Unit I Business Finance Final

8/16/2019 Unit I Business Finance Final

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Unit I

Introduction

We all know that every business requires some amount of money to start and

run the business. Whether it is a small business or large, manufacturing ortrading or transportation business, money is an essential requirement forevery activity. Money required for any activity is known as nance. So theterm ‘business nance refers to the money required for business purposesand the ways by which it is raised. !hus, it involves procurement andutilisation of funds so that business rms will be able to carry out theiroperations e"ectively and e#ciently.

$ou know that a business unit cannot move a single step without su#cientamount of nance. %ut before discussing the importance of nance, let uslearn in detail as to why does the business need funds.

&very business needs funds mainly for the following purposes'(. !o purchase )ed assets ' &very type of business needs some )ed assetslike land and building, furniture, machinery etc. * large amount of money isrequired for purchase of these assets.+. !o meet day to day e)penses ' *fter establishment of a business, fundsare needed to carry out day to day operations e.g., purchase of rawmaterials, payment of rent and ta)es, telephone and electricity bills, wagesand salaries, etc.-. !o fund business growth ' rowth of business may include e)pansion of e)isting line of business as well as adding new lines. !o nance such growth,one needs more funds./. !o bridge the time gap between production and sales ' !he amount spenton production is realised only when sales are made. 0ormally, there is a timegap between production and sales and also between sales and realisation of cash. 1ence, during this interval, e)penses continue to be incurred, for whichfunds are required.2. !o meet contingencies ' 3unds are always required to meet the ups anddowns of business and for some unforeseen problems. Suppose, amanufacturer anticipates shortage of raw materials after a period, then hewould like to stock the raw materials in large quantity. %ut he will be able todo so only if su#cient money is available with him.4. !o avail of business opportunities ' 3unds are also required to avail of business opportunities. Suppose a company wants to submit a tender forwhich some amount of money is required to be deposited along with theapplication. 5n case of non availability of funds it would not be possible forthe company to submit the tender. !ake another e)ample. When a stockisto"ers special discount on large amount of purchase of any particularmaterial then a manufacturer can avail of such o"er, only if he has adequatefunds to buy it.


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Business Finance : Meaning, Need and Importance

%usiness nance refers to money and credit employed in business. 5t

involves procurement and utili6ation of funds so that business rms may beable to carry out their operations e"ectively and e#ciently. !he followingcharacteristics of business nance will make its meaning more clear'

7i8 %usiness nance includes all types of funds used in business.

7ii8 %usiness nance is needed in all types of organisations large or small,manufacturing or trading.

7iii8 !he amount of business nance di"ers f rom one business rm toanother depending upon its nature and si6e. 5t also varies from time to time.

7iv8 %usiness nance involves estimation of funds. 5t is concerned withraising funds from di"erent sources as well as investment of funds fordi"erent purposes.

Objectives & Scope

%usiness nance is required for the establishment of every businessorganisation. With the growth in activities, nancial needs also grow. 3undsare required for the purchase of land and building, machinery and other )edassets. %esides this, money is also needed to meet day to day e)penses e.g.purchase of raw material, payment of wages and salaries, electricity bills,telephone bills etc. $ou are aware that production continues in anticipation of demand. &)penses continue to be incurred until the goods are sold andmoney is recovered. Money is required to bridge the time gap betweenproduction and sales. %esides producers, may be necessary to change theo#ce set up in order to install computers. 9enovation of facilities can betaken up only when adequate funds are available.

&very business needs funds mainly for the following purposes'(.!o purchase )ed assets ' &very type of business needs some )ed assetslike land and building, furniture, machinery etc. * large amount of money isrequired for purchase of these assets.+.!o meet day to day e)penses ' *fter establishment of a business, funds areneeded to carry out day to day operations e.g., purchase of raw materials,


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payment of rent and ta)es, telephone and electricity bills, wages andsalaries, etc.-.!o fund business growth ' rowth of business may include e)pansion of e)isting line of business as well as adding new lines. !o nance such growth,one needs more funds.

/.!o bridge the time gap between production and sales ' !he amount spenton production is realised only when sales are made. 0ormally, there is a timegap between production and sales and also between sales and realisation of cash. 1ence, during this interval, e)penses continue to be incurred, for whichfunds are required.2.!o meet contingencies ' 3unds are always required to meet the ups anddowns of business and for some unforeseen problems. Suppose, amanufacturer anticipates shortage of raw materials after a period, then hewould like to stock the raw materials in large quantity. %ut he will be able todo so only if su#cient money is available with him.4.!o avail of business opportunities ' 3unds are also required to avail of

business opportunities. Suppose a company wants to submit a tender forwhich some amount of money is required to be deposited along with theapplication. 5n case of non availability of funds it would not be possible forthe company to submit the tender.

!ake another e)ample. When a stockist o"ers special discount on largeamount of purchase of any particular material then a manufacturer can availof such o"er, only if he has adequate funds to buy it.

Recent Reforms in Financia Sector

3inancial sector is the mainstay of any economy and it contributesimmensely in the mobilisation and distribution of resources. 3inancial sectorreforms have long been viewed as signi cant part of the program for policyreform in developing nations. &arlier, it was thought that they were e)pectedto increase the e#ciency of resource mobili6ation and allocation in the realeconomy to generate higher rates of growth. 9ecently, they are also seen tobe critical for macroeconomic stability. 5t was due to the repercussion of the&ast *sian crisis, since weaknesses in the nancial sector are broadlyregarded as one of the ma:or causes of collapse in that region.

!he elements of the nancial sector are %anks, 3inancial 5nstitutions,

5nstruments and markets which mobilise the resources from the surplussector and channeli6e the same to the di"erent needy sectors in theeconomy. !he process of accumulative capital growth throughinstitutionalisation of savings and investment fosters economic growth.9eform of the nancial sector was recogni6ed, from the very beginning, as anintegral part of the economic reforms initiated in (;;(. !he economic reformprocess occurred amidst two serious crisis involving the nancial sector thebalance of payments crisis that endangered the international credibility of


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the country and pushed it to the edge of default< and the grave threat of insolvency confronting the banking system which had for years concealed itsproblems with the help of faulty accounting strategies. 3urthermore, somedeep rooted problems of the 5ndian economy in the early nineties were alsostrongly related to the nancial sector such as large scale pre emption of

resources from the banking system by the government to nance its scalde cit. &)cessive structural and micro regulation that inhibited nancialinnovation and increased transaction costs. 9elatively inadequate level of prudential regulation in the nancial sector. =oorly developed debt andmoney markets. *nd outdated 7often primitive8 technological andinstitutional structures that made the capital markets and the rest of the

nancial system highly ine#cient 7Mathieu, (;;>8.

Ma:or aims of the nancial sector reforms are to allocate the resourcespro ciently, increasing the return on investment and hastened growth of thereal sectors in the economy. !he processes introduced by the overnment of

5ndia under the reform process are intended to upturn the operationale#ciency of each of the constituent of the nancial sector.

!he ma:or delineations of the nancial sector reforms in 5ndia were found asunder'

• 9emoval of the erstwhile e)isting nancial repression.

• ?reation of an e#cient, productive and pro table nancial sector.

• &nabling the process of price discovery by the market determination of interest rates that improves allocate e#ciency of resources.

• =roviding operational and functional autonomy to institutions.

• =reparing the nancial system for increasing international competition.

• @pening the e)ternal sector in a calibrated manner.

• =romoting nancial stability in the wake of domestic and e)ternalshocks.

*t global level, nancial sector reforms have been driven by two apparentlycontrary forces. !he rst is a thrust towards liberali6ation, which seeks todecrease, if not eliminate a number of direct controls over banks and other

nancial market participants. !he second is a thrust in favour of strictregulation of the nancial sector. !his dual approach is also apparent in thereforms tried in 5ndia.


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3inancial and banking sector reforms are in following areas'3inancial markets

• 9egulators

• !he banking system

• 0on banking nance companies

• !he capital market

• Mutual funds

• @verall approach to reforms

•

Aeregulation of banking system• ?apital market developments

• ?onsolidation imperative

Regu ators

!he 3inance Ministry constantly formulated ma:or strategies in the eld of nancial sector of the country. !he overnment acknowledged the important

role of regulators. !he 9eserve %ank of 5ndia 79%58 has become more

independent. Securities and &)change %oard of 5ndia 7S&%58 and the5nsurance 9egulatory and Aevelopment *uthority 759A*8 became importantinstitutions. Some opinions are also there that there should be a superregulator for the nancial services sector instead of multiplicity of regulators.

Indian Ban!ing Sector and Financia Reforms

!he main intent of banking sector reforms was to uphold a diversi ed,e#cient and competitive nancial system with the aim of improving theallocative e#ciency of resources through operational Be)ibility, improved

nancial viability and institutional solidi cation.

*s early as *ugust (;;(, the government selected a high level ?ommittee onthe 3inancial System 7the 0arasimham ?ommittee8 to look into all facets of the nancial system and make comprehensive recommendations forimprovements. !he ?ommittee submitted its report in 0ovember (;;(,making several recommendations for reforms in the banking sector and alsoin the capital market. Soon thereafter, the government announced broadacceptance of the approach of the 0arasimham ?ommittee and a process of


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gradualist reform in the banking sector and in the capital market was set inmotion, a process that has now been under way for more than si) year.

5n 5ndia, around >CD of businesses are regulated by public sector banks.=S%s are still governing the commercial banking system. !he 9%5 has givenlicenses to new private sector banks as part of the liberali6ation process. !he9%5 has also been granting licenses to industrial houses. Many banks aree"ectively running in the retail and consumer segments but are yet todeliver services to industrial nance, retail trade, small business andagricultural nance. Ma:or change observed by individuals is manytransformation in policies of the banking sector. !he reforms have focussedon eliminating nancial repression through reductions in statutory preemptions, while stepping up prudential regulations at the same time.

*dditionally, interest rates on both deposits and lending of banks have beengradually deregulated.

"#e major reforms re ating to t#e ban!ing s$stem %ere:

• ?apital base of the banks were strengthened by recapitali6ation, publicequity issues and subordinated debt.

• =rudential norms were introduced and progressively tightened forincome recognition, classi cation of assets, provisioning of bad debts,marking to market of investments.

• =re emption of bank resources by the government was reducedsharply.

• 0ew private sector banks were licensed and branch licensingrestrictions were rela)ed.

Simi ar $, severa operationa reforms %ere introduced in t#e area of credit po ic$:

• Aetailed regulations relating to Ma)imum =ermissible %ank 3inancewere abolished.

• ?onsortium regulations were rela)ed substantially.

• ?redit delivery was shifted away from cash credit to loan method.


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Many reports signi ed that the initial steps have been taken in the form of allowing new banks to set up shop. =rivate ?orporates, public sector entitiesand 0on %anking 3inance ?ompanies with a strong track record can nowapply to set up new banks and the 9eserve bank of 5ndia will consider theseapplications in the coming months. !he addition of new banks will mean

more competition for this sector in the country and it will lead to adevelopment in services for the end customer. 5t is anticipated to increasenancial enclosure as more and more people across the country will be able

to access banking facilities. 5n reforms for the e)isting banks the publicsector banks have been allowed to increase or decrease the authorisedcapital without the presence of an overall ceiling. !his will provide greaterBe)ibility to the banks to conduct their fund raising activities as per therequirements. !he strict restriction of voting rights in banks will also berela)ed and this will aid the banking sector to develop, as large investors willbe able to get a bigger voice in the coming days in the banks and themanner in which they operate.

When evaluating banking sector reform, it can be identi ed that banks havee)perienced strong balance sheet growth in the post reform period in anenvironment of operational Be)ibility. &nhancement in the nancial health of banks, reBected in noteworthy improvement in capital adequacy andimproved asset quality, is distinctly observable. 5t is striking that thisprogress has been realised despite the espousal of international bestpractices in prudential norms. ?ompetitiveness and productivity gains havealso been enabled by proactive technological deepening and Be)ible humanresource management. !hese signi cant gains have been achieved evenwhile renewing goals of social banking vi6. maintaining the wide reach of the

banking system and directing credit towards important but underprivilegedsectors of civilisation.

Foreign 'c#ange Mar!et Reform

3ore) market reform took place in (;;- and the successive adoption of current account convertibility were the acmes of the fore) reformsintroduced in the 5ndian market. Ender these reforms, authorised dealers of foreign e)change as well as banks have been given greater sovereignty toperform in activities and numerous operations. *dditionally, the entry of newcompanies have been allowed in the market. !he capital account has

become e"ectively adaptable for non residents but still has somereservations for residents.

Impact on t#e Reform Measures

!he broader ob:ectives of the nancial sector reform process are to articulatethe policy to enhance the nancial condition and to reinforce the institutions.*s part of the reforms process, many private banks were granted licence to


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operate in 5ndia. !his has resulted into a competitive environment in thebanking industry which in turn has assisted in using the resources morecompetently. ?onventionally, the industrial units were sanctioned term loanby the development banks and working capital by the commercial banks.

!he reform process has transformed the pattern of nancing and now both

the institutions are willing to e)tend long term loan as well as working capitalloan. %ut there is some di"erence in the mode of operation. !his hasempowered the industrial units to avail credit facilities from a singleinstitution. Aespite the fact that the banks provide both the term loan andthe working capital loans, the industrial units prefer the development banksfor the following reasons.

5t provides equal support to the new as well as e)isting industries.

!he period of repayment of loan is comparatively longer.%esides providing nancial backing, it acts as the implementing agency for

the di"erent government sponsored schemes. 1ence the industrial units canavail of both the nancial assistance as well as the incentives o"ered undervarious development schemes through a Single Window System. *s lendingis the main activity of these institutions, it acquires specialisation in this eldand can share its e)pertise with the industrial units.

Reform of t#e Insurance Sector

!he 5nsurance sector in 5ndia directed by 5nsurance *ct, (;->, the Fife5nsurance ?orporation *ct, (;24 and eneral 5nsurance %usiness70ationalisation8 *ct, (;G+, 5nsurance 9egulatory and Aevelopment *uthority

759A*8 *ct, (;;; and other related *cts. !he basis of liberali6ing the bankingsystem and encouraging competition among the three ma:or participantsHvi6. public sector banks, 5ndian private sector banks, and foreign banks,applies equally to insurance. !here is a strong case for ending the publicsector monopoly in insurance and opening it up to private sector participantssub:ect to suitable prudential regulation.

?ross country data advocates that contractual savings institutions are highlysigni cant determinant of the aggregate rate of savings and insurance andpension schemes are the most important form of contractual savings in thisreference. * competitive insurance industry providing diversi ed insurance

products to ful l di"ering customer needs, can help increase savings in thissituation and allocate them e#ciently. !he insurance and pensions industryhas long term liabilities which it seeks to match by investing in long termsecure assets. * healthy insurance is an important source of long termcapital in domestic currency which is especially for infrastructure nancing.5mprovements in insurance will strengthen the capital market at the longterm end by adding new companies in this section of the market, giving itgreater depth or liquidity. 9eforms in insurance are likely to create a Bow of


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nance for the corporate sector if people can simultaneously make progressin reducing nancial de cit.

"#e Ma #otra (ommittee had suggested opening up the insurance sectorto new private companies as early as (;;/. 5t took ve years to build an

agreement on this issue and legislation to open up insurance, allowingforeign equity up to +4 per cent was nally submitted to =arliament in (;;;.

Overa )pproac# to Reforms

5t is assessed that since last many years, there have seen ma:orimprovements in the working of various nancial market contributors. !hegovernment and the regulatory authorities have followed a step by stepapproach. !he entry of foreign companies has helped in the start of international practices and systems. !echnology developments haveenhanced customer service. Some gaps however remain such as lack of an

inter bank interest rate benchmark, an active corporate debt market and adeveloped derivatives market. 5n general, the cumulative e"ect of thedevelopments since (;;( has been quite encouraging. *n indication of thestrength of the reformed 5ndian nancial system can be seen from the way5ndia was not a"ected by the Southeast *sian crisis.

!o summari6e, the nancial sector is main element of the 5ndian economicsystem. 3inancial e)perts suggested that there is a need for e"ective reformsto ensure that this remains competitive and attractive for investors fromacross the world. !he economic reforms have preferred the need forchanging the policy ob:ective to promotion of industries and the formation of

more integrated infrastructural facilities. 3inancial sector reforms are centrepoint of the economic liberali6ation that was introduced in 5ndia in mid (;;(.5t was witnessed that national nancial liberalisation has brought about thederegulation of interest rates, dismantling of directed credit, improving thebanking system, enhancing the functioning of the capital market that includethe government securities market. 9egulators and economic e)perts putmore emphasis on banking reforms to enhance economy and enable peopleto access numerous facilities. 3undamental ob:ective of nancial sectorreforms in the (;;Cs was to create an e"ectual, competitive and steady thatcould contribute in greater measure to inspire progression.

Sources of Business Finance

!he type and amount of funds required usually di"ers from one business toanother. 3or instance, if the si6e of business is large, the amount of fundsrequired will also be large. Fikewise, the nancial requirements are more inmanufacturing business as compared to trading business. !he business


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needs funds for longer period to be invested in )ed assets like land andbuilding, machinery etc. Sometimes, the business also needs funds to beinvested for shorter period. So based on the period for which the funds arerequired, the business nance is classi ed into three categories.7a8 Short term 3inance<

7b8 Medium term 3inance< and7c8 Fong term 3inance<

S#ort term Finance3unds required to meet day to day e)penses are known as short term

nance. !his is required for purchase of raw materials, payment of wages,rent, insurance, electricity and water bills, etc. !he short term nance isrequired for a period of one year or less. !his nancial requirement for shortperiod is also known as working capital requirement or circulating capitalrequirement. 5t may be noted that a part of the working capital requirement

is of a long term nature, as certain minimum amount of funds are alwayskept to meet the requirement of stock and regular day to day e)penses.Medium*term FinanceMedium term nance is utilised for all such purposes where investments arerequired for more than one year but less than ve years. *mount required tofund moderni6ation and renovation, special promotional programmes etc. fallin this category.+ong*term Finance

!he amount of funds required by a business for more than ve years is calledlong term nance. enerally this type of nance is required for the purchaseof )ed assets like land and building, plant and machinery, furniture etc. !he

long term nance is also known as )ed capital as such need in fact is, of apermanent nature.


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(apita Mar!et

?apital market is de ned as a nancial market that works as a channel for

demand and supply of debt and equity capital. 5t channels the moneyprovided by savers and depository institutions 7banks, credit unions,insurance companies, etc.8 to borrowers and investees through a variety of

nancial instruments 7bonds, notes, shares8 called securities. * capitalmarket is not a compact unit, but a highly decentrali6ed system made up of three ma:or parts that include stock market, bond market, and moneymarket. 5t also works as an e)change for trading e)isting claims on capital inthe form of shares. !he ?apital Market deals in the long term capitalSecurities such as &quity or Aebt o"ered by the private business companiesand also governmental undertakings of 5ndia.

Structure of (apita Mar!et of India

5n the agenda of nancial sector reforms, 5mprovement of the capital marketis important area and action has been taken parallel with reforms in banking.5ndia has e)perienced functioning in capital markets the %ombay Stock&)change 7%S&8 for over a hundred years but until the (;>Cs, the volume of activity in the capital market was relatively limited. ?apital market activitye)tended rapidly in the (;>Cs and the market capitali6ation of companiesregistered in the %S& rose from 2 per cent of A= in (;>C to (- per cent in(;;C. 5t is observed that the 5ndian capital market has perceived ma:orreforms in the decade of (;;Cs and thereafter. 5t is on the edge of thegrowth. !hus, the overnment of 5ndia and S&%5 took numerous measures inorder to improve the working of the 5ndian stock e)changes and to make itmore progressive and energetic. !he Securities and &)change %oard of 5ndia7S&%58 was well known in (;>>. 5t got a legal status in (;;+. S&%5 wasprincipally set up to control the activities of the commercial banks, to controlthe operations of mutual funds, to work as a promoter of the stock e)changeactivities and to act as a regulatory authority of new issue activities of companies. !he S&%5 was established with the vital ob:ective, Ito protect theinterest of investors in securities market and for matters connectedtherewith or incidental thereto.I !he main functions of S&%5 are as follows'

• !o control the business of the stock market and other securitiesmarket.

• !o promote and regulate the self regulatory organi6ations.

• !o forbid fraudulent and unfair trade practices in securities market.


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• !o promote awareness among investors and training of intermediariesabout safety of market.

• !o prohibit insider trading in securities market.

• !o regulate huge acquisition of shares and takeover of companies.

1owever the stock market remained primeval and poorly controlled.?ompanies who want to access the capital market needed prior permissionof the government which also had to approve the price at which new equitycould be raised. While new issues were strictly controlled, there wasinsu#cient regulation of stock market activity and also of various marketparticipants including stock e)changes, brokers, mutual funds, etc. !hedomestic capital market was also closed to portfolio investment from abroade)cept through a few closed ended mutual funds Boated abroad by the Enit

!rust of 5ndia 7E!58 which were committed to 5ndian investment.

!he practice of reform of the capital market was started in (;;+ along thelines recommended by the 0arasimham ?ommittee. 5t was intended toremove direct government control and replacing it by a regulatory frameworkbased on transparency and disclosure supervised by an independentregulator. !he rst step was taken in (;;+ when the Securities and &)change%oard of 5ndia 7S&%58, which was initially established as a non statutory bodyin (;>>, was raised to a complete capital market regulator with statutorypowers in (;;+. !he requirement of prior government permission foraccessing capital markets and for prior approval of issue pricing was stoppedand companies were permissible to access markets and price issues freely,sub:ect only to disclosure norms laid down by S&%5.

Opening t#e (apita Mar!et to Foreign Investors

Signi cant policy initiative in (;;- was the opening of the capital market toforeign institutional investors 7355s8 and allowing 5ndian companies to raisecapital abroad by issue of equity in the form of global depository receipts7 A9s8.

Moderni ation of "rading and Sett ement S$stems

Ma:or developments occurred in trading methods which were highlyantiquated earlier. !he 0ational Stock &)change 70S&8 was established in(;;/ as an automated electronic e)change. 5t empowered brokers in ++Ccities all over the country to link up with the 0S& computers via JS*!s andtrade in a uni ed e)change with automatic matching of buy and sell orderswith price time priority, thus ensuring ma)imum transparency for investors.


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!he initiation of electronic trading by the 0S& generated competitivepressure which forced the %S& to also introduce electronic trading in (;;2.

Futures "rading

?urrently, an important gap in 5ndiaHs capital market is future markets. oodmarket in inde) futures would help in risk management and provide greaterliquidity to the market. * decision to present futures trading has been takenand the legislative changes needed to implement this decision have beensubmitted to parliament.

=rimary Market 70ew 5ssue Market8

=rimary market is also known as new issue market. *s in this marketsecurities are sold for the rst time, i.e., new securities are issued from thecompany. =rimary capital market directly contributes in capital formationbecause in primary market company goes directly to investors and utilisesthese funds for investment in buildings, plants, machinery etc.

!he primary market does not include nance in the form of loan fromnancial institutions because when loan is issued from nancial institution it

implies converting private capital into public capital and this process of converting private capital into public capital is called going public. !hecommon securities issued in primary market are equity shares, debentures,bonds, preference shares and other innovative securities.

Met#od of F oatation of Securities in -rimar$ Mar!et !he securities may be issued in primary market by the following methods'


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./ -ub ic Issue t#roug# -rospectus

Ender this method company issues a prospectus to inform and attractgeneral public. 5n prospectus company provides details about the purpose forwhich funds are being raised, past nancial performance of the company,background and future prospects of company.

!he information in the prospectus helps the public to know about the riskand earning potential of the company and accordingly they decide whetherto invest or not in that company !hrough 5=@ company can approach largenumber of persons and can approach public at large. Sometimes companiesinvolve intermediaries such as bankers, brokers and underwriters to raisecapital from general public.


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0/ O1er for Sa e

Ender this method new securities are o"ered to general public but notdirectly by the company but by an intermediary who buys whole lot of securities from the company. enerally the intermediaries are the rms of


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brokers. So sale of securities takes place in two steps' rst when thecompany issues securities to the intermediary at face value and secondwhen intermediaries issue securities to general public at higher price to earnpro t. Ender this method company is saved from the formalities andcomple)ities of issuing securities directly to public.

2/ -rivate - acement

Ender this method the securities are sold by the company to an intermediaryat a )ed price and in second step intermediaries sell these securities not togeneral public but to selected clients at higher price. !he issuing company

issues prospectus to give details about its ob:ectives, future prospects sothat reputed clients prefer to buy the security from intermediary. Ender thismethod the intermediaries issue securities to selected clients such as E!5,F5?, eneral 5nsurance, etc.

!he private placement method is a cost saving method as company is savedfrom the e)penses of underwriter fees, manager fees, agents commission,listing of company s name in stock e)change etc. Small and new companiesprefer private placement as they cannot a"ord to raise from public issue.

3/ Rig#t Issue 4For 'isting (ompanies5

!his is the issue of new shares to e)isting shareholders. 5t is called right issuebecause it is the pre emptive right of shareholders that company must o"erthem the new issue before subscribing to outsiders. &ach shareholder hasthe right to subscribe to the new shares in the proportion of shares he


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already holds. * right issue is mandatory for companies under ?ompanies*ct (;24.

!he stock e)change does not allow the e)isting companies to go for newissue without giving pre emptive rights to e)isting shareholders because if new issue is directly issued to new subscribers then the e)isting equityshareholders may lose their share in capital and control of company i.e., itwould water their equity. !o stop this the pre emptive or right issue iscompulsory for e)isting company.

6/ e*I-Os, 4e ectronic Initia -ub ic O1er5

5t is the new method of issuing securities through on line system of stocke)change. 5n this company has to appoint registered brokers for the purposeof accepting applications and placing orders. !he company issuing securityhas to apply for listing of its securities on any e)change other than the


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e)change it has o"ered its securities earlier. !he manager coordinates theactivities through various intermediaries connected with the issue.

Secondary Market 7Stock &)change8'

!he secondary market is the market for the sale and purchase of previouslyissued or second hand securities.

5n secondary market securities are not directly issued by the company toinvestors. !he securities are sold by e)isting investors to other investors.Sometimes the investor is in need of cash and another investor wants to buythe shares of the company as he could not get directly from company. !henboth the investors can meet in secondary market and e)change securities forcash through intermediary called broker.

5n secondary market companies get no additional capital as securities arebought and sold between investors only so directly there is no capitalformation but secondary market indirectly contributes in capital formation byproviding liquidity to securities of the company.

5f there is no secondary market then investors could get back theirinvestment only after redemption period is over or when company getsdissolved which means investment will be blocked for a long period of timebut with the presence of secondary market, the investors can convert theirsecurities into cash whenever they want and it also gives chance to investorsto make pro t as securities are bought and sold at market price which isgenerally more than the original price of the securities.

!his liquidity o"ered by secondary market encourages even those investorsto invest in securities who want to invest for small period of time as there isoption of selling securities at their convenience.

Unit I Business Finance Final

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Transcript of Unit I Business Finance Final