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Management of risk in financial services
1. Presentation
On
Management of risks in financial services
Submitted to -Alka Sood Submitted to :Vipin Singh Bisht
Assistant professor. 18pba006
School of management studies MBA 2nd year
2. Stock exchange
A stock or share (also known as a company's "equity") is a financial instrument that
represents ownership in a company or corporation and represents a proportionate
claim on its assets (what it owns) and earnings (what it generates in profits).
Stock ownership implies that the shareholder owns a slice of the company equal to
the number of shares held as a proportion of the company's total outstanding
shares. For instance, an individual or entity that owns 100,000 shares of a company
with one million outstanding shares would have a 10% ownership stake in it. Most
companies have outstanding shares that run into the millions or billions
3. How Share Prices Are Set
• The prices of shares on a stock market can be set in a number of ways, but most the
most common way is through an auction process where buyers and sellers place bids and
offers to buy or sell. A bid is the price at which somebody wishes to buy, and an offer
(or ask) is the price at which somebody wishes to sell. When the bid and ask coincide, a
trade is made.
• The overall market is made up of millions of investors and traders, who may have
differing ideas about the value of a specific stock and thus the price at which they are
willing to buy or sell it. The thousands of transactions that occur as these investors and
traders convert their intentions to actions by buying and/or selling a stock cause minute-
by-minute gyrations in it over the course of a trading day. A stock exchange provides a
platform where such trading can be easily conducted by matching buyers and sellers of
stocks. For the average person to get access to these exchanges, they would need a
stockbroker. This stockbroker acts as the middleman between the buyer and the seller.
Getting a stockbroker is most commonly accomplished by creating an account with a well
established retail broker
4. Stock Market Supply and Demand
• The stock market also offers a fascinating example of the laws of supply and
demand at work in real time. For every stock transaction, there must be a buyer
and a seller. Because of the immutable laws of supply and demand, if there are
more buyers for a specific stock than there are sellers of it, the stock price will
trend up. Conversely, if there are more sellers of the stock than buyers, the price
will trend down.
• The bid-ask or bid-offer spread—the difference between the bid price for a stock
and its ask or offer price—represents the difference between the highest price
that a buyer is willing to pay or bid for a stock and the lowest price at which a
seller is offering the stock. A trade transaction occurs either when a buyer
accepts the ask price or a seller takes the bid price. If buyers outnumber sellers,
they may be willing to raise their bids in order to acquire the stock; sellers will,
therefore, ask higher prices for it, ratcheting the price up. If sellers outnumber
buyers, they may be willing to accept lower offers for the stock, while buyers will
also lower their bids, effectively forcing the price down.
5. Benefits of Stock Exchange Listing
• Until recently, the ultimate goal for an entrepreneur was to get his or her
company listed on a reputed stock exchange such as the New York Stock
Exchange (NYSE) or Nasdaq, because of the obvious benefits, which include:
• An exchange listing means ready liquidity for shares held by the company's
shareholders.
• It enables the company to raise additional funds by issuing more shares.
• Having publicly traded shares makes it easier to set up stock options plans that
are necessary to attract talented employees.
• Listed companies have greater visibility in the marketplace; analyst coverage and
demand from institutional investors can drive up the share price.
6. Problems of Stock Exchange Listing
• But there are some drawbacks to being listed on a stock exchange, such as:
• Significant costs associated with listing on an exchange, such as listing fees and higher costs
associated with compliance and reporting.
• Burdensome regulations, which may constrict a company's ability to do business.
• The short-term focus of most investors, which forces companies to try and beat their
quarterly earnings estimates rather than taking a long-term approach to their corporate
strategy.
7. Investing in Stocks
• Numerous studies have shown that, over long periods of time, stocks generate
investment returns that are superior to those from every other asset class. Stock
returns arise from capital gains and dividends. A capital gain occurs when you sell
a stock at a higher price than the price at which you purchased it. A dividend is
the share of profit that a company distributes to its shareholders. Dividends are
an important component of stock returns—since 1956, dividends have
contributed nearly one-third of total equity return, while capital gains have
contributed two-thirds..
• While the allure of buying a stock similar to one of the fabled FAANG quintet—
Facebook, Apple Inc. (AAPL), Amazon.com Inc. (AMZN), Netflix Inc. (NFLX), and
Google parent Alphabet Inc. (GOOGL)—at a very early stage is one of the more
tantalizing prospects of stock investing, in reality, such home runs are few and far
between.
8. Mutual fund
• A mutual fund is an open-end professionally managed investment fund[1] that
pools money from many investors to purchase securities. These investors may be
retail or institutional in nature. The term is typically used in the United States,
while similar structures across the globe include the SICAV in Europe ('investment
company with variable capital') and open-ended investment company (OEIC) in
the UK.Mutual funds have advantages and disadvantages compared to direct
investing in individual securities. Advantages of mutual funds include economies
of scale, diversification, liquidity, and professional management. However, these
come with mutual fund fees and expenses.Not all investment funds are mutual
funds;[2] alternative structures include unit investment trusts, closed-end funds,
and exchange-traded funds (ETFs). These alternative structures share similarities
such as liquidity due to trading on exchanges and, in the United States, similar
consumer protections under the Investment Company Act of 1940.
9. • Mutual funds have advantages and disadvantages compared to alternative
structures or investing directly in individual securities. According to Robert Pozen
and Theresa Hamacher, these are:
• Advantages
• Increased diversification: A fund diversifies holding many securities.
This diversification decreases risk.
• Professional investment management: Open-and closed-end funds hire portfolio
managers to supervise the fund's investments.
• Ability to participate in investments that m
• ay be available only to larger investors. For example, individual investors often
find it difficult to invest directly in foreign markets.
• Service and convenience: Funds often provide services such as check writing
10. • Lower cost: The cost of a single investor to buy a stock or a bond is lower than
investing individually.
• Flexibility: Mutual funds enables changes portfolio with market conditions change
• Government oversight: Mutual funds are regulated by a governmental body.
• Transparency and ease of comparison: All mutual funds are required to report the
same information to investors, which makes them easier to compare to each
other
11. Disadvantages
• Mutual funds have disadvantages as well, which include:
• Fees
• Less control over timing of recognition of gains
• Less predictable income
• No opportunity to customize
12. Insurance
• Insurance is a contract, represented by a policy, in which an individual or entity
receives financial protection or reimbursement against losses from an insurance
company. The company pools clients' risks to make payments more affordable for
the insured.
• Insurance policies are used to hedge against the risk of financial losses, both big
and small, that may result from damage to the insured or her property, or from
liability for damage or injury caused to a third party.
•
13. How Insurance Works
• There is a multitude of different types of insurance policies available, and virtually
any individual or business can find an insurance company willing to insure them—
for a price. The most common types of personal insurance policies are auto,
health, homeowners, and life. Most individuals in the United States have at least
one of these types of insurance, and car insurance is required by law.
• Businesses require special types of insurance policies that insure against specific
types of risks faced by a particular business. For example, a fast-food restaurant
needs a policy that covers damage or injury that occurs as a result of cooking with
a deep fryer. An auto dealer is not subject to this type of risk but does require
coverage for damage or injury that could occur during test drives.
14. Insurance Policy Components
• When choosing a policy, it is important to understand how insurance
works.
• A firm understanding of these concepts goes a long way in helping you
choose the policy that best suits your needs. There are three components
(premium, policy limit, and deductible) to most insurance policies that are
crucial.
Premium
• A policy's premium is its price, typically expressed as a monthly cost. The
premium is determined by the insurer based on your or your business's risk
profile, which may include creditworthiness.
15. Policy Limit
• The policy limit is the maximum amount an insurer will pay under a policy for a
covered loss. Maximums may be set per period (e.g., annual or policy term), per
loss or injury, or over the life of the policy, also known as the lifetime maximum.
• Typically, higher limits carry higher premiums. For a general life insurance policy,
the maximum amount the insurer will pay is referred to as the face value, which
is the amount paid to a beneficiary upon the death of the insured.
16. Deductible
• The deductible is a specific amount the policy-holder must pay out-of-pocket
before the insurer pays a claim. Deductibles serve as deterrents to large volumes
of small and insignificant claims.
• Deductibles can apply per-policy or per-claim depending on the insurer and the
type of policy. Policies with very high deductibles are typically less expensive
because the high out-of-pocket expense generally results in fewer small claims.
17. Merchant banking services
• Any person who is engaged in the business of issue management either by
making arrangement regarding buying, selling or subscribing to securities or
acting as manager, consultant or rendering corporate advisory services in relation
to such issue management”.
• Merchant bankers provide advice to entrepreneurs right from the stage of
conception of the project till the commencement of production. Merchant
bankers are in charge of the issue process. They act as intermediaries between
the company and the investors. They are also responsible for preparing the
prospectus and marketing the issue.
18. Services provided by merchant bankers
• The services provided by Merchant Bankers include:
• Project counseling
• Market survey and forecasting
• Estimating the amount of funds required.
• Raising funds from capital market.
• Raising of funds through new instruments.
• Bought out deals.
• OTC market operations.
• Mergers and amalgamations
19. Regulation of Merchant Bankers
• Merchant banking activity in India is regulated by the SEBI (Merchant Bankers)
Rules, 1992. The Rules provide that:
• . no person shall carry on any activity as a merchant banker unless he holds a
certificate granted by SEBI.
• b. SEBI would grant the certificate:
• on payment of the registration fee.
• on condition that the merchant banker would redress investor grievances within I
month of investors complaint and would inform
SEBI of all such complaints received.
• only if the applicant has the necessary infrastructure and manpower to carry out
the functions as a merchant banker.
20. Categories of Merchant Bankers
• The following are the categories of merchant bankers:
• 1. Category I – can carry on all activities relating to management of issues
such as preparation of prospectus, determining financial structure, conduct
of market surveys, raising funds from capital market, raising of funds through
new instruments, arranging bought out deals and to provide advice
on: mergers and amalgamations, loan syndication, technology tie-ups,
working capital finance, venture capital, lease finance, fixed deposit
management, factoring, portfolio management of mutual funds,
rehabilitation of sick units etc.
• 2. Category II – to act as advisor, consultant, co-manager, underwriter and
portfolio manager.
• 3. Category III – to act as underwriter, advisor and consultant to an issue.
• 4. Category IV – to act only as advisor or consultant to an issue
21. Managing of issue share and bonds
• What is a New Issue?
• A new issue describes a security – generally equity or debt – that is
registered in a publicly-traded market for the first time. A common new
issue is known as an Initial Public Offering (IPO), which takes place when a
business or company sells securities on a stock market for the first time.
Companies issue new stocks or bonds to raise capital for growth and
expansion.
• A company has two primary ways to raise capital: one is through debt
– such as issuing bonds, and the other is through equity – issuing
stocks. A good mixture of both types of instruments is important for
good capital management and minimizing the company’s WACC.
22. How to record a new issue
• When a company issues new stock, the shares may be issued at par, above par, or
below the par value. When issued at par, the proceeds from the issue are debited
in the cash account while the paid-in capital account is credited. If issued above
par, the proceeds from the issuance are debited in the cash account, the paid-in
capital is credited for the par value (multiplied by the total number of issued
shares), and the excess of cash above the par value is credited to the additional
paid-in capital account.
• When the stocks are issued below par, the total cash received is debited from the
cash account, while the paid-in capital is credited for the total par value. The
discount on stocks issued is debited through the discount on capital account. The
transaction also appears as a deduction from the equity accounts on the balance
sheet. The new issue of stock is recorded as paid-in capital in the balance sheet.
23. Investors’ perspective on a new issue
• Investors have mixed views on how they perceive new issues of stocks and
bonds. Most investors prefer new issues because they present new avenues
for price appreciation. Price increases are often brought about by the huge
demand for new shares, especially if they are being sold by known
companies with a good track record with investors. When these shares
trade in the secondary market and the demand continues, the investors
benefit from increased prices and, hence, a bigger return on their
investments.
24. New bond issues
• One of the ways that companies use to raise large sums of money is by
selling bonds in the public market. By selling bonds, the company is
essentially borrowing money from investors, in exchange for periodic
interest payments.
• Advantages of new bond issues
• Tax advantages: Selling bonds on the market can reduce the amount of tax
a company owes the tax authorities. This is because the interest payable to
lenders is a tax-deductible expense that reduces the overall tax liability.
25. • Can be issued whenever the company needs money: A company that requires a
large sum of money can issue bonds more than once. The practice makes bonds
the more preferred option since issuing more stocks dilutes the ownership of a
company every time they are issued to the public.
• Disadvantages
• Risker than other sources of capital: Even though debt has its advantages, it
carries a higher risk since the company may be unable to service the debts later
and end up in bankruptcy. Borrowing too much money will require the business
to formulate a concrete plan on how to repay the principal and interests to
lenders on time.
26. Credit Rating
• A credit rating is an opinion of a particular credit agency regarding the ability
and willingness an entity (government, business, or individual) to fulfill its
financial obligations in completeness and within the established due dates. A
credit rating also signifies the likelihood a debtor will default. It is also
representative of the credit risk carried by a debt instrument – whether a
loan or a bond issuance.
• A credit rating is, however, not an assurance or guarantee of a kind of
financial performance by a certain instrument of debt or a specific debtor.
The opinions provided by a credit agency do not replace those of a financial
advisor or portfolio manager.
27. Who Evaluates Credit Ratings?
• A credit agency evaluates the credit rating of a debtor by
analyzing the qualitative and quantitative attributes of the entity
in question. The information may be sourced from internal
information provided by the entity, such as audited financial
statements, annual reports, as well as external information such
as analyst reports, published news articles, overall industry
analysis, and projections.
• A credit agency is not involved in the transaction of the deal
and, therefore, is deemed to provide an independent and
impartial opinion of the credit risk carried by a particular entity
seeking to raise money through loans or bond issuance.
28. • Types of Credit Ratings
• Each credit agency uses its own terminology to determine credit ratings. That
said, the notations are strikingly similar among the three credit agencies. Ratings
are bracketed into two groups: investment grade and speculative grade.
• Investment grade ratings mean the investment is considered solid by the rating
agency, and the issuer is likely to honor the terms of repayment. Such
investments are typically less competitively priced in comparison to speculative
grade investments.
• Speculative grade investments are high risk and, therefore, offer higher interest
rates to reflect the quality of the investments
29. Credit Rating Agencies
• The three primary rating agencies are as follows:
1. Moody’s Investor Service
• 2. Standard & Poor’s
• 3. Fitch
Moody’s and S&P are generally considered the most influential because
they have the widest geographical coverage.
30. • The agencies operate without government mandate, and have
remained independent from the investment community.
• It is because of their independence and reputation for being objective
that their opinions are accepted as credible by the investment
community.
31. Rating agencies generate their revenues from two
primary sources:
• 1. Fees from issuers that solicit ratings for their securities, which consist of
both per-issue fees and annual fees.
• The amount of the fee depends on the type and size of security being rated
and on the total number of securities of the issuer already rated by the agency.
• For bonds and preferred stock, per-issue fees for both Moody’s and S&P have a
minimum of $25,000–$30,000 and a maximum of 225,000–$250,000. Annual
fees range from $12,500 to $15,000.
32. The Rating Process
• The first step in the process is for the rating agencies to meet with company
management.
• The purpose of this meeting is to discuss the proposed offering, the company’s
operating and financial performance and outlook, and a host of other factors that
might affect the rating.
• The company’s chief financial officer is the main participant in these discussions,
with the chief executive officer participating in any strategy discussions.
33. • Following this meeting, the rating agencies assign a team of individuals to analyze
the transaction.
• This team includes the relevant industry analyst and a product analyst if the
security to be rated is specialized.
• The team reviews the offering documents, financial statements, and
management’s presentation, which includes the terms of the proposed offering,
use of proceeds, historical and pro forma financial analysis, competitive analysis,
capital-expenditure plans, etc.
• The rating agency’s analysis, projections, and opinions may vary from those of the
company’s management or their investment bankers.
34. Rating Methodology
• Assigning a rating involves a comprehensive review and analysis of a number of
important categories of information with respect to the issue or issuer.
• Because ratings are relative measures of default risk,
• it is not surprising that companies with stronger financial measures have higher
ratings, on average.