Banking and Financial Services Questions with answers for Internal 3

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1 Banking and Financial Services Questions with answers for Internal 3 1 (a) XYZ Ltd enters into a factoring arrangement with SBI Factors Ltd. According to the agreement, the factor would pay in advance 80% of the value of the factored receivables at 25% interest compounded quarterly, the balance retained as factor reserve to disputes and deductions. It also provides for guaranteed payment after three months from the date of purchase of the receivables. The factoring commission would be two percent of the value of factored receivables. It is stipulated that interest and commission would be collected in advance. Assuming an advance payment of 42 lakh, compute Advance payable to ABC Ltd (3 marks) Ans :Advance payable to XYZ Ltd lakh Value of receivables factored (42*100/80) Maximum advance 42.0 Less : commission (0.02 *52.5) Less : Discount /Interest(42*0.25*1/4 yrs) 2.62 Advance payable is (b) Explain SPV s and their role in Securitisation. List any four advantages of securitisation (7 marks) Ans: Special Purpose Vehicle Entity that intermediates between the originator and the end-investor Usually a Merchant Banker/ Investment Banker SPV is called the issuer since it manages the issue of securities to investors Advantages: (any four) Easy lending and recycling of funds, Facilitates effective capital utilisation in the economy To originator Off-balance sheet financing, Credit enhancement, Low cost alternative source of funding,access to market, Re-allocation of risks,can meet priority sector lending targets, ALM To investors Multiple new investment instruments for investors to meet their preferences Reduction in uncertainty Higher yield

2 (c) Explain the process of credit rating of financial instruments in India (10 marks) Ans : Meaning / definition of Credit rating: Credit rating is the symbolic indicator of the current opinion of the rating agency regarding the relative ability of the issuer of the financial (debt) instrument to meet the (debt) service obligations as and when they arise The process of assigning a symbol with specific reference to the instrument being rated, that acts as an indicator of the current opinion on relative capability on the issuer to service its debt obligation in a timely fashion. 1. Contract between rater and client 2. Sending expert team to client s place 3. Data collection 4. Data Analysis : Business factors & Financial Factors 5. Discussion 6. Credit report preparation 7. Submission to Grading Committee 8. Grade Communication to client Brief the various international banking services. Ans- Correspondent Bank: A correspondent bank is bank located elsewhere that provides a service on behalf of another bank, besides its normal business. The correspondent banking system enables a bank s foreign client to conduct business worldwide through his local bank or its contacts. The most important correspondent banking service often is related to the foreign exchange transactions of the client. However, correspondent bank services also include assistance with trade financing, such as honoring letters of credit and accepting drafts drawn on the correspondent bank. The correspondent bank mode is ideal because of its low cost when the volume of business is small. The possible disadvantage is that the clients may not receive- the required level of service.

3 Representative Offices: A Representative Office is a small service facility staffed by the parent bank personnel that is designed to assist the foreign clients of the parent bank in dealings with the bank s correspondents and to provide the clients with a level of service>greater than that provided through merely a correspondent relationship. Foreign Branches: Foreign branches, which may provide full services, may be established when the volume of business is sufficiently large and when the law of the land permits it. Foreign branches facilitate better service to the clients and help the growth of business. Subsidiaries and Affiliates: A subsidiary bank is a locally incorporated bank that is either wholly or majority owned by a foreign parent and an affiliate bank is one that is only partially owned but not controlled by its foreign parent. Subsidiaries and affiliates are normally meant to handle substantial volume of business. Their autonomy, compared to branches, more operational and strategic management leverage. Offshore Financial Centres A major contributor to the growth of international banking is the offshore banking centres. An offshore banking center is a country whose banking system is organised to permit external accounts beyond the normal economic activity of the country The principal features that make a country attractive for establishing an offshore banking operation are virtually total freedom from host-country governmental banking regulations for example, low reserve requirements and no deposit insurance, low taxes, a favourable time zone that facilitates international banking transactions, and to a minor extent, strict banking secrecy laws. What is a hire purchase contract? Brief its characteristics. Ans- Hire-Purchase has emerged as a source of equipment financing in recent years as A Hire-Purchase transaction in which the goods are let out on hire with the option to the hirer to purchase them, with following stipulations: A. Payment to be made in instalment over a specified period. B. Hire-Purchase has emerged as a source of equipment financing in recent years as C. A Hire-Purchase transaction in which the goods are let out on hire with the D. A. Payment to be made in instalment over a specified period. E. Hire-Purchase has emerged as a source of equipment financing in recent years as F. A Hire-Purchase transaction in which the goods are let out on hire with the G. A. Payment to be made in instalment over a specified period. H. Hire-Purchase has emerged as a source of equipment financing in recent years as

4 I. A Hire-Purchase transaction in which the goods are let out on hire with the J. A. Payment to be made in instalment over a specified period. K. Hire-Purchase has emerged as a source of equipment financing in recent years as L. A Hire-Purchase transaction in which the goods are let out on hire with the M. A. Payment to be made in instalment over a specified period. N. Hire-Purchase has emerged as a source of equipment financing in recent years as O. A Hire-Purchase transaction in which the goods are let out on hire with the P. A. Payment to be made in instalment over a specified period. Q. Hire-Purchase has emerged as a source of equipment financing in recent years as R. A Hire-Purchase transaction in which the goods are let out on hire with the S. A. Payment to be made in instalment over a specified period. Nature of the Agreement: Stating the nature, terms & commencement of the agreement. Delivery of Equipment: The place & time of delivery and the hirer s liability to bear delivery charges. Location: The place where the equipment shall be kept during the period of hire. Hire-Charges: To be paid by hirer, the time schedule, the rate of interest/penalty for delayed payment/default. Termination: The events or acts of hirer that would constitutes a default eligible to terminate the agreement. Risk: Of loss and damage to be borne by the hirer. Registration and Fees: The hirer to comply with the relevant laws, registration and bear all requisite fees. Schedule of equipment forming subject-matter of the agreement. Schedule of hire charges. Indemnity clause and Stamp Duty Explain the different types of leasing? Ans- The three main types of leasing are finance leasing, operating leasing and contract hire. Finance leasing A long-term lease over the expected life of the equipment, usually three years or more, after which you pay a nominal rent or can sell or scrap the equipment - the leasing company will not want it any more.

5 The leasing company recovers the full cost of the equipment, plus charges, over the period of the lease.although you don't own the equipment, you are responsible for maintaining and insuring it.you must show the leased asset on your balance sheet as a capital item, or an item that has been bought by the company. Leases of over seven years, and in some cases over five years, are known as 'long funding leases' under which you can claim capital allowances as if you had bought the asset outright.for detailed guidance on tax and leasing, see our guide on how to acquire assets and borrow money tax efficiently. You can also read the Business Leasing Manual on the HM Revenue & Customs website. Operating leasing If you are considering operating leasing, remember the following points: it is useful if you don't need the equipment for its entire working life the leasing company will take the asset back at the end of the lease the leasing company is responsible for maintenance and insurance you don't have to show the asset on your balance sheet Contract hire Contract hire is often used for company cars and:the leasing company takes some responsibility for management and maintenance, such as repairs and servicing you don't have to show the asset on your balance sheet 3.The CFO of GEC ltd has been analysing the firm s policy regarding the computers, which are now being leased on a yearly basis on rental amounting to Rs per year. The computer can be bought for Rs The purchase would be financed by 16% loan repayable in 4 equal annual instalments. On account of rapid technological growth in the computer industry, it is suggested that a 4-year economic life should be used, instead of the 10-year physical life. It is estimated that the computers would be sold for Rs at the end of 4years. The company uses the straight line method of depreciation. Corporate tax rate is 50%. a) Comment on whether the equipment should be bought or leased? b) Analyse the financial viability form the point of view of the lessor, assuming 14% cost of capital. c) Determine the minimum lease rent at which the lessor would breakeven. d) Determine the lease rent which will yield an IRR of 16% to the lessor. Ans-a)PV of Cash flow under Leasing alternatives= PV of Cash Flow under buying alternative= (The leasing option is financially superior.) b)determination of CFAT=87500

6 Determination of NPV=(126625) (The proposal is not financially viable to the lessor) c)lease rent at which lessor would break even=1,86,908 d)lease rent to yield 16 percent IRR=2,03,484

3 Leasing Decisions. The Institute of Chartered Accountants of India

3 Leasing Decisions. The Institute of Chartered Accountants of India 3 Leasing Decisions BASIC CONCEPTS AND FORMULAE 1. Introduction Lease can be defined as a right to use an equipment or capital goods on payment of periodical amount. Two principal parties to any lease