claim to the family of assured in an event of his death within the policy'sterm or in an event of the assured surviving the policy's term.

3. Assurance for children: Under this policy, claim by insurance company is paidon the option date which is calculated to coincide with the child's eighteenth ortwenty first birthday. In case the parent survives till option date, policy may eitherbe continued or payment may be claimed on the same date. However, if the parent

dies before the option date, the policy remains continued until the option datewithout any need for payment of premiums. If the child dies before the optiondate, the parent receives back all premiums paid to the insurance company.

4. Term Assurance: The basic feature of term assurance plans is that they providedeath risk-cover. Term assurance policies are only for a limited time, claim forwhich is paid to the family of the assured only when he dies. In case the assuredsurvives the term of policy, no claim is paid to the assured.


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5. Annuities: Annuities are just opposite to life insurance. A person entering into anannuity contract agrees to pay a specified sum of capital (lump sum or byinstallments) to the insurer. The insurer in return promises to pay the insured aseries of payments until insured's death. Generally, life annuity is opted by a

person having surplus wealth and wants to use this money after his retirement.

There are two types of annuities, namely:

Immediate Annuity: In an immediate annuity, the insured pays a lump sumamount (known as purchase price) and in return the insurer promises to pay himin installments a specified sum on a monthly/quarterly/half-yearly/yearly basis.

Deferred Annuity: A deferred annuity can be purchased by paying a singlepremium or by way of installments. The insured starts receiving annuity paymentafter a lapse of a selected period (also known as Deferment period).

6. Money Back Policy: Money back policy is a policy opted by people who wantperiodical payments. A money back policy is generally issued for a particularperiod, and the sum assured is paid through periodical payments to the insured,spread over this time period. In case of death of the insured within the term of thepolicy, full sum assured along with bonus accruing on it is payable by hteinsurance company to the nominee of the deceased.

General Insurance:

Insurance other than Life Insurance falls under the category of General Insurance. General

Insurance comprises of insurance of property against fire, burglary etc, personal insurance suchas Accident and Health Insurance, and liability insurance which covers legal liabilities. There arealso other covers such as Errors and Omissions insurance for professionals, credit insurance etc.

Non-life insurance companies have products that cover property against Fire and allied perils,flood storm and inundation, earthquake and so on. There are products that cover property againstburglary, theft etc. The non-life companies also offer policies covering machinery againstbreakdown, there are policies that cover the hull of ships and so on. A Marine Cargo policycovers goods in transit including by sea, air and road. Further, insurance of motor vehiclesagainst damages and theft forms a major chunk of non-life insurance business.

General Insurance is normally meant for a short term period of twelve months or less. Recently,longer-term insurance agreements have made an entry into the business of general insurance buttheir term does not exceed five years. General insurance can be classified as follows:

1. Fire Insurance: It provides protection against damage to property caused by accidents

due to fire, lightening or explosion, whereby the explosion is caused by boilers not being

used for industrial purposes. Fire insurance also includes damage caused due to other


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perils like storm tempest or flood; burst pipes; earthquake; aircraft; riot, civil commotion;

malicious damage; explosion; impact.

2. Marine Insurance: It basically covers three risk areas, namely, hull, cargo and freight.The risks which these areas are exposed to are collectively known as "Perils of the Sea".

These perils include theft, fire, collision etc.

3. Miscellaneous: As per the Insurance Act, all types of general insurance other than fire

and marine insurance are covered under miscellaneous insurance. Some of the examples

of general insurance are motor insurance, theft insurance, health insurance, personal

accident insurance, money insurance, engineering insurance etc.

ULIPS:ULIP is an abbreviation for Unit Linked Insurance Policy. A ULIP is a life

insurance policy which provides a combination of risk cover and investment.The dynamics of the capital market have a direct bearing on the performanceof the ULIPs. In unitlinked policies, the investment risk is generally borne bythe investor.

Selection of Insurance Policies:

With so many insurance deals on the market key points to compare include the insurance re:

suitability for your particular needs cost

flexibility: what happens if you miss a payment or wish to cancel or switch? terms: when does the policy pay out/are there restrictions?

Essentials of a valid Insurance Contract:

1. Offer and Acceptance: When applying for insurance, the first thing you do is get the

proposal form of a particular insurance company. After filling in the requested details,

you send the form to the company (sometimes with a premium check). This is your offer.

If the insurance company accepts your offer and agrees to insure you, this is called an

acceptance. In some cases, your insurer may agree to accept your offer after making some

changes to your proposed terms (for example, charging you a double premium for your

chain-smoking habit).


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2. Consideration: This is the premium or the future premiums that you have pay to your

insurance company. For insurers, consideration also refers to the money paid out to you

should you file an insurance claim. This means that each party to the contract must

provide some value to the relationship.

3. Legal Capacity: You need to be legally competent to enter into an agreement with your

insurer. If you are a minor or are mentally ill, for example, then you may not be qualified

to make contracts. Similarly, insurers are considered to be competent if they are licensed

under the prevailing regulations that govern them.

4. Legal Purpose: If the purpose of your contract is to encourage illegal activities, it isinvalid.

Advanced technologies in banking:

E-banking (Electronic Banking)With advancement in information and communication technology, banking services are alsomade available through computer. Now, in most of the branches you see computers being used torecord banking transactions. Information about the balance in your deposit account can beknown through computers. In most banks now a days human or manual teller counter is beingreplaced by the Automated Teller Machine (ATM). Banking activity carried on throughcomputers and other electronic means of communication is called electronic banking or e-banking. Let us now discuss about some of these modern trends in banking in India.

Automated Teller Machine

Banks have now installed their own Automated Teller Machine (ATM) throughout the country atconvenient locations. By using this, customers can deposit or withdraw money from their ownaccount any time.

Debit Card

Banks are now providing Debit Cards to their customers having saving or current account in thebanks. The customers can use this card for purchasing goods and services at different places inlieu of cash. The amount paid through debit card is automatically debited (deducted) from thecustomers account.

Credit Card

Credit cards are issued by the bank to persons who may or may not have an account in the bank.


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Just like debit cards, credit cards are used to make payments for purchase, so that the individualdoes not have to carry cash. Banks allow certain credit period to the credit cardholder to makepayment of the credit amount. Interest is charged if a cardholder is not able to pay back thecredit extended to him within a stipulated period. This interest rate is generally quite high.

Net BankingWith the extensive use of computer and Internet, banks have now started transactions overInternet. The customer having an account in the bank can log into the banks website and accesshis bank account. He can make payments for bills, give instructions for money transfers, fixeddeposits and collection of bill, etc.

Phone Banking

In case of phone banking, a customer of the bank having an account can get information of hisaccount, make banking transactions like, fixed deposits, money transfers, demand draft,collectionand payment of bills, etc. by using telephone . As more and more people are now using mobile

phones, phone banking is possible through mobile phones. In mobile phone a customer canreceive and send messages (SMS) from and to the bank in addition to all the functions possiblethrough phone banking.

RTGS

The acronym RTGS stands forReal Time Gross Settlement. RTGS system is a funds transfer

mechanism where transfer of money takes place from one bank to another on a real time and

on gross basis. This is the fastest possible money transfer system through the banking channel.

Settlement in real time means payment transaction is not subjected to any waiting period. The

transactions are settled as soon as they are processed. Gross settlement means the transaction is

settled on one to one basis without bunching with any other transaction. Considering that moneytransfer takes place in the books of the Reserve Bank of India, the payment is taken as final and

irrevocable.

The RTGS system is primarily for large value transactions. The minimum amount to be

remitted through RTGS is Rs.1 lakh. There is no upper ceiling for RTGS transactions. No

minimum or maximum stipulation has been fixed for EFT and NEFT transactions.

The remitting customer has to furnish the following information to a bank for effecting a RTGS

remittance:

1. Amount to be remitted2. His account number which is to be debited3. Name of the beneficiary bank4. Name of the beneficiary customer5. Account number of the beneficiary customer6. Sender to receiver information, if any7. The IFSC code of the receiving branch


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Before the innovation of RTGS system, EFT and NEFT were used by banks for Fund

transfer:

EFT (Electronic Fund Transfer) and NEFT (National Electronic Fund Transfer) are electronic

fund transfer modes that operate on a deferred net settlement (DNS) basis which settles

transactions in batches. In DNS, the settlement takes place at a particular point of time. Alltransactions are held up till that time. For example, NEFT settlement takes place 6 times a day

during the week days (9.30 am, 10.30 am, 12.00 noon. 1.00 pm, 3.00 pm and 4.00 pm) and 3

times during Saturdays (9.30 am, 10.30 am and 12.00 noon). Any transaction initiated after a

designated settlement time would have to wait till the next designated settlement time. Contrary

to this, in RTGS, transactions are processed continuously throughout the RTGS business hours.

ECS (Electronic Clearing System)

It is a mode of electronic funds transfer from one bank account to another bank account using the

services of a Clearing House. This is normally for bulk transfers from one account to many

accounts or vice-versa. This can be used both for making payments like distribution of dividend,

interest, salary, pension, etc. by institutions or for collection of amounts for purposes such as

payments to utility companies like telephone, electricity, or charges such as house tax, water tax,

etc or for loan installments of financial institutions/banks or regular investments of persons.

Advantages to Beneficiary:

The end beneficiary need not make frequent visits to his bank for depositing the physical

paper instruments.

He need not apprehend loss of instrument and fraudulent encashment.

The delay in realization of proceeds after receipt of paper instrument.

Advantages to user-like corporate bodies/institutions

The ECS user saves on administrative machinery for printing,dispatch and reconciliation.

Avoids chances of loss of instruments in postal transit.

Avoids chances of frauds due to fraudulent access to the paper instruments and

encashment.

Ability to make payment and ensure that the beneficiaries' accountgets credited on a

designated date.

Advantages to the banks


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Banks handling ECS get freed of paper handling.

Paper handling also creates lot of pressure on banks as they have to encode the

instruments, present them in clearing, monitor their return and follow up with the

concerned bank and customers.

In ECS banks simply get the payment particulars relating to their customers. All they

need to do is to match the account particulars like name, a/c number and credit the

proceeds

Wherever the details do not match, they have to return it back, as per the procedure

Securitization:It is the process of taking an illiquid asset, or group of assets, and through financial engineering,

transforming them into a security.

Debt Securitization

It is nothing but the packaging of a pool of financial assets into marketable securities. It involves

issue of securities against illiquid assets of financial institutions and such securities are really

structured, whereby the originator transfer or sells some of the assets to a SPV which breaks

these assets into tradable securities of smaller value then sold to the investing public. Thegeneral principle is that the maturities of these securities must coincide with the maturity

of the securitized loan.

This makes the bank independent in the field of raising funds other than the money market, loan

market etc. ..EG: A securitization is a financial transaction in which assets are

pooled and securities representing interests in the pool are issued. An example

would be a financing company that has issued a large number of auto loans and

wants to raise cash so it can issue more loans. One solution would be to sell off its

existing loans, but there isn't a liquid secondary market for individual auto loans.

Instead, the firm pools a large number of its loans and sells interests in the pool to

investors. For the financing company, this raises capital and gets the loans off itsbalance sheet, so it can issue new loans. For investors, it creates a liquid

investment in a diversified pool of auto loans, which may be an attractive

alternative to a corporate bond or other fixed income investment. The ultimate

debtorsthe car ownersneed not be aware of the transaction. They continue

making payments on their loans, but now those payments flow to the new investors

as opposed to the financing company.
http://www.investopedia.com/terms/s/securitization.asphttp://www.investopedia.com/terms/s/security.asphttp://www.riskglossary.com/articles/liquidity.htmhttp://www.riskglossary.com/articles/hedging_and_diversification.htmhttp://www.riskglossary.com/articles/corporate_bond.htmhttp://www.investopedia.com/terms/s/securitization.asphttp://www.investopedia.com/terms/s/security.asphttp://www.riskglossary.com/articles/liquidity.htmhttp://www.riskglossary.com/articles/hedging_and_diversification.htmhttp://www.riskglossary.com/articles/corporate_bond.htm


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SPV (Special

Purpose

The Following Diagram shows the process of Debt Securitization:

Security 1

Parties to the Securitization:

1. The Originator also interchangeably referred to as the Seller is the entity whose

receivable portfolio forms the basis for ABS issuance.

2. Special Purpose Vehicle (SPV)- which as the issuer of the ABS ensures adequate cash

flow to the investors.

3. The Servicer- who bears all administrative responsibilities relating to the securitizationtransaction.

4. The Trustee or the Investor Representative: who act in a fiduciary capacity

safeguarding the interests of investors in the ABS.

5. The Credit Rating Agency: which provides an objective estimate of the credit risk in

the securitization transaction by assigning a well-defined credit rating.

6. Investors: However, more important than all the afore mentioned are the investors in the

securitised paper. Investors are the ultimate judges of any securitization effort.

Originators should therefore interact actively with the investor community to get to knowinvestor preferences and concerns for effective structuring and distribution of ABS. Such

knowledge would also make the origination process more efficient.

Process of Securitization:

1. Creation of asset pool and its sale:

The originator/seller (of assets) creates a pool of assets and executes a legal true sale of

Sells the

Financial

Assets

Secu

rity

Securi

ty 4

Secu

rity 5

Secu

rity 6

Secur

ity 7

Secur

ity 8

Secu

rity

Breaks into

small securities

Originator

(Eg. Banks,

Lic, Co. etc)


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the same to a special purpose vehicle (SPV). A SPV in such cases is either a trust or a

company, as may be appropriate under applicable law, setup to carry out a restricted set

of activities, management of which would usually rest with an independent board of

directors.

2. Designing the securities: The SPV will break the financial asset purchased from theoriginator in securities of smaller value so as to make it convenient and affordable for the

public/investors. . Design of the instrument however would be based on the nature of

interest that investors would have on the asset pool. These securities will be designed in

such a manner that the maturity of the ABS(Asset Backed Securities) will have to match

with that of the underlying financial asset.

3. Credit rating: Once the securities has been designed, it should get approval and rated

from one of the recognized credit rating agency.

4. Issuance of the securitised paper:This activity is usually performed by the SPV.

5. Credit Risk:

It must be made abundantly clear at the very outset that the accretions on the asset-

backed security, i.e., interest, amortisation and redemption payments, are entirely

dependent on the performance of the pooled assets, and will have nothing to do with the

credit of the originator. By the same argument, such cash flows would also be not

influenced by events affecting the condition of the originator, including insolvency.

6. Administration:

Formal delineation of duties and responsibilities relating to administration of securitisedassets, including payment servicing and managing relationship with the final obligorsmust be spelt out clearly through a contractual agreement with the entity who wouldperform those functions.

Advantages to issuer/Originator:

1. Reduces funding costs: Through securitization, a company rated BB but with AAA

worthy cash flow would be able to borrow at possibly AAA rates. This is the number one

reason to securitize a cash flow and can have tremendous impacts on borrowing costs.

The difference between BB debt and AAA debt can be multiple hundreds ofbasis points.

For example, Moody's downgraded Ford Motor Credit's rating in January 2002, but

senior automobile backed securities, issued by Ford Motor Credit in January 2002 and

April 2002, continue to be rated AAA because of the strength of the underlying collateral

and other credit enhancement.

2. Reduces asset-liability mismatch: "Depending on the structure chosen, securitization

can offer perfect matched funding by eliminating funding exposure in terms of both
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duration and pricing basis." Essentially, in most banks and finance companies, the

liability book or the funding is from borrowings. This often comes at a high cost.

Securitization allows such banks and finance companies to create a self-funded asset

book.

3. Lower capital requirements: Some firms, due to legal, regulatory, or other reasons,have a limit or range that their leverage is allowed to be. By securitizing some of their

assets, which qualifies as a sale for accounting purposes, these firms will be able to lessen

the equity on their balance sheets while maintaining the "earning power" of the asset.

4. Locking in profits: For a given block of business, the total profits have not yet emerged

and thus remain uncertain. Once the block has been securitized, the level of profits has

now been locked in for that company, thus the risk of profit not emerging, or the benefit

of super-profits, has now been passed on.

5. Transfer risks (credit, liquidity, prepayment, reinvestment, asset concentration):Securitization makes it possible to transfer risks from an entity that does not want to bear

it, to one that does. Similarly, by securitizing a block of business (thereby locking in a

degree of profits), the company has effectively freed up its balance to go out and write

more profitable business.

6. Increases Earnings: Securitization makes it possible to record an earnings bounce

without any real addition to the firm. When a securitization takes place, there often is a

"true sale" that takes place between the Originator (the parent company) and the SPE.

This sale has to be for the market value of the underlying assets for the "true sale" to stick

and thus this sale is reflected on the parent company's balance sheet, which will boostearnings for that quarter by the amount of the sale. While not illegal in any respect, this

does distort the true earnings of the parent company.

7. Liquidity: Future cashflows may simply be balance sheet items which currently are not

available for spending, whereas once the book has been securitized, the cash would be

available for immediate spending or investment. This also creates a reinvestment book

which may well be at better rates.

Disadvantages to issuer/originator:

1. Costs: Securitizations are expensive due to management and system costs, legal fees,underwriting fees, rating fees and ongoing administration. An allowance for unforeseen

costs is usually essential in securitizations, especially if it is an atypical securitization.

2. Size limitations: Securitizations often require large scale structuring, and thus may not

be cost-efficient for small and medium transactions.
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3. Risks: Since securitization is a structured transaction, it may include par structures as

well as credit enhancements that are subject to risks of impairment, such as prepayment

Advantages to investors:

1. Opportunity to potentially earn a higher rate of return (on a risk-adjusted basis)

Opportunity to invest in a specific pool of high quality credit-enhanced assets: Due to the

stringent requirements for corporations (for example) to attain high ratings, there is a

dearth of highly rated entities that exist. Securitizations, however, allow for the creation

of large quantities of AAA, AA or A rated bonds, and risk averse institutional investors,

or investors that are required to invest in only highly rated assets, have access to a larger

pool of investment options.

2. Portfolio diversification: Depending on the securitization, hedge funds as well as other

institutional investors tend to like investing in bonds created through Securitizations

because they may be uncorrelated to their other bonds and securities.

3. Isolation of credit risk from the parent entity: Since the assets that are securitized are

isolated (at least in theory) from the assets of the originating entity, under securitization it

may be possible for the securitization to receive a higher credit rating than the "parent,"

because the underlying risks are different. Even if the originator becomes bankrupt, it

will not have any effect on these securities because the financial asset is already sold

to the SPV and is not in the balance sheet of the originator. The creditors of the

originator cannot claim or have charge on the underlying asset of these Asset

Backed Securities.

Risks to investors

1. Liquidity risk

2. Credit/default: Default risk is generally accepted as a borrowers inability to meet

interest payment obligations on time.

3. Prepayment/reinvestment/early amortization: The majority of revolving ABS are

subject to some degree of early amortization risk. The risk stems from specific early

amortization events or payout events that cause the security to be paid off prematurely.

Typically, payout events include insufficient payments from the underlying borrowers,

insufficient excess Fixed Income Sectors: Asset-Backed Securities spread, a rise in the

default rate on the underlying loans above a specified level, a decrease in credit

enhancements below a specific level, and bankruptcy on the part of the sponsor or

servicer.
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Also known as a "pass-through certificate" or "pay-through security."

The most common type of pass-through is a mortgage-backed certificate(MBS) and not Assetbacked securities (ABS), where homeowners' payments pass from the original bank through a

government agency or investment bank to investors. Presently the three institutions (FannieMae, Freddie Mac and Ginnie Mae) act as the principal intermediaries in the market in as muchas they perform the activity of purchasing mortgages from home loan Originators and sellingMBS.

As an investor in Pass-Through Certificates, you are not necessarily the Holder of those Pass-Through Certificates. You will ordinarily hold your Pass-Through Certificates through one ormore financial intermediaries. Your rights as an investor may be exercised only through theHolder of your Pass-Through Certificates, and Freddie Mac may treat the Holder as the absoluteowner of your Pass-Through Certificates

Security that represents an undivided interest in pools of mortgages, backed by federallyguaranteed loans of the same maturity and coupon date are the Pass through cettificates.

EG: When a mortgage banker has collected at least $2 million in mortgages, the loans aredeposited in a custodian bank and a certificate is issued against the mortgages. Payments ofprincipal and interest are made monthly to certificate holders, and are guaranteed by theGovernment National Mortgage Association(US) regardless of whether payments are received,as borrowers pay down the loans. There is no holding back of interest payments as withcollateralized mortgage obligations and mortgage backed bonds.

Risk involved in pass through certificate:

1. Pass-Through Certificates May Not be Suitable Investments for You: If you require a

definite payment stream, or a single payment on a specific date, Pass-Through

Certificates are not suitable investments for you. If you purchase Pass-Through

Certificates, you need to have enough financial resources to bear all of the risks related to

your Pass-Through Certificates.

2. Principal Payment Rates are Uncertain: Principal payment rates on the Pass-Through

Certificates will depend on the rates of principal payments on the underlying Mortgages.

In general, prepayments tend to increase when current interest rates decline, as more

borrowers choose to take out their existing Mortgages. As current interest rates increase,prepayments generally decline.

3. Prepayments Can Reduce Your Yield: Your yield on a class of Pass-Through

Certificates will depend on its price, the rate of prepayments on its underlying Mortgages

and the actual characteristics of those Mortgages. The Mortgages may be prepaid at any

time, in most cases without penalty.


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4. Pass-Through Certificates are Subject to Market Risks: The market values of your

Pass-Through Certificates will vary over time, primarily in response to changes in prevailing

interest rates. If you sell your Pass-Through Certificates when their market values are low,

you may experience significant losses. A secondary market for some types of Pass-Through

Certificates may not develop. Even if a market does develop, it may not be liquid enough to

allow you to sell your Pass-Through Certificates easily or at your desired price.

Special Purpose Vehicle (SPV) or Special Purpose Entity (SPE):

Securitisation offers higher quality assets to investors by virtue of the fact that the structuresinsulate investors from the bankruptcy risk of the Originator. In order to ensure that the assetsactually achieve the bankruptcy remoteness, it is essential to move them out of the balance sheetof the Originator and park them with another independent entity. Typically an SPV is employedto purchase the assets from the Originator and issue securities against these assets. Such astructure provides a comfort to the investors that they are investing in a pool ofassets which is held on their behalf only by the SPV and which is not subject to any subsequent

deterioration in the credit quality of the Originator. The SPV is usually a thinly capitalisedvehicle whose ownership and management are independent of the Originator. The main objectiveof SPV is to distinguish the instrument from the Originator.

A special purpose entity (SPE) is a body corporate (usually a limited company of some type

or, sometimes, a limited partnership) created to fulfill narrow, specific or temporary

objectives, primarily to isolate financial risk, usually bankruptcy, specific taxation or

regulatory risk.

It is also referred to as a "bankruptcy-remote entity" whose operations are limited to theacquisition and financing of specific assets. The SPV is usually a subsidiary company with an

asset/liability structure and legal status that makes its obligations secure even if the parentcompany goes bankrupt.

A special purpose entity may be owned by one or more other entities and certain jurisdictionsmay require ownership by certain parties in specific percentages. Often it is important that theSPE not be owned by the entity on whose behalf the SPE is being set up (the sponsor). Forexample, in the context of aloan securitisation, if the SPE securitisation vehicle were owned orcontrolled by the bank whose loans were to be secured, the SPE would be consolidated with therest of the bank's group for regulatory, accounting, and bankruptcy purposes, which would defeatthe point of the securitisation. Therefore many SPEs are set up as 'orphan' companieswith theirshares settled on charitable trust and with professional directors provided by an administration

company to ensure there is no connection with the sponsor.

Key features desired in an ideal SPV:

1. An SPV must be capable of acquiring, holding and disposing of assets.2. It would be an entity, which would undertake only the activity of asset

securitisation and no other activity.3. An SPV must be bankruptcy remote i.e. the bankruptcy of Originator should not
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affect the interests of holders of instruments issued by SPV.4. An SPV must be bankruptcy proof. i.e. it should not be capable of being taken

into bankruptcy in the event of any inability to service the securitised paper issuedby it.

5. An SPV must have an identity totally distinct from that of its promoters/ sponsors/

constituents/ shareholders. Its creditors cannot obtain satisfaction from them.6. The investors must have undivided interest in the underlying asset (asdistinguished from an interest in the SPV which is a mere conduit).

7. A SPV must be tax neutral i.e. there should be no additional tax liability or doubletaxation on the transaction on account of the SPV acting as a conduit.

8. A SPV must have the capability of housing multiple securitisation. However, SPVmust take precaution to avoid co-mingling of assets of multiple securitisation. Incase of transactions involving various kinds of assets, they should restrict therights of investors to the specific pool.

Advantages of SPV:

Conducting large and very risky projects without putting the parent firm at risk.

Operate in ways that are "barely legal".

A special Joint-Venture for sharing intellectual property.

Securitizing loan portfolios of banks.

Securitizing financial assets such as auto loans, credit card and hire purchase receivables,

finance leases, aircraft operating leases, real estate mortgages.

Aircraft and ship financing.

Protection from tax or legal consequences of the activities of the SPV (reinvoicing

subsidiaries and offshore insurance companies).

Disadvantage of SPV:

A corporation can use such a vehicle to finance a large project without putting the entire firm at

risk. Problem is, due to accounting loopholes, these vehicles became a way for CFOs to hide

debt. Essentially, it looks like the company doesn't have a liability when they really do.

MODULE 3

LEASING:
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Meaning of Leasing:

Leasing is an agreement which consists of two parties, viz., Lessor and Lessee

Lease is defined as An agreement whereby the lessee uses the asset owned by the lessor by paying some

consideration.

Lessor is a person who owns the asset.

Lessee is a person who uses the asset.

Lease Rentals refers to the consideration paid to the lessor in lump sum or in fixed installments by the

lessee for using the asset.

The various factors to be considered in leasing of an asset are:

1. Insufficient Funds: When there are insufficient in the business and if the business want to

allocate its funds in a more rational manner instead of investing in an asset, then the business unit

can go for leasing of an asset.

2. Lease Rentals: Lease rentals are cash outflows and are an expense which is deductible for tax.

Hence the benefit of tax savings can be taken in case of payment of lease rentals.

3. Duration: If the life time of the project is long, leasing is preferred.

4. No Obsolescence risk: As the asset is not owned, there is no risk of obsolescence as the lease

contract can be terminated for the obsolete one and new contract can be entered into. There are

also no replacement expenses for the obsolete asset in case of leasing.

5. Depreciation: There will not be any depreciation expenses as the asset is not owned by the

business unit and hence tax savings on depreciation cannot be claimed.

6. Interest: As the funds in not borrowed, there is no interest expense and thereby, tax savings on

interest cannot be claimed.

7. No loss: There is no risk of Short or Long Term Capital Loss as the asset is not sold at the end of

the project, but transferred back to lessor. As there is no ownership, sale does not occur in this

case.

8. Salvage value: There is no salvage value because asset is not sold as it is not owned but

transferred to the lessor at the end of the project.

HIRE PURCHASE:

Hire purchase is a system in which a buyer takes possession of an asset on payment of a deposit andcompletes the purchase by paying a series of installments while the seller retains ownership until the finalinstallment is paid.


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The various factors to be considered in purchase of an asset through hire purchase are:

1. Insufficient Funds: The business unit can go for this option in case of in sufficient funds as

purchase down payment will usually be 10 to 20% of the value of the asset. The remaining

amount can be paid in small installments annually.

2. Interest: Installments payment includes interest factor in it. And interest is an expense

deductible for tax, the benefit of tax savings arises.

3. Ownership: The business unit after the payment of entire series of installment claims the

ownership of the asset.

4. Depreciation: As the business unit owns the asset, it can claim depreciation which is an expense

deductible for tax and hence the benefit of tax savings also arises.

5. Salvage Value: At the end of the life time of the asset, the asset can be sold and the scrap value

realized will be considered as a cash inflow.

6. Profit or loss on sale of asset: Short or Long Term Profit or Loss on sale of asset has to be

considered. If it is a profit, well and good. If it is loss, tax savings can be claimed on the loss.

Difference between hire purchase and installment purchase:

In case of hire purchase, ownership is transferred at the end once all the installments are paid; in case of

installment purchase, ownership is transferred at the beginning as soon as the initial deposit is made.

However, this does not impact on any entries in the books of accounts.

HIRING:

Hiring is similar to that of leasing. In case of hiring, the hiree uses the asset of the owner by paying him a

consideration (rent).

The various factors to be considered in hiring an asset are:

1. No investment: As the business unit is not going for the purchase of the asset, no huge initial

investment is required.

2. Rent: The rent paid for hiring an asset is considered for the purpose for tax calculation.

Therefore, the tax benefit can be availed on rental expenses.

3. No Obsolescence risk: As the asset is not owned, there is no risk of obsolescence as the asset is

hired for some particular point of time, especially for a short period.

4. Depreciation: There will not be any depreciation expenses as the asset is not owned by the

business unit and hence tax savings on depreciation cannot be claimed.


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5. Interest: As the funds in not borrowed, there is no interest expense and thereby, tax savings on

interest cannot be claimed.

6. No loss: There is no risk of Short or Long Term Capital Loss as the asset is not sold at the end of

the project, but transferred back to owner of the asset. As there is no ownership, sale does not

occur in this case.

7. Salvage value: There is no salvage value because asset is not sold as it is not owned but

transferred to the owner of the asset at the end of the project.

CREDIT RATING AND ITS PROCESS

Meaning:

Credit rating refers to the assessment of the credit worthiness of individuals and corporations. It

is based upon the history of borrowing and repayment, as well as the availability of assets and

extent of liabilities.

Credit is important since individuals and corporations with poor credit will have difficulty

finding financing, and will most likely have to pay more due to the risk of default.

The rating is based on the opinions ofbanks, financial institutions and financial analysis toinvestigate stability and credit history and they consistently provide ratings which areindependent, objective and of the highest possible quality.

How are instruments are rated?

The rating process begins with an application to the rating agencies by the issuer in writing.

The rating request is usually done several weeks before the issuance of the instruments to allowtime for the rating agencies to perform their review and analysis. Generally, the followingdocumentations are provided to the rating agencies as soon as possible:

the preliminary official statement;

latest audited and unaudited financial statements;

the latest budget information, including economic assumptions and trends;

capital outlay plans;

the bond counsel opinion addressing the authority and tax-exempt status ofthe bond issuance;

all legal documents relating to the security for the bonds; and
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any other documents that may pertain to the bond issuance as requested bythe rating agencies.

Following this, a meeting is set up at the rating agency's or issuer's office to present thecreditworthiness. The credit analyst prepares a municipal credit report which discusses key

analytical factors. The credit analyst presents credit for "sign-off" with the senior analyst andmakes a recommendation for rating. The credit analyst makes a presentation before a ratingcommittee comprised of senior analysts. Finally, the rating is released to the issuer.

The credit ratings effectively categorise issuers into corresponding grades, depending on whetherthey are considered as more or less default-prone. Credit rating agencies employ comprehensivecreditworthiness scales, with the critical border line running between the so-called in

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