External Sources of Finance

Sources of Finance

External Sources of Finance

Shares

Shares represent ownership in a company. When an individual buys shares of a company, they become a shareholder, which means they own a portion of that company. Shareholders are entitled to certain rights, such as voting at shareholder meetings and receiving dividends, which are a portion of the company's profits distributed to shareholders.

Equity shares, also known as common shares or ordinary shares, represent ownership in a company. 

Features of equity shares:

1. Ownership Stake: Equity shareholders are the owners of the company. They have a claim on the company's assets and earnings proportional to the number of shares they hold. This ownership stake gives them the right to participate in company decisions through voting rights.

2. Voting Rights: Equity shareholders typically have the right to vote on matters such as the election of the board of directors, approval of major corporate actions (e.g., mergers, acquisitions), and changes to the company's charter or bylaws. Each share usually entitles the shareholder to one vote, although certain classes of shares may have different voting rights.

3. Dividends: Equity shareholders may receive dividends, which represent a portion of the company's profits distributed to shareholders. However, dividends are not guaranteed and are subject to the discretion of the company's management and board of directors. The amount of dividends paid per share may vary from year to year based on the company's financial performance and dividend policy.

4. Residual Claim on Assets and Earnings: In the event of liquidation or bankruptcy, equity shareholders have a residual claim on the company's assets and earnings. This means they are entitled to receive a portion of the remaining assets after all other obligations, such as debt payments and preferred share dividends, have been satisfied.

5. Risk and Return: Equity shares represent a higher risk investment compared to debt instruments or preferred shares. However, they also offer the potential for higher returns, as shareholders benefit directly from the company's profitability and growth.

6. Capital Appreciation: Equity shareholders can profit from increases in the company's share price, known as capital appreciation. If the company performs well and its stock price rises, shareholders can sell their shares at a higher price than they originally paid, realizing a capital gain.

7. Limited Liability: Shareholders enjoy limited liability, meaning their liability is generally limited to the amount invested in the company's shares. They are not personally liable for the company's debts or obligations beyond their investment.

Overall, equity shares provide investors with the opportunity to participate in the ownership and growth of a company, while bearing the risks associated with fluctuating stock prices and uncertain dividends.

Types of Shares

There are several types of shares, each with its own characteristics and rights. The main types include:

1. Ordinary Shares (Common Stock): These are the most common type of shares issued by a company. Ordinary shareholders have voting rights and may receive dividends, though the amount can vary based on the company's performance.

2. Preference Shares: Preference shareholders have a priority claim on the company's assets and earnings over ordinary shareholders. They typically receive a fixed dividend before any dividends are paid to ordinary shareholders. However, they may not have voting rights or their voting rights may be limited.

Features of Preference Shares

Preference shares have several distinct features that differentiate them from common shares. Here are the key features of preference shares:

1. Fixed Dividend: Preference shares typically carry a fixed rate of dividend, which is specified in the share's prospectus or terms of issue. This means that preference shareholders are entitled to receive a predetermined amount of dividend before any dividends can be paid to common shareholders.

2. Priority in Dividend Payments: In the event of profit distribution, preference shareholders have priority over common shareholders in receiving dividends. They must be paid their fixed dividend before any dividends can be distributed to common shareholders. However, dividends on preference shares are subject to the availability of distributable profits.

3. Preference in Assets in Liquidation: In case of liquidation or winding up of the company, preference shareholders have priority over common shareholders in receiving assets. After satisfying the claims of creditors, preference shareholders are entitled to receive their capital back before any amount can be distributed to common shareholders.

4. Limited Voting Rights: Preference shareholders usually have limited or no voting rights compared to common shareholders. In some cases, they may have voting rights only in certain circumstances, such as when the company fails to pay dividends for a specified period.

5. Cumulative and Non-cumulative: Preference shares may be cumulative or non-cumulative. Cumulative preference shares entitle shareholders to receive any unpaid dividends in subsequent years, whereas non-cumulative preference shares do not accumulate unpaid dividends. Cumulative preference shares are often more attractive to investors as they provide greater assurance of dividend payments over time.

6. Redeemable or Irredeemable: Preference shares may be redeemable or irredeemable. Redeemable preference shares can be redeemed by the company at a predetermined date or at the option of the shareholder, while irredeemable preference shares have no fixed redemption date.

7. Convertible: Some preference shares come with the option to convert them into a specified number of common shares after a certain period. This feature provides flexibility to investors who may wish to convert their preference shares into common shares to benefit from potential capital appreciation.

8. Participation Rights: Certain preference shares may include participation rights, allowing shareholders to participate in the company's profits beyond the fixed dividend rate. This feature provides an opportunity for preference shareholders to earn additional returns in favorable circumstances.

Overall, preference shares offer investors a combination of fixed income, priority in dividend payments and asset distribution, and limited voting rights, making them an attractive investment option for those seeking stable returns and capital preservation.

There are different types of Preference Shares

3. Cumulative Preference Shares: These shares accumulate any unpaid dividends, meaning if the company does not pay dividends in one year, it must pay those dividends in future years before paying dividends to ordinary shareholders.

4. Non-cumulative Preference Shares: These shares do not accumulate unpaid dividends. If the company does not pay dividends in a particular year, the shareholders do not have the right to claim those dividends in the future.

5. Redeemable Shares: Redeemable shares can be bought back by the company at a predetermined price after a certain period of time.

6. Convertible Shares: Convertible shares can be converted into a different type of security, such as ordinary shares, at a predetermined conversion ratio and price.

Advantages and Limitations:

1. Ordinary Shares:

   - Equity shares, also known as common shares or ordinary shares, have several advantages for both companies and investors. Some of the key advantages of equity shares include:

1. Ownership and Control: Equity shareholders are owners of the company and have voting rights in proportion to their shareholdings. This allows them to participate in key decisions affecting the company's management and direction.

2. Potential for High Returns: Equity shares have the potential to offer high returns, especially in the form of capital appreciation, if the company performs well and its stock price increases over time. This makes them attractive for investors seeking growth opportunities.

3. Dividend Income: While dividend payments are not guaranteed, companies may choose to distribute a portion of their profits to equity shareholders in the form of dividends. This can provide investors with a regular income stream, especially if they invest in established companies with a history of dividend payments.

4. Liquidity: Equity shares are typically traded on stock exchanges, making them highly liquid investments. Investors can easily buy and sell shares in the secondary market, providing flexibility and the ability to quickly convert their investment into cash if needed.

5. Diversification: Investing in equity shares allows investors to diversify their portfolios by spreading their investment across different companies and industries. This can help reduce overall risk by not being overly reliant on the performance of a single company or sector.

6. Inflation Hedge: Equities have historically provided a hedge against inflation, as companies can adjust their prices and earnings to keep pace with rising prices. This can help preserve the purchasing power of investors' capital over the long term.

7. Transferability: Equity shares are transferable securities, meaning they can be easily transferred or sold to other investors. This provides investors with the flexibility to adjust their investment portfolios according to changing market conditions or personal financial goals.

Overall, equity shares offer the potential for significant returns and ownership benefits, making them an important component of a diversified investment portfolio. However, it's essential for investors to carefully assess the risks and conduct thorough research before investing in individual stocks.

   - Limitations: However, they are last in line to receive dividends and assets in the event of liquidation, after preference shareholders and debt holders.

1. Higher Risk: Equity shares are more volatile compared to other forms of investments such as bonds or preferred shares. The value of equity shares can fluctuate significantly based on factors such as company performance, market conditions, and investor sentiment.

2. Uncertain Dividend Payments: Unlike preferred shares, dividend payments for common shareholders are not guaranteed. Companies may choose to distribute profits to shareholders in the form of dividends, but they are not obligated to do so. In some cases, companies may suspend or reduce dividend payments during periods of financial difficulty or to reinvest profits into the business.

3. Limited Priority in Liquidation: In the event of liquidation or bankruptcy, common shareholders are last in line to receive assets after preferred shareholders, creditors, and other stakeholders have been paid. This means that common shareholders may receive little to no compensation if the company's assets are insufficient to cover its liabilities.

4. Dilution of Ownership: When a company issues additional equity shares through methods such as secondary offerings or stock options, existing shareholders' ownership stakes can be diluted. This dilution can reduce the proportionate share of future profits and voting rights for existing shareholders.

5. Lack of Control: While common shareholders have voting rights that allow them to participate in major corporate decisions, the level of control they exert may be limited, especially in large publicly traded companies where ownership is dispersed among numerous shareholders. Majority shareholders or institutional investors may have significant influence over company decisions.

6. Market Dependency: The value of equity shares is subject to market fluctuations and investor perceptions. External factors such as economic conditions, geopolitical events, and industry trends can impact share prices, sometimes irrespective of the company's underlying fundamentals.

7. Potential for Losses: Investing in equity shares carries the risk of losing part or all of the invested capital. If the company's performance deteriorates or if adverse events occur, the value of equity shares may decline, resulting in financial losses for shareholders.

2. Preference Shares:

Advantages

Preference shares offer several advantages to both investors and companies:

1. Fixed Dividend Payments: Preference shares typically come with a fixed dividend rate, which provides investors with a predictable income stream. This stability can be attractive to income-seeking investors, such as retirees or those looking for steady returns.

2. Priority in Dividend Payments: In the event of dividend distribution, preference shareholders are entitled to receive dividends before common shareholders. This priority ensures that preference shareholders receive their dividends before any payments are made to common shareholders.

3. Priority in Asset Distribution: In the event of liquidation or bankruptcy, preference shareholders have priority over common shareholders in receiving assets from the company. This can provide a degree of protection to preference shareholders in case of financial distress.

4. Lower Risk: Preference shares typically carry lower risk compared to common shares, as they offer more stability in terms of dividend payments and asset distribution. This makes them appealing to investors who prioritize capital preservation and steady income over capital appreciation.

5. No Dilution of Control: Unlike issuing additional common shares, issuing preference shares does not dilute the voting power or control of existing shareholders. This allows companies to raise capital without relinquishing control over decision-making processes.

6. Flexibility in Capital Structure: Preference shares offer flexibility in structuring the company's capital, as they can be tailored to meet the specific needs of both investors and companies. For example, companies can issue different classes of preference shares with varying dividend rates and redemption features to attract different types of investors.

Overall, preference shares provide a balance between fixed income and equity investment, offering investors a combination of steady returns and downside protection while providing companies with a flexible financing option.

Disadvantages of Preference Shares

1. No Voting Rights: Preference shareholders often have limited or no voting rights compared to common shareholders. This means they have less influence over company decisions and may not be able to participate in important corporate matters.

2. Fixed Dividend Obligation: While fixed dividend payments can provide stability and income for investors, they also represent a financial obligation for the company. In times of financial difficulty, the company may be obligated to pay dividends to preference shareholders even if it cannot afford to do so, which can strain its financial resources.

3. Limited Potential for Capital Appreciation: Preference shares typically offer a fixed rate of return and have limited potential for capital appreciation compared to common shares. As a result, investors may miss out on the opportunity to benefit from significant increases in the company's share price.

4. Subordination in Liquidation: In the event of liquidation or bankruptcy, preference shareholders have priority over common shareholders but are still subordinate to creditors. This means they may not receive full repayment of their investment if there are insufficient assets to cover all obligations.

5. Call Risk: Some preference shares may be callable, meaning the issuing company has the right to redeem them at a predetermined price after a certain period. This introduces call risk for investors, as they may be forced to sell their shares before they are ready or at a less favorable price.

6. Inflation Risk: Fixed dividend payments may not keep pace with inflation, leading to a decrease in the purchasing power of the income generated from preference shares over time.

7. Market Risk: Preference shares are traded on the open market and their prices can fluctuate based on factors such as interest rates, market sentiment, and the financial performance of the issuing company. Investors may experience losses if they need to sell their shares during periods of market downturn.

DEBENTURE

A debenture is a type of debt instrument issued by a company or government entity to raise capital. Essentially, it is a bond or promissory note that acknowledges a debt owed by the issuer to the holder of the debenture. Investors who purchase debentures are effectively lending money to the issuer in exchange for regular interest payments and the repayment of the principal amount at maturity.

Definition:

A debenture is a long-term debt instrument issued by a corporation or government, typically with a fixed interest rate and a specified maturity date. It is not secured by collateral and represents an unsecured obligation of the issuer.

Thus, debentures provide companies and governments with an alternative means of raising capital, while investors receive fixed income payments and the assurance of repayment at maturity, albeit with some level of risk depending on the creditworthiness of the issuer.

Features of Debentures :

Debentures are debt instruments issued by companies or governments to raise funds from investors. They typically have the following features:

1. Fixed Maturity Date: Debentures have a specified maturity date, at which point the issuer is obligated to repay the principal amount to the debenture holders. The maturity period can range from a few months to several years, depending on the terms of the debenture.

2. Fixed Interest Rate: Debentures usually pay a fixed rate of interest to investors, known as the coupon rate. This rate is determined at the time of issuance and remains constant throughout the life of the debenture. Interest payments are typically made semi-annually or annually.

3. Secured or Unsecured: Debentures can be either secured or unsecured. Secured debentures are backed by specific assets of the issuer, which serve as collateral for the debenture holders in case of default. Unsecured debentures, also known as "naked" debentures, are not backed by any collateral and rely solely on the issuer's creditworthiness.

4. Convertible or Non-Convertible: Some debentures come with an option for the holder to convert them into equity shares of the issuing company after a certain period. These are known as convertible debentures. Non-convertible debentures, on the other hand, cannot be converted into equity shares and remain as debt instruments throughout their tenure.

5. Callable or Non-Callable: Callable debentures give the issuer the right to redeem the debentures before their maturity date, usually at a predetermined price. This provides flexibility for the issuer to refinance its debt at lower interest rates if market conditions are favorable. Non-callable debentures cannot be redeemed by the issuer before maturity, providing more stability for investors.

6. Transferability: Debentures are usually freely transferable, allowing investors to buy and sell them on secondary markets such as stock exchanges. This provides liquidity to investors who may wish to exit their investment before maturity.

7. Priority in Liquidation: In the event of liquidation or bankruptcy of the issuing company, debenture holders have priority over equity shareholders but are usually subordinate to secured creditors. This means they have a higher claim on the company's assets compared to equity shareholders but may still face losses if there are insufficient assets to cover all obligations.

Overall, debentures offer investors a relatively stable source of fixed income with defined terms and conditions, making them a popular investment choice for those seeking income and capital preservation.

Advantages of Debentures

Debentures offer several advantages to both issuers (companies borrowing money) and investors (lenders). Some of the advantages of debentures include:

1. Lower Interest Rates: Debentures often come with lower interest rates compared to other forms of debt, such as bank loans or bonds. This can make them an attractive option for companies looking to raise capital at a lower cost.

2. Flexibility in Repayment: Debentures can be structured with flexible repayment terms, allowing companies to tailor the repayment schedule to their cash flow and financial needs.

3. No Dilution of Ownership: Unlike equity financing, debentures do not dilute the ownership stake of existing shareholders. Companies can raise funds through debentures without giving up control or ownership rights.

4. Tax Deductibility: Interest payments on debentures are typically tax-deductible expenses for the issuing company, reducing the overall cost of borrowing.

5. Security Options: Debentures can be secured by company assets, providing investors with a level of security in case of default. Secured debentures are often perceived as less risky than unsecured debentures, leading to lower interest rates for issuers.

6. Diversification for Investors: For investors, debentures offer an opportunity to diversify their investment portfolios beyond traditional stocks and bonds. Debentures provide a fixed income stream with relatively low risk compared to equities.

7. Preference in Liquidation: In the event of bankruptcy or liquidation, debenture holders typically have priority over equity shareholders in receiving payments from the company's assets. This can provide some level of protection for investors in case of financial distress.

8. Marketability: Debentures are often traded on secondary markets, providing investors with liquidity and the ability to buy and sell their investments easily.

Overall, debentures offer a flexible and cost-effective financing option for companies while providing investors with a steady income stream and potential capital appreciation.

Disadvantages of Debentures :

Debentures, while offering certain advantages, also have their disadvantages:

1. Fixed Interest Payments: Debentures typically require the issuer to make fixed interest payments to debenture holders. This can be a disadvantage for the issuer if the company's financial performance deteriorates or if it faces cash flow problems, as it must still make these payments regardless of its profitability.

2. Risk of Default: Debentures are a form of debt, meaning the issuer has an obligation to repay the principal amount borrowed at maturity. There is always a risk of default, where the issuer may be unable to make interest payments or repay the principal amount due to financial difficulties or bankruptcy.

3. Subordination: In the event of liquidation, debenture holders are typically considered creditors and may be subordinate to other creditors, such as secured lenders and bondholders. This means they may have lower priority in receiving repayment from the company's assets.

4. Limited Voting Rights: Debenture holders usually do not have voting rights in the company's affairs, unlike shareholders. This means they have limited influence over corporate decisions and management.

5. Interest Rate Risk: If interest rates rise after the issuance of debentures, the fixed interest payments may become less attractive compared to newly issued debt instruments with higher interest rates. This can reduce the market value of existing debentures, leading to capital losses for debenture holders who wish to sell their holdings before maturity.

6. Liquidity Risk: Debentures may have lower liquidity compared to publicly traded stocks and bonds. It may be difficult for debenture holders to sell their holdings quickly at fair market prices, especially for debentures issued by smaller or less well-known companies.

7. Market Risk: The market value of debentures can fluctuate due to changes in interest rates, credit risk perceptions, and overall market conditions. Debenture holders may experience capital losses if they need to sell their holdings when market prices are depressed.

PUBLIC DEPOSITS

Public deposits refer to funds deposited by individuals or entities with non-banking financial companies (NBFCs) or other corporate entities for a specified period, typically ranging from a few months to a few years. These deposits are a form of unsecured borrowing for the company accepting the deposits and are not subject to the strict regulations that govern bank deposits.

Definition: Public deposits are funds deposited by the general public, including individuals, trusts, and corporations, with non-banking financial companies (NBFCs) or other corporate entities. These deposits are considered unsecured loans provided to the company accepting the deposits and are governed by the terms and conditions specified in the deposit agreement.

Features of Public Deposits:

   - Unsecured: Public deposits are unsecured in nature, meaning they are not backed by any collateral. If the company defaults on repayment, depositors may face challenges in recovering their funds.

   - Interest: Companies offering public deposits typically offer a fixed or variable rate of interest on the deposits, which may be paid periodically (monthly, quarterly, annually) or at maturity.

   - Maturity Period: Public deposits have a specified maturity period, ranging from a few months to a few years. Depositors can choose the maturity period based on their investment preferences and financial goals.

   - Withdrawal Restrictions: Some public deposits may have restrictions on early withdrawal or may incur penalties for premature withdrawal before the maturity date.

   - Credit Rating: Investors may assess the creditworthiness of the company accepting public deposits by considering its credit rating, financial performance, and reputation.

Regulation: 

Public deposits are regulated by various laws and regulations, including the Companies Act, 2013, and the Reserve Bank of India (RBI) guidelines. Companies accepting public deposits are required to comply with regulatory requirements, including obtaining necessary approvals, maintaining adequate reserves, and submitting periodic reports to regulatory authorities.

Purpose:

Companies may raise funds through public deposits to finance their working capital requirements, fund expansion projects, or meet short-term financing needs. Public deposits provide an alternative source of funding to companies, especially when traditional financing options such as bank loans are limited or expensive.

Risk: While public deposits offer higher returns compared to bank deposits, they also involve higher risk due to their unsecured nature. Depositors face the risk of default if the company accepting the deposits fails to repay the principal amount or interest as per the agreed terms.

Thus, public deposits serve as a means for companies to raise funds from the public and provide individuals and entities with an investment opportunity offering higher returns than traditional bank deposits. However, investors should carefully assess the creditworthiness and reputation of the company before investing in public deposits to mitigate the risk of default.

Advantages of Public Deposits

Public deposits offer several advantages for both depositors and companies accepting the deposits:

1. Alternative Source of Funding: Public deposits provide companies with an alternative source of funding, especially when traditional financing options such as bank loans are limited or expensive. This allows companies to raise capital for various purposes, including working capital requirements, expansion projects, and short-term financing needs.

2. Diversification of Funding: By accepting public deposits, companies can diversify their sources of funding, reducing reliance on bank loans or equity financing. This diversification can help mitigate risks and improve financial stability by spreading the company's funding across different sources.

3. Flexible Terms: Public deposits can be structured with flexible terms and conditions to meet the needs of both companies and depositors. Companies can offer different maturity periods, interest rates, and withdrawal options to attract depositors and manage their cash flow effectively.

4. Fixed Income Stream: Public deposits offer depositors a fixed income stream in the form of interest payments, providing a predictable source of income over the deposit period. This can be attractive for individuals and organizations seeking stable returns on their investments, especially in a low-interest-rate environment.

5. Higher Returns: Public deposits often offer higher returns compared to traditional bank deposits, making them an attractive investment option for depositors looking to earn a competitive rate of return on their savings. Companies may offer higher interest rates on public deposits to attract investors and compete with other investment opportunities.

6. Accessibility: Public deposits are accessible to a wide range of investors, including individuals, trusts, and corporations. This accessibility allows companies to tap into a larger pool of potential investors and raise funds from diverse sources.

7. Regulatory Compliance: Companies accepting public deposits are subject to regulatory oversight and must comply with relevant laws and regulations, including the Companies Act and RBI guidelines. This helps protect depositors' interests and ensures transparency and accountability in the deposit-taking process.

Disadvantages of Public Deposits:

1. Default Risk: One of the main disadvantages of public deposits is the risk of default. Since these deposits are unsecured, there is a possibility that the company or institution accepting the deposits may fail to repay the principal amount and interest on time or may default entirely, leading to loss of funds for the depositors.

2. Lack of Government Insurance: Unlike bank deposits, public deposits are not typically insured by government-backed deposit insurance schemes. This means that if the company accepting the deposits goes bankrupt or defaults, depositors may not have recourse to insurance coverage to recover their funds.

3. Higher Risk: Public deposits are generally riskier than bank deposits, which are usually backed by government regulations and deposit insurance. Since public deposits are unsecured, they carry a higher risk of loss for depositors, especially if the company's financial health deteriorates.

4. Limited Regulatory Oversight: While public deposits may be subject to certain regulations and guidelines, they are generally less regulated than bank deposits. This lack of regulatory oversight may expose depositors to greater risks, as companies accepting public deposits may not adhere to stringent financial standards or reporting requirements.

5. Illiquidity: Public deposits may lack liquidity, meaning that depositors may not be able to access their funds quickly or easily. Unlike bank deposits, which can often be withdrawn on short notice, public deposits may have restrictions or penalties for early withdrawal, making it difficult for depositors to access their money when needed.

6. Limited Returns: While public deposits may offer higher returns compared to traditional bank deposits, they typically provide lower returns compared to riskier investments such as stocks or mutual funds. Therefore, depositors may face the trade-off between higher returns and higher risk when investing in public deposits.

Borrowings from Banks:

Borrowings from banks refer to obtaining funds from banking institutions for various purposes, such as personal expenses, business investments, or capital projects. Individuals, businesses, and governments can borrow money from banks through different financial products and lending arrangements.

Features of Borrowings from Banks:

1. Interest Rate: Borrowings from banks typically involve payment of interest on the borrowed amount. The interest rate may be fixed or variable, depending on the type of loan and prevailing market conditions.

2. Repayment Terms: Banks offer different repayment terms, including the duration of the loan, frequency of payments (e.g., monthly, quarterly), and the option for flexible or structured repayment schedules.

3. Collateral: Some bank borrowings may require collateral, such as real estate, inventory, or equipment, to secure the loan. Collateral provides the bank with a form of security in case the borrower defaults on the loan.

4. Credit Assessment: Banks assess borrowers' creditworthiness based on factors such as credit history, income, assets, debt levels, and repayment capacity. Borrowers with a strong credit profile are more likely to qualify for favorable loan terms.

5. Loan Amount: Banks determine the maximum loan amount based on factors such as the borrower's creditworthiness, the purpose of the loan, and the collateral provided (if any).

6. Fees and Charges: Borrowings from banks may involve additional fees and charges, such as loan origination fees, processing fees, prepayment penalties, and late payment fees.

Types of Borrowings from Banks:

1. Term Loans: Term loans are a common type of bank borrowing where the borrower receives a lump sum of money upfront and repays it over a specified period, usually with fixed monthly payments.

2. Overdraft Facilities: Overdraft facilities allow account holders to withdraw more money than they have in their accounts, up to a predetermined limit. Overdrafts are typically used for short-term financing needs and may incur interest charges.

3. Lines of Credit: Lines of credit provide borrowers with access to a revolving credit facility, allowing them to borrow funds as needed up to a predefined credit limit. Borrowers only pay interest on the amount borrowed and can repay and reuse the funds as required.

4. Credit Cards: Credit cards are a form of revolving credit issued by banks, allowing cardholders to make purchases or cash advances up to a specified credit limit. Cardholders must repay the borrowed amount, along with any accrued interest, by the due date.

Advantages of Borrowings from Banks:

1. Convenient Access to Funds: Borrowings from banks provide quick and convenient access to funds for various financial needs.

2. Flexible Repayment Options: Banks offer a range of loan products with flexible repayment terms, allowing borrowers to choose the option that best suits their financial situation.

3. Diversification of Funding Sources: Borrowing from banks allows individuals and businesses to diversify their funding sources and reduce reliance on personal savings or equity financing.

4. Opportunity to Build Credit History: Responsible borrowing and timely repayment of bank loans can help individuals and businesses establish and improve their credit history, making it easier to access credit in the future.

Limitations of Borrowings from Banks

1. Interest Costs: Borrowings from banks involve payment of interest, increasing the overall cost of borrowing and reducing the borrower's net returns or profits.

2. Risk of Default: Failure to repay bank loans as agreed can lead to default, damaging the borrower's credit score and potentially resulting in legal action or asset seizure.

3. Collateral Requirements: Some bank borrowings may require collateral, increasing the risk of asset loss in case of default.

4. Impact on Cash Flow: Loan repayments can impact the borrower's cash flow, especially if repayment obligations are significant or if the borrower experiences financial difficulties.

5. Creditworthiness Criteria: Banks assess borrowers' creditworthiness based on various factors, making it challenging for individuals or businesses with poor credit to qualify for loans.

6. Regulatory Constraints: Banks are subject to regulatory requirements and lending standards imposed by government authorities, limiting the availability of credit and imposing restrictions on lending practices.

Financial Services (Fundamentals of Financial Markets)

FUNDAMENTALS OF FINANCIAL MARKET

Primary Markets

Meaning of Primary Market

- The primary market, also known as the new issue market, is where newly issued securities are initially offered and sold to investors.

- It is the first point of entry for securities into the financial markets.

- Securities offered in the primary market can include stocks, bonds, debentures, and other financial instruments.

Functions of Primary Market

1. Capital Raising: Primary markets provide companies with a platform to raise capital by issuing new securities. This capital can be used for various purposes such as funding expansion projects, research and development, or debt repayment.

  

2. Price Discovery: The process of issuing securities in the primary market helps establish their initial price through the mechanism of supply and demand. This price discovery process reflects the perceived value of the securities by investors.

3. Facilitating Investment: Primary markets offer individual and institutional investors opportunities to invest in newly issued securities. Investors can participate in initial public offerings (IPOs) or purchase newly issued bonds to diversify their investment portfolios.

4. Information Disclosure: Companies seeking to issue securities in the primary market are required to disclose relevant information about their financial health, operations, and future prospects. This transparency helps investors make informed decisions.

5. Corporate Growth: By providing a source of capital for companies, primary markets contribute to corporate growth and expansion. This, in turn, can stimulate economic activity, create jobs, and drive innovation.

6. Enhancing Liquidity: The issuance of securities in the primary market increases their liquidity by introducing them to a wider pool of investors. This liquidity allows investors to buy and sell securities more easily, thereby increasing market efficiency.

Role in Economic Development:

- Primary markets play a crucial role in fostering economic development by channeling savings into productive investments.

- They provide businesses with access to capital, allowing them to finance growth initiatives, invest in new technologies, and create employment opportunities.

- By enabling companies to raise capital, primary markets contribute to the development of infrastructure, industries, and innovation, which are essential drivers of economic growth.

- Primary markets also promote financial inclusion by allowing individuals to participate in the ownership of businesses and share in their success through investment in IPOs and other offerings.

- Overall, primary markets serve as a vital link between savers and investors, facilitating the efficient allocation of capital in the economy and supporting long-term sustainable growth.

Secondary Market

Meaning of Secondary Market

- The secondary market, also known as the aftermarket, is where previously issued securities are bought and sold among investors.

- Unlike the primary market, where securities are issued for the first time, the secondary market involves the trading of existing securities.

- Securities traded in the secondary market include stocks, bonds, derivatives, and other financial instruments.

Functions of Secondary Market

1. Liquidity Provision: Secondary markets provide liquidity to investors by offering a platform for buying and selling securities after their initial issuance. This liquidity allows investors to exit or adjust their investment positions easily.

2. Price Discovery: Secondary markets facilitate the continuous valuation of securities through the process of buying and selling. Prices in the secondary market are determined by supply and demand dynamics, reflecting investors' perceptions of the value of the securities.

3. Risk Management: Investors use secondary markets to manage risk by diversifying their investment portfolios, hedging against price fluctuations, or adjusting their exposure to specific assets or sectors.

4. Capital Formation: While primary markets are the primary source of capital for companies, secondary markets play a role in capital formation by providing liquidity to investors. This liquidity encourages investment in primary offerings by providing an exit strategy for investors.

5. Enhancing Market Efficiency: The continuous trading and price discovery process in secondary markets contribute to market efficiency by incorporating new information and reflecting changes in investor sentiment. Efficient secondary markets facilitate fair pricing and allocation of resources.

6. Access to Capital: Secondary markets offer companies access to additional capital through the issuance of secondary offerings, such as rights issues or follow-on public offerings (FPOs). These offerings allow companies to raise funds without issuing new securities.

Role in Economic Development:

- Secondary markets play a crucial role in economic development by providing liquidity, promoting capital formation, and enhancing market efficiency.

- They offer investors the flexibility to buy and sell securities based on changing market conditions, encouraging investment and participation in the financial markets.

- By facilitating the efficient allocation of capital, secondary markets help channel savings into productive investments, supporting entrepreneurship, innovation, and economic growth.

- Secondary markets also contribute to financial stability by providing an avenue for risk management and portfolio diversification, reducing the impact of market fluctuations on investors and the economy.

- Overall, secondary markets serve as an essential component of the financial system, complementing primary markets and supporting the long-term development and prosperity of economies.

Initial Public Offerings (IPOs): Issue and Management

1. Definition:

- An Initial Public Offering (IPO) refers to the process through which a private company offers its shares to the public for the first time, thereby becoming a publicly traded company.

- IPOs allow companies to raise capital from public investors to finance growth initiatives, repay debts, or provide liquidity to existing shareholders.

2. Process of IPO:

   a. Preparatory Stage:

   - Selecting Advisors: The company selects investment banks or underwriters to manage the IPO process. These advisors help the company navigate regulatory requirements, determine valuation, and market the offering to investors.

   - Due Diligence: The company conducts thorough due diligence to ensure compliance with regulatory requirements, assess financial performance, and prepare offering documents.

   - Valuation: Investment banks assist in valuing the company based on financial performance, industry trends, market conditions, and comparable companies.

   b. Registration and Filing:

   - Drafting Prospectus: The company prepares a prospectus, which provides detailed information about the company's business, financials, risks, and offering terms. The prospectus is filed with the securities regulator, such as the Securities and Exchange Commission (SEC) in the United States.

   - Review Process: The securities regulator reviews the prospectus to ensure compliance with disclosure requirements and investor protection regulations. Any required revisions are made before final approval.

   c. Marketing and Roadshow:

   - Investor Outreach: The company and its underwriters conduct a roadshow to market the IPO to institutional investors, analysts, and potential retail investors. The roadshow involves presentations and meetings to generate interest in the offering.

   - Price Setting: Based on investor feedback and demand generated during the roadshow, the offering price is determined. The final offering price reflects a balance between maximizing proceeds and ensuring investor demand.

   d. Offering and Listing:

   - Allocation of Shares: The underwriters allocate shares to institutional investors and retail brokerage firms based on demand, investor profile, and other factors.

   - Trading Debut: The company's shares begin trading on the stock exchange after the offering is completed. The opening price is typically higher than the offering price due to investor demand.

   - Stabilization: Underwriters may engage in stabilization activities to support the stock price in the aftermarket, such as purchasing additional shares or providing liquidity.

3. Management of IPO:

- Post-IPO Governance: After becoming a publicly traded company, the company's management team must adhere to regulatory requirements, financial reporting standards, and corporate governance practices. They are accountable to shareholders and must act in their best interests.

- Investor Relations: The company's management team engages in ongoing communication with investors, analysts, and other stakeholders to provide updates on financial performance, business strategy, and other relevant information.

- Use of Proceeds: The company utilizes the funds raised through the IPO to execute its growth strategy, such as investing in research and development, expanding operations, acquiring assets, or reducing debt.

- Market Performance Monitoring: Management closely monitors the company's stock performance in the secondary market, analyzing factors affecting share price, investor sentiment, and market trends. They may adjust strategies or initiatives based on market conditions.

4. Benefits of IPOs:

- Access to Capital: IPOs provide companies with access to a broader pool of capital from public investors, enabling them to fund expansion, innovation, and strategic initiatives.

- Liquidity for Shareholders: Existing shareholders, including founders, employees, and early investors, can monetize their investments by selling shares in the IPO.

- Brand Visibility: Going public increases the company's visibility and credibility, enhancing its brand reputation and market recognition.

- Acquisition Currency: Publicly traded companies can use their stock as a currency for acquisitions, facilitating growth through mergers and acquisitions.

5. Challenges of IPOs:

- Regulatory Compliance: IPOs involve extensive regulatory requirements and compliance obligations, which can be time-consuming and costly for companies.

- Market Volatility: Market conditions and investor sentiment can affect the success of an IPO, leading to pricing fluctuations and volatility in the aftermarket.

- Investor Expectations: Public companies face pressure to meet shareholder expectations for growth, profitability, and corporate governance, which may require increased transparency and accountability.

- Management Distractions: The IPO process can divert management's attention from day-to-day operations and strategic priorities, potentially impacting business performance.

6. Conclusion:

- Initial Public Offerings (IPOs) are a critical milestone for companies seeking to raise capital and access the public markets.

- The IPO process involves multiple stages, including preparation, registration, marketing, and listing, with the goal of issuing shares to public investors.

- Post-IPO, companies must manage governance, investor relations, and capital deployment effectively to deliver value to shareholders and sustain long-term growth.

Role of Stock Exchanges in Economic Development :

Stock exchanges play a crucial role in economic development by facilitating the efficient allocation of capital, providing liquidity to investors, and fostering corporate growth and entrepreneurship. Here's a detailed explanation of their role:

1. Capital Formation:

   - Stock exchanges provide companies with a platform to raise capital by issuing shares to investors. This capital can be used to finance expansion projects, research and development, mergers and acquisitions, and other growth initiatives.

   - By enabling companies to access a broader pool of capital from public investors, stock exchanges contribute to the development of businesses across various sectors, driving innovation, job creation, and economic growth.

2. Investment Opportunities:

   - Stock exchanges offer individual and institutional investors a wide range of investment opportunities, allowing them to diversify their portfolios and participate in the ownership of businesses.

   - Investors can invest in stocks, bonds, exchange-traded funds (ETFs), and other financial instruments traded on the exchange, providing avenues for wealth accumulation and long-term financial planning.

3. Liquidity Provision:

   - Stock exchanges provide liquidity to investors by offering a platform for buying and selling securities. Investors can easily convert their investments into cash by trading on the exchange, reducing the risk of illiquidity.

   - Liquidity in the stock market enhances market efficiency, as investors can quickly execute trades at fair market prices, leading to better price discovery and allocation of resources.

4. Corporate Governance and Transparency:

   - Listed companies are subject to stringent regulatory requirements and corporate governance standards enforced by stock exchanges and securities regulators.

   - Listing requirements compel companies to adhere to transparency and disclosure standards, providing investors with timely and accurate information about the company's financial performance, operations, and risks.

   - Strong corporate governance practices enhance investor confidence, reduce agency costs, and mitigate the risk of fraud or misconduct, fostering trust in the financial markets.

5. Market Efficiency and Price Discovery:

   - Stock exchanges facilitate the continuous trading of securities, allowing prices to adjust in response to new information and changes in investor sentiment.

   - Efficient stock markets reflect the collective wisdom of investors, incorporating all available information into security prices. This price discovery mechanism ensures that securities are traded at fair and transparent prices, reflecting their intrinsic value.

   - Market efficiency encourages capital flow to productive investments, allocates resources efficiently, and supports economic growth.

6. Access to Global Capital:

   - Stock exchanges provide companies with access to global capital markets by attracting international investors and listings. Companies can raise capital from investors worldwide, expanding their funding sources and enhancing their global presence.

   - Cross-listing on multiple stock exchanges enables companies to tap into different investor bases, enhance liquidity, and increase visibility, strengthening their competitiveness and growth prospects.

7. Job Creation and Economic Stability:

   - The growth of listed companies on stock exchanges stimulates economic activity, leading to job creation, income generation, and poverty alleviation.

   - Stock markets contribute to economic stability by providing an alternative source of funding for companies, reducing dependence on bank loans and government support during economic downturns.

In conclusion, stock exchanges play a multifaceted role in economic development by facilitating capital formation, providing investment opportunities, ensuring liquidity, promoting corporate governance, enhancing market efficiency, enabling access to global capital, and fostering job creation and economic stability. Their efficient operation is essential for promoting entrepreneurship, innovation, and sustainable economic growth.

Functions of the Bombay Stock Exchange (BSE), the National Stock Exchange (NSE), and the Over-The-Counter Exchange of India (OTCEI):

1. Bombay Stock Exchange (BSE):

a. Trading Platform:

- The BSE provides a platform for trading a wide range of financial instruments, including equities, derivatives, debt instruments, and mutual funds.

- It operates various trading segments such as the equity segment, derivatives segment (Futures & Options), currency derivatives segment, and debt segment.

b. Listing and Capital Raising:

- BSE facilitates the listing of companies seeking to raise capital through Initial Public Offerings (IPOs) and follow-on public offerings (FPOs).

- Companies list their shares on the BSE to access capital from investors and provide liquidity to existing shareholders.

c. Market Surveillance and Regulation:

- BSE ensures market integrity and investor protection through robust surveillance and regulatory mechanisms.

- It monitors trading activities, detects market manipulation or abuse, and enforces compliance with regulatory requirements and listing norms.

d. Index Calculation:

- BSE calculates and maintains various benchmark stock market indices, including the BSE Sensex and BSE Nifty, which track the performance of listed companies on the exchange.

- These indices serve as barometers of market sentiment and provide valuable insights for investors and market participants.

e. Investor Education and Awareness:

- BSE conducts investor education programs, seminars, and workshops to enhance financial literacy and promote investor awareness.

- It provides educational resources, research reports, and market data to help investors make informed investment decisions.

2. National Stock Exchange (NSE):

a. Electronic Trading Platform:

- NSE operates a sophisticated electronic trading platform that enables seamless and efficient trading of various financial instruments.

- It offers trading in equities, equity derivatives (Futures & Options), currency derivatives, interest rate derivatives, and debt securities.

b. Market Infrastructure:

- NSE provides state-of-the-art market infrastructure, including trading systems, clearing and settlement mechanisms, risk management frameworks, and surveillance systems.

- Its robust infrastructure ensures the integrity, transparency, and efficiency of the trading process.

c. Index Management:

- NSE manages and maintains several benchmark indices, including the Nifty 50, Nifty Bank, and Nifty Midcap, which reflect the performance of specific segments of the market.

- These indices serve as key indicators of market trends and are widely used by investors, fund managers, and analysts for benchmarking and investment purposes.

d. Derivatives Market Development:

- NSE has played a significant role in the development of the derivatives market in India, particularly in equity derivatives.

- It offers a wide range of derivative products, including index futures and options, stock futures and options, and currency derivatives, providing investors with hedging and trading opportunities.

e. Investor Services and Education:

- NSE offers various investor services, including trading terminals, online trading platforms, and investor education programs.

- It collaborates with market participants, educational institutions, and regulatory bodies to promote investor education, awareness, and protection.

3. Over-The-Counter Exchange of India (OTCEI):

a. Platform for SMEs:

- OTCEI was established to provide a platform for small and medium-sized enterprises (SMEs) to raise capital and access the capital market.

- It caters to companies with lower capital requirements and facilitates their listing and trading of shares in a regulated environment.

b. Screen-Based Trading:

- OTCEI introduced screen-based trading systems, allowing investors to buy and sell securities electronically through computer terminals.

- This technology-driven trading platform enhances transparency, efficiency, and accessibility for investors and market participants.

c. Market Making:

- OTCEI facilitates market making to ensure liquidity and price discovery for securities traded on the exchange.

- Market makers quote bid and ask prices for securities, providing continuous liquidity and facilitating trading activity.

d. Investor Protection and Regulation:

- OTCEI operates under the regulatory oversight of the Securities and Exchange Board of India (SEBI) and adheres to regulatory requirements to ensure investor protection and market integrity.

- It enforces listing norms, disclosure requirements, and surveillance mechanisms to maintain market confidence and trust.

e. SME Development:

- OTCEI supports the development and growth of SMEs by providing them with a platform to raise capital, enhance visibility, and access a broader investor base.

- It promotes entrepreneurship, innovation, and job creation, contributing to economic development and prosperity.

Summary

The Bombay Stock Exchange (BSE), National Stock Exchange (NSE), and Over-The-Counter Exchange of India (OTCEI) play critical roles in facilitating capital raising, trading, investor protection, and market development in India's financial markets. Each exchange has its unique functions and characteristics, catering to the diverse needs of investors and companies across different segments of the market.

MONEY MARKET INSTRUMENTS

Money market instruments are short-term debt securities that serve as a means for governments, financial institutions, and corporations to borrow and lend money. They play a crucial role in the money market, which encompasses the trading of short-term, highly liquid, low-risk financial assets. Here's a detailed explanation of the commonly used money market instruments:

1. Treasury Bills (T-Bills):

   - T-Bills are short-term debt securities issued by governments, typically with maturities ranging from a few days to one year.

   - They are sold at a discount to face value and redeemed at face value upon maturity, with the difference between the purchase price and face value representing the investor's return.

   - T-Bills are considered one of the safest investments because they are backed by the full faith and credit of the government.

2. Certificates of Deposit (CDs):

   - CDs are time deposits issued by banks and financial institutions with fixed terms ranging from a few weeks to several years.

   - They offer higher interest rates than savings accounts but require the investor to keep the funds deposited for the duration of the term.

   - CDs are insured by the Federal Deposit Insurance Corporation (FDIC) in the United States, making them relatively low-risk investments.

3. Commercial Paper:

   - Commercial paper is an unsecured, short-term debt instrument issued by corporations to finance short-term funding needs such as working capital or inventory purchases.

   - It typically has maturities ranging from one to 270 days and is issued at a discount to face value.

   - Commercial paper is usually issued by highly creditworthy corporations and financial institutions, making it a relatively safe investment.

4. Repurchase Agreements (Repos):

   - Repos are short-term loans secured by the sale of securities with an agreement to repurchase them at a later date at a slightly higher price.

   - They are commonly used by financial institutions and central banks to raise short-term funds or manage liquidity.

   - Repos are considered low-risk because they are collateralized by high-quality securities, such as government bonds or T-Bills.

5. Banker's Acceptances (BAs):

   - BAs are short-term promissory notes issued by corporations and guaranteed by a bank.

   - They are used to finance international trade transactions, with the bank's guarantee providing assurance of payment to the seller.

   - BAs typically have maturities ranging from 30 to 180 days and are often discounted in the secondary market.

6. Money Market Mutual Funds (MMFs):

   - MMFs are investment funds that invest in a diversified portfolio of money market instruments, providing investors with liquidity and stability.

   - They offer a convenient way for investors to access the money market while earning a competitive yield and maintaining liquidity.

   - MMFs invest in a variety of money market instruments, including T-Bills, commercial paper, CDs, and repos, to maximize returns while minimizing risk.

7. Treasury Inflation-Protected Securities (TIPS):

   - TIPS are Treasury securities that are indexed to inflation, providing investors with protection against inflationary pressures.

   - They pay a fixed rate of interest, with the principal adjusted semiannually based on changes in the Consumer Price Index (CPI).

   - TIPS provide investors with a hedge against inflation and are considered relatively low-risk investments.

These money market instruments play vital roles in providing liquidity, managing short-term funding needs, and facilitating efficient capital allocation in the financial markets. They are favored by investors seeking safety, liquidity, and relatively stable returns over short investment horizons.

Difference Between Money Market and Capital Market :

Money market and capital market are two distinct segments of the financial market that serve different purposes and cater to different types of financial instruments and participants. Here's a breakdown of their differences:

1. Purpose:

   - Money Market: The primary purpose of the money market is to facilitate short-term borrowing and lending, typically for periods ranging from overnight to one year. Participants in the money market include banks, financial institutions, corporations, and governments seeking short-term funds to meet their liquidity needs.

   - Capital Market: The capital market, on the other hand, deals with long-term securities, where funds are raised for periods exceeding one year. It serves the purpose of facilitating the issuance and trading of long-term debt and equity instruments to finance capital expenditures, expansion plans, and other long-term investments.

2. Instruments Traded:

   - Money Market: The money market deals with short-term debt instruments such as treasury bills, certificates of deposit (CDs), commercial paper, repurchase agreements (repos), and short-term bonds with maturities typically ranging from overnight to one year.

   - Capital Market: The capital market deals with long-term securities such as stocks (equity), bonds (fixed-income securities), preference shares, debentures, and other complex financial instruments. These instruments have maturities exceeding one year.

3. Risk and Return:

   - Money Market: Investments in the money market are considered relatively low risk compared to the capital market. However, the returns on money market investments are generally lower due to the short-term nature of the instruments and the lower associated risk.

   - Capital Market: Investments in the capital market carry higher risk compared to the money market due to the longer investment horizon and greater exposure to market fluctuations. However, potential returns in the capital market can be higher to compensate for this increased risk.

4. Participants:

   - Money Market: Participants in the money market include banks, financial institutions, corporations, governments, and other institutional investors.

   - Capital Market: Participants in the capital market include individual investors, institutional investors (such as mutual funds, pension funds, and insurance companies), corporations, governments, and other entities seeking long-term capital.

5. Regulation:

   - Money Market: The money market is subject to regulatory oversight by central banks, financial regulators, and other relevant authorities to ensure liquidity and stability in short-term funding markets.

   - Capital Market: The capital market is also subject to regulatory oversight by securities regulators and other authorities to ensure fairness, transparency, and investor protection in the issuance and trading of long-term securities.

Thus, while both money market and capital market serve as important components of the financial system, they differ in terms of purpose, instruments traded, risk and return characteristics, participants, and regulatory framework.

Business Taxation

INTRODUCTION TO INCOME TAX ACT, 1961

The Income Tax Act is a piece of legislation that governs the taxation of income in a particular jurisdiction. It outlines the rules, regulations, and procedures related to the assessment, collection, and administration of income tax. Below, I'll provide an overview of the meaning, concepts, and definitions commonly found in income tax acts:

1. Meaning of Income Tax Act:

The Income Tax Act is a statute enacted by the government to impose a tax on the income of individuals, corporations, estates, and trusts within its jurisdiction. It serves as the primary legal framework for determining how income is taxed, what constitutes taxable income, and the procedures for filing tax returns and paying taxes.

2. Concepts and Definitions:

a. Income: Generally, income refers to money or assets received by an individual or entity from various sources, including employment, investments, business activities, and other sources. The Income Tax Act defines different types of income, such as earned income, passive income, capital gains, dividends, interest, etc.

b. Taxable Income: Taxable income is the portion of an individual's or entity's income that is subject to taxation after allowable deductions, exemptions, and credits are applied. The Income Tax Act specifies what types of income are taxable and the deductions or exemptions that can be claimed to reduce taxable income.

c. Tax Rates: The Income Tax Act sets out the tax rates applicable to different levels of income. These rates may vary depending on the taxpayer's filing status, type of income, and other factors. Progressive tax rates mean that higher levels of income are taxed at higher rates.

d. Deductions and Exemptions: The Income Tax Act allows taxpayers to claim deductions and exemptions to reduce their taxable income. Deductions are expenses or allowances that can be subtracted from gross income to arrive at taxable income, while exemptions exclude certain types of income from taxation altogether.

e. Filing Requirements: The Income Tax Act specifies the requirements for filing tax returns, including deadlines, forms to be used, and penalties for non-compliance. It also outlines the procedures for reporting income, claiming deductions, and paying any taxes owed.

f. Credits and Rebates: Tax credits and rebates are provided under the Income Tax Act to reduce the amount of tax owed by taxpayers. These credits may be based on specific expenses, such as education or childcare expenses, or they may be targeted at certain groups, such as low-income individuals or seniors.

g. Capital Gains Tax: The Income Tax Act typically includes provisions for taxing capital gains, which are profits realized from the sale of assets such as stocks, real estate, or business assets. The Act specifies the rules for calculating and reporting capital gains and may provide for preferential tax treatment in certain cases.

3. Administration and Enforcement:

The Income Tax Act also establishes the authority responsible for administering and enforcing tax laws, such as the tax authority or revenue agency. It outlines the powers and duties of these authorities, as well as the rights and obligations of taxpayers in relation to tax compliance and enforcement actions.

Overall, the Income Tax Act plays a crucial role in regulating the taxation of income and ensuring compliance with tax laws, providing the legal framework within which income tax systems operate.

Income tax in India has a long history, dating back to the British colonial era. Here's a brief overview:

1. Colonial Era: The concept of income tax was first introduced in India by the British in 1860, under the Indian Income Tax Act of 1860. This Act was modelled on the UK's income tax law of the time.

2. Provisional Collection of Taxes Act, 1931: This Act empowered the British government in India to collect income tax at source during the time of colonial rule.

3. Income Tax Act, 1922: After independence, the Indian Income Tax Act of 1922 was enacted, which served as the first comprehensive legislation for income tax in India. This Act was based on the recommendations of the All India Income Tax Committee, also known as the Col. Wanchoo Committee.

4. Income Tax Act, 1961: The current income tax law in India is governed by the Income Tax Act of 1961. This Act came into effect on April 1, 1962, and has since undergone numerous amendments to keep pace with changing economic conditions and tax requirements.

Some fundamental concepts and definitions under the Income Tax Act, 1961, include:

1. Assessee: Any person who is liable to pay tax under the Income Tax Act is referred to as an assessee. This includes individuals, Hindu Undivided Families (HUFs), companies, firms, etc.

2. Income: Income is broadly defined under the Act and includes various categories such as salary, house property income, profits and gains of business or profession, capital gains, and income from other sources.

3. Assessment Year (AY): The year following the financial year for which income is being assessed. For example, if the financial year is April 1, 2023, to March 31, 2024, the assessment year would be 2024-25.

4. Residential Status: The residential status of an individual or entity determines the taxability of their income in India. It is classified into three categories: Resident, Non-Resident, and Resident but Not Ordinarily Resident.

5. Tax Deduction at Source (TDS): It is the obligation of the payer to deduct tax at the source when certain types of payments are made. The deducted tax is then deposited with the government on behalf of the payee.

6. Permanent Account Number (PAN): It is a unique alphanumeric identifier issued by the Income Tax Department to individuals, companies, and entities.

7. Taxable Income: It is the total income of an assessee after allowing for deductions and exemptions as per the provisions of the Income Tax Act.

These are just a few of the fundamental concepts and definitions under the Income Tax Act, 1961, which governs income tax in India. The Act is comprehensive and covers various aspects of taxation, including computation of income, deductions, exemptions, and assessment procedures.

CANONS OF TAXATION

The "canons of taxation" refer to a set of fundamental principles or guidelines that are often used to evaluate the effectiveness and fairness of a tax system. These principles were first proposed by Adam Smith, a renowned economist, in his seminal work "The Wealth of Nations" published in 1776. The canons of taxation serve as a framework for designing tax policies and assessing their implications on society. There are generally considered to be four main canons of taxation:

1. Canon of Equity (or Canon of Equality): This principle suggests that taxes should be levied in such a way that each taxpayer contributes to the government's revenue burden in proportion to their ability to pay. In other words, individuals or entities with higher incomes or greater wealth should bear a larger tax burden compared to those with lower incomes or less wealth. This principle promotes fairness and distributive justice within the tax system.

2. Canon of Certainty (or Canon of Clarity): According to this principle, taxpayers should be able to understand how taxes are levied and calculated with clarity and predictability. The tax laws and procedures should be transparent, unambiguous, and consistent over time, reducing uncertainty and promoting compliance. Certainty in taxation also helps in avoiding arbitrary or unfair treatment of taxpayers.

3. Canon of Convenience (or Canon of Economy): This canon emphasizes that the tax system should be convenient for both the government and the taxpayers to administer and comply with. Taxes should be collected at a time and in a manner that is convenient for the taxpayers, minimizing administrative burdens and compliance costs. Additionally, tax administration should be efficient and cost-effective for the government, ensuring that resources are utilized optimally.

4. Canon of Efficiency (or Canon of Productivity): Efficiency in taxation refers to the ability of the tax system to raise revenue without causing significant distortions in economic behavior. Taxes should be structured in a way that minimizes deadweight losses (losses in economic efficiency) and maximizes economic welfare. This canon encourages policymakers to design taxes that minimize market distortions, such as excessive disincentives to work, save, invest, or innovate.

These canons provide a framework for evaluating tax policies and guiding tax reforms. While it may be challenging to satisfy all canons simultaneously, tax systems strive to strike a balance among these principles to achieve optimal outcomes in terms of revenue generation, equity, efficiency, and compliance.

OBJECTIVES OF INCOME TAX IN INDIA

1. Equity Objective: Income tax aims to achieve equity by ensuring that individuals and entities contribute to the government's revenue burden in proportion to their ability to pay. This principle is often implemented through progressive tax rates, where higher-income earners are subject to higher tax rates. The equity objective seeks to promote fairness and distributive justice within society by reducing income inequality and ensuring that the tax burden is distributed fairly across different income groups.

2. Revenue Mobilization Objective: One of the primary objectives of income tax is to mobilize revenue for the government. Tax revenue is essential for funding public goods and services, such as education, healthcare, infrastructure, and defense. Income tax is a significant source of government revenue in many countries and plays a crucial role in financing government expenditures and reducing budget deficits. The revenue mobilization objective ensures that the government has the necessary funds to meet its expenditure requirements and provide essential services to the public.

3. Growth Objective: Income tax policies can also be designed to promote economic growth and development. By implementing tax incentives, deductions, and credits, governments can encourage investment, entrepreneurship, innovation, and productivity growth. For example, tax incentives for research and development (R&D) activities or investment in certain industries can stimulate economic growth and enhance competitiveness. The growth objective aims to create a favorable environment for economic expansion, job creation, and overall prosperity.

4. Stabilization Objective: Income tax can be used as a tool for macroeconomic stabilization to mitigate economic fluctuations and stabilize the economy. During periods of economic downturns or recessions, governments may use fiscal policy, including changes in tax rates or tax credits, to stimulate aggregate demand, boost consumer spending, and promote investment. Conversely, during periods of inflation or overheating, governments may increase tax rates to reduce excessive demand and control inflationary pressures. The stabilisation objective seeks to maintain macroeconomic stability, promote full employment, and ensure sustainable economic growth over the long term.

These objectives of income tax reflect the multifaceted role that taxation plays in modern economies, encompassing considerations of fairness, revenue generation, economic development, and macroeconomic stability. Governments must carefully balance these objectives when formulating tax policies to achieve optimal outcomes for society as a whole.

TAXATION STRUCTURE IN INDIA

The taxation structure in India is comprehensive and includes various types of taxes levied by both the central and state governments. Here's an overview of the taxation structure in India:

1. Direct Taxes: Direct taxes are levied on individuals and entities directly by the government. The major direct taxes in India are:

- Income Tax: This tax is levied on the income earned by individuals, Hindu Undivided Families (HUFs), companies, and other entities. The Income Tax Act, 1961 governs the provisions related to income tax in India. Income tax is levied at progressive rates, meaning the tax rate increases with higher levels of income.

- Corporate Tax: Corporate tax is levied on the income earned by companies operating in India. The Finance Act governs the provisions related to corporate taxation. The tax rates for domestic and foreign companies may vary, and there are also provisions for tax incentives and deductions for certain sectors and activities.

- Capital Gains Tax: Capital gains tax is levied on the profit earned from the sale of capital assets such as real estate, stocks, and mutual funds. The tax rates for capital gains depend on the holding period of the asset and whether it qualifies for any exemptions or deductions.

- Dividend Distribution Tax (DDT): DDT is a tax levied on companies that distribute dividends to their shareholders. However, as of 2020, DDT has been abolished, and dividends are now taxable in the hands of the shareholders.

2. Indirect Taxes: Indirect taxes are imposed on goods and services and are usually collected by intermediaries (such as businesses) on behalf of the government. The major indirect taxes in India are:

- Goods and Services Tax (GST): GST is a comprehensive indirect tax levied on the supply of goods and services across India. It replaced various central and state taxes, such as central excise duty, service tax, VAT, and others, creating a unified tax regime. GST is administered by the Goods and Services Tax Council, which consists of representatives from the central and state governments.

- Customs Duty: Customs duty is a tax imposed on the import and export of goods. It is levied by the central government and helps regulate foreign trade and protect domestic industries. Customs duty rates vary depending on the type and value of goods imported or exported.

3. Other Taxes: Apart from direct and indirect taxes, there are other taxes levied by the central and state governments, including:

- Excise Duty: Excise duty is a tax levied on the production or manufacture of goods within the country. It is imposed on specific goods such as petroleum products, tobacco, alcohol, and certain luxury items.

- State Taxes: State governments in India levy various taxes such as state excise duty, stamp duty, property tax, entertainment tax, and professional tax. These taxes contribute to the revenue of state governments and are used to finance state expenditures.

Overall, the taxation structure in India is complex, with multiple taxes levied by different levels of government. The government periodically reviews and revises tax laws and rates to ensure efficiency, equity, and revenue generation while promoting economic growth and development.

A Permanent Account Number (PAN)

A Permanent Account Number (PAN) is a unique alphanumeric identifier assigned to individuals, companies, and other entities in India. It serves several purposes and offers various benefits:

1. Tax Identification: PAN serves as a primary identification for taxpayers in India. It is mandatory for filing income tax returns (ITR) and conducting financial transactions beyond certain thresholds.

2. Income Tax Filing: PAN is essential for filing income tax returns, claiming tax refunds, and engaging in tax-related transactions with the Income Tax Department.

3. Financial Transactions: PAN is required for various financial transactions such as opening a bank account, investing in stocks and mutual funds, buying or selling immovable property, making high-value transactions, and more.

4. Opening Bank Account: PAN is necessary for opening new bank accounts, including savings accounts, current accounts, and fixed deposit accounts.

5. Credit Card Application: PAN is often required when applying for a credit card or any other form of credit facility from banks or financial institutions.

6. Investments: PAN is mandatory for investing in securities like stocks, bonds, and mutual funds. It helps in tracking and reporting financial transactions for regulatory compliance.

7. Property Transactions: PAN is required for purchasing or selling immovable property valued above a specified threshold. It helps the government in curbing black money transactions in the real estate sector.

8. Identity Proof: PAN serves as a valid identity proof accepted by various government and private entities in India. It is often required for verification purposes in official and financial transactions.

9. TDS Deduction: PAN is used for deducting Tax Deducted at Source (TDS) by employers, banks, and other entities. It ensures proper tracking of tax deductions and facilitates tax compliance.

10. International Transactions: PAN may be required for certain international transactions, especially those involving remittances, foreign investments, or dealing with foreign entities.

11. GST Registration: PAN is necessary for registering under the Goods and Services Tax (GST) regime for businesses with a turnover above the specified threshold.

12. Government Subsidies and Benefits: PAN may be required for availing government subsidies, benefits, and welfare schemes.

Thus, PAN is a crucial identifier for tax purposes and facilitates various financial and regulatory transactions in India, ensuring transparency, accountability, and compliance with taxation laws.

1. Salient Features of Income from Salary

1. Employer-Employee Relationship: Income is classified as "Salary" only when there is a relationship of employer and employee.
2. Fixed Periodic Payment: Salary is paid periodically, usually monthly.
3. TDS Deduction: Tax is deducted at source (TDS) by the employer under Section 192 of the Income Tax Act.
4. Receipts Basis/Accrual Basis: Salary is taxable in the hands of the employee either when it is received or when it is accrued, whichever is earlier.
5. Taxable Under the Head 'Income from Salary': The income must arise out of an employment contract.

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2. Meaning of Salary

The term "salary" includes:

• Basic Pay: Fixed amount paid for services rendered.
• Allowances: Fixed monetary payments over and above the basic salary.
• Perquisites: Non-monetary benefits provided by the employer.
• Bonus/Commission: Extra payments made as incentives.
• Retirement Benefits: Such as gratuity, pension, and provident fund contributions.

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3. Allowances and Tax Liability

Allowances are fixed amounts given to meet specific requirements. They are classified into three categories:

1. Fully Taxable Allowances:

   • Dearness Allowance (DA): To offset the impact of inflation.
   • Overtime Allowance: For extra hours worked.
   • City Compensatory Allowance (CCA): For high living costs in metro cities.
   • Bonus and Commission: Fully taxable.

2. Partially Exempt Allowances:

   • House Rent Allowance (HRA): Exemption under Section 10(13A).
     • Exemption is the least of:
       • Actual HRA received.
       • 50% (metro cities) or 40% (non-metro cities) of salary.
       • Rent paid - 10% of salary.
   • Children Education Allowance: Exemption up to ₹100 per month per child (maximum 2 children).
   • Transport Allowance: Exemption up to ₹1,600 per month for a disabled employee.

3. Fully Exempt Allowances:

   • Allowances given to government employees serving abroad.
   • Certain allowances under Section 10 for specific professions (e.g., armed forces).

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4. Perquisites and Their Valuation

Perquisites are non-monetary benefits provided by the employer. They may be:

1. Taxable Perquisites:

   • Rent-Free Accommodation (RFA): Valued based on rules.
   • Car Provided for Personal Use: Valuation depends on car size and fuel cost.
   • Interest-Free Loan: Valued at the difference between actual and prescribed interest rates.

2. Exempt Perquisites:

   • Medical facility provided in employer's hospital.
   • Use of laptop or computer for official purposes.
   • Health insurance premium paid by the employer.

3. Perquisites Taxable Only for Specified Employees:

   • Salary above ₹50,000 or a director in the company.

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5. Deductions from Salary (Section 16)

1. Standard Deduction:

   • ₹50,000 or actual salary, whichever is less.

2. Entertainment Allowance (Only for Government Employees):

   • Least of:
     • ₹5,000
     • 20% of Basic Salary
     • Actual Entertainment Allowance Received

3. Professional Tax:

   • Deductible if paid by the employee.

Financial Services (Indian Financial System : An Overview)

Indian Financial System

Introduction to Financial System:

The financial system of any country encompasses a complex network of institutions, markets, and instruments that facilitate the flow of funds between savers and borrowers. It plays a crucial role in allocating resources efficiently, promoting economic growth, and managing risk within the economy.

Financial systems are typically characterized by their structure, which includes various components such as financial institutions, financial markets, financial instruments, and financial services. These components interact to mobilize savings, allocate capital, facilitate trade, and manage risks.

Now, let's look at some definitions provided by renowned professors in the field of finance:

1. Definition by Professor Mishkin

Professor Frederic S. Mishkin, a prominent economist and author, defines the financial system as:

"The set of markets, instruments, and institutions through which financial resources are allocated in the economy."

2. Definition by Professor Saunders

Professor Anthony Saunders, an esteemed academic in banking and finance, offers this definition:

"The financial system consists of markets, institutions, regulations, and laws that exist to facilitate the flow of financial resources and risks within an economy."

3. Definition by Professor Allen

Professor Franklin Allen, a leading scholar in financial economics, defines the financial system as:

"The network of institutions and markets that help facilitate the transfer of funds from savers to borrowers and the allocation of capital resources."

These definitions highlight the interconnected nature of the financial system and emphasize its role in mobilizing savings, channeling funds to productive investments, and managing financial risks. Understanding the functioning and structure of the financial system is crucial for policymakers, investors, and individuals alike, as it influences economic growth, stability, and welfare.

Indian Financial System : An Overview

The Indian financial system is structured in a hierarchical manner, comprising various institutions and markets that facilitate the flow of funds between savers and investors. Here's a detailed breakdown of its structure:

1. Financial Institutions

Regulatory Bodies

These entities oversee and regulate the financial system to ensure stability and fairness. Examples include the Reserve Bank of India (RBI), Securities and Exchange Board of India (SEBI), Insurance Regulatory and Development Authority of India (IRDAI), and Pension Fund Regulatory and Development Authority (PFRDA).

Banking Institutions

Banks play a crucial role in the financial system by accepting deposits, providing loans, and offering various financial services. These include commercial banks, cooperative banks, regional rural banks, and development banks like the National Bank for Agriculture and Rural Development (NABARD) and the Export-Import Bank of India (EXIM Bank).

Non-Banking Financial Companies (NBFCs)

NBFCs provide financial services like loans, advances, acquisition of shares / stocks / bonds / debentures / securities issued by the government or local authority, leasing, hire-purchase, insurance business, and chit business.

Insurance Companies

Insurance firms offer various types of insurance products to protect individuals and businesses against financial losses. These include life insurance companies, general insurance companies, and reinsurance companies.

Mutual Funds

Mutual funds pool money from multiple investors to invest in stocks, bonds, or other securities according to predefined investment objectives. They offer a range of schemes catering to different risk appetites and investment goals.

Pension Funds

These funds manage retirement savings and provide pension benefits to individuals. Examples include the Employees' Provident Fund Organisation (EPFO) and the National Pension System (NPS).

2. Financial Markets

Money Market

The money market deals with short-term borrowing, lending, buying, and selling of financial instruments with maturities of one year or less. It includes instruments like Treasury Bills, Commercial Papers, Certificates of Deposit, and Call Money.

Capital Market

The capital market facilitates the buying and selling of long-term financial instruments such as stocks, bonds, debentures, and derivatives. It comprises the primary market (where new securities are issued) and the secondary market (where existing securities are traded).

Foreign Exchange Market

This market deals with the buying and selling of foreign currencies. It includes banks, financial institutions, corporations, and individual traders engaged in currency trading.

Commodity Market

Commodity exchanges facilitate the trading of commodities such as metals, energy, agricultural products, and precious metals. Futures and options contracts are commonly traded in commodity markets.

3. Financial Instruments

Equity Shares

Represent ownership in a company and entitle shareholders to a portion of its profits.

Debt Instruments

Include bonds, debentures, and loans that represent borrowed funds with an obligation to repay the principal amount along with interest.

Derivatives

Financial contracts whose value is derived from the value of an underlying asset, index, or rate. Examples include futures, options, swaps, and forwards.

Insurance Policies

Contracts that offer financial protection or reimbursement against specified risks in exchange for premium payments.

4. Financial Services

Deposit Services

Offered by banks and NBFCs, including savings accounts, current accounts, fixed deposits, and recurring deposits.

Loan Services

Providing funds to individuals and businesses for various purposes like housing, education, business expansion, and infrastructure development.

Investment Services

Helping investors make informed decisions and manage their investment portfolios through services like wealth management, portfolio advisory, and investment banking.

Insurance Services

Offering life insurance, health insurance, property insurance, and other risk management solutions.

This hierarchical structure of the Indian financial system ensures efficient allocation of resources, risk diversification, and overall economic growth.

STRUCTURE OF FINANCIAL SYSTEM

The structure of financial services encompasses various institutions, markets, products, and regulations that facilitate the management of money, investments, and risk. Here's a breakdown of its components:

1. Financial Institutions: These are entities that provide financial services to customers. They can be categorized into several types:

- Banks: Offer services like savings accounts, checking accounts, loans, and mortgages.

- Credit Unions: Similar to banks but owned by their members, often with a focus on serving specific communities.

- Insurance Companies: Provide coverage and financial protection against risks such as accidents, illnesses, and property damage.

- Investment Banks: Assist in large financial transactions such as mergers and acquisitions, underwriting securities issuance, and providing advisory services.

- Brokerage Firms: Facilitate buying and selling of financial securities like stocks, bonds, and mutual funds for clients.

- Asset Management Firms: Manage investment portfolios on behalf of clients, including mutual funds, hedge funds, and pension funds.

2. Financial Markets: These are platforms where financial assets are bought and sold. They can be categorized based on the type of assets traded:

- Stock Market: Where shares of publicly traded companies are bought and sold.

- Bond Market: Where debt securities issued by governments, municipalities, and corporations are traded.

- Foreign Exchange Market (Forex): Where currencies are exchanged.

- Commodities Market: Where physical goods like gold, oil, and agricultural products are traded.

- Derivatives Market: Where financial contracts whose value is derived from the value of an underlying asset are traded (e.g., futures, options, swaps).

3. Financial Products and Services: These are offerings provided by financial institutions to meet the needs of customers:

- Deposit Accounts: Such as savings accounts, checking accounts, and certificates of deposit (CDs).

- Loans and Credit: Including mortgages, personal loans, credit cards, and lines of credit.

- Investment Products: Like stocks, bonds, mutual funds, exchange-traded funds (ETFs), and retirement accounts.

- Insurance Products: Such as life insurance, health insurance, auto insurance, and property insurance.

- Financial Advisory Services: Including financial planning, retirement planning, and investment advice.

4. Regulatory Framework: Financial services are heavily regulated to ensure stability, fairness, and consumer protection. Regulatory bodies such as central banks, securities commissions, and insurance regulators oversee different aspects of the financial system and enforce rules and regulations.

5. Technology and Innovation: With the advancement of technology, financial services are increasingly delivered through digital channels like mobile apps and online platforms. Fintech (financial technology) companies are disrupting traditional financial services with innovative solutions such as peer-to-peer lending, robo-advisors, and blockchain-based transactions.

Overall, the structure of financial services is complex and interconnected, serving the diverse needs of individuals, businesses, and governments in managing their finances and investments.

FINANCIAL INTERMEDIARIES IN FINANCIAL SYSTEM

Financial intermediaries in the financial system serve various roles and functions, each contributing to the efficient allocation of capital and risk management. Here's an explanation of the roles of different financial intermediaries:

1. Merchant Bankers

   - Merchant bankers are financial intermediaries that specialize in corporate finance and investment banking services.

   - They assist companies in raising capital through methods such as IPOs (Initial Public Offerings), private placements, and rights issues.

   - Merchant bankers provide advisory services on mergers and acquisitions, corporate restructuring, and other strategic transactions.

   - They also engage in underwriting securities issuances, assuming the risk of purchasing unsold securities from the issuer and reselling them to investors.

2. Underwriters

   - Underwriters are financial intermediaries that assess and assume the risk of issuing securities on behalf of companies or governments.

   - They guarantee the sale of a certain number of securities at a predetermined price, ensuring that the issuer receives the necessary funds.

   - Underwriters may work independently or as part of investment banks or brokerage firms.

3. Depositors

   - Depositors are individuals or entities that deposit funds into banks or other financial institutions.

   - By depositing funds, depositors provide the financial institution with a source of funding that can be used to extend loans and other credit products to borrowers.

   - Depositors typically earn interest on their deposits, providing an incentive to save and invest their funds.

4. Brokers

   - Brokers are intermediaries that facilitate the buying and selling of financial securities on behalf of investors.

   - They execute trades on stock exchanges or other trading platforms, matching buyers with sellers and ensuring the efficient functioning of financial markets.

   - Brokers may provide investment advice, research, and other services to their clients, helping them make informed investment decisions.

5. Sub-Brokers

   - Sub-brokers are individuals or firms that are authorized by registered brokers to act on their behalf in executing trades and providing services to clients.

   - They assist brokers in expanding their client base and servicing clients in different geographic regions or market segments.

   - Sub-brokers may receive commissions or fees from brokers for their services.

6. Bankers

   - Bankers refer to financial institutions that provide a wide range of financial services, including deposit-taking, lending, and other banking services.

   - They serve as intermediaries between savers and borrowers, accepting deposits from individuals and businesses and using those funds to extend loans and credit.

   - Banks also offer various other financial products and services, such as investment products, insurance, and wealth management services.

Overall, these financial intermediaries play crucial roles in the financial system by facilitating the efficient allocation of capital, managing risks, and providing liquidity to markets. They help connect borrowers with lenders, investors with investment opportunities, and contribute to the overall functioning and stability of the financial system.