dba 1724 merchant banking and financial services[1]

MBA(DISTANCE MODE)

DBA 1724

MERCHANT BANKING ANDFINANCIAL SERVICES

IV SEMESTER

COURSE MATERIAL

Centre for Distance EducationAnna University Chennai

Chennai – 600 025

Author

Reviewer

DrDrDrDrDr.T.T.T.T.T.V.V.V.V.V.Geetha.Geetha.Geetha.Geetha.GeethaProfessor

Department of Computer Science and EngineeringAnna University Chennai

Chennai - 600 025

DrDrDrDrDr.H.P.H.P.H.P.H.P.H.Peereereereereeru Mohamedu Mohamedu Mohamedu Mohamedu MohamedProfessor

Department of Management StudiesAnna University Chennai

Chennai - 600 025

DrDrDrDrDr.C.C.C.C.C. Chella. Chella. Chella. Chella. ChellappanppanppanppanppanProfessor


Chennai - 600 025

DrDrDrDrDr.A.K.A.K.A.K.A.K.A.KannanannanannanannanannanProfessor


Chennai - 600 025

Copyrights Reserved(For Private Circulation only)

Editorial Board

ii

MrMrMrMrMr. K. K. K. K. K. K. K. K. K. Karararararthik Sridarthik Sridarthik Sridarthik Sridarthik SridarFaculty Member

ICFAI Adamsmith Institute of ManagementChennai - 600 015

DrDrDrDrDr. H. P. H. P. H. P. H. P. H. Peereereereereeru Mohamedu Mohamedu Mohamedu Mohamedu MohamedProfessor

Department of Management StudiesAnna University Chennai

Chennai - 600 025

ACKNOWLEDGEMENT

The author has drawn inputs from several sources for the preparation of this course material, to meet the

requirements of the syllabus. The author gratefully acknowledges the following sources:

• Agarwal, Sanjiv, “The Indian Money market”, Facts for you, Jan. 1994

• Chartered financial Analyst, 2002

• Chugh, Anup Kumar, “Capital Market Instruments”, State Bank of India, Monthly Review

• Goiporia, M.N., “ An Overview of the Financial Markets”

• Madden, J.T. and M. Nadler, The International Money market.

• Reserve Bank of India Bulletin, May 1999.

• Singh, K.P. and A.k. Sinha, “Primary Market and Spread of equity Culture in India”. The Indian Journalof commerce.

• Tripathy, Nalini Prava, “Capital Market – A better Environment for Better Tomorrow”, Internal Conferenceon Accounting in Changing Perspectives.

• Verma, Sanjeev, “ Innovations in Financial products”. ICFAI National Convention,1994.

• Baver, Hans Peter, “What is a Merchant Bank”, The Banker, London, July 1976. Francis, Jack Clark,Management of Investments”, 2nd ed., McGraw Hill International.

• Phadnis, Abhijit P., “Role of a Merchant Banker”, ICFAI Study Materials. Sivaloga-

• nathan, K., “Merchant Banking; Coming of the Age”, The Indian Journal of Commerce.

• Avadhani, V.A., “Investment Management”, Himalaya Publishing House, New Delhi, 1996,

• Desai, Vasant, “The Indian Financial System”, Himalaya Publishing House, New Delhi

• Government of India, Report of the High Powered Committee on Stock Exchanges, 1985,

• Gemarat, Sanjeev, “Insider Trading” The Chartered Accountant, July 1993.

• Pandya, V.H., “Emerging Scenario in the Capital Market and SEBI’s Role”, Forum of Free Enterprise,1994.

• Avadhani, V.A., “Investment Management”, Himalaya Publishing House, New Delhi, 1996,

• Desai, Vasant, “The Indian Financial System”, Himalaya Publishing House, New Delhi

• Government of India, Report of the High Powered Committee on Stock Exchanges, 1985,

• Gemarat, Sanjeev, “Insider Trading” The Chartered Accountant, July 1993.

• Pandya, V.H., “Emerging Scenario in the Capital Market and SEBI’s Role”, Forum of Free Enterprise,1994.

• Rao, Mohana P., “Working of Mutual Fund Organizations in India, Kaniska Publishers, New Delhi,1998.

• Bombay Stock Exchange Annual Reports, 1996-97 and 1999-2000.

• Rastogi, A.B., “Reforms at the Stock Exchange, Mumbai”, 1997, Corporate Planning Group, the StockExchange, Mumbai”.

v

vi

• Rastogi, A.B., “Trade Guarantee Fund”.

• Reserve Bank of India, Bulletin 1996-97, 2000-2002.

• Chandra, Prasanna, “The Investment GAME”, Tata McGraw-Hill, New Delhi, 1993.

• Chartered Financial Analyst, October, 1994.

• Chartered Financial Analyst, April-March, 1995.

• Dedhia, Manish V “OTCEI –A New Dimension in the Capital Market in India”, Management Accountant,June 1992.

• Chandra, Prasanna, “The Investment GAME”, Tata McGraw-Hill, New Delhi, 1993.

• Chartered Financial Analyst, October, 1994.

• Chartered Financial Analyst, April-March, 1995.

• Dedhia, Manish V “OTCEI –A New Dimension in the Capital Market in India”, Management Accountant,June 1992.

• Goiporia, M.N., “ An Overview of the Financial Markets”

• Madden, J.T. and M. Nadler, The International Money market.

• Reserve Bank of India Bulletin, May 1999.

• Singh, K.P. and A.k. Sinha, “Primary Market and Spread of equity Culture in India”. The Indian Journalof commerce.

• Tripathy, Nalini Prava, “Capital Market – A better Environment for Better Tomorrow”, Internal Conferenceon Accounting in Changing Perspectives.

• Verma, Sanjeev, “ Innovations in Financial products”. ICFAI National Convention,1994.

• Chakravarthi, Anand, “Securitization Market: Indian and Global Scenario”, ICFHI Reader March 2004.

• Bansal, L.K., “Asset Securitization”, Journal of Accounting and Finance, Feb., 1995.

• Gupta, G.D., “Debt Securitization – Making Money from Money”, The Chartered Accountant, May, 1997.

• Narender, V, and C.S. Mishra, “Securitization – A New Mode of Financing”, Chartered Secretary, February1996.

• Nair, T.C., and R.Gurcemurthy, “Securitization of Debt: Some issues”, The Journal of The Indian Instituteof Bankers, July 1995.

• Rai, Rita, “Securitization: The Concept and its Relevance to Indian Banks”, IBA Bulletin, October 1994.

• Sen, Abhijit, “securitization – Plenty of Potential”, Chartered Financial Analyst, Decem- ber 1995.

• Surey, Rajat and Kalpesh Gada, “Securitization in India: Coming of Age”, ICFAI Reader, January 2004.

• Tehnmozhi, M., “Critical Issues in Debt Securitizaation in India”, Accounting in Chang- ing Perspectives,January 1997.

• Ali ki lian, Mohd. Akbar, “CRISIL Rating in India – A New financial service in capital Market”, FinanceIndia, Sept. 1993.

• CRISIL, “Rating Set — Debentures”, Aug. 1993.

vii

• Choudhury, P.K., “Credit Rating: A few simple facts”, The Economic Times, Calcutta, August, 1994.

• Dhileepan, P., “Rating of Banks and Financial Companies”, The Economic Times, Calcutta, Aug. 1994.

• Gupta, R.I., and M. Radhaswami, “Financial Statement Analysis”, Sultan Chand and Sons, New Delhi,1982.

• Jhaveri, M.S., “Premium Investments”, 16th July-22nd July, 1993, IBA Bulletin, January 1993, IBA Bulletin,January 1993.

• Menon, A., “ICRA forms Novel Cash flow Structure for SEBI Raising Funds”, The Economic Times,Calcutta, Dec., 1994.

• Mohansule, “The Importance of being CRISIL”, The Economic Times, March, 1991.

• Punjab National Bank, Monthly Review, November, 1992.

• Ramachandran, Kalyani, “Critical Factors Influencing Financing Decisions Credit Rating”, Asian, Journalof Management, (Sept.-Dec. 1990).

• Rao, B. Ramachandra, “banking on Credit Rating”, The Banker, May 1993. Shah, Pradip P., “CreditRating and the Role of CRISIL”, Chartered Secretary, July, 1993.

• Ansari, M.N.A., “Mutual Funds in India: Emerging Trends”, The Chartered Accountant, August 1993.

• Bansal, L.K., “Mutual Funds: Management and Working”, Deep and Deep Publications, New Delhi.

• Chartered Financial Analyst, February 2000.

• Dewan, Sonica, “Mutual Funds in India: A Review”, Business Analyst, Jan. – June, 1998.

• Fortune India, March 31, 1999.

• Freedman, Albert J, and Russ Wiles, “How Mutual Funds Work”, Prentice-Hall of India, New Delhi,1997.

• Goyal, Madan, “Mutual Funds in India, Here We Come”, The Journal of Indian Institute of Bankers,Oct.-Dec. 1989.

• Gangadhar, V., “The Changing Pattern of Mutual Funds in India”, The Management Accountant, December1992.

• Indro, D.C., C.S. Jiang, B.E. Patuwo, and G.P. Zhang, “Predicting Mutual Fund

• Singh, K.P. and A.k. Sinha, “Primary Market and Spread of equity Culture in India”.

• The Indian Journal of commerce.

• Tripathy, Nalini Prava, “Capital Market – A better Environment for Better

• Tomorrow”, Internal Conference on Accounting in Changing Perspectives.

• Verma, Sanjeev, “Innovations in Financial products”. ICFAI National Convention,1994.

Inspite of at most care taken to prepare the list of references any omission in the list is only accidental and

not purposeful

K. Karthik Sridar

Author

DBA 1724 MERCHANT BANKING AND FINANCIAL SERVICES

UNIT I - MERCHANT BANKING

Introduction – An Overview of Indian Financial System – Merchant Banking in India –Recent Developments andChallenges ahead – Institutional structure – Functions of Merchant Banking – Legal and Regulatory Frameworks– Relevant Provisions of Companies Act- SERA-SEBI guidelines- FEMA etc. – Relation with stock Exchanges, OTCEI and NES.

UNIT II - ISSUE MANAGEMENT

Role of Merchant Banking in Appraisal of projects, Designing Capital Structures and Instruments – Issue Pricing– 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. –Offerfor sale – Book- Building – Green Shoe Option –E –IPO Private Placement- Bought out Deals –Placement withFis,MFs, FIIs , etc. off- Shore Issues. – Issue Marketing – Advertising Strategies-NRI Marketing- Post IssueActivities.

UNIT III - OTHER FEE BASED MANAGEMENT

Mergers and Acquisitions – Portfolio Management Services – Credit Syndication – Credit Rating – MutualFunds – 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 inFactoring 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.

8. Ennew.C.Trevor Watkins & Mike Wright, ‘Marketing of Financial Services’, Heinemann Professionalpub., 1990.

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CONTENTS

UNIT IMERCHANT BANKING

LESSON 11.1 INTRODUCTION 1

1.2 LEARNING OBJECTIVES 1

1.3 INANCIAL SYSTEM 1

1.3.1 Objectives 2

1.3.2 Functions 2

1.3.3 Significance Of Financial System 3

1.3.4 Introduction To Financial System In India 4

1.3.5 Structure Of Indian Financial System 6

1.3.6 Limitations of the financial system in India 11

LESSON – 2

2.1 INTRODUCTION 14


2.3 MERCHANT BANKING 15

2.3.1 Objectives 15

2.3.2 Functions 16

2.3.3 Classification of Merchant Bankers by Sebi 19

2.3.4 Merchant Banking in India 19

2.3.5 Recent Developments in Merchant Banking and Challenges Ahead 20

LESSON – 3

3.1 INTRODUCTION 22


3.3 MERCHANT BANKING AND LEGAL REGULATORY FRAME WORK 22

3.3.1 Companies Act 23

3.3.2 Provisions under Companies Act 25

LESSON – 4

4.1 INTRODUCTION 27


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4.2.1 SCRA 27

4.2.2 Recognized Stock Exchanges 29

4.2.3 Grant of Recognition of Stock Exchanges 29

LESSON – 5

5.1 INTRODUCTION 31


5.3 SEBI 31

5.3.1 Objectives 32

5.3.2 Functions 32

5.3.3 SEBI Regulations on Merchant Bankers 33

5.3.4 SEBI guidelines on merchant banking 48

LESSON – 6

6.1 INTRODUCTION 56


6.3 STOCK EXCHANGES 56

6.3.1 Objectives of stock exchanges 57

6.3.2 Functions of stock exchanges 57

6.3.3 Organization of stock exchanges 59

6.3.4 Methods of trading in stock exchanges 60

LESSON – 7

7.1 INTRODUCTION 64


7.3 OTCEI 64

7.3.1 Objectives of OTCEI 65

7.3.2 Benefits of OTCEI 66

7.3.3 Securities traded under OTCEI 68

LESSON – 8

8.1 INTRODUCTION 70


8.3 NSE 70

8.3.1 Operations of NSE 72

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UNIT IIISSUE MANAGEMENT

LESSON - 1

1.1 INTRODUCTION 77


1.3 MERCHANT BANKERS AND CAPITAL ISSUES MANAGEMENT 77

1.3.1 Issue Management 78

1.3.2 Functions of Merchant Bankers 80

LESSON - 2

2.1 INTRODUCTION 123


2.3 MERCHANT BANKING AND MARKETING OF NEW ISSUES 123

2.3.1 Methods 124

2.3.2 Advertising Strategies 139

2.3.3 FIIs 140

2.3.4 NRI 142

2.3.5 Pricing of New Issues 145

2.3.6 Post issue activities 147

2.3.7 Law relating to issue management 147

UNIT IIIOTHER FEE BASED MANAGEMENT

LESSON – 1



1.3 MERGERS & ACQUISITIONS 151

1.3.1 Objectives 151

1.3.2 Steps in Mergers and Acquisitions 152

1.3.3 Takeovers 153

1.3.4 Major Issues in Mergers & Acquisitions 155

LESSON – 2



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2.3 PORTFOLIO MANAGEMENT SERVICES 157


2.3.2 Functions 158

2.3.3 Strategies 159

LESSON – 3



3.3 CREDIT SYNDICATION SERVICES 161


3.3.2 Scope 161

LESSON – 4



4.3 CREDIT RATING 169

4.3.1 Basis of Credit Rating 170

4.3.2 Credit Rating Companies in India 170

4.3.3 Types of Credit Rating 171

LESSON – 5



5.3 MUTUAL FUNDS 175


5.3.2 Mutual funds set up in India 176

5.3.3 Types of Mutual funds 177

5.3.4 History of Mutual funds in India 179

5.3.5 Business valuation 180

UNIT –IVFUND BASED FINANCIAL SERVICES

LESSON – 1



1.3 FUND BASED FINANCIAL SERVICES 185

1.3.1 Leasing 185

1.3.2 Basic concepts in Leasing 186

1.3.3 Evolution of Leasing 187

1.3.4 Types of Leasing 188

1.3.5 Regulatory Authority 193

1.3.6 Lease Market in India 194

1.3.7 Players in Leasing 195

1.3.8 Hire purchase 196

1.3.9 Difference between Leasing and Hire purchase 198

1.3.10 Financial Evaluation 198

1.3.11 Tax Implication 199

UNIT V

OTHER FUND BASED FINANCIAL SERVICES

LESSON 1



1.3 CONSUMER CREDIT 201

1.3.1 Consumer Finance Transactions 202

1.3.2 Nature of Consumer Classes in India 203

1.3.3 Latest developments in Consumer Credit 206

1.3.4 Importance of Consumer Credit in India 209

LESSON – 2



2.3 CREDIT CARDS 212

2.3.1 Origin of Credit Cards in India 212

2.3.2 Types 214

2.3.3 Benefits of Credit Cards 218

LESSON – 3



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3.3 REAL ESTATE FINANCING 222

3.3.1 Factors determining the Real Estate finance assistance 222

3.3.2 Sources of Finance 224

LESSON – 4



4.3 BILL DISCOUNTING 227

4.3.1 Features 228

4.3.2 Steps in Bill Discounting 228

4.3.3 Bill Systems 229

LESSON – 5



5.3 FACTORING AND FORFAITNG 232

5.3.1 Features of Factoring 233

5.3.2 Types of Factoring 234

5.3.3 Difference between Factoring and Forfaiting 237

LESSON – 6



6.3 VENTURE CAPITAL 239


6.3.2 Financing by Venture Capital Institutions 240

6.3.3 Venture Capital in India 242

6.3.4 Guide lines for providing Venture Capital 244

6.3.5 Investment pattern in Venture Capital 244

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NOTES

1 ANNA UNIVERSITY CHENNAI

MERCHANT BANKING AND FINANCIAL SERVICES

UNIT I

MERCHANT BANKINGLESSON 1

1.1 INTRODUCTION

The word ‘system’ implies a set of complex and interrelated factors organized in aparticular form. These factors are mostly interdependent but not always mutually exclusive.The financial system of any country consists of several ingredients. It includes financialinstitutions, markets, financial instruments, services, transactions, agents, claims and liabilitiesin the economy.

‘Financial system’ is a system to canalize the funds from the surplus units to the deficitunits. ‘Deficit units’ is a case where current expenditure exceeds their current income.There are other entities whose current income exceeds current expenditure which is calledas ‘Surplus Units’.

An efficient financial system not only encourages savings and investments, it alsoefficiently allocates resources in different investment avenues and thus accelerates the rateof economic development. The financial system of a country plays a crucial role of allocatingscarce capital resources to productive uses. Its efficient functioning is of critical importanceto the economy.

1.2 LEARNING OBJECTIVES

After reading the unit, you will understand:

- The functions of financial system

- The importance of financial System

- The financial system in India and its structure

- Limitations of financial system in India

1.3 FINANCIAL SYSTEM

• It is a system for the efficient management and creation of finance

DBA 1724

NOTES


According to Robinson, financial system provides a link between savings andinvestment for the creation of new wealth and to permit portfolio adjustment in thecomposition of the existing wealth.

According to Van Horne, financial system is defined as the purpose of financialmarkets to allocate savings efficiently in an economy to ultimate users – either for investmentin real assets or for consumption.

Thus the financial system mainly stands on three factors

1 Money

2 Credit

3 Finance

1. ‘Money’ is the unit of exchange or medium of payment. It represents the value offinancial transactions in qualitative terms.

2. ‘Credit’, on the other hand, is a debt or loan which is to be returned normally withinterest.

3. ‘Finance’ is monetary wealth of the state, an institution or a person. Comprisingthese factors in a systematic order forms a financial system.

1.3.1 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

1.3.2 Functions

Functions of financial system are distributed from creation of money to efficientmanagement. 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.

NOTES



1. CONTROLLING FUNCTIONS

Government imposes certain controls over the financial and business activities ofdifferent organizations through the regulatory bodies. E.g. RBI plays an important part inregulatory functions. They are

(i) Supervision of financial institutions

(ii) Restrictions on interest and bank rates

(iii) Selective credit control

(iv) Controlling foreign exchange

(v) Regulation of stock exchanges

(vi) Framing rule for effective portfolio management and distribution, diversificationand reduction of risk

(vii)Imposing monetary control

(viii)Prevention of unfair trade practices

(ix) Formulating policies on licensing, investment or credit

(x) Acting as the government’s and other banks’ bankers.

2. PROMOTIONAL FUNCTIONS

The promotional activities are

i. Efficient operation of the payment mechanism.

ii. Managing information to make it easily available to all interested parties

iii. Providing training to investors, intermediaries and employees in order toupgrade their skills.

iv. Conducting development and research activities in order to update thesystem.

v. Creation and establishment of need based financial institutions.

vi. Promotion of fair practices which are transparent and effective.

vii.Creating financial awareness to captivate investors, entrepreneurs andborrowers.

viii.Organizing seminar, dialogues, collection of data and publication.

1.3.3 Significance Of Financial System

Financial system of a country or an organization is the main motivating factor to runthe economy. It ensures that transactions are effected smoothly and quickly on an ongoingbasis. It enables the financial agents to accelerate financial growth and economic prosperityof the unit.

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NOTES


The significance of financial system are

(i) It involves an efficient operation of payment mechanism.

(ii) Enhancing liquidity of financial claims through securities trading.

(iii)Portfolio management.

(iv)Diversification and reduction of financial risk

(v)Acting as intermediaries between savers and investors.

1.3.4 Introduction To Financial System In India

The evolution of the financial system in India is nothing but the reflections of its politicaland economic history. The evolution process has been influenced by the factors ofurbanization of society, advent or large scale industrialization, introduction of railways andtelegraphic communications in the 19th century, nationalization of financial institutions in20th century and implementation of information technology on the eve of the 21st century.The growth of Indian Financial System is not the outcome of a normal process ofdevelopment; rather, it is created by the government and mainly expanded through itsintervention. Government policies have greatly influenced the interest rates, credit controland functions of financial intermediaries.

PRE INDEPENDENCE SITUATIONS

During the 274 year regime of the East India Company (1600-1874) the financialsystem of the country was not at all organized. It was monopolized by the mercantilehouses who were involved in banking business by providing loans, receiving deposits andissuing currency. They are commonly known as ‘agency houses’ who actually laid thefoundation of modern banking. The formal banking business was developed by establishmentof three Presidency Banks, namely

1. The Bank of Bengal (1806)

2. Bank of Bombay (1840)

3. The Bank of Madras (1846).

Apart from these, some exchange banks and Indian joint stock banks were set up. In 1858, as a consequence of Sepoy Mutiny, the administrative power of the East IndiaCompany was transferred to the Governor General of India. The financial system of thecountry started to be organized during this period. In 1861, the Central Government tookthe responsibility of issuing currency notes throughout the country. Between 1865 to 1905,nine joint stock banks, each with a capital of Rs.5 lakh and over were established. In1921, the three Presidency Banks were amalgamated under a special legislation to formthe Imperial Bank of India.

The first central bank was established in 1935 in the country which is known as theReserve Bank of India. At the time of independence, banking system in India was controlled

NOTES



by RBI, IBI, exchange banks, cooperative banks and Indian joint stock banks and thetotal deposits in these banks during 1948 were Rs.957 Crores. During this period, thebanking sector was in the making though there was lack of supply of long term funds to allindustrial units, specially to small scale industries. The cooperative movement did not helpmuch as it was disorganized and not properly aided with adequate funds. In the fields ofsmall savings and post office savings bank played a vital role to accumulate deposits,though it is insignificant in terms of total deposits into the country.

The private sector acted a strong role in the stock market during the first half of the20th century. The first stock exchange was established at Bombay in 1887 where theprivate sector industrial units and the Government raised large amount of funds. The paidup capital of Joint Stock companies increased from Rs.24 Crores in 1890 to Rs. 570Crores in 1948 with an average capital issue of Rs.70 Crores per year during 1918 to1939. This boom is due to the increased; pace of industrialization, protection of domesticindustries and government policies during this period.

POST INDEPENDENCE ERA (1950-1991)

During this period, the Indian financial system passed the second phase of evolution.It has grown rapidly since 1950 in terms of size, innovations, diversity, complicity andsophistication. The banking system has been expanded in the rural areas through theestablishment of State Bank of India in 1955.

In 1951, economic planning was initiated in India. The mixed economy model hasbeen adopted which enhanced government control over the financial system and directgovernment participation in industrialization process.. The different landmarks during thisphase were

• Bank nationalization in 1969

• Establishment of various financial institutions which are need based and useful forexpansion of financial sector.

• Imposing overall control on insurance sector by the Government.

• Establishment of large scale industrial units and introduction of long term finance toall industries.

• Emphasizing the growth of small scale industries by helping them through subsidizedfunding and direct investment.

• Imposition of regulatory measures and inserting Government intervention in businessthrough amending the companies Act, Securities Contracts (Regulation) Act, 1956,Monopolies and Restrictive Trade practices Act 1970, Foreign ExchangeRegulation Act 1973 etc.,

DBA 1724

NOTES


ERA AFTER LIBERALISATION

The announcement of the New Economic Policy in 1991, the India Financial Systemhas shown quite flexibility in terms of transformation . The reformation process has beenstarted in order to remove the stagnation of growth described before and, till date, theresponse is positive. This is the phase of liberalization and globalization of Indian economyfollowing the world trend which is duly supported by deregulation of Government Control.Market force becomes dominant resulting in privatization of industries, emergence of newgeneration financial institutions with competitive ability and introduction of computerizedbusiness environment where information technology plays a vital role. The regulatoryframework has been duly changed giving space to this reform process and one can saythat the Indian financial sector is gradually moving towards attainment of global standards.

1.3.5 Structure Of Indian Financial System

Financial system is a system of arranging different types of funds required for thebusiness. It deals about

(a) Financial Institutions

(b) Financial Markets

(c) Financial Instruments

(d) Financial Services

Figure 1.1 Components of Financial System

Financial Financial Institutions Markets

Financial Financial Instruments Services

NOTES



(A) FINANCIAL INSTITUTIONS

Structure of Financial Institutions

COMMERCIAL BANKS:

Commercial Banks

Classification of Commercial Banks

Financial Institutions

Banking Non

Non Banking Companies

Non Banking Financial Co’s

Central Bank

Commercial Banks

Co-Operative Banks

Non Banking Financial

Intermediaries

Joint Stock

Co’s

Public Sector Banks Private Sector Banks Foreign Banks

Commercial Banks

SBI & Subsidiaries Nationalized

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NOTES


CO-OPERATIVE BANKS

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

NOTES



(a) CAPITAL MARKET

It is the market for long term funds i.e., raising capital for Companies through issue ofshares and debentures. The Capital market can further divided into (a) Primary Marketand (b) Secondary Market

Fig 1.7Classification of Capital Market

(i) Primary Market : It is the market for primary needs of the company . The Companysells its shares at the time of promotion and the investors directly buy the shares from thecompany through application.

(ii) Secondary Market: It is the market for secondary needs of the company. The saleand purchase of securities i.e., shares and debentures will take place through the recognizedstock exchanges.

(b) MONEY MARKET:

It is a market for short term funds. Money market provides working capital.

Structure of Indian Money Market

(c) FOREIGN MONEY MARKET

It is a market for foreign exchange which is bought and sold. In India the foreignmarket is controlled by Reserve Bank of India. Foreign Exchange Management Act (FEMA)deals with foreign exchange.

(d) GOVERNMENT SECURITIES MARKET

It is a market for Government securities like Treasury Bills and Bonds . TreasuryBills are bills issued for meeting the short term revenue expenditure of the Government.

Capital Market

Primary Market Secondary Market

Capital Market

Organized Money Market Unorganized Money Market

Reserve Bank of India Indigenous bankers

Money Lenders

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NOTES


Bonds are issued for raising Long term loans which are repayable over a period of 15 to20 years.

Government Securities Market

(C) FINANCIAL INSTRUMENTS

Financial instruments include both instruments and products. Instruments includecheques, drafts, letter of credit, travellers’ cheques, commercial paper, GDR’s, bondsetc.,. Products may be in the form of Credit Cards, Debit Cards etc.,

Classification of Financial Instruments

(a) Negotiable Instruments

A negotiable instrument is an instrument that is transferable from one person to another.Negotiable instrument may be a bearer instrument or an order instrument. A negotiableinstrument may be promissory notes, bills of exchange or cheque etc.,

(b) Commercial Paper

A commercial paper is one which is issued by leading financial institution which canbe taken by any borrower and discounted with commercial banks.

(c) Bill of lading

It is a document signed by the carrier, acknowledging shipment of the goods andcontaining the terms and conditions of carriage.

Government Securities Market

Treasury bills Bonds

NOTES



(d) Letter of Credit

It is a letter by the importer bank guaranteeing the credit worthiness of the importer.

(e) Travellers’ Cheques

It is a cheque issued by banks to the traveling public which can be cashed at ease.

(D) FINANCIAL SERVICES

Financial service, as a part of financial system provides different types of financethrough various credit instruments, financial products and services. It enables the user toobtain any asset on credit according to his convenience and at a reasonable interest rate.

FINANCIAL SERVICES

Components of Financial Services

1.3.6 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 scaleindustries. It has rather patroned the big industrial houses who are already well off.

• The mushrooming of financial institutions has deteriorated the quality andeffectiveness of the sector to some extent.

• In many cases, it could not impose adequate control towards financial irregularitiesand frauds, often influenced by politically and economically organized pressuregroups.

• The Indian financial system fails to create a well defined and organized capitalmarket.

• It fails to motivate economically marginal or small entrepreneurs by providing microcredit to them.

• The Indian financial system is not flexible at the desired level. It takes abnormaltime to cope with the changing situation.

Factoring Asset Liability Management

Leasing Housing Finance

Forfaiting Portfolio Finance

Hire Purchase Finance Underwriting

Credit Card Credit rating

Merchant Banking Interest and Credit Swap

Book Building Mutual fund

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Have you understood questions?

Objective Type Questions

Q 1.3.a Define “Financial System”.

Q.1.3.b Mention the categories of financial institutions.

Q.1.3.c State two ‘Non banking financial institutions’.

Q.1.3.d What do you mean by primary markets?

Q.1.3.e What is meant by money market?

Q.1.3.f Give two examples of financial services.

Short Answer Type Questions

Q.1.3.g Describe the types of financial markets with examples.

Q.1.3.h Mention the major objectives of a sound financial system.

Q.1.3.i What are the main functions of a financial system?

Q.1.3.k Illustrate the structure of the Indian Financial System.

Q.1.3.l State the limitations of the Indian Financial System.

Long Answer Type Questions

Q.1.3.m Draw an account of the growth of the Indian financial System after Independence.

Q.1.3.n What is the role of Indian Financial Sector in her economic Development?

Q.1.3.o Illustrate the different components of the Indian financial System

and explain their activities.

Q.1.3.p What are ‘financial services’? State the objectives and functions of the same.

Q.1.3.q What are the general problems faced by financial services firms in India?

Q.1.3.r What is the need for regulating the financial services sector in India?

NOTES



SUMMARY

Four and half decades of Indian economic planning and subsequent liberalization hadled the country to an ecstatic phase of development The development throughdisintermediation, deregulation, globalization, and emergence of vibrant capital market hascontributed to the expansion of opportunities. As a result, capital market has emerged asthe major contributor to the growth of foreign exchange reserves of the country. In fact, inthe merging world market, India has beaten several developing countries. In the postliberalization era, the finance sector has witnessed a complete metamorphosis. The recenteconomic reforms encompassed a series of measures to promote investors protection andencourage the growth of capital market. Free entry into capital market for new issues bycompanies and free pricing of share for new issues has been ensured. Different financialinstitutions and markets compete for a limited pool of savings by offering differentinstruments. Money and capital markets increase competition between suppliers. Capitalmarket enables contractual savings and collective investment institutions to play a moreactive role in the financial system.

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LESSON – 22.1 INTRODUCTION

The Progress of any economy mainly depends on the efficient financial system of thecountry. Indian economy is no exception of this. This importance of the financial sectorreforms affirms an effective means for solving the problems of economic, financial andsocial in India and elsewhere in the developing nations of the world. The progress of thesecurities Industry of any country depends mainly on the flow of funds. In fact, Capitalgeneration is the lifeblood of the capital market without which the health and soundness ofthe financial system cannot be geared up and for which well-developed capital market aswell as money market are essential.

A Merchant bank is a financial institution primarily engaged in internal finance andlong term loans for multinational corporations and governments. It can also be used todescribe the private equity activities of banking. Merchant banks tend to advise corporationsand wealthy individuals on how to use their money. The advice varies from counsel onmergers and acquisitions to recommendation on the type of credit needed. The job ofgenerating loans and initiating other complex financial transactions has been taken over byinvestment banks and private equity firms.

Thus, the function of merchant banking which originated, and grew in Europe wasenriched by American patronage, and these services are now being provided throughoutthe world by both banking and Non-banking Institutions. The word “Merchant Banking”originated among the Dutch and the Scottish Traders, and was later on developed andprofessionalized in Britain.



• Definition of merchant banking

• Merchant bank objectives

• Merchant bank functions

• Institutional structure

• Merchant banking in India

• Recent developments in Merchant banking and challenges ahead

NOTES



2.3 MERCHANT BANKING

Securities and Exchange Board of India (Merchant Bankers) Rules, 1992

“ A merchant banker has been defined as any person who is engaged in the businessof issue management either by making arrangements regarding selling, buying or subscribingto securities or acting as manager, consultant, adviser or rendering corporate advisoryservices 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 merchantswho 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 frequentlyencountered a prolonged intermediate stage known in England originally as merchantbanking”

The Notification of the Ministry of finance defines

A merchant banker as ,”any person who is engaged in the business of issue managementeither by making arrangements regarding selling, buying or subscribing to the securities asmanager, consultant, adviser or rendering corporate advisory service in relation to suchissue management”.

• A merchant banker is one who is a critical link between a company raisingfund and the investors.

• Merchant banker is one who underwrites corporate securities and advicesclients on issues like corporate mergers.

• The merchant banker may be in the form of a bank, a company, firm or evena proprietary concern.

• Merchant Banker understands the requirements of the business concern andarranges finance with the help of financial institutions, banks, stock exchangesand money market.

2.3.1 Objectives

• Channellising the financial surplus of the general public into productive investmentsavenues

• 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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NOTES


Merchant Bankers as intermediaries

2.3.2 Functions

Merchant banking functions in India is the same as merchant banks in UK and otherEuropean countries. The following are the functions of merchant bankers in India.

Functions of Merchant Bankers

WHO OWN THE

CAPITAL

MERCHANT BANKERS AS

INTERMEDIARIES FOR

TRANSFER OF CAPITAL

WHO NEED THE

CAPITAL

C orp ora te C ou n selin g

P ro jec t C oun selin g

C ap ita l S tru ctu rin g

P o rtfo lio M anagem en t

Issu e M anagem en t

C red it S yn d ica tion

W ork in g cap ita l

V en tu re C ap ita l

L ease F in a nc e

F ix ed D ep osits

NOTES



(i) Corporate counseling

Corporate counseling covers counseling in the form of project counseling, capitalrestructuring, project management, public issue management, loan syndication, workingcapital fixed deposit, lease financing, acceptance credit etc., The scope of corporatecounseling is limited to giving suggestions and opinions to the client and help taking actionsto solve their problems. It is provided to a corporate unit with a view to ensure betterperformance, 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. Itbroadly covers the study of the project, offering advisory assistance on the viability andprocedural 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) forpreparing project reports

f. Assisting in the preparation of project report

g. Assisting in obtaining approvals , licenses, grants, foreign collaboration etc., fromgovernment

h. Capital structuring

i. Arranging and negotiating foreign collaborations, amalgamations, mergers andtakeovers.

j. Assisting clients in preparing applications for financial assistance to various nationaland state level institutions banks etc.,

k. Providing assistance to entrepreneurs coming to India in seeking approvals fromthe Government of India.

(iii)Capital Structure

Here the Capital Structure is worked out i.e., the capital required, raising of thecapital, debt-equity ratio, issue of shares and debentures, working capital, fixed capitalrequirements, etc.,

(iv)Portfolio Management

It refers to the effective management of Securities i.e., the merchant banker helps theinvestor in matters pertaining to investment decisions. Taxation and inflation are taken intoaccount while advising on investment in different securities. The merchant banker also

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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., equityshares, preference shares and debentures or bonds by offering them to public. Merchantbanks act as intermediary whose main job is to transfer capital from those who own it tothose 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 financeinstitution or a syndicate or consortium. Merchant Banks help corporate clients to raisesyndicated loans from commercials banks.

Merchant banks helps in identifying which financial institution should be approachedfor term loans. The merchant bankers follow certain steps before assisting the clients approachthe 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 andarriving at a figure of approximate amount of term loan to be raised.

d. After verifications of the project, the Merchant Banker arranges for a preliminarymeeting with financial institution.

e. If the financial institution agrees to consider the proposal, the application is filledand submitted along with other documents.

(vii) Working Capital

The Companies are given Working Capital finance, depending upon their earningcapacities 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 henceonly few institutions come forward to finance. The merchant banker looks in to the technicalcompetency of the entrepreneur for venture capital finance.

NOTES



(ix)Fixed Deposit

Merchant bankers assist the companies to raise finance by way of fixed depositsfrom the public. However such companies should fulfill credit rating requirements.

(x)Other Functions

• Treasury Management- Management of short term fund requirements by clientcompanies.

• Stock broking- helping the investors through a network of service units

• Servicing of issues- servicing the shareholders and debenture holders indistributing dividends, debenture interest.

• Small Scale industry counseling- counseling SSI units on marketing and finance

• Equity research and investment counseling – merchant banker plays animportant role in providing equity research and investment counseling because theinvestor is not in a position to take appropriate investment decision.

• Assistance to NRI investors - the NRI investors are brought to the notice of thevarious investment opportunities in the country.

• Foreign Collaboration: Foreign collaboration arrangements are made by themerchant bankers.

2.3.3 Classification Of Merchant Bankers By Sebi

Classification of Merchant bankers

2.3.4 Merchant Banking In India

The first merchant bank was set up in 1969 by Grind lays Bank. Initially they wereissue mangers looking after the issue of shares and raising capital for the company. Butsubsequently they expanded their activities such as working capital management; syndicationof project finance, global loans, mergers, capital restructuring, etc., initially the merchantbanker in India was in the form of management of public issue and providing financialconsultancy for foreign banks. In 1973, SBI started the merchant banking and it wasfollowed by ICICI. SBI capital market was set up in August 1986 as a full fledged merchantbanker. Between 1974 and 1985, the merchant banker has promoted lot of companies.However they were brought under the control of SEBI in 1992.

Classification of Merchant bankers

Issue management Underwriters Consultants to Issue Mobilization of foreign funds

for companies

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RANKING OF MERCHANT BANKING IN INDIA

Note:

OE : Overall Excellence

FSS : Financial Soundness

QPS : Quality Product/Service

QM : Quality Management

INN : Innovativeness

Table showing ranking of Merchant Bankers in India

2.3.5 Recent Developments in Merchant Banking and Challenges Ahead

The recent developments in Merchant banking are due to certain contributory factorsin India. They are

1. The Merchant Banking was at its best during 1985-1992 being when there weremany new issues. It is expected that 2010 that it is going to be party time formerchant banks, as many new issue are coming up.

2. The foreign investors – both in the form of portfolio investment and through foreigndirect investments are venturing in Indian Economy. It is increasing the scope ofmerchant bankers in many ways.

3. Disinvestment in the government sector in the country gives a big scope to themerchant banks to function as consultants.

4. New financial instruments are introduced in the market time and again. This basicallyprovides more and more opportunity to the merchant banks.

5. The mergers and corporate restructuring along with MOU and MOA are givingimmense opportunity to the merchant bankers for consultancy jobs.

Merchant Banker OE FSS QPS QM INN ICICI Securities 4.0 4.0 4.2 3.8 4.3 IDBI 4.2 3.2 4.5 4.0 4.8 SBI Caps 4.4. 3.9 4.6. 6.7 5.2 DPS 6.1 5.7 6.0 6.0 5.3 IFCI 6.1 5.7 6.0 6.0 6.3 Bank of Baroda 6.7 6.5 6.7 6.6 6.8 Jardine Fleming 5.8 6.2 5.9 5.0 5.5 JM Finance 6.0 6.5 5.5 5.9 5.4 ENAM 6.3 6.8 6.4 6.3 6.2 PNB Caps 6.8 6.8 6.7 6.8 6.8

NOTES



However the challenges faced by merchant bankers in India are

1. SEBI guideline has restricted their operations to Issue Management and PortfolioManagement 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 areinto trouble without any fault of their own.

3. The net worth requirement is very high in categories I and II specially, so manyprofessionally experienced person/ organizations cannot come into the picture.

4. Poor New issues market in India is drying up the business of the merchant bankers.

Have you understood questions?

Short Answer Type Questions

Q 2.3.a Define the term ‘merchant banking’

Q.2.3.b What are the activities connected with ‘corporate counseling’ ?

Q.2.3.c What are the activities undertaken by a merchant banker in relation to project counseling?

Q.2.3.d What are ‘capital restructuring’ services of a merchant banker?

Q.2.3.e What are the codes of conduct to be observed by Indian merchant bankers’?

Long Answer Type Questions

Q.2.3.m What is merchant banking ? Discuss in detail the various functions performed by merchant bankers.

Q.2.3.n Give a detailed account of the regulatory framework available for merchant banking activity in India.

Summary

Thus the merchant bankers are those financial intermediary involved with the activityof 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

a. The management of the customers securities

b. The management of the portfolio

c. The management of projects and counseling as well as appraisal

d. The management of underwriting of shares and debentures

e. The circumvention of the syndication of loans

f. Management of the interest and dividend etc

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NOTES



Merchants and banks are currently engaged in a wide-ranging struggle for controlover payment systems. The conflict is playing itself out in business practices, in bankingregulation, in corporate governance, in corporate restructuring, in securities offerings, andin the biggest antitrust litigation Yet, it is possible that the extraordinary energy being spentin this fight is for naught, as the growth of national bank brands, technological developments,and innovative business models are likely to result in a radical reshaping of the paymentsworld. This chapter reviews the factors behind the struggle between merchant banks andthe law relating to it , the strategies adopted by each.



• Merchant banking legal and regulatory frameworks

• Companies act

• Provisions under companies act and merchant banking

3.3 MERCHANT BANKING AND LEGAL REGULATORY FRAME WORK

Registration with SEBI as Merchant Banker

Q. Is it mandatory for a merchant banker to register with the SEBI?

A. Yes. Without holding a certificate of registration granted by the Securities andExchange Board of India, no person can act as a merchant banker.

Q. Who is eligible to obtain registration as a merchant banker?

A. Only a body corporate other than a non-banking financial company shall be eligibleto get registration as merchant banker.

Q. What are the various categories for which registration can be obtained?

A. The categories for which registration may be granted are given below:

• Category I – to carry on the activity of issue management and to act as adviser,consultant, manager, underwriter, portfolio manager.

• Category II - to act as adviser, consultant, co-manager, underwriter, portfoliomanager.

• Category III - to act as underwriter, adviser or consultant to an issue

• Category IV – to act only as adviser or consultant to an issue

NOTES



Q. What is the capital requirement for carrying on activity as merchant banker?

A. The capital requirement depends upon the category. The minimum net worthrequirement for acting as merchant banker is given below:

• Category I – Rs. 5 crores

• Category II – Rs, 50 lakhs

• Category III – Rs. 20 lakhs

• Category IV – Nil

Q. What is the procedure for getting registration?

A. An application should be submitted to SEBI in Form A of the SEBI (MerchantBankers) Regulations, 1992. SEBI shall consider the application and on being satisfiedissue a certificate of registration in Form B of the SEBI (Merchant Bankers) Regulations,1992.

Q. What is the registration fee payable to SEBI?

A. Rs. 5 lakhs which should be paid within 15 days of date of receipt of intimationregarding grant of certificate.

Q. What is the validity period of certificate of registration?

A . Three years from the date of issue.

Q. How to renew the certificate?

A. Three months before the expiry period, an application should be submitted toSEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall considerthe application and on being satisfied renew certificate of registration for a further period of3 years.

Q. What is the renewal fee payable to SEBI?

A. Rs.2.5 lakhs which should be paid within 15 days of date of receipt of intimationregarding renewal of certificate.

Q. What is the consequence of non-registration or failure to renew registration?

A. The person whose registration is not current shall not carry on the activity asmerchant banker from the date of expiry of validity period.

3.3.1 Companies Act

(i) “company” means a company formed and registered under this Act or an existing

company as defined in clause (ii);

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NOTES


(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 membersof the company while in that employment and have continued to be members after theemployment ceased; and

c. prohibits any invitation to the public to subscribe for any sharesin, or debentures of, the company;

d. prohibits any invitation or acceptance of deposits from personsother than its members, directors or their relatives

Provided that where two or more persons hold one or more shares in a companyjointly, 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 paid-up capital of five lakh rupees or such higher paid-upcapital, s may be prescribed

c. is a private company which is a subsidiary of a company which is not aprivate company.

NOTES



DEFINITIONS

In this Act, unless the context otherwise requires,-

1. “abridged prospectus” means a memorandum containing such salient features of aprospectus 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 Administrationconstituted under section 10E

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 SecuritiesContracts (Regulation) Act, 1956

6. “hybrid” means any security which has the character of more than one type ofsecurity, including their derivatives;

7. “issued generally” means, in relation to a prospectus, issued to persons irrespectiveof their being existing members or debenture-holders of the body corporate towhich the prospectus relates;

8. “prospectus” means any document described or issued as a prospectus and includesany notice, circular, advertisement or other document inviting deposits from thepublic or inviting offers from the public for the subscription or purchase of anyshares in, or debentures of, a body corporate;

9. “recognized stock exchange” means, in relation to any provision of this Act inwhich it occurs a stock exchange whether in or outside India, which is notified bythe Central Government in the Official Gazette as a recognized stock exchange forthe purposes of that provision;

10. “Registrar” means a Registrar, or an Additional, a Joint, a Deputy or an AssistantRegistrar, having the duty of registering companies under this Act;

11. “securities” means securities as defined in clause (h) of section 2 of the SecuritiesContracts (Regulation) Act, 1956

12. “Securities and Exchange Board of India” means the Securities and ExchangeBoard of India established under section 3 of the Securities and Exchange Boardof India Act, 1992

13. “share” means share in the share capital of a company, and includes stock exceptwhere a distinction between stock and shares is expressed or implied;

3.3.2 Provisions Under Companies Act

The various regulations which govern the merchant bankers on the capital issue areprescribed 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)

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NOTES


c. Commissions and discounts (Sec. 76 & 77)

d. Issue of shares at premium and at discount (Sec. 78 & 79)

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)

1. Matters to be specified in prospectus and reports to be set out therein (Schedule 11)

2. The Securities Contracts (Regulations) Act, 1957 regarding transactions in securities

3. The Securities Contracts (Regulation)Rules, 1957.

HAVE YOU UNDERSTOOD QUESTIONS?

Q.3.3.a State the capital adequacy requirements prescribed for the merchant bankers by the SEBI.

Q.3.3.b Discuss the various general obligations of merchant bankers under the SEBI regulation.

Q.3.3.c State the circumstances under which SEBI would suspend the certificate of registration of a merchant banker.

Q.3.3.d State the circumstances under which SEBI would cancel the certificate of registration of a merchant banker.

Q.3.3.e Write a note on the fees structure levied by the SEBI on the merchant bankers.

SUMMARY

Beyond this SEBI grants recognition to a merchant banker after taking into accountthe following aspects

1. professional competence of merchant bankers

2. their capital adequacy

3. their track record, experience and general reputation

4. Adequacy and quality of personnel employed by them and also the availableinfrastructure.

NOTES




The Securities Contracts (Regulations) Act was passed in 1956 by Parliament and itcame into force in February 1957.

An act to prevent undesirable transactions in securities by regulating the business ofdealing therein, by providing for certain other matters connected therewith.



• SCRA

• The different definitions in the Act related to capital market

• Regulations for stock exchanges

• Recognition of stock exchanges

4.2.1 SCRA

1. This Act may be called the Securities Contracts (Regulation) Act, 1956.

2. It extends to the whole of India.

3. It shall come into force on such date as the Central Government may, by notificationin the Official Gazette, appoint.

Definitions

a. “Contract” means a contract for or relating to the purchase or sale of securities;

b. “Corporatisation” means the succession of a recognized stock exchange, being aBody of individuals or a society registered under the Societies Registration Act,1860 (21 of 1860), by another stock exchange, being a company incorporatedfor The purpose of assisting, regulating or controlling the business of buying, sellingor dealing in securities carried on by such individuals or society;

c. “demutualization” means the segregation of ownership and management from thetrading rights of the members of a recognized stock exchange in accordance witha scheme approved by the Securities and Exchange Board of India;

(c) “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;

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NOTES


b. a contract which derives its value from the prices, or index of prices, of underlyingsecurities;

c. “Government security” means a security created and issued, whether before orafter the commencement of this Act, by the Central Government or a StateGovernment for the purpose of raising a public loan and having one of the formsspecified 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 orsell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a tejimandi, 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 beingrecognized 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 lieuof 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, contractsof the recognized stock exchange, legal proceedings by, or against, the recognizedstock exchange, whether in the name of the recognized stock exchange or anytrustee or otherwise and any permission given to, or by, the recognized stockexchange;

(iv) the transfer of employees of a recognized stock exchange to another recognizedstock exchange;

(v) any other matter required for the purpose of, or in connection with, thecorporatisation or demutualization, as the case may be, of the recognized stockexchange

h. “securities” include—

i. shares, scrips, stocks, bonds, debentures, debenture stock or other marketablesecurities of a like nature in or of any incorporated company or other bodycorporate;

(h) Government securities;

i. such other instruments as may be declared by the Central Government to besecurities; and

ii. rights or interest in securities;

NOTES



(j) “stock exchange” means—

a. any body of individuals, whether incorporated or not, constituted beforecorporatisation and demutualization under sections 4A and 4B, or

b. a body corporate incorporated under the Companies Act 1956 whether under ascheme of corporatisation and demutualization or otherwise, for the purpose ofassisting, regulating or controlling the business of buying,

4.2.2 Recognised Stock Exchanges

APPLICATION FOR RECOGNITION OF STOCK EXCHANGES

Any stock exchange, which is desirous of being recognized for the purposes of thisAct, 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 acopy of the bye-laws of the stock exchange for the regulation and control of contractsand also a copy of the rules relating in general to the constitution of the stock exchangeand in particular, to—

a. the governing body of such stock exchange, its constitution and powers ofmanagement 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, thequalifications for membership, and the exclusion, suspension, expulsion and re-admission of members there from or thereinto;

d. the procedure for the registration of partnerships as members of the stock exchangein cases where the rules provide for such membership; and the nomination andappointment of authorized representatives and clerks.

4.2.3 Grant of Recognition of Stock Exchanges

1. If the Central Government is satisfied, after making such inquiry as may be necessaryin this behalf and after obtaining such further information, if any, as it may require,—

a. that the rules and bye-laws of a stock exchange applying for registration areinconformity with such conditions as may be prescribed with a view to ensurefairdealing and to protect investors;

b. that the stock exchange is willing to comply with any other conditions (includingconditions as to the number of members) which the Central Government, afterconsultation with the governing body of the stock exchange and having regard tothe area served by the stock exchange and its standing and the nature of the securitiesdealt with by it, may impose for the purpose of carrying out the objects of this Act;and

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NOTES


c. that it would be in the interest of the trade and also in the public interest to grantrecognition to the stock exchange; it may grant recognition to the stock exchangesubject to the conditions imposed upon it as aforesaid and in such form as may beprescribed.

2. The conditions which the Central Government may prescribe under clause (a) of sub-section (1) for the grant of recognition to the stock exchanges may include, amongother matters, conditions relating to,—

i. the qualifications for membership of stock exchanges;

ii. the manner in which contracts shall be entered into and enforced as between members;

iii.the representation of the Central Government on each of the stock exchange bysuch number of persons not exceeding three as the Central Government may nominatein this behalf; and

iv.the maintenance of accounts of members and their audit by chartered accountantswhenever such audit is required by the Central Government.

3. Every grant of recognition to a stock exchange under this section shall be publishedin the Gazette of India and also in the Official Gazette of the State in which theprincipal office as of the stock exchange is situate, and such recognition shall haveeffect 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 anopportunity to the stock exchange concerned to be heard in the matter; and thereasons 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 insub-section (2) of section 3 shall be amended except with the approval of theCentral Government.


Q.4.3.a. What are securities?

Q.4.3.b. What are the conditions for granting recognition o f stock exchange?

Q.4.3.c. What is a derivative contract?

Q.4.3.d. State the reasons of setting up of SEBI

Q.4.3.e. Explain the various terms used inn stock exchange.

Q.4.3.f. Do you consider SEBI as an effective regulator of capital market?

SUMMARY

Thus the act has successfully prevented dealing of stock and shares outside the marketand any transactions outside the market as illegal.

NOTES




Even though we have 23 stock exchanges in India, a major part of the transactions iscontrolled by Bombay Stock Exchange. This has led to enormous speculation, rigging andcornering of shares by a few speculators. To prevent these malpractices by companies,brokers and merchant bankers, the government constituted Securities Exchange Board ofIndia in April 1988 for regulating and promoting the stock market in the country andeffective from 1992.



• SEBI

• Objectives of SEBI

• Functions of SEBI

• SEBI Regulations on Merchant Bankers

• SEBI guidelines on merchant banking

5.3 SEBI

SEBI is a body corporate with head office at Bombay. The Chairman and the boardmembers are appointed by the Central government. SEBI has two major functions. Theare :

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 insider-trading, take-over bids and imposing penalties

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

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5.3.1 Objectives

1. To deal with development and regulation of stock market in India.

2. To promote fair dealings by the issue of securities and ensure a market placewhere they can raise funds.

3. To provide protection to the investors.

4. Regulate and develop a code of conduct for brokers, merchant bankers, etc.

5. To have check on preferential allotment to promoters at a very low price.

6. To prevent deviations and violations of rules prescribed by stock exchange.

7. To verify listing requirements, listing procedures, and ensure compliance of thesame by the companies, so that only financially sound companies are listed.

8. To prescribe required standards for merchant bankers.

9. The promote healthy growth of security market for the development of capitalmarket in the country.

5.3.2 Powers of Sebi

As per the Act, SEBI has powers

a. To file complaints in a court

b. To regulate companies in the issue and transfer of shares including bonus andrights shares.

c. It can levy penalties on companies and on brokers for violating transactions.

d. Power to summon any broker or intermediaries and call for documents.

e. It can issue directions to all brokers for protecting the interests of investors.

In addition to the above powers

a. it can call for periodical returns from stock exchange.

b. seek any information from stock exchange.

c. It can enquire into the functioning of stock exchange.

d. It can grant permission for the change of bye-laws of any stock exchange.

e. It can compel listing of securities of public company.

f. It can control and regulate stock exchanges.

g. Granting registration to market intermediaries, prohibit inside-trading and prohibitfraudulent and unfair trade practices.

h. Promoting investor-education, and trading of intermediaries in capital market.

i. Regulating purchase of shares and take-over of companies.

NOTES



5.3.3 SEBI Regulations on merchant bankers

SEBI has brought about a effective regulative measures for the purpose of discipliningthe functioning of the merchant bankers in India. The objective is to ensure an era ofregulated financial markets and thus streamline the development of the capital market inIndia. The measures were introduced by the SEBI in the year 1992. The measures wererevised by SEBI in 1997. The salient features of the regulative framework of merchantbanking in India are discussed below.

5.3.3.1 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 inForm A. The application shall be made for any one of the following categories of themerchant banker namely:

1. Category I- To carry on any activity of the issue management, which will inter-alia consist of preparation of prospectus and other information relating to the issue,determining financial structure, tie-up of financiers and final allotment and refund ofthe subscription; and to act as adviser, consultant, manager, underwriter, portfoliomanager.

2. Category II- To act as adviser, consultant, co-manager, underwriter, portfoliomanager.

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 carryingon the activities mentioned in category I. An applicant can carry on the activity asunderwriter only if he contains separate certificate of registration under the provisionsof Securities and Exchange Board of India (Underwriters) Regulations, 1993, andas portfolio manager only if he obtains separate certificate of registration under theprovisions of Securities and Exchange Board of India (Portfolio Manager)Regulations, 1993.

Conformance to Requirements

Subject to the provisions of the regulations, any application, which not complete in allrespects 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 opportunityto remove within the time specified such objections and may be indicated by the board.

Furnishing of Information

The Board may require the applicant to furnish further information or clarificationregarding matter relevant to the activity of a merchant banker for the purpose of disposalof the application. The applicant or its principal officer shall, if so required, appear beforethe Board for personal representation.

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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 whetherthe applicant complies with the following requirements;

1. That the applicant shall be a body corporate other than a non-banking financialcompany as defined by the Reserve Bank of India Act, 1934.

2. That the merchant banker who has been granted registration by the Reserve Bankof India to act as Primary or Satellite Dealer may carry on such activity subject tothe 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.

4. That the applicant has in his employment minimum of two persons who have theexperience to conduct the business of the merchant banker.

5. That a person (any person being an associate, subsidiary, inter-connected or groupCompany of the applicant in case of the applicant being a body corporate) directlyor indirectly connected with the applicant has not been granted registration by theBoard.

6. That the applicant fulfils the capital adequacy as specified.

7. That the applicant, his partner, director or principal officer is not involved in anylitigation connected with the securities market which has an adverse bearing on thebusiness of the applicant.

8. That the applicant, his director, partner or principal officer has not at any time beenconvicted for any offence involving moral turpitude or has been found guilt of anyeconomic offence.

9. That the applicant has the professional qualification from an institution recognizedby 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.

Capital Adequacy Requirement

According to the regulations, the capital adequacy requirement shall not be less thanthe net worth of the person making the application for grant of registration. For this purpose,the net wroth 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

NOTES



For the purpose of this regulation ‘net worth” means in the case of an applicant whichis a partnership firm or a body corporate, the value of the capital contributed to the businessof such firm or the paid up capital of such body corporate plus free reserves as the casemay be at the time of making application.

Procedure for Registration

The Board on being satisfied that the applicant is eligible shall grant a certificate inForm B. On the grant of a certificate the applicant shall be liable to pay the fees in accordancewith Schedule II.

Renewal of Certificate

Three months before expiry of the period of certificate, the merchant banker, may ifhe so desired, make an application for renewal in Form A. The application for renewalshall be dealt with in the same manner as if it were a fresh application for grant of acertificate. In case of an application for renewal of certificate of registration, the provisionsof clause (a) of regulation 6 shall not be applicable up to June 30th , 1998. The Board onbeing satisfied that the applicant is eligible for renewal of certificate shall grant a certificatein form B and send intimation to the applicant. On the grant of a certificate the applicantshall 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 underregulation 9, does not satisfy the criteria set out in regulation 6, the Board may reject theapplication after giving an opportunity of being heard. The refusal to grant registration shallbe communicated by the Board within thirty days of such refusal to the applicant statingtherein 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 intimationto the Board for reconsideration for its decision. The Board shall reconsider an applicationmade under sub-regulation (3) and communicate its decision as soon as possible in writingto the applicant.

Effect of Refusal to Grant Certificate

Any merchant banker whose application for a certificate has been refused by theBoard 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.

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Payment of Fees

Every applicant eligible for grant of a certificate shall pay such fees in such mannerand within the period specified in Schedule II. Where a merchant banker fails to anyannual fees as provided in sub-regulation (1), read with Schedule II, the Board may suspendthe registration certificate, whereupon the merchant banker shall cease to carry on anyactivity as a merchant banker for the period during which the suspension subsists.

GENERAL OBLIGATIONS

The 1992 regulations have enunciated the following general obligations andresponsibilities for the merchant bankers.

Sole Function

Every merchant banker shall abide by the Code of Conduct as specified in ScheduleIII. They are as follows

1. Merchant Banker not to associate with any business other that that of the securitiesmarket.

2. No merchant banker, other than a bank or a public financial institution, who hasbeen granted certificate of registration under these regulations, shall after June30th, 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 Securitiesand exchange board of India (Merchant Bankers) Amendment Regulations, 1997, hasentered into a contract in respect of a business other that that of the securities market may,f he so desires, discharge his obligations under such contract. Similarly, a merchant bankerwho has been granted certificate of registration to act as primary or satellite dealer by theReserve Bank of India may carry on such business as may be permitted by Reserve Bankof 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 ofaccounts, record and documents are maintained. Every merchant banker shall, after theend of each accounting period furnish to the Board copies of the Balance sheet, profit andloss account and such other documents for any other preceding five accounting yearswhen required by the Board.

NOTES



Submission of Half-yearly Results

Every merchant banker shall furnish to the Board half-yearly unaudited financial resultswhen required by the Board with a view to monitor the capital adequacy of the merchantbanker.

Preservation of Books of Account, Records, etc.,

The merchant banker shall preserve the books of accounts and other records anddocuments 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’ reporttake 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 leadmerchant banker. In an issue of offer of rights to the existing members with or without theright of renunciation, the amount of the issue of the body corporate does not exceedrupees fifty lakhs, the appointment of a lead merchant banker shall not be essential. Everylead merchant banker shall before taking up the assignment relating to an issue enter intoan agreement with such body corporate setting out their mutual right, liabilities andobligations 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 thefollowing:

Responsibilities of Lead Managers

No lead manager shall agree to manage or be associated with any issue unless hisresponsibilities 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

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NOTES


clearly defined, allocated and determined and a statement specifying such responsibilitiesis furnished to the Board at least one month before the opening of the issue for subscription.Where there are more than one lead merchant bankers to the issue the responsibilities ofeach of such lead merchant banker shall clearly be demarcated and a statement specifyingsuch responsibilities shall be furnished to the Board at least one month before the openingof the issue for subscription.

No lead merchant banker shall, agree to manage the issue made by any body corporate,if such body corporate is an associate of the lead merchant banker. A lead merchantbanker shall not be associated with any issue if a merchant banker who is not holding acertificate is associated with the issue.

Underwriting Obligations

In respect of every issue to be managed, the lead merchant banker holding a certificateunder Category I shall accept a minimum Underwriting obligation of five percent of thetotal underwriting commitment or rupees twenty-five lakhs whichever is less. If the leadmerchant banker is unable to accept the minimum underwriting obligation, that lead merchantbanker shall make arrangement for having the issue underwritten to that extent by a merchantbanker 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 aprospectus or the Letter of Offer in respect of an issue and the reasonableness of the viewsexpressed therein, shall submit to the Board at least two weeks prior to the opening of theissue for subscription, a due diligence certificate in Form C.

Documents to be furnished to the Board

The lead manager responsible for the issue shall furnish to the Board, the followingdocuments

1. Particulars of the issue;

2. Draft prospectus or where there is an offer to the existing shareholders, the draftletter of offer;

3. Any other literature intended to be circulated to the investors, including theshareholders; 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 thedraft prospectus or the letter of the offer, as the case may be, with the Registrar of Companiesor with the Regional Stock Exchanges or with both. The lead manager shall ensure that themodifications and suggestions, if any, made by the Board on the draft prospectus or the

NOTES



Letter of Offer as the case may be, with respect to information to be given to the investorsare incorporated therein.

Payment of fees to the Board

The draft prospectus or draft letter of offer referred to in regulation 24 shall be submittedalong with such fees and in such manner as may be specified in Schedule IV.

Continuance of Association of Lead Manager

The lead manager undertaking the responsibility for refunds or allotment of securitiesin respect of any issue shall continue to be associated with the issues till the subscriber havereceived the share or debenture certificates or refund of excess application money. Wherea person other than the lead manager is entrusted with the refund or allot of securities inrespect of any issue the lead manager shall continue to be responsible for ensuring thatsuch other person discharges the requisite responsibilities in accordance with the provisionsof the Companies Act and the listing agreement entered into but the body corporate withthe stock Exchange.

Acquisition of shares Prohibited

No merchant banker or any of its directors, partner manager or principal shall eitheron their respective accounts or through their associates or relative enter into transaction insecurities of bodies corporate on the basis of unpublished price sensitive information obtainedby 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 anytransaction for acquisition of securities of any body corporate whose issue is being managedby 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 followinginformation:

1. His responsibilities with regard to the management of the issue; Any change in theinformation o particulars previously furnished, which have a bearing on the certificategranted to it;

2. The names of the body corporate whose issues he has managed or has beenass0oiciated with;

3. The particulars relating to breach of the capital adequacy requirement as specifiedin regulation 7;

4. Relating to his activities as a manager, underwriter, consultant or adviser to anissue as the case may be.

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Appointment of Compliance Officer

Every merchant banker shall appoint a compliance officer who shall be responsiblefor monitoring the compliance of the Act, rules and regulations notifications, guidelines,instructions etc., issued by the board or the Central Government and for redressed ofinvestors’ grievances. The compliance officer shall immediately and independently reportto the Board any non-compliance observed by him and ensure that the observations madeor deficiencies pointed out by the Board on/in the draft prospectus or the Letter of offer asthe case may be, do not recur.

5.3.3.2 Procedure For Inspection

Board’s Right to inspect

The Board may appoint one or more persons as inspecting authority to undertakeinspection of the books of accounts, records and documents of the merchant banker forany 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 bankersor any other person on any matter having a bearing on the activities of the merchantbanker; and

4. To investigate suo-moto in the interest of securities business or investors interest inthe affairs of the merchant banker.

Notice before inspection

Before undertaking an inspection under regulation 29 the Board shall give a reasonablenotice to the merchant banker for that purpose. Where the Board is satisfied that in theinterest of the investors no such notice should be given, it may, by an order in writingdirecting that the inspection of the affairs of the merchant banker be taken up without suchnotice. During the course of inspection, the merchant banker against whom an inspection isbeing carried out shall be bound to discharge his obligations as provided under regulation31.

Obligations of Merchant Banker on Inspection

It shall be the duty of every director, proprietor, partner, officer and employee of themerchant banker, who is being inspected, to produce to the inspecting authority suchbooks, accounts and other documents in his custody or control and furnish him with thestatements and information relating to his activities as a merchant banker within such timeas the inspecting authority may require.

NOTES



The merchant banker shall allow the inspecting authority to have reasonable accessto the premises occupied by such merchant banker or by any other person on his behalfand also extend reasonable facility for examining any books, records, documents andcomputer data in the possession of the merchant banker or any such other person and alsoprovide copies of documents or other materials which, in the opinion of the inspectingauthority are relevant for the purposes of the inspection.

The inspecting authority, in the course of inspection, shall be entitled to examine orrecord statements of any principal officer, director, partner, proprietor and employee ofthe merchant banker. It shall be the duty of every director, proprietor, partner, officer oremployee of the merchant banker to give to the inspecting authority all assistance inconnection with the inspection which the merchant banker may be reasonably expected togive.

Submission of Report to the Board

The inspecting authority shall, as soon as possible submit, an inspection report to theBoard.

Action on Inspection or Investigation Report

The Board of the Chairman shall after consideration of inspection or investigationreport take such action and the board or chairman may deem fit and appropriate includingaction under the Securities and Exchange Board of India (Procedure for Holding Enquiryby Enquiry Officer and imposing Penalty) Regulations, 2002.

Appointment of Auditor

The Board may appoint a qualified auditor to investigate into the books of account orthe affairs of the merchant banker. The auditor so appointed shall have the same powers ofthe inspecting authority as are mentioned in regulation 29 and the obligations of the merchantbanker in regulation 31 shall be applicable to the investigations under this regulation.

Communication of findings

The Board shall after consideration of the inspection report communicate the findingsto the merchant banker to give him an opportunity of being heard before any action istaken by the Board on the findings of the inspecting authority. On receipt of the explanationif any, from the merchant banker, the Board may call upon the merchant banker to takesuch measures as the Board may deem fit in the interest of the securities market and fordue compliance with provisions of the Act, rules and regulations.

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5.3.3.3 Procedure For Action Incase Of Default

Liability for Action in case of Default

A merchant banker who fails to comply with any conditions subject to which certificatehas been granted, and contravenes any of the provisions of the Act rules or regulationsshall be dealt with in the manner provided under the Securities and Exchange Board ofIndia (Procedure for Holding Enquiry by Enquiry Officer and imposing Penalty) Regulations,2002.

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 underthe 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 activityas merchant banker as required by the Board; or furnishes wrong or falseinformation, or does not submit periodical returns as required by the Board; ordoes not co-operate in any enquiry conducted by the Board ; or

• Where the merchant banker fails to resolve the complaints of the investors or failsto give a satisfactory reply to the Board in this behalf; or

• Where the merchant banker indulges in manipulation or price rigging or corneringactivities; or

• Where the merchant banker is guilty of misconduct or improper or unbusiness likeor unprofessional conduct which is not in accordance with the Code of Conductspecified in Schedule III; or

• Where the merchant banker fails to maintain the capital adequacy requirement inaccordance 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 theregulation.

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 corneringactivities affecting the securities market and the investors interest;

NOTES



• The financial position of the merchant banker deteriorates to such an extent thatthe Board is of the opinion that his continuance as merchant banker is not in theinterest of investors;

• The merchant banker is guilty of fraud, or is convicted of a criminal offence;

• In case of repeated defaults of the nature mentioned in regulation 36 provided thatthe 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 imposedexcept 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 anenquiry officer. The enquiry officer shall issue to the merchant banker a notice the registeredoffice 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 evidencerelied on by him or sought by the Board from the merchant banker.

The enquiry officer shall, give a reasonable opportunity or hearing to the merchantbanker to enable him to make submissions in support of his reply made under sub-regulation(3). The merchant banker may either appear in person or through any duly authorizedperson. No lawyer or advocate shall be permitted to represent the merchant banker at theenquiry. Where a lawyer or an advocate has been appointed by the Board as a presentingofficer under sub-regulation (6), it shall be lawful for the merchant banker to present itscase through a lawyer or advocate.

It is considered necessary that the enquiry officer may ask the Board to appoint apresenting officer to present its case. The enquiry officer shall, after taking into account allrelevant facts and submissions made by the merchant banker, submit a report the Boardand recommend the penalty to be imposed as also the grounds on the basis of whichproposed penalty is justified.

Show case Notice and Order

On receipt of the report from the enquiry officer, the Board shall consider the sameand issue a show-cause notice as to why the penalty as proposed by the enquiry officershould not be imposed. The merchant banker shall within twenty-one days of the date ofthe 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 assoon as possible or not later than thirty days from the receipt of the reply, if any, pass such

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order as it deems fit. Every order passed under sub-regulation (3) shall be self-containedand give reasons for the conclusions stated therein including justification of the penaltyimposed by that order. The Board shall send a copy of the order under sub-regulation (3)to the merchant banker.

Effect of Suspension and Cancellation

On and from the date of the suspension of their merchant banker he shall cease tocarry on any activity as a merchant banker during the period of suspension. On and fromthe date of cancellation the merchant banker shall with immediate effect cease to carry onany activity as a merchant banker. The order of suspension or cancellation of certificatepassed under sub-regulation (3) of regulation 40 shall be published in at least two dailynewspapers by the Board.

Appeal to the Securities Appellate Tribunal

Any person aggrieved by an order of the board may, on and after the commencementof the /securities Laws (second amendment) Act, 1999, under these regulations may preferan appeal to a Securities Appellate Tribunal having jurisdiction in the matter.

Fees

Every merchant banker shall pay a sum of Rupees five lacs as registration fees at thetime of the grant of certificate by the Board. The fee shall be paid by the merchant a bankerwithin 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 payrenewal fee of Rs.2.5 lacs every three years from the fourth year from the date of initialregistration. The fee shall be paid by the merchant banker within fifteen days from the dateof 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 favourof ‘securities and Exchange Board of India’ payable at Mumbai or at the respective regionaloffice.

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 forthe first two years commencing from the date of initial registration and thereafterfor 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 lakhs to be paid annually forthe first two years commencing from the date of initial registration and thereafterfor 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 forthe first two years commencing from the date of initial registration and thereafterfor the third year a sum of Rs.25,000 to keep his registration in force.

NOTES



4. Category IV merchant bankers ; A sum of Rs.5,000/- to be paid annually forthe first two years commencing from the date of initial registration and thereafterfor the third year a sum of Rs.1000/- to keep his registration in force.

Renewal Fees :

1. Category I merchant bankers : A sum of Rs.1 lakh to be paid annually for thefirst two years commencing from the date of each renewal and thereafter for thethird 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 forthe first two years commencing from the date of each renewal and thereafter forthe 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 forthe first two years commencing from the date of each renewal and thereafter forthe 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 forthe first two years commencing from the date of each renewal and thereafter forthe 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 100 crores and up to 500 crores 2,50,000

More than 500 crores 5,00,000

IV. CODE OF CONDUCT FOR MERCHANT BANKERS

The SEBI regulations have outlined the following code of conduct for the merchantbankers operation in India ;

• A merchant banker shall make all efforts to protect the interests of investors.

• A Merchant Banker shall maintain high standards of integrity, dignity and fairnessin the conduct of its business.

• A Merchant Banker shall fulfill its obligations in a prompt, ethical, and professionalmanner.

• A Merchant Banker shall at all times exercise due diligence, ensure proper careand exercise independent professional judgment.

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• A Merchant Banker shall Endeavour to ensure that enquiries from the investorsare adequately dealt with, grievances of investors are redressed in a timely andappropriate manner, where a complaint is not remedied promptly, the investor isadvised of any further steps which may be available to the investor under theregulatory system.

• A Merchant Banker shall ensure that adequate disclosures are made to theinvestors in a timely manner in accordance with the applicable regulations andguidelines so as to enable them to make a balanced and informed decision.

• A Merchant Banker shall endeavour to ensure that the investors are provided withtrue and adequate information without making any misleading or exaggeratedclaims or any misrepresentation and are made aware of the attendant risks beforetaking any investment decision.

• A Merchant Banker shall endeavour to ensure that copies of the prospectus,offer document, letter of offer or any other related literature is made available tothe investors at the time of issue of the offer.

• A Merchant Banker shall not discriminate amongst its clients, save and excepton ethical and commercial considerations.

• A Merchant Banker shall not make any statement, either oral or written, whichwould misrepresent the services that the Merchant Banker is capable ofperforming for any client or has rendered to any client.

• A Merchant Banker shall avoid conflict of interest and make adequate disclosureof its interest.

• A Merchant Banker shall put in place a mechanism to resolve any conflict ofinterest situation that may arise in the conduct of its business or where any conflictof interest arises, shall take reasonable steps to resolve the same in an equitablemanner.

• Merchant Banker shall make appropriate disclosure to the client of its possiblesource or potential areas of conflict of duties and interest while acting as MerchantBanker which would impair its ability to render fair, objective and unbiased services.

• A Merchant Banker shall always endeavour to render the best possible advice tothe clients having regard to their needs.

• A Merchant Banker shall not divulge to anybody either oral or in writing, directlyor indirectly, any confidential information about its clients which has come to itsknowledge, without taking prior permission of its client, except where suchdisclosures are required to be made in compliance with any law for the time beingin force.

• A Merchant Banker shall ensure that any change in registration status/any penalaction taken by the Board or any material change in the Merchant Banker’s financialstatus, which may adversely affect the interests of clients/investors is promptlyinformed to the clients and any business remaining outstanding is transferred toanother registered intermediary in accordance with any instructions of the affectedclients.

NOTES



• A Merchant Banker shall not indulge in any unfair competition, such asweaning away the clients on assurance of higher premium or advantageous offerprice or which is likely to harm the interests of other Merchant Bankers or investorsor is likely to place such other Merchant Bankers in a disadvantageous positionwhile competing for or executing any assignment.

• A Merchant Banker shall maintain arms length relationship between itsmerchant banking activity and any other activity.

• A Merchant Banker shall have internal control procedures and financial andoperational capabilities which can be reasonably expected to protect its operations,its clients, investors and other registered entities from financial loss arising fromtheft, fraud, and other dishonest acts, professional misconduct or omissions.

• A Merchant Banker shall not make untrue statement or suppress any materialfact in any documents, reports or information furnished to the Board.

• A Merchant Bankers shall maintain an appropriate level of knowledge andcompetence and abide by the provisions of the Act, regulations made there under,circulars and guidance, which may be applicable and relevant to the activities carriedon by it. The merchant banker shall also comply with the award of the Ombudsmanpassed under Securities and Exchange Board of India (Ombudsman) Regulations,2003.

• A Merchant Banker shall ensure that the Board is promptly informed about anyaction, legal proceedings etc., initiated against it in respect of material breach ornon-compliance by it, of any law, rules, regulations, directions of the Board or ofany other regulatory body.

• 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, whetherreal-time , unless a disclosure of his interest including a long or short position, inthe said security has been made, while rendering such advice. In the event of anemployee of the Merchant Banker rendering such advice, the merchant bankershall 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 saidsecurity, while rendering such advice.

• A Merchant Banker shall demarcate the responsibilities of the variousintermediaries appointed by it clearly so as to avoid any conflict or confusion intheir job description.

• A Merchant Banker shall provide adequate freedom and powers to its complianceofficer for the effective discharge of the compliance officer’s duties.

• A Merchant Banker shall develop its own internal code of conduct for governingits internal operations and laying down its standards of appropriate conduct for itsemployees and officers in carrying out their duties. Such a code may extend to themaintenance of professional excellence and standards, integrity, confidentiality,objectivity, avoidance or resolution of conflict of interests, disclosure ofshareholdings and interests etc.

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• A Merchant Banker shall ensure that good corporate policies and corporategovernance are in place.

• A Merchant Banker shall ensure that any person it employs or appoints to conductbusiness is fit and proper and otherwise qualified to act in the capacity soemployed or appointed

• A Merchant Banker shall ensure that it has adequate resources to supervisediligently and does supervise diligently persons employed if appointed by it in theconduct of its business, in respect of dealings in securities market.

• A Merchant Banker shall be responsible for the acts or omissions of itsemployees and agents in respect of the conduct of its business.

• A Merchant Banker shall ensure that the senior management, particularly decisionmakers have access to all relevant information about the business on a timelybasis.

• A Merchant Banker shall not be a party to or instrumental for creation of falsemarket; price rigging or manipulation; or passing of unpublished price sensitiveinformation in respect of securities which are listed and proposed to be listed inany stock exchange to any person or intermediary in the securities market.

5.3.4 Sebi Guidelines

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 croresshall be filed by lead merchant bankers with the concerned regional office of the Boardunder the jurisdiction of which the registered office of the issuer company falls. Thejurisdiction of regional offices/head office shall be as per Schedule XXII. According toClause 5.6 of Chapter V of the Guidelines, the draft offer document filed with the Boardshall be made public.

The lead merchant banker shall make available 10 copies of the draft offer documentto the Board and 25 copies to the stock exchange(s) where the issue is proposed to belisted. Copies of the draft offer document shall be made available to the public by the leadmerchant bankers/Stock Exchange. The lead merchant banker and the Stock Ex change(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 ona computer floppy in the format specified in Schedule XXIII. The Lead Merchant Bankershall submit two copies of the printed copy of the final offer document to dealing offices ofthe Board within three days of filing offer document with Registrar of companies/concernedStock Exchange(s) as the case may be. “The lead merchant banker shall submit oneprinted copy of the final offer document to the Primary Market Department, SEBI, Head

NOTES



Office, “within three days of filing the offer document with Registrar of Companies/concernedStock Exchange(s) as the case may be.” The lead merchant banker shall submit a computerfloppy 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 finalprospects/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 thatthe contents of the floppy are in HTML, format, and are identical to the printed version ofthe 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

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 companyis associated with securities-related business and registered with SEBI

j. If any one or more of these persons/entities are registered with SEBI, theirrespective 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 berejected. Lead merchant bankers shall obtain similar information from other intermediariesto ensure that they comply with these guidelines and are eligible to be associated with theconcerned issue. The intermediaries shall also indicate in their letters that they have obtainedsuch information from other intermediaries.

2. Dispatch of issue material : Lead merchant bankers shall ensure that wheneverthere is a reservation for NRIs, 10 copies of the prospectus together with 1000 applicationforms are dispatched in advance of the issue opening date, directly along with a letter

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addressed in person to Adviser (NRI), Indian Investment Centre, Jeevan Vihar BuildingSansad Marg, New Delhi. Twenty copies of the prospectus and application forms shall bedispatched in advance of the issue opening date to the various Investors Associations.

3. Underwriting

While selecting underwriters and finalizing underwriting arrangement, lead merchantbankers shall ensure that the underwriters do not overexpose themselves so that it becomesdifficult 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 thelead merchant banker. OTC Dealers registered with the Board under SEBI (Stock Brokersand Sub-Brokers) Rules and Regulations, 1992 shall be treated at par with the brokers ofother stock exchanges in respect of underwriting arrangement.

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 theseGuidelines, in case of over-subscription in public issues, a Board nominated publicrepresentative shall be associated in the process of finalization of the basis of allotment.The lead merchant banker shall intimated to the person so nominated the date, time, venueetc. regarding the process of finalization of the basis of allotment.

The expenses of the public representatives associated in the allotment process ofoversubscribed issues shall be borne by the lead merchant bankers, and recovered fromthe issues. Honorarium at a minimum of Rs.500/- per day, plus normal conveyance chargesshall be paid to them, and the Board’s Regional Managers at New Delhi, Chennai andCalcutta shall be associated with them.

b. Redressal of investor grievances

The merchant bankers shall assign high priority to investor grievances, and take allpreventive steps to minimize the number of complaints. The lead merchant banker shall setup a proper grievance monitoring and redressal system in co-ordination with the issuersand the Registrars to Issue.. They shall take all necessary measures to resolve the grievancesquickly. They shall actively associate with post-issue refund and allotment activities andregularly monitor investor grievances arising there from.

c. Submission of post issue monitoring reports

The concerned lead merchant banker shall submit, in duplicate, the Post IssueMonitoring Reports specified in Clause 7.2 of Chapter VII of these Guidelines, within 3working days from the due dates, either by registered post or deliver them at the respectiveregional offices/head office give in Schedule XXII. Where the offer documents have been

NOTES



dealt with by any of the regional offices of the Board, a copy of the report shall be sent tothe Board’s Head office, Mumbai. The Lead Merchant Banker(s) shall inform the Boardon important developments about the particular issues being lead managed by them duringthe period intervening the reports.

d. Issue of No objection Certificate (NOC)

In accordance with the Listing Agreement of the Stock Exchanges, the issuer companiesshall deposit 1% of the amount of securities offered to the public and/or to the holders ofthe 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 anNOC from the Board. An application for NOC shall be submitted by the issue companyto the Board in the format specified in Schedule XXIV.

The following conditions shall be complied with before submitting the application forthe issue of NOC.

• Completion of 4 months from the date of obtaining the listing permission from theconcerned Regional Stock Exchange, or the last date when the listing permissionwas obtained from any of the other Stock Exchanges, where the securities areproposed 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 effectthat underwriting/brokerage commission as well as the Registrars/Lead merchantbankers fees been duly paid by the company

Application for issue of NOC shall be filed with the concerned regional office of theBoard , under the jurisdiction in which the registered office of the issuer company falls, asspecified in Schedule XXII..

In cases where issues fail, and the investors’ monies are fully refunded, an NOC fromthe Board may not be required, and the concerned regional Stock Exchange can refundthe 1% security deposit after duly verifying that the refund orders have actually beendispatched.

The complaints with respect to non-receipt of underwriting/brokerage commissionand Registrars/Lead merchant banker’s fees may be filed with the concerned regionalStock Exchanges. Responses to complaints forwarded by the Board to the concernedcompanies shall be submitted to the Board in the proforma specified in Schedule XXV forupdation of records.

e. Registration of merchant bankers

Application for renewal of Certificate of Registration shall be made by the merchantbankers according to Regulation 9 of SEBI (Merchant Bankers) Rules and Regulations,

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1992. While filing the renewal application for the certificate of registration as merchantbanker, it shall provide a statement highlighting the changes that have taken place in theinformation that was submitted to the Board for the earlier registration, and a declarationstating that no other changes besides those mentioned in the above statement have takenplace.

Merchant Bankers, while forwarding the renewal application in Form A of the SEBI(Merchant Bankers) Rules and Regulations, 1992, shall also forward the additionalinformation as specified in Schedule XXVI. Registered Merchant Bankers shall informthe 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 merchantbankers shall send a half yearly report, in the format specified in Schedule XXVII, relatingto their merchant banking activities. The report referred to in sub-clause (a) shall besubmitted twice a year, on March 31 and September 30, and it should reach the Boardwithin 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 theprovisions for operational guidelines. The merchant banker, on whom penalty points offour or more has been imposed, may be restrained from filing any offer document orassociating or managing any issues for a particular period.

The Board may initiate action under the SEBI (Merchant Bankers) Regulations againstthe 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 themerchant banker under the SEBI (Merchant Bankers) Regulations.

Guidelines on Advertisement

Following are the guidelines applicable le to the lead merchant banker who shallensure due compliance by the issuer company :

1. Factual and truthful

An issue advertisement shall be truthful, fair and clear, and shall not contain anystatement that is untrue or misleading. Any advertisement reproducing, or purporting toreproduce, any information contained in an offer document shall reproduce such informationin full and disclose all relevant facts. It should not be restricted to select extracts relating tothat item. An issue advertisement shall be considered to be misleading, if it contains :

NOTES



a. Statements made about the performance or activities of the company in the absenceof necessary explanatory or qualifying statements, which may give an exaggeratedpicture of the performance or activities.

b. An inaccurate portrayal of past performance, or its portrayal in a manner whichimplies 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 ofexcessive details, which may distract the investor, shall be avoided.

3. Promise or profits

An issue advertisement shall not contain statements which promise or guarantee rapidincrease in profits. An issue advertisement shall not contain any information that is notcontained in the offer document.

4. Mode of advertising

No models, celebrities, fictional characters, landmarks, caricatures or the likes shallbe displayed on or form part of the offer documents or issue advertisements. Issueadvertisements shall not appear in the form of crawlers (the advertisements which runsimultaneously with the program in a narrow strip at the bottom of the television screen) ontelevision. Similarly, no advertisement shall include any issue slogans or brand names forthe issue, except the normal commercial name of the company or commercial brand namesof its products already in use. No slogans, expletives or non-factual and unsubstantiatedtitles 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 pastthree years and shall include particulars relating to sales, gross profit, not profit, sharecapital, 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 containingdetailed information on the risk factors. The print size of highlights and risk factors in issueadvertisements shall not be less than point 7 size. It shall contain the names of issuercompany, address of its registered office, names of the main lead merchant bankers andRegistrars to the Issue. No issue advertisement shall be released without giving “RiskFactors” in respect of the concerned issue, provided that an issue opening/closingadvertisement which does not contain the highlights need not contain risk factors.

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7. Issue date

No corporate advertisement of issuer company shall be issued after 21 days of filingof the offer document with the Board until the closure of the issue, unless the risk factorswhich are required to be mentioned in the offer document, are mentioned in theadvertisement.

8. Product advertisement

No product advertisement of the company shall contain any reference, directly orindirectly, to the performance of the company during the period.

9. Subscription

No advertisement shall be issued stating that the issue has been fully subscribed oroversubscribed during the period the issue is open for subscription, except to the effectthat the issue is open or closed.

10. Issue closure

No announcement regarding closure of the issue shall be made except on the closingdate. 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 suchannouncement is made on the date on which the issued is to be closed. Announcementsregarding closure of the issue shall be made only after the lead merchant banker is satisfiedthat at least 90% of the issue has been subscribed, and a certificate has been obtained tothat 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.

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 procureapplication forms.

13. Undertaking

An undertaking has to be obtained from the issuer as part of the MoU between thelead merchant banker and the issue company to the effect that the issuer company shall notdirectly or indirectly release, during any conference or at any other time, any material orinformation which is not contained in the offer documents.

NOTES



14. Availability of copies

To ensure that the issuer company obtains approval for all issue advertisements andpublicity materials from the lead merchant banker responsible for marketing the issue andalso ensure the availability of copies of all issue related materials with the lead merchantbanker, at least until the allotment is completed.


Q.5.3.a. How ‘merchant banker’ is defined under the SEBI regulations?

Q.5.3.b. State the SEBI regulations pertaining to registration of merchant bankers.

Q.5.3.c. What are essential considerations of SEBI before the grant of certificate of registration?

Q.5.3.d. State the capital adequacy requirements prescribed for the merchant bankers by the SEBI.

Q.5.3.e. Discuss the various general obligations of merchant bankers under the SEBI regulation.

Q.5.3.f. State the disclosures to be made to the SEBI as part of general obligations of merchant bankers.

Q.5.3.g. State the procedures relating to inspection of merchant bankers carried out by the SEBI.

Q.5.3.h. State the circumstances under which SEBI would suspend the certificate of registration of a merchant banker.

Q.5.3.i. Write a note on the fees structure levied by the SEBI on the merchant bankers.

Q.5.3.j. Write a detailed note on the code of conduct prescribed for the merchant bankers by the SEBI.

SUMMARY

Currently, Merchant banking in India is considered fairly matured in terms of supply,product range and reach, even though the reach India still remains a challenge for theprivate sector and foreign banks. With the growth of Indian economy expected to bestrong for quite some time especially in its service sector, the demand for Merchant bankingservices esp. investment services are expected to be strong.

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Stock exchange is an organized market place for the investors to buy and sell securitiesfreely. The market offers perfectly competitive conditions where a large number of sellersand buyers participate. Further stock exchange provides an auction market in which membersof the exchange participate to ensure continuity of price and liquidity to investors.

An active and healthy secondary market in existing securities leads to a betterpsychology of expectations, considerably broadening the investment enquiries and thereby,rendering the task of raising resources by entrepreneurs easier.



• Stock exchanges

• The objective

• Functioning of Stock Exchanges

• The relationship between Stock Exchanges and Merchant Bankers

6.3 STOCK EXCHANGES

• It is the market for exchange of stocks.

• ‘Stocks’ refers to the old securities i.e., those which have been already issuedand listed on a stock exchange.

• These securities are purchased and sold continuously among investors withoutthe 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-quo-non for the primary market. In fact, the success of the issues taking place in the primarymarket depends much on the soundness and the depth of the secondary market. It providesthe 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 placeswhere buyers and sellers of stocks and bonds or their representatives undertake transactionsinvolving the sale of securities’.

According to Derek Koney gold, “Stock exchange can be described as the placewhere a marriage of convenience is enacted between those who wish to raise capital, such

NOTES



as companies, governments and local authorities , and those who wish to invest – largelyhouseholds through the medium of institutions acting upon their behalf”.

According to Section 2(3) of the Securities Contract Regulation Act 1956. “ Thestock exchange has been defined as any body 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, scrips, stock, bonds, debentures, debentures stocks or other marketablesecurities of a like nature in or of any incorporated company or other body corporate

b. Government securities; and

c. Rights or interests in securities

6.3.1 Objectives 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.

6.3.2 Functions of Stock Exchanges

The stock market occupies a pivotal position in the financial system. It performsseveral 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 intocash at any time according to the discretion of the investor by selling them at the listedprices. They facilitate buying and selling of securities at listed prices by providing continuousmarketability to the investors in respect of securities they hold or intend to hold. Thus, theycreate a ready outlet for dealing in securities.

2. Safety of Funds

Stock exchanges ensure safety of funds invested because they have to function understrict 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 setof 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 istransacted one investor is substituted by another.

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4. Flow of Capital to Profitable Ventures.

The profitability and popularity of companies are reflected in stock prices. The pricesquoted indicate the relative profitability and performance of companies. Funds tend to beattracted towards securities of profitable companies and this facilitates the flow of capitalinto 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 forthis price quotation for those securities listed by it. This public exposure makes a companyconscious of its status in the market and it acts as a motivation to improve its performancefurther.

6. Promotion of Investment

Stock exchanges mobilize the savings of the public and promote investment throughcapital formation. But for these stock exchanges, surplus funds available with individualsand 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 thestock exchanges. Booms and depressions cane be identified through the dealings on thestock 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 concernedso 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, listingpresupposes their evaluation by concerned stock exchange authorities. Costs of underwritingsuch 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 andyields. It enables the investors to diversity their risks by a wider portfolio of investment. Italso 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 listedsecurities and by disclosing the trends of dealings on the stock exchange. It enablescompanies and the Government to raise resources by providing a ready market for theirsecurities.

NOTES



6.3.3 Organisation of Stock Exchanges

The first organized stock exchange in India was started in Bombay in 1875 with theformation of the ‘Native share and Stock Brokers Association’. Thus the Bombay StockExchange is the oldest one in the country. With the growth of Joint stock companies, thestock exchanges also made a steady growth and at present these are 23 recognized stockexchanges with about 6000 stock brokers.

Traditional Structure of stock Exchanges

The stock exchanges in India can be classified into two broad groups on the basis oftheir 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 byguarantees 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

Demutualization of Stock Exchanges

• The transition process of an exchange from a “mutually-owned” associationto a company “owned by Shareholders” is called demutualization.

• Demutualization is transforming the legal structure, of an exchange from amutual form to a business corporation form.

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In a mutual exchange, the three functions of ownership, management and trading areintervened into a single group. It means that the broker members of the exchange areowners as well as traders on the exchange and further they themselves manage the exchange.These three functions are segregated from one another after demutualization. Thedemutualised stock exchanges in India are;

1. The National Stock Exchange (NSE)

2. Over the Counter Exchange of India (OTCEI)

Corporatisation of Stock Exchanges

The process of converting the organizational structure of the stock exchange from anon-corporate structure to a corporate structure is called Corporatisation of stock exchanges.As stated earlier, some of the stock exchanges were established as “Association of persons”in India like BSE, ASE and MPSE. Corporatisation of these exchanges is the process ofconverting then into incorporated companies.

Management

The recognized stock exchanges are managed by “ Governing Boards’. The governingboards consist of elected member directors from stock broker members, publicrepresentatives and government nominees nominated by the SEBI. The government hasalso powers to nominate Presidents and Vice-presidents of stock exchanges and to approvethe appointment of the chief Executive and public representatives. The major stock exchangesare managed by the Chief Executive Director and the smaller stock exchanges are underthe control of a Secretary.

Membership

To become a member of a recognized stock exchange, a person must possess thefollowing 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 adefaulter by any other stock exchange.

6.3.4 Methods of Trading in a Stock Exchange

The stock exchange operation at follow level is highly technical in nature. Non-members are not permitted to enter into the stock market. Hence, various stages have tobe completed in executing a transaction at a stock exchange. The steps involved in themethods of trading have been given below:

NOTES



(1) Choice of Broker

The prospective investor who wants to buy shares or the investor who wants to sellhis shares cannot enter into the hall of exchange and transact business. They have to actthrough 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 ora banker. Such persons alone can ensure prompt and quick execution of a transaction atthe best possible and profitable price.

(2) Placement of Order

Placement of order refers to the purchase or sale of securities with the broker. Theorder 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 theirbusiness personally. Orders are executed in Trading ring of a stock exchange which worksfrom 12 noon to 2 p.m. on all working days from Monday to Friday and a special one hoursession on Saturday. Trading outside the trading hours is called ‘kerb dealings”.

(4) Preparation of Contract Notes

A contract note is a written agreement between the broker and his client for thetransactions executed. It contains the details of the contract made for the purchase/sale ofsecurities, 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 theclient.

(5) Settlement of Transactions

The settlement of transactions is made by means of delivering the share certificatesalong with the transfer deed. The transfer deed is duly signed by the transferor, i.e., theseller. It bears the stamp of the selling broker. The buyer then fills up the particulars in thetransfer deed. 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 theseare affected on the date of the contract itself or on the next day.

• Hand Delivery Settlement: i.e., the delivery of securities and payment areaffected within the time stipulated in the agreement or within 14 days from the dateof the contract whichever is earlier.

• Clearing Settlement: i.e., the transactions are cleared and settled through theclearing house. Usually those securities which are frequently traded and are usuallyin demand are cleared through the clearing house. These transactions are alsoreferred to as the transaction for the “account”.

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• Special Delivery Settlement: i.e., the delivery of securities and payment maytake place at any time exceeding 14 days following the date of the contract asspecified in the contract and permitted by the governing board.

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 traditionalmethod and the limits on trading volumes the NSE has introduced a nation-wide on linefully automated Screen Based Trading System (SBTS). Now, other stock exchanges havebeen forced to adopt SBTS and today India can boast that almost 100% trading takeplace through electronic order matching.

Under SBTS, a member can punch into the computers quantities of securities and theprices at which he likes to transact the transaction. It is executed as soon as it finds amatching sale or buy order from a counter party; Thus, technology is used to carry thetrading platform from the trading hall of the exchanges to the premises of the brokers. NSEhas carried the trading platform further to the PCs at the residence of the investors throughthe internet and the hand held devices through WAP for the convenience of the mobileinvestors.

This system also provides complete market information on-line. The market screens at anypoint 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

(4) the high and the low price for each security

(5) the last traded price for a security etc.,

BSE BOLT SYSTEM, BOLT (Bombay on line Trading) has been introduced in theBombay Stock Exchange. All the scrips are being traded through BOLT.


Q.6.3.a. What is a stock exchange ? What are its features?

Q.6.3.b. Define stock exchange, Trace its history.

Q.6.3.c. What are the functions of a stock exchange?

Q.6.3.d. Give an account of stock exchanges around the world.

Q.6.3.e. What is NASDAQ system?

Q.6.3.f. Discuss the working of Indian stock exchanges.

Q.6.3.g. Trace the origin and the growth of stock exchange system in India.

NOTES



Q.6.3.h. State the organization structure of stock exchanges in India.

Q.6.3.i. Identify the major tasks of governing body of a stock exchange.

Q.6.3.j. How are stock exchanges organized in India?:

Q.6.3.k. Discuss the membership aspects of a stock exchange.

Q.6.3.l. Who are stock exchange traders? Categorize them.

Q.6.3.m. What are the weaknesses of Indian stock exchanges?

Q.6.3.n. How are stock exchanges in Indian regulated?

Q.6.3.o. Write a note on the departments of a stock exchange.

Q.6.3.p. Explain the various steps involved in trading on a stock exchange.

Q.6.3.q. Explain the mechanics of Stock Trading.

Q.6.3.r. What is ‘auction trading system’? How does it work?

Q.6.3.s. What is ‘dealer trading system’? How does it work?

Q.6.3.t. State the recent developments in the realm of stock exchanges in India.

Q.6.3.u. What is ‘over-the-counter’ market system?

Q.6.3.v. Trace the background of the interconnected Stock Exchange of India Limited.

SUMMARY

Beyond these the National Stock Exchange was set up to serve as a model exchangeproviding nationwide screen based trading and electronic clearing and settlement systems.Stock Holding Corporation of India was incorporated in 1987 to act as a central depositoryin the country offering post trading and custodial services to institutional investors.

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Many small companies in India re finding it difficult to raise adequate capital throughstock exchanges as the conditions stipulated by them could not be fulfilled. The companiesmust have run for minimum three years and they must have earned profit and the minimumcapital 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 companiesin India will be able to raise sufficient capital, Once these companies enlarge their resources,they can list themselves in the regular stock exchanges.



• OTCEI

• Objectives of OTCEI

• Benefits of OTCEI

7.3 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 takingplace through computer operations. Thus, the development in information technology hasgiven scope for starting this type of stock exchange. This stock exchange is recognizedunder the Securities Contract ( Regulation) Act and so all the stocks listed in this exchangeenjoy the same benefits as other listed securities enjoy.

OTCEI has been incorporated under Section 25 of the companies Act. As a result ofwhich the word ‘Limited’ need not be used since it is promoted for a common case ofpromoting the interest of small and medium companies. This privilege has been given to thecompany by the Central government.

This company was promoted by a group of financial institutions owned by Governmentof India, consisting of UTI, ICICI, IDBI, SBI Capital Market , IFCI, LIC, GIC andCAN BANK financial Services.

NOTES



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 exchangeswill not be listed in the OTCEI and similarly, stock listed in OTCEI will not belisted in other stock exchanges.

(3) Minimum issued capital requirements: Minimum issued equity capital shouldbe 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 sharecapital of more than Rs.25 crores is permitted for listing.

(5) Base Capital requirement for members: Members will be required to maintaina 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 indifferent parts of the country.

(7) Satellite facility: The satellite required for OTCEI for its operations is jointlyheld with Press Trust of India

(8) Computerization of transactions: Computers at each counter enable the dealersto enter various transactions or queries or quotes through a central OTCEI computer,using telecommunication links.

7.3.1 Objectives of Otcei

The following are the objectives of OTCEI

1. Assisting and guiding small companies to raise funds from the capital market in acost-effective manner

2. Providing a convenient and an efficient avenue of capital market investments forsmall investors

3. Strengthening investors’ confidence in the financial market by offering them thetwo-way best prices to them

4. Ensuring transparency, redressing investors’ complaints and unifying the country’ssecurities 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

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7.3.2 Benefits of Otcei

OTCEI offers the following benefits :

7.3.2.1 Benefits To Listed Companies

The benefits that are offered to companies listed with OTCEI are as follows :

1. Negotiability : The company can negotiate the issue price with the sponsorswho have to market the issue. It provides an opportunity for fair pricing of anissue through negotiation with the sponsors.

2. Fixation of premium : In consultation with the sponsors, the company can fixan optimum level of premium on issue with minimum risk of non-subscription ofthe issue.

3. Savings in costs : Lots of costs associated with public issue of capital are savedthrough this mode. It provides an opportunity to companies to raise funds throughcapital market instruments at an extremely low cost as compared to a public issue.The method of sponsors placing the scrips with members who in turn will offloadthe scrips to public will obviate the need for a public issue and its associated costs.

4. No take-over threat : OTCEI lists scrips even with 40 percent of the capitaloffered for public trading. The limit has now been brought down to 20 percent inthe case of closely held companies and new companies. As a result, the presentmanagement of the companies are saved of threats of takeover if they restrictpublic offer.

5. Large access : Accessing a large pool of captive investor base through theOTCEI’s computerized network is made possible for companies. Thoughnationwide network for servicing of investors, companies listed on OTC Exchangecan 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 levelfinancial corporations, Foreign Institutional Investors, etc.

d. System for defining benchmark for securitiese. Increasing business for the market constituents

7.3.2.2 Benefits To Investors

OTCEI offers the following benefits for investors :

1. Safety : OTCEI’s ring less and scrip less electronic trading ensure safety oftransactions 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 shouldbe used in all OTC transactions and applications of OTC issues. This card provides

NOTES



for the safety and security of the investors’ investments. The mechanism offersgreater security to investors as the sponsors investigate into the company and theprojects, before accepting sponsorship thus building up much needed greaterinvestor confidence.

1. Transparency : OTC screens at every OTC counter display the best buy/sellprices. The exact trading prices are printed in the trading documents forconfirmations. This protects the investor interest and thereby minimize disputes.

2. Liquidity : A great advantage of the OTC is that the scrips traded are liquid.This is because there are at least two market-makers who indulge in continuousbuying and selling. This enables investors to buy and sell the scrips any time. 4.Appraisal : OTC members sponsor each scrip listed in an OTC counter. Thesponsor makes an appraisal of the scrips for investor worthiness. This ensuresquality of investments.

3. Access : Every OTC counter serves as a single window to the entire OTC exchangethroughout the country and throughout the world too. Therefore, buying and sellingmay be resorted to from any part of the world. It offers the facility of faster dealsettlement for investors across the counters spread over the entire country.

4. Transfer : It is important that OTC shares are transferable within 7 days, wherethe consolidated holdings of the scrips do not exceed 0.5 percent of the issuedcapital of the company.

5. Allotment : There is not much waiting for the investors when it comes to allotmentof scrips. Allotment is completed in all respects within a matter of 35 days andtrading begins immediately thereafter.

6. Other benefits :

a. Derivatives such as futures and options, forward contracts on stock, and otherforms 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 theinvestors 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

7.3.2.3 Benefits To Financial System

The OTCEI’s role has been laudable in as far as it helps contribute improving thefinancial system of India in the following ways :

1. National network of OTCEI operations facilitates the integration of capital marketin the country

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2. Boon to closely-held companies as they are encouraged to go public becausescrips can be listed even if only 40 percent of capital (now a minimum of 20percent in case of closely held and new companies) is offered for public trading

3. Facilities wider dispersal of economic activities by encouraging small companiesand small investors

4. Promoting savings and investments by offering easier avenues for raising capital

5. Providing over-all stimulation to venture capital activities thereby promotingentrepreneurship

6. Market-making assistance by the sponsors on the OTCEI that helps in making anappraised future projections in the issue documents which in turn helps prospectiveinvestors 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 nowhave 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

7.3.3 Securities Traded

Following are the securities that are traded on the OTCEI :

1. Listed equity (exclusive) : These are equity shares of the companies listedexclusively 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 theOTCEI, cannot be traded on other stock exchanges.

2. Listed debt : These are the debentures/bonds that are issued through a publicissue or a private placement and are listed on OTCEI. Any entity holding theentire series of a particular debt instrument can also offer them for trading on theOTCEI, 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 securitiesare traded in this segment. Banks, Foreign Investors, Foreign Institutional Investors,NBFCs and Provident Funds can trade in these securities through OTCEIdesignated members/dealers.. PSU Bonds, Commercial Paper, and Certificatesof Deposit will also be traded in this segment.

4. Permitted securities : These are the securities listed on other exchanges, whichare permitted for trading on OTCEI. Securities of Blue Chip companies likeACC, Reliance Industries Ltd., State Bank of India, ITC, etc. are traded in thissegment.

5. Listed mutual funds : Listed mutual funds are units of mutual funds that arelisted on OTCEI. Mutual fund units like units of Unit-64, Monthly Income Plan,and IISFUS ’97 are also listed under this category.

NOTES




Q.7.3.a. What is meant by the term ‘over-the-counter’?

Q.7.3.b. What is OTCEI? What are its distinct features’?

Q.7.3.c. Distinguish between the OTCEI and the other stock exchanges.

Q.7.3.d. What are the benefits accruing from the OTCEI?

Q.7.3.e.State the need and the objectives of the OTCEI.

Q.7.3.f. What benefits accrue from OTCEI to the Indian financial system?

Q.7.3.g. Discuss briefly the various players in the OTCEI.

Q.7.3.h. What is ‘market-making’? What are the functions of a market-maker?

Q.7.3.i. What are the eligibility requirements for companies, financial and non-financial, to be listed on the OTCEI?

Q.7.3.j. What are the obligations of the companies listed on the OTCEI?

Q.7.3.k. What are the obligations of the sponsor under the OTCEI?

Q.7.3.l. Name the documents to be submitted seeking listing on the OTCEI.

Q.7.3.m. What causes would you attribute for the show growth of the OTCEI?

Q.7.3.n. How does OTCEI work with NASDAQ?

Q.7.3.o. State the profile of the securities traded on the OTCEI.

Q.7.3.p. Explain the OTCEI’s interface with the NASSCOM.

Q.7.3.q. How is OTCEI beneficial to investors?

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To counter the influence of Bombay Stock Exchange and reduce the influence ofcertain powerful intermediaries in the stock market, a new stock market was promoted inwhich both securities of companies and debt instruments are traded, namely the NationalStock Exchanges. NSE takes into account the screen based trading and so it is the mostadvanced. The success of this stock exchange is quite evident that within a few years of itspromotion the volume and the value of transactions have surpassed the BSE.



• NSE

• Objectives

• Operations of NSE

• NSE and Merchant banking

8.3 NSE NATIONAL STOCK EXCHANGE OF INDIA

• It is the screen based trading established to counter the influence of BombayStock Exchange and to reduce the influence of certain powerful intermediariesin the stock market.

• Both securities of companies and debt instruments are traded here.

The success of this stock exchange is quite evident that within a few years of itspromotion the volume and the value of transactions have surpassed the Bombay StockExchange. Apart from this, the prices of securities prevailing in this market have its influenceon the Bombay Stock Exchange.

PROMOTERS AND COMMITTEES

The National Stock Exchange was promoted in November 1992, as a limited companyby insurance companies, commercial banks and other financial institutions. Besides, SBICapital Markets Limited, Infrastructure leasing and financial services Ltd., and StockHolding Corporation Ltd., were also part of the promoters of NSE. The NSE wasincorporated with an equity capital of Rs.25 crores. The International Securities Consultancy(ISC) of Hong Kong has helped in setting up of the NSE.

NOTES



FEATURES OF NSE

1. The NSE employs a fully automated screen based trading system. Investors cantrade from 400 cities on a real time basis.

2. It has three segments: the capital market segment, whole sale debt market segmentand derivatives market

• The capital market segments covers equities, convertible debentures andretail trade in debt instruments like non- convertible debentures. Securitiesof medium and large companies with nation wise investor base, includingsecurities traded on other stock exchanges are traded in NSE throughtrading members.

• The wholesale debt market segment is a market for high value transactionsin government securities, public sector bonds, commercial papers and otherdebt instruments.

• On the wholesale market segment, there are two types of entities viz.,trading members and participants. Trading members are recognizedmembers of the exchange selected on the basis of selection criteria laiddown under the provisions of SEBI and the securities contract (Regulation)Act, 1956. They can trade on their own or on behalf of their clients.Participants are the organizations directly responsible for the settlement oftrades.

3. The NSE has no trading floor as is prevalent in the traditional stock exchanges.

4. The market operates with all participants stationed at their offices and making useof their computer terminals, to receive market information to enter orders and toexecute trade.

5. The trading members in the capital market segment are connected to the centralcomputer in Bombay through a satellite link –up using VSATs (Very small apertureTerminals). The trading members in the whole sale debt market segment are linked,through high speed lines, to the central computer Mumbai.

6. The NSE has opted for an order driven system. The system provides enormousflexibility to trading members. A trading member can place various conditions onthe order in terms of price, time or size. When an order is placed by a tradingmember, an order confirmation slip is generated. All orders received are started inprice and time priority. The computer system automatically searches for a matchand no sooner to the same is found, the deal is struck. If it does not find a matchimmediately as may happen in the case of less liquid securities, the order is keptpending in the computer unless specified otherwise by the trading member.

7. When a trade takes place, a trade confirmation slip is printed at the trading member’swork station. It gives details like price, quantity, code number of the party and soon.

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8. The identity of the trading member is not revealed to others when he places anorder or when his pending orders are delayed. Hence large order can be placedin NSE without the fear of influencing the market sentiment.

9. On the eight day of trading, each member gets a statement showing his net position,the amount of cash he has to transfer to the clearing bank and the securities he hasto deliver to the clearing house.

10. Members are required to deliver securities and cash by the thirteenth and fourteenthday, respectively. The fifteenth day is the pay-out day.

11. The automated trade matching system secures the best price available in the marketto the investor. The trading member can transact a high volume of businessefficiently.

8.3.1 Operations of NSE

NSE and Wholesale Debt Market (WDM)

Prior to the commencement of trading in WDM segment of NSE, the only tradingmechanism available in the debt market was the telephone market. NSE provided for thefirst time in the country, an online, automated trading facility across a wide range of debtinstruments.

Comparison Between Stock Exchange, OTCEI and NSE

Stock Exchange OTCEI NSE 1. Membership 2. Methods of Trading 3. System of Trading 4. Settlement 5. Transparency 6. Intermediary

Individuals, Firms and Corporate Floor Screen based Quote-driven Manual T + 2 NIL Jobber needed

Corporates only Screen based Code driven Computers linked to central OTCEI through telephone lines T + 2 rolling settlement Ensured Not needed

Individuals, Firms and Corporates Screen based Order driven Computer linked by satellite through VSAT Same day to T + 2 in WDM Standard Delivery in Equity market Total transparency Not needed

NOTES



TABLE Operations of the National Stock Exchange

*Working of NSE during 1997-98

Of the total trading turnover of Rs.9,08,691 crores by the 22 stock exchanges in1997-98 the trading turnover of NSE was the highest which accounted for about 45% ofthe total trading volume during 2000.

TABLE Operations of the National Stock Exchange

The trading system of the exchange known as NEAT (National Exchange for AutomatedTrading) is fully automated, screen based trading system that enables members across thecountry to trade simultaneously with enormous easy and efficiency.

WDM segment provides trading facilities for a variety of debt instruments. InitiallyGovernment securities, Treasury Bills and Bonds issued by public sector undertakingswere made available for trading. This range has been widened to include non-traditionalinstruments like Fleeting Rate Deposits, Corporate Debentures, State Government Loans,Bonds issued by Financial Institutions, units of Mutual Funds and Securitized debt.

In order to enable investors like Provident Fund, Trusts, NBFCs and other high networth investors to deal in debt instruments, the exchange has introduced a small book letfacility where an order of minimum of Rs. 1 lakh can be placed on the trading system ofthe exchange.

The volume of NSE has increased multifold in the last four years. Average dailyvolume has increased from 30 crores in the year 1994-95 to Rs.385 Crores in 1997-98,The number of trades which were around 5 per day in 1994-95 has gone up to 59 tradesper day in 1997-98.

1994-95 1995-96 1999-2000 Turnover (Cr) Number of listed companies Market capitalization (Cr)

1,850 135

75,223

67,287 422

2,17,721

138,39.051 673

8,50,880

Year No. of companies

No. of Securities traded

Turnover (Mrs.)

2001-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 May 2007

785 793 818 909 970 1,069 1,228 1,267

1,201 1,019 899 804 870 956 1,191 1,149

13,39,510 5,13,167 6,17,989 10,99,535 11,40,071 15,69,556 9,45,285 2,07,585

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The year wise turnover in NSE for the period from 1995-96 to 1997-98 is shown inthe table below.

TABLE NSE Trading in WDM Segment

National Stock Exchanges Proposed System of Public Issue Offering (PIO)

The current process of initial offering is a lengthy one involving considerable time andcosts. Considering several infirmities afflicting primary issue market for all types of securities,NSE has worked out an unique facility for achieving quantum improvement in the processof primary issues. The Exchange is proposing to provide a facility for issue of securities fortime bound Initial Public Offerings (IPO) and perpetual IPO.

Time bound IPO includes primary issues for initial public offers and subsequent issuesby companies. Perpetual IPO includes continuous offering of securities by the issues likeopen ended mutual funds.

NSE, PIO facility would operate through a fully automated screen based system. Itsfacility can be used for all types of primary issues which are designed to meet specificrequirements of issuer, investors and trading members. The system can also be used forissues which have various combinations or components of book building and fixed priceissues. The software designed by the exchange provides flexibility for making issues ofany security whether equity, debt or any other hybrid instrument.

Objectives

The main objectives of starting the primary issues through a screen based automatedtrading system are :

1. To provide facility to the issuer for on-line issue of securities.

2. To provide wide retail distribution network.

3. To reduce the cost of issue of securities.

4. To reduce the delay in listing of securities.

Time Bound PIO System

This system can be used for price/rate discovery in case of book building as well asfor collecting subscription for fixed price. Issuer will announce certain number of securitiesin case of fixed price offerings and the total amount to be raised in case of book building.Eligible trading members will place subscription orders of investors specifying the numberof shares or price as the case may be. The issue will be closed after a specified number of

1995-96 1996-97 1997-98 Traded value Average daily volume Average No. of trades per day

11,867.68 40.78 0.10

42,277,60 145.28

0.27

1,11,263.28 384.99

0.59

NOTES



days after which the issuer will decide the allocation based on the offers received. Theexchange proposes to provide a software which will help the issuer in finalizing the basis ofallotment as per the guidelines issued by SEBI.

After the allotment, the Exchange will generate dummy trades for successful investorsand send it to the respective members in the form of obligation. After the receipt of theobligation data, the members will initiate and expedite the process of fund collection andprinting of application forms. The exchange proposes to provide a special software totrading members who will maintain a complete IPO back office system including printingof application forms, fund management and report generation.

Completed application forms and funds will be received by the exchange on a pre-determined day based on which final dispatch of certificates and release of funds will bedone.

Internet Broking

NSE launched internet trading in early February 2000. It is the first exchange in thecountry to provide web based access to investors to trade directly on the exchange. Theorders originating from the PCs of the investors are routed through the internet to thetrading terminals of the designated brokers with whom they are connected and further tothe exchange for trade executions. Soon after these orders get matched and result intotrades, the investors get confirmation about them on their PCs through the same internetroute.

Wireless Application Protocol (WAP)

SEBI has approved trading through wireless medium on WAP platform. WAP wasintroduced in November 2000. This provides access to its order book through the handheld devices, which use WAP technology. This serves primarily retail investors who aremobile and want to trade from any place when he market prices for stocks at their choiceare attractive.

NATIONAL SECURITIES CLEARING CORPORATION

NSC has set up a wholly owned subsidiary – National Securities Clearing Corporationthat takes up the responsibility of settlement by opening guarantee. There is seamlessintegration of trading and settlement with full guarantee which protects the interest ofinvestors fully.


Q.8.3.a. How many stock exchanges are there in India? Name them.

Q.8.3.b. When was the Bombay stock Exchange (BSE) started? How is it managed?

Q.8.3.c. What are the opportunities made available by the BSE to foreign investors?

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Q.8.3.d. What do you know of ‘BOLT’?

Q.8.3.e. What is ‘scrips group’?

Q.8.3.f. How does settlement take place at the BSE?

Q.8.3.g. State the function of the clearing house at the BSE.

Q.8.3.h. How does book-building work at the BSE?

Q.8.3.i. State the genesis of the National Stock Exchange of India Limited (NSE).

Q.8.3.j. How does settlement take place at the NSE?

Q.8.3.k. How does counter guarantee work at the NSE?

Q.8.3.l. What are the factors that determine the measure of liquidity of a security?

Q.8.3.m. What are products offered by the NSE?

NOTES



UNIT II

ISSUE MANAGEMENTLESSON 1

1.1 INTRODUCTION

Merchant Banking, as a commercial activity, took shape in India through themanagement of Public Issues of capital and Loan Syndication. It was originated in 1969with the setting up of the Merchant Banking Division by ANZ Grind lays Bank. The mainservice offered at that time to the corporate enterprises by the merchant banks includedthe management of public issues and some aspects of financial consultancy. The early andmid-seventies witnessed a boom in the growth of merchant banking organizations in thecountry with various commercial banks, financial institutions, and broker’s firms enteringinto the field of merchant banking.

Reform measures were initiated in the capital market from 1992, starting with theconferring of statutory powers on the Securities and Exchange Board of India (SEBI) andthe repeal of Capital Issues Control Act and the abolition of the office of the Controller ofCapital Issues. These have brought about significant improvement in the functional andregulatory efficiency of the market, enabling the Merchant Bankers shoulder greater legaland moral responsibility towards the investing public.


After reading the unit, you will understand

• The functions of merchant bankers in detail

1.3 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 issuemanagement either by making arrangements regarding selling, buying or subscribing tosecurities as manager, consultant, advisor or rendering corporate advisory service in relationto such issue management”.

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The capital issue management comprises of the effective management of market relatedfactors. 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

1.3.1 Issue Management

• The management of issues for raising funds

The management of issues for raising funds through various types of instruments bycompanies is known as “ issue management”. The function of capital issues management inIndia is carried out by merchant bankers. The Merchant Bankers have the requisite skilland 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) Rulesand 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 makingarrangement regarding selling, buying or subscribing to securities as manager, consultant,advisor or rendering corporate advisory services in relation to such issue management”.

NOTES



MERCHANTS OF PUBLIC ISSUE MANAGEMENT

1.3.1.1 Classification Of Securites 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

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1. Public Issue of Securities

When capital funds are raised through the issue of a prospectus, it is called ‘’publicissue of securities’. It is the most common method of raising funds in the capital market. Asecurity issue may take place either at part, or at a premium or at a discount. The Prospectushas to disclose all the essential facts about the company to the prospective purchasers ofthe shares. Further, the prospectus must conform to the formal set out in Schedule II of theCompanies Act, 1956, besides taking into the account SEBI guidelines. SEBI insists onthe adequacy of disclosure of information that should serve as the basis for investors tomake a decision about the investment of their money.

2. Rights Issue

When shares are issued to the existing shareholders of a company on a privilegedbasis, it is called as ‘Rights Issue’. The existing shareholders have a pre-emptive right tosubscribe to the new issue of shares. Rights shares are offered as additional issues bycorporate to mop up further capital funds. Such shares are offered in proportion to thecapital 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 termsadvantageous to the shareholders.

3. Private Placement

When the issuing company sells securities directly to the investors, especially institutionalinvestors, 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 arecapable of evaluating the risks of the investment. Private placement covers shares,preference shares and debentures. The role of the financial intermediary, such as themerchant bankers and lead managers, assures great significance in private placement. Theyinvolve themselves in the task of preparing an offer memorandum and negotiating withinvestors.

1.3.2 Merchant Bankers Functions

The different functions of merchant bankers towards the capital issues managementare

1. Designing Capital Structures

2. Capital Market Instruments

3. Preparation of prospectus

4. selection of bankers

5. Advertising Consultants

NOTES



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 thetotal long-term capitalization of a company.

According to Weston and Brigham, “Capital structure is the permanent financing ofthe firm, represented primarily by long-term-debt, preferred stock and common equity,but excluding all short-term credit. Common equity includes common stock, capital surplusand accumulated retained earnings.”

OPTIMAL CAPITAL STRUCTURE

An ideal mix of various sources of long-term funds that aims at minimizing the overallcost 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:

a. Simplicity

An optimal capital structure must be simple to formulate and implement by the financialexecutives. For simplicity, it is imperative that the number of securities is limited to debtand equity.

b. Low Cost

A sound capital structure must aim at obtaining the capital required for he firm at thelowest possible cost. For this purpose, financial executives must pay attention to keep theexpenses of issue and fixed annual payments at a minimum. This would help maximize theshareholders’ value.

c. Maximum Return and Minimum Risks

An ideal capital structure must have a combination of debt and equity in such a manneras to maximize the firm’s profits. Similarly, the firm must be guarded against risks such astaxes, 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 existingshareholders. The issue of securities should be based on the pattern of voting rights. It

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NOTES


must affect favorably the voting structure of the existing shareholders, and increase theircontrol on the company’s affairs.

e. Liquidity

In order to have a sound capital structure, it is important that the various componentshelp provide the firm greater solvency through higher liquidity. To attain a high order ofliquidity, 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 tocarry 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 theexisting 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 equitablecapitalization 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 equityat certain ideal proportions. It is best for the firm to issue debt when the rate of interest islow. Conversely, equity is suitable where the rate of capitalization is high.

PATTERN OF CAPITAL STRUCTURE

The different forms of capital structure are :

DECISIONS ON CAPITAL STRUCTURE

The decisions regarding the use of different types of capital funds in the overall long-term capitalization of a firm are known as capital structure decisions.

Any decisions on Capital Structure are based on different principles.

a. Cost Principle

An ideal pattern of capital structure is one that costs the least. The returns must bemaximized and cost minimized. The cost of capital of a firm is greatly influenced by theamount of interest to be paid to its debenture holders in a particular period. A firm wouldbe well advised to employ the debt capital, as it is a cheap source of funds. Using debtwould give the firm a tax shield advantage. Such an arrangement is technically known as‘trading on equity’.

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b. Control Principle

The amount of control to be exercised by the shareholders over the management is animportant principle underlining capital structure decisions. Accordingly, the finance manager,while making a fresh issue of capital funds, should ensure that the control of the existingshareholders remain unaffected. In this connection, it is to be noted that the issue of bondsand preference shares offers the advantage of non-dilution of existing ownership. However,debt funds pose the formidable problem of a heavy interest cost burden and the consequentrisk of bankruptcy.

c. Return Principle

According to his principle, the patterns of capital structure must be devised to allowfor enhanced returns to the shareholders. It also implies that the kind of capital sourcechosen must be secure. Besides, the principal amount having to be returned immediatelyafter the expiry of the stipulated time period the bonds require obligated debt servicing byway of fixed periodic interest. Hence, debt capital may prove fatal to the company in timeof low/non-profits. In the context of risk, equity stands a fair chance of being included aspart of an efficient capital structure.

d. Flexibility Principle

For capital structure decisions to be efficient, there must be adequate flexibility in thecapitalization. The addition of a capital fund must be such that it should be possible for afirm to redeem or add capital to the existing capital structure. It is equally important thatthe terms and conditions of raising funds be flexible. This maneuverability would give thefirm a more efficient capital structure.

e. Timing Principle

The quality of decisions depends on the time at which the capital funds are eitherraised or returned. This would help minimize the cost of capital, and thus help maximizereturns to shareholders. Timing greatly affects the preferences and choices of investors,which in turn depends on the general state of the economy. Accordingly, in periods ofboom equity shares should be issued to raise resources. Conversely, in periods of depression,bonds are ideal, as they entail payment of lower rate interest.

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 offirms. In order words, the way the economy of a country is managed determines the way

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the capital structure of a firm will be determined. Factors that are active in the economyare:

1. Business activity : The quality of business activity prevailing in the economy determinesthe 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 undertakeprofitable investment activities. Under these circumstances, it is advisable for a firm toundertake equity funding rather than debt funding.

2. Stock market : The buoyancy, or otherwise, of the capital market greatly influencescapital structure decisions. A study of the capital market trends would greatly help a firmsdecision on the quantum and cost of issue. Accordingly, if the stock market is expected towitness 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 capitalstructure decisions. For instance, higher rates of taxation will be advantageous due to thetax 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. ofcapital funds to be raised also influences the capital raised by a firm. For instance, restrictionshave been imposed by SEBI on the issue and allotment of shares and bonds to differenttype of investors. A finance manager should take this factor into consideration while designingthe capital structure.

5. Credit policy : The credit policy pronouncements made by the central monetaryauthority, such as the RBI, affects the way capital is raised in the market. For instance, theinterest rate liberalization announced by RBI has been dominating the lending policies offinancial institutions. This affects the ability of finance managers to raise the required funds.

6. Financial institutions : The credit policy followed by financial institutions determinesthe capital structure decisions of firms. For instance, restrictive lending terms by financialinstitutions 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 capitalmarket are known as Capital Market Instruments’.

The changes that are sweeping across the Indian capital market especially in therecent past are something phenomenal. It has been experiencing metamorphic in the lastdecade, thanks to a host of measures of liberalization, globalization, and privatization thathave been initiated by the Government. Pronounced changes have occurred in the realm

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of industrial policy. Licensing policy, financial services industry, interest rates, etc. Thecompetition has become very intense and real in both industrial sector and financial servicesindustry.

As a result of these changes, the financial services industry has come to introduce anumber of instruments with a view to facilitate borrowing and lending of money in thecapital market by the participants.

TYPES OF CAPITAL MARKET INSTRUMENTS

The various capital market instruments used by corporate entities for raising resourcesare 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

PREFERENCE SHARFES

Shares that carry preferential rights in comparison with ordinary shares are called’Preference Shares’. The preferential rights are the rights regarding payment of dividendand the distribution of the assets of the company in the event of its winding up, in preferenceto equity shares.

TYPES OF PREFERENCE SHARES

1. Cumulative preference shares : Shares where the arrears of dividends in times ofno and/or lean profits can be accumulated and paid in the year in which the companyearns good profits.

2. Non-cumulative preference shares : Shares where the carry forward of the arrearsof dividends is not possible.

3. Participating preference shares : Shares that enjoy the right to participate insurplus profits or surplus assets on the liquidation of a company or in both, if the Articles ofAssociation provides for it.

4. Redeemable preference shares : Shares that are to be repaid at the end of the termof issue, the maximum period of a redemption being 20 years with effect from 1.3.1997under the Companies amendment Act 1996. Since they are repayable, they are similar todebentures. Only fully paid shares are redeemed. Where redemption is made out of

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profits, a Capital Redemption Reserve Account is opened to which a sum equal to thenominal value of the shares redeemed is transferred. It is treated as paid-up share capitalof 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 onthe date of allotment. Part B will be redeemed at par/converted into equity shares after alock-in period at the option of the investor, conversion into equity shares taking place afterthe lock-in period, at a price, which would be 30 percent lower than the average marketprice. The average market price shall be the average of the monthly high and low price ofthe shares in a stock exchange over a period of 6 months including the month in which theconversion takes place.

6. Preference shares with warrants attached : The attached warrants entitle theholder to apply for equity shares for cash, at a ‘premium’, at any time, in one or morestages between the third and fifth year from the date of allotment. If the warrant holderfails to exercise his option, the unsubscribed portion will lapse. The holders of warrantswould be entitled to all rights/bonus shares that may be issued by the company. Thepreference shares with warrants attached would not be transferred/sold for a period of 3years from the date of allotment.

EQUITY SHARES

Equity shares, also known as ‘ordinary shares’ are the shares held by the ownersof 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 preferenceshareholders, provided the company’s performance is excellent. Directors declare nodividends in case there are no profits or the profits do not justify dividend for previousyears even when the company makes substantial profits in subsequent years. Equityshareholders also enjoy the benefit of ploughing back of undistributed profits kept as reservesand surplus for the purposes of business expansion. Often, part of these is distributed tothem, as bonus shares. Such bonus shares are entitled to a proportionate or full dividendin the succeeding year.

A strikingly noteworthy feature of equity shares is that holders of these shares enjoysubstantial rights in the corporate democracy, namely the rights to approve the company’sannual accounts, declaration of dividend, enhancement of managerial remuneration in excessof specified limits and fixing the terms of appointment and election of directors, appointmentof auditors and fixing of their remuneration, amendments to he Articles and Memorandumof Association, increase of share capital and issue of further shares or debentures, proposals

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for mergers and reconstruction and any other important proposal on which member’sapproval is required under the Companies Act.

Equity shares in the hands of shareholders are mainly reckoned for determining themanagement’s control over the company. Where shareholders are widely disbursed, it ispossible for the management to retain the control, as it is not possible for all the shareholdersto attend the company’s meeting in full strength. Furthermore, the management group canbolster 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 placementexercise. Such a method, however, is brought with the danger of takeover attempt byfinancial institutions.

Equity shareholders represent proportionate ownership in a company. They haveresidual claims on the assets and profits of the company. They have unlimited potential fordividend payments and price appreciation in comparison to thse owners of debenturesand preference shares who enjoy just a fixed assured return in the form of interest anddividend. Higher the risk, higher the return and vice-versa.

Share certificates either in physical form or in the demat (with the introduction ofdepository system in 1999) form are issued as a proof of ownership of the shares in acompany. Fully paid equity shares with detachable warrants entitle the warrant holder toapply for a specified number of shares at a determined price. Detachable warrants areseparately registered with stock exchange and traded separately. The company woulddetermine 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 eachshareholder is eligible for votes proportionate to the number of shares held or the amountof stock owned. A company cannot issue shares carrying disproportionate voting rights.Similarly , voting right cannot be exercised in respect of shares on which the shareholderowes some money to the company.

CAPITAL

Equity shares are of different types. The maximum value of shares as specified in theMemorandum of Association of the company is called the authorized or registered ornominal 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 capitalsubscribed is called subscribed capital. This is less than the issued capital Paid-up capitalis the share capital paid-up by shareowners which is credited as paid-up on the shares.

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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 beissued below the par value. The financial institutions that convert their unpaid principal andinterest into equity in sick companies are compelled to do if at a minimum of Rs.10 becauseof the par value concept even though the market price might be much less than Rs.10. Parvalue can also lead to unhealthy practices like price rigging by promoters of sick companiesto 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 tocontrol the number of shares that can be issued by the company. The par value of Rs.10per 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 ofthe shareholders of a corporate entity.

Cash Dividends

These are dividends paid in cash. A stable payment of cash dividend is the hallmarkof stability of share prices.

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 andsurplus is altered.

NON-VOTING EQUITY SHARES

Consequent to the recommendations of the ‘Abid Hussain Committee’ and subsequentto the amendment to the Companies Act, corporate managements are permitted to mobilizeadditional capital without diluting the interest of existing shareholders with the help of anew instrument called ‘non-voting equity shares’. Such shares will be entitled to all thebenefits except the right to vote in general meetings. Such non-voting equity share is beingconsidered 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 thirdcategory of shares. Corporates will be permitted to issue such share up to a certainpercentage of the total share capital.

Non-voting equity shares will be entitled to rights and bonus issues and preferentialoffer of shares on the same lines as that of ordinary shares. The objective will be tocompensate the sacrifice made for the voting rights. For this purpose, these shares willcarry higher dividend rate than that of voting shares. If a company fails to pay dividend,

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non-voting shareholders will automatically be entitled to voting rights on a prorate basisuntil the company resumes paying dividend.

The mechanism of issue of non-voting shares is expected to overcome such problemsas are associated with the voting shares as that the ordinary investors are more inclinedtowards high return on capital through sizeable dividends and capital appreciation throughthe issue of bonus shares and the inability of corporate to respond to the investors’ justaspiration for reasonable dividends. Moreover, there is every need for corporate to spendhuge sums of money on a variety of not-so-useful items including colorful and costly annualreports. For all these above-mentioned reasons, non-voting equity shares are expected tohave a ready and popular marker. In effect, this kind of share is similar to preferenceshares with regard to non-voting right but may get the advantage of higher dividends aswell as appreciation in share values through entitlement to bonus shares which is not availableto preference shares.

CONVERTIBLE CUMULATIVE PREFERENCE SHARES (CCPS)

These are the shares that have the twin advantage of accumulation of arrears ofdividends and the conversion into equity shares. Such shares would have to be the facevalue of Rs.100 each. The shares have to be listed on one or more stock exchanges in thecountry. The object of the issue of CCP shares is to allow for the setting up of newprojects, expansion or diversification of existing projects, normal capital expenditure formodernization 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 maybe applicable CCPS is be deemed to be an equity issue.

2. Compulsory conversion : The conversion into equity shares must be for theentire issue of CCP shares and shall be done between the periods at the end ofthree years and five years as may be decided by the company. This implies thatthe conversion of the CCP into equity shares would be compulsory at the end offive years and the aforesaid preference shares would not be redeemable at anystage.

3. Fresh issue : The conversion of CCP shares into equity would be deemed asbeing one resulting from the process of redemption of the preference shares out ofthe proceeds of a fresh issue of shares made for the purposes of redemption.

4. Preference dividend : The rate of preference dividend payable on CCP shareswould be 10 percent.

5. Guideline ratio : The guideline ratio of 1:3 as between preference shares andequity shares would not be applicable to these shares.

6. Arrears of dividend : The right to receive arrears of dividend up to the date ofconversion, if any, shall devolve on the holder of the equity shares on such

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conversion. The holder of the equity shares shall be entitled to receive the arrearsof dividend as and when the company makes profit and is able to declare suchdividend.

7. Voting right : CCPS would have voting rights as applicable to preference sharesunder the companies Act, 1956.

8. Quantum : The amount of the issue of CCP shares would be to the extent thecompany would be offering equity shares to the public for subscription.

COMPANY FIXED DEPOSITS

Fixed deposits are the attractive source of short-term capital both for the companiesand investors as well. Corporates favour fixed deposits as an ideal form of workingcapital mobilization without going through the process of mortgaging assets. Investorsfind fixed deposits a simple avenue for investment in popular companies at attractivelyreasonable and safe interest rates. Moreover, investors are relieved of the problem of thehassles of market value fluctuation to which instruments such as shares and debentures areexposed. There are no transfer formalities either. In addition, it is quite possible forinvestors to have the option of premature repayment after 6 months, although such anoption entails some interest loss.

Regulations

Since these instruments are unsecured, there is a lot of uncertainty about the repaymentof deposits and regular payment of interest. The issue of fixed deposits is subject to theprovisions of the Companies Act and the Companies (Acceptance of Deposits) Rulesintroduced in February 1975. Some of the important regulations are:

1. Advertisement : Issue of an advertisement as approved by the Board of Directorsin dailies circulating in the state of incorporation.

2. Liquid assets : Maintenance of liquid assets equal to 15 percent (substituted for10% by Amendment Rules, 1992) of deposits (maturing during the year endingMarch 31) in the form of bank deposits, unencumbered securities of State andCentral Governments or unencumbered approved securities.

3. Disclosure : Disclosure in the newspaper advertisement the quantum of depositsremaining unpaid after maturity. This would help highlight the defaults, if any, bythe company and caution the depositors.

4. Deemed public Company : Private company would become a deemed publiccompany (from June 1998, Section 43A of the Act) where such a private company,after inviting public deposits through a statutory advertisement, accepts or renewsdeposits from the public other than its members, directors or their relatives. Thisprovision, to a certain extent, enjoins better accountability on the part of themanagement and auditors.

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5. Default : Penalty under the law for default by companies in repaying deposits asand when they mature for payment where deposits were accepted in accordancewith the Reserve Bank directions.

6. CLB : Empowerment to the Company Law Board to direct companies to repaydeposits, which have not been repaid as per the terms and conditions governingsuch deposits, within a time frame and according to the terms and conditions ofthe order.

WARRANTS

An option issued by a company whereby the buyer is granted the right to purchase anumber of shares of its equity share capital at a given exercise price during a given periodis called a ‘warrant’. Although trading in warrants are in vogue in the U.S,. Stock marketsfor more than 6 to 7 decades, they are being issued to meet a range of financial requirementsby the Indian corporate.

A security issued by a company, granting its holder the right to purchase a specifiednumber 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 clearlyspecify the number of shares entitled, the expiration date, along with the stated/exerciseprice. The expiration date of warrants in USA is generally 5 to 10 years from the date ofissue and the exercise price is 10 to 30 percent above the prevailing market price. Warrantshave a secondary market. The exchange value between the share of its current price andthe 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 additionalfinds at a price lower than the current market, yet higher than those prevailing at the time ofissue. Warrants are issued by new/growing firms and venture capitalists. They are alsoissued 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 yearswhereas, rights have a life span of only four to twelve weeks (duration between the openingand closing date of subscription list). Moreover, rights are normally issued to effectcurrent financing, and warrants are sold to facilitate future financing. Similarly, the exerciseprice of warrant, i.e. The price at which it can be exchanged for share, is usually above themarket price of the share so as to encourage existing shareholders to purchase it. On theother hand, one warrant buys one equity share generally, whereas more than one rightsmay be needed to buy one share. The detachable warrant attached to each share providesa right to the warrant holder to apply for additional equity share against each warrant.

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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. Adebenture, issued under the common seal of the company, usually takes the form of acertificate that acknowledges indebtedness of the company.

A document that shows on the face of it that a company has borrowed a sum ofmoney 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 thecompany. These are the instruments that are generally used for raising long-term debtcapital.

Following are the features of a debenture

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 theregulations of the SEBI. Section 117 of the Companies Act prohibits issue of debentureswith voting rights. Generally, they are issued against a charge on the assets of the companybut at times may be issued without any such charge also. Debentures can be issued at adiscount 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 itsbearer. Such instruments are negotiable and are transferable by delivery. Registereddebentures are payable to the registered holder whose name appears both on the debentureand in the register of debenture holders maintained by the company. Further, transfer ofsuch debentures should be registered. They are not negotiable instruments and contain acommitment to pay the principal and interest.

3. Security : Secured debentures create a charge on the assets of the company. Such acharge may be either fixed or floating. Debentures that are issued without any charge onassets of the company are called ‘unsecured or marked debentures’.

4. Duration : Debentures, which could be redeemed after a certain period of time arecalled Redeemable Debentures. There are debentures that are not to be returned exceptat the time of winding up of the company. Such debentures are called IrredeemableDebentures.

5. Convertibility : Where the debenture issue gives the option of conversion into equityshares after the expiry of a certain period of time, such debentures are called ConvertibleDebentures. Non-convertible Debentures, on the other hand, do not have such an exchangefacility.

6. Return : Debentures have a great advantage in them in that they carry a regular andreasonable income for the holders. There is a legal obligation for the company to makepayment of interest on debentures whether or not any profits are earned by it.

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7. Claims : Debenture holders command a preferential treatment in the matters ofdistribution of the final proceeds of the company at the time of its winding up. Their claimsrank prior to the claims of preference and equity shareholders.

KINDS OD DEBENTURES

Innovative debt instruments that are issued by the public limited companies aredescribed 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 Debentures (NCDs) with detachable equity warrant

7. Zero-interest Fully Convertible Debentures (FCDs)

8. Secured zero-interest Partly Convertible Debentures (PCDs) with detachable andseparately 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 whichentitle the holders to participate in its profits are called ‘Participating Debentures’. Theseare the unsecured corporate debt securities. They are popular among existing dividendpaying corporates.

2. Convertible debentures

a. Convertible debentures with options are a derivative of convertible debenturesthat give an option to both the issuer, as well as the investor, to exit from the termsof the issue. The coupon rate is specified at the time of issue.

b. Third party convertible debentures are debts with a warrant that allow theinvestor to subscribe to the equity of a third firm at a preferential price vis-à-vismarket price, the interest rate on the third party convertible debentures being lowerthan pure debt on account of the conversion option.

c. Convertible debentures redeemable at a premium are issued at face valuewith a put option entitling investors to sell the bond to the issuer, at a premium lateron. 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. Theinstrument is quite risky for the investor because the anticipated capital appreciation maynot materialize.

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4. Zero-coupon convertible note : These are debentures that can be converted intoshares and on its conversion the investor forgoes all accrued and unpaid interest. Thezero-coupon convertible notes are quite sensitive to changes in the interest rates.

5. SPN with detachable warrants : These are the Secured Premium Notes (SPN) withdetachable warrants. These are the redeemable debentures that are issued along with adetachable warrant. The warrant entitles the holder to apply and get equity shares allotted,provided the SPN is fully paid. The warrants 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 afterthe lock-in period. If this option is exercised by the holder, no interest/premium will bepaid 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 ofdetachable warrant into equity shares will have to be done within the time limit notified bythe 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 numberof shares from the company at a predetermined price within a definite time frame. Thewarrants attached to NCDEs are issued subject to full payment of the NCDs’ value. Theoption can be exercised after the specific lock-in period. The company is at liberty todispose off 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 whichno interest will be paid by the issuer during the lock-in period. However, there is a notifiedperiod after which fully paid FCDs will be automatically and compulsorily converted intoshares. 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 theFCD holders are offered securities.

8. Secured Zero interest PCDs with detachable and separately tradable warrantsThese are Secured Zero Interest Partly Convertible Debentures with detachable andseparately tradable warrants. They are issued in two parts. Part A is a convertible portionthat allows equity shares to be exchanged for debentures at a fixed amount on the date ofallotment. Part B is a non-convertible portion to be redeemed at par at the end of aspecific period from the date of allotment. Part B which carries a detachable and separatelytradable warrant provides the warrant holder an option to received equity shares for everywarrant held, at a price worked out by the company.

9. Fully Convertible Debentures (FCDs) with interest(optional) These are thedebentures that will not yield any interest for an initial short period after which the holder isgiven an option to apply for equities at a premium. No additional amount needs to be paid

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for this. The option has to be indicated in the application form itself. Interest on FCDs ispayable at a determined rate from the date of first conversion to the date of second/finalconversion 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 abenchmark interest rate like the prime rate in USA or LIBOR in the Euro currency market.For instance, the Sate Bank of India’s floating rate bond, issue was linked to the maximuminterest on term deposits that was 10 percent at the time. The floating rate is quoted interms of a margin above of below the benchmark rate. Interest rates linked to the benchmarkensure 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 wheninterest rates fall and inequitable to the lender when interest rates rise subsequently.

Shares Vs. Debentures

1. Shareholder has a proprietary interest in the company, and debenture holder isonly a creditor of the company.

2. Debenture holder is entitled to fixed interest whereas the shareholder is entitled todividends depending on and varying with profits.

3. Shareholders have voting rights whereas debenture holders do not have votingrights.

4. Debentures may be redeemable whereas share except preference shares are notredeemable

5. Debenture holders get priority over shareholders when assets are distributed uponwinding up

SEBI GUIDELINES

The preferential issue of equity shares/Fully Convertible Debentures (FCDs/PartlyConvertible Debentures (PCDs) or any other financial instruments which would beconverted into or exchanged with equity shares at a later date, by listed companies whoseequity share capital is listed on any stock exchange, to any selected group of personsunder the Companies Act, 1956 on private placement basis shall be governed by theseguidelines.

Such preferential issues by listed companies by way of equity shares/Fully ConvertibleDebentures (FCDs)/Partly Convertible Debentures (PCDs) or any other financialinstruments which would be converted into/exchanged with equity shares at a later date,shall be made in accordance with the pricing provisions mentioned below

PRICING OF THE ISSUE

Preferential Issue of Shares : The issue of shares on a preferential basis can be madeat a price not less than the higher of the following :

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a. The average of the weekly high and low of the closing prices of the related sharesquoted 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 shareholdersis held in terms of Section 81(1A) of the Companies Act, 1956 to consider theproposed issue) ( or )

b. The average of the weekly high and low of the closing prices of the related sharesquoted on a stock exchange (any of the recognized stock exchanges in which theshares are listed and in which the highest trading volume in respect of the shares ofthe company has been recorded during the preceding 6 months prior to the relevantdate) 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 beallotted shares, the issuer company shall determine the price of the resultant shares. Therelevant date for the above purpose may, at he option of the issuer be either the onereferred to above or a date 30 days prior to the date on which the holder of the warrantsbecomes entitled to apply for the said shares. The resolution to be passed in terms ofsection 81(1A) shall clearly specify the relevant date on the basis of which price of theresultant shares shall be calculated.

An amount equivalent to at least ten percent of the price fixed in terms of the aboveshall become payable for the warrants on the date of their allotment. The amount referredto above shall be adjusted against the price payable subsequently for acquiring the sharesby exercising an option for the purpose. The amount so referred to above shall be forfeitedif 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 samemanner 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 provisionfor 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 issueof the relevant instrument.

Non-transferability of Financial Instruments

The instruments allotted on a preferential basis to the promoter/promoter group shallbe subject to lock-in period of 3 years from the date of their allotment. In any case, notmore than 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/

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exercise of warrants and equity shares or any other security convertible at a later date intoequity 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 3years from the date of allotment. The lock-in on shares acquired by conversion of theconvertible instrument/exercise of warrants, shall be reduced to the extent the convertibleinstrument warrants have already been locked-in.

For computation of 20 percent of the total capital of the company, the amount ofminimum promoters contribution held and locked-in, in the past as per guidelines shall betaken into account. The minimum promoters contribution shall not again be put underfresh lock-in, even though it is considered for computing the requirement of 20 percent ofthe total capital of the company, in case the said minimum promoters contribution is free oflock-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 remainingperiod, and compliance of Securities and Exchange Board of India (Substantial Acquisitionof shares and Takeovers) Regulations, 1997, if applicable.

Currency of Shareholders Resolutions

Allotment pursuant to any resolution passed at a meeting of shareholders of a DFIgranting consent for preferential issues of any financial instrument, shall be completed withina period of 3 months from the date of passing of the resolution. If allotment of instrumentsand dispatch of certificates is not completed within three months from the date of suchresolution, a fresh consent of the shareholders shall be obtained and the relevant datereferred to above will relate to the new resolution.

Certificate from Auditors

In case of every issue of shares/warrants/FCDs/PCDs/other financial instrumentshaving conversion option, the statutory auditors of the issuer DFI shall certify that the issueof said instruments is being made in accordance with the requirements contained in theseguidelines. Copies of the auditors certificate shall also be laid before the meeting of theshareholders convened to consider the proposed issue.

Preferential Allotments to FIIs

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/ReserveBank of India on the subject.

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Non-applicability of the Guidelines

The above guidelines shall not be applicable where the further shares are allotted inpursuance to the merger and amalgamation scheme approved by the High Court andwhere further shares are allotted to a person/group of persons in accordance with theprovisions of rehabilitation packages approved by BIFR.

In case, such persons are promoters or belong to promoter group lock-in provisionsshall continue to apply unless otherwise stated in the BIFR order. Similarly, the aboveguidelines are not applicable where further shares are allotted to all India public financialinstitutions in accordance with the provision of the loan agreements signed prior to August4, 1994.

GLOBAL DEBT INSTRUMENTS

Following are some of the debt instruments that are popular in the international financialmarkets :

Income Bonds

Interest income on such bonds is paid only where the corporate command adequatecash flows. They resemble cumulative preference shares in respect of which fixed dividendis paid only if there is profit earned in a year, but carried forward and paid in the followingyear. There is no default on income bonds if interest is not paid. Unlike the dividend oncumulative preference shares, the interest on income bond is tax deductible. These bondsare issued by corporates that undergo financial restructuring.

Asset Backed Securities

These are a category of marketable securities that ate collateralized by financial assetssuch as installment loan contracts. Asset backed financing involves a disinter- mediatingprocess called ‘securitization’, whereby credit from financial intermediaries in the form ofdebentures are sold to third parties to finance the pool. REPOS are the oldest assetbacked security in our country. In USA, securitization has been undertaken for the followingthe oldest asset backed security in our country. In USA, securitization has been undertakenfor 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

NOTES



Junk Bonds

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 USAand are used primarily for financing takeovers. The coupon rates range from 16 to 25percent. Attractive deals were put together establishing their feasibility in terms of adequacyof cash flows to meet interest payments. Michael Milken (the junk bond king) of DrexelBurmham Lambert was the real developer of the market.

Indexed Bonds

These are the bonds whose interest payment and redemption value are indexed withmovements in prices. Indexed bonds protect the investor from the eroding purchasingpower of money because of inflation. For instance, an inflation-indexed bond implies thatthe payment of the coupon and/or the redemption value increases of decreases accordingto movements in prices. The bonds are likely to hedge the principal amount against inflation.Such bonds are designed to provide investors an effective edge against inflation so as toenhance the credibility of the anti-inflationary policies of the Government. The yields of aninflation-indexed bond provide vital information on the expected rate of inflation.

United Kingdom, Australia, and Canada have introduced index linked governmentsecurities as a segmented internal debt management operation with a view to increase therange of assets available in the system, provide an inflation hedge to investors, reduceinterest costs and pick up direct signals, and the expected inflation and real rate of interestfrom the market.

Zero-Coupon Bonds (ZCBs)/Zero Coupon 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 largesecurity brokers in large chunks, who resold them to individual investors, at a slightlyhigher price in affordable lots. Such bonds were called “Treasury Investment GrowthReceipts’(TIGRs) or ‘Certificate of Accruals on Treasury Securities’ (CATSs) or ZEROsas their coupon rate is Zero.

Moreover, these certificates were sold to investors at a hefty discount and the differencebetween the face value of the certificate and the acquisition cost was the gain. The holdersare 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, theinvestors usually being rewarded by way of a low premium on conversion

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c. There is only capital gains tax on the price differential and there is no tax on accruedincome

d. Possibility of efficient servicing of equity as there is no obligation to pay interest tillmaturity and the eventual conversion.

Mahindra & Mahindra came out with the scheme of Zero Coupon Bonds for the firsttime in India along with 12.5 percent convertible bonds for part financing of its modernizationand diversification scheme. Similarly, Deep Discount Bonds were issued by IDBI atRs.2,000 for a maturity of Rs.1 lakh after 25 years. These are negotiable instrumentstransferable by endorsement and delivery by the transferor. IDBI also offered OptionBonds which may be either cumulative or non-cumulative bonds where interest is payableeither on maturity or periodically. Redemption is also offered to attract investors.

Floating Rate Bonds (FRB’s)

Bonds that carry the provision for payment of interest at different rates for differenttime periods are known as ‘Floating Rate Bonds’. The first floating rate bond was issuedby the SBI in the Indian capital market. The SBI, while issuing such bonds, adopted areference rate of highest rate of interest on fixed deposit of the Bank, provided a minimumfloor rate payable at 12 percent p.a. and attached a call option to the Bank after 5 years toredeem the bonds earlier than the maturity period of 10 years at a certain premium. Amajor highlight of the bonds was the provision to reduce interest risk and assurance ofminimum 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 facevalue are called secured premium notes. Such bonds have a lock-in period during whichperiod no interest will be paid. It entitles the holder to sell back the bonds to the issuingcompany at par after the lock-in period.

A case in point was the issue made by the TISCO in the year 1992, where thecompany wanted to raise money for its modernization program without expanding itsequity excessively in the next few years. The company made the issue to the existingshareholders on a rights basis along with the rights issue. The salient features of the TISCOissue 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. (Lowinterest and high premium or high interest and low premium, at the option to beexercised by the SPN holder at the end of the third year)

NOTES



5. Warrant attached to each SPN entitled the holder the right to apply for or seekallotment of one equity share for cash payment of Rs.80 per share. Such a rightwas exercisable between first year and one.-and-a-half year after allotment bywhich time the SPN would be fully paid up.

This instrument tremendously benefited TISCO, as there was no interest outgo. Thishelped TISCO to meet the difficulties associated with the cash generation. In addition, thecompany was able to borrow at a cheap rate of 13.65 percent as against 17 to 18 percentoffered by most companies. This enabled the company to start redemption earlier throughthe generation of cash flow by the company’s projects. The investors had the flexibility oftax planning while investing in SDPNs. The company was also equally benefited as it gavemore flexibility.

Euro Convertible Bonds

Bonds that give the holders of euro bonds to have the instruments converted into awide variety of options such as the call option for the issuer and the put option for theinvestor, which makes redemption easy are called ‘Euro-convertible bonds’. A euro-convertible bond essentially resembles the Indian convertible debenture but comes withnumerous options attached. Similarly, a euro-convertible bond is an easier instrument tomarket than equity. This is because it gives the investor an option to retain his investmentsas a pure debt instrument in the event of the price of the equity share falling below theconversion 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 theEuro market and ensures that the issue has a better market reception than would bepossible for a direct equity issue. Moreover, newly industrialized countries such as Koreahave chosen the convertible bond market as a stepping-stone to familiarity and acceptanceof their industrial companies in the international market. The convertible bonds offer thefollowing advantages:

a. Protection : Euro convertible bonds are favoured by international investors as itoffers them the advantage of protection of their wealth from erosion. This is possiblebecause the conversion is only an option, which the investors may choose toexercise only if it works to their benefit. This facility is not available for equityissues.

b. Liquidity : Convertible bond market offers the benefit of the most liquid secondarymarket for new issues. Fixed income funds as well as equity investment managerspurchase convertible bonds.

c. Flexibility : The feature of flexibility in structuring convertible bonds allows thecompany to include some of the best possible clauses of investors’ protection byincorpo0rating the unusual features of equity investments. A case in point is the

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issues made by the Korean corporate sector, which contained a provision in theissue of convertible euro bonds. The provision entitled the holders to ensure thedue compliance of the liberalization measures that had already been announcedwithin a specified period of time. Such a provision enabled the investor to opt fora ‘put’ option.

d. Attraction investment : The issue of convertible debentures facilitates removalof many of the unattractive features of equity investment. For investors, convertiblebond 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 specialand innovative bond instruments exclusively structured on the investors’ preferences andfunds requirement of the issuers. The emphasis from the issuer’s view point is the resourcemobilization and not risk exposure. Several financial institutions such as the IDBI, theICICI, etc. are engaged in the sale of such bonds. A brief description of some thesebonds are presented below :

1. IDBI’s Zero Coupon Bonds, 1996 :

These bonds are sold at a discount and are paid no interest. It is of great advantageto issuers as it is not required for them to make periodic interest payment.

2. IDBI’s Regular Income Bonds, 1996 :

These were the bonds issued by the IDBI as 10-year bonds carrying a coupon of 16percent, payable half-yearly. The bonds provided an annualized yield equivalent to 16.64percent. The bonds, which were priced at Rs.5,000 can be redeemed at the end of everyyear, after the third year allotment. There was also a call option that entitled the IDBI toredeem 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 investorswho are planning for retirement. Under the scheme,. Investors get a monthly income for10 years after the 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 thebond.

4. IFCI’s 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 semi-annual yield of 16 percent and a front-end discount of 4 percent. The bonds hadthree-year put option and an early bird incentive of 0.75 percent.

NOTES



c. Step-up Liquid Bond – The five-year bonds with a put option every year with areturn of 16 percent, 16.25 percent, 16.5 percent, 16.75 percent, and 17 percentat the end of every year.

d. Growth Bond – An investment of Rs.20,000 per bond under this scheme entitlesinvestors to a Rs.1 lakh face-value bond maturing after 10 years. Put options canbe exercised at the end of 5 and 7 years respectively. If exercised, the investorgets 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 wasRs.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. ICICI’s Bonds, 1997

ICICI came out with as many as five bonds in March 1997. These are encashbonds, 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, besidescontributing to the widening of the bond market so as to bring the benefits of these securitiesto even the smallest investors.

a. Capital gains bond - Also called infrastructure bonds incorporated the capitalgains tax relaxations under Section 54EA of the Income Tax Act announced in theUnion Budget for 1997-98. They are issued for 3 and 7 years maturity. 20percent rebate was available under Section 88 of the I.T. Act for investors on theamount invested in the capital gains bonds up to a maximum of Rs.70,000. Theycan avail benefit under Section 88. The annual interest rate worked out to 13.4percent while the annual yield came to 20.7 percent. However, investment throughstock invest will not qualify for the rebate.

b. Encash Bond – The five-year encash bonds were issued at a face value ofRs.2,000 and can be redeemed at par across the country in 200 cities during 8months in a year after 12 months. The bond had a step-up interest every yearfrom 12 to 18.5 percent and the annualized yield at maturity for the bond worksout to 15.8 percent. The encashing facility, however, is available only to the originalbondholders. The bonds not only offer higher return but also help widen thebanking facilities to investors. The secondary market price of the bonds is likelyto be favourably influenced by the step-up interest that results in an improvedYTM every year.

c. Index Bond – It gives the investor both the security of the debt instrument andthe potential of the appreciation in the return on the stock market. Priced atRs.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 yearperiod. Its calculated yield was 15.26 percent. It also has a call and a put option attachedto it assuring the investor a return of Rs.9,300 after 6 years option is exercised. Part B is

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a detachable index warrant issued for 12 years and priced at Rs.2,000. The yield waslinked to the BSE SENSEX. The face value of the bond will appreciate the number oftimes 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 tobe 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 itsmultiples.

h. Maturity value – The cumulative maturity value of the bond will be Rs.1.511 atthe end of six years.

i. Form of issue – The bonds will be both in demat form as well as in the traditionalform of stock certificates. Option once chosen cannot be changed.

j. Transferability – Bonds will not be transferable except by way of gift to relativesas defined in the Companies Act.

k. Collaterals – The bonds cannot be used as collaterals for obtaining loans frombanks, financial institutions and non-banking financial companies.

l. Nomination – A sole holder or a sole surviving holder of the bond being an

individual can make a nomination.

3. PREPARATION OF PROSPECTUS

“ Prospectus” is defined a document through which public are solicited to subscribeto the share capital of a corporate entity.

Its purpose is invite the public for the subscription/purchase of any securities of acompany.

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

NOTES



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 registeredoffice consent of the Central Government for the issue and names of regionalstock exchanges etc.,

b. Capital Structure such as authorized, issued, subscribed and paid up capitaletc.,

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 ofthe project etc.,

f. Disclosures of public issues made by the Company, giving information abouttype 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, availabilityof 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 proposition. A memorandumcontaining the salient features of a prospectus as prescribed is called as ‘AbridgedProspectus’

4. SELECTION OF BANKERS

Merchant bankers assist in selecting the appropriate bankers based on the proposalsor projects. Because the commercial bankers are merely financiers and their activities are

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appropriately arrayed around credit proposals, credit appraisal and loan sanctions. Butmerchant banking include services like project counseling , corporate counseling in areasof capital restructuring amalgamations, mergers, takeover etc., discounting and rediscountingof short term paper in money markets, managing, underwriting and supporting public issuesin new issue market and acting as brokers and advisers on portfolio management in stockexchange.

5. ADVERTISING CONSULTANTS

Merchant bankers arrange a meeting with company representatives and advertisingagents 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 approveand 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 conferenceetc., The merchant bankers help choosing the media, determining the size and publicationsin 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 andprospectus conform to the standard prescribed by the stock exchange. The Merchantbanker has to ensure that the material is delivered to the stock exchange at least 21 daysbefore the issue opens and to brokers to the issue, branches of brokers to the issue andunderwriter in time.

Securities issues are underwritten to ensure that in case of under subscription theissues are taken up by the underwriters. SEBI has made underwriting mandatory for issuesto 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 boundprogramme which has to be promptly attended to. The execution of the activities withclock work efficiency would lead to a successful issue.

6. REGISTRARS TO AN ISSUE AND SHARE TRANSFER AGENTS

REGISTRATION

The registrars to an issue, as an intermediary in the primary market, carry on activitiessuch as collecting application from the investors, keeping a proper record of applicationsand money received from investors or paid to the seller of securities and assisting companiesin determining the basis of allotment of securities in consultation with stock exchanges,finalizing the allotment of securities and processing/despatching allotment letters, refund

NOTES



orders, certificates and other related documents in respect of issue of capital. The sharetransfer agents maintain the records of holders of securities or on behalf of companies, anddeal with all matters connected with the transfer/redemption of its securities. To carry ontheir activities, they must be registered with the SEBI which can also renew the certificateof registration.

They are divided into two categories;

a. Category I, to carry on the activities as a registrar to an issue and share transferagent;

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 relevantmatters 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 registrationand any director/partner/principal officer has not been convicted for any offence involvingmoral turpitude or has been found guilty of any economic offence.

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 sharetransfer agents respectively. However, the capital adequacy requirements are not applicablesince November 1999 for a department/division of a body corporate maintaining the recordsof 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 payan annual fee respectively of Rs.15,000 and Rs.10,000 for initial registration a well asrenewal. With effect from November 1999, while Category I is required to pay a registrationfee of Rs.50,000 and a renewal fee of Rs.40,000 every three years, Category II has topay Rs.30,000 and Rs.25,000 respectively.

GENERAL OBLIGATIONS AND RESPONSIBILITIES

CODE OF CONDUCT FOR REGSTER TO AN ISSUE AND SHARETRANSFER 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 independentprofessional judgment.

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4. Exercise adequate care, caution and due diligence before dematerialization ofsecurities by confirming and verifying that the securities to be dematerialized havebeen granted listing permission by the stock exchange(s).

5. Always endeavour to ensure that (a) inquiries from investors are adequately dealtwith; (b) grievances of investors are redressed without any delay; (c) transfer ofsecurities held in physical form and confirmation of dematerialization/rematerialisation requests and distribution of corporate benefits and allotment ofsecurities is done within the time specified under any law.

6. Make reasonable efforts to avoid misinterpretation and ensure that the informationprovided to the investors is not misleading.

7. Not reject the dematerialization/rematerialisation requests on flimsy grounds. Suchrequests could be rejected only on valid and proper grounds and supported byrelevant 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 arisein the conduct of its business or where any conflict of interest arises, should takereasonable steps to resolve the same in an equitable manner.

10. Make appropriate disclosure to the client of its source or potential areas of conflictof duties and interest which would impair its ability to render fair, objective andunbiased services.

11. Not indulge in any unfair competition, which is likely to harm the interests of otherregistrar to the issue and share transfer agent or investors or is likely to place himin disadvantageous position while competing for or executing any assignment.

12. Always endeavour to render the best possible advice to the clients having regardto their needs.

13. Not divulge to other clients, press or any other person any confidential informationabout its clients which as come to its knowledge except with the approval/authorization of the client or when it is required to disclose the information underany law for the time being in force.

14. Not discriminate among its clients, save and except on ethical and commercialconsiderations.

15. Ensure that any change in registration status/any penal action taken by the SEBI orany material change in financials which may adversely affect the interest of clients/investors is promptly informed to the clients.

16. Maintain the required level of knowledge and competence and abide by theprovisions of the SEBI Act, rules, regulations, circulars and directions issued bythe 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.

NOTES



18. Not neglect or fail or refuse to submit to the SEBI or other agencies with which heis registered, such books, documents, correspondence, and papers or any partthereof 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 anylaw, rules, regulations, directions of the SEBI or of any other regulatory body.

20. Take adequate and necessary steps to ensure that continuity in data and record-keeping 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 upis always available with it.

21. Endeavour to resolve all the complaints against it or in respect of the activitiescarried out by it as quickly as possible.

22. (a) Not render, directly or indirectly any investment advice about any security inthe publicly accessible media, whether real-time or non-real time, unless a disclosureof its long or short position in he securities has been made, while rendering suchadvice; (b) In case an employee of a registrar to an issue and share transfer agentis rendering such advice, the registrar to an issue and share transfer agent shouldensure that it also discloses its own interest, the interests of his dependent familymembers and that of the employer including their long or short position in thesecurity, while rendering such advice.

23. Handover all the records/data and all related documents which are in its possessionin its capacity as a registrar to an issue and/or share transfer agent to the respectiveclients, within one month from the date of termination of agreement with therespective clients within or within one month from the date of expiry/cancellationof 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 eitherabout its qualifications or capability to render certain services or should itsachievements in regard to services rendered to other clients.

25. Ensure that it has satisfactory internal control procedures in place as well as adequatefinancial and operational capabilities which can be reasonably expected to takecare of any losses arising due to theft, fraud and other dishonest acts, professionalmisconduct or omission.

26. Provide adequate freedom and powers to its compliance officer for the effectivedischarge of its duties.

27. Develop its own internal code of conduct for governing its internal operations andlaying down its standards of appropriate conduct for its employees and officers incarrying out its duties as a registrar to an issue and share transfer agent and as apart of the industry. Such a code may extend to the maintenance of professionalexcellence and standards, integrity, confidentiality, objectivity, avoidance of conflictof interests, disclosure of shareholdings and interests, etc.

28. Ensure that good corporate policies and corporate governance are in place.

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29. Ensure that any person it employs or appoints to conduct business is fit and properand otherwise qualified to act in the capacity so employed or appointed (includinghaving relevant professional training or experience).

30. Be responsible for the acts or omissions of its employees and agents in respect ofthe 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 unpublishedprice 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 allapplications received from investors in respect of an issue, all rejected applications togetherwith 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 andnon-allotees, refund orders, and so on. In addition, they should also keep a record to thelist of holders of securities of corporates, the names of transfer agents to file the books ofaccounts, and records, and so on. These have to be preserved by them for a period ofthree years.

INSPECTION

The SEBI is authorized to undertake the inspection of the books of accounts, otherrecords, and documents of the registrars and share transfer agents to ensure that they arebeing maintained in a proper manner and the provisions of the SEBI Act, rules, regulationsand the provisions of the SCRA and the relevant rules are complied with, to investigateinto complaints from investors/other registrars and share transfer agents/other intermediariesin the securities market or any matter relating to their activities, and to investigate on itsown in the interest of securities market/investors into their affairs. On the basis of theinspection report, the SEBI can direct the concerned partly to take such measures as itdeems fit in the circumstances. It can also appoint a qualified auditor to investigate into thebooks 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 towhich 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 suspensionor cancellation of registration.

The penalty for suspension is imposed for (a) violations of the provisions of the SEBIAct, rules/regulations, (b) non-observance of the code of conduct, (c) failure to furnishinformation, furnishing of wrong/false information, non-submission of periodical information

NOTES



and non-cooperation in any enquiry, (d) failure to resolve investor complaints or give asatisfactory reply to the SEBI in this behalf, (e) involvement in manipulation/price rigging/cornering activities, (f) guilty of misconduct/improper business-like or unprofessionalconduct business-like or unprofessional conduct, (g) failure to maintain capital adequacyrequirement or to pay the requirement or to pay the requisite fee; and (h) violation of theconditions of registration.

In case of their repeated defaults, the certificate of registration can be cancelled. Theother reasons for cancellation of registration are deliberate manipulation/price rigging/cornering activities affecting the securities market and the investor interest; violation of theprovisions 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 procedurefor inspection, holding enquiry and suspension/cancellation is the same as in the case oflead managers, underwriters, bankers to the issue, and so on.

8. UNDERWRITERS

Another important intermediary in the new issue/primary market is the underwritersto issues of capital who agree to take up securities which are not fully subscribed. Theymake a commitment to get the issue subscribed either by others or by themselves. Thoughunderwriting is not mandatory after April 1995, its organization is an important element ofthe primary market. Underwriters are appointed by the issuing companies in consultationwith the lead managers/merchant bankers to the issues. A statement to the effect that in theopinion of the lead manager, the underwriters’ assets are adequate to meet their obligationshould be incorporated in the prospectus.

REGISTRATION

To act as underwriter, a certificate of registration must be obtained from the SEBI. Ingranting the certificate of registration, the SEBI considers all matters relevant/relating tothe underwriting and in particular,

a) the necessary infrastructure like adequate office space, equipment and manpowerto effectively discharge the activities

b) past experience in underwriting/employment of at least two persons with experiencein underwriting

c) any person directly/indirectly connected with the applicant is not registered withthe SEBI as under or a previous application of any such person has been rejectedor 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) ofRs.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.

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FEE

Underwriters, had to, for grant or renewal of registration, pay a fee to the SEBI fromthe date of initial grant of certificate, Rs. 2 lakhs for the first and second years and Rs.1lakh for the third year. A fee of Rs.20,000 was payable every year to keep the certificatein 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 thefourth year from the date of initial registration is payable. Failure to pay the fee would resultin the suspension of the certificate of registration.

GENERAL OBLIGATIONS AND RESPONSIBILITIES

CODE OF CODUCT 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 abody corporate making an issue of securities (i.e. the issuer).

4. Endeavour to ensure all professional dealings are effected in a prompt, efficientand effective manner.

5. At all times render high standards of service, exercise due diligence, ensure propercare and exercise independent professional judgment.

6. Not make any statement, either oral or written, which would misrepresent (a) theservices that the underwriter is capable of performing for its client, or has renderedto 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 arisein the conduct of its business or where any conflict of interest arises, should takereasonable steps to resolve the same in any equitable manner.

9. Make appropriate disclosure to the client of its possible source or potential inareas of conflict of duties and interest while acting as underwriter which wouldimpair its ability to render fair, objective and unbiased services.

10. Not divulge to other issuer, press or any party any confidential information aboutits issuer company, which has come to its knowledge and deal in securities of anyissuer company without making disclosure to the SEBI as required under theseregulations and also to the Board directors of the issuer company.

11. Not discriminate amongst its clients, save and except on ethical and commercialconsiderations.

12. Ensure that any charge in registration status/any penal action taken by SEBI or anymaterial change in financials which may adversely affect the interests of clients/investors is promptly informed to the clients and any business remaining outstanding

NOTES



is transferred to another registered person in accordance with any instructions ofthe affected clients/investors.

13. Maintain an appropriate level of knowledge and competency and abide by theprovisions of the SEBI Act, regulations, circulars and guidelines issued by theSEBI. The underwriter should also comply with the award of the Ombudsmanunder 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, ofany law, rules, regulations, 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 inthe publicly accessible media, whether real-time or non-real-time, unless a disclosureof 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 renderingsuch advice, the underwriter should ensure that he should disclose his interest,the interest of his dependent family members and that of the employer includingtheir long or short position in the security, while rendering such advice.

17. Not either through its account or their respective accounts or through their associatesor family members, relatives or friends indulge in any insider trading.

18. Not indulge in any unfair competition, which is likely to be harmful to the interest ofother underwriters carrying on the business of underwriting or likely to place suchother underwriters in a disadvantageous position in relation to the underwriterwhile competing for, or carrying out any assignment.

19. Have internal control procedures and financial and operational capabilities whichcan be reasonably expected to protect its operations, its clients and other registeredentities 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 effectivedischarge of his duties.

21. Develop its own internal code of conduct for governing its internal operations andlaying down its standards of appropriate conduct for its employees and officers inthe carrying out of their duties. Such a code may extend to the maintenance ofprofessional 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 properand otherwise qualified to act in the capacity so employed or appointed (includinghaving relevant professional training or experience).

24. Ensure that it has adequate resources to supervise diligently and does supervisediligently persons employed or appointed by it to conduct business on its behalf.

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NOTES


25. Be responsible for the acts or omissions of its employees and agents in respect tothe conduct of its business.

26. Ensure that the senior management, particularly decision makers have access to allrelevant information about the business on a timely basis.

27. Not be party to or instrumental for (a) certain of false market, (b) price rigging ormanipulation, or; (c) passing of unpublished price sensitive information in respectof securities which are listed and proposed to be listed in any stock exchange toany person or intermediary.

AGREEMENT WITH CLIENTS

Every underwriter has to enter into an agreement with the issuing company. Theagreement, 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 besubscribe to the issue after being intimated by/on behalf of the issuer, the amount ofcommission/brokerage, and details of arrangements, if any, made by the underwriter forfulfilling the underwriting obligations.

GENERAL RESPONSIBILITIES

An underwriter cannot derive any direct or indirect benefit from underwriting theissue other than by the underwriting commission. The maximum obligation under allunderwriting agreements of an underwriter cannot exceed twenty times his net worth.Underwriters have to subscribe for securities under the agreement with 45 days of thereceipt 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 andobligations of the underwriters is broadly on the same pattern as applicable to the leadmanagers.

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 underwriterinvolves the suspension/cancellation of registration, the effect of suspension/cancellation are on the lines followed by the SEBI in case of lead managers.

NOTES



9. BANKERS TO AN ISSUE

The bankers to an issue are engaged in activities such as acceptance of applicationsalong with application money from the investors in respect of issues of capital and refundof application money.

REGISTRATION

To carry on activity as a banker to issue, a person must obtain a certificate of registrationfrom the SEBI. The SEBI grants registration on the basis of all the activities relating tobanker to an issue in particular with reference to the following requirements:

a) The applicant has the necessary infrastructure, communication and data processingfacilities and manpower to effectively discharge his activities,

b) The applicant/any of the directors of the applicant is not involved in any litigationconnected with the securities market/has not been convicted of any economicoffence;

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 canapply 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 thefirst two years from the date of initial registration, and Rs.1 lakh for the third year to keephis registration in force. The renewal fee to be paid by him annually for the first two yearswas Rs.1 lakh and Rs.20,000 for the third year. Since 1999, schedule of fee is Rs.5 lakhsas initial registration fee and Rs.2.5 lakhs renewal fee every three years from the fourthyear from the date of initial registrations. Non-payment of the prescribed fee may lead tothe suspension of the registration certificate.

GENERAL OBLIGATIONS AND RESPONISBILITIES

FURNISH INFORMATION

When required, a banker to an issue has to furnish to the SEBI the followinginformation;

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 issuingcompany /registrar to an issue;

d) The dates/amount of refund to the investors.

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NOTES


BOOKS OF ACCOUNT/RECORD/DOCUMENTS

A banker to an issue is required to maintain books of accounts/records/documentsfor a minimum period of three years in respect of, inter-alia, the number of applicationsreceived, the names of the investors, the time within which the applications received wereforwarded to the issuing company/registrar to the issue and dates and amounts of refundmoney to investors.

DISCIPLINARY ACTION BY THE RBI

If the RBI takes any disciplinary action against a banker to an issue in relation to issuepayment, the latter should immediately inform the SEBI. If the banker is prohibited fromcarrying on his activities as a result of the disciplinary action, the SEBI registration isautomatically deemed as suspended/cancelled.

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.

4. At all times exercise due diligence, ensure proper care and exercise independentprofessional judgment

5. Not any time act in collusion with other intermediates over the issuer in a mannerthat 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 anyfurther 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 bankpremises or peddled anywhere near the entrance of the premises;

b) Accept applications after office hours or after the date of closure of the issueor 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 designatedregistrar to the issue;

d) Part with the issue proceeds until listing permission is granted by the stockexchange to the body corporate;

NOTES



e) Delay in issuing the final certificate pertaining to the collection figures to theregistrar to the issue, the lead manager and the body corporate and suchfigures should be submitted within seven working days from the issue closuredate.

8. Be prompt in disbursing dividends, interests or any such accrual income receivedor collected by him on behalf of his clients.

9. Not make any exaggerated statement whether oral or written to the client, eitherabout its qualification or capability to render certain services or its achievements inregard to services rendered to other client.

10. Always endeavour to render the best possible advice to the clients having regardto the clients’ needs and the environments and his own professional skill.

11. Not divulge to any body either orally or in writing, directly or indirectly, anyconfidential information about its clients which has come to its knowledge, withouttaking 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 arisein the conduct of its business or where any conflict of interest arise, should takereasonable steps to resolve the same in an equitable manner.

14. Make appropriate disclosure to the client of its possible source or potential areasof conflict of duties and interest while acting as banker to an issue which wouldimpair its ability to render fair, objective and unbiased services.

15. Not indulge in any unfair competition, which is likely to harm the interests of otherbankers to an issue or investors or is likely to place such other bankers to an issuein a disadvantageous position while competing for or executing any assignment.

16. Not discriminate amongst its clients, save and except on ethical and commercialconsiderations.

17. Ensure that any change in registration status/any penal action taken by the SEBI orany material change in financials which may adversely affect the interests of clients/investors is promptly informed to the clients and business remaining outstanding istransferred to another registered person in accordance with any instructions of theaffected clients/investors.

18. Maintain an appropriate level of knowledge and competency and abide by theprovisions of the SEBI Act, regulations, circulars and guidelines of the SEBI. Thebanker to an issue should also comply with the award of the Ombudsman passedunder 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 regulatorybody.

20. Not make any untrue statement of suppress any material fact in any documents,reports, papers or information furnished to the SEBI.

DBA 1724

NOTES


21. Not neglect or fail or refuse to submit to the SEBI or other agencies with which itis registered, such books, documents, correspondence, and papers or any partthereof 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 totime by the Central Government, relevant to the activities carried on the banker toan issue.

23. (a) Not render, directly or indirectly, any investment advice about any security inthe publicly accessible media, whether real-time or non-real-time, unless a disclosureof its interest including long or short position in the security has been made, whilerendering such advice; (b) in case an employee of the banker to an issue is renderingsuch advice, the banker to an issue should ensure that he discloses his interest, theinterest of his dependent family members and that of the employer includingemployer’s long or short position in the security, while rendering such advice.

24. A banker to an issue or any of its directors, or employee having the managementof the whole or substantially the whole of affairs of the business, should not, eitherthrough its account or their respective accounts or through their family members,relatives or friends indulge in any insider trading.

25. Have internal control procedures and financial and operational capabilities whichcan be reasonable expected to protect its operations, its clients, investors andother registered entities from financial loss arising from theft, fraud, and otherdishonest acts, professional misconduct or omissions.

26. Provide adequate freedom and powers to its compliance officer for the effectivedischarge of its duties.

27. Develop its own internal code of conduct for governing its internal operations andlaying down its standards of appropriate conduct for its employees and officers inthe carrying out of their duties as a banker to an issue and as a part of the industry.Such a code may extend to the maintenance of professional excellence andstandards, integrity, confidentiality, objectivity, avoidance of conflict of interests,disclosure of shareholding and interests, etc.

28. Ensure that any person it employs or appoints to conduct a business is fit andproper and otherwise qualified to act in the capacity so employed or appointed(including having relevant professional training or experience).

29. Ensure that it has adequate resources to supervise diligently and does supervisediligently persons employed or appointed by it to conduct business on its behalf.

30. Be responsible for the acts or omissions of its employees and agents in respect tothe conduct of its business.

31. Ensure that the senior management, particularly decision makers have access to allrelevant information about the business on a timely basis.

32. Endeavour to ensure that arms length relationship is maintained in terms of bothmanpower and infrastructure between the activities carried out as banker to anissue and other permitted activities.

NOTES



33. Not be a party to or instrumental for (a) creation of false market; (b) price riggingor manipulations; or (c) passing of unpublished price sensitive information in respectof securities which are listed and proposed to be listed in any stock exchange toany person or intermediary.

INSPECTION

Such inspection is done by the RBI upon the request of the SEBI. The purpose ofinspection is largely to ensure that the required books of accounts are maintained and toinvestigate 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 theregulatory framework of the SEBI with a view to ensuring greater investor protection. Onthe basis of the inspection report, the SEBI can direct the banker to an issue to take suchmeasures as it may deem fit in the interest of the securities market and for due compliancewith 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/falseinformation;

c) Fails to resolve investor complaints/to give satisfactory reply to SEBI;

d) Is guilty of misconduct/unprofessional conduct inconsistent with the prescribedcode 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.

10. BROKERS TO THE ISSUE

Brokers are the persons mainly concerned with the procurement of subscriptionto the issue from the prospective investors. The appointment of brokers is not compulsoryand the companies are free to appoint any number of brokers. The managers to the issueand the official brokers organize the preliminary distribution of securities and procuredirect subscriptions from as large or as wide a circle of investors as possible.

DBA 1724

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The stock exchange bye-laws prohibits the members from the acting as managers orbrokers to the issue and making preliminary arrangement in connection with any flotationor new issue, unless the stock exchange of which they are members gives its approval andthe company conforms to the prescribed listing requirements and undertakes to have itssecurities listed on a recognized stock exchange. The permission granted by the stockexchange is also subject o other stipulations which are set out in the letter of consent. Theiractive assistance is indispensable for broad basing the issue and attracting investors. Byand large, the leading merchant bankers in India who act as managers to the issue haveparticulars of the performance of brokers in the country.

The company in consultation with the stock exchange writes to all active brokers ofall exchanges and obtains their consent to act as brokers to the issue. Thereby, the entryof 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 befiled along with the prospectus to the ROC. The names and addresses of the brokers tothe 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 at1.5 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 brokersand no payment on that account is made by the companies. A clause to this effect must beincluded in the agreement to be entered into between the broker and the company. Thelisted companies are allowed to pay a brokerage on private placement of capital at amaximum rate of 0.5 percent. Brokerage is not allowed in respect of promoters quotaincluding the amounts taken up by the directors, their friends and employees, and inrespect of the rights issues taken by or renounced by the existing shareholders. Brokerageis not payable when the applications are made by the institutions/bankers against theirunderwriting commitments or on the amounts devolving on them as underwriters consequentto the under subscription of the issues.

The issuing company is expected to pay brokerage within two months from the dateof allotment and furnish to the broker, on request, the particulars of allotments made againstapplications bearing their stamp, without any charge. The Cheques relating to brokerageon new issues and underwriting commission, if any, should be made payable at par at allcentres where the recognized stock exchanges are situated. The rate of brokerage payablemust be is enclosed in the prospectus.


Q.1.3.a. What are the functions performed by the merchant banker in connection with management of public issue of corporate enterprise ?

Q.1.3.b. Explain with the help of a chart the mechanics of public issue management

NOTES



Q.1.3.c. What are the different categories of security issue ?

Q.1.3.d. Write a note on ‘rights issue’.

Q.1.3.e. State the advantages of ‘private placement’.

Q.1.3.f. Who is an issue manager ? What are the requirements to be fulfilled for carrying out his functions ?

Q.1.3.g. What are the restrictions placed on the issue managers by the SEBI ?

Q.1.3.h. What is the role of an issue manager as regards public issue management ?

Q.1.3.i. Elaborate on the pre-issue activities involved in the management of public issue.

Q.1.3.j. Define ‘capital structure’.

Q.1.3.k. What does the term ‘optimal capital structure’ refer to? Bring out the salient features of optimal capital structure of a firm.

Q.1.3.l. State the fundamental patterns of capital structure.

Q.1.3.m. What do you mean by capital structure decisions? What principles govern such decisions?

Q.1.3.n. What are capital market instruments? What are its features?

Q.1.3.o. State the various types of capital market instruments.

Q.1.3.p. What are preference shares? What are its types?

Q.1.3.q. Write a short note on fully convertible preference shares.

Q.1.3.r. What are equity shares? What are its features?

Q.1.3.s. What are convertible cumulative preference shares? What are the terms and conditions governing the issue of such shares?

Q.1.3.t. What are the different types of debt instruments issued by companies in India?

Q.1.3.u. What are the SEBI guidelines relating to convertible debentures?

Q.1.3.v. What are ‘junk bonds’? How are they different from ‘indexed bonds’?

Q.1.3.w. How are floating rate bonds different from secured premium notes?

SUMMARY

Thus the Merchant Banking functions can be simplified as

(i) Banking

All types of foreign exchange transactions including advice on exchange, imports,exports finance, financing the movement of goods through acceptance credits, the handlingof commercial letters of credit, the negotiation and collection of foreign bills, accepting callor term deposits, short or medium term finance, bridging finance, leading; corporate banking,treasury/trading services, discount/guarantee facilities.

Issuing and underwriting.

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Public issues; underwriting of issues, preparation of prospectuses; new equity; obtainingstock exchange listings/broking services.

(ii) Corporate Finance

New issues; development capital; negotiation of mergers and takeovers; capitalreconstruction; bridging finance, medium term loans; public sector finance.

(iii) Management Services

Economic planning; trusts administration; share secretarial services; primary capitalmarket 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, estateplanning, trusts, share transfers.

NOTES



LESSON 22.1 INTRODUCTION

Marketing the public issue arises because of the highly competitive nature of thecapital market. Moreover, there is a plethora of companies, which knock at the doors ofinvestors seeking to sell their securities. Above all the media bombards the modern investorswith eye catching advertisement to sell their concepts to prospective investors.



• The different steps in marketing new issues

• The different methods of marketing new issues

• The pricing of new issues

• The law relating to issue management

2.3 MERCHANT BANKING AND MARKETING OF NEW ISSUES

Following are the steps involved in the marketing of the issue of securities to beundertaken by the lead manager:

1. Target market : The first step towards the successful marketing of securities isthe identification of a target market segment where the securities can be offeredfor sale. This ensures smooth marketing of the issue. Further, it is possible toidentify whether the market comprises of retail investors, wholesale investors orinstitutional investors.

2. Target concentration : After having chosen the target market for selling thesecurities, steps are to be taken to assess the maximum number of subscriptionsthat can be expected from the market. It would work to the advantage of thecompany if it concentrates on the regions where it is popular among prospectiveinvestors.

3. Pricing : After assessing market expectations, the kind and level of price to becharged for the security must be decided. Pricing of the issue also influences thedesign of capital structure. The offer has to be made more attractive by includingsome unique features such as safety net, multiple options for conversion, attachingwarrants, etc.

4. Mobilizing intermediaries : For successful marketing of public issues, it isimportant that efforts are made to enter into contracts with financial intermediariessuch as an underwriter, broker/sub-broker, fund arranger, etc.

5. Information contents : Every effort should be mad3e to ensure that the offerdocument for issue is educative and contains maximum relevant information.Institutional investors and high net worth investors should also be provided with

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detailed research on the project, specifying its uniqueness and its advantage overother existing or upcoming projects in a similar field.

6. Launching advertisement campaign : In order to push the public issue, thelead manager should undertake a high voltage advertisement campaign. Theadvertising agency must be carefully selected for this purpose. The task of advertisingthe issue shall be entrusted to those agencies that specialize in launching capitalofferings. The theme of the advertisement should be finalized keeping in viewSEBI 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 leadmanager should arrange for brokers’ and investors’ conferences in the metropolitancities and other important centres which have sufficient investor population. Inorder to make such endeavors more successful, advance planning is required . Itis important that conference materials such as banners, brochures, application forms,posters, etc. reach the conference venue in time. In addition, invitation to all theimportant 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 companywith 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.

2.3.1 Methods

Following are the various methods being adopted by corporate entities for marketingthe securities in the new Issues Market:

1. Pure Prospectus Method

2. Offer for Sale Method

3. Private Placement Method

4. Initial Public Offers Method

NOTES



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 Brought-Out Deals Method

1. PURE PROSPECTUS METHOD

The method whereby a corporate enterprise mops up capital funds from the generalpublic by means of an issue of a prospectus, is called ‘Pure Prospectus Method’. It is themost 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 areoffered for exclusive subscription of the general public. According to the SEBInorms, a minimum of 49 percent of the total issue at a time is to be offered topublic.

b. Issue price : Direct offer is made by the issuing company to the general public tosubscribe to the securities at a staged price. The securities may be issued either atpar, of at a discount or at a premium.

c. Underwriting : Public issue through the ‘pure prospectus method’ is usuallyunderwritten. This is to safeguard the interest of the issuer in the event of anunsatisfactory response from the public.

d. Prospectus : A document that information relating to the various aspects of theissuing company, besides other details of the issue is called a ‘Prospectus’. Thedocument is circulated to the public. The general details include the company’sname and address of the registered office, the names and addresses of the company’spromoters, manager, managing director, directors, company secretary, legal adviser,auditors, bankers, brokers, etc. the date of opening and closing of subscription

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NOTES


list, contents of Articles, the names and addresses of underwriters, the amountunderwritten and the underwriting commission, material details regarding the project,i.e. Location, plant and machinery, technology, collaboration, performanceguarantee, infrastructure facilities etc. nature of products, marketing set-up, exportpotentials and obligations, past performance and future prospects, management’sperception regarding risk factor, credit rating obtained from any other recognizedrating 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 securitiesserves as an excellent mode of disclosure of all the information pertaining to theissue. Besides, it also facilitates satisfactory compliance with the legal requirementsof transparency etc.. It also allows for good publicity for the issue. The methodpromotes confidence of investors through transparency and non-discriminatorybasis of allotment. It prevents artificial packing up of prices as the issue is madepublic.

b. Benefits to Issuers : The pure prospectus method is the most popular methodamong the large issuers. In addition, it provides for wide diffusion of ownership ofsecurities 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 expensivemode of raising funds from the capital market. Costs of various hues are incurredin mobilizing capital. Such costs as underwriting expenses, brokerage, administrativecosts, 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 onlyfor 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 couldtake place. For instance, a lot of work such as underwriting, etc. should beformalized before the printing and the issue of a prospectus.

2. OFFER FOR SALE METHOD

Where the marketing of securities takes place through intermediaries, such as issuehouses, 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, inthe first stage, the issuer company makes an en-block sale of securities to intermediariessuch 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 differencebetween the purchase price and the issue price constitutes ‘profit’ for the intermediaries.

NOTES



The intermediaries are responsible for meeting various expenses such as underwritingcommission, prospectus cost, advertisement expenses, etc.

The issue is also underwritten to ensure total subscription of the issue. The biggestadvantage of this method is that it saves the issuing company the hassles involved in sellingthe shares to the public directly through prospectus. This method is, however, expensivefor the investor as it involves the offer of securities by issue houses at very high prices.

3. PRIVATE PLACEMENT METHOD

A method of marketing of securities whereby the issuer makes the offer of sale toindividuals and institutions privately without the issue of a prospectus is known as ‘PrivatePlacement Method’. This is the most popular method gaining momentum in recent timesamong the corporate enterprises.

Under this method, securities are offered directly to large buyers with the help ofshares 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 arein turn placed at higher prices to individuals and institutions. Institutional investors play asignificant role in the realm of private placing. The expenses relating to placement areborne by such investors.

ADVANTAGES

1. Less expensive as various types of costs associated with the issue are borne bythe issue houses and other intermediaries.

2. Less troublesome for the issuer as there is not much of stock exchange requirementsconnecting 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 temporarilyand misleading general public.

3. Depriving the common investors of an opportunity to subscribe to the issue, thus

affecting their confidence levels.

4. INTIAL PUBLIC OFFER (IPO) METHOD

The public issue made by a corporate entity for the first time in its life is called ‘InitialPublic Offer’ (IPO). Under this method of marketing, securities are issued to successfulapplicants on the basis of the orders placed by them, through their brokers.

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When a company whose stock is not publicly traded wants to offer that stock to thegeneral public, it takes the form of ‘Initial Public Offer’. The job of selling the stock isentrusted to a popular intermediary, the underwriter. An underwriter is invariably aninvestment banking company. He agrees to pay the issuer a certain price for a minimumnumber of shares, and then resells those shares to buyers, who are often the clients of theunderwriting firm. The underwriters charge a fee for their services.

Stocks are issued to the underwriter after the issue of prospectus which providesdetails of financial and business information as regards the issuer. Stocks are then releasedto 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 withwords in red letters which say this is preliminary and the price is not yet set) may or maynot be close to the final issue price. IPO stock at the release price is usually not availableto most of the public. Good relationship between the broker and the investor is a pre-requisite for the stock being acquired.

Full disclosure of all material information in connection with the offering of new securitiesmust be made as part of the new offerings. A statement and preliminary prospectus (alsoknown as a red herring) containing the following information is to be filed with the Registrarof Companies:

1. A description of the issuer’s business

2. The names and addresses of the key company offers, with salary and a 5 yearbusiness 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 offeringwill 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 intimatedof the share allocation by the issuer. The amount becomes payable to the issuer throughthe broker only on final allocation. The allotment is credited and share certificates deliveredto 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 theclient with the issuer.

b. Share allocation : The issuer finalizes share allocation and informs the brokerregarding the same.

NOTES



c. The client : The broker advises the successful clients of his share allocationClients then submit the application forms for shares and make payment to theissuer through the broker.

d. Primary issue account : The issuer opens a separate escrow account (primaryissue account) for the primary market issue. The clearing house of the exchangedebits 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 noneed for the investors to part with the money even before the shares are allotted in hisfavour. Further, the method allows for elimination of unnecessary hassles involved in makinga public issue. Under the regulations of the SEBI, IPOS can be carried out through thesecondary market and the existing infrastructure of stock exchanges can be used for thispurpose.

5. RIGHTS ISSUE METHOD

Where the shares of an existing company are offered to its existing shareholders, ittakes the form of ‘rights issue’. Under this method, the existing company issues shares toits 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 wherewithdrawn, no security shall be eligible for listing up to 12 months

3. Underwriting as to rights issue is optional and appointment of Registrar iscompulsory

4. Appointment of category I Merchant Bankers holding a certificate of registrationissued 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 securitiesto be issued

8. Issue shall be kept open for a minimum period of 30 days and for a maximumperiod 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’ is to be filed by the ‘Lead Merchant Banker’ withthe SEBI after 21 days from the date of issue of offer document

12. Obligatory for a company where increase in subscribed capital is necessary aftertwo years of its formation or after one year of its first issue of shares, whichever isearlier

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ADVANTAGES

Rights issue offers the following advantages :

1. Economy : Rights issue constitutes the most economical method of raising freshcapital, as it involves no underwriting and brokerage costs. Further, the expensesby way of advertisement and administration, etc. are less.

2. Easy : The issue management procedures connected with the rights issue areeasier as only a limited number of applications are to be handled.

3. Advantage of shareholders: Issue of rights shares does not involve any dilutionof ownership of existing shareholders. Further, it offers freedom to shareholders

to subscribe or not to subscribe the issue.

DRAWBACKS

The method suffers from the following limitations:

1. Restrictive : The facility of rights issue is available only to existing companiesand not to new companies.

2. Against society : The issue of rights shares runs counter to the overall societalconsiderations of diffusion of shares ownership for promoting dispersal of wealthand economic power.

6. BONUS ISSUES METHOD

Where the accumulated reserves and surplus of profits of a company are convertedinto paid up capital, it takes the form of issue of ‘bonus shares’. It merely implies capitalizationof exiting reserves and surplus of a company. The issue of bonus shares is subject tocertain rules and regulations. The issue does not in any way affect the resources base ofthe 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 theguidelines issued by the SEBI (applicable to listed companies only) as follows:

SEBI GUIDELINES

Following are the guidelines pertaining to the issue of bonus shares by a listed corporateenterprise:

1. Reservation

In respect of FCDs and PCDs, bonus shares must be reserved in proportion to suchconvertible part of FCDs and PCDs. The shares so reserved may be issued at the time ofconversion(s) of such debentures on the same terms on which the bonus issues weremade.

NOTES



2. Reserves

The bonus issue shall be made out of free reserves built out of the genuine profits orshare premium collected in cash only. Reserves created by revaluation of fixed assets arenot 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 fixeddeposits and interest on existing debentures or principal on redemption thereof and hassufficient reason to believe that it has not defaulted in respect of the payment of statutorydues of the employees such as contribution to provident fund, gratuity, bonus etc.

6. Implementation

A company that announces its bonus issue after the approval of the Board of Directorsmust implement the proposal within a period of 6 months from the date of such approvaland shall not have the option of changing the decision.

7. The articles

The articles of Association of the company shall contain a provision for capitalizationof reserves, etc. If there is no such provision in the Articles, the company shall pass aresolution at its general body meeting making provisions in the Articles of Associations forcapitalization.

8. Resolution

Consequent to the issue of bonus shares if the subscribed and paid-up capital exceedsthe authorized share capital, the company at its general body meeting for increasing the

authorized capital shall pass a resolution.

7. BOOK BUILDING METHOD

A method of marketing the shares of a company whereby the quantum and the priceof the securities to be issued will be decided on the basis of the ‘bids’ received from theprospective shareholders by the lead merchant bankers is known as ‘book-building method.

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Under the book-building method, share prices are determined on the basis of realdemand for the shares at various price levels in the market. For discovering the price atwhich issue should be made, bids are invited from prospective investors from which thedemand at various price levels is noted. The merchant bankers undertake full responsibilityfor the same.

The option of book-building is available to all body corporate, which are otherwiseeligible to make an issue of capital to the public. The initial minimum size of issue throughbook-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, acompany can opt for book-building route for the sale of shares to the extent of the percentageof the issue that can be reserved for firm allotment as per the prevailing SEBI guidelines. Itis therefore possible either to reserve securities for firm allotment or issue them through thebook-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 inturn forms a syndicate for the book-building. A syndicate member should be a member ofNational Stock Exchange (NSE) or Over-the-Counter Exchange of India (OTCEI). Offersof ‘bids’ are to be made by investors to the syndicate members, who register the demandsof investors. The bid indicates the number of shares demanded and the prices offered.This information, which is stored in the computer, is accessible to the company managementor to the book-runner. The name of the book-runner is to be mentioned in the draftprospectus submitted to SEBI.

2. Drafting prospectus

The draft prospectus containing all the information except the information regardingthe price at which the securities are offered is to be filed with SEBI as per the prevailingSEBI guidelines. The offer of securities through this process must separately be disclosedin the prospectus, under the caption ‘placement portion category’. Similarly, the extent ofshares offered to the public shall be separately shown under the caption ‘net offer to thepublic’. According to the latest SEBI guidelines issued in October 1999, the earlierstipulation that at least 25 percent of the securities were to be issued to the public has beendone away with. This is aimed at enabling companies to offer the entire public issuethrough the book-building route.

NOTES



3. Circulating draft prospectus

A copy of the draft prospectus filed with SEBI is to be circulated by the book-runnerto the prospective institutional buyers who are eligible for firm allotment and also to theintermediaries who are eligible to act as underwriters. The objective is to invite offers forsubscribing 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 nameand the number of securities ordered together with the price at which each institutionalbuyer or underwriter is willing to sub scribe to securities under the placement portion mustfind 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 aggregateof 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 thebid offer date. An appropriate final price is arrived at after a careful evaluation of demandsat various prices and the quantity. The final price is generally fixed reasonably lower thanthe possible offer price. This way, the success of the issue is ensured. The issuer companyannounce the pay-in-date at eh expiry of which shares are allotted.

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 fullyunderwritten. In case an issue is made through book-building route, it is mandatory thatthe portion of the issue offered to the public be underwritten. This is the purpose, anagreement has to be entered into with the underwriter by the issuer. The agreement shallspecify the number of securities as well as the price at which the underwriter wouldsubscribe to the securities. The book-runner may require the underwriter of the net offerto the public to pay in advance all moneys required to be paid in respect of their underwritingcommitment.

8. Filling with ROC

A copy of the prospectus as certified by the SEBI shall be filed with the Registrar ofCompanies within two days of the receipt of the acknowledgement card from the SEBI.

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9. Bank accounts

The issuer company has to open two separate accounts for collection of applicationmoney, 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 theapplication forms along with the application money to the extent of the securities proposedto be allotted to them or subscribed by them. This is to be done one day before theopening of the issue to the public.

11. Allotment of securities

Allotment for the private placement portion may be made on the second day fromthe closure of the issue. The issuer company, however, has the option to choose one datefor both the placement portion and the public portion. The said date shall be consideredto 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 ofallotment or the deemed date of allotment provided that payment of interest is uniformlygiven to all the applicants.

12. Payment schedule and listing

The book-runner may require the underwriters to the ‘net offer to the public’ to payin advance all moneys required to be paid in respect of their underwriting commitment bythe eleventh day of the closure of the issue. In that case, the shares allotted as per theprivate placement category will become eligible for being listed. Allotment of securitiesunder 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 spilloverto the extent of under-subscription is to be permitted from the ‘placement portion’ categorysubject to the condition that preference is given to the individual investors. In the case ofunder-subscription in the placement portion, spillover is to be permitted from the net offerto the public to the placement portion.

ADVANTAGES 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

NOTES



STOCK OPTION OF EMPLOYEES STOCK OPTION SCHEME (ESOP)

A method of marketing the securities of a company whereby its employees areencouraged to take up shares and subscribe to it is knows as ‘stock option’.. It is avoluntary scheme on the part of the company to encourage employees’ participation in thecompany. 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 isdominantly based on the talent of the employees, as in the case of software industry. Thescheme helps retain their most productive employees in an industry, which is known for itsconstant churning of personnel.

SEBI GUIDELINES

Company whose securities are listed on any stock exchange can introduce the schemeof employees’ stock option. The offer can be made subject to the conditions specifiedbelow:

1. Issue at discount

Issue of stock option at a discount to the market price would be regarded as anotherform of employee compensation and would be treated as such in the financial statementsof 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 specialresolution.

3. Maximum limit

There would be no restriction on the maximum number of shares to be issued to asingle 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 beenprescribed. After one year, the company would determine the period during which theoption can be exercised.

5. Superintendence

The operation of the ESOP Scheme would have to be under the superintendenceand direction of a Compensation Committee of the Board of Directors in which therewould be a majority of independent directors.

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6. Eligibility

ESOP scheme is open to all permanent employees and to the directors of the companybut not to promoters and large shareholders. The scheme would be applicable to theemployees of the subsidiary or a holding company with the express approval of theshareholders.

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 seniormanagerial personnel and to any other employee who receive a grant in any oneyear 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 outstandingoptions should not apply to ESOP. If any ESOPs are outstanding at the time of an IPOissue by an unlisted company, the promoters’ contribution shall be calculated with referenceto the enlarged capital that would arise if all vested options were exercised.

8. STOCK OPTION NORMS FOR SOFTWARE COMPANIES

The relevant guidelines issued by the SEBI as regards ‘employees stock option’ forsoftware companies are as follows :

1. Minimum issue

A minimum issue of 10 percent of its paid-up capital can be made by a softwarecompany which has already floated American Depository Receipts (ADRs) and GlobalDepository Receipts (GDRs) or a company which is proposing to float these is entitled toissue ADR/GDR-linked stock options to its employees. For this purpose, prior permissionfrom the Department of Economic Affairs is to be obtained.

2. Mode of Issue

Listed stock options can be issued in foreign currency convertible bonds and ordinaryshares (through depository receipt mechanism) to the employees of subsidiaries of InfoTechcompanies.

NOTES



3. Permanent employees

Indian IT companies can issue ADR/GDR linked stock options to permanentemployees, including Indian and overseas directors, of their subsidiary companiesincorporated in India or outside.

4. Pricing

The pricing provisions of SEBI’s preferential allotment guidelines would not coverthe scheme. The purpose is to enable the companies to issue stock options to its employeesat 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.

9. BOUGHT OUT DEALS

A method of marketing of securities of a body corporate whereby the promotersof an unlisted company make an outright sale of a chunk of equity shares to a singlesponsor 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 arepromoters of the company, sponsors and co-sponsors who are generally merchantbankers and investors.

2. Outright sale : Under this arrangement, there is an outright sale of a chunk ofequity shares to a single sponsor or the lead sponsor.

3. Syndicate : Sponsor forms syndicate with other merchant bankers for meetingthe resource requirements and for distributing the risk.

4. Sale price : The s ale price is finalized through negotiations between the issuingcompany and the purchaser, the sale being influenced by such factors as projectevaluation, promoters image and reputation, current market sentiments, prospectsof off-loading these shares at a future date, etc.

5. Fund-based : Bought-out deals are in the nature of fund-based activity where thefunds of the merchant bankers get locked in for at least the prescribed minimumperiod.

6. Listing : The investor-sponsors make a profit, when at a future date, the sharesget listed and higher prices prevail. Listing generally takes place at a time when thecompany is performing well in terms of higher profits and larger cash generationsfrom projects.

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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.

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 securitiesat lower costs relating to the issue.

2. Freedom : Bought-out deals offer freedom for promoters to set a realistic priceand convince the sponsor about the same.

3. Investor protection : Bought-out deals facilities better investor protection assponsors are rigorously evaluated and appraised by the promoters before off-loading 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 andinvestors:

1. Loss of control : The apprehensions in the minds of promoters, particularly ofthe private or the closely held companies that the sponsors may control thecompany as they own large chunk of the shares of the company.

2. Loss of sales : Bought-out deals pose considerable difficulties in off-loading theshares in times of unfavourable market conditions. This results in locking up ofinvestments and entailing losses to sponsors.

3. Wrong appraisal : Bought-out deals cause loss to sponsors on account of wrongappraisal of the project and overestimation of the potential price of the share.

4. Manipulation : Bought-out deals give great scope for manipulation at the handsof the sponsor through insider trading and rigging.

5. No accountability : Bought-out deals pose difficulty of penalizing the sponsor asthere are no SEBI guidelines to regulate offerings by sponsors.

6. Windfall profits : Bought-out deals offer the advantage of windfall profits bysponsors at the cost of small investors.

7. Loss to investors : Where the shares taken up by issue brokers and a group ofselect clients are being bought back by the promoters at a pre-fixed higher price

after allotment causing loss to investors of the company.

NOTES



2.3.2 Advertising Strategies

SEBI GUIDELINES FOR ISSUE ADVERISEMENT (11.10.1993)

SEBI issued Guidelines in 1993 to ensure that the advertisement are truthful fair andclear and do not contain statements to mislead the investors to imitate their judgment. Alllead managers are expected to ensure that issuer companies strictly observe the code ofadvertisement set-out in the guidelines.

For the purpose of these guidelines the expression advertisement, means notices,brochures, pamphlets, circulars show cards, catalogues, boardings, placards, posters,insertions in newspapers, pictures, films, radio/television program or through any electronicmedia and would also include the cover pages of the offer documents.

CODE OF ADVERTISEMENTS- CAPITAL ISSUES

1. An issue advertisement shall be truthful fair and clear and shall not contain anystatement which is untrue or misleading.

2. An issue advertisement shall be considered to be misleading,

It contains

a. Statements made about the performance or activities of the company inthe absence of necessary explanatory or qualifying statements, which maygive an exaggerated picture of the performance or activities than what itrally is.

b. An inaccurate portrayal of a past performance in a manner which impliesthat past gains or income will be repeated in the future.

3. As investors may not be well versed in legal or financial matter, care should betaken to ensure that the advertisement is set forth in a clear, concise andunderstandable language. Extensive use of technical, legal terminology or complexlanguages and the inclusion of excessive details which may distract the investorshould be avoided.

4. An issue advertisement shall not contain statements which promise or guaranteean appreciation or rapid profits.

5. An issue advertisement shall not contain any inform or language that not containedin the offer documents.

6. All issue advertisement in newspapers, magazines, brochures, pamphlets containinghighlights relating to any issue should also contain risk factors with the same printsize. It should mention the names of lead Managers, Registers to the issue.

7. No corporate advertisement except product advertisements shall be issued betweenthe date of opening and closing of subscription of any public issue. Such productadvertisement shall not make any reference directly or indirectly on the performanceof the company during the said period.

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8. No advertisement shall be issued stating that the issue has been fully subscribed oroversubscribed during the period the issue is open for subscription, except to theeffect that the issue is open or closed. No announcement regarding closure of theissue shall be made except on closing date. If the issue is fully subscribed beforethe last closing date as state in the prospectus, the announcement should be madeonly after the issue is fully subscribed and such announcement is made on the dateon which the issue is to be closed.

9. No model, celebrities, fictional characters, landmarks or caricatures or the likeshall be displayed on or form pat of the offer documents or issue advertisements.

10. No slogans, expletives or non factual and unsubstantiated titles should appear inthe issue advertisement or offer documents.

11. If any advertisements carries any financial data it should also contain data for lastthree years and shall include particulars relating to sales, gross profits, net profitshare capital reserves, earning per share, dividends and book values.

12. No incentives, apart from the permissible underwriting commission and brokerages,shall be offered through any advertisements to anyone associated with marketing

the issue.

2.3.3 FIIs (Foreign Institutional Investors)

GUIDELINES OF GOVERNMENT OF INDIA

Government of India through Guidelines issued on September 14, 1992 has allowedreputed foreign Institutional Investors (FIIs) including pension funds, mutual funds, assetmanagement companies, investment trusts, nominee companies and incorporated orinstitutional portfolio managers to invest in the India capital market subject to the conditionthat they register with the Securities and Exchange Board of India and obtain RBI approvalunder FERA. The different forms in which the portfolio investment flows into the countryare global depository receipts(GDR’s), investment in primary and secondary market,offshore funds and government securities. At the end of March 2000, 506 FIIs wereregistered with SEBI. Their total cumulative investment in securities market was Rs.57,038crores 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 inperiod.

Portfolio investment by the FIIs are required to allocate their total investment betweenequities and debentures in the ratio of 70:30. FII s can make purchases and sales only fordelivery. A FII cannot engage in short sales. FII investing under the scheme, enjoy aconfessional tax rate of 205 on dividend and interest and 10% on long term capital gainsshort term capital gains arising out of transfer of securities are taxed at 30%. Tax is deductedat 20% on interest and dividends.

NOTES



FII and SEBI Regulations , 1995

The regulations stipulate that foreign institutional investors have to be registered withSEBI and obtain a certificate from SEBI. For the purpose of grant of the certificate SEBItakes 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 ExchangeRegulating Act for making investments in India as a foreign institutional investorand

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 institutionalportfolio manager, established or incorporated outside India and proposingto make investments in India on behalf of broad based funds; or

c. A trustee or power of attorney holder established or incorporated outsideIndia 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 isvalid for 5 Years and can be renewed thereafter.

Net investment by FIIs in Indian Capital Market

Rs. In Crores

1992 – 1993 4

1993 – 1994 5445

1994 – 1995 4777

1995 – 1996 6721

1996 – 1997 7386

1997 – 1998 5908

1998 – 1999 (-) 729

1999 – 2000 9765

2000 – 2001 9682

RBI hand Book of Statistics on Indian Economy , 2001, p.299.

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Provision is also made for registration of sub accounts on whose behalf FII proposesto make the investment in India.

The purchases of shares of each company should not be more than ten percent of thetotal issued capital of the company.

The investment by foreign institutional investor is also subject to GOI Guidelines.

The general obligations and responsibilities of FIIs include appointment of a domesticcustodian, appointment of designated bank, maintenance of proper books of accounts,records and their reservation for five years and information to the Board or Reserve Bankof India.

Defaults are punished by suspension and cancellation of certificate after show causenotice and enquiry.

PREFERENTIAL ALLOTMENTS TO FIIs

Listed companies have been allowed by SEBI to make preferential allotment toregistered FIIs subject to certain conditions. A company desiring to make a preferentialallotment should obtain the shareholders’ consent. The allotment should be in accordancewith ceilings of 10% of total issued capital for individual FII and 30% of all FIIs and non-resident Indian investors. The preferential allotment should be made at a price not less thanthe highest price during the last 26 weeks on all stock exchanges where the companysecurities are listed.

2.3.4 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 countriesincluding such persons of Indian origin as is in the status of stateless, because noforeign country has as yet accepted them as their national and they are not Indiannational 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.

INVESTMENT POTENTIAL OF NRI’s

It is estimated that currently about 25 million Indians living abroad would fall into thedefinition of NRI. Of these about 20 million have taken up foreign nationality (FNIOs) andthe remaining 5 million are still Indian passport holders. The pattern of earning andconsumption of NRIs is such that it leaves annually a fairly large amount of investableresources. 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

NOTES



India succeeds in persuading NRIs to invest 10 % of their total saving into investments inIndia, the estimate of possible inflow is about US$ 1.5 billion per year.

AVENUES FOR INVESTMENT BY NRI’s

NRIs can have three different types of bank accounts, buy securities in the primaryand secondary markets, and do business on non-repatriable basis as well as reparablebasis.

NRI’s have also made in the past large investments in specific bonds, i.e., the IndiaDevelopment Bond in 1991, the Resurgent India Bond in 1998 and India MillenniumDeposits 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 isallowed on repatriation basis in certain high priority industries. NRI’s can take up thebalance 49% of equity in such cases on repatriation basis.

Non Repatriable Basis

1. Investment in new issues of shares/ debentures of Indian companies (1992) RBIhas granted general permission to NRIs/OCBs to take up or subscribe on non-repatriation basis shares or convertible debentures issued whether by public issueor private placement in companies other than those in agricultural/plantation and /or real estate business.

2. Investment in non-convertible debentures (1992) RBI permission has to be obtainedby Indian Company for investment by NRI/OCB in non-convertible debentures.

INVESTMENT IN NEW ISSUES (PRIMARY MARKET)

Forty percent scheme

Indian companies engaged in industry and manufacturing, Hotel (3,4, and 5 starcategory), hospitals and diagnostic enters, shipping companies, development of computersoftware and oil exploration services are allowed by RBI to issue shares/debentures toNRIs with repatriation benefits to the extent of 40% of new issue.

No permission for investment is required in cases where the company has obtainedpermission from RBI. This is generally granted in the green field project (e.g. ChambalFertilizers, Mangalore Refineries). NRI has to obtain permission from RBI even if the saleis to be effected after 12 month. Blanket permission can be obtained before completing 12months of each investment.

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Generally RBI does not permit NRI investment at issue prices in case of

a. Right issues of existing companies (excluding existing NRI shareholders) and

b. Public issues of an existing profit making company.

NRI can repatriate original investment, profit and dividend provided they are held fora minimum period of one year. On long term capital gains a rate of 10% is applicable.

If the investment is sold before one year the investment and all related receipts becomenon-repatriable unless RBI permission is taken in advance with clearance from IncomeTax department, with long term capital gains (LTCG) provisions as applicable to residentassesses.

In the case of non allotment or allotment of less than requested amount, refunds canbe credited to NRE accounts.

In case of debentures, long term capital gains (LTCG) provisional apply after threeyears (in place of one year for equity issues). But the proceeds are fully repatriable. Forinvestment and sale through secondary market a blanket permission valid for 5 years is tobe obtained through an NRE banker. RBI permission stipulates that such investments berouted through any one bank branch to facilitate control/monitoring.

There is a ceiling for NRI investment in each company. For an individual NRI it is onepercent of paid up capital and five percent for all NRI’s and it could be raised to 24 % forall NRI’s wherever the company passes a special resolution at is annual general meeting.Repatriation of original investment, profits and dividends is allowed. The lock-in periodhas been removed on 12.10.1994.

PORTFOLIO INVESTMENT

NRI Portfolio Investment – One hundred percent scheme:

Repatriable Basis

NRIs and overseas corporate bodies predominantly owned by them are permitted toinvest up to 100% equity in high priority industries with repatriability of capital and income.NRI investment up to 100 % of equity is also allowed in export houses, trading houses,star trading houses, hospital EOU’s. Sick industries, hotel and tourism related industriesare without the right of repatriation in the previously excluded areas of real estate, housingand infrastructure. Power is another sector where 100% investment is allowed. Repatriationof profits is permitted.

Forty Percent scheme: Reptraible Basis

On repatraible basis investment by to 40% of equity of any company promoted byNRI in any industry or for exports subject to prior permission from RBI is allowed.

NOTES



Non Repatriation Basis

Investment in Mutual funds:

Mutual funds seeking investment from NRI’S have to obtain approval from RBI.NRIs do not need a separate approval from RBI. NRIs can make investments in mutualfunds through purchases from secondary market on non repatriation basis. In such casesthey have to submit the application through a designated branch of an authorized dealer.

Investment in Money market mutual Funds (MMFs)

NRIs are permitted to invest on non – repatriation basis in MMFs floated bycommercial banks and public/private sector financial institutions. The concerned bank/institution should get authorization from RBI/SEBI . NRIs do not need separate permission.

Purchase of Share by Private Arrangement

NRIs/OCBs require permission of RBI for purchasing shares of Indian companies byprivate arrangement.

2.3.5 Pricing of Issues

A listed company can freely price equity shares/convertible securities through public/rights issues. An unlisted company eligible to make a public issue and desirous of gettingits securities listed on a recognized stock exchange can also freely price shares andconvertible securities. The free pricing of equity shares by an infrastructure company 8issubject to the compliance with disclosure norms as specified by the SEBI from time totime. While freely pricing their initial public issue of share/convertibles, all banks requireapproval by the Reserve Bank of India (RBI).

DIFFERENTIAL PRICING

Listed/unlisted companies may issue shares/convertible securities to applicants in thefirm allotment category (i.e. Allotment on a firm basis made to Indian and multilateraldevelopment finance institutions, Indian mutual funds, foreign institutional investors includingnon-resident Indians/overseas corporate bodies and permanent/regular employees of theissuing company) at a price different from the price at which the net offer to the public (i.e.the Indian public, excluding firm allotments/reservations/ promoters contribution) is made,provided the price at which the security is offered to the applicants in firm allotmentcategory is higher than the price at which securities are offered to the public.

A listed company making a composite issue of capital (i.e. Public-cum-rights basismade through a single offer document in which he allotment for both public and rightscomponents is proposed to be made simultaneously) may issue securities at differentialprices in its public and rights issue. In the public issue, which is a part of a composite issue,differential pricing in the firm allotment category vis-à-vis the net offer to he public is also

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permissible. However, justification for the price differential should be given in the offerdocument in case of firm allotment category as well as in all composite issues.

PRICE BAND

The issuer/issuing companies can mention a price band of 20 percent (cap in the priceband should not exceed 20 percent of the floor price) in the offer document filed with theSEBI and the actual price can be determined at a later date before filing it with the ROCs(Registrar of Companies). If the Board of Directors (BOD) of the issuing company hasbeen authorized to determine the offer price within a specified price band, a resolutionwould have to be passed by them to determine such a price. The lead merchant bankersshould ensure that in the case of listed companies, a 48-hour notice of the meeting of theBOD, for passing the resolution for determination of price, is given to the designated stockexchange. The final offer document should contain only one price and one set of financialprojections, if applicable.

PAYMENTS OF DISCOUNTS/ COMMISSIONS

Any direct/indirect payment in the nature of discount/commission/allowance orotherwise cannot be made by the issuer company/promoters to any firm allotted in a publicissue.

DENOMINATION OF SHARES

Public/rights issue of equity shares can be made in any denomination in accordancewith Section 13(4) of the Companies Act and in compliance with norms specified by theSEBI from time to time. The companies that have already issued shares in the denominationsof Rs.10 or Rs.100 may change their standard denomination by splitting/consolidatingthem The issue of shares in any denomination or change in the standard denomination issubject to the following;

i. The shares should not be issued in the denomination of a decimal of a rupee;

ii. The denomination of the existing shares should not be altered to a denomination ofa decimal of a rupee;

iii. At any given time, there would be only one denomination for the shares of a company,

iv. The companies seeking to change the standard denomination may do so only ittheir memorandum and articles of association permit and

v. The company should adhere to the disclosure and accounting norms specified by

the SEBI from time to time.

NOTES



2.3.6 Merchant Banking And Post Issue Activities

The major activities covered are :

Finalization of Basis of Allotment

If the public issue is oversubscribed to the extent of greater than five times, a SEBI-nominated public representative is required to participate in the finalization of Basis ofallotment (BoA). In case of rights issue that is oversubscribed greater than two times, aSEBI-nominated public representative is required to participate in the finalization of Boa.If it is under subscribed, information regarding acce4pted applications is formalized, andRegional Stock Exchanges are approached for finalization of BoA.

Dispatch of Share Certificates

Immediately after finalizing the Boa, share certificates are dispatched to the eligibleallotees, and refund orders made to unsuccessful applications. In addition, a 78 daysreport is to be filed with SEBI. Permission for listing of securities is also obtained from thestock exchange.

Advertisement

An announcement in the newspaper has to be made regarding the basis of allotment,the number of applications received and the date of dispatch of share certificates andrefund orders, etc.

2.3.7 Law Relating To Issue Management

It is important that the lead managers take into account the regulations of the capitalissue as prescribed by the various 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)

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)

i. Matters to be specified in prospectus and reports to be set out therein (Schedule 11)

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2. The Securities Contracts (Regulations) Act, 1957 regarding transactions in securities

3. The Securities Contracts (Regulation (Rules, 1957.


Q.2.3.a. What is meant by ‘pure prospectus method’? What are its features ? What are its advantages ?

Q.2.3.b. What are the limitations of marketing securities through the pure prospectus method?

Q.2.3.c. What do you mean by ‘offer for sale’ method? What are its features?

Q.2.3.d. What is ‘private placement’? What are its features?

Q.2.3.e. Bring out the advantages and drawbacks of private placement method of marketing of securities by companies.

Q.2.3.f. What do you know of the ‘IPO’ method of marketing securities? Explain the procedure involved in the same.

Q.2.3.g. What is ‘rights issue method’ of share offer? What are its advantages and drawbacks?

Q.2.3.h. State the SEBI guidelines relating to the rights issue.

Q.2.3.i. What is bonus issue? Bring out the relevant SEBI guidelines in this regard.

Q.2.3.j. Distinguish between rights issue and bonus issue methods of marketing new securities.

Q.2.3.k. What is ‘book-building’ as a method of offering securities? Explain briefly the steps involved in it. Also state its advantages.

Q.2.3.l. How is an issue marketed through the ESOP? State the relevant SEBI guidelines in this regard.

Q.2.3.m. What are bought-out deals? What are its features?

Q.2.3.n. Bring out the differences between bought-out deals and private placement.

Q.2.3.o. Outline the merits and demerits of bought-out deals as a method of marketing of securities.

Q.2.3.p. What are the OTCEI guidelines relating to bought-out deals?

Q.2.3.q. Define the term ‘prospectus’.

Q.2.3.r. What is the information to be provided as regards management discussion and analysis in respect of a public issue?

Q.2.3.s. State the provisions as regards the issue of securities by a company through the information memorandum and the red-herring prospectus.

Q.2.3.t. What are the guidelines issued by SEBI with regard to the underwriting business in India?

Q.2.3.u. What are post-issue activities? Explain.

NOTES



Q.2.3.v. State the need for marketing of security issue.

Q.2.3.w. Identify the steps involved in marketing the issue of securities?

Q.2.3.x. What are the factors influencing the choice of an appropriate public issue:?

Q.2.3.y. How are public issues priced?

Q.2.3.z. What are the regulations and laws that govern issue management in India?

SUMMARY

Thus marketing of new issues help the investors avoiding any need to part with themoney even before the shares are allotted in his favour. It allows elimination of unnecessaryhassles involved in making a public issue.

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NOTES



UNIT III

OTHER FEE BASED MANAGEMENT


Mergers and Acquisitions (M&A) as forms of business combination are increasinglybeing 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 hostiletakeovers). The merger wave which began in the U.S. first occurred during the periodbetween 1890 and 1904. Of late, mergers happen in all the sectors of the economy, theprime driving force being the accomplishment of synergetic effect for both the acquiringand the acquirer companies.



1. Mergers and Acquisitions

2. The different steps in mergers and Acquisitions

3. Different issues connected thereon

1.3 MERGERS

A type of business combination where two or more firms amalgamate into one singlefirm is known as a merger. In a merger, one or more companies may merge with an existingcompany or they may combine to form a new company. In India mergers and amalgamationsare used interchangeably.

In the wider sense, merger includes consolidation, amalgamation, absorption andtakeover. It signifies the transfer of all assets and liabilities of one or more existing companiesto another existing or new company.

1.3.1 Objectives

The main purpose of merges is to achieve the advantage of fusion and synergy throughexpansion and diversification.

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1.3.2 Steps 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 thereview of the purpose for which the proposal to merge is to be considered. Major objectivesof merger include attaining faster growth, improving profitability, improving managerialeffectiveness, gaining market power and leadership, achieving cost reduction, etc. Thereview of objectives is done to assess the strengths and weaknesses, and corporate goalsof the merging enterprise. In addition, the need for elimination of inefficient operations,cost reduction and productivity improvement, etc. should also be considered. Such amove would help the acquiring company to decide as to the kind of business units thatmust be acquired.

2. Data for analysis

After reviewing the relevant objective of acquisition the acquiring firm needs to collectdetailed 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 labour intensity, degree of regulation, etc.Similarly, firm-centric information will be needed to assess quality of management, marketshare, size, capital structure, profitability, production and marketing capabilities, etc. Thedata to be collected serves as the criteria for evaluation.

3. Analysis of information

After collecting both industry-specific and firm-specific information, the acquiring firmundertakes analysis of data and the pros and cons are weighed. Data is to be analyzedwith a view to determine the earnings and cash flows, areas of risk, the maximum pricepayable 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 considerationthe current market value of share of the company being acquired. The price shall usuallybe above the current market price of the share. A merger may take place at a premium. Insuch a case, the firm would pay an offer price which is higher than the target firm’s pre-merger market value. This would happen where the acquiring firm is of the firm opinionthat such an option would augment operational results of the target firm owing to synergiceffect.

NOTES



5. Finding merger value

Value created by merger is to be found so that it is possible for the merging firms todetermine their respective share. Merger value is equal to the excess of combined presentvalue of the merged firms over and above the sum of their individual present values asseparate entities. Any cost incurred towards the merging process is subtracted to arrive atthe figure of net economic advantage of merger. This advantage is shared between theshareholders of the merging firms.

1.3.3 Take Overs

Take over is the case where one company obtains control over the management ofanother company.

Under both acquisition and takeover, it is possible for a company to have effectivecontrol over another company even by holding minority ownership. For instance, theMonopolies and Restrictive Trade Practices (MRTP) Act prescribes that a minimum of 25percent voting power must be acquired as to constitute a takeover. Similarly, section 372of the Companies Act defines the limit of a company’s investment in the shares of anothercompany as anything more than 10 percent of the subscribed capital so as to constitute atakeover.

DISTINCTION BETWEEN ACQUISITION AND TAKE OVER

Where a distinction between acquisition and takeover is made, takeover usually takesthe form of ‘hostile’ or ‘forced’ or ‘unwilling acquisition and acquisition happens at theinstance and the willingness of the company management and the shareholders. It is forthis 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 ofjeeps 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 Oliverby Chablis and Ashok Leyland by Hindujas, etc.

HOSILE TAKEOVERS

Where in a merger one firm acquires another firm without the knowledge and consentof the management of the target firm, it takes the form of a ‘hostile takeover’. The acquiringfirm makes a unilateral attempt to gain a controlling interest in the target firm, by purchasingshares of the later firm directly in the open (stock) market.

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An example of hostile takeover was the takeover of TMBL by Sivasankaran of theSterling Group. Since this type of takeover is generally prejudicial to the interest of thestakeholders, SEBI has come out with relevant code of conduct for the purpose of regulatingthe takeover practice in India.

DISTINCTION BETWEEN MERGERS Vs. TAKEOVERS

The following are the differences between “Mergers” and “Takeovers”

Sl. No.

Distinction Merger Takeover

1 Definition Defined as an arrangement whereby the assets of two companies become vested in, or under the control of, one company (which may or may not be one of the original two companies), which has as its shareholders all, or substantially all, the shareholders of the two companies.

Defined as a transaction or series of transactions whereby a person (individual, group of individuals or company) acquires control over the assets of a company, either directly by becoming the owner of those assets or indirectly by obtaining control of the management of the company.

2. Mode Effected by the shareholders of one or both of the merging companies exchanging their shares (either voluntarily or as the result of a legal operation) for shares in the other or a third company, the arrangement being frequently effected by means of a takeover bid by one of the companies for the shares of the other, or of a takeover bid by a third company for the shares of both

Effected by agreement with the holders of the whole of the share capital of the company being acquired, where the shares are held by the public generally, the takeover may be effected by agreement between the acquirer and the controllers of the acquired company, or by purchases of shares on the Stock Exchange, or by means of a “takeover bid”.

3. Control over assets

Shareholding in the combined enterprise will be spread between the shareholders of the two companies

Direct or indirect control over the assets of the acquired company passes to the acquirer

4. Bid Bid is generally by the consent of the management of both companies

Bid is frequently against the wishes of the management of the offeree company.

NOTES



1.3.4 Major Issues Of M&A In India

Business combinations and re-structuring in the form of merger, etc. have been attemptedto face the challenge of increasing competition and to achieve synergy in business operations.The major issues of M&A are as follows :

Depreciation

The acquiring firm claims depreciation in respect of fixed assets transferred to it bythe target firm. The depreciation allowance is available on the written down value of fixedassets. Further, the depreciation charge is based on the consideration paid and withoutany revaluation.

R&D Expenditure

It is possible for the acquiring firm to claim the benefit of tax deduction under section35 of the Income Tax Act, 1961 in respect of transfer of any asset representing capitalexpenditure on R&D.

Tax Exemption

The fixed assets transferred to the acquiring firm by the target firm are exempt fromcapital gains tax. This is however subject to the condition that the acquiring firm is anIndian Company and that shares are swapped for shares in the target firm. Further, as theswap of shares is not considered as sale by the shareholders, profit or loss on such swapis not taxable in the hands of the shareholders of the amalgamated company.

Carry Forward Losses

The Indian Income Tax Act, 1961 contains highly favourable provision with regard tomerger of a sick company with a healthy company. For instance, section 72A(1) of theAct gives the advantage of carry forward of losses of the target firm. The benefit is howeveravailable 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.


Q.1.3.a. What are M&A advisory services?

Q.1.3.b. Define the term ‘merger’.

Q.1.3.c. Distinguish between merger and takeover.

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Q.1.3.d. What are the different forms of a merger?

Q.1.3.e. What are the arguments that are put forth in favour of M&A proposal. .

Q.1.3.f. Elaborate on the steps that are involved in a typical M&A proposal.

Q.1.3.g. Ring out the rationale for the heightened M&A activity in the Indian corporate world

Q.1.3.h. Discuss the major issues of M&A in India.

SUMMARY

Thus M& A as an important corporate restructuring activity enquires the impositionand implementation of strict measures of control and regulation by the state authority. Theobjective is to ensure that the M&A proposals do not degenerate into the exploitation ofshareholders, particularly minority shareholders. Further to ward off the potentially dangerouseffects of M&A such as stifling of competition and encouraging monopoly and monopolisticcorporate behavior, it is essential that proper and adequate regulatory measures are put inplace

In India M & A is governed by a host of regulations, enactments and guidelines. Theregulatory provisions concerning the M& A in India are contained in MRTP Act, 1969,Income Tax Act, 1961, Companies Act, 1956, Securities Contracts (regulations) act,1956, Sick Industries Companies (special provisions)Act, 1985, Securities and ExchangeBoard of India Act, 1992 and Listing Agreement of the Stock Exchanges.

NOTES




Preserving and growing capital is as hard as earning it. Knowing what one want is asimportant as achieving those goals. Assessing one’s risk profile and aligning potential returnsfor the risk assumed from various investment options is the crucial task. In today’s fluidenvironment, that has become a hard task to achieve. As the investor’s net worth increases,financial complexity expands exponentially and the investment needs and options multiply.And equities offer one of the best options for investments.

Mutual funds as an investment vehicle are structured to reduce risks as far as possible,as they cater to thousands of investors. This results in some limitations as far as the investmentstrategy is concerned despite adopting the active management approach. As a discerninginvestor, one who is not averse to taking on more risk in order to achieve greater returns,one want his investments to be managed more actively compared to a mutual fund. Hewants his investments to be managed in a way that tries to maximize value.

To achieve this objective of preserving and growing one’s capital a new service tohelp in this onerous but rewarding task, there emerged the concept of portfolio managementservices. A focus on providing one with options which would aim at wealth accretion whileminimizing the risk .



• Portfolio management services

a. definition

b. objectives

c. functions

d. latest developments

2.3 PORTFOLIO AND MANAGEMENT SERVICES:

A list of all those services and facilities that are provided by a portfolio manager to itsclients, relating to the management and administration of portfolio of securities or the fundsof the client, is referred to as ‘portfolio management services’. The term ‘portfolio’ meansthe total holdings of securities belonging to any person.

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Portfolio Manager

According to SEBI, ‘Portfolio Manager’ means any person who pursuant to a contractor arrangement with a client, advises or directs or undertakes on behalf of he client (whetheras a discretionary portfolio manager or otherwise) the management or administration of aportfolio of securities or the funds of the client, as the case may be.

Discretionary Portfolio Manager

According to SEBI, ‘discretionary portfolio manager’ means a portfolio managerwho exercises or may, under a contract relating to portfolio management, exercises anydegree of discretion as to the investments or management of the portfolio of securities orthe funds of the client, as the case may be.

2.3.1 Objectives

a. Provide long term capital appreciation with lower volatility, compared to thebroad equity markets.

b. Takes long positions in the cash market and short positions in the index futuresmarkets.

c. Invests in the model portfolios thus downside the risk by selling index futures in thederivatives market.

2.3.2 Functions

The objective of portfolio management is to develop a portfolio that has a maximumreturn at whatever level of risk the investor deems appropriate.

Risk Diversification

An essential function of portfolio management is spread risk akin to investment ofassets. Diversification could take place across different securities and across differentindustries. Is an effective way of diversifying the risk in an investment. Simple diversificationreduces 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 attainingthe operational proportions of investments from asset categories. Portfolio managersbasically aim of stock-bond mix. For this purpose, equally weighted categories of assetsare used.

Bets Estimation

Another important function of a portfolio manager is to make an estimate of bestcoefficient. It measurers and ranks the systematic risk of different assets. Best coefficientis an index of the systematic risk. This is useful in making ultimate selection of securities forinvestment by a investment by a portfolio manager.

NOTES



Rebalancing Portfolios

Rebalancing of portfolios involves the process of periodically adjusting the portfoliosto maintain the original conditions of the portfolio. The adjustment may be made either byway of ‘Constant proportion portfolio’ or by way of ‘Constant best portfolio’.

In Constant proportion portfolio, adjustments are made in such a way as to maintainthe relative weighing in portfolio components according to the change in prices.

Under the constant beta portfolio, adjustments are made to accommodate the valuesof component betas in the portfolio.

2.3.3 Strategies

A portfolio manager may adopt any of the following strategies an part of an efficientportfolio management.

Buy and Hold Strategy

Under the ‘buy and hold’ strategy, the portfolio manager builds a portfolio of stockwhich is not disturbed at all for a long period of time. This practice is common in the caseof perpetual securities such as common stock.

Indexing

Another strategy employed by portfolio managers is ‘indexing’. Indexing involves anattempt 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 maturitiesare spread uniformly over a long period of time. This way a portfolio manager aims atdistributing the funds throughout the yield curve.

Barbell Portfolio

Under the laddered portfolio, bonds are selected in such a way as that their maturitiesare spread uniformly over a long period of time. This way a portfolio manager aims atdistributing the funds throughout the yield curve.


Q.2.3.a. Who is a portfolio manager?

Q.2.3.b. Who is a discretionary portfolio manager?

Q.2.3.c. What are the functions of a portfolio manager?

Q.2.3.d. State the strategies employed by a portfolio manager.the SEBI regulations, 1993.

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Q.2.3.e. Outline the procedures relating to the registration of portfolio managers under

Q.2.3.f. What are the aspects considered by the SEBI before granting the certificate of registration to commence the business of portfolio management?

SUMMARY

Thus the portfolio management services are mapped to suit a conservative or aggressiverisk profile. This service focuses on large cap stocks that are well researched, so as toreduce negative surprises in terms of corporate governance and management quality. Thelarge cap orientation of this offering gives you the reassurance that one’s money is investedonly in established blue-chip stocks, which enjoy an established performance. One canalso benefit from lower transaction costs because of better liquidity.

NOTES



LESSON – 3

3.1 INTRODUCTION

‘Credit syndication services’ are services rendered by the merchant bankers in theform of organizing and procuring the financial facilities form financial institutions, banks, orother lending agencies.

Financing arranged on behalf of the client for meeting both fixed capital as well asworking capital requirements is known as ‘loan syndication service’



• Credit syndication services

• Its scope

3.3 CREDIT SYNDICATION SERVICES

Merchant bankers provide various services towards syndication of loans. The servicesmay be either loan sought for long term fixed capital or of working capital funds. They arediscussed in detail.

3.3.1 Objectives

• arranging medium and long term funds for long term fixed capital and workingcapital fund needs.

3.3.2 Scope

The scope of syndicated loan services as provided by merchant bankers includeidentifying the sources of finance, approaching these sources, applying for the credit, andsanction and disbursal of loans to the clients.

While carrying out the activities connected with credit syndication, the merchant bankerensure due compliance with the formalities of the financial institution, banks and regulatoryauthority. They are :

1. General Information : The purpose of furnishing general information is to enable thefinancing company to obtain a general idea about the applicant company and its proposedproject.

2. Promoter information : Information about promoters is furnished by the merchantbanker with the objective of helping the lending agency to gain an understanding of thepromoter, his activities economic background, credibility and integrity.

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3. Company information : The merchant banker has to furnish the following informationas 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 ofa 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 financialassistance is sought is furnished by the merchant banker. The type of information maypertain to plant capacity, nature of production process to be employed, nature of technicalarrangements available for the project.

5. Project cost information : Details of the estimated cost of the project should beprovided to the lending institution. This includes information as regards rupee cost/rupeeequivalent of foreign exchange cost/total cost for land or site development/buildings/plantand machinery, imported/indigenous, technical know-how, etc. to be furnished. Besides,details of expenses likely to be incurred on foreign technicians/training of Indian techniciansabroad, miscellaneous fixed assets, preliminary pre-operative expenses, provision forcontingencies, 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 theproject should be stated. This includes information on the extent of debt and equity capitalfunding source. Besides, details of rupee loans, foreign currency loans, debentures, internalcash accruals, promoters’ contribution. The security offered for he loan/bank guarantee,etc. should also be specified. Data should also be provided on the extent of loanarrangements already applied for and the limit of financial arrangements thereto.

7. Project marketing information : As part of the credit syndication exercise, it isincumbent on the part of the merchant banker to furnish adequate information about themarketing arrangements made for the products of the borrowing unit.

8. Cash flow information : The merchant banker has to furnish details as to profitabilityand expected stream of cash flows and cost of the proposed project for this purpose, it isessential that working results of operations, cash flow statements and projected balancesheet 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 ofthe 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.

NOTES



1. CIF/FOB international price of inputs to be imported/exported

2. Economic benefits in general and the region in particular available to the nationfrom the project

3. Economic benefits in general and the region in particular available to the nationfrom 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, foreignexchange 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 theterm-lending institution. While presenting the application, it is incumbent on the part of themerchant banker to ensure that all the required formalities have been complied with. Forinstance, it is important that necessary sanction is obtained from the Government for theproposed project. Loans are syndicated by development financial institutions though the‘lead institution’ especially in the case of ‘consortium financing’ or ‘joint lending’. Whereloans are sought in huge amounts consortium approach to lending is followed. The leadinstitution adopts ‘single window scheme’ while appraising, sanctioning and disbursingloans.

A part of credit syndication services, the merchant banker arranges for appraisal ofthe project by sufficiently interacting with the officials of the development financial institutions.The merchant banker holds formal discussions with the appraisal team of financial institutions.He helps the promoters/chief executive of the company by providing information to theappraisal team. He takes part in the site inspection with the appraisal team and providesinformation to them about the technical aspect of the project implementation. He alsoassists the appraisal team on matters connected with the choice of technique to be adoptedfor appraisal of the project. Merchant banker provides advice in the preparation ofproject/feasibility report and the market survey report, and the financial projections relatingto the project.

1 Technical appraisal : Technical appraisal involves the assessment of technical andengineering 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; abilityof consultants and their costs for services, are looked into. Attention is also paid to theaspects concerning the scale of operation, cost of production and prospective demand.Similarly, attention is paid to understand the appropriateness of the methods and processesto be used for the project. Consideration is also given to the level of availability of latesttechnology, degree of obsolescence in technological process, etc.

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2 Ecological appraisal : Regarding the ecological aspects of the project, the merchantbanker 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. Acertificate from the State Pollution Control Board has to be produced to the effect that thecompany has installed equipment adequate and appropriate to the requirement of meetingthe environment protection. Ecological appraisal is mandatory with respect to highly pollutingindustries 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 ofthe project under consideration. Analysis of the need for fixed capital and working capitalis also carried out. Consideration is also given to the cost of the project as relating toacquisition of capital assets, interest cost on loans obtained for promotional, organizational,training and other purposes.

4 Promoters’ contribution: Promoter’s contribution for establishment and running ofa project is vital. The important sources of promoters’ contribution in the case of newlyestablished companies include own equity, managed equity from special funds such asRisk Capital/venture Capital Funds or Seed Capital from IDBI through SFCs, etc. andforeign equity, deposits contributed by promoters, etc. In the case of existing companiesthe sources of promoter contribution include internal accruals, right issues, divestment ofshares, additional equity, unsecured loans, etc. The extent of promoters’ contribution anddebt-equity norms must be scrutinized by the merchant banker.

5 Economic appraisal: The project involves making an analysis of the expectedcontribution of the project to the particular sector, besides its contribution to thedevelopment of the national economy. Particular attention is paid to the project’s usefulnessin terms of best possible utilization of scarce resources. It is essential to consider thepriority nature of the project. Accordingly, a project will be considered desirable if it hasa tremendous impact on the balance of payment and the capacity to generate exchangesurplus through new exports, import substitution and resultant savings in foreign exchange.

6 Commercial appraisal: It involves the determination of commercial viability of theproject in terms of arrangements for buying, transporting and marketing the product.

7 Managerial appraisal: It is concerned with the evaluation of effectiveness andefficiency of the managerial personnel who are vested with the responsibility of organizingthe available resources of the project. The merchant banker checks the managerialcompetency 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 obtainthe letter of intent/sanction from the lending institution/bank. The lending agency informsthe merchant banker about the sanction of loan by the sanctioning authority. The sanction

NOTES



letter invariably contains terms and conditions pertaining to the sanction of loan. Somethese terms include amount of loan, rate of interest applicable, commitment charge leviedby 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 toensure compliance of terms and conditions to have the loan facility disbursed by the bankor the financial institution. Compliance is required in respect of the following.

9.3 Compliance with the 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 Memorandumand Articles of Association of the borrowing unit. This is to check the extent ofpowers commanded by the Board of Directors of the company to make borrowingsfrom the lending agency. The borrowing powers of the Board are enshrined in thememorandum by means of its ‘objects clause’. The compliance would help the lendingagency to ensure that the acts of directors are not ultra-vires so as to safeguard itsinterest.

b. STATUTORY COMPLIANCE

In addition, compliance is also called for with regard to the provisions constrained invarious enactments concerning the management and regulation of joint stock companies inIndia. Some of these enactments include Companies Act, 1956, Industries (Developmentand 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 ofborrowings vested with the Board of Directors of the company. For instance, section 292and 293 of the Act outline the exercise of powers to borrow from banks and financialinstitutions. Similarly, sections 17 and 31 of the said Act give an account of restrictivecovenants pertaining to powers of directors to borrow to be contained in the Memorandumof Association and Articles of Association of a company. The provisions mainly outlinethe procedures such as passing of resolutions etc. to be followed for raising loans fromterm lending agencies.

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2 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 industriesand also expansion of existing industries. The provisions mainly relate to registration andrevocation of registration of industrial undertaking, licensing of new industrial undertakings,license and revocation of license for producing or manufacturing new articles, licensing ofindustrial undertakings in special cases, etc. Besides, provisions also outline the powers ofthe Central Government to specify the requirements which shall be complied with by small-scale industrial undertakings, power of the Central Government to exempt any industrialundertaking in special cases, etc.

3 Compliance is called for as regards provisions contained in the ForeignExchange Management Act (FEMA).

The provisions are applicable in the case of non-resident Indians being associated in anymanner with the organization or management or operations of the client company or whereforeign capital in any manner with the organization or management or operations of theclient company or where foreign capital in any manner (i.e. By way of foreign collaborator’scontribution to equity capital, loans etc.) is being utilized or foreign currency loans arebeing raised from financial institutions or banks.

(IV) Provisions of the Securities Contracts (Regulation) Act, 1956 (SCRA) arealso required to be complied with by the borrowing unit before seeking financial assistancefrom the term lending agency. Compliance is related to stipulations of enlistment of securitiesof the company in recognized stock exchanges (although listing is not mandatory under thesaid Act). Under Section 21 of the Act, Central Government is empowered to compelany public limited company to enlist its securities with a recognized stock exchange.

(V) Compliance with the provisions of the FIDRA (Foreign Trade Developmentand Regulation Act), 1992 are required compliance by the borrowing unit. This becomesnecessary where the client company envisages to procure raw material, machinery, plantand equipments from overseas through imports under the import license granted by theCentral Government under Import and Export (Control) Act, 1947.

(VI) An important enactment in India that requires closer compliance by theborrowing units is the Income-Tax Act, 1961.

The Act contains provisions that require furnishing of a tax clearance certificate fromassessing officer under section 230A of Income Tax Act before creation of security byway of English mortgage in favour of lenders.

NOTES



C. DOCUMENTATION AND CREATION OF SECURITY

An important function of a merchant banker is to create an adequate documentation ofsecurity by working closely with the ‘lead financial institution,’ so as to ensure quickerdisbursement of loan. The type of documents to be prepared and executed by the merchantbanker will be as per the requirements of the lead financial institution. Depending on theloan 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 theloan:

1. First mortgage and charge of all immovable properties both present and futureof the borrower company in the form as may be indicated by lenders which isequitable mortgage by deposit of title deeds.

2. First charge by way of hypothecation : (i) of all movables such as stocks ofraw material, semi-finished and finished goods, consumable stores and such offermovables as may be agreed to by the lead institution for securing the borrowingsfor 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 bepurchased by the client company under the deferred payment facilities granted tothe 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 theloan 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 loanagreement 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 andunconditional personal guarantee from its promoters/directors in favour of thelending institutions.

D. PRE – DISBURSEMENT COMPLIANCE

This function is aimed at merchant bankers assisting the borrowing unit in the withdrawalof the loan amount from the financial institution. This done with additional compliance offormalities of provision of information and documentation. Some of the pre-disbursementconditions that require compliance by the merchant banker are documentation. Some ofthe pre-disbursement conditions that require compliance by the merchant banker are asfollows:

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1. Completion of creation of security as stipulated in loan agreement

2. Completion of borrowing arrangements with other institutions and banks for raisingfunds 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 andas stipulated in proposal of financing the project cost.


Q.3.3.a. State the details to be furnished by the merchant banker as regards ‘promoter’.

Q.3.3.b. What are the details to be furnished by the merchant banker as to cost of project?

Q.3.3.c. What are the major funding sources identified by the merchant banker?

Q.3.3.d. What are the important data to be supplied by the merchant banker regarding the

borrowing company:?

Q.3.3.e. What is the project marketing information to be supplied by the merchant banker?

Q.3.3.f. How do merchant bankers assist the term lending institutions in making appraisal

of the project? Elaborate.

Q.3.3.g. Write a note on the compliance of terms and conditions for loan disbursement as

regards statutes.

SUMMARY

Thus the institutions with which the merchant bankers syndicate include Industrialfinance corporate of India, Industrial Development Bank of India, Industrial Credit andInvestment Corporation of India Ltd., Industrial Reconstruction bank of India, and ShippingCredit and Investment Company of India Ltd., the state level bodies such as State FinancialCorporations, State Industrial Development Corporations, State Industrial and InvestmentCorporations an all-India investment institutions such as Life Insurance Corporation ofIndia, Unit Trust of India, General Insurance Corporation of India, and its subsidiarycompanies etc.,

NOTES






• the basis of credit rating

• the credit rating companies in India

• the different types of credit rating

4.3 CREDIT RATING

Credit rating is a mechanism by which the reliability and viability of a credit instrumentis brought out. When a company borrows or when a businessman raises loan, the lendersare interested in knowing the credit worthiness of the borrower not only in the presentcondition but also in future. Hence, credit rating reveals the soundness of any creditinstruments 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.

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 toborrow from recognized institutions. In India, we have Onida Individual Credit RatingAgency (ONICRA) which gives credit rating for individuals.

b) RATING OF COMPANIES: As per the guidelines of SEBI and RBI, companieshave 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.

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c) RATING OF COUNTRIES: Credit rating is resorted to by countries for borrowingin international market or for attracting foreign investments or for raising funds from theinternational institutions like IMF and IBRD.

4.3.1 Basis of Credit Rating

Various aspects are taken into account by a credit rating agency when a borrowingcompany 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. Labour turnover

o. Regulatory and competitive environment

p. Asset quality

q. Financial position-interest/tax sensitivity

4.3.2. Credit Rating Companies in India

Credit rating companies were started in India during the late 1980s. Credit RatingInformation 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 asubsidiary of IDBI. In 993, Credit Analysis and Research Ltd. (CARE) was started.

NOTES



8. The suffix of “+” (plus) or “-” (minus) signs are used with the rating symbols toindicate the comparative position of the instrument within the group covered bythe symbol.

4.3.3 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 differentsecurities. These are :

1. Equity rating

2. Bond rating

3. Promissory note rating

Debt Category

Debt instrument Rating symbols Remarks

CRISIL ICRA CARE

Long term instrument Medium term Instrument Short term instrument

Debentures Bonds, Preference Fixed Deposits Commercial Paper

AAA *AA *A

*BBB *BB *B *C D

FAAA *FAA *FA *FB

*FC FD *P1 *P2 *P3 *P4 P5

LAAA *LAA *LA

*LBBB

*LBB *LB *LC LD

MAAA

*MAA *MA *MB

*MC MD *A1

*LAA *LA

*LAA *LA

CARE AAA

*CARE AA

*CARE A *CARE B *CARE

BB *CARE B *CARE C CARE D

CARE AAA

*CARE AA

*CARE A *CARE

BBB *CARE

BB *CARE B CARE C CARE D

*PR-1 *PR-2 *PR-3 *PR-4 PR-5

Highest safetyHigh safety Adequate safety Moderate safety Inadequate safety Risk prone Substantial risk Default Highest safetyHigh safety Adequate safety Inadequate safety 1. Do – 2. Do – Risk prone Default High safety Highest safetyAdequate safety Risk prone Default

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NOTES


4. Commercial paper rating

5. Sovereign rating.

1. EQUITY RATING

When different companies are issuing shares, equity rating will enable the investor tochoose proper equity share on the basis of the credit rating. While judging the equityrating, the past performance of the company, the earning per share and the turn-over of thecompany will be taken into account. If a loss making company turns into a profit makingone, 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 theinternational market, rating of bonds will depends on the rate of interest offered and thevalue of the currency it represents. If the bond is issued in terms of U.S. Dollar or PoundSterling, its value will be high and the rating will naturally be on the positive side. But thebonds of under developed countries will have lesser credit rating due to high fluctuations intheir 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 alsoissue bonds for raising long-term finance in India, government bonds are preferred toprivate 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 commercialcompanies and depending upon their resources, these promissory notes will have creditrating. But, the issue of promissory notes will have no backing and the person advancingthe resources against the promissory notes will undertake greater risks. Depending uponthe credit rating, ranging from P1 to P6, promissory notes are preferred as a short-datedinstrument. The unutilized resources lying with commercial banks may be invested inpromissory 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 canbe obtained by companies for raising short-term loans from commercial banks. On duedate, commercial banks will present these papers to the NBFC which has issued thecommercial paper and funds will be obtained along with interest. Later on, the NBFC will

NOTES



collect the amount from the company which has utilized its commercial paper for raising itsshort-term loans.

In order to enable the commercial banks to discount commercial papers, credit ratingis provided to the commercial papers which depends upon the standing of the non-bankingfinancial company NBFC) which is issuing the commercial paper.

5. SOVEREIGN RATING

When countries are issuing credit instruments in the international market such as Treasurybills 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 countrieslike India which have slightly lesser credit rating and in the third category we have some ofthe African countries such as Rwanda, Kenya, Zulu, etc. The credit rating of the thirdcategory of countries will certainly be lower.

In India, State Bank of India issued in the international market different creditinstruments such as India Resurgent Bonds and Millennium Deposits and they wereover subscribed owing to the reputation of SBI,. All the NRIs throughout the world, couldsubscribe to these bonds and SBI could raise a substantial amount in terms of foreignexchange.


Q.4.3.a. What do you mean by the term ‘Credit Rating’? What are its features?

Q.4.3.b. What are the benefits of credit rating?

Q.4.3.c. What are the limitations of credit rating?

Q.4.3.d. Discuss the major issues of credit rating in the context of the rapid growth

witnessed in the global financial markets.

Q.4.3.e. Give an account of some of the credit rating agencies, both domestic and international.

Q.4.3.f. Discuss the regulatory framework available for credit rating in various countries of the world.

Q.4.3.g. What are rating symbols? What do they connote? Give a brief account of the rating symbols of the leading credit rating agency in India.

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Q.4.3.h. What is ‘equity grading’? State the need for equity rating.

Q.4.3.i. Explain the process of equity grading. Attempt your answer with reference to aleading credit rating agency.

SUMMARY

The outlook for the credit rating industry appears positive. But the industry has tocontinuously strive to improve the professional capabilities and sustain its credibility. Nodoubt the credit rating agencies today have ample opportunities to play a unique role instrengthening the capital market and building investors’ confidence in the financial system.

NOTES




A mutual fund is a professionally managed firm of collective investments that collectsmoney from many investors and puts it in stocks, bonds, short-term money marketinstruments, and/or other securities. The fund manager, also known as portfolio manager,invests and trades the fund’s underlying securities, realizing capital gains or losses andpassing any proceeds to the individual investors.



• Mutual funds

o objectives

o types of mutual funds

o latest developments

5.3 MUTUAL FUNDS

a. A mutual fund is a fund exchanged between the public and the capital marketthrough a corporate body.

b. The Securities and Exchange Board of India Regulations, 1993 defines amutual fund as ‘a fund established in the form of a trust by a sponsor, to raisemonies by the trustees through the sale of units to the public, under one or moreschemes, for investing in securities in accordance with these regulations’.

c. Kamm, J.O. defines an open end investment company or Mutual fund company inU.S.A as ‘an organization formed for the investment of funds obtained fromindividuals and institutional investors who in exchange for the funds receive shareswhich can be redeemed at any time at their underlying asset values’.

d According to Weston j. Fred and Brighmam, Eugene, F. Unit Trusts in U.K. are ‘Corporations w

Thus mutual fund is nothing but a form of collective investment. It is formed by thecoming together of a number of investors who transfer their surplus funds to a professionallyqualified organization to manage it.

To get the surplus funds from investors, the fund adopts a simple technique. Eachfund is divided in to a small fraction called “units’ of equal value. Each investor is allocatedunits in proportion to the size of his investment.

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Thus, every investor, whether big or small, will have a stake in the fund and can enjoythe wide portfolio of the investment held by the fund. Hence, mutual funds enable millionsof small and large investors to participate in and derive the benefit of the capital marketgrowth. It has emerged as a popular vehicle of creation of wealth due to high return, lowercost and diversified risk.

5.3.1 Objectives

Mutual funds came into existence in order to attract the savings of lower and middleincome group people and give them the benefit of corporate profits by distributing attractivedividends at the end of the year. Mutual funds cater the different types of customers whoare interested in

(a) fixed income or

(b) a higher return for investment or

(c) who is growth oriented.

5.3.2 Mutual Funds Set Up In India

The structure of mutual fund operations in India envisages a three tier establishmentnamely:

(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 haslaid down certain criteria to be met by the sponsor. These criteria mainly deal with adequateexperience, 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 andthey 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 alarge number of professionals to make investments, carry out research and to do agent andinvestor servicing. Infact, the success of any Mutual Fund depends upon the efficiency of

NOTES



this AMC. The AMC submits a quarterly report on the functioning of the mutual fund to thetrustees who will guide and control the AMC.

5.3.3 Types of Mutual Funds

4 CLOSE ENDED FUNDS

Close ended funds are funds which have definite period or target amount . Once theperiod is over and or the target is reached, the door is closed for the investors. Theycannot purchase any more units. These units are publicly traded through stock exchangeand generally, there is no repurchase facility by the fund. The main objective of this fund iscapital appreciation. Thus after the expiry of the fixed period, the entire corpus is disinvestedand 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.

5 OPEN ENDED FUNDS

Open ended funds are those which have no fixed maturity periods. Open endedscheme consists of mutual funds which sell the units to the public. These mutual funds canalso repurchase the units. Initial Public Offer (IPO) is open for a period of 30 days andthen reopens as an open-ended scheme after a period not exceeding 30 days from thedate of closure of the IPO. Investors can buy or repurchase units at net asset value or netvalue related prices, as decided by the mutual fund. Example: Unit Trust of India’s Growthsector funds.

MUTUAL FUND On the basis of execution and operation On the basis of yield and investment Close ended Open ended

Income fund Growth fund Balance specialized Money Taxation

Fund Fund Market Fund Fund

Classification of Mutual Funds

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ON THE BASIS OF YIELD AND INVESTMENT

1. INCOME FUND

Income funds are those which generate regular income to the members on a periodicalbasis. It concentrates more on the distribution of regular income and it also sees that theaverage 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 growthpotential.

c. The Investment tries to get capital appreciation by taking much risks and investingon 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 theinvestments are made in high growth equity shares and also the fixed income earning securities.

4. SPECIALISED FUNDS

These are special funds to meet specific needs of specific categories of people likepensioners, widows etc.

5. MONEY MARKET MUTUAL FUNDS

The funds are invested in money market instruments. These funds basically have allthe features of open ended funds but they invest in highly liquid and safe securities likecommercial paper, bankers’ acceptances, and certificates of deposits treasury bills. Thesefunds are called “money funds” in the U.S.A. The RBI has fixed the minimum amount ofinvestment as Rs.1 Lakh, it is out of the reach of many small investors. However, the

NOTES



private sector funds have been permitted to deal in money market mutual funds. It is bestsuited 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 foreigncapital market. It is suitable to salaried people who want to enjoy tax rebates particularlyduring the month of February and March. An investor is entitled to get 20% rebated inIncome Tax for investments made under this fund subject to a maximum investment ofRs.10,000 per annum. E.g. Tax Saving Magnum of SBI Capital Market Limited.

7. OTHER CLASSIFICATION

i. Leveraged Funds: Also called as borrowed funds as the are used primarily toincrease the size of the value of portfolio of a mutual funds. 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 twodifferent types of investors. It sells income shares and capital. Those investorswho seek current investment income can purchase incomes shares. The capitalshares receive all the capital gains earned on those shares and they are not entitledto receive any dividend of any type.

iii. Index Fund: It is a fund based the some broad market index. This is done byholding securities in the same proportion as the index itself. The value of theseindex linked funds will automatically go up whenever the market index goes upand vice versa.

iv. Bond Funds: The funds have portfolios consisting mainly of fixed income securitieslike bonds. The main thrust is income rather than capital gains.

v. Aggressive Growth Funds: These funds are capital gains oriented and thus thethrust area of these funds is capital gains. Hence, these funds are generally investedin speculative stocks They may also use specialized investment techniques likeshort term trading, option writing etc.,

vi. Off shore Mutual Funds: These funds are meant for non resident investors.These funds facilitate flow of funds across different countries, with free and efficientmovement of capital for investment and repatriation.

vii. Property Fund: These funds are real estate mutual funds. Its investment alsoincludes shares/bonds of companies involved in real estate and mortgage backedcompanies.

viii.Fund of Funds: It is a fund that invests in other mutual fund schemes. Theconcept in prevalent in abroad.

5.3.4 History of Mutual Funds In India

The Mutual fund concept in India was launched by Unit Trust of India (UTI) in theyear 1964 by a special Act of Parliament. The first scheme offered was the “US-64”. A

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host of other fund schemes were subsequently introduced by the UTI. The basic objectivebehind the setting up of the Trust was to mobilize small savings and to allow channeling ofthose savings into productive sectors of the economy, so as to accelerate the industrial andeconomic development of the country.

In 1987, the Government of India permitted commercial banks in the public sector toset up subsidiaries operating as trusts to perform the functions of mutual funds by amendingthe Banking Regulation Act. SBI set its first mutual fund, followed by Canara Bank. Latermany large financial institutions under government control also came out with mutual fundssubsidiaries. Recently, with the beginning of the economic reforms and liberalization of theeconomy, based on the recommendations of the Abid Hussain committee, foreign companieswere also permitted to start mutual funds in India. The government introduced a number ofregulatory measures, through various agencies such as the SEBI, to the benefit the investors,esp. the small investors.

5.3.5. Business Valuation

The basic valuation methods of holdings by the Mutual funds should be done bykeeping in view the following elements:

• For listed securities – take last sale price quoted in the stock exchange dealinglist

• for OTCEI securities – take bid/ask price as may be relevant on case to casebasis

• Trustees may determine market value at a reasonable price as per current marketat which the investors would buy at fairly reasonable rate.

• For short term investments the basis of valuation should be the amortizedcost.

NET ASSETS VALUE

It is a parameter used to measure the operational efficiency of mutual funds. Theintrinsic 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 tothe 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

NOTES



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

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.

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

E.g. ABC Mutual fund has in its investment portfolio following shares:

1. DEF Industries Ltd., 100 shares of Rs. 10 each at market value of

Rs. 20 each.

2. OPQ Industries Ltd., 200 shares of Rs.10 each at market value of

Rs.50 each.

3. Other Assets Rs.100

4. Accrued expenses Rs.100

Mutual fund has 100 investors who have contributed to Mutual funds Rs.100 each atthe initial price of Rs.10 per share. In other words, there are 1000 shares outstanding (100x 10)

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We have:

Market value of investments=

100 shares x 20 2,000

200 shares x 50 10,000

————

12,000

Other assets 100

————

X= 12,100

L= (-) 100

————

Net assets 12,000

Y= 1,000

NAV = X – L / Y 12,000/1000 = Rs.12

NAV per share = Rs.12

Appreciation (A) in value is calculated as under:

A= Current Market Value 12,000

Less Original cost of securities Rs.1,000

Rs.2,000 3,000

—————

Unrealized appreciation Rs.9,000

—————

However has come out with the recommendations of the L.C. Gupta, a committeeappointed by it to review the accounting polices, NAV and pricing of Mutual Funds.


Q.5.3.a. What is a ‘Mutual Fund’?

Q.5.3.b. Explain the features and role of mutual funds.

Q.5.3.c. Give an account of the various schemes of mutual funds.

Q.5.3.d. Distinguish between an open-ended fund and a close-ended fund.

Q.5.3.e. Write short notes on:

a. Sectoral funds b. Index funds c. Gilt funds

d. Growth funds e. Income funds f. Equity funds

g. Debt funds

NOTES



Q.5.3.f. What are offshore mutual funds?

Q.5.3.g. How are mutual funds managed in India?

Q.5.3.h. What are the causes for the slow growth of mutual funds in India?: What are

your suggestions to overcome this?

SUMMARY

Despite all the advantages linked with mutual funds, people still prefer to invest theirmoney independently. So far mutual funds have not been able to introduce the schemeswhich are suitable to the needs of farmers, small entrepreneurs, and merchants to tap therural savings. Further mutual funds have not yet developed product structuring to tap targetcustomers. There is a lack of product conceptualization and innovation. Weak distributionand marketing channels are another problem which the mutual funds industry is facingtoday. The merchant banking industry is not sufficiently matured and this has led to slowdevelopment of mutual funds industry. The interesting thing is that mutual funds are themost misunderstood financial products in India. Mutual fund industries are also not makingefforts in investor awareness programmes which are the need of the day.

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NOTES



UNIT IV

FUND BASED FINANCIAL SERVICESLESSON – 1

1.1 INTRODUCTION

Leasing is not a concept which emerged in the modern days. Even in the olden dayswe had leasing in the form of Charter Party agreement, when in an entire ship is taken onlease either for a particular period or for a particular voyage. Similarly we had agriculturallands are given on lease for a specified period.


1.3 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.

1.3.1 Leasing

It is a contract by which one party conveys land, property, services etc., toanother 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 aprice paid or promised or of money, a share of crops, service or any other things ofvalue, to be rendered periodically or on specified occasions to the transferor bythe transferee, who accepts the transfer on such terms.”

• The transferor is called the ‘lessor’

• The transferee is called the ‘lessee’

• The price is called the ‘premium’

• The money, share, service or other thing to be rendered is called the ‘rent’.

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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 considerationmay be a price or a rent. The rent may be either money, or share of crops, serviceof anything of value, to be rendered periodically by the transferee to thetransferor.”

1.3.2 Basic Concepts In Leasing

Broker

An agent who brings two parties together, enabling them to enter into a contract towhich he is not a principal. His remuneration consists of a brokerage, which is usuallycalculated 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 toreserve it. Depending on the terms agreed, the deposit may or may not be returnedif the sale is not completed.

2. A sum of money left with an organization, such as a bank, for safekeeping or toearn interest or with a broker, dealer, etc., as a security to cover any trading lossesincurred.

3. A sum of money paid as the first installment on a hire-purchase agreement. It isusually 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 usefullife. It is an amount charged to the profit and loss account of an organization to representthe wearing out or diminution in value of an asset. The amount charged is normally basedon a percentage of the value of the asset as shown in the books.

Finance Broker

A broker who arranges finance.

Hire Purchase

System of purchase by paying in installments.

Interest

It is the charge made for borrowing a sum of money. The rate of interest is the chargemade, expressed as a percentage of the total sum borrowed for a specific stated periodof time.

NOTES



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 thelessee’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 freshloans, usually at a lower rate of interest.

Residual Value

The expected selling price of an asset at the end of its useful life.

Term :

A specified period of time.

1.3.3 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 fivecenturies earlier. Such leases were for leasing land, agricultural tools, animals and ships, asdocumented in the Sumerian and Greek civilizations.

These operators found leasing a viable alternative for enhanced operations as theywere desperately short of their own funds. They could not also rely upon conventionalsources of funds.

The unparalleled success of Rail Road companies highlighted the importance ofequipment leasing as a tool for promoting capital formation.

In the post-Second World War era, European rail companies also took to equipmentleasing on a large scale. In the early sixties, this practice of equipment leasing has gainedpopularity and it is believed that approximately 25% of all business equipments in terms ofvalue are leased.

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The later half of 19th century bore witness to this practice as the Rail Road operatorsin the USA leased Rail Cars and Locomotives.

The practice of Equipment Leasing is of recent origin in India. Equipment leasingtook roots only in the eighties. Equipment leasing includes, leasing of plant and machinery,office equipments, automobiles, ships and aircrafts.

1.3.4 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

• A lease is defined as a finance lease if it transfers a substantial part of the risks andrewards 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 leaseterm; or

b) The lessee has the option to purchase the asset at a price within is expected to besufficiently lower than the Fair Market Value (FMV) at the date, the option becomesexercisable that, at the inception of the lease it is reasonably certain that the optionwill be exercised; or

c) The lease term is for a major part of the useful life of the asset. The title may ormay not be transferred eventually; or

d) The Present Value of the minimum lease payments is greater than or substantiallyequal 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 StandardsBoard (FASB) of the USA.

If the lease term exceeds 75% of the useful life of the asset or if the presentvalue of the minimum lease payments exceeds 90% of the FMV of the asset, at theinception 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 bethe rate of interest implicit in the lease and the discount rate to be used by thelessee will be its incremental borrowing rate. In the Indian context, criteria (a) and

NOTES



(b) above are inapplicable, because, inclusion of any one of these conditions in thelease agreement will make the agreement being treated as a Hire PurchaseAgreement. Hence a lease can be classified as a finance lease only if any one ofcriteria (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 thecondition or the suitability of the asset.

• A finance lease, which prevails over the entire useful life of the equipment, is calleda ‘full payout lease’.

Illustration : ABC Company has leased equipments costing Rs.400 lakhs with thefollowing terms :

Lease term : 5 years

Lease rents : Rs.300/1,000 p.a.

The incremental borrowing rate for ABC Co., is 18% p.a. is this transaction a financelease ?

Consider the useful life of the equipments to be—

(a) 6 years, and (b) 10 years.

Solution :

a) (1) Lease term : 5 years

(2) Estimated life of the equipment : 6 years

As percentage of (1) & (2) : 83.3

As a leased term exceeds 75% of the estimated useful life of the equipments, thistransaction is classified as finance lease.

b) (1) Lease term : 5 years

(2) Estimated useful life : 10 years

1) As a percentage of (1) & (2) : 50

The third criterion specified by the FASB for classifying a lease, as finance lease

Is not fulfilled.

2) Present value of minimum lease payments

= (400 x 0.3) x PVIFA (18.5)

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NOTES


= 120 X 3.127

= Rs.375.24 lakhs.

3) FMV at the time of inception = Rs.400 lakhs

4) As a percentage of (2) & (3) = 94

The fourth criterion given by FASB is fulfilled and hence the transaction is a financelease

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.

2. The lessee enjoys the right to terminate the lease at short notice without any significantpenalty.

3. The lessor usually provides the operating know-how, supplies the related servicesand undertakes the responsibility of insuring and maintaining the equipment, inwhich case the operating lease is called a ‘Wet Lease’.

4. An operating lease where the lessee bears the cost of insuring and maintaining theleased equipment is called a ‘Dry Lease’.

5. An operating lease does not shift the equipment-related, business and technologicalrisks from the lessor to lessee.

The lessor structuring an operating lease transaction has to depend upon multiplelease or on the realization of substantial resale value (on the expiry of first lease), to recoverthe instrument cost plus reasonable rate of return thereon.

To deal in operating leasing one requires an in-depth knowledge of the equipmentsand the resale market. In our country, as the resale market for most of the used capitalequipments is not active, operating leases are not very popular.

SALE AND LEASE BACK

In the case of sale and lease back, the owner of an equipment sells it to a leasingcompany, which, in turn, lease it back to the seller of the equipment, who then becomes thelessee.

The ‘Lease Back’ arrangement in this transaction can be in the form of either a financelease or an operating lease e.g., the sale and lease back of safe deposit vaults practiced bycommercial banks.

NOTES



The banks sell the safe deposit vaults in its custody to a leasing company at a marketprice, 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 theexpansion and diversification programmes of a firm where high-cost short-term debt hasbeen used for capital investments in the past, the sale and lease back gives an opportunityto substitute the short-term debt by medium-term finance (provided the lease backarrangement is a finance lease).

For the leasing company offering sale and lease back arrangement, it is difficult toestablish a fair market value of the asset being acquired as the resale markets are virtuallyabsent.

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

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 theequipments called as ‘Upgrade Lease’.

The lessor undertakes to maintain the equipment and even replaces the equipmentthat is in need of major repair with the similar functioning equipment called as “SwapLease”.

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

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NOTES


1. The equipment supplier may provide a reference about the customer to the leasingcompany.

2. The equipment supplier can negotiate the terms of the lease with the customer andcomplete 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 receivableswith the designated leasing company. So the leasing company owns the equipmentand obtains an assignment of the lease rentals.

This form of lease has recourse to the supplier in case of default by the lessee, eitherto buy back the equipment from the lessor on default or providing a guarantee on behalf oflessee.

SINGLE INVESTOR LEASE

The entire investment is funded by the lessor by arriving at a judicious mix of debtand equity. The debt funds raised by the leasing company are without recourse to thelessee, 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 inequipments by borrowing large investments with full recourse to the lessee without anyrecourse to it.

The lender (loan participant) gets an assignment of the lease and enjoys benefit of therentals to be paid by the lessee and a first mortgage on the leased assets. This transactionis routed through the trustee to take care of the lender and the lessee.

Leveraged Lease Process

LOAN PARTICIPANT : A leveraged lease entitles the lessor to avail the shields ondepreciation, other capital allowances on the entire investment cost, though, a substantialpart 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 taxbenefits to the lessee in the form of lower rental payments. This lease is usually preferredfor leasing investment-intensive assets like aircraft, ships, etc.

Lessor

Trustee Leases the Lessee Equipment to Loan Participant

NOTES



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 presupposes :

1. An understanding of the political and economic climate; and

2. A knowledge about the tax and other regulatory framework governing thesetransactions in the respective countries, the payments to be effected in differentcurrencies and hence knowledge about exchange rate variation.

As a result international lease is exposed to country risk and currency risk.

1.3.5 Regulatory Authority

No specific Act or Authority regulates leasing in India. Some of the Acts which indirectlygoverns are :

• Income Tax Act, 1962

• Indian Contract Act, 1872

• Indian Stamp Act, 1899

• Manufacturing and Other Companies (Auditor’s Report) Order, 1988

• Motor vehicles Act, 1988

• Recovery of Debts due to Bank and Financial Institutions Act, 1993

• Registration Act, 1908

• Reserve Bank of India Act, 1934

• Sale of Goods Act, 1930

• Sick Industrial Companies (Special Provisions) Act, 1985

• Transfer of Property Act, 1882

• Companies Act, 1956

• Consumer Protection Act, 1986

• Easements Act, 1882

• Foreign Exchange Management Act, 2000.

• Hire Purchase Act, 1972

Reserve Bank of India’s (RBI) Supervision of NBFCs

The RBI has also proposed the following measures to track the performance ofNBFCs. NBFCs that do not conform to the requirements may find their registrationscancelled on 5 February 2003, the RBI has said that NBFCs not having a minimum NetOwned Fund (NOF) of Rs.25 lakhs as on 9 January 2003, would not be allowed tocontinue with their business.

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Off Site Monitoring

Monitoring of large NBFCs with asset bases exceeding US $ 23 million must furnishthree years of operations data in the annual returns.

On Site Inspection

Periodic inspection of NBFCs are conducted especially those suspected of unhealthyfinancial positions or non-compliance of prudential requirements.

External Audit

External auditors must certify important returns of NBFCs, Certified Public Accountant(CPA) firms are engaged to conduct special examinations of certain NBFCs, which aresuspected of poor financial strength or violations of regulations. Reports prepared by theCPA firms on NBFCs’ operations are scrutinized further by the RBI’s Department ofSupervision.

1.3.6 Lease Market In India

Lease market in India may be in the form

a. Formal market

b. Informal market

The formal players in the market are the financial institutions, commercial banks,foreign financial institutions, manufacturers and non-banking financial companies (NBFCs).

Individuals and families handle leasing in the informal market.

Market Size

The market size of the leased asset base in India’s organized sector is estimated at3% to 4% of the total gross fixed capital formation. The specific reason for slow growth ofleasing finance in India is due to

• Depreciation - high rate of depreciation allowed in India.

• Tax Exemption - the hire purchase system has an edge over leasing with respectto tax exemption in India from the point of lessor and lessee.

• Time Factor - Financial institutions make loans with favorable terms to companiesto assist them in establishing themselves in the market. The financial institutionshave a low cost of capital and can offer cheap loans. It is a time-consumingprocess. Only few companies prefer leasing to avoid time-consuming process ofavailing loans from financial institutions.

NOTES



Slow Down

The total base of leased assets (excluding real estate) in India in 1997-98 the formalsector was estimated at approximately US $ 37.0 billion. This figure represents 7.6 percent nominal growth from the 1996-97 level of US $ 34.0 billion. The latter figure was upapproximately 20 per cent from US $ 28.5 billion in 1995-96. The slow down is due tothree reasons :

1. The slow down in the market since 1996. Clients began defaulting on payments.Consequently, a number of lease financing companies faced a severe asset-liabilitymismatch. That led to a repayment crises and bankruptcy. However, even to-day, there are over 38,000 estimated players in the market.

2. Since 1996, most existing leasing companies have become more conservative intheir lending practices following the collapse of several leasing and hire-purchasefinance companies.

The Players

The market shares for the various players in the leasing market in India in 1996-97appear in the table.

Market Shares of Players in the Leasing Market, 1996-97

1.3.7 Players In Leasing

Financial Institutions (FIs)

FIs are term lending institutions. There are over 10 such institutions handling projectfinance on an all-India basis and over 20 State-level institutions. While FIs have over 30per 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 verylarge deposit base from savings accounts and deposit accounts, leading to the lowest costof capital amongst all players.

Market Player Category Share Financial Institutions Scheduled Commercial Banks Non-banking financial Institutions Foreign Institutional Investors Others

30 per cent 10 per cent 52 per cent 6 per cent 2 per cent

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NOTES


Foreign banks

The role of foreign banks are very limited in the leasing market. Few foreign bankssuch as ABN-AMRO and ANZ Grind lays, have organized aircraft leasing for privateairlines.

Citicorp Securities & investment, the financial services arm of Citibank has leasedassets 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 categoriesare called as NBFCs. NBFCs has a market share of over 50 per cent of the leasingmarket. On the other hand, 70 per cent of NBFCs’ business originates with leasing andhire-purchase activities.

In 1998, Anagram Finance and ITC Classic merged with the Industrial Credit andInvestment Corporation of India (ICICI), a leading all-India FI. In addition, Twenty-FirstCentury Finance merged with Centurion Bank. Although all of the companies recordedprofits in 1996-97, fears of a harder recovery and squeezed margins led them to thedecision 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 Capitaland the Japanese company Orix Corporation.

1.3.8 Hire Purchase

• It is the purchase of goods on hire

• The buyer makes payment for goods on a monthly installment basis and atthe same time is allowed to be used by the buyer

• The buyer becomes the owner of the goods only on the payment of the lastinstallment.

• Till such time, the amount paid by the buyer is treated as hiring charges.

• If the buyer fails to pay any installment, the goods will be seized for nonpayment of the installment amount.

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 topurchase them in accordance with the terms of the agreement, and includes an agreementunder which

NOTES



a. Possession of goods is delivered by the owner thereof to a person on the conditionthat 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 ofsuch installment

c. Such a person has a right to terminate the agreement any time before the propertyso 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 IndianContract Act, 1872 and Sale under the Sale of Goods Act, 1930.

HIRE PURCHASE AGREEMENT

A Hire Purchase Agreement is an agreement between the seller and the buyer, wherethe ownership of goods does not pass to the buyer until he pays the last installment. Thereare two parties to the hire purchase agreement.

The hire vendor, who is the seller and

The other is the hire purchaser, the buyer.

The purchaser has to make a down payment of 20 to 25% of the cost and the remainingamount 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 companywhich is returned together with interest after the payment of the last installment.

PARTIES TO THE HIRE PURCHASE CONTRACT

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

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NOTES


1.3.9 Difference Between Hire Purchase And Leasing

1.3.10 Financial Evaluation

It is an evaluation by the hirer of the desirability for lease and hire purchase. The hirermakes decision based on the Present Value of Net Cash Outflow. The decision is consideredfavourable when the PV of Net Cash Outflow under Hire Purchase is less than the PV ofNet 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

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

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.

NOTES



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

1.3.11 Tax Implication

Tax Benefits in Hire purchase transaction

A hire purchaser can claim the benefits by claming depreciation on the good whichare use in his business. Such tax benefits are applicable to sole trader, partnership firms, aswell as Joint Hindu firms. Depreciation can be claimed on the entire purchase price.

Income Tax

Deductions could be made on account of interest charged e.g. In the purchase ofhouse on hire purchase basis, the initial payment of interest charges will be totally waivedform income tax as per the new regulations. Even the principal amount is entitled for 20%deduction under Section 80( C) of the Income Tax Act.

Sales Tax

Sales Tax is levied on the total value of the goods and not on the installment payment.The respective State is benefited when there are more sales under hire purchase transactionsas they get more revenue.

HP Transactions

Benefits in Income Tax Benefits in Sales Tax Benefits in interest Tax

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NOTES


Interest Tax

It is the tax payable by the Hire Purchase Companies on Interest under the InterestTax Act 1974. However the tax is treated as a tax deductible expense for the purpose ofcomputing taxable income under the Income Tax Act.


Q.1.3.a. Define the term ‘leasing’? What are its features?

Q.1.3.b. What is a financial lease? What are its special features? What tests will you use to determine that a lease is a financial lease?

Q.1.3.c. What is an operating lease? What are its features?

Q.1.3.d. Distinguish between a financial lease and an operating lease.

Q.1.3.e. Give a detailed account of the different types of lease.

Q.1.3.f. What is ‘sale and lease back’?

Q.1.3.g. What is an ‘open-end lease?

Q.1.3.h. What is ‘swap leasing’?

Q.1.3.i. What are the myths regarding leasing?

Q.1.3.j. Discuss briefly the role played by various participants in lease finance services.

Q.1.3.k. Explain the process of leasing.

Q.1.3.l. What are the services rendered by the lessor?

Q.1.3.m. What are the advantages and disadvantages of leasing?

Q.1.3.n. State the shortcomings of leasing as a financial service.

Q.1.3.o. State the special procedures involved in ‘import leasing’ under the export-import policy of the government.

Q.1.3.p. What is cross-border leasing?

Q.1.3.q. What is ‘hire purchase finance’?

Q.1.3.r. What are the terms of agreement as prescribed under the provisions of the Hire Purchase act of 1972?

Q.1.3.s. Enumerate the rights available to a hirer under the hire purchase finance agreement.

Q.1.3.t. Identify the different ways of determining the rate of interest under the hire purchase finance arrangement.

Q.1.3.u. Distinguish between lease financing and hire purchase financing.

SUMMARY

Thus leasing finance provides enough opportunity for both lessor and lessee to gain inboth income tax and sales tax, as a result of which there is more scope for this kind ofbusiness in future in India.

NOTES



UNIT V

OTHER FUND BASED FINANCIAL SERVICES


A consumer may obtain loan for the purchase of a vehicle, refrigerator, washingmachines, etc., when a bank or any other financial agency provides loan to a consumer forthe purchase of consumer durables it is called as consumer credit.

The consumer with his income is not in a position to repay the full value of consumerdurables but would like to take advantage of his future earning and purchase them throughinstallment payment to his creditor. By doing so, he not only enjoys the product, but he isalso in a position to repay the value of the product. Hence, through consumer credit banksprovide loans to enable the consumer to purchase valuable goods.


Once you finish this unit, you should be able to understand:

Consumer Finance and its transactions

Nature of Consumer Classes in India

Importance of Consumer Credit in India

1.3 CONSUMER CREDIT

It is a finance to consumers

For the purchase of semi durables and durables by paying a part of the totalprice

Reavis Cox, an authority on economics of consumer finance defines consumer finance as“Business procedure through which the consumers purchase semi-durables and durablesother than real estate, in order to obtain from them a series of payments extending over aperiod of three months to five years, and obtain possession of them when only a fraction ofthe total price has been paid.”

According to E.R.A. Seligman, an authority on consumer finance, “the termconsumer finance refers to a transfer of wealth, the payment of which is deferred in whole

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NOTES


or in part, to future, and is liquidated piecemeal or in successive fractions under a planagreed upon at the time of the transfer.”

CHARACTERISTICS OF CONSUMER CREDIT

The nature of consumer credit may be

the transfer of wealth to consumers for purchase of semi durables or durablesexcept 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’s

1.3.1 Consumer Finance Transactions

The nature of consumer finance transactions may be

(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 orcredit sale, but a majority of the tripartite consumer finance transactions are of the hirepurchase 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 valueof goods and financing is available for 75%-80% or as the case may be.

NOTES



In a deposit-linked scheme, the down payment in the form initial deposit varyingfrom 15% and 25% of the total value of the asset. The financier pays the full amount to theseller. 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 normaldeposit schemes.

(c) Repayment Period

The repayment period ranges from 12-60 months. Finance companies notify thecustomer indicating the amount of equated monthly installments to be paid through post-dated Cheques.

(d) Security

The asset is secured through first charge on it for the credit provided. The borroweris prohibited from disposing, pledging or hypothecating the asset during above said creditperiod.

(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.

1.3.2 Nature Of Consumer Classes In India

MIDDLE-INCOME CLASSES IN INDIA

• The middle income class refers to that class of people between the lowerincome groups and higher income groups.

The need to study the middle income class in India was felt because the consumerfinance was absolutely designed to meet their financial requirements and in turn upgradetheir standard of living. Moreover the total population of middle class in India exceedsmore than 2/3 rd of the total population.

• India has registered a very impressive growth of its middle class – a class whichwas 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 300million people.

• The middle class comprises of three sub-classes: the upper-middle, middle-middleand lower-middle 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.

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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 fordifferent consumer product in India.

a. This because of the lack of homogeneity of the consuming class and the varyingprices of a single product in different parts of India.

b. Consumption habits of households are therefore better determinants of consumermarket size than income distribution.

2. While determining market size for a consumer product, the structure of the consumingclass as seen in the above, can be both revealing as well as misleading depending onthe kind of product. For example, any specific consuming class would be fit to be amarket for consumer products like tea or soap, but a product such as vacuum cleanerswould find market largely only in the “consumers” and “rich” segments of the marketas defined in the above table .

3. Identifying a plausible market size for a consumer product is therefore a hazardoustask in a heterogeneous country like India. Yet, the marketer needs some data tocome as close to the real picture as possible. For this purpose, it can be cautiouslyassumed that purchasing power is proportional to income despite variables such aslocation, taste etc. Companies are therefore advised to plan their consumer productmarketing strategies on an area-by-area basis, rather than on the country as a whole.

Annual income (in Rupees) at 1994-95 prices

No. of households (in million)

<25,000 25,001-50,000 50,001-77,000 77,001-106,000 >106,000 Total no. of households:

80.7 50.4 19.7 8.2 5.8 164.9 million

Number of households (in million) Annual income (In Rupees) at 1994-95

Prices Classification

Urban Rural total

<16,000 16,001-22,000 22,001-45,000 45,001-215,000 >215,000 Total no. of households

Destitute Aspirants Climbers Consumers The rich

5.3 7.1 16.8 16.6 0.8 46.6

27.7 36.9 37.3 15.9 0.4

118.2

33.0 44.0 54.1 32.5 1.2

164.8

NOTES



4. Income data is insufficient. Therefore, it must be supplemented by product-specificinformation regarding its existing stock in the marketplace (in the case of consumerdurables) and existing rate of purchases.

5. It is also advisable to further refine the plausible market size by taking into accountdetails based on social, cultural and demographic factors.

6. Marketing a super-premium product such as a Rolex watch is relatively easy. Just gofor the income class above Rs.2,15,000 per annum (in 1995-96) as per Table above.This class, the table shows, comprises 5.8 million households. But the problem lies inthe fact that the 5.8 million households are spread all over India.

7. The prime market for consumer products in India is aware of the cost-benefit or valuefor money aspect. Their concept of value incorporates socio-cultural benefits in additionto product utility. For example, many households in the “consumers” class and the“rich” class (as defined in Table ) may have two television sets, but both the sets maynot be top-of-the-line. Thus, while there may be demand for an additional TV set inmany households in the two mentioned classes, it must not be mistaken as demand forthe higher-priced TV models. The prime consumer market in India therefore is not amarket for absolute premium products, but for something between the “high end popularbrands” to the “premium brands”.

8. The class described in the previous paragraph is actually the “consumers” class definedin Table. This class comprises 33.5 million households as at 1995-96 and it ownedand ‘consumed’ most of the expensive consumer products such as refrigerators andwashing machines as well as premium expendables. At 1994-95 prices, their annualhousehold incomes ranged between Rs.45,000 and Rs.2,15,000 (to calculate the latestincome statistics, use an annual inflator of 5 percent). In addition to this class, the“climbers” and “aspirant” classes (defined in the Table ) totaling 23.9 million householdsin urban India, also have the socio-cultural traits of the “consumers” class and, withtime, will join the consumer’s class. Medium-to-long-term marketing strategy musttherefore aim at the aspirants and the climbers as well. This is based on the safeassumption that, except for the destitute class as defined in Table , the other classesare on the way to the next higher class. For companies with long-term marketing plansin India, the “consumers” (urban + rural), “climbers” (urban only) and “aspirants”(urban only) classes can be clubbed together to give a market size of around 57 millionhouseholds which can be said to be the “prime segment” of the Indian consumer market.This becomes even truer as consumer finance and the credit card culture picks up.Fine-tuning between the classes is of course important.

9. Suppose you are marketing washing machines. Go for two broad types : fully automaticand semi-automatic. Target the fully automatic machines at the “consumers” class andthe semi-automatic at the “aspirant” class, the “climbers” class will then overlap themarket for both the types of washing machines.

10. All of the above may be confusing, but the marketing strategist has to live with itbecause that’s how the Indian consumer market is in reality. There is hardly acharacteristic that applies across the market. It would be more accurate to describe itas a collection of distinct consumer markets.

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1.3.3 Latest Developments In Consumer Credit Changing Consumer Behaviour

The behavior of the consumers in India witnessed a remarkable change esp. theattitude. The Indian consumer is fast changing his habits, borrowing money to buy theproducts he wants, not content with buying what he can afford. The resultant consumerboom is what market strategists explain as the key to the success of the Indian consumerfinance market.

a. Consumer finance today helps everyone to upgrade his standard of living rightnow 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 variousforms like consumer lending, consumer credit, consumer loans, friendly and familyborrowings, daily payment schemes etc.

c. The basic objective of consumer financing is that the consumer’s present spendinghabits tend to be geared to expectations of future income. They are losing theirfear of borrowing of consumer finance.

d. Along with buying a home, consumers prefer consumer finance to buy homeappliances and vehicles, opting for finance based on the rate of interest,administrative fee, processing fee, commitment charges, pre-payment penalty, typesof facilities, standard and kind of services mix other terms and conditions.

e. These are members of a growing breed of normally conservative middle-classIndians who are opting for consumer finance loans despite the high interest costbeing charged.

IMPACT OF CONSUMER FINANCE GROWTH ON CONSUMERDURABLES MARKET:

The impact of consumer finance has a direct impact on the fortunes of the consumerdurables market including two wheelers and passenger cars. This correlation is alreadyclear from the surge in demand in recent times. Sales of cars would grow at an even faster20% 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 thelowering 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,

NOTES



as the agricultural slowdown last year hit rural incomes. Two-wheeler sales are expectedto 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 creditinformation system, which will ease the process, making it faster and easier to determinethe creditworthiness of customers.

• Ability to offer simple, convenient and innovative consumer finance products, awide distribution network and choice of repayment tenor, documentation and loanoffer.

• As a result of the large number of players, market pressures, increased competition,increased awareness and wider offerings consumer-financing activities need tobecome customer-oriented and user-friendly.

• One of the perceived problems relating to consumer finance is the absence ofcredit bureaus to rate the creditworthiness of consumers. As of now, the adventof information technology has paved way for sharing data about defaulters amongprivate sector banks. Any loan proposal is based on this shared information beforefurther process.

(c) Innovative Solutions

The banks are lending against collateral and have concentrated on small potentialborrowers to achieve disbursal targets.

• The Vijaya Bank offers ‘V stock’ for loans against shares; ‘V equip’ loans to helpprofessionals acquire equipment and vehicles; and ‘V-cash’ to enable clean loansagainst salaries after getting an employer’s guarantee.

• Judges, cops and teachers can now get cheaper loans with banks spinning out ofnew products to cash in on the great retail rush. The country’s largest commercialbank, State Bank of India, will charge lower interests to these set of borrowersfor buying a home, car, two-wheeler or simply opting for personal or festival loans.Concessions would be give to them on interest rate, processing fees and marginsunder three new schemes; ‘teacher plus’, police plus’ and ‘justice plus’. Themove, 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 debitedfrom 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 thaninterest charged to other borrowers. At present, the normal SBI home loan rates are9.25% for 10 to 20 years. Similarly, car loans will also be charged 0.25% lower than theusual rate, currently pegged at the medium-term lending rate (MTLR) of 11.25%. Forscooter and motorcycle loans, the rates will be 0.35% lower. SBI normally charges a

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spread of 0.85% over its MTLR, but for teachers, policemen and judges, the spread willbe 0.50%. 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, asagainst 2.5% charge to its regular customers. Thus, the festival loans would cost13.5%, as against 13.75%.

• Again, the processing fee on personal and two-wheeler schemes will stand reducedto 0.75%, as against 1% charged to its regular customers. The absolute fee forfestival loan schemes has been reduced from Rs.100 to Rs.75. Margins are alsobeing relaxed. For home loans, it has been brought down from 15% to 10%, andfor repair and renovation, it will be reduced from 20% to 15%. In case of carloans, the margins are pegged at 10%, against 15% for cars priced up to Rs.4lakhs and 20% margins, while a 2-4 years old car will attract 30% margin. Forscooters and motorcycles up to Rs.50,000, the margin would be 5% as against10% for regular customer and 10% (as against 20%) for over Rs.50,000. Thebank 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 byChennai-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 lackof electricity in 2/3rd of the homes. “Penetration of consumer durables would be cheaperin rural India if banks were ready to finance them. Banks have shown reluctance in thissector and restrict themselves to tractors and diesel pumps.”

While the consumer durables market is facing a slowdown due to saturation in theurban market, rural consumers are ready to put their money on the counter if consumerfinance is made available and basic infrastructure requirements such as electricity and voltageare ironed out. Currently, rural consumers purchase their durables from the nearest towns,leading to increased expenses due to transportation, Hence, purchase is necessarily onlydone during the harvest, festive and wedding seasons – April to June and October toNovember 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 financingrural consumers.

(e) Consumer Preferences

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.

NOTES



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 moresatisfied 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 reasonsfor customers who opted either for an NBFC or a foreign bank. In comparison, pastexperience and personalized service are the main reasons indicated by those opting for anationalized bank. Furthermore, more than 50% of NBFC and foreign bank customersobtained their financing at an automobile dealer or through a direct selling agent of thefinance provider. In contrast, more than 90% of nationalized bank customers obtainedtheir financing directly through the bank.

The car finance market has reached a new level of maturity, so much so that the car-maker, the automobile dealer and the financier now work together to provide better featuresand funding options for the buyer. Depending on the manufacturer, tenure of the loan andcredit 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 preferencefor financing car purchases through loans.

1.3.4 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 spotfor finance . The supernormal growth in retail finance has made it the primary driver ofbanks’ asset books. It is expected to capture 40-50% of banks’ incremental lending byend 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 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

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(b) Housing Loans

Housing loans have been the product of choice for state-owned banks because oftheir attractive profitability, low risk weight-low delinquency history, and the ease ofprocessing loans.

All the state-owned banks have recorded explosive growth in their mortgages; this hasvastly expanded the market.

(c) Consumer Durables

Banks have entered almost all the segments in retail finance. They are gaining sharefrom NBFCs. Private Banks have started offering loans for low-ticket items like consumerdurables and two-wheelers, besides personal loans. Some schemes of some banks aregiven below :

• SBI has struck a preferred-financier arrangement with carmaker Maruti, andnow markets these can loans from more than 2,000 branches. The bank has alsotied 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 allsales outlets of these companies. These alliances are significant, because theyhave extended the availability of car and two-wheeler finance to second-andthird-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 yearsto come.

(d) Reduction in Interest Rates

Falling interest rates, coupled with increasing loan durations, have substantially reducedthe EMIs on retail loans, thereby making them affordable to more people than ever before.The table below shows the fall in interest Rates :

Table harply falling interest costs

Year to 31 March 1999 2002 Current Rates Cars Basic IRR (%) Less manufacturer subventions (%) Dealer (%) DSA (%) Net rate to customer (%) Housing For 10-15-year loans (%) Tax benefit on interest payment Net rate (%) 2 wheelers Basic IRR (%) Commercial vehicles Basic IRR (%)

18 1-1.5 16.5-17 15.0-15.4 75,000 12.75-13.1 25 18-18

13.5 1-1.5 1.5 1 9.5-10 10.5-11 150,000 7.3-7.7 20-23 13-13

9.5 1.5 1.5 1 5.5 7.75 150,000 5.4 17 8.5

NOTES



(e) Expanding Target Market : Loans becoming more affordable

The target market for retail loans have grown the fastest because the incomes ofmiddle and upper-middle class households have grown substantially. The table belowshows the expanding market in loan products.

Expanding Target Population


Q.1.3.a. what do you mean by ‘consumer finance’?

Q.1.3.b. Explain briefly the different types of consumer finance.

Q.1.3.c. What are the different sources of consumer finance?

Q.1.3.d. What is ‘consumer finance insurance’?

Q.1.3.e. State the arguments in favor of and against consumer finance.

Q.1.3.f. Sketch the factors that have caused a boom in consumer finance in Indiain recent past.

Q.1.3.g. What is ‘hire purchase finance system’? What are its features?

Q.1.3.h. Bring out the advantages and disadvantages of the hire purchase system.

Q.1.3.i. Identify the safeguards to be followed by a banker while granting consumercredit.

Q.1.3.j. What is ‘hire purchase cost’?

SUMMARY

There has been a major improvement in consumer finance segment to cater to thegrowing needs of the consumers. But it’s high time to streamline the different segments ofconsumer credit facilitators. A bill was passed in 2002, called The consumer protection(amendment)bill, 2002 to enable state governments to setup up District Consumer councilon their own, make the compliance of the orders of the National Consumer Council ontheir own, make the compliance of the orders of the National Consumer Council, StateConsumer Council and District Consumer council meaningful and effective.

Loan Products FY1996 FY2002 CAGR (%) FY2005E FY2007E Mortgages 22.9 35.4 9.1 48 51.1 Car 9.5 17.2 12.6 29.6 31.7 2-wheeler 62.8 77.3 4.2 98.3 102.8 Consumer Durables 65.1 83 5 90.4 106.1 Personal 12.9 22.7 11.9 30.2 32.7 Credit cards 12.9 22.7 11.9 30.2 32.7

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The commercial banks extends different functions to customers. The most importantin the modern days are credit card facilities to customers. These facilities are not extendedto not only customers in the urban areas or cities but also to customers residing in ruralareas. Agriculturist are enjoying the facility of credit card and the card extended to themare called as green card.



• Types of Credit Cards

• The importance of Credit cards

• Future of Consumer Credit in India

2.3 CREDIT CARDS

A credit card is given by the banker to the customer in which the name of the customeris embossed in block letters. The name of the bank and the date of issue and expiry arealso mentioned on the face of the card. The reverse side of the card will bear the specimensignature of the customer. A list of vendors or sellers will be gibe by the banker to thecustomers. A credit card is a thin plastic card, usually 3 1/8 inches x 2 1/8 inches in sizethat contains identification information such as signature or picture or both and authorizesthe person named on it to charge for purchases or services to his account. In addition tothis, the card can be used in automated teller machines for withdrawing cash and themachine stores the information and also transactions through electronic date processingsystem.

2.3.1 Origin of Credit Cards In India

The usage of Credit Cards in India is less when compared to the usage of creditcards in China, Taiwan and Malaysia. It picked up only in the last 10 years until then theIndian looked it as a luxury. The idea of owning a credit card has had its roots in the mindsof millions of Indians. They started viewing the card as a convenient substitute to carryingcash. The change in mindset is clear from the growth, both in terms of absolute numbersand growth rates. The industry has grown at the rate of 30% and strongly counts forsteady years to come.

NOTES



Source : Chartered Financial Analyst, Jan. 2004.

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 andalmost 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 Visaor 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 20banks offering 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 bya bank are very high. The income per card is low, thereby requiring large volumes in termsof cards issued and the transactions finance to make the operations profitable.

Another reason for the inability of players to upstage the well-entrenched ones islower patronage by the merchant and business outfits. The bigger businesses and merchantsare already acquired by the existing players, so far new banks, braking into this businessand convincing a merchant is increasing because the banks are shifting towards lower endmerchants. Secondly, because of competition in acquiring business, new categories ofmerchants are coming up.

The foreign banks have a dominant share due to various reasons like having been inthe field for decades, sound operational and financial strength, strong brand recognitionetc. They were catering to the upper segments and charged high annual fees. Later, withaggressive 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 beacquired 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 issuerof credit cards today. It positioned itself in a segment as to be of mass appeal and at thesame time reinforced a clean and dependable image of the bank.

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Source : Chartered Financial Analyst – January 2004

Table : Major players and their ranks

The new private banks like ICICI and HDFC are also aggressively increasing theirshare. They adopted a strategy of reaching lower down the income strata by loweringdown their eligibility norms. Of course, the credit limits are set at lower levels as comparedto the foreign banks. As a result of this strategy, the credit cards base is widening day byday with the increase of base in B-grade cities.

2.3.2 Types of Credit Cards

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

__________________________________________________________________ No. of Cards (in Lakhs) -------------------------------------- Banks 2001 2002 2003 --------------------------------------------------------------------------------------------------- Citibank 14.00 16.00 20.00 StanChart 12.50 14.00 18.00 SBI-GE 6.00 9.03 13.00 HSBC 4.73 5.88 7.40 ICICI 2.50 5.00 8.0 AMEX 2.90 3.53 7.00

NOTES



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 forpeople who spend responsibly.

2. Debit Card :

A debit card is different from credit card. Debit card is issued by a bank. The followingare 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 aftercertain 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 is 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.

4. A debit card holder has his purchases restricted to his credit balance.

5. Credit card can be used for withdrawing money only from ATMs.

5. A debit card can be used even for with drawing money from the bank and hence it is account holders’ mobile

6. 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.

6. 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.

7. Loss of credit card should be reported to the issuing agency.

7. Loss of debit card should be reported to The issuing bank.

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4. Affinity card

A card offered by two organizations of which one is a lending institution and the othera non-financial group. Here, schools, non-profit groups, airlines, petroleum companiesissue affinity cards. These cards carry special discounts.

5. Standard Card

It is a normal credit card which carries limit on transactions, according to the creditworthiness 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 gettingthis card is higher. Gold card is given to very rich customers or persons with high socialstatus.

8. Platinum card

In order to distinguish credit cards belonging to certain companies, platinum creditcards 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. Thereis lowest interest rate for the outstanding, and the cards will have no annual fee or applicationfee 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 fromany 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 careof his outstanding balance, in case of his default on payment.

NOTES



14. Smart card

The revolution in Information Technology is responsible for the invention of Smartcard. The development in semiconductors has advanced so much that computing powerthat was available in a computer matching a room size in the early days, is now available ona visiting card-sized plastic. Kit is an embedded micro-chip card and it can store 1280times more data than the magnetic strip card. The can store data for more than 10 yearsand can be read or written for more than 1 lakh times.

For example : Visa is converting 22 million Brazilian debt and credit cards to Smartcards.

Sim card in the mobile phone is an example for the use of Smart cards in the telecomsector. There are 3 types of Smart cards. 1. Storage/memory cards 2. Intelligent cardsand 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.

Use of smart cards

1. A smart card can be used for multiple applications. Government agencies are a bigtarget for Smart card manufacturers.

2. Gemplus and Schlumberger are the major players in the Smart card market. InIndia, Bharat Petroleum and Indian Postal department have introduced this.

3. Smart cards can be used by government agencies for large data storage such as drivinglicense, vehicle registration and national permit for commercial vehicles, etc. Gujaratand Andhra Pradesh have already introduced this. IDBI’s Bank’s Money Smart card,a stored value card for even small transactions such as buying coffee and BharatPetroleum’s pre-paid perto-card are some of the examples of Smart cards.

4. Other applications of smart cards consist of :

(a) Public telephone (b) e-Commerce (c) Electronic wallet

(d) Cable TV (e) Internet banking

(f) Transportation This card can be used in different modes of transport.

(g) In health card, a patient’s blood pressure, sugar, blood group and other

Vital data could be obtained.

(h) Miscellaneous, such as insurance, club subscription and school fees, etc.

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NOTES


2.3.3 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 preventmisuse by others

iv. One can take benefit of lower prices by purchasing goods before the hike inprices.

v. During inflation period, credit card benefits customers as the payments are madeafter one month from the date of purchase.

vi. Railway ticket or Air ticket reservation can be done by using credit card evenduring night when banking facility is not available.

vii. Credit card can be used even through computers and purchases can be made bysitting at home.

viii. More customers will come forward to avail banking facility

ix. At any point of time, the customer will be able to know the available credit evenafter purchases.

x. Credit card can be used even for withdrawing cash through ATM (AutomaticTeller 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.

NOTES



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 tocustomers 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 updue to credit card.

ii. The wholesaler will be dealing products of different manufacturers due to creditextended 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 gettrade credit as well as cash credit from the manufacturers.

(4) Manufacturer

i. With orders continuously received from the wholesalers, the manufacturer canincrease his production.

ii. Due to large scale production, the cost of production will come down and themanufacturer will be able to sell at a lower price.

iii. Since the orders are received throughout the year, there will be continuousproduction even for goods which are seasonal in nature. Example : Manufactureof umbrellas.

iv. The manufacturer will also diversify his production due to the goodwill he hasenjoyed due to increased production.

v. The profit of the manufacturer will also increase and he will extend a highercommission 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 usecredit card for their purchase.

iii. The bank, by extending credit to customer, retailer, wholesaler and manufactureris able to earn interest on the credit.

iv. The credit facility is extended only in the books of accounts and there will be nocash withdrawals. The account of the customer is debited for the purchases whilethe account of the seller is credited. Both the parties are given credit and the bankenjoys interest on the loan.

v. All the transactions in the country are done through the banking system, as a resultof 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 differentparties.

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(6) Central bank

It is a national bank that provides financial and banking service for its country’sgovernment and commercial banking system and issues currency. Central bank forIndia is Reserve Bank of India.

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 headoffice of commercial banks to reduce the quantum of credit extended to customersunder credit card. This will reduce the demand and thereby prices will comedown.

iii. Central bank is able to take instantaneous action on the economy as credit cardprovides information regarding purchases and sale in the country.

iv. The activity of Non Banking Financial Companies will also be reduced due tothe credit card facility extended by commercial banks. So, the Central bank neednot control NBFCS.

v. By extending credit card facility to agriculturists, agricultural finance is improvedand this relieves the farmers from the clutches of money lenders.

(7) Government

i. Whenever any sale is made, it is properly billed. That means sales tax, commercialtax 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 themanufacturers. 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 territorysectors. . Transport system will improve with movement of goods to different places.Exports will improve, increasing the earnings of foreign exchange. Employment opportunitieswill increase not only in production centers but also in the service sector. Marketing willdevelop with increasing advertisements. Stiff competition will bring out good products forthe benefit of consumers.


Q.2.3.a. What is a ‘credit card’? Explain its features.

Q.2.3.b. Trace the history of credit cards.

Q.2.3.c. How will you classify credit cards?

Q.2.3.d. Write a note on ‘Innovative Cards’.

NOTES



Q.2.3.e. What are the facilities and services provided by credit card issuers?

Q.2.3.f. Give a brief account of the credit card business in India.

Q.2.3.g. What are the benefits of credit cards?

Q.2.3.h. What are the drawbacks of credit cards?

Q.2.3. What is a ‘smart card’?

Q.2.3.j What are ‘pre-paid cards’?

Q.2.3.k. What is a ‘chip card’?

SUMMARY

Credit card which was considered to be a luxury, has become one of necessity. Itwas considered to be used only by higher income group. But today, with development inbanking and trading activities, fixed income group or salaried class has also started usingthe same. There may be the criticism that it induces far more purchases or makes peopleSpend-thrift. This may be so in the initial stage, but when once a customer gets used tothe credit card, he/she will know how to use the same in a discretionary manner.

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The Real Estate financing has become so popular, that the procedure for obtaining aloan has become so simplified that housing loans are easily available. This may be attributedto the change in the housing policy of both the Central and Sate Governments. A redeemingfeature of Indian real estate finance is the recent entry of real estate commercial banks in abig way.



• Factors determining the Real Estate finance

• The different sources of finance

• Future of Real Estate Financing

3.3 REAL ESTATE FINANCING

• It is financing for the purchase of real property, where real property refers toland or buildings.

It’s a set of all financial arrangements that are made available by housing financeinstitutions to meet the requirements of housing. Housing finance institutions include banks,housing finance companies, special lousing finance institutions, etc.

3.3.1 Factors Determining the Real Estate Finance Assistance

Real estate finance companies consider the following factors before making any financialassistance 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

NOTES



1. The Loan Amount

The amount of loan that any HFC decides to provide to a loan seeker depends on thefollowing variables :

1. Customer’s repayment capacity

2. Rate of interest charged

3. Term of the loan

2. Tenure

Repayment is done through EMI, which includes principal and the interest. As arule, an HFC fixes the EMI between 30 and 40 percent of the customer’s gross monthlyincome, or 50 percent of the net monthly income. For instance, considering a loan ofRs.10, 00,000/- for 10 years, at 13 percent flat interest rate, the EMI would beRs.19,166.66/-. This way the gross earnings of the loan-seeker must be Rs.54,761.88per month, where the installment to income ratio is 35 percent. The general trend in themarket is that customers try to obtain loans for longer tenures, without realizing that thelonger the duration the more will be the amount paid by them. An increase in the tenurefrom 10 to 15 years increases the amount payable by 28 percent. In case the tenure of theloan 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 orfinance companies. Based on the method, the principal component, which is paid monthly,is deducted from the outstanding principal amount. The two methods, which banks andfinance companies generally follow, they are:

a. Monthly rest system

Under this system, the principal amount is deducted every month from the outstandingamount, 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

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NOTES


b. Annual rest system

Under this system, although the principal amount is paid every month, it is accountedonly 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 withPLR). Floating rates are better in a falling rate scenario, but expensive in an increasing ratescenario. The borrower should check whether it is viable to shift the loan from fixed rateto 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 abilityto repay the loan matters. There are certain HVCs which charge pre-payment, in case theloan is repaid before schedule. This pushes up the cost of fund of the borrower. Borrowerswho desirous of repaying ahead of schedule should approach HFCs which do not have apre-payment charge.

5. Value addition

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.,

3.3.2 Sources Of Finance

1. THE NATIONAL HOUSING BANK (NHB)

The National Housing Bank (NHB) was set up in July 1988, under an Act ofParliament, and is wholly owned by RBI, NHB, at present, has a paid-up capital ofRs.350/- Crores. It was conceived and promoted to function as the apex institution in thehousing sector. The need to set up this institution stemmed from the fact that the housingsector had not received the attention it required, not only in terms of finance for individualloans, but also in terms of buildable or serviced land, building materials and cost effectivetechnology.

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

NOTES



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 thehousing finance industry. It has a wide network in the industry with 67 Area/Unit Officesand 6 Regional Offices across the length and breadth of the country besides about 5,000LIC 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 theCentral Government towards the deteriorating housing conditions in the country, and adesire to assist various agencies in dealing with it in a positive manner. The principalmandate of HUDCO was to ameliorate the housing conditions of all groups and with athrust to meet the needs of the low-income group and economically weaker sections.


Q.3.3.a. How will you define the term ‘housing’?

Q.3.3.b. What is real estate finance?

Q.3.3.c. Describe briefly the different models of housing development.

Q.3.3.d. Discuss the major issues confronting real estate financing in India.

Q.3.3.e. Identify the major factors responsible for the growth of housing finance in India.

Q.3.3.f. How does competition shape the growth of institutions pursuing real estate financeschemes in India?

Q.3.3.g. What are the factors considered by the HFC while granting housing finance assistance? Discuss briefly.

Q.3.3.h. Give an account of the genesis and the objectives of major real estate finance institutions in India.

Q.3.3.i. What are the objectives of NHB?

Q.3.3.j. State the objectives of HDFC.

Q.3.3.k. State the type of loans offered by HDFC.

Q.3.3.l. Write a note on the Life Insurance Corporation Housing Finance Limited .

Q.3.3.m. Describe the role of HUDCO in the sphere of housing finance in India.

Q.3.3.n. What are the businesses undertaken by the NHB?

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NOTES


SUMMARY

Thus the different financial institutions are accomplished with the major objective ofpromoting a sound, healthy, viable and efficient housing finance system to cater to all segmentsof the populations, promote savings from housing , make housing more affordable , upgradethe housing stock in the country, and enable the housing finance system to access thecapital market for resources.

NOTES




Bills of exchange that are used in the course of normal trade and commercial activitiesare called ‘commercial bills’. Bill financing, is an ideal mode of short-term financing availableto business concerns. It imparts flexibility to the money market, besides providing liquiditywithin the banking system. It also contributes towards the effective-ness of the monetarypolicy of the central bank of a country.

According to the Indian Negotiable Instruments Act 1881, “Bill of Exchange is aninstrument in writing containing an unconditional order, signed by the marker, directing acertain 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-relatedinstrument, 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 bankingsystem. It also contributes towards the effectiveness of the monetary policy of the centralbank of a country.



• Bill discounting

• Steps in Bills Discounting

• Bill Systems

4.3 BILL DISCOUNTING

When the seller (drawer) deposits genuine commercial bills and obtains financialaccommodation from a bank or financial institution, it is known as ‘bill discounting’. Theseller, 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 obtainsready cash, which can be used for meeting immediate business requirements. However, inthe process, the seller may lose a little by way of discount charged by the discountingbanker.

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4.3.1 Features

Following are the salient features of bill discounting financing:

1. Discount charge : The margin between advance granted by the bank and face valueof the bill is called the discount, and is calculated on the maturity value at rate a certainpercentage per annum.

2. Maturity : 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 90days are the most popular.

3. Ready finance : Banks discount and purchase the bills of their customers so that thecustomers get immediate finance from the bank. They need not wait till the bank collectsthe payment of the bill.

4. Discounting and purchasing : The term ‘discounting of bills’ is used for ‘demandbills’, where the term ‘purchasing of bills’ is used for ‘usance bills’. In both cases, thebank immediately credits the account of the customer with the amount of the bill, less itscharges.

Charges are less in case of ‘purchasing of bill’ because the bank can collect thepayment 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 notonly the charges for service rendered, but also the interest for the period from the date ofdiscounting the bill to the date of its maturity. In addition, there are also charges when billsare dishonored. In such circumstances, the bank will debit the account of the customerwith the amount of the bill along with interest and other charges.

Since the bank is granting advance to the customers in both the discounting andpurchasing of bills, “bills discounted and purchased’ are shown as advances (Schedule 9)by a bank in its balance sheet.

4.3.2 Steps In Discounting And Purchasing

Following steps are involved in the discounting and purchas8isng of commercial billsof 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 documentsalong with the bill.

2. Crediting Customer Account After examining the genuineness of the bill, thebanker grants a credit limit, either on a regular or on an adhoc basis. The customer’saccount is credited with the net amount of the bill i.e. value of bill minus discountcharges. 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.

NOTES



3. Control over Accounts : To ensure that no customer borrows more than thesanctioned limit, a separate register is maintained for determining the amount availedby 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 bereadily known.

4. Sending Bill for collection : The bill, together with documents duly stampedby the banker, is sent to the banker’s branch (or some other bank’s branch if thebanker does not have a branch of its own) for presenting the bill for acceptance orpayment, in accordance with the instructions accompanying the bill.

5. Action by the Branch : On receipt of payment, the collecting bank remits thepayment 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 ofthe bill. It would be appropriate for the collecting banker to get the protested fordishonor. For this purpose, the collecting banker or branch of the bank maintainsa 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 thenpresents them for acceptance or payment, as required. The banker debits thecustomers’ (drawer / borrower) account with the amount of the bill and also allcharges incurred due to dishonor of the bill. Such a bill should not be purchasedin the event of its being presented again. However, the banker may agree toaccept it for collection.

4.3.3 BILL SYSTEMS

There are essentially two systems of bills, the drawer bill system and the drawee billsystem, which are explained blow :

Drawer Bills System

‘Drawer Bills System’ is 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’ is characterized by :

a. The banker accepting the bill drawn by the seller at the instance of the buyer (thedrawee)

b. The banker providing assistance, primarily on the strength of the creditworthiness ofthe buyer

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NOTES


The two types of the drawee bills system are as follows :

1. Acceptance credit system : Under this system, the buyer’s banker accepts the billof exchange for the goods purchased by the drawee. Such a bill may either be drawn onthe buyer or the banker. The banker also requires the borrower to show separately, thegoods purchased under acceptance credit in periodical stock statements submitted to thebanker.

2. Bills discounting system : Under this system, the seller directly draws the bill onthe 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 andstill outstanding. This is to ensure that the advance sanctioned does not exceed the creditlimit.

The main advantages of the Drawee bill scheme are as follows :

1. Assured payment : Since the banker has accepted the bill, the seller is assuredof payment. Moreover, if the seller decides to get it discounted, the discount ratewill be lower because the drawee is the banker itself.

2. Buying advantage : Due to the surety and standing of the banker, it is possiblefor 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 isaccepted 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 advantageousfor the seller’s bank, since the discounted bill may be rediscounted with any otherfinancial institution. This is because, a banker has accepted the bill.


Q.4.3.a. What are commercial bills? What are the features of such bills?

Q.4.3.b. Explain the different types of commercial bills.

Q.4.3.c. What do you mean by the term ‘commercial bill discounting’?

Q.4.3.d. Bring out the features of commercial bill discounting.

Q.4.3.e. State the advantages of commercial bill discounting.

Q.4.3.f. What are the precautions to be taken by a banker while discounting/ purchasingcommercial bills?

Q.4.3.g. Outline the steps in Discounting and Purchasing of bills.

Q.4.3.h. What is a bills system? Explain its types, bringing out the salient features.

NOTES



SUMMARY

Thus commercially, the option of discounting will be advantageous because the sellerobtains 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 thediscounting banker.

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An important development in the Indian factoring services took place with the RBIsetting up a ‘Study Group’ under the chairmanship of Shri C.S. Kalyanasundaram inJanuary, 1988. The study group aimed at examining the feasibility and mechanism oforganizing factoring business in India. The group submitted its report in January 1989.



• The characteristics of Factoring and Forfaiting

• The different types of Factoring

• The major distinction between Factoring and Forfaiting

5.3 FACTORING AND FORFAITING

Peter M. Biscose defines the term ‘Factoring’ in his treatise ‘Law and Practice ofCredit 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 tothe client, and in relation thereto, controls the credit extended to customers, and administersthe sales ledger”.

C.S. Kalyansundaram, in his report (1988) submitted to the RBI defines factoringas, “a continuing arrangement under which a financing institution assumes he credit andcollection functions for its client, purchases receivables as they arise (with or without recoursefor 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 auxiliaryfunctions”.

According to the study Group appointed by the International Institute for theUnification of Private Law (UNIDROTT), Rome, 1988". “A domestic factoring means anarrangement between a Factor and his client, which includes at least two of the followingservices to be provided by the Factor.

a. Finance

b. Maintenance of accounts

c. Collection of debts

d. Protection against credit risk.

NOTES



FORFAITING

A form of financing of receivables arising from international trade is known as forfaitng.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 thedocuments covering the entire risk of non-payment at the time of collection. All risks becomethe full responsibility of the purchaser. Forfaiter pays cash to the seller after discounting thebills/notes.

5.3.1 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. Factoringis a specialized activity whereby a firm converts its receivables into cash by selling them toa factoring organization. The Factor assumes the risk associated with the collection ofreceivables, and in the event of non-payment by the customers/debtors, bears the risk of abad debt loss.

2. The Form

Factoring takes the form of a typical ‘Invoice Factoring’ since it covers only thosereceivables 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 theevent of receivables being backed by bills. Factoring of receivables helps the client doaway with the credit department, and the debtors of the firm become the debtors of theFactor.

3. The Assignment

Under factoring, there is an assignment of debt in favor of the Factor. This is the basicrequirement for the working of a factoring service.

4. Fiduciary Position

The position of the Factor is fiduciary in nature, since it arises from the relationshipwith the client firm. The factor is mainly responsible for fulfilling the terms of the contractbetween the parties.

5. Professionalism

Factoring firms are professionally competent, with skilled persons to handle creditsales realizations for different clients in different trades, for better credit management.

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NOTES


6. Credit Realizations

Factors assist in realization of credit sales. They help in avoiding the risk of bad debtloss, 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 thesupplier on non-payment from the customer. Factoring may also be with recourse, inwhich case the Factor will have recourse to the seller in the event of non-payment by thebuyers.

9. Compensation

A Factor works in return for a service charge calculated on the turnover. Actor paysthe net amount after deducing the necessary chares, some of which may be special termsto handle the accounts of certain customers.

5.3.2 Types of Factoring

Factors take different forms, depending upon the type of specials features attachedto them. Following are the important forms of factoring arrangements:

1. Domestic Factoring

Factoring that arises from transactions relating to domestic sales is known as ‘DomesticFactoring’. 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 onthe face of the invoice made out by the seller of goods. In this type of factoring, thepayment has to be made by the buyer directly to the Factor named in the invoice. Thearrangement for factoring may take the form of ‘recourse’, whereby the supplier maycontinue to bear the risk of non-payment by the buyer without passing it on to the Factor.In the case of non-recourse factoring, Factor, assumes the risk of bad debt arising fromnon-payment.

3. Undisclosed factoring

Under ‘undisclosed factoring’, the name of the proposed Factor finds no mention onthe invoice made out by the seller of goods. Although the control of all monies remain with

NOTES



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.

4. Discount factoring

‘Discount Factoring’ is a process where the Factor discounts the invoices of the sellerat a pre-agreed credit limit with the institutions providing finance. Book debts andreceivables 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 guaranteedpayments, it is called ‘export factoring’. An important feature of this type of factoring isthat the Factor=-bank is located in the country of the exporter. If the importer does nothonor claims, exporter has to make payment to the Factor. The Factor-bank admits ausual advance of 50 to 75 percent of the export claims as advance. Export factoring isoffered 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 abanker or any financial institution in the importers’ country and financial assistance is obtainedon the strength of the export documents and guaranteed payments. International factoringessentially works on a non-recourse factoring model. They handle exporter’s overseassales on credit terms. Complete protection is provided to the clients (exporter against baddebt loss on credit-approved sales. The Factors take requisite assistance and avail thefacilities provided for export promotion by the exporting country. When once documentationis complete, and goods have been shipped, the Factor becomes the sole debtor to theexporter.

7. Full-service Factoring

Full-service factoring, also known as Old-line factoring, is a type of factoring wherebythe Factor has no recourse to the seller in the event of the failure of the buyers to makeprompt 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 combinesthe features of almost all factoring services, especially those of non-recourse and advancefactoring.

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 purchasedbecoming irrecoverable

2. The Factor assumes no credit risks associated with the receivables

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3. If the consumer defaults in payment, the resulting bad debts loss shall be met bythe firm

4. The Factor becomes entitled to recover dues from the amount paid in advance ifthe customer commits a default on maturity

5. The Factor charges the client for services rendered to the client, such as maintaining

sales ledger, collecting customers’ 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 acompensation for the said loss

4. The Factor actively involves in the process of grant of credit and the extension ofline 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 thereceivables factored and approved from the client, the balance amount beingpayable 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 financialstanding of the client and the volume of turnover while determining the rate ofinterest

11. Bank Participation Factoring

It is variation of advance and maturity factoring. Under this type of factoring, theFactor 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 theclient. The Factor makes payment either on the guaranteed payment date or on the date ofcollection, the guaranteed payment date being fixed after taking into account the previousledger experience of the client and the date of collection being reckoned after the due dateof the invoice.

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5.3.3 Difference Between Factoring And Forfaiting

The following are differences between factoring and forfeiting


Q.5.3.a. Define factoring. State the mechanism involved in a factoring financial service.

Q.5.3.b. What are the characteristic features of factoring?

Q.5.3.c. Briefly explain the different types of factoring.

Q.5.3.d. State the salient features of cross border factoring.

Q.5.3.e. Detail the services of various players in the Indian factoring business.

Q.5.3.f. Discuss the functions performed by a Factor.

Q.5.3.g. What are the advisory services rendered by a Factor?

Sl. No.

Characteristic Factoring Forfaiting

1. Suitability For transactions with short-term maturity

For transactions with medium-term maturity period

2. Recourse Can be either with or without recourse

Can be without recourse only

3. Risk Risk can be transferred to seller

All risks are assumed by the forfaiter

4. Cost Cost of factoring is usually borne by the seller

Cost of forfeiting is borne by the overseas buyer (importer)

5. Coverage Covers a whole set of jobs at a predetermined price

Structuring and costing is done on a case-to-case basis

6. Extent of Financing

Only a certain percent of receivables factors is advanced

Hundred percent finance is available

7. Basis of financing

Financing depends on the credit standing of the exporter

Financing depends on the financial standing of the availing bank

8. Services

Besides financing a Factor also provides other services such as ledger administration etc.

It is a pure financing arrangement

9. Exchange fluctuations

No security against exchange rate fluctuations

A forfeiter guards against exchange rate fluctuations for a premium charge

10. Contract Between seller and Factor Between exporter and Forfaiter

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Q.5.3.h. Evaluate the methods used by a Factory to determine the line of credit.

Q.5.3.i. Bring out RBI guidelines relating to the factoring business in India.

Q.5.3.j. Discuss the scenario of factoring in India with specific reference to the working offactoring institutions.

Q.5.3.k. Explain the operational profile of the factoring business in India.

Q.5.3.l. What hurdles do you think factoring in India is faced with in is operations?

Q.5.3.m. What is ‘forfaiting’? What are its features?

Q.5.3.n. Explain the modus operandi involved in forfeiting.

Q.5.3.o. How is factoring different from forfeiting?

SUMMARY

Factoring in India is still in the infant stage. If we have to improve factoring organizationsin the country, there should be more credit investigating agencies so that they can recommendgenuine business transactions. However, factoring service has a very bright future in India.In fact, it will be a boon for small scale sector.

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An entrepreneur, with a good technical knowledge, raising of capital in the conventionalmethod will be very difficult. So, by a new technique of financing, long term capital isprovided to small and medium sector through an institutional mechanism. So capital assistanceagainst high growth oriented along with managerial assistance was felt necessary. Thisgave to the birth of Venture Capital Assistance.

6.2 LERNING OBJECTIVES


• The financing by venture capital institutions

• The present status of venture capital in India

• Guidelines for providing venture capital

• The investment pattern in venture capital

6.3 VENTURE CAPITAL VENTURE

A business enterprise involving considerable risk

VENTURE CAPITAL

It is a long term capital invested in companies which involves high risk.

The financing involves high risk but is compensated by high return.

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 theborrowing concern.

4. Venture capital is always a long-term investment and made in companies whichhave high growth potential.

5. The venture capital provider take part in the business of borrowing concernsimultaneously provides managerial skill.

6. Venture capital financing contains risks. But the risk is compensated with a higherreturn.

7. It involves financing mainly small and medium size firms, which are in their earlystages. When the assistance of venture capital, these firms will stabilize and latercan go in for traditional finance.

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6.3.1 Objectives

• 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

6.3.2 Financing By Venture Capital Institutions

Before going in for venture capital finance, the venture capital institution will have toassess the potentiality of the borrowing concern by a proper appraisal. This appraisal willbe similar to the project appraisal undertaken by commercial banks. There are threestages involved in the venture capital finance.

1. Seed capital

It is the capital provided for testing the product and examining the commercial viabilityof the product. It enables the venture capital institution to find out the technical skill of theborrowing concern and its market potentially. So, we can say seed capital is more of aproduct development and all the finance required at this stage is provided by the venturecapital institution.

2. Start up

Start up of the product refers to the is tested in the market and after being satisfiedwith its acceptability by the market, financing will be provided for further development ofthe product and marketing of the product.

The start up 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 knowledgeand experience – normally started by persons who were working in an establishedfirm 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 capitalinstitution is keen to have a first-rated management which may have a secondrated product. But not vice versa i.e., venture capital will not be provided for aconcern 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 successfulfor want of some more finance.

NOTES



4. Later stage financing

It is the financing after second round finance. The business concern which has borrowedventure capital has now become a well established business. But still, it is not able to go infor 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 hasovercome the risks and has started earning profits. But they have to go for some more yearbefore reaching the stage of self sustenance. This finance is used by the borrowing companyfor 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 extendinga 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 externalcontrol.

Example : An Indian company’s shares may be purchased by NRIs at the initialstage and after sometime these shares are bought back by the company with the help ofprofits and finance by venture capital institutions.

8. Management buy-in (MBI)

Management buy in is the case where the funds are provided for an outside group tobuy an on going company.

9. Turn Arounds

Turn around may be

Financial Turn around : When the company is able to improve its conditionsfinancially, it is called financial turn around, which is due to the financial assistance byventure capital institution.

Management Turn around : similarly, when the management of the company makesa turn around by becoming self dependent and is able to face the challenges of business, itis called management turn around.

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Infrastructure financing

Incubators :

Incubators are non profit entities providing consultancy services in promoting venturecapital.

To encourage venture capital industry, it is necessary to develop proper infrastructurefor venture capital, as being done in foreign countries. Consultancy may be about officeenvironment, finance and other complimentary resources. Incubators are promoted normallyby government or professional organizations interested in developing small companies.

The venture capital fund companies also have their own incubators and they providein-house incubators. The job of incubators will be to provide early support to youngentrepreneurs so that the enterprise is converted into a successful commercial venture atthe 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 bySmall Business Administrator (SBA)

2. Bilateral Industrial Research and Development Foundation (BIRD).

SBIC, USA provides venture capital to private investment managers who promotesmall companies. SBIC provides two-third of the capital and the remaining one-third isprovided by insurance companies, endowments, foundations, etc.

The capital supplied by SBA requires rate of return which is much lower than themarket rate. SBIC will also raise capital from the open market. 45% of the total equity isprovided by venture capital firms in America for the small enterprises. This method can beadopted in India also.

The second model, BIRD is introduced by Israel – The Israeli government withinternational corporation, could mobilize funds for providing venture capital fund. Thefund provides not merely financial assistance but infrastructure development, assistancefor manufacturing and for selling innovative products.

6.3.3 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.

NOTES



1. VC companies promoted by Development banks

a) IDBI – VFC (Venture Fund Company) : IDBI promoted venture fund companyin the year 1986. It is promoted by the Technology Development Wing of IDBI.

b) TDICI - Technology Development and Information company of IndiaLtd. This was started in January 1988 with the support of ICICI and UTI. Thisis the country’s first venture fund (Venture Capital Unit Scheme). It was startedwith an initial fund of Rs.20 Crores and it has financed nearly 37 small and mediumscale enterprises. At present, it has a total fund of Rs.120 crores. The initial fundhas yielded a return of Rs.16 crores.

c) RCTC – Risk Capital and Technology Finance Corporation Ltd.: It is asubsidiary 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., alongwith Gujarat Lease Finance Corporation Ltd., Gujarat Alkalies & Chemicals Ltd., andGujarat State Fertilizer Ltd., promoted Gujarat Venture finance Ltd. It has a venture fundof 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 IndianOverseas Bank.

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 InvestmentFund.

iii. SBI Capital Venture Capital Fund.

4. Private sector Venture Capital companies

In private sector, we have Larazd Credit Capital Venture Fund and Indus VentureManagement Ltd. (IVML).

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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.

6.3.4 Guidelines For Providing Venture Capital

The venture capital companies have been given certain guidelines for providing venturecapital. Accordingly, the venture capital companies must obtain a detailed report from theborrowing 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 applicationduring which period, aspects such as the organizational structure, competition for thecompany’s product, etc., are studied.

6.3.5 Investment Pattern In Venture Capital

The investment plan will consist of 3 stages –

a) Basic stage

b) Operating stage

c) Exit stage

• Basic stage involves the study and evaluation of the project.

• Operating stage deals with monitoring the functioning of the management of theborrowing 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

NOTES



• Exit stage – The borrowing company may be sold to a third party or the companymay 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


Q.6.3.a. What is venture capital? What are the characteristics features of venture capital?

Q.6.3.b. What are the stage involved in venture capital financing?

Q.6.3.c. How a venture capital firm evaluates a borrowing company?

Q.6.3.d. What are the different types of venture capital companies?

Q.6.3.e. What is the significance of venture capital? How does it promote new class of entrepreneurs?

SUMMARY

In spite of the major steps taken by SEBI to encourage venture capital investor thereis still slow growth of venture capital companies in India. They are due to

a. Lack of understanding of venture capital

b. The companies act s not in favour of venture capital fund

c. No proper exit policy

d. Lack of training to employees of venture capital companies

e. Unfavourable tax regulations

f. Too many restrictions on foreign venture capital companies

g. Lack of clarity in the calculation of equity of borrowing companies.

h. Lack of capital market support

i. Failure to revive sick companies by the venture capital companies.

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NOTES

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NOTES

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dba 1724 merchant banking and financial services[1]

Documents

indian money market

himalaya publishing

indian financial system

new delhi government

investment management

primary market

capital market instruments

international money