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Sikkim Manipal University 4th Semester Spring 2011

Name

: Alaji Mamadou Cire BAH

Roll No.

: 540910685

Subject : Merchant Banking and Financial Services Subject Code : MF0008

Program

: MBA Semester 4

University University

Sikkim Manipal

Learning Centre : KnowledgeWorkz Limited (02544)


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Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

MBA SEMESTER 4 MERCHANT BANKING AND FINANCIAL SERVICES MF0008 SET - 1 1. Differentiate between capital market and money market instruments. Answer: Capital Market Instruments The capital market in India is being subject to various types of reforms following the recommendations of various committees set-up by the Government from time to time including the S. Chakravarty Committee on working of the Monetary System (1985), G.S.Patel Committee on Organization and Management of Stock Exchanges (1986), M. Narasimham Committee on the Financial Systems (December 1991), Shah Committee on Financial Companies (1992), Nadkarni Committee on Trading in Public Sector Bonds and units of Mutual Funds, and report of Jankiraman Committee set up on April 30, 1992 to investigate irregularities in funds management by commercial banks and financial institutions and their dealings in government securities, public sector bonds, UTI units and similar instruments. The Government has adopted vigorously the policy of implementing the economic liberalization and reforms since June, 1991 by effecting changes in its industrial policy, trade and exchange rate policy, foreign investment policy, taxation, financial sector reforms, etc. which have been carrying cumulative impact on the health of corporate sector and the capital market in general and on the profession of the persons engaged in the services of capital market in particular through reduction of bureaucratic control on the economic system, covering liberalization in licensing system, foreign exchange controls, removal of MRTP hindrances etc. The Central Government vide press release on July 3, 1993 has exhibited the outcome of various reforms. Money Market Instruments Money market is comprised of the following important instruments:
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Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

1) Call Money Market: In call money market, day to day surplus funds are traded in. Loans are made in this market for short-term duration with maturity varying between one day to a fortnight repayable on demand at the option of borrower or lender. It is highly liquid. Participants in call money market are scheduled commercial banks, non-scheduled commercial banks, foreign banks, state, district and urban co-operative banks, co-operative banks, DFHI, ICICI, IFCI, IDBI, LIC, GIC, UTI, NABARD as allowed by RBI as lenders and not the borrowers in call money market, in case these institutions are having bulk lendable resources. Rs.20 cr. per transaction is minimum size for the institutions to lend. The institutions have to operate through DFHI. There is no interest ceiling at present. The market operates at the principal industrial and commercial centers like Bombay, Calcutta, Madras and Delhi. There are two call rates at present viz. Inter bank call rate and DFHI rate in the money market. 2) Treasury Bills: There are three types of treasury bills at present in vogue in the money market viz. 91 days treasury bills, 182 days treasury bills and 364 days treasury bills. Treasury bills represent central government borrowings against a bill or a promissory note. Treasury bills are highly liquid and risk- free instruments backed by RBIs purchase. There are two forms of treasury bills: a) Ordinary Issued to public and RBI by the Government to meet the short term requirements of funds: and, b) Ad hoc Created in favour of RBI. Nearly 90% of the treasury bills are subscribed by banks, financial institutions, RBI and DFHI. RBI rediscounts the treasury bills held by banks, financial institutions and DFHL. However, DFHL does not deal in 91 days treasury bills. Treasury Bill Rate is the rate of discount at which treasury bills are solved by RBI. Return on treasury bills is the discount at which they are sold and difference between the selling price and their redemption value.

Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

Rate of interest on treasury bills is lowest. The rate of interest is fixed by RBI from time to time. Secondary markets in treasury bills require involvement of brokers and dealers and banks have to seek RBI permission to avail of their services. 3) Commercial Bills: Bills of Exchange are an important financial instrument used for financing the credit sales. It is a self-liquidating instrument. It carries low degree of risk. It is also known as bankers acceptances. Commercial bills may be demand bills and usance bills. Demand bill is payable immediately at sight, or on presentation to the drawee. Time may or may not be specified for maturity of bills. Usance bill or time bill is payable at a specified later date as recognized by custom or usage for payment of bills. Commercial bills may be clean or documentary bills. A Clean bill is the one when documents are enclosed, deliverable against acceptance of drawee (D/A). After delivery of documents it becomes clean bill. Documentary bill is document against payment (D/P) bill, accepted by the drawee and documents of title are held by the bankers till the bill is matured and paid. The bills could be inland bills, foreign bills, export bills import bills as per circumstances. Commercial bills are used for financing the trade between countries. Hundis are the indigenous form of commercial bills which are used by usage for financing the movement for agricultural produce, inland trade by indigenous bankers. Hundis are known by different regions viz.shahjog, namjog, dekharnoor jog, jokhmi jog, dhani jog. Two types of Hundis, Darshni (sight or demand) or Muddati (usance) are in use for 30 to 120 days. Commercial banks used to discount hundis but now RBI has banned rediscounting of commercial bills. Size of bill market in India- Commercial bills help inter-corporate movement of funds for financing the trade but RBI has put ban on the banks to rediscount the CBs. The usual maturity period for bill is: (a) Usance bills/Hundis- 30 to 120 days;
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Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

(b) Export bills- 90 days; and (c) Import bills- 60 days. 4) Commercial Paper: Commercial papers are new instruments in the form of short duration usance promissory notes with fixed maturity issued mostly by the leading, creditworthy and highly credit rated companies. Commercial papers are unsecured instruments negotiable by endorsement and delivery. Commercial papers have buy-back facility from the issuer and are issued in a bearer form on discount to face value basis. Commercial papers are usually in large denomination and are released in the market through banks or merchant banks or dealers or brokers in the open market or are sold through direct placement with lenders or investors. Issue of commercial paper may be backed by a line of credit or a revolving underwriting facility from banks to ensure continued availability of funds on each rollover of the paper. RBI issued guidelines on January 1, 1990 introducing commercial papers in Indian money market. CP has gained importance in the Indian money market. The outstanding amount of CP issued increased sharply from Rs. 577.25 cr. as on March 31, 1993 to Rs. 3264.05 cr. as on March 31, 1994 and further Rs. 4210.55 as on July 31, 1994. 5) Certificate of Deposit: Certificate of deposits are also known as Negotiable Certificate of Deposits (NCDs) and represent bank deposit accounts which are transferable from one party to another. In other words, Certificate of deposits are documents of title to time deposits with banks and they are marketable in bearer or registered form, bearing a specified rate of interest for a specified period. Certificate of deposits are traded in the secondary market and are highly liquid and risk-free for payment of interest and repayment of principal. In India, Certificate of deposits was permitted by RBI through a scheme launched in June, 1989 and modified subsequently in May, 1990. Certificate of deposit can be issued to individuals, corporations, companies, trusts, funds, associations and NRIs. The maturity period of Certificate of deposits vary between 3 months to 12 months. Rate of interest is market determined. The
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Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

minimum amount of Certificate of deposits is one crore of rupees or more in multiples of Rs.25 Lakh. Banks have to seek authorization from RBI for issuing Certificate of deposits. DFHI has been helping in creating the secondary market for Certificate of deposits. Apart from 46 scheduled commercial banks, all India financial institutions viz. IDBI, ICICI, IFCI, IRBI, SIDBI, EXIM, BANK, SCICI and CDs. As on 31-5-1994 Rs. 2249 cr. was outstanding against CDs issued by them as against Rs. 6121 cr. by banks. 2. Compare the marketing strategy of any financial services company with another. Answer: Marketing of Financial Services: The role of financial services in stimulating and sustaining economic growth is well-known. Financial services because of their intangible nature and the fact that services delivery is variable have traditionally been considered more difficult to market than physical products. However, the service organizations make an attempt to tangibalise their services with the help of something. For e. g. LICs logo of two hands protecting the light of the lamp indicates the protection assured by the company. Services are inseparable from the one who is providing it. Services cannot be sold like goods wherever the customer wants it. Whenever a service like banking is given, the banker and the customer must come together for an interaction. Though the technology is trying to make some changes in this regard; separation of the service provider and the service receiver has not been achieved completely. Services are also perishable. Because of their intangibility, they cannot be stored. The intangibility of the service also makes it heterogeneous in nature. The service provided by one stock broker will be completely different from the other one. The services provided by ICICI Bank and those provided by Vijaya
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Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

Bank differ completely. Because of the heterogeneity of the service, it becomes very difficult to standardize them. Because of all the above-mentioned features, providing a consistent level of service becomes a major challenge to the marketer in todays competitive environment. Marketing Strategies for services: Marketing strategies refer to the plan of action that the organization will have to adopt as regards its marketing mix elements are concerned. Marketing mix is defined as the elements an organization controls that can be used to satisfy or communicate with customers. The traditional marketing mix is composed of the four Ps: product, price, place (distribution) and promotion. These elements appear as are decision variables in any marketing text or marketing plan. The marketing mix philosophy implies that there is an optional mix of the four factors for a given market segment at a given point of time. The concept of four Ps is very essential to the successful marketing of services. However, the strategies for the four Ps require some modifications when applied to services. In case of marketing of products, the 4th P i.e., Promotion include advertising, sales promotion, publicity No doubt, the promotion is important in services too, but as the employees are also involved in the real time marketing in addition to their regulars operational roles, the promotion includes training the service delivery people, their dress, appearance etc. Moreover, in the absence of a physical product, convincing the customer about the features of the service is more challenging. At the same time, fixing the right price for the intangible $ service is a very difficult task. Now let us try to understand the decisions that the marketer has to take regarding the Product, Price, Place and Promotion. The following sections deal with the important decisions that the manager has to take to satisfy the customer in a better way.

Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

3. Explain the mechanism of securitization and the benefits for a company: Answer: The concept of securitisation is best understood by considering a typical transaction.

In securitisation, the originator sells receivables to a Special Purpose Vehicle (SPV) established to isolate the receivables and to perform other functions (e.g. restructuring of cash flows and provision of credit enhancement and liquidity support). The SPV is usually structured as a bankruptcy-remote trust or incorporated entity. The SPV finances the purchase of receivables by issuing securities (usually notes, commercial paper, bills, bonds, or preferred stock) to investors. Legal agreements delineate the rights and obligations of all parties to the transaction, including the appointment of an administrator to manage the receivables where necessary. One or more financial institutions are usually involved in structuring and marketing the securities issued by the SPV. To facilitate investor demand, credit rating agencies assess the likelihood that the SPV will default on its obligations
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Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

and assign an appropriate credit rating. Credit enhancement and liquidity support is usually obtained by the SPV to ensure a high rating for the securities. Features of Securitization A securitized instrument generally has the following features: Wide distribution: The basic purpose of securitization is to distribute the product. The extent of distribution which the originator would like to achieve is based on a comparative analysis of the costs and the benefits that can be achieved. Wider distribution leads to a cost-benefit in that the issuer is able to market the product with lower return and hence, lower financial cost to him. In practice, securitization issues are still difficult for retail investors to understand. Hence, most securitizations are privately placed with professional investors. However, it is likely that in the future, retail investors could be attracted into buying securitized products. Homogeneity: To serve as a marketable instrument, the instrument should be packaged into homogenous lots. Most securitized instruments are broken into lots affordable to the marginal investor, and hence, the minimum denomination becomes relative to the needs of the small investor. The need to break the whole lot to be securitized into several homogenous lots makes securitization an exercise of integration and differentiation; integration of several assets into one lump and then differentiation into uniform marketable lots. Marketability: The purpose of securitization is to ensure marketability to financial claims. Liquidity is afforded to a securitized instrument either by introducing it into an organized market or by one or more agencies acting as market makers i.e. agreeing to buy and sell the instrument at their market determined prices. This is one of the most important features of a securitized instrument, and the others that follow are mostly imported only to ensure this one. The concept of marketability involves two postulates: (a) the legal and systemic possibility of marketing the instrument; (b) the existence of a market for the instrument.

Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

Merchantable quality: To be market-acceptable, a securitized product should be of saleable quality. This concept, in case of physical goods, is something which is acceptable in normal trade. When applied to financial products, it would mean that the financial commitments embodied in the instruments are secured to the investors satisfaction. In case of securitization of receivables, the concept of quality undergoes a drastic change, making rating a universal requirement for securitizations. The quality of the debtors claim assumes significance, which at times enables investors to rely purely on the credit rating of the debtors and hence, make the instrument totally independent of the originators own rating. Deconstruction: Securitization is the process of deconstruction wherein, if one envisages an entitys assets as being composed of claims to various cash flows, the process of securitization would split apart these cash flows into different buckets, classify them, and sell these classified parts to different investors according to their needs. Thus securitization breaks the entity into various sub-sets. Integration and differentiation: Securitization is the process of integration and differentiation where the entity that securitizes its assets first pools them together into a common pool. This is called the process of integration. Then, the pool itself is broken into instruments of fixed denomination. This is the process of differentiation. Commoditization: Securitization is the process of commoditization, where the basic idea is to take the outcome of this process into the capital market. Thus, the result of every securitization process, whatever might be the area to which it is applied, is to create certain instruments which can be placed in the market.

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Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

Sikkim Manipal University 4th Semester Spring 2011

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Alaji Mamadou Cire BAH 540910685

MF0008 SET 1

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