Q1. Rating methodology is used by the major Indian credit rating agencies.

Explain the main factors of that are analyzed in detail by the credit rating
agencies.
Solution: Rating Methodology Rating methodology used by the major Indian credit rating
agencies is more or less the same. The rating methodology involves an analysis of all
the factors affecting the creditworthiness of an issuer company e.g. business, financial
and industry characteristics, operational efficiency, management quality, competitive
position of the issuer and commitment to new projects etc. A detailed analysis of the
past financial statements is made to assess the performance and to estimate the future
earnings. The companys ability to service the debt obligations over the tenure of the
instrument being rated is also evaluated. In fact, it is the relative comfort level of the
issuer to service
1. Business Risk Analysis: Business risk analysis aims at analyzing the industry
risk, market position of the company, operating efficiency and legal position of
the company. This includes an analysis of industry risk, market position of the
company, operating efficiency of the company and legal position of the company.
2. Industry risk: The rating agencies evaluates the industry risk by taking into
consideration various factors like strength of the industry prospect, nature and
basis of competition, demand and supply position, structure of industry, pattern
of business cycle etc.
3. Market position of the company: Rating agencies evaluate the market standing of
a company taking into account: i. Percentage of market share ii. Marketing
infrastructure iii. Competitive advantages iv. Selling and distribution channel v.
Diversity of products vi. Customers base vii. Research and development projects
undertaken to identify obsolete products.
4. Operating efficiency: Favorable locational advantages, management and labor
relationships, cost structure, availability of raw-material, labor, compliance to
pollution control programs, level of capital employed and technological
advantages etc.
5. Legal position: Legal position of a debt instrument is assessed by letter of offer
containing terms of issue, trustees and their responsibilities, mode of payment of
interest and principal in time, provision for protection against fraud etc.
6. Size of business: The size of business of a company is a relevant factor in the
rating decision. Smaller companies are more prone to risk due to business cycle
changes as compared to larger companies. Smaller companies operations are
limited in terms of product, geographical area and number of customers.
7. Financial Analysis Financial analysis aims at determining the financial strength
of the issuer company through ratio analysis, cash flow analysis and study of the
existing capital structure. This includes an analysis of four important factors
namely:

8. Accounting quality: As credit rating agencies rely on the audited financial

statements, the analysis of statements begins with the study of accounting
quality. For the purpose, qualification of auditors, overstatement/ understatement
of profits, methods adopted for recognising income, valuation of stock and
charging depreciation on fixed assets are studied.
9. Earnings potential/profitability: Profits indicate companys ability to meet its fixed
interest obligation in time. A business with stable earnings can withstand any
adverse conditions and also generate capital resources internally. Profitability
ratios like operating profit and net profit ratios to sales are calculated and
compared with last 5 years figures or compared with the similar other companies
carrying on same business. As a rating is a forward-looking exercise, more
emphasis is laid on the future rather than the past earning capacity of the issuer.
10. Cash flow analysis: Cash flow analysis is undertaken in relation to debt and fixed
and working capital requirements of the company. It indicates the usage of cash
for different purposes and the extent of cash available for meeting fixed interest
obligations. Cash flows analysis facilitates credit rating of a company as it better
indicates the issuers debt servicing capability compared to reported earnings.
11. Financial flexibility: Existing Capital structure of a company is studied to find the
debt/equity ratio, alternative means of financing used to raise funds, ability to
raise funds, asset deployment potential etc. The future debt claims on the
issuers as well as the issuers ability to raise capital is determined in order to
find issuers financial flexibility.
III. Management Evaluation: Any companys performance is significantly affected by
the management goals, plans and strategies, capacity to overcome unfavorable
conditions, staffs own experience and skills, planning and control system etc. Rating of
a debt instrument requires evaluation of the management strengths and weaknesses.
1. Geographical Analysis: Geographical analysis is undertaken to determine the
locational advantages enjoyed by the issuer company. An issuer company having
its business spread over large geographical area enjoys the benefits of
diversification and hence gets better credit rating. A company located in
backward area may enjoy subsidies from government thus enjoying the benefit of
lower cost of operation. Thus geographical analysis is undertaken to determine
the locational advantages enjoyed by the issuer company.
2. Regulatory and Competitive Environment Credit rating agencies evaluate
structure and regulatory framework of the financial system in which it works.
While assigning the rating symbols, CRAs evaluate the impact of regulation/
deregulation on the issuer company.

1. Fundamental Analysis: Fundamental analysis includes an analysis of liquidity

management, profitability and financial position, interest and tax rates sensitivity

2.

3.
4.
5.

of the company. This includes an analysis of liquidity management, profitability

and financial position, interest and tax rates sensitivity of the company.
Liquidity management involves study of capital structure, availability of liquid
assets corresponding to financing commitments and maturing deposits, matching
of assets and liabilities.
Asset quality covers factors like quality of companys credit risk management,
exposure to individual borrowers and management of problem credits etc.
Profitability and financial position covers aspects like past profits, funds
deployment, revenues on non-fund based activities, addition to reserves.
Interest and tax sensitivity reflects sensitivity of company following the changes
in interest rates and changes in tax law. Fundamental analysis is undertaken for
rating debt instruments of financial institutions, banks and non-banking finance
companies.

Q2. Give the meaning of the concept of venture capital funds. Explain the
features of venture capital fund.
Solution: Venture capital is the money provided by investors to start firms and small
businesses with long-term growth potential. This is a very important source of funding
for start-ups that do not have access to capital markets. It typically entails high risk for
the investor, but it has the potential for above-average returns.
Venture capital can be defined as investment (long term) which is made in:

Ventures that are promoted by persons who though they are qualified and

technically sound but do not have any entrepreneurial experience.

Projects which involves high degree of risk. The concept of venture capital
financing is very old but todays changing business environment makes it more
tempting for businesses. The reason being, venture capital companies give risky
capital to the entrepreneur so that they can meet the minimum requirements of
the promoters contribution. Venture capitalists not only provide the finance for
risky business but also provide value added services and business and
managerial support. In situations where firms are not able to raise finance by
conventional means, like public issue, etc., the importance of venture capital is
greater. Thus, we can say that venture capital institutions are financial
intermediaries between the entrepreneurs who need institutional capital (as they
are not ready for public finance) and investors who are looking for higher returns.

Features of a Venture Capital Fund

As venture capital is provided for businesses which involve higher risk and also a higher
rate of return, it has some specific features. These are:

(i) Long-term investment: Venture capital is provided for the long term. This is
generally provided to high-risk businesses (small and medium enterprises) who cannot
arrange funds from other sources of finance. Venture capital is for that project which
starts earning returns after some time. Due to all these reasons, venture capital is
provided for the long term.
(ii) Participation in equity capital: Venture capital is always invested in equity
capital (actual or potential). The reason for this is that the venture capitalist can sell his
part of equity when they start earning profit from their equity holding. In the beginning,
the equity capital of new ventures is risky but when they start earning profits and the
market gains confidence in them, the venture capitalist can sell his portion of equity
capital at a profit.
(iii) High risk: Venture capital signifies equity investment (ownership participation) in
highly risky projects which have growth prospective and a projected high rate of return.
Projects, in which markets have no earlier experience of earning profits, are the target
of the venture capitalists.
(iv)Management participation: Venture capital funds not only provide equity capital
to the firms or businesses but also provide them with various kinds of services like
participation in management of the assisted business. Due to this reason they are
different from bankers. They are not like other stock market investors who do not
participate in the management of companies but invest and trade in shares in the stock
market. In this way, venture capital is different from investors (equity) also. Moreover, it
is the combination of bankers, stock market investors and entrepreneurs.
(v) Liquid investment: Investment made by venture capital fund is in equity portion
of the company which makes it less liquid. Funds cannot demand its money back
anytime during the life of the assisted business. They get their money back when the
assisted business goes into liquidation.
(vi) Fulfils its social objectives: Unlike several state and central-level government
organizations, venture capitalists provide finance with profit as their main objective. But
venture capital funds help in generating new employment opportunities and also help in
the balanced growth of the economy by the development of new and innovative
business.
(vii) Large scope of venture capital activities: Venture capital is not merely a
means for financing technology. It is beyond financing new technology oriented
companies and businesses. It extends to involve the financing of small and medium
enterprises at their early stages of business and helps them establish in the market. So,
it can be said that the scope of venture capital activities is big.

Q3. Hire purchase is one of the important concept. There are certain features
of hire purchase agreement so explain the points of it. Differentiate between
hire purchase and leasing.
Solution: In a hire purchase system, the buyer acquires the property by promising to pay
in monthly, quarterly and half-yearly installments. The period of payment has to be
fixed while signing the hire sale agreement. Though the buyer acquires the asset after
signing the agreement, the title of ownership remains with the vendor until the buyer
pays the entire liability. When the buyer pays the entire installment and any other
obligation according to hire purchase agreement, only then the title of ownership of
goods would be transferred to the hirer. If the hirer makes any default in the payment of
any installment, the hire vendor has the right to repossess the goods. In this case, the
amount that is already paid so far by the hirer will be forfeited.
The hire purchase price of goods is normally higher than the cash price of the good,
because it includes interest on the balance payable amount charged by the vendor as
well as the cash price. Under this system, the vendor is responsible to repair the goods
which are in possession of buyer provided that the buyer takes the utmost proper care
of the goods acquired. The risk is also borne by the vendor until the payment of last
installment. The buyer has the right to return the goods to the vendor, if they are not
according to the terms and condition of the hire purchase agreement. Generally, a
higher purchase agreement has the following features:
1. The buyer (hirer) buys some goods from the hiree and the possession of the
goods is immediately given to the buyer while the ownership rests with the
merchant (vendor).
2. This payment for goods is made in installments and this must be completed in a
specific period of time. In other words, we can say that hire purchase agreement
is for a specific period of time.
3. The ownership of the asset transfer to the buyer when he pays the last
instalment for it; till then ownership lies with the merchant or vendor.
4. In this agreement hiree charges interest on flat rate.
5. The hiree or vender has the right to repossess the asset in case there is default in
the payment of installments from buyer side.
6. Each instalment paid by buyer includes the amount of interest as well as the
repayment of the loan amount or principal amount.
7. The hire purchaser generally makes a down payment (initial payment) in signing
the agreement and the balance of the amount along with the interest is paid in
the installments at regular intervals.
8. The hire purchaser has the right to terminate the agreement at any time before
the property so passes.
Difference between Hire Purchase and Leasing
1. Ownership
In leasing ownership is never transfer to the

lessee even after the payment of last lease

rentals. But in hire purchase, after the
payment of last installment ownership is
transferred to the buyer of the goods.
Generally in lease, repayment is called lease
2. Repayment
rentals and that in case of hire purchase is
amount
called installments.
In lease financing lease rentals are tax
3. Advantage of deductible expenses. However, in hire
purchase arrangement only the amount of
tax
interest is tax deductible not the full
deductibility
installment.
Lessee cannot claim depreciation as he is not
the owner of the asset.
In hire purchase the buyer can have the claim
of depreciation with other expenses.
4. Depreciation
Lessee cannot realize salvage value of the
leased asset after the end of the lease
5. Realization of contract.
salvage value
The hirer can claim salvage value.
In leasing, magnitude of funds involved is
very large because these contracts are
generally for capital goods such as plant and
machinery, ships, among others. In the case
6. Magnitude of of hire purchase, the magnitude of funds
involved is low. Generally, these contracts are
funds
for the purchase of office equipments,
involved
automobiles, furniture among others.
In lease, rentals paid by the lessee are
entirely revenue expenditure of the lessee.
7. Nature of
But, only interest element included in the HP
Expenditure
installment is revenue expenditure.
Lease rental comprises two elements: (1)
finance charge and (2) capital recovery.
In case of Hire Purchase, HP installments
comprise three elements (1) normal trading
profit (2) finance charge and (3) recovery of
cost goods/assets.
8. Components

Q4. Explain the concept of Depository receipts. Write down the difference
between American Depository Receipts (ADR) and Global Depository Receipts
(GDR) also mention the issues involved in ADR/GDR.
Solution: Depository receipts are securities that are traded in foreign currency. These
receipts are issued by the foreign bank or institution which acts as a depository of
shares issued by a domestic company.
Depository receipts can be classified into sponsored and unsponsored ones.

1. Sponsored depository receipts: It is created by a single depository which is

appointed by the issuing company under rules provided in a deposit agreement.
The issues of sponsored ADR/GDR require prior approval of the Ministry of
Finance.
1. Unsponsored depository receipts: These are issued without any formal
agreement between the issuing company and the depository, although the
issuing company must consent to the creation of the ADR/GDR facility.
How does the depository work?
If an Indian company wants to raise funds from the investors in the United States it will
have to list itself in the US Stock Exchange (NASDAQ). Since the shares are in the
denomination of Indian rupees, these are not directly listed on the stock exchange of
USA, hence, the depository works as an intermediary. Here the Indian company releases
and deposits the new shares with the depository. The depository in turn issues the
depository receipts to the investors in the US. A depository in the US generally will be
an investment bank registered with the Securities and Exchange Commission (SEC).
As Securities and Exchange Board of India (SEBI) is the capital market regulator in India,
SEC is in the US. The depository will have a custodian in India where the new shares are
deposited. The custodian can be the Indian arm of the depository or an independent
company which provides the related services to the US-based depository.
Depository receipts can be of two forms Global Depository Receipts (GDRs) and
American Depository Receipts (ADRs). GDRs are usually listed on a European stock
exchange and ADRs on the US stock exchange. In case of issue of a depository receipt
by the Indian company, the dividend payment to the investor is made in terms of Indian
rupee, which is converted into dollars by the international depository, after deduction of
withholding tax.

Difference between ADRs and GDRs

The following are the main points of difference between ADRs and GDRs.
(i) The ADRs are issued by the companies to raise funds from the US markets and GDRs
are issued by the companies to raise funds from international markets.
(ii) Even though both are negotiable instruments, ADRs are negotiable in the US
markets only and GDRs are negotiable in international markets.
(iii) The GDRs can be used as a substitute of ADRs, but ADRs cannot be substituted for
GDRs.
(iv) Companies prefer to issue GDRs in comparison to ADRs due to wider scope to
access the international markets by GDRs.
(v) ADRs are found in three forms from level-I to level-III, but GDRs are already called in
high preference receipt of level-II and level-III.

Issues involved in ADR/GDR

ADR/GDR issue involves various parties who have some specific role to play in the
global issue.
These parties can be a single individual or a group of individuals and ingenuous
endeavors are required from them to make a global issue successful.
(I) Issuer Company: A company, which wants to tap the foreign market by raising
foreign funds by way of ADR/GDR issue is called Issuer Company. This company is
responsible for making draft of the issue proposals as per the regulations applicable to
them.
(II) Lead manager: Responsibility of marketing the issue lies with the lead manager. A
lead manager:
1. a) Advise the issuer company about the type of securities which the former can
issue in the global market. These securities can be equity, bonds, foreign
currency convertible bonds (FCCBs);
2. b) Give suggestions about the rate of interest, price of the securities, market
conditions, nature of investment conversion price etc. to the issuer company.
(III) Co-managers/underwriters: Underwriters assists the lead managers to perform
their duties with regard to the global issue to make it a successful effort.
(IV) Depository: Depository is a bank authorized by the issuer company to raise funds
by issuing ADRs/GDRs. Depository is the overseas agent of the issuer company who
performs the function of issuing ADR/GDR to the investors to compensate for shares

allotted to them. Depositorys name appears in the register of members of the issuer
company, as he is the registered owner of the shares.
(V) Custodian: It is a banking company situated in India which acts as a custodian for
the ordinary shares or FCCBs of an Indian company and is appointed by the issuer
company. Custodian has physical possession of the shares (although its ownership rests
with the investors) and it works in coordination with the depository.
(VI) Legal advisors: Legal advisors actually help the issuer, lead manager,
underwriters in giving legal advice in various documents published by them, viz.,
prospectus, various agreements etc.
(VII) Auditors: Various information need to be verified to be included in the prospectus,
therefore, auditors provide report of verified information about the issuer company. The
auditors also participate in the meetings for due diligence and provide a report on that
as well.

Q5. What is Online Trading? Explain the process of online trading.

Solution: Online trading is one of the crucial financial services provided by financial
institutions and merchant bankers. For example, Indiabulls Securities Limited is one of
Indias foremost stock brokerage house having a pan India presence. The organization is
a pioneer in providing online stock trading platform in India and currently has a
customer base of seven lakh customers.
Online trading is completed through Bombay Stock Exchange (BSE) and National Stock
Exchange (NSE). Market timings are 9 am to 4 pm and traders carry out trading in these
markets. On a days trading, stock rise is dependent and fluctuations are linked to the
trading on these exchanges. Online trading leads to smoother and quicker transaction
on these exchanges. Some 5,000 companies were listed on the BSE and 1,650
companies were listed on the NSE till December 2011. The government recognized BSE
in 1956. In 1995, in a span of fifty days BSE was converted into an electronic trading
system from an open outcry floor trading exchange system. In the new electronic
trading system, there is an automated screen-based trading platform which is known as
BOLT (i.e. BSE online trading system) and at present it has an ability of eight million
orders a day. This system enables an investor to trade from any part of the world. This
system is the worlds first centralized exchange-based internet trading system
called BSEWEBx.co.in.
NSE was established by the efforts of leading financial institutions, banks, insurance
companies and few financial intermediaries on behalf of the government and was
incorporated in November 1992. It was the first ever exchange with electronic limit
order book (called LOB), which permits trading in securities, has investor grievance cell
and investor protection fund, supports gold ETFs, and uses satellite communication
technology for trading (NEAT National Exchange for Automatic Trading).

These two exchanges are the backbone of the Indian economy and their functionaries
are movement setters to numerous other stock exchanges across the country and the
world.
Both NSE and BSE have switched over to computerized online trading system from open
outcry trading system. BSE has BOLT (BSE Online Trading) and NSE has NEAT (National
Exchange Automated Trading). With these highly efficient online trading systems,
efficiency and transparency of BSE and NSE have increased dramatically.

Process of Online Trading

Online trading can be defined as the procedure through which transaction of financial
securities, currencies and commodities takes place through the internet. Investors
should use the right software made available by several brokers for making online
transactions. Several leading online transaction portals are available in India besides the
ones provided by NSE and BSE. The settlement cycle in India is T+2 days i.e. trade + 2
days. T+2 means the transactions done on the trade day, will be resolved by exchange
of money and securities on the second business day (excluding Saturday, Sundays,
bank and exchange trading holidays). Pay-in and pay-out for securities settlement is
done on a T+2 basis.
The trading and settlement process in India has been listed below:

Orders are placed at the trading depots by investors.

It is the responsibility of the broker houses to confirm the orders and then certify

them to the exchange (BSE or NSE as per the clients choice).

Order corresponding at the exchange.
Trade confirmation information is provided by brokers to the investors.
The clearing corporation obtains the particulars of trade from the exchange.
The clearing corporation conveys the particulars of trade to clearing

members/custodians who validate it. Based on the validation, the clearing

corporation decides the duties and responsibilities.
Understanding of duties and responsibilities and pay-in advice of funds/ securities

by the clearing corporation.

The clearing corporation orders the clearing banks to make funds available by

pay-in time.
The clearing corporation orders the depositories to make securities available by

pay-in-time.
Pay-in of securities: The clearing corporation recommends the depository to debit
pool account of custodians/clearing members and credit its (clearing
corporations) account and depository does the same.

Pay-in of funds: The clearing corporation recommends the clearing banks to debit

account of custodians/clearing members and credit its account and clearing bank
does the same.
Hence, in online trading, orders are executed through online trading platforms
presented by various brokers. Orders are straightaway placed at a brokers site by the
investors. The broker is responsible for carrying out the orders on the stock exchange
and also makes payments on behalf of the clients. Besides, brokers also provide clients
with information related to current market trends, news and charts through their online
portals. This helps the investor in taking correct decisions. In return for these services,
brokers charge software usage fees and trading commissions for their services. An
investor is able to trade in more than one product/market through the same account
and software.
Q6. Write short notes on:
1. a) Depository Participants: All the functions performed by depositories are
actually executed by the depository participants (DPs). All activities related to
recording of allotment of securities, transfer of securities etc. are executed
through depository participants and no investor can directly open an account
with a depository. A depository can enter into an agreement with various
depository participants who would work as agents of the depository. Depository
Participant works as an intermediary between the investor and depository and
they are called as agents of the depository. The
Depositories Act, 1996, and SEBI (Depository & Participants) Regulations, 1996, specify
the relationship between a depository and depository participant. Any issue related to
the governance of relationship between the depository and DPs will be in accordance
with the Depositories Act and SEBI regulations. A depository participant is always
registered with SEBI and is a legal entity. Once a depository participant obtains a
certification of registration with SEBI after that it can start giving its depositories-related
services.

SEBI (Depository & Participants) Regulations, 1996, has prescribed a minimum

net worth of `50 lakh for the applicants who are stockbrokers or Non-Banking
Finance Companies (NBFCs), for granting a certificate of registration to act as a
depository participant.
For R&T agents, a minimum net worth of `10 crore is prescribed in addition to a

grant of certificate of registration by SEBI.

A stockbroker can act as a depository participant in more than one depository but

in that case the stockbroker has to comply with the criteria of each depository in
order to maintain a specified net worth.
Similarly some other specifications are given for the NBFCs when they work as
depository participant on behalf of a person.

For R&T agents, the specifications for net worth are different and given in SEBI
(D&P) Regulations, 1996.

1. b) Benefits of depository system: In the depository system, share certificates

belonging to the investors are dematerialized and their names are entered in the
records of depositary as beneficial owners. Investors names in the companies
register are replaced by the name of depository as the registered owner of the
securities. The beneficial owner continues to enjoy all the rights and benefits and
be subject to all the liabilities in respect of the securities held by the depository.
The ownership changes in, the depositary are done automatically on the basis of
delivery vs. payment.
The investors opting to join depository mode are required to enter into agreement with
depository through a participant who acts as an agent of depository. The agencies such
as custodians, bank, financial institutions, large corporate brokerage firms, non
banking financial companies etc. act as participants of depositaries. The companies
issuing securities are also required to enter into an agreement with the depositary.
Benefits of Depository system
The benefits from the depositary system are following:

It reduces the cost of the issue and the transfer of securities by eliminating

stamp duty.
It reduces the scope of theft, forgery damages to securities certificates.
It eliminates bad deliveries.
It entitles the transferee to all the rights associated with the securities

immediately on the settlement of purchase transaction.

It enhances the liquidity of securities in the market.
It makes faster disbursement of non-cash corporate benefits like rights, bonus,

etc. possible.
It reduces brokerage by many brokers for trading in dematerialized securities.
It eliminates problems relating to change of address of investors, transmission

etc.
It eliminates problems relating to selling securities on behalf of a minor.