A Course Material on
BA 7022- MERCHANT BANKING AND FINANCIAL SERVICES
By
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DEPARTMENT OF MANAGEMENT STUDIES
Mr.P.TAMILSELVAN
ASSISTANT PROFESSOR
DEPARTMENT OF MANAGEMENT SCIENCE
SASURIE COLLEGE OF ENGINEERING
VIJAYAMANGALAM – 638 056
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DEPARTMENT OF MANAGEMENT STUDIES
QUALITY CERTIFICATE
This is to certify that the e-course material
Subject Code : BA7022
Subject
: MERCHANT BANKING AND FINANCIAL SERVICES
Class
: II MBA
Being prepared by me and it meets the knowledge requirement of the university curriculum.
Signature of the Author
Name
: P.TAMILSELVAN
Designation: Assistant Professor
This is to certify that the course material being prepared by Mr. P. TAMILSELVAN is of adequate
quality. He has referred more than five books amount them minimum one is from abroad
author.
Signature of HD
Name
:
S.ARUNKUMAR
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DEPARTMENT OF MANAGEMENT STUDIES
SEAL
CONTENTS
CHAPTER
TOPICS
PAGE
NO
MERCHANT BANKING
1.1
An Overview of Indian Financial System
financial system
1.1.2. Objectives
1.1.3 Components of Financial System
1.1.4 Limitations of the financial system in India
1.1.5 Functions of merchant Banking
1.2 Merchant Banking In India
1.2.1 Recent Developments in Merchant Banking and Challenges
Ahead
1.3 Merchant Banking And Legal Regulatory Frame Work
1.3.1 Companies Act
1.3.2 Provisions under Companies Act
1.3.3 SCRA (Security contract regulation Act)
10- 57
I
1.4 Recognized Stock Exchanges
1.5 Security Exchange Board Of India (SEBI)
1.5.1 General Obligations
1.5.2 Appeal to the Securities Appellate Tribunal
1.5.3 SEBI Regulations on merchant bankers
1.5.4 Code Of Conduct For Merchant Bankers
1.6 SEBI Guidelines
1.6.1 Operational Guidelines
1.7 Stock Exchanges
1.7.1Objectives of Stock Exchanges
1.7.2 Functions of Stock Exchanges
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1.8. Organization of Stock Exchanges
1.8.1 Traditional Structure of stock Exchanges
1.8.2 Demutualization of Stock Exchanges
1.8.3 Corporatization of Stock Exchanges
1.9 ONLINE TRADING
1.9.1 BSE Bolt System, Bolt
1.10 OTCEI (Over the Counter Exchange of India)
1.10.1 Features Of OTCEI
1.10.2 Objectives of OTCEI
1.10.3 Benefits to Financial System
II. ISSUE MANAGEMENT INTRODUCTION
2.1 Introduction
2.2 Merchant Bankers And Capital Issues Management
2.2.1 Merchants Of Public Issue Management
2.2.2 Merchant Bankers Functions
2.3 Pricing Of The Issue (Preferential Issue Of Shares)
2.3.1 Global Debt Instruments
2.3 PREPARATION OF PROSPECTUS
2.3.1 Prospectus For Public Offer
2.3.2 General Obligations And Responsibilities Code Of Conduct For
Register To An Issue And Share Transfer Agents
2.4 Underwriters
2.4.1 General Obligations And Responsibilities Code Of Conduct For
Underwriters
II
58- 115
2.5 Bankers to an Issue
2.5.1Code of Conduct for Bankers To Issue
2.6 Brokers To The Issue
2.6.1Merchant Banking And Marketing of New Issues
2.7 Offer for Sale Method
2.8 Private Placement Method
2.9 Initial Public Offer (IPO) Method
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2.10 Rights Issue Method
2.11 Bonus Issues Method
2.11.1SEBI Guidelines
2. 12 Book Building Method
2.12.1Advantages of Book Building
2.13 Stock Option Of Employees Stock Option Scheme (ESOP)
2.13.1Stock Option Norms for Software Companies
2. 14 Bought Out Deals
2.14.1 Bought Out Deals vs. Private Placements Benefits
2.15 Advertising Strategies
2.16 Foreign Institutional Investors (FIIS)
2.16.1 FII and SEBI Regulations, 1995
2.17 Investment Potential Of NRIS
III. OTHER FEE BASED MANAGEMENT INTRODUCTION
3.1 Mergers
3.1.1steps in M & A
3.1.2 Take Over
3.13 Distinction between Mergers vs. Takeovers
III
116-137
3.14 Major Issues of M&A in India
3.2 Portfolio And Management Services
3.2.1 Functions of Portfolio and Management
3.3 Credit Syndication
3.3.1 Credit Syndication Services
3.4 Credit Rating
3.4.1 Credit Rating Of Individuals, Companies And Countries
3.4.2 Basis of Credit Rating
3.4.3 Credit Rating Companies in India
3.4.4 Types of Credit Rating
3.5 Mutual Fund
3.5.1 Mutual Funds Set Up In India
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3.5.2 Types of Mutual Funds
3.5.3 History of Mutual Funds In India
3.6 Business Valuation
3.6.1 Net Assets Value
3.6.2 Capital Stock and Distribution
FUND BASED FINANCIAL SERVICES
4.1 LEASING
4.1.1 Definition
4.1.2 Evolution of Leasing
4.1.3Legal aspects of Leasing
IV
138-149
4.1.4 Contents of a Lease Agreement
4.1.5 Types of Leasing
4.2 HIRE PURCHASE
4.2.1 Hire Purchase Agreement
4.3.2 Difference between Hire Purchase and Leasing
4.3 HIRE PURCHASE LEASING
5. OTHER FUND BASED FINANCIAL SERVICES
5.1 CONSUMER CREDIT
5.1.1Characteristics of Consumer Credit
5.1.2 Nature of Consumer Classes In India
5.1.3 Consuming Class in India
5.1.4 Importance of Consumer Credit In India
5.2.CREDIT CARDS
5.2.1 Introduction
V
150-189
5.2.2 Origin of Credit Cards In India
5.2.3 Types of Credit Cards or Types of Cards
5.3 REAL ESTATE FINANCING
5.3.1 Introduction
5.3.2 Factors Determining the Real Estate Finance Assistance
5.4 BILL DISCOUNTING
5.4.1 Introduction
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5.4.2Definition of Bill Discounting
5.4.3 Following are the salient features of bill discounting financing
5.4.4 Steps In Discounting And Purchasing
5.4.5 Bill Systems
5.5 FACTORING AND FORFAITING
5.5.1 Introduction
5.5.2 Factoring And Forfeiting
5.5.3 Functions of a factor
5.5.4 Factoring mechanism
5.5.5 Features of Factoring
5.5.6 Types of Factoring
5.6 FORFAITING
5.6.1 Forfeiting Mechanism
5.6.2 Benefits to Exporter
5.6.3 Benefits to Banks
5.7 VENTURE CAPITAL
5.7.1 Introduction
5.7.2 Meaning of Venture Capital
5.7.3 Features of Venture Capital
5.7.4 Objectives of Venture Capital
5.7.5 Financing By Venture Capital Institutions
5.7.6 Stages/Process
5.7.7 Infrastructure financing Incubators
5.7.8 Venture Capital in India
5.7.9Investment Pattern In Venture Capital
QUESTION BANK
190-206
UNIVERSITY QUESTIONS
207-214
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SYLLABUS
MERCHANT BANKING ANF FINANCIAL SERVICES
UNIT- 1 Introduction – An Overview of Indian Financial System – Merchant Banking in India –
Recent Developments and Challenges ahead – Institutional structure – Functions of Merchant
Banking – Legal and Regulatory Frameworks- Relevant Provisions of Companies Act- SCRASEBI guidelines- FEMA etc. – Relation with stock Exchanges and OTCEI
UNIT II - ISSUE MANAGEMENT Role of Merchant Banking in Appraisal of projects,
Designing Capital Structures and Instruments – Issue Pricing - Preparation of prospectus
selection of bankers, Advertising Consultants etc. – Role of Registrars –Underwriting
Arrangements. Dealing with Bankers to the Issue, Underwriters, Registrars, and Brokers. –Offer
for sale – Book- Building – Green Shoe Option –E –IPO Private Placement- Bought out Deals –
Placement with FIs, MFs, FIIs, etc. off- Shore Issues. – Issue Marketing – Advertising
Strategies-NRI Marketing- Post Issue Activities.
UNIT III - OTHER FEE BASED MANAGEMENT Mergers and Acquisitions – Portfolio
Management Services – Credit Syndication – Credit Rating – Mutual Funds – Business
Valuation.
UNIT IV - FUND BASED FINANCIAL SERVICES Leasing and Hire Purchasing – Basics of
Leasing and Hire Purchasing – Financial Evaluation –Tax Implication.
UNIT V - OTHER FUND BASED FINANCIAL SERVICES Consumer Credit – Credit
Cards- Real Estate Financing – Bills Discounting – Recent Developments in Factoring and
Forfeiting – Venture Capital.
REFERENCES
1. M.Y.Khan, ‗Financial Services‗– Tata McGraw –Hill, 3 rd Edition, 2005.
2. Machiraju, ‗ Indian Financial System ‗- Vikas Publishing House, 2 nd Edition, 2002.
3. J.C.Verma, ‗ A Manual of Merchant Banking ‗, Bharath Publishing House, New Delhi, 2001.
4. K.Sriram, ‗Hand Book of Leasing, Hire Purchase & Factoring‗, ICFAI, Hyderabad, 1992.
5. Economic Dailies, Relevant Publication of AMFS.
6. Bhalla. V.K.-‗Management of Financial Services‗ – Mnmol, New Delhi 2001.
7. Bhalla V.K.and Dilbag, Singh , ‗International Financial Centers‗, New Delhi, Anmol,1997.
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8. Ennew.C.Trevor Watkins & Mike Wright, ‗Marketing of Financial Services‗, Heinemann
Professional.
CHAPTER I
MERCHANT BANKING
1.1.
An overview of Indian Financial System
The word system implies a set of complex and interrelated factors organized in a
particular form. These factors are mostly interdependent but not always mutually exclusive. The
financial system of any country consists of several ingredients. It includes financial institutions,
markets, financial instruments, services, transactions, agents, claims and liabilities in the
economy.
Financial system‘s a system to canalize the funds from the surplus units to the deficit
Units. ‗Deficit units‘ is a case where current expenditure exceeds their current income. There are
other entities whose current income exceeds current expenditure which is called as ‗Surplus
Units‗.
An efficient financial system not only encourages savings and investments, it also
efficiently allocates resources in different investment avenues and thus accelerates the rate of
economic development. The financial system of a country plays a crucial role of allocating
scarce capital resources to productive uses. Its efficient functioning is of critical importance to
the economy.
1.1.1 FINANCIAL SYSTEM:
• It is a system for the efficient management and creation of finance. According to Robinson,
financial system provides a link between savings and investment for the creation of new wealth
and to permit portfolio adjustment in the composition of the existing wealth. According to Van
Horne, financial system is defined as the purpose of financial markets to allocate savings
efficiently in an economy to ultimate users – either for investment in real assets or for
consumption. Thus the financial system mainly stands on three factors
 Money
 Credit
 Finance
1. Money‘s the unit of exchange or medium of payment. It represents the value of financial
transactions in qualitative terms.
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2. Credit‗, on the other hand, is a debt or loan which is to be returned normally with interest.
3. Finance‘ is monetary wealth of the state, an institution or a person. Comprising these factors in
a systematic order forms a financial system.
1.1.2. Objectives
The objectives of the financial system are
1. Accelerating the growth of economic development.
2. Encouraging rapid industrialization
3. Acting as an agent to various economic factors such as industry, agricultural sector,
Government etc.
4. Accelerating rural development
5. Providing necessary financial support to industry
6. Financing housing and small scale industries
7. Development of backward areas, infrastructure and livelihood
8. Imposing price control in need
9. Protecting environment. Functions of financial system are distributed from creation of money
to efficient Management. It is the sum total of the functions of the various intermediaries.
The functions of financial system can be classified into two broad categories:
1. Controlling functions
2. Promotional functions.
1.1.3 Components of Financial System:
Financial system Institutions Markets Financial Institutions Instruments Services Structure of
Financial Institutions:
COMMERCIAL BANKS:
Commercial Banks Classification of Commercial Banks
 Financial Institutions
 Banking
 Non Banking
 Companies
 Non Banking
 Financial companies
 Central Bank
 Commercial
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 Banks
 Co-Operative
 Banks
 Non Banking
 Financial
 Intermediaries
 Joint Stock companies
Classification of Co-operative Banks NON BANKING FINANCIL INTERMEDIARIES
Classification of Non Banking Financial Intermediaries (B) FINANCIAL MARKETS:
Components of Financial Market Co-operative Banks
 State Co-operative
 Apex Banks
 State Co-operative Urban
 Banks
 Co-operative Land
 Development
 Banks
 Central Co-operative
 Banks Primary Co-operative
 Land Development
 Banks
 Primary Co-operative
 Banks
1.1.4 Limitations of the financial system in India
The following are the limitations of the Indian financial system. • The Indian Financial system
has failed to meet the financial needs of small scale Industries. It has rather patroned the big
industrial houses who are already well off. • The mushrooming of financial institutions has
deteriorated the quality and effectiveness of the sector to some extent. • In many cases, it could
not impose adequate control towards financial irregularities and frauds, often influenced by
politically and economically organized pressure groups. • The Indian financial system fails to
create a well defined and organized capital market. • It fails to motivate economically marginal
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or small entrepreneurs by providing micro credit to them. • The Indian financial system is not
flexible at the desired level. It takes abnormal time to cope with the changing situation.
 Factoring Asset Liability Management
 Leasing Housing Finance
 Forfeiting Portfolio Finance
 Hire Purchase Finance Underwriting
 Credit Card Credit rating
 Merchant Banking Interest and Credit Swap
 Book Building Mutual fund
Securities and Exchange Board of India (Merchant Bankers) Rules, 1992 ― A merchant
banker has been defined as any person who is engaged in the business of issue management
either by making arrangements regarding selling, buying or subscribing to securities or acting as
manager, consultant, adviser or rendering corporate advisory services in relation to such issue
management.
Random House Dictionary ―Merchant banker is an organization that underwrites securities for
corporations, advices such clients on mergers and is involved in the ownership of commercial
ventures. These organizations are sometime banks which are not merchants and sometimes
merchants who are not banks and sometimes houses which are neither merchants nor banks.
Charles P. Kindleberger ―Merchant banking is the development of banking from commerce
which frequently encountered a prolonged intermediate stage known in England originally as
merchant banking. The Notification of the Ministry of finance defines A merchant banker as
any person who is engaged in the business of issue management either by making arrangements
regarding selling, buying or subscribing to the securities as manager, consultant, adviser or
rendering corporate advisory service in relation to such issue management.
Objectives
 Channelizing the financial surplus of the general public into productive investments
avenues
 Co-coordinating the activities of various intermediaries like the registrar, bankers,
advertising agency, printers, underwriters, brokers, etc., to the share issue
 Ensuring the compliance with rules and regulations governing the securities market.
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1.1.5 Functions of merchant Banking: Merchant banking functions in India is the same as
merchant banks in UK and other European countries. The following are the functions of
merchant bankers in India.
 Corporate counseling
 Project Counseling
 Capita l Structuring
 Portfolio Management
 Issue Management
 Credit Syndication
 Working capital
 Venture Capital

Lease Finance
 Fixed Deposits
(i) Corporate counseling: Corporate counseling covers counseling in the form of project
counseling, capital restructuring, project management, public issue management, loan
syndication, working capital fixed deposit, lease financing, acceptance credit etc., The scope of
corporate counseling is limited to giving suggestions and opinions to the client and help taking
actions to solve their problems. It is provided to a corporate unit with a view to ensure better
performance, maintain steady growth and create better image among investors.
(ii) Project counseling Project counseling is a part of corporate counseling and relates to project
finance. It broadly covers the study of the project, offering advisory assistance on the viability
and procedural steps for its implementation.
a. Identification of potential investment avenues.
b. A general view of the project ideas or project profiles.
c. Advising on procedural aspects of project implementation
d. Reviewing the technical feasibility of the project
e. Assisting in the selection of TCO‗s (Technical Consultancy Organizations) for preparing
project reports
f. Assisting in the preparation of project report
g. Assisting in obtaining approvals, licenses, grants, foreign collaboration etc., from government
h. Capital structuring
i. Arranging and negotiating foreign collaborations, amalgamations, mergers and takeovers.
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j. Assisting clients in preparing applications for financial assistance to various national and state
level institutions banks etc.,
k. Providing assistance to entrepreneurs coming to India in seeking approvals from the
Government of India.
(iii) Capital Structure Here the Capital Structure is worked out i.e., the capital required, raising
of the capital, debt-equity ratio, issue of shares and debentures, working capital, fixed capital
requirements, etc.,
(iv) Portfolio Management It refers to the effective management of Securities i.e., the merchant
banker helps the investor in matters pertaining to investment decisions. Taxation and inflation
are taken into account while advising on investment in different securities. The merchant banker
also undertakes the function of buying and selling of securities on behalf of their client
companies. Investments are done in such a way that it ensures maximum returns and minimum
risks.
(v) Issue Management: Management of issues refers to effective marketing of corporate
securities viz., equity shares, preference shares and debentures or bonds by offering them to
public. Merchant banks act as intermediary whose main job is to transfer capital from those who
own it to those who need it. The issue function may be broadly divided in to pre issue and post
issue management.
a. Issue through prospectus, offer for sale and private placement.
b. Marketing and underwriting
c. pricing of issues
(vi) Credit Syndication:
Credit Syndication refers to obtaining of loans from single
development finance institution or a syndicate or consortium. Merchant Banks help corporate
clients to raise syndicated loans from commercials banks. Merchant banks helps in identifying
which financial institution should be approached for term loans. The merchant bankers follow
certain steps before assisting the clients approach the appropriate financial institutions. a.
Merchant banker first makes an appraisal of the project to satisfy that it is viable b. He ensures
that the project adheres to the guidelines for financing industrial projects. c. It helps in designing
capital structure, determining the promoter‗s contribution and arriving at a figure of approximate
amount of term loan to be raised. d. After verifications of the project, the Merchant Banker
arranges for a preliminary meeting with financial institution. e. If the financial institution agrees
to consider the proposal, the application is filled and submitted along with other documents.
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(vii) Working Capital: The Companies are given Working Capital finance, depending upon
their earning capacities in relation to the interest rate prevailing in the market.
(viii)Venture Capital: Venture Capital is a kind of capital requirement which carries more risks
and hence only few institutions come forward to finance. The merchant banker looks in to the
technical competency of the entrepreneur for venture capital finance.
(ix). Fixed Deposit: Merchant bankers assist the companies to raise finance by way of fixed
deposits from the public. However such companies should fulfill credit rating requirements.
(x)Other Functions
• Treasury Management- Management of short term fund requirements by client companies.
• Stock broking- helping the investors through a network of service units
• Servicing of issues- servicing the shareholders and debenture holders in distributing dividends,
debenture interest.
• Small Scale industry counseling- counseling SSI units on marketing and finance
• Equity research and investment counseling – merchant banker plays an important role in
providing equity research and investment counseling because the investor is not in a position to
take appropriate investment decision.
• Assistance to NRI investors - the NRI investors are brought to the notice of the various
investment opportunities in the country.
• Foreign Collaboration: Foreign collaboration arrangements are made by the Merchant
bankers.
1.2. Merchant Banking in India
The first merchant bank was set up in 1969 by Grind lays Bank. Initially they were issue
mangers looking after the issue of shares and raising capital for the company. But subsequently
they expanded their activities such as working capital management; syndication of project
finance, global loans, mergers, capital restructuring, etc., initially the merchant banker in India
was in the form of management of public issue and providing financial consultancy for foreign
banks. In 1973, SBI started the merchant banking and it was followed by ICICI. SBI capital
market was set up in August 1986 as a fully fledged merchant banker. Between 1974 and 1985,
the merchant banker has promoted lot of companies. However they were brought under the
control of SEBI in 1992.
1.2.
1 Recent Developments in Merchant Banking and Challenges Ahead:
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The recent developments in Merchant banking are due to certain contributory factors
in India. They are
 The Merchant Banking was at its best during 1985-1992 being when there were
 Many new issues. It is expected that 2010 that it is going to be party time for
 Merchant banks, as many new issues are coming up.
 The foreign investors – both in the form of portfolio investment and through foreign
 Direct investments are venturing in Indian Economy. It is increasing the scope of
 Merchant bankers in many ways.
 Disinvestment in the government sector in the country gives a big scope to the
 Merchant banks to function as consultants.
 New financial instruments are introduced in the market time and again. This basically
 Provides more and more opportunity to the merchant banks.
 The mergers and corporate restructuring along with MOU and MOA are giving
 Immense opportunity to the merchant bankers for consultancy jobs.
However the challenges faced by merchant bankers in India are
1. SEBI guideline has restricted their operations to Issue Management and Portfolio Management
to some extent. So, the scope of work is limited.
2. In efficiency of the clients are often blamed on to the merchant banks, so they are into trouble
without any fault of their own.
3. The net worth requirement is very high in categories I and II specially, so many professionally
experienced person/ organizations cannot come into the picture.
4. Poor New issues market in India is drying up the business of the merchant bankers. Thus the
merchant bankers are those financial intermediary involved with the activity of transferring
capital funds to those borrowers who are interested in borrowing. The activities of the merchant
banking in India is very vast in the nature of
 The management of the customers securities
 The management of the portfolio
 The management of projects and counseling as well as appraisal
 The management of underwriting of shares and debentures
 The circumvention of the syndication of loans
 Management of the interest and dividend etc.
1.3 MERCHANT BANKING AND LEGAL REGULATORY FRAME WORK
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1.3.1 Companies Act
(i). Company means a company formed and registered under this Act or an existing company as
defined in clause (ii);
(ii). Existing company means a company formed and registered under any of the previous
companies laws specified below:
a. any Act or Acts relating to companies in force before the Indian Companies Act, 1866 (10 of
1866) and repealed by the Act;
b. The Indian Companies Act, 1866
c. The Indian Companies Act, 1882 d. the Indian Companies Act, 1913 e. the Registration of
Transferred Companies Ordinance 1942.
iii. Private company means a company which has a minimum paid-up capital of one lakh rupees
or such higher paid-up capital as may be prescribed, and by its articles,
a. Restricts the right to transfer its shares, if any;
b. Limits the number of its members to fifty not including i. persons who are in the employment
of the company, and ii. persons who, having been formerly in the employment of the company,
were members of the company while in that employment and have continued to be members
after the employment ceased; and
c. Prohibits any invitation to the public to subscribe for any shares in, or debentures of, the
company;
d. Prohibits any invitation or acceptance of deposits from persons other than its members,
directors or their relatives Provided that where two or more persons hold one or more shares in a
company jointly, they shall, for the purposes of this definition, be treated as a single member;
iv. Public company means a company which a. is not a private company; b. has a minimum paidup capital of five lakh rupees or such higher paid-up capital, s may be prescribed c. is a private
company which is a subsidiary of a company which is not a private company.
In this Act, unless the context otherwise requires,
1. Abridged prospectus means a memorandum containing such salient features of a prospectus as
may be prescribed
2. Banking company has the same meaning as in the Banking Companies Act, 1949
3. Company Law Board means the Board of Company Law Administration constituted under
section 10E
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4. Debenture includes debenture stock bonds and any other securities of a company, whether
constituting a charge on the assets of the company or not;
5. Derivative has the same meaning as in clause (aa) of section 2 of the Securities Contracts
(Regulation) Act, 1956
6. Hybrid means any security which has the character of more than one type of security,
including their derivatives;
7. Issued generally means, in relation to a prospectus, issued to persons irrespective of their
being existing members or debenture-holders of the body corporate to which the prospectus
relates;
8. Prospectus means any document described or issued as a prospectus and includes any notice,
circular, advertisement or other document inviting deposits from the public or inviting offers
from the public for the subscription or purchase of any shares in, or debentures of, a body
corporate;
9. Recognized stock exchange means, in relation to any provision of this Act in which it occurs a
stock exchange whether in or outside India, which is notified by the Central Government in the
Official Gazette as a recognized stock exchange for the purposes of that provision;
10. Registrar means a Registrar, or an Additional, a Joint, a Deputy or an Assistant Registrar,
having the duty of registering companies under this Act;
11. Securities means securities as defined in clause (h) of section 2 of the Securities Contracts
(Regulation) Act, 1956
12. Securities and Exchange Board of India means the Securities and Exchange Board of India
established under section 3 of the Securities and Exchange Board of India Act, 1992
13. Share means share in the share capital of a company, and includes stock except where a
distinction between stock and shares is expressed or implied;
1.3.2 Provisions under Companies Act
The various regulations which govern the merchant bankers on the capital issue are prescribed by
the companies act, and the other enactments mentioned below.
1. Provisions of the Companies Act, 1956
a. Prospectus (Sec. 55 to 68A)
b. Allotment (Sec. 55 to 75)
c. Commissions and discounts (Sec. 76 & 77)
d. Issue of shares at premium and at discount (Sec. 78 & 79)
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e. Issue and redemption of preference shares (Sec. 80 & 80A)
f. Further issues of capital (Sec. 81)
g. Nature, numbering and certificate of shares (Sec. 82 to 84)
h. Kinds of share capital and prohibition on issue of any other kind of shares (Sec. 85 & 86)
 Matters to be specified in prospectus and reports to be set out therein (Schedule 11)
 The Securities Contracts (Regulations) Act, 1957 regarding transactions in securities
 The Securities Contracts (Regulation) Rules, 1957.
2. Their capital adequacy
3. Their track record, experience and general reputation
4. Adequacy and quality of personnel employed by them and also the available infrastructure.
1.3.3 SCRA (Security contract regulation Act):
The Securities Contracts (Regulations) Act was passed in 1956 by Parliament and it came
into force in February 1957. An act to prevent undesirable transactions in securities by regulating
the business of dealing therein, by providing for certain other matters connected therewith.
1.
This
Act
may
be
called
the
Securities
Contracts
(Regulation)
Act,
1956.
2. It extends to the whole of India.
2. It shall come into force on such date as the Central Government may, by notification in the
Official Gazette, appoint.
Definitions
a. Contract means a contract for or relating to the purchase or sale of securities;
b. Corporatization means the succession of a recognized stock exchange, being a Body of
individuals or a society registered under the Societies Registration Act, 1860 (21 of 1860), by
another stock exchange, being a company incorporated for The purpose of assisting, regulating
or controlling the business of buying, selling or dealing in securities carried on by such
individuals or society;
c. demutualization means the segregation of ownership and management from the trading rights
of the members of a recognized stock exchange in accordance with a scheme approved by the
Securities and Exchange Board of India;
(d) Derivative includes:
a. a security derived from a debt instrument, share, loan, whether secured or unsecured, risk
instrument
or
contract
for
differences
or
any
other
form
of
security;
b. a contract which derives its value from the prices, or index of prices, of underlying securities;
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DEPARTMENT OF MANAGEMENT STUDIES
c. Government security means a security created and issued, whether before or after the
commencement of this Act, by the Central Government or a State Government for the purpose of
raising a public loan and having one of the forms specified in clause (2) of section 2 of the Public
Debt Act, 1944 (18 of 1944);
d. Member means a member of a recognized stock exchange;
e. Option in securities means a contract for the purchase or sale of a right to buy or sell, or a right
to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call
or a put and call in securities;
f. ―Recognized stock exchange means a stock exchange which is for the time being recognized
by the Central Government under section 4;
g. Stock exchange which may provide for
(i) The issue of shares for a lawful consideration and provision of trading rights in lieu of
membership cards of members of a recognized stock exchange;
(ii) The restrictions on voting rights;
(iii) the transfer of property, business, assets, rights, liabilities, recognitions, contracts of the
recognized stock exchange, legal proceedings by, or against, the recognized stock exchange,
whether in the name of the recognized stock exchange or any trustee or otherwise and any
permission
given
to,
or
by,
the
recognized
stock
exchange;
(iv) the transfer of employees of a recognized stock exchange to another recognized stock
exchange;
(v) any other matter required for the purpose of, or in connection with, the corporatization or
demutualization,
as
the
case
may
be,
of
the
recognized
stock
exchange
h. Securities include i. shares, scrip‘s, stocks, bonds, debentures, debenture stock or other
marketable securities of a like nature in or of any incorporated company or other body corporate;
(h) Government securities;
i. Such other instruments as may be declared by the Central Government to be securities; and ii.
rights or interest in securities;
(j). Stock Exchange means a anybody of individuals, whether incorporated or not, constituted
before corporatization and demutualization under sections 4A and 4B, or b. a body corporate
incorporated under the Companies Act 1956 whether under a scheme of corporatization and
demutualization or otherwise, for the purpose of assisting, regulating or controlling the business
of buying,
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DEPARTMENT OF MANAGEMENT STUDIES
1.4 RECOGNIZED STOCK EXCHANGES
Application for Recognition of Stock Exchanges
Any stock exchange, which is desirous of being recognized for the purposes of this Act,
may make an application in the prescribed manner to the Central Government. (2) Every
application under sub-section 1. shall contain such particulars as may be prescribed, and shall be
accompanied by a copy of the bye-laws of the stock exchange for the regulation and control of
contracts and also a copy of the rules relating in general to the constitution of the stock exchange
and in particular, to— a. the governing body of such stock exchange, its constitution
and powers of management and the manner in which its business is to be transacted; b. the
powers and duties of the office bearers of the stock exchange; c. the admission into the stock
exchange of various classes of members, the qualifications for membership, and the exclusion,
suspension, expulsion and readmission of members there from or there into; d. the procedure for
the registration of partnerships as members of the stock exchange in cases where the rules
provide for such membership; and the nomination and appointment of authorized representatives
and clerks.
Grant of Recognition of Stock Exchanges
1. If the Central Government is satisfied, after making such inquiry as may be necessary in this
behalf and after obtaining such further information, if any, as it may require,
 That the rules and bye-laws of a stock exchange applying for registration are inconformity
with such conditions as may be prescribed with a view to ensure fair dealing and to protect
investors;
 That the stock exchange is willing to comply with any other conditions (including conditions
as to the number of members) which the Central Government, after consultation with the
governing body of the stock exchange and having regard to the area served by the stock
exchange and its standing and the nature of the securities dealt with by it, may impose for the
purpose of carrying out the objects of this Act; and
 That it would be in the interest of the trade and also in the public interest to grant recognition
to the stock exchange; it may grant recognition to the stock exchange subject to the
conditions imposed upon it as aforesaid and in such form as may be prescribed.
2. The conditions which the Central Government may prescribe under clause (a) of subsection
(1) for the grant of recognition to the stock exchanges may include, among other matters,
conditions relating to,
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DEPARTMENT OF MANAGEMENT STUDIES
 The qualifications for membership of stock exchanges;
 The manner in which contracts shall be entered into and enforced as between members.
 The representation of the Central Government on each of the stock exchange by such
number of persons not exceeding three as the Central Government may nominate in this
behalf; and
 The maintenance of accounts of members and their audit by chartered accountants
whenever such audit is required by the Central Government.
3. Every grant of recognition to a stock exchange under this section shall be published in the
Gazette of India and also in the Official Gazette of the State in which the principal office as of
the stock exchange is situate, and such recognition shall have effect as from the date of its
publication in the Gazette of India.
4. No application for the grant of recognition shall be refused except after giving an opportunity
to the stock exchange concerned to be heard in the matter; and the reasons for such refusal shall
be communicated to the stock exchange in writing.
5. No rules of a recognized stock exchange relating to any of the matters specified in sub-section
(2) of section 3 shall be amended except with the approval of the Central Government. Even
though we have 23 stock exchanges in India, a major part of the transactions is controlled by
Bombay Stock Exchange. This has led to enormous speculation, rigging and cornering of shares
by a few speculators. To prevent these malpractices by companies, brokers and merchant
bankers, the government constituted Securities Exchange Board of India in April 1988 for
regulating and promoting the stock market in the country and effective from 1992.
1.5 Security Exchange Board of India (SEBI)
SEBI is a body corporate with head office at Bombay. The Chairman and the board
members are appointed by the Central government. SEBI has two following major functions:
1. Regulatory and
2. Development
1. Regulatory
a). Registering the brokers and sub-brokers b). Registration of mutual funds c). Regulation of
stock exchanges d). Prohibition of fraudulent and unfair trade practice e). Controlling insidertrading, take-over bids and imposing penalties.
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DEPARTMENT OF MANAGEMENT STUDIES
2. Development a. Educating investors b. Training intermediaries in stock market transactions c.
Promoting fair transactions d. Undertaking research and publishing useful information to all
Objectives:
 To deal with development and regulation of stock market in India.
 To promote fair dealings by the issue of securities and ensure a market place where they
can raise funds.
 To provide protection to the investors.
 Regulate and develop a code of conduct for brokers, merchant bankers, etc.
 To have check on preferential allotment to promoters at a very low price.
 To prevent deviations and violations of rules prescribed by stock exchange.
 To verify listing requirements, listing procedures, and ensure compliance of the same by
the companies, so that only financially sound companies are listed.
 To prescribe required standards for merchant bankers.
 To promote healthy growth of security market for the development of capital market in
the country.
Powers of SEBI as per the Act, SEBI has powers
 To file complaints in a court
 To regulate companies in the issue and transfer of shares including bonus and rights
shares.
 It can levy penalties on companies and on brokers for violating transactions.
 Power to summon any broker or intermediaries and call for documents.
 It can issue directions to all brokers for protecting the interests of investors.
In addition to the above powers:
 It can call for periodical returns from stock exchange.
 Seek any information from stock exchange.
 It can enquire into the functioning of stock exchange.
 It can grant permission for the change of bye-laws of any stock exchange.
 It can compel listing of securities of public company.
 It can control and regulate stock exchanges.
 Granting registration to market intermediaries, prohibit insider-trading and prohibit
Fraudulent and unfair trade practices.
 Promoting investor-education, and trading of intermediaries in capital market.
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DEPARTMENT OF MANAGEMENT STUDIES
 Regulating purchase of shares and take-over of companies.
1.5.1 GENERAL OBLIGATIONS
The 1992 regulations have enunciated the following general obligations and
responsibilities for the merchant bankers.
Sole Function Every merchant banker shall abide by the Code of Conduct as specified in
Schedule III. They are as follows:
1. Merchant Banker not to associate with any business other than the securities market.
2. No merchant banker, other than a bank or a public financial institution, who has been granted
certificate of registration under these regulations, shall after June 30th, 1998 carry on any
business other than that in the securities market. However , a merchant banker who prior to the
date of notification of the Securities and exchange board of India (Merchant Bankers)
Amendment Regulations, 1997, has entered into a contract in respect of a business other that of
the securities market may, f he so desires, discharge his obligations under such contract.
Similarly, a merchant banker who has been granted certificate of registration to act as primary or
satellite dealer by the Reserve Bank of India may carry on such business as may be permitted by
Reserve Bank of India.
Maintenance of Books
Every merchant banker shall keep and maintain the following books of accounts, records
and documents: 1. A copy of balance sheet as at the end of each accounting period; 2. A copy
of profit and loss account for that period; 3. A copy of the auditor‗s report on the accounts for
that period; and 4. A statement of financial position. Every merchant banker shall intimate to the
Board the place where the books of accounts, record and documents are maintained. Every
merchant banker shall, after the end of each accounting period furnish to the Board copies of the
Balance sheet, profit and loss account and such other documents for any other preceding five
accounting years when required by the Board.
Submission of Half-yearly Results:
Every merchant banker shall furnish to the Board half-yearly unaudited financial results
when required by the Board with a view to monitor the capital adequacy of the merchant banker.
Preservation of Books of Account, Records:
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DEPARTMENT OF MANAGEMENT STUDIES
The merchant banker shall preserve the books of accounts and other records and
documents maintained under regulation 14 for a minimum period of five years.
Report on Steps taken on Auditor‟s Report:
Every merchant banker shall within two months from the date of the auditors‗ report take
steps to rectify the deficiencies, made out in the auditor‗s report.
Appointment of Lead Merchant Bankers:
All issues should be managed by at least one merchant banker functioning as the lead
merchant banker. In an issue of offer of rights to the existing members with or without the right
of renunciation, the amount of the issue of the body corporate does not exceed rupees fifty lakh,
the appointment of a lead merchant banker shall not be essential. Every lead merchant banker
shall before taking up the assignment relating to an issue enter into an agreement with such body
corporate setting out their mutual right, liabilities and obligations relating to such issue an in
particular to disclosures, allotment and refund.
Restriction on Appointment of Lead Managers:
The number of lead merchant bankers may not, exceed in case of any issue of the
following:
Responsibilities of Lead Managers:
No lead manager shall agree to manage or be associated with any issue unless his
responsibilities relating to the issue mainly, those of disclosures, allotment and refund are:
Size of Issue
Number of Merchant Bankers
Less than Rs. 50 Crores
Two Above
Rs. 50 Crores but less than Rs.100 Crores
Three Above
Rs. 100 Crores but less that Rs.200 Crores
Four Above
Rs.200 Crores but less that Rs.400 Crores
Five Above
Rs.400 Crores
Five or more
as agreed by SEBI clearly defined, allocated and determined and a statement specifying
such responsibilities is furnished to the Board at least one month before the opening of the issue
for subscription. Where there are more than one lead merchant banker to the issue the
responsibilities of each of such lead merchant banker shall clearly be demarcated and a statement
specifying such responsibilities shall be furnished to the Board at least one month before the
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DEPARTMENT OF MANAGEMENT STUDIES
opening of the issue for subscription. No lead merchant banker shall, agree to manage the issue
made by anybody corporate, if such body corporate is an associate of the lead merchant banker.
A lead merchant banker shall not be associated with any issue if a merchant banker who is not
holding a certificate is associated with the issue.
Underwriting Obligations:
In respect of every issue to be managed, the lead merchant banker holding a certificate
under Category I shall accept a minimum underwriting obligation of five percent of the total
underwriting commitment or rupees twenty-five lakh whichever is less. If the lead merchant
banker is unable to accept the minimum underwriting obligation, that lead merchant banker shall
make arrangement for having the issue underwritten to that extent by a merchant banker
associated with the issue and shall keep the board informed of such arrangement.
Submission of Due Diligence Certificate:
The lead merchant bankers, who is responsible for verification of the contents of a
prospectus or the Letter of Offer in respect of an issue and the reasonableness of the views
expressed therein, shall submit to the Board at least two weeks prior to the opening of the issue
for subscription, a due diligence certificate in Form
Documents to be furnished to the Board:
The lead manager responsible for the issue shall furnish to the Board, the following
documents
1. Particulars of the issue;
2. Draft prospectus or where there is an offer to the existing shareholders, the draft letter of offer;
3. Any other literature intended to be circulated to the investors, including the shareholders; and
4. Such other documents relating to prospectus or letter of offer as the case may be.
The documents shall be furnished at least two weeks prior to the date of filing of the draft
prospectus or the letter of the offer, as the case may be, with the Registrar of Companies or with
the Regional Stock Exchanges or with both. The lead manager shall ensure that the modifications
and suggestions, if any, made by the Board on the draft prospectus or the Letter of Offer as the
case may be, with respect to information to be given to the investors are incorporated therein.
Payment of fees to the Board:
The draft prospectus or draft letter of offer referred to in regulation 24 shall be submitted
along with such fees and in such manner as may be specified in Schedule IV.
Continuance of Association of Lead Manager:
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DEPARTMENT OF MANAGEMENT STUDIES
The lead manager undertaking the responsibility for refunds or allotment of securities in
respect of any issue shall continue to be associated with the issues till the subscriber have
received the share or debenture certificates or refund of excess application money. Where a
person other than the lead manager is entrusted with the refund or allot of securities in respect of
any issue the lead manager shall continue to be responsible for ensuring that such other person
discharges the requisite responsibilities in accordance with the provisions of the Companies Act
and the listing agreement entered into but the body corporate with the stock Exchange.
Acquisition of shares Prohibited: No merchant banker or any of its directors, partner manager
or principal shall either on their respective accounts or through their associates or relative enter
into transaction in securities of bodies corporate on the basis of unpublished price sensitive
information obtained by them during the course of any professional assignment either from the
clients or otherwise.
Information to the Board:
Every merchant banker shall submit to the Board complete
particulars of any transaction for acquisition of securities of anybody corporate whose issue is
being managed by that merchant banker within fifteen days from the date of entering into such
transaction.
Disclosures to the Board: A merchant banker shall disclose to the Board as and when required,
the following information:
1. His responsibilities with regard to the management of the issue; Any change in the information
o particulars previously furnished, which have a bearing on the certificate granted to it;
2. The names of the body corporate whose issues he has managed or has been ass0oiciated with;
3. The particulars relating to breach of the capital adequacy requirement as specified in
regulation 7;
4. Relating to his activities as a manager, underwriter, consultant or adviser to an issue as the
case may be.
Appointment of Compliance Officer: Every merchant banker shall appoint a compliance
officer who shall be responsible for monitoring the compliance of the Act, rules and regulations
notifications, guidelines, instructions etc., issued by the board or the Central Government and for
redressed of investors‗ grievances. The compliance officer shall immediately and independently
report to the Board any non-compliance observed by him and ensure that the observations made
or deficiencies pointed out by the Board on/in the draft prospectus or the Letter of offer as the
case may be, do not recur.
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Procedure For Inspection Boards Right to inspect: The Board may appoint one or more
persons as inspecting authority to undertake inspection of the books of accounts, records and
documents of the merchant banker for any of the purposes specified in sub-regulation(2).
The purposes referred to in sub-regulation (1) may be as follows:
1. To ensure that the books of account are being maintained in the manner required;
2. To ensure that the provisions of the Act, rules, regulations are being complied with;
3. To investigate into the complaints received from investors, other merchant bankers or any
other person on any matter having a bearing on the activities of the merchant banker; and
4. To investigate suo-moto in the interest of securities business or investors interest in the affairs
of the merchant banker.
Notice before Inspection:
Before undertaking an inspection under regulation 29 the Board shall give a reasonable
notice to the merchant banker for that purpose. Where the Board is satisfied that in the interest of
the investors no such notice should be given, it may, by an order in writing directing that the
inspection of the affairs of the merchant banker be taken up without such notice. During the
course of inspection, the merchant banker against whom an inspection is being carried out shall
be bound to discharge his obligations as provided under regulation 31.
Obligations of Merchant Banker on Inspection:
It shall be the duty of every director, proprietor, partner, officer and employee of the
merchant banker, who is being inspected, to produce to the inspecting authority such books,
accounts and other documents in his custody or control and furnish him with the statements and
information relating to his activities as a merchant banker within such time as the inspecting
authority may require. The merchant banker shall allow the inspecting authority to have
reasonable access to the premises occupied by such merchant banker or by any other person on
his behalf and also extend reasonable facility for examining any books, records, documents and
computer data in the possession of the merchant banker or any such other person and also
provide copies of documents or other materials which, in the opinion of the inspecting authority
are relevant for the purposes of the inspection. The inspecting authority, in the course of
inspection, shall be entitled to examine or record statements of any principal officer, director,
partner, proprietor and employee of the merchant banker. It shall be the duty of every director,
proprietor, partner, officer or employee of the merchant banker to give to the inspecting authority
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DEPARTMENT OF MANAGEMENT STUDIES
all assistance in connection with the inspection which the merchant banker may be reasonably
expected to give.
Submission of Report to the Board:
The inspecting authority shall, as soon as possible submit, an inspection report to the
Board.
Suspension of Registration
SEBI Regulations, 2002 published in the official Gazette of India dated 27.09.2002 A
penalty for suspension of registration of a merchant banker may be imposed under the following
circumstances:
• Where the merchant banker violates the provisions of the Act, rules or regulations; or
• Where the merchant banker fails to furnish any information relating to his activity as merchant
banker as required by the Board; or furnishes wrong or false information, or does not submit
periodical returns as required by the Board; or does not co-operate in any enquiry conducted by
the Board; or
• Where the merchant banker fails to resolve the complaints of the investors or fails to give a
satisfactory reply to the Board in this behalf; or
• Where the merchant banker indulges in manipulation or price rigging or cornering activities; or
• Where the merchant banker is guilty of misconduct or improper or unbusiness like or
unprofessional conduct which is not in accordance with the Code of Conduct specified in
Schedule III; or
• Where the merchant banker fails to maintain the capital adequacy requirement in accordance
with provisions of regulation 7; or
• Where the merchant banker fails to pay the fees; or
• Where the merchant banker violates the conditions of registration; or
• Where the merchant banker does not carry out his obligations as specified in the regulation.
Cancellation or Registration
A penalty of cancellation of registration of a merchant banker may be imposed where;
• The merchant banker indulges in deliberate manipulation or price rigging or cornering activities
affecting the securities market and the investor‘s interest;
• The financial position of the merchant banker deteriorates to such an extent that the Board is of
the opinion that his continuance as merchant banker is not in the interest of investors;
• The merchant banker is guilty of fraud, or is convicted of a criminal offence;
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• In case of repeated defaults of the nature mentioned in regulation 36 provided that the Board
furnishes reasons for cancellation in writing.
Manner of Making Order of Suspension or Cancellation:
No order of penalty of suspension or cancellations the case may be shall be imposed
except after holding an enquiry in accordance with procedure specified in regulation.
Manner of Holding Enquiry before Suspension or Cancellation:
For the purpose of holding an enquiry under regulation 38, the board may appoint an
enquiry officer. The enquiry officer shall issue to the merchant banker a notice the registered
office or the principal place of business of the merchant banker. The merchant banker may,
within thirty days from the date of receipt of such notice, furnish to the enquiry officer a reply
together with copies of documentary or other evidence relied on by him or sought by the Board
from the merchant banker. The enquiry officer shall, give a reasonable opportunity or hearing to
the merchant banker to enable him to make submissions in support of his reply made under subregulation (3). The merchant banker may either appear in person or through any duly authorized
person. No lawyer or advocate shall be permitted to represent the merchant banker at the
enquiry. Where a lawyer or an advocate has been appointed by the Board as a presenting officer
under sub-regulation (6), it shall be lawful for the merchant banker to present its case through a
lawyer or advocate. It is considered necessary that the enquiry officer may ask the Board to
appoint a presenting officer to present its case. The enquiry officer shall, after taking into
account all relevant facts and submissions made by the merchant banker, submit a report the
Board and recommend the penalty to be imposed as also the grounds on the basis of which
proposed penalty is justified.
Show case Notice and Order:
On receipt of the report from the enquiry officer, the Board shall consider the same and
issue a show-cause notice as to why the penalty as proposed by the enquiry officer should not be
imposed. The merchant banker shall within twenty-one days of the date of the receipt of the
show-cause send a reply to the Board. The Board after considering the reply to the show-cause
notice, if received, shall as soon as possible or not later than thirty days from the receipt of the
reply, if any, pass such order as it deems fit. Every order passed under sub-regulation (3) shall be
self-contained and give reasons for the conclusions stated therein including justification of the
penalty imposed by that order. The Board shall send a copy of the order under sub-regulation (3)
to the merchant banker.
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Effect of Suspension and Cancellation:
On and from the date of the suspension of their merchant banker he shall cease to carry
on any activity as a merchant banker during the period of suspension. On and from the date of
cancellation the merchant banker shall with immediate effect cease to carry on any activity as a
merchant banker. The order of suspension or cancellation of certificate passed under subregulation (3) of regulation 40 shall be published in at least two daily newspapers by the Board.
1.5.2 Appeal to the Securities Appellate Tribunal:
Any person aggrieved by an order of the board may, on and after the commencement of
the /securities Laws (second amendment) Act, 1999, under these regulations may prefer an
appeal to a Securities Appellate Tribunal having jurisdiction in the matter. Fees Every merchant
banker shall pay a sum of Rupees five lacks as registration fees at the time of the grant of
certificate by the Board. The fee shall be paid by the merchant a banker within fifteen days from
the date of receipt of the intimation from the Board under sub regulation (1) of regulation 8. A
merchant banker to keep registration in force shall pay renewal fee of Rs.2.5 lacs every three
years from the fourth year from the date of initial registration. The fee shall be paid by the
merchant banker within fifteen days from the date of receipt of intimation from the Board under
sub-regulation (3) of regulation 9. The fees specified shall be payable by merchant banker by a
demand draft in favor securities and Exchange Board of India‘ payable at Mumbai or at the
respective regional office. Every Merchant banker shall pay registration fees as set out below:
1. Category I merchant banker; A sum of Rs. 2.5 lakhs to be paid annually for the first two
years commencing from the date of initial registration and thereafter for the third year a sum of
Rs. 1 lakh to keep his registration in force.
2. Category II merchant banker; A sum of Rs. 1.5 lakh to be paid annually for the first two
years commencing from the date of initial registration and thereafter for the third year a sum of
Rs. 50,000 to keep his registration in force.
3. Category III merchant bankers ; A sum of Rs.1 lakh to be paid annually for the first two
years commencing from the date of initial registration and thereafter for the third year a sum of
Rs.25,000 to keep his registration in force.
4. Category IV merchant bankers ; A sum of Rs.5,000/- to be paid annually for the first two
years commencing from the date of initial registration and thereafter for the third year a sum of
Rs.1000/- to keep his registration in force.
Renewal Fees:
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1. Category I merchant bankers : A sum of Rs.1 lakh to be paid annually for the first two years
commencing from the date of each renewal and thereafter for the third year a sum of Rs.20,000/to keep his registration in force;
2. Category II merchant bankers : A sum of Rs.75,000/- to be paid annually for the first two
years commencing from the date of each renewal and thereafter for the third year a sum of
Rs.10,000/- to keep his registration in force ;
3. Category III merchant bankers : A sum of s.50,000/ to be paid annually for the first two
years commencing from the date of each renewal and thereafter for the third year a sum of
Rs.5,000/- to keep his registration in force ;
4. Category IV merchant bankers : A sum of Rs.5,000/- to be paid annually for the first two
years commencing from the date of each renewal and thereafter for the third year a sum of
Rs.2,500/- to keep his registration in force ; In addition, the merchant banker has to pay the
following fees towards documentation
Size of the Issue
Fee per Document (Rs.)
Up to 5 crores
10,000
More than 5 crores and up to 10 crores
15,000
More than 10 crores and up to 50 crores
25,000
More than 50 crores and up to 100 crores
50,000
More than 100 crores and up to 500 crores
2, 50,000
More than 500 crores
5, 00,000
1.5.3 SEBI Regulations on merchant bankers:
SEBI has brought about a effective regulative measures for the purpose of disciplining
the functioning of the merchant bankers in India. The objective is to ensure an era of regulated
financial markets and thus streamline the development of the capital market in India. The
measures were introduced by the SEBI in the year 1992. The measures were revised by SEBI in
1997. The salient features of the regulative framework of merchant banking in India are
discussed below.
Registration of Merchant Bankers Application for Grant of Certificate
An application by a person for grant of a certificate shall be made to the Board in Form
A. The application shall be made for any one of the following categories of the merchant banker
namely:
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1. Category I- To carry on any activity of the issue management, which will inter alliance
consist of preparation of prospectus and other information relating to the issue, determining
financial structure, tie-up of financiers and final allotment and refund of the subscription; and
to act as adviser, consultant, manager, underwriter, portfolio manager.
2. Category II- To act as adviser, consultant, co-manager, underwriter, portfolio manager.
3. Category III- To act as underwriter, adviser, consultant to an issue.
4. Category IV- To act only as adviser or consultant to an issue. 5. With effect from 9th
December, 1997, an application can be made only for carrying on the activities mentioned in
category I. An applicant can carry on the activity as underwriter only if he contains separate
certificate of registration under the provisions of Securities and Exchange Board of India
(Underwriters) Regulations, 1993, and as portfolio manager only if he obtains separate
certificate of registration under the provisions of Securities and Exchange Board of India
(Portfolio Manager) Regulations, 1993.
5. Conformance to Requirements Subject to the provisions of the regulations, any application,
which not complete in all respects and does not conform to the instructions specified in the
form, shall be rejected. However, before rejecting any such application, the applicant will be
given an opportunity to remove within the time specified such objections and may be
indicated by the board.
6. Furnishing of Information The Board may require the applicant to furnish further
information or clarification regarding matter relevant to the activity of a merchant banker for
the purpose of disposal of the application. The applicant or its principal officer shall, if so
required, appear before the Board for personal representation.
7. Consideration of Application: The Board shall take into account for considering the grant
of a certificate, all matters, which are relevant to the activities relating to merchant banker
and in particular whether the applicant complies with the following requirements;
1. That the applicant shall be a body corporate other than a non-banking financial company
as defined by the Reserve Bank of India Act, 1934.
2. That the merchant banker who has been granted registration by the Reserve Bank of India
to act as Primary or Satellite Dealer may carry on such activity subject to the condition that
it shall not accept or hold public deposit.
3. That the applicant has the necessary infrastructure like adequate office space, equipments,
and manpower to effectively discharge his activities.
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4. That the applicant has in his employment minimum of two persons who have the
experience to conduct the business of the merchant banker.
5. That a person (any person being an associate, subsidiary, inter-connected or group
Company of the applicant in case of the applicant being a body corporate) directly or
indirectly connected with the applicant has not been granted registration by the Board.
6. That the applicant fulfils the capital adequacy as specified.
7. That the applicant, his partner, director or principal officer is not involved in any litigation
connected with the securities market which has an adverse bearing on the business of the
applicant.
8. That the applicant, his director, partner or principal officer has not at any time been
convicted for any offence involving moral turpitude or has been found guilty of any
economic offence.
9. That the applicant has the professional qualification from an institution recognized by the
Government in finance, law or business management.
10. That the applicant is a fit and proper person. 11. That the grant of certificate to the
applicant is in the interest of investors.
8. Capital Adequacy Requirement According to the regulations, the capital adequacy
requirement shall not be less than the net worth of the person making the application for grant of
registration. For this purpose, the net worth shall be as follows:
Category
Minimum Amount
Category I
Rs.5, 00, 00,000
Category II
Rs.50, 00,000
Category III
Rs.20, 00,000
Category IV
Nil
For the purpose of this regulation ‗net worth means in the case of an applicant which is a
partnership firm or a body corporate, the value of the capital contributed to the business of
such firm or the paid up capital of such body corporate plus free reserves as the case may be
at the time of making application.
Procedure for Registration The Board on being satisfied that the applicant is eligible shall
grant a certificate in Form B. On the grant of a certificate the applicant shall be liable to pay
the fees in accordance with Schedule II.
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Renewal of Certificate Three months before expiry of the period of certificate, the merchant
banker, may if he so desired, make an application for renewal in Form A. The application for
renewal shall be dealt with in the same manner as if it were a fresh application for grant of a
certificate. In case of an application for renewal of certificate of registration, the provisions
of clause (a) of regulation 6 shall not be applicable up to June 30th, 1998. The Board on
being satisfied that the applicant is eligible for renewal of certificate shall grant a certificate
in form B and send intimation to the applicant. On the grant of a certificate the applicant shall
be liable to pay the fees in accordance with Schedule II.
Procedure where Registration is not granted:
Where an application for grant of a certificate under regulation 3 or of renewal under
regulation 9, does not satisfy the criteria set out in regulation 6, the Board may reject the
application after giving an opportunity of being heard. The refusal to grant registration shall be
communicated by the Board within thirty days of such refusal to the applicant stating therein the
grounds on which the application has been rejected. Any applicant may, being aggrieved by the
decision of the Board, under sub regulation (1), apply within a period of thirty days from the date
of receipt of such intimation to the Board for reconsideration for its decision. The Board shall
reconsider an application made under sub-regulation (3) and communicate its decision as soon as
possible in writing to the applicant.
Effect of Refusal to Grant Certificate:
Any merchant banker whose application for a certificate has been refused by the Board
shall on and from the date of the receipt of the communication under sub-regulation (2) of
regulation 10 cease to carry on any activity as merchant banker.
Payment of Fees Every applicant eligible for grant of a certificate shall pay such fees in
such manner and within the period specified in Schedule II. Where a merchant banker fails to
any annual fees as provided in sub-regulation (1), read with Schedule II, the Board may suspend
the registration certificate, whereupon the merchant banker shall cease to carry on any activity as
a merchant banker for the period during which the suspension subsists.
1.5.4 CODE OF CONDUCT FOR MERCHANT BANKERS
The SEBI regulations have outlined the following code of conduct for the merchant bankers
operation in India;
• A merchant banker shall make all efforts to protect the interests of investors.
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• A Merchant Banker shall maintain high standards of integrity, dignity and fairness in the
conduct of its business.
• A Merchant Banker shall fulfill its obligations in a prompt, ethical, and professional manner.
• A Merchant Banker shall at all times exercise due diligence, ensure proper care and exercise
independent professional judgment.
• A Merchant Banker shall Endeavour to ensure that enquiries from the investors are adequately
dealt with, grievances of investors are redressed in a timely and appropriate manner, where a
complaint is not remedied promptly, the investor is advised of any further steps which may be
available to the investor under the regulatory system.
• A Merchant Banker shall ensure that adequate disclosures are made to the investors in a
timely manner in accordance with the applicable regulations and guidelines so as to enable them
to make a balanced and informed decision.
• A Merchant Banker shall endeavor to ensure that the investors are provided with true and
adequate information without making any misleading or exaggerated claims or any
misrepresentation and are made aware of the attendant risks before taking any investment
decision.
• A Merchant Banker shall endeavor to ensure that copies of the prospectus, offer document,
letter of offer or any other related literature is made available to the investors at the time of issue
of the offer.
• A Merchant Banker shall not discriminate amongst its clients, save and except on ethical and
commercial considerations.
• A Merchant Banker shall not make any statement, either oral or written, which would
misrepresent the services that the Merchant Banker is capable of performing for any client or
has rendered to any client.
• A Merchant Banker shall avoid conflict of interest and make adequate disclosure of its
interest. • A Merchant Banker shall put in place a mechanism to resolve any conflict of interest
situation that may arise in the conduct of its business or where any conflict of interest arises,
shall take reasonable steps to resolve the same in an equitable manner.
• Merchant Banker shall make appropriate disclosure to the client of its possible source or
potential areas of conflict of duties and interest while acting as Merchant Banker which would
impair its ability to render fair, objective and unbiased services.
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• A Merchant Banker shall always endeavor to render the best possible advice to the clients
having regard to their needs.
• A Merchant Banker shall not divulge to anybody either oral or in writing, directly or
indirectly, any confidential information about its clients which has come to its knowledge,
without taking prior permission of its client, except where such disclosures are required to be
made in compliance with any law for the time being in force.
• A Merchant Banker shall ensure that any change in registration status/any penal action taken by
the Board or any material change in the Merchant Banker‗s financial status, which may
adversely affect the interests of clients/investors is promptly informed to the clients and any
business remaining outstanding is transferred to another registered intermediary in accordance
with any instructions of the affected clients.
• A Merchant Banker shall not indulge in any unfair competition, such as weaning away the
clients on assurance of higher premium or advantageous offer price or which is likely to harm the
interests of other Merchant Bankers or investors or is likely to place such other Merchant
Bankers in a disadvantageous position while competing for or executing any assignment.
• A Merchant Banker shall maintain arms length relationship between its merchant banking
activity and any other activity.
• A Merchant Banker shall have internal control procedures and financial and operational
capabilities which can be reasonably expected to protect its operations, its clients, investors and
other registered entities from financial loss arising from theft, fraud, and other dishonest acts,
professional misconduct or omissions.
• A Merchant Banker shall not make untrue statement or suppress any material fact in any
documents, reports or information furnished to the Board.
• A Merchant Bankers shall maintain an appropriate level of knowledge and competence and
abide by the provisions of the Act, regulations made there under, circulars and guidance, which
may be applicable and relevant to the activities carried on by it. The merchant banker shall also
comply with the award of the Ombudsman passed under Securities and Exchange Board of India
(Ombudsman) Regulations, 2003.
• A Merchant Banker shall ensure that the Board is promptly informed about any action, legal
proceedings etc., initiated against it in respect of material breach or non-compliance by it, of any
law, rules, regulations, directions of the Board or of any other regulatory body.
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• A Merchant Banker or any of its employers shall not render, directly or indirectly, any
investment advice about any security in any publicly accessible media, whether real-time ,
unless a disclosure of his interest including a long or short position, in the said security has been
made, while rendering such advice. In the event of an employee of the Merchant Banker
rendering such advice, the merchant banker shall ensure that such employee shall also disclose
the interests, if any, of himself, his dependent family members including their long or short
position in the said security, while rendering such advice.
• A Merchant Banker shall demarcate the responsibilities of the various intermediaries
appointed by it clearly so as to avoid any conflict or confusion in their job description.
• A Merchant Banker shall provide adequate freedom and powers to its compliance officer for
the effective discharge of the compliance officer‗s duties.
• A Merchant Banker shall develop its own internal code of conduct for governing its internal
operations and laying down its standards of appropriate conduct for its employees and officers in
carrying out their duties. Such a code may extend to the maintenance of professional excellence
and standards, integrity, confidentiality, objectivity, avoidance or resolution of conflict of
interests, disclosure of shareholdings and interests etc.
• A Merchant Banker shall ensure that good corporate policies and corporate governance are in
place.
• A Merchant Banker shall ensure that any person it employs or appoints to conduct business is
fit and proper and otherwise qualified to act in the capacity so employed or appointed
• A Merchant Banker shall ensure that it has adequate resources to supervise diligently and
does supervise diligently persons employed if appointed by it in the conduct of its business, in
respect of dealings in securities market.
• A Merchant Banker shall be responsible for the acts or omissions of its employees and agents
in respect of the conduct of its business.
• A Merchant Banker shall ensure that the senior management, particularly decision makers have
access to all relevant information about the business on a timely basis.
• A Merchant Banker shall not be a party to or instrumental for creation of false market; price
rigging or manipulation; or passing of unpublished price sensitive information in respect of
securities which are listed and proposed to be listed in any stock exchange to any person or
intermediary in the securities market.
1.6 SEBI Guidelines
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1.6.1 Operational Guidelines
SEBI has pronounced the following guidelines for merchant bankers:
1. Submission of offer document:
The offer documents of issue size up to Rs. 20 crores shall be filed by lead merchant
bankers with the concerned regional office of the Board under the jurisdiction of which the
registered office of the issuer company falls. The jurisdiction of regional offices/head office shall
be as per Schedule XXII. According to Clause 5.6 of Chapter V of the Guidelines, the draft offer
document filed with the Board shall be made public. The lead merchant banker shall make
available 10 copies of the draft offer document to the Board and 25 copies to the stock
exchange(s) where the issue is proposed to be listed. Copies of the draft offer document shall be
made available to the public by the lead merchant bankers/Stock Exchange. The lead merchant
banker and the Stock Exchange(s) may charge a reasonable charge for providing a copy of the
draft offer document. The lead merchant banker shall also submit to the Board the daft offer
document on a computer floppy in the format specified in Schedule XXIII. The Lead Merchant
Banker shall submit two copies of the printed copy of the final offer document to dealing offices
of the Board within three days of filing offer document with Registrar of companies/concerned
Stock Exchange(s) as the case may be.
The lead merchant banker shall submit one printed copy of the final offer document to
the Primary Market Department, SEBI, Head Office, within three days of filing the offer
document with Registrar of Companies/concerned Stock Exchange(s) as the case may be. The
lead merchant banker shall submit a computer floppy containing the final prospectus/letter of
offer to the Primary Market Department, SEBI, Head Office, as specified in Schedule XXIII
within three days of filing the final prospects/letter of offer with the Registrar of
Companies/concerned Stock Exchange(s). Along with the floppy, the lead manager shall submit
an undertaking to SEBI certifying that the contents of the floppy are in HTML, format, and are
identical to the printed version of the proposes/letter of offer filed with the registrar of
Companies/concerned Stock Exchange, as the case may be. Wherever offer documents (for
public/rights issues, takeovers or for any other purpose) are filed with any Department/Office of
the Board, the following details ―certified as correct shall be given by the lead merchant banker
in the forwarding letters:
a. Registration number
b. Date of registration/Renewal of registration
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c. Date of expiry of registration
d. If applied for renewal, date of application
e. Any communication from the Board prohibiting them from acting as a
f. merchant banker
g. Any inquiry/investigation being conducted by the Board
h. Period up to which registration/renewal fees has been paid
i. Whether any promoter/group and/or associate company of the issuer company is
associated with securities-related business and registered with SEBI
j. If any one or more of these persons/entities are registered with SEBI, their respective
registration numbers
k. If registration has expired, reasons for non-renewal
l. Details of any enquiry/investigation conducted by SEBI at any time
m. Penalty imposed by SEBI
n. Outstanding fees payable to SEBI by these entities, if any Offer documents not
accompanied by the information as contained above may be rejected. Lead merchant bankers
shall obtain similar information from other intermediaries to ensure that they comply with these
guidelines and are eligible to be associated with the concerned issue. The intermediaries shall
also indicate in their letters that they have obtained such information from other intermediaries.
2. Dispatch of issue material:
Lead merchant bankers shall ensure that whenever there is a reservation for NRIs, 10
copies of the prospectus together with 1000 application forms are dispatched in advance of the
issue opening date, directly along with a letter addressed in person to Adviser (NRI), Indian
Investment Centre, Jeevan Vihar Building Sansad Marg, and New Delhi. Twenty copies of the
prospectus and application forms shall be dispatched in advance of the issue opening date to the
various Investors Associations.
3. Underwriting while selecting underwriters and finalizing underwriting arrangement, lead
merchant bankers shall ensure that the underwriters do not overexpose themselves so that it
becomes difficult to fulfill their underwriting commitments. The overall exposure of
underwriter(s) belonging to the same group or management in an issue shall be assessed
carefully by the lead merchant banker. OTC Dealers registered with the Board under SEBI
(Stock Brokers and Sub-Brokers) Rules and Regulations, 1992 shall be treated at par with the
brokers
of
other
stock
exchanges
in
respect
of
underwriting
arrangement.
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4. Compliance obligations: The merchant banker shall ensure compliance with the following
post-issue obligations
a. Association of resource personnel:
In terms of Clause 7.1 of Chapter VII of these
Guidelines, in case of over-subscription in public issues, a Board nominated public
representative shall be associated in the process of finalization of the basis of allotment. The lead
merchant banker shall intimate to the person so nominated the date, time, venue etc. regarding
the process of finalization of the basis of allotment. The expenses of the public representatives
associated in the allotment process of oversubscribed issues shall be borne by the lead merchant
bankers, and recovered from the issues. Honorarium at a minimum of Rs.500/- per day, plus
normal conveyance charges shall be paid to them, and the Board‗s Regional Managers at New
Delhi, Chennai and Calcutta shall be associated with them.
b. Redressal of investor grievances:
The merchant bankers shall assign high priority to
investor grievances, and take all preventive steps to minimize the number of complaints. The
lead merchant banker shall set up a proper grievance monitoring and redressal system in coordination with the issuers and the Registrars to Issue.. They shall take all necessary measures to
resolve the grievances quickly. They shall actively associate with post-issue refund and allotment
activities and regularly monitor investor grievances arising there from.
c. Submission of post issue monitoring reports: The concerned lead merchant banker shall
submit, in duplicate, the Post Issue Monitoring Reports specified in Clause 7.2 of Chapter VII of
these Guidelines, within 3 working days from the due dates, either by registered post or deliver
them at the respective regional offices/head office give in Schedule XXII. Where the offer
documents have been dealt with by any of the regional offices of the Board, a copy of the report
shall be sent to the Board‗s Head office, Mumbai. The Lead Merchant Banker(s) shall inform the
Board on important developments about the particular issues being lead managed by them during
the period intervening the reports.
d. Issue of No objection Certificate (NOC: In accordance with the Listing Agreement of the
Stock Exchanges, the issuer companies shall deposit 1% of the amount of securities offered to
the public and/or to the holders of the existing securities of the company, as the case may be,
with the regional Stock Exchange. These securities can be related by the concerned Stock
Exchange only after obtaining an NOC from the Board. An application for NOC shall be
submitted by the issue company to the Board in the format specified in Schedule XXIV. The
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following conditions shall be complied with before submitting the application for the issue of
NOC.
• Completion of 4 months from the date of obtaining the listing permission from the concerned
Regional Stock Exchange, or the last date when the listing permission was obtained from any of
the other Stock Exchanges, where the securities are proposed to be listed, whichever is later
• Satisfactory Redressal of all complaints received by the Board against the company
• Certificate from the Regional Stock Exchange to the issuer company to the effect that
underwriting/brokerage commission as well as the Registrars/Lead merchant bankers fees been
duly paid by the company Application for issue of NOC shall be filed with the concerned
regional office of the Board, under the jurisdiction in which the registered office of the issuer
company falls, as specified in Schedule XXII.. In cases where issues fail, and the investors‘
monies are fully refunded, an NOC from the Board may not be required, and the concerned
regional Stock Exchange can refund the 1% security deposit after duly verifying that the refund
orders have actually been dispatched. The complaints with respect to non-receipt of
underwriting/brokerage commission and Registrars/Lead merchant banker‗s fees may be filed
with the concerned regional Stock Exchanges. Responses to complaints forwarded by the Board
to the concerned companies shall be submitted to the Board in the proforma specified in
Schedule XXV for updating of records.
e. Registration of merchant bankers: Application for renewal of Certificate of Registration
shall be made by the merchant bankers according to Regulation 9 of SEBI (Merchant Bankers)
Rules and Regulations, 1992. While filing the renewal application for the certificate of
registration as merchant banker, it shall provide a statement highlighting the changes that have
taken place in the information that was submitted to the Board for the earlier registration, and a
declaration stating that no other changes besides those mentioned in the above statement have
taken place. Merchant Bankers, while forwarding the renewal application in Form A of the SEBI
(Merchant Bankers) Rules and Regulations, 1992, shall also forward the additional information
as specified in Schedule XXVI. Registered Merchant Bankers shall inform the Board of their
having become a member of AMBI, with the relevant details.
f. Reporting requirements: In terms of Regulation 28 of SEBI (Merchant Bankers Regulation)
1992, the merchant bankers shall send a half yearly report, in the format specified in Schedule
XXVII, relating to their merchant banking activities. The report referred to in sub-clause (a) shall
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be submitted twice a year, on March 31 and September 30, and it should reach the Board within
three months from the close of the period to which it relates.
g. Impositions of penalty points: Penalty points may be imposed on the merchant banker for
violation of any of the provisions for operational guidelines. The merchant banker, on whom
penalty points of four or more has been imposed, may be restrained from filing any offer
document or associating or managing any issues for a particular period. The Board may initiate
action under the SEBI (Merchant Bankers) Regulations against the merchant bankers,
irrespective of whether any penalty point is imposed or not. Imposition of penalty point is not a
precondition for initiation of proceedings against the merchant banker under the SEBI (Merchant
Bankers) Regulations.
Guidelines on Advertisement Following are the guidelines applicable le to the lead merchant
banker who shall ensure due compliance by the issuer company:
1. Factual and truthful: An issue advertisement shall be truthful, fair and clear, and shall not
contain any statement that is untrue or misleading. Any advertisement reproducing, or purporting
to reproduce, any information contained in an offer document shall reproduce such information
in full and disclose all relevant facts. It should not be restricted to select extracts relating to that
item. An issue advertisement shall be considered to be misleading, if it contains : a. Statements
made about the performance or activities of the company in the absence of necessary explanatory
or qualifying statements, which may give an exaggerated picture of the performance or activities.
b. An inaccurate portrayal of past performance, or its portrayal in a manner which implies that
past gains or income, will be repeated in the future.
2. Clear and concise: An advertisement shall be set forth in a clear, concise and understandable
language. Extensive use of technical, legal terminology or complex language and the inclusion of
excessive details, which may distract the investor, shall be avoided.
3. Promise or profits: An issue advertisement shall not contain statements which promise or
guarantee rapid increase in profits. An issue advertisement shall not contain any information that
is not contained in the offer document.
4. Mode of advertising: No models, celebrities, fictional characters, landmarks, caricatures or
the likes shall be displayed on or form part of the offer documents or issue advertisements. Issue
advertisements shall not appear in the form of crawlers (the advertisements which run
simultaneously with the program in a narrow strip at the bottom of the television screen) on
television. Similarly, no advertisement shall include any issue slogans or brand names for the
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issue, except the normal commercial name of the company or commercial brand names of its
products already in use. No slogans, expletives or non-factual and unsubstantiated titles shall
appear in the issue advertisements or offer documents.
5. Financial data: If any advertisement carries any financial data, it shall also contain data for
the past three years and shall include particulars relating to sales, gross profit, not profit, share
capital, reserves, earnings per share, dividends, and book values.
6. Risk factors: All issue advertisements carried in the print media such as newspapers,
magazines, brochures or, pamphlets shall contain highlights relating to any issue, besides
containing detailed information on the risk factors. The print size of highlights and risk factors in
issue advertisements shall not be less than point 7 sizes. It shall contain the names of Issuer
Company, address of its registered office, names of the main lead merchant bankers and
Registrars to the Issue. No issue advertisement shall be released without giving ―Risk Factors in
respect of the concerned issue, provided that an issue opening/closing advertisement which does
not contain the highlights need not contain risk factors.
7. Issue date No corporate advertisement of Issuer Company shall be issued after 21 days of
filing of the offer document with the Board until the closure of the issue, unless the risk factors
which are required to be mentioned in the offer document, are mentioned in the advertisement.
8. Product advertisement No product advertisement of the company shall contain any
reference, directly or indirectly, to the performance of the company during the period.
9. Subscription No advertisement shall be issued stating that the issue has been fully subscribed
or oversubscribed during the period the issue is open for subscription, except to the effect that
the issue is open or closed.
10. Issue closure No announcement regarding closure of the issue shall be made except on the
closing date. If the issue is fully subscribed before the closing date stated in the offer document,
the announcement should be made only after the issue is fully subscribed and such
announcement is made on the date on which the issued is to be closed. Announcements regarding
closure of the issue shall be made only after the lead merchant banker is satisfied that at least
90% of the issue has been subscribed, and a certificate has been obtained to that effect from the
Registrar to the issue.
11. Incentives No incentives, apart from the permissible underwriting commission and
brokerage, shall be offered through advertisements to anyone associated with marketing the
issue.
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12. Reservation In case there is a reservation for NRIs, the issue advertisement shall specify the
same, and also indicate the place in India from where the individual NRI applicant can procure
application forms.
13. Undertaking: An undertaking has to be obtained from the issuer as part of the MoU between
the lead merchant banker and the issue company to the effect that the issuer company shall not
directly or indirectly release, during any conference or at any other time, any material or
information which is not contained in the offer documents.
14. Availability of copies: To ensure that the issuer company obtains approval for all issue
advertisements and publicity materials from the lead merchant banker responsible for marketing
the issue and also ensure the availability of copies of all issue related materials with the lead
merchant banker, at least until the allotment is completed by the SEBI.
1.7 STOCK EXCHANGES:
• It is the market for exchange of stocks.
• Stock refers to the old securities i.e., those which have been already issued and listed on a stock
exchange.
• These securities are purchased and sold continuously among investors without the involvement
of companies.
• Stock exchange provides not only free transferability of shares but also makes continuous
evaluation of securities traded in the market.
It is also called a ‗Secondary Market‘ for securities. It is considered to be sine-quonon
for the primary market. In fact, the success of the issues taking place in the primary market
depends much on the soundness and the depth of the secondary market. It provides the investor,
the facility of disposing off their holdings as and when the need for it arises.
According to Hastings, Stock exchange or securities market comprises all the places
where buyers and sellers of stocks and bonds or their representatives undertake transactions
involving the sale of securities‗.
According to Derek Koney gold, Stock exchange can be described as the place where a
marriage of convenience is enacted between those who wish to raise capital, such as companies,
governments and local authorities, and those who wish to invest – largely households through the
medium of institutions acting upon their behalf.
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According to Section 2(3) of the Securities Contract Regulation Act 1956.bThe stock
exchange has been defined as anybody of individuals whether incorporated or not, constituted for
the purpose of assisting, regulating or controlling the business of buying, selling or dealing in
securities.
The following securities can be traded at the stock exchange a. Shares, scrip‘s, stock,
bonds, debentures, debentures stocks or other marketable securities of a like nature in or of any
incorporated company or other body corporate b. Government securities; and c. Rights or
interests in securities
1.7.1Objectives of Stock Exchanges
The Objectives of stock exchanges are
1. Assisting in buying and selling of securities
2. Regulating the business of buying and selling or dealing in securities.
1.7.2 Functions of Stock Exchanges
The stock market occupies a pivotal position in the financial system. It performs several
economic functions and renders invaluable services to the investors, companies, and to the
economy as a whole. They may be summarized as follows:
1. Liquidity and marketability of Securities:
Stock exchanges provide liquidity to securities since securities can be converted into
cash at any time according to the discretion of the investor by selling them at the listed prices.
They facilitate buying and selling of securities at listed prices by providing continuous
marketability to the investors in respect of securities they hold or intend to hold. Thus, they
create a ready outlet for dealing in securities.
2. Safety of Funds:
Stock exchanges ensure safety of funds invested because they have to function under
strict rules and regulations and the bye laws are meant to ensure safety of investible funds. Over
trading, illegitimate speculation etc., are prevented through carefully designed set of rules. This
would strengthen the investor‗s confidence and promote larger investment.
3. Supply of Long term funds:
The Company is assured of long term availability of funds because the security is
transacted one investor is substituted by another.
4. Flow of Capital to Profitable Ventures:
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The profitability and popularity of companies are reflected in stock prices. The prices
quoted indicate the relative profitability and performance of companies. Funds tend to be
attracted towards securities of profitable companies and this facilitates the flow of capital into
profitable channels.
5. Motivation for improved performance:
The performance of a company is reflected on the prices quoted in the stock market.
These prices are more visible in the eyes of the public. Stock market provides room for this price
quotation for those securities listed by it. This public exposure makes a company conscious of its
status in the market and it acts as a motivation to improve its performance further.
6. Promotion of Investment:
Stock exchanges mobilize the savings of the public and promote investment through
capital formation. But for these stock exchanges, surplus funds available with individuals and
institutions would not have gone for productive and remunerative ventures.
7. Reflection of Business Cycle:
The changing business conditions in the economy are immediately reflected on the stock
exchanges. Booms and depressions cane be identified through the dealings on the stock
exchanges and suitable monetary and fiscal policies can be taken by the government. Thus a
stock market portrays the prevailing economic situation instantly to all concerned so that suitable
actions can be taken.
8. Marketing of New Issues:
If the new issues are listed, they are readily acceptable to the public, since, listing
presupposes their evaluation by concerned stock exchange authorities. Costs of underwriting
such issues would be less. Public response to such new issues would be relatively high. Thus, a
stock market helps in the marketing of new issues also.
9. Miscellaneous Services:
Stock exchange supplies securities of different kinds with different maturities and yields.
It enables the investors to diversity their risks by a wider portfolio of investment. It also
inculcates saving habits among the community and paves the ways for capital formation. It
guides the investors in choosing securities by supplying him daily quotation of listed securities
and by disclosing the trends of dealings on the stock exchange. It enables companies and the
Government to raise resources by providing a ready market for their securities.
1.8. Organization of Stock Exchanges:
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The first organized stock exchange in India was started in Bombay in 1875 with the
formation of the ‗Native share and Stock Brokers Association‗. Thus the Bombay Stock
Exchange is the oldest one in the country. With the growth of Joint stock companies, the stock
exchanges also made a steady growth and at present these are 23 recognized stock exchanges
with about 6000 stock brokers.
1.8.1 Traditional Structure of stock Exchanges The stock exchanges in India can be classified
into two broad groups on the basis of their legal structure.
They are; 1. Three stock exchanges which are functioning as association of person‗s viz., BSE,
ASE and Madhya Pradesh Stock Exchange.
2. Twenty stock exchanges which have been set up as companies, either limited by guarantees or
by shares. They are
 Bangalore Stock Exchange
 Bhubaneswar Stock exchange
 Calcutta Stock Exchange
 Cochin Stock Exchange
 Coimbatore Stock Exchange
 Delhi Stock Exchange
 Gauhati Stock Exchange
 Hyderabad Stock Exchange
 Interconnected Stock Exchange
 Jaipur Stock Exchange
 Ludhiana Stock Exchange
 Madras Stock Exchange
 Magadh Stock Exchange
 Mangalore Stock Exchange
 National Stock Exchange
 Pune Stock Exchange
 OTCEI
1.8.2 Demutualization of Stock Exchanges
• The transition process of an exchange from a ―mutually-owned‖ association to a company
―owned by Shareholders‖ is called demutualization.
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• Demutualization is transforming the legal structure, of an exchange from a mutual form to a
business corporation form. In a mutual exchange, the three functions of ownership, management
and trading are intervened into a single group. It means that the broker members of the exchange
are owners as well as traders on the exchange and further they themselves manage the exchange.
These three functions are segregated from one another after demutualization.
The demutualised stock exchanges in India are;
1. The National Stock Exchange (NSE)
2. Over the Counter Exchange of India (OTCEI)
1.8.3 Corporatization of Stock Exchanges
The process of converting the organizational structure of the stock exchange from a noncorporate structure to a corporate structure is called Corporatization of stock exchanges. As
stated earlier, some of the stock exchanges were established as ―Association of persons in India
like BSE, ASE and MPSE. Corporatization of these exchanges is the process of converting then
into incorporated companies.
Management:
The recognized stock exchanges are managed by ― Governing Boards‗. The governing
boards consist of elected member directors from stock broker members, public representatives
and government nominees nominated by the SEBI. The government has also powers to nominate
Presidents and Vice-presidents of stock exchanges and to approve the appointment of the chief
Executive and public representatives. The major stock exchanges are managed by the Chief
Executive Director and the smaller stock exchanges are under the control of a Secretary.
Membership:
To become a member of a recognized stock exchange, a person must possess the
following qualifications:
• He should be a citizen of India,
• He should not be less than 21 years of age,
• He should not have been adjudged bankrupt or insolvent,
• He should not have been convicted for an offence involving fraud or dishonesty,
• He should not be engaged in any other business except dealing in securities,
• He should not have been expelled by any other stock exchange or declared a defaulter by any
other stock exchange.
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Methods of Trading in a Stock Exchange:
The stock exchange operation at follow level is highly technical in nature. Nonmembers
are not permitted to enter into the stock market. Hence, various stages have to be completed in
executing a transaction at a stock exchange. The steps involved in the methods of trading have
been given below:
1. Choice of Broker:
The prospective investor who wants to buy shares or the investor who wants to sell his
shares cannot enter into the hall of exchange and transact business. They have to act through
only member brokers. They can also appoint their bankers for this purpose, since; bankers can
become members of the stock exchange as per the present regulations. So, the first task in
transacting business on a stock exchange is to choose a broker of repute or a banker. Such
persons alone can ensure prompt and quick execution of a transaction at the best possible and
profitable price.
2. Placement of Order:
Placement of order refers to the purchase or sale of securities with the broker. The order
is usually placed by telegram, telephone, letter, fax etc., or in person.
3. Execution of Orders:
The Orders are executed through their authorized clerks. Small one carries out their
business personally. Orders are executed in Trading ring of a stock exchange which works from
12 noon to 2 p.m. on all working days from Monday to Friday and a special one hour session on
Saturday. Trading outside the trading hours is called kerb dealings.
(1) Preparation of Contract Notes:
A contract note is a written agreement between the broker and his client for the
transactions executed. It contains the details of the contract made for the purchase/sale of
securities, the brokerage chargeable, name of the company, number of shares bought/ sold, net
rate, etc., it is prepared in a prescribed from and a copy of it is also sent to the client.
(2) Settlement of Transactions:
The settlement of transactions is made by means of delivering the share certificates along
with the transfer deed. The transfer deed is duly signed by the transferor, i.e., the seller. It bears
the stamp of the selling broker. The buyer then fills up the particulars in the transfer deed.
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At present, the settlement can be made by any one of the following methods;
• Spot delivery settlement:
i.e., the delivery of securities and payment for these are affected on the date of the
contract itself or on the next day.
• Hand Delivery Settlement:
i.e., the delivery of securities and payment are affected within the time stipulated in the
agreement or within 14 days from the date of the contract whichever is earlier.
• Clearing Settlement:
i.e., the transactions are cleared and settled through the clearing house. Usually those
securities which are frequently traded and are usually in demand are cleared through the clearing
house. These transactions are also referred to as the transaction for the account.
• Special Delivery Settlement:
i.e., the delivery of securities and payment may take place at any time exceeding 14 days
following the date of the contract as specified in the contract and permitted by the governing
board.
1.9 ONLINE TRADING
• It is the trading over the net i.e., E-trading
To overcome the wastage of time consumed and inefficient operations of the traditional
method and the limits on trading volumes the NSE has introduced a nation-wide on line fully
automated Screen Based Trading System (SBTS). Now, other stock exchanges have been forced
to adopt SBTS and today India can boast that almost 100% trading take place through electronic
order matching. Under SBTS, a member can punch into the computers quantities of securities
and the prices at which he likes to transact the transaction. It is executed as soon as it finds a
matching sale or buys order from a counter party; Thus, technology is used to carry the trading
platform from the trading hall of the exchanges to the premises of the brokers. NSE has carried
the trading platform further to the PCs at the residence of the investors through the internet and
the hand held devices through WAP for the convenience of the mobile investors. This system
also provides complete market information on-line. The market screens at any point of time
provide complete information as to
(1). Total order depth in a security
(2). The best five buys and sells in the market
(3). The quantity traded during the day in that security
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(4). The high and the low price for each security
(5). The last traded price for a security etc.,
1.9.1 BSE BOLT SYSTEM, BOLT:
(Bombay on line Trading) has been introduced in the Bombay Stock Exchange. All the
scrip‘s are being traded through BOLT. Many small companies in India re finding it difficult to
raise adequate capital through stock exchanges as the conditions stipulated by them could not be
fulfilled. The companies must have run for minimum three years and they must have earned
profit and the minimum capital requirement for listing is also quite high which is at present is
Rs.5 Crores. Hence, promoting a new stock exchange with flexible conditions, the small and
medium companies in India will be able to raise sufficient capital, once these companies enlarge
their resources, they can list themselves in the regular stock exchanges.
1.10 OTCEI (Over the Counter Exchange of India)
It is a Stock Exchange without a proper trading floor
All stock exchanges have a specific place for trading their securities through counters.
But, OTCEI is connected through a computer network and the transactions are taking place
through computer operations. Thus, the development in information technology has given scope
for starting this type of stock exchange. This stock exchange is recognized under the Securities
Contract (Regulation) Act and so all the stocks listed in this exchange enjoy the same benefits as
other listed securities enjoy.
OTCEI has been incorporated under Section 25 of the companies Act. As a result of
which the word limited‘ need not be used since it is promoted for a common case of promoting
the interest of small and medium companies. This privilege has been given to the company by
the Central government. This company was promoted by a group of financial institutions owned
by Government of India, consisting of UTI, ICICI, IDBI, SBI Capital Market, IFCI, LIC, GIC
and CAN BANK financial Services.
1.10.1 FEATURES OF OTCEI
(1) Use of Modern Technology: It is an electronically operated stock exchange.
(2) Restrictions for other stocks: Stocks and shares listed in other stock exchanges will not be
listed in the OTCEI and similarly, stock listed in OTCEI will not be listed in other stock
exchanges.
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(3) Minimum issued capital requirements: Minimum issued equity capital should be Rs.30
lakhs, out of which minimum public offer should be Rs.20 lakhs. (4) Restrictions for large
companies: No company with the issued equity share capital of more than Rs.25 crores is
permitted for listing.
(5) Base Capital requirement for members: Members will be required to maintain a minimum
base capital of Rs. 4 lakhs to trade on the permitted or on listed segment.
(6) All India network: The network of counters links OTCEI members, located in different
parts of the country.
(7) Satellite facility: The satellite required for OTCEI for its operations is jointly held with Press
Trust of India
(8) Computerization of transactions: Computers at each counter enable the dealers to enter
various transactions or queries or quotes through a central OTCEI computer, using
telecommunication links.
1.10.2 Objectives of OTCEI:
The following are the objectives of OTCEI
1. Assisting and guiding small companies to raise funds from the capital market in a costeffective manner
2. Providing a convenient and an efficient avenue of capital market investments for small
investors
3. Strengthening investors‘ confidence in the financial market by offering them the two-way best
prices to them
4. Ensuring transparency, redressing investors‘ complaints and unifying the country‗s securities
market to cover even those places which do not have a stock exchange
5. Acting as a launch pad to an IPO
6. Providing liquidity advantage to the securities traded
7. Promoting organized trading in Unlisted Securities
8. Providing a source of valuation for securities traded OTCEI offers the following benefits :
Benefits to Listed Companies
The benefits that are offered to companies listed with OTCEI are as follows:
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1. Negotiability: The Company can negotiate the issue price with the sponsors who have to
market the issue. It provides an opportunity for fair pricing of an issue through negotiation with
the sponsors.
2. Fixation of premium: In consultation with the sponsors, the company can fix an optimum
level of premium on issue with minimum risk of non-subscription of the issue.
3. Savings in costs: Lots of costs associated with public issue of capital are saved through this
mode. It provides an opportunity to companies to raise funds through capital market instruments
at an extremely low cost as compared to a public issue. The method of sponsors placing the
scrip‘s with members who in turn will offload the scrip‘s to public will obviate the need for a
public issue and its associated costs.
4. No take-over threat: OTCEI lists scrip‘s even with 40 percent of the capital offered for
public trading. The limit has now been brought down to 20 percent in the case of closely held
companies and new companies. As a result, the present management of the companies are saved
of threats of takeover if they restrict public offer.
5. Large access: Accessing a large pool of captive investor base through the OTCEI‗s
computerized network is made possible for companies. Though nationwide network for servicing
of investors, companies listed on OTC Exchange can have a larger investor base.
6. Other benefits:
a. Helpful to small companies
b. Shares of all unlisted companies can now be traded on OTCEI
c. Platform for issuers and first-level investors like financial institutions, state level financial
corporations, Foreign Institutional Investors, etc.
d. System for defining benchmark for securities
e. Increasing business for the market constituents
Benefits to Investors
OTCEI offers the following benefits for investors:
1. Safety: OTCEI‗s ring less and scrip less electronic trading ensure safety of transactions of the
investor. For instance, every investor in a OTCEI is given an ‗Invest-OTC-Card free. This code
is allotted on a permanent basis and should be used in all OTC transactions and applications of
OTC issues. This card provides for the safety and security of the investors investments. The
mechanism offers greater security to investors as the sponsors investigate into the company and
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the projects, before accepting sponsorship thus building up much needed greater investor
confidence.
2. Transparency: OTC screens at every OTC counter display the best buy/sell prices. The exact
trading prices are printed in the trading documents for confirmations. This protects the investor
interest and there by minimize disputes.
3. Liquidity: A great advantage of the OTC is that the scrip‘s traded are liquid. This is because
there are at least two market-makers who indulge in continuous buying and selling. This enables
investors to buy and sell the scrip‘s any time.
4. Appraisal: OTC members sponsor each scrip listed in an OTC counter. The sponsor makes an
appraisal of the scrip‘s for investor worthiness. This ensures quality of investments.
5. Access: Every OTC counter serves as a single window to the entire OTC exchange throughout
the country and throughout the world too. Therefore, buying and selling may be resorted to from
any part of the world. It offers the facility of faster deal settlement for investors across the
counters spread over the entire country.
6. Transfer: It is important that OTC shares are transferable within 7 days, where the
consolidated holdings of the scrip‘s do not exceed 0.5 percent of the issued capital of the
company.
7. Allotment: There is not much waiting for the investors when it comes to allotment of scrip‘s.
Allotment is completed in all respects within a matter of 35 days and trading begins immediately
thereafter.
8. Other benefits : a. Derivatives such as futures and options, forward contracts on stock, and
other forms of forward transactions and stock lending are allowed on OTCEI b. Scrip less trading
makes dealings simper and easier c. Market-making system in OTC Exchange gives sufficient
opportunities for the investors to exit d. Acts as a benchmark to value securities e. Creating an
exit option for illiquid stocks/venture capitalists f. Shuffling portfolios for the investors g.
Organizing and broad-basing trading in the existing market
1.10.3 Benefits to Financial System
The OTCEI‗s role has been laudable in as far as it helps contribute improving the
financial system of India in the following ways:
1. National network of OTCEI operations facilitates the integration of capital market in the
country.
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2. Boon to closely-held companies as they are encouraged to go public because scrip‘s can be
listed even if only 40 percent of capital (now a minimum of 20 percent in case of closely held
and new companies) is offered for public trading.
3. Facilities wider dispersal of economic activities by encouraging small companies and small
investors.
4. Promoting savings and investments by offering easier avenues for raising capital.
5. Providing over-all stimulation to venture capital activities thereby promoting entrepreneurship.
6. Market-making assistance by the sponsors on the OTCEI that helps in making appraised future
projections in the issue documents which in turn helps prospective investors in determining the
usefulness of the issues for investment purposes, promoting investment environment in general.
7. Those members of the OTCEI who did not have multiple memberships can now have an
opportunity to trade in some of the large capital index stocks.
8. Encourage venture capital activities and boost entrepreneurship
9. Spread of stock exchange operations geographically all over India
Securities Traded Following are the securities that are traded on the OTCEI:
1. Listed equity (exclusive): These are equity shares of the companies listed exclusively on the
OTCEI. The shared can be bought or sold at any of the member/ dealer‗s office all over India.
The securities, which are listed exclusively on the OTCEI, cannot be traded on other stock
exchanges.
2. Listed debt: These are the debentures/bonds that are issued through a public issue or a private
placement and are listed on OTCEI. Any entity holding the entire series of a particular debt
instrument can also offer them for trading on the OTCEI, by appointing an OTCEI
member/dealer to carry out compulsory market making in those securities.
3. Gilts: The securities issued by the Central and State Governments are called ‗gilts‗.
Government of India Dated Securities, Treasury Bills and special securities are traded in this
segment. Banks, Foreign Investors, Foreign Institutional Investors, NBFCs and Provident Funds
can trade in these securities through OTCEI designated members/dealers.. PSU Bonds,
Commercial Paper, and Certificates of Deposit will also be traded in this segment.
4. Permitted securities: These are the securities listed on other exchanges, which are permitted
for trading on OTCEI. Securities of Blue Chip companies like ACC, Reliance Industries Ltd.,
State Bank of India, ITC, etc. are traded in this segment.
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5. Listed mutual funds: Listed mutual funds are units of mutual funds that are listed on OTCEI.
Mutual fund units like units of Unit-64, Monthly Income Plan, and IISFUS ‗97 are also listed
under this category. To counter the influence of Bombay Stock Exchange and reduce the
influence of certain powerful intermediaries in the stock market, a new stock market was
promoted in which both securities of companies and debt instruments are traded, namely the
National Stock Exchanges. NSE takes into account the screen based trading and so it is the most
advanced. The success of this stock exchange is quite evident that within a few years of its
promotion the volume and the value of transactions have surpassed the BSE.
CHAPTER II
ISSUE MANAGEMENT INTRODUCTION
2.1 INTRODUCTION
Merchant Banking, as a commercial activity, took shape in India through the
management of Public Issues of capital and Loan Syndication. It was originated in 1969 with the
setting up of the Merchant Banking Division by ANZ Grind lays Bank. The main service offered
at that time to the corporate enterprises by the merchant banks included the management of
public issues and some aspects of financial consultancy. The early and mid-seventies witnessed a
boom in the growth of merchant banking organizations in the country with various commercial
banks, financial institutions, and broker‗s firms entering into the field of merchant banking.
Reform measures were initiated in the capital market from 1992, starting with the conferring of
statutory powers on the Securities and Exchange Board of India (SEBI) and the repeal of Capital
Issues Control Act and the abolition of the office of the Controller of Capital Issues. These have
brought about significant improvement in the functional and regulatory efficiency of the market,
enabling the Merchant Bankers shoulder greater legal and moral responsibility towards the
investing public.
2.2 MERCHANT BANKERS AND CAPITAL ISSUES MANAGEMENT
Merchant Banker has been defined under the Securities & Exchange Board of India
(Merchant Bankers) Rules, 1992 as ―any person who is engaged in the business of issue
management either by making arrangements regarding selling, buying or subscribing to
securities as manager, consultant, advisor or rendering corporate advisory service in relation to
such issue management‖. The capital issue management comprises of the effective management
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of market related factors. They are • Transition to rolling settlement on the equity market •
Impact on different classes of market users • Obtaining a liquid bond market • Impact of reforms
of 1990s • Law and taxation • Taxation of capital • Legal reforms • Political economy of
financial sector reforms • Market design, market inefficiencies, trading profits
Issue Management: The management of issues for raising funds The management of issues for
raising funds through various types of instruments by companies is known as ― issue
management. The function of capital issues management in India is carried out by merchant
bankers. The Merchant Bankers have the requisite skill and competence to carry out capital
issues management. The funds are raised by companies to finance new projects, expansion /
modernization/ diversification of existing units etc., The definition of ‗merchant banker‗, as
contained in SEBI (Merchant Banker) Rules and Regulations, 1992 clearly brings out the
significance of Issue Management as follows: ―any person who is engaged in the business of
issue management either by making arrangement regarding selling, buying or subscribing to
securities as manager, consultant, advisor or rendering corporate advisory services in relation to
such issue management.
2.2.1 MERCHANTS OF PUBLIC ISSUE MANAGEMENT
Classification of Securities Issue
1. Public Issue
2. Right Issue
3. Private Placement
Decision to Raise Capital Funds Preparation and Finalization of Prospectus Obtaining
SEBI Approval Arranging underwriting Selection of Registrars, Brokers, Bankers, etc. Printing
and Publicity of Public Issue Documents Arranging Press for investor Conference Issue Launch
SEBI Compliance
1. Public Issue of Securities When capital funds are raised through the issue of a prospectus, it
is called ‗‗public issue of securities‗. It is the most common method of raising funds in the
capital market. A security issue may take place either at part, or at a premium or at a discount.
The Prospectus has to disclose all the essential facts about the company to the prospective
purchasers of the shares. Further, the prospectus must conform to the formal set out in Schedule
II of the Companies Act, 1956, besides taking into the account SEBI guidelines. SEBI insists on
the adequacy of disclosure of information that should serve as the basis for investors to make a
decision about the investment of their money.
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2. Rights Issue When shares are issued to the existing shareholders of a company on a privileged
basis, it is called as ‗Rights Issue‗. The existing shareholders have a pre-emptive right to
subscribe to the new issue of shares. Rights shares are offered as additional issues by corporate
to mop up further capital funds. Such shares are offered in proportion to the capital paid up on
the shares held by them at the time of the offer. It is to be noted that the shareholders, although
privileged to be offered on the issue, are under no legal obligation to accept the offer. Right
shares are usually offered on terms advantageous to the shareholders.
3. Private Placement When the issuing company sells securities directly to the investors,
especially institutional investors; it takes the form of private placement. In this case, no
prospectus is issued, since it is presumed that the investors have sufficient knowledge and
experience and are capable of evaluating the risks of the investment. Private placement covers
shares, preference shares and debentures. The role of the financial intermediary, such as the
merchant bankers and lead managers, assures great significance in private placement. They
involve themselves in the task of preparing an offer memorandum and negotiating with investors.
2.2.2 MERCHANT BANKERS FUNCTIONS
The different functions of merchant bankers towards the capital issues management are 1.
Designing Capital Structures. 2. Capital Market Instruments. 3. Preparation of prospectus. 4.
Selection of bankers. 5. Advertising Consultants. 6. Choice regarding registrar to the issue. 7.
Arranging for underwriting the proposed issue. 8. Choice for the bankers to the issue. 9. Choice
for the brokers.
1. DESIGNING CAPITAL STRUCTURE DECISIONS The term capital structure refers to
the proportionate claims of debt and equity in the total long-term capitalization of a company.
According to Weston and Brigham, ―Capital structure is the permanent financing of the firm,
represented primarily by long-term-debt, preferred stock and common equity, but excluding all
short-term credit. Common equity includes common stock, capital surplus and accumulated
retained earnings.
Optimal Capital Structure An ideal mix of various sources of long-term funds that aims at
minimizing the overall cost of capital of the firm, and maximizes the market value of shares of a
firm is known as ‗Optimal capital structure‗. An optimal capital structure should possess the
following characteristics:
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a. Simplicity An optimal capital structure must be simple to formulate and implement by the
financial executives. For simplicity, it is imperative that the number of securities is limited to
debt and equity.
b. Low Cost A sound capital structure must aim at obtaining the capital required for he firm at
the lowest possible cost. For this purpose, financial executives must pay attention to keep the
expenses of issue and fixed annual payments at a minimum. This would help maximize the
shareholders‘ value. c. Maximum Return and Minimum Risks An ideal capital structure must
have a combination of debt and equity in such a manner as to maximize the firm‗s profits.
Similarly, the firm must be guarded against risks such as taxes, interest rates, costs, etc. with the
aim of either reducing them or removing them.
d. Maximum Control The capital structure must aim at retaining maximum control with the
existing shareholders. The issue of securities should be based on the pattern of voting rights. It
must affect favorably the voting structure of the existing shareholders, and increase their control
on the company‗s affairs.
e. Liquidity In order to have a sound capital structure, it is important that the various
components help provide the firm greater solvency through higher liquidity. To attain a high
order of liquidity, all such debts that threaten the company‗s solvency must be avoided.
f. Flexibility The capital structure should be so constructed that it is possible for the company to
carry out any required change in the capitalization in tune with the changing conditions.
Accordingly, the firm must be able to either raise a new level of capital, or reduce the existing
level of capital.
g. Equitable Capitalization An ideal capital structure must be neither over capitalized nor
under-capitalized. Capitalization must be based purely on the financial needs of the enterprise.
An equitable capitalization would help make full utilization of the available capital at minimum
cost.
h. Optimum Leverage The firm must attempt to secure a balanced leverage by issuing both debt
and equity at certain ideal proportions. It is best for the firm to issue debt when the rate of
interest is low. Conversely, equity is suitable where the rate of capitalization is high.
Factors Affecting Capital Structure Decisions The following factors significantly influence
the capital structure decision of a firm: Economy Characteristics The major developments
taking place in the economy affect the capital structure of firms. In order words, the way the
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economy of a country is managed determines the way the capital structure of a firm will be
determined. Factors that are active in the economy are:
1. Business activity: The quality of business activity prevailing in the economy determines the
capital structure pattern of a firm. Under conditions of expanding business activities, the firm
must have several alternatives to source the required capital in order to undertake profitable
investment activities. Under these circumstances, it is advisable for a firm to undertake equity
funding rather than debt funding.
2. Stock market: The buoyancy, or otherwise, of the capital market greatly influences capital
structure decisions. A study of the capital market trends would greatly help a firms decision on
the quantum and cost of issue. Accordingly, if the stock market is expected to witness bullish
trends, the interest rates will go up and debt will become costlier.
3. Taxation: The rates and rules of taxation prevalent in an economy also affect capital structure
decisions. For instance, higher rates of taxation will be advantageous due to the tax deductibility
benefit of debt funding. Similarly, the taxes on dividend income, if any, would adversely affect
the ability of firms to raise equity capital.
4. Regulations: The regulations imposed by the state on the quantum, pricing etc. of capital
funds to be raised also influences the capital raised by a firm. For instance, restrictions have been
imposed by SEBI on the issue and allotment of shares and bonds to different type of investors. A
finance manager should take this factor into consideration while designing the capital structure.
5. Credit Policy: The credit policy pronouncements made by the central monetary authority,
such as the RBI, affects the way capital is raised in the market. For instance, the interest rate
liberalization announced by RBI has been dominating the lending policies of financial
institutions. This affects the ability of finance managers to raise the required funds.
6. Financial Institutions: The credit policy followed by financial institutions determines the
capital structure decisions of firms. For instance, restrictive lending terms by financial
institutions may deter firms from raising long-term funds at reasonable rates of interest. Easy
terms, on the other hand, may encourage firms to obtain a higher quantum of loans.
2. CAPITAL MARKET INSTRUMENTS Financial instruments that are used for raising
capital resources in the capital market are known as Capital Market Instruments. The changes
that are sweeping across the Indian capital market especially in the recent past are something
phenomenal. It has been experiencing metamorphic in the last decade, thanks to a host of
measures of liberalization, globalization, and privatization that have been initiated by the
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Government. Pronounced changes have occurred in the realm of industrial policy. Licensing
policy, financial services industry, interest rates, etc. The competition has become very intense
and real in both industrial sector and financial services industry. As a result of these changes, the
financial services industry has come to introduce a number of instruments with a view to
facilitate borrowing and lending of money in the capital market by the participants.
Types of Capital Market Instruments The various capital market instruments used by
corporate entities for raising resources are as follows: 1. Preference shares 2. Equity shares 3.
Non-voting equity shares 4. Cumulative convertible preference shares 5. Company fixed deposits
6. Warrants 7. Debentures and Bonds
1. PREFERENCE SHARES: Shares that carry preferential rights in comparison with ordinary
shares are called ‗Preference Shares‗. The preferential rights are the rights regarding payment of
dividend and the distribution of the assets of the company in the event of its winding up, in
preference to equity shares.
Types of Preference Shares
1. Cumulative preference shares: Shares where the arrears of dividends in times of no and/or
lean profits can be accumulated and paid in the year in which the company earns good profits.
2. Non-cumulative preference shares: Shares where the carry forward of the arrears of
dividends is not possible.
3. Participating preference shares: Shares that enjoy the right to participate in surplus profits
or surplus assets on the liquidation of a company or in both, if the Articles of Association
provides for it.
4. Redeemable preference shares: Shares that are to be repaid at the end of the term of issue,
the maximum period of a redemption being 20 years with effect from 1.3.1997 under the
Companies amendment Act 1996. Since they are repayable, they are similar to debentures. Only
fully paid shares are redeemed. Where redemption is made out of profits, a Capital Redemption
Reserve Account is opened to which a sum equal to the nominal value of the shares redeemed is
transferred. It is treated as paid-up share capital of the company.
5. Fully convertible cumulative preference shares: Shares comprise two parts viz., Part A and
B. Part A is convertible into equity shares automatically and compulsorily on the date of
allotment. Part B will be redeemed at par/converted into equity shares after a lock-in period at
the option of the investor, conversion into equity shares taking place after the lock-in period, at a
price, which would be 30 percent lower than the average market price. The average market price
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shall be the average of the monthly high and low price of the shares in a stock exchange over a
period of 6 months including the month in which the conversion takes place.
6. Preference shares with warrants attached: The attached warrants entitle the holder to apply
for equity shares for cash, at a ‗premium‗, at any time, in one or more stages between the third
and fifth year from the date of allotment. If the warrant holder fails to exercise his option, the
unsubscribed portion will lapse. The holders of warrants would be entitled to all rights/bonus
shares that may be issued by the company. The preference shares with warrants attached would
not be transferred/sold for a period of 3 years from the date of allotment.
2. EQUITY SHARES:
Equity shares, also known as „ordinary shares are the shares held by the owners of a
corporate entity. Since equity shareholders face greater risks and have no specified preferential
rights, they are given larger share in profits through higher dividends than those given to
preference shareholders, provided the company‗s performance is excellent. Directors declare no
dividends in case there are no profits or the profits do not justify dividend for previous years
even when the company makes substantial profits in subsequent years. Equity shareholders also
enjoy the benefit of ploughing back of undistributed profits kept as reserves and surplus for the
purposes of business expansion. Often, part of these is distributed to them, as bonus shares. Such
bonus shares are entitled to a proportionate or full dividend in the succeeding year. A strikingly
noteworthy feature of equity shares is that holders of these shares enjoy substantial rights in the
corporate democracy, namely the rights to approve the company‗s annual accounts, declaration
of dividend, enhancement of managerial remuneration in excess of specified limits and fixing the
terms of appointment and election of directors, appointment of auditors and fixing of their
remuneration, amendments to the Articles and Memorandum of Association, increase of share
capital and issue of further shares or debentures, proposals for mergers and reconstruction and
any other important proposal on which member‗s approval is required under the Companies Act.
Equity shares in the hands of shareholders are mainly reckoned for determining the
management‗s control over the company. Where shareholders are widely disbursed, it is possible
for the management to retain the control, as it is not possible for all the shareholders to attend the
company‗s meeting in full strength. Furthermore, the management group can bolster its
controlling power by acquiring further shares in the open market or otherwise. Equity shares may
also be offered to financial institutions as part of the private placement exercise. Such a method,
however, is brought with the danger of takeover attempt by financial institutions. Equity
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shareholders represent proportionate ownership in a company. They have residual claims on the
assets and profits of the company. They have unlimited potential for dividend payments and
price appreciation in comparison to these owners of debentures and preference shares who enjoy
just a fixed assured return in the form of interest and dividend. Higher the risk, higher the return
and vice-versa. Share certificates either in physical form or in the demat (with the introduction of
depository system in 1999) form are issued as a proof of ownership of the shares in a company.
Fully paid equity shares with detachable warrants entitle the warrant holder to apply for a
specified number of shares at a determined price. Detachable warrants are separately registered
with stock exchange and traded separately. The company would determine the terms and
conditions relating to the issue of equity against warrants. Voting rights are granted under the
Companies Act (Sections 87 to 89) wherein each shareholder is eligible for votes proportionate
to the number of shares held or the amount of stock owned. A company cannot issue shares
carrying disproportionate voting rights. Similarly, voting right cannot be exercised in respect of
shares on which the shareholder owes some money to the company.
Capital Equity shares are of different types. The maximum value of shares as specified in the
Memorandum of Association of the company is called the authorized or registered or nominal
capital. Issued capital is the nominal value of shares offered for public subscription. In case
shares offered for public subscription are not taken up, the portion of capital subscribed is called
subscribed capital. This is less than the issued capital Paid-up capital is the share capital paid-up
by shareowners which is credited as paid-up on the shares.
Par Value and Book Value
The face value of a share is called its Par value. Although shares can be sold below the par value,
it is possible that shares can be issued below the par value. The financial institutions that convert
their unpaid principal and interest into equity in sick companies are compelled to do if at a
minimum of Rs.10 because of the par value concept even though the market price might be much
less than Rs.10. Par value can also lead to unhealthy practices like price rigging by promoters of
sick companies to take market prices above Rs.10 to get their new offers subscribed. Par value is
of use to the regulatory agency and the stock exchange. It can be used to control the number of
shares that can be issued by the company. The par value of Rs.10 per share serves as a floor price
for issue of shares. Book value is the intrinsic value of a share that is calculated to reflect the net
worth of the shareholders of a corporate entity. Cash Dividends These are dividends paid in
cash. A stable payment of cash dividend is the hallmark of stability of share prices.
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Stock Dividends These are the dividends distributed as shares and issued by capitalizing
reserves. While net worth remains the same in the balance sheet, its distribution between shares
and surplus is altered.
3. NON-VOTING EQUITY SHARES
Consequent to the recommendations of the Abid Hussain Committee‗ and subsequent to the
amendment to the Companies Act, corporate managements are permitted to mobilize additional
capital without diluting the interest of existing shareholders with the help of a new instrument
called non-voting equity shares‗. Such shares will be entitled to all the benefits except the right
to vote in general meetings. Such non-voting equity share is being considered as a possible
addition to the two classes of share capital currently in vogue. This class of shares has been
included by an amendment to the Companies Act as a third category of shares. Corporates will
be permitted to issue such share up to a certain percentage of the total share capital. Non-voting
equity shares will be entitled to rights and bonus issues and preferential offer of shares on the
same lines as that of ordinary shares. The objective will be to compensate the sacrifice made for
the voting rights. For this purpose, these shares will carry higher dividend rate than that of voting
shares. If a company fails to pay dividend, non-voting shareholders will automatically be entitled
to voting rights on a prorate basis until the company resumes paying dividend. The mechanism
of issue of non-voting shares is expected to overcome such problems as are associated with the
voting shares as that the ordinary investors are more inclined towards high return on capital
through sizeable dividends and capital appreciation through the issue of bonus shares and the
inability of corporate to respond to the investors‗ just aspiration for reasonable dividends.
Moreover, there is every need for corporate to spend huge sums of money on a variety of not-souseful items including colorful and costly annual reports. For all these above-mentioned reasons,
non-voting equity shares are expected to have a ready and popular marker. In effect, this kind of
share is similar to preference shares with regard to non-voting right but may get the advantage of
higher dividends as well as appreciation in share values through entitlement to bonus shares
which is not available to preference shares.
4. CONVERTIBLE CUMULATIVE PREFERENCE SHARES (CCPS)
These are the shares that have the twin advantage of accumulation of arrears of dividends and the
conversion into equity shares. Such shares would have to be the face value of Rs.100 each. The
shares have to be listed on one or more stock exchanges in the country. The object of the issue of
CCP shares is to allow for the setting up of new projects, expansion or diversification of existing
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projects, normal capital expenditure for modernization and for meeting working capital
requirements. Following are some of the terms and conditions of the issue of CCP shares :
1. Debt-equity ratio: For the purpose of calculation of debt-equity ratio as may be applicable
CCPS is be deemed to be an equity issue.
2. Compulsory conversion: The conversion into equity shares must be for the entire issue of
CCP shares and shall be done between the periods at the end of three years and five years as may
be decided by the company. This implies that the conversion of the CCP into equity shares
would be compulsory at the end of five years and the aforesaid preference shares would not be
redeemable at any stage.
3. Fresh issue: The conversion of CCP shares into equity would be deemed as being one
resulting from the process of redemption of the preference shares out of the proceeds of a fresh
issue of shares made for the purposes of redemption.
4. Preference dividend: The rate of preference dividend payable on CCP shares would be 10
percent.
5. Guideline ratio: The guideline ratio of 1:3 as between preference shares and equity shares
would not be applicable to these shares.
6. Arrears of dividend: The right to receive arrears of dividend up to the date of conversion, if
any, shall devolve on the holder of the equity shares on such conversion. The holder of the equity
shares shall be entitled to receive the arrears of dividend as and when the company makes profit
and is able to declare such dividend.
7. Voting right: CCPS would have voting rights as applicable to preference shares under the
companies Act, 1956.
8. Quantum: The amount of the issue of CCP shares would be to the extent the company would
be offering equity shares to the public for subscription.
5. COMPANY FIXED DEPOSITS:
Fixed deposits are the attractive source of short-term capital both for the companies and
investors as well. Corporates favor fixed deposits as an ideal form of working capital
mobilization without going through the process of mortgaging assets. Investors find fixed
deposits a simple avenue for investment in popular companies at attractively reasonable and safe
interest rates. Moreover, investors are relieved of the problem of the hassles of market value
fluctuation to which instruments such as shares and debentures are exposed. There are no
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transfer formalities either. In addition, it is quite possible for investors to have the option of
premature repayment after 6 months, although such an option entails some interest loss.
Regulations Since these instruments are unsecured; there is a lot of uncertainty about the
repayment of deposits and regular payment of interest. The issue of fixed deposits is subject to
the provisions of the Companies Act and the Companies (Acceptance of Deposits) Rules
introduced in February 1975. Some of the important regulations are:
1. Advertisement: Issue of an advertisement as approved by the Board of Directors in dailies
circulating in the state of incorporation.
2. Liquid assets : Maintenance of liquid assets equal to 15 percent (substituted for 10% by
Amendment Rules, 1992) of deposits (maturing during the year ending March 31) in the form of
bank deposits, unencumbered securities of State and Central Governments or unencumbered
approved securities.
3. Disclosure: Disclosure in the newspaper advertisement the quantum of deposits remaining
unpaid after maturity. This would help highlight the defaults, if any, by the company and caution
the depositors.
4. Deemed public Company : Private company would become a deemed public company (from
June 1998, Section 43A of the Act) where such a private company, after inviting public deposits
through a statutory advertisement, accepts or renews deposits from the public other than its
members, directors or their relatives. This provision, to a certain extent, enjoins better
accountability on the part of the management and auditors.
5. Default: Penalty under the law for default by companies in repaying deposits as and when
they mature for payment where deposits were accepted in accordance with the Reserve Bank
directions.
6. CLB : Empowerment to the Company Law Board to direct companies to repay deposits,
which have not been repaid as per the terms and conditions governing such deposits, within a
time frame and according to the terms and conditions of the order.
6. WARRANTS
An option issued by a company whereby the buyer is granted the right to purchase a
number of shares of its equity share capital at a given exercise price during a given period is
called a ‗warrant‗. Although trading in warrants are in vogue in the U.S,. Stock markets for more
than 6 to 7 decades, they are being issued to meet a range of financial requirements by the Indian
corporate. A security issued by a company, granting its holder the right to purchase a specified
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number of shares, at a specified price, any time prior to an expirable date is known as a
‗warrant‗. Warrants may be issued with either debentures or equity shares. They clearly specify
the number of shares entitled, the expiration date, along with the stated/exercise price. The
expiration date of warrants in USA is generally 5 to 10 years from the date of issue and the
exercise price is 10 to 30 percent above the prevailing market price. Warrants have a secondary
market. The exchange value between the share of its current price and the shares to be purchased
at the exercise price represents the minimum value of warrant. They have no floatation costs and
when they are exercised, the firm receives additional finds at a price lower than the current
market, yet higher than those prevailing at the time of issue. Warrants are issued by new/growing
firms and venture capitalists. They are also issued during mergers and acquisitions. Warrants in
the Indian context are called ‗sweeteners‗and were issued by a few Indian companies since
1993. Both warrants and rights entitle a buyer to acquire equity shares of the issuing company.
However, they are different in the sense that warrants have a life span of three to five years
whereas; rights have a life span of only four to twelve weeks (duration between the opening and
closing date of subscription list). Moreover, rights are normally issued to effect current
financing, and warrants are sold to facilitate future financing. Similarly, the exercise price of
warrant, i.e. The price at which it can be exchanged for share, is usually above the market price
of the share so as to encourage existing shareholders to purchase it. On the other hand, one
warrant buys one equity share generally, whereas more than one rights may be needed to buy one
share. The detachable warrant attached to each share provides a right to the warrant holder to
apply for additional equity share against each warrant.
7. DEBENTURES AND BONDS
A document that either creates a debt or acknowledges it is known as a debenture.
Accordingly, any document that fulfills either of these conditions is a debenture. A debenture,
issued under the common seal of the company, usually takes the form of a certificate that
acknowledges indebtedness of the company. A document that shows on the face of it that a
company has borrowed a sum of money from the holder thereof upon certain terms and
conditions is called a debenture. Debentures may be secured by way of fixed or floating charges
on the assets of the company. These are the instruments that are generally used for raising longterm debt capital.
Following are the features of a debenture
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1. Issue: In India, debentures of various kinds are issued by the corporate bodies, Government,
and others as per the provisions of the Companies Act, 1956 and under the regulations of the
SEBI. Section 117 of the Companies Act prohibits issue of debentures with voting rights.
Generally, they are issued against a charge on the assets of the company but at times may be
issued without any such charge also. Debentures can be issued at a discount in which case, the
relevant particulars are to be filed with the Registrar of Companies.
2. Negotiability: In the case of bearer debentures the terminal value is payable to its bearer. Such
instruments are negotiable and are transferable by delivery. Registered debentures are payable to
the registered holder whose name appears both on the debenture and in the register of debenture
holders maintained by the company. Further, transfer of such debentures should be registered.
They are not negotiable instruments and contain a commitment to pay the principal and interest.
3. Security: Secured debentures create a charge on the assets of the company. Such a charge
may be either fixed or floating. Debentures that are issued without any charge on assets of the
company are called ‗unsecured or marked debentures‗.
4. Duration: Debentures, which could be redeemed after a certain period of time are called
Redeemable Debentures. There are debentures that are not to be returned except at the time of
winding up of the company. Such debentures are called Irredeemable Debentures.
5. Convertibility: Where the debenture issue gives the option of conversion into equity shares
after the expiry of a certain period of time, such debentures are called Convertible Debentures.
Non-convertible Debentures, on the other hand, do not have such an exchange facility.
6. Return: Debentures have a great advantage in them in that they carry a regular and reasonable
income for the holders. There is a legal obligation for the company to make payment of interest
on debentures whether or not any profits are earned by it.
7. Claims: Debenture holders command a preferential treatment in the matters of distribution of
the final proceeds of the company at the time of its winding up. Their claims rank prior to the
claims of preference and equity shareholders.
KINDS OF DEBENTURES
Innovative debt instruments that are issued by the public limited companies are described below :
1. Participating debentures 2. Convertible debentures. 3. Debt-equity swaps 4. Zero-coupon
convertible notes 5. Secured Premium Notes (SPN) with detachable warrants 6. Non-Convertible
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Debentures (NCDs) with detachable equity warrant 7. Zero-interest Fully Convertible
Debentures (FCDs) 8. Secured zero-interest Partly Convertible Debentures (PCDs) with
detachable and separately tradable warrants 9. Fully Convertible Debentures (FCDs) with
interest (optional) 10. Floating Rate Bonds (FRB)
1. Participating debentures: Debentures that are issued by a body corporate which entitle the
holders to participate in its profits are called ‗Participating Debentures‗. These are the unsecured
corporate debt securities. They are popular among existing dividend paying Corporates.
2. Convertible debentures
a. Convertible debentures with options are a derivative of convertible debentures that give an
option to both the issuer, as well as the investor, to exit from the terms of the issue. The coupon
rate is specified at the time of issue.
b. Third party convertible debentures are debts with a warrant that allow the investor to
subscribe to the equity of a third firm at a preferential price vis-à-vis market price, the interest
rate on the third party convertible debentures being lower than pure debt on account of the
conversion option.
c. Convertible debentures redeemable at a premium:
Premium are issued at face value with a put option entitling investors to sell the bond to
the issuer, at a premium later on. They are basically similar to convertible debentures but have
less risk.
3. Debt-equity swaps:
They are offered from an issue of debt to swap it for equity. The instrument is quite risky
for the investor because the anticipated capital appreciation may not materialize.
4. Zero-coupon convertible note:
These are debentures that can be converted into shares and on its conversion the investor
forgoes all accrued and unpaid interest. The zero-coupon convertible notes are quite sensitive to
changes in the interest rates.
5. SPN with detachable warrants:
These are the Secured Premium Notes (SPN) with detachable warrants. These are the
redeemable debentures that are issued along with a detachable warrant. The warrant entitles the
holder to apply and get equity shares allotted, provided the SPN is fully paid. The warrants
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attached to it assure the holder such a right. No interest will be paid during the lock-in period for
SPN. The SPN holder has an option to sell back the SPN to the company at par value after the
lock-in period. If this option is exercised by the holder, no interest/premium will be paid on
redemption. The holder will be repaid the principal and the additional interest/ premium amount
in installments as may be decided by the company. The conversion of detachable warrant into
equity shares will have to be done within the time limit notified by the company.
6. NCDs with detachable equity warrants:
These are Non-Convertible Debentures (NCDs) with detachable equity warrants. These
entitle the holder to buy a specific number of shares from the company at a predetermined price
within a definite time frame. The warrants attached to NCDEs are issued subject to full payment
of the NCDs value. The option can be exercised after the specific lock-in period. The company is
at liberty to dispose of the unapplied portion of shares if the option to apply for equalities is not
exercised.
7. Zero interest FCDs:
These are Zero-interest Fully Convertible Debentures on which no interest will be paid
by the issuer during the lock-in period. However, there is a notified period after which fully paid
FCDs will be automatically and compulsorily converted into shares. In the event of a company
going in for rights issue prior to the allotment of equity (resulting from the conversion of equity
shares into FCDs), it shall do so only after the FCD holders are offered securities.
8. Secured Zero interest PCDs with detachable and separately tradable warrants:
These are Secured Zero Interest Partly Convertible Debentures with detachable and
separately tradable warrants. They are issued in two parts. Part A is a convertible portion that
allows equity shares to be exchanged for debentures at a fixed amount on the date of allotment.
Part B is a non-convertible portion to be redeemed at par at the end of a specific period from the
date of allotment. Part B which carries a detachable and separately tradable warrant provides the
warrant holder an option to received equity shares for every warrant held, at a price worked out
by the company.
9. Fully Convertible Debentures (FCDs) with interest (optional):
These are the debentures that will not yield any interest for an initial short period after
which the holder is given an option to apply for equities at a premium. No additional amount
needs to be paid for this. The option has to be indicated in the application form itself. Interest on
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FCDs is payable at a determined rate from the date of first conversion to the date of second/final
conversion and in lieu of it, equity shares will be issued.
10. Floating Rate Bonds (FRB‟s):
These are the bonds where the yield is linked to a benchmark interest rate like the prime
rate in USA or LIBOR in the Euro currency market. For instance, the State Bank of India‗s
floating rate bond, issue was linked to the maximum interest on term deposits that was 10
percent at the time. The floating rate is quoted in terms of a margin above of below the
benchmark rate. Interest rates linked to the benchmark ensure that neither the borrower nor the
lender suffer from the changes in interest rates. Where interest rates are fixed, they are likely to
be inequitable to the borrower when interest rates fall and inequitable to the lender when interest
rates rise subsequently.
SEBI Guidelines:
The preferential issue of equity shares/Fully Convertible Debentures (FCDs/Partly
Convertible Debentures (PCDs) or any other financial instruments which would be converted
into or exchanged with equity shares at a later date, by listed companies whose equity share
capital is listed on any stock exchange, to any selected group of persons under the Companies
Act, 1956 on private placement basis shall be governed by these guidelines. Such preferential
issues by listed companies by way of equity shares/Fully Convertible Debentures (FCDs)/Partly
Convertible Debentures (PCDs) or any other financial instruments which would be converted
into/exchanged with equity shares at a later date, shall be made in accordance with the pricing
provisions mentioned below
2.3 PRICING OF THE ISSUE Preferential Issue of Shares:
The issue of shares on a preferential basis can be made at a price not less than the higher
of the following:
a. The average of the weekly high and low of the closing prices of the related shares quoted on
the stock exchange during the six months preceding the relevant date (thirty days prior to the
date on which the meeting of general body of shareholders is held in terms of Section 81(1A) of
the Companies Act, 1956 to consider the proposed issue) (or)
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b. The average of the weekly high and low of the closing prices of the related shares quoted on a
stock exchange (any of the recognized stock exchanges in which the shares are listed and in
which the highest trading volume in respect of the shares of the company has been recorded
during the preceding 6 months prior to the relevant date) during the two weeks preceding the
relevant date.
Pricing of Shares arising out of warrants, etc
Where warrants are issued on a preferential basis with an option to apply for and be
allotted shares, the issuer company shall determine the price of the resultant shares. The relevant
date for the above purpose may, at the option of the issuer be either the one referred to above or a
date 30 days prior to the date on which the holder of the warrants becomes entitled to apply for
the said shares. The resolution to be passed in terms of section 81(1A) shall clearly specify the
relevant date on the basis of which price of the resultant shares shall be calculated. An amount
equivalent to at least ten percent of the price fixed in terms of the above shall become payable for
the warrants on the date of their allotment. The amount referred to above shall be adjusted
against the price payable subsequently for acquiring the shares by exercising an option for the
purpose. The amount so referred to above shall be forfeited if the option to acquire shares is not
exercised.
Pricing of shares on conversion:
Where PCDs/FCDs/other convertible instruments, are issued on a preferential basis,
providing for the issuer to allot shares at a future date, the issuer shall determine the price at
which the shares could be allotted in the same manner as specified for pricing of shares allotted
in lieu of warrants as indicated above.
Currency of Financial instruments:
In case of warrants/PCDs/FCDs/or any other financial instruments with a provision for
the allotment of equity shares at a future date, either through conversion or otherwise, the
currency of the instruments shall not exceed beyond 18 months from the date of issue of the
relevant instrument.
Non-Transferability of Financial Instruments:
The instruments allotted on a preferential basis to the promoter/promoter group shall be
subject to lock-in period of 3 years from the date of their allotment. In any case, not more than
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20 percent of the total capital (equity share capital issued by way of public/ rights issue including
equity shares emerging at a later date out of any convertible securities/ exercise of warrants and
equity shares or any other security convertible at a later date into equity issued on a preferential
basis in favor of promoter/promoter groups) of the company, including capital brought in by way
of preferential issue, shall be subject to lock-in of 3 years from the date of allotment. The lock-in
on shares acquired by conversion of the convertible instrument/exercise of warrants shall be
reduced to the extent the convertible instrument warrants have already been locked-in. For
computation of 20 percent of the total capital of the company, the amount of minimum
promoter‘s contribution held and locked-in, in the past as per guidelines shall be taken into
account. The minimum promoter‘s contribution shall not again be put under fresh lock-in, even
though it is considered for computing the requirement of 20 percent of the total capital of the
company, in case they said minimum promoter‘s contribution is free of lock-in at the time of the
preferential issue. These locked in shares/instruments can be transferred to and amongst
promoter/ promoter group subject to continuation of lock-in the hands of transferees for the
remaining period, and compliance of Securities and Exchange Board of India (Substantial
Acquisition of shares and Takeovers) Regulations, 1997, if applicable.
Currency of Shareholders Resolutions:
Allotment pursuant to any resolution passed at a meeting of shareholders of a DFI
granting consent for preferential issues of any financial instrument, shall be completed within a
period of 3 months from the date of passing of the resolution. If allotment of instruments and
dispatch of certificates is not completed within three months from the date of such resolution, a
fresh consent of the shareholders shall be obtained and the relevant date referred to above will
relate to the new resolution.
Certificate from Auditors:
In case of every issue of shares/warrants/FCDs/PCDs/other financial instruments having
conversion option, the statutory auditors of the issuer DFI shall certify that the issue of said
instruments is being made in accordance with the requirements contained in these guidelines.
Copies of the auditor‘s certificate shall also be laid before the meeting of the shareholders
convened to consider the proposed issue.
Preferential Allotments to FIIs:
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Preferential allotments, if any to be made in case of Foreign Institutional Investors, shall
also be governed by the guidelines issued by the Government of India/Board/Reserve Bank of
India on the subject.
Non-applicability of the Guidelines:
The above guidelines shall not be applicable where the further shares are allotted in
pursuance to the merger and amalgamation scheme approved by the High Court and where
further shares are allotted to a person/group of persons in accordance with the provisions of
rehabilitation packages approved by BIFR. In case, such persons are promoters or belong to
promoter group lock-in provisions shall continue to apply unless otherwise stated in the BIFR
order. Similarly, the above guidelines are not applicable where further shares are allotted to all
India public financial institutions in accordance with the provision of the loan agreements signed
prior to August 4, 1994.
2.2.1 Global Debt Instruments
Following are some of the debt instruments that are popular in the international financial
markets:
Income Bonds Interest income on such bonds is paid only where the corporate command
adequate cash flows. They resemble cumulative preference shares in respect of which fixed
dividend is paid only if there is profit earned in a year, but carried forward and paid in the
following year. There is no default on income bonds if interest is not paid. Unlike the dividend
on cumulative preference shares, the interest on income bond is tax deductible. These bonds are
issued by Corporates that undergo financial restructuring.
Asset Backed Securities
These are a category of marketable securities that are collateralized by financial assets
such as installment loan contracts. Asset backed financing involves a disinter- mediating process
called ‗securitization‗, whereby credit from financial intermediaries in the form of debentures
are sold to third parties to finance the pool. REPOS are the oldest asset backed security in our
country. In USA, securitization has been undertaken for the following the oldest asset backed
security in our country. In USA, securitization has been undertaken for the following: 1. Insured
mortgages 2. Mortgage backed bonds 3. Student loans 4. Trade credit receivable backed bonds 5.
Equipments leasing backed bonds 6. Certificates of automobile receivable securities 7. Small
business administration loans 8. Credit and receivable securities
Junk Bonds
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Junk bond is a high risk, high yield bond which finances either a Leveraged Buyout
(LBO) or a merger of a company in financial distress Junk bonds are popular in the USA and are
used primarily for financing takeovers. The coupon rates range from 16 to 25 percent. Attractive
deals were put together establishing their feasibility in terms of adequacy of cash flows to meet
interest payments. Michael Milken (the junk bond king) of Drexel Burnham Lambert was the
real developer of the market.
Indexed Bonds
These are the bonds whose interest payment and redemption value are indexed with
movements in prices. Indexed bonds protect the investor from the eroding purchasing power of
money because of inflation. For instance, an inflation-indexed bond implies that the payment of
the coupon and/or the redemption value increases or decreases according to movements in prices.
The bonds are likely to hedge the principal amount against inflation. Such bonds are designed to
provide investors an effective hedge against inflation so as to enhance the credibility of the antiinflationary policies of the Government. The yields of an inflation-indexed bond provide vital
information on the expected rate of inflation. United Kingdom, Australia, and Canada have
introduced index linked government securities as a segmented internal debt management
operation with a view to increase the range of assets available in the system, provide an inflation
hedge to investors, reduce interest costs and pick up direct signals, and the expected inflation and
real rate of interest from the market.
Zero-Coupon Bonds (ZCBs)/Zero Coupons Convertible Debentures
Zero Coupon Bonds first came to be introduced in the U.S. securities market. Initially,
such bonds were issued for high denominations. These bonds were purchased by large security
brokers in large chunks, who resold them to individual investors, at a slightly higher price in
affordable lots. Such bonds were called ―Treasury Investment Growth Receipts‗(TIGRs) or
‗Certificate of Accruals on Treasury Securities‗(CATSs) or ZEROs as their coupon rate is Zero.
Moreover, these certificates were sold to investors at a hefty discount and the difference between
the face value of the certificate and the acquisition cost was the gain. The holders are not entitled
for any interest except the principal sum on maturity.
Advantages:
Zero-Coupon Bonds offer a number of advantages as shown below a. No botheration of
periodical interest payment for the issues b. The attraction of conversion of bonds into equity
shares at a premium or at par, the investors usually being rewarded by way of a low premium on
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conversion c. There is only capital gains tax on the price differential and there is no tax on
accrued income d. Possibility of efficient servicing of equity as there is no obligation to pay
interest till maturity and the eventual conversion. Mahindra & Mahindra came out with the
scheme of Zero Coupon Bonds for the first time in India along with 12.5 percent convertible
bonds for part financing of its modernization and diversification scheme. Similarly, Deep
Discount Bonds were issued by IDBI at Rs.2, 000 for a maturity of Rs.1 lakh after 25 years.
These are negotiable instruments transferable by endorsement and delivery by the transferor.
IDBI also offered Option Bonds which may be either cumulative or non-cumulative bonds where
interest is payable either on maturity or periodically. Redemption is also offered to attract
investors.
Floating Rate Bonds (FRBs)
Bonds that carry the provision for payment of interest at different rates for different time
periods are known as ‗Floating Rate Bonds‗. The first floating rate bond was issued by the SBI
in the Indian capital market. The SBI, while issuing such bonds, adopted a reference rate of
highest rate of interest on fixed deposit of the Bank, provided a minimum floor rate payable at 12
percent p.a. and attached a call option to the Bank after 5 years to redeem the bonds earlier than
the maturity period of 10 years at a certain premium. A major highlight of the bonds was the
provision to reduce interest risk and assurance of minimum interest on the investment provided
by the Bank.
Secured Premium Notes (SPNs)
Secured debentures that are redeemable of a premium over the issue price or face value
are called secured premium notes. Such bonds have a lock-in period during which period no
interest will be paid. It entitles the holder to sell back the bonds to the issuing company at par
after the lock-in period. A case in point was the issue made by the TISCO in the year 1992,
where the company wanted to raise money for its modernization program without expanding its
equity excessively in the next few years. The company made the issue to the existing
shareholders on a rights basis along with the rights issue. The salient features of the TISCO issue
were as follows : 1. Face value of each SPN was Rs.300 2. No interest was payable during the
first three years after allotment 3. The redemption started at the end of the fourth year of issue 4.
Each of the SPN of Rs.300 was repaid in four equal annual installments of Rs.75, which
comprised of the principal, the interest and the relevant premium. (Low interest and high
premium or high interest and low premium, at the option to be exercised by the SPN holder at
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the end of the third year) 5. Warrant attached to each SPN entitled the holder the right to apply
for or seek allotment of one equity share for cash payment of Rs.80 per share. Such a right was
exercisable between first year and one.-and-a-half year after allotment by which time the SPN
would be fully paid up. This instrument tremendously benefited TISCO, as there was no interest
outgo. This helped TISCO to meet the difficulties associated with the cash generation. In
addition, the company was able to borrow at a cheap rate of 13.65 percent as against 17 to 18
percent offered by most companies. This enabled the company to start redemption earlier
through the generation of cash flow by the company‗s projects. The investors had the flexibility
of tax planning while investing in SDPNs. The company was also equally benefited as it gave
more flexibility.
Euro Convertible Bonds
Bonds that give the holders of euro bonds to have the instruments converted into a wide
variety of options such as the call option for the issuer and the put option for the investor, which
makes redemption easy are called ‗Euro-convertible bonds‗. A euro convertible bond essentially
resembles the Indian convertible debenture but comes with numerous options attached.
Similarly, a euro-convertible bond is an easier instrument to market than equity. This is because
it gives the investor an option to retain his investments as a pure debt instrument in the event of
the price of the equity share falling below the conversion price or where the investor is not too
sure about the prospects of the company.
Popularity of convertible euro bonds
A convertible bond issue allows an Indian company far greater flexibility to tap the Euro market
and ensures that the issue has a better market reception than would be possible for a direct equity
issue. Moreover, newly industrialized countries such as Korea have chosen the convertible bond
market as a stepping-stone to familiarity and acceptance of their industrial companies in the
international market. The convertible bonds offer the following advantages:
a. Protection: Euro convertible bonds are favored by international investors as it offers them the
advantage of protection of their wealth from erosion. This is possible because the conversion is
only an option, which the investors may choose to exercise only if it works to their benefit. This
facility is not available for equity issues.
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b. Liquidity: Convertible bond market offers the benefit of the most liquid secondary market for
new issues. Fixed income funds as well as equity investment managers purchase convertible
bonds.
c. Flexibility: The feature of flexibility in structuring convertible bonds allows the company to
include some of the best possible clauses of investors‗ protection by incorpo0rating the unusual
features of equity investments. A case in point is the issues made by the Korean corporate sector,
which contained a provision in the issue of convertible euro bonds. The provision entitled the
holders to ensure the due compliance of the liberalization measures that had already been
announced within a specified period of time. Such a provision enabled the investor to opt for a
put‘ option.
d. Attraction investment: The issue of convertible debentures facilitates removal of many of the
unattractive features of equity investment. For investors, convertible bond market makers are the
principal sources of liquidity in their securities.
Bond Issue – Indian Experience
In recent times, all-India financial institutions have come to design and introduce special and
innovative bond instruments exclusively structured on the investors‗ preferences and funds
requirement of the issuers. The emphasis from the issuer‗s view point is the resource
mobilization and not risk exposure. Several financial institutions such as the IDBI, the ICICI, etc.
are engaged in the sale of such bonds. A brief description of some these bonds are presented
below:
1. IDBIs Zero Coupon Bonds, 1996:
These bonds are sold at a discount and are paid no interest. It is of great advantage to issuers as it
is not required for them to make periodic interest payment.
2. IDBIs Regular Income Bonds, 1996:
These were the bonds issued by the IDBI as 10-year bonds carrying a coupon of 16 percent,
payable half-yearly. The bonds provided an annualized yield equivalent to 16.64 percent. The
bonds, which were priced at Rs.5, 000 can be redeemed at the end of every year, after the third
year allotment. There was also a call option that entitled the IDBI to redeem the bonds five years
from the date of allotment.
3. Retirement Bonds, 1996:
The IDBI Retirements Bonds were issued at a discount. The issue targeted investors who are
planning for retirement. Under the scheme,. Investors get a monthly income for 10 years after the
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expiry of a wait period, the wait period being chosen by the investor. Thereafter, the investors
also get a lump sum amount, which is the maturity value of the bond.
4. IFCIs Bonds, 1996
These bonds include:
a. Deep Discount Bonds – Issued for a face value of Rs.1 lakh each.
b. Regular Income and Retirement Bonds – They had a five-year tenure, a semiannual yield of
16 percent and a front-end discount of 4 percent. The bonds had three-year put option and an
early bird incentive of 0.75 percent.
c. Step-up Liquid Bond – The five-year bonds with a put option every year with a return of 16
percent, 16.25 percent, 16.5 percent, 16.75 percent, and 17 percent at the end of every year.
d. Growth Bond – An investment of Rs.20, 000 per bond under this scheme entitles investors to
a Rs.1 lakh face-value bond maturing after 10 years. Put options can be exercised at the end of 5
and 7 years respectively. If exercised, the investor gets Rs.43, 500 after 5 years and Rs.60, 000
after a 7 year period.
e. Lakhpati Bond – The maturity period of these bonds varied from l5 to 10 years, after which
the investor gets Rs.1 lakh. The initial investment required was Rs.20,000 for 10 years maturity,
Rs,.23,700 for 9 years, Rs,28,000 for 8 years, Rs.33,000 for 7 years, Rs.39,000 for 6 years and
Rs.46,000 for 5 years maturity.
5. ICICIs Bonds, 1997 ICICI came out with as many as five bonds in March 1997. These are
encash bonds, index bonds, regular income bonds, deep discount bonds, and capital gain bonds.
The bonds were aimed at meeting the diverse needs of all categories of investors, besides
contributing to the widening of the bond market so as to bring the benefits of these securities to
even the smallest investors.
a. Capital gains bond - Also called infrastructure bonds incorporated the capital gains tax
relaxations under Section 54EA of the Income Tax Act announced in the Union Budget for
1997-98. They are issued for 3 and 7 years maturity. 20 percent rebate was available under
Section 88 of the I.T. Act for investors on the amount invested in the capital gains bonds up to a
maximum of Rs.70, 000. They can avail benefit under Section 88. The annual interest rate
worked out to 13.4 percent while the annual yield came to 20.7 percent. However, investment
through stock invest will not qualify for the rebate.
b. Encash Bond – The five-year encash bonds were issued at a face value of Rs.2,000 and can
be redeemed at par across the country in 200 cities during 8 months in a year after 12 months.
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The bond had a step-up interest every year from 12 to 18.5 percent and the annualized yield at
maturity for the bond works out to 15.8 percent. The encashing facility, however, is available
only to the original bondholders. The bonds not only offer higher return but also help widen the
banking facilities to investors. The secondary market price of the bonds is likely to be favorably
influenced by the step-up interest that results in an improved YTM every year.
c. Index Bond – It gives the investor both the security of the debt instrument and the potential of
the appreciation in the return on the stock market. Priced at Rs.6,000 the index bond has two
parts:
Part A is a deep discount bond of the face value of Rs.22,000 issued for a 12 year period. Its
calculated yield was 15.26 percent. It also has a call and a put option attached to it assuring the
investor a return of Rs.9, 300 after 6 years option is exercised.
Part B is a detachable index warrant issued for 12 years and priced at Rs.2,000. The yield was
linked to the BSE SENSEX. The face value of the bond will appreciate the number of times the
SENSEX has appreciated. The investors‘ returns will be treated as capital gains.
6. Tax Free Bonds: The salient features of the tax-free Government of India bonds to be issued
from October 1, 2002 are as follows:
a. Interest rate – The bonds will carry an interest rate of 7 percent.
b. Tax exemption – The bonds will be exempt from Income-tax and Wealth-tax.
c. Maturity – The bonds will have a maturity period of six years.
d. Ceiling –The bonds investment will have no ceiling.
e. Tradability - The bonds will not be traded in the secondary market.
f. Investors – The eligible investors include individuals and Hindu Undivided Families, NRIs
are not eligible for investing in these bonds.
g. Issue price Bonds will be issued for a minimum amount of Rs.1,000 and its multiples.
h. Maturity value – The cumulative maturity value of the bond will be Rs.1.511 at the end of
six years.
i. Form of issue – The bonds will be both in demat form as well as in the traditional form of
stock certificates. Option once chosen cannot be changed.
j. Transferability – Bonds will not be transferable except by way of gift to relatives as defined
in the Companies Act.
k. Collaterals – The bonds cannot be used as collaterals for obtaining loans from banks,
financial institutions and non-banking financial companies.
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l. Nomination – A sole holder or a sole surviving holder of the bond being an individual can
make a nomination.
2.3 PREPARATION OF PROSPECTUS ― Prospectus is defined a document through which
public are solicited to subscribe to the share capital of a corporate entity. Its purpose is inviting
the public for the subscription/purchase of any securities of a company.
2.3.1 PROSPECTUS FOR PUBLIC OFFER 1. Regular prospectus 2. Abridged prospectus 3.
Prospectus for rights issue 4. Disclosures in prospectus 5. Disclosures in abridged prospectus and
letter of offer
1. REGULAR PROSPECTUS The regular prospectus are presented in three parts
PART I
a. General Information about the company e.g. Name and address of the registered office
consent of the Central Government for the issue and names of regional stock exchanges etc.,
b. Capital Structure such as authorized, issued, subscribed and paid up capital etc.,
c. Terms of the issue like mode of payment, rights of instruments holders etc.,
d. Particulars of the issue like project cost, means of financing etc.,
e. Company, Management and project like promoters for the project, location of the project
etc.
f. Disclosures of public issues made by the Company, giving information about type of issue,
amount of issue, date of closure of issue, etc.,
g. Disclosure of Outstanding Litigation, Criminal Prosecution and Defaults
h. Perception of Risk factors like difficulty in marketing the products, availability of raw
materials etc.
PART II
a. General Information
b. Financial Information like Auditor‗s Report, Chartered Accountant‗s Report etc.,
c. Statutory and Other Information
PART III
a. Declaration i.e., by the directors that all the relevant provisions of the companies Act, 1956
and guidelines issued by the Government have been complied with.
b. Application with prospectus
2. ABRIDGED PROSPECTUS The concept of abridged prospectus was introduced by the
Companies (amendment) Act of 1988 to make the public issue of shares an inexpensive
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proposition. A memorandum containing the salient features of a prospectus as prescribed is
called as ‗Abridged Prospectus‗
3. SELECTION OF BANKERS Merchant bankers assist in selecting the appropriate bankers
based on the proposals or projects. Because the commercial bankers are merely financiers and
their activities are appropriately arrayed around credit proposals, credit appraisal and loan
sanctions. But merchant banking include services like project counseling , corporate counseling
in areas of capital restructuring amalgamations, mergers, takeover etc., discounting and
rediscounting of short term paper in money markets, managing, underwriting and supporting
public issues in new issue market and acting as brokers and advisers on portfolio management in
stock exchange.
4. ADVERTISING CONSULTANTS Merchant bankers arrange a meeting with company
representatives and advertising agents to finalize arrangements relating to date of opening and
closing of issue, registration, of prospectus, launching publicity campaign and fixing date of
board meeting to approve and sign prospectus and pass the necessary resolutions. Publicity
campaign covers the preparation of all publicity material and brochures, prospectus,
announcement, advertisement in the press, radio, TV, investors conference etc., The merchant
bankers help choosing the media, determining the size and publications in which the
advertisement should appear. The merchant Bankers role is limited to deciding the number of
copies to be printed, checking accuracy of statements made and ensure that the size of the
application form and prospectus conform to the standard prescribed by the stock exchange. The
Merchant banker has to ensure that the material is delivered to the stock exchange at least 21
days before the issue opens and to brokers to the issue, branches of brokers to the issue and
underwriter in time. Securities issues are underwritten to ensure that in case of under
subscription the issues are taken up by the underwriters. SEBI has made underwriting mandatory
for issues to the public. The underwriting arrangement should be filed with the stock exchange.
Particulars of underwriting arrangement should be mentions in the prospectus. The various
activities connected with pres issue management are a time bound program which has to be
promptly attended to. The execution of the activities with clockwork efficiency would lead to a
successful issue.
5. REGISTRARS TO AN ISSUE AND SHARE TRANSFER AGENTS REGISTRATION
The registrars to an issue, as an intermediary in the primary market, carry on activities such as
collecting application from the investors, keeping a proper record of applications and money
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received from investors or paid to the seller of securities and assisting companies in determining
the basis of allotment of securities in consultation with stock exchanges, finalizing the allotment
of securities and processing/dispatching allotment letters, refund orders, certificates and other
related documents in respect of issue of capital. The share transfer agents maintain the records of
holders of securities or on behalf of companies, and deal with all matters connected with the
transfer/redemption of its securities. To carry on their activities, they must be registered with the
SEBI which can also renew the certificate of registration. They are divided into two categories;
a. Category I, to carry on the activities as a registrar to an issue and share transfer agent; b.
Category II; to carry on the activity either as a registrar or as a share transfer agent. The
registration is granted by the SEBI on the basis of consideration of all relevant matters and, in
particular, the necessary infrastructure, past experience and capital adequacy. It also takes into
account the fact that any connected person has not been granted registration and any
director/partner/principal officer has not been convicted for any offence involving moral
turpitude or has been found guilty of any economic offence.
6. CAPITAL ADEQUACY FEE The capital adequacy requirement in terms of net worth
(capital and free reserves) was Rs.6 lakh and Rs.3 lakh for Category I and Category II of
registrars and share transfer agents respectively. However, the capital adequacy requirements are
not applicable since November 1999 for a department/division of a body corporate maintaining
the records of holders of securities issued by them and deal with all matters connected with
transfer/ redemption of securities. The two categories of registrars and transfer agents had to pay
an annual fee respectively of Rs.15, 000 and Rs.10, 000 for initial registration a well as renewal.
With effect from November 1999, while Category I is required to pay a registration fee of
Rs.50,000 and a renewal fee of Rs.40,000 every three years, Category II has to pay Rs.30,000
and Rs.25,000 respectively.
2.3.2 GENERAL OBLIGATIONS AND RESPONSIBILITIES CODE OF CONDUCT
FOR REGSTER TO AN ISSUE AND SHARE TRANSFER AGENTS: A registrar to an
issue and share transfer agent should:
1. Maintain high standards of integrity in the conduct of its business.
2. Fulfill its obligations in a prompt, ethical and professional manner.
3. At all times exercise due diligence, ensure proper care and exercise independent professional
judgment.
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4. Exercise adequate care, caution and due diligence before dematerialization of securities by
confirming and verifying that the securities to be dematerialized have been granted listing
permission by the stock exchange(s).
5. Always endeavor to ensure that
(a) Inquiries from investors are adequately dealt with;
(b) Grievances of investors are redressed without any delay;
(c) Transfer of securities held in physical form and confirmation of dematerialization/
rematerialization requests and distribution of corporate benefits and allotment of securities is
done within the time specified under any law.
6. Make reasonable efforts to avoid misinterpretation and ensure that the information provided to
the investors is not misleading.
7. Not reject the dematerialization/ rematerialization requests on flimsy grounds. Such requests
could be rejected only on valid and proper grounds and supported by relevant documents.
8. Avoid conflict of interest and make adequate disclosure of its interest.
9. Put in place a mechanism to resolve any conflict of interest situation that may arise in the
conduct of its business or where any conflict of interest arises, should take reasonable steps to
resolve the same in an equitable manner.
10. Make appropriate disclosure to the client of its source or potential areas of conflict of duties
and interest which would impair its ability to render fair, objective and unbiased services.
11. Not indulge in any unfair competition, which is likely to harm the interests of other registrar
to the issue and share transfer agent or investors or is likely to place him in disadvantageous
position while competing for or executing any assignment.
12. Always endeavor to render the best possible advice to the clients having regard to their
needs. 13. Not divulge to other clients, press or any other person any confidential information
about its clients which has come to its knowledge except with the approval/ authorization of the
client or when it is required to disclose the information under any law for the time being in force.
14. Not discriminate among its clients, save and except on ethical and commercial
considerations.
15. Ensure that any change in registration status/any penal action taken by the SEBI or any
material change in financials which may adversely affect the interest of clients/ investors is
promptly informed to the clients.
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16. Maintain the required level of knowledge and competence and abide by the provisions of the
SEBI Act, rules, regulations, circulars and directions issued by the SEBI and also comply with
the award of the Ombudsman under the SEBI (Ombudsman) Regulations, 2003.
17. Co-operate with the SEBI as and when required.
18. Not neglect or fail or refuse to submit to the SEBI or other agencies with which he is
registered, such books, documents, correspondence, and papers or any part thereof as may be
demanded/requested from time to time.
19. Ensure that the SEBI is promptly informed about any action, legal proceeding, etc. Initiated
against it in respect of any material breach or non-compliance by it, of any law, rules, and
regulations, directions of the SEBI or of any other regulatory body.
20. Take adequate and necessary steps to ensure that continuity in data and recordkeeping is
maintained and that the data or records are not lost or destroyed. Further, it should ensure that for
electronic records and data, up-to-date back up is always available with it.
21. Endeavour to resolve all the complaints against it or in respect of the activities carried out by
it as quickly as possible.
22. (a) Not render, directly or indirectly any investment advice about any security in the publicly
accessible media, whether real-time or non-real time, unless a disclosure of its long or short
position in the securities has been made, while rendering such advice; (b) In case an employee of
a registrar to an issue and share transfer agent is rendering such advice, the registrar to an issue
and share transfer agent should ensure that it also discloses its own interest, the interests of his
dependent family members and that of the employer including their long or short position in the
security, while rendering such advice.
23. Handover all the records/data and all related documents which are in its possession in its
capacity as a registrar to an issue and/or share transfer agent to the respective clients, within one
month from the date of termination of agreement with the respective clients within or within one
month from the date of expiry/cancellation of certificate of registration as registrar to an issue
and/or share transfer agent, whichever is earlier.
24. Not make any exaggerated statement, whether oral or written, to the clients either about its
qualifications or capability to render certain services or should its achievements in regard to
services rendered to other clients.
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25. Ensure that it has satisfactory internal control procedures in place as well as adequate
financial and operational capabilities which can be reasonably expected to take care of any losses
arising due to theft, fraud and other dishonest acts, professional misconduct or omission.
26. Provide adequate freedom and powers to its compliance officer for the effective discharge of
its duties.
27. Develop its own internal code of conduct for governing its internal operations and laying
down its standards of appropriate conduct for its employees and officers in carrying out its duties
as a registrar to an issue and share transfer agent and as a part of the industry. Such a code may
extend to the maintenance of professional excellence and standards, integrity, confidentiality,
objectivity, avoidance of conflict of interests, disclosure of shareholdings and interests, etc.
28. Ensure that good corporate policies and corporate governance are in place.
29. Ensure that any person it employs or appoints to conduct business is fit and proper and
otherwise qualified to act in the capacity so employed or appointed (including having relevant
professional training or experience).
30. Be responsible for the acts or omissions of its employees and agents in respect of the conduct
of its business.
31. Not in respect of any dealings in securities be party to or instrumental for: (a) creation of
false market, (b) price rigging or manipulations; (c) passing of unpublished price sensitive
information in respect of securities which are listed and proposed to be listed in any stock
exchange to any person or intermediary.
MAINTENANCE OF RECORDS
The registrars and share transfer agents have to maintain records relating to all
applications received from investors in respect of an issue, all rejected applications together with
reasons, basis of allotment of securities in consultation with the stock exchanges, terms and
conditions of purchase of securities, allotment of securities, list of allottees and non-allotees,
refund orders, and so on. In addition, they should also keep a record to the list of holders of
securities of Corporates, the names of transfer agents to file the books of accounts, and records,
and so on. These have to be preserved by them for a period of three years.
INSPECTION
The SEBI is authorized to undertake the inspection of the books of accounts, other
records, and documents of the registrars and share transfer agents to ensure that they are being
maintained in a proper manner and the provisions of the SEBI Act, rules, regulations and the
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provisions of the SCRA and the relevant rules are complied with, to investigate into complaints
from investors/other registrars and share transfer agents/other intermediaries in the securities
market or any matter relating to their activities, and to investigate on its own in the interest of
securities market/investors into their affairs. On the basis of the inspection report, the SEBI can
direct the concerned partly to take such measures as it deems fit in the circumstances. It can also
appoint a qualified auditor to investigate into the books of accounts and affairs of the registrars
and share transfer agents.
ACTION IN DEFAULT
A registrar/share transfer agent who fails to comply with any condition subject to which
registration is granted, or contravenes any of the provisions of the SEBI Act/SCRA,
rules/regulations and stock exchange bye-laws, rules and regulations is liable to suspension or
cancellation of registration. The penalty for suspension is imposed for (a) violations of the
provisions of the SEBI Act, rules/regulations, (b) non-observance of the code of conduct, (c)
failure to furnish information, furnishing of wrong/false information, non-submission of
periodical information and non-cooperation in any enquiry, (d) failure to resolve investor
complaints or give a satisfactory reply to the SEBI in this behalf, (e) involvement in
manipulation/price rigging/ cornering activities, (f) guilty of misconduct/improper business-like
or unprofessional conduct business-like or unprofessional conduct, (g) failure to maintain capital
adequacy requirement or to pay the requirement or to pay the requisite fee; and (h) violation of
the conditions of registration. In case of their repeated defaults, the certificate of registration can
be cancelled. The other reasons for cancellation of registration are deliberate manipulation/price
rigging/ cornering activities affecting the securities market and the investor interest; violation of
the provisions of the SEBI Act, rules/regulations; violation of any provisions of insider trading/
take-over regulations and guilty of fraud/conviction on a criminal offence. The procedure for
inspection, holding enquiry and suspension/cancellation is the same as in the case of lead
managers, underwriters, bankers to the issue, and so on.
2.4 UNDERWRITERS
Another important intermediary in the new issue/primary market is the underwriters to
issues of capital who agree to take up securities which are not fully subscribed. They make a
commitment to get the issue subscribed either by others or by themselves. Though underwriting
is not mandatory after April 1995, its organization is an important element of the primary
market. Underwriters are appointed by the issuing companies in consultation with the lead
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managers/merchant bankers to the issues. A statement to the effect that in the opinion of the lead
manager, the underwriters‘ assets are adequate to meet their obligation should be incorporated in
the prospectus.
Registration
To act as underwriter, a certificate of registration must be obtained from the SEBI. In
granting the certificate of registration, the SEBI considers all matters relevant/relating to the
underwriting and in particular, a) the necessary infrastructure like adequate office space,
equipment and manpower to effectively discharge the activities b) past experience in
underwriting/employment of at least two persons with experience in underwriting c) any person
directly/indirectly connected with the applicant is not registered with the SEBI as under or a
previous application of any such person has been rejected or any disciplinary action has been
taken against such person under the SEBI Act/ rules/regulations, d) capital adequacy requirement
of not less than net worth (capital + free reserves) of Rs.20 lakhs; and e) the
applicant/director/principal officer/partner has been convicted of offence involving moral
turpitude or found gully of any economic offence.
FEE Underwriters had to, for grant or renewal of registration; pay a fee to the SEBI from the
date of initial grant of certificate, Rs. 2 lakhs for the first and second years and Rs.1 lakh for the
third year. A fee of Rs.20, 000 was payable every year to keep the certificate in force or for its
renewal. Since 1999, the registration fee has been raised to Rs.5 lakhs. To keep the registration in
force, renewal fee of Rs.2 lakhs every three years from the fourth year from the date of initial
registration is payable. Failure to pay the fee would result in the suspension of the certificate of
registration.
2.4.1 General Obligations and Responsibilities Code of Conduct for Underwriters
An underwriter should:
1. Make all efforts to protect the interests of its clients.
2. Maintain high standards of integrity, dignity and fairness in the conduct of its business.
3. Ensure that it and its personnel will act in an ethical manner in all its dealings with a body
corporate making an issue of securities (i.e. the issuer).
4. Endeavour to ensure all professional dealings are affected in a prompt, efficient and effective
manner.
5. At all times render high standards of service, exercise due diligence, ensure proper care and
exercise independent professional judgment.
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6. Not make any statement, either oral or written, which would misrepresent (a) the services that
the underwriter is capable of performing for its client, or has rendered to any other issuer
company; (b) his underwriting commitment.
7. Avoid conflict of interest and make adequate disclosure of his interest.
8. Put in place a mechanism to resolve any conflict of interest situation that may arise in the
conduct of its business or where any conflict of interest arises, should take reasonable steps to
resolve the same in any equitable manner.
9. Make appropriate disclosure to the client of its possible source or potential in areas of conflict
of duties and interest while acting as underwriter which would impair its ability to render fair,
objective and unbiased services.
10. Not divulge to other issuer, press or any party any confidential information about its issuer
company, which has come to its knowledge and deal in securities of any issuer company without
making disclosure to the SEBI as required under these regulations and also to the Board directors
of the issuer company.
11. Not discriminate amongst its clients, save and except on ethical and commercial
considerations. 12. Ensure that any charge in registration status/any penal action taken by SEBI
or any material change in financials which may adversely affect the interests of clients/ investors
is promptly informed to the clients and any business remaining outstanding is transferred to
another registered person in accordance with any instructions of the affected clients/investors.
13. Maintain an appropriate level of knowledge and competency and abide by the provisions of
the SEBI Act, regulations, circulars and guidelines issued by the SEBI. The underwriter should
also comply with the award of the Ombudsman under the SEBI (Ombudsman) Regulations,
2003.
14. Ensure that the SEBI is promptly informed about any action, legal proceedings, etc. initiated
against it in respect of any material breach or non-compliance by it, of any law, rules,
regulations, and directions of the SEBI or of any other regulatory body.
15. Not make any untrue statement or suppress any material fact in any documents, reports,
papers or information furnished to the SEBI.
16. (a) Not render, directly or indirectly any investment advice about any security in the publicly
accessible media, whether real-time or non-real-time, unless a disclosure of his interest including
its long or short position in the security has been made, while rendering such advice; (b) In case
an employee or an underwriter is rendering such advice, the underwriter should ensure that he
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should disclose his interest, the interest of his dependent family members and that of the
employer including their long or short position in the security, while rendering such advice.
17. Not either through its account or their respective accounts or through their associates or
family members, relatives or friends indulges in any insider trading.
18. Not indulge in any unfair competition, which is likely to be harmful to the interest of other
underwriters carrying on the business of underwriting or likely to place such other underwriters
in a disadvantageous position in relation to the underwriter while competing for, or carrying out
any assignment.
19. Have internal control procedures and financial and operational capabilities which can be
reasonably expected to protect its operations, its clients and other registered entities from
financial loss arising from theft, fraud, and other dishonest acts, professional misconduct or
commissions.
20. Provide adequate freedom and powers to its compliance officer for the effective discharge of
his duties.
21. Develop its own internal code of conduct for governing its internal operations and laying
down its standards of appropriate conduct for its employees and officers in the carrying out of
their duties. Such a code may extend to the maintenance of professional excellence and
standards, integrity, confidentiality, objectivity, avoidance of conflict of interest, disclosure of
shareholdings and interests, etc.
22. Ensure that good corporate policies and corporate governance is in place.
23. Ensure that any person it employs or appoints to conduct business is fit and proper and
otherwise qualified to act in the capacity so employed or appointed (including having relevant
professional training or experience).
24. Ensure that it has adequate resources to supervise diligently and does supervise diligently
persons employed or appointed by it to conduct business on its behalf.
25. Be responsible for the acts or omissions of its employees and agents in respect to the conduct
of its business.
26. Ensure that the senior management, particularly decision makers have access to all relevant
information about the business on a timely basis.
27. Not be party to or instrumental for (a) certain of false market, (b) price rigging or
manipulation, or; (c) passing of unpublished price sensitive information in respect of securities
which are listed and proposed to be listed in any stock exchange to any person or intermediary.
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Agreement with Clients
Every underwriter has to enter into an agreement with the issuing company. The
agreement, among others, provides for the period during which the agreement is in force, the
amount of underwriting obligations, the period within which the underwriter has to be subscribe
to the issue after being intimated by/on behalf of the issuer, the amount of
commission/brokerage, and details of arrangements, if any, made by the underwriter for fulfilling
the underwriting obligations.
General Responsibilities
An underwriter cannot derive any direct or indirect benefit from underwriting the issue
other than by the underwriting commission. The maximum obligation under all underwriting
agreements of an underwriter cannot exceed twenty times his net worth. Underwriters have to
subscribe for securities under the agreement with 45 days of the receipt of intimation from the
issuers.
Inspection and Disciplinary Proceedings
The framework of the SEBI‗s right to undertake the inspection of the books of accounts,
other records and documents of the underwriters, the procedure for inspection and obligations of
the underwriters is broadly on the same pattern as applicable to the lead managers.
Action In Case Of Default
The liability for action in case of default arising out of i. non-compliance with any
conditions subject to which registration was granted. ii. contravention of any provision of the
SEBI Act/rules/regulations, by an underwriter involves the suspension/cancellation of
registration, the effect of suspension/ cancellation are on the lines followed by the SEBI in case
of lead managers.
2.5 BANKERS TO AN ISSUE
The bankers to an issue are engaged in activities such as acceptance of applications along
with application money from the investors in respect of issues of capital and refund of
application money.
Registration
To carry on activity as a banker to issue, a person must obtain a certificate of registration
from the SEBI. The SEBI grants registration on the basis of all the activities relating to banker to
an issue in particular with reference to the following requirements: a) The applicant has the
necessary infrastructure, communication and data processing facilities and manpower to
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effectively discharge his activities, b) The applicant/any of the directors of the applicant is not
involved in any litigation connected with the securities market/has not been convicted of any
economic offence; c) The applicant is a scheduled bank and d) Grant of a certificate is in the
interest of the investors. A banker to an issue can apply for the renewal of his registration three
months before the expiry of the certificate. Every banker to an issue had to pay to the SEBI an
annual fee of Rs.2.5 lakhs for the first two years from the date of initial registration, and Rs.1
lakh for the third year to keep his registration in force. The renewal fee to be paid by him
annually for the first two years was Rs.1 lakh and Rs.20,000 for the third year. Since 1999,
schedule of fee is Rs.5 lakhs as initial registration fee and Rs.2.5 lakhs renewal fee every three
years from the fourth year from the date of initial registrations. Non-payment of the prescribed
fee may lead to the suspension of the registration certificate.
General Obligations and Responsibilities Furnish INFORMATION When required, a banker
to an issue has to furnish to the SEBI the following information; a) The number of issues for
which he was engaged as a banker to an issue; b) The number of application/details of the
application money received, c) The dates on which applications from investors were forwarded
to the issuing company /registrar to an issue; d) The dates/amount of refund to the investors.
DBA 1724 Books of Account/Record/Documents
A banker to an issue is required to maintain books of accounts/records/documents for a minimum
period of three years in respect of, inter-alia, the number of applications received, the names of
the investors, the time within which the applications received were forwarded to the issuing
company/registrar to the issue and dates and amounts of refund money to investors.
Disciplinary Action by the RBI
If the RBI takes any disciplinary action against a banker to an issue in relation to issue payment,
the latter should immediately inform the SEBI. If the banker is prohibited from carrying on his
activities as a result of the disciplinary action, the SEBI registration is automatically deemed as
suspended/cancelled.
2.5.1 Code of Conduct for Bankers To Issue
A banker to an issue should:
1. Make all efforts to protect the interest of investors.
2. Observe high standards of integrity and fairness in the conduct of its business.
3. Fulfill its obligations in a prompt, ethical and professional manner.
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4. At all times exercise due diligence, ensure proper care and exercise independent professional
judgment
5. Not any time act in collusion with other intermediates over the issuer in a manner that is
detrimental to the investor
6. Endeavour to ensure that a) inquiries from investors are adequately dealt with; b) grievances
of investors are redressed in a timely and appropriate manner; c) where a complaint is not
remedied promptly, the investor is advised of any further steps which may be available to the
investor under the regulatory system.
7. Not a) Allow blank applications forms bearing brokers stamp to be kept the bank premises or
peddled anywhere near the entrance of the premises; b) Accept applications after office hours or
after the date of closure of the issue or on bank holidays; c) After the closure of the public issue
accept any instruments such as Cheques/ demand drafts/stock invests from any other source
other than the designated registrar to the issue; d) Part with the issue proceeds until listing
permission is granted by the stock exchange to the body corporate; e) Delay in issuing the final
certificate pertaining to the collection figures to the registrar to the issue, the lead manager and
the body corporate and such figures should be submitted within seven working days from the
issue closure date.
8. Be prompt in disbursing dividends, interests or any such accrual income received or collected
by him on behalf of his clients.
9. Not make any exaggerated statement whether oral or written to the client, either about its
qualification or capability to render certain services or its achievements in regard to services
rendered to other client.
10. Always Endeavour to render the best possible advice to the clients having regard to the
clients‘ needs and the environments and his own professional skill.
11. Not divulge to anybody either orally or in writing, directly or indirectly, any confidential
information about its clients which has come to its knowledge, without taking prior permission
of its clients
12. Avoid conflict of interest and make adequate disclosure of his interest.
13. Put in place a mechanism to resolve any conflict of interest situation that may arise in the
conduct of its business or where any conflict of interest arise, should take reasonable steps to
resolve the same in an equitable manner.
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14. Make appropriate disclosure to the client of its possible source or potential areas of conflict
of duties and interest while acting as banker to an issue which would impair its ability to render
fair, objective and unbiased services.
15. Not indulge in any unfair competition, which is likely to harm the interests of other bankers
to an issue or investors or is likely to place such other bankers to an issue in a disadvantageous
position while competing for or executing any assignment.
16. Not discriminate amongst its clients, save and except on ethical and commercial
considerations. 17. Ensure that any change in registration status/any penal action taken by the
SEBI or any material change in financials which may adversely affect the interests of clients/
investors is promptly informed to the clients and business remaining outstanding is transferred to
another registered person in accordance with any instructions of the affected clients/investors.
18. Maintain an appropriate level of knowledge and competency and abide by the provisions of
the SEBI Act, regulations, circulars and guidelines of the SEBI. The banker to an issue should
also comply with the award of the Ombudsman passed under the SEBI (Ombudsman)
Regulations, 2003. 19. Ensure that the SEBI is promptly informed about any action, legal
proceedings, etc., initiated against it in respect of any material breach of non-compliance by it, of
any law, rules, regulations, and directions of the SEBI or of any other regulatory body.
20. Not make any untrue statement of suppress any material fact in any documents, reports,
papers or information furnished to the SEBI.
21. Not neglect or fail or refuse to submit to the SEBI or other agencies with which it is
registered, such books, documents, correspondence, and papers or any part thereof as may be
demanded/requested from time to time.
22. Abide by the provisions of such acts and rules, regulations, guidelines, resolutions,
notifications, directions, circulars and instructions as may be issued from time to time by the
Central Government, relevant to the activities carried on the banker to an issue.
23. (a) Not render, directly or indirectly, any investment advice about any security in the publicly
accessible media, whether real-time or non-real-time, unless a disclosure of its interest including
long or short position in the security has been made, while rendering such advice; (b) in case an
employee of the banker to an issue is rendering such advice, the banker to an issue should ensure
that he discloses his interest, the interest of his dependent family members and that of the
employer including employer‗s long or short position in the security, while rendering such
advice.
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Inspection
Such inspection is done by the RBI upon the request of the SEBI. The purpose of
inspection is largely to ensure that the required books of accounts are maintained and to
investigate into the complaints received from the investors against the bankers to an issue. The
foregoing rules and regulations have brought the bankers to an issue under the regulatory
framework of the SEBI with a view to ensuring greater investor protection. On the basis of the
inspection report, the SEBI can direct the banker to an issue to take such measures as it may
deem fit in the interest of the securities market and for due compliance with the provision of the
SEBI Act.
Action In Case of Default
With a view to ensure effective regulation of the activities of the bankers to an issue, the
SEBI is empowered to suspend/cancel their registration certificate. The grounds of suspension
are: a) The banker violates the provisions of the SEBI Act, rules/regulations; b) Fails to/does not
furnish the required information or furnishes wrong/false information; c) Fails to resolve investor
complaints/to give satisfactory reply to SEBI; d) Is guilty of misconduct/unprofessional conduct
inconsistent with the prescribed code of conduct; and e) Fails to pay fees and carry out his
obligations as specified in the regulations. The SEBI can cancel registration in case of i.
Repeated defaults leading to suspension of a banker, ii. The deterioration in is financial position
which likely to adversely affect the interest of the investors, and iii. The being found guilty of
fraud/convicted of a criminal offence.
2.6 BROKERS TO THE ISSUE
Brokers are the persons mainly concerned with the procurement of subscription to the
issue from the prospective investors. The appointment of brokers is not compulsory and the
companies are free to appoint any number of brokers. The managers to the issue and the official
brokers organize the preliminary distribution of securities and procure direct subscriptions from
as large or as wide a circle of investors as possible. The stock exchange bye-laws prohibits the
members from the acting as managers or brokers to the issue and making preliminary
arrangement in connection with any flotation or new issue, unless the stock exchange of which
they are members gives its approval and the company conforms to the prescribed listing
requirements and undertakes to have its securities listed on a recognized stock exchange. The
permission granted by the stock exchange is also subject o other stipulations which are set out in
the letter of consent. Their active assistance is indispensable for broad basing the issue and
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attracting investors. By and large, the leading merchant bankers in India who act as managers to
the issue have particulars of the performance of brokers in the country. The company in
consultation with the stock exchange writes to all active brokers of all exchanges and obtains
their consent to act as brokers to the issue. Thereby, the entry of experienced and unknown
agencies in to the field of new issue activity as issue managers, underwriters, brokers, and so on,
is discouraged. A copy of the consent letter should be filed along with the prospectus to the
ROC. The names and addresses of the brokers to the issue are required to be disclosed in the
prospectus. Brokerage may be paid within the limits and according to other conditions
prescribed. The brokerage rate applicable to all types of public issue of industrial securities is
fixed at 1.5 percent, whether the issue is underwritten or not. The mailing cost and other out-of
pocket expenses for canvassing of public issues have to be borne by the stock brokers and no
payment on that account is made by the companies. A clause to this effect must be included in
the agreement to be entered into between the broker and the company. The listed companies are
allowed to pay a brokerage on private placement of capital at a maximum rate of 0.5 percent.
Brokerage is not allowed in respect of promoter‘s quota including the amounts taken up by the
directors, their friends and employees, and in respect of the rights issues taken by or renounced
by the existing shareholders. Brokerage is not payable when the applications are made by the
institutions/bankers against their underwriting commitments or on the amounts devolving on
them as underwriters consequent to the under subscription of the issues. The issuing company is
expected to pay brokerage within two months from the date of allotment and furnish to the
broker, on request, the particulars of allotments made against applications bearing their stamp,
without any charge. The Cheques relating to brokerage on new issues and underwriting
commission, if any, should be made payable at par at all centre where the recognized stock
exchanges are situated. The rate of brokerage payable must be is enclosed in the prospectus.
(i) Banking All types of foreign exchange transactions including advice on exchange, imports,
exports finance, financing the movement of goods through acceptance credits, the handling of
commercial letters of credit, the negotiation and collection of foreign bills, accepting call or term
deposits, short or medium term finance, bridging finance, leading; corporate banking,
treasury/trading services, discount/guarantee facilities. Issuing and underwriting. Public issues;
underwriting of issues, preparation of prospectuses; new equity; obtaining stock exchange
listings/broking services.
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(ii) Corporate Finance New issues; development capital; negotiation of mergers and takeovers;
capital reconstruction; bridging finance, medium term loans; public sector finance.
(iii) Management Services Economic planning; trusts administration; share secretarial services;
primary capital market participation.
(iv) Product Knowledge Foreign exchange, import finance; export finance; commercial LCs;
FBCSs; Call/ Term deposits; medium term loans (MTL); Bridging finance; leasing, treasury
services, discount/guarantees, Acceptance credits, public issues, underwriting, equity, broking,
estate planning, trusts, share transfers. Marketing the public issue arises because of the highly
competitive nature of the capital market. Moreover, there is a plethora of companies, which
knock at the doors of investors seeking to sell their securities. Above all the media bombards the
modern investors with eye catching advertisement to sell their concepts to prospective investors.
2.6.1Merchant Banking And Marketing of New Issues Following are the steps involved in the
marketing of the issue of securities to be undertaken by the lead manager:
1. Target market: The first step towards the successful marketing of securities is the
identification of a target market segment where the securities can be offered for sale. This
ensures smooth marketing of the issue. Further, it is possible to identify whether the market
comprises of retail investors, wholesale investors or institutional investors.
2. Target concentration: After having chosen the target market for selling the securities, steps
are to be taken to assess the maximum number of subscriptions that can be expected from the
market. It would work to the advantage of the company if it concentrates on the regions where it
is popular among prospective investors.
3. Pricing: After assessing market expectations, the kind and level of price to be charged for the
security must be decided. Pricing of the issue also influences the design of capital structure. The
offer has to be made more attractive by including some unique features such as safety net,
multiple options for conversion, attaching warrants, etc.
4. Mobilizing intermediaries: For successful marketing of public issues, it is important that
efforts are made to enter into contracts with financial intermediaries such as an underwriter,
broker/sub-broker, fund arranger, etc.
5. Information contents: Every effort should be mad3e to ensure that the offer document for
issue is educative and contains maximum relevant information. Institutional investors and high
net worth investors should also be provided with detailed research on the project, specifying its
uniqueness and its advantage over other existing or upcoming projects in a similar field.
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6. Launching advertisement campaign: In order to push the public issue, the lead manager
should undertake a high voltage advertisement campaign. The advertising agency must be
carefully selected for this purpose. The task of advertising the issue shall be entrusted to those
agencies that specialize in launching capital offerings. The theme of the advertisement should be
finalized keeping in view SEBI guidelines. An ideal mix of different advertisement vehicles such
as the press, the radio and the television, the hoarding, etc. should be used. Press meets, brokers
and investor‗s conference, etc. shall be arranged by the lead manager at targeted in carrying out
opinion polls. These services would useful in collecting data on investors‗ opinion and reactions
relating to the public issue of the company, such a task would help develop an appropriate
marketing strategy. This is because; there are vast numbers of potential investors in semi-urban
and rural areas. This calls for sustained efforts on the part of the company to educate them about
the various avenues available for investment.
7. Brokers and investors conferences: As part of the issue campaign, the lead manager should
arrange for brokers‘ and investors‘ conferences in the metropolitan cities and other important
centre which have sufficient investor population. In order to make such endeavors more
successful, advance planning is required. It is important that conference materials such as
banners, brochures, application forms, posters, etc. reach the conference venue in time. In
addition, invitation to all the important people, underwriters, bankers at the respective places,
investors‘ associations should also be sent.
8. A critical factor that could make or break the proposed pu8blic issue is its timing. The market
conditions should be favorable. Otherwise, even issues from a company with an excellent track
record, and whose shares are highly priced, might flop. Similarly, the number and frequency of
issues should also be kept to a minimum to ensure success of the public issue.
Methods Following are the various methods being adopted by corporate entities for marketing
the securities in the new Issues Market: 1. Pure Prospectus Method 2. Offer for Sale Method 3.
Private Placement Method 4. Initial Public Offers Method 5. Rights Issue Method 6. Bonus Issue
Method 7. Book-building Method 8. Stock Option Method and 9. Bought-out Deals Method
Abbreviations • PPM Pure Prospectus Method • OSM Offer for Sale Method • PPM Private
Placement Method • IPOM Initial Public Offers Method • RIM Right Issue Method • BIM Bonus
Issue Method • BBM Book Building Method • SOM Stock Option Method • BODM BroughtOut Deals Method
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1. Pure Prospectus Method The method whereby a corporate enterprise mops up capital funds
from the general public by means of an issue of a prospectus, is called ‗Pure Prospectus
Method‗. It is the most popular method of making public issue of securities by corporate
enterprises. The features of this method are
a. Exclusive subscription: Under this method, the new issues of a company are offered for
exclusive subscription of the general public. According to the SEBI norms, a minimum of 49
percent of the total issue at a time is to be offered to public.
b. Issue price: Direct offer is made by the issuing company to the general public to subscribe to
the securities at a staged price. The securities may be issued either at par, of at a discount or at a
premium.
c. Underwriting: Public issue through the pure prospectus method‘s usually underwritten. This
is to safeguard the interest of the issuer in the event of an unsatisfactory response from the
public.
d. Prospectus: A document that information relating to the various aspects of the
Issuing company, besides other details of the issue is called a Prospectus‗. The document is
circulated to the public. The general details include the company‗s name and address of the
registered office, the names and addresses of the company‗s promoters, manager, managing
director, directors, company secretary, legal adviser, auditors, bankers, brokers, etc. the date of
opening and closing of subscription list, contents of Articles, the names and addresses of
underwriters, the amount underwritten and the underwriting commission, material details
regarding the project, i.e. Location, plant and machinery, technology, collaboration, performance
guarantee, infrastructure facilities etc. nature of products, marketing set-up, export potentials and
obligations, past performance and future prospects, management‗s perception regarding risk
factor, credit rating obtained from any other recognized rating agency, a statement regarding the
fact that the company will make an application to specified stock exchange(s) for listing its
securities and so on.
Advantages
a. Benefits to Investors: The pure prospectus method of marketing the securities serves as an
excellent mode of disclosure of all the information pertaining to the issue. Besides, it also
facilitates satisfactory compliance with the legal requirements of transparency etc.. It also allows
for good publicity for the issue. The method promotes confidence of investors through
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transparency and non-discriminatory basis of allotment. It prevents artificial packing up of prices
as the issue is made public.
b. Benefits to Issuers: The pure prospectus method is the most popular method among the large
issuers. In addition, it provides for wide diffusion of ownership of securities contributing to
reduction in the concentration of economic and social power.
Draw Backs
a. High Issue Costs: A major drawback of this method is that it is an expensive mode of raising
funds from the capital market. Costs of various hues are incurred in mobilizing capital. Such
costs as underwriting expenses, brokerage, administrative costs, publicity costs, legal costs and
other costs are incurred for raising funds. Due to the high cost structure, this type of marketing of
securities is followed only for large issues.
b. Time consuming: The issue of securities through prospectus takes more time, as it requires
the due compliance with various formalities before an issue could take place. For instance, a lot
of work such as underwriting, etc. should be formalized before the printing and the issue of a
prospectus.
2.7 OFFERS FOR SALE METHOD
Where the marketing of securities takes place through intermediaries, such as issue
houses, stockbrokers and others, it is a case of ‗Offer for Sale Method‗. Under this method, the
sale of securities takes place in two stages. Accordingly, in the first stage, the issuer company
makes an end-block sale of securities to intermediaries such as the issue houses and share
brokers at an agreed price. Under the second stage, the securities are re-sold to ultimate investors
at a market-related price. The difference between the purchase price and the issue price
constitutes profit for the intermediaries. The intermediaries are responsible for meeting various
expenses such as underwriting commission, prospectus cost, advertisement expenses, etc. The
issue is also underwritten to ensure total subscription of the issue. The biggest advantage of this
method is that it saves the issuing company the hassles involved in selling the shares to the
public directly through prospectus. This method is, however, expensive for the investor as it
involves the offer of securities by issue houses at very high prices.
2.8 PRIVATE PLACEMENT METHOD
A method of marketing of securities whereby the issuer makes the offer of sale to
individuals and institutions privately without the issue of a prospectus is known as ‗Private
Placement Method‗. This is the most popular method gaining momentum in recent times among
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the corporate enterprises. Under this method, securities are offered directly to large buyers with
the help of shares brokers. This method works in a manner similar to the ‗Offer for Sale Method
whereby securities are first sold to intermediaries such as issues houses, etc. They are in turn
placed at higher prices to individuals and institutions. Institutional investors play a significant
role in the realm of private placing. The expenses relating to placement are borne by such
investors.
Advantages
1. Less expensive as various types of costs associated with the issue are borne by the issue
houses and other intermediaries.
2. Less troublesome for the issuer as there is not much of stock exchange requirements
connecting contents of prospectus and its publicity etc. to be complied with.
3. Placement of securities suits the requirements of small companies.
4. The method is also resorted to when the stock market is dull and the public response to the
issue is doubtful.
Disadvantages
1. Concentration of securities in a few hands. 2. Creating artificial scarcity for the securities thus
jacking up the prices temporarily and misleading general public. 3. Depriving the common
investors of an opportunity to subscribe to the issue, thus affecting their confidence levels.
2.9 INTIAL PUBLIC OFFER (IPO) METHOD
The public issue made by a corporate entity for the first time in its life is called ‗Initial Public
Offer‗(IPO). Under this method of marketing, securities are issued to successful applicants on
the basis of the orders placed by them, through their brokers. When a company whose stock is
not publicly traded wants to offer that stock to the general public, it takes the form of ‗Initial
Public Offer‗. The job of selling the stock is entrusted to a popular intermediary, the underwriter.
An underwriter is invariably an investment banking company. He agrees to pay the issuer a
certain price for a minimum number of shares, and then resells those shares to buyers, who are
often the clients of the underwriting firm. The underwriters charge a fee for their services. Stocks
are issued to the underwriter after the issue of prospectus which provides details of financial and
business information as regards the issuer. Stocks are then released to the underwriter and the
underwriter releases the stock to the public. The issuer and the underwriting syndicate jointly
determine the price of a new issue. The approximate price listed in the red herring (the
preliminary prospectus – often with words in red letters which say this is preliminary and the
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price is not yet set) may or may not be close to the final issue price. IPO stock at the release price
is usually not available to most of the public. Good relationship between the broker and the
investor is a prerequisite for the stock being acquired. Full disclosure of all material information
in connection with the offering of new securities must be made as part of the new offerings. A
statement and preliminary prospectus (also known as a red herring) containing the following
information is to be filed with the Registrar of Companies:
1. A description of the issuer‗s business
2. The names and addresses of the key company offers, with salary and a 5 year business history
on each
3. The amount of ownership of the key officers
4. The company‗s capitalization and description of how the proceeds from the offering will be
used and
5. Any legal proceedings that the company is involved in. Applications are made by the investors
on the advice of their brokers who are intimated of the share allocation by the issuer. The amount
becomes payable to the issuer through the broker only on final allocation. The allotment is
credited and share certificates delivered to the depository account of the successful investor.
The essential steps involved in this method of marketing of securities are as follows:
a. Order Broker receives order from the client and places orders on behalf of the client with the
issuer.
b. Share allocation: The issuer finalizes share allocation and informs the broker regarding the
same. c. The client: The broker advises the successful clients of his share allocation Clients then
submit the application forms for shares and make payment to the issuer through the broker.
d. Primary issue account: The issuer opens a separate escrow account (primary issue account)
for the primary market issue. The clearing house of the exchange debits the primary issue
account of the broker and credits the issuer‗s account.
e. Certificates: Certificates are then delivered to investors. Otherwise depository account may be
credited. The biggest advantage of this method of marketing of securities is that there is no need
for the investors to part with the money even before the shares are allotted in his favor. Further,
the method allows for elimination of unnecessary hassles involved in making a public issue.
Under the regulations of the SEBI, IPOS can be carried out through the secondary market and
the existing infrastructure of stock exchanges can be used for this purpose.
2.10 RIGHTS ISSUE METHOD
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Where the shares of an existing company are offered to its existing shareholders, it takes
the form of ‗rights issue‗. Under this method, the existing company issues shares to its existing
shareholders in proportion to the number of shares already held by them. The relevant guidelines
issued by the SEBI in this regard are as follows;
1. Shall be issued only by listed companies
2. Announcement regarding rights issue once made, shall not be withdrawn and where
withdrawn, no security shall be eligible for listing up to 12 months
3. Underwriting as to rights issue is optional and appointment of Registrar is compulsory
4. Appointment of category I Merchant Bankers holding a certificate of registration issued by
SEBI shall be compulsory
5. Rights shares shall be issued only in respect of fully paid shares
6. Letter of Offer shall contain disclosures as per SEBI requirements
7. Agreement shall be entered into with the depository for materialization of securities to be
issued
8. Issue shall be kept open for a minimum period of 30 days and for a maximum period of 60
days
9. A minimum subscription of 90 percent of the issue shall be received
10. No reservation is allowed for rights issue as regards FCDs and PCDs
11. A No Complaints Certificate‘s to be filed by the Lead Merchant Banker‘ with the SEBI after
21 days from the date of issue of offer document
12. Obligatory for a company where increase in subscribed capital is necessary after two years of
its formation or after one year of its first issue of shares, whichever is earlier?
Advantages
Rights issue offers the following advantages:
1. Economy: Rights issue constitutes the most economical method of raising fresh capital, as it
involves no underwriting and brokerage costs. Further, the expenses by way of advertisement
and administration, etc. are less.
2. Easy: The issue management procedures connected with the rights issue are easier as only a
limited number of applications are to be handled.
3. Advantage of shareholders: Issue of rights shares does not involve any dilution of ownership
of existing shareholders. Further, it offers freedom to shareholders to subscribe or not to
subscribe the issue.
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Drawbacks
The method suffers from the following limitations:
1. Restrictive: The facility of rights issue is available only to existing companies and not to new
companies.
2. Against society : The issue of rights shares runs counter to the overall societal considerations
of diffusion of shares ownership for promoting dispersal of wealth and economic power.
2.11 Bonus Issues Method
Where the accumulated reserves and surplus of profits of a company are converted into
paid up capital, it takes the form of issue of ‗bonus shares‗. It merely implies capitalization of
exiting reserves and surplus of a company. The issue of bonus shares is subject to certain rules
and regulations. The issue does not in any way affect the resources base of the enterprise. It
saves the company enormously of the hassles of capital issue. Issued under Section 205 (3) of the
Companies Act, such shares are governed by the guidelines issued by the SEBI (applicable to
listed companies only) as follows:
2.11.1SEBI Guidelines
Following are the guidelines pertaining to the issue of bonus shares by a listed corporate
enterprise:
1. Reservation In respect of FCDs and PCDs, bonus shares must be reserved in
proportion to such convertible part of FCDs and PCDs. The shares so reserved may be issued at
the time of conversion(s) of such debentures on the same terms on which the bonus issues were
made.
2. Reserves The bonus issue shall be made out of free reserves built out of the genuine
profits or share premium collected in cash only. Reserves created by revaluation of fixed assets
are not capitalized.
3. Dividend mode The declaration of bonus issue, in lieu of dividend, is not made
4. Fully paid The bonus issue is not made unless the partly paid shares, if any are made
fully paid-up.
5. No default The Company has not defaulted in payment of interest or principal in
respect of fixed deposits and interest on existing debentures or principal on redemption thereof
and has sufficient reason to believe that it has not defaulted in respect of the payment of statutory
dues of the employees such as contribution to provident fund, gratuity, bonus etc.
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6. Implementation A company that announces its bonus issue after the approval of the
Board of Directors must implement the proposal within a period of 6 months from the date of
such approval and shall not have the option of changing the decision.
7. The articles The articles of Association of the company shall contain a provision for
capitalization of reserves, etc. If there is no such provision in the Articles, the company shall
pass a resolution at its general body meeting making provisions in the Articles of Associations
for capitalization.
8. Resolution Consequent to the issue of bonus shares if the subscribed and paid-up
capital exceeds the authorized share capital, the company at its general body meeting for
increasing the authorized capital shall pass a resolution.
2. 12 BOOK BUILDING METHOD
A method of marketing the shares of a company whereby the quantum and the price of
the securities to be issued will be decided on the basis of the ‗bids‗ received from the
prospective shareholders by the lead merchant bankers is known as ‗book-building method.
Under the book-building method, share prices are determined on the basis of real demand for the
shares at various price levels in the market. For discovering the price at which issue should be
made, bids are invited from prospective investors from which the demand at various price levels
is noted. The merchant bankers undertake full responsibility for the same. The option of bookbuilding is available to all body corporate, which are otherwise eligible to make an issue of
capital to the public. The initial minimum size of issue through book-building route was fixed at
Rs.100 crores. However, beginning from December 9, 1996 issues of any size will be allowed
through the book-building route. Book-building facility is available as an alternative to firm
allotment. Accordingly, a company can opt for book-building route for the sale of shares to the
extent of the percentage of the issue that can be reserved for firm allotment as per the prevailing
SEBI guidelines. It is therefore possible either to reserve securities for firm allotment or issue
them through the book-building process. The book-building process involves the following steps:
1. Appointment of book-runners:
The first step in the book-building process is the appointment by the issuer company, of
the book-runner, chosen from one of the lead merchant bankers. The book-runner in turn forms a
syndicate for the book-building. A syndicate member should be a member of National Stock
Exchange (NSE) or Over-the-Counter Exchange of India (OTCEI). Offers of bids‘ are to be
made by investors to the syndicate members, who register the demands of investors. The bid
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indicates the number of shares demanded and the prices offered. This information, which is
stored in the computer, is accessible to the company management or to the book-runner. The
name of the book-runner is to be mentioned in the draft prospectus submitted to SEBI.
2. Drafting prospectus:
The draft prospectus containing all the information except the information regarding the
price at which the securities are offered is to be filed with SEBI as per the prevailing SEBI
guidelines. The offer of securities through this process must separately be disclosed in the
prospectus, under the caption ‗placement portion category‗. Similarly, the extent of shares
offered to the public shall be separately shown under the caption ‗net offer to the public‗.
According to the latest SEBI guidelines issued in October 1999, the earlier stipulation that at
least 25 percent of the securities were to be issued to the public has been done away with. This is
aimed at enabling companies to offer the entire public issue through the book-building route.
3. Circulating draft prospectus
A copy of the draft prospectus filed with SEBI is to be circulated by the book-runner to
the prospective institutional buyers who are eligible for firm allotment and also to the
intermediaries who are eligible to act as underwriters. The objective is to invite offers for
subscribing to the securities. The draft prospectus to be circulated must indicate the price band
within which the securities are being offered for subscription.
4. Maintaining offer records:
The book-runner maintains a record of the offers received. Details such as the name and
the number of securities ordered together with the price at which each institutional buyer or
underwriter is willing to sub scribe to securities under the placement portion must find place in
the record. SEBI has the right to inspect such records.
5. Intimation about aggregate orders:
The underwriters and the institutional investors shall give intimation on the aggregate of
the offers received to the book-runner.
6. Bid analysis:
The bid analysis is carried out by the book-runner immediately after the closure of the bid
offer date. An appropriate final price is arrived at after a careful evaluation of demands at various
prices and the quantity. The final price is generally fixed reasonably lower than the possible offer
price. This way, the success of the issue is ensured. The issuer company announce the pay-indate at eh expiry of which shares are allotted.
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7. Mandatory Underwriting:
Where it has been decided to make offer of shares to public under the category of ‗Net
Offer to the Public‗; it is incumbent that the entire portion offered to the public is fully
underwritten. In case an issue is made through book-building route, it is mandatory that the
portion of the issue offered to the public be underwritten. This is the purpose, an agreement has
to be entered into with the underwriter by the issuer. The agreement shall specify the number of
securities as well as the price at which the underwriter would subscribe to the securities. The
book-runner may require the underwriter of the net offer to the public to pay in advance all
moneys required to be paid in respect of their underwriting commitment.
8. Filling with ROC:
A copy of the prospectus as certified by the SEBI shall be filed with the Registrar of
Companies within two days of the receipt of the acknowledgement card from the SEBI.
9. Bank accounts:
The issuer company has to open two separate accounts for collection of application
money, one for the private placement portion and the other for the public subscription.
10. Collection of Completed Applications:
The book-runner collects from the institutional buyers and the underwriters the
application forms along with the application money to the extent of the securities proposed to be
allotted to them or subscribed by them. This is to be done one day before the opening of the issue
to the public.
11. Allotment of securities:
Allotment for the private placement portion may be made on the second day from the
closure of the issue. The issuer company, however, has the option to choose one date for both the
placement portion and the public portion. The said date shall be considered to be the date of
allotment for the issue of securities through the book-building process. The issuer company is
permitted to pay interest on the application moneys till the date of allotment or the deemed date
of allotment provided that payment of interest is uniformly given to all the applicants.
12. Payment schedule and listing:
The book-runner may require the underwriters to the ‗net offer to the public to pay in
advance all moneys required to be paid in respect of their underwriting commitment by the
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eleventh day of the closure of the issue. In that case, the shares allotted as per the private
placement category will become eligible for being listed. Allotment of securities under the public
category is to be made as per the prevailing statutory requirements.
13. Under-subscription:
In the case of under-subscription in the ‗net offer to the public‘ category, any spillover to
the extent of under-subscription is to be permitted from the ‗placement portion category subject
to the condition that preference is given to the individual investors. In the case of undersubscription in the placement portion, spillover is to be permitted from the net offer to the public
to the placement portion.
2.12.1Advantages of Book Building
Book-building process is of immense use in the following ways: 1. Reduction in the
duration between allotment and listing 2. Reliable allotment procedure 3. Quick listing in stock
exchanges possible 4. No price manipulation as the price is determined on the basis of the bids
received.
2.13 STOCK OPTION OF EMPLOYEES STOCK OPTION SCHEME (ESOP)
A method of marketing the securities of a company whereby its employees are
encouraged to take up shares and subscribe to it is known as ‗stock option‗.. It is a voluntary
scheme on the part of the company to encourage employees‘ participation in the company. The
scheme also offers an incentive to the employees to stay in the company. The scheme is
particularly useful in the case of companies whose business activity is dominantly based on the
talent of the employees, as in the case of software industry. The scheme helps retain their most
productive employees in an industry, which is known for its constant churning of personnel.
SEBI Guidelines Company whose securities are listed on any stock exchange can introduce the
scheme of employees‘ stock option. The offer can be made subject to the conditions specified
below:
1. Issue at discount Issue of stock option at a discount to the market price would be regarded as
another form of employee compensation and would be treated as such in the financial statements
of the company regardless the quantum of discount on the exercise price of the options.
2. Approval The issue of ESOPs is subject to the approval by the shareholders through a special
resolution.
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3. Maximum limit There would be no restriction on the maximum number of shares to be issued
to a single employee. However, in case of employees being offered more than 1 percent shares, a
specific disclosure and approval would be necessary in the AGM.
4. Minimum period A minimum period of one year between grant of options and its vesting has
been prescribed. After one year, the company would determine the period during which the
option can be exercised.
5. Superintendence The operation of the ESOP Scheme would have to be under the
superintendence and direction of a Compensation Committee of the Board of Directors in which
there would be a majority of independent directors.
6. Eligibility ESOP scheme is open to all permanent employees and to the directors of the
company but not to promoters and large shareholders. The scheme would be applicable to the
employees of the subsidiary or a holding company with the express approval of the shareholders.
7. Director‟s report The Director‗s report shall make a disclosure of the following : a. Total
number of shares as approved by the shareholders b. The pricing formula adopted c. Details as to
options granted, options vested, options exercised and options forfeited, extinguishments or
modification of options, money realized by exercise of options, total number of options in force,
employee-wise details of options granted to senior managerial personnel and to any other
employee who receive a grant in any one year of options amounting to 5 percent or more of
options granted during that year d. Fully diluted EPS computed in accordance with the IAS IPO
SEBI‗s stipulations prohibiting initial public offerings by companies having outstanding options
should not apply to ESOP. If any ESOPs are outstanding at the time of an IPO issue by an
unlisted company, the promoters‘ contribution shall be calculated with reference to the enlarged
capital that would arise if all vested options were exercised.
2.13.1Stock Option Norms for Software Companies
The relevant guidelines issued by the SEBI as regards employees stock option‗for software
companies are as follows:
1. Minimum issue A minimum issue of 10 percent of its paid-up capital can be made by a
software company which has already floated American Depository Receipts (ADRs) and Global
Depository Receipts (GDRs) or a company which is proposing to float these is entitled to issue
ADR/GDR-linked stock options to its employees. For this purpose, prior permission from the
Department of Economic Affairs is to be obtained.
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2. Mode of Issue Listed stock options can be issued in foreign currency convertible bonds and
ordinary shares (through depository receipt mechanism) to the employees of subsidiaries of
InfoTech companies.
3. Permanent employees Indian IT companies can issue ADR/GDR linked stock options to
permanent employees, including Indian and overseas directors, of their subsidiary companies
incorporated in India or outside.
4. Pricing The pricing provisions of SEBI‗s preferential allotment guidelines would not cover
the scheme. The purpose is to enable the companies to issue stock options to its employees at a
discount to the market price which serves as another form of compensation.
5. Approval Shareholders‘ approval through a special resolution is necessary for issuing the
ESOPs. A minimum period of one year between grant of option and its vesting has been
prescribed. After one year, the company would determine the period in which option can be
exercised.
2. 14 BOUGHT OUT DEALS
A method of marketing of securities of a body corporate whereby the promoters of an
unlisted company make an outright sale of a chunk of equity shares to a single sponsor or the
lead sponsor is known as bought-out deals‗.
The following are the characteristics of Bought out deals
1. Parties: There are three parties involved in the bought-out deals. They are promoters of the
company, sponsors and co-sponsors who are generally merchant bankers and investors.
2. Outright sale: Under this arrangement, there is an outright sale of a chunk of equity shares to
a single sponsor or the lead sponsor.
3. Syndicate: Sponsor forms syndicate with other merchant bankers for meeting the resource
requirements and for distributing the risk.
4. Sale price: The s ale price is finalized through negotiations between the issuing company and
the purchaser, the sale being influenced by such factors as project evaluation, promoters image
and reputation, current market sentiments, prospects of off-loading these shares at a future date,
etc.
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5. Fund-based: Bought-out deals are in the nature of fund-based activity where the funds of the
merchant bankers get locked in for at least the prescribed minimum period.
6. Listing: The investor-sponsors make a profit, when at a future date, the shares get listed and
higher prices prevail. Listing generally takes place at a time when the company is performing
well in terms of higher profits and larger cash generations from projects.
7. OTCEI: Sale of these shares at Over-the-Counter Exchange of India (OTCEI) or at a
recognized stock exchanges, the time of listing these securities and off loading them
simultaneously are being generally decided in advance.
2.14.1 BOUGHT OUT DEALS vs. PRIVATE PLACEMENTS BENEFITS
Bought-out deals provide the following benefits:
1. Speedy sale: Bought-out deals offer a mechanism for a speedier sale of securities at lower
costs relating to the issue.
2. Freedom: Bought-out deals offer freedom for promoters to set a realistic price and convince
the sponsor about the same.
3. Investor protection: Bought-out deals facilities better investor protection as sponsors are
rigorously evaluated and appraised by the promoters before offloading the issue.
4. Quality offer: Bought-out deals help enhance the quality of capital floatation and primary
market offerings.
Limitations Bought-out deals pose the following difficulties for the promoters, sponsors and
investors:
1. Loss of control: The apprehensions in the minds of promoters, particularly of the private or
the closely held companies that the sponsors may control the company as they own large chunk
of the shares of the company.
2. Loss of sales: Bought-out deals pose considerable difficulties in off-loading the shares in
times of unfavorable market conditions. This results in locking up of investments and entailing
losses to sponsors.
3. Wrong appraisal: Bought-out deals cause loss to sponsors on account of wrong appraisal of
the project and overestimation of the potential price of the share.
4. Manipulation: Bought-out deals give great scope for manipulation at the hands of the sponsor
through insider trading and rigging.
5. No accountability: Bought-out deals pose difficulty of penalizing the sponsor as there are no
SEBI guidelines to regulate offerings by sponsors.
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6. Windfall profits: Bought-out deals offer the advantage of windfall profits by sponsors at the
cost of small investors.
7. Loss to investors: Where the shares taken up by issue brokers and a group of select clients are
being bought back by the promoters at a pre-fixed higher price after allotment causing loss to
investors of the company.
2.15 ADVERTISING STRATEGIES
SEBI Guidelines For Issue Advertisement (11.10.1993) SEBI issued Guidelines in
1993 to ensure that the advertisement are truthful fair and clear and do not contain statements to
mislead the investors to imitate their judgment. All lead managers are expected to ensure that
issuer companies strictly observe the code of advertisement set-out in the guidelines. For the
purpose of these guidelines the expression advertisement, means notices, brochures, pamphlets,
circulars show cards, catalogues, boarding‘s, placards, posters, insertions in newspapers,
pictures, films, radio/television program or through any electronic media and would also include
the cover pages of the offer documents.
2.16 FIIs (Foreign Institutional Investors)
GUIDELINES OF GOVERNMENT OF INDIA
Government of India through Guidelines issued on September 14, 1992 has allowed
reputed foreign Institutional Investors (FIIs) including pension funds, mutual funds, asset
management companies, investment trusts, nominee companies and incorporated or institutional
portfolio managers to invest in the India capital market subject to the condition that they register
with the Securities and Exchange Board of India and obtain RBI approval under FERA. The
different forms in which the portfolio investment flows into the country are global depository
receipts (GDR‗s), investment in primary and secondary market, offshore funds and government
securities. At the end of March 2000, 506 FIIs were registered with SEBI. Their total cumulative
investment in securities market was Rs.57,038 crores as at March 2002. Of the FIIs only 205
were active and 10 % accounted for 70% of transactions. There is no restriction on amount of
investment and there is no lock in period. Portfolio investment by the FIIs are required to
allocate their total investment between equities and debentures in the ratio of 70:30. FII s can
make purchases and sales only for delivery. A FII cannot engage in short sales. FII investing
under the scheme, enjoy a confessional tax rate of 205 on dividend and interest and 10% on long
term capital gains short term capital gains arising out of transfer of securities are taxed at 30%.
Tax is deducted at 20% on interest and dividends.
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2.16.1 FII and SEBI Regulations, 1995
The regulations stipulate that foreign institutional investors have to be registered with
SEBI and obtain a certificate from SEBI. For the purpose of grant of the certificate SEBI takes
into account, 1. The applicant‗s track record, professional competence, financial soundness,
experience, general reputation of fairness and integrity 2. Whether the applicant is regulated by
appropriate foreign regulatory authority 3. Whether the applicant has been granted permission by
RBI under Foreign Exchange Regulating Act for making investments in India as a foreign
institutional investor and 4. Where the applicant is, a. an institution established or incorporated
outside India as a pension fund, mutual fund or investment trust ; or b. an asset management
company or nominee company or bank or institutional portfolio manager, established or
incorporated outside India and proposing to make investments in India on behalf of broad based
funds; or c. A trustee or power of attorney holder established or incorporated outside India and
proposing to make investments in India on behalf of broad based funds. The certificate is granted
in Form B subject to payment of prescribed fees which is valid for 5 Years and can be renewed
thereafter.
Preferential Allotments To FIIs Listed companies have been allowed by SEBI to make
preferential allotment to registered FIIs subject to certain conditions. A company desiring to
make a preferential allotment should obtain the shareholders‗consent. The allotment should be in
accordance with ceilings of 10% of total issued capital for individual FII and 30% of all FIIs and
nonresident Indian investors. The preferential allotment should be made at a price not less than
the highest price during the last 26 weeks on all stock exchanges where the company securities
are listed. NRI The term NRI includes the following categories of persons:
1. Indian national holding Indian passports with non-resident status (INNR),
2. Person of Indian origin, foreign nationals of Indian origin, living in foreign countries including
such persons of Indian origin as is in the status of stateless, because no foreign country has as yet
accepted them as their national and they are not Indian national either by birth or residence,
(FNIO). The term NRI also includes companies, partnership firms, trusts, societies and other
corporate bodies called OCBs where 60% of the equity is owned by the NRIs.
2.17 INVESTMENT POTENTIAL OF NRIs
It is estimated that currently about 25 million Indians living abroad would fall into the
definition of NRI. Of these about 20 million have taken up foreign nationality (FNIOs) and the
remaining 5 million are still Indian passport holders. The pattern of earning and consumption of
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NRIs is such that it leaves annually a fairly large amount of investable resources. Conservative
estimates place such resources at Rs.45,000 crores or about US $15 billion annually and the
wealth at $200 billion or Rs.7,20,000 crores. Assuming that India succeeds in persuading NRIs
to invest 10 % of their total saving into investments in India, the estimate of possible inflow is
about US$ 1.5 billion per year.
Avenues for Investment by NRIS
NRIs can have three different types of bank accounts, buy securities in the primary and
secondary markets, and do business on non-reparable basis as well as reparable basis. NRI‗s
have also made in the past large investments in specific bonds, i.e., the India Development Bond
in 1991, the Resurgent India Bond in 1998 and India Millennium Deposits in 2000.
Foreign Direct Investment under New Industrial Policy (1991) Repatriable Basis:
Under the new industrial policy, foreign direct investment up to 51% of the equity is
allowed on repatriation basis in certain high priority industries. NRI‗s can take up the balance
49% of equity in such cases on repatriation basis.
CHAPTER III
3. OTHER FEE BASED MANAGEMENT INTRODUCTION:
Mergers and Acquisitions (M&A) as forms of business combination are increasingly
being used for undertaking restructuring of corporate enterprises the world over. In fact, the
corporate world is in the grip of merger-mania (mega mergers and hostile takeovers). The merger
wave which began in the U.S. first occurred during the period between 1890 and 1904. Of late,
mergers happen in all the sectors of the economy, the prime driving force being the
accomplishment of synergetic effect for both the acquiring and the acquirer companies.
3.1 MERGERS
A type of business combination where two or more firms amalgamate into one single firm is
known as a merger. In a merger, one or more companies may merge with an existing company or
they may combine to form a new company. In India mergers and amalgamations are used
interchangeably. In the wider sense, merger includes consolidation, amalgamation, absorption
and takeover. It signifies the transfer of all assets and liabilities of one or more existing
companies to another existing or new company.
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Objectives The main purpose of merges is to achieve the advantage of fusion and synergy
through expansion and diversification.
3.1.1STEPS IN M & A Following are the steps involved in M&A:
1. Review of Objectives: The first and foremost step in M&A is that the merging companies must
undertake the review of the purpose for which the proposal to merge is to be considered. Major
objectives of merger include attaining faster growth, improving profitability, improving
managerial effectiveness, gaining market power and leadership, achieving cost reduction, etc.
The review of objectives is done to assess the strengths and weaknesses, and corporate goals of
the merging enterprise. In addition, the need for elimination of inefficient operations, cost
reduction and productivity improvement, etc. should also be considered. Such a move would
help the acquiring company to decide as to the kind of business units that must be acquired.
2. Data for analysis: After reviewing the relevant objective of acquisition the acquiring firm
needs to collect detailed information pertaining to financial and other aspects of the firm and the
industry. Industry-centric information will be needed to make an assessment of market growth,
nature of competition, case of entry, capital and labor intensity, degree of regulation, etc.
Similarly, firm-centric information will be needed to assess quality of management, market
share, size, capital structure, profitability, production and marketing capabilities, etc. The data to
be collected serves as the criteria for evaluation
3. Analysis of information: After collecting both industry-specific and firm-specific information,
the acquiring firm undertakes analysis of data and the pros and cons are weighed. Data is to be
analyzed with a view to determine the earnings and cash flows, areas of risk, the maximum price
payable to the target company and the best way to finance the merger.
4. Fixing price: Price to be paid for the company being acquired shall be fixed taking into
consideration the current market value of share of the company being acquired. The price shall
usually be above the current market price of the share. A merger may take place at a premium. In
such a case, the firm would pay an offer price which is higher than the target firm‗s premerger
market value. This would happen where the acquiring firm is of the firm opinion that such an
option would augment operational results of the target firm owing to synergic effect.
5. Finding merger value: Value created by merger is to be found so that it is possible for the
merging firms to determine their respective share. Merger value is equal to the excess of
combined present value of the merged firms over and above the sum of their individual present
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values as separate entities. Any cost incurred towards the merging process is subtracted to arrive
at the figure of net economic advantage of merger. This advantage is shared between the
shareholders of the merging firms.
3.1.2 Take Over
Takeover is the case where one company obtains control over the management of another
company. Under both acquisition and takeover, it is possible for a company to have effective
control over another company even by holding minority ownership. For instance, the Monopolies
and Restrictive Trade Practices (MRTP) Act prescribes that a minimum of 25 percent voting
power must be acquired as to constitute a takeover. Similarly, section 372 of the Companies Act
defines the limit of a company‗s investment in the shares of another company as anything more
than 10 percent of the subscribed capital so as to constitute a takeover.
Distinction between Acquisition and Take Over
Where a distinction between acquisition and takeover is made, takeover usually takes the
form of hostile or forced or unwilling acquisition and acquisition happens at the instance and the
willingness of the company management and the shareholders. It is for this reason that
acquisition is generally referred to as ‗friendly takeover‗. “Acquisition”: e.g. An example of
acquisition is Mahindra and Mahindra Ltd., a leading manufacturer of jeeps and tractors,
acquiring equity stake of Allwyn Nissan Ltd. “Hostile takeovers”: e.g. The acquisition of Shaw
Wallace, Dunlop, Mather and Platt and Hindustan Dorr Oliver by Chablis and Ashok Leyland by
Hindujas, etc.
Hosile Takeovers Where in a merger one firm acquires another firm without the knowledge and
consent of the management of the target firm, it takes the form of a ‗hostile takeover‗. The
acquiring firm makes a unilateral attempt to gain a controlling interest in the target firm, by
purchasing shares of the later firm directly in the open (stock) market.
An example of hostile takeover was the takeover of TMBL by Sivasankaran of the Sterling
Group. Since this type of takeover is generally prejudicial to the interest of the stakeholders,
SEBI has come out with relevant code of conduct for the purpose of regulating the takeover
practice in India.
3.13 Distinction between Mergers vs. Takeovers The following are the differences between
Mergers and Takeover:
Distinction
Mergers
Takeover
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Defined as an arrangement whereby the Defined as a transaction or series of
assets of two companies become vested in, transactions
whereby
a
person
or under the control of, one company (individual, group of individuals or
1.Definition (which may or may not be one of the company) acquires control over the
original two companies), which has as its assets of a company, either directly
shareholders all, or substantially all, the by becoming the owner of those
shareholders of the two companies.
assets or indirectly by obtaining
control of the management of the
company
Effected by the shareholders of one or both Effected by agreement with the
of the merging companies exchanging their holders of the whole of the share
shares (either voluntarily or as the result of capital
of
the
company being
a legal operation) for shares in the other or acquired, where the shares are held
2. Mode
a third company, the arrangement being by the public generally, the takeover
frequently effected by means of a takeover may be effected by agreement
bid by one of the companies for the shares between
of the other, or of a takeover bid by a third controllers
company for the shares of both
the
acquirer
of
the
and
the
acquired
company, or by purchases of shares
on the Stock Exchange, or by means
of a ―takeover bid
3.
Control Shareholding in the combined enterprise Direct or indirect control over the
over assets
will be spread between the shareholders of assets of the acquired company
the two companies
passes to the acquirer
Bid is generally by the consent of the Bid is frequently against the wishes
4. Bid
management of both companies
of the management of the offeree
company.
3.14 Major Issues of M&A in India
Business combinations and re-structuring in the form of merger, etc. have been attempted to face
the challenge of increasing competition and to achieve synergy in business operations. The major
issues of M&A are as follows:
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Depreciation The acquiring firm claims depreciation in respect of fixed assets transferred to it by
the target firm. The depreciation allowance is available on the written down value of fixed assets.
Further, the depreciation charge is based on the consideration paid and without any revaluation.
R&D Expenditure It is possible for the acquiring firm to claim the benefit of tax deduction under
section 35 of the Income Tax Act, 1961 in respect of transfer of any asset representing capital
expenditure on R&D.
Tax Exemption The fixed assets transferred to the acquiring firm by the target firm are exempt
from capital gains tax. This is however subject to the condition that the acquiring firm is an
Indian Company and that shares are swapped for shares in the target firm. Further, as the swap of
shares is not considered as sale by the shareholders, profit or loss on such swap is not taxable in
the hands of the shareholders of the amalgamated company.
Carry Forward Losses The Indian Income Tax Act, 1961 contains highly favorable provision
with regard to merger of a sick company with a healthy company. For instance, section 72A (1)
of the Act gives the advantage of carry forward of losses of the target firm. The benefit is
however available only:
• Where the acquiring from is an Indian Company;
• Where the target firm is not financially viable;
• Where the merger is in public interest,
• Where the merger facilities the revival of the business of the target firm; and
• Where the scheme of amalgamation is approved by a specified authority.
3.2 PORTFOLIO AND MANAGEMENT SERVICES: A list of all those services and
facilities that are provided by a portfolio manager to its clients, relating to the management and
administration of portfolio of securities or the funds of the client, is referred to as ‗portfolio
management services‗. The term Portfolio means the total holdings of securities belonging to any
person.
Portfolio Manager According to SEBI, Portfolio Manager means any person who pursuant to a
contract or arrangement with a client, advises or directs or undertakes on behalf of the client
(whether as a discretionary portfolio manager or otherwise) the management or administration of
a portfolio of securities or the funds of the client, as the case may be.
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Discretionary Portfolio Manager According to SEBI, ‗discretionary portfolio manager‗ means a
portfolio manager who exercises or may, under a contract relating to portfolio management,
exercises any degree of discretion as to the investments or management of the portfolio of
securities or the funds of the client, as the case may be.
Objectives
a. Provide long term capital appreciation with lower volatility, compared to the broad equity
markets.
b. Takes long positions in the cash market and short positions in the index futures markets.
c. Invests in the model portfolios thus downside the risk by selling index futures in the
derivatives market.
3.2.1 Functions of Portfolio and Management: The objective of portfolio management is to
develop a portfolio that has a maximum return at whatever level of risk the investor deems
appropriate.
Risk Diversification An essential function of portfolio management is spread risk akin to
investment of assets. Diversification could take place across different securities and across
different industries. Is an effective way of diversifying the risk in an investment. Simple
diversification reduces risk within categories of stocks that all have the same quality rating.
Asset Allocation An important function of portfolio management is asset allocation. It deals with
attaining the operational proportions of investments from asset categories. Portfolio managers
basically aim of stock-bond mix. For this purpose, equally weighted categories of assets are
used.
Bets Estimation Another important function of a portfolio manager is to make an estimate of
best coefficient. It measurers and ranks the systematic risk of different assets. Best coefficient is
an index of the systematic risk. This is useful in making ultimate selection of securities for
investment by investment by a portfolio manager.
E-Balancing Portfolios Rebalancing of portfolios involves the process of periodically adjusting
the portfolios to maintain the original conditions of the portfolio. The adjustment may be made
either by way of ‗Constant proportion portfolio or by way of Constant best portfolio‗. In
Constant proportion portfolio, adjustments are made in such a way as to maintain the relative
weighing in portfolio components according to the change in prices. Under the constant beta
portfolio, adjustments are made to accommodate the values of component betas in the portfolio.
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Strategies A portfolio manager may adopt any of the following strategies an part of an efficient
portfolio management.
Buy and Hold Strategy Under the buy and hold‘ strategy, the portfolio manager builds a
portfolio of stock which is not disturbed at all for a long period of time. This practice is common
in the case of perpetual securities such as common stock.
Indexing Another strategy employed by portfolio managers is indexing‗. Indexing involves an
attempt to replicate the investment characteristics of a popular measure of the bond market.
Securities that are held in best-known bond indexes are basically high grade issues.
Laddered Portfolio Under the laddered portfolio, bonds are selected in such a way as that their
maturities are spread uniformly over a long period of time. This way a portfolio manager aims at
distributing the funds throughout the yield curve.
Barbell Portfolio Under the laddered portfolio, bonds are selected in such a way as that their
maturities are spread uniformly over a long period of time. This way a portfolio manager aims at
distributing the funds throughout the yield curve can also benefit from lower transaction costs
because of better liquidity.
3.3 CREDIT SYNDICATION
INTRODUCTION
Credit syndication services are services rendered by the merchant bankers in the form of
organizing and procuring the financial facilities form financial institutions, banks, or other
lending agencies. Financing arranged on behalf of the client for meeting both fixed capital as
well as working capital requirements is known as loan syndication service‗
3.3.1 CREDIT SYNDICATION SERVICES
Merchant bankers provide various services towards syndication of loans. The services
may be either loan sought for long term fixed capital or of working capital funds.
Objectives arranging medium and long term funds for long term fixed capital and working
capital fund needs.
Scope The scope of syndicated loan services as provided by merchant bankers include
identifying the sources of finance, approaching these sources, applying for the credit, and
sanction and disbursal of loans to the clients. While carrying out the activities connected with
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credit syndication, the merchant banker ensure due compliance with the formalities of the
financial institution, banks and regulatory authority. They are:
1. General Information: The purpose of furnishing general information is to enable the
financing company to obtain a general idea about the applicant company and its proposed
project.
2. Promoter Information: Information about promoters is furnished by the merchant banker
with the objective of helping the lending agency to gain an understanding of the promoter, his
activities economic background, credibility and integrity.
3. Company Information: The merchant banker has to furnish the following information as
regard the company for loan syndication arrangements to be made:
• Brief history of the concern
• Schemes already executed in the case of existing company
• Expansion/diversification plans in the case of an existing company
• Nature, size and status of the project to assess the funds requirement in the case of a new
company
• Changes in names, business, management, etc. and mergers, reorganizations, etc. that have
taken place in the past.
4. Project profile Information: Full information relating to the project for which financial
assistance is sought is furnished by the merchant banker. The type of information may pertain to
plant capacity, nature of production process to be employed, and nature of technical
arrangements available for the project.
5. Project cost Information: Details of the estimated cost of the project should be provided to
the lending institution. This includes information as regards rupee cost/rupee equivalent of
foreign exchange cost/total cost for land or site development/buildings/plant and machinery,
imported/indigenous, technical know-how, etc. to be furnished. Besides, details of expenses
likely to be incurred on foreign technicians/training of Indian technicians abroad, miscellaneous
fixed assets, preliminary pre-operative expenses, provision for contingencies, margin money for
working capital etc. should be stated in the loan application.
6. Project financing Information: Details regarding the mode of financing used for the project
should be stated. This includes information on the extent of debt and equity capital funding
source. Besides, details of rupee loans, foreign currency loans, debentures, internal cash accruals,
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and promoter‘s contribution. The security offered for the loan/bank guarantee, etc. should also be
specified. Data should also be provided on the extent of loan arrangements already applied for
and the limit of financial arrangements thereto.
7. Project marketing Information: As part of the credit syndication exercise, it is incumbent on
the part of the merchant banker to furnish adequate information about the marketing
arrangements made for the products of the borrowing unit.
8. Cash flow information : The merchant banker has to furnish details as to profitability and
expected stream of cash flows and cost of the proposed project for this purpose, it is essential
that working results of operations, cash flow statements and projected balance sheet are given in
prescribed form along with the basis of the calculations.
9. Other Information: The merchant banker has to indicate as to how the purpose of the
economic and national importance of the proposed project will be realized. Besides, following
are the other details to be furnished by the merchant banker to the lending agency.
1. CIF/FOB international price of inputs to be imported/exported.
2. Economic benefits in general and the region in particular available to the nation from the
project.
3. Economic benefits in general and the region in particular available to the nation from the
project.
4. Expected contribution to the growth, if any of ancillary industries in the region.
5. Government consent by way issue of letter of intent, industrial license, foreign exchange
permission, approval of technical financial collaboration etc.
a. Making Application
The merchant banker files the duly filled-in application in a manner as desired by the termlending institution. While presenting the application, it is incumbent on the part of the merchant
banker to ensure that all the required formalities have been complied with. For instance, it is
important that necessary sanction is obtained from the Government for the proposed project.
Loans are syndicated by development financial institutions though the lead institution especially
in the case of consortium financing or joint lending‗. Where loans are sought in huge amounts
consortium approach to lending is followed. The lead institution adopts single window scheme
while appraising, sanctioning and disbursing loans. A part of credit syndication services, the
merchant banker arranges for appraisal of the project by sufficiently interacting with the officials
of the development financial institutions. The merchant banker holds formal discussions with the
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appraisal team of financial institutions. He helps the promoters/chief executive of the company
by providing information to the appraisal team. He takes part in the site inspection with the
appraisal team and provides information to them about the technical aspect of the project
implementation. He also assists the appraisal team on matters connected with the choice of
technique to be adopted for appraisal of the project. Merchant banker provides advice in the
preparation of project/feasibility report and the market survey report, and the financial
projections relating to the project.
1. Technical Appraisal: Technical appraisal involves the assessment of technical and
engineering soundness of the project. While carrying out the technical appraisal of a project,
aspects such as competence of the experts preparing design of facilities and specifications;
purchase arrangements of equipments; supervision of construction and installation; ability of
consultants and their costs for services, are looked into. Attention is also paid to the aspects
concerning the scale of operation, cost of production and prospective demand. Similarly,
attention is paid to understand the appropriateness of the methods and processes to be used for
the project. Consideration is also given to the level of availability of latest technology, degree of
obsolescence in technological process, etc.
2. Ecological Appraisal: Regarding the ecological aspects of the project, the merchant banker
ensures that the borrowing company has taken all possible steps for preventing air, water and soil
pollution arising out of the industrial project proposed to be undertaken. A certificate from the
State Pollution Control Board has to be produced to the effect that the company has installed
equipment adequate and appropriate to the requirement of meeting the environment protection.
Ecological appraisal is mandatory with respect to highly polluting industries such as zinc, lead,
copper, aluminum, steel, paper, pesticides/insecticides, refineries, fertilizers, paints, dyes,
leathering tanning, rayon, sodium/potassium cyanide, basic drugs, foundry, batteries,
acids/alkalis, plastics, rubber, cement, asbestos, fermentation, electro placing,etc.
3. Financial Appraisal: Financial appraisal involves analyzing the financial viability of the
project under consideration. Analysis of the need for fixed capital and working capital is also
carried out. Consideration is also given to the cost of the project as relating to acquisition of
capital assets, interest cost on loans obtained for promotional, organizational, training and other
purposes.
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4. Promoters contribution: Promoter‗s contribution for establishment and running of a project
is vital. The important sources of promoters‗ contribution in the case of newly established
companies include own equity, managed equity from special funds such as Risk Capital/venture
Capital Funds or Seed Capital from IDBI through SFCs, etc. and foreign equity, deposits
contributed by promoters, etc. In the case of existing companies the sources of promoter
contribution include internal accruals, right issues, divestment of shares, additional equity,
unsecured loans, etc. The extent of promoter‘s contribution and debt-equity norms must be
scrutinized by the merchant banker.
5. Economic Appraisals: The project involves making an analysis of the expected contribution
of the project to the particular sector, besides its contribution to the development of the national
economy. Particular attention is paid to the project‗s usefulness in terms of best possible
utilization of scarce resources. It is essential to consider the priority nature of the project.
Accordingly, a project will be considered desirable if it has a tremendous impact on the balance
of payment and the capacity to generate exchange surplus through new exports, import
substitution and resultant savings in foreign exchange.
6. Commercial Appraisal: It involves the determination of commercial viability of the project
in terms of arrangements for buying, transporting and marketing the product.
7. Managerial Appraisals: It is concerned with the evaluation of effectiveness and efficiency of
the managerial personnel who are vested with the responsibility of organizing the available
resources of the project. The merchant banker checks the managerial competency both at
construction and operation stages to ensure the success of the project.
8. Arrangement of Loan Sanction – It is the function of a merchant banker to obtain the letter
of intent/sanction from the lending institution/bank. The lending agency informs the merchant
banker about the sanction of loan by the sanctioning authority. The sanction letter invariably
contains terms and conditions pertaining to the sanction of loan. Some these terms include
amount of loan, rate of interest applicable, commitment charge levied by the lender in order to
motivate the borrowing unit to make efficient use of the loan, security for the loan, conversion
option in the case of default and rehabilitation assistance, repayment terms of loan, and other
terms and conditions.
9. Compliance for Loan Disbursement: It is essential duty of the merchant banker to ensure
compliance of terms and conditions to have the loan facility disbursed by the bank or the
financial institution. Compliance is required in respect of the following. 9.3 Compliance with the
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provisions of Memorandum and the Articles 9.4 Compliance with the provisions of Acts 9.5
Compliance with the provisions of loan agreement.
10. Compliance with memorandum and the articles The merchant banker ensures due
compliance with the provisions of Memorandum and Articles of Association of the borrowing
unit. This is to check the extent of powers commanded by the Board of Directors of the company
to make borrowings from the lending agency. The borrowing powers of the Board are enshrined
in the memorandum by means of its ‗objects clause‗. The compliance would help the lending
agency to ensure that the acts of directors are not ultra-vires so as to safeguard its interest.
b. Statutory Compliance
In addition, compliance is also called for with regard to the provisions constrained in various
enactments concerning the management and regulation of joint stock companies in India. Some
of these enactments include Companies Act, 1956, Industries (Development and Regulation)
Act, 1951, Foreign Exchange Regulation Act, 1973, Securities Contracts (Regulation) Act, 1956.
The Foreign Trade (Development and Regulation) Act, 1992, Income-Tax Act, 1961.
(i) The companies Act, 1956 contains specific provisions that stipulate the powers of
borrowings vested with the Board of Directors of the company. For instance, section 292 and
293 of the Act outline the exercise of powers to borrow from banks and financial institutions.
Similarly, sections 17 and 31 of the said Act give an account of restrictive covenants pertaining
to powers of directors to borrow to be contained in the Memorandum of Association and Articles
of Association of a company. The provisions mainly outline the procedures such as passing of
resolutions etc. to be followed for raising loans from term lending agencies.
(ii) Compliance is also required under the provisions of the Industries (Development and
Regulation) Act, 1951. The Act contains provisions of control and regulation for the setting up
of new industries and also expansion of existing industries. The provisions mainly relate to
registration and revocation of registration of industrial undertaking, licensing of new industrial
undertakings, license and revocation of license for producing or manufacturing new articles,
licensing industrial undertakings in special cases, etc. Besides, provisions also outline the powers
of the Central Government to specify the requirements which shall be complied with by small
scale industrial undertakings, power of the Central Government to exempt any industrial
undertaking in special cases, etc.
(iii) Compliance is called for as regards provisions contained in the Foreign Exchange
Management Act (FEMA). The provisions are applicable in the case of non-resident Indians
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being associated in any manner with the organization or management or operations of the client
company or where foreign capital in any manner with the organization or management or
operations of the client company or where foreign capital in any manner (i.e. By way of foreign
collaborator‗s contribution to equity capital, loans etc.) is being utilized or foreign currency loans
are being raised from financial institutions or banks.
(iv) Provisions of the Securities Contracts (Regulation) Act, 1956 (SCRA) are also required
to be complied with by the borrowing unit before seeking financial assistance from the term
lending agency. Compliance is related to stipulations of enlistment of securities of the company
in recognized stock exchanges (although listing is not mandatory under the said Act). Under
Section 21 of the Act, Central Government is empowered to compel any public limited company
to enlist its securities with a recognized stock exchange.
(v) Compliance with the provisions of the FIDRA (Foreign Trade Development and
Regulation Act), 1992 are required compliance by the borrowing unit. This becomes necessary
where the client company envisages to procure raw material, machinery, plant and equipments
from overseas through imports under the import license granted by the Central Government
under Import and Export (Control) Act, 1947.
(vi) An important enactment in India that requires closer compliance by the borrowing
units is the Income-Tax Act, 1961. The Act contains provisions that require furnishing of a tax
clearance certificate from assessing officer under section 230A of Income Tax Act before
creation of security by way of English mortgage in favor of lenders.
c. Documentation and Creation of Security
An important function of a merchant banker is to create an adequate documentation of security
by working closely with the ‗lead financial institution,‗ so as to ensure quicker disbursement of
loan. The type of documents to be prepared and executed by the merchant banker will be as per
the requirements of the lead financial institution. Depending on the loan type, the merchant
banker executes bridge loan document or interim loan document. The merchant banker provides
the following details with regard to the security for the loan:
1. First mortgage and charge of all immovable properties both present and future of the
borrower company in the form as may be indicated by lenders which are equitable mortgage by
deposit of title deeds.
2. First charge by way of hypothecation:
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(i) All movables such as stocks of raw material, semi-finished and finished goods, consumable
stores and such offer movables as may be agreed to by the lead institution for securing the
borrowings for working capital requirements in the ordinary course of the business, and
(ii) On specific items of machinery as permitted by the lender purchased and/or to be purchased
by the client company under the deferred payment facilities granted the client company.
3. Security for bridge loan
4. Security for interim loan
5. Substantive security: Where the loan amount is being secured in terms of the loan agreement
by first charge on the company‗s immovable and movable assets, present and future
6. Personal guarantee: Where the loan amount is being secured in terms of the loan agreement
by first charge on the company‗s immovable and movable assets, present and future
7. Personal guarantee: Where the borrowing is being secured by irrevocable and unconditional
personal guarantee from its promoters/directors in favor of the lending institutions.
d. Pre – Disbursement Compliance
This function is aimed at merchant bankers assisting the borrowing unit in the withdrawal of the
loan amount from the financial institution. This done with additional compliance of formalities
of provision of information and documentation. Some of the pre-disbursement conditions that
require compliance by the merchant banker are documentation. Some of the pre-disbursement
conditions that require compliance by the merchant banker are as follows:
1. Completion of creation of security as stipulated in loan agreement
2. Completion of borrowing arrangements with other institutions and banks for raising funds as
per the financing plan
3. Non-existence of event of default in payment of principal sum of the loan interest, arrears of
interest, and in performance of other terms and conditions of the loan
4. Compliance of special conditions of sanction of loan
5. Review of progress as satisfactory
6. Subscription of share capital by promoters as stipulated in the loan agreement and as stipulated
in proposal of financing the project cost.
3.4 CREDIT RATING
Credit rating is a mechanism by which the reliability and viability of a credit instrument
is brought out. When a company borrows or when a businessman raises loan, the lenders are
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interested in knowing the credit worthiness of the borrower not only in the present condition but
also in future. Hence, credit rating reveals the soundness of any credit instruments issued by
various business concerns for the purpose of financing their business,. In credit rating, the
investor is not only able to know the soundness of the credit instrument, but be is also able to
analyze between different credit instruments and he can make a tradeoff between risk and return.
3.4.1 CREDIT RATING OF INDIVIDUALS, COMPANIES AND COUNTRIES
Credit rating is resorted to: a) Companies b) Individuals c) Countries
a) Rating of Individuals: Individuals go for credit rating when they want to borrow from
recognized institutions. In India, we have Onida Individual Credit Rating Agency (ONICRA)
which gives credit rating for individuals.
b) Rating of Companies: As per the guidelines of SEBI and RBI, companies have to resort to
credit rating when they : (i) accept public deposits (ii) issue credit instruments in domestic
market (iii) issue credit instruments in overseas market.
c) Rating of Countries: Credit rating is resorted to by countries for borrowing in international
market or for attracting foreign investments or for raising funds from the international
institutions like IMF and IBRD.
3.4.2 Basis of Credit Rating Various aspects are taken into account by a credit rating agency
when a borrowing company applies for rating. They are :
a. Business Analysis
b. Evaluation of industrial risks
c. Market position of the company within the industry
d. Operating efficiency of the company
e. Legal position in terms of prospectus
f. Financial analysis based on accounting quality
g. Statement of profits
h. Earnings protection
i. Cash flow and their adequacy
j. Financial flexibility
k. Track record of management
l. Capacity to overcome adverse situations
m. Goals philosophy and strategy
n. Labor turnover
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o. Regulatory and competitive environment
p. Asset quality
q. Financial position-interest/tax sensitivity
3.4.3 Credit Rating Companies in India
Credit rating companies were started in India during the late 1980s. Credit Rating Information
Services of India Ltd (CRISIL) was started in 1988 as a subsidiary of ICICI. Information and
Credit Rating Services Ltd., (ICRA)was started in 1990, which is a subsidiary of IDBI. In 993,
Credit Analysis and Research Ltd. (CARE) was started. 8. The suffix of ―+ (plus) or ―(minus) signs are used with the rating symbols to indicate the comparative position of the
instrument within the group covered by the symbol.
3.4.4 Types of Credit Rating We have seen the various rating symbols for different categories
of the debt instruments. We can also classify credit rating as types of credit rating which are
based on different securities. These are: 1. Equity rating 2. Bond rating 3. Promissory note rating
1. Equity Rating
When different companies are issuing shares, equity rating will enable the investor to choose
proper equity share on the basis of the credit rating. While judging the equity rating, the past
performance of the company, the earning per share and the turn-over of the company will be
taken into account. If a loss making company turns into a profit making one, after wiping off its
losses, its equity rating will go up. At the same time, if there is a decline in the dividend rate of
an existing concern, compared to its previous years, its rating will get a beating.
2. Bond Rating Bonds are issued both by Government as well as by private sector companies. In
the international market, rating of bonds will depends on the rate of interest offered and the value
of the currency it represents. If the bond is issued in terms of U.S. Dollar or Pound Sterling, its
value will be high and the rating will naturally be on the positive side. But the bonds of under
developed countries will have lesser credit rating due to high fluctuations in their currency value.
Bonds are also issued in the domestic market by both State and Central governments. Even the
local governments, such as Corporation, such as Corporations and Boards also issue bonds for
raising long-term finance in India; government bonds are preferred to private bonds as there is a
guarantee for repayment of the principal and interest amount.
3. Promissory Note Rating In order to raise short-term loans, promissory note are issued by
different commercial companies and depending upon their resources, these promissory notes will
have credit rating. But, the issue of promissory notes will have no backing and the person
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advancing the resources against the promissory notes will undertake greater risks. Depending
upon the credit rating, ranging from P1 to P6, promissory notes are preferred as a short-dated
instrument. The unutilized resources lying with commercial banks may be invested in
promissory notes of a better credit rating so that within a short period, a reasonable return‗ can be
obtained on idle funds.
4. Commercial Papers These are instruments issued by leading non-banking financial
companies which can be obtained by companies for raising short-term loans from commercial
banks. On due date, commercial banks will present these papers to the NBFC which has issued
the commercial paper and funds will be obtained along with interest. Later on, the NBFC will
collect the amount from the company which has utilized its commercial paper for raising its
short-term loans. In order to enable the commercial banks to discount commercial papers, credit
rating is provided to the commercial papers which depends upon the standing of the non-banking
financial company NBFC) which is issuing the commercial paper.
5. Sovereign Rating When countries are issuing credit instruments in the international market
such as Treasury bills and Bonds, they will be rated according to the economic condition of the
country. Generally, the countries in the world are grouped under three categories, viz.,
(a) Countries which are politically and economically well developed.
(b) Countries which are politically stable but economically week.
(c) Countries which are politically and economically unstable or weak. In the first category, we
have all the developed countries like U.S.A., U.K., Japan, etc., and their bonds will have high
credit rating. In the second category we have countries like India which have slightly lesser
credit rating and in the third category we have some of the African countries such as Rwanda,
Kenya, Zulu, etc. The credit rating of the third category of countries will certainly be lower. In
India, State Bank of India issued in the international market different credit instruments such as
India Resurgent Bonds and Millennium Deposits and they were oversubscribed owing to the
reputation of SBI,. All the NRIs throughout the world, could subscribe to these bonds and SBI
could raise a substantial amount in terms of foreign exchange.
3.5 MUTUAL FUND
I NTRODUCTION
A mutual fund is a professionally managed firm of collective investments that collects money
from many investors and puts it in stocks, bonds, short-term money market instruments, and/or
other securities. The fund manager, also known as portfolio manager, invests and trades the
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fund‗s underlying securities, realizing capital gains or losses and passing any proceeds to the
individual investors.
• Mutual funds
a. A mutual fund is a fund exchanged between the public and the capital market through a
corporate body.
b. The Securities and Exchange Board of India Regulations, 1993 defines a mutual fund as a
fund established in the form of a trust by a sponsor, to raise monies by the trustees through the
sale of units to the public, under one or more schemes, for investing in securities in accordance
with these regulations‗.
c. Kamm, J.O. defines an open end investment company or Mutual fund company in U.S.A as an
organization formed for the investment of funds obtained from individuals and institutional
investors who in exchange for the funds receive shares which can be redeemed at any time at
their underlying asset values‗.
d According to Weston j. Fred and Brigham, Eugene, F. Unit Trusts in U.K. are Corporations
Thus mutual fund is nothing but a form of collective investment. It is formed by the coming
together of a number of investors who transfer their surplus funds to a professionally qualified
organization to manage it. To get the surplus funds from investors, the fund adopts a simple
technique. Each fund is divided in to a small fraction called units‗ of equal value. Each investor
is allocated units in proportion to the size of his investment. Thus, every investor, whether big or
small, will have a stake in the fund and can enjoy the wide portfolio of the investment held by
the fund. Hence, mutual funds enable millions of small and large investors to participate in and
derive the benefit of the capital market growth. It has emerged as a popular vehicle of creation of
wealth due to high return, lower cost and diversified risk.
Objectives
Mutual funds came into existence in order to attract the savings of lower and middle income
group people and give them the benefit of corporate profits by distributing attractive dividends at
the end of the year. Mutual funds cater the different types of customers who are interested in
(a) Fixed income or
(b) A higher return for investment or
(c) Who is growth oriented.
3.5.1 Mutual Funds Set Up In India
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The structure of mutual fund operations in India envisages a three tier establishment namely: (II)
A Sponsor institution to promote the fund (III)A team of Trustees to oversee the operations and
to provide checks for the efficient, profitable and transparent operations of the fund and (IV)An
Asset Management Company to actually deal with the funds. Sponsoring Institution The
Company which sets up the Mutual Fund is called the sponsor‗. The SEBI has laid down certain
criteria to be met by the sponsor. These criteria mainly deal with adequate experience, good past
tract record, net worth etc.
Trustees: Trustees are people with long experience and good integrity in their respective fields.
They carry the crucial responsibility of safeguarding the interest of investors. For this purpose,
they monitor the operations of the different schemes. They have wide ranging powers and they
can even dismiss Asset Management Companies with the approval of the SEBI.
Asset Management Company (AMC) The AMC actually manages the funds of the various
schemes. The AMC employs a large number of professionals to make investments, carry out
research and to do agent and investor servicing. Infact, the success of any Mutual Fund depends
upon the efficiency of this AMC. The AMC submits a quarterly report on the functioning of the
mutual fund to the trustees who will guide and control the AMC.
3.5.2 Types of Mutual Funds
1 Close Ended Funds Close ended funds are funds which have definite period or target amount.
Once the period is over and or the target is reached, the door is closed for the investors. They
cannot purchase any more units. These units are publicly traded through stock exchange and
generally, there is no repurchase facility by the fund. The main objective of this fund is capital
appreciation. Thus after the expiry of the fixed period, the entire corpus is disinvested and the
proceeds are distributed to the various unit holders in proportion to their holding. Thus the fund
ceases to be a fund, after the final distribution. E.g. UTI Master Share, 1986.
2 Open Ended Funds Open ended funds are those which have no fixed maturity periods. Open
ended scheme consists of mutual funds which sell the units to the public. These mutual funds can
also repurchase the units. Initial Public Offer (IPO) is open for a period of 30 days and then
reopens as an open-ended scheme after a period not exceeding 30 days from the date of closure
of the IPO. Investors can buy or repurchase units at net asset value or net value related prices, as
decided by the mutual fund. Example: Unit Trust of India‗s Growth sector funds.
Classification of Mutual Funds
On The Basis Of Yield and Investment
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1. Income Fund Income funds are those which generate regular income to the members on a
periodical basis. It concentrates more on the distribution of regular income and it also sees that
the average return is higher than that of the income from bank deposits. a. The investor is assured
of regular income at periodical intervals b. The main objective is to declare regular dividends and
not capital appreciation. c. The investment pattern is towards high and fixed income yielding
securities d. It is concerned with short run gains only.
2. Growth Fund Growth are those which concentrate mainly on long term gains i.e., capital
appreciation. Hence they are termed as “Nest Eggs” investments. a. It aims at meeting the
investors need for capital appreciation. b. The investor‗s strategy conforms to investing the funds
on equities with high growth potential. c. The Investment tries to get capital appreciation by
taking much risks and investing on risk bearing equities and high growth equity shares. d. The
fund declares dividends. e. It is best suited to salaried and business people.
3. Balanced Fund It is a balance between income and growth fund. This is called as Income
cum growth. It aims at distributing regular income as well as capital appreciation. Thus the
investments are made in high growth equity shares and also the fixed income earning securities.
4. Specialized Funds These are special funds to meet specific needs of specific categories of
people like pensioners, widows etc.
5. Money Market Mutual Funds The funds are invested in money market instruments. These
funds basically have all the features of open ended funds but they invest in highly liquid and safe
securities like commercial paper, banker‘s acceptances, and certificates of deposits treasury bills.
These funds are called money funds in the U.S.A. The RBI has fixed the minimum amount of
investment as Rs.1 Lakh; it is out of the reach of many small investors. However, the private
sector funds have been permitted to deal in money market mutual funds. It is best suited to
institutional investors like banks and other financial institutions.
6. Taxation Funds It is a fund which offers tax rebated to the investors either in the domestic or
foreign capital market. It is suitable to salaried people who want to enjoy tax rebates particularly
during the month of February and March. An investor is entitled to get 20% rebated in Income
Tax for investments made under this fund subject to a maximum investment of Rs.10,000 per
annum. E.g. Tax Saving Magnum of SBI Capital Market Limited.
7. Other Classification
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i. Leveraged Funds: Also called as borrowed funds as they are used primarily to increase the
size of the value of portfolio of a mutual fund. When the value increases, the earning capacity of
the fund also increases.
ii. Dual Funds: It is a fund which gives a single investment opportunity for two different types
of investors. It sells income shares and capital. Those investors who seek current investment
income can purchase incomes shares. The capital shares receive all the capital gains earned on
those shares and they are not entitled to receive any dividend of any type.
iii. Index Fund: It is a fund based the some broad market index. This is done by holding
securities in the same proportion as the index itself. The value of these index linked funds will
automatically go up whenever the market index goes up and vice versa.
iv. Bond Funds: The funds have portfolios consisting mainly of fixed income securities like
bonds. The main thrust is income rather than capital gains.
v. Aggressive Growth Funds: These funds are capital gains oriented and thus the thrust area of
these funds is capital gains. Hence, these funds are generally invested in speculative stocks They
may also use specialized investment techniques like short term trading, option writing etc.,
vi. Off shore Mutual Funds: These funds are meant for nonresident investors. These funds
facilitate flow of funds across different countries, with free and efficient movement of capital for
investment and repatriation.
vii. Property Fund: These funds are real estate mutual funds. Its investment also includes
shares/bonds of companies involved in real estate and mortgage backed companies.
viii. Fund of Funds: It is a fund that invests in other mutual fund schemes. The concept in
prevalent in abroad.
3.5.3 History of Mutual Funds In India
The Mutual fund concept in India was launched by Unit Trust of India (UTI) in the year 1964 by
a special Act of Parliament. The first scheme offered was the ―US-64. A host of other fund
schemes were subsequently introduced by the UTI. The basic objective behind the setting up of
the Trust was to mobilize small savings and to allow channeling of those savings into productive
sectors of the economy, so as to accelerate the industrial and economic development of the
country. In 1987, the Government of India permitted commercial banks in the public sector to set
up subsidiaries operating as trusts to perform the functions of mutual funds by amending the
Banking Regulation Act. SBI set its first mutual fund, followed by Canara Bank. Later many
large financial institutions under government control also came out with mutual funds
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subsidiaries. Recently, with the beginning of the economic reforms and liberalization of the
economy, based on the recommendations of the Abid Hussain committee, foreign companies
were also permitted to start mutual funds in India. The government introduced a number of
regulatory measures, through various agencies such as the SEBI, to the benefit the investors, esp.
the small investors.
3.6 BUSINESS VALUATION
The basic valuation methods of holdings by the Mutual funds should be done by keeping in view
the following elements:
• For listed securities – take last sale price quoted in the stock exchange dealing list
• For OTCEI securities – take bid/ask price as may be relevant on case to case basis
• Trustees may determine market value at a reasonable price as per current market at which the
investors would buy at fairly reasonable rate.
• For short term investments the basis of valuation should be the amortized cost.
3.6.1 Net Assets Value It is a parameter used to measure the operational efficiency of mutual
funds. The intrinsic value of a unit under a particular scheme is referred to as the NAV of the
scheme. The value gives an idea of the amount that may be obtained by the unit holder on its sale
to the mutual fund company.
The main components of Net assets value are • Investment income and expenses • Capital
stocks and distribution
Investment Income and Expenses: Investment income covers the following major items:
1. Dividend income from accounting point of view
2. Capital changes i.e., resulting from return on capital, stock dividends, bonus shares, rights
shares and stock split, mergers, litigation settlement, tax treatment.
3. Interest income from fixed income investment
4. Costs of carrying on Mutual fund business as highlighted in the Enclosure I
3.6.2 Capital Stock and Distribution - The capital stock and distribution involving share
purchases and sales or redemptions.
Calculation of NAV
The NAV calculation should include the following elements for open end funds.
1. Investment at value recorded on first business day after trade transaction.
2. Changes in outstanding shares on first business day after trade transaction.
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3. Dividend and distribution to shareholder ex-date.
4. Expenses (estimated and accrued to date of calculation)
5. Dividends receipts from investments ex-date 6. Interest and other income (estimated and
accrued to date of calculation) 7. Other assets /organization costs.
Formula for calculating NAV is given below:
NAV = X- L divided by Y or Net assets / No. of shares outstanding
Where, X= market value of investments and other assets. L= Liabilities Y = fund shares
outstanding.
CHAPTER IV
FUND BASED FINANCIAL SERVICES
INTRODUCTION
Leasing is not a concept which emerged in the modern days. Even in the olden days we
had leasing in the form of Charter Party agreement, when in an entire ship is taken on lease
either for a particular period or for a particular voyage. Similarly we had agricultural lands are
given on lease for a specified period.
FUND BASED FINANCIAL SERVICES
Some of the fund based financial services are leasing, hire purchase agreements. These are
discussed below in detail in the pages to come.
4.1 LEASING: It is a contract by which one party conveys land, property, services etc., to
another for a specified time.
Definitions:
The Transfer of Property Act, 1882 (as amended in 1952) describes Lease as follows ―A
Lease of the movable property is a transfer of a right to enjoy such property, made for a certain
time, express of implied, or in perpetuity, inconsideration of a price paid or promised or of
money, a share of crops, service or any other things of value, to be rendered periodically or on
specified occasions to the transferor by the transferee, who accepts the transfer on such terms.‖
• The transferor is called the Lessor‗
• The transferee is called the Lessee‗
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• The price is called the Premium‗
• The money, share, service or other thing to be rendered is called the Rent‗.
4.1.1 Definition:
Section 105 of the above Act defines a lease as follows: ―A Lease is a transfer of a right
to enjoy the property. The consideration may be a price or a rent. The rent may be either money,
or share of crops, service of anything of value, to be rendered periodically by the transferee to
the transferor.‖
Basic Concepts: In Leasing Broker an agent who brings two parties together, enabling them to
enter into a contract to which he is not a principal. His remuneration consists of a brokerage,
which is usually calculated as a percentage of the sum involved in the contract.
Deposit
1. A sum of money paid by a buyer as part of the sale price of something in order to reserve it.
Depending on the terms agreed, the deposit may or may not be returned if the sale is not
completed.
2. A sum of money left with an organization, such as a bank, for safekeeping or to earn interest
or with a broker, dealer, etc., as a security to cover any trading losses incurred.
3. A sum of money paid as the first installment on a hire-purchase agreement. It is usually paid
when the buyer takes possession of the goods.
Depreciation
1. Depreciation is principally a means of allocating the cost of an asset over its useful life. It is an
amount charged to the profit and loss account of an organization to represent the wearing out or
diminution in value of an asset. The amount charged is normally based on a percentage of the
value of the asset as shown in the books.
Finance Broker A broker who arranges finance.
Lease Broker Any broker who arranges a lease between a lender and a lessee.
Lease Purchases It is a type of leasing where, at the end of the lease period the goods become
the lessee‗s property.
Lender The person or institution, that grants a loan.
Operating Lease Essentially long term rent, not a capital expense transaction.
Refinancing The process of repaying some or all of the loan capital of a firm by obtaining fresh
loans, usually at a lower rate of interest.
Residual Value The expected selling price of an asset at the end of its useful life.
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Term: A specified period of time.
4.1.2 Evolution of Leasing
The concept and practice of leasing is not an innovation of the late 20th century. There
are historical evidences to show that the practice of leasing was found even five centuries earlier.
Such leases were for leasing land, agricultural tools, animals and ships, as documented in the
Sumerian and Greek civilizations. These operators found leasing a viable alternative for
enhanced operations as they were desperately short of their own funds. They could not also rely
upon conventional sources of funds. The unparalleled success of Rail Road companies
highlighted the importance of equipment leasing as a tool for promoting capital formation. In the
post-Second World War era, European rail companies also took to equipment leasing on a large
scale. In the early sixties, this practice of equipment leasing has gained popularity and it is
believed that approximately 25% of all business equipments in terms of value are leased. The
later half of 19th century bore witness to this practice as the Rail Road operators in the USA
leased Rail Cars and Locomotives. The practice of Equipment Leasing is of recent origin in
India. Equipment leasing took roots only in the eighties. Equipment leasing includes, leasing of
plant and machinery, office equipments, automobiles, ships and aircrafts.
4.1.3Legal aspects of Leasing
As there is no separate statue for equipment leasing in India, the provisions relating to
bailment in the Indian Contract Act govern equipment leasing agreements as well section 148 of
the Indian Contract Act defines bailment as:
―The delivery of goods by one person to another, for some purpose, upon a contract that
they shall, when the purpose is accomplished, be returned or otherwise disposed off according to
the directions of the person delivering them. The person delivering the goods is called the
‗bailor‘ and the person to whom they are delivered is called the ‗bailee‘.
Since an equipment lease transaction is regarded as a contract of bailment, the obligations
of the lessor and the lessee are similar to those of the bailor and the bailee (other than those
expressly specified in the least contract) as defined by the provisions of sections 150 and 168 of
the Indian Contract Act. Essentially these provisions have the following implications for the
lessor and the lessee.
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 The lessor has the duty to deliver the asset to the lessee, to legally authorize the lessee to
use the asset, and to leave the asset in peaceful possession of the lessee during the
currency of the agreement.
 The lessor has the obligation to pay the lease rentals as specified in the lease agreement,
to protect the lessor‘s title, to take reasonable care of the asset, and to return the leased
asset on the expiry of the lease period.
4.1.4 Contents of a Lease Agreement:
The lease agreement specifies the legal rights and obligations of the lessor and the lessee.
It typically contains terms relating to the following:
 Description of the lessor, the lessee, and the equipment.
 Amount, time and place of lease rentals payments.
 Time and place of equipment delivery.
 Lessee‘s responsibility for taking delivery and possession of the leased equipment.
 Lessee‘s responsibility for maintenance, repairs, registration, etc. and the lessor‘s right in
case of default by the lessee.
 Lessee‘s right to enjoy the benefits of the warranties provided by the equipment
manufacturer/supplier.
 Insurance to be taken by the lessee on behalf of the lessor.
 Variation in lease rentals if there is a change in certain external factors like bank interest
rates, depreciation rates, and fiscal incentives.
 Options of lease renewal for the lessee.
 Return of equipment on expiry of the lease period.
 Arbitration procedure in the event of dispute.
4.1.5 Types of Leasing
Classification of Lease
Lease may be classified as
1. Finance Lease and Operating Lease.
2. Sale and Lease Back and Direct Lease.
3. Single Investor Lease and Leveraged Lease.
4. Domestic Lease and International Lease.
Finance Lease:
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A lease is defined as a finance lease if it transfers a substantial part of the risks and
rewards associated with ownership from the lessor to the lessee. Thus the finance lease is
characterized by whether:
a) The lease transfers ownership of the asset to the lessee by the end of the lease term; or
b) The lessee has the option to purchase the asset at a price within is expected to be
sufficiently lower than the Fair Market Value (FMV) at the date, the option becomes
exercisable that, at the inception of the lease it is reasonably certain that the option will
be exercised; or
c) The lease term is for a major part of the useful life of the asset. The title may or may
not be transferred eventually; or
d) The Present Value of the minimum lease payments is greater than or substantially
equal to the Fair Market Value (FMV) of the asset at the inception of the lease. The title
may or may not be transferred eventually.
These are largely based on the criteria laid down by the Financial Accounting Standards
Board (FASB) of the USA. If the lease term exceeds 75% of the useful life of the asset or if the
present value of the minimum lease payments exceeds 90% of the FMV of the asset, at the
inception of the lease, the lease will be classified as „Financial Lease.
To determine the present value, the discount rate to be used by the lessor will be the rate
of interest implicit in the lease and the discount rate to be used by the lessee will be its
incremental borrowing rate. In the Indian context, criteria (a) and (b) above are inapplicable,
because, inclusion of any one of these conditions in the lease agreement will make the agreement
being treated as a Hire Purchase Agreement. Hence a lease can be classified as a finance lease
only if any one of criteria (c) and (d) are satisfied.
The lessee is responsible for repair, maintenance and insurance of the asset. • The lessee
also undertakes an extreme obligation to pay rental regardless of the condition or the suitability
of the asset.
A finance lease, which prevails over the entire useful life of the equipment, is called a
‗full payout lease.
Operating Lease
The International Accounting Standard Committee defines operating lease as “any lease
other than a finance lease”. An operating lease has the following characteristics:
1. The lease term is significantly less than the economic life of the equipment.
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2. The lessee enjoys the right to terminate the lease at short notice without any significant
penalty.
3. The lessor usually provides the operating know-how, supplies the related services and
undertakes the responsibility of insuring and maintaining the equipment, in which case the
operating lease is called a Wet Lease‗.
4. An operating lease where the lessee bears the cost of insuring and maintaining the leased
equipment is called a Dry Lease‗.
5. An operating lease does not shift the equipment-related, business and technological risks from
the lessor to lessee. The lessor structuring an operating lease transaction has to depend upon
multiple lease or on the realization of substantial resale value (on the expiry of first lease), to
recover the instrument cost plus reasonable rate of return thereon. To deal in operating leasing
one requires an in-depth knowledge of the equipments and the resale market. In our country, as
the resale market for most of the used capital equipments is not active, operating leases are not
very popular.
Sale and Lease Back
In the case of sale and lease back, the owner of equipment sells it to a leasing company,
which, in turn, lease it back to the seller of the equipment, who then becomes the lessee. The
‗Lease Back‗ arrangement in this transaction can be in the form of either a finance lease or an
operating lease e.g., the sale and lease back of safe deposit vaults practiced by commercial
banks. The banks sell the safe deposit vaults in its custody to a leasing company at a market
price, which is substantially higher than the book value. The leasing company then offers these
lockers on a long-term lease to the bank. This sale and lease back‗ arrangement is an easily
available source of funds for the expansion and diversification programmes of a firm where highcost short-term debt has been used for capital investments in the past, the sale and lease back
gives an opportunity to substitute the short-term debt by medium-term finance (provided the
lease back arrangement is a finance lease). For the leasing company offering sale and lease back
arrangement, it is difficult to establish a fair market value of the asset being acquired as the
resale markets are virtually absent.
Direct Lease:
It is defined as any lease, which is not a sale and lease back transaction‗. A direct lease
can be of two types: (i) Bipartite lease, and (ii) Tripartite Lease.
Bipartite Lease:
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There are two parties to the transaction, 1. Equipment supplier cum lessor 2. The lessee.
It functions like an operating lease with built-in facilities like up gradation of the equipments
called as Upgrade Lease. The lessor undertakes to maintain the equipment and even replaces the
equipment that is in need of major repair with the similar functioning equipment called as Swap
Lease‖.
Tripartite Lease
It involves three different parties
1. The equipment supplier
2. The lessor
3. The lessee. Most of the equipment lease transactions fall under this category.
In this form of lease
1. The equipment supplier may provide a reference about the customer to the leasing company.
2. The equipment supplier can negotiate the terms of the lease with the customer and complete
the necessary paper work on behalf of the leasing company.
3. The supplier can take the lease on his own account and discount the lease receivables with the
designated leasing company. So the leasing company owns the equipment and obtains an
assignment of the lease rentals. This form of lease has recourse to the supplier in case of default
by the lessee, either to buy back the equipment from the lessor on default or providing a
guarantee on behalf of lessee.
Single Investor Lease
The entire investment is funded by the lessor by arriving at a judicious mix of debt and
equity. The debt funds raised by the leasing company are without recourse to the lessee, i.e., in
the event of the default by the leasing company on its debt-servicing obligation, the lender
cannot demand payment from the lessee.
Leveraged Lease
It is a lease which is leveraged through a trustee. The leasing company invests in
equipments by borrowing large investments with full recourse to the lessee without any recourse
to it. The lender (loan participant) gets an assignment of the lease and enjoys benefit of the
rentals to be paid by the lessee and a first mortgage on the leased assets. This transaction is
routed through the trustee to take care of the lender and the lessee.
Leveraged Lease Process Loan Participant
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A leveraged lease entitles the lessor to avail the shields on depreciation, other capital
allowances on the entire investment cost, though; a substantial part of the investment cost is
funded with non-recourse debt. So, the return on equity (profit after tax divided by net worth)
tends to be high. For, the lessee, the rate of interest is less than that of a straight loan as the lessor
extends the tax benefits to the lessee in the form of lower rental payments. This lease is usually
preferred for leasing investment-intensive assets like aircraft, ships, etc. Lessor Trustee Leases
the Lessee Equipment to Loan Participant.
Domestic Lease and International Lease
In domestic lease, all the parties to the lease transaction i.e., the equipment supplier,
lessor and lessee are domiciled in the same country. An international lease transaction pre
supposes : 1. An understanding of the political and economic climate; and 2. A knowledge about
the tax and other regulatory framework governing these transactions in the respective countries,
the payments to be effected in different currencies and hence knowledge about exchange rate
variation. As a result international lease is exposed to country risk and currency risk.
Players In Leasing Financial Institutions (FIs) FIs are term lending institutions. There are over
10 such institutions handling project finance on an all-India basis and over 20 State-level
institutions. While FIs have over 30 per cent of the total lease market, it is not their main line of
business.
Commercial Banks State Bank of India, India‗s largest commercial bank, entered the market in
1997. This has altered market dynamics considerably because State Bank of India has a very
large deposit base from savings accounts and deposit accounts, leading to the lowest cost of
capital amongst all players.
Foreign banks The roles of foreign banks are very limited in the leasing market. Few foreign
banks such as ABN-AMRO and ANZ Grind lays, have organized aircraft leasing for private
airlines. Citicorp Securities & investment, the financial services arm of Citibank has leased
assets worth US $ 6.7 million in 1996-97.
Non-banking Finance Companies (NBFCs) All those Indian finance companies that do not fall
into any of the above categories are called as NBFCs. NBFCs has a market share of over 50 per
cent of the leasing market. On the other hand, 70 per cent of NBFCs‗ business originates with
leasing and hire-purchase activities. In 1998, Anagram Finance and ITC Classic merged with the
Industrial Credit and Investment Corporation of India (ICICI), a leading all-India FI. In addition,
Twenty-First Century Finance merged with Centurion Bank. Although all of the companies
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recorded profits in 1996-97, fears of a harder recovery and squeezed margins led them to the
decision to exit the NBFC segment of the market.
Foreign Institutional Investors (FIls): There are no legislative barriers that prevent FIIs from
entering the leasing market, the only FIIs with measurable involvement in the market are the
U.S. Company GE Capital and the Japanese company Orix Corporation.
Advantages of Lease Financing:
 It offers fixed rate financing; you pay at the same rate monthly.
 Leasing is inflation friendly. As the costs go up over five years, you still pay the same
rate as when you began the lease, therefore making your dollar stretch farther. (In
addition, the lease is not connected to the success of the business. Therefore, no matter
how well the business does, the lease rate never changes.)
 There is less upfront cash outlay; you do not need to make large cash payments for the
purchase of needed equipment.
 Leasing better utilizes equipment; you lease and pay for equipment only for the time you
need it.
 There is typically an option to buy equipment at end of lease term.
 You can keep upgrading; as new equipment becomes available you can upgrade to the
latest models each time your lease ends.
 Typically, it is easier to obtain lease financing than loans from commercial lenders.
 It offers potential tax benefits depending on how the lease is structured.
There are several extolled advantages of acquiring capital assets on lease:
(1) Saving Of Capital: Leasing covers the full cost of the equipment used in the business by
providing 100% finance. The lessee is not to provide or pay any margin to Manufacturer, Lessor
and Lessee.
(2) Flexibility and Convenience: The lease agreement can be tailor- made in respect of lease
period and lease rentals according to the convenience and requirements of all lessees.
(3) Planning Cash Flows: Leasing enables the lessee to plan its cash flows properly. The
rentals can be paid out of the cash coming into the business from the use of the same assets.
(4) Improvement in Liquidity: Leasing enables the lessee to improve their liquidity position by
adopting the sale and lease back technique.
Disadvantages of lease financing:
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 Leasing is a preferred means of financing for certain businesses. However it is not for
everyone. The type of industry and type of equipment required also need to be
considered. Tax implications also need to be compared between leasing and
purchasing equipment.
 You have an obligation to continue making payments. Typically, leases may not be
terminated before the original term is completed. Therefore, the renter is responsible
for paying off the lease. This can pose a major financial problem for the owners of a
business experiences a downturn.
 You have no equity until you decide to purchase the equipment at the end of the lease
term, at which point the equipment has depreciated significantly.
 Although you are not the owner, you are still responsible for maintaining the
equipment as specified by the terms of the lease. Failure to do so can prove costly.
4.2 HIRE PURCHASE
According to the Hire Purchase Act of 1972, the term hire purchase is defined as, an
agreement under which goods are let on hire and under which the hirer has an option to purchase
them in accordance with the terms of the agreement, and includes an agreement under which a.
Possession of goods is delivered by the owner thereof to a person on the condition that such
person pays the agreed amount in periodic payments b. The property of the goods is to pass to
such a person on the payment of the last of such installment c. Such a person has a right to
terminate the agreement any time before the property so passes‖. All Hire purchase finance
companies are controlled by the Hire Purchase Act, 1972. A Hire purchase transaction has two
elements, Bailment which is governed by the Indian Contract Act, 1872 and Sale under the Sale
of Goods Act, 1930.
4.2.1 Hire Purchase Agreement
A Hire Purchase Agreement is an agreement between the seller and the buyer, where the
ownership of goods does not pass to the buyer until he pays the last installment. There are two
parties to the hire purchase agreement. The hire vendor, who is the seller and other, is the hire
purchaser, the buyer. The purchaser has to make a down payment of 20 to 25% of the cost and
the remaining amount has to be paid in equal monthly installments. In the case of a Deposit
linked plan, the hire purchaser has to invest a fixed amount as fixed deposits in the finance
company which is returned together with interest after the payment of the last installment.
Parties to the Hire Purchase Contract:
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There are two parties in a hire purchase contract 1. The intending seller 2. The intending
purchaser or the hirer.
Tripartite agreement 1. Seller 2. Financier 3. Hirer/Purchaser
4.3.2 Difference between Hire Purchase and Leasing:
Characteristics Leasing
ownership
With the finance company, the
lessor
Hire purchasing
It is transferred to the hirer on the
payment of the last installment
Depreciation
Lessor, and not the lessee is
entitled to claim depreciation tax
shield
Done in the books of lessor
The hirer is entitled to claim
depreciation tax shield
The entire lease payments are
eligible for tax computation in
the books of lessee
Used as a source of finance,
usually for acquiring high cost
assets such as machinery, ships
etc
Lessee in case of financial,
Upkeep is the responsibility of
the lessor in the case of
operating lease
Only the hire interest is eligible for
tax computation in the books of
hirer
Used as a source of finance, usually
for acquiring low cost assets such
as automobiles, office equipments
etc
It is the hirer‘s responsibility to
ensure the maintenance of the asset
bought
Asset- as a fixed asset of the
lessor
No down payment required
Shows the asset either as a stock in
trade or as receivables
It is required
Capitalization
Payments
Magnitude
Maintenance of
asset
Nature of asset
Down payment
Done in the books of hirer
Financial Evaluation:
It is an evaluation by the hirer of the desirability for lease and hire purchase. The hirer
makes decision based on the Present Value of Net Cash Outflow. The decision is considered
favorable when the PV of Net Cash Outflow under Hire Purchase is less than the PV of Net cash
Outflow under leasing. Following are the steps involved.
Step 1 Calculate annual interest amount
Step 2 Find the principal amount outstanding at the beginning of the each year = Total
outstanding principal – principal paid in the previous year.
Step 3 Find principal paid in the previous year = Annual installment amount – Annual Interest
Step 4 Find Annual ITS = Annual Interest x Tax rate
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Step 5 Find Annual Depreciation
Step 6 Find Annual DTS = Annual depreciation x Tax rate
Step 7 Find Total TS = Step 4 + Step 6
Step 8 Find Annual installment amount = Total HP amount + (HP amount x flat rate of interest) /
No. of HP years
Step 9 Find PV of salvage value of assets = SV x PVF
Step 10 Find Net Cash Outflow of HP = Step 8 – Step 7
4.3 HIRE PURCHASE LEASING
1. It is a tripartite agreement, involving the seller, finance company and the purchaser/hirer
2. Depreciation is claimed by the purchaser/hirer
3. The agreement is entered for the transfer of ownership after a fixed period. 1. It is a bipartite
agreement involving lessor and lessee. 2. Depreciation is claimed by the lessor in the lease
agreement. 3. In finance lease the ownership will get transferred. While in operating lease, the
ownership is not transferred.
Step 11 Find PV of net cash outflow of HP at the appropriate discount rate.
Step 12 Find Total PV net cash outflow of HP = Step 11 – Step 9.
Step 13 Find Tax shield on annual ease rentals = Annual Lease rental x Tax rate.
Step 14 Find Net cash outflow of Leasing = Annual lease rental – Step 13.
Step 15 Find Total PV of net cash outflow of Leasing at the approp. Discount rate = Net cash
outflow of Leasing x PVAF.
Step 16 Make a decision: HP is desirable if total PV of net cash flow of HP is Less than that of
leasing.
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CHAPTER V
OTHER FUND BASED FINANCIAL SERVICES
5.1 CONSUMER CREDIT
It is a finance to consumers For the purchase of semi durables and durables by paying a
part of the total price Reavis Cox, an authority on economics of consumer finance defines
consumer finance as ―Business procedure through which the consumers purchase semi-durables
and durables other than real estate, in order to obtain from them a series of payments extending
over a period of three months to five years, and obtain possession of them when only a fraction
of the total price has been paid.
According to E.R.A. Seligman, an authority on consumer finance, ―the term consumer
finance refers to a transfer of wealth, the payment of which is deferred in whole or in part, to
future, and is liquidated piecemeal or in successive fractions under a plan agreed upon at the time
of the transfer.
5.1.1Characteristics of Consumer Credit
The nature of consumer credit may be the transfer of wealth to consumers for purchase of
semi durables or durables except real estate where the payment is deferred in whole or in part
upon agreed terms the agreed terms for repayment may be in the form of EMI.
Consumer Finance Transactions
The nature of consumer finance transactions may be
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(a) Parties and Structure of the Transaction: The parties and the structure of the transaction
may be either (i) Bipartite (ii) Tripartite.
A bipartite transaction involves two parties i.e.
1. Dealer-Cum-Financer and
2. Borrower or Customer.
A tripartite transaction involves three parties
1. The dealer
2. The financier
3. Borrower or customer
Transactions can either be structured in the form of hire purchase, conditional sale or
credit sale, but a majority of the tripartite consumer finance transactions are of the hire purchase
type.
(b) Payment for the transaction: The payment for specific transactions is divided into two
categories: (i) Down Payment Schemes (ii) Deposit Linked Schemes.
The down payment varies from initial payments ranging from 20%-25% of the value of goods
and financing is available for 75%-80% or as the case may be.
In a deposit-linked scheme, the down payment in the form initial deposit varying from 15% and
25% of the total value of the asset. The financier pays the full amount to the seller. Deposits
carry a prescribed interest rate. Zero Deposit schemes are also available, under which the
Equated Monthly Installment (EMI) is higher than the EMI under normal deposit schemes.
(c) Repayment Period The repayment period ranges from 12-60 months. Finance companies
notify the customer indicating the amount of equated monthly installments to be paid through
postdated Cheques.
(d) Security: The asset is secured through first charge on it for the credit provided. The borrower
is prohibited from disposing, pledging or hypothecating the asset during above said credit period.
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(e) Eligibility Criteria for Borrowers There is no specific criteria for borrowers, all the
borrowers in the form of individuals, partnership firms, private and public limited companies are
eligible to borrow.
5.1.2 Nature of Consumer Classes In India
The middle income class refers to that class of people between the lower income groups
and higher income groups. The need to study the middle income class in India was felt because
the consumer finance was absolutely designed to meet their financial requirements and in turn
upgrade their standard of living. Moreover the total population of middle class in India exceeds
more than 2/3 rd of the total population.
• India has registered a very impressive growth of its middle class – a class which was virtually
nonexistent in 1947 when India became a politically sovereign nation.
• At the start of 1999, the size of the middle class was unofficially estimated at 300 million
people.
• The middle class comprises of three sub-classes: the upper-middle, middle-middle and lowermiddle classes.
• The upper-middle class has an estimated 40 million people.
• The middle-middle class has an estimated 150 million people,
• The lower middle class comprises an estimated 110 million people.
5.1.3 Consuming Class in India:
Source: National Council of Applied Economic Research (NCAER). Estimated households by
annual income Structure of the Indian consumer market (1995-96)
1. Data on income distribution of households is insufficient in determining market size for
different consumer product in India. a. This because of the lack of homogeneity of the
consuming class and the varying prices of a single product in different parts of India. b.
Consumption habits of households are therefore better determinants of consumer market size
than income distribution.
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2. While determining market size for a consumer product, the structure of the consuming class as
seen in the above, can be both revealing as well as misleading depending on the kind of product.
For example, any specific consuming class would be fit to be a market for consumer products
like tea or soap, but a product such as vacuum cleaners would find market largely only in the
―consumers and rich segments of the market as defined in the above table .
3. Identifying a plausible market size for a consumer product is therefore a hazardous task in a
heterogeneous country like India. Yet, the marketer needs some data to come as close to the real
picture as possible. For this purpose, it can be cautiously assumed that purchasing power is
proportional to income despite variables such as location, taste etc. Companies are therefore
advised to plan their consumer product marketing strategies on an area-by-area basis, rather than
on the country as a whole.
Latest Developments in Consumer Credit Changing Consumer Behavior
The behavior of the consumers in India witnessed a remarkable change esp. the attitude. The
Indian consumer is fast changing his habits, borrowing money to buy the products he wants, not
content with buying what he can afford. The resultant consumer boom is what market strategists
explain as the key to the success of the Indian consumer finance market.
a. Consumer finance today helps everyone to upgrade his standard of living right now instead of
waiting for years for his savings to accumulate.
For manufacturers, it stimulates demand and lowers inventory
For middlemen, it‗s a sales boosting device
For players of consumer finance, it‗s a means of profit generation.
b. The culture of buy-now-pay-later is fairly present in India, evolving through various forms
like consumer lending, consumer credit, consumer loans, friendly and family borrowings, daily
payment schemes etc.
c. The basic objective of consumer financing is that the consumer‗s present spending habits tend
to be geared to expectations of future income. They are losing their fear of borrowing of
consumer finance.
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d. Along with buying a home, consumers prefer consumer finance to buy home appliances and
vehicles, opting for finance based on the rate of interest, administrative fee, processing fee,
commitment charges, pre-payment penalty, types of facilities, standard and kind of services mix
other terms and conditions.
e. These are members of a growing breed of normally conservative middle-class Indians who are
opting for consumer finance loans despite the high interest cost being charged.
Impact of Consumer Finance Growth on Consumer Durables Market:
The impact of consumer finance has a direct impact on the fortunes of the consumer
durables market including two wheelers and passenger cars. This correlation is already clear
from the surge in demand in recent times. Sales of cars would grow at an even faster 20%
annualized, as the gradual decline in excise duties makes the vehicles more affordable.
(a) Passenger Cars and Two-wheelers:
Sales of passenger cars increased by 26.5% in the first half of this fiscal, owing to the
lowering of excise duties in the general budget. The two-wheeler industry grew by 8.9% during
this period, much slower than the heady high-teens growth over the past two years, as the
agricultural slowdown last year hit rural incomes. Two-wheeler sales are expected to increase at
a compounded 15.6%. Car sales would rise at an even faster 20%.
(b) Key Issues and Success Factors:
For the consumer finance companies to flourish there is need to develop a credit
information system, which will ease the process, making it faster and easier to determine the
creditworthiness of customers.
• Ability to offer simple, convenient and innovative consumer finance products, a wide
distribution network and choice of repayment tenor, documentation and loan offer.
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• As a result of the large number of players, market pressures, increased competition, increased
awareness and wider offerings consumer-financing activities need to become customer-oriented
and user-friendly.
• One of the perceived problems relating to consumer finance is the absence of credit bureaus to
rate the creditworthiness of consumers. As of now, the advent of information technology has
paved way for sharing data about defaulters among private sector banks. Any loan proposal is
based on this shared information before further process.
(c) Innovative Solutions The banks are lending against collateral and have concentrated on
small potential borrowers to achieve disbursal targets.
• The Vijaya Bank offers V stock‗ for loans against shares; V equip‗ loans to help professionals
acquire equipment and vehicles; and V-cash‗ to enable clean loans against salaries after getting
an employer‗s guarantee.
• Judges, cops and teachers can now get cheaper loans with banks spinning out of new products
to cash in on the great retail rush. The country‗s largest commercial bank, State Bank of India,
will charge lower interests to these set of borrowers for buying a home, car, two-wheeler or
simply opting for personal or festival loans. Concessions would be given to them on interest rate,
processing fees and margins under three new schemes;
 Teacher plus‗,
 Police plus‗ and
 Justice plus‗.
The move, SBI officials say, is aimed at capturing the market share in different segments.
The bank aims to tie-up with various organizations, to put in place a structure, where the EMI or
(equal monthly installment) for servicing the loan will be debited from the salary accounts of the
borrower. A tie-up would minimize default risk. On home loans, teachers, policemen and judges
will be charged 0.25% lower than interest charged to other borrowers. At present, the normal SBI
home loan rates are 9.25% for 10 to 20 years. Similarly, car loans will also be charged 0.25%
lower than the usual rate, currently pegged at the medium-term lending rate (MTLR) of 11.25%.
For scooter and motorcycle loans, the rates will be 0.35% lower. SBI normally charges a spread
of 0.85% over its MTLR, but for teachers, policemen and judges, the spread will be 0.50%.
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Effectively, they would be charged 11.75% as against 12.1% for other customers. In case of
personal loans, the spread over MTLR will be reduced to 2% against 2.23%. Effectively, these
three special categories of borrowers would be required to pay 13.25%, instead of 13.6% for
festival loans, SBI would be offering a spread of 2.25% over the MTLR, as against 2.5% charge
to its regular customers. Thus, the festival loans would cost 13.5%, as against 13.75%.
Again, the processing fee on personal and two-wheeler schemes will stand reduced to
0.75%, as against 1% charged to its regular customers. The absolute fee for festival loan schemes
has been reduced from Rs.100 to Rs.75. Margins are also being relaxed. For home loans, it has
been brought down from 15% to 10%, and for repair and renovation, it will be reduced from
20% to 15%. In case of car loans, the margins are pegged at 10%, against 15% for cars priced up
to Rs.4 lakhs and 20% margins, while a 2-4 years old car will attract 30% margin. For scooters
and motorcycles up to Rs.50, 000, the margin would be 5% as against 10% for regular customer
and 10% (as against 20%) for over Rs.50,000. The bank does not charge any margin for festival
and personal loans.
(d) Credit Constraint in Rural India for Consumer Durables
According to a new survey, Role of Consumer Finance in Rural India‘ conducted by
Chennai-based Anugrah Madison and Delhi-based Marketing and Research Team (MART), the
future growth for consumer durable is Rural India. The constraints involved are the reluctance of
banks to provide finance and the lack of electricity in 2/3rd of the homes. Penetration of
consumer durables would be cheaper in rural India if banks were ready to finance them. Banks
have shown reluctance in this sector and restrict themselves to tractors and diesel pumps. While
the consumer durables market is facing a slowdown due to saturation in the urban market, rural
consumers are ready to put their money on the counter if consumer finance is made available and
basic infrastructure requirements such as electricity and voltage are ironed out. Currently, rural
consumers purchase their durables from the nearest towns, leading to increased expenses due to
transportation, Hence, purchase is necessarily only done during the harvest, festive and wedding
seasons –April to June and October to November in North India and October to February in the
South, believed to be months good for buying‗. The question remains as to why the Banks shy
away from financing rural consumers.
(e) Consumer Preferences:
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Indian consumers identify ease and speed of the loan application and approval process, as
well as flexibility of evaluation procedures, as the key drivers of financing satisfaction.
Consumer financing Satisfaction performance is measured by four factors:
• Application process (44 %);
• Approval and documentation (22 %)‗
• Finance advisor (18 %); and
• Loan value (16 %).
Customers who obtained their loans from a nationalized bank are relatively more satisfied
than those choosing a non-banking finance company (NBFC) or a foreign bank. Low interest
rates and the reputation of the finance company are among the key reasons for customers who
opted either for an NBFC or a foreign bank. In comparison, past experience and personalized
service are the main reasons indicated by those opting for a nationalized bank. Furthermore,
more than 50% of NBFC and foreign bank customers obtained their financing at an automobile
dealer or through a direct selling agent of the finance provider. In contrast, more than 90% of
nationalized bank customers obtained their financing directly through the bank. The car finance
market has reached a new level of maturity, so much so that the carmaker, the automobile dealer
and the financier now work together to provide better features and funding options for the buyer.
Depending on the manufacturer, tenure of the loan and credit history of the car buyer, interest
rates, on a reducing balance basis in the 10-13.5 % range for new cars compared to 13-16.5 %
for old cars. There is an increased preference for financing car purchases through loans.
5.1.4 Importance of Consumer Credit In India
The following best explains the importance of consumer credit in India.
(a) Increasing Risk in Corporate Lending increasing risk in corporate lending, banks are
forced to opt for an alternative spot for finance. The supernormal growth in retail finance has
made it the primary driver of banks‘ asset books. It is expected to capture 40-50% of banks‘
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incremental lending by end of financial year 2004. Banks share in incremental retail advances
(%) FY2003 FY2004 State Bank of India 39.1 40.4 HDFC Bank 39.1 62.9 ICICI Bank 209.7
174.1 Corporation Bank 72.0 64.3 Andhra Bank, 48.8 Union Bank of India 23.5 21.3 Punjab
Nation Bank 0 0 ING Vysya Bank 28.1 22.8 Oriental Bank of Commerce 107.0 66.2 Bank of
Baroda 75.3 29.4 Canara Bank 25.6 35.7
(b) Housing Loans Housing loans have been the product of choice for state-owned banks
because of their attractive profitability, low risk weight-low delinquency history, and the ease of
processing loans. All the state-owned banks have recorded explosive growth in their mortgages;
this has vastly expanded the market.
(c) Consumer Durables Banks have entered almost all the segments in retail finance. They are
gaining share from NBFCs. Private Banks have started offering loans for low-ticket items like
consumer durables and two-wheelers, besides personal loans. Some schemes of some banks are
given below:
• SBI has struck a preferred-financier arrangement with carmaker Maruti, and now markets these
can loans from more than 2,000 branches. The bank has also tied up with Bajaj Auto and TVS
Motors to finance two-wheelers.
• SBI is offering 3-year two-wheeler loans at an interest rate of 10% across all sales outlets of
these companies. These alliances are significant, because they have extended the availability of
car and two-wheeler finance to second-and third-tier towns.
• Axis Bank has tied up with Ford Credit as a preferred financer for Ford cars.
• Punjab National Bank has struck a similar arrangement with Hyundai.
• More such alliances are expected between carmakers and state-owned banks. These
arrangements will drive strong growth in car finance market over the years to come.
(d) Reduction in Interest Rates Falling interest rates, coupled with increasing loan durations,
have substantially reduced the EMIs on retail loans, thereby making them affordable to more
people than ever before.
5.2. CREDIT CARDS
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5.2.1INTRODUCTION
The commercial banks extend different functions to customers. The most important in the
modern days are credit card facilities to customers. These facilities are not extended to not only
customers in the urban areas or cities but also to customers residing in rural areas. Agriculturist
are enjoying the facility of credit card and the card extended to them are called as green card.
A credit card is given by the banker to the customer in which the name of the customer is
embossed in block letters. The name of the bank and the date of issue and expiry are also
mentioned on the face of the card. The reverse side of the card will bear the specimen signature
of the customer. A list of vendors or sellers will be gibe by the banker to the customers. A credit
card is a thin plastic card, usually 3 1/8 inches x 2 1/8 inches in size that contains identification
information such as signature or picture or both and authorizes the person named on it to charge
for purchases or services to his account. In addition to this, the card can be used in automated
teller machines for withdrawing cash and the machine stores the information and also
transactions through electronic date processing system.
5.2.2 Origin of Credit Cards In India:
The usage of Credit Cards in India is less when compared to the usage of credit cards in
China, Taiwan and Malaysia. It picked up only in the last 10 years until then the Indian looked it
as a luxury. The idea of owning a credit card has had its roots in the minds of millions of Indians.
They started viewing the card as a convenient substitute to carrying cash. The change in mindset
is clear from the growth, both in terms of absolute numbers and growth rates. The industry has
grown at the rate of 30% and strongly counts for steady years to come.
Credit Cards in India:
According to Visa International an average Indian cardholder uses his card 9.3 times,
spending about Rs.23, 000 per year. A number of card owners do not use their cards and almost
20-23% cards are inactive. In India, two players dominate the credit cards industry. Visa and
Master Cards and 15 out of 17 banks provide credit card services through Visa or Master Cards.
The importance of having a pie in the credit cards segment was not lost on any bank, and
most banks started their credit card operations. Currently, there are more than 20 banks offering
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credit cards, but the market share of the top five exceeds 75%. Credit card is a low margin, high
volume business. The initial investments required by a bank are very high. The income per card
is low, thereby requiring large volumes in terms of cards issued and the transactions finance to
make the operations profitable. Another reason for the inability of players to upstage the wellentrenched ones is lower patronage by the merchant and business outfits.
The bigger businesses and merchants are already acquired by the existing players, so far
new banks, braking into this business and convincing a merchant is increasing because the banks
are shifting towards lower end merchants. Secondly, because of competition in acquiring
business, new categories of merchants are coming up. The foreign banks have a dominant share
due to various reasons like having been in the field for decades, sound operational and financial
strength, strong brand recognition etc. They were catering to the upper segments and charged
high annual fees. Later, with aggressive entry of SBI, ICICI Bank and HDFC Bank, the rules of
the game changed. The cards were positioned in manners which gave an impression that the
cards can be acquired by people from not only the upper class, but also the middle income
categories. This was the strategy followed by SBI-GE as a result of which it is the third largest
issuer of credit cards today. It positioned itself in a segment as to be of mass appeal and at the
same time reinforced a clean and dependable image of the bank.
The new private banks like ICICI and HDFC are also aggressively increasing their share.
They adopted a strategy of reaching lower down the income strata by lowering down their
eligibility norms. Of course, the credit limits are set at lower levels as compared to the foreign
banks. As a result of this strategy, the credit cards base is widening day by day with the increase
of base in B-grade cities.
5.2.3 Types of Credit Cards or Types of Cards:
1. Charge Card 2. Debit Card 3. Deferred Debit card 4. Affinity card 5. Standard card 6.
Classic card 7. Gold card 8. Platinum card 9. Best Platinum credit card 10. Fleet Platinum credit
card 11. Next card Platinum credit card 12. Titanium card 13. Secured card 14. Smart card
1. Charge card in this card, the cardholder has to make full payment of the charge by the due
date. Unlike other credit cards, here dues are not allowed to carry forward. It is meant for people
who spend responsibly.
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2. Debit Card: A debit card is different from credit card. Debit card is issued by a bank. The
following are the differences between credit and debit cards:
3. Deferred debit card: When a debit card carries the benefit of the credit card, allowing the
payment after certain period, it is called deferred debit card.
Credit Card Debit Card
1 It is issued by an agency such as Master or Visa
1. A debit card is issued by a bank in which the customer has an account.
2. A credit card allows certain period for making payment for the purchases made which may
vary from 30 to 45 days.
2. The bank account in a debit card is debited immediately the moment the card is used. They
have no credit period.
3. The credit worthiness of the customer is based on income eligibility criteria on the basis of
which the credit card is issued.
3. There are no such income criteria but the credit balance, maintained in the account is the
criterion. 4. A credit card holder has a ceiling limit for his purchases and also for his cash
withdrawals through ATM.
5. A debit card holder has his purchases restricted to his credit Balance.
6. Credit card can be used for withdrawing money only from ATMs.
7. A debit card can be used even for withdrawing money from the bank and hence it is account
holders‗ mobile
8. When the purchase are made by using The Credit Card, the retail seller swipes the card over
an electronic terminal at his outlet, and enters the personal identification number (PIN) and the
transactions are recorded by the card issuing authority.
9. Any use of debit card by a similar method will be immediately recorded by the bank and the
account of the customer is debited. Thus, it is an online transaction.
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10. Loss of credit card should be reported to the issuing agency.
11. Loss of debit card should be reported to The issuing bank.
4. Affinity card A card offered by two organizations of which one is a lending institution and
the other a non-financial group. Here, schools, non-profit groups, airlines, petroleum companies
issue affinity cards. These cards carry special discounts.
5. Standard Card It is a normal credit card which carries limit on transactions, according to the
credit worthiness of the card holder.
6. Classic card A credit card issues by Visa, carrying the logo of Visa.
7. Gold card A higher line of credit is given than a standard card. The income eligibility for
getting this card is higher. Gold card is given to very rich customers or persons with high social
status.
8. Platinum card In order to distinguish credit cards belonging to certain companies, platinum
credit cards are issued. Some companies use these to denote their best premium credit card.
9. Best Platinum credit card Companies which set highest standard in customer service issue
these cards. There is lowest interest rate for the outstanding, and the cards will have no annual
fee or application fee and can be applied online in seconds.
10. Fleet Platinum credit card
It is a zero liability guarantee for purchases. It protects the credit card holder from any
unauthorized use.
11. Next card platinum credit card This is given to those with a good credit and it offers a low
introductory rate.
12. Titanium card: A card which has a higher credit limit than a platinum card.
13. Secured card: A credit card is given to a card holder who has Savings deposit which will
take care of his outstanding balance, in case of his default on payment.
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14. Smart card: The revolution in Information Technology is responsible for the invention of
Smart card. The development in semiconductors has advanced so much that computing power
that was available in a computer matching a room size in the early days, is now available on a
visiting card-sized plastic. Kit is an embedded micro-chip card and it can store 1280 times more
data than the magnetic strip card. The can store data for more than 10 years and can be read or
written for more than 1 lakh times. For example: Visa is converting 22 million Brazilian debt and
credit cards to Smart cards. Sim card in the mobile phone is an example for the use of Smart
cards in the telecom sector. There are 3 types of Smart cards. 1. Storage/memory cards 2.
Intelligent cards and 3. Hybrid cards. • Storage card has an inherent monetary value associated
with it.‗ • Intelligent card acts as a store-house of information. • Hybrid card contains a micro
processor chip and a magnetic strip and bar coding.
Benefits of Credit Cards Benefits derived from credit card
The following persons derives benefits from the credit card system: (1) Customer (2)
Seller (3) Wholesaler (4) Manufacturer (5) Commercial banks (6) Central bank (7) Government
(8) Economy
1. Customer
i. A customer can make purchases at any time
ii. One need not carry cash for making purchases
iii. In case of losing credit card, one can immediately inform the bank and prevent misuse by
others iv. One can take benefit of lower prices by purchasing goods before the hike in prices.
v. During inflation period, credit card benefits customers as the payments are made after one
month from the date of purchase.
vi. Railway ticket or Air ticket reservation can be done by using credit card even during night
when banking facility is not available.
vii. Credit card can be used even through computers and purchases can be made by sitting at
home. viii. More customers will come forward to avail banking facility
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ix. At any point of time, the customer will be able to know the available credit even after
purchases.
x. Credit card can be used even for withdrawing cash through ATM (Automatic Teller Machine)
up to a certain limit.
xi. The holders of credit card are given insurance cover by the banks.
(2) Seller
The benefits to seller are as follows:
i. Sales are affected throughout the year.
ii. With increasing sales, the turnover of the seller increases.
iii. The seller can go for competitive price as he can get credit from the bank.
iv. Due to credit card facility, he can attract customers from far off places also.
v. Durable goods can be sold easily through credit card.
vi. Bad debts can be avoided as the bank arranges for payment under credit card.
vii. Sellers extending sales through credit card can also extend additional credit to customers as
they can receive payment in installment through the credit card.
(3) Wholesaler
i. The wholesaler will be getting more orders from the retailer as the sales will go up due to
credit card.
ii. The wholesaler will be dealing products of different manufacturers due to credit extended by
them iii. The wholesaler will also be given credit by the banks.
iv. The wholesaler will be able to place orders throughout the year and hence can get trade credit
as well as cash credit from the manufacturers.
(4) Manufacturer
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i. With orders continuously received from the wholesalers, the manufacturer can increase his
production.
ii. Due to large scale production, the cost of production will come down and the manufacturer
will be able to sell at a lower price.
iii. Since the orders are received throughout the year, there will be continuous production even
for goods which are seasonal in nature. Example: Manufacture of umbrellas.
iv. The manufacturer will also diversify his production due to the goodwill he has enjoyed due to
increased production.
v. The profit of the manufacturer will also increase and he will extend a higher commission to his
wholesalers.
(5) Commercial banks Due to credit card facility
i. More customers will avail the banking facility.
ii. There will not be cash withdrawals from the bank as most of the customers use credit card for
their purchase.
iii. The bank, by extending credit to customer, retailer, wholesaler and manufacturer is able to
earn interest on the credit.
iv. The credit facility is extended only in the books of accounts and there will be no cash
withdrawals. The account of the customer is debited for the purchases while the account of the
seller is credited. Both the parties are given credit and the bank enjoys interest on the loan.
v. All the transactions in the country are done through the banking system, as a result of which,
the role of money lenders and other financiers is reduced.
vi. The profit of the bank will also increase due to the extension of credit to different parties.
(6) Central bank: It is a national bank that provides financial and banking service for its country
government and commercial banking system and issues currency. Central bank for India is
Reserve Bank of India.
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i. A better control on the banking system is evolved by the Central bank.
ii. During inflation, the Central bank can control the price level by instructing the head office of
commercial banks to reduce the quantum of credit extended to customers under credit card. This
will reduce the demand and thereby prices will come down.
iii. Central bank is able to take instantaneous action on the economy as credit card provides
information regarding purchases and sale in the country.
iv. The activity of Non Banking Financial Companies will also be reduced due to the credit card
facility extended by commercial banks. So, the Central bank need not control NBFCS.
v. By extending credit card facility to agriculturists, agricultural finance is improved and this
relieves the farmers from the clutches of money lenders.
(7) Government: Whenever any sale is made, it is properly billed. That means sales tax;
commercial tax due to the government will not be evaded.
ii. It prevents the growth of unaccounted money as all transactions are recorded.
iii. It improves the revenue of the government due to increase in production by the
manufacturers. Excise duty will be paid to the government.
iv. Government employees can also avail credit card facility against their salaries.
(8) Economy: Economy gets benefited in all its different sectors like primary, secondary and
territory sectors. . Transport system will improve with movement of goods to different places.
Exports will improve, increasing the earnings of foreign exchange. Employment opportunities
will increase not only in production centers but also in the service sector. Marketing will develop
with increasing advertisements. Stiff competition will bring out good products for the benefit of
consumers. Credit card which was considered to be a luxury has become one of necessity. It was
considered to be used only by higher income group. But today, with development in banking and
trading activities, fixed income group or salaried class has also started using the same. There
may be the criticism that it induces far more purchases or makes people Spend-thrift. This may
be so in the initial stage, but when once a customer gets used to the credit card, he/she will know
how to use the same in a discretionary manner.
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5.3 REAL ESTATE FINANCING
5.3.1 INTRODUCTION
The Real Estate financing has become so popular, that the procedure for obtaining a loan has
become so simplified that housing loans are easily available. This may be attributed to the
change in the housing policy of both the Central and Sate Governments. A redeeming feature of
Indian real estate finance is the recent entry of real estate commercial banks in a big way.
REAL ESTATE FINANCING:
It is financing for the purchase of real property, where real property refers to land or
buildings. It‗s a set of all financial arrangements that are made available by housing finance
institutions to meet the requirements of housing. Housing finance institutions include banks,
housing finance companies, special lousing finance institutions, etc.
5.3.2 Factors Determining the Real Estate Finance Assistance:
Real estate finance companies consider the following factors before making any financial
assistance for housing: 1. Loan Amount 2. Tenure 3. Administrative and processing costs, etc. 4.
Pre-payment charges 5. Services 6. Value Addition 7. Sources of finance like HFC‗s and Banks
8. EMI calculation methods:
1. The Loan Amount The amount of loan that any
HFC decides to provide to a loan seeker depends on the following variables:
1. Customers repayment capacity
2. Rate of interest charged
3. Term of the loan
2. Tenure:
Repayment it is done through EMI, which includes principal and the interest. As a rule,
an HFC fixes the EMI between 30 and 40 percent of the customer‗s gross monthly income, or 50
percent of the net monthly income. For instance, considering a loan of Rs.10, 00,000/- for 10
years, at 13 percent flat interest rate, the EMI would be Rs.19,166.66/-. This way the gross
earnings of the loan-seeker must be Rs.54, 761.88 per month, where the installment to income
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ratio is 35 percent. The general trend in the market is that customers try to obtain loans for longer
tenures, without realizing that the longer the duration the more will be the amount paid by them.
An increase in the tenure from 10 to 15 years increases the amount payable by 28 percent. In
case the tenure of the loan is decreased from 15 years to 10 years, the monthly EMI becomes
Rs.16,388.77/-.
3. Administrative and processing cost:
The effective cost of the loan depends on the type of method used by banks or finance
companies. Based on the method, the principal component, which is paid monthly, is deducted
from the outstanding principal amount. The two methods, which banks and finance companies
generally follow, they are:
a. Monthly rest system Under this system, the principal amount is deducted every month from
the outstanding amount, and the interest for the following month is calculated on the outstanding
amount. This is illustrated as follows: Loan Amount (Rs.) Tenure (Years) Interest (%) EMI
(Rs.) Total Payment (Rs.) 1,00,000 5 13 2,275 1,36,500 1,00,000 10 13 1,493 1,79,160
1,00,000 15 13 1,265 2,27,700
b. Annual rest system Under this system, although the principal amount is paid every month, it
is accounted only at the end of the year. This is illustrated as follows:
c. Fixed and Floating Rate Customers should check whether the rates offered are fixed or
floating (varies with PLR). Floating rates are better in a falling rate scenario, but expensive in an
increasing rate scenario. The borrower should check whether it is viable to shift the loan from
fixed rate to the floating rate in a decreasing rate scenario by carrying out a cost benefit analysis.
4. Pre-payment Charges:
This is an important factor to be considered, especially in situations where the ability to
repay the loan matters. There are certain HVCs which charge pre-payment, in case the loan is
repaid before schedule. This pushes up the cost of fund of the borrower. Borrowers who desirous
of repaying ahead of schedule should approach HFCs which do not have a pre-payment charge.
5. Value addition:
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The value addition includes the additional or supplementary services that HFCs provide,
such as fast disbursals of loan, legal services, meeting with brokers, builders etc.,
6. Sources of Finance
1. The National Housing Bank (NHB):
The National Housing Bank (NHB) was set up in July 1988, under an Act of Parliament,
and is wholly owned by RBI, NHB, at present, has a paid-up capital of Rs.350/- Crores. It was
conceived and promoted to function as the apex institution in the housing sector. The need to set
up this institution stemmed from the fact that the housing sector had not received the attention it
required, not only in terms of finance for individual loans, but also in terms of buildable or
serviced land, building materials and cost effective technology. Loan Amount (Rs.) Tenure
(Years) Interest (%) EMI (Rs.) Total Payment (Rs.) 1,00,000 5 13 2,370 1,42,200 1,00,000
10 13 1,536 1,84,320 1,00,000 15 13 1,290 2,32,200
2. Life Insurance Corporate Housing Finance Limited (LICHFL):
The Corporation was set up under the Companies Act, 1956. Incorporated on 19th June
1989, it is recognized by NHB. It commands about 25 percent market share in the housing
finance industry. It has a wide network in the industry with 67 Area/Unit Offices and 6 Regional
Offices across the length and breadth of the country besides about 5,000 LIC Agents trained for
housing finance.
3. Housing And Urban Development Corporation of India (HUDCO):
Incorporated on 25th April, 1970, HUDCO was an expression of the concern of the
Central Government towards the deteriorating housing conditions in the country, and a desire to
assist various agencies in dealing with it in a positive manner. The principal mandate of HUDCO
was to ameliorate the housing conditions of all groups and with a thrust to meet the needs of the
low-income group and economically weaker sections.
5.4 BILL DISCOUNTING
5.4.1 INTRODUCTION:
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Bills of exchange that are used in the course of normal trade and commercial activities
are called commercial bills‗. Bill financing, is an ideal mode of short-term financing available to
business concerns. It imparts flexibility to the money market, besides providing liquidity within
the banking system. It also contributes towards the effectiveness of the monetary policy of the
central bank of a country.
According to the Indian Negotiable Instruments Act 1881, ―Bill of Exchange is an
instrument in writing containing an unconditional order, signed by the marker, directing a certain
person to pay a certain sum of money only to, or to the order of, a certain person, or to the bearer
of that instrument.
The bill of exchange is essentially a trade-related instrument, and is used for financing
genuine transactions. Bill financing, is an ideal mode of short term financing available to
business concerns. It imparts flexibility to the money market, besides providing liquidity within
the banking system. It also contributes towards the effectiveness of the monetary policy of the
central bank of a country.
5.4.2 BILL DISCOUNTING
When the seller (drawer) deposits genuine commercial bills and obtains financial
accommodation from a bank or financial institution, it is known as ‗bill discounting‗. The seller,
instead of discounting the bill immediately may choose to wait till the date of maturity.
Commercial, the option of discounting will be advantageous because the seller obtains ready
cash, which can be used for meeting immediate business requirements. However, in the process,
the seller may lose a little by way of discount charged by the discounting banker.
5.4.3 Following are the salient features of bill discounting financing:
1. Discount charge:
The margin between advance granted by the bank and face value of the bill is called the
discount, and is calculated on the maturity value at rate a certain percentage per annum.
2. Maturity:
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Maturity date of a bill is defined as the date on which payment will fall due. Normal
maturity periods are 30, 60, 90 or 120 days. However, bills maturing within 90 days are the most
popular.
3. Ready finance:
Banks discount and purchase the bills of their customers so that the customers get
immediate finance from the bank. They need not wait till the bank collects the payment of the
bill.
4. Discounting and purchasing:
The term discounting of bills is used for demand bills‗, where the term purchasing of bills
is used for usance bills‗. In both cases, the bank immediately credits the account of the customer
with the amount of the bill, less its charges. Charges are less in case of purchasing of bill because
the bank can collect the payment immediately by presenting the bill to the drawee for payment.
Charges are, however, higher in the case of discounting of bill‗ because the bank charges include
not only the charges for service rendered, but also the interest for the period from the date of
discounting the bill to the date of its maturity. In addition, there are also charges when bills are
dishonored. In such circumstances, the bank will debit the account of the customer with the
amount of the bill along with interest and other charges. Since the bank is granting advance to
the customers in both the discounting and purchasing of bills, bills discounted and purchased are
shown as advances (Schedule 9) by a bank in its balance sheet.
5.4.4 Steps In Discounting And Purchasing Following steps are involved in the discounting
and purchas8isng of commercial bills of exchange:
1. Examination of Bill: The banker verifies the nature of the bill and the transaction. The banker
then ensures that the customer has supplied all required documents along with the bill.
2. Crediting Customer Account after examining the genuineness of the bill, the banker grants a
credit limit, either on a regular or on an adhoc basis. The customer‗s account is credited with the
net amount of the bill i.e. value of bill minus discount charges. The amount of discount is the
income earned by the bank on discounting / purchasing. The amount of the bill is taken as
advance by the bank.
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3. Control over Accounts: To ensure that no customer borrows more than the sanctioned limit,
a separate register is maintained for determining the amount availed by each customer. Separate
columns are allotted to show the names of customers, limits sanctioned, bills discounted, bills
collected, loans granted and loans repaid. Thus, at any given point in time the extent of limit
utilized by the customer can be readily known.
4. Sending Bill for collection: The bill, together with documents duly stamped by the banker, is
sent to the banker‗s branch (or some other bank‗s branch if the banker does not have a branch of
its own) for presenting the bill for acceptance or payment, in accordance with the instructions
accompanying the bill.
5. Action by the Branch: On receipt of payment, the collecting bank remits the payment to the
banker which has sent the bill for collection.
6. Dishonor: In the event of dishonor, the dishonor advice is sent to the drawer of the bill. It
would be appropriate for the collecting banker to get the protested for dishonor. For this purpose,
the collecting banker or branch of the bank maintains a separate register in which details such as
date on which the bills are to be presented, the party to whom it is to be presented, etc. are
recorded. The banker then presents them for acceptance or payment, as required. The banker
debits the customers‗ (drawer / borrower) account with the amount of the bill and also all charges
incurred due to dishonor of the bill. Such a bill should not be purchased in the event of its being
presented again. However, the banker may agree to accept it for collection.
5.4.5 BILL SYSTEMS There are essentially two systems of bills, the drawer bill system and the
drawee bill system, which are explained blow:
Drawer Bills System ‗Drawer Bills System‘s characterized by: 1. Bills being drawn by the
sellers of goods on the buyer of the goods 2. Bills being discounted or purchased at the instance
of the drawer of the bills 3. The banker primarily taking into consideration the credit of the
drawer of bill, while discounting or purchasing these bills this system of financing goods is quite
popular in our country.
Drawee Bills System „Drawee Bills System‘s characterized by : a. The banker accepting the bill
drawn by the seller at the instance of the buyer (the drawee) b. The banker providing assistance,
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primarily on the strength of the creditworthiness of the buyer the two types of the drawee bills
system are as follows:
1. Acceptance credit system: Under this system, the buyer‗s banker accepts the bill of exchange
for the goods purchased by the drawee. Such a bill may either be drawn on the buyer or the
banker. The banker also requires the borrower to show separately, the goods purchased under
acceptance credit in periodical stock statements submitted to the banker.
2. Bills discounting system: Under this system, the seller directly draws the bill on the buyer‗s
bank. The buyer‗s bank discounts the bill and sends the proceeds to the seller. The buyer‗s
banker will show the bill as bill discounted‗. Under both the systems, the banker keeps a record
of the bills, both accepted and still outstanding. This is to ensure that the advance sanctioned
does not exceed the credit limit. The main advantages of the Drawee bill scheme are as follows:
1. Assured payment: Since the banker has accepted the bill, the seller is assured of
payment. Moreover, if the seller decides to get it discounted, the discount rate will be lower
because the drawee is the banker itself.
2. Buying advantage: Due to the surety and standing of the banker, it is possible for the
buyer to obtain goods at competitive rates.
3. Safety of funds: There is hardly any risk for the buyer‗s bank because the bill is
accepted or discounted against the security of the goods purchased by the buyer. Moreover, the
goods are under the control of the banker. It is equally advantageous for the seller‗s bank, since
the discounted bill may be rediscounted with any other financial institution. This is because; a
banker has accepted the bill.
5.5 FACTORING AND FORFAITING
5.5.1 INTRODUCTION
An important development in the Indian factoring services took place with the RBI
setting up a Study Group under the chairmanship of Shri C.S. Kalyanasundaram in January,
1988. The study group aimed at examining the feasibility and mechanism of organizing factoring
business in India. The group submitted its report in January 1989.
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5.5.2 FACTORING AND FORFAITING
Peter M. Biscose defines the term Factoring‗in his treatise Law and Practice of Credit
Factoring as a continuing legal relationship between a financial institution (the factor) and a
business concern (the client) selling goods or providing services to trade customers, whereby the
factory purchases the clients‗ book debts, either with or without recourse to the client, and in
relation thereto, controls the credit extended to customers, and administers the sales ledger.
C.S. Kalyansundaram, in his report (1988) submitted to the RBI defines factoring as,
―a continuing arrangement under which a financing institution assumes he credit and collection
functions for its client, purchases receivables as they arise (with or without recourse for credit
losses, i.e., the customer‗s financial inability to pay), maintains the sales ledger, attends to other
book-keeping duties relating to such accounts, and performs other auxiliary functions.
According to the study Group appointed by the International Institute for the Unification
of Private Law (UNIDROTT), Rome, 1988". ―A domestic factoring means an arrangement
between a Factor and his client, which includes at least two of the following services to be
provided by the Factor. a. Finance b. Maintenance of accounts c. Collection of debts d.
Protection against credit risk.
Factoring is a receivables management and financing mechanism which is designed to
improve cash flows and cover the credit risk of the seller. Unlike other forms of receivables
financing, like bills discounting and forfeiting; factoring involves a continuous relationship
between a factor and a seller, to finance and administer the receivables of the latter. Factors are
financial companies which pay cash against the credit sales of the client, and obtain the right to
receive the future payments on those invoices from the debtors of the client.
5.5.3 Functions of a factor
Factoring constitutes a suite of financial services offered under a factoring agreement,
which includes receivables financing, credit protection, accounts receivables collection and
management, sales ledger administration and advisory services.
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I. Receivables financing: The factoring institution advances a proportion of the value of the
book debts immediately to the client and the balance is paid on maturity of the book debts. This
improves the cash flow position of the client, by replacing the credit sales for cash.
II. Credit protection: The factoring institution takes over the credit risk of the client, and agrees
to bear the loss in case of default by the debtor. Credit protection is provided by the factor only
in case of non-recourse factoring.
III. Accounts receivables collection and management: The factoring company collects the
receivables of the client and also manages the credit collection schedule. By reducing the time
invested by the client in such activities, it allows the client to focus on business development.
IV. Sales Ledger management: The factor undertakes sales ledger management, including
maintenance of credit records, collection schedules, discounts allowed and ascertainment of
balance due from all debtors.
V. Advisory Services: A factoring company advises the client on its export and import potential,
and also helps the client in identification and selection of potential trade debtors, based on the
credit information available with it. The factor also advises on the prevailing business trends,
Policies, impending developments in the commercial and industrial sector etc.
5.5.4 Factoring mechanism
The parties involved in a factoring arrangement are:
1. The Client, or the seller
2. The Debtor, or the buyer
3. The Factor (International factoring may have a correspondent factor in addition to the
domestic
factor)
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Detailed Steps:
1. Client approaches Factor Company and requests for factoring facility.
2. Factor asks for Client‘s financial statements (last three years‘ balance sheet).
3. Client fills the application form and submits his last three years‘ financial statements.
4. Factor company conducts Client appraisal by conducting his credit assessment on the
quantitative (this includes analysis of current ratios, gearing ratios, profitability ratios, etc.) and
qualitative parameters such as integrity, management etc and approves/ disapproves client
request.
5. Once approved, the Factor Company assigns overall factoring limit to the client. The client is
required to submit sales ledger of his customers to the factor, who assesses the customers to
determine limit of sanction according to the quality of customers.
6. Bank NOC / Letter of Disclaimer (LOD) are called for after sanction of limit but before
Operationalisation of the account.
7. In case of approval of client request, client is asked to submit following documents:
a. documents for collateral, if any
b. Personal guarantee of directors, etc
8. Factor Company examines the sales ledgers of client‘s customers and conducts Buyers‘ due
diligence. For this, it seeks bank reports, credit reports from credit bureaus, D&B report, etc.
9. Based on the credit assessment of each customer of the client, Factor company sets credit
limits
for each customer.
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10. Factor Company grants in-house approval.
11. Factoring Company is required to send letter of notification to the client‘s buyers and the
buyers
are required to accept the same and send it to the factor company.
12. A factoring agreement is signed between the client and the factoring company.
13. Client is required to submit original invoices with assignment clause written on these and
proof
of delivery of these invoices.
14. Factor Company makes advance prepayment (Up to 80% of invoice value).
15. Factoring company manages client‘s ledger, sends due date reminders to client‘s customers
and
collects payments as and when due.
16. Factoring company uses appropriate software to manage the above processes.
17. Factoring company pays balance due to the client upon receipt of full payment.
Detailed Steps in International Factoring (Two Factor Model)
1. The importer places the order for purchase of goods with the exporter
2. The exporter approaches the export factor (in the exporter‘s country) for limit approval on the
importer. Export Factor in turn requests the import factor in the Importer's country for the
arrangement
3. The import factor assesses the importer and approves/rejects the arrangement and accordingly
conveys to the export factor
4. Exporter is informed of the commencement or otherwise, of the factoring arrangement
5. The exporter delivers the goods to the importer
6. Exporter produces the documents to the export factor
7. The export factor disburses funds to the exporter up to the prepayment amount and forwards
the documents to the Import factor as well as the Importer8. On the due date of the invoice, the
Importer pays the Import Factor, who in turn remits the payment to the export factor.
9. The exporter receives the balance payment from the export factor.
Charges applicable
Usually, a onetime setup fee, a service fee and an interest charge is levied for a factoring
transaction.
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The service fee is levied for the additional services of the factor, besides financing. It is
calculated as a percentage of the gross value of the invoices factored, and is based on:
I. The gross sales volume
II. The number of customers/debtors of the client
III. The number of invoices and credit notes
IV. The credit risk involved
5.5.5 Features of Factoring
The characteristics of Factoring are as follows:
1. The Nature The nature of the Factoring contract is similar to that of a bailment contract.
Factoring is a specialized activity whereby a firm converts its receivables into cash by selling
them to a factoring organization. The Factor assumes the risk associated with the collection of
receivables, and in the event of non-payment by the customers/debtors, bears the risk of a bad
debt loss.
2. The Form Factoring takes the form of a typical Invoice Factoring‗since it covers only those
receivables which are not supported by negotiable instruments, such as bills of exchange, etc.
This is because, the firm resorts to the practice of bill discounting with its banks, in the event of
receivables being backed by bills. Factoring of receivables helps the client do away with the
credit department, and the debtors of the firm become the debtors of the Factor.
3. The Assignment Under factoring, there is an assignment of debt in favor of the Factor. This is
the basic requirement for the working of a factoring service.
4. Fiduciary Position The position of the Factor is fiduciary in nature, since it arises from the
relationship with the client firm. The factor is mainly responsible for fulfilling the terms of the
contract between the parties.
5. Professionalism Factoring firms are professionally competent, with skilled persons to handle
credit sales realizations for different clients in different trades, for better credit management.
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6. Credit Realizations Factors assist in realization of credit sales. They help in avoiding the risk
of bad debt loss, which might arise otherwise.
7. Less Dependence Factors help in reducing the dependence on bank finance towards working
capital. This greatly relieves the firm of the burden of finding financial facility.
8. Recourse Factoring: Factoring may be non-recourse, in which case the Factor will have no
recourse to the supplier on non-payment from the customer. Factoring may also be with recourse,
in which case the Factor will have recourse to the seller in the event of non-payment by the
buyers.
9. Compensation A Factor works in return for a service charge calculated on the turnover. Actor
pays the net amount after deducting the necessary chares, some of which may be special terms to
handle the accounts of certain customers.
5.5.6 Types of Factoring
Factors take different forms, depending upon the type of specials features attached to them.
Following are the important forms of factoring arrangements:
1. Domestic Factoring: Factoring that arises from transactions relating to domestic sales is
known as Domestic Factoring‗. Domestic Factoring may be of three types, as described below.
2. Disclosed factoring: In the case of disclosed factoring‘ the name of the proposed actor is
mentioned on the face of the invoice made out by the seller of goods. In this type of factoring,
the payment has to be made by the buyer directly to the Factor named in the invoice. The
arrangement for factoring may take the form of recourse‗, whereby the supplier may continue to
bear the risk of non-payment by the buyer without passing it on to the Factor. In the case of nonrecourse factoring, Factor, assumes the risk of bad debt arising from non-payment.
3. Undisclosed factoring: Under undisclosed factoring‗, the name of the proposed Factor finds
no mention on the invoice made out by the seller of goods. Although the controls of all monies
remain with the Factory, the entire realization of the sales transaction is done in the name of the
seller. This type of factoring is quite popular in the UK.
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4. Discount factoring: Discount Factoring‘s a process where the Factor discounts the invoices of
the seller at a pre-agreed credit limit with the institutions providing finance. Book debts and
receivables serve as securities for obtaining financial accommodation.
5. Export Factoring: When the claims of an exporter are assigned to a banker or any financial
institution, and financial assistance is obtained on the strength of export documents and
guaranteed payments, it is called export factoring‗. An important feature of this type of factoring
is that the Factor bank is located in the country of the exporter. If the importer does not honor
claims, exporter has to make payment to the Factor. The Factor-bank admits a usual advance of
50 to 75 percent of the export claims as advance. Export factoring is offered both as a re-course‗
and as a non-recourse‗ factoring.
6. Cross-border Factoring: Cross-border Factoring‗ involves the claims of an exporter which
are assigned to a banker or any financial institution in the importers‗ country and financial
assistance is obtained on the strength of the export documents and guaranteed payments.
International factoring essentially works on a non-recourse factoring model. They handle
exporter‗s overseas sales on credit terms. Complete protection is provided to the clients (exporter
against bad debt loss on credit-approved sales. The Factors take requisite assistance and avail the
facilities provided for export promotion by the exporting country. When once documentation is
complete, and goods have been shipped, the Factor becomes the sole debtor to the exporter.
7. Full-service Factoring: Full-service factoring, also known as Old-line factoring, is a type of
factoring whereby the Factor has no recourse to the seller in the event of the failure of the buyers
to make prompt payment of their dues to the Factor, which might result from financial inability/
insolvency/bankruptcy of the buyer. It is a comprehensive form of factoring that combines the
features of almost all factoring services, especially those of non-recourse and advance factoring.
8. With Recourse Factoring: The salient features of the type of factoring arrangement are as
follows 1. The Factor has recourse to the client firm in the event of the book debts purchased
becoming irrecoverable
2. The Factor assumes no credit risks associated with the receivables
3. If the consumer defaults in payment, the resulting bad debts loss shall be met by the firm
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4. The Factor becomes entitled to recover dues from the amount paid in advance if the customer
commits a default on maturity
5. The Factor charges the client for services rendered to the client, such as maintaining sales
ledger, collecting customer‘s debt, etc.
9. Without Recourse Factoring: The salient features of this type of factoring are as follows : 1.
No right with the Factor to have recourse to the client 2. The Factor bears the loss arising out of
irrecoverable receivables 3. The Factor charges higher commission called del credere
commission‗ as a compensation for the said loss 4. The Factor actively involves in the process of
grant of credit and the extension of line of credit to the customers of the client
10. Advance and Maturity Factoring: The essential features of this type of factoring are as
follows : 1. The Factor makes an advance payment in the range of 70 to 80 percent of the
receivables factored and approved from the client, the balance amount being payable after
collecting from customers 2. The Factor collects interest on the advance payment from the client
3. The Factor considers such conditions as the prevailing short-term rate, the financial standing
of the client and the volume of turnover while determining the rate of interest
11. Bank Participation Factoring: It is variation of advance and maturity factoring. Under this
type of factoring, the Factor arranges a part of the advance to the clients through the banker. The
net Factor advance will be calculated as follows: (Factor Advance Percent x Bank Advance
Percent)
12. Collection / Maturing Factoring: Under this type of factoring, the Factor makes no
advancement of finance to the client. The Factor makes payment either on the guaranteed
payment date or on the date of collection, the guaranteed payment date being fixed after taking
into account the previous ledger experience of the client and the date of collection being
reckoned after the due date of the invoice.
5.6 FORFAITING
A form of financing of receivables arising from international trade is known as forfeiting.
Within this arrangement, a bank/financial institutions undertakes the purchase of trade bills/
promissory notes without recourse to the seller. Purchase is through discounting of the
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documents covering the entire risk of non-payment at the time of collection. All risks become the
full responsibility of the purchaser. Forfeiter pays cash to the seller after discounting the
bills/notes.
5.6.1 Forfeiting Mechanism:
In order to illustrate how forfeiting takes place in practice, the following is a typical forfeiting
transaction where the buyer and the seller of goods are located in different countries.
1.
During the course of negotiations between an exporter and an importer for the supply of
goods, the importer asks for credit terms.
2.
The exporter approaches a forfeiter and asks for an indication of whether the forfeiter is
willing to provide this credit and how much it is likely to cost. At this stage the forfeiter will
need to know:
1. The country of the importer
2. The importer‘s name
3. The type of goods
4. The value of the goods
5. The expected shipment date
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6. The repayment terms sought by the importer
7. Whether the importer‘s obligations will be guaranteed by a bank, and if so, who?
The forfeiter provides the exporter with an indication of the costs involved. At this stage
neither party is committed in any way.
When the details of the commercial contract have been agreed, but usually before it has
been signed, the exporter asks the forfeiter for a commitment to purchase the debt obligations
(bills of exchange, promissory notes etc) created under the export transaction.
The information required for this is the same as for an indication.
The forfeiter issues a commitment which is accepted by the exporter and which is binding
on both parties (1). This commitment will contain the following points:
0.
The details of the underlying commercial transaction.
1.
The nature of the debt instruments to be purchased by the forfeiter.
2.
The discount (interest) rate to be applied, together with any other charges
3.
The documents that the forfeiter will require in order to be satisfied that the debt
being purchased is valid and enforceable
4.
The latest date that the exporter can deliver these documents to the forfeiter
The exporter signs the commercial contract with the importer and delivers the goods.
(2+3).
In return, if required, the importer obtains a guarantee from his bank (4) provides the
documents that the exporter requires in order to complete the forfaiting (5). This exchange of
documents is usually handled by a bank, often using a Letter of Credit, in order to minimise
the risk to the exporter.
The exporter delivers the documents to the forfaiter who checks them and pays for them
as agreed in the commitment (6+7).
Since this payment is without recourse, the exporter has no further interest in the
transaction. It is the forfeiter who collects the future payments due from the importer (8)and it
is
the
forfeiter
who
runs
all
the
risks
of
non-payment.
5.6.2 Benefits to Exporter

100 per cent financing: Without recourse and not occupying exporter's credit line That
is to say once the exporter obtains the financed fund, he will be exempted from the
responsibility to repay the debt.
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
Improved cash flow: Receivables become current cash inflow and its is beneficial to the
exporters to improve financial status and liquidation ability so as to heighten further the
funds raising capability.

Reduced administration cost: By using forfeiting, the exporter will spare from the
management of the receivables. The relative costs, as a result, are reduced greatly.

Advance tax refund: Through forfeiting the exporter can make the verification of export
and get tax refund in advance just after financing.

Risk reduction: forfeiting business enables the exporter to transfer various risk resulted
from deferred payments, such as interest rate risk, currency risk, credit risk, and political
risk to the forfeiting bank.

Increased trade opportunity: With forfeiting, the export is able to grant credit to his
buyers freely, and thus, be more competitive in the market.
5.6.3 Benefits to Banks
Forfeiting provides the banks following benefits:

Banks can offer a novel product range to clients, which enable the client to gain 100%
finance, as against 8085% in case of other discounting products.

Bank gain fee based income.
Lower credit administration and credit follow up.
5.7 VENTURE CAPITAL
5.7.1 INTRODUCTION
An entrepreneur, with a good technical knowledge, raising of capital in the conventional
method will be very difficult. So, by a new technique of financing, long term capital is provided
to small and medium sector through an institutional mechanism. So capital assistance against
high growth oriented along with managerial assistance was felt necessary. This gave to the birth
of Venture Capital Assistance.
VENTURE A business enterprise involving considerable risk
5.7.2 Meaning of Venture Capital:
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It is a long term capital invested in companies which involves high risk. The financing
involves high risk but is compensated by high return.
5.7.3 FEATURES OF VENTURE CAPITAL The following are the features of venture capital
1. It is the financing of capital for new companies.
2. This finance can also be loan-based or in convertible debentures
3. Providers of venture capital aim at capital gain due to the success achieved by the borrowing
concern.
4. Venture capital is always a long-term investment and made in companies which have high
growth potential.
5. The venture capital provider take part in the business of borrowing concern simultaneously
provides managerial skill.
6. Venture capital financing contains risks. But the risk is compensated with a higher return.
7. It involves financing mainly small and medium size firms, which are in their early stages.
When the assistance of venture capital, these firms will stabilize and later can go in for
traditional finance.
5.7.4 Objectives of Venture Capital
• To finance new companies who find it difficult to go to capital market
• To provide long term finance to small and medium scale industries
• To provide managerial assistance
• To bring in rapid growth in the business
5.7.5 Financing By Venture Capital Institutions:
Before going in for venture capital finance, the venture capital institution will have to
assess the potentiality of the borrowing concern by a proper appraisal. This appraisal will be
similar to the project appraisal undertaken by commercial banks. There are three stages involved
in the venture capital finance.
5.7.6 Stages/Process
1. Seed capital It is the capital provided for testing the product and examining the commercial
viability of the product. It enables the venture capital institution to find out the technical skill of
the borrowing concern and its market potentially. So, we can say seed capital is more of a
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product development and all the finance required at this stage is provided by the venture capital
institution.
2. Start up Start up of the product refers to the tested in the market and after being satisfied with
its acceptability by the market, financing will be provided for further development of the product
and marketing of the product. The startup may be classified into four categories: 1. A new high
technology, introduced by the entrepreneur. 2. A new business started by an entrepreneur who
has a thorough working knowledge and experience – normally started by persons who were
working in an established firm and having gained sufficient experience. 3. New projects started
by existing companies. Example: Retail business started by Hindustan Lever Limited. 4. A new
company promoted by existing company. Here, the venture capital institution is keen to have a
first-rated management which may have a second rated product. But not vice versa i.e., venture
capital will not be provided for a concern having a second-rated management but a first-quality
product.
3. Second round finance It is the second round of finance after the initial stage after being
commercially successful for want of some more finance.
4. Later stage financing It is the financing after second round finance. The business concern
which has borrowed venture capital has now become a well established business. But still, it is
not able to go in for public issue of shares. At this stage, the venture capital institution will
provide finance.
5. Messanine capital This is a stage where the borrowing company is not only well established
but has overcome the risks and has started earning profits. But they have to go for some more
year before reaching the stage of self sustenance. This finance is used by the borrowing company
for purchase of plant and machinery, repayment of past debts, and entering new areas.
6. Bridge capital A capital of medium term finance ranging from one to three years and used for
extending a business Example: bridge loan for acquiring other firms.
7. Management Buy-outs (MBO) It is the capital used for acquiring all the shares and the
voting rights to remove external control. Example : An Indian company‗s shares may be
purchased by NRIs at the initial stage and after sometime these shares are bought back by the
company with the help of profits and finance by venture capital institutions.
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8. Management buy-in (MBI) Management buy in is the case where the funds are provided for
an outside group to buy an ongoing company.
9. Turn Around Turn around may be
Financial Turnaround: When the company is able to improve its conditions financially,
it is called financial turnaround, which is due to the financial assistance by venture capital
institution.
Management Turn around: similarly, when the management of the company makes a
turn around by becoming self dependent and is able to face the challenges of business, it
is called management turn around.
5.7.7 Infrastructure financing Incubators:
Incubators are non profit entities providing consultancy services in promoting venture
capital. To encourage venture capital industry, it is necessary to develop proper infrastructure for
venture capital, as being done in foreign countries. Consultancy may be about office
environment, finance and other complimentary resources. Incubators are promoted normally by
government or professional organizations interested in developing small companies. The venture
capital fund companies also have their own incubators and they provide in-house incubators. The
job of incubators will be to provide early support to young entrepreneurs so that the enterprise is
converted into a successful commercial venture at the earliest. For this purpose, proper financial
support and managerial support are given. There are two successful incubator models. These are:
1. Small Business Investment Company Programme (SBIC), administrated by Small Business
Administrator (SBA).
2. Bilateral Industrial Research and Development Foundation (BIRD).
SBIC, USA provides venture capital to private investment managers who promote small
companies. SBIC provides two-third of the capital and the remaining one-third is provided by
insurance companies, endowments, foundations, etc. The capital supplied by SBA requires rate
of return which is much lower than the market rate. SBIC will also raise capital from the open
market. 45% of the total equity is provided by venture capital firms in America for the small
enterprises. This method can be adopted in India also. The second model, BIRD is introduced by
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Israel – The Israeli government with International Corporation could mobilize funds for
providing venture capital fund. The fund provides not merely financial assistance but
infrastructure development, assistance for manufacturing and for selling innovative products.
5.7.8 Venture Capital in India
The venture capital institutions (VCIs) in India can be broadly classified into 5 types. 1.
Venture Capital companies promoted by Development Banks 2. State level Venture capital
companies 3. Commercial banks promoted Venture capital companies 4. Private sector Venture
capital companies 5. Foreign venture Capital funds.
1. VC companies promoted by Development banks
a) IDBI – VFC (Venture Fund Company) : IDBI promoted venture fund company in the year
1986. It is promoted by the Technology Development Wing of IDBI.
b) TDICI - Technology Development and Information company of India Ltd. This was
started in January 1988 with the support of ICICI and UTI. This is the country‗s first venture
fund (Venture Capital Unit Scheme). It was started with an initial fund of Rs.20 Crores and it has
financed nearly 37 small and medium scale enterprises. At present, it has a total fund of Rs.120
crores. The initial fund has yielded a return of Rs.16 crores.
c) RCTC – Risk Capital and Technology Finance Corporation Ltd: It is a subsidiary of IFCI,
started in January 1988. Its resource base has Rs.30 crores which has contributions from UTI,
IFCI and World Bank.
2. State level Venture Capital companies There are two state-level venture fund companies in
India. They are 1. Gujarat Venture Finance Ltd. 2. Andhra Pradesh Venture Capital Limited
(AVCL). Gujarat Venture Finance Ltd: Gujarat Industries Investment Corporation Ltd., along
with Gujarat Lease Finance Corporation Ltd., Gujarat Alkalies & Chemicals Ltd., and Gujarat
State Fertilizer Ltd., promoted Gujarat Venture finance Ltd. It has a venture fund of Rs.24 crores
and was started in 1990. Andhra Pradesh Venture Capital Limited (AVCL): This was
promoted by APIDC (Andhra Pradesh Industrial Development Corporation), IDBI, Andhra Bank
and Indian Overseas Bank.
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3. Venture Capital Companies promoted by Commercial Banks Notable among the venture
companies promoted by the commercial banks i. Canara Bank venture Capital Fund (CVCF) : ii.
Grind lays Bank has promoted India Investment Fund and Second India Investment Fund. iii.
SBI Capital Venture Capital Fund.
4. Private sector Venture Capital companies in private sector, we have Larazd Credit Capital
Venture Fund and Indus Venture Management Ltd. (IVML).
5. Foreign Venture Capital funds The Hong Kong Bank has promoted venture fund. Alliance
Capital of U.S.A. has also promoted venture capital fund.
Guidelines For Providing Venture Capital:
The venture capital companies have been given certain guidelines for providing venture
capital. Accordingly, the venture capital companies must obtain a detailed report from the
borrowing company. The report should contain the following details: 1. History of the borrowing company
2. Available facility for the borrowing company
3. Description of the products manufactured by the company
4. Market trend of the products
5. Cash flow position of the concern
6. Operating profit
7. Key personnel.
It takes about 6 months for a venture capital company to process the application during
which period, aspects such as the organizational structure, competition for the company‗s
product, etc., are studied.
5.7.9Investment Pattern In Venture Capital:
The investment plan will consist of 3 stages –
a). Basic stage
b). Operating stage
c). Exit stage
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• Basic stage involves the study and evaluation of the project. • Operating stage deals with
monitoring the functioning of the management of the borrowing concerns and advice for
providing new round of finance. In the course of studying the managerial skill, the following
aspects will be taken a) product quality b) Market size c) rate of return d) venture location e)
growth potential f) state of entrepreneur
• Exit stage – The borrowing company may be sold to a third party or the company may be left
to look after itself. While studying the managerial skill, he following aspects will be taken: a)
Product quality b) Market size c) Rate of return d) Venture location e) Growth potential f) State
of entrepreneur
QUESTION BANK WITH ANSWER KEY
TWO MARK QUESTIONS WITH ANSWER KEY
1.
UNIT-I
What do you mean by financial system?
A financial system or financial sector functions as an intermediary and facilitates the flow
of funds from the areas of surplus to the areas of deficit. It is a composition of various
institutions, markets, regulations and laws, practices, money manager, analysts, transactions,
claims and liabilities.
2. Give meaning the meaning of unorganized market.
In unorganized markets, there are a number of money lenders, indigenous bankers,
traders, etc. who lend money to the public. Indigenous bankers also collect deposits from the
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public. There are also private finance companies, chit funds, etc. whose activities are not
controlled by the RBI. The RBI has already taken some steps to bring unorganized sector under
the organized fold.
3. What is primary market?
Primary market also known as New Issues Market (NIM) is a market for raising fresh
capital in the form of shares and debentures. Corporate enterprises, which are desirous of raising
capital funds through the issue of securities, approach the primary market. Issuers exchange
financial securities for long -term funds.
4. What do you understand by financial deepening and broadening?
Financial deepening refers to an increase of financial assets as percentage of the Gross
Domestic Product (GDP). Financial broadening refers to building an increasing number and a
variety of participants and instruments.
5. Who is a merchant banker?
Merchant banker means any person who is engaged in th e business of issue management
either by making arrangements regarding selling, buying or subscribing to securities as manager
-consultant, advisor or rendering corporate advisory services in relation to such issue
management.
6. Give the meaning of portfolio managers.
Portfolio managers are defined as persons who, in pursuance of a contract with clients,
advise/direct/undertake, the management/administration of portfolio of securities/funds of clients
on behalf of the latter. The term portfolio means the total holdings of securities belonging to any
person.
7. What do you mean by project counseling?
Project counseling is a part of corporate counseling and relates to project finance. It
broadly covers the study of the project, offering advisory assistance on the viability and
procedural steps for its implementation.
8.
Define loan syndication.
It refers to a loan arranged by a bank for a borrower who is likely to be a large company,
a local authority, or a government department. So the merchant banker first finalizes the cost of
the project before approaching to financial institutions for term loans.
9.
Expand SEBI and FEMA.
SEBI-Security and Exchange Board of India
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FEMA - Foreign Exchange Management Act.
10. What are stock exchanges?
Stock Exchanges are a structured market place for the proper conduct of trading in
company stocks and other securities. The main services of the Indian Stock Exchanges all over
the country are to provide nation -wide services to investors and to facilitate the issue and
redemption of securities and other financial instruments.
11. Name two stock exchanges of India.
The two most important exchange houses of the Indian stock market are
 The National Stock Exchange and
 The Bombay Stock Exchange.
UNIT - II
1.
What is issue management?
Public issue management involves marketing of corporate securities by offering the
securities to the public, procuring private subscription to the securities and offering securities to
existing shareholders of the company.
2.
Define project appraisal.
Project appraisal is a process of investigation, review and evaluation undertaken as the
project or alternative concepts of the project are defined. This study is designed to assist the
client to reach informed and rational choices concerning the nature and scale of investment in the
project and to provide the brief for subsequent implementation.
3.
What is capital structure?
Capital Structure of a company refers to the composition or make -up of its capitalization
and it includes all long-term capital resources viz. loans, reserves, shares and bonds.
4.
Define equity shares.
Equity shareholders are the real owners of the company as they have the voting rights and enjoy
decision - making authority on important matters, related to the company. The shareholders‟
return is in the form of dividend, which is dependent on the profits of the company and capital
gain/loss, at the time of their sale.
5.
What are participating preference shares?
The holders of these shares participate in surplus profits of the company. They are firstly
paid a fixed rate of dividend and then a reasonable rate of dividend is paid on equity shares. If
some profits remain after paying both these dividends, then preference shareholders participate
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in the surplus profits.
6.
What is meant by debentures?
It is type of debt instrument that is not secured by physical asset or collateral. Debentures
are backed only by the general credit worthiness and reputation of the issuer. Both corporations
and governments frequently issue this type of bond in order to secure capital. Like other types of
bonds, debentures are documented in an indenture.
7.
Define Red Hiring Prospectus.
It is a prospectus which does not have details of either price or number of shares being
offered or the amount of issue. This means that in case price is not disclosed, the number of
shares and the upper and lower price bands are disclosed.
8.
Give the meaning of Bought out Deals (BOD).
Bought out Deal (BOD) is a process of investment by a sponsor or a syndicate of
investors/sponsors directly in a company. Such direct investment is being made with an
understanding between the company and the sponsor to go for public offering in a mutually
agreed time.
9.
What is green shoe option?
Green shoe option means an option of allocating shares in excess of the shares included
in the public issue and operating a post -listing price stabilizing mechanism for a period not
exceeding 30 days in accordance with the provisions of Chapter VIII A of DIP Guidelines, which
is granted to a company to be exercised through a Stabilizing Agent.
10. What is Book-Building?
Book building is actually a price discovery method. In this method, the company does not
fix up a particular price for the shares, but instead gives a price range, e.g. Rs.80 -100.
UNIT - III
1.
Define merger.
A merger is a combination of two or more companies into one company. It may be in the
form of one or more companies being merged into an existing company or a new company may
be formed to merge two or more existing companies. The Income Tax Act, 19 61 of India uses
the term „amalgamation‟ for merger.
2.
Explain absorption.
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A Combination of two or more companies into an existing company is known as
„absorption‟. In a merger through absorption all companies except one go into liquidation and
lose their separate id entities.
3.
What is congeneric merger?
It occurs where two merging firms are in the same general industry, but they have to
mutual buyer/customer or supplier relationship, such as a merger between a bank and a leasing
company. For example Prudential‘s acquisition of Bache and Company.
4.
Who is a portfolio manager?
Portfolio manager means any person who pursuant to a contract or arrangement with a
client, advises or directs or undertakes on behalf of the client (whether as a discretionary
portfolio manage r or otherwise) the management or administration of a portfolio of securities or
the funds of the client, as the case may be.
5.
What is an underwritten deal?
An underwritten deal is one for which the arrangers guarantee the entire commitment,
and then syndicate the loan. If the arrangers cannot fully subscribe the loan, they are forced to
absorb the difference, which they may later try to sell to investors.
6.
What is novation?
Novation is the only way in which a lender can effectively „transfer‟ all its right s and
obligations under the Loan Agreement. The process of transfer effectively cancels the existing
lender’s obligations and rights under the loan, while the new lender assumes identical new
rights and obligations in their place. The documentation require d to affect a novation of a
participation in a syndicated loan depends on the provisions in the Loan Agreement.
7.
Define credit rating.
Credit rating is an assessment of the credit worthiness of individuals and corporations. It
is based upon the history of borrowing and repayment as well as the availability of assets and
extent of liabilities. A credit rating tells a lender or investors the probability of the subject being
able to pay back a loan.
8.
Expand CRISIL and ICRA.
CRISIL – Credit Rating Information Services of India Limited
ICRA – Investment Information and Credit Rating Agencies of India
9.
What do you understand by mutual fund?
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A mutual fund is a professionally -managed form of collective investments that pools
money from many investors and invests it in stocks, bonds, short -term money market
instruments, and/or other securities. fund, the fund manager, who is also known as the portfolio
manager, trades the funds underlying securities, realizing capital gains or losses, and collects the
dividend or interest income.
10. Who are trustees?
Persons who hold the property of the mutual fund in trust for the benefit of the
unit holders are called trustees. Trustees look after the mutual fund, which is constituted as a
trust under the provisions of the Indian Trust Act.
11. What is meant by asset Management Company?
The investment manager of a mutual fund is technically known as the „Asset
Management Company‟, and is appointed by the sponsor or the trustees. The AMC manages the
affairs of the mutual fund. It is responsible for operating all the schemes of the fund, and can act
as the AMC of only one mutual fund.
12. What are Gilt funds?
Gift funds are also known as Government Securities in India, Gift Funds invest in
government papers (named dated securities) having medium to long -term maturity period.
Issued by the Government of India, these investments have little credit risk (risk of default) and
provide safety of principal to the investors.
13. What is business valuation?
Business valuation is a process and a set of procedures used to estimate the economic
value of an owners interest in a business. Valuation is used by financial market participants to
determine the price they are willing to pay or receive to consummate a sale of a business.
UNIT - IV
1. Define Leasing.
A lease may be defined as a contractual arrangement/transaction in which a party owning
an asset/equipment (lessor) provides the asset for use to another/transfer the right to use the
equipment to the user (lessee) over a certain/for an agreed period of time for consideration in
form of/in return for periodic payment (rentals) with or without a further payment (premium).
2. Write the elements of leasing.
 Parties to the contract
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 Asset
 Ownership Separated from user
 Term of lease
 Lease Rentals
 Modes of terminating lease
2. Define Angel Finance.
Angel investors are private investors, typically wealthy individuals who provide financial
support in return for an equity stake. Angel investors have personal interest in the venture and
offer advice, and support to promoters for achieving success.
4. Write the entities of Direct Lease.
In direct lease, the lessee and the owner of the equipment are two different entities. A direct
lease can be of two types:
 Bipartite and
 Tripartite Lease.
4. Mention the six players of leasing.
o Independent Leasing Companies
o Other finance companies
o Manufacturer-Lessor
o Financial Institutions
o In-house Lessor
o Commercial Banks
5. Write any four advantages of lease financing.
The advantages of leasing are as follows:
 To the Lessee:
Lease financing has following advantages to the lessee:
 Financing of Capital Goods
 Additional Source of Finance
 Less Costly
 Obsolescence Risk is Averted
 To the Lessor:
A lessor has the following advantages:
 Full Security
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 Tax Benefit
 High Profitability
6. Write any four advantages of lease financing.
The advantages of leasing are as follows:
To the Lessee:
Lease financing has following advantages to the lessee:
 Financing of Capital Goods
 Additional Source of Finance
 Less Costly
 Obsolescence Risk is Averted
To the Lessor:
A lessor has the following advantages:
 Full Security
 Tax Benefit
 High Profitability
Trading on Equity
7. List out the types of leasing.
Leasing can be classified into the following types:
 Finance lease and Operating Lease,
 Sales and lease back and Direct lease,
 Single investor lease and Leveraged lease and
 Domestic lease and International lease.
8. Give the meaning of hire purchasing.
Hire-purchase is a mode of financing the price of the goods to be sold on a future date. In
a hire -purchase to be transaction, the goods are let on hire, the purchase price is option to paid in
installments and the hirer is allowed an purchase the goods by paying all the installments.
9. Write any two characteristics of hire purchase.
 Payment to be made in installments over a specified period.
 The possession is delivered to the hirer at the time of entering into the contract. 
10. Define Contract of Sales of Goods.
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A contract of sales of goods is a contract whereby the seller transfers or agrees to transfer
the property in goods to the buyer for a price. It includes both an actual „sale‟ and an „agreement
to sell‟ which vastly differ from each other.
UNIT-V
1. Define venture capital.
Venture capital is defined as providing seed, start up and first stage financing and
also funding expansion of companies that have already demonstrated their business potential
but do not yet have access to the public securities market or to credit -oriented institutional
funding sources.
2. What is last stage financing?
This stage of venture capital financing involves established businesses which require
additional financial support. At this stage, the firm is not ripe enough to go for a public offer
as it has not reached the profit -earning stage.
3. Mention any two venture capital industry of India.
Two venture capital industry of India are
(i) Risk Capital and Technology Finance Corporation Limited.
(ii) Technology Development and Information Company of India Limited (TDICI).
4. What is foreign venture capital?
Foreign Venture Capital Investors (FVCIs) are those funds that are not constituted in
India but make investments in Indian capital market.
5. Define bill of exchange.
According to the Indian Negotiable Instruments Act, 1881: ―The bill of exchange is
an instrument in writing containing an unconditional order, signed by the maker, directing a
certain person to pay a certain sum of money only to, or to the order of, a certain person, or
to the bearer of that instrument.‖
6. Write a note on consumer credit.
Consumer credit includes all asset-based financing plans offered to primarily
individuals to acquire durable consumer goods. Typically, in a consumer credit transaction
the individual-consumer-buyer pays a fraction of the cash purchase price at the time of the
delivery of the asset and pays the balance with interest over a specified period of time.
7. What is the meaning of „factoring‟?
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―Factoring means an arrangement between a factor and his client which includes at
least two of the following service to be provided by the factor:
(i)
Finance,
(ii)
Maintenance of accounts,
(iii)
Collection of debts and
(iv)
Protection against credit risk‖.
8. What is the meaning of „Forfeiting‟?
Forfeiting is a form of financing of receivables pertaining to international trade. It
denotes the purchase of trade bills/promissory notes by a bank/financial institution without
recourse to the seller. The purchase is in the form of discounting the documents covering the
entire risk of non -payment in collection.
9. What do you mean by real estate financing?
A set of all financial arrangements that are made available by housing finance
institutions to meet the requirements of housing is called real estate financing. Housing
finance institutions includes banks, housing finance companies, special housing finance
institutions, etc.
10. What are the factors of real estate finance assistance?
 Loan Amount
 Tenure
 Administrative & Processing Cost
 Prepayment charges
 Services
 Value addition
 Sources of finance like HFCs and banks
 EMI calculation method.
SIXTEEN MARK QUESTIONS WITH ANSWER KEY
UNIT-I
1. Briefly explain the three tier system of stock exchange of India.
The three-tier stock market system as follows:
(i) Principal Stock Exchanges comprising of five major exchanges currently functioning
in the metropolitan centers of Mumbai, Delhi, Kolkata, Chennai and Ahmadabad.
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(ii) Regional Stock Exchanges comprising of exchanges established in smaller metros
and urban centre, i.e., comprises of all other existing Stock Exchange.
(iii)Additional Trading Floors (ATFs) sponsored and managed by either a principal or a
Regional Stock Exchange.
2. Describe about the SEBI Regulations on Merchant Banking.
Following are the SEBI regulations on merchant banking:
 Registration of Merchant Bankers
 Requirements for Granting of Certificate
 Capital Adequacy Requirements
 Procedure for Registration
 Renewal of Certificate
3. List out the important functions of merchant banking and explain it.
Some of the most important functions of investment banking are as follows:
 Underwriter
 Banker
 Broker
 Registrar
 Debenture Trustee
 Portfolio Manager
4. Give the meaning and definition of financial system. What are the functions of it?
A good financial system serves in the following ways:
 Link between Savers and Investors
 Helps in Projects Selection
 Allocation of Risk
 Information Available
 Minimizes Situations of Asymmetric Information
 Reduce Cost of Transaction and Borrowing
 Promotion of Liquidity
 Financial Deepening and Broadening
5. Write about the institutional structure of merchant banking and explain its elements.
The main elements of the re -organization of the institutional structure are briefly outlined
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below:
 Development/Public Financial Institutions (DFIs/PFIs)
 Commercial banks
 Non-Banking Financial Companies (NBFCs)
 Mutual Funds
 Securities/Capital Market
o Primary Market
o Secondary Market
 Money Market
UNIT - II
1. Explain capital structure and its instruments.
There are four basic instruments of capital structure, viz.
 Equity Shares
 Preference Shares
 Retained Earnings/Ploughing Back of Profits
 Debenture
2. Describe placement of the issues
 Initial Public Offer (IPO)
 Follow on Public Offer (FPO)
 Rights Issue
 Offer for Sale
 Green Shoe Option
 E-IPO
 Private Placement/Placement with FIs, MFs, FIIs, etc.
 Bought Out Deal
 Off-Shore Issues
2. Explain about the post-issue management.
After closing the public issue the next task of the merchant bankers is post issue
management. It includes
 Collection of Application Forms,
 Screening of Applications,
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 Deciding Allotment Procedure,
 Mailing of Allotment Letters and
 Share Certificates and Refund Orders.
3. Give some details about SEBI Guidelines for Post -Issue Management.
The Post-issue obligations/requirements of lead managers/merchant bankers to an issue are
discussed below.
o Post-Issue Monitoring Reports
o Redressal of Investors‟ Grievances
o Co-ordination with Intermediaries
o Finalization of Basis of Allotment
o Dispatch of Share Certificates.
4. Explain issue marketing and its steps.
Following are the steps involved in the marketing of the issue of securities to be undertaken
by the lead manager:
 Target Market
 Target Concentration
 Pricing
 Mobilizing Intermediaries
 Information Contents
 Launching Advertisement Campaign
 Brokers and Investors Conferences
 Timing of the Issue
UNIT-III
1. What are the types of Mergers and also explain the process of mergers.
The following are the types of mergers:
o Horizontal Merger
o Vertical Merger
o Conglomerate Merger
o Congeneric Mergers
o Reverse Merger
The process of merger or the steps involved in merger are as follows:
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o Defining the Corporate Strategy
o Implementing the Corporate Strategy
o Target Identification
o Valuation of the Merger
o Merger Implementation
o Post-Merger Integration
1. Explain the details about Business Valuation.
Business valuation is a process and a set of procedures used to estimate the
economic value of an owners interest in a business.
Valuation is just to estimate:
What (cash flow) +When (time period) + How (risk), we receive in future out of a subject
property.
(i) Approaches for Valuation

Asset-Based Approaches

Earning Value Approaches

Market Value Approaches
(ii) Reasons for Business Valuation
(iii)Valuation Procedures
(iv) Common Errors in Business Valuation
(v) Advantages of Business Valuation Methods
(vi) Disadvantages of Business Valuation Methods
3. What are all the techniques of Investment Analysis/Performance Evaluation of Mutual
funds?
Performance evaluation methods generally fall into four categories:
 Sharps Ratio
 Treynors Measure
 Jensen Measure
 Modigliani and Modigliani Measure.
4. What are the types of mutual funds?
Mutual funds can be classified under two different categories:
(i) General Classification
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
Open-Ended Schemes

Close-Ended Schemes

Interval Scheme

Load Funds

Non-Load funds

Tax-Exempt Funds

Non-Tax-Exempt Funds
(ii) Broad Classification

Equity Funds

Money Marker/Liquid Funds

Hybrid Funds

Debt/Income Funds

Gilt Funds

Commodity Funds

Real Estate Funds

Exchange Traded Funds(ETF)

Fund of Funds
5. Explain the functions of Credit Rating Agency.
A credit rating agency serves following functions:
 Provides Unbiased Opinion
 Provides Quality and Dependable Information
 Provides Information at Low
 Provide Easy to Understand Information
 Provide Basis for Investment
 Healthy Discipline on Corporate Borrowers.
 Formation of Public Policy.
UNIT-IV
1. Difference between Leasing and Hire purchase financing.
These two modes of financing differ in the following respects:
o Ownership
o Depreciation
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o Magnitude
o Extent
o Maintenance
o Tax Benefits
2. What are all the income tax considerations for the lessees?
The income tax considerations for the lessees are
o Allow ability of lessee rentals
o Deduction of Incidental Expenses and
o Tax Planning
o Flexible structuring of lease rentals
o Transfer of unabsorbed capital allowance to the lessor.
3. What are the limitations of lease financing?
Lease financing suffers from certain limitations too:
o Restrictions on Use of Equipment
o Limitations of Financial Lease
o Loss of Residual Value
o Consequences of Default
o Understatement of Lessee‟s Asset
o Double Sales -Tax.
4. What are the types of leasing?
Leasing can be classified into the following types:
o Finance lease and Operating Lease,
o Sales and lease back and Direct lease,
o Single investor lease and Leveraged lease and
o Domestic lease and International lease.
5. What are the advantages of leasing?
The advantages of leasing are as follows:
To the Lessee:
Lease financing has following advantages to the lessee:
 Financing of Capital Goods
 Additional Source of Finance
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






Less Costly
Ownership Preserved
Avoids Conditionality‘s
Flexibility in Structuring of Rentals
Simplicity
Tax Benefits
Obsolescence Risk is Averted
To the Lessor:
A lessor has the following advantages:





Full Security
Tax Benefit
High Profitability
Trading on Equity
High Growth Potential
UNIT-V
1. What are the characteristics of Venture Capital?
Following are the characteristics of venture capital.
 Mode of Investment
 Objective
 Hands -On Approach
 High Risk-Return Ventures
 Nature Of Firms
 Liquidity
 New Ventures
 Continuous Involvement.
2. What are the features of Consumer Credit?
The features of Consumer Credit are as follows:
 Parties to the transaction
 Structure of the transaction
 Mode of Payment
 Payment period and Rate of Interest
 Security
What are the functions of a factor?
Depending on the type/form of factoring, the main functions of a factor, in general
terms, can be classified into five categories:
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 Maintenance/administration of sales ledger
 Collection facility of accounts receivable
 Financing facility/trade debts
 Assumption of credit risk/credit control and credit protection and
 Provision of advisory services.
4. What are the types of bills?
There are various types of bills. They can be classified on the basis of when they
are due for payment, whether the documents of title of goods accompany such bills or not,
the type of activity they finance, and so on. Some of these bills are:
o Demand Bill
o Usance Bills
o Documentary Bills
o D/A Bills
o D/P Bills
o Clean Bills
5. What are the types of factoring?
The important forms/types of factoring are as follows:
o Recourse and Non-recourse Factoring
o Advance and Maturity Factoring
o Full Factoring
o Disclosed and Undisclosed Factoring
o
Domestic and Export/Cross -Border/International Factoring.
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