View
217
Download
0
Category
Preview:
Citation preview
7/29/2019 Functions of a Credit Rating Agency
1/22
Functions of a Credit Rating Agency
A credit rating agency serves following functions:
1. Provides unbiased opinion:An independent credit ratingagency is likely to provide an unbiased opinion as to relative
capability of the company to service debt obligations
because of the following reasons:
i. It has no vested interest in an issue unlike brokers,
financial intermediaries.ii. Its own reputation is at stake.
2. Provides quality and dependable information:. A credit
rating agency is in a position to provide quality information
on credit risk which is more authenticate and reliable
because:
i. It has highly trained and professional staff who has
better ability to assess risk.
ii. It has access to a lot of information which may not be
publicly available.
3. Provides information at low cost: Most of the investors
rely on the ratings assigned by the ratings agencies while
taking investment decisions. These ratings are published in
the form of reports and are available easily on the payment
7/29/2019 Functions of a Credit Rating Agency
2/22
of negligible price. It is not possible for the investors to
assess the creditworthiness of the companies on their own.
4. Provide easy to understand information: Rating agencies
first of all gather information, then analyse the same. At last
these interpret and summarise complex information in a
simple and readily understood formal manner. Thus in
other words, information supplied by rating agencies can be
easily understood by the investors. They need not go into
details of the financial statements.
5. Provide basis for investment: An investment rated by a
credit rating enjoys higher confidence from investors.
Investors can make an estimate of the risk and return
associated with a particular rated issue while investing
money in them.
6. Healthy discipline on corporate borrowers: Higher credit
rating to any credit investment enhances corporate image
and builds up goodwill and hence it induces a healthy/
discipline on corporate.
7. Formation of public policy: Once the debt securities are
rated professionally, it would be easier to formulate public
policy guidelines as to the eligibility of securities to be
7/29/2019 Functions of a Credit Rating Agency
3/22
included in different kinds of institutional port-folio.
Functions ofCRISIL
CRISIL is acronym for Credit Rating Information Services of India
Limited. CRISIL is India's leading Ratings, Financial News, Risk
and Policy Advisory company. Since 1987 when CRISIL was
incorporated, CRISIL has played an integral role in India's
development milestones.
CRISIL's majority shareholder is Standard & Poor's, the world's
7/29/2019 Functions of a Credit Rating Agency
4/22
foremost provider of independent credit ratings, indices, risk
evaluation, investment research and data. CRISIL's association
with Standard & Poor's, a division of The McGraw-Hill
Companies, dates back to 1996 when both companies started
working together on rating methodologies and joint projects.
CRISIL Ratings is the only ratings agency in India to operate on
the basis of sectoral specialisation. CRISIL Ratings plays a
leading role in the development of the debt markets in India.
CRISIL has also spearheaded the formation of the CariCRIS, the
world's first regional credit rating agency.
The main functions of CRISIL can be classified into following
subheads:
1. Ratings
CRISIL Ratings: It is the only ratings agency in India with
sectoral specialization It has played a critical role in the
7/29/2019 Functions of a Credit Rating Agency
5/22
development of the debt markets in India. The agency has
developed new ratings methodologies for debt instruments and
innovative structures across sectors. CRISIL Ratings provides
technical know-how to clients all over the world and has helped
set up ratings agencies in Malaysia (RAM), Israel (MAALOT) and
in the Caribbean.
2. Research
CRISIL Research: It provides research, analysis and forecasts on
the Indian economy, industries and companies to over 500
Indian and international clients across financial, corporate,
consulting and public sectors.
CRISIL FundServices: It provides fund evaluation services and
risk solutions to the mutual fund industry.
The Centre for Economic Research: It applies economic
principles to live business applications and provide benchmarks
7/29/2019 Functions of a Credit Rating Agency
6/22
and analyses for India's policy and business decision makers.
Investment Research Outsourcing: CRISIL added equity
research to its wide bouquet of services, by acquiring Irevna, a
leading global equity research and analytics company. Irevna
offers investment research services to the world's leading
investment banks and financial institutions.
3. Advisory
CRISIL Infrastructure Advisory: It provides policy, regulatory
and transaction level advice to governments and leading
organisations across sectors.
Investment and Risk Management Services: CRISIL Risk
Solutions offers integrated risk management solutions and
advice to Banks and Corporates by leveraging the experience
and skills of CRISIL in the areas of credit and market risk.
7/29/2019 Functions of a Credit Rating Agency
7/22
ICRA:
ICRA was established in the year 1991 by the collaboration of
financial institutions, investment companies, and banks. The
company has formed the ICRA group together with its
subsidiaries. The company is headed by Mr. Piyush G. Mankad
and offers products like short-term debt schemes, Issue-specific
long-term rating and offers fund based as well as non-fund
based facilities to its clients.
7/29/2019 Functions of a Credit Rating Agency
8/22
The most important criticism levied against public sector
undertakings has been that in relation to thecapital employed,
the level of profits has been too low. Even the government has
criticized the publicsector undertakings on this count. Of thevarious factors responsible for low profits in the public
sector Undertakings, the following are particularly important:-
7/29/2019 Functions of a Credit Rating Agency
9/22
Price policy of public sector undertakings
Under utilization of capacity
Problem related to planning and construction of projects
Problems of labor, personnel and management
Lack of autonomy
REASONS FOR DISINVESTMENT
The public sector in India at present is at cross roads. The new
economic policy initiated in July 1991, clearly indicated that
the public sector undertakings have shown a very negative rate
of return oncapital employed. On account of this phenomenon
many public sector undertakings have become burden to the
government. They are in fact turning out to be liabilities to the
government rather than being assets.This is a sector which the
government clearly wants to get rid off. In this direction the
government hasadopted a new approach to reform and improve
the public sector undertakings performance i.e.Disinvestment
policy'. This has gained lot of importance especially in latter part
7/29/2019 Functions of a Credit Rating Agency
10/22
of 90s. At present thegovernment seriously perceives the
disinvestment policy as inactive tool to reduce the burden to
financingthe public sectorOBJECTIVE OF THE DISINVESTMENT:
Privatization intended to achieve the following:
Releasing large amount of public resources
Reducing the public debt
Transfer of Commercial Risk
Releasing other tangible and intangible resources
Expose the privatized companies to market discipline
Wider distribution of wealth
Definition of 'Loan Syndication'
7/29/2019 Functions of a Credit Rating Agency
11/22
The process of involving several different lenders in providing
various portions of a loan. Loan syndication most often occurs
in situations where a borrower requires a large sum of capitalthat may either be too much for a single lender to provide, or
may be outside the scope of a lender's risk exposure levels.
Thus, multiple lenders will work together to provide the
borrower with the capital needed, at an appropriate rate agreed
upon by all the lenders.
The Process
The process of bond valuation takes into consideration the cash
flow, or interest payments, connected with the bond issue.
Typically, the cash flow is realized from the interest paymentsthat are made on the bond at regularly scheduled intervals. This
in turn is related to the par value of the bond, or the face value
that the bond holds at the time it reaches maturity. By
approaching the overall worth of the investment from both these
angles, it is easier for an investor to evaluate the issue anddecide if it is worth his or her time, or if another investment
option should be selected.
http://www.wisegeek.com/what-is-cash-flow.htmhttp://www.wisegeek.com/what-is-cash-flow.htmhttp://www.wisegeek.com/what-is-cash-flow.htmhttp://www.wisegeek.com/what-is-cash-flow.htmhttp://www.wisegeek.com/what-is-cash-flow.htm7/29/2019 Functions of a Credit Rating Agency
12/22
There are multiple, in-depth calculations that may be used to
figure bond valuation. Under the relative pricing approach, the
face value of a bond is often determined by comparing the bondto a standard bond, usually one issued by the government; the
credit rating of a bond with comparable maturity dates and cash
flow can be used to determine a bond's fair market value.
Arbitrage-free pricing involves subtracting each cash flow
payment separately; the amount is determined by the rate of azero-coupon bond on the same date the interest payment is
made. Another option, the stochastic calculus approach,
recognizes the possibility of fluctuating interest rates and uses a
partial differential math equation to determine a bond's fair
market value. The equations for each of these processes can be
found online, or calculated on the Internet by use of a free
financial calculator; a financial advisor is often very helpful
when trying to determine the most accurate value of a bond.
Raising Foreign Currency Finance:
The major sources available to an Indian firm for raising foreign
currency finance are:
http://www.wisegeek.com/what-is-a-coupon-bond.htmhttp://www.wisegeek.com/what-is-a-coupon-bond.htmhttp://www.wisegeek.com/what-is-a-coupon-bond.htmhttp://www.wisegeek.com/what-is-a-coupon-bond.htm7/29/2019 Functions of a Credit Rating Agency
13/22
(1) Foreign currency term loans from financial institutions
(2) Export credit schemes
(3) External commercial borrowing(4) Euro issues
(5) issues in foreign domestic markets
Foreign Currency Term loans Financial Institutions:
Financial institutions provide foreign currency term loans formeeting the foreign currency expenditures towards import of
plant, machinery, and equipment and also towards payment of
foreign technical know how fees. The periodical liability for
interest and principal remains in the currency/currencies of the
loans and is translated into rupees at the then prevailing rate ofexchange for making payments to the financial institution.
Export Credit Schemes:
Export credit agencies have been established by the
governments of major industrialized countries for financingexports of capital goods and related technical services. These
agencies follow certain consensus guidelines for supporting
exports under a convention known as the Berne Union. As per
7/29/2019 Functions of a Credit Rating Agency
14/22
these guidelines, the interest ate applicable for export credits to
Indian companies for various maturities are regulated. Two
kinds of export credit are provided: buyers credit and supplierscredit.
Buyers credit: Under this arrangement, credit is provided
directly to the Indian buyer for purchase of capital goods and/or
technical services from the overseas exporter. The buyers credit
facility operates as follows:
(1) The overseas exporter and the Indian buyer negotiate a
contract.
(2) An application of the buyers credit facility is made to the
export agency of the exporters country along with relevantdetails like the types of goods/services to be exported
approximate value of the contract, terms of payments schedule
of protected shipment of goods or provision of services,
percentage of financing required etc.
(3) The buyers credit facility is approved by the export creditagency of the exporters country.
(4) A loan agreement delineating the terms and conditions of the
buyers credit is negotiated between the overseas exporters
7/29/2019 Functions of a Credit Rating Agency
15/22
bank, the Indian borrowers, and where applicable, the Indian
guarantor.
Suppliers Credit: This is a credit provided to the overseas
exporters so that they can make available medium-term finance
to Indian importers. The suppliers credit facility operates as
follows:
(1) The overseas exporter notifies his bank and the export credit
agency of a potential export order of an Indian buyer who
requires medium-term finance.
(2) The export credit agency communicates to the bank its
willingness to provide the facility.
(3) The terms of the facility are incorporated in the contract
between the overseas exporter and the Indian buyer.
more at http://www.citeman.com/4041-basic-foreign-
currency-financial.html#ixzz2Dc60yNIS
http://www.citeman.com/4041-basic-foreign-currency-financial.html#ixzz2Dc60yNIShttp://www.citeman.com/4041-basic-foreign-currency-financial.html#ixzz2Dc60yNIShttp://www.citeman.com/4041-basic-foreign-currency-financial.html#ixzz2Dc60yNIShttp://www.citeman.com/4041-basic-foreign-currency-financial.html#ixzz2Dc60yNIShttp://www.citeman.com/4041-basic-foreign-currency-financial.html#ixzz2Dc60yNIS7/29/2019 Functions of a Credit Rating Agency
16/22
Below mentioned are disadvantages/ demerits of Derivatives:
1. Raises Volatility: As a large no. of market participants can
take part in derivatives with a small initial capital due to
leveraging derivatives provide, it leads to speculation and raises
volatility in the markets.
2. Higher no. of Bankruptcies: Due to leveraged nature of
derivatives, participants assume positions which do not matchtheir financial capabilities and eventually lead to bankruptcies.
3. Increased need of regulation: Large no. of participants take
positions in derivatives and take speculative positions. It is
necessary to stop these activities and prevent people from
getting bankrupt and to stop the chain of defaults.
the major types of financial derivatives:
1. Forwards: A forward contract is a contract between two
parties obligating each to exchange a particular good or
instruments at a set price on a future date. It is an over the
counter agreement and has standardized market features.
2. Futures: Futures are standardized contracts between the
7/29/2019 Functions of a Credit Rating Agency
17/22
buyers and sellers, which fix the terms of the exchange that will
take place between them at some fixed future date. A futures
contract is a legally binding agreement. Futures are special typesof forward contracts which are exchange traded, that is traded on
an organized exchange. The major types of futures are stock
index futures, interest rate futures, and currency futures.
3. Options: Options are contracts between the option writers ad
buyers which obligate the former and entitles (withoutobligation) the latter to sell/buy stated assets as per the
provisions of contracts. The major types of options are stock
options, bond options, currency options, stock index options,
futures options, and options on swaps. Options are of two types:
calls and Puts. A call option gives a buyer/holder a right but not
an obligation to buy the underlying on or before specified time
at a specified price (usually called strike/exercise price) and
quantity. A put option gives a holder of that option a right but
not an obligation to sell the underlying on or before specified
time at a specified price and quantity.
4. Warrants: Warrants are long term options with three to seven
years of expiration. In contrast, stock options have a maximum
life of nine months. Warrants are issued by companies as a
7/29/2019 Functions of a Credit Rating Agency
18/22
means of raising finance with no initial servicing costs, such as
divided or interest. They are like a call option on the stock of the
issuing firm. A warrant is a security with a market price of itsown that can be converted into a specific share which leads at a
predetermined price and date. If warrants are exercised, the
issuing firm has to create a new share which leads to a dilution
of ownership. Warrants are sweeteners attached to bonds to
make these bonds more attractive to the investor. Most of thewarrants are detachable and can be traded in their own right or
separately. Warrants are also available on stock indices and
currencies.
5. Swaps: Swaps are generally customized arrangements
between counterparties to exchange one set of financial
obligations for another as per the terms of agreement. The major
types of swaps are currency swaps, and interest rate swaps, bond
swaps, coupon swaps, debt equity swaps.
6. Swaptions: Swaptions are options on swaps. It is an option
that entitles the holder the right to enter into having calls and
puts, swaptions have receiver swaption (an option to receive
fixed and pay floating) and a payer swaption (an option to pay
fixed and receive floating).
7/29/2019 Functions of a Credit Rating Agency
19/22
more at http://www.citeman.com/5293-need-and-types-of-
financial-derivatives.html#ixzz2Dc7TIZ2t
Problems associated with Disinvestment
A number of problems and issues have bedevilled the
disinvestment process. The number of bidders for equity has
been small not only in the case of financially weak PSUs, but
also in that of better-performing PSUs. Besides, the
government has often compelled financial institutions, UTI and
other mutual funds to purchase the equity which was being
unloaded through disinvestment. These organizations have not
been very enthusiastic in listing and trading of shares
purchased by them as it would reduce their control over PSUs.
Instances of insider trading of shares by them have also come
http://www.citeman.com/5293-need-and-types-of-financial-derivatives.html#ixzz2Dc7TIZ2thttp://www.citeman.com/5293-need-and-types-of-financial-derivatives.html#ixzz2Dc7TIZ2thttp://www.citeman.com/5293-need-and-types-of-financial-derivatives.html#ixzz2Dc7TIZ2thttp://www.citeman.com/5293-need-and-types-of-financial-derivatives.html#ixzz2Dc7TIZ2thttp://www.citeman.com/5293-need-and-types-of-financial-derivatives.html#ixzz2Dc7TIZ2t7/29/2019 Functions of a Credit Rating Agency
20/22
to light. All this has led to low valuation or under pricing of
equity.
Further, in many cases, disinvestment has not really
changed the ownership of PSUs, as the government has
retained a majority stake in them. There has been some
apprehension that disinvestment of PSUs might result in the
crowding out of private corporates (through lowered
subscription to their shares) from the primary capital market...
An important fact that needs to be remembered in the context
of divestment is that the equity in PSUs essentially belongs to
the people. Thus, several independent commentators have
maintained that in the absence of wider national consensus, a
mere government decision to disinvest is not enough to carry
out the sale of peoples assets. Inadequate information about
PSUs has impeded free, competitive and efficient bidding of
shares, and a free trading of those shares. Also, since the PSUs
do not benefit monetarily from disinvestment, they have been
reluctant to prepare and distribute prospectuses. This has in
7/29/2019 Functions of a Credit Rating Agency
21/22
turn prevented the disinvestment process from being
completely open and transparent.
It is not clear if the rationale for divestment process is well-
founded. The assumption of higher efficiency, better / ethical
management practices and better monitoring by the private
shareholders in the case of the private sector all of which
supposedly underlie the disinvestment rationale is not
always borne out by business trends and facts.
Total disinvestment of PSUs would naturally concentrate
economic and political power in the hands of the private
corporate sector. The US economist Kenneth Galbraith had
visualized a role ofcountervailing power for the PSUs.While the creation of PSUs originally had economic, social
welfare and political objectives, their current restructuring
through disinvestment is being undertaken primarily out of
need of government finances and economic efficiency.
Lastly, to the extent that the sale of government equity in
PSUs is to the Indian private sector, there is no decline in
national wealth. But the sale of such equity to foreign
7/29/2019 Functions of a Credit Rating Agency
22/22
companies has far more serious implications relating to
national wealth, control and power, particularly if the equity is
sold below thecorrect price!
If the disinvestment policy is to be in wider public interests,
it is necessary to examine systematically, issues such as - the
correct valuation of shares, the crowding out
possibility, the appropriate use of disinvestment proceeds and
the institutional and other prerequisites.
Recommended