Financial Services Short Answer Type Questions

Question 1.
Explain the features of financial services.
Answer:
Like any other service, financial services are characterized by the following:
(a) Intangibility:
The basic characteristics of financial services are that they are intangible in nature. For financial services to be successfully created and marketed, the institutions providing them must have a good image and the confidence of its clients. Quality and innovativeness of services are the focal points for building credibility and gaining the trust of the clients.

(b) Customer Orientation:
The institutions providing financial services study the needs of the customers in detail. Based On the results of the study, they come out with innovative financial strategies that give due regard to costs, liquidity, and maturity considerations for various financial products. This way, financial services are customer – oriented.

(c) inseparability:
The functions of producing and supplying financial services have to be carried out simultaneously. This case for a perfect understanding between the financial services firms and their clients.

(d) Perishability:
Financial services have to be created and delivered to the target clients. They cannot be stored. They have to be supplied according to the requirements of customers. Hence, it is imperative that the providers of financial services ensure a match between demand and supply.

(e) Dynamism:
The financial services must be dynamic. They have to be constantly redefined and refined. On the basis of socio-economic changes occurring in the economy, such as disposable income, standard of living, level of education, etc. Financial services institutions must be proactive in nature and evolve new. services by visualizing the expectations of the market

Question 2.
What are the importances of financial services?
Answer:
(a) Economic Growth:
The financial service industry mobilizes the savings of the people and channels them into productive investment by providing various services to the people. In fact, the economic development of a nation depends upon these savings and investment.

(b) Promotion of Savings:
The financial service industry promotes savings in the country by providing transformation services. It provides liability, asset and size transformation service by providing large loans on the basis of numerous small deposits. It also provides maturity transformation services by offering short-term claim to savers on their liquid deposit and providing long-term loans to borrowers.

(c) Capital Formation:
The financial service industry facilitates capital formation by rendering various capital market intermediary services ± capital formation in the very basis for economic growth. It is the principal mobilize, of surplus funds to finance productive activities and thus it promotes capital accumulation.

(d) Provision of Liquidity:
The financial service industry promotes liquidity in the system by allocating and reallocating savings and investment into various avenues of economic activity. It facilitates easy conversion of financial asset into liquid cash at the discretion of the holder of such assets.

(e) 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.

(f) Contribution to GNP:
The contribution of financial services to GNP has been going on increasing year after year in almost all countries in recent times.

(g) Creation of Employment Opportunities:
The financial service industry creates and provides employment opportunities to millions of people all over the world.

Question 3.
Explain the features of venture capital.
Answer:
The terms and conditions on which venture capital is provided are not standardized, the following are the main 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.
What is the eligibility for venture capital financing?
Answer:
According to Government of India guidelines, the following enterprises are eligible for venture capital financing:
(a) Size:
Total investment should not exceed Rs, 100 million.

(b) Technology:
New or relatively untried or very closely held or being taken from pilot to commercial stage or incorporating some significant improvement over the existing ones in India.

(c) Entrepreneur:
Relatively new, professionally or technically qualified persons with inadequate resources or backing to finance the project. Venture capital excludes financing of enterprises engaged in trading, broking, and investment of financing services, and agency or liaison work. A venture capital Firm in India is required to invest at least 75 percent of its funds in venture: capital activity, and must be managed by professionals.

Question 5.
What are the advantages and disadvantages of housing finance?
Answer:
Housing finance service is financial service provided by commercial works and housing finance companies to people who wish to acquire or construct houses for their residence housing finance also covers finance for the acquisition or development of plots or lands for construction of houses.

Advantages of housing finance:

  • Housing finance helps the middle and low incomes groups to have their own houses easily.
  • The cost of housing finance is not very high.
  • There is also the advantage of convenient repayment of housing loans provided by the housing finance companies.

Disadvantages of housing finance:

  • The cost of housing finance is unreasonable in many cases.
  • The procedure for obtaining housing finance is though
  • The methods of recovering of housing finance adopted by many housing finance providers are not fair.

Question 6.
What are the advantages and disadvantages of vehicle finance services?
Answer:
Many commercial banks and finance companies provide vehicle loans to persons who wish to buy vehicles like carstmotor bikes, scooters etc.

Advantages of vehicle finance:

  • Vehicle loans help middle income groups and salaried people to own vehicle without having funds in their hands for the same.
  • The cost of vehicles loans are not very high
  • There is also the advantages of convenient repayment of vehicle loans

Disadvantages of vehicle finance:

  • The cost of vehicle loans is very high in many cases
  • The procedures for obtaining is too laborious

Question 7.
Explain the various types of leases.
Answer:
There are two main types of lease: Finance Leases and Operating Leases.
(a) Financial leases:
Under a finance lease, the finance company owns the asset throughout and the agreement covers a set period – considered to be the full economic life of the asset. Often, there is an option to continue leasing at a reduced, or ‘peppercorn’ rate, at the end of the contracted period. As we are not the owner of the asset, you cannot sell the asset during the rental period. The. finance company can claim the writing-down allowances and pass this benefit to you in reduced rentals.

(b) Operating leases:
An operating lease runs for less than the full economic life of the asset, and the lessee is not liable for the financing of its full value. The lessor carries the risk associated with the residual value of the asset at the end of the lease. This type of lease is often used when the asset is likely to have a resale value, for example, aircraft and vehicles.

The customer gets the use of the asset, sometimes along with other services. Operating leases are particularly attractive to companies that frequently update or replace equipment and want to use equipment without ownership. The most common form of operating lease in motor finance is contract hire, particularly in the provision of vehicle fleets.

Question 8.
Define factoring. State the characteristics of factoring.
Answer:
Definition of factoring is very simple and can be defined as the conversion of credit sales into cash. Here, a financial institution which is usually a bank buys the accounts receivable of a company usually a client and then pays up to 80% of the amount immediately on agreement. The remaining amount is paid to the client when the customer pays the debt. Examples includes factoring against goods purchased, factoring against medical insurance, factoring for construction services etc.

Characteristics of Factoring:

  • The normal period of factoring is 90-150 days and rarely exceeds more than 150 days.
  • It is costly.
  • Factoring is not possible in case of bad debts.
  • Credit rating is not mandatory.
  • It is a method of off balance sheet financing.
  • Cost of factoring is always equal to finance cost plus operating cost.

Question 9.
Explain the various types of international factoring.
Answer:
Types of International Factoring:
The following are the important types of International Factoring. The client can choose any type of international factoring depending upon exporter – client needs and his price bearing capacity.

Two Factor Systems:
his is the most common system of international factoring and involves four parties i.e., Exporter, Importer, Export Factor in exporter’s country and Import Factor in Importer’s country.
The functions of the export Factor are:

  • Assessment of the financial strength of the exporter
  • Prepayment to the exporter
  • Follow-up with the Import Factor
  • Sharing of commission with the import Factor

The functions of the Import Factor are:

  • Maintaining the books of the exporter in respect of sales to the debtors in his country
  • Collection of debts from the importer and remitting the proceeds to the exporter’s Factor
  • Providing credit protection in case of financial inability on the part of any of the debtors

Single / Direct Factoring System:
In this system, a special agreement is signed between two Factoring companies for single Factoring. Whereas in Two Factor System, credit is provided by import Factor and pre-payment, book keeping and collection responsibilities remain with export Factor. For this system to be effective there should be strong co-ordination and co-operation between two Factoring companies. Pricing is lower when compared to Two Factor System.
(a) Direct Export Factoring:
Here only one Factoring company is involved, i.e., export Factor, which provides all services including finance to the exporter.

(b) Direct Import Factoring:
Under this system, the seller chooses to work directly with Factor of the importing country. The Factoring agreement is executed between the exporter and the import Factor. The import Factor is responsible for sales ledger administration, collection of debts and providing bad debt protection up to the agreed level of risk cover.

(c) Back to Back Factoring:
It is a very specialized form of International Factoring, used when suppliers are selling large volumes to a few debtors for which it is difficult to cover the credit risk in International Factoring. In this case, International Factor can sign a domestic Factoring agreement with the debtor whereby it will be getting the receivables as security for the credit risk taken in favour of Export Facto

Question 10.
Distinguish between factoring and bill discounting.
Answer:
Though both factoring and bill discounting provides short term finance, however in bill discounting the drawer undertakes the responsibility of collecting the bills and pay the proceeds while in factoring it is the factor that usually undertakes the responsibility of collecting the bills. Given below are some more differences between the two –
(a) Bill discounting is always of recourse type while factoring can be either with or without recourse. In case of recourse the factor does not assume the credit risk and it is the company which assumes the credit risk.

(b) Factoring is an off balance sheet entry in the sense that both amount of receivables and bank credit are not shown in the balance sheet which is not the case with the bill discounting which is shown in the balance sheet.

(c) In bill discounting there is only provision of finance while in factoring factor provides in addition to finance facility other facilities like- sales ledger maintenance, collection etc..

(d) Discounted bills may be re-discounted several times before they mature for payment which is not the case with factoring.

Question 11.
What is financial services? State the components of financial services.
Answer:
Financial services refers to services provided by the financial institutions in a financial system. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are Asset Management Companies like leasing companies, merchant bankers and Liability Management Companies like discounting houses and acceptance houses, and further general financial institutions like banks, credit card companies, insurance companies, consumer finance companies, stock exchanges, and some government sponsored enterprises. The term ‘Financial Services’ in a broad sense means “mobilising and allocating savings.” Thus, it includes all activities involved in the transformation of savings into investment.

Following are some of the examples of financial services:

  • Leasing, credit card services, factoring, portfolio management and financial consultancy services.
  • Underwriting, discounting and rediscounting of bills.
  • Acceptances, brokerage and stock holding.
  • Depository services, housing finance and book building
  • Hire purchases and installment credit.
  • Mutual Fund management.
  • Deposit insurance.
  • Financial and performance guarantees.
  • E-commerce and securat3.isation of debts.
  • Loan syndicating and credit rating.

Question 12.
Explain the objectives of portfolio management.
Answer:
Objectives of Portfolio Management:
The major objectives of portfolio management are summarized as below:

  • Keep the security, safety of Principal sum intact both in terms of money as well as its purchasing power.
  • Stability of the flow of income so as to facilitate planning more accurately and systematically the re-investment or consumption of income.
  • To attain capital growth by re-investing in growth securities or through purchase of growth securities.
  • Marketability of the security which is essential for providing flexibility to investment portfolio.
  • Liquidity i.e. nearness to money which is desirable for the investor so as to take advantage of attractive opportunities upcoming in the market.
  • Diversification: The basic objective of building a portfolio is to educe the risk of loss of capital and income by investing in various types of securities and over a wide range of industries.
  • Favourable tax status: The effective yield an investor gets from his investment depends on tax to which it is subject. By minimizing the tax burden, yield can be effectively improved.

Question 13.
State the characteristics of hire purchase system.
Answer:
Characteristics of Hire-Purchase System: The characteristics of hire-purchase system are as under –

  • Hire-purchase is a credit purchase.
  • The price under hire-purchase system is paid in instalments.
  • The goods are delivered in the possession of the purchaser at the time of commencement of the agreement.
  • Hire vendor continues to be the owner of the goods till the payment of last instalment.
  • The hire-purchaser has a right to use the goods as a bailer.
  • The hire-purchaser has a right to terminate the agreement at any time in the capacity of a hirer.
  • The hire-purchaser becomes the owner of the goods after the payment of all instalments as per the agreement.
  • If there is a default in the payment of any instalment, the hire vendor will take away the goods from the possession of the purchaser without refunding him any amount.

Question 14.
State the modern financial service activities.
Answer:

  • Rendering project advisory services.
  • Planning for mergers and acquisitions.
  • Guiding corporate customers in capital restructuring.
  • Acting as Trustees to Debenture holders.
  • Recommending suitable changes in financial structure.
  • Structuring the financial collaboration through joint ventures
  • Rehabilitating and reconstructing sick companies through reconstruction.
  • Hedging of risks through derivative trading.
  • Managing portfolio of public sector corporations.
  • Asset liability management.
  • Undertaking risk management services through insurance.
  • Advising clients for selecting the best source of funds.
  • Guiding clients for determining the optimum debt-equity mix.
  • Undertaking specialized services like credit rating, underwriting, registration and transfers, clearing services, custodian services etc.

Question 15.
Explain the advantages of leasing.
Answer:
(a) Saving of Capital:
Leasing covers the full cost of the equipment used in the business by providing 100% finance. The lessee is not to provide or pay any margin money as there is no down payment. In this way the saving in capital or financial resources can be used for other productive purposes e.g. purchase of inventories.

(b) Flexibility and Convenience:
The lease agreement can be tailor- made in respect of lease period and lease rentals according to the convenience and requirements of all lessees.

(c) Planning Cash Flows:
Leasing enables the lessee to plan its cash flows properly. The rentals can be paid out of the cash coming into the business from the use of the same assets.

(d) Improvement in Liquidity:
Leasing enables the lessee to improve their liquidity position by adopting the sale and lease back technique.

Question 16.
Explain the advantages and disadvantages of venture capital.
Answer:
Advantages of venture capital:
(a) Mentoring – Venture capitalists provide companies with ongoing strategic, operational and financial advice. They will typically have nominee directors appointed to the company’s board and often become intimately involved with the strategic direction of the company.

(b) Alliances – Venture capitalists can introduce the company to an extensive network of strategic partners both domestically and internationally and may also identify potential acquisition targets for the business and facilitate the acquisition.

(c) Facilitate exit – Venture capitalists are experienced in the process of preparing a company for an initial public offering (IPO) of its shares onto the Australian Stock Exchange (ASX) or overseas stock exchange such as NASDAQ. They can also facilitate a trade sate.

Disadvantages:
(a) Most venture capitalists seek to realise their investment in a company in three to five year If an entrepreneur’s business plan contemplates a longer timetable before providing liquidity, venture capital may not be appropriate. Entrepreneurs should also consider:

(b) Pricing – Venture capitalists are typically more sophisticated and may drive a harder bargain. Intrusion – Venture capitalists are more likely to want to influence the strategic direction of the company.

(c) Control – Venture capitalists are more likely to be interested in taking control of the company if the management is unable to drive the business.

Question 17.
List the various financial intermediaries.
Answer:

  • Commercial banks and other banks
  • Insurance companies
  • Credit card and issue companies
  • Stock exchanges
  • Leasing companies
  • Mutual fund corporations
  • Investment agencies
  • Finance companies and other financial institutions

Question 18.
Explain the disadvantages of leasing.
Answer:
Disadvantages of Leasing:
→ The leasing is efficient only if the equipment can be operated over the whole period of the contract; not using this equipment over the whole period of the contract, mainly due to the lack of orders, leads to losses for the beneficiary.

→ In case the lessee could obtain a bank credit under advantageous conditions, the cost of leasing would be higher.

→ The good that makes the object of the leasing contract doesn’t belong to the lessee, and therefore he cannot sell it during the period of the contract, and the sublease can be accomplished only with the owner’s agreement.

→ Through leasing only the usage right is given away, the ownership right being kept, but therefore the supplier’s goods can be damaged by improper usage, after the first lease being possible that the good will not find other users.

Question 19.
Discuss the various schemes of housing loans.
Answer:
The various schemes of housing loans are as follows:
(a) Home loans for construction of new house / flat,purchase of old house/ flat, etc: Initially, lenders approved a home loan for family/own residence only. After gaining experience and more importantly to be competitive, lenders now approve loans even when the applicant has more than one house or flat/apartment. Today there is no general restriction on the number of houses owned by an individual. The only stipulation is that the home loan funds should not be used for commercial purposes.

(b) Home extension loan: These loans are given for expanding or extending an existing home. These are some of the instances for which you could take an Extension Loan. To construct an additional room or floor by getting additional FSI granted. Using grills or sliding windows to enclose the balcony. Construction of a garden or garage in the building vicinity.

(c) Home improvement loan: Home improvement loans for repairs /renovation including water proof, plumbing, compound wall, digging of well/tube-well, flooring/tiling, additions like built-in cupboards/shelves, internal repairs including replacing doors windows, etc. A loan for purchase of household furniture including space-saving furniture (kitchen racks, cupboards, etc) may also be sanctioned as a home improvement loan.

(d) Home loan for purchase of housing site: Here again, initially many banks did not approve such loans. However, market forces have now made this a universal feature of the home loan market. However, care has been taken in structuring the schemes for avoiding financing for purchase of land for speculative purposes.

(e) Home equity loans:
A home equity loan (sometimes abbreviated HEL) is a type of loan in which the borrower uses the equity in their home as collateral. These loans are sometimes useful to help finance major home repairs, medical bills or college education. A home equity loan creates a lien against the borrower’s house, and reduces actual home equity.

Question 20.
Explain the scope of financial services.
Answer:
Scope of Financial Services:
The objectives of financial services mainly includes Fund Raising, Funds Deployment which helps in decision making regarding financing mix, rendering Specialised Services like credit rating, underwriting, merchant banking, depository, mutual fund, book building etc., which provides for the speeding up of the process of economic growth and development.

Financial services cover wide range of activities which can be broadly classified as:

  • Traditional Activities
  • Modern Activities

(a) Traditional Activities:
It includes services rendered for both money and capital market, which can be grouped under two heads:

  • Fund Based Activities
  • Non Fund Based or Fee Based Activities

(I) Fund Based Activities:
Fund based activities are the activities which come under the following:

  • Primary Market Activities
  • Secondary Market Activities
  • Foreign Exchange Market Activities
  • Specialised Financial Services Activities
  • Financial Engineering Activities.

The important fund based services include:

  • Equipment Leasing / Finance
  • Hire Purchase and Consumer Credit
  • Bill Discounting
  • Venture Capital
  • Housing Finance
  • Insurance Services
  • Factoring etc.

(II) Non Fund Based or Fee Based Activities:
Today, customers whether individual or corporates are not satisfied with the mere provision of finance. They expect more sophisticated financial services and wide range in it which usually includes the following fee based activities:

  • Managing Capital Issues according to SEBI guidelines.
  • Making arrangements of funds from financial institutions to meet the project cost and working capital.
  • Making arrangements for the placement of capital and debt instruments with investment institutions.
  • Assisting in the process of getting all government and legislative clearances.
  • Managing the portfolio

The fee based / advisory services include:

  • Issue Management
  • Portfolio
  • Management
  • Corporate Counselling
  • Loan Syndication
  • Merger and Acquisition
  • Capital Restructuring
  • Credit Rating
  • Stock Broking etc.