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Presented by Saurabh Shah
Financial Services Management
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Introduction to Financial Services
Chapter 1
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Introduction to Financial Services
Financial intermediaries provide key financial services such as
merchant banking, leasing, hire purchase, credit-rating, and so on
which indirectly deals with the management of money.
These financial services are vital for creation of firms, industrial
expansion, and economic growth.
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Fund Based v/s Non Fund based
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Fund Based
Loans&
Advances
CASHCREDIT
OVERDRAFT
RETAILFINANCE
TERMFINANCE
BILLSFINANCE
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Comparison
Fund Based Fee Based
Service provider invests or commits to invest his own funds.
Service provider does not investhis own funds.
Service provider is exposed to highrisk.
Service provider is exposed tominimal risk.
This is participative role.This is assistance or more of advisory role.
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Non Fund Based
Letter of Credit
Bank Guarantee
Co Acceptanceof Bills
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Agencies Providing Financial servicesCommercial Banks
Merchant Bankers
Leasing and Hire Purchase Companies
Mutual Funds
Venture Capital Funds
Rating Agencies
Other NBFCs
The Stock Exchanges
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Financial Innovation and Engineering
Financial Engineering involves the design, the development andthe implementation of innovative financial instruments andprocesses and the formulation of creative solutions to problemsin finance.One of the essential characteristics of financial engineering
products is Financial Innovation .Factors that propagate need for financial engineering i.e.innovation are:
1. Competition2. Liberalization3. Technology4. Financial Awareness5. Matured Legal Processes
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Process of Financial Engineering
The process of Financial Engineering is same as the process for developing new value added product and services.Stages in Financial Engineering
1. Need Identification2. Idea formation of the Product3. Product development, Model Building4. Product Testing5. Product Improvement based on test feedback6. Product Pricing
7. Restructuring the product to suit pricing idea8. Test Marketing9. Launching of the Product
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Types of Financially Engineered Products
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Financial Return
Risk
Debt Equity Proportion
Strategic Goals
High Low
Moderate Strategic
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Types of Financially Engineered Products
Preference SharesConvertible Debentures
Call & Put OptionWarrantsDerivatives
Non Voting SharesESOPsSweat Equity Shares
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Read explanation from Text Book
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Securitization of Debt
Chapter 4
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Securitization of Debt
Securitization is the process of conversion of existing assets or future cash
flows into marketable securities.In other words, securitization deals with the conversion of assets which are notmarketable into marketable ones.The segments that dominated the securitization market are:
1. Asset-backed securities (ABS) such as commercial vehicle, car, two-
wheeler and personal loans;2. Mortgage-backed (home loan) securities (MBS)
Securities issued by the SPV in a securitization transaction are referred to as Asset Backed Securities (ABS) because investors rely on the performance of the assets that collateralize the securities.
They do not take an exposure either on the previous owner of the assets (theOriginator), or the entity issuing the securities (the SPV).
Clearly, classifying securities as asset -backed seeks to differentiate them fromregular securities, which are the liabilities of the entity issuing them.
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Securitization of Debt
In practice, a further category is identified securities backed by mortgageloans (loans secured by specified real estate property, wherein the lender hasthe right to sell the property, if the borrower defaults). Such securities arecalled Mortgage Backed Securities (MBS).
All securitized instruments are either MBS or ABS.
IllustrationSuppose Mr. X wants to open a multiplex and is in need of funds for the same.To raise funds, Mr. X can sell his future cash flows (cash flows arising fromsale of movie tickets and food items in the future) in the form of securities toraise money.
This will benefit investors as they will have a claim over the future cash flowsgenerated from the multiplex. Mr. X will also benefit as loan obligations will bemet from cash flows generated from the multiplex itself.
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INVESTORS GIC
LIC
Barclays
Banks
Arcil as a Trust100
Principal + Interest300 + 400
Purchase Consideration(100)
Borrower
NAV is declared Quarterly andcrystallization( M to M) is done atthe end of the year.
Cash Realization20
Payment of SRs80
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Parties Involved
Securitization programmes usually involve several participants, each carrying out
a specialist function such as creating and analyzing the asset pool, administration,credit rating, accounting, legal negotiation, etc. These include:
Primary Parties
1. The Originator also interchangeably referred to as the Seller is the entity
on whose books the assets to be securitized exist. It is the prime mover of thedeal i.e. it sets up the necessary structures to execute the deal. It sells theassets on its books and receives the funds generated from such sale. In a truesale, the Originator transfers both the legal and the beneficial interest in theassets to the SPV.
2. Special Purpose Vehicle (SPV) - the SPV is the entity, which would typically
buy the assets (to be securitized) from the Originator against issue of securities. As one of the main objectives of securitization is to remove theassets from the balance sheet of the Originator, the SPV plays a very importantrole in as much as it holds the assets in its books and makes the upfrontpayment for them to the Originator.
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The Investors The investors may be in the form of Individuals or institutional investors like FIs, Mutual funds etc. They buy a participatinginterest in the total pool of receivables and receive their payment in the form of interest and principal as per agreed pattern.
Parties Involved
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Parties Involved
Other parties
The Obligor(s): The Obligor is the Originator's debtor (borrower of the originalloan). The amount outstanding from the Obligor is the asset that is transferredto the SPV. The credit standing of the Obligor(s) is of paramount importance ina securitization transaction.The Rating Agency: Since the investors take on the risk of the asset poolrather than the Originator, an external credit rating plays an important role. Therating process would assess the strength of the cash flow and the mechanismdesigned to ensure full and timely payment by the process of selection of loansof appropriate credit quality, the extent of credit and liquidity support providedand the strength of the legal framework.
Administrator or Servicer: It collects the payment due from the Obligor/s andpasses it to the SPV, follows up with delinquent borrowers and pursues legalremedies available against the defaulting borrowers. Since it receives theinstallments and pays it to the SPV, it is also called the Receiving and Paying
Agent.
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Parties Involved
Agent and Trustee: It accepts the responsibility for overseeing that all theparties to the securitization deal perform in accordance with the securitizationtrust agreement. Basically, it is appointed to look after the interest of theinvestors.Structurer: Normally, an investment banker is responsible as structurer for bringing together the Originator, credit enhancer/s, the investors and other
partners to a securitization deal. It also works with the Originator and helps instructuring deals.
The different parties to a securitization deal have very different roles to play. Infact, firms specialize in those areas in which they enjoy competitiveadvantage. The entire process is broken up into separate parts with differentparties specializing in origination of loans, raising funds from the capitalmarkets, servicing of loans etc. It is this kind of segmentation of market rolesthat introduces several efficiencies securitization is so often credited with.
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Pass Through &Pay Through Certificates
Pass through Certificates Pay through Certificates
It enable the investors to take a directexposure on the performance of thesecuritized assets.
On the other hand, Pay throughCertificates gives investors only acharge against the securitized assets,while the assets themselves are ownedby the SPV.
Payments as per obligors payments Payments are structured as per demanded by investors
Mostly Pass through are without anyrecourse to the originator in the case of default
Pay through are mostly with recourse tothe originator, ratings are enhance dueto originators guarantee.
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What type of assetscan be securitized ?
Existing assets in the form of Long Term Receivables( E.g. Housing Loans)
Existing assets in the form of Short Term Receivables( E.g. Credit Card Receivables)
Existing physical assets in the nature of Current Assets (E.g. Stock)
Existing Fixed Assets (E.g. Aircraft Lease)
Future Receivables (Infrastructure projects)
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The Procedure
Selection and pooling of assets
These assets are sold or pass throughanother orgn called Special Purpose Vehicle(SPV)
The SPV then splits the pool into units/securitiessells them to the investors at large and reimburses it.
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Venture Capital
Chapter 3
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WHAT IS VC FUNDING?
IS IT JUST THE STORY OF THE MAN WITH THE IDEA AND THE MAN WITH THE MONEY?
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WHAT IS VENTURE CAPITAL ?
Venture Capital is the early financing of new and youngenterprises seeking to grow rapidly.
It is the support by investors of entrepreneurial talents withfinance and business skills to exploit market opportunitiesand to obtain capital gains
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Features of Venture Capital
It is usually in the form of Equity or mix of Equity +Debt.Commercial success of the funded venture is nottested hence very risky, if successful VC can earnextraordinary profits.Venture capitalist are interested in capital gains andcash gains.VCs generally exit business after achieving desired
growth.It is not just a fund provider but also involved inmanaging the envisaged growth.
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Stages of VC
Stop Gap or IntermediateStage
Concept & IdeaDevelopment
Stage
ImplementationStage
Expansion Stage
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Initial screening
Presenting a detailed business plan
Valuation and structuring the deal
Monitoring the project
Exit
Investment Process
Due diligence
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Investment Process
Initial Screening
Average rates of return on their investment. A majority of the proposal are screened out, after a very
brief initial review.
Business Plan
Business plan is the main vehicle for getting potentialinvestment. The business plan should mirror the clarity of thinking
and the business.
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Investment Process
Due Diligence
Research conducted by the VC to verify the accuracy of the statements made by the entrepreneur.
Competence of management team.
Market potential.
Uniqueness of product.
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Investment Process
Monitoring the project
Advise could be in areas of strategy, finance,technology, acquiring key executive personnel or negotiating contracts.
Exit
Buy back of shares by promoters or company. Sale of stock. Selling to a new investor.
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EXIT OPTIONS:IPO'sMergers & Acquisitions
Management Buy-outSale to Another FundBuyback by Promoter/ CompanyStock Market
EXIT
OPTIONS
AVAILABLE
TO
VENTURE
CAPITALIST
Duration of Venture Capital Investmentnormally ranges from 3-7 years
In case of Buyback by Promoter/Company , the valueat which VC Fund would exit is IRR or market-basedand is pre decided at the time of investment on acertain valuation
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Merchant Banking
Chapter 2
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Merchant Banking In India
The Grindlays Bank initiated the merchant banking activity inIndian Capital Market in 1969.
Its business forms was on the management of Public Issues
and Financial Consultancy.
Citi Bank introduced its merchant banking division in 1970.
In the view of the widening industrial base of the country, the
Banking commission report in 1972, stressed the need for
merchant banking in India.
Following the recommendations of the banking Commission
(1972), the State Bank of India (SBI) established its Merchant
Banking Division in 1973, in the name of SBI Capital Markets
Ltd. (SBICAP).
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Merchant Banking In India
ICICI started merchant banking services in 1974.
Mid seventies onwards, there was a mushroom growth of
merchant banking sector.
Bank of Baroda, Canara Bank, Merchantile Bank, United Bank
of India, IFCI and IDBI also started merchant banking services.
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Merchant Banking
Only a body corporate other than a non-banking financial
company shall be eligible to get registration as merchant
banker.
Without holding a certificate of registration granted by theSecurities and Exchange Board of India, no person can act as
a merchant banker.
The validity period of certificate of registration is 3 years from
the date of issue.
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Services of Merchant Bankers
Managing of public issue of capital such as determining the type of
securities to be issuedDraft of prospectus and application forms
Appointment of Registrar to deal with share application andtransfers
Listing of SecuritiesProject Feasibility study
Assistance in ADR/GDR
Arrangement of underwriting
Placing of issuesSelection of brokers and bankers to the issue
Publicity and advertising agent
Private Placement of Securities
Management of Debenture issue and syndication of loan 40
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Categories of Merchant Bankers
CAT I
Lead manager,adviser, consultant, underwriter, portfolio manager. Rs.5 cr
CAT II
Adviser, consultant,underwriter, portfolio manager. Rs 50 lacs
CAT III
Underwriter, adviser or consultant to an issue. Rs 20 lacs
CAT IV
Adviser or consultant to an issue. NIL
As per the new amendment, only one category exists, that is Category 1
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Qualities required of Merchant Bankers
KnowledgeCapital Market Familiarity Liaisoning Ability
InnovationIntegrity
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Fee based (non-fund based) . Public offers ( known as issue management ) + private
placement of securities in the capital market. Narrow term.
Merchant Banking :
Fund based and non-fund based. Merchant banking services as well as other capital market
activities such as, specialized corporate advisory servicesin the area of mergers and acquisitions etc.
Wider term.
Investment Banking:
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Merchant Banks & Commercial Banks
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Merchant Banks Commercial banks Assist in raising capital in theform of equity, preference shares,syndicated loan and workingcapital instruments.
Provide funds in the form of termloan and working capital.
Advisory is the main business. Financing is the main business.
Do not accept chequable deposits. Demand deposits is the key feature.
Mainly fee based business. Mainly fund based business.
They are mainly into managementof equity, pricing of issue, book running etc.
They are mainly into term lendingand bank deposits.
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Credit Rating Agencies(CRAs)
Chapter 5
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Introduction
Credit ratings are judgments of borrowers (Standard & Poor)
Credit rating is essentially the opinion of the rating agency of the
relative ability and willingness of the issuer of a debt instrument to
meet the debt service obligation as and when they arise (CARE)
It is mandatory for the issuance of Debt instruments, Debentures,
Commercial Paper issued by Corporate and Public deposits of all
NBFCs (Non Banking Financial Companies).
It is an independent assessment of the creditworthiness of a bond(note or any security of any indebtness) by a credit rating agency.
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Functions of Credit Rating Agency(CRA)
CRAs reduce the informative asymmetry between lenders andinvestors, on one side, and issuers on the other side, about thecreditworthiness of companies or countries.
Credit Ratings determine the eligibility of debt and other financial
instruments for the portfolios of certain institutional investors due tonational regulations that restrict investment in speculative gradebonds.
CRAs assess creditworthiness of the issuer of bonds and financialinstruments.
In a way, regulators have outsourced to CRAs for assessing debtrisk.
CRAs role has expanded with financial globalization and hasreceived an additional boost from Basel II.
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Supplementary Functions of CRAs
In addition to the main task of rating, CRAs carryout somesupplementary functions to assist the corporate:
The credit rating agencies in India offer varied services likemutual consulting services, companies up gradation, riskmanagement etc..CRAs carryout research and development work of theindustries.They provide training to the employees and executives of thecompanies for better management.They examine the risk involved in a new project, chalk out plansto fight with the problem successfully and thus improve thepercentage of risk largely.For this, they carry on thorough research into the respectiveindustry.CRAs have started offering services to the mutual fund sector through the application of fund utilization services.
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Global Credit Rating Agencies
MOODYS
STANDARD & POORSCORPORATION [S & P]
DUFF AND PHELPS CREDITRATING CO [CDR]
JAPAN CREDIT RATING AGENCY [JCR]
IBCA LTD
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Domestic Credit Rating Agencies
CRISIL [Credit Rating and
Information Services Of India]
ICRA [Investment Information
Services Of India]
CARE [Credit Analysis and
Research]
FITCH
SMERA [SME Rating Agency of India Ltd.]
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Working of Credit Rating Agency Rating Request
Collection ofInformation
ManagementMeeting
Rating Committee/Assignment of
RatingAdvice to Issuer
Publication
Surveillance &Annual Review
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Benefits to Investors
Safeguards against bankruptcy
Recognition of risk
Credibility of issuer
Easy understandability of theinvestment proposal
Saving of resources i.e. Energy
and time
Independence of investmentdecision
Good bye to thumb rule
Lower cost of borrowing
Wider audience for borrowing
Rating as marketing tool
Self discipline by companies
Benefits of Rating to
Company
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Disadvantage of Credit Rating
Biased Rating and Misrepresentations
Static study
Concealment of Material information
Rating is no guarantee for soundness of the companyHuman Bias
Reflection of temporary adverse conditions
Down grade
Validity of Rating
Difference in Rating of two agencies
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Mutual Funds
Chapter 10
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Assessment of Investor Needs
Clarity of Purpose Purpose of investment has to be clear Liquidity Requirement Depending on purpose and cash
position
Risk Appetite Depending upon the risk taking capacity of an
investor
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Assessment of Investment Avenues
Stock MarketsDebt MarketsMutual Funds
InsuranceMoney MarketsReal Estate Markets
BullionCommodities
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Mutual Fund
The value associated with each of these units is known as (NAV). Mutualfund issue securities known as units to the investors known as unit holdersin accordance with quantum of money invested by them.
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Structure of Mutual Fund
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Structure of Mutual Fund
Trustees arelegal owners
Investors arebeneficial owners
Mutual is a Trust
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Working of Mutual Fund
Investors
FundManagers
Securities
Returns
Pool their money
Invest inGenerates
Passed back to
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Organization of Mutual Fund A mutual fund is set up in theform of a trust, which has
sponsor, trustees, AssetManagement Company (AMC) and a custodian.The trust is established by asponsor or more than one
sponsor who is like a promoter of a company.The trustees of the mutual fundhold its property for the benefit of the unit-holders.
The AMC, approved by SEBI,manages the funds by makinginvestments in various types of securities.
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The custodian, who is registeredwith SEBI, holds the securities of various schemes of the fund in itscustody.
The trustees are vested with thegeneral power of superintendenceand direction over AMC.They monitor the performance andcompliance of SEBI Regulations by
the mutual fund.
Types of Mutual Funds
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Mutual Fund
Structure
CloseEnded
OpenEnded
Investment
GrowthFund
IncomeFund
BalanceFund
IndexFunds
MoneyMarket
Types of Mutual Funds
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Closed Ended
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Open Ended Schemes
Accepts funds from investors oncontinuous basis.
Repurchase facility available.
No listing on the stock exchange.
Better liquidity due to continuous
repurchase.
Sale and Repurchase based on
NAV
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Closed EndedSchemes
Schemes are opened for
specified time period.Corpus normally does not changethroughout the year.
Such schemes are normally listed
in the stock exchange. Otherwiserepurchase facility provided.
Liquidity normally at the time of redemption.
Long term investment strategiesdepending on the life of thescheme.
Market price may be below or above par.
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Growth FundsThe aim of growth funds is to provide capital appreciation over the medium to long- term.
Such schemes normally invest a major part of their corpus inequities. Such funds have comparatively high risks.
These schemes provide different options to the investors likedividend option, capital appreciation, etc. and the investors maychoose an option depending on their preferences.
The mutual funds also allow the investors to change the options
at a later date.
Growth schemes are good for investors having a long-term
outlook seeking appreciation over a period of time .63
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Income Funds
These funds provide regular and steady income to investors.
Such schemes generally invest in fixed income securities
such as bonds, corporate debentures and Government
securities.
Income Funds are ideal for capital stability and regular
income.
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Balance FundsBalanced funds work particularly well during a downturn in equity
markets.These funds invest both in equity shares and fixed-income-
bearing instruments (debt) in some proportion.
While selecting a balanced fund, choose the conventional type
60:40 (equity: debt) with a steady track record.
Make sure the fund manager sticks to the 60:40 mandates even
during bullish times, when most balanced fund managers
succumb to the temptation of over-allocation to equities for higher
growth.
They are ideal for medium to long-term investors who are willingto take moderate risks.
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Money Market Mutual Funds
These mutual funds would invest exclusively in money market
instruments.
RBI introduced to provide an additional short- term avenue for
investment and bring money market within reach of individuals.
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Index Funds
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Index Funds
Index Funds replicate the portfolio of a particular index such as
the BSE Sensitive index, S&P NSE 50 index (Nifty), etc these
schemes invest in the securities in the same weight age
comprising of an index.
NAVs of such schemes would rise or fall in accordance with therise or fall in the index, though not exactly by the same
percentage.
There are also exchange traded index funds launched by the
mutual funds which are traded on the stock exchanges.
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Diversification
Mutual funds invest in a number of companies across a broadcross-section of industries and sectors.
This diversification reduces the risk because seldom do allstocks decline at the same time and in the same proportion
One achieves this diversification through a mutual fund with far less money than you can do on your own.
Professional managementMutual funds provide the services of experienced and skilledprofessionals, backed by a dedicated investment research teamthat analyses the performance and prospects of companies andselects suitable investments to achieve the objectives of thescheme.
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Advantages of Mutual FundsReturn potential
Over a medium to long-term, mutual funds have the potential
funds to provide a higher return as they invest in a diversifiedbasket of selected securities.
Reduction in transaction cost
Mutual funds are a relatively less expensive way to invest ascompared to directly investing in the capital markets becausethe benefits of scale in brokerage, custodial and other feestranslate into lower costs for investors.
FlexibilityThrough features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans we cansystematically invest or withdraw funds according to our needs
and convenience.69
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Advantages of Mutual FundsChoice of schemes
Mutual funds offer a family of schemes to suit our varying needs over a life time.
LiquidityIn open-end schemes, the investor gets the money back promptly at
net asset value related prices from the mutual fund.In the closed-end schemes, the units can be sold on a stockexchange at the prevailing market price or the investor can avail of the facility of direct repurchased at NAV related prices by the mutual
fund.
Well regulated All mutual funds are registered SEBI and they function within theprovisions of strict regulations designed to protect the interests of investors.70
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Portfolio Management ServicesPortfolio management involves deciding what assets to include inthe portfolio, given the goals of the portfolio owner and changingeconomic conditions.
Selection involves deciding what assets to purchase, how many topurchase, when to purchase them, and what assets to divest.
These decisions always involve some sort of performancemeasurement, most typically expected return on the portfolio, andthe risk associated with this return.
Typically the expected return from portfolios comprised of differentasset bundles are compared Portfolio management makes use of analytical techniques of analysis and conceptual theories regardingrational allocation of funds.
Portfolio management is a complex process which tries to makeinvestment activity more rewarding and less risky.
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M l F d / PMS
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Mutual Fund v/s PMSMany people get confused between Mutual Fund and PortfolioManagement Service, they think both are the same, one has to just
invest money in a particular fund and let the fund manager doinvesting on their behalf and give returns.But, in actual terms there is lot of difference between both theservices.
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Mutual Funds PMS
Product Mass product Customized Product
Service Common service to all Personalized
Cost Entry & Exit Loads NO entry exit loads
Fee Structure FIXED Either Fixes or on Performance basis
Portfolio Profiling NO As per risk appetite of the customer
Sector/Stock limits YES NO
Updates MONTLY DAILY
Cross Subsidiary YES NO
Transparency NO YES
Tax Benefit YES (under section 80C) NO
Lock in period YES NO
Load Funds and No Load Funds
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Load Funds and No Load FundsLoads are sales fees. Most common are front-end loads
and back-end loads.If you are in a fund with a back-end load, you'll be hit witha sales fee when you sell your shares.
Some funds claim to be "no load" but charge reinvestment
fees when distributions are reinvested in a fund.If youre a do-it-yourself investor, avoid funds that chargeloads.
No-load funds generally outperform load funds for the
simple reason that the sales fee adds to the cost, andtherefore lower returns.
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Illustration
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IllustrationCompare two mutual fund schemes, one with a low cost structure(say Fund A) and the other which isnt quite as charitable (sayFund B). Investments in Fund A attract an entry load of 1.0%,while the number is 2.5% for Fund B. Similarly, the recurringexpenses are 1.5% and 2.5% for fund A and fund B respectively.
Assume that Rs 100,000 (one-time investment) is invested in each
fund for a 10-Yr period and that both the investments grow at15.0% per annum.
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Fund A Fund B
Entry load 1.00% 2.50%
Recurring expenses 1.50% 2.50%
Amount invested (Rs) 100,000 100,000
Growth rate (per annum) 15.00% 15.00%
Maturity amount (Rs) 344,331 306,217
On maturity (i.e. at the end of 10years), the investment in fund A
would be worth Rs 344, 331,while that in fund B would beworth Rs 306, 217. Thedifferential can be traced toFund As cost effectiveness.
Association of Mutual Funds
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Association of Mutual Fundsin India(AMFI)
With the increase in Mutual Fund players in India, a need for Mutual Fund Association in India was generated to function as anon-profit organization.
Association of Mutual Funds in India (AMFI) was incorporatedon 22nd August, 1995.
AMFI is an apex body of all Asset Management Companies(AMC) which has been registered with SEBI.Till date all the AMCs are that have launched mutual fundschemes are its members. It functions under the supervisionand guidelines of its Board of Directors.
Association of Mutual Funds India has brought down the IndianMutual Fund Industry to a professional and healthy market withethical lines enhancing and maintaining standards.It follows the principle of both protecting and promoting theinterests of mutual funds as well as their unit holders.
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Association of Mutual Funds
in IndiaThe Association of Mutual Funds of India works with 30registered AMCs of the country. The objectives are as follows:This Mutual Fund Association of India maintains highprofessional and ethical standards in all areas of operation of the industry.
It also recommends and promotes the top class businesspractices and code of conduct which is followed by membersand related people engaged in the activities of mutual fund andasset management.The agencies who are by any means connected or involved in
the field of capital markets and financial services also involvedin this code of conduct of the association. AMFI interacts with SEBI and works according to SEBIsguidelines in the mutual fund industry.
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Association of Mutual Funds
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Association of Mutual Fundsin India
Association of Mutual Fund of India does represent theGovernment of India, the Reserve Bank of India and other related bodies on matters relating to the Mutual Fund Industry.It develops a team of well qualified and trained Agentdistributors. It implements a program of training and certificationfor all intermediaries and other engaged in the mutual fundindustry.
AMFI undertakes all India awareness program for investors inorder to promote proper understanding of the concept andworking of mutual funds.
At last but not the least association of mutual fund of India alsodisseminate information on Mutual Fund Industry andundertakes studies and research either directly or in associationwith other bodies
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Derivatives
Chapter 7
Derivatives
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DerivativesIn recent years, financial markets have developed many new
products whose popularity has become phenomenal.
Derivative products initially emerged, as hedging devices against
fluctuations in commodity prices.
A derivative is an instrument whose value depends on the
values of one or more basic underlying variables called
bases. The underlying variables are forex, equity,
commodity, bonds, debentures etc.
Illustration : Wheat farmers may wish to sell their harvest at afuture date to eliminate the risk of a change in prices by that
date. The price of this derivative is driven by the spot price of
wheat which is the underlying .79
Derivatives
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DerivativesIn derivative market when enter into a contract to buy or sell
particular underlying:
Long position means to have a buy position for particular
stock
Short position means to have a sell position for particular
stock
Bid price (buyers price) is the rate/price at which there is a
ready buyer for the stock.
Ask price (sellers price) is the rate/ price at which there is
seller ready to sell his stock.
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Terminologies related to Futures
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gSpot price: the price at which an asset trades in the spot market.
Futures price: the price at which the futures contract trades in thefutures market.
Initial margin: the amount that must be deposited in the margin
account at the time a futures contract is first entered into is known
as initial margin.Maintenance margin: This is somewhat lower than the initial
margin. This is set to ensure that the balance in the margin
account never becomes negative.
Marked-to-market (M to M): in the futures market, at the end of
each trading day, the margin account is adjusted to reflect the
investors gain or loss depending upon the futures closing price.
This is called marked-to-market.81
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Option price/premium: Option price is the price which the
option buyer pays to the option seller. It is also referred to as
the option premium.
Strike price: The price specified in the options contract is
known as the strike price or the exercise price.
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Options terminology
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p gyIn-the-money option:
Spot price > Strike Price in case of
call option.
Spot price < Strike Price in case of
put option.
If exercised immediately it would
lead to positive cash flow.
E.g.: Spot value of Nifty is 2157. An
investor buys a one-month nifty2140 call option for a premium of
Rs.7. the option is?
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Out-of-the-money option:
Spot price < Strike price in case
of call option.
Spot price > Strike price in case
of put option.
If exercised immediately it would
lead to negative cash flow.
E.g.: Spot value of Nifty is 2140.
An investor buys a one-monthnifty 2157 call option for a
premium of Rs.7. the option is?
Kinds of Derivatives
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Derivatives
Forwards FuturesSwaps
Options
Kinds of Derivatives
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Forward Contract
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o wa d Co t act A forward contract is a customized contract between two entities,where settlement takes place on a specific date in the future at
todays pre-agreed price.No cash is exchanged when the contract is entered into.
IllustrationShyam wants to buy a TV, which costs Rs 10,000 but he has no cash tobuy it outright.
He can only buy it 3 months hence. He, however, fears that prices of televisions will rise 3 months from now.
So in order to protect himself from the rise in prices Shyam enters into acontract with the TV dealer that 3 months from now he will buy the TV for
Rs 10,000.What Shyam is doing is that he is locking the current price of a TV for aforward contract. The forward contract is settled at maturity.
The dealer will deliver the asset to Shyam at the end of three months andShyam in turn will pay cash equivalent to the TV price on delivery.
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Features of Forward Contract
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Features of Forward ContractThey are bilateral contracts and hence exposed to counter
party risk.
Each contract is custom designed, and hence is unique in terms
of contract size, expiration date and the asset type and quality.
The contract price is generally not available in public domain.
On the expiration date, the contract has to be settled by delivery
of the asset.
If the party wishes to reverse the contract, it has to compulsorily
go to the same counter-party, which often results in high prices
being charged.
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Futures Contract
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A future contract is similar to Forward account.
A futures contract is an agreement between two parties to buy
or sell an asset at a certain time in the future at a certain price.
Futures contracts are special types of forward contracts in the
sense that the former are standardized exchange-tradedcontracts.
Index futures are all futures contracts where the underlying is
the stock index (Nifty or Sensex) and helps a trader to take a
view on the market as a whole.
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Features of Futures Contract
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The standardized items in a futures contract are:
Quantity of the underlyingQuality of the underlying
The date and the month of delivery
The units of price quotation and minimum price changeLocation of settlement
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Futures payoffs
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Futures payoffs
Payoff for buyer of futures: Long futures
Payoff for seller of futures: Short futures
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The figure shows the profits / losses for long futures position
2220
Profit
Loss
Figure 1. Payoff for a buyer of Niftyfutures
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The figure shows the profits / losses for short futures position
2220
Profit
Loss
Figure 2. Payoff for a seller of Niftyfutures
Example 1
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On 15th
Jan Mr. Aakash Mehta bought a Jan Niftyfutures contract which cost him Rs.2,40,000.Each Nifty Future Contract is for delivery of 100Nifties. On 25 th Jan, the Index closed at 2460.How much profit/loss did he make?
Ans: +6000 [(2460 2400) * 100]
Example 2
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Amitabh Bachpan sold a Jan Nifty Futures contractfor Rs.2,40,000 on 15 th Jan. Each Nifty FuturesContract is for delivery of 100 Nifties. On 25 th Jan,the Index closed at 2450. How much profit/loss didhe make?
Ans: -5000 [(2450 2400) * 100]
Forwards v/s Futures
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Forwards Futures
OTC in nature Traded on organized stockexchange
Contract terms are customized Contract terms are standardized
Requires no margin payment Requires margin paymentSettlement happens at end of period
Follows daily settlement
One delivery date which isspecified Range of delivery dates
Some credit risk No credit risk
Counterparties have to takeexposure
Clearing house takes the exposureon both the parties
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Types of Futures
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The different types of Futures are but different facets of the same
Futures.Currencies
Commodities.
Interest RatesStocks
Index
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Options
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Option, as the word suggests, is a choice given to the investor
to either honor the contract; or if he chooses not to walk awayfrom the contract.
An option gives its owner the right but not the obligation to
purchase or sell an asset on or before some date in future.
The date when option expires is known as the exercise date,
the expiration date or the maturity date.
The price at which asset can be purchased or sold is known as
strike price.
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Types of Options
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Call Option is the right, but not the obligation, to buy the
underlying asset by a certain date for a certain price.
Put Option is the right, but not the obligation, to sell the
underlying asset by a certain date for a certain price.
American options: are options that can be exercised at any
time up-to the expiration date. Most exchange-traded options
are American.
European options: are options that can be exercised only on
the expiration date itself.
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Swaps
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SWAPS have been termed as private agreement between the two
parties to exchange cash flows or payments which will take place inthe future.
SWAPS is also called as financial swap in global financial market.
There are different types of swaps such as interest rate swaps,
currency swaps, equity swaps etc.
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Features of Swap
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A swap is nothing but the combination of Forwards, so it has
all the properties of forward contract.It requires 2 parties with equal and opposite needs.
There is no exchange of principal on the other hand fixed
interest is exchanged for floating rate of interest.
Swaps are in the nature of long term agreement and they are
just like long dated forward contracts.
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Leasing & Hire Purchasee
Chapter 6
Introduction
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Cash Purchase outright purchase for cash
i.e. buyer gets unconditional ownership andpossession.Credit Purchase Ownership and possession
is established immediately after transaction.Leasing Its like rented asset. Ownership isnot with the user.
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Credit Cards
Chapter 9
Introduction
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A credit card system is a type of retail transaction settlement and
credit system using a small plastic card issued to users of the
system.
With a credit card, a person can make purchases without using cash.
The credit card company pays for the purchase, but the card user
has to repay the money borrowed to the card company at a later
time.
In addition to the amount of the purchase, the card user also has topay interest on the loan.
When purchase is made the user would indicate his/her consent to
pay, by signing a receipt with a record of the card details and103
Visual Features of Credit Cards
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The shape and size of the credit card is specified by the ISOstandard usually 3 -1/8 inches by 2-1/8 inches in size.Front side contains following informationa) Printed
Name and logo of issuing BankName and logo of co branding Merchant establishment.
Name and logo of member affiliatePhoto of card holder / family (optional)Picture (any deity or scene of holders choice optional)
b) EmbossedPeriod of validity
Name of Card holder Card Number
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Visual Features of Credit Cards
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Visual Features of Credit Cards
Back sideMagnetic stripe often called as magstripeCredit card number in printContact number of issuing bankSpace for holders signature
Terms and disclaimer clause of the bank
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Working of Credit Card
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Clearing and Settlement
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Financial Features of Credit Card
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Annual Membership FeeMinimum PaymentRate of Interest
EMI ConversionBalance Transfer Personal LoansInsurance
ATM
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