StudyNotes on

Indian Financial Systems & Services

(for MBA1st year as per BPUT Syllabus)

Prepared By:
Prof. Sudeep Kumar Bharati
Asst. Professor(DRIEMS-MBA)

Dhaneswar Rath Institute of Engineering and

Management Studies (DRIEMS MBA)
Tangi, Cuttack
 MODULE-I
Components of Indian Financial System:
The financial system of an economy provides the way to collect money from the people who
have it and distribute it to those who can use it best. So, the efficient allocation of economic
resources is achieved by a financial system that distributes money to those people and for those
purposes that will yield the best returns.

According to Prasanna Chandra, “financial system consists of a variety of institutions,

markets, and instruments related in a systematic manner and provide the principal means by
which savings are transformed into investments”.

A financial system refers to a system which enables the transfer of money between investors and
borrowers. A financial system could be defined at an international, regional or organizational
level. The term ―system‖ in ―Financial System‖ indicates a group of complex and closely linked
institutions, agents, procedures, markets, transactions, claims and liabilities within an economy.
There are four components of Financial System which is discussed below:

1. Financial Institutions:It ensures smooth working of the financial system by making investors
and borrowers meet. They mobilize the savings of investors either directly or indirectly via
financial markets by making use of different financial instruments as well as in the process using
the services of numerous financial services providers. They could be categorized into
Regulatory, Intermediaries, Non-intermediaries and Others. They offer services to organizations
looking for advises on different problems including restructuring to diversification strategies.
They offer complete series of services to the organizations who want to raise funds from the
markets and take care of financial assets, for example deposits, securities, loans, etc.

2. Financial Markets: A Financial Market can be defined as the market in which financial assets
are created or transferred. As against a real transaction that involves exchange of money for real
goods or services, a financial transaction involves creation or transfer of a financial asset.
Financial Assets or Financial Instruments represent a claim to the payment of a sum of money
sometime in the future and /or periodic payment in the form of interest or dividend. There are
four components of financial market are given below:

I. Money Market: The money market is a wholesale debt market for low-risk, highly-liquid,
short-term instrument. Funds are available in this market for periods ranging from a single day
up to a year. This market is dominated mostly by government, banks and financial institutions.

II. Capital Market: The capital market is designed to finance the long-term investments. The
transactions taking place in this market will be for periods over a year.

III. Foreign Exchange Market: The Foreign Exchange market deals with the multicurrency
requirements which are met by the exchange of currencies. Depending on the exchange rate that
is applicable, the transfer of funds takes place in this market. This is one of the most developed
and integrated markets across the globe.

IV. Credit Market- Credit market is a place where banks, Financial Institutions (FIs) and Non
Bank Financial Institutions (NBFCs) purvey short, medium and long-term loans to corporate and
individuals.

3.Financial Instruments: This is an important component of financial system. The products

which are traded in a financial market are financial assets, securities or other types of financial
instruments. There are a wide range of securities in the markets since the needs of investors and
credit seekers are different. They indicate a claim on the settlement of principal down the road or
payment of a regular amount by means of interest or dividend. Equity shares, debentures, bonds,
etc. are some examples.

4. Financial Services: It consists of services provided by Asset Management and Liability

Management Companies. They help to get the required funds and also make sure that they are
efficiently invested. They assist to determine the financing combination and extend their
professional services up to the stage of servicing of lenders. They help with borrowing, selling
and purchasing securities, lending and investing, making and allowing payments and settlements
and taking care of risk exposures in financial markets. These range from the leasing companies,
mutual fund houses, merchant bankers, portfolio managers, bill discounting and acceptance
houses. The financial services sector offers a number of professional services like credit rating,
venture capital financing, mutual funds, merchant banking, depository services, book building,
etc. Financial institutions and financial markets help in the working of the financial system by
means of financial instruments. To be able to carry out the jobs given, they need several services
of financial nature. Therefore, financial services are considered as the 4th major component of
the financial system.
Functions of Indian financial system:

Liquidity function

The most important function of a financial system is to provide money and monetary assets for
the production of goods and services. Monetary assets are those assets which can be converted
into cash or money easily without loss of value. All activities in a financial system are related
to the liquidity-either provision of liquidity or trading in liquidity.

Payment function

The financial system offers a very convenient mode of payment for goods and services. The
cheque system and credit card system are the easiest methods of payment in the economy. The
cost and time of transactions are considerably reduced.

Saving function

An important function of a financial system is to mobilize savings and channelize them into
productive activities. It is through the financial system the savings are transformed into
investments.
Risk function

The financial markets provide protection against life, health, and income risks. These guarantees
are accomplished through the sale of life, health insurance, and property insurance policies.

Transfer function

A financial system provides a mechanism for the transfer of resources across geographic
boundaries.

Reformatory functions

A financial system undertaking the functions of developing, introducing innovative financial

assets/instruments services and practices and restructuring the existing assets, services, etc, to
cater to the emerging needs of borrowers and investors.

Reforms in Indian Financial system:

Financial sector reforms refer to the reforms in the banking system and capital market.

An efficient banking system and a well-functioning capital market are essential to mobilize
savings of the households and channel them to productive uses. The high rate of saving and
productive investment are essential for economic growth. Prior to 1991 while the banking system
and the capital market had shown impressive growth in the volume of operations, they suffered
from many deficiencies with regard to their efficiency and the quality of their operations.

The weaknesses of the banking system was extensively analyzed by the committee (1991) on
financial sector reforms, headed by Narasimham. The committee found that banking system was
both over-regulated and under-regulated. Prior to 1991 system of multiple regulated interest rates
prevailed. Besides, a large proportion of bank funds was preempted by Government through high
Statutory Liquidity Ratio (SLR) and a high Cash Reserve Ratio (CRR). As a result, there was a
decrease in resources of the banks to provide loans to the private sector for investment.

This preemption of bank funds by Government weakened the financial health of the banking
system and forced banks to charge high interest rates on their advances to the private sector to
meet their needs of credit for investment purposes. Further, the lack of transparency in the
accounting practice of the banks and non-application of international norms by the banks meant
that their balance sheets did not reflect their underlying financial position.

This was prominently revealed by 1992 scarcity scam triggered by Harshad Mehta. In this
situation the quality of investment portfolio of the banks deteriorated and culture of‘ non-
recovery‘ developed in the public sector banks which led to a severe problem of non-performing
assets (NPA) and low profitability of banks. Financial sector reforms aim at removing all these
weaknesses of the financial system.
Under these reforms, attempts have been made to make the Indian financial system more viable,
operationally efficient, more responsive and improve their allocative efficiency. Financial
reforms have been undertaken in all the three segments of the financial system, namely banking,
capital market and Government securities market.

Financial Sector Reforms since 1991:

1. Reduction in Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR):

An important financial reform has been the reduction in Statutory Liquidity Ratio (SLR) and
Cash Reserve Ratio (CRR) so that more bank credit is made available to the industry, trade and
agriculture. The statutory liquidity ratio (SLR) which was as high as 39 per cent of deposits with
the banks has been reduced in a phased manner to 25 per cent.

It may be noted that under statutory liquidity ratio banks are required to maintain a minimum
amount of liquid assets such as government securities and gold reserves of not less than 25 per
cent of their total liabilities. In 2008, statutory liquidity ratio was reduced to 24 per cent by RBI.

Similarly, cash reserve ratio (CRR) which was 15 per cent was reduced over phases to 4.5 per
cent in June 2003. It may be noted that reduction in CRR has been possible with reduction of
monetized budget deficit of the government and doing away with the automatic system of
financing government‘s budget deficit through the practice of issuing ad hoc treasury bills to the
Central Government.

2. End of Administered Interest Rate Regime:

A basic weakness of the Indian financial system was that interest rates were administered by the
Reserve Bank/Government. In the case of commercial banks, both deposit rates and lending rates
were regulated by Reserve Bank of India. Before 1993, rate of interest on Government Securities
could be maintained at low levels through the means of high Statutory Liquidity Ratio (SLR).

Under SLR regulation commercial banks and certain other financial institutions were required by
law to invest a large proportion of their liabilities in Government securities. The purpose behind
the administered interest-rate structure was to enable certain priority sectors to get funds at
concessional rates of interest. Thus the system of administered interest rates involved cross
subsidization; concessional rates charged from primary sectors were compensated by higher rates
charged from other non-concessional borrowers.

The structure of administered rates has been almost totally gone away with in a phased manner.
RBI no longer prescribes interest rates on fixed or time deposits paid by their banks to their
depositors. Banks have also been freed from any prescribed conditions of premature withdrawal
by depositors. Individual banks are free to determine their conditions for premature withdrawal.
Currently, there is prescribed rate of 3.5 per cent for Savings Bank Accounts.
3. Prudential Norms: High Capital Adequacy Ratio:

In order to ensure that financial system operates on sound and competitive basis, prudential
norms, especially with regard to capital-adequacy ratio, have been gradually introduced to meet
the international standards. Capital adequacy norm refers to the ratio of paid-up capital and
reserves to deposits of banks. The capital base of Indian banks has been very much lower by
international standards and in fact declined over time.

As a part of financial sector reforms, capital adequacy norm of 8 per cent based on risk-weighted
asset ratio system has been introduced in India. Indian banks which have branches abroad were
required to achieve this capital-adequacy norm by March 31, 1994. Foreign banks operating in
India had to achieve this norm by March 31, 1993.

Other Indian banks had to achieve this capital adequacy norm of 8 per cent latest by March 31,
1996. Banks were advised by RBI to review their existing level of capital funds as compared to
the prescribed capital adequacy norm and take steps to increase their capital base in a phased
manner to achieve the prescribed norm by the stipulated date.

4. Competitive Financial System:

After nationalization of 14 large banks in 1969, no bank had been allowed to be set up in the
private sector. While the importance and role of public sector banks in Indian financial system
continued to be emphasized, it was however recognized that there was urgent need for
introducing greater competition in the Indian money market which could lead to higher
efficiency of the financial system.

Accordingly, private sector banks such as HDFC, Corporation Bank, ICICI Bank, UTI Bank,
IDBI Bank and some others have been set up. Establishment of these banks has made substantial
contribution to housing finance, car loans and retail credit through credit card system. They have
made possible the wider use of what is often called plastic money, namely, ITM cards, Debit
Cards, and Credit Cards.

In addition to the setting up of private sector Indian banks, competition has also sought to be
promoted by permitting liberal entry of branches of foreign banks, therefore, CITI Bank,
Standard Chartered Bank, Bank of America, American Express, HSBC Bank have opened more
branches in India, especially in the metropolitan cities

5. Non-Performing Assets (NPA) and Income Recognition Norm:

Non-performing assets of banks have been a big problem of commercial banks. Non-performing
assets mean bad loans, that is, loans which are difficult to recover. A large quantity of non-
performing assets also lowers the profitability of bank. In this regard, a norm of income
recognition introduced by RBI is worth mentioning. According to this, income on assets of a
bank is not recognized if it is not received within two quarters after the last date.
In order to improve the performance of commercial banks recovery management has been
greatly strengthened in recent years. Measures taken to reduce non-performing assets include
restructuring at the bank level, recovery of bad debt through Lok Adalats, Civil Courts, setting
up of Recovery Tribunals and compromise settlements. The recovery of bad debt got a great
boost with the enactment of ‗Securitization and Reconstruction of Financial Assets and
Enforcement of Security Interest‘ (SARFAESI). Under this Act, Debt Recovery Tribunals have
been set up which will facilitate the recovery of bad debts by the banks.

As a result of the above measures gross NPA declined from Rs. 70,861 crores in 2001-02 to Rs.
68, 715 crores in 2002-03. But there are substantial amounts of non-performing assets whose
recovery is still to be made. Besides, as a result of introduction of risk-based supervision by RBI,
the ratio of gross NPA to gross advances of scheduled commercial banks declined from 12.7 per
cent in 1999-2000 to 8.8 per cent in 2002-03.

6. Elimination of Direct Credit Controls:

Another significant financial sector reform is the elimination of direct or selective credit controls.
Selective credit controls have been done way with. Under selective credit controls RBI used to
control through the system of changes in margin for provision of bank credit to traders against
stocks of sensitive commodities and to stock brokers against shares. As a result, there is now
greater freedom to both the banks and borrowers in respect of credit.

But it is worth mentioning that banks are required to observe the guidelines issued by RBI
regarding lending to priority sectors such as small scale industries and agriculture. The advances
eligible for priority sectors lending have been increased at deregulated interest rates.

This is in accordance with the recognition that the main problem is more of availability of credit
than the cost of credit. In June 2004 UPA Government announced that credit to farmers for
agriculture will be available at 2 per cent below PLR of banks. Further, credit for agriculture will
be doubled in three years time.

7. Promoting Micro-Finance to Increase Financial Inclusion:

To promote financial inclusion the government has started the scheme of micro finance. RBI
provides guidelines to banks for mainstreaming micro-credit providers and enhancing the
outreach of micro-credit providers inter alia stipulated that micro-credit extended by banks to
individual borrowers directly or through any intermediary would henceforth be reckoned as part
of their priority-sector lending. However, no particular model was prescribed for micro-finance
and banks have been extended freedom to formulate their own model(s) or choose any
conduit/intermediary for extending micro-credit.

Though there are different models for pursuing micro-finance, the Self-Help Group (SHG)-Bank
Linkage Programme has emerged as the major micro-finance programme in the country. It is
being implemented by commercial banks, regional rural banks (RRBs), and cooperative banks
Definition of bank:
"A bank is a reliable financial institution which receives the money from one group of people
and lends to other group of people. So, bank performs the duty of financial intermediary among
the people and creates the credit money".

Structure and Types of Banks:

Reserve Bank of India (RBI)

The country had no central bank prior to the establishment of the RBI. The RBI is the supreme
monetary and banking authority in the country and controls the banking system in India. It is
called the Reserve Bank‘ as it keeps the reserves of all commercial banks.

Scheduled & Non –scheduled Banks

A scheduled bank is a bank that is listed under the second schedule of the RBI Act, 1934. In
order to be included under this schedule of the RBI Act, banks have to fulfil certain conditions
such as having a paid-up capital and reserves of at least 0.5 million and satisfying the Reserve
Bank that its affairs are not being conducted in a manner prejudicial to the interests of its
depositors. Scheduled banks are further classified into commercial and cooperative banks. Non-
scheduled banks are those which are not included in the second schedule of the RBI Act, 1934.
At present these are only four such banks in the country (i.e. Akhand Anand Co-operative Bank
Limited, Alavi Co-Operative Bank Limited, Amarnath Co-Operative Bank Limited, Amod
Nagrik Sahakari Bank Limited)

Commercial Banks

Commercial banks may be defined as, any banking organization that deals with the deposits and
loans of business organizations. Commercial banks issue bank checks and drafts, as well as
accept money on term deposits. Commercial banks also act as moneylenders, by way of
instalment loans and overdrafts. Commercial banks also allow for a variety of deposit accounts,
such as checking, savings, and time deposit. These institutions are run to make a profit and
owned by a group of individuals.

Scheduled Commercial Banks (SCBs):

Scheduled commercial banks (SCBs) account for a major proportion of the business of the
scheduled banks. SCBs in India are categorized into the five groups based on their ownership
and/or their nature of operations. State Bank of India and its six associates (excluding State Bank
of Saurashtra, which has been merged with the SBI with effect from August 13, 2008) are
recognised as a separate category of SCBs, because of the distinct statutes (SBI Act, 1955 and
SBI Subsidiary Banks Act, 1959) that govern them. Nationalised banks and SBI and associates
together form the public sector banks group IDBI ltd. has been included in the nationalised banks
group since December 2004. Private sector banks include the old private sector banks and the
new generation private sector banks- which were incorporated according to the revised
guidelines issued by the RBI regarding the entry of private sector banks in 1993.

Foreign banks are present in the country either through complete branch/subsidiary route
presence or through their representative offices.

Types of Scheduled Commercial Banks

Public Sector Banks

These are banks where majority stake is held by the Government of India.
Examples of public sector banks are: SBI, Bank of India, Canara Bank, etc.

Private Sector Banks

These are banks majority of share capital of the bank is held by private individuals. These banks
are registered as companies with limited liability. Examples of private sector banks are: ICICI
Bank, Axis bank, HDFC, etc.

Foreign Banks

These banks are registered and have their headquarters in a foreign country but operate their
branches in our country. Examples of foreign banks in India are: HSBC, Citibank, Standard
Chartered Bank, etc
Regional Rural Banks

Regional Rural Banks were established under the provisions of an Ordinance promulgated on the
26th September 1975 and the RRB Act, 1976 with an objective to ensure sufficient institutional
credit for agriculture and other rural sectors. The area of operation of RRBs is limited to the area
as notified by Government of India covering one or more districts in the State.

RRBs are jointly owned byGovernment of India, the concerned State Government and Sponsor
Banks (27 scheduled commercial banks and one State Cooperative Bank); the issued capital of a
RRB is shared by the owners in the proportion of 50%, 15% and 35% respectively.

Prathama bank is the first Regional Rural Bank in India located in the city Moradabad in Uttar
Pradesh.

Type of
Commercial Major Shareholders Major Players
Banks
Public Sector SBI, PNB, Canara Bank, Bank of
Government of India
Banks Baroda, Bank of India, etc
Private Sector ICICI Bank, HDFC Bank, Axis Bank,
Private Individuals
Banks Kotak Mahindra Bank, Yes Bank etc.
Standard Chartered Bank, Citi Bank,
Foreign Banks Foreign Entity HSBC, Deutsche Bank, BNP Paribas,
etc.
Central Govt,
Andhra Pradesh Grameena Vikas
Regional Rural Concerned State Govt and
Bank, Uttranchal Gramin Bank,
Banks Sponsor Bank in the ratio of 50 :
Prathama Bank, etc.
15 : 35

Cooperative Banks

A co-operative bank is a financial entity which belongs to its members, who are at the same time
the owners and the customers of their bank. Co-operative banks are often created by persons
belonging to the same local or professional community or sharing a common interest. Co-
operative banks generally provide their members with a wide range of banking and financial
services (loans, deposits, banking accounts, etc).

They provide limited banking products and are specialists in agriculture-related products.

Cooperative banks are the primary financiers of agricultural activities, some small-scale
industries and self-employed workers.

Co-operative banks function on the basis of ―no-profit no-loss‖.

Anyonya Co-operative Bank Limited (ACBL) is the first co-operative bank in India located in
the city of Vadodara in Gujarat.

The co-operative banking structure in India is divided into following main 5 categories:

 Primary Urban Co-op Banks

 Primary Agricultural Credit Societies
 District Central Co-op Banks
 State Co-operative Banks
 Land Development Banks

Roles & Functions of Banks in India:

Though there are money types of banks; yet commercial banks stand out as the most prominent
and popular category of banks.

Function of commercial banks may be described by classifying these into the following
three categories:

(a) Primary functions

(b) Secondary functions

(c) Modern functions

Following is a brief account of the functions comprised in the above-stated three categories:

(a) Primary Functions:

(i) Accepting deposits:

Accepting deposits is the main function of a commercial bank. Banks accept deposits of money
from people who have surplus money. Banks offer the following types of deposit schemes to
attract money from all quarters of public.

(I) Fixed deposits:

Under fixed deposits schemes, people deposit their money for a period from six months to five
years; and fixed deposit is repayable by bank only after the expiry of the specified period. In fact,
the longer is the period of deposit; the higher is the rate of interest.

(II) Savings deposits:

The aim of savings deposits scheme is to mobilize the small savings of the public. A person can
open a savings bank account, by depositing a small amount of money. He/.she can withdraw
money from his/her account and also make additional deposits.
However, there may be restrictions on the number of withdrawals and the amount to be
withdrawn, in a given period. The rate of interest on saving deposits is lower than payable on
fixed deposits.

(III) Recurring deposits:

The aim of recurring deposit scheme is to encourage regular savings by people. A person can
deposit a fixed amount say Rs. 100, every month for a fixed period. The amount deposited,
together with interest, is repayable on maturity.

(IV) Current deposit accounts:

Current deposit accounts are opened by businessmen. The account holder can deposit and
withdraw money, whenever required. No interest is paid on current deposit accounts. Rather, a
certain charge is made by the bank from the account holder, for the services provided by the
bank.

(ii) Lending money Banks lend money, usually, in the following ways:

(I) Loans:

Banks advance a certain sum of money to a customer; which is called a loan. A loan, by a bank,
is granted against some security or mortgage. Normally banks do not advance loans for long
periods. However, of late, there is a change in this policy.

(II) Overdraft:

Under the overdraft facility, a customer having a current account is allowed to withdraw more
than what he has deposited. The excess amount withdrawn by the customer is known as
overdraft. The overdraft is allowed up to a certain limit and for an agreed period. Interest is
charged by the bank on the overdrawn amount.

(III) Cash credit:

Under cash credit scheme, a loan limit is sanctioned and a cash credit account is opened in the
name of the borrower. The borrower can withdraw money from the account from time to time –
subject to the sanctioned limit. Interest is charged by the bank on the amount actually withdrawn
by the borrower, and not on the sanctioned amount.

(IV) Discounting of bills:

Under this form of lending money, banks en-cash customers‘ bills of exchange, before they
become actually due for payment. For this, banks charge what is known as a nominal discount.
(b) Secondary Functions:

Following are the important secondary functions of banks:

(i) Collection of cheques and bills:

Banks collect cheques of their customers drawn on other banks; and credit their proceeds to the
accounts of their customers. Banks also collect bills of exchange on behalf of their customers
from the acceptors of bills on due dates; and credit the proceeds to the accounts of their
customers.

(ii) Agency functions:

Banks, under instructions of the customers:

1. Undertake to pay insurance premium

2. Collect dividend, interest etc. on their investments

3. Undertake to buy or sell shares, debentures etc. on behalf of their customers.

(iii)Provision of remittance facilities:

Banks provide remittance facilities for transfer of funds from one place to another, usually
through bank drafts. The banks charge commission for issuing bank drafts.

(iv) Issuing letters of credit:

Letters of credit are most useful in import trade. They give a proof of the credit worthiness of the
importer. A letter of credit issued by the importer‘s bank contains an undertaking by the bank to
honour the bills of exchange drawn by the exporter on the importer up to the amount specified, in
the letter of credit.

(v) Letter of reference:

Through a letter of reference, a bank provides information about the financial condition of the
customer to traders of the same country or other countries.

(vi) Traveller’s cheques:

Banks provide the facility of traveller‘s cheques to their customers who are travelling. With this
facility, the customer need not carry cash (which is risky) with him and can travel safety.

(vii) Lockers facility:

Banks provide lockers facility to their customers, where customers can keep their gold, silver
ornaments and important documents safely.

(c) Modern Functions:

Some modern functions of a commercial bank are:

(i) Electronic Funds Transfer System (EFTs):

This system enables employers to transfer salary/wages to the accounts of employees directly
from the company (i.e. employer) bank account.

(ii)Automated Teller Machines (ATMs):

It is freestanding self-service terminal. To use an ATM, one has to insert a plastic card into the
terminal and then enter an identification code.

The machine responds by:

1. Giving cash

2. Taking deposits

3. Handling other simple banking transactions

(iii) Credit card:

Credit card enables the card holders to have overdraft facilities of a certain amount. It can be
used (by cardholders) for making payments of goods and services. Credit cards are issued to
selected customers of the bank. The credit card is a plastic card having the photo identity and
signatures of the customer. It includes the issuing bank‘s name and validity period of the card.

(iv) Debit card:

Debit cards are issued by bank to those customers who keep deposits with it. The card holder can
buy goods from the designated retail store and make payment through his/her debit card. A debit
card is a plastic card, bearing banks‘ name and customer‘s name, identity and signatures.

(v) Collection of information:

Banks collect information about trade and industry and supply it to interested parties. They also
offer advice on financial matters.

Different banking services:

In the modern world, banks offer a variety of services to attract customers. However, some basic
modern services offered by the banks are discussed below:

1. Advancing of Loans

Banks are profit-oriented business organizations.

So they have to advance a loan to the public and generate interest from them as profit.

After keeping certain cash reserves, banks provide short-term, medium-term and long-term loans
to needy borrowers.

2. Overdraft

Sometimes, the bank provides overdraft facilities to its customers through which they are
allowed to withdraw more than their deposits.

Interest is charged from the customers on the overdrawn amount.

3. Discounting of Bills of Exchange

This is another popular type of lending by modern banks.

Through this method, a holder of a bill of exchange can get it discounted by the bank, in a bill of
exchange, the debtor accepts the bill drawn upon him by the creditor (i.e., holder of the bill) and
agrees to pay the amount mentioned on maturity.

After making some marginal deductions (in the form of commission), the bank pays the value of
the bill to the holder.

When the bill of exchange matures, the bank gets its payment from the party, which had accepted
the bill.

4. Check/Cheque Payment

Banks provide cheque pads to the account holders. Account holders can draw cheque upon the
bank to pay money.

Banks pay for cheques of customers after formal verification and official procedures.

5. Collection and Payment Of Credit Instruments

In modern business, different types of credit instruments such as the bill of exchange, promissory
notes, cheques etc. are used.
Banks deal with such instruments. Modern banks collect and pay different types of credit
instruments as the representative of the customers.

6. Foreign Currency Exchange

Banks deal with foreign currencies. As the requirement of customers, banks exchange foreign
currencies with local currencies, which is essential to settle down the dues in the international
trade.

7. Consultancy

Modern commercial banks are large organizations.

They can expand their function to a consultancy business. In this function, banks hire financial,
legal and market experts who provide advice to customers regarding investment, industry, trade,
income, tax etc.

8. Bank Guarantee

Customers are provided the facility of bank guarantee by modern commercial banks.

When customers have to deposit certain fund in governmental offices or courts for a specific
purpose, a bank can present itself as the guarantee for the customer, instead of depositing fund by
customers.

9. Remittance of Funds

Banks help their customers in transferring funds from one place to another through cheques,
drafts, etc.

10. Credit cards

A credit card is cards that allow their holders to make purchases of goods and services in
exchange for the credit card‘s provider immediately paying for the goods or service, and the
cardholder promising to pay back the amount of the purchase to the card provider over a period
of time, and with interest.

11. ATMs Services

ATMs replace human bank tellers in performing giving banking functions such as deposits,
withdrawals, account inquiries. Key advantages of ATMs include:

 24-hour availability
 Elimination of labor cost
 Convenience of location
12. Debit cards

Debit cards are used to electronically withdraw funds directly from the cardholders‘ accounts.

Most debit cards require a Personal Identification Number (PIN) to be used to verify the
transaction.

13. Home banking

Home banking is the process of completing the financial transaction from one‘s own home as
opposed to utilizing a branch of a bank.

It includes actions such as making account inquiries, transferring money, paying bills, applying
for loans, directing deposits.

14. Online banking

Online banking is a service offered by banks that allows account holders to access their account
data via the internet. Online banking is also known as ―Internet banking‖ or ―Web banking.‖

Online banking through traditional banks enable customers to perform all routine transactions,
such as account transfers, balance inquiries, bill payments, and stop-payment requests, and some
even offer online loan and credit card applications.

Account information can be accessed anytime, day or night, and can be done from anywhere.

15. Mobile Banking

Mobile banking (also known as M-Banking) is a term used for performing balance checks,
account transactions, payments, credit applications and other banking transactions through a
mobile device such as a mobile phone or Personal Digital Assistant (PDA),

16. Accepting Deposit

Accepting deposit from savers or account holders is the primary function of a bank. Banks accept
deposit from those who can save money but cannot utilize in profitable sectors.

People prefer to deposit their savings in a bank because by doing so, they earn interest.

17. Priority banking

Priority banking can include a number of various services, but some of the popular ones include
free checking, online bill pay, financial consultation, and information.
18. Private banking

Personalized financial and banking services that are traditionally offered to a bank‘s digital, high
net worth individuals (HNWIs). For wealth management purposes,

HNWIs have accrued far more wealth than the average person, and therefore have the means to
access a larger variety of conventional and alternative investments.

Recent trends of banking system in India:

In the era of ―Digital India‖, the banking and financial services in India have undergone a
massive evolution and the phenomenon continues. Few Trends in Banking sector in India that
are changing the entire scenario includes:
1. Digitization:

With the rapid growth of digital technology, it became imperative for banking and financial
services in India to keep up with the changes and innovate digital solutions for the tech-savvy
customers. Besides the financial institutions, insurance, healthcare, retail, trade, and commerce
are some of the major industries that are experiencing the enormous digital shift. To stay
competitive, it is necessary for the banking and financial industry to take the leap on the digital
bandwagon.

In India, it all began not earlier than the 1980s when the banking sector introduced the use of
information technology to perform basic functions likes customer service, book-keeping, and
auditing. Soon, Core Banking Solutions were adopted to enhance customer experience.
However, the transformation began in the 1990s during the time of liberalization, when the
Indian economy exposed itself to the global market. The banking sector opened itself for private
and international banks which is the prime reason for technological changes in the banking
sector. Today, banks and financial institutions have benefitted in many ways by adopting newer
technologies. The shift from conventional to convenience banking is incredible.

Modern trends in banking system make it easier, simpler, paperless, signatureless and branchless
with various features like IMPS (Immediate Payment Service), RTGS (Real Time Gross
Settlement), NEFT (National Electronic Funds Transfer), Online Banking, and Telebanking.
Digitization has created the comfort of ―anywhere and anytime banking.‖ It has resulted in the
reduced cost of various banking procedures, improved revenue generation, and reduced human
error. Along with increased customer satisfaction, it has enabled the customers creating
personalized solutions for their investment plans and improve the overall banking experience.
2. Enhanced Mobile Banking:

Mobile banking is one of the most dominant current trends in banking systems. As per the
definition, it is the use of a smartphone to perform various banking procedures like checking
account balance, fund transfer, and bill payments, without the need of visiting the branch. This
trend has taken over the traditional banking systems. In the coming years, mobile banking is
expected to become even more efficient and effortless to keep up with the customer demands.
Mobile banking future trends hint at the acquisition of IoT and Voice-Enabled Payment Services
to become the reality of tomorrow. These voice-enabled services can be found in smart
televisions, smart cars, smart homes, and smart everything. Top industry leaders are
collaborating to adopt IoT-connected networks to create mobile banking technologies that
require users‘ voice to operate.

3. UPI (Unified Payments Interface):

UPI or Unified Payments Interface has changed the way payments are made. It is a real-time
payment system that enables instant inter-bank transactions with the use of a mobile platform. In
India, this payment system is considered the future of retail banking. It is one of the fastest and
most secure payment gateways that is developed by National Payments Corporation of India and
regulated by the Reserve Bank of India. The year 2016 saw the launch of this revolutionary
transactions system. This system makes funds transfer available 24 hours, 365 days unlike other
internet banking systems. There are approximately 39 apps and more than 50 banks supporting
the transaction system. In the post-demonetization India, this system played a significant role. In
the future, with the help of UPI, banking is expected to become more ―open.‖

4. The rise of Fintech Companies:

Previously, banks considered Fintech companies a disrupting force. However, with the changing
trends in the financial services sector in India, fintech companies have become an important part
of the sector. The industry has emerged as a significant part of the ecosystem. With the use of
financial technology, these companies aim to surpass the traditional methods of finance. In the
past few decades, massive investment has been made in these companies and it has emerged into
a multi-billion-dollar industry globally.
Fintech companies and fintech apps have changed the way financial solutions are provided to the
customers. Besides easy access to financial services, fintech companies have led to a massive
improvement in services, customer experience, and reduced the price paid. In India, the dynamic
transformation has been brought upon by several important elements like fintech startups,
established financial institutions, initiatives like ―Start-Up India‖ by Government of India,
incubators, investors, and accelerators. According to a report by National Association of
Software and Services Companies (NASSCOM), the fintech services market is expected to grow
by 1.7 times into an $8 billion market by 2020.

5. Digital-Only Banks:

It is a recent trend in the Indian financial system and cannot be ignored. With the entire banking
and financial services industry jumping to digital channels, digital-only banks have emerged to
create paperless and branchless banking systems. This is a new breed of banking institutions that
are overtaking the traditional models rapidly. These banks provide banking facilities only
through various IT platforms that can be accessed on mobile, computers, and tablets. It provides
most of the basic services in the most simplified manner and gives access to real-time data. The
growing popularity of these banks is said to be a real threat to traditional banks.

ICICI Pockets is India‘s first digital-only bank. These banks are attractive to the customers
because of their cost-effective operating models. At the same time, though virtually, they provide
high-speed banking services at very low transaction fees. In today‘s fast lane life, these banks
suit the customer needs because they alleviate the need of visiting the bank and standing in a
queue.

6. Cloud Banking:

Cloud technology has taken the world by storm. It seems the technology will soon find its way in
the banking and financial services sector in India. Cloud computing will improve and organize
banking and financial activities. Use of cloud-based technology means improved flexibility and
scalability, increased efficiency, easier integration of newer technologies and applications, faster
services and solutions, and improved data security. In addition, the banks will not have to invest
in expensive hardware and software as updating the information is easier on cloud-based models.

7. Biometrics:

Essentially for security reasons, a Biometric Authentication system is changing the national
identity policies and the impact is expected to be widespread. Banking and financial services are
just one of the many other industries that will be experiencing the impact. With a combination of
encryption technology and OTPs, biometric authentication is forecasted to create a highly-secure
database protecting it from leaks and hackers attempts. Financial services in India are exploring
the potential of this powerful technology to ensure sophisticated security to customers‘ account
and capital.

10. Wearables:

With smartwatch technology, the banking and financial services technology is aiming to create
wearables for retail banking customers and provide more control and easy access to the data.
Wearables have changed the way we perform daily activities. Therefore, this technology is
anticipated to be the future retail banking trend by providing major banking services with just a
click on a user-friendly interface on their wearable device.

These are some of the recent trends in the banking and financial sector of India and all these new
technologies are predicted to reshape the industry of business and money. The future is going to
bring upon a revolution of sorts with historical changes in traditional models. The massive shift
in the landscape has few challenges. Nonetheless, the customers are open to banking innovations
and the government is showing great support with schemes like ―Jan Dhan Yojana,‖ which aims
at proving a bank account to every citizen. Meanwhile, the competition from the foreign and
private sector banks have strained the government regulators, nationalized banks and financial
institutions to adopt new technology in order to stay relevant in the race.

Basic concepts of insurance:

Insurance is defined as the equitable transfer of risk of loss from one entity to another, in
exchange for a premium.

Insurance may be defined as form of contract between two parties (namely insurer and insured)
whereby one party (insurer) undertakes in exchange for a fixed amount of money (premium) to
pay the other party (Insured), a fixed amount of money on the happening of certain event (death
or attaining a certain age in case of life) or to pay the amount of actual loss when it takes place
through the risk insured (in case of property).
Terminology used in definition of Insurance
 Insurer or insurance company – The agency involved in Insurance business is known as
insurer
 Insured/ Assured – The person who gets his property/life insured is known as insured
 Policy - The agreement or contract which is put in writing is known as a Policy
 Premium – The consideration in return of which the insurer undertakes to make goods the
loss or give a certain amount in case of life insurance is known as premium
Principles of Insurance
The basic principles which govern the insurance are -
1. Principle of utmost good faith: A contract of insurance is a contract of ‗Uberrimae
Fidei‘ i.e., of utmost good faith. Both insurer and insured should display the utmost good
faith towards each other in relation to the contract. In other words, each party must reveal
all material information to the other party whether such information is asked or not.
There should not be any fraud, non disclosure or misrepresentation of material facts.
Example – in case of life insurance, the insured must revel the true age and details of the
existing illness/diseases. If he does not disclose the true fact while getting his life insured,
the insurance company can avoid the contract.
Similarly, incase of the insurance of a building against fire, the insured must disclose the
details of the goods stored, if such goods are of hazardous nature
A material fact means important facts which would influence the judgment of the insurer
in fixing the premium or deciding whether he should accept the risk, on what terms. All
material facts should be disclosed in true and full form
2. Principle of Insurable Interest: This principle requires that the insured must have a
insurable interest in the subject matter of insurance. Insurable interest means some
financial interest in the subject matter of contract of insurance. Insurance interest is that
interest, when the policy holders get benefited by the existence of the subject matter and
loss if there is death or damage to the subject matter.
For example – In life insurance, a man cannot insured the life of a stranger as he has no
insurable interest in him but he can get insured the life of himself and of persons in
whose life he has a pecuniary interest. So, in the life insurance interest exists in the
following cases: -
- Husband in the life of his wife and wife in the life of her husband
- Parents in the life of a child if there is pecuniary benefit derived from the life of a
Child
 - Creditor in the life of debtor
- Employer in the life of an employee
- Surety in the life of a principle debtor
In life insurance, insurable interest must be present at the time when the policy is taken. In fire
insurance, it must be present at the time of insurance and at the time if loss is subject matter. In
marine insurance, it must be present at the time of loss of the subject matter.
3. Principle of Indemnity: This principle is applicable in case of fire and marine insurance
only. It is not applicable in case of life, personal accident and sickness insurance. A
contract of indemnity means that the insured in case of loss against which the policy has
been issued, shall be paid the actual cost of loss not exceeding the amount of the
insurance policy. The purpose of contract of insurance is to place the insured in the same
financial position, as he was before the loss.
Example – A house is insured against fire for Rs. 50000. It is burnt down and found that the
expenditure of Rs. 30000 will restore it to its original condition. The insurer is liable to
pay only Rs. 30000.
In life insurance, principle of indemnity does not apply as there is no question of actual
loss. The insurer is required to pay a fixed amount upon in advance in the event of
accident,death or at the expiry of the fixed term of the policy. Thus, a contract of a life
insurance is a contingent contract and not a contract of indemnity.
4. Principle of Contribution: The principle of contribution is a corollary to the doctrine of
indemnity. It applies to any insurance which is a contract of indemnity. So, it does not
apply to life insurance. A particular property may be insured with two or more insurers
against the same risks. In such cases, the insurers must share the burden of payment in
proportion to the amount insured by each. If one of the insurers pays the whole loss, he is
entitled tocontribution from other insurers

Example – B gets his house insured against fire for Rs. 10000 with insurer P and for Rs. 20000
with insurer Q. a loss of Rs. 15000 occurs, P is liable to pay for Rs. 5000 and Q is labile
to pay Rs 10000. If the whole amount pf loss is paid by Q, then Q can recover Rs. 5000
from P. The liability of P &Q will be determined as under:

Sum insured with Individual insurer (i.e. P or Q ) x Actual Loss = Total sum insured

Liability of P = 10000 x 15000 = Rs.5000

30000
 Liability of Q = 20000 x 15000 = Rs.10000
30000
The right of contribution arises when:
(a) There are different policies which related to the same subject matters;
(b) The policies cover the same period which caused the loss;
(c) All the policies are in force at the time of loss; and
(d) One of the insurer has paid to the insured more than his share of loss.
5. Principle of Subrogation: The doctrine of subrogation is a corollary to the principle of
indemnity and applies only to fire and marine insurance. According to doctrine of
subrogation, after the insured is compensated for the loss caused by the damage to the
property insured by him, the right of ownership to such property passes to the insurer
after settling the claims of the insured in respect of the covered loss.
Example – Furniture is insured for Rs. 1 lacs against fire, it is burnt down and the insurer
pays the full value of Rs. 1 Lacs to the insured, later on the damage Furniture is sold for
Rs. 10000. The insurer is entitled to receive the sum of Rs. 10000.
A loss may occur accidentally or by the action or negligence of third party. If the insured
suffer a loss because of action of third party and he is in a position to recover the loss
from the insurer then insured can not take action against third party, his right is
subrogated (substituted) to the insurer on settlement of the claim. The insurer, therefore,
can recover the claim from the third party.
If the insured recovers any compensation for the loss (due to third party), from the third
party, after he has already been indemnified by the insurer, he holds the amount of such
compensation as the trustee of the insurer.
The insurer is entitled to the benefits out of such rights only to the extent of the amount
he has paid to the insured as compensation
6. Principle of Causa Proxima: Causa Proxima, means proximate cause which is a natural
and unbroken series of events, is responsible for a loss or damage. The insurer is liable
for loss only when such a loss is proximately caused by the peril insured against. The
cause should be the proximate cause and cannot the remote cause. If the risk insured is
the remote cause of the loss, then the insurer is not bound to pay compensation. The
nearest cause should be considered while determining the liability of the insured. The
insurer is liable to pay if the proximate cause is insured.
 Example – In a marine insurance policy, the goods were insured against damage by sea
water, some rats on the board made a hole in a bottom of the ship causing sea water to
pour into the ship and damage the goods. Here, the proximate cause of loss is sea water
which is covered by the policy and the hole made by the rats is a remote cause.
Therefore, the insured can recover damage from the insurer
Example – A ship was insured against loss arising from collision. A collision took place
resulting in a few days delay. Because of the delay, a cargo of oranges becomes
unsuitable for human consumption. It was held that the insurer was not liable for the loss
because the proximate cause of loss was delay and not the collision of the ship.
7. Principle of Mitigation of Loss: An insured must take all reasonable care to reduce the
loss. We must act as if the property was not insured.
Example – If a house is insured against fire, and there is accidental fire, the owner must
take all reasonable steps to keep the loss minimum. He is supposed to take all steps which
a man of ordinary prudence will take under the circumstances to save the insured
property.

Classification of Insurance:
Insurance cover various types of risks and include various insurance policies which provide
protection against various losses.
The insurance can be classified into two categories from business point of view
1. Life insurance;
2. Non-life insurance or General Insurance
1. Life Insurance: The life insurance contract provides elements of protection and
investment after getting insurance, the policyholder feels a sense of protection because he
shall be paid a definite sum at the death or maturity. Since a definite sum must be paid,
the element of investment is also present. In other words, life insurance provides against
pre-mature death and a fixed sum at the maturity of policy. At present, life insurance
enjoys maximum scope because each and every person requires the insurance.
Life insurance is a contract under which one person, in consideration of a premium paid
either in lump sum or by monthly, quarterly, half yearly or yearly instalments, undertakes
to pay to the person (for whose benefits the insurance is made), a certain sum of money
either on the death of the insured person or on the expiry of a specified period of time.
Life insurance offers various polices according to the requirement of the persons -

- It is the most basic type of insurance.

Term Insurance
- It covers you for a specific period.
 - Your family gets a lump-sum amount in the case of your death.
- If, however, you survive the term, no money will be paid to you or
your family.
- Like a term policy, it is also valid for a certain period.
- A lump-sum amount will be paid to your family in the event of your
Endowment Policy
death.
- Unlike a term plan, you get the maturity proceeds after the term period.
- A certain percentage of the sum assured will be paid to you
periodically throughout the term as survival benefit.
- After the expiry of the term, you get the balance amount as maturity
Money-back Policy
proceeds.
- Your family gets the entire sum assured in case of death during the
policy period. This is regardless of the survival benefit payments made.
- Such products double up as investment tools.
- A part of your premium goes towards your insurance cover.
Unit-linked Insurance
- The remaining amount is invested in Debt and Equity.
Plans (ULIPs)
- A lump-sum amount will be paid to your family in the event of your
death.
- This helps build your retirement fund.
Pension Plans - You can get a regular pension amount after retirement.
- In the case of your death, your family can claim the sum assured.

2. General Insurance: A general insurance is a contract that offers financial compensation on

any loss other than death. It insures everything apart from life. A general insurance compensates
you for financial loss due to liabilities related to your house, car, bike, health, travel, etc. The
insurance company promises to pay you a sum assured to cover damages to your vehicle,
medical treatments to cure health problems, losses due to theft or fire, or even financial problems
during travel.

Simply put, a general insurance offers financial protection for all your assets against loss,
damage, theft, and other liabilities. It is different from life insurance.

Different types of general insurance include:

Health Insurance

This type of general insurance covers the cost of medical care. It pays for or reimburses the
amount you pay towards the treatment of any injury or illness.

It usually covers:

 Hospitalisation
 The treatment of critical illnesses
 Medical bills prior to or post hospitalisation
  Day care procedures like Cataract operations

You can also opt for add-on benefits like:

 Maternity cover: Your health insurance covers you for the costs related to childbirth. This
includes pre-delivery check-ups, hospitalisation during delivery, and post-natal care.
 Pre-existing diseases cover: Your health insurance takes care of the treatment of diseases
you may have before buying the health insurance policy.
 Accident cover: Your health insurance can pay for the medical treatment of injuries
caused due to accidents and mishaps.

Motor Insurance

Motor insurance is for your car or bike what health insurance is for your health.

It is a general insurance cover that offers financial protection to your vehicles from loss due to
accidents, damage, theft, fire or natural calamities

You can also get motor insurance for your commercial vehicles.

In India, you cannot drive or ride without motor insurance.

Let‘s look at the two key types:

1. Car Insurance

It‘s precious—your car. You paid lakhs of rupees to buy that beauty. Even a single scratch can
be painful, forget about bigger damages.

Car insurance can reduce this pain for a few thousand rupees.

How it works:

What the insurer will pay for depends on the type of car insurance plan you purchase

2. Two-wheeler Insurance

This is your bike‘s guardian angel. It‘s similar to Car insurance.

You cannot ride a bike or scooter in India without insurance.

How it works:

As with car insurance, what the insurer will pay depends on the type of insurance and what it
covers.

Types of Motor Insurance:

Third Party Insurance Comprehensive Car Insurance

Compensates for the damages caused Covers all kinds of damages and liabilities caused to you
to another individual, their vehicle or or a third party. It includes damages caused by accidents,
a third-party property. sabotage, theft, fire, natural calamities, etc.

You can increase your insurance protection with these Add-on covers for your car and bike
insurance:

For more details about Motor Insurance, click here.

Travel insurance

A travel insurance compensates you or pays for any financial liabilities arising out of medical
and non-medical emergencies during your travel abroad or within the country.

There are two types of Travel Insurance.

Single Trip Policy Annual Multi Trip

It covers you during a trip that lasts under 180 It covers you for several trips you take within a
days. year.

What all does travel insurance usually cover?

 Loss of baggage
 Emergency medical expenses
 Loss of passport
  Hijacking
 Delayed flights
 Accidental death

Home Insurance

Home insurance is a cover that pays or compensates you for damage to your home due to natural
calamities, man-made disasters or other threats.

It covers liabilities due to fire, burglary, theft, flood, earthquakes, and sabotage. It not only offers
financial protection to your home, but also takes care of the valuables inside the property.

Some of the common types of home insurance are:

This covers your home against fire outbreaks and special perils.
The dangers covered are:
- Natural calamities like lightening, flood, storm, earthquake, etc.
Standard fire and special
- Damage caused due to overflowing or bursting of water tanks,
perils policy
pipes, etc.
- Damage caused due to man-made activities such as riots, strikes,
etc.

This protects the structure of your home from any kinds of risks and
damages.
Home structure insurance
The cover is also extended to the permanent fixtures within the house
such as kitchen and bathroom fittings.

The damage caused to another person or their property inside the

Public liability coverage
insured home can also be compensated.

This covers the content inside the insured home.

Content Insurance What‘s commonly covered: Television, refrigerator, portable
equipment, etc.

Fire Insurance

Fire insurance pays or compensates for the damages caused to your property or goods due to fire.

It covers the replacement, reconstruction or repair expenses of the insured property as well as the
surrounding structures.

It also covers the damages caused to a third-party property due to fire.

In addition to these, it takes care of the expenses of those whose livelihood has been affected due
to fire.

Types of fire insurance

Some of the common types are:

The insurer firsts value the property and then undertakes to pay
Valued policy
compensation up to that value in the case of loss or damage.

Floating policy It covers the damages to properties lying at different places.

Comprehensive This is known as an all-in-one policy.

policy It has a wide coverage and includes damages due to fire, theft, burglary, etc.

This covers you for a specific amount which is less than the real value of the
Specific policy
property.

Reinsurance:
Reinsurance means where a risk is considerable. Any insurance company would like to insure
the risk up to a certain amount themselves and put the excess risk out to a re-insurance company,
or to a more than one, on the principle of diversifying the risk.

In case of insurance companies, if any claim is raised by the insured, the insurance company is
liable to make good the losses incurred by the insured, if the claim satisfies all the terms and
condition of the policy purchased by him. In such cases the insurance company has to bear the
financial burden.

In order to share such burden, the insurance companies get themselves also insured against such
financial burdens. The insurance companies therefore to protect themselves enter into a contract
with another company engaged in the business of reinsurance popularly known as third party.

Micro-insurance:
The term "microinsurance‖ typically refers to insurance services offered primarily to clients with
low income and limited access to mainstream insurance services and other means of effectively
coping with risk.

More precisely, microinsurance is a means of protecting low income people against specific risks
in exchange for a regular payment of premiums whose amount is proportional to the likelihood
and cost of the relevant risk. The principal distinction from traditional insurance is in the
targeting of low-income people, which leads to distinct characteristics and objectives, including
addressing the particular risks of low-income people, affordability and inclusiveness, simplicity
and clarity in documentation, accessible processes, and building trust among target clients.

Microinsurance is a highly diversified sector, in terms of:

 Stakeholders: Microinsurance is developed and offered by commercial insurers, mutual

funds, microfinance institutions, NGOs, governments or semi-public bodies.
Microinsurance ventures are often joint efforts among several of these stakeholders, who
can play roles ranging from market research and product design to selling, delivering, and
servicing claims.
 Products: Microinsurance products can cover any insurable risk, including death, illness,
accident, property damage, unemployment, crop failure, or loss of livestock.
 Portfolio size: Microinsurance can operate at any scale; a microinsurer may cover dozens
of policyholders, or millions.

Examples of microinsurance products include crop, insurance disability insurance, natural

disaster insurance, livestock or cattle insurance, etc.

Bancassurance:

Bancassurance means selling insurance through banks. Banks and insurance companies
collaborate in a partnership, where the bank sells the partner insurance company‘s products to its
customers.

Banks and insurance companies collaborate to form a partnership in which the bank sells the
insurance firm‘s products to its customers. This arrangement of selling an insurance product
through banks is known as Bancassurance.

This arrangement profits both the bank and the insurance company, as the bank earns a
commission amount from the insurance company while the insurance firm broadens its market
share and customers. The bank acts as a mediator by helping an insurance firm reach its target
customers to increase its market reach.

Importance of Bancassurance

The importance of Bancassurance are listed as follows:

 Cost-effectiveness: Insurance companies look to Bancassurance as a cost-effective mode

of distribution.
 Helpful environment: Given that the customers already trust the bank with their money,
they are also generally more willing to consider new products from the same financial
institution, thereby creating an enabling environment to sell the products.
  Commission-based income: A bank is able to income base and increase its overall
productivity by strengthening its branch network, goodwill and client base by presenting
itself as a one-stop-shop for its customers, therefore improving customer

Bancassurance is a relatively new idea in the financial sector. The belief behind Bancassurance is
to combine the marketing capabilities and selling-culture of insurance companies with the
distribution network and sizeable customer base of banks.

In this arrangement, insurance products are traded through the broad distribution sections of the
banking services accompanied by a comprehensive range of banking and investment products. In
short, Bancassurance has a tremendous chance, if appropriately implemented, to be a win-win
situation for banks, insurers and the customer.

IRDA:
In order to control private sector insurance companies, the Government of India passed the
IRDA Act (Insurance Regulatory and Development Authority Act, 1999) which enabled it to
regulate the private sector companies in insurance business. What was the sole monopoly of the
LIC is now thrown open to the private sector for covering the life and property of individuals.
Now, the IRDA controls the entire insurance business in India.
Composition of IRDA

One chairperson and not more than 9 members of whom not more than 5 would be full time
members and they are appointed by the government. Those who have experience in life and
general insurance, actuarial service, finance, economics etc., are appointed.

Roles of IRDA
1. Regulates insurance companies

The working of insurance companies will be regulated in the following aspects

 the persons to be employed,

 the nature of business,
 covering of risks,
 terms and agreements for covering risks etc., will be prescribed by IRDA.

2. Promotes insurance companies

Corporate set-up is a must for establishing an insurance company and they have to submit
periodical reports to IRDA. Different kinds of policies and different types of insurance are also
suggested by IRDA to these insurance companies.
3. Ensures growth of insurance and reinsurance companies

Here, the promotion of new companies is encouraged. Even banks are also permitted to promote
insurance companies as a subsidiary.

Functions of IRDA

1. Issuing certificate of registration.

2. protecting the interest of policy holders.

3. issuing license to agents.

4. Specifying code of conduct for surveyors and loss assessors.

5. Promoting efficiency in the insurance business.

6. Undertaking inspection, conducting enquiries etc., on insurance companies.

7. Control and regulations of rates, terms and conditions by insurance company to policy holders.

8. Adjudication of disputes between insurance company and others in the insurance business.

9. Fixing the percentage of insurance business to rural and social sectors.

Powers of IRDA

The following are the powers of IRDA

1. All insurance companies have to register with IRDA compulsorily.

2. Companies can undertake only insurance business.

3. The capital structure of the companies will be determined by IRDA.

4. Companies have to deposit with RBI the amount stipulated by IRDA.

5. Accounts and balance sheets of companies have to be submitted to IRDA.

6. Insurance companies have to appoint actuaries and they will value the liabilities of the
insurance companies and report the same to IRDA.

7. Investment of assets will be prescribed by IRDA in the form of approved securities.

8. The nature of general insurance business will be prescribed by IRDA.

9. Statements of investment assets to be submitted to IRDA every financial year.

10. All insurance companies have to devote certain percentage of their business including
insurance for crops. This should cover unorganized sector including the economically weaker
sections.

11. The appointment of chief executive officer requires prior permission of the IRDA.

12. All insurance agents must obtain license from IRDA.

13. IRDA has powers for levying penalty on companies which fail to comply with the rules and
regulations.

MODULE – II
Features of money market:
Money market is a market for short term funds meant for use for a period of up to one year.
Generally, money market is the source of finance for working capital. Transactions of money
market include lending and borrowing of cash for a short period of time and also sale and
purchase of securities having one-year term or which gets redeemed (paid back) within one-year
period.

Money market is not a fixed geographical area but it constitutes all organisations and institutions
which deal with short term debts. The common institutes are Reserve Bank of India, State Bank
of India, other Commercial Banks, LIC, GIC, UTI etc. Many of these institutions deal on
telephone and fax only.
Main Features of Money Market:

1. Market for short term.

2. No fixed geographical location.

3. Major Institutions involved in money market are R.B.I., Commercial Banks, LIC, GIC, etc.

4. Common Instruments of money market are Call money, Treasury Bill, CP, CD, Commercial
bill, etc.

Players of Money Market:

RBI

The reserve Bank of India is the most important player in the Indian Money Market. The
Organised money market comes under the direct regulation of the RBI. The RBI operates in the
money market is to ensure that the levels of liquidity and short-term interest rates are maintained
at an optimum level so as to facilitate economic growth and price stability RBI also plays the
role of a merchant banker to the government. It issues Treasury Bills and other Government
Securities to raise funds for the government.

Government:

The Government is the most active playerand the largest borrower in the moneymarket.It raises
funds to make up the budgetdeficit.The funds may be raised through the issueof Treasury Bills
(with a maturity periodof 91day/182day/364 days) andgovernment securities.

Commercial banks:

Commercial Banks play an important rolein the money market.They undertake lending and
borrowing ofshort term funds.The collective operations of the banks on aday to day basis are
very predominantand hence have a major impact andinfluence on the interest rate structure
andthe liquidity position.

Financial Institutions:

Financial institutions also deal in themoney market.They undertake lending and borrowing
ofshort-term funds.They also lend money to banks byrediscounting Bills of Exchange.Since, they
transact in large volumes, theyhave a significant impact on the moneymarket.

Corporate Firms:

Corporate firms operate in the moneymarket to raise short-term funds to meettheir working
capital requirements.They issue commercial papers with amaturity period of 7 days to 1 year.
Thesepapers are issued at a discount andredeemed at face value on maturity.These corporate
firms use both organisedand unorganized sectors of money market.

Instruments of Money Market:

The common instruments of money market are:

1. Call Money:

The money borrowed or lent on demand for a short period which is generally one day. Sundays
and other holidays are excluded for this purpose. Mostly Banks use call money. When one bank
faces temporary shortage of cash then the bank with surplus cash lends to bank in shortage for
one or two days.

Call money is called interbank call money market. But even other organisations such as
insurance companies, mutual fund companies etc. also deal with call money. It is a market over
the telephone. The maturity periods of call money are extremely short and its liquidity is just
next to cash.

Most of the time banks require call money to meet the minimum requirement of Cash Reserve
Ratio (CRR). The interest paid on call money is called call rate. It is very volatile rate which
varies from day to day and sometimes from hour to hour. There is an inverse relation between
the rate of interest of call money and other securities as when rate of interest of call money
increases the other securities become cheap.

2. Treasury Bills (T. Bills):

Treasury bills are issued by Reserve Bank of India on behalf of the Government of India. These
bills enable government to get short term borrowings as these bills are sold to banks and general
public. These bills are negotiable instruments and are freely transferable. These are issued at a
discount. These are considered safest investment as these are issued by R.B.I. The maturity
period of Treasury Bills varies from 14 to 364 days.

Treasury Bills are also called Zero Coupon Bonds. They are issued at a price lower than their
face value and repaid at par. These are available for minimum amount of Rs 25000 and in
multiples thereof.

Example: Suppose an investor purchases a 3 months treasury bill with a face value of Rs 2,
00,000 for Rs 1, 90,000. By holding the bill till maturity period he will get Rs 2, 00,000 and
difference between the bill amount and amount paid to purchase the bill is the interest received
by him.
3. Commercial Bills:

Trade bills or accommodation bills are bills drawn by one business firm on another. These are
common instruments used in credit purchase and sale. These have short term maturity period
generally 90 days and can be discounted with bank even before the maturity period.

These are negotiable instruments and can be easily transferred. The drawee of the bill honours
the bill on due date. A trade bill is nothing but written acknowledgement of debt where the
maker or drawer instructs or directs the payee or drawee to make payment within a fix period of
time. The drawee accepts the bill and becomes liable to make payment on due date.

4. Commercial Paper (C.P.):

The commercial paper was introduced in India for the first time in 1990. It is an unsecured
promissory note issued by public or private sector companies with a fixed maturity period which
varies from 3 to 12 months. Since commercial papers are unsecured so these can be issued by
companies having good reputation and creditworthiness. The commercial banks and mutual
funds are the main investors of commercial papers.

Funds raised through commercial paper are used to meet the floatation cost. This is known as
bridge financing. For example firm wants to raise long term funds to buy a new office building
and machinery. To raise long term funds by issue of shares, debentures the company will have to
incur floatation cost such as brokerage, commission, printing of prospectus etc. The firm can
meet this cost by issue of commercial papers.

5. Certificate of Deposits (C.D.):

It is a time or deposit which can be sold in the secondary market. Only a bank can issue C.D. It is
a bearer certificate or document of title.

It is also a negotiable instrument and can be transferred easily. C.D. is issued by banks against
the deposits kept by companies and institutions. The time period of C.D. ranges from 91 days to
one year. Banks are not allowed to discount these documents.

Capital Market:
It is Markets for buying and selling equity and debt instruments. Capital markets channel savings
and investment between suppliers of capital such as retail investors and institutional investors,
and users of capital like businesses, government and individuals. Capital markets are vital to the
functioning of an economy, since capital is a critical component for generating economic output.
Capital markets include primary markets, where new stock and bond issues are sold to investors,
and secondary markets, which trade existing securities.
Primary Market:
It is that market in which shares, debenturesand other securities are sold for the firsttime for
collecting long-term capital.This market is concerned with new issues.Therefore, the primary
market is also calledNew Issue Market.The money collected from this market isgenerally used
by the companies tomodernize the plant, machinery andbuildings, for extending business, and for
setting up new business unit.
Functions of primary market:

The main function of the New Issue Market, i.e. channeling of investible funds, can be divided,
from the operational stand-point, into a triple-service function:

(a) Origination:

Origination refers to the work of investigation and analysis and processing of new proposals.
This in turn may be:

(i) A preliminary investigation undertaken by the sponsors (specialised agencies) of the issue.
This involves a/careful study of the technical, economic, financial and/legal aspects of the
issuing companies to ensure that/it warrants the backing of the issue house.

(ii) Services of an advisory nature which go to improve the quality of capital issues. These
services include/advice on such aspects of capital issues as: determination of the class of security
to be/issued and price of the issue in terms of market conditions; the timing and magnitude of
issues; method of flotation; and technique of selling and so on.

The importance of the specialized services provided by the New Issue Market organisation in
this respect can hardly be over-emphasized. On the thoroughness of investigation and soundness
of judgement of the sponsoring institution depends, to a large extent, the allocative efficiency of
the market. The origination, however, thoroughly done, will not by itself guarantee success of an
issue. A second specialized service i.e. ―Underwriting‖ is often required.

(b) Underwriting:

The idea of underwriting originated on account of uncertainties prevailing in the capital market
as a result of which the success of the issue becomes unpredictable. If the issue remains
undersubscribed, the directors cannot proceed to allot the shares, and have to return money to the
applicants if the subscription is below a minimum amount fixed under the Companies Act.
Consequently, the issue and hence the project will fail.

Underwriting entails an agreement whereby a person/organisation agrees to take a specified

number of shares or debentures or a specified amount of stock offered to the public in the event
of the public not subscribing to it, in consideration of a commission, i.e., the underwriting
commission.
If the issue is fully subscribed by the public, there is no liability attaching to the underwriters;
else they have to come forth to meet the shortfall to the extent of the under- subscription. The
underwriters in India may broadly be classified into the following two types:

(i) Institutional Underwriters;

(ii) Non-Institutional Underwriting.

Institutional Underwriting in our country has been development oriented. It stands as a major
support to those projects which often fail to catch the eye of investing public. These projects rank
high from the points of view of national importance e.g. steel, fertilizer, and generally receive
higher priority by such underwriters.

Thus, institutional underwriting may be broadly recognized, in the context of development

credit, as playing a decisive role in directing the economic resources of the country towards
desired activities.

This does not mean that they are barred entrance in the issue market from so called glamorous
issues to which public can be expected to readily subscribe. They may be underwriting in such
cases, but what is expected of them is their support to projects in the priority sector.

One of the principal advantages they offer is that resource-wise they are undoubted. They are in
a position to fulfill their underwriting commitments even in the worst foreseeable situations.

The public financial institutions namely IDBI, IFCI, ICICI, LIC and UTI, underwrite a portion of
the issued capital. Usually, the underwriting is done in addition to granting term finance by way
of loans on debentures. These institutions are usually approached when one or more of the
following situations prevail:

(i) The issue is so large that broker-underwriting may not be able to cover the entire issue.

(ii) The gestation period is long enough to act as distinctive

(iii) The project is weak, inasmuch as it is being located in a backward area.

(iv) The project is in the priority sector which may not be able to provide an attractive return on
investment.

(v) The project is promoted by technicians.

(vi) The project is new to the market.

The quantum of underwriting assistance varies from institution to institution according to the
commitments of each of them for a particular industry.

However, institutional underwriting suffers from the following two drawbacks:

1. The institutional handling involves procedural delays which sometimes dampen the initiative
of the corporate managers or promoters.

2. The other disadvantage is that the institutions prefer to wait and watch the results to fulfill
their obligations only where they are called upon to meet the deficit caused by under
subscription.

(c) Distribution:

The sale of securities to the ultimate investors is referred to as distribution; it is another

specialized job, which can be performed by brokers and dealers in securities who maintain
regular and direct contact with the ultimate investors. The ability of the New Issue Market to
cope with the growing requirements of the expanding corporate sector would depend on this
triple-service function.

IPO:
Initial public offering is the process by which a private company can go public by sale of its
stocks to general public. It could be a new, young company or an old company which decides to
be listed on an exchange and hence goes public.

Companies can raise equity capital with the help of an IPO by issuing new shares to the public or
the existing shareholders can sell their shares to the public without raising any fresh capital.

A company offering its shares to the public is not obliged to repay the capital to public investors.

The company which offers its shares, known as an 'issuer', does so with the help of investment
banks. After IPO, the company's shares are traded in an open market. Those shares can be further
sold by investors through secondary market trading.
SEBI guidelines for IPO:

An issue making public offer issue shall adhere to the conditions of Chapter III of SEBI (ICDR)
Regulations as on the date of filing a draft offer document with the Board (SEBI) and also at the
time of registering the offer document with the Registrar of Companies.

Necessary conditions for Making an initial Public Offer (IPO) issue:

1. An issuer making an initial public offer must fulfill that:

o It has net tangible assets of at least three crore rupees in each of the preceding
three full years (each year of twelve months), of which not more than fifty
percent. are held in monetary assets:
o it has a past record of distributable profits for at least three out of the immediately
preceding five years as per section 205 of the Companies Act, 1956. Thus, it shall
 be a profit-making company.While calculating the distributable profits
extraordinary items shall be excluded in such calculation;
o it must have a net worth of at least one crore rupees in each of the preceding three
full years (each year of twelve months);
o the aggregate of the proposed issue and all previous issues made in the same
financial year in terms of issue size must not exceed five times its pre-issue net
worth calculated as per the audited balance sheet of the preceding financial year;
o if it has changed its name during the last one year, at least fifty percent of the
revenue generated for the preceding one full year has been earned by it from the
activity mentioned by the new name.

2. An issuer not fulfilling any of the conditions prescribed in sub-regulation (1) may make
an initial public offer if:
1.
 The issue is made through the book building process and the issuer
promises to allow at least fifty percent. of the net offer to the public,
qualified institutional buyers and to refund full subscription amount if it
fails to make an allotment to the qualified institutional buyers, or
 At least fifteen percent. Of the cost of the project is contributed by
scheduled commercial banks or public financial institutions, out of which
at least ten percent. Shall come from the appraisers and the issuer
guarantees to allow at least ten percent. of the net offer to the public, to
qualified institutional buyers and to refund full subscription amount if it
fails to make the allotment to the qualified institutional buyers;
2.
 the minimum amount post-issue face value capital of the issuer is ten crore
rupees; or
 the issuer commits to furnish market-making for at least two years from
the date of listing of the particular securities, subject to the following:
 the market makers offer to buy and sell quotes for at least of three
hundred specified securities and confirm that the bid-ask spread for
their quotes does not, at any point of time, exceed ten percent.;
 The inventory of the market makers, as on the date of allotment of
the specified securities, shall not be less than five percent. of the
proposed issue.
3. An issuer may make an initial public offer(IPO) of convertible debt instruments even
though he has not undertaken a prior public issue of its equity shares and further listing
thereof.
4. An issuer shall not make an allotment pursuant to a public issue if the number of
prospective allottees is below one thousand.
5. No issuer shall make an initial public offer(IPO) if [as on the date of registering the
prospectus with the Registrar of Companies] i) there are any outstanding convertible
securities or ii) any other right entitling any person any option to receive equity shares
after the initial public offer:
Provided that the norms of this sub-regulation shall not apply to:
 o a public issue brought out during the prevalence of convertible debt instruments
issued through an earlier initial public offer if the conversion price of such
convertible debt instruments was fixed and mentioned in the prospectus of the
earlier issue of convertible debt instruments;
o Outstanding options permitted to employees under an employee stock option
scheme (ESOS) formulated in consonance with the relevant Guidance Note or
Accounting Standards, if any, issued by the Institute of Chartered Accountants of
India (ICAI) in this matter.

6. Subject to provisions of the Companies Act, 1956, equity shares may be offered for sale
to the public if such equity shares have been held by the sellers for a period of at least one
year before the filing of draft offer document with the Board under the provisions of sub-
regulation (1) of regulation 6:

Provided that in the case where the equity shares received on conversion or exchange of fully
paid-up compulsorily convertible securities and also depository receipts are being offered for
sale, the holding period of such convertible securities and that of resultant equity shares together
shall be considered for calculation of one-year period prescribed in this sub-regulation:

Provided further that the requirement of holding equity shares for a period of one year will not be
applicable:

7.

1. in case of an offer for sale of specified government company securities or

statutory authority or corporation or any special purpose vehicle formed and
controlled by any one or more of them, which is engaged in infrastructure sector
activities;
2. if the specified securities offered for sale were acquired under any scheme
approved by a High Court under sections 391-394 of the Companies Act, 1956, in
place of business and invested capital which is existing for a period of more than
one year prior to such approval.

8. No issuer shall make an initial public offer without obtaining grading for the initial public
offer from at least one credit rating agency registered with the Board. This has to be as on
the date of registering prospectus or red herring prospectus with the Registrar of
Companies.

Methods of Issuing IPO:

Some of the major methods of issuing corporate securities are as follows:
1. Public Issue or Initial Public Offer (IPO):

Under this method, the company issues a prospectus to the public inviting offers for subscription.
The investors who are interested in the securities apply for the securities they are willing to buy.
Advertisements are also issued in the leading newspapers. Under the Company Act it is
obligatory for a public limited company to issue a prospectus or file a statement in lieu of
prospectus with the Registrar of Companies.

Once subscriptions are received, the company makes allotment of securities keeping in view the
prescribed requirements. The prospectus must be drafted and issued in accordance with the
provisions of the Companies Act and the guidelines of SEBI. Otherwise it may lead to civil and
criminal liabilities.

Public issue or direct selling of securities is the most common method of selling new issues of
securities. This method enables a company to raise funds from a large number of investors
widely scattered throughout the country. This method ensures a wider distribution of securities
thereby leading to diffusion of ownership and avoids concentration of economic power in a few
hands.

However, this method is quite cumbersome involving a large number of administrative problems.
Moreover, this method does not guarantee the raising of adequate funds unless the issue is
underwritten. In short, this method is suitable for reputed companies which want to raise large
capital and can bear the large costs of a public issue.

2. Private Placement:

In this method, the issuing company sells its securities privately to one or more institutional
brokers who in turn sell them to their clients and associates. This method is quite convenient and
economical. Moreover, the company gets the money quickly and there is no risk of non-receipt
of minimum subscription.

Private placement, however suffers from certain drawbacks. The financial institution may insist
on a huge discount or other conditions for private purchase of securities. Secondly, it may not
sell the securities in the market but keep them with it.

This deprives the public a chance to purchase securities of a flourishing company and there may
be concentration of the company‘s ownership in a few hands. Private placement is very suitable
for small issues particularly during depression.

3. Offer for Sale:

Under this method, the issuing company allots or agrees to allot the security to an issue house at
an agreed price. The issue house or financial institution publishes a document called an ‗offer for
sale‘. It offers to the public shares or debentures for sale at higher price. Application form is
attached to the offer document. After receiving applications, the issue house renounces the
allotment in favour of the applicants who become direct allottees of the shares or debentures.

This method saves the company from the cost and trouble of selling securities directly to the
investing public. It ensures that the whole issue is sold and stamp duty payable on transfer of
shares is saved. But the entire premium received is retained by the offerer and not the issuing
company.
4. Sale through Intermediaries:

In this method, a company appoints intermediaries like stock brokers, commercial banks and
financial institutions to assist in finding market for the new securities on a commission basis. The
company supplies blank application forms to each intermediary who affixes his seal on them and
distributes the among prospective investors. Each intermediary gets commission on the amount
of security applications bearing his seal. However, intermediaries do not guarantee the sale of
securities.

This method is useful when a company has already offered 49 per cent of issue to the general
public which is essential for listing of securities. The pace of sale of securities may be very slow
and there is uncertainty about the sale of whole lot of securities offered through intermediaries.
But this method saves the administrative problems and expenses involved in direct selling of
securities to the public.

5. Sale to Inside Coterie:

A company may resort to subscription by promoters and directors. This method helps to save the
expenses of public issue. Generally, a percentage of new issue of securities is reserved for
subscription by the inside coterie who can in this way share the future prosperity of the company.

6. Sale through Managing Brokers:

Sale of securities through managing brokers is becoming popular particularly among new
companies. Managing brokers advise companies about the proper timing and terms of the issue
of securities. They assist companies in pre-issue publicity, drafting and issue of prospectus and
getting stock exchange listing. They also enlist the support and cooperation of share brokers.

7. Privileged Subscriptions:

When an existing company wants to issue further securities, it is required to offer them to
existing shareholders on prorate basis. This is known as ‗Rights Issue‘. Sale of shares by rights
issues is simpler and cheaper as compared to sale through prospectus.

But the existing shareholders will subscribe to the new issues only when the past performance
and future prospects of the company are good. An existing company may also issue Bonus
Shares free of charge to the existing shareholders by capitalising its reserves and surplus.

Secondary Market:
A secondary market is a marketplace where already issued securities – both shares and debt –
can be bought and sold by the investors. So, it is a market where investors buy securities from
other investors, and not from the issuing company.

When a company issues its securities for the time, it does it in the primary market. After the IPO
(Initial Public Offering), those securities get available for trade in the secondary market. Stock
markets such as the BSE and the NSE are examples of the secondary markets.

Functions of secondary market:

(a) Providing Liquidity and Marketability to Existing Securities: The basic function of a
stock exchange is the creation of a continuous market where securities are bought and sold. It
gives investors the chance to disinvest and reinvest. This provides both liquidity and easy
marketability to already existing securities in the market.
(b) Pricing of Securities: Share prices on a stock exchange are determined by the forces of
demand and supply. A stock exchange is a mechanism of constant valuation through which the
prices of securities are determined. Such a valuation provides important instant information to
both buyers and sellers in the market.
(c) Safety of Transaction: The membership of a stock exchange is well regulated and its
dealings are well defined according to the existing legal framework. This ensures that the
investing public gets a safe and fair deal on the market.
(d) Contributes to Economic Growth: A stock exchange is a market in which existing
securities are resold or traded. Through this process of disinvestment and reinvestment savings
get channelized into their most productive investment avenues. This leads to capital formation
and economic growth.
(e) Spreading of Equity Cult: The stock exchange can play a vital role in ensuring wider share
ownership by regulating new issues, better trading practices and taking effective steps in
educating the public about investments.
(f) Providing Scope for Speculation: The stock exchange provides sufficient scope within the
provisions of law for speculative activity in a restricted and controlled manner. It is generally
accepted that a certain degree of healthy speculation is necessary to ensure liquidity and price
continuity in the stock market.

Instruments traded in secondary market:

Instruments which are dealt in the secondary market are:

1. Equity:

The ownership interest in a company of holders of its common and preferred stock.

The various kinds of equity shares are:

Equity Shares:

An equity share commonly referred to as ordinary share also represents the form of fractional
ownership in which a shareholder, as a fractional owner, undertakes the maximum
entrepreneurial risk associated with a business venture. The holders of such shares are members
of the company and have voting rights.

Right Issues/Rights Shares:

The issue of new securities to existing shareholders at a ratio to those already held.

Bonus Shares:

Shares issued by the companies to their shareholders free of cost by capitalization of

accumulated reserves from the profits earned in the earlier years.

Preferred Stock/Preference shares:

Owners of these kinds of shares are entitled to a fixed dividend or dividend calculated at a fixed
rate to be paid regularly before dividend can be paid in respect of equity share. They also enjoy
priority over the equity shareholders in payment of surplus. But in the event of liquidation, their
claim rank below the claims of the company‘s creditors, bond holders/debenture holders.

Cumulative Preference Shares:

A type of preference shares on which dividend accumulates if remains unpaid. All arrears of
preference dividend have to be paid out before paying dividend on equity shares.

Cumulative convertible Preference Shares:

A type of preference shares where the dividend payable on the same accumulates, if not paid.
After a specified date, these shares will be converted into equity capital of the company.

Participating Preference Shares:

The right of certain preference shareholders to participate in profits after a specified fixed
dividend contracted far is paid. Participation right is linked with the quantum of dividend paid on
the equity shares over and above a particular specified level.

Government securities (G-Secs):

These are sovereign (credit risk-free) coupon bearing instruments which are issued by the
Reserve Bank of India on behalf of Government of India, in lieu of the Central Government‘s
market borrowing programme. These securities have a fixed coupon that is paid on specific dates
on half-yearly basis. These securities are available in wide range of maturity dates, from short
dated (less than one year) to long dated (up to twenty years).
Bonds & Debentures:

Whether it may be a small enterprise, an established company or the Government itself, the need
for money to make it run is ever accepted. Borrowing is one of the most common ways of
availing the needful fund. There are many ways different ways to borrow money among which
Bonds and Debentures are the prominent ones.

A bond and debenture both are debt instrument issued by the government or companies. Both of
these are fundraising tools for the issuer. Bonds are generally issued by the government, the
agencies of government or by large corporations whereas debentures are issued by public
companies to raise money from the market. Sometimes both the words are used interchangeably
but both are distinctly different. Let‘s understand both the investment tools and how they are
different from each other.

A bond is a secured investment as it is secured by collaterals. In bonds, an asset is pledged as the

security of lending so that if the issuer fails to pay the sum, the bondholders can sell the asset to
discharge their debts.

Bonds are issued for a fixed period. The interest on a bond is paid at regular intervals which are
called coupons.

A debenture is another form of debt fund which is generally Secured / unsecured in nature. Both
the bonds and debentures are fundraisers but debentures are more specific in nature. Debentures
are not backed by any of the assets of the issuer hence depends only on the faith factors of the
investor on the issuer. Debentures are issued by the issuer for any specific need such as
upcoming expenses or to pay for expansions. The capital raised here is borrowed capital hence
the debenture holders are treated as creditors of the company.

BONDS DEBENTURES
Debentures can be secure as well as
Bonds are secure in nature.
unsecured.
One can have bonds of a corporation,
On the other hand debentures are issued by
government agencies or it can be of any
private companies.
financial institution.
Bonds are less risky comparatively. Whereas debentures are at high risk.
Whereas in the case of debentures liquidity
Talking about liquidity bonds are at the first
can only be done after the bondholders are
priority.
paid.
Bonds give you low interest, but it depends on
Whereas debentures give you high interest.
the issuing body totally.
The various types of Bonds are as follows:

1. Zero Coupon Bond:

Bond issued at a discount and repaid at a face value. No periodic interest is paid. The difference
between the issue price and redemption price represents the return to the holder. The buyer of
these bonds receives only one payment, at the maturity of the bond.

2. Convertible Bond:

A bond giving the investor the option to convert the bond into equity at a fixed conversion price.

Commercial Paper:

A short term promise to repay a fixed amount that is placed on the market either directly or
through a specialized intermediary. It is usually issued by companies with a high credit standing
in the form of a promissory note redeemable at par to the holder on maturity and therefore,
doesn‘t require any guarantee. Commercial paper is a money market instrument issued normally
for tenure of 90 days.

Treasury Bills:

Short-term (up to 91 days) bearer discount security issued by the Government as a means of
financing its cash requirements.

Trading Mechanism in secondary market:

Now we are moving to the real-life scenario of stock market i.e. how trading occurs and what are
the criteria for trading. Before moving to trading we have to know two important terms, stock
exchange and broker. Basically stock exchange is an entity that provides facility or service to the
broker and trader to trade on stocks, bonds, derivatives.

In India we have two stock exchanges

 BSE (Bombay Stock Exchange)

 NSE (National Stock Exchange)

About BSE (Bombay Stock Exchange)

BSE is the oldest stock exchange of Asia established way back in 1875 and is located in the
Dalal Street, Mumbai. Some of the features of BSE are as follows:

 Till 2016 BSE had a market Capitalization of INR. 154.01 Lakh crore
  It has 5,749 listing of companies ranging from small capitalization to large capitalization
companies.
 It is also called as BSE 30 or simply SENSEX
 It is the 12th largest stock exchange in the world and claims to be the fastest stock
exchange in the world with a median trading speed of 6 micro seconds.

About NSE (National Stock Exchange)

NSE is the most influential stock exchange in India, the reason being that it provides derivatives
trading apart from the normal shares trading. Salient features of NSE are as follows:

 NSE has a market Capitalization of more than US$1.41 trillion.

 It is the 10th largest Stock Exchange in India.
 It is also called as NSE 50 or Nifty.
 It provides trading in equity, derivatives and debt.

Mechanism of trading

Now we will be dealing on the trading platforms or the software used for trading. In order to
induce more transparency and efficiency in the trading system, NSE and BSE introduced
nationwide online fully automated ―Screen Based Trading System‖. The trading platform used
by BSE is called BOLT-Bombay Online Trading. The order of investors is placed on the basis of
time and price basis.

Recently BSE has launched new software for trading called BEST (BSE Electronic Smart
Trader). It can be downloaded directly from Android play store and an investor can enjoy zero
transaction charges for 6 months on cross currency derivatives.

Now we will be moving into the trading Process

STEP 1: Finding a Broker

A broker acts as an intermediary or a mediator between the investor and the stock exchange. The
work of a broker is transfer of order electronically from the investor to the exchange. Any
transaction that occurs in stock market is taken care by the stock exchange. Normally in India the
stock exchange for trading is active from 9:15 AM to 3:30 PM. However from 1st October, 2018
SEBI has decided to extend the trading hours till 11:55 pm in a move to attract the investors
dealing in Indian products on overseas exchanges. The brokers should be selected on the
following basis:

 Watching out for fees taken for opening an online trading account
 Having a proper look at ratings and customer service.
 Brokerage charge for intraday trading
 Brokerage charge on selling a long held share
 Margin provided by the broker on intraday trading
 The broker must provide information regarding investment opportunities on a regular
basis.

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transactions, 24/7 customer support, call and trade facility, and easy and instant payout options.

STEP 2: Opening Account with the Broker

Having selected a broker it is time to open an online trading account with the broker. A broker
always opens a trading account in the name of the investor/ client only if he/she is satisfied about
the credit worthiness of the client. If the broker feels satisfied with the client he/she will open the
account by writing the client‘s name in the broker‘s book. The minimum requirement for
opening a trading account is PAN card, and bank account failing to which the account cannot be
opened.

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STEP 3: Placing the Order

After the account is opened successfully a notification will be provided via email or message.
Then the investor can begin the trading as per his/her wish. The trading or investment is done by
purchasing a specified number of shares of a particular company. The order when placed is
incomplete until the order status shows complete. Different online trading platforms follow
different symbols to mark the order placing. Order can also be placed via a telephonic call with
the broker. There are different types of orders:

Buy Orders

Buy orders are placed when the price of the share is expected to rise. This can be understood by
simple Demand-Supply curve. As the demand increases people buy more and the price gradually
rises. The same logic applies in the share market. As the price of the share rises, the investors
feel the price will further rise and they buy the shares. However the amount of quantity is fully
dependent on the availability of funds and risk associated with the particular share.

Sell orders

Sell orders are executed when the investor feels that the price of the share will decline from now
on. However, it is totally based on analysis and predictions.

Limit order

It is an order for buying or selling of securities at a particular price as set by the investor.
However there is no guarantee that the limit order will be executed. For example the price of a
Share X is Rs. 234.65 and the investor places an order to buy the share X 100 quantity at Rs.
223.05 or less. But if the price of share X doesn‘t fall till Rs. 223.05 then the investor cannot buy
the shares.

Stop Loss order

It is an order to sell the shares as soon as the price of the share falls up to a particular level or
from the buy side to buy the share when the price rises up to a specified level. This is set by the
client to avert the loss which can occur in share market. This is done to not suffer loss more than
the specified limit.

Fixed Price order

When the investor specifies the price at which he/she wants to buy/sell the shares is called fixed
price order.
Market order:

A market order is executed at CMP (Current Market Price). It occurs mainly during intraday
trading. When the buyer has bought the shares and has not sold the shares before 3:15pm then
from the broker side the shares are sold at CMP.
Discretionary order
It is normally done by the broker from their side when the investor has complete faith and trusts
the broker. It is an order to the broker to buy/sell the shares at whatever price the broker thinks
will be good for the investor.
Cancel order
If the price is not matched then the order is cancelled and new fresh orders have to be placed
again. Also, however if the margins are insufficient then order is cancelled. In that case the trader
has to place order with a reduced number of order quantity.
Day order

The validity of these orders is for the day in which they are put in the trading platform. However
if they are not executed (buy/sell) then the orders are cancelled automatically from the broker
side.
STEP 4:Execution of the Order

The orders are executed by the broker on behalf of the clients. The buy orders must tally the sell
orders if not then the broker will sell/buy to match the order. For this the broker charges an
amount. Normally in an electronic platform the execution occurs automatically.
STEP5: Preparation of Contract Notes

A contract note is a written agreement between the broker and the investor for smooth execution
of the transaction. A contract note is sent through an automated message and via mail through
the registered phone and mail respectively by the end of the day. However it varies from broker
to broker and the timing varies.

A contract contains the transaction name, brokerage charges, trading on BSE/ NSE, SEBI
registration number of the broker, settlement number and a digital signature by the broker.

STEP 6: Contract Settlement

The settlement is done by the clearing agency which functions in each stock exchange. The
clearing agency delivers the share certificates by the end of the day.

Trading Cycle Process

Online trading & dematerialization of account:
Online trading is simply buying and selling assets through a brokerage's internet-based
proprietary trading platforms. Stocks, bonds, mutual funds, ETFs, options, futures, and
currencies can all be traded online. Also known as e-trading or self-directed investing.

Demat Account is an account that is used to hold shares and securities in electronic format. The
full form of Demat account is a dematerialized account. The purpose of opening a Demat
account is to hold shares that have been bought or dematerialized (converted from physical to
electronic shares), thus making share trading easy for the users during online trading.

In India, Free Demat account service is provided by depositories such as NSDL and CDSL
through intermediaries / Depository Participant / Stock Broker such as Angel Broking. The
charges of Demat account vary as per the volume held in the account, type subscribed, and the
terms and conditions laid by the depository and the stock broker.

During online trading, shares are bought and held in a Demat account, thus facilitating easy trade
for the users. A Demat Account holds all the investments an individual makes in shares,
government securities, exchange-traded funds, bonds and mutual funds in one place.

Dematerialization is the process of converting the physical share certificates into electronic form,
which is a lot easier to maintain and is accessible from anywhere throughout the world. An
investor who wants to trade online needs to open a Demat with a Depository Participant (DP).
The purpose of dematerialization is to eliminate the need for the investor to hold physical share
certificates and facilitating a seamless tracking and monitoring of holdings.
Brokers:
A stock broker or brokerage is licensed and regulated financial firm that facilitates buying and
selling transactions in various financial instruments for investor clients, institutions and or for the
firm. All financial market transactions have to be executed through a broker. Basically, a broker
is responsible for facilitating all stock trades you place. Most brokers allow users to sign up
through online applications. Brokers charge commissions for their services. The type of broker
will determine how expensive and how the commissions are structured.

Kinds of brokers:
There are three main types of brokerage firms: Full-service, discount and direct-access.

Full-Service Brokers:

These firms charge higher commissions or a percentage of assets. They offer the largest
assortment of diversified financial services and usually assign a licensed individual broker to
each client. These firms tend to have their own investment banking and research departments
that provide their own analyst recommendations, products and access to initial public offerings
(IPOs). Clients have the option of calling their personal broker directly to place trades or use
various other platforms including online and mobile. Full-service brokers have physical offices
and locations. They also offer financial planning, asset management and banking services. In
addition to savings and checking accounts many full service brokers provide personal, business
and home loans services. While most full-service brokers provide online access and trading
functions, they tend to charge higher commissions and route orders directly to their own market
makers or through order-fill agreements with other firms. Full-service broker online platforms
tend to have less day trading tools and indicators as they cater more towards long-term investors.

Discount Brokers:

Discount brokers have narrowed the gap with full-service brokers in terms of financial products
and services providing independent research, mutual fund access and basic banking products. As
the name says, discount brokers have smaller commissions for trades. Usually the commissions
will range for $9.99 to $4.99 per trade ticket, which may appeal to swing traders and less active
day traders. The platforms tend to have more trading and research tools than the full-service
brokers since they cater to active investors and day traders. Many of the larger discount brokers
provide their own direct-access trading platforms and physical office locations throughout the
country.

Online Brokers:

Online brokers also known as direct-access brokers cater to active day trading clients with the
smallest commissions often priced on a per-share basis, which is needed when scaling in and out
of positions. These firms provide direct-access platforms with charting and routing capabilities
with access to electronic communication networks (ECN), market makers, specialists, dark pools
and multiple exchanges. Speed and access are the top benefits of direct-access brokers, often
 allowing for point-and-click executions and programmable hot-keys. Complex stock and options
orders can be placed on these platforms. The heavy-duty platforms often carry a monthly fee
composed of software fees and exchange fees. The software fees can usually be waived or
discounted based on the client‘s monthly trading volume. Active day traders are best advised to
use reputable online/direct-access brokers to ensure maximum control and flexibility as well as
speedy order fills. To keep overhead low and pass on the cheaper rates, online brokers usually
don‘t provide physical office locations for customers.

Registration of brokers:

Application process for stock broker or sub-broker or dealer: A stock broker and a sub-broker
need to follow the guidelines laid down by SEBI for the registration process. The application
process is the same where information such as Name, Address, PAN Number and other
important details need to be mentioned, while applying. You will need to also mention the stock
exchange in which you would like to trade in. Mention the different segments that you are
trading in such as equity derivatives, equities, currency derivatives and also for each category
such as trading members, trading cum self-clearing members and professional clearing members.

Getting registered: Stock brokers and sub-brokers need to get a Certificate of Registration
(CoR) from SEBI in order to proceed with trading. Under the guidelines of the stock exchange,
no stock broker or sub-broker is allowed to practice until he/she has a vaildCoR from SEBI. A
sub-broker can register as a sub-broker with SEBI,similar to a stock broker.

License and registration fees: Stock brokers need to pay membership fees to the stock exchange.
Sub-brokers also need to pay a similar amount. These fees are only applicable once the SEBI
deems the applicants are eligible to become SEBI registered stock brokers and sub-brokers.

Starting the practise: After receiving a membership number, one can begin trading in stocks on
behalf of clients. All stock brokers and sub-brokers are listed on the SEBI website of registered
brokers.

NSE India has created the National Institute of Securities Markets (NISM) to educate stock
brokers, sub-brokers and investors about the stock market. In some cases, having the certification
of the NISM is mandatory by some broking firms. Stock broking and sub-broking firms recruit
individuals who are proficient in the various concepts of the stock market. In order to become a
proficient stock market expert, one needs to have a detailed analysis of the market in addition to,
following the guidelines laid down by SEBI.
 MODULE - III

Introduction to Mutual Fund:

Mutual fund is a unique investment pooling entity which enables investors to invest in a wide
range of securities through a single platform. Mutual Funds are excellent for long-term wealth
creation. However, with more and more funds flooding the market, the task of selecting the most
suitable scheme for you gets even more complicated.

In other words, a mutual fund is an investment company wherein many investors pool in
different sums of money to make up a large lump sum. The money collected is invested by the
fund manager in shares, bonds and other securities - across companies, industries and sectors. As
an investor, you are issued units in proportion to the money invested.

Classification of mutual funds:

Mutual fund types can be classified based on the following characteristics.

1. Based on Asset Class

2. Based on Structure
3. Based on Investment Goals
4. Based on Risk
5. Specialized Mutual Funds

1. Based on Asset Class

a. Equity Funds

Equity funds primarily invest in stocks, and hence go by the name of stock funds as well. They
invest the money pooled in from various investors from diverse backgrounds into shares/stocks
of different companies. The gains and losses associated with these funds depend solely on how
the invested shares perform (price-hikes or price-drops) in the stock market. Also, equity funds
have the potential to generate significant returns over a period. Hence, the risk associated with
these funds also tends to be comparatively higher.

b. Debt Funds

Debt funds invest primarily in fixed-income securities such as bonds, securities and treasury
bills. They invest in various fixed income instruments such as Fixed Maturity Plans (FMPs), Gilt
Funds, Liquid Funds, Short-Term Plans, Long-Term Bonds and Monthly Income Plans, among
others. Since the investments come with a fixed interest rate and maturity date, it can be a great
option for passive investors looking for regular income (interest and capital appreciation) with
minimal risks.

c. Money Market Funds

Investors trade stocks in the stock market. In the same way, investors also invest in the money
market, also known as capital market or cash market. The government runs it in association with
banks, financial institutions and other corporations by issuing money market securities like
bonds, T-bills, dated securities and certificates of deposits, among others. The fund manager
invests your money and disburses regular dividends in return. Opting for a short-term plan (not
more than 13 months) can lower the risk of investment considerably on such funds.

d. Hybrid Funds

As the name suggests, hybrid funds (Balanced Funds) is an optimum mix of bonds and stocks,
thereby bridging the gap between equity funds and debt funds. The ratio can either be variable or
fixed. In short, it takes the best of two mutual funds by distributing, say, 60% of assets in stocks
and the rest in bonds or vice versa. Hybrid funds are suitable for investors looking to take more
risks for ‗debt plus returns‘ benefit rather than sticking to lower but steady income schemes.

2. Based on Structure

Mutual funds are also categorised based on different attributes (like risk profile, asset class, etc.).
The structural classification – open-ended funds, close-ended funds, and interval funds – is quite
broad, and the differentiation primarily depends on the flexibility to purchase and sell the
individual mutual fund units.

a. Open-Ended Funds

Open-ended funds do not have any particular constraint such as a specific period or the number
of units which can be traded. These funds allow investors to trade funds at their convenience and
exit when required at the prevailing NAV (Net Asset Value). This is the sole reason why the unit
capital continually changes with new entries and exits. An open-ended fund can also decide to
stop taking in new investors if they do not want to (or cannot manage significant funds).

b. Closed-Ended Funds

In closed-ended funds, the unit capital to invest is pre-defined. Meaning the fund company
cannot sell more than the pre-agreed number of units. Some funds also come with a New Fund
Offer (NFO) period; wherein there is a deadline to buy units. NFOs comes with a pre-defined
maturity tenure with fund managers open to any fund size. Hence, SEBI has mandated that
investors be given the option to either repurchase option or list the funds on stock exchanges to
exit the schemes.

c. Interval Funds

Interval funds have traits of both open-ended and closed-ended funds. These funds are open for
purchase or redemption only during specific intervals (decided by the fund house) and closed the
rest of the time. Also, no transactions will be permitted for at least two years. These funds are
suitable for investors looking to save a lump sum amount for a short-term financial goal, say, in
3-12 months.

3. Based on Investment Goals

a. Growth Funds

Growth funds usually allocate a considerable portion in shares and growth sectors, suitable for
investors (mostly Millennials) who have a surplus of idle money to be distributed in riskier plans
(albeit with possibly high returns) or are positive about the scheme.

b. Income Funds

Income funds belong to the family of debt mutual funds that distribute their money in a mix of
bonds, certificate of deposits and securities among others. Helmed by skilled fund managers who
keep the portfolio in tandem with the rate fluctuations without compromising on the portfolio‘s
creditworthiness, income funds have historically earned investors better returns than deposits.
They are best suited for risk-averse investors with a 2-3 years perspective.

c. Liquid Funds

Like income funds, liquid funds also belong to the debt fund category as they invest in debt
instruments and money market with a tenure of up to 91 days. The maximum sum allowed to
invest is Rs 10 lakh. A highlighting feature that differentiates liquid funds from other debt funds
is the way the Net Asset Value is calculated. The NAV of liquid funds is calculated for 365 days
(including Sundays) while for others, only business days are considered.

d. Tax-Saving Funds

ELSS or Equity Linked Saving Scheme, over the years, have climbed up the ranks among all
categories of investors. Not only do they offer the benefit of wealth maximisation while allowing
you to save on taxes, but they also come with the lowest lock-in period of only three years.
Investing predominantly in equity (and related products), they are known to generate non-taxed
returns in the range 14-16%. These funds are best-suited for salaried investors with a long-term
investment horizon.

e. Aggressive Growth Funds

Slightly on the riskier side when choosing where to invest in, the Aggressive Growth Fund is
designed to make steep monetary gains. Though susceptible to market volatility, one can decide
on the fund as per the beta (the tool to gauge the fund‘s movement in comparison with the
market). Example, if the market shows a beta of 1, an aggressive growth fund will reflect a
higher beta, say, 1.10 or above.

f. Capital Protection Funds

If protecting the principal is the priority, Capital Protection Funds serves the purpose while
earning relatively smaller returns (12% at best). The fund manager invests a portion of the
money in bonds or Certificates of Deposits and the rest towards equities. Though the probability
of incurring any loss is quite low, it is advised to stay invested for at least three years (closed-
ended) to safeguard your money, and also the returns are taxable.

g. Fixed Maturity Funds

Many investors choose to invest towards the of the FY ends to take advantage of triple
indexation, thereby bringing down tax burden. If uncomfortable with the debt market trends and
related risks, Fixed Maturity Plans (FMP) – which invest in bonds, securities, money market etc.
– present a great opportunity. As a close-ended plan, FMP functions on a fixed maturity period,
which could range from one month to five years (like FDs). The fund manager ensures that the
money is allocated to an investment with the same tenure, to reap accrual interest at the time of
FMP maturity.
h. Pension Funds

Putting away a portion of your income in a chosen pension fund to accrue over a long period to
secure you and your family‘s financial future after retiring from regular employment can take
care of most contingencies (like a medical emergency or children‘s wedding). Relying solely on
savings to get through your golden years is not recommended as savings (no matter how big) get
used up. EPF is an example, but there are many lucrative schemes offered by banks, insurance
firms etc.

4. Based on Risk
a. Very Low-Risk Funds

Liquid funds and ultra-short-term funds (one month to one year) are known for its low risk, and
understandably their returns are also low (6% at best). Investors choose this to fulfil their short-
term financial goals and to keep their money safe through these funds.

b. Low-Risk Funds

In the event of rupee depreciation or unexpected national crisis, investors are unsure about
investing in riskier funds. In such cases, fund managers recommend putting money in either one
or a combination of liquid, ultra short-term or arbitrage funds. Returns could be 6-8%, but the
investors are free to switch when valuations become more stable.

c. Medium-risk Funds

Here, the risk factor is of medium level as the fund manager invests a portion in debt and the rest
in equity funds. The NAV is not that volatile, and the average returns could be 9-12%.

d. High-Risk Funds

Suitable for investors with no risk aversion and aiming for huge returns in the form of interest
and dividends, high-risk mutual funds need active fund management. Regular performance
reviews are mandatory as they are susceptible to market volatility. You can expect 15% returns,
though most high-risk funds generally provide up to 20% returns.

5. Specialized Mutual Funds

a. Sector Funds

Sector funds invest solely in one specific sector, theme-based mutual funds. As these funds
invest only in specific sectors with only a few stocks, the risk factor is on the higher side.
Investors are advised to keep track of the various sector-related trends. Sector funds also deliver
great returns. Some areas of banking, IT and pharma have witnessed huge and consistent growth
in the recent past and are predicted to be promising in future as well.
b. Index Funds

Suited best for passive investors, index funds put money in an index. A fund manager does not
manage it. An index fund identifies stocks and their corresponding ratio in the market index and
put the money in similar proportion in similar stocks. Even if they cannot outdo the market
(which is the reason why they are not popular in India), they play it safe by mimicking the index
performance.

c. Funds of Funds

A diversified mutual fund investment portfolio offers a slew of benefits, and ‗Funds of Funds‘
also known as multi-manager mutual funds are made to exploit this to the tilt – by putting their
money in diverse fund categories. In short, buying one fund that invests in many funds rather
than investing in several achieves diversification while keeping the cost down at the same time.

d. Emerging market Funds

To invest in developing markets is considered a risky bet, and it has undergone negative returns
too. India, in itself, is a dynamic and emerging market where investors earn high returns from the
domestic stock market. Like all markets, they are also prone to market fluctuations. Also, from a
longer-term perspective, emerging economies are expected to contribute to the majority of global
growth in the following decades.

e. International/ Foreign Funds

Favoured by investors looking to spread their investment to other countries, foreign mutual funds
can get investors good returns even when the Indian Stock Markets perform well. An investor
can employ a hybrid approach (say, 60% in domestic equities and the rest in overseas funds) or a
feeder approach (getting local funds to place them in foreign stocks) or a theme-based allocation
(e.g., gold mining).

f. Global Funds

Aside from the same lexical meaning, global funds are quite different from International Funds.
While a global fund chiefly invests in markets worldwide, it also includes investment in your
home country. The International Funds concentrate solely on foreign markets. Diverse and
universal in approach, global funds can be quite risky to owing to different policies, market and
currency variations, though it does work as a break against inflation and long-term returns have
been historically high.

g. Real Estate Funds

Despite the real estate boom in India, many investors are still hesitant to invest in such projects
due to its multiple risks. Real estate fund can be a perfect alternative as the investor will be an
indirect participant by putting their money in established real estate companies/trusts rather than
projects. A long-term investment negates risks and legal hassles when it comes to purchasing a
property as well as provide liquidity to some extent.

Structure of mutual fund company:

In India, the structure of Mutual Funds is a three-tier structure with a few other significant
components. It is not just the different banks or AMCs that create or float different mutual fund
schemes; instead, there are other players that are involved in the structure of mutual funds. The
primary watchdog in all these transactions is the Securities Exchange Board of India (‗SEBI‘)
under whom each entity is required to be registered with. The inception of SEBI (Mutual Funds)
Regulations, 1996, revolutionized the structure of mutual funds and since then all the entities are
regulated under it. Currently, mutual funds comprise of five basic participants, namely a
Sponsor, Mutual Fund Trustee, Asset Management Company, Custodian & Registrar and a
Transfer Agent.

The Hierarchy looks like this:

Sponsor

A sponsor is any person or entity that can set up a mutual fund scheme to generate income
through fund management. The sponsor can be said as the first layer of the three-tier structure of
mutual funds in India. The sponsor is required to approach SEBI and get a mutual fund scheme
approved. The sponsor cannot work alone. It needs to create a Public Trust under the Indian
Trust Act 1882 and get the same registered with SEBI. Once the trust is created, the Trustee is
registered with SEBI and is appointed as the trustee of the fund in order to safeguard the interest
of the unit holders and to adhere the SEBI Mutual Fund regulations. The Sponsor subsequently
creates an Asset Management Company under the Companies Act, 1956 to deal with the fund
management. There are certain eligibility criteria to become a Sponsor, as prescribed under:
a. The Sponsor must have profit in 3 of the last 5 years including immediately preceding year.

b. The Sponsor must have a minimum of 5 years of experience in financial services.

c. The net worth of the Sponsor must be positive for all the preceding five years.

d. Out of the total net worth of the AMC, 40% must be participated by the Sponsor.

As seen above, the position of a Sponsor is crucial and they should have high credibility. Strict
norms show that the sponsor must have enough liquidity and faithfulness to return the money of
an innocent investor, in case of a financial meltdown.

Trust and Trustees

Trust and trustees make up the second layer of the structure of mutual funds. Trustees are also
known as the protectors of the fund and are employed by the fund sponsor. As the name
suggests, they have a very important role in maintaining the trust of the investors and to oversee
the growth of the fund. SEBI mandates the trustees to provide a report on the fund and the
functioning of the AMC on a half-yearly basis. Trustees can be created either in the form of
Board of Trustees or a Trust Company. The Trustees supervise the entire functioning of the
AMC and regulate the operations of the mutual fund schemes. The SEBI has tightened the rule
of transparency so as to avoid any conflict of interest between the Sponsor and the AMC.
Without the permission and approval of the Trust, an AMC cannot float a new mutual fund
scheme. It is important for the Trustees to act independently and take appropriate measures to
safeguard the hard earned money of the investors. The Trustees are also required to be registered
under SEBI, and SEBI further regulates their registration by either suspending or revoking the
registration if found breaching any conditions.

Asset Management Company

An AMC is the third working layer in the structure of mutual funds. An AMC floats various
schemes of mutual fund in the market, pursuant to the needs of the investors and the nature of the
market. They create mutual funds along with the trustee and the sponsor and then oversee its
development. While creating the scheme, they take help of bankers, brokers, RTAs auditors etc.
and enter into an agreement with them. An AMC is a company formed under Companies Act and
needs to be registered under SEBI. Similar to the Trustees, an AMC also needs to ensure that
there is no conflict of interest amongst them, the sponsor and the trustees.

Other Participants in the Structure of Mutual Funds

Custodian

A Custodian is an entity, which is responsible for the safekeeping of the securities. Custodians
are registered with SEBI and are responsible for the transfer and delivery of units and securities.
Custodians also enable investors in updating their holdings at a particular point of time and help
them in keeping track of their investments. Along with the primary job of safekeeping,
custodians are also in charge of the collection of corporate benefits such as bonus issue, interest,
dividends etc.

Registrar and Transfer Agents

RTAs are an important link between fund managers and investors. They cater to the fund
managers by updating them with the investor details and to investors by delivering the benefits
of the fund to them. RTAs are SEBI registered entities who process the applications of mutual
funds, help with investor KYC, manage and deliver periodical statements of investments, update
records of investors and process investor requests. Link-in time, Karvy etc. are some of the
famous RTAs in India and they provide the requisite operational support to the AMC in mutual
fund activities.

Other Participants

Some other participants in the structure of mutual funds are brokers, auditors, and bankers. The
brokers are responsible to attract investors and help to disseminate the fund. The brokers help
investors in sell, purchase of units and provide with their valuable advice. Brokers also study the
market trend and predict the future movement of the market. Unlike brokers, auditors are an
independent internal watchdog, who audit the financials of the AMC, Trustee, and Sponsor and
provide their report. Bankers are also an important participant, who act as collecting agents on
behalf of the fund managers.

These are the participants who play a key role in the management of mutual funds. Each
participant has their individual role to play. However, their functions are interlinked with each
other. Mutual fund regulations are the bible by which all the participants are bound together, to
perform their functions more diligently and without prejudice to the interest of the investors.

Functions of Mutual Fund company:

The functions of Mutual Fund Organizations (MFO) can be described as (a) Collection of funds
from public (b) Investment of funds collected from public in capital market (c) Proper
management of investment portfolio as a trustee to the investor‘s money. The investment made
by the public/investors in the AMC under a scheme is divided into number of units. The investor
will be allotted number units in the scheme proportionate to total investment in the scheme. The
investor is thus called unit holders. The Mutual Fund Organizations (MFO)s with huge resource
of investments of public and a team of experts in their employees roll, analyses investment
opportunities in various securities, bonds and financial investments. Based on the appraisal made
by the specialists, investment decisions in the capital market to buy/sell the securities will be
taken. The profit earned in the form of capital appreciation is distributed among the investors in
the scheme after appropriating the administrative and other overhead expenses.

Who are the parties to mutual funds?

Besides investors the following three parties are involved in Mutual Funds Set up.
 1. Trustees
2. Asset Management Company
3. SEBI the regulator.

Trustees: All mutual funds are set up in the form of a trust, which has sponsor,
trustees, asset Management Company (AMC) and custodian. The trust is established by a
sponsor or sponsors like a promoter of a company. The trustees of the mutual fund hold its
property for the benefit of the unit holders. Asset Management Company (AMC) approved by
SEBI manages the funds by making investments in various types of securities. Custodian, who is
registered with SEBI, holds the securities of various schemes of the fund in its custody. The
trustees are vested with the general power of management and supervision over AMC and they
monitor the performance and compliance of SEBI regulations. As per SEBI regulations at least
two thirds of the directors of trustee company or board of trustees must be independent i.e. they
should not be associated with the sponsors. Also, 50% of the directors of AMC must be
independent. All mutual funds are required to be registered with SEBI before they launch any
scheme.

The Asset Management Company (AMC): The Asset Management Company is formed by the
Mutual Fund Organization (MFO) which invests the money for buying of shares, deposits,
bonds, Government securities etc. The AMC makes profit or loss by regular trading of assets
held by it. An AMC should have a minimum of net worth of Rs.10 Crores. The AMC invest their
funds in small cap, mid cap and large cap companies. The companies are classified as small cap
(up to 150Crores), mid cap (between 150 crores to 1500 Crores) , large cap (above 1500 crores)
on the Market capitalization of Companies.

SEBI as regulator: The Mutual funds are subject to SEBI regulations and they are monitored
and inspected by SEBI. The set of regulations for the mutual funds was notified by SEBI in 1993.
Subsequently, mutual funds sponsored by private sector entities were allowed to enter the capital
market. The regulations were fully revised in 1996 and have been amended thereafter from time
to time. SEBI has been issuing guidelines to the mutual funds from time to time to protect the
interests of investors.

Mutual fund investment vs Stock market investment:

The key difference between Stock and Mutual Funds is that Stock is the term which is used to
represent the shares held by the person in one or more than one companies in the market
indicating the ownership of a person in those companies, whereas, the mutual funds is the
concept where the asset management company pools the funds from the different investors and
invests it in the portfolio of different assets with the investors having the shares of the fund for
their invested money.

Key Differences

1. A stock is a collection of shares owned by an individual investor indicating their

proportion of ownership in the assets and earnings of a corporation. On the other hand,
mutual funds are a pool of money from a number of small-scale investors which is further
 invested in a portfolio of assets. These include equity, debt or other money market
instruments.
2. The performance of the stock depends on the overall performance of the company in
which the investment is made and the sector. Various macroeconomic factors can have a
direct impact. Mutual funds‘ performance depends on the macroeconomic factors but the
skills of the fund managers and the pool of securities can help in maintaining stable and
regular returns.
3. The strategies of stocks are determined by the board of directors and can change
according to the prevailing conditions and the skills of the directors whereas in Mutual
funds the rules and regulations have been stated as per the Red Herring Prospectus. It is
essential to follow the rules as per the prospectus since the aim is to beat the returns
offered by the market without having any impact on the principal amount invested.
4. Stocks represent ownership stake to the investors whereas mutual funds offer fractional
ownership to the overall basket of securities.
5. The investor is individually responsible for the management and administration of the
stock or can be done by appointing a stockbroker. Conversely, mutual funds are managed
by a professional fund manager on behalf of the investors.
6. Risk component in case of stocks is larger as the direction of investment is in a single
company whereas Mutual funds offer the benefit of diversification thereby offering
robust earning opportunities in case of failure in a single company or sector.
7. The trading of stocks can take place at any time during the day including intra-day
trading at the existing price whereas mutual funds are traded only once a day probably at
the end of the daily basis in which the NAV is finalized.
8. The individual share price of the stock is multiplied by the number of shares determining
the value of stock held by the investor. On the other hand, the value of the mutual funds
can be calculated by arriving at the NAV which is the total value of assets net of
expenses.
9. Stocks get regular returns in the form of dividend earned and can vary depending on the
performance of the firm and decisions taken by the management. Mutual funds aim to
offer regular dividends to the investors and more than that offered in the market. They
also provide a timely statement on the performance of the overall fund which helps
investors in decision making.
10. The stockholder is directly responsible for the returns in the stock market as the investor
is directly managing the same whereas the fund manager is not directly responsible for
the results. However, their personal increment and commission do depend on the funds
they are managing.

Venture Capital:

Start up companies with a potential to grow need a certain amount of investment. Wealthy
investors like to invest their capital in such businesses with a long-term growth perspective. This
capital is known as venture capital and the investors are called venture capitalists.

Such investments are risky, but are capable of giving impressive returns if invested in the right
venture. The returns to the venture capitalists depend upon the growth of the company. Venture
capitalists have the power to influence major decisions of the companies they are investing in as
it is their money at stake.

Types of venture capital financing:

The followings are the different types of venture capital financing:

Seed Capital: If you‘re just starting out and have no product or organized company yet, you
would be seeking seed capital. Few VCs fund at this stage and the amount invested would
probably be small. Investment capital may be used to create a sample product, fund market
research, or cover administrative set-up costs.

Startup Capital: At this stage, your company would have a sample product available with at
least one principal working full-time. Funding at this stage is also rare. It tends to cover
recruitment of other key management, additional market research, and finalizing of the product
or service for introduction to the marketplace.

Early Stage Capital: Two to three years into your venture, you‘ve gotten your company off the
ground, a management team is in place, and sales are increasing. At this stage, VC funding
could help you increase sales to the break-even point, improve your productivity, or increase
your company‘s efficiency.

Expansion Capital: Your company is well established, and now you are looking to a VC to
help take your business to the next level of growth. Funding at this stage may help you enter
new markets or increase your marketing efforts. You should seek out VCs that specialize in later
stage investing.

Late Stage Capital: At this stage, your company has achieved impressive sales and revenue and
you have a second level of management in place. You may be looking for funds to increase
capacity, ramp up marketing, or increase working capital.

Bridge Financing: You may also be looking for a partner to help you find a merger or
acquisition opportunity, or attract public financing through a stock offering. There are VCs that
focus on this end of the business spectrum, specializing in initial public offerings (IPOs),
buyouts, or recapitalizations. If you are planning an IPO, a VC may also assist with mezzanine
or bridge financing – short-term financing that allows you to pay for the costs associated with
going public.

Stages of venture capital financing:

There are five stages in venture capital financing, and they include:
The Seed Stage

Venture capital financing starts with the seed-stage when the company is often little more than
an idea for a product or service that has the potential to develop into a successful business down
the road. Entrepreneurs spend most of this stage convincing investors that their ideas represent a
viable investment opportunity. Funding amounts in the seed stage are generally small, and are
largely used for things like marketing research, product development, and business expansion,
with the goal of creating a prototype to attract additional investors in later funding rounds.

The Startup Stage

In the startup stage, companies have typically completed research and development and devised
a business plan, and are now ready to begin advertising and marketing their product or service to
potential customers. Typically, the company has a prototype to show investors, but has not yet
sold any products. At this stage, businesses need a larger infusion of cash to fine tune their
products and services, expand their personnel, and conducting any remaining research necessary
to support an official business launch.

The First Stage

Sometimes also called the ―emerging stage,‖ first stage financing typically coincides with the
company‘s market launch, when the company is finally about to start seeing a profit. Funds from
this phase of a venture capital financing typically go to actual product manufacturing and sales,
as well as increased marketing. To achieve an official launch, businesses usually need a much
bigger capital investment, so the funding amounts in this stage tend to be much higher than in
previous stages.

The Expansion Stage

Also commonly referred to as the second or third stages, the expansion stage is when the
company is seeing exponential growth and needs additional funding to keep up with the
demands. Because the business likely already has a commercially viable product and is starting
to see some profitability, venture capital funding in the emerging stage is largely used to grow
the business even further through market expansion and product diversification.

The Bridge Stage

The final stage of venture capital financing, the bridge stage is when companies have reached
maturity. Funding obtained here is typically used to support activities like mergers, acquisitions,
or IPOs. The bridge state is essentially a transition to the company being a full-fledged, viable
business. At this time, many investors choose to sell their shares and end their relationship with
the company, often receiving a significant return on their investments.

An experienced business attorney can guide you through the different stages of venture capital
financing and advise you on the best ways to secure funding for your company in its current
stage.
Exit routes:
An important aspect of venture capital investing is the exit strategies. Venture capital funds
primarily invest with an exit in mind after a few years. After successfully funding at seed, pre-
production, production and expansion stages, a venture capitalist will start assessing exit
strategies. The exit in the form of disinvestment or liquidation is the last and final stage of the
venture capital funding. The key types of liquidation/disinvestment are trade sales, sale of quoted
equity post initial public offering (IPO), and write-offs.

The exit routs of VCF are as follows:

Trade Sales: In this type of strategy the private company is sold or merged with an acquirer for
stocks, cash, or a combination of both.

IPO: If the company has done well, the venture capital investors will take the IPO route, by
issuing shares registered for public offering. An example is the upcoming Facebook IPO, which
is expecting to raise about $15 billion through IPO and is valued at approx. 100 billion. The
venture capital investors and other private investors will get their portion of shares who can put
them in the open marketplace for trading after an initial lock-in period.

Write-offs: These are voluntary liquidations that may or may not result in any proceeds.

Apart from the above three types of disinvestment, there are a few other options:

Bankruptcy: The company may just go bankrupt.

Buy-back: In this method the entrepreneur buys-back the investment share from the venture
capitalists and takes it back to being a privately held company.

Leasing:
A ―lease‖ is defined as a contract between a lessor and a lessee for the hire of a specific asset for
a specific period on payment of specified rentals.

The maximum period of lease according to law is for 99 years. Previously land or real real estate,
mines were taken on lease. But now a day‘s plant and equipment, modem civil aircraft and ships
are taken.

Types of Leases:

The different types of leases are discussed below:

1. Financial Lease:
This type of lease which is for a long period provides for the use of asset during the primary
lease period which devotes almost the entire life of the asset. The lessor assumes the role of a
financier and hence services of repairs, maintenance etc., are not provided by him. The legal title
is retained by the lessor who has no option to terminate the lease agreement.

The principal and interest of the lessor is recouped by him during the desired playback period in
the form of lease rentals. The finance lease is also called capital lease is a loan in disguise. The
lessor thus is typically a financial institution and does not render specialized service in
connection with the asset.

2. Operating Lease:

It is where the asset is not wholly amortized during the non-cancellable period, if any, of the
lease and where the lessor does not rely for is profit on the rentals in the non- cancellable period.
In this type of lease, the lessor who bears the cost of insurance, machinery, maintenance, repair
costs, etc. is unable to realize the full cost of equipment and other incidental charges during the
initial period of lease.

The lessee uses the asset for a specified time. The lessor bears the risk of obsolescence and
incidental risks. Either party to the lease may termite the lease after giving due notice of the same
since the asset may be leased out to other willing leases.

3. Sale and Lease Back Leasing:

To raise funds a company may-sell an asset which belongs to the lessor with whom the
ownership vests from there on. Subsequently, the lessor leases the same asset to the company
(the lessee) who uses it. The asset thus remains with the lessee with the change in title to the
lessor thus enabling the company to procure the much needed finance.

4. Sales Aid Lease:

Under this arrangement the lessor agrees with the manufacturer to market his product through his
leasing operations, in return for which the manufacturer agrees to pay him a commission.

5. Specialized Service Lease:

In this type of agreement, the lessor provides specialized personal services in addition to
providing its use.

6. Small Ticket and Big Ticket Leases:

The lease of assets in smaller value is generally called as small ticket leases and larger value
assets are called big ticket leases.

7. Cross Border Lease:

Lease across the national frontiers is called cross broker leasing. The recent development in
economic liberalisation, the cross border leasing is gaining greater importance in areas like
aviation, shipping and other costly assets which base likely to become absolute due to
technological changes.

Financial Evaluation of Leasing:

The methods used in evaluation of lease decision are as follows:

1. Present Value Method:

Under this method the present value of lease rentals are compared with the present value of the
cost of an asset acquired on outright purchase by availing a loan. In leasing, the tax advantage in
payment of lease rentals will reduce the cash outflow.

In case an asset is purchased by borrowing a loan, the repayment of principal and interest
charges on loan is considered as cash outflow and it is reduced by tax advantage of depreciation
claim and interest charge. The present value of the net cash outflows over the period of lease is
considered to ascertain the present value over the lease/loan period. The alternative with low
total present value of cash outflow will be selected.

2. Cost of Capital Method:

Under this method, the rate of cost of capital is calculated for the payments of installments and
then it is compared with the cost of capital of the other available sources of finance such as fresh
issue of equity capital, retained earnings, debentures, term loans etc. The lease option is chosen if
the rate is lower than the cost of equity capital etc. This method does not require the prior
selection of any discounting rate.

Conceptual framework of hire purchase:

Hire Purchase is defined as an agreement in which the owner of the assets lets them on hire for
regular installments paid by the hirer. The hirer has the option to purchase and own the asset
once all the agreed payments have been made. These periodic payments also include an interest
component paid towards the use of the asset apart from the price of the asset.

In other words, hire purchase can be defined as an option of financing or acquiring an asset for
use whereby the financing company let the goods on hire to the buyer against small installments
called hire charges and the buyer gets the right to use the asset with an option to purchase the
asset by paying all such installments spread over a period of time. Hire purchase was very
prominent for vehicle financing whether that is a personal car, commercial vehicle etc but now
equipment, machinery etc are also financed with hire purchase method.

Features of hire purchase:

  Rental payments are paid in installments over the period of the agreement.
 Each rental payment is considered as a charge for hiring the asset. This means that, if the
hirer defaults on any payment, the seller has all the rights to take back the assets.
 All the required terms and conditions between both the parties involved are documented
in a contract called Hire-Purchase agreement.
 The frequency of the installments may be annual, half-yearly, quarterly, monthly, etc.
according to the terms of the agreement.
 Assets are instantly delivered to the hirer as soon as the agreement is signed.
 If the hirer uses the option to purchase, the assets are passed to him after the last
installment is paid.
 If the hirer does not want to own the asset, he can return the assets any time and is not
required to pay any installment that falls due after the return.
 However, once the hirer returns the assets, he cannot claim back any payments already
paid as they are the charges towards the hire and use of the assets.
 The hirer cannot pledge, sell or mortgage the assets as he is not the owner of the assets
till the last payment is made.
 The hirer, usually, pays a certain amount as an initial deposit / down payment while
signing the agreement.
 Generally, the hirer can terminate the hire purchase agreement any time before the
ownership rights pass to him.

Financial evaluation of hire purchase:

The decision-criterion for evaluation of a hire-purchase deal from the point of view of a hirer is
the cost of hire-purchase vis-a-vis the cost of leasing.

If the discounted cost of hire-purchase is less than the discounted cost of leasing, the hire-
purchase alternative should be preferred and vice versa.

The preference for the alternative implies that the equipment should be acquired under that
alternative. The decision-criteria from the viewpoint of the financial intermediary is based on a
comparison of the NPVs of the hire-purchase and the leasing alternatives. The finance company
would choose the financing plan with higher NPV.

Leasing Vs Hire purchase:

 Points of
Leasing Hire Purchase
Distinction
Lessor is the owner until the end of Hirer has the option of purchasing the
Ownership
the agreement asset at the end of the agreement
Duration Done for longer duration Done for a shorter duration
Depreciation Lessor claims the depreciation Hirer claims the depreciation
Payments include the principal amount
Rental payments are the cost of
Payments and the effective interest for the duration
using the asset
of the agreement
Lease rentals categorized as Only interest component is categorized
Tax Impact
expenditure by the lessee as expenditure by the hirer
The Extent of
Complete financing Partial financing
Financing
Responsibility of the lessee in the
Repairs and
financial lease, and of the lessor in Responsibility of the hirer
Maintenance
operating lease

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