123mfs.pptx mfs presentation on basics of mfs

managenment of financial services

1. Management of Financial Services

2. INTRODUCTION Management of financial services refer to the management which is done by the company/for the company so as to achieve the goals of the organization. The goals of the company can be anything but as per finance point of view the motive is to increase the wealth of the company.

3. 1.Introduction to Indian Financial System

4. Development of indian financial system: the structure of financial system becomes important in determining the nature of growth. The formal financial system is undertaken by ministry of finance,SEBI & RBI. Such institutions help in formulating the rules and policies which every investor has to follow while opting for investment. Such system consists of various institutions,markets,regulations and laws,practices,money managersanalysts,transactions and claims and liabilities.

5. Functions of financial system: Savings function: if the flow of savings decline the growth of investment and living standard begins to fall. So, for investment and future contingencies, savings are important. Liquidity function: the compromise one has to make in purchasing of stocks,debentures is that (1) risk involved is more (2) degree of liquidity is less. the financial markets provide the investor with the opportunity to liquidate the investments.

6. Contd.: Payment function: payment to the creditors can be done via various sources like credit card,cheques, drfts etc. Risk function: the financial markets provide immense opportunities for the investor to hedge himself against or reduce the possible risks involved in various investments.

7. Financial instruments: Financial instruments are the assets that can be traded. These are basically the monetary contracts between parties. They can be cash, shares, debentures or bonds. There are various types of bonds available in the market. Some of them are-simple bonds,zero coupon bonds, term bonds, compound bonds, convertible bonds etc.

8. Simple bonds: Bonds constitute long term debts. Have fixed rate of interest. Divided in two categories: zero coupon bonds,term bonds. Zero coupon bonds:they do not contain any interest,but are redeemed at par rendering profit and issued at deep discount. Gain=redemption value-issue value. Term bonds:provides interest annually.

9. Compound bonds: These can be composed of variable interest rates and rights. Helps in achieving financial goals sooner.

10. Treasury bonds: Issued by federal govt. to finance budget deficits. Credit risk free. Yields are low. Interest is exempted from state tax laws.

11. Foreign bonds: Relatively lesser known bonds by foreign entities for raising medium to long-term financing from domestic money centres in their domestic currencies. Yankee bonds-US dollar denominated issued by foreign borrowers in US bond market. Samurai bonds: issued by non-japanese borrowers in domestic japanese markets Bulldog bonds: sterling denominated foreign bonds raised in the UK domestic securities market. Shibosai bonds: privately placed bonds issued in japanese markets.

12. Eurobonds: No taxes on any kind of interest payments Interest coupon attached Listed on one or more stock exchanges but issues are generally traded over the counter market Issued outside the country of the currency in which it is denominated Paper can be sold without any geographical boundaries.

13. Types of euro bonds: Fixed rate bonds/straight debt bonds: Fixed interest bearing securities Redemption at face value Repayment of debt will be in one lump sum at the end of maturity period Floating rate notes(FRN) Varying coupon rates(refixed at periodic intervals) Maturity period of 5-7 yrs.

14. Weakness of indian financial system: Lack of coordination amond different financial system: As the controlling power rests with the govt. of India problem of coordination arises. As there is multiplicity of institutions,there is a lack of coordination in the working of these institutions. Monopolistic market structure: Some of the financial institutions are so large that they have created a monopolistic market like LIC,UTI etc.

15. Contd.: Dominance of development banks in industrial financing: The development banks constitute the backbone of Indian financial system occupying major capital market. The industrial financing today is largely trough the financial institutions created by govt. due to which they fail to mobilise the savings of public

16. Structure of Indian Financial System:

17. Financial Institutions: Financial Institution is an establishment that conducts financial transactions such as investments,loans and deposits. FIs are categorised in two parts: Banking Institutions Non-Banking Institutions

18. Banking Institutions: Classification of banking institutions: Commercial banks Public banks Private banks Foreign banks Co-operative Banks

19. Commercial Banks: Commercial banks accept deposits and provide security and convenience to their customers. These banks also provide the facilities of credit cards,debit cards,cheques etc. due to which customers do not have to keep large amount of cash. Banks also provide loans that individuals and business use to buy goods or expand business operations and in return they provide ROI to banks.

20. Public Banks: Public Sector Banks (PSBs) are a major type of bank in India, where a majority stake (i.e. more than 50%) is held by a government. The shares of these banks are listed on stock exchanges. There are a total of 18 Public Sector Banks alongside 1 state-owned Payments Bank in India.

21. Nationalised Banks: Allahabad Bank (79.41%) Andhra Bank(84.83%) Bank of India (87.0535%) Bank of Baroda (63.74%) Bank of Maharashtra(87.01%) Canara Bank (72.55%) Central Bank of India (88.02%) Corporation Bank (84.96%) Indian Bank(81.73%) Indian Overseas Bank (91.99%) Oriental Bank of Commerce (77.23%) Punjab & Sind Bank (79.62%) Punjab National Bank (70.22%) State Bank of India (58.53%) Syndicate Bank (81.23%) UCO Bank(93.29%) Union Bank of India (67.43%) United Bank of India (92.25%) Payments Bank (PB)India Post Payments Bank (100%)

22. Private sector banks: The private sector banks in India are banks where the majority of the shares or equity are not held by the government but by private share holders. The old private sector banks existed prior to nationalisation in 1968 and kept their independence because they were either too small or specialist to be included in nationalisation. The new private sector banks are those that have gained their banking license since the change of policy in the 1990s.

23. List of the old private sector banks in India: City Union Bank Karur Vysya Bank Catholic Syrian Bank Tamilnad Mercantile Bank Nainital Bank (Wholly owned subsidiary of Bank Of Baroda) Karnataka Bank Lakshmi Vilas Bank Dhanlaxmi Bank South Indian Bank Federal Bank Jammu and Kashmir Bank RBL Bank

24. List of the new private sector banks in India : ICICI Bank Axis Bank HDFC Bank IndusInd Bank Kotak Mahindra Bank Yes Bank IDFC First Bank Bandhan Bank DCB Bank IDBI Bank

25. Foreign banks: A foreign branch bank is a type of foreign bank that is obligated to follow the regulations of both the home and host countries. Because the foreign branch banks ' loan limits are based on the parent bank's capital, foreign banks can provide more loans than subsidiary banks.

26. Co-operative Banks: These banks usually provide funds to the small industries/businesses and for the poor segment of society. Indian Co-operative Credit Societies Act 1904(rural and urban areas both). Primary agriculture and rural dev. Banks,state agriculture and rural dev. Banks,NABARD,GLS Bank

27. Non-banking sector: Non-banking institutions are further classified in 2 categories: Organised -organised firms are those institutions which are registered under their relevant acts. For eg.-LIC,UTI,GIC etc. unorganised –these are those mediums which are not legally registered under any act but are still a part of IFS.

28. Financial Markets: These are those markets where different types of securities can be traded for short term as well as long term. Money market. Capital market.

29. Money market: Money markets are the markets where short term dealings of securities are done ranging from 1 day to 1 year. Examples-Commercial Paper,Certificate of Deposits,T-Bills,call money,notice money.

30. Commercial paper: Commercial papers are the securities dealt by the companies for raising funds from the market. These are the paper denominated loans. When a company does not want to raise loan from banks,they issue commercial papers(CP).

31. Features of Commercial Papers: Negotiable in nature and hence flexible. These are liquid instruments. Flexibility in maturity as per the requirements of company. Unsecured instruments as they do not consists of any mortgage/security. Can be sold directly or via investors or issuers. Cheaper than bank loans. Issued in multiples of 5 lakhs generally. Maturity upto 1 year. does not need to be registered with the Securities and Exchange Commission (SEC) as long as it matures before nine months, or 270 days, making it a very cost-effective means of financing. Generally have buy-back security. No prior approval of RBI is required.

32. Limitations: Limited to blue chip companies. These are unsecured in nature i.e.,the investors have to invest according to risk-return profile.

33. Certificate of deposits: These are the instruments issued by the banks in the form of usance promissory notes. A certificate of deposit (CD) is a savings certificate with a fixed maturity date and specified fixed interest rate that can be issued in any denomination aside from minimum investment requirements. CDs are generally issued by commercial banks.

34. Features: CDs are considered as riskless instruments as the default risk is almost nil. These instruments are easily marketable in nature. Issued at discount,redeemed at par. Have stamp duty and there is no grace period. CDs can be issued with the limits set by RBI. Denomination generally of 1 lakhs. Maturity from 15 days to 1 year.

35. Limitations: Withdrawl of cash before maturity may lead to penalties. CD rates may be lower than the rate of inflation i.e., money may lose purchasing power overtime. Do not provide high rate of return. No free transferability.

36. T-Bills: T-Bills are raised to met short term requirements required by govt. of India. These are basically done to perform OMOwhich indirectly regulate money supply in the economy. Highly liquid in nature. Assured returns. No default risk. No capital depreciation. Eligibility for statutory requirements. Issued in the form of promissory notes. Multiples of $1000 or more. Issued at discount,redeemed at par.

37. Call and notice money: Call money forms a part of the national money market where day-to-day surplus funds are traded mostly by banks. Short term in naturefrom 1-15 days. Money lent for 1 day is called as call money. Interest is quoted at mutual understanding. Highly liquid in nature. Repayable on demand.

38. Bonus issue/scrip issue/capitalization issue sec 63: A bonus issue, also known as a scrip issue or a capitalization issue, is an offer of free additional shares to existing shareholders. A company may decide to distribute further shares as an alternative to increasing the dividend payout. For example, a company may give one bonus share for every five shares held.

39. Bonus issue/scrip issue/capitalization issue sec 63: The shares issue made by a company having share capitalbto its existing shareholders without receipt of any consideration from the shareholders for such issue. It is an offer of free additional shares to the existing shareholders in proportion to their holdings. These are the co’s accumulated earnings which are not given in the form of dividends,but are converted into free shares.

40. Bonus issue/scrip issue/capitalization issue sec 63: Althought he issue of bonus shares increases the total no. of shares issued and owned,it doesn’t change the company’s value. The ratio of shares held is also constant. Cos. Issue these shares to encourage the retail participation and increase their equity base. When price per share is high,it becomes difficult for new investors to buy shares,but increase in no. of shares decreasesthe price and the overall capital remains the same.

41. Bonus issue/scrip issue/capitalization issue sec 63: Bonus issues are given to shareholders when companies are short of cash and shareholders expect a regular income. Shareholders may sell the bonus shares and meet their liquidity needs. Bonus shares may also be issued to restructure company reserves. Issuing bonus shares does not involve cash flow. It increases the company’s share capital but not its net assets.

42. Bonus issue/scrip issue/capitalization issue sec 63: Bonus shares are not taxable. But the stockholder may have to pay capital gains tax, if one sells them. Sources of bonus issue Free reserves Securities premium a/c CRR a/c

43. Conditions: only fully paid-up shares can be issued to the members of company. Articles must contain provision for issue of bonus shares It must be authorised by the members of the company on recommendation of board Company should not have defaulted in respect of the payment of statutory dues of employees such as contribution to PF,gratuity,bonus Partly paid-up shares,if any o/s on date of allotment should be made fully paid-up.

44. procedure: 1. Call the Board Meeting: As per Section 173(3): Issue Notice of atleast 7 days for calling meeting of Board of Directors. 2.Hold the Board Meeting: Check the Quorum as per Section 174(1): Quorum for the Meeting of Board of Directors is 1/3rd of total strength of Board or 2 directors, whichever is higher. Place before the Board Resolution for issue of Bonus Shares. Pass Board Resolution for issue of shares. Decide the Ratio of Shares offering to share holders.

45. procedure: Fixing the date, time, and venue of the general meeting and authorizing a director or any other person to send the notice for the same to the members. Provisions of the Section 101 of the Companies Act 2013 provides for issue of notice of EGM in writing to below mentions atleast 21 days before the actual date of the EGM : All the Directors. Members Auditors of Company The notice shall specify the place, date, day and time of the meeting and contain a statement on the business to be transacted at the EGM. Authorize a director to do all the work relating to issue notice of right issue.

46. procedure: 3.File MGT-14: File e-form- MGT-14 with in 30 days of Passing of Board Resolution for issue of shares. Attachment: Resolution for issue of shares.

47. procedure: 4. CONVENE A GENERAL MEETING: Check the Quorum. Check whether auditor is present, if not. Then Leave of absence is Granted or Not. (As per Section- 146). Pass Ordinary Resolution for bonus issue of shares.

48. procedure: 5. Call the Board Meeting: As per Section 173(3): Issue Notice of atleast 7 days for calling meeting of Board of Directors. Hold the Board Meeting Pass Board Resolution for allotment of shares. 6. Filling of e-Forms 1. File PAS-3: File e-form PAS-3 with in 30 days of passing of Board Resolution for allotment of shares.

49. procedure: Attachment: Ordinary Resolution for Bonus issue of shares. Board Resolution for allotment of shares. List of Allottees. (as per annexure –B of PAS-3)- Mentioning Name, Address, occupation if any and number of securities allotted to each of the allottees and the list shall be certified by the signatory of the form pas-3.

50. procedure: 7.Issue Share Certificates: Company will issue share certificate to the share holders with in 2 month from the date of allotment of shares.

51. Private placement: A private placement involves the sale of securities to a relatively small number of select investors. When a company sells its stocks to private investors instead of going public. The co. sells its shares to some limited number of private investors like banks,mutual funda,insurance companies etc.

52. Private placement: PP need not to be registered with SEC. The SEC regulates how securities are sold to the public through the Securities Act of 1933 No prospectus to be issued. No detatched information to be disclosed. A private placement has minimal regulatory requirements and standards that it must abide by.

53. Securities Exempt from SEC Registration Some securities offerings are exempted from the registration requirement of the act. These include: Intrastate offerings Offerings of limited size Securities issued by municipal, state governments Private offerings to a limited number of persons or institutions The other main goal of the Securities Act of 1933 was to prohibit breach and misrepresentations. The act aimed to eliminate fraud that happens during the sales of securities.

54. Advantages: Less time consuming Economical Sold to known investors Can avoid time for generating credit rating Process of underwriting is quick

55. Disadvantages: Buyer expects higher ROI. As there is no credit rating buyer may not find safe to purchase such stocks

56. Bought out deals: A bought out deal is a method of offering securities to the public through a sponsor or underwriter (a bank, financial institution, or an individual). The securities are listed in one or more stock exchanges within a time frame mutually agreed upon by the company and the sponsor. In BODs the sponsor buys the whole lot of shares from the company at a amount fixed by them.

57. Bought out deals: BOD is a risky work for sponsor because they further sell these securities to other investors at profit While buying from company they buy at a discount rates.

58. Advantages: Easy to sell No financial risk No liquidity risk Less time consuming

59. Disadvantages: Low price Risky as unknown investors purchase the stocks

60. Secondary market:-SEBI The secondary market is where investors buy and sell securities they already own. . The national exchanges, such as the New York Stock Exchange (NYSE) and the NASDAQ, are secondary markets. In secondary markets, investors exchange with each other rather than with the issuing entity. Through massive series of independent yet interconnected trades, the secondary market drives the price of securities toward their actual value.

61. Function In the secondary market, securities are sold by and transferred from one investor or speculator to another. It is therefore important that the secondary market be highly liquid (originally, the only way to create this liquidity was for investors and speculators to meet at a fixed place regularly). As a general rule, the greater the number of investors that participate in a given marketplace, and the greater the centralization of that marketplace, the more liquid the market is.

62. Features Gives liquidity to all investors. Very little time lag between any new news or information on the company and the stock price reflecting that news. The secondary market quickly adjusts the price to any new development in the security. Lower transaction costs due to the high volume of transactions. Demand and supply economics in the market assist in price discovery. An alternative to saving . Secondary markets face heavy regulations from the government . High regulations ensure the safety of the investor’s money

63. Types of Secondary Markets Exchanges It is a marketplace, wherein there is no direct contact between the buyer and the seller, like NYSE or NASDAQ. There is no counterparty risk as an exchange is a guarantor. heavy regulations make it a safe place for investors to trade securities. investors face a comparatively higher transaction cost due to exchange fees and commission

64. Over-The-Counter (OTC) Markets It is a decentralized place, where the market is made up of members trading among themselves. Foreign exchange market (FOREX) is one such type of market. There is more competition among the participants to get higher volume, so prices of security may vary from seller to seller. Also, OTC markets suffer from counterparty risk as parties deal with each other directly.

65. Function of stock exchange: Economic indicator Pricing of securities Safety of transactions Helps in economic growth Increases standard of living Helps in healthy speculation Liquidity Allocation of funds Creates habits of savings and investment

66. Securities and Exchange Board of India: The Securities and Exchange Board of India was established on April 12, 1992 in accordance with the provisions of the Securities and Exchange Board of India Act, 1992. The Preamble of the Securities and Exchange Board of India describes the basic functions of the Securities and Exchange Board of India as "...to protect the interests of investors in securities and to promote the development of, and to regulate the securities market”.

67. Structure of SEBI: Some of the departments are foreign portfolio investors, communications, human resources, collective investment schemes, commodity and derivative market regulation, legal affairs department, etc. SEBI’s hierarchical organisation structure consists of nine members: a chairman nominated by the Union Government of India two members who are officers from the Union Finance Ministry one member from the Reserve Bank of India five other members who are also nominated by the Union Government of India.

68. Functions of SEBI To protect the interests of investors and to make regulations to drive the capital market. To regulate the share markets and other security exchanges. To control the working of share brokers, sub brokers, share transfer agents, merchant bankers, underwriters, portfolio managers etc. and also to make their registration.    To guide the employees and individuals related with the security exchanges and to encourage healthy competition in the security markets.

69. Functions of SEBI To eliminate corruption in the security markets. To register the mutual fund securities and keep an eye on their activities in the market. To arrange training programmes for new investors. (also printing of training booklets) To eliminate the insider trading activities. To supervise the working of various organizations trading n the security market and also to ensure systematic dealings. To increase research and investigation in order to achieve above objectives.

70. Powers of SEBI: For the discharge of its functions efficiently, SEBI has been vested with the following powers: to approve by−laws of stock exchanges. To require the stock exchange to amend their by−laws. To inspect the books of accounts and call for periodical returns from recognized stock exchanges. To inspect the books of accounts of financial intermediaries. To compel certain companies to list their shares in one or more stock exchanges. Registration of brokers.

71. OTCEI: The over-the-counter exchange of India (OTCEI) is an electronic stock exchange based in India that consists of small- and medium-sized firms aiming to gain access to the capital markets like electronic exchanges in the U.S. such as the Nasdaq, there is no central place of exchange, and all trading occurs through electronic networks.

72. OTCEI: The first electronic OTC stock exchange in India was established in 1990 to provide investors and companies with an additional way to trade and issue securities. This was the first exchange in India to introduce market makers, which are firms that hold shares in companies and facilitate the trading of securities by buying and selling from other participants.

73. features of OTCEI: Easy accessebility Easy to liquidate Investor registration Ringless trading Transparent trading Authorised dealers Information about the company

74. Objectives of OTCEI: Advising small investors to invest in the companies Assisting small firms with paid-up capital of less than 3 crores to raise funds from general public Provides a convenient market to small investors Helps in building investors’ confidence by offering two way prices Ensuring transparency

75. Objectives of OTCEI: To provide easy liquidity advantage If a company is unlisted in stock exchange,it can go for OTCEI Securities Traded on the OTCEI 1.Listed Equity (exclusive): 2.Listed Debt: 3.Gilts: 4.Permitted Securities: 5.Listed Mutual Funds

76. Emergence of NSE: To counter the influence of Bombay Stock Exchange and reduce the influence of certain powerful intermediaries in the stock market, a new stock market was promoted in which both securities of companies and debt instruments are traded, namely the National Stock Exchanges. NSE takes into account the screen based trading and so it is the most advanced. The success of this stock exchange is quite evident that within a few years of its promotion the volume and the value of transactions have surpassed the BSE.

77. ADVANTAGES : It provides a trading platform for smaller and less liquid companies as they are not qualified for listing on a standard exchange. It is a cost-effective method for corporate as there is a lower cost of new issues and lower expenses of servicing the investors. Dealers can operate both in new issues and secondary market at their option. It gives greater freedom of choice to investors to choose stocks by dealers for market making in both primary and secondary markets. It is a transparent system of trading with no problem of bad or short deliveries.

78. ADVANTAGES : Information flows are free and more direct from market makers to customers since there is close contact between them. OTC trading is a regular practice in many markets, representing the biggest volume of market transactions in many countries. OTC trades take place electronically and directly between two parties.

79. ADVANTAGES : For both investors and companies, OTC markets are more cost-efficient than customary stock exchanges. This feature is used to carry out bigger trades without any difficulty with a counterparty without having to go through the public order books.

80. Diadvantages:  Lack of a clearinghouse or exchange results in increased credit or default risk associated with each OTC contract. Lack of transparancy due to lack of transparancy  large bid-ask spreads makes it very hard to trade beneficially.

81. Financial intermediaries:

82. Introduction: A financial intermediary is an entity that acts as the middleman between two parties in a financial transaction, such as a commercial bank, investment banks, mutual funds and pension funds. Financial intermediaries offer a number of benefits to the average consumer, including safety, liquidity, and economies of scale involved in commercial banking, investment banking and asset management.

83. Functions of Financial Intermediaries: Financial intermediaries move funds from parties with excess capital to parties needing funds. The process creates efficient markets and lowers the cost of conducting business. Banks connect borrowers and lenders by providing capital from other financial institutions and from the Federal Reserve. Insurance companies collect premiums for policies and provide policy benefits. A pension fund collects funds on behalf of members and distributes payments to pensioners.  Financial institutions help provide opportunity for our economic growth and improve our living standards

84. Financial instruments: Financial instruments are assets that can be traded, or they can also be seen as packages of capital that may be traded. These assets can be cash, a contractual right to deliver or receive cash or another type of financial instrument, or evidence of one's ownership of an entity. Financial instruments  are monetary contracts between parties. They can be created, traded, modified and settled. They can be cash (currency), evidence of an ownership interest in an entity (share), or a contractual right to receive or deliver cash (bond).

85. Classification of financial instruments: Financial instruments can be classified in two categories: Term: short term,middle term and long term Type:primary,secondary

86. Term: Short term:these are those securities which are invested for less than 1 year. Medium term: these are those securities which are invested for more than 1 year but less than 5 years. Long term: term:these are those securities which are invested for more than 5 years.

87. Types of Financial Instruments Financial Instruments are intangible assets, which are expected to provide future benefits in the form of a claim to future cash. It is a tradable asset representing a legal agreement or a contractual right to evidence monetary value / ownership interest of an entity. Under the subject of Finance Management, Financial Instrumentscan be classified as cash instruments and derivative instruments. Financial Instruments are typically traded in financial marketswhere price of a security is arrived at based on market forces.

88. Cash Instruments: Cash Instruments are tradable and derive their value from financial markets. Cash Instruments can be further classified into equity instruments and debt instruments. Equity Instruments refer to instruments which represent ownership of the asset. Types of Equity Instruments are as follows: Equity shares Prefrence shares Derivative instruments

89. Derivatives: Investments based on some underlying assets are known as derivatives. In general derivatives contracts promise to deliver underlying products at some time in the future or give the right to buy or sell them in the future.

90. Types: Forward Contract : A forward contract gives the holder the obligation to buy or sell a certain underlying instrument at a certain date in the future at a specified price. Futures Contract:  Futures contracts are forward contracts traded on organized exchanges. A futures contract is a legally binding commitment to buy or sell a standard quantity at a price determined in the present (the futures price) on a specified future date.

91. Types: Swaps : A swap is an agreement whereby two parties (called counterparties) agree to exchange periodic payments. The cash amount of the payments exchanged is based on some predetermined principal amount. Options : An option is a contract in which the option seller grants the option buyer the right to enter into a transaction with the seller to either buy or sell an underlying asset at a specified price on or before a specified date.

92. Financial services: Financial services  are the economic services provided by the finance industry, which encompasses a broad range of businesses that manage money, including credit unions, banks, credit-card companies, insurance companies, accountancy companies, consumer-finance companies, stock brokerages, investment funds, individual managers and some government-sponsored enterprises.

93. Classification: Financial services can be classified in two categories: Fund based services Fee based services

94. Fund based: Leasing Hire purchasing Factoring Forfaiting etc.

95. Fee based: Merchant banking Broking Credit rating Portfolio management Underwriting etc.

96. Leasing: The periodical payment made by the lessee to the lessor is known as lease rental. Under lease financing, lessee is given the right to use the asset but the ownership lies with the lessor and at the end of the lease contract, the asset is returned to the lessor or an option is given to the lessee either to purchase the asset or to renew the lease agreement.

97. Leasing: A lease is a contract which explains the terms under which one party agrees to provide his property to a rentor. The owner is known as lessor The rentor is known as lessee Lessor gets a regular payment for a specified number of years but the possession rests with the lessee.

98. Features of Lease Contract: The lease finance is a contract. The parties to contract are lessor and lessee.  Equipment are bought by lessor at the request of lessee. The lease contract specifies the period of contract. The lessee uses these equipment’s. The lessee, in consideration, pays the lease rentals to the lessor

99.  The lessor is the owner of the assets and is entitled to the benefit of depreciation and other allied benefits e.g., under sections 32A and 32B of the Income-tax Act. The lessee claims the rentals as expenses chargeable to his income.

100. Types of lease: Financial Lease: A lease is considered as a financial lease if the lessor intends to recover his capital outlay plus the required rate of return on funds during the period of lease. It is a form of financing the assets under the cover of lease transaction. In this type of leases, lessee will use and have control over the asset without holding the title to it.

101. The lessee acquires most of the economic values associated with the outright ownership of the asset. The lessee is expected to pay for upkeep and maintenance of the asset. This is also known by the name ‘capital lease. The essential point of this type of lease agreement is that it contains a condition whereby the lessor agrees to transfer the title for the asset at the end of the lease period at a nominal cost.

102. At the end of lease it must give an option to the lessee to purchase the asset he has used at the expiry of the lease. Under this lease usually 90% of the fair value of the asset is recovered by the lessor as lease rentals and the lease period is 75% of the economic life of the asset. The lease agreement is irrevocable. Practically all the risks incidental to the asset ownership and all the benefits arising therefrom is transferred to the lessee who bears the cost of maintenance, insurance and repairs. Only the title deeds remain with the lessor.

103. Suitability:  When the lessee wants to own the asset but does not have enough funds to invest. The time period to use the asset is substantially long at lower lease rentals.

104. Operating Lease : An operating lease is similar to the financial lease in almost all aspects. This lease agreement gives to the lessee only a limited right to use the asset. The operating lease is generally for a short-term, where the lessor is usually the manufacturer of the asset, who want to increase his sales by allowing the customers to pay in installments for a short-term and ultimately the title to the asset will be transferred to the lessee on making full payment.

105. In some cases the lessor keeps the title to the goods and he continues to lease the asset to other party until the life of the asset is completed. In the operating lease, it is the responsibility of the lessee to maintain and upkeep the asset properly when the asset is under his control. The lessor will enjoy the depreciation claim and the lessee will show his lease rentals and asset maintenance expenses as business expenditure. At the end of the life of the asset, it will be sold off by the lessor to get the salvage value.

106. Suitability: When the long-term suitability of asset is uncertain. When the asset is subject to rapid obsolescence. When the asset is required for immediate use to tie over a temporary problem.

107. Sale and Lease Back: Under this the lessee first purchases the equipment of his choice and then sells it to the lessor firm. The lessor in turn leases out the asset to the same lessee. The advantage of this method is that the lessee can satisfy himself completely regarding the quality of the asset and after possession of the asset convert the sale into a lease arrangement. This option he can exercise even in the case of an old asset used by him for some time to get the release of a lump-sum cash which he can put into alternative use.

108. This method of financing an asset is also popular when the lessee is in liquidity problems, he can sell the asset to a leasing company and takes it back on lease. This will improve the liquidity position of the lessee and will continue to use the asset without parting with it.

109. Leveraged Lease: In this form of lease agreement, the lessor undertakes to finance only a part of the money required to purchase the asset. The major part of the finance is arranged with a financier to whom the title deeds for the asset as well as the lease retails are assigned. There are usually three parties involved, the lessor, the lessee and the financier. The lease agreement is between the lessee and lessor as in any other case. But it is supplemented by another separate agreement between the lessor and the financier who agrees to provide a major part (say 75%) of the money required. This is a type of lease agreement which will enable the lessor to undertake an expand volume of lease business with a limited amount of capital and hence it is named leverage leasing.

110. Sales Aid Leasing: A leasing company will enter into an agreement with the seller, usually manufacturer of the equipment, to market the latter’s product through its leasing operations. The leasing company will also get commission for such sales, which add up to its profits.

111. Structure of Lease Rentals: The lease rentals are payable on periodical basis over the specified lease period. The lease rentals should be structured in such a way that it will be convenient for both lessor and lessee. In a competitive situation, the lessee will tend to obtain lease finance where the lease rentals are lowest. The lessor has to recover his principal amount invested as well as the desired return on investment.

112. Lease rent structure may be in the following ways: Equal Annual Plan: In this plan, the annual lease rent payable is divided into equal amounts by applying the annuity factor for the specified period of lease at a predetermined interest rate taken as discount rate.  Stepped-Up Plan: Under this plan, the annual lease rent will go on increasing every year with a specified rate of increase.

113. Balloon Payment Plan: In this plan, the annual lease rent payable in the initial year would be less, fixed up in such a way to meet the nominal amount comparative to the cost of investment, but the ending years of lease periods, the rest of the amount is payable in lump sum.

114. Deferred Payment Plan: Under this plan, the lease rent need not be paid for the initial specified period. But lease rent payable in the subsequent period, in equal annual amounts will recover the cost of financing for the deferred payment period also.

115. Importance of lease financing: Lease finance is easy to get than getting loan for buying all fixed assets.  Monthly rent payment for lease finance will be operating expenses. It will be allowed to deduct total income. So, company can get tax benefits in lease financing. One of major important point is that it is more flexible way of finance.    

116.  Advantages to lessor: Assured Regular Income Preservation of ownership High profitability Recovery of investment

117. To lessee: Use of capital goods Tax benefits Cheaper Technical assistance No effect of inflation Ownership

118. Other advantages: Liquidity Convenience Hidden Liability Time Saving No Risk of Obsolescence Cost Saving Flexibility

119. Disadvantages to lessor: Loss at inflation Chances of damage To lessee: Compulsion Ownership Costly Understatement of asset

120. Hire purchasing: Hire purchase is a method of financing of the fixed asset to be purchased on future date. Under this method of financing, the purchase price is paid in installments. Ownership of the asset is transferred after the payment of the last installment.

121. Features: The hire purchaser becomes the owner of the asset after paying the last installments. Every installment is treated as hire charge for using the asset. Hire purchaser can use the asset right after making the agreement with the hire vendor. The hire vendor has the right to repossess the asset in case of difficulties in obtaining the payment of installment.

122. Advantages of Hire Purchase: Financing of an asset through hire purchase is very easy. ii. Hire purchaser becomes the owner of the asset in future. iii. Hire purchaser gets the benefit of depreciation on asset hired by him/her.

123. Disadvantages of Hire Purchase:  Ownership of asset is transferred only after the payment of the last installment. ii. The magnitude of funds involved in hire purchase are very small and only small types of assets like office equipment’s, automobiles, etc., are purchased through it. iii. The cost of financing through hire purchase is very high.

124. Factoring: Factoring is a continuous arrangement between a financial intermediary called a factor and a seller called client of goods and services. Based on the type of factoring,the factor performs the services in respect of the accounts receivables arising from the sale of such goods and services. Purchases all A/R of the seller for immediate cash. Administers the sales ledger of seller Collects the A/R Assumes the losses which may arise from bad debts Provides relevant advisory services to the seller.

125. Types of factoring: Recourse factoring:under recourse factoring,the factor purchases the receivables on the condition that any los arising out of irrecoverable receivables will be borne by the client. Non-recourse or full factoring:the factor has no recourse to the client if the receivables are not covered.

126. Types of factoring: Maturity factoring:the factor does not make any advance payment or pre pyment. Invoice discounting:the factor provides a pre payment to the client against the purchase of A/R and collects interest for the period extending from the date of pre payment to the date of collection.

127. Table: Types/service Short term finance Sales ledger administration Credit protection Recourse factoring yes yes No Non recourse factoring Yes yes Yes Maturity fatoring No Yes No Invoice discounting yes No no