B.

Com Semester 4

BUSINESS FINANCE
Module 1 — Indian Financial System

Exam-Ready Notes | 60 Marks External Paper

Aim: A / A+ Grade

Info Details

Exam Pattern Q1-Q5 | Attempt 2 of 3 sub-questions | 12 marks each

Each Answer ≈ 6 marks

This Module Financial System | Markets | Derivatives | Services | MF | SIP

 UNIT 1 — INDIAN FINANCIAL SYSTEM
1.1 Definition & Overview
Financial System: A well-integrated set of financial institutions, markets, instruments, and services that
facilitate the transfer and allocation of funds in an economy.

1.2 Four Components of the Formal Financial System

# Component Examples

Banks (SCBs, Cooperative) + Non-Banking (NBFCs, DFIs: IDBI, SIDBI,

1 Financial Institutions
NABARD, EXIM Bank)

2 Financial Markets Capital Market (long-term) + Money Market (short-term)

Claims against persons/institutions for future cash flows — equity, bonds,

3 Financial Instruments
derivatives

Fund-based (Leasing, Factoring, VC, MF) + Fee-based (Merchant Banking,

4 Financial Services
Credit Rating)

■ EXAM TIP: Questions on 'components of financial system' are very common. Learn all 4 with examples.

1.3 Financial Markets

Capital Market
• Definition: Market for long-term funds (equity + debt). Includes Primary & Secondary markets.
• Primary Market (New Issue Market): Fresh capital raised by issuing new securities to investors.
• Secondary Market: Trading of existing securities (NSE, BSE, OTCEI). Provides liquidity + price discovery.

Types of Issues
Type Full Form Key Point

IPO Initial Public Offering First-ever public issue by an UNLISTED company

FPO Further Public Offering Public issue by an ALREADY LISTED company

Rights Issue — Offered to EXISTING shareholders at record date in fixed ratio

Composite Issue — Public issue + Rights issue simultaneously

FREE shares from free reserves/share premium — NO

Bonus Issue —
consideration paid

Private Placement Max 49 persons Includes: Preferential Allotment, QIP (to QIBs), IPP

■ QIP = Qualified Institutional Placement (to Qualified Institutional Buyers only). IPP = Institutional Placement Programme
(for minimum public shareholding compliance).

1.4 International Capital Markets

Why Companies Prefer International Markets (since 1993)
• Shorter time + lower cost (book building process)
• Offshore issues allow foreign ownership beyond prescribed ceiling
• FIIs prefer Euro issues: no SEBI registration, no capital gains tax on GDRs
• Larger volume of funds available internationally
• Euro bond market popular: no regulatory restrictions, outside single-country framework

International Instruments
 Instrument Full Form Key Features

Equity instruments issued ABROAD by overseas corporate bodies against

Global Depositary
GDR Indian company shares; listed on Luxembourg/London SE; fungible; NO
Receipt
voting rights till conversion; dividend in INR

American Depositary Dollar-denominated; issued by US Depository Bank; listed on

ADR
Receipt NYSE/NASDAQ; more liquid than GDR; requires SEC compliance

Offshore bonds in currency other than issuer's home country; 5–30 year
Eurobonds —
maturity; fixed/floating coupon; NO regulatory restrictions

Foreign Currency Bonds by Indian companies subscribed by non-residents in foreign

FCCBs
Convertible Bonds currency; convertible to equity; interest in dollars; HIGHER exchange risk

■ EXAM TIP: GDR vs ADR is a favourite 6-mark question. Key diff: GDR = Luxembourg/London, ADR =
NYSE/NASDAQ + requires SEC compliance.

1.5 Stock Exchange — Functions & Significance

10 Functions of Stock Exchange
1. Continuous market for securities

2. Evaluation/price discovery of securities

3. Capital formation for the economy

4. Safety and security in dealings

5. Regulates company management

6. Facilitates public borrowing

7. Provides clearing house facility

8. Facilitates healthy speculation

9. Acts as economic barometer

10. Facilitates bank lending against securities

Significance of Stock Exchange

Stakeholder Benefits

To Investors Liquidity, collateral value, participation in industrial growth, worth estimation

To Companies Widens market, creates goodwill, fair pricing, better investor response

Economic development, diversification of funds, optimum use of funds, public borrowing,

To Society
savings habit
 UNIT 2 — MONEY MARKET
2.1 Definition & Features
Money Market: Market for short-term financial assets with maturity up to 1 year. Also called 'telephone
market' as transactions happen over phone. Instruments are highly liquid.

Functions of Money Market

• Balances demand and supply of short-term funds
• Focal point for RBI intervention in the economy
• Provides access to both suppliers and users of short-term funds
• Transmits monetary policy signals effectively

2.2 Money Market Instruments

■ Treasury Bills (T-Bills)
Govt short-term borrowing (up to 1 year). Types: 91-day, 182-day, 364-day. Zero-coupon — sold at DISCOUNT,
redeemed at face value. Min ■25,000. No TDS. Negotiable. No default risk. SLR eligible.

■ Call Money
Inter-bank overnight lending. Unsecured. Highly liquid. Volatile rates. Overnight = Call Money | 2–14 days = Notice
Money.

■ Commercial Papers (CP)

Promissory notes issued by large, high-credit companies. Negotiable. Unsecured. Denomination: ■5 lakh. Min
investment: ■25 lakh. Redeemable at par.

■ Certificate of Deposits (CD)

Introduced by RBI in 1989. Marketable document of title to a time deposit. Negotiable. Maturity: 7 days–12 months
(banks); 1–3 years (FIs). Freely transferable after 7 days.

■ Commercial Bills
Short-term, negotiable, self-liquidating instruments. Maturity: 30/60/90 days. Trade bills accepted by commercial
banks = Commercial Bills.

■ EXAM TIP: Treasury Bills are ZERO COUPON — issued at discount. CDs are introduced in 1989 by RBI.
These dates/facts fetch marks.
 UNIT 3 — FINANCIAL DERIVATIVES
3.1 Definition & Need
Derivative: A financial contract whose value is DERIVED from an underlying asset (share, index, interest
rate, commodity, or currency).

Need for Derivatives

• Risk management (hedging)
• Price discovery
• Liquidity enhancement
• Capital efficiency
• Risk transfer mechanism
• Speculation/investment opportunities

3.2 Types of Derivatives

Forward Contracts
• Over-The-Counter (OTC) — not exchange traded
• Customized/tailor-made terms
• Bilateral agreement — counter-party risk exists
• Settled by actual delivery
• Non-tradeable; single delivery date

Futures Contracts
• Exchange-traded (standardized)
• Marked-to-market DAILY
• Clearing house ELIMINATES counter-party risk
• Multiple delivery dates
• More liquid than forwards; regulated

Options
• Definition: Right but NOT obligation to buy/sell at the strike price. Buyer pays PREMIUM.
Type Meaning

Call Option Right to BUY the underlying asset

Put Option Right to SELL the underlying asset

European Option Can be exercised ONLY on the expiry date

American Option Can be exercised ANY TIME on or before expiry

3.3 Forwards vs Futures — Comparison Table

Basis Forwards Futures

Trading OTC (bilateral) Exchange-traded

Standardization Customized Standardized

Counter-party Risk YES NO (clearing house)

Marked-to-Market No Daily

Liquidity Less More

Basis Forwards Futures

Regulation Minimal Regulated

Settlement By delivery Cash/delivery

■ EXAM TIP: Forwards vs Futures table is extremely high probability. Memorize all 7 differences.

3.4 Traders in Derivatives Market

Trader Role

Hedger Reduces pre-existing risk by taking opposite position in derivatives market

Speculator Takes deliberate risk for profit; provides liquidity to the market

Arbitrageur Exploits price differences across markets simultaneously; ensures price uniformity
 UNIT 4 — REGULATORY STRUCTURE
4.1 Regulatory Framework Overview
Regulator Jurisdiction

RBI Commercial banks, cooperative banks, NBFCs, All-India FIs, forex market

SEBI Capital market, mutual funds, venture capital, corporate bonds

IRDAI Public and private insurance companies

State Govts Urban cooperative banks, state financial corporations

SIDBI/NABARD Small industries and rural banking supervision

4.2 SEBI — Securities & Exchange Board of India

■ Established: 12 April 1988 | Became Statutory Body: January 1992

3 Functions of SEBI
A) Protective Functions
• Prohibits price rigging and insider trading
• Prohibits fraudulent and unfair trade practices
• Undertakes investor education and awareness programs
• Promotes fair practices among corporate entities

B) Developmental Functions
• Training of intermediaries in securities markets
• Promotes internet-based trading
• Made underwriting optional to cut issue costs
• Research and development in the securities market

C) Regulatory Functions
• Frames rules for conduct of intermediaries
• Registers and regulates brokers, sub-brokers, merchant bankers
• Regulates mutual funds and portfolio managers
• Conducts audits and inquiries of stock exchanges
• Regulates takeover and acquisition of companies

SEBI Powers
• Power 1: Over stock exchanges and intermediaries — can demand information, conduct inspections
• Power 2: Impose monetary penalties on intermediaries for violations
• Power 3: Initiate legal actions for functions assigned to it
• Power 4: Regulate insider trading activities
• Power 5: Powers under Securities Contracts (Regulation) Act; nominate 3 members on governing body of every
stock exchange
• Power 6: Regulate business of stock exchanges, mutual funds, and takeover bids

SEBI Investor Protection Measures

• Issue of guidelines (transparency, code of advertisement)
• Public interest advertisements in media
• Dealing with and redressing investor complaints
• Investor education — SEBI Market Review, SEBI Newsletter, IEPF
• Conducting investor surveys
• Introduction of Stockinvest scheme
• Mandatory disclosures by companies (half-yearly results, abridged prospectus)
• Code of conduct regarding corporate takeovers

4.3 RBI Functions

Function Details

1. Monetary Authority Formulates & implements monetary policy; maintains price stability

2. Regulator/Supervisor Sets parameters for banking operations; ensures financial stability

3. Forex Manager Manages foreign exchange under FEMA 1999

4. Currency Issuer Issues, exchanges, and destroys currency notes; coins issued by Govt of India

5. Developmental Role Undertakes promotional functions for financial sector development

6. Payment Systems Regulator of payment and settlement systems

7. Banker to Govt + Banks Manages govt accounts; provides credit facilities to banks

RBI Powers Over NBFCs

• Registration (Sec 45-IA): Min Net Owned Funds = ■2 crore required
• Remove directors (Sec 45-ID): Can supersede Board up to 5 years if detrimental to public interest
• Issue policy/directions (Sec 45-JA): Income recognition, accounting standards
• File winding-up petition (Sec 45-MC) if NBFC fails to comply
• Cause inspection (Sec 45-N) of NBFC books and operations
• Mandate minimum Net Owned Fund of ■2 crore
• Maintain credit rating requirement for certain NBFC categories
 UNIT 5 — FINANCIAL SERVICES
5.1 Fund-Based vs Fee-Based Services
Basis Fund-Based Fee-Based

Nature Direct investment / lending Advisory / consultancy

Revenue Source Interest, dividends, capital gains Fees, commissions, brokerage

Risk Level Higher (bears credit risk) Lower (no direct credit risk)

Capital Required Yes — large funds needed Minimal

Leasing, Hire Purchase, Factoring, Merchant Banking, Credit Rating,

Examples
Forfaiting, VC, MF Depositories, Investment Banking

5.2 Lease Financing

Lease: Contract between Lessor (owner) and Lessee (user) granting right to use an asset for an agreed
period in exchange for periodic lease rental payments.

Types of Leases
Type Key Features

Long-term = full economic life of asset. Non-cancellable. Lessee bears ALL

Financial Lease (Capital Lease)
risks/rewards. Option to buy at end. Lessee claims depreciation.

Short-term. Cancellable. Lessor bears obsolescence risk. Lessor responsible for

Operating Lease
maintenance. No purchase option.

Owner sells asset to lessor then LEASES IT BACK. Frees up capital. Improves
Sale and Leaseback
liquidity.

Third party lender involved. Lessor borrows ~80% from lender. Asset serves as
Leverage Leasing
security.

Open-ended Lease Lessee has option to PURCHASE the asset at the end.

Close-ended Lease Asset returns to lessor at the end of lease period.

Cross-border Lease Lessee and lessor are in DIFFERENT COUNTRIES.

3N / Net-Net Lease Lessee responsible for maintenance, insurance, AND taxes.

Finance Lease vs Operating Lease

Point Finance Lease Operating Lease

Duration Full economic life of asset Shorter than economic life

Cancellation Non-cancellable Cancellable

Maintenance Lessee bears Lessor bears

Obsolescence Risk Lessee bears Lessor bears

Purchase Option Yes No

Advantages & Disadvantages of Leasing

Advantages:
• 100% financing — no large capital outlay required
• Tax advantage — lease rentals are fully deductible operating costs
• Easy budgeting — fixed periodic payments
• Hedge against technological obsolescence
• Flexible financing arrangement

Disadvantages:
• No ownership of asset
• Costlier in the long-term overall
• Lessee may bear maintenance costs
• Restrictions on use of asset
• Default consequences — loss of asset

5.3 Hire Purchase

Hire Purchase: Contract where owner lets goods ON HIRE. Title (ownership) passes to hirer ONLY on
payment of the LAST instalment. Hirer can return goods anytime without further obligation.

Essentials of Hire Purchase

• Delivery of goods to hirer on signing contract
• Payment made in instalments over agreed period
• Ownership passes ONLY on payment of last instalment
• On default — seller has right to repossess goods
• Money paid before default = rent for use (not part-payment)

Lease vs Hire Purchase

Basis Lease Hire Purchase

Remains with LESSOR (except finance

Ownership Passes to hirer on LAST instalment
lease)

Depreciation Claimed by LESSOR Claimed by HIRE PURCHASER

Trading profit + Finance charge + Cost

Revenue Components Finance charge + Capital recovery
recovery

Tax Benefit Lessor: depreciation; Lessee: full rentals HP: depreciation + interest deduction

■ EXAM TIP: Lease vs HP ownership/depreciation comparison is a standard 6-mark question.

5.4 Factoring
Factoring: Financial service where a factor (financial institution) PURCHASES the receivables of a
company, converting credit sales to IMMEDIATE CASH. Factor assumes collection risk and bad debt loss.

Factoring Process
• Seller assigns invoice to factor → Factor advances 80–90% immediately
• Factor collects from buyer on due date
• Balance paid to seller on realization (max debt period: 150 days + 60 days grace)

5 Functions of a Factor
• Assumption of credit risk
• Maintenance of sales ledger
• Collection of accounts receivable
• Financing trade debts (advance payment)
• Advisory services and credit analysis

Types of Factoring
 Type Key Feature

Recourse Factor can recover from client if receivable is irrecoverable. CLIENT bears default risk.

Non-Recourse FACTOR bears default risk. Higher commission (del credere commission) charged.

Advance Factoring Factor provides 75–90% advance against receivables immediately.

Maturity Factoring No advance. Full amount paid only at maturity of the invoice.

Undisclosed Customers are UNAWARE that receivables have been assigned to factor.

Disclosed Factor's name appears on the invoice; customers know about arrangement.

Domestic All parties (seller, buyer, factor) in the same country.

International 4 parties: Exporter + Importer + Export Factor + Import Factor.

5.5 Forfaiting
Forfaiting: NON-RECOURSE discounting of international trade receivables at 100% of value. Converts
exporter's credit sale to immediate cash sale. Protects exporter from ALL risks (commercial, political,
exchange, interest).

Benefits of Forfaiting
• Full export value received without waiting for payment
• Eliminates commercial, political, transfer, interest, and exchange risk
• Improves exporter's liquidity and cash flow
• Relieves balance sheet (converts receivable to cash)
• Enhances competitive advantage (can offer credit terms)
• Simple documentation; no long-term banking relationship required
• Saves insurance costs

Forfaiting vs Factoring
Basis Forfaiting Factoring

Scope International trade only Domestic + International

Recourse Always NON-recourse Can be recourse or non-recourse

Coverage 100% of invoice value 75–90% advance (rest on collection)

Risk Transfer ALL risks transferred Only credit risk (in non-recourse)

Instrument Bills of exchange/promissory notes Book debts/invoices

■ EXAM TIP: Key phrase: Forfaiting = NON-RECOURSE + INTERNATIONAL + 100%. Factoring = can be
recourse + domestic/international + 80-90%.
 UNIT 6 — VENTURE CAPITAL & MUTUAL FUNDS
6.1 Venture Capital
Venture Capital (Risk Capital): Fund available for investment in enterprises offering high probability of
profit with possibility of loss. Equity investment in small/medium high-growth businesses with new
technology.

Features of VC
• Investment via equity through private placements or bought-out deals
• Focus on NEW enterprises with new/innovative technology
• VC investor maintains close contact but does NOT interfere in day-to-day management
• Investment is NOT liquid — no easy exit
• No fixed repayment schedule
• Investment can be ENTIRELY LOST if enterprise fails

Stages of VC Financing
Stage Description

1. Seed Stage Initial funding for R&D;, concept validation — highest risk

2. Startup Stage Product development, initial marketing

3. First/Emerging Stage Business begins operations, product launched

4. Expansion (2nd/3rd) Scaling up, entering new markets

5. Bridge Stage Pre-IPO/merger/acquisition stage — exit planning

Methods of VC Financing
Equity:
• Ordinary shares — most common
• Preference shares — cumulative, participating, or convertible

Debt:
• Conditional Loans — interest as % of sales (royalty basis)
• Convertible Loans — can be converted to equity later
• Conventional Loans — fixed interest rate

6.2 Mutual Funds

Mutual Fund (SEBI 1996): Fund established as a TRUST to raise money through sale of units to the public
under various schemes for investing in securities including money market instruments, gold, and real
estate.

■ UTI established in 1963 — first mutual fund in India. Industry AUM: ■68.08 lakh crore (Nov 2024). Inflows: ■60,295
crore (Nov 2024) — +135% YoY.

Benefits of Mutual Funds

• Professional fund management
• Portfolio diversification — reduces risk
• Lower transaction costs (economies of scale)
• High liquidity (especially open-ended)
• Convenience and flexibility
• Tax benefits (Section 80C, ■1 lakh limit for ELSS)
• Transparency — monthly portfolio disclosure
• SEBI regulated — strong investor protection
• Contributes to stock market stability
• Equity research benefits passed to investors

Classification of MF Schemes
By Structure (Functional)
Type Features

Open-Ended Continuous buy/sell at NAV anytime. No fixed corpus. KEY FEATURE = Liquidity.

Close-Ended Fixed corpus. 2–5 year maturity. Listed on stock exchange. NAV disclosed weekly.

Interval Combines open + close. Open for transactions at predetermined intervals only.

By Portfolio / Investment Objective

Type Features

Income Fund Safety + regular income. Bonds, debentures, govt securities. Lower risk.

Growth Fund Capital appreciation. Equity shares. Higher risk/return. No guarantee.

Balanced Fund Both appreciation + income. Mix of equity + fixed income. Moderate risk.

Equity Fund Types

• Diversified Equity Fund
• Large-cap (companies with market cap >■1000 crore)
• Mid-cap (■500–1000 crore market cap)
• Small-cap (<■500 crore market cap)
• Value Fund — undervalued stocks
• Sectoral Fund — specific sector (IT, Pharma, Banking)
• ELSS (Equity Linked Savings Scheme) — 3-year lock-in, tax benefit u/s 80C
• Index Fund — passive, tracks market index (Nifty/Sensex)
• ETF — Exchange Traded Fund, listed on NSE, passive management
• Arbitrage Fund — exploits price differences

Debt Fund Types

• Liquid/Money Market Fund — maturity <91 days
• Short-term Bond Fund
• Long-term Bond Fund
• Gilt Fund — ONLY government securities
• Floating Rate Fund — variable interest rate instruments
• Fixed Maturity Plans (FMPs) — fixed tenure
• Capital Protection Schemes — protects principal

Hybrid Fund Types

Type Composition

Equity-Oriented Hybrid More than 65% in equity

Debt-Oriented Hybrid More than 65% in debt instruments

Balanced Fund Approximately 50:50 equity-debt split

Special MF Types
 Type Key Feature

ETF (Exchange Traded Fund) Index-tracking; passive management; listed and traded on NSE like shares

Gold ETF Based on gold prices; lower cost than holding physical gold; listed on exchanges

Fund-of-Funds Invests in other mutual fund schemes instead of direct securities

Offshore Funds Attract foreign capital; India's first = 'India Fund' by UTI in 1986

Real Estate MF Invests in real estate assets and REITs

■ EXAM TIP: MF scheme classification is guaranteed in exams. Open vs Close-ended + ELSS tax benefit
(Section 80C) + Gilt = only govt securities — memorize these.

6.3 Systematic Investment Plan (SIP)

SIP: A financial planning tool where a fixed amount is invested on a pre-set date every month in a specific
mutual fund scheme. Enables disciplined investing with small amounts.

12 Advantages of SIP
• 1. Achieves financial goals through small monthly amounts (as low as ■500)
• 2. Flexible — no long-term commitment like PPF
• 3. Open-ended MF = can invest/withdraw anytime
• 4. Full or partial withdrawal is possible
• 5. Amount can be increased or decreased anytime
• 6. Longer investment horizon = better wealth accumulation (compounding)
• 7. COST AVERAGING = biggest benefit — buy more units when market is down
• 8. Easy to start — minimal documentation, ■500/month minimum
• 9. Creates savings discipline; enables tax-free wealth creation
• 10. Automated process — no monthly effort required after setup
• 11. Flexibility to discontinue or change fund/amount anytime
• 12. Provides liquidity — can exit anytime from open-ended funds

Disadvantages of SIP
• Lump-sum investment can sometimes be more profitable in bull markets
• All limitations of mutual funds apply to SIP as well
• Rigid product — must stop and restart to change fund or amount
• Irregular income earners (freelancers, seasonal workers) cannot benefit fully
★ QUICK REVISION — HIGH-YIELD FACTS ★
Key Fact Detail

SEBI established 12 April 1988 | Statutory body: January 1992

UTI established 1963 — India's first mutual fund

First Offshore Fund 'India Fund' by UTI — 1986

CDs introduced by RBI 1989

T-Bill denominations 91-day, 182-day, 364-day | Min ■25,000 | Zero-coupon

CP denomination ■5 lakh | Min investment ■25 lakh

NBFC min Net Owned Fund ■2 crore (Section 45-IA of RBI Act)

Factoring advance 80–90% of invoice | Max 150 + 60 days

Forfaiting NON-RECOURSE | INTERNATIONAL | 100% of value

ELSS lock-in 3 years | Tax benefit under Section 80C (up to ■1 lakh)

Gilt Fund ONLY government securities — zero default risk

Private Placement Maximum 49 persons

Rights Issue To EXISTING shareholders at record date in fixed ratio

GDR listing Luxembourg Stock Exchange / London Stock Exchange

ADR listing NYSE / NASDAQ | Requires SEC compliance

Call Money Overnight inter-bank | Notice Money = 2–14 days

Cost Averaging Biggest benefit of SIP — more units when price is low

MF AUM (Nov 2024) ■68.08 lakh crore | Inflows: ■60,295 crore (+135% YoY)

■ Exam Strategy: For each 6-mark answer, write a definition + 4–5 key points + one comparison table if applicable.
Always attempt 2 sub-questions from each module. Module 1 = Financial System, Markets, Derivatives, Regulators,
Services, MF, SIP.