1. Financial Environment

2. Money Supply 2
A few preliminaries
• Reserves (R ): the portion of deposits that banks have
not lent.
• To a bank, liabilities include deposits,
assets include reserves and outstanding loans
• 100-percent-reserve banking: a system in which
banks hold all deposits as reserves.
• Fractional-reserve banking:
a system in which banks hold a fraction of their
deposits as reserves.
slide 2

3. SCENARIO 1: No Banks
With no banks,
D = 0 and M = C = $1000.
we assume there’s $1000 in currency circulating in the economy.
We then compare the size of the money supply in different scenarios about the
banking system: no banks, 100% reserve banking, and fractional reserve
banking.
slide 3

4. SCENARIO 2: 100 Percent Reserve Banking
 Initially C = $1000, D = $0, M = $1000.
 Now suppose households deposit the $1000 at “Firstbank.”
• After the deposit,
FIRSTBANK’S
C = $0,
balance sheet D = $1000,
Assets Liabilities M = $1000.
reserves $1000 deposits $1000 • 100% Reserve
Banking has no
impact on size of
money supply.
slide 4

5. SCENARIO 3: Fractional-Reserve Banking
 Suppose banks hold 20% of deposits in reserve, making loans with
the rest.
 Firstbank will make $800 in loans.
The money supply now
FIRSTBANK’S equals $1800:
balance sheet The depositor still has
Assets Liabilities $1000 in demand
reserves $200 deposits $1000
$1000 deposits,
loans $800 but now the
borrower holds $800
in currency.
slide 5

6. SCENARIO 3: Fractional-Reserve Banking
Thus, in a fractional-reserve
banking system, banks create money.
The money supply now
FIRSTBANK’S equals $1800:
balance sheet The depositor still has
Assets Liabilities $1000 in demand
reserves $200 deposits $1000 deposits,
loans $800 but now the
borrower holds $800
in currency.
slide 6

7. SCENARIO 3: Fractional-Reserve Banking
 Suppose the borrower deposits the $800 in Secondbank.
 Initially, Secondbank’s balance sheet is:
SECONDBANK’S
balance sheet
• But then Secondbank
Assets Liabilities will loan 80% of this
deposit
• and its balance sheet
reserves
reserves deposits $800 will look like this:
$160
$800
loans $640
loans the borrower deposits the $800 in the bank. Or maybe the borrower
$0
Maybe
uses the money to buy something from someone else, who then deposits it
in the bank. In either case, the $800 finds its way back into the banking
slide 7 system.

8. SCENARIO 3: Fractional-Reserve Banking
 If this $640 is eventually deposited in Thirdbank,
 then Thirdbank will keep 20% of it in reserve, and loan the rest out:
• Again, the person who
THIRDBANK’S borrowed the $640 will
either deposit it in his
balance sheet own checking account, or
Assets Liabilities will use it to buy
something from
somebody who, in turn,
reserves deposits $640 deposits it in her checking
$128
$640 account. In either case,
the $640 winds up in a
bank somewhere, and
loans $512
$0 that bank can then use it
to make new loans.
slide 8

9. Finding the total amount of money:
Original deposit = $1000
+ Firstbank lending = $ 800
+ Secondbank lending = $ 640
+ Thirdbank lending = $ 512
+ other lending…
Total money supply = (1/rr ) × $1000
where rr = ratio of reserves to deposits
In our example, rr = 0.2, so M = $5000
A fractional reserve banking system creates money,
but it doesn’t create wealth:
bank loans give borrowers
some new money
slide 9 and an equal amount of new debt.

10. Financial Institutions
• DEFINITION
• Institution which collects funds from the
public and places them in financial assets,
such as deposits, loans, and
bonds, rather than tangible property
are called Financial Institution. In financial
economics, a financial institution is an
institution that provides financial services for
its clients or member

11. What is a bank?
• A bank is a commercial or state institution
that provides financial services, including
issuing money in various forms, receiving
deposits of money, lending money and
processing transactions and the creating of
credit.

12. 1. Central Bank
• A central bank, reserve bank or monetary authority, is an
entity responsible for the monetary policy of its country or of
a group of member states, such as the European Central Bank
(ECB) in the European Union, the Federal Reserve System in
the United States of America, State Bank in Pakistan.
• Its primary responsibility is to maintain the stability of the
national currency and money supply, but more active duties
include controlling subsidized-loan interest rates, and acting
as a “lender of last resort” to the banking sector during times
of financial crisis

13. 2. Savings 3. Life Insurance
Bank Companies
• A savings bank is a Insurance companies may
financial institution be classified as
whose primary purpose 1. Life insurance
is accepting savings companies, which sell life
deposits. It may also insurance, annuities and
perform some other pensions products.
functions. 2. Non-life or general
insurance companies,
which sell other types of
insurance.

14. 4. Investment
company
• Generally, an "investment company" is a company
(corporation, business trust, partnership, or limited liability
company) that issues securities and is primarily engaged in
the business of investing in securities.
• An investment company invests the money it receives from
investors on a collective basis, and each investor shares in
the profits and losses in proportion to the investor’s interest
in the investment company.

15. 4. Pension Funds
• A fund established by an employer to facilitate and organize the
investment of employees' retirement funds contributed by the
employer and employees. The pension fund is a common asset
pool meant to generate stable growth over the long term,
and provide pensions for employees when they reach the end of
their working years and commence retirement.
• Pension funds are commonly run by some sort of financial
intermediary for the company and its employees, although some
larger corporations operate their pension funds in-house. Pension
funds control relatively large amounts of capital and represent the
largest institutional investors in many nations.

16. 5. Leasing Companies
• A lease or tenancy is the right to use or occupy personal
property or real property given by a lessor to another person
(usually called the lessee or tenant) for a fixed or indefinite
period of time, whereby the lessee obtains exclusive
possession of the property in return for paying the lessor a
fixed or determinable consideration (payment).
6. Brokerage Houses
• Stock brokers assist people in investing, online only
companies are called 'discount brokerages', companies with a
branch presence are called 'full service brokerages' or 'private
client services.

17. Financial Intermediation
• Financial intermediation consists of “channeling funds
between surplus and deficit agents”. A financial
intermediary is a financial institution that connects surplus
and deficit agents. The classic example of a financial
intermediary is a bank that transforms bank deposits into
bank loans
• As such, financial intermediaries channel funds from people
who have extra money (savers) to those who do not have
enough money to carry out a desired activity (borrowers).

18. Kinds of Financial Intermediation
• Denomination Intermediation
– When small amounts of savings from individuals and others
are collected and pooled so as to give loans to others
• Default-risk intermediation
– occurs when financial intermediaries provide loans to risky
borrowers and simultaneously issue relatively safe and liquid
securities to attract loanable funds from savers.
• Maturity intermediation
– occurs when financial intermediaries borrow short-term
funds from savers and make long- term loans to borrower.
Maturity intermediation is most often undertaken by many
financial intermediaries.

19. Financial Products: Mutual Funds
• A Mutual Fund is a trust that pools the savings of a number
of investors who share a common financial goal.
• The money thus collected is then invested in capital market
instruments such as shares, debentures and other
securities.
• The income earned through these investments and the
capital appreciation realized are shared by its unit holders
in proportion to the number of units owned by them.
• Thus a Mutual Fund is the most suitable investment for the
common man as it offers an opportunity to invest in a
diversified, professionally managed basket of securities at a
relatively low cost.

20. Regulations
• Governed by SEBI (Mutual Fund) Regulation 1996
– All MFs registered with it, constituted as trusts ( under Indian Trusts
Act, 1882)
• Bank operated MFs supervised by RBI too
• AMC registered as Companies registered under Companies Act, 1956
• SEBI- Very detailed guidelines for disclosures in offer document, offer
period, investment guidelines etc.
– NAV to be declared everyday for open-ended, every week for closed
ended
– Disclose on website, AMFI, newspapers
– Half-yearly results, annual reports
– Select Benchmark depending on scheme and compare
chopra.rajiv@icai.org

21. Types of Mutual Fund Schemes
• By Structure
– Open-Ended – anytime enter/exit
– Close-Ended Schemes – listed on exchange, redemption after period of
scheme is over.
• By Investment Objective
– Equity (Growth) – only in Stocks – Long Term (3 years or more)
– Debt (Income) – only in Fixed Income Securities (3-10 months)
– Liquid/Money Market (including gilt) – Short-term Money Market (Govt.)
– Balanced/Hybrid – Stocks + Fixed Income Securities (1-3 years)
– Specialized Funds- particular industries, sectors or markets. Eg
Infrastructure funds
– International- Only in foreign Markets
– Global- Both Foregn and Domestic
• By Types of Investors
• Other Schemes
– Tax Saving Schemes
– Some funds differ from other funds
– Special Schemes
because of investor profile. Pension
• ULIP
Fund. These funds manage the
pension moneys of their clients.

22. Advantages of Mutual Fund
Schemes
• Diversification Benefit
• Improves the risk-return profile of the portfolio
• Small investors may not have the amount of capital that would allow optimal
Diversification
• Low Transaction Cost
• Transactions are generally large
• Large volumes attract lower brokerage commissions as a percentage of the
volume of transaction and other costs as compared to the smaller volumes of
the transactions entered into by individual investors
• Availability of Various Schemes
• Schemes to suit the requirements of the investors
• Choose between regular income schemes and growth schemes, between
schemes that invest in money market and schemes that invest in Stock market
• Professional Management
• Continuous monitoring of various securities
• Liquidity
• Portfolio vs mutual funds

23. Disadvantages of Mutual Fund
Schemes
• Investors cannot choose the securities they want to invest in or
securities they want to sell.
• Investors face the risk of fund managers not performing well.
• If Manager’s incentive is linked to the fund he may perform
well in the short run but hamper the long run
• Management fees
• Investors in Securities can decide the amount of earnings they want to
withdraw in a particular period, investors in MF have no such discretion as
the amount of earnings that are to be paid out to the investors in a
particular year is decidd by the mutual Fund

24. Venture Capital
• Investment in
• High risk projects
• High return potential projects
• Equity related instruments
• Unlisted companies
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25. What is VC?
• Investment in
• High risk projects
• High return potential projects
• Equity related instruments
• Unlisted companies
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26. Types of risk financiers
• Regular VCs
• Corporate VCs
• Angel investors
– An angel investor or angel (also known as a business
angel or informal investor) is an affluent individual who
provides capital for a business start-up, usually in
exchange for convertible debt or ownership equity
• Incubators
– A firm engaged in the business of fostering early-stage
companies through the developmental phases until such
time as the company has sufficient financial, human and
physical resources to function on its own.
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27. Changing patterns
• Seed Stage
Stages of VCs • Early stage
investment • Later stage • Earlier domestic funds
• Turnaround • Now more offshore funds
• Moved towards
Changing trends
globalisation with Indian
• Successful entrepreneurs in funds investing outside
US turned financiers, TiE
and foreign funds
• Successful Indians
investing inside India
• Foreign VCs directly
investing in India • Fund of eg SIDBI, UTI
• NRI entrepreneurs tapping • State governments have
Indian VC funds their state specific funds,
• Banks and other institutions i.e. KITVEN
also looking at innovative
ways to fund SMEs
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28. VC investment & exit
Promoters
with
Project Prelimnary Term Sheet Due
Initial Project Signed by Diligence
Meetings Review by Venture Review of
Venture Capitalist & Project
Capitalist Promoters
Venture
Capitalist
with Funds
Promoters
Divestment Mentoring Investment Legal
& Exit & made by Documents
from Monitoring Venture /Agreement
Project of Project Capitalist Signed
in Project
Venture
Capitalist
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29. What a project
must have VC looks for
• Potential for high
growth
• Team – leadership,
• High upside potential multidisciplinary,
• Potential for integrity,
extraordinary returns competence, domain
to investor knowledge
• Exit route plan • Project, product, USP
• Market, opportunity,
growth expected,
barriers to
competition
• Exit avenue
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30. Business Plans
Business plans…
• are to be forward looking, based on past
knowledge of promoters and their work
experience in the existing or new company
• Must discount revenues expected, account for
all expected costs and project expected cash
flows
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31. Due diligence reviews
• Investment decision based on DDR
• Business
• Market
• Accounting
• Tax and Legal
• Technical
• HR
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32. Term Sheet
• Term sheet is a letter of intent and may or
may not be legally binding
• Term sheet terms give a summary of proposed
principal terms of investment
• Term sheet is usually subject to satisfactory
completion of due diligence reviews
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33. Term Sheet extract
Amount of investment Rs. 100 million
Type of security Equity Shares
Pre-money valuation Rs. 300 million
Post-money valuation Rs. 400 million
Equity shareholding of Existing holders of a 15%
the company post equity b 15%
investment c 10%
d 10%
e 5%
f 5%
Stock options pool 15%
VC Investor Limited
33 25%

34. Post Venture Capital investment
• Is a partner in the project
• Mentors and monitors the project
• Hand holds through the investment
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35. Post VC investment
• Networks on behalf of the investee,
provides contacts, opens doors…
• flip side could be perceived as interfering,
this depends on VC/entrepreneur
relationship
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36. What a VC does
• Each fund manager mentors only a
handful of projects
• While fund size is big, no. of investments
cannot be too much, hence project size
increases
• Unlike debt/other investor, VC is not silent
spectator,often is on the Board of investee
company
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37. VC investment
• Some VCs therefore have separate persons
to look at investment and others to look at
post investment, monitoring as the skill sets
can be different
• Others have the same fund manager looking
at project from day one of receiving proposal
thru exit from investment
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38. Mature markets
• Different VCs may target different
industries such as:
– IT further split into niche areas
– Agri related
– Bioinformatics
– Manufacturing - new materials
– Service
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39. Future of VC in India
• Industry has not grown to meet needs of a variety of
entrepreneurs
• Too much money chasing too few projects, in select
industries, not in the majority
• Move towards consortium financing, risks spread for
a smaller piece of pie
• Many have dropped out and many coming in - churn
is there, as players are to get established
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40. Future of VC in India
• Potential is there, needs to be tapped
• Lack of appropriately trained persons to manage
funds
• General public, including others like bank staff, CAs,
legal advisors etc. not completely aware of finer
points of such funding
• The entrepreneurial ecosystem is yet to develop, of
course some cities like Bangalore are slowly having a
variety of experts in this space
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41. Future VCs in India
• There are limited takers for smaller projects
• Real early stage, high growth, high risk projects,
finding it difficult to raise funding
• There are issues of exit and other related issues
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42. Future VCs in India
• In the recent times some groups have showed
interest in getting together those who need funds
on the one hand and those who want to invest on
the other, including high net worth individuals etc.
• This includes industry groups, academic institutions
and other groups
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