Model Answer. M.Com IV Semester. Financial market and financial services. Paper code- AS 2384

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1 Model Answer M.Com IV Semester Financial market and financial services Paper code- AS (I) Money Market is a market for short term loans or financial assets. As the name implies it does not deal with cash or money but deals with near substitute for money or near money like trade bills, promissory notes and Govt. papers having maturity for a period less than one year. Composition of Money market: Call Money market Commercial bills market Acceptance market Treasury bill market (II) Four terms and conditions included in factoring agreement are as follows: Assignment of debt in favor of the factor Selling limits for the client Limits of any overdraft facility and rate of interest to be charged Details regarding payment to the factor (III) Marketable financial asset are those asset which can be easily transferred from one person to another like shares, bonds of PSUs etc. Non Marketable financial asset are those asset which cannot be easily transferred from one person to another like bank deposits, Provident fund, pension schemes etc. (IV) Financial market is a place where buying and selling of financial assets takes place. It also refers to the centers and arrangement which facilitates buying and selling of financial assets. Classifications of financial market are as follows (i) Unorganized Markets like Chit funds, Indigenous banker etc. (ii) Organized Markets like Capital Market, Money market etc.

2 (V) Two role financial system in economic development are as follows: (i) Mobilization of saving (ii) Creation of credt Brief explanation required (VI) Treasury bills are nothing but promissory note issued by government generally at discount payable at maturity. Here govt. promises to pay a certain sum at end of the maturity to the bearer of the instrument. Types of Treasury bills are as follows (i) Ordinary Bills (ii) Ad-Hoc Treasury bills. On the basis of period (i) 91 days (ii) 182 days (iii) 364 days. (VII) Two promotional role of development banking in India (i) Entrepreneurial Development Programmes Industrial development of a country is directly influenced by the quality of entrepreneurs it has produced, with a view to impart requisite training to entrepreneurs. IDBI has been encouraging entrepreneurial development programmes. It has mainly used the agency of TCO s for drawing up and conducting these programmes to cater to the needs of entrepreneurs from small and medium scale sectors. IDBI meets up to 50 per cent of the cost of such programmes and the balance cost is met by state governments or other sponsoring institutions. (ii) Technological Improvements Development banks, especially IDBI have been helping small and medium sectors in developing and upgrading of their technology so that they arc able to match the pace of development. These banks also encourage entrepreneurs to adopt sophisticated technology with the help of academic and research institutes and also to encourage entrepreneurship among science and technology graduates.

3 (VIII) Two benefits of securitization Greater profitability Securitization helps financial institutions to get liquid cash from medium term and long term assets immediately rather than over a longer period. Enhancement of capital adequacy ratio Securitization enables financial institutions to enhance their capital adequacy ratio by reducing their assets volume. (Ix) Factoring and forfeiting Factoring is much broader than forfaiting which includes administration of sales ledger, credit risk and many more. Factoring is used for short term financing where as forfeiting is used for medium and long term financing. Factoring is used in case of both import and export transactions where as forfeiting is used in case of export. The theme of factoring is purchase of invoice while the theme of forfaiting is purchase of export bills. (X) Reverse Repo Rate Reverse repo rate is the rate at which the central bank of a country (Reserve Bank of India in case of India) borrows money from commercial banks within the country. It is a monetary policy instrument which can be used to control the money supply in the country. Description: An increase in the reverse repo rate will decrease the money supply and vice-versa, other things remaining constant. An increase in reverse repo rate means that commercial banks will get more incentives to park their funds with the RBI, thereby decreasing the supply of money in the market.

4 Long Answer type questions: 2. In this answer students are expected to write a brief explanation and then they have to explain following points (a) Lack of co-ordination between different financial institutions (b) Monopolistic Market structures (c) Dominance of development banks in industrial financing (d) Inactive and erratic capital market (e) Imprudent financial practice 3. In this answer students are expected to give brief explanation about development banking including its meaning. Then the background and developments are needed to be explained. This should give special reference to the following IDBI NABARD EXIM Housing development banks 4. Liquidity Adjustment facility A tool used in monetary policy that allows banks to borrow money through repurchase agreements. This arrangement allows banks to respond to liquidity pressures and is used by governments to assure basic stability in the financial markets. LAF is used to aid banks in adjusting the day to day mismatches in liquidity.laf consists of repo and reverse repo operations. Repo or repurchase option is a collaterised lending i.e. banks borrow money from Reserve bank of India to meet short term needs by selling securities to RBI with an agreement to repurchase the same at predetermined rate and date. The rate charged by RBI for this transaction is called the repo rate. Repo operations therefore inject liquidity into the system. Reverse repo operation is when RBI borrows money from banks by lending securities. The interest rate paid by RBI is in this case is called the reverse repo rate. Reverse repo operation therefore absorbs the liquidity in the system. The collateral used for repo and reverse repo operations are Government of India securities. Oil bonds have been also suggested to be included as collateral for Liquidity adjustment facility. Liquidity adjustment facility has emerged as the principal operating

5 instrument for modulating short term liquidity in the economy. Repo rate has become the key policy rate which signals the monetary policy stance of the economy. Along with above introduction students are expected to explain CRR, SLR, Bank rate, Repo rate and Reverse repo rate. 5. (a) Government securities market: In this answer the students are required to write a paragraph explaining briefly about Govt. securities market. The hint about the paragraph is given below: It is also known as gilt edged securities market. It is a market where govt. securities are traded. In Indian there are many types of Govt. securities-short term and long term. Long term securities are traded in this market while short term, are traded in money market. These securities are issued by Central or state govt., semi Govt. authorities like city corporations, port trusts etc. these securities are issued in denomination of Rs.100 and interest is payable half yearly. The Govt. securities are in many forms like Stock certificates Promissory notes Bearer bonds. (b) Commercial paper market: In this answer the students are required to write a paragraph explaining briefly about Commercial paper market. The hint about the paragraph is given below: A commercial paper is one which arises out of a genuine trade transaction, i.e. credit transaction. As soon as goods are sold on credit, the seller draws a bill on the buyer for the amount due. The buyer accepts it immediately agreeing to pay the amount mentioned therein after a certain specified date. Types of bills traded in market are Demand and usance bills Clean bills and documentary bills Inland and foreign bills Export and import bills Indigenous bills Accommodation and supply bills

6 Advantages: Liquidity Self liquidating and negotiable instrument Certainty of payment Ideal investment Simple legal remedy Central bank control Drawbacks of this market Absence of bill culture Stamp duty Absence of secondary market Limited foreign trade Attitude of banks Absence of acceptance services 6. Steps should be taken while evaluating a project are given as follows: Technical appraisal (a) Technical arrangement (b) Size of plant (c) Product mix (d) Selection of plant and equipment (e) Manufacturing evaluation (f) Cost evaluation (g) Location of the project Commercial Appraisal (a) Demand analysis (b) Supply Analysis Finance appraisal (a) Sources of finance (b) Ratio analysis (c) Discounted cash flow techniques

7 (d) BEP analysis Appraisal of management Environment appraisal Brief explanation to above points are required 7. NBFCs constitute an important segment of financial system. These are the financial institution or intermediaries engaged primarily in the business of accepting deposits and delivering credit. They play an important role in channelizing the scarce financial resources to capital formation. NBFCs supplement the role of banking in meeting the increasing financial needs of the corporate sector, delivering credit to the unorganized sector and to small, local borrowers. They have more flexible structure than banks. Types of NBFCs Asset Finance company Investment company Loan company Growth of NBFCs In India NBFCs have existed since long. They came into lime light in the second half of the 1980s and in the first half of the 1990s. NBFCs flourished during stock market boom of the early 1990s. Guidelines: In this students are required to give highlights of RBI guidelines for NBFCs. Problems and Prospects of NBFCs Problems No debt recovery tribunal High borrowing rate Service tax to hire purchase, lease Prospects Wealth management Provide loans & credit Trading money market instrument Funding private education

8 Underwriting stocks and shares Retirement planning Discount services Advise companies in merger and acquisition Explanation to above points are required 8. Securitisation It is a process of liquidating long term illiquid assets like loans & receivables of any financial institution or banks by issuing a marketable security against them. Advantages Alternative sources of funds More profitable Risk management Enhancement of capital adequacy ratio Spreading credit risk Provision of multiple instruments Higher rate of return Cheaper source of finance Prevention of idle capital Causes for the unpopularity of securitization in India New concept Difficulty in assignments of debts Lack of knowledge Lengthy process High stamp duty Absence of proper guidance Absence of proper accounting.

9 Factoring Factoring is a method of financing whereby a company sells its trade debts at a discount to a financial institution. In other words factoring is a continuous arrangement between a financial institution and a company which sells goods and services to trade customers on credit. Terms and conditions included in factoring agreement are as follows: Assignment of debt in favor of the factor Selling limits for the client Limits of any overdraft facility and rate of interest to be charged Details regarding payment to the factor Interest to be allowed to the factor on the account where credit has been sanctioned to the supplier Functions Purchase and collection of debts Credit investigation and underwriting of credit risk Provision of finance Rendering consultancy services Types of Factoring Full service factoring With recourse factoring Maturity factoring International factoring Invoice factoring Bulk factoring Prepared By: Gnyana Ranjan Bal Assistant Professor Dept. of Commerce GGV (Bilaspur)