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Explain the four types of preference shares that a company can issue
Ans: (i) Convertible and Non-convertible Preference Share : The preference shares which can be converted into equity shares after a specified period of time are known as convertible preference shares. Otherwise, it is known as nonconvertible preference share.
(ii) Cumulative and Non-cumulative Preference Share : In cumulative preference shares, the unpaid dividends are accumulated and carried forward for payment in future years. On the other hand, in non-cumulative preference shares, the dividend is not accumulated if it is not paid out of the current year’s profit.
(iii) Participating and Non-participating Preference Share : Participating preference shares have a right to share the profit after making payment of dividend at a pre-decided rate to the equity shares. The non-participating preference shares do not enjoy such a right.
(iv) Redeemable and Irredeemable Preference Share : Preference shares having a fixed date of maturity are called redeemable preference shares. Here, the company undertakes to return the amount to the preference shareholders immediately after the expiry of a fixed period. Where the amount of the preference shares is refunded only at the time of liquidation, are known an irredeemable preference shares.
Describe ‘External borrowings’ as a form of getting funds from foreign sources.
Ans:
External Borrowings include loans obtained at concessional rates of interest with a long maturity period and commercial borrowings.
The major sources of concessional loans have been the International Monetary Fund (IMF), Aid India Consortium (AIC), Asian Development Bank (ADB), World Bank (International Bank for Reconstruction and Development), and International Financial Corporation.
The World Bank grants loans for specific industrial projects of high priority and given either directly to an industrial concern or through a government agency.
The International Finance Corporation, an affiliate of the World Bank, grants loans to industrial units for a period of 8 to 10 years. Such loans do not require a government guarantee.
The external commercial borrowings are permitted by the government as an important source of finance for Indian firms for expansion investments
What are ‘Debentures’? Describe three merits and three limitations of debentures as a source of long-term finance for a company.
Ans:
The companies can raise long term funds by issuing debentures that carry an assured rate of return for investors in the form of a fixed rate of interest. It is known as debt capital or borrowed capital of the company. The debenture is a written acknowledgement of money borrowed.
The debentureholders are the creditors of the company and are entitled to get interest irrespective of profit earned by the company.
Three merits of Debentures are :
(a) Debentures are secured loans. On winding up of the company, they are repayable before making any payment to the equity and preference shareholders.
(b) The debentureholders get assured return irrespective of profit.
(c) Debentureholders have no right either to vote or take part in the management of the company. So by issuing debentures the company raises the additional capital without diluting the control over its management.
Three Demerits of Debentures :
(a) If the earnings of the company are uncertain and unpredictable, the issue of debentures may pose serious problems due to a fixed obligation to pay interest and repay the principal. So, when the company expects good and stable income, then only it should issue debentures.
(b) The company, which issues debentures, creates a charge on its assets in favour of debentureholders. So a company not having enough fixed assets cannot borrow money by issuing debentures.
(c) The assets of the company once mortgaged cannot be used for further borrowing. So, the issue of debentures reduces the borrowing capacity of the company.
What is meant by ‘Mutual Funds’? Explain its features in brief.
Ans.Mutual fund refers to a fund established in the form of a trust by a sponsor to raise money through one or more schemes for investing in securities.
The essential features of mutual funds are as follows:
1. It is a trust into which a number of investors invest their money in the form of units to form a large pool of funds.
2. The amount is invested in securities by the managers of the fund.
3. The amount is invested in different securities of reputed companies to ensure definite and regular income. Thus, it helps in minimizing the risk.
4. The mutual fund schemes often have the advantages of high return, easy liquidity, safety and tax benefits to the investors.
5. The net income received on the investments of the fund is distributed over the units held.
6. The managers of the fund are obliged to redeem the units on demand or on the expiry of a specified period
Explain the main purposes for which business needs funds
Ans: Every business needs funds mainly for the following purposes:
1. To purchase fixed assets : Every type of business needs finance to purchase some fixed assets like land and building, furniture, machinery etc.
2. To meet day-to-day expenses : Funds are needed to carry out day-to-day operations e.g., purchase of raw materials, payment of rent and taxes, telephone and electricity bills, wages and salaries, etc.
3. To fund business growth : Finance is required for expansion of existing
line of business as well as adding new lines.
4. To bridge the time gap between production and sales : Finance is required to meet expenses that could occur between production and sales.
5. To meet contingencies : Funds are always required to meet the ups and downs
of business and for some unforeseen problems.
6. To avail of business opportunities : Funds are also required to avail of business
opportunities. For example: When a stockist offers special discount on large amount of purchase of any particular material then a manufacturer can avail of
such offer, only if he has adequate funds to buy it.
Name any three special financial institutions and state their objectives.
Ans:
1. Industrial Finance Corporation of India (IFCI) : It is the oldest SFI set up in 1948 with the primary objective of providing long-term and medium-term finance to large industrial enterprises. It provides financial assistance for setting up of new industrial enterprises and for expansion or diversification of activities.
2. Industrial Credit and Investment Corporation of India (ICICI): It was set up in 1955 for providing long-term loans to companies for a period up to 15 years and subscribes to their shares and debentures.
3.Industrial Development Bank of India (IDBI): It was set up in 1964 as a subsidiary of the Reserve Bank of India for providing financial assistance to all types of industrial enterprises without any restriction on the type of finance and the number of funds.
4. Industrial Investment Bank of India (IIBI): The former Industrial Reconstruction Bank of India (IRBI), an institution which was set up for rehabilitation of small units have been reconstituted in 1997 as Industrial Investment Bank of India. It is a full-fledged all-purpose development bank with adequate operational flexibility and autonomy.
“Issuing equity shares for raising long-term finance, from the point of view of management of a company, is considered more advantageous than issuing debentures.” Do you agree? Give reasons in support of your answer.
Answer: I do agree that, Issuing equity shares for raising long-term finance, from the point of view of management of a company, is considered more advantageous than issuing debentures because of the following:
A company can raise capital by issuing equity shares without creating any charge on its fixed assets.
The capital raised by issuing equity shares is not required to be paid back during the lifetime of the company. It will be paid back only when the company is winding up.
There is no binding on the company to pay dividend on equity shares. The company may declare dividend only if there are enough profits.
If a company raises more capital by issuing equity shares, it leads to greater confidence among the creditors.
Explain ‘Capital Market’ as a source of long-term finance.
Ans:
Capital market refers to the organization and the mechanism through which the companies, other institutions, and the government raise long-term funds.
It constitutes all long-term borrowings from banks and financial institutions, borrowings from foreign markets, and raising of capital by issuing various securities such as shares, debentures, bonds, etc.
For the trading of securities, there are two different segments in the capital market i.e.primary market and secondary market.
The primary market deals with new/fresh issue of securities and is, therefore, known as the new issue market.
The secondary market provides a place for the purchase and sale of existing securities and is known as the stock market or stock exchange.
‘Soham & Anei’ is a business firm marketing apparels in Delhi. They are interested in raising short-term finance and approach State Bank of India for the same. Explain any four ways in which bank credit may be granted.
Answer: Four ways in which bank credit may be granted are:
Loans and Advances: When a certain amount of money is advanced by a bank repayable after a specified period, it is known as bank loan. Usually loans are granted against security of assets.
Cash Credit: It is an arrangement whereby banks allow the borrower to withdraw money upto a specified limit. This limit is known as cash credit limit. This facility is granted against the security of goods in stock or other marketable securities like government bonds.
Bank Overdraft: When a bank allows its depositors or account holders to withdraw money in excess of the balance in his current deposit account up to a specified limit, it is known as overdraft facility. This limit is granted purely on the basis of credit-worthiness of the borrower.
Factoring: Factoring is a method of raising short-term finance for the business in which the business can take advance money from the bank against the amount to be realised from the debtors.
Explain the role of NBFCs in providing long-term finance.
Ans:
Non-Banking Financial Companies perform the twin functions of accepting deposits from the public and providing loans.
However, they are not regarded as banking companies as they do not carry on the normal banking activities.
They raise funds from the public by offering an attractive rate of interest and give loans mainly to wholesale and retail traders, small-scale industries, and self-employed persons.
The loans granted by these finance companies are generally unsecured and the interest charged by them ranges between 24 to 36 percent per annum.
Besides giving loans and advances, the NBFCs also have purchase and discount hundis, undertaken merchant banking, housing finance, lease financing, hire purchase business, etc.