Introduction to Financial Services

Agencies Providing Financial Services

Commercial Banks: Mainly involved in

fund based activities Term loans, working capital, cash credit and overdraft facilities Fee based services Project appraisal services, loan syndication, debt restructuring

Merchant Bankers: Management

activities related to capital raising in the form of IPO, debenture issue and loan syndication

Agencies Providing Financial Services

Shares and debentures issue management, underwriting, selling, advisory, consultancy, appraisal etc., raising funds for working capital

Leasing and Hire Purchase Companies: Leasing and hire purchase are
financial facilities which allow a business to use an asset over a fixed period, in return for regular payments

Agencies Providing Financial Services

Many kinds of business asset are suitable for financing using hire purchase or leasing, including: - Plant and machinery - Business cars - Commercial vehicles - Agricultural equipment - Hotel equipment - Medical and dental equipment - Computers, including software packages -Office equipment

Agencies Providing Financial Services

With a hire purchase agreement, after all the payments have been made, the business customer becomes the owner of the equipment. The fundamental characteristic of a lease is that ownership never passes to the business customer.

Agencies Providing Financial Services

Venture capital financing is a type of financing by venture capital: the type of private equity capital is provided as seed funding to early-stage, high-potential, growth companies and more often after the seed funding round as growth funding round A mutual fund is a type of professionallymanaged collective investment scheme that pools money from many investors to purchase securities.

Agencies Providing Financial Services

Rating Agencies: A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments NBFCs: Consumer finance companies, portfolio management companies Stock Exchanges: Marketplace for funds going public

Stock Exchanges
Marketplace: Maintains liquidity: Allows investors to maintain liquidity Stocks which are not listed on stock exchanges are traded at lower price as they cant be easily liquidated

Stock Exchanges
Monitoring agency: If the stock is listed on stock exchange it ensures stability as before listing it has to fulfill the requirements of SEBI The listing requirements vary for each stock exchange Easy to get listed on local stock exchange than getting listed on NSE or BSE

Services provided by Stock Exchanges

Provides liquidity to investment : Stock exchange provides liquidity (i.e easy convertibility to cash) to investment in securities. An investor can sell his securities at any time because of the ready market provided by the stock exchange. Stock exchange provides easy marketability to corporate securities. Provides collateral value to securities : Stock exchange provides better value to securities as collateral for a loan. This facilitates borrowing from a bank against securities on easy terms.

Services provided by Stock Exchanges

Offers opportunity to participate in the industrial growth : Stock exchange provides capital for industrial growth. It enables an investor to participate in the industrial development of the country. Estimates the worth of securities : Stock exchange provides the facility of knowing the worth (i.e true market value) of investment due to quotations (i.e price list) and reports published regularly by the exchange. This type of information guides investors as regards their future investments. They can purchase or sell securities as per the price trends (i.e latest price value) in the market.

Services provided by Stock Exchanges

Offers safety in corporate investment : An investor can invest his surplus money (i.e extra money) in the listed securities with reasonable safety. The risk in such investment is reduced considerably due to the supervision of stock exchange authorities on listed companies. Moreover, securities are listed only when the exchange authorities are satisfied as regards legality and solvency of company concerned. Such scrutiny (detailed checking) avoids listing, of securities of unsound companies (i.e companies with bad financial status).

Services given by Stock Exchange to Companies

Widens market for securities : Stock exchange widens the market for the listed securities and enables the companies to collect capital for promotion, expansion and modernization purpose. It indirectly provides financial support to companies / corporations. Creates goodwill and reputation : Stock exchange enhances the goodwill and the reputation of the companies whose securities are listed. Listing acts as a charater certificate given to a company. It gives prestigious position to company.

Services given by Stock Exchange to Companies

Facilitates fair pricing of listed securities : The market price of listed securities tends to be slightly higher in relation to earnings and property values. Provides better response from investors : Listed securities get better response from the investor due to safety and security. Listing of securities is a unique service which stock exchanges offer to companies. It is a moral support given to stable companies. Facilitates quick selling of securities : Stock exchange enables companies to sell their securities easily and quickly. This is natural as investors always prefer to invest money in listed securities.

Service given by Stock Exchange to Economy

Brings economic development : Stock exchanges brings rapid economic development through mobilization of funds for productive purposes. This facilitates the process of economic growth.

Financial Services and Innovation

Introduction of newer services and functions in finance is called as financial innovation Engineering is the process by which some value is added to the raw materials and semi finished goods to make it useful for its customers Financial engineering is adding value to existing financial products

Financial Engineering
Financial engineering is the design and construction of a new financial contract or the packaging of existing financial instruments to meet very specific risk and return requirements of the client Design, development and implementation of innovative financial instruments and processes Not all engineered products are innovative Engineered products should be different and should add value to users Innovative products become common after certain period of time

Financial Engineering
For example, the building construction contract may include specifications regarding size, number of rooms, adequate plumbing and heat, quality of materials to be used, and a completion date. The financially engineered contract may also include specifications of size (or dollar amount), the types of securities that will be used, the cash flows that they will generate, the risk associated with those cash flows, and the date upon which the contract will be renewed or expired.

Financial Engineering
This very general definition of financial engineering includes many contracts that are now considered commonplace. For example, banks sustained large losses in the early 1980s when their cost of funds rose sharply with interest rates. These banks had made large, long-term, fixed interest rate loans to families purchasing homes. The banks found, however, that the moderate fixed interest charges they received on these loans was not sufficient to cover the interest expense that was incurred to attract new funds to the bank. Hence, banks began to write adjustable-rate loans that would vary interest charges to borrowers

Financial Engineering
Another common example of financial engineering is the mutual fund. Individual investors realized that there were benefits in terms of risk reduction if they could invest in a broad array of securities. Most individuals, however, had limited resources and found it very expensive to purchase small amounts of many securities. A basic mutual fund is a portfolio of securities that can be as diverse and numerous as the client demands. The creation of these funds allowed individuals to purchase shares of an already diversified portfolio and establish an investment with lower risk, and at a more moderate cost than they could achieve otherwise.

Need for Financial Engineering

Competition: Liberalization: Technology: Financial Awareness: Matured Legal Processes:

Stages involved in Financial Engineering

Need Identification Idea Formation of the Product Product development and Model building Product testing Product improvement based on test feedback Product Pricing Restructuring the product Test marketing Launching the product

Financially engineered products Preference shares: High risk high return product
Compared to equity it is lower risk lower return product Cumulative and Non cumulative Preference shares Cumulative preference shares give the right to the preference shareholders to receive arrears of dividend which were not paid in previous years due to company making loss. While Non- cumulative Preference shareholders do not have right like Cumulative preference shareholders and therefore they cannot demand any arrears of dividend which were not paid during previous years by the company.

Financially engineered products

Participating and Non Participating Preference shares Participating Preference shareholders have the right to receive any remaining profit which is left after payment of dividend to the equity shareholders, while Non Participating Preference shareholders do not have such rights. Convertible and Non Convertible Preference shares Convertible Preference shares can be converted into equity shares if preference shareholder decides to do so while Non Convertible Preference shares does not have any such right.

Financially engineered products

Redeemable and Non Redeemable Preference shares Redeemable Preference shares are those shares which have to be repaid by the company after a fixed period of time from the date of issue of such shares while Non Redeemable Preference shares cannot be redeemed repaid by the company except on winding up of the company.

Financially engineered products

Convertible Debentures: Can be converted into shares Gives an opportunity to the investor to share the reward if equity prices go up A type of loan issued by a company that can be converted into stock by the holder and, under certain circumstances, the issuer of the bond. By adding the convertibility option the issuer pays a lower interest rate on the loan compared to if there was no option to convert.

Financially engineered products

An option contract gives the buyer the right, but not the obligation to buy/sell an underlying asset at a pre-determined price on or before a specified time. The option buyer acquires a right, while the option seller takes on an obligation The underlying asset for option contracts may be stocks, indices, commodity futures, currency or interest rates When you buy a call option, on a stock, you acquire a right to buy the stock. And when you buy a put option, you acquire a right to sell the stock

Financially engineered products

Warrants: a warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed exercise price until the expiry date. The word warrant simply means to "endow with the right Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends

Financially engineered products

Derivatives: A derivative instrument is a contract between two parties that specifies conditions (especially the dates, resulting values of the underlying variables, and notional amounts) under which payments are to be made between the parties Derivatives are broadly categorized by the relationship between the underlying asset and the derivative (such as forward, option, swap); the type of underlying asset (such as equity derivatives, foreign exchange derivatives, interest rate derivatives, commodity derivatives, or credit derivatives); the market in which they trade (such as exchange-traded or over-the-counter); and their payoff profile.

Financially engineered products

Non-Voting Shares: Non-voting stock is stock that provides the shareholder very little or no vote on corporate matters, such as election of the board of directors or mergers. This type of share is usually implemented for individuals who want to invest in the companys profitability and success at the expense of voting rights in the direction of the company. Preferred stock typically has nonvoting qualities

Financially engineered products

ESOP: An employee stock ownership plan (ESOP) is a defined contribution plan that provides a company's workers with an ownership interest in the company. In an ESOP, companies provide their employees with stock ownership, typically at no cost to the employees. Shares are given to employees and are held in the ESOP trust until the employee retires or leaves the company, or earlier diversification opportunities arise.

Financially engineered products

Sweat Equity Shares: Sweat equity is a party's contribution to a project in the form of effort -- as opposed to financial equity, which is a contribution in the form of capital. In a partnership, some partners may contribute to the firm only capital and others only sweat equity. Similarly, in a startup company formed as a corporation, employees may receive stock or stock options, becoming thus part-owners of the firm, in return for accepting salaries that are below their respective market values (this includes zero wages). The term used to refer to a form of compensation by businesses to their owners or employees.

Challenges before financial services industry

Market issues: Competitive marketplace focus on customer retention Customer retention can be achieved through customer management and customer segmentation Regulatory issues: Regulatory requirements often consume time and money Operational issues: To improve the efficiency and effectiveness of operations due to globalization and competition

Challenges before financial services industry

Operational issues: Cost control is the major issue These issues need to be addressed through business process management (BPM), Business Activity Monitoring (BAM), Corporate performance management (CPM), and Employee Performance management (EPM) Technology Issues: Need to replace and upgrade technology and infrastructure Manpower Issues: Difficult to get and retain the necessary manpower