Q1 ) RATING METHODOLOGY ADOPTED BY CREDIT RATING ANENCY/ ICRA

rating scale of corporate governance:

A large number of variables affect the quality of rating of a debt instrument of an
organization. The rating methodology should include these variables. The variables are:
history, quality of management, business fundamentals, accounting quality, liquidity
management, quality of the assets, profitability, return on equity and investment,
capital structure, past performance, effect of normal business cycle, and interest and debt
coverage ratios. This section discusses these variables briefly.
1.

His tory : The rat ing agenc y mus t unders tand the ow ners hip, s ize,
geographical spread, product spread, and the organizational structure of the issuer. The
size of the issuer can have some access to some sources of funds and to some market
segments, and thus impact credit quality. The history of the issuer could establish its
export in certain product market and thus have a bearing in credit quality.
2. Accounting quality: The accounting policies followed should strictly adhere to
the concepts, principles, and conventions of accounting so as to ascertain a true and fair
view of the financial state of affairs of the company. Neither should the accounting
methods be manipulated nor there do any chance of doing so in the accounting practices
followed by the issuer company. No controversial accounting practices should be followed
by it just to portray a good balance sheet.
3.Business fundamentals: Under this category the issuer company is assessed in
the area of its competitive position as compared to the competitors operating in the
similar line. Its strategies, policies, strengths, and weaknesses and goals have to be
analyzed as they have some sort of bearings in measuring the ratings of the
organizations. Its diversification activities having a sound track record of profitability
in the industry and future projections of demand for output can have an important
bearing in rating the debt instruments issued. If the product is export-oriented or
import-substituted, the debt issued for the purpose should obviously influence the
rating decision of the rating agency.
4. Liquidity management: The issuer's sources and uses of funds in terms of cost and
availability have to be studied in relation to debt issue. The issuer's innovativeness and
competitive ability to attract cheaper funds is also analyzed. Foreign exchange and interest rate
risks associated with each source and management of such risk are scrutinized to estimate the
probable impact of credit quality. To understand the liquidity of the issuer, the maturing match
between sources and deployment of funds is studied. The rating agency must understand the
quantity and quality of liquid assets, past trends, unutilized refinance limit available, and issuer's
standing in the financial market to raise resources quickly. A careful study of the liquidity position
of the firm in terms of its current ratio and acid test ratio , the debtors turnover and stock turnover

has also some bearing on the rating of the debt instruments. Projected income and expenses
statement as well as balance sheet and cash flow statements can be computed to have an idea
about the liquidity position of the company which has a bearing on credit quality.
5. Quality of management: This is judged by the team of executives, human resource
policies, organizational structure, and the extent of delegation of authority and responsibility.
The support of group companies could also be important in determining their success. The
management's attitude towards risk is measured as revealed by the track record in the choice of
segments, dividend policy, accounting practices, and funding policies. Systems also play an
important role in determining the credit quality of the issuer.
6.Quality of assets:. The quality of the assets in investments is judged by analyzing the type of
investment, the internal system for management of investments, policies in respect of
disinvestment, and charging depreciation in the value of the investments. In this connection, fixed
assets turnover and fixed assets to net worth ratio and the rate of return on performing assets must
be computed to study the fixed assets components as a portion of net worth or to study the
earning power of fixed assets of the firm. The more the earning powers of the fixed assets, the
more will be the source of funds generated to the company and more will be the positive impacts
felt in assessing the quality of the debt instruments. The extent of non-performing assets in the
portfolio and the provisions available to meet any losses from such assets are considered as
important indicators of the quality of the asset.
7.Profitability: Since non-fund based income plays an important role in boosting the
earnings of the issuer, the rating agency should determine the probability of continuance of such
income in relation to sales, component-wise expenses ratios, operating expenses ratio, and
operating net profit ratios determined in the past and budgeted figures in the future would also
affect the quality of rating.
8.Capital structure: The most important indicator in analyzing the capital structure is the capital
adequacy ratio. To warrant adequate safety the borrowing of the company as a rule of thumb
should not exceed two times its shareholders' funds. This is also an important indicator that
determines the quality of rating of debt issues. A lower debt equity ratio indicates a higher degree
of protection enjoyed by the creditors and the less is the likelihood of insolvency in future which
favourably influence the rating of the debt instruments and vice versa.
9.Past performance: The increasing trend of revenues, profit after taxes, net worth, and net
asset value of the firm, keeping the total investments, constant indicates the financial strength
of the firm. These variables are also useful in judging the assignment of ratings to the issuance
of debt instrument. These variables linked with cash flow statements will have a favourable
bearing on the ratings of the debt instruments. Therefore a rating agency should carefully
analyze these indicators prior to assigning any rating to the instruments issued by a company.
10.Effect of normal business cycle: The business activities of the firm can be categorized as
normal, recovery, boom, recession, and slump. So the rating agency has to consider the state
of economic activity facing the company at the time of assigning rating to the debt instruments.

This is one of the important factors which the rating agency cannot ignore prior to deciding the
worth of the debt instrument.
Q2) Functions of Investment banker:
1. Corporate Counselling: Corporate counselling covers the entire field of merchant
banking activities for better corporate performance, terms of image building among
investors, steady growth through good working, and appreciation in market value of
equity shares. The scope of corporate counselling is wide enough to include all activities
such as project counselling, capital restructuring, portfolio management, and full range of
financial services including venture capital, public issue management, loan syndication,
working capital, fixed deposit, lease finacing etc. However, the counselling is limited to
only opinion and suggestions and any detailed analysis would form part of a specific
group.
2. Project Counselling: Project counselling includes preparation of project reports,
deciding upon the finacing of the project and appraising project report with the financial
institutions or banks. Project reports are prepared to obtain government approval, get
financial assistance from institutions and plan for public issue.
3. Issue Management: The procedure of managing a public issue by merchant bankers can
be divided into 2 phases: (A) Pre-issue management (B) Post issue management.
(A) Pre-issue management:
Steps required to be taken to manage pre-issue activity is as follows:
1. Obtaining stock exchange approvals to memorandum and articles of association.
2. Taking action as per SEBI guidelines.
3. Finalising the appointments of the following agencies:
a. Co-managers/ Advisers to the issue.
b. Underwriters to the issue.
c. Brokers to the issue.
d. Bankers to the issue
e. Advertising agency
f. Registrar of the issue.
4. Advise the company to appoint auditors, legal advisers and broad base
board
of directors.
5. Drafting the prospectus.
6. Obtaining the approval of Draft prospectus.
7. Obtaining approvals of draft prospectus from the companys legal advisers,
underwriting financial institution / banks.
8. Obtaining consent from the parties and agencies acting for the issue to be
enclosed with prospectus.

9. Approval of prospectus from SEBI

10. Filing of the Prospectus with ROC.
11. Making an application for enlistment with stock exchange along with copy of
prospectus.
12. Publicity of the issue with advertisement and conferences.
13. Open subscription list.
(B) Post-issue management:
Steps involved in post-issue management are:
1. To verify and confirm that issue is subscribed to the extent of 90% including
devolvement from underwriters in case of under subscription.
2. To supervise and co-ordinate the allotment procedure of registrar to the issue as
per prescribed stock exchanges.
3. To ensure issue of refund order, allotment letters, certificate within the prescribed
time limit of 10 weeks after the closure of subscription list.
4. To report periodically to SEBI about the progress in the matters related to
allotment and refunds.
5. To ensure the listing of securities at stock exchanges.
6. To attend the investors grievances regarding the public issue.
4. Underwriting of Public issue: Underwriting is a guarantee given by the underwriter that
in the event of under subscription the amount underwritten would be subscribed by him.
As per sec 76 of companies Act , UW commission should not be more than 2.5 % in case
of debenture and 5 % incase of shares subject to provision in the articles of association.
As per SEBI guidelines should have a networth of Rs 20 Lacs and his total obligation
should not exceed 20 times its net worth.
5. Portfolio Management: Portfolio refers to investment in different kind of securities such
as shares, debentures or bonds issued by different companies and securities issued by
government. Portfolio management refers to maintaining proper combinations of
securities in amanner that they give maximum return with minimum risk.
6. Merger and Acquisitions: For merchant bankers merger and acquisition is a promising
new business. ICICI-Securities, Kotak Mahindra, J.M. Financial are actively involved in
bringing together buyers and sellers. They have already set up separate teams of
professional for this purpose. They are all in process of building a database where by they
will constantly monitoring the companies deal for takeovers.
7. Equipment Leasing and Hire purchase: The financial services of equipment and hire
purchase are offered by most of the merchant bankers. Leasing and hire purchase

constitute a major portion of total income generation at present day merchant banking
organisations. The lease rental/ installments provide a return of about 20% and in
addition provide tax shield.
8. Off shore finance: The merchant bankers help their clients in following area of foreign
currency.
(a) Long term foreign currency loans.
(b) Joint venture abroad.
(c) Financing exports and imports.
(d) Foreign collaboration arrangements.
9. Non-resident: The services of merchant bankers include investment advisory services to
NRI in terms of identification of suitable investment opportunities. selection of securities
investment management etc They also take care of the operational details like purchase
and sale of securities securing necessary clearance from RBI for repatriation of interest
and dividend.
10.Loan syndication; Loan syndication refers to assistance rendered by merchant bank to get
mainly term loans for projects . Such loans may be obtained from a single financial institution or
a syndicate or consortium. Merchant bankers help corporate clients to raise syndicated loans
from commercial banks. Merchant bankers help corporate clients to raise syndicated loans from
commercial banks. Merchant banks help clients approach financial institutions for term loans
Q3) Due Diligence
The basic function of due diligence is to assess the benefits and the costs of a proposed
acquisition by inquiring into all relevant aspects of the past, present and the predictable future of
a business to be purchased. Due diligence is of vital importance to prevent unpleasant surprises
after completing the acquisition. The due diligence should be thorough and extensive. Both the
parties to the transaction should conduct their own due diligence to get the accurate assessment
of potential risks and rewards. Generally, it is a process of enquiry and investigation about
proposed merger deal. It is a judgment process of the deal. The due diligence consists of five
strands, viz.,
The verification of assets and liabilities.
The identification and quantification of risks.
The protection needed against such risks which will in turn feed into the negotiations.
The identification of synergy benefits.
Post-acquisition planning.
Due Diligence Topics and-their Focus on Enquiry
Due Diligence

Focus of Enquiries

Expected Results

Topics
Financial

Historical records, review of

management and systems.

Confirms underlying profits.

Provides basis for valuation.

Legal

Various contractual Acts in the

country.

Warranties and indemnities,

validation of all existing contracts,
sale and purchase agreement.

Commercial

Market conditions, competitive

position and targets commercial
prospects.

Sustainability of future profits,

planning, decision on strategy to be
adopted for the combined business.

Tax

Existing tax levels, liabilities and

arrangements.

Avoid any unforeseen tax

liabilities, opportunities to optimize
position of combined business.

Management

Management quality,
organizational structure

Identification of key integration

issues, outline of new structure for
the combined business.

Q4) FACTORS AFFECTING DIVIDENED POLICY OF THE COMAPNY

1.Profitability of the company: For instance a high profitable company raises less amount of
money with help of borrowed funds since most of the funds can be done through internal
accruals
2. Stability of Earnings. The nature of business has an important bearing on the dividend policy.
Industrial units having stability of earnings may formulate a more consistent dividend policy
than those having an uneven flow of incomes because they can predict easily their savings and
earnings. Usually, enterprises dealing in necessities suffer less from oscillating earnings than
those dealing in luxuries or fancy goods.
3. Age of corporation. Age of the corporation counts much in deciding the dividend policy. A
newly established company may require much of its earnings for expansion and plant
improvement and may adopt a rigid dividend policy while, on the other hand, an older company
can formulate a clear cut and more consistent policy regarding dividend.
4. Liquidity of Funds. Availability of cash and sound financial position is also an important
factor in dividend decisions. A dividend represents a cash outflow, the greater the funds and the
liquidity of the firm the better the ability to pay dividend. The liquidity of a firm depends very
much on the investment and financial decisions of the firm which in turn determines the rate of

expansion and the manner of financing. If cash position is weak, stock dividend will be
distributed and if cash position is good, company can distribute the cash dividend.
5. Extent of share Distribution. Nature of ownership also affects the dividend decisions. A
closely held company is likely to get the assent of the shareholders for the suspension of
dividend or for following a conservative dividend policy. On the other hand, a company having a
good number of shareholders widely distributed and forming low or medium income group,
would face a great difficulty in securing such assent because they will emphasise to distribute
higherdividend.
6. Needs for Additional Capital. Companies retain a part of their profits for strengthening their
financial position. The income may be conserved for meeting the increased requirements of
working capital or of future expansion. Small companies usually find difficulties in raising
finance for their needs of increased working capital for expansion programmes. They having no
other alternative, use their ploughed back profits. Thus, such Companies distribute dividend at
low rates and retain a big part of profits.
7. Trade Cycles. Business cycles also exercise influence upon dividend Policy. Dividend policy
is adjusted according to the business oscillations. During the boom, prudent management creates
food reserves for contingencies which follow the inflationary period. Higher rates of dividend
can be used as a tool for marketing the securities in an otherwise depressed market. The financial
solvency can be proved and maintained by the companies in dull years if the adequate reserves
have been built up.
8. Government Policies. The earnings capacity of the enterprise is widely affected by the
change in fiscal, industrial, labour, control and other government policies. Sometimes
government restricts the distribution of dividend beyond a certain percentage in a particular
industry or in all spheres of business activity as was done in emergency. The dividend policy has
to be modified or formulated accordingly in those enterprises.

9. Taxation Policy. High taxation reduces the earnings of he companies and consequently the
rate of dividend is lowered down. Sometimes government levies dividend-tax of distribution of
dividend beyond a certain limit. It also affects the capital formation. N India, dividends beyond
10 % of paid-up capital are subject to dividend tax at 7.5 %.
10. Legal Requirements. In deciding on the dividend, the directors take the legal requirements
too into consideration. In order to protect the interests of creditors an outsiders, the companies
Act 1956 prescribes certain guidelines in respect of the distribution and payment of dividend.
Moreover, a company is required to provide for depreciation on its fixed and tangible assets
before declaring dividend on shares. It proposes that Dividend should not be distributed out of

capita, in any case. Likewise, contractual obligation should also be fulfilled, for example,
payment of dividend on preference shares in priority over ordinary dividend.
11. Past dividend Rates. While formulating the Dividend Policy, the directors must keep in
mind the dividend paid in past years. The current rate should be around the average past rat. If it
has been abnormally increased the shares will be subjected to speculation. In a new concern, the
company should consider the dividend policy of the rival organisation.
12. Ability to Borrow. Well established and large firms have better access to the
capital market than the new Companies and may borrow funds from the external
sources if there arises any need. Such Companies may have a better dividend payout ratio. Whereas smaller firms have to depend on their internal sources and
therefore they will have to built up good reserves by reducing the dividend pay out
ratio for meeting any obligation requiring heavy funds.

Q5) BOOK BUILDING:

Book building is a process of price discovery. The issuer discloses a price band in the Red
Herring Prospectus. On the basis of the demands received at various price levels within the price
band specified by the issuer, Book Running Lead Manager (BRLM) in close consultation with
the issuer arrives at a price at which the security offered by the issuer, can be issued.

How is book built in India?

The main parties who are directly associated with book building process are the issuer company,
the Book Runner Lead Manager (BRLM) and the syndicate members. The Book Runner Lead
Manager (i.e. merchant banker) and the syndicate members who are the intermediaries are both
eligible to act as underwriters. The steps which are usually followed in the book building process
can be summarised below:
(1) The issuer company proposing an IPO appoints a lead merchant banker as a BRLM.
(2) Initially, the issuer company consults with the BRLM in drawing up a draft prospectus (i.e.
offer document) which does not mention the price of the issues, but includes other details about
the size of the issue, past history of the company, and a price band. The securities available to the
public are separately identified as net offer to the public.

(3) The draft prospectus is filed with SEBI which gives it a legal standing.
(4) A definite period is fixed as the bid period and BRLM conducts awareness campaigns like
advertisement, road shows etc.
(5)The BRLM appoints a syndicate member, a SEBI registered intermediary to underwrite the
issues to the extent of net offer to the public.
(6) The BRLM is entitled to remuneration for conducting the Book Building process.
(7) The copy of the draft prospectus may be circulated by the BRLM to the institutional investors
as well as to the syndicate members.
(8) The syndicate members create demand and ask each investor for the number of shares and the
offer price.
(9) The BRLM receives the feedback about the investors bids through syndicate members.
(10) The prospective investors may revise their bids at any time during the bid period.
(11) The BRLM on receipts of the feedback from the syndicate members about the bid price and
the quantity of shares applied has to build up an order book showing the demand for the shares of
the company at various prices. The syndicate members must also maintain a record book for
orders received from institutional investors for subscribing to the issue out of the placement
portion.
(12) On receipts of the above information, the BRLM and the issuer company determine the
issue price. This is known as the market-clearing price.
(13) The BRLM then closes the book in consultation with the issuer company and determine the
issue size of (a) placement portion and (b) public offer portion.
(14) Once the final price is determined, the allocation of securities should be made by the BRLM
based on prior commitment, investors quality, price aggression, earliness of bids etc. The bid of
an institutional bidder, even if he has paid full amount may be rejected without being assigned
any reason as the Book Building portion of institutional investors is left entirely at the discretion
of the issuer company and the BRLM.
Q6) Industrial Sickness: 'Sick Industrial Company' means an industrial company which has

i) The Accumulated losses in any financial year equal to 50 per cent or more of its average net worth during
four years immediately preceding such financial year; or
ii) Failed to repay its debts within any three consecutive quarters on demand made in writing for its repayment
by a creditor or creditors of such company

Internal causes for sickness

a) Lack of Finance: This including weak equity base, poor utilization of assets, inefficient working capital
management, absence of costing & pricing, absence of planning and budgeting and inappropriate utilization or
diversion of funds.
b) Bad Production Policies : The another very important reason for sickness is wrong selection of site which is
related to production, inappropriate plant & machinery, bad maintenance of Plant & Machinery, lack of quality
control, lack of standard research & development and so on.
c) Marketing and Sickness : This is another part which always affects the health of any sector as well as SSI.
This including wrong demand forecasting, selection of inappropriate product mix, absence of product planning,
wrong market research methods, and bad sales promotions.
d) Inappropriate Personnel Management: The another internal reason for the sickness of SSIs is
inappropriate personnel management policies which includes bad wages and salary administration, bad labour
relations, lack of behavioural approach causes dissatisfaction among the employees and workers.
e) Ineffective Corporate Management: Another reason for the sickness of SSIs is ineffective or bad corporate
management which includes improper corporate planning, lack of integrity in top management, lack of
coordination and control etc.

External causes for sickness

a) Personnel Constraint: The first for most important reason for the sickness of small scale industries are non
availability of skilled labour or manpower wages disparity in similar industry and general labour invested in the
area.
b) Marketing Constraints: The second cause for the sickness is related to marketing. The sickness arrives due
to liberal licensing policies, restrain of purchase by bulk purchasers, changes in global marketing scenario,
excessive tax policies by govt. and market recession.
c) Production Constraints: This is another reason for the sickness which comes under external cause of
sickness. This arises due to shortage of raw material, shortage of power, fuel and high prices, import-export
restrictions.

d) Finance Constraints: The another external cause for the sickness of SSIs is lack of finance. This arises due
to credit restrains policy, delay in disbursement of loan by govt., unfavorable investments, fear
of nationalization.
e)credit squeeze initiated by the government policies.

Q7) ALTAMAN Z Score Model to derive industrial Sickness

The Z-score formula for predicting bankruptcy was published in 1968 by
Edward I. Altman, who was, at the time, an Assistant Professor of Finance at New
York University. The formula may be used to predict the probability that a firm will
go into bankruptcy within two years.
Z-scores are used to predict corporate defaults and an easy-to-calculate control
measure for the financial distress status of companies in academic studies. The Zscore uses multiple corporate income and balance sheet values to measure the
financial health of a companyThe Altman Z-score is a combination of five weighted
business ratios that is used to estimate the likelihood of financial distress. The ZScore was developed in 1968 by Edward I. Altman, an Assistant Professor of Finance
at New York University, as a quantitative balance-sheet method of determining a
companys financial health. A Z-score can be calculated for all non-financial
companies and the lower the score, the greater the risk of the company falling into
financial distress.

The z-score is calculated as follows: 1.2*T1 + 1.4*T2 + 3.3*T3 + 0.6*T4 + 1.0*T5.

T1 = Working Capital / Total Assets.

T2 = Retained Earnings / Total Assets.

T3 = Earnings Before Interest and Taxes / Total Assets.

T4 = Market Value of Equity / Book Value of Total Liabilities.

T5 = Sales/ Total Assets.

Morgan Stanley strategy analyst, Graham Secker, used the Z-score to rank a basket
of European companies. He found that the companies with weaker balance sheets
underperformed the market more than two thirds of the time. Morgan Stanley also
found that a company with an Altman Z-score of less than 1 tended to underperform
the wider market by more than 4%.
The study reveals the extent to which Altman model predict sickness in terms of percentage for four years prior to
sickness

Q8) Break even

The break-even level or break-even point (BEP) represents the sales amountin either unit or revenue terms
that is required to cover total costs (both fixed and variable). Total profit at the break-even point is zero.
In economics and business, specifically cost accounting, the break-even point (BEP) is the point at which total
cost and total revenue are equal: there is no net loss or gain.
For example, if a business sells fewer than 200 tables each month, it will make a loss; if it sells more, it will
make a profit. With this information, the business managers will then need to see if they expect to be able to
make and sell 200 tables per month.
If they think they cannot sell that many, to ensure viability they could:
1. Try to reduce the fixed costs (by renegotiating rent for example, or keeping better control of telephone
bills or other costs)
2. Try to reduce variable costs (the price it pays for the tables by finding a new supplier)
3. Increase the selling price of their tables.
Any of these would reduce the break-even point. In other words, the business would not need to sell so many
tables to make sure it could pay its fixed costs.
The main purpose of break-even analysis is to determine the minimum output that must be exceeded in order
to make profit. It also is a rough indicator of the earnings impact of a marketing activity.[1]
The break-even point is one of the simplest yet least used analytical tools in management. It helps to provide a
dynamic view of the relationships between sales, costs, and profits. For example, expressing break-even
sales as a percentage of actual sales can give managers a chance to understand when to expect to break
even (by linking the percent to when in the week/month this percent of sales might occur).

Q9)Function of SEBI
It was established by The Government of India in the year 1988 and given statutory powers in 1992 with SEBI
Act 1992 being passed by the Indian Parliament. SEBI has its Headquarters at the business district of Bandra
Kurla Complex in Mumbai, and has Northern, Eastern, Southern and Western Regional Offices in New
Delhi, Kolkata, Chennai and Ahmedabad respectively.
Objectives of SEBI:
As an important entity in the market it works with following objectives:

1. It tries to develop the securities market.

2. Promotes Investors Interest.
3. Makes rules and regulations for the securities market.

The of the Securities and Exchange Board of India describes the basic functions of the Securities and
Exchange Board of India as "...to protect the interests of investors in securities and to promote the
development of, and to regulate the securities market and for matters connected therewith or incidental
thereto".
SEBI has to be responsive to the needs of three groups, which constitute the market:

the issuers of securities

the investors

the market intermediaries

Functions Of SEBI:

Find below SEBI's important functions:

1. Regulates Capital Market

2. Checks Trading of securities.
3. Checks the malpractices in securities market.
4. It enhances investor's knowledge on market by providing education.
5. It regulates the stockbrokers and sub-brokers.
6. To promote Research and Investigation

10) Trading on Equity Trading on equity is sometimes referred to as financial leverage or

the leverage factor.
Trading on equity occurs when a corporation uses bonds, other debt instrument to increase its
earnings to equity shareholder. For example, a corporation might use long term debt to purchase
assets that are expected to earn more than the interest on the debt. The earnings in excess of
the interest expense on the new debt will increase the earnings of the corporation's common
stockholders. The increase in earnings indicates that the corporation was successful in trading on
equity.

If the newly purchased assets earn less than the interest expense on the new debt, the earnings of
the common stockholders will decrease.
11) Value-based management-EVA
The objective of value-based management, simply stated, is to improve performance. "If everyone in an
organization knows how he or she creates value and acts on that knowledge, the organization will achieve
its objective. " The reward for this achievement is a higher share price, more innovation, and greater
efficiency and growth." Value, he says, is the combination of both current operations value and future
growth value. Current operations value is current performance, as measured by a tool such as Economic
Value Added (EVA).
In corporate finance, Economic Value Added (EVA), is an estimate of a firm's economic profit being
the value created in excess of the required return of the company's investors (being shareholders and
debt holders). Quite simply, EVA is the profit earned by the firm less the cost of financing the firm's
capital . The idea is that value is created when the return on the firm's economic capital employed is
greater than the cost of that capital.
EVA = NOPAT (cost of capital capital employed)

12) Pecking theory:

In corporate finance, pecking order theory (or pecking order model) postulates that the cost of financing
increases with asymmetric information. Financing comes from three sources, internal funds, debt and new
equity. Companies prioritize their sources of financing, first preferring internal financing, and then debt, lastly
raising equity as a last resort. Hence: internal financing is used first; when that is depleted, then debt is
issued; and when it is no longer sensible to issue any more debt, equity is issued. This theory maintains that
businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is
preferred over equity if external financing is required (equity would mean issuing shares which meant 'bringing
external ownership' into the company). Thus, the form of debt a firm chooses can act as a signal of its need for
external finance.
The pecking order theory is popularized by Myers and Majluf (1984) [1 when they argue that equity is a less
preferred means to raise capital because when managers (who are assumed to know better about true
condition of the firm than investors) issue new equity, investors believe that managers think that the firm is

overvalued and managers are taking advantage of this over-valuation. As a result, investors will place a lower
value to the new equity issuance.

13) AMERICAN DEPOSIT RECEIPT AND GLOBAL DEPOSIT RECEIPT:

American depository Receipts

Depositary receipts
An American depositary receipt (ADR) is a negotiable security that represents the underlying
securities of a non-U.S. company that trades in the US financial markets. Individual shares of the
securities of the foreign company represented by an ADR are called American depositary
shares (ADSs).
The stock of many non-US companies trade on US stock exchanges through the use of ADRs.
ADRs are denominated, and pay dividends, in US dollars, and may be traded like shares of stock
of US-domiciled companies.
Certificates that are issued by a bank of US origin and traded in the U.S. as domestic shares. The
certificates represent the foreign securities that the bank holds in that security's country of origin.

There are three different types of ADR issues:

Level 1 - This is the most basic type of ADR where foreign companies either don't
qualify or don't wish to have their ADR listed on an exchange. Level 1 ADRs are
found on the over-the-counter market and are an easy and inexpensive way to gauge
interest for its securities in North America. Level 1 ADRs also have the loosest
requirements from theSecurities and Exchange Commission (SEC).

Level 2 - This type of ADR is listed on an exchange or quoted on Nasdaq. Level 2

ADRs have slightly more requirements from the SEC, but they also get higher
visibility trading volume.

Level 3 - The most prestigious of the three, this is when an issuer floats a public
offering of ADRs on a U.S. exchange. Level 3 ADRs are able to raise capital and
gain substantial visibility in the U.S. financial markets.

GLOBAL DEPOSITARY RECEIPT - GDR'

1. A bank certificate issued in more than one country for shares in a foreign company. The
shares are held by a foreign branch of an international bank. The shares trade as domestic
shares, but are offered for sale globally through the various bank branches.
2. A financial instrument used by private markets to raise capital denominated in either U.S.
dollars or euros.

Q14)Loan syndication:
The process of involving several different lenders in providing various portions of a loan.
Loan syndication most often occurs in situations where a borrower requires a large sum of
capital that may either be too much for a single lender to provide, or may be outside the
scope of a lender's risk exposure levels. Thus, multiple lenders will work together to provide
the borrower with the capital needed, at an appropriate rate agreed upon by all the lenders.
Mainly used in extremely large loan situations, syndication allows any one lender to provide
a large loan while maintaining a more prudent and manageable credit exposure, because
the lender isn't the only creditor. Loan syndication is common in mergers, acquisitions and
buyouts, where borrowers often need very large sums of capital to complete a transaction,
often more than a single lender is able or willing to provide.
Leveraged transactions fund a number of purposes. They provide support for general corporate purposes,
including capital expenditures, working capital, and expansion. They refinance the existing capital structure,.
they provide funding to corporations undergoing restructurings,. Their primary purpose, however, is to fund
M&A activity, specifically leveraged buyouts, where the buyer uses the debt markets to acquire the acquisition
targets equity.

Q15) FIPB and Joint venture:

A joint venture is a new enterprise owned by two or more participants. It represents a combination of
subsets of assets contributed by two (or more) business entities for a specific business purpose and a
limited duration. It is essentially a medium to long-term contract which is specific and flexible. Though,
the joint venture represents a newly created business enterprise, its participants continue to exist as

separate firms. A joint venture can be organized as a partnership firm, a corporation or any other form of
business organization, which the participating firms choose to select. It generally has the following
characteristics: Contribution by partners of money, property, effort, knowledge, skill or other assets to the common
undertaking.

Joint property interest in the subject matter of the venture.

Right of mutual control or management of the enterprise.

Right to share in the property.

All the joint ventures in India require governmental approvals, if a foreign partner or an NRI or PIO partner is
involved. The approval can be obtained from either from RBI or FIPB. In case, a joint venture is covered under
automatic route, then the approval of Reserve bank of India is required. In other special cases, not covered under
the automatic route, a special approval of FIPB is required
The Government has outlined 37 high priority areas covering most of the industrial sectors. Investment proposals
involving up to 74% foreign equity in these areas receive automatic approval within two weeks. Approval of foreign
equity is not limited to 74% and to high priority industries.
For major investment proposals or for those that do not fit within the existing policy parameters, there is the highpowered Foreign Investment Promotion Board ("FIPB"). The FIPB is located in the office of the Prime Minister and
can provide single-window clearance to proposals in their totality without being restricted by any predetermined
parameters.

Q16)Techniques used By MNC to Hedgeing Risk

Forward: A forward is an agreement between two counterparties - a buyer and seller. The
buyer agrees to buy an underlying asset from the other party (the seller). The delivery of the
asset occurs at a later time, but the price is determined at the time of purchase. Key
features of forward contracts are:

Highly customized - Counterparties can determine and define the terms and features
to fit their specific needs, including when delivery will take place and the exact
identity of the underlying asset.

All parties are exposed to counterparty default risk - This is the risk that the other
party may not make the required delivery or payment.

Transactions take place in large, private and largely unregulated markets consisting
of banks, investment banks, government and corporations.

Underlying assets can be a stocks, bonds, foreign currencies, commodities or some

combination thereof. The underlying asset could even be interest rates.

They tend to be held to maturity and have little or no market liquidity.

Any commitment between two parties to trade an asset in the future is a forward
contract.

Future: Future contracts are also agreements between two parties in which the buyer
agrees to buy an underlying asset from the other party (the seller). The delivery of the asset
occurs at a later time, but the price is determined at the time of purchase.

Terms and conditions are standardized.

Trading takes place on a formal exchange wherein the exchange provides a place to
engage in these transactions and sets a mechanism for the parties to trade these
contracts.

There is no default risk because the exchange acts as a counterparty, guaranteeing

delivery and payment by use of a clearing house.

The clearing house protects itself from default by requiring its counterparties to settle
gains and losses or mark to market their positions on a daily basis.

Futures are highly standardized, have deep liquidity in their markets and trade on an
exchange.

An investor can offset his or her future position by engaging in an opposite

transaction before the stated maturity of the contract.

OPTION: An option is a contract that gives the buyer the right, but not the obligation, to buy
or sell an underlying asset at a specific price on or before a certain date. An option, just like
a stock or bond, is a security. It is also a binding contract with strictly defined terms and
properties.
Calls and Puts
The two types of options are calls and puts:
1. A call gives the holder the right to buy an asset at a certain price within a specific
period of time. Calls are similar to having a long position on a stock. Buyers of calls
hope that the stock will increase substantially before the option expires.

2. A put gives the holder the right to sell an asset at a certain price within a specific
period of time. Puts are very similar to having a short position on a stock. Buyers of
puts hope that the price of the stock will fall before the option expires

Q17) Interest rate Swap: An agreement between two parties (known as counterparties)
where one stream of future interest payments is exchanged for another based on a specified
principal amount. Interest rate swaps often exchange a fixed payment for a floating payment
that is linked to an interest rate (most often the LIBOR). A company will typically use interest
rate swaps to limit or manage exposure to fluctuations in interest rates, or to obtain a
marginally lower interest rate than it would have been able to get without the swap.
Interest rate swaps are simply the exchange of one set of cash flows (based on interest rate
specifications) for another. Because they trade OTC, they are really just contracts set up
between two or more parties, and thus can be customized in any number of ways.
Interest rate swaps expose users to interest rate risk and credit risk.

Market Risk: A typical swap consists of two legs, one fixed, the other floating. The risks of these two
component will naturally differ. Newcomers to market finance may think that the risky component is the
floating leg, since the underlying interest rate floats, and hence, is unknown. This first impression is wrong.
The risky component is in fact the fixed leg and it is very easy to see why this is so. [7]

Credit risk on the swap comes into play if the swap is in the money or not. If one of the parties is in the
money, then that party faces credit risk of possible default by another party. However, when the swap is
negotiated through an intermediary financial institution, usually the intermediary assumes the default risk in
exchange for a fixed percentage of the transaction (the bid-ask spread). In an intermediated swap, the two
parties are not typically even aware of the identity of the second party to the transaction, making a
quantification of the other party's credit risk not only irrelevant, but impossible.

Q18) Infrastructure financing: write about ADR and GDR, BONDS, Shares and debenture.
EQUITY SHARES:
Equity Capital, being risk capital, considers no fixed rate of dividend. Equity capital represents
ownership capital as equity shareholders collectively own the firm, enjoy the reward and bear the
risk of ownership. The equity shares are those shares which do not enjoy any special rights with
respect to payment of dividend and repayment of capital. Equity shares are those which do not
enjoy any special rights in respect to dividend and capital. If the profits are inadequate they may
not receive any dividend. Also the rate of dividend fluctuates depending upon the availability of
profits and recommendation by board of directors. In event of liquidation of the company, the
equity shareholders is the last person to receive the money back.

DEBENTURE
1) Debenture holders are not the owners of the company. They are considered the creditors of the
corporation or in other words, the company borrow money from them through issuing debenture.
2) No voting rights. The debenture-holder is not a shareholder and cannot vote in the company's
general meetings.
3) Fixed rate of interest. A debenture with a fixed charge has a fixed rate of interest. It can be
presented as "10% Debenture". They are always unsecured and earns a fixed rate of interest but
has no share of the profit.
4) Compulsory payment of interest. The interest on debenture is payable irrespective of whether
there are profits made or not.
B0NDS
A debt investment in which an investor loans money to an entity (corporate or governmental)
that borrows the funds for a defined period of time at a fixed interest rate.
1. Government of India Bonds: The Government of India (GOI) from time to time, issues bonds
through RBI.
2. Fixed Rate Bonds: These Bonds carry fixed rate of interest which is declared at the time of
issue and remains same till maturity.
3. Floating Rate Bonds: These Bonds carry interest rate which is linked to independent reference
rates, independent index, commodities etc.
4. Deep Discount Bonds: This bond is issued at a discount to the face value. The face value is
paid at the maturity. These bonds are also know as Zero coupon bonds or "Zeros".
5. Gilts :Fixed interest securities issued by the Government to raise money for public
expenditure. In India these securities are issued by RBI on behalf of Govt. of India by auction
process.
6. Public Sector Bonds: These bonds are medium and long term obligations issued by public
sector companies where the Government shareholding is 51% and more. Most of PSU bonds are
in form of promissory notes transferable by endorsement and delivery. No stamp duty or transfer
deed is required at the time of transfer of bonds transferable by endorsement.
Q19) Onshore / offshore financing: Offshore instrument includes ADR, GDR. Onshore
instrument includes bonds, equity shares and debenture