FINANCIAL INSTRUMENTS & SERVICES

Financial Instruments- Meaning, importance & types of Equity Shares – Meaning and
features. Preference shares – Meaning, features and types of Debentures – Meaning, feature
and types of Financial Services- Meaning, importance, and types of Financial Services – Fund
based services and Fee based services – Meaning, features and types Specialized Financial
Services- Meaning, features and types of Leasing, Factoring, Forfeiting, Credit Rating and
Venture Capital.

FINANCIAL INSTRUMENTS
A financial instrument is defined as a contract between individuals/parties that holds a
monetary value. They can either be created, traded, settled, or modified as per the involved
parties' requirement.

A financial instrument is an instrument that has monetary value or records a monetary

transaction or any contract that imposes on one party financial liability and represents to the
other a financial asset or equity instrument. Stock, bonds, and options contracts are some
examples of financial instruments.

Types of Primary market/capital market instruments

Types of shares: Shares in the company may be similar i.e. they may carry the same rights
and liabilities and confer on their holders the same rights, liabilities and duties. There are two
types of shares under Indian Company Law: -

1. Equity shares means that part of the share capital of the company which are not
preference shares.
2. Preference Shares means shares which fulfill the following 2 conditions. Therefore, a
share which does not fulfill both these conditions is an equity share.
1. It carries Preferential rights in respect of Dividend at fixed amount or at fixed rate i.e.
dividend payable is payable on fixed figure or percent and this dividend must paid before
the holders of the equity shares can be paid dividend.
2. It also carries preferential rights regarding payment of capital on winding up or otherwise.
It means the amount paid on preference share must be paid back to preference shareholders
before anything in paid to the equity shareholders. In other words, preference share capital
has priority both in repayment of dividend as well as capital.

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Types of Preference Shares

1. Cumulative or Non-cumulative: A non-cumulative or simple preference share gives the

right to a fixed percentage dividend of profit of each year. In the event no dividend thereon is
declared in any year because of absence of profit, the holders of preference shares get
nothing, nor can they claim unpaid dividend in the subsequent year or years in respect of that
year. Cumulative preference shares, however, give the right to the preference shareholders to
demand the unpaid dividend in any year during the subsequent year or years when the profits
are available for distribution. In this case dividends which are not paid in any year are
accumulated and are paid out when the profits are available.

2. Redeemable and Non- Redeemable: Redeemable Preference shares are preference shares
which must be repaid by the company after the term of which for which the preference shares
have been issued. Irredeemable Preference shares mean shares which are not repaid by the
company until winding up of the company. However, under the Indian Companies Act, a
company cannot issue irredeemable preference shares

3. Participating Preference Share or non-participating preference shares: Participating

Preference shares are entitled to a preferential dividend at a fixed rate with the right to
participate further in the profits either along with or after payment of certain rate of dividend
on equity shares. A non-participating share is one which does not such right to participate in
the profits of the company after the dividend and capital have been paid to the preference
shareholders.

Rights Issue of Shares

If, at any time after the expiry of 2 Years from the date of incorporation of the company or
after one year from the date of first allotment of shares, whichever is earlier, a public
company limited by shares issues further shares within the limit of authorized capital, its
directors must first offer such shares to the existing holders of equity shares in proportion to
the capital paid up on their shares at the time of further issue. This is commonly known as
"Rights Issue of shares". In case where the rights shares are not taken by the shareholders, the
directors of the company may dispose of the shares in the manner they think fit.

Issue of bonus shares

Bonus shares are issued by converting the reserves of the company into share capital. It is
nothing but capitalization of the reserves of the company. Bonus shares can be issued by a
company only if the Articles of Association of the company authorizes a bonus issue.

Sweat Equity and Employee Stock Options

Sweat Equity Shares mean equity shares issued by the company to its directors and / or
employees at a discount or for consideration other than cash for providing know how or
making available the rights in intellectual property rights or value additions.

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Debentures
Debentures are creditor ship securities representing long-term indebtedness of a company. A
debenture is an instrument executed by the company under its common seal acknowledging
indebtedness to some person or persons to secure the sum advanced.
Types of Debentures
The major types of debentures are as follows:

Types of Debentures Based on Record Point of View

a. Registered Debentures These are the debentures that are registered with the company.
The amount of such debentures is payable only to those debenture holders whose name
appears in the register of the company.

b. Bearer Debentures These are the debentures which are not recorded in the register of the
company. Such debentures are transferable merely by delivery. Holder of bearer debentures is
entitled to get the interest.

Types of Debentures Based on Security

a. Secured or Mortgage Debentures These are the debentures that are secured by a charge
on the assets of the company. These are also called mortgage debentures. The holders of
secured debentures have the right to recover their principal amount with the unpaid amount of
interest on such debentures out of the assets mortgaged by the company.

b. Unsecured Debentures - Debentures which do not carry any security regarding the
principal amount or unpaid interest are unsecured debentures. These are also called simple
debentures.

Types of Debentures on The Basis Of Redemption

a. Redeemable Debentures These are the debentures which are issued for a fixed period.
The principal amount of such debentures is paid off to the holders on the expiry of such
period. These debentures can be redeemed by annual drawings or by purchasing from the
open market.

b. Non-redeemable Debentures These are the debentures which are not redeemed in the
lifetime of the company. Such debentures are paid back only when the company goes to
liquidation.

Types of Debentures Based on Convertibility

a. Convertible Debentures These are the debentures that can be converted into shares of the
company on the expiry of pre-decided period. The terms and conditions of conversion are
generally announced at the time of issue of debentures.

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b. Non-convertible Debentures The holders of such debentures cannot convert their
debentures into the shares of the company.

Types of Debentures Based on Priority

a. First Debentures These debentures are redeemed before other debentures.

b. Second Debentures These debentures are redeemed after the redemption of the first
debentures.

Other types of debentures/bonds

Zero Coupon bonds - Zero-coupon bondholders gain on the difference between what they
pay for the bond and the amount they will receive at maturity. Zero-coupon bonds are
purchased at a large discount, known as deep discount, to the face value of the bond.
Secured premium notes - Secured premium notes (SPNs) are financial instruments
which are issued with detachable warrants and are redeemable after a certain period. SPN is a
kind of non-convertible debenture (NCD) attached with warrant. It can be issued by the
companies with the lock-in-period of say four to seven years. This means an investor can
redeem his SPN after lock-in-period. SPN holders will get principal amount with interest on
installment basis after lock in period of said period. However, during the lock-in period no
interest is paid.
Share warrants - Share warrants are securities issued by a company which give their
owners the right to purchase shares in the company at a specified price at a future date. The
warrants are tradable, and their value will go up and down as the price of the shares to
which they relate goes up and down. They have no right to dividend and no voting rights.
Callable bonds - A bond that can be redeemed by the issuer company prior to its maturity.
Usually, a premium is paid to the bond owner when the bond is called. It is also known as
a "redeemable bond."
Floating-rate Bond (or Variable or Adjustable-rate Bond) - A bond whose interest rate is
adjusted periodically according to a predetermined formula; it is usually linked to an interest
rate index such as Sensex.
Inflation adjusted bonds - Inflation-adjusted/protected bonds are primarily debt securities
that adjust their principal values in line with the rate of inflation. These bonds can be issued
by any organization.

Advantages/Merits of Debenture Issue:

 It enables a company to raise funds for a specific period.
 No dilution of control as debenture holders don’t possess voting rights
 Debenture (debt) enables the company to Trade on equity. It can pay dividends to equity
shareholders at a rate higher than overall ROI.
 Debenture holders are entitled to a fixed rate of interest. Eg: 10% debenture
 They enjoy priority over other unsecured creditors with respect to debt repayment.
 Suitable for conservative investors who seek steady ROI with little or no risk.

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 Interest on debentures is treated as expense and is tax deductible.
 The company can adjust its gearing in accordance with its financial plan.
 Debenture holders are regarded as creditors of the company, and they receive preference
over equity shareholders and preference shareholders.
Disadvantages/Demerits of Debenture issue:
 They have a fixed maturity; hence provision must be made for repayment.
 There is a limit to which funds can be raised through debentures.
 It is risky if the company fails to pay interest or principal installment on time, as
debenture holders can file a petition for winding up the company.
 It is not suitable for a company with fluctuating earnings as it may also lead to
fluctuations in payment of dividend payable to equity shareholders.
 With more risk, you get more return. Debentures being secure investments, returns are
less.
 Like ordinary shares, debenture holders will not be regarded as owners of the company
and have no voting rights.

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 FINANCIAL SERVICES
Financial services are an important component of financial system. Financial services
cater to the needs of financial institutions, financial markets and financial
instruments.

‘Financial Services’ can also be called “FINANCIAL INTERMEDIATION”.

Financial service is a process by which funds are mobilized from many savers and
make them available to all those who need it and particularly to corporate
customers. Thus, the financial services sector is a key area, and it is vital for
industrial development.

Financial services are the economic services provided by the finance industry, which
encompasses a broad range of organizations that manage money, including credit unions,
banks, credit-card companies, insurance companies, accountancy companies, consumer
finance companies, stock brokerages, investment funds and some government sponsored
enterprises.

Functions of Financial Services

• Facilitating transactions (exchange of goods and services) in the economy.
• Mobilizing savings
• Allocating capital funds (notably to finance productive investment).
• Monitoring managers (so that the funds allocated will be spent as envisaged).
• Transforming risk (reducing it through aggregation and enabling it to be carried by
those more willing to bear it).

Characteristics and Features of Financial Services

1. Customer-Specific: Financial services are usually customer focused. The firms
providing these services study the needs of their customers in detail before
deciding their financial strategy, giving due regard to costs, liquidity and maturity
considerations.

2. Intangibility: In a highly competitive global environment brand image is crucial.

Unless the financial institutions providing financial products and services have a
good image, enjoying the confidence of their clients, they may not be successful.
Thus, institutions must focus on the quality and innovativeness of their services to
build up their credibility.

3. Concomitant: Production of financial services and supply of these services must

be concomitant. Both these functions, i.e. production of new and innovative

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 financial services and supplying of these services are to be performed
simultaneously.

4. Tendency to Perish: Unlike any other service, financial services do tend to perish
and hence cannot be stored. They must be supplied as required by the customers.
Hence financial institutions have to ensure a proper synchronization of demand
and supply.

5. People Based Services: Marketing of financial services must be people intensive

and hence it’s subjected to variability of performance or quality of service. The
personnel in financial services organizations need to be selected based on their
suitability and trained properly, so that they can perform their activities efficiently
and effectively.

6. Market Dynamics: The market dynamics largely depend on socioeconomic

changes such as disposable income, standard of living and educational changes
related to the various classes of customers. Therefore, financial services must be
constantly redefined and refined taking into consideration the market dynamics.
The institutions providing financial services, while evolving new services, could
be proactive in visualizing in advance what the market wants or being reactive to
the needs and wants of their customers.

Advantages of financial services

1. It helps in raising the sufficient funds required for carrying out different development
activities.
2. It also assists to deploy the funds which are raised through issue of different financial
instruments.
3. They provide specialized services like, credit rating, venture capital, leasing etc.
[Link] services helps in economic development of a country by contributing greatly
to GDP.
5. Financial services provide lot of employment opportunities.
6. Financial services help in the movement of resources from one sector of the economy
to another.

Scope of Financial Services

Financial services cover a wide range of activities. They can be broadly classified into
two, namely:

1. Traditional Activities

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Traditionally, financial intermediaries have been rendering a wide range of services
encompassing both capital and money market activities. They can be grouped under
two heads, viz.

 Fund based activities and

 Non-fund-based activities.
Fund based activities: The traditional services which come under fund-based
activities are the following:

• Underwriting or investment in shares, debentures, bonds, etc. of new issues

(primary market activities).
• Dealing in secondary market activities.
• Participating in money market instruments like commercial papers, certificate of
deposits, treasury bills, discounting of bills etc.
• Involving equipment leasing, hire purchase, venture capital, seed capital etc.
• Dealing in foreign exchange market activities.

Non-fund-based activities: Financial intermediaries provide services based on non-

fund activities also. This can be called ‘fee based’ activity. Today customers, whether
individual or corporate, are not satisfied with mere provisions of finance. They expect
more from financial services companies. Hence a wide variety of services are being
provided under this head. They include:

 Managing the capital issue i.e. management of pre-issue and post-issue activities
relating to the capital issue in accordance with the SEBI guidelines and thus
enabling the promoters to market their issue.
• Planning for the placement of capital and debt instruments with investment
institutions.
• Arrangement of funds from financial institutions for the client’s project cost or
his working capital requirements.
• Assisting in the process of getting all Government and other clearances.
2. Modern Activities

Beside the above traditional services, financial intermediaries render innumerable

services in recent times. Most of them are non-fund-based activities. In view of their
importance, these activities have been in brief under the head ‘New financial products
and services. However, some of the modern services provided by them are given in
brief here under.

• Rendering project advisory services right from the preparation of the project report
till the raising of funds for starting the project with necessary Government
approvals.
• Planning for M&A and assisting for their smooth carry out.

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 • Guiding corporate customers in capital restructuring.
• Acting as trustees to the debenture holders.
• Recommending suitable changes in the management structure and management
style with a view to achieving better results.
• Structuring financial collaborations/joint ventures by identifying suitable joint
venture partners and preparing joint venture agreements.
• Rehabilitating and restructuring sick companies through appropriate scheme of
reconstruction and facilitating the implementation of the scheme.
• Hedging of risks due to exchange rate risk, interest rate risk, economic risk,
and political risk by using swaps and other derivative products.
• Managing in-portfolio of large Public Sector Corporations.
• Undertaking risk management services like insurance services, buy-back options
etc.
• Advising the clients on the question of selecting the best source of funds taking
into consideration the quantum of funds required, their cost, lending period etc.
• Guiding the clients in the minimization of the cost of debt and in the determination
of the optimum debt-equity mix.
• Promoting credit rating agencies for the purpose of rating companies which want
to go public by the issue of debt instrument.
• Undertaking services relating to the capital market, such as 1) Clearing services,
2) Registration and transfers, 3)Safe custody of securities, 4)Collection of income
on securities.
Different financial services offered in India
1. Merchant banking: A merchant banker is a financial intermediary who helps to
transfer capital from those who possess it to those who need it. Merchant banking
includes wide range of activities such as management of customers’ securities, portfolio
management, project counseling and appraisal, underwriting of shares and debentures,
loan syndication, acting as banker for the refund orders, handling interests and dividend
warrants etc. Thus, a merchant banker renders a host of services to corporate and thus
promotes industrial development in the country.

2. Project management: It is the disciple of planning, organizing, motivating, controlling

resources to achieve specific goals.

3. Portfolio management: Portfolio manager is either a person who makes investment

decision using money that other people have placed under his control or a person who
manages a financial institution’s assets and liability portfolio.

4. Equipment leasing: Equipment leasing is a process by which a firm can obtain the use
of certain fixed assets for which it must pay a series of contractual, periodic, tax-
deductible payments. The lessee is the receiver of the services or the assets under the
lease contract and the lessor is the owner of the assets.

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5. Issues management: It involves prioritizing and proactively addressing public policy
and reputation issues that can affect an organization’s success. Many large companies use
issues management techniques to keep their external relations activities focused on high-
priority challenges and opportunities.

6. Mutual funds: A mutual fund refers to a fund raised by a financial company by

pooling the savings of the public. It is invested in a diversified portfolio with a view to
spreading and minimizing risk. The fund provides Investment Avenue for small investors
who cannot participate in the equities of big companies. It ensures low risk, steady
returns, high liquidity and better capital appreciation in the long run.

7. Factoring: Factoring is an agreement between a firm (client) and factoring

organization (factor) under which the sales ledger administration and receivables
collection of the firm (client-firm) are entrusted to an external agency called the factor.

8. Forfeiting: It is a technique by which a forfeiter (financing agency) discounts an

export bill and pays cash to the exporter. The exporter can concentrate on the export front
without botheration. The exporter is protected against the risk of non-payment of debts.
Exporters get 100% of the bill amount minus service charges.

9. Loan syndication: It is like consortium financing. It is loans arranged by banks for

corporate or government departments. Number of banks join and form syndicate. Other
banks can participate by pooling their money and sharing the credit risk.

10. Venture Capital: It is a method of financing in the form of equity. Much thrust is
given to new innovations and ideas. Financing is done for both start-up capital and
development capital.

11. Securitization: It is a technique whereby a financial company converts its ill-liquid,

non- negotiable and high value financial assets into securities of small values which are
made tradable and transferable. It helps to raise cash against such assets. It is best suited
to housing finance companies whose loans are long term.

12. Custodial services: A financial intermediary provides services to clients for a

prescribed fee. Services like- safe keeping of shares and debentures, collection of interest
and dividend, reporting of matters on corporate developments. Customers are mainly
foreign investors.

13. Derivative security: A security whose value depends upon the values of other basic
variables backing the security. These variables are the prices of the traded securities. It is
used as a risk management tool. Examples- forward contracts, options & futures.

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LEASING
Leasing, as a financing concept, is an arrangement between two parties, the company or
lessor and the user or lessee, whereby the former arranges to buy capital equipment for
the use of the latter for an agreed period in return for the payment of rent. The rentals are
payable at fixed intervals of time, the lessor remains the owner of the equipment over the
primary period.

A Lease is an agreement whereby the lessor conveys to the lessee, in return for rent, the
right to use an asset for an agreed period.

A financing arrangement that provides a firm with an advantage of using an asset, without
owning it, may be termed leasing.

Features
 Assets owned by the lessor are used by the lessee for which he makes periodical
lease rentals.
 Ownership of the lease remains with the lessor throughout the period of the lease.
 The scrap value of the asset is enjoyed by the lessor, as he is the owner of the
assets.
 Lease rental payment made by lessee is allowed as a deduction for tax purposes.
 The period of the lease agreement may be throughout the economic life of the
asset, or for a period shorter than that.

Objectives
 Leasing frees working capital for more productive use.
 Accelerated depreciation write off is the use of lease.
 A leasing arrangement is simple to negotiate & administer.
 Leasing provides off balance sheet funding.
 A leasing arrangement does not limit the firm’s ability to raise credit.

Advantages of leasing
 Permit Alternative Use of Funds.
 Faster and Cheaper Credit.
 Flexibility.
 Facilitates Addition Borrowings.
 Protection against Obsolescence.

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  No Restrictive Covenants.
 Hundred Percent Financing.
 Boon to Small Firm.

Disadvantages of leasing
 Lease is not a suitable mode of project finance.
 Certain tax benefits incentives such as subsidies may not be available on leased
equipment.
 The value of real assets such as land & buildings may increase during lease period.
 The cost of financing is generally higher than that of debt financing.
 If the lessee is not able to pay rentals regularly, the lessor would suffer a loss
particularly when the asset is less liquid.

FACTORING SERVICE
• Factoring is one of the techniques of managing receivables.

• Factoring is an agreement between a firm (client) and factoring organization

(factor) under which the sales ledger administration and receivables collection of
the firm (client-firm) are entrusted to an external agency called the factor.

• Factoring is defined as buying at a discount the debts owed to another to profit by

collecting them. Factoring can be considered as an alternative to in-house
management of receivables.

Process of factoring

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Functions of factor
 Undertake credit evaluation: Assessment of the creditworthiness of a customer or
debtor.
 Undertake sales ledger administration: Involves recording all credit sale
transactions, analysis of credit sales data & preparing reports for monitoring and
management of credit collection.
 Collect book debts: Factor undertakes collection of accounts receivable from the
customers as and when they become due.
 Assumes the risk of default
 Provide finance
 Provide information
 Provide insurance

Salient Features of Factoring:

(i) Credit Cover:
The factor takes over the risk burden of the client and thereby the client’s credit is
covered through advances.

(ii) Cash advances:

The factor makes cash advances to the client within 24 hours of receiving the documents.

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(iii) Sales ledgering:
As many documents are exchanged, all details pertaining to the transaction are
automatically computerized and stored.

(iv) Collection Service:

The factor buys the receivables from the client, they become the factor’s debts, and the
collection of cheques and other follow-up procedures are done by the factor in its own
interest.

(v) Provide Valuable advice:

The factors also provide valuable advice on country-wise and customer-wise risks. This is
because the factor can know the companies of its country better than the exporter clients.

Types of Factoring:
The types of factoring are discussed below:
(i) Recourse Factoring- the credit risk remains with the client though the debt is assigned to
the factor, i.e., the factor can have recourse to the client in the event of non-payment by the
customer.

(ii) Non-Recourse Factoring - also called ‘Old-line factoring’. It is an arrangement whereby

he factor has no recourse to the client when the bill remains unpaid by the customer. Thus,
the risk of bad debt is absorbed by the factor.

(iii) Advance Factoring - Where the payment is made by the factor immediately is called
Advance Factoring Under this type of factoring, the factor provides financial accommodation
apart from non-financial services rendered by him.

(iv) Confidential and Undisclosed Factoring - the arrangements between the factor and the
client are left unnotified to the customers and the client collects the bills from the customers
without intimating them to the factoring arrangements.

(v) Maturity Factoring - the factor may agree to pay an amount to the client for the bills
purchased by him either immediately or on maturity. The latter refers to a date agreed upon
on which the factor pays the client.

(vi) Supplier Guarantee Factoring - is also known as ‘drop shipment factoring’. This
happens when the client is a mediator between supplier and customer. When the client is a
distributor, the factor guarantees the supplier against the invoices raised by the supplier upon
the client and the goods may be delivered to the customer. The client thereafter raises bills to
the customer and assigns them to the factor. The factor thus enables the client to make a gross
profit with no financial involvement at all.

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(vii) Bank Participation Factoring - the bank takes a floating charge on the client’s equity
i.e., the amount payable by the factor to the client in respect of his receivables. On this basis,
the bank lends to the client and enables him to have double financing.

Benefits of factoring
1. It helps to improve the current ratio. Improvement in the current ratio is an indication
of improved liquidity. Enables better working capital management. This will enable the
unit to offer better credit terms to its customers and increase orders.

2. It will increase the turnover of stocks. The turnover of stock into cash is speeded up
and this results in larger turnover on the same investment.

3. It ensures prompt payment and reduction in debt.

4. It helps to reduce the risk. The present risk in bills financing like finance against
accommodation bills can be reduced to a minimum.

5. It helps to avoid the collection department. The client need not undertake any
responsibility of collecting the dues from the buyers of the goods.

Limitations of Factoring
1. Factoring is a high-risk area, and it may result in over dependence on factoring,
mismanagement, overtrading of even dishonesty on behalf of the clients.

2. It is uneconomical for small companies with less turnover.

3. The factoring is not suitable for the company’s manufacturing and selling highly
specialized items because the factor may not have sufficient expertise to assess the credit
risk.

4. The developing countries such as India are not able to be well verse in factoring. The
reason is lack of professionalism, non-acceptance of change and developed expertise.

FORFEITING
Forfaiting is a method of trade finance that allows exporters to obtain cash by selling their
medium and long-term foreign accounts receivable at a discount to a forfeiter, a
specialized finance firm or a department in a bank.

Forfaiting is a trade finance option that allows exporters to receive immediate cash for
their foreign accounts receivable. In this arrangement, the exporter sells their receivables

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to a forfeiter, a financial institution that specializes in international trade, at a
discount. The exporter then receives immediate cash and transfers the risk of non-
payment to the forfeiter.

Forfaiting can help exporters improve their cash flow, especially when selling to foreign
buyers who need longer financing terms. It can also help businesses manage financial
risks associated with international trade.

CREDIT RATING

• Credit Rating is an analysis of a business entities or Individual creditworthiness

and ability to repay a financial obligation, as per its income and past repayment
histories.

• It indicates the loan repayment capabilities of an enterprise or company that has

borrowed money.

• The credit ratings are generated and assigned by the Credit Rating Agencies based
on the borrower's income, debt, profits, etc.

• Credit rating is considered as the foremost thing that lenders check before any loan
approval.

• A good credit rating signifies that the borrowing enterprise can repay the loan in
time.

How do Credit Rating Agencies Work in India

1. Every credit rating agency has its own algorithm to evaluate the credit rating
through major factors, such as timely repayment of supplies and dues, cash flow,
working capital, net worth, etc.

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 2. Every month, these credit rating agencies collect credit information from partner
banks and other financial institutions.

3. Once the request for credit rating has been made, these agencies dig out the
information and prepare a report based on such factors.

4. Based on that credit report, they grade every individual or company and give them
a credit rating.

5. This rating is used by banks, financial institutions and investors to decide of

investing money, buy bonds or give loan or credit card.

6. The better the rating is, the more the chances of getting loan at lower interest rates.

Types of Credit Ratings

Credit Rating is measured broadly under two main categories, that is Investment Grade
and Speculative Grade. However, the risk associated with a corporate entity is scaled as
per the credit ratings defined by each CRAs in India. The credit ratings are majorly
graded from the highest (AAA) to (D) lowest that shall vary as per the agency and
company’s profile.

a) Investment Grade

Investment grade credit ratings signify that the company has made perfect investment
decisions and is in a good position to repay their debts on time. Corporate entities falling
under this category can avail themselves of loans easily and at low interest rates.

b) Speculative Grade

Companies falling under this category have made risky business investments and shall
not be able to repay the loan on time. Therefore, these corporate entities do get loans but
at higher interest rates.

Entities that check Credit Ratings

Entities that check credit ratings of companies and enterprises include the following:

1. Lenders (Banks/NBFCs and other financial institutions)

2. Investment Banks

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 3. Debt Issuers

4. Retail and Institutional Investors

5. Other business entities

Top 7 Credit Rating Agencies in India

Below stated are the leading CRAs in India:

1. Credit Rating Information Services of India Ltd. (CRISIL)

2. Investment Information and Credit Rating Agency of India (ICRA) Ltd.

3. Credit Analysis and Research (CARE) Ltd.

4. India Ratings and Research Pvt. Ltd.

5. Brickwork Ratings India Private Ltd.

6. INFOMERICS Valuation and Rating Private Ltd.

7. Acuite Ratings & Research Ltd.

VENTURE CAPITAL
Venture capital is long-term risk capital to finance high technology projects involving
risk but at the same time has strong potential for growth. Venture capitalists pool their
resources including managerial abilities to assist new entrepreneurs in the project or reach
the stage of probability; they sell their equity holdings at high premium.

Venture capital is money for new, young, and/or small businesses that typically have little
or no access to capital markets.

Money provided by investors to startup firms and small businesses with perceived long-
term growth potential. This is a very important source of funding for startups that do not
have access to capital markets. It typically entails high risk for the investor (venture
capitalist), but it has the potential for above-average returns.

Venture capital can also include Managerial and technical expertise. Most venture capital
comes from a group of wealthy investors, investment banks and other financial
institutions that pool such investments or partnerships. This form of raising capital is
popular among new companies or ventures with limited operating history, which cannot

Every accomplishment starts with the decision to try.

raise funds by issuing debt. The downside for entrepreneurs is that venture capitalists
usually get a say in company decisions, in addition to a portion of the equity.

Finance is provided during the following 3 stages:

1. Seed Stage - For research, assessment and development of an initial concept

2. Start-up Stage - To finance product development and initial marketing of the
product
3. Expansion Stage - For the increase of production capacity, development of
markets or products or enhancement of working capital.

Features of Venture Capital:

The main features of venture capital can be summarized as follows:

i. High Degrees of Risk: Venture capital represents financial investment in a highly
risky project with the objective of earning a high rate of return.

ii. Equity Participation Venture capital financing is, invariably, an actual or

potential equity participation wherein the objective of venture capitalist is to make
capital gain by selling the shares once the firm becomes profitable.

iii. Intermediary: A venture capital firm serves as an intermediary between investors

looking for high returns for their money and entrepreneurs in search of needed
capital for their start-ups.

iv. Long Term Investment Venture capital financing is a long-term investment. It

generally takes a long period to encash the investment in securities made by the
venture capitalists.

v. Participation in Management In addition to providing capital, venture capital

funds take an active interest in the management of the assisted firms. Thus, the
approach of venture capital firms is different from that of a traditional lender or
banker. It is also different from that of an ordinary stock market investor who
merely trades in the shares of a company without participating in their
management. It has been rightly said, “venture capital combines the qualities of
banker, stock market investor and entrepreneur in one”

vi. Achieve Social Objectives It is different from the development capital provided
by several central and state level government bodies in that the profit objective is
the motive behind the financing. But venture capital projects generate
employment, and balanced regional growth indirectly due to setting up of
successful new businesses.

vii. Investment is illiquid A venture capital is not subject to repayment on demand as

with an overdraft or following a loan repayment schedule. The investment is

Every accomplishment starts with the decision to try.

 realized only when the company is sold or achieves a stock market listing. It is lost
when the company goes into liquidation.

viii. Opportunity for disinvestment: Once the venture has reached its full potential
the venture capitalists disinvest their holding either to the promoters or in the
market. The basic objective of investment is not profit, but capital appreciation at
the time of disinvestment.

Advantages of venture capital

1. A development venture capital institutional set-up reduces the time lag between a
technological innovation and its commercial exploitation.

2. It helps in developing new processes/products in a conductive atmosphere free

from the deal weight of corporate bureaucracy, which helps in exploiting full
potential.

3. Venture capital acts as a cushion to support business borrowing, as bankers and

investors will not lend money with an inadequate margin of equity capital.

4. Once venture capital funds start earning profits, it will be very easy for them to
raise resources from the primary capital market in the form of equity and debts.
Therefore, the investors would be able to invest in new business through venture
funds, at the same time, they can directly invest in existing business when venture
fund disposes its own holding. This mechanism will help to channelize investment
in new high-tech business or the existing sick business. These businesses will take
off with the help of finance from venture funds and this would help in increasing
productivity, better capacity utilization, etc.

5. The economy with well-developed venture capital network induces the entry of
large number of technocrats in industry, help in stabilizing industries and in
creating a new set of trained technocrats to build and manage medium and large
industrial development.

6. A venture capital firm serves as an intermediary between investors looking for

high returns for their money and entrepreneurs in search of needed capital for their
start-ups.

7. It also paves the way for private to share the responsibility with public sector.

Disadvantages of venture capital

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• Securing a venture capital deal can be a difficult process due to accounting and
legal costs a firm must shoulder.
• The start-up company must also give up some ownership stake to the VC
Company investing in it. This results in a partial loss of autonomy that finds
venture capitalists involved in decision-making processes.
• VC deals also come with stipulations and restrictions in composition of the start-
up's management team, employee salary and other factors.
• Furthermore, with the VC firm literally invested in the company's success, all
business operations will be under constant scrutiny. The loss of control varies
depending on the terms of the VC deal.

Questions
Section A

1. What are the different types of financial instruments?

2. What is an equity share?
3. Mention any two features of equity shares.
4. What is the right issue?
5. What is a bonus issue?
6. Mention any two advantages of equity shares.
7. What is sweat equity?
8. What is a preference share?
9. Mention any two features of preference shares.
10. Differentiate between redeemable and irredeemable preference shares.

11. Differentiate between participating and non-participating preference shares.

12. What is sweat equity?
13. What is a financial service?
14. Mention any two features of financial service.
15. What is leasing?
16. What is factoring?
17. What is forfeiting?
18. What is venture capital?

Section B & C

1. Explain the different types of preference shares.

2. Explain the different types of debentures.
3. Give the meaning of financial services. Explain the various financial services.
4. Explain the advantages and limitations of factoring service.
5. Explain the advantages and limitations of leasing.
6. Write a short note on fund-based and fee-based services.
7. Explain the advantages and limitations of venture capital.

Every accomplishment starts with the decision to try.

Every accomplishment starts with the decision to try.