advanced financial mgmnt

7/31/2019 advanced financial mgmnt

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4.Investment Banker and his role in mgmt. 5.Methods foll by rating agency to fin instruments 12.Process of Bond valuation/ Bond bldg. 14.Factors determining cap structure of a company 15.Imp functions of CRA 18.MOU bet Govt and PSU 19.Venture cap funding in india 20.Invt bank and its funcions 21.Rationale of disinvestment

19. Venture capital Funding in India

Venture capital provides long-term, committed share capital, to help unquoted companies grow andsucceed. If an entrepreneur is looking to start-up, expand, buy-into a business, buy-out a business in whichhe works, turnaround or revitalise a company, venture capital could help do this. Obtaining venture capitalis substantially different from raising debt or a loan from a lender. Lenders have a legal right to interest ona loan and repayment of the capital, irrespective of the success or failure of a business. Venture capital isinvested in exchange for an equity stake in the business. As a shareholder, the venture capitalist's return isdependent on the growth and profitability of the business. This return is generally earned when the venturecapitalist "exits" by selling its shareholding when the business is sold to another owner.

Types of Venture Capital Funds

1.

VCFs promoted by the Central govt. controlled development financial institutions such asTDICI, by ICICI, Risk capital and Technology Finance Corporation Limited (RCTFC) by theIndustrial Finance Corporation of India (IFCI) and Risk Capital Fund by IDBI.

2. 2.2. VCFs promoted by the state government-controlled development finance institutions such as Andhra Pradesh Venture Capital Limited (APVCL) by Andhra Pradesh State FinanceCorporation (APSFC) and Gujarat Venture Finance Company Limited (GVCFL) by GujaratIndustrial Investment Corporation (GIIC)

3. 2.3. VCFs promoted by Public Sector banks such as Canfina by Canara Bank and SBI-Cap byState Bank of India.

4. 2.4. VCFs promoted by the foreign banks or private sector companies and financialinstitutions such as Indus Venture Fund, Credit Capital Venture Fund and Grind lays India

Development Fund.

Forms of Venture Capital

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

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

3.2 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%; actual ratedepends on other factors of the venture such as gestation period, cost-flow patterns, riskiness and otherfactors of the enterprise.


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3.3 Income Note: It is a hybrid security which combines the features of both conventional loan andconditional loan. The entrepreneur has to pay both interest and royalty on sales, but at substantially lowrates.

3.4 Other Financing Methods: A few venture capitalists, particularly in the private sector, have startedintroducing innovative financial securities like participating debentures, introduced by TCFC is anexample.

SEBI (Venture Capital Funds) Regulations, 1996

According to SEBI (Venture Capital) Regulations, 1996, a venture capital fund can be formed as:

Trust, registered under Indian Trusts Act, 1882 or Company, registered under Companies Act, 1956 or A body corporate, set up or established under the laws of the central or state legislature

In all forms, the main objective of the entity should be to engage in venture capital investment and thetrust deed or the memorandum should explicitly state that [Section 4].

6.2 Registration

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

6.3 Recommendations of SEBI (Chandrasekhar) Committee,2000 SEBI appointed the ChandrasekharCommittee to identify the impediments in the growth of venture capital industry in the country andsuggest suitable measures for its rapid growth. Its report was submitted in January, 2000. Therecommendations pertain to

Harmonisation of multiplicity of regulations VCF structures Resource raising Investments Exit SEBI regulations Company law related issues and Other related issues.

Fund Generation

Investors can invite contribution to the pool either through private placement or through an agreement

with investors for contribution or subscription. The minimum pool size for each fund is fixed at INR 50

million [Section 11(c)].

Investment

Regulation 1996 makes it mandatory for the VC firm to disclose the investment strategy of the fund at theapplication stage itself [Section 12(a)]. It caps the investment in any one firm at 25% of the corpus[Section 12(b)].

A venture capital undertaking could be an Indian company or a firm registered in a foreign country. Firmsnot registered in India should with RBI regulations in addition to that of SEBI. Of the generated pool of

capital, at least 66.67% should be invested in equities or equity linked instruments of unlisted entities[Section 12(d-i)]. Remaining 33.33% of the pool can be invested in:

IPOs of venture capital undertakings


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Debt instruments of the portfolio firms Preferential allotment of equity shares of listed companies with one year lock-in period [Section

12(d-ii-c)] The equity shares or equity linked instruments of financially weak or sick companies whose shares

are listed [Section 12(d-ii-d)] SPVs created by the firm in accordance with SEBI (VC) Regulations 1996 [Section 12(d-ii e)].

Section 12 (c) prohibits investment in associate companies

Winding-up

Section (23) lists down the occasions under which a fund can be wound-up. The first and most obviousreason is the fund maturity as per the memorandum. Additionally, a fund can be wound-up on followingoccasions before the period of the scheme is over:

In the opinion of the trustee / trustee company, it is beneficial for the investors to have the fundwound up

75% of the investors pass a resolution at a meeting of unit holders in support of winding up If SEBI so directs in the interest of the investors

Once wound-up, no further investment can be made on behalf of the scheme and within 3 months, thescheme should be liquidated and proceeds distributed to the investors after meeting all liabilities.

SEBI (Foreign Venture Capital Investors) Regulations, 2000

According to SEBI (FVCI) Regulations, 2000 a "foreign venture capital investor" means an investorincorporated and established outside India, is registered under the Regulations and proposes to makeinvestment in accordance with the Regulations. An FVCI has to appoint a domestic custodian for thepurpose of custody of securities. The domestic custodian would monitor the investment of FVCI in Indiaand furnish periodic reports and other information as required to SEBI.

A foreign VC fund is exempted from the 25% cap on investment in a single VC undertaking through anAmendment in 2004. All other conditions on investment like the minimum 66.67% of the pool to beinvested in unlisted equities, 33.33% on other securities of the funded ventures, lock-in period forpreferential allotment, and investment in equities of listed but financially weak or sick companies remainthe same as given in SEBI (VC) Regulations, 1996, for domestic VCs.

Venture Capital Financing Process

The Seed Stage

This is where the seed funding takes place. It is considered as the setup stage where a person or a ventureapproaches an angel investor or an investor in a VC-firm for funding for their idea/product. During thisstage, the person or venture has to convince the investor why the idea/product is worthwhile. The investorwill investigate into the technical and the economic feasibility (Feasibility Study) of the idea. In somecases, there is some sort of prototype of the idea/product that is not fully developed or tested.

The Start-up Stage

If the idea/product/process is qualified for further investigation and/or investment, the process will go tothe second stage; this is also called the start-up stage. At this point many exciting things happen.A business plan is presented by the attendant of the venture to the VC-firm. A management team is beingformed to run the venture. If the company has a board of directors, a person from the VC-firms will takeseats at the board of directors.


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The Second Stage

At this stage, we presume that the idea has been transformed into a product and is being produced andsold. This is the first encounter with the rest of the market, the competitors. The venture is trying tosqueeze between the rest and it tries to get some market share from the competitors. This is one of themain goals at this stage. Another important point is the cost. The venture is trying to minimize their lossesin order to reach the break-even.

The Third Stage

This stage is seen as the expansion/maturity phase of the previous stage. The venture tries to expand themarket share they gained in the previous stage. This can be done by selling more amount of the productand having a good marketing campaign. Also, the venture will have to see whether it is possible to cutdown their production cost or restructure the internal process. This can become more visible by doinga SWOT analysis. It is used to figure out the strength, weakness, opportunity and the threat the venture isfacing and how to deal with it.

The Bridge/Pre-public Stage

In general this stage is the last stage of the venture capital financing process. The main goal of this stage isto achieve an exit vehicle for the investors and for the venture to go public. At this stage the ventureachieves a certain amount of the market share. This gives the venture some opportunities like for example:

Hostile take over Merger with other companies; Keeping away new competitors from approaching the market; Eliminate competitors.

Venture Capital in India

Phase I - Formation of TDICI in the 80s and regional funds as GVFL & APIDC in the early 90s. Phase II - Entry of Foreign Venture Capital funds (VCF) between 1995-1999 Phase III - (2000 onwards). Emergence of successful India-centric VC firms Phase IV(current) Global VCs and PE firms actively investing in India 150 Funds active in the

last 3 years (Government, Overseas, Corporate, Domestic)

The Opportunity

High Growth in Technology and Knowledge based Industries (KBI) KBI growing fast and mostly global, less affected by domestic issues. Several emerging centers of innovationbiotech, wireless, IT, semiconductor, pharmaceutical. Ability to build market leading companies in India that serves both global and domestic markets. India moving beyond supplier of low-cost services to higher-value products. Quality of entrepreneurship on ascending curve.


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4.& 20. Investment Banking and their Investment Banker

An investment bank is a financial institution which raises capital, trades securities, and manages corporate

mergers and acquisitions. Another term used for investment banking is corporate finance.

An individual or institution which acts as an underwriter or agent for corporations and municipalities issuing

securities, and also offer advisory services to investors

As investment Banking falls under two broad headings:

The provision of financial advice Capital raising

Functions of Investment Banking

Investment banks carry out multilateral functions. Some of the most important functions ofinvestment banking are as follows:

Investment banking helps public and private corporations in issuance of securities in the primarymarket. They also act as intermediaries in trading for clients.

Investment banking provides financial advice to investors and helps them by assisting inpurchasing and trading securities as well as managing financial assets

Investment banking differs from commercial banking as investment banks don't accept depositsneither do they grant retail loans.

Small firms which provide services of investment banking are called boutiques. They mainlyspecialize in bond trading, providing technical analysis or program trading as well as advising for

mergers and acquisitions.

2010 M&A Volume Rank Firm1 Goldman Sachs & Co

2 J.P. Morgan Chase

3 Morgan Stanley

4 Credit Suisse

5 Bank of America / Merrill Lynch

6 Deutsche Bank

7 Barclays Capital

8 UBS

9 Citigroup10 Lazard

Source: New York Times, September 2010 citing Thomson Reuters.Important roles of investment bankers:

1. Investigation, Analysis and Research (Origination):Origination includes the subsidiary operations of discovery, investigation, and negotiation.

Discovery is the finding of a prospective issue of securities; investigation is the testing of the investmentcredit of the prospective security issuer, and the intrinsic soundness of the issue; negotiation is thedetermination of the amount, the price, and the terms of the proposed issue.

2. Underwriting (Public Cash offerings):

When a corporation wishes to issue new securities and sell them to the public, it makes anarrangement with an investment banker whereby the investment banker agrees to purchase the entire issueat a set price, known as underwriting.


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Distribution:Another function of investment banker it to market the security issues. The investment banker acts

as a specialist to distribute securities efficiently for the corporation. It can be very expensive andineffective for a corporation to sell an issue by establishing marking and selling organization by its own.Investment banker has established marketing and sales network to distribute securities.

21. The Rationale of Disinvestments of PSU in IndiaAfter the announcement of the NEW Industrial Policy in July 1991, the government of India has made

several moves towards privatisation It is realized that without privatisation, the pace of liberalisation and

marketization of the' economy would not attain the take off stage. Some of the measures undertaken by the

Government include

1. Permitting the entry of the private corporate sector in such core sectors as steel, ports, Airlines,Power and Telecommunication.

2. No fresh budgetary support for public sector enterprises. This will lead toa. Dilution of government: equity is most public enterprises which decide, in for new

projects and expansions

b. No new central public sector undertakings being set up in the countryc. Issue of equity to the public by the identified public sector undertakings.

As a part of the on-going process of privatisation, public sector enterprises' equity is being unloaded in the

market. This is what we call disinvestment

Disinvestment of PSU's (Rs. In Crores)

Year Modes of Disinvestment As on 30.06.2011

Minority

Sale

Strategic

SaleOthers Total

1991-92 3,037.74 0.00 0.00 3,037.74

1992-93 1,912.51 0.00 0.00 1,912.51

1993-94 0.00 0.00 0.00 0.00

1994-95 4,843.10 0.00 0.00 4,843.10

1995-96 168.48 0.00 0.00 168.48

1996-97 379.67 0.00 0.00 379.67

1997-98 910.00 0.00 0.00 910.001998-99 5,371.11 0.00 0.00 5,371.11

1999-00 1,479.27 105.45 275.42 1,860.14

2000-01 0.00 1,871.26 0.00 1,871.26

2001-02 0.00 3,090.09 2,567.60 5,657.69

2002-03 0.00 2,252.72 1,095.26 3,347.98

2003-04 12,741.62 2,805.79 0.00 15,547.41

2004-05 2,700.06 64.81 0.00 2,764.87

2005-06 0.00 1,569.68 0.00 1,569.68

2006-07 0.00 0.00 0.00 0.002007-08 1,814.45 2,366.94 0.00 4,181.39

2008-09 0.00 0.00 0.00 0.00

2009-10 23,552.93 0.00 0.00 23,552.93


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2010-11 22,762.96 0.00 0.00 22,762.96

2011-12 1,144.55 0.00 0.00 1,144.55

Total 82,818.45 14,126.74 3,938.28 1,00,883.47Source: Dept. on Disinvestment, Ministry of Finance, Govt. of India. http://www.divest.nic.in/

It is evident from the table that two methods of disinvestment form the backbone of the disinvestment

strategy of the Government. They are minority sale and strategic sale. Out of the proceeds of thedisinvestment till mid 2011 amounting to Rs. 1,00,883.47 crores, they together occupy 92% of the total

proceeds. The difference between the two modes lies with the extent of dilution of control in PSUs.

Strategic sales involves transfer of control to private entrepreneurs whereas, minority sales involves

dilution of Government stake without transfer of control. Another marked feature of Indian

disinvestment experience explained by the table is the most of the disinvestment in the early periods of

privatization was marked by minority sales. It took nearly 10 years to introduce strategic sales into the

disinvestment strategy. This clearly shows the conservative approach of the Government in the

implementation of the disinvestment policy.

1.Models of disinvestmenta) Public offer: In this model which was adopted in the early 1990's equity was offered to retail

investors through domestic public issues.

b) Cross-holdings, golden share and warehousing: the government would simply sell a part of itsshares of one public sector unit to other public sector units. Under the model of warehousing,

government-owned financial institutions were expected to buy the governments' stake in selected

Public sector enterprises and hold them until any third buyer emerged. In the golden share model

the governmental; retains a 26% stake in the public sector enterprise, but a lesser stake does not

make it a minority stakeholder

c) Strategic sale: This plan is being currently pursed by the government. Its major features arei. Government: to offload above 51% in strategic sales; new cap fixed at 74%.

ii. Disinvestment price to be marked determined and not pre-fixed.iii. Structural mechanism to speed up the disinvestment process to be put in place.

The public sector enterprises selected for disinvestment will be freed from administrative control of the

parent ministry and placed under a new body be to create for piloting the process.

As a part of this strategy, important changes have been introduced recently

1. The sale of public sector undertaking' shares will be under the newly Department forDisinvestment.

2. The disinvestment of these shares will be delinked from the Union budget3. Several benefits are expected to be derived from the disinvestment polity. They may be stated

as follows:

i. survive on their ownii. wider distribution of wealth

iii. beneficial effect on the capital market.iv. establishing more accurate benchmarks and pricingv. expansion in the future.

vi. increase economic activityvii. positive impact on the economy, employment and tax revenues in the long-run.


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viii. access to cheaper and better quality products and services. This can already be seen in thetelecom sector.

Problems in PSU Disinvestment

Public sector units in all countries typically suffer from three major problems.

1. The soft budget constraint: Unlike private companies, many loss-making PSUs are kept afloatby either direct government subsidy or by directed bank credit from state-owned banks. In the past,

even `sick private companies have been taken over by the state, out of political considerations,

creating a further drag on state finances. In fact, these have been major factors behind the near-

bankruptcy of many State governments and some public sector banks.

2. Multiple objectives: PSUs were often not designed to be primarily profit-making enterprises.They were expected to promote social objectives such as generating guaranteed employment,

taking industries to backward areas, buying inputs from other PSUs to support them, providing

output at reasonable prices to people, irrespective of costs, and so on.

3. Multiple-control authorities: Unlike the private sector manager, the public sector manager issubject to control and scrutiny by different ministries, the Bureau of Public Enterprise, variousparliamentary committees and investigating agencies.

14. Factors Determining Capital Structure

To Reduce the overall risk of the company:When we make capital structure before actual getting money from money supplier, we can do manyadjustments for reducing our overall risk. We try to get minimum debt in new business because in newbusiness our rate of return will be less than rate of interest and for getting more loan means taking highrisk of return more amount of interest even there is no profit. But, if our business will be succeeded, atthat time, we can increase estimated amount of debt by just changing the value of debt in capital structure.

To do adjustment according to business environment:

Company also adjusts different sources expected amount according to business environment. Suppose infuture, if government of India cuts off his relation with China, from where our company is getting fund, itwill definitely tough for us to get more money from China. But proper planning of capital structure offuture sources will be helpful for us to enlarge our area for getting money. In finance, it is called


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maneuverability. It means to create mobility of sources of fund by including maximum alternatives inplanned capital structure.

Idea generation of new source of funds:

Good planning of capital structure will make versatile to finance manager for getting money from newsources.

Factors Determining Capital Structure

Trading on EquityThe word equity denotes the ownership of the company. Trading on equity means taking advantage ofequity share capital to borrowed funds on reasonable basis.

Degree of controlIn a company, it is the directors who are so called elected representatives of equity shareholders. Thesemembers have got maximum voting rights in a concern as compared to the preference shareholders anddebenture holders. Preference shareholders have reasonably less voting rights while debenture holdershave no voting rights. If the companys management policies are such that they want to retain their votingrights in their hands, the capital structure consists of debenture holders and loans rather than equity shares.

Flexibility of financial plan

In an enterprise, the capital structure should be such that there is both contractions as well as relaxation inplans. Debentures and loans can be refunded back as the time requires. While equity capital cannot berefunded at any point which provides rigidity to plans. Therefore, in order to make the capital structurepossible, the company should go for issue of debentures and other loans.

Choice of investorsThe companys policy generally is to have different categories of investors for securities. Therefore, a

capital structure should give enough choice to all kind of investors to invest. Bold and adventurous

investors generally go for equity shares and loans and debentures are generally raised keeping into mindconscious investors.

Capital market conditionIn the lifetime of the company, the market price of the shares has got an important influence. During thedepression period, the companys capital structure generally consists of debentures and loans. While in

period of boons and inflation, the companys capital should consist of share capital generally equityshares.

Period of financingWhen company wants to raise finance for short period, it goes for loans from banks and other institutions;while for long period it goes for issue of shares and debentures.

Cost of financingIn a capital structure, the company has to look to the factor of cost when securities are raised. It is seenthat debentures at the time of profit earning of company prove to be a cheaper source of finance ascompared to equity shares where equity shareholders demand an extra share in profits.

Stability of salesAn established business which has a growing market and high sales turnover, the company is in positionto meet fixed commitments. Interest on debentures has to be paid regardless of profit. Therefore, whensales are high, thereby the profits are high and company is in better position to meet such fixedcommitments like interest on debentures and dividends on preference shares

Sizes of a companySmall size business firms capital structure generally consists of loans from banks and retained profits.While on the other hand, big companies having goodwill, stability and an established profit can easily go


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for issuance of shares and debentures as well as loans and borrowings from financial institutions. Thebigger the size, the wider is total capitalization.

5.& 15.Credit Rating Agencies Importance and methods.

Credit ratings are forward-looking opinions about credit risk. Standard & Poors credit ratings

express the agencys opinion, about the ability and willingness of an issuer, such as a corporation or

state or city government, to meet its financial obligations in full and on time.

Credit Rating Agencies rate the aforesaid debt instruments of companies. They do not rate the

companies, but their individual debt securities are been rated. Rating is an opinion regarding the timely

repayment of principal and interest thereon; it is expressed by assigning symbols, which have definite

meaning

CRAs registered with SEBI

Name of CRA Year of commencement of operations

CRISIL 1988

ICRA 1991

CARE 1993

Fitch India 1996

Brickworks 2008

Functions and Approaches of Credit rating Agencies

Rating related products and activities

CRAs in India rate a large number of financial products:

1. Bonds/ debentures

2. Commercial paper

3. Structured finance products

4. Bank loans

5. Fixed deposits and bank certificate of deposits

6. Mutual fund debt schemes

7. Initial Public Offers (IPOs)

Rating Methodology

History

The rating agency must understand the ownership , size, geographical spread, product spread and the

organisational structure of the issuer.

Accounting QualityThe accounting policies followed should strictly adhere to the concepts, principles and conventions of accounting

theory so as to ascertain a true and a fair view of the financial state of affairs of the company.

Business fundamentals


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Under this category the issuer company is assessed in the area of its competitive position as compared to the

competitor operating in the similar line. Its strategies, policies, strengths, and weaknesses and goals have to be

analysed as they have some sort of bearings in the measuring the ratings of the organisations.

Liquidity Management

The issuers sources and uses of funds in terms of cost and availability have to be studied in relation to debt issue.

Volatility trends of these parameters are also studied. The issuer s innovativeness and competitiveness ability to

attract cheaper fund is also analysed. Foreign exchange and interest risks associated with each source andmanagement of such risk are scruitinized to estimate the probable impact of credit quality. To understand the

liquidity of the issuer, the maturing match between sources and deployment of funds is studied.

Quality of management

This is judged by the team of executives, human resource policies, organisational structure and the extent of the

delegation of the authority and responsibility. The support of the group companies could also be important in

determining their success. The managements attitude towards risk measured as revealed by the track record in

the choice of segments, dividend policy, accounting practices, and funding policies.

Quality of assets

Rating agency should analyse the issuers segment of operation its competitive environment, and market share in

each segment vis a vis the risk profile each segment. Thus issuers prudential norms for credit concentration are

studied in relation to the past performance to understand their effectiveness. Such credit concentration norms

could be fixed for each borrower, each industry, or each geographic areas. The extent of non-performing assets in

the portfolio and the provisions available to meet any losses from such assets are considered as important

indicators of the quality of the assets.

Profitability

Since non-fund based income plays an important role in boosting the earnings of the issuer, the rating agency

should determine the profitability of the continuance of such income in relation to sales, componentwise

expenses ratios, operating expense ratio and operating net profit ratios determined in the past and budgeted

figures in the future would also affect the quality of rating .

Return on Equity and Investment

Return on Equity measures the profitability of the equity funds invested in the funds after the payment of taxes

whereas the return on total investment measures the percentage of earnings remaining after the payment of

taxes. The total investments comprises creditors and shareholders fund, and is a product of net profit ratio and

investment turnover ratio. This aspect has an important bearing on credit quality of the company. As a matter of

rule of thumb, operating profit as the percentage of total funds employed should not be less than the lending rate

of the commercial banks.

Capital Structure

The most important indicator in analysing the capital structure is the capital adequacy ratio. To warrant adequate

safety the borrowing of the company as a rule of the thumb should not exceed two times its shareholders funds.

This is also important indicator that determines the quality of rating of the debt issues. A lower debt equity ratio

indicates a higher degree of protection enjoyed by the creditors and the less is the debt instrument and vice versa.

Then shareholders equity to fixed assets ratio for the company is analysed. If the assets are more than the

shareholders, equity, it means that a part of the assets has been financed by the borrowed capital and hence,

would deteriorate the quality of ratings of the debt issues.

Past performance

Effect of normal Business cycle


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The business activities of the firm can be categorised as normal, recovery, boom, recession and slump. So the

rating agency had to consider the state of economic activity facing the company at the time of assigning rating to

the debt instrument. This is one of the important factors which the rating agency cannot ignore prior to deciding

the worth of the debt instrument

Interest and the debt coverage ratio including tax consideration

Past trends in connection with interest and debt coverage ratio and payment of taxes are carefully scrutinised to

understand the issuers policy of redemption of debt and payment of taxes in the past and provisions made to doso for the new debt which is proposed to be issued in the future. Since profits are estimated for the future, this

type of ratio can serve as a good index of thr long term solvency of the firm. This is considered a pivotal factor in

influencing the judgement on rating assigned by various rating agencies.

The rating agency may ignore any of the above factors while assigning the rating of the debt issued but cannot

ignore this prominent factor. To warrant adequate safety as matter of rule of thumb, the firms operating profit

before interest and depreciation should atleast be three times the interest commitments.


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Fees Charged by CARE on Rating Instrument (Sep.2011)

Instruments

CARE

Rating one time Annual Surveillance

Fixed Deposits 0.1% or Min Rs.200,000 0.03% or Min Rs.100,000

Debentures 0.1% or Min Rs.200,000 0.03% or Min Rs.100,000

Commercial Paper 0.1% or Min Rs.200,000 0.03% or Min Rs.100,000

Issuer Rating 0.05% or Min Rs.300,000 0.05% or Min Rs.200,000

Cal. Of Fees: 0.1% multiplied by total amt of Instrument, or min applied.

Credit Ratings Symbols given by three Major Companies

RATINGS CRISIL CARE ICRA

Highest degree of safety with regard to timely paymentof financial obligations

AAA CAREAAA

LAAA

High degree of safety with regard to timely payment offinancial obligations.

AA CAREAA

LAA

Adequate degree of safety with regard to timelypayment of financial obligations. However, changes incircumstances can adversely affect such issues more

than those in the higher rating categories.

A CARE A LA

Moderate safety with regard to timely payment offinancial obligations for the present; changing

circumstances are more likely to lead to a weakencapacity to pay interest and repay principal.

BBB CAREBBB

LBBB

Inadequate safety with regard to timely payment offinancial obligations; less likely to default in the

immediate future.

BB CARE BB LBB

Greater likelihood of default; while currently financialobligations are met, adverse business or economic

conditions would lead to lack of ability or willingness topay interest or principal.

B CARE B LB

Vulnerable to default; timely payment of financialobligations is possible only if favorable circumstances

continue.

C CARE C LC

In default or are expected to default on scheduledpayment dates. Such instruments are extremely

speculative and returns from these instruments may berealized only on reorganization or liquidation.

D CARE D LD

Instruments rated 'NM' have factors present in them,which render the rating outstanding meaningless. Theseinclude reorganization or liquidation of the issuer, the

obligation is under dispute in a court of law or before astatutory authority etc.

NM

12. BOND MARKETS AND PROCESS OF BOND VALUATIONChart no. 2 Credit Ratings Symbols


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A bond is a debt security, similar to an I.O.U. When you purchase a bond, you are lending money to a

government, municipality, corporation, federal agency or other entity known as the issuer. Bonds issued

by corporations or the US government are usually taxable. Bonds issued by state governments or

municipalities are usually exempt from tax.

Components:

The issuer, similar to a holder of an option Principal amount Specified interest rate; paid to the issuer yearly (also known as the coupon) Date of maturity

Variables that Effect Value:

Maturity Redemption Features Credit Quality Interest Rate Price Yield Tax Status

MATURITY:

Short-term notes: maturities of up to 4 years; Medium-term notes/bonds: maturities of five to 12 years; 3. Long-term bonds: maturities of 12 or more years.

REDEMPTION FEATURES:Bond with a redemption provision usually has higher return to compensate for the risk that the bondsmight be called early.

1. CALL OPTION: provisions that allow or require the issuer to repay the investors principal at aspecified date before maturity.

2. PUT OPTION: option of requiring the issuer to repurchase the bonds, at a specified time, prior tomaturity.

INTEREST RATES:

FIXED: Stays same until maturity; i.e.: buy a $1000 bond with 8% fixed interest rate and you willreceive $80 every year until maturity and at maturity you will receive the $1000 back.

FLOATING: adjustable to prevailing market rates. PAYABLE AT MATURITY: receive no payments until maturity and at that time you receive

principal plus the total interest earned compounded semi-annually at the initial interest rate.PRICE:

The amount you pay for the bond Newly issued bonds will pay close to their face-value Traded bonds fluctuate in response to changing interest rates Bonds traded higher than their face-value are said to be sold at a premium Bonds traded lower than their face-value are said to be sold at discount

YIELDYield is the return you actually earn on the bond--based on the price you paid and the interest paymentyou receive

Two Types of Yields:

Current Yield: annual return on the dollar amount paid for the bond and is derived by dividing thebond's interest payment by its purchase price

Yield to Maturity: total return you will receive by holding the bond until it matures or is called.


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TAXABLE STATUS:

Some bonds offer special tax advantages. There is no state or local income tax on the interest from U.S.

Treasury bonds, and no federal income tax on the interest from most municipal bonds, and in many cases

no state or local income tax, as well.

INTEREST RATE-INFLATION: As a general rule: the bond market, and the overall economy, benefits from steady, sustainable

growth rates. But steep rises in economic growth can lead to inflation, which raises the costs of goods and

services for everyone, leads to higher interest rates and erodes a bond's value.TYPES OF BONDS:

1. Municipal: issued to raise money for schools, hospitals, highways, etc.2. Corporate: debt obligations issued by private and public corporations.3. Zero-Coupon: Bonds with no periodic interest payments (introduced to the marketplace in

1982)

BOND VALUATION

Bond valuation is the determination of the fair price of a bond. As with any security or capital investment,

the theoretical fair value of a bond is the present value of the stream of cash flows it is expected togenerate. Hence, the value of a bond is obtained by discounting the bond's expected cash flows to the

present using an appropriate discount rate. In practice, this discount rate is often determined by reference

to similar instruments, provided that such instruments exist.

PRESENT VALUE APPROACH

Below is the formula for calculating a bond's price, which uses the basic present value (PV) formula for agiven discount rate. (This formula assumes that a coupon payment has just been made ;)F = face valueIf = contractual interest rateC = F * If = coupon payment (periodic interest payment)N = number of payments

1. i = market interest rate, or required yield, or observed / appropriate yield to maturity (see below)M = value at maturity, usually equals face valueP = market price of bond

1. If the market price of bond is less than its face value (par value), the bond is selling at a discount.Conversely, if the market price of bond is greater than its face value, the bond is selling at a

premium.

RELATIVE PRICE APPROACH

Under this approach, the bond will be priced relative to a benchmark, usually a government security; Here,the yield to maturity on the bond is determined based on the bond's Credit rating relative to a government

security with similar maturity or duration; The better the quality of the bond, the smaller the spread

between its required return and the YTM of the benchmark. This required return, i in the formula, is then

used to discount the bond cash flows as above to obtain the price.

YIELD TO MATURITYThe yield to maturity is the discount rate which returns the market price of the bond; it is identical to r(required return) in the above equation. YTM is thus the internal rate of return of an investment in thebond made at the observed price. Since YTM can be used to price a bond, bond prices are often quoted interms of YTM.To achieve a return equal to YTM, i.e. where it is the required return on the bond, the bond owner must:

buy the bond at price P0, hold the bond until maturity, and Redeem the bond at par.


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18. MOU between Government & PSU

The government introduced the concept of the MOU in 1988 to improve the performance of PSEs and to

introduce an objective system of evaluating the performance of the management of the enterprises.

The MOU is a negotiated document between the government, as the owner of the PSU, and specific publicsector enterprises. It is clearly specify the intention, obligations and responsibility of both these parties, that is,the government and the PSE. The stated sets of obligation and responsibilities then form the basis ofperformance evaluation of the PSE. As a result, the MOU attempts to make the management of PSEs result-oriented; this also facilitates the way to ex-postcontrol of PSEs in place of the earlier reliance on ex-antecontrols.

1.1 Objectives(i) To measure the performance of PSEs, taking into account the complexity of fusing social and financialobjectives and translating them into measurable parameters;

(ii) To ensure concurrent increase in autonomy as well as accountability of the board of directors of the PSUs;

(iii) To set up new institutions and administrative and personnel system and

(iv) To replace multiples principles with multiple objective, with clarity in goals and objectives.

StructureThe MOU is essentially a management system consisting of aA. Performance information system,

B. Performance evaluation system and

C. Performance incentive system.

Performance Information System

The system provides sources of information that could assist in designing a performance evaluation system.The major sources are:The original objectives, at the project formulation stage;Comparison with similar firms in the PSEs and private sector;Standards achieved by similar undertaking of other selected developed and developing countries;Comparison with the parties at ministry level and at the enterprise level

Performance Evaluation SystemThe performance evaluation system involves five steps.1. Criterion selection

2. Criterion weight selection3. Criterion value selection

This three steps taken in to beginning of the year and the other two steps, that is , evaluation and reward ofperformance are take at the end of the year.1. Criterion selection

A performance criterion must be selected carefully and not arbitrarily. These should be based on the

enterprises corporate plan which looks at three to five years in the future. They must also be consistent with

the plans and budgetary goals of the government. In the MOUs for the central public sector enterprises,

therefore, the MOU target and budgetary goal kept identical

Criterion Weight Selection


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Criterion weight selection deal for running an enterprise successfully, a chief executive has to undertaken anumber of tasks. However, all the tasks are not equal importance. An efficient chief executive, therefore,priorities his tasks based on his perception of the relative importance of the different activities on hand.3. Criterion Value Selection

It is value that distinguishes various levels of performance. It suggested that value should be set through a

participative process. For instance, kilometers per liter are a criterion to measures efficiency of all types of

motor vehicles; 10 kms per liter is excellent for truck but is indicative of very poor performance in the case of

a scooter.

Performance EvaluationPerformance is to be evaluated on a 5 points scale. Where one would represent as excellent performance and

five would represent as poor performance. According, the value of the composite score lies between 1 and 5. In

case the management performance is excellent in terms of meeting the entire target set out in MOU, its score is

to be 1. In contrast, if it has failed to meet any target specified in the MOU, its score is to be 5; a mixed

performance will get the PSE a score between 1 and 5. Score also facilitates the comparison and ranking of

PSEs.

Performance RewardA transparent system of rewards and punishment is thus a corollary to the introduction of an objective

performance evaluation system of PSEs. Thus a performance reward scheme constitutes an essential

complement of the MOU system.

RationaleThe main reasons for having institutional arrangement in this regard are as follows;(i) It ensures commitment from the higher levels of the government

(ii) In enables objectives, third party

(iii) The task force ensures professionalism and prevent bureaucratization;

(iv) The high power committee can demand information and make binding recommendations

(v) It ensures fairness and equality in the process of negotiation of MOUs.

Composition1. High Power Committee2. Task Force And3. The MOU Division

High Power Committee

At the apex of this institutional arrangement is the high power committee (HPC), consisting of the followingmembers.1. Cabinet secretary, chairman

2. Finance secretary, member

3. Secretary (expenditure), member

4. Secretary (planning commission), member

5. Secretary (statistics and programme implementation), member

6. Chairman (public enterprises selection board), member

7. Chief economic adviser, member

8. Secretary (public enterprises), member-secretary

Task forceAn objective of task force is to care of the concern regarding the imbalance in the technical expertise available

between the government and PSEs.


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MOU DivisionThe HPC and task force are assisted by the MOU division in the department of public enterprises. It acts as the

permanent secretariat to the HPC and task force

Working of MOU SystemThe process of signing of MOU is initiated with the issue of guidelines by the MOU Division for drafting of

MOUs. These guidelines indicate the broad structure and the aspects to be covered in the draft MOU including

the weights to be assigned to the financial parameters. These guidelines reflect the main concerns of theGovernment and contain the general direction to the PSEs.

Evaluation of MOUPerformance of MOU signing PSEs is evaluated with reference to their MOU targets and secondly on the basis

of audited data. The MOU evaluation is finalized on the basis of the actual performance and the PSEs are

graded as "EXCELLENT", "VERY GOOD", "GOOD", "FAIR" & "POOR"

Achievements of the MOU System

The focus, under the MOU system, has shifted to achievements of results. Operational autonomy has also been encouraged and increased by delegation of more financial andadministrative powers to the MOU signing PSEs.

By laying stress on marketing effort and comparing with private sector enterprises MOU are helpingPSEs to face competition.

The quarterly performance review (QPR) meetings have become more focused since the introductionof MOUs. Discussion is confined to overall achievement as outlined in the MOUs.

advanced financial mgmnt

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