Financial Services Long Answer Type Questions

Question 1.
Give a detailed explanation of lease finance.
Answer:
State the features of leasing:

The lessee (customer or borrower) will select an asset (equipment, vehicle, software)
The lessor (finance company) will purchase that asset
The lessee will have use of that asset during the lease
The lessee will pay a series of rentals or instalments for the use of that asset
The lessor will recover a large part or all of the cost of the asset plus earn interest from the rentals paid by the lessee
The lessee has the option to acquire ownership of the asset (e.g. paying the last rental, or bargain option purchase price)
The finance company is the legal owner of the asset during duration of the lease.

Question 2.
State the features of financial leasing.
Answer:

Asset finance (leasing and hire purchase) is a very flexible way of raising funds. The advantages include:
Assets and capital equipment can be paid for from the revenue they earn.
Rates can be as competitive, or even better, than bank funding rates because of the security provided by the asset.
Longer-term and more flexible options than many bank loans, typically 3 to 5 years.
It is generally non-cancellable by the lessor, providing certainty to businesses.
Asset finance offers real value to businesses with limited capital, or those that need to manage their cash flow.
It is highly accessible, as it is secured – largely or entirely – on the asset being financed.
In a recession, leasing is particularly well positioned to help businesses when most have low taxable profits.
Depending on the situation, companies may benefit from tax advantages.

Question 3.
What is venture capital? Explain the features of venture capital.
Answer:
Venture capital is long-term risk capital to finance high technology projects which involve risk but at the same time has strong potential for growth. Venture capitalist pools their resources including managerial abilities to assist new entrepreneur in the early years of the project. Once the project reaches the stage of profitability, they sell their equity holdings at high premium.

Features of venture capital:

The venture capitalist participates in the entrepreneur’s business through direct purchase of shares, options or convertible shares.
The objectives of the venture capitalist are to make capital gains by selling off the investment once the enterprise becomes profitable.
The venture capital firm (VCF) is inclined to assume a high degree of risk to make capital gains.
Venture financing is a long-term illiquid investment where investment can be liquidated in the assisted firm only after a long-period, say 4-8 years.
The financial burden of the assisted firm tends to be negligible during the first few years.
The VCF, in addition to providing funds, takes an active interest in guiding the firm in various ways and supports the entrepreneur through all the stages of the company’s development – monetarily and non-monetarily.

Question 4.
Explain the different types of factoring.
Answer:
The different types of Factoring are as follows:
For International Trade:

Full Factoring
Recourse Factoring
Maturity Factoring
Advance Factoring
Undisclosed Factoring
Invoice Discounting
Bulk Factoring
Agency Factoring

A. Domestic Factoring:
→ Factoring can be both domestic and for exports. In domestic Factoring, the client sells goods and services to the customer and delivers the invoices, order, etc., to the Factor and informs the customer of the same.

→ In return, the Factor makes a cash advance and forwards a statement to the client. The Factor then sends a copy of all the statements of accounts, remittances, receipts, etc., to the customer. On receiving them the customer sends the payment to the Factor.

Different types of Domestic Factoring are as follows:
(a) Full Factoring: This is also known as “Without Recourse Factoring” . It is the most comprehensive type of facility offering all types of services namely finance sales ledger administration, collection, debt protection and customer information.

(b) Recourse Factoring: The Factoring provides all types of facilities except debt protection. This type of service is offered in India. As discussed earlier, under Recourse Factoring, the client’s liability to Factor is hot discharged until the customer pays in full.

(c) Maturity Factoring: It is also known as “Collection Factoring”. Under this arrangement, except pro-viding finance, all other basic characteristics of Factoring are present. The payment is effected to the client at the end of collection period or the day of collecting accounts which-ever is earlier.

(d) Advance Factoring:
This could be with or without recourse. Under this arrangement, the Factor pro-vides advance at an agreed rate of interest to the client on uncollected and non-due receivables. This is only a pre-payment and not an advance. Under this method, the customer is not notified about the arrangement between the client and.the Factor. Hence the buyer is unaware of factoring arrangement. Debt collection is organized by the client who makes payment of each invoice to the Factor, if ad-vance payment had been received earlier.

(e) Invoice Discounting:
In this arrangement, the only facility provided by the Factor is finance. In this method the client is a reputed company who would like to deal with its customers directly, including collection, and keep this Factoring arrangement confidential. The client collects pay-ments from customer and hands it over to Factor. The risk involved in invoice discounting is much higher than in any other methods. The Factor has liberty to convert the facility by notifying all the clients to protect his interest. This service is becoming quite popular in Europe and nearly one third of Factoring business comprises this facility.

(f) Bulk Factoring:
It is a modified version of Involve discounting wherein notification of assignment of debts is given to the customers. However, the client is subject to full recourse and he carries out his own administration and collection.

(g) Agency Factoring:
Under this arrangement, the facilities of finance and protection against bad debts are provided by the Factor whereas the sales ledger administration and collection of debts are carried out by the client.

Question 5.
Explain briefly the various types of venture capital.
Answer:
There are several types of venture capital that are extremely crucial in the context of the modern day business world. The types of venture capital are classified as per the purpose and time of their application. The 3 principal types of venture capital are early stage financing, expansion financing and acquisition/buyout financing.
(a) Early Stage Financing:
Early stage financing has three sub divisions – seed financing, start up financing and first stage financing. Seed financing is basically a small amount that an entrepreneur receives for the purpose of being eligible for a start up loan. Start up financing is given to companies for the purpose of finishing the development of products and services. However, this type of venture capital may also be used for initial marketing as well. Companies that have spent all their starting capital and need finance for beginning business activities at the full-scale are the major beneficiaries of the First Stage Financing.

(b) Expansion Financing:
Expansion financing may be categorized into second-stage financing, bridge financing and third stage financing or mezzanine financing. Second-stage financing is provided to companies for the purpose of beginning their expansion. Second-stage financing is also known as mezzanine financing. It is provided basically for the purpose of assisting a particular company to expand in a major way. Bridge financing is useful in many ways. It may be provided as a short term interest only finance option as well as a form of monetary assistance to companies that employ the Initial Public Offers as a major business strategy.

(c) Acquisition or Buyout Financing:
Acquisition or buyout financing is categorized into acquisition finance and management or leveraged buyout financing. Acquisition financing assists a company to acquire certain parts or an entire company. Management or leveraged buyout financing helps a particular management group to obtain a particular product of another company.

Question 6.
State the objectives of financial services.
Answer:
Financial Intermediation: The financial service industry facilitates the function of intermediation between savers and investors by providing a means and a medium of exchange and by undertaking innumerable services.

State the objectives of financial services:
(a) Fund raising: Financial services help to raise the required funds from a host of investors, individuals, institution and corporate. For this purpose, various instruments of finance are used.

(b) Funds deployment: An array of financial services is available in the financial markets which help the players to ensure an effective deployment of funds raised. Services such as bill discounting, parking of short-term funds in the money market, credit rating &securitization of debts are provided by financial services firms in order to ensure efficient management of funds.

(c) Specialized services: The financial service sector provides specialized services such as credit rating, venture capital financing lease financing, mutual funds, credit cards, housing finance, etc besides banking and insurance. Institutions and agencies such as stock exchanges, non-banking finance companies, subsidiaries of financial institutions, banks & insurance companies also provide these services.

(d) Regulation: There are agencies that are involved in the regulation of the financial services activities. In India, agencies such as the Securities and Exchange Board of India (SEBI), Reserve Bank of India (RBI) and the Department of Banking and Insurance of the Government of India, regulate the functioning of the financial service institutions.

(e) Economic growth: Financial services contribute, in good measure, to speeding up the process of economic growth & development.

Question 7.
Explain the various types of fund based financial services offered by banks.
Answer:
(a) Working Capital Finance:
Bank offer working capital facilities – both fund-based and fee-based. Fund- based working capital products include cash credit, overdraft, bill discounting, short-term loans, export financing (pre-shipment as well as post-shipment). Fee based facilities include letters of credit and bank guarantees. Working Capital facilities are provided to finance the day-to-day business requirements. Funding requirements are structured to finance procurement of raw materials/stores and payment towards manufacturing costs and other overheads. Sales are financed against sundry debtors/ receivables. The Bank offers a combination of operative cash credit and working capital demand loan to meet the domestic working capital requirements of our clients.

(b) Short Term Finance:
The Bank offers short-term loans for a period ranging from 3 months to 12 months to sound corporate for meeting their specific short-term working capital requirements. The funds are provided with interest rates either linked to our BPLR or at a fixed rate with varying repayment patterns.

(c) Bill Discounting:
This product enables corporate to fund their operating cycle right from the stage of procurement to sale. Bill Financing is extended by Induslnd Bank to its clients at competitive rates. Letter of credit backed bill discounting and clean bill discounting are the convenient mode of financing for domestic trade transactions. BOE could be broadly classified into Demand and Usance bills and are further classified into clean and documentary bills.

(d) Export Finance:
As an important incentive to the exporters community for boosting exports, financial assistance in Rupees is extended to exporters on priority basis on relatively liberal terms. Such finance is provided both at pre-shipment stage (as working capital finance) and at post-shipment stage (to bridge the time lag between the shipment of goods and the realization of proceeds). Interest charged on export credit is exempted from the purview of interest tax.

(e) Term Lending:
We offer term loans to both Industrial as well as Infrastructure sectors promoted by strong business houses. These loans are for a period of 3-5 years with a moratorium period. Interest rates could be fixed or floating linked to the bank’s BPLR.

(f) Buyer’s Credit / Supplier’s Credit:
This facility provides total flexibility to corporate to utilise the line (sanctioned limit) of credit. The terms of the line of credit are either predetermined or negotiated at the time of availment. This facility is used as and when the client has a requirement.

Question 8.
Explain the important financial services.
Answer:
The important financial services are:

Underwriting of shares.
Secondary market activities.
Equipment leasing.
Arranging capital issues.
Project advisory services.
Assisting mergers and acquisitions.
Guidance in capital restricting.
Debenture trustee services.
Financial collaboration service.
Recommending changes in management structure.
Rehabilitating and restricting sick companies.
Portfolio management.
Capital market services such as registration and transfers, clearing services, collection of income on securities, safe custody of securities, etc.
Advice to client on best source of funds and cost of capital.

Question 9.
Explain the any five important financial services.
Answer:
The five important financial services are explained below:
(i) Underwriting services:
Underwriting is an agreement whereby underwriter promises to subscribe to a specified number of shares or debentures or a specified amount of stock in the event of public not subscribing to the issue. If the issue is fully subscribed then there is no liability for the underwriter. If a part of shares remain unsold, the underwriter will buy the shares. Thus, underwriting is a guarantee for the marketability of shares.

(ii) Factoring services:
Factoring refers to the process of managing the sales ledger of a client by a financial service company. It is an arrangement under which a financial intermediary assumes the credit risk in the collection of book debts for its client.

(iii) Custodial services:
Under custodial services, a financial intermediary mainly provides services to clients, particularly to foreign investors, for a prescribed fee. It involves providing agency services like safe keeping of shares and debentures, collection of interest and dividend etc.

(iv) Mutual Fund;
A mutual fund is a financial service organization that receives money from shareholders, invest it, earns returns on it, attempts to make it grow and agrees to pay the share holders cash on demand for the current value of his investment. The fund provides investment avenues for small investors who cannot participate in the equities of big companies.

(v) Leasing services:
A lease is an agreement under which a company or a firm requires a right to make use of a capital assets like machinery, on payment of a prescribed fee called ‘rental charges’ Under this system, the lessee cannot acquire any ownership to the asset, but he can use it and have full control over it. the lease is also expected to pay for all maintenance charges and repairing the operating costs.

Question 10.
Explain the advantages and disadvantages of factoring.
Answer:
Advantages of factoring:

Factoring is a way to finance requirement of working capital of the company in respect of receivables.
It provides a large and quick increase in cash flow of the business.
Due to existence of many factoring companies prices are usually competitive.
It is a cost effective way, of outsourcing your sales ledger at the same time managing your business.
Factoring firms are specialized in their field thus the company might get useful information about the creditworthiness of its customers.
Protection from bad debts if non-recourse factoring is chosen.
Factors check the credibility of company’s customers which help business trade with better quality customers.

Disadvantages of factoring:
(a) Cost : Factoring is a costly mean of financing as the cash price of the invoices is discounted by the factor company, the upfront cash price being usually 70-90% of the face value, depending on the credit history of the customers and the nature of selling company’s business which reduces the profit margin of the selling company.

(b) Selling company gets locked in to the relationship with the factor as they rely completely on the services of a factor because of the cash flow implications of any arrangements.

(c) Possible harm to the customer: Selling company fully gives the charge of collecting invoice to the factoring company and pays more attention on money collection methods which impairs company’s relationship with their customers.

(d) Company image distortion: In the past, factoring was considered a sign on the financial difficulties of the company. However in recent times this perception has changed and it has considered a normal way of doing business.

(e) Impose constrains the way of doing business: In the case of non-recourse factoring the factoring company pre-approve the selling company’s customers, which cause delay in placing new orders. Also the factoring company applies its credit limits to individual customers and will apply credit limits to individual customers.

(f) The selling company may have to pay extra to remove its liability for bad debtors.

(g) Some customers might want to deal directly with the selling company instead of dealing with factor.