deal with funds raised through the money and stock markets. 2. Commercial banks base their lending decisions on a comprehensive credit analysis of loan proposals as well as the value of the collateral offered. They are normally fearful of taking risks. Resources are valued highly by them. Merchant bankers, on the other hand, are mostly concerned with management issues. They are willing to take commercial risks. 3. Commercial banks are essentially money lenders. They don't, for example, provide project or organisational advice, tackle public issues, underwrite public issues, or provide portfolio management advice. The primary responsibility of merchant bankers is to provide financial services to their clients. Project consulting, business consulting in fields like capital restructuring, mergers and acquisitions, short-term paper discounting and rediscounting in money markets, handling and underwriting public issues in the new issue market, and serving as brokers and consultants on fund management are just a few examples. 5.4 SUMMARY Merchant banking is a form of financial service that entails the management of issues and other related tasks. Merchant bankers are financial companies that provide merchant banking services to businesses. Merchant bankers have a range of different services. Project consultancy, credit syndication, business counselling, fund management, stockbroking, venture capital, bill discounting, leasing, factoring, underwriting, and other services are among them. On merchant banking, SEBI has released SEBI (Merchant Banking) Regulation. The law only applies to a small set of merchant banker's activities. Aside from that, merchant bankers must adhere to operational guidelines when conducting their duties. They have pre-issue and post- issue roles as part of the issue management process. 5.5 KEYWORDS Merchant Bank A Bank that handles equity and equity related finances Commercial banks Those Banks that deals in debt and debt related finance Underwriting — A banks sign into documents that agree to provide financial payment to their clients in case of any damage or losses Portfolio Management A kind of services to check on the liquidation of assets to track the income made by these companies and study how they can make it better Advisory Services A type of service that advises especially on starting companies & those that would want to expand 51 CU IDOL SELF LEARNING MATERIAL (SLM)
5.6 LEARNING ACTIVITY 1. Visit Merchant Banking division of Indian Bank to understand the various activities performed. ___________________________________________________________________________ ___________________________________________________________________________ 2. Study the activities and process followed in SME Branch of Indian bank. ___________________________________________________________________________ ___________________________________________________________________________ 5.7 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Discuss the services rendered by merchant bankers. 2. Definition of Merchant Banker by SEBI? 3. What is the difference between Merchant Bank and Commercial Bank? Long Questions 1. Discuss the objective of Merchant Banking. 2. What do you mean by underwriting? B. Multi-Choice Questions 1. A merchant bank is a financial institution that invests in the money market and: a. Lending b. Underwriting and financial advice c. Investment service d. All of these 2. Merchant banking development activities: a. Sources of funds forever b. Expanding industry and trade c. Leaving a widening gap unbridged between supply and demand of investible funds. d. All of these 52 CU IDOL SELF LEARNING MATERIAL (SLM)
3. A merchant bank is a corporation that specialises in: a. Underwrites securities for corporations b. Advice clients on mergers c. Involved in ownership of commercial ventures d. All of these 4. The functions of ______and _______involve issue management. a. Merchant banker, lead manager b. Public banker, Merchant banker c. Lead banker, Private banking d. None of these 5. One of the following entities is a merchant bank? a. ICICI Bank b. Retail Bank of India c. Reserve Bank of India d. All of these Answers 1 – d, 2 – c, 3 – c, 4 – a, 5 – a, 5.8 REFERENCES Text Books: Bhole, L.M., Financial Institutions & Markets. Tata McGraw Hill, New Delhi Meir, Kohn, Financial Institutions & Markets, Tata McGraw Hill, New Delhi Prasanna Chandra: Financial Management, Tata McGraw Hill. Reference Books: Kothari, C.R., Investment Banking & Customer Services Arihant Publishers, Jaipur Sharpe, William F. etc. Investment. New Delhi, PHI Pandey, I.M., Financial Management, Vikas Publishing House, New Delhi 53 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 6 - PORTFOLIO MANAGEMENT Structure 6.0 Learning Objectives 6.1 Setting Scope 6.2 Underwriter 6.3 Portfolio Management 6.4 Role of Merchant Bankers in Managing Public Issue 6.5 Summary 6.6 Keywords 6.7 Learning Activity 6.8 Unit End Questions 6.9 References 6.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Describe nature of Portfolio Management Identify scope of Portfolio Management Benefits of Portfolio Management Process involved in Portfolio Management 6.1 SCOPE OF PORTFOLIO MANAGEMENT` Portfolio management is a never-ending practise. It's a fast-paced game. The basic operations of portfolio management are as follows. 1. Keeping track of the portfolio's results when taking into account current market conditions. 2. Deciding the investor's target, restrictions, and preferences. 3. Conducting a portfolio income analysis (comparison with targets and achievement). 4. Make adjustments to the portfolio. 5. Putting the techniques into effect in line with the investment targets. 54 CU IDOL SELF LEARNING MATERIAL (SLM)
6.2 UNDERWRITER The underwriters of capital issues who consent to take securities that are not completely subscribed are a significant intermediary in the new issue/primary sector. They pledge to have the issue subscribed, either by themselves or by others. While underwriting is no longer needed after April 1995, it is still an essential part of the primary market. The issuing companies nominate them in consultation with the issue's lead manager/merchant banker. The prospectus certificate should contain a statement that the underwriter's asset is sufficient to satisfy their duty, in the opinion of the lead manager. 6.3 PORTFOLIO MANAGEMENT Client fund management is a service offered by merchant bankers. Every investor today is concerned with the protection, liquidity, and profitability of his or her investment. Investors, on the other hand, are unable to research and choose suitable securities. In this situation, merchant bankers will assist investors. They study the government's monetary and fiscal policies. They review the financial statements of companies in which investors must make investments. They even keep a close eye on the stock market's price fluctuations. In relation to portfolio management, merchant bankers have the following services: (a) Making a securities investment. (b) Achieving a return on investment and reinvesting it in profitable avenues, as well as supplying investors with investment advisory services and other related services. c) Aiding in the collection of investments. (d) Conducting a critical review of an investment portfolio. e) Obtaining RBI approval for the purchase/sale of securities (for NRI clients). f) Collecting and remitting investment interest and dividends. (g) Use tax advisors to provide tax advice and file tax returns. 6.4 ROLE OF MERCHANT BANKERS IN MANAGING PUBLIC ISSUE Merchant bankers' primary function in issue management is to assist companies issuing securities in raising funds for new ventures, expansion/modernization/diversification of existing units, and augmenting long-term resources for working capital needs. The most critical part of the merchant banking business is acting as problem management lead managers. The following points can be used to analyse the merchant banker's position as an issue manager: 1. Simple fund-raising: An issue manager is an important pilot for a public-interest or human-rights issue. This is made possible by the one-of-a-kind talents he possesses for problem-solving. 2. Financial consultant: A problem manager acts as the business's financial architect, 55 CU IDOL SELF LEARNING MATERIAL (SLM)
advising on capital structuring, capital gearing, and financial planning. 3. Underwriting: An issue manager is an individual who assists companies in the underwriting of their securities issues. This indicates that the issue has been adequately subscribed. 4. SEBI guidelines compliance: The issue manager must adhere to SEBI guidelines. The merchant banker would conduct business responsibly and submit a Due Diligence Certificate to SEBI. The Association of Merchant Bankers of India (AMBI) has comprehensive due diligence guidelines that must be strictly followed. SEBI has also established a code of conduct for merchant bankers. 5. Collaboration: To efficiently handle a problem, the issue manager must work with a variety of organisations and agencies. 6. SEBI liaison: The issue manager should register with SEBI as part of merchant banking operations. When dealing with issues such as filing of offer papers, etc., constant interaction with the SEBI is required. They may also file a series of papers about the issues they're dealing with. 6.5 SUMMARY It could be more beneficial to invest in a portfolio rather than individual stocks. The disadvantage of concentrating on individual shares is that it allows the investor to \"put all her eggs in one basket.\" Portfolios have substantial risk diversification benefits, allowing risk to be reduced while maintaining a positive return. Accept the client's needs and draught an investment strategy statement as the first steps in the portfolio management process. The steps that follow are asset allocation, security analysis, portfolio formation, portfolio monitoring and rebalancing, and performance evaluation and reporting. 6.6 KEYWORDS (AMBI) Association of Merchant Bankers of India (NRI) Non Resident Indian Portfolio Management A kind of services to check on the liquidation of assets to track the income made by these companies and study how they can make it better Advisory Services A type of service that advises especially on starting companies & those that would want to expand 56 CU IDOL SELF LEARNING MATERIAL (SLM)
Underwriter An important intermediary in the new issue/primary market is the underwriters to the issues of capital who agree to take u securities which are not fully, subscribed. 6.7 LEARNING ACTIVITY 1. Stocks are considered to be risky but bonds are not – Elucidate. ___________________________________________________________________________ ___________________________________________________________________________ 2. Explore how is a portfolio managed & how is it revised. ___________________________________________________________________________ ___________________________________________________________________________ 6.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain what are merchant bankers rendered services in connection with portfolio management? 2. Describe briefly about portfolio management. Long Questions 1. Explain what are the basic operations of Portfolio Management? 2. Discuss in detail what is underwriting and Who is an underwriter? 3. Discuss in detail the Role of Merchant Bankers in Managing Public Issue? B. Multi-Choice Questions 1. Which one of the items mentioned below is a financial institution? a. Share b. Farm house c. Car d. TV Set 2. The aim of portfolio is to decrease ……by diversification 57 a. Return b. Risk c. Uncertainty CU IDOL SELF LEARNING MATERIAL (SLM)
d. Percentage 3. Return of investment is calculated by a. Net profit b. Capital employed c. Net worth d. Net profit & capital employed 4. What is ROI from a Portfolio stand point a. Rate of Investment b. Return on Investment c. Returning to India d. All of these 5. Which one of the following items is a tax saving investment? a. Fixed deposit b. Shares c. NSC d. PPF Answers 1 – a, 2 – b, 3 – d, 4 – b, 5 – d, 6.9 REFERENCES Text Books: Bhole, L.M., Financial Institutions & Markets. Tata McGraw Hill, New Delhi Khan, M.Y.Financial Services Tata McGraw Hill, New Delhi Meir, Kohn, Financial Institutions & Markets, Tata McGraw Hill, New Delhi Prasanna Chandra: Financial Management, Tata McGraw Hill. Reference Books: Kothari, C.R., Investment Banking & Customer Services Arihant Publishers, Jaipur Sharpe, William F. etc. Investment. New Delhi, PHI Pandey, I.M., Financial Management, Vikas Publishing House, New Delhi 58 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 7 - MERCHANT BANKING IN INDIA Structure 7.0 Learning Objectives 7.1 Introduction 7.2 Setting up and Management 7.3 Categories 7.4 Weakness & Problem 7.5 Summary 7.6 Keywords 7.7 Learning Activity 7.8 Unit End Questions 7.9 References 7.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Describe nature of Merchant Banking Identify scope of Merchant Banking Benefits of Merchant Banking Process involved in Merchant Banking 7.1 INTRODUCTION Prior to the 1956 enactment of the Indian Companies Act, managing agents operated as merchant bankers. Among other things, they acted as stock issuers, reviewed project reports, and provided venture capital to new businesses. Just a few stockbroking firms also functioned as merchant bankers. The rapid growth in the number and size of primary market issues fuelled demand for specialised merchant banking services. Grindlays Bank (a foreign bank) formed a merchant banking division in 1967, and Citibank followed suit in 1970. SBI established its merchant banking division in 1972, and SBI Capital Markets Ltd, a wholly owned subsidiary, was established in 1980. Other nationalised banks and financial institutions, including IDBI, IFCI, ICICI, Securities and Finance Company Ltd., Canara Bank (Can Bank Financial Services Ltd.), Bank of India (BOI Finance Ltd.), and private sector financial institutions, including JM Financial and Investment Consultancy Services Ltd. and DSP Financial Consultancy Ltd., 59 CU IDOL SELF LEARNING MATERIAL (SLM)
have formed merchant banking divisions. With over 1,100 merchant bankers operating in the city, primary market activity is picking up. Merchant banking services have become more relevant in the current capital market environment. As investors have become more cautious and discerning, the role of merchant banker has become more important. In India, the SEBI, in addition to the RBI's overall control, closely monitors merchant bankers' operations for proper functioning and investor protection. 7.2 SETTING UP AND MANAGEMENT OF MERCHANT BANKS IN INDIA In India, merchant bankers work for Indian and foreign banks and financial institutions, as well as subsidiary companies formed by banks like SBI, Canara Bank, Punjab National Bank, Bank of India, and others. Several companies also employ financial and technical consultants and experts. On the basis of capital adequacy, SEBI (Securities and Exchange Board of India) has divided merchant bankers into four classes. Permission is given to each group to carry out specific tasks. From an organisational standpoint, India's merchant banking organisations can be divided into four groups based on their links to parent operations. The following are the details: a) Institutional Base: Merchant banks are either independent entities or subsidiaries of a number of private, public, and state-owned financial institutions. Since the bulk of India's financial institutions are public, they have a say in government priorities and policies. b) Merchant Bankers: These merchant bankers work for a banking company as a division or subsidiary. The parent banks are either nationalised commercial banks or multinational banks operating in India. By bringing integrity to the merchant banking industry, these organisations have assisted their parent companies in establishing a presence in the stock market. c) The Broker Base: In recent years, India's stock exchanges have seen an influx of skilled and highly trained brokers. In addition to merchant banking, these brokers provide investment and fund management services. d) Personal Base: These merchant banking firms can trace their origins back to the private sector. These companies are the product of the merchant banking industry's opportunities and scope, and they offer skill-oriented specialised services to their clients. Some foreign merchant bankers are also breaking into the Indian market, either on their own or in collaboration with Indian counterparts. Sole proprietorships, partnerships, private limited companies, and public limited companies have arisen as merchant banking firms in the private sector. Many of these businesses had been around for a while before deciding to branch out into merchant banking by forming new divisions similar to commercial banks and All India Financial Institutions (AIFI). 60 CU IDOL SELF LEARNING MATERIAL (SLM)
7.3 CATEGORIES OF MERCHANT BANKS Merchant bankers are classified into four classes under the SEBI (Merchant Banking) Regulations 1992. Any of them are as follows: (a) Category I: Any problem-solving activity, such as working as an analyst, consultant manager, underwriter, or portfolio manager for capital issues. (b) Category – II: Capital issue adviser, consultant, co-founder, underwriter, and fund manager (c) Category – III: Underwriting, advising, and consulting on a topic. (d) Category – IV: To act exclusively as a topic consultant or counsellor. 7.4 WEAKNESS OF MERCHANT BANKS / PROBLEMS OF MERCHANT BANKS 1. Under SEBI guidelines, merchant bankers are only permitted to engage in issue-related activities, with the exception of portfolio management. It restricts merchant banks' operations. 2. To be authorised, merchant bankers must have a minimum net worth of Rs.1 crore, according to SEBI guidelines. Small yet reputable merchant bankers are struggling to meet such net worth requirements. 3. The inability of issuing companies to participate in the timely allocation of securities and refund of application capital is another problem that merchant bankers face. 4. Unhealthy competition among a large number of merchant banks causes profit margins, fees, and other costs to be slashed. 5. There is no specific regulatory framework in place in India to regulate and manage merchant bank operations. 6. Merchant banks operating as lead manager or issue manager of such issues face problems as a result of fraudulent and invented share capital issues by companies. 7.5 SUMMARY The Merchant Banking industry in India has faced multiple challenges over the years, starting with large foreign banks and firms and then being embraced by Indian Commercial Banks and firms. When more individuals and companies began to grow during the time of economic liberalisation in the 1990s, new prospects arose. Despite the fact that these banks are subject to a slew of rules and regulations enforced by the SEBI and the Reserve Bank of India, they continue to thrive. With changing international conditions and market patterns, it is now up to 61 CU IDOL SELF LEARNING MATERIAL (SLM)
the government to implement changes that protect customers' interests while also allowing these banking services to flourish. 7.6 KEYWORDS (AIFI) All India Financial Institution Commercial banks Those Banks that deals in debt and debt related finance Underwriting — A banks sign into documents that agree to provide financial payment to their clients in case of any damage or losses Portfolio Management A kind of services to check on the liquidation of assets to track the income made by these companies and study how they can make it better Advisory Services A type of service that advises especially on starting companies & those that would want to expand 7.7 LEARNING ACTIVITY 1. Visit Merchant Banking division of PNB Bank to understand the various activities performed ___________________________________________________________________________ ___________________________________________________________________________ 2. Study the activities and process followed in IRAM Branch of Punjab National Bank for sanction of Business / MSME loan. ___________________________________________________________________________ ___________________________________________________________________________ 7.8 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Discuss what are the Categories of Merchant Banks 2. Outline about the Authority(s) who regulate merchant Banking business in India. Long Questions 1. Explain the problems of merchant banks in India 2. Discuss categories of India’s merchant banking organizations 3. Discuss in detail about setting up merchant banking in India. 62 CU IDOL SELF LEARNING MATERIAL (SLM)
B. Multi Choice Questions 1. A merchant bank is a financial institution conducting money market activities and: a. Lending b. Underwriting and financial advice c. Investment service d. All of these 2. Merchant-banking activity, in India was started with the merchant banking division set up by the __________. a. Barclays bank b. Grind lays bank c. Yes bank d. None of these 3. The early development of merchant banking in the country is given to the ________. a. FEMA b. Foreign Exchange Regulation Act, 1973 c. Securities Contracts Act d. Income-tax Act 4. _____ is basically a savings and investment corporation. a. UTI b. IDBI c. SBI d. RB 5. Developmental activities of merchant banking. a. Sources of funds forever b. Expanding industry and trade c. Leaving a widening gap unabridged between supply and demand of investible funds. d. All of these Answers 63 1 – d, 2 – c, 3 – a, 4 – a, 5 – d, 7.9 REFERENCES Text Books: Bhole, L.M., Financial Institutions & Markets. Tata McGraw Hill, New Delhi Khan, M.Y.Financial Services Tata McGraw Hill, New Delhi CU IDOL SELF LEARNING MATERIAL (SLM)
Meir, Kohn, Financial Institutions & Markets, Tata McGraw Hill, New Delhi Prasanna Chandra: Financial Management, Tata McGraw Hill. Reference Books: Kothari, C.R., Investment Banking & Customer Services Arihant Publishers, Jaipur Sharpe, William F. etc. Investment. New Delhi, PHI Pandey, I.M., Financial Management, Vikas Publishing House, New Delhi 64 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 8 - INSURANCE Structure 8.0 Learning Objective 8.1 Objective 8.2 Nature 8.3 Functions 8.4 Limitation 8.5 Classification 8.6 Principles of Insurance 8.7 Summary 8.8 Keywords 8.9 Learning Activity 8.10 Unit End Questions 8.11 References 8.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Describe nature of Insurance Identify scope of Insurance Benefits of Insurance Process involved in Insurance 8.1 OBJECTIVES Granting Security to People Insurance is mainly used to provide protection from personal injuries and penalties. It's a deal between two parties in which one agrees to cover the other from damages in exchange for a fee charged by the other. The insurance provider is one entity, and the insured is another. Insurance providers promise that the insured will be compensated in the event of an unfavorable event. In exchange for a guarantee of compensation, insureds must pay premiums to insurance providers. Minimization of Losses Insurance seeks to reduce damages incurred by potential threats and uncertainty. It increases the certainty of compensation to citizens in exchange for the occurrence of unknown events. Individuals are protected by insurers in the case of a loss. Through proper planning and 65 CU IDOL SELF LEARNING MATERIAL (SLM)
administration, it reduces the risk. Insurance firms advise citizens to install fire warning equipment, alarm systems, and surveillance cameras, among other things. They also collaborate with other agencies such as the fire department, the health department, and other organizations that seek to reduce casualties and damages. This is how insurance works to reduce the risk of multiple losses. Diversifying the Risk Insurance seeks to distribute the risk over a wide number of individuals. Its aim is to distribute the total risk associated with any potential contingency, thus reducing the negative consequences. It's a forum for people to share their risk with others. Insurance firms reimburse policyholders for losses by deducting premiums from their various policyholders. Insurance firms distribute the possibility of a single individual's loss to a wide number of people by paying compensations with the premiums received. Reduces the Anxiety and Fear Individuals are relieved of any anxiety and uncertainty about potential threats and uncertainties thanks to insurance plans. It ensures that they will be compensated in the event of any unfavorable circumstances. For stressed and anxious people, the assurance of reward is the most reassuring factor. They are assured of reimbursement in the event of a variety of uncertain incidents. It instils faith in them, and they devote their full attention to their tasks. Mobilizes The Saving Another essential goal of insurance is to mobilize investment. It entices people to invest by providing a range of insurance plans that guarantee coverage for losses. A large number of people purchase this insurance policy to protect themselves from injuries and damages. Insurance firms may raise a huge amount of money by charging premiums to their policyholders on a regular basis. These funds are then invested in shares and stock in the market by these firms, which produce profits. Insurance firms use ideal lying tools with the general public to generate revenue. Generation of Capital Insurance firms generate capital by raising vast sums of money from the general public. They charge a premium for offering loss insurance to their large customers on a daily basis. These funds are invested in the growth of industry by purchasing company stock. Companies may obtain the money they need from the insurance industry, which invests in companies in order to gain dividends and other incomes. This improves the country's industrial production and economic growth. Larger investments also result in the development of a variety of job opportunities. 8.2 NATURE Sharing of risks: Insurance is a cooperative device for sharing the danger of 66 unexpected incidents, such as the death of the family's head of household, the occurrence of maritime perils, or the loss of property due to fire. Insurance is a mutual method of spreading a specific risk among a group of people CU IDOL SELF LEARNING MATERIAL (SLM)
who are exposed to it. A large number of people share the losses caused by a specific risk. Assessment of risk: The volume of risk, which forms the basis of the insurance contract, is calculated for the purpose of determining the insurance premium. Payment upon the occurrence of a specified incident: The insurance provider is 67 obliged to pay the insured upon the occurrence of a specified event. The occurrence of the stated incident is guaranteed in life insurance; however, it is not required in fire, marine, or accidental insurance. In such situations, the insurer is not responsible for indemnity payments. Payment Amount: The indemnity insurance payment amount is determined by the essence of the damages suffered and is limited to the sum insured. However, when it comes to life insurance, a fixed amount is paid when an unpredictable occurrence happens or when the policy matures. A large number of people are insured: The success of an insurance company is dependent on a large number of people being insured against the same risk. This will allow the insurer to spread the risk of loss over a large number of people, lowering the premium rate. Insurance isn't a game of chance: Insurance isn't a game of chance. Gambling is prohibited because it benefits one party while harming the other. A legal policy for indemnity against damages is known as insurance. Furthermore, insurable interest is present in insurance contracts and involves an investment aspect. Insurance is not charity: charity provides without expecting anything in return, but in the case of insurance, the insured pays a fee to the insurer in exchange for a potential playout. Risk protection: Insurance protects against threats in the areas of life, products, and property. It's a tool for avoiding or reducing risks. Risk-spreading: Insurance is a strategy that spreads the costs and liabilities of a few individuals over a wide group of people. “Insurance is a plan with which a vast number of people associate themselves and pass risks associated with individuals to the shoulders of all,” writes John Magee. Insurance is a risk-transfer scheme in which the insured entrusts his risk to the insurer. This may be why, as Myerson points out, insurance is a device for transferring any economic risks to the insurer, which would otherwise be incurred by the insureds. Losses can be estimated: By purchasing a life insurance policy, one can estimate potential financial losses. The insurer uses this to assess the premium rate, which is determined based on the maximum risks. Insurance is a legal arrangement between the insurer and the insured in which the insurer agrees to financially reimburse the insured within the terms of the insurance policy and the insured promises to pay the insurer a fixed rate of premium. Insurance is a policy based on such basic insurance concepts, CU IDOL SELF LEARNING MATERIAL (SLM)
such as utmost good faith, insurable interest, contribution, indemnity, causa Proxima, subrogation, and so on, which are the cornerstone for the effective operation of an insurance scheme. Institutional framework: After nationalisation, the country's insurance sector works under a statutory organisational structure. The Life Insurance Company, the General Insurance Corporation and its related companies, as well as private players, operate in India's various insurance fields. Insurance for pure risks only: Insurance for pure risks only results in damages for the insured, not money. Accidents, misfortune, death, fire, injury, and other one-sided threats are examples of pure risks, which all result in loss. Insurance firms only write plans for pure risks, not for speculative risks. Speculative risks can result in both gains and losses. Insurance is a social device, according to Miller, because it is a plan for social security and the defence of people's interests. Based on mutual good faith: Insurance is a deal between two parties based on mutual good faith. As a result, all parties are obligated to reveal relevant information surrounding the contract before the other. One of the most relevant insurance values is absolute good faith. Regulation by law: Every country's government enacts legislation governing the insurance industry in order to regulate and control its activities in the public interest. The main enactments in this direction in India are the Life Insurance Act 1956, the General Insurance (Nationalisation) Act 1972, and the Insurance Regulatory and Development Authority Act 1999. Insurance has a much broader and more detailed scope. In the region, different types of policies have been developed to cover risks such as life, fire, marine, accident, robbery, and burglary. 8.3 FUNCTIONS The functions of insurance may be categorized as below: I. Primary Functions II. Secondary Functions III. Other Functions I. Primary Functions The primary functions of insurance include the following: 68 1. Provide protection: Insurance is primarily designed to protect against potential danger, injuries, and uncertainty. Insurance cannot eliminate a danger from happening, but it will definitely compensate for the risk's damages. Professor Hopkins observes, “Insurance is a protection against economic loss by sharing the CU IDOL SELF LEARNING MATERIAL (SLM)
risk with others.” He further adds “Insurance is the protection against economic loss.” 2. Collective bearing of risk: Insurance is a medium to share the financial loss of few among many others. Dinsdale opines, insurance is a mean by which few losses are shares among longer people. Similarly, William Beveridge observes, “The collective bearing of risks is insurance.” All the insureds contribute the premiums towards a fund and out of which the persons exposed to a particular risk is paid. Similarly, Rigel and Miller observe, “Insurance is a device whereby the uncertain risk may be made more certain.” 3. Evaluation of risk: Insurance assesses a number of risk factors to determine the possible magnitude of risk. Risk is often used to determine the premium rate. 4. Provide certainty against risk: Insurance is a device which helps to change from uncertainty to certainty. This may the reason that John Magee writes that the function of insurance is to provide certainty. Similarly, Riegel and Miller observe, “The function of insurance is primarily to decrease the uncertainty of events.” 5. Spreading risks: Professor Thomas has correctly written that “Insurance is the device for spreading or distributing risks.” II. Secondary Functions 1. Prevention of losses: Individuals and businesspeople are encouraged to use 69 appropriate equipment to avoid unfavourable risk outcomes by following safety directions, installing automatic sparkler or alarm systems, and so on. Preventing risks results in the insurer paying the assured a lower amount, which encourages more premium savings. Reduced premium rates encourage more business and provide greater insurance to insureds. The Loss Prevention Association of India, which was established by insurers, uses public awareness campaigns to alert people about potential threats and uncertainties. 2. Small capital to cover larger risks: According to Dinsdale, insurance frees businesspeople and others from risky investments by paying a small premium against a greater danger and uncertainty. They don't need to spend individually for security purposes, and the money they save can be put to better use. 3. Contributes towards the development of larger enterprises: Insurance offers opportunities for growth for larger companies that face more risks in their start-up. Financial institutions may be willing to lend money to sick industrial units that have insured their properties, such as plant and CU IDOL SELF LEARNING MATERIAL (SLM)
machinery. III. Other Functions There are indirect functions of insurance which benefit the economy indirectly. Some of such functions are: 1. Means of savings and investment: Insurance is both a savings and an investment vehicle. Insurance is a required form of savings that limits the insured's excessive expenditures. People engage in insurance for a variety of reasons, including income tax deductions. “Although investment is not the primary function of insurance,” writes Magee. Insurance has been shown to have an important advantage in the form of investment services. 1. Source of earning foreign exchange: Insurance is a worldwide market. The country will produce foreign currency by selling marine insurance policies. 2. Promotes exports: Via various types of policies offered under maritime insurance cover, insurance makes international trade risk-free. The insurance company compensates for freight and other losses caused by maritime perils. 3. Provides social security: The insurance provides individuals with social security through a variety of social care schemes. It not only offers protection in the event of death, but also assists insureds in the event of illness, old age, pregnancy, and other events. 8.4 LIMITATIONS Despite the many benefits of insurance, it does have certain drawbacks. Because of 70 these restrictions, insurance benefits could not be fully used. What are the restrictions: 1. All risks are not insurable: All risks are not insurable; only pure risks are insurable, and speculative risks are not insurable. 2. Insurable interest (financial interest) in the subject matter: Insurance is only available if the insured has an insurable interest in the subject matter of the insurance at the time of insurance, at the time of loss, or all times; otherwise, the insurance arrangement is invalid. 3. Impossibility of calculating actual loss: Such risks are not insurable if the loss arising from the occurrence of the incident cannot be valued in terms of money. 4. It is not possible to cover the risk posed by a single individual or a small group of people: Protection against the risk posed by a single person or a small group of people is not advised because it is impractical due to the higher costs involved. CU IDOL SELF LEARNING MATERIAL (SLM)
5. Higher premium rates: Another significant drawback is that premium rates in our country are higher, excluding some groups of citizens from benefiting from insurance. The primary explanation for the higher premium rate is that the operating costs are higher. 6. Moral hazards: In the insurance industry, moral hazards can be difficult to handle. Certain individuals take advantage of insurance policies for their own gain by filing false claims with insurance agencies. 7. Such privileges are not insured by private insurers: Private insurers are not allowed to insure such forms of risks such as unemployment insurance, bank bankruptcy insurance, and so on. 8. Insurance is a poor investment: Insurance is not a safe investment. Its key goal is to protect people from dangers. The insurance industry cannot be a source of benefit. 9. In certain situations, government cooperation is required: Such risks can only be insured with government cooperation; for example, unemployment insurance, bank insolvency, food insurance, and so on. 10. The insurer does not cover all pure risks: The insurer does not cover all pure risks. Even if it is just with a higher premium rate. For example, an insurer is unlikely to approve a proposal from a person who has undergone heart surgery. 8.5 CLASSIFICATION Broadly, insurance may be classified into the following categories: I. Classification on the basis of nature of business II. Classification from business point of view III. Classification from risk point of view I. On the basis of nature of business 1. Life Insurance 2. Fire Insurance 3. Marine Insurance 4. Social Insurance, and 5. Miscellaneous Insurance 71 CU IDOL SELF LEARNING MATERIAL (SLM)
1. Life Insurance: If a designated event affecting human life happens, the insurer promises to pay the assured, or the individual for whose benefit the policy is taken, the assured amount of money in exchange for a certain fee, either in a lump sum or by other periodic payments. As any other form of insurance, a life insurance policy requires the assured to have an insurable interest in his life at the time of the deal. Unlike most other forms of insurance, interest on a life insurance policy must be proved only when the contract is signed, not when the policy is due. A person can insure his or her own life, including all aspects of it, for any amount he wants. In the same way, a wife's love for her husband is unbreakable, and vice versa. Natural affection and devotion, on the other hand, are insufficient to create an insurable interest. It must be shown that the person who has an impact on another's life is so inextricably connected to that person that he or she has a right to assist. A sister, for example, has an inexhaustible interest in the life of a respectful brother. An individual who is not related to the other may have a strong desire to help them. For example, a creditor has an insurable interest in his debtor's life equal to the debt amount. A borrower can guarantee the life of his debtor up to the amount owed at the time the policy is given. As a result of the employer's contractual obligation to hire him for a set period of time at a set salary, an employee has an insurable interest in the employer's life. Similarly, from an employer to an employee who is contractually bound to work for a set period of time. 2. Fire Insurance: A fire insurance policy protects the insured against the loss or damage to their property caused by a fire. Up to the policy's maximum cap, the insurer decides to pay the entire amount of the insured's damage. Fire insurance is essentially an indemnity contract that protects against losses caused by fires, rather than against the occurrence of accidents. A provision known as the average clause, in which the insured is required to bear a portion of the loss himself, is becoming more common in fire insurance contracts. This provision's key aim is to avoid underinsurance and encourage full coverage. It teaches the property owner the importance of properly valuing his property before buying insurance. In terms of insurable interest, the insured must have an insurable interest in the subject matter both at the time of affecting the policy and at the time of failure. The risk of a fire insurance policy begins when the cover notice, deposit receipt, or temporary security is issued and continues during the insurance contract. If the parties so like, it might also go back in time. The amount of risk or danger involved determines the premium rate. 3. Marine Insurance: A marine insurance policy is an arrangement in which the insurer agrees to indemnify the assured in the manner and to the degree decided 72 CU IDOL SELF LEARNING MATERIAL (SLM)
upon against marine damages, that is, losses incurred as a result of engaging in a marine adventure. When every insurable property is exposed to underwater perils, it becomes a marine adventure. Marine perils, also known as perils of the seas, include fire, war perils, pirates, criminals, bandits, captures, jettisons, barratry, and all other perils of the seas that are either of the same nature or may be planned by the policy. Different types of marine policies are identified by different names depending on how they are implemented or the danger they cover. They are the voyage policy, the time policy, the valued policy, the unvalued policy, the floating policy, and the wager or honour policy. 4. Social Insurance: Social insurance was created to provide financial coverage to those in society who could not afford to pay the premiums for sufficient insurance. Social insurance can cover the following forms of insurance: (i) Sickness Insurance: Under this form of insurance, the covered person who becomes ill receives medical care, medications, and compensation reimbursement during the sickness time, among other things. ii) Death Insurance: In the event of the assured's death while on the job, financial support is given to his or her dependents. By purchasing an insurance policy against workers, the employer may pass his responsibility. iii) Disability Insurance: Factory workers are covered by disability insurance in the event of a complete or partial disability caused by an accident while on the job. The employer is responsible for paying overtime, according to the Employees Compensation Act. However, when purchasing a community insurance policy, the employer passes his responsibility to the insurer. iv) Unemployment Insurance: If an insured person becomes unemployed for a particular purpose, he is provided with financial aid before he seeks work. v) Old-age Insurance: Under this form of insurance, the insured or his dependents receive financial support after reaching a certain age. The Indian government has been widening the reach of Social Insurance in recent years. Via various insurance plans, this scheme has now been expanded to daily wage earners, Rickshaw pullers, Landless farmers, Sweepers, Craftsmen, and others under the principle of social justice. 5. Miscellaneous Insurance: The rapid growth of society has resulted in a variety of risks or hazards. Many other forms of insurance have been created to provide protection against such risks. The most significant are: (i) Vehicle insurance on buses, automobiles, vans, bikes, and other equipment, which has been made mandatory so that injuries sustained as a result of accidents can be collected from the insurance provider. (ii) Personal injury insurance by paying a Rs.12 annual premium on a Rs.12,000 73 CU IDOL SELF LEARNING MATERIAL (SLM)
policy. A fixed sum is paid to the insured in the event of accidental death or total/partial disability, according to the terms of the insurance policy. (iii) Fraud insurance — (against theft, dacoity etc.) (iv) Legal liability insurance (insurance under which the assured is responsible for property harm or compensation for personal injury or death). This can take the form of fidelity guarantee insurance, car insurance, and machinery insurance, among other things. crop insurance (vi) Insurance for cattle (Insurance for indemnity against the loss of cattle from various kinds of diseases). In addition to the above, insurance policies for crime, medical insurance, bullock carts, jewellery, bike rickshaws, radios, and televisions are available. 6. Classification from business point of view From business point of view, insurance can be classified into two broad categories: 1. Life Insurance; and 2. General Insurance 1. Life Insurance: According to Life Insurance Act, 1938, life insurance refers to the contract of insurance on human life, under which if any individual’s death, other than accident, or happening of any event concerning to human life, a certain amount is guaranteed to be paid to assured or his/her legal representative. According to the terms of contract the assured should pay premium, the rate of which may differ according to the human life. The act also provides for : (a) Payment of double or triple rate of accidental benefits, as per terms of contract. (b) Annuity on human life, and (c) Superannuation allowance and annuity from the funds created for granting assistance to such persons. 2. General Insurance: General insurance business refers to fire, marine, and miscellaneous insurance business whether carried on singly or in combination with one or more of them, but does not include capital redemption business and annuity certain business. (According to Sec.3(g) of the General Insurance Business (Nationalisation) Act, 1972). II. Classification from Risk Point of View 74 CU IDOL SELF LEARNING MATERIAL (SLM)
From risk point of view, insurance can be classified into four categories: 1. Personal Insurance 2. Property Insurance 3. Liability Insurance 4. Fidelity Guarantee Insurance A brief description of each is given below: 1. Personal insurance pays out if a person dies as a result of an accident or disease covered by the policy. If a specific occurrence occurs or the insurance period ends, the insurer agrees to reimburse the amount covered. This insurable sum is determined when the policy is purchased and provides health, accident, and illness coverage. In life insurance, the factor of investment and security is present, while indemnity is only present in involuntary, sickness, or health insurance. 2. Homeowners Insurance: A homeowner's insurance policy is an indemnity policy. Property insurance allows the insured party to have evidence of injury. Robbery, break-ins, and stealing, among other things, are all included under this category. The assured is in charge of protecting the insured property. After the loss has happened, the assured is usually supposed to notify the police. 3. Liability Insurance: Liability insurance is a type of general insurance in which the insurer offers to pay for any collateral damage or compensation for third-party losses. The compensation is paid directly to a third party. Liability insurance includes things like workers' compensation, third-party motor insurance, technical indemnity insurance, and third-party liability insurance. Industrial accidents, defective goods, plant fires during construction, the production of poisonous gas within the factory, and the use of chemicals and other such substances in the manufacturing process are all potential sources of liability in liability insurance. 4. Fidelity Guarantee Insurance: In this type of insurance, the insurer promises to compensate the guaranteed (employer) for damages caused by employee fraud or embezzlement in return for a premium. This type of insurance is sometimes used as a precautionary measure when new and untrained employees are placed in positions of trust and confidence. 8.6 PRINCIPLES OF INSURANCE A contract of insurance, like any other contract, must include all of the basic 75 elements of a contract, such as the nature of an agreement, the parties' free consent, CU IDOL SELF LEARNING MATERIAL (SLM)
their competence to enter into an agreement, lawful consideration, and so on. In addition to these, the following conditions (principles) are absolutely important for the validity of an insurance contract: 1. Good Faith: The legal principle of caveat emptor (let the buyer beware) applies to ordinary business contracts. The caveat emptor principle, on the other hand, does not apply to insurance policies. An uberimae fidei contract is a form of insurance bid (i.e. based on absolute good faith). It means that the insured is responsible for reporting all relevant details about the insurance's subject matter. The policy may be voidable at the insurer's discretion if a material fact is not revealed, or if there is misrepresentation or fraud. The definition of a material fact differs according to the circumstances of each case. As a consequence, rather than a statute, it is a matter of fact. The law court will decide if there was a failure to disclose relevant information. A material fact is one that the insurer must take into account when deciding whether or not to accept the risk. It is also significant if the reality has an impact on the amount of premium the insurer can offer. It's important to remember that the burden of proof of concealment falls on the insurer. Furthermore, the doctrine of good faith is not one-sided. The insurer, like the insured, is required to disclose all relevant information that is not known to him or his agents. He must, for example, point out any weaknesses in his plan. 2. Indemnity: Life insurance is a contingent agreement, meaning that the money is only paid out if a predetermined event occurs. An endowment scheme, for example, pays out the negotiated sum after a set period of time or death, whichever comes first. As a consequence, sooner or later, the agreed-upon sum is due. Some insurance policies, such as fire and marine, are not reliant. There are indemnity contracts. Under these cases, the insurer offers to compensate the insured for any actual losses incurred as a result of an accident or misfortune. “The guarantee of insurance contained in a marine or fire policy is a contract of indemnity and indemnity only, and this contract implies that in the case of a loss against which the policy has been made, the assured shall be fully indemnified but no more than fully indemnified.” The public interest frequently demands that the insured receive no more than the actual loss, since otherwise, the assured would be tempted to destroy his property and perform a certain social act on a regular basis. The guaranteed is only liable to actual loss except in cases of over-insurance (i.e., where a policy is taken for a sum greater than the property's real value). 3. Subrogation: Under the principle of subrogation, the insurer acquires all of the insured's rights in relation to the insurance subject matter. The theory has been articulated in the following terms in an American case: “Subrogation is the act of substituting one individual for another, whether as a creditor or as the owner of some other legitimate claim, such that the person who is substituted 76 CU IDOL SELF LEARNING MATERIAL (SLM)
succeeds to the other's rights in relation to the claim, its rights, remedies, or securities.” 77 The insured of be protected from the third party as a consequence of the third party's incompetence, mischief, or an agreement between the insured and the third party, among other things. The following basic characteristics of the subrogation doctrine should be considered: (a) Contracts of Life and Personal Accident Insurance: Since the doctrine of subrogation is merely a corollary of the \"doctrine of indemnity,\" it only applies to contracts of indemnity (i.e., contracts of fire and marine insurance). It does not extend to life and personal injury insurance policies. As a result, the legal agent will receive the insured amounts from the insurance company as well as any damages from the third party, if any. (b) Payment of the whole loss: The \"doctrine of subrogation\" only applies if the insurer pays the whole loss to the insured. The theory does not apply in the case of partial loss. The express clause, on the other hand, can allow the insurer to exercise his right of subrogation even before the insured is charged. (c) The insured to surrender all his rights claims and remedies in favour of insurers: When insurers pay the whole loss to the insured, the insurers take the place of the insured and exercise all of the rights, lawsuits, and remedies that the insured has against the third party/parties. If the insured seeks reimbursement for the loss from a third party after his insurer has indemnified him, he retains that additional compensation as a trustee for his insurer to the degree that the latter is entitled. (d) Insurer entitled to benefit only to the extent of his payment: By way of subrogation, the insurer is only entitled to rights, claims, and remedies to the degree of his pay-out. In a recent case in the United States, it was determined that if the insurer receives more money from the defaulting third party after paying the claim to the insured, he must pay the excess to the insured, while he may charge the insured his share of fair expenses incurred in collecting the money. (e) The insured to provide facility to the insurer: The assured is generally named in any action taken by the insurer against a third party. The insurer, on the other hand, bears the burden of any action taken. The insured owes it to the insurer to provide all fair assistance that the latter should need in enforcing his rights against third parties. (f) The insurer entitled to only such rights as are available to the insured: Only the rights applicable to the insured are available to the insurer. He CU IDOL SELF LEARNING MATERIAL (SLM)
would not be able to claim greater rights against the at-fault parties than the 78 insurer would have had. 1. Insurable Interest: The insured must have an \"insurable interest\" in the subject matter of the insurance policy. An insurance policy must have the legal right to insure in order to be valid. The legal right to insure is based on monetary value and is given to a person who is recognised by the law as being interested in the security of an object or the continuation of a life. Mutual love and affection are not considered insurable interests by the statute for the purposes of insurance coverage. A wagering arrangement is an insurance policy without an insurable interest. The term \"insurable interest\" is used to describe a variety of insurance policies. Here are some examples of when someone has an insurable interest in the life of another: 1. A son who is financially reliant on his father can purchase life insurance for him. Similarly, if his son is financially dependent on him, the father would buy him a life insurance policy. The overall profit of a life insurance policy is limited to the amount or value of the insured's insurable interest in the life insured at the time the policy is issued. 2. A creditor can only guarantee the life of his debtor up to the amount of his mortgage, plus any premiums and interest charges. 3. A partner can only guarantee the life of another partner to the extent that the latter is wealthy. It's because, in the event of his death, only his share of the company must be paid out in order for the business to continue operating smoothly in terms of money. 4. A business has an insurable interest in the life of a senior officer who is employed by the company and whose death could harm the company's income, and an employer has an insurable interest in the life of his contractor. 5. A trustee's interest in the interests entrusted to him is insurable. 6. An insured can pursue re-insurable coverage if he has an insurable interest in the policy's subject matter. 7. Surety in the lives of his principal debtors only up to the point of his vow. 3. Causa Proxima: Causa Proxima is a Latin term that means \"nearest cause\" (i.e., nearest cause). If a loss occurs as a result of several causes, the cause that is nearest to the loss is considered to be at fault. In a normal and unbroken chain of events, it is the catalyst that causes failure or damage. The cause is nearest to the result in terms of consequence, but not necessarily in time. As a consequence, a cause like this is successful. When deciding whether or not the insurer is responsible for the damage, the principle of causa Proxima states that the proximate cause, not the remote cause, must be considered. It's simple to CU IDOL SELF LEARNING MATERIAL (SLM)
determine the insurer's liability when there's only one cause of damage or loss. In most cases, however, a combination of factors is to blame for the loss or injury. In this case, the causa Proxima principle is applied. However, the word \"proximate\" should not be overemphasised to the point that the concept of the cause is lost or obliterated. The real and overriding principle is to examine the contract as a whole and determine what the parties really want, what caused the default, the event, or the accident, and this is not in the artificial sense that the contracting parties have in mind when they speak of cause. 4. Doctrine of Contribution: It is another corollary of the Indemnity Doctrine. If the insured has more than one policy on the same subject matter that has been destroyed, he will recover his losses from the insurance firms in whatever order he wants. Of course, he isn't allowed to regain more than the sum of the loss. Inequity between insurers is sometimes caused by the insured's recovery of loss at his discretion. The doctrine of contribution ensures that losses are spread equally among insurers. According to the theory of contribution, an insurer/insurer who has/have paid more than his/her proportionate share to the insured has the right to recover the difference from other insurers/insurers. For example, a person insures his house under two policies--with A for Rs.20,000 and with B for Rs.8,000. Now suppose the loss if for Rs.18,000, the contribution shall be as follows : A shall pay 20,000 ---------- X 18,000 = Rs. 12857.00 28,000 B shall pay 8,00 X 18,000 = Rs. 5,143.00 0 --------- 28,000 The above discussion reveals the following characteristics of the doctrine of 79 contribution: CU IDOL SELF LEARNING MATERIAL (SLM)
(1) The subject-matter of insurance must be same to all the policies; (2) The peril which is insured against must be the same in all the policies; (3) The same insured must be there in all the policies; and (4) All the policies must be in force when the loss occurs. It should be noted, however, that the donation clause is normally included in the policy. If the insured has some other insurance effected by or on behalf of the insured covering any of the property lost or injured, this provision restricts the insurance company's responsibility to its retable proportion of the loss attributable to the insured peril. This provision discourages multiple or unnecessary insurance, avoiding unfair competition. Only fire and marine policies are subject to the doctrine of contribution, as are the rules of subrogation and indemnity. 8.7 SUMMARY Insurance is a contract that reimburses the insured for injuries or liabilities sustained as a result of the occurrence of specified events. The premium is charged for the entire term of the policy. Insurance policies are built on the principles of good faith, insurable benefit, compensation, subrogation, contribution, and other values. A life insurance policy can serve as both a safety net and an investment vehicle. It is an insurance arrangement since it covers the assured by paying the whole sum assured in the event of his or her death. It's also an insurance plan, since it guarantees that the money will be returned to the insured with interest and a bonus at the end of the policy. A general insurance policy is merely a security arrangement, not an investment contract, in which the premiums paid are only returned to the insured in the form of claims if such events arise. 8.8 KEYWORDS Transfer of risk: Insurance is a plan in which the insured transfers his risk on the insurer. Evaluation of risk: Insurance determines the probable volume of risk by evaluating various factors that give rise to risk. Underwriting — A banks sign into documents that agree to provide financial payment to their clients in case of any damage or losses (IRDAI) Insurance Regulatory and Development Authority of India 80 CU IDOL SELF LEARNING MATERIAL (SLM)
8.9 LEARNING ACTIVITY 1. Understand the Process of Insurance underwriting for LIC ___________________________________________________________________________ ___________________________________________________________________________ 2. Analyse & find 5 high demand policy offered by Life Insurance Corporation of India. ___________________________________________________________________________ ___________________________________________________________________________ 8.10 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Briefly discuss about Life Insurance and its importance 2. Explain briefly about different types of Insurances 3. Describe about Ubermefedai principle Long Questions 1. “Insurance is a process in which uncertainties are made certain.” Discuss the statement and explain the importance of insurance. 2. Define insurance and describe its main characteristics. 3. Describe the various kinds of insurance in detail. 4. “A contract of insurance is a contract of utmost good faith.” Discuss. 5. Define insurable interest. Discuss the importance of this principle. B. Multi Choice Questions. 1. Which of the following types of companies/organisations gives ULIP? a. Insurance companies b. Banks c. NABARD d. RBI 2.Which of the following is only the public sector company under the category of life 81 insurance? CU IDOL SELF LEARNING MATERIAL (SLM)
a. General insurance company b. New India assurance company c. Oriental insurance company d. Life Insurance Corporation of India 3. Which of the following is the regulator of insurance sector in India? a. RBI b. AMFI c. IRDA d. SEBI 4. One of the following terms is NOT relevant to the insurance sector? a. Indemnity b. Coverage c. Misuse Alert d. Annuity 5._______refers, the loss of life by accident, or sickness to individual which is covered by the policy. a. Personal Insurance b. Property Insurance c. Fidelity Guarantee Insurance d. Liability Insurance Answers 1 – a, 2 –d, 3 – c, 4 – c, 5 – a, 8.11 REFERENCES Text Books: Bhole, L.M., Financial Institutions & Markets. Tata McGraw Hill, New Delhi Khan, M.Y.Financial Services Tata McGraw Hill, New Delhi Meir, Kohn, Financial Institutions & Markets, Tata McGraw Hill, New Delhi Prasanna Chandra: Financial Management, Tata McGraw Hill. Reference Books: Kothari, C.R., Investment Banking & Customer Services Arihant Publishers, Jaipur Sharpe, William F. etc. Investment. New Delhi, PHI Pandey, I.M., Financial Management, Vikas Publishing House, New Delhi 82 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT 9 - BANKING Structure 9.0 Learning Objective 9.1 Introduction 9.2 Meaning 9.3 Objective 9.4 Type 9.5 Functions 9.6 Summary 9.7 Keywords 9.8 Learning Activity 9.9 Unit End Questions 9.10 References 9.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Describe nature of Banking Identify scope of Banking Benefits of Banking Process involved in Banking 9.1 INTRODUCTION As for as the origin of the present banking system in the world is concerned, the first bank called the “Bank of Venice” is believed to be established in Italy in the year 1157. The first bank in India was started in the year 1770 by the Alexander & Co., an English Agency as “Bank of Hindustan” which failed in 1782 due to the closure of the Agency House in India. The first bank in the modern sense was established in the Bengal Presidency as “Bank of Bengal” in the year 1806. According to G. Crowther the modern banking has three ancestors in the history of banking in this world:- i) The Merchants 83 CU IDOL SELF LEARNING MATERIAL (SLM)
ii) The Goldsmiths iii) The Money Lenders i. The Merchants The merchants were the ones who invented banking because their trading practises necessitated money transfers from one location to another, which is still one of the most important functions of a bank today. Because of the risk of money being stolen during physical transportation, traders started to issue documents that could be used as money titles. This scheme gave birth to the “Hundi,” a letter of transfer in which a merchant instructs another merchant to pay the bearer of Hundi the specified sum of money in the Hundi and debit this amount against the drawer of Hundi. ii. The Goldsmiths The role of goldsmiths was the second stage in the development of banking. Goldsmithing was such a dangerous business that he needed to keep the gold in a safe and take extra precautions. People began entrusting their valuable bullion and coins to goldsmiths at a time when paper was not in use and money consisted solely of gold and silver. As word of this activity spread, goldsmiths began to charge for the treatment of the gold and silver. He began to issue a receipt as proof of obtaining valuables. The goldsmiths began lending the gold and silver coins because the owners' markings were missing. The goldsmiths were willing to give the receipt holder an equivalent sum of gold or silver money, so the goldsmith receipts functioned as a medium of trade and a means of payment from one merchant to another. iii. The Money Lenders The third stage in the development of the banking system is the transformation of goldsmiths into money lenders. Through the passage of time and practise, goldsmiths discovered that coin withdrawals were much less than coin deposits, and that it was not appropriate to keep any of the coins with them. The goldsmiths began advancing the coins on loan, charging interest, after holding the contingency fund. As a result, the goldsmith money lender evolved into a banker, capable of performing two crucial roles in the modern banking system: taking deposits and making loans. The main difference is that today's currency is paper money, while historically it was gold or silver coins. 9.2 MEANING Since a modern bank performs a number of functions, it is difficult to provide a precise 84 description of a bank. Usually, a ‘Bank' is an entity that deals with money and credit in such a way that it accepts public deposits, makes surplus funds available to those in need, and assists in the secure remittance of money from one location to another. CU IDOL SELF LEARNING MATERIAL (SLM)
Different economists have defined a bank in various ways. Some of the important definitions are as under: “A bank collects money from those who have it to spare or who are saving it out of their incomes, and it lends this money to those who require it.” G.Crother “Banking means the accepting for the purpose of Indian companies lending or investment, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft or otherwise.” The Banking Companies (Regulation) Act, 1949 An ideal definition of a bank can be given as under: - “A bank is a commercial establishment which deals in debts and aims at earning profits by accepting deposits from general public at large, which is repayable on demand or otherwise through cheques or bank drafts and otherwise which are used for lending to the borrowers or invested in Government securities.” 9.3 OBJECTIVES Safeguard Deposits The primary role of a bank is to accept and safeguard public deposits. It provides consumers with assurances about the protection of their funds when they deposit money into their accounts. Provide Loans It offers loans to consumers on a short-term and long-term basis, depending on their requirements. Customers are paid interest on the amount lent by the bank, which is extracted from the deposits they obtain. Encourage Savings Banking institutions play an important role in motivating people to save. It allows people to save and invest their earnings in bank accounts by giving them a fixed rate of interest on the sum they deposit on a regular basis. Capital Formation Banking increases the rate of capital creation in a region. It extends credit to different sectors of the economy on a regular basis, enabling all growth and development activities to continue uninterruptedly. Various sectors and companies turn to banks to meet their financial needs. Currency Issue Banking institutions are responsible for issuing currency that is used as legal tender in the country. Our country's central bank (RBI) prints and distributes all currency notes to the general public. Enhances Living Standards 85 CU IDOL SELF LEARNING MATERIAL (SLM)
It provides credit to people to help them improve their quality of life. Customers can buy high-quality, expensive products on credit or via a hire purchase agreement with the bank. Generates Employment Banking institutions also contribute to the creation of a large number of job opportunities in the country. It assists businesses in expanding their operations by offering credit tailored to their needs. As a result, the demand for human capital for different roles will grow. In addition, the banking sector employs a sizable portion of the workforce. 9.4 TYPES OF BANKS Banks are of various types and can be classified: 1. On the basis of Reserve Bank Schedule. 2. On the basis of ownership. 3. On the basis of domicile. 4. On the basis of functions. A. ON THE BASIS OF RESERVE BANK SCHEDULE Bank can be of the following two types on the basis of Second Schedule of the Reserve Bank of India Act, 1934: i) Schedules Banks and ii) Non-scheduled Banks i) Scheduled Banks The Scheduled Bank refers to all banks that are listed on the Reserve Bank of India's Schedule Second list. Only those banks that meet the following criteria are included in the list of scheduled banks: a) It must have Rs.5 lakhs in paid-up capital and reserves. b) That it must ensure that the Reserve Bank's activities do not jeopardise depositors' interests. c) It must be a corporation or a cooperative society, rather than a sole proprietorship or a partnership. 86 CU IDOL SELF LEARNING MATERIAL (SLM)
i) Non-scheduled Banks Non-scheduled banks are those that are not listed in the second schedule of the Reserve Bank of India Act, 1934. They are not included in the second schedule because they do not meet the three criteria set out in the act for induction into the second schedule. ON THE BASIS OF OWNERSHIP Banks can be classified on the basis of ownership in the following categories: iii) Public Sector Banks iv) Private Sector Banks v) Cooperative Bank i) Sector Banks \"Public Sector Banks\" are banks that are owned or operated by the government. The 87 first public sector commercial bank, known as the State Bank of India, was established in 1955 by a special Act of Parliament. Following that, the government purchased the majority of shares in other state-owned banks, including the State Bank of Patiala, the State Bank of Bikaner & Jaipur, the State Bank of Travancore, the State Bank of Mysore, the State Bank of Indore, the State Bank of Saurashtra, and the State Bank of Hyderabad, which are now subsidiaries of the State Bank of India. The nationalisation of 14 major commercial banks by Mrs. Indira Gandhi through an ordinance on July 19, 1969 marked the beginning of the public sector's growth in the banking sector. On April 15, 1980, another group of six commercial banks with deposits totalling Rs.200 crores were nationalised, bringing the total number of such banks to 20. However, the number of nationalised banks has been reduced to 19 following the merger of New Bank of India and Punjab National Bank in 1993-94. Nationalization of the State Bank of India and its seven branches had already taken place. The country's public sector banking has risen in importance as banks have been increasingly nationalised. In 1996, these nationalised commercial banks had 31,055 branches across India, compared to 12,903 branches for the State Bank of India and its subsidiaries. The Oriental Bank of Commerce, State Bank of India, Corporation Bank, Bank of India, and Bank of Baroda have offered their shares to the general public and financial institutions as part of the government's current liberalisation strategy, and these banks are no longer 100 percent owned by the government of India. Although the government owns the majority of the shares, these are all public sector banks. CU IDOL SELF LEARNING MATERIAL (SLM)
ii. Private Sector Banks Private Sector Banks, on the other hand, are those that are owned and operated by the private sector, that is, private individuals and businesses. In India, the private sector played a crucial role in the growth of joint stock banks. In 1951, there were a total of 566 private sector banks, with 92 scheduled banks and the remaining 474 non-scheduled. There was no such thing as a public sector bank at the time. The nationalisation of banks in 1969 and 1980 dramatically reduced their position in commercial banking. The number of private sector banks has decreased since then, while the number of public sector banks has increased. iii) Co-operative banks Working together is what the term \"cooperative\" means. As a result, cooperative banking refers to a financial institution established on the principle of cooperation and engaged in ordinary banking activities. Cooperative banks are a special form of bank that conducts ordinary banking business and in which members work together to promote their mutual economic interests. Features of Cooperative Banking Following Are the Distinguishing Main Features of a Cooperative Bank: - i) Membership of Cooperative Banks is voluntary. Functions of a Cooperative Bank are common banking functions. ii) Organization and management of a Cooperative Bank is based on democratic principles. iii) Main objectives of a Cooperative bank are to promote economic, social and moral development of its members. iv) Basic principle of Cooperative Bank is equality. Therefore, we can conclude and define a cooperative bank as under: “Cooperative Bank is an institution established on cooperative basis which deals in ordinary banking business for the promotion of economic, social and moral development of its members on the principle of equality.” The short term agriculture credit institutions cater to the short term financial needs of the agriculturists which have the following three tier federal structure in cooperative: a) At the Village level : Primary Agricultural Credit Societies b) At the District level : Central Cooperative Banks c) At the State level : State Cooperative Banks 88 CU IDOL SELF LEARNING MATERIAL (SLM)
B. ON THE BASIS OF DOMICILE The banks can be classified into the following two categories on the basis of domicile: i) Domestic Banks ii) Foreign Banks i) Domestic Banks Those banks which are incorporated and registered in the India are called domestic banks. ii) Foreign Banks International banks are those that have their headquarters in a foreign country but have business branches in India. They are regulated and operated by their head office in their home country. International Exchange Banks or Exchange Banks are other names for foreign banks. These banks were originally founded to fund India's foreign trade and to discount foreign exchange bills. However, these banks are now taking deposits and making advances in the same way as other Indian commercial banks are. D. ON THE BASIS OF FUNCTIONS The banks can be classified on the basis of functions in the following categories: iii) Commercial Banks iv) Industrial Banks v) Agricultural Banks vi) Exchange Banks vii) Central Bank i. Commercial Banks Commercial banks are those that conduct all forms of banking transactions and functions for their clients, such as taking deposits, advancing loans, generating credit, and serving as an agent. Since the majority of their deposits are for a short time, they only make short and medium term business, trade, and commerce loans. The majority of commercial banks are owned by the government. To compete in the commercial money market, they have recently begun to offer long-term loans. Since they are formed and structured in the same way as joint stock companies are, these commercial banks are also known as joint stock banks. 89 CU IDOL SELF LEARNING MATERIAL (SLM)
ii) Industrial Banks Industrial banks provide medium and long-term loans to companies for the acquisition of land and houses, plant and machinery, and other industrial equipment. They also contribute to and underwrite the industries' shares and debentures. The key functions of an Industrial Bank are as follows: (i) They offer long-term funding to businesses for land and house purchases, plant and machinery purchases, and factory construction. (ii) They also accept long-term deposits. (iii) They underwrite and often contribute to the securities and debentures issued by the industry. There are a number of financial institutions in India that fulfil the function of an Industrial Bank. The following are major financial institutions: - (i) Indian Industrial Development Bank (IDBI) (ii) India's Industrial Finance Corporation (IFCI) (iii)ICICI Bank and Industrial Credit and Investment Corporation of India (iv) State Industrial Development Corporations including Haryana State Industrial Development Corporation (v) Corporation for Growth (HSIDC) Agriculture Banks Agricultural credit requirements vary from those of industry, company, trade, and commerce. Agriculture credit financing is not handled by commercial or industrial banks. Both types of needs exist for an agriculturist: i) He needs short-term credit to buy seeds, fertilisers, and other inputs; ii) He needs long-term credit to buy land, make permanent improvements to land, and buy farm machinery and equipment like tractors. Agricultural credit is generally provided in India by the Cooperative institutions. The Cooperative Agricultural Credit Institutions are divided into two categories: - a. Short term agricultural credit institutions and b. Long term agricultural credit institutions Short Term Agricultural Credit Institutions The Short Term Agricultural Credit Institutions Cater To The Short Term Financial Needs Of The Agriculturists Which Have The Following Three Tier Federal Structure :- a) At the Village level : Primary Agricultural Credit Societies 90 CU IDOL SELF LEARNING MATERIAL (SLM)
b) At the District level : Central Cooperative Banks c) At the State level : State Cooperative Banks Long Term Agricultural Credit Institutions Land Development Banks, which were formerly known as Land Mortgage Banks, offer long- term agricultural credit. Agriculturists may borrow money from land development banks for a period ranging from 5 to 25 years. Exchange Banks Exchange banks are financial institutions that deal in foreign exchange and specialise in funding international trade. As a result, they're also known as foreign exchange banks. Foreign Exchange Banks are banks that are based in a foreign country but have business branches in India. They are regulated and managed by their head office in their home country. Central Bank The Central Bank is a country's apex bank, in charge of controlling, regulating, and supervising the country's banking, monetary, and credit systems. The government of the country owns and controls the Central Bank. India's central bank is the Reserve Bank of India. The central bank performs the following important functions: i) It serves as a banker to the government of the country. ii) It also serves as an agent and financial adviser to the country's government. iii) It has a monopoly on issuing the country's currency. iv) It acts as a lender of last resort. v) It functions as a clearing house for commercial banks' cash reserves. 9.5 FUNCTIONS OF BANK There are two types of functions of banks: 1. Primary functions – being primary are also called banking functions. 2. Secondary Functions Both the types of functions of bank are explained below in detail: Primary Functions of Bank All banks have to perform two major primary functions namely: 91 1. Accepting of deposits 2. Granting of loans and advances CU IDOL SELF LEARNING MATERIAL (SLM)
Accepting of Deposits Mobilizing public funds, providing secure custody of deposits, and paying interest to depositors are all very simple yet essential functions of all commercial banks. The bank accepts a variety of deposits from the general public, including: 1. Savings Deposits: Encourages people to put money aside. It is suitable for those who are paid a salary or wage. The interest rate is very low. There are no restrictions on how many or how much money you can withdraw. A single or joint name may be used to open a savings deposit account. Only a certain minimum balance, which varies by bank, is required of depositors. The bank also provides ATM, debit card, check-writing, and Internet banking facilities. On the linked tab, candidates will learn about the various types of checks. 2. Fixed Deposits: Another name for them is Term Deposits. Money is held for a certain amount of time. No money can be taken out at this moment. If depositors take money out before the maturity date, the bank may incur a tax. Since a lump-sum payment is made all at once for a set time, the interest rate is high, but it varies depending on the deposit period. 3. Businessmen are the ones who open current deposits. The account holders have access to an overdraft facility on this account. These deposits may be used to cover unforeseen expenses as a short-term loan. The bank charges a high interest rate in addition to the fees for the overdraft facility in order to retain a fund for accidental overdraft requests. 4. Recurring Deposits: A set amount of money is deposited in the bank at regular intervals. After a certain period of time has elapsed, money can be withdrawn. Recurring deposits pay a higher interest rate because they benefit from compounded interest and enable depositors to save a significant amount of money. This type of account is used by salaried people and small business owners. 5. Making Loans and Advances Banks use public deposits to make loans to businesses and individuals to help them meet their financial obligations. The bank charges a higher rate of interest on loans and advances than on deposits. The disparity between the lending and deposit interest rates is known as the bank advantage. Bank offers the following types of Loans and Advances: 1. Bank Overdraft: Only current account holders are eligible for this programme. It allows holders to withdraw money up to a certain limit, regardless of the amount of money in their bank account. In return for collateral security, an overdraft is granted. An overdraft's interest is only paid on the amount borrowed for the term of the loan. 2. Cash Credits: a loan for a certain amount of time up to a predetermined limit. Customers may borrow money against a mortgage on a particular piece of property (tangible assets and/or guarantees) from banks. Cash credit is open to account holders of all forms, as well as 92 CU IDOL SELF LEARNING MATERIAL (SLM)
those without a bank account. Interest is charged for any amount withdrawn in excess of the limit. In comparison to an overdraft, cash credit allows for a larger loan amount to be accepted for a longer period of time. 3. Loans: Banks lend money to customers in return for tangible assets for a short or medium period of time, such as 1 to 5 years. Long-term loans are also available from banks. The creditor has the option of repaying the money in one lump sum or over a fixed period of time. The bank charges interest on the actual amount of the loan accepted, whether it is withdrawn or not. The interest rates on overdrafts and cash lending facilities are higher. 4. Bill of Exchange Discounting: This is a type of short-term loan in which the seller gives the bank a discount on the bill in exchange for a fee. The bank advances money by discounting or purchasing bills of exchange. It pays the bill total to the drawer (seller) on behalf of the drawee after deducting the usual discount costs (buyer). When the bill reaches maturity, the bank presents it to the drawee or acceptor in order to collect the bill number. Secondary Functions of Bank Like Primary Functions of Bank, the secondary functions are also classified into two parts: 1. Agency functions 2. Utility Functions Agency Functions of Bank Since banks act as agents for their customers, they must perform a variety of agency functions, as described below: Transfer of Funds: Funds are transferred from one branch/location to another. Periodic Collections: Collecting dividends, salaries, pensions, and other related annual payments on behalf of customers. Periodic Payments: Paying the client's deposit, utility bills, and other bills on a regular basis. Collection of Cheques: The bank collects money from cheques through the clearing portion of its clients, similar to how it collects money from bills of exchange. Portfolio Management: Client portfolios are managed by banks. It purchases and sells the clients' shares and debentures, debiting or crediting the account in the process. Other Agency Functions: This bank acts as a representative of its customers for other financial institutions. It serves as the client's executor, trustee, trustees, advisers, and so on. Utility Functions of Bank • Issuing letters of credit, traveller’s checks, and other similar documents. 93 CU IDOL SELF LEARNING MATERIAL (SLM)
• Having safe deposit vaults or lockers for the safekeeping of valuables, important papers, and securities. • Providing foreign exchange trading services to customers • Shares and debentures underwriting • Foreign exchange dealings • Programs for social welfare • Notes on projects • A standing pledge on behalf of its clients, and so on. 9.6 SUMMARY A bank is a financial institution that deals with money and credit in such a way that it accepts public deposits, makes surplus funds available to those in need, and assists in the secure transfer of money from one location to another. The Reserve Bank Schedule, ownership, domicile, and functions can all be used to classify banks. Basic functions, agency functions, and general utility functions are all performed by commercial banks. 9.7 KEYWORDS (IDBI) Industrial Development Bank of India (IFCI) Industrial Finance Corporation of India (ICICI) Industrial Credit and Investment Corporation of India (HSIDC) State Industrial Development Corporation such as Haryana State Industrial Development Corporation Recurring Deposits: A certain sum of money is deposited in the bank at a regular interval. 9.8 LEARNING ACTIVITY 1. Learn about the process documentation for opening a Savings Account & Recurring account in Union Bank of India ___________________________________________________________________________ ___________________________________________________________________________ 94 CU IDOL SELF LEARNING MATERIAL (SLM)
2. Study the activities and process followed in Agriculture Banks ___________________________________________________________________________ ___________________________________________________________________________ 9.9 UNIT END QUESTIONS A. Descriptive Questions Short Questions 1. Explain what the process is to open a Fixed Deposit 2. Describe How to apply for a Bank Overdraft 3. Describe about Utility functions of a bank Long Questions 1. Define a bank. Explain the origin and growth of banking in the modern sense. 2. Explain Why is an institution called a bank? What are the different types of a bank? 3. Explain the functions which a modern bank performs. B. Multi Choice Questions 1. The rate of interest is low and here is no limit on the no. and amount of withdrawals in ___ a. Savings Deposit b. Fixed Deposit c. Recurring Deposit d. Personal Deposit 2. It is a kind of short term loan, where the seller discounts the bill from the bank for some amount. a. Cash Credit b. Bank Overdraft c. Discounting the Bill of Exchange d. Bank Challan 3. The business of __________was such that he had to keep safe to guard the gold against theft and take special precautions steps. a. Merchant 95 CU IDOL SELF LEARNING MATERIAL (SLM)
b. Goldsmith c. Money Lenders d. Carpenter 4. Which of the below are Public Sector Banks a. SBI b. Union Bank of India c. Indian Bank d. All of these 5. Agriculture Bank cannot give a. Personal Loan b. Car Loan c. Home Loan d. All of these Answers 1 – a, 2 – b, 3 – b, 4 – d, 5 – d 9.10 REFERENCES Text Books: Bhole, L.M., Financial Institutions & Markets. Tata McGraw Hill, New Delhi Khan, M.Y.Financial Services Tata McGraw Hill, New Delhi Meir, Kohn, Financial Institutions & Markets, Tata McGraw Hill, New Delhi Prasanna Chandra: Financial Management, Tata McGraw Hill. Reference Books: Kothari, C.R., Investment Banking & Customer Services Arihant Publishers, Jaipur Sharpe, William F. etc. Investment. New Delhi, PHI Pandey, I.M., Financial Management, Vikas Publishing House, New Delhi 96 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT-10 MUTUAL FUNDS Structure 10.0 Learning Objective 10.1 Introduction 10.2 Concept & Origin 10.3 Types 10.4 Operations 10.5 Investors Right & Facilities 10.6 New Assets Value 10.7 Selection of Funds 10.8 General Guidelines 10.9 Summary 10.10 Keywords 10.11 Learning Activity 10.12 Unit End Questions 10.13 References 10.0 LEARNING OBJECTIVES After studying this unit, you will be able to: Describe nature of Mutual Funds Identify scope of Mutual Funds Benefits of Mutual Funds Process involved in Mutual Funds 10.1 INTRODUCTION Mutual funds are a form of investment. These funds pool money from a variety of investors to invest in stocks, short-term money market financial instruments, shares, and other securities, with the proceeds distributed as dividends. Fund Managers, also known as portfolio managers, are in charge of Mutual Funds in India. Mutual Funds in India are controlled by the Securities Exchange Board of India. Net asset value per share is the unit value of mutual funds in India (NAV). On a regular basis, the NAV is determined by dividing the total sum of Mutual Funds in India by the number of units issued and outstanding. 97 CU IDOL SELF LEARNING MATERIAL (SLM)
10.2 CONCEPT AND ORIGIN OF MUTUAL FUNDS To put it another way, a mutual fund gathers small investor funds, invests them in government and other corporate assets, and earns profits from interest and dividends, as well as capital gains. It operates on the premise that \"tiny drops of water create a large ocean.\" For example, if one has Rs.1000 to invest, it is unlikely to yield a high return on its own. However, if it is pooled with Rs. 1000 from a large number of other individuals, it can be used to build a ‘big fund' large enough to invest in a diverse range of shares and debentures on a large scale and thereby benefit from the economies of scale. As a result, a mutual fund is simply a form of collective investment. It is founded by a group of investors pooling their surplus funds and entrusting their management to a professionally qualified organisation. The fund uses a straightforward method to obtain surplus funds from investors. Each fund is divided into small fractions known as \"units\" that have the same value. The number of units allotted to each investor is proportional to the size of his investment. As a result, any investor, large or small, will have a stake in the fund and will be able to benefit from the fund's diverse portfolio of investments. As a result, mutual funds allow millions of small and large investors to profit from the capital market's growth. Due to its high return, low cost, and diversified risk, it has become a common vehicle for wealth creation. The Securities and Exchange Board of India (Mutual Funds) Regulations, 1993 defines a mutual fund as “a fund established in the form of a trust by a sponsor, to raise monies by the trustees through the sale of units to the public, under one or more schemes, for investing in securities in accordance with these regulations”. These mutual funds are referred to as Unit Trusts in the U.K. and as open end investment companies in the U.S.A. Therefore, Kamm, J.O. defines an open end investment company as “an organization formed for the investment of funds obtained from individuals and institutional investors who in exchange for the funds receive shares which can be redeemed at any time at their underlying asset value”. According to Weston J. Fred and Brigham, Eugene, F., Unit Trusts are “Corporations which accept dollars from savers and then use these dollars to buy stocks, long term bonds, short term debt instruments issued by business or government units; these corporations pool funds and thus reduce risk by diversification”. Thus, mutual funds are corporations which pool funds by selling their own shares and reduce risk by diversification. Fund Unit Vs. Share: Just like shares, the price of units of a fund is also quoted in the market. This price is governed basically by the value of the underlying investments 98 CU IDOL SELF LEARNING MATERIAL (SLM)
held by that fund. At this juncture, one should not confuse a mutual fund investment on units. 10.3 TYPES Investors with various needs, goals, and risk-taking capacities can be found on the investment market. A young businessman, for example, would like to see more capital gains for his money and would be willing to take more risk than someone who is nearing retirement age. As a result, offering a single fund that meets all of an investor's needs is extremely difficult. One fund will not be able to satisfy the diverse needs of all investors, just as one shoe will not fit all feet. As a result, the investor has a wide range of options. The investor has full freedom to select all of them based on his requirements and risk tolerance. Mutual fund schemes can broadly be classified into many types as given below: 1. On the basis of execution and operation A) Close-ended Funds The fund's corpus and duration are predetermined by this scheme. To put it another way, the fund's corpus and number of units are set. The investors' entry is locked until the subscription sum hits the predetermined amount. The entire corpus is disinvested at the end of the set term, and the proceeds are allocated to the various unit holders in proportion to their properties. As a result, after the final payment, the fund is no longer active. Features: The main features of the close-ended funds are: (i) The fund's duration and/or goal amount are predetermined and set. (ii) The investors' door is closed until the deadline has ended and/or the goal has been met. They are unable to buy any additional units. (iii) These units are publicly traded on a stock exchange, and the fund does not typically repurchase them. (iv) The primary goal of this fund is capital growth. (v) The whole fund is valid for the lifetime of the programme, and no withdrawal requests can be made prior to its maturity. As a result, the fund manager can handle the assets effectively and profitably without having to worry about liquidity. (vi) When a closed-end scheme is redeemed, the entire investment is liquidated and the proceeds are distributed among the unit holders. (vii) From the investor's perspective, it may result in a higher tax bill since the whole capital gain is realised at once. 99 CU IDOL SELF LEARNING MATERIAL (SLM)
(viii) If market conditions are unfavourable, the investor may be harmed because he may not receive the full gain of capital appreciation in the value of his investment. (ix) Closed-end scheme unit prices are typically quoted at a discount of up to 40% below their Net Asset Value (NAV). Open-ended funds Closed-ended funds are the polar opposite of open-ended funds. The size of the fund and/or the duration of the fund are not pre-determined in this scheme. Investors have complete freedom to buy and sell any amount of units at any time. For example, the Unit Trust of India's Unit Scheme (1964) is open ended in terms of both duration and target number. This unit can be purchased and sold at any time by anyone at their discretion. The main features of the Open-Ended Funds are: (i) The investor is guaranteed a steady stream of income at regular intervals, such as half-yearly or yearly, and so on. (ii) The aim of this form of fund is to pay out daily dividends rather than capital gains. (iii) The investment trend favours high-yielding, fixed-income securities such as debentures and bonds. (iv) This is ideally suited to the elderly and retired who do not have a steady source of income. (v) It is only interested in short-term benefits. B) Pure Growth Funds (Growth Oriented Funds) Growth Funds, unlike Income Funds, focus on long-term returns, such as capital appreciation. They do not have daily income and are intended to increase in value over time. As a result, they've been dubbed \"Nest Egg\" investments. The main features of the Growth Funds are: (i) The growth-oriented fund seeks to satisfy investors' need for capital growth. (ii) As a result, the investment approach adheres to the fund's objective by focusing on equities with high growth potential. (iii) The fund seeks capital appreciation by taking on a high level of risk and investing in risky equities and high-growth equity stocks. (iv) Although the fund can pay dividends, its primary goal is capital appreciation. (i) This is ideal for salaried and business people with a high risk tolerance and the opportunity to delay liquidity. They will save money for their future needs. 100 CU IDOL SELF LEARNING MATERIAL (SLM)
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