BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

UNIT IV
Business Finance: Financial need of Business methods & sources of finance. Security Market, Money Market, Study of Stock
Exchanges & SEBI.
Domestic and Foreign Trade: Whole sale and Retail Trade Emergence of Foreign players in trading Government policy-Effects
of FDI on retail tradeImport and Export procedure

BUSINESS FINANCE
Business finance refers to money and credit employed in business. It involves procurement and utilization of funds so that
business firms may be able to carry out their operations effectively and efficiently. The following characteristics of business
finance will make its meaning more clear:
(i)
Business finance includes all types of funds used in business.
(ii)
Business finance is needed in all types of organisations large or small, manufacturing or trading.
(iii)
The amount of business finance differs from one business firm to another depending upon its nature and size. It
also varies from time to time.
(iv)
Business finance involves estimation of funds. It is concerned with raising funds from different sources as well as
investment of funds for different purposes.
NEED AND IMPORTANCE
A business cannot function unless adequate funds are made available to it. The initial capital contributed by the entrepreneur is
not always sufficient to take care of all financial requirements of the business. A business person, therefore, has to look for
different other sources from where the need for funds can be met. A clear assessment of the financial needs and the
identification of various sources of finance, therefore, is a significant aspect of running a business organisation. The need for
funds arises from the stage when an entrepreneur makes a decision to start a business. Some funds are needed immediately say
for the purchase of plant and machinery, furniture, ad other fixed assets.
Similarly, some funds are required for day-to-day operations, say to purchase raw materials, pay salaries to employees, etc. Also
when the business expands, it needs funds. The financial needs of a business can be categorised as follows:
FIXED CAPITAL REQUIREMENTS: In order to start business, funds are required to purchase fixed assets like land and building,
plant and machinery, and furniture and fixtures. This is known as fixed capital requirements of the enterprise. The funds
required in fixed assets remain invested in the business for a long period of time. Different business units need varying amount
of fixed capital depending on various factors such as the nature of business, etc. A trading concern for example, may require
small amount of fixed capital as compared to a manufacturing concern. Likewise, the need for fixed capital investment would be
greater for a large enterprise, as compared to that of a small enterprise.
WORKING CAPITAL REQUIREMENTS: The financial requirements of an enterprise do not end with the procurement of fixed
assets. No matter how small or large a business is, it needs funds for its day-to-day operations. This is known as working capital
of an enterprise, which is used for holding current assets such as stock of material, bills receivables and for meeting current
expenses like salaries, wages, taxes, and rent.
The amount of working capital required varies from one business concern to another depending on various factors. A business
unit selling goods on credit, or having a slow sales turnover, for example, would require more working capital as compared to a
concern selling its goods and services on cash basis or having a speedier turnover. The requirement for fixed and working capital
increases with the growth and expansion of business. At times additional funds are required for upgrading the technology
employed so that the cost of production or operations can be reduced. Similarly, larger funds may be required for building
higher inventories for the festive season or to meet current debts or expand the business or to shift to a new location. It is,
therefore, important to evaluate the different sources from where funds can be raised.

CLASSIFICATION OF SOURCES OF FUNDS

In case of proprietary and partnership concerns, the funds may be raised either from personal sources or borrowings from
banks, friends etc. In case of company form of organisation, the different sources of business finance which are available may be
categorised as given in chart. As shown in the chart, the sources of funds can be categorised using different basis viz., on the
basis of the period, source of generation and the ownership. A brief explanation of these classifications and the sources is
provided as follows:

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The long-term sources fulfil the financial requirements of an enterprise for a period exceeding 5 years and include sources such
as shares and debentures, long-term borrowings and loans from financial institutions. Such financing is generally required for
the acquisition of fixed assets such as equipment, plant, etc. Where the funds are required for a period of more than one year
but less than five years, medium-term sources of finance are used. These sources include borrowings from commercial banks,
public deposits, lease financing and loans from financial institutions.

PERIOD BASIS: On the basis of period, the different sources of funds can be categorised into three parts. These are long-term
sources, medium-term sources and short-term sources.

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

Short-term funds are those which are required for a period not exceeding one year. Trade credit, loans from commercial banks
and commercial papers are some of the examples of the sources that provide funds for short duration. Short-term financing is
most common for financing of current assets such as accounts receivable and inventories. Seasonal businesses that must build
inventories in anticipation of selling requirements often need short term financing for the interim period between seasons.
Wholesalers and manufacturers with a major portion of their assets tied up in inventories or receivables also require large
amount of funds for a short period.
OWNERSHIP BASIS
On the basis of ownership, the sources can be classified into owners funds and borrowed funds.
Owners funds: Owners funds means funds that are provided by the owners of an enterprise, which may be a sole trader or
partners or shareholders of a company. Apart from capital, it also includes profits reinvested in the business. The owners capital
remains invested in the business for a longer duration and is not required to be refunded during the life period of the business.
Such capital forms the basis on which owners acquire their right of control of management. Issue of equity shares and retained
earnings are the two important sources from where owners funds can be obtained.
Borrowed funds: Borrowed funds on the other hand, refer to the funds raised through loans or borrowings. The sources for
raising borrowed funds include loans from commercial banks, loans from financial institutions, issue of debentures, public
deposits and trade credit. Such sources provide funds for a specified period, on certain terms and conditions and have to be
repaid after the expiry of that period. A fixed rate of interest is paid by the borrowers on such funds. At times it puts a lot of
burden on the business as payment of interest is to be made even when the earnings are low or when loss is incurred. Generally,
borrowed funds are provided on the security of some fixed assets.
SOURCE OF GENERATION BASIS
Another basis of categorising the sources of funds can be whether the funds are generated from within the organisation or from
external sources. Internal sources of funds are those that are generated from within the business.

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External sources of funds include those sources that lie outside an organisation, such as suppliers, lenders, and investors. When
large amount of money is required to be raised, it is generally done through the use of external sources. External funds may be
costly as compared to those raised through internal sources. In some cases, business is required to mortgage its assets as
security while obtaining funds from external sources. Issue of debentures, borrowing from commercial banks and financial
institutions and accepting public deposits are some of the examples of external sources of funds commonly used by business
organisations.

A business, for example, can generate funds internally by accelerating collection of receivables, disposing of surplus inventories
and ploughing back its profit. The internal sources of funds can fulfil only limited needs of the business.

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

SHORT-TERM FINANCE
After establishment of a business, funds are required to meet its day to day expenses. For example raw materials must be
purchased at regular intervals, workers must be paid wages regularly, water and power charges have to be paid regularly. Thus
there is a continuous necessity of liquid cash to be available for meeting these expenses. For financing such requirements shortterm funds are needed. The availability of short-term funds is essential. Inadequacy of short-term funds may even lead to
closure of business.
SHORT-TERM FINANCE SERVES FOLLOWING PURPOSES
1. It facilitates the smooth running of business operations by meeting day to day financial requirements.
2. It enables firms to hold stock of raw materials and finished product.
3. With the availability of short-term finance goods can be sold on credit. Sales are for a certain period and collection of
money from debtors takes time. During this time gap, production continues and money will be needed to finance
various operations of the business.
4. Short-term finance becomes more essential when it is necessary to increase the volume of production at a short notice.
5. Short-term funds are also required to allow flow of cash during the operating cycle. Operating cycle refers to the time
gap between commencement of production and realisation of sales.
SOURCES OF SHORT-TERM FINANCE
There are a number of sources of short-term finance which are listed below:
1. Trade credit
2. Factoring
3. Bank credit
Loans and advances
Cash credit
Overdraft
Discounting of bills
4. Customers advances
5. Instalment credit
6. Loans from co-operatives
7. Commercial Papers

MERITS AND DEMERITS OF SHORT-TERM FINANCE

Short-term loans help business concerns to meet their temporary requirements of money. They do not create a heavy burden of
interest on the organisation. But sometimes organisations keep away from such loans because of uncertainty and other reasons.
Let us examine the merits and demerits of short-term finance.
MERITS OF SHORT-TERM FINANCE
I.
Economical: Finance for short-term purposes can be arranged at a short notice and does not involve any cost of raising.
The amount of interest payable is also affordable. It is, thus, relatively more economical to raise short-term finance.
II.
Flexibility: Loans to meet short-term financial need can be raised as and when required. These can be paid back if not
required. This provides flexibility.
III.
No interference in management: The lenders of short-term finance cannot interfere with the management of the
borrowing concern. The management retain their freedom in decision making.
IV.
May also serve long-term purposes: Generally business firms keep on renewing short-term credit, e.g., cash credit is
granted for one year but it can be extended upto 3 years with annual review. After three years it can be renewed. Thus,
sources of short-term finance may sometimes provide funds for long-term purposes.

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DEMERITS OF SHORT-TERM FINANCE

Short-term finance suffers from a few demerits which are listed below:
I.
Fixed Burden: Like all borrowings interest has to be paid on short-term loans irrespective of profit or loss earned by the
organisation. That is why business firms use short-term finance only for temporary purposes.
II.
Charge on assets: Generally short-term finance is raised on the basis of security of moveable assets. In such a case the
borrowing concern cannot raise further loans against the security of these assets nor can these be sold until the loan is
cleared (repaid).
III.
Difficulty of raising finance: When business firms suffer intermittent losses of huge amount or market demand is
declining or industry is in recession, it loses its creditworthiness. In such circumstances they find it difficult to borrow
from banks or other sources of short-term finance.
IV.
Uncertainty: In cases of crisis business firms always face the uncertainty of securing funds from sources of short-term
finance. If the amount of finance required is large, it is also more uncertain to get the finance.
V.
Legal formalities: Sometimes certain legal formalities are to be complied with for raising finance from short-term
sources. If shares are to be deposited as security, then transfer deed must be prepared. Such formalities take lot of
time and create lot of complications.

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BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

1 TRADE CREDIT: Trade credit is the credit extended by one trader to another for the purchase of goods and services. Trade
credit facilitates the purchase of supplies without immediate payment. Such credit appears in the records of the buyer of goods
as sundry creditors or accounts payable. Trade credit is commonly used by business organisations as a source of short-term
financing. It is granted to those customers who have reasonable amount of financial standing and goodwill. The volume and
period of credit extended depends on factors such as reputation of the purchasing firm, financial position of the seller, volume
of purchases, past record of payment and degree of competition in the market. Terms of trade credit may vary from one
industry to another and from one person to another. A firm may also offer different credit terms to different customers.
MERITS
The important merits of trade credit are as follows:
1. Trade credit is a convenient and continuous source of funds;
2. Trade credit may be readily available in case the credit worthiness of the customers is known to the seller;
3. Trade credit needs to promote the sales of an organisation;
4. If an organisation wants to increase its inventory level in order to meet expected rise in the sales volume in the near
future, it may use trade credit to, finance the same;
5. It does not create any charge on the assets of the firm while providing funds.
LIMITATIONS
Trade credit as a source of funds has certain limitations, which are given as follows:
1. Availability of easy and flexible trade credit facilities may induce a firm to indulge in overtrading, which may add to the
risks of the firm;
2. Only limited amount of funds can be generated through trade credit;
3. It is generally a costly source of funds as compared to most other sources of raising money.
2 FACTORING
A factor is a financial intermediary that purchases receivables from a company. A factor is essentially a funding source that
agrees to pay the company the value of the invoice less a discount for commission and fees. The factor advances most of the
invoiced amount to the company immediately and the balance upon receipt of funds from the invoiced party.

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Factoring is a financial service under which the factor renders various services which includes:
(a) Discounting of bills (with or without recourse) and collection of the clients debts. Under this, the receivables on
account of sale of goods or services are sold to the factor at a certain discount. The factor becomes responsible for all
credit control and debt collection from the buyer and provides protection against any bad debt losses to the firm. There
are two methods of factoringrecourse and non-recourse. Under recourse factoring, the client is not protected against
the risk of bad debts. On the other hand, the factor assumes the entire credit risk under non-recourse factoring i.e., full
amount of invoice is paid to the client in the event of the debt becoming bad.
(b) Providing information about credit worthiness of prospective clients etc., Factors hold large amounts of information
about the trading histories of the firms. This can be valuable to those who are using factoring services and can thereby
avoid doing business with customers having poor payment record. Factors may also offer relevant consultancy services
in the areas of finance, marketing, etc. The factor charges fees for the services rendered. Factoring appeared on the
Indian financial scene only in the early nineties as a result of RBI initiatives. The organisations that provide such services
include SBI Factors and Commercial Services Ltd., Canbank Factors Ltd., Foremost Factors Ltd., State Bank of India,
Canara Bank, Punjab National Bank, Allahabad Bank. In addition, many non-banking finance companies and other
agencies provide factoring service.
Merits
The merits of factoring as a source of finance are as follows:
(i)
Obtaining funds through factoring is cheaper than financing through other means such as bank credit;
(ii)
With cash flow accelerated by factoring, the client is able to meet his/her liabilities promptly as and when these
arise;
(iii)
Factoring as a source of funds is flexible and ensures a definite pattern of cash inflows from credit sales. It provides
security or a debt that a firm might otherwise be unable to obtain;
(iv)
It does not create any charge on the assets of the firm;
(v)
The client can concentrate on other functional areas of business as the responsibility of credit control is shouldered
by the factor.
Limitations
The limitations of factoring as a source of finance are as follows:
(i)
This source is expensive when the invoices are numerous and smaller in amount;
(ii)
The advance finance provided by the factor firm is generally available at a higher interest cost than the usual rate
of interest;
(iii)
The factor is a third party to the customer who may not feel comfortable while dealing with it.

Example of Factoring
Assume a factor has agreed to purchase an invoice of $1 million from Clothing Manufacturers Inc., representing outstanding
receivables from Behemoth Co. The factor may discount the invoice by say 4%, and will advance $720,000 to Clothing
Manufacturers Inc. The balance of $240,000 will be forwarded by the factor to Clothing Manufacturers Inc. upon receipt of the
$1 million from Behemoth Co. The factor's fees and commissions from this factoring deal amount to $40,000.

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

3 BANK CREDIT
Commercial banks grant short-term finance to business firms which are known as bank credit. When bank credit is granted, the
borrower gets a right to draw the amount of credit at one time or in instalments as and when needed. Bank credit may be
granted by way of loans, cash credit, overdraft and discounted bills.
I. Loans: When a certain amount is advanced by a bank repayable after a specified period, it is known as bank loan. Such
advance is credited to a separate loan account and the borrower has to pay interest on the whole amount of loan
irrespective of the amount of loan actually drawn. Usually loans are granted against security of assets.
II. 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. Initially this limit is granted for one year. This limit can be extended after review for another
year. However, if the borrower still desires to continue the limit, it must be renewed after three years. Rate of interest
varies depending upon the amount of limit. Banks ask for collateral security for the grant of cash credit. In this
arrangement, the borrower can draw, repay and again draw the amount within the sanctioned limit. Interest is charged
only on the amount actually withdrawn and not on the amount of entire limit.
III. Overdraft : When a bank allows its depositors or account holders to withdraw money in excess of the balance in his
account upto a specified limit, it is known as overdraft facility. This limit is granted purely on the basis of credit-worthiness
of the borrower. Banks generally give the limit upto Rs.20,000. In this system, the borrower has to show a positive balance
in his account on the last Friday of every month. Interest is charged only on the overdrawn money. Rate of interest in case
of overdraft is less than the rate charged under cash credit.
IV. Discounting of Bill: Banks also advance money by discounting bills of exchange, promissory notes and hundies. When these
documents are presented before the bank for discounting, banks credit the amount to customers account after deducting
discount. The amount of discount is equal to the amount of interest for the period of bill.
DISTINCTION BETWEEN BANK OVERDRAFT AND CASH CREDIT
a. Cash credit is a separate arrangement of credit granted by a bank to a firm. The firm may or may not have an account
with the bank. Overdraft is granted to an account holder purely on the basis of his credit-worthiness. Credit worthiness is
decided by the financial soundness of past dealings of the customer with the bank.
b. In case of cash credit, the amount of credit is placed in a separate account of the borrower. Overdraft limit is generally
granted to an existing account of the customer.
c. The amount of credit in case of cash credit depends upon the value of securities offered. But overdraft limit is decided on
the average balance of the customer in his account.
d. Overdraft is granted without the security of tangible assets. But for cash credit security of tangible assets is an essential
requirement.

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4 CUSTOMERS ADVANCES
Sometimes businessmen insist on their customers to make some advance payment. It is generally asked when the value of order
is quite large or things ordered are very costly. Customers advance represents a part of the payment towards price on the
product (s) which will be delivered at a later date. Customers generally agree to make advances when such goods are not easily
available in the market or there is an urgent need of goods. A firm can meet its short-term requirements with the help of
customers advances.
Merits and Demerits of Customers advances as a source of Short-term Finance
Customers advance refers to advance made by the customer against the value of order placed. It is, thus, a part payment of the
value of goods to be supplied later.
Merits
a. Interest free: Amount offered as advance is interest free. Hence funds are available without involving financial burden.
b. No tangible security: The seller is not required to deposit any tangible security while seeking advance from the customer.
Thus assets remain free of charge.
c. No repayment obligation: Money received as advance is not to be refunded. Hence there are no repayment obligations.
Demerits
a. Limited amount: The amount advanced by the customer is subject to the value of the order. Borrowers need may be
more than the amount of advance.
b. Limited period: The period of customers advance is only upto the delivery goods. It can not be reviewed or renewed.
c. Penalty in case of non-delivery of goods: Generally advances are subject to the condition that in case goods are not
delivered on time, the order would be cancelled and the advance would have to be refunded along with interest.

RELATIVE MERITS OF TRADE CREDIT AND BANK CREDIT

Trade credit is extended by the supplier for a limited period to facilitate purchases. Bank credit is obtained from banks and can
be utilised for any purpose. The relative merits of trade credit and bank credit are as follows:a. Trade credit is available only with purchase of raw material or finished goods. It serves a limited purpose. But bank credit
can be utilised by the borrower for any purpose that he may have in view.
b. In case of trade credit, payment has to be made after the expiry of credit period. However in case of bank credit
(overdraft, cash credit, etc.) repayment after a certain period is not compulsory. The arrangement may be continued.
c. No security is required to avail of trade credit. Banks generally ask for some security while advancing credit.
d. Interest is not payable in case of trade credit, provided payments are made within the credit period. Interest has to be
paid on bank credit in all circumstances.
e. The terms and conditions of trade credit vary according to the custom and usage of trade. Bank credit is granted on the
terms and conditions which generally are the same for all types of business.

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5 INSTALMENT CREDIT
Instalment credit is now-a-days a popular source of finance for consumer goods like television, refrigerators as well as for
industrial goods. You might be aware of this system. Only a small amount of money is paid at the time of delivery of such
articles. The balance is paid in a number of instalments. The supplier charges interest for extending credit. The amount of
interest is included while deciding on the amount of instalment. Another comparable system is the hire purchase system under
which the purchaser becomes owner of the goods after the payment of last instalment. Sometimes commercial banks also grant
instalment credit if they have suitable arrangements with the suppliers.
Advantages
a. Immediate possession of assets: Delivery of assets is assured immediately on payment of initial instalment (down
payment).
b. Convenient payment for assets and equipments: Costly assets and equipments which cannot be purchased due to
inadequacy of long-term funds can be conveniently purchased on payment by instalments.
c. Saving of one time investment: If the value of asset or equipment is very high, funds of the business are likely to be
blocked if lumpsum payment is made. Instalment credit leads to saving on one time investment.
d. Facilitates expansion and modernisation of business and office: Business firms can afford to buy necessary
equipments and machines when the facility of payment in instalments is available.
e. Thus, expansion and modernisation of business and office are facilitated by instalment credit.
Disadvantages
a. Committed expenditure: Payment of instalment is a commitment to pay irrespective of profit or loss in the business.
b. Obligation to pay interest: Under instalment credit system payment of interest of obligatory. Generally sellers charge a
high rate of interest.
c. Additional burden in case of default: Sellers sometimes impose stringent conditions in the form of penalty or
additional interest, if the buyer fails to pay the instalment amount.
d. Cash does not flow: Like trade credit, instalment credit facilitates the purchase of asset or equipment. It does not make
cash available which can be utilised for all needful purposes.
6 LOANS FROM CO-OPERATIVE BANKS
Co-operative banks are a good source to procure short-term finance. Such banks have been established at local, district and
state levels. District Cooperative Banks are the federation of primary credit societies. The State Cooperative Bank finances and
controls the District Cooperative Banks in the state. They are also governed by Reserve Bank of India regulations. Some of these
banks like the Vaish Co-operative Bank was initially established as a co-operative society and later converted into a bank. These
banks grant loans for personal as well as business purposes. Membership is the primary condition for securing loan. The
functions of these banks are largely comparable to the functions of commercial banks.
Benefits
I.
Loans from co-operative banks are easily available to farmers and small businessmen involving minimium formalities.
II.
Co-operative banks provide a convenient means of borrowing. Loans are generally granted at a lower rate of interest.
III.
Sometimes co-operative banks organise training programmes for members to familiarise them with the various
avenues of business and regarding proper utilisation of loan money.
IV.
Being a member of a cooperative bank, the borrower can participate in the management and also share in the profits of
the society.
V.
Co-operative loans create a sense of thrift and self-reliance among the low income group.
VI.
Loans are generally given for productive purposes and that helps to develop the financial and social status of the
people.
Drawbacks
I.
Loan from co-operative banks is available only to members.
II.
Co-operative banks find it difficult to ensure repayment of loan money due to inadequate information about the need
and utilisation of funds by the borrower. There is little scrutiny of the repaying capacity of the loan seeker at the time of
granting loan.
III.
Inadequate resources and lack of trained personnel for management have restricted the spread of co-operative banking
facilities.
IV.
Co-operative banks depend largely on the support of the Government. Therefore Government rules and regulations
sometime create hurdles for the borrowers.
V.
Credit from co-operative banks is available only for limited purposes.

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Example of Commercial Paper

An example of commercial paper is when a retail firm is looking for short-term funding to finance some new inventory for an
upcoming holiday season. The firm needs $10 million and it offers investors $10.1 million in face value of commercial paper in

7 COMMERCIAL PAPER (CP)

Commercial paper is an unsecured form of promissory note that pays a fixed rate of interest. It is typically issued by large banks
or corporations to cover short-term receivables and meet short-term financial obligations, such as funding for a new project. As
with any other type of bond or debt instrument, the issuing entity offers the paper assuming that it will be in a position to pay
both interest and principal by maturity.

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

exchange for $10 million in cash, according to prevailing interest rates. In effect, there would be a $0.1 million interest payment
upon maturity of the commercial paper in exchange for the $10 million in cash, equating to an interest rate of 1%. This interest
rate can be adjusted for time, contingent on the number of days the commercial paper is outstanding.
Commercial Paper emerged as a source of short term finance in our country in the early nineties. Commercial paper is an
unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days. It is issued by
one firm to other business firms, insurance companies, pension funds and banks. The amount raised by CP is generally very
large. As the debt is totally unsecured, the firms having good credit rating can issue the CP. Its regulation comes under the
purview of the Reserve Bank of India. The merits and limitations of a Commercial Paper are as follows:

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Merits
I.
A commercial paper is sold on an unsecured basis and does not contain any restrictive conditions;
II.
As it is a freely transferable instrument, it has high liquidity;
III.
It provides more funds compared to other sources. Generally, the cost of CP to the issuing firm is lower than the cost of
commercial bank loans;
IV.
A commercial paper provides a continuous source of funds. This is because their maturity can be tailored to suit the
requirements of the issuing firm. Further, maturing commercial paper can be repaid by selling new commercial paper;
V.
Companies can park their excess funds in commercial paper thereby earning some good return on the same.
Limitations
I.
Only financially sound and highly rated firms can raise money through commercial papers. New and moderately rated
firms are not in a position to raise funds by this method.

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BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

LONG TERM FINANCE

MEANING AND PURPOSE
A business requires funds to purchase fixed assets like land and building, plant and machinery, furniture etc. These assets may
be regarded as the foundation of a business. The capital required for these assets is called fixed capital. A part of the working
capital is also of a permanent nature. A fund required for this part of the working capital and for fixed capital is called long term
finance.
PURPOSE OF LONG TERM FINANCE:
Long term finance is required for the following purposes:
1. To Finance fixed assets:
Business requires fixed assets like machines, Building, furniture etc. Finance required to buy these assets is for a long period,
because such assets can be used for a long period and are not for resale.
2. To finance the permanent part of working capital:
Business is a continuing activity. It must have a certain amount of working capital which would be needed again and again. This
part of working capital is of a fixed or permanent nature. This requirement is also met from long term funds.
3. To finance growth and expansion of business:
Expansion of business requires investment of a huge amount of capital permanently or for a long period.
FACTORS DETERMINING LONG-TERM FINANCIAL REQUIREMENTS:
The amount required to meet the long term capital needs of a company depend upon many factors. These are:
(a) Nature of Business:
The nature and character of a business determines the amount of fixed capital. A manufacturing company requires land,
building, machines etc. So it has to invest a large amount of capital for a long period. But a trading concern dealing in, say,
washing machines will require a smaller amount of long term fund because it does not have to buy building or machines.
(b) Nature of goods produced:
If a business is engaged in manufacturing small and simple articles it will require a smaller amount of fixed capital as compared
to one manufacturing heavy machines or heavy consumer items like cars, refrigerators etc. which will require more fixed capital.
(c) Technology used:
In heavy industries like steel the fixed capital investment is larger than in the case of a business producing plastic jars using
simple technology or producing goods using labour intensive technique.

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1 SHARES
Issue of shares is the main source of long term finance. Shares are issued by joint stock companies to the public. A company
divides its capital into units of a definite face value, say of Rs. 10 each or Rs. 100 each. Each unit is called a share. A person
holding shares is called a shareholder.
Characteristics of shares:
The main characteristics of shares are following:
1. It is a unit of capital of the company. 2. Each share is of a definite face value.
3. A share certificate is issued to a shareholder indicating the number of shares and the amount.
4. Each share has a distinct number.
5. The face value of a share indicates the interest of a person in the company and the extent of his liability.

SOURCES OF LONG TERM FINANCE

The main sources of long term finance are as follows:
1. Shares:
These are issued to the general public. These may be of two types: (i) Equity and (ii) Preference. The holders of shares are the
owners of the business.
2. Debentures:
These are also issued to the general public. The holders of debentures are the creditors of the company.
3. Public Deposits:
General public also like to deposit their savings with a popular and well established company which can pay interest periodically
and pay-back the deposit when due.
4. Retained earnings:
The company may not distribute the whole of its profits among its shareholders. It may retain a part of the profits and utilize it
as capital.
5. Term loans from banks:
Many industrial development banks, cooperative banks and commercial banks grant medium term loans for a period of three to
five years.
6. Loan from financial institutions:
There are many specialised financial institutions established by the Central and State governments which give long term loans at
reasonable rate of interest. Some of these institutions are:
Industrial Finance Corporation of India ( IFCI), Industrial Development Bank of India (IDBI), Industrial Credit and Investment
Corporation of India (ICICI), Unit Trust of India ( UTI ), State Finance Corporations etc. These sources of long term finance will be
discussed in the next lesson.

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BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

6. Shares are transferable units. Investors are of different habits and temperaments. Some want to take lesser risk and are
interested in a regular income. There are others who may take greater risk in anticipation of huge profits in future. In order to
tap the savings of different types of people, a company may issue different types of shares. These are:
1. Preference shares, and
2. Equity Shares.
Preference Shares:
Preference Shares are the shares which carry preferential rights over the equity shares. These rights are (a) receiving dividends
at a fixed rate, (b) getting back the capital in case the company is wound-up. Investment in these shares is safe, and a preference
shareholder also gets dividend regularly.
Equity Shares:
Equity shares are shares which do not enjoy any preferential right in the matter of payment of dividend or reppayment of
capital. The equity shareholder gets dividend only after the payment of dividends to the preference shares. There is no fixed rate
of dividend for equity shareholders. The rate of dividend depends upon the surplus profits. In case of winding up of a company,
the equity share capital is refunded only after refunding the preference share capital. Equity shareholders have the right to take
part in the management of the company. However, equity shares also carry more risk. Following are the merits and demerits of
equity shares:
(a) Merits
(A) To the shareholders:
1. In case there are good profits, the company pays dividend to the equity shareholders at a higher rate.
2. The value of equity shares goes up in the stock market with the increase in profits of the concern.
3. Equity shares can be easily sold in the stock market.
4. Equity shareholders have greater say in the management of a company as they are conferred voting rights by the
Articles of Association.
(B) To the Management:
1. A company can raise fixed capital by issuing equity shares without creating any charge on its fixed assets.
2. The capital raised by issuing equity shares is not required to be paid back during the life time of the company. It will
be paid back only if the company is wound up.
3. There is no liability on the company regarding payment of dividend on equity shares. The company may declare
dividend only if there is enough profits.
4. If a company raises more capital by issuing equity shares, it leads to greater confidence among the investors and
creditors.
Demerits :
(A) To the shareholders
1. Uncertainly about payment of dividend:
Equity share-holders get dividend only when the company is earning sufficient profits and the Board of Directors
declare dividend. If there are preference shareholders, equity shareholders get dividend only after payment of dividend
to the preference shareholders.
2. Speculative:
Often there is speculation on the prices of equity shares. This is particularly so in times of boom when dividend paid by
the companies is high.
3. Danger of overcapitalisation:
In case the management miscalculates the long term financial requirements, it may raise more funds than required by
issuing shares. This may amount to over-capitalization which in turn leads to low value of shares in the stock market.
4. Ownership in name only:
Holding of equity shares in a company makes the holder one of the owners of the company. Such shareholders enjoy
voting rights. They manage and control the company. But then it is all in theory. In practice, a handful of persons
control the votes and manage the company. Moreover, the decision to declare dividend rests with the Board of
Directors.
5. Higher Risk:
Equity shareholders bear a very high degree of risk. In case of losses they do not get dividend. In case of winding up of a
company, they are the very last to get refund of the money invested. Equity shares actually swim and sink with the
company.
B) To the Management
1. No trading on equity:
Trading on equity means ability of a company to raise funds through preference shares, debentures and bank loans etc.
On such funds the company has to pay at a fixed rate. This when profits are large. The major part of the profit earned is
paid to the equity shareholders because borrowed funds carry only a fixed rate of interest. But if a company has only
equity shares and does not have either preference shares, debentures or loans, it cannot have the advantage of trading
on equity.
2. Conflict of interests:
As the equity shareholders carry voting rights, groups are formed to corner the votes and grab the control of the
company. There develops conflict of interests which is harmful for the smooth functioning of a company.

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BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

2 DEBENTURES
Whenever a company wants to borrow a large amount of fund for a long but fixed period, it can borrow from the general public
by issuing loan certificates called Debentures. The total amount to be borrowed is divided into units of fixed amount say of
Rs.100 each. These units are called Debentures. These are offered to the public to subscribe in the same manner as is done in
the case of shares. A debenture is issued under the common seal of the company. It is a written acknowledgement of money
borrowed. It specifies the terms and conditions, such as rate of interest, time repayment, and security offered, etc.
Characteristics of Debenture
Following are the characteristics of Debentures:
i) Debenture holders are the creditors of the company. They are entitled to periodic payment of interest at a fixed rate.
ii) Debentures are repayable after a fixed period of time, say five years or seven years as per agreed terms.
iii) Debenture holders do not carry voting rights.
iv) Ordinarily, debentures are secured. In case the company fails to pay interest on debentures or repay the principal
amount, the debenture holders can recover it from the sale of the assets of the company.
Types of Debentures:
Debentures may be classified as:
a) Redeemable Debentures and Irredeemable Debentures
b) Convertible Debentures and Non-convertible Debentures.
c) Secured and Unsecured Debenture
d) Registered and Bearer Denecture
Redeemable Debentures:
These are debentures repayable on a pre-determined date or at any time prior to their maturity, provided the company so
desires and gives a notice to that effect.
Irredeemable Debentures:
These are also called perpetual debentures. A company is not bound to repay the amount during its life time. If the issuing
company fails to pay the interest, it has to redeem such debentures.
Convertible Debentures:
The holders of these debentures are given the option to convert their debentures into equity shares at a time and in a ratio as
decided by the company.
Non-convertible Debentures:
These debentures cannot be converted into shares.
Secured and Unsecured: Secured debentures are such which create a charge on the assets of the company, thereby
mortgaging the assets of the company. Unsecured debentures on the other hand do not carry any charge or security on the
assets of the company.

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Merits of debentures:
Following are some of the advantages of debentures:
1) Raising funds without allowing control over the company: Debenture holders have no right either to vote or take
part in the management of the company.
2) Reliable source of long term finance: Since debentures are ordinarily issued for a fixed period, the company can
make the best use of the money. It helps long term planning.
3) Tax Benefits: Interest paid on debentures is treated as an expense and is charged to the profits of the company. The
company thus saves income tax.
4) Investors Safety: Debentures are mostly secured. On winding up of the company, they are repayable before any
payment is made to the shareholders. Interest on debentures is payable irrespective of profit or loss.
Demerits of debentures:
Following are the demerits of debentures:
1. As the interests on debentures have to be paid every year whether there are profits or not, it becomes burdensome
in case the company incurs losses.
2. Usually the debentures are secured. The company creates a charge on its assets in favour of debenture holders. So a
company which does not own enough fixed assets cannot borrow money by issuing debentures. Moreover, the assets
of the company once mortgaged cannot be used for further borrowing. 3. Debenture-finance enables a company to
trade on equity. But too much of such finance leaves little for shareholders, as most of the profits may be required to
pay interest on debentures. This brings frustration in the minds of shareholders and the value of shares may fall in the
securities markets.
4. Burdensome in times of depression: During depression the profits of the company decline. It may be difficult to pay
interest on debentures. As interest goes on accumulating, it may lead to the closure of the company. Until now you
have learnt about issue of shares and debentures as two main sources of raising long term finance. You have also learnt
about the merits and demerits of the two. Now let us make a comparative study of shares and debentures for raising
long term capital.

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Registered and Bearer: Registered debentures are those which are duly recorded in the register of debenture holders
maintained by the company. These can be transferred only through a regular instrument of transfer. In contrast, the
debentures which are transferable by mere delivery are called bearer debentures.

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

3 RETAINED EARNINGS
Like an individual, companies also set aside a part of their profits to meet future requirements of capital. Companies keep these
savings in various accounts such as General Reserve, Debenture Redemption Reserve and Dividend Equalisation Reserve etc.
These reserves can be used to meet long term financial requirements. The portion of the profits which is not distributed among
the shareholders but is retained and is used in business is called retained earnings or ploughing back of profits. As per Indian
Companies Act., companies are required to transfer a part of their profits in reserves. The amount so kept in reserve may be
used to buy fixed assets. This is called internal financing.
Merits:
Following are the benefits of retained earnings:
1. Cheap Source of Capital: No expenses are incurred when capital is available from this source. There is no obligation
on the part of the company either to pay interest or pay back the money. It can safely be used for expansion and
modernization of business.
2. Financial stability: A company which has enough reserves can face ups and downs in business. Such companies can
continue with their business even in depression, thus building up its goodwill.
3. Benefits to the shareholders: Shareholders may get dividend out of reserves even if the company does not earn
enough profit. Due to reserves, there is capital appreciation, i.e. the value of shares go up in the share market.
Limitation:
Following are the limitations of Retained Earnings:
1. Huge Profit: This method of financing is possible only when there are huge profits and that too for many years.
2. Dissatisfaction among shareholders: When funds accumulate in reserves, bonus shares are issued to the
shareholders to capitalise such funds. Hence the company has to pay more dividends. By retained earnings the real
capital does not increase while the liability increases. In case bonus shares are not issued, it may create a situation of
undercapitalisation because the rate of dividend will be much higher as compared to other companies.
3. Fear of monopoly: Through ploughing back of profits, companies increase their financial strength. Companies may
throw out their competitors from the market and monopolize their position.
4. Mis-management of funds: Capital accumulated through retained earnings encourages management to spend
carelessly.

4 PUBLIC DEPOSITS

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Procedure to raise funds through public deposits:

An undertaking which wants to raise funds through public deposits advertises in the newspapers. The advertisement highlights
the achievements and future prospects of the undertaking and invites the investors to deposit their savings with it. It declares
the rate of interest which may vary depending upon the period for which money is deposited.
It also declares the time and mode of payment of interest and the repayment of deposits. A depositor may get his money back
before the date of repayment of deposits for which he will have to give notice in advance.
Features:
1. These deposits are not secured.
2. They are available for a period ranging between 6 months and 3 years.
3. They carry fixed rate of interest.
4. They do not require complicated legal formalities as are required in the case of shares or debentures. Keeping in view
the malpractices of certain companies, such as not paying interest for years together and not refunding the money, the
Government has framed certain rules and regulations regarding inviting public to deposit their savings and accepting
them.
Rules governing Public Deposits
Following are the main rules governing public deposits:
1. Deposits should not be made for less than six months or more than three years.
2. Public is invited to deposit their savings through an advertisement in the press. This advertisement should contain all
relevant information about the company.
3. Maximum rate of interest is fixed by the Reserve Bank of India.
4. Maximum rate of brokerage is also fixed by the Reserve Bank of India.
5. The amount of deposit should not exceed 25% of the paid up capital and general reserves.
6. The company is required to maintain Register of Depositors containing all particulars as to public deposits.
7. In case the interest payable to any depositor exceeds Rs. 10,000 p.a., the company is required to deduct income-tax
at source.
Advantages:
Following are the advantages of public deposits:
1. Simple and easy: The method of borrowing money through public deposit is very simple. It does not require many
legal formalities. It has to be advertised in the newspapers and a receipt is to be issued.
2. No charge on assets: Public deposits are not secured. They do not have any charge on the fixed assets of the
company.

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It is a very old source of finance in India. When modern banks were not there, people used to deposit their savings with business
concerns of good repute. Even today it is a very popular and convenient method of raising medium term finance. The period for
which business undertakings accept public deposits ranges between six months to three years.

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

3. Economical: Expenses incurred on borrowing through public deposits is much less than expenses of other sources
like shares and debentures.
4. Flexibility: Public deposits bring flexibility in the structure of the capital of the company. These can be raised when
needed and refunded when not required.
Disadvantages:
Following are the disadvantages of public deposits:
1. Uncertainty: A concern should be of high repute and have a high credit rating to attract public to deposit their savings.
There may be sudden withdrawals of deposits which may create financial problems.
2. Insecurity: Public deposits do not have any charge on the assets of the concern. It may not always be safe to deposit
savings with companies particularly those which are not very sound.
3. Lack of attraction for professional investors: As the rate of return is low and there is no capital appreciation, the
professional investors do not appreciate this mode of investment.
4. Uneconomical: The rate of interest paid on public deposits may be low but then there are other expenses like
commission and brokerage which make it uneconomical.
5. Hindrance to growth of capital-market: If more and more money is deposited with the companies in this form there will
be less investment in securities. Hence the capital market will not grow. This will deprive both the companies and the
investors of the benefits of good securities.
6. Overcapitalisation: As it is an easy, convenient and cheaper source of raising money, companies may raise more money
than is required. In that case it may not be able to make the best use of the funds or may indulge in speculative activities.
5 BORROWING FROM COMMERCIAL BANKS
Traditionally, commercial banks in India do not grant long term loans. They grant loans only for short period not extending one
year. But recently they have started giving loans for a long period. Commercial banks give term loans i.e. for more than one year.
The period of repayment of short term loan is extended at intervals and in some cases loan is given directly for a long period.
Commercial banks provide long term finance to small scale units in the priority sector.

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12

Merits of long term borrowings from Commercial Banks:

The merits of long-term borrowing from banks are as follows:
1. It is a flexible source of finance as loans can be repaid when the need is met.
2. Finance is available for a definite period; hence it is not a permanent burden.
3. Banks keep the financial operations of their clients secret.
4. Less time and cost is involved as compared to issue of shares, debentures etc. 5. Banks do not interfere in the
internal affairs of the borrowing concern; hence the management retains the control of the company.
6. Loans can be paid-back in easy instalments.
7. In case of small-scale industries and industries in villages and backward areas, the interest charged is low.
Demerits:
Following are the demerits of borrowing from commercial banks:
1. Banks require personal guarantee or pledge of assets and business cannot raise further loans on these assets.
2. In case the short term loans are extended again and again, there is always uncertainty about this continuity.
3. Too many formalities are to be fulfilled for getting term loans from banks. These formalities make the borrowings
from banks time consuming and inconvenient.

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BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

Securities Market
The Securities Market refers to the markets for those financial instruments/ claims/obligations that are commonly and readily
transferable by sale. The Securities Market has two interdependent and inseparable segments, the new issues (primary) market
and the stock (secondary) market.
PRIMARY MARKETS
Companies raise funds to finance their projects through various methods. The promoters can bring their own money of borrow
from the financial institutions or mobilize capital by issuing securities. The funds may be raised through issue of fresh shares at
par or premium, preferences shares, debentures or global depository receipts. The main objectives of a capital issue are given
below:
1. To promote a new
company
2. To expand an existing
company
3. To
diversify
the
production
4. To meet the regular
working
capital
requirements
5. To
capitalize
the
reserves
Stocks available for the first
time are offered through
primary market. The issuer may be a new company or an existing company. These issues may be of new type or the security
used in the past. In the primary market the issuer can be considered as a manufacturer. The issuing houses, investment bankers
and brokers act as the channel of distribution for the new issues. They take the responsibility of selling the stocks to the public.
The Primary market provides the channel for sale of new securities. The issuer of securities sells the securities in the primary
market to raise funds for investment and/or to discharge some obligation.

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This secondary market has further two components. First, the spot market where securities are traded for immediate delivery
and payment. The other is forward market where the securities are traded for future delivery and payment. This forward
market is further divided into Futures and Options Market (Derivatives Markets). In futures Market the securities are traded for
conditional future delivery whereas in option market, two types of options are traded. A put option gives right but not an
obligation to the owner to sell a security to the writer of the option at a predetermined price before a certain date, while a call
option gives right but not an obligation to the buyer to purchase a security from the writer of the option at a particular price
before a certain date.
DISTINCTION BETWEEN PRIMARY MARKET AND SECONDARY MARKET
The main points of distinction between the primary market and secondary market are as follows:
1. Function: While the main function of primary market is to raise long-term funds through fresh issue of securities, the main
function of secondary market is to provide continuous and ready market for the existing long-term securities.
2. Participants: While the major players in the primary market are financial institutions, mutual funds, underwriters and
individual investors, the major players in secondary market are all of these and the stockbrokers who are members of the stock
exchange.
3. Listing Requirement: While only those securities can be dealt within the secondary market, which have been approved for the
purpose (listed), there is no such requirement in case of primary market.
4. Determination of prices: In case of primary market, the prices are determined by the management with due compliance with
SEBI requirement for new issue of securities. But in case of secondary market, the price of the securities is determined by forces
of demand and supply of the market and keeps on fluctuating.
DISTINCTION BETWEEN CAPITAL MARKET AND MONEY MARKET
Capital Market differs from money market in many ways. Firstly, while money market is related to short-term funds, the capital
market related to long term funds. Secondly, while money market deals in securities like treasury bills, commercial paper, trade
bills, deposit certificates, etc., the capital market deals in shares, debentures, bonds and government securities. Thirdly, while
the participants in money market are Reserve Bank of India, commercial banks, non-banking financial companies, etc., the
participants in capital market are stockbrokers, underwriters, mutual funds, financial institutions, and individual investors.
Fourthly, while the money market is regulated by Reserve Bank of India, the capital market is regulated by Securities Exchange
Board of India (SEBI).

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SECONDARY MARKET
The Secondary market deals in securities previously issued. The secondary market enables those who hold securities to adjust
their holdings in response to charges in their assessment of risk and return. They also sell securities for cash to meet their
liquidity needs. The price signals, which subsume all information about the issuer and his business including associated risk,
generated in the secondary market, help the primary market in allocation of funds.

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BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

MONEY MARKET
The Money market refers to the market where borrowers and lenders exchange short term funds to solve their liquidity needs.
Money market instruments are generally financial claims that have low default risk, maturities under one year and high
marketability.
MONEY MARKET INSTRUMENTS
By convention, the term "Money Market" refers to the market for short-term requirement and deployment of funds. Money
market instruments are those instruments, which have a maturity period of less than one year. The most active part of the
money market is the market for overnight call and term money between banks and institutions and repo transactions. Call
Money/Repo are very short-term Money Market products. The below mentioned instruments are normally termed as money
market instruments:
1. GOVERNMENT SECURITIES (G- SECS)
Government Securities are securities issued by the Government for raising a public loan or as notified in the official Gazette. Gsecs are sovereign securities mostly interest bearing dated securities which are issued by RBI on behalf of Govt. of India(GOI).
GOI uses these borrowed funds to meet its fiscal deficit, while temporary cash mismatches are met through treasury bills of 91
days.
G-secs consist of Government Promissory Notes, Bearer Bonds, Stocks or Bonds, Treasury Bills or Dated Government Securities.
Government bonds are theoretically risk free bonds, because governments can, up to a point, raise taxes, reduce spending, and
take various measures to redeem the bond at maturity.
Features of Government Securities
Usually issued and redeemed at face value
1. No default risk as the securities carry sovereign guarantee.
2. Ample liquidity as the investor can sell the security in the secondary market
3. Interest payment on a half yearly basis on face value
4. No tax deducted at source
5. Can be held in D-mat form
6. Rate of interest and tenor of the security is fixed at the time of issuance and is not subject to change (unless intrinsic to
the security like FRBs).
7. Redeemed at face value on maturity
8. Maturity ranges from of 2-30 years.
Securities qualify as SLR investments (unless otherwise stated).
2. MONEY MARKET AT CALL AND SHORT NOTICE
Next in liquidity after cash, money at call is a loan that is repayable on demand, and money at short notice is repayable within 14
days of serving a notice. The participants are banks & all other Indian Financial Institutions as permitted by RBI.
The market is over the telephone market, non bank participants act as lender only. Banks borrow for a variety of reasons to
maintain their CRR, to meet their heavy payments, to adjust their maturity mismatch etc.
3. MONEY MARKET MUTUAL FUNDS (MMMFs)
A money market fund is a mutual fund that invests solely in money market instruments. Money market instruments are forms of
debt that mature in less than one year and are very liquid.
Treasury bills make up the bulk of the money market instruments. Securities in the money market are relatively risk-free. Money
market funds are generally the safest and most secure of mutual fund investments. The goal of a money-market fund is to
preserve principal while yielding a modest return by investing in safe and stable instruments issued by governments, banks and
corporations etc.

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Treasury bills are an effective cash management product since short term surpluses or idle funds can be conveniently deployed
in treasury bills depending upon the availability and requirement. Even funds in current accounts with Banks can be deployed for
short term periods. One can purchase treasury bills of different maturities as per requirements so as to match the respective
outflow of funds.
Advantages of investing in Treasury Bills:
1. No Tax Deducted at Source (TDS)

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4. TREASURY BILLS
Treasury Bills are short term (up to one year) borrowing instruments of the Government of India which enable investors to park
their short term surplus funds while reducing their market risk. These are discounted securities and thus are issued at a discount
to face value. The return to the investor is the difference between the maturity value and issue price.
Any person in India including Individuals, Firms, Companies, Corporate bodies, Trusts and Institutions can purchase Treasury
Bills.
At present, RBI issues T-Bills for three different maturities: 91 days, 182 days and 364 days. Treasury Bills are available for a
minimum amount of Rs.25,000 and in multiples of Rs. 25,000 thereafter. They are available in both Primary and Secondary
market. Treasury Bills are eligible securities for SLR purposes.

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

2. Zero default risk as these are the liabilities of GOI
3. Liquid money Market Instrument
4. Active secondary market thereby enabling holder to meet immediate fund requirement.
5. CERTIFICATES OF DEPOSITS
A CD is a time deposit, financial product commonly offered to consumers by banks. In case of CDs the banks issue a certificate
for a deposit made, such certificate is transferable, i.e. holder of CD is holder of deposit. CDs are negotiable instrument issued
either in physical form transferable by endorsement and delivery or in demat form or as a Usance Promissory Notes. CDs issued
by banks should not have the maturity less than seven days and not more than one year. Financial Institutions are allowed to
issue CDs for a period between 1 year and up to 3 years. They normally give a higher return than Bank term deposit, and are
rated by approved rating agencies (e.g. CARE, ICRA, CRISIL, and FITCH) which considerably enhance their tradability in the
secondary market, depending upon demand. SBI DFHI is an active player in secondary market of CDs.
CDs can be issued to individuals, corporations, trusts, funds and associations. NRIs can also subscribe to CDs, but on nonrepatriable basis only. In secondary market such CDs cannot be endorsed to another NRI. They are issued at a discount rate
freely determined by the issuer and the market/investors. CDs are issued in denominations of Rs.1 Lac and in the multiples of
Rs. 1 Lac thereafter. Loans cannot be granted against CDs and Banks/FIs cannot buy back their own CDs before maturity.
6. INTER CORPORATE DEPOSITS
An ICD is an unsecured loan extended by one corporate to another. This market allows corporate with surplus funds to lend to
other corporate. Also the better-rated corporate can borrow from the banking system and lend in this market. As the cost of
funds for a corporate is much higher than that for a bank, the rates in this market are higher than those in the other markets.
Also, as ICDs are unsecured, the risk inherent is high and the risk premium is also built into the rates.
7. COMMERCIAL BILLS
Commercial bill is a short term, negotiable, and self-liquidating instrument with low risk. It enhances the liability to make
payment within a fixed date when goods are bought on credit.
Bills of exchange are negotiable instruments drawn by the seller (drawer) on the buyer (drawee) or the value of the goods
delivered to him. Such bills are called trade bills. When trade bills are accepted by commercial banks, they are called commercial
bills. The bank discounts this bill by keeping a certain margin and credits the proceeds. Banks can also get such bills rediscounted
by financial institutions such as LIC, UTI, GIC, ICICI and IRBI. The maturity period of the bills varies from 30 days, 60 days or 90
days, depending on the credit extended in the industry.
Commercial bill is an important tool finance credit sales. It may be a demand bill or a issuance bill; clean bills or documentary
bills: inland bills or foreign bills.
8. COMMERCIAL PAPER
Commercial Paper is a money-market security issued (sold) by large banks and corporations to get money to meet short term
debt obligations , and is only backed by an issuing bank or corporation's promise to pay the face amount on the maturity date
specified on the note. Since it is not backed by collateral, only firms with excellent credit ratings from a recognized rating agency
will be able to sell their commercial paper at a reasonable price. Commercial paper is usually sold at a discount from face value,
and carries shorter repayment dates than bonds. The longer the maturity on a note, the higher the interest rate the issuing
institution must pay. Interest rates fluctuate with market conditions, but are typically lower than banks' rates. Corporate
Borrowers, especially the large and financially sound, can diversify their short term borrowing by the issue of Commercial Paper.
Commercial Paper is especially attractive for companies with cyclical cash flows and for cash rich companies during periods of
greater cash inflows than overdraft or cash credit since monitoring is more convenient.
Maturity: 7days -1 year

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10. INTER BANK PARTICIPATION CERTIFICATES

With a view for providing an additional instrument for evening out short-term liquidity within the banking system, two types of
Inter-Bank Participations (IBPs) were introduced, one on risk sharing basis and the other without risk sharing. These are strictly
inter-bank instruments confined to scheduled commercial banks excluding regional rural banks. The IBP with risk sharing can be
issued for 91-180 days. Under the uniform grading system introduced by Reserve Bank for application by banks to measure the
health of bank advances portfolio, a borrower account considered satisfactory if the one in which the conduct of account is
satisfactory, the safety of advance is not in doubt, all the terms and conditions are complied with, and all the accounts of the
borrower are in order. The IBP risk sharing provides flexibility in the credit portfolio of banks. The rate of interest is left free to
be determined between the issuing bank and the participating bank subject to a minimum 14.0 per cent per annum. The
aggregate amount of such IBPs under any loan account at the time of issue is not to exceed 40 per cent of the outstanding in the
account.

15

9. CALL MONEY MARKET AND SHORT TERM DEPOSIT MARKET

The borrowers are essentially the banks. DFHI plays a vital role in stabilizing the call and short term deposit rates through larger
turnover and smaller spread. It ascertains the prospective lenders and borrowers, the money available and needed and
exchanges a deal settlement advice with them indicating the negotiated interest rates applicable to them. When DFHI borrows,
a call deposit receipt is issued to the lender against a cheque drawn on RBI for the amount lent. If DFHI lends it issues to the RBI
a cheque representing the amount lent to the borrower against the call deposit receipt.

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

The IBP without risk sharing is a money market instrument with a tenure not exceeding 90 days and the interest rate on such
IBPs is left to be determined by the two concerned banks without any ceiling on interest rate.

11. BILLS REDISCOUNTING

It is an important segment of money market and the bill as an instrument provides short term liquidity to the suppliers in need
of funds. Bill financing seller drawing a bill of exchange & the buyer accepting it, thereafter the seller discounting it, say with a
bank. Hundies, an indigenous form of bill of exchange, have been popular in India, but there has been a general reluctance on
the part of the buyers to commit themselves to payments on maturity. Hence the Bills have been not so popular.
12. GILT EDGED GOVERNMENT SECURITIES
These are issued by governments such as Central Government, State Government, Semi Government authorities, City
Corporations, Municipalities, Port trust, State Electricity Board, Housing boards etc.
The gilt-edged market refers to the market for Government and semi-government securities, backed by the Reserve Bank of
India (RBI). Government securities are tradable debt instruments issued by the Government for meeting its financial
requirements. The term gilt-edged means 'of the best quality'. This is because the Government securities do not suffer from risk
of default and are highly liquid (as they can be easily sold in the market at their current price). The open market operations of
the RBI are also conducted in such securities.

13. BANKERS ACCEPTANCE

It is a short-term credit investment. It is guaranteed by a bank to make payments. The Banker's Acceptance is traded in the
Secondary market. The banker's acceptance is mostly used to finance exports, imports and other transactions in goods. The
banker's acceptance need not be held till the maturity date but the holder has the option to sell it off in the secondary market
whenever he finds it suitable

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14. REPOS
The Repo or the repurchase agreement is used by the government security holder when he sells the security to a lender and
promises to repurchase from him at a specified time. Hence the Repos have terms raging from 1 night to 30 days. They are very
safe due to government backing.

Pashupati Nath Verma

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

STOCK EXCHANGE
Stock exchange is the term commonly used for a secondary market, which provide a place where different types of existing
securities such as shares, debentures and bonds, government securities can be bought and sold on a regular basis. A stock
exchange is generally organised as an association, a society or a company with a limited number of members. It is open only to
these members who act as brokers for the buyers and sellers. The Securities Contract (Regulation) Act has defined stock
exchange as an association, organisation or body of individuals, whether incorporated or not, established for the purpose of
assisting, regulating and controlling business of buying, selling and dealing in securities.
The main characteristics of a stock exchange are:
1. It is an organised market.
2. It provides a place where existing and approved securities can be bought and sold easily.
3. In a stock exchange, transactions take place between its members or their authorised agents.
4. All transactions are regulated by rules and by laws of the concerned stock exchange.
5. It makes complete information available to public in regard to prices and volume of transactions taking place every day.
It may be noted that all securities are not permitted to be traded on a recognised stock exchange. It is allowed only in those
securities (called listed securities) that have been duly approved for the purpose by the stock exchange authorities. The method
of trading now-a-days, however, is quite simple on account of the availability of on-line trading facility with the help of
computers. It is also quite fast as it takes just a few minutes to strike a deal through the brokers who may be available close by.
Similarly, on account of the system of script-less trading and rolling settlement, the delivery of securities and the payment of
amount involved also take very little time, say, 2 days.

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FUNCTIONS OF A STOCK EXCHANGE

The functions of stock exchange can be enumerated as follows:
1. Provides ready and continuous market: By providing a place where listed securities can be bought and sold regularly and
conveniently, a stock exchange ensures a ready and continuous market for various shares, debentures, bonds and government
securities.
This lends a high degree of liquidity to holdings in these securities as the investor can encash their holdings as and when they
want.
2. Provides information about prices and sales: A stock exchange maintains complete record of all transactions taking place in
different securities every day and supplies regular information on their prices and sales volumes to press and other media. In
fact, now-a-days, you can get information about minute to minute movement in prices of selected shares on TV channels like
CNBC, Zee News, NDTV and Headlines Today. This enables the investors in taking quick decisions on purchase and sale of
securities in which they are interested. Not only that, such information helps them in ascertaining the trend in prices and the
worth of their holdings. This enables them to seek bank loans, if required.
3. Provides safety to dealings and investment: Transactions on the stock exchange are conducted only amongst its members
with adequate transparency and in strict conformity to its rules and regulations which include the procedure and timings of
delivery and payment to be followed. This provides a high degree of safety to dealings at the stock exchange. There is little risk
of loss on account of non-payment or nondelivery.
Securities and Exchange Board of India (SEBI) also regulates the business in stock exchanges in India and the working of the stock
brokers.
Not only that, a stock exchange allows trading only in securities that have been listed with it; and for listing any security, it
satisfies itself about the genuineness and soundness of the company and provides for disclosure of certain information on
regular basis. Though this may not guarantee the soundness and profitability of the company, it does provide some assurance
on their genuineness and enables them to keep track of their progress.
4. Helps in mobilisation of savings and capital formation: Efficient functioning of stock market creates a conducive climate for
an active and growing primary market. Good performance and outlook for shares in the stock exchanges imparts buoyancy to
the new issue market, which helps in mobilising savings for investment in industrial and commercial establishments. Not only
that, the stock exchanges provide liquidity and profitability to dealings and investments in shares and debentures. It also
educates people on where and how to invest their savings to get a fair return. This encourages the habit of saving, investment
and risk-taking among the common people. Thus it helps mobilising surplus savings for investment in corporate and government
securities and contributes to capital formation.
5. Barometer of economic and business conditions: Stock exchanges reflect the changing conditions of economic health of a
country, as the shares prices are highly sensitive to changing economic, social and political conditions. It is observed that during
the periods of economic prosperity, the share prices tend to rise. Conversely, prices tend to fall when there is economic
stagnation and the business activities slow down as a result of depressions. Thus, the intensity of trading at stock exchanges and
the corresponding rise on fall in the prices of securities reflects the investors assessment of the economic and business
conditions in a country, and acts as the barometer which indicates the general conditions of the atmosphere of business.
6. Better Allocation of funds: As a result of stock market transactions, funds flow from the less profitable to more profitable
enterprises and they avail of the greater potential for growth. Financial resources of the economy are thus better allocated.

Pashupati Nath Verma

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

18.7.2 ADVANTAGES OF STOCK EXCHANGES
Having discussed the functions of stock exchanges, let us look at the advantages which can be outlined from the point of view of
(a) Companies, (b) Investors, and (c) the Society as a whole.
(a) To the Companies
I.
The companies whose securities have been listed on a stock exchange enjoy a better goodwill and credit-standing than
other companies because they are supposed to be financially sound.
II.
The market for their securities is enlarged as the investors all over the world become aware of such securities and have
an opportunity to invest
III.
As a result of enhanced goodwill and higher demand, the value of their securities increases and their bargaining power
in collective ventures, mergers, etc. is enhanced.
IV.
The companies have the convenience to decide upon the size, price and timing of the issue.
(b) To the Investors:
I.
The investors enjoy the ready availability of facility and convenience of buyingand selling the securities at will and at an
opportune time.
II.
Because of the assured safety in dealings at the stock exchange the investors are free from any anxiety about the
delivery and payment problems.
III.
Availability of regular information on prices of securities traded at the stock exchanges helps them in deciding on the
timing of their purchase and sale.
IV.
It becomes easier for them to raise loans from banks against their holdings in securities traded at the stock exchange
because banks prefer them as collateral on account of their liquidity and convenient valuation.
(c) To the Society
I.
The availability of lucrative avenues of investment and the liquidity thereof induces people to save and invest in longterm securities. This leads to increased capital formation in the country.
II.
The facility for convenient purchase and sale of securities at the stock exchange provides support to new issue market.
This helps in promotion and expansion of industrial activity, which in turn contributes, to increase in the rate of
industrial growth.
III.
The Stock exchanges facilitate realisation of financial resources to more profitable and growing industrial units where
investors can easily increase their investment substantially.
IV.
The volume of activity at the stock exchanges and the movement of share prices reflect the changing economic health.

ROLE OF SEBI
As part of economic reforms programme started in June 1991, the Government of India initiated several capital market reforms,
which included the abolition of the office of the Controller of Capital Issues (CCI) and granting statutory recognition to Securities
Exchange Board of India (SEBI) in 1992 for:
a. protecting the interest of investors in securities;
b. promoting the development of securities market;
c. regulating the securities market; and
d. matters connected there with or incidental thereto.

Pashupati Nath Verma

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SEBI REFORMS ON STOCK EXCHANGES

The SEBI regulation of stock exchanges and their members had started as early as February 1992 and the reforms later
introduced have been on a continuous basis. It was started with the licensing and registration of brokers and sub-brokers in the
recognized stock exchanges. This was later extended to underwriters, portfolio managers and other categories of players in the
stock market including foreign securities firms, FFIs, OCBs, FIIs, Debenture Trustees, Collecting Bankers, etc.
The other reforms are briefly summarized below:
I.
Compulsory audit and inspection of stock exchanges and their member brokers and their accounts.
II.
Transparency in the prices and brokerage charged by brokers by showing them in their contract notes.
III.
Broker accounts and client accounts are to be kept separate and clients' money is to be separately maintained in bank's
accounts and the same to be reported to the stock exchanges.

18

SEBI has been vested with necessary powers concerning various aspects of capital market such as:
I.
regulating the business in stock exchanges and any other securities market;
II.
registering and regulating the working of various intermediaries and mutual funds;
III.
promoting and regulating self regulatory organisations;
IV.
promoting investors education and training of intermediaries;
V.
prohibiting insider trading and unfair trade practices;
VI.
regulating substantial acquisition of shares and take over of companies;
VII.
calling for information, undertaking inspection, conducting inquiries and audit of stock exchanges, and intermediaries
and self regulation organisations in the stock market; and
VIII.
performing such functions and exercising such powers under the provisions of the Capital Issues (Control) Act, 1947 and
the Securities Contracts (Regulation) Act, 1956 as may be delegated to it by the Central Government.

IV.
V.
VI.
VII.

BBA101: BUSINESS ORGANIZATION& BUSINESS ETHICS/UNIT-III

Board of Directors of stock exchanges has to be reconstituted so as to include non-brokers, public representative, and
Government representatives to the extent of 50% of the total number of members.
Capital adequacy norms have been laid down for members of various stock exchanges separately and depending on
their turnover of trade and other factors.
Guidelines have been laid down for dealings of FIIs and Foreign broker firms in the Indian stock exchanges through
Indian brokers.
New guidelines for corporate members have been laid down with limited liability of directors and opening up of their
membership to more than one stock exchange without the limiting requirement of experience of five years in one
exchange, as imposed earlier.

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The term "Investor Protection" is a wide term encompassing various measures designed to protect the investors from
malpractices of companies, brokers, merchant bankers, issue managers, Registrars of new issues, etc. "Investors Beware" should
be the watchword of all programs for mobilization of savings for investment. As all investments have some risk element, this risk
factor should be borne in mind by the investors and they should take all precautions to protect their interests in the first place. If
caution is thrown to the winds and they invest in any venture without a proper assessment of the risk, they have only to blame
themselves. But if there are malpractices by companies, brokers etc., they have every reason to complain. Such grievances have
been increasing in number in recent years.
The complaints of investors come from two major sources:
Against member broker of Stock Exchanges;
Against companies listed for trading on the Stock Exchanges.
Besides, there can be complaints against sub-brokers, agents, merchant bankers, issue managers, etc., which cannot be
entertained by the stock exchanges as per their rules.

Pashupati Nath Verma