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MMPF 06
MANAGEMENT OF FINANCIAL SERVICES
TABLE OF
CONTENTS
01 LONG IMP QUESTIONS
02 EXTRA LONG QUESTIONS
03 VERY IMP SHORT NOTES
04 EXTRA SHORT NOTES

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MMPF 06- MANAGEMENT OF FINANCIAL SERVICES

FIRST PRIORITY MOST IMPORTANT QUESTIONS
Answer any 5 questions from OUT OF 8
Q1- Define ‘Asset Securitisation’. Explain the process of Asset Securitisation and discuss the role of
different parties involved therein? (v v v v v imp).
ANS- MEANING OF SECURITISATION-- Asset securitisation is defined as a process whereby assets
like loans and receivables are used to create and sell asset backed securities. The assets which can
be used for securitisation include receivables from the government departments, loan assets like
housing loan and automobile loans, leased assets and credit card receivables etc. In fact, any asset
can be considered for securitisation provided it is possible to forecast future cash flows to be
generated from such assets with reasonable accuracy. In a nutshell, asset securitisation can be
defined as the process which takes place when a lending institution’s assets are removed in one way
or another from the balance sheet of that lending institution and are funded instead by investors
who purchase an instrument created from these assets without recourse or with recourse towards
seller of the asset (i.e., originator’s of the asset). The yield to the investors is set at a market level
appropriate to the characteristics and the quality of the asset pool. Thus, under asset securitisation a
bank or lending institution like financial institution sells loan assets and receivables to an
independent entity like special purpose vehicle (SPV) who pools and packages individual loans and
receivables and creates securities against them, gets them rated and sells them to the investors at
large through public offerings or private placements (Trustee). The future cash flow (to be received
by originator of a loan) are remitted to the trustee who in turn pays agreed interest and principal
amount to the investors as per the terms of an agreement. Thus, “Asset Securitisation is a synthetic
technique of converting illiquid assets into liquid assets through the process of issuing securities to
the investors by SPV” thereby providing market determined yield on such securities and
marketability in respect of such instruments. The whole process of asset securitisation is beneficial
to both lending institutions (originator’s of loan) as well as to the investors
In a securitisation exercise, the underlying assets are used both as a collateral to the security and
also to generate the income to pay the principal and interest on such securities. This is in contrast to
a traditional secured debt instrument where the debt may be serviced from not only the income
generated from the assets secured, but also from the entire operations of the issuers. Further under
securitisation having characteristic of without recourse the credit risk is shifted completely from the
originator of the loan assets to SPVs. In order to get the full benefits of securitisation, it needs to be
considered as a structured financial product and accordingly a systematic methodology needs to be
followed based on certain parameters. Few of these parameters are given below :
1-- The cash flows from the underlying assets are packaged to attract targeted investors.
2--- The tax and accounting needs of the issuers and investors are satisfied.
3-- The criteria for choosing the pool of assets so as to ensure minimum cost of funds.
4-- A bankruptcy or a winding up of the originator does not have any impact on the cash generated
from assets and use of the same to make payment to the investors.
PROCESS AND MECHANISM OF SECURITISATION-
PARTIES INVOLVED IN TRANSACTION OF ASSET SECURITISATION

Q2- Define Venture Capital. How does it differ from other forms of finance ? Describe the different
stages of venture capital financing. Discuss the alternatives available to a venture capitalist to exit
from an investee company? (v v v v v imp).
ANS- Venture Capital -Venture Capital may be broadly defined as long-term investment in business,
which has potential for significant growth and financial returns. This is usually provided in the form
of equity apart from conditional loans and conventional loans. Venture Capitalists is thus not a
financier only, but bears the risk as well. His return from the enterprise depends upon the extent of
the success achieved by it. The most distinguishing feature of Venture Capital is that it meets the
needs of a business wherein the probability of loss is quite high because of the uncertainties
associated with the enterprise, but the returns expected are also higher than normal. The
entrepreneur intends to enter into an untrodden field. Thus, the Venture Capitalist invests in a
business where uncertainties have yet to be quantified into risks. Venture Capital is thus termed as
high risk, high return capital.
STAGES OF VENTURE CAPITAL FINANCING-
A venture capital fund provides finance to the venture capital undertaking at different stages of its
life cycle according to requirements. These stages are broadly classified into two, viz. (i) Early stage
financing, and (ii) Later stage financing. Each of them is further sub-divided into a number of stages.
We shall deal with them individually. Early Stage Financing includes: (i) Seed capital stage, (ii) Start-
up stage, and (iii) Second round financing
EXIT ROUTES
Q3- What are the basic principles of Insurance ? Discuss the various types of insurable risks.
Explain the major contingencies covered under the Life Insurance contract? (v v v v v imp).
ANS- BASIC PRINCIPLES OF INSURANCE- A contract is an agreement. It includes a set of promises
that are imposed by law and for breach of promises law provides a remedy. Hence Insurance is
under the purview of Contract Act. Non life insurance policies are contracts of indemnity and
involves insurable interest of insured. Basic principles of insurance are utmost good faith, insurable
interest, indemnity, subrogation and contribution. Before proceeding to the classification of
Insurance, let’s review the principles of Insurance.
Utmost Good Faith
Insurance contract is done on utmost good faith i.e. in a contract of insurance, there is an implied
condition that each party must disclose every material fact known to him. A representation is a
statement made by an applicant (proposer) for insurance before the contract is effected. A
misrepresentation of material fact makes the contract voidable at the option of insurer. Like
misrepresentation , concealment has also the same legal effect. A concealment is defined as a failure
of applicant to reveal the facts when obligated to speak. Applicant should not conceal the facts, even
if the disclosure of the same may result into rejection of application. e.g. In case of fire insurance
material facts are information regarding construction of the building, nature of goods stored, nature
of process carried on, location, etc. To give one more example in case of accident insurance, one
should give information regarding type of vehicle, nature of operation, tonnage, etc. in motor and in
case of burglary, nature of goods, security arrangements, etc
Principle of Insurable Interest
Insurable interest exists only if insured would suffer economic loss in the event of damage or
destruction of insured object. For e.g. insurance of house or shop; damage to the house will result
into financial loss to the owner. It is also necessary that insurable interest must exist at the time of
loss. Secured creditors have insurable interest in the property for which they have given loan. To
illustrate, Mr. Iyer cannot purchase insurance of Mr. Shah’s house and collect the insurance claim if
house is damaged. By doing this Mr. Iyer will be profiting from the insurance.
Principle of Indemnity
This principle argues that individual should not be permitted to make profit from the contract but
should be re-established to the same financial conditions that existed prior to the occurrence of loss.
In other words, insurance company agrees to pay not more than the actual amount of loss suffered
by the insured. There are two fundamental purposes involved; first is to prevent the insured from
making profits from occurrence of loss and second is to reduce moral hazard.
Subrogation
Another provision under the insurance contract which is preventing insured from making profits is
subrogation. Subrogation means substitution of the insurer in place of insured for the purpose of
claiming indemnity from third party for a loss covered by Life Insurance insured. e.g. a negligent car
driver fails to stop at red signal and smashes into the car causing damage worth Rs. 10000. If he has
comprehensive car insurance then insurance company will pay physical damage expenses and then
make an effort to collect the cost of damage from negligent driver who caused accident
INSURABLE RISKS
Insurable risks include Personal risk, Property risk and Liability risks.
Q4- Explain the role of an Asset Management Company (AMC) in managing Mutual Funds. Discuss
the functions and working mechanism of an AMC.? (v v v v v imp).
ANS- Assets Management Company (AMC)
The sponsor or the trustees appoint an AMC, also known as ‘Investment Manager’, to manage the
affairs of the mutual fund. It is the AMC which operates all the schemes of the fund. Any AMC
cannot act as a trustee of any other mutual fund. AMC can act as an AMC of only one mutual fund.
AMC is not permitted to undertake any business activity except activities in the nature of
management and advisory services to off shore funds, pension funds, provident funds, venture
capital funds, management of insurance funds, financial consultancy and exchange of research on
commercial basis, if these activities are not in conflict with the activities of the mutual fund. It can
also operate as an underwriter provided it gets registered under SEBI (Merchant Bankers)
Regulations. SEBI regulations in this matter are as under:
Q5- Define Mutual Funds. Discuss the role and responsibilities of the trustees of a mutual fund and
its Assess Management Company.? (v v v v v imp).
ANS- role and responsibilities of the trustees of a mutual fund- A mutual fund is to be constituted
as a Trust under Indian Trust Act and trustees are to look after the trust. A trustee is a person who
holds the property of the mutual fund in trust for the benefit of the unit holders. A company is
appointed as a trustee to manage the mutual fund with approval of SEBI. To ensure fair dealings, at
least 75 per cent of the trustees are to be independent of the sponsors. Trustees take into their
custody, or under their control all the property of the schemes of mutual fund. It is the duty of the
trustees to provide information to unit holders as well as to SEBI about the mutual fund schemes.
Trustees are to appoint Asset Management Company (AMC) to float the schemes. The trustees are
to evolve Investment Management Agreement to be entered into with AMC. It is trustee’s duty to
observe and ensure that AMC is managing schemes in accordance with the trust deed. Trustees can
dismiss the appointed AMC. It is the responsibility of trustees to supervise the collection of any
income due to be paid to the scheme. Trustees for their services are paid trusteeship fee which is to
be specified in the trust deed. Trustees are to present annual report to the investors and registered
under SEBI. A trustee is appointed who holds the property of the mutual fund in trust for the benefit
of the unit holders. Once the mutual fund trust is formed, the role of sponsor virtually becomes nil
as it is the trust which now interacts with SEBI. SEBI regulations desire appointing a trustee either as
individuals, comprising a board of trustee, or a trustee company. Traditionally mutual funds have
been operating with a board of trustees but some new entrants in this field have opted for a
company to be appointed as a trustee to manage the mutual fund. The main reason why a trustee
company is preferred over a board of trustees is that in their individual capacity, board of trustees
have an unlimited liability. Consequently, their personal property may be at stake if a scheme fails.
Where as for trustee company board of directors have limited liability.
Trustees, are regulated by a Trust- Deed which is to be submitted to SEBI. The trustees are to
manage the Mutual Fund in accordance with the laws, regulations, directions and guidelines issued
by SEBI, the stock exchanges and other governmental and regulatory agencies. They are to hold in
safe custody and preserve the mutual fund’s property. Trustees are to report on operations to SEBI
and the Unit holders. They are to ensure that AMC has been diligent in conducting the affairs. The
trustees’ working has been made subject to a code of conduct. To ensure fair dealings, mutual fund
regulations require that one cannot be a trustee or a director of a trustee company in more than one
mutual fund. Further, at least two- third of the trustees are to be independent of the sponsors.
These independent trustees, of course, enjoy multi trusteeship. Asset management company or its
directors or employees shall not act as trustees of any MF. Trustees should be persons with
experience in financial services. Every trustee should be a person of ability, integrity and standing.
Trustees appoint Asset Management Company (AMC) to float the schemes in consultation with
sponsors. The trustees are to evolve Investment Management Agreement (IMA) to be entered into
with AMC. It is trustee’s duty to observe and ensure that AMC is managing schemes in accordance
with the trust deed
Trustees can dismiss the AMC. It is the responsibility of trustees to supervise the collection of any
income due to be paid to the scheme. Trustees for their services are paid trusteeship fee which is to
be specified in the trust deed. Trustees are to present annual report to the investors. They can call a
meeting of the unit holders if a requisition is filed. Rights and obligations of the trustees under SEBI
(Mutual fund) Regulations along with due diligence (general and specific) are as under:
Assess Management Company- discussed earlier

Q6- What is ‘Leasing’ ? What are the main clauses of a leasing contract ? How is leasing beneficial
to the lessee.? (v v v v v imp).
ANS- LEASING - A lease is a contract whereby the owner of an asset (the lessor) grants to another
person (the lessee) exclusive right to use the asset for an agreed period of time, in return for the
payment of a rent (called lease rental). Capital assets like land, buildings, equipments, machinery,
vehicles are the usual assets which are generally acquired on lease basis. The lessor remains the
owner of the asset, but the possession and economic use of the asset is vested in the lessee.
As there is no separate statute in India to govern the contracts of leasing, which is akin to a contract
of bailment, the provisions of the Indian Contract Act apply to it. According to Section 146 of the
Indian Contract Act, 1872 bailment is “the delivery of goods by one person to another person for
some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or
otherwise disposed of according to the directions of the person delivering them.” The person
delivering the goods is called the bailor and the person to whom they are delivered is called the
bailee.
Since an equipment lease transaction falls in the category of a bailment contract, the obligations of
the lessor and the lessee are similar to those of the bailor and the bailee (unless expressly specified
otherwise in the lease agreement) as given in the Indian Contract Act. Briefly, these may be stated as
follows:
MAIN CLAUSES IN THE LEASE AGREEMENT

TO BUY OR LEASE : A CRUCIAL DECISION

1-- Lessee’s Point of View
2-- Lessor’s Perspective

The lessor shall have to take a decision whether to lease an asset or not. He will be willing to go for
leasing only when the leased asset earns a return higher than his weighted average cost of capital. In
other words, after-tax cash inflows accruing to him must give a rate of return which is greater than
the cost of capital. In substance, the Net Present Value (NPV) should be positive. Following steps are
required to be undertaken by the lessor for cost-benefit analysis of leasing out the asset.
Q7- Explain the concept of 'Credit Rating'. Describe the various steps involved in the credit rating
process. Give names of credit rating companies operating in India..? (v v v v v imp).
ANS- CONCEPT OF CREDIT RATING Credit rating may be defined as an expression, through use of
symbols, of opinion about the quality of credit of the issuer of debt securities with reference to a
particular instrument. As per the SEBI regulations, credit rating is nothing but an opinion regarding
securities expressed in the form of standard symbol or in any other standardised form assigned by a
credit rating agency. The symbol given by rating agency for credit rating indicates a credit character
of that particular security and thus it only facilitates to take a view on credit risk pertaining to that
security. However, it does not directly recommend whether to purchase, sale or hold that security.
Thus, rating is a measure of credit risk only and hence it does not communicate anything about the
degree of market risk. Credit rating is considered predominantly in respect of debt instruments only.
In addition to this, lenders like banks and non-banking finance companies use internally developed
credit rating score models in assessing credit worthiness of their borrowers or depend on even
rating agencies to get rating for the same. The companies which issue debt instruments cannot on
their own rate instruments.
RATING PROCESS
The Rating process starts with a rating request from the issuer company followed by the signing of
the rating agreement with the credit rating company which employs a multi-layered decision making
process while giving a credit rating symbol. Credit rating agency sends its team of analysts to the
issuer company who interacts with the company’s management.
REGULATION OF CREDIT RATING AGENCIES IN INDIA

Q8- Define Insurance and discuss the various types of insurable risks. Explain the contingencies
that are covered under the life insurance contract.? (v v v v v imp).
ANS- PRINCIPAL CONTINGENCIES –
Death- In any life insurance product naturally the first and foremost contingency is contingency of
death. Death is certain but when it will occur is always uncertain. In the event of untimely death of
breadwinner, life insurance makes funds available to protect the family. Such untimely death creates
substantial financial problems to the dependents even forcing them to compromise on standard of
living. Death benefits can be paid within a few days of the claim and are, therefore, excellent source
of immediate cash to the surviving family members.
Surviving Too Long
Second important contingency is contingency of living too long. It is a fact that the mortality rates
are decreasing all over the world. Therefore, this contingency that one must anticipate to take care
of post retirment needs of insured and the spouse. It is well known that the life span of an average
Indian is also increasing. In 1947, at the time of independence, the average life span was 35 years, it
increased to 61 in 1991 census and is expected to increase to 80 by 2020. Thus, the present
generation of Indians who are in the age group of 30 to 45 would be expected to live for at least 15
years after retirement. Because of unpredictability of human life there would be a danger of
surviving more than expected lifetime and finding the assets and income totally consumed prior to
death due to the increasing cost of medical expenses with the age and cost of self-maintenance
rising due to inflation. Annuity plans help elderly persons by giving them income and some deferral
income taxes as long as annuitant lives. There is also an option available that the purchase price will
be paid back to the beneficiary in the event of death of the annuitant. This amount can then be used
to support the surviving spouse or to make a bequest.
Disability-
Third important contingency is the contingency of total disability. Unlike death and retirement,
becoming disabled is only a possibility. But it is a devastating one because it not only partially or
totally eliminates an individual’s ability to earn living but also entails additional cost of rehabilitative
therapy and purchase of special equipment to cope up with the new limitation. Therefore the need
to cover this contingency is greater than ever. Though the mortality rates have declined in the recent
years the incidence of disability due to accident, chronic diseases, emergence of AIDS and injuries
due to rigorous fitness programme activities like jogging, high-impact aerobics, etc. The disability
cover not only provides cover to disabled individual for treatment but also dependent family
members with the amount of monthly indemnity as per policy conditions and waiver of premium
during any period of disability. These are the three principal contingencies covered in life insurance
products for protection against financial consequences associated with early death, living death
(disability), living too long (postponed death). In addition to these main contingencies there are
some other low priority contingencies. The most prominent among those are Mortgage Redemption,
Children’s education, Marriages of children
OTHER CONTINGENCIES-
INSURANCE-
Insurance is a technique involving collection of small amounts of premium from many individuals
and companies out of which losses suffered by a few are reimbursed. In this method the individual
insured who is exposed to uncertain and accidental loss is able to get protection through payment of
a small but definite cost, namely premium. In other words the risk is transferred from the insured to
the insurer. Insurance is a contract between two parties i.e. insurer and insured, where by in
consideration of payment of premium by the insured, the insurer agrees to reimburse a financial loss
which the insured may incur due to an insured peril. The contract is again subject to the Indian
Contract Act coupled with special principles evolved by common law. The policy which is the
document issued by insurer is an evidence of the contract. Early insurance goes back to the Egyptian
times. Around 3000 BC, Chinese merchants dispersed their shipments among several vessels to
avoid the possibility of damage or loss. Insurance understood as a technique providing protection
against the fortuitous events for a consideration had its origin in the bottomry bonds which were
issued by the Mediterranean merchants as early as the fourth century B.C. This loan was an advance
of money on a ship during the period of voyage and the loan was repayable with the agreed rate of
interest on arrival of the ship safely at the destination. During the voyage if ship was lost, the
obligation to repay the loan was extinguished. The interest payable constituted a sort of premium
for the risk of total loss. Now, there is insurance for many aspects of daily living Business, Auto,
Health, Life, Travel. Each of those categories include sub-categories, branching off into numerous
divisions.
INSURABLE RISKS
Q9- Explain the objective, role and scope of Fire Insurance. Discuss the perils covered as well as
the perils excluded under Standard Fire Policy.? (v v v v v imp).
ANS- FIRE INSURANCE –
Introduction - As compared to marine insurance, fire insurance is of comparatively recent origin. Fire
is ignition under accidental circumstances. Generally almost all the material objects are vulnerable to
fire. Vulnerability of wood is more than steel structure. Fire causes huge losses due to material
damage. Therefore it is necessary to take some preventive measures to avoid or reduce fire losses
and protect the property against pecuniary losses. Fire Insurance is governed by All India Fire Tariff
effective from 31.3.2001 issued by Tariff Advisory Committee, a Statutory Body. The tariff contains
among other things, the rates to be charged for different types of risks. These risks have been
codified and a great deal of simplification has been brought about by applying the principle of one
risk-one rate, especially for industrial and manufacturing risks. Insurers are permitted to charge rates
higher than those given under the tariff. The minimum premium will be Rs. 50/- per policy for
dwellings and small sector industries and Rs. 100/- for all other sectors.
Perils Covered Under Standard Fire Policy

Role of Fire Insurance
Scope of Fire Policy

Q10- Explain the meaning, concept and basic characteristics of financial services. Discuss the
significance of the financial services sector in a country’s economy? (v v v v v imp).
ANS- MEANING AND CONCEPT–
The Financial Services Sector per se has become known in the past 25-30 years, although the
concept of financial services has been in existence since times immemorial. However, there is no
straight forward defintion for the term Financial Services, but if we look at the meaning of the term
‘financial services’ as it is applied in UK, it could be understood to be including banking, insurance,
stock broking and investment services as well as a wide range of other business and professional
services. In other words, what we can say is that financial services are services that ensure the
smooth flow of financial activities in the economy. Financial services are an important component of
the financial system. They cater to the needs of financial institutions, financial markets and financial
instruments which are geared to serve individual and institutional investors. Financial institutions
and financial markets facilitate functioning of the financial system through financial instruments. In
order to fulfil the tasks assigned, they require a number of services of financial nature and hence
financial services are regarded as the fourth element of the financial system. Thus, functioning of the
financial system depends to a great deal on the range of financial services extended by the
providers, and their efficiency and effectiveness
Financial services include the services offered by both Asset Management Companies and the
Liability Management Companies. The asset management companies are viz. leasing companies,
mutual funds, merchant bankers and issue/ portfolio managers. Bill discounting houses and
acceptance houses come under the liability management companies. Technological innovation and
globalization has brought about a key change in the financial services sector, i.e. the convergence
occurring within the sector. Similar services are now being offered by different players. Financial
services not only help to raise the required funds but also ensure their efficient deployment. They
assist in deciding the financing mix and extend their services up to the stage of servicing of lenders.
In order to ensure an efficient management of funds, services such as bill discounting, factoring of
debtors, parking of short-term funds in the money market, e-commerce and securitisation of debts
are provided by financial services firms. This sector provides services such as banking, insurance,
credit rating, lease financing, factoring, venture capital, mutual funds, merchant banking, stock
lending, depository services, housing finance, etc. These services are provided by various institutions
like stock exchanges, specialised and general financial institutions, non-banking finance companies,
subsidiaries of financial institutions, banks and insurance companies. Financial services sector is
regulated by the Securities and Exchange Board of India (SEBI), Reserve Bank of India and the
Department of Banking and Insurance, Government of India, through a plethora of legislations.
CHARACTERISTICS OF FINANCIAL SERVICES
Financial services are quite distinct in nature from the other services. The services provided by the
financial institutions have some typical characteristics that make these products quite distinct from
the products turned out by the industrial enterprises. Some of the basic characteristics of financial
services are as discussed :
SIGNIFICANCE OF FINANCIAL SERVICES

Q11- What is a Financial Market? Explain its Role and Functions.? (v v v v v imp).
ANS- FINANCIAL MARKETS: AN INTRODUCTION-
The term ‘market’ usually brings to mind a geographical place where people exchange goods and
services. However, it is a narrow view of market and does not reflect that the term market includes
mechanisms also. Financial market, like any other market; facilitates the exchange of financial assets
among the dealers. In other words, it refers to place or mechanism where financial assets are sold
and purchased. Further, financial market transaction may be at specific place or location, for
example stock exchange or the same may be just through a particular mechanism like telephone,
telex, or any other electronic media. To enter the share market as a trader or investor, one must
open a demat account (Account for holding shares /securities in electronic form) or brokerage
account for brokers. Without a demat account one cannot trade in the stock market. The demat
account works like a bank account where money is held to use for trading. The securities bought are
maintained electronically in the demat account
Financial markets are the centres or arrangements that provide facilities for buying and selling of
financial claims and services. These are the markets in which money as well as monetary claim is
traded in. Financial markets facilitate trading in financial assets. These assets are also referred to as
financial instruments or securities. Unlike goods or services, financial assets are not consumed.
These are claims against the money and enable their holders, upon disposing off the claims, to
obtain consumable goods or services. Since financial assets are not consumed, what is bought and
sold is their use for a particular period of time.
The participants in the financial markets are corporations, financial institutions, individuals and the
government. These participants trade in financial products in these markets. They trade either
directly or through brokers and dealers. In short, financial markets are markets that deal in financial
assets and credit instruments. In other markets, goods and services are exchanged through price
mechanism. Similarly in the financial markets, the price for the use of investible funds is the interest
paid on a loan. The interest payable depends upon various factors like; size of the fund, length of the
period of loan, risk involved, etc. Thus, the rate of interest, often known as discount rate, is the rate
charged to obtain present funds in exchange for future funds.
ROLE OF FINANCIAL MARKETS-
All the countries, irrespective of their state of development, need funds for their economic
development and growth. In the economy, these funds are obtained from the savers or ‘surplus
units (the units which have more income than their consumption) which may be Household
individuals, Business firms, Public sector units, Central Government, State Governments, Local
Governments, Semi-Governments, etc.. At any point in time, we have people that have money that
they don’t want to spend but rather save for future uses. This set of people choose to save because
they have more than what they needed to spend for the time being. On the other hand, there are
people who want to spend money to undertake some economic activities but don’t have the
required amount of financial resources. Therefore, Financial markets play a significant role in
transferring these surplus from savers (lenders) to ‘borrowers (investors). This role of transferring
financial resources from the surplus units to the deficit units is what is referred to as financial
intermediation. Thus, a Financial Market comprises of all institutions that play the role of financial
intermediation.
Financial Markets play an important role in promoting economic growth. It is commonly argued in
the economic literature that a well-functioning financial sector creates strong incentives for
investment and also fosters trade and business linkages thereby facilitating improved resource use
and technological diffusion. By mobilizing savings for productive investment and facilitating capital
inflows, financial markets stimulate investment in both physical and human resources. In an
economy, flow of surplus funds from surplus units to deficit units is essential for desired
achievement of national goals and priorities. Thus, this flow must be in right direction and for
productive purposes. For this, appropriate financial instruments and opportunities must be
available. The financial markets provide the platform for such flow’ where each saver can find and
exchange the appropriate financial assets as per his/her requirement. So, the efficiency of financial
market depends upon how efficiently the flow of funds is managed in an economy. Further, the
financial market must induce people to become producers/entrepreneurs and motivate individuals
and institutions to save more.
The most common method of raising capital by new companies is through sale of securities to the
public. It is called public issue. Corporate enterprises and Govt. raises long term funds from the
primary market by issuing financial securities. Both the new companies and the existing companies
can issue new securities on the primary market. When an existing company wants to raise additional
capital, securities are first offered to the existing shareholders on a preemptive basis. It is called
rights issue. Private placement is a way of selling securities privately to a small group of investors.
Figure : : Flow of funds from lenders to borrowers

The Figure is simplified form of the flow of funds from saving-surplus units (ultimate lenders) to
saving-deficit units (ultimate borrowers). The flow of funds moves from left to right, either directly
though financial markets or indirectly through financial intermediaries. A financial market helps to
link the savers and the investors by mobilizing funds between them. In doing so it performs what is
known as an allocative function. The financial markets not only help in the fast growth of industry
and economy but also contribute to the society’s well being and raising of the standard of living. So
financial markets should grow at a fast rate. Moreover, they should be efficient and more diversified.
As rightly pointed out by a financial expert, “The more varied the vehicle by which savings can flow
from ultimate savers to ultimate users of funds, the more efficient the financial markets or an
economy tend to be”. In brief, the financial market plays a significant role in the allocation of the
economy’s savings in efficient production of goods and services, and thus, assist in achieving the
desired national objectives.
FUNCTIONS OF FINANCIAL MARKETS
Q12- Explain the chronological progress of technology and its application in the financial sector..?
(v v v v v imp).
ANS- CHRONOLOGICAL PROGRESS OF TECHNOLOGY IN BANKING -
TECHNOLOGY AND PAYMENTS REVOLUTION

NPCI was set up under the Payment and Settlement Systems Act 2007 as a ‘not-for-profit’
organization conceived on the recommendation of the Payment and Banking Systems Board set up
by RBI in 2005 NPCI was incorporated in 2008 as a joint initiative of the Reserve Bank of India (RBI)
and the Indian Banks’ Association (IBA) with an ambitious vision of becoming the “best payments
network globally” and a mission to touch “every Indian with one or other payment services”. The
government envisioned NPCI a robust ‘backbone’ to digitize the economy. NCPI started off in 2008
by taking over the National Financial Switch (NFS) from the Institute of Development and Research in
Banking Technology (IDRBT), and began formal operations in 2010. Since then, it has made rapid
progress as the pioneer of the fintech revolution in India over the last decade. It came up with a
range of services and products: IMPS, CTS, NACH, UPI, RuPay, BHIM and AePS to name a few, all of
which have helped the financial sector to diversify their digital portfolios and also aid in the financial
inclusion goals of the country. In just one decade, NPCI has grown 10 times—from handling 2 mn
transactions per day to 22 mn transactions per day — and is well on its way to its target to process
100 mn transactions per day.
Q14- Explain he concept, features and relevance of portfolio management services? (v v v v v imp).
ANS- Concept of portfolio management services
Financial services are comprised of fund based financial services, non- fund based financial services
and fee based financial services. Portfolio management service (PMS) is a part of fee based financial
services group. Portfolio management service is a facility offered by a portfolio manager with the
intent to achieve the required rate of return on the corpus within the acceptable level of investment
risk. An investment portfolio is comprised of shares, fixed income securities, commodities, real
estate, structured finance products, and cash. A portfolio manager is a licensed investment
professional who specializes in analysing the investment objectives of the investor. The portfolio
manager has a vast professional knowledge of the financial and commodities markets and
investment management. On this backdrop the portfolio manager is better positioned to make
informed decisions for investments in securities as opposed to a layman. The portfolio manager
helps to build and maintain a robust investment portfolio. PMS is a typical customized service
offered to High Net-worth Individuals (HNI) customers. The service is tailored as per the investor’s
return requirements and the ability and willingness to assume the risk. The portfolio manager
ensures that the return requirements coincide with the risk profile.
FEATURES OF PMS
• The PMS is based on written contract between portfolio manager and investor. Such contract must
be in compliance with rules and regulations of the regulator. Investors are mainly high net value
individuals.
• The performance of the portfolio is fully dependent on the portfolio manager’s ability to beat or
outperform the market expectation. Therefore, a crucial aspect of using PMS is to conduct due
diligence of the portfolio managers past and current performance. A portfolio manager’s educational
and professional background, experience and expertise ultimately have significant impact on the
performance of a fund.
• The investor has to understand the investment strategy to be pursued by funds manager before
funds are committed. Under PMS arrangement, funds manager share all the details of proposed
investment portfolio including structure and strategies to be pursued to achieve agreed objectives. It
makes sense for the investor to understand the strategy before committing funds. If the strategies
are complex, then the viability of such strategies over the long-term period needs to be outlined
with complete transparency.
• The fee of the PMS is based on the performance of the portfolio manager. It provides a win-win
situation for both the parties. Fees charged for the management of the portfolio is expected not to
exceed industry standards, which is in the range of 1 to 3 per cent of the total value of investment. A
hurdle rate clause ensures profit sharing with the portfolio manager only if the performance of the
portfolio beats the minimum required hurdle rate. The profit-sharing of returns is typically 20 per
cent.
• Customer support and transparency are valued by investors, especially for discretionary portfolios.
Portfolio manager appraising portfolio performances frequently benefits from customer
engagement and establish a long-standing agreement.
How PMS is different from Mutual Funds
PMS and mutual funds are considered for investment of funds and hence are considered as a part of
investment banking business. However PMS is different from mutual funds. The following points
bring out how PMS is different from mutual funds.
• Customization: PMS is a complete customized service. Such service is tailor made keeping in view
the customer’s expectation and preference. As against this, mutual fund is not fully customized
product. It is customized only to the extent of classification of schemes and portfolio composition.
• Engagement: PMS is personalized service based on understanding between the portfolio manager
and investor. An investor can communicate any changes in the profile of portfolio, selection of asset
mix and trade-off between risk and return to maximize returns and trading profit. Mutual funds offer
limited engagement with the investor that includes purchase of units and sharing of financial data
such as net asset value of a unit and return per unit.
RELEVANCE AND BENEFITS OF PMS

Relevance of PMS- Portfolio Management Services are relevant to certain segment of Investors, who
have huge financial resources (wealth) but do not have proper understanding of financial markets
and investment management. The Investment services provided by portfolio manager under PMS
cater to a niche segment of investors. Such investors can be Individuals or Institutions who belongs
to the high net worth group. These investors look for –
Benefits of PMS
Q15- Explain he concept , Nature, Need of Merchant Banking and philosophy of merchant
banking? (v v v v v imp).
ANS- Concept - Despite the fact that merchant banking is emerging as one of the prominent
segment of financial service sector, it is difficult to define what merchant banking is. The reason is
very obvious as its limits have never been adequately and strictly defined and it caters to wide
variety of financial activities. Its scope of operation differs from country to country. Dictionary of
Banking and Finance explains merchant bank as an organisation that underwrites securities for
corporations, advises such clients on mergers and is involved in the ownership of commercial
ventures. The Guidelines for Merchant Bankers (issued by Ministry of Finance, Deptt of Economic
Affairs, Stock Exchange Division on 9-4- 1990) instead of defining merchant banking stated that
these guidelines shall apply to those presently engaged in merchant banking activity including as
managers to issue and undertake authorised activities. These activities interalia include
underwriting, portfolio management etc. Thus, to define merchant bankers a definite better
approach is to include those agencies as merchant bankers which do what a merchant banker does.
Securities and Exchange Board of India (Merchant Bankers) Regulations defines merchant bankers as
“any person who is engaged in the business of issue management either by making arrangement
regarding selling buying or subscribing to securities or acting as manager, consultant, adviser or
rendering corporate advisory services in relation to such issue management.”
NATURE
To understand nature of merchant banking well, a contrast may be involved, between commercial
banking, development banking, investment banking and merchant banking. Although the terms ‘
Merchant’ and‘ Commercial ‘ have similar connotations yet Commercial Banking and Merchant
Banking are different. Commercial bankers are basically a financing agency where as merchant banks
provide basically financial (not financing) services. Commercial bankers are comparatively retail
banking activity where as merchant banking is a whole sale banking (even if it provides finance). A
merchant banking firm does not undertake commercial banking where as its reverse is possible.
Basically the commercial banks concentrate their activities in accepting the deposits and providing
short-term finance to the customers. On the other hand, the basic objective of merchant banking, as
stated in previous section is to offer a package of services relating to the promotion and
development of the industrial projects, which includes counselling, advisory services, restructuring,
financial engineering, etc. These services of merchant banking ensure efficient procurement and
better utilization of funds. Thus, direct lending is not the main concern of merchant bankers. Hence,
both the banking systems are different in their nature of activities. While comparing the
development banks with merchant banks, a close relationship arises in certain areas like,
promotional and development activities. The basic objective of development bank in the developing
economy is to boost the process of economic development by providing long term and medium term
funds to the industrial sector. They also provide funds at the concessional rates of interest and other
incentives to establish industrial units in the rural and backward regions. Besides this, they also assist
in developing particular industry, entrepreneurship development and technology up-gradation from
time to time. Development banks strengthen and broaden the capital markets where they exist
actively. However where capital market is not active, development banks work as channelising
agency between the savers and users of the fund. Merchant banks in their own roles assist in this
process by providing various services to the clients, In brief some functions of development banks
and merchant banks are inter-related and close relationship exists between them. In India almost all
development banks have established their merchant banking division. Merchant banks and
investment banks are different kinds of financial institutions that perform different services. In
practice, the fine lines that separate the functions of merchant banks and investment banks tend to
blur. Traditional merchant banks often expand into the field of securities underwriting, while many
investment banks participate in trade financing activities. In theory, investment banks and merchant
banks render different services. Pure investment banks raise funds by registering and issuing debt or
equity and selling it in a market. Generally investment banks only participated in underwriting and
selling securities in large blocks. Investment banks facilitate mergers and acquisitions through share
sales and provide research and financial consulting to companies. Traditionally, investment banks
did not deal with the general public on the other hand merchant banks primarily perform
international financing activities such as foreign corporate investing, foreign real estate investment,
trade finance and international transaction facilitation. Some of the activities that a pure merchant
bank is involved in may include issuing letters of credit, transferring funds internationally, trade
consulting and co-investment in projects involving trade of one form or another. The current
offerings of investment banks and merchant banks varies by the institution offering the services, but
there are a few characteristics that most companies that offer both investment and merchant
banking, share.
NEED OF MERCHANT BANKING
Setting up of new industrial units, expansion, diversification and modernisation of existing units have
been the central plank for the rapid industrialisation of an economy. This process besides adequate
financial resources requires sound technical and managerial inputs. Though, a number of financial
agencies are instituted to cater to the needs of rapid industrialisation, the task of financing has
become more complicated, thus requiring a fresh look. In view of increasing specialisation in every
sphere the process of industrialisation from the primary planning stages of setting up a new unit to
that of research and development including expansion, diversification or modernisation requires the
services of specialists or professionals. Thus, the need for having expert advice, guidance of
specialists or professionals in the field has become an absolute necessity with rapid economic
growth, elaborated procedures and spectacular industrial development in India. It has also been
necessitated by a plethora of regulations for industry, capital, issues, foreign investment and
collaboration, amalgamations, Companies Act, SEBI, Government policy regarding backward area
development, export promotion and import substitution etc. A few agencies are able to provide
expert advice in the diversified areas mentioned above. But it is inconvenient for entrepreneurs/
industrialists to knock at the doors of several agencies in getting the guidance of specialists and
professionals. Hence, it is highly essential to make available expert advice in diversified areas under
a single roof to provide a comfortable cushion to entrepreneurs to accelerate industrial
development. This is where merchant bankers come to picture
FIRST PRIORITY MOST IMPORTANT SHORT QUESTIONS

Q1- Certificate of deposits? (v v v v v imp).
ANS- Certificate of Deposit (CD) is a money market debt instrument. CDs are issued as a discounted
instruments. CDs are issued by banks and financial institutions mainly to raise funds by offering
higher interest rates from corporates, high net worth individuals and trusts etc. Some of the top
commercial banks in India have been getting their CDs rated for better access to the market even
though such rating is not required under existing guidelines. Foreign and private sector banks
especially those who do not have wide branch network in urban and rural areas to tap low cost
deposit funds use this instrument to raise funds. Banks can issue CDs from 7 days to 1 year period.
Financial institutions can issue CDs with an initial maturity of one year to 3 years. CDs have to be
compulsorily issued in the dematerialised form.
Q2- Forfaiting? (v v v v v imp).

ANS- Forfaiting is a financial tool for exporters, enabling them to convert their ‘credit sales’ to ‘cash
sales’ by discounting their receivables with an agency called forfaitor. Forfaiting denotes the
purchase of trade bills or promissory notes by a bank or financial institution without recourse to
seller. For exporters it is a ‘Risk Management’ tool as well because by selling the export receivables
to the forfaiter the exporter is relieved of the inherent political and commercial risks involved in
international trade. Thus, all risks and collection problems are fully the purchaser’s (forfaiter’s)
responsibility who pays cash to seller after discounting the notes or bills. It is backed by bank
guarantee. In India, the Export Import Bank of India (EXIM Bank) facilitates this service with an
overseas forfaiter agency for which they charge a commission.
Q3- Burglary Insurance? (v v v v v imp).

ANS-
Q4- Functions of a Reinsurance Broker? (v v v v v imp).

ANS-
Q5- Securitisation of Housing Loans? (v v v v v imp).

ANS- In order to mobilise more resources for the housing sector, National Housing Bank has taken a
new initiative by undertaking securitisation of home loans granted by housing finance companies
and banks. Securitisation by NHB involves purchase of home loans backed by mortgages from
housing finance companies and banks (called the originators) and transfer of the same to the
investors for consideration. NHB acts as trustee for such investors and issues Pass Through
Certificates to the investors. As trustees, NHB arranges for collection of cash flows on the securitised
loans and its distribution to the investors. It receives Trusteeship Fee for this purpose. The process of
securitisation called Residential Mortgage-backed Securitisation (RMBS) is beneficial to both the
orginators and the investors. Originators augment their liquid resources immediately — they need
not wait for long to realize the EMIs from their borrowers. Hence they can lend further on the basis
of resources received on securitisation. For credit enhancement of the Pass Through Certificates
(PTCs), orginators provide to the trustees a collateral in the form of cash deposit or bank gurantee.
The investors — institutions and individuals — get an additional avenue for investment of their
excess funds with greater degree of security. The recovery of housing loans has generally proved to
be very high and hence chances of bad debts are very insignificant. The investors get a return
payable monthly. Till 2003-04 the NHB has completed ten securitisation transactions involving 35116
individual home loans originated by 6 housing finance companies and one public sector bank,
aggregating Rs. 663.92 crore. NHB has also invested a small sum in these PTCs. The average
collection efficiency in each securitised pool ranged between 95% to 99%. The total collections from
the pools were adequate to service the investors. Therefore, necessity was not felt to tap the
collaterals
Q6- Perils covered under standard fire insurance policy? (v v v v v imp).

ANS- Discussed in long
Q7- Credit Cards and Debit Cards? (v v v v v imp).

ANS- Debit Card
On production of a debit card the card details are fed through a terminal at the merchant
establishment and the card holder is asked to key in his personal identification number which is
allotted by the card issuer. On completion of the transaction the amount is immediately debited
from the card holder’s account and transferred to the account of merchant establishment. In the
case of the debit card no over drawing is allowed. The debit card system is growing very fast in India
due to massive computerization of banking business. Many banks are issuing Debit-cumATM cards
and are also sharing their networks.
Credit Cards
The credit card system can give a wide range of products and services. The varied uses of credit
cards can be obtained from a spectrum of acceptance venues. Today’s payment business is growing
dramatically while consumer demand is driving the industry’s growth, technology is making it
possible to address that demand with a broader range of products and with the ability to support
these products, at an expanded spectrum of points of interaction. The growth of service industry
mainly depends on knowing the needs of the customer. These needs are taken care off by different
card issuers which target different segments of customers. Thus there are generally four basic types
of cards based on the issuers:
Q8- Treasury Bills? (v v v v v imp).

ANS- Treasury bills are issued under multiple price based auctions. Bidders are required to quote
price per Rs. 100 face value of treasury bill. The competitive bids offered at the minimum offer price
as determined by the RBI are accepted. Other bids tendered at higher than the minimum offer price
are accepted at the price as quoted in the respective bid. Bids quoted lower than the minimum price
are rejected. The details about the size of issue and implicit yield emerged in recent auctions of
various T-bills are given in Table
Q9- Over the Counter Exchange of India (OTCEI)? (v v v v v imp).

ANS- ‘Over The Counter’ (OTC) market is an informally organised group of brokers and dealers. It
handles both primary issues and secondary transactions especially of those securities which are not
listed in stock exchanges. The Over the Counter market is a negotiated market, because prices are
settled through individual bargaining between buyers and sellers. In OTC market the business is not
conducted at any one place designated as market place. Some stocks trade in the Over the Counter
Market because the company is small or unknown or the company simply does not wish to list the
security on a stock exchange or stock is closely held. Thus, over the counter market is the only place
where certain stocks can be purchased or sold. Small companies or companies that do not meet
exchange listing requirements are traded in over the counter market that have limited marketability
and liquidity. The market is not well organised. Recently SEBI has taken steps to activate this market
and OTCEI is established.
Q10- Depository Participants (DP)? (v v v v v imp).

ANS- A DP is investors’ representative in the depository system and as per the SEBI guidelines,
financial institutions/banks/custodians/stock brokers etc. can become DPs provided they meet the
necessary requirements prescribed by SEBI. DP is also an agent of depository which functions as a
link between the depository and the beneficial owner of the securities. DP has to get itself registered
as such under the SEBI Act. The relationship between the depository and the DP will be of a principal
and agent and their relation will be governed by the bye-laws of the depository and the agreement
between them. Application for registration as DP is to be submitted to a depository with which it
wants to be associated. The registration granted is valid for five years and can be renewed. As
depository holding the securities shall maintain ownership records in the name of each DP, DP in
return as an agent of depository, shall maintain ownership records of every beneficial owner
(investor) in book entry form. A DP is the first point of contact with the investor and serves as a link
between the investor and the company through depository in dematerialisation of shares and other
electronic transactions. A company is not allowed to entertain a demat request from investors
directly and investors have to necessarily initiate the process through a DP.
Q11- Liability insurance? (v v v v v imp).

ANS-
Q12- Commercial paper? (v v v v v imp).

ANS- Commercial papers are unsecured money market instruments. These are issued in the form of
promissory notes. CPs are issued by corporates, financial institutions and primary dealers to raise
funds for working capital. All CP issues have to be mandatorily rated by one of the recognised credit
rating agencies in India. The minimum required rating is P-2 of CRISIL or such equivalent rating by
other recognised rating agencies in India. In view of this, companies having highest rating will be
able to raise funds at reasonable cost through CP for working capital. Every issuer must appoint a
schedule bank as an Issuing and Paying Agent (IPA) for issuance of CPs. The IPA has to ensure that
the issuer has the minimum rating stipulated by the RBI and amount mobilised through the issuance
of CP is within the quantum indicted by the credit rating agency. In order to provide transparency
and also facilitate benchmarking of CP issues, IPA would report issuance of CP on NDS platform by
the end of the day. Individuals, corporates, insurance companies, banks, etc., are eligible to
subscribe CPs. Non-Resident Indians can invest in CP on a non-repatriable, non-transferable basis.
FIIs (Foreign Institutional Investors) also can invest in CPs within the overall limits prescribed by the
SEBI. Of these various investors, banks, corporates and mutual funds are the most active investors in
CPs.
Q13- Motor Insurance? (v v v v v imp).

ANS- Today, almost all the countries have some legislation mandating compulsory TP cover for
motor vehicles. In the face of mounting costs of automobile accidents and the probability of being
involved in one what should the driver do to protect against financial consequences of risk? Inspite
of increased cost everyone prefers insurance. Non-life Insurance Because of personal catastrophic
loss hazard involved in liability risk, insurance is the only feasible solution. The growth of motor
insurance business induced intense competition in the market and the consequent rate cuts and
huge losses to motor insurers. In India, a statutory body called Tariff Advisory Committee was
constituted in 1968 to fix control, and regulate the motor insurance premium rates, terms and
conditions to be offered to insuring public. Currently no insurer in India can offer Motor insurance
rates, terms and conditions beyond what is prescribed by the Motor Tariff. In many developed
markets of the world tariff agreements have been withdrawn and motor insurance rates have been
left to be governed by free market forces. In India too the Insurance regulatory body, Insurance
Regulatory and Development Authority, has decided, in principle, to withdraw the tariff for at least
Own Damage portion of Motor Insurance w.e.f. 01.04.2005.
Scope of Motor Insurance

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01 LONG IMP QUESTIONS

02 EXTRA LONG QUESTIONS

03 VERY IMP SHORT NOTES

04 EXTRA SHORT NOTES

ये book के वल ignou एग्जाम की तैयारी कराने के

IInluces very important

fully focused for exam

Minimum preparation maximum

100 percent result

High quality materials in books

only important questions

MMPF 06- MANAGEMENT OF FINANCIAL SERVICES

PARTIES INVOLVED IN TRANSACTION OF ASSET SECURITISATION

Assess Management Company- discussed earlier

MAIN CLAUSES IN THE LEASE AGREEMENT

TO BUY OR LEASE : A CRUCIAL DECISION

2-- Lessor’s Perspective

REGULATION OF CREDIT RATING AGENCIES IN INDIA

Perils Covered Under Standard Fire Policy

Role of Fire Insurance

Scope of Fire Policy

SIGNIFICANCE OF FINANCIAL SERVICES

Figure : : Flow of funds from lenders to borrowers

TECHNOLOGY AND PAYMENTS REVOLUTION

RELEVANCE AND BENEFITS OF PMS

FIRST PRIORITY MOST IMPORTANT SHORT QUESTIONS

Q2- Forfaiting? (v v v v v imp).

Q3- Burglary Insurance? (v v v v v imp).

Q4- Functions of a Reinsurance Broker? (v v v v v imp).

Q5- Securitisation of Housing Loans? (v v v v v imp).

Q6- Perils covered under standard fire insurance policy? (v v v v v imp).

Q7- Credit Cards and Debit Cards? (v v v v v imp).

Q8- Treasury Bills? (v v v v v imp).

Q9- Over the Counter Exchange of India (OTCEI)? (v v v v v imp).

Q10- Depository Participants (DP)? (v v v v v imp).

Q11- Liability insurance? (v v v v v imp).

Q12- Commercial paper? (v v v v v imp).

Q13- Motor Insurance? (v v v v v imp).

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