Chapter_1 3rd Sem

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CHAPTER – 1

MERCHANT BANKING: NATURE AND SCOPE

INVESTMENT BANKING:

Investment banks in USA are the most important participantsin the direct market by bringing financial claims for sale. Theyspecialize in helping businesses and governments sell theirnew security issues, whether debt or equity in the primarymarket to finance capital expenditures. Once the securities aresold, investment bankers make secondary markets for thesecurities as brokers and dealers.

INVESTMENT BANKS V/S COMMERCIAL BANKS

Early investment banks in USA differed from commercial

banks which accepted deposits and madecommercial loans. Commercial banks were chartered

exclusively to issue bank notes and make shortterm business loans. On the other hand, early

investment banks were partnership and were not subject toregulations that apply to corporations. Investment banks werereferred to as private banks and engaged in any business theyliked and could locate their offices anywhere. While investmentbanks could not issue notes, they could accept deposits as wellas underwrite and trade in securities.

The distinction between commercial banking andinvestment banking is unique and confined to the UnitedStates, where legislation separates them. In countries wherethere is no legislated separation, banks provide investmentbanking services as part of their normal range of business

activities. Countries where investment banking andcommercial banking are combined have‘universal banking’ systems. European countries haveuniversal banking system which accept deposits, make loans,underwrite securities, engage in brokerage activities and offer

financial services.

RESTRICTIONS ON COMMERCIAL BANKS

In India commercial banks are restricted from buying andselling securities beyond 5% of their net incremental depositsof the previous year. They can subscribe to securities in theprimary market and trade in shares and debentures in thesecondary market. Issue management activities which are not

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fund based are managed by wholly owned subsidiaries anddistinct from the Banks’ operations. Further, acceptance of deposits is limited to commercial banks. Non-bank financialintermediaries accept deposits for fixed term and arerestricted to financial intermediaries accept deposits for fixedterm and are restricted to financing leasing/hire purchase,

investment and loan activities and housing finance. Theycannot act as issue managers or merchant banks. Onlymerchant bankers registered with Securities and ExchangeBoard of India (SEBI) can undertake issue management andunderwriting, arrange mergers and offer portfolio services..

INVESTMENT BANKING IN USA

English and European merchant banks played a prominentrole in the United States until indigenous investment bankersemerged in the 1880’s. In the early 19th century English andEuropean merchant bankers met the requirements of finance

for rail road construction and international trade. Later theyopened their own offices in USA. Kidder, Peabody & Co. wassetup in 1824 and John Eliot Thayar banking firm in 1857.During 1850-60 several merchant banks were set up to arrangecapital and enterprise to promote railways, industrial projectsand trade and commerce. In the late 1890’s and 1900’sinvestment bankers replaced brokers and promoters whoearlier played a prominent role in the issue of securities.Investment bankers apart from launching and organizationindustrial units and mergers helped transform privately heldcompanies into publicly owned companies.

Investment banking largely remained unregulated untilthe Blue Sky laws were introduced in Kansas to protectinvestors from fraudulent promoters and security salesman.However, their growth was facilitated by the enactment of federal Act in 1914, emergence of US dollar as leadinginternational currency and expansion of activities of USbanking system.

Prominent investment bankers in 1920’s were Kidder,Peabody, Drexel, Morgon & Co., Brown Bros and J.P.Morgonwho bought and sold corporate bonds and stocks oncommission, dealt in federal, state and municipal securities,trading and investing in securities on their own account,originating and distributing new issues and participating in themanagement of corporations whose securities they had helpeddistribute or in which they invested.

INVESTMENT BANKING V/S MERCHANT BANKING

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There is a subtle difference between merchant bankingand investment banking. Merchant banking purely fee- based(except for underwriting) whereas investment banking is bothfee- and fund- based. Investment bankers commit their ownfunds.

Evidence of the trend is the adoption of bought out deals(BOD’s), initial placement of equity, compulsory sponsorshipon OTCEI, venture capital fund, influx of foreign investmentbanks and acquisition of stake in Indian merchant banks byforeign investment banks (Merill Lynch in DSP). ICICI can beregarded as an investment banking outfit.

POTENTIAL FOR INVESTMENT BANKING IN INDIA

The bane of Indian Capital Markets today is the lack of investor’s confidence. This is reflected in the poor performancein both primary and secondary markets. The causes for the

existing situation are many but primary arise on account of lack of liquidity, unscrupulous issuers and merchant bankersand poor or unappraised issues. Investment, banking can solvethis problem because investors would be dealing with reputedinvestment bankers in the primary market rather thanunknown issuers. The investment banks whatever are theirissue management techniques have their own capital on hold.The issues are likely to be properly appraised and priced andsponsors on OTCEI (Over The-Counter Exchange of India) havea 2- year lock- in period. Similarly, investment banks wouldhold the issues until market conditions are appropriate forissue, thus reducing the risk of investors to gestation for issue.

Moreover, the price of reissue will be a better indicator of issue’s performance. Investment banks make the primarymarket for IPOs, thus assuring protection to the issue aboutsubscription.

In sum, the quality of pricing, appraisal, and primarymarket function will improve resulting in substantialimprovement in investor confidence. Since the investmentbank lends its name to the issue it will imply that investors cantrust the issue.

UNIVERSAL BANKING

A good deal of interest is generated in Indian in theconcept of universal banking in view of the expansion of theactivities of all India development banks into traditionalcommercial banking activity such as working capital financeand the participation of commercial banks in project finance,an area earlier confined to all India as well as state levelfinancial institutions. Further, the reforms in the financial

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sector since 1992 have ushered in significant changes in theoperating environment of banks and financial institutionsdriven by deregulation of interest rate and emergence of disintermediation pressures arising from liberalized capitalmarkets. In the light of these developments, the Reserve Bank appointed a Working Group (Chairman Shri S.H. Khan) in

December 1997 to examine and suggest policy measure forharmonizing the role and operations of development financeinstitutions and banks.

DEFINITION OF UNIVERSAL BANKING

Universal banking refers to the combination of commercial banking and investment banking includingsecurities business. “Universal Banking can be defined as theconduct of range of financial services comprising deposit

taking and lending, trading of financial instruments andforeign exchange (and their derivatives) underwriting of newdebt and equity issues, brokerage, investment managementand insurance”. The concept of universal banking envisagesmultiple business activities.

MERCHANT BANKS V/S COMMERCIAL BANKS

There are difference in approach, attitude and areas of operation between commercial banks and merchant banks. Thedifference between merchant banks and commercial banks arelisted below:

1. Commercial banks basically deal in debt and debt relatedfinance and their activities are appropriately arrayed aroundcredit proposals, credit appraisal and loan sanctions. On theother hand, the area of activity of merchant bankers is ‘equityand equity related finance’. They deal with mainly fund raisedthrough money market and capital market.

2. Commercial banks are asset oriented and their lendingdecisions are based on detailed credit analysis of loanproposals and the value of security offered against loans. Theyare generally avoiding risks. The merchant bankers aremanagement oriented. They are willing to accept risk of

business.

3. Commercial banks are merely financiers. The activities of merchant bankers include project counseling, corporatecounseling in areas of capital restructuring, amalgamations,mergers, takeover etc., discounting and rediscounting of shortterm paper in money markets, managing, underwriting andsupporting public issues in the new issue market and acting asbrokers and advisors on portfolio management in stock

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exchange. Merchant banking activities have impact on growth,stability and liquidity of money markets.

ORIGIN OF MERCHANT BANKING

The origin of merchant banking is traced back to Italy inlate medieval times and France during the 17th and 18th

centuries. The Italian merchant bankers introduced intoEnglish not only the bell of exchange but also all theinstitutions and techniques connected with an organizedmoney market. Merchant banking consisted initially of merchants who assisted in financing the transactions of othermerchants in addition to their own trade. In France, during 17th

and 18th centuries a merchant banker (le merchand banquer)was not merely a trader but an entrepreneur par excellence.He invested his accumulated profits in all kinds of promising

activities. He added banking business to his merchantactivities and become a merchant banker.

MONEY CHANGER AND EXCHANGER

In the Late medieval to early modern times, a distinctionexisted in banking systems between money changer andexchanger. Money changers concentrated on the manualchange of different currencies operated locally and lateraccepted deposits for security reasons. In course of time,money changers evolved into public or deposit banks;exchangers who operated internationally, engaged in bill-

broking, raising foreign exchange and provision of long termcapital for public borrowers. The exchangers were remittersand merchant bankers. In the 17th century, a merchant bankerwas a dealer in bills of exchange who operated withcorrespondents abroad and speculated on the rate of exchange.

Initially, merchant banks were not banks at all and adistinction was drawn between banks, merchant banks andother financial institutions. Among all these institutions, it wasonly banks accepted deposits from public.

MERCHANT BANKS IN THE UNITED KINGDOM

In the United Kingdom, merchant banks came on thescene in the late 18th century and early 19th century. Industrialrevolution made England into a powerful trading nation. Richmerchant houses that made their fortunes in colonial tradediversified into banking. Their principal activity started withacceptance of commercial bills pertaining to domestic as wellas international trade. The acceptance of the trade bills and

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their discounting gave rise to acceptance houses, discounthouses and issue houses. Merchant banks initially includedacceptance houses discount houses and issue houses. Amerchant banker was primarily a merchant rather than abanker but he was entrusted with funds by his customers.

The term merchant bank is used in the United Kingdom(the oldest merchant bank in London was Baring Brothers andit was very prominent in Europe during 19th century, and it hadconsiderable representation in North and South America) todenote banks that are not merchants, sometimes formerchants who are not bankers and sometimes for businesshouses that are neither merchants nor banks. The confusionhas arisen because modern merchant banks have a wide rangeof activities. Merchant banks in United Kingdom (a) Financeforeign trade, (b) Issue capital, (c) Manage individual funds,and (d) undertake foreign security business and (e) foreignloan business. Many major merchant banking activities

(money-market lending, corporate finance, and investmentmanagement), are also performed by money-market dealers,commercial banks and finance companies share brokers andinvestment consultants, and unit trust managers.

A merchant bank should have 11 characteristics: highproportion of decision makers as a percentage of total staff;quick decision process; high density of information; intensecontact with the environment; loose organizational structure;concentration of short and medium term engagements;emphasis on fee and commission services on a national andinternational level; low rate of profit distribution; and highliquidity ratio.

Since the end of the 2nd world war commercial banks inWestern Europe have been offering multiple services includingmerchant banking services to their individual and corporateclients. British banks set up divisions or subsidiaries to offertheir customers merchant banking services.

MERCHANT BANKING IN INDIA

As planning and industrial policy envisaged the settingup of new industries and technology greater financialsophistication and financial services are required.

Economic development requires specialist financial skills:savings banks to marshal individual saving; finance companiesfor consumer lending and mortgage finance; insurancecompanies for life and property cover; agricultural banks forrural development; and a range of specialized government orgovernment sponsored institutions. As new units were set up

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and businesses expanded, they required additional financialservices which were then not provided by the banking system.Like the local banking system and the trade before, the localsystem of family enterprises was unsuited for raising largeamounts of capital. A merchant equity or debt issue was thelogical source of funds.

Merchant banks serve a dual role within the financialsector. Through deposits or sales of securities they obtainfunds for lending to their clients (SEBI forbids lending bygovernment): a function similar to most institutions. Theirother role is to act as agents in return for fee. SEBI envisages amandatory role for merchant banks in exercising due diligenceapart from issue management, in buy-backs and public offerintake over bids. Their underwriting and corporate financialservices are all fees rather than fund based and theirsignificance is not reflected in their total assets of theindustry. SEBI has been pressing for merchant banks to be

primarily fee based institutions.

BANKING COMMISSION REPORT, 1972

The banking commission in its report in 1972 hasindicated the necessity of merchant banking service in view of the wide industrial base of the Indian Economy. Thecommission was in favor of a separate institutions (as distinctfrom commercial banks and term lending institutions) torender merchant banking services. The Commission suggestedthat they should offer investment management and advisory

services particularly to the medium and small savers. TheCommission also suggested that they should be able tomanage provident funds, pension funds and trusts of varioustypes.

Merchant banking activity was formally initiated into theIndian capital markets when Grind lays Banks received thelicense from Reserve Bank in 1967. Grind lays which startedwith management of capital issues recognized the needs of emerging class of entrepreneurs for diverse financial servicesranging from production planning and systems design tomarket. Apart from meeting specially, the needs of small scale

units, it provided management consultancy services to largeand medium size computers. Following Grindlays Banks,Citibank set up its merchant banking division in 1970. Thedivision took up the task assisting new entrepreneurs andexisting units in the evaluation of new projects raising fundsthrough borrowing and issues of equity. Managementconsultancy services were also offered.

Consequent to the recommendations of bankingcommission in 1972, that Indian banks should start merchant

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banking services as part of their multiple services they couldoffer their clients, State Bank of India started the merchantbanking division in 1972. In the initial years the SBI’s objectivewas to render corporate advice and assistance to small andmedium entrepreneurs.

The commercial banks that followed State Bank of India insetting up merchant banking units were Central Bank of India,Bank of India and syndicate bank in 1977; Bank of Baroda,Standard Chartered Bank, and Mercantile bank in 1978; andUnited Bank of India, United Commercial Bank, Punjab NationalBank, Canara Bank and Indian Overseas Bank in late 70’s andearly 80’s. Among the development banks, ICICI startedmerchant banking activities in 1973, followed by IFCI (1986)and IDBI (1991).

ORGANIZATION OF MERCHANT BANKING UNITS

The structure of organization of merchant banks revealscertain similar characteristics:

• A high proportion of professionals to total staff;

• A substantial delegation of decision making;

• A short chain of command;

• Rapid decision making;

• Flexible organization structure;

• Innovative approaches to problem solving; and

• High level of financial sophistication.

In the words of Skully, a Merchant Bank could be bestdefined as a “financial institution conducting money marketactivities and lending, underwriting and financial advice, andinvestment services whose organization is characterized by ahigh proportion of professional staff able to approach problemsin an innovative manner and to make and implement decisionsrapidly”.

Merchant banking activities are regulated by(1) Guidelines of SEBI and Ministry of Finance,(2) Companies Act, 1956 and(3) Listing Guidelines of stock Exchange and(4) Securities Contracts (Regulation) Act, 1956.

NATURE OF MERCHANT BANKING

The service of merchant banker could cover projectcounseling and pre- investment activities, feasibility studies,project reports, design of capital structure, issue managementand underwriting, loan syndication, mobilization of funds fromnon- resident Indians, foreign currency finance, mergers,

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amalgamations and takeovers, venture capital, buy back andpublic deposits. A category – 1 merchant banker can undertakeissue management only. Separate registration is not necessaryto carry on the activity as underwriter.

Merchant banking is a skill based activity and involves

servicing every financial need of the client. It requires focusedskill base to provide for the requirements of a client. SEBI hasmade the quality of manpower as one of the criteria forregistration as merchant banker. These skills should not beconcentrated in issue management and underwriting alone,which may have an adverse impact on business as witnessed in1995. Merchant banker can turn into any of the activitiesmentioned above, depending on resources, such as capital,foreign tie- ups for overseas activities and skills. They canprovide the entire gamut of services or develop niche business.The depth and sophistication in merchant banking business areimproving since the avenues for participating in capital market

activities have widened from issue management andunderwriting to private placement, bought out deals (BODS),buy- back of shares, mergers and takeovers.

DEFINITION OF MERCHANT BANKER

The Notification of the Ministry of Finance defines amerchant banker as, “ Any person who is engaged in thebusiness of issue management either by making arrangementsregarding selling, buying or subscribing to securities asmanager, consultant, advisor or rendering corporate advisoryservice in relation to such issue management”. The

Amendment Regulations specify that issue managementconsist of prospectus and other information relating to theissue, determining financial structure, tie- up of financiers andfinal allotment and refund of the subscriptions, underwritingand portfolio management services.

CATEGORIES OF MERCHANT BANKERS

Initially, merchant bankers were classified into fourcategories having regard to their nature and range of activitiesand their range of responsibilities to SEBI, investors andissuers of securities. The minimum net worth and initial

authorization fee depend on the category. Since September 5,1997 only category 1 exists. The first category consist of merchant banker who carry on any activity of issuemanagement, which will inter alia consist of preparation of prospectus and other information relating to the issue,determining financial structure, tie- up of financiers and finalallotment and refund of subscription and to act in the capacityof managers, advisors or consultant to an issue.

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Net worth: Minimum net worth for first category is Rs. 1crore.

Registration Fee: Registration fee for first category is Rs.5lacks annually in the first 3 years, Rs. 25 lacks in fourth year.Renewal is every 3 years.

In addition merchant banker has to pay fees per offerdocument: Rs.10, 000 up to Rs. 5 crores; Rs. 15000 for Rs. 5 –10 crores; Rs. 25,000 for 25 – 50 crores; Rs. 50,000 for Rs. 50 –100 crores.

SERVICES OF MERCHANT BANKS

The financial institutions in India could not meet thedemand for the long term funds required by the everexpanding industry and trade. The corporate sectorenterprises, therefore, meet their requirements through issueof shares and debentures in the capital market. To raise moneyfrom capital market, promoters bank upon merchant bankerswho manage the whole show by rendering multiple services.The merchant bankers also advise the investors of theincentives available in the form of tax reliefs and otherstatutory obligations.

The services of merchant bankers are described in detail in thefollowing section.

1. Corporate counseling:

Corporate counseling covers the entire field of merchantbanking activities viz. project counseling, capital restructuring,project management, public management, loan syndication,working capital, fixed deposit lease financing, acceptancecredit etc.. The scope of corporate counseling is limited togiving suggestions and opinions of the client and help takingactions to solve their problems. It is provided to a corporateunit with a view to ensure better performance, maintain steadygrowth and create better image among investors.

2. Project counseling

Project counseling includes the preparation of project reports,deciding upon financing pattern to finance the cost of theproject and appraising project report with financial institutionsor banks. Project reports are prepared to obtain governmentapproval, get financial assistance from institution and plan forpublic issue. The financing mix is to be decided keeping in viewthe rules, regulations norms prescribed by the government orfollowed by the financial institutions. The projects areappraised, as to the location, technical, commercial and

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financial viability of the project. Project counseling also includefilling up of application forms with relevant information forobtaining funds from financial institutions.

3. Loan syndication:

Loan syndication refers to the assistance rendered by themerchant banks to get mainly term loans for the projects. Suchloans may be obtained from a single development financeinstitution or syndicate or consortium. Merchant bankers helpcorporate clients to raise syndicated loans from commercialbanks.

Merchant bankers help clients approach financial institutionsfor term loans. The decision as to which financial institutionshould be approached depends upon industry, location of theunit and size of the project cost. The merchant bankers firstmake an appraisal of the project to satisfy that is viable. The

next step is designing the capital structure, determiningpromoter’s contribution and arriving at a figure of approximateamount of term loan to be raised. The merchant bankersshould ensure that the project adheres to the guidelines of financing industrial projects. After verification that the projectwould be eligible for term loan, a preliminary meeting is fixedwith financial institutions. If the financial institution agrees toconsider the proposal, the application is filled in and submittedalong with other documents. The merchant banker’sinvolvement enables the company to state that it has exercisedits due diligence in the exercise of obligations under variousregulations.

4. Issue management:

Management of issue involves marketing of corporatesecurities viz., equity shares, preference shares, anddebenture or bonds by offering them to the public. Merchantbanks act as an intermediary whose main job is to transfercapital from those who own it to those who need it.

The issue function may be broadly divided in to pre issuemanagement and post issue management. In both the stages,legal requirements have to be complied with and severalactivities connected with the issue have to be coordinated.

The pre-issue management is divided into:-

• Issue through prospectus, offer for sale and privateplacement.

• Marketing and underwriting.

• Pricing of issues.

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(i) Public issue through prospectus

• The most common method of public issue is throughprospectus.

• Offers for sale are offers through the intermediary of issue house of firm of stock broker. The company sells theentire issue of shares or debentures to the issue house at anagreed price which is generally below the par value.

• The direct sale of securities by a company to investors iscalled private placement. The investors include LIC, UTI, GIC,SFC etc. To bring out a public issue, merchant bankers have to co-ordinate the activities relating to issue with differentgovernment and public bodies, professionals and privateagencies.They have to ensure that the information required by the

Companies Act and SEBI are furnished in the prospectus andget it vetted by reputed solicitor.

The copies of consent of experts, legal adviser, attorney,solicitor, bankers, and bankers to the issue, brokers andunderwriters are to be obtained from the company making theissue, to be filed along with the prospectus to the Registrar of Companies. After the prospectus is ready, it has to be sent toSEBI for vetting. It is only after clearance by SEBI, theprospectus can be filed with the Registrar of Companies.

Brokers to the issue canvass subscription by mailing the

literature to the clients and undertaking wide publicity.Members of stock exchange are appointed as brokers to issue.Principal brokers, in addition to the functions of brokers assistmerchant bankers to devise strategy for success of the publicissue, keep liaison between merchant banker and stock exchanges and canvass support for the issue among stock brokers. Sometimes, they undertake centralized mailing of prospectus, application forms and other publicity material atthe instant of the merchant banker.Bankers to the issue accept applications along withsubscriptions tendered at their designated branches andforward them to the Registrar. The brokers to the issue,

principal agent and bankers to issue are appointed byMerchant Bankers.

(ii) Marketing

After dispatch of prospectus to SEBI, the merchant bankersarrange a meeting with company representatives andadvertising agents to finalize arrangements relating to date of opening and closing of issue, registration of prospectus,

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launching publicity campaign and fixing date of board meetingto approve and sign prospectus and pass the necessaryresolutions.

Publicity campaign covers the preparation of all publiclymaterial and brochures prospectus, announcement,

advertisement in the press, radio, TV, investors conferenceetc. the merchant bankers help choosing the media,determining the size and publications in which theadvertisement should appearThe Merchant Bankers role is limited to deciding the number of copies to be printed,Checking accuracy of statements made and ensure that thesize of the application form and prospectus conform to thestandard prescribed by the stock exchange. The merchantbanker has to ensure that the material is delivered to the stock exchange atleast 21 days before the issue opens and tobrokers to the issue, branches of brokers to the issue and

underwriters on time.

Security issues are underwritten to ensure that in case of under subscription the issues are taken up by theunderwriters. SEBI has made underwriting mandatory forissues to the public. The underwriting arrangement should befiled with the stock exchange. Particulars of underwritingarrangement should be mentioned in the prospectus.

The various activities connected with pre-issue managementare a time bound program which has to be promptly attendedto. The execution of the activities with clockwork efficiencywould lead to a successful issue.

(iii) Pricing of issues

The SEBI guidelines 1992 for capital issues have opened thecapital market to free pricing of issues. Pricing of issues isdone by companies themselves in consultation with themerchant bankers. Pricing of issue is part of pre-issuemanagement.

An existing listed company and a new company set up by anexisting company with five year track record and existingprivate closely held company and existing unlisted companygoing in for public issues for the first time with two and half years record of constant profitability can freely price the issue.The premium has to be decided after taking into account netasset value, profit earning capacity and market price.

Justification of price has to be stated and included in theprospectus.

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(iv) Post Issue Management

The post issue management consists of collection of application forms and statement of amount received frombankers, screening applications, deciding allotment procedure,mailing of allotment letters, share certificates and refund

ordersRegistrar to the issue plays a major role in post issuemanagement. They receive the applications, verify them andsubmit the basis of allotment to the stock exchange. After thebasis of allotment is approved by the stock exchange andallotted by the Board, he auditor/company secretary has tocertify that the allotment has been made by the company asper the basis of allotment approved by the exchange.Registrars have to ensure that the applications are processedand allotment/refund orders are sent within 70 days of theclose of the issue. The time limit of 70 days has proved difficultto adhere and applicants have to wait for anytime between 90

and 180 days. Merchant bankers assist the company bycoordinating the above activities.

5. Underwriting of public issue

Underwriting is a guarantee given by the underwriterthat in the event of under subscription the amountunderwritten would be subscribed by him. It is an insurane tothe company which proposes to make public offer against therisk of under subscription. The issues packed by well-knownunderwriters generally receive a high premium from the public.This enables the issuing company to sell securities quickly.

All public issues have to be fully underwritten. Onlycategory I,II and III merchant bankers are permitted tounderwrite an issue subject to the limit that the outstandingcommitments of any such individual merchant banker at anypoint of time do not exceed five times of his net worth (paid-upcapital and free reserves excluding revaluation reserves). Thiscriterion is applicable to brokers also. Lead managers have tounderwrite mandatorily 5% of the issue or Rs 2.5 lakhwhichever is less. Banks/ Merchant banking subsidiaries cannotunderwrite more than 15% of any issue.

6. Managers, Consultants or Advisers to the Issue

The managers to the issue assist in the drafting of prospectus, application forms and completion of formalitiesunder the Companies Act, appointment of Registrar for dealingwith share applications and transfer and listing of shares of the company on the stock exchange. Companies are free toappoint one or more agencies as managers to the issue.

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7. Portfolio Management

Portfolio refers to investment in different kinds of securities such as shares, debentures or bonds issued bydifferent companies and securities issued by the government.

It is not merely a collection of unrelated assets but a carefullyblended asset combination within a unified framework.Portfolio management refers to maintaining propercombination of securities in a manner that they give maximumreturn with minimum risk.

Merchant bankers provide portfolio management serviceto their clients; today the investor is very prudent. Everyinvestor is interested in safety, liquidity and profitability of hisinvestment. But investors cannot study and choose theappropriate securities.

8. Advisory service related to mergers and takeovers.

A merger is a combination of two or more companies in tosingle company where one survives and others lost theircorporate existence. A takeover is the purchase by onecompany acquiring controlling interest in the share capital of another existing company. Merchant bankers are themiddleman in setting negotiation between the offeree and theofferor.

9. off shore finance

The merchant bankers help their clients’ interpretation in thefollowing areas including foreign currency.

• Long tern foreign currency loans

• Joint venture abroad

• Financing exports and imports

• Foreign collaboration arrangementsThe bankers render other financial services such as appraisal,negotiation and compliance with procedural and legal aspects.

10. Non-resident investment

The services of merchant bankers include investment advisoryservices to NRI in terms of identification of investmentopportunities, selection of securities, investment managementetc. they also take care of the operational details like purchaseand sale of securities, securing necessary clearance from RBIfor repatriation of interest and dividend.

MERCHANT BANKERS AS LEAD MANAGERS

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As per SEBI guidelines it is mandatory that all public issuesshould be managed by merchant bankers in the capacity of lead managers. Only in the case of rights issues not exceedingRs. 50 lakhs such an obligation are not necessary. The numberof lead managers to be appointed by a company depends uponthe size of the issue as shown below:

S. No Size of theissue

Max. no. of Lead

Managers

1 Less thanRs.50crores

2

2 Rs.50croresto Rs.

100crores

3

3 Rs. 100crores

to Rs.200crores

4

4 Rs. 200croresto Rs.

400crores

5

5 Above Rs.400crores

5 or more asprescribed by

SEBI

DUTIES AND RESPONSIBILITIES OF LEAD MANAGERS

The most important aspect of Merchant Banking is to function

as lead managers to the issue management. As lead managers,they have to exercise reasonable care and diligence in issuemanagement by paying attention to the following:

• It is the duty of every lead manager to enter into anagreement with the issuing companies stating the detailsregarding their responsibilities, liabilities, mutual rights,functions, disclosures, refund, allotment etc. a copy of thisagreement should be submitted to the SEBI atleast one monthbefore the opening of the issue for subscription.

• One merchant banker cannot have association withanother merchant banker who does not hold a certificate of registration with the SEBI.

• Similarly a lead manager cannot undertake the work of issue management if the issuing company is its associate.

• Incase there are more than one lead managers to an issue,the responsibilities of each of item should be clearly defined inthe agreement.

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• A lead manager is under an obligation to accept aminimum underwriting obligation of 5% of the totalunderwriting commission or Rs. 25lakhs whichever is less. If heis not able to comply with the above provision it is his duty tomake arrangements with another Merchant banker associatedwith that issue to underwrite the said amount. Ofcourse it

must by duly intimated to the SEBI.

• A lead manager has to exercise due care and diligence inthe verification of prospectus or letter of offer.

• He has to submit due diligence certificate rating that theprospectus or letter of offer is in conformity with thedocuments relevant to the issue, the disclosures are true, fairand adequate and all legal requirements connected with theissue have been duly complied with.

GUIDELINES FOR MERCHANT BANKERS

Merchant banking has been statutorily brought within theframework of the Securities and Exchange Board of India underSEBI (Merchant Bankers) Regulations, 1992.

(1) In terms of guidelines during April 1990, all merchant

bankers will require authorization by SEBI to carry out

business.

The criteria for authorization include:

(i) Professional qualification in finance, law or business

management;

(ii) Infrastructure like adequate office space, equipment and

manpower;

(iii) Employment of two persons who have the experience to

conduct business of merchant bankers;

(iv) Capital adequacy;

(v) Past track of record, experience, general reputation and

fairness in all transactions.

(2) SEBI issued further guidelines classifying the merchant

bankers into four categories based on the nature and range of

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activities and their responsibilities to SEBI investors and

issuers of securities. SEBI has issued revised guidelines on

December 22, 1992 classifying the activities of merchant

bankers as follows:

The first category consists of merchant bankers who carry onany activity of issue management which will inter alia consistsof preparation of prospectus and other information relating tothe issue, determining financial structure, tie-up of financiersand final allotment and refund of subscription and to act in thecapacity of managers, advisor or consultant to an issue,portfolio manager and underwriter.

The second category consists of those authorized to act in thecapacity of co-manager/advisor, consultant, and underwriter toan issue or portfolio manager.

The fourth category consists of merchant bankers who act as a

advisor or consultant to an issue.

Minimum net worth for first category is Rs. 1 crore, secondcategory Rs. 50 lakhs, third category Rs.20 lakhs, and fourthcategory is nil.

The above classification was valid upto December 1997 only.

(3) An initial authorization fee, an annual fee and renewal

fee may be collected by SEBI.

(4) All issues must be managed at least by one authorized

banker, functioning as the sole manager or the lead manager.Ordinarily not more than two merchant bankers should be

associated as lead managers. But, for issues over Rs. 100

crores and above, the number of lead managers may go up to a

maximum of four. The specific responsibilities of each lead

manager must be submitted to SEBI prior to the issue.

SCOPE FOR MERCHANT BANKING IN INDIA

In the present day capital market scenario, the merchant

bank play the role of an encouraging and supporting force tothe entrepreneurs, corporate sectors and the investors. Thereis vast scope for merchant bankers to enlarge their operationsboth in domestic and international market.

• Growth of new issue market

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The growth of new issue market is unprecedented since 1990-

91. The amount of annual average of capital issued by non-

government public companies was only about 90 crores in the

70s, the same rose to over Rs. 1000 crs in the 80s’ and further

to Rs. 12700 crores in the first four years of 1990’s. This figure

could be well beyond Rs.40000 crores by the end of 1994-95.The number of capital issues has also increased from 363 in

1990-91 to 900 in 1993-94. The trend is expected to continue in

future.

• Entry of foreign investors

All outstanding development in the history of Indian capital

market was its opening up in 1992 by allowing foreign

institutional investors to invest in primary and secondary

market and also permitting Indian companies to directly tap

foreign capital through euro issues. Within 2 years to March1994, the total inflow of foreign capital through these routes

reached to about $5 billion. It is estimated that this figure may

go up to $ 35-40 billion by the turn of this century. Further,

foreign direct investment as investment by NRIs has risen

considerably due to number of incentives offered to them.

They need the service of Merchant Bankers to advice them for

their investment in India. The increasing number of joint

ventures abroad by Indian companies also requires expert

service of Merchant Bankers.

• Change policy of financial institutions

With the changing emphasis in the lending policies of financial

institutions from security orientation to project orientation,

corporate enterprise would require the expert service of

merchant bankers for project appraisal, financial management

etc. The policy of decentralization and encouragement of small

and medium industries will further increase the demand for

technical and financial services which can be provided by

merchant bankers.

• Development of Debt Market

The concept of debt market has set to work through National

Stock Exchange and the Over the Counter Exchange of India.

Experts feel that of the estimated capital issues of Rs. 40,000

crores in 1994-95, a good portion may be raised through debt

19



instruments. The development of debt market will offer

tremendous opportunity to Merchant Bankers.

• Innovations in Financial Instruments

The Indian capital market has witnessed innovations in the

introduction of financial instruments such as non-convertible

debentures with detachable warrants, cumulative convertible

preference shares, zero coupon bonds, deep discount bonds,

triple option bonds, secured premium notes, floating rates

bonds, auction rated debentures etc. This has further extended

the role of Merchant Bankers as market makers for these

instruments.

• Corporate Restructuring

As a result of liberalization and globalization the competition in

the corporate sector is becoming intense. To survive in the

competition, companies are reviewing their strategies,

structure and functioning. This had led to corporate

restructuring including mergers, acquisitions, splits,

disinvestments and financial restructuring. This offers good

opportunity to Merchant Bankers to extend the area of their

operations.

• Disinvestment

The government raised Rs.2000 crores through disinvestment

of equity shares of selected public sector undertakings in

1993-94. The government proposes to shift the present method

of periodic sale of public sector shares to round the year off

loading of shares directly on the stock exchange from the year

1995-96. The government will sell the shares of identified

public sector at any time during the year when they get a good

price above minimum stipulated level. This is likely to provide

good business to Merchant Bankers in future.

The above discussion highlights, that the scope of merchant

banking is vast and there lies immense opportunities ahead of Merchant Bankers. They should develop adequateinfrastructure including expertise in order to provide full rangeof merchant banking services to corporate sector.

CLASSIFICATION OF FINANCIAL MARKETS

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The classification of financial markets in India is shown inChart below:

Classification of Financial Markets

Organized MarketUnorganized Market

Capital Market Money MarketMoney Lenders

Industrial Govt. Long term

Securities Securities Loans Market Call money Commercial Treasury Short term

Market Market Market Bill Market Bill Market Loan Market

Primary Secondary Term Market Market for

Market Market Loan for Mortgages Financial

Market Guarantees

Unorganized Markets

In these markets there are a number of money lenders,indigenous bankers, traders etc., who lend money to thepublic. Indigenous bankers also collect deposits from thepublic. There are also private finance companies, chit fundsetc., whose activities are not controlled by the RBI. Recentlythe RBI has taken steps to bring private finance companies andchit funds under its strict control by issuing non-bankingfinancial companies (Reserve Bank) Directions, 1998. The RBIhas already taken some steps to bring the unorganized sectorunder the organised fold. They have not been successful. Theregulations concerning their financial dealings are stillinadequate and their financial instruments have not been

standardized.

Organized Markets

In the organised markets, there are standardized rules andregulations governing their financial dealings. There is also ahigh degree of institutionalization and instrumentalisation.

21



These markets are subject to strict supervision and control bythe RBI or other regulatory bodies.

These organized markets can be further classified into two.They are:

• Capital market

• Money market

Capital market

The capital market is a market for financial assets which havea long or indefinite maturity. Generally, it deals with long termsecurities which have a maturity period of above one year.Capital market may be further divided into three namely:

• Industrial securities market

• Government securities market

• Long term loans market

(I) INDUSTRIAL SECURITIES MARKET

As the very name implies, it is a market for industrial securitiesnamely:

• Equity shares or ordinary shares

• Preference shares

• Debentures or bonds

It is a market where industrial concerns raise their capital ordebt by issuing appropriate instruments. It can be furthersubdivided into two. They are:

• Primary market or New issue market

• Secondary market or Stock exchange

Primary market

Primary market is a market for new issues or new financialclaims. Hence, it is also called New Issue market. The primarymarket deals with those securities which are issued to thepublic for the first time. In the primary market, borrowers

22



exchange new financial securities for long term funds. Thus,primary market facilitates capital formation.

There are three ways by which a company may raise capital ina primary market. They are:

• Public issue

• Rights issue

• Private placement

The most common method of raising capital by new companiesis through sale of securities to the public. It is called publicissue. When an existing company wants to raise additionalcapital, securities are first offered to the existing shareholderson a pre-emptive basis. It is called rights issue. Privateplacement is a way of selling securities privately to a small

group of investors.

Secondary market

Secondary market is a market for secondary sale of securities.In other words, securities which have already passed throughthe new issue market are traded in this market. Generally,such securities are quoted in the Stock Exchange and itprovides a continuous and regular market for buying andselling of securities. This market consists of all stock exchanges recognised by the Government of India. The stock exchanges in India are regulated under the SecuritiesContracts (Regulation) Act, 1956. The Bombay Stock Exchangeis the principal stock exchange in India which sets the tone of the other stock markets.

(II) GOVERNMENT SECURITIES MARKET

It is otherwise called Gilt-Edged securities market. It is amarket where Government securities are traded. In India thereare many kinds of Government securities- short term and long-term. Long-term securities are traded in this market whileshort term securities are traded in the money market.

Securities issued by the Central Government, StateGovernments, Semi-Government authorities like CityCorporations, Port Trusts etc. Improvement Trusts, StateElectricity Boards, All India and State level financialinstitutions and the public sector enterprises are dealt in thismarket.

Government securities are issued in denominations of Rs 100.Interest is payable half-yearly and they carry tax exemptions

23



also. The role of brokers in marketing these marketingsecurities is practically very limited and the major participantin this market is the “Commercial Banks” because they hold avery substantial portion of these securities to satisfy theirS.L.R. requirements.

The secondary market for these securities is very narrow sincemost of the institutional investors tend to retain thesesecurities until maturity.

The Government securities are in many forms. These aregenerally:

• Stock certificates or inscribed stock

• Promissory Notes

• Bearer Bonds which can be discounted

Government securities are sold through the Public Debt Officeof the RBI while Treasury Bills (short term securities) are soldthrough auctions.

Government securities offer a good source of raisinginexpensive finance for the Government exchequer and theinterest on these securities influences the prices and yields inthis market. Hence this market also plays a vital role inmonetary management.

(III) LONG-TERM LOANS MARKET

Development banks and commercial banks play a significantrole in this market by supplying long term loans to corporatecustomers. Long-term loans market may further be classifiedinto:

• Term loans market

• Mortgages market

• Financial guarantees market

Term Loans Market

In India, many industrial financing institutions have been

created by the Government both at the national and regionallevels to supply long-term and medium term loans to corporatecustomers directly as well as indirectly. These developmentbanks dominate the industrial finance in India. Institutions likeIDBI, IFCI, ICICI, and other state financial corporations comeunder this category. These institutions meet the growing andvaried long-term financial requirements of industries bysupplying long-term loans. They also help in identifying

24



investment opportunities, encourage new entrepreneurs andsupport modernization efforts.

Mortgages Market

The mortgages market refers to those centers which

supply mortgage loan mainly to individual customers. Amortgage loan is a loan against the security of immovableproperty like real estate. The transfer of interest in a specificimmovable property to secure a loan is called mortgage. Thismortgage may be equitable mortgage or legal one. Again itmay be a first Charge or second charge. Equitable mortgage iscreated by a mere deposit of title deeds to properties assecurity whereas in the case of a legal mortgage the title in theproperty is legally transferred to the lender by the borrower.Legal mortgage is less risky.

Similarly, in the first charge, the mortgager transfers his

interest in the specific property to the mortgagee as security.When the property in question in already mortgaged once toanother creditor, it becomes a second charge when it issubsequently mortgaged to somebody else. The mortgagee canalso further transfer his interest in the mortgaged property toanother. In such a case, it is called a sub-mortgage.

The mortgage market may have primary market as wellsecondary market. The primary market consists of originalextension of credit and secondary market has sales and re-sales of existing mortgages at prevailing prices.

In India, residential mortgages are the most commonones. The Housing and Urban Development Corporation(HUDCO) and the LIC play a dominant role in financingresidential projects. Besides, the Land Development Banksprovide cheap mortgage loans for the development of lands,purchase of equipment etc. these development bands raisefinance through the sale of debentures which are treatedwhich are treated as trustee securities.

Financial Guarantees Market

A Guarantee marker is a centre where finance is providedagainst the guarantee of a reputed person in the financial

circle. Guarantee is a contract to discharge the liability of athird party in case of his default. Guarantee acts as a securityfrom the creditor’s point of view. In case the borrower fails torepay the loan, the liability falls on the shoulders of theguarantor. Hence the guarantor must be known to both theborrower and the lender and he must have the means todischarge his liability.

25



Though there are many types of guarantees, the commonforms are:

• Performance Guarantee and

• Financial Guarantee

Performance guarantees cover the payment of earns money,retention money, advance payments, non-completion of contracts etc. On the other hand financial guarantees coveronly financial contracts.

In India, the market for financial guarantees is well organized.The financial guarantees in India relate to:

• Deferred payments for imports and exports.

• Medium and long-term loans raised abroad.

• Loans advanced by banks and other financial institutions.

These guarantees are provided mainly by commercial banks,development banks, government both central and states andother specialized guarantee institutions like ECGC ( ExportCredit Guarantee Corporation ) and DTCGC ( Deposit Insuranceand Credit Guarantee Corporations). This guarantee financialservice is available to both individual and corporate customers.For a smooth functioning of any financial system, thisguarantee service absolutely essential.

IMPORTANCE OF CAPITAL MARKET

Absence of capital market acts as a deterrent factor to capitalformations and economic growth. Resources would remain idleif finances are not funneled through the capital market. Theimportance of capital market can be briefly summarized asfollows:

i) The capital market serves as an important source for theproductive use of the economy’s savings. It mobiles thesavings of the people for further investment and thus avoidstheir wastage in unproductive uses.ii) It provides incentives to saving and facilities capitalformations by offering suitable rates of interest as the price of

capital.iii) It provides an avenue for investors, particularly thehousehold sector to invest in financial assets which are moreproductive than physical assets.iv) It facilitates increase in production and productivity in theeconomy and thus, enhances the economic welfare of thesociety. Thus, it facilitates “the movement of stream commandover capital to the point of highest yield” towards those who

26



can apply them productively and profitably to enhance thenational income in the aggregate.v)The operations of different institutions in the capital marketsinduce economic growth. They give quantitative andqualitative directions to the flow of funds and bring aboutrational allocation of scarce resources.

vi) A healthy capital market consisting of expertintermediaries promotes stability in values of securitiesrepresenting capital funds.vii) More over, it serves as an important source fortechnological up gradation in the industrial sector by utilizingthe funds invested by the public.

Thus, a capital marker serves as an important link betweenthose who save and those who aspire to invest their savings.

Money Market

Money market is a market for short term loans orfinancial assets. It is a market for the lending and borrowing of short term funds. As the name implies, it does not actually dealin cash or money. But it actually deals with near substitutes formoney or near money like trade bills, promissory notes andgovernment papers drawn for a short period not exceeding 1year. These short term instruments can be converted into cashreadily without any loss and at low transaction cost.

Money market is the centre for dealing mainly in shortterm money assets. It meets the short term requirements of borrowers and provides liquidity or cash to lenders. It is theplace where short term surplus funds at the disposal of financial institutions and individuals are borrowed byindividuals, institutions and also the government.

The Money market does not refer to particular placewhere short term funds are dealt with. It includes allindividuals, institutes and intermediaries dealing with shortterm funds. The transactions between borrowers, lenders and

middlemen take place through telephones, telegraphs, mailsand agents. No personal contact or presence of the two partiesis essential for negotiations in a money market. However, ageographical name may be given to a money market accordingto its locations. For example, the London Money marketoperates from Lambard Street and New York money marketoperates from wall streets. But, they attract funds from allover the world to be lent to borrowers from all over the globe.Similarly, the Mumbai Money market is the centre for short

27



term loanable funds of not only Mumbai, but also the whole of India.

DEFINITION

According to Geottery Crowther, “the Money market isthe collective name given to the various firms and institutionsthat deal in the various grades of near money”.

The RBI defines the Money market as, “a market forshort term financial assets that are close substitutes formoney, facilities the exchange of money for new financialclaims in the preliminary market as also for financial claims,already issued, in the secondary market”.

MONEY MARKET V/S CAPITAL MARKET

Money market Capital market

i) It is a market

for short term

loanable funds for a

period of not

exceeding one year.

ii) This market

supplies funds for

financing currentbusiness operations,

working capital

requirements of the

govt

iii) The

instruments that are

dealt in a money

market are bills of

exchange, treasury

bills, commercialpapers, certificate of

deposit etc.

iv) Each single

money market

instrument is of

large amount. A TB

i) It is a market for

long term funds

exceeding a period

one year.

ii) This market

supplies funds forfinancing the fixed

capital requirements

of trade and

commerce as well as

long term

requirements of the

govt.

iii) This market

deals in instruments

like shares,debentures, govt

bonds etc.

iv) Each single

capital market

28



is of minimum for

one lakh. Each CD or

CP is for a minimum

of Rs 25lakhs.

v) The Centralbank and

Commercial banks

are the major

institutions in the

money market.

vi) Money market

instruments

generally do not

have secondary

markets.

vii) Transactions

mostly take place

over-the-phone and

there is no formal

place.

viii) Transactions

have to be

conducted without

the help of brokers.

instrument is of small

amount. Each share

value is Rs. 10. Each

debenture value is Rs

100.

v) Development

banks and Insurance

companies play a

dominant role in the

capital market.

vi) Capital market

instruments generally

have secondary

markets.

vii) Transactions

take place at formal

place viz.. Stock

exchange.

viii) Transactions

have to be conducted

only through

authorised dealers.

FEATURES OF MONEY MARKET

The following are the general features of a money market:

i) It is a market purely for short term funds or financial

assets called near money

ii) It deals with financial assets having a maturity period

upto one year only.

iii) It deals with only those assets which can be converted

into cash readily without loss and with minimum transaction

cost.

iv) Generally transactions take place through phone i.e. oral

communication. Relevant documents and written

communications can be exchanged subsequently. There is no

29



formal place like stock exchange as in the case of capital

market.

v) Transactions have to be conducted without the help of

brokers.

vi) It is not a single homogeneous market. It comprises of

several submarkets, each specializing in a particular type of

financing. E.g. calls money market, acceptance market, bill

market and so on.

vii) The components of a money market are the Central Bank,

Commercial Banks, non banking financial companies, discount

houses and acceptance houses. Commercial banks generally

play a dominant role in this market.

OBJECTIVES

The following are the important objectives of a money market:

• To provide a parking place to employ short term surplus

funds.

• To provide room for overcoming short term deficits.

• To enable the Central Banks to influence and regular

liquidity in the economy through its intervention in this

market.

• To provide a reasonable access to users of short term

funds to meet their requirements quickly, adequately and at

reasonable cost

IMPORTANCE OF MONEY MARKET

A developed money market plays an important role in thefinancial system of a country by supplying short term fundsadequately and quickly to trade and industry. The moneymarket is an integral part of a countries economy. Therefore, adeveloped money market is highly indispensible for the rapid

development of the economy. A developed money market helpsthe smooth functioning of the financial system.

I. Development of Trade and Industry

Money market is an important source of financing trade andindustry. The money market, through discounting operationsand commercial papers, finances the short term workingcapital requirements of trade and industry and facilitates the

30



development of industry and trade both national andinternational.

II. Development of capital market

The short term rates of interest and the conditions that prevail

in the money market influence the long term interest as well asthe resource mobilisation in the capital market. Hence, thedevelopment of capital market depends upon the existence of a developed money market.

III. Smooth functioning of Commercial banks

The money market provides the commercial banks withfacilities for temporarily employing their surplus funds in easilyrealisable assets. The banks can get back the funds quickly, intimes of need, by resorting to money market. The commercialbanks gain immensely by economising on their cash balances

in hand and at the same time meeting the demand for largewithdrawal of their depositors. It also enables commercialbanks to meet their statutory requirements of cash reserveratio and statutory liquidity ratio by utilising the money marketmechanism.

IV. Effective Central bank control

A developed money market helps the effective functioning of central bank. It facilitates effective implementation of themonetary policy of a central bank. The central bank, throughthe money market, pumps new money into the economy inslumps and siphons it off in boom. The central bank, thus,regulates the flow of money so as to promote economic growthwith stability.

V. Formalization of suitable monetary policy

Conditions prevailing in a money market serve as a trueindicator of the monetary state of an economy. Hence, itserves as a guide to the government in formulating andrevising the monetary policy then and there depending uponthe monetary conditions prevailing in the market.

VI. Non availability source of finance to government

A developed money market helps the government to raiseshort term funds through the treasury bills floated in themarket. In the absence of a developed money market, thegovernment would be forced to print and issue more money orborrow from the central bank. Both ways would lead to anincrease in prices and the consequent inflationary trend in theeconomy.

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COMPOSITION OF MONEY MARKET

It consists of number of sub markets in which collectivelyconstitute the money market. There should be competitionwithin each sub market as well as between different submarkets. The following are the main sub markets of money

market:

1. Call money market

2. Commercial bills market or discount market

3. Treasury bill market

4. Short-term loan market

Call Money Market

The call money market is a market extremely short period

loans say one day to fourteen days. So, it is highly liquid. Theloans are repayable on demand at the option of either thelender or the borrower. In India, call money markers areassociated with the presence of stock exchanges and hence,they are located in major industrial towns like Mumbai,collated, Chennai, Delhi, Ahmadabad etc., The special featureof this market is that the interest rate varies from day to dayand even from hour to hour and centre to centre. It is verysensitive to changes in demand and supply of call loans.

Commercial Bills Market

It is a market for Bills of Exchange arising out of genuinetrade transactions. In the case of credit sale, the seller maydraw a bill of exchange on the buyer. The buyer accepts such abill promising to pay at a later date the amount specified in thebill. The seller need not wait until the due date of the bill.Instead, he can get immediate payment by discounting the bill.

In India the bill market is under developed. The RBI has takenmany steps to develop a sound bill market. The RBI hasenlarged the list of participants in the bill market. The discountand finance house of India was set up in 1988 to promote

secondary market in bills. Inspite of all these, the growth of the bill market is slow in India. There are no specializedagencies for discounting bills. The commercial banks play asignificant role in this market.

Treasury Bills Market

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It is a market for treasury bills which have short termmaturity. A treasury bill is a promissory note or a finance billissued by the government. It is highly liquid because itsrepayment is guaranteed by the government. It is an importantinstrument for short term borrowing of the government. Thereare two types of treasury bills namely

i) ordinary or regular andii)ad hoc treasury bills popularly known as ‘ad hocs’

Ordinary treasury bills are issued to the public, banks andother financial institutions with a view to raising resources forthe Central Government to meet its short term financial needs.Ad hoc treasury bills are issued in favor of the RBI only. Theyare not sold through tender or auction. They can be purchasedby the RBI only. Ad hocs are not marketable in India butholders of these bills can sell them back to RBI. Treasury bills

have a maturity period of 91 days or 182 days or 364 daysonly. Financial intermediaries can park their temporarysurpluses in these instruments and earn income.

Short -Term Loan Market

It is a market where short term loans are given tocorporate customers for meeting their working capitalrequirements. Commercial banks play a significant role in thismarket. Commercial banks provide short term loans in the formof cash credit and overdraft. Overdraft facility is mainly givento business people whereas cash credit is given toindustrialists. Overdraft is purely a temporary accommodationand it is given a sanctioned in a separate account.

FOREIGN EXCHANGE MARKET

The term foreign exchange refers to the process of converting home currencies into foreign currencies and viceversa. According to Dr. Paul Einzing “Foreign exchange is thesystem or process of converting one national currency intoanother, and of transferring money from one country to

another”

The market where foreign exchange transactions take place iscalled a foreign exchange market. It does not refer to a marketplace in the physical sense of the term. In fact, it consists of anumber of dealers, banks and brokers engaged in the businessof buying and selling foreign exchange. It also includes thecentral bank of each country and the treasury authorities whoenter into this market as controlling authorities. Those

33



engaged in the foreign exchange business are controlled bythe Foreign Exchange Maintenance Act. (FEMA)

FUNCTIONS

The most important functions of this market are:

i) To make necessary arrangements to transfer purchasingpower from one country to another.ii) To provide adequate credit facilities for the promotions of foreign trade.iii) To cover foreign exchange risks by providing hedgingfacilities.

In India, the foreign exchange business has a three- tiredstructure consisting of:

i) Trading between banks and their commercial customers.ii) Trading between banks through authorized brokers.iii) Trading with banks abroad.

Foreign exchange market in India comprises of authorized dealers consisting mainly of commercial banks,customers and Reserves Bank of India. There are seven majorcenters in Mumbai, Delhi, Calcutta, Chennai, Bangalore, Kochiand Ahmedabad with Mumbai accounting for the major portionof the transactions. The Foreign Exchange Dealers Associationof India (FEDAI) plays an important role by laying down rulesfor commission and other charges. The customer segment isdominated by Indian Oil Corporation and other public sector

undertakings and Government of India for defense and debtservicing and large private sector corporate like Reliance, TataGroup, Larsen and Turbo on the other.

The foreign exchange market has a merchant segmentconsisting of transactions put through by customers to meettheir transactions needs of foreign exchange and interbank segment encompassing about 100 authorized dealers. Theinterbank market is dominated by State Bank of India and afew foreign banks. SBI, along with a few other banks act asmarket makers quoting two-way prices in the spot and swapsegments. The normal spot market quote has a spread of 0.5 to

1 paisa while the paisa while the swap quotes available at 2 to4 paisa spread. The merchant turnover varied between US$ 54billion in April, 2004 to US $88.6 billion in March, 2005; and theinterbank turnover 4195.7billion to $237 billion. The ratio of interbank to merchant turnover hovered in the range of 2.7 –3.6 during the year. While the average daily global turnoverwas US $2.4 trillion in 2004, India’s share was 0.3%

34



Commercial banks finance foreign trade and helpadminister the Foreign Exchange Management Act. Apart fromthe correspondent or agency relationship with banks abroad,commercial banks in India maintain accounts abroad to meetthe public’s requirements of foreign exchange. All sales andpurchases of foreign exchange are routed through the

accounts they maintain with the banks is important financialcenters abroad. They quote rates at which they buy and sellforeign exchange in accordance with the rules and regulationsof the Reserve Bank and Foreign Exchange Dealers Associationof India. The rates quoted depend upon the rates prevailing ininterbank or international markets and the banks’ margin of profit.

NEW ISSUE MARKET

MEANING

The industrial Securities market in India consists of new issuemarket and stock exchange. The new issue market deals withthe new securities which were not previously available to theinvesting public, that is, securities that are offered to theinvesting public for the first time. The market, therefore,makes available a new block of securities for the publicsubscription in other words; new issue market deals with risingof fresh capital by companies either for cash or forconsideration other than cash.

The new issue market encompasses all institutions dealing infresh claim. These claims may be in the form of equity shares,preference shares, debentures, price issue, deposits etc. Allfinancial institutions which contribute, underwrite and directlysubscribe to the securities are part of new issue market.

STOCK EXCHANGE

The stock exchange is a market for old securities i.e. thosewhich have been already issued and listed on a stock exchange. These securities are purchased and soldcontinuously among investors without involvement of companies. Stock exchange provides not only free

transferability of shares but also makes continuous evaluationof securities traded in the market.

DISTINCTIONS BETWEEN NEW ISSUE MARKET AND STOCK EXCHANGE

The distinctions between new issue market and the stock exchange can be made on three grounds.

35



• Functional difference –

The new issue market deals with new securities which are

issued for the first time for the public subscription. The stock

exchange provides a ready market for buying and selling of old

securities.

• Organistional difference –

The stock exchanges have physical existence and are located

in particular geographic areas. The stock exchange is a place

where dealers of security meet regularly at appointed time

announced by the market. It is a well established organisation

with rules and regulations for a smooth conduct of the

business. The members are supplied with information about

companies and daily changes in prices of stocks.

The new issue market enjoys neither any tangible nor any

administrative organisational setup nor is subject to any

centralized control and administration for the execution of the

business. It renders service to the lenders and borrowers of

funds at the time of any particular operation and the services

are taken up entirely by banks, brokers and underwriters.

• Nature of contribution to industrial finance –

The new issue market provides the issuing company with funds

for starting a new enterprise or for either expansion or

diversification of an existing one by making a direct link

between companies which require funds and the investing

public. So, the contribution of new issue market is direct. The

role of stock exchange in providing capital is indirect as it

provides marketability to shares.

RELATIONSHIP BETWEEN NEW ISSUE MARKET AND STOCK

EXCHANGE

Despite the above mentioned differences, the new issuemarket and the stock exchange are inseparably connected andwork in conjunction with each other.

The new issues first placed in the new issue market can bedisposed off subsequently in the stock exchange. The stock exchange provides the mechanism for regular and continuous

36



purchase and sale of securities. This facility is of immenseutility to potential investors who are assured that they will beable to dispose off the allotment of shares at any time. Thusthe two markets are complementary in nature.

Both the markets are connected to each other even at the time

of new issue. The company which makes new issue applies forlisting of shares on a recognized stock exchange. Listing of shares adds prestige to the firms and widens the market forthe investors. The companies which want stock exchangelisting have to comply with statutory rules and regulations of the stock exchange to ensure fair dealings in them.

The new issue market and stock market are economically anintegral part of a single market i.e., industrial securities. Bothare susceptible to the common influence of the environmentalconditions such as political stability, economic conditions,monetary policy of the Central Bank and Fiscal policy of the

government.

FUNCTIONS OF NEW ISSUE MARKET

The main functions of new issue market are to facilitatetransfer of resources from savers to the users. The savers areindividuals, commercial banks, insurance companies etc. Theusers are public limited companies and the government. Thenew issue market plays an important role in mobilizing thefunds from the savers and transfers them to borrowers forproduction purposes, an important requisite for economicgrowth. In this basis the new issue market can be classifiedas-:

• Market where firms go to the public for the first time for

initial public offering (IPO).

• Market where firms which are already trading raise

additional capital through Seasoned Equity Offering (SCO).

The main function of a new issue market can be divided into atriple service functions.

1. Origination

Origination refers to the work of investigation, analysis and

processing of new project proposals. Origination starts before

an issue is actually floated in the market. There are two

aspects in this function:-

• A careful study of the technical, economic and financial

viability to ensure soundness of the project. This is a

37



preliminary investigation undertaken by the sponsors of the

issue.

• Advisory services which improve the quality off capital

issues and ensure its success.

The advisory services include:-

• Type of issue

• Magnitude of issue

• Time of floating an issue

• Pricing of an issue

• Methods of issue

• Technique of selling the security

The function of origination is done by merchant bankers whomay be commercial banks, All India Financial Institutions orprivate firms. The origination itself does not guarantee thesuccess of the issue. Underwriting, a specialized service isrequired in this regard.

2. Underwriting

Underwriting is an agreement whereby the underwriter

promises to subscribe a specified no. of shares or debentures

of a specified amount of stock in the event of public not

subscribing to the issue. If the issue is fully subscribed then

there is no liability for the underwriter. If a part of share issues

remains unsold, the underwriter will buy the shares. Thus,

underwriting is a guarantee for the marketability of shares.

METHODS OF UNDERWRITING

• Standing behind the issue –

Under this method the underwriter guarantees the sale of a

specified no. of shares within a specified period. If the publicdo not subscribe to the specified amount of issue, the

underwriter buys the balance in the issue.

• Outright purchase –

The underwriter, in this method, makes outright purchase of

shares and resells them to the investors.

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• Consortium method –

Underwriting is jointly done by a group of underwriters in this

method. The underwriters form a syndicate for this purpose.

ADVANTAGES OF UNDERWRITING

• The issuing company is relieved from the risk of finding

buyers for the issue offered to the public. The company is

assured of raising adequate capital.

• The company is assured of getting minimum subscription

within the stipulated time, a statutory obligation to be fulfilled

by the issuing company.

• Underwriters undertake the burden of highly specialised

function of distributing securities.

• They provide expert advice with regard to timing of

security issue, the pricing of issue, the size and types of

securities to be issued.

• Public confidence on the issue is enhanced when

underwritten is done by reputed underwriters.

The underwriters in India may be classified into twocategories:-

• Institutional underwriters

• Non – institutional underwriters

The institutional underwriters are Life Insurance Corporation of India, Unit Trust of India, and Industrial Development Bank of India. The non institutional underwriters are brokers. They

guarantee shares only with a view to any commission from thecompany floating the issue. The brokers work with profitmotive in underwriting industrial securities.

Distribution

It is the function of sale of securities to ultimate investors. Thisservice is performed by rolers and agents who maintain aregular and direct contact with ultimate investors.

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1. It is an expensive method.

2. This method is suitable only for large issues.

2) Offer of sale

The method of offer of sale consists in outright sale of securities through the intermediary of issue houses orsharebrokers. In other words, the shares are not offered to thepublic directly.

Price is called turn or spread. It is otherwise called Bought OutDeals (BOD).

Let us take a simple example. ‘X’ a small company has aturnover of RS.2 crore a year. It requires additional funding of Rs.8 crore to expand its capacity. The merchant banker seespotential business for the company. He asks the promoter of the company to sell 8 lakh shares of its capital to it. Thecompany gets 8crore to expand its business. The merchantbanker or issue house is now holding 80% of the company’sentire capital, in 12 months time. The company expanded itsoperation marketed its products successfully and earnedsufficient profits. Now, the issue house decides to offload the80% capital to the public at a premium of Rs.30 per share. In aperiod of 18 months the merchant banker or the issue househas earned a profit.

ADVANTAGES:

Bought Out Deal (BOD) enables an issuer with good project toobtain funds with a minimum cost without the fear of undersubscription. The intermediary i.e. Merchant banker orissue houses get higher return than the conventional merchantbanking services.

Indbank Merchant Banking had gone in for a buy outagreement with Madhya Pradesh based distillery to buy sharesworth Rs.2.5 crore each at Rs 60/- . After six months the shareswere sold at Rs 71.50 per share with a assured return of 38.33% for the sponsor.

The advantages of this method:

1) The company is relieved from the problem of printing

2) Advertisement of prospectus and making allotment of

shares.

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Offer for sale is not common in India. This method is usedgenerally in two instances:

1) Offer by a foreign company of a part of it to Indian

investors

2) Promoters diluting their stake to comply withrequirements of stock exchange at the time of listing of

shares.

3) Placement:

Under this method, the issuer house or brokers buy thesecurities outright with the intention of placing them with theirclients afterwards. Here the brokers act as almost wholesalersselling them in retail to the public. The brokers would makeprofit in the process of reselling to the public. The IssuerHouse or brokers maintain their own list of clients and through

customer contact sell the securities. There is no need for aformal prospectus as well as underwriting agreement.

Placement has the following advantages:

1) Timing of issue is important for successful floatation of

shares : in a depressed market conditions when the issues are

not likely to get public response through prospectus,

placement method is a useful method of floatation of shares.

2) This method is suitable when small companies issue their

shares

3) It avoids delay involved in public issue and it also reduces

the expenses involved in public issue.

4) There are no entry barriers for a company to access the

private placement market. This route is also available to

unlisted and closely held public companies.

5) A private placement deal can be successfully executed

much faster than a public offering. The procedural formalities

for a private placement are minimal. A private placement deal

can be successfully closed in 4 to 6 weeks.

6) There is greater flexibility in the working out its terms of

the issue. The issues deals with only a few institutional

investors and hence renegotiating the terms of issue is easy

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7) This method is also suitable to first generation

entrepreneurs who are less known to the public which makes

the public issue less successful.

8) The issue expense in case of private placement is low. The

absence of several statutory and non statutory expensesassociated with underwriting, brokerage, printing, promotion

etc. makes the transaction cost of private placement

approximately to 2% of the total cost of issue.

The main disadvantage of this method is that the securities arenot widely distributed to the large section of investors. Aselected group of small investors are able to buy a largenumber of shares and get majority holding in a company.

This method of private placement is used to a limited extend inIndia. The promoters sell the shares to their friends, relatives

and well wishers to get minimum subscription which is aprecondition for issue of shares to the public.

Reliance industries raised the highest amount by way of private placement of equity shares. It raised Rs. 945 crore byprivately placing shares with three financial institutions of which UTI was the most important.

In the public sector, Konkan Railway Corporation placed taxfree bonds worth Rs.70 crore with banks and financialinstitutions.

4) Rights Issue:

Rights issue is a method of raising funds in the market by anexisting company.

A right means an option to buy certain securities at a certainprivileged price with a certain specified period. Shares sooffered to the existing shareholders are called rights shares.

Rights shares are offered to the existing shareholders in aparticular proportion to their existing share ownership. Theratio in which the new shares or debentures are offered to theexisting share capital would depend upon the requirement of

capital. The rights themselves are transferable and saleable inthe market.

Section 81 of the Companies Act deals with rights issue,According to this section, where a company increases thesubscribed capital by the issue of new shares either after twoyears of its formation or after one year of its first issue of share whichever is earlier, these have to be first offered to the

43



existing shareholders with the right to reserve them in favourof a nominee.

A company issuing rights is required to send a circular to allexisting shareholders. The circular should provide informationon how additional funds would be used and their effect on the

earning capacity of the company. The company shouldnormally give a time limit of atleast one month to two monthsto shareholders to exercise their rights. If the rights are notfully taken up, the balance is to be equitable still left over maybe disposed off in the market in a way which is most beneficialto the company.

Advantages:

1) The cost of issue is minimal. There is no underwriting,

brokerage, advertising and printing of prospectus expenses.

2) It ensures equitable distribution of shares to all existing

shareholders and so control of company remains undistributed

as proportionate ownership in the company remains the same.

3) It prevents the directors from issuing new shares in their

own name or to their relatives at a lower price and get

controlling right.

SEBI GUIDELINES FOR ISSUE OF SECURITIES

SEBI has issued detailed guidelines in respect to issue of securities to public. The guidelines were first issued on 11th

June 1992 and were amended subsequently from time to time.SEBI as now issued consolidated guidelines as SEBI (Disclosureand Investor Protection) guidelines 2000 vide its circular No. 1dated 19-1-2000. These guidelines shall be applicable to allpublic issues by listed and unlisted companies, all offers forsale and rights issues by listed companies whose equity shareis listed, except in case of rights issues where the aggregatevalue of securities offered does not exceed Rs.50 lacs. Broadlythere are three methods for issuing securities to the public (a)conventional mode of receiving applications through bankers

(b) book building and (c) on line system of stock exchange (e-IPO).

(I) Eligibility norms for companies issuing securities

(a) Filling of offer documents

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1) No company shall make any public issue of securities,unless a draft prospectus has been filed with the Board,through an eligible merchant banker at least 21 days prior tothe filing of Prospectus with the Register of Companies.

2) No listed company shall make any issue of securitiesthrough a rights issue where the aggregate value of securities,including premium, if any, exceeds Rs 50 lacs unless the lettersof offer is filed with the Board, through an eligible merchantbanker at least 21 days prior to the filing of the letter of offerto the Regional Stock Exchange.

3) No company shall make an issue of securities if thecompany has been prohibited from accessing the capitalmarket under any order or direction of the Board

4) No company shall make any public issue of securitiesunless it has made an application for listing of those securitiesin the stock exchange.

5) No company shall make public or rights issue or an offerfor sale of securities, unless the company enters into anagreement with a depository for dematerialisation of securities, and the company gives option o investors to receivethe security certificates in dematerialised form with adepository.

6) No company shall make a public or rights issue of equityshares unless all the existing partly paid up shares have beenfully paid or forfeited in the specified manner.

7) No unlisted company shall make a public issue an equityshare, if there are any outstanding financial instruments or anyother right which would entitle the existing promoters orshareholders any option to receive equity share capital afterthe initial public offering.

8) Companies not fulfilling the aforesaid condition cab raisetheir funds by listing in Over the Counter Exchange of India(OTCEI).

(b) Public issue by unlisted companies

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An unlisted company shall make a public issue of any equityshares or any security convertible into equity shares at a laterdate subject to the following:

1) It has a pre issue net worth of not less than Rs.1 crore inthree out of preceding five years, with a minimum net worth to

be met during immediate preceding two years.

2) It has a track record of distributable profits in terms of section 205 of the companies Act 1956 for at least three out of immediately preceding five years

3) The issue size i.e. offer through offer document + firmallotment + promoters contribution through offer documentdoes not exceed five times the pre issue net worth

4) If an unlisted company does not comply with theconditions to track record or is its size exceeds five times thepre issue net worth, it can make a public issue of equity sharesor any security convertible into equity shares at a later dateonly through the book building process provided that 60% of the issue size shall be allotted to the qualified institutionalinvestor otherwise the full subscription moneys shall berefundable.

(c) Public issue by listed companies

1) A limited company shall be eligible to make a public issueof equity shares or any security convertible into equity sharesprovided that the issue size does not exceed five times its preissue net worth.

2) If a company does not fulfil the above condition of issue

size it shall be eligible to make a public issue only through thebook building process provided that 60% of the issue size shallbe allotted to qualified institutional buyers

3) Special provisions have been laid in respect of companiesin the IT sector.

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(II) Pricing by companies issuing securities:

1) There is no restriction on the price at which shares can beissued. The price can be decided freely by the issuer companyand the lead managers

2) A company may charge different prices for firm allotmentand public offer, however price for firm allotment should behigher than the price at which public offer is made

3) A listed company making a composite issue of capital mayissue securities at different prices in its public and rights

issues

4) Issuer Company can mention a price bond of 20% in theoffer documents with the Board and actual price can bedetermined at a later date before filing of the offer documentwith Register of Companies. The final offer document shouldcontain only one price

5) No payment, direct or indirect in the nature of a discount,commission, allowance or otherwise shall be made either bythe issuer company or the promoters in any public issue, to thepersons who have received firm allotment in such public issue

6) An eligible company is free to make public or rights issueof shares in denominations of Re 1, Rs 5, Rs 10, Rs 50 or Rs100 etc. If shares are issued in demat form. The shares cannotbe issued or altered to a denomination of decimal of a rupee.

(III) Promoters contribution:

1) In a public issue by an unlisted company or offer for sale,the promoters shall contribute not less than 20% of the postissue capital

2) In case of public issues or composite issues by listedcompanies the promoters shall participate to the extent of 20%

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of the proposed issue or ensure post issue shareholding to theextent of 20% of the post issue.

3) If promoters have acquired equity during proceedingthree years for consideration there than cash or by way of

bonus shares, such shares shall not be considered forcomputation of promoters’ contribution.

4) In case of public issue by unlisted companies, securitieswhich have been issued to the promoters during the precedingone year, at a price lower than the price at which equity isbeing offered to public shall not be eligible for computation of promoters’ contribution. However, if promoters bring thedifference, after passing necessary resolutions and filing of revised returns of allotment the shares shall be consideredeligible.

5) Promoters’ shall bring in full amount of promoterscontribution including premium at least one day prior to theissue opening date which shall be kept in an escrow accountwith a scheduled commercial bank and the said amount shallbe released to the company along with the public issueproceeds:

Provided that where the promoters’ contribution has been

brought prior to the public issue and has already been

deployed by the company, the company shall give the cash

flow statement in the offer document disclosing the use of

such funds.

Provided further that where the promoters’ minimum

contribution exceeds Rs.100 crores the promoters shall bring

in Rs. 100 crores before the opening of the issue and the

remaining contribution shall be brought in by promoters in

advance on pro rata basis before the calls are made on public.

6) The requirement of promoters’ contribution shall not beapplicable if (a) the company is listed on a stock exchange forat least 3 years and has a track record of dividend payment for

at least three immediately preceding years. (b) in case of companies where no identifiable promoter or promoter groupexists (c) in case of right issue. However, in case of (a) and (c)the promoters shall disclose existing shareholding in the offerdocument.

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(IV) Lock – in of minimum specified promoters contribution

1) The lock in shall start from the date of allotment in the

proposed public issue and last date of the lock shall bereckoned as three years from the date of commencement of commercial production or the date of allotment in the publicissue whichever is earlier. Thus, the normal lock in period is 3years.

2) In case of a public issue by unlisted company, if thepromoters contribution in the proposed issue exceeds therequired minimum contribution, such excess contribution shallalso be locked in period of 1 year

3) In case of a public issue by a listed company, excess shallbe locked in for a period of 1 year as per the lock in provisionsprescribed in guidelines on preferential issues

4) If shortfall in firm allotment category is met by thepromoters it will be lockedin for a period of one year

5) Securities issued last will be locked in first

6) The entire pre issue share capital, other than that lockedin as promoters contribution, shall be locked-in for a period of

one year from the date of commencement of commercialproduction or the date of allotment in the public issue,whichever is later

7) Locked-in securities held by promoters may be pledgedonly with banks or financial institutions as collateral securityfor loans

8) Transfer of locked in securities amongst promoters asnamed in the offer document, can be made subject to the lock-in being applicable to the transferees for the remaining period

of lock-in

9) The securities which are subject to lock-in shall carryinscription ‘non-transferable’ along with duration on the fareof the security certificates.

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(V) Pre issue and post issue obligations

SEBI has issued detailed guidelines with regard to both pre-issue obligations as well as appointment of ‘lead merchantbanker’ to manage the public issue is compulsory. The lead

merchant banker is responsible for following various guidelinesissued by SEBI. He is expected to exercise due diligence andthe standard of due diligence shall be such that the merchantbanker shall satisfy himself about all aspects of offering,veracity and adequacy of disclosure in the offering documents.The liability of the merchant banker continues even after thecompletion of issue process.

1. Documents to be submitted: The lead manager shall submit

following documents to SEBI:

i. Memorandum of Understanding (MOU) between lead merchant

banker and Issuer Company specifying their mutual rights,

liabilities and obligations relating to the issue.

ii. Due diligence certificate by lead merchant banker as specified

in schedule III along with draft prospectus.

iii. Certificates signed by the company secretary or chartered

accountant in case of listed companies making further issue of

capital with regard to (a) dispatch of all refund orders of

previous years in time and in prescribed manner, (b) dispatch

of security certificates, and (c) listing of securities on the stock

exchange.

iv.A list of persons who constitute the promoters group and their

individual share holdings.

v. Draft prospectus in computer floppy in prescribed manner.

vi.Ten copies of draft offer document.

vii. The issuer shall submit an undertaking to the Board to the

effect that transactions in securities by promoter, the

promoter group and the immediate relatives of promoters

between the date of filing of offer documents with registrar of

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companies or Stock Exchange as the case maybe and the date

of closure of issue will be reported to stock exchange within 24

hours of the transaction.

2. Appointment of intermediaries: In case a public or rights issue

managed by more than one merchant banker, the rights

obligations and responsibilities of each merchant banker shall

be demarcated as specified in Schedule II. Other intermediaries

such as advisors, bankers to the issue, registrars,

underwriters, etc shall be appointed in consultation with lead

merchant banker.

3. Underwriting: Underwriting of public issue is not mandatory.

However, if an issue is underwritten, the unsubscribed portion

has to be purchased by the underwriters. In respect of every

underwritten issue, the lead merchant banker shall undertake

a minimum underwriting obligation of 5% of the total

underwriting commitment or Rs. 25lacs whichever is less. The

outstanding underwriting commitments of a merchant banker

should not exceed 20 times its net worth at any point of time.

4. Offer documents to be made public: the draft offer filed with theBoard shall be made public for a period of 21 days from the

date of filing the offer document with the Board. The lead

merchant banker shall also fill the draft offer document with

the stock exchange where the securities are proposed to be

listed; and make it available to the public.

5. Appointment of the Compliance Officer: An issuer company shall

appoint a compliance officer who shall directly have liaison

with the Board with regard to compliance with various laws,

rules, regulations and other directives issued by the Board.

6. Mandatory collection centers: the minimum number of collection

centers for issue of capital shall be (a) four metropolitan cities

situated in Mumbai, Delhi, Calcutta and Chennai; (b) all such

51



centers where the stock exchanges are located in the region in

which registered office of the company is situated.

7. Final offer of the Document: the offer document/prospectus

shall be finalized on the basis of complaints received and

observations made by SEBI, if any. Lead manager shall certify

that all amendments, suggestions or observations made by

SEBI have been carried out. Final prospectus is to be submitted

with the Registrar of Companies and the offer document with

the regional stock exchange.

8. Application forms: Application for must be accompanied by

abridged prospectus. Disclaimer clause of SEBI should be

printed in bold. Highlights and risk factors should be given

same prominence. It should also contain instruction to mention

application form number on the back of the cheque, demand

draft or the stocks invest as the case maybe.

9. Listing of securities: Minimum application money to be paid by

the applicant along with application shall not be less than 25%

of issue price. Application for shares or debenture should be

for such a number that total amount payable is not less thanRs. 2000.

10.Listing of securities: The securities of public issues shall be

listed in the stock exchange. In case these are not listed,

entire application money becomes refundable.

11.Period of Subscription: subscription for public issues shall be

kept open for at least 3 working days and not more than 10

working days. However, in case of infrastructure company, itmay be kept open for 21 working days.

12.Oversubscription: The quantum of issue whether through a

rights or a public issue shall not exceed the amount specified

in the prospectus/letter of offer, however an oversubscription

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to the extent of 10% of the net offer to public is permissible for

the purpose or rounding off to the nearer multiple of 100 while

finalizing the allotment

Provisions of the SCRA and the SEBI and also the bye-laws andregulations duly approved by the Government.

Any stock exchange which needs recognition under the SEBIact has to submit an application in the prescribed manner tothe Central Government. This application must be accompaniedby the following documents:

i. A copy of the bye-laws of the stock exchange for its

operations

ii. A copy of the rules relating to its constitution, governing

body, powers and duties of the office-bearers, the admission

procedures etc.

GRANT OF RECOGNITION

Recognition will be granted by the Central Governmentprovided the following conditions are fulfilled:

i. The rules and bye-laws of the stock exchange applying for

registration must ensure fair dealing and protect the interest

of investors.

ii. The stock exchange concerned must be willing to comply

with any other conditions that may be imposed by the

government from time to time.

iii. The grant of recognition must be in the interest of trade

as well as in the public interest.

While granting recognition, the central government mayprescribe conditions regarding the qualifications formembership, the method of entering into contracts, therepresentation of the central government on the stock exchange and the maintenance of accounts and their audit.

RENEWAL OF RECOGNITION

If any stick exchange intends to renew its recognition, it mustonce again make an application to the central government inthe aforesaid manner three months before the expiry of theperiod of recognition.

WITHDRAWAL OF RECOGNITION

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Ludhiana stock exchange

Madras stock exchange

Magadh stock exchange

Mangalore stock exchange

National stock exchange

Pune stock exchange

OTCEI

DEMUTUALISATION OF STOCK EXCHANGES

The transition process of an exchange from a ‘mutually-owned’ association to a company ‘owned by shareholders’ is

called demutualization .In other words, transforming the legal structure of anexchange from a mutual form to a business corporation form isreferred to as demutualization.

In a mutual exchange, the three functions of ownership,management and trading are intervened into a single group. Itmeans that the broker members of the exchange are theowners as well as traders on the exchange and further theythemselves manage the exchange. These three functions aresegregated from one another after demutualization. Thedemutualised stock exchanges in India are:

i. The National Stock Exchange (NSE)

ii. Over The Counter Exchange of India (OTCEI)

CORPORATISATION OF STOCK EXCHANGES

The process of converting the organizational structure of thestock exchange from a non-corporate structure to a corporatestructure is called Corporatization of stock exchanges. Asstated earlier, some of the stock exchanges were establishedas ‘Association of persons’ in India like BSE, ASE and MPSE.Corporatization of these exchanges is the process of converting them into incorporated companies.

MANAGEMENT

The recognized stock exchanges are managed by ‘GoverningBoards’. The governing boards consist of elected memberdirectors from stock brokers’ members, public representatives

55



and government nominees nominated by the SEBI. Thegovernment has also powers to nominate Presidents and Vice-Presidents of stock exchanges and to approve the appointmentof the Chief Executive and public representatives. The majorstock exchanges are manages by the Chief Executive Directorand the smaller stock exchanges are under the control of a

Secretary.

The governing boards have wide powers such as :

i. Election of office bearers and setting up of committees

like Listing Committee, Arbitration Committee, Defaulter’s

Committee etc.

ii. Admission and expulsion of members

iii. Management of the properties and finances of the

exchange

iv. Framing and interpretation of rules, bye-laws etc. for the

regulation of stock exchange

v. Adjudication of disputes among members or outsiders

vi. Management of the affairs of the exchange in the best

interest of the investors and public interest.

MEMBERSHIP

To become a member of a recognized stock exchange, a personmust possess the following qualifications:

i. He should be a citizen of India

ii. He should not be less than 21 years of age

iii. He should not have been adjudged bankrupt or insolvent

iv. He should not have been convicted for an offence

involving fraud or dishonesty

v. He should not be engaged in any other business except

dealing in securities

vi. He should not have been expelled by any other stock

exchange or declared a defaulter by any other stock exchange.

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Apart from individuals a company is also eligible to become amember provided it satisfies the conditions imposed by thestock exchange concerned.

II. LISTING OF SECURITIES

Listing of securities means that the securities mean that thesecurities are admitted for trading on a recognized stock exchange. Transactions in the securities of any companycannot be conducted on stock exchanges unless they are listedthe green signal given to selected securities to get the tradingprivileges of the stock exchange concerned. Securities becomeeligible for trading only through listing.

Listing is compulsory for those companies which intend to offershares/debentures to the public for subscription by means of issuing a prospectus. Moreover, the SEBI insists on listing forgranting permission to a new issue by a public limited

company. Again, financial institutions do insist on listing forunderwriting new issues. Thus, listing becomes an unavoidableone today.

The companies which have got their shares or debentureslisted in one or more stock exchanges must submit themselvesto the various regulatory measures of the stock exchangeconcerned as well as the SEBI. They must maintain necessarybooks; documents etc. and disclose any information which thestock exchange may call for.

GROUP A, GROUP B AND GROUP C SHARES (BSE)

The listed shares are generally divided into two categoriesnamely

1. Group A Shares (Specified shares or cleared securities)

2. Group B shares (Non-specified shares or non-cleared

securities)

Group A shares represent large and well establish companieshaving a broad investor base. These shares are actively traded.Naturally, these shares attract a lot of speculative multiples.These facilities are not available to Group B shares. However,

shares can be moved from Group B to Group A and vice-versadepending upon the criteria for shifting. For instance, the BSEhas laid down several criteria for shifting shares from Group Bto Group A, such as, an equity base of Rs.10 Crores and amarket capitalization of Rs.25 to 30 crores, a public holding of 35 to 40%, share holding population of 15000 to 20000, a gooddividend paying status etc. Group B2 shares are again dividedinto B1and B shares on the Bombay Stock Exchange B1 shares

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represent well-traded scrip’s among the B group and they haveweekly settlement.

Apart from the above, there is another group called Group Cshares. Under Group C, only lots and permitted securities areincluded. A number of shares that are less than the market lot

are known as odd lots. Markets lot refers to the minimumnumber of shares of a particular security that must betransacted on a stock exchange. Odd lots have settlement oncein a fortnight or once on Saturdays. Permitted securities arethose that are not listed on a stock exchange but are listed onother stock exchanges in India. So they are permitted to betraded on this stock exchange. Odd lots cannot be easilytransacted on the stock exchange and so they are illiquid innature.

Advantages of Listing

The advantages of listing may be summarized as follows:(i)Facilitates buying and Selling Securities

Listing paves way for easy buying and selling of securities.Constant marketing facilities are assured for listed securities.

(ii)Ensures Liquidity

The prices of listed securities are quoted daily in the market.Hence, securities cab be converted into cash readily at quotedprices and thus listing ensures liquidity.

(iii)Offers wide PublicityListed securities give wide publicity to the companiesconcerned. It is so because the names of listed companies arefrequently mentioned in stock market reports, T.V.,Newspapers, Radio, etc. this has an advertising effect for suchcompanies and this will automatically widen the market fortheir securities. According to Hasting, “A listed security willreceive more attention from investment advisory services thanan unlisted one”

(iv)Assures Finance

The very fact that a security is listed in a recognized stock exchange adds the prestige of that company and it enables thecompany to raise the necessary finance by the issue of suchsecurities expeditiously.

(v)Enables Borrowing

Listed securities are preferred as collateral securities bycommercial banks and other lending institutions because they

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are rated high in market quotations and there is a readymarket for them also. Thus borrowings are made easier againstthe securities of the listed companies.

(vi)Protects Investors

Listing companies have to necessarily submit themselves tothe various regulatory measures by disclosing vital informationabout their assets, capital structure, profits, dividend policy,allotment procedure, bonuses etc. hence, listing aims atprotecting the interest of investors to a greater extent.

Drawbacks

At the same time, listing brings some bad effects also. Thedisadvantages of listing are as follows:

(i)Leads to Speculation

Listed securities offer wide scope for the speculators tomanipulate the values in such a way as may be detrimental tothe interests of the company. In such a situation, artificialforces play a more dominant role than the free market forces.The stock market may not reflect the true picture of a listedsecurity. Again, the managerial personnel may themselvesindulge in speculative activities with regard to listed securitiesby misusing the inside information available to them.

(ii)Degrades Company’s Reputation

Some times listed securities are subject to wide fluctuations in

their values. They may become a victim of depression. Theyare immediately reflected on the stock exchange whereasunlisted securities escape from this misery. These widefluctuations in their values have the effect of degrading thecompany’s reputation and image in the eyes of the public aswell as the financial intermediaries.

(iii)Discloses Vital Information to Competitors

For getting the securities listed, a company has to disclosevital informations such as, dividends and bonuses declared, abrief history of the company, sales, remuneration tomanagerial personnel and so on. It amounts to leaking of

secrecy of the company’s operations to trade rivals. Even tradeunions may demand higher wages and bonus on the basis of these informations. Thus, listing may prove disadvantageousto a company.

Listing Procedure

As stated earlier, listing enables a company to include itssecurities in the official list of one or more recognized stock

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exchanges of the purpose of trading. A company whichrequires its securities to be listed must comply with thefollowing formalities:

The company concerned must apply in the prescribed formalong with the following documents and details:

(i) Certified copies of Memorandum and Articles of Association,Prospectus or Statement in lieu of Prospectus, Underwritingagreements, agreements with vendors and promoters etc.

(ii) Specimen copies of shares and debenture certificates, letter of call, allotment, acceptance and renunciation.

(iii) Copies of balance sheets and audited accounts for the last 5years.

(iv) Copies of offers for sale and circulars or advertisementsoffering any securities for subscription or sale during the last 5

years.

(iv) Certified copies of agreements with managerial personnel.

(v) Particulars of dividends and bonuses paid during the last 10years.

(vii) A statement showing dividends or interest in arrears if any.

(viii) A brief history of the Co since its incorporation, givingdetails of its activities.

(ix) Particulars regarding its capital structure.

(x) Particulars of shares and debentures for whichpermission to deal is applied.

(xi) A statement showing the distribution of shares along witha list of highest 10 holders of each class or kind of securities of the company stating the number of securities held by them.

(xii) Particulars of shares forfeited.

(xiii) Certified copies of agreements if any with the IndustrialFinance Corporation, ICICI etc.

(xiv) Listing agreement with the necessary initial and annuallisting fee.

REGISTRATION OF STOCK BROKERS:

A broker is none other than a commission agent who transacts

business in securities on behalf of his clients who are non

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members of a stock exchange. Thus, a non-member can

purchase and sell securities only through a broker who is a

member of stock exchange. To deal is securities on recognized

stock exchanges; the broker should register his name as a

broker with the SEBI. A stock broker must possess the

following qualifications to register as a broker:

1. He must be an Indian citizen with 21 years of age.

2. He should neither be a bankrupt nor compounded with

creditors.

3. He should not be convicted for any offence, fraud etc.

4. He should not have engaged in any other business other

than of a broker in securities.

5. He should not be s defaulter of any stock exchange.

6. He should have completed 12th standard examination.

FUNTIONS OF THE BROKERS

The following are the important functions generally performedby all the brokers.

I. Client registration:

First of all, a trading broker has to enter into an agreement inthe specified format with his client before accepting any orders

on his clients’ behalf. The said agreement has to be executed

on Non-judicial stamp paper, duly signed by both the parties

on all the pages. In addition to that agreement, the broker

shall seek other information about the client in the client

registration form. The information may relate to:

• Investors financial profile

• Investors risk profile and risk taking ability.

• Investor’s social profile.

• Investor’s identification details.

• Family, income, age and employment details.

• Details of investments in other assets

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• Financial liabilities etc.

The broker has to obtain recent passport photos (3 copies) in

the case of individual clients and of all partners in case of

partnership firms. In case of corporate customers, he has to

obtain the photos of dominant promoters. The broker should

not forget to take proof of identification of the client. It is also

mandatory to give an unique code for each client for easy

identification. There is no limit on the maximum number of

clients for a broker.

II. Obtaining margin money:

It is also mandatory for the broker to collect margins from hisclients in all cases where the margin in respect to the client in

settlement, would work out to be more than Rs. 50,000. The

margins so collected must be kept separately in the client’s

bank account and it must be utilized to make

payment/settlement in respect of that client.

III. Execution of orders:

The important function of a broker is to execute his clientsorders swiftly and carefully. Hence, he has to obtain clear cut

confirmed order instructions from the clients so that the

necessary orders may be placed on the system. To execute a

trade order for a client, the broker must obtain specific

instructions as to:

• The name of the company whose securities have to be

bought or sold.

• The precise number of shares required.

• The limit /market price condition etc.

IV. Supply of necessary slips:

On the execution of trade, the broker, i.e., the trading member

should inform his client the order number. He should also give

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copies of the trade confirmation slip, modification slip,

cancellation slip etc. to enable the client to take necessary

follow up action.

V. Issue of contract note:

The broker should then issue the contract note to his clients

for all trades, whether purchase or sale of securities, executed

with all relevant details. This contract note should be issued

within 24 hrs of the execution of the contract. It should be duly

signed by the broker or his authourised signatory or client

attorney. Each broker is expected to maintain a duplicate copy

of each contract note issued for 5 yrs.

VI. Statement of particulars in a contract note:

It is mandatory to mention the following particulars in a

contract note issued by a dtock exchange.

• The name, address and SEBI registration number of the

member broker.

• The name of partner/proprietor/authorized signatory

• Dealing office address, tel. no, fax no code no, of the

member given by the exchange.

• Unique identification number

• Contract number, date of issue of contract note,

settlement number and a period for settlement.

• Clients name and code number

•Order number and order time corresponding to trade

• Trade member and trade time

• Quantity and kind of security bought or sold by the client

• Purchase/sale rate and brokerage

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• Service tax rates and any other charges levied by the

broker

• Affixing of appropriate stamps on the original contract

note as per the Stamp Act of the relevant state.

• Addition of a clause stating that ‘the client will hold the

security blank at his own risk’.

VII. Payment/delivery of securities:

It is the duty of every trading member (broker) to make

payments to his clients (in the case of sale) or deliver the

securities purchased within 24 hrs to pay out unless the client

has requested otherwise. All brokers have to exercise a great

caution in accepting deliveries of securities on behalf of theirclients to avoid the introduction of any fake/forged/stolen

securities into the market.

VIII. Charging of brokerage and other charges:

As per the SEBI guidelines, every broker is entitled to charge

brokerage not exceeding 2.5%. in addition to brokerage, the

following items are charged:

1. Service tax (5% of the brokerage)

2. Stamp duty as per the Stamp Act of the State

Government.

3. SEBI turnover fee

4. Transaction tax as presented by the Central Government

(Rs 1500 per crore trade)

IX. Maintenance of bank Account:

It is the function of a broker to maintain separate bank

accounts for his client’s funds and also for his own funds.

However, funds can be transferred from the client’s accounts

to the clearing accounts for the purpose of meeting pay in

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obligations on behalf of the clients and vice versa in the case

of funds pay out.

X. Receipt of interest, dividends, rights etc.

In case securities are brought cum vouchers, cum coupons,

cum dividend, cum cash, cum bonus issues, cum rights etc.,

the client is entitled to receive all vouchers, coupons, dividend,

cash, bonus etc. in addition to original securities bought. In

such a case, it is the duty of the broker to receive all such

privileges on behalf of his client

XI. Settlement of Disputes:

In case any disputes arise between the broker and his client, it

is the duty of the broker himself to take the initiative andresolve the dispute.

Kinds of offer document:

An offer document means ‘prospect’ in case of public issue or

an offer for sale and letter of offer in case of right issue, which

is required to be filled with the Register of Companies(ROC)

and stock Exchange. An offer document covers all relevant

information to help an investor in making wise investment

decision.

Draft Prospects: A company before making any public issue of

securities, shall file a draft prospect with SEBI, through an

eligible merchant bank, at least 21 days prior to the filing of

prospectus with the ROC .If any specific changes are suggested

by SEBI within said 21 days, the issuing company or the lead

merchant banker shall carry out such changes in the draft

prospects before filling the prospect with ROC.

Draft letter of offer: A listed company before making any right

issue for an amount exceeding Rs. 50 lakhs shall file a Draft

letter of offer with SEBI at least 21 days prior to the filing of

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prospectus with the regional stock exchange and shall carry

out any changes as suggested by SEBI before filling the draft

offer letter with regional stock exchange.

Prospectus: A company issuing shares to public must issue

Prospects. It is an invitation to the public to take shares, or

debentures in the company or deposit money in the company.

Definition- “any document described or issued as a prospect

and includes any notice, circular, advertisement or other

document inviting deposit from the public or inviting offers

from the public for subscription or purchase of share in, or

debentures of , a body corporate.”

Abridged Prospectus: sec (2) of the company’s act 1956

defines abridged prospectus as “a memorandum containing

such salient features of a prospectus as may be prescribed.” A

company can not supply application forms for shares or

debentures unless the form is accompanied by abridged

prospectus.

Shelf Prospectus: Sometimes securities are issued in stages

spread over a period of time, particularly in respect of infrastructure projects, where the size of the issue is large, as

huge funds have to be collected. In such cases, filling of

prospectus each time will be very expensive. In such cases,

companies act allows a prospectus called Shelf Prospectus to

be filed with ROC at subsequent stages only “information

memorandum” is required to be filled. It is valid for a period of

1 yr from the date of opening of first issue of security under

those prospects.

Information Memorandum (IM): The IM shall contain all

material facts relating to new charges created, change in

financial position as have accrued between the first offer,

previous offer and succeeding offer. The IM shall be filed with

period 3 months prior to making of 2nd and subsequent offer

of securities under Shelf Prospectus filed at the 1st stage of

offer. Where an update of IM is filed every time an offer of

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security is made, such memorandum, together with the Self

Prospectus shall constitute the Prospectus.

EQUITY SHARE CAPITAL

Equity means ‘equal’. Equity share is a share that gives equalrights to holders. Equity share have to share the rewards andrisk associated with ownership of the company. For exampleABC Company has 10,000 Equity shareholders and it hasearned Rs. 10,000 profit last year and assumes it may earn aloss of Rs. 10,000 in the next year. Here, the shareholders willget Re. 1 as profit from last year and Re. 1 loss in the comingyear. It is also called as ordinary share capital. Equity shareholders are the owners of the company, who have control overthe working of the company. They are paid dividend at the raterecommended by the Board of Directors (BOD). The dividend

rate depends upon the profits, no dividends will be payable.But some companies pay dividend even if the company has noprofits to maintain dividend stability. The amount required topay dividends will be transferred from general reserve a/c. theEquity shareholders take more risk when compared topreference share holders.

FEATURES OF EQUITY STOCK

The following are the features of Equity stock:

• Permanent capital: An Equity source is the main long termor permanent source of finance. They can be redeemed orrefunded only at the time of liquidation that too from theresidue left after meeting all the obligations. In other wordsthere is no agreement between Equity share holders and thecompany with regard to refund of the capital. Shareholderscannot sell shares to the company, but he can sell in the stock market to others, if he wants to get back his money. Hence it isa permanent source of finance for the company.

• Residual claim to income: Equity shareholders have a

residual claim to the income of the company. Residual claimmeans the income left over after paying the outsider claims.The residual income is also known as earnings available toEquity shareholders, which is equal to profit after tax minuspreference dividend. But the total residual income may or maynot be paid as dividends, since the BOD’s have the right todecide the portions of the earnings available to shareholders

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that will be paid as dividends. Payment depends on retentionor plough back profits.

• Residual claim to assets: Equity shareholders have aresidual claim on the firm’s assets. In an event of liquidation of a firm, the assets are used first to settle the claims of outsidecreditors and preference shareholders. In other words Equity

shareholders have last priority on assets; hence their capitalbecomes cushion to absorb losses on liquidation.

• Voting right/ right to control: Equity shareholders as realowners of the company, have the voting right, in appointingDirectors and Auditors of the company, participate and vote inannual general meeting, which helps to control the company.BODs have the control power of the company, because themajor decisions are taken by the BODs

• Pre-emptive right: Equity shareholders have the pre-emptive right, which means they have legal right to buy newissues, before offering to public. Sec 18 of the companies Act,

1956 puts company under legal compulsion to offer new sharesto existing shareholders before offering to the public

ADVANTAGES OF EQUITY SHARES:

• ADVANTAGES TO THE COMPANY:1. It is permanent source of long-term source of finance.2. there is no repayment liability3. it does not create ant obligation to pay dividend4. this capital can be issued without creating any charge of

assets of the company5. issue of Equity share capital increases the creditworthiness of the company

• ADVANTAGES TO INVESTOR:1. Equity shares provide more income2. Equity shares give the right to participate in the companyand management of the company3. capital appreciation(if share price increased whencompared to purchase price)

DISADVANTAGES OF EQUITY SHARES:

• DISADVANTAGES TO THE COMPANY:1. high cost source of funds2. involves high floatation costs3. issue of additional shares dilutes control4. no tax advantage5. it makes capital structure rigid

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• DISADVANTAGES TO INVESTOR:1. no guarantee or regularity in receipt of dividend2. no guarantee in receipt of principle amount of investment3. loss of capital due to fluctuation in share prices

TYPES OF EQUITY SHARES

1. Sweat equity shares: the companies act of 1999, hasinserted a new section 79A that allows issue of sweat equityshares. Sweat equity shares defined as “equity shares issuedat a discount or for consideration other than cash for providingknow-how or making available rights in nature of intellectualproperty rights or value additions by whatever mane called”.Issue of sweat equity by listed company should be according toSEBI guidelines. The issue should be authorized by aspecialized resolution passed by a company in the generalmeeting, which specifies the number of shares, price and

consideration if any. However non-listed companies can issuesweat equity in accordance with prescribed guidelines.

2. Par-value shares: Unlike bonds, which always have a parvalue, equity stock may be sold with par value or without parvalue. Par value means the nominal value of the shares in theMemorandum of Association (MOA) established for legalpurpose. The par value decided by promoters of first directorsof the company such may be issued at par, at premium, or atdiscount price to public.

3. No-par value shares: These type of shares are without parvalue. In this arrangement MOA, specifies the number of shares and not the price of the share. They will be issued tothe public at the stated price decided by the BODs. Payment of dividend on this type of shares is much many rupees per sharei.e., Rs. 5 per share or Rs. 6 per share.

PREFERENCE SHARE CAPITAL

Capital stock which provides a specific dividend that is paidbefore any dividend are paid to the common stock holders, and

which takes precedence over common stock in the event of liquidation. Like common stock, preference share representpartial ownership in the company, although preferred stock shareholders do not enjoy any of the voting rights of commonstockholders. Also unlike common stock, preference shares paya fixed dividend that does not fluctuate, although the companydoes not have to pay this dividend if it lacks the financialability to do so. The main benefit of owning preference shares

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are that the investor has a greater claim on the company’sassets than common stockholders. Preferred shareholdersalways receive their dividend first and, in the event thecompany goes bankrupt, preferred shareholders are paid off before common stockholders. In general, there are fourdifferent types of preferred stock:

1. Cumulative2. Non-Cumulative3. Participating4. Convertible

It is also called as preferred stock.

Features of preference shares

1. Claim on Assets: Companies do not create any charge onthe assets while issuing the preference shares, still preferenceshareholders have prior claim on assets of the company in the

event of liquidation. It means before payment of ordinaryshareholders, preference shareholders are paid.

2. Claim on Income: Not only the prior assets at time of liquidation, they also have prior claim on income or profits.Preference dividend must be paid in full before payment of anydividend on the equity share capital. As the preference sharecapital lies between debenture capital and equity share capitalwith regard to claim on assets and income of company. Henceit is called “senior security”.

3. Accumulation of dividends: Most of the preference sharedividend is cumulative. It means that all unpaid/ arrearsdividends are carried forward for the next year and paid withthe current year dividend before payment of any dividend tothe equity shareholders.

4. Redeemable: Preference share capital has limited maturityperiod after that the share capital has to be refunded. Itprovides flexibility in the capital structure which is beneficialto the company.

5. Fixed rate of dividend: Issues of preference share are nota fixed rate of dividend. The rate is at par value basis. It helpsthe management to avoid the provision of equal participationin earnings. The fixed dividend rate would be lower whencompared to ordinary shareholders’ dividend.

Advantages/Merits of Preference Shares:

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(a) Advantages/ merits to company

• There is no legal obligation to pay preference dividend

• There is no share in control of the company throughparticipation in voting

• They provide flexibility in the capital structure by issue of redeemable preference share

• It enhances credit worthiness because preference sharecapital is generally treated as a part of net worth.

• Preference share provides long term capital for thecompany

• Mortgageable assets are conserved, due to the issue of preference share capital without pledging assets(b) Merits to investors

• stable rate of preference dividend

• prior claim on assets

• less risk when compared to equity shareholders

Disadvantages/ demerits of Preference Shares

(a) Disadvantages to company

• Tax disadvantage, because preference dividend is not atax deductible, which makes preference share capital a costlysource of finance

• Adverse effect on credit worthiness, if the company avoidspayment of dividend

• Permanent burden of payment of dividend, if preferenceshares are cumulative in nature(b) Disadvantages to investors

• Limited returns, as preference shareholders do not havevoting rights, their returns depend on managerial decision,which is arbitrage and shareholders cannot force managementto pay more dividend

• Rate of preference dividend is generally less than the rateof dividend on equity shares

• The market price of equity shares fluctuate more whencompared to debentures.

CLASSIFICATION OF PREFERENCE SHARES

1. Cumulative Preference Shares: they are those shares on

which the amount of dividend payable goes on cumulating untilit is fully paid. If the full dividend or partial dividend cannot bepaid in any year, the same can be paid out of future profits.Even if the company is not able to pay the last year’s dividendin the next year, the same is cumulated for the future periodtill the full payment. Preference shares are generallycumulative unless otherwise expressly stated in Articles of Association or if there are terms of the issue of those shares.

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2. Non-cumulative preference shares: these are those shareson which the unpaid dividend does not cumulate to the nextyear’s dividend. It means in any year, if the company fails toearn profit to pay fixed dividend for that year, the preferenceshareholders cannot ask from the next year’s profit. Thus the

right to claim unpaid dividends will lapse.

3. Redeemable preference shares: these are those shares,which can be redeemed or repaid to the holders after lapse of the stipulated period, which is stated by issue of such a share.A company limited by a share may redeem, if articles permit.

4. Irredeemable preference shares or perpetual shares: theyare those shares, which are not repayable and are redeemableonly at the time of liquidation. These shares are also called

perennial shares.

5. Participatory preference shares: these are the shares thatenjoy the right to participated in surplus profits that are leftout after payment of a fixed rate of dividend to equityshareholders. This additional return apart from getting a fixedrate of preference dividend. Not only a share in surplus profit,may they also participate in surplus assets of the firm at thetime of liquidation.6. Non-participatory preference shares: they have no claim inthe surplus profit or assets of the firm are deemed to be non-

participatory preference shares.

7. Convertible preference shares: here convertible meansequity and not cash. The preference shares, which are havingthe right to convert their holdings into equity shares within aspecified period, are known as convertible preference shares.

8. Non-convertible preference shares: the preference sharesthat do not enjoy the option of converting their holdings intoequity are known as non-convertible preference shares.

DEBENTURES/BONDS

Debentures/bonds are an important source of long-termfinance. Raising of funds by issue of debenture or bonds isallowed to public limited companies. If Memorandum of Association (MOA) is permitted.

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The term ‘debenture’ is derived from a Latin word ‘debere’which means to be ‘debtor’. Companies Act of 1956‘debenture’ as including debenture stock, bond and othersecurities of a company, whether constituting the charge onthe assets of the company or not. It is not clear or does notexplain fully what is debenture. According to Naidu or Datta,

“a debenture is an instrument issues by a company under itscommon seal acknowledgement a dent and setting forth theterms under which they are issued are to be paid”. A personwho buys the debenture is the debenture holder and thecreditor of the company. Debenture can be priced in the samemanner as a share. In other words, that can be issued at face(par) value, at the premium or at the discount.

FEATURES OF DEBENTURE:

1. Fixed rate of interest: in general, debentures are issuedat the fixed rate of interest but they may also be issued at

floating rate of interest or at zero interest. The fixed ratedebentures are more popular in India. The rate of interest is onthe face value of the debenture that will be out annually orsemi-annually. The interest payable on debentures is taxdeductable. Company is free to determine the interest rate,which may be fixed or floated.

2. Maturity: the debenture capital is the cheapest form of long-term finance, but it should be repaired after a fixedperiod of time. In other words, debentures are issued for afixed period. The period in which debentures r issued or period

after which debenture capital is repaid is known as maturityperiod. The maturity period may vary between 1year to 20years. In India, non convertible debentures are redeemed after7-10 years.3. Redemption: debenture can be repaid either ininstallment wise or lump sum. If it is repaid in one lump sumamount, it can be done by creation of debenture redemptionreserve. It is compulsory for all debentures whose maturityperiod exceeds 18 months.Company should create a dividenedredemption reserve (DRR) equivalent to atleast 50 % of theamount of issue before commencement of repayment.

4. Call and put option: debenture may have “call” option,which gives the right to ‘buy’ to issuing company at a certainprice before the maturity period. The buy back (call) price maybe more than the fac3 value of debenture generally 5% whichis known as premium on redemption. Sometimes, debenturesmay also put an option, which gives a right to the determineholder to seek redemption at specified times and at pre-decided prices.

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5. Debenture Indenture: A debenture is a legal document, whichspecifies the right of both the issuing company and thedebenture holder. The debenture indenture includesdescriptions of the amount and timing of the interest and theprinciple amount payments (installments or lump sum), variousstandards and restrictive provisions. The indenture gives the

responsibility to the trustee to protect the interest of hedebenture holders by fulfilling the above stated descriptions.

6. Security interest: Debenture may either be secured orunsecured. A secured debenture is a debenture which issecured by a charge on the company’s immovable assets andfloating charge on other assets. An secured debenture is onewhich is without any charge on the firm’s assets, these areknown as naked debentures.

7. Convertibility: Companies can also issue convertibledebentures. It is the debenture that is convertible into equity

shares at the option of the debenture holder. The conversionratio and the period during which conversion can be affectedare specified at the time of issue of debentures.

8. Credit ratings: Before issue of debentures to the public, theissuing company needs to get the debentures rated by anyoneof the credit rating agencies. The four credit rating agenciesare:

• Credit Rating Information Services of India Limited(CRISIL)

• Investment Information and Credit Rating Agency of India

Limited (ICRA).• Credit Analysis and Research Limited (CARL)

• FITCH India and Duff & Phelps Credit Rating India pvt. Ltd(DCRI)

9. Claim on income and assets: Debenture interest is taxdeductible. In other words, debenture interest is paid formearning before interest and taxes (EBIT) or operating profit.The interest is payable before payment of tax, preferencedividend and equity dividend. So, debenture holders havepriority of claim on income. At the same time they also have

priority of claim on company assets at the time of winding up.Failure of interest force to bankruptcy.

TYPES OF DEBENTURES.

1. From the redemption point of view, the debentures aresubdivided into two:(a) Redeemable Debenture: They are those debentures, whichare to be repaid by the company at the end of a specified

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period or with in the specified period at the option of thecompany by giving a notice to the debenture holder with theintention to redeem debentures either lump sum orinstallments

(b) Irredeemable Debentures: Irredeemable Debentures arethose that are not redeemable during the existence of thecompany. They are repayable either if the company fails to payinterest to them or at the time of liquidation of the company.These are also called as perpetual debentures.2. From the conversion point of view, the debentures aresubdivided into two:(a) Convertible Debentures: They are those debentures thatare convertible into equity shares at the option of debentureholder after stating period at a predetermined price. Thedebenture capital may be Fully Convertible Debenture (FCD) orPartially Convertible Debenture (PCD). This type of debenture

is attractive, even though they carry a low rate of interestwhen compared to non-convertible debentures.

(b) Non-convertible debentures: They are those debenturesthat do not carry the option of conversion into equity.

3. From the transfer of registration of view, the debenturesare subdivided into two:(a) Registered debentures: These are those debentures thatare registered with the issuing company. Name, addresses and

other particulars of the holders are recorded in the debentureregister, which is kept by the issuing company. Transfer of these types of debentures need a regular transfer deed, at thetime of transfer of such debentures. The interest is paid only tothe person on whose name the debenture is registered.

(b) Bearer debenture: These are those debentures that arepayable to the bearer and the transferable by delivery only.They are negotiable instruments and the company keeps onrecords for them. The interest is paid to the bearer of thedebenture.

4. Other types of debentures:(a) Zero interest debentures: These are innovative debtinstruments. These types of debentures do not carry anyinterest rate. Generally, they are issued at a discount fromtheir maturity/ redeemable value. The return for the holders of this type of debentures is the difference between purchase(issue) price and maturity (redeemable) value.

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(b) Deep discount debenture/ bond (DDB): It is the same aszero coupon bonds but deep discount bond is issued at a deepdiscount from its redeemable value. In India, DDBs are beingissued by the public financial institutions. They are Industrial

Development Bank of India, Small Industries DevelopmentBank of India, etc. DDBs enable the issuing company toconsume cash during maturity period. The issuing companyneed not serve the debt by paying interest. It reduces the risk of reinvestment of interest, which is receivable at the end of every year. However, DDBs are exposed to high risk since theentail balloon payment at the end of the maturity period.

(c) Floating Rate Bonds (FRBs): These are bonds in which therate of interest and its linked interest rate on Treasury Bills,

bank rate, which are considered as benchmark. In India, StateBank of India (SBI) was one of the earliest financial institutionsto successfully sell floating rate bonds. Later, IDBI also issuedthese type of debentures. FRBs provide protection againstinflation risk to investors and bondholders.

(d) Secured Premium Notes: SPN is a type of secureddebenture redeemable at a premium over the face or purchaseprice. It is like zero interest debentures, since there will be nointerest payment in the lock-in-period. SPN holders have theoption to sell back the debenture/note to the issuing firm at

face value after the given lock-in-period. SPNs are tradableinstruments.

(e) Guaranteed Debentures: these are debentures on which thepayment of interest and principle amount is guaranteed by athird party at the time of their issue. The third parties arefinancial institutions, governments, etc.

(f) Callable Bonds: these are bonds that can be called in andpurchased at a price. Companies generally call back bonds onlywhen the interest rates fall in the market less than the bond’sinterest rate. Companies redeem high interest bonds and raisefunds by issue of low interest bonds.

ADVANTAGES OF DEBENTURES/BONDS

Advantages to the Company

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1. Debenture Capital is one of the cheapest source of long-term finance, since interest payments on debentures is a tax-deductible expenditure and low floatation cost.2. Issue of debenture does not dilute control, since they arenot entitled to voting rights.3. Debentures enable the company to take advantage of

trading on equity, which results in shareholder’s wealthmaximization.4. Debenture capital provides flexibility in capital structure,if they are issued as redeemable or if not so also, since theyhave call option.5. Debenture holders do not participate in the surplus profitsof the company since payments to them are limited to theinterest and principle amount.6. Debenture capital provides protection against inflationsince the interest rate is fixed.

Advantages to Debenture Holders

1. Debentures provide a fixed, regular and stable source of income.2. Debenture holder’s investment is safe and secure since,debentures with a charge on company is an asset.3. Debentures are issued for a definite maturity period.4. Debenture holder’s interest (payments of interest andprinciple amounts) is protected by the debenture indenture.

DISADVANTAGES OF DEBENTURES/BONDS

Disadvantages to the Company

1. Raising debenture capital is a risky one, since it involvespayment of fixed interest charges and repayment of principleamount, which are legal obligations of the issuing company.Failure to do so may lead to bankruptcy.2. Raising debenture capital increases financial leverages,which will raise the cost of equity of the company.3. Raising debenture capital involves restrictions likeborrowing limit, dividend payment limit, etc.4. Debenture capital is a costly one, when the rate oninflation increases. Since interest comes down in the market.

5. This is not the stable source of long-term finance for afirm with variable earnings.

Disadvantages to the Debenture Holders

1. Debentures do not carry any voting rights, which give nocontrolling power on the working of the company.

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2. Debentures holders do not have any claim on the surplusprofit since they are not the owners of the company.3. Receipt of debentures is fully taxable under the headincome from other sources.4. Debenture holders lose interest charges, if the inflationincreases.

5. Debenture prices are vulnerable with changing interestrates.

BOOK-BUILDING- ABOUT BOOK BUILDING

Book building is basically a capital issuance process used ininitial public offer (IPO) aiding price and demand discovery. Itis a process used for marketing a Public offer of equity sharesof a company. It is a mechanism wherein during the period forwhich the book for the IPO is open, bids are collected frominvestors at various prices, which are above or equal to the

floor price. The process aims at tapping both the wholesalerand retailer investors. the offer/issue price is then determinedafter the bid closing date based on certain evaluation criteria.

THE PROCESS:

• The issuer who is planning an IPO nominates a lead

merchant banker as a ‘book runner’

• The issuer specifies the number of securities to be issued

and the price band for orders.

• The issuer also appoints syndicate members with whomorders can be placed by the investors.

• Investors place their order with a syndicate member who

inputs the orders into the electronic book. This process is

called ‘bidding’ and is similar to open auction.

• A book should remain open for a minimum of 5 days.

• Bids cannot be entered less than the floor price.

• The bidder can revise the price before the issue closes.

• On the close of the book-building period, the ‘book no

evaluates the bids on the basis of the evaluation criteria which

may include:

Price aggression

Investor quality

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Earliness of bids etc.

• The book runner and the company conclude the final price

at which it is willing to issue the stock and allocation of

securities.

• Generally the no of shares is fixed; the issue size gets

frozen based on the price per share discovered through the

book building process.

• Allocation of securities is made to the successful bidders.

• Book building is a good concept and represents a capital

market that is in the process of maturing.

SAFETY NET:

Safety net is a process under which a person or a company(generally a finance company) undertakes to buy shares issuedand allotted in a new issue from the allottees at a stipulatedprice. This is an agreement in relation to the issue of equityshares. The main feature of the safety net is to provide theequity investors of the safety of their investments from fall of the share price below the issue price. This facility will begenerally provided in a bear market environment. Closely-heldcompanies that are going to issue shares to the public for thefirst time may also provide safety net facility to the investors

in their shares where the investors have no benchmark price togo by and therefore the safety net provide them a sort of confidence regarding safety for their investment into equityshares. The safety net scheme generally puts provision forbuying back the shares at a price lower than the issue price,and the e difference will be the premium to the buyer for therisk taken in purchase of shares back from the investors.

STOCKINVEST:

In case of over subscription of issue, there have been aninordinate delays in refund of excess of application money andlarge amounts of investors funds remain locked up incompanies for long periods, affecting the liquidity of theinvesting public. To overcome the said problem a newinstrument called the stockinvest is introduced. The stock invest is a non-negotiable bank instrument issued by the bank in different denominations. The investor who has a savings or acurrent a/c with the bank will obtain the stockinvest inrequired denominations and will have to enclose it with theshare/ debenture application. The face of the instrument

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provides for space for the investor to indicate the name of theissues, the number and amount of shares/debentures appliedfor and the signature of the investor. The stockinvest issued bythe bank will be signed by it and the date of issue will also beindicated on the instrument. Simultaneously with the issue of stockinvest, the bank will mark the lien for the amounts of

stockinvest issued in the deposit a/c of the investor. On full orpartial allotment of shares to the investors, the Registrar toissue will fill the columns of the stockinvest indicating theentitlement for allotment of shares/debentures, in terms of number, amount and application no and send it for clearing.

The investors’ bank would get debited only after the shares/debentures are allotted. In respect of the unsuccessfulapplicants, the funds continue to remain in their a/c and earninterest if the a/c is a savings or a term deposit. The excessapplication money of partly successful applicants also, willremain in their a/c s. there will be a lien on the funds for

maximum of 4 months period. The stockinvest is intended tobe only utilized by the a/c holders and that it should not behanded over to any third party for use. In case thecancelled/partly utilized stockinvest is not received by aninvestor from the Registrar, lien will be lifted by the issuingbranch upon expiry of 4 months from the date of issue againstan indemnity bond from the investor.

LOAN SYNDICATION

INTRODUCTION

Loan syndication, a method used in Eurodollar market. Loansyndication refers to assistance rendered by merchant banksto get mainly term loans for projects. Such loans may beobtained from a single development finance institution or asyndicate or consortium as in the case of large term loans.Merchant banks can also help corporate clients to raisesyndicated loans from commercial banks. Major benefitsreaped by corporate in syndication are amount, tenor andprice. The syndication method reverses the current practicewhere the corporate borrower faces rigid terms in a take it orleave it situation. The cost of syndication is likely to vary with

credit risk.

"Syndication is an arrangement where a group of banks, which may not have any other business relationship with the borrower,

participate for a single loan."

"A syndicated facility is a lending facility, defined by a single loanarrangement, in which several or many banks participate."

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WHY DO BANKS GO FOR LOAN SYNDICATION?

RISK DIVERSIFICATION

In syndication, many banks come together and fund a singleproject, hence sharing the risks.

This also assists in getting competitive interest rates for thebanks. When a group of banks get together, they select a leadbank which handles all the dealings with the company, such asnegotiating the interest rates, and hence a deal is signedbetween the company and the banks. Loan syndication isbasically done to share the total loss or liability.

WHEN DOES A CORPORATE GO FOR SYNDICATION?

Corporate opt for syndication when: -

• The borrower wants to raise large amount of moneyquickly and conveniently.

• The amount exceeds the exposure limits or appetite of anyone lender.

• The borrower does not want to deal with a large numberof lenders

PARTIES OF LOAN SYNDICATION

1. Arranger / Lead Manager:The lead manager is a bank that is awarded the mandate bythe prospective borrower and is responsible for placing thesyndicated loan with the other banks and ensures that thesyndication is fully subscribed. They are entitled to thearrangement fee and undergo a reputation risk during thisprocess. They prepare a placement memorandum and the loanis marketed to other banks who may be interested in taking upshares.2. Underwriting Bank:It is the bank that commits to supplying the funds to theborrower - if necessary from its own resources if the loan is notfully subscribed. The lead manager or another bank may play

this role. Not all syndications are underwritten. The risk is thatthe loan may not be fully subscribed.3. Participating Bank:

This bank participates in the syndication by lending a portionof the total amount required. It is entitled to receive theinterest and the participation fee. But it, however, faces riskssuch as:* Borrower credit risk

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* Passive approval and complacency

4. Facility Manager / Agent:

This bank takes care of all the administrative arrangementsover the term of loan, e.g., disbursements, repayments,

compliance. This bank acts on behalf of all the banksparticipating. This may be either the lead manger or theunderwriting bank.

STAGES INVOLVED IN THE PROCESS

1. Premandate Phase:

The prospective borrower may liaise with a single bank or itmay invite competitive bids from a number of banks. The leadbank identifies the needs of the borrower, designs anappropriate loan structure, develops a persuasive credit

proposal, and obtains internal approval. The mandate iscreated. The documentation is created with the help of specialist lawyers. 2. Placing the Loan:

The lead bank can start to sell the loan in the market place.The lead bank needs to prepare an information memorandum,term sheet, and legal documentation and approach selectedbanks and invite participation. The lead manager carries outthe negotiations and controversies are ironed out. Thesyndication deal is closed, including signing of the mandate.

3. Post Closure Phase:The agent now handles the day-to-day running of the loan

facility.

DISADVANTAGES

1.Managing multiple bank relationships is no small feat. Eachbank needs to come to an

understanding of the business and how its financial activitiesare conducted.

2. A comfort level must be established on both sides of thetransaction, which requires time and effort.

3. Negotiating a document with one bank can take days. Tonegotiate documents with four to five banks separately is atime-consuming, inefficient task.

4. Moreover, multiple lines require an inter-creditor agreementamong the banks, which takes additional time to negotiate.

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Depositary Receipt (DR)

A negotiable financial instrument issued by a bank torepresent a foreign company's publicly traded securities. Thedepositary receipt trades on a local stock exchange. Depositary

receipts make it easier to buy shares in foreign companiesbecause the shares of the company don't have to leave thehome state. For eg -When the depositary bank is in U.S., theinstruments are known as American Depositary Receipts(ADRs). European banks issue European depositary receipts.

One of the most common types of DRs is the American depositary receipt (ADR), which has been offering companies,investors and traders global investment opportunities sincethe 1920s. Since then, DRs have spread to other parts of theglobe in the form of global depositary receipts (GDRs) (theother most common type of DR), European DRs and

international DRs. ADRs are typically traded on a U.S. nationalstock exchange, such as the New York Stock Exchange (NYSE)or the American Stock Exchange, while GDRs are commonlylisted on European stock exchanges such as the London Stock Exchange. Both ADRs and GDRs are usually denominated inU.S. dollars, but can also be denominated in euros.

The DR functions as a means to increase global trade,which in turn can help increase not only volumes on local andforeign markets but also the exchange of information,technology, regulatory procedures as well as markettransparency. Thus, instead of being faced with impediments

to foreign investment, as it often the case in many emergingmarkets, the DR investor and company cab both benefit frominvestment abroad. Depositary receipts encourage a globalshareholder base, and provide expatriates living abroad withan easier opportunity to invest in their home countries.

The DR is created when a foreign company wishes to listits already publicly traded shares or debt securities on aforeign stock exchange. Before it can be listed to a particularstock exchange, the company in question will first have tomeet certain requirements put forth by the exchange. Initial public offerings, however, can also issue a DR. DRs can betraded publicly or over-the-counter.

The Benefits of Depositary Receipts

The DR functions as a means to increase global trade,which in turn can help increase not only volumes on local andforeign markets but also the exchange of information,technology, regulatory procedures as well as markettransparency. Thus, instead of being faced with impediments

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to foreign investment, as is often the case in many emergingmarkets, the DR investor and company can both benefit frominvestment abroad. Let's take a closer a look at the benefits:

For the Company A company may opt to issue a DR to obtain greater

exposure and raise capital in the world market. Issuing DRshas the added benefit of increasing the share's liquidity whileboosting the company's prestige on its local market ("thecompany is traded internationally"). Depositary receiptsencourage an international shareholder base, and provideexpatriates living abroad with an easier opportunity to investin their home countries. Moreover, in many countries,especially those with emerging markets, obstacles oftenprevent foreign investors from entering the local market. Byissuing a DR, a company can still encourage investment fromabroad without having to worry about barriers to entry that aforeign investor might face.

For the Investor Buying into a DR immediately turns an investors'

portfolio into a global one. Investors gain the benefits of diversification while trading in their own market under familiarsettlement and clearance conditions. More importantly, DRinvestors will be able to reap the benefits of these usuallyhigher risk, higher return equities, without having to endurethe added risks of going directly into foreign markets, whichmay pose lack of transparency or instability resulting fromchanging regulatory procedures. It is important to rememberthat an investor will still bear some foreign-exchange risk ,stemming from uncertainties in emerging economies andsocieties. On the other hand, the investor can also benefit fromcompetitive rates the U.S. dollar and euro have to most foreigncurrencies.

American Depositary Receipt (ADR)

A negotiable certificate issued by a U.S. bank representing a specified number of shares (or one share) in aforeign stock that is traded on a U.S. exchange. ADRs aredenominated in U.S. dollars, with the underlying security heldby a U.S. financial institution overseas. ADRs help to reduce

administration and duty costs that would otherwise be leviedon each transaction. This is an excellent way to buy shares in aforeign country/ company while realizing any dividends andcapital gains in US dollars. ADRs do not eliminate the currencyand economic risks for the underlying shares in anothercountry. For example, dividend payments in euros would beconverted to U.S. dollars, net of conversion expenses andforeign taxes and in accordance with the depositagreement. ADRs are listed on the NYSE, AMEX or NASDAQ.

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Each ADR is issued by a U.S. depositary bank and can

represent a fraction of a share, a single share, or multiple

shares of the foreign stock. An owner of an ADR has the right

to obtain the foreign stock it represents, but US investors

usually find it more convenient simply to own the ADR. The

price of an ADR often tracks the price of the foreign stock in itshome market, adjusted for the ratio of ADRs to foreign

company shares. In the case of companies incorporated in the

United Kingdom, creation of ADRs attracts a 1.5% stamp duty

reserve tax (SDRT) charge by the UK government.

Depositary banks have various responsibilities to an ADR

shareholder and to the non-US company the ADR represents.

The first ADR was introduced by JPMorgan in 1927, for the

British retailer Selfridges&Co. There are currently four major

commercial banks that provide depositary bank services -

JPMorgan, Citibank , Deutsche Bank and the Bank of New York

Mellon. Individual shares of a foreign corporation represented

by an ADR are called American Depositary Shares (ADS). The

main objective of ADRs is to save individual investors money

by reducing administration costs and avoiding duty on each

transaction. For individuals, ADRs are an excellent way to buy

shares in a foreign company and capitalize on growth

potential. ADRs offer a good opportunity for capital

appreciation as well as income if the company pays dividends.

Global Depositary Receipt (GDR)

A bank certificate issued in more than one country forshares in a foreign company. The shares are held by a foreignbranch of an international bank. The shares trade as domesticshares, but are offered for sale globally through the variousbank branches. A financial instrument used by private marketsto raise capital denominated in either U.S. dollars or euros.GDR is very similar to an American Depositary Receipt.These instruments are called European Depositary Receipt(EDR) when private markets are attempting to obtain euros.GDRs represent ownership of an underlying number of shares.

They facilitate trade of shares, and are commonly used toinvest in companies from developing or emerging markets –especially Russia.

Several global banks issue GDRs, such as JPMorganChase, Citigroup, Deutsche Bank, Bank of New York. They tradeon the Global Order Book (GOB) of the London Stock Exchange.Normally 1 GDR = 10 shares.

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International Depository Receipt (IDR)

IDR is a negotiable bank-issued certificate representingownership of stock securities by an investor outside thecountry of origin. An IDR is a non-U.S. equivalent of anAmerican Depositary Receipt (ADR). The IDR is denominated in

the local currency, and entitles the bearer to any dividends andother benefits associated with the shares. IDRs can be tradedlike any other security. Using IDRs shields the investor fromforeign exchange risk and any applicable tariffs he/she wouldhave had to pay if he/she had bought the stock outright. It alsoexempts the investor from any requirements the foreign exchange might have levied. The advantage of the IDRstructure is that the corporation does not have to comply withall the issuing requirements of the foreign country where thestock is to be traded.

External Commercial Borrowing (ECB)

ECB is a term used to refer to commercial loans availedfrom non resident lenders with a minimum average maturity of 3 years in the form of bank loans, buyers credit, supplierscredit, securitized instruments (eg:- fixed rate bonds). Acompany is free to raise ECB from any internationallyrecognized source such as banks, export credit agencies,suppliers of equipment, foreign collaborators, foreign equityholders, international capital markets etc.

ECB can be provided by eligible lenders which can bedefined as those persons who have share in the equity of company or firm to which they have right to lend money.

Benefits of Raising Capital from International Markets

• Cost of funds, at times, works out to be cheaper to cost of

rupee funds.

• Availability of funds in international markets is huge.

• Corporate can raise a large amount of funds depending on

the risk perception of the international financial institutions.

Problems involved

• Arbitraging risk

• Political risk

• Exchange rate risk

• Inflationary risk

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Use of ECB

ECBs are being permitted by the Government as a sourceof finance for Indian Corporate for expansion of existingcapacity as well as for fresh investment,

such as Power, oil Exploration, Telecom, Railways, Roads &Bridges, Ports, Industrial Parks and Urban Infrastructure etc.and the export sector. Development Financial Institutions,through their sub-lending against the ECB approvals are alsoexpected to give priority to the needs of medium and smallscale units ECBs are to be utilized for foreign exchange costs of capital goods and services (on FOB and CIF basis). Proceedsshould be utilized at the earliest and corporate should complywith RBI's guidelines on parking ECBs outside till actualimports.

Recent Trend In ECB

The cost of funds in the Indian Market has been relativelyhigher than International Market and there is a growingtendency for Indian Business Houses to raise funds fromInternational Markets. Such financing is arranged for reputedcorporate houses on prevalent rates of interest. The interestrates are fixed in terms of Basic rate of LIBOR plus othercharges.The Registered Foreign Financial Institutionsinterested in lending funds to Indian Business Houses can earnhandsome interest from Indian Markets. Demand for E.C.B isrising rapidly in this market and the Govt.

Chapter_1 3rd Sem

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