A partnership firm is A company is governed by the governed by the partnership Memorandum of Association deed and may be altered at and Articles of Association and any time with the consent of can be altered according to the all partners.procedure laid down in the Act. Each partner is an agent of A member of company is not the firm and of other partners an agent of the company or of and therefore, binds the firm other members and therefore, and
other partners of the does not bind the company or firm.other members by his acts. Manage mer+ vests in the M11nagement vests in the Board hands of the partners except of Directors elected by the in the case of a dormant or shareholders. 1 sleeping partner. A partner cannot tr:mster his interest in the firm without the consent of all other partners Accounts of the partnership tirm need not be audited by an auditor.A partnership firm can be wound up at any
time by any partner, if it is, 'at will' without legal formalities. In the case of a private company also the transfer of shares requires the prior permission of the
board of directors. But in the ease of a public company a shareholder can transfer his shares freely without restrictions. Accounts of a company mu:;;t be
audited by an Auditor. In the case of a company, no one member can require it to be wound up at will and winding up involves legal formalities.
Wednesday, December 26, 2007
Saturday, December 22, 2007
Foreign Currency Management and Exchange Risk Management and External Financing
1) Exchange risk
a) Spot Exchange Transactions
b) Forward Exchange Transactions
2) Exchange risk management
a) Forward market
b) Foreign currency swap
c) Arbitrage
I. Space Arbitrage
II. Time Arbitrage
d) Long term rollover cover
Exchange Risk
The price payable to a foreign buyer can be in seller or buyer’s currency or an
international currency such s US $.
The seller may prefer another currency in the following cases...
1) If his own currency is depreciating rapidly in value.
2) His government prefers to have some other currency.
3) The seller himself wishes to make payment abroad, where another currency
is more acceptable.
The buyer will also have to purchase the necessary foreign exchange to make
payments.
An exchange rate represents the number of currency units of one currency that
can be exchanged for another country’s currency units.
Exchange rates are established for two types of transactions…
1) Spot Exchange transactions
2) Forward Exchange transactions
1) Spot Exchange Transactions
They occur when currencies are traded for immediate delivery.
2) Forward Exchange Transactions
They occur when purchases & sellers contracted to buy & sell currencies for
delivery at a future date.
In case of specific rate of exchange & at a specific future date.
Exchange Risk Management
1) Forward Market
A company can protect itself against exchange rate fluctuations by use of
forward or future market.
One locks in the rate of exchange by entering into contract to buy specific
currency at specific time at a specific exchange ratio.
A future contract is a guarantee to obtain conversion at a specified exchange
rate.
2) Foreign currency swap
This is agreement between two parties to exchange one currency for another at
a simultaneous spot & forward transaction.
In swap deal buying & selling involves same currency of the same value at
different maturities.
a) Simultaneous purchase of currency on spot & its forward sale or vice versa.
b) Simultaneous purchase & sale, both forward for different maturities.
A foreign currency is said to be at a premium, if that currency is costlier under
the forward rate than under the spot rate.
When the foreign currency is cheaper in forward market than in spot market, it
is to be at a discount.
3) Arbitrage
It is a method of making profits from exchange dealings.
Arbitrage is a situation where a guaranteed profit can be made by purchasing &
selling a currency simultaneously is one or more foreign exchange markets.
Arbitrage profits arise because of …
a) The difference in exchange rates at two different exchange centers.
b) The difference due to interest yield, which can be earned at different
exchanges.
1) Space
Arbitrage
It is highly probable that when two markets are separated by physical
distance the exchange rates may vary.
This is a situation, when speculator executes two or more
simultaneous contracts to buy & sell currencies in two or more capital
markets for delivery on the same day.
2) Time
Arbitrage
Here an investor benefits by executing a spot and a forward contract
to buy & sell a currency.
4) Long term rollover cover
The major risk faced by a borrower of foreign currency is that of adverse spot
exchange rate fluctuations, from the time of borrowing to the time of repayment.
Financial Multinational Organizations
External Financing
1) Commercial
Banks
This provides foreign currency loans for international operations as
they do for the domestic operations.
These banks also provide facility to over draw.
2) Discounting
of trade Bills
This is used as a short term financing method.
3) Eurocurrency
Markets
When the currency is deposited outside the country of origin, it is
termed as Eurocurrency.
4) Euro Bond
Markets
Eurobond market has emerged as another significant source of
capital.
Euro bands are primarily sold in countries other than that of the
country in whose currency the bond is denominated.
5) Development
Banks
EXIM Band in United States
6) International
Agencies
International Finance Corporation and World Bank assist developing
countries by financing projects in private & public sectors.
Modes of Payment in International Trade
Most of the transactions are performed on credit basis on account of the
following reasons…
1) Intensive competition & increase in number of sellers have given buyer the
option to purchase goods from seller who can offer him the most for his money.
2) Credit terms have become one of the most important factors in negotiating a
sale.
3) Credit insurance has reduced the risk of credit extension.
1) Open Account The seller debits the account of the importer whenever he
exports goods.
2) Consignment
sale
The exporter has selling agents abroad.
Sale is made by the agent for and on behalf of the exporter.
3) Deferred
payments
In case of expensive capital equipment or machinery.
The importer pays a part of the price in advance & another part
on receiving the shipping documents.
The unpaid balance is generally guaranteed by the importer’s
bank.
4) Bank transfers The importer makes payment to a local bank in home currency
which arranges for payment to the payee abroad in the currency
of his country.
a) Telegraphic
Transfer (TT)
It is also known as cable transfer.
Its correspondent branch telegraphically to pay money to the
payee abroad.
It is the quick mode of remitting funds. No stamp duty is payable
on such transfer.
b) Mail transfer
(MT)
The local bank is sent to its correspondent or branch by post or
mail, surface or air.
It also does not require any stamp.
In this case, delays in payment to the exporter who will charge
interest for the periods.
c) Banker’s draft
or cheque
A draft is issued at the request of the remitter.
5) Bills of
exchange
Bills are prepared in triplicate, each copy is known as a via.
In case of only one copy is made, it is called solo bill.
The documentary bill is sent by the exporter’s bank to its branch
or correspondent.
6) Letters of Credit This is the most common method of remittance used in the
export trade.
Kinds of letters of Credit
1) General & special letters of capital.
A general letter of credit is one addressed by the issuing bank to the world
generally requesting that advance by made to a third person by any one to
whom it is shown.
A special letter of credit.
2) Open (Clean) and documentary letters of capital
An open letter of credit is one in which the issuing bank undertakes to honor the
bill draw under the credit without security of any documents.
Banker only at the request of customers of very sound financial position.
A documentary letter of credit is one in which the issuing bank undertakes to
honor the bill drawn under it only if it receives with it certain documents of title.
3) Fixed & revolving letters of credit
A fixed letter of credit – the issuing banker specifies the amount up to which
and the period in which beneficiary can draw one or more bills.
In case of revolving credit, the issuing banker specifies the total amount up to
which the bills drawn may remain outstanding at a time & not the total amount
up to which the bills can be drawn.
4) Revocable & irrevocable letters of capital
The issuing banker reserves to itself the right to concede or modify the credit at
any moment it likes without notice to the beneficiary.
A letter of credit, unless stated to be irrevocable, is presumed to be always
revocable.
An irrevocable letter of credit is one, which can not be withdrawn by the issuing
banker without the consent of the beneficiary.
5) Confirmed an unconfirmed letters of credit
A confirmed letter of credit is on where the advising banker of the exporter’s
country.
It is confirmation to an irrevocable credit.
The advising banker takes up on itself the liabilities as that of the issuing
banker.
a) Spot Exchange Transactions
b) Forward Exchange Transactions
2) Exchange risk management
a) Forward market
b) Foreign currency swap
c) Arbitrage
I. Space Arbitrage
II. Time Arbitrage
d) Long term rollover cover
Exchange Risk
The price payable to a foreign buyer can be in seller or buyer’s currency or an
international currency such s US $.
The seller may prefer another currency in the following cases...
1) If his own currency is depreciating rapidly in value.
2) His government prefers to have some other currency.
3) The seller himself wishes to make payment abroad, where another currency
is more acceptable.
The buyer will also have to purchase the necessary foreign exchange to make
payments.
An exchange rate represents the number of currency units of one currency that
can be exchanged for another country’s currency units.
Exchange rates are established for two types of transactions…
1) Spot Exchange transactions
2) Forward Exchange transactions
1) Spot Exchange Transactions
They occur when currencies are traded for immediate delivery.
2) Forward Exchange Transactions
They occur when purchases & sellers contracted to buy & sell currencies for
delivery at a future date.
In case of specific rate of exchange & at a specific future date.
Exchange Risk Management
1) Forward Market
A company can protect itself against exchange rate fluctuations by use of
forward or future market.
One locks in the rate of exchange by entering into contract to buy specific
currency at specific time at a specific exchange ratio.
A future contract is a guarantee to obtain conversion at a specified exchange
rate.
2) Foreign currency swap
This is agreement between two parties to exchange one currency for another at
a simultaneous spot & forward transaction.
In swap deal buying & selling involves same currency of the same value at
different maturities.
a) Simultaneous purchase of currency on spot & its forward sale or vice versa.
b) Simultaneous purchase & sale, both forward for different maturities.
A foreign currency is said to be at a premium, if that currency is costlier under
the forward rate than under the spot rate.
When the foreign currency is cheaper in forward market than in spot market, it
is to be at a discount.
3) Arbitrage
It is a method of making profits from exchange dealings.
Arbitrage is a situation where a guaranteed profit can be made by purchasing &
selling a currency simultaneously is one or more foreign exchange markets.
Arbitrage profits arise because of …
a) The difference in exchange rates at two different exchange centers.
b) The difference due to interest yield, which can be earned at different
exchanges.
1) Space
Arbitrage
It is highly probable that when two markets are separated by physical
distance the exchange rates may vary.
This is a situation, when speculator executes two or more
simultaneous contracts to buy & sell currencies in two or more capital
markets for delivery on the same day.
2) Time
Arbitrage
Here an investor benefits by executing a spot and a forward contract
to buy & sell a currency.
4) Long term rollover cover
The major risk faced by a borrower of foreign currency is that of adverse spot
exchange rate fluctuations, from the time of borrowing to the time of repayment.
Financial Multinational Organizations
External Financing
1) Commercial
Banks
This provides foreign currency loans for international operations as
they do for the domestic operations.
These banks also provide facility to over draw.
2) Discounting
of trade Bills
This is used as a short term financing method.
3) Eurocurrency
Markets
When the currency is deposited outside the country of origin, it is
termed as Eurocurrency.
4) Euro Bond
Markets
Eurobond market has emerged as another significant source of
capital.
Euro bands are primarily sold in countries other than that of the
country in whose currency the bond is denominated.
5) Development
Banks
EXIM Band in United States
6) International
Agencies
International Finance Corporation and World Bank assist developing
countries by financing projects in private & public sectors.
Modes of Payment in International Trade
Most of the transactions are performed on credit basis on account of the
following reasons…
1) Intensive competition & increase in number of sellers have given buyer the
option to purchase goods from seller who can offer him the most for his money.
2) Credit terms have become one of the most important factors in negotiating a
sale.
3) Credit insurance has reduced the risk of credit extension.
1) Open Account The seller debits the account of the importer whenever he
exports goods.
2) Consignment
sale
The exporter has selling agents abroad.
Sale is made by the agent for and on behalf of the exporter.
3) Deferred
payments
In case of expensive capital equipment or machinery.
The importer pays a part of the price in advance & another part
on receiving the shipping documents.
The unpaid balance is generally guaranteed by the importer’s
bank.
4) Bank transfers The importer makes payment to a local bank in home currency
which arranges for payment to the payee abroad in the currency
of his country.
a) Telegraphic
Transfer (TT)
It is also known as cable transfer.
Its correspondent branch telegraphically to pay money to the
payee abroad.
It is the quick mode of remitting funds. No stamp duty is payable
on such transfer.
b) Mail transfer
(MT)
The local bank is sent to its correspondent or branch by post or
mail, surface or air.
It also does not require any stamp.
In this case, delays in payment to the exporter who will charge
interest for the periods.
c) Banker’s draft
or cheque
A draft is issued at the request of the remitter.
5) Bills of
exchange
Bills are prepared in triplicate, each copy is known as a via.
In case of only one copy is made, it is called solo bill.
The documentary bill is sent by the exporter’s bank to its branch
or correspondent.
6) Letters of Credit This is the most common method of remittance used in the
export trade.
Kinds of letters of Credit
1) General & special letters of capital.
A general letter of credit is one addressed by the issuing bank to the world
generally requesting that advance by made to a third person by any one to
whom it is shown.
A special letter of credit.
2) Open (Clean) and documentary letters of capital
An open letter of credit is one in which the issuing bank undertakes to honor the
bill draw under the credit without security of any documents.
Banker only at the request of customers of very sound financial position.
A documentary letter of credit is one in which the issuing bank undertakes to
honor the bill drawn under it only if it receives with it certain documents of title.
3) Fixed & revolving letters of credit
A fixed letter of credit – the issuing banker specifies the amount up to which
and the period in which beneficiary can draw one or more bills.
In case of revolving credit, the issuing banker specifies the total amount up to
which the bills drawn may remain outstanding at a time & not the total amount
up to which the bills can be drawn.
4) Revocable & irrevocable letters of capital
The issuing banker reserves to itself the right to concede or modify the credit at
any moment it likes without notice to the beneficiary.
A letter of credit, unless stated to be irrevocable, is presumed to be always
revocable.
An irrevocable letter of credit is one, which can not be withdrawn by the issuing
banker without the consent of the beneficiary.
5) Confirmed an unconfirmed letters of credit
A confirmed letter of credit is on where the advising banker of the exporter’s
country.
It is confirmation to an irrevocable credit.
The advising banker takes up on itself the liabilities as that of the issuing
banker.
Finance & Strategic Management and International Financial Management
Finance manger, along with his team of experts contributes significantly in the
process of strategic decision making.
1) The investment
decision
The investment decision is concerned with allocation & reallocation
of capital to projects, products, assets & divisions of an
organization.
2) Financing
Decision
This is concerned with determining the best financing mix or capital
structure for the organization.
3) Dividend Decision Involve such issues as the percentage of earnings paid to the
shareholders, the stability of dividend paid over the period and the
repurchase or issuance of stock.
Financial Policies
The value of owner’s wealth depends upon…
1) Their expected future cash flows.
2) The dispersion of possibly flows around the expected value – return
various risk.
Decision that affect earning power & financial leverage may affect both these
factors.
Planning & Managing Assets
1) Management of Cash
2) Management of Accounts receivables
a) Management of Inventory
b) Capital Budgeting
3) Source of Finance
a) The external sources of finance
b) The internal sources of finance
4) Capital Structure
5) Dividend policy
1) Management of Cash
Management of cash brings into sharp focus on the trade off between risk &
return faced by the financial manager.
There are 2 stages of cash management…
a) Cash should be managed & near cash efficiently.
The waste can be reduced.
This stage includes efficient management of near cash in order to produce
the highest return consistent with a low risk.
b) Efficient handling of cash flows & balances, the principal task of cash
management can be taken up.
2) Management of Accounts Receivables
The management of accounts receivables involves many complex &
interrelated decisions.
These decisions involve risk & uncertainty.
The company does not know clearly when the customer will pay.
2A) Management of Inventory
Investment in inventories is costly & also a risk of loss.
The management should not reduce the idle stock to zero level.
Some stocks must be maintained to allow for unforeseen changes.
Some stocks are maintained to meet forthcoming demand.
2B) Capital Budgeting
Capital budgeting probably spells the difference between success & failure for
many business firms.
The methods of capital budgeting are net present value & discounted rate of
return.
Major policies are…
a) Source of Finance & Capital Structure Scissions
b) Investment Decisions
c) Financing Decisions & Dividend Policy
3) Sources of Finance
Strategy implementation fundamentally requires financial resources.
3A) The external sources of finance include…
Equity capital Public Deposits Long term loans from development banks
Preference Capital Bill Discounting Short term public deposits
Debenture Capital Overdrafts Factoring issues of commercial paper
Cash credits Loans from non banking financial companies
3B) The internal source of finance include…
This reserves of the company for long term purposes & bank balances & cash
on hand with the company for short term purposes.
4) Capital Structure
These decisions are concerned with the optimum mix of equity capital & debt
capital.
The operating leverage or the proportion of fixed costs in the operating cost
structure.
The factors ….
a) Overall weighted cost of capital.
b) The debt capacity of the firm in terms of adequacy of cash flows to meet the
fixed interest rate burden & principal amount.
c) The need for flexibility in the capital structure should also be considered in
deciding the capital structure.
5) Dividend Policy
The proportion of profit to be distributed to shareholders as dividend & the
proportion of the profit retained in the company as reserves.
This decision is affected by factors like…
a) The shareholders preference as to current dividend income against capital
gains.
b) The reinvestment opportunities & financial needs of the company.
c) Need for stability of dividend distribution.
d) Advantages & disadvantages of cash dividend & stock dividend.
International Financial Management
Most of the experts are of the view that an organization having at least 50 % of
its total profits from international operations do require efficient utilization of
their financial resources.
The environment relates to political risk, Governments tax & investment policy,
foreign exchange risks, sources of finance, etc.
Reasons for Investing Abroad
Qualifying the parameters for a project abroad is more complicated because of
disparities in currency exchange rates, tax structures, accounting practices &
factors affecting risk.
1) Reducing
risk
This implies that the degree of risk is different in different countries.
It has been observed that international diversification is often more
effective than domestic diversification.
2) Higher
returns
Investing abroad is the expectation of higher returns for a given risk
level.
The labor & other associated costs may be less in a foreign country –
simply to operate at lower cost, which increase the profit.
3) Tax Benefits A multinational enterprise is exposed to various tax laws due to its
operations in different countries.
4) Seeking
political
stability
The government policy provides the biggest threat to the existence of
a multinational organization.
Political risk may range from regular interference to complete
confiscation of company’s assets.
Basic Problems in Financial Management
1) Foreign
Exchange
Fluctuations
The transactions necessarily involve currency of those countries.
The fall in value or devaluation may affect future sales, costs &
remittances.
2) Financing Facilities
The major area of concern for the FM is rising funds on as favorable
terms as possible.
process of strategic decision making.
1) The investment
decision
The investment decision is concerned with allocation & reallocation
of capital to projects, products, assets & divisions of an
organization.
2) Financing
Decision
This is concerned with determining the best financing mix or capital
structure for the organization.
3) Dividend Decision Involve such issues as the percentage of earnings paid to the
shareholders, the stability of dividend paid over the period and the
repurchase or issuance of stock.
Financial Policies
The value of owner’s wealth depends upon…
1) Their expected future cash flows.
2) The dispersion of possibly flows around the expected value – return
various risk.
Decision that affect earning power & financial leverage may affect both these
factors.
Planning & Managing Assets
1) Management of Cash
2) Management of Accounts receivables
a) Management of Inventory
b) Capital Budgeting
3) Source of Finance
a) The external sources of finance
b) The internal sources of finance
4) Capital Structure
5) Dividend policy
1) Management of Cash
Management of cash brings into sharp focus on the trade off between risk &
return faced by the financial manager.
There are 2 stages of cash management…
a) Cash should be managed & near cash efficiently.
The waste can be reduced.
This stage includes efficient management of near cash in order to produce
the highest return consistent with a low risk.
b) Efficient handling of cash flows & balances, the principal task of cash
management can be taken up.
2) Management of Accounts Receivables
The management of accounts receivables involves many complex &
interrelated decisions.
These decisions involve risk & uncertainty.
The company does not know clearly when the customer will pay.
2A) Management of Inventory
Investment in inventories is costly & also a risk of loss.
The management should not reduce the idle stock to zero level.
Some stocks must be maintained to allow for unforeseen changes.
Some stocks are maintained to meet forthcoming demand.
2B) Capital Budgeting
Capital budgeting probably spells the difference between success & failure for
many business firms.
The methods of capital budgeting are net present value & discounted rate of
return.
Major policies are…
a) Source of Finance & Capital Structure Scissions
b) Investment Decisions
c) Financing Decisions & Dividend Policy
3) Sources of Finance
Strategy implementation fundamentally requires financial resources.
3A) The external sources of finance include…
Equity capital Public Deposits Long term loans from development banks
Preference Capital Bill Discounting Short term public deposits
Debenture Capital Overdrafts Factoring issues of commercial paper
Cash credits Loans from non banking financial companies
3B) The internal source of finance include…
This reserves of the company for long term purposes & bank balances & cash
on hand with the company for short term purposes.
4) Capital Structure
These decisions are concerned with the optimum mix of equity capital & debt
capital.
The operating leverage or the proportion of fixed costs in the operating cost
structure.
The factors ….
a) Overall weighted cost of capital.
b) The debt capacity of the firm in terms of adequacy of cash flows to meet the
fixed interest rate burden & principal amount.
c) The need for flexibility in the capital structure should also be considered in
deciding the capital structure.
5) Dividend Policy
The proportion of profit to be distributed to shareholders as dividend & the
proportion of the profit retained in the company as reserves.
This decision is affected by factors like…
a) The shareholders preference as to current dividend income against capital
gains.
b) The reinvestment opportunities & financial needs of the company.
c) Need for stability of dividend distribution.
d) Advantages & disadvantages of cash dividend & stock dividend.
International Financial Management
Most of the experts are of the view that an organization having at least 50 % of
its total profits from international operations do require efficient utilization of
their financial resources.
The environment relates to political risk, Governments tax & investment policy,
foreign exchange risks, sources of finance, etc.
Reasons for Investing Abroad
Qualifying the parameters for a project abroad is more complicated because of
disparities in currency exchange rates, tax structures, accounting practices &
factors affecting risk.
1) Reducing
risk
This implies that the degree of risk is different in different countries.
It has been observed that international diversification is often more
effective than domestic diversification.
2) Higher
returns
Investing abroad is the expectation of higher returns for a given risk
level.
The labor & other associated costs may be less in a foreign country –
simply to operate at lower cost, which increase the profit.
3) Tax Benefits A multinational enterprise is exposed to various tax laws due to its
operations in different countries.
4) Seeking
political
stability
The government policy provides the biggest threat to the existence of
a multinational organization.
Political risk may range from regular interference to complete
confiscation of company’s assets.
Basic Problems in Financial Management
1) Foreign
Exchange
Fluctuations
The transactions necessarily involve currency of those countries.
The fall in value or devaluation may affect future sales, costs &
remittances.
2) Financing Facilities
The major area of concern for the FM is rising funds on as favorable
terms as possible.
Unit Trust of India and Real Estate Investments
UTI set up as a statutory corporation under UTI act 1963
Objectives of UTI: The main objectives of UTI are…
Enabling common investors to participate the prosperity of capital market
through portfolio management aimed at …
Reasonable Returns / Liquidity / Safety
UTI has played a significant role in the institutional building.
It has co promoted many institutions to aid healthy development of the financial
sector.
UTI Schemes and Plans
All the schemes of UTI with the exception of unit scheme 1964
a) Open end scheme e) Interval Scheme
b) Closed end scheme f) Balanced Scheme
c) Growth scheme g) Liquid Fund
d) Income scheme h) Money Market Fund
Real Estate Investments
Real estate offers an attractive way to diversify an investment portfolio.
Real estate differs from security investment in two ways…
1. It involves ownership of the tangible asset – real property rather than a
financial claim.
2. Managerial decisions about real estate greatly affect the returns earned
from investment in it.
Setting Real Estate Investment Objectives
1) The investor should consider how the investment characteristics of real estate
differ.
2) The investor should establish investment constraints & goals.
3) The investor should analyze important features.
Investment Characteristics
To select wisely, the investor needs to consider the available types of
properties & whether the investor wants equity or a debt position.
Classification of real estate into two investment categories…
1) Income Properties.
2) Speculative Properties.
1) Income Properties are residential & commercial properties that are leased out &
expected to provide returns primarily from periodic rental income.
2) Speculative properties typically include raw land & investment properties that
are expected to provide returns primarily from appreciation in value due to
location, scarcity, etc rather than from periodic rental income.
Constraints & Goals
One financial constraint is the risk return relationship he finds acceptable.
The investor must consider how much money he wants to allocate to the real
estate portion of his portfolio.
Investor needs to consider how his technical skills, temperament, repair skills &
managerial talents fir a potential investment.
Analysis of Important Features
General features relating to real estate investment.
1) Physical Property Make sure to get both the quantity & quality of property.
2) Property Rights Law such as deeds, titles, easements, liens & encumbrances.
Make sure that along with various physical inspections, to get a
legal inspection from a qualified attorney.
3) Time Horizon Real estate prices to p & down.
Market forces pull them up slowly but surely.
Prices can fall so fast they tae an investor’s breathe away.
The investor must decide what time period is relevant.
4) Geographic Area Real estate is spatial commodity, which means that its value is
directly linked to what is going on around it.
Determinants of Value
The investor should evaluate the four major determents of real estate value.
Demand / Supply / The property / The property transfer process
1) Demand Demand refers to people’s willingness & ability to buy on rent a
given property.
Property values follow an upward path when employment is
increasing & values typically fall when employers begin to lay off
personnel.
2) Supply Supply analysis means sizing up the competition.
An integral part of value analysis required to identify sources of
potential competition & than inventory them by price & features.
3) The Property The price that people will pay is governed by their needs & the
relative price of the properties available to meet those needs.
To try to develop a property’s competitive edge, an investor should
consider five items.
Restrictions on use / Location / Site characteristics / Improvements
/ Property management
a) Restrictions on
use
Government restrictions derive from zoning laws, building &
occupancy codes, & health & sanitation requirements.
Private restrictions include deeds, leases & condominium bylaws
and operating rules.
b) location
analysis
Convenience – accessibility to the property
Environment – trees / river / lakes / air quality / esthetic
socioeconomic / legal & fiscal environments / Government services
/ Property tax
c) Site
Characteristics
The most important features of a property site are its size.
For residential property - a large yard for children to play in or for a
garden.
For Commercial property – adequate parking space
Site quality such as soil fertility, topography, elevation & drainage
d) Improvements This refers to the man made additions to a site such as buildings,
sidewalks & various on site amenities.
Amenities such as air conditioning, swimming pools & elevators
can significantly.
e) Property
Management
Management assumes responsibility for maintenance & repair of
buildings & their physical systems (electrical, heating, air
conditioning & plumbing) & for keeping revenues & expense
records.
Property management means finding the optimal level of benefits
for a property.
4) Property transfer
Process
The cash flows a property earns can be influenced significantly
through promotion & negotiation.
Real estate valuation
In real estate the concept of market value or actual worth, must be interpreted
differently from its meaning in stocks & bond.
The difference arises for a number of reasons.
1) Each property is unique.
2) Terms & conditions of sale may vary widely.
3) Market information is imperfect.
4) Properties may need substantial time for market exposure, time that may
not be available to any given seller.
5) Buyers sometimes need to act quickly.
Estimating Market Value
In real state, estimating the current market value of a piece of property is done
through a process known as a real estate appraisal.
3 imperfect approaches to real estate market values...
1) The cost approach Based in the notion that an investor should not pay more for a
property than it would cost to rebuild it.
2) The comparative
approach
This method is based on the idea that the value of a given property
is about the same as the prices for which other similar properties
have recently sold.
3) The income
approach
A property’s value is viewed as the present value of all its future
income.
The most popular income approach is called direct capitalization.
Market value = Annual net operating income
Market capitalization rate
Annual net operating income is calculated by subtracting vacancy
& collection losses & property operating expenses, including
property insurance & property taxes from an income property’s
gross potential rental income.
Using an Expert Real estate valuation is a complex & technical procedure that
requires reliable information about the features of comparable
properties, their selling prices & applicable terms of financing.
Strategic Financial Management
A unified, comprehensive & integrated plan that relates to the strategic
advantages of the firm to the challenges of the environment.
It is designed to ensure that the basic objectives of the enterprise are achieved
through proper execution by the organization.
The determination of the basic long term goals & objectives of an enterprise &
the adoption of the courses of action & the allocation of resources necessary
for carrying out these goals.
Forms and Kinds of Strategies
1) Planned Strategy Precise intentions are formulated & articulated by a central
leadership & baked up by formal controls to ensure their surprise
free implementation.
2) Entrepreneurial
Strategy
Intentions exist as the personal, unarticulated visions of a single
leader.
The organization is under the personal control of the leader &
located in a protected niche in its environment.
3) Ideological
Strategy
Intentions exist as the collective vision of the members of the
organization, controlled through strong share norms.
4) Umbrella Strategy A leadership in partial control of organizational actions defines
strategic targets or boundaries within which others must act.
5) Process Strategy The leadership controls the process aspects of strategy, leaving
the actual content of strategy to others.
6) Disconnected Strategy
Members or subunits loosely coupled to the rest of the organization
produce patterns in the streams of their own actions in the absence
of, or in direct contradiction to the central or common intentions of
the organization at large.
The strategies can be deliberate for those who make them.
7) Consensus
Strategy
Through mutual adjustment, various members converge on
patterns that pervade the organization in the absence of central or
common intentions.
The Five Tasks of Strategic Management
1) Articulating a vision of the organization’s future where the organization
needs to be heeded.
2) Translating that vision in to a mission that defines the organization purpose.
3) Converting the mission into performance objectives.
4) Detailing each objective into specific goals.
5) Formulating strategies & tactics to achieve the goals.
Objectives of UTI: The main objectives of UTI are…
Enabling common investors to participate the prosperity of capital market
through portfolio management aimed at …
Reasonable Returns / Liquidity / Safety
UTI has played a significant role in the institutional building.
It has co promoted many institutions to aid healthy development of the financial
sector.
UTI Schemes and Plans
All the schemes of UTI with the exception of unit scheme 1964
a) Open end scheme e) Interval Scheme
b) Closed end scheme f) Balanced Scheme
c) Growth scheme g) Liquid Fund
d) Income scheme h) Money Market Fund
Real Estate Investments
Real estate offers an attractive way to diversify an investment portfolio.
Real estate differs from security investment in two ways…
1. It involves ownership of the tangible asset – real property rather than a
financial claim.
2. Managerial decisions about real estate greatly affect the returns earned
from investment in it.
Setting Real Estate Investment Objectives
1) The investor should consider how the investment characteristics of real estate
differ.
2) The investor should establish investment constraints & goals.
3) The investor should analyze important features.
Investment Characteristics
To select wisely, the investor needs to consider the available types of
properties & whether the investor wants equity or a debt position.
Classification of real estate into two investment categories…
1) Income Properties.
2) Speculative Properties.
1) Income Properties are residential & commercial properties that are leased out &
expected to provide returns primarily from periodic rental income.
2) Speculative properties typically include raw land & investment properties that
are expected to provide returns primarily from appreciation in value due to
location, scarcity, etc rather than from periodic rental income.
Constraints & Goals
One financial constraint is the risk return relationship he finds acceptable.
The investor must consider how much money he wants to allocate to the real
estate portion of his portfolio.
Investor needs to consider how his technical skills, temperament, repair skills &
managerial talents fir a potential investment.
Analysis of Important Features
General features relating to real estate investment.
1) Physical Property Make sure to get both the quantity & quality of property.
2) Property Rights Law such as deeds, titles, easements, liens & encumbrances.
Make sure that along with various physical inspections, to get a
legal inspection from a qualified attorney.
3) Time Horizon Real estate prices to p & down.
Market forces pull them up slowly but surely.
Prices can fall so fast they tae an investor’s breathe away.
The investor must decide what time period is relevant.
4) Geographic Area Real estate is spatial commodity, which means that its value is
directly linked to what is going on around it.
Determinants of Value
The investor should evaluate the four major determents of real estate value.
Demand / Supply / The property / The property transfer process
1) Demand Demand refers to people’s willingness & ability to buy on rent a
given property.
Property values follow an upward path when employment is
increasing & values typically fall when employers begin to lay off
personnel.
2) Supply Supply analysis means sizing up the competition.
An integral part of value analysis required to identify sources of
potential competition & than inventory them by price & features.
3) The Property The price that people will pay is governed by their needs & the
relative price of the properties available to meet those needs.
To try to develop a property’s competitive edge, an investor should
consider five items.
Restrictions on use / Location / Site characteristics / Improvements
/ Property management
a) Restrictions on
use
Government restrictions derive from zoning laws, building &
occupancy codes, & health & sanitation requirements.
Private restrictions include deeds, leases & condominium bylaws
and operating rules.
b) location
analysis
Convenience – accessibility to the property
Environment – trees / river / lakes / air quality / esthetic
socioeconomic / legal & fiscal environments / Government services
/ Property tax
c) Site
Characteristics
The most important features of a property site are its size.
For residential property - a large yard for children to play in or for a
garden.
For Commercial property – adequate parking space
Site quality such as soil fertility, topography, elevation & drainage
d) Improvements This refers to the man made additions to a site such as buildings,
sidewalks & various on site amenities.
Amenities such as air conditioning, swimming pools & elevators
can significantly.
e) Property
Management
Management assumes responsibility for maintenance & repair of
buildings & their physical systems (electrical, heating, air
conditioning & plumbing) & for keeping revenues & expense
records.
Property management means finding the optimal level of benefits
for a property.
4) Property transfer
Process
The cash flows a property earns can be influenced significantly
through promotion & negotiation.
Real estate valuation
In real estate the concept of market value or actual worth, must be interpreted
differently from its meaning in stocks & bond.
The difference arises for a number of reasons.
1) Each property is unique.
2) Terms & conditions of sale may vary widely.
3) Market information is imperfect.
4) Properties may need substantial time for market exposure, time that may
not be available to any given seller.
5) Buyers sometimes need to act quickly.
Estimating Market Value
In real state, estimating the current market value of a piece of property is done
through a process known as a real estate appraisal.
3 imperfect approaches to real estate market values...
1) The cost approach Based in the notion that an investor should not pay more for a
property than it would cost to rebuild it.
2) The comparative
approach
This method is based on the idea that the value of a given property
is about the same as the prices for which other similar properties
have recently sold.
3) The income
approach
A property’s value is viewed as the present value of all its future
income.
The most popular income approach is called direct capitalization.
Market value = Annual net operating income
Market capitalization rate
Annual net operating income is calculated by subtracting vacancy
& collection losses & property operating expenses, including
property insurance & property taxes from an income property’s
gross potential rental income.
Using an Expert Real estate valuation is a complex & technical procedure that
requires reliable information about the features of comparable
properties, their selling prices & applicable terms of financing.
Strategic Financial Management
A unified, comprehensive & integrated plan that relates to the strategic
advantages of the firm to the challenges of the environment.
It is designed to ensure that the basic objectives of the enterprise are achieved
through proper execution by the organization.
The determination of the basic long term goals & objectives of an enterprise &
the adoption of the courses of action & the allocation of resources necessary
for carrying out these goals.
Forms and Kinds of Strategies
1) Planned Strategy Precise intentions are formulated & articulated by a central
leadership & baked up by formal controls to ensure their surprise
free implementation.
2) Entrepreneurial
Strategy
Intentions exist as the personal, unarticulated visions of a single
leader.
The organization is under the personal control of the leader &
located in a protected niche in its environment.
3) Ideological
Strategy
Intentions exist as the collective vision of the members of the
organization, controlled through strong share norms.
4) Umbrella Strategy A leadership in partial control of organizational actions defines
strategic targets or boundaries within which others must act.
5) Process Strategy The leadership controls the process aspects of strategy, leaving
the actual content of strategy to others.
6) Disconnected Strategy
Members or subunits loosely coupled to the rest of the organization
produce patterns in the streams of their own actions in the absence
of, or in direct contradiction to the central or common intentions of
the organization at large.
The strategies can be deliberate for those who make them.
7) Consensus
Strategy
Through mutual adjustment, various members converge on
patterns that pervade the organization in the absence of central or
common intentions.
The Five Tasks of Strategic Management
1) Articulating a vision of the organization’s future where the organization
needs to be heeded.
2) Translating that vision in to a mission that defines the organization purpose.
3) Converting the mission into performance objectives.
4) Detailing each objective into specific goals.
5) Formulating strategies & tactics to achieve the goals.
Accounting for Leasing in the Financial Statements of the Lessee and Mutual Fund
Finance Lease
An asset acquired under a finance lease could be reflected on both sides of the
balance sheet of the lessee.
It should be shown on the assets side at the present value of minimum lease
payments over the lease period.
If the fair value of the leased property is lower than the present value of the
minimum lease payments, the leased asset should be at the fair value.
The rentals should be appropriated between finance charges and the reduction
of the outstanding liability.
Operating lease
The rental payments should be charged on a systematic basis as expenses to
the revenues of the accounting period over which the benefits of the asset will
be available.
Accounting for Leasing in the Financial Statements of the Lesser
Finance Lease
An asset held under a finance lease should be recorded in the Balance sheet
not as property, plant & equipment, but as receivable at an amount equal to the
net investment in the lease.
Manufacturer or dealer lesser should include selling profit or loss in income in
accordance with the policy normally followed by the enterprise for outright
sales.
Operating Lease
Assets held for operating lease should be recorded as property, plant &
equipment in the balance sheet of the lesser.
Rental income should be recognized on a straight line basis over lease term.
The depreciation of the leased assets should be on a basis consistent with the
lesser normal depreciation policy for similar assets.
Leasing in India
FLC – First Leasing Company – based at Madras, India.
1) All India financial
institutions
ICICI – Industrial credit investment corporation of India ltd
IFCI – Industrial Finance corporation of India Ltd
RBI – Reconstruction bank of India
2) Independent Leasing
Companies in the
Private sector
First Leasing Company of India
20th Century Leasing Corporation Ltd
Express Leasing Limited
Grover Leasing Limited
Mazda Leading Limited
3) Finance Companies Sundaram Finance Limited
Motor & General Finance Limited
Nagarjuna Finance Limited
4) Group Related Leasing
Companies
Cholamandal Investment & finance company Limited
Investment Trust Company Ltd
Oriented Leasing Limited
DCL Finance Limited
Reasons for Popularity
1) A greater role in industrial investment has been envisaged in the Eighth Plan
for the private sector.
2) Greater emphasis on priority sector lending by banks has resulted in reduced
availability of bank finance for private sector.
3) Reduced availability of funds for private sector lending with the financial
institutions and great emphasis by the Government on the private sector to
generate its own resources.
4) As a result withdrawal of investment allowance i.e. April 1, 1990. It is more
beneficial for a manufacturer to get the plant & equipment on lease as
compared to purchase it.
Difficulties Ahead
The market for leasing has not grown with the same pace as the number of
lesser.
There is an oversupply of lesser.
There is a scarcity of the right type of personnel.
The top management should have expertise in accounting, finance, legal &
decision areas.
Leasing companies have not been in a position to maintain ideal debt equity
mix.
In order to get popularity among investors, some of the leasing companies have
not been providing adequate depreciation.
Government, financial institutions and leasing companies to join hands together
if they with to reap the maximum benefits.
Mutual Fund
Mutual funds are associations or trusts of public members who wish to make
investments I the financial instruments or assets of the business sectors or
corporate sector for the mutual benefit of their members.
The fund collects the money of these members of their savings & invests them
in a diversified portfolio of financial assets with a view to reduce risks & to
maximize their income.
Mutual fund is a concept of mutual help of subscribers for portfolio investment &
management of these investments by experts in the field.
Open ended mutual fund – whose units can be sold & repurchased at any time.
RBI Guidelines on Mutual Funds
1) MF shall be constituted as a trust under the Indian Trust Act & the sponsoring
Bank should vest in the Board of Trustees.
2) The day to day management of the schemes under the fund should be looked
after by a full time executive trustee who shall not be discharging any other
responsibility of in the convened bank.
3) The sponsor banks should contribute the minimum amount or such high
amount specified by the RBI.
4) Other trustee securities, shares / debentures of the public limited companies,
bonds of public sector undertaking, etc.
5) There is no objection to the mutual funds investing the amounts in the Money
Market instruments like commercial paper, certificate of deposits, treasury bills,
bill re discounting, short term bank deposits, short term government securities
and any other such short term instruments as may be allowed under the
regulations prevailing from time to time.
6) MF should invariably take delivery of the scripts purchased & in the case of
scripts sold, give delivery there of to the purchaser.
7) The MFS should not make investments in any other unit trust.
8) The total cost of managing any scheme under a fund including management
fees & other administrative costs should be kept within a prescribed percentage
of total income of the scheme.
9) The income distribution by way of dividend or capitalization of gains should not
be made on the basis of the revaluation of the stock holding or unrealized
capital appreciation.
10) Depreciation on investment held & provision for bad & doubtful debts if any
have to be provided for to the satisfaction f auditors before declaring any
dividend.
Statement of accounts & disclosure
A MF should maintain separate accounts for each scheme launched by it.
The board of trustees of MF should prepare an annual statement of accounts.
Auditors & board of trustees should be published for the information the
subscribers to the concerned scheme.
The trustees should disclose the NAV of each of the schemes & the method of
valuation for benefit of the concerned subscribers.
Sponsor banks should furnish to RBI the report such as half yearly report
indicating the performance of MF.
Guidelines for Mutual Fund by SEBI
It has become necessary to evolve a comprehensive set of prudential
guidelines for the all round development & regulation of mutual funds.
Money Market Mutual Funds investing exclusively in money market instruments
would be regulated by RBI.
Establishment of MFS
MFS shall be authorized for business by the SEBI.
They shall be sponsored by…
1) Registered companies with a sound track record
2) General reputation
3) Fairness in all their business transactions.
They shall be established in the form of trusts under the Indian Trust Act.
Asset Management Company (AMC)
AMC shall be authorized for business by SEBI.
AMC should have…
1) Sound track record
2) General reputation & fairness in all their business tractions
3) The directors of AMCs should have professional experience in the fields
such as…
Portfolio investment / Investment analysis / financial administration
AMC should not be allowed to act as the trustee of a Unit Trust.
Trustees & trust companies
At least 50 % of board of trustees shall be independent out side members,
having no affiliation with sponsoring institution.
The sponsor should submit the trust deed to SEBI for approval.
Responsibility of Trustees : This entails following checks
To see that the investments are of permitted kind & within the set limit.
The funds assets are duly protected.
Transaction is units are properly checked.
Internal controls.
Incomes are properly accounted for & payments & expenses are properly
made.
Pricing of units & distributions from the fund are properly made.
Schemes
Each authorized unit should be allowed to float different schemes.
MFs should be allowed to start & operate both closed end & open end scheme.
1) Closed end scheme
Closed end scheme should have a duration fixed in a number of years, at the
end of which it should be wound up or extended with the permission of SEBI.
2) Open end scheme
NAV and Valuation of Assets of the Scheme
The net asset value shall be calculated by dividing the net assets of the
scheme by the total number of units outstanding on the valuation date.
The NAV will be calculated every day & has to be published at such intervals as
are prescribed by SEBI.
An asset acquired under a finance lease could be reflected on both sides of the
balance sheet of the lessee.
It should be shown on the assets side at the present value of minimum lease
payments over the lease period.
If the fair value of the leased property is lower than the present value of the
minimum lease payments, the leased asset should be at the fair value.
The rentals should be appropriated between finance charges and the reduction
of the outstanding liability.
Operating lease
The rental payments should be charged on a systematic basis as expenses to
the revenues of the accounting period over which the benefits of the asset will
be available.
Accounting for Leasing in the Financial Statements of the Lesser
Finance Lease
An asset held under a finance lease should be recorded in the Balance sheet
not as property, plant & equipment, but as receivable at an amount equal to the
net investment in the lease.
Manufacturer or dealer lesser should include selling profit or loss in income in
accordance with the policy normally followed by the enterprise for outright
sales.
Operating Lease
Assets held for operating lease should be recorded as property, plant &
equipment in the balance sheet of the lesser.
Rental income should be recognized on a straight line basis over lease term.
The depreciation of the leased assets should be on a basis consistent with the
lesser normal depreciation policy for similar assets.
Leasing in India
FLC – First Leasing Company – based at Madras, India.
1) All India financial
institutions
ICICI – Industrial credit investment corporation of India ltd
IFCI – Industrial Finance corporation of India Ltd
RBI – Reconstruction bank of India
2) Independent Leasing
Companies in the
Private sector
First Leasing Company of India
20th Century Leasing Corporation Ltd
Express Leasing Limited
Grover Leasing Limited
Mazda Leading Limited
3) Finance Companies Sundaram Finance Limited
Motor & General Finance Limited
Nagarjuna Finance Limited
4) Group Related Leasing
Companies
Cholamandal Investment & finance company Limited
Investment Trust Company Ltd
Oriented Leasing Limited
DCL Finance Limited
Reasons for Popularity
1) A greater role in industrial investment has been envisaged in the Eighth Plan
for the private sector.
2) Greater emphasis on priority sector lending by banks has resulted in reduced
availability of bank finance for private sector.
3) Reduced availability of funds for private sector lending with the financial
institutions and great emphasis by the Government on the private sector to
generate its own resources.
4) As a result withdrawal of investment allowance i.e. April 1, 1990. It is more
beneficial for a manufacturer to get the plant & equipment on lease as
compared to purchase it.
Difficulties Ahead
The market for leasing has not grown with the same pace as the number of
lesser.
There is an oversupply of lesser.
There is a scarcity of the right type of personnel.
The top management should have expertise in accounting, finance, legal &
decision areas.
Leasing companies have not been in a position to maintain ideal debt equity
mix.
In order to get popularity among investors, some of the leasing companies have
not been providing adequate depreciation.
Government, financial institutions and leasing companies to join hands together
if they with to reap the maximum benefits.
Mutual Fund
Mutual funds are associations or trusts of public members who wish to make
investments I the financial instruments or assets of the business sectors or
corporate sector for the mutual benefit of their members.
The fund collects the money of these members of their savings & invests them
in a diversified portfolio of financial assets with a view to reduce risks & to
maximize their income.
Mutual fund is a concept of mutual help of subscribers for portfolio investment &
management of these investments by experts in the field.
Open ended mutual fund – whose units can be sold & repurchased at any time.
RBI Guidelines on Mutual Funds
1) MF shall be constituted as a trust under the Indian Trust Act & the sponsoring
Bank should vest in the Board of Trustees.
2) The day to day management of the schemes under the fund should be looked
after by a full time executive trustee who shall not be discharging any other
responsibility of in the convened bank.
3) The sponsor banks should contribute the minimum amount or such high
amount specified by the RBI.
4) Other trustee securities, shares / debentures of the public limited companies,
bonds of public sector undertaking, etc.
5) There is no objection to the mutual funds investing the amounts in the Money
Market instruments like commercial paper, certificate of deposits, treasury bills,
bill re discounting, short term bank deposits, short term government securities
and any other such short term instruments as may be allowed under the
regulations prevailing from time to time.
6) MF should invariably take delivery of the scripts purchased & in the case of
scripts sold, give delivery there of to the purchaser.
7) The MFS should not make investments in any other unit trust.
8) The total cost of managing any scheme under a fund including management
fees & other administrative costs should be kept within a prescribed percentage
of total income of the scheme.
9) The income distribution by way of dividend or capitalization of gains should not
be made on the basis of the revaluation of the stock holding or unrealized
capital appreciation.
10) Depreciation on investment held & provision for bad & doubtful debts if any
have to be provided for to the satisfaction f auditors before declaring any
dividend.
Statement of accounts & disclosure
A MF should maintain separate accounts for each scheme launched by it.
The board of trustees of MF should prepare an annual statement of accounts.
Auditors & board of trustees should be published for the information the
subscribers to the concerned scheme.
The trustees should disclose the NAV of each of the schemes & the method of
valuation for benefit of the concerned subscribers.
Sponsor banks should furnish to RBI the report such as half yearly report
indicating the performance of MF.
Guidelines for Mutual Fund by SEBI
It has become necessary to evolve a comprehensive set of prudential
guidelines for the all round development & regulation of mutual funds.
Money Market Mutual Funds investing exclusively in money market instruments
would be regulated by RBI.
Establishment of MFS
MFS shall be authorized for business by the SEBI.
They shall be sponsored by…
1) Registered companies with a sound track record
2) General reputation
3) Fairness in all their business transactions.
They shall be established in the form of trusts under the Indian Trust Act.
Asset Management Company (AMC)
AMC shall be authorized for business by SEBI.
AMC should have…
1) Sound track record
2) General reputation & fairness in all their business tractions
3) The directors of AMCs should have professional experience in the fields
such as…
Portfolio investment / Investment analysis / financial administration
AMC should not be allowed to act as the trustee of a Unit Trust.
Trustees & trust companies
At least 50 % of board of trustees shall be independent out side members,
having no affiliation with sponsoring institution.
The sponsor should submit the trust deed to SEBI for approval.
Responsibility of Trustees : This entails following checks
To see that the investments are of permitted kind & within the set limit.
The funds assets are duly protected.
Transaction is units are properly checked.
Internal controls.
Incomes are properly accounted for & payments & expenses are properly
made.
Pricing of units & distributions from the fund are properly made.
Schemes
Each authorized unit should be allowed to float different schemes.
MFs should be allowed to start & operate both closed end & open end scheme.
1) Closed end scheme
Closed end scheme should have a duration fixed in a number of years, at the
end of which it should be wound up or extended with the permission of SEBI.
2) Open end scheme
NAV and Valuation of Assets of the Scheme
The net asset value shall be calculated by dividing the net assets of the
scheme by the total number of units outstanding on the valuation date.
The NAV will be calculated every day & has to be published at such intervals as
are prescribed by SEBI.
Lease Financing and Types of Lease Agreements with Advantages of Leasing
The funds required for capital investment are to be raised.
The term capital investment includes investment in fixed assets such as…
1) Land & building
2) Plant & Machinery
3) Other fixed assets
The expenditure in capital assets is a sunken investment.
An alternative to own & use the capital assets is to get them on lease & use
them as per the terms of the leasing agreement.
A contract of lease may be defined as a contract whereby the owner of an
asset (lesser) grants to another party (lessee) the exclusive right to use the
asset usually for an agreed period of time in return for the payment of rent.
The two important rights to the property….
1) Right to own
2) Right to use
Important steps involved in a leasing transaction…
1) The asset required & determines the manufacturer or the supplier.
Requirements of lessee
a) The design specifications b) The price c) Warranties
d) Terms of delivery e) Installation & servicing
2) Lease agreement
a) The basic lease period
b) The timing & amount of periodical rental payments
c) Details of any option to renew the lese or to purchase the asset at the
end of the basic period.
d) Details regarding the responsibility for payment of cost of
maintenance & repairs, taxes, insurance & other expenses.
Net Lease Agreement – The lessee pays all these costs.
Maintenance Lease Agreement – The lesser maintains the asset &
also pays for the insurance.
3) The manufacturer / supplier to supply the asset has been delivered, tested
& accepted by the lessee.
Types of Lease Agreements
Capital Lease
A capital lease is a long term arrangement, which is irrevocable during its
primary lease period.
1) The lesser transfer title to the lessee at the end.
2) The lease contains an option to purchase the asset at a bargain price.
3) The lease period is equal to or greater than 75 % if the estimated economic
life of the asset.
4) The present value of the minimum lease payments equals or exceeds 90 %
of the fair value of the leased property to the lesser.
The lessee has also to bear costs of insurance, repairs & maintenance of the
asset & other related expenses.
The capital lease – Close end lease.
Operating Lease
The right to use the leased property for a limited period of time.
The lesser is responsible for the maintenance of the asset, insurance and al
other relevant expenditure.
An operating lease is generally preferred in the following circumstances…
1) Sale & Lease back
A firm sells an asset to another person who in turn leases it back to the firm.
The lessee gets immediate cash, which results in improvement in his cash flow
position.
The lesser gets the benefit in terms of tax credit due to depreciation.
2) Leveraged Leasing
This form a leasing has become very popular in recent years.
This type of lease agreement is used for financing those assets, which require
large capital outlays.
Involves three parties the lessee, the lesser and lender.
Advantages of Leasing
1) Permits alternative use of funds.
2) Arranges faster and cheaper credit.
Acquisition of assets under a leasing arrangement is cheaper & faster as
compared to acquisition of assets through any other source.
3) Increases lessee’s capacity to borrow.
Lessee to utilize more of his funds for working capital purposes.
4) Protects against obsolescence.
The lessee can protect himself against the risk of obsolescence by entering into
operating lease arrangements.
5) Boo for small firms.
6) Absence of restrictive covenants.
7) Trading on tax shield.
When a tax paying lesser owns the asset, he generally passes a part of the tax
benefit to the lessee by means of lower rental charges.
8) Invisible privileges.
The lessee gets a right to use the asset without owing it.
Disadvantages of Leasing
1) Deprived of ownership.
The lessee does not get the ownership of asset. He gets only a right to use.
2) Deprivation of the asset in case of default.
In case the lessee makes a default in rental payments, the lesser is entitled to
take over the asset & the lessee has no right to prevent.
3) No protection against supplier’s warranties.
Choice of Lesser
Now days any asset can be obtained on lease, from a transport vehicle to
heavy industrial equipment.
It is the perception & capability of both the lesser & the lessee which can make
leasing agreement to work effectively as a source of modern business finance...
1) Comparative market rate
The lessee must ensure that comparisons are made on the basis of rentals with
or without stamp duty.
2) Supply of correct information.
The lessee must give a full & accurate description of the equipment to be
purchased to avoid any complications & delay in settlement with the lesser.
The lesser should also provide all information regarding the asset proposed to
be leased which may be of interest of the lessee.
3) Service quality.
The liability of maintaining the leased asset rests with the lesser.
4) Financial strength.
The lesser should be a person of sufficient financial means required for
absorbing market fluctuations.
5) Professional skills
Leasing business requires specialized professional skill.
Lesser should be a person who can….
a) Explain to the lessee all legal aspects involved in the leasing transaction.
b) Structure the lease rentals
c) Advise the lessee regarding the period over which capital cost will be
Recovered.
6) Proper documentation
Documentation is extremely important & particularly when long term period is
involved.
Account for Leases
1) Discloser regarding lease transactions should be made at all in the financial
statements of the lesser and the lessee.
2) In case the disclosure is made in the financial statements, whether it should
be shown only by way of a footnote or should it form an integral part of the
annual accounts.
3) In case, Lease transactions form an integral part of the financial statements,
how it should be treated in the books of the lesser and the lessee.
IAS – Accounting for Leases
1) Lease
An agreement where by the lesser can convey to the lessee in return for
rent the right to use an asset for an agreed period of time.
2) Finance Lease
A lease, which transfers substantially all the risks & rewards incidental to
ownership of an asset.
3) Operating Lease
A lease other than the Finance Lease.
4) Minimum Lease Payments
The payment over the lease term that the lessee is or can required making
together with…
5) Face value
The amount for which as asset can be exchanged between a
knowledgeable willing buyer and a knowledgeable willing seller in an arm’s
length transaction.
6) Inception of the Lease
The earlier of the date of lease agreement or of a commitment by the parties
to the principal provisions of the lease.
The term capital investment includes investment in fixed assets such as…
1) Land & building
2) Plant & Machinery
3) Other fixed assets
The expenditure in capital assets is a sunken investment.
An alternative to own & use the capital assets is to get them on lease & use
them as per the terms of the leasing agreement.
A contract of lease may be defined as a contract whereby the owner of an
asset (lesser) grants to another party (lessee) the exclusive right to use the
asset usually for an agreed period of time in return for the payment of rent.
The two important rights to the property….
1) Right to own
2) Right to use
Important steps involved in a leasing transaction…
1) The asset required & determines the manufacturer or the supplier.
Requirements of lessee
a) The design specifications b) The price c) Warranties
d) Terms of delivery e) Installation & servicing
2) Lease agreement
a) The basic lease period
b) The timing & amount of periodical rental payments
c) Details of any option to renew the lese or to purchase the asset at the
end of the basic period.
d) Details regarding the responsibility for payment of cost of
maintenance & repairs, taxes, insurance & other expenses.
Net Lease Agreement – The lessee pays all these costs.
Maintenance Lease Agreement – The lesser maintains the asset &
also pays for the insurance.
3) The manufacturer / supplier to supply the asset has been delivered, tested
& accepted by the lessee.
Types of Lease Agreements
Capital Lease
A capital lease is a long term arrangement, which is irrevocable during its
primary lease period.
1) The lesser transfer title to the lessee at the end.
2) The lease contains an option to purchase the asset at a bargain price.
3) The lease period is equal to or greater than 75 % if the estimated economic
life of the asset.
4) The present value of the minimum lease payments equals or exceeds 90 %
of the fair value of the leased property to the lesser.
The lessee has also to bear costs of insurance, repairs & maintenance of the
asset & other related expenses.
The capital lease – Close end lease.
Operating Lease
The right to use the leased property for a limited period of time.
The lesser is responsible for the maintenance of the asset, insurance and al
other relevant expenditure.
An operating lease is generally preferred in the following circumstances…
1) Sale & Lease back
A firm sells an asset to another person who in turn leases it back to the firm.
The lessee gets immediate cash, which results in improvement in his cash flow
position.
The lesser gets the benefit in terms of tax credit due to depreciation.
2) Leveraged Leasing
This form a leasing has become very popular in recent years.
This type of lease agreement is used for financing those assets, which require
large capital outlays.
Involves three parties the lessee, the lesser and lender.
Advantages of Leasing
1) Permits alternative use of funds.
2) Arranges faster and cheaper credit.
Acquisition of assets under a leasing arrangement is cheaper & faster as
compared to acquisition of assets through any other source.
3) Increases lessee’s capacity to borrow.
Lessee to utilize more of his funds for working capital purposes.
4) Protects against obsolescence.
The lessee can protect himself against the risk of obsolescence by entering into
operating lease arrangements.
5) Boo for small firms.
6) Absence of restrictive covenants.
7) Trading on tax shield.
When a tax paying lesser owns the asset, he generally passes a part of the tax
benefit to the lessee by means of lower rental charges.
8) Invisible privileges.
The lessee gets a right to use the asset without owing it.
Disadvantages of Leasing
1) Deprived of ownership.
The lessee does not get the ownership of asset. He gets only a right to use.
2) Deprivation of the asset in case of default.
In case the lessee makes a default in rental payments, the lesser is entitled to
take over the asset & the lessee has no right to prevent.
3) No protection against supplier’s warranties.
Choice of Lesser
Now days any asset can be obtained on lease, from a transport vehicle to
heavy industrial equipment.
It is the perception & capability of both the lesser & the lessee which can make
leasing agreement to work effectively as a source of modern business finance...
1) Comparative market rate
The lessee must ensure that comparisons are made on the basis of rentals with
or without stamp duty.
2) Supply of correct information.
The lessee must give a full & accurate description of the equipment to be
purchased to avoid any complications & delay in settlement with the lesser.
The lesser should also provide all information regarding the asset proposed to
be leased which may be of interest of the lessee.
3) Service quality.
The liability of maintaining the leased asset rests with the lesser.
4) Financial strength.
The lesser should be a person of sufficient financial means required for
absorbing market fluctuations.
5) Professional skills
Leasing business requires specialized professional skill.
Lesser should be a person who can….
a) Explain to the lessee all legal aspects involved in the leasing transaction.
b) Structure the lease rentals
c) Advise the lessee regarding the period over which capital cost will be
Recovered.
6) Proper documentation
Documentation is extremely important & particularly when long term period is
involved.
Account for Leases
1) Discloser regarding lease transactions should be made at all in the financial
statements of the lesser and the lessee.
2) In case the disclosure is made in the financial statements, whether it should
be shown only by way of a footnote or should it form an integral part of the
annual accounts.
3) In case, Lease transactions form an integral part of the financial statements,
how it should be treated in the books of the lesser and the lessee.
IAS – Accounting for Leases
1) Lease
An agreement where by the lesser can convey to the lessee in return for
rent the right to use an asset for an agreed period of time.
2) Finance Lease
A lease, which transfers substantially all the risks & rewards incidental to
ownership of an asset.
3) Operating Lease
A lease other than the Finance Lease.
4) Minimum Lease Payments
The payment over the lease term that the lessee is or can required making
together with…
5) Face value
The amount for which as asset can be exchanged between a
knowledgeable willing buyer and a knowledgeable willing seller in an arm’s
length transaction.
6) Inception of the Lease
The earlier of the date of lease agreement or of a commitment by the parties
to the principal provisions of the lease.
Factors Affecting Investment Decisions and Fundamental versus Technical Approaches
1) Amount of Investment The amount of surplus funds available with the organization.
The purpose of best utilization of their available surplus
cash resources.
2) Objective of investment
portfolio
High capital appreciation
Assure safety of the funds & a steady return
3) Selection of Investment What to buy
3A) Type of securities Debentures convertible / non convertible, etc
3B) Proportion between fixed & variable yield securities Fixed yield securities
Debentures / Government securities / Preferences shares /
Variable yield securities
Do not ensure a fixed return. The return depends upon the
earnings of the company.
3C) Selection of Industries Select the industries whose securities should comprise his
investment portfolio.
This will require a careful analysis of the past performance &
future prospectus of different industries.
3D) Selection of companies The FM has to select particular companies in that industry
whose securities have to constitute his investment portfolio.
4) Timing of Purchase The time of purchasing the securities is also of crucial
significance for the FM.
Fundamental versus Technical Approaches
According to the Fundamental Approach, the intrinsic value of a security is
equivalent to the present value of the future stream of income from the security
discounted at an appropriate risk adjusted interest rate.
The estimate of the real work of the security can be made on the basis of...
1) Earning potentials of the company & various other factors like business
environment.
2) Prevalent competition in the industry
3) Competitive strength of the company
4) Quality of management
5) Operational efficiency
6) Stock exchange quotations
According to Technical Approach, the decision to buy / sell a security can be
made on the basis of assessment of the demand & supply factors.
Technical Approach is basically based on this premise that there are persistent
& recurring patterns of price movements.
3 categories…
1) Stock Price & Volume Techniques
A) Primary Movements
B) Secondary Movements
C) Daily Movements
Dow Jones Theory
2) General Market Analysis Attempts to determine the basis & the general
trend of security prices.
3) Theory of Contrary Opinion Based on the general principle "Go against the
market".
Dow Jones Theory
1) Primary Movements
These are the long term movements of the prices of securities
on the stock exchange.
Market prices show a rising trend – Bull Phase
Market prices show a falling trend – Bear Phase
2) Secondary Movements
These represent short term movements in stock exchange.
They are opposite in direction to the primary movements.
Market prices show a rising trend – Bear Phase
Market prices show a falling trend – Bull Phase
3) Daily Movements These represent daily irregular fluctuations in the stock
exchange prices.
They are without any definite trend.
This fluctuation can only be of interest to a speculator.
Random Walk Theory
The theory predictions can be made about the future behavior of stock
exchange prices.
According to the theory, the stock exchange prices can never be predicted.
Stock exchange prices are absolutely unconnected & they are a mere statistical
happening.
Stock exchange prices exactly behave in a way in which a drunken person
would behave.
The stock exchange prices are absolutely independent & they can not form a
proper base for the Finance Manger to take investment decisions.
Formula Plans
This plan provides an automatic timing device for the investor when to buy &
sell the securities.
1) Rupee cost
Averaging Plan
Rupee averaging / Strict rupee averaging plan
This plan consists of investing at regular intervals a fixed rupee
amount in selected securities / group of securities.
2) Modified rupee
averaging plan
The investor should put an equal amount of money into each of
the fixed list of securities at the same time each year.
An investor may investor a fixed amount every time but may
continuously vary the securities purchased.
The investor may buy the same securities each time but may
vary the timings of his investment during the year.
3) Ratio Formula
Plan
Ratio formula plan requires an alternation of investment
between different securities.
Ratio formula plan requires an alternation of investment
between different securities.
The investor switch from shares when others are anxious to sell
them.
Sale of securities is made gradually as the prices rise &
purchases are made which will automatically determine the
timing & amount of transaction.
3A) Constant ratio formula plans
The amount available for investment is pre determined.
The population between fixed yield bearing securities
Variable yield securities - Defensive component.
Variable yield bearing securities – Aggressive component
At pre determined intervals, as the case may be the market
value of total investment portfolio is worked out.
3B) Variable ratio
formula plan
The FM under this plan sells the shares within their prices rise &
buys the bonds in their price.
He continuously reduces the proportion of his portfolio when the
share prices fall.
Markowitz Efficient Model
An investor should seek a portfolio of securities that lies on the efficient frontier.
Markowitz emphasized that variance of the return was a significant yardstick for
measuring risk under reasonable assumptions.
Assumptions regarding the Markowitz Model…
1) An investor considers each investment alternative as being represented by
a probable distribution of the expected returns over the some holding
period.
2) An investor estimates his risk on the basis of variability of expected returns.
3) The decision of the investor regarding selection of his investment portfolio
lays basically on expected return & risk from the investment.
4) The investor prefers a higher return to lower return for a given degree of risk
level. He prefers less risk to more risk for a given level of expected return.
Capital Assets Pricing Model
The model explains the relationship between the expected return, unavoidable
risk & the valuation of securities.
The term unavoidable risk means the risk which simply can not be avoided by
diversification.
CAPM expresses the following ideas…
1) The required rate of return of all financial assets depends in part on risk less
rate of return.
2) Investors are primarily concerned with unavoidable risk.
3) Investors require premium for bearing the risk depending upon the degree
or risk.
4) Since the investors are risk - averse, the higher the risk the greater is the
expected return.
Re = Rf + (Rm – Rf)
Re = Expected return
Rf = Risk free return
Rm – Rf = Risk premium = Risk management
The CAPM is based on the following assumptions…
1) Capital markets are highly efficient & investors are well informed.
2) Transactions costs are nil & there are negligible restrictions on investment.
3) No investor is large enough to affect the market price of the stock.
4) Investors are risk averse.
5) Investors have homogenous expectations regarding risk & return on
securities.
The purpose of best utilization of their available surplus
cash resources.
2) Objective of investment
portfolio
High capital appreciation
Assure safety of the funds & a steady return
3) Selection of Investment What to buy
3A) Type of securities Debentures convertible / non convertible, etc
3B) Proportion between fixed & variable yield securities Fixed yield securities
Debentures / Government securities / Preferences shares /
Variable yield securities
Do not ensure a fixed return. The return depends upon the
earnings of the company.
3C) Selection of Industries Select the industries whose securities should comprise his
investment portfolio.
This will require a careful analysis of the past performance &
future prospectus of different industries.
3D) Selection of companies The FM has to select particular companies in that industry
whose securities have to constitute his investment portfolio.
4) Timing of Purchase The time of purchasing the securities is also of crucial
significance for the FM.
Fundamental versus Technical Approaches
According to the Fundamental Approach, the intrinsic value of a security is
equivalent to the present value of the future stream of income from the security
discounted at an appropriate risk adjusted interest rate.
The estimate of the real work of the security can be made on the basis of...
1) Earning potentials of the company & various other factors like business
environment.
2) Prevalent competition in the industry
3) Competitive strength of the company
4) Quality of management
5) Operational efficiency
6) Stock exchange quotations
According to Technical Approach, the decision to buy / sell a security can be
made on the basis of assessment of the demand & supply factors.
Technical Approach is basically based on this premise that there are persistent
& recurring patterns of price movements.
3 categories…
1) Stock Price & Volume Techniques
A) Primary Movements
B) Secondary Movements
C) Daily Movements
Dow Jones Theory
2) General Market Analysis Attempts to determine the basis & the general
trend of security prices.
3) Theory of Contrary Opinion Based on the general principle "Go against the
market".
Dow Jones Theory
1) Primary Movements
These are the long term movements of the prices of securities
on the stock exchange.
Market prices show a rising trend – Bull Phase
Market prices show a falling trend – Bear Phase
2) Secondary Movements
These represent short term movements in stock exchange.
They are opposite in direction to the primary movements.
Market prices show a rising trend – Bear Phase
Market prices show a falling trend – Bull Phase
3) Daily Movements These represent daily irregular fluctuations in the stock
exchange prices.
They are without any definite trend.
This fluctuation can only be of interest to a speculator.
Random Walk Theory
The theory predictions can be made about the future behavior of stock
exchange prices.
According to the theory, the stock exchange prices can never be predicted.
Stock exchange prices are absolutely unconnected & they are a mere statistical
happening.
Stock exchange prices exactly behave in a way in which a drunken person
would behave.
The stock exchange prices are absolutely independent & they can not form a
proper base for the Finance Manger to take investment decisions.
Formula Plans
This plan provides an automatic timing device for the investor when to buy &
sell the securities.
1) Rupee cost
Averaging Plan
Rupee averaging / Strict rupee averaging plan
This plan consists of investing at regular intervals a fixed rupee
amount in selected securities / group of securities.
2) Modified rupee
averaging plan
The investor should put an equal amount of money into each of
the fixed list of securities at the same time each year.
An investor may investor a fixed amount every time but may
continuously vary the securities purchased.
The investor may buy the same securities each time but may
vary the timings of his investment during the year.
3) Ratio Formula
Plan
Ratio formula plan requires an alternation of investment
between different securities.
Ratio formula plan requires an alternation of investment
between different securities.
The investor switch from shares when others are anxious to sell
them.
Sale of securities is made gradually as the prices rise &
purchases are made which will automatically determine the
timing & amount of transaction.
3A) Constant ratio formula plans
The amount available for investment is pre determined.
The population between fixed yield bearing securities
Variable yield securities - Defensive component.
Variable yield bearing securities – Aggressive component
At pre determined intervals, as the case may be the market
value of total investment portfolio is worked out.
3B) Variable ratio
formula plan
The FM under this plan sells the shares within their prices rise &
buys the bonds in their price.
He continuously reduces the proportion of his portfolio when the
share prices fall.
Markowitz Efficient Model
An investor should seek a portfolio of securities that lies on the efficient frontier.
Markowitz emphasized that variance of the return was a significant yardstick for
measuring risk under reasonable assumptions.
Assumptions regarding the Markowitz Model…
1) An investor considers each investment alternative as being represented by
a probable distribution of the expected returns over the some holding
period.
2) An investor estimates his risk on the basis of variability of expected returns.
3) The decision of the investor regarding selection of his investment portfolio
lays basically on expected return & risk from the investment.
4) The investor prefers a higher return to lower return for a given degree of risk
level. He prefers less risk to more risk for a given level of expected return.
Capital Assets Pricing Model
The model explains the relationship between the expected return, unavoidable
risk & the valuation of securities.
The term unavoidable risk means the risk which simply can not be avoided by
diversification.
CAPM expresses the following ideas…
1) The required rate of return of all financial assets depends in part on risk less
rate of return.
2) Investors are primarily concerned with unavoidable risk.
3) Investors require premium for bearing the risk depending upon the degree
or risk.
4) Since the investors are risk - averse, the higher the risk the greater is the
expected return.
Re = Rf + (Rm – Rf)
Re = Expected return
Rf = Risk free return
Rm – Rf = Risk premium = Risk management
The CAPM is based on the following assumptions…
1) Capital markets are highly efficient & investors are well informed.
2) Transactions costs are nil & there are negligible restrictions on investment.
3) No investor is large enough to affect the market price of the stock.
4) Investors are risk averse.
5) Investors have homogenous expectations regarding risk & return on
securities.
Instruments Dealt in a Money Market and Bill Market in India
A money market deals with near money or short term credit instruments.
The chief short term credit instruments that are dealt with in a money market…
1) Trade Bills Short term periods of 1/2/3/6 months
Accepted either by the purchasers of goods or by banks or
acceptance houses on their behalf.
2) Bankers’
Acceptance
Bills of exchange drawn by business concerns on specified
banks.
3) Commercial
Papers
These are promissory notes given by certain well known
business house.
They are issued for period of 3 or 6 months.
4) Treasury Bills These are promissory notes of 90 days maturity issued by the
government.
They don’t carry interest.
5) Sort term
Government Bonds
Short term government bonds are securities issued by the
Government for short periods.
6) Hundi This is unique feature of the indigenous sector of the Indian
Money Market.
They are inland bills of exchange drawn in vernacular
languages.
They can be used either for making payments or for transferring
funds from one place to another.
Bill Market in India – The evolution of the Bill Market in India
A bill market is the market for short term bills, which are generally of 3 months
duration.
Bills are promises to pay a specified amount by a particular company or the
government & may be bought and sold in the bill market.
1) Commercial Bills Companies for production process use bank credit.
Trade credit is used for buying & selling of materials.
2) Commercial Banks Liquid funds
Find short term bills highly attractive for the interest income &
also because of their shift ability to the central bank.
3) Central Bank Controlling & influencing the market the central bank can control
the volume of trade credit available to industry & business.
Origin of the Bill Market
It was developed as an important weapon to influence the money market.
1) There was generally strict financial discipline.
2) The hundi which was the indigenous bill of exchange could not be
converted into proper bill of exchange.
3) The indigenous bankers who specialized in hundi business were unwilling
to convent themselves into discount houses.
4) The bills are not subject to any specified time limit.
5) The stamp duty on such bills was unusually high.
6) RBI was asked to create the bill maker or discount market.
Prospects for the Bill Market in India
3 types of customers who may not be amenable to the bill system of finance.
a) Large customers – Bulk buyers & substantial parties – social concessions
b) Weak parties – finances are always precariously
c) Public sector – Delaying payments on account…
Investment Portfolio Management
3 concepts of Investment…
1) Economic Investment
The term investment refers to net additions to the capital stock
of society.
The term stock includes goods which are used in the production
of other goods.
2) Business
Investment
It refers to the money to be put or held in a private business.
3) Financial
Investment
This refers to putting money into securities, i.e. shares /
debentures, real estate, mortgages, etc.
Investment & Speculation
The dealings in securities with the purpose of getting a fair return on the
investment, is called investment.
The purchase & sale of securities on stock exchange with purpose of making
profits out of price fluctuations is termed as speculation.
The difference between investment & speculation may be as follows
Speculation & Gambling
Gambling represents creation of risk not previously existing.
Speculation involves taking of risks that are implicit in a situation & so must be
taken by someone.
Speculation is taking of risk which appears justified after carefully studying the
pros & cons.
Gambling involves taking risk without adequate study.
Meaning of Investment Portfolio & Investment Portfolio Management
A collection of unrelated assets, but a carefully blended asset combination,
within a unified framework.
Management means utilization of resource in the best possible manner.
Investment Portfolio management – Combination of securities which comprise
the investor’s portfolio in a manner that they give maximum return with
minimum risk.
Any investment can conveniently be divided into 2 groups…
1. Individual Investor
2. Institutional Investor
Individual Investors
Individual investors do not usually have time to research a share / debenture
in depth.
Investment selection becomes almost a hit & run operation for individual
investor.
An average investor may not be able to devote sufficient time.
Institutional Investors
The Institutional investors have both time & resources to dig deeper than the
individual investors.
They can employ skilled economists, financial analysts & investment managers.
The institutional investor can have continuous review & scrutiny of his
investment portfolio.
The institutional investors own a major portion of the corporate securities.
The chief short term credit instruments that are dealt with in a money market…
1) Trade Bills Short term periods of 1/2/3/6 months
Accepted either by the purchasers of goods or by banks or
acceptance houses on their behalf.
2) Bankers’
Acceptance
Bills of exchange drawn by business concerns on specified
banks.
3) Commercial
Papers
These are promissory notes given by certain well known
business house.
They are issued for period of 3 or 6 months.
4) Treasury Bills These are promissory notes of 90 days maturity issued by the
government.
They don’t carry interest.
5) Sort term
Government Bonds
Short term government bonds are securities issued by the
Government for short periods.
6) Hundi This is unique feature of the indigenous sector of the Indian
Money Market.
They are inland bills of exchange drawn in vernacular
languages.
They can be used either for making payments or for transferring
funds from one place to another.
Bill Market in India – The evolution of the Bill Market in India
A bill market is the market for short term bills, which are generally of 3 months
duration.
Bills are promises to pay a specified amount by a particular company or the
government & may be bought and sold in the bill market.
1) Commercial Bills Companies for production process use bank credit.
Trade credit is used for buying & selling of materials.
2) Commercial Banks Liquid funds
Find short term bills highly attractive for the interest income &
also because of their shift ability to the central bank.
3) Central Bank Controlling & influencing the market the central bank can control
the volume of trade credit available to industry & business.
Origin of the Bill Market
It was developed as an important weapon to influence the money market.
1) There was generally strict financial discipline.
2) The hundi which was the indigenous bill of exchange could not be
converted into proper bill of exchange.
3) The indigenous bankers who specialized in hundi business were unwilling
to convent themselves into discount houses.
4) The bills are not subject to any specified time limit.
5) The stamp duty on such bills was unusually high.
6) RBI was asked to create the bill maker or discount market.
Prospects for the Bill Market in India
3 types of customers who may not be amenable to the bill system of finance.
a) Large customers – Bulk buyers & substantial parties – social concessions
b) Weak parties – finances are always precariously
c) Public sector – Delaying payments on account…
Investment Portfolio Management
3 concepts of Investment…
1) Economic Investment
The term investment refers to net additions to the capital stock
of society.
The term stock includes goods which are used in the production
of other goods.
2) Business
Investment
It refers to the money to be put or held in a private business.
3) Financial
Investment
This refers to putting money into securities, i.e. shares /
debentures, real estate, mortgages, etc.
Investment & Speculation
The dealings in securities with the purpose of getting a fair return on the
investment, is called investment.
The purchase & sale of securities on stock exchange with purpose of making
profits out of price fluctuations is termed as speculation.
The difference between investment & speculation may be as follows
Speculation & Gambling
Gambling represents creation of risk not previously existing.
Speculation involves taking of risks that are implicit in a situation & so must be
taken by someone.
Speculation is taking of risk which appears justified after carefully studying the
pros & cons.
Gambling involves taking risk without adequate study.
Meaning of Investment Portfolio & Investment Portfolio Management
A collection of unrelated assets, but a carefully blended asset combination,
within a unified framework.
Management means utilization of resource in the best possible manner.
Investment Portfolio management – Combination of securities which comprise
the investor’s portfolio in a manner that they give maximum return with
minimum risk.
Any investment can conveniently be divided into 2 groups…
1. Individual Investor
2. Institutional Investor
Individual Investors
Individual investors do not usually have time to research a share / debenture
in depth.
Investment selection becomes almost a hit & run operation for individual
investor.
An average investor may not be able to devote sufficient time.
Institutional Investors
The Institutional investors have both time & resources to dig deeper than the
individual investors.
They can employ skilled economists, financial analysts & investment managers.
The institutional investor can have continuous review & scrutiny of his
investment portfolio.
The institutional investors own a major portion of the corporate securities.
Money Market and Capital Market
Characteristics of Money Market…
Liquidity – Quick conversion of money
Minimum transaction cost & no loss in value
The money market provides a reasonable source to those who require short
term funds to meet their requirements at a minimum cost.
The money market is the major mechanism through which the central bank
influences liquidity.
In a money market, funds may be borrowed for periods varying from a day, a
week, 3 to 6 months and against different types of instruments such as bills of
exchange, short term securities, banker’s acceptances, etc called near money.
The short term requirements of borrowers & provides liquidity or cash to the
lenders.
Distinction Between Money Market and Capital Market
Capital market is meant the market for long term funds, while money market is
meant for short term funds.
1) A Money market deals in short term funds, whereas capital market deals in
long term funds.
2) Money Market – Commercial banks
Capital Market – Investment banks
3) Money market – Short term credit instruments
Trade bills / bankers acceptances / Treasury bills / Short term governments
bonds
Capital Market – Long term securities of government & semi government
institutions.
Functions & Significance of Money Market
The basic function of the money market is to provide facilities for adjustment of
liquidity positions of commercial banks, business corporations, non banking
financial institutions & other investor.
The main functions of money markets…….
1) The flow of funds to the most important uses throughout the country.
2) It provides funds to finance production & distribution.
3) It helps to promote economic growth of the money market.
4) The money market constitutes a highly efficient mechanism for credit
control.
5) It enables the business community to economize its use of cash by inducing
it to invest extra funds for short periods.
The significance of the money market is described as …
1) Helps trade & industry.
Provide adequate finance to trade & industry.
2) Channel to non banking financial institutions.
3) Outlets to commercial banks funds.
4) Serves as a good barometer.
5) Development of capital market
The capital market is dependent on the money market.
6) Helps the Central Bank.
7) Capital Formation.
Help in selection of profitable securities.
8) Establishes Equilibrium
Establish equilibrium between demand & supply of money.
9) Public Debt Policy
Dealers in the Money Market
Lenders – Suppliers of short term funds
Central Bank / Commercial Bank / Discount houses / Acceptance houses / Bill
Brokers / Insurance companies / Financial corporations / Business houses
Commercial banks This is the most important suppliers of shot term funds.
Central bank This is the lender of last resort.
Acceptance houses They merely accept commercial bills of exchange
Bill Brokers Provide short term funds to businessmen by purchasing
their bills of exchange
Discount houses
Insurance companies Short term funds by granting the loans
Financial corporations
Borrowers
Government / Semi government institutions / Commercial banks / Industrial &
business concerns / Stock exchange dealers / Farmers & Private individuals.
The Government This is the biggest borrower.
Semi Government Borrow short term funds through the sale of bonds &
debentures.
Commercial banks Raise short term funds from the public by way of deposits.
Call loans
Central Bank In the way of rediscounting of treasury bills & eligible
commercial bills or advances against approved securities.
Rediscounting of treasury bills & eligible commercial bills or
advances against approved securities
Business & Industrial concern
Short term funds from commercial banks & also from non
banking financial institutions for working capital requirements.
Stock exchange
dealers
Secure very short term loans called call loans from commercial
banks for financing their stock exchange transactions.
Farmers Short term funds from commercial banks & agricultural banks.
Private individuals Borrow money from commercial banks for meeting their
household or personal requirements.
Liquidity – Quick conversion of money
Minimum transaction cost & no loss in value
The money market provides a reasonable source to those who require short
term funds to meet their requirements at a minimum cost.
The money market is the major mechanism through which the central bank
influences liquidity.
In a money market, funds may be borrowed for periods varying from a day, a
week, 3 to 6 months and against different types of instruments such as bills of
exchange, short term securities, banker’s acceptances, etc called near money.
The short term requirements of borrowers & provides liquidity or cash to the
lenders.
Distinction Between Money Market and Capital Market
Capital market is meant the market for long term funds, while money market is
meant for short term funds.
1) A Money market deals in short term funds, whereas capital market deals in
long term funds.
2) Money Market – Commercial banks
Capital Market – Investment banks
3) Money market – Short term credit instruments
Trade bills / bankers acceptances / Treasury bills / Short term governments
bonds
Capital Market – Long term securities of government & semi government
institutions.
Functions & Significance of Money Market
The basic function of the money market is to provide facilities for adjustment of
liquidity positions of commercial banks, business corporations, non banking
financial institutions & other investor.
The main functions of money markets…….
1) The flow of funds to the most important uses throughout the country.
2) It provides funds to finance production & distribution.
3) It helps to promote economic growth of the money market.
4) The money market constitutes a highly efficient mechanism for credit
control.
5) It enables the business community to economize its use of cash by inducing
it to invest extra funds for short periods.
The significance of the money market is described as …
1) Helps trade & industry.
Provide adequate finance to trade & industry.
2) Channel to non banking financial institutions.
3) Outlets to commercial banks funds.
4) Serves as a good barometer.
5) Development of capital market
The capital market is dependent on the money market.
6) Helps the Central Bank.
7) Capital Formation.
Help in selection of profitable securities.
8) Establishes Equilibrium
Establish equilibrium between demand & supply of money.
9) Public Debt Policy
Dealers in the Money Market
Lenders – Suppliers of short term funds
Central Bank / Commercial Bank / Discount houses / Acceptance houses / Bill
Brokers / Insurance companies / Financial corporations / Business houses
Commercial banks This is the most important suppliers of shot term funds.
Central bank This is the lender of last resort.
Acceptance houses They merely accept commercial bills of exchange
Bill Brokers Provide short term funds to businessmen by purchasing
their bills of exchange
Discount houses
Insurance companies Short term funds by granting the loans
Financial corporations
Borrowers
Government / Semi government institutions / Commercial banks / Industrial &
business concerns / Stock exchange dealers / Farmers & Private individuals.
The Government This is the biggest borrower.
Semi Government Borrow short term funds through the sale of bonds &
debentures.
Commercial banks Raise short term funds from the public by way of deposits.
Call loans
Central Bank In the way of rediscounting of treasury bills & eligible
commercial bills or advances against approved securities.
Rediscounting of treasury bills & eligible commercial bills or
advances against approved securities
Business & Industrial concern
Short term funds from commercial banks & also from non
banking financial institutions for working capital requirements.
Stock exchange
dealers
Secure very short term loans called call loans from commercial
banks for financing their stock exchange transactions.
Farmers Short term funds from commercial banks & agricultural banks.
Private individuals Borrow money from commercial banks for meeting their
household or personal requirements.
Venture capital in India and Their Guideline
1) IDBI Managing venture scheme established by the union
government in 1986
2) ICICI + UTI Has set up a venture finance company named TDICI
3) Canara Bank Canbank venture capital fund in October 1989
4) The ANZ Grind LaysIndian Investment Funds
Venture funding company having been supportedmainly by NRIs.
Guidelines
(a) The emphasis – new technology to the market.
(b) The project should not have been tried in the market.
(c) VC would get tax concession on capital gains.
(d) Investment deals of the VC must be approved by all India financial
institutions.
(e) The government insists on an early stage financing of project utilizing new
technology.
(f) The entrepreneurs should be relatively new in the market, technically
qualified wit inadequate resources.
IDBI and Venture Capital
a) Encouraging the commercial application of indigenously developed
technology.
b) Adopting imported technology to widen domestic applications.
The VCF would be concerned wit proposals relating to development of
technology from the level of lab or bench scale onwards till the stage where it is
matured for commercial application.
1) Setting up a pilot plant
2) Up scaling of the pilot to the demonstration scale capable of commercial
operations.
3) Technological innovation leading to quality up gradation
4) Adoptions / modifications to imported process administration
5) Cost of studies surveys
Present Scenario
1) VC prefers to finance the project later stage than at the start up stage
2) Lack of government financial support
3) Declining financial support to research & development activities.
4) Complicated procedure of commercializing the know how.
5) Lack of sufficient financial support from pension & provident funds.
6) Restrictions on financial institutions
7) Exemption on income tax
8) New to the market & assumes managerial & technological risks
9) Frequent changes in the policies of SEBI
10) Conservative attitude of the investor in taking the risk of financing
Future Prospects of Venture Capital in India
The central government in its periodical budgets encouraged venture capitalists
by offering fiscal concessions on the dividend & capital gains.
Establishing OTCEI – Over The Counter Exchange of India
Invite foreign investor to invest their funds in this industry
GOI should protect the intellectual property rights
This is essentially needed in biotech innovations
Money Market & Bill Market
Financial assets & credit instruments of different types such as currency /
cheque / Bank deposits / Bills / Bonds
Credit is generally required & supplied on short term / long term basis.
The financial markets are broadly divided into two categories…
(a) Money Market
(b) Capital Market
government in 1986
2) ICICI + UTI Has set up a venture finance company named TDICI
3) Canara Bank Canbank venture capital fund in October 1989
4) The ANZ Grind LaysIndian Investment Funds
Venture funding company having been supportedmainly by NRIs.
Guidelines
(a) The emphasis – new technology to the market.
(b) The project should not have been tried in the market.
(c) VC would get tax concession on capital gains.
(d) Investment deals of the VC must be approved by all India financial
institutions.
(e) The government insists on an early stage financing of project utilizing new
technology.
(f) The entrepreneurs should be relatively new in the market, technically
qualified wit inadequate resources.
IDBI and Venture Capital
a) Encouraging the commercial application of indigenously developed
technology.
b) Adopting imported technology to widen domestic applications.
The VCF would be concerned wit proposals relating to development of
technology from the level of lab or bench scale onwards till the stage where it is
matured for commercial application.
1) Setting up a pilot plant
2) Up scaling of the pilot to the demonstration scale capable of commercial
operations.
3) Technological innovation leading to quality up gradation
4) Adoptions / modifications to imported process administration
5) Cost of studies surveys
Present Scenario
1) VC prefers to finance the project later stage than at the start up stage
2) Lack of government financial support
3) Declining financial support to research & development activities.
4) Complicated procedure of commercializing the know how.
5) Lack of sufficient financial support from pension & provident funds.
6) Restrictions on financial institutions
7) Exemption on income tax
8) New to the market & assumes managerial & technological risks
9) Frequent changes in the policies of SEBI
10) Conservative attitude of the investor in taking the risk of financing
Future Prospects of Venture Capital in India
The central government in its periodical budgets encouraged venture capitalists
by offering fiscal concessions on the dividend & capital gains.
Establishing OTCEI – Over The Counter Exchange of India
Invite foreign investor to invest their funds in this industry
GOI should protect the intellectual property rights
This is essentially needed in biotech innovations
Money Market & Bill Market
Financial assets & credit instruments of different types such as currency /
cheque / Bank deposits / Bills / Bonds
Credit is generally required & supplied on short term / long term basis.
The financial markets are broadly divided into two categories…
(a) Money Market
(b) Capital Market
Characteristic Features and Venture Capital Investment Process
Investments are made in equity in high tech industry & wait for 5 – 7 years to
reap the benefit of capital gains.
Investments are made in innovative projects with new technology.
The claim over the management is decided on the basis of proportion to
investment.
Venture capital investor does not interfere in the day to day business.
Venture capital funds need not be repaid in the course of business units, but it
is realized through the exit route.
Venture Capital Investment Process
1) Establishment of contact between the Entrepreneur and the Venture Capitalist.
Prepare a project report.
5 important feasibility reports…..
Technical / Financial / managerial / Marketing / Socio economic
2) Preliminary Evaluation
3) Detailed Approval
Techno – economic feasibility
4) Sensitivity Analysis
The forecasted results of both sales & profits are tested & analyzed.
The risks & threats are evaluated.
5) Investment in the Project
a) The amount of funds required
b) Profile of the business
c) The life Time technology
d) The possible competition in the business
6) Monitoring the project & post investment support
The venture capitalist role begins with financing the project.
Stages of Venture Capital Financing
1) Early Stage Financing Initiate the new projects
a) Seed Capital Implementation of the research project
Starting from the all initial conceptual stage
1. The technology used – New technology
2. Different aspects of the product life cycle.
3. The total investment required
b) Start up Financing The innovator requires finance to commercialize the
product.
The research must be done to evaluate the probable
opportunities to exploit the market.
c) Second round of financing
This type of financing is required when the project
incurs loss or shows inability to yield sufficient profits.
They should decide on second round financing or may
seek the support of new investors.
2) Later Stage Financing Easy means of assistance.
a) Expansion Finance Executed to expand the market / production / To
establish warehouses
b) Replacement Capital Preferred at the time of public issues.
c) Management Buy Out Management Buy In
The venture capitalist helps the management of a
company to buy or take over the ownership of the
business.
Outsiders prefer to invest in buying the existing
business.
d) Rescue Capital Known as turn around capital
Risky & the investor may ask for major changes in the
management.
Types of Venture Capital Organization
1) Captive Venture Capital Funds
Wholly owned by financial institutions & are operated
as subsidiaries.
IDBI – Captive funds to assist venture capital
TDICI – Funds for venture capital [UTI – ICICI]
RCTC – Funds of UTI & IFCI
2) Independent Venture Capital Funds
Closed ended with minimum capital base & equity
oriented instruments.
The amount invested in the project will be realized
through the exit route.
3) Government Funds Wholly owned by the government
Exit Route of Venture Capital
The main aim of the venture capitalist is to realize the investment with huge
profit after the completion of successful efforts with the promoter in launching or
commercializing the product.
Exit means realization of investment through the issue of equity shares to the
public.
The main aim of venture capitalist is to find exit at maximum profit or if it is
unavoidable, exit with minimum loss.
5 Alternatives to routes of disinvestments practiced in a real life solution…
1) Going Public Prefer to go in for public issues.
Increases the liquidity of the business firm.
Opportunity for the company to list its shares in the
stock market.
It has to observe several legal formalities of stock
exchange.
They have to be accountable to all the organs of the
society.
2) Sale of Shares to Entrepreneur
An Entrepreneur himself prefers to buy the entire
shares with the help of his won group – even
employees.
3) Sale of a company to another company
Venture capitalist & the entrepreneur may agree to sell
the business unit to some other company.
Sale will be made on the basis of level of operations &
the nature of venture.
4) Finding a new investor Investor may decide to sell the unit to another new
investor.
5) Liquidation This is a lender of last resort.
When a firm performs very badly…
Cash loss over the years, the venture capitalist & the
entrepreneur decides to close down the operations.
reap the benefit of capital gains.
Investments are made in innovative projects with new technology.
The claim over the management is decided on the basis of proportion to
investment.
Venture capital investor does not interfere in the day to day business.
Venture capital funds need not be repaid in the course of business units, but it
is realized through the exit route.
Venture Capital Investment Process
1) Establishment of contact between the Entrepreneur and the Venture Capitalist.
Prepare a project report.
5 important feasibility reports…..
Technical / Financial / managerial / Marketing / Socio economic
2) Preliminary Evaluation
3) Detailed Approval
Techno – economic feasibility
4) Sensitivity Analysis
The forecasted results of both sales & profits are tested & analyzed.
The risks & threats are evaluated.
5) Investment in the Project
a) The amount of funds required
b) Profile of the business
c) The life Time technology
d) The possible competition in the business
6) Monitoring the project & post investment support
The venture capitalist role begins with financing the project.
Stages of Venture Capital Financing
1) Early Stage Financing Initiate the new projects
a) Seed Capital Implementation of the research project
Starting from the all initial conceptual stage
1. The technology used – New technology
2. Different aspects of the product life cycle.
3. The total investment required
b) Start up Financing The innovator requires finance to commercialize the
product.
The research must be done to evaluate the probable
opportunities to exploit the market.
c) Second round of financing
This type of financing is required when the project
incurs loss or shows inability to yield sufficient profits.
They should decide on second round financing or may
seek the support of new investors.
2) Later Stage Financing Easy means of assistance.
a) Expansion Finance Executed to expand the market / production / To
establish warehouses
b) Replacement Capital Preferred at the time of public issues.
c) Management Buy Out Management Buy In
The venture capitalist helps the management of a
company to buy or take over the ownership of the
business.
Outsiders prefer to invest in buying the existing
business.
d) Rescue Capital Known as turn around capital
Risky & the investor may ask for major changes in the
management.
Types of Venture Capital Organization
1) Captive Venture Capital Funds
Wholly owned by financial institutions & are operated
as subsidiaries.
IDBI – Captive funds to assist venture capital
TDICI – Funds for venture capital [UTI – ICICI]
RCTC – Funds of UTI & IFCI
2) Independent Venture Capital Funds
Closed ended with minimum capital base & equity
oriented instruments.
The amount invested in the project will be realized
through the exit route.
3) Government Funds Wholly owned by the government
Exit Route of Venture Capital
The main aim of the venture capitalist is to realize the investment with huge
profit after the completion of successful efforts with the promoter in launching or
commercializing the product.
Exit means realization of investment through the issue of equity shares to the
public.
The main aim of venture capitalist is to find exit at maximum profit or if it is
unavoidable, exit with minimum loss.
5 Alternatives to routes of disinvestments practiced in a real life solution…
1) Going Public Prefer to go in for public issues.
Increases the liquidity of the business firm.
Opportunity for the company to list its shares in the
stock market.
It has to observe several legal formalities of stock
exchange.
They have to be accountable to all the organs of the
society.
2) Sale of Shares to Entrepreneur
An Entrepreneur himself prefers to buy the entire
shares with the help of his won group – even
employees.
3) Sale of a company to another company
Venture capitalist & the entrepreneur may agree to sell
the business unit to some other company.
Sale will be made on the basis of level of operations &
the nature of venture.
4) Finding a new investor Investor may decide to sell the unit to another new
investor.
5) Liquidation This is a lender of last resort.
When a firm performs very badly…
Cash loss over the years, the venture capitalist & the
entrepreneur decides to close down the operations.
Value Analysis Vs Work Study and Corporate Tax Planning
J.H.Westing, I.V.Fine & Joseph Zenz have recommend certain techniques
which include….
1) Design analysis
2) The preparation of a detailed checklist
3) A study of other manufacturers cost reduction efforts
4) Brain storming or hitch hiking
5) Price analysis & supplier assistance
Alan Fields holds opinion that an investigation of value analysis precedes 5
Stages…
1) The information stage Complete background information
2) The speculation stage Basic & secondary functions are presented
3) The investigation stage Proposals are passed for the production or
purchasing department
4) The recommendation stage Value analyzed alternative is put into production
5) The implementation stage Ensure that the proposal is put into production
Value Analysis Vs Work Study
Value analysis primarily aims at controlling materials cost & sometimes, as a
consequence may affect labor costs & overheads while work study aims just at
labor cost.
Value analysis overs the
Value Analysis – A Fresh Look
3 approaches to the practice of value analysis.
1) Committee arrangement with co-ordination to direct team efforts.
2) Operating personnel
3) Value analysis, awareness & appreciation in the existing organization
structure.
Corporate Tax Planning
The major success to economic stability is gained only by industrial activities
which may be small scale, medium & large scale.
When the corporate make use of facilities, resources & infrastructure of the
nation, it’s the basic obligation of the corporation to contribute to the revenue of
the government.
The revenues may be collected in different forms, …
Sales tax, central sales tax, excise, customs & income tax
The income tax levied under Income Tax Act, 1961 is known as Corporate Tax.
Tax planning helps the corporate to gain more profit.
Tax Planning – Tax Evasion – Tax Avoidance
Tax Planning - Tax saving device under legal framework.
Corporate will take advantage of the…
1) Exemptions
2) Deductions
3) Rebate
4) Relief & other tax concessions allowed by taxing status leading to the
reduction of tax liability of the tax payer.
Tax Evasion Illegally hiding income or concealing the particulars of income or
manipulating the accounts so as to inflate the expenditure & other
outgoing with a view to illegally reduce the burden of the tax.
Tax Avoidance Refer to dodging the payment of the taxes without breaking the law.
A corporate dodges the payment of income tax within the legal
framework, it amounts to tax avoidance.
Tax Planning Tax saving device under legal framework.
Objects of Tax Planning
1) To reduce the burden of paying high percentage of tax
2) To take advantage of the exemptions, deductions, rebates, relieves & other
tax concessions
3) To avoid unwarranted addition to trading account as account of low gross
profit
4) To avoid worries & tensions
Some important Tax Planning Techniques Practiced by the corporate
Venture Capital
It is considered as life blood of economic activities.
FARA Act, 1973
It is defined as long term funds in equity or semi equity form to finance hi-tech
projects involving high risk & yet having strong potential of high profitability.
Venture capital refers to capital investment made in a business or industrial
enterprise.
Capital investment may assume the form of either equity or debt or both as
derivative instrument.
The investment made in the form of equity – Prime objective being Capital gain
Equity investment enables the investor to convert the investment into cash
when required.
The 1995 Finance bill, defined Venture Capital as long term equity investment
in novel technology based projects with display potential for significant growth
and financial returns.
Venture capital implies an investment in the form of equity for high risk projects
with the expectation of higher returns.
which include….
1) Design analysis
2) The preparation of a detailed checklist
3) A study of other manufacturers cost reduction efforts
4) Brain storming or hitch hiking
5) Price analysis & supplier assistance
Alan Fields holds opinion that an investigation of value analysis precedes 5
Stages…
1) The information stage Complete background information
2) The speculation stage Basic & secondary functions are presented
3) The investigation stage Proposals are passed for the production or
purchasing department
4) The recommendation stage Value analyzed alternative is put into production
5) The implementation stage Ensure that the proposal is put into production
Value Analysis Vs Work Study
Value analysis primarily aims at controlling materials cost & sometimes, as a
consequence may affect labor costs & overheads while work study aims just at
labor cost.
Value analysis overs the
Value Analysis – A Fresh Look
3 approaches to the practice of value analysis.
1) Committee arrangement with co-ordination to direct team efforts.
2) Operating personnel
3) Value analysis, awareness & appreciation in the existing organization
structure.
Corporate Tax Planning
The major success to economic stability is gained only by industrial activities
which may be small scale, medium & large scale.
When the corporate make use of facilities, resources & infrastructure of the
nation, it’s the basic obligation of the corporation to contribute to the revenue of
the government.
The revenues may be collected in different forms, …
Sales tax, central sales tax, excise, customs & income tax
The income tax levied under Income Tax Act, 1961 is known as Corporate Tax.
Tax planning helps the corporate to gain more profit.
Tax Planning – Tax Evasion – Tax Avoidance
Tax Planning - Tax saving device under legal framework.
Corporate will take advantage of the…
1) Exemptions
2) Deductions
3) Rebate
4) Relief & other tax concessions allowed by taxing status leading to the
reduction of tax liability of the tax payer.
Tax Evasion Illegally hiding income or concealing the particulars of income or
manipulating the accounts so as to inflate the expenditure & other
outgoing with a view to illegally reduce the burden of the tax.
Tax Avoidance Refer to dodging the payment of the taxes without breaking the law.
A corporate dodges the payment of income tax within the legal
framework, it amounts to tax avoidance.
Tax Planning Tax saving device under legal framework.
Objects of Tax Planning
1) To reduce the burden of paying high percentage of tax
2) To take advantage of the exemptions, deductions, rebates, relieves & other
tax concessions
3) To avoid unwarranted addition to trading account as account of low gross
profit
4) To avoid worries & tensions
Some important Tax Planning Techniques Practiced by the corporate
Venture Capital
It is considered as life blood of economic activities.
FARA Act, 1973
It is defined as long term funds in equity or semi equity form to finance hi-tech
projects involving high risk & yet having strong potential of high profitability.
Venture capital refers to capital investment made in a business or industrial
enterprise.
Capital investment may assume the form of either equity or debt or both as
derivative instrument.
The investment made in the form of equity – Prime objective being Capital gain
Equity investment enables the investor to convert the investment into cash
when required.
The 1995 Finance bill, defined Venture Capital as long term equity investment
in novel technology based projects with display potential for significant growth
and financial returns.
Venture capital implies an investment in the form of equity for high risk projects
with the expectation of higher returns.
Meaning of Value Analysis and Value Engineering
Any attempt at saving cost Cut back on cost without having to sacrifice quality or disturb the marketing situation.
One must give value for money & that the manufacturer must ensure that he is
in turn gets value for money at all the stages of his manufacturing operations.
Value engineering or value analysis means that everything you make or buy
serves a purpose.
Value Analysis – Cost saving device.
Value analysis or value engineering is an effective cost reduction technique.
An industrial buyer is competent to generate profits depends on his information,
analytical capacity & negotiating ability.
Value analysis is a part of purchasing activity.
Value analysis is typical of the systematic comparison & analytical approach
which enables a firm to get value for money with its purchases.
Value analysis ensures cost reduction through a careful study.
Value analysis seeks to cut down unnecessary material costs which are built
into manufactured articles or services.
Value Analysis & Value Engineering
Value engineering is considered as cost avoidance.
Value analysis as cost reduction.
Value engineering refers to what engineers do.
Value analysis is to what the purchasing department does.
Value engineering is reserved for cost prevention exercise. It’s the application
of the value analysis technique.
Objective of Value Analysis
To reduce cost by closely approximating all the features of the design making it
suitable to the needs of the product & the economy of the purchasing
manufacturing distribution cycle.
1) Modification of the design or material specification
2) New sources of supply
3) Elimination or combination of components
4) Use of more efficient processes
5) Standardization & rationalization of dimensional tolerances & finishes
The Use value Determined by the properties which, perform a particular service
or work.
The Esteem value By features of the article
The Cost value By the monetary sum of labor, materials, overheads & any other
source
The Exchangevalue
The price a purchaser offers for the product & total of the esteem
& use values Profit The difference between the cost value & exchange value is profit.
The Functional Value
This pertains to an evaluation of the specifications, qualification or
design of a resource against background of what is required to be
achieved through that particular resource.
The utilization value
This determines the extent to which an effective use is made of
the specified resources.
Steps in Conducting Value Analysis
1) Select the product to be analyzed.
2) Obtain the cost of the product.
3) Record the number of components.
4) Record all the functions.
5) Record the number of required components, currently & in the foreseeable
future.
6) Determine the primary function.
One must give value for money & that the manufacturer must ensure that he is
in turn gets value for money at all the stages of his manufacturing operations.
Value engineering or value analysis means that everything you make or buy
serves a purpose.
Value Analysis – Cost saving device.
Value analysis or value engineering is an effective cost reduction technique.
An industrial buyer is competent to generate profits depends on his information,
analytical capacity & negotiating ability.
Value analysis is a part of purchasing activity.
Value analysis is typical of the systematic comparison & analytical approach
which enables a firm to get value for money with its purchases.
Value analysis ensures cost reduction through a careful study.
Value analysis seeks to cut down unnecessary material costs which are built
into manufactured articles or services.
Value Analysis & Value Engineering
Value engineering is considered as cost avoidance.
Value analysis as cost reduction.
Value engineering refers to what engineers do.
Value analysis is to what the purchasing department does.
Value engineering is reserved for cost prevention exercise. It’s the application
of the value analysis technique.
Objective of Value Analysis
To reduce cost by closely approximating all the features of the design making it
suitable to the needs of the product & the economy of the purchasing
manufacturing distribution cycle.
1) Modification of the design or material specification
2) New sources of supply
3) Elimination or combination of components
4) Use of more efficient processes
5) Standardization & rationalization of dimensional tolerances & finishes
The Use value Determined by the properties which, perform a particular service
or work.
The Esteem value By features of the article
The Cost value By the monetary sum of labor, materials, overheads & any other
source
The Exchangevalue
The price a purchaser offers for the product & total of the esteem
& use values Profit The difference between the cost value & exchange value is profit.
The Functional Value
This pertains to an evaluation of the specifications, qualification or
design of a resource against background of what is required to be
achieved through that particular resource.
The utilization value
This determines the extent to which an effective use is made of
the specified resources.
Steps in Conducting Value Analysis
1) Select the product to be analyzed.
2) Obtain the cost of the product.
3) Record the number of components.
4) Record all the functions.
5) Record the number of required components, currently & in the foreseeable
future.
6) Determine the primary function.
Friday, December 21, 2007
Non Commercial OR Policy Risk consist of …
Non Commercial OR Policy Risk consist of …
1. Project
a. Specific Policy risks arising from expropriation
b. Changes in the regulatory regime
c. The failure of the government or its public enterprises to meet
contractual obligations
2. Political from events such as war or civil disturbance
Staged Approach to Risk
Most projects consists of three main phases
1 Development Risk – Very High
Only equity capital from the main sponsor is generally used
2 Construction &
start up
Risk – high
Large volumes of finances are required
Typically in a mixture of equity, senior debt, subordinated debt
& guarantees
3 Operation Risk – Generally lower
It may be possible to refinance senior bank debt in the capital
markets with cheaper less restrictive bonds
Importance of construction risk…
In the construction phase, the major risk is that construction will not be
complete on time or will not meet the specifications set for the project.
Long delays in construction may raise costs of a project significantly &
erode it financial viability.
A project may fail to reach completion for any of a number of reasons
ranging from…
Technical design flows Financial problems
Difficulties with sponsor management Changes in government regulation
Project companies hedge construction risk primarily by using…
1. Fixed price
2. Certain date construction contracts – including turnkey contracts
3. With built I provisions for liquidated damages if the contractor fails to
perform
4. Bonuses for better than expected performance
5. Business start up & other kinds of standard insurance
6. Include a construction contingency in the total cost of the project
7. Build in some excess capacity to allow for technical failures that may
prevent the project from reaching the required capacity.
Typically, creditors & investors are interested in both the physical &
financial aspects of project completion.
Project completion & financial completion
Project completion is defined as the project’s ability to sustain production
at a certain capacity for a specified period of time.
It may be one month or one quarter of the operating year.
Financial completion is defined as the project’s ability to produce below
a certain unit cost for a specified period of time.
Cost Overruns
The most common threat to physical completion is cost overruns.
If costs significantly exceed the initial financing plan, they will affect the
project’s financial rate of return & if they cannot be financed, may even
lead those involved abandon the project.
Market risk & its mitigation
Off take agreement
An off take agreement obliges the off taker to purchase all part of the
product’s output.
Few examples…
o Agreement to buy up to a certain amount per year at the prevailing
market price
o Buy enough to ensure debt payment
o Buy enough to provide foreign exchange for debt services or to reduce
foreign exchange risk
Some instruments of mitigating market risk are…
1. Power purchase agreement (PPA)
2. Call and put options
3. Forward sales & purchase contracts
Power Purchase Agreement (PPA)
A Power purchase agreement is a form of off take agreement commonly
used in power projects in emerging markets.
A PPA specifies the power purchasing price or the method of arriving at it.
Call & Put Options
A Put option gives a project company the option to sell its output at a
fixed price at some point in the future.
A call option would allow the project company to buy its input at a fixed
price in the future.
Forward sales & purchase contracts
Forward sales & purchase contracts provide another means of hedging
product price risk.
A project may wish to enter into a forward purchase contracts to stabilize
the price of a key raw material.
Other Risks & their Mitigation
Mitigation of some other forms of risks…
1. Management, Technical or maintenance risk
2. Economic risks
3. Environment risks
4. Political risks.
1. Project
a. Specific Policy risks arising from expropriation
b. Changes in the regulatory regime
c. The failure of the government or its public enterprises to meet
contractual obligations
2. Political from events such as war or civil disturbance
Staged Approach to Risk
Most projects consists of three main phases
1 Development Risk – Very High
Only equity capital from the main sponsor is generally used
2 Construction &
start up
Risk – high
Large volumes of finances are required
Typically in a mixture of equity, senior debt, subordinated debt
& guarantees
3 Operation Risk – Generally lower
It may be possible to refinance senior bank debt in the capital
markets with cheaper less restrictive bonds
Importance of construction risk…
In the construction phase, the major risk is that construction will not be
complete on time or will not meet the specifications set for the project.
Long delays in construction may raise costs of a project significantly &
erode it financial viability.
A project may fail to reach completion for any of a number of reasons
ranging from…
Technical design flows Financial problems
Difficulties with sponsor management Changes in government regulation
Project companies hedge construction risk primarily by using…
1. Fixed price
2. Certain date construction contracts – including turnkey contracts
3. With built I provisions for liquidated damages if the contractor fails to
perform
4. Bonuses for better than expected performance
5. Business start up & other kinds of standard insurance
6. Include a construction contingency in the total cost of the project
7. Build in some excess capacity to allow for technical failures that may
prevent the project from reaching the required capacity.
Typically, creditors & investors are interested in both the physical &
financial aspects of project completion.
Project completion & financial completion
Project completion is defined as the project’s ability to sustain production
at a certain capacity for a specified period of time.
It may be one month or one quarter of the operating year.
Financial completion is defined as the project’s ability to produce below
a certain unit cost for a specified period of time.
Cost Overruns
The most common threat to physical completion is cost overruns.
If costs significantly exceed the initial financing plan, they will affect the
project’s financial rate of return & if they cannot be financed, may even
lead those involved abandon the project.
Market risk & its mitigation
Off take agreement
An off take agreement obliges the off taker to purchase all part of the
product’s output.
Few examples…
o Agreement to buy up to a certain amount per year at the prevailing
market price
o Buy enough to ensure debt payment
o Buy enough to provide foreign exchange for debt services or to reduce
foreign exchange risk
Some instruments of mitigating market risk are…
1. Power purchase agreement (PPA)
2. Call and put options
3. Forward sales & purchase contracts
Power Purchase Agreement (PPA)
A Power purchase agreement is a form of off take agreement commonly
used in power projects in emerging markets.
A PPA specifies the power purchasing price or the method of arriving at it.
Call & Put Options
A Put option gives a project company the option to sell its output at a
fixed price at some point in the future.
A call option would allow the project company to buy its input at a fixed
price in the future.
Forward sales & purchase contracts
Forward sales & purchase contracts provide another means of hedging
product price risk.
A project may wish to enter into a forward purchase contracts to stabilize
the price of a key raw material.
Other Risks & their Mitigation
Mitigation of some other forms of risks…
1. Management, Technical or maintenance risk
2. Economic risks
3. Environment risks
4. Political risks.
Risk Profile of Infrastructure Projects
Risk Profile of Infrastructure Projects
At the heart of project financing is a contract that allocates risks
associated with a project & defines the claims on rewards.
Four kinds of risks can be distinguished …
1. Currency
2. Commercial
3. Policy induced
4. Country
Currency risk
The risk of currency depreciation falls on the project sponsor, & ultimately
on the consumers of the service.
Service prices have been linked to an international currency.
Commercial or Market Risk
Two types of commercial risk may be distinguished…
1. Relating to costs of production
2. Arising from uncertainties in demand for services
Contracts include bonuses for early commissioning of the project &
penalties for late completion.
A fixed payment for overall capacity also shifts the risks of cost overruns
to the private sponsor.
A power or water supplier is sometimes penalized for capacity availability
below pre specified levels or the contract may require that a plant be
available in effective working order for a specified period of time.
Project sponsors are able to transfer some of these risks to other private
parties.
To transfer construction risk to specialized construction companies
through turnkey contracts.
Sector specific market risk bearing features are…
1 In telecommunications
projects
The market risk is typically borne by the sponsor.
2 In electric power &
water sectors
Limitations on assumption of market risk arise because
payments to cover costs are not assured.
Governments need to decisively eliminate the prospect
that investor will be bailed out if circumstances are
unfavorable.
3 In transportation
Project
Mexican toll roads & certain Argentine rail concessions
Governments permitted revisions in contract terms
when traffic levels were lower than expected
Private investors may wish to insure themselves against commercial risks.
The private market for risk insurance for international transactions is
small. While short term insurance for trade credit is available, private
insurance for infrastructure projects is uncommon.
Sector policy induced Market risk
The instrument that protects the power supplier is the "Take or Pay"
contract, or power purchase agreement.
Under such a contract, the buyer agrees to pay a specified amount
regardless of whether the service is used.
The government thus provides a contract compliance guarantee – a useful
transitional measure while the long term goal of sector reform is being
addressed.
At the heart of project financing is a contract that allocates risks
associated with a project & defines the claims on rewards.
Four kinds of risks can be distinguished …
1. Currency
2. Commercial
3. Policy induced
4. Country
Currency risk
The risk of currency depreciation falls on the project sponsor, & ultimately
on the consumers of the service.
Service prices have been linked to an international currency.
Commercial or Market Risk
Two types of commercial risk may be distinguished…
1. Relating to costs of production
2. Arising from uncertainties in demand for services
Contracts include bonuses for early commissioning of the project &
penalties for late completion.
A fixed payment for overall capacity also shifts the risks of cost overruns
to the private sponsor.
A power or water supplier is sometimes penalized for capacity availability
below pre specified levels or the contract may require that a plant be
available in effective working order for a specified period of time.
Project sponsors are able to transfer some of these risks to other private
parties.
To transfer construction risk to specialized construction companies
through turnkey contracts.
Sector specific market risk bearing features are…
1 In telecommunications
projects
The market risk is typically borne by the sponsor.
2 In electric power &
water sectors
Limitations on assumption of market risk arise because
payments to cover costs are not assured.
Governments need to decisively eliminate the prospect
that investor will be bailed out if circumstances are
unfavorable.
3 In transportation
Project
Mexican toll roads & certain Argentine rail concessions
Governments permitted revisions in contract terms
when traffic levels were lower than expected
Private investors may wish to insure themselves against commercial risks.
The private market for risk insurance for international transactions is
small. While short term insurance for trade credit is available, private
insurance for infrastructure projects is uncommon.
Sector policy induced Market risk
The instrument that protects the power supplier is the "Take or Pay"
contract, or power purchase agreement.
Under such a contract, the buyer agrees to pay a specified amount
regardless of whether the service is used.
The government thus provides a contract compliance guarantee – a useful
transitional measure while the long term goal of sector reform is being
addressed.
Bond Markets
Bond Markets
Bonds can attract to infrastructure financing a whole new class of
investors, such as pension funds and insurance companies seeking long
term, stable returns.
In developing countries, the use of bond financing is in its early stages.
Revenue bonds – used for Greenfield projects & paid back from the
project’s revenues – are now in infrastructure finance in developing
countries.
They have been used to help toll roads in Mexico & the Subic Bay Power
Station in the Philippines.
Corporate or municipal bonds, based on the credit of a company or
government authority, have been used by infrastructure entities.
In industrial countries, bond financing is widely used to raise funds for
municipal infrastructure.
Contractual Savings
Contractual savings institutions, such as pension funds and life insurance
companies, are particularly suited to making long term investments.
These institution levy fixed premiums, have stead and predictable cash
inflows, and incur long term liabilities, making them ideal suppliers of term
finance for infrastructure projects.
Chile has used its pension fund system to promote the privatization of
public utilities, including the Santiago subway system.
The social security system assumes only the bank risk.
Government sponsored pension funds have often suffered from
mismanagement & misuse.
Chilean regulations stipulate maximum investment limits by instrument &
by issue although with increasing experience.
The Chilean model of privately managed but publicly mandated and
regulated pension funds is being adopted more widely in Latin America.
Prospects
Where domestic capital markets are not well developed & financial
intermediaries are weak, the only other option may be to strengthen
specialized infrastructure finance institutions.
Risk Profile of Infrastructure Projects
The three broad stages in an infrastructure project with different risk
profiles & financing requirements may be identified as follows…
1 Development Risk The initial very high risk phase
Only equity capital can be used for financing
2 Construction Risk The next high risk phase
Cost & time spillovers tend to distort the future revenue
generation & profitability prospects of the project.
This phase may be financed by a combination of equity &
debt with guarantees.
3 Operating Risk Risk emerges due to underestimation of operating costs &
occasionally an overestimation of the output from the
proposed infrastructure facility.
Relative low risk & may be financed through bond issues
The Phases of Operating Risk …
1 The introductory
operation phase
The revenue stream is thin & operational bottlenecks
hinder achievement of high capacity utilization
2 The project
stabilization phase
Risks reduce considerably & revenues are more steady &
predictable
Other Risks…
1 Demand Risk Result of an overestimation of the demand & willingness to
pay for the proposed infrastructure facility
Mexico the demand for the facility is high but inadequate
willingness to pay
2 Financial Risk Foreign Exchange & Interest rate risks
Costs & revenues in the local currency
3 Market Risk Important when consumers can choose alternative service
such as with toll roads, railways, & even ports
The government absorbs this risk explicitly or by default
4 Political Risk Inadequate clarity in government policies & selection
procedures has made political risk the fulcrum of
infrastructure development
Bonds can attract to infrastructure financing a whole new class of
investors, such as pension funds and insurance companies seeking long
term, stable returns.
In developing countries, the use of bond financing is in its early stages.
Revenue bonds – used for Greenfield projects & paid back from the
project’s revenues – are now in infrastructure finance in developing
countries.
They have been used to help toll roads in Mexico & the Subic Bay Power
Station in the Philippines.
Corporate or municipal bonds, based on the credit of a company or
government authority, have been used by infrastructure entities.
In industrial countries, bond financing is widely used to raise funds for
municipal infrastructure.
Contractual Savings
Contractual savings institutions, such as pension funds and life insurance
companies, are particularly suited to making long term investments.
These institution levy fixed premiums, have stead and predictable cash
inflows, and incur long term liabilities, making them ideal suppliers of term
finance for infrastructure projects.
Chile has used its pension fund system to promote the privatization of
public utilities, including the Santiago subway system.
The social security system assumes only the bank risk.
Government sponsored pension funds have often suffered from
mismanagement & misuse.
Chilean regulations stipulate maximum investment limits by instrument &
by issue although with increasing experience.
The Chilean model of privately managed but publicly mandated and
regulated pension funds is being adopted more widely in Latin America.
Prospects
Where domestic capital markets are not well developed & financial
intermediaries are weak, the only other option may be to strengthen
specialized infrastructure finance institutions.
Risk Profile of Infrastructure Projects
The three broad stages in an infrastructure project with different risk
profiles & financing requirements may be identified as follows…
1 Development Risk The initial very high risk phase
Only equity capital can be used for financing
2 Construction Risk The next high risk phase
Cost & time spillovers tend to distort the future revenue
generation & profitability prospects of the project.
This phase may be financed by a combination of equity &
debt with guarantees.
3 Operating Risk Risk emerges due to underestimation of operating costs &
occasionally an overestimation of the output from the
proposed infrastructure facility.
Relative low risk & may be financed through bond issues
The Phases of Operating Risk …
1 The introductory
operation phase
The revenue stream is thin & operational bottlenecks
hinder achievement of high capacity utilization
2 The project
stabilization phase
Risks reduce considerably & revenues are more steady &
predictable
Other Risks…
1 Demand Risk Result of an overestimation of the demand & willingness to
pay for the proposed infrastructure facility
Mexico the demand for the facility is high but inadequate
willingness to pay
2 Financial Risk Foreign Exchange & Interest rate risks
Costs & revenues in the local currency
3 Market Risk Important when consumers can choose alternative service
such as with toll roads, railways, & even ports
The government absorbs this risk explicitly or by default
4 Political Risk Inadequate clarity in government policies & selection
procedures has made political risk the fulcrum of
infrastructure development
Infrastructure development Banks
Infrastructure development Banks
Specialized infrastructure development banks have suffered from all the
negative features associated with government ownership, such as
1. Inefficient targeting
2. Subsidization of lending
3. Interference in operations
4. Corruption
Japan – Postal Savings have constituted the primary source of long term
funds used by such institutions as the Japan Development Bank (JDB).
In Europe – Municipal banks obtaining their resources from contractual
savings institutions & other long term sources have generally performed
well where local governments have had operational independence.
Few municipal banks n developing countries have shown a capacity for
sustained investment, largely because of under capitalization, poor
financial discipline & substantial arrears.
Exceptions include a facility in Colombia that rediscounts lending by
commercial banks to municipal infrastructure projects.
Morocco – reformed FEC – Fond d’ Equipment Communal – An agency
established in 1959 to fund municipal investments.
Specialized infrastructure bank, BANOBRAS in Mexico – Privatization of
municipal infrastructure. BANOBRAS is playing an important role in
facilitating private water & sewage projects by guaranteeing that
municipalities will pay for services provided. BANOBRAS is working to
strengthen municipal finances by demanding better operational & financial
performance as a condition for its support.
BANOBRAS provides short term loans for public works against
contractors’ receivables from the government agency sponsoring a
project. It also operates a special fund that can provide up to 25 % of the
full cost of a project to finance the start up costs of construction.
New Infrastructure
Two types of infrastructure funds have emerged in recent years.
1. Government sponsored infrastructure development funds are designed
as transitional mechanisms to provide long term finance until markets
are better developed.
2. Private funds, of which there are a growing number, serve the
commercially useful function of diversifying investor risk. As transitional
mechanisms, these funds serve two purposes.
a) They allow the leveraging of government resources or official
development assistance by attracting co-financing from private
sources.
b) They can also create credit histories for borrowers perceived as
risky. In time, these borrowers can secure direct access to
capital markets.
The Private Sector Energy Development fund in Pakistan & Private Sector
energy Fund in Jamaica is designed to catalyze private financing for
power projects.
The Jamaican government makes long term financing available through
the Energy Fund as a means of attracting private investments.
Thai Guaranty Facility for financing environmental infrastructure. It will
guarantee private loans to municipalities & private operators.
The Regional Development Account (RDA) in Indonesia is a transitional
credit system designed to shift financing of infrastructure projects from
governments grants to debt instruments. The RDA lends at near market
rates. The goal is to give local authorities three to five years to establish
measures for cost recovery and to demonstrate adequate financial
management.
Pension fund with little interest in investing directly in a toll road in Mexico
might be interested in participating in a fund that invests in a portfolio of
toll roads.
Privatization
Aggregate proceeds from infrastructure privatization have been highest in
Latin America, with the most activity being in telecommunications.
Some Asian Countries, such as Malaysia & Korea, have opted for partial
privatization.
Outside Latin America & America – Privatization has so far had a limited
impact.
The two Argentine telephone companies constitute almost 40 % of the
market capitalization in Buenos Aires & Telmex dominates in Mexico with
a 20 % share.
The large capitalizations have attracted financing from pension funds,
creating the basis for long term capital flows in to the capital market.
Argentine government used a debt equity swap mechanism in the
privatization of ENTel, bringing in caps proceeds of around $ 2.2 billion
and reducing its commercial bank debt.
Specialized infrastructure development banks have suffered from all the
negative features associated with government ownership, such as
1. Inefficient targeting
2. Subsidization of lending
3. Interference in operations
4. Corruption
Japan – Postal Savings have constituted the primary source of long term
funds used by such institutions as the Japan Development Bank (JDB).
In Europe – Municipal banks obtaining their resources from contractual
savings institutions & other long term sources have generally performed
well where local governments have had operational independence.
Few municipal banks n developing countries have shown a capacity for
sustained investment, largely because of under capitalization, poor
financial discipline & substantial arrears.
Exceptions include a facility in Colombia that rediscounts lending by
commercial banks to municipal infrastructure projects.
Morocco – reformed FEC – Fond d’ Equipment Communal – An agency
established in 1959 to fund municipal investments.
Specialized infrastructure bank, BANOBRAS in Mexico – Privatization of
municipal infrastructure. BANOBRAS is playing an important role in
facilitating private water & sewage projects by guaranteeing that
municipalities will pay for services provided. BANOBRAS is working to
strengthen municipal finances by demanding better operational & financial
performance as a condition for its support.
BANOBRAS provides short term loans for public works against
contractors’ receivables from the government agency sponsoring a
project. It also operates a special fund that can provide up to 25 % of the
full cost of a project to finance the start up costs of construction.
New Infrastructure
Two types of infrastructure funds have emerged in recent years.
1. Government sponsored infrastructure development funds are designed
as transitional mechanisms to provide long term finance until markets
are better developed.
2. Private funds, of which there are a growing number, serve the
commercially useful function of diversifying investor risk. As transitional
mechanisms, these funds serve two purposes.
a) They allow the leveraging of government resources or official
development assistance by attracting co-financing from private
sources.
b) They can also create credit histories for borrowers perceived as
risky. In time, these borrowers can secure direct access to
capital markets.
The Private Sector Energy Development fund in Pakistan & Private Sector
energy Fund in Jamaica is designed to catalyze private financing for
power projects.
The Jamaican government makes long term financing available through
the Energy Fund as a means of attracting private investments.
Thai Guaranty Facility for financing environmental infrastructure. It will
guarantee private loans to municipalities & private operators.
The Regional Development Account (RDA) in Indonesia is a transitional
credit system designed to shift financing of infrastructure projects from
governments grants to debt instruments. The RDA lends at near market
rates. The goal is to give local authorities three to five years to establish
measures for cost recovery and to demonstrate adequate financial
management.
Pension fund with little interest in investing directly in a toll road in Mexico
might be interested in participating in a fund that invests in a portfolio of
toll roads.
Privatization
Aggregate proceeds from infrastructure privatization have been highest in
Latin America, with the most activity being in telecommunications.
Some Asian Countries, such as Malaysia & Korea, have opted for partial
privatization.
Outside Latin America & America – Privatization has so far had a limited
impact.
The two Argentine telephone companies constitute almost 40 % of the
market capitalization in Buenos Aires & Telmex dominates in Mexico with
a 20 % share.
The large capitalizations have attracted financing from pension funds,
creating the basis for long term capital flows in to the capital market.
Argentine government used a debt equity swap mechanism in the
privatization of ENTel, bringing in caps proceeds of around $ 2.2 billion
and reducing its commercial bank debt.
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