Unit 7: Sources of Business Finance

MEANING OF BUSINESS FINANCE

Business finance refers to the money required for carrying out business activities. It is basically concerned with acquisition of funds, use of funds and distribution of profits by a business enterprise. A business cannot function unless adequate funds are made available to it. The initial capital in the business is not always sufficient for all financial requirements of the business. It is necessary to estimate this financial needs of the business and to identify the various sources of finance.

NATURE OF REATURES OF BUSINESS FINANCE

The following points will clarify the nature of Business Finance:

Necessary for all businesses:- Financing is an essential business activity. So, business finance is needed in all types of business, manufacturing or trading, large or small, and so on.
Depends on Nature and size of business:- The quantum of business finance needed depends on nature and size of the business. Small sized business enterprises need lesser funds, while large sized business houses need more funds.
Includes all types of Funds:- It includes all types of funds used in the business, i.e. both Owners’ Funds and Borrowed Funds are included in business finance.
Required on Continuous Basis:- Business finance is required on continuous basis during the life of the business enterprise.
Wider Term:- Business finance is a wider term as it involves estimation, procurement, utilization and investment of funds.
Fluctuation Nature:- The need for business finance depends on many factors like inflation rate, changes in demand, supply, fashion, technology, etc. So, need for business finance keeps on fluctuating when any of such factors changes.

Significance of Business Finance

Finance provides access to all the resources to be employed in manufacturing and merchandising activities.

Finance is needed to start and establish a business.
Finance is required to modernize, expand and diversify the business to grow.
Finance is required to face and remain ahead of competition in the market.
A business can survive during the period of recession and depression only when it has enough of finance.
Finance is necessary to smoothly run day-to-day activities of business like payment for raw material, salaries, etc.

Sources of Funds

Owners’ funds:- The funds provided by the owner of the business enterprise are known as owners’ funds. For example, funds or capital provided by sole trader or partners or shareholders of a company. In addition to capital, it also includes profits reinvested in the business.

Features

Permanent capital:- Owners’ funds are permanent source of finance as they are not required to be refunded during the life period of business.
Control:- They provide the right of control over the management of business.
Risk bearer Capital:- The providers of Owner’s Funds are the primary risk bearers.
Return:- Return on such capital is dependent on profitability of operations and availability of distributable surplus.
No Security Needed:- No security is required against owners’ funds.
Sources:- Owners’ funds comprise of Equity Shares, Preference Shares, Retained Earnings, GDRs, ADRs and IDRs.

2. Borrowed Funds:- The funds raised through loans or borrowings, are known as borrowed funds. Loans are borrowed for a specified period, depending upon the nature of need.

Features

Temporary Capital:- Borrowed Funds provide funds for a specified period, on certain terms and conditions and have to be repaid after the expiry of that period.
Periodic Interest Payment:- Borrowers are under legal obligation to pay interest at a fixed rate at regular intervals, even in case of low earnings or losses.
Control:- The providers of borrowed funds do not get the right to control over the management of business.
Security:- Borrowed funds are generally provided on the security of some fixed assets.
Sources:- Borrowed funds comprise of Debentures and bonds, Loans, Inter-Corporate Deposits, Trade Credit, Public Deposits, etc.

Sources of owners’ funds

Equity Shares
Preference Shares
Retained Earnings

Issue of shares

The capital of a company is divided into small units called shares. Share is the interest of the shareholder in the company, which is measured in terms of money. Share means a share in the share capital of a company and includes stock. The capital obtained by issue of shares is known as share capital.

Each share has its nominal value/ face value/ par value.

For example:- If a company issues 25,000 share of Rs.10 each, then Rs.10 is the nominal value of each share.

Types

Equity Shares;
Preference Shares.

Equity Shares:- Equity shares are the most important source of raising long-term capital by a company. Equity shares are those shares which do not carry any special or preferential rights in respect of payment of annual dividend and repayment of capital. The money raised by issue of equity shares is termed as ‘Equity Share Capital’.

Features

Risk bearer capital:- The equity shareholders are the primary risk bearers. They enjoy the reward as well as bear the risk of ownership.
Maturity:- Equity shares provide permanent capital to the company and cannot be reddemed during the life time of the company.
Return:- The return earned by equity shareholders is known as ‘dividend’, which varies with the earnings of the company.
Claim over residual income:- Equity shareholders are referred to as ‘residual owners’ as they get dividend, only after all other claims on the company’s income and assets have been settled.
Voting rights:- Equity shareholders have voting rights in proportion to the shares held b shareholders. They have a right to participate in the company’s management.
Limited Liability:- The liability of equity shareholders is limited to the extent of capital contributed by them in the company.

2. Preference Shares:- Preference shares are those shares, which enjoy certain priorities regarding the payment of dividend at a fixed rate and return of the investment (capital). The capital raised by issue of preference shares is called ‘preference share capital.’

Features

Fixed rage of dividend:- Preference shareholders receive dividend at a fixed rate before any dividend is paid to equity shareholders.
Repayment of capital:– Preference shareholders have preferential right as to the redemption of capital at the time of winding up of company.
No voting rights:- Preference shares are also issued without creating any voting rights.
No charge on assets:- Preference shares are also issued without creating any charge on the fixed assets of the company.
Hybrid Security:- Hybrid security is a single security is a single financial instrument which offers the features of two or more different types of financial securities. Preference shares are referred to as Hybrid Securities because they have features of both Equity shares and Debentures.

3. Retained Earnings:- The entire earnings of a company are not distributed as dividends among the shareholders. A reasonable part of it is retained as reserves or surplus. Retained Earnings refer to that part of profits which is kept as reserve for use in the future.

Important

It is also known as ‘Internal Financing’, ‘Self-Financing’ or ‘Ploughing back of profits’.
Retained earnings are shareholders funds and there is no external liability, i.e. company is under no pressure to pay back this amount.
Retained earnings cannot be used by a newly established company and it has to rely on external sources of finances.
The amount of retained earnings depends on many factors like net profits, dividend policy, age of the organization, etc.

Features

Dependable source:- Retained earnings are more dependable than external sources as they do not depend on investors’ preference and market conditions and are permanent funds.
Economical:- It is an economical method of financing as it does not involve any cost in the form of interest, dividend or floatation cost.
No dilution of control:- Retained earnings do not dilute the control as there is no increase in the number of sharesholders. As funds are generated internally, there is greater degree of operational freedom and flexibility.
Conversion into Share capital:- The surplus retained earnings can be converted into share capital through issue of bonus shares.
Medium and long-term finance:- Retained Earnings serves the purpose of medium and long-term finance for the business.
Ability to absorb shocks in business:- It enhances the capacity of the business t absorb unexpected and sudden business shocks arising due to economic depression and uncertainty of the capital market.
Enhances market value of shares: Retained earnings increase the financial strength, credibility and earning capacity of the business.
Stability of dividend:- A company with adequate surplus can pay a stable rate of dividend to the equity shareholders even during insufficient profits.

Sources of Borrowed funds

Debentures and Bonds:- Debentures/ bonds are an important instrument for raising long-term debt capital. According to Section 2(30) of the Companies Act, 2013, “Debenture includes debenture stock, bonds or any other instrument of company evidencing a debt, whether constituting a charge on the assets of the company or not”.

A debenture is a document or certificate, which is issued under the common seal of the company, acknowledging its debt to the holder at given terms and conditions. The amount of the loan, rate of interest and the security offered are clearly mentioned by the company on that document.

Features

Borrowed Fund:- Debentures constitute the borrowed funds of a company. Therefore, debenture holders are termed as creditors of the company.
Periodic interest payment:- Debenture holders are paid fixed rate of interest at specified intervals, say six months or one year.
Compulsory payment of interest:- payment of interest is a legal compulsion on the company. It has to be paid whether the profits are earned or not.
No voting rights:- Debenture holders do not have voting rights, i.e. they cannot participate in the management of the company.
Redemption of debentures:- Debentures have to be redeemed or paid back after the expiry of a fixed period or when the company is in the process of winding up.
Economical:- Raising finance through debentures is less costly as compared to preference or equity as interest payment on debentures is a tax deductible expense.
Security:- Generally, debentures are secured by charge on or mortgage of the assets of the company, which can be realized in the event of default of the company.

2. Loan from Financial Institutions:- The central and state governments have established various financial institutions in the country to provide finance to business organizations. The institutions are also known as ‘Development Banks’ as they aim at promoting industrial development of a country.

These institutions also conduct market surveys and provide technical assistance and managerial services to people who run the enterprises. This source is suitable to raise large funds for long-term requirements for expansion, reorganization and modernization of an enterprise.

Features

Medium and long-term fiancé:- Financial institutions provide medium and long-term finance.
Assistance in business:- Financial institutions also provide financial, managerial and technical advice and consultancy to business firm.
Source of goodwill:- Obtaining loan from financial institutions increases the goodwill of the borrowing company and it can raise funds easily from other sources as well.
Easy Repayment scheme:- Loan form financial institutions does not lead to high burden on the business as loan can be easily repaid in installment.
Finance even during depression:- funds can be raised from financial institutions even during periods of depression or recession, when other sources of finance are not available.

3. Loans from commercial Banks:- Commercial banks are an important source of raising funds for different purposes as well as for different time periods. Commercial bank is an institution which performs the functions of accepting deposits, granting loans and making investments, with the aim of earing profits. State Bank of India (SBI), Punjab National Bank (PNB), Canara Bank, etc.

Features

Commercial Banks extend loans to firms of all sizes and in many ways.
They provide finance in the form of cash credits, overdrafts, term loans, discounting of bills, etc. It is a cheaper source of finance as no expense is incurred on underwriting, issue of prospectus, etc.
Usually, commercial banks provide funds for short-term and medium-term. However, now banks have also started extending loans for longer periods.
Interest rate charged by banks depends on factors like period of finance, amount of loan, characteristics of firm, interest rate in the economy, etc.
The loan taken from the banks can be repaid either in lump sum or in installments.
Loan is generally provided on the security of assets of the firm.
The secrecy of business can be maintained as information supplied to the bank by the borrowers is kept confidential.
Bank loan can be easily raised and it does not require formalities like issue of prospectus or underwriting.

4. Public Deposits:- Public deposits are the deposits raised by organizations directly from the public. Under this method, companies inviting public deposits are required to advertise publicly along with its financial position. Public deposits can take care of both medium and short-term financial requirements of a business.

Important

Companies generally invite public deposits for a period of six months to three years.
Any person who is interested in depositing money can do so by filling up a prescribed form.
The company issues a deposit receipt which is an acknowledgement of debt taken by company.
Interest rates offered on public deposits are usually higher than that offered on bank deposits.
The acceptance of public deposits is regulated by the Reserve Bank of India.

Features

Simple Procedure:- It is a simple method of raising finance as it does not involve legal formalities and does not contain restrictive conditions like in case of other loan agreements.
Economical:- It is an economical source of finance as cost of obtaining deposits from public is generally lower than the cost of borrowings form banks and financial institutions.
No Security:- The public deposits are not secured by any charge on the assets of the company. The assets can be used as security for raising loans from other sources.
No loss of control:- The control of the company is not diluted as the depositors do not have voting rights.
Limited funds:- This source is suitable to raise limited funds. Public deposits of a company cannot exceed 25 per cent of its share capital and free reserves.

5. Trade Credit:- Trade credit is the credit extended by one trader to another for the purchase of goods and services. It facilitates the purchase of supplies without immediate payment. It is also known as ‘Mercantile credit’. Trade credit appears in the records of the buyer of goods as ‘sundry creditors’ or ‘accounts payable’.

Features

Short-term finance:- It is commonly used as a source of short-term financing for periods ranging from 15 days to 90 days.
Convenient source:- It is a convenient and continuous source of finance as it does not required any legal formalities.
Ready availability:- it is based on financial strength and goodwill of buyer and the custom of trade. It is readily to credit worthy firms.
No interest commitment:- No interest is payable on trade credit.
Promotes sales:- Trade credit helps to promote the sales of an organization.
No security:- there is no need for creating any sort of charge against firm’s assets for obtaining the trade credit.
Helps in raising inventory level:- Trade credit can be used to finance the increase in inventory of goods, if the organization expects higher sales in future.
Depends on many factors:- Terms of trade credit may vary form one industry to another and from one person to another. A firm any also offer different credit terms to different customers.

6. Inter-corporate deposits:- Inter-Corporate Deposit (ICD) is an unsecured borrowing by companies (corporates) from other corporate entities registered under the companies Act.

Features

Short-term source of finance:- ICD are generally considered by the borrowers to solve problems of short-term capital inadequacy. The corporate having surplus funds would lend to another corporate in need of funds. As per the RBI guidelines, the minimum period of ICDs is 7 days with can be extended to one year.
Interest:- Interest rates on ICDs may remain fixed or may be floating. Interest rates are higher than bank rates as ICDs is an unsecured borrowings. The range of interest varies, depending upon the quantum, tenure and credit rating of the borrower.
Free from bureaucratic and legal problems:- Inter-corporate deposits are free from bureaucratic and legal hassles.
Secrecy is maintained:- the brokers in this market never reveal the lists of lenders and borrowers as it is believed that in the absence of secrecy, rate of interest will fall abruptly.
Meeting working capital requirements:- Inter-corporate deposits are good source of finance to overcome the problem of shortage of working capital.

Types

Call Deposit:- Such a deposit can be withdrawn by the lender by giving a one day notice. The interest rate on call deposits is around 10% per annum.
Three month deposits:- These are the most popular type of ICD and are generally considered by the borrowers to solve problems of short-term capital inadequacy, such as payment of tax, excessive import of raw material, payment of dividend, etc. The rate of interest on three month deposits is 12% per annum.
Six month deposits:- these deposits are usually made with first class borrowers for a term of six months. The rate of interest for such deposits is 15% per annum.

Short Answer Questions

What is business finance? Why do businesses need funds? Explain.

Ans:

Business is concerned with the production and distribution of goods and services for satisfaction of needs of society. For carrying out various activities, business requires money. Finance therefore, is called the life blood of any business. The Requirements of funds by business to carry out its various activities is called business finance.

NEED OF FUND

The need for funds arises from the stage when an entrepreneur makes a decision to start a business. Some funds are needed immediately say for the purchase of plant and machinery, furniture, and other fixed assets, similarly, some funds are required for day – to – day operations, say to purchase raw materials, pay salaries to employees, etc. Also when the business expands, it needs funds. The financial needs of a business can be categorized as follows:

Fixed capital requirements:
Working capital requirements:

2.List sources of raising long-term and short-term finance.

Ans:

Financial needs of a business are of different types – long term, short term, fixed and fluctuating. Therefore, business firms resort to different types of sources for raising funds.

Short-term borrowings offer the benefit of reduced cost due to reduction of idle capital, but

Long-term borrowings are considered a necessity on many grounds. Similarly equity capital has a role to play in the scheme for raising funds in the corporate sector.

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3.What is the difference between internal and external sources of raising funds? Explain.

Ans:

aspect	Internal Sources	External Sources
Source	Within the organization	Outside the organization
Control	Retains full control	May dilute control (e.g., equity)
Cost	No interest/fees, low cost	May involve interest/fees
Availability	Limited	Broad, depending on creditworthiness or market conditions
Risk	Low financial risk	Higher risk (e.g., debt default)

4.What preferential rights are enjoyed by preference shareholders. Explain.

Ans:

The capital raised by issue of preference shares is called preference share capital. The preference shareholders enjoy a preferential position over equity shareholders in two ways:

Receiving a fixed rate of dividend, out of the net profits of the company, before any dividend, is declared for equity shareholders; and
Receiving their capital after the claims of the company’s creditors have been settled, at the time of liquidation. In other words, as compared to the equity shareholders, the preference shareholders have a preferential claim over dividend and repayment of capital. Preference shares resemble debentures as they bear fixed rate of return. Preference shareholders generally do not enjoy any voting rights. A company can issue different types of preference shares.

5.Name any three special financial institutions and state their objectives.

Ans

The government has established a number of financial institutions all over the country to provide finance to business organization.

1. Industrial Development Bank of India (IDBI)

Objective:

To provide financial assistance for industrial growth and development.
To promote entrepreneurship and small-scale industries.
To bridge the gap in long-term financing for industrial projects.

2. National Bank for Agriculture and Rural Development (NABARD)

Objective:

To promote rural development through financial assistance for agriculture and rural infrastructure.
To support credit and banking needs in rural areas.
To facilitate sustainable rural livelihoods and poverty alleviation.

3. Small Industries Development Bank of India (SIDBI)

Objective:

To support and promote micro, small, and medium enterprises (MSMEs).
To provide financial and developmental services for MSME growth.
To facilitate the development of entrepreneurship and employment opportunities.

6.What is the difference between GDR and ADR? Explain.

Ans:

Global Depository Receipts (GDR’s): The local currency shares of company are delivered to the depository bank. The depository bank issues depository receipts against these shares. Such depository receipts denominated in US dollars are known as Global Depository Receipts (GDR), GDR is a negotiable instrument and can be traded freely like any other security. In the Indian context, a GDR is an instrument issued abroad by an Indian company to raise funds in some foreign currency and is listed and traded on a foreign stock exchange.
American Depository Receipts (ADRs): The depository receipts issued by a company in the USA are known as American Depository Receipts. ADRs bought and sold in American markets, like regular stocks. It is similar to a GDR except that it can be issued only to American citizens and can be listed and traded on a stock exchange of USA.
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Long Answer Questions

Explain trade credit and bank credit as sources of short-term finance for business enterprises.

Ans:

Trade Credit

Trade credit is the credit extended by one trader to another for the purchase of goods and services. Trade credit facilitates the purchase of supplies without immediate payment.
Such credit appears in the records of the buyer of goods s ‘sundry creditors’ or ‘accounts payable
Trade credit is commonly used by Business organizations as a source of short-term financing. It is granted to those customers who have reasonable amount of financial standing and goodwill.

Bank Credit

Commercial banks occupy a vital position as they provide funds for different purposes as well as for different time periods. Banks extend loans to firms of all sizes and in many ways, like, cash credits, overdrafts, term loans, purchase/discounting of bills, and issue of letter of credit.
The rate of interest charged by banks depends on various factors such as the characteristics of the firm and the level of interest rates in the economy. The loan is repaid either in lump sum or in installments.
Bank credit is not a permanent source of funds. Though banks have started extending loans for longer periods, generally such loans are used for medium to short periods. The borrower is required to provide some security or create on the assets of the firm before a loan is sanctioned by a commercial bank.

2.Discuss the sources from which a large industrial enterprise can raise capital for financing modernization and expansion.

Ans-

Issue of Shares

The capital obtained by issue of shares is known as share capital. The capital of a company is divided into small units called shares. Each share has its nominal value. For example, a company can issue 1,00,000 shares of Rs.10 each for a total value of Rs.10,00,000. The person holding the share is known as shareholder. There are two types of shares normally issued by a company. These are equity shares and preference shares. The money raised by issue of equity shares is called equity share capital, while the money raised by issue of preference shares is called preference share capital.

2.Financial Institutions

The government has established a number of financial institutions all over the country to provide finance to business organization. These institutions are established by the central as well as state governments. They provide both owned capital and loan capital for long and medium term requirements and supplement the traditional financial agencies like commercial banks. As these institutions aim at promotion the industrial development of a country, these are also called ‘development banks’.

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3.Debentures

Debentures are an important instrument for raising long term debt capital. A company can raise funds through issue of debentures, which bear a fixed rate of interest. The debenture issued by a company is an acknowledgment that the company has borrowed a certain amount of money, which it promises to repay at a future date. Debenture holders are, therefore, termed as creditors of the company. Debenture holders are paid a fixed stated amount of interest at specified intervals say six months or one year.

4.Commercial Paper (CP)

Commercial Paper emerged as a source of short term finance in our country in the early nineties. Commercial paper is an unsecured promissory note issued by a firm to raise funds for a short period, varying from 90 days to 364 days. It is issued by one firm to other business firms, insurance companies, pension funds and banks. The amount raised by CP is generally very large. As the debt is totally unsecured, the firms having good credit rating can issue the CP. Its regulation comes under the purview of the Reserve Bank of India.

5.Lease Financing

A lease is a contractual agreement whereby one party i.e., the owner of an asset grants the other party the right to use the asset in return for a periodic payment. In other words it is a renting of an asset for some specified period. The owner of the assets is called the ‘lessor’ while the party that uses the assets is known as the ‘lessee’ (see Box A). The terms and conditions regulating the lease arrangements are given in the lease contract. At the end of the lease period, the asset goes back to the lessor.

6.Retained Earnings

A company generally does not distribute all its earnings amongst the shareholders as dividends. A portion of the net earnings may be retained in the business for use in the future. This is known as retained earnings. It is a source of internal financing or self-financing or ‘ploughing back of profits’. The profit available for ploughing back in an organization depends on many factors like net profits, dividend policy and age of the organization.

3.What advantages does issue of debentures provide over the issue of equity shares?

Ans:

Issuing debentures instead of equity shares offers several advantages to a company, particularly in terms of financial and ownership considerations. Here’s a breakdown:

1. Ownership Control

Debentures: Do not dilute ownership. Debenture holders are creditors, not owners, so issuing debentures allows existing shareholders to retain control over the company.

Equity Shares: Dilute ownership. Issuing more equity shares means existing shareholders’ ownership stake is reduced.

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2. Fixed Cost of Capital

Debentures: Carry a fixed interest rate, which can be planned and budgeted. The interest is paid irrespective of profits.

Equity Shares: Dividends are not fixed and can fluctuate, potentially costing the company more if profits rise.

3. Tax Benefits

Debentures: Interest paid on debentures is tax-deductible, reducing the company’s taxable income.

Equity Shares: Dividends are paid from post-tax profits, offering no tax advantage to the company.

4. Lower Cost of Raising Capital

Debentures: Generally less expensive to issue compared to equity because the cost of interest is often lower than the return expected by equity shareholders.

Equity Shares: Involve higher costs due to underwriting fees, promotional expenses, and shareholder expectations for higher returns.

5. Flexibility in Financing

Debentures: Have a fixed maturity date, allowing the company to repay the debt and reduce obligations when it chooses.

Equity Shares: Are permanent capital, and the company cannot “repay” the equity to shareholders.

6. No Sharing of Profits

Debentures: Only require fixed interest payments, meaning additional profits remain with the company.

Equity Shares: Shareholders expect a proportion of profits through dividends, especially in highly profitable years.

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7. Market Perception

Debentures: Are seen as a sign of confidence in the company’s ability to generate consistent income to service its debt.

Equity Shares: Excessive equity dilution may signal a lack of confidence in the company’s financial stability.

8. Capital Structure Optimization

Debentures: Help maintain an optimal capital structure by adding debt, which can improve the company’s weighted average cost of capital (WACC) when used judiciously.

Equity Shares: Over-reliance on equity can increase the WACC, making financing less efficient.

4.State the merits and demerits of public deposits and retained earnings as methods of business finance.

Ans:

Public Deposits

The deposits that are raised by organisations directly from the public are known as public deposits. Rates of interest offered on public deposits are usually higher than that offered on bank deposits. Any person who is interested in depositing money in an organization can do so by filling up a prescribed form. The organization in return issues a deposit receipt as acknowledgment of the debt. Public deposits can take care of both medium and short-term financial requirements of a business. The deposits are beneficial to both the depositor as well as to the organization.

Merits

The merits of public deposits are:

The procedure of obtaining deposits is simple and does not contain restrictive conditions as are generally there in a loan agreement;
Cost of public deposits is generally lower than the cost of borrowings from banks and financial institutions;
Public deposits do not usually create any charge on the assets of the company. The assets can be used as security for raising loans from other sources;
As the depositors do not have voting rights, the control of the company is not diluted.

Limitations

The major limitation of public deposits are as follows:

New companies generally find it difficult to raise funds through public deposits;
It is an unreliable source of finance as the public may not respond when the company needs money;
Collection of public deposits may prove difficult, particularly when the size of deposits required is large.

Retained Earnings

Merits

The merits of retained earning as a source of finance are as follows:

Retained earnings is a permanent source of funds available to an organization .
It does not involve any explicit cost in the form of interest, dividend or floatation cost;
As the funds are generated internally, there is a greater degree of operational freedom and flexibility;
It enhances the capacity of the business to absorb unexpected losses;
It may lead to increase in the market price of the equity shares of a company.

Limitations

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Retained earning as a source of funds has the following limitations;

Excessive ploughing back may cause dissatisfaction amongst the shareholders as they would get lower dividends;
It is an uncertain source of funds as the profits of business are fluctuating;
The opportunity cost associated with these founds is not recognized by many firms. This may lead to sub-optimal use of the funds.

5.Discuss the financial instruments used in international financing.

Ans-

The financial instruments used in international financing are as follows:

i. Global Depository Receipts (GDR.s): The local currency shares of a company are delivered to the depository bank. The depository bank issues depository receipts against these shares. Such depository receipts denominated in US dollars are known as Global Depository Receipts(GDR).

ii. American Depository Receipts (ADRs): The depository receipts issued by a company in the USA are known as American Depository Receipts. ADRs are bought and sold in American markets, like regular stocks.

iii. Indian Depository Receipt (IDRs): An Indian Depository Receipt is a financial instrument denominated in Indian Rupees in the form of a Depository Receipt. It is created by an Indian Depository to enable a foreign company to raise funds from the Indian securities market. The IDR is a specific Indian version of the similar global depository receipts.

iv. Foreign Currency Convertible Bonds (FCCBs): Foreign currency convertible bonds are equity-linked debt securities that are to be converted into equity or depository receipts after a specific period. The FCCB.s are issued in a foreign currency and carry a fixed interest rate which is lower than the rate of any other similar non-convertible debtinstrument.

6.What is a commercial paper? What are its advantages and limitations.

Ans:

Commercial Paper (CP)

Merits

A commercial paper is sold on an unsecured basis and does not contain any restrictive conditions;
As it is a freely transferable instrument, it has high liquidity;
It provides more funds compared to other sources. Generally, the cost of CP to the issuing firm is lower than the cost of commercial bank loans;
A commercial paper provides a continuous source of funds. This is because their maturity can be tailored to suit the requirements of the issuing firm. Further, maturing commercial paper can be repaid by selling new commercial paper’
Companies can park their excess funds in commercial paper thereby earning some good return on the same.

Limitations

Only financially sound and highly rated firms can raise money through commercial papers. New and moderately rated firms are not in a position to raise funds by this method;
The size of money that can be raised through commercial paper is limited to the excess liquidity available with the suppliers of funds at a particular time;
Commercial paper is an impersonal method of financing. As such if a firm is not in a position to redeem its paper due to financial difficulties, extending the maturity of a CP is not possible.

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