2017
COMMERCE
Paper: 205
(Financial Services)
Full Marks: 80
Time: 3 hours
The figures in the margin indicate full marks for the questions
1. (a) Who are merchant bankers? Discuss about the services offered by merchant bankers to the capital market with reference to the SEBI regulation. (6+12=18)
-> A merchant banker underwrites corporate securities and provides guidelines to clients on issues like corporate mergers. The merchant banker may be in the form of a bank, a firm, company or even a proprietary concern. It is basically service banking which provides non-financial services such as arranging for funds rather than providing them.
The merchant banker understands the requirements of the business concerns and arranges finance with the help of financial institutions, banks, stock exchanges, and money market.
Regulations by SEBI on Merchant Banking
Reforms for the merchant bankers
SEBI has made the following reforms for the merchant banker
1. Multiple categories of merchant banker will be abolished and there will be only one equity merchant banker.
2. The merchant banker is allowed to perform underwriting activity. For performing portfolio manager, the merchant banker has to seek separate registration from SEBI.
3. A merchant banker cannot undertake the function of a non banking financial company, such as accepting deposits, financing others’ business, etc.
4. A merchant banker has to confine himself only to capital market activities.
Recognition by SEBI on merchant bankers
SEBI will grant recognition a merchant banker after taking into account the following aspects
1. Considering how much the merchant are professionally competent.
2. Whether they have adequate capital
3. Track record, experience and general reputation of merchant bankers.
4. Quality of staff employed by merchant bankers, their adequacy and available infrastructure are taken into account. After considering the above aspects, SEBI will grant permission for the merchant banker to start functioning.
Conditions by SEBI for merchant bankers
SEBI has laid the following conditions on the merchant bankers, for conducting their operations. They are
1. SEBI will give authorization for a merchant banker to operate for 3 years only. Without SEBI’s authorization, merchant bankers cannot operate.
2. The minimum net worth of merchant banker should be Rs. 1 crore.
3. Merchant banker has to pay authorization fee, annual fee and renewal fee.
4. All issue of shares must be managed by one authorized merchant banker. It should be the lead manager.
5. The responsibility of the lead manager will be clearly indicated by SEBI.
6. Lead managers are responsible for allotment of securities, refunds, etc.
7. Merchant banker will submit to SEBI all returns and send reports regarding the issue of shares.
8. A code of conduct for merchant bankers will be given by SEBI, which has to be followed by them.
9. Any violation by the merchant banker will lead to the revocation of authorization by SEBI.
(b) Briefly explain the following: (6×3=18)
1) New Issue Market.
-> Primary market is also known as new issue market. As in this market
securities are sold for the first time, i.e., new securities are issued
from the company. Primary capital market directly contributes in capital
formation because in primary market company goes directly to investors and
utilizes these funds for investment in buildings, plants, machinery etc.
The primary market does not include finance in the form of loan from
financial institutions because when loan is issued from financial
institution it implies converting private capital into public capital and
this process of converting private capital into public capital is called
going public. The common securities issued in primary market are equity
shares, debentures, bonds, preference shares and other
innovative securities.
Method of Floatation of Securities in Primary Market:
The securities may be issued in primary market by the following methods:
1. Public Issue through Prospectus:
Under this method company issues a prospectus to inform and attract general
public. In prospectus company provides details about the purpose for which
funds are being raised, past financial performance of the company,
background and future prospects of company. The information in the
prospectus helps the public to know about the
risk and earning potential of the company and accordingly they decide
whether to invest or not in that company Through IPO company can approach
large number of persons and can approach public at large. Sometimes
companies involve intermediaries such as bankers, brokers and underwriters
to raise capital from general public.
2. Offer for Sale:
Under this method new securities are offered to general public but not
directly by the company but by an intermediary who buys whole lot of
securities from the company. Generally the intermediaries are the firms of
brokers. So sale of securities takes place in two steps: first when the
company issues securities to the intermediary at face value and second when
intermediaries issue securities to general public at higher price to earn
profit. Under this method company is saved from the formalities and
complexities of issuing securities directly to public.
3. Private Placement:
Under this method the securities are sold by the company to an intermediary
at a fixed price and in second step intermediaries sell these securities
not to general public but to selected clients at higher price. The issuing
company issues prospectus to give details about its objectives, future
prospects so that reputed clients prefer to buy the security from
intermediary. Under this method the intermediaries issue securities to
selected clients such as UTI, LIC, General Insurance, etc. The private
placement method is a cost saving method as company is saved from the
expenses of underwriter fees, manager fees, agents’ commission, listing of
company’s name in stock exchange etc. Small and new companies prefer
private placement as they cannot afford to rise from public issue.
4. Right Issue (For Existing Companies):
This is the issue of new shares to existing shareholders. It is called
right issue because it is the pre-emptive right of shareholders that
company must offer them the new issue before subscribing to outsiders. Each
shareholder has the right to subscribe to the new shares in the proportion
of shares he already holds. A right issue is mandatory for companies under
Companies’ Act 1956. The stock exchange does not allow the existing
companies to go for new issue without giving pre-emptive rights to existing
shareholders because if new issue is directly issued to new subscribers
then the existing equity shareholders may lose their share in capital and
control of company i.e., it would water their equity. To stop this
pre-emptive or right issue is compulsory for existing company.
5. e-IPOs, (electronic Initial Public Offer):
It is the new method of issuing securities through on line system of stock
exchange. In this company has to appoint registered brokers for the purpose
of accepting applications and placing orders. The company issuing security
has to apply for listing of its securities on any exchange other than the
exchange it has offered its securities
earlier. The manager coordinates the activities through various
intermediaries connected with the issue.
2) Listing of Securities.
-> Listing means the admission of securities of a company to trading on a stock exchange. Listing is not compulsory under the Companies Act. It becomes necessary when a public limited company desires to issue shares or debentures to the public. When securities are listed in a stock exchange , the company has to comply with the requirements of the exchange .
Objectives of Listing
The major objectives of listing are
1. To provide ready marketability and liquidity of a company’s securities.
2. To provide free negotiability to stocks.
3. To protect shareholders and investors interests.
4. To provide a mechanism for effective control and supervision of trading.
Types of Listing of Securities
1. Initial listing: Here, the shares of the company are listed for the first time on a stock exchange.
2. Listing for public Issue: When a company which has listed its shares on a stock exchange comes out with a public issue.
3. Listing for Rights Issue: When the company which has already listed its shares.in the stock exchange issues securities to the existing shareholders on rights basis.
4. Listing of Bonus shares: When a listed company in a stock exchange is capitalizing its profit by issuing bonus shares to the existing shareholders.
5. Listing for merger or amalgamation: When the amalgamated company issues new shares to the shareholders of amalgamated company, such shares are listed.
Conditions for Listing
Before listing securities, a company has to fulfill the following conditions:
1. Shares of the company must be offered to the public through a prospectus and 25% of each class of securities must be offered.
2. The prospectus should clearly mention opening of subscription, receipt of application, etc.
3. The capital structure of the company should be broad-based and there should-be public interest in securities.
4. The minimum issued capital must be Rs. 3 crores of which Rs. 1.80 crores must be offered to the public.
5. There must be at least five public shareholders for every Rs. 1 lakh of fresh issue of capital and 10 shareholders for every Rs. 1 lakh of offer for sale of existing capital. On the excess application money, the company will have to pay interest from 4% to 15%, if there is delay in refund and delay should not be more than 10 weeks from the date of closure of subscription list.
6. A company with paid up capital of more than Rs. 5 crores should get itself listed in more than one stock exchange, it includes the compulsory listing on regional stock exchange.
7. The auditor or secretary of the company applying for listing should declare that the share certificates have been stamped so that shares belonging to the promoter’s quota cannot be sold or hypothecated or transferred for a period of 5 years.
8. Articles of Association of the company must have the following provisions:
- A common form of transfer shall be used
- Fully paid shares shall be used
- No lien on fully paid shares
· Calls paid in advance will not carry a right to dividend and will not be forfeited before the claim becomes time-barred.
· Option to call off shares shall be given only after sanction by the general meeting.
9. Letter of allotment, Letter of regret and letter of rights shall be issued simu1taneously.
10. Receipts for all the securities deposited, whether for registration or split and no charges will be made for the services.
11. The company will issue consolidation and renewal certificates for split certificate, letter of allotment, letter of rights and transfer, etc. when required.
12. The stock exchange should be notified by the company regarding the date of board meeting, change in the composition of board of directors, and any new issue of securities, in place of reissue of forfeited shares .
13. Closing the transfer books for the purpose of declaration of dividend, rights issue or bonus issue. And for this purpose, due notice should be given to stock exchange.
14. Annual return of the company to be filed soon after the annual general body meeting.
15. The company will have to comply with conditions imposed by the stock exchange now and then for 1istmg of security.
3) Responsibilities of Portfolio Managers.
-> A portfolio manager is a person or group of people responsible for investing a mutual, exchange traded or closed-end fund’s assets, implementing its investment strategy , and managing day-to-day portfolio trading. A portfolio manager is one of the most important factors to consider when looking at fund investing. Portfolio management can be active or passive, and historical performance records indicate that only a minority of active fund managers consistently beat the market.
General Responsibilities of a Portfolio Manager
The general responsibilities of a portfolio manager are as follows.
1. The funds of clients should be managed by portfolio managers in accordance with clients needs and direction.
2. He should act in a fiduciary capacity with regard to the client’s funds.
3. He should transact in securities within the limitations placed by the client himself with regard to dealing in securities under the provision of the Reserve Bank of India Act, 1934.
4. He should not derive any direct or indirect benefit out of the clients funds or securities.
5. He, cannot pledge or lend securities held on behalf of clients, to a third person without client’s permission.
6. It is the responsibility of a Portfolio Manager to attend to the clients complaints in a proper and timely manner. He should also ensure that proper action is taken immediately.
2. (a) Why mutual fund mechanism is considered as very useful vehicle for investment to the small investors? Explain. (10)
(b) Give an overview of mutual fund investment in India. (10)
-> A mutual fund is a way to pool money in a variety of underlying securities to pool money from investors for investment. In ratio to their investment amount, a mutual fund house issues unit of mutual funds to unit holders. The investment objectives of a mutual fund are revealed in the offer document. Profits or losses are proportionately distributed to the unit holders. Before it can collect funds from the public, mutual funds in India must be registered with the Securities and Exchanges Board of India (SEBI).
Types of Mutual Funds in India
Mutual funds are categorized into several types based on their maturity period and investment objective. In India, mutual funds are categorized on basis on the type of underlying asset.
Equity schemes: These mutual funds provide capital appreciation for individuals who focus on medium- and long-term investment horizon. According to the Security and Exchange Board of India, equity mutual fund schemes should invest at least 65 per cent of the scheme’s assets in equities and equity-related instruments. These mutual funds are usually considered high-risk, as most of the investments are focused on equity products. These mutual fund schemes are best suited for those who are open to taking a market risk, and those looking for good returns over a long-term investment horizon.
Debt schemes: If you’re someone who invests in debt mutual funds, chances are your money will be distributed in a variety of fixed income instruments such as government and corporate bonds, debt securities, as well as money market instruments. The units of the mutual fund have a fixed rate of interest which allows the investors to be aware of the returns right from the beginning. For investors who don’t want to take huge risks but want constant yields, it’s an excellent investment alternative.
Hybrid schemes: Hybrid schemes invest in a mixture of equity and debt securities. The investment is in the proportion indicated in their offer documents. These mutual funds provide both growth and regular income. It is an excellent option for investors looking for moderate growth. Usually, the investments are made in a 40:60 ratio to keep it safe. However, the equity portfolio of the fund is subject to market volatility.
In addition, mutual funds are also classified based on structure
Open-Ended Funds : Open-ended mutual schemes are continuously available for subscription and repurchase. The important thing about open-ended mutual funds is that there is no set maturity period and investors have the choice of regularly buying and selling units at net asset value (NAV). The previous performance of these funds can be monitored, enabling the investor to make a well-informed choice. These funds are an excellent choice if the investor is looking for liquidity alone.
Close-Ended Funds : A closed-end fund works like a fund traded in exchange. A limited number of units are available for purchase in a close-ended mutual fund. During the New Fund Offer (NFO) period, the units of a closed mutual fund are available to the unit holders. The investors can trade the units on their NAVs at premiums or discounts. However, the redemption of these mutual funds is only permitted after the fund’s maturity, which is typically between 3 to 7 years. These funds are a perfect choice for those investors who are not investing in short-term financial goals of a few months.
Interval Funds : These mutual funds consist of both open-ended and close-ended mutual funds. However, the units of these funds can be purchased only during particular periods, which are determined by the fund house launching the scheme. For the rest of the duration, the fund remains shut and no purchases or sale of units can be made. This operates best for investors, who in a brief span of time want a lump sum return.
Finally, mutual funds are also classified based on the types of investment strategy Growth Funds: Growth funds make up a large portion of the investment money in shares. This is a good option for investors who want to invest their surplus money and have a high risk appetite. Income Funds: These mutual funds invest the investment amount in fixed income securities such as bonds, certificates of deposits and securities among others. It is a great option for risk-averse investors who have a few years of experience in investment.
Liquid Funds: These mutual funds invest in debt instruments and money market instruments with a short tenure of up to 91 days. Each investor is allowed to invest up to Rs 10 lakhs only. The NAV of the liquid fund is calculated for 365 days, whereas the NAV of other funds is calculated only on the basis of business days.
Tax-Saving Funds: One of the most popular investment options which assist in efficient tax planning are tax saving mutual funds, otherwise known as Equity Linked Savings Scheme or ELSS. The majority of the corpus in ELSS is invested in equity. ELSS has a mandatory lock-in period of 3 years. ELSS is the only pure equity investment that offers tax benefits up to RS 1.5 lakh in a financial year under Section 80C.
Aggressive Growth Funds: These mutual funds help you make tremendous returns from equity market investments. Using a beta tool, you can gauge the movement of the fund. This fund is, however, highly vulnerable to market volatility.
Capital Protection Funds: These mutual funds invest much of the money in bonds and deposit certificates and equity balance. The fund does offer small returns, however. This scheme can give your capital full protection.
Fixed Maturity Funds: These mutual funds invest for a maturity period which is usually between 1 month to 5 years. The investment is primarily in bonds, securities, money market etc.
Pension Funds: A pension fund is a category of mutual funds that enables you to build a retirement corpus. The pooled in money is invested through the pension fund in a variety of assets. Some of India’s common pension plans are unit-linked, investing in equity and debt instruments. The government has also launched the National Pension Scheme that invests either 100% of the investment amount in government securities or 100% of the investment amount in debt securities (other than government securities), or up to 75% in equity.
Mutual funds based on the risk factor
Mutual funds are subject to various risk factors. On the basis of the level of risk involved, here are the various types of mutual funds in India:
High-risk Funds
The majority of equity plans are at high risk. These operate best for investors who want enormous yields with enormous risk appetite. These funds need to be managed actively. These mutual funds are subject to the volatility of the industry. An investor can get returns of 15%, although in some other instances most high-risk funds usually provide yields of 20% to 30%.
Medium-risk Funds
This category includes most debt mutual funds. The risk factor is average since the bulk of the investment is in debt and the remainder is in equity. The NAV isn’t so volatile compared to high-risk funds. The average yields range from 9-12 %. For investors who do not have a high-risk appetite and want constant yields, these funds are the best option.
Low-Risk Funds
If the investor is uncertain of the investment decision or the industry is in a sudden crisis, low-risk mutual funds such as liquid, ultra-short-term or arbitrage assets or a mixture of these is a good option. The yields provided are smaller compared to the other funds. However, the risk factor is very low.
Very Low-Risk Funds
These investments are not risky at all. Examples of this category of mutual funds are liquid funds and ultra-short-term funds. However, the returns from this scheme are very low. These work best when the investor needs to fulfill a short term financial goal and does not want to take a risk.
Features of Mutual Funds in India
Here are the important features of mutual funds:
· Mutual funds are actively managed by a fund manager. These managers are skilled experts who ensure that the investment goals of the investor are met. There is a thorough assessment and analysis before any investment decision is taken by the fund house. This ensures that your investment gains greater yields.
· Open-ended mutual funds allow the investors to redeem all or part of the investments to be liquidated at any moment. The redemption is done at the prevailing net asset value.
· There is always a mutual fund for everyone. With the right investment advice, it is possible to find the mutual fund suited to your investment objectives and horizon. The investor can gain maximum out of any mutual fund investment, irrespective of the investment amount.
· Most mutual funds in India invest in a wide variety of assets, which are determined based on market capitalization and the industry. It is an excellent investment avenue if an investor wants to diversify their portfolio. It is an impossible feat to actively manage investments made in a broad variety of schemes. However, professionally managed mutual funds are just the solution you need, if you are keen to test the waters.
3. (a) Discuss the importance of Venture capital financing. Why Venture capital financing service is not satisfactory in Assam? (10)
-> Importance of Venture Capital Financing
The following are the importance of venture capital financing.
1. Promotes Entrepreneurs: Just as a scientist brings out his laboratory findings to reality and makes it commercially successful, similarly, an entrepreneur converts his technical know-how to a commercially viable project with the assistance of venture capital institutions.
2. Promotes products: New products with modern technology become commercially feasible mainly due to the financial assistance of venture capital institutions.
3. Encourages customers: The financial institutions provide venture capital to their customers not as a mere financial assistance but more as a package deal which includes assistance in management, marketing, technical and others.
4. Brings out latent talent: While funding entrepreneurs, the venture capital institutions give more thrust to potential talent of the borrower which helps in the growth of the borrowing concern.
5. Promotes exports: The Venture capital institution encourages export oriented units because of which there is more foreign exchange earnings of the country.
6. As Catalyst: A venture capital institution acts as more as a catalyst in improving the financial and managerial talents of the borrowing concern. The borrowing concerns will be more keen to become self dependent and will take necessary measures to repay the loan.
7. Creates more employment opportunities: By promoting entrepreneurship, venture capital institutions are encouraging self employment and this will motivate more educated unemployed to take up new ventures which have not been attempted so far.
8. Brings financial viability: Through their assistance, the venture capital institutions not only improve the borrowing concern but create a situation whereby they can raise their own capital through the capital market. In the process they strengthen the capital market also.
9. Helps technological growth: Modern technology will be put to use in the country when financial institutions encourage business ventures with new technology.
10. Helps sick companies: Many sick companies are able to turn around after getting proper nursing from the venture capital institutions.
11. Helps development of Backward areas: By promoting industries in backward areas, venture capital institutions are responsible for the development of the backward regions and human resources.
12. Helps growth of economy: By promoting new entrepreneurs and by reviving sick units, a fillip is given to the economic growth. There will be increase in the production of consumer goods which improves the standard of living of the people.
4. (a) Make a comparative discussion on lease financing and debt financing. (10)
(b) What is Lease Agreement? Discuss about the contents of a model lease agreement. (10)
-> A lease agreement is an arrangement between two parties – lessor and lessee, by which the lessor allows the lessee the right to use a property owned or managed by the lessor for a specified period of time, in exchange for periodic payment of rentals.
The agreement does not provide ownership rights to the lessee. However, the lessor may grant permission to the lessee to modify or change the property to suit his needs. The lessee is responsible for the condition of the property during the lease period.
Lease agreements may be used for the lease of properties, vehicles, household appliances, construction equipment, and other items.
Contents of a lease agreement
Common contents of a lease agreement include:
· Names of the lessor and lessee or their agents.
- Description of the property.
· Amount of rent and due dates, grace period, late charges.
- Mode of rent payment.
· Methods to terminate the agreement prior to the expiration date and charges if any.
· Amount of security deposit and the account where it is held.
· Utilities furnished by the lessor and, if the lesser charges for such utilities, how the charge will be determined.
· Amenities and facilities on the premises which the lessee is entitled to use such as swimming pool, laundry or security systems.
· Rules and regulations such as pet rules, noise rules and penalty for violation.
· Identification of parking available, including designated parking spaces, if provided.
· How tenant repair requests are handled and procedures for emergency requests.
Terms commonly included in a lease agreement
Duration: Period for which the lease agreement will be in effect.
Rent: The consideration or payment made by the lessee to the lessor in exchange for the property leased out.
Deposits: The amount of deposit required (if any), the purpose of each deposit, and conditions for return or adjustment of deposit at the end of the lease period.
Terms of Use: The purpose for which the property is to be used and terms and conditions regarding use of the property.
Utilities: Which utilities are included in the rent, and which utilities the tenant is responsible for?
Insurance : Whether the lessee is required to ensure the property – this is most often used in commercial rental agreements.
Repairs and Maintenance: Party responsible for repairs and maintenance of the property – lessor or lessee.
5. (a) What do you mean by Credit Rating? Discuss how the credit rating mechanism can help in protecting the rights of investors in the financial market. (6+10=16)
-> Credit rating involves analysis and assessment of companies and government that issues securities for raising finance from various markets.
The credit rating agencies collects the data from various sources about the issuer of securities, the market in which issuer operates, the overall economy etc. and provides guidance to the investors in matter of credit risk associated with the securities so that the investor can take informed decisions.
Therefore, credit rating agencies are specialized institutions that evaluate the issuer of securities for raising funds and assign a rating or grade according to creditworthiness of the issuer.
Types of Credit Rating
A credit rating reflects current opinion on the relative likelihood of timely payment of interest and principal on the rated obligation. It is an unbiased, objective, and independent opinion as to the issuer’s capacity to meet its financial obligations.
The following are the common types of credit rating:
1. Sovereign credit rating: It is credit rating of a
sovereign entity, i.e., government. The sovereign credit rating indicates
the risk level of the investing environment of a country and is used by
investors looking to invest abroad.
2. Credit Rating of Real Estate Builders and Developers:
Housing and real estate form the backbone of the country’s infrastructure,
and are critical drivers of economic development. With government policies
emphasising faster economic growth, the real estate sector is attracting
large investments from both domestic and foreign investors.
Investors and customers, however, need to exercise caution in their
exposure, as the sector is largely unorganized. Recently, credit rating
agencies have started assigning rating to the builders and developers with
the objective of helping and guiding prospective real estate buyers.
National developers rating and Real estate rating are example of credit
rating provided by CRISIL.
3. Corporate Debt credit rating: The credit rating of a
corporation is a financial indicator to potential investors of debt
securities such as bonds. Credit rating is usually of a financial
instrument such as a bond, secured debt, debentures and rather than the
whole corporation.
Equity rating or IPO grading
: Equity grading is the grade assigned by a Credit Rating Agency (CRAs)
registered with SEBI, to the initial public offering (IPO) of equity shares
or any other security which may be converted into or exchanged with equity
shares at a later date.
The grade represents a relative assessment of the fundamentals of that
issue in relation to the other listed equity securities in India.
Credit rating mechanism can help in protecting the rights of investors in the financial market-
For a lender, the importance of credit rating is that it helps determine whether it’s fiscally sound decision to lend money to you. It simplifies this decision by condensing the relevant information into a single score. From the point of view of a borrower, a high score gives access to a higher loan amount more easily, along with flexibility in negotiating loan terms. Moreover, having a high score means that you don’t have to settle and can choose from several beneficial options.
For instance, when you have a score of 750 or more, you can qualify for Bajaj Finserv’s Personal Loan with ease and make use of the Flexi Loan facility . This allows you to borrow from the total loan amount that you’ve been given in parts, when you need funds, and pay interest only on the amount that you use. Moreover, you have the option of servicing the loan through EMIs comprising interest only for the duration of the tenor, and paying the principal at the end of the term.
Once you’re sure of your credit score being apt, you can also expedite loan application. You can check your pre-approved offer for a customized loan deal and get a personal loan in no time at all.
Scope:-
Here is the scope of credit rating:
For The Money Lenders
1. Better Investment Decision: No bank or money lender companies would like to give money to a risky customer. With credit rating, they get an idea about the credit worthiness of an individual or company (who is borrowing the money) and the risk factor attached with them. By evaluating this, they can make a better investment decision.
2. Safety Assured: High credit rating means an assurance about the safety of the money and that it will be paid back with interest on time.
For Borrowers
1. Easy Loan Approval: With high credit rating, you will be seen as low/no risk customer. Therefore, banks will approve your loan application easily.
2. Considerate Rate of Interest: You must be aware of the fact every bank offers loan at a particular range of interest rates. One of the major factors that determine the rate of interest on the loan you take is your credit history. Higher the credit rating, lower will the rate of interest.
6. (a) What do you mean by flow of foreign capital? Discuss the role played by Foreign Direct Investment (FDI) in the flow of foreign capital in our country. (16)
(b) Briefly explain the following: (8×2=16)
1) External Commercial Borrowing (ECB).
-> ECB, or External Commercial Borrowing as it is known in its extended form, is an instrument that helps Indian firms and organizations raise funds from outside India in foreign currencies. Indian corporate is permitted by the Indian government to raise funds using External Commercial Borrowing in an effort to help the companies expand their current capacity. External Commercial Borrowing can also be used to bring in fresh investments.
The sources similar to ECBs include Foreign Currency Convertible Bonds (FCCBs) and Foreign Currency Exchangeable Bonds (FCEBs). While the main purpose for the issuance of FCCBs is to raise capital, External Commercial Borrowing is applicable to commercial loans that can include securitized instruments, bank loans, suppliers’ credit, buyers’ credit, and bonds that are availed from lenders that are not Indian residents. The minimum maturity of these instruments, on average, is three years.
Benefits of External Commercial Borrowing
The following are some of the main benefits of raising funds using ECB:
· The value of funds is generally lower when borrowed from external sources. For instance, there are economies that have a lower interest rate, and Indian firms and organizations can borrow money at lower interest rates from the Eurozone and the United States as the rates are comparatively low.
· Since the markets are larger when raising funds through ECB, companies can meet larger requirements from international players in comparison with what can be achieved through domestic players.
· External Commercial Borrowing is basically just a way to take a loan. It does not necessarily have to be of equity nature, and therefore the company’s stakes will not be diluted. Borrowers can essentially raise funds without relinquishing control as debtors will not have any voting rights in the company.
· The investor base can be diversified by the borrower.
· ECB offers access to global markets so that borrowers have greater exposure to worldwide opportunities.
· ECB offers benefits to the economy as well. Inflows can be directed into the sector by the government of India, thereby increasing its potential for growth. For instance, a greater percentage of funding through ECB can be allowed by the government for the SME and infrastructure industry. This aids significantly in the overall growth of the country.
· Companies can become increasingly profitable through ECB.
Disadvantages of External Commercial Borrowing
The following are the main disadvantages of raising funds through ECB:
· The company could develop a lax attitude as the funds are available at lower rates. Companies could borrow excessively due to this and it could eventually lead to higher debt on the company’s balance sheet, thereby adversely affecting financial ratios.
· Rating agencies see companies with higher debt on their balance sheets in a negative light, which could lead to a potential downgrade of such companies. Eventually, this could enhance the company’s cost of debt, thereby destroying the image of the company in the market. Furthermore, the shares of the company could also be subject to a decline in market value over a period of time.
· Considering the fact that raising funds through External Commercial Borrowing is done in foreign currencies, the principal as well as the interest will have to be paid in foreign currencies. As such, the company is exposed to risks associated with exchange rates. Hedging costs may have to be incurred by the company, thereby leading the company to incur heavy losses.
2) Foreign Portfolio Investors (FPIs).
-> Foreign Portfolio Investment (FPI) involves an investor buying foreign financial assets. It involves an array of financial assets like fixed deposits, stocks, and mutual funds. All the investments are passively held by the investors. Investors who invest in foreign portfolios are known as Foreign Portfolio Investors.
Foreign Portfolios increase the volatility. As a result, it leads to increased risk. The intent of investing in foreign markets is to diversify the portfolio and get some handsome return on investments. Investors expect to receive high returns owing to the risk they’re willing to take. Foreign Portfolio Investment is a prominent investment alternative nowadays. From individuals and businesses to even Governments invest in Foreign Portfolios.
This article will take you through the benefits of foreign portfolio investment, categories of foreign portfolio investment, criteria of FPI, and various risks associated with it.
Benefits:-
1. Investment Diversity
FPI provides investors an opportunity to diversify their portfolio. As an investor, you can diversify your portfolio to achieve high returns. Suppose if you incur major losses in investment assets of a Country X, you can accrue profits in investment assets of a country Y. In this way, you can experience less volatility in your investments and increase chances of profits.
2. International Credit
Investors can get access to increased amounts of credit in foreign countries. They can broaden their credit base. By expanding their credit base, investors can secure their line of credit. In case the domestic credit score is unfavourable, having an international credit score can be beneficial. This allows the investor to utilize more leverage and get high returns on equity investment.
3. Access to a Bigger Market
Sometimes, foreign market can be less competitive than the domestic market. Hence, FPI gives you an exposure to a wider market. The foreign markets are comparatively less saturated and hence, they may offer higher returns and more diversity as well.
High Liquidity
Foreign Portfolio Investments provides high liquidity. An investor can buy and sell foreign portfolios seamlessly. This offers buying power for investors to act when good buy opportunities arise. Investors can buy and sell trades in a quick and seamless manner.
4. Exchange Rate Benefit
An investor can leverage the dynamic nature of international currencies. Some currencies can drastically rise or fall and a strong currency can be used in investor’s favor.
Categories in Foreign portfolio investment:-
One can register FPI in one of the below categories:
· Category I: This includes investors from the Government sector. Such as central banks, Governmental agencies, and international or multilateral organizations or agencies.
· Category II: This category includes :
· Regulated broad-based funds such as mutual funds, investment trusts, insurance/reinsurance companies.-
· Also include regulated banks, asset management companies, portfolio managers, investment advisors, and managers.
· Category III: It includes those who are not eligible in the first two categories. It includes endowments, charitable societies, charitable trusts, foundations, corporate bodies, trusts, individuals.
