FINANCIAL MARKETS AND SERVICES

UNIT-3 FINANCIAL SERVICES

Meaning of Financial Services

Financial services refer to the activities of channelizing the flow of funds from
the savers to the users. It involves the mobilization of savings of the persons and
institutions that have surplus funds and allocating or lending them to the
persons and institutions who are in need of such funds.

Features or Characteristics of financial services

1. Intangible
2. Heterogeneity
3. Dominance of human element
4. Perishability
5. Information based
6. Fluctuating demand
7. Customer orientation
8. Simultaneous performance
9. Protection of customer’s interest
10. Dynamism

Objectives of financial services

1. Mobilization of funds
2. Allocations of funds
3. Rendering of specialized services like credit rating, venture capital financing,
leasing, housing finance, etc.,
4. Contributing to the economic development of the country

Advantages / Significance of financial services

1. Promotion of savings
2. Economic growth
3. Capital formation
4. Provision of liquidity
5. Financial intermediation
6. Contribution to GDP & GNP
7. Creation of employment opportunities

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Types of financial services
1. Fund Based Financial services
2. Fee Based Financial services

1. Fund based services are those where banks provide short and long term
funds to individuals and businesses. The financing is provided based on
the repayment power of an individual or a business. These are basically
different types of loans offered by banks.

a. Leasing
b. Factoring
c. Discounting of Bill
d. Venture Capital
e. Loan
f. Housing and Vehicle Finance
g. Hire Purchase System

2. Non-fund based services or fee based services are those banks operate
certain functions and earn a fee out of the same. This fee can be in the form
of dividends or brokerages or a commission.

a. Portfolio management
b. Loan Syndication
c. Corporate Counselling
d. Foreign Collaborations
e. Mergers and Acquisitions
f. Capital Restricting
g. Issue Management
h. Merchant Banking

Leasing (Lease Financing)

Lease financing is one
of the important sources of medium- and long-term financing where the owner
of an asset gives another person, the right to use that asset against periodical
payments. The owner of the asset is known as lessor and the user is called
lessee. 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

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is returned to the lessor or an option is given to the lessee either to purchase the
asset or to renew the lease agreement.

Types of Lease
Depending upon the transfer of risk and rewards to the lessee, the period of
lease and the number of parties to the transaction, lease financing can be
classified into two categories. Finance lease and operating lease.

Finance Lease
It is the lease where the lessor transfers substantially all the risks and rewards
of ownership of assets to the lessee for lease rentals. In other words, it puts the
lessee in the same condition as he/she would have been if he/she had purchased
the asset. Finance lease has two phases: The first one is called primary period.
This is non-cancellable period and in this period, the lessor recovers his total
investment through lease rental. The primary period may last for indefinite
period of time. The lease rental for the secondary period is much smaller than
that of primary period.

Features of Finance Lease

a) A finance lease is a device that gives the lessee a right to use an asset.
b) The lease rental charged by the lessor during the primary period of lease is
sufficient to recover his/her investment.
c) The lease rental for the secondary period is much smaller. This is often known
as peppercorn rental.
d) Lessee is responsible for the maintenance of asset.
e) No asset-based risk and rewards is taken by lessor.
f) Such type of lease is non-cancellable; the lessor’s investment is assured.

Operating Lease / Service Lease

Lease other than finance lease is called operating lease. Here risks and rewards
incidental to the ownership of asset are not transferred by the lessor to the
lessee. The term of such lease is much less than the economic life of the asset
and thus the total investment of the lessor is not recovered through lease rental
during the primary period of lease. In case of operating lease, the lessor usually
provides advice to the lessee for repair, maintenance and technical knowhow of
the leased asset and that is why this type of lease is also known as service lease.

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Features of Operating/Service Lease
a) The lease term is much lower than the economic life of the asset.
b) The lessee has the right to terminate the lease by giving a short notice and no
penalty is charged for that.
c) The lessor provides the technical knowhow of the leased asset to the lessee.
d) Risks and rewards incidental to the ownership of asset are borne by the
lessor.
e) Lessor has to depend on leasing of an asset to different lessee for recovery of
his/her investment.

Advantages of lease financing

Leasing is becoming a preferred solution to resolve fixed asset requirements vs.

purchasing the asset.
While evaluating this investment, it is essential for the owner of the capital to
understand whether leasing would yield better returns on capital or not. Let us
have a look at leasing advantages and disadvantages:

1. Balanced Cash Outflow: The biggest advantage of leasing is that cash outflow
or payments related to leasing are spread out over several years, hence saving
the burden of one-time significant cash payment. This helps a business to
maintain a steady cash-flow profile.

2. Quality Assets: While leasing an asset, the ownership of the asset still lies
with the lessor whereas the lessee just pays the rental expense. Given this
agreement, it becomes plausible for a business to invest in good quality assets
which might look unaffordable or expensive otherwise.

3. Better Usage of Capital: Given that a company chooses to lease over

investing in an asset by purchasing, it releases capital for the business to fund its
other capital needs or to save money for a better capital investment decision.

4. Tax Benefit: Leasing expense or lease payments are considered as operating

expenses, and hence, of interest, are tax deductible.

5. Off-Balance Sheet Debt: Although lease expenses get the same treatment as
that of interest expense, the lease itself is treated differently from debt. Leasing
is classified as an off-balance sheet debt and doesn’t appear on company’s
balance sheet.

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6. Better Planning: Lease expenses usually remain constant for over the asset’s
life or lease tenor, or grow in line with inflation. This helps in planning expense
or cash outflow when undertaking a budgeting exercise.

7. Low Capital Expenditure: Leasing is an ideal option for a newly set-up

business given that it means lower initial cost and lower CapEx requirements.

8. No Risk of Obsolescence: For businesses operating in the sector, where there

is a high risk of technology becoming obsolete, leasing yields great returns and
saves the business from the risk of investing in a technology that might soon
become out-dated. For example, it is ideal for the technology business.

9. Termination Rights: At the end of the leasing period, the lessee holds the
right to buy the property and terminate the leasing contract, this providing
flexibility to business.

Disadvantages of lease financing

1. Lease Expenses: Lease payments are treated as expenses rather than as

equity payments towards an asset.

2. Limited Financial Benefits: If paying lease payments towards a land, the

business cannot benefit from any appreciation in the value of the land. The long-
term lease agreement also remains a burden on the business as the agreement is
locked and the expenses for several years are fixed. In a case when the use of
asset does not serve the requirement after some years, lease payments become a
burden.

3. Reduced Return for Equity Holders: Given that lease expenses reduce the
net income without any appreciation in value, it means limited returns or
reduced returns for an equity shareholder.
In such case, the objective of wealth maximization for shareholders is not
achieved.

4. Debt: Although lease doesn’t appear on the balance sheet of a company,

investors still consider long-term lease as debt and adjust their valuation of a
business to include leases.

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5. Limited Access of Other Loans: Given that investors treat long-term leases
as debt, it might become difficult for a business to tap capital markets and raise
further loans or other forms of debt from the market.

6. Processing and Documentation: Overall, to enter into a lease agreement is a

complex process and requires thorough documentation and proper examination
of an asset being leased.

7. No Ownership: At the end of leasing period the lessee doesn’t end up

becoming the owner of the asset though quite a good sum of payment is being
done over the years towards the asset.

8. Maintenance of the Asset: The lessee remains responsible for the

maintenance and proper operation of the asset being leased.

9. Limited Tax Benefit: For a new start-up, the tax expense is likely to be
minimal. In these circumstances, there is no added tax advantage that can be
derived from leasing expenses.

Factoring

Factoring is a financial service in which the business entity sells its bill
receivables to a third party at a discount in order to raise funds. It differs from
invoice discounting.
The concept of invoice discounting involves, getting the invoice discounted at a
certain rate to get the funds, whereas the concept of factoring is broader.

Factoring involves the selling of all the accounts receivable to an outside agency.
Such an agency is called a factor.

Concept of Factoring
The seller makes the sale of goods or services and generates invoices for the
same. The business then sells all its invoices to a third party called the factor.
The factor pays the seller, after deducting some discount on the invoice value.
The rate of discount in factoring ranges from 2 to 6 percent. However, the factor
does not make the payment of all invoices immediately to the seller. Rather, it
pays only up to 75 to 80 percent of the invoice value after deducting the
discount. The remaining 20 to 25 percent of the invoice value is paid after the

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factor receives the payments from the seller’s customers. It is called factor
reserve.

Functions of Factor

The factor performs the following functions:

1. Maintenance of Sales Ledger: A factor is responsible for maintaining the

sales ledger of the client. So the factor takes care of all the sales transactions of
the client.
2. Financing: The factor finances the client by purchasing all the account
receivables.
3. Credit Protection: In the case of non-recourse factoring, the risk of non-
payment or bad debts is on the factor.
4. Collection of Money: The factor performs the duty of collecting funds from
the client’s debtors. This enables the client to focus on core areas of business
instead of putting energies in the collection of money.

Types of Factoring
 Recourse: Recourse factoring is the most common form of factoring. Here,
a company sells a receivable to the factoring provider. The factoring
company pays the company a certain amount of the invoice immediately.
 If the customer fails to pay, the company must buy back the receivable
from the factoring provider - minus the amount already received. With
recourse factoring, the risk of non-payment is always borne by the party
selling the receivable.
 Non-Recourse: In non-recourse factoring, the risk of non-payment is
borne by the factoring provider. This means that a company receives part
of the receivable amount immediately and the factoring company then
takes care of collecting the receivable from the debtor.
 With non-recourse factoring, however, it always depends on the
conditions in the factoring contract. Some providers only bear the risk of
non-payment if the debtor has filed for insolvency. If the debtor is not
insolvent and only refuses to pay an invoice, the default risk may still lie
with the selling company.

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 Advance: In this, advance is paid to the client by factor against uncollected
receivables.
 Maturity: In this, bank collects money from the customer and pays to firm
on due date or before.
 Full Factoring:

a) Disclosed: If factor name is represented on the invoice of the goods or

services and asks customer to pay the factor.
b) Undisclosed: Factor is not mentioned on the invoice of the goods or
services by manufacturer.
c) Domestic: If factor name is represented on the invoice of the goods or
services and asks customer to pay the factor.
d) Cross-Border: It involves four parties, the exporter, the export factor, the
import factor and the importer. It is also called as cross border factoring.
e) Agency factoring: In this, finance and protection against bad debts is
done by factor, administration and collection is done by client.

Factoring Process
The following steps are involved in the process of factoring:

1. The seller sells the goods to the buyer and raises the invoice on the
customer.
2. The seller then submits the invoice to the factor for funding. The factor
verifies the invoice.
3. After verification, the factor pays 75 to 80 percent to the client/seller.
4. The factor then waits for the customer to make the payment to him.
5. On receiving the payment from the customer, the factor pays the
remaining amount to the client.
6. Fees charged by factor or interest charged by a factor may be upfront i.e.
in advance or it may be in arrears. It depends upon the type of factoring
agreement.

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7. In case of non–recourse factoring services factor bears the risk of bad debt
so in that case factoring commission rate would be comparatively higher.
8. The rate of factoring commission, factor reserve, the rate of interest, all of
them is negotiable.

These are decided depending upon the financial situation of the client.

Advantages of Factoring

The following are the advantages:

1. It reduces the credit risk of the seller.
2. The working capital cycle runs smoothly as the factor immediately
provides funds on the invoice.
3. Sales ledger maintenance by the factor leads to a reduction of cost.
4. Improves liquidity and cash flow in the organization.
5. It leads to improvement of cash in hand. This helps the business to pay its
creditors in a timely manner which helps in negotiating better discount
terms.
6. It reduces the need for the introduction of new capital in the business.
7. There is a saving of administration or collection cost.

Disadvantages of Factoring

The following are the disadvantages:

1. Factor collecting the money on behalf of the company can lead to stress in
the company and the client relationships.
2. The cost of factoring is very high.
3. Bad behavior of factor with the debtors can hamper the goodwill of the
company.

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4. Factors often avoid taking responsibility for risky debtors. So the burden
of managing such debtor is always in the company.
5. The company needs to show all the details about company customers and
sales to factor.

Thus, factoring forms an important part of a business, especially those

businesses which are big in size. However, if used wisely and to the benefit of
the company, it can help the business to grow significantly.

MERCHANT BANKING

Merchant Banking is a combination of Banking and consultancy services. It

provides consultancy to its clients for financial, marketing, managerial and legal
matters. Consultancy means to provide advice, guidance and service for a fee. It
helps a businessman to start a business. It helps to raise (collect) finance. It
helps to expand and modernize the business. It helps in restructuring of a
business. It helps to revive sick business units. It also helps companies to
register, buy and sell shares at the stock exchange.

Functions of Merchant Banking

The functions of merchant banking are listed as follows:

1. Raising Finance for Clients

Merchant Banking helps its clients to raise finance through issue of shares,
debentures, bank loans, etc. It helps its clients to raise finance from the domestic
and international market. This finance is used for starting a new business or
project or for modernization or expansion of the business.

2. Broker in Stock Exchange

Merchant bankers act as brokers in the stock exchange. They buy and sell shares
on behalf of their clients. They conduct research on equity shares. They also
advise their clients about which shares to buy, when to buy, how much to buy
and when to sell. Large brokers, Mutual Funds, Venture capital companies and
Investment Banks offer merchant banking services.

3. Project Management
Merchant bankers help their clients in the many ways. For e.g. Advising about
location of a project, preparing a project report, conducting feasibility studies,

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making a plan for financing the project, finding out sources of finance, advising
about concessions and incentives from the government.

4. Advice on Expansion and Modernization

Merchant bankers give advice for expansion and modernization of the business
units. They give expert advice on mergers and amalgamations, acquisition and
takeovers, diversification of business, foreign collaborations and joint-ventures,
technology up-gradation, etc.

5. Managing Public Issue of Companies

Merchant bank advice and manage the public issue of companies. They provide
following services:
1. Advise on the timing of the public issue.
2. Advise on the size and price of the issue.
3. Acting as manager to the issue, and helping in accepting applications and
allotment of securities.
4. Help in appointing underwriters and brokers to the issue.
5. Listing of shares on the stock exchange, etc.

6. Handling Government Consent for Industrial Projects

A businessman has to get government permission for starting of the project.
Similarly, a company requires permission for expansion or modernization
activities. For this, many formalities have to be completed. Merchant banks do all
this work for their clients.

7. Special Assistance to Small Companies and Entrepreneurs

Merchant banks advise small companies about business opportunities,
government policies, incentives and concessions available. It also helps them to
take advantage of these opportunities, concessions, etc.

8. Services to Public Sector Units

Merchant banks offer many services to public sector units and public utilities.
They help in raising long-term capital, marketing of securities, foreign
collaborations and arranging long-term finance from term lending institutions.

9. Revival of Sick Industrial Units

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Merchant banks help to revive (cure) sick industrial units. It negotiates with
different agencies like banks, term lending institutions, and BIFR (Board for
Industrial and Financial Reconstruction). It also plans and executes the full
revival package.

10. Portfolio Management

A merchant bank manages the portfolios (investments) of its clients. This makes
investments safe, liquid and profitable for the client. It offers expert guidance to
its clients for taking investment decisions.

11. Corporate Restructuring

It includes mergers or acquisitions of existing business units, sale of existing unit
or disinvestment. This requires proper negotiations, preparation of documents
and completion of legal formalities. Merchant bankers offer all these services to
their clients.

12. Money Market Operation

Merchant bankers deal with and underwrite short-term money market
instruments, such as:
 Government Bonds.
 Certificate of deposit issued by banks and financial institutions.
 Commercial paper issued by large corporate firms.
 Treasury bills issued by the Government (Here in India by RBI).

13. Leasing Services

Merchant bankers also help in leasing services. Lease is a contract between the
lessor and lessee, whereby the lessor allows the use of his specific asset such as
equipment by the lessee for a certain period. The lessor charges a fee called
rentals.

14. Management of Interest and Dividend

Merchant bankers help their clients in the management of interest on
debentures / loans, and dividend on shares. They also advise their client about
the timing (interim / yearly) and rate of dividend.

Services offered by Merchant Banks

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Merchant Banks offers a range of financial and consultancy services, to the
customers, which are related to:
• Marketing and underwriting of the new issue.
• Merger and acquisition related services.
• Advisory services, for raising funds.
• Management of customer security.
• Project promotion and project finance.
• Investment banking
• Portfolio Services
• Insurance Services

Merchant Banker
Any person indulged in issue management business by making arrangements
with respect to trade and subscription of securities or by playing the role of
manager/consultant or by providing advisory services, is known as a merchant
banker.
The activities carried out by merchant bankers are:
1. Private placement of securities.
2. Managing public issue of securities
3. Satellite dealership of government securities
4. Management of international offerings like Depository Receipts & bonds.
5. Syndication of rupee term loans
6. Stock broking
7. International financial advisory services.

Objectives
1. Provide funds to companies: This usually includes loans for startup
companies. They decide how much money a company needs to function
through proposals created by these companies. They also help their clients
raise funds through the stock exchange and other activities. Merchant

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banks act as a foundation for small scale companies in terms of their
finances.
2. Underwriting: This is like insurance where banks sign into documents
that agree to provide financial payment to their clients in case of any
damage or losses. This is very important for clients to ensure that the bank
will help them gain more income. If not, in case they would incur losses,
the bank will pay them for the losses.
3. Manage their portfolios: The bank will look into the companies’ assets
and will do the computation of their credits and debits to ensure they are
not incurring any losses. They also provide other kinds of services to
check on the liquidation of assets to track the income made by these
companies and study how they can make it better.
4. Offering corporate advisory: They offer advises specially to starting
companies and those that would want to expand. This advice involves
financial aid to ensure that the company will be successful and will not
have any problems along the way.
5. Managing corporate issues: Help incorporate securities management;
they also serve as an intermediary bank in transferring capitals.

Qualities of A Good Merchant Bankers

 Ability to analyse
 Abundant knowledge
 Ability to build up relationship
 Innovative approach
 Integrity
 Capital Market facilities
 Liaisoning ability
 Cooperation and friendliness contacts
 Attitude toward problem Solving

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Venture Capital

This is a very important source of financing for a new business. Here money is
provided by investors to start a business that has strong potentiality of high
growth and profitability. The provider of venture capital also provides
managerial and technical support. Venture capital is also known as risk capital.

Concept of Venture Capital

Narrowly speaking, venture capital refers to the risk capital supplied to growing
companies and it takes the form of share capital in the business firms. Both
money provided as start-up capital and as development capital for small but
growing firms are included in this definition.

In developing countries like India, venture capital concept has been understood
in this sense. In our country venture capital comprises only seed capital, finance
for high technology and funds to turn research and development into
commercial production.

In broader sense, venture capital refers to the commitment of capital and

knowledge for the formation and setting up of companies particularly to those
specializing in new ideas or new technologies. Thus, it is not merely an injection
of funds into a new firm but also a simultaneous input of skills needed to set the
firm up, design its marketing strategy, organize and manage it.

In western countries like the USA and UK, venture capital perspective scans a
much wider horizon along the above sense. In these countries, venture capital
not only consists of supply of funds for financing technology but also supply of
capital and skills for fostering the growth and development of enterprises.
Much of this capital is put behind established technology or is used to help the
evolution of new management teams. It is this broad role which has enabled
venture capital industry in the West to become a vibrant force in the industrial
development. It will, therefore, be more meaningful to accept broader sense of
venture capital.

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Features of Venture Capital

Venture capital has the following features:

1. Venture capital investments are made in innovative projects.
2. Benefits from such investments may be realized in the long run.
3. Suppliers of venture capital invest money in the form of equity capital.
4. As investment is made through equity capital, the suppliers of venture
capital participate in the management of the company.

Advantages of Venture Capital

1. New innovative projects are financed through venture capital which
generally offers high profitability in long run.
2. In addition to capital, venture capital provides valuable information,
resources, technical assistance, etc., to make a business successful.

Disadvantages of Venture Capital

1. It is an uncertain form of financing
2. Benefit from such financing can be realized in long run only.

Characteristics of Venture Capital

Venture capital as a source of financing is distinct from other sources of

financing because of its unique characteristics, as set out below:
1. Venture capital is essentially financing of new ventures through equity
participation. However, such investment may also take the form of long-
term loan, purchase of options or convertible securities. The main
objective underlying investment in equities is to earn capital gains there
on subsequently when the enterprise becomes profitable.
2. Venture capital makes long-term investment in highly potential ventures
of technical savvy entrepreneurs whose returns may be available after a
long period, say 5-10 years.

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3. Venture capital does not confine to supply of equity capital but also supply
of skills for fostering the growth and development of enterprises. Venture
capitalists ensure active participation in the management which is the
entrepreneur’s business and provide their marketing, technology,
planning and management expertise to the firm.

4. Venture capital financing involves high risk return spectrum. Some of the
ventures may yield very high returns to more than compensates for heavy
losses on others which may also have earning prospects.

In nut shell, a venture capital institution is a financial intermediary between

investors looking for high potential returns and entrepreneurs who need
institutional capital as they are yet not ready/able to go to the public.

Dimensions of Venture Capital

Venture capital is associated with successive stages of the firm’s development

with distinctive types of financing, appropriate to each stage of development.
Thus, there are four stages of firm’s development, viz., development of an
idea, start up, fledgling and establishment.

The first stage of development of a firm is development of an idea for

delineating precise specification for the new product or service and to
establish a business-plan. The entrepreneur needs seedling finance for this
purpose. Venture capitalist finds this stage as the most hazardous and
difficult in view of the fact that majority of the business projects are
abandoned at the end of the seedling phase.

Start-up stage is the second stage of the firm’s development. At this stage,
entrepreneur sets up the enterprise to carry into effect the business plan to
manufacture a product or to render a service. In this process of development,
venture capitalist supplies start-up finance.

In the third phase, the firm has made some headway, entered the stage of
manufacturing a product or service, but is facing enormous teething
problems. It may not be able to generate adequate internal funds. It may also
find its access to external sources of finance very difficult. To get over the
problem, the entrepreneur will need a large amount of fledgling finance from
the venture capitalist.

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In the last stage of the firm’s development when it stabilizes itself and may
need, in some cases, establishment finance to explicit opportunities of scale.
This is the final injection of funds from venture capitalists. It has been
estimated that in the U.S.A., the entire cycle takes a period of 5 to 10 years.

Importance of Venture Capital

Venture Capital institutions let entrepreneurs convert their knowledge into

viable projects with the assistance of such Venture Capital institutions.

1. It helps new products with modern technology become commercially

feasible.
2. It promotes export-oriented units to earn more foreign exchange.
3. It not only provides the financial institution but also assist in management,
technical and others.
4. It strengthens the capital market which not only improves the borrowing
concern but also creates a situation whereby they can raise their own
capital through capital market.
5. It promotes modern technology through the process where financial
institutions encourage business ventures with new technology.
6. Many sick companies get a turn around after getting proper nursing from
such Venture Capital institutions.

Mutual Funds

A mutual fund is a professionally managed investment product in which a pool

of money from a group of investors is invested across assets such as equities,
bonds, etc

Types of Mutual Fund

We can classify mutual funds based on structure and asset class.

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1) Based on Structure

Open-ended funds – They are very common and allow investors to trade units
at any point of time at the NAV.

Close-ended funds – Involves issuing shares to the general public only once
during the IPO. Once listed on the exchange, they can be sold only to another
investor and not to the fund. Shares are traded at a premium or discount of the
NAV.

Unit Investment Funds – where trusts issue shares only once upon their
creation with the overall portfolio also remaining unchanged. They don’t come
with the services of a professional fund manager and have a restricted life span
although investors can sell anytime.

2) Based on Asset Type

Money Market Funds: They pool money towards short-term low risk assets
such as certificates of deposits and treasury bills.

Equity Funds: They could contain value stocks, growth equity, small-cap
stocks, mid-cap stocks, large-cap stocks, or a combination of all.

Bonds Funds: These products are made of bonds giving interests as an income.
Fixed interest bonds are low risk, giving stable earnings. Those with floating
interests allow higher chances of profits but through greater risks.

Balanced Funds: They are a combination of equities and bonds, usually in the
2:3 proportion, to balance the risk and return profile of the product.

Index Funds: Such a fund traces the change in the value of its underlying market
index like S&P 500.

Speciality Funds: Here, the securities belong to a specific segment like

healthcare, automobile, technology, energy, industrial or telecommunication.

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The Advantages of Mutual Funds

1. Liquidity: The biggest advantage of investing in a mutual fund scheme is that

you can redeem your units anytime you want. Unlike FDs (Fixed Deposits),
mutual funds offer very flexible and convenient withdrawals. However, factors
like exit load and pre-existing penalties should be taken into consideration while
exiting from an MF scheme.

2. Diversification: Diversification is another advantage of mutual funds. It

lowers the risks involved in building an investment portfolio and hence reduces
the risk for the investors. Because mutual funds contain multiple securities,
investors' gains are safeguarded even if there is a drop in some of the securities
in their portfolios.

3. Expert Management: Beginner investors may not have the knowledge of

where and how to invest. Such people can invest in mutual funds because they
are managed by experienced professionals. These experts collect money from
several investors and allocate this fund to different securities and thereby
helping investors generate more gains. The professionals keep an eye on timely
entry and exit and also handle all the challenges incurred in the investment
horizon. In mutual funds, you just have to make an investment, the rest is taken
care of by the professionals who will help you succeed in this field.

4. Flexibility: Mutual funds offer the flexibility to invest in smaller amounts.

That means you don't need a lot of money to invest in mutual funds. You can
invest according to your income and cash flow. For example, if you depend on a
monthly salary, then you can select the SIP (Systematic Investment Plan) mode
of investment and invest a fixed amount every month or at regular intervals.

5. Accessibility: Mutual funds are very easy to buy/sell. They are easily
accessible and you can buy them from anywhere. There are various Asset
Management Companies that offer funds and distribute them through the
following channels:
Registrars
Brokerage Firms
Mutual Fund AMCs
Mutual Funds investment online platforms
Banks
Agents

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6. Suitable for Every Financial Goal: This is perhaps the best part of investing
in mutual funds. You can start investing with as little as Rs. 500 and there is no
limit for maximum investment. The only things investors should consider before
investing in mutual funds are their expenses, income, financial goals, and risk-
taking ability. In a nutshell, any individual with any financial goal can invest in a
mutual fund regardless of his income.

7. Safety and Transparency: All the mutual fund products have been labelled
after the strict SEBI guidelines. This means, all the mutual fund schemes now
come with color coding. This color scheme allows investors to determine the
level of risk involved in the investment, making the entire investment process
safe and transparent.
The color coding has three different colors to indicate different levels of
risk:
 The blue color denotes low risk.
 Brown color denotes high risk.
 The yellow color indicates moderate risk.
Further, in mutual funds, investors are free to verify the credentials of
their fund manager. You can cross-check their experience, qualification,
history, and so on.

8. Lower cost: In a mutual fund scheme, funds are pooled from multiple
investors, and then this fund is used to buy securities. However, these funds are
invested in assets which allows one to save on transaction charges and other
expenses as compared to a single transaction. Further, the Asset Management
Service charges are also lowered and then divided between all the investors of
the scheme.

9. Tax Savings: Another benefit of mutual funds is tax saving options. Note that
the ELSS funds come with 1.5 lakh of tax reduction per year, under section 80C
of the Income Tax Act. Further, all of the other mutual funds are taxed on the
basis of the tenure and type of the investment. Moreover, ELSS tax saving funds
have the potential to offer higher returns as compared to other tax-saving
instruments like FDs, NPS, and PPF.

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Disadvantages of Mutual Funds

1. Entry or Exit Load: Some mutual funds may charge either entry or exit load
or both. They levy this charge primarily to maintain their operations and pay
staff salaries. Sometimes, the charge may go up to a high 3% of the net
investment amount. However, it mostly remains around 1%.

While the load might seem one of the significant disadvantages of mutual
funds, funds charging a high load usually offer much higher returns than the
average mutual funds. Hence, while the load certainly eats into your profit, you
must analyse the fund’s past performance before deciding.

2. Diversification Might Cause Lower Profits: While diversification might

significantly reduce your risks, it may also reduce your profit margin. This may
become more prominent if you invest in balanced or hybrid mutual funds. Since
these funds invest a part of your capital in equity and the other part in debt, any
profit in one might be muted due to a loss in the other.

3. Difficult Phases: Although long-term investors seldom endure losses, you

may have to suffer a capital loss if you accidentally invest before a bad phase.
Mutual fund returns are never guaranteed. Hence, it is wise to know a little
about the economy and the fund performance before investing.

4. Liquidity: Fixed maturity and ELSS schemes come with a lock-in period. ELSS
usually has a lock-in period of three (3) years. And a fixed maturity plan’s lock-in
period depends on the instrument it invests in. For example, if it invests in a
bond with a 5-year maturity, you cannot withdraw the units before five years.

5. Capital Gains Tax: Both short-term and long-term capital gains from mutual
funds are taxable. If you withdraw your profits before one year from the
investment date, you may have to pay a 15% to 20% tax. And, if you withdraw it
after a year, you may have to pay a 10% capital gains tax. You may also need to
understand the concept of indexation to calculate the taxes efficiently.

MEANING OF CREDIT RATING

A credit rating is an assessment of the creditworthiness of a borrower in general

terms or with respect to a particular debt or financial obligation. It can be

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assigned to any entity that seeks to borrow money — an individual, corporation,
state or provincial authority, or sovereign government.

Factors Affecting Credit Rating

Credit rating depends on the various factors as various agencies use different formulas to
calculate a credit rating but most are based on the following factors:

 Payment history: Payment history indicates how company has managed various
payments in the past. How timely payments are made to the lender, creditor and other
suppliers. Records of late payments on current and past credit accounts will lower
company’s credit rating.

 Public records: Public records about the events such as bankruptcies, negative
judgments from legal authorities can lower the credit rating of company.

 Duration of credit history: Longer credit history is better for the company and it result
into better credit rating.

 New accounts: In general, opening of multiple new accounts in a short period may lower
the credit rating of company.

Functions of Credit Rating Agencies

Credit rating agencies (CRAs) helps the investors to take more informed decision by
providing assessment about the company. However, credit rating is not a recommendation
on whether or not to buy a debt instrument. Credit rating is a powerful tool to assist the
investor in arriving at a decision about the worth of a company proposing to offer a debt
instrument. The main functions of credit rating agencies are as follows:

 Credit rating agencies credit awareness about the issuing company’s debt instrument to
prospective investors.

 Providing key inputs helpful in taking investment decision.

 CRAs services as a guide about the company coming out with the issue.

 It provides a performance benchmark independent evaluation of the business and

financial performance of a company.

 It provides user- friendly symbols instead of complex financial structures.

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 It monitors and disseminates credit opinions on the rated companies/ securities in a
timely and efficient manner.

 CRAs bridge the information gap between issuer and investors.

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