IGNOU MBA MS- 46 Free Solved Assignments 2010

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IGNOU MBA MS- 46 Free Solved Assignments 2010

MS- 46: Management of Financial Services

ASSIGNMENT 2010

Course Code : MS-46Course Title : Management of Financial Services Assignment Code : 46/TMA/SEM-II/2010Coverage : All Blocks

Attempt All the Questions.

1. List & explain the nature of risk associated with financial services companies.

Solution: When we think of large risks, we often think in terms of natural hazards such as hurricanes, earthquakes, or tornados. Perhaps man-made disasters come to mind—such as the terrorist attacks that occurred in the United States on September 11, 2001. We typically have overlooked financial crises, such as the credit crisis of 2008. However, these types of man-made disasters have the potential to devastate the global marketplace. Losses in multiple trillions of dollars and in much human suffering and insecurity are already being totaled as the U.S. Congress fights over a $700 billion bailout. The financial markets are collapsing as never before seen.

Many observers consider this credit crunch, brought on by subprime mortgage lending and deregulation of the credit industry, to be the worst global financial calamity ever. Its unprecedented worldwide consequences have hit country after country—in many cases even harder than they hit the United States.[2] The world is now a global village; we’re so fundamentally connected that past regional disasters can no longer be contained locally.

We can attribute the 2008 collapse to financially risky behavior of a magnitude never before experienced. Its implications dwarf any other disastrous events. The 2008 U.S. credit markets were a financial house of cards with a faulty foundation built by unethical behavior in the financial markets:

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1.Lenders gave home mortgages without prudent risk management to under qualified home buyers, starting the so-called subprime mortgage crisis. 2.Many mortgages, including subprime mortgages, were bundled into new instruments called mortgage-backed securities, which were guaranteed by U.S. government agencies such as Fannie Mae and Freddie Mac. 3. These new bundled instruments were sold to financial institutions around the world. Bundling the investments gave these institutions the impression that the diversification effect would in some way protect them from risk. 4. Guarantees that were supposed to safeguard these instruments, called credit default swaps, were designed to take care of an assumed few defaults on loans, but they needed to safeguard against a systemic failure of many loans. 5. Home prices started to decline simultaneously as many of the unqualified subprime mortgage holders had to begin paying larger monthly payments. They could not refinance at lower interest rates as rates rose after the 9/11 attacks. 6. These subprime mortgage holders started to default on their loans. This dramatically increased the number of foreclosures, causing nonperformance on some mortgage-backed securities. 7. Financial institutions guaranteeing the mortgage loans did not have the appropriate backing to sustain the large number of defaults. These firms thus lost ground, including one of the largest global insurers, AIG (American International Group). 8.Many large global financial institutions became insolvent, bringing the whole financial world to the brink of collapse and halting the credit markets. 9. Individuals and institutions such as banks lost confidence in the ability of other parties to repay loans, causing credit to freeze up. 10.Governments had to get into the action and bail many of these institutions out as a last resort. This unfroze the credit mechanism that propels economic activity by enabling lenders to lend again.

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As we can see, a basic lack of risk management (and regulators’ inattention or inability to control these overt failures) lay at the heart of the global credit crisis. This crisis started with a lack of improperly underwritten mortgages and excessive debt. Companies depend on loans and lines of credit to conduct their routine business. If such credit lines dry up, production slows down and brings the global economy to the brink of deep recession—or even depression. The snowballing effect of this failure to manage the risk associated with providing mortgage loans to unqualified home buyers has been profound, indeed. The world is in a global crisis due to the prevailing (in)action by companies and regulators who ignored and thereby increased some of the major risks associated with mortgage defaults. When the stock markets were going up and homeowners were paying their mortgages, everything looked fine and profit opportunities abounded. But what goes up must come down, as Flannery O’Conner once wrote. When interest rates rose and home prices declined, mortgage defaults became more common. This caused the expected bundled mortgage-backed securities to fail. When the mortgages failed because of greater risk taking on Wall Street, the entire house of cards collapsed.

Additional financial instruments (called credit derivatives)[3] gave the illusion of insuring the financial risk of the bundled collateralized mortgages without actually having a true foundation—claims, that underlie all of risk management.[4] Lehman Brothers represented the largest bankruptcy in history, which meant that the U.S. government (in essence) nationalized banks and insurance giant AIG. This, in turn, killed Wall Street as we previously knew it and brought about the restructuring of government’s role in society. We can lay all of this at the feet of the investment banking industry and their inadequate risk recognition and management. Probably no other risk-related event has had, and will continue to have, as profound an impact worldwide as this risk management failure (and this includes the terrorist attacks of 9/11). Ramifications of this risk management failure will echo for decades. It will affect all voters and taxpayers throughout the world and potentially change the very structure of American government.

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2. Explain the various types of debt instruments that are trade in Indian Debt Market. Discuss how the settlement of trades in debt securities is done ?

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Solution: Debt Instruments are obligations of issuer of such instrument as regards certain future cash flow representing Interest & Principal, which the issuer would pay to the legal owner of the Instrument. They can also be said to be tradable form of loans.Debt Instruments are of various types like Bonds, Debentures, Commercial Papers, Certificates of Deposit, Government Securities (G secs) etc. The Government Securities (G-Secs) market is the oldest and the largest component of the Indian debt market in terms of market capitalization, trading volumes and outstanding securities. The G-Secs market plays a vital role in the Indian economy as it provides the benchmark for determining the level of interest rates in the country through the yields on the government securities which are treated as the risk-free rate of return in any economy. The reserve Bank of India has permitted Primary Dealers, Banks and Financial Institutions in India to do transactions in debt instruments among themselves or with non-bank clients. Debt instruments provide fixed return declared as coupon rate. Retail investors would have a natural preference for fixed income returns and especially so in the current situation of increasing volatility in the financial markets. Now, retail investors are also showing keen interest in Debt Instruments particularly in the Central Government Securities (G-secs).For an individual investor G-secs are one of the best investment options as there is zero default risk and lower volatility in case of G-secs.SBI DFHI is a major player in G-Secs market and widely deals in other debt instruments also.The distinguishing factors of the Debt Instruments are as follows: -

1. Issuer class 2. Coupon bearing / Discounted 3. Interest Terms 4. Repayment Terms (Including Call / put etc.) 5. Security / Collateral / Guarantee

SBI DFHI Ltd. has several options like SBI DFHI Invest, SBI DFHI Trade and SBI DFHI Invest Plus (details available on website) through which investors can participate in the G-Sec and Corporate Debt Market.

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3. What are depositories? Explain the functioning of a depository.

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Solution: An Depository otherwise referred to as a custodian is a commercial bank or a financial institution, approved by the Authority to hold in custody funds, securities, financial instruments or documents of title to assets registered in the name of local investors, East African investors, or foreign investors or an investment portfolio.

Other Depositories include Barclays Bank of Kenya, National Bank of Kenya, Stanbic Bank, Kenya Commercial Bank, National Industrial Credit Bank, Co-operative Bank of Kenya, Investment & Mortgage Bank, CFC Bank, Equity Bank, Dubai Bank and African Banking Corporation.

A licensed custodian also acts as a Central Depository Agent (CDA) for the Central Depository and Settlement Corporation Ltd. (CDSC).

To be licensed as a custodian a firm must first be licensed to operate as a bank, under the Banking Act, or as a financial institution.

Meanwhile, President Mwai Kibaki has confirmed Mrs. Stella Kilonzo as the Chief Executive of CMA. She has been working in an acting capacity since December last year.

Here are the functions of the depository:-

Dematerialisation: One of the primary functions of depository is to eliminate or minimise the movement of physical securities in the market. This is achieved through dematerialisation of securities. Dematerialisation is the process of converting securities held in physical form into holdings in book entry form.

Account Transfer: The depository gives effects to all transfers resulting from the settlement of trades and other transactions between various beneficial owners by recording entries in the accounts of such beneficial owners.

Transfer and Registration: A transfer is the legal change of ownership of a security in the records of the issuer. For effecting a transfer, certain legal steps have to be taken likeendorsement, execution of a transfer instrument and payment of stamp duty. The depository accelerates the transfer process by registering the ownership of shares in the name of the depository. Under a depository system, transfer

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of security occurs merely by passing book entries in the records of the depositories, on the instructions of the beneficial owners.

Corporate Actions: A depository may handle corporate actions in two ways. In the first case, it merely provides information to the issuer about the persons entitled to receive corporate benefits. In the other case, depository itself takes the responsibility of distribution of corporate benefits.

Pledge and Hypothecation: The securities held with NSDL may be used as collateral to secure loans and other credits by the clients. In a manual environment, borrowers are required to deliver pledged securities in physical form to the lender or its custodian. These securities are verified for authenticity and often need to be transferred in the name of lender. This has a time and money cost by way of transfer fees or stamp duty. If the borrower wants to substitute the pledged securities, these steps have to be repeated. Use of depository services for pledging/ hypothecating the securities makes the process very simple and cost effective. The securities pledged/hypothecated are transferred to a segregated or collateral account through book entries in the records of the depository.

Linkages with Clearing System: Whether it is a separate clearing corporation attached to a stock exchange or a clearing house (department) of a stock exchange, the clearing system performs the functions of ascertaining the pay-in (sell) or pay-out (buy) of brokers who have traded on the stock exchange. Actual delivery of securities to the clearing system from theselling brokers and delivery of securities from the clearing system to the buying broker is done by the depository. To achieve this, depositories and the clearing system should be electronically linked.

Having understood the depository system, let us now look at the organisation and functions of National Securities Depository Limited (NSDL).

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4. What do you mean by corporate advisory service? Explain the main corporate advisory services.

Solution: Corporate Advisory Service (CAS)

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CAS provides the intelligence you need to incorporate the latest developments in industry trends, best practices, supply chain management, asset and product lifecycle management, production management and plant automation.Corporate advisory refers to the activity of advising organisations, including corporations, institutions and government bodies, on mergers and acquisitions and other transactions that involve a change in ownership of a company or business. In investment banking circles, this activity is commonly known by the general term M&A (Mergers and Acquisitions).

Transaction types include mergers, acquisitions, disposals, defences, spin-offs, demergers, joint ventures, privatisations, leveraged buyouts and many others. Transactions may be "public" transactions, where the target is a listed public company, or "private" transactions, where the target company is not listed.

There will normally be a minimum of two parties to an M&A transaction, namely the bidder and the target. In a sale transaction, there will also be a vendor, i.e. the seller of the target business.

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5. Explain the process and mechanism of securitization and discuss about the instruments of securitization.

Solution: Securitization is a structured finance process that distributes risk by aggregating assets in a pool (often by selling assets to a special purpose entity), then issuing new securities backed by the assets and their cash flows. The securities are sold to investors who share the risk and reward from those assets.

Securitization is similar to a sale of a profitable business ("spinning off") into a separate entity. The previous owner trades its ownership of that unit, and all the profit and loss that might come in the future, for present cash. The buyers invest in the success and/or failure of the unit, and receive a premium (usually in the form of interest) for doing so. In most securitized investment structures, the investors' rights to receive cash flows are divided into "tranches": senior tranche investors lower their risk of default in return for lower interest payments, while junior tranche investors assume a higher risk in return for higher interest.

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Securitization is designed to reduce the risk of bankruptcy and thereby obtain lower interest rates from potential lenders. A credit derivative is also sometimes used to change the credit quality of the underlying portfolio so that it will be acceptable to the final investors. As a portfolio risk backed by amortizing cash flows - and unlike general corporate debt - the credit quality of securitized debt is non-stationary due to changes in volatility that are time- and structure-dependent. If the transaction is properly structured and the pool performs as expected, the credit risk of all tranches of structured debt improves; if improperly structured, the affected tranches will experience dramatic credit deterioration and loss.[1]

Securitization has evolved from its tentative beginnings in the late 1970s to a vital funding source with an estimated outstanding of $10.24 trillion in the United States and $2.25 trillion in Europe as of the 2nd quarter of 2008. In 2007, ABS issuance amounted to $3,455 billion in the US and $652 billion in Europe

The instruments of securitization:Securitized debt instruments are the products of securitization, which in turn is the process of passing debts onto entities that in turn break them into bonds and sell them. As of 2010, the most common form of securitized debt are mortgage-backed securities, but moves are being made to securitize other debts, such as credit cards and student loans.

Securitized debts have the benefit of lowering interest rates and freeing up capital to banks, but they have the drawback of encouraging lending for purposes other than long-term profit.Process

Securitized debt instruments are created when the original holder (like a bank) sells its debt obligation to a third party, called a Special Purpose Vehicle (SPV).

The SPV pays the original lender the balance of the debt sold, which gives it greater liquidity. It then goes on to divide the debt into bonds, which are then sold on the open market. These bonds are divided into "tranches," which represent different amounts of risk and correspondingly different

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yields for the bondholder. There are definite benefits to securitization of debt. For one, a bank with a large amount of cash instead of a large amount of debt owed to it is more liquid. This means it has more money to spend right now, which in turn drives down interest rates on new mortgages as the bank's supply of money rises.

Another benefit of securitization of debt is the fact that it allows people to invest in things they would not otherwise be able to invest in. To invest in an entire mortgage requires enough capital to lend to someone--usually hundreds of thousands of dollars. To invest in several small chunks of several mortgages, however, does not require as much money and is not as risky.

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6. Explain in detail the concept of leasing and hire purchase.

Solution: Detail the Concept of Leasing A leasing is a contract calling for the lessee (user) to pay the lessor (owner) for use of an asset.[1] A rental agreement is a leasing in which the asset is tangible property.[2] Leasings for intangible property could include use of a computer program (similar to a license, but with different provisions), or use of a radio frequency (such as a contract with a cell-phone provider). A gross leasing is when the tenant pays a flat rental amount and the landlord pays for all property charges regularly incurred by the ownership from lawnmowers and washing machines to handbags and jewellry.[3]

A cancelable leasing is a leasing that may be terminated solely by the lessee or solely by the lessor. A non-cancelable leasing is a leasing that cannot be so terminated. In common parlance, “leasing” may connote a non-cancelable leasing, whereas “rental agreement” may connote a cancelable leasing.

The leasing will either provide specific provisions regarding the responsibilities and rights of the lessee and lessor, or there will be automatic provisions as a result of local law. In general, by paying the negotiated fee to the lessor, the lessee (also called a tenant) has possession and use (the rental) of the leasingd property to the exclusion of the lessor and all others except with the invitation of the tenant. The most common form of real property leasing is a residential rental agreement between landlord and tenant.[4] The relationship between the tenant and the landlord is called a tenancy, and the

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right to possession by the tenant is sometimes called a leasinghold interest. A leasing can be for a fixed period of time (called the term of the leasing) but (depending on the terms of the leasing) may be terminated sooner.

A leasing should be contrasted to a license, which may entitle a person (called a licensee) to use property, but which is subject to termination at the will of the owner of the property (called the licensor). An example of a licensor/licensee relationship is a parking lot owner and a person who parks a vehicle in the parking lot. A license may be seen in the form of a ticket to a baseball game. The difference would be that if possession is subject to ongoing, recurrent payments and is generally not subject to termination except for misconduct or nonpayment, it is a leasing; if it's a one-time entrance onto someone else's property, it's probably a license. The seminal difference between a leasing and a license is that a leasing generally provides for regular periodic payments during its term and a specific ending date. If a contract has no ending date then it may be in the form of a perpetual license and still not be a leasing.

Under normal circumstances, owners of property are at liberty to do what they want with their property (for a lawful purpose), including dealing with it or handing over possession of the property to a tenant for a limited period of time. If an owner has surrendered possession to another (i.e., the tenant) then any interference with the quiet enjoyment of the property by the tenant in lawful possession is itself unlawful.

Similar principles apply to real property as well as to personal property, though the terminology would be different. Similar principles apply to sub-leasing, that is the leasing by a tenant in possession to a sub-tenant. The right to sub-leasing can be expressly prohibited by the main leasing, sometimes referred to as a "master leasing".

The concept of Hire purchase:Hire purchase (abbreviated HP) is the legal term for a contract, in this persons usually agree to pay for goods in parts or a percentage at a time. It was developed in the United Kingdom and can now found in China, Japan, Malaysia, India, Australia, and New Zealand. It is also called closed-end leasing. In cases where a buyer cannot afford to pay the asked price for an item of property as a lump sum but can afford to pay a percentage as a deposit, a hire-purchase contract allows the buyer to hire the goods for a monthly rent. When a sum equal to the original full price plus interest has

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been paid in equal installments, the buyer may then exercise an option to buy the goods at a predetermined price (usually a nominal sum) or return the goods to the owner. In Canada and the United States, a hire purchase is termed an installment plan; other analogous practices are described as closed-end leasing or rent to own.

Hire purchase differs from a mortgage and similar forms of lien-secured credit in that the so-called buyer who has the use of the goods is not the legal owner during the term of the hire-purchase contract. If the buyer defaults in paying the installments, the owner may repossess the goods, a vendor protection not available with unsecured-consumer-credit systems. HP is frequently advantageous to consumers because it spreads the cost of expensive items over an extended time period. Business consumers may find the different balance sheet and taxation treatment of hire-purchased goods beneficial to their taxable income. The need for HP is reduced when consumers have collateral or other forms of credit readily available.

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7. Explain the concept of Factoring, Forfeiting and Bill discounting.

Solution: Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount in exchange for immediate money with which to finance continued business. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset)[1], not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three.

It is different from the forfeiting in the sense that forfeiting is a transaction based operation while factoring is a firm-based operation - meaning, in factoring, a firm sells all its receivables while in forfeiting, the firm sells one of its transactions.

Factoring is a word often misused synonymously with invoice discounting [citation needed] - factoring is the sale of receivables whereas invoice discounting is borrowing where the receivable is used as collateral.

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The three parties directly involved are: the one who sells the receivable, the debtor, and the factor. The receivable is essentially a financial asset associated with the debtor’s liability to pay money owed to the seller (usually for work performed or goods sold). The seller then sells one or more of its invoices (the receivables) at a discount to the third party, the specialized financial organization (aka the factor), to obtain cash. The sale of the receivables essentially transfers ownership of the receivables to the factor, indicating the factor obtains all of the rights and risks associated with the receivables. Accordingly, the factor obtains the right to receive the payments made by the debtor for the invoice amount and must bear the loss if the debtor does not pay the invoice amount. Usually, the account debtor is notified of the sale of the receivable, and the factor bills the debtor and makes all collections. Critical to the factoring transaction, the seller should never collect the payments made by the account debtor, otherwise the seller could potentially risk further advances from the factor. There are three principal parts to the factoring transaction; a.) the advance, a percentage of the invoice face value that is paid to the seller upon submission, b.) the reserve, the remainder of the total invoice amount held until the payment by the account debtor is made and c.) the fee, the cost associated with the transaction which is deducted from the reserve prior to it being paid back the seller. Sometimes the factor charges the seller a service charge, as well as interest based on how long the factor must wait to receive payments from the debtor. The factor also estimates the amount that may not be collected due to non-payment, and makes accommodation for this when determining the amount that will be given to the seller. The factor's overall profit is the difference between the price it paid for the invoice and the money received from the debtor, less the amount lost due to non-payment.

American Accounting considers the receivables sold when the buyer has "no recourse", or when the financial transaction is substantially a transfer of all of the rights associated with the receivables and the seller's monetary Liability under any "recourse" provision is well established at the time of the sale.[5] Otherwise, the financial transaction is treated as a loan, with the receivables used as collateral.

The concept of Bill discounting: Business activities across borders are done through letter of credit. Letter of credit is an instrument issued in the favor of the seller by the buyer bank assuring that payment will be made after certain timer frame depending upon the terms and conditions agreed, it could be either sight, 30 days from the

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Bill of Lading or 120 days from the date of bill of lading. Now when the seller receives the letter of credit through bank, seller prepares documents and presents the same to the bank.

The most important element in the same is the bill of exchange which is used to negotiate a letter of credit. Seller discounts that bill of exchange with the bank and gets money. Discounting bill terminology is used for this purpose. Now it is seller's bank responsibility to send documents and bill of exchange to buyer's bank for onward forwarding to the buyer for the acceptance and the buyer finally, accepts bill of exchange drawn by the seller on buyer's bank because he has opened that LC. Buyers bank than get that signed bill of exchange from the buyer as guarantee and release payment to the sellers bank and waits for the time span will buyer will pay the bank against that bill of exchange.

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8. Explain the broad attributes of a Life Insurance Products.

Solution: Life insurance provides payment of a death benefit at the death of the insured(s). However, life insurance has many unique characteristics that may make it an appropriate solution for a variety of uses in addition to the death benefit protection. Some of these characteristics include:

* Policy cash values accumulate on a tax-deferred basis. * Policy death benefits are received income tax-free. * Policy cash values may be accessed on a tax advantaged basis.

Please keep in mind loans and partial withdrawals may decrease the death benefit and cash value and may be subject to policy limitations and income tax. Function: Insurance SalesLife insurance salespeople or producers sell products that provide money to a person's relatives or friends after he dies. The life insurance producer helps customers determine how much insurance a person's family will need to afford burial arrangements, pay off bills and debt, and replace the income the customer would have earned throughout his life.

Function: Annuity Sales

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Life insurance producers also sell annuities. An annuity is an investment product that helps investors earn interest and receive income during retirement.

Use of TechnologyLife insurance producers use computers to calculate insurance benefits and needs, and to determine how much the insurance will cost the customer monthly or yearly. They also enter customer information required for the application into the computer.

Education and LicensingMost life insurance companies prefer applicants who have a minimum of a bachelor's degree in a field such as business administration, finance or economics. Before a producer can sell insurance, she must receive a license in the state where she wishes to work by passing a life, accident and health insurance exam.

ConsiderationsLife insurance producers travel to meet with customers within a defined territory, but this sometimes allows them to work from a home-based office. The life insurance field is highly regulated at the federal and state levels, with policies changing frequently. Producers must stay abreast of regulations to avoid fees and fines.

Compensation Many life insurance sales positions are commission-based, meaning that producers receive a percentage of the revenue generated by sales and receive no compensation if they sell nothing. The average annual median salary for insurance producers in the United States was $60,440 in May 2008.

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IGNOU MBA MS- 46 Free Solved Assignments 2010