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IGNOU MBA MS- 46 Free Solved Assignments 2010

MS- 46: Management of Financial Services

ASSIGNMENT 2010

Course Code : MS-46

Course Title : Management of Financial

ServicesAssignment Code : 46/TMA/SEM-II/2010

Coverage : All Blocks

Attempt All the Questions.

1. List & explain the nature of risk associated with financialservices 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 terroristattacks that occurred in the United States on September 11,2001. We typically have overlooked financial crises, such as thecredit crisis of 2008. However, these types of man-made disastershave the potential to devastate the global marketplace. Losses inmultiple trillions of dollars and in much human suffering and



insecurity are already being totaled as the U.S. Congress fightsover a $700 billion bailout. The financial markets are collapsing asnever before seen.

Many observers consider this credit crunch, brought on bysubprime mortgage lending and deregulation of the creditindustry, to be the worst global financial calamity ever. Itsunprecedented worldwide consequences have hit country aftercountry—in many cases even harder than they hit the UnitedStates.[2] The world is now a global village; we’re sofundamentally 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 anyother disastrous events. The 2008 U.S. credit markets were afinancial house of cards with a faulty foundation built by unethicalbehavior in the financial markets:

1.Lenders gave home mortgages without prudent riskmanagement 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, whichwere guaranteed by U.S. government agencies such as FannieMae and Freddie Mac.



3. These new bundled instruments were sold to financialinstitutions around the world. Bundling the investments gavethese institutions the impression that the diversification effectwould in some way protect them from risk.

4. Guarantees that were supposed to safeguard theseinstruments, called credit default swaps, were designed to takecare of an assumed few defaults on loans, but they needed tosafeguard against a systemic failure of many loans.

5. Home prices started to decline simultaneously as many of theunqualified subprime mortgage holders had to begin payinglarger monthly payments. They could not refinance at lowerinterest rates as rates rose after the 9/11 attacks.

6. These subprime mortgage holders started to default on theirloans. This dramatically increased the number of foreclosures,

causing nonperformance on some mortgage-backed securities.

7. Financial institutions guaranteeing the mortgage loans did nothave the appropriate backing to sustain the large number of defaults. These firms thus lost ground, including one of the largestglobal insurers, AIG (American International Group).

8.Many large global financial institutions became insolvent,bringing the whole financial world to the brink of collapse andhalting the credit markets.



9. Individuals and institutions such as banks lost confidence inthe ability of other parties to repay loans, causing credit to freezeup.

10.Governments had to get into the action and bail many of theseinstitutions out as a last resort. This unfroze the credit mechanismthat propels economic activity by enabling lenders to lend again.

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 theirroutine business. If such credit lines dry up, production slowsdown and brings the global economy to the brink of deeprecession—or even depression. The snowballing effect of thisfailure to manage the risk associated with providing mortgageloans to unqualified home buyers has been profound, indeed. The

world is in a global crisis due to the prevailing (in)action bycompanies and regulators who ignored and thereby increasedsome of the major risks associated with mortgage defaults. Whenthe stock markets were going up and homeowners were payingtheir mortgages, everything looked fine and profit opportunitiesabounded. But what goes up must come down, as FlanneryO’Conner once wrote. When interest rates rose and home pricesdeclined, mortgage defaults became more common. This caused

the expected bundled mortgage-backed securities to fail. Whenthe mortgages failed because of greater risk taking on WallStreet, the entire house of cards collapsed.



Additional financial instruments (called credit derivatives)[3] gavethe illusion of insuring the financial risk of the bundledcollateralized mortgages without actually having a truefoundation—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) nationalizedbanks and insurance giant AIG. This, in turn, killed Wall Street aswe 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 riskrecognition and management. Probably no other risk-relatedevent has had, and will continue to have, as profound an impact

worldwide as this risk management failure (and this includes theterrorist attacks of 9/11). Ramifications of this risk managementfailure will echo for decades. It will affect all voters and taxpayersthroughout 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 tradein Indian Debt Market. Discuss how the settlement of trades indebt securities is done ?

Solution: Debt Instruments are obligations of issuer of suchinstrument as regards certain future cash flow representingInterest & Principal, which the issuer would pay to the legal ownerof 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, GovernmentSecurities (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 andoutstanding securities. The G-Secs market plays a vital role in theIndian economy as it provides the benchmark for determining thelevel of interest rates in the country through the yields on thegovernment securities which are treated as the risk-free rate of return in any economy. The reserve Bank of India has permittedPrimary Dealers, Banks and Financial Institutions in India to dotransactions in debt instruments among themselves or with non-

bank clients. Debt instruments provide fixed return declared ascoupon rate. Retail investors would have a natural preference forfixed income returns and especially so in the current situation of increasing volatility in the financial markets. Now, retail investorsare also showing keen interest in Debt Instruments particularly inthe Central Government Securities (G-secs).For an individualinvestor G-secs are one of the best investment options as there iszero 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 debtinstruments also.

The distinguishing factors of the Debt Instruments are as follows:-

1. Issuer class

2. Coupon bearing / Discounted3. 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 andCorporate Debt Market.

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3. What are depositories? Explain the functioning of adepository.

Solution: An Depository otherwise referred to as a custodian is acommercial bank or a financial institution, approved by theAuthority to hold in custody funds, securities, financial

instruments or documents of title to assets registered in the nameof local investors, East African investors, or foreign investors or aninvestment portfolio.

Other Depositories include Barclays Bank of Kenya, National Bankof Kenya, Stanbic Bank, Kenya Commercial Bank, NationalIndustrial Credit Bank, Co-operative Bank of Kenya, Investment &

Mortgage Bank, CFC Bank, Equity Bank, Dubai Bank and AfricanBanking 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 tooperate as a bank, under the Banking Act, or as a financialinstitution.

Meanwhile, President Mwai Kibaki has confirmed Mrs. StellaKilonzo 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 toeliminate 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 inphysical form into holdings in book entry form.

Account Transfer: The depository gives effects to all transfersresulting from the settlement of trades and other transactionsbetween 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 like endorsement,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 adepository system, transfer of security occurs merely by passingbook entries in the records of the depositories, on the instructionsof the beneficial owners.

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

Pledge and Hypothecation: The securities held with NSDL may beused as collateral to secure loans and other credits by the clients.In a manual environment, borrowers are required to deliverpledged securities in physical form to the lender or its custodian.

These securities are verified for authenticity and often need to betransferred in the name of lender. This has a time and money costby way of transfer fees or stamp duty. If the borrower wants tosubstitute the pledged securities, these steps have to berepeated. Use of depository services for pledging/ hypothecatingthe securities makes the process very simple and cost effective.

The securities pledged/hypothecated are transferred to asegregated or collateral account through book entries in therecords of the depository.

Linkages with Clearing System: Whether it is a separate clearingcorporation 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 deliveryof securities to the clearing system from the

selling brokers and delivery of securities from the clearing systemto the buying broker is done by the depository. To achieve this,depositories and the clearing system should be electronicallylinked.

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

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

Solution: Corporate Advisory Service (CAS)

CAS provides the intelligence you need to incorporate the latestdevelopments in industry trends, best practices, supply chainmanagement, asset and product lifecycle management,production management and plant automation.Corporate

advisory refers to the activity of advising organisations, includingcorporations, institutions and government bodies, on mergers andacquisitions and other transactions that involve a change inownership of a company or business. In investment bankingcircles, 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&Atransaction, namely the bidder and the target. In a saletransaction, there will also be a vendor, i.e. the seller of the targetbusiness.

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

Solution: Securitization is a structured finance process thatdistributes risk by aggregating assets in a pool (often by sellingassets to a special purpose entity), then issuing new securitiesbacked by the assets and their cash flows. The securities are soldto 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 tradesits ownership of that unit, and all the profit and loss that mightcome in the future, for present cash. The buyers invest in the



success and/or failure of the unit, and receive a premium (usuallyin the form of interest) for doing so. In most securitizedinvestment structures, the investors' rights to receive cash flowsare divided into "tranches": senior tranche investors lower their

risk of default in return for lower interest payments, while juniortranche investors assume a higher risk in return for higherinterest.

Securitization is designed to reduce the risk of bankruptcy andthereby obtain lower interest rates from potential lenders. Acredit derivative is also sometimes used to change the credit

quality of the underlying portfolio so that it will be acceptable tothe final investors. As a portfolio risk backed by amortizing cashflows - and unlike general corporate debt - the credit quality of securitized debt is non-stationary due to changes in volatility thatare time- and structure-dependent. If the transaction is properlystructured 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 thelate 1970s to a vital funding source with an estimatedoutstanding of $10.24 trillion in the United States and $2.25trillion in Europe as of the 2nd quarter of 2008. In 2007, ABSissuance 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 mostcommon form of securitized debt are mortgage-backed securities,but moves are being made to securitize other debts, such ascredit cards and student loans.

Securitized debts have the benefit of lowering interest rates andfreeing 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 aSpecial 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 debtinto bonds, which are then sold on the open market. These bondsare divided into "tranches," which represent different amounts of risk and correspondingly different yields for the bondholder. Thereare definite benefits to securitization of debt. For one, a bank witha large amount of cash instead of a large amount of debt owed toit is more liquid. This means it has more money to spend rightnow, which in turn drives down interest rates on new mortgagesas the bank's supply of money rises.



Another benefit of securitization of debt is the fact that it allowspeople to invest in things they would not otherwise be able toinvest in. To invest in an entire mortgage requires enough capitalto 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 thelessor (owner) for use of an asset.[1] A rental agreement is aleasing in which the asset is tangible property.[2] Leasings forintangible property could include use of a computer program(similar to a license, but with different provisions), or use of aradio frequency (such as a contract with a cell-phone provider). Agross leasing is when the tenant pays a flat rental amount andthe landlord pays for all property charges regularly incurred bythe ownership from lawnmowers and washing machines tohandbags and jewellry.[3]

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



The leasing will either provide specific provisions regarding theresponsibilities and rights of the lessee and lessor, or there will be

automatic provisions as a result of local law. In general, by payingthe negotiated fee to the lessor, the lessee (also called a tenant)has possession and use (the rental) of the leasingd property tothe exclusion of the lessor and all others except with theinvitation of the tenant. The most common form of real propertyleasing is a residential rental agreement between landlord andtenant.[4] The relationship between the tenant and the landlord iscalled a tenancy, and the right to possession by the tenant issometimes called a leasinghold interest. A leasing can be for afixed period of time (called the term of the leasing) but(depending on the terms of the leasing) may be terminatedsooner.

A leasing should be contrasted to a license, which may entitle aperson (called a licensee) to use property, but which is subject totermination at the will of the owner of the property (called thelicensor). An example of a licensor/licensee relationship is aparking lot owner and a person who parks a vehicle in the parkinglot. A license may be seen in the form of a ticket to a baseballgame. The difference would be that if possession is subject toongoing, recurrent payments and is generally not subject totermination except for misconduct or nonpayment, it is a leasing;if it's a one-time entrance onto someone else's property, it'sprobably a license. The seminal difference between a leasing anda license is that a leasing generally provides for regular periodicpayments during its term and a specific ending date. If a contracthas no ending date then it may be in the form of a perpetuallicense and still not be a leasing.



Under normal circumstances, owners of property are at liberty todo what they want with their property (for a lawful purpose),including dealing with it or handing over possession of theproperty to a tenant for a limited period of time. If an owner has

surrendered possession to another (i.e., the tenant) then anyinterference with the quiet enjoyment of the property by thetenant in lawful possession is itself unlawful.

Similar principles apply to real property as well as to personalproperty, though the terminology would be different. Similarprinciples apply to sub-leasing, that is the leasing by a tenant in

possession to a sub-tenant. The right to sub-leasing can beexpressly prohibited by the main leasing, sometimes referred toas a "master leasing".

The concept of Hire purchase:

Hire purchase (abbreviated HP) is the legal term for a contract, inthis persons usually agree to pay for goods in parts or apercentage at a time. It was developed in the United Kingdom andcan now found in China, Japan, Malaysia, India, Australia, and NewZealand. It is also called closed-end leasing. In cases where abuyer cannot afford to pay the asked price for an item of propertyas a lump sum but can afford to pay a percentage as a deposit, ahire-purchase contract allows the buyer to hire the goods for amonthly rent. When a sum equal to the original full price plusinterest has been paid in equal installments, the buyer may thenexercise an option to buy the goods at a predetermined price(usually a nominal sum) or return the goods to the owner. InCanada and the United States, a hire purchase is termed aninstallment plan; other analogous practices are described asclosed-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-purchasecontract. If the buyer defaults in paying the installments, theowner may repossess the goods, a vendor protection notavailable with unsecured-consumer-credit systems. HP isfrequently advantageous to consumers because it spreads thecost of expensive items over an extended time period. Businessconsumers may find the different balance sheet and taxationtreatment of hire-purchased goods beneficial to their taxableincome. The need for HP is reduced when consumers havecollateral or other forms of credit readily available.

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7. Explain the concept of Factoring, Forfeiting and Billdiscounting.

Solution: Factoring is a financial transaction whereby a businesssells its accounts receivable (i.e., invoices) to a third party (calleda factor) at a discount in exchange for immediate money with

which to finance continued business. Factoring differs from a bankloan in three main ways. First, the emphasis is on the value of thereceivables (essentially a financial asset)[1], not the firm’s creditworthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves twoparties whereas factoring involves three.



It is different from the forfeiting in the sense that forfeiting is atransaction based operation while factoring is a firm-based

operation - meaning, in factoring, a firm sells all its receivableswhile in forfeiting, the firm sells one of its transactions.

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

The three parties directly involved are: the one who sells thereceivable, the debtor, and the factor. The receivable isessentially a financial asset associated with the debtor’s liabilityto pay money owed to the seller (usually for work performed orgoods sold). The seller then sells one or more of its invoices (thereceivables) at a discount to the third party, the specializedfinancial organization (aka the factor), to obtain cash. The sale of the receivables essentially transfers ownership of the receivablesto the factor, indicating the factor obtains all of the rights andrisks associated with the receivables. Accordingly, the factorobtains the right to receive the payments made by the debtor forthe invoice amount and must bear the loss if the debtor does notpay the invoice amount. Usually, the account debtor is notified of the sale of the receivable, and the factor bills the debtor andmakes all collections. Critical to the factoring transaction, theseller should never collect the payments made by the accountdebtor, otherwise the seller could potentially risk furtheradvances from the factor. There are three principal parts to thefactoring transaction; a.) the advance, a percentage of the invoiceface value that is paid to the seller upon submission, b.) thereserve, the remainder of the total invoice amount held until the



payment by the account debtor is made and c.) the fee, the costassociated with the transaction which is deducted from thereserve prior to it being paid back the seller. Sometimes thefactor charges the seller a service charge, as well as interest

based on how long the factor must wait to receive payments fromthe debtor. The factor also estimates the amount that may not becollected due to non-payment, and makes accommodation for thiswhen determining the amount that will be given to the seller. Thefactor's overall profit is the difference between the price it paidfor the invoice and the money received from the debtor, less theamount lost due to non-payment.

American Accounting considers the receivables sold when thebuyer has "no recourse", or when the financial transaction issubstantially a transfer of all of the rights associated with thereceivables 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 thereceivables 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 theseller by the buyer bank assuring that payment will be made aftercertain timer frame depending upon the terms and conditionsagreed, it could be either sight, 30 days from the Bill of Lading or120 days from the date of bill of lading. Now when the sellerreceives the letter of credit through bank, seller preparesdocuments and presents the same to the bank.



The most important element in the same is the bill of exchangewhich is used to negotiate a letter of credit. Seller discounts thatbill of exchange with the bank and gets money. Discounting billterminology is used for this purpose. Now it is seller's bank

responsibility to send documents and bill of exchange to buyer'sbank for onward forwarding to the buyer for the acceptance andthe buyer finally, accepts bill of exchange drawn by the seller onbuyer's bank because he has opened that LC. Buyers bank thanget that signed bill of exchange from the buyer as guarantee andrelease payment to the sellers bank and waits for the time spanwill 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 atthe death of the insured(s). However, life insurance has manyunique characteristics that may make it an appropriate solutionfor 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 advantagedbasis.



Please keep in mind loans and partial withdrawals may decreasethe death benefit and cash value and may be subject to policylimitations and income tax.

Function: Insurance SalesLife insurance salespeople or producers sell products that providemoney to a person's relatives or friends after he dies. The lifeinsurance producer helps customers determine how muchinsurance a person's family will need to afford burialarrangements, pay off bills and debt, and replace the income thecustomer would have earned throughout his life.

Function: Annuity Sales

Life insurance producers also sell annuities. An annuity is aninvestment product that helps investors earn interest and receiveincome during retirement.

Use of Technology

Life insurance producers use computers to calculate insurancebenefits and needs, and to determine how much the insurancewill cost the customer monthly or yearly. They also entercustomer information required for the application into thecomputer.

Education and Licensing

Most life insurance companies prefer applicants who have aminimum of a bachelor's degree in a field such as businessadministration, finance or economics. Before a producer can sellinsurance, she must receive a license in the state where she



wishes to work by passing a life, accident and health insuranceexam.

Considerations

Life insurance producers travel to meet with customers within adefined territory, but this sometimes allows them to work from ahome-based office. The life insurance field is highly regulated atthe federal and state levels, with policies changing frequently.Producers must stay abreast of regulations to avoid fees andfines.

Compensation

Many life insurance sales positions are commission-based,meaning that producers receive a percentage of the revenuegenerated by sales and receive no compensation if they sellnothing. The average annual median salary for insuranceproducers in the United States was $60,440 in May 2008.

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