Merchant Banking and Financial Services

Einstein College of Engineering

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BA 958 MERCHANT BANKING ANF FINANCIAL SERVICES

Syllabus

UNIT- 1

Introduction – An Overview of Indian Financial System – Merchant Banking in India –Recent

Developments and Challenges ahead – Institutional structure – Functions of Merchant Banking –

Legal and Regulatory Frameworks- Relevant Provisions of Companies Act- SERA-SEBI

guidelines- FEMA etc. – Relation with stock Exchanges and OTCEI

UNIT II - ISSUE MANAGEMENT

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

Instruments – Issue Pricing Pricing- Preparation of prospectus selection of bankers, Advertising

Consultants etc. – Role of Registrars –Underwriting Arrangements. Dealing with Bankers to the

Issue, Underwriters, Registrars, and Brokers. –Offer for sale – Book- Building – Green Shoe

Option –E –IPO Private Placement- Bought out Deals –Placement with FIs, MFs, FIIs, etc. off-

Shore Issues. – Issue Marketing – Advertising Strategies-NRI Marketing- Post Issue Activities.

UNIT III - OTHER FEE BASED MANAGEMENT

Mergers and Acquisitions – Portfolio Management Services – Credit Syndication – Credit Rating

– Mutual Funds – Business Valuation.

UNIT IV - FUND BASED FINANCIAL SERVICES

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

Tax Implication.

UNIT V - OTHER FUND BASED FINANCIAL SERVICES

Consumer Credit – Credit Cards- Real Estate Financing – Bills Discounting – Recent

Developments in Factoring and Forfeiting – Venture Capital.

REFERENCES

1. M.Y.Khan, ‗Financial Services‘ – Tata McGraw –Hill, 3 rd Edition, 2005.

2. Machiraju, ‗ Indian Financial System ‗- Vikas Publishing House, 2 nd Edition, 2002.

3. J.C.Verma, ‗ A Manual of Merchant Banking ‗, Bharath Publishing House, New Delhi, 2001.

4. K.Sriram, ‗Hand Book of Leasing, Hire Purchase & Factoring‘, ICFAI, Hyderabad, 1992.

5. Economic Dailies, Relevant Publication of AMFS.

6. Bhalla. V.K.-‗Management of Financial Services‘ – Mnmol, New Delhi 2001.

7. Bhalla V.K.and Dilbag, Singh , ‗International Financial Centers‘, New Delhi, Anmol,1997.

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

Professional


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UNIT I

Merchant Banking

INTRODUCTION: An overview of Indian Financial System

The word ‗system‘ implies a set of complex and interrelated factors organized in a

particular form. These factors are mostly interdependent but not always mutually exclusive.

The financial system of any country consists of several ingredients. It includes financial

institutions, markets, financial instruments, services, transactions, agents, claims and liabilities

in the economy.

‗Financial system‘ is a system to canalize the funds from the surplus units to the deficit

Units. ‗Deficit units‘ is a case where current expenditure exceeds their current income.

There are other entities whose current income exceeds current expenditure which is called

as ‗Surplus Units‘.

An efficient financial system not only encourages savings and investments, it also

efficiently allocates resources in different investment avenues and thus accelerates the rate

of economic development. The financial system of a country plays a crucial role of allocating

scarce capital resources to productive uses. Its efficient functioning is of critical importance

to the economy.

FINANCIAL SYSTEM:

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

According to Robinson, financial system provides a link between savings and

investment for the creation of new wealth and to permit portfolio adjustment in the

composition of the existing wealth.

According to Van Horne, financial system is defined as the purpose of financial

markets to allocate savings efficiently in an economy to ultimate users – either for investment

in real assets or for consumption.

Thus the financial system mainly stands on three factors

Money

Credit

Finance

1. ‗Money‘ is the unit of exchange or medium of payment. It represents the value of

financial transactions in qualitative terms.

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

interest.

3. ‗Finance‘ is monetary wealth of the state, an institution or a person. Comprising

These factors in a systematic order forms a financial system.

Objectives

The objectives of the financial system are

1. Accelerating the growth of economic development.

2. Encouraging rapid industrialization

3. Acting as an agent to various economic factors such as industry, agricultural sector,

Government etc.

4. Accelerating rural development

5. Providing necessary financial support to industry


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6. Financing housing and small scale industries

7. Development of backward areas, infrastructure and livelihood

8. Imposing price control in need

9. Protecting environment.

Functions of financial system are distributed from creation of money to efficient

Management. It is the sum total of the functions of the various intermediaries.

The functions of financial system can be classified into two broad categories:

1. Controlling functions

2. Promotional functions.

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

i. Efficient operation of the payment mechanism.

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

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

upgrade their skills.

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

system.

v. Creation and establishment of need based financial institutions.

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

vii. Creating financial awareness to captivate investors, entrepreneurs and

borrowers.

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

1.3.3 Significance Of Financial System

Financial system of a country or an organization is the main motivating factor to 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.


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(iv)Diversification and reduction of financial risk

(v) Acting as intermediaries between savers and investors.

Introduction To 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.

PRE INDEPENDENCE SITUATIONS

During the 274 year regime of the East India Company (1600-1874) the financial

system of the country was not at all organized. It was monopolized by the mercantile

houses who were involved in banking business by providing loans, receiving deposits and

issuing currency. They are commonly known as ‗agency houses‘ who actually laid the

foundation of modern banking. The formal banking business was developed by establishment

of three Presidency Banks, namely

Apart from these, some exchange banks and Indian joint stock banks were set up.

In 1858, as a consequence of Sepoy Mutiny, the administrative power of the East India

Company was transferred to the Governor General of India. The financial system of the

country started to be organized during this period. In 1861, the Central Government took

the responsibility of issuing currency notes throughout the country. Between 1865 to 1905,

nine joint stock banks, each with a capital of Rs.5 lakh and over were established. In

1921, the three Presidency Banks were amalgamated under a special legislation to form

the Imperial Bank of India.

The first central bank was established in 1935 in the country which is known as the

Reserve Bank of India. At the time of independence, banking system in India was controlled

by RBI, IBI, exchange banks, cooperative banks and Indian joint stock banks and the

total deposits in these banks during 1948 were Rs.957 Crores. During this period, the

banking sector was in the making though there was lack of supply of long term funds to all

industrial units, specially to small scale industries. The cooperative movement did not help

much as it was disorganized and not properly aided with adequate funds. In the fields of

small savings and post office savings bank played a vital role to accumulate deposits,

though it is insignificant in terms of total deposits into the country.

The private sector acted a strong role in the stock market during the first half of the

20th century. The first stock exchange was established at Bombay in 1887 where the

private sector industrial units and the Government raised large amount of funds. The paid

up capital of Joint Stock companies increased from Rs.24 Crores in 1890 to Rs. 570

Crores in 1948 with an average capital issue of Rs.70 Crores per year during 1918 to

1939. This boom is due to the increased; pace of industrialization, protection of domestic

industries and government policies during this period.

POST INDEPENDENCE ERA (1950-1991)


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During this period, the Indian financial system passed the second phase of evolution.

It has grown rapidly since 1950 in terms of size, innovations, diversity, complicity and

sophistication. The banking system has been expanded in the rural areas through the

establishment of State Bank of India in 1955.

In 1951, economic planning was initiated in India. The mixed economy model has

been adopted which enhanced government control over the financial system and direct

government participation in industrialization process.. The different landmarks during this

phase were

• Bank nationalization in 1969

• Establishment of various financial institutions which are need based and useful for

expansion of financial sector.

• Imposing overall control on insurance sector by the Government.

• Establishment of large scale industrial units and introduction of long term finance to

all industries.

• Emphasizing the growth of small scale industries by helping them through subsidized

funding and direct investment.

• Imposition of regulatory measures and inserting Government intervention in business

through amending the companies Act, Securities Contracts (Regulation) Act, 1956,

Monopolies and Restrictive Trade practices Act 1970, Foreign Exchange

Regulation Act 1973 etc.,

ERA AFTER LIBERALISATION

The announcement of the New Economic Policy in 1991, the India Financial System

has shown quite flexibility in terms of transformation . The reformation process has been

started in order to remove the stagnation of growth described before and, till date, the

response is positive. This is the phase of liberalization and globalization of Indian economy

following the world trend which is duly supported by deregulation of Government Control.

Market force becomes dominant resulting in privatization of industries, emergence of new

generation financial institutions with competitive ability and introduction of computerized

business environment where information technology plays a vital role. The regulatory

framework has been duly changed giving space to this reform process and one can say

that the Indian financial sector is gradually moving towards attainment of global standards.

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

Components of Financial System:

Financial system

Institutions Markets

Financial Institutions

Instruments Services

Structure of Financial Institutions:

COMMERCIAL BANKS:


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Commercial Banks

Classification of Commercial Banks


Banking

Non Banking

Companies

Non Banking

Financial companies

Central Bank

Commercial

Banks

Co-Operative

Banks

Non Banking

Financial

Intermediaries

Joint Stock companies

Classification of Co-operative Banks

NON BANKING FINANCIL INTERMEDIARIES

Classification of Non Banking Financial Intermediaries

(B) FINANCIAL MARKETS:

Components of Financial Market

Co-operative Banks

State Co-operative

Apex Banks

State Co-operative Urban

Banks

Co-operative Land

Development

Banks

Central Co-operative

Banks Primary Co-operative

Land Development

Banks

Primary Co-operative

Banks

(a) 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 (a) Primary Market

and (b) Secondary Market

Classification of Capital Market

(i) 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


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company through application.

(ii) 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.

(b) MONEY MARKET:

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

(c) 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.

(d) 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.

Capital Market

Primary Market Secondary Market

Capital Market

Organized Money Market Unorganized Money Market.

Bonds are issued for raising Long term loans which are repayable over a period of 15 to

20 years.

Government Securities Market

(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.,

Classification of Financial Instruments

(a) Negotiable Instruments

A negotiable instrument is an instrument that is transferable from one person to another.

Negotiable instrument may be a bearer instrument or an order instrument. A 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.

Government Security

(d) Letter of Credit

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

(e) Travellers‟ Cheques

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

(D) FINANCIAL SERVICES

Financial service, as a part of financial system provides different types of 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.


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FINANCIAL SERVICES

Components of Financial Services

1.3.6 Limitations of the financial system in India

The following are the limitations of the Indian financial system.

• The Indian Financial system has failed to meet the financial needs of small 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.

Factoring Asset Liability Management

Leasing Housing Finance

Forfeiting Portfolio Finance

Hire Purchase Finance Underwriting

Credit Card Credit rating

Merchant Banking Interest and Credit Swap

Book Building Mutual fund

.

Four and half decades of Indian economic planning and subsequent liberalization had

led the country to an ecstatic phase of development The development through

disintermediation, deregulation, globalization, and emergence of vibrant capital market has

contributed to the expansion of opportunities. As a result, capital market has emerged as

the major contributor to the growth of foreign exchange reserves of the country. In fact, in

the merging world market, India has beaten several developing countries. In the post

liberalization era, the finance sector has witnessed a complete metamorphosis. The recent

economic reforms encompassed a series of measures to promote investors protection and

encourage the growth of capital market. Free entry into capital market for new issues by

companies and free pricing of share for new issues has been ensured. Different financial

institutions and markets compete for a limited pool of savings by offering different

instruments. Money and capital markets increase competition between suppliers. Capital

market enables contractual savings and collective investment institutions to play a more

active role in the financial system.

The Progress of any economy mainly depends on the efficient financial system of the

country. Indian economy is no exception of this. This importance of the financial sector

reforms affirms an effective means for solving the problems of economic, financial and

social in India and elsewhere in the developing nations of the world. The progress of the

securities Industry of any country depends mainly on the flow of funds. In fact, Capital

generation is the lifeblood of the capital market without which the health and soundness of


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the financial system cannot be geared up and for which well-developed capital market as

well as money market are essential.

A Merchant bank is a financial institution primarily engaged in internal finance and

long term loans for multinational corporations and governments. It can also be used to

describe the private equity activities of banking. Merchant banks tend to advise corporations

and wealthy individuals on how to use their money. The advice varies from counsel on

mergers and acquisitions to recommendation on the type of credit needed. The job of

generating loans and initiating other complex financial transactions has been taken over by

investment banks and private equity firms.

Thus, the function of merchant banking which originated, and grew in Europe was

enriched by American patronage, and these services are now being provided throughout

the world by both banking and Non-banking Institutions. The word ―Merchant Banking‖

originated among the Dutch and the Scottish Traders, and was later on developed and

professionalized in Britain.

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

― A merchant banker has been defined as any person who is engaged in the business

of issue management either by making arrangements regarding selling, buying or subscribing

to securities or acting as manager, consultant, adviser or rendering corporate advisory

services in relation to such issue management‖.

Random House Dictionary

―Merchant banker is an organization that underwrites securities for corporations,

advices such clients on mergers and is involved in the ownership of commercial ventures.

These organizations are sometime banks which are not merchants and sometimes merchants

who are not banks and sometimes houses which are neither merchants nor banks‖.

Charles P. Kindleberger

―Merchant banking is the development of banking from commerce which frequently

encountered a prolonged intermediate stage known in England originally as merchant

banking‖

The Notification of the Ministry of finance defines

A merchant banker as ,‖any person who is engaged in the business of issue management

either by making arrangements regarding selling, buying or subscribing to the securities as

manager, consultant, adviser or rendering corporate advisory service in relation to such

issue management‖.

• A merchant banker is one who is a critical link between a company raising

fund and the investors.

• Merchant banker is one who underwrites corporate securities and advices

clients on issues like corporate mergers.

• The merchant banker may be in the form of a bank, a company, firm or even

a proprietary concern.

• Merchant Banker understands the requirements of the business concern and

arranges finance with the help of financial institutions, banks, stock exchanges

and money market.

2.3.1 Objectives

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

avenues


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• Co-coordinating the activities of various intermediaries like the registrar, bankers,

advertising agency, printers, underwriters, brokers, etc., to the share issue

• Ensuring the compliance with rules and regulations governing the securities market.

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 c ounseling

Project C ounseling

Capita l S tructuring

Portfolio M anagement

Issue M anagement

C redit Syndication

Working capital

Ven ture C apital

Lease Finance

Fixed D eposits

(i) Corporate counseling:

Corporate counseling covers counseling in the form of project counseling, capital

restructuring, project management, public issue management, loan syndication, working

capital fixed deposit, lease financing, acceptance credit etc., The scope of corporate

counseling is limited to giving suggestions and opinions to the client and help taking actions

to solve their problems. It is provided to a corporate unit with a view to ensure better

performance, maintain steady growth and create better image among investors.

(ii) Project counseling

Project counseling is a part of corporate counseling and relates to project finance. It

broadly covers the study of the project, offering advisory assistance on the viability and

procedural steps for its implementation.

a. Identification of potential investment avenues.

b. A general view of the project ideas or project profiles.

c. Advising on procedural aspects of project implementation

d. Reviewing the technical feasibility of the project

e. Assisting in the selection of TCO‘s (Technical Consultancy Organizations) for

preparing project reports

f. Assisting in the preparation of project report

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

government

h. Capital structuring

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

takeovers.

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


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Here the Capital Structure is worked out i.e., the capital required, raising of the

capital, debt-equity ratio, issue of shares and debentures, working capital, fixed capital

requirements, etc.,

(iv)Portfolio Management

It refers to the effective management of Securities i.e., the merchant banker helps the

investor in matters pertaining to investment decisions. Taxation and inflation are taken into

account while advising on investment in different securities. The merchant banker also

undertakes the function of buying and selling of securities on behalf of their client companies.

Investments are done in such a way that it ensures maximum returns and minimum risks.

(v) Issue Management

Management of issues refers to effective marketing of corporate securities viz., equity

shares, preference shares and debentures or bonds by offering them to public. Merchant

banks act as intermediary whose main job is to transfer capital from those who own it to

those who need it.

The issue function may be broadly divided in to pre issue and post issue management.

a. Issue through prospectus, offer for sale and private placement.

b. Marketing and underwriting

c. Pricing of issues

(vi) Credit Syndication

Credit Syndication refers to obtaining of loans from single development finance

institution or a syndicate or consortium. Merchant Banks help corporate clients to raise

syndicated loans from commercials banks.

Merchant banks helps in identifying which financial institution should be approached

for term loans. The merchant bankers follow certain steps before assisting the clients approach

the appropriate financial institutions.

a. Merchant banker first makes an appraisal of the project to satisfy that it is viable

b. He ensures that the project adheres to the guidelines for financing industrial projects.

c. It helps in designing capital structure, determining the promoter‘s contribution and

arriving at a figure of approximate amount of term loan to be raised.

d. After verifications of the project, the Merchant Banker arranges for a preliminary

meeting with financial institution.

e. If the financial institution agrees to consider the proposal, the application is filled

and submitted along with other documents.

(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


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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.

Merchant Banking in India

The first merchant bank was set up in 1969 by Grind lays Bank. Initially they were

issue mangers looking after the issue of shares and raising capital for the company. But

subsequently they expanded their activities such as working capital management; syndication

of project finance, global loans, mergers, capital restructuring, etc., initially the merchant

banker in India was in the form of management of public issue and providing financial

consultancy for foreign banks. In 1973, SBI started the merchant banking and it was

followed by ICICI. SBI capital market was set up in August 1986 as a full fledged merchant

banker. Between 1974 and 1985, the merchant banker has promoted lot of companies.

However they were brought under the control of SEBI in 1992.

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 for

merchant banks, as many new issue are coming up.

The foreign investors – both in the form of portfolio investment and through foreign

direct investments are venturing in Indian Economy. It is increasing the scope of

merchant bankers in many ways.

Disinvestment in the government sector in the country gives a big scope to the

merchant banks to function as consultants.

New financial instruments are introduced in the market time and again. This basically

provides more and more opportunity to the merchant banks.

The mergers and corporate restructuring along with MOU and MOA are giving

immense opportunity to the merchant bankers for consultancy jobs.

However the challenges faced by merchant bankers in India are

1. SEBI guideline has restricted their operations to Issue Management and Portfolio

Management to some extent. So, the scope of work is limited.

2. In efficiency of the clients are often blamed on to the merchant banks, so they are


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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

MERCHANT BANKING AND LEGAL REGULATORY FRAME WORK

Registration with SEBI as Merchant Banker:

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

A. Yes. Without holding a certificate of registration granted by the Securities and

Exchange Board of India, no person can act as a merchant banker.

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

A. Only a body corporate other than a non-banking financial company shall be eligible

to get registration as merchant banker.

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

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

• Category I – to carry on the activity of issue management and to act as adviser,

consultant, manager, underwriter, portfolio manager.

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

manager.

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

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

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

A. The capital requirement depends upon the category. The minimum net worth

requirement for acting as merchant banker is given below:

• Category I – Rs. 5 crores

• Category II – Rs, 50 lakhs

• Category III – Rs. 20 lakhs

• Category IV – Nil

Q. What is the procedure for getting registration?

A. An application should be submitted to SEBI in Form A of the SEBI (Merchant

Bankers) Regulations, 1992. SEBI shall consider the application and on being satisfied

issue a certificate of registration in Form B of the SEBI (Merchant Bankers) Regulations,

1992.

Q. What is the registration fee payable to SEBI?

A. Rs. 5 lakhs which should be paid within 15 days of date of receipt of intimation

regarding grant of certificate.


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

A . Three years from the date of issue.

Q. How to renew the certificate?

A. Three months before the expiry period, an application should be submitted to

SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall consider

the application and on being satisfied renew certificate of registration for a further period of

3 years.

Q. What is the renewal fee payable to SEBI?

A. Rs.2.5 lakhs which should be paid within 15 days of date of receipt of intimation

regarding renewal of certificate.

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

A. The person whose registration is not current shall not carry on the activity as

merchant banker from the date of expiry of validity period.

Companies Act

(i) ―company‖ means a company formed and registered under this Act or an existing

company as defined in clause (ii);

(ii) ―existing company‖ means a company formed and registered under any of the

previous companies laws specified below:

a. any Act or Acts relating to companies in force before the Indian Companies Act,

1866 (10 of 1866) and repealed by the Act;

b. the Indian Companies Act, 1866

c. the Indian Companies Act, 1882

d. the Indian Companies Act, 1913

e. the Registration of Transferred Companies Ordinance 1942

iii. ―private company‖ means a company which has a minimum paid-up capital of one

lakh rupees or such higher paid-up capital as may be prescribed, and by its articles,

a. restricts the right to transfer its shares, if any;

b. limits the number of its members to fifty not including

i. persons who are in the employment of the company, and

ii. persons who, having been formerly in the employment of the company, were members

of the company while in that employment and have continued to be members after the

employment ceased; and

c. prohibits any invitation to the public to subscribe for any shares

in, or debentures of, the company;

d. prohibits any invitation or acceptance of deposits from persons

other than its members, directors or their relatives

Provided that where two or more persons hold one or more shares in a company

jointly, they shall, for the purposes of this definition, be treated as a single member;

iv. ―public company‖ means a company which

a. is not a private company;

b. has a minimum paid-up capital of five lakh rupees or such higher paid-up

capital, s may be prescribed

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

private company.

In this Act, unless the context otherwise requires,-


15

1. ―abridged prospectus‖ means a memorandum containing such salient features of a

prospectus as may be prescribed

2. ―banking company‖ has the same meaning as in the Banking Companies Act, 1949

3. ―Company Law Board‖ means the Board of Company Law Administration

constituted under section 10E

4. ―debenture‖ includes debenture stock bonds and any other securities of a company,

whether constituting a charge on the assets of the company or not;

5. ―derivative‖ has the same meaning as in clause (aa) of section 2 of the Securities

Contracts (Regulation) Act, 1956

6. ―hybrid‖ means any security which has the character of more than one type of

security, including their derivatives;

7. ―issued generally‖ means, in relation to a prospectus, issued to persons irrespective

of their being existing members or debenture-holders of the body corporate to

which the prospectus relates;

8. ―prospectus‖ means any document described or issued as a prospectus and includes

any notice, circular, advertisement or other document inviting deposits from the

public or inviting offers from the public for the subscription or purchase of any

shares in, or debentures of, a body corporate;

9. ―recognized stock exchange‖ means, in relation to any provision of this Act in

which it occurs a stock exchange whether in or outside India, which is notified by

the Central Government in the Official Gazette as a recognized stock exchange for

the purposes of that provision;

10. ―Registrar‖ means a Registrar, or an Additional, a Joint, a Deputy or an Assistant

Registrar, having the duty of registering companies under this Act;

11. ―securities‖ means securities as defined in clause (h) of section 2 of the Securities

Contracts (Regulation) Act, 1956

12. ―Securities and Exchange Board of India‖ means the Securities and Exchange

Board of India established under section 3 of the Securities and Exchange Board

of India Act, 1992

13. ―share‖ means share in the share capital of a company, and includes stock except

where a distinction between stock and shares is expressed or implied;

Provisions Under Companies Act

The various regulations which govern the merchant bankers on the capital issue are

prescribed by the companies act, and the other enactments mentioned below.

1. Provisions of the Companies Act, 1956

a. Prospectus (Sec. 55 to 68A)

b. Allotment (Sec. 55 to 75)

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

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

e. Issue and redemption of preference shares (Sec. 80 & 80A)

f. further issues of capital (Sec. 81)

g. Nature, numbering and certificate of shares (Sec. 82 to 84)

h. Kinds of share capital and prohibition on issue of any other kind of shares

(Sec. 85 & 86)

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


16

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

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

2. their capital adequacy

3. their track record, experience and general reputation

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

infrastructure.

SCRA ( Security contract regulation Act)

The Securities Contracts (Regulations) Act was passed in 1956 by Parliament and it

came into force in February 1957.

An act to prevent undesirable transactions in securities by regulating the business of

dealing therein, by providing for certain other matters connected therewith.

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

2. It extends to the whole of India.

3. It shall come into force on such date as the Central Government may, by notification

in the Official Gazette, appoint.

Definitions

a. ―Contract‖ means a contract for or relating to the purchase or sale of securities;

b. ―Corporatisation‖ means the succession of a recognized stock exchange, being a

Body of individuals or a society registered under the Societies Registration Act,

1860 (21 of 1860), by another stock exchange, being a company incorporated

for The purpose of assisting, regulating or controlling the business of buying, selling

or dealing in securities carried on by such individuals or society;

c. ―demutualization‖ means the segregation of ownership and management from the

trading rights of the members of a recognized stock exchange in accordance with

a scheme approved by the Securities and Exchange Board of India;

(c) ―derivative‖ includes

a. a security derived from a debt instrument, share, loan, whether secured or unsecured,

risk instrument or contract for differences or any other form of security;

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

securities;

c. ―Government security‖ means a security created and issued, whether before or

after the commencement of this Act, by the Central Government or a State

Government for the purpose of raising a public loan and having one of the forms

specified in clause (2) of section 2 of the Public Debt Act, 1944 (18 of 1944);

d. ―member‖ means a member of a recognized stock exchange;

e. ―option in securities‖ means a contract for the purchase or sale of a right to buy or

sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji

mandi, a galli, a put, a call or a put and call in securities;

f. ―recognized stock exchange‖ means a stock exchange which is for the time being

recognized by the Central Government under section 4;

g. stock exchange which may provide for—

(i) the issue of shares for a lawful consideration and provision of trading rights in lieu

of membership cards of members of a recognized stock exchange;

(ii) the restrictions on voting rights;

(iii) the transfer of property, business, assets, rights, liabilities, recognitions, contracts


17

of the recognized stock exchange, legal proceedings by, or against, the recognized

stock exchange, whether in the name of the recognized stock exchange or any

trustee or otherwise and any permission given to, or by, the recognized stock

exchange;

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

stock exchange;

(v) any other matter required for the purpose of, or in connection with, the

corporatisation or demutualization, as the case may be, of the recognized stock

exchange

h. ―securities‖ include—

i. shares, scrips, stocks, bonds, debentures, debenture stock or other marketable

securities of a like nature in or of any incorporated company or other body

corporate;

(h) Government securities;

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

securities; and

ii. rights or interest in securities;

(j) ―stock exchange‖ means—

a. any body of individuals, whether incorporated or not, constituted before

corporatisation and demutualization under sections 4A and 4B, or

b. a body corporate incorporated under the Companies Act 1956 whether under a

scheme of corporatisation and demutualization or otherwise, for the purpose of

assisting, regulating or controlling the business of buying,

Recognised Stock Exchanges

APPLICATION FOR RECOGNITION OF STOCK EXCHANGES

Any stock exchange, which is desirous of being recognized for the purposes of this

Act, may make an application in the prescribed manner to the Central Government.

(2) Every application under sub-section

1. shall contain such particulars as may be prescribed, and shall be accompanied by a

copy of the bye-laws of the stock exchange for the regulation and control of contracts

and also a copy of the rules relating in general to the constitution of the stock exchange

and in particular, to—

a. the governing body of such stock exchange, its constitution and powers of

management and the manner in which its business is to be transacted;

b. the powers and duties of the office bearers of the stock exchange;

c. the admission into the stock exchange of various classes of members, the

qualifications for membership, and the exclusion, suspension, expulsion and readmission

of members there from or thereinto;

d. the procedure for the registration of partnerships as members of the stock exchange

in cases where the rules provide for such membership; and the nomination and

appointment of authorized representatives and clerks.

Grant of Recognition of Stock Exchanges

1. If the Central Government is satisfied, after making such inquiry as may be necessary

in this behalf and after obtaining such further information, if any, as it may require,—

a. that the rules and bye-laws of a stock exchange applying for registration are


18

inconformity with such conditions as may be prescribed with a view to ensure

fairdealing and to protect investors;

b. that the stock exchange is willing to comply with any other conditions (including

conditions as to the number of members) which the Central Government, after

consultation with the governing body of the stock exchange and having regard to

the area served by the stock exchange and its standing and the nature of the securities

dealt with by it, may impose for the purpose of carrying out the objects of this Act;

and

c. that it would be in the interest of the trade and also in the public interest to grant

recognition to the stock exchange; it may grant recognition to the stock exchange

subject to the conditions imposed upon it as aforesaid and in such form as may be

prescribed.

2. The conditions which the Central Government may prescribe under clause (a) of subsection

(1) for the grant of recognition to the stock exchanges may include, among

other matters, conditions relating to,—

i. the qualifications for membership of stock exchanges;

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

iii.the representation of the Central Government on each of the stock exchange by

such number of persons not exceeding three as the Central Government may nominate in this

behalf; and

iv.the maintenance of accounts of members and their audit by chartered accountants

whenever such audit is required by the Central Government.

3. Every grant of recognition to a stock exchange under this section shall be published

in the Gazette of India and also in the Official Gazette of the State in which the

principal office as of the stock exchange is situate, and such recognition shall have

effect as from the date of its publication in the Gazette of India.

4. No application for the grant of recognition shall be refused except after giving an

opportunity to the stock exchange concerned to be heard in the matter; and the

reasons for such refusal shall be communicated to the stock exchange in writing.

5. No rules of a recognized stock exchange relating to any of the matters specified in

sub-section (2) of section 3 shall be amended except with the approval of the

Central Government.

Even though we have 23 stock exchanges in India, a major part of the transactions is

controlled by Bombay Stock Exchange. This has led to enormous speculation, rigging and

cornering of shares by a few speculators. To prevent these malpractices by companies,

brokers and merchant bankers, the government constituted Securities Exchange Board of

India in April 1988 for regulating and promoting the stock market in the country and

effective from 1992.

SEBI

SEBI is a body corporate with head office at Bombay. The Chairman and the board

members are appointed by the Central government. SEBI has two major functions. The

are :

1. Regulatory and

2. Development

1. Regulatory


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a. Registering the brokers and sub-brokers

b. Registration of mutual funds

c. Regulation of stock exchanges

d. Prohibition of fraudulent and unfair trade practice

e. Controlling insider-trading, take-over bids and imposing penalties

2. Development

a. Educating investors

b. Training intermediaries in stock market transactions

c. Promoting fair transactions

d. Undertaking research and publishing useful information to all

Objectives:

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

To promote fair dealings by the issue of securities and ensure a market place

where they can raise funds.

To provide protection to the investors.

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

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

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

To verify listing requirements, listing procedures, and ensure compliance of the

same by the companies, so that only financially sound companies are listed.

To prescribe required standards for merchant bankers.

The promote healthy growth of security market for the development of capital

market in the country.

Powers of Sebi

As per the Act, SEBI has powers

To file complaints in a court

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

rights shares.

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

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

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

In addition to the above powers:

it can call for periodical returns from stock exchange.

seek any information from stock exchange.

It can enquire into the functioning of stock exchange.

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

It can compel listing of securities of public company.

It can control and regulate stock exchanges.

Granting registration to market intermediaries, prohibit inside-trading and prohibit

Fraudulent and unfair trade practices.

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

Regulating purchase of shares and take-over of companies.

SEBI Regulations on merchant bankers:


20

SEBI has brought about a effective regulative measures for the purpose of disciplining

the functioning of the merchant bankers in India. The objective is to ensure an era of

regulated financial markets and thus streamline the development of the capital market in

India. The measures were introduced by the SEBI in the year 1992. The measures were

revised by SEBI in 1997. The salient features of the regulative framework of merchant

banking in India are discussed below.

Registration of Merchant Bankers

Application for Grant of Certificate

An application by a person for grant of a certificate shall be made to the Board in

Form A. The application shall be made for any one of the following categories of the

merchant banker namely:

1. Category I- To carry on any activity of the issue management, which will interalia

consist of preparation of prospectus and other information relating to the issue,

determining financial structure, tie-up of financiers and final allotment and refund of

the subscription; and to act as adviser, consultant, manager, underwriter, portfolio

manager.

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

manager.

3. Category III- To act as underwriter, adviser, consultant to an issue.

4. Category IV- To act only as adviser or consultant to an issue.

5. With effect from 9th December, 1997, an application can be made only for carrying

on the activities mentioned in category I. An applicant can carry on the activity as

underwriter only if he contains separate certificate of registration under the provisions

of Securities and Exchange Board of India (Underwriters) Regulations, 1993, and

as portfolio manager only if he obtains separate certificate of registration under the

provisions of Securities and Exchange Board of India (Portfolio Manager)

Regulations, 1993.

Conformance to Requirements

Subject to the provisions of the regulations, any application, which not complete in all

respects and does not conform to the instructions specified in the form, shall be rejected.

However, before rejecting any such application, the applicant will be given an opportunity

to remove within the time specified such objections and may be indicated by the board.

Furnishing of Information

The Board may require the applicant to furnish further information or clarification

regarding matter relevant to the activity of a merchant banker for the purpose of disposal

of the application. The applicant or its principal officer shall, if so required, appear before

the Board for personal representation.

Consideration of Application

The Board shall take into account for considering the grant of a certificate, all matters,

which are relevant to the activities relating to merchant banker and in particular whether

the applicant complies with the following requirements;

1. That the applicant shall be a body corporate other than a non-banking financial

company as defined by the Reserve Bank of India Act, 1934.

2. That the merchant banker who has been granted registration by the Reserve Bank

of India to act as Primary or Satellite Dealer may carry on such activity subject to


21

the condition that it shall not accept or hold public deposit.

3. That the applicant has the necessary infrastructure like adequate office space,

equipments, and manpower to effectively discharge his activities.

4. That the applicant has in his employment minimum of two persons who have the

experience to conduct the business of the merchant banker.

5. That a person (any person being an associate, subsidiary, inter-connected or group

Company of the applicant in case of the applicant being a body corporate) directly

or indirectly connected with the applicant has not been granted registration by the

Board.

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

7. That the applicant, his partner, director or principal officer is not involved in any

litigation connected with the securities market which has an adverse bearing on the

business of the applicant.

8. That the applicant, his director, partner or principal officer has not at any time been

convicted for any offence involving moral turpitude or has been found guilt of any

economic offence.

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

by the Government in finance, law or business management.

10. That the applicant is a fit and proper person.

11. That the grant of certificate to the applicant is in the interest of investors.

Capital Adequacy Requirement

According to the regulations, the capital adequacy requirement shall not be less than

the net worth of the person making the application for grant of registration. For this purpose,

the net wroth shall be as follows:

Category Minimum Amount

Category I Rs.5,00,00,000

Category II Rs.50,00,000

Category III Rs.20,00,000

Category IV Nil

For the purpose of this regulation ‗net worth‖ means in the case of an applicant which

is a partnership firm or a body corporate, the value of the capital contributed to the business

of such firm or the paid up capital of such body corporate plus free reserves as the case

may be at the time of making application.

Procedure for Registration

The Board on being satisfied that the applicant is eligible shall grant a certificate in

Form B. On the grant of a certificate the applicant shall be liable to pay the fees in accordance

with Schedule II.

Renewal of Certificate

Three months before expiry of the period of certificate, the merchant banker, may if

he so desired, make an application for renewal in Form A. The application for renewal

shall be dealt with in the same manner as if it were a fresh application for grant of a

certificate. In case of an application for renewal of certificate of registration, the provisions

of clause (a) of regulation 6 shall not be applicable up to June 30th , 1998. The Board on

being satisfied that the applicant is eligible for renewal of certificate shall grant a certificate

in form B and send intimation to the applicant. On the grant of a certificate the applicant


22

shall be liable to pay the fees in accordance with Schedule II.

Procedure where Registration is not Granted

Where an application for grant of a certificate under regulation 3 or of renewal under

regulation 9, does not satisfy the criteria set out in regulation 6, the Board may reject the

application after giving an opportunity of being heard. The refusal to grant registration shall

be communicated by the Board within thirty days of such refusal to the applicant stating

therein the grounds on which the application has been rejected.

Any applicant may, being aggrieved by the decision of the Board, under subregulation(

1), apply within a period of thirty days from the date of receipt of such intimation

to the Board for reconsideration for its decision. The Board shall reconsider an application

made under sub-regulation (3) and communicate its decision as soon as possible in writing

to the applicant.

Effect of Refusal to Grant Certificate

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

Board shall on and from the date of the receipt of the communication under sub-regulation

(2) of regulation 10 cease to carry on any activity as merchant banker.

Payment of Fees

Every applicant eligible for grant of a certificate shall pay such fees in such manner

and within the period specified in Schedule II. Where a merchant banker fails to any

annual fees as provided in sub-regulation (1), read with Schedule II, the Board may suspend

the registration certificate, whereupon the merchant banker shall cease to carry on any

activity as a merchant banker for the period during which the suspension subsists.

GENERAL OBLIGATIONS

The 1992 regulations have enunciated the following general obligations and

responsibilities for the merchant bankers.

Sole Function

Every merchant banker shall abide by the Code of Conduct as specified in Schedule

III. They are as follows

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

market.

2. No merchant banker, other than a bank or a public financial institution, who has

been granted certificate of registration under these regulations, shall after June

30th, 1998 carry on any business other than that in the securities market.

However , a merchant banker who prior to the date of notification of the Securities

and exchange board of India (Merchant Bankers) Amendment Regulations, 1997, has

entered into a contract in respect of a business other that that of the securities market may,

f he so desires, discharge his obligations under such contract. Similarly, a merchant banker

who has been granted certificate of registration to act as primary or satellite dealer by the

Reserve Bank of India may carry on such business as may be permitted by Reserve Bank

of India.

Maintenance of Books

Every merchant banker shall keep and maintain the following books of accounts,

records and documents:

1. A copy of balance sheet as at the end of each accounting period;


23

2. A copy of profit and loss account for that period;

3. A copy of the auditor‘s report on the accounts for that period; and

4. A statement of financial position.

Every merchant banker shall intimate to the Board the place where the books of

accounts, record and documents are maintained. Every merchant banker shall, after the

end of each accounting period furnish to the Board copies of the Balance sheet, profit and

loss account and such other documents for any other preceding five accounting years

when required by the Board.

Submission of Half-yearly Results

Every merchant banker shall furnish to the Board half-yearly unaudited financial results

when required by the Board with a view to monitor the capital adequacy of the merchant

banker.

Preservation of Books of Account, Records, etc.,

The merchant banker shall preserve the books of accounts and other records and

documents maintained under regulation 14 for a minimum period of five years.

Report on Steps taken on Auditor‟s Report

Every merchant banker shall within two months from the date of the auditors‘ report

take steps to rectify the deficiencies, made out in the auditor‘s report.

Appointment of Lead Merchant Bankers

All issues should be managed by at least one merchant banker functioning as the lead

merchant banker. In an issue of offer of rights to the existing members with or without the

right of renunciation, the amount of the issue of the body corporate does not exceed

rupees fifty lakhs, the appointment of a lead merchant banker shall not be essential. Every

lead merchant banker shall before taking up the assignment relating to an issue enter into

an agreement with such body corporate setting out their mutual right, liabilities and

obligations relating to such issue an in particular to disclosures, allotment and refund.

Restriction on Appointment of Lead Managers

The number of lead merchant bankers may not, exceed in case of any issue of the

following:

Responsibilities of Lead Managers

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

responsibilities relating to the issue mainly, those of disclosures, allotment and refund are

Size of Issue

Number of Merchant Bankers

Less than Rs. 50 Crores Two

Above Rs. 50 Crores but less than Rs.100 Crores Three

Above Rs. 100 Crores but less that Rs.200 Crores Four

Above Rs.200 Crores but less that Rs.400 Crores Five

Above Rs.400 Crores Five or more as agreed by SEBI

clearly defined, allocated and determined and a statement specifying such responsibilities

is furnished to the Board at least one month before the opening of the issue for subscription.

Where there are more than one lead merchant bankers to the issue the responsibilities of

each of such lead merchant banker shall clearly be demarcated and a statement specifying

such responsibilities shall be furnished to the Board at least one month before the opening

of the issue for subscription.


24

No lead merchant banker shall, agree to manage the issue made by any body corporate,

if such body corporate is an associate of the lead merchant banker. A lead merchant

banker shall not be associated with any issue if a merchant banker who is not holding a

certificate is associated with the issue.

Underwriting Obligations

In respect of every issue to be managed, the lead merchant banker holding a certificate

under Category I shall accept a minimum Underwriting obligation of five percent of the

total underwriting commitment or rupees twenty-five lakhs whichever is less. If the lead

merchant banker is unable to accept the minimum underwriting obligation, that lead merchant

banker shall make arrangement for having the issue underwritten to that extent by a merchant

banker associated with the issue and shall keep the board informed of such arrangement.

Submission of Due Diligence Certificate

The lead merchant bankers, who is responsible for verification of the contents of a

prospectus or the Letter of Offer in respect of an issue and the reasonableness of the views

expressed therein, shall submit to the Board at least two weeks prior to the opening of the

issue for subscription, a due diligence certificate in Form C.

Documents to be furnished to the Board

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

documents

1. Particulars of the issue;

2. Draft prospectus or where there is an offer to the existing shareholders, the draft

letter of offer;

3. Any other literature intended to be circulated to the investors, including the

shareholders; and

4. Such other documents relating to prospectus or letter of offer as the case may be.

The documents shall be furnished at least two weeks prior to the date of filing of the

draft prospectus or the letter of the offer, as the case may be, with the Registrar of Companies

or with the Regional Stock Exchanges or with both. The lead manager shall ensure that the

modifications and suggestions, if any, made by the Board on the draft prospectus or the

Letter of Offer as the case may be, with respect to information to be given to the investors

are incorporated therein.

Payment of fees to the Board

The draft prospectus or draft letter of offer referred to in regulation 24 shall be submitted

along with such fees and in such manner as may be specified in Schedule IV.

Continuance of Association of Lead Manager

The lead manager undertaking the responsibility for refunds or allotment of securities

in respect of any issue shall continue to be associated with the issues till the subscriber have

received the share or debenture certificates or refund of excess application money. Where

a person other than the lead manager is entrusted with the refund or allot of securities in

respect of any issue the lead manager shall continue to be responsible for ensuring that

such other person discharges the requisite responsibilities in accordance with the provisions

of the Companies Act and the listing agreement entered into but the body corporate with

the stock Exchange.

Acquisition of shares Prohibited

No merchant banker or any of its directors, partner manager or principal shall either


25

on their respective accounts or through their associates or relative enter into transaction in

securities of bodies corporate on the basis of unpublished price sensitive information obtained

by them during the course of any professional assignment either from the clients or otherwise.

Information to the Board

Every merchant banker shall submit to the Board complete particulars of any

transaction for acquisition of securities of any body corporate whose issue is being managed

by that merchant banker within fifteen days from the date of entering into such transaction.

Disclosures to the Board

A merchant banker shall disclose to the Board as and when required, the following

information:

1. His responsibilities with regard to the management of the issue; Any change in the

information o particulars previously furnished, which have a bearing on the certificate

granted to it;

2. The names of the body corporate whose issues he has managed or has been

ass0oiciated with;

3. The particulars relating to breach of the capital adequacy requirement as specified

in regulation 7;

4. Relating to his activities as a manager, underwriter, consultant or adviser to an

issue as the case may be.

Appointment of Compliance Officer

Every merchant banker shall appoint a compliance officer who shall be responsible

for monitoring the compliance of the Act, rules and regulations notifications, guidelines,

instructions etc., issued by the board or the Central Government and for redressed of

investors‘ grievances. The compliance officer shall immediately and independently report

to the Board any non-compliance observed by him and ensure that the observations made

or deficiencies pointed out by the Board on/in the draft prospectus or the Letter of offer as the

case may be, do not recur.

Procedure For Inspection

Board‟s Right to inspect

The Board may appoint one or more persons as inspecting authority to undertake

inspection of the books of accounts, records and documents of the merchant banker for

any of the purposes specified in sub-regulation(2). The purposes referred to in sub-regulation

(1) may be as follows:

1. To ensure that the books of account are being maintained in the manner required;

2. To ensure that the provisions of the Act, rules, regulations are being complied with;

3. To investigate into the complaints received from investors, other merchant bankers

or any other person on any matter having a bearing on the activities of the merchant

banker; and

4. To investigate suo-moto in the interest of securities business or investors interest in

the affairs of the merchant banker.

Notice before inspection

Before undertaking an inspection under regulation 29 the Board shall give a reasonable

notice to the merchant banker for that purpose. Where the Board is satisfied that in the

interest of the investors no such notice should be given, it may, by an order in writing

directing that the inspection of the affairs of the merchant banker be taken up without such


26

notice. During the course of inspection, the merchant banker against whom an inspection is

being carried out shall be bound to discharge his obligations as provided under regulation

31.

Obligations of Merchant Banker on Inspection

It shall be the duty of every director, proprietor, partner, officer and employee of the

merchant banker, who is being inspected, to produce to the inspecting authority such

books, accounts and other documents in his custody or control and furnish him with the

statements and information relating to his activities as a merchant banker within such time

as the inspecting authority may require.

The merchant banker shall allow the inspecting authority to have reasonable access

to the premises occupied by such merchant banker or by any other person on his behalf

and also extend reasonable facility for examining any books, records, documents and

computer data in the possession of the merchant banker or any such other person and also

provide copies of documents or other materials which, in the opinion of the inspecting

authority are relevant for the purposes of the inspection.

The inspecting authority, in the course of inspection, shall be entitled to examine or

record statements of any principal officer, director, partner, proprietor and employee of

the merchant banker. It shall be the duty of every director, proprietor, partner, officer or

employee of the merchant banker to give to the inspecting authority all assistance in

connection with the inspection which the merchant banker may be reasonably expected to

give.

Submission of Report to the Board

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

Board.

Action on Inspection or Investigation Report

The Board of the Chairman shall after consideration of inspection or investigation

report take such action and the board or chairman may deem fit and appropriate including

action under the Securities and Exchange Board of India (Procedure for Holding Enquiry

by Enquiry Officer and imposing Penalty) Regulations, 2002.

Appointment of Auditor

The Board may appoint a qualified auditor to investigate into the books of account or

the affairs of the merchant banker. The auditor so appointed shall have the same powers of

the inspecting authority as are mentioned in regulation 29 and the obligations of the merchant

banker in regulation 31 shall be applicable to the investigations under this regulation.

Communication of findings

The Board shall after consideration of the inspection report communicate the findings

to the merchant banker to give him an opportunity of being heard before any action is

taken by the Board on the findings of the inspecting authority. On receipt of the explanation

if any, from the merchant banker, the Board may call upon the merchant banker to take

such measures as the Board may deem fit in the interest of the securities market and for

due compliance with provisions of the Act, rules and regulations.

Procedure For Action Incase Of Default

Liability for Action in case of Default

A merchant banker who fails to comply with any conditions subject to which certificate

has been granted, and contravenes any of the provisions of the Act rules or regulations


27

shall be dealt with in the manner provided under the Securities and Exchange Board of

India (Procedure for Holding Enquiry by Enquiry Officer and imposing Penalty) Regulations,

2002.

Suspension of Registration

SEBI Regulations, 2002 published in the official Gazette of India dated 27.09.2002

A penalty for suspension of registration of a merchant banker may be imposed under

the following circumstances:

• Where the merchant banker violates the provisions of the Act, rules or regulations;

or

• Where the merchant banker fails to furnish any information relating to his activity

as merchant banker as required by the Board; or furnishes wrong or false

information, or does not submit periodical returns as required by the Board; or

does not co-operate in any enquiry conducted by the Board ; or

• Where the merchant banker fails to resolve the complaints of the investors or fails

to give a satisfactory reply to the Board in this behalf; or

• Where the merchant banker indulges in manipulation or price rigging or cornering

activities; or

• Where the merchant banker is guilty of misconduct or improper or unbusiness like

or unprofessional conduct which is not in accordance with the Code of Conduct

specified in Schedule III; or

• Where the merchant banker fails to maintain the capital adequacy requirement in

accordance with provisions of regulation 7; or

• Where the merchant banker fails to pay the fees; or

• Where the merchant banker violates the conditions of registration ; or

• Where the merchant banker does not carry out his obligations as specified in the

regulation.

Cancellation or Registration

A penalty of cancellation of registration of a merchant banker may be imposed where;

• The merchant banker indulges in deliberate manipulation or price rigging or cornering

activities affecting the securities market and the investors interest;

• The financial position of the merchant banker deteriorates to such an extent that

the Board is of the opinion that his continuance as merchant banker is not in the

interest of investors;

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

• In case of repeated defaults of the nature mentioned in regulation 36 provided that

the Board furnishes reasons for cancellation in writing.

Manner of Making Order of Suspension or Cancellation

No order of penalty of suspension or cancellations the case may be shall be imposed

except after holding an enquiry in accordance with procedure specified in regulation.

Manner of Holding Enquiry before Suspension or Cancellation.

For the purpose of holding an enquiry under regulation 38, the board may appoint an

enquiry officer. The enquiry officer shall issue to the merchant banker a notice the registered

office or the principal place of business of the merchant banker.

The merchant banker may, within thirty days from the date of receipt of such notice,


28

furnish to the enquiry officer a reply together with copies of documentary or other evidence

relied on by him or sought by the Board from the merchant banker.

The enquiry officer shall, give a reasonable opportunity or hearing to the merchant

banker to enable him to make submissions in support of his reply made under sub-regulation

(3). The merchant banker may either appear in person or through any duly authorized

person. No lawyer or advocate shall be permitted to represent the merchant banker at the

enquiry. Where a lawyer or an advocate has been appointed by the Board as a presenting

officer under sub-regulation (6), it shall be lawful for the merchant banker to present its

case through a lawyer or advocate.

It is considered necessary that the enquiry officer may ask the Board to appoint a

presenting officer to present its case. The enquiry officer shall, after taking into account all

relevant facts and submissions made by the merchant banker, submit a report the Board

and recommend the penalty to be imposed as also the grounds on the basis of which

proposed penalty is justified.

Show case Notice and Order

On receipt of the report from the enquiry officer, the Board shall consider the same

and issue a show-cause notice as to why the penalty as proposed by the enquiry officer

should not be imposed. The merchant banker shall within twenty-one days of the date of

the receipt of the show-cause send a reply to the Board.

The Board after considering the reply to the show-cause notice, if received, shall as

soon as possible or not later than thirty days from the receipt of the reply, if any, pass such

order as it deems fit. Every order passed under sub-regulation (3) shall be self-contained

and give reasons for the conclusions stated therein including justification of the penalty

imposed by that order. The Board shall send a copy of the order under sub-regulation (3)

to the merchant banker.

Effect of Suspension and Cancellation

On and from the date of the suspension of their merchant banker he shall cease to

carry on any activity as a merchant banker during the period of suspension. On and from

the date of cancellation the merchant banker shall with immediate effect cease to carry on

any activity as a merchant banker. The order of suspension or cancellation of certificate

passed under sub-regulation (3) of regulation 40 shall be published in at least two daily

newspapers by the Board.

Appeal to the Securities Appellate Tribunal

Any person aggrieved by an order of the board may, on and after the commencement

of the /securities Laws (second amendment) Act, 1999, under these regulations may prefer

an appeal to a Securities Appellate Tribunal having jurisdiction in the matter.

Fees

Every merchant banker shall pay a sum of Rupees five lacs as registration fees at the

time of the grant of certificate by the Board. The fee shall be paid by the merchant a banker

within fifteen days from the date of receipt of the intimation from the Board under subregulation

(1) of regulation 8. A merchant banker to keep registration in force shall pay

renewal fee of Rs.2.5 lacs every three years from the fourth year from the date of initial

registration. The fee shall be paid by the merchant banker within fifteen days from the date

of receipt of intimation from the Board under sub-regulation (3) of regulation 9.

The fees specified shall be payable by merchant banker by a demand draft in favour


29

of ‗securities and Exchange Board of India‘ payable at Mumbai or at the respective regional

office.

Every Merchant banker shall pay registration fees as set out below:

1. Category I merchant banker; A sum of Rs. 2.5 lakhs to be paid annually for

the first two years commencing from the date of initial registration and thereafter

for the third year a sum of Rs. 1 lakh to keep his registration in force.

2. Category II merchant banker; A sum of Rs. 1.5 lakhs to be paid annually for


for the third year a sum of Rs. 50,000 to keep his registration in force.

3. Category III merchant bankers ; A sum of Rs.1 lakh to be paid annually for


for the third year a sum of Rs.25,000 to keep his registration in force.

4. Category IV merchant bankers ; A sum of Rs.5,000/- to be paid annually for


for the third year a sum of Rs.1000/- to keep his registration in force.

Renewal Fees :

1. Category I merchant bankers : A sum of Rs.1 lakh to be paid annually for the

first two years commencing from the date of each renewal and thereafter for the

third year a sum of Rs.20,000/- to keep his registration in force;

2. Category II merchant bankers : A sum of Rs.75,000/- to be paid annually for

the first two years commencing from the date of each renewal and thereafter for

the third year a sum of Rs.10,000/- to keep his registration in force ;

3. Category III merchant bankers : A sum of s.50,000/ to be paid annually for



4. Category IV merchant bankers : A sum of Rs.5,000/- to be paid annually for



In addition, the merchant banker has to pay the following fees towards documentation

Size of the Issue Fee per Document (Rs.)

Up to 5 crores 10,000

More than 5 crores and up to 10 crores 15,000



More than 100 crores and up to 500 crores 2,50,000

More than 500 crores 5,00,000

IV. CODE OF CONDUCT FOR MERCHANT BANKERS

The SEBI regulations have outlined the following code of conduct for the merchant

bankers operation in India ;

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

• A Merchant Banker shall maintain high standards of integrity, dignity and fairness

in the conduct of its business.

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

manner.

• A Merchant Banker shall at all times exercise due diligence, ensure proper care


30

and exercise independent professional judgment.

• A Merchant Banker shall Endeavour to ensure that enquiries from the investors

are adequately dealt with, grievances of investors are redressed in a timely and

appropriate manner, where a complaint is not remedied promptly, the investor is

advised of any further steps which may be available to the investor under the

regulatory system.

• A Merchant Banker shall ensure that adequate disclosures are made to the

investors in a timely manner in accordance with the applicable regulations and

guidelines so as to enable them to make a balanced and informed decision.

• A Merchant Banker shall endeavour to ensure that the investors are provided with

true and adequate information without making any misleading or exaggerated

claims or any misrepresentation and are made aware of the attendant risks before

taking any investment decision.

• A Merchant Banker shall endeavour to ensure that copies of the prospectus,

offer document, letter of offer or any other related literature is made available to

the investors at the time of issue of the offer.

• A Merchant Banker shall not discriminate amongst its clients, save and except

on ethical and commercial considerations.

• A Merchant Banker shall not make any statement, either oral or written, which

would misrepresent the services that the Merchant Banker is capable of

performing for any client or has rendered to any client.

• A Merchant Banker shall avoid conflict of interest and make adequate disclosure

of its interest.

• A Merchant Banker shall put in place a mechanism to resolve any conflict of

interest situation that may arise in the conduct of its business or where any conflict

of interest arises, shall take reasonable steps to resolve the same in an equitable

manner.

• Merchant Banker shall make appropriate disclosure to the client of its possible

source or potential areas of conflict of duties and interest while acting as Merchant

Banker which would impair its ability to render fair, objective and unbiased services.

• A Merchant Banker shall always endeavour to render the best possible advice to

the clients having regard to their needs.

• A Merchant Banker shall not divulge to anybody either oral or in writing, directly

or indirectly, any confidential information about its clients which has come to its

knowledge, without taking prior permission of its client, except where such

disclosures are required to be made in compliance with any law for the time being

in force.

• A Merchant Banker shall ensure that any change in registration status/any penal

action taken by the Board or any material change in the Merchant Banker‘s financial

status, which may adversely affect the interests of clients/investors is promptly

informed to the clients and any business remaining outstanding is transferred to

another registered intermediary in accordance with any instructions of the affected

clients.

• A Merchant Banker shall not indulge in any unfair competition, such as

weaning away the clients on assurance of higher premium or advantageous offer


31

price or which is likely to harm the interests of other Merchant Bankers or investors

or is likely to place such other Merchant Bankers in a disadvantageous position

while competing for or executing any assignment.

• A Merchant Banker shall maintain arms length relationship between its

merchant banking activity and any other activity.

• A Merchant Banker shall have internal control procedures and financial and

operational capabilities which can be reasonably expected to protect its operations,

its clients, investors and other registered entities from financial loss arising from

theft, fraud, and other dishonest acts, professional misconduct or omissions.

• A Merchant Banker shall not make untrue statement or suppress any material

fact in any documents, reports or information furnished to the Board.

• A Merchant Bankers shall maintain an appropriate level of knowledge and

competence and abide by the provisions of the Act, regulations made there under,

circulars and guidance, which may be applicable and relevant to the activities carried

on by it. The merchant banker shall also comply with the award of the Ombudsman

passed under Securities and Exchange Board of India (Ombudsman) Regulations,

2003.

• A Merchant Banker shall ensure that the Board is promptly informed about any

action, legal proceedings etc., initiated against it in respect of material breach or

non-compliance by it, of any law, rules, regulations, directions of the Board or of

any other regulatory body.

• A Merchant Banker or any of its employers shall not render, directly or indirectly,

any investment advice about any security in any publicly accessible media, whether

real-time , unless a disclosure of his interest including a long or short position, in

the said security has been made, while rendering such advice. In the event of an

employee of the Merchant Banker rendering such advice, the merchant banker

shall ensure that such employee shall also disclose the interests, if any, of himself,

his dependent family members including their long or short position in the said

security, while rendering such advice.

• A Merchant Banker shall demarcate the responsibilities of the various

intermediaries appointed by it clearly so as to avoid any conflict or confusion in

their job description.

• A Merchant Banker shall provide adequate freedom and powers to its compliance

officer for the effective discharge of the compliance officer‘s duties.

• A Merchant Banker shall develop its own internal code of conduct for governing

its internal operations and laying down its standards of appropriate conduct for its

employees and officers in carrying out their duties. Such a code may extend to the

maintenance of professional excellence and standards, integrity, confidentiality,

objectivity, avoidance or resolution of conflict of interests, disclosure of

shareholdings and interests etc.

• A Merchant Banker shall ensure that good corporate policies and corporate

governance are in place.

• A Merchant Banker shall ensure that any person it employs or appoints to conduct

business is fit and proper and otherwise qualified to act in the capacity so

employed or appointed


32

• A Merchant Banker shall ensure that it has adequate resources to supervise

diligently and does supervise diligently persons employed if appointed by it in the

conduct of its business, in respect of dealings in securities market.

• A Merchant Banker shall be responsible for the acts or omissions of its

employees and agents in respect of the conduct of its business.

• A Merchant Banker shall ensure that the senior management, particularly decision

makers have access to all relevant information about the business on a timely

basis.

• A Merchant Banker shall not be a party to or instrumental for creation of false

market; price rigging or manipulation; or passing of unpublished price sensitive

information in respect of securities which are listed and proposed to be listed in

any stock exchange to any person or intermediary in the securities market.

Sebi Guidelines

Operational Guidelines

SEBI has pronounced the following guidelines for merchant bankers :

1. Submission of offer document : The offer documents of issue size up to Rs. 20 crores

shall be filed by lead merchant bankers with the concerned regional office of the Board

under the jurisdiction of which the registered office of the issuer company falls. The

jurisdiction of regional offices/head office shall be as per Schedule XXII. According to

Clause 5.6 of Chapter V of the Guidelines, the draft offer document filed with the Board

shall be made public.

The lead merchant banker shall make available 10 copies of the draft offer document

to the Board and 25 copies to the stock exchange(s) where the issue is proposed to be

listed. Copies of the draft offer document shall be made available to the public by the lead

merchant bankers/Stock Exchange. The lead merchant banker and the Stock Ex change(s)

may charge a reasonable charge for providing a copy of the draft offer document.

The lead merchant banker shall also submit to the Board the daft offer document on

a computer floppy in the format specified in Schedule XXIII. The Lead Merchant Banker

shall submit two copies of the printed copy of the final offer document to dealing offices of

the Board within three days of filing offer document with Registrar of companies/concerned

Stock Exchange(s) as the case may be. ―The lead merchant banker shall submit one

printed copy of the final offer document to the Primary Market Department, SEBI, Head

Office, ―within three days of filing the offer document with Registrar of Companies/concerned

Stock Exchange(s) as the case may be.‖ The lead merchant banker shall submit a computer

floppy containing the final prospectus/letter of offer to the Primary Market Department,

SEBI, Head Office, as specified in Schedule XXIII within three days of filing the final

prospects/letter of offer with the Registrar of Companies/concerned Stock Exchange(s).

Along with the floppy, the lead manager shall submit an undertaking to SEBI certifying that

the contents of the floppy are in HTML, format, and are identical to the printed version of

the proposes/letter of offer filed with the registrar of Companies/concerned Stock Exchange,

as the case may be.

Wherever offer documents (for public/rights issues, takeovers or for any other purpose)

are filed with any Department/Office of the Board, the following details ―certified as correct‖

shall be given by the lead merchant banker in the forwarding letters:

a. Registration number


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b. Date of registration/Renewal of registration

c. Date of expiry of registration

d. If applied for renewal, date of application

e. Any communication from the Board prohibiting them from acting as a

f. merchant banker

g. Any inquiry/investigation being conducted by the Board

h. Period up to which registration/renewal fees has been paid

i. Whether any promoter/group and/or associate company of the issuer company

is associated with securities-related business and registered with SEBI

j. If any one or more of these persons/entities are registered with SEBI, their

respective registration numbers

k. If registration has expired, reasons for non-renewal

l. Details of any enquiry/investigation conducted by SEBI at any time

m. Penalty imposed by SEBI

n. Outstanding fees payable to SEBI by these entities, if any

Offer documents not accompanied by the information as contained above may be

rejected. Lead merchant bankers shall obtain similar information from other intermediaries

to ensure that they comply with these guidelines and are eligible to be associated with the

concerned issue. The intermediaries shall also indicate in their letters that they have obtained

such information from other intermediaries.

2. Dispatch of issue material : Lead merchant bankers shall ensure that whenever

there is a reservation for NRIs, 10 copies of the prospectus together with 1000 application

forms are dispatched in advance of the issue opening date, directly along with a letter

addressed in person to Adviser (NRI), Indian Investment Centre, Jeevan Vihar Building

Sansad Marg, New Delhi. Twenty copies of the prospectus and application forms shall be

dispatched in advance of the issue opening date to the various Investors Associations.

3. Underwriting

While selecting underwriters and finalizing underwriting arrangement, lead merchant

bankers shall ensure that the underwriters do not overexpose themselves so that it becomes

difficult to fulfill their underwriting commitments. The overall exposure of underwriter(s)

belonging to the same group or management in an issue shall be assessed carefully by the

lead merchant banker. OTC Dealers registered with the Board under SEBI (Stock Brokers

and Sub-Brokers) Rules and Regulations, 1992 shall be treated at par with the brokers of

other stock exchanges in respect of underwriting arrangement.

4. Compliance obligations

The merchant banker shall ensure compliance with the following post-issue obligations

a. Association of resource personnel : In terms of Clause 7.1 of Chapter VII of these

Guidelines, in case of over-subscription in public issues, a Board nominated public

representative shall be associated in the process of finalization of the basis of allotment.

The lead merchant banker shall intimated to the person so nominated the date, time, venue

etc. regarding the process of finalization of the basis of allotment.

The expenses of the public representatives associated in the allotment process of

oversubscribed issues shall be borne by the lead merchant bankers, and recovered from

the issues. Honorarium at a minimum of Rs.500/- per day, plus normal conveyance charges

shall be paid to them, and the Board‘s Regional Managers at New Delhi, Chennai and


34

Calcutta shall be associated with them.

b. Redressal of investor grievances

The merchant bankers shall assign high priority to investor grievances, and take all

preventive steps to minimize the number of complaints. The lead merchant banker shall set

up a proper grievance monitoring and redressal system in co-ordination with the issuers

and the Registrars to Issue.. They shall take all necessary measures to resolve the grievances

quickly. They shall actively associate with post-issue refund and allotment activities and

regularly monitor investor grievances arising there from.

c. Submission of post issue monitoring reports

The concerned lead merchant banker shall submit, in duplicate, the Post Issue

Monitoring Reports specified in Clause 7.2 of Chapter VII of these Guidelines, within 3

working days from the due dates, either by registered post or deliver them at the respective

regional offices/head office give in Schedule XXII. Where the offer documents have been

dealt with by any of the regional offices of the Board, a copy of the report shall be sent to

the Board‘s Head office, Mumbai. The Lead Merchant Banker(s) shall inform the Board

on important developments about the particular issues being lead managed by them during

the period intervening the reports.

d. Issue of No objection Certificate (NOC)

In accordance with the Listing Agreement of the Stock Exchanges, the issuer companies

shall deposit 1% of the amount of securities offered to the public and/or to the holders of

the existing securities of the company, as the case may be, with the regional Stock Exchange.

These securities can be related by the concerned Stock Exchange only after obtaining an

NOC from the Board. An application for NOC shall be submitted by the issue company

to the Board in the format specified in Schedule XXIV.

The following conditions shall be complied with before submitting the application for

the issue of NOC.

• Completion of 4 months from the date of obtaining the listing permission from the

concerned Regional Stock Exchange, or the last date when the listing permission

was obtained from any of the other Stock Exchanges, where the securities are

proposed to be listed, whichever is later

• Satisfactory redressal of all complaints received by the Board against the company

• Certificate from the Regional Stock Exchange to the issuer company to the effect

that underwriting/brokerage commission as well as the Registrars/Lead merchant

bankers fees been duly paid by the company

Application for issue of NOC shall be filed with the concerned regional office of the

Board , under the jurisdiction in which the registered office of the issuer company falls, as

specified in Schedule XXII..

In cases where issues fail, and the investors‘ monies are fully refunded, an NOC from

the Board may not be required, and the concerned regional Stock Exchange can refund

the 1% security deposit after duly verifying that the refund orders have actually been

dispatched.

The complaints with respect to non-receipt of underwriting/brokerage commission

and Registrars/Lead merchant banker‘s fees may be filed with the concerned regional

Stock Exchanges. Responses to complaints forwarded by the Board to the concerned

companies shall be submitted to the Board in the proforma specified in Schedule XXV for


35

updation of records.

e. Registration of merchant bankers

Application for renewal of Certificate of Registration shall be made by the merchant

bankers according to Regulation 9 of SEBI (Merchant Bankers) Rules and Regulations,

1992. While filing the renewal application for the certificate of registration as merchant

banker, it shall provide a statement highlighting the changes that have taken place in the

information that was submitted to the Board for the earlier registration, and a declaration

stating that no other changes besides those mentioned in the above statement have taken

place.

Merchant Bankers, while forwarding the renewal application in Form A of the SEBI

(Merchant Bankers) Rules and Regulations, 1992, shall also forward the additional

information as specified in Schedule XXVI. Registered Merchant Bankers shall inform

the Board of their having become a member of AMBI, with the relevant details.

f. Reporting requirements

In terms of Regulation 28 of SEBI (Merchant Bankers Regulation) 1992, the merchant

bankers shall send a half yearly report, in the format specified in Schedule XXVII, relating

to their merchant banking activities. The report referred to in sub-clause (a) shall be

submitted twice a year, on March 31 and September 30, and it should reach the Board

within three months from the close of the period to which it relates.

g. Impositions of penalty points

Penalty points may be imposed on the merchant banker for violation of any of the

provisions for operational guidelines. The merchant banker, on whom penalty points of

four or more has been imposed, may be restrained from filing any offer document or

associating or managing any issues for a particular period.

The Board may initiate action under the SEBI (Merchant Bankers) Regulations against

the merchant bankers, irrespective of whether any penalty point is imposed or not.

Imposition of penalty point is not a precondition for initiation of proceedings against the

merchant banker under the SEBI (Merchant Bankers) Regulations.

Guidelines on Advertisement

Following are the guidelines applicable le to the lead merchant banker who shall

ensure due compliance by the issuer company :

1. Factual and truthful

An issue advertisement shall be truthful, fair and clear, and shall not contain any

statement that is untrue or misleading. Any advertisement reproducing, or purporting to

reproduce, any information contained in an offer document shall reproduce such information

in full and disclose all relevant facts. It should not be restricted to select extracts relating to

that item. An issue advertisement shall be considered to be misleading, if it contains :

a. Statements made about the performance or activities of the company in the absence

of necessary explanatory or qualifying statements, which may give an exaggerated

picture of the performance or activities.

b. An inaccurate portrayal of past performance, or its portrayal in a manner which

implies that past gains or income, will be repeated in the future.

2. Clear and concise

An advertisement shall be set forth in a clear, concise and understandable language.

Extensive use of technical, legal terminology or complex language and the inclusion of


36

excessive details, which may distract the investor, shall be avoided.

3. Promise or profits

An issue advertisement shall not contain statements which promise or guarantee rapid

increase in profits. An issue advertisement shall not contain any information that is not

contained in the offer document.

4. Mode of advertising

No models, celebrities, fictional characters, landmarks, caricatures or the likes shall

be displayed on or form part of the offer documents or issue advertisements. Issue

advertisements shall not appear in the form of crawlers (the advertisements which run

simultaneously with the program in a narrow strip at the bottom of the television screen) on

television. Similarly, no advertisement shall include any issue slogans or brand names for

the issue, except the normal commercial name of the company or commercial brand names

of its products already in use. No slogans, expletives or non-factual and unsubstantiated

titles shall appear in the issue advertisements or offer documents.

5. Financial data

If any advertisement carries any financial data, it shall also contain data for the past

three years and shall include particulars relating to sales, gross profit, not profit, share

capital, reserves, earnings per share, dividends, and book values.

6. Risk factors

All issue advertisements carried in the print media such as newspapers, magazines,

brochures or, pamphlets shall contain highlights relating to any issue, besides containing

detailed information on the risk factors. The print size of highlights and risk factors in issue

advertisements shall not be less than point 7 size. It shall contain the names of issuer

company, address of its registered office, names of the main lead merchant bankers and

Registrars to the Issue. No issue advertisement shall be released without giving ―Risk

Factors‖ in respect of the concerned issue, provided that an issue opening/closing

advertisement which does not contain the highlights need not contain risk factors.

7. Issue date

No corporate advertisement of issuer company shall be issued after 21 days of filing

of the offer document with the Board until the closure of the issue, unless the risk factors

which are required to be mentioned in the offer document, are mentioned in the

advertisement.

8. Product advertisement

No product advertisement of the company shall contain any reference, directly or

indirectly, to the performance of the company during the period.

9. Subscription

No advertisement shall be issued stating that the issue has been fully subscribed or

oversubscribed during the period the issue is open for subscription, except to the effect

that the issue is open or closed.

10. Issue closure

No announcement regarding closure of the issue shall be made except on the closing

date. If the issue is fully subscribed before the closing date stated in the offer document,

the announcement should be made only after the issue is fully subscribed , and such

announcement is made on the date on which the issued is to be closed. Announcements


37

regarding closure of the issue shall be made only after the lead merchant banker is satisfied

that at least 90% of the issue has been subscribed, and a certificate has been obtained to

that effect from the Registrar to the issue.

11. Incentives

No incentives, apart from the permissible underwriting commission and brokerage,

shall be offered through advertisements to anyone associated with marketing the issue.

12. Reservation

In case there is a reservation for NRIs, the issue advertisement shall specify the same,

and also indicate the place in India from where the individual NRI applicant can procure

application forms.

13. Undertaking

An undertaking has to be obtained from the issuer as part of the MoU between the

lead merchant banker and the issue company to the effect that the issuer company shall not

directly or indirectly release, during any conference or at any other time, any material or

information which is not contained in the offer documents.

14. Availability of copies

To ensure that the issuer company obtains approval for all issue advertisements and

publicity materials from the lead merchant banker responsible for marketing the issue and

also ensure the availability of copies of all issue related materials with the lead merchant

banker, at least until the allotment is completed.

by the SEBI.

SUMMARY

Currently, Merchant banking in India is considered fairly matured in terms of supply,

product range and reach, even though the reach India still remains a challenge for the

private sector and foreign banks. With the growth of Indian economy expected to be

strong for quite some time especially in its service sector, the demand for Merchant banking

services esp. investment services are expected to be strong.

Stock exchange is an organized market place for the investors to buy and sell securities

freely. The market offers perfectly competitive conditions where a large number of sellers

and buyers participate. Further stock exchange provides an auction market in which members

of the exchange participate to ensure continuity of price and liquidity to investors.

An active and healthy secondary market in existing securities leads to a better

psychology of expectations, considerably broadening the investment enquiries and thereby,

rendering the task of raising resources by entrepreneurs easier.

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 primary


38

market depends much on the soundness and the depth of the secondary market. It provides

the investor, the facility of disposing off their holdings as and when the need for it arises.

According to Hastings, ―Stock exchange or securities market comprises all the places

where buyers and sellers of stocks and bonds or their representatives undertake transactions

involving the sale of securities‘.

According to Derek Koney gold, ―Stock exchange can be described as the place

where a marriage of convenience is enacted between those who wish to raise capital, such

as companies, governments and local authorities , and those who wish to invest – largely

households through the medium of institutions acting upon their behalf‖.

According to Section 2(3) of the Securities Contract Regulation Act 1956. ― The

stock exchange has been defined as any body of individuals whether incorporated or not,

constituted for the purpose of assisting, regulating or controlling the business of buying,

selling or dealing in securities‖.

The following securities can be traded at the stock exchange

a. Shares, scrips, stock, bonds, debentures, debentures stocks or other 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

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


39

into profitable channels.

5. Motivation for improved performance

The performance of a company is reflected on the prices quoted in the stock market.

These prices are more visible in the eyes of the public. Stock market provides room for

this price quotation for those securities listed by it. This public exposure makes a company

conscious of its status in the market and it acts as a motivation to improve its performance

further.

6. Promotion of Investment

Stock exchanges mobilize the savings of the public and promote investment through

capital formation. But for these stock exchanges, surplus funds available with individuals

and institutions would not have gone for productive and remunerative ventures.

7. Reflection of Business Cycle

The changing business conditions in the economy are immediately reflected on the

stock exchanges. Booms and depressions cane be identified through the dealings on the

stock exchanges and suitable monetary and fiscal policies can be taken by the government.

Thus a stock market portrays the prevailing economic situation instantly to all concerned

so that suitable actions can be taken.

8. Marketing of New Issues

If the new issues are listed, they are readily acceptable to the public, since, listing

presupposes their evaluation by concerned stock exchange authorities. Costs of underwriting

such issues would be less. Public response to such new issues would be relatively high.

Thus, a stock market helps in the marketing of new issues also.

9. Miscellaneous Services

Stock exchange supplies securities of different kinds with different maturities and

yields. It enables the investors to diversity their risks by a wider portfolio of investment. It

also inculcates saving habits among the community and paves the ways for capital formation.

It guides the investors in choosing securities by supplying him daily quotation of listed

securities and by disclosing the trends of dealings on the stock exchange. It enables

companies and the Government to raise resources by providing a ready market for their

securities.

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


40

Calcutta Stock Exchange

Cochin Stock Exchange

Coimbatore Stock Exchange

Delhi Stock Exchange

Gauhati Stock Exchange

Hyderabad Stock Exchange

Interconnected Stock Exchange

Jaipur Stock Exchange

Ludhiana Stock Exchange

Madras Stock Exchange

Magadh Stock Exchange

Mangalore Stock Exchange

National Stock Exchange

Pune Stock Exchange

OTCEI

Demutualization of Stock Exchanges

• The transition process of an exchange from a “mutually-owned” 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 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)

Corporatisation 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:


41

• 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:

(1) Choice of Broker

The prospective investor who wants to buy shares or the investor who wants to sell

his shares cannot enter into the hall of exchange and transact business. They have to act

through only member brokers. They can also appoint their bankers for this purpose, since,

bankers can become members of the stock exchange as per the present regulations. So,

the first task in transacting business on a stock exchange is to choose a broker of repute or

a banker. Such persons alone can ensure prompt and quick execution of a transaction at

the best possible and profitable price.

(2) Placement of Order

Placement of order refers to the purchase or sale of securities with the broker. The

order is usually placed by telegram, telephone, letter, fax etc., or in person.

(3)Execution of Orders

The Orders are executed through their authorized clerks. Small one carries out their

business personally. Orders are executed in Trading ring of a stock exchange which works

from 12 noon to 2 p.m. on all working days from Monday to Friday and a special one hour

session on Saturday. Trading outside the trading hours is called ‗kerb dealings‖.

(4) 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.

(5) 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: i.e., the delivery of securities and payment for these

are affected on the date of the contract itself or on the next day.

• Hand Delivery Settlement: i.e., the delivery of securities and payment are

affected within the time stipulated in the agreement or within 14 days from the date

of the contract whichever is earlier.

• Clearing Settlement: i.e., the transactions are cleared and settled through the


42

clearing house. Usually those securities which are frequently traded and are usually

in demand are cleared through the clearing house. These transactions are also

referred to as the transaction for the ―account‖.

• Special Delivery Settlement: i.e., the delivery of securities and payment may

take place at any time exceeding 14 days following the date of the contract as

specified in the contract and permitted by the governing board.

ONLINE TRADING

• It is the trading over the net i.e., E-trading

To overcome the wastage of time consumed and inefficient operations of the traditional

method and the limits on trading volumes the NSE has introduced a nation-wide on line

fully automated Screen Based Trading System (SBTS). Now, other stock exchanges have

been forced to adopt SBTS and today India can boast that almost 100% trading take

place through electronic order matching.

Under SBTS, a member can punch into the computers quantities of securities and the

prices at which he likes to transact the transaction. It is executed as soon as it finds a

matching sale or buy order from a counter party; Thus, technology is used to carry the

trading platform from the trading hall of the exchanges to the premises of the brokers. NSE

has carried the trading platform further to the PCs at the residence of the investors through

the internet and the hand held devices through WAP for the convenience of the mobile

investors.

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

point of time provide complete information as to

(1) total order depth in a security

(2) the best five buys and sells in the market

(3) the quantity traded during the day in that security

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

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

BSE BOLT SYSTEM, BOLT (Bombay on line Trading) has been introduced in the

Bombay Stock Exchange. All the scrips are being traded through BOLT.

Many small companies in India re finding it difficult to raise adequate capital through

stock exchanges as the conditions stipulated by them could not be fulfilled. The companies

must have run for minimum three years and they must have earned profit and the minimum

capital requirement for listing is also quite high which is at present is Rs.5 Crores. Hence,

promoting a new stock exchange with flexible conditions, the small and medium companies

in India will be able to raise sufficient capital, Once these companies enlarge their resources,

they can list themselves in the regular stock exchanges.

OTCEI

• Over the Counter Exchange of India

• It is a Stock Exchange without a proper trading floor

All stock exchanges have a specific place for trading their securities through counters.

But, OTCEI is connected through a computer network and the transactions are taking

place through computer operations. Thus, the development in information technology has

given scope for starting this type of stock exchange. This stock exchange is recognized

under the Securities Contract ( Regulation) Act and so all the stocks listed in this exchange

enjoy the same benefits as other listed securities enjoy.


43

OTCEI has been incorporated under Section 25 of the companies Act. As a result of

which the word ‗Limited‘ need not be used since it is promoted for a common case of

promoting the interest of small and medium companies. This privilege has been given to the

company by the Central government.

This company was promoted by a group of financial institutions owned by Government

of India, consisting of UTI, ICICI, IDBI, SBI Capital Market , IFCI, LIC, GIC and

CAN BANK financial Services.

FEATURES OF OTCEI

(1) Use of Modern Technology: It is an electronically operated stock exchange.

(2) Restrictions for other stocks: Stocks and shares listed in other stock exchanges

will not be listed in the OTCEI and similarly, stock listed in OTCEI will not be

listed in other stock exchanges.

(3) Minimum issued capital requirements: Minimum issued equity capital should

be Rs.30 lakhs, out of which minimum public offer should be Rs.20 lakhs.

(4) Restrictions for large companies: No company with the issued equity share

capital of more than Rs.25 crores is permitted for listing.

(5) Base Capital requirement for members: Members will be required to maintain

a minimum base capital of Rs. 4 lakhs to trade on the permitted or on listed segment.

(6) All India network: The network of counters links OTCEI members, located in

different parts of the country.

(7) Satellite facility: The satellite required for OTCEI for its operations is jointly

held with Press Trust of India

(8) Computerization of transactions: Computers at each counter enable the dealers

to enter various transactions or queries or quotes through a central OTCEI computer,

using telecommunication links.

Objectives of OTCEI:

The following are the objectives of OTCEI

1. Assisting and guiding small companies to raise funds from the capital market in a

cost-effective manner

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

small investors

3. Strengthening investors‘ confidence in the financial market by offering them the

two-way best prices to them

4. Ensuring transparency, redressing investors‘ complaints and unifying the country‘s

securities market to cover even those places which do not have a stock exchange

5. Acting as a launch pad to an IPO

6. Providing liquidity advantage to the securities traded

7. Promoting organized trading in Unlisted Securities

8. Providing a source of valuation for securities traded

OTCEI offers the following benefits :

Benefits To Listed Companies

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

1. Negotiability : The company can negotiate the issue price with the sponsors

who have to market the issue. It provides an opportunity for fair pricing of an

issue through negotiation with the sponsors.


44

2. Fixation of premium : In consultation with the sponsors, the company can fix

an optimum level of premium on issue with minimum risk of non-subscription of

the issue.

3. Savings in costs : Lots of costs associated with public issue of capital are saved

through this mode. It provides an opportunity to companies to raise funds through

capital market instruments at an extremely low cost as compared to a public issue.

The method of sponsors placing the scrips with members who in turn will offload

the scrips to public will obviate the need for a public issue and its associated costs.

4. No take-over threat : OTCEI lists scrips even with 40 percent of the capital

offered for public trading. The limit has now been brought down to 20 percent in

the case of closely held companies and new companies. As a result, the present

management of the companies are saved of threats of takeover if they restrict

public offer.

5. Large access : Accessing a large pool of captive investor base through the

OTCEI‘s computerized network is made possible for companies. Though

nationwide network for servicing of investors, companies listed on OTC Exchange

can have a larger investor base.

6. Other benefits :

a. Helpful to small companies

b. Shares of all unlisted companies can now be traded on OTCEI

c. Platform for issuers and first-level investors like financial institutions, state level

financial corporations, Foreign Institutional Investors, etc.

d. System for defining benchmark for securities

e. Increasing business for the market constituents

Benefits To Investors

OTCEI offers the following benefits for investors :

1. Safety : OTCEI‘s ring less and scrip less electronic trading ensure safety of

transactions of the investor. For instance, every investor in a OTCEI is given an

‗Invest-OTC-Card‘ free. This code is allotted on a permanent basis and should

be used in all OTC transactions and applications of OTC issues. This card provides

for the safety and security of the investors‘ investments. The mechanism offers

greater security to investors as the sponsors investigate into the company and the

projects, before accepting sponsorship thus building up much needed greater

investor confidence.

1. Transparency : OTC screens at every OTC counter display the best buy/sell

prices. The exact trading prices are printed in the trading documents for

confirmations. This protects the investor interest and thereby minimize disputes.

2. Liquidity : A great advantage of the OTC is that the scrips traded are liquid.

This is because there are at least two market-makers who indulge in continuous

buying and selling. This enables investors to buy and sell the scrips any time. 4.

Appraisal : OTC members sponsor each scrip listed in an OTC counter. The

sponsor makes an appraisal of the scrips for investor worthiness. This ensures

quality of investments.

3. Access : Every OTC counter serves as a single window to the entire OTC exchange

throughout the country and throughout the world too. Therefore, buying and selling


45

may be resorted to from any part of the world. It offers the facility of faster deal

settlement for investors across the counters spread over the entire country.

4. Transfer : It is important that OTC shares are transferable within 7 days, where

the consolidated holdings of the scrips do not exceed 0.5 percent of the issued

capital of the company.

5. Allotment : There is not much waiting for the investors when it comes to allotment

of scrips. Allotment is completed in all respects within a matter of 35 days and

trading begins immediately thereafter.

6. Other benefits :

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

forms of forward transactions and stock lending are allowed on OTCEI

b. Scrip less trading makes dealings simper and easier

c. Market-making system in OTC Exchange gives sufficient opportunities for the

investors to exit

d. Acts as a benchmark to value securities

e. Creating an exit option for illiquid stocks/venture capitalists

f. Shuffling portfolios for the investors

g. Organizing and broad-basing trading in the existing market

Benefits To Financial System

The OTCEI‘s role has been laudable in as far as it helps contribute improving the

financial system of India in the following ways :

1. National network of OTCEI operations facilitates the integration of capital market

in the country

2. Boon to closely-held companies as they are encouraged to go public because

scrips can be listed even if only 40 percent of capital (now a minimum of 20

percent in case of closely held and new companies) is offered for public trading

3. Facilities wider dispersal of economic activities by encouraging small companies

and small investors

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

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

entrepreneurship

6. Market-making assistance by the sponsors on the OTCEI that helps in making an

appraised future projections in the issue documents which in turn helps prospective

investors in determining the usefulness of the issues for investment purposes,

promoting investment environment in general

7. Those members of the OTCEI who did not have multiple memberships can now

have an opportunity to trade in some of the large capital index stocks

8. Encourage venture capital activities and boost entrepreneurship

9. Spread of stock exchange operations geographically all over India

Securities Traded

Following are the securities that are traded on the OTCEI :

1. Listed equity (exclusive) : These are equity shares of the companies listed

exclusively on the OTCEI. The shared can be bought or sold at any of the member/

dealer‘s office all over India. The securities, which are listed exclusively on the

OTCEI, cannot be traded on other stock exchanges.


46

2. Listed debt : These are the debentures/bonds that are issued through a public

issue or a private placement and are listed on OTCEI. Any entity holding the

entire series of a particular debt instrument can also offer them for trading on the

OTCEI, by appointing an OTCEI member/dealer to carry out compulsory marketmaking

in those securities.

3. Gilts : The securities issued by the Central and State Governments are called

‗gilts‘. Government of India Dated Securities, Treasury Bills and special securities

are traded in this segment. Banks, Foreign Investors, Foreign Institutional Investors,

NBFCs and Provident Funds can trade in these securities through OTCEI

designated members/dealers.. PSU Bonds, Commercial Paper, and Certificates

of Deposit will also be traded in this segment.

4. Permitted securities : These are the securities listed on other exchanges, which

are permitted for trading on OTCEI. Securities of Blue Chip companies like

ACC, Reliance Industries Ltd., State Bank of India, ITC, etc. are traded in this

segment.

5. Listed mutual funds : Listed mutual funds are units of mutual funds that are

listed on OTCEI. Mutual fund units like units of Unit-64, Monthly Income Plan,

and IISFUS ‘97 are also listed under this category.

To counter the influence of Bombay Stock Exchange and reduce the influence of

certain powerful intermediaries in the stock market, a new stock market was promoted in

which both securities of companies and debt instruments are traded, namely the National

Stock Exchanges. NSE takes into account the screen based trading and so it is the most

advanced. The success of this stock exchange is quite evident that within a few years of its

promotion the volume and the value of transactions have surpassed the BSE.

NSE NATIONAL STOCK EXCHANGE OF INDIA

• It is the screen based trading established to counter the influence of Bombay

Stock Exchange and to reduce the influence of certain powerful intermediaries

in the stock market.

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

The success of this stock exchange is quite evident that within a few years of its

promotion the volume and the value of transactions have surpassed the Bombay Stock

Exchange. Apart from this, the prices of securities prevailing in this market have its influence

on the Bombay Stock Exchange.

PROMOTERS AND COMMITTEES

The National Stock Exchange was promoted in November 1992, as a limited company

by insurance companies, commercial banks and other financial institutions. Besides, SBI

Capital Markets Limited, Infrastructure leasing and financial services Ltd., and Stock

Holding Corporation Ltd., were also part of the promoters of NSE. The NSE was

incorporated with an equity capital of Rs.25 crores. The International Securities Consultancy

(ISC) of Hong Kong has helped in setting up of the NSE.

FEATURES OF NSE

1. The NSE employs a fully automated screen based trading system. Investors can

trade from 400 cities on a real time basis.

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

and derivatives market


47

• The capital market segments covers equities, convertible debentures and

retail trade in debt instruments like non- convertible debentures. Securities

of medium and large companies with nation wise investor base, including

securities traded on other stock exchanges are traded in NSE through

trading members.

• The wholesale debt market segment is a market for high value transactions

in government securities, public sector bonds, commercial papers and other

debt instruments.

• On the wholesale market segment, there are two types of entities viz.,

trading members and participants. Trading members are recognized

members of the exchange selected on the basis of selection criteria laid

down under the provisions of SEBI and the securities contract (Regulation)

Act, 1956. They can trade on their own or on behalf of their clients.

Participants are the organizations directly responsible for the settlement of

trades.

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

4. The market operates with all participants stationed at their offices and making use

of their computer terminals, to receive market information to enter orders and to

execute trade.

5. The trading members in the capital market segment are connected to the central

computer in Bombay through a satellite link –up using VSATs (Very small aperture

Terminals). The trading members in the whole sale debt market segment are linked,

through high speed lines, to the central computer Mumbai.

6. The NSE has opted for an order driven system. The system provides enormous

flexibility to trading members. A trading member can place various conditions on

the order in terms of price, time or size. When an order is placed by a trading

member, an order confirmation slip is generated. All orders received are started in

price and time priority. The computer system automatically searches for a match

and no sooner to the same is found, the deal is struck. If it does not find a match

immediately as may happen in the case of less liquid securities, the order is kept

pending in the computer unless specified otherwise by the trading member.

7. When a trade takes place, a trade confirmation slip is printed at the trading member‘s

work station. It gives details like price, quantity, code number of the party and so

on.

8. The identity of the trading member is not revealed to others when he places an

order or when his pending orders are delayed. Hence large order can be placed

in NSE without the fear of influencing the market sentiment.

9. On the eight day of trading, each member gets a statement showing his net position,

the amount of cash he has to transfer to the clearing bank and the securities he has

to deliver to the clearing house.

10. Members are required to deliver securities and cash by the thirteenth and fourteenth

day, respectively. The fifteenth day is the pay-out day.

11. The automated trade matching system secures the best price available in the market

to the investor. The trading member can transact a high volume of business

efficiently.


48

Operations of NSE

NSE and Wholesale Debt Market (WDM)

Prior to the commencement of trading in WDM segment of NSE, the only trading

mechanism available in the debt market was the telephone market. NSE provided for the

first time in the country, an online, automated trading facility across a wide range of debt

instruments.

Comparison Between Stock Exchange, OTCEI and NSE

Stock Exchange OTCEI NSE

1. Membership

2. Methods of Trading

3. System of Trading

4. Settlement

5. Transparency

6. Intermediary

Individuals, Firms and Corporate Floor Screen based

Quote-driven

Manual

T + 2

NIL

Jobber needed

Corporates only

Screen based

Code driven

Computers linked

to central OTCEI

through telephone

lines

T + 2 rolling

settlement

Ensured

Not needed

Individuals, Firms

and Corporates

Screen based

Order driven

Computer linked by

satellite through

VSAT

Same day to T + 2

in WDM Standard

Delivery in Equity

market

Total transparency

Not needed

TABLE Operations of the National Stock Exchange


49

*Working of NSE during 1997-98

Of the total trading turnover of Rs.9,08,691 crores by the 22 stock exchanges in

1997-98 the trading turnover of NSE was the highest which accounted for about 45% of

the total trading volume during 2000.

TABLE Operations of the National Stock Exchange

The trading system of the exchange known as NEAT (National Exchange for Automated

Trading) is fully automated, screen based trading system that enables members across the

country to trade simultaneously with enormous easy and efficiency.

WDM segment provides trading facilities for a variety of debt instruments. Initially

Government securities, Treasury Bills and Bonds issued by public sector undertakings

were made available for trading. This range has been widened to include non-traditional

instruments like Fleeting Rate Deposits, Corporate Debentures, State Government Loans,

Bonds issued by Financial Institutions, units of Mutual Funds and Securitized debt.

In order to enable investors like Provident Fund, Trusts, NBFCs and other high net

worth investors to deal in debt instruments, the exchange has introduced a small book let

facility where an order of minimum of Rs. 1 lakh can be placed on the trading system of

the exchange.

The volume of NSE has increased multifold in the last four years. Average daily

volume has increased from 30 crores in the year 1994-95 to Rs.385 Crores in 1997-98,

The number of trades which were around 5 per day in 1994-95 has gone up to 59 trades

per day in 1997-98.

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

the table below.

TABLE NSE Trading in WDM Segment

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

The current process of initial offering is a lengthy one involving considerable time and

costs. Considering several infirmities afflicting primary issue market for all types of securities,

NSE has worked out an unique facility for achieving quantum improvement in the process

of primary issues. The Exchange is proposing to provide a facility for issue of securities for

time bound Initial Public Offerings (IPO) and perpetual IPO.

Time bound IPO includes primary issues for initial public offers and subsequent issues

by companies. Perpetual IPO includes continuous offering of securities by the issues like

open ended mutual funds.

NSE, PIO facility would operate through a fully automated screen based system. Its

facility can be used for all types of primary issues which are designed to meet specific

requirements of issuer, investors and trading members. The system can also be used for

issues which have various combinations or components of book building and fixed price

issues. The software designed by the exchange provides flexibility for making issues of

any security whether equity, debt or any other hybrid instrument.

Objectives

The main objectives of starting the primary issues through a screen based automated

trading system are :

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

2. To provide wide retail distribution network.

3. To reduce the cost of issue of securities.


50

4. To reduce the delay in listing of securities.

Time Bound PIO System

This system can be used for price/rate discovery in case of book building as well as

for collecting subscription for fixed price. Issuer will announce certain number of securities

in case of fixed price offerings and the total amount to be raised in case of book building.

Eligible trading members will place subscription orders of investors specifying the number

of shares or price as the case may be. The issue will be closed after a specified number of

1995-96 1996-97 1997-98

Traded value

Average daily volume

Average No. of trades per day

11,867.68

40.78

0.10

42,277,60

145.28

0.27

1,11,263.28

384.99

0.59 days after which the issuer will decide the allocation based on the offers received. The

exchange proposes to provide a software which will help the issuer in finalizing the basis of

allotment as per the guidelines issued by SEBI.

After the allotment, the Exchange will generate dummy trades for successful investors

and send it to the respective members in the form of obligation. After the receipt of the

obligation data, the members will initiate and expedite the process of fund collection and

printing of application forms. The exchange proposes to provide a special software to

trading members who will maintain a complete IPO back office system including printing

of application forms, fund management and report generation.

Completed application forms and funds will be received by the exchange on a predetermined

day based on which final dispatch of certificates and release of funds will be

done.

Internet Broking

NSE launched internet trading in early February 2000. It is the first exchange in the

country to provide web based access to investors to trade directly on the exchange. The

orders originating from the PCs of the investors are routed through the internet to the

trading terminals of the designated brokers with whom they are connected and further to

the exchange for trade executions. Soon after these orders get matched and result into

trades, the investors get confirmation about them on their PCs through the same internet

route.

Wireless Application Protocol (WAP)

SEBI has approved trading through wireless medium on WAP platform. WAP was

introduced in November 2000. This provides access to its order book through the hand

held devices, which use WAP technology. This serves primarily retail investors who are

mobile and want to trade from any place when he market prices for stocks at their choice

are attractive.


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NATIONAL SECURITIES CLEARING CORPORATION

NSC has set up a wholly owned subsidiary – National Securities Clearing Corporation

that takes up the responsibility of settlement by opening guarantee. There is seamless

Integration of trading and settlement with full guarantee which protects the interest of

Investors fully.

UNIT II

ISSUE MANAGEMENT

INTRODUCTION

Merchant Banking, as a commercial activity, took shape in India through the

management of Public Issues of capital and Loan Syndication. It was originated in 1969

with the setting up of the Merchant Banking Division by ANZ Grind lays Bank. The main

service offered at that time to the corporate enterprises by the merchant banks included

the management of public issues and some aspects of financial consultancy. The early and

mid-seventies witnessed a boom in the growth of merchant banking organizations in the

country with various commercial banks, financial institutions, and broker‘s firms entering

into the field of merchant banking.

Reform measures were initiated in the capital market from 1992, starting with the

conferring of statutory powers on the Securities and Exchange Board of India (SEBI) and

the repeal of Capital Issues Control Act and the abolition of the office of the Controller of

Capital Issues. These have brought about significant improvement in the functional and

regulatory efficiency of the market, enabling the Merchant Bankers shoulder greater legal

and moral responsibility towards the investing public.

MERCHANT BANKERS AND CAPITAL ISSUES MANAGEMENT Merchant Banker has been defined under the Securities & Exchange Board of India

(Merchant Bankers) Rules, 1992 as ―any person who is engaged in the business of issue

management either by making arrangements regarding selling, buying or subscribing to

securities as manager, consultant, advisor or rendering corporate advisory service in relation

to such issue management‖.

The capital issue management comprises of the effective management of market related

factors. They are

• Transition to rolling settlement on the equity market

• Impact on different classes of market users

• Obtaining a liquid bond market

• Impact of reforms of 1990s

• Law and taxation

• Taxation of capital

• Legal reforms

• Political economy of financial sector reforms

• Market design, market inefficiencies, trading profits

Issue Management

• The management of issues for raising funds

The management of issues for raising funds through various types of instruments by

companies is known as ― issue management‖. The function of capital issues management in

India is carried out by merchant bankers. The Merchant Bankers have the requisite skill

and competence to carry out capital issues management.


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The funds are raised by companies to finance new projects, expansion / modernization/

diversification of existing units etc.,

The definition of ‗merchant banker‘, as contained in SEBI (Merchant Banker) Rules

and Regulations, 1992 clearly brings out the significance of Issue Management as follows:

―any person who is engaged in the business of issue management either by making

arrangement regarding selling, buying or subscribing to securities as manager, consultant,

advisor or rendering corporate advisory services in relation to such issue management‖.

MERCHANTS OF PUBLIC ISSUE MANAGEMENT

Classification Of Securites Issue

1. Public Issue

2. Right Issue

3. Private Placement

Decision to Raise Capital Funds

Preparation and Finalization of Prospectus

Obtaining SEBI Approval

Arranging underwriting

Selection of Registrars, Brokers, Bankers, etc.

Printing and Publicity of Public Issue Documents

Arranging Press for investor Conference

Issue Launch

SEBI Compliance

1. Public Issue of Securities

When capital funds are raised through the issue of a prospectus, it is called ‗‘public

issue of securities‘. It is the most common method of raising funds in the capital market. A

security issue may take place either at part, or at a premium or at a discount. The Prospectus

has to disclose all the essential facts about the company to the prospective purchasers of

the shares. Further, the prospectus must conform to the formal set out in Schedule II of the

Companies Act, 1956, besides taking into the account SEBI guidelines. SEBI insists on

the adequacy of disclosure of information that should serve as the basis for investors to

make a decision about the investment of their money.

2. Rights Issue

When shares are issued to the existing shareholders of a company on a privileged

basis, it is called as ‗Rights Issue‘. The existing shareholders have a pre-emptive right to

subscribe to the new issue of shares. Rights shares are offered as additional issues by

corporate to mop up further capital funds. Such shares are offered in proportion to the

capital paid up on the shares held by them at the time of the offer.

It is to be noted that the shareholders, although privileged to be offered on the issue,

are under no legal obligation to accept the offer. Right shares are usually offered on terms

advantageous to the shareholders.

3. Private Placement

When the issuing company sells securities directly to the investors, especially institutional

investors, it takes the form of private placement. In this case, no prospectus is issued,

since it is presumed that the investors have sufficient knowledge and experience and are

capable of evaluating the risks of the investment. Private placement covers shares,


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preference shares and debentures. The role of the financial intermediary, such as the

merchant bankers and lead managers, assures great significance in private placement. They

involve themselves in the task of preparing an offer memorandum and negotiating with

investors.

Merchant Bankers Functions

The different functions of merchant bankers towards the capital issues management

are

1. Designing Capital Structures

2. Capital Market Instruments

3. Preparation of prospectus

4. selection of bankers

5. Advertising Consultants

6. Choice regarding registrar to the issue

7. Arranging for underwriting the proposed issue

8. Choice for the bankers to the issue

9. Choice for the brokers.

1. DESIGNING CAPITAL STRUCTURE DECISIONS

The term capital structure refers to the proportionate claims of debt and equity in the

total long-term capitalization of a company.

According to Weston and Brigham, ―Capital structure is the permanent financing of

the firm, represented primarily by long-term-debt, preferred stock and common equity,

but excluding all short-term credit. Common equity includes common stock, capital surplus

and accumulated retained earnings.‖

OPTIMAL CAPITAL STRUCTURE

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

cost of capital of the firm, and maximizes the market value of shares of a firm is known as

‗Optimal capital structure‘.

An optimal capital structure should possess the following characteristics:

a. Simplicity

An optimal capital structure must be simple to formulate and implement by the financial

executives. For simplicity, it is imperative that the number of securities is limited to debt

and equity.

b. Low Cost

A sound capital structure must aim at obtaining the capital required for he firm at the

lowest possible cost. For this purpose, financial executives must pay attention to keep the

expenses of issue and fixed annual payments at a minimum. This would help maximize the

shareholders‘ value.

c. Maximum Return and Minimum Risks

An ideal capital structure must have a combination of debt and equity in such a manner

as to maximize the firm‘s profits. Similarly, the firm must be guarded against risks such as

taxes, interest rates, costs, etc. with the aim of either reducing them or removing them.

d. Maximum Control

The capital structure must aim at retaining maximum control with the existing

shareholders. The issue of securities should be based on the pattern of voting rights. It

must affect favorably the voting structure of the existing shareholders, and increase their


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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.

PATTERN OF CAPITAL STRUCTURE

The different forms of capital structure are :

DECISIONS ON CAPITAL STRUCTURE

The decisions regarding the use of different types of capital funds in the overall longterm

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

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


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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.

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.

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


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the capital structure decisions of firms. For instance, restrictive lending terms by financial

institutions may deter firms from raising long-term funds at reasonable rates of interest.

Easy terms, on the other hand, may encourage firms to obtain a higher quantum of loans.

2. Capital Market Instruments

Financial instruments that are used for raising capital resources in the capital

market are known as Capital Market Instruments‟.

The changes that are sweeping across the Indian capital market especially in the

recent past are something phenomenal. It has been experiencing metamorphic in the last

decade, thanks to a host of measures of liberalization, globalization, and privatization that

have been initiated by the 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.

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


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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. 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 he 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.


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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 thse owners of debentures

and preference shares who enjoy just a fixed assured return in the form of interest and

dividend. Higher the risk, higher the return and vice-versa.

Share certificates either in physical form or in the demat (with the introduction of

depository system in 1999) form are issued as a proof of ownership of the shares in a

company. Fully paid equity shares with detachable warrants entitle the warrant holder to

apply for a specified number of shares at a determined price. Detachable warrants are

separately registered with stock exchange and traded separately. The company would

determine the terms and conditions relating to the issue of equity against warrants.

Voting rights are granted under the Companies Act (Sections 87 to 89) wherein each

shareholder is eligible for votes proportionate to the number of shares held or the amount

of stock owned. A company cannot issue shares carrying disproportionate voting rights.

Similarly , voting right cannot be exercised in respect of shares on which the shareholder

owes some money to the company.

CAPITAL

Equity shares are of different types. The maximum value of shares as specified in the

Memorandum of Association of the company is called the authorized or registered or

nominal capital. Issued capital is the nominal value of shares offered for public subscription.

In case shares offered for public subscription are not taken up, the portion of capital

subscribed is called subscribed capital. This is less than the issued capital Paid-up capital

is the share capital paid-up by shareowners which is credited as paid-up on the shares.

PAR VALUE AND BOOK VALUE

The face value of a share is called its Par value.

Although shares can be sold below the par value, it is possible that shares can be

issued below the par value. The financial institutions that convert their unpaid principal and

interest into equity in sick companies are compelled to do if at a minimum of Rs.10 because

of the par value concept even though the market price might be much less than Rs.10. Par

value can also lead to unhealthy practices like price rigging by promoters of sick companies

to take market prices above Rs.10 to get their new offers subscribed.

Par value is of use to the regulatory agency and the stock exchange. It can be used to

control the number of shares that can be issued by the company. The par value of Rs.10

per share serves as a floor price for issue of shares.

Book value is the intrinsic value of a share that is calculated to reflect the net worth of

the shareholders of a corporate entity.

Cash Dividends

These are dividends paid in cash. A stable payment of cash dividend is the hallmark

of stability of share prices.

Stock Dividends

These are the dividends distributed as shares and issued by capitalizing reserves.

While net worth remains the same in the balance sheet, its distribution between shares and

surplus is altered.

NON-VOTING EQUITY SHARES

Consequent to the recommendations of the ‗Abid Hussain Committee‘ and subsequent


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to the amendment to the Companies Act, corporate managements are permitted to mobilize

additional capital without diluting the interest of existing shareholders with the help of a

new instrument called ‗non-voting equity shares‘. Such shares will be entitled to all the

benefits except the right to vote in general meetings. Such non-voting equity share is being

considered as a possible addition to the two classes of share capital currently in vogue.

This class of shares has been included by an amendment to the Companies Act as a third

category of shares. Corporates will be permitted to issue such share up to a certain

percentage of the total share capital.

Non-voting equity shares will be entitled to rights and bonus issues and preferential

offer of shares on the same lines as that of ordinary shares. The objective will be to

compensate the sacrifice made for the voting rights. For this purpose, these shares will

carry higher dividend rate than that of voting shares. If a company fails to pay dividend,

non-voting shareholders will automatically be entitled to voting rights on a prorate basis

until the company resumes paying dividend.

The mechanism of issue of non-voting shares is expected to overcome such problems

as are associated with the voting shares as that the ordinary investors are more inclined

towards high return on capital through sizeable dividends and capital appreciation through

the issue of bonus shares and the inability of corporate to respond to the investors‘ just

aspiration for reasonable dividends. Moreover, there is every need for corporate to spend

huge sums of money on a variety of not-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.


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4. Preference dividend : The rate of preference dividend payable on CCP shares

would be 10 percent.

5. Guideline ratio : The guideline ratio of 1:3 as between preference shares and

equity shares would not be applicable to these shares.

6. Arrears of dividend : The right to receive arrears of dividend up to the date of

conversion, if any, shall devolve on the holder of the equity shares on such

conversion. The holder of the equity shares shall be entitled to receive the arrears

of dividend as and when the company makes profit and is able to declare such

dividend.

7. Voting right : CCPS would have voting rights as applicable to preference shares

under the companies Act, 1956.

8. Quantum : The amount of the issue of CCP shares would be to the extent the

company would be offering equity shares to the public for subscription.

COMPANY FIXED DEPOSITS:

Fixed deposits are the attractive source of short-term capital both for the companies

and investors as well. Corporates 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 : 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


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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 effect

current financing, and warrants are sold to facilitate future financing. Similarly, the exercise

price of warrant, i.e. The price at which it can be exchanged for share, is usually above the

market price of the share so as to encourage existing shareholders to purchase it. On the

other hand, one warrant buys one equity share generally, whereas more than one rights

may be needed to buy one share. The detachable warrant attached to each share provides

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

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.


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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.

6. Return : Debentures have a great advantage in them in that they carry a regular and

reasonable income for the holders. There is a legal obligation for the company to make

payment of interest on debentures whether or not any profits are earned by it.

7. Claims : Debenture holders command a preferential treatment in the matters of

distribution of the final proceeds of the company at the time of its winding up. Their claims

rank prior to the claims of preference and equity shareholders.

KINDS OD DEBENTURES

Innovative debt instruments that are issued by the public limited companies are

described below :

1. Participating debentures

2. Convertible debentures

3. Debt-equity swaps

4. Zero-coupon convertible notes

5. Secured Premium Notes (SPN) with detachable warrants

6. Non-Convertible Debentures (NCDs) with detachable equity warrant

7. Zero-interest Fully Convertible Debentures (FCDs)

8. Secured zero-interest Partly Convertible Debentures (PCDs) with detachable and

separately tradable warrants

9. Fully Convertible Debentures (FCDs) with interest (optional)

10. Floating Rate Bonds (FRB)

1. Participating debentures : Debentures that are issued by a body corporate which


63

entitle the holders to participate in its profits are called ‗Participating Debentures‘. These

are the unsecured corporate debt securities. They are popular among existing dividend

paying corporates.

2. Convertible debentures

a. Convertible debentures with options are a derivative of convertible debentures

that give an option to both the issuer, as well as the investor, to exit from the terms

of the issue. The coupon rate is specified at the time of issue.

b. Third party convertible debentures are debts with a warrant that allow the

investor to subscribe to the equity of a third firm at a preferential price vis-à-vis

market price, the interest rate on the third party convertible debentures being lower

than pure debt on account of the conversion option.

c. Convertible debentures redeemable at a premium are issued at face value

with a put option entitling investors to sell the bond to the issuer, at a premium later

on. They are basically similar to convertible debentures but have less risk.

3. Debt-equity swaps : They are offered from an issue of debt to swap it for equity. The

instrument is quite risky for the investor because the anticipated capital appreciation may

not materialize.

4. Zero-coupon convertible note : These are debentures that can be converted into

shares and on its conversion the investor forgoes all accrued and unpaid interest. The

zero-coupon convertible notes are quite sensitive to changes in the interest rates.

5. SPN with detachable warrants : These are the Secured Premium Notes (SPN) with

detachable warrants. These are the redeemable debentures that are issued along with a

detachable warrant. The warrant entitles the holder to apply and get equity shares allotted,

provided the SPN is fully paid. The warrants attached to it assure the holder such a right.

No interest will be paid during the lock-in period for SPN.

The SPN holder has an option to sell back the SPN to the company at par value after

the lock-in period. If this option is exercised by the holder, no interest/premium will be

paid on redemption. The holder will be repaid the principal and the additional interest/

premium amount in installments as may be decided by the company. The conversion of

detachable warrant into equity shares will have to be done within the time limit notified by

the company.

6. NCDs with detachable equity warrants : These are Non-Convertible Debentures

(NCDs) with detachable equity warrants. These entitle the holder to buy a specific number

of shares from the company at a predetermined price within a definite time frame. The

warrants attached to NCDEs are issued subject to full payment of the NCDs‘ value. The

option can be exercised after the specific lock-in period. The company is at liberty to

dispose off the unapplied portion of shares if the option to apply for equalities is not exercised.

7. Zero interest FCDs : These are Zero-interest Fully Convertible Debentures on which

no interest will be paid by the issuer during the lock-in period. However, there is a notified

period after which fully paid FCDs will be automatically and compulsorily converted into

shares. In the event of a company going in for rights issue prior to the allotment of equity

(resulting from the conversion of equity shares into FCDs), it shall do so only after the

FCD holders are offered securities.

8. Secured Zero interest PCDs with detachable and separately tradable warrants

These are Secured Zero Interest Partly Convertible Debentures with detachable and


64

separately tradable warrants. They are issued in two parts. Part A is a convertible portion

that allows equity shares to be exchanged for debentures at a fixed amount on the date of

allotment. Part B is a non-convertible portion to be redeemed at par at the end of a

specific period from the date of allotment. Part B which carries a detachable and separately

tradable warrant provides the warrant holder an option to received equity shares for every

warrant held, at a price worked out by the company.

9. Fully Convertible Debentures (FCDs) with interest(optional) These are the

debentures that will not yield any interest for an initial short period after which the holder is

given an option to apply for equities at a premium. No additional amount needs to be paid

for this. The option has to be indicated in the application form itself. Interest on FCDs is

payable at a determined rate from the date of first conversion to the date of second/final

conversion and in lieu of it, equity shares will be issued.

10. Floating Rate Bonds (FRB‟s) These are the bonds where the yield is linked to a

benchmark interest rate like the prime rate in USA or LIBOR in the Euro currency market.

For instance, the Sate Bank of India‘s floating rate bond, issue was linked to the maximum

interest on term deposits that was 10 percent at the time. The floating rate is quoted in

terms of a margin above of below the benchmark rate. Interest rates linked to the benchmark

ensure that neither the borrower nor the lender suffer from the changes in interest rates.

Where interest rates are fixed, they are likely to be inequitable to the borrower when

interest rates fall and inequitable to the lender when interest rates rise subsequently.

Shares Vs. Debentures

1. Shareholder has a proprietary interest in the company, and debenture holder is

only a creditor of the company.

2. Debenture holder is entitled to fixed interest whereas the shareholder is entitled to

dividends depending on and varying with profits.

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

rights.

4. Debentures may be redeemable whereas share except preference shares are not

redeemable

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

winding up

SEBI GUIDELINES

The preferential issue of equity shares/Fully Convertible Debentures (FCDs/Partly

Convertible Debentures (PCDs) or any other financial instruments which would be

converted into or exchanged with equity shares at a later date, by listed companies whose

equity share capital is listed on any stock exchange, to any selected group of persons

under the Companies Act, 1956 on private placement basis shall be governed by these

guidelines.

Such preferential issues by listed companies by way of equity shares/Fully Convertible

Debentures (FCDs)/Partly Convertible Debentures (PCDs) or any other financial

instruments which would be converted into/exchanged with equity shares at a later date,

shall be made in accordance with the pricing provisions mentioned below

PRICING OF THE ISSUE

Preferential Issue of Shares : The issue of shares on a preferential basis can be made

at a price not less than the higher of the following :


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a. The average of the weekly high and low of the closing prices of the related shares

quoted on the stock exchange during the six months preceding the relevant date

(thirty days prior to the date on which the meeting of general body of shareholders

is held in terms of Section 81(1A) of the Companies Act, 1956 to consider the

proposed issue) ( or )

b. The average of the weekly high and low of the closing prices of the related shares

quoted on a stock exchange (any of the recognized stock exchanges in which the

shares are listed and in which the highest trading volume in respect of the shares of

the company has been recorded during the preceding 6 months prior to the relevant

date) during the two weeks preceding the relevant date.

Pricing of Shares arising out of warrants, etc

Where warrants are issued on a preferential basis with an option to apply for and be

allotted shares, the issuer company shall determine the price of the resultant shares. The

relevant date for the above purpose may, at he option of the issuer be either the one

referred to above or a date 30 days prior to the date on which the holder of the warrants

becomes entitled to apply for the said shares. The resolution to be passed in terms of

section 81(1A) shall clearly specify the relevant date on the basis of which price of the

resultant shares shall be calculated.

An amount equivalent to at least ten percent of the price fixed in terms of the above

shall become payable for the warrants on the date of their allotment. The amount referred

to above shall be adjusted against the price payable subsequently for acquiring the shares

by exercising an option for the purpose. The amount so referred to above shall be forfeited

if the option to acquire shares is not exercised.

Pricing of shares on conversion : Where PCDs/FCDs/other convertible instruments,

are issued on a preferential basis, providing for the issuer to allot shares at a future date,

the issuer shall determine the price at which the shares could be allotted in the same

manner as specified for pricing of shares allotted in lieu of warrants as indicated above.

Currency of Financial instruments

In case of warrants/PCDs/FCDs/or any other financial instruments with a provision

for the allotment of equity shares at a future date, either through conversion or otherwise,

the currency of the instruments shall not exceed beyond 18 months from the date of issue

of the relevant instrument.

Non-transferability of Financial Instruments

The instruments allotted on a preferential basis to the promoter/promoter group shall

be subject to lock-in period of 3 years from the date of their allotment. In any case, not

more than 20 percent of the total capital (equity share capital issued by way of public/

rights issue including equity shares emerging at a later date out of any convertible securities/

exercise of warrants and equity shares or any other security convertible at a later date into

equity issued on a preferential basis in favor of promoter/promoter groups) of the company,

including capital brought in by way of preferential issue, shall be subject to lock-in of 3

years from the date of allotment. The lock-in on shares acquired by conversion of the

convertible instrument/exercise of warrants, shall be reduced to the extent the convertible

instrument warrants have already been locked-in.

For computation of 20 percent of the total capital of the company, the amount of

minimum promoters contribution held and locked-in, in the past as per guidelines shall be


66

taken into account. The minimum promoters contribution shall not again be put under

fresh lock-in, even though it is considered for computing the requirement of 20 percent of

the total capital of the company, in case the said minimum promoters contribution is free of

lock-in at the time of the preferential issue.

These locked in shares/instruments can be transferred to and amongst promoter/

promoter group subject to continuation of lock-in the hands of transferees for the remaining

period, and compliance of Securities and Exchange Board of India (Substantial Acquisition

of shares and Takeovers) Regulations, 1997, if applicable.

Currency of Shareholders Resolutions

Allotment pursuant to any resolution passed at a meeting of shareholders of a DFI

granting consent for preferential issues of any financial instrument, shall be completed within

a period of 3 months from the date of passing of the resolution. If allotment of instruments

and dispatch of certificates is not completed within three months from the date of such

resolution, a fresh consent of the shareholders shall be obtained and the relevant date

referred to above will relate to the new resolution.

Certificate from Auditors

In case of every issue of shares/warrants/FCDs/PCDs/other financial instruments

having conversion option, the statutory auditors of the issuer DFI shall certify that the issue

of said instruments is being made in accordance with the requirements contained in these

guidelines. Copies of the auditors certificate shall also be laid before the meeting of the

shareholders convened to consider the proposed issue.

Preferential Allotments to FIIs

Preferential allotments, if any to be made in case of Foreign Institutional Investors,

shall also be governed by the guidelines issued by the Government of India/Board/Reserve

Bank of India on the subject.

Non-applicability of the Guidelines

The above guidelines shall not be applicable where the further shares are allotted in

pursuance to the merger and amalgamation scheme approved by the High Court and

where further shares are allotted to a person/group of persons in accordance with the

provisions of rehabilitation packages approved by BIFR. In case, such persons are promoters or

belong to promoter group lock-in provisions shall continue to apply unless otherwise stated in

the BIFR order. Similarly, the above guidelines are not applicable where further shares are

allotted to all India public financial institutions in accordance with the provision of the loan

agreements signed prior to August 4, 1994.

GLOBAL DEBT INSTRUMENTS

Following are some of the debt instruments that are popular in the international financial

markets :

Income Bonds

Interest income on such bonds is paid only where the corporate command adequate

cash flows. They resemble cumulative preference shares in respect of which fixed dividend

is paid only if there is profit earned in a year, but carried forward and paid in the following

year. There is no default on income bonds if interest is not paid. Unlike the dividend on

cumulative preference shares, the interest on income bond is tax deductible. These bonds

are issued by corporates that undergo financial restructuring.

Asset Backed Securities


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These are a category of marketable securities that ate collateralized by financial assets

such as installment loan contracts. Asset backed financing involves a disinter- mediating

process called ‗securitization‘, whereby credit from financial intermediaries in the form of

debentures are sold to third parties to finance the pool. REPOS are the oldest asset

backed security in our country. In USA, securitization has been undertaken for the following

the oldest asset backed security in our country. In USA, securitization has been undertaken

for the following :

1. Insured mortgages

2. Mortgage backed bonds

3. Student loans

4. Trade credit receivable backed bonds

5. Equipments leasing backed bonds

6. Certificates of automobile receivable securities

7. Small business administration loans

8. Credit and receivable securities

Junk Bonds

Junk bond is a high risk, high yield bond which finances either a Leveraged Buyout

(LBO) or a merger of a company in financial distress Junk bonds are popular in the USA

and are used primarily for financing takeovers. The coupon rates range from 16 to 25

percent. Attractive deals were put together establishing their feasibility in terms of adequacy

of cash flows to meet interest payments. Michael Milken (the junk bond king) of Drexel

Burmham Lambert was the real developer of the market.

Indexed Bonds

These are the bonds whose interest payment and redemption value are indexed with

movements in prices. Indexed bonds protect the investor from the eroding purchasing

power of money because of inflation. For instance, an inflation-indexed bond implies that

the payment of the coupon and/or the redemption value increases of decreases according

to movements in prices. The bonds are likely to hedge the principal amount against inflation.

Such bonds are designed to provide investors an effective edge against inflation so as to

enhance the credibility of the anti-inflationary policies of the Government. The yields of an

inflation-indexed bond provide vital information on the expected rate of inflation.

United Kingdom, Australia, and Canada have introduced index linked government

securities as a segmented internal debt management operation with a view to increase the

range of assets available in the system, provide an inflation hedge to investors, reduce

interest costs and pick up direct signals, and the expected inflation and real rate of interest

from the market.

Zero-Coupon Bonds (ZCBs)/Zero Coupon Convertible Debentures

Zero Coupon Bonds first came to be introduced in the U.S. securities market. Initially,

such bonds were issued for high denominations. These bonds were purchased by large

security brokers in large chunks, who resold them to individual investors, at a slightly

higher price in affordable lots. Such bonds were called ―Treasury Investment Growth

Receipts‘(TIGRs) or ‗Certificate of Accruals on Treasury Securities‘ (CATSs) or ZEROs

as their coupon rate is Zero.

Moreover, these certificates were sold to investors at a hefty discount and the difference

between the face value of the certificate and the acquisition cost was the gain. The holders


68

are not entitled for any interest except the principal sum on maturity.

Advantages : Zero-Coupon Bonds offer a number of advantages as shown below

a. No botheration of periodical interest payment for the issues

b. The attraction of conversion of bonds into equity shares at a premium or at par, the

investors usually being rewarded by way of a low premium on conversion

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

income

d. Possibility of efficient servicing of equity as there is no obligation to pay interest till

maturity and the eventual conversion.

Mahindra & Mahindra came out with the scheme of Zero Coupon Bonds for the first

time in India along with 12.5 percent convertible bonds for part financing of its modernization

and diversification scheme. Similarly, Deep Discount Bonds were issued by IDBI at

Rs.2,000 for a maturity of Rs.1 lakh after 25 years. These are negotiable instruments

transferable by endorsement and delivery by the transferor. IDBI also offered Option

Bonds which may be either cumulative or non-cumulative bonds where interest is payable

either on maturity or periodically. Redemption is also offered to attract investors.

Floating Rate Bonds (FRB‟s)

Bonds that carry the provision for payment of interest at different rates for different

time periods are known as ‗Floating Rate Bonds‘. The first floating rate bond was issued

by the SBI in the Indian capital market. The SBI, while issuing such bonds, adopted a

reference rate of highest rate of interest on fixed deposit of the Bank, provided a minimum

floor rate payable at 12 percent p.a. and attached a call option to the Bank after 5 years to

redeem the bonds earlier than the maturity period of 10 years at a certain premium. A

major highlight of the bonds was the provision to reduce interest risk and assurance of

minimum interest on the investment provided by the Bank.

Secured Premium Notes (SPNs)

Secured debentures that are redeemable of a premium over the issue price or face

value are called secured premium notes. Such bonds have a lock-in period during which

period no interest will be paid. It entitles the holder to sell back the bonds to the issuing

company at par after the lock-in period.

A case in point was the issue made by the TISCO in the year 1992, where the

company wanted to raise money for its modernization program without expanding its

equity excessively in the next few years. The company made the issue to the existing

shareholders on a rights basis along with the rights issue. The salient features of the TISCO

issue were as follows :

1. Face value of each SPN was Rs.300

2. No interest was payable during the first three years after allotment

3. The redemption started at the end of the fourth year of issue

4. Each of the SPN of Rs.300 was repaid in four equal annual installments of Rs.75,

which comprised of the principal, the interest and the relevant premium. (Low

interest and high premium or high interest and low premium, at the option to be

exercised by the SPN holder at the end of the third year)

5. Warrant attached to each SPN entitled the holder the right to apply for or seek

allotment of one equity share for cash payment of Rs.80 per share. Such a right

was exercisable between first year and one.-and-a-half year after allotment by


69

which time the SPN would be fully paid up.

This instrument tremendously benefited TISCO, as there was no interest outgo. This

helped TISCO to meet the difficulties associated with the cash generation. In addition, the

company was able to borrow at a cheap rate of 13.65 percent as against 17 to 18 percent

offered by most companies. This enabled the company to start redemption earlier through

the generation of cash flow by the company‘s projects. The investors had the flexibility of

tax planning while investing in SDPNs. The company was also equally benefited as it gave

more flexibility.

Euro Convertible Bonds

Bonds that give the holders of euro bonds to have the instruments converted into a

wide variety of options such as the call option for the issuer and the put option for the

investor, which makes redemption easy are called ‗Euro-convertible bonds‘. A euroconvertible

bond essentially resembles the Indian convertible debenture but comes with

numerous options attached. Similarly, a euro-convertible bond is an easier instrument to

market than equity. This is because it gives the investor an option to retain his investments

as a pure debt instrument in the event of the price of the equity share falling below the

conversion price or where the investor is not too sure about the prospects of the company.

Popularity of convertible euro bonds

A convertible bond issue allows an Indian company far greater flexibility to tap the

Euro market and ensures that the issue has a better market reception than would be

possible for a direct equity issue. Moreover, newly industrialized countries such as Korea

have chosen the convertible bond market as a stepping-stone to familiarity and acceptance

of their industrial companies in the international market. The convertible bonds offer the

following advantages:

a. Protection : Euro convertible bonds are favoured by international investors as it

offers them the advantage of protection of their wealth from erosion. This is possible

because the conversion is only an option, which the investors may choose to

exercise only if it works to their benefit. This facility is not available for equity

issues.

b. Liquidity : Convertible bond market offers the benefit of the most liquid secondary

market for new issues. Fixed income funds as well as equity investment managers

purchase convertible bonds.

c. Flexibility : The feature of flexibility in structuring convertible bonds allows the

company to include some of the best possible clauses of investors‘ protection by

incorpo0rating the unusual features of equity investments. A case in point is the

issues made by the Korean corporate sector, which contained a provision in the

issue of convertible euro bonds. The provision entitled the holders to ensure the

due compliance of the liberalization measures that had already been announced

within a specified period of time. Such a provision enabled the investor to opt for

a ‗put‘ option.

d. Attraction investment : The issue of convertible debentures facilitates removal

of many of the unattractive features of equity investment. For investors, convertible

bond market makers are the principal sources of liquidity in their securities.

Bond Issue – Indian Experience

In recent times, all-India financial institutions have come to design and introduce special


70

and innovative bond instruments exclusively structured on the investors‘ preferences and

funds requirement of the issuers. The emphasis from the issuer‘s view point is the resource

mobilization and not risk exposure. Several financial institutions such as the IDBI, the

ICICI, etc. are engaged in the sale of such bonds. A brief description of some these

bonds are presented below :

1. IDBI‟s Zero Coupon Bonds, 1996 :

These bonds are sold at a discount and are paid no interest. It is of great advantage

to issuers as it is not required for them to make periodic interest payment.

2. IDBI‟s Regular Income Bonds, 1996 :

These were the bonds issued by the IDBI as 10-year bonds carrying a coupon of 16

percent, payable half-yearly. The bonds provided an annualized yield equivalent to 16.64

percent. The bonds, which were priced at Rs.5,000 can be redeemed at the end of every

year, after the third year allotment. There was also a call option that entitled the IDBI to

redeem the bonds five years from the date of allotment.

3. Retirement Bonds, 1996 :

The IDBI Retirements Bonds were issued at a discount. The issue targeted investors

who are planning for retirement. Under the scheme,. Investors get a monthly income for

10 years after the expiry of a wait period, the wait period being chosen by the investor.

Thereafter, the investors also get a lump sum amount, which is the maturity value of the

bond.

4. IFCI‟s Bonds, 1996

These bonds include :

a. Deep Discount Bonds – Issued for a face value of Rs.1 lakh each.

b. Regular Income and Retirement Bonds – They had a five-year tenure, a semiannual

yield of 16 percent and a front-end discount of 4 percent. The bonds had

three-year put option and an early bird incentive of 0.75 percent.

c. Step-up Liquid Bond – The five-year bonds with a put option every year with a

return of 16 percent, 16.25 percent, 16.5 percent, 16.75 percent, and 17 percent

at the end of every year.

d. Growth Bond – An investment of Rs.20,000 per bond under this scheme entitles

investors to a Rs.1 lakh face-value bond maturing after 10 years. Put options can

be exercised at the end of 5 and 7 years respectively. If exercised, the investor

gets Rs.43,500 after 5 years and Rs.60,000 after a 7 year period.

e. Lakhpati Bond – The maturity period of these bonds varied from l5 to 10 years,

after which the investor gets Rs.1 lakh. The initial investment required was

Rs.20,000 for 10 years maturity, Rs,.23,700 for 9 years, Rs,28,000 for 8 years,

Rs.33,000 for 7 years, Rs.39,000 for 6 years and Rs.46,000 for 5 years maturity.

5. ICICI‟s Bonds, 1997

ICICI came out with as many as five bonds in March 1997. These are encash

bonds, index bonds, regular income bonds, deep discount bonds, and capital gain bonds.

The bonds were aimed at meeting the diverse needs of all categories of investors, besides

contributing to the widening of the bond market so as to bring the benefits of these securities

to even the smallest investors.

a. Capital gains bond - Also called infrastructure bonds incorporated the capital

gains tax relaxations under Section 54EA of the Income Tax Act announced in the


71

Union Budget for 1997-98. They are issued for 3 and 7 years maturity. 20

percent rebate was available under Section 88 of the I.T. Act for investors on the

amount invested in the capital gains bonds up to a maximum of Rs.70,000. They

can avail benefit under Section 88. The annual interest rate worked out to 13.4

percent while the annual yield came to 20.7 percent. However, investment through

stock invest will not qualify for the rebate.

b. Encash Bond – The five-year encash bonds were issued at a face value of

Rs.2,000 and can be redeemed at par across the country in 200 cities during 8

months in a year after 12 months. The bond had a step-up interest every year

from 12 to 18.5 percent and the annualized yield at maturity for the bond works

out to 15.8 percent. The encashing facility, however, is available only to the original

bondholders. The bonds not only offer higher return but also help widen the

banking facilities to investors. The secondary market price of the bonds is likely

to be favourably influenced by the step-up interest that results in an improved

YTM every year.

c. Index Bond – It gives the investor both the security of the debt instrument and

the potential of the appreciation in the return on the stock market. Priced at

Rs.6,000 the index bond has two parts:

Part A is a deep discount bond of the face value of Rs.22,000 issued for a 12 year

period. Its calculated yield was 15.26 percent. It also has a call and a put option attached

to it assuring the investor a return of Rs.9,300 after 6 years option is exercised. Part B is

a detachable index warrant issued for 12 years and priced at Rs.2,000. The yield was

linked to the BSE SENSEX. The face value of the bond will appreciate the number of

times the SENSEX has appreciated. The investors‘ returns will be treated as capital gains.

6. Tax Free Bonds : The salient features of the tax-free Government of India bonds to

be issued from October 1,2002 are as follows :

a. Interest rate – The bonds will carry an interest rate of 7 percent.

b. Tax exemption – The bonds will be exempt from Income-tax and Wealth-tax.

c. Maturity – The bonds will have a maturity period of six years.

d. Ceiling –The bonds investment will have no ceiling.

e. Tradability - The bonds will not be traded in the secondary market.

f. Investors – The eligible investors include individuals and Hindu Undivided Families,

NRIs are not eligible for investing in these bonds.

g. Issue price Bonds will be issued for a minimum amount of Rs.1,000 and its

multiples.

h. Maturity value – The cumulative maturity value of the bond will be Rs.1.511 at

the end of six years.

i. Form of issue – The bonds will be both in demat form as well as in the traditional

form of stock certificates. Option once chosen cannot be changed.

j. Transferability – Bonds will not be transferable except by way of gift to relatives

as defined in the Companies Act.

k. Collaterals – The bonds cannot be used as collaterals for obtaining loans from

banks, financial institutions and non-banking financial companies.

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


72

individual can make a nomination.

3. PREPARATION OF PROSPECTUS

― Prospectus‖ is defined a document through which public are solicited to subscribe

to the share capital of a corporate entity.

Its purpose is 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 are presented in three parts

PART I

a. General Information about the company e.g. Name and address of the registered

office consent of the Central Government for the issue and names of regional

stock exchanges etc.,

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

etc.,

c. Terms of the issue like mode of payment , rights of instruments holders etc.,

d. Particulars of the issue like project cost , means of financing etc.,

e. Company, Management and project like promoters for the project, location of

the project etc.,

f. Disclosures of public issues made by the Company, giving information about

type of issue, amount of issue, date of closure of issue, etc.,

g. Disclosure of Outstanding Litigation, Criminal Prosecution and Defaults

h. Perception of Risk factors like difficulty in marketing the products, availability

of raw materials etc.,

PART II

a. General Information

b. Financial Information like Auditor‘s Report, Chartered Accountant‘s Report etc.,

c. Statutory and Other Information

PART III

a. Declaration i.e., by the directors that all the relevant provisions of the companies

Act, 1956 and guidelines issued by the Government have been complied with.

b. Application with prospectus

2. ABRIDGED PROSPECTUS

The concept of abridged prospectus was introduced by the Companies (amendment)

Act of 1988 to make the public issue of shares an inexpensive proposition. A memorandum

containing the salient features of a prospectus as prescribed is called as ‗Abridged

Prospectus‘

4. 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


73

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.

5. 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

clock work efficiency would lead to a successful issue.

6. REGISTRARS TO AN ISSUE AND SHARE TRANSFER AGENTS

REGISTRATION

The registrars to an issue, as an intermediary in the primary market, carry on activities

such as collecting application from the investors, keeping a proper record of applications

and money received from investors or paid to the seller of securities and assisting companies

in determining the basis of allotment of securities in consultation with stock exchanges,

finalizing the allotment of securities and processing/despatching allotment letters, refund

orders, certificates and other related documents in respect of issue of capital. The share

transfer agents maintain the records of holders of securities or on behalf of companies, and

deal with all matters connected with the transfer/redemption of its securities. To carry on

their activities, they must be registered with the SEBI which can also renew the certificate

of registration.

They are divided into two categories;

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

agent;

b. Category II; to carry on the activity either as a registrar or as a share transfer

agent.


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The registration is granted by the SEBI on the basis of consideration of all relevant

matters and, in particular, the necessary infrastructure, past experience and capital adequacy.

It also takes into account the fact that any connected person has not been granted registration

and any director/partner/principal officer has not been convicted for any offence involving

moral turpitude or has been found guilty of any economic offence.

CAPITAL ADEQUACY FEE

The capital adequacy requirement in terms of net worth (capital and free reserves)

was Rs.6 lakh and Rs.3 lakh for Category I and Category II of registrars and share

transfer agents respectively. However, the capital adequacy requirements are not applicable

since November 1999 for a department/division of a body corporate maintaining the records

of holders of securities issued by them and deal with all matters connected with transfer/

redemption of securities. The two categories of registrars and transfer agents had to pay

an annual fee respectively of Rs.15,000 and Rs.10,000 for initial registration a well as

renewal. With effect from November 1999, while Category I is required to pay a registration

fee of Rs.50,000 and a renewal fee of Rs.40,000 every three years, Category II has to

pay Rs.30,000 and Rs.25,000 respectively.

GENERAL OBLIGATIONS AND RESPONSIBILITIES

CODE OF CONDUCT FOR REGSTER TO AN ISSUE AND SHARE

TRANSFER AGENTS:

A registrar to an issue and share transfer agent should :

1. Maintain high standards of integrity in the conduct of its business.

2. Fulfill its obligations in a prompt, ethical and professional manner.

3. At all times exercise due diligence, ensure proper care and exercise independent

professional judgment.

4. Exercise adequate care, caution and due diligence before dematerialization of

securities by confirming and verifying that the securities to be dematerialized have

been granted listing permission by the stock exchange(s).

5. Always endeavour to ensure that (a) inquiries from investors are adequately dealt

with; (b) grievances of investors are redressed without any delay; (c) transfer of

securities held in physical form and confirmation of dematerialization/

rematerialisation requests and distribution of corporate benefits and allotment of

securities is done within the time specified under any law.

6. Make reasonable efforts to avoid misinterpretation and ensure that the information

provided to the investors is not misleading.

7. Not reject the dematerialization/rematerialisation requests on flimsy grounds. Such

requests could be rejected only on valid and proper grounds and supported by

relevant documents.

8. Avoid conflict of interest and make adequate disclosure of its interest.

9. Put in place a mechanism to resolve any conflict of interest situation that may arise

in the conduct of its business or where any conflict of interest arises, should take

reasonable steps to resolve the same in an equitable manner.

10. Make appropriate disclosure to the client of its source or potential areas of conflict

of duties and interest which would impair its ability to render fair, objective and

unbiased services.

11. Not indulge in any unfair competition, which is likely to harm the interests of other


75

registrar to the issue and share transfer agent or investors or is likely to place him

in disadvantageous position while competing for or executing any assignment.

12. Always endeavour to render the best possible advice to the clients having regard

to their needs.

13. Not divulge to other clients, press or any other person any confidential information

about its clients which as come to its knowledge except with the approval/

authorization of the client or when it is required to disclose the information under

any law for the time being in force.

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

considerations.

15. Ensure that any change in registration status/any penal action taken by the SEBI or

any material change in financials which may adversely affect the interest of clients/

investors is promptly informed to the clients.

16. Maintain the required level of knowledge and competence and abide by the

provisions of the SEBI Act, rules, regulations, circulars and directions issued by

the SEBI and also comply with the award of the Ombudsman under the SEBI

(Ombudsman) Regulations, 2003.

17. Co-operate with the SEBI as and when required.

18. Not neglect or fail or refuse to submit to the SEBI or other agencies with which he

is registered, such books, documents, correspondence, and papers or any part

thereof as may be demanded/requested from time to time.

19. Ensure that the SEBI is promptly informed about any action, legal proceeding, etc.

Initiated against it in respect of any material breach or non-compliance by it, of any

law, rules, regulations, directions of the SEBI or of any other regulatory body.

20. Take adequate and necessary steps to ensure that continuity in data and recordkeeping

is maintained and that the data or records are not lost or destroyed.

Further, it should ensure that for electronic records and data, up-to-date back up

is always available with it.

21. Endeavour to resolve all the complaints against it or in respect of the activities

carried out by it as quickly as possible.

22. (a) Not render, directly or indirectly any investment advice about any security in

the publicly accessible media, whether real-time or non-real time, unless a disclosure

of its long or short position in he securities has been made, while rendering such

advice; (b) In case an employee of a registrar to an issue and share transfer agent

is rendering such advice, the registrar to an issue and share transfer agent should

ensure that it also discloses its own interest, the interests of his dependent family

members and that of the employer including their long or short position in the

security, while rendering such advice.

23. Handover all the records/data and all related documents which are in its possession

in its capacity as a registrar to an issue and/or share transfer agent to the respective

clients, within one month from the date of termination of agreement with the

respective clients within or within one month from the date of expiry/cancellation

of certificate of registration as registrar to an issue and/or share transfer agent,

whichever is earlier.

24. Not make any exaggerated statement, whether oral or written, to the clients either


76

about its qualifications or capability to render certain services or should its

achievements in regard to services rendered to other clients.

25. Ensure that it has satisfactory internal control procedures in place as well as adequate

financial and operational capabilities which can be reasonably expected to take

care of any losses arising due to theft, fraud and other dishonest acts, professional

misconduct or omission.

26. Provide adequate freedom and powers to its compliance officer for the effective

discharge of its duties.

27. Develop its own internal code of conduct for governing its internal operations and

laying down its standards of appropriate conduct for its employees and officers in

carrying out its duties as a registrar to an issue and share transfer agent and as a

part of the industry. Such a code may extend to the maintenance of professional

excellence and standards, integrity, confidentiality, objectivity, avoidance of conflict

of interests, disclosure of shareholdings and interests, etc.

28. Ensure that good corporate policies and corporate governance are in place.

29. Ensure that any person it employs or appoints to conduct business is fit and proper

and otherwise qualified to act in the capacity so employed or appointed (including

having relevant professional training or experience).

30. Be responsible for the acts or omissions of its employees and agents in respect of

the conduct of its business.

31. Not in respect of any dealings in securities be party to or instrumental for: (a)

creation of false market, (b) price rigging or manipulations; (c) passing of unpublished

price sensitive information in respect of securities which are listed and proposed

to be listed in any stock exchange to any person or intermediary.

MAINTENANCE OF RECORDS

The registrars and share transfer agents have to maintain records relating to all

applications received from investors in respect of an issue, all rejected applications together

with reasons, basis of allotment of securities in consultation with the stock exchanges,

terms and conditions of purchase of securities, allotment of securities, list of allottees and

non-allotees, refund orders, and so on. In addition, they should also keep a record to the

list of holders of securities of corporates, the names of transfer agents to file the books of

accounts, and records, and so on. These have to be preserved by them for a period of

three years.

INSPECTION

The SEBI is authorized to undertake the inspection of the books of accounts, other

records, and documents of the registrars and share transfer agents to ensure that they are

being maintained in a proper manner and the provisions of the SEBI Act, rules, regulations

and the provisions of the SCRA and the relevant rules are complied with, to investigate

into complaints from investors/other registrars and share transfer agents/other intermediaries

in the securities market or any matter relating to their activities, and to investigate on its

own in the interest of securities market/investors into their affairs. On the basis of the

inspection report, the SEBI can direct the concerned partly to take such measures as it

deems fit in the circumstances. It can also appoint a qualified auditor to investigate into the

books of accounts and affairs of the registrars and share transfer agents.

ACTION IN DEFAULT


77

A registrar/share transfer agent who fails to comply with any condition subject to

which registration is granted, or contravenes any of the provisions of the SEBI Act/SCRA,

rules/regulations and stock exchange bye-laws, rules and regulations is liable to suspension

or cancellation of registration.

The penalty for suspension is imposed for (a) violations of the provisions of the SEBI

Act, rules/regulations, (b) non-observance of the code of conduct, (c) failure to furnish

information, furnishing of wrong/false information, non-submission of periodical information

and non-cooperation in any enquiry, (d) failure to resolve investor complaints or give a

satisfactory reply to the SEBI in this behalf, (e) involvement in manipulation/price rigging/

cornering activities, (f) guilty of misconduct/improper business-like or unprofessional

conduct business-like or unprofessional conduct, (g) failure to maintain capital adequacy

requirement or to pay the requirement or to pay the requisite fee; and (h) violation of the

conditions of registration.

In case of their repeated defaults, the certificate of registration can be cancelled. The

other reasons for cancellation of registration are deliberate manipulation/price rigging/

cornering activities affecting the securities market and the investor interest; violation of the

provisions of the SEBI Act, rules/regulations; violation of any provisions of insider trading/

take-over regulations and guilty of fraud/conviction on a criminal offence. The procedure

for inspection, holding enquiry and suspension/cancellation is the same as in the case of

lead managers, underwriters, bankers to the issue, and so on.

8. UNDERWRITERS

Another important intermediary in the new issue/primary market is the underwriters

to issues of capital who agree to take up securities which are not fully subscribed. They

make a commitment to get the issue subscribed either by others or by themselves. Though

underwriting is not mandatory after April 1995, its organization is an important element of

the primary market. Underwriters are appointed by the issuing companies in consultation

with the lead managers/merchant bankers to the issues. A statement to the effect that in the

opinion of the lead manager, the underwriters‘ assets are adequate to meet their obligation

should be incorporated in the prospectus.

REGISTRATION

To act as underwriter, a certificate of registration must be obtained from the SEBI. In

granting the certificate of registration, the SEBI considers all matters relevant/relating to

the underwriting and in particular,

a) the necessary infrastructure like adequate office space, equipment and manpower

to effectively discharge the activities

b) past experience in underwriting/employment of at least two persons with experience

in underwriting

c) any person directly/indirectly connected with the applicant is not registered with

the SEBI as under or a previous application of any such person has been rejected

or any disciplinary action has been taken against such person under the SEBI Act/

rules/regulations,

d) capital adequacy requirement of not less than net worth (capital + free reserves) of

Rs.20 lakhs; and

e) the applicant/director/principal officer/partner has been convicted of offence

involving moral turpitude or found gully of any economic offence.


78

FEE

Underwriters, had to, for grant or renewal of registration, pay a fee to the SEBI from

the date of initial grant of certificate, Rs. 2 lakhs for the first and second years and Rs.1

lakh for the third year. A fee of Rs.20,000 was payable every year to keep the certificate

in force or for its renewal. Since 1999, the registration fee has been raised to Rs.5 lakhs.

To keep the registration in force, renewal fee of Rs.2 lakhs every three years from the

fourth year from the date of initial registration is payable. Failure to pay the fee would result

in the suspension of the certificate of registration.

GENERAL OBLIGATIONS AND RESPONSIBILITIES

CODE OF CODUCT FOR UNDERWRITERS

An underwriter should :

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

2. Maintain high standards of integrity, dignity and fairness in the conduct of its business.

3. Ensure that it and its personnel will act in an ethical manner in all its dealings with 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.


in the conduct of its business or where any conflict of interest arises, should take

reasonable steps to resolve the same in any equitable manner.

9. Make appropriate disclosure to the client of its possible source or potential in

areas of conflict of duties and interest while acting as underwriter which would

impair its ability to render fair, objective and unbiased services.

10. Not divulge to other issuer, press or any party any confidential information about

its issuer company, which has come to its knowledge and deal in securities of any

issuer company without making disclosure to the SEBI as required under these

regulations and also to the Board directors of the issuer company.

11. Not discriminate amongst its clients, save and except on ethical and commercial

considerations.

12. Ensure that any charge in registration status/any penal action taken by SEBI or any

material change in financials which may adversely affect the interests of clients/

investors is promptly informed to the clients and any business remaining outstanding

is transferred to another registered person in accordance with any instructions of

the affected clients/investors.

13. Maintain an appropriate level of knowledge and competency and abide by the

provisions of the SEBI Act, regulations, circulars and guidelines issued by the

SEBI. The underwriter should also comply with the award of the Ombudsman

under the SEBI (Ombudsman) Regulations, 2003.

14. Ensure that the SEBI is promptly informed about any action, legal proceedings,


79

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. (a) Not render, directly or indirectly any investment advice about any security in

the publicly accessible media, whether real-time or non-real-time, unless a disclosure

of his interest including its long or short position in the security has been made,

while rendering such advice; (b) In case an employee or an underwriter is rendering

such advice, the underwriter should ensure that he 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 indulge 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.


discharge of his duties.



the carrying out of their duties. Such a code may extend to the maintenance of

professional excellence and standards, integrity, confidentiality, objectivity,

avoidance of conflict of interest, disclosure of shareholdings and interests, etc.

22. Ensure that good corporate policies and corporate governance is in place.

23. Ensure that any person it employs or appoints to conduct business is fit and proper

and otherwise qualified to act in the capacity so employed or appointed (including

having relevant professional training or experience).

24. Ensure that it has adequate resources to supervise diligently and does supervise

diligently persons employed or appointed by it to conduct business on its behalf.

25. Be responsible for the acts or omissions of its employees and agents in respect to


26. Ensure that the senior management, particularly decision makers have access to all

relevant information about the business on a timely basis.

27. Not be party to or instrumental for (a) certain of false market, (b) price rigging or

manipulation, or; (c) passing of unpublished price sensitive information in respect

of securities which are listed and proposed to be listed in any stock exchange to

any person or intermediary.

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,


80

the amount of underwriting obligations, the period within which the underwriter has to be

subscribe to the issue after being intimated by/on behalf of the issuer, the amount of

commission/brokerage, and details of arrangements, if any, made by the underwriter for

fulfilling the underwriting obligations.

GENERAL RESPONSIBILITIES

An underwriter cannot derive any direct or indirect benefit from underwriting the

issue other than by the underwriting commission. The maximum obligation under all

underwriting agreements of an underwriter cannot exceed twenty times his net worth.

Underwriters have to subscribe for securities under the agreement with 45 days of the

receipt of intimation from the issuers.

INSPECTION AND DISCIPLINARY PROCEEDINGS

The framework of the SEBI‘s right to undertake the inspection of the books of accounts,

other records and documents of the underwriters, the procedure for inspection and

obligations of the underwriters is broadly on the same pattern as applicable to the lead

managers.

ACTION IN CASE OF DEFAULT

The liability for action in case of default arising out of

i. non-compliance with any conditions subject to which registration was granted.

ii. contravention of any provision of the SEBI Act/rules/regulations, by an underwriter

involves the suspension/cancellation of registration, the effect of suspension/

cancellation are on the lines followed by the SEBI in case of lead managers.

9. BANKERS TO AN ISSUE

The bankers to an issue are engaged in activities such as acceptance of applications

along with application money from the investors in respect of issues of capital and refund

of application money.

REGISTRATION

To carry on activity as a banker to issue, a person must obtain a certificate of registration

from the SEBI. The SEBI grants registration on the basis of all the activities relating to

banker to an issue in particular with reference to the following requirements:

a) The applicant has the necessary infrastructure, communication and data processing

facilities and manpower to effectively discharge his activities,

b) The applicant/any of the directors of the applicant is not involved in any litigation

connected with the securities market/has not been convicted of any economic

offence;

c) The applicant is a scheduled bank and

d) Grant of a certificate is in the interest of the investors. A banker to an issue can

apply for the renewal of his registration three months before the expiry of the

certificate.

Every banker to an issue had to pay to the SEBI an annual fee of Rs.2.5 lakhs for the

first two years from the date of initial registration, and Rs.1 lakh for the third year to keep

his registration in force. The renewal fee to be paid by him annually for the first two years

was Rs.1 lakh and Rs.20,000 for the third year. Since 1999, schedule of fee is Rs.5 lakhs

as initial registration fee and Rs.2.5 lakhs renewal fee every three years from the fourth

year from the date of initial registrations. Non-payment of the prescribed fee may lead to

the suspension of the registration certificate.


81

GENERAL OBLIGATIONS AND RESPONISBILITIES

FURNISH INFORMATION

When required, a banker to an issue has to furnish to the SEBI the following

information;

a) The number of issues for which he was engaged as a banker to an issue;

b) The number of application/details of the application money received,

c) The dates on which applications from investors were forwarded to the issuing

company /registrar to an issue;

d) The dates/amount of refund to the investors.

DBA 1724

BOOKS OF ACCOUNT/RECORD/DOCUMENTS

A banker to an issue is required to maintain books of accounts/records/documents

for a minimum period of three years in respect of, inter-alia, the number of applications

received, the names of the investors, the time within which the applications received were

forwarded to the issuing company/registrar to the issue and dates and amounts of refund

money to investors.

DISCIPLINARY ACTION BY THE RBI

If the RBI takes any disciplinary action against a banker to an issue in relation to issue

payment, the latter should immediately inform the SEBI. If the banker is prohibited from

carrying on his activities as a result of the disciplinary action, the SEBI registration is

automatically deemed as suspended/cancelled.

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;


82

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 any body 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.


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.

15. Not indulge in any unfair competition, which is likely to harm the interests of other

bankers to an issue or investors or is likely to place such other bankers to an issue

in a disadvantageous position while competing for or executing any assignment.

16. Not discriminate amongst its clients, save and except on ethical and commercial

considerations.

17. Ensure that any change in registration status/any penal action taken by the SEBI or

any material change in financials which may adversely affect the interests of clients/

investors is promptly informed to the clients and business remaining outstanding is

transferred to another registered person in accordance with any instructions of the

affected clients/investors.

18. Maintain an appropriate level of knowledge and competency and abide by the

provisions of the SEBI Act, regulations, circulars and guidelines of the SEBI. The

banker to an issue should also comply with the award of the Ombudsman passed

under the SEBI (Ombudsman) Regulations, 2003.

19. Ensure that the SEBI is promptly informed about any action, legal proceedings,

etc., initiated against it in respect of any material breach of non-compliance by it,

of any law, rules, regulations, and directions of the SEBI or of any other regulatory

body.

20. Not make any untrue statement of suppress any material fact in any documents,

reports, papers or information furnished to the SEBI.

21. Not neglect or fail or refuse to submit to the SEBI or other agencies with which it

is registered, such books, documents, correspondence, and papers or any part

thereof as may be demanded/requested from time to time.

22. Abide by the provisions of such acts and rules, regulations, guidelines, resolutions,


83

notifications, directions, circulars and instructions as may be issued from time to

time by the Central Government, relevant to the activities carried on the banker to

an issue.

23. (a) Not render, directly or indirectly, any investment advice about any security in

the publicly accessible media, whether real-time or non-real-time, unless a disclosure

of its interest including long or short position in the security has been made, while

rendering such advice; (b) in case an employee of the banker to an issue is rendering

such advice, the banker to an issue should ensure that he discloses his interest, the

interest of his dependent family members and that of the employer including

employer‘s long or short position in the security, while rendering such advice.

24. A banker to an issue or any of its directors, or employee having the management

of the whole or substantially the whole of affairs of the business, should not, either

through its account or their respective accounts or through their family members,

relatives or friends indulge in any insider trading.

25. Have internal control procedures and financial and operational capabilities which

can be reasonable expected to protect its operations, its clients, investors and

other registered entities from financial loss arising from theft, fraud, and other

dishonest acts, professional misconduct or omissions.


discharge of its duties.



the carrying out of their duties as a banker to an issue and as a part of the industry.

Such a code may extend to the maintenance of professional excellence and

standards, integrity, confidentiality, objectivity, avoidance of conflict of interests,

disclosure of shareholding and interests, etc.

28. Ensure that any person it employs or appoints to conduct a business is fit and

proper and otherwise qualified to act in the capacity so employed or appointed

(including having relevant professional training or experience).

29. Ensure that it has adequate resources to supervise diligently and does supervise

diligently persons employed or appointed by it to conduct business on its behalf.

30. Be responsible for the acts or omissions of its employees and agents in respect to


31. Ensure that the senior management, particularly decision makers have access to all

relevant information about the business on a timely basis.

32. Endeavour to ensure that arms length relationship is maintained in terms of both

manpower and infrastructure between the activities carried out as banker to an issue and other

permitted activities.

33. Not be a party to or instrumental for (a) creation of false market; (b) price rigging

or manipulations; or (c) passing of unpublished price sensitive information in respect

of securities which are listed and proposed to be listed in any stock exchange to

any person or intermediary.

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


84

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.

10. BROKERS TO THE ISSUE

Brokers are the persons mainly concerned with the procurement of subscription

to the issue from the prospective investors. The appointment of brokers is not compulsory

and the companies are free to appoint any number of brokers. The managers to the issue

and the official brokers organize the preliminary distribution of securities and procure

direct subscriptions from as large or as wide a circle of investors as possible.

The stock exchange bye-laws prohibits the members from the acting as managers or

brokers to the issue and making preliminary arrangement in connection with any flotation

or new issue, unless the stock exchange of which they are members gives its approval and

the company conforms to the prescribed listing requirements and undertakes to have its

securities listed on a recognized stock exchange. The permission granted by the stock

exchange is also subject o other stipulations which are set out in the letter of consent. Their

active assistance is indispensable for broad basing the issue and 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


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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,

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.

MERCHANT BANKING AND MARKETING OF NEW ISSUES

Following are the steps involved in the marketing of the issue of securities to be

undertaken by the lead manager:


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1. Target market : The first step towards the successful marketing of securities is

the identification of a target market segment where the securities can be offered

for sale. This ensures smooth marketing of the issue. Further, it is possible to

identify whether the market comprises of retail investors, wholesale investors or

institutional investors.

2. Target concentration : After having chosen the target market for selling the

securities, steps are to be taken to assess the maximum number of subscriptions

that can be expected from the market. It would work to the advantage of the

company if it concentrates on the regions where it is popular among prospective

investors.

3. Pricing : After assessing market expectations, the kind and level of price to be

charged for the security must be decided. Pricing of the issue also influences the

design of capital structure. The offer has to be made more attractive by including

some unique features such as safety net, multiple options for conversion, attaching

warrants, etc.

4. Mobilizing intermediaries : For successful marketing of public issues, it is

important that efforts are made to enter into contracts with financial intermediaries

such as an underwriter, broker/sub-broker, fund arranger, etc.

5. Information contents : Every effort should be mad3e to ensure that the offer

document for issue is educative and contains maximum relevant information.

Institutional investors and high net worth investors should also be provided with

detailed research on the project, specifying its uniqueness and its advantage over

other existing or upcoming projects in a similar field.

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.


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8. A critical factor that could make or break the proposed pu8blic issue is its timing.

The market conditions should be favorable. Otherwise, even issues from a company

with an excellent track record, and whose shares are highly priced, might flop.

Similarly, the number and frequency of issues should also be kept to a minimum to

ensure success of the public issue.

Methods

Following are the various methods being adopted by corporate entities for marketing

the securities in the new Issues Market:

1. Pure Prospectus Method

2. Offer for Sale Method

3. Private Placement Method

4. Initial Public Offers Method

5. Rights Issue Method

6. Bonus Issue Method

7. Book-building Method

8. Stock Option Method and

9. Bought-out Deals Method

ABBREVIATIONS

• PPM Pure Prospectus Method

• OSM Offer for Sale Method

• PPM Private Placement Method

• IPOM Initial Public Offers Method

• RIM Right Issue Method

• BIM Bonus Issue Method

• BBM Book Building Method

• SOM Stock Option Method

• BODM Brought-Out Deals Method

1. PURE PROSPECTUS METHOD

The method whereby a corporate enterprise mops up capital funds from the general

public by means of an issue of a prospectus, is called ‗Pure Prospectus Method‘. It is the

most popular method of making public issue of securities by corporate enterprises.

The features of this method are

a. Exclusive subscription : Under this method, the new issues of a company are

offered for exclusive subscription of the general public. According to the SEBI

norms, a minimum of 49 percent of the total issue at a time is to be offered to

public.

b. Issue price : Direct offer is made by the issuing company to the general public to

subscribe to the securities at a staged price. The securities may be issued either at

par, of at a discount or at a premium.

c. Underwriting : Public issue through the ‗pure prospectus method‘ 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


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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 : A major drawback of this method is that it is an expensive

mode of raising funds from the capital market. Costs of various hues are incurred

in mobilizing capital. Such costs as underwriting expenses, brokerage, administrative

costs, publicity costs, legal costs and other costs are incurred for raising funds.

Due to the high cost structure, this type of marketing of securities is followed only

for large issues.

b. Time consuming : The issue of securities through prospectus takes more time,

as it requires the due compliance with various formalities before an issue could

take place. For instance, a lot of work such as underwriting, etc. should be

formalized before the printing and the issue of a prospectus.

2. 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


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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.

3. 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

1. Less expensive as various types of costs associated with the issue are borne by

the issue houses and other intermediaries.

2. Less troublesome for the issuer as there is not much of stock exchange requirements

connecting contents of prospectus and its publicity etc. to be complied with.

3. Placement of securities suits the requirements of small companies.

4. The method is also resorted to when the stock market is dull and the public response

to the issue is doubtful.

DISADVANTAGES

1. Concentration of securities in a few hands.

2. Creating artificial scarcity for the securities thus jacking up the prices temporarily

and misleading general public.

3. Depriving the common investors of an opportunity to subscribe to the issue, thus

affecting their confidence levels.

4. INTIAL PUBLIC OFFER (IPO) METHOD

The public issue made by a corporate entity for the first time in its life is called ‗Initial

Public Offer‘ (IPO). Under this method of marketing, securities are issued to successful

applicants on the basis of the orders placed by them, through their brokers.

When a company whose stock is not publicly traded wants to offer that stock to the

general public, it takes the form of ‗Initial Public Offer‘. The job of selling the stock is

entrusted to a popular intermediary, the underwriter. An underwriter is invariably an

investment banking company. He agrees to pay the issuer a certain price for a minimum

number of shares, and then resells those shares to buyers, who are often the clients of the

underwriting firm. The underwriters charge a fee for their services.

Stocks are issued to the underwriter after the issue of prospectus which provides

details of financial and business information as regards the issuer. Stocks are then released

to the underwriter and the underwriter releases the stock to the public. The issuer and the

underwriting syndicate jointly determine the price of a new issue. The approximate price listed in

the red herring (the preliminary prospectus – often with

words in red letters which say this is preliminary and the 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


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for the stock being acquired.

Full disclosure of all material information in connection with the offering of new securities

must be made as part of the new offerings. A statement and preliminary prospectus (also

known as a red herring) containing the following information is to be filed with the Registrar

of Companies:

1. A description of the issuer‘s business

2. The names and addresses of the key company offers, with salary and a 5 year

business history on each

3. The amount of ownership of the key officers

4. The company‘s capitalization and description of how the proceeds from the offering

will be used and

5. Any legal proceedings that the company is involved in.

Applications are made by the investors on the advice of their brokers who are intimated

of the share allocation by the issuer. The amount becomes payable to the issuer through

the broker only on final allocation. The allotment is credited and share certificates delivered

to the depository account of the successful investor.

The essential steps involved in this method of marketing of securities are as follows:

a. Order Broker receives order from the client and places orders on behalf of the

client with the issuer.

b. Share allocation : The issuer finalizes share allocation and informs the broker

regarding the same.

c. The client : The broker advises the successful clients of his share allocation

Clients then submit the application forms for shares and make payment to the

issuer through the broker.

d. Primary issue account : The issuer opens a separate escrow account (primary

issue account) for the primary market issue. The clearing house of the exchange

debits the primary issue account of the broker and credits the issuer‘s account.

e. Certificates : Certificates are then delivered to investors. Otherwise depository

account may be credited.

The biggest advantage of this method of marketing of securities is that there is no

need for the investors to part with the money even before the shares are allotted in his

favor. Further, the method allows for elimination of unnecessary hassles involved in making

a public issue. Under the regulations of the SEBI, IPOS can be carried out through the

secondary market and the existing infrastructure of stock exchanges can be used for this

purpose.

5. 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


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4. Appointment of category I Merchant Bankers holding a certificate of registration

issued by SEBI shall be compulsory

5. Rights shares shall be issued only in respect of fully paid shares

6. Letter of Offer shall contain disclosures as per SEBI requirements

7. Agreement shall be entered into with the depository for materialization of securities

to be issued

8. Issue shall be kept open for a minimum period of 30 days and for a maximum

period of 60 days

9. A minimum subscription of 90 percent of the issue shall be received

10. No reservation is allowed for rights issue as regards FCDs and PCDs

11. A ‗No Complaints Certificate‘ 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 counter to the overall societal

considerations of diffusion of shares ownership for promoting dispersal of wealth

and economic power.

6. 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


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Following are the guidelines pertaining to the issue of bonus shares by a listed corporate

enterprise:

1. Reservation

In respect of FCDs and PCDs, bonus shares must be reserved in proportion to such

convertible part of FCDs and PCDs. The shares so reserved may be issued at the time of

conversion(s) of such debentures on the same terms on which the bonus issues were

made.

2. Reserves

The bonus issue shall be made out of free reserves built out of the genuine profits or

share premium collected in cash only. Reserves created by revaluation of fixed assets are

not capitalized.

3. Dividend mode

The declaration of bonus issue, in lieu of dividend, is not made

4. Fully paid

The bonus issue is not made unless the partly paid shares, if any are made fully paidup.

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.

7. BOOK BUILDING METHOD

A method of marketing the shares of a company whereby the quantum and the price

of the securities to be issued will be decided on the basis of the ‗bids‘ received from the

prospective shareholders by the lead merchant bankers is known as ‗book-building method.

Under the book-building method, share prices are determined on the basis of real

demand for the shares at various price levels in the market. For discovering the price at

which issue should be made, bids are invited from prospective investors from which the

demand at various price levels is noted. The merchant bankers undertake full responsibility

for the same. The option of 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.


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

company can opt for book-building route for the sale of shares to the extent of the percentage

of the issue that can be reserved for firm allotment as per the prevailing SEBI guidelines. It

is therefore possible either to reserve securities for firm allotment or issue them through the

book-building process.

The book-building process involves the following steps:

1. Appointment of book-runners

The first step in the book-building process is the appointment by the issuer company,

of the book-runner, chosen from one of the lead merchant bankers. The book-runner in

turn forms a syndicate for the book-building. A syndicate member should be a member of

National Stock Exchange (NSE) or Over-the-Counter Exchange of India (OTCEI). Offers

of ‗bids‘ are to be made by investors to the syndicate members, who register the demands

of investors. The bid 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 priceband

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


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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 case an issue is made through book-building route, it is mandatory that

the portion of the issue offered to the public be underwritten. This is the purpose, an

agreement has to be entered into with the underwriter by the issuer. The agreement shall

specify the number of securities as well as the price at which the underwriter would

subscribe to the securities. The book-runner may require the underwriter of the net offer

to the public to pay in advance all moneys required to be paid in respect of their underwriting

commitment.

8. Filling with ROC

A copy of the prospectus as certified by the SEBI shall be filed with the Registrar of

Companies within two days of the receipt of the acknowledgement card from the SEBI.

9. Bank accounts

The issuer company has to open two separate accounts for collection of application

money, one for the private placement portion and the other for the public subscription.

10. Collection of completed applications

The book-runner collects from the institutional buyers and the underwriters the

application forms along with the application money to the extent of the securities proposed

to be allotted to them or subscribed by them. This is to be done one day before the

opening of the issue to the public.

11. Allotment of securities

Allotment for the private placement portion may be made on the second day from

the closure of the issue. The issuer company, however, has the option to choose one date

for both the placement portion and the public portion. The said date shall be considered

to be the date of allotment for the issue of securities through the book-building process.

The issuer company is permitted to pay interest on the application moneys till the date of

allotment or the deemed date of allotment provided that payment of interest is uniformly

given to all the applicants.

12. Payment schedule and listing

The book-runner may require the underwriters to the ‗net offer to the public‘ to pay

in advance all moneys required to be paid in respect of their underwriting commitment by

the eleventh day of the closure of the issue. In that case, the shares allotted as per the

private placement category will become eligible for being listed. Allotment of securities

under the public category is to be made as per the prevailing statutory requirements.

13. Under-subscription

In the case of under-subscription in the ‗net offer to the public‘ category, any spillover

to the extent of under-subscription is to be permitted from the ‗placement portion‘ category

subject to the condition that preference is given to the individual investors. In the case of

under-subscription in the placement portion, spillover is to be permitted from the net offer

to the public to the placement portion.

ADVANTAGES OF BOOK BUILDING

Book-building process is of immense use in the following ways:

1. Reduction in the duration between allotment and listing


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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

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.

7. Director‟s report

The Director‘s report shall make a disclosure of the following :

a. Total number of shares as approved by the shareholders

b. The pricing formula adopted

c. Details as to options granted, options vested, options exercised and options forfeited,


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extinguishments or modification of options, money realized by exercise of options,

total number of options in force, employee-wise details of options granted to senior

managerial personnel and to any other employee who receive a grant in any one

year of options amounting to 5 percent or more of options granted during that year

d. Fully diluted EPS computed in accordance with the IAS

IPO

SEBI‘s stipulations prohibiting initial public offerings by companies having outstanding

options should not apply to ESOP. If any ESOPs are outstanding at the time of an IPO

issue by an unlisted company, the promoters‘ contribution shall be calculated with reference

to the enlarged capital that would arise if all vested options were exercised.

8. STOCK OPTION NORMS FOR SOFTWARE COMPANIES

The relevant guidelines issued by the SEBI as regards ‗employees stock option‘ for

software companies are as follows :

1. Minimum issue

A minimum issue of 10 percent of its paid-up capital can be made by a software

company which has already floated American Depository Receipts (ADRs) and Global

Depository Receipts (GDRs) or a company which is proposing to float these is entitled to

issue ADR/GDR-linked stock options to its employees. For this purpose, prior permission

from the Department of Economic Affairs is to be obtained.

2. Mode of Issue

Listed stock options can be issued in foreign currency convertible bonds and ordinary

shares (through depository receipt mechanism) to the employees of subsidiaries of InfoTech

companies.

3. Permanent employees

Indian IT companies can issue ADR/GDR linked stock options to permanent

employees, including Indian and overseas directors, of their subsidiary companies

incorporated in India or outside.

4. Pricing

The pricing provisions of SEBI‘s preferential allotment guidelines would not cover

the scheme. The purpose is to enable the companies to issue stock options to its employees

at a discount to the market price which serves as another form of compensation.

5. Approval

Shareholders‘ approval through a special resolution is necessary for issuing the ESOPs.

A minimum period of one year between grant of option and its vesting has been prescribed.

After one year, the company would determine the period in which option can be exercised.

9. 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.


97

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 : 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.

6. Windfall profits : Bought-out deals offer the advantage of windfall profits by

sponsors at the cost of small investors.


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7. Loss to investors : Where the shares taken up by issue brokers and a group of

select clients are being bought back by the promoters at a pre-fixed higher price

after allotment causing loss to investors of the company.

Advertising Strategies

SEBI GUIDELINES FOR ISSUE ADVERISEMENT (11.10.1993)

SEBI issued Guidelines in 1993 to ensure that the advertisement are truthful fair and

clear and do not contain statements to mislead the investors to imitate their judgment. All

lead managers are expected to ensure that issuer companies strictly observe the code of

advertisement set-out in the guidelines.

For the purpose of these guidelines the expression advertisement, means notices,

brochures, pamphlets, circulars show cards, catalogues, boardings, placards, posters,

insertions in newspapers, pictures, films, radio/television program or through any electronic

media and would also include the cover pages of the offer documents.

CODE OF ADVERTISEMENTS- CAPITAL ISSUES

1. An issue advertisement shall be truthful fair and clear and shall not contain any

statement which is untrue or misleading.

2. An issue advertisement shall be considered to be misleading,

It contains

a. Statements made about the performance or activities of the company in

the absence of necessary explanatory or qualifying statements, which may

give an exaggerated picture of the performance or activities than what it

rally is.

b. An inaccurate portrayal of a past performance in a manner which implies

that past gains or income will be repeated in the future.

3. As investors may not be well versed in legal or financial matter, care should be

taken to ensure that the advertisement is set forth in a clear, concise and

understandable language. Extensive use of technical, legal terminology or complex

languages and the inclusion of excessive details which may distract the investor

should be avoided.

4. An issue advertisement shall not contain statements which promise or guarantee

an appreciation or rapid profits.

5. An issue advertisement shall not contain any inform or language that not contained

in the offer documents.

6. All issue advertisement in newspapers, magazines, brochures, pamphlets containing

highlights relating to any issue should also contain risk factors with the same print

size. It should mention the names of lead Managers, Registers to the issue.

7. No corporate advertisement except product advertisements shall be issued between

the date of opening and closing of subscription of any public issue. Such product

advertisement shall not make any reference directly or indirectly on the performance

of the company during the said period.

8. No advertisement shall be issued stating that the issue has been fully subscribed or

oversubscribed during the period the issue is open for subscription, except to the

effect that the issue is open or closed. No announcement regarding closure of the


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issue shall be made except on closing date. If the issue is fully subscribed before

the last closing date as state in the prospectus, the announcement should be made

only after the issue is fully subscribed and such announcement is made on the date

on which the issue is to be closed.

9. No model, celebrities, fictional characters, landmarks or caricatures or the like

shall be displayed on or form pat of the offer documents or issue advertisements.

10. No slogans, expletives or non factual and unsubstantiated titles should appear in

the issue advertisement or offer documents.

11. If any advertisements carries any financial data it should also contain data for last

three years and shall include particulars relating to sales, gross profits, net profit

share capital reserves, earning per share, dividends and book values.

12. No incentives, apart from the permissible underwriting commission and brokerages,

shall be offered through any advertisements to anyone associated with marketing

the issue.

FIIs (Foreign Institutional Investors)

GUIDELINES OF GOVERNMENT OF INDIA

Government of India through Guidelines issued on September 14, 1992 has allowed

reputed foreign Institutional Investors (FIIs) including pension funds, mutual funds, asset

management companies, investment trusts, nominee companies and incorporated or

institutional portfolio managers to invest in the India capital market subject to the condition

that they register with the Securities and Exchange Board of India and obtain RBI approval

under FERA. The different forms in which the portfolio investment flows into the country

are global depository receipts(GDR‘s), investment in primary and secondary market,

offshore funds and government securities. At the end of March 2000, 506 FIIs were

registered with SEBI. Their total cumulative investment in securities market was Rs.57,038

crores as at March 2002. Of the FIIs only 205 were active and 10 % accounted for 70%

of transactions. There is no restriction on amount of investment and there is no lock in

period.

Portfolio investment by the FIIs are required to allocate their total investment between

equities and debentures in the ratio of 70:30. FII s can make purchases and sales only for

delivery. A FII cannot engage in short sales. FII investing under the scheme, enjoy a

confessional tax rate of 205 on dividend and interest and 10% on long term capital gains

short term capital gains arising out of transfer of securities are taxed at 30%. Tax is deducted

at 20% on interest and dividends.

FII and SEBI Regulations , 1995

The regulations stipulate that foreign institutional investors have to be registered with

SEBI and obtain a certificate from SEBI. For the purpose of grant of the certificate SEBI

takes into account,

1. The applicant‘s track record, professional competence, financial soundness,

experience, general reputation of fairness and integrity

2. Whether the applicant is regulated by appropriate foreign regulatory authority

3. Whether the applicant has been granted permission by RBI under Foreign Exchange

Regulating Act for making investments in India as a foreign institutional investor

and

4. Where the applicant is,


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a. an institution established or incorporated outside India as a pension fund,

mutual fund or investment trust ; or

b. an asset management company or nominee company or bank or institutional

portfolio manager, established or incorporated outside India and proposing

to make investments in India on behalf of broad based funds; or

c. A trustee or power of attorney holder established or incorporated outside

India and proposing to make investments in India on behalf of broad based funds.

The certificate is granted in Form B subject to payment of prescribed fees which is

valid for 5 Years and can be renewed thereafter.

Net investment by FIIs in Indian Capital Market

Rs. In Crores

1992 – 1993 4

1993 – 1994 5445

1994 – 1995 4777

1995 – 1996 6721

1996 – 1997 7386

1997 – 1998 5908

1998 – 1999 (-) 729

1999 – 2000 9765

2000 – 2001 9682

RBI hand Book of Statistics on Indian Economy , 2001, p.299.

Provision is also made for registration of sub accounts on whose behalf FII proposes

to make the investment in India.

The purchases of shares of each company should not be more than ten percent of the

total issued capital of the company.

The investment by foreign institutional investor is also subject to GOI Guidelines.

The general obligations and responsibilities of FIIs include appointment of a domestic

custodian, appointment of designated bank, maintenance of proper books of accounts,

records and their reservation for five years and information to the Board or Reserve Bank

of India.

Defaults are punished by suspension and cancellation of certificate after show cause

notice and enquiry.

PREFERENTIAL ALLOTMENTS TO FIIs

Listed companies have been allowed by SEBI to make preferential allotment to

registered FIIs subject to certain conditions. A company desiring to make a preferential

allotment should obtain the shareholders‘ consent. The allotment should be in accordance

with ceilings of 10% of total issued capital for individual FII and 30% of all FIIs and nonresident

Indian investors. The preferential allotment should be made at a price not less than

the highest price during the last 26 weeks on all stock exchanges where the company

securities are listed.

NRI

The term NRI includes the following categories of persons:

1. Indian national holding Indian passports with non-resident status (INNR),

2. Person of Indian origin, foreign nationals of Indian origin, living in foreign countries

including such persons of Indian origin as is in the status of stateless, because no


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foreign country has as yet accepted them as their national and they are not Indian

national either by birth or residence, (FNIO). The term NRI also includes companies,

partnership firms, trusts, societies and other corporate bodies called OCBs where

60% of the equity is owned by the NRIs.

INVESTMENT POTENTIAL OF NRI‟s

It is estimated that currently about 25 million Indians living abroad would fall into the

definition of NRI. Of these about 20 million have taken up foreign nationality (FNIOs) and

the remaining 5 million are still Indian passport holders. The pattern of earning and

consumption of NRIs is such that it leaves annually a fairly large amount of investable

resources. Conservative estimates place such resources at Rs.45,000 crores or about US

$15 billion annually and the wealth at $200 billion or Rs.7,20,000 crores. Assuming that

India succeeds in persuading NRIs to invest 10 % of their total saving into investments in

India, the estimate of possible inflow is about US$ 1.5 billion per year.

AVENUES FOR INVESTMENT BY NRI‟s

NRIs can have three different types of bank accounts, buy securities in the primary

and secondary markets, and do business on non-reparable basis as well as reparable

basis.

NRI‘s have also made in the past large investments in specific bonds, i.e., the India

Development Bond in 1991, the Resurgent India Bond in 1998 and India Millennium

Deposits in 2000.

FOREIGN DIRECT INVESTMENT UNDER NEW INDUSTRIAL POLICY

(1991)

Repatriable Basis

Under the new industrial policy, foreign direct investment up to 51% of the equity is

allowed on repatriation basis in certain high priority industries. NRI‘s can take up the

balance 49% of equity in such cases on repatriation basis.

Non Repatriable Basis

1. Investment in new issues of shares/ debentures of Indian companies (1992) RBI

has granted general permission to NRIs/OCBs to take up or subscribe on non repatriation

basis shares or convertible debentures issued whether by public issue

or private placement in companies other than those in agricultural/plantation and /

or real estate business.

2. Investment in non-convertible debentures (1992) RBI permission has to be obtained

by Indian Company for investment by NRI/OCB in non-convertible debentures.

INVESTMENT IN NEW ISSUES (PRIMARY MARKET)

Forty percent scheme

Indian companies engaged in industry and manufacturing, Hotel (3,4, and 5 star

category), hospitals and diagnostic enters, shipping companies, development of computer

software and oil exploration services are allowed by RBI to issue shares/debentures to

NRIs with repatriation benefits to the extent of 40% of new issue.

No permission for investment is required in cases where the company has obtained

permission from RBI. This is generally granted in the green field project (e.g. Chambal

Fertilizers, Mangalore Refineries). NRI has to obtain permission from RBI even if the sale

is to be effected after 12 month. Blanket permission can be obtained before completing 12

months of each investment.


102

Generally RBI does not permit NRI investment at issue prices in case of

a. Right issues of existing companies (excluding existing NRI shareholders) and

b. Public issues of an existing profit making company.

NRI can repatriate original investment, profit and dividend provided they are held for

a minimum period of one year. On long term capital gains a rate of 10% is applicable.

If the investment is sold before one year the investment and all related receipts become

non-repatriable unless RBI permission is taken in advance with clearance from Income

Tax department, with long term capital gains (LTCG) provisions as applicable to resident

assesses.

In the case of non allotment or allotment of less than requested amount, refunds can

be credited to NRE accounts.

In case of debentures, long term capital gains (LTCG) provisional apply after three

years (in place of one year for equity issues). But the proceeds are fully repatriable. For

investment and sale through secondary market a blanket permission valid for 5 years is to

be obtained through an NRE banker. RBI permission stipulates that such investments be

routed through any one bank branch to facilitate control/monitoring.

There is a ceiling for NRI investment in each company. For an individual NRI it is one

percent of paid up capital and five percent for all NRI‘s and it could be raised to 24 % for

all NRI‘s wherever the company passes a special resolution at is annual general meeting.

Repatriation of original investment, profits and dividends is allowed. The lock-in period

has been removed on 12.10.1994.

PORTFOLIO INVESTMENT

NRI Portfolio Investment – One hundred percent scheme:

Repatriable Basis

NRIs and overseas corporate bodies predominantly owned by them are permitted to

invest up to 100% equity in high priority industries with repatriability of capital and income.

NRI investment up to 100 % of equity is also allowed in export houses, trading houses,

star trading houses, hospital EOU‘s. Sick industries, hotel and tourism related industries

are without the right of repatriation in the previously excluded areas of real estate, housing

and infrastructure. Power is another sector where 100% investment is allowed. Repatriation

of profits is permitted.

Forty Percent scheme: Reptraible Basis

On repatraible basis investment by to 40% of equity of any company promoted by

NRI in any industry or for exports subject to prior permission from RBI is allowed.

Non Repatriation Basis

Investment in Mutual funds:

Mutual funds seeking investment from NRI‘S have to obtain approval from RBI.

NRIs do not need a separate approval from RBI. NRIs can make investments in mutual

funds through purchases from secondary market on non repatriation basis. In such cases

they have to submit the application through a designated branch of an authorized dealer.

Investment in Money market mutual Funds (MMFs)

NRIs are permitted to invest on non – repatriation basis in MMFs floated by

commercial banks and public/private sector financial institutions. The concerned bank/

institution should get authorization from RBI/SEBI . NRIs do not need separate permission.

Purchase of Share by Private Arrangement


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NRIs/OCBs require permission of RBI for purchasing shares of Indian companies by

private arrangement.

2.3.5 Pricing of Issues

A listed company can freely price equity shares/convertible securities through public/

rights issues. An unlisted company eligible to make a public issue and desirous of getting

its securities listed on a recognized stock exchange can also freely price shares and

convertible securities. The free pricing of equity shares by an infrastructure company 8is

subject to the compliance with disclosure norms as specified by the SEBI from time to

time. While freely pricing their initial public issue of share/convertibles, all banks require

approval by the Reserve Bank of India (RBI).

DIFFERENTIAL PRICING

Listed/unlisted companies may issue shares/convertible securities to applicants in the

firm allotment category (i.e. Allotment on a firm basis made to Indian and multilateral

development finance institutions, Indian mutual funds, foreign institutional investors including

non-resident Indians/overseas corporate bodies and permanent/regular employees of the

issuing company) at a price different from the price at which the net offer to the public (i.e.

the Indian public, excluding firm allotments/reservations/ promoters contribution) is made,

provided the price at which the security is offered to the applicants in firm allotment

category is higher than the price at which securities are offered to the public.

A listed company making a composite issue of capital (i.e. Public-cum-rights basis

made through a single offer document in which he allotment for both public and rights

components is proposed to be made simultaneously) may issue securities at differential

prices in its public and rights issue. In the public issue, which is a part of a composite issue,

differential pricing in the firm allotment category vis-à-vis the net offer to he public is also

permissible. However, justification for the price differential should be given in the offer

document in case of firm allotment category as well as in all composite issues.

PRICE BAND

The issuer/issuing companies can mention a price band of 20 percent (cap in the price

band should not exceed 20 percent of the floor price) in the offer document filed with the

SEBI and the actual price can be determined at a later date before filing it with the ROCs

(Registrar of Companies). If the Board of Directors (BOD) of the issuing company has

been authorized to determine the offer price within a specified price band, a resolution

would have to be passed by them to determine such a price. The lead merchant bankers

should ensure that in the case of listed companies, a 48-hour notice of the meeting of the

BOD, for passing the resolution for determination of price, is given to the designated stock

exchange. The final offer document should contain only one price and one set of financial

projections, if applicable.

PAYMENTS OF DISCOUNTS/ COMMISSIONS

Any direct/indirect payment in the nature of discount/commission/allowance or

otherwise cannot be made by the issuer company/promoters to any firm allotted in a public

issue.

DENOMINATION OF SHARES

Public/rights issue of equity shares can be made in any denomination in accordance

with Section 13(4) of the Companies Act and in compliance with norms specified by the

SEBI from time to time. The companies that have already issued shares in the denominations


104

of Rs.10 or Rs.100 may change their standard denomination by splitting/consolidating

them The issue of shares in any denomination or change in the standard denomination is

subject to the following;

i. The shares should not be issued in the denomination of a decimal of a rupee;

ii. The denomination of the existing shares should not be altered to a denomination of

a decimal of a rupee;

iii. At any given time, there would be only one denomination for the shares of a company,

iv. The companies seeking to change the standard denomination may do so only it

their memorandum and articles of association permit and

v. The company should adhere to the disclosure and accounting norms specified by

the SEBI from time to time.

Merchant Banking And Post Issue Activities

The major activities covered are :

Finalization of Basis of Allotment

If the public issue is oversubscribed to the extent of greater than five times, a SEBI nominated

public representative is required to participate in the finalization of Basis of

allotment (BoA). In case of rights issue that is oversubscribed greater than two times, a

SEBI-nominated public representative is required to participate in the finalization of Boa.

If it is under subscribed, information regarding acce4pted applications is formalized, and

Regional Stock Exchanges are approached for finalization of BoA.

Dispatch of Share Certificates

Immediately after finalizing the Boa, share certificates are dispatched to the eligible

allotees, and refund orders made to unsuccessful applications. In addition, a 78 days

report is to be filed with SEBI. Permission for listing of securities is also obtained from the

stock exchange.

Advertisement

An announcement in the newspaper has to be made regarding the basis of allotment,

the number of applications received and the date of dispatch of share certificates and

refund orders, etc.

2.3.7 Law Relating To Issue Management

It is important that the lead managers take into account the regulations of the capital

issue as prescribed by the various enactments mentioned below :

1. Provisions of the Companies Act, 1956

a. Prospectus (Sec. 55 to 68A)

b. Allotment (Sec. 55 to 75)

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

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

e. Issue and redemption of preference shares (Sec. 80 & 80A)

F. further issues of capital (Sec. 81)

g. Nature, numbering and certificate of shares (Sec. 82 to 84)

h. Kinds of share capital and prohibition on issue of any other kind of shares

(Sec. 85 & 86)

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

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

3. The Securities Contracts (Regulation (Rules, 1957


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UNIT III

OTHER FEE BASED MANAGEMENT

INTRODUCTION:

Mergers and Acquisitions (M&A) as forms of business combination are increasingly

being used for undertaking restructuring of corporate enterprises the world over.

In fact, the corporate world is in the grip of merger-mania (mega mergers and hostile

takeovers). The merger wave which began in the U.S. first occurred during the period

between 1890 and 1904. Of late, mergers happen in all the sectors of the economy, the

prime driving force being the accomplishment of synergetic effect for both the acquiring

and the acquirer companies.

MERGERS

A type of business combination where two or more firms amalgamate into one single

firm is known as a merger. In a merger, one or more companies may merge with an existing

company or they may combine to form a new company. In India mergers and amalgamations

are used interchangeably.

In the wider sense, merger includes consolidation, amalgamation, absorption and

takeover. It signifies the transfer of all assets and liabilities of one or more existing companies

to another existing or new company.

Objectives

The main purpose of merges is to achieve the advantage of fusion and synergy through

expansion and diversification.

Steps IN M & A

Following are the steps involved in M&A :

1. Review of Objectives

The first and foremost step in M&A is that the merging companies must undertake the

review of the purpose for which the proposal to merge is to be considered. Major objectives

of merger include attaining faster growth, improving profitability, improving managerial

effectiveness, gaining market power and leadership, achieving cost reduction, etc. The

review of objectives is done to assess the strengths and weaknesses, and corporate goals

of the merging enterprise. In addition, the need for elimination of inefficient operations,

cost reduction and productivity improvement, etc. should also be considered. Such a

move would help the acquiring company to decide as to the kind of business units that

must be acquired.

2. Data for analysis

After reviewing the relevant objective of acquisition the acquiring firm needs to collect

detailed information pertaining to financial and other aspects of the firm and the industry.

Industry-centric information will be needed to make an assessment of market growth,

nature of competition, case of entry, capital and labour intensity, degree of regulation, etc.

Similarly, firm-centric information will be needed to assess quality of management, market

share, size, capital structure, profitability, production and marketing capabilities, etc. The

data to be collected serves as the criteria for evaluation.


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3. Analysis of information

After collecting both industry-specific and firm-specific information, the acquiring firm

undertakes analysis of data and the pros and cons are weighed. Data is to be analyzed

with a view to determine the earnings and cash flows, areas of risk, the maximum price

payable to the target company and the best way to finance the merger.

4. Fixing price

Price to be paid for the company being acquired shall be fixed taking into consideration

the current market value of share of the company being acquired. The price shall usually

be above the current market price of the share. A merger may take place at a premium. In

such a case, the firm would pay an offer price which is higher than the target firm‘s premerger

market value. This would happen where the acquiring firm is of the firm opinion

that such an option would augment operational results of the target firm owing to synergic

effect.

5. Finding merger value

Value created by merger is to be found so that it is possible for the merging firms to

determine their respective share. Merger value is equal to the excess of combined present

value of the merged firms over and above the sum of their individual present values as

separate entities. Any cost incurred towards the merging process is subtracted to arrive at

the figure of net economic advantage of merger. This advantage is shared between the

shareholders of the merging firms.

Take Overs

Take over is the case where one company obtains control over the management of

another company. Under both acquisition and takeover, it is possible for a company to have

effective control over another company even by holding minority ownership. For instance, the

Monopolies and Restrictive Trade Practices (MRTP) Act prescribes that a minimum of 25

percent voting power must be acquired as to constitute a takeover. Similarly, section 372

of the Companies Act defines the limit of a company‘s investment in the shares of another

company as anything more than 10 percent of the subscribed capital so as to constitute a

takeover.

DISTINCTION BETWEEN ACQUISITION AND TAKE OVER

Where a distinction between acquisition and takeover is made, takeover usually takes

the form of ‗hostile‘ or ‗forced‘ or ‗unwilling acquisition and acquisition happens at the

instance and the willingness of the company management and the shareholders. It is for

this reason that acquisition is generally referred to as ‗friendly takeover‘.

“Acquisition”: e.g.

An example of acquisition is Mahindra and Mahindra Ltd., a leading manufacturer of

jeeps and tractors, acquiring equity stake of Allwyn Nissan Ltd.

“Hostile takeovers”: e.g.

The acquisition of Shaw Wallace, Dunlop, Mather and Platt and Hindustan Dorr Oliver

by Chablis and Ashok Leyland by Hindujas, etc.

HOSILE TAKEOVERS

Where in a merger one firm acquires another firm without the knowledge and consent

of the management of the target firm, it takes the form of a ‗hostile takeover‘. The acquiring

firm makes a unilateral attempt to gain a controlling interest in the target firm, by purchasing

shares of the later firm directly in the open (stock) market.


107

An example of hostile takeover was the takeover of TMBL by Sivasankaran of the

Sterling Group. Since this type of takeover is generally prejudicial to the interest of the

stakeholders, SEBI has come out with relevant code of conduct for the purpose of regulating

the takeover practice in India.

DISTINCTION BETWEEN MERGERS Vs. TAKEOVERS

The following are the differences between ―Mergers‖ and ―Takeovers‖

Distinction Merger Takeover

1 Definition: Defined as an arrangement whereby

the assets of two companies become vested in, or under the control of, one company

(which may or may not be one of the original two companies), which has as its shareholders

all, or substantially all, the shareholders of the two companies. Defined as a transaction or

series of transactions whereby a person (individual, group of individuals or company) acquires

control over the assets of a company, either

directly by becoming the

owner of those assets or

indirectly by obtaining

control of the management

of the company.

2. Mode Effected by the

shareholders of one or

both of the merging

companies exchanging

their shares (either

voluntarily or as the

result of a legal

operation) for shares in

the other or a third

company, the

arrangement being

frequently effected by

means of a takeover bid

by one of the companies

for the shares of the

other, or of a takeover

bid by a third company

for the shares of both

Effected by agreement with

the holders of the whole of

the share capital of the

company being acquired,

where the shares are held by

the public generally, the

takeover may be effected by

agreement between the

acquirer and the controllers


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of the acquired company, or

by purchases of shares on

the Stock Exchange, or by

means of a ―takeover bid‖.

3. Control

over assets

Shareholding in the

combined enterprise

will be spread between

the shareholders of the

two companies

Direct or indirect control

over the assets of the

acquired company passes to

the acquirer

4. Bid Bid is generally by the

consent of the

management of both

companies

Bid is frequently against the

wishes of the management

of the offeree company.

Major Issues Of M&A In India

Business combinations and re-structuring in the form of merger, etc. have been attempted

to face the challenge of increasing competition and to achieve synergy in business operations.

The major issues of M&A are as follows :

Depreciation

The acquiring firm claims depreciation in respect of fixed assets transferred to it by

the target firm. The depreciation allowance is available on the written down value of fixed

assets. Further, the depreciation charge is based on the consideration paid and without

any revaluation.

R&D Expenditure

It is possible for the acquiring firm to claim the benefit of tax deduction under section

35 of the Income Tax Act, 1961 in respect of transfer of any asset representing capital

expenditure on R&D.

Tax Exemption

The fixed assets transferred to the acquiring firm by the target firm are exempt from

capital gains tax. This is however subject to the condition that the acquiring firm is an

Indian Company and that shares are swapped for shares in the target firm. Further, as the

swap of shares is not considered as sale by the shareholders, profit or loss on such swap

is not taxable in the hands of the shareholders of the amalgamated company.

Carry Forward Losses

The Indian Income Tax Act, 1961 contains highly favourable provision with regard to

merger of a sick company with a healthy company. For instance, section 72A(1) of the

Act gives the advantage of carry forward of losses of the target firm. The benefit is however


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available only :

• Where the acquiring from is an Indian Company;

• Where the target firm is not financially viable;

• Where the merger is in public interest,

• Where the merger facilities the revival of the business of the target firm; and

• Where the scheme of amalgamation is approved by a specified authority.

INTRODUCTION

Preserving and growing capital is as hard as earning it. Knowing what one want is as

important as achieving those goals. Assessing one‘s risk profile and aligning potential returns

for the risk assumed from various investment options is the crucial task. In today‘s fluid

environment, that has become a hard task to achieve. As the investor‘s net worth increases,

financial complexity expands exponentially and the investment needs and options multiply.

And equities offer one of the best options for investments.

Mutual funds as an investment vehicle are structured to reduce risks as far as possible,

as they cater to thousands of investors. This results in some limitations as far as the investment

strategy is concerned despite adopting the active management approach. As a discerning

investor, one who is not averse to taking on more risk in order to achieve greater returns,

one want his investments to be managed more actively compared to a mutual fund. He

wants his investments to be managed in a way that tries to maximize value.

To achieve this objective of preserving and growing one‘s capital a new service to

help in this onerous but rewarding task, there emerged the concept of portfolio management

services. A focus on providing one with options which would aim at wealth accretion while

minimizing the risk .

PORTFOLIO AND MANAGEMENT SERVICES:

A list of all those services and facilities that are provided by a portfolio manager to its

clients, relating to the management and administration of portfolio of securities or the funds

of the client, is referred to as ‗portfolio management services‘. The term ‗portfolio‘ means

the total holdings of securities belonging to any person.

Portfolio Manager

According to SEBI, ‗Portfolio Manager‘ means any person who pursuant to a contract

or arrangement with a client, advises or directs or undertakes on behalf of he client (whether

as a discretionary portfolio manager or otherwise) the management or administration of a

portfolio of securities or the funds of the client, as the case may be.

Discretionary Portfolio Manager

According to SEBI, ‗discretionary portfolio manager‘ means a portfolio manager

who exercises or may, under a contract relating to portfolio management, exercises any

degree of discretion as to the investments or management of the portfolio of securities or

the funds of the client, as the case may be.

2.3.1 Objectives

a. Provide long term capital appreciation with lower volatility, compared to the

broad equity markets.

b. Takes long positions in the cash market and short positions in the index futures

markets.

c. Invests in the model portfolios thus downside the risk by selling index futures in the

derivatives market.


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Functions:

The objective of portfolio management is to develop a portfolio that has a maximum

return at whatever level of risk the investor deems appropriate.

Risk Diversification

An essential function of portfolio management is spread risk akin to investment of

assets. Diversification could take place across different securities and across different

industries. Is an effective way of diversifying the risk in an investment. Simple diversification

reduces risk within categories of stocks that all have the same quality rating.

Asset Allocation

An important function of portfolio management is asset allocation. It deals with attaining

the operational proportions of investments from asset categories. Portfolio managers

basically aim of stock-bond mix. For this purpose, equally weighted categories of assets

are used.

Bets Estimation

Another important function of a portfolio manager is to make an estimate of best

coefficient. It measurers and ranks the systematic risk of different assets. Best coefficient

is an index of the systematic risk. This is useful in making ultimate selection of securities

forinvestment by a investment by a portfolio manager.

Rebalancing Portfolios

Rebalancing of portfolios involves the process of periodically adjusting the portfolios

to maintain the original conditions of the portfolio. The adjustment may be made either by

way of ‗Constant proportion portfolio‘ or by way of ‗Constant best portfolio‘.

In Constant proportion portfolio, adjustments are made in such a way as to maintain

the relative weighing in portfolio components according to the change in prices.

Under the constant beta portfolio, adjustments are made to accommodate the values

of component betas in the portfolio.

Strategies

A portfolio manager may adopt any of the following strategies an part of an efficient

portfolio management.

Buy and Hold Strategy

Under the ‗buy and hold‘ strategy, the portfolio manager builds a portfolio of stock

which is not disturbed at all for a long period of time. This practice is common in the case

of perpetual securities such as common stock.

Indexing

Another strategy employed by portfolio managers is ‗indexing‘. Indexing involves an

attempt to replicate the investment characteristics of a popular measure of the bond market.

Securities that are held in best-known bond indexes are basically high grade issues.

Laddered Portfolio

Under the laddered portfolio, bonds are selected in such a way as that their maturities

are spread uniformly over a long period of time. This way a portfolio manager aims at

distributing the funds throughout the yield curve.

Barbell Portfolio

Under the laddered portfolio, bonds are selected in such a way as that their maturities

are spread uniformly over a long period of time. This way a portfolio manager aims at


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distributing the funds throughout the yield curve can also benefit from lower transaction costs

because of better liquidity.

INTRODUCTION

„Credit syndication services‘ are services rendered by the merchant bankers in the

form of organizing and procuring the financial facilities form financial institutions, banks, or

other lending agencies.

Financing arranged on behalf of the client for meeting both fixed capital as well as

working capital requirements is known as ‗loan syndication service‘

CREDIT SYNDICATION SERVICES

Merchant bankers provide various services towards syndication of loans. The services

may be either loan sought for long term fixed capital or of working capital funds. They are

discussed in detail.

Objectives

arranging medium and long term funds for long term fixed capital and working

capital fund needs.

Scope

The scope of syndicated loan services as provided by merchant bankers include

identifying the sources of finance, approaching these sources, applying for the credit, and

sanction and disbursal of loans to the clients.

While carrying out the activities connected with credit syndication, the merchant banker

ensure due compliance with the formalities of the financial institution, banks and regulatory

authority. They are :

1. General Information : The purpose of furnishing general information is to enable the

financing company to obtain a general idea about the applicant company and its proposed

project.

2. Promoter information : Information about promoters is furnished by the merchant

banker with the objective of helping the lending agency to gain an understanding of the

promoter, his activities economic background, credibility and integrity.

3. Company information : The merchant banker has to furnish the following information

as regard the company for loan syndication arrangements to be made:

• Brief history of the concern

• Schemes already executed in the case of existing company

• Expansion/diversification plans in the case of an existing company

• Nature, size and status of the project to assess the funds requirement in the case of

a new company

• Changes in names, business, management, etc. and mergers, reorganizations, etc.

that have taken place in the past.

4. Project profile information : Full information relating to the project for which financial

assistance is sought is furnished by the merchant banker. The type of information may

pertain to plant capacity, nature of production process to be employed, nature of technical

arrangements available for the project.

5. Project cost information : Details of the estimated cost of the project should be

provided to the lending institution. This includes information as regards rupee cost/rupee

equivalent of foreign exchange cost/total cost for land or site development/buildings/plant

and machinery, imported/indigenous, technical know-how, etc. to be furnished. Besides,


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details of expenses likely to be incurred on foreign technicians/training of Indian technicians

abroad, miscellaneous fixed assets, preliminary pre-operative expenses, provision for

contingencies, margin money for working capital etc. should be stated in the loan application.

6. Project financing information : Details regarding the mode of financing used for the

project should be stated. This includes information on the extent of debt and equity capital

funding source. Besides, details of rupee loans, foreign currency loans, debentures, internal

cash accruals, promoters‘ contribution. The security offered for he loan/bank guarantee,

etc. should also be specified. Data should also be provided on the extent of loan

arrangements already applied for and the limit of financial arrangements thereto.

7. Project marketing information : As part of the credit syndication exercise, it is

incumbent on the part of the merchant banker to furnish adequate information about the

marketing arrangements made for the products of the borrowing unit.

8. Cash flow information : The merchant banker has to furnish details as to profitability

and expected stream of cash flows and cost of the proposed project for this purpose, it is

essential that working results of operations, cash flow statements and projected balance

sheet are given in prescribed form along with the basis of the calculations.

9. Other information : The merchant banker has to indicate as to how the purpose of

the economic and national importance of the proposed project will be realized. Besides,

following are the other details to be furnished by the merchant banker to the lending agency.

1. CIF/FOB international price of inputs to be imported/exported

2. Economic benefits in general and the region in particular available to the nation

from the project

3. Economic benefits in general and the region in particular available to the nation

from the project

4. Expected contribution to the growth, if any of ancillary industries in the region

5. Government consent by way issue of letter of intent, industrial license, foreign

exchange permission, approval of technical financial collaboration etc.

a. Making Application

The merchant banker files the duly filled-in application in a manner as desired by the

term-lending institution. While presenting the application, it is incumbent on the part of the

merchant banker to ensure that all the required formalities have been complied with. For

instance, it is important that necessary sanction is obtained from the Government for the

proposed project. Loans are syndicated by development financial institutions though the

‗lead institution‘ especially in the case of ‗consortium financing‘ or ‗joint lending‘. Where

loans are sought in huge amounts consortium approach to lending is followed. The lead

institution adopts ‗single window scheme‘ while appraising, sanctioning and disbursing

loans.

A part of credit syndication services, the merchant banker arranges for appraisal of

the project by sufficiently interacting with the officials of the development financial institutions.

The merchant banker holds formal discussions with the appraisal team of financial institutions.

He helps the promoters/chief executive of the company by providing information to the

appraisal team. He takes part in the site inspection with the appraisal team and provides

information to them about the technical aspect of the project implementation. He also

assists the appraisal team on matters connected with the choice of technique to be adopted

for appraisal of the project. Merchant banker provides advice in the preparation of


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project/feasibility report and the market survey report, and the financial projections relating

to the project.

1 Technical appraisal : Technical appraisal involves the assessment of technical and

engineering soundness of the project. While carrying out the technical appraisal of a project,

aspects such as competence of the experts preparing design of facilities and specifications;

purchase arrangements of equipments; supervision of construction and installation; ability

of consultants and their costs for services, are looked into. Attention is also paid to the

aspects concerning the scale of operation, cost of production and prospective demand.

Similarly, attention is paid to understand the appropriateness of the methods and processes

to be used for the project. Consideration is also given to the level of availability of latest

technology, degree of obsolescence in technological process, etc.

2 Ecological appraisal : Regarding the ecological aspects of the project, the merchant

banker ensures that the borrowing company has taken all possible steps for preventing air,

water and soil pollution arising out of the industrial project proposed to be undertaken. A

certificate from the State Pollution Control Board has to be produced to the effect that the

company has installed equipment adequate and appropriate to the requirement of meeting

the environment protection. Ecological appraisal is mandatory with respect to highly polluting

industries such as zinc, lead, copper, aluminum, steel, paper, pesticides/insecticides, refineries,

fertilizers, paints, dyes, leathering tanning, rayon, sodium/potassium cyanide, basic drugs,

foundry, batteries, acids/alkalis, plastics, rubber, cement, asbestos, fermentation, electro

placing,etc.

3 Financial appraisal : Financial appraisal involves analyzing the financial viability of

the project under consideration. Analysis of the need for fixed capital and working capital

is also carried out. Consideration is also given to the cost of the project as relating to

acquisition of capital assets, interest cost on loans obtained for promotional, organizational,

training and other purposes.

4 Promoters‟ contribution: Promoter‘s contribution for establishment and running of

a project is vital. The important sources of promoters‘ contribution in the case of newly

established companies include own equity, managed equity from special funds such as

Risk Capital/venture Capital Funds or Seed Capital from IDBI through SFCs, etc. and

foreign equity, deposits contributed by promoters, etc. In the case of existing companies

the sources of promoter contribution include internal accruals, right issues, divestment of

shares, additional equity, unsecured loans, etc. The extent of promoters‘ contribution and

debt-equity norms must be scrutinized by the merchant banker.

5 Economic appraisal: The project involves making an analysis of the expected

contribution of the project to the particular sector, besides its contribution to the

development of the national economy. Particular attention is paid to the project‘s usefulness

in terms of best possible utilization of scarce resources. It is essential to consider the

priority nature of the project. Accordingly, a project will be considered desirable if it has

a tremendous impact on the balance of payment and the capacity to generate exchange

surplus through new exports, import substitution and resultant savings in foreign exchange.

6 Commercial appraisal: It involves the determination of commercial viability of the

project in terms of arrangements for buying, transporting and marketing the product.

7 Managerial appraisal: It is concerned with the evaluation of effectiveness and

efficiency of the managerial personnel who are vested with the responsibility of organizing


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the available resources of the project. The merchant banker checks the managerial

competency both at construction and operation stages to ensure the success of the project.

8 Arrangement of Loan Sanction – It is the function of a merchant banker to obtain

the letter of intent/sanction from the lending institution/bank. The lending agency informs

the merchant banker about the sanction of loan by the sanctioning authority. The sanction

letter invariably contains terms and conditions pertaining to the sanction of loan. Some

these terms include amount of loan, rate of interest applicable, commitment charge levied

by the lender in order to motivate the borrowing unit to make efficient use of the loan,

security for the loan, conversion option in the case of default and rehabilitation assistance,

repayment terms of loan, and other terms and conditions.

9 Compliance for Loan Disbursement: It is essential duty of the merchant banker to

ensure compliance of terms and conditions to have the loan facility disbursed by the bank

or the financial institution. Compliance is required in respect of the following.

9.3 Compliance with the provisions of Memorandum and the Articles

9.4 Compliance with the provisions of Acts

9.5 Compliance with the provisions of loan agreement.

10. Compliance with memorandum and the articles

The merchant banker ensures due compliance with the provisions of Memorandum

and Articles of Association of the borrowing unit. This is to check the extent of

powers commanded by the Board of Directors of the company to make borrowings

from the lending agency. The borrowing powers of the Board are enshrined in the

memorandum by means of its ‗objects clause‘. The compliance would help the lending

agency to ensure that the acts of directors are not ultra-vires so as to safeguard its

interest.

b. STATUTORY COMPLIANCE

In addition, compliance is also called for with regard to the provisions constrained in

various enactments concerning the management and regulation of joint stock companies in

India. Some of these enactments include Companies Act, 1956, Industries (Development

and Regulation) Act, 1951, Foreign Exchange Regulation Act, 1973, Securities Contracts

(Regulation) Act, 1956. The Foreign Trade (Development and Regulation) Act, 1992,

Income-Tax Act, 1961.

(I) The companies Act, 1956 contains specific provisions that stipulate the powers of

borrowings vested with the Board of Directors of the company. For instance, section 292

and 293 of the Act outline the exercise of powers to borrow from banks and financial

institutions. Similarly, sections 17 and 31 of the said Act give an account of restrictive

covenants pertaining to powers of directors to borrow to be contained in the Memorandum

of Association and Articles of Association of a company. The provisions mainly outline

the procedures such as passing of resolutions etc. to be followed for raising loans from

term lending agencies.

2 Compliance is also required under the provisions of the Industries

(Development and Regulation) Act, 1951.

The Act contains provisions of control and regulation for the setting up of new industries

and also expansion of existing industries. The provisions mainly relate to registration and

revocation of registration of industrial undertaking, licensing of new industrial undertakings,

license and revocation of license for producing or manufacturing new articles, licensing of


115

industrial undertakings in special cases, etc. Besides, provisions also outline the powers of

the Central Government to specify the requirements which shall be complied with by smallscale

industrial undertakings, power of the Central Government to exempt any industrial

undertaking in special cases, etc.

3 Compliance is called for as regards provisions contained in the Foreign

Exchange Management Act (FEMA).

The provisions are applicable in the case of non-resident Indians being associated in any

manner with the organization or management or operations of the client company or where

foreign capital in any manner with the organization or management or operations of the

client company or where foreign capital in any manner (i.e. By way of foreign collaborator‘s

contribution to equity capital, loans etc.) is being utilized or foreign currency loans are

being raised from financial institutions or banks.

(IV) Provisions of the Securities Contracts (Regulation) Act, 1956 (SCRA) are

also required to be complied with by the borrowing unit before seeking financial assistance

from the term lending agency. Compliance is related to stipulations of enlistment of securities

of the company in recognized stock exchanges (although listing is not mandatory under the

said Act). Under Section 21 of the Act, Central Government is empowered to compel

any public limited company to enlist its securities with a recognized stock exchange.

(V) Compliance with the provisions of the FIDRA (Foreign Trade Development

and Regulation Act), 1992 are required compliance by the borrowing unit. This becomes

necessary where the client company envisages to procure raw material, machinery, plant

and equipments from overseas through imports under the import license granted by the

Central Government under Import and Export (Control) Act, 1947.

(VI) An important enactment in India that requires closer compliance by the

borrowing units is the Income-Tax Act, 1961.

The Act contains provisions that require furnishing of a tax clearance certificate from

assessing officer under section 230A of Income Tax Act before creation of security by

way of English mortgage in favor of lenders.

C. DOCUMENTATION AND CREATION OF SECURITY

An important function of a merchant banker is to create an adequate documentation of

security by working closely with the ‗lead financial institution,‘ so as to ensure quicker

disbursement of loan. The type of documents to be prepared and executed by the merchant

banker will be as per the requirements of the lead financial institution. Depending on the

loan type, the merchant banker executes bridge loan document or interim loan document.

The merchant banker provides the following details with regard to the security for the

loan:

1. First mortgage and charge of all immovable properties both present and future

of the borrower company in the form as may be indicated by lenders which is

equitable mortgage by deposit of title deeds.

2. First charge by way of hypothecation : (i) of all movables such as stocks of

raw material, semi-finished and finished goods, consumable stores and such offer

movables as may be agreed to by the lead institution for securing the borrowings

for working capital requirements in the ordinary course of the business, and (ii)

on specific items of machinery as permitted by the lender purchased and/or to be

purchased by the client company under the deferred payment facilities granted to


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the client company.

3. Security for bridge loan

4. Security for interim loan

5. Substantive security where the loan amount is being secured in terms of the

loan agreement by first charge on the company‘s immovable and movable assets,

present and future

6. Personal guarantee where the loan amount is being secured in terms of the loan

agreement by first charge on the company‘s immovable and movable assets,

present and future

7. Personal guarantee where the borrowing is being secured by irrevocable and

unconditional personal guarantee from its promoters/directors in favour of the

lending institutions.

D. PRE – DISBURSEMENT COMPLIANCE

This function is aimed at merchant bankers assisting the borrowing unit in the withdrawal

of the loan amount from the financial institution. This done with additional compliance of

formalities of provision of information and documentation. Some of the pre-disbursement

conditions that require compliance by the merchant banker are documentation. Some of

the pre-disbursement conditions that require compliance by the merchant banker are as

follows:

1. Completion of creation of security as stipulated in loan agreement

2. Completion of borrowing arrangements with other institutions and banks for raising

funds as per the financing plan

3. Non-existence of event of default in payment of principal sum of the loan interest,

arrears of interest, and in performance of other terms and conditions of the loan

4. Compliance of special conditions of sanction of loan

5. Review of progress as satisfactory

6. Subscription of share capital by promoters as stipulated in the loan agreement and

as stipulated in proposal of financing the project cost.

4.3 CREDIT RATING

Credit rating is a mechanism by which the reliability and viability of a credit instrument

is brought out. When a company borrows or when a businessman raises loan, the lenders

are interested in knowing the credit worthiness of the borrower not only in the present

condition but also in future. Hence, credit rating reveals the soundness of any credit

instruments issued by various business concerns for the purpose of financing their business,.

In credit rating, the investor is not only able to know the soundness of the credit instrument,

but be is also able to analyze between different credit instruments and he can make a trade

off between risk and return.

CREDIT RATING OF INDIVIDUALS, COMPANIES AND COUNTRIES

Credit rating is resorted to :

a) Companies

b) Individuals

c) Countries

a) RATING OF INDIVIDUALS : Individuals go for credit rating when they want to

borrow from recognized institutions. In India, we have Onida Individual Credit Rating

Agency (ONICRA) which gives credit rating for individuals.


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b) RATING OF COMPANIES: As per the guidelines of SEBI and RBI, companies

have to resort to credit rating when they :

(i) accept public deposits

(ii) issue credit instruments in domestic market

(iii) issue credit instruments in overseas market.

c) RATING OF COUNTRIES: Credit rating is resorted to by countries for borrowing

in international market or for attracting foreign investments or for raising funds from the

international institutions like IMF and IBRD.

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

Credit Rating Companies in India

Credit rating companies were started in India during the late 1980s. Credit Rating

Information Services of India Ltd (CRISIL) was started in 1988 as a subsidiary of ICICI.

Information and Credit Rating Services Ltd., (ICRA)was started in 1990, which is a

subsidiary of IDBI. In 993, Credit Analysis and Research Ltd. (CARE) was started.

8. The suffix of ―+‖ (plus) or ―-‖ (minus) signs are used with the rating symbols to

indicate the comparative position of the instrument within the group covered by

the symbol.

Types of Credit Rating

We have seen the various rating symbols for different categories of the debt instruments.

We can also classify credit rating as types of credit rating which are based on different

securities. These are :

1. Equity rating

2. Bond rating

3. Promissory note rating

Debt

Category


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Debt

instrument Rating symbols Remarks

CRISIL ICRA CARE

Long term

instrument

Medium

term

Instrument

Short term

instrument

Debentures

Bonds,

Preference

Fixed

Deposits

Commercial

Paper

AAA

*AA

*A

*BBB

*BB

*B

*C

D

FAAA

*FAA

*FA

*FB

*FC

FD

*P1

*P2

*P3

*P4

P5

LAAA

*LAA

*LA

*LBB

B

*LBB

*LB

*LC

LD


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MAA

A

*MAA

*MA

*MB

*MC

MD

*A1

*LAA

*LA

*LAA

*LA

CARE

AAA

*CARE

AA

*CARE A

*CARE B

*CARE

BB

*CARE B

*CARE C

CARE D

CARE

AAA

*CARE

AA

*CARE A

*CARE

BBB

*CARE

BB

*CARE B

CARE C

CARE D

*PR-1

*PR-2

*PR-3

*PR-4

PR-5

Highest safety

High safety

Adequate

safety

Moderate


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safety

Inadequate

safety

Risk prone

Substantial

risk

Default

Highest safety

High safety

Adequate

safety

Inadequate

safety

1. Do –

2. Do –

Risk prone

Default

High safety

Highest safety

Adequate

safety

Risk prone

Default

4. Commercial paper rating

5. Sovereign rating.

1. EQUITY RATING

When different companies are issuing shares, equity rating will enable the investor to

choose proper equity share on the basis of the credit rating. While judging the equity

rating, the past performance of the company, the earning per share and the turn-over of the

company will be taken into account. If a loss making company turns into a profit making

one, after wiping off its losses, its equity rating will go up.

At the same time, if there is a decline in the dividend rate of an existing concern,

compared to its previous years, its rating will get a beating.

2. BOND RATING

Bonds are issued both by Government as well as by private sector companies. In the

international market, rating of bonds will depends on the rate of interest offered and the

value of the currency it represents. If the bond is issued in terms of U.S. Dollar or Pound

Sterling, its value will be high and the rating will naturally be on the positive side. But the

bonds of under developed countries will have lesser credit rating due to high fluctuations in

their currency value.

Bonds are also issued in the domestic market by both State and Central governments.

Even the local governments, such as Corporation, such as Corporations and Boards also

issue bonds for raising long-term finance in India, government bonds are preferred to


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private bonds as there is a guarantee for repayment of the principal and interest amount.

3. PROMISSORY NOTE RATING

In order to raise short-term loans, promissory note are issued by different commercial

companies and depending upon their resources, these promissory notes will have credit

rating. But, the issue of promissory notes will have no backing and the person advancing

the resources against the promissory notes will undertake greater risks. Depending upon

the credit rating, ranging from P1 to P6, promissory notes are preferred as a short-dated

instrument. The unutilized resources lying with commercial banks may be invested in

promissory notes of a better credit rating so that within a short period, a reasonable ‗return‘

can be obtained on idle funds.

4. COMMERCIAL PAPERS

These are instruments issued by leading non-banking financial companies which can

be obtained by companies for raising short-term loans from commercial banks. On due

date, commercial banks will present these papers to the NBFC which has issued the

commercial paper and funds will be obtained along with interest. Later on, the NBFC will

collect the amount from the company which has utilized its commercial paper for raising its

short-term loans.

In order to enable the commercial banks to discount commercial papers, credit rating

is provided to the commercial papers which depends upon the standing of the non-banking

financial company NBFC) which is issuing the commercial paper.

5. SOVEREIGN RATING

When countries are issuing credit instruments in the international market such as Treasury

bills and Bonds, they will be rated according to the economic condition of the country.

Generally, the countries in the world are grouped under three categories, viz.,

(a) Countries which are politically and economically well developed.

(b) Countries which are politically stable but economically week.

(c) Countries which are politically and economically unstable or weak.

In the first category, we have all the developed countries like U.S.A., U.K., Japan,

etc., and their bonds will have high credit rating. In the second category we have countries

like India which have slightly lesser credit rating and in the third category we have some of

the African countries such as Rwanda, Kenya, Zulu, etc. The credit rating of the third

category of countries will certainly be lower.

In India, State Bank of India issued in the international market different credit

instruments such as India Resurgent Bonds and Millennium Deposits and they were

over subscribed owing to the reputation of SBI,. All the NRIs throughout the world, could

subscribe to these bonds and SBI could raise a substantial amount in terms of foreign

exchange.

I NTRODUCTION

A mutual fund is a professionally managed firm of collective investments that collects

money from many investors and puts it in stocks, bonds, short-term money market

instruments, and/or other securities. The fund manager, also known as portfolio manager,

invests and trades the fund‘s underlying securities, realizing capital gains or losses and

passing any proceeds to the individual investors.

LEARNING OBJECTIVES

After reading the unit, you will understand:


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• Mutual funds

o objectives

o types of mutual funds

o latest developments

MUTUAL FUNDS

a. A mutual fund is a fund exchanged between the public and the capital market

through a corporate body.

b. The Securities and Exchange Board of India Regulations, 1993 defines a

mutual fund as ‗a fund established in the form of a trust by a sponsor, to raise

monies by the trustees through the sale of units to the public, under one or more

schemes, for investing in securities in accordance with these regulations‘.

c. Kamm, J.O. defines an open end investment company or Mutual fund company in

U.S.A as ‗an organization formed for the investment of funds obtained from

individuals and institutional investors who in exchange for the funds receive shares

which can be redeemed at any time at their underlying asset values‘.

d According to Weston j. Fred and Brighmam, Eugene, F. Unit Trusts in U.K. are ‗

Corporations w

Thus mutual fund is nothing but a form of collective investment. It is formed by the

coming together of a number of investors who transfer their surplus funds to a professionally

qualified organization to manage it.

To get the surplus funds from investors, the fund adopts a simple technique. Each

fund is divided in to a small fraction called ―units‘ of equal value. Each investor is allocated

units in proportion to the size of his investment.

Thus, every investor, whether big or small, will have a stake in the fund and can enjoy

the wide portfolio of the investment held by the fund. Hence, mutual funds enable millions

of small and large investors to participate in and derive the benefit of the capital market

growth. It has emerged as a popular vehicle of creation of wealth due to high return, lower

cost and diversified risk.

Objectives

Mutual funds came into existence in order to attract the savings of lower and middle

income group people and give them the benefit of corporate profits by distributing attractive

dividends at the end of the year. Mutual funds cater the different types of customers who

are interested in

(a) fixed income or

(b) a higher return for investment or

(c) who is growth oriented.

Mutual Funds Set Up In India

The structure of mutual fund operations in India envisages a three tier establishment

namely:

(II) A Sponsor institution to promote the fund

(III)A team of Trustees to oversee the operations and to provide checks for the efficient,

profitable and transparent operations of the fund and

(IV)An Asset Management Company to actually deal with the funds.

Sponsoring Institution

The Company which sets up the Mutual Fund is called the ‗sponsor‘. The SEBI has


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laid down certain criteria to be met by the sponsor. These criteria mainly deal with adequate

experience, good past tract record, net worth etc.

Trustees

Trustees are people with long experience and good integrity in their respective fields.

They carry the crucial responsibility of safeguarding the interest of investors. For this purpose,

they monitor the operations of the different schemes. They have wide ranging powers and

they can even dismiss Asset Management Companies with the approval of the SEBI.

Asset Management Company (AMC)

The AMC actually manages the funds of the various schemes. The AMC employs a

large number of professionals to make investments, carry out research and to do agent and

investor servicing. Infact, the success of any Mutual Fund depends upon the efficiency of

this AMC. The AMC submits a quarterly report on the functioning of the mutual fund to the

trustees who will guide and control the AMC.

Types of Mutual Funds

1 CLOSE ENDED FUNDS

Close ended funds are funds which have definite period or target amount . Once the

period is over and or the target is reached, the door is closed for the investors. They

cannot purchase any more units. These units are publicly traded through stock exchange

and generally, there is no repurchase facility by the fund. The main objective of this fund is

capital appreciation. Thus after the expiry of the fixed period, the entire corpus is disinvested

and the proceeds are distributed to the various unit holders in proportion to their holding.

Thus the fund ceases to be a fund, after the final distribution. E.g. UTI Master Share,

1986.

2 OPEN ENDED FUNDS

Open ended funds are those which have no fixed maturity periods. Open ended

scheme consists of mutual funds which sell the units to the public. These mutual funds can

also repurchase the units. Initial Public Offer (IPO) is open for a period of 30 days and

then reopens as an open-ended scheme after a period not exceeding 30 days from the

date of closure of the IPO. Investors can buy or repurchase units at net asset value or net

value related prices, as decided by the mutual fund. Example: Unit Trust of India‘s Growth

sector funds.

MUTUAL FUND

On the basis of execution

and operation On the basis of yield and investment

Close ended Open ended

Income fund Growth fund Balance specialized Money Taxation

Fund Fund Market Fund Fund

Classification of Mutual Funds

ON THE BASIS OF YIELD AND INVESTMENT

1. INCOME FUND

Income funds are those which generate regular income to the members on a periodical

basis. It concentrates more on the distribution of regular income and it also sees that the

average return is higher than that of the income from bank deposits.


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

b. The main objective is to declare regular dividends and not capital appreciation.

c. The investment pattern is towards high and fixed income yielding securities

d. It is concerned with short run gains only.

2. GROWTH FUND

Growth are those which concentrate mainly on long term gains i.e., capital appreciation.

Hence they are termed as “Nest Eggs” investments.

a. It aims at meeting the investors‘ need for capital appreciation.

b. The investor‘s strategy conforms to investing the funds on equities with high growth

potential.

c. The Investment tries to get capital appreciation by taking much risks and investing

on risk bearing equities and high growth equity shares.

d. The fund declares dividends.

e. It is best suited to salaried and business people.

3. BALANCED FUND

It is a balance between income and growth fund. This is called as ―Income –cumgrowth‖.

It aims at distributing regular income as well as capital appreciation. Thus the

investments are made in high growth equity shares and also the fixed income earning securities.

4. SPECIALISED FUNDS

These are special funds to meet specific needs of specific categories of people like

pensioners, widows etc.

5. MONEY MARKET MUTUAL FUNDS

The funds are invested in money market instruments. These funds basically have all

the features of open ended funds but they invest in highly liquid and safe securities like

commercial paper, 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.

6. TAXATION FUNDS

It is a fund which offers tax rebated to the investors either in the domestic or foreign

capital market. It is suitable to salaried people who want to enjoy tax rebates particularly

during the month of February and March. An investor is entitled to get 20% rebated in

Income Tax for investments made under this fund subject to a maximum investment of

Rs.10,000 per annum. E.g. Tax Saving Magnum of SBI Capital Market Limited.

7. OTHER CLASSIFICATION

i. Leveraged Funds: Also called as borrowed funds as the are used primarily to

increase the size of the value of portfolio of a mutual funds. When the value increases,

the earning capacity of the fund also increases.

ii. Dual Funds: It is a fund which gives a single investment opportunity for 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.


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iii. Index Fund: It is a fund based the some broad market index. This is done by

holding securities in the same proportion as the index itself. The value of these

index linked funds will automatically go up whenever the market index goes up

and vice versa.

iv. Bond Funds: The funds have portfolios consisting mainly of fixed income securities

like bonds. The main thrust is income rather than capital gains.

v. Aggressive Growth Funds: These funds are capital gains oriented and thus the

thrust area of these funds is capital gains. Hence, these funds are generally invested

in speculative stocks They may also use specialized investment techniques like

short term trading, option writing etc.,

vi. Off shore Mutual Funds: These funds are meant for non resident 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.

History of Mutual Funds In India

The Mutual fund concept in India was launched by Unit Trust of India (UTI) in the

year 1964 by a special Act of Parliament. The first scheme offered was the ―US-64‖. A

host of other fund schemes were subsequently introduced by the UTI. The basic objective

behind the setting up of the Trust was to mobilize small savings and to allow channeling of

those savings into productive sectors of the economy, so as to accelerate the industrial and

economic development of the country.

In 1987, the Government of India permitted commercial banks in the public sector to

set up subsidiaries operating as trusts to perform the functions of mutual funds by amending

the Banking Regulation Act. SBI set its first mutual fund, followed by Canara Bank. Later

many large financial institutions under government control also came out with mutual funds

subsidiaries. Recently, with the beginning of the economic reforms and liberalization of the

economy, based on the recommendations of the Abid Hussain committee, foreign companies

were also permitted to start mutual funds in India. The government introduced a number of

regulatory measures, through various agencies such as the SEBI, to the benefit the investors,

esp. the small investors.

Business Valuation

The basic valuation methods of holdings by the Mutual funds should be done by

keeping in view the following elements:

• For listed securities – take last sale price quoted in the stock exchange dealing

list

• for OTCEI securities – take bid/ask price as may be relevant on case to case

basis

• Trustees may determine market value at a reasonable price as per current market

at which the investors would buy at fairly reasonable rate.

• For short term investments the basis of valuation should be the amortized

cost.


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NET ASSETS VALUE

It is a parameter used to measure the operational efficiency of mutual funds. The

intrinsic value of a unit under a particular scheme is referred to as the NAV of the scheme.

The value gives an idea of the amount that may be obtained by the unit holder on its sale to

the mutual fund company.

The main components of Net assets value are

• Investment income and expenses

• Capital stocks and distribution

INVESTMENT INCOME AND EXPENSES:

Investment income covers the following major items:

1. Dividend income from accounting point of view

2. Capital changes i.e., resulting from return on capital, stock dividends, bonus shares,

rights shares and stock split, mergers, litigation settlement, tax treatment.

3. Interest income from fixed income investment

4. Costs of carrying on Mutual fund business as highlighted in the Enclosure I

CAPITAL STOCK AND DISTRIBUTION

- The capital stock and distribution involving share purchases and sales or redemptions.

CALCULATION OF NAV

The NAV calculation should include the following elements for open end funds.

1. Investment at value recorded on first business day after trade transaction.

2. Changes in outstanding shares on first business day after trade transaction.

3. Dividend and distribution to shareholder ex-date.

4. Expenses (estimated and accrued to date of calculation)

5. Dividends receipts from investments ex-date

6. Interest and other income (estimated and accrued to date of calculation)

7. Other assets /organization costs.

Formula for calculating NAV is given below:

NAV = X- L divided by Y or Net assets / No. of shares outstanding

Where , X= market value of investments and other assets.

L= Liabilities

Y = fund shares outstanding

E.g. ABC Mutual fund has in its investment portfolio following shares:

1. DEF Industries Ltd., 100 shares of Rs. 10 each at market value of

Rs. 20 each.

2. OPQ Industries Ltd., 200 shares of Rs.10 each at market value of

Rs.50 each.

3. Other Assets Rs.100

4. Accrued expenses Rs.100

Mutual fund has 100 investors who have contributed to Mutual funds Rs.100 each at

the initial price of Rs.10 per share. In other words, there are 1000 shares outstanding (100

x 10)

We have:

Market value of investments=

100 shares x 20 2,000

200 shares x 50 10,000


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————

12,000

Other assets 100

————

X= 12,100

L= (-) 100

————

Net assets 12,000

Y= 1,000

NAV = X – L / Y 12,000/1000 = Rs.12

NAV per share = Rs.12

Appreciation (A) in value is calculated as under:

A= Current Market Value 12,000

Less Original cost of securities Rs.1,000

Rs.2,000 3,000

—————

Unrealized appreciation Rs.9,000

—————

However has come out with the recommendations of the L.C. Gupta, a committee

appointed by it to review the accounting polices, NAV and pricing of Mutual Funds.

Q.5.3.g. How are mutual funds managed in India?

Q.5.3.h. What are the causes for the slow growth of mutual funds in India?: What are

your suggestions to overcome this?

efforts in investor awareness programmes which are the need of the day.

UNIT IV

FUND BASED FINANCIAL SERVICES

INTRODUCTION:

Leasing is not a concept which emerged in the modern days. Even in the olden days

we had leasing in the form of Charter Party agreement, when in an entire ship is taken on

lease either for a particular period or for a particular voyage. Similarly we had agricultural

lands are given on lease for a specified period.

FUND BASED FINANCIAL SERVICES

Some of the fund based financial services are leasing, hire purchase agreements.


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These are discussed below in detail in the pages to come.

Leasing:

It is a contract by which one party conveys land, property, services etc., to

another for a specified time.

Definitions :

The Transfer of Property Act, 1882 (as amended in 1952) describes Lease as follows

“A Lease of the movable property is a transfer of a right to enjoy such property,

made for a certain time, express of implied, or in perpetuity, inconsideration of a

price paid or promised or of money, a share of crops, service or any other things of

value, to be rendered periodically or on specified occasions to the transferor by

the transferee, who accepts the transfer on such terms.”

• The transferor is called the ‗lessor‘

• The transferee is called the ‗lessee‘

• The price is called the ‗premium‘

• The money, share, service or other thing to be rendered is called the ‗rent‘.

Definition : Section 105 of the above Act defines a lease as follows :

“A Lease is a transfer of a right to enjoy the property. The consideration

may be a price or a rent. The rent may be either money, or share of crops, service

of anything of value, to be rendered periodically by the transferee to the

transferor.”

Basic Concepts In Leasing

Broker

An agent who brings two parties together, enabling them to enter into a contract to

which he is not a principal. His remuneration consists of a brokerage, which is usually

calculated as a percentage of the sum involved in the contract

Deposit

1. A sum of money paid by a buyer as part of the sale price of something in order to

reserve it. Depending on the terms agreed, the deposit may or may not be returned

if the sale is not completed.

2. A sum of money left with an organization, such as a bank, for safekeeping or to

earn interest or with a broker, dealer, etc., as a security to cover any trading losses

incurred.

3. A sum of money paid as the first installment on a hire-purchase agreement. It is

usually paid when the buyer takes possession of the goods.

Depreciation

1. Depreciation is principally a means of allocating the cost of an asset over its useful

life. It is an amount charged to the profit and loss account of an organization to represent

the wearing out or diminution in value of an asset. The amount charged is normally based

on a percentage of the value of the asset as shown in the books.

Finance Broker

A broker who arranges finance.

Hire Purchase

System of purchase by paying in installments.

Interest

It is the charge made for borrowing a sum of money. The rate of interest is the charge


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made, expressed as a percentage of the total sum borrowed for a specific stated period

of time.

Lease Broker

Any broker who arranges a lease between a lender and a lessee.

Lease Purchases

It is a type of leasing where, at the end of the lease period the goods become the

lessee‘s property.

Lender

The person or institution, that grants a loan.

Operating Lease

Essentially long term rent, not a capital expense transaction.

Refinancing

The process of repaying some or all of the loan capital of a firm by obtaining fresh

loans, usually at a lower rate of interest.

Residual Value

The expected selling price of an asset at the end of its useful life.

Term :

A specified period of time.

Evolution of Leasing

The concept and practice of leasing is not an innovation of the late 20th century.

There are historical evidences to show that the practice of leasing was found even five

centuries earlier. Such leases were for leasing land, agricultural tools, animals and ships, as

documented in the Sumerian and Greek civilizations.

These operators found leasing a viable alternative for enhanced operations as they

were desperately short of their own funds. They could not also rely upon conventional

sources of funds.

The unparalleled success of Rail Road companies highlighted the importance of

equipment leasing as a tool for promoting capital formation.

In the post-Second World War era, European rail companies also took to equipment

leasing on a large scale. In the early sixties, this practice of equipment leasing has gained

popularity and it is believed that approximately 25% of all business equipments in terms of

value are leased. The later half of 19th century bore witness to this practice as the Rail Road

operators in the USA leased Rail Cars and Locomotives. The practice of Equipment Leasing is of

recent origin in India. Equipment leasing took roots only in the eighties. Equipment leasing

includes, leasing of plant and machinery, office equipments, automobiles, ships and aircrafts.

Types of Leasing

CLASSIFICATION OF LEASE

Lease may be classified as

1. Finance Lease and Operating Lease.

2. Sale and Lease Back and Direct Lease.

3. Single Investor Lease and Leveraged Lease.

4. Domestic Lease and International Lease.

FINANCE LEASE

• A lease is defined as a finance lease if it transfers a substantial part of the risks and

rewards associated with ownership from the lessor to the lessee.


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Thus the finance lease is characterized by whether :

a) The lease transfers ownership of the asset to the lessee by the end of the lease

term; or

b) The lessee has the option to purchase the asset at a price within is expected to be

sufficiently lower than the Fair Market Value (FMV) at the date, the option becomes

exercisable that, at the inception of the lease it is reasonably certain that the option

will be exercised; or

c) The lease term is for a major part of the useful life of the asset. The title may or

may not be transferred eventually; or

d) The Present Value of the minimum lease payments is greater than or substantially

equal to the Fair Market Value (FMV) of the asset at the inception of the lease.

The title may or may not be transferred eventually.

• These are largely based on the criteria laid down by the Financial Accounting Standards

Board (FASB) of the USA.

If the lease term exceeds 75% of the useful life of the asset or if the present

value of the minimum lease payments exceeds 90% of the FMV of the asset, at the

inception of the lease, the lease will be classified as „Financial Lease‟.

• To determine the present value, the discount rate to be used by the lessor will be

the rate of interest implicit in the lease and the discount rate to be used by the

lessee will be its incremental borrowing rate. In the Indian context, criteria (a) and

(b) above are inapplicable, because, inclusion of any one of these conditions in the

lease agreement will make the agreement being treated as a Hire Purchase

Agreement. Hence a lease can be classified as a finance lease only if any one of

criteria (c) and (d) are satisfied.

• The lessee is responsible for repair, maintenance and insurance of the asset.

• The lessee also undertakes an extreme obligation to pay rental regardless of the

condition or the suitability of the asset.

• A finance lease, which prevails over the entire useful life of the equipment, is called

a ‗full payout lease‘.

Illustration : ABC Company has leased equipments costing Rs.400 lakhs with the

following terms :

Lease term : 5 years

Lease rents : Rs.300/1,000 p.a.

The incremental borrowing rate for ABC Co., is 18% p.a. is this transaction a finance

lease ?

Consider the useful life of the equipments to be—

(a) 6 years, and (b) 10 years.

Solution :

a) (1) Lease term : 5 years

(2) Estimated life of the equipment : 6 years

As percentage of (1) & (2) : 83.3

As a leased term exceeds 75% of the estimated useful life of the equipments, this

transaction is classified as finance lease.

b) (1) Lease term : 5 years

(2) Estimated useful life : 10 years


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1) As a percentage of (1) & (2) : 50

The third criterion specified by the FASB for classifying a lease, as finance lease

Is not fulfilled.

2) Present value of minimum lease payments

= (400 x 0.3) x PVIFA (18.5)

= 120 X 3.127

= Rs.375.24 lakhs.

3) FMV at the time of inception = Rs.400 lakhs

4) As a percentage of (2) & (3) = 94

The fourth criterion given by FASB is fulfilled and hence the transaction is a finance

lease

OPERATING LEASE :

The International Accounting Standard Committee defines operating lease as

“any lease other than a finance lease”.

An operating lease has the following characteristics :

1. The lease term is significantly less than the economic life of the equipment.

2. The lessee enjoys the right to terminate the lease at short notice without any significant

penalty.

3. The lessor usually provides the operating know-how, supplies the related services

and undertakes the responsibility of insuring and maintaining the equipment, in

which case the operating lease is called a ‗Wet Lease‘.

4. An operating lease where the lessee bears the cost of insuring and maintaining the

leased equipment is called a ‗Dry Lease‘.

5. An operating lease does not shift the equipment-related, business and technological

risks from the lessor to lessee.

The lessor structuring an operating lease transaction has to depend upon multiple

lease or on the realization of substantial resale value (on the expiry of first lease), to recover

the instrument cost plus reasonable rate of return thereon.

To deal in operating leasing one requires an in-depth knowledge of the equipments

and the resale market. In our country, as the resale market for most of the used capital

equipments is not active, operating leases are not very popular.

SALE AND LEASE BACK

In the case of sale and lease back, the owner of an equipment sells it to a leasing

company, which, in turn, lease it back to the seller of the equipment, who then becomes the

lessee.

The ‗Lease Back‘ arrangement in this transaction can be in the form of either a finance

lease or an operating lease e.g., the sale and lease back of safe deposit vaults practiced by

commercial banks.

The banks sell the safe deposit vaults in its custody to a leasing company at a market

price, which is substantially higher than the book value.

The leasing company then offers these lockers on a long-term lease to the bank.

This sale and lease back‘ arrangement is an easily available source of funds for the

expansion and diversification programmes of a firm where high-cost short-term debt has

been used for capital investments in the past, the sale and lease back gives an opportunity

to substitute the short-term debt by medium-term finance (provided the lease back


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arrangement is a finance lease).

For the leasing company offering sale and lease back arrangement, it is difficult to

establish a fair market value of the asset being acquired as the resale markets are virtually

absent.

DIRECT LEASE

It is defined as any lease, which is not a ‗sale and lease back transaction‘.

A direct lease can be of two types :

(i) Bipartite lease, and

(ii) Tripartite Lease.

BIPARTITE LEASE

There are two parties to the transaction,

1. Equipment supplier cum lessor

2. The lessee.

It functions like an operating lease with built-in facilities like up gradation of the

equipments called as ‗Upgrade Lease‟.

The lessor undertakes to maintain the equipment and even replaces the equipment

that is in need of major repair with the similar functioning equipment called as ―Swap

Lease”.

TRIPARTITE LEASE

It involves three different parties

1. The equipment supplier

2. The lessor

3. The lessee.

Most of the equipment lease transactions fall under this category. In this form of lease

1. The equipment supplier may provide a reference about the customer to the leasing

company.

2. The equipment supplier can negotiate the terms of the lease with the customer and

complete the necessary paper work on behalf of the leasing company.

3. The supplier can take the lease on his own account and discount the lease receivables

with the designated leasing company. So the leasing company owns the equipment

and obtains an assignment of the lease rentals.

This form of lease has recourse to the supplier in case of default by the lessee, either

to buy back the equipment from the lessor on default or providing a guarantee on behalf of

lessee.

SINGLE INVESTOR LEASE

The entire investment is funded by the lessor by arriving at a judicious mix of debt

and equity. The debt funds raised by the leasing company are without recourse to the

lessee, i.e., in the event of the default by the leasing company on its debt-servicing obligation,

the lender cannot demand payment from the lessee.

LEVERAGED LEASE

It is a lease which is leveraged through a trustee. The leasing company invests in

equipments by borrowing large investments with full recourse to the lessee without any

recourse to it.

The lender (loan participant) gets an assignment of the lease and enjoys benefit of the

rentals to be paid by the lessee and a first mortgage on the leased assets. This transaction


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is routed through the trustee to take care of the lender and the lessee.

Leveraged Lease Process

LOAN PARTICIPANT : A leveraged lease entitles the lessor to avail the shields on

depreciation, other capital allowances on the entire investment cost, though, a substantial

part of the investment cost is funded with non-recourse debt.

So, the return on equity (profit after tax divided by net worth) tends to be high. For,

the lessee, the rate of interest is less than that of a straight loan as the lessor extends the tax

benefits to the lessee in the form of lower rental payments. This lease is usually preferred

for leasing investment-intensive assets like aircraft, ships, etc.

Lessor

Trustee Leases the Lessee

Equipment to

Loan

Participant

DOMESTIC LEASE AND INTERNATIONAL LEASE

In domestic lease, all the parties to the lease transaction i.e., the equipment supplier,

lessor and lessee are domiciled in the same country.

An international lease transaction presupposes :

1. An understanding of the political and economic climate; and

2. A knowledge about the tax and other regulatory framework governing these

transactions in the respective countries, the payments to be effected in different

currencies and hence knowledge about exchange rate variation.

As a result international lease is exposed to country risk and currency risk.

Regulatory Authority

No specific Act or Authority regulates leasing in India. Some of the Acts which indirectly

governs are :

• Income Tax Act, 1962

• Indian Contract Act, 1872

• Indian Stamp Act, 1899

• Manufacturing and Other Companies (Auditor‘s Report) Order, 1988

• Motor vehicles Act, 1988

• Recovery of Debts due to Bank and Financial Institutions Act, 1993

• Registration Act, 1908

• Reserve Bank of India Act, 1934

• Sale of Goods Act, 1930

• Sick Industrial Companies (Special Provisions) Act, 1985

• Transfer of Property Act, 1882

• Companies Act, 1956

• Consumer Protection Act, 1986

• Easements Act, 1882

• Foreign Exchange Management Act, 2000.

• Hire Purchase Act, 1972

Reserve Bank of India‟s (RBI) Supervision of NBFCs

The RBI has also proposed the following measures to track the performance of

NBFCs. NBFCs that do not conform to the requirements may find their registrations


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cancelled on 5 February 2003, the RBI has said that NBFCs not having a minimum Net

Owned Fund (NOF) of Rs.25 lakhs as on 9 January 2003, would not be allowed to

continue with their business.

Off Site Monitoring

Monitoring of large NBFCs with asset bases exceeding US $ 23 million must furnish

three years of operations data in the annual returns.

On Site Inspection

Periodic inspection of NBFCs are conducted especially those suspected of unhealthy

financial positions or non-compliance of prudential requirements.

External Audit

External auditors must certify important returns of NBFCs, Certified Public Accountant

(CPA) firms are engaged to conduct special examinations of certain NBFCs, which are

suspected of poor financial strength or violations of regulations. Reports prepared by the

CPA firms on NBFCs‘ operations are scrutinized further by the RBI‘s Department of

Supervision.

Lease Market In India

Lease market in India may be in the form

a. Formal market

b. Informal market

The formal players in the market are the financial institutions, commercial banks,

foreign financial institutions, manufacturers and non-banking financial companies (NBFCs).

Individuals and families handle leasing in the informal market.

Market Size

The market size of the leased asset base in India‘s organized sector is estimated at

3% to 4% of the total gross fixed capital formation. The specific reason for slow growth of

leasing finance in India is due to

• Depreciation - high rate of depreciation allowed in India.

• Tax Exemption - the hire purchase system has an edge over leasing with respect

to tax exemption in India from the point of lessor and lessee.

• Time Factor - Financial institutions make loans with favorable terms to companies

to assist them in establishing themselves in the market. The financial institutions

have a low cost of capital and can offer cheap loans. It is a time-consuming

process. Only few companies prefer leasing to avoid time-consuming process of

availing loans from financial institutions.

Slow Down

The total base of leased assets (excluding real estate) in India in 1997-98 the formal

sector was estimated at approximately US $ 37.0 billion. This figure represents 7.6 per

cent nominal growth from the 1996-97 level of US $ 34.0 billion. The latter figure was up

approximately 20 per cent from US $ 28.5 billion in 1995-96. The slow down is due to

three reasons :

1. The slow down in the market since 1996. Clients began defaulting on payments.

Consequently, a number of lease financing companies faced a severe asset-liability

mismatch. That led to a repayment crises and bankruptcy. However, even today,

there are over 38,000 estimated players in the market.

2. Since 1996, most existing leasing companies have become more conservative in


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their lending practices following the collapse of several leasing and hire-purchase

finance companies.

The Players

The market shares for the various players in the leasing market in India in 1996-97

appear in the table.

Market Shares of Players in the Leasing Market, 1996-97

Players In Leasing

Financial Institutions (FIs)

FIs are term lending institutions. There are over 10 such institutions handling project

finance on an all-India basis and over 20 State-level institutions. While FIs have over 30

per cent of the total lease market, it is not their main line of business.

Commercial Banks

State Bank of India, India‘s largest commercial bank, entered the market in 1997.

This has altered market dynamics considerably because State Bank of India has a very

large deposit base from savings accounts and deposit accounts, leading to the lowest cost

of capital amongst all players.

Market Player Category Share


Scheduled Commercial Banks

Non-banking financial Institutions

Foreign Institutional Investors

Others

30 per cent

10 per cent

52 per cent

6 per cent

2 per cent

Foreign banks

The role of foreign banks are very limited in the leasing market. Few foreign banks

such as ABN-AMRO and ANZ Grind lays, have organized aircraft leasing for private

airlines.

Citicorp Securities & investment, the financial services arm of Citibank has leased

assets worth US $ 6.7 million in 1996-97.

Non-banking Finance Companies (NBFCs)

All those Indian finance companies that do not fall into any of the above categories

are called as NBFCs. NBFCs has a market share of over 50 per cent of the leasing

market. On the other hand, 70 per cent of NBFCs‘ business originates with leasing and

hire-purchase activities.

In 1998, Anagram Finance and ITC Classic merged with the Industrial Credit and

Investment Corporation of India (ICICI), a leading all-India FI. In addition, Twenty-First

Century Finance merged with Centurion Bank. Although all of the companies recorded

profits in 1996-97, fears of a harder recovery and squeezed margins led them to the

decision to exit the NBFC segment of the market.

Foreign Institutional Investors (FIls)

There are no legislative barriers that prevent FIIs from entering the leasing market,


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the only FIIs with measurable involvement in the market are the U.S. company GE Capital

and the Japanese company Orix Corporation.

Hire Purchase

• It is the purchase of goods on hire

• The buyer makes payment for goods on a monthly installment basis and at

the same time is allowed to be used by the buyer

• The buyer becomes the owner of the goods only on the payment of the last

installment.

• Till such time, the amount paid by the buyer is treated as hiring charges.

• If the buyer fails to pay any installment, the goods will be seized for non

payment of the installment amount.

According to the Hire Purchase Act of 1972, the term ‗hire purchase‘ is defined as,

an agreement under which goods are let on hire and under which the hirer has an option to

purchase them in accordance with the terms of the agreement, and includes an agreement

under which

a. Possession of goods is delivered by the owner thereof to a person on the condition

that such person pays the agreed amount in periodic payments

b. The property of the goods is to pass to such a person on the payment of the last of

such installment

c. Such a person has a right to terminate the agreement any time before the property

so passes‖.

All Hire purchase finance companies are controlled by the Hire Purchase Act, 1972.

A Hire purchase transaction has two elements, Bailment which is governed by the Indian

Contract Act, 1872 and Sale under the Sale of Goods Act, 1930.

HIRE PURCHASE AGREEMENT

A Hire Purchase Agreement is an agreement between the seller and the buyer, where

the ownership of goods does not pass to the buyer until he pays the last installment. There

are two parties to the hire purchase agreement.

The hire vendor, who is the seller and

The other is the hire purchaser, the buyer.

The purchaser has to make a down payment of 20 to 25% of the cost and the remaining

amount has to be paid in equal monthly installments. In the case of a Deposit linked plan,

the hire purchaser has to invest a fixed amount as fixed deposits in the finance company

which is returned together with interest after the payment of the last installment.

PARTIES TO THE HIRE PURCHASE CONTRACT

There are two parties in a hire purchase contract

1. The intending seller

2. The intending purchaser or the hirer.

Tripartite agreement

1. Seller

2. Financier

3. Hirer/Purchaser

Difference Between Hire Purchase And Leasing:

Financial Evaluation

It is an evaluation by the hirer of the desirability for lease and hire purchase. The hirer


137

makes decision based on the Present Value of Net Cash Outflow. The decision is considered

favourable when the PV of Net Cash Outflow under Hire Purchase is less than the PV of

Net cash Outflow under leasing. Following are the steps involved.

Step 1 Calculate annual interest amount

Step 2 Find the principal amount outstanding at the beginning of the each year

= Total outstanding principal – principal paid in the previous year.

Step 3 Find principal paid in the previous year

= Annual installment amount – Annual Interest

Step 4 Find Annual ITS

= Annual Interest x Tax rate

Step 5 Find Annual Depreciation

Step 6 Find Annual DTS = Annual depreciation x Tax rate

Step 7 Find Total TS

= Step 4 + Step 6

Step 8 Find Annual installment amount

= Total HP amount + (HP amount x flat rate of interest) / No. of HP years

Step 9 Find PV of salvage value of assets = SV x PVF

Step 10 Find Net Cash Outflow of HP

= Step 8 – Step 7

HIRE PURCHASE LEASING

1. It is a Tripartite agreement,

involving the seller, finance company

and the purchaser/hirer

2. Depreciation is claimed by the

purchaser/hirer

3. The agreement is entered for the

transfer of ownership after a fixed

period.

1. It is a bipartite agreement involving

lessor and lessee.

2. Depreciation is claimed by the lessor in

the lease agreement.

3. In finance lease the ownership will get

transferred. While in operating lease, the

ownership is not transferred.

Step 11 Find PV of net cash outflow of HP at the appropriate discount rate

Step 12 Find Total PV net cash outflow of HP

= Step 11 – Step 9

Step 13 Find Tax shield on annual ease rentals

= Annual Lease rental x Tax rate

Step 14 Find Net cash outflow of Leasing

= Annual lease rental – Step 13

Step 15 Find Total PV of net cash outflow of Leasing at the approp. discount rate

= Net cash outflow of Leasing x PVAF

Step 16 Make a decision : HP is desirable if total PV of net cash flow of HP is


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Less than that of leasing

1.3.11 Tax Implication

Tax Benefits in Hire purchase transaction

A hire purchaser can claim the benefits by claming depreciation on the good which

are use in his business. Such tax benefits are applicable to sole trader, partnership firms, as

well as Joint Hindu firms. Depreciation can be claimed on the entire purchase price.

Income Tax

Deductions could be made on account of interest charged e.g. In the purchase of

house on hire purchase basis, the initial payment of interest charges will be totally waived

form income tax as per the new regulations. Even the principal amount is entitled for 20%

deduction under Section 80( C) of the Income Tax Act.

Sales Tax

Sales Tax is levied on the total value of the goods and not on the installment payment.

The respective State is benefited when there are more sales under hire purchase transactions

as they get more revenue.

HP Transactions

Benefits in Income Tax Benefits in Sales Tax Benefits in interest Tax

Interest Tax

It is the tax payable by the Hire Purchase Companies on Interest under the Interest

Tax Act 1974. However the tax is treated as a tax deductible expense for the purpose of

computing taxable income under the Income Tax Act.

UNIT V

OTHER FUND BASED FINANCIAL SERVICES

INTRODUCTION:

A consumer may obtain loan for the purchase of a vehicle, refrigerator, washing

machines, etc., when a bank or any other financial agency provides loan to a consumer for

the purchase of consumer durables it is called as consumer credit.

The consumer with his income is not in a position to repay the full value of consumer

durables but would like to take advantage of his future earning and purchase them through

installment payment to his creditor. By doing so, he not only enjoys the product, but he is

also in a position to repay the value of the product. Hence, through consumer credit banks

provide loans to enable the consumer to purchase valuable goods.

LEARNING OBJECTIVES

Once you finish this unit, you should be able to understand:

Consumer Finance and its transactions

Nature of Consumer Classes in India

Importance of Consumer Credit in India

CONSUMER CREDIT

It is a finance to consumers

For the purchase of semi durables and durables by paying a part of the total

price

Reavis Cox, an authority on economics of consumer finance defines consumer finance as

―Business procedure through which the consumers purchase semi-durables and durables


139

other than real estate, in order to obtain from them a series of payments extending over a

period of three months to five years, and obtain possession of them when only a fraction of

the total price has been paid.‖

According to E.R.A. Seligman, an authority on consumer finance, ―the term

consumer finance refers to a transfer of wealth, the payment of which is deferred in whole

or in part, to future, and is liquidated piecemeal or in successive fractions under a plan

agreed upon at the time of the transfer.‖

CHARACTERISTICS OF CONSUMER CREDIT

The nature of consumer credit may be

the transfer of wealth to consumers for purchase of semi durables or durables

except real estate

where the payment is deferred in whole or in part upon agreed terms

the agreed terms for repayment may be in the form of EMI‟s

Consumer Finance Transactions

The nature of consumer finance transactions may be

(a) Parties and structure of the transaction

The parties and the structure of the transaction may be either

(i) Bipartite

(ii) Tripartite.

A bipartite transaction involves two parties i.e.

1. dealer-cum-financer and

2. Borrower or customer.

A tripartite transaction involves three parties

1. The dealer

2. The financier

3. Borrower or customer

Transactions can either be structured in the form of hire purchase, conditional sale or

credit sale, but a majority of the tripartite consumer finance transactions are of the hire

purchase type.

(b) Payment for the transaction

The payment for specific transactions is divided into two categories:

(i) Down Payment Schemes

(ii) Deposit Linked Schemes

The down payment varies from initial payments ranging from 20%-25% of the value

of goods and financing is available for 75%-80% or as the case may be.

In a deposit-linked scheme, the down payment in the form initial deposit varying

from 15% and 25% of the total value of the asset. The financier pays the full amount to the

seller. Deposits carry a prescribed interest rate. Zero Deposit schemes are also available,

under which the Equated Monthly Installment (EMI) is higher than the EMI under normal

deposit schemes.

(c) Repayment Period

The repayment period ranges from 12-60 months. Finance companies notify the

customer indicating the amount of equated monthly installments to be paid through postdated

Cheques.

(d) Security


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The asset is secured through first charge on it for the credit provided. The borrower

is prohibited from disposing, pledging or hypothecating the asset during above said credit

period.

(e) Eligibility Criteria for Borrowers

There is no specific criteria for borrowers, all the borrowers in the form of individuals,

partnership firms, private and public limited companies are eligible to borrow.

Nature Of Consumer Classes In India

MIDDLE-INCOME CLASSES IN INDIA

• The middle income class refers to that class of people between the lower

income groups and higher income groups.

The need to study the middle income class in India was felt because the consumer

finance was absolutely designed to meet their financial requirements and in turn upgrade

their standard of living. Moreover the total population of middle class in India exceeds

more than 2/3 rd of the total population.

• India has registered a very impressive growth of its middle class – a class which

was virtually nonexistent in 1947 when India became a politically sovereign nation.

• At the start of 1999, the size of the middle class was unofficially estimated at 300

million people.

• The middle class comprises of three sub-classes: the upper-middle, middle-middle

and lower-middle classes.

• The upper-middle class has an estimated 40 million people.

• The middle-middle class has an estimated 150 million people,

• The lower middle class comprises an estimated 110 million people.

CONSUMING CLASS IN INDIA:

Source : National Council of Applied Economic Research (NCAER).

Estimated households by annual income

Structure of the Indian consumer market (1995-96)

1. Data on income distribution of households is insufficient in determining market size for

different consumer product in India.

a. This because of the lack of homogeneity of the consuming class and the varying

prices of a single product in different parts of India.

b. Consumption habits of households are therefore better determinants of consumer

market size than income distribution.

2. While determining market size for a consumer product, the structure of the consuming

class as seen in the above, can be both revealing as well as misleading depending on

the kind of product. For example, any specific consuming class would be fit to be a

market for consumer products like tea or soap, but a product such as vacuum cleaners

would find market largely only in the ―consumers‖ and ―rich‖ segments of the market

as defined in the above table .

3. Identifying a plausible market size for a consumer product is therefore a hazardous

task in a heterogeneous country like India. Yet, the marketer needs some data to

come as close to the real picture as possible. For this purpose, it can be cautiously

assumed that purchasing power is proportional to income despite variables such as

location, taste etc. Companies are therefore advised to plan their consumer product

marketing strategies on an area-by-area basis, rather than on the country as a whole.


141

Annual income (in Rupees) at

1994-95 prices

No. of households

(in million)

<25,000

25,001-50,000

50,001-77,000

77,001-106,000

>106,000

Total no. of households:

80.7

50.4

19.7

8.2

5.8

164.9 million

Number Annual income of households (in million)

(In Rupees) at 1994-95

Prices

Classification

Urban Rural total

<16,000

16,001-22,000

22,001-45,000

45,001-215,000

>215,000

Total no. of households

Destitute

Aspirants

Climbers

Consumers

The rich

5.3

7.1

16.8

16.6

0.8

46.6

27.7

36.9

37.3

15.9

0.4

118.2

33.0


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44.0

54.1

32.5

1.2

164.8

4. Income data is insufficient. Therefore, it must be supplemented by product-specific

information regarding its existing stock in the marketplace (in the case of consumer

durables) and existing rate of purchases.

5. It is also advisable to further refine the plausible market size by taking into account

details based on social, cultural and demographic factors.

6. Marketing a super-premium product such as a Rolex watch is relatively easy. Just go

for the income class above Rs.2,15,000 per annum (in 1995-96) as per Table above.

This class, the table shows, comprises 5.8 million households. But the problem lies in

the fact that the 5.8 million households are spread all over India.

7. The prime market for consumer products in India is aware of the cost-benefit or value

for money aspect. Their concept of value incorporates socio-cultural benefits in addition

to product utility. For example, many households in the ―consumers‖ class and the

―rich‖ class (as defined in Table ) may have two television sets, but both the sets may

not be top-of-the-line. Thus, while there may be demand for an additional TV set in

many households in the two mentioned classes, it must not be mistaken as demand for

the higher-priced TV models. The prime consumer market in India therefore is not a

market for absolute premium products, but for something between the ―high end popular

brands‖ to the ―premium brands‖.

8. The class described in the previous paragraph is actually the ―consumers‖ class defined

in Table. This class comprises 33.5 million households as at 1995-96 and it owned

and ‗consumed‘ most of the expensive consumer products such as refrigerators and

washing machines as well as premium expendables. At 1994-95 prices, their annual

household incomes ranged between Rs.45,000 and Rs.2,15,000 (to calculate the latest

income statistics, use an annual inflator of 5 percent). In addition to this class, the

―climbers‖ and ―aspirant‖ classes (defined in the Table ) totaling 23.9 million households

in urban India, also have the socio-cultural traits of the ―consumers‖ class and, with

time, will join the consumer‘s class. Medium-to-long-term marketing strategy must

therefore aim at the aspirants and the climbers as well. This is based on the safe

assumption that, except for the destitute class as defined in Table , the other classes

are on the way to the next higher class. For companies with long-term marketing plans

in India, the ―consumers‖ (urban + rural), ―climbers‖ (urban only) and ―aspirants‖

(urban only) classes can be clubbed together to give a market size of around 57 million

households which can be said to be the ―prime segment‖ of the Indian consumer market.

This becomes even truer as consumer finance and the credit card culture picks up.

Fine-tuning between the classes is of course important.

9. Suppose you are marketing washing machines. Go for two broad types : fully automatic

and semi-automatic. Target the fully automatic machines at the ―consumers‖ class and

the semi-automatic at the ―aspirant‖ class, the ―climbers‖ class will then overlap the

market for both the types of washing machines.

10. All of the above may be confusing, but the marketing strategist has to live with it


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because that‘s how the Indian consumer market is in reality. There is hardly a

characteristic that applies across the market. It would be more accurate to describe it

as a collection of distinct consumer markets.

Latest Developments In Consumer Credit Changing Consumer Behavior

The behavior of the consumers in India witnessed a remarkable change esp. the

attitude. The Indian consumer is fast changing his habits, borrowing money to buy the

products he wants, not content with buying what he can afford. The resultant consumer

boom is what market strategists explain as the key to the success of the Indian consumer

finance market.

a. Consumer finance today helps everyone to upgrade his standard of living right

now instead of waiting for years for his savings to accumulate.

For manufacturers, it stimulates demand and lowers inventory

For middlemen, it‘s a sales boosting device

For players of consumer finance, it‘s a means of profit generation.

b. The culture of buy-now-pay-later is fairly present in India, evolving through various

forms like consumer lending, consumer credit, consumer loans, friendly and family

borrowings, daily payment schemes etc.

c. The basic objective of consumer financing is that the consumer‘s present spending

habits tend to be geared to expectations of future income. They are losing their

fear of borrowing of consumer finance.

d. Along with buying a home, consumers prefer consumer finance to buy home

appliances and vehicles, opting for finance based on the rate of interest,

administrative fee, processing fee, commitment charges, pre-payment penalty, types

of facilities, standard and kind of services mix other terms and conditions.

e. These are members of a growing breed of normally conservative middle-class

Indians who are opting for consumer finance loans despite the high interest cost

being charged.

IMPACT OF CONSUMER FINANCE GROWTH ON CONSUMER

DURABLES MARKET:

The impact of consumer finance has a direct impact on the fortunes of the consumer

durables market including two wheelers and passenger cars. This correlation is already

clear from the surge in demand in recent times. Sales of cars would grow at an even faster

20% annualized, as the gradual decline in excise duties makes the vehicles more affordable.

(a) Passenger Cars and Two-wheelers

Sales of passenger cars increased by 26.5% in the first half of this fiscal, owing to the

lowering of excise duties in the general budget. The two-wheeler industry grew by 8.9%

during this period, much slower than the heady high-teens growth over the past two years,

as the agricultural slowdown last year hit rural incomes. Two-wheeler sales are expected

to increase at a compounded 15.6% . Car sales would rise at an even faster 20%.

(b) Key Issues and Success Factors

For the consumer finance companies to flourish, there is need to develop a credit

information system, which will ease the process, making it faster and easier to determine

the creditworthiness of customers.

• Ability to offer simple, convenient and innovative consumer finance products, a

wide distribution network and choice of repayment tenor, documentation and loan


144

offer.

• As a result of the large number of players, market pressures, increased competition,

increased awareness and wider offerings consumer-financing activities need to

become customer-oriented and user-friendly.

• One of the perceived problems relating to consumer finance is the absence of

credit bureaus to rate the creditworthiness of consumers. As of now, the advent

of information technology has paved way for sharing data about defaulters among

private sector banks. Any loan proposal is based on this shared information before

further process.

(c) Innovative Solutions

The banks are lending against collateral and have concentrated on small potential

borrowers to achieve disbursal targets.

• The Vijaya Bank offers ‗V stock‘ for loans against shares; ‗V equip‘ loans to help

professionals acquire equipment and vehicles; and ‗V-cash‘ to enable clean loans

against salaries after getting an employer‘s guarantee.

• Judges, cops and teachers can now get cheaper loans with banks spinning out of

new products to cash in on the great retail rush. The country‘s largest commercial

bank, State Bank of India, will charge lower interests to these set of borrowers

for buying a home, car, two-wheeler or simply opting for personal or festival loans.

Concessions would be give to them on interest rate, processing fees and margins

under three new schemes; ‗teacher plus‘, police plus‘ and ‗justice plus‘. The

move, SBI officials say, is aimed at capturing the market share in different segments.

The bank aims to tie-up with various organizations, to put in place a structure,

where the EMI or (equal monthly installment) for servicing the loan will be debited

from the salary accounts of the borrower. A tie-up would minimize default risk.

On home loans, teachers, policemen and judges will be charged 0.25% lower than

interest charged to other borrowers. At present, the normal SBI home loan rates are

9.25% for 10 to 20 years. Similarly, car loans will also be charged 0.25% lower than the

usual rate, currently pegged at the medium-term lending rate (MTLR) of 11.25%. For

scooter and motorcycle loans, the rates will be 0.35% lower. SBI normally charges a

spread of 0.85% over its MTLR, but for teachers, policemen and judges, the spread will

be 0.50%. Effectively, they would be charged 11.75% as against 12.1% for other customers.

In case of personal loans, the spread over MTLR will be reduced to 2% against 2.23%.

Effectively, these three special categories of borrowers would be required to pay 13.25%,

instead of 13.6%

• For festival loans, SBI would be offering a spread of 2.25% over the MTLR, as

against 2.5% charge to its regular customers. Thus, the festival loans would cost

13.5%, as against 13.75%.

• Again, the processing fee on personal and two-wheeler schemes will stand reduced

to 0.75%, as against 1% charged to its regular customers. The absolute fee for

festival loan schemes has been reduced from Rs.100 to Rs.75. Margins are also

being relaxed. For home loans, it has been brought down from 15% to 10%, and

for repair and renovation, it will be reduced from 20% to 15%. In case of car

loans, the margins are pegged at 10%, against 15% for cars priced up to Rs.4

lakhs and 20% margins, while a 2-4 years old car will attract 30% margin. For


145

scooters and motorcycles up to Rs.50,000, the margin would be 5% as against

10% for regular customer and 10% (as against 20%) for over Rs.50,000. The

bank does not charge any margin for festival and personal loans.

(d) Credit Constraint in Rural India for Consumer Durables

According to a new survey, ‗Role of Consumer Finance in Rural India‘ conducted by

Chennai-based Anugrah Madison and Delhi-based Marketing and Research Team

(MART), the future growth for consumer durable is Rural India.

The constraints involved are the reluctance of banks to provide finance and the lack

of electricity in 2/3rd of the homes. ―Penetration of consumer durables would be cheaper

in rural India if banks were ready to finance them. Banks have shown reluctance in this

sector and restrict themselves to tractors and diesel pumps.‖

While the consumer durables market is facing a slowdown due to saturation in the

urban market, rural consumers are ready to put their money on the counter if consumer

finance is made available and basic infrastructure requirements such as electricity and voltage

are ironed out. Currently, rural consumers purchase their durables from the nearest towns,

leading to increased expenses due to transportation, Hence, purchase is necessarily only

done during the harvest, festive and wedding seasons – April to June and October to

November in North India and October to February in the South, believed to be months

‗good for buying‘. The question remains as to why the Banks shy away from financing

rural consumers.

(e) Consumer Preferences

Indian consumers identify ease and speed of the loan application and approval process,

as well as flexibility of evaluation procedures, as the key drivers of financing satisfaction.

Consumer financing Satisfaction performance is measured by four factors :

• Application process (44 %);

• Approval and documentation (22 %)‘

• Finance advisor (18 %); and

• Loan value (16 %).

Customers who obtained their loans from a nationalized bank are relatively more

satisfied than those choosing a non-banking finance company (NBFC) or a foreign bank.

Low interest rates and the reputation of the finance company are among the key reasons

for customers who opted either for an NBFC or a foreign bank. In comparison, past

experience and personalized service are the main reasons indicated by those opting for a

nationalized bank. Furthermore, more than 50% of NBFC and foreign bank customers

obtained their financing at an automobile dealer or through a direct selling agent of the

finance provider. In contrast, more than 90% of nationalized bank customers obtained

their financing directly through the bank.

The car finance market has reached a new level of maturity, so much so that the carmaker,

the automobile dealer and the financier now work together to provide better features

and funding options for the buyer. Depending on the manufacturer, tenure of the loan and

credit history of the car buyer, interest rates, on a reducing balance basis in the 10-13.5 %

range for new cars compared to 13-16.5 % for old cars. There is an increased preference

for financing car purchases through loans.

Importance of Consumer Credit In India

The following best explains the importance of consumer credit in India.


146

(a) Increasing Risk in Corporate Lending

Increasing risk in corporate lending, banks are forced to opt for an alternative spot

for finance . The supernormal growth in retail finance has made it the primary driver of

banks‘ asset books. It is expected to capture 40-50% of banks‘ incremental lending by

end of financial year 2004.

Banks‟ share in incremental retail advances (%)

FY2003 FY2004

State Bank of India 39.1 40.4

HDFC Bank 39.1 62.9

ICICI Bank 209.7 174.1

Corporation Bank 72.0 64.3

Andhra Bank 48.8 48.8

Union Bank of India 23.5 21.3

Punjab Nation Bank 0 0

ING Vysya Bank 28.1 22.8

Oriental Bank of Commerce 107.0 66.2

Bank of Baroda 75.3 29.4

Canara Bank 25.6 35.7

(b) Housing Loans

Housing loans have been the product of choice for state-owned banks because of

their attractive profitability, low risk weight-low delinquency history, and the ease of

processing loans.

All the state-owned banks have recorded explosive growth in their mortgages; this has

vastly expanded the market.

(c) Consumer Durables

Banks have entered almost all the segments in retail finance. They are gaining share

from NBFCs. Private Banks have started offering loans for low-ticket items like consumer

durables and two-wheelers, besides personal loans. Some schemes of some banks are

given below :

• SBI has struck a preferred-financier arrangement with carmaker Maruti, and

now markets these can loans from more than 2,000 branches. The bank has also

tied up with Bajaj Auto and TVS Motors to finance two-wheelers.

• SBI is offering 3-year two-wheeler loans at an interest rate of 10% across all

sales outlets of these companies. These alliances are significant, because they

have extended the availability of car and two-wheeler finance to second-and

third-tier towns.

• Axis Bank has tied up with Ford Credit as a preferred financer for Ford cars.

• Punjab National Bank has struck a similar arrangement with Hyundai.

• More such alliances are expected between carmakers and state-owned banks.

These arrangements will drive strong growth in car finance market over the years

to come.

(d) Reduction in Interest Rates

Falling interest rates, coupled with increasing loan durations, have substantially reduced

the EMIs on retail loans, thereby making them affordable to more people than ever before.

The table below shows the fall in interest Rates :


147

Table sharply falling interest costs

Year to 31 March 1999 2002 Current Rates

Cars

Basic IRR (%)

Less manufacturer subventions (%)

Dealer (%)

DSA (%)

Net rate to customer (%)

Housing

For 10-15-year loans (%)

Tax benefit on interest payment

Net rate (%)

2 wheelers Basic IRR (%)

Commercial vehicles Basic IRR (%)

18

1-1.5

16.5-17

15.0-15.4

75,000

12.75-13.1

25

18-18

13.5

1-1.5

1.5

1

9.5-10

10.5-11

150,000

7.3-7.7

20-23

13-13

9.5

1.5

1.5

1

5.5

7.75

150,000

5.4

17

8.5

(e) Expanding Target Market : Loans becoming more affordable

The target market for retail loans have grown the fastest because the incomes of

middle and upper-middle class households have grown substantially. The table below


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shows the expanding market in loan products..

Loan Products FY1996 FY2002 CAGR (%) FY2005E FY2007E

Mortgages 22.9 35.4 9.1 48 51.1

Car 9.5 17.2 12.6 29.6 31.7

2-wheeler 62.8 77.3 4.2 98.3 102.8

Consumer Durables 65.1 83 5 90.4 106.1

Personal 12.9 22.7 11.9 30.2 32.7

Credit cards 12.9 22.7 11.9 30.2 32.7

INTRODUCTION

The commercial banks extends different functions to customers. The most important

in the modern days are credit card facilities to customers. These facilities are not extended

to not only customers in the urban areas or cities but also to customers residing in rural

areas. Agriculturist are enjoying the facility of credit card and the card extended to them

are called as green card.

LEARNING OBJECTIVES


• Types of Credit Cards

• The importance of Credit cards

• Future of Consumer Credit in India

CREDIT CARDS

A credit card is given by the banker to the customer in which the name of the customer

is embossed in block letters. The name of the bank and the date of issue and expiry are

also mentioned on the face of the card. The reverse side of the card will bear the specimen

signature of the customer. A list of vendors or sellers will be gibe by the banker to the

customers. A credit card is a thin plastic card, usually 3 1/8 inches x 2 1/8 inches in size

that contains identification information such as signature or picture or both and authorizes

the person named on it to charge for purchases or services to his account. In addition to

this, the card can be used in automated teller machines for withdrawing cash and the

machine stores the information and also transactions through electronic date processing

system.

Origin of Credit Cards In India

The usage of Credit Cards in India is less when compared to the usage of credit

cards in China, Taiwan and Malaysia. It picked up only in the last 10 years until then the

Indian looked it as a luxury. The idea of owning a credit card has had its roots in the minds

of millions of Indians. They started viewing the card as a convenient substitute to carrying

cash. The change in mindset is clear from the growth, both in terms of absolute numbers

and growth rates. The industry has grown at the rate of 30% and strongly counts for

steady years to come.

Source : Chartered Financial Analyst, Jan. 2004.

Credit Cards in India

According to Visa International an average Indian cardholder uses his card 9.3 times,

spending about Rs.23,000 per year. A number of card owners do not use their cards and

almost 20-23% cards are inactive. In India, two players dominate the credit cards industry.

Visa and Master Cards and 15 out of 17 banks provide credit card services through Visa

or Master Cards.


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The importance of having a pie in the credit cards segment was not lost on any bank,

and most banks started their credit card operations. Currently, there are more than 20

banks offering credit cards, but the market share of the top five exceeds 75%.

Credit card is a low margin, high volume business. The initial investments required by

a bank are very high. The income per card is low, thereby requiring large volumes in terms

of cards issued and the transactions finance to make the operations profitable.

Another reason for the inability of players to upstage the well-entrenched ones is

lower patronage by the merchant and business outfits. The bigger businesses and merchants

are already acquired by the existing players, so far new banks, braking into this business

and convincing a merchant is increasing because the banks are shifting towards lower end

merchants. Secondly, because of competition in acquiring business, new categories of

merchants are coming up.

The foreign banks have a dominant share due to various reasons like having been in

the field for decades, sound operational and financial strength, strong brand recognition

etc. They were catering to the upper segments and charged high annual fees. Later, with

aggressive entry of SBI, ICICI Bank and HDFC Bank, the rules of the game changed.

The cards were positioned in manners which gave an impression that the cards can be

acquired by people from not only the upper class, but also the middle income categories.

This was the strategy followed by SBI-GE as a result of which it is the third largest issuer

of credit cards today. It positioned itself in a segment as to be of mass appeal and at the

same time reinforced a clean and dependable image of the bank.

Source : Chartered Financial Analyst – January 2004

Table : Major players and their ranks

The new private banks like ICICI and HDFC are also aggressively increasing their

share. They adopted a strategy of reaching lower down the income strata by lowering

down their eligibility norms. Of course, the credit limits are set at lower levels as compared

to the foreign banks. As a result of this strategy, the credit cards base is widening day by

day with the increase of base in B-grade cities.

Types of Credit Cards

Types of Cards :

1. Charge Card

2. Debit Card

3. Deferred Debit card

4. Affinity card

5. Standard card

6. Classic card

7. Gold card

8. Platinum card

9. Best Platinum credit card

10. Fleet Platinum credit card

11. Next card Platinum credit card

12. Titanium card

13. Secured card

14. Smart card

__________________________________________________________________


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No. of Cards (in Lakhs)

--------------------------------------

Banks 2001 2002 2003

---------------------------------------------------------------------------------------------------

Citibank 14.00 16.00 20.00

StanChart 12.50 14.00 18.00

SBI-GE 6.00 9.03 13.00

HSBC 4.73 5.88 7.40

ICICI 2.50 5.00 8.0

AMEX 2.90 3.53 7.00

1. Charge card

In this card, the cardholder has to make full payment of the charge by the due date.

Unlike other credit cards, here dues are not allowed to carry forward. It is meant for

people who spend responsibly.

2. Debit Card :

A debit card is different from credit card. Debit card is issued by a bank. The following

are the differences between credit and debit cards :

3. Deferred debit card

When a debit card carries the benefit of the credit card, allowing the payment after

certain period, it is called deferred debit card.

Credit Card Debit Card

1 It is issued by an agency such as

Master or Visa

1. A debit card is issued by a bank in

which the customer has an account.

2. A credit card allows certain

period for making payment for the

purchases made which may vary

from 30 to 45 days.

2. The bank account in a debit card is

debited immediately the moment the

card is used. They have no credit

period.

3. The credit worthiness of the

customer is based on incomeeligibility

criteria on the basis of

which the credit card is issued .

3. There is no such income criteria but

the credit balance, maintained in the

account is the criterion.

4. A credit card holder has a ceiling

limit For his purchases and also for

his cash withdrawals through ATM.

4. A debit card holder has his

purchases restricted to his credit


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balance.

5. Credit card can be used for

withdrawing money only from

ATMs.

5. A debit card can be used even for

with drawing money from the bank and

hence it is account holders‘ mobile

6. When the purchase are made by

using The Credit Card, the retail

seller swipes the card over an

electronic terminal at his outlet, and

enters the personal identification

number (PIN) and the transactions

are recorded by the card issuing

authority.

6. Any use of debit card by a similar

method will be immediately recorded

by the bank and the account of the

customer is debited. Thus, it is an

online transaction.

7. Loss of credit card should be

reported to the issuing agency.

7. Loss of debit card should be

reported to The issuing bank.

4. Affinity card

A card offered by two organizations of which one is a lending institution and the other

a non-financial group. Here, schools, non-profit groups, airlines, petroleum companies

issue affinity cards. These cards carry special discounts.

5. Standard Card

It is a normal credit card which carries limit on transactions, according to the credit

worthiness of the card holder.

6. Classic card

A credit card issues by Visa, carrying the logo of Visa.

7. Gold card

A higher line of credit is given than a standard card. The income eligibility for getting

this card is higher. Gold card is given to very rich customers or persons with high social

status.

8. Platinum card

In order to distinguish credit cards belonging to certain companies, platinum credit

cards are issued. Some companies use these to denote their best premium credit card.

9. Best Platinum credit card

Companies which set highest standard in customer service issue these cards. There

is lowest interest rate for the outstanding, and the cards will have no annual fee or application

fee and can be applied online in seconds.

10. Fleet Platinum credit card


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It is a zero liability guarantee for purchases. It protects the credit card holder from

any unauthorized use.

11. Next card platinum credit card

This is given to those with a good credit and it offers a low introductory rate.

12. Titanium card

A card which has a higher credit limit than a platinum card.

13. Secured card

A credit card is given to a card holder who has Savings deposit which will take care

of his outstanding balance, in case of his default on payment.

14. Smart card

The revolution in Information Technology is responsible for the invention of Smart

card. The development in semiconductors has advanced so much that computing power

that was available in a computer matching a room size in the early days, is now available on

a visiting card-sized plastic. Kit is an embedded micro-chip card and it can store 1280

times more data than the magnetic strip card. The can store data for more than 10 years

and can be read or written for more than 1 lakh times.

For example : Visa is converting 22 million Brazilian debt and credit cards to Smart

cards.

Sim card in the mobile phone is an example for the use of Smart cards in the telecom

sector. There are 3 types of Smart cards. 1. Storage/memory cards 2. Intelligent cards

and 3. Hybrid cards.

• Storage card has an inherent monetary value associated with it.‗

• Intelligent card acts as a store-house of information.

• Hybrid card contains a micro processor chip and a magnetic strip and bar coding.

Use of smart cards

1. A smart card can be used for multiple applications. Government agencies are a big

target for Smart card manufacturers.

2. Gemplus and Schlumberger are the major players in the Smart card market. In

India, Bharat Petroleum and Indian Postal department have introduced this.

3. Smart cards can be used by government agencies for large data storage such as driving

license, vehicle registration and national permit for commercial vehicles, etc. Gujarat

and Andhra Pradesh have already introduced this. IDBI‘s Bank‘s Money Smart card,

a stored value card for even small transactions such as buying coffee and Bharat

Petroleum‘s pre-paid perto-card are some of the examples of Smart cards.

4. Other applications of smart cards consist of :

(a) Public telephone (b) e-Commerce (c) Electronic wallet

(d) Cable TV (e) Internet banking

(f) Transportation This card can be used in different modes of transport.

(g) In health card, a patient‘s blood pressure, sugar, blood group and other

Vital data could be obtained.

(h) Miscellaneous, such as insurance, club subscription and school fees, etc.

Benefits Of Credit Cards

Benefits derived from credit card

The following persons derives benefits from the credit card system :

(1) Customer (2) Seller


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(3) Wholesaler (4) Manufacturer

(5) Commercial banks (6) Central bank

(7) Government (8) Economy

1. Customer

i. A customer can make purchases at any time

ii. One need not carry cash for making purchases

iii. In case of losing credit card, one can immediately inform the bank and prevent

misuse by others

iv. One can take benefit of lower prices by purchasing goods before the hike in

prices.

v. During inflation period, credit card benefits customers as the payments are made

after one month from the date of purchase.

vi. Railway ticket or Air ticket reservation can be done by using credit card even

during night when banking facility is not available.

vii. Credit card can be used even through computers and purchases can be made by

sitting at home.

viii. More customers will come forward to avail banking facility

ix. At any point of time, the customer will be able to know the available credit even

after purchases.

x. Credit card can be used even for withdrawing cash through ATM (Automatic

Teller Machine) up to a certain limit.

xi. The holders of credit card are given insurance cover by the banks.

(2) Seller

The benefits to seller are as follows :

i. Sales are affected throughout the year.

ii. With increasing sales, the turnover of the seller increases.

iii. The seller can go for competitive price as he can get credit from the bank.

iv. Due to credit card facility, he can attract customers from far off places also.

v. Durable goods can be sold easily through credit card.

vi. Bad debts can be avoided as the bank arranges for payment under credit card.

vii. Sellers extending sales through credit card can also extend additional credit to

customers as they can receive payment in installment through the credit card.

(3) Wholesaler

i. The wholesaler will be getting more orders from the retailer as the sales will go up

due to credit card.

ii. The wholesaler will be dealing products of different manufacturers due to credit

extended by them

iii. The wholesaler will also be given credit by the banks.

iv. The wholesaler will be able to place orders throughout the year and hence can get

trade credit as well as cash credit from the manufacturers.

(4) Manufacturer

i. With orders continuously received from the wholesalers, the manufacturer can

increase his production.

ii. Due to large scale production, the cost of production will come down and the

manufacturer will be able to sell at a lower price.


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iii. Since the orders are received throughout the year, there will be continuous

production even for goods which are seasonal in nature. Example : Manufacture

of umbrellas.

iv. The manufacturer will also diversify his production due to the goodwill he has

enjoyed due to increased production.

v. The profit of the manufacturer will also increase and he will extend a higher

commission to his wholesalers.

(5) Commercial banks

Due to credit card facility

i. More customers will avail the banking facility.

ii. There will not be cash withdrawals from the bank as most of the customers use

credit card for their purchase.

iii. The bank, by extending credit to customer, retailer, wholesaler and manufacturer

is able to earn interest on the credit.

iv. The credit facility is extended only in the books of accounts and there will be no

cash withdrawals. The account of the customer is debited for the purchases while

the account of the seller is credited. Both the parties are given credit and the bank

enjoys interest on the loan.

v. All the transactions in the country are done through the banking system, as a result

of which, the role of money lenders and other financiers is reduced.

vi. The profit of the bank will also increase due to the extension of credit to different

parties.

(6) Central bank

It is a national bank that provides financial and banking service for its country‟s

government and commercial banking system and issues currency. Central bank for

India is Reserve Bank of India.

i. A better control on the banking system is evolved by the Central bank.

ii. During inflation, the Central bank can control the price level by instructing the head

office of commercial banks to reduce the quantum of credit extended to customers

under credit card. This will reduce the demand and thereby prices will come

down.

iii. Central bank is able to take instantaneous action on the economy as credit card

provides information regarding purchases and sale in the country.

iv. The activity of Non Banking Financial Companies will also be reduced due to

the credit card facility extended by commercial banks. So, the Central bank need

not control NBFCS.

v. By extending credit card facility to agriculturists, agricultural finance is improved

and this relieves the farmers from the clutches of money lenders.

(7) Government

i. Whenever any sale is made, it is properly billed. That means sales tax, commercial

tax due to the government will not be evaded.

ii. It prevents the growth of unaccounted money as all transactions are recorded.

iii. It improves the revenue of the government due to increase in production by the

manufacturers. Excise duty will be paid to the government.

iv. Government employees can also avail credit card facility against their salaries.


155

(8) Economy

Economy gets benefited in all its different sectors like primary, secondary and territory

sectors. . Transport system will improve with movement of goods to different places.

Exports will improve, increasing the earnings of foreign exchange. Employment opportunities

will increase not only in production centers but also in the service sector. Marketing will

develop with increasing advertisements. Stiff competition will bring out good products for

the benefit of consumers.

Credit card which was considered to be a luxury, has become one of necessity. It

was considered to be used only by higher income group. But today, with development in

banking and trading activities, fixed income group or salaried class has also started using

the same. There may be the criticism that it induces far more purchases or makes people

Spend-thrift. This may be so in the initial stage, but when once a customer gets used to

the credit card, he/she will know how to use the same in a discretionary manner.

INTRODUCTION

The Real Estate financing has become so popular, that the procedure for obtaining a

loan has become so simplified that housing loans are easily available. This may be attributed

to the change in the housing policy of both the Central and Sate Governments. A redeeming

feature of Indian real estate finance is the recent entry of real estate commercial banks in a

big way.

LEARNING OBJECTIVES


• Factors determining the Real Estate finance

• The different sources of finance

• Future of Real Estate Financing

REAL ESTATE FINANCING

• It is financing for the purchase of real property, where real property refers to

land or buildings.

It‘s a set of all financial arrangements that are made available by housing finance

institutions to meet the requirements of housing. Housing finance institutions include banks,

housing finance companies, special lousing finance institutions, etc.

Factors Determining the Real Estate Finance Assistance

Real estate finance companies consider the following factors before making any financial

assistance for housing :

1. Loan Amount

2. Tenure

3. Administrative and processing costs, etc.

4. Pre-payment charges

5. Services

6. Value Addition

7. Sources of finance like HFC‘s and Banks

8. EMI calculation methods

1. The Loan Amount


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The amount of loan that any HFC decides to provide to a loan seeker depends on the

following variables :

1. Customer‟s repayment capacity

2. Rate of interest charged

3. Term of the loan

2. Tenure

Repayment is done through EMI, which includes principal and the interest. As a

rule, an HFC fixes the EMI between 30 and 40 percent of the customer‘s gross monthly

income, or 50 percent of the net monthly income. For instance, considering a loan of

Rs.10, 00,000/- for 10 years, at 13 percent flat interest rate, the EMI would be

Rs.19,166.66/-. This way the gross earnings of the loan-seeker must be Rs.54,761.88

per month, where the installment to income ratio is 35 percent. The general trend in the

market is that customers try to obtain loans for longer tenures, without realizing that the

longer the duration the more will be the amount paid by them. An increase in the tenure

from 10 to 15 years increases the amount payable by 28 percent. In case the tenure of the

loan is decreased from 15 years to 10 years, the monthly EMI becomes Rs.16,388.77/-.

3. Administrative and processing cost

The effective cost of the loan depends on the type of method used by banks or

finance companies. Based on the method, the principal component, which is paid monthly,

is deducted from the outstanding principal amount. The two methods, which banks and

finance companies generally follow, they are:

a. Monthly rest system

Under this system, the principal amount is deducted every month from the outstanding

amount, and the interest for the following month is calculated on the outstanding amount.

This is illustrated as follows:

Loan Amount (Rs.) Tenure

(Years)

Interest

(%)

EMI

(Rs.)

Total Payment

(Rs.)

1,00,000 5 13 2,275 1,36,500

1,00,000 10 13 1,493 1,79,160

1,00,000 15 13 1,265 2,27,700

b. Annual rest system

Under this system, although the principal amount is paid every month, it is accounted

only at the end of the year. This is illustrated as follows:

c. Fixed and Floating Rate

Customers should check whether the rates offered are fixed or floating (varies with

PLR). Floating rates are better in a falling rate scenario, but expensive in an increasing rate

scenario. The borrower should check whether it is viable to shift the loan from fixed rate

to the floating rate in a decreasing rate scenario by carrying out a cost benefit analysis.

4. Pre-payment Charges


157

This is an important factor to be considered, especially in situations where the ability

to repay the loan matters. There are certain HVCs which charge pre-payment, in case the

loan is repaid before schedule. This pushes up the cost of fund of the borrower. Borrowers

who desirous of repaying ahead of schedule should approach HFCs which do not have a

pre-payment charge.

5. Value addition

The value addition includes the additional or supplementary services that HFCs provide,

such as fast disbursals of loan, legal services, meeting with brokers, builders etc.,

3.3.2 Sources Of Finance

1. THE NATIONAL HOUSING BANK (NHB)

The National Housing Bank (NHB) was set up in July 1988, under an Act of

Parliament, and is wholly owned by RBI, NHB, at present, has a paid-up capital of

Rs.350/- Crores. It was conceived and promoted to function as the apex institution in the

housing sector. The need to set up this institution stemmed from the fact that the housing

sector had not received the attention it required, not only in terms of finance for individual

loans, but also in terms of buildable or serviced land, building materials and cost effective

technology.

Loan Amount (Rs.) Tenure

(Years)

Interest

(%)

EMI

(Rs.)

Total Payment (Rs.)

1,00,000 5 13 2,370 1,42,200

1,00,000 10 13 1,536 1,84,320

1,00,000 15 13 1,290 2,32,200

2. LIFE INSURANCE CORPORATE HOUSING FINANCE LIMITED

(LICHFL)

The corporation was set up under the Companies Act, 1956. Incorporated on 19th

June 1989, it is recognized by NHB. It commands about 25 percent market share in the

housing finance industry. It has a wide network in the industry with 67 Area/Unit Offices

and 6 Regional Offices across the length and breadth of the country besides about 5,000

LIC Agents trained for housing finance.

3. HOUSING AND URBAN DEVELOPMENT CORPORATION OF INDIA

(HUDCO)

Incorporated on 25th April, 1970, HUDCO was an expression of the concern of the

Central Government towards the deteriorating housing conditions in the country, and a

desire to assist various agencies in dealing with it in a positive manner. The principal

mandate of HUDCO was to ameliorate the housing conditions of all groups and with a

thrust to meet the needs of the low-income group and economically weaker sections.

SUMMARY

Thus the different financial institutions are accomplished with the major objective of

promoting a sound, healthy, viable and efficient housing finance system to cater to all segments

of the populations, promote savings from housing , make housing more affordable , upgrade


158

the housing stock in the country, and enable the housing finance system to access the

capital market for resources.

INTRODUCTION:

Bills of exchange that are used in the course of normal trade and commercial activities

are called ‗commercial bills‘. Bill financing, is an ideal mode of short-term financing available

to business concerns. It imparts flexibility to the money market, besides providing liquidity

within the banking system. It also contributes towards the effective-ness of the monetary

policy of the central bank of a country.

According to the Indian Negotiable Instruments Act 1881, ―Bill of Exchange is an

instrument in writing containing an unconditional order, signed by the marker, directing a

certain person to pay a certain sum of money only to, or to the order of, a certain person,

or to the bearer of that instrument‖. The bill of exchange is essentially a trade-related

instrument, and is used for financing genuine transactions.

Bill financing, is an ideal mode of short term financing available to business concerns.

It imparts flexibility to the money market, besides providing liquidity within the banking

system. It also contributes towards the effectiveness of the monetary policy of the central

bank of a country.

LEARNING OBJECTIVES


• Bill discounting

• Steps in Bills Discounting

• Bill Systems

BILL DISCOUNTING

When the seller (drawer) deposits genuine commercial bills and obtains financial

accommodation from a bank or financial institution, it is known as ‗bill discounting‘. The

seller, instead of discounting the bill immediately may choose to wait till the date of maturity.

Commercial, the option of discounting will be advantageous because the seller obtains

ready cash, which can be used for meeting immediate business requirements. However, in

the process, the seller may lose a little by way of discount charged by the discounting

banker.

Features

Following are the salient features of bill discounting financing:

1. Discount charge : The margin between advance granted by the bank and face value

of the bill is called the discount, and is calculated on the maturity value at rate a certain

percentage per annum.

2. Maturity : Maturity date of a bill is defined as the date on which payment will fall due.

Normal maturity periods are 30, 60,90 or 120 days. However, bills maturing within 90

days are the most popular.

3. Ready finance : Banks discount and purchase the bills of their customers so that the

customers get immediate finance from the bank. They need not wait till the bank collects

the payment of the bill.

4. Discounting and purchasing : The term ‗discounting of bills‘ is used for ‗demand

bills‘, where the term ‗purchasing of bills‘ is used for ‗usance bills‘. In both cases, the

bank immediately credits the account of the customer with the amount of the bill, less its


159

charges.

Charges are less in case of ‗purchasing of bill‘ because the bank can collect the

payment immediately by presenting the bill to the drawee for payment. Charges are,

however, higher in the case of ‗discounting of bill‘ because the bank charges include not

only the charges for service rendered, but also the interest for the period from the date of

discounting the bill to the date of its maturity. In addition, there are also charges when bills

are dishonored. In such circumstances, the bank will debit the account of the customer

with the amount of the bill along with interest and other charges.

Since the bank is granting advance to the customers in both the discounting and

purchasing of bills, ―bills discounted and purchased‘ are shown as advances (Schedule 9)

by a bank in its balance sheet.

Steps In Discounting And Purchasing

Following steps are involved in the discounting and purchas8isng of commercial bills

of exchange :

1. Examination of Bill : The banker verifies the nature of the bill and the transaction.

The banker then ensures that the customer has supplied all required documents

along with the bill.

2. Crediting Customer Account After examining the genuineness of the bill, the

banker grants a credit limit, either on a regular or on an adhoc basis. The customer‘s

account is credited with the net amount of the bill i.e. value of bill minus discount

charges. The amount of discount is the income earned by the bank on discounting

/ purchasing. The amount of the bill is taken as advance by the bank.

3. Control over Accounts : To ensure that no customer borrows more than the

sanctioned limit, a separate register is maintained for determining the amount availed

by each customer. Separate columns are allotted to show the names of customers,

limits sanctioned, bills discounted, bills collected, loans granted and loans repaid.

Thus, at any given point in time the extent of limit utilized by the customer can be

readily known.

4. Sending Bill for collection : The bill, together with documents duly stamped

by the banker, is sent to the banker‘s branch (or some other bank‘s branch if the

banker does not have a branch of its own) for presenting the bill for acceptance or

payment, in accordance with the instructions accompanying the bill.

5. Action by the Branch : On receipt of payment, the collecting bank remits the

payment to the banker which has sent the bill for collection.

6. Dishonor : In the event of dishonor, the dishonor advice is sent to the drawer of

the bill. It would be appropriate for the collecting banker to get the protested for

dishonor. For this purpose, the collecting banker or branch of the bank maintains

a separate register in which details such as date on which the bills are to be presented,

the party to whom it is to be presented, etc. are recorded. The banker then

presents them for acceptance or payment, as required. The banker debits the

customers‘ (drawer / borrower) account with the amount of the bill and also all

charges incurred due to dishonor of the bill. Such a bill should not be purchased

in the event of its being presented again. However, the banker may agree to

accept it for collection.

BILL SYSTEMS


160

There are essentially two systems of bills, the drawer bill system and the drawee bill

system, which are explained blow :

Drawer Bills System

‗Drawer Bills System‘ is characterized by :

1. Bills being drawn by the sellers of goods on the buyer of the goods

2. Bills being discounted or purchased at the instance of the drawer of the bills

3. The banker primarily taking into consideration the credit of the drawer of bill,

while discounting or purchasing these bills

This system of financing goods is quite popular in our country.

Drawee Bills System

„Drawee Bills System‘ is characterized by :

a. The banker accepting the bill drawn by the seller at the instance of the buyer (the

drawee)

b. The banker providing assistance, primarily on the strength of the creditworthiness of

the buyer

The two types of the drawee bills system are as follows :

1. Acceptance credit system : Under this system, the buyer‘s banker accepts the bill

of exchange for the goods purchased by the drawee. Such a bill may either be drawn on

the buyer or the banker. The banker also requires the borrower to show separately, the

goods purchased under acceptance credit in periodical stock statements submitted to the

banker.

2. Bills discounting system : Under this system, the seller directly draws the bill on

the buyer‘s bank. The buyer‘s bank discounts the bill and sends the proceeds to the seller.

The buyer‘s banker will show the bill as ‗bill discounted‘.

Under both the systems, the banker keeps a record of the bills, both accepted and

still outstanding. This is to ensure that the advance sanctioned does not exceed the credit

limit.

The main advantages of the Drawee bill scheme are as follows :

1. Assured payment : Since the banker has accepted the bill, the seller is assured

of payment. Moreover, if the seller decides to get it discounted, the discount rate

will be lower because the drawee is the banker itself.

2. Buying advantage : Due to the surety and standing of the banker, it is possible

for the buyer to obtain goods at competitive rates.

3. Safety of funds : There is hardly any risk for the buyer‘s bank because the bill is

accepted or discounted against the security of the goods purchased by the buyer.

Moreover, the goods are under the control of the banker. It is equally advantageous

for the seller‘s bank, since the discounted bill may be rediscounted with any other

financial institution. This is because, a banker has accepted the bill.

SUMMARY

Thus commercially, the option of discounting will be advantageous because the seller

obtains ready cash, which can be used for meeting immediate business requirements.

However, in the process, the seller may lose a little by way of discount charged by the

discounting banker.

INTRODUCTION

An important development in the Indian factoring services took place with the RBI


161

setting up a ‗Study Group‘ under the chairmanship of Shri C.S. Kalyanasundaram in

January, 1988. The study group aimed at examining the feasibility and mechanism of

organizing factoring business in India. The group submitted its report in January 1989.

LEARNING OBJECTIVES


• The characteristics of Factoring and Forfaiting

• The different types of Factoring

• The major distinction between Factoring and Forfaiting

FACTORING AND FORFAITING

Peter M. Biscose defines the term ‗Factoring‘ in his treatise ‗Law and Practice of

Credit Factoring as a‖ continuing legal relationship between a financial institution (the factor)

and a business concern (the client) selling goods or providing services to trade customers,

whereby the factory purchases the clients‘ book debts, either with or without recourse to

the client, and in relation thereto, controls the credit extended to customers, and administers

the sales ledger‖.

C.S. Kalyansundaram, in his report (1988) submitted to the RBI defines factoring

as, ―a continuing arrangement under which a financing institution assumes he credit and

collection functions for its client, purchases receivables as they arise (with or without recourse

for credit losses, i.e., the customer‘s financial inability to pay), maintains the sales ledger,

attends to other book-keeping duties relating to such accounts, and performs other auxiliary

functions‖.

According to the study Group appointed by the International Institute for the

Unification of Private Law (UNIDROTT), Rome, 1988". ―A domestic factoring means an

arrangement between a Factor and his client, which includes at least two of the following

services to be provided by the Factor.

a. Finance

b. Maintenance of accounts

c. Collection of debts

d. Protection against credit risk.

FORFAITING

A form of financing of receivables arising from international trade is known as forfaitng.

Within this arrangement, a bank/financial institutions undertakes the purchase of trade bills/

promissory notes without recourse to the seller. Purchase is through discounting of the

documents covering the entire risk of non-payment at the time of collection. All risks become

the full responsibility of the purchaser. Forfaiter pays cash to the seller after discounting the

bills/notes.

Features of Factoring

The characteristics of Factoring are as follows :

1. The Nature

The nature of the Factoring contract is similar to that of a bailment contract. Factoring

is a specialized activity whereby a firm converts its receivables into cash by selling them to

a factoring organization. The Factor assumes the risk associated with the collection of

receivables, and in the event of non-payment by the customers/debtors, bears the risk of a

bad debt loss.

2. The Form


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Factoring takes the form of a typical ‗Invoice Factoring‘ since it covers only those

receivables which are not supported by negotiable instruments, such as bills of exchange,

etc. This is because, the firm resorts to the practice of bill discounting with its banks, in the

event of receivables being backed by bills. Factoring of receivables helps the client do

away with the credit department, and the debtors of the firm become the debtors of the

Factor.

3. The Assignment

Under factoring, there is an assignment of debt in favor of the Factor. This is the basic

requirement for the working of a factoring service.

4. Fiduciary Position

The position of the Factor is fiduciary in nature, since it arises from the relationship

with the client firm. The factor is mainly responsible for fulfilling the terms of the contract

between the parties.

5. Professionalism

Factoring firms are professionally competent, with skilled persons to handle credit

sales realizations for different clients in different trades, for better credit management.

6. Credit Realizations

Factors assist in realization of credit sales. They help in avoiding the risk of bad debt

loss, which might arise otherwise.

7. Less Dependence

Factors help in reducing the dependence on bank finance towards working capital.

This greatly relieves the firm of the burden of finding financial facility.

8. Recourse Factoring

Factoring may be non-recourse, in which case the Factor will have no recourse to the

supplier on non-payment from the customer. Factoring may also be with recourse, in

which case the Factor will have recourse to the seller in the event of non-payment by the

buyers.

9. Compensation

A Factor works in return for a service charge calculated on the turnover. Actor pays

the net amount after deducing the necessary chares, some of which may be special terms

to handle the accounts of certain customers.

5.3.2 Types of Factoring

Factors take different forms, depending upon the type of specials features attached

to them. Following are the important forms of factoring arrangements:

1. Domestic Factoring

Factoring that arises from transactions relating to domestic sales is known as ‗Domestic

Factoring‘. Domestic Factoring may be of three types, as described below.

2. Disclosed factoring

In the case of ‗disclosed factoring‘ the name of the proposed actor is mentioned on

the face of the invoice made out by the seller of goods. In this type of factoring, the

payment has to be made by the buyer directly to the Factor named in the invoice. The

arrangement for factoring may take the form of ‗recourse‘, whereby the supplier may

continue to bear the risk of non-payment by the buyer without passing it on to the Factor.

In the case of non-recourse factoring, Factor, assumes the risk of bad debt arising from

non-payment.


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3. Undisclosed factoring

Under ‗undisclosed factoring‘, the name of the proposed Factor finds no mention on

the invoice made out by the seller of goods. Although the control of all monies remain with

the Factory, the entire realization of the sales transaction is done in the name of the seller.

This type of factoring is quite popular in the UK.

4. Discount factoring

‗Discount Factoring‘ is a process where the Factor discounts the invoices of the seller

at a pre-agreed credit limit with the institutions providing finance. Book debts and

receivables serve as securities for obtaining financial accommodation.

5. Export Factoring

When the claims of an exporter are assigned to a banker or any financial institution,

and financial assistance is obtained on the strength of export documents and guaranteed

payments, it is called ‗export factoring‘. An important feature of this type of factoring is

that the Factor=-bank is located in the country of the exporter. If the importer does not

honor claims, exporter has to make payment to the Factor. The Factor-bank admits a

usual advance of 50 to 75 percent of the export claims as advance. Export factoring is

offered both as a ‗re-course‘ and as a ‗non-recourse‘ factoring.

6. Cross-border Factoring

‗Cross-border Factoring‘ involves the claims of an exporter which are assigned to a

banker or any financial institution in the importers‘ country and financial assistance is obtained

on the strength of the export documents and guaranteed payments. International factoring

essentially works on a non-recourse factoring model. They handle exporter‘s overseas

sales on credit terms. Complete protection is provided to the clients (exporter against bad

debt loss on credit-approved sales. The Factors take requisite assistance and avail the

facilities provided for export promotion by the exporting country. When once documentation

is complete, and goods have been shipped, the Factor becomes the sole debtor to the

exporter.

7. Full-service Factoring

Full-service factoring, also known as Old-line factoring, is a type of factoring whereby

the Factor has no recourse to the seller in the event of the failure of the buyers to make

prompt payment of their dues to the Factor, which might result from financial inability/

insolvency/bankruptcy of the buyer. It is a comprehensive form of factoring that combines

the features of almost all factoring services, especially those of non-recourse and advance

factoring.

8. With Recourse Factoring

The salient features of the type of factoring arrangement are as follows

1. The Factor has recourse to the client firm in the event of the book debts purchased

becoming irrecoverable

2. The Factor assumes no credit risks associated with the receivables

3. If the consumer defaults in payment, the resulting bad debts loss shall be met by

the firm

4. The Factor becomes entitled to recover dues from the amount paid in advance if

the customer commits a default on maturity

5. The Factor charges the client for services rendered to the client, such as maintaining

sales ledger, collecting customers‘ debt, etc.


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9. Without Recourse Factoring

The salient features of this type of factoring are as follows :

1. No right with the Factor to have recourse to the client

2. The Factor bears the loss arising out of irrecoverable receivables

3. The Factor charges higher commission called ‗del credere commission‘ as a

compensation for the said loss

4. The Factor actively involves in the process of grant of credit and the extension of

line of credit to the customers of the client

10. Advance and Maturity Factoring

The essential features of this type of factoring are as follows :

1. The Factor makes an advance payment in the range of 70 to 80 percent of the

receivables factored and approved from the client, the balance amount being

payable after collecting from customers

2. The Factor collects interest on the advance payment from the client

3. The Factor considers such conditions as the prevailing short-term rate, the financial

standing of the client and the volume of turnover while determining the rate of

interest

11. Bank Participation Factoring

It is variation of advance and maturity factoring. Under this type of factoring, the

Factor arranges a part of the advance to the clients through the banker.

The net Factor advance will be calculated as follows :

(Factor Advance Percent x Bank Advance Percent)

12. Collection / Maturing Factoring

Under this type of factoring, the Factor makes no advancement of finance to the

client. The Factor makes payment either on the guaranteed payment date or on the date of

collection, the guaranteed payment date being fixed after taking into account the previous

ledger experience of the client and the date of collection being reckoned after the due date

of the invoice.

Difference Between Factoring And Forfaiting

The following are differences between factoring and forfeiting

HAVE YOU UNDERSTOOD QUESTIONS?

Sl.

No.

Characteristic Factoring Forfaiting

1. Suitability For transactions with short-term

maturity

For transactions with

medium-term

maturity period

2. Recourse Can be either with or

without recourse

Can be without recourse

only

3. Risk Risk can be transferred to

seller


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All risks are assumed by

the forfaiter

4. Cost Cost of factoring is usually

borne by the seller

Cost of forfeiting is borne

by the overseas buyer

(importer)

5. Coverage Covers a whole set of jobs

at a predetermined price

Structuring and costing is

done on a case-to-case

basis

6. Extent of

Financing

Only a certain percent of

receivables factors is

advanced

Hundred percent finance

is available

7. Basis of

financing

Financing depends on the

credit standing of the

exporter

Financing depends on the

financial standing of the

availing bank

8.

Services

Besides financing a Factor

also provides other services

such as ledger

administration etc.

It is a pure financing

arrangement

9. Exchange

fluctuations

No security against

exchange rate fluctuations

A forfeiter guards against

exchange rate fluctuations

for a premium charge

10. Contract Between seller and Factor Between exporter and

Forfaiter

SUMMARY


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Factoring in India is still in the infant stage. If we have to improve factoring organizations

in the country, there should be more credit investigating agencies so that they can recommend

genuine business transactions. However, factoring service has a very bright future in India.

In fact, it will be a boon for small scale sector.

INTRODUCTION

An entrepreneur, with a good technical knowledge, raising of capital in the conventional

method will be very difficult. So, by a new technique of financing, long term capital is

provided to small and medium sector through an institutional mechanism. So capital assistance

against high growth oriented along with managerial assistance was felt necessary. This

gave to the birth of Venture Capital Assistance.

LERNING OBJECTIVES


• The financing by venture capital institutions

• The present status of venture capital in India

• Guidelines for providing venture capital

• The investment pattern in venture capital

VENTURE CAPITAL VENTURE

A business enterprise involving considerable risk

VENTURE CAPITAL

It is a long term capital invested in companies which involves high risk.

The financing involves high risk but is compensated by high return.

FEATURES OF VENTURE CAPITAL

The following are the features of venture capital

1. It is the financing of capital for new companies.

2. This finance can also be loan-based or in convertible debentures

3. Providers of venture capital aim at capital gain due to the success achieved by the

borrowing concern.

4. Venture capital is always a long-term investment and made in companies which

have high growth potential.

5. The venture capital provider take part in the business of borrowing concern

simultaneously provides managerial skill.

6. Venture capital financing contains risks. But the risk is compensated with a higher

return.

7. It involves financing mainly small and medium size firms, which are in their early

stages. When the assistance of venture capital, these firms will stabilize and later

can go in for traditional finance.

Objectives

• To finance new companies who find it difficult to go to capital market

• To provide long term finance to small and medium scale industries

• To provide managerial assistance

• To bring in rapid growth in the business

Financing By Venture Capital Institutions

Before going in for venture capital finance, the venture capital institution will have to

assess the potentiality of the borrowing concern by a proper appraisal. This appraisal will

be similar to the project appraisal undertaken by commercial banks. There are three


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stages involved in the venture capital finance.

1. Seed capital

It is the capital provided for testing the product and examining the commercial viability

of the product. It enables the venture capital institution to find out the technical skill of the

borrowing concern and its market potentially. So, we can say seed capital is more of a

product development and all the finance required at this stage is provided by the venture

capital institution.

2. Start up

Start up of the product refers to the is tested in the market and after being satisfied

with its acceptability by the market, financing will be provided for further development of

the product and marketing of the product.

The start up may be classified into four categories :

1. A new high technology, introduced by the entrepreneur.

2. A new business started by an entrepreneur who has a thorough working knowledge

and experience – normally started by persons who were working in an established

firm and having gained sufficient experience.

3. New projects started by existing companies.

Example: Retail business started by Hindustan Lever Limited.

4. A new company promoted by existing company. Here, the venture capital

institution is keen to have a first-rated management which may have a second

rated product. But not vice versa i.e., venture capital will not be provided for a

concern having a second-rated management but a first-quality product.

3. Second round finance

It is the second round of finance after the initial stage after being commercially successful

for want of some more finance.

4. Later stage financing

It is the financing after second round finance. The business concern which has borrowed

venture capital has now become a well established business. But still, it is not able to go in

for public issue of shares. At this stage, the venture capital institution will provide finance.

5. Messanine capital

This is a stage where the borrowing company is not only well established but has

overcome the risks and has started earning profits. But they have to go for some more year

before reaching the stage of self sustenance. This finance is used by the borrowing company

for purchase of plant and machinery, repayment of past debts, and entering new areas.

6. Bridge capital

A capital of medium term finance ranging from one to three years and used for extending

a business

Example : bridge loan for acquiring other firms.

7. Management Buy-outs (MBO)

It is the capital used for acquiring all the shares and the voting rights to remove external

control.

Example : An Indian company‘s shares may be purchased by NRIs at the initial

stage and after sometime these shares are bought back by the company with the help of

profits and finance by venture capital institutions.

8. Management buy-in (MBI)


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Management buy in is the case where the funds are provided for an outside group to

buy an on going company.

9. Turn Arounds

Turn around may be

Financial Turn around : When the company is able to improve its conditions

financially, it is called financial turn around, which is due to the financial assistance by

venture capital institution.

Management Turn around : similarly, when the management of the company makes

a turn around by becoming self dependent and is able to face the challenges of business, it

is called management turn around.

Infrastructure financing

Incubators :

Incubators are non profit entities providing consultancy services in promoting venture

capital.

To encourage venture capital industry, it is necessary to develop proper infrastructure

for venture capital, as being done in foreign countries. Consultancy may be about office

environment, finance and other complimentary resources. Incubators are promoted normally

by government or professional organizations interested in developing small companies.

The venture capital fund companies also have their own incubators and they provide

in-house incubators. The job of incubators will be to provide early support to young

entrepreneurs so that the enterprise is converted into a successful commercial venture at

the earliest. For this purpose, proper financial support and managerial support are given.

There are two successful incubator models. These are :

1. Small Business Investment Company Programme (SBIC), administrated by

Small Business Administrator (SBA)

2. Bilateral Industrial Research and Development Foundation (BIRD).

SBIC, USA provides venture capital to private investment managers who promote

small companies. SBIC provides two-third of the capital and the remaining one-third is

provided by insurance companies, endowments, foundations, etc.

The capital supplied by SBA requires rate of return which is much lower than the

market rate. SBIC will also raise capital from the open market. 45% of the total equity is

provided by venture capital firms in America for the small enterprises. This method can be

adopted in India also.

The second model, BIRD is introduced by Israel – The Israeli government with

international corporation, could mobilize funds for providing venture capital fund. The

fund provides not merely financial assistance but infrastructure development, assistance

for manufacturing and for selling innovative products.

Venture Capital In India

The venture capital institutions (VCIs) in India can be broadly classified into 5 types.

1. Venture Capital companies promoted by Development Banks

2. State level Venture capital companies

3. Commercial banks promoted Venture capital companies

4. Private sector Venture capital companies

5. Foreign venture Capital funds.

1. VC companies promoted by Development banks


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a) IDBI – VFC (Venture Fund Company) : IDBI promoted venture fund company

in the year 1986. It is promoted by the Technology Development Wing of IDBI.

b) TDICI - Technology Development and Information company of India

Ltd. This was started in January 1988 with the support of ICICI and UTI. This

is the country‘s first venture fund (Venture Capital Unit Scheme). It was started

with an initial fund of Rs.20 Crores and it has financed nearly 37 small and medium

scale enterprises. At present, it has a total fund of Rs.120 crores. The initial fund

has yielded a return of Rs.16 crores.

c) RCTC – Risk Capital and Technology Finance Corporation Ltd.: It is a

subsidiary of IFCI, started in January 1988. Its resource base has Rs.30 crores

which has contributions from UTI, IFCI and World Bank.

2. State level Venture Capital companies

There are two state-level venture fund companies in India. They are

1. Gujarat Venture Finance Ltd.

2. Andhra Pradesh Venture Capital Limited (AVCL).

Gujarat Venture Finance Ltd : Gujarat Industries Investment Corporation Ltd., along

with Gujarat Lease Finance Corporation Ltd., Gujarat Alkalies & Chemicals Ltd., and

Gujarat State Fertilizer Ltd., promoted Gujarat Venture finance Ltd. It has a venture fund

of Rs.24 crores and was started in 1990.

Andhra Pradesh Venture Capital Limited (AVCL) : This was promoted by APIDC

(Andhra Pradesh Industrial Development Corporation), IDBI, Andhra Bank and Indian

Overseas Bank.

3. Venture Capital Companies promoted by Commercial Banks

Notable among the venture companies promoted by the commercial banks

i. Canara Bank venture Capital Fund (CVCF) :

ii. Grind lays Bank has promoted India Investment Fund and Second India Investment

Fund.

iii. SBI Capital Venture Capital Fund.

4. Private sector Venture Capital companies

In private sector, we have Larazd Credit Capital Venture Fund and Indus Venture

Management Ltd. (IVML).

5. Foreign Venture Capital funds

The Hong Kong Bank has promoted venture fund.

Alliance Capital of U.S.A. has also promoted venture capital fund.

Guidelines For Providing Venture Capital

The venture capital companies have been given certain guidelines for providing venture

capital. Accordingly, the venture capital companies must obtain a detailed report from the

borrowing company. The report should contain the following details : -

1. History of the borrowing company

2. Available facility for the borrowing company

3. Description of the products manufactured by the company

4. Market trend of the products

5. Cash flow position of the concern

6. Operating profit

7. key personnel.


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It takes about 6 months for a venture capital company to process the application

during which period, aspects such as the organizational structure, competition for the

company‘s product, etc., are studied.

Investment Pattern In Venture Capital

The investment plan will consist of 3 stages –

a) Basic stage

b) Operating stage

c) Exit stage

• Basic stage involves the study and evaluation of the project.

• Operating stage deals with monitoring the functioning of the management of the

borrowing concerns and advice for providing new round of finance.

In the course of studying the managerial skill, the following aspects will be taken

a) product quality

b) Market size

c) rate of return

d) venture location

e) growth potential

f) state of entrepreneur

• Exit stage – The borrowing company may be sold to a third party or the company

may be left to look after itself.

While studying the managerial skill, he following aspects will be taken :

a) Product quality

b) Market size

c) Rate of return

d) Venture location

e) Growth potential

f) State of entrepreneur

SUMMARY

In spite of the major steps taken by SEBI to encourage venture capital investor there

is still slow growth of venture capital companies in India. They are due to

a. Lack of understanding of venture capital

b. The companies act s not in favor of venture capital fund

c. No proper exit policy

d. Lack of training to employees of venture capital companies

e. Unfavorable tax regulations

f. Too many restrictions on foreign venture capital companies

g. Lack of clarity in the calculation of equity of borrowing companies.

h. Lack of capital market support

i. Failure to revive sick companies by the venture capital companies.


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PREPARED BY

A.SHANMUGA PRIYA MBA

LECTURER, (DEPT OF MGT STUDIES)

EINSTIEN COLLEGE OF ENGINEERING

TIRUNELVELI – 12.

Merchant Banking and Financial Services

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Transcript of Merchant Banking and Financial Services