Debt Funding – Indian Fund Based (Govt. Debt and Banking Finance) – Corporate Funding and Listings in Stock Exchanges Important Questions

Question 1.
Write a short note on: “Bills re-discoun ting”
Answer:
Bills Re-discounting:

  • Bills Re-discounting means the re-discounting of trade bills which have already been purchased by/discounted with the bank by the customer. These trade bills arise out of supply of goods/services.
  • Bill re-discounting is a money market instrument where the bank buys the bill (Le. Bill of Exchange of Promissory Note) before it is due and credits the value of the bill after a discount- charge to the customer’s account.
  • The bank now-a-days has discounted the bill may require getting it ‘re-discounted’ with some other bank to get the fund.

Question 2.
Distinguish between the following: Bill Discounting and Factoring
Answer:
Difference between “Bill Discounting” and “Factoring”:
Bill Discounting:
In common practice, the seller who gets the accepted bills of exchange discounts it with the Bank or financial institution or a bill discounting house and collects the money (less the interest charged for the discounting).

Commercial bills are basically negotiable instruments accepted by buyers for goods or services obtained by them on credit. Such bills being bills of exchange can be kept up to the maturity date and encashed by the seller or may be endorsed to a third party in payment of dues owing to the latter.

Factoring:

  • Factoring is a financial transaction wherein an entity sells its receivables to a third party called a ‘factor’, at discounted prices.
  • Factoring is a financial option for the management of receivables.
  • It is the conversion of credit sales into cash.
  • In factoring, a financial institution (factor) buys the accounts receivable of a company (Client) and pays up to 80% (rarely up to 90%) of the amount immediately on formation of agreement.

Question 3.
Distinguish between the following: Bills Finance and Project Finance
Answer:
Distinguish between “Bills Finance” and “Project Finance”:
“Bills Finance”:

  • Bills finance is short term and self liquidating finance in nature.
  • Bills can be classified as Demand Bills and Usance Bills.
  • Demand Bill is purchased and Usance bill is discounted by the banks. The credits available to the seller against the bills drawn under Letter of Credit either on sight draft or usance draft are called bills negotiated by the banks.
  • Advantage of bills finance is that the seller of goods (borrower) gets immediate money from the bank for the goods sold by him irrespective of whether it is a purchase, discount or negotiation by the bank.
  • The ‘Demand Bills’ can be documentary or clean. Generally, banks accept only documentary bills for purchase. However, clean bills from good parties also purchased by the banks.

“Project Finance”:

  • It is the long-term financing of infrastructure and industrial projects based upon the projected cash flows of the project.
  • Generally, a project financing structure involves a number of equity investors, known as ‘sponsors’, a ‘syndicate’ of banks or other lending institutions that provide loans to the operation.
  • Most commonly loans which are secured by the proj ect assets and paid entirely from project cash flow rather than from the general assets or creditworthiness of the project sponsors.
  • The financing is typically secured by all of the project assets including the revenue-producing contracts.
  • Project lenders are given a lien on all of these assets and are able to assume control of a project if the project company has difficulties complying with the loan terms.

Question 4.
Discuss the steps involved in the process of factoring.
Answer:
Following steps are involved in “Factoring Process”:

  • The seller interacts with the funding specialist or broker and explains the funding needs.
  • The broker prepares a preliminary client profile form and submits to the appropriate funder for consideration.
  • Once both parties agree that factoring is possible, the broker puts the seller in direct contact with the funder to ask/answer any additional questions and to negotiate a customized factoring agreement, which will meet the needs of all concerned.
  • At this point, the seller may be asked to remit a fee with formal application to cover legal research costs, which will be incurred dining the course of “due diligence”. Here “Due Diligence” means a process by which the buyer’s credit worthiness is evaluated through background checks, using national database services
  • During the next several days, the funder completes the “due diligence” process on the seller, further verifies invoices and acknowledges any liens, UCC filings, judgments or other recorded encumbrances on the seller’s accounts receivables.
  • The seller is advised of the facility and is asked to advise the buyers of the Factor by letter and submit an acknowledged copy of the same to the Factor for records.
  • A detailed sanction letter is given to the seller and their acceptance on the same taken, with the required signatories. (Authorized signatories would be mentioned in the “Signing Authorities” section of the Proposal presented by seller).

Sanction terms must contain the following:

  • All facilities covered under the sanction.
  • The period for which the sanction is valid.
  • The Limits.
  • The seller has to advise the buyer of the Factoring agreement.
  • Copy of such advice acknowledged by the buyer should be submitted to the Factor. Buyer’s consent is not required to decide on the Factor.
  • Who is an authorized signatory are for signing invoices for factoring

Question 5.
“Factoring is a financial option for the management of receivables.” In the light of this statement, explain the meaning and advantages of factoring.
Answer:
‘Factoring is a financial option for the management of receivables.’ It is the conversion of credit sales into cash. In factoring, a financial institution J (factor) buys the accounts receivable of a company (Client) and generally pays up to 80% of the amount immediately on agreement. Factoring company pays the remaining amount (Balance 20%- Finance cost-operating cost) to the client when the customer pays the debt. Collection of debt from the customer is done either by the factor or the client depending upon the type of factoring.

The following are the advantages of factoring for a seller:

  • Seller gets funds immediately after the sale is affected and on presentation of accepted sales invoices and Promissory notes.
  • Major part of paper work and correspondence is taken care of by the factor.
  • Follow-up for recovery of funds is done mainly by the factor.
  • Interest rates are not as high as normal discounting.
  • Increased cash flow to meet payroll.
  • Immediate funding arrangements.
  • No additional debt is incurred on balance sheet.
  • Other assets are not encumbered.
  • Approval is not based on seller’s credit rating.

Question 6.
“Treasury bills are effective cash management product.” Comment.
Answer:

  • “Treasury Bills” are very useful instruments to deploy short term surpluses depending upon the availability and requirement.
  • Generally, Banks do not pay any interest on fixed deposits of less than 15 days or balances maintained in current accounts whereas treasury bills can be purchased for any number of days depending on the requirements. This helps in deployment of fund for very short periods as well.
  • Since every week there is a 91 days treasury bill maturing and every fortnight a 364 days treasury bills maturing, one can purchase treasury bills of different maturities as per requirements so as to match with the respective outflow of funds.
  • When the liquidity in economy is tight the returns on treasury bills are much higher as compared to bank deposits even for longer term.
  • Apart from the better yields and availability for very short tenures, another advantage of treasury bills over bank deposits is that surplus cash can be invested.

Question 7.
In the recent past, a listed housing finance company issued MASALA BONDS for a sum of ₹ 3,000 crore.
Explain the term MASALA BONDS. Is there any advantage of MASALA BONDS over NORMAL BONDS?
Answer:

  • Masala Bonds are rupee denominated borrowings by Indian companies in the overseas markets. This is different from the other overseas borrowings in the sense that in the other borrowings, the currency is normally dollar, euro, yen etc.
  • The masala bonds were reckoned under both corporate debt and external commercial borrowings for Foreign Portfolio investment.
  • The Reserve Bank of India recently amended the Regulations and currently treats Masala Bonds under the ECB category only where a borrower just needs to seek the RBI’s approval to sell those securities.
  • The main advantage of issuing masala bonds is that the company does not have to worry about the depreciation in the rupee in comparison to the other currencies.
  • In order to compensate the risk of currency depreciation, the buyer of the Masala Bond will get a higher coupon rate and therefore earns a higher yield.
  • Many companies are in the battle to issue masala bonds as the com-panies can have access to more funds at a marginally higher cost of financing.

Question 8.
Write a detailed note on Islamic banking.
Answer:

  • Islamic Banking or Sharia – Compliant Finance is banking or financing activity that complies with sharia (Islamic law) and its practical application through the development of Islamic economics.
  • Some of the modes of Islamic banking/finance include Mudarahah (Profit sharing and loss bearing), Wadiah (safekeeping), Musharaka (joint venture), Murabahah (cost plus), and Ijara (leasing).
  • Sharia prohibits riba, or usury, defined as interest paid on all loans (although some Muslims dispute whether there is a consensus that interest is equivalent to riba). Investment in businesses that provide goods or services considered contrary to Islamic principles (e.g. pork or alcohol) is also haraam (sinful).
  • Islamic Banks work on the principles of an interest free banking. Riba or interest under Islamic Law basically means anything in “excess” – the investor should not make an “undue” profit from the hard work of the other.
  • Islamic banks make available accounts which provide profit or loss instead of interest rates. The banks use this money collected by them and invest in something that is shari at compliant that is not haraam and does not involve high risks.

Question 9.
You are required to compute Maximum Permissible Bank Borrowings (MPBB) under three methods of Tandon Committee Norms pertaining to M Ltd. from following data and how you will present it to the Board:

Existing Current Assets Amount in ₹ Amount in ₹
Raw Materials 8,00,000
Work in progress 80,000
Finished Goods 3,60,000
Receivables 2,00,000
Other current assets 40,000 14,80,000
Existing Current Liabilities
Creditors for purchase 4,00,000
Other current liabilities 2,00,000
Bank borrowings 8,00,000 14,00,000

Core Current assets are ₹ 3,80,000
Answer:
Maximum Bank Borrowings: (Tandon Committee norms):

Method-I Method-II Method-III
= 0.75(Current Assets – Current Liabilities) = 0.75 (Current Assets) – Current Liabilities = 0.7 5 (Current Assets – CAA) – Current Liabilities
= 0.75 (14,80,000 – 6,00,000) = 0.75 (14,80,000) – 6,00,000 = 0.75(14,80,000 – 3,80,000)  – 6,00,000
= 0.75 (8,80,000)
= 6,60,000.		 = 11,10,000 – 6,00,000
= 5,10,000		 = 0.75 (11,00,000) – 6,00,000
= 2,25,000.

Recapitulation:

Particulars Method – I Method – II Method – III
Maximum Bank Borrowings 6,60,000 5,10,000 2,25,000
Actual Bank Borrowings 8,00,000 8,00,000 8,00,000
Excess Bank Borrowings 1,40,000 2,90,000 5,75,000

Note: Under all three methods, the excess bank borrowings can be converted in to long term debt.

Question 10.
Following data relates to M/s ABC Pvt. Ltd.:

 Particulars Amount (₹ in lakh)  Particulars Amount (₹ in lakh)
Creditor for purchases 200 Raw Material 380
Other current liabilities 100 Work in process 40
Finished Goods 180
Receivables 110
Other current Assets 30

Calculate the Maximum Permissible Bank Finance (MPBF) as per the Tandon Committee Recommendations using the norm of a current ratio of 1.33.
Answer:
Calculation of Maximum Permissible Bank Finance (MPBF) as per 2nd Method of Lending (Tandon Committee Recommendations) are as under:

Sr. No. Particulars Amount
(₹ in Lakh)
1 Total Current Assets (TCA) 740
2 Less : Current Liabilities other than banking borrowing 300
3 Working Capital Gap (WCG) ( 1-2) 440
4 Less : 25% of Total Current Assets (25% of 1) 185
5 Maximum Permissible Bank Finance (MP BF) (3-4) 255

With this additional borrowing the Current Liabilities shall become ₹ 555 lakhs (300 + 255) and the new Current Ratio shall become 1.33 (740/555).

Working Note:

Sr. No. Particulars Amount (₹ in Lakh)
1 Raw Material 380
2 Work in Process 40
3 Finished Goods 180
4 Receivables 110
5 Other Current Assets 30
Total Cur­rent Assets 740

Question 11.
Discuss the parties in factoring?
Answer:
The factoring transaction involves three parties:

  • The Seller who has produced the goods /services and raised the invoice.
  • The Buyer who is the consumer of goods/services and the party to pay.
  • The Factor i.e. the financial institution that advances the portion of funds to the seller.

Question 12.
What are types of factoring?
Answer:
Types of factoring are as follows:

  • Recourse Factoring: In this type of factoring the bank purchases the receivables on the condition that any loss arising out or bad debts will be borne by the company which has taken factoring.
  • Non-Recourse or Full Factoring: In this type of factoring the bank takes all the risk and bear all the loss in case of debts becoming bad debts.
  • Advance Factoring: In advance factoring arrangement the factor provides an advance against the uncollected and non-due receivables to the firm.
  • Maturity Factoring: In this type of factoring bank does not give any advance to the company rather bank collects it from customers and pays to the company either on the date of collection from the customers or on a guaranteed payment date.
  • Undisclosed Factoring: In this type of factoring, the customer is not informed of the factoring arrangement. The firm may collect dues from the customer on its own or instruct to make remit once at some other address.
  • Invoice Discounting: In this type of factoring the bank provide an advance to the company against the account receivables and in turn charges interest rate from the company for the payment which bank has given to the company.

Question 13.
What are the features of Loan against Securities?
Answer:
Following are features of Loan against Securities:

  • Tenure – Generally, the tenure of loan against securities is one year.
  • Processing Fees – Banks and financial institutions usually charge approximately 2 % as processing fees.
  • Prepayment Charges – Generally, there are no prepayment charges.
  • Secured Loan – Loan against securities is a secured loan as the bonds, shares, debentures or mutual funds owned by the borrower are kept as collateral security when this loan is advanced.
  • Rate of Interest – Generally interest rates at which loan against securities is advanced varies from 12% – 15% p.a.
  • Loan Amount – The loan amount for which the borrower may be eligible depends upon the type of security that is being offered.

Question 14.
Define Project Report. What are important aspects covered in the project report?
Answer:
Project Report: A Project Report is a detailed report containing all the details of company. A good project report must present diverse range analytical challenges to its clients and shareholders.

Following Important aspects covered in the project report are as follows:

  • Introductory Page
  • Summary of the project
  • Details about the Promoters, their educational qualifications, work experience, etc.
  • Current Status of the Bank, its products and services, target market, and activities.
  • Infrastructure facilities, tools deployed, operational premises, machinery, etc.
  • Customers, details about them as well as prospective customers
  • Fiscal acquisitions and tie-ups
  • Means of Financing
  • Profitability projections and Cash flows for the entire repayment period of financial assistance
  • Break Even Point Evaluations
  • Product with capacity to be built up and processes involved
  • Project location
  • Cost of the Project and Means of financing thereof
  • Availability of utilities
  • Technical arrangements
  • Market Prospects and Selling arrangements
  • Environmental aspects.
  • Balance Sheet
  • Profit and Loss Statements
  • Fund Flow Statement

Question 15.
Define project finance? Discuss features of project finance transactions?
Answer:
“Project Finance”: Project Finance is the long-term financing of in-frastructure and industrial projects based upon the projected cash flows of the project. A project financing structure involves a number of equity investors, known as ‘sponsors’, a ‘syndicate’ of banks or other lending institutions that provide loans to the operation.

Following are features of project finance transactions are:

  • Highly leveraged: These transactions have high debt proportion as compared to equity.
  • Capital Intensive: They tend to be large scale projects requiring debt and equity in a large amount.
  • Long Term: The tenor for project financings can easily reach 15 to 20 years.
  • Independent Entity with A Finite Life: They form a new legal entity with the sole purpose of executing the project.
  • Non-Recourse Or Limited Recourse Financing: It means the creditor has no or limited claims on the loan in case of default.
  • Many Participants: There are many national and international participants involved in a project laying different risk.
  • Allocated Risk: There are many risk involved in a project for example Environmental, Country risk, market risk, project risk, Product risk, Supply risk, Funding risk, Currency risk, Interest risk.
  • Costly: Raising capital through project finance is generally more costly than through typical corporate finance avenues.

Question 16.
Write Short Note on: “Cash Credit Account (CC Account)”.
Answer:
“Cash Credit Account (CC Account)”:
A cash credit facility is a short-term finance to a borrower company having a tenure of up to one year which can be renewed for further period by the bank on the basis of projected sales and satisfactory operation in the account during the period of finance.

Cash credit facility is extended in two forms viz. Open Cash Credit and Key Cash Credit.
Open Cash Credit: Open Cash credit account is a running account just like a current account where the borrower is allowed to maintain debit balance in the account up to a sanctioned limit or drawing power whichever is lower.

Key Cash Credit: In the case of Key Cash Credit, the borrower lodges the stocks in his godown and the key of the godown will be handed over to the bank. With this process the goods lodged in the godown are pledged to the bank and the bank will allow the customer to draw funds against the value of the goods less margin. This is known as Drawing Power.

Question 17.
Describe the various types of bonds in India?
Answer:
Government Bonds:

  • The bonds which are issued either directly by Government of India or by the Public Sector Units (PSU’s) in India.
  • These bonds are seemed as they are backed up with security from Government.
  • These are generally offered with low rate of interest com­pared to other types of bonds.

Tax saving bonds:

  • The tax saving bonds is issued by the Government of India for providing benefit to investors in the form of tax savings.
  • The bond holder would also get tax benefit along-with normal interest.

Corporate Bonds:

  • These are the bonds issued by the private corporate com­panies.
  • Indian corporate issue secured or non-secured bonds

Banks and other financial institutions bonds:

  • These bonds are issued by banks or any financial institution.
  • The financial market is well regulated and the majority of the bond markets are from this segment.
  • However care to be taken to consider the credit rating given by crredit Rating Agencies before investing in these  bonds.

Corporate Funding and Listings in Stock Exchanges Notes