Unit 3: Credit rating & mutual funds
Management of Financial Services notes · PTU syllabus (BCOP 612-18)
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Unit summary
Investors need to judge credit risk, and savers need professionally managed funds. This unit covers the concept, types, advantages and disadvantages of credit rating, credit rating agencies and their methodology, the growth of mutual funds in India, mutual fund schemes, and the concept and mechanism of factoring and securitisation of debt.
After this unit you can
- Explain credit rating, its types, benefits and limitations
- Describe Indian credit rating agencies and rating methodology
- Explain the growth and schemes of mutual funds in India
- Explain factoring and securitisation of debt
PTU syllabus topics
- Concept
- types
- advantages and disadvantages of credit rating
- credit rating agencies and their methodology
- growth of mutual funds in India
- mutual fund schemes
- concept and mechanism of factoring and securitisation of debt
- 1Sell on credit
Firm raises an invoice
- 2Assign invoice
Firm sells it to a factor
- 3Advance
Factor pays most of it at once
- 4Collect
Factor collects from the customer
- 5Settle
Balance paid, less fees
Topic 1
Credit rating: concept, types, advantages and disadvantages
Credit rating is an opinion of a rating agency about the relative ability and willingness of an issuer to meet its debt obligations in full and on time, expressed through symbols.
Long-term debt
Bonds, debentures (AAA to D)
Short-term instruments
Commercial paper, CDs (A1+ to D)
Bank loan ratings
Under Basel norms
Structured finance
Securitised instruments
Sovereign ratings
Countries (by S&P, Moody's, Fitch)
Others
IPO grading (earlier), MSME ratings, ESG ratings, mutual fund scheme ratings
| Long-term symbol | Meaning |
|---|---|
| AAA | Highest safety |
| AA | High safety |
| A | Adequate safety |
| BBB | Moderate safety (lowest investment grade) |
| BB, B | Moderate to high risk (speculative) |
| C | Very high risk |
| D | Default |
- Advantages: helps investors judge risk; lowers borrowing cost for good issuers; wider investor base; regulators and banks use ratings (capital adequacy).
- Limitations: ratings are opinions, not guarantees; conflict of interest (issuer pays); rating lag (IL&FS 2018 was AAA until shortly before default); rating shopping.
Topic 2
Credit rating agencies and methodology
- SEBI (Credit Rating Agencies) Regulations, 1999 govern CRAs; registered CRAs include CRISIL (1987), ICRA (1991), CARE (1993), India Ratings & Research (Fitch), Acuité, Brickwork (registration cancelled 2022), Infomerics.
- 1
Request and agreement with the issuer
- 2
Assignment of analytical team
- 3
Information gathering
Financials, management meetings, site visits
- 4
Analysis
Business risk, financial risk, management, industry
- 5
Rating committee decision
- 6
Communication to issuer and publication
- 7
Surveillance
Continuous monitoring; upgrade/downgrade/watch
- Methodology factors: business risk (industry, market position, operations), financial risk (leverage, interest cover, cash flows, liquidity), management risk (track record, governance), project risk, support from parent/government.
Topic 3
Growth of mutual funds in India
- 1Phase I (1964–1987)
UTI monopoly — Unit Scheme 1964
- 2Phase II (1987–1993)
Public sector funds by banks and LIC/GIC
- 3Phase III (1993–2003)
Private sector entry; SEBI (MF) Regulations 1993, revised 1996
- 4Phase IV (2003–2014)
UTI bifurcated; consolidation; global crisis
- 5Phase V (2014 onwards)
SIP boom — "Mutual Funds Sahi Hai" campaign; AUM crosses ₹70 lakh crore (2025)
- Structure: sponsor → trust (trustees) → AMC (manages funds) → custodian, registrar and transfer agent; regulated by SEBI; AMFI is the industry body.
Topic 4
Mutual fund schemes
Equity
Large cap, mid cap, small cap, multi cap, flexi cap, ELSS, sectoral/thematic, dividend yield, value/contra, focused
Debt
Overnight, liquid, ultra-short, money market, short/medium/long duration, corporate bond, banking and PSU, gilt, credit risk, dynamic bond
Hybrid
Conservative, balanced advantage, aggressive, multi-asset, arbitrage, equity savings
Solution-oriented
Retirement, children's funds
Others
Index funds, ETFs, fund of funds
- By structure: open-ended, close-ended, interval schemes.
- Investment options: growth vs IDCW (income distribution cum capital withdrawal); direct vs regular plans; SIP, STP, SWP.
- Key terms: NAV, expense ratio (TER limits), exit load, riskometer, benchmark.
Topic 5
Factoring and securitisation of debt
Factoring
Factoring is a financial service in which a business sells its receivables to a factor at a discount for immediate cash; the factor also manages the sales ledger and collections.
- 1Seller supplies goods on credit to buyer
- 2Seller assigns invoice to factor
- 3Factor pays 75–90% advance
- 4Factor collects from buyer on due date
- 5Factor pays balance less charges to seller
- Types: recourse (seller bears bad-debt risk) and non-recourse; disclosed and undisclosed; domestic and export factoring; forfaiting (export receivables, non-recourse, medium term).
- Legal framework: Factoring Regulation Act, 2011 (amended 2021); TReDS platforms (RXIL, M1xchange, Invoicemart) for MSME invoices.
Securitisation of debt
- Pooling illiquid loans (home, auto, microfinance) and selling them to an SPV that issues pass-through certificates (PTCs) to investors.
- Benefits: liquidity for lenders, risk transfer, capital relief, new investment instruments.
- Legal framework: SARFAESI Act, 2002; RBI Master Direction on securitisation (2021) — minimum holding period and minimum retention requirement.
Assets
Short-term trade receivables
Long-term loans and receivables
Buyer
Factor (bank/NBFC)
SPV funded by investors
Instrument issued
None
Pass-through certificates
Users
Businesses, MSMEs
Banks, NBFCs, HFCs
Key terms
- Credit rating
- Opinion on an issuer's ability to repay debt on time
- Investment grade
- Ratings of BBB and above
- AMC
- Asset management company that manages mutual fund schemes
- Factoring
- Sale of receivables to a factor for immediate cash
- Pass-through certificate
- Security issued by an SPV backed by a pool of loans
Quick revision
- Rating symbols: AAA to D; short-term A1+ to D.
- CRAs: CRISIL, ICRA, CARE, India Ratings; SEBI regulations 1999.
- MF growth: UTI era → private entry → SIP boom; structure sponsor–trust–AMC.
- Schemes: equity, debt, hybrid, solution-oriented, index/ETF.
- Factoring (receivables, TReDS) vs securitisation (SPV, PTCs).
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.What is credit rating?
- Q2.Name four credit rating agencies in India.
- Q3.What is investment grade rating?
- Q4.What is an AMC?
- Q5.Distinguish recourse and non-recourse factoring.
- Q6.What is securitisation?
Long-answer questions
- Q1.Explain credit rating, its types, advantages and limitations.
- Q2.Explain the credit rating process and methodology.
- Q3.Trace the growth of mutual funds in India and explain types of schemes.
- Q4.Explain the concept and mechanism of factoring and securitisation of debt.
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