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BA7022 Merchant Banking and Financial Services

BA7022 MERCHANT BANKING AND FINANCIAL SERVICES LTPC


3003
OBJECTIVES :
To enable student Understand the modes of issuing securities
Acquire financial evaluation technique of leasing and hire purchase
OUTCOME
Good knowledge on merchant banking activities

UNIT I -MERCHANT BANKING 5

Introduction –An Over view of Indian Financial System –Merchant Banking in India –Recent
Developments and Challenges ahead Institutional Structure –Functions of Merchant Bank -Legal
and Regulatory Framework –Relevant Provisions of Companies Act- SERA-SEBI guidelines-
FEMA, etc. -Relation with Stock Exchanges and OTCEI.

UNIT II -ISSUE MANAGEMENT 12

Role of Merchant Banker in Appraisal of Projects, Designing Capital Structure and Instruments –
Issue Pricing –Book Building –Preparation of Prospectus Selection of Bankers, Advertising
Consultants, etc. -Role of Registrars –Bankers to the Issue, Underwriters, and Brokers. –Offer
for Sale –Green Shoe Option –E-IPO, Private Placement –Bought out Deals –Placement with
FIs, MFs, FIIs, etc. Off -Shore Issues. –Issue Marketing –Advertising Strategies –NRI Marketing
–Post Issue Activities.

UNIT III- OTHER FEE BASED SERVICES 10

Mergers and Acquisitions –Portfolio Management Services –Credit Syndication –Credit Rating –
Mutual Funds -Business Valuation.

UNIT IV -FUND BASED FINANCIAL SERVICES 10

Leasing and Hire Purchasing –Basics of Leasing and Hire purchasing Financial Evaluation.

UNIT V- OTHER FUND BASED FINANCIAL SERVICES 8

Consumer Credit –Credit Cards –Real Estate Financing –Bills Discounting –factoring and
Forfeiting –Venture Capital.

TOTAL: 45 PERIODS
TEXTBOOKS
1.M.Y.Khan, Financial Services, Tata McGraw-Hill, 12thEdition, 2012
2.Nalini Prava Tripathy, Financial Services, PHI Learning, 2011.
REFERENCES:
1. Machiraju, Indian Financial System, Vikas Publishing House, 2 nd Edition, 2010.
2. J.C.Verma, A Manual of Merchant Banking, Bharath Publishing House, New Delhi,
3. Varshney P.N. & Mittal D.K., Indian Financial System, Sultan Chand & Sons, New Delhi.
4. Sasidharan, Financial Services and System, Tata Mcgraw Hill, New Delhi, 2nd Edition, 2011.
5. Website of SEBI

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

UNIT I -MERCHANT BANKING

Introduction –An Over view of Indian Financial System –Merchant Banking in India –Recent
Developments and Challenges ahead Institutional Structure –Functions of Merchant Bank -Legal
and Regulatory Framework –Relevant Provisions of Companies Act- SERA-SEBI guidelines-
FEMA, etc. -Relation with Stock Exchanges and OTCEI.

PART-A

1. What is merchant banking?


A set of functions and services rendered by a merchant banker may be termed as
‘merchant banking’.

2. Define merchant banking.


The term merchant banking is generally understood to mean negotiated private equity
investment by financial institutions in the unregistered securities of either privately or publicly
held companies.

3. How is ‘merchant banker’ defined under the SEBI regulation?


According to the SEBI, ‘merchant banker’ means any person who is engaged in the
business of issue management either by making arrangements regarding selling, buying or
subscribing or rendering corporate advisory service in relation to such issue management.

4. What is role of merchant banker?


The role of the merchant banker, who had the expertise to understand a particular
transaction, was to arrange the necessary capital and ensure that the transaction would ultimately
produce ‘collectable’ profits.

The merchant banker also became involved in the actual negotiations between a buyer
and seller in a transaction.

5. What are characteristics of merchant banker?


 Equity issue management
 Debt issue management
 Private placements
 Project appraisals
 Monitoring agency assignments
 IPO funding
 Security trustee services
 Agriculture consultancy services
 Corporate advisory services

6. What are issue management services?


 Project proposal
 Capital structuring
 Preparation of offer document
 Tie ups
 Underwriting

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

 Post issue management


 Refund bankers
 Debenture trusteeship
 Banker to an issue

7. What are the advantages of merchant bank?


 Merchant banks perform functions that cannot be carried out by business on their own.
 Merchant banks have access to traders, financial institutions and markets that companies
or individuals could not possibly reach.
 By using their skills and contacts, merchant banks can get the best possible deals for their
clients.

8. What are the disadvantages of merchant banks?


i. Merchant banks are really only for large corporate customers, or extremely wealthy
smaller businesses owned by individual client.
ii. Not all deals carried out by merchant banks meet with unqualified success.
iii. There is always risk attached to the kinds of deal that merchant banks undertake.

9. What is financial system?


A financial system is a composition of various institutions, markets, regulations and laws,
practices, money manager, analysts, transactions and claims and liabilities.

10. Define Indian financial system.


Indian financial system consists of financial market, financial instruments and financial
intermediation.

11. State financial market.


The market in which financial assets are created and transferred is known as financial
market.

12. Define money market.


The money market is a wholesale debt market for low-risk, highly-liquid, short-term
instrument. Funds are available in this market for periods ranging from a single day up to a year.
This market is dominated mostly by government, banks and financial institutions.

13. Define capital market.


The capital market is designed to finance the long-term investments. The transactions taking
place in this market will be for periods over a year.

14. Define FOREX market.


The forex market deals with the multicurrency requirements, which are met by the exchange
of currencies. Depending on the exchange rate that is applicable, the transfer of funds takes
place in this market. This is one of the most developed and integrated market across the globe.

15. What is credit market?


Credit market is a place where banks, FIs and NBFCs purvey short, medium and long-term
loans to corporate and individuals.

16. What are the money market instruments?

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

1. Call/notice money
2. Treasury bills
3. Term money
4. Certificate of deposit
5. Commercial papers
17. What is call/notice money?
Call/notice money is the money borrowed or lent on demand for a very short period.
When money is borrowed or lent for a day, it is known as call(overnight)money.
When money is borrowed or lent for more than a day and up to 14days, it is “notice money”.

18. What is a treasury bill?


Treasury bills are short term (up to one year) borrowing instruments of the union
government. It is an IOU of the government. It is a promise by the government to pay a stated
sum after expiry of the stated period from the date of issue(less than one year).

19. What is certificate of deposits?


Certificate of deposit (CD) is a negotiable money market instrument and issued in
dematerialised form or as a usance promissory note, for funds deposited at a bank or other
eligible financial institution for a specified time period.

20. What is a commercial paper?


CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper
the debt obligation is transformed into an instrument.

21. What are important functions of merchant bank/banker?

 Management of debt and equity offerings


 Placement and distribution
 Corporate advisory services
 Project advisory services
 Loan syndication
 Providing venture capital financing

22. State SEBI.


‘Stock Exchange Board of India’ –the SEBI has started with issuing guidelines for
merchant bankers, mutual funds, portfolio managers and then extended its regulations to all
intermediaries in the market, like brokers, sub-brokers, underwriters, registrars, collecting
bankers, debentures trustees etc.

23. Define stock exchange.


A stock exchange is an entity that provides ‘trading’ facilities for stock brokers and
traders, to trade stocks, bonds, and other securities.
According to Hastings, Stock exchange or securities market comprises all the places where
buyers and sellers of stocks and bonds or their representatives undertake transactions involving
the sale of securities.

24. What are the objectives of stock exchange?


1. Assisting in buying and selling of securities
2. Regulating the business of buying and selling or dealing in securities.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

25. What are the functions of stock exchange?


1. Liquidity and marketability of securities.
2. Safety of funds
3. Supply of Long term funds
4. Flow of Capital to Profitable Ventures
5. Motivation for improved performance
6. Promotion of Investment
7. Reflection of Business Cycle
8. Marketing of New Issues
9. Miscellaneous Services

26. List out some of the stock exchanges.


 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

27. What is OTCEI? (Nov/Dec 2010, Nov/Dec 2011, Apr/May 2011, May/June 2012,
Nov/Dec 2013, May/June 2.014)

Over the Counter Exchange of India (OTCEI) is a Stock Exchange without a proper
trading floor all stock exchanges have a specific place for trading their securities through
counters. But, OTCEI is connected through a computer network and the transactions are taking
place through computer operations. Thus, the development in information technology has given
scope for starting this type of stock exchange. This stock exchange is recognized under the
Securities Contract (Regulation) Act and so all the stocks listed in this exchange enjoy the same
benefits as other listed securities enjoy.

28. What is portfolio management? (Nov/Dec 2013)


Portfolio management refers to the professional management of securities and other assets.
Also referred to as "asset management" and "wealth management."

29. What are the various services offered by the Merchant bankers? (May/June 2.014)
 Project counseling
 Pre-investment studies
 Credit syndication
 Issues management and underwriting

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

PART-B

1. Explain an overview of Indian financial system.

FINANCIAL SYSTEM:

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


According to Robinson, financial system provides a link between savings and investment for the
wealth.
According to Van Horne, financial system is defined as the purpose of financial markets to
allocate savings efficiently in an economy to ultimate users either for investment in real assets
for consumption. Thus the financial system mainly stands on three factors,
 Money
 Credit
 Finance

Money:
Money is the unit of exchange or medium of payment. It represents the value of financial
transactions in qualitative terms.

Credit:
Credit on the other hand, is a debt or loan which is to be returned normally with interest.

Finance:
Finance is monetary wealth of the state, an institution or a person. Comprising these
factors in a systematic order forms a financial system.
Objectives of financial system:
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.
4. Accelerating rural development.
5. Providing necessary financial support to industry.
6. Financing housing and small scale industries.
7. Development of backward areas, infrastructure and livelihood
8. Imposing price control in need
9. Protecting environment.

Functions of financial system:


Functions of financial system are distributed from creation of money to efficient Management. It
is the sum total of the functions of the various intermediaries.
The functions of financial system can be classified into two broad categories:

1. Controlling functions
2. Promotional functions

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

1. Controlling functions:

Government imposes certain controls over the financial and business activities of
different organizations through the regulatory bodies. E.g. RBI plays an important part in
regulatory 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, diversification and
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 efficient operation of the payment mechanism. Managing
information to make it easily available to all interested parties. Providing training to investors,
intermediaries and employees in order to upgrade their skills. Conducting development and
research activities in order to update the system. Creation and establishment of need based
financial institutions. Promotion of fair practices which are transparent and effective. Creating
financial awareness to captivate investors, entrepreneurs and borrowers Organizing seminar,
dialogues, collection of data and publication.
Significance of financial system:
Financial system of a country or an organization is the main motivating factor to run the
economy. It ensures that transactions are effected smoothly and quickly on an ongoing basis. It
enables the financial agents to accelerate financial growth and economic prosperity of the unit.

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.

Financial system in india:


The evolution of the financial system in India is nothing but the reflections of its political
and economic history. The evolution process has been influenced by the factors of urbanization
of society, advent or large scale industrialization, introduction of railways and telegraphic
communications in the 19th century, nationalization of financial institutions in 20th 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 of development; rather, it is created by
the government and mainly expanded through its intervention. Government policies have greatly
influenced the interest rates, credit control and functions of financial intermediaries.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

Structure of indian financial system:


Financial system is a system of arranging different types of funds required for the
Business. It deals about,

(a) Financial Institutions


(b) Financial Markets
(c) Financial Instruments
(d) Financial Services

A) FINANCIAL INSTITUTIONS:
Commercial banks:
Some of the commercial banks are,
 Financial Institutions
 Banking
 Non Banking
 Companies
 Non Banking
 Financial companies
 Central Bank
 Commercial
 Co-Operative
 Non Banking
 Financial
 Intermediaries
 Joint Stock companies

Explain the various new instruments introduced in the capital market. (Nov/Dec 2013)

B) FINANCIAL MARKETS:
1) Capital market :
It is the market for long term funds i.e., raising capital for Companies through issue of shares and
debentures. The Capital market can further divided into
 Primary Market :
It is the market for primary needs of the company . The Company sells its shares at the time
of promotion and the investors directly buy the shares from the company through application.

 Secondary Market:
It is the market for secondary needs of the company. The sale and purchase of securities i.e.,
shares and debentures will take place through the recognized stock exchanges.

(2) Money market:


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

(3) Foreign Money Market:


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

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

(4) Government Securities Market:


It is a market for Government securities like Treasury Bills and Bonds.

Treasury Bills are bills issued for meeting the short term revenue expenditure of the
Government.
Bonds are issued for raising Long term loans which are repayable over a period of 15 to 20
years.

(C) Financial Instruments:


Financial instruments include both instruments and products. Instruments include cheques,
drafts, letter of credit, travellers‘cheques, commercial paper, GDR‘s, bonds etc.,. Products may
be in the form of Credit Cards, Debit Cards etc.,
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 negotiable
instrument 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 can be
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 and Containing
the terms and conditions of carriage.
D. Letter of Credit:
It is a letter by the importer bank guaranteeing the credit worthiness of the importer.

E. Travelers 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 finance through
various credit instruments, financial products and services. It enables the user to obtain any asset
on credit according to his convenience and at a reasonable interest rate.

Limitations of the financial system in india:

The following are the limitations of the Indian financial system.


• The Indian Financial system has failed to meet the financial needs of small scale Industries. It
has rather patroned the big industrial houses who are already well off.
• The mushrooming of financial institutions has deteriorated the quality and effectiveness of the
sector to some extent.
• In many cases, it could not impose adequate control towards financial irregularities and frauds,
often influenced by politically and economically organized pressure groups.
• The Indian financial system fails to create a well defined and organized capital market.
• It fails to motivate economically marginal or small entrepreneurs by providing micro credit to
them.
• The Indian financial system is not flexible at the desired level. It takes abnormal time to cope
with the changing situation.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

2. DESCRIBE MERCHANT BANKING IN INDIA. (MAY/JUNE 2014)


Merchant banks, also known as investment banks, offer various services in international
finance and long-term loans for wealthy individuals, multinational corporations, and
governments.

An investment bank is split into the so-called front, middle, and back office functions.
The front office deals with investment banking and management, sales and trading, structured
products, private equity investment, research, and strategy. The middle office deals with risk
management, finance, and compliance. The back office deals with transactions, operations, and
technology.

The main function of a merchant bank is to buy and sell financial products. They manage
risk through proprietary trading, carried out by special traders who do not interface with
clients. The trader manages the risk for the principal after they buy or sell a product to a
client but does not hedge their total exposure. Banks also try to maximize the profitability of
certain risk on their balance sheets.

Merchant banks manage debt and equity offerings. They assist companies in raising
funds from the market. This can include designing instruments, pricing issues, registering offer
documents, underwriting support, issue marketing, allotment and refund, and stock exchange
listing. They also help in distributing securities such as equity shares, mutual fund products, debt
instruments, insurance products, and fixed deposits among others. Merchant banks use a mix of
institutional networks-mutual funds, foreign institutional in vestors, pension funds, private equity
funds, and financial institutions-and retail networks, depending on how they interact with
specifics clients.

Merchant banks offer corporate advisory services to clients for their financial problems.
Advice may be sought in such areas as determining the right debt-to-equity ratio, the ration, and
the appropriate capital structure. Other areas of advice may be in areas of refinancing and
seeking sources of cheaper funds, risk management, and hedging strategies. Further areas for
advice are rehabilitation and turnaround management. Merchant bankers may design a revival
package in conjunction with other financial institutions.

Merchant bankers assist clients with project advice, helping them from the project
concept stage, through feasibility studies to examine a project’s viability, to the preparation of
documents such as a detailed project report.

Merchant banks arrange loan syndication for their clients. This begins with an analysis of
the client’s cash flow patterns, helping to determine the terms for borrowing. The merchant bank
then prepares a detailed loan memorandum to be circulated to the banks and financial institutions
that are to join the syndicate. Finally, the terms of lending are negotiated for the final allocation.

Merchant banks provide venture capital and mezzanine financing (a hybrid of debt and
equity financing that is typically used to finance the expansion of existing companies). In this
way they can help companies to finance new and innovative ventures.

Following the global financial crisis of 2008, which the collapse of several prominent
investment banks in Europe and the Unites States in September of that year, the viability of using
a business model that is based heavily on banks purchasing each others’ debts has been

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

questioned, Certainly in the United States, the view is that this business model is no longer
sustainable and is unlikely to continue in the same form in the future. It remains to be seen how
merchant banks will restructure in the aftermath of the financial turbulence of 2008.

ADVANTAGES;
i) Merchant banks perform functions that cannot be carried out by businesses on their own.
ii) Merchant banks have access to traders, financial institutions, and markets that companies or
individuals could not possibly reach.
iii) By using their skills and contacts, merchant banks can get the best possible deals for their
clients.
DISADVANTAGES:
i) Merchant banks are really only for large corporate customers, or extremely wealthy smaller
businesses owned by individual clients.
ii) Not all deals carried out by merchant banks meet with unqualified success.
iii) There is always risk attached to the kinds of deal that merchant banks undertake;
DO’S:
i) Use a merchant bank with good standing and history.
ii) Use a merchant bank with a firm financial-footing-especially in times of uncertainty about
financial institutions.
DON’T:
i) Don’t use a merchant bank if you are a small business.
ii) Don’t use the first merchant bank you find.
iii) Don’t go in blindly without understanding the risks involved.

Indian banking system:


 Development banks
 Export-import bank of India(EXIM bank)
 Small scale Industrial Development Bank of India (SIDBI)

India’s apex bank:


 The Reverse Bank of India (RBI)

3. Explain briefly about functions of merchant banking.


Functions of merchant Banking: Merchant banking functions in India is the same as merchant
banks in UK and other European countries. The following are the functions of merchant bankers
in India.
 Corporate counseling
 Project Counseling
 Capita l Structuring
 Portfolio Management
 Issue Management
 Credit Syndication
 Working capital
 Venture Capital
 Lease Finance
 Fixed Deposits

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

Corporate counseling: Corporate counseling covers counseling in the form of project


counseling, capital restructuring, project management, public issue management, loan
syndication, working capital fixed deposit, lease financing, acceptance credit etc., The scope of
corporate counseling is limited to giving suggestions and opinions to the client and help taking
actions to solve their problems. It is provided to a corporate unit with a view to ensure better
performance, maintain steady growth and create better image among investors.

Project counseling Project counseling is a part of corporate counseling and relates to project
finance. It broadly covers the study of the project, offering advisory assistance on the viability
and procedural steps for its implementation.
a. Identification of potential investment avenues.
b. A general view of the project ideas or project profiles.
c. Advising on procedural aspects of project implementation
d. Reviewing the technical feasibility of the project
e. Assisting in the selection of TCO‘s (Technical Consultancy Organizations) for
preparing project reports
f. Assisting in the preparation of project report
g. Assisting in obtaining approvals , licenses, grants, foreign collaboration etc., from
government
h. Capital structuring
i. Arranging and negotiating foreign collaborations, amalgamations, mergers and
takeovers. j. Assisting clients in preparing applications for financial assistance to various
national and state level institutions banks etc.,
k. Providing assistance to entrepreneurs coming to India in seeking approvals from the
Government of India.

(iii) Capital Structure


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

(iv) Portfolio Management It refers to the effective management of Securities i.e., the merchant
banker helps the investor in matters pertaining to investment decisions. Taxation and inflation
are taken into account while advising on investment in different securities. The merchant banker
also undertakes the function of buying and selling of securities on behalf of their client
companies. Investments are done in such a way that it ensures maximum returns and minimum
risks.
(v) Issue Management of issues refers to effective marketing of corporate securities viz., equity
shares, preference shares and debentures or bonds by offering them to public. Merchant banks
act as intermediary whose main job is to transfer capital from those who own it to those who
need it. The issue function may be broadly divided in to pre issue and post issue management.
a. Issue through prospectus, offer for sale and private placement.
b. Marketing and underwriting
c. Pricing of issues

(vi) Credit Syndication Credit Syndication refers to obtaining of loans from single development
finance institution or a syndicate or consortium. Merchant Banks help corporate clients to raise
syndicated loans from commercials banks. Merchant banks helps in identifying which financial
institution should be approached for term loans. The merchant bankers follow certain steps
before assisting the clients approach the appropriate financial institutions.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

a. Merchant banker first makes an appraisal of the project to satisfy that it is viable
b. He ensures that the project adheres to the guidelines for financing industrial projects.
c. It helps in designing capital structure, determining the promoter‘s contribution and
arriving at a figure of approximate amount of term loan to be raised.
d. After verifications of the project, the Merchant Banker arranges for a preliminary
meeting with financial institution.
e. If the financial institution agrees to consider the proposal, the application is filled and
submitted along with other documents.
(vii) Working Capital The Companies are given Working Capital finance, depending upon their
earning capacities in relation to the interest rate prevailing in the market.

(viii) Venture Capital Venture Capital is a kind of capital requirement which carries more risks
and hence only few institutions come forward to finance. The merchant banker looks in to the
technical competency of the entrepreneur for venture capital finance.

(ix) Fixed Deposit Merchant bankers assist the companies to raise finance by way of fixed
deposits from the public. However such companies should fulfill credit rating requirements.

(x) Other Functions


• Treasury Management- Management of short term fund requirements by client companies.
• Stock broking- helping the investors through a network of service units
• Servicing of issues- servicing the shareholders and debenture holders in distributing dividends,
debenture interest.
• Small Scale industry counseling- counseling SSI units on marketing and finance
• Equity research and investment counseling – merchant banker plays an important role in
providing equity research and investment counseling because the investor is not in a position to
take appropriate investment decision.
• Assistance to NRI investors - the NRI investors are brought to the notice of the various
investment opportunities in the country.
• Foreign Collaboration: Foreign collaboration arrangements are made by the Merchant
bankers.

4. Explain legal and regulatory framework of merchant banking.

Merchant banking activity was formally initiated into the Indian capital Markets in 1967.
Started with various services like management of capital issues, production planning and system
design to market research and management consulting services to omit the requirements of small
and medium sector rather than large sector. Citibank setup its merchant banking division in 1970.

The various tasks performed by this divisions namely assisting new entrepreneur,
evaluating new projects, raising funds through borrowing and issuing equity. State bank of India
started the merchant banking division in 1972. In the Initial years the SBI’S objective was to
render corporate advice and assistance to small and medium entrepreneurs.

The services of merchant bank cover project counseling, pre investment activities,
feasibility studies, project reports, design of capital structure, issue management, underwriting,
loan syndication, mobilization of funds, foreign currency finance, mergers, amalgamation,
takeover, venture capital and public deposits. Merchant banking is skill based activities an
involves serving financial need of every client.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

The depth and sophistication in merchant banking business are improving since the
avenues for raising funds are widening and demands for funds is increasing. Merchant bankers
can turn to any of the activities depending upon resources, such as capital, foreign tie-ups for
overseas activities and skills.

Merchant bankers, irrespective of the form in which they are organized governed by the
Merchant Bankers Rules(M.B.Rules) issued by Ministry of Finance, and Merchant Bankers
Regulations(M.B.Regulations)issued by SEBI(22.12.1992) and Amended Regulations,9.12.1997.

The merchant banker’s regulations, which regulate the raising of funds in the primary
market, would assure for the issuer market for rising resources at low cost, effectively and easily,
ensure high degree of protection of investors interest. The regulations provide for the merchant
bankers a dynamic and competitive market with the high standard of professional competence,
dignity, integrity and solvency. The regulations promote a primary market, which is fair,
efficient, and flexible, and inspire confidence.

“Any person who is engaged in the business of issue management either by making
arrangements regarding selling, buying or subscribing to securities as manager, consultant,
advisor or rendering corporate advisory services in relation to such issue management”. The
Notification of the Ministry of Finance defines merchant banker as, 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 of the subscription; and to act as adviser, consultant, manager,
underwriter, portfolio manager.

The Registrar of companies has been advised that prospectus for public issue can only be
filed by merchant bankers who are authorized by SEBI and given a code number.

The Capital Adequacy Requirement (CAR) for a merchant banker is a minimum net
worth of Rs.5 crores.

The SEBI on being satisfied that the applicant is eligible shall grant a certificate in Form
B. On the grant of a certificate the applicant shall be liable to pay the fees in accordance with
schedule II as shown below: Registration fee is Rs.10lakhs.

Three months before expiry of the period of certificate, the merchant banker, may if he so
desires, make an application for renewal in Form A. The application for renewal shall be dealt
within the same manner as if it were a fresh application for grant of a certificate. The SEBI on
being satisfies that the applicant is eligible for renewal of certificate shall grant a certificate in
Form B and send intimation to the applicant. On the grant of a certificate the applicant shall be
liable to pay the fees in accordance with Schedule II as shown below: Renewal fee is Rs.5lakhs.

RBI exempted merchant banking companies from compulsory registration (section 45


IA), maintenance of liquid assets (section 45IB), creation of reserve fund (section 45IC) and all
the provisions of the recent directions relating to deposit acceptance and prudential norms.
Conditions: Such companies are registered with SEBI under section 12 of the SEBI act,
1992 and are carrying on the business of merchant banker in accordance with rules/regulations
framed by SEBI; They require securities only as part of their merchant banking business; they do

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not carry on any other financial activities as mentioned in section 45IC of the RBI act, 1934; and
they do not accept/hold public deposits.

a) Obligations and responsibilities:


Code of Conduct Maintenance of Books of Accounts, Records, etc. Submission of Half
Yearly Results Appointment of Lead Merchant Bankers & Restrictions Responsibilities of Lead
Managers Underwriting Obligations Appointment of Compliance Officers.

b) Code of conduct:
Every merchant banker shall abide buy the Code of Conduct of specified in Schedule III.
No merchant banker, other than a bank or public financial institution, who has been granted a
certificate of registration to act as primary dealer by Reserve Bank of India, may carry on such
business as may be permitted by Reserve Bank of India. Regulation 13A was inserted by SEBI,
1996 published in the official Gazette of India dated 06.06.1996.
c) Maintenance Of Books Of Accounts, Records Etc:
Maintenance of books of accounts, records etc. every merchant banker shall keep and
maintain the following books of accounts, records and documents namely:
a) A copy of balance sheet and P&L account as at the end of each accounting period
b) A copy of the auditor’s report on the accounts for that period
c) A statement of financial position. Every merchant banker shall intimate to the SEBI
the place where the books of accounts, records and documents and maintained. Every merchant
banker shall, after the end of each accounting period furnish to the SEBI copies of the balance
sheet, profit and loss account and such other documents for any other preceding five accounting
years when required by the SEBI.

Submission of half yearly records:

Submission of half yearly record every merchant banker shall furnish to the SEBI
half-yearly unaudited financial results when required by the SEBI with a view to monitor the
capital adequacy of the merchant banker.

Appointment of lead manager all issues should be managed by at least one


merchant banker functioning as the lead merchant banker. Every lead merchant banker shall
before taking up the assignment relating to an issue, enter into an agreement with such body
corporate setting out their mutual rights, liabilities and obligations relating to such issue and 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 Size of issue No. of
Merchant Bankers

a) Less than rupees fifty crore.


b) Rupees fifty crore but less than rupees one hundred crore.
c) Rupees one hundred crore but less than rupees four hundred crore.
d) Above Rupees four hundred crore five or more as may be agreed by the SEBI.

e) Responsibility Of Lead Manager:

Responsibility of lead manager no lead manager shall agree to manage or be associated


with any issue unless his responsibilities relating to the issue mainly, those of disclosures,
allotment and refund are clearly defined, allocated and determined and a statement specifying

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such responsibilities is furnished to the SEBIat least one month before the opening of the issue
for subscription: In case there are more than one lead merchant bankers, the responsibilities
should be clearly demarcated. No lead merchant banker shall, agree to manage the issue made by
anybody corporate, if such body corporate is an associate of the lead merchant banker, Lead
merchant banker not to associate with a merchant banker without registration
f) Underwriter Obligations:
Underwriter obligations In respect of every issue to be managed, the lead merchant
banker holding a certificate under category I shall accept a minimum underwriting obligation of
five percent of the total underwriting commitment or rupees twenty-five lakh, whichever is less.
Incase of the lead merchant banker is unable to accept the minimum underwriting obligation, that
lead merchant banker shall make arrangement for having the issue underwritten to that extent by
a merchant banker associated with the issue and shall keep the SEBI informed of such
arrangement
g) Appointment Of Compliance Officer:
Appointment of compliance officer every merchant banker shall appoint a compliance
officer who shall be responsible for monitoring the compliance of the act, rules and regulations,
notifications, guidelines, instructions etc. issued by the SEBI or the central government and for
redressal of investor’s grievances. The compliance officer shall immediately and independently
report to the SEBI any non-compliance observed by him and ensure that the observations made
or deficiencies pointed out by the SEBI in the draft prospectus or the letter of offer as the case
may be, do not recur. Regulation 28A was inserted by SEBI regulations, 2001 published in the
Official Gazette of India dated 29.05.2001.
g) Sebi’s Right To Inspect:
SEBI’S right to inspect the SEBI may appoint one or more person s as inspecting
authority to undertake inspection of the books of accounts, records and documents of the
merchant banker.

Purpose of Inspection to ensure that the books of account are being maintained in the
manner required; to ensure the provisions of the act, rules, regulations are being complied with;
to investigate into the complaints received from investors, other merchant bankers or any other
person on any matter having a bearing on the activities of the merchant banker; and to investigate
suo-moto in the interest of securities business or investors interest into the affairs of the merchant
banker SEBI’s right to inspect.
h) Notice before inspection:
Before undertaking an inspection under regulation 29 the SEBI give a reasonable notice
to the merchant banker for that purpose. During the course of inspection, the merchant banker
against whom an inspection is being carried out shall be bound to discharge his obligations.

5. Describe briefly SEBI’s guidelines. (Nov/Dec 2013)

The SEBI has first started with issuing guidelines for merchant bankers, mutual
funds, Portfolio Managers and then extended its regulations to all intermediaries in the market,
like brokers, sub brokers, underwriters, Registrars, collecting bankers, debentures trustees etc.

SEBI has issued Regulations for controlling Insider trading frauds and malpractices, for
takeovers and acquisitions, central depositions and practices of brokers in particular of all stock
exchanges.

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A code of conduct to be followed by all registered intermediaries in the market has been laid
down by the SEBI, separately for each.

The SEBI guideline have also provided for market makers who will specialize in buying
and selling of securities by offering two ways quotes. To ensure that market makers would be in
a position to impart liquidity to scrip’s and reduce volatile movements in share prices bank
finance is made available to them as per the RBI guidelines of August 1993.

Banks have been permitted to grant limits to market makers by banks. The existing
minimum margin of 50% of loans to individuals against shares/debentures/bonds would not be
applicable to bank advances to market makers as also the prudential limits of Rs.5lakhs for each
against shares.

Regulations of underwriters of capital issues and capital adequacy norms for the stock
brokers in the recognized stock Exchange were announced in October 1993. At the same time,
the SEBI issued guideline for investor protection.

Strengthening of SEBI powers:

By a gradual process the powers of the Govt. under the securities contracts Act 1956 to
control the stock exchange and their members were delegated to the SEBI; with final appellate
power however resting with the Ministry of Finance.

Options and futures which were earlier illegal are permitted to be introduced subject to
the SEBI’s approval. Control on provisions of listing agreement now rest with the SEBI.

Even companies are brought under the SEBI powers in respect of their capital market
operations. Powers to grant recognition to stock Exchange, inspection and audit of stock
exchanges and stock brokers’ membership and other matters relating to stock exchanges,
including the recognition to attached trading floors have been given to the SEBI.

Venture capital funds are brought under the control of SEBI and similar to guidelines are
also given for venture capital funds in February 1996. Under the amendment to SEBI Act 1995,
many more powers on controlling the intermediaries investors and all players in the stock and
capital markets including penal powers both civil and criminal are now vested in SEBI.

Changes in listing guidelines:

The listing agreement has been amended in many directions since the reforms were
started.

Firstly, the unabridged balance sheets have to be given to the shareholders. Secondly, the
company has to submit statement on a yearly basis to the stock exchange showing the variations
between utilization of funds and projections given the prospectus or letter of offer. Thirdly, the
minimum paid up capital has to be Rs.10 crores for getting itself listed on the B.S.E as in the
case of N.S.E in the case of other stock exchanges the minimum paid up capital for listing was
raised from Rs. 3 crores to Rs.5 crores only.

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The exchange can reject listing for violations of the requirements. The listed companies
have to affect transfer and splits and consolidation etc. within one month of the receipt of
request. In the event of signature differences, the company has to send to the seller to get his
signature authenticated by a registered stock broker and should be taken as final for effecting
transfers. This measures announced by the B.S.E should help the process of quickening the
transfers and reduction of delay in bad deliveries.

Guidelines for Takeovers:

The SEBI has issued guidelines for takeovers and substantial acquisitions to supplement
the provisions of the listing agreement in this regard-clause 40 A and 40 B. In November 1994,
the SEBI issued the regulations for “substantial acquisitions of shares and takeovers”. These
regulations provide for disclosure within 4 days. When acquirer’s shareholding exceeds 5% of
the paid up capital of the listed company and requires half year disclosures. If the holding
exceeds beyond 10% it is necessary for the acquirer offer to other shareholders, shares in case of
takeovers. It contains separate provisions for bail-out takeovers and negotiated acquisitions of
shares. SEBI has power to investigate any violations of these regulations.

In March 1995,SEBI permitted listing of investment and finance companies, leasing and
hire purchase companies and amusement parks on the OTCEI. Those were prohibited earlier to
be listed on the OTCEI. Even in the case of regular stock exchanges, the listing requirements for
finance and investment companies are more rigorous and need a three year track record of
profitability, before getting listed, in addition to a paid up capital of more than 5 crores and the
company should have been registered with the RBI as the NBFC.

6. Explain stock exchange.

STOCK EXCHANGES:

It is the market for exchange of stocks. “Stocks” refers to the old securities i.e., those which have
been already issued and listed on a stock exchange. These securities are purchased and sold
continuously among investors without the involvement of companies. Stock exchange provides
not only free transferability of shares but also makes continuous evaluation of securities traded in
the market. It is also called a Secondary Market’ for securities. It is considered to be sine-quonon
for the primary market. In fact, the success of the issues taking place in the primarymarket
depends much on the soundness and the depth of the secondary market. It provides the investor,
the facility of disposing off their holdings as and when the need for it arises.
According to Hastings, Stock exchange or securities market comprises all the places
where buyers and sellers of stocks and bonds or their representatives undertake transactions
involving the sale of securities.
According to Section 2(3) of the Securities Contract Regulation Act 1956. The stock
exchange has been defined as anybody of individuals whether incorporated or not, constituted for
the purpose of assisting, regulating or controlling the business of buying, selling or dealing in
securities. The following securities can be traded at the stock exchange

a. Shares, scrip’s, stock, bonds, debentures, debentures stocks or other marketable securities of a
like nature in or of any incorporated company or other body corporate
b. Government securities; and
c. Rights or interests in securities.

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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.

Functions of stock exchanges:


The stock market occupies a pivotal position in the financial system. It performs several
economic functions and renders invaluable services to the investors, companies, and to the
economy as a whole. They may be summarized as follows:

1. Liquidity and marketability of securities:


Stock exchanges provide liquidity to securities since securities can be converted into cash at
any time according to the discretion of the investor by selling them at the listed prices. They
facilitate buying and selling of securities at listed prices by providing continuous marketability to
the investors in respect of securities they hold or intend to hold. Thus, they create a ready outlet
for dealing in securities.

2. Safety of funds:
Stock exchanges ensure safety of funds invested because they have to function under strict
rules and regulations and the bye laws are meant to ensure safety of investible funds. Over –
trading, illegitimate speculation etc., are prevented through carefully designed set of rules. This
would strengthen the investor‘s confidence and promote larger investment.

3. Supply of long term funds:


The company is assured of long term availability of funds because the security is transacted
one investor is substituted by another.

4. Flow of capital to profitable ventures:


The profitability and popularity of companies are reflected in stock prices. The prices quoted
indicate the relative profitability and performance of companies. Funds tend to be attracted
towards securities of profitable companies and this facilitates the flow of capital into profitable
channels.

5. Motivation for improved performance:


The performance of a company is reflected on the prices quoted in the stock market. These
prices are more visible in the eyes of the public. Stock market provides room for this price
quotation for those securities listed by it. This public exposure makes a company conscious of its
status in the market and it acts as a motivation to improve its performance further.

6. Promotion of investment:
Stock exchanges mobilize the savings of the public and promote investment through capital
formation. But for these stock exchanges, surplus funds available with individuals and
institutions would not have gone for productive and remunerative ventures.

7. Reflection of business cycle:


The changing business conditions in the economy are immediately reflected on the stock
exchanges. Booms and depressions cane be identified through the dealings on the stock

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exchanges and suitable monetary and fiscal policies can be taken by the government. Thus a
stock market portrays the prevailing economic situation instantly to all concerned so that suitable
actions can be taken.

8. Marketing of new issues:


If the new issues are listed, they are readily acceptable to the public, since, listing
presupposes their evaluation by concerned stock exchange authorities. Costs of underwriting
such issues would be less. Public response to such new issues would be relatively high. Thus, a
stock market helps in the marketing of new issues also.

9. Miscellaneous services:
Stock exchange supplies securities of different kinds with different maturities and yields. It
enables the investors to diversity their risks by a wider portfolio of investment. It also inculcates
saving habits among the community and paves the ways for capital formation. It guides the
investors in choosing securities by supplying him daily quotation of listed securities and by
disclosing the trends of dealings on the stock exchange. It enables companies and the
Government to raise resources by providing a ready market for their securities.

Organisation of stock exchanges:


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

TRADITIONAL STRUCTURE OF STOCK EXCHANGES:


The stock exchanges in India can be classified into two broad groups on the basis of their
legal structure. They are; 1. Three stock exchanges which are functioning as association of
person‘s viz., BSE, ASE and Madhya Pradesh Stock Exchange. 2. Twenty stock exchanges
which have been set up as companies, either limited by guarantees or by shares.
They are
 Bangalore Stock Exchange
 Bhubaneswar Stock exchange
 Calcutta Stock Exchange
 Cochin Stock Exchange
 Coimbatore Stock Exchange
 Delhi Stock Exchange
 Gauhati Stock Exchange
 Interconnected Stock Exchange
 Jaipur Stock Exchange
 Ludhiana Stock Exchange
 Hyderabad Stock Exchange
 Madras Stock Exchange

Demutualization of stock exchanges:


The transition process of an exchange from a “mutually-owned” association to a
company “owned by Shareholders” is called demutualization. Demutualization is transforming
the legal structure, of an exchange from a mutual form to a business corporation form. In a
mutual exchange, the three functions of ownership, management and trading are intervened into

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a single group. It means that the broker members of the exchange are owners as well as traders
on the exchange and further they themselves manage the exchange. These three functions are
segregated from one another after demutualization. The demutualised stock exchanges in India
are; 1. The National Stock Exchange (NSE) 2.Over the Counter Exchange of India (OTCEI).

Corporatization of stock exchanges:


The process of converting the organizational structure of the stock exchange from a non-
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 of converting then
into incorporated companies.

Management:
The recognized stock exchanges are managed by ― Governing Boards‘. The governing
boards consist of elected member directors from stock broker members, public representatives
and government nominees nominated by the SEBI. The government has also powers to nominate
Presidents and Vice-presidents of stock exchanges and to approve the appointment of the chief
Executive and public representatives. The major stock exchanges are managed by the Chief
Executive Director and the smaller stock exchanges are under the control of a Secretary.

Membership:
To become a member of a recognized stock exchange, a person must possess the
following qualifications:
• He should be a citizen of India,
• He should not be less than 21 years of age,
• He should not have been adjudged bankrupt or insolvent,
• He should not have been convicted for an offence involving fraud or dishonesty,
• He should not be engaged in any other business except dealing in securities,
• He should not have been expelled by any other stock exchange or declared a defaulter by any
other stock exchange.

Methods of trading in a stock exchange:


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

Choice of broker:
The prospective investor who wants to buy shares or the investor who wants to sell his
shares cannot enter into the hall of exchange and transact business. They have to act through
only member brokers. They can also appoint their bankers for this purpose, since, bankers can
become members of the stock exchange as per the present regulations. So, the first task in
transacting business on a stock exchange is to choose a broker of repute or a banker. Such
persons alone can ensure prompt and quick execution of a transaction at the best possible and
profitable price.

Placement of order:
Placement of order refers to the purchase or sale of securities with the broker. The order
is usually placed by telegram, telephone, letter, fax etc., or in person.

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Execution of orders:
The Orders are executed through their authorized clerks. Small one carries out their
business personally. Orders are executed in Trading ring of a stock exchange which works from
12 noon to 2 p.m. on all working days from Monday to Friday and a special one hour session on
Saturday. Trading outside the trading hours is called kerb dealings.

Preparation of contract notes:


A contract note is a written agreement between the broker and his client for the
transactions executed. It contains the details of the contract made for the purchase/sale of
securities, the brokerage chargeable, name of the company, number of shares bought/ sold, net
rate, etc., it is prepared in a prescribed from and a copy of it is also sent to the client.

Settlement of transactions:
The settlement of transactions is made by means of delivering the share certificates along
with the transfer deed. The transfer deed is duly signed by the transferor, i.e., the seller. It bears
the stamp of the selling broker. The buyer then fills up the particulars in the transfer deed. At
present, the settlement can be made by any one of the following methods;

• Spot delivery settlement:


The delivery of securities and payment for these are affected on the date of the contract
itself or on the next day.

• Hand Delivery Settlement:


The delivery of securities and payment are affected within the time stipulated in the
agreement or within 14 days from the date of the contract whichever is earlier.

• Clearing Settlement:
The transactions are cleared and settled through the clearing house. Usually those
securities which are frequently traded and are usually in demand are cleared through the clearing
house. These transactions are also referred to as the transaction for the account.

• Special Delivery Settlement:


The delivery of securities and payment may take place at any time exceeding 14 days
following the date of the contract as specified in the contract and permitted by the government.

7. Discuss the recent developments and challenges ahead of merchant banking in India.

Recent Developments in Merchant Banking and Challenges Ahead:

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

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

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

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

 New financial instruments are introduced in the market time and again. This basically
Provides more and more opportunity to the merchant banks.

 The mergers and corporate restructuring along with MOU and MOA are giving immense
opportunity to the merchant bankers for consultancy jobs.

However the challenges faced by merchant bankers in India are


1. SEBI guideline has restricted their operations to Issue Management and Portfolio
management to some extent. So, the scope of work is limited.

2. In efficiency of the clients are often blamed on to the merchant banks, so they are into
trouble without any fault of their own.

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

4. Poor New issues market in India is drying up the business of the merchant bankers. Thus
the merchant bankers are those financial intermediary involved with the activity of
transferring capital funds to those borrowers who are interested in borrowing.

The activities of the merchant banking in India is very vast in the nature of,
 The management of the customers securities

 The management of the portfolio

 The management of projects and counseling as well as appraisal

 The management of underwriting of shares and debentures

 The circumvention of the syndication of loans

 Management of the interest and dividend etc

8. Discuss in detail the various services rendered by merchant bankers.

SERVICES RENDERED BY MERCHANT BANKERS:


Merchant banks in India carry out the following functions and services:

 Project counseling
 Pre-investment studies
 Credit syndication
 Issues management and underwriting

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PROJECT COUNSELLING:

Project counseling is a part of corporate counseling, and relates to project finance. It broadly
covers the study of the project, offering advisory assistance on the viability and procedural steps
for its implementation.

Following are the activities forming part of the project counseling:

1. Undertaking the general review of the project ideas/project profile.


2. Providing advice on procedural aspects of project implementation.
3. Conducting review of technical feasibility of the project on the basis of the report prepared by
own experts or by outside consultants.
4. Assisting in the selection of a Technical Consultancy Organization (TCO) for preparing
project reports and market surveys, or review of the project reports on market survey reports
prepared by TCO.
5. Assisting in the preparation of project report from a financial angle, and advising and acting
on various procedural steps including obtaining government consents for implementation of the
project.
6. Assisting in the obtaining approvals/licenses/permission/grants, etc from government agencies
in the form of letter of intent, industrial license, DGTD registration, and government approval for
foreign collaboration.
7. Providing guidance to Indian entrepreneurs for making investment in Indian project in India
and in Indian joint ventures overseas.
8. Identification of potential investment avenues.
9. Carrying out precise capital structuring and shaping the pattern of financing.
10. Arranging and negotiating foreign collaboration, amalgamation, mergers, and takeovers.
11. Undertaking financial study of the project and preparation of viability reports to advise on the
framework of institutional guidelines and laws governing corporate finance.
12. Providing assistance in the preparation of project and feasibility studies based on
preliminary project ideas, covering the technical, financial and economic aspects of the project
from the point of view of their acceptance by financial institutions and banks.
13. Advising and assisting clients in preparing application for financial assistance to various
nationals’ financial institution, state level institution, banks, etc.
14. Assisting clients in making application for obtaining letters of intent, industrial licence,
DGTD registration, etc.
15. Providing assistance in seeking approval from the government of India for foreign technical
and financial collaboration agreement, guidance on investment opportunities for entrepreneurs
coming to India.

PRE-INVESTMENT STUDIES:

Activities that are connected with making a detailed feasibility exploration to evaluate
alternatives avenues of capital investment in terms of growth and profit prospects are called ‘pre-
investment studies’. Some of these activities are as follows:

1. Carrying out an in-depth investigation of environment and regulatory factors, location of raw
materials supplies, demand projection and requirements in order to assess the financial and
economic viability of given project.

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2. Helping the client in identifying and short-listing those projects which are built upon the
clients inherent strength with a view accentuate corporate profitability and growth in the long
run.
3. Conducting such studies as may required for foreign companies wishing to participate in joint
ventures in India.
4. Offering a package of services, including advice on the extent of participate, government
regulatory factors and an environment scan of certain industries in India.

CREDIT SYNDICATION:

Activities connected with credit procurement and financing, aiming at raising Indian and
foreign currency loans from banks and financial institutions, are collectively known’s as ‘credit
syndication’.

Activities covered under credit syndication are as follows:

1. Estimating the total cost of the project to be undertaken.


2. Drawing up a financing plan for the total project cost which conforms to the requirements of
the promoters and their collaborates, financial institutions and banks, government agencies and
underwriters.
3. Preparing loan application for assistance from term lender/financial institutions/banks, and
monitoring their progress, including pre-sanction negotiations.
4. Selecting institutions and banks for participation in financing.
5. Follow-up of term loan application with the financial institution and banks, and obtaining the
approval for their respective share of participation.
6. Arranging bridge finance.
7. Assisting in completion formalities for drawing of term finance sanctioned by institution by
expending legal documentation formalities, drawing up agreements etc as prescribed by the
participating financial institutions and banks.
8. Assessing working capital requirements.

ISSUE MANAGEMENT AND UNDERWRITING:

Issue management and underwriting connotes activities that are concerned with the
management of the public issues of corporate securities, viz. Equity shares, preference shares,
and debentures or bonds, and are aimed at mobilization of money from the capital market.

Following are some of the popular services provided by merchant bankers in this regard:

1. Preparation of an action plan.


2. Preparation of budget for the total expenses for the issues.
3. Preparation of CCI application and assisting in obtaining consent/acknowledgement.
4. Drafting of prospectus.
5. Selection of institutional and broker underwriters for syndicating/underwriting
arrangement.
6. Selection of issues houses and advertising agencies for undertaking pre & post-issue
publicity.
7. Obtaining the approval of institutional underwriters & stock exchanges for publication of
the prospectus.

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BA7022 Merchant Banking and Financial Services

8. Making arrangements for designing & printing of prospectus and application forms, as well
as their dispatch, if necessary.
9. Providing assistance in launching the issue in the form of advertisement campaigns by
holding press, brokers’ and investors’ conferences etc.
10. Coordination with the underwriters, brokers’& bankers to issue, and the stock exchanges
11. Providing advice on the design of a sound capital structure, acceptable to financial
institutions.
12. Determining the quantum, terms and timing of the public issue of different forms of
securities, the extent and source, loan finance and deployment of internal resources etc in
compliance with the requirements of the companies act/stock exchanges etc.
13. Arranging for stock exchange clearances and listing of securities.
14. Liaisoning and coordination with various constituents of the public issue to make the
function of issue management successful.

Anna University Questions

PART-A

1. What is merchant banking? (Nov/Dec 2010)(Refer page1)


2. Define merchant banking. (Apr/May 2011)(Refer page1)
3. How is ‘merchant banker’ defined under the SEBI regulation?(May/June 2012)(Refer page1)
4. What is OTCEI? (Nov/Dec 2010, Nov/Dec 2011, Apr/May 2011, May/June 2012,(Referpage4)
5. What is portfolio management (Nov/Dec 2013) Refer page5
6. What is OTECI? (Nov/Dec 2013) ,(Refer page4)
7. What are the various services offered by the Merchant bankers? (May/June 2.014)
8. Write short note on OTECI? (May/June 2.014) ,(Refer page4)

PART-B

1. Discuss in detail the various services rendered by merchant bankers.(May/June 2012)(Refer


page 21)
2. Discuss the guidelines of SEBI for merchant banking.(May/June 2010, Nov/Dec 2011)(Refer
page 15)
3. Discuss the recent developments and challenges ahead of merchant banking in India.(Nov/Dec
2011,Nov/Dec 2010,April/May 2011)(Refer page20)3
4. Explain the various new instruments introduced in the capital market. (Nov/Dec 2013)
5.Explain functions and powers of SEBI. (Nov/Dec 2013) Refer Page18
6. Explain the role of financial services in the Indian economy. Mention the key factors for the
growth of the financial services in India. (May/June 2.014)
7. Explain the need for regulation of financial markets in India. (May/June 2014)

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

UNIT II
ISSUE MANAGEMENT

Role of Merchant Banking in Appraisal of projects, Designing Capital Structures and


Instruments – Issue Pricing- Preparation of prospectus selection of bankers, Advertising
Consultants etc. – Role of Registrars –Underwriting Arrangements. Dealing with Bankers to the
Issue, Underwriters, Registrars, and Brokers. –Offer for sale – Book- Building – Green Shoe
Option –E –IPO Private Placement- Bought out Deals –Placement with FIs, MFs, FIIs, etc. off-
Shore Issues. – Issue Marketing – Advertising Strategies-NRI Marketing- Post Issue Activities.

PART-A

9. What is offer for sale?


By an offer for sale, this is a public invitation by a sponsoring intermediary such as
investment bank.

10. What is book building? (May/June 2013), (Nov/Dec 2013)


Book building refers to the process of generating, capturing, and recording investor
demand for shares during an IPO (or other securities during their issuance process) in order to
support efficient price discovery.

11. Define underwriting.


Underwriting refers to the process that a large financial service provider (bank, insurer,
investment house) uses to access the eligibility of a customer to receive their products( equity
capital, insurance, mortgage, or credit).

12. Define IPO.


An initial public offering(IPO), referred to simply as an “offering” or “floatation”, is
when a company(called the issuer) issues common stock or shares to the public for the first time.

13. Who is a broker?


A broker is a party that arranges transactions between a buyer and a seller, and a
commission when the deal is executed.

14. What is issue price?


A company that is planning an IPO appoints lead managers to help it decide on an
appropriate price at which the shares should be issued.

15. What is bought out deal? (May/June 2014)


A bought out deal is a deal in which the company sells its shares to an agent or a
merchant banker, this merchant banker then offloads or sells the shares at an appropriate time.

16. Define private placement. (Nov/Dec 2012)


Private placement is a round of securities which are sold without an initial public
offering, usually to a small number of chosen private investors.

17. Define green shoe option. (May/June 2013), (Nov/Dec 2013)

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

A green shoe legally called an “over-allotment option”, gives underwriters the right to
sell additional shares in a registered securities offering at the offering price.

18. What are the types of brokers?


 Aircraft broker
 Broker-dealer
 Business broker
 Commodity broker
 Customs broker
 Leasing broker
 Mortgage broker
 Real estate broker
 Joint venture broker

19. What is stock broker?


A stock broker is a regulated professional broker who buys and sells shares.

20. Define the term “prospectus”. (Nov/Dec 2012)

Prospectus is defined a document through which public are solicited to subscribe to the
share capital of a corporate entity. Its purpose is inviting the public for the
subscription/purchase of any securities of a company.

13. Write a note on credit syndication. (Nov/Dec 2012) (May/June 2013), (Nov/Dec 2013)
Activities connected with joint credit procurement and project financing, aimed at raising
Indian and foreign currency loans from banks and financial institutions are called credit
syndication.
14. What is conglomerate merger? (Nov/Dec 2012)
A merger between firms that are involved in totally unrelated business activities. There
are two types of conglomerate mergers: pure and mixed. Pure conglomerate mergers involve
firms with nothing in common, while mixed conglomerate mergers involve firms that are
looking for product extensions or market extensions.

15. What is management buyout?(May/June 2012)


A management buyout (MBO) is a form of acquisition where a company's existing
managers acquire a large part or all of the company from either the parent company or from
the private owners.

16. What is issue management?


The management of issues for raising funds through various types of instruments by
companies is known as issue management. The function of capital issues management in India is
carried out by merchant bankers.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

17. What is Public issue?


When capital funds are raised through the issue of a prospectus, it is called ‘public issue
of securities‘. It is the most common method of raising funds in the capital market. A security
issue may take place either at part, or at a premium or at a discount.

18. Define Rights issue.


When shares are issued to the existing shareholders of a company on a privileged basis, it
is called as Rights Issue. The existing shareholders have a pre-emptive right to subscribe to the
new issue of shares

PART-B

1. Explain designing capital structure and instruments.

Designing capital structure decisions:

The term capital structure refers to the proportionate claims of debt and equity in the total
long-term capitalization of a company.

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

Optimal capital structure:


An ideal mix of various sources of long-term funds that aims at minimizing the overall
cost of capital of the firm, and maximizes the market value of shares of a firm is known as
Optimal capital structure.
An optimal capital structure should possess the following characteristics:
a. Simplicity:

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

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

c. Maximum Return and Minimum Risks:


An ideal capital structure must have a combination of debt and equity in such a manner as
to maximize the firm‘s profits. Similarly, the firm must be guarded against risks such as taxes,
interest rates, costs, etc. with the aim of either reducing them or removing them.

d. Maximum Control:

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BA7022 Merchant Banking and Financial Services

The capital structure must aim at retaining maximum control with the existing
shareholders. The issue of securities should be based on the pattern of voting rights. It must
affect favorably the voting structure of the existing shareholders, and increase their control on
the company‘s affairs.

e. Liquidity:
In order to have a sound capital structure, it is important that the various components help
provide the firm greater solvency through higher liquidity. To attain a high order of liquidity, all
such debts that threaten the company‘s solvency must be avoided.

f. Flexibility:
The capital structure should be so constructed that it is possible for the company to carry
out any required change in the capitalization in tune with the changing conditions. Accordingly,
the firm must be able to either raise a new level of capital, or reduce the existing level of capital.

g. Equitable Capitalization:
An ideal capital structure must be neither over capitalized nor under-capitalized.
Capitalization must be based purely on the financial needs of the enterprise. An equitable
capitalization would help make full utilization of the available capital at minimum cost.

h. Optimum Leverage:
The firm must attempt to secure a balanced leverage by issuing both debt and equity at
certain ideal proportions. It is best for the firm to issue debt when the rate of interest is low.
Conversely, equity is suitable where the rate of capitalization is high.

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 be
maximized and cost minimized. The cost of capital of a firm is greatly influenced by the amount
of interest to be paid to its debenture holders in a particular period. A firm would be well advised
to employ the debt capital, as it is a cheap source of funds. Using debt would give the firm a tax
shield advantage. Such an arrangement is technically known as trading on equity.

b. Control Principle
The amount of control to be exercised by the shareholders over the management is an
important principle underlining capital structure decisions. Accordingly, the finance manager,
while making a fresh issue of capital funds, should ensure that the control of the existing
shareholders remain unaffected. In this connection, it is to be noted that the issue of bonds and
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 consequent risk of
bankruptcy.

c.Return Principle

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BA7022 Merchant Banking and Financial Services

According to his principle, the patterns of capital structure must be devised to allow for
enhanced returns to the shareholders. It also implies that the kind of capital source chosen must
be secure. Besides, the principal amount having to be returned immediately after the expiry of
the stipulated time period the bonds require obligated debt servicing by way of fixed periodic
interest. Hence, debt capital may prove fatal to the company in time of low/non-profits. In the
context of risk, equity stands a fair chance of being included as part of an efficient capital
structure.

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

e. Timing Principle:
The quality of decisions depends on the time at which the capital funds are either raised or
returned. This would help minimize the cost of capital, and thus help maximize returns 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 of boom equity shares
should be issued to raise resources. Conversely, in periods of depression, bonds are ideal, as they
entail payment of lower rate interest.

2. What are the various Factors affecting capital structure decisions?

The following factors significantly influence the capital structure decision of a firm:
Economy Characteristics The major developments taking place in the economy affect the
capital structure of firms. In order words, the way the economy of a country is managed
determines the way the capital structure of a firm will be determined. Factors that are active in
the economy are:

1. Business activity :
The quality of business activity prevailing in the economy determines the capital
structure pattern of a firm. Under conditions of expanding business activities, the firm must have
several alternatives to source the required capital in order to undertake profitable investment
activities. Under these circumstances, it is advisable for a firm to undertake equity funding rather
than debt funding.

2. Stock market :
The buoyancy, or otherwise, of the capital market greatly influences capital structure
decisions. A study of the capital market trends would greatly help a firms decision on the
quantum and cost of issue. Accordingly, if the stock market is expected to witness bullish trends,
the interest rates will go up and debt will become costlier.

3. Taxation :
The rates and rules of taxation prevalent in an economy also affect capital structure
decisions. For instance, higher rates of taxation will be advantageous due to the tax deductibility
benefit of debt funding. Similarly, the taxes on dividend income, if any, would adversely affect
the ability of firms to raise equity capital.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

4. Regulations :
The regulations imposed by the state on the quantum, pricing etc. of capital funds to be
raised also influences the capital raised by a firm. For instance, restrictions have been imposed
by SEBI on the issue and allotment of shares and bonds to different type of investors. A finance
manager should take this factor into consideration while designing the capital structure.

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

6. Financial institutions :
The credit policy followed by financial institutions determines the capital structure
decisions of firms. For instance, restrictive lending terms by financial institutions may deter
firms from raising long-term funds at reasonable rates of interest. Easy terms, on the other hand,
may encourage firms to obtain a higher quantum of loans.

3. What is capital market? Explain various capital market instruments.

Capital market instruments:


Financial instruments that are used for raising capital resources in the capital market are
known as Capital Market Instruments. The changes that are sweeping across the Indian capital
market especially in the recent past are something phenomenal. It has been experiencing
metamorphic in the last decade, thanks to a host of measures of liberalization, globalization, and
privatization that have been initiated by the Government. Pronounced changes have occurred in
the realm of industrial policy. Licensing policy, financial services industry, interest rates, etc.
The competition has become very intense and real in both industrial sector and financial services
industry. As a result of these changes, the financial services industry has come to introduce a
number of instruments with a view to facilitate borrowing and lending of money in the capital
market by the participants.

Types of capital market instruments:

The various capital market instruments used by corporate entities for raising resources are
as follows:
1. Preference shares
2. Equity shares
3. Non-voting equity shares
4. Cumulative convertible preference shares
5. Company fixed deposits
6. Warrants
7. Debentures and Bonds

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 dividend and the
distribution of the assets of the company in the event of its winding up, in preference to equity
shares.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

Types of preference shares:

1. Cumulative preference shares :


Shares where the arrears of dividends in times of no and/or lean profits can be
accumulated and paid in the year in which the company earns good profits.

2. Non-cumulative preference shares :


Shares where the carry forward of the arrears of dividends is not possible.

3. Participating preference shares :


Shares that enjoy the right to participate in surplus profits or surplus assets on the
liquidation of a company or in both, if the Articles of Association provides for it.

4. Redeemable preference shares:


Shares that are to be repaid at the end of the term of issue, the maximum period of a
redemption being 20 years with effect from 1.3.1997 under the Companies amendment Act 1996.
Since they are repayable, they are similar to debentures. Only fully paid shares are redeemed.
Where redemption is made out of profits, a Capital Redemption Reserve Account is opened to
which a sum equal to the nominal value of the shares redeemed is transferred. It is treated as
paid-up share capital of the company.

5. Fully convertible cumulative preference shares


Shares comprise two parts viz., Part A and B. Part A is convertible into equity shares
automatically and compulsorily on the date of allotment. Part B will be redeemed at
par/converted into equity shares after a lock-in period at the option of the investor, conversion
into equity shares taking place after the lock-in period, at a price, which would be 30 percent
lower than the average market price. The average market price shall be the average of the
monthly high and low price of the shares in a stock exchange over a period of 6 months
including the month in which the conversion takes place.

6. Preference shares with warrants attached


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

EQUITY SHARES
Equity shares, also known as „ordinary shares‟ are the shares held by the owners of a
corporate entity. Since equity shareholders face greater risks and have no specified preferential
rights, they are given larger share in profits through higher dividends than those given to
preference shareholders, provided the company‘s performance is excellent. Directors declare no
dividends in case there are no profits or the profits do not justify dividend for previous years
even when the company makes substantial profits in subsequent years. Equity shareholders also
enjoy the benefit of ploughing back of undistributed profits kept as reserves and surplus for the
purposes of business expansion.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

Often, part of these is distributed to them, as bonus shares. Such bonus shares are
entitled to a proportionate or full dividend in the succeeding year. A strikingly noteworthy
feature of equity shares is that holders of these shares enjoy substantial rights in the corporate
democracy, namely the rights to approve the company‘s annual accounts, declaration of
dividend, enhancement of managerial remuneration in excess of specified limits and fixing the
terms of appointment and election of directors, appointment of auditors and fixing of their
remuneration, amendments to the Articles and Memorandum of Association, increase of share
capital and issue of further shares or debentures, proposals for mergers and reconstruction and
any other important proposal on which member‘s approval is required under the Companies Act.

Equity shares in the hands of shareholders are mainly reckoned for determining the
management‘s control over the company. Where shareholders are widely disbursed, it is possible
for the management to retain the control, as it is not possible for all the shareholders to attend the
company‘s meeting in full strength. Furthermore, the management group can bolster its
controlling power by acquiring further shares in the open market or otherwise. Equity shares may
also be offered to financial institutions as part of the private placement exercise. Such a method,
however, is brought with the danger of takeover attempt by financial institutions.

Equity shareholders represent proportionate ownership in a company. They have residual


claims on the assets and profits of the company. They have unlimited potential for dividend
payments and price appreciation in comparison to these owners of debentures and preference
shares who enjoy just a fixed assured return in the form of interest and dividend.

Higher the risk, higher the return and vice-versa. Share certificates either in physical form
or in the demits (with the introduction of depository system in 1999) form are issued as a proof
of ownership of the shares in a company. Fully paid equity shares with detachable warrants
entitle the warrant holder to apply for a specified number of shares at a determined price.
Detachable warrants are separately registered with stock exchange and traded separately. The
company would determine the terms and conditions relating to the issue of equity against
warrants. Voting rights are granted under the Companies Act (Sections 87 to 89) wherein each
shareholder is eligible for votes proportionate to the number of shares held or the amount of
stock owned. A company cannot issue shares carrying disproportionate voting rights. Similarly,
voting right cannot be exercised in respect of shares on which the shareholder owes some money
to the company.

Non-voting equity shares:


Consequent to the recommendations of the AbidHussain Committee and subsequentto the
amendment to the Companies Act, corporate managements are permitted to mobilize additional
capital without diluting the interest of existing shareholders with the help of a new instrument
called ‗non-voting equity shares‘. Such shares will be entitled to all the benefits except the right
to vote in general meetings. Such non-voting equity share is being considered as a possible
addition to the two classes of share capital currently in vogue. This class of shares has been
included by an amendment to the Companies Act as a third category of shares.

Corporate will be permitted to issue such share up to a certain percentage of the total
share capital. Non-voting equity shares will be entitled to rights and bonus issues and preferential
offer of shares on the same lines as that of ordinary shares.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

The objective will be to compensate the sacrifice made for the voting rights. For this
purpose, these shares will carry higher dividend rate than that of voting shares. If a company fails
to pay dividend, non-voting shareholders will automatically be entitled to voting rights on a
prorate basis until the company resumes paying dividend. The mechanism of issue of non-voting
shares is expected to overcome such problems as are associated with the voting shares as that the
ordinary investors are more inclined towards high return on capital through sizeable dividends
and capital appreciation through the issue of bonus shares and the inability of corporate to
respond to the investors‘ just aspiration for reasonable dividends.

Moreover, there is every need for corporate to spend huge sums of money on a variety of
not-so-useful items including colorful and costly annual reports. For all these above-mentioned
reasons, non-voting equity shares are expected to have a ready and popular marker. In effect, this
kind of share is similar to preference shares with regard to non-voting right but may get the
advantage of higher dividends as well as appreciation in share values through entitlement to
bonus shares which is not available to preference shares.

CONVERTIBLE CUMULATIVE PREFERENCE SHARES (CCPS):


These are the shares that have the twin advantage of accumulation of arrears of dividends
and the conversion into equity shares. Such shares would have to be the face value of Rs.100
each. The shares have to be listed on one or more stock exchanges in the country. The object of
the issue of CCP shares is to allow for the setting up of new projects, expansion or diversification
of existing projects, normal capital expenditure for modernization and for meeting working
capital requirements.
Following are some of the terms and conditions of the issue of CCP shares :

1. Debt-equity ratio :
For the purpose of calculation of debt-equity ratio as may be applicable CCPS is be
deemed to be an equity issue.

2. Compulsory conversion :
The conversion into equity shares must be for the entire issue of CCP shares and shall be
done between the periods at the end of three years and five years as may be decided by the
company. This implies that the conversion of the CCP into equity shares would be compulsory at
the end of five years and the aforesaid preference shares would not be redeemable at any stage.

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

4. Preference dividend :

The rate of preference dividend payable on CCP shares would be 10 percent.

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

6. Arrears of dividend :

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BA7022 Merchant Banking and Financial Services

The right to receive arrears of dividend up to the date of conversion, if any, shall devolve
on the holder of the equity shares on such conversion. The holder of the equity shares shall be
entitled to receive the arrears of dividend as and when the company makes profit and is able to
declare such dividend.

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

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

Company Fixed Deposits:

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

Regulations Since these instruments are unsecured, there is a lot of uncertainty about the
repayment of deposits and regular payment of interest. The issue of fixed deposits is subject to
the provisions of the Companies Act and the Companies (Acceptance of Deposits) Rules
introduced in February 1975.

Some of the important regulations are:

1. Advertisement :

Issue of an advertisement as approved by the Board of Directors in dailies circulating in


the state of incorporation.

2. Liquid assets :
Maintenance of liquid assets equal to 15 percent (substituted for 10% by Amendment
Rules, 1992) of deposits (maturing during the year ending March 31) in the form of bank
deposits, unencumbered securities of State and Central Governments or unencumbered approved
securities.

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

4. Deemed public Company :

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BA7022 Merchant Banking and Financial Services

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

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

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

WARRANTS:

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

A security issued by a company, granting its holder the right to purchase a specified
number of shares, at a specified price, any time prior to an expirable date is known as a warrant.
Warrants may be issued with either debentures or equity shares. They clearly specify the number
of shares entitled, the expiration date, along with the stated/exercise price. The expiration date of
warrants in USA is generally 5 to 10 years from the date of issue and the exercise price is 10 to
30 percent above the prevailing market price.

Warrants have a secondary market. The exchange value between the share of its current
price and the shares to be purchased at the exercise price represents the minimum value of
warrant. They have no floatation costs and when they are exercised, the firm receives additional
finds at a price lower than the current market, yet higher than those prevailing at the time of
issue.

Warrants are issued by new/growing firms and venture capitalists. They are also issued
during mergers and acquisitions. Warrants in the Indian context are called sweeteners ‘and were
issued by a few Indian companies since 1993. Both warrants and rights entitle a buyer to acquire
equity shares of the issuing company. However, they are different in the sense that warrants have
a life span of three to five years whereas; rights have a life span of only four to twelve weeks
(duration between the opening and closing date of subscription list).

Moreover, rights are normally issued to affect current financing, and warrants are sold to
facilitate future financing. Similarly, the exercise price of warrant, i.e. the price at which it can
be exchanged for share, is usually above the market price of the share so as to encourage existing
shareholders to purchase it. On the other hand, one warrant buys one equity share generally,
whereas more than one right may be needed to buy one share. The detachable warrant attached to

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BA7022 Merchant Banking and Financial Services

each share provides a right to the warrant holder to apply for additional equity share against each
warrant.

DEBENTURES AND BONDS:

A document that either creates a debt or acknowledges it is known as a debenture.


Accordingly, any document that fulfills either of these conditions is a debenture. A debenture,
issued under the common seal of the company, usually takes the form of a certificate that
acknowledges indebtedness of the company. A document that shows on the face of it that a
company has borrowed a sum of money from the holder thereof upon certain terms and
conditions is called a debenture. Debentures may be secured by way of fixed or floating charges
on the assets of the company. These are the instruments that are generally used for raising long-
term debt capital.

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 the regulations of the SEBI. Section
117 of the Companies Act prohibits issue of debentures with voting rights. Generally, they are
issued against a charge on the assets of the company but at times may be issued without any such
charge also. Debentures can be issued at a discount in which case, the relevant particulars are to
be filed with the Registrar of Companies.

2. Negotiability :
In the case of bearer debentures the terminal value is payable to its bearer. Such
instruments are negotiable and are transferable by delivery. Registered debentures are payable to
the registered holder whose name appears both on the debenture and in the register of debenture
holders maintained by the company. Further, transfer of such debentures should be registered.
They are not negotiable instruments and contain a commitment to pay the principal and interest.

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

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

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

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BA7022 Merchant Banking and Financial Services

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

4. Explain preparation of prospectus, selection of bankers, advertising consultants.


Prospectus is defined a document through which public are solicited to subscribe to the
share capital of a corporate entity. Its purpose is invite the public for the subscription/purchase of
any securities of a company.

PROSPECTUS FOR PUBLIC OFFER:


1. Regular prospectus
2. Abridged prospectus
3. Prospectus for rights issue
4. Disclosures in prospectus
5. Disclosures in abridged prospectus and letter of offer

1. REGULAR PROSPECTUS:
The regular prospectus is presented in three parts;

PART I
a. General Information about the company e.g. Name and address of the registered office
consent of the Central Government for the issue and names of regional stock exchanges etc.,
b. Capital Structure such as authorized, issued, subscribed and paid up capital etc.,
c. Terms of the issue like mode of payment , rights of instruments holders etc.,
d. Particulars of the issue like project cost , means of financing etc.,
e. Company, Management and project like promoters for the project, location of the project
etc.,
f. Disclosures of public issues made by the Company, giving information about type of issue,
amount of issue, date of closure of issue, etc.,
g. Perception of Risk factors like difficulty in marketing the products, availability of raw
materials etc.,

PART II:
a. General Information.
b. Financial Information like Auditor‘s Report, Chartered Accountant‘s Report etc.,
c. Statutory and Other Information.

PART III:
a. Declaration i.e., by the directors that all the relevant provisions of the companies Act,
1956 and guidelines issued by the Government have been complied with.
b. Application with prospectus.

2. ABRIDGED PROSPECTUS:
The concept of abridged prospectus was introduced by the Companies (amendment) Act
of 1988 to make the public issue of shares an inexpensive proposition. A memorandum
containing the salient features of a prospectus as prescribed is called as Abridged Prospectus.

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BA7022 Merchant Banking and Financial Services

3. SELECTION OF BANKERS:
Merchant bankers assist in selecting the appropriate bankers based on the proposals or
projects. Because the commercial bankers are merely financiers and their activities are
appropriately arrayed around credit proposals, credit appraisal and loan sanctions. But merchant
banking include services like project counseling , corporate counseling in areas of capital
restructuring amalgamations, mergers, takeover etc., discounting and rediscounting of short term
paper in money markets, managing, underwriting and supporting public issues in new issue
market and acting as brokers and advisers on portfolio management in stock exchange.

4. Advertising consultants:
Merchant bankers arrange a meeting with company representatives and advertising agents
to finalize arrangements relating to date of opening and closing of issue, registration, of
prospectus, launching publicity campaign and fixing date of board meeting to approve and sign
prospectus and pass the necessary resolutions. Publicity campaign covers the preparation of all
publicity material and brochures, prospectus, announcement, advertisement in the press, radio,
TV, investors conference etc., The merchant bankers help choosing the media, determining the
size and publications in which the advertisement should appear.

The merchant Bankers role is limited to deciding the number of copies to be printed,
checking accuracy of statements made and ensure that the size of the application form and
prospectus conform to the standard prescribed by the stock exchange. The Merchant banker has
to ensure that the material is delivered to the stock exchange at least 21 days before the issue
opens and to brokers to the issue, branches of brokers to the issue and underwriter in time.
Securities issues are underwritten to ensure that in case of under subscription the issues are taken
up by the underwriters.

SEBI has made underwriting mandatory for issues to the public. The underwriting
arrangement should be filed with the stock exchange. Particulars of underwriting arrangement
should be mentions in the prospectus. The various activities connected with pres issue
management are a time bound programme which has to be promptly attended to. The execution
of the activities with clockwork efficiency would lead to a successful issue.

5. What are the activities connected with “Issue Management and Underwriting” of
Merchant Bankers? Explain. (May/June 2014)

Important intermediary in the new issue/primary market is the underwriters to issues of


capital who agree to take up securities which are not fully subscribed. They make a commitment
to get the issue subscribed either by others or by themselves. Though underwriting is not
mandatory after April 1995, its organization is an important element of the primary market.
Underwriters are appointed by the issuing companies in consultation with the lead
managers/merchant bankers to the issues.

A statement to the effect that in the opinion of the lead manager, the underwriters‘ assets
are adequate to meet their obligation should be incorporated in the prospectus.

Registration:
To act as underwriter, a certificate of registration must be obtained from the SEBI. In
granting the certificate of registration, the SEBI considers all matters relevant/relating to the
underwriting and in particular,

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BA7022 Merchant Banking and Financial Services

 The necessary infrastructure like adequate office space, equipment and manpower to
effectively discharge the activities
 Past experience in underwriting/employment of at least two persons with experience in
underwriting
 Any person directly/indirectly connected with the applicant is not registered with the SEBI as
under or a previous application of any such person has been rejected or any disciplinary
action has been taken against such person under the SEBI Act/ rules/regulations,
 Capital adequacy requirement of not less than net worth (capital + free reserves) of Rs.20
lakhs; and
 The applicant/director/principal officer/partner has been convicted of offence involving
moral turpitude or found gully of any economic offence.

General obligations and responsibilities code of conduct for underwriters:

An underwriter should:

1. Make all efforts to protect the interests of its clients.


2. Maintain high standards of integrity, dignity and fairness in the conduct of its business.
3. Ensure that it and its personnel will act in an ethical manner in all its dealings with a body
corporate making an issue of securities (i.e. the issuer).
4. Endeavour to ensure all professional dealings are effected in a prompt, efficient and effective
manner.
5. At all times render high standards of service, exercise due diligence, ensure proper care and
exercise independent professional judgment.
6. Not make any statement, either oral or written, which would misrepresent (a) the services
that the underwriter is capable of performing for its client, or has rendered to any other issuer
company; (b) his underwriting commitment.
7. Avoid conflict of interest and make adequate disclosure of his interest.
8. Put in place a mechanism to resolve any conflict of interest situation that may arise in the
conduct of its business or where any conflict of interest arises, should take reasonable steps
to resolve the same in any equitable manner.
9. Make appropriate disclosure to the client of its possible source or potential in areas of
conflict of duties and interest while acting as underwriter which would impair its ability to
render fair, objective and unbiased services.
10. Not divulge to other issuer, press or any party any confidential information about its issuer
company, which has come to its knowledge and deal in securities of any issuer company
without making disclosure to the SEBI as required under these regulations and also to the
Board directors of the issuer company.
11. Not discriminate amongst its clients, save and except on ethical and commercial
considerations.
12. Ensure that any charge in registration status/any penal action taken by SEBI or any material
change in financials which may adversely affect the interests of clients/ investors is promptly
informed to the clients and any business remaining outstanding is transferred to another
registered person in accordance with any instructions of the affected clients/investors.
13. Maintain an appropriate level of knowledge and competency and abide by the provisions of
the SEBI Act, regulations, circulars and guidelines issued by the SEBI. The underwriter
should also comply with the award of the Ombudsman under the SEBI (Ombudsman)
Regulations, 2003.

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BA7022 Merchant Banking and Financial Services

14. Ensure that the SEBI is promptly informed about any action, legal proceedings, etc. initiated
against it in respect of any material breach or non-compliance by it, of any law, rules,
regulations, 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. Not render, directly or indirectly any investment advice about any security in the publicly
accessible media, whether real-time or non-real-time, unless a disclosure of his interest
including its long or short position in the security has been made, while rendering such
advice; (b) In case an employee or an underwriter is rendering such advice, the underwriter
should ensure that he should disclose his interest, the interest of his dependent family
members and that of the employer including their long or short position in the security, while
rendering such advice.
17. Not either through its account or their respective accounts or through their associates or
family members, relatives or friends indulges in any insider trading.
18. Not indulge in any unfair competition, which is likely to be harmful to the interest of other
underwriters carrying on the business of underwriting or likely to place such other
underwriters in a disadvantageous position in relation to the underwriter while competing for,
or carrying out any assignment.
19. Have internal control procedures and financial and operational capabilities which can be
reasonably expected to protect its operations, its clients and other registered entities from
financial loss arising from theft, fraud, and other dishonest acts, professional misconduct or
commissions.
20. Provide adequate freedom and powers to its compliance officer for the effective discharge of
his duties.

Agreement with clients:


Every underwriter has to enter into an agreement with the issuing company. The
agreement, among others, provides for the period during which the agreement is in force, the
amount of underwriting obligations, the period within which the underwriter has to be subscribe
to the issue after being intimated by/on behalf of the issuer, the amount of
commission/brokerage, and details of arrangements, if any, made by the underwriter for fulfilling
the underwriting obligations.

General responsibilities:
An underwriter cannot derive any direct or indirect benefit from underwriting the issue
other than by the underwriting commission. The maximum obligation under all underwriting
agreements of an underwriter cannot exceed twenty times his net worth. Underwriters have to
subscribe for securities under the agreement with 45 days of the receipt of intimation from the
issuers.

Inspection and disciplinary proceedings:


The framework of the SEBI‘s right to undertake the inspection of the books of accounts,
other records and documents of the underwriters, the procedure for inspection and obligations of
the underwriters is broadly on the same pattern as applicable to the lead managers.

Action in case of default:


The liability for action in case of default arising out of i. non-compliance with any
conditions subject to which registration was granted. ii. contravention of any provision of the
SEBI Act/rules/regulations, by an underwriter involves the suspension/cancellation of

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BA7022 Merchant Banking and Financial Services

registration, the effect of suspension/ cancellation are on the lines followed by the SEBI in case
of lead managers.

6. Discuss briefly about bankers to the Issue Management (Nov/Dec 2013)

Bankers to an issue:
The bankers to an issue are engaged in activities such as acceptance of applications along
with application money from the investors in respect of issues of capital and refund of
application money.

Registration:
To carry on activity as a banker to issue, a person must obtain a certificate of registration
from the SEBI. The SEBI grants registration on the basis of all the activities relating to banker to
an issue in particular with reference to the following requirements:
 The applicant has the necessary infrastructure, communication and data processing facilities
and manpower to effectively discharge his activities,
 The applicant/any of the directors of the applicant is not involved in any litigation connected
with the securities market/has not been convicted of any economic offence The applicant is a
scheduled bank and
 Grant of a certificate is in the interest of the investors.

A banker to an issue can apply for the renewal of his registration three months before the
expiry of the certificate. Every banker to an issue had to pay to the SEBI an annual fee of Rs.2.5
lakhs for the first two years from the date of initial registration, and Rs.1 lakh for the third year
to keep his registration in force. The renewal fee to be paid by him annually for the first two
years was Rs.1 lakh and Rs.20,000 for the third year. Since 1999, schedule of fee is Rs.5 lakhs as
initial registration fee and Rs.2.5 lakhs renewal fee every three years from the fourth year from
the date of initial registrations. Non-payment of the prescribed fee may lead to the suspension of
the registration certificate.

General obligations and responsibilities furnish information:

When required, a banker to an issue has to furnish to the SEBI the following information;
a) The number of issues for which he was engaged as a banker to an issue;
b) The number of application/details of the application money received,
c) The dates on which applications from investors were forwarded to the issuing
company registrar to an issue; d) The dates/amount of refund to the investors.

Books of account/record/documents:
A banker to an issue is required to maintain books of accounts/records/documents for a
minimum period of three years in respect of, inter-alias, the number of applications received, the
names of the investors, the time within which the applications received were forwarded to the
issuing company/registrar to the issue and dates and amounts of refund money to investors.

Disciplinary action by the rbi:


If the RBI takes any disciplinary action against a banker to an issue in relation to issue
payment, the latter should immediately inform the SEBI. If the banker is prohibited from

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BA7022 Merchant Banking and Financial Services

carrying on his activities as a result of the disciplinary action, the SEBI registration is
automatically 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 independent professional
judgment.
5. Not any time act in collusion with other intermediates over the issuer in a manner that is
detrimental to the investor
6. Endeavour to ensure that
a) inquiries from investors are adequately dealt with;
b) grievances of investors are redressed in a timely and appropriate manner;
c) where a complaint is not remedied promptly, the investor is advised of any further steps
which may be available to the investor under the regulatory system.
7. Not
a) Allow blank applications forms bearing brokers stamp to be kept the bank premises or
peddled anywhere near the entrance of the premises;
b) Accept applications after office hours or after the date of closure of the issue or on bank
holidays;
c) After the closure of the public issue accept any instruments such as Cheques/ demand
drafts/stock invests from any other source other than the designated registrar to the issue;
d) Part with the issue proceeds until listing permission is granted by the stock exchange to
the body corporate;
e) Delay in issuing the final certificate pertaining to the collection figures to the registrar to
the issue, the lead manager and the body corporate and such figures should be submitted
within seven working days from the issue closure date.
8. Be prompt in disbursing dividends, interests or any such accrual income received or collected
by him on behalf of his clients
9. Not make any exaggerated statement whether oral or written to the client, either about its
qualification or capability to render certain services or its achievements in regard to services
rendered to other client.
10. Always Endeavour to render the best possible advice to the clients having regard to the
clients‘ needs and the environments and his own professional skill.
11. Not divulge to anybody either orally or in writing, directly or indirectly, any confidential
information about its clients which has come to its knowledge, without taking prior
permission of its clients
12. Avoid conflict of interest and make adequate disclosure of his interest.
13. Put in place a mechanism to resolve any conflict of interest situation that may arise in the
conduct of its business or where any conflict of interest arise, should take reasonable steps to
resolve the same in an equitable manner.
14. Make appropriate disclosure to the client of its possible source or potential areas of conflict
of duties and interest while acting as banker to an issue which would impair its ability to
render fair, objective and unbiased services.

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BA7022 Merchant Banking and Financial Services

15. Not indulge in any unfair competition, which is likely to harm the interests of other bankers
to an issue or investors or is likely to place such other bankers to an issue in a
disadvantageous position while competing for or executing any assignment.
16. Not discriminate amongst its clients, save and except on ethical and commercial
considerations.
17. Ensure that any change in registration status/any penal action taken by the SEBI or any
material change in financials which may adversely affect the interests of clients/ investors is
promptly informed to the clients and business remaining outstanding is transferred to another
registered person in accordance with any instructions of the affected clients/investors.
18. Maintain an appropriate level of knowledge and competency and abide by the provisions of
the SEBI Act, regulations, circulars and guidelines of the SEBI. The banker to an issue
should also comply with the award of the Ombudsman passed under the SEBI (Ombudsman)
Regulations, 2003.
19. Ensure that the SEBI is promptly informed about any action, legal proceedings, etc., initiated
against it in respect of any material breach of non-compliance by it, of any law, rules,
regulations, and directions of the SEBI or of any other regulatory body.
20. Not make any untrue statement of suppress any material fact in any documents, reports,
papers or information furnished to the SEBI.

Inspection:
Such inspection is done by the RBI upon the request of the SEBI. The purpose of
inspection is largely to ensure that the required books of accounts are maintained and to
investigate into the complaints received from the investors against the bankers to an issue. The
foregoing rules and regulations have brought the bankers to an issue under the regulatory
framework of the SEBI with a view to ensuring greater investor protection. On the basis of the
inspection report, the SEBI can direct the banker to an issue to take such measures as it may
deem fit in the interest of the securities market and for due compliance with the provision of the
SEBI Act.

Action in case of default:


With a view to ensure effective regulation of the activities of the bankers to an issue, the
SEBI is empowered to suspend/cancel their registration certificate.
The grounds of suspension are:
a) The banker violates the provisions of the SEBI Act, rules/regulations;
b) Fails to/does not furnish the required information or furnishes wrong/false information;
c) Fails to resolve investor complaints/to give satisfactory reply to SEBI;
d) Is guilty of misconduct/unprofessional conduct inconsistent with the prescribed code of
conduct; and
e) Fails to pay fees and carry out his obligations as specified in the regulations.

The SEBI can cancel registration in case of


i. Repeated defaults leading to suspension of a banker,
ii. The deterioration in is financial position which likely to adversely affect the interest of
the investors, and
iii. The being found guilty of fraud/convicted of a criminal offence.

7. Discuss about brokers to the issue. (Nov/Dec 2013)

Brokers to the issue:

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BA7022 Merchant Banking and Financial Services

Brokers are the persons mainly concerned with the procurement of subscription to the
issue from the prospective investors. The appointment of brokers is not compulsory and the
companies are free to appoint any number of brokers. The managers to the issue and the official
brokers organize the preliminary distribution of securities and procure direct subscriptions from
as large or as wide a circle of investors as possible.
The stock exchange bye-laws prohibits the members from the acting as managers or
brokers to the issue and making preliminary arrangement in connection with any flotation or new
issue, unless the stock exchange of which they are members gives its approval and the company
conforms to the prescribed listing requirements and undertakes to have its securities listed on a
recognized stock exchange. The permission granted by the stock exchange is also subject o other
stipulations which are set out in the letter of consent. Their active assistance is indispensable for
broad basing the issue and attracting investors.

By and large, the leading merchant bankers in India who act as managers to the issue
have particulars of the performance of brokers in the country. The company in consultation with
the stock exchange writes to all active brokers of all exchanges and obtains their consent to act as
brokers to the issue. Thereby, the entry of experienced and unknown agencies in to the field of
new issue activity as issue managers, underwriters, brokers, and so on, is discouraged.

A copy of the consent letter should be filed along with the prospectus to the ROC. The
names and addresses of the brokers to the issue are required to be disclosed in the prospectus.
Brokerage may be paid within the limits and according to other conditions prescribed. The
brokerage rate applicable to all types of public issue of industrial securities is fixed at 1.5
percent, whether the issue is underwritten or not.

The mailing cost and other out-ofpocket expenses for canvassing of public issues have to
be borne by the stock brokers and no payment on that account is made by the companies.

A clause to this effect must be included in the agreement to be entered into between the
broker and the company. The listed companies are allowed to pay a brokerage on private
placement of capital at a maximum rate of 0.5 percent. Brokerage is not allowed in respect of
promoters quota including the amounts taken up by the directors, their friends and employees,
and in respect of the rights issues taken by or renounced by the existing shareholders. Brokerage
is not payable when the applications are made by the institutions/bankers against their
underwriting commitments or on the amounts devolving on them as underwriters consequent to
the under subscription of the issues.

The issuing company is expected to pay brokerage within two months from the date of
allotment and furnish to the broker, on request, the particulars of allotments made against
applications bearing their stamp, without any charge. The Cheques relating to brokerage on new
issues and underwriting commission, if any, should be made payable at par at all centre where
the recognized stock exchanges are situated. The rate of brokerage payable must be is enclosed
in the prospectus.

(i) Banking:
All types of foreign exchange transactions including advice on exchange, imports, exports
finance, financing the movement of goods through acceptance credits, the handling of
commercial letters of credit, the negotiation and collection of foreign bills, accepting call or term
deposits, short or medium term finance, bridging finance, leading; corporate banking,

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treasury/trading services, discount/guarantee facilities. Issuing and underwriting. Public issues;


underwriting of issues, preparation of prospectuses; new equity; obtaining stock exchange
listings/broking services.

(ii) Corporate Finance:


New issues; development capital; negotiation of mergers and takeovers; capital
reconstruction; bridging finance, medium term loans; public sector finance.

(iii) Management Services:


Economic planning; trusts administration; share secretarial services; primary capital market
participation.

(iv) Product Knowledge:


Foreign exchange, import finance; export finance; commercial LCs; FBCSs; Call/ Term
deposits; medium term loans (MTL); Bridging finance; leasing, treasury services,
discount/guarantees, Acceptance credits, public issues, underwriting, equity, broking, estate
planning, trusts, share transfers. Marketing the public issue arises because of the highly
competitive nature of the capital market. Moreover, there is a plethora of companies, which
knock at the doors of investors seeking to sell their securities. Above all the media bombards the
modern investors with eye catching advertisement to sell their concepts to prospective investors.

8. Explain briefly about marketing of new issues (OR) Explain the various methods of
marketing the securities adopted by the Indian Corporate entities.( May/June 2013)

Following are the steps involved in the marketing of the issue of securities to be
undertaken by the lead manager:

1. Target market :
The first step towards the successful marketing of securities is the identification of a target
market segment where the securities can be offered for sale. This ensures smooth marketing of
the issue. Further, it is possible to identify whether the market comprises of retail investors,
wholesale investors or institutional investors.

2. Target concentration :
After having chosen the target market for selling the securities, steps are to be taken to
assess the maximum number of subscriptions that can be expected from the market. It would
work to the advantage of the company if it concentrates on the regions where it is popular among
prospective investors.

3. Pricing :
After assessing market expectations, the kind and level of price to be charged for the
security must be decided. Pricing of the issue also influences the design of capital structure. The
offer has to be made more attractive by including some unique features such as safety net,
multiple options for conversion, attaching warrants, etc.

4. Mobilizing intermediaries :
For successful marketing of public issues, it is important that efforts are made to enter
into contracts with financial intermediaries such as an underwriter, broker/sub-broker, fund
arranger, etc.

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BA7022 Merchant Banking and Financial Services

5. Information contents :
Every effort should be mad3e to ensure that the offer document for issue is educative and
contains maximum relevant information. Institutional investors and high net worth investors
should also be provided with detailed research on the project, specifying its uniqueness and its
advantage over other existing or upcoming projects in a similar field.

6. Launching advertisement campaign :


In order to push the public issue, the lead manager should undertake a high voltage
advertisement campaign. The advertising agency must be carefully selected for this purpose. The
task of advertising the issue shall be entrusted to those agencies that specialize in launching
capital offerings. The theme of the advertisement should be finalized keeping in view SEBI
guidelines. An ideal mix of different advertisement vehicles such as the press, the radio and the
television, the hoarding, etc. should be used. Press meets, brokers and investor‘s conference, etc.
shall be arranged by the lead manager at targeted in carrying out opinion polls. These services
would useful in collecting data on investors‘ opinion and reactions relating to the public issue of
the company, such a task would help develop an appropriate marketing strategy. This is because,
there are vast numbers of potential investors in semi-urban and rural areas. This calls for
sustained efforts on the part of the company to educate them about the various avenues available
for investment.

7. Brokers‟ and investors‟ conferences :


As part of the issue campaign, the lead manager should arrange for brokers‘ and investors‘
conferences in the metropolitan cities and other important centre which have sufficient investor
population. In order to make such endeavors more successful, advance planning is required . It is
important that conference materials such as banners, brochures, application forms, posters, etc.
reach the conference venue in time. In addition, invitation to all the important people,
underwriters, bankers at the respective places, investors‘associations should also be sent.

Methods:
Following are the various methods being adopted by corporate entities for marketing the
securities in the new issues.

 Pure prospectus method


 Offer for sale method
 private placement method
 Initial public officer(IPO) method
 Rights issue method
 bonus issue method
 book building method
 Stock Option Method and
 Bought-out Deals Method

Pure prospectus method:


The method whereby a corporate enterprise mops up capital funds from the general
public by means of an issue of a prospectus, is called Pure Prospectus Method. It is the most
popular method of making public issue of securities by corporate enterprises.

The features of this method are

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a. Exclusive subscription: Under this method, the new issues of a company are offered for
exclusive subscription of the general public. According to the SEBI norms, a minimum of 49
percent of the total issue at a time is to be offered to public.

b. Issue price: Direct offer is made by the issuing company to the general public to subscribe to
the securities at a staged price. The securities may be issued either at par, of at a discount or at a
premium.

c. Underwriting: Public issue through the ‗pure prospectus method‘ is usually underwritten.
This is to safeguard the interest of the issuer in the event of an unsatisfactory response from the
public.

d. Prospectus:
A document that information relating to the various aspects of the issuing company,
besides other details of the issue is called a Prospectus. The document is circulated to the public.
The general details include the company‘s name and address of the registered office, the names
and addresses of the company‘s promoters, manager, managing director, directors, company
secretary, legal adviser, auditors, bankers, brokers, etc. the date of opening and closing of
subscription list, contents of Articles, the names and addresses of underwriters, the amount
underwritten and the underwriting commission, material details regarding the project, i.e.
Location, plant and machinery, technology, collaboration, performance guarantee, infrastructure
facilities etc. nature of products, marketing set-up, export potentials and obligations, past
performance and future prospects, management‘s perception regarding risk factor, credit rating
obtained from any other recognized rating agency, a statement regarding the fact that the
company will make an application to specified stock exchange(s) for listing its securities and so
on.

ADVANTAGES:

a. Benefits to Investors :

The pure prospectus method of marketing the securities serves as an excellent mode of
disclosure of all the information pertaining to the issue. Besides, it also facilitates satisfactory
compliance with the legal requirements of transparency etc.. It also allows for good publicity for
the issue. The method promotes confidence of investors through transparency and non-
discriminatory basis of allotment. It prevents artificial packing up of prices as the issue is made
public.

b. Benefits to Issuers :

The pure prospectus method is the most popular method among the large issuers. In addition,
it provides for wide diffusion of ownership of securities contributing to reduction in the
concentration of economic and social power.

DRAW BACKS:

a. High Issue Costs :

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A major drawback of this method is that it is an expensive mode of raising funds from the
capital market. Costs of various hues are incurred in mobilizing capital. Such costs as
underwriting expenses, brokerage, administrative costs, publicity costs, legal costs and other
costs are incurred for raising funds. Due to the high cost structure, this type of marketing of
securities is followed only for large issues.

b. Time consuming :
The issue of securities through prospectus takes more time, as it requires the due compliance
with various formalities before an issue could take place. For instance, a lot of work such as
underwriting, etc. should be formalized before the printing and the issue of a prospectus.

OFFER FOR SALE METHOD:


Where the marketing of securities takes place through intermediaries, such as issue
houses, stockbrokers and others, it is a case of Offer for Sale Method. Under this method, the
sale of securities takes place in two stages. Accordingly, in the first stage, the issuer company
makes an en-block sale of securities to intermediaries such as the issue houses and share brokers
at an agreed price. Under the second stage, the securities are re-sold to ultimate investors at a
market-related price. The difference between the purchase price and the issue price constitutes
profit for the intermediaries. The intermediaries are responsible for meeting various expenses
such as underwriting commission, prospectus cost, advertisement expenses, etc. The issue is also
underwritten to ensure total subscription of the issue. The biggest advantage of this method is
that it saves the issuing company the hassles involved in selling the shares to the public directly
through prospectus. This method is, however, expensive for the investor as it involves the offer
of securities by issue houses at very high prices.

9. What are the advantages and disadvantages of private placement?(May/June 2008)

PRIVATE PLACEMENT METHOD:


A method of marketing of securities whereby the issuer makes the offer of sale to
individuals and institutions privately without the issue of a prospectus is known as Private
Placement Method. This is the most popular method gaining momentum in recent times among
the corporate enterprises. Under this method, securities are offered directly to large buyers with
the help of shares brokers. This method works in a manner similar to the Offer for Sale Method
whereby securities are first sold to intermediaries such as issues houses, etc. They are in turn
placed at higher prices to individuals and institutions. Institutional investors play a significant
role in the realm of private placing. The expenses relating to placement are borne by such
investors.

Advantages:
 Less expensive as various types of costs associated with the issue are borne by the issue
houses and other intermediaries.
 Less troublesome for the issuer as there is not much of stock exchange requirements
connecting contents of prospectus and its publicity etc. to be complied with.
 Placement of securities suits the requirements of small companies.
 The method is also resorted to when the stock market is dull and the public response to
the issue is doubtful.

Disadvantages:
 Concentration of securities in a few hands.

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 Creating artificial scarcity for the securities thus jacking up the prices temporarily and
misleading general public.
 Depriving the common investors of an opportunity to subscribe to the issue, thus
affecting their confidence levels.

Initial public offer (ipo) method:


The public issue made by a corporate entity for the first time in its life is called Initial
Public Offer (IPO). Under this method of marketing, securities are issued to successful
applicants on the basis of the orders placed by them, through their brokers. When a company
whose stock is not publicly traded wants to offer that stock to the general public, it takes the
form of Initial Public Offer.

The job of selling the stock is entrusted to a popular intermediary, the underwriter. An
underwriter is invariably an investment banking company. He agrees to pay the issuer a certain
price for a minimum number of shares, and then resells those shares to buyers, who are often the
clients of the underwriting firm.

The underwriters charge a fee for their services. Stocks are issued to the underwriter after
the issue of prospectus which provides details of financial and business information as regards
the issuer. Stocks are then released to the underwriter and the underwriter releases the stock to
the public. The issuer and the underwriting syndicate jointly determine the price of a new issue.
The approximate price listed in the red herring (the preliminary prospectus often with words in
red letters which say this is preliminary and the price is not yet set) may or may not be close to
the final issue price. IPO stock at the release price is usually not available to most of the public.
Good relationship between the broker and the investor is a prerequisite for the stock being
acquired. Full disclosure of all material information in connection with the offering of new
securities must be made as part of the new offerings.

RIGHTS ISSUE METHOD:


Where the shares of an existing company are offered to its existing shareholders, it takes
the form of ‗rights issue‘. Under this method, the existing company issues shares to its existing
shareholders in proportion to the number of shares already held by them.

The relevant guidelines issued by the SEBI in this regard are as follows;
1. Shall be issued only by listed companies
2. Announcement regarding rights issue once made, shall not be withdrawn and where
withdrawn, no security shall be eligible for listing up to 12 months
3. Underwriting as to rights issue is optional and appointment of Registrar is compulsory
4. Appointment of category I Merchant Bankers holding a certificate of registration issued by
SEBI shall be compulsory
5. Rights shares shall be issued only in respect of fully paid shares
6. Letter of Offer shall contain disclosures as per SEBI requirements
7. Agreement shall be entered into with the depository for materialization of securities to be
issued
8. Issue shall be kept open for a minimum period of 30 days and for a maximum period of 60
days
9. A minimum subscription of 90 percent of the issue shall be received
10. No reservation is allowed for rights issue as regards FCDs and PCDs

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11. A no Complaints Certificate is to be filed by the Lead Merchant Banker with the SEBI after
21 days from the date of issue of offer document
12. Obligatory for a company where increase in subscribed capital is necessary after two years of
its formation or after one year of its first issue of shares, whichever is earlier

ADVANTAGES:
Rights issue offers the following advantages :
1. Economy :
Rights issue constitutes the most economical method of raising fresh capital, as it
involves no underwriting and brokerage costs. Further, the expenses by way of advertisement
and administration, etc. are less.
2. Easy :
The issue management procedures connected with the rights issue are easier as only a
limited number of applications are to be handled.
3. Advantage of shareholders:
Issue of rights shares does not involve any dilution of ownership of existing shareholders.
Further, it offers freedom to shareholders to subscribe or not to subscribe the issue.

Drawbacks:
The method suffers from the following limitations:
1. Restrictive:
The facility of rights issue is available only to existing companies and not to new companies.

2. Against society :
The issue of rights shares runs counters to the overall societal considerations of diffusion
of shares ownership for promoting dispersal of wealth and economic power.

BONUS ISSUES METHOD:


Where the accumulated reserves and surplus of profits of a company are converted into
paid up capital, it takes the form of issue of bonus shares. It merely implies capitalization of
exiting reserves and surplus of a company. The issue of bonus shares is subject to certain rules
and regulations. The issue does not in any way affect the resources base of the enterprise. It
saves the company enormously of the hassles of capital issue. Issued under Section 205 (3) of the
Companies Act, such shares are governed by the guidelines issued by the SEBI (applicable to
listed companies only) as follows:

SEBI GUIDELINES:
Following are the guidelines pertaining to the issue of bonus shares by a listed corporate
enterprise:

1. Reservation:
In respect of FCDs and PCDs, bonus shares must be reserved in proportion to such
convertible part of FCDs and PCDs. The shares so reserved may be issued at the time of
conversion(s) of such debentures on the same terms on which the bonus issues were made.

2. Reserves:
The bonus issue shall be made out of free reserves built out of the genuine profits or share
premium collected in cash only. Reserves created by revaluation of fixed assets are not
capitalized.

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3. Dividend mode:
The declaration of bonus issue, in lieu of dividend, is not made
4. Fully paid:
The bonus issue is not made unless the partly paid shares, if any are made fully paid-up.

5. No default:
The company has not defaulted in payment of interest or principal in respect of fixed deposits
and interest on existing debentures or principal on redemption thereof and has sufficient reason
to believe that it has not defaulted in respect of the payment of statutory dues of the employees
such as contribution to provident fund, gratuity, bonus etc.

6. Implementation:
A company that announces its bonus issue after the approval of the Board of Directors must
implement the proposal within a period of 6 months from the date of such approval and shall not
have the option of changing the decision.

7. The articles:
The articles of Association of the company shall contain a provision for capitalization of
reserves, etc. If there is no such provision in the Articles, the company shall pass a resolution at
its general body meeting making provisions in the Articles of Associations for capitalization.

8. Resolution:
Consequent to the issue of bonus shares if the subscribed and paid-up capital exceeds the
authorized share capital, the company at its general body meeting for increasing the authorized
capital shall pass a resolution.

10Explain about the book building process

BOOK BUILDING METHOD:


A method of marketing the shares of a company whereby the quantum and the price of
the securities to be issued will be decided on the basis of the bids received from the prospective
shareholders by the lead merchant bankers is known as boo building method. Under the book-
building method, share prices are determined on the basis of real demand for the shares at
various price levels in the market. For discovering the price at which issue should be made, bids
are invited from prospective investors from which the demand at various price levels is noted.
The merchant bankers undertake full responsibility for the same. The option of book-building is
available to all body corporate, which are otherwise eligible to make an issue of capital to the
public. The initial minimum size of issue through book-building route was fixed at Rs.100
crores. However, beginning from December 9, 1996 issues of any size will be allowed through
the book-building route.

Book-building facility is available as an alternative to firm allotment. Accordingly, a


company can opt for book-building route for the sale of shares to the extent of the percentage of
the issue that can be reserved for firm allotment as per the prevailing SEBI guidelines. It is
therefore possible either to reserve securities for firm allotment or issue them through the book-
building process.

The book-building process involves the following steps:

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BA7022 Merchant Banking and Financial Services

1. Appointment of book-runners:

The first step in the book-building process is the appointment by the issuer company, of the
book-runner, chosen from one of the lead merchant bankers. The book-runner in turn forms a
syndicate for the book-building. A syndicate member should be a member of National Stock
Exchange (NSE) or Over-the-Counter Exchange of India (OTCEI). Offers of ‗bids‘ are to be
made by investors to the syndicate members, who register the demands of investors. The bid
indicates the number of shares demanded and the prices offered. This information, which is
stored in the computer, is accessible to the company management or to the book-runner. The
name of the book-runner is to be mentioned in the draft prospectus submitted to SEBI.

2. Drafting prospectus:
The draft prospectus containing all the information except the information regarding the price
at which the securities are offered is to be filed with SEBI as per the prevailing SEBI guidelines.
The offer of securities through this process must separately be disclosed in the prospectus, under
the caption ‗placement portion category‘. Similarly, the extent of shares offered to the public
shall be separately shown under the caption ‗net offer to the public‘. According to the latest
SEBI guidelines issued in October 1999, the earlier stipulation that at least 25 percent of the
securities were to be issued to the public has been done away with. This is aimed at enabling
companies to offer the entire public issue through the book-building route.

3. Circulating draft prospectus:


A copy of the draft prospectus filed with SEBI is to be circulated by the book-runner to the
prospective institutional buyers who are eligible for firm allotment and also to the intermediaries
who are eligible to act as underwriters. The objective is to invite offers for subscribing to the
securities. The draft prospectus to be circulated must indicate the price band within which the
securities are being offered for subscription.

4. Maintaining offer records:


The book-runner maintains a record of the offers received. Details such as the name and the
number of securities ordered together with the price at which each institutional buyer or
underwriter is willing to sub scribe to securities under the placement portion must find place
in the record. SEBI has the right to inspect such records.

5. Intimation about aggregate orders:


The underwriters and the institutional investors shall give intimation on the aggregate of the
offers received to the book-runner.

6. Bid analysis:
The bid analysis is carried out by the book-runner immediately after the closure of the bid
offer date. An appropriate final price is arrived at after a careful evaluation of demands at various
prices and the quantity. The final price is generally fixed reasonably lower than the possible offer
price. This way, the success of the issue is ensured. The issuer company announce the pay-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 fully underwritten. In

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BA7022 Merchant Banking and Financial Services

case an issue is made through book-building route, it is mandatory that the portion of the issue
offered to the public be underwritten. This is the purpose, an agreement has to be entered into
with the underwriter by the issuer. The agreement shall specify the number of securities as well
as the price at which the underwriter would subscribe to the securities. The book-runner may
require the underwriter of the net offer to the public to pay in advance all moneys required to be
paid in respect of their underwriting commitment.

8. Filling with ROC:


A copy of the prospectus as certified by the SEBI shall be filed with the Registrar of
Companies within two days of the receipt of the acknowledgement card from the SEBI.

9. Bank accounts:
The issuer company has to open two separate accounts for collection of application money,
one for the private placement portion and the other for the public subscription.

10. Collection of completed applications:


The book-runner collects from the institutional buyers and the underwriters the application
forms along with the application money to the extent of the securities proposed to be allotted to
them or subscribed by them. This is to be done one day before the opening of the issue to the
public.

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

Stock option of employees stock option scheme (esop):


A method of marketing the securities of a company whereby its employees are
encouraged to take up shares and subscribe to it is knows as stock option. It is a voluntary
scheme on the part of the company to encourage employees‘participation in the company. The
scheme also offers an incentive to the employees to stay in the company. The scheme is
particularly useful in the case of companies whose business activity is dominantly based on the
talent of the employees, as in the case of software industry. The scheme helps retain their most
productive employees in an industry, which is known for its constant churning of personnel.

SEBI Guidelines:
Company whose securities are listed on any stock exchange can introduce the scheme of
employees‘stock option.

The offer can be made subject to the conditions specified below:


1. Issue at discount:
Issue of stock option at a discount to the market price would be regarded as another form of
employee compensation and would be treated as such in the financial statements of the company
regardless the quantum of discount on the exercise price of the options.

2. Approval:

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BA7022 Merchant Banking and Financial Services

The issue of ESOPs is subject to the approval by the shareholders through a special
resolution.

3. Maximum limit:
There would be no restriction on the maximum number of shares to be issued to a single
employee. However, in case of employees being offered more than 1 percent shares, a specific
disclosure and approval would be necessary in the AGM.

4. Minimum period:

A minimum period of one year between grant of options and its vesting has been
prescribed. After one year, the company would determine the period during which the option can
be exercised.

5. Superintendence:
The operation of the ESOP Scheme would have to be under the superintendence and
direction of a Compensation Committee of the Board of Directors in which there would be a
majority of independent directors.

6. Eligibility:
ESOP scheme is open to all permanent employees and to the directors of the company
but not to promoters and large shareholders. The scheme would be applicable to the employees
of the subsidiary or a holding company with the express approval of the shareholders.

Bought out deals:


A method of marketing of securities of a body corporate whereby the promoters of an
unlisted company make an outright sale of a chunk of equity shares to a single sponsor or the
lead sponsor is known as bought-out deals.

The following are the characteristics of Bought out deals:


1. Parties :
There are three parties involved in the bought-out deals. They are promoters of the company,
sponsors and co-sponsors who are generally merchant bankers and investors.

2. Outright sale :
Under this arrangement, there is an outright sale of a chunk of equity shares to a single
sponsor or the lead sponsor.

3. Syndicate :
Sponsor forms syndicate with other merchant bankers for meeting the resource
requirements and for distributing the risk.

4. Sale price :
The s ale price is finalized through negotiations between the issuing company and the
purchaser, the sale being influenced by such factors as project evaluation, promoters image and
reputation, current market sentiments, prospects of off-loading these shares at a future date, etc.

5. Fund-based :

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Bought-out deals are in the nature of fund-based activity where the funds of the merchant
bankers get locked in for at least the prescribed minimum period.

6. Listing :
The investor-sponsors make a profit, when at a future date, the shares get listed and
higher prices prevail. Listing generally takes place at a time when the company is performing
well in terms of higher profits and larger cash generations from projects.

7. OTCEI :
Sale of these shares at Over-the-Counter Exchange of India (OTCEI) or at a recognized
stock exchanges, the time of listing these securities and off loading them simultaneously are
being generally decided in advance.

Bought out deals vs. Private placements benefits:


Bought-out deals provide the following benefits:

1. Speedy sale: Bought-out deals offer a mechanism for a speedier sale of securities at
lower costs relating to the issue.

2. Freedom :Bought-out deals offer freedom for promoters to set a realistic price and
convince the sponsor about the same.
3. Investor protection :Bought-out deals facilities better investor protection as sponsors are
rigorously evaluated and appraised by the promoters before offloading the issue.

4. Quality offer :Bought-out deals help enhance the quality of capital floatation and primary
market offerings.

Limitations:
Bought-out deals pose the following difficulties for the promoters, sponsors and investors:

1. Loss of control :
The apprehensions in the minds of promoters, particularly of the private or the closely held
companies that the sponsors may control the company as they own large chunk of the shares of
the company.
2. Loss of sales: Bought-out deals pose considerable difficulties in off-loading the shares in
times of unfavorable market conditions. This results in locking up of investments and entailing
losses to sponsors.
3. Wrong appraisal :
Bought-out deals cause loss to sponsors on account of wrong appraisal of the project and
overestimation of the potential price of the share.

4. Manipulation :
Bought-out deals give great scope for manipulation at the hands of the sponsor through
insider trading and rigging.

5. No accountability :
Bought-out deals pose difficulty of penalizing the sponsor as there are no SEBI
guidelines to regulate offerings by sponsors.

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BA7022 Merchant Banking and Financial Services

6. Windfall profits :
Bought-out deals offer the advantage of windfall profits by sponsors at the cost of small
investors.

9. What are the advantages and disadvantages of private placement?

ADVANTAGES:
 Less expensive as various types of costs associated with the issue are borne by the issue
houses and other intermediaries.
 Less troublesome for the issuer as there is not much of stock exchange requirements
connecting contents of prospectus and its publicity etc. to be complied with.
 Placement of securities suits the requirements of small companies.
 The method is also resorted to when the stock market is dull and the public response to
the issue is doubtful.

DISADVANTAGES:
 Concentration of securities in a few hands.
 Creating artificial scarcity for the securities thus jacking up the prices temporarily and
misleading general public.
 Depriving the common investors of an opportunity to subscribe to the issue, thus
affecting their confidence levels.
10. Elaborate on the pre-issue activities involved in the management of public price.
(May/June 2008)

Activities involved in public issue management:

There are several activities that have to be performed by the issue manager in order to
raise money from the capital market. Adequate planning needs to be done while chalking out an
appropriate marketing. An analytical study of various sources, the quantum, the appropriate time,
the cost of raising capital and the possible impact of such resources of the overall capital
structure will greatly help this task. The various activities involved in raising funds from the
capital markets are described below:

Pre-Issue Activities:

1. Signing of MoU: Signing of MoU between the client company and the merchant banker-issue
management activities marks the award of the contract. The role and responsibility of the
merchant banker as against the issuing company are clearly spelt out in the MoU.

2. Obtaining appraisal note:

An appraisal note containing he details of the proposed capital outlay of the project and
the sources of funding is either prepared in-house or is obtained from external appraising
agencies viz., financial institutions/banks etc. A project may be funded either by borrowing
money from outside agencies or by injecting capital.

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3. Optimum capital structure:

The level of capital that would maximize the shareholders value and minimize the overall
cost of capital has to be determined. This has to be done considering the nature and size of the
project. Equity funding is preferable especially when the project is capital intensive.

4. Convening meeting:

A meeting of the board of directors of the issuing company is convened. This is followed
by an EGM of its members. The purpose of these meetings is to decide the various aspects
related to the issue of securities. An application to RBI, seeking its permission is made, where
capital issue of shares is to be offered to NRIs/OCBs or FIIs.

5. Appointment financial Intermediary:

Financial intermediaries such as Underwriters, Registrars, etc. have to be appointed.


Necessary contracts need to be made with the underwriter to ensure due subscription to offer.
Similar contracts when entered into with the Registrars to an issue, will help in share allotment
related work, appointment of bankers to an issue for handling the collection of applications at
various centers, printers for bulk printing of Issue related stationery, legal advisors and
advertising agency. Simultaneously consents from various experts such as auditors, solicitors,
legal advisors etc has to be obtained under Section 58 of the Companies Act, 1956.

6. Preparing documents:

As part of the issue management procedure the documents to be prepared are initial
applications of submission to those stock exchanges where the issuing company intends to get its
securities listed. MoU with the registrar, with bankers to the issue, with advisors to the issue and
co-managers to the issue, agreement for purchase of properties etc. This has to be sent for
inclusion in the prospectus.

7. Due diligence certificate: T

he lead manager issue a due diligence certificate which certifies that the company has
scrupulously followed all legal requirements has exercised utmost care while preparing the offer
document and has made a true fair and adequate disclosures in the draft offer document.
8. Submission of offer document:

The draft offer document along with the due diligence certificate is filed with SEBI. The
SEBI in turn makes necessary corrections in the offer document and returns the same with
relevant observations, if any within 21 days from the receipt of the offer document.

9. Finalization of collection centers:

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BA7022 Merchant Banking and Financial Services

In order to collect the issue application forms from the prospective investors to lead
manager finalizes the collection centers.
10. Filing with RoC:

The offer document completed in all respects after incorporating SEBI observation is filed with
Registrar of Companies (RoC) to obtain acknowledgement.

11. Launching the issue:

The process of marketing the issue starts once legal formalities are completed and
statutory permission for issue of capital is obtained. The lead manager has to arrange for the
distribution of public issue stationary to various collecting banks, brokers, investors etc. The
issue is opened for public immediately after obtaining the observation letter from SEBI which is
valid for a period of 365 days from the date of issue. Conducting press conferences, brokers’
meets, issuing advertisements in various newspapers and mobilizing brokers and sub-brokers
marks the launching of a public issue. The announcement regarding opening of issue is also
required to be made through advertising in newspapers, 10 days before the opening of the public
issue.

12. Promoters’ contribution:

A certificate to the effect that the required contribution of the promoters has been raised
before opening the issue, has to be obtained from a Chartered Accountant, and duly filed with
SEBI.

13. Issue closure:

An announcement regarding the closure of the issue should be made in the newspaper.

11. What are the main post-issue activity/activities relating to the issue(s) of capital through
prospectus?
Post- issue Monitoring Reports
Irrespective of the level of subscription, the post-issue Lead Merchant Banker shall
ensure the submission of the post-issue monitoring reports as per formats specified in Schedule
XVI. These reports shall be submitted within 3 working days from the due dates.
Public Issues
(a) 3-Day Post Issue Monitoring Report
The due date for this report shall be the 3rd day from the date of closure of subscription of the
issue.
(b) 78-Day Post Issue Monitoring Report
The due date for this report shall be the 78th day from the date of closure of subscription of the
issue.
Rights Issues

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(a) 3-Day Post-Issue Monitoring Report


The due date for this report shall be the 3rd day from the date of closure of subscription of the
issue.
(b) 50-Day Post-Issue Monitoring Report
The due date for this report shall be the 50th day from the date of closure of subscription of the
issue.
Redressal of Investor Grievances
The Post -issue Lead Merchant Banker shall actively associate himself with post-issue activities
namely, allotment, refund and despatch and shall regularly monitor redressal of investor
grievances arising there from.
Co-ordination with Intermediaries
(i) The Post-issue lead merchant banker shall maintain close co-ordination with the Registrars to
the Issue and arrange to depute its officers to the offices of various intermediaries at regular
intervals after the closure of the issue to monitor the flow of applications from collecting bank
branches, processing of the applications including those accompanied by stock invest and other
matters till the basis of allotment is finalised, despatch security certificates and refund orders
completed and securities listed.

(ii) Any act of omission or commission on the part of any of the intermediaries noticed during
such visits shall be duly reported to the Board.
Stock Invest
The lead merchant banker shall ensure compliance with the instructions issued by the
RBI on handling of stock invest by any person including Registrars.
Underwriters
a) i) If the issue is proposed to be closed at the earliest closing date, the lead Merchant Banker
shall satisfy himself that the issue is fully subscribed before announcing closure of the issue.
ii) In case, there is no definite information about subscription figures, the issue shall be kept open
for the required number of days to take care of the underwriters' interests and to avoid any
dispute, at a later date, by the underwriters in respect of their liability.
b) In case there is a devolvement on underwriters, the lead Merchant Banker shall ensure that the
underwriters honour their commitments within 60 days from the date of closure of the issue.
c) In case of undersubscribed issues, the lead merchant banker shall furnish information in
respect of underwriters who have failed to meet their underwriting devolvement’s to the Board in
the format specified at Schedule - XVII.
Bankers to an issue

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The post-issue Lead Merchant Banker shall ensure that moneys received pursuant to the
issue and kept in a separate bank (i.e. Bankers to an Issue), as per the provisions of section 73(3)
of the Companies Act 1956, is released by the said bank only after the listing permission under
the said Section has been obtained from all the stock exchanges where the securities was
proposed to be listed as per the offer document.
Post-issue Advertisements
Post-issue Lead Merchant Banker shall ensure that in all issues, advertisement giving
details relating to oversubscription, basis of allotment, number, value and percentage of
applications received along with stock invest, number, value and percentage of successful
allottees who have applied through stock invest, date of completion of despatch of refund orders,
date of despatch of certificates and date of filing of listing application is released within 10 days
from the date of completion of the various activities at least in an English National Daily with
wide circulation, one Hindi National Paper and a Regional language daily circulated at the place
where registered office of the issuer company is situated.
Post-issue Lead Merchant Banker shall ensure that issuer company / advisors / brokers or any
other agencies connected with the issue do not publish any advertisement stating that issue has
been oversubscribed or indicating investors’ response to the issue, during the period when the
public issue is still open for subscription by the public.
Advertisement stating that "the subscription to the issue has been closed" may be issued after the
actual closure of the issue.
Other Responsibilities
Lead Merchant Banker shall ensure payment of interest to the applicants for delayed dispatch of
allotment letters, refund orders, etc. as prescribed in the offer document.
The Post-issue Lead Merchant Banker shall ensure that the despatch of refund orders / allotment
letters /share certificates is done by way of registered post / certificate of posting as may be
applicable.
In case of all issues, advertisement giving details relating to oversubscription, basis of allotment,
number, value and percentage of applications received along with stock invest, number, value
and percentage of successful allottees who have applied through stock invest, date of completion
of despatch of refund orders, date of despatch of certificates and date of filing of listing
application.
Such advertisement shall be released within 10 days from the date of completion of the various
activities.
Post-issue Lead merchant banker shall continue to be responsible for post issue activities till the
subscribers have received the shares/debenture certificates or refund of application moneys and
the listing agreement is entered into by the issuer company with the stock exchange and listing/
trading permission is obtained.
Certificate Regarding Realization of Stock invests

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BA7022 Merchant Banking and Financial Services

The Post -Issue Lead Merchant Banker shall submit within two weeks from the date of allotment,
a Certificate to the Board certifying that the stock invests on the basis of which allotment was
finalised, have been realized.
Anna university questions

PART-A
1. What is green shoe option?(April/May 2012, May/June 2008, Nov/Dec 2010, (May/June
2013)
2. Define the term ‘prospectus’.(May/June 2008) ,(Nov/Dec 2012)
3. What is management buyout?(May/June 2012)
4. What is book building? (Nov/Dec 2010, May/June 2013)
5. What is private placement? (Nov/Dec 2012)
6. What is conglomerate merger? (Nov/Dec 2012)
7. Write a note on credit syndication. (Nov/Dec 2012, (May/June 2013)
8. What is the role of Merchant Banker in Appraisal of Projects? (May/June 2014)
9. Write short notes on “Bought out Deals”. (May/June 2014)
10. What is book building? (Nov/Dec 2013)
11. Give an example for ‘Green shoe option’. (Nov/Dec 2013)
12. What is credit syndication? (Nov/Dec 2013)

PART-B

1. Elaborate on the pre-issue activities involved in the management of public price.(May/June


2008)
2. What are the advantages and disadvantages of private placement?(May/June 2008)
3. What are the main post-issue activity/activities relating to the issue(s) of capital through
prospectus?
4. Explain the role of merchant bankers in project counselling.
5. Discuss the factors that influence the capital structure decision of a firm
6. Explain the various methods of marketing the securities adopted by the Indian Corporate
entities.
7. Narrate the regulatory frame work meant for issue management. (Nov/Dec 2013)
8. Explain the code of conduct prescribed by SEBI for stock brokers. Discuss the functions of
registrars and transfer agents. (Nov/Dec 2013)
9. What are the activities connected with “Issue Management and Underwriting” of Merchant
Bankers? Explain. (May/June 2014)
10. Discuss the Role of Merchant banker in the appraisal of projects. (May/June 2014)

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

UNIT III- OTHER FEE BASED SERVICES

Mergers and Acquisitions –Portfolio Management Services –Credit Syndication –Credit Rating –
Mutual Funds -Business Valuation.

PART-A

1. What is merger?
A type of business combination where two or more firms amalgamate into one single
firm is known as a merger.
2. What is acquisition?
An acquisition is the purchase of one company by another company.
3. What are steps of mergers and acquisitions?
 Review of Objectives
 Data for analysis
 Analysis of information
 Fixing price
 Finding merger value
4. What are the types of mergers?
 Horizontal merger
 Vertical merger
 Diagonal merger
 Forward merger
 Reverse merger
 Conglomerate merger
 Negotiated merger
 Arranged merger
5. Define reverse merger. (Nov/Dec 2010)
In a reverse merger, the shareholders of the acquiring company exchange their shares for
shares of the target company. It is a case of the acquiring company merging into the target
company. Where a prosperous and profit making company acquires a loss-making sick
company with substantial erosion in its net worth, it is a case of ‘reverse merger’.
6. What is conglomerate merger? (Nov/Dec 20110029 (May/June 2013), (Nov/Dec 2012)
Where several firms engaged in unrelated lines of business activity combine together to
form a new company, it takes the form of ‘conglomerate merger’.
7. What is portfolio management?( Nov/Dec 2010) (Nov/Dec 2011)
Portfolio management is a process encompassing many activities of investment in assets
and securities.

8. How ‘portfolio manager’ does call under SEBI?


According to SEBI, ’portfolio manager means any person who pursuant to a contract or
arrangement with a client, advises or directs or undertakes on behalf of the client the
management or administration of a portfolio of securities or the funds of the client.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

9. What is credit syndication? (Nov/Dec 2012)


It is the alternative term for syndicated loan. It is the process of involving numerous
different lenders in providing various portions of a loan.
10. What are the types of syndicated loans?
 Loans for setting up new projects
 Loans for expansion, modernization, diversification, rehabilitation of projects
 Participatory loans
 Loans for making investment in corporate securities
 Consortium loans
 Refinancing loans(IDBI)
 Rediscounting loans(IDBI)
11. What is credit rating? (MAY/JUNE 2012.)
A credit rating is also known as an evaluation of a potential borrower’s ability to repay
debt, prepared by a credit bureau at the request of the lender.

12. What is credit rating agency?


A credit rating agency is a company that assigns credit ratings for issuers of certain types
of debt obligations as well as the debt instruments themselves.
13. What are the features / characteristics of credit rating?
 Specificity
 Relativity
 Guidance
 Not a recommendation
 Broad parameters
 No guarantee
 Quantitative and qualitative
14. What are the advantages of credit rating?
 Information service
 Systematic risk evaluation
 Professional competency
 Easy to understand
 Low cost
 Efficient portfolio management
 Other benefits

15. Define mutual fund.


Mutual funds are associations or trusts of public members who wish to make investment
in the financial instrument or assets of the business sector or corporate sector for the mutual
benefit of its members.
16. What is mutual fund? (May/June 2013)

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BA7022 Merchant Banking and Financial Services

An investment vehicle that is made up of a pool of funds collected from many investors
for the purpose of investing in securities such as stocks, bonds, money market instruments
and similar assets.
17. What are the disadvantages of credit rating?
 Guidance, not recommendation
 Based on assumption
 Competitive ratings
18. How does a mutual fund operate?
A mutual fund is a company that pools money from investors. It takes this money and
invests it in a variety of stocks, bonds, and short term money market investments. Each fund
has operating rules put in place to help define what sort of he fund can make. For example, a
mutual fund that emphasizes buying bonds will not purchase many (or any) stocks.
19. What is Sensex? (APRIL/MIAY 2010)

BSE SENSEX (Bombay Stock Exchange Sensitive Index), also-called the BSE 30 or simply
the SENSEX, is a free-float market-weighted stock market index of 30 well-established and
financially sound companies listed on Bombay Stock Exchange.
20. How is NAV computed? ( APRIL/MAY 2011)

NET ASSETS VALUE It is a parameter used to measure the operational efficiency of


mutual funds. The intrinsic value of a unit under a particular scheme is referred to as the
NAV of the scheme. The value gives an idea of the amount that may be obtained by the unit
holder on its sale to the mutual fund company.
21. List the services rendered by Portfolio Managers. ( APRIL/MAY 2011)

SEBI regulations provide that the portfolio manager shall charge a fee as per the agreement with
the client for rendering portfolio management services. The fee so charged may be a fixed
amount or a return based fee or a combination of both. The portfolio manager shall take specific
prior permission from the client for charging such fees for each activity for which service is
rendered by the portfolio manager directly or indirectly (where such service is outsourced).

A portfolio manager is either a person who makes investment decisions using money other
people have placed under his or her control or a person who manages a financial institution's
asset and liability (loan and deposit) portfolios.

22. What is management buyout? (MAY/JUNE 2012.)

A management buyout (MBO) is a transaction where a company's managers obtain debt and/or
equity financing to purchase the same company's assets and operations that they are responsible
for managing. Investors and bankers are open to management buyouts because the managers are
intimately familiar with the operations, and they can create value by continuing on in the
business.

23. Name any four 'credit rating agencies' functioning in India. (Nov/Dec 2013)

 CRISIL Limited
 Fitch Ratings India Private Ltd.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

 ICRA Limited
 Credit Analysis & Research Ltd. (CARE)
 Brickwork Ratings India Private Limited
 SME Rating Agency of India Ltd. (SMERA)

PART-B
1. Discuss the legal process relating to approval of merger. (Nov/Dec 2012), (Nov/Dec 2011)

Legal Procedure for Bringing About Merger Of Companies:

(1) Examination of object clauses:

The MOA of both the companies should be examined to check the power to amalgamate
is available. Further, the object clause of the merging company should permit it to carry on the
business of the merged company. If such clauses do not exist, necessary approvals of the share
holders, board of directors, and company law board are required.
(2) Intimation to stock exchanges:

The stock exchanges where merging and merged companies are listed should be informed
about the merger proposal. From time to time, copies of all notices, resolutions, and orders
should be mailed to the concerned stock exchanges.

(3) Approval of the draft merger proposal by the respective boards:

The draft merger proposal should be approved by the respective BOD’s. The board of
each company should pass a resolution authorizing its directors/executives to pursue the matter
further.

(4) Application to high courts:

Once the drafts of merger proposal is approved by the respective boards, each company
should make an application to the high court of the state where its registered office is situated so
that it can convene the meetings of share holders and creditors for passing the merger proposal.

(5) Dispatch of notice to share holders and creditors:


In order to convene the meetings of share holders and creditors, a notice and an
explanatory statement of the meeting, as approved by the high court, should be dispatched by
each company to its shareholders and creditors so that they get 21 days advance intimation. The
notice of the meetings should also be published in two news papers.

(6) Holding of meetings of share holders and creditors:

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BA7022 Merchant Banking and Financial Services

A meeting of share holders should be held by each company for passing the scheme of
mergers at least 75% of shareholders who vote either in person or by proxy must approve the
scheme of merger. Same applies to creditors also.

(7) Petition to High Court for confirmation and passing of HC orders:


Once the mergers scheme is passed by the share holders and creditors, the companies
involved in the merger should present a petition to the HC for confirming the scheme of merger.
A notice about the same has to be published in 2 newspapers.

(8) Filing the order with the registrar:


Certified true copies of the high court order must be filed with the registrar of companies
within the time limit specified by the court.

(9) Transfer of assets and liabilities:

After the final orders have been passed by both the HC’s, all the assets and liabilities of
the merged company will have to be transferred to the merging company.

(10) Issue of shares and debentures:


The merging company, after fulfilling the provisions of the law, should issue shares and
debentures of the merging company. The new shares and debentures so issued will then be listed
on the stock exchange.

2. Discuss the important forces of M & A in modern scenario. (May/June 2013)

Following are the important forces of M& A:


1. Healthy corporate balance sheets
2. Low interest rates with inexpensive refinancing opportunities
3. Marginal growth

Healthy corporate balance sheets


Global companies (excluding financial service providers), especially US ones, seem to have
dramatically scaled back their investments as a result of the financial crisis, thereby cutting their
costs. As a result, their capital gearing ratios – the ratio of net debt to earnings before interest,
tax, depreciation and amortization (EBITDA) – have been trending towards a long-term low.

The challenge: A low-interest-rate environment


It is almost logical for corporate management to now turn its thoughts back to how they can use
their free cash flow. After all, the current low-interest-rate environment equates to negative real
returns in some cases, making cash an unattractive option in terms of yield. For companies, two
options seem to stand out among a sea of possibilities:+

1. Increased investment activity: The uncertainty about further economic growth seems to be

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

Increasingly giving way to wider-spread optimism. According to various preliminary indicators,


companies seem to be taking a more optimistic view of the future, prompting them to be more
willing to step up their investment activity. In fact, capital expenditures (“capex”) has recently
reached a new all-time high in the US and emerging countries.

2. Increased M&A activity: Companies with a high free cash flow could increasingly look for
M&A opportunities. A look at the number of mergers and acquisitions announced in the
corporate sector in the first quarter of 2013 indicates that many corporate decision makers will
likely focus on M&A activities in the months to come. Whether it is increased investment
activity or M&A activity, both options seem likely to profit from companies’ increasingly
opportune refinancing conditions. Not only have interest charges improved in relation to revenue
over the past few years (from some 2.5 % of revenue around the year 2000 to 1.7 % of revenue
today), the improvement in balance- sheet structure has made it easier for companies to take out
loans, as evidenced by the returns on US corporate bonds.

3. Discuss the important forces of M & A in modern scenario. (May/June 2013)


Short-run factors:

One of the major short run factors that sparked The Great Merger Movement was the desire to
keep prices high. However, high prices attracted the entry of new firms into the industry who
sought to take a piece of the total product. With many firms in a market, supply of the product
remains high.

A major catalyst behind the Great Merger Movement was the Panic of 1893, which led to a
major decline in demand for many homogeneous goods. For producers of homogeneous goods,
when demand falls, these producers have more of an incentive to maintain output and cut prices,
in order to spread out the high fixed costs these producers faced (i.e. lowering cost per unit) and
the desire to exploit efficiencies of maximum volume production. However, during the Panic of
1893, the fall in demand led to a steep fall in prices.

However, also being in a high fixed costs industry, these costs can be spread out through greater
production (i.e. Higher quantity produced). To return to the quasi-monopoly model, in order for a
firm to earn profit, firms would steal part of another firm’s market share by dropping their price
slightly and producing to the point where higher quantity and lower price exceeded their average
total cost. As other firms joined this practice, prices began falling everywhere and a price war
ensued.

One strategy to keep prices high and to maintain profitability was for producers of the same good
to collude with each other and form associations, also known as These cartels were thus able to
raise prices right away, sometimes more than doubling prices. However, these prices set by
cartels only provided a short-term solution because cartel members would cheat on each other by
setting a lower price than the price set by the cartel.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

Also, the high price set by the cartel would encourage new firms to enter the industry and offer
competitive pricing, causing prices to fall once again. As a result, these cartels did not succeed in
maintaining high prices for a period of no more than a few years. The most viable solution to this
problem was for firms to merge, through with other top firms in the market in order to control a
large market share and thus successfully set a higher price.

Long-run factors

In the long run, due to desire to keep costs low, it was advantageous for firms to merge and
reduce their transportation costs thus producing and transporting from one location rather than
various sites of different companies as in the past.

Low transport costs, coupled with economies of scale also increased firm size by two- to fourfold
during the second half of the nineteenth century. In addition, technological changes prior to the
merger movement within companies increased the efficient size of plants with capital intensive
assembly lines allowing for economies of scale.

Thus improved technology and transportation were forerunners to the Great Merger Movement.
In part due to competitors as mentioned above, and in part due to the government, however,
many of these initially successful mergers were eventually dismantled.

The U.S. government passed the in 1890, setting rules against and monopolies. Starting in the
1890s with such cases as, the courts attacked large companies for strategizing with others or
within their own companies to maximize profits. Price fixing with competitors created a greater
incentive for companies to unite and merge under one name so that they were not competitors
anymore and technically not price fixing.

4. Outline the procedure related to the registration of portfolio managers under the SEBI
regulation 1993. (MAY/JUNE 2012.)

REGISTRATION OF PORTFOLIO MANAGERS:

Application for grant of certificate:

(1) An application by a portfolio manager for grant of a certificate shall be made to the Board
in Form A.

(2) Notwithstanding anything contained in sub-regulation (1), any application made by a


portfolio manager prior to coming into force of these regulations containing such particulars or
as near thereto as mentioned in Form A shall be treated as an application made in pursuance of
sub-regulation (1) and dealt with accordingly.

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

Application to conform to the requirements:

Subject to the provisions of sub-regulation (2) of Regulation 3, any application, which is


not complete in all respects and does not conform to the instructions specified in the form, shall
be rejected:

Provided that before rejecting any such application, the applicant shall be given an
opportunity to remove within the time specified such objections as may be indicated by the
Board.

Furnishing of further information, clarification, and personal representation:

(1) The Board may require the applicant to furnish further information or clarification regarding
matters relevant to his activity of a portfolio manager for the purposes of disposal of the
application.

(2) The applicant or, its principal officer shall, if so required, appear before the Board for
personal representation.

Consideration of application:

(1) For considering the grant of certificate of registration to the applicant, the Board shall take
into account all matters which it deems relevant to the activities relating to portfolio
management.

(2) Without prejudice to the generality of the foregoing provisions, the Board shall consider
whether -

a) The applicant is a body corporate;

(b) The applicant has the necessary infrastructure like adequate office space, equipments and the
manpower to effectively discharge the activities of a portfolio manager;

(c) The principal officer of the applicant has the professional qualifications in finance, law,
accountancy or business management from an institution recognized by the Government;

(d) the applicant has in its employment minimum of two persons who, between them, have
atleast five years experience as portfolio manager or stock broker or investment manager or in
the areas related to fund management;

(e) Any previous application for grant of certificate made by any person directly or indirectly
connected with the applicant has been rejected by the Board;

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BA7022 Merchant Banking and Financial Services

(f) Any disciplinary action has been taken by the Board against a person directly or indirectly
connected with the applicant under the Act or the Rules or the Regulations made there under;

Explanation - For the purposes of sub-clauses (e) and (f), the expression " person directly or
indirectly connected" means any person being an associate, subsidiary, inter connected company
or a company under the same management within the meaning of section 370(1B) of the
Companies Act,1956 or in the same group;

(g) The applicant fulfills the capital adequacy requirements specified in regulation 7;

(h) the applicant, its director, principal officer or the employee as specified in clause (d) is
involved in any litigation connected with the securities market which has an adverse bearing on
the business of the applicant;

(i) the applicant, its director, principal officer or the employee as specified in clause (d) has at
any time been convicted for any offence involving moral turpitude or has been found guilty of
any economic offence;

(j) The applicant is a fit and proper person;

(k) Grant of certificate to the applicant is in the interests of investors.

Capital Adequacy Requirement:

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BA7022 Merchant Banking and Financial Services

The capital adequacy requirement referred to in clause (g) of regulation 6 shall not be less than the net worth of fifty
lacks rupees;Explanation: For the purposes of this regulation, "networth" means the aggregate value of paid up equity capital
plus free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulate d losses and
deferred expenditure not written off, including miscellaneous expenses not written off.
Procedure for registration:
The Board on being satisfied that the applicant fulfils the requirements specified in Regulation 6 shall send intimation
to the applicant and on receipt of the payment of fees as specified in Schedule II then grant a certificate in Form B.
Renewal of certificate:
(1) A portfolio manager may, three months before the expiry of the validity of the certificate, make an application for ren ewal in
Form A.
(2) The application for renewal, under sub-Regulation (1) shall be dealt with in the same manner as if it were an application for
grant of a certificate made under Regulation 3.
(3) The Board on being satisfied that the applicant fulfils the requirements specified in Regulation 6 for renewal of certificate
shall grant a certificate in Form B and send intimation to the applicant.
Procedure where registration is not granted
(1) Where an application for grant of a certificate under Regulation 3 or of renewal under Regulation 9 does not satisfy the
requirements set out in Regulation 6, the Board may reject the application, after giving an opportunity of being heard.
(2) The refusal to grant registration shall be communicated by the Board within thirty days of such refusal to the applicant
stating therein the grounds on which the application has been rejected.
(3) Any applicant may, being aggrieved by the decision of the Board under sub-regulation (1), apply within a period of thirty days
from the date of receipt of such intimation, to the Board for reconsideration of its decision.
(4) The Board shall reconsider an application made under sub- Regulation (3) and communicate its decision as soon as possible
in writing to the applicant.
Effect of refusal to grant certificate:
Any portfolio manager whose application for a certificate has been refused by the Board shall on and from the date of
the receipt of the communication under sub-Regulation (2) of Regulation 10 cease to carry on any activity as portfolio manager.
Payment of fees, and the Consequences of failure to pay fees:
(1) Every applicant eligible for grant of a certificate shall pay fees in such manner and within the period specified in Schedule II.
(2) Where a portfolio manager fails to pay the fees as provided Schedule II, the Board may suspend the certificate, whereupon
the Portfolio Manager shall forthwith cease to carry on the activity as a portfolio manager for the period during which the
suspension subsists.

5. What is credit rating? What functions does it provide? Why do companies go for rating
their security? What benefits do the investors get form CR? (Nov/Dec 2010)

A credit rating is also known as an evaluation of a potential borrower’s ability to repay


debt, prepared by a credit bureau at the request of the lender.
CREDIT RATING OF INDIVIDUALS, COMPANIES AND COUNTRIES:

Credit rating is resorted to : a) Companies b) Individuals c) Countries

a) RATING OF INDIVIDUALS :
Individuals go for credit rating when they want to borrow from recognized institutions. In
India, we have Onida Individual Credit Rating Agency (ONICRA) which gives credit rating
for individuals.
b) RATING OF COMPANIES:

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

As per the guidelines of SEBI and RBI, companies have to resort to credit rating when they :
(i) accept public deposits (ii) issue credit instruments in domestic market (iii) issue credit
instruments in overseas market.

c) RATING OF COUNTRIES:
Credit rating is resorted to by countries for borrowing in international market or for
attracting foreign investments or for raising funds from the international institutions like IMF
and IBRD.
BASIS OF CREDIT RATING:
Various aspects are taken into account by a credit rating agency when a borrowing
company applies for rating. They are:
a. Business Analysis
b. Evaluation of industrial risks
c. Market position of the company within the industry
d. Operating efficiency of the company
e. Legal position in terms of prospectus
f. Financial analysis based on accounting quality
g. Statement of profits
h. Earnings protection
i. Cash flow and their adequacy
j. Financial flexibility
k. Track record of management
l. Capacity to overcome adverse situations
m. Goals philosophy and strategy
n. Labor turnover
o. Regulatory and competitive environment
p. Asset quality
q. Financial position-interest/tax sensitivity

FUNCTIONS OF CREDIT RATING AGENCIES:


· Superior information
· Low cost information
· Basis for proper risk, return & Trade off
· Healthy discipline on corporate borrowers
· Formulation of public policy guidelines on Institutional investment.

BENEFITS:
Benefits to Investors:
· Safeguard against bankruptcy
· Recognition of risk
· Credibility of issuer
· Easy understandability of investment proposal
· Saving of resource
· Independent of investment decision
· Choice of investments
· Benefits of rating surveillance
Benefits of Rating to Company:
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BA7022 Merchant Banking and Financial Services

· Lower cost of borrowing


· Wider audience for borrowing
· Rating as marketing tool
· Reduction of cost in public issues
· Motivation for growth
· Unknown issuer recognition
· Benefits to brokers and financial intermediaries

For Brokers and financial intermediaries:


· Saves time, money, energy, and manpower in convincing their clients about
investments.

CREDIT RATING COMPANIES IN INDIA:

Credit rating companies were started in India during the late 1980s. Credit Rating
Information Services of India Ltd (CRISIL) was started in 1988 as a subsidiary of ICICI.
Information and Credit Rating Services Ltd., (ICRA) was started in 1990, which is a subsidiary
of IDBI. In 993, Credit Analysis and Research Ltd. (CARE) were started. 8. The suffix of +
(plus) or - (minus) signs are used with the rating symbols to indicate the comparative position of
the instrument within the group covered by the symbol.

6. Discuss the rating methodology used by rating companies for manufacturing and finance
companies. (APRIL/MAY 2011)

RATING METHODOLOGY FOR MANUFACTURING COMPANIES:

Credit analysis of an entity begins with a review of the Economy/Industry in which the
entity operates along with an assessment of the business risk factors specific to the entity.
This is followed by an assessment of the financial risk factors and quality of management
of the entity. The degree of financial risk exposure of the entity within the overall context of the
business risk together with the evaluation of the entity management forms the basis for arriving
at the rating level.

ECONOMY AND INDUSTRY RISK ANALYSIS:

CARE’s analysis of industry risk focuses on the prospects of the industry and the
competitive factors affecting the industry. The economic/industry environment is assessed to
determine the degree of operating risk faced by the entity in a given business. Investment plans
of the major players in the industry, demand-supply factors, price trends, changes in technology,
international/domestic competitive factors in the industry, entry barriers, capital intensity,
business cycles etc are key ingredients of industry risk.

CARE also takes into account the economy-wide factors which have a bearing on the
industry under consideration. The strategic nature of the industry in the prevailing policy
environment, regulatory oversight governing industries etc, is also analyzed.

BUSINESS RISK ANALYSIS:

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BA7022 Merchant Banking and Financial Services

Against the backdrop of economy and industry risk, CARE assesses the entity’s position
within the industry.
Some of the key parameters used to assess business risk are discussed below

 Diversification:
For entities that operate in several industries, each major business segment is analyzed
separately. The contribution of each business segment to the entity’s overall profitability is
assessed. While diversification results in better sustainability in cash flows, CARE also analyses
the suitability and adequacy of management structure in such scenarios and forward and
backward linkages present.
 Seasonality and Cyclicality:
Some industries are cyclical in nature with their performance varying through the
economic cycle. Moreover, certain industries are seen to exhibit seasonality. CARE’s ratings aim
to be stable across seasons and economic cycles and are arrived at after deliberating on the long-
term fundamentals.
 Size:
Small size presents a significant hurdle in getting higher ratings commensurate with an
entity’s financials. Presence in selected market segments, limited access to funds leading to lack
of financial flexibility etc, result in lower protection of margins when faced with adverse
developments in business areas. Large firms, on the other hand, tend to have higher sustaining
power, even during troubled times.
 Cost structure:
The cost factors and efficiency parameters of the existing operations are assessed with
respect to expenditure levels required to maintain its existing operating efficiencies as well as to
improve its efficiency parameters in a competitive scenario. Nature of technology may also
influence the cost structure.
 Market share:
An entity’s current market share and the trends in market share in the past are important
indicators of the competitive strengths of the entity. A sustained leadership position leads to
ability to generate cash over the long term. A market leader generally has financial resources to
meet competitive pricing challenges.

FINANCIAL RISK ANALYSIS:


Financial risk analysis involves evaluation of past and expected future financial
performance with emphasis on assessment of adequacy of cash flows towards debt servicing.
CARE’s analysis is mainly based on audited accounts of the entity although unaudited accounts
are noted. A review of accounting quality and adherence to prudential accounting norms (if any,
set by local regulations) are examined for measuring the entity’s performance. Accounting
policies relating to depreciation, inventory valuation, income recognition, valuation of
investments, provisioning/write off etc are given special attention. Prudent disclosures of
material events affecting the entity are reviewed. Impact of the auditors’ qualifications and
comments are quantified to the extent possible and analytical adjustments are made to the
accounts, if material. The rating team meets the auditors to understand their comfort level with
the accounting policies, systems and controls within the entity and his assessment of the
management of the entity.
Off-balance sheet items are factored into the financial analysis and adjustments made to
the accounts, wherever necessary. Change of accounting policy in a particular year which results
in improved reported performance is analysed more closely.

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BA7022 Merchant Banking and Financial Services

 Financial ratios
(i) Growth Ratios
(ii) Profitability Ratios
(iii) Leverage and Coverage Ratios
(iv) Turnover Ratios
(v) Liquidity Ratios
 Cash flows
Future debt obligations are required to be met by cash and hence only a thorough analysis
of cash flow statements would reveal the level of debt servicing capability of an entity. Cash
flow analysis forms an important part of credit rating decisions. Availability of internally
generated cash for servicing debt is a more comforting factor in a credit perspective as compared
to dependence on external sources of cash to cover temporary shortfalls. Cash flow adequacy is
viewed by the capability of an entity to finance normal capital expenditure, as well as its ability
to manage capital expenditure programmes as per envisaged plans apart from meeting debt
servicing requirements
 Financial flexibility
Financial flexibility refers to alternative sources of liquidity available to the entity as and
when required. The entity’s contingency plans under various stress scenarios are considered and
examined. Ability to access capital markets and other sources of funds whenever required is
reviewed. Existence of liquid investments, availability of support (implied or demonstrated) from
strong group concerns to tide over stress situations, ability to sell idle assets quickly, deferment
of capital expenditure etc are favorably considered.
 Validation of projections and sensitivity analysis:
The projected performance of the entity over the life of the instrument is critically
examined and assumptions underlying the projections are validated. The critical parameters
affecting the industry and the anticipated performance of the industry are identified. Each critical
parameter is then stress-tested to arrive at the performance of the entity in a stress situation. Debt
service coverage for each of the scenarios would indicate the capability of the entity to service its
debt, under each scenario.
Management Evaluation:
Management evaluation is one of the most important factors supporting an entity’s credit
standing. An assessment of the management’s plan in comparison to those of their industry peers
can provide important insights into the entity’s ability to sustain its business. Capability of the
management to perform under stress provides an added level of comfort. Meetings with the top
management of the entity are an essential part of CARE’s rating process.
Some key dimensions of management evaluation are:
 Track record:
The track record of the management team is a good indicator for evaluating the
performance of the management. Management’s response to key issues/events in the past like
liquidity problems, competitive pressures, new project implementation, expansions and
diversifications, etc are assessed.
 Corporate Strategy:
The entity’s business plans, mission, policies and future strategies in relation to the
general industry scenario are assessed. An important factor in management evaluation is
assessment of the management’s ability to look into the future and its strategies and policies to
tackle emerging challenges, in addition to succession planning.
 Performance of group concerns:

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

Interests and capabilities of the group concerns belonging to the same management give
important insights into the management’s capabilities and performance in general.
 Organizational structure:
Assessment of the organizational structure would indicate the adequacy of the same in
relation to the size of the entity and also give an insight on the levels of authority and extent of
its delegation to lower levels in the organization. The extent to which the current organizational
structure is attuned to management strategy is assessed carefully.
 Control systems:
Adequacy of the internal control systems to the size of business is closely examined.
Existence of proper accounting records and control systems adds credence to the accounting
numbers. Management information systems commensurate with the size and nature of business
enable the management to stay tuned to the current business environment and take timely,
judicious decisions.
 Personnel policies:
Personnel policies laid down by the entity would critically determine its ability to attract
and retain human resources. Incidence of labour strikes/unrest, attrition rates etc, are seen in
perspective of nature of business and relative importance of human capital.
 Corporate governance:
Extent of transparency in the entity’s dealings with various stakeholders, financial prudence and
compliance with extant laws and regulations is seen closely.

CARE'S RATING METHODOLOGY FOR NON BANKING FINANCE COMPANIES:


CARE's ratings are an opinion on the relative ability and willingness of an issuer to make
timely payments on the specific debt obligations over the life of the instrument, CARE has
developed a comprehensive methodology for credit rating of debt instruments issued by NBFCs.
Some of the factors considered in CARE's rating analysis are described below:
QUANTITATIVE FACTORS:
The starting point in reaching a rating decision is a detailed review of key measures of
financial performance and stability.
a) Capital Adequacy:
Capital Adequacy Ratio (CAR) is a measure of the degree to which the company's capital
is available to absorb possible losses; High CAR indicates the ability of the company to
undertake additional business. Debt equity ratio is also examined as a measure of gearing. CARE
examines the conformity of the Company to the regulatory guidelines on capital adequacy norms
and further examines the capital adequacy on the basis of expected erosion of capital arising as a
result of additional provisioning for NPAs etc.
The impact of mark to market gains/losses from investment portfolio on capital adequacy is also
examined.
b) Asset Quality:
Asset Quality review begins with the examination of the company’s credit risk
management framework. The overall asset quality is assessed by evaluating the asset class wise
exposures. The historical recovery rate of annual demands of principal and interest and the
company's experience of loan losses and write-off/provisions are studied. The proportion of
assets classified into standard, substandard, doubtful or loss and the track record of recoveries of
the company is examined closely. The portfolio diversification and exposure to vulnerable
sectors is evaluated to arrive at the level of weak assets.
c) Resources:
Resource base of the NBFC is analyzed in terms of cost and composition. Deposits form
an important funding source for many NBFCs. Proportion of deposits /loans/bonds in funding
Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

mix is examined. Deposit growth rates and their rollover rates are also analyzed. Average as well
as incremental cost of funds is examined in the context of prevailing interest rate regime. Ability
of the company to raise additional resources at competitive rates is examined critically.
d) Liquidity:
Lack of liquidity can lead an NBFC towards failure, while, strong liquidity can help even
an otherwise weak company to remain adequately funded during difficult times. CARE evaluates
the internal and external sources of funds to meet the company's requirements. The liquidity risk
is evaluated by examining the assets liabilities maturity (ALM) profile, collection efficiency,
deposit renewal rates and proportion of liquid assets to total assets. The short term external
funding sources in the form of unutilized lines of credit available from banks etc along with
directed and other investments if any are important sources of reserve liquidity.
e) Earning Quality:
CARE analyzes the composition of income of the company by segregating it into fee
based and fund based activities. Core earnings are also identified by excluding non-recurring
income from total income. Each business area that contributes to the core earnings is assessed for
risks as well as for its earning prospect and growth rate.
Profitable operations are essential for NBFCs to operate as an ongoing concern. Yield on
business assets and investments are viewed in conjunction with cost of funds to arrive at the
spreads earned by the company. Interest cover is also an useful indicator of the extent of cover
over the interest paid by the company. Operating efficiency is examined in terms of expense
ratios. Quality of company's earnings is also influenced by the level of interest rate and foreign
exchange rate risks that the company is exposed to.
Finally, the overall profitability is examined in terms of, return on Capital employed,
return on assets and return on shareholders’ fund. Evaluation of quantitative factors is done, not
only of the absolute numbers and ratios, but their volatility and trends as well. The attempt is to
determine core measures of performance. CARE also compares the company's performance on
each of the above discussed parameters with its peers. Detailed inter-company analysis is done to
determine the relative strengths and weaknesses of the company in its present operating
environment and its prospects.
QUALITATIVE FACTORS:
Some of the qualitative factors that are deemed critical in the rating process are:
a) Ownership:
Ownership pattern and track record of the promoters/group companies is examined.
Strong promoters are more likely to provide support to the company in times of crisis.
b) Management quality:
The composition of the board, credentials of the CEO and the organisational structure of
the company are considered. The company's strategic objectives and initiatives in the context of
resources available, its ability to identify opportunities and track record in managing stress
situations are taken as indicators of managerial competence. Adequacy of the information
systems used by the management is evaluated. CARE focuses on modern practices and systems,
degree of computerization, capabilities of senior management, personnel policies and extent of
delegation of powers.
c) Risk Management:
The management stance on risk and risk management framework is examined. Credit risk
management is evaluated by examining the appraisal, monitoring and recovery systems and
prudential lending norms of the company. The company's policy and exposure to interest rate
and foreign currency risk is examined. Interest rate risk arises due to differing maturity of assets
and liabilities and mismatch between the floating and fixed rate assets and liabilities. Foreign
currency risk arises due to difference in currency denomination of assets and liabilities. The

Prepared by : Ms.Dheeba.J AP
BA7022 Merchant Banking and Financial Services

derivatives and other risk management products used in the past and implication of these deals
are also analyzed.
d) Compliance with statutory requirements:
CARE examines track record of the company in complying with regulatory requirements
of RBI.

e) Accounting Quality:
Rating relies heavily on audited data. Policies for income recognition, provisioning and
valuation of investments are examined. Suitable adjustments to reported figures are made for
consistency of evaluation and meaningful interpretation.
f) Size and Market Presence:
The fund base and network of the NBFC may have a bearing on the company's
Competitive position. In the rapidly changing competitive environment, the niche strategy of
smaller companies against the scale advantages of larger players/banks would be carefully
examined to understand the business model of each company.
All relevant quantitative and qualitative factors are considered together, as relative
weakness in one area of the company's performance may be more than adequately compensated
for by strengths elsewhere. However, the weightage assigned to factors are different for short
term ratings and long term ratings. The intention of long term ratings is to look over a business
cycle and not adjust ratings frequently for what appear to be short term performance aberrations.
The quality of the management and the competitiveness of the company are of greater
importance in long term rating decisions.
The rating process is ultimately a search for the fundamentals and the probabilities for
change in the fundamentals. The assessment of management quality and the company's operating
environment are used to interpret current data and to forecast how well the company is
positioned for the future. The final rating decision is made by the Rating Committee after a
thorough deliberation on the rating report on the company.
7. What are the functions of credit rating? Explain the methodology followed by ICRA in
rating credit instruments? (Nov/Dec 2011)

FUNCTIONS OF CREDIT RATING AGENCIES:


· Superior information
· Low cost information
· Basis for proper risk, return & Trade off
· Healthy discipline on corporate borrowers
· Formulation of public policy guidelines on Institutional investment.

ICRA (INFORMATION CREDIT RATING SERVICES):

ICRA was promoted in 1991, by IFCI and 21 other shareholders comprising of


nationalized and foreign banks and insurance companies. It is the second rating agency to be
established in India. The services offered can be broadly classified as rating services advisory
services, and investment information services. The rating service comprises rating of debt
instruments and credit assessment. Advisory services include strategic counseling general
assessment such as restructuring, and services specific to sectors, such as for power, telecom,
ports, municipal ratings, etc.

Prepared by : Ms.Dheeba.J AP
The information desk provides research reports on specific industries, sectors and corporate. The
information services also include equity related services, viz. equity grading and equity
assessment. In 1996, ICRA entered into a strategic alliance with financial proforma Inc, a
Moody’s subsidiary, to offer services on Risk Management Training and Software. Moody’s and
ICRA have entered into a Memorandum of Understanding to support those efforts.

An ICRA Rating is a symbolic indicator of ICRA's current opinion on the relative capability of
the corporate entity concerned to timely service debts and obligations, with reference to the
instrument Rated. The Rating is based on an objective analysis of the information and
clarifications obtained from the entity, as also other sources considered reliable by ICRA. The
independence and professional approach of ICRA ensure reliable, consistent and unbiased
Ratings. Ratings allow investors to factor credit risk in their investment decision. ICRA Rates
long-term, medium-term, and short-term debt instruments. ICRA offers its Credit Rating services
to a wide range of issuers including:

 Manufacturing companies

 Banks and financial institutions

 Infrastructure sector companies

 Service companies

 Municipal and other local bodies

 State governments

 Non-banking finance companies

 Small and medium sector entities

Rating Process

ICRA's Rating process is initiated on receipt of a formal request (or mandate) from the
prospective issuer. A Rating team, which usually consists of two analysts with the expertise and
skills required to evaluate the business of the issuer, is involved with the Rating assignment. An
issuer is provided a list of information requirements and the broad framework for discussions.
These requirements are worked out on the basis of ICRA's understanding of the issuer's business,
and broadly cover all aspects that may have a bearing on the Rating. ICRA also draws on
secondary sources of information, including its own Research Division, while working on the
Rating assignment. The Rating involves assessment of a number of qualitative factors with a
view to estimating the future earnings of the issuer. This requires extensive interactions with the
issuer's management, specifically on subjects relating to plans, outlook, competitive position, and
funding policies.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


In the case of manufacturing companies, plant visits are made to gain a better
understanding of the issuer's production process, make an assessment of the state of equipment
and main facilities, evaluate the quality of technical personnel, and form an opinion on the key
variables that influence the level, quality and cost of production. These visits also help in
assessing the progress of projects under implementation. After completing the analysis, a Rating
Report is prepared, which is then presented to the ICRA Rating Committee. A presentation on
the issuer's business and management is also made by the Rating Team. The Rating Committee
is the final authority for assigning Ratings. The assigned Rating, along with the key issues, is
communicated to the issuer's top management for acceptance. Non-accepted Ratings are not
disclosed and complete confidentiality is maintained on them unless such disclosure is required
under any laws/regulations.

If the issuer does not find the Rating acceptable, it has a right to appeal for a review. Such
reviews are usually taken up if the issuer provides certain fresh inputs. During a review, the
issuer's response is presented to the Rating Committee. If the inputs and/or fresh clarifications so
warrant, the Rating Committee would revise the initial Rating decision. As part of a mandatory
surveillance process, ICRA monitors all accepted Ratings over the tenure of the Rated
instruments. The Ratings are generally reviewed once every year, unless the circumstances of the
case warrant an earlier review. The Rating outstanding may be retained or revised (that is,
upgraded or downgraded) on surveillance.

Methodology

ICRA considers all relevant factors that have a bearing on the future cash generation of the
issuer. These factors include: industry characteristics, competitive position of the issuer,
operational efficiency, management quality, commitment to new projects and other associate
companies, and funding policies of the issuer. A detailed analysis of the past financial statements
is made to assess performance under "real world" business dynamics. Estimates of future
earnings under various sensitivity scenarios are drawn up and evaluated against the claims and
obligations that require servicing over the tenure of the instrument being Rated. Primarily, it is
the relative comfort level on the issuers' cash flows to service obligations that determines the
Rating.

8. Explain the meaning, objective and types of credit rating. (Nov/Dec 2012)

MEANING:

A credit rating is also known as an evaluation of a potential borrower’s ability to repay


debt, prepared by a credit bureau at the request of the lender..
OBJECTIVES:

To perform the credit rating of various debt instruments as Commercial papers, Bonds
and Debentures, Islamic bonds, Preference shares, Equity instruments, Rights issue,
Mutual fund units etc.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


To perform grading of various institutions as banks, non banking financial institutions,
insurance companies, corporations, non-corporations, societies, trusts or individuals or
their clients for purposes requested clients or required by authorities.
To accumulate, process and offer information services in broad areas for the use of
organization and clients at different levels.
To provide consultancy and advisory services in broad areas to our clients at different
levels.
To act as trustees of any debentures, bonds, securities, commercial papers or any other
obligations and to exercise the powers of executor, administrator, receiver, treasurer,
custodian in respect of such debts and securities.

TYPES OF CREDIT RATING:

International Ratings

Issuer Credit Ratings (for governments, financial institutions and corporates): these
summarize an entity's overall creditworthiness and its ability and willingness to meet its financial
obligations as they come due. Ratings assigned to an entity are comparable across international
borders. Sectors and the types of ratings that may be assigned are given below.

Sovereigns and Local Government

 Long- and short-term local currency ratings


 Long- and short-term foreign currency ratings

Banks and other Financial Institutions

 Long- and short-term local currency ratings


 Long- and short-term foreign currency ratings
 Financial strength ratings (an opinion of stand-alone financial health)
 Support ratings (an assessment of the likelihood that a bank would receive external
support in case of financial difficulties)

Corporate

 Long- and short-term local currency ratings


 Long- and short-term foreign currency ratings

Issue Credit Ratings (for bonds, Sukuk and other financial obligations): these are an opinion of
an entity's ability and willingness to honour its financial obligations with respect to a specific
bond or other debt instrument. The ratings assigned to the debt issues of financial institutions and
corporate can be either short-term or long-term, depending on the tenor of the financial
obligation. A short-term rating is assigned to debt instruments with an original maturity of up to
one year.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


National Ratings

National Ratings measure the creditworthiness of issuers or issues relative to all other issuers
or issues within the same country, and unlike CI's other ratings are not intended to be comparable
across countries. National Ratings are used in countries whose sovereign credit ratings are some
way below 'AAA' on CI's international ratings scales, and where there is sufficient demand from
capital market participants for such ratings. National Ratings enable the ratings of obligors in a
given country to be distributed across a full rating scale (from 'AAA' to 'D'), thereby allowing
greater credit differentiation than may be possible under internationally comparable rating scales.

9. Define mutual funds and describe the various schemes that can be offered by it. Explain
the various factors to be considered before selecting mutual.

Mutual funds are associations or trusts of public members who wish to make investment
in the financial instrument or assets of the business sector or corporate sector for the mutual
benefit of its members.
VARIOUS SCHEMES OF MUTUAL FUNDS:
Operational classification:
 CLOSE ENDED FUNDS:
Close ended funds are funds which have definite period or target amount. Once the
period is over and or the target is reached, the door is closed for the investors. They cannot
purchase any more units. These units are publicly traded through stock exchange and generally,
there is no repurchase facility by the fund. The main objective of this fund is capital appreciation.
Thus after the expiry of the fixed period, the entire corpus is disinvested and the proceeds are
distributed to the various unit holders in proportion to their holding. Thus the fund ceases to be a
fund, after the final distribution.
E.g. UTI Master Share, 1986

 OPEN ENDED FUNDS:


Open ended funds are those which have no fixed maturity periods. Open ended scheme
consists of mutual funds which sell the units to the public. These mutual funds can also
repurchase the units. Initial Public Offer (IPO) is open for a period of 30 days and then reopens
as an open-ended scheme after a period not exceeding 30 days from the date of closure of the
IPO. Investors can buy or repurchase units at net asset value or net value related prices, as
decided by the mutual fund. Example: Unit Trust of India‘s Growth sector funds.
 INCOME FUND:
Income funds are those which generate regular income to the members on a periodical
basis. It concentrates more on the distribution of regular income and it also sees that the average
return is higher than that of the income from bank deposits.

a. The investor is assured of regular income at periodical intervals


b. The main objective is to declare regular dividends and not capital appreciation.
c. The investment pattern is towards high and fixed income yielding securities
d. It is concerned with short run gains only.
 GROWTH FUND:
Growth are those which concentrate mainly on long term gains i.e., capital appreciation.
Hence they are termed as “Nest Eggs” investments.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


a. It aims at meeting the investors’ need for capital appreciation.
b. The investor‘s strategy conforms to investing the funds on equities with high
growth potential.
c. The Investment tries to get capital appreciation by taking much risks and
investing on risk bearing equities and high growth equity shares.
d. The fund declares dividends.
e. It is best suited to salaried and business people.
 BALANCED FUND:
It is a balance between income and growth fund. This is called as Income cum growth. It
aims at distributing regular income as well as capital appreciation. Thus the investments are
made in high growth equity shares and also the fixed income earning securities.
 SPECIALISED FUNDS:
These are special funds to meet specific needs of specific categories of people like
pensioners, widows etc.
 MONEY MARKET MUTUAL FUNDS:

The funds are invested in money market instruments. These funds basically have all the
features of open ended funds but they invest in highly liquid and safe securities like commercial
paper, bankers’ acceptances, and certificates of deposits treasury bills. These funds are called
money funds in the U.S.A. The RBI has fixed the minimum amount of investment as Rs.1 Lakh;
it is out of the reach of many small investors. However, the private sector funds have been
permitted to deal in money market mutual funds. It is best suited to institutional investors like
banks and other financial institutions.
 TAXATION FUNDS:
It is a fund which offers tax rebated to the investors either in the domestic or foreign
capital market. It is suitable to salaried people who want to enjoy tax rebates particularly during
the month of February and March. An investor is entitled to get 20% rebated in Income Tax for
investments made under this fund subject to a maximum investment of Rs.10, 000 per annum.
E.g. Tax Saving Magnum of SBI Capital Market Limited.

 OTHER CLASSIFICATION:
i. Leveraged Funds:
Also called as borrowed funds as they are used primarily to increase the size of the value of
portfolio of 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 two different types of
investors. It sells income shares and capital. Those investors who seek current investment
income can purchase incomes shares. The capital shares receive all the capital gains earned on
those shares and they are not entitled to receive any dividend of any type.
iii. Index Fund:
It is a fund based the some broad market index. This is done by holding securities in the
same proportion as the index itself. The value of these index linked funds will automatically go
up whenever the market index goes up and vice versa.
iv. Bond Funds:
The funds have portfolios consisting mainly of fixed income securities like bonds. The
main thrust is income rather than capital gains.
v. Aggressive Growth Funds:

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


These funds are capital gains oriented and thus the thrust area of these funds is capital
gains. Hence, these funds are generally invested in speculative stocks They may also use
specialized investment techniques like short term trading, option writing etc.,
vi. Off shore Mutual Funds:
These funds are meant for nonresident investors. These funds facilitate flow of funds
across different countries, with free and efficient movement of capital for investment and
repatriation.
vii. Property Fund:
These funds are real estate mutual funds. Its investment also includes shares/bonds of
companies involved in real estate and mortgage backed companies.
viii. Fund of Funds:
It is a fund that invests in other mutual fund schemes. The concept in prevalent in abroad.

FACTORS TO BE CONSIDER BEFORE SELECTING A MUTUAL FUND:


Here are a few factors to consider before selecting a mutual fund:

Risk appetite:

Those who start investing early in life benefit because their investments have more time
to grow. So, the younger investors can take more risk compared to people close to their
retirement years. People with more disposable incomes and lesser debt obligations can invest in
growth-oriented funds.

Some people are simply not comfortable with funds that are risky. They constantly fear
that they might lose their investments. Risk-averse investors must be cautious when they make
investment decisions. Balanced funds invest largely in equity and have exposure to debt
instruments as well. Hence, for those with a moderate risk appetite, balanced funds yield decent
returns.

Investment tenure:

It makes more sense to hold investments carrying higher risk for longer time periods.
Investments held for more than five years have the potential to generate higher returns. In the
event of an economic slowdown or a market crash, long-term investments have more time to
recover.

Investment goals:

Some people want to save for children's education or augment funds for retirement
planning. If these are goals set over the long term, equity funds may yield good returns.
However, if you need funds for your child's marriage that might take place after two years,
locking all your money in equity mutual funds may not be a good idea. This is because capital
preservation is not guaranteed by funds.

A popular strategy is that when you near your goal (say close to two years), start
redeeming your equity investments and reinvest these in safer debt-oriented instruments. Growth

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


funds fluctuate more to stock market movements and hence may see disappointing spells.
However, well-managed growth funds out-perform other funds over the long term. The fund's
objectives and investment strategy must be the same as that of the investor.

Performance:

Compare the mutual fund's performance with that of other similar funds. While there is
no guarantee that the fund can repeat the previous year's performance, it will give an idea of the
fund and the manager's strategy. Verify if the performance is consistent over the last few years.
Further, select a fund with lower expense ratio and other administrative charges.

Research the underlying stocks. It is not worth paying more, if the fund is over-valued. Finally,
diversify in terms of business areas of underlying stocks and size.

10. Discuss the features of mutual fund investment. (May/June 2013)

 Qualified and experienced professionals manage Mutual Funds. Generally, investors, by


themselves, may have reasonable capability, but to assess a financial instrument, a
professional analytical approach is required in addition to access to research and
information, time and methodology to make sound investment decisions.
 Since Mutual Funds make investments in a number of stocks, the resultant diversification
reduces risk. They provide the small investors with an opportunity to invest in a larger
basket of securities.
 The investor is spared the time and effort of tracking investments, collecting income, etc.
from various issuers, etc.
 It is possible to invest in small amounts as and when the investor has surplus funds to
invest.
 Mutual Funds are well regulated & governed by SEBI (Mutual Funds) Regulations, 1996
thereby ensuring transparency of investments.
 In case of open-ended funds, the investment is very liquid as it can be redeemed at any
time with the fund, unlike direct investment in stocks/bonds.

ANNA UNIVERSITY QUESTIONS

Part A

1. What is Sensex? (APRIL/MIAY 2010)


2. Who do You mean by AMC? (APRIL/MIAY 2010)
3. Define reverse merger. (Nov/Dec 2010)
4. What is portfolio management? (Nov/Dec 2010)
5. How is NAV computed? ( APRIL/MAY 2011)
6. List the services rendered by Portfolio Managers. ( APRIL/MAY 2011)
7. What is conglomerate merger? (Nov/Dec 2011)
8. Define portfolio Management. (Nov/Dec 2011)
9. What is management buyout? (MAY/JUNE 2012.)

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


10. What is credit rating? (MAY/JUNE 2012.)
11. What is Conglomerate Merger? (Nov/Dec 2012)
12. Write a note on Credit Syndication. What is swap leasing? (Nov/Dec 2012)
13. Define credit syndication. (MAY/JUNE 2013)
14. What is mutual funds? (MAY/JUNE 2013)
15. What is credit syndication? (Nov/Dec 2013)
16. Name any four 'credit rating agencies' functioning ln India. (Nov/Dec 2013)
17. What is "Credit Syndication"? (MAY/JUNE 2014)
18. What are the various services offered by a typical rating agency? (MAY/JUNE 2014)

Part-B

1. What are the characteristic features that distinguish venture capital from other capital
investments? Describe in detail. (APRIL/MIAY 2010)
2. what is credit rating? what functions does it provide? why do companies go for rating
their securities? what benefits do the investors get from credit rating? (Nov/Dec 2010)
3. Define a mutual fund and describe the various schemes that can he offered by it. Explain
the various factors to be considered before selecting a mutual. (Nov/Dec 2010)
4. Explain the credit rating process followed by any one credit rating agency f61r r long
term instrument. ( APRIL/MAY 2011)
5. Discuss the methods of business valuation followed during Mergers and acquisitions. (
APRIL/MAY 2011)
6. What are the functions of credit rating? Explain the methodology followed by ICRA
in rating credit instruments. (Nov/Dec 2011)
7. Define a mutual fund and describe the various type: of mutual funds. Explain the various
factors to be considered before selecting a Mutual. (Nov/Dec 2011)
8. Outline the procedure related to the, registration of portfolio mangers under the SEBI
regulations, -1993. (MAY/JUNE 2012.)
9. Define a mutual fund and describe the various schemes that can be offered by it.
(MAY/JUNE 2012.)
10. Discuss the important forces of M & A in modern scenario. (Nov/Dec 2012)
11. Discuss the features of Mutual Fund investment" (Nov/Dec 2012)
12. Discuss the various mutual fund schemes offered in India. (Nov/Dec 2013)
13. "Rating agencies does not follow uniform method of evaluation. As a result the investors
are not benefited" — Discuss. (Nov/Dec 2013)
14. Identify the specialized services rendered by merchant bankers as regards "Merger
and Acquisition". (May/June-2014)

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


UNIT IV -FUND BASED FINANCIAL SERVICES

Leasing and Hire Purchasing –Basics of Leasing and Hire purchasing Financial Evaluation.

PART-A

1. What is leasing? (OR) What is leasing in financial services? (May/June 2013)


A lease is an agreement whereby the lessor conveys to the lease, in return for rent, the
right to use an asset for an agreed period for time.

2. Who are the parties involved in leasing?


Lessor: Lessor is a person who conveys to another person (lessee) the right to use an asset
in consideration of a periodical rental payment, under a lease agreement.
Lessee: lessee is a person who obtains the right to use the asset from the lessor for a periodical
rental payment for an agreed period of time.

3. What are the characteristics of leasing?

 The parties
 The asset/lease property
 The term
 The lease rentals

4. What are the types of leasing?


 Financial lease
 Operating lease
 Net lease
 Leveraged lease
 Sale and lease back
 Partial pay-out lease
 Consumer lease
 Close-end lease
 Open-end lease
 Cross-border lease
 Direct lease
 Bipartite lease
 Tripartite lease
 Single investor lease

5. State the various elements of lease (MAY/JUNE 2014)

 Property Address
 Start and Termination
 Parties involved

 Mode and Interval of Payment 

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


 Provision of lease renewal

6. What is financial lease?


A lease is defined as a finance lease if it transfers a substantial part of the risks and
rewards associated with ownership from the lessor to the lessee.
7. What is operating lease?
An operating lease is any other type of lease whereby the asset is not fully amortized
during the non-cancelable period of the lease, and where the lessor does not rely on the lease
rentals for profits.
8. What is swap lease? (Nov/Dec2012)

Swap a lease used for both sellers and buyers who are looking to lease swap their automobile
leases for other vehicles. Pricealease is the one of the best swap a lease of automobile leases.
Swap a lease of a car by transferring out of a car lease. However if you are the person who has
assumed a lease or swap a lease or lease trader then you may want to check carefully before you
allow the original lessee to terminate their lease. Swap a lease is the most important thing when
you have fallen on hard times.
9. What are the advantages of leasing?
 Efficient use of funds
 Cheaper source
 Flexible source
 Enhanced borrowing capacity
 Off-balance sheet financing
 Tax benefits
 Better liquidity

10. What are the disadvantages of leasing?


 Limitations of lease financing
 Disguised debt financing
 Costly option
 Loss of tax shield
 Double sales-tax
 Loss of residual value
 Unfavorable gearing
 No ownership
 Risk of default
 No working capital
 Indiscriminate finance
 Long-term venture

12. What is hire purchase agreement?


A Hire Purchase Agreement is an agreement between the seller and the buyer, where the
ownership of goods does not pass to the buyer until he pays the last installment.

13. Write a note on consumer credit. (NOV/DEC-2012)

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


A debt that someone incurs for the purpose of purchasing a good or service. This includes
purchases made on credit cards, lines of credit and some loans.

PART-B

1. Explain the various types of leases. Evaluate leasing by highlighting its advantages and
disadvantages? (MAY/JUNE 2012)

TYPES OF LEASING:

Finance lease:
A lease is defined as a finance lease if it transfers a substantial part of the risks and
rewards associated with ownership from the lessor to the lessee.

Operating lease:
The International Accounting Standard Committee defines operating lease as “any lease
other than a finance lease”.

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 significant
penalty.
3. The lessor usually provides the operating know-how, supplies the related services and
undertakes the responsibility of insuring and maintaining the equipment, in which case the
operating lease is called a Wet Lease.
4. An operating lease where the lessee bears the cost of insuring and maintaining the leased
equipment is called a Dry Lease.
5. An operating lease does not shift the equipment-related, business and technological risks from
the lessor to lessee. The lessor structuring an operating lease transaction has to depend upon
multiple lease or on the realization of substantial resale value (on the expiry of first lease), to
recover the instrument cost plus reasonable rate of return thereon. To deal in operating leasing
one requires an in-depth knowledge of the equipments and the resale market. In our country, as
the resale market for most of the used capital equipments is not active, operating leases are not
very popular.

Sale and lease back:


Under this type of lease, the owner of an asset sells it to the lessor, and gets the asset back
under the lease agreement. The ownership of the asset changes hands from the original owner to
the lessor, who in turn leases out the assets, back to the original owner. This paper exchange of
title has the effect of providing immediate free finance to the selling company, the lessee. This
transaction also helps the release of funds tied up in the particular asset.

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, bipartite lease and Tripartite Lease.

Bipartite lease:
There are two parties to the transaction,
1. Equipment supplier cum lessor

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


2. The lessee. It functions like an operating lease with built-in facilities like up gradation of the
equipments called as ‗Upgrade Lease‟.
The lessor undertakes to maintain the equipment and even replaces the equipment that is
in need of major repair with the similar functioning equipment called as ―Swap Lease”.

Tripartite lease:
It involves three different parties
1. The equipment supplier
2. The lessor
3. The lessee. Most of the equipment lease transactions fall under this category.
In this form of lease
 The equipment supplier may provide a reference about the customer to the leasing
company.
 The equipment supplier can negotiate the terms of the lease with the customer and
complete the necessary paper work on behalf of the leasing company.
 The supplier can take the lease on his own account and discount the lease receivables
with the designated leasing company. So the leasing company owns the equipment and
obtains an assignment of the lease rentals. This form of lease has recourse to the supplier
in case of default by the lessee, either to buy back the equipment from the lessor on
default or providing a guarantee on behalf of lessee.

Single investor lease:


The entire investment is funded by the lessor by arriving at a judicious mix of debt and
equity. The debt funds raised by the leasing company are without recourse to the lessee, i.e., in
the event of the default by the leasing company on its debt-servicing obligation, the lender
cannot demand payment from the lessee.

Leveraged lease:
It is a lease which is leveraged through a trustee. The leasing company invests in
equipments by borrowing large investments with full recourse to the lessee without any recourse
to it. The lender (loan participant) gets an assignment of the lease and enjoys benefit of the
rentals to be paid by the lessee and a first mortgage on the leased assets.

Advantages of leasing:
 Efficient use of funds
 Cheaper source
 Flexible source
 Enhanced borrowing capacity
 Off-balance sheet financing
 Tax benefits
 Better liquidity

Disadvantages of leasing:

 Limitations of lease financing


 Disguised debt financing
 Costly option
 Loss of tax shield
 Double sales-tax

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


 Loss of residual value
 Unfavorable gearing
 No ownership
 Risk of default
 No working capital
 Indiscriminate finance
 Long-term venture

2. Who are the parties to Hire Purchase contract? Distinguish Hire Purchase from
Leasing.(May/June2013), (APRIL/MAY 2011), (NOV/DEC-2011), (MAY/JUNE 2012),
(NOV/DEC-2013), (MAY/JUNE 2014).
There are two parties in a hire purchase contract The intending seller, the
intending purchaser or the hirer presently we have three parties involved consisting of
seller, financier and the hirer/purchaser.

Hire Purchase Leasing


1. The agreement is entered for the 1. It is only in financial lease the ownership
transfer of ownership after a fixed will get transferred. While in operating the
period ownership lease is not transferred.
2. It is a tripartite agreement involving the 2. It is only a bipartite agreement involving
seller, finance company and the lessor and lessee.
purchaser/hirer.
3. Depreciation is claimed by the 3. Depreciation is claimed by the lessor in the
purchaser/hirer. lease agreement.
4. In hire purchase, the goods or property 4. In operating lease, though the lessor can be
is sold once and there cannot be more one person, there can be number of lessees.
than one buyer.
5. Period of HP agreement is longer as 5. Period of lease will of shorter duration as
valuable goods or properties are technological change will affect the lessee.
purchased.
6. The relationship between the seller and 6. The relationship in a lease agreement is that
the purchaser will be that of owner and of lessor and lessee.
hirer.
7. Ownership passes on to the buyer only 7. Ownership will pass on when the lessor has
on the last installment from the finance collected sufficient money from the lessee,
company. which is equivalent to the value of the
goods or equipment.
8. Hire purchase agreement is more 8. Lease agreement is entered more among
common with the consumer durable business concerns.
goods.
9. Sales tax is paid by the buyer on the 9. Sales tax depends on the actual value at the
total value of goods. time of sale.
10. Any default in payment of installment 10. On the termination of lease agreement if it
enables the seller/finance company to is an operating lease, the equipment is taken
seize the goods from the back by the lessor.
purchaser/hirer.
11. The interest rate is collected with the 11. Interest does not form a major part of lease
principal amount on the equated but the lease charges include interest as a
monthly installment part of it.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


12. 12.

3. Difference between Financial Lease and Operating Lease. (May/June 2013),


(NOV/DEC-2012)

Financial Lease Operating Lease

1. The asset is procured purely for the benefit 1. The asset is meant for a number of lessees.
of the lessee and the lessor has lesser benefit
compared to the lessee.
2. The risk and benefit of the asset is passed on 2. The lessee is in possession of the asset
to the lessee and only ownership is with the only for a particular time and hence risk is
lessor. more borne by lessor.
3. If the asset becomes obsolete, it is the risk of 3. Since the lease time is short, the risk of
the lessee. obsolescence is with the lessor.
4. The lessor is more concerned with the rent or 4. The lessor is not only concerned with the
lease amount as there is repayment of the rentals but also the asset as it has to be given
principal amount along with the interest. to number of lessees.
5. The lease is non revocable or irrevocable by 5. The lease is revocable especially by the
either party. lessee.
6. Lease period goes along side with life of the 6. The lease period is small and the lessor
asset and there is primary and secondary period. leases the asset number of times with
different users.
7. The lessor is only a financier and does not 7. The lessor bears cost of repair,
bear the cost of operation. maintenance, etc.
8. It is mostly a single lease by which the lessee 8. The lease is non pay-out and lessor can
replays the cost of the asset with interest. recover the value of asset only by repeated
leasing to different lessees.

4. Explain the taxation benefits of leasing. (NOV/DEC-2013)

As the equipment is purchased by the lessor and handed over to the lessee, the ownership
is retained by the lessor but only the possession is given to the lessee. The lessor claims
depreciation and thereby gets some concessions under the Income Tax Act. The depreciation
claimed is also on the basis of written down value method (WDV).

Sales tax will be paid by the lessor as the equipment is bought by him. But later on, under
financial lease he can claim a part of the sales tax from the lessee, when it is transferred to
lessee. The lessee will be paying the sales tax on lesser amount. This is so because by the time
property or equipment is sold to him, its value gets reduced.

The lessee gets certain benefits in the payment of rent, maintenance of the equipment and
other promotional expenditure incurred by him in making the equipment operational. For all
these expenses, the lessee will be claiming tax benefits under the Indian Income Tax Act. The
benefits will be more when initial rentals are higher. During the later part of the period, it will
become less.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


With the enhancement in the limit on investment on fixed capital for small scale
industries and tiny sector, the importance of leasing companies has gone up. At present, small
scale industries can have fixed capital up to Rs.1 crore and tiny sector up to Rs.2lakhs Hence,
most of the small scale industries are going in for modernization through lease finance. The tiny
sector also putting to use the benefit of leasing companies.

The public sector commercial banks have entered the field of leasing and factoring by
starting separate subsidiary companies. State Bank of India and Canara Bank are the pioneering
banks in the leasing finance which is now adopted by other commercial banks. Even the foreign
banks are taking up lease finance.

Thus, leasing finance provides enough opportunity for both lessor and lessee to gain in
both income tax and sales tax, as a result of which there is more scope for this kind of business.

5. Distinguish between hire purchase and lease and explain its pros and cons in practices.
(Nov/Dec2012)
Hire Purchase Leasing
13. The agreement is entered for the 13. It is only in financial lease the ownership
transfer of ownership after a fixed will get transferred. While in operating
period the ownership lease is not transferred.
14. It is a tripartite agreement involving 14. It is only a bipartite agreement involving
the seller, finance company and the lessor and lessee.
purchaser/hirer.
15. Depreciation is claimed by the 15. Depreciation is claimed by the lessor in
purchaser/hirer. the lease agreement.
16. In hire purchase, the goods or 16. In operating lease, though the lessor can
property is sold once and there cannot be one person, there can be number of
be more than one buyer. lessees.
17. Period of HP agreement is longer as 17. Period of lease will of shorter duration as
valuable goods or properties are technological change will affect the
purchased. lessee.
18. The relationship between the seller 18. The relationship in a lease agreement is
and the purchaser will be that of that of lessor and lessee.
owner and hirer.
19. Ownership passes on to the buyer only 19. Ownership will pass on when the lessor
on the last installment from the has collected sufficient money from the
finance company. lessee, which is equivalent to the value
of the goods or equipment.
20. Hire purchase agreement is more 20. Lease agreement is entered more among
common with the consumer durable business concerns.
goods.
21. Sales tax is paid by the buyer on the 21. Sales tax depends on the actual value at
total value of goods. the time of sale.
22. Any default in payment of installment 22. On the termination of lease agreement if
enables the seller/finance company to it is an operating lease, the equipment is
seize the goods from the taken back by the lessor.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


purchaser/hirer.
23. The interest rate is collected with the 23. Interest does not form a major part of
principal amount on the equated lease but the lease charges include
monthly installment interest as a part of it.
ADVANTAGES OF LEASING:
 Efficient use of funds
 Cheaper source
 Flexible source
 Enhanced borrowing capacity
 Off-balance sheet financing
 Tax benefits
 Better liquidity

DISADVANTAGES OF LEASING:

 Limitations of lease financing


 Disguised debt financing
 Costly option
 Loss of tax shield
 Double sales-tax
 Loss of residual value
 Unfavorable gearing
 No ownership
 Risk of default
 No working capital
 Indiscriminate finance

Advantages

 HP or leasing allows companies to control and deploy assets without significant drain on
working capital
 fixed-rate funding makes budgeting easy as the lessee has clear sight of future
expenditures
 flexibility of repayment structuring is available to allow for seasonal business (eg one
repayment a year), and to reduce monthly outlay by factoring in a ‘balloon’ payment at
the end of the term
 leasing prevents the risk of an asset’s value depreciating quickly and provides flexibility
to enter into a new contract at the end of the original lease’s fixed term
 financing asset purchases can be more tax efficient than standard-term loans due to lease
payments being booked as expenses. Although asset depreciation also provides tax
benefits, the useable lifetime of the asset will vary depending on the asset and on local
regulation
 high accessibility of financing for businesses due to the financing being secured with the
leased asset and the asset being owned by the financing company
 in certain circumstances there is maintenance included within the terms of the agreement.

Disadvantages

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


 total sum of capital payments for HP or leasing will be higher than the full payment on
the asset purchase
 administrative complexity and costs will be greater if any covenants are applied to the
arrangement. For example, updates on change of equipment locations
 if the business changes its strategy, resulting in the leased asset no longer being useful,
there can be early termination charges or restrictions on subleasing.

7. Outline the legal framework relating to hire purchase transactions in India. (Nov/Dec
2012)
There is no exclusive legislation dealing with hire purchase transaction in India. The Hire
purchase Act was passed in 1972. An Amendment bill was introduced in 1989 to amend some of
the provisions of the act. However, the act has been enforced so far. The provisions of are not
inconsistent with the general law and can be followed as a guideline particularly where no
provisions exist in the general laws which, in the absence of any specific law, govern the hire
purchase transactions.

The act contains provisions for regulating:


1. The format / contents of the hire-purchase agreement
2. Warrants and the conditions underlying the hire-purchase agreement,
3. Ceiling on hire-purchase charges,
4. Rights and obligations of the hirer and the owner.
In absence of any specific law, the hire purchase transactions are governed by the
provisions of the Indian Contract Act and the Sale of Goods Act. Here we will discuss the
provisions of Sale of Goods Act.

Sale of goods act:


In a contract of hire purchase, the element of sale is inherent as the hirer always has the
option to purchase the movable asset by making regular payment of hire charges and the
property in the goods passes to him on payment of the last installment. So in this context we will
discuss the provisions of Sales of Goods Act, which apply to hire purchase contract.

Contract of Sale of Goods:


A contract of sales of goods is a contract whereby the seller transfers or agrees to transfer
the property in goods to the buyer for a price. It includes both an actual sale and an agreement to
sell.
Essential Ingredients of a Sale: A contract of sale is constituted of following elements:
i. Two parties: namely the buyer and the seller, both competent to contract to effectuate the sale.
ii. Goods: The subject matter of the contract.
iii. Money consideration: price of the goods.
iv. Transfer of ownership: of the general property in goods from the seller to the buyer.
v. Essentials of a valid contract under the Indian Contract Act.

Sales v/s Bailment:


In a sales, there is a conveyance of property in goods from seller to the buyer for a price
and the
buyer becomes the owner of goods and can deal with them in the manner he likes. In case of
bailment (or leasing) there is a mere transfer of possession of goods from the bailor to the bailee.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Sales v/s Mortgage, Pledge and Hypothecation:
The essence of contract of a sale is the transfer of general property in the goods. A
mortgage is a transfer of interest in the goods from a mortgagor to mortgagee to secure a debt. A
pledge is a bailment of goods by one person to another to secure payment of a
debt. A hypothecation is an equitable charge on goods without possession, but not amounting to
mortgage. The essence and purpose of these contract is to secure a debt. All the three differ
from sale, since the ownership in the goods is not transferred which is an essential condition of
sale.
Sale v/s hire purchase:
A hire purchase agreement is a kind of bailment whereby the owner of the goods lets
them on hire to another person called hirer, on payment of certain stipulated periodical payments
as hire charges or rent. If the hirer makes payments regularly, he gets an option to purchase the
goods on
making the full payment. Before this option is exercised, the hirer may return the goods without
any obligation to pay the balance rent. The hirer is however, under no compulsion to exercise the
option and purchase the goods at the end of the agreement period.
A hire purchase contract, therefore, differs from sale in the sense
that:
(i) In a hire purchase the possession of the goods is with the
hirer while the ownership vests with the original owner.
(ii) There is no agreement to buy but only an option is given to
hirer to buy the goods under certain conditions, and
(iii) The ownership in the goods passes to the hirer when he exercises his option by making the
full payment.
Goods:
The subject matter of a contract of sale is the ‘goods’. ‘Goods’ mean every kind of
movable property excluding money and auctionable claims. Besides, growing crops, standing
trees and other things attached to or forming part of land, also fall in the meaning of goods,
provided these are agreed to be severed from land before sale or under the contract of sale.
Further, stocks, shares, bonds, goodwill, patent, copyright, trademarks, water, gas, electricity,
ships and so on are all
regarded as goods.
Destruction of goods before making of contract: Where in a contract for sale of specific
goods, at the time of making the contract, the goods, without knowledge of the seller, have
perished or become so damaged as no longer to answer to their description in the contract, the
contract is null and void. This rule, however, does not apply in case of unascertained goods.
Destruction of Goods after the Agreement to sell butbefore sale:
Where in an agreement to sell specific goods, if the goods without any fault on the part of
the seller, have perished or become so damaged as no longer answer to their description
in the agreement, the agreement becomes void, provided the ownership has not passed to the
buyer. If the title to the goods has already passed to the buyer he must pay for the goods
though the same cannot be delivered.
Document of Title to goods:
A document of title to goods is one which entitles and enables its rightful holder to deal
with the goods represented by it, as if he were the owner. It is used in the ordinary course of
business as proof of ownership, possession or control of goods, e.g. cash memo, bill of lading,
dock warrant, warehouse keeper’s or wharfingers certificate, lorry receipt, railway receipt and
delivery order.
Price:

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


The price means the money consideration for transfer of property in goods from the
seller to the buyer. The price may be ascertained in any of the following modes:
i. The price may be expressly stated in the contact.
ii. The price may be left to be fixed in manner provided in the
contract.
iii. Where the price is neither expressed in the contract nor there
is any provision for its determination, it may be ascertained
by the course of dealings between the parties.
iv. It may be a ‘reasonable price’.
v. It may be agreed to be fixed by ‘third party valuation’.
The most usual mode is however, by expressly providing price
in the contract.

EM or security deposit:
In certain contract the buyer pays an amount in advance as earnest money deposit or as a
security deposit, for the due performance on his part of the contract. Though the amount of
earnest money is adjustable towards the price of the goods, it differs from the price in the sense
that while payment towards the prices is recoverable, EM is liable to be forfeited if the buyer
fails to perform his part and the contract goes off.

Doctrine of Caveat Emptor (Let the Buyer Beware):


If the buyer relies on his own skill and judgment and takes the risk of the suitability of the goods
for his purpose, it is no part of the seller’s obligation to caution the buyer of the defects in the
goods or to give to the buyer an article suitable for his purpose. If the buyer relies on his own
skill and judgment and the goods turn out to be defective, he cannot hold the seller responsible
for the same. This is known as the ‘doctrine of caveat emptor’ or ‘let the buyer beware’. This
applies to all sale contracts invariably, except in following cases:

a. When the buyer makes known to the seller the particular purpose for which he requires the
goods and relies on the seller’s skill and judgment.
b. When the goods are sold by description by a manufacturer or seller who deals in goods of that
description, the seller is bound to deliver the goods of merchantable quality.
c. When the purpose for which the goods are purchased is implied from the conduct of the parties
or from the nature or description of the goods, the condition of quality or fitness for that
particular purpose is annexed by the usage of trade.
d. When the seller either fraudulently misrepresents or actively conceals the latent defects.

Transfer of Property in goods:


The property in goods is said to be transferred from the seller to the buyer when the latter
acquires the proprietary rights over the goods and the obligations linked thereto. The transfer of
property in goods is the essence of a contract of sale. The moment when the property in goods
passes from the seller to the buyer is significant from the point that risks associated with the
goods follow the ownership, irrespective of the delivery. If the goods are damaged or destroyed,
the loss is borne by the person who is the owner of the goods at the time of damage or
destruction. The two essential requirements for transfer of property in the goods are

a. Goods must be ascertained and


b. The parties must intend to pass the property in the goods.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Performance of a sale contract:
Performance of a sale contract implies, as regards the seller to deliver the goods, and as
regards the buyer to accept the delivery and make payment for them, in accordance with the
terms of the contract. Unless there is a contract to the contrary, delivery of the goods and
payment of the price are concurrent conditions and are to be performed simultaneously.

Delivery of goods:
‘Delivery’ means ‘voluntary transfer of possession of goods from one person to another’.
Delivery may be (a) actual (b) symbolic or (c) constructive.
Delivery is said to be actual when the goods are handed over physically. A symbolic delivery
takes place where the goods are bulky and incapable of actual delivery e.g. a car is delivered by
handing over the keys to the buyer. A constructive delivery is a delivery by attornment which
takes place when the person in possession of the goods acknowledges that he holds the goods on
behalf and at the disposal of the other person.

Acceptance of Delivery:
The buyer is said to have accepted the goods, when he signifies his assent that he has received
the goods under, and in performance of the contract of sale. A buyer cannot reject the goods after
he has accepted them. A buyer is deemed to have accepted the goods, when:
a. He intimates to the seller, his acceptance or
b. He retains the goods, beyond a reasonable time, without intimating to the seller that he
has rejected them or
c. He does any act in relation to the goods which is consistent with the ownership of the
seller.

7. Enumerate the rights of hirer and discuss the terms and conditions of hire purchase
finance agreement. (May/ June 2013)
The Rights Of Hirer:
Under Hire Purchase Act 1967,
1. Right to copy of statement relating to his financial position- section 9
2. Right to appropriation of payment- section 10
3. Right to apply for an order of goods to be removed- section 11
4. Right to assign- section 12
5. Right by operation of law in the event of death- section 13
6. Right to early completion of agreement- section 14
7. Right to terminate agreement- section 15

Terms and conditions:


1. Duration:
The hiring shall commence on the date specified in the Agreement and shall continue
until determined as therein and hereinafter provided.

2. Rentals:
The Hirer shall punctually and without prior demand pay the instalments as set out in the
Schedule the Agreement on the dates therein provided and time of payment shall be of the
essence of this Agreement. The Hirer shall pay interest at the rate of 9 per cent per annum on all
overdue instalments from the due date until payment thereof and the rights of the Owner
hereunder shall not in any way be affected by any time or other indulgence that the Owner may
see fit to grant to the Hirer..

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


3. Repayment:
The Hirer will repay the amount financed by the Owner to the Hirer in accordance with the terms
and conditions of this credit agreement. Such repayments shall be in euro.

4. Purchase Installment
When:-
i] the Hirer pays the Purchase Instalment and
ii] all instalments and other monies payable by the Hirer to the Owner under the Agreement shall
have been duly paid and provided that the Hirer shall not have committed any breach of these
terms and conditions or of the Agreement and paid the Purchase Instalment, then title to the
goods will pass to the Hirer.

5. Other covenants by hirer


a] The Hirer shall:-

 Keep the Goods in good repair and condition and make good the loss of and all damage
to the Goods whether occasioned by his or her own act, default, neglect or otherwise;
 Keep the Goods at all times in his or her possession and control and not take, send, use,
cause or permit the Goods to be taken, sent or used out of the Republic of Ireland without
prior written consent of the Owner;
 In the event of the Goods being damaged, lost, destroyed or stolen, immediately notify
the Owner thereof in writing;
 Immediately notify the Owner in writing of any change of the Hirer’s address;
 Keep the Goods free from distress, execution or other legal process and punctually pay or
cause to be paid all rent, rates, taxes and other outgoings payable in respect of the
premises where the Goods may be, and produce to the Owner on demand the receipts for
the last payments made in respect thereof;
 Permit the Owner and his authorised agent at all reasonable times to inspect the Goods
and for such purpose to enter upon the premises where the Goods may be;
 Punctually pay all licence duties, registration charges, taxes, insurance premiums and
other charges and outgoings payable in respect of the Goods and/or the use thereof and
produce the receipts for such payments to the Owner and/or his authorised agent on
demand in writing;
 Within 10 days of receipt of a request in writing from the Owner inform the Owner where
the Goods are at the time the information is given or, if sent by post, at the time of
posting;

b] The Hirer shall not during the continuance of the hiring:-


 By any act of omission cause or permit to be done any act or thing which is likely to or
may prejudice the Owner's rights or property in the Goods;
 Abandon, assign, charge, mortgage, pledge, part with possession of, sell, sub-hire or
otherwise deal in the Goods or any licences, registration books or other documents relating
thereto or any interest therein, or in the Agreement or the Purchase Instalment or allow any
lien be created on the Goods or the aforementioned licences, registration books, or
document, whether for repair charges, expenses, storage or otherwise;
 Use or allow the Goods to be used for any unlawful purpose or in contravention of any
statute or regulations for the time being in force or otherwise contrary to law or drive or

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


allow the Goods to be driven in a negligent manner or in breach of the Road Traffic Acts
or any Bye-laws or Regulations made thereunder;
 Remove, alter or change any identification marks, name-plate, trade mark or name on the
Goods or any part thereof, or destroy, damage or alter any registration book, licence or
other document relating to the said Goods.

6. Insurance
The Hirer shall maintain insurance in respect of the Goods where required by law. As the
Hirer is liable to the Owner for any loss or damage arising out of his or her liability to take
reasonable care of the Goods he or she is strongly recommended to keep the Goods
comprehensively insured against all risks for their full replacement value.

7. Termination by Owner
a] Should the Hirer fail to comply with any of these terms and conditions and the
terms of the Agreement or if any information provided by the Hirer is incorrect or untrue the
Owner is entitled to terminate the Agreement after giving notice to the Hirer. Before termination
the Owner shall serve a notice on the Hirer telling the Hirer of the action the Owner proposes to
take. If the Hirer does not remedy the breach detailed in the notice or pay such sum as is stated to
be compensation for the breach within 21 days of the date of service of the notice to the Hirer,
the Owner shall then enforce its rights against the Hirer.

b] On termination of the agreement by the Owner the Hirer will no longer be in possession of the
Goods with the Owner's consent and will be liable to pay to the Owner:-
i] all instalments due to the date of termination;
ii] such sum as will bring the total of the sums paid and sums due under [i]
above to one-half of the Hire Purchase Price;
iii] Damages for any failure to take reasonable care of the Goods.
c] Should the Owner become entitled, pursuant to the provisions of the Agreement or otherwise,
to recover possession of the Goods and should the Goods not forthwith be surrendered by the
Hirer to the Owner, the Hirer hereby irrevocably grants to the Owner, his servants and agents,
full permission, leave and licence, without previous notice, to enter upon any premises owned or
occupied by the Hirer or of which he appears to be the owner or occupier or tenant [other than a
house used as a dwelling or a building within the cartilage thereof] for the purpose of taking
possession of the Goods, and the Hirer expressly agrees that the Owner, his servants or agents
shall not incur any liability to the Hirer or any person claiming through him or her for or in
respect of such entry.

8. General
a] No relaxation, forbearance, indulgence or delay by the Owner in enforcing any of the terms or
conditions of this Agreement or the granting of time by the Owner to the Hirer, shall prejudice,
affect or restrict the rights and powers of the Owner hereunder nor shall any waiver by the
Owner or any breach operate as a waiver of any subsequent or any continuing breach;
b] Any notice, letter or document permitted or required to be given to the Hirer under this
Agreement shall be deemed to have been validly given if served on the Hirer personally or sent
to him by prepaid ordinary post or left at the address of the Hirer stated in the Agreement or at
the last address which shall have been notified in writing to the Owner, and any such notice,
letter or document sent by post shall be conclusively deemed to have been received by the Hirer
within 48 hours after the time of posting;
c] The liability of two or more Hirers signing the Agreement as Hirers shall be joint and several;

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


d] The Agreement shall in all respects be interpreted in accordance with the laws of Ireland.

ANNA UNIVERSITY QUESTIONS


PART-A
1. Explain if leasing or hire purchase should be the financing option, when a firm is short of
cash (APRIL/MAY 2011)
2. What is the tax advantage of financial lease? (APRIL/MAY 2011)
3. What is hire purchase? (NOV/DEC-2011)
4. Define Hire Purchase Agreement. (NOV/DEC-2011)
5. What is forfaiting? (MAY/JUNE 2012)
6. What is loan syndication? (MAY/JUNE 2012)
7. Write a note on Efficient Rate Interest calculation in hire purchase financing.
(NOV/DEC-2012)
8. Write a note on consumer credit. (NOV/DEC-2012)
9. Define hire purchasing. (MAY/JUNE 2013)
10. What is leasing in financial services? (MAY/JUNE 2013)
11. Define leasing. (NOV/DEC-2013)
12. State any four features of Hire purchasing. (NOV/DEC-2013)
13. State the various elements of lease (MAY/JUNE 2014)
14. What are the characteristics of a hire-purchase transaction? (MAY/JUNE 2014)

PART-B
1. Distinguish between Financial and Operating Lease. (APRIL/MAY 2011)
2. Explain the parameters that should be considered when evaluating lease as a financing
option. (APRIL/MAY 2011)
3. What is hire purchase? In what Mays it is different from leasing? Explain the guidelines
applicable to banks for hire purchase business. (NOV/DEC-2011)
4. Explain the different kinds of leasing. Distinguish operating lease from financial lease.
(NOV/DEC-2011)
5. Explain the various types of leases. Highlight their major advantages and disadvantages.
(MAY/JUNE 2012)
6. Who are the parties to HP contract? Distinguish hire purchase from .leasing (MAY/JUNE
2012)
7. Who are the parties involved in leasing? Differentiate financial lease from the operating
lease. (NOV/DEC-2012)
8. Enumerate the rights of hirer and discuss the terms and conditions of hire purchase
finance, agreement. (NOV/DEC-2012)
9. Discuss the income tax implications to a less or and a lessee. (NOV/DEC-2013)
10. Distinguish between hire purchase and leasing. (NOV/DEC-2013)
11. "Lease financing as an best alternative source of finance to
manufacturing industries" Discuss. (MAY/JUNE 2014)
12. List out and explain the point of differences between leasing and hire purchasing.
(MAY/JUNE 2014)

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


UNIT V- OTHER FUND BASED FINANCIAL SERVICES

Consumer Credit –Credit Cards –Real Estate Financing –Bills Discounting –factoring and
Forfeiting –Venture Capital

PART-A

1. Define venture capital.

Venture capital investment is defined as the provision of risk bearing capital, usually in
the form of a participation in equity, to companies with high growth potential.

2. What are the methods of venture capital?


 Conventional method
 First Chicago method
 Revenue method
3. What is credit card?
A card issued by a financial company giving the holder an option to borrow funds,
usually at point of sale. Credit cards charge interest and are primarily used for short-
term financing. Interest usually begins one month after a purchase is made and borrowing
limits are pre-set according to the individual's credit rating.

4. What are the types of credit card?

 Standard card
 Business card
 Gold card
 Master card
 VISA card
 Smart card
 Debit card

5. Define factoring. (May/June 2013), (MAY/JUNE 2014)

A continuing legal relationship between a financial institution and a business concern


selling goods or providing service to trade customers, whereby the factor purchases the clients
book debts, either with or without recourse to the client, and in relation thereto, controls the
credit extended to customers, and administers the sales ledger.

• SBI Factors and Commercial Services Pvt. Ltd

• HSBC Factoring Solutions

• PNB Factoring:PNB Subsidiary Company IFCI Ltd.

• Small Industries Development Bank of India (SIDBI)

6. What are the types of factoring?

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


 Full factoring
 With recourse factoring
 Without recourse factoring
 Maturity factoring
 Advance factoring
 Confidential factoring
 International factoring
 Bank financing factoring

7. What are the steps involved in the factoring transactions?


 Order received by the seller from buyer
 Seller obtains details of buyer’s credit worthiness with the factor.
 Seller executes the order
 Seller raising the invoice with the factor.

7. Define forfeiting. (APRIL/MIAY 2011), (MAY/JUNE 2012)

A form of financing of receivables arising from international trade is known a forfeiting.

Forefaiting is a mechanism by which the right for export receivables of an exporter (Client) is
purchased by a Financial Intermediary (Forfaiter) without recourse to him. It is different from
International Factoring in as much as it deals with receivables relating to deferred payment
exports, while Factoring deals with short term receivables.

8. What is a bill discounting? (May/June 2013), (NOV/DEC 2010)

When the seller deposits genuine commercial bills and obtains financial accommodation
from a bank or financial institution. It is known as “bill discounting”. The sellers, instead of
discounting the bill immediately may choose to wait choose to wait till the date of maturity.

9. Write a note on consumer credit. (Nov/Dec 2012), (APRIL/MIAY 2011)


Consumer credit is basically the amount of credit used by consumers to purchase non-
investment goods or services that are consumed and whose value depreciates quickly.

 What is seed capital? (Nov/Dec 2012)

Seed capital is the earliest stage of for a start-up venture.The seed capital stage is the
earliest stage of capital in a startup company. Seed capital is usually provided by the
owners, family, friends, or angels (i.e. individuals who invest in companies on an individual

11. What are the various types of venture capital? (APRIL/MIAY 2010)

 VCFs promoted by the Central govt. controlled development financial institutions


 VCFs promoted by the state government-controlled development finance institutions

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


 VCFs promoted by Public Sector banks
 VCFs promoted by the foreign banks or private sector companies and financial
institutions

12. What is real estate financing? (NOV/DEC 2010), (NOV/DEC 20110029

Real estate is "property consisting of land and the buildings on it, along with its natural
resources such as crops, minerals, or water; immovable property of this nature; an interest vested
in this; (also) an item of real property; (more generally) buildings or housing in general. Also:
the business of real estate; the profession of buying, selling, or renting land, buildings or
housing."

13. What is 'smart card'? (NOV/DEC 2013)

A smart card is a plastic card about the size of a credit card, with an embedded microchip that
can be loaded with data, used for telephone calling, electronic cash payments, and other
applications, and then periodically refreshed for additional use.

14. List out the different stages of venture capital financing (MAY/JUNE 2014)

 Seed stage
 Early Stage
 Formative Stage
 Later Stage
 Balanced-stage

15. What is EDI factoring? (NOV/DEC 2011), (NOV/DEC 2013)

EDI factoring refers to availing of factoring services via the computer.

EDI-Electronic Data Interchange.

• Automatic credit requests via modem with factor after you have entered the customers
orders

• Automatic credit approvals via modem with factor

• Automatic transfer of invoice assignments to factor

• Receipt of factor's accounts receivable information to support in-house order approvals


based on the customer's credit line established by the factor

PART-B

1. What are the methods of venture Capital finance in India? Explain the importance of
venture capital for the development of a country?

OR

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Explain the importance of venture capital for the development of a country.

OR

Discuss the performance of various venture capital firms in India. (NOV/DEC 2013)

The venture capital investment helps for the growth of innovative entrepreneurships in India.
Venture capital has developed as a result of the need to provide non-conventional, risky finance
to new ventures based on innovative entrepreneurship. Venture capital is an investment in the
form of equity, quasi-equity and sometimes debt - straight or conditional, made in new or untried
concepts, promoted by a technically or professionally qualified entrepreneur. Venture capital
means risk capital. It refers to capital investment, both equity and debt, which carries substantial
risk and uncertainties. The risk envisaged may be very high may be so high as to result in total
loss or very less so as to result in high gains

The concept of Venture Capital

Venture capital means many things to many people. It is in fact nearly impossible to come across
one single definition of the concept.

Jane Koloski Morris, editor of the well known industry publication, Venture Economics,
defines venture capital as 'providing seed, start-up and first stage financing' and also 'funding the
expansion of companies that have already demonstrated their business potential but do not yet
have access to the public securities market or to credit oriented institutional funding sources.

The European Venture Capital Association describes it as risk finance for entrepreneurial
growth oriented companies. It is investment for the medium or long term return seeking to
maximize medium or long term for both parties. It is a partnership with the entrepreneur in
which the investor can add value to the company because of his knowledge, experience and
contact base.

Venture Capital in India

In India the Venture Capital plays a vital role in the development and growth of innovative
entrepreneurships. Venture Capital activity in the past was possibly done by the developmental
financial institutions like IDBI, ICICI and State Financial Corporations. These institutions

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


promoted entities in the private sector with debt as an instrument of funding. For a long time
funds raised from public were used as a source of Venture Capital. This source however
depended a lot on the market vagaries. And with the minimum paid up capital requirements
being raised for listing at the stock exchanges, it became difficult for smaller firms with viable
projects to raise funds from public. In India, the need for Venture Capital was recognized in the
7th five year plan and long term fiscal policy of GOI. In 1973 a committee on Development of
small and medium enterprises highlighted the need to faster VC as a source of funding new
entrepreneurs and technology. VC financing really started in India in 1988 with the formation of
Technology Development and Information Company of India Ltd. (TDICI) - promoted by ICICI
and UTI. The first private VC fund was sponsored by Credit Capital Finance Corporation (CFC)
and promoted by Bank of India, Asian Development Bank and the Commonwealth Development
Corporation viz. Credit Capital Venture Fund. At the same time Gujarat Venture Finance Ltd.
and APIDC Venture Capital Ltd. were started by state level financial institutions. Sources of
these funds were the financial institutions, foreign institutional investors or pension funds and
high net-worth individuals. The venture capital funds in India are listed in Annexure I.
Venture Capital Investments in India

The venture capital investment in India till the year 2001 was continuously increased and thereby
drastically reduced. Chart I shows that there was a tremendous growth by almost 327 percent in
1998-99, 132 percent in 1999-00, and 40 percent in 2000-01 thereafter venture capital investors
slow down their investment. Surprisingly, there was a negative growth of 4 percent in 2001-02 it
was continued and a 54 percent drastic reduction was recorded in the year 2002-2003.

Companies based in north India accounted for 24% of the investments in 2013 (23% by value),
Among cities, companies headquartered in Bangalore and Mumbai were the favourite among VC
investors during 2013 attracting 49 investments each, followed by Delhi-based companies that
accounted for 24 investments and Chennai-based companies with 21 investments. Gurgaon and
Hyderabad followed with 15 deals and 8 deals respectively.

Venture capital firms invested about $805 million over 206 deals in India during the twelve
months ended December 2013, according to analysis by Venture Intelligence, a research service
focused on private company financials, transactions and valuations. The VC investment activity

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


was about 18% lower compared to 2012 which had witnessed 252 transactions worth $898
million.

SEBI Venture Capital Funds (VCFs) Regulations, 1996

A Venture Capital Fund means a fund established in the form of a trust/company; including a
body corporate, and registered with SEBI which (i) has a dedicated pool of capital raised in a
manner specified in the regulations and (ii) invests in venture capital undertakings (VCUs) in
accordance with these regulations.

A Venture Capital Undertaking means a domestic company (i) whose shares are not listed on a
recognized stock exchange in India and (ii) which is engaged in the business of providing
services/production/manufacture of articles/things but does not include such activities/sectors as
are specified in the negative list by SEBI with government approval-namely, real estate, non-
banking financial companies (NBFCs), gold financing, activities not permitted under the
industrial policy of the Government and any other activity which may be specified by SEBI in
consultation with the Government from time to time.

Registration

All VCFs must be registered with SEBI and pay Rs.25, 000 as application fee and Rs. 5, 00,000
as registration fee for grant of certificate.

Recommendations of SEBI (Chandrasekhar) Committee, 2000 SEBI appointed the


Chandrasekhar Committee to identify the impediments in the growth of venture capital industry
in the country and suggest suitable measures for its rapid growth. Its report was submitted in
January, 2000. The recommendations pertain to

1. Harmonization of multiplicity of regulations


2. VCF structures
3. Resource raising
4. Investments
5. Exit
6. SEBI regulations
7. Company law related issues and

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


8. Other related issues.

2.Explain the various types of venture capital and its process.

Types of Venture Capital Funds

Generally there are three types of organized or institutional venture capital funds: venture capital
funds set up by angel investors, that is, high net worth individual investors; venture capital
subsidiaries of corporations and private venture capital firms/ funds. Venture capital subsidiaries
are established by major corporations, commercial bank holding companies and other financial
institutions. Venture funds in India can be classified on the basis of the type of promoters.

1. VCFs promoted by the Central govt. controlled development financial institutions


such as TDICI, by ICICI, Risk capital and Technology Finance Corporation Limited (RCTFC)
by the Industrial Finance Corporation of India (IFCI) and Risk Capital Fund by IDBI.
2. VCFs promoted by the state government-controlled development finance
institutions such as Andhra Pradesh Venture Capital Limited (APVCL) by Andhra Pradesh State
Finance Corporation (APSFC) and Gujarat Venture Finance Company Limited (GVCFL) by
Gujarat Industrial Investment Corporation (GIIC)
3. VCFs promoted by Public Sector banks such as Canfina by Canara Bank and SBI-
Cap by State Bank of India.
4. VCFs promoted by the foreign banks or private sector companies and financial
institutions such as Indus Venture Fund, Credit Capital Venture Fund and Grind lay’s India
Development Fund.

The Venture Capital Investment Process:

The venture capital activity is a sequential process involving the following six steps.

1) Deal origination
2) Screening
3) Due diligence Evaluation
4) Deal structuring
5) Post-investment activity
6) Exist

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Venture Capital Investment Process

Deal origination:

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


In generating a deal flow, the VC investor creates a pipeline of deals or investment opportunities
that he would consider for investing in. Deal may originate in various ways. referral system,
active search system, and intermediaries. Referral system is an important source of deals. Deals
may be referred to VCFs by their parent organizations, trade partners, industry associations,
friends etc. Another deal flow is active search through networks, trade fairs, conferences,
seminars, foreign visits etc. Intermediaries is used by venture capitalists in developed countries
like USA, is certain intermediaries who match VCFs and the potential entrepreneurs.

Screening:

VCFs, before going for an in-depth analysis, carry out initial screening of all projects on the
basis of some broad criteria. For example, the screening process may limit projects to areas in
which the venture capitalist is familiar in terms of technology, or product, or market scope. The
size of investment, geographical location and stage of financing could also be used as the broad
screening criteria.

Due Diligence:

Due diligence is the industry jargon for all the activities that are associated with evaluating an
investment proposal. The venture capitalists evaluate the quality of entrepreneur before
appraising the characteristics of the product, market or technology. Most venture capitalists ask
for a business plan to make an assessment of the possible risk and return on the venture. Business
plan contains detailed information about the proposed venture. The evaluation of ventures by
VCFs in India includes;

Preliminary evaluation: The applicant required to provide a brief profile of the proposed venture
to establish prima facie eligibility.

Detailed evaluation: Once the preliminary evaluation is over, the proposal is evaluated in greater
detail. VCFs in India expect the entrepreneur to have:- Integrity, long-term vision, urge to grow,
managerial skills, commercial orientation.

VCFs in India also make the risk analysis of the proposed projects which includes: Product risk,
Market risk, Technological risk and Entrepreneurial risk. The final decision is taken in terms of
the expected risk-return trade-off as shown in Figure.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Deal Structuring:

In this process, the venture capitalist and the venture company negotiate the terms of the deals,
that is, the amount, form and price of the investment. This process is termed as deal structuring.
The agreement also include the venture capitalist's right to control the venture company and to
change its management if needed, buyback arrangements, acquisition, making initial public
offerings (IPOs), etc. Earned out arrangements specify the entrequreneur's equity share and the
objectives to be achieved.

Post Investment Activities:

Once the deal has been structured and agreement finalised, the venture capitalist generally
assumes the role of a partner and collaborator. He also gets involved in shaping of the direction
of the venture. The degree of the venture capitalist's involvement depends on his policy. It may
not, however, be desirable for a venture capitalist to get involved in the day-to-day operation of
the venture. If a financial or managerial crisis occurs, the venture capitalist may intervene, and
even install a new management team.

Exit:

Venture capitalists generally want to cash-out their gains in five to ten years after the initial
investment. They play a positive role in directing the company towards particular exit routes. A
venture may exit in one of the following ways:

1. Initial Public Offerings (IPOs)

2. Acquisition by another company

3. Purchase of the venture capitalists shares by the promoter, or

4. Purchase of the venture capitalists share by an outsider.

3. Explain the stages of venture capital

Venture Capital Financing Process

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


There are several ways to attract funding. However in general, the venture capital financing
process can be distinguished into five stages;

1. The Seed stage


2. The Start-up stage
3. The Second stage
4. The Third stage
5. The Bridge/Pre-public stage

The Stages in Venture Capital (VC) Investing


Angel investors are most often individuals (friends, relations or entrepreneurs) who want to help
other entrepreneurs get their businesses off the ground - and earn a high return on their
investment. The term "angel" comes from the practice in the early 1900s of wealthy businessmen
investing in Broadway productions. Usually they are the bridge from the self-funded stage of the
business to the point that the business needs true venture capital. Angel funding usually ranges
from $150,000 to $1.5 million. They typically offer expertise, experience and contacts in
addition to money.

1. Seed - The first stage of venture capital financing. -stage financings are often
comparatively modest amounts of capital provided to inventors or entrepreneurs to
finance the early development of a new product or service. These early financings may be
directed toward product development, market research, building a management team. A
genuine seed-stage company has usually not yet established commercial operations - a
cash infusion to fund continued research and product development is essential. These

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


early companies are typically quite difficult business opportunities to finance, often
requiring capital for pre-startup R&D, Seed-stage VC funds will typically participate in
later investment rounds with other equity players to finance business expansion costs
such as sales and distribution, parts and inventory, hiring, training and marketing.
2. Early Stage - For companies that are able to begin operations but are not yet at the stage
of commercial manufacturing and sales, early stage financing supports a step-up in
capabilities. At this point, new business can consume vast amounts of cash, while VC
firms with a large number of early-stage companies in their portfolios can see costs
quickly escalate.
o Start-up - Supports product development and initial marketing. Start-up
financing provides funds to companies for product development and initial
marketing. This type of financing is usually provided to companies just organized
or to those that have been in business just a short time but have not yet sold their
product in the marketplace. Generally, such firms have already assembled key
management, prepared a business plan and made market studies. At this stage, the
business is seeing its first revenues but has yet to show a profit. This is often
where the enterprise brings in its first "outside" investors.
o First Stage - Capital is provided to initiate commercial manufacturing and sales.
Most first-stage companies have been in business less than three years and have a
product or service in testing or pilot production. In some cases, the product may
be commercially available.
3. Formative Stage - Financing includes seed stage and early stage.
4. Later Stage - Capital provided after commercial manufacturing and sales but before any
initial public offering. The product or service is in production and is commercially
available. The company demonstrates significant revenue growth, but may or may not be
showing a profit. It has usually been in business for more than three years.
o Third Stage - Capital provided for major expansion such as physical plant
expansion, product improvement and marketing.
o Expansion Stage - Financing refers to the second and third stages.
o Mezzanine (bridge) - Finances the step of going public and represents the bridge
between expanding the company and the IPO
5. Balanced-stage financing refers to all the stages, seed through mezzanine.

Methods of Venture Financing

Venture capital is typically available in three forms in India, they are:

Equity : All VCFs in India provide equity but generally their contribution does not exceed 49
percent of the total equity capital. Thus, the effective control and majority ownership of the firm
remains with the entrepreneur. They buy shares of an enterprise with an intention to ultimately
sell them off to make capital gains.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Conditional Loan: It is repayable in the form of a royalty after the venture is able to generate
sales. No interest is paid on such loans. In India, VCFs charge royalty ranging between 2 to 15
percent; actual rate depends on other factors of the venture such as gestation period, cost-flow
patterns, riskiness and other factors of the enterprise.

Income Note : It is a hybrid security which combines the features of both conventional loan and
conditional loan. The entrepreneur has to pay both interest and royalty on sales, but at
substantially low rates.

Other Financing Methods: A few venture capitalists, particularly in the private sector, have
started introducing innovative financial securities like participating debentures, introduced by
TCFC is an example.

A Case on Technology Development & Information Company Of India Ltd.

TDICI was incorporated in January 1988 with the support of the ICICI and the UTI. The
country's first venture fund managed by the TDICI called VECAUS ( Venture Capital Units
Scheme) was started with an initial corpus of Rs.20 crore and was completely committed to 37
small and medium enterprises. The first project of the TDICI was loan and equity to a computer
software company called Kale Consultants.

Present Status: At present the TDICI is administering two UTI –mobilised funds under
VECAUS-I and II, totaling Rs.120 crore. the Rs.20 crore invested under the first fund,
VECAUS-I, has already yielded returns totaling Rs. 16 crore to its investors.

Some important Venture Capital Funds in India

1) APIDC Venture Capital Limited ,1102, Babukhan Estate, Hyderabad


2) Canbank Venture Capital Fund Limited, IInd Floor, Kareem Towers, Bangalore
3) Gujarat Venture Capital Fund 1997, Ashram Road, Ahmedabad
4) Industrial Venture Capital Limited, Thyagaraya Road, Chennai
5) Auto Ancillary Fund Opp. Signals Enclave, New Delhi
6) Gujarat Venture Capital Fund 1995 Ashram Road Ahmedabad
7) Karnataka Information Technology Venture Capital Fund Cunningham Rd Bangalore
8) India Auto Ancillary Fund Nariman Point, Mumbai

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


9) Information Technology Fund, Nariman Point, Mumbai
10) TamilnaduInfotech Fund Nariman Point, Mumbai
11) Orissa Venture Capital Fund Nariman Point Mumbai
12) Uttar Pradesh Venture Capital Fund Nariman Point, Mumbai
13) SICOM Venture Capital Fund Nariman Point Mumbai
14) Punjab Infotech Venture Fund 18 Himalaya Marg, Chandigarh
15) National Venture Fund for Software and Information Technology Industry, Nariman
Point, Mumbai

4. Discuss in detail the various services rendered by factoring intermediaries.


OR
Explain the mechanism of factoring with the help of a diagram. (MAY/JUNE 2014)

Factoring is defined 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 (the
customers) on open account basis whereby the Factor purchases the client’s book debts (accounts
receivables) either with or without recourse to the client and in relation thereto controls the credit
extended to customers and administers the sales ledgers’.
“Factoring is an arrangement under which a financial institution (called factor) undertakes the
task of collecting the book debts of its client in return for a service charge in the form of discount
or rebate.”
 Factoring is a financial service covering the financing and collection of accounts
receivables in domestic as well as in international trade. Basically, factoring is an
arrangement in which receivables on account of sale of goods or services are sold to the
factor at a certain discount. Factoring is a service of financial nature involving the
conversion of credit bills into cash.
 In simple definition it is the converstion of credit sales into cash.
Factoring –meaning:
 Factoring is the Sale of Book Debts by a firm (Client) to a financial institution (Factor)
on the understanding that the Factor will pay for the Book Debts as and when they are
collected or on a guaranteed payment date.
 Normally, the Factor makes a part payment (usually upto 80%) immediately after the
debts is purchased thereby providing immediate liquidity to the Client.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


 As the factor gets the title to thereceivables on account of the factoringcontract, factor
becomes responsible for allcredit control, sales ledger administrationand debt collection
from the customers.
Factor - Meaning

 Factor means “to make or to do” in other words ‘to get things done’.
 Dictionary meaning of Factor means ‘an agent’, engaged in financing the operations of
certain companies, through the purchase of account receivables.
Functions of factoring:

 Purchase and collection of debt


 Sales ledger management
 Credit investigation and undertaking of credit risk
 Provision of finance against debts
 Rendering consulting services

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET



PROCESS INVOLVED IN FACTORING

 Client concludes a credit sale with a customer.


 Client sells the customer’s account to the Factor and notifies the customer.
 Factor makes part payment (advance) against account purchased, after adjusting for
commission and interest on the advance.
 Factor maintains the customer’s account and follows up for payment.
 Customer remits the amount due to the Factor.
 Factor makes the final payment to the Client when the account is collected or on the
guaranteed payment date.

MECHANICS OF FACTORING

 The Client (Seller) sells goods to the buyer and prepares invoice with a notation that debt
due on account of this invoice is assigned to and must be paid to the Factor (Financial
Intermediary).

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


 The Client (Seller) submits invoice copy only with Delivery Challan showing receipt of
goods by buyer, to the Factor.
 The Factor, after scrutiny of these papers, allows payment (, usually upto 80% of invoice
value). The balance is retained as Retention Money (Margin Money). This is also called
Factor Reserve.
 The drawing limit is adjusted on a continuous basis after taking into account the
collection of Factored Debts.
 Once the invoice is honoured by the buyer on due date, the Retention Money credited to
the Client’s Account.
 Till the payment of bills, the Factor follows up the payment and sends regular statements
to the Client.
INDUSTRIES THAT CAN BE COVERED BY FACTORING:

 Small Scale Industries with growth potentials


 Medium Scale Industries
 Service Industries
CHARGES FOR FACTORING SERVICES

 Factor charges Commission (as a flat percentage of value of Debts purchased) (0.50% to
1.50%)
 Commission is collected up-front.
 For making immediate part payment, interest charged. Interest is higher than rate of
interest charged on Working Capital Finance by Banks.
 If interest is charged up-front, it is called discount.

Explain the various Types of factoring:

The factoring facility available worldwide can be broadly classified into four main groups:

• Full service non-recourse

• Full service recourse factoring

• Non-notification factoring

• Domestic Factoring & Export Factoring

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Full service Non recourse factoring:

 Under this method, book debts are purchased by the factor, assuming 100% credit risk.
The full amount of invoices has to be paid to clients in the event of debt becoming bad.
The client prefers this type of factoring to obtain 100% cover under factoring rather than
take insurance policy which provides only 70%-80% cover.
 Factor purchases Receivables on the condition that the Factor has no recourse to the
Client, if the debt turns out to be non-recoverable.
 Credit risk is with the Factor.
 Higher commission is charged.
 Factor participates in credit sanction process and approves credit limit given by the Client
to the Customer.
 In USA/UK, factoring is commonly done without recourse.
Full service recourse factoring:

 Upto 75% to 85% of the Invoice Receivable is factored.


 Interest is charged from the date of advance to the date of collection.
 Factor purchases Receivables on the condition that loss arising on account of non-
recovery will be borne by the Client.
 Credit Risk is with the Client.
 Factor does not participate in the credit sanction process.
 In India, factoring is done with recourse.
Non-notification factoring

In this type of factoring, customers are not informed about the factoring agreement. It is through
this company that the factor deals with the client’s customers. This type of factoring is available
in the UK to financially strong companies.

Domestic Factoring

Domestic factoring provides funding against invoices raised on customers within India.

Three parties: 1.Customer 2.Client 3.Factor

Export Factoring

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Export factoring provides immediate financing against your export receivables. Financing can be
availed in Rupees or in foreign currency.

Four parties:
1. Customer (importer)
2. Client (exporter)
3. Import factor
4. Export factor
It’s also called ‘Two-Factor System of Factoring’
CROSS - BORDER FACTORING

 It is similar to domestic factoring except that there are four parties, viz.,
a) Exporter,
b) Export Factor,
c) Import Factor, and
d) Importer.
 It is also called two-factor system of factoring.
 Exporter (Client) enters into factoring arrangement with Export Factor in his country and
assigns to him export receivables.
 Export Factor enters into arrangement with Import Factor and has arrangement for credit
valuation & collection of payment for an agreed fee.
 Notation is made on the invoice that importer has to make payment to the Import Factor.
 Import Factor collects payment and remits to Export Factor who passes on the proceeds
to the Exporter after adjusting his advance, if any.
 Where foreign currency is involved, Factor covers exchange risk also.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


MATURITY FACTORING

 Factor does not make any advance payment to the Client.


 Pays on guaranteed payment date or on collection of Receivables.
 Guaranteed payment date is usually fixed taking into account previous collection
experience of the Client.
 Nominal Commission is charged.
 No risk to Factor.

STATUTES APPLICABLE TO FACTORING

Factoring transactions in India are governed by the following Acts:-

a) Indian Contract Act


b) Sale of Goods Act
c) Transfer of Property Act
d) Banking Regulation Act.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


e) Foreign Exchange Regulation Act.

WHY FACTORING HAS NOT BECOME POPULAR IN INDIA

 Banks’ reluctance to provide factoring services


 Bank’s resistance to issue Letter of Disclaimer (Letter of Disclaimer is mandatory as per
RBI Guidelines).
 Problems in recovery.
 Factoring requires assignment of debt which attracts Stamp Duty.
 Cost of transaction becomes high.

Factoring companies in India

 SBI Factors and Commercial Services Pvt. Ltd


 HSBC Factoring Solutions
 PNB Factoring:PNB Subsidiary Company IFCI Ltd.
 Small Industries Development Bank of India (SIDBI)

5. What is forfeiting? Explain the mechanism of forfeiting.


 Forefaiting is a mechanism by which the right for export receivables of an exporter
(Client) is purchased by a Financial Intermediary (Forfaiter) without recourse to him. It is

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


different from International Factoring in as much as it deals with receivables relating to
deferred payment exports, while Factoring deals with short term receivables.
 Exporter under Forfaiting surrenders his right for claiming payment for services rendered
or goods supplied to Importer in favour of Forefaiter.
 Bank (Forefaiter) assumes default risk possessed by the Importer.
 Credit Sale gets converted as Cash Sale.
 Forfaiting is arrangement without recourse to the Exporter (seller)
 Operated on fixed rate basis (discount)
 Finance available upto 100% of value (unlike in Factoring)
 Introduced in the country in 1992.

Six Parties in Forfaiting

1) Exporter (India)
2) Importer (Abroad)

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


3) Exporter’s Bank (India)
4) Importer’s/Avalising Bank (Abroad)
5) EXIM Bank (India)
6) Forfaiter (Abroad)
Forfaiting: 8 Steps

1) Commercial contract: Exporter & Foreign Buyer


2) Commitment to Forfait BE, Pro Notes
3) Delivery of Goods by Exporter to Buyer
4) Delivery of BE / PN to Bank to EXIM Bk
5) Endorsement of BE / PN without recourse
6) Cash Payment/ thro’ a Nostro Account
7) Presentation of BE / PN to Buyer on maty
8) Payment of Debt Instrument on maturity
COSTS INVOLVED IN FORFAITING

 Commitment Fee: - Payable to Forfaiter by Exporter in consideration of forefaiting


services.
 Commission: - Ranges from 0.5% to 1.5% per annum.
 Discount Fee: - Discount rate based on LIBOR for the period concerned.
 Documentation Fee: - where elaborate legal formalities are involved.
 Service Charges: - payable to Exim Bank.
CHARACTERISTICS OF FORFAITING

 Converts Deferred Payment Exports into cash transactions, providing liquidity and cash
flow to Exporter.
 Absolves Exporter from Cross-border political or conversion risk associated with Export
Receivables.
 Finance available upto 100% (as against 75-80% under conventional credit) without
recourse.
 Acts as additional source of funding and hence does not have impact on Exporter’s
borrowing limits. It does not reflect as debt in Exporter’s Balance Sheet.
 Provides Fixed Rate Finance and hence risk of interest rate fluctuation does not arise.
Benefits to Exporters

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


1) Converts a Deferred Payment export into a cash transaction, improves liquidity
2) Frees Exporter from cross-border political or commercial risks associated
3) Finances upto100 percent of export value
4) It is“Without Recourse” finance
5) Hedges against Interest and Exchange Risks
Benefits to the importer
1) The Importer can match repayments to projected revenues, allowing for grace periods.
2) The Importer can obtain 100% financing, and avoid paying out cash in advance.
3) The Importer can pay interest on a fixed rate basis for the life of the credit, which will
make budgeting simpler and safer.
4) The Importer can access medium to long term financing which may be prohibitively
expensive or completely unavailable locally.
5) The Importer may be able to take advantage of export subsidy schemes which are often
available from the Exporter's government.
Drawbacks of forfaiting

1) Non-availability for short Periods


2) Non-availability for financially weak countries
3) Dominance of western currencies
4) Difficulty in procuring international bank’s guarantee
5) Forfaiting is not available for deferred pauments especially while exporting capital goods
for which payment will be made on a deferred basis by the importer.
Difference between factoring and forfaiting:

S.No Factoring Forfaiting


1 Suitable for ongoing open account Oriented towards single transactions
sales, not backed by LC or accepted backed by LC or bank guarantee.
bills or exchange.
2 Usually provides financing for Financing is usually for medium to long-
short-term credit period of upto 180 term credit periods from 180 days upto7
days years though shorterm credit of 30–180
days is also available for large transactions
3 Requires a continuous arrangements Seller need not route or commit other
between factor and client, whereby business to the forfaiter. Deals are

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


all sales are routed through the concluded transaction-wise.
factor
4 Factor assumes responsibility for Forfaiter’s responsibility extends to
collection, helps client to reduce his collection of forfeited debt only. Existing
own overheads. financing lines remains unaffected
5 Separate charges are applied for Single discount charges is applied which
— financing depend on
— collection — guaranteeing bank and country risk,
— administration — credit period involved and
— credit protection and — Currency of debt.
— provision of information. An only additional charge is commitment
fee, if firm commitment is required prior to
draw down during delivery period.
6 Service is available for domestic Usually available for export receivables
and export receivables. only denominated in any freely convertible
Currency.
7 Financing can be with or without It is always ‘without recourse’ and
recourse; the credit protection essentially a financing product.
collection and administration
services may also be provided
without financing.

6. What is a credit card? What are the facilities offered to credit card holders? Discuss the
advantage and disadvantage of credit card to various parties. (MAY/JUNE 2014)

A card issued by a financial company giving the holder an option to borrow funds,
usually at point of sale. Credit cards charge interest and are primarily used for short-
term financing. Interest usually begins one month after a purchase is made and borrowing limits
are pre-set according to the individual's credit rating.

FACILITIES:

 The main facility to each customer is convenience.


 Compared to debit card and cheques, a credit card allows small short-term loans to be quickly
made to a customer who need not calculate a balance remaining before every transaction,
provided the total charges do not exceed the maximum credit line for the card.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


 Credit cards also provide more fraud protection than debit cards. In the UK for example, the
bank is jointly liable with the merchant for purchases of defective products over £100.
 Many credit card offer rewards and benefit packages, such as offering enhanced product
warranties at no cost, free loss/damage coverage on new purchases, and point which may be
redeemed for cash, products, or airline tickets.
 Additionally. Carrying a credit card may be a convenience to some customer as it eliminates a
need to carry any cash for most purposes.
 Low introductory credit card rates are limited to a fixed term, usually between 6 and 12
months, after which a higher rate is charged.
 In some cases universal default may apply: the high default rate is applied to a card in good
standing by missing a payment on an unrelated account from the same provider. This can lead to
a snowball effect in which the consumer is drowned by unexpectedly high interest rates.
 Further, most card holder agreements enable the issuer to arbitrarily raise the interest rate for
any reason they see fit. As of December 2010, First Premier Bank is reportedly offering a credit
card with a 79.9% interest rate.

BENEFITS TO MERCHANTS:

 For merchants, a credit card transaction is often more secure than other of payment, such as
cheques, because the issuing bank to pay the merchant the moment the transaction is
authtrorized, regardless of whether the consumer defaults on the credit card payment.
 Prior to credit cards, each merchant had to evaluate each customer’s credit history before
extending credit. That task is now performed by the banks which assume the credit risk.
 Credit cards can also aid in securing a sale, especially if the customer does not have enough
cash on his or her person or checking account.
 For each purchase, the bank charges the merchant a commission (discount fee) for the service
and there may be a certain delay before the agreed payment is received by the merchant.
 The commission is often a percentage of the transaction amount, plus a fixed fee ( Interchange
rate)
 In addition, a merchant may be penalized or have their ability to receive payment using that
credit card restricted if there are too many cancellations or reversals of charges as a result of
disputes. Some small merchants require credit purchases to have a minimum amount to
compensate for the transaction cost.
 In some countries, for example the Nordic countries, bank guarantee payment stolen cards
only if an ID card is checked and the ID card number/ civic registration number is written down
on the receipt together with the signature. In these countries merchants therefore usually ask for
ID.
 Non-Nordic citizens, who are unlikely to possess a Nordic ID card or driving licenses, will
instead, have to show their passport, and the passport number will be written down on the
receipt, sometimes together with other information.
 Some shops use the card’s PIN for identification, and in that case showing an ID card is not
necessary.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


7. How bills discounting does differ from factoring?

Bills Discounting Factoring


1. The drawer undertakes the responsibility of 1. Factoring undertakes to collect the bills of
collecting the bills and remitting the proceeds the client.
to financing agency.
2. Bills discounted may be re-discounted Debts purchased for factoring can be re-
several times before the maturity. discounted, they can only be refinanced.
3. Bills discounting is always with recourse Factoring may be with or without recourse.
i.e. in case of default the client will have to
make good the loss.
4. Bill financing is individual transaction- 4. Whereas is factoring, bulk is provided
oriented i.e. each bill is separately assessed on against several unpaid trade generated invoices
its merit and got discounted purchased. in batches. It follows the principle of ‘whole
turnover’.
5. Bills finance is always ‘In balance sheet’ 5. in full factoring services facility is ‘off-
financing i.e. both the amounts of receivables balance sheet’ arrangement, as the client
and bank credit are reflected in the balance company completes his double entry
sheet of the client as current assets and current accounting by crediting the factor for
liabilities respectively. This is because of the consideration value.
‘with recourse’ nature of the facility i.e. the
bank reserving the right to back upon the
client (the drawer of the bill) in case of
dishonor of the same by the acceptor or the
drawee.
6. The drawee or the acceptor of the bills is in 6. Factoring services like ‘undisclosed
full knowledge of the bank’s charge on the factoring’ is confidential in nature i.e. the
sale of goods/services. debtors are not aware of the arrangement.
Thus, the large industrial house savailing of
such facility can successfully claim of running
business of their own without any outside
financial support.

8. What is Real Estate financing? Explain Real Estate Funding in India (NOV/DEC 2013),(
NOV/DEC 2012)

 It is a tangible asset.
 It is an immovable asset. Each real estate asset is a unique investment because of the
property and buildings that can be built on it.
 Real estate can be very illiquid if the land and buildings are purchased outright. On the
other hand, investors can enjoy higher liquidity if the same asset (either land or buildings)
is purchased through a fund or some other vehicle.
 It can be divided among a pool of investors, and can be categorized by the way the
property is used by the owners or tenants.
 Can be owned in various forms such as public, private or financed through equity of debt.

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Forms of Real Estate Investments

1. Free and Clear Equity - A free and clear equity investment confers full ownership for an
indefinite period of time. The investor gets all ownership rights. It is an outright purchase
of the asset with no encumbrances.
2. Leverage Equity - Leverage equity has same ownership rights as free and clear equity but
is subject to debt (promissory note) or a pledge (mortgage) to hand over those rights if
payments and terms of the debt are not met.
3. Mortgages- Mortgages are debt investments in which the mortgage holder receives a
stream of payments like a bondholder (principal and interest). Mortgage holders are a
type of real estate investor because they are entitled to take possession of the real estate
asset if the mortgagee defaults. Mortgages can include a clause for early prepayment,
which impacts the investor's payment flows. Investors diversify their real estate portfolios
by purchasing mortgages that vary in terms of region, duration of the mortgage and type
of property (commercial, residential, etc.)

Aggregation Vehicles - Aggregation vehicles pool investors' funds together, giving them broader
and deeper access to the real estate market.

Real Estate Funding in India

The Real Estate Market has witnessed a sea change on the front of Financing in the recent
past. To quote the statistics of one of the Report of Cushman & Wakefield: - "About 2.1 million
new homes are needed by top 8 Indian cities by 2016". The report further states that more than
50% of this need will be for properties in the mid-income segment, around 18% of this demand
is likely to be concentrated in the top eight cities including Mumbai, National Capital Region,
Bangalore, Chennai, Pune and Kolkata. Keeping the report in mind and adding few more inputs
we can easily calculate the growing potential of Indian Real Estate Market and the dire need of
Financing for the above probable housing projects.

Conceptlegal represents banks and other financial institutions in connection with


financing transactions secured by real estate, including development, construction and long term
financing, as well as secured and unsecured loans to real estate developers and owners. The Firm
also frequently serves as counsel to its clients as borrowers in real estate-backed transactions,
whether in direct loan, conduit or structured finance transactions. When representing clients in
real estate finance transactions, the law firm's attorneys are actively involved in all aspects of
structuring and documenting the transaction.

The Firm's Attorneys in the Real Estate and Real Estate Finance Group have significant
experience in restructuring and "working out" troubled real estate loans, and in cases where a
workout is not achievable in foreclosing commercial real estate. Utilizing the depth of its asset-
based lending experience, the Group has represented clients in the entire spectrum of debt
structures. The Firm also represents underwriters, lenders, borrowers and credit support
providers in industrial tax exempt revenue bond financings.

Acquisition of Real Estate in India

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


The Firm's attorneys regularly represent clients in connection with acquisitions and
dispositions of real estate, real estate / properties in India. Whether acquiring dozens of
residential lots as part of a master assemblage strategy or raw land for development purposes, the
firm's attorneys are experienced in all aspects of real estate acquisition and disposition
transactions. Working closely with the firm's Environmental Law and Litigation Department, the
firm is able to assist clients in due diligence investigations of proposed acquisitions and provide
guidance with the myriad of regulatory approvals.

Leasing of Real Estate in India

The Firm's Attorneys represent Lessor and Lessees, Developers and owners in all aspects
of traditional and financing leasing transactions, ranging from raw land to commercial, retail,
institutional, industrial and office properties. The firm represents developers and owners in
creating leasing programs for office parks or individual buildings. The Firm's attorneys also
represent tenants with national property management groups in leasing commercial or retail
space throughout the region and the nation.

Conceptlegal also conducts a Indian mortgage banking practice, representing various participants
in the primary and secondary mortgage markets.

ANNA UNIVERSITY QUESTIONS

PART-A

1. What are the various types of venture capital? (APRIL/MIAY 2010)


2. What is bill discounting? (NOV/DEC 2010)
3. What is real estate financing? (NOV/DEC 2010)
4. What is Consumer credit? Give an example. (APRIL/MIAY 2011)
5. Define Forfaiting. (APRIL/MIAY 2011)
6. What is EDI factoring? (NOV/DEC 2011)
7. What is Real estate financing? (NOV/DEC 2011)
8. What is forfaiting? (MAY/JUNE 2012)
9. Write a note on consumer credit. (NOV/DEC 2012)
10. What is seed capital? (NOV/DEC 2012)
11. Define bills discounting. (MAY/JUNE 2013)
12. What do you mean by factoring? (MAY/JUNE 2013)
13. What is 'smart card'? (NOV/DEC 2013)
14. What is 'Edi factoring'? (NOV/DEC 2013)

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


15. What do you mean by Factoring Services? And give any four companies involved in this
services(MAY/JUNE 2014)
16. List out the different stages of venture capital financing (MAY/JUNE 2014)
PART-B

1. Explain the factors influencing issue pricing when the pricing mechanism is considered to
be right. (APRIL/MIAY 2010)
2. Bring to light the recent developments in merchant banking in India. (APRIL/MIAY
2010)
3. What is a credit card? What are the facilities offered to credit card Holders? Discuss the
Advantages and disadvantages of credit card to various parties. (NOV/DEC 2010)
4. what are the methods of venture capital financing in India. Explain the importance of
venture capital for the development of a country. (NOV/DEC 2010)
5. What are the advantages of Factoring over Bills Discounting? Explain with a suitable
example. (APRIL/MIAY 2011)
6. Explain the stages in venture capital financing. (APRIL/MIAY 2011)
7. Explain the methods of venture financing in India. Explain the advantages of venture
capital to investing public, promoters and economy. (NOV/DEC 2011)
8. Discuss in detail the various services rendered by factoring intermediaries.
Critically evaluate role of factoring as a source of financing(NOV/DEC 2011)
9. What is a credit card? Discuss the facilities and difficulties while transacting through
credit cards. (MAY/JUNE 2012)
10. Explain the need for the regulation of venture capital funds in India. (MAY/JUNE 2012)
11. Explain the factoring services in India and its features. (NOV/DEC 2012)
12. Critically examine the growth and issues of Real Estate Financing in India. (NOV/DEC
2012)
13. Explain the factors that make real estate investment attractive and discuss the emerging
scenarios of real estate investment. (NOV/DEC 2013)
14. Discuss the performance of various venture capital firms in India. (NOV/DEC 2013)
15. Explain the role of Credit card in consumer credit by Commercial Banks. Also highlight
the recent issues in Credit card usage. (MAY/JUNE 2014)
16. Explain the mechanism of factoring with the help of a diagram. (MAY/JUNE 2014)

Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET


Prepared by : Dr.M.KRISHNAMOORTHI. M.Com.,M.B.A,M.Phil., Ph.D.,UGC-NET