1.Q: Explain the functions of Merchant Banking.

Functions

Merchant banking is a service oriented industry. Merchant banks all over

the world carry out the same set of services. Merchant banks in India
carry out the following functions and services specifically.

1. Corporate Counseling

2. Project counseling

3. Pre-investment Studies

4. Capital restructuring

5. Credit Syndication

6. Issue Management and underwriting

7. Portfolio Management

8. Working Capital Finance

9. Acceptance Credit and Bill discounting

10. Mergers, Amalgamations and Takeovers

11. Venture Capital

12. Lease Financing

13. Foreign Currency Finance

14. Fixed Deposit Broking

15. Mutual funds

16. Relief to Sick Industries

17. Project Appraisal

Each of these functions is detailed briefly below.

Corporate Counseling

The set of activities that is undertaken to ensure the efficient running of a

corporate enterprise is known as corporate counseling. It may include the

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 rejuvenating of old line companies and ailing units, and guiding the
existing units in identifying the areas or activities for growth and
diversification. The merchant banker guides the clients on various
aspects like Locational factors, organizational size, operational scale,
choice of product, market survey, cost analysis, cost reduction, allocation
of resources, investment decision, capital management and expenditure
contro, pricing, etc.

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 Following are the activities which form part of corporate counseling:

1. Providing guidance in areas of diversification based on the

Government’s economic and licensing policies.

2. Undertaking appraisal of product lines, analyzing their growth and

profitability and forecasting future trends.

3. Rejuvenating old-line companies and ailing sick and units by appraising

their technology and process assessing their requirements and
restructuring their capital based.

4. Commissioning of diagnostic studies.

5. Assessment of the revival prospects and planning for rehabilitation

through modernization and diversification and revamping of the
financial and organizational structure.

6. Arranging for the approval of the financial institutions/banks for

schemes of rehabilitation involves financial relief, etc.

7. Providing assistance in getting soft loans from financial institutions for

capital expenditure, and the requisite credit facilities from the bank.

8. Monitoring of rehabilitation schemes.

9. Exploring possibilities for takeover of sick units and providing

assistance in making consequential arrangements and negotiations
with financial institutions/banks and other interests/authorities
involved.

Project counseling

Project counseling relates to project counseling and is part of corporate

counseling. The study and analysis of the project viability and the steps
required for its effective and efficient implementation are broadly the subject
matter of project counseling.

Following are the activities forming part of the Project counseling:

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

2. Providing advice on procedural aspects of project implementation.

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 3. Conducting review of technical feasibility of the project on the basis of
the report prepared by own exerts or by outside consultants.

4. Assisting in the selection of a Technical consultancy Organization

(TCO) for preparing project reports and market surveys, or review of
the project report or market survey reports prepared by TCO.

5. Assisting in the preparation of project report from a financial angle,

and advising and acting on various procedural steps including
obtaining government consents for implementation of the project.

6. Assisting in obtaining approvals/licenses/permissions/grants, etc from

government agencies in the form of letter of intent, industrial license,
DGTD registration, and government approval for foreign collaboration.

7. Providing guidance to Indian entrepreneurs for making investment in

Indian project in India and in Indian joint ventures overseas.

8. Identification of potential investment avenues.

9. Carrying out precise capital structuring and shaping the pattern of

financing.

10. Arranging and negotiating foreign collaborations,

amalgamations, mergers, and takeovers.

Pre-Investment Studies

Pre-investment studies relate to the activities that are concerned with

making a detailed feasibility exploration to evaluate alternative avenues of
capital investment in terms of growth and profit prospects. Some of these
activities are as follows:

1. Carrying out an in-depth investigation of environment and regulator

factors, location of raw material supplies, demand projections and
financial requirements in order to assess the financial and economic
viability of a given project.

2. Helping the client in identifying and short-listing those projects which

are built upon the client’s inherent strength with a view to accentuate
corporate profitability and growth in the long run.

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Capital Restructuring Services

Merchant bankers assist the corporate enterprise in structuring their capital

in such a way that it would minize the cost of capital and maximize its return
on capital invested.

Following are the services covered:

1. Examining the capital structure of the client company to determine the

extent of capitalization required.

2. Preparing a comprehensive memorandum for the controller of Capital

issues, and securing consent where the capitalization takes place
through issue of bonus shares.

3. Suggesting an alternative capital structure conforming to legal

requirements, viz., extent of capitalization on reserve and quantum of
disinvestments by ‘offer for sale’ and/or fresh issues of corporate
securities such as equity share, and preference share in the case of
FERA/FEMA companies.

4. Preparing a memorandum covering valuation of shares and justifying

the level of premium applied for.

Credit Syndication

Credit syndication relates to activities connected with credit procurement

and project financing, aimed at raising Indian and foreign currency loans
from banks and financial institutions, are collectively known as ‘credit
syndication’.

Activities covered under credit syndication are as follows:

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

2. Drawing up a financing plan for the total project cost which conforms
to the requirements of the promoters and their collaborators, financial
institutions and banks, government agencies and underwriters.

3. Preparing loan application for financial assistance from term

lenders/financial institutions/banks, and monitoring their progress,
including pre-sanction negotiations.

4. Selecting institutions and banks for participation for financing.

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Credit syndication services overlap with the act ivies of project counseling
and project finance. But the loan syndication also incluses the preparation of
applications for financial assistance from financial institutions/banks.

Issue Management and Underwriting

Issue management and underwriting concerns with the activities relating to

the management of the public issues of corporate securities, viz. equity
shares, preference shares, and debentures of bonds, and are aimed at
mobilization of money from the capital market.

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

this regard:

1. Preparation of an action plant.

2. Preparation of budget for the local expenses for the issues.

3. Preparation of CCI application and assisting in obtaining

consent/acknowledgement.

4. Drafting of prospectus

5. Selection of institutional and broker underwriters for

syndicating/underwriting arrangements.

6. Selection of issues Houses and advertising agencies for undertaking

pre and post-issue publicity.

7. Obtaining the approval of institutional underwriters and stock

exchanges for publication of the prospectus.

Portfolio management is making decisions for the investment of cash

resources of a corporate enterprise in marketable securities by deciding the
quantum, timing and the type of security to be bough.

The services covered are as follows:

1. Undertaking investment in securities.

2. Undertaking investment for non-resident Indians, on both repatriation

and non-repatriation basis.

3. Undertaking review of Provident fund investment, Trust investment,

etc.

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 4. Safe custody of securities in India and overseas.

5. Providing advice on selection of investments.

6. Carrying out a critical evaluation of investment portfolio.

7. Collecting and remitting interest and dividend on investment.

Working Capital Finance

The finance required for meeting the day-to-day expenses of an enterprise is

known as ‘Working Capital finance’.

1. Assessment of working capital requirements.

2. Preparing the necessary application to negotiations for the sanction of

appropriate credit facilities.

3. Assisting, co-coordinating and expediting documentation and other

formalities for disbursement.

4. Advising on the issue of debentures for augmenting long-term

requirements of working capital.

Acceptance Credit and Bill discounting

Acceptance credit and bill discounting connotes the activities relating to the
acceptance and the discounting of bills of exchange, besides the
advancement loans to business concerns on the strength of such
instruments, are collectively known as ‘Acceptance Credit and Bill of
discounting.

In order that the bill accepting and discounting takes place on sound lines, it
is imperative that the firm involved command a good reputation and
financial standing.

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Merger and Acquisition

This is a specialized service provided by the merchant banker who arranges

for negotiating acquisitions and mergers by offering expert valuation
regarding the quantum and the nature of considerations, and other related
matters.

The various functions that form part of this activity are as follows:

1. Undertaking management audit to identify areas of corporate strength

and weakness in order to help formulate guidelines and directions for
future growth.

2. Conducting exploratory studies on a global basis to locate overseas

markets, foreign collaborations and prospective joint venture
associates.

3. Obtaining approvals from shareholders, depositors, creditors,

government, and other authorities.

4. Monitoring the implementation of merger and amalgamation schemes.

5. Identifying organizations with matching characteristics.

Merchant bankers provide advice on acquisition propositions after careful

examination of all aspects, viz, financial statements, articles of associations,
provisions of companies act, rules and guidance of trade chambers, the
issuing house associations, etc.

There are many reasons for the recent trend towards mergers and
amalgamations, such as:

• Existence of excess unused manufacturing capacity of the purchasing

company, which can be utilized efficiently by taking over other units.

• Lack of manufacturing space with the purchase company. The best

solution may be to buy the controlling interest in another company
having excessive manufacturing space or capacity.

Venture Financing

Venture capital is the equity financing for high-risk and high-reward projects.
The concept of venture capital originated in the USA in the 1950s, when

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business magnates like Rockefeller financed new technology companies.
The concept became more popular during the sixties and seventies, when
several private enterprises undertook the financing of high-risk and high
reward projects.

Lease Financing

Leasing is an important alternative source of financing a capital outlay. It

involves letting out assets on lease for use by the lessee for a particular
period of time.

Following are the important services provided in regard to leasing:

1. Providing advice on the viability of leasing as an alternative source for

financing capital investment projects.

2. Providing advice on the choice of a favorable rental structure.

In India, leasing is a non-banking financial activity. Commercial banks like

State Bank of India and Canara Bank also provide lease financing by forming
subsidiaries under the amended Banking Regulations Act of 1949.

Foreign Currency Financing

Foreign currency finance is the fund provided for foreign trade transactions.
It may take the form of export-import trade finance, euro currency loans.
Indian joint venture abroad or foreign collaborations. The main areas that
are covered in this type of merchant activity are as follows:

1. Providing assistance for carrying out the study of turnkey and

construction contract projects.

2. Providing assistance in applications to working groups, liaison with RBI,

ECGD and other institutions.

3. Providing assistance in opening and operating banks accounts abroad.

4. Providing assistance in obtaining export credit facilities from the EXIM

bank for export of capital goods, and arranging for the necessary
government approvals and clearance.

5. Providing guidance on forward cover for exchange risk.

6. Assisting in arranging foreign currency guarantees and performance

bonds for exporters.

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Forms of Foreign Currency Loans

The various types of foreign currency loans are:

a) Euro-currency Loans

b) Financing Indian Joint Ventures abroad through:

1. Advice on the nature of client’s investment.

2. Financial structuring of the project

3. Syndication of Euro loans

4. Bank guarantees

5. Procuring euro-currency facilities in the form of management and

syndication of Euro-currency loans, bonds, floating Rate Notes (FRNs),
floating Rate Certificates of Deposits (FRCDs), US commercial papers,
with the assistance of International Treasury Management Limited
(ITM).

6. Providing advice on currency swaps and interest rate swaps.

7. Arranging deferred term export finance to Indian entrepreneurs by

maintaining a quick liaison with the export country’s Export Credit
Agencies who offer fixed rate finance at concessionary interest rates,
in particular export credit agencies in the UK (ECGD), USA (EXIM Bank),
Japan, Italy, Norway, East Germany (HERMES), and who enjoy lines of
credit from France (COFACE), Korea, Spain, Austria, Canada, Denmark,
and India.

c) Providing assistance in foreign collaborations through:

1. Helping locate foreign collaboration and joint venture partners

abroad.

2. Providing advice on local laws, product risk, government regulations

regarding shareholdings, exchange restrictions, taxation, dividends,
incentives and subsidies, etc.

Brokering Fixed Deposits

Following are the services rendered by merchant bankers in this regard:

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 1. Computation of the amount that could be raised by a company in the
form of deposits from the public and loans from shareholders.

2. Drafting of advertisement for inviting deposits.

3. Filing a copy of advertisement with the Registrar of Companies for

registration.

4. Making arrangement for payment of interest amounts.

5. Providing advice to the company on the terms and conditions of fixed

deposits, and deciding on the appropriate rate of interest, keeping in
view the prevailing capital and money market conditions.

6. Helping the company of observe all the rules and regulation in the
connection.

Mutual Funds

Mutual funds are institutions that mobilize the savings of innumerable

investors for the purpose of channeling them into productive investments in
a wide variety of corporate and other securities.

Some of the services rendered by mutual funds are as follows:

1. Mopping up public savings.

2. Investing the funds in a diversified portfolio of shares and debentures

belonging to well managed and growing companies.

3. Earning investors a steady return on investments with an assurance of

capital appreciation.

Relief to Sick Industries

Merchant bankers extend the following services as part of providing relief to

sick industries:

1. Rejuvenating old-lines and ailing units by appraising their technology

and process, assessing their requirements and restructuring their
capital base.

2. Evolving rehabilitation packages which are acceptable to financial

institutions and banks.

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 3. Exploring the possibilities of mergers/amalgamations, wherever called
for.

Project Appraisal

The evaluation of industrial projects in terms of alternative variants in

technology, raw materials, production capacity and location of plant is known
as ‘Project Appraisal’.

Financial appraisal

Financial appraisal involves assessing the feasibility of a new proposal for

setting up a new project or the expansion of existing production facilities.

Financial appraisal is undertaken through an analysis which takes into

account the financial features of a project, including sources of financing.
Financial analysis helps trace the smooth operation of the project over its
entire life cycle.

Technical Appraisal

Technical appraisal is primarily concerned with the project concept in terms

of technology, design, scope and content of the plant, as well as inputs are
infrastructure facilities envisaged for the project, Basically, the project
should be able to deliver a marketable product fro the resources deployed, a
t a cost which would leave a margin that would be adequate to service the
investment, and also plough back a reasonable amount into the project to
enable the enterprise to consolidate its positions.

Economic Appraisal

Economic appraisal of a project deals with the impact of the project on

economic aggregates. These may be classified under two broad categories.
The first deals with the effect of the project on employment and foreign
exchange, and the second deals with the impact of the project on net social
benefits or welfare. *************

2.Q:Briefly explain the regulator framework on merchant banking

Introduction

According to the SEBI,” merchant banker” means any person who is engaged
in the business of issue management either by making arrangements

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regarding selling, buying or subscribing to securities as manager, consultant
adviser or rendering corporate advisory service in relation to such issue
management.

The SEBI has brought about a number of regulative measures for the
purpose of disciplining the functioning of the merchant bankers in India. The
objective is to usher in an era of regulated financial markets and thereby
pave way for the development of the capital market in India. The measures
were introduced by the SEBI in the year 1992 . The measures were revised
by SEBI in 1997. The salient features of the regulative framework of
merchant banking in India are described below:

SEBI Regulations

1. Registration of Merchant Bankers

The relevant guidelines with regard to the registration of merchant

bankers are as follows:

Application for Grant of Certificate

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

Board in Form A. The application shall be made for anyone of the
following categories of the merchant banker namely:

1. Category I, to carry on any activity of the issue management, which

will inter-alia consist of prepared of prospectus and other information
relating to the issue, determining financial structure, tie-up of
financiers and final allotment and refund of the subscription; and to act
as adviser, consultant, manage underwriter, portfolio manager.

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

portfolio manager.

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

4. Category Iv, to act only as adviser or consultant to an issue.

With effect from 9th December, 1997, an application can be made only for
carrying on the activities mentioned in category I. An applicant can carry on
the activity as underwriter only if he obtains separate certificate of
registration under the provisions of Securities and Exchange Board of India
(Underwriting Regulations, 1993), and as portfolio manager only if he obtains

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separate certificate of registration under the provisions of Securities and
Exchange Board of India (portfolio Manager) Regulations, 1993.

Conformance to Requirements

Subject to the provisions of the regulations, any application, which is not

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

Furnishing of Information

The Board may require the applicant to furnish further information or

clarification regarding matters relevant to the activity of a merchant banker
for the purpose of disposal of the application.

Consideration of Application

The Board shall take into account for considering the grant of a certificate, all
maters, which are relevant to the activities relating to merchant banker and
in particular whether the applicant complied with the following requirement.

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

financial company as defined under clause (f) of section 45-I of the
Reserve Bank of India Act, (2 of 1934) as amended from time to time;

2. That the merchant banker who has been granted registration by the
Reserve Bank of India to act as a primary or Satellite Dealer may carry
on such activity subject to the condition that it shall not accept or hold
public deposit;

3. That the applicant has the necessary infrastructure like adequate office
space, equipments, and manpower to effectively discharge his
activities;

4. That the applicant has in his employment minimum of two persons who
have the experience to conduct the business of the merchant banker;

5. That the applicant fulfils the capital adequacy requirement as specified

in the relevant;

6. That the applicant is a fit and proper person; and

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

Capital Adequacy Requirement

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

less than the net worth of the person making the application for grant of
registration.

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Procedure for Registration

The Board on being satisfied that the applicant is eligible shall grant a
certificate in Form B. On the grant of certificate the applicant shall be liable
to pay the fees in accordance with Schedule II.

Renewal of Certificate

Three months before expiry of the period of certificate, the merchant banker,
may if he so desires, make an application for renewal in form A. The
application for renewal shall be dealt with in the same manner as if it were a
fresh application for grant of a certificate. On the grant of a certificate the
applicant shall be liable to pay the fees in accordance with Schedule II.

Procedure where registration is not granted

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

renewal under regulation 9, does not satisfy the criteria set out in regulation
6, the Board may reject the application after giving an opportunity being
heard. The refusal to grant registration shall be communicated by the Board
within thirty days of such refusal to the applicant stating therein the grounds
on which the application has been rejected.

************

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3.Q:Explain the activities involved in Public Issue Management

Activities involved in Public Issue Management

There are several activities that have to be performed by the issue manager
in order to raise money from the capital market. Adequate planning needs
to be done while chalking out an appropriate marketing strategy. The
various activities involved in raising funds from the capital markets are
described below:

Pre-issue Activities

1. Signing of Memorandum of Understanding (MOU): Signing of

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

2. Obtaining appraisal note: An appraisal note containing the details

of the proposed capital outlay of the project and the sources of
funding is either prepared in-house or is obtained from external
appraising agencies, viz, financial institutions/banks, etc.

3. Optimum capital structure: The level of capital that would maximize

the shareholders vale and minimize the overall cost of capital has to
be determined.

4. Convening Meeting: A meeting of the Board of Directors of the

issuing company is convened. This is followed by an EGM of its
members.

5. Appointment of financial intermediary: Financial intermediaries

such as Underwriters, registrars, etc have to be appointed. Necessary
contracts need to be made with the underwriter to ensure due
subscription to the offer. Similar contracts, when entered into with
the Registrars to an issued, will help in share allotment related work.

6. Preparing documents: As part of the issue management procedure,

the documents to be prepared are initial listing application for
submission to those stock exchanges where the issuing company

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 intends to get its securities listed, MoU with the registrar, with bankers
to the issue, with advisors to the issue and co-managers to the issue,
agreement for purchase or properties, etc.

7. Due diligence certificate: The lead manager issues a ‘due diligence

certificate’ which certifies that the company has scrupulously
following all legal requirements, has exercised utmost care while
preparing the offer document and has made a true, fair and adequate
disclosure in the draft offer document.

8. Submission of offer document: The draft offer document along

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

9. Finalization of collection centers: In order to collect the issue

application forms from the prospective investors, the lead manager
finalizes the collection centers.

10. Filing with RoC: The offer document, completed in all respects after
incorporating SEBI observations, is filed with Registrar of Companies
(RoC) to obtain acknowledgement.

11. Launching the issue: The process of marketing the issue starts
once the legal formalities are completed and statutory permission for
issue of capital is obtained. The lead manager has to arrange for the
distribution of public issue stationery to various collecting banks,
brokers, investors, etc. the issue is opened for public immediately
after obtaining the observation letter from SEBI, which is valid for a
period of 365 days from the date of issue.

12. Promoters’ contribution: a certificate to the effect that the

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

13. Issue closure: An announcement regarding the closure of the issue

should be made in the newspapers.

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 ***************

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4Q:Explain the different methods of marketing securities

Methods of Marketing Securities

Following are the various methods being adopted by corporate entities for
marketing the securities in the New Issue Market:

1. Pure Prospectus Method

2. Offer for Sale Method

3. Private Placement Method

4. Initial public Offers (IPOs) Method

5. Rights Issue Method

6. Bonus Issue Method

7. Book-building Method

8. Stock Option Method and

9. Bought-out Deals Method

Pure prospectus Method

Meaning

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

Features

Exclusive subscription: Under this method, the new issues of a company

are offered for exclusive subscription of the general public.

Issue Price: Direct officer is made by the issuing company to the general
public to subscribe to the securities as a stated price.

Underwriting: Public issue through the ‘pure prospectus method’ is usually

underwritten. This is to safeguard the interest of the issuer in the event of
an unsatisfactory response from the public.

Prospectus: A document that contains information relating to the various

aspects of the issuing company, besides other details of the issue is called a

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‘Prospectus’. The document is circulated to the public. The general details
include the company’s name and address of its registered office, the names
and addresses of the company’s promoters, manager, managing director,
directors, company secretary, legal adviser, auditors, bankers, brokers, etc.

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Advantages

The pure prospectus method offers the following advantages to the issuer
and the investors alike:

Benefits to investors: The pure prospectus method of marketing the

securities serves as an excellent mode of disclosure of all the information
pertaining to the issue. Besides, it also facilitates satisfactory compliance
with the legal requirements of transparency, etc.

Benefits to issuers: The pure prospectus method is the most popular

method among the larger issuers. In addition, it provides for wide diffusion
of ownership of securities contributing to reduction in the concentration of
economic and social power.

Drawbacks

The raising of capital through the pure prospectus method is fraught with a
number of drawbacks as specified below:

High issue costs: A major drawback of this method is that it is an

expensive mode of raising funds from the capital market. Costs of various
hues are incurred in mobilizing capital.

Time Consuming: The issue of securities through prospectus takes more

time, as its requires the due compliance with various formalities before an
issue could take place.

Offer for Sale Method

Meaning

Where the marketing of securities takes place through intermediaries, such

as issue houses, stockholders and others, it is a case of ‘Offer for sale
Method’.

Features

Under this method, the sale of securities takes place in two stages.
Accordingly, in the first stage, the issuer company makes an en-block sale of
securities to intermediaries such as the issue houses and share brokers of an
agreed price. Under the second stage, the securities are re-sold to ultimate
investors at a market-related price.

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The issue is also underwritten to ensure total subscription of the issue. The
biggest advantage of this method is that it saves the issuing company the
hassles involved in selling the shares to the public directly through
prospectus.

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Private Placement Method

Meaning

A method of marketing of securities whereby the issuer makes the offer of

sale of individuals and institutions privately without the issue of a prospectus
is known as ‘Private Placement Method.’

Features

Under this method, securities are offered directly to large buyers with the
help of share brokers. This method works in a manner similar to the ‘Offer
for Sale Method’ whereby securities are first sold to intermediaries such as
issues houses, etc.

Advantages

Private placement of securities offers the following advantages:

1. Less expensive as various types of costs associated with the issue are
borne by the issue houses and other intermediaries.

2. Placement of securities suits the requirements of small companies.

3. The method is also resorted to when the stock market is dull and the
public response to the issue is doubtful.

Disadvantages

The major weaknesses of the private placement of securities are as follows:

1. Concentration of securities in a few hands.

2. Creating artificial scarcity for the securities thus jacking up the prices
temporarily and misleading general public.

3. Depriving the common investors of an opportunity to subscribe to the

issue, thus affecting their confidence levels.

Initial Public Offer (IPO) Method

The public issue made by a corporate entity for the first time in its life is
called ‘Initial public Offer’ (IPO), Under this method of marketing, securities

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are issue to successful applicants on the basis of the orders placed by them,
through their brokers.

When a company whose stock is not publicly traded wants to offer that stock
to the general public, it takes the form of ‘Initial public offer’. The job of
selling the stock is entrusted to a popular intermediary, the underwriter. The
underwriters charge a fee for their services.

Stocks are issued to the underwriter after the issue of prospectus which
provides details of financial and business information as regards the issuer.

The issuer and the underwriting syndicate jointly determine the price of a
new issue. IPO stock at the release price is usually not available to most of
the public. Good relationship between, the broker and the investor is a pre-
requisite for the stock being acquired.

Full disclosure of all material information in connection with the offering of

new securities must be made as part of the new offerings. A statement and
preliminary prospectus (also known as a red herring) containing the following
information is to be filled with the Registrar of Companies:

1. A description of the issuer’s business.

2. The names and addresses of the Key company officers, with salary and
a 5 year business history on each.

3. The amount of ownership of the key officers

4. Any legal proceedings that the company is involved in

The essential steps involved in this method of marketing of securities are as

follows:

1. Order: Broker receives order from the client and places orders on
behalf of the client with the issuer.

2. Share Allocation: The issuer finalizes share allocation and informs

the broker regarding the same.

3. The Client: The broker advises the successful clients of the share
allocation. Clients then submit the application forms for shares and
make payment to the issuer through the broker.

4. Primary issue account: The issuer opens a separate escrow account

(primary issue account) for the primary market issue. The clearing

25
 house of the exchange debits the primary issue account of the broker
and credits the issuer’s account.

5. Certificates: Certificates are then delivered to investors. Otherwise

depository account may be credited.

Rights issue Method

Where the shares of an existing company are offered to its existing

shareholders. It takes the form of rights issue. Under this method, the
existing company issues shares to its existing shareholder sin proportion in
the number of shares already held by them.

The relevant guidelines issued by the SEBI in this regard are as follows:

26
 1. Shall be issued only by listed companies.

2. Announcement regarding rights issue once made, shall not be

withdrawn and where withdrawn, no security shall be eligible for listing
upto 12 months.

3. Underwriting as to rights issue is optional and appointment of Registrar

is compulsory.

4. Appointment of category I Merchant Bankers holding a certificate of

registration issued by SEBI shall be compulsory.

5. Rights share shall be issued only in respect of fully paid share.

6. Letter of Offer shall contain disclosures as per SEBI requirements.

7. Issue shall be kept open for a minimum period of 30 days and for a
maximum period of 60 days.

8. A ‘No complaints Certificate’ is to be filed by the Legal Merchant

Banker’ with the SEBI after 21 days from the date of issue of the
document.

9. Obligatory for a company where increase in subscribed capital is

necessary after two years of its formation of after one year of its first
issue of shares, whichever is earlier (this requirement may be
dispensed with by a special resolution).

Advantages

Rights issue offers the following advantages

1. Economy: Rights issue constitutes the most economical method of

raising fresh capital, as it involves no underwriting and brokerage
costs.

2. Easy: The issue management procedures connected with the rights

issue are easier as only a limited number of applications are to be
handled.

27
 3. Advantage to shareholders: Issue of rights shares does not involve
any dilution of ownership of existing shareholders.

Drawbacks

The method suffers from the following limitations:

1. Restrictive:The facility of rights issue is available only to existing

companies and not to new companies.

2. Against society: the issue of rights shares runs counter to the overall
societal consideration of diffusion of share ownership for promoting
dispersal of wealth and economic power.

28
Bonus Issues Method

Where the accumulated reserves and surplus of profits of a company are

converted into paid up capital, it takes the form of issue of bonus shares. It
merely implied capitalization of existing reserves and surplus of a company.

Issue under Section 205 (3) of the companies Act, such shares is governed
by the guidelines issued by the SEBI (applicable of listed companies only) as
follows:

SEBI Guidelines

Following are the guidelines pertaining to the issue of bonus shares by a

listed corporate enterprise:

1. Reservation: In respect of FCDs and PCDs, bonus shares must be

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

2. Reserves: the bonus issue shall be made out of free reserves built
out of the genuine profits or share premium collected in cash only.

3. Dividend mode: the declaration of bonus issue, in lieu of dividend, is

not made.

4. Fully paid: The bonus issue is not made unless the partly paid
shares, if any are made fully paid-up.

5. No default: The Company has not defaulted in payment of interest or

principal in respect of fixed deposits and interest on existing
debentures or principal on redemption thereof and has sufficient
reason to believe that it has not defaulted in respect of the payment of
statutory dues of the employees such as contribution to provident
fund, gratuity, bonus, etc.

6. Implementation: A company that announces its bonus issue after

the approval of the Board of Directors must implement the proposal
within a period of 6 months from the date of such approval and shall
not have the option of changing the decision.

29
 7. The articles: The articles of Association of the company shall contain
a provision for capitalization of reserves, etc. if there is no such
provision in the articles, the company shall pass a resolution at is
general body meeting making provision in the Articles of Association
for capitalization.

8. Resolution: consequent to the issue of bonus shares if the subscribed

and paid-up capital exceeds the authorized share capital, the company
at its general body meeting for increasing the authorized capital shall
pass a resolution.

30
Book-building Method

A method of marketing the shares of a company whereby the quantum and

the price of the securities to be issued will be decided on the basis of the
‘bids’ received from the prospective shareholders by the lead merchant
bankers is known as ‘book-building method’.

The option of book-building is available to all body corporate, which are

otherwise eligible to make an issue of capital of the public. The initial
minimum size of issue through book-building route was fixed at Rs.100
crores.

The book-building process involves the following steps:

1. Appointment of book-runners: the first step in the book-building is

the appointment by the issuer company, of the book-runner, chosen
from one of the lead merchant bankers. The book-runner in the forms
a syndicate for the book building. A syndicate member should be a
member of National Stock Exchange (NSE) or Over-the-Counter
Exchange of India (OTCEI). Offers of ‘bids’ are to be made by
investors to the syndicate members, who register the demands of
investors.

2. Drafting prospectus: The draft prospectus containing all the

information except the information regarding the price at which the
securities are offered is to be filed with SEBI as per the prevailing SEBI
guidelines. The offer of securities through this process must
separately be disclosed in the prospectus, under the caption
‘placement portion category’.

3. Circulating draft prospectus: A copy of the draft prospectus filed

with SEBI is to be circulated by the book-runner to the prospective
institutional buyers who are eligible for firm allotment and also to the
intermediaries who are eligible to act as underwriters.

4. Maintain offer records: The book-runner maintain a record to the

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

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 5. Intimation about aggregate orders: The underwriters and the
institutional investors shall give intimation on the aggregate of the
offers received to the book-runner.

6. Bid analysis: The bid analysis is carried out by the book-runner

immediately after the closure of the bid offer date. An appropriate
final price is arrived at after a careful evaluation of demands at
various prices and the quantity.

7. Mandatory underwriting: Where it has been decided to make offers

of shares to public under the category of ‘Net offer of the Public’, it is
incumbent that the entire portion offered to the public is fully
underwritten.

8. Filling with ROC: A copy of the prospectus as certified by the SEBI

shall be filed with the Registrar of Companies within two days of the
receipt of the acknowledgement card from the SEBI.

9. Bank accounts: The issuer company has to open two separate

accounts for collection of application money, one for the private
placement portion and the other for the public subscription.

10. Collection of completed applications: The book-runner collects

from the institutional buyers and the underwriters the application
forms along with the application money to the extent of the securities
proposed to be allotted to them or subscribed by them.

11. Allotment of securities: Allotment for the private placement

portion may be made on the second day from the closure of the issue.
The issuer company, however, has the option to choose one date for
both the placement portion and the public portion.

12. Payment schedule and listing: The book-runner may require the
underwriters to the ‘net offer to the public’ to pay in advance all
moneys required to be paid in respect of their underwriting
commitment by the eleventh day of the closure of the issue.

13. Under-subscription: In the case of under-subscription in the ‘net

offer to the public’ category, any spillover to the extent of under
subscription is to be permitted from the ‘placement portion’ category
subject to the condition that preference is given to the individual
investors.

32
Advantages of book-building

Book building process is of immense use in the following ways:

1. Reduction in the duration between allotment and listing

2. Reliable allotment procedure

3. Quick listing in stock exchanges possible

4. No price manipulation as the price is determined on the basis of the

bids received.

Stock Option or employees Stock Option Scheme (ESOP)

A method of marketing the securities of a company whereby its employees

are encouraged to take up shares and subscribe to it is know as ‘stock
option’. It is a voluntary scheme on the part of the company to encourage
employees’ participation in the company. The scheme also offers an
incentive to the employees to stay in the company.

33
SEBI Guidelines

Company whose securities are listed on any stock exchange can introduce
the scheme of employees stock option. The offer can be made subject to the
conditions specified below:

1. Issue at discount: Issue of stock options at a discount to the market

price would be regarded as another form of employee compensation
and would be treated as such in the financial statements of the
company regardless the quantum of discount on the exercise price of
the option.

2. Approval: The issue of ESOP’s is subject to the approval by the

shareholders through a special resolution.

3. Maximum limit: There would be no restriction on the maximum

number of shares to be issued to a single employee.

4. Minimum period: A minimum period of one year between grant of

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

5. Superintendence: The operation of the ESOP Scheme would have to

be under the superintendence and direction of a Compensation
Committee of the Board of Directors in which there would be a majority
of independent directors.

6. Eligibility: ESOP scheme is open to all permanent employees and to

the directors of the company but not to promoters and large
shareholders.

7. Director’s report: The Director’s report shall make a disclosure of

the following:

a. Total number of shares as approved the shareholders

b. The pricing formula adopted

c. Details as to options grated, options vested, options exercised and

options forfeited, extinguishments or modification of options, money

34
 realized by exercise of options, total number of options in force,
employee-wise details of options granted to senior managerial
personnel and to any other employee who received a grant in
anyone year of options amounting to 5 percent or more of options
granted during that year.

d. Fully diluted EPS computed in accordance with the IAS

8. IPO: SEBI’s stipulations prohibiting initial public offerings by

companies having outstanding options should not apply to ESOP.

Stock Option Norms for Software Companies

The relevant guidelines issued by the SEBI as regards ‘employees stock

option’ for software companies are as follows:

1. Minimum issue: A minimum issue of 10 percent of its paid-up capital

can be made by a software company which has already floated
American Depository Receipts (ADRs) and Global Depository Receipts
(GDRs) or a company which is proposing to float these is entitled to
issue ADR/GDR linked stock options to its employees.

2. Mode of Issue: Listed stock options can be issued in foreign currency

convertible bonds and ordinary shares (through depository receipt
mechanism) to the employees of subsidiaries of Info Tech Companies.

3. Permanent employees: Indian IT companies can issue ADR/GDR

linked stock options to permanent employees, including Indian and
overseas directors, of their subsidiary companies incorporated in India
or outside.

4. Pricing: The pricing provisions of SEBI’s preferential allotment

guidelines would not cover the scheme. The purpose is to be enable
the companies to issue stock options to its employees at a discount to
the market price which serves as another form of compensation.

5. Approval: Shareholders’ approval through a special resolution is

necessary for issuing the ESOPs. A minimum period of one year
between grant of option and its vesting has been prescribed. After one
year, the company would determine the period in which option can be
exercised.

Bought-out Deals

35
Meaning

A method for marketing of securities of a body corporate whereby the

promoters of an unlisted company make an outright sale of a chunk of equity
shares to a single sponsor or the lead sponsor is known as ‘bought-out
deals’.

Features

1. Parties: There are three parties involved in the bought-out deals.

They are promoters of the company sponsors and co-sponsors who are
generally merchant bankers and investors.

2. Outright Sale: Under this arrangement, there is an outright sale of a

chunk of equity shares to a single sponsor or the lead sponsor.

3. Syndicate: Sponsor forms a syndicate with other merchant bankers

for meeting the resource requirements and for distributing the risk.

4. Sale price: The sale price is finalized through negotiations between

the issuing company and the purchaser, the sale being influenced by
such factors as project evaluation, promoters image and reputation,
current market sentiments, prospects of off-loading these shares at a
future date, etc.

5. Listing: The investor-sponsor make a profit, when at a future date,

the shares get listed and higher prices prevail. Listing generally takes
place at a time when the company is performing well in terms of higher
profits and larger cash generations from projects.

6. OTCEI: Sale of these share at Over-the-Counter Exchange of India

(OTCEI) or at a recognized stock exchanges, the time of listing these
securities and off-loading them simultaneously are being generally
decided in advance.

***********

36
5.Q:Explain briefly the mechanism of underwriting

Benefits/Functions

The financial service of ‘underwriting’ is found advantageous for the issuers

and the public alike. The function and the role of underwriting firms is given
below:

Adequate Funds

Underwriting being a kind of a guarantee for subscription of a public issue of

securities enables a company to raise the necessary capital funds. By
undertaking to take up the whole issue, or the remaining shares not
subscribed by the public, it helps a company to undertake project
investments with the assurance of adequate capital funds. Underwriting
agreement assures the company of the required funds within a reasonable or
agreed time.

Expert Advice

Underwriters of repute often help the company by providing advice on

matter pertaining to the soundness of the proposed plan etc. thus enabling
the company in avoid certain pitfalls. It is therefore, possible for an issuing
company to obtain the benefit of expert advice through underwriting before
entering into a n agreement.

Enhanced Goodwill

The fact that the issues of securities of a firm are underwritten would help
the firm achieve a successful subscription of securities by the public. This is
because, intermediaries, of financial integrity and established reputation
usually do they. Such an activity, therefore, helps enhance the goodwill of
the issuing company.

Assurance to investors

Under writers, before underwriting the issue, satisfy themselves with the
financial integrity of the Issuer Company and viability of the plan. The
underwriting firms assure this way, the soundness of the company the
investors are, therefore, assured of having low risk when they buy shares or
debentures which have been underwritten by them. There firm commitment
towards fulfilling their underwriting obligations helps creates confidence in
the minds of the investing public about the company.

37
Better Marketing

Underwriters ensure efficient and successful marketing of the securities of

the firm through their network arrangements with other underwriters and
brokers at national and global level.

Benefits to Buyers

Underwriters are very useful to the buyers of securities due to their ability to
give expert regarding the safety of the investment and the soundness of
companies. The information and the expert opinion published by them in
various newspapers and journals are also helpful.

Price Stability

Underwriters provide stability to the price of securities by purchasing and

selling various securities. This ultimately benefits the stock market.

Indian Scenario

Underwriting, as an important type of financial service, became popular in

the Indian capital market only recently. It made its beginning in 1912 when
M/s. Batliwala and Karni underwrote the shares of the Central India Spinning
and Weaving Co. Ltd. Underwriting, on a substantial scale, started in the
Indian Capital market only after World War I. The Tatas started the first
underwriting business in India in 1937, with the setting up of the ‘Investment
Corporation of India ltd.’

Underwriting gained momentum and popularity after January 1955, with the
setting up of he Industrial Credit and Investment Corporation of India (ICICI).
Later, other development financial institutions such as Life Insurance
Corporation of India, Industrial Development Bank of India (IDBI) and Unit
Trust of India (UTI) started taking an active part in the underwriting of new
issues, with IDBI being one of the largest.

********

38
6.Q:Explain the different types of capital market instruments

Introduction

Indian capital market has been experiencing metamorphic changes in the

last decade, thanks to a host of measures of liberalization, globalization, and
privatization that have been initiated by the Government. Pronounced
changes have occurred in the realm of industrial policy, licensing policy,
financial services industry, interest rates, etc. As a result of these changes,
the financial services industry has come to introduce a number of
instruments with a view to facilitate borrowing and lending of money of
money in the capital market by the participants.

Types

Financial instruments that are used for raising capital resources in the capital
market are know as ‘Capital Market Instruments’,

The various capital market instruments used by corporate entities for raising
resources are as follows:

1. Preference shares

2. Equity shares

3. Non-voting equity shares

4. Cumulative convertible preference shares

5. Company fixed deposits

6. Warrants

7. Debentures and Bonds

Preference Shares

Meaning

Shares that carry preferential rights in comparison with ordinary shares are
called ‘Preference Shares’. The preferential rights are the rights regarding

39
payment of dividend and the distribution of the assets of he company in the
event of its winding up, in preference to equity shares.

Types

1. Cumulative preference share where the arrears of dividends in times of

no and/or lean profits can accumulated and paid in the year in which
the company earns good profits.

2. Non cumulative preference shares Shares where the carry forward of

the arrears of dividends is not possible.

3. Participating preference shares Shares that enjoy the right to

participate in surplus profits or surplus assets on the liquidation of a
company or in the both, if the Articles of Association provides for its.

4. Redeemable preference shares Shares that are to be repaid at the end

of the term of issue. The maximum period of a redemption being 20
years with effect from 1.3.1997 under the Companies Amendment Act,
1996.

5. Preference shares with warrants attached The attached warrants

entitle the holder to apply for equity shares for cash, at a ‘premium’, at
any time, in one or more stages between the third and fifth year from
the date of allotment.

Equity Shares

Meaning

Equity shares, also known as ‘ordinary shares’ are the shares held by the
owners of a corporate entity.

Features

Since equity shareholders face greater risks and have no specific preferential
rights, they are given larger share in profits through higher dividends than
those given to preference shareholders, provided the company’ performance
is excellent.

A strikingly noteworthy feature of equity shares is that holders of these

shares enjoy substantial rights in the corporate democracy, namely the
rights to approve the company’s annual accounts, declaration of dividend
enhancement of managerial remuneration in excess of specified limits and

40
fixing the terms of appointment and election of directors, appointment of
auditors and fixing of their remuneration.

Equity shares in the hands of shareholders are mainly reckoned for

determining the management’s control over the company. Where
shareholders are widely disbursed, it is possible for the management to
retain the control, as it is not possible for all the shareholders to attend the
company’s meeting in full strength.

Equity shareholders represent proportionate ownership in a company. They

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

Voting rights are granted under the Companies Act (Sections 87 to 89)
wherein each shareholder is eligible for votes proportionate to the number of
shares held or the amount of stock owned.

Capital

Equity shares are of different types. The maximum values of shares as

specified in the Memorandum of Association of the company is called the
authorized or registered or nominal capital. Issued capital is the nominal
value of shares offered for public subscription.

Par Value and Book Value

The face value of a share is called its Par value. Although shares can be sold
below the par value, it is possible that shares can be issued below the par
value. The financial institutions that convert their unpaid principal and
interest into equity in sick companies are compelled to do it at a minimum of
Rs.10 because of the par value concept even though the market price might
be much less than Rs.10.

Par value is of use to the regulatory agency and the stock exchange. It can
be used to control the number of shares that can be issued by the company.
The par value of Rs.10 per shares serves as a floor price for issue of shares.

Cash Dividends

These are dividends paid in cash; a stable payment of cash dividend is the
hallmark of stability of shares prices.

41
Stock dividends

These are the dividends distributed as shares and issued by capitalizing

shares reserves. While net worth remains the same in the balance sheet, its
distribution between shares and surplus is altered.

Non Voting Equity Shares

Consequent to the recommendations of the ‘Abid Hussain Committee’ and

subsequent to the amendment to the Companies Act, corporate
managements are permitted to mobilize additional capital without diluting
the interest of existing shareholders with the help of a new instrument called
‘non-voting equity shares’. Such shares will be entitled to all the benefits
except the right to vote in general meetings. Such non-voting equity share
is being considered as a possible addition to the two classes of share capital
currently in vogue. This class of shares has been included to an amendment
to the Companies Act as a third category of shares Corporate will be
permitted to issue such shares upto a certain percentage of the total Non-
voting equity shares will be entitled to rights and bonus issued and
preferential offer of shares on the same lines as that of ordinary shares.

Convertible Cumulative Preference Shares (CCPS)

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

Following are some of the terms and conditions of the issue of CCP shares:

1. Debt-equity ratio: For the purpose of calculation of debt-equity ratio

as may be applicable CCPS are be deemed to be an equity issue.

2. Compulsory conversion: The conversion into equity shares must be

for the entire of issue of CCP shares and shall be done between the
period at the end of three years and five years as may be decide by
the company.

3. Fresh Issue: The conversion of CCP shares into equity would be

deemed as being one resulting from the process of redemption of the

42
 preference shares out of the proceeds of a fresh issue of shares made
for the purposes of redemption.

4. Preference dividend: The rate of preference dividend payable on

CCP shares would be 10 percent.

5. Guideline ratio: The guidelines ratio of 1:3 as between preference

shares and equity shares would not be applicable to these shares.

6. Arrears of dividend: The right to receive arrears of dividend up to

the date of conversion, if any, shall devolve on the holder of the equity
shares on such conversion.

7. Voting right: CCPS would have voting rights as applicable to

preference shares under the companies Act, 1956.

8. Quantum: The amount of the issue of CCP shares would be to the

extent the company would be offering equity shares to the public for
subscription.

Company Fixed Deposits

Fixed deposits are the attractive source of short-term both for the companies
and investors as well. Corporates favor fixed deposits as n ideal form of
working capital mobilization without going through the process of
mortgaging assets and the associated rigmaroles of documentation, etc.
investors find fixed deposits a simple avenue for investment in popular
companies at attractively reasonable and safe intrest rates.

Regulations

Since these instruments are unsecured, there is a lot of uncertainty about

the repayment of deposits and regular payment of interest. The issue of
fixed deposits is subject to the provisions of the Companies Act and he
companies (Acceptance of Deposits) Rules introduced in February 1975,
some of the important regulations in this regard as follows:

1. Advertisement: Issue of an advertisement (with the prescribed

information) as approved by the Board of Directors in dailies circulating
in the state of incorporation.

2. Liquid assets: Maintenance of liquid assets equal to 15 percent

(substituted for 10% by Amendment Rules, 1992) of deposits
(maturing during the year ending March 31) in the form of bank

43
 deposits, unencumbered securities of State and Central Governments
or unencumbered approved securities.

3. Disclosure: Disclosure in the newspaper advertisement the quantum

of deposits remaining unpaid after maturity. This would help highlight
the defaults, if any, by the company and caution the depositors.

4. Deemed public Company: Private company would become a

deemed public company where such a private company, after inviting
public deposits through a statutory advertisement, accepts or renews
deposits from the public other than the members, directors or their
relatives.

5. Default: Penalty under the law for default by companies in repaying

deposits as and when they mature for payment where deposits were
accepted in accordance with the Reserve Bank directions.

6. CLB: Empowerment to the Company Law Board to direct companies

to repay deposits, which have not been repaid as per the terms and
conditions governing such deposits, with a time frame and according to
the terms and conditions of the order.

Warrants

An option issued by a company whereby the buyer is granted the right to

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

Both warrants and rights entitle a buyer to acquire equity shares of the
issuing company. However, they are different in the sense that warrants
have a life span of three of five years whereas, rights have a life span of only
four to twelve weeks (duration between the opening and closing date of
subscription list). Moreover rights are normally issued to effect current
financing, and warrants are sold to facilitate future financing. Similarly, the
share, is usually above the market price of the share so as to encourage
existing shareholders to purchase it. On the other hand, one warrant buys
one equity share generally, whereas more than one rights may be needed to
buy one share. The detachable warrant attached to each share provides a
right to the warrant holder to apply for additional equity share against each
warrant.
44
Debentures and Bonds

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

debenture. Accordingly, any document that fulfills either of these conditions
is a debenture, issued under the common seal of a company, usually takes
the form of a certificate that acknowledges indebtedness of the company.

Features

Following are the features of a debenture:

1. Issue: In India, debentures of various kinds are issued by the

corporate bodies, Government, and others as per the provision of e
Companies Act, 1956 and under the regulations of the SEBI. Section
117 of the Companies Act prohibits issue of debentures with voting
rights. Generally, they are issued against a charge or the assets of he
company but at times may be issued without any such charge also.
Debentures can be issued at a discount in which case, the relevant
particulars are to be filed with the Registrar of Companies.

2. Negotiability: In the case of bearer debentures the terminal value is

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

3. Security: Secured debentures create a charge on the assets of the

company. Such a charge may be either fixed or floating. Debentures
that are issued without any charge on assets of the company are called
‘unsecured or naked debentures’.

4. Duration: Debentures, which could be redeemed after a certain

period of time are called Redeemable Debentures. There are
debentures that are not to be returned except at the time of winding
up of the company. Such debentures are called Irredeemable
Debentures.

5. Convertibility: Where the debenture issue gives the option of

conversion into equity shares after the expiry of a certain period of
time, such debentures are called Convertible Debentures.

45
 6. Return: Debenture have a great advantage in them, in that they
carry a regular and reasonable income for the holders. There is a legal
obligation for the company to make payment of interest on debentures
whether or not any profits are earned by it.

7. Claims: Debentures holders command a preferential treatment in the

matters of distribution of he final proceeds of he company at the time
of its winding up . There claim of preference and equity shareholders.

Kinds

Innovative debt instruments that are issued by the public limited companies
in India are described below:

1. Participating debentures

2. Convertible debentures

3. Debut-Equity swaps

4. Zero-coupon convertible notes

5. Secured Premium Notes (SPN) with detachable warrants

6. Non-Convertible Debenture (NCDs) with detachable equity warrants

7. Zero-interest Fully Convertible Debentures (FCDs)

8. Secured Zero-interest Partly Convertible Debentures (PCDs) with

detachable and separately tradable warrants.

9. Fully Convertible Debentures (FCDs) with interest (optional).

10. Floating Rate Bonds (FRB)

1. Participating debentures: Debentures that are issued by a body

corporate which entitle the holders to participate in its profits are
called ‘Participating Debentures’. These are the unsecured corporate
debt securities. They are popular among existing dividend paying
corporate.

2. Convertible debentures

46
 a) Convertible debentures with options. Are a derivative of convertible
debentures that give an option to both the issuer, as well as
investor, to exist from the terms of the issue.

b) Third party convertible debentures are debts with a warrant that

allow the investor to subscribe to the equity of a third firm at a
preferential price viz-a-vis market price, the interest rate on the
third party convertible debentures being lower than pure debt on
account of the conversion option.

47
 3. Debt-equity swaps: They are offered from a n issuer of debt to swap
it for equity. The instrument is quite risky for the investor because the
anticipated capital appreciation may not materialize.

4. Zero-coupon convertible note: These are debentures that can be

converted into shares and on its conversion the investor forgoes all
accrued and unpaid interest. The Zero-coupon convertible notes are
quite sensitive to changes in the interest rates.

5. SPN with detachable warrants: These are the Secured Premium

Notes (SPN) with detachable warrants. These are the redeemable
debentures that are issued along with a detachable warrant. The
warrant entitles the holder to apply and get equity shares allotted,
provided the SPN is fully paid. The warrants attached it assured the
holder such a right. No interest will be paid during the lock-in period
for SPN.

6. NCDs with detachable equity warrants: These are Non-

Convertible Debentures (NCDs) with detachable equity warrants.
These entitle the holder to buy a specific number of shares from the
company at a predetermined price within a definite time frame.

7. Zero interest FCDs: These are Zero-interest Fully Convertible

Debentures on which no interest will be paid by the issuer during the
lock-in-period. However, there is a notified period after which fully
paid FDCs will be automatically and compulsorily converted into
shares.

8. Secured Zero interest PDCs with detachable and separately tradable

warrants. These are Secured Zero interest Partly Convertible
Debentures with detachable and separately tradable warrants.

9. Fully convertible debentures (FCDs) with interest (Optional):

These are the debentures that will not yield any interest for an initial
short period after which the holder is given an option to apply for
equities at a premium.

10. Floating Rate Bonds (FRBs): These are the bonds where the yield is
linked to a benchmark interest rate like the prime rate in USA or LIBOR
in the Euro currency market. For instance, the State Bank of India’s
floating rate bond, issue was lined to the maximum interest on term

48
 deposits that was 10 percent at the time. The floating rate is quoted in
terms of a margin above or below the benchmark rate. Interest rates
linked to the benchmark ensure that neither the borrower nor the
lender suffer from the change sin interest rates. Where interest rates
are fixed, they are likely to be inequitable to the borrower when
interest rates fall and inequitable to he lender when interest rates rise
subsequently.

************

49
 SET 2

1. Explain the different types of merger.

Merger – Types

Mergers are of different types as discussed below:

1. Horizontal merger: Where two or more companies that complete in

the same industry amalgamate, it is a case of ‘horizontal merger’. The
objective of horizontal merger is to expand the firm’s operations in the
same industry through the substantial economies of scale and through
the elimination of competition. The merger of Tata oil Mills Ltd. With
the Hindustan Level ltd. Is an example of a horizontal merger. Under
horizontal merger combination of two or more firms that are engaged
in similar type of production, distribution or area of business takes
place. For instance where two or more cement manufacturing
companies are combined, it makes the form of ‘horizontal merger’.

2. Vertical merger: A company is said to be adopting a vertical

integration strategy where it seeks to participate in other links in the
value chain by remaining in the same industry by acquiring suppliers
or production technology, or acquiring sales or distribution capacity.
Where two or more companies that operate in the same industry but at
different stages of production or distribution system amalgamate, it is
a case of ‘vertical merger’. Vertical merger happens by means of
combination of two or more firms that are engaged in different stages
of operation, production or distribution. For instance, where a
company that manufactures laptops combines with a company that
markets laptops, it is a case of a vertical merger.

Vertical merger may take the form of either a forward merger or a

backward merger. A backward merger happens where a
manufacturing company joins with a company that supplier raw
material. On the other hand, a forward merger happens where a
company that supplies raw material joints hands with a company the
manufacturers.

3. Diagonal Merger: A company is said to be adopting a diagonal

integration strategy where it pursues an acquisition that involves both
horizontal and vertical elements. Under this merger strategy, content
and intellectual property ownership is combined with distribution

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 technology and infrastructure, resulting in so entirely new media
industry.

4. Forward merger: In a forward merger, the shareholders of the target

company exchange their shares for the shares of the acquiring
company and all of the assets and liabilities of the target company are
automatically transferred to the acquire.

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 5. Reverse merger: In a reverse merger, the shareholders of the
acquiring company exchange their shares for shares of the target
company. It is a case of the acquiring company merging into the
target company. Where a prosperous and profit making company
acquires a loss-making sick company with substantial erosion in its net
worth, it is a case of ‘reverse merger’.

6. Forward triangular merger: In a forward triangular merger, a

subsidiary company is formed by the parent company for the purpose
of engaging in the merger deal. A parent company funds a subsidiary
formed for this purpose. The stock of the parent company is
transferred to the target company by the subsidiary.

7. Reverse triangular merger: In a reverse triangular merger, the

parent company funds a subsidiary company with stock of the parent.
The shareholders of the target company exchange their stock for the
stock of the parent company, which is held by the subsidiary company.

8. Conglomerate merger: A company is said to be adopting a

conglomerate merger strategy where it makes acquisitions across
different industries. Where several firms engaged in unrelated lines of
business activity combine together to for a new company, it takes the
form of ‘conglomerate merger’.

A conglomerate takeover or merger involves the coming together of

two companies in different industries i.e. the businesses of the two
companies are into related to each other horizontally (in the sense of
producing the same or competing products), or vertically (in the sense
of standing towards each other in the relationship of supplier and
buyer, or potential supplier and buyer).

A co generic merger is said to take place where the companies that are
getting merged are engaged in complementary activities and not in
direct competitive activities, amalgamate to form a new company. The
coming together of a car manufacturer with a scooter manufacturer is
an example of a co generic merger.

Conglomerate takeovers or mergers may in turn be classified

according to the purpose of the dominant party. The dominant party

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 may itself be a ‘fully-fledged conglomerate’ company, i.e. a holding
company staffed by professional managers exercising management
control over a substantial number of subsidiaries in a wide range of
industries.

To dominant party may be a ‘financial conglomerate’, i.e. the group

may have been put together largely on the basis of financial
engineering by the holding company, usually be exchanging its highly
priced quoted securities (frequently in the form of convertible
securities) for shares of companies in a wide range of industries.

9. Negotiated merger: Where merger of two or more companies takes

place after protracted negotiations, it is a case of ‘negotiated merger’.
Under this type of merger, the acquiring firm negotiates directly with
the management of the target firm. The merging companies willingly
reach an agreement for the merger proposal. Accordingly, of the
parties to the agreement fall to reach an agreement, the merger
proposal will be terminated and dropped out. The merger of ITC
Classic Ltd., with ICICI Ltd., is an example of a negotiated merger.

10. Arranged merger: Where merger of a financially sick company takes

place with another sound company as part of package of financial
rehabilitation under the initiative of a financial body, it is a case of an
‘arranged merger’. Merger schemes are crafted in consultation with
the lead bank, the target firm and the acquiring firm. These are
motivated mergers and the led bank takes the initiative and decides
the terms and conditions of merger.

11. Agreed merger: Where the directors of target firm agree to the
takeover or merger, accept the offer in respect of their own
shareholdings (which might range from nil or negligible to controlling
shareholdings) and recommend other shareholders to accept the offer,
it is a case of ‘agreed takeover or merger’. The directors may agree
right from the start or after early negotiations or even after public
opposition to the bid (which may or may not have resulted in an
improvement in the terms of the proposed offer).

12. Unopposed merger: Where the directors of the target firm, while
making a deal with the acquiring firm, do not oppose the offer or
recommend rejection, it is a case of ‘unopposed merger’.

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 13. Defended merger: Where the directors of a target firm decide to
oppose the bid, recommending shareholders to reject the offer and
perhaps taking further defensive action, it takes the form of a
‘defending merger’. The decision to defend may be with the intention
of stopping the take over (which in turn may be prompted either by the
genuine belief of the directors that it is in the interests of the company
to remain independent or by a desire of the directors to protect their
own personal positions) or persuading the bidder to improve its terms.

14. Competitive merger: Where a second bidder (and perhaps even a

third bidder) comes into the scene with a rival bid, it is a case of a
‘competitive merger’. This may be an independent action on the part
of the rival bidder or it may be at the invitation of the directors of the
target firm, who deciding that a takeover is inevitable, feel that the
company comes under the control of a bidder selected by them rather
than the original bidder.

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 15. Tender offer: Where a bid is made by an acquiring firm to acquire
controlling interest in a target firm by purchasing the shares of the
target firm at a fixed price. It is a case of ‘tender offer’. Under this
type of merger, the acquiring firm directly approaches the
shareholders of the target firm and makes them sell their
shareholdings at a fixed price. The offer prices is generally fixed at a
level higher than the current market price in order to induce the
shareholders to divest their holding in favor of the acquiring firm.

16. Diversification: Diversification is a case of ‘conglomerate merger’.

Diversification consists of a company, deriving all or the greater part of
its revenue from the particular industry, acquiring subsidiaries
operating in other industries for one or more of the following reasons.

17. To obtain greater stability of earnings through spreading

activities in different industries with different business cycles or to
diversify out of a static or dying industry.

18. To employ spare resources, whether or capital or management

19. To obtain benefit of economies of scale, particularly in regard to

“staff” functions (such as personnel, advertising, accounting and
financial) where there are some common factors.

20. To make the company too large to be likely to be the object of a

takeover or perhaps to make it a less attractive object in the case of
defensive diversification.

21. To provide an outlet for the ambitions of management, here

antimonopoly laws make further acquisitions (or perhaps even growth)
in the company’s own field impracticable.

Conglomerate takeovers and mergers do not usually raise anti-monopoly

questions, but may do so where it is feared that the firm may abuse its
market power, such as by exerting pressure on firms from which some
companies in the group purchase supplies to place business with other
companies in the group, and it is also argued that a decision by a company
to enter a new field by acquisition reduced by one to number of potential

55
competitors in that field in so far as the acquiring company might otherwise
have entered the field direct.

Apart from categorizing mergers in the after and merger, takeovers and
mergers may also be classified according to the degree of cooperation
between the boards of directors of the two companies concerned.

***********

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2.Q:Explain the steps involved in M&A

Following are the steps involved in M&A:

1. Review of objectives: The first and foremost step in M&A is that the
merging companies must undertake the review of the purpose for
which the proposal to merge is to be considered. Major objectives of
merger include attaining faster growth, improving profitability,
improving managerial effectiveness, gaining market power and
leadership, achieving cost reduction, etc. the review of objectives is
done to assess the strengths and weaknesses, and corporate goals of
the merging enterprise.

2. Data for analysis: After reviewing the relevant objective of

acquisition the acquiring firm needs to collect detailed information
pertaining to financial and other aspects of the firm and the industry.
Industry centric information will be needed to make an assessment of
market growth, nature of competition, ease of entry, capital and labour
intensity, degree of regulation, etc. similarly, firm-centric information
will be needed to assess quality of management, market share, size,
capital structure, profitability, production and marketing capabilities
etc. the date to be collected serves as the criteria for evaluation.

3. Analysis of Information: After collecting both industry-specific and

firm-specific information, the acquiring firm undertakes analysis of
data and the pros and cons are weighed. Data is to be analyzed with a
view of determine the earnings and cash flows, area of risk, the
maximum price payable to the target company and the best way to
finance the merger.

4. Fixing price: Price to be paid for the company being acquired shall
be fixed taking into consideration the current market value of share
of the company being acquired. The price shall usually be above the
current market price of the share. A merger may take place at a
premium. In such a case, the firm would pay an offer price which is
higher that the target firm’s pre-merger market value.

5. Finding merger value: Value created by merger is to be found so

that it is possible for the merging firms to determine their respective
share. Merger value is equal to the excess of combined present value
of the merged firms over and above the sum of their individual present
57
 values as separate entities. Any cost incurred towards the merging
process is subtracted to arrive at the figure of net economic advantage
of the merging this advantage is shared between the shareholders of
the merging firms.

******

58
3.Q:Explain the general obligation of portfolio managers as enunciated by
the SEBI

Following are the general obligations of portfolio managers as enunciated by

the SEBI:

A. Contract with Clients

Every portfolio manager shall, before taking up an assignment of

management of funds or portfolio of securities in writing on behalf of a
client, enter into an agreement in writing with such client clearly
defining the interrelationship, and setting out their mutual rights,
liabilities and obligation relating to management of funds or portfolio of
securities containing the details as specified in Schedule IV. The
agreement between the portfolio manager and the client shall, inter
alia, contain the following:

The funds of all clients shall be placed by the portfolio manager in a

separate account to be maintained by him in a scheduled commercial
bank (any bank included in the

Second Schedule to the Reserve bank of India Act, 1934 (2 f 1934)

Notwithstanding anything contained in the agreement between a

portfolio manager and his client referred to in regulation 14 hereof, the
portfolio funds can be withdrawn or taken back by Portfolio client at his
risk before the maturity date of the contract the following
circumstances:

1. Voluntary or compulsory, termination of Portfolio management

services by the Portfolio manager;

2. Suspension or termination of registration of Portfolio manager by

the Board;

3. Bankruptcy or liquidation in case the portfolio manager is a body

corporate; and

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 4. Permanent disability, lunacy or insolvency in case the portfolio
manager is an individual.

The portfolio manager shall not, while dealing with clients funds, indulge in
speculative transactions, that is, he shall not enter into any transaction for
purchase or sale of any security, which transaction is periodically or
ultimately settled otherwise than by actual delivery or transfer of security.

In the even of any dispute between the portfolio manager and his clients, the
client shall have the right to obtain details of his portfolio from the portfolio
manager.

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Contents

The contents of agreement between the Portfolio Manager and His clients
are as follows:

1. Appointment of Portfolio manager.

2. Scope of services to be provided by the Portfolio Manager subject to

the activities permitted under SEBI (Portfolio Managers) regulations,
1993, viz. advisory, investment management, custody of securities and
keeping track of corporate benefits associated with the securities. The
portfolio Manager shall act in a fiduciary capacity and as a trustee and
agent of the client’s account.

3. Function, obligations, duties and responsibilities (as

discretionary and non-discretionary to be given separately) with
specific provisions regarding instruction for nondiscretionary portfolio
manager inter alia:

a) Terms in compliance with the Act, SEBI (Portfolio Managers)

Regulations, 1993, rules, regulations guidelines made under the Act
and any other laws/rules/regulations/guidelines etc.

b) Providing reports to clients.

c) Maintenance of client-wide transactions and related books of accounts.

d) Provisions regarding audit of accounts as required under the SEBI

(Portfolio Manager Regulations, 1993).

e) Settlement of accounts and procedure therefore, including the

provisions for payment of maturity or early termination of contract.

4. Investment objectives and guidelines such as following:

a. Types of securities in which investment would be made specifying

restrictions, if any.

b. Particulars regarding amount, period of management, repayment or

withdrawal

c. Taxation aspects such as Tax Deducted at Source, etc. if any.

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 d. Condition that the portfolio manager shall not lend the securities of the
client unless authorized by him in writing.

5. Risk factors: A detailed statement of risks associated with each type

of investment including the standard risks associated with each type of
investment risk factors specific to the scheme as well as the attendant
to specific investment policies and objectives of the scheme are to be
mentioned.

6. Period of agreement: Minimum period of any, and provision for

renewal, if any.

7. Conditions under which agreement may be altered, terminated and

implications thereof, such as settlement of amounts invested,
repayment obligations, etc.

8. Maintenance of Accounts: Maintenance of accounts separately in

the name of the client as are necessary of account for the assets and
any additions, income, receipts and disbursements in connection
therewith, as provided under SEBI (Portfolio Managers) regulations,
1993.

9. Terms of Fees: The quantum and manner of payment of fees and

charges for each activity for which services are rendered by the
Portfolio Manager directly or indirectly (where such service is
outsourced) such as invest management, advisory, transfer,
registration and transaction costs with specific references to brokerage
costs, custody charges, cost related to furnishing regular
communication, accountant statement, miscellaneous expenses
(individual expenses in excess of 5 percent to be indicated separately).
Etc.

10. Billing: Periodicity of billing, whether payment to be made in advance,

manner of payment of fees, whether setting off against the account,
etc. type of documents evidencing receipt of payment of fees.

11. Liability of Portfolio Manager: Liability of Portfolio Manager in

connection with recommendations made, to cover errors of judgment,
negligence, willful misfeasance in connection with discharge of duties,
acts of other intermediaries, brokers, custodian, etc.

12. Liability of client restricting the liability of the client to the extent of
his investment.

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 13. Death or disability: Providing for continuation/termination of the
agreement in the event of client’s death/disability, succession,
nomination, representation, etc. to be incorporated.

14. Assignment conditions for assignment of the agreement by client.

15. Governing Law: The law/jurisdiction of country/State which governs

the agreement are to be stated.

16. Settlement of grievances/disputes and provision for

arbitration:

Provisions to cover protection of act done in good faith, risks and

losses, rederessal of grievances, dispute resolution mechanism
reference for arbitration and the situations under which such rights
may arise, may be made.

B. Disclosures

The Portfolio Manager shall provide to the client the Disclosure Document as
specified in Schedule V, along with a certificate in Form C as specified in
Schedule I, at least two days prior to entering into an agreement with the
client as referred to in sub-regulation (1). The disclosure document shall
inter alia contain the following:

1. The quantum and manner of payment of fees payable by y the client

for each activity for which service is rendered by the Portfolio Manager
in Schedule I, at least two days prior to entering into an agreement
with the client as referred to in sub-regulation (1). The Disclosure
Document shall inter alia contain the following:

2. Portfolio risks;

3. Complete disclosures in respect of transactions with related parties as

per the accounting standards specified by the institute of chartered
accountants of India in this regard.

4. The performance of the Portfolio Manager; and

5. The audited financial statements of the Portfolio Manager for the

immediately preceding three years.

The Portfolio Manager shall charge an agreed fee from the clients for
rendering portfolio management services without guaranteeing or assuring,

63
either directly or indirectly, any return and the fee so charged may be a fixed
fee or a return based fee or a combination of both.

The Portfolio Manager may, subject to the disclosure in terms of the

disclosure Document and specific permission from the client, charge such
fees from the client for each activity for which service is rendered by the
Portfolio Manager directly or indirectly (where such service is out sourced).

********

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4.Q:Describe Depository receipts

Introduction

A receipt issued by a ‘Depository’ of a country against the deposit of shares

issued by a domestic company which is eligible for issue of foreign investors
and is eligible for trading on an overseas stock exchange, is known as a
‘Depository Receipt’ (DR), issue of a depository receipt connotes issue of
ordinary share to global investor, by keeping the share sunder the custody of
a ‘Domestic custodian Bank’.

A ‘Depository Receipt’ is a type of negotiable (transferable) financial security

that is traded on a local stock exchange but represents a security, usually in
the form of equity that is issued by a foreign publicity listed company. The
DR, which is a physical certificate, allows investors to hold share is equity of
other countries.

Depository receipts make it easier to buy shares in foreign companies

because the shares of the company don’t have to leave the home State.
When the depository bank is in the USA, the instruments are known as
American Depository receipt (ADR). European banks issue European
Depository receipts, and other banks issue Global Depository receipt (GDR).

ADRs are typically traded on a U.S national stock exchange, such as the New
York Stock Exchange (NYSE) or the American Stock Exchange (AMEX), while
GDRs are commonly listed on European stock exchanges such as the London
Stock Exchange (LSE). Both ADRs and GDRs are usually denominated in
U.S.dollars, but can also be denominated in Euros.

Working Mechanism

ADR is created when a foreign company wishes to list its already publicly
traded shares or debt securities or a foreign stock exchange. Initial Public
Offerings (IPOs), however, can also issue a DR as well, DRs can be traded
publicly over the counter. Let us look at an example of how an ADR is
created and traded.

Based on a determined ADR ratio, each ADR may be issued as representing

one or more of the Indian local shares, and the price of each ADR would be
issued in U.s.dollars converted from the equivalent Indian price of the shares
being held by the depository bank. The ADRs now represent the local Indian

65
shares held by the depository, and can now be freely traded equity on the
NYSE. After the process, whereby the new ADR of the Indian company is
issued, the ADR can be traded freely among investor sand transferred from
the buyer to the seller on the NYSE, through a procedure known as intra
market trading. The rights of the ADR holder are stated on the ADR
certificate.

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Pricing and Cross-trading

When any DR is traded, the broker will aim to find the best price of the share
in question. Investor will therefore compare the U.S. dollar price of the ADR
with the U.S. dollar equivalent price of the local share on the domestic
market. If the ADR of the Indian company is trading at USD 42 per share and
the share trading on the Indian market is trading at USD 41 per share
(converted from rupees to dollars), a broker would aim to buy more local
shares from India and issue ADRs on the U.S. market.

A U.S. broker may also sell ADRs back into the local Indian market. This is
known as “cross – border trading.” When this happens, an amount of ADRs
is cancelled by the depository and the local shares are released from the
custodian bank and delivered back to the Indian broker who bought them.

Benefits of Depository Receipts

The DR functions as a means to increase global trade, which in trade can

help to increase not only volumes on local and foreign markets but also the
exchange of information, technology, regulatory procedures, and market
transparence. Thus, instead of being faced with impediments of foreign
investment, as it often the case in many emerging markets, the DR investor
as well as the company can be benefited from investment 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 DRs has the added
benefit of increasing the share’s liquidity while boosting the company’s
prestige on its local market. Moreover, in many countries, especially those
with emerging markets, obstacles often prevent foreign investors from
entering the local market. By issuing a DR, a company can still encounter
investment from abroad without having to worry about barriers that a foreign
investor might face.

For the investor buying into a DR immediately turns an investor’s portfolio

into a global one. Investor’s gain the benefits of diversification, while trading
in their own market under familiar settlement and clearance conditions.
More importantly, DR investors will be able to reap the benefits of these
usually higher-risk, higher-return, without having to endure the added risks
of going directly into foreign markets, which may pose considerable

67
difficulties in the for of lack of transparency or instability resulting from
changing regulatory procedures.

***********

5.Q:Briefly explain the Credit Syndication Services

Credit Syndication Services

Merchant bankers provide various services towards syndication of loans. The

services vary depending on whether loans sought or of long-term fixed
capital or of working capital funds. Following are the credit syndication
services rendered by merchant bankers with regard to long-term loans:

1. Ascertaining promoter details

2. Ascertaining of cost details

3. Comparison of cost details

4. Identification of funding sources

5. Ascertainment of loan details

6. Furnishing beneficiary details

7. Making application

8. Project appraisal

9. Compliance for loan disbursement

10. Documentation and creation of security

11. Pre-disbursement compliance

Ascertaining of Promoter Details

This is the fundamental credit syndication service extended by merchant

bankers, whereby attempts are made to gain an understanding about the
promoters, who are involved in the launch and running of the project.
Information is collected about the promoters, their knowledge, reputation,
creditworthiness, experience in trade or industry and relevance of such skills

68
and competence, etc. For this purpose, the merchant banker holds
discussions with promoters. Information is also gleaned to know the extent
of contribution made by promotes to fund the project. The contributions
may include the quantum of preliminary expenses already incurred by them.
Etc.

Ascertainment of Project Cost Details

Here, the merchant banker investigates about the project for which finance
is to be arranged. Details about the project are collected with the help of
information given by the consultant in the project report.

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Merchant banks make an estimate of the capital cost of the project. This
involves ascertaining the cost details of different items of expenditure.
Some of the important items of costs that need to be ascertained by
merchant banker are preliminary expenses connected with cost of
promotion, incorporation, legal expenses etc., as applicable to setting up of
new units.

Comparison of cost Details

Here, the merchant banker investigates about the project for which finance
is to be arranged. Details about the project are collected with the help of
information given by the consultant in the project report.

Merchant banks make an estimate of the capital cost of the project. This
involves ascertaining the cost details of different items of expenditure.
Some of the important items of costs that need to be ascertained by
merchant banker are preliminary expenses connected with cost of
promotion, incorporation, legal expenses etc., as applicable to setting up
new units. Cost details pertaining to expansion, renovation, modernization
of diversification programmes of existing units include cost of fixed assets
that include cost of acquisition of land, construction of building, roads,
railway siding, procurement of plant and equipment, furniture and fixtures of
other miscellaneous fixed assets.

Comparison of cost Details

Another important function undertaken by merchant bankers is the

comparison of the details of costs with the benchmarks available in the same
industry. Other aspects such as the geographical area, size of scale of
operations, etc. are also used for comparison. Adjustments are also made
for inflationary conditions which help capturing rising prices of different
elements of cost.

Identification of Funding Sources

Identifying appropriate sources of capital required for financing the project is

another function of a merchant banker in his credit syndication services.
Many factors determine the choice of capital funding source. Most important
among them are the nature of the project, and the quantum of the project

70
cost. Nature of a project helps determine the quantum of project cost. For
instance, scale of cost involved in a project would vary depending on
whether the project is a small or medium or a large-sized project.

The sources of capital required for a project would be short-term, medium

term, or long-term. A brief description of each source of fund is attempted
below:

Short term source: Short-term funding source refers to funds required for
a period upto one year short-term funds are required for meeting the
working capital requirements or special seasonal needs of a industrial unit
the popular sources of short-term funds are commercial banks, trade credit,
public deposits, finance companies and also customers.

Medium-term source: Medium-term funding source refers to funds

required for a period ranging from one to five years. Medium-term funds are
needed for permanent working capital, expansion or replacement assets, or
acquisition of balancing equipments. Such funding is made available by
banks and financial institutions loans. Medium-term loans are provided
under the auspices of various lending schemes designed and operated by
the all-India financial institutions.

Long-term source: Long-term funding source refers to funds required for a

period of more than five years long-term funding is needed for undertaking
the establishment of new units, for permanent investment, fixed assets,
modernization, major expansion, diversification or rehabilitation of the
existing projects. The chief source of long-term capital funds are debt funds
and equity funds.

In addition to domestic sources available such as IDBI, ICICI, LIC, UTI, IRBI,
SFCs, SIDCs etc., for securing long-term debt funds, international capital
market sources are also tapped for raising debt fund.

Ascertainment of Loan Details

Merchant bankers ascertain details of criteria followed by the term-lending

institutions to entertain projects for granting assistance. The objective is to
pave way for the expeditious and favorable considerations of the loan
application by the development finance institutions. For this purpose,
merchant bankers hold preliminary discussions with the executives of the
lending institutions. The preliminary discussions help the merchant banker
clear the clouds as regards various aspects of seeking syndicated loan
arrangements with the financial institutions.
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The merchant banker also discusses matters connected with process of
production, technical arrangements, plant capacity, professional skill
required, procurement of license/DGTD registration, import license in case of
any import of capital goods/raw material is involved, foreign collaboration,
etc. Consultations are also held with the officials of the development finance
institutions on the status of Foreign Exchange Management Act compliance,
etc.

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Furnishing Beneficiary Details

An important function of credit syndication is furnishing of information

relating to the borrower-beneficiary to the financial institution. The
information is to be furnished in the application to be submitted by the
merchant banker to the lending agency as part of the credit syndication
arrangements. Following details are furnished by the merchant banker in
this regard.

1. General Information: The purpose of furnishing general information

is to enable the financing company to obtain a general idea about the
applicant company and its proposed project. The information to be
furnished by the merchant banker in this regard is stated below:

a. Name of constitution, date of incorporation and commencement of

business.

b. Nature of organization, viz, public/private/joint/cooperative sectors

c. Name of the business house/group to which it belongs.

d. Location of registered office/head office

e. Nature of concessions to which the project seeking financial assistance

is eligible.

f. Nature of industry and product

g. Installed capacity, both existing and proposed

h. Nature of currency loans applied for (whether rupee loans or foreign

currency loans)

i. License issued by the government for undertaking production.

j. Financial assistance applied for by way of underwriting for equity

capital/preference capital/ debenture.

2. Promoter Information: Information about promoters is furnished by

the merchant banker with the objective of helping the lending agency
to gain an understanding of the promoter, his activities, economic
background, credibility and integrity.

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 a. Brief account of activities and past performance/other expansion
programmes

b. Certified copies of Memorandum of Association. Articles of Association,

audited balance Sheet and Profit and Loss Account for last five years.

3. Company Information: The merchant banker has to furnish the

following information as regards the company for loan syndication
arrangements to be made:

a. Brief history of the concern.

b. Schemes already executed in the case of existing company

c. Expansion/diversification plans in the case of an existing company

d. Nature, size and status of the project to assess the funds requirement
in the case of a new company

e. List of subsidiaries (with percentage of holding s and nature of

business)

f. Directors of the company, their names, age, address, qualifications,

past experience, business or industrial background, existing proposed
shareholding in the company.

g. Certified copies of audited balance sheet and profit and loss account
for the last five years with proformas balance sheet and profit and loss
account of a recent date.

h. Tax status of the company

i. Export of product (destination, export sales for past five years with
export incentives available)

j. Insurance of fixed/other assets and risk covered and details of research

and development activities of the company.

4. Project profile information: Full information relating to the project

for which financial assistance is sought is furnished by the merchant
banker. The type of information may pertain to plant capacity, nature
of production process to be employed, nature of technical

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 arrangements available for the project, and other information as
specified below:

a. Plant capacity information about the product-wise installed

capacity/proposed capacity/ maximum production envisaged,
section wise capacities for major sections of the plant.

b. Plant process: Information about the technical process to be

employed by the plant with a flow chart depicting material process
and results.

c. Plant technical arrangements: Details of technical arrangements

made/proposed for implementation of the project, details of
collaboration, if any, with write-up on their activities, size, turnover,
particulars of existing plant, other projects in India and abroad
along with copies of broachers as published by them for the last 3
years/ collaboration agreement/Government approval for
collaborators/foreign technicians to be employed; name of
consultants manner of payment, brief particulars of consultants
(bio-data of senior personnel, names of directors), partners,
particular of work done in the past and work on hand with copies of
published material of consultant/ agreements with them and
Government approval for foreign consultants.

d. Plant management: Details of arrangements for executive

management, particulars of proposed key technical / administrative
and accounting personnel (with proposed organization chart
indicating lines of authority).

e. Plant assets: Details about various assets used by the borrowing

firm are to be furnished by the merchant banker. The details as
regards land and building include location of plant/requirement of
land, Locational advantages of the land, details of the land area and
cost, basis of valuation, mode of payment, date of purchase, lease,
previous owner and relationship with promoters/ directors,
conversion of land to industrial use, along with copies of sale/lease
deeds/ soil test reports/Government order converting land into
industrial use/location map/site plan showing contour lines/internal
roads/ power receiving station/railway siding/tube wells,
arrangements made proposed for constructions of buildings, etc.

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 f. Plant transport: Arrangements proposed for carrying raw
materials/ finished goods by own trucks/railway siding, etc/private
trucks should be furnished by the merchant banker.

g. Other details: In addition to the above, the merchant banker has

to furnish information pertaining to the type and the nature of raw
materials used and the source of availability, whether domestic or
foreign. Details as to be demand, availability, tariff, cost, and the
supply sources of utilities such as water, power, steam, compressed
air, etc. should be furnished.

5. Project cost information: Details of the estimated cost of the

project should be provided to the lending institution. This includes
information as regards rupee cost/ rupee equivalent of foreign
exchange cost/total cost for land or site development/ buildings/ plant
and machinery, imported/indigenous, technical know-how etc. to be
furnished.

6. Project marketing information: As part of the credit syndication

exercise, it is incumbent on the part of the merchant banker to furnish
adequate information about the marketing arrangements made for the
products of the borrowing unit. Following are the information to be
provided to the fund supplier in this regard.

a. Brief profile of the products beings offered

b. Scope of market for the products

c. Price aspects of the product

d. Estimates of existing and future demands and supply of proposed

product

e. Special and the outstanding feature of the product that would give the
firm a competitive advantage.

f. International CIF, FOB prices and landed cost of the propose product

g. List of principal customers and particulars of firms with whom such sale
arrangements have been made

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 h. Details of restrictions imposed by the Government as regards price,
distribution, export, etc.

7. Cash Flow information: The merchant banker has to furnish details

as to profitability and expected stream of cash flows and cost of the
propose project. For this purpose, it is essential that working results of
operations, cash flow statements and project balance sheet are given
in prescribed form along with the basis of the calculations.

8. Other information: The merchant banker has to indicate as to how

the purpose of the economic and national importance of the proposed
project will be realized. Besides, following are the other details to be
furnished by the merchant banker to the lending agency:

a. CIF/FOB international price of inputs to be imported/exported

b. Excise duty, export duty, export assistance (replenishment license,

duty drawback, cash subsidy, etc.)

c. Expected contribution to the growth, if any of ancillary industries in

the region.

d. Government consent by way issue of letter of intent, industrial

license, foreign exchange permission, approval of technical financial
collaboration, etc.

In addition to the above, merchant banker has to furnish a declaration

stating that all the necessary details have been furnished and that all the
information so provided are correct.

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6.Q:Write a note on electronic settlement of Trade Procedure

I. For Selling Dematerialized Securities

The procedure for selling dematerialized securities in stock exchanges is

similar to the procedure for selling physical securities. Instead of delivering
physical securities to the broker, the investor must instruct his/her DP to
debit his/her demat account with the number of securities sold by him/her
and credit broker’s clearing account. Procedure for selling securities is as
follows:

1. Investor sells securities in any of the stock exchanges linked to

Depository through a broker.

2. Investor gives instruction to DP to debit his account and credit the

broker’s (Clearing member proof) account.

3. Before the pay-in-day, investor’s broker transfers the securities to

clearing corporation.

4. The broker receives payment from the stock exchange (clearing

corporation).

5. The investor receives payment from the broker for the sale in the same
manner as that is received for a sale in the physical mode.

II. For Buying Dematerialized Securities

The procedure for buying dematerialized securities from stock exchanges in

similar to the procedure for buying physical securities. Investor may give a
one-time standing instruction to receive credits in his/her account or may
give separate instruction each time in the prescribed format.

The transactions relating to purchase of securities are as follows:

1. Investor purchase securities in any of the stock exchanges connected

to Depository through a broker.

2. Broker receives payment from investors

3. Broker arranges payment to the clearing corporation

4. Broker receives credit of securities in clearing account and credit

client’s account.

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 5. Investor receives shares in his account.

Demat of Debt Instruments

Debts instruments can also be held in demat form. Instruments like Bonds,
Debentures, commercial Paper, Certificate of Deposit, etc. irrespective
whether these instruments are listed/ unlisted/ privately placed or even
issued to a single holder can be dematerialized. Commercial paper can also
be kept in demat form. As per RBI Monetary and Credit Policy 2001-2002,
Banking And Financial Institutions, Primary Dealers and Satelite Dealers are
directed to convert their outstanding investment in commercial paper in
scrip form, into demat for latest by October, 2001. The above entities have
also been directed make fresh investment in commercial paper only in
demats form w.e.f. June 30, 2001.

Allocation

Any new instrument can be issued directly in dematerialized form without

resources to printing of either Letter of Allotment or Certificates. Securities
will be directly credited into the demat account of the investor by the
depositories on receipt of allotment details from RTA/company. The investor
need not open separate demat account for demat of debt instruments.

Dematerialization

The procedure for dematerialization of debt instrument is the same as

applicable for equity shares. In order to dematerialize his/her certificates; an
investor will have to first open a debt account with a DP and then request for
the dematerialization certificates by filling up a Dematerialization Request
Form (DRF) which is available with DP and submitting the same along with
the physical certificates. The investor has to ensure that the certificates
handed over to the DP for demat, are marked “surrendered for
dematerialization” on the face of the certificates.

Statement of holdings

A regular single statement of holding will reflect all the holdings in a

particular demat account, irrespective of type of instrument.

Safety system for Demat

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Demat services in order to be carried out effectively requires the following
safety system to be put in place:

1. Strict norms for becoming a depository participant (DP), net worth

criteria. SEBI approval, etc. are mandatory.

2. DP cannot effect any debit or credit in the demat account of the

investor without the valid authorization of the investor.

3. Regular reconciliation between DP and Depositories

4. Periodic inspection of Depositories of the office of DP and Registrar

(RTA)

5. All investors have a right to receive their statement of accounts

periodically from the DP.

6. In the depository system, the depository holds the investor accounts

on trust. Therefore, if the DP goes bankrupt the creditors of the DP will
have no access to the holdings in the name of the clients of the DP.
These investors can transfer their holdings to an account held with
another DP.

7. Compulsory internal audit of operations of DP every quarter by

practicing company secretary or chartered accountant.

8. Various procedures for back up and safe keeping of data all levels.

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