CHAPTER 1: INTRODUCTION TO FINANCIAL MARKETS

1. Introduction to Financial Markets

Financial markets are platforms where buyers and sellers trade financial instruments like equity,
bonds, derivatives, and commodities. They ensure efficient allocation of resources in an economy.

Types of Financial Markets:

 Stock Market: Deals with equity shares of companies. Investors gain through capital
appreciation and dividends. The market reflects future expectations of the economy,
making it volatile.
 Bond Market: Companies and governments raise funds by issuing bonds, which offer fixed
interest payments to investors until maturity.
 Commodities Market: Trades natural resources like gold, oil, and agricultural goods. Prices
are determined today for future delivery (futures contracts).
 Currency Market: Helps participants manage foreign exchange risks, offering a platform
for cross-currency transactions.
 Money Market: Facilitates short-term borrowing and lending (less than a year) using
instruments like Treasury Bills (T-Bills), Certificates of Deposit (CDs), and Commercial
Papers (CPs).
 Derivatives Market: Trades in financial contracts whose value depends on an underlying
asset (e.g., stock or commodity).

2. Importance of Financial Markets

Financial markets are critical for economic stability and growth.

 Channel for Investments: They transfer surplus funds (savings) to deficit areas
(investments), ensuring efficient capital allocation.
 Liquidity: Securities traded in financial markets are liquid, allowing participants to convert
assets into cash when needed.
 Job Creation: Financial markets generate direct and indirect employment through brokers,
underwriters, and other service providers.
 Price Discovery: Markets determine the value of securities based on demand and supply,
helping investors make informed decisions.

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  Transaction Efficiency: Markets reduce the cost of accessing and processing information
about securities.

3. Role of Financial Markets in Economic Development

Financial markets are essential for sustainable economic growth:

 Mobilizing Savings: They convert household savings into productive investments,

promoting industrial growth.
 Supporting Employment: Investments boost production, creating jobs and improving
living standards.
 Tax Revenue: Growth in jobs and production increases tax collection for the government,
enabling more public expenditure.
 Continuous Growth Cycle: Markets create a feedback loop where investments lead to
economic activity, further boosting savings and investments.

4. Stakeholders in Financial Markets

Stakeholders are entities or individuals involved in market activities.

Categories of Stakeholders:

1. Primary Stakeholders:
o Shareholders: Own shares in companies and participate in markets for profits.
o Lenders: Provide funds to borrowers (companies or governments) through bonds
or loans.
o Corporates: Raise funds via equity (shares) or debt (bonds) to finance operations
or growth.
o Mutual Funds: Pool investments from individuals to invest in diversified portfolios.
2. Service Providers:
o Brokers: Facilitate trading of securities for clients.
o Merchant Bankers: Manage IPOs, mergers, and fundraising activities.
o Underwriters: Guarantee the sale of securities by purchasing unsold portions
during public issues.
o Depositories: Hold securities in electronic form and facilitate secure transactions.
o Custodians: Safeguard securities and manage related transactions like dividends or
interest payments.
3. Regulators:

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 o SEBI: Oversees the securities market to protect investor interests and ensure
transparency.
o RBI: Regulates monetary policy, currency markets, and banking operations.
o IRDAI: Monitors insurance markets to protect policyholders.
o PFRDA: Develops and regulates pension markets for sustainable retirement
systems.

4. Administrative Authorities in Financial Markets:

The chapter outlines administrative authorities that support the smooth functioning of
financial markets in India by providing guidelines, ethical standards, and coordination
among stakeholders.

1. Association of Mutual Funds in India (AMFI)

 Purpose: AMFI was established in 1995 as a non-profit organization dedicated to

developing the Indian mutual fund industry in a professional, ethical, and
transparent manner.
 Roles and Responsibilities:
o Acts as an advisory body for the mutual fund industry.
o Represents the mutual fund sector in front of the Government and SEBI.
o Develops and implements the Code of Conduct and Ethics for asset
management companies (AMCs).
o Provides information on all mutual fund schemes through its website, ensuring
transparency for investors.
o Protects the interests of investors by ensuring fair practices.
 Global Counterpart:
o The Mutual Fund Dealers Association of Canada (MFDA) performs similar
functions by overseeing mutual fund dealers, setting standards, and ensuring
ethical practices.

2. Foreign Exchange Dealers Association of India (FEDAI)

 Purpose: Founded in 1958, FEDAI is a self-regulatory body for banks dealing in foreign
exchange.
 Major Activities:
o Frames rules for conducting interbank foreign exchange business.
o Collaborates with the Reserve Bank of India (RBI) to bring reforms and ensure the
development of the forex market.
o Sets operational and procedural guidelines for Authorized Dealers (ADs).
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  Global Counterpart:
o In the United States, forex dealers are regulated by the Commodity Futures
Trading Commission (CFTC) and the National Futures Association (NFA), ensuring
compliance and ethical practices.

3. Fixed Income Money Market and Derivative Association of India (FIMMDA)

 Purpose: FIMMDA was established in 1998 as a voluntary market body for participants in
bond, money, and derivatives markets.
 Key Members:
o Scheduled Commercial Banks (e.g., SBI, ICICI Bank).
o Public Financial Institutions (e.g., NABARD, IDFC).
o Insurance Companies (e.g., LIC).
 Major Roles:
o Develops policies, practices, and standards for its members.
o Promotes transparency and ethical behavior in fixed-income markets.
 Global Counterpart:
o The International Swaps and Derivatives Association (ISDA) standardizes
contracts (e.g., ISDA Master Agreement) and promotes risk management in the
derivatives market globally.

4. Association of Investment Bankers of India (AIBI)

 Purpose: AIBI was established to regulate the investment banking industry in India and
promote ethical practices.
 Key Functions:
o Acts as a self-regulatory organization (SRO) for merchant bankers.
o Ensures compliance with SEBI’s statutory requirements.
o Frames and promotes ethical guidelines for investment bankers.
 Global Counterpart:
o The International Association of Investment Bankers (IAIB) provides advisory
services on mergers, acquisitions, and partnerships for middle-market and
emerging companies globally.

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Significance of Administrative Authorities

 These bodies complement regulatory agencies like SEBI and RBI by ensuring operational
efficiency, transparency, and ethical practices.
 They bridge the gap between stakeholders and regulators, facilitating smooth
communication and implementation of policies.
 Administrative authorities enhance investor trust by maintaining high standards in
operations and ensuring fair market practices.

Financial Instruments

Financial instruments are tools that facilitate the transfer of funds between entities in financial
markets. They can be classified based on the market they belong to, their tenure, and the purpose
they serve.

1. Money Market Instruments

Money market instruments are short-term debt instruments (maturity of less than 1 year) used
to manage liquidity and meet short-term funding requirements.

1.1 Treasury Bills (T-Bills)

 Issuer: Central Government of India.

 Tenure: 91 days, 182 days, and 364 days.
 Purpose: Used to meet short-term funding needs of the government.
 Features:
o Issued at a discount and redeemed at face value.
o Safe investment option as they are government-backed.

1.2 Cash Management Bills (CMBs)

 Issuer: Government of India.

 Tenure: Less than 91 days.
 Purpose: Issued to manage temporary cash flow mismatches.
 Features:
o Similar to T-Bills but with shorter maturities.
o Issued at a discount like zero-coupon bonds.

1.3 Call Money, Notice Money, and Term Money

 Call Money: Overnight borrowing and lending between banks.

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  Notice Money: Borrowing/lending for 2 to 14 days.
 Term Money: Borrowing/lending for 15 days or longer.
 Purpose: Used by banks to manage their daily liquidity requirements.

1.4 Certificates of Deposit (CDs)

 Issuer: Commercial banks.

 Tenure: 3, 6, or 12 months.
 Purpose: Used by banks to raise funds when deposit growth is low.
 Features:
o Issued at a discount to face value.
o Bulk instrument, saving operational costs for banks.

1.5 Commercial Papers (CPs)

 Issuer: Corporates, non-banking financial companies (NBFCs), primary dealers.

 Tenure: Short-term, generally up to 1 year.
 Purpose: Used as an alternative to bank loans for short-term financing.
 Features:
o Issued at a discount.
o Higher risk and yield compared to T-Bills.

1.6 Repurchase Agreements (Repos)

 Definition: Short-term borrowing where a security is sold with an agreement to

repurchase it later.
 Tenure: As per agreement (overnight to weeks).
 Purpose: Helps manage short-term liquidity in the market.
 Features:
o Buyer’s perspective: Reverse Repo.
o Seller’s perspective: Repo.

2. Capital Market Instruments

Capital market instruments are used for long-term financing and include equity and debt
instruments.

2.1 Equity Shares

 Definition: Represents ownership in a company.

 Purpose: Used by companies to raise capital.

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  Features:
o Returns come from dividends and capital appreciation.
o High risk and high return instrument.

2.2 Bonds/Debentures

 Definition: Fixed-income securities issued by governments or corporates.

 Purpose: Used for raising long-term funds.
 Features:
o Interest payments (coupon) are made regularly.
o Principal repaid at maturity.
o Lower risk compared to equity.

3. Derivatives Instruments

Derivatives are contracts whose value is derived from an underlying asset (e.g., stock, bond,
commodity).

3.1 Futures

 Standardized contracts traded on exchanges to buy/sell an asset at a predetermined price

in the future.

3.2 Options

 Contracts giving the holder the right, but not the obligation, to buy/sell an asset at a
specified price within a specific period.

3.3 Forwards

 Non-standardized contracts between two parties to trade an asset at a future date.

3.4 Swaps

 Contracts to exchange cash flows or liabilities between two parties, often used for interest
rate or currency management.

4. Commodities Market Instruments

 Definition: Instruments for trading physical commodities like gold, oil, or agricultural
products.
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  Features:
o Prices determined in the present for future delivery.
o Used for hedging and speculative purposes.

5. Foreign Exchange Instruments

 Definition: Instruments for trading currencies (e.g., currency swaps, forwards).

 Purpose: Helps manage foreign exchange risks for importers, exporters, and businesses
with international exposure.

6. Hybrid Instruments

These are financial instruments that combine the features of both debt and equity:

 Convertible Bonds: Bonds that can be converted into equity shares.

 Preference Shares: Shares that pay a fixed dividend and have priority over equity shares
for dividend payments.

Significance of Financial Instruments

 They facilitate efficient allocation of resources in the economy.

 Help individuals, corporates, and governments manage their finances.
 Promote liquidity and transparency in the financial system.

Role of Key Organizations

 SEBI: Prevents market malpractices, regulates intermediaries, and fosters market

development.
 RBI: Controls inflation and interest rates, manages the money supply, and oversees the
banking system.
 IRDAI & PFRDA: Regulate insurance and pension systems to ensure financial security for
individuals.

Key Highlights of the Indian Financial Market

 Regulatory Framework:
The market is governed by regulatory bodies like SEBI (securities market) and RBI (money
market and currency management).

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  Growth in Equity Returns:
Historically, equity has provided higher returns over long periods despite being more
volatile.
 Debt Market Expansion:
Includes government bonds, corporate bonds, and debentures. The government
securities market forms the backbone of the Indian debt market.
 Diverse Instruments:
The availability of financial instruments caters to varied risk appetites and investment
needs, ensuring market depth and liquidity.

4. Challenges and Opportunities

 Challenges:
o Need for financial literacy among retail investors.
o Dependence on foreign capital flows for equity markets.
o Volatility due to global economic uncertainties.
 Opportunities:
o Growing investor participation in equity and mutual funds.
o Expanding debt market with infrastructure and green bonds gaining traction.

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CHAPTER 2: IMPACT OF VARIOUS POLICIES OF FINANCIAL MARKETS

This chapter explores the implications of credit, monetary, and financial policies on the economy,
with a focus on their objectives, tools, and effects. Key areas include:

1. Credit Policy of the Reserve Bank of India (RBI)

The RBI's credit policy is a strategic plan to regulate money and credit flow in the economy,
aligning with government objectives like growth, price stability, and employment generation.

1.1 Meaning:

 It controls money supply, credit demand, and overall economic activity using various
monetary tools.

1.2 Objectives:

 Price Stability: Controls inflation through interest rates, either increasing them to curb
demand during inflation or reducing them to stimulate demand.
 Economic Growth: Ensures sufficient liquidity to spur demand and productivity, indirectly
supporting GDP growth.
 Exchange Rate Stability: Balances foreign exchange inflows and outflows to stabilize the
rupee.
 External Balance of Payments: Maintains equilibrium in economic transactions with other
countries.
 Credit Flow to Productive Sectors: Ensures continuous credit to key sectors to boost
production and employment.
 Interest Rate Management: Balances inflation and investments by moderating interest
rates.

1.3 Mechanisms of Credit Policy:

 Interest Rate Channel: Changes in interest rates affect borrowing and spending by firms
and households, influencing overall demand.
 Exchange Rate Channel: Currency appreciation or depreciation affects exports, imports,
and trade balance.
 Quantum Channel: Changes in money supply influence access to credit, impacting
aggregate demand and production.
 Asset Price Channel: Credit policy affects asset prices, which in turn influence
consumption, investment, and employment.
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1.4 Operating Framework:

 Involves choosing targets (inflation or stability), intermediate variables (economic

stability), and instruments for policy implementation.

1.5 Instruments of Credit Policy:

 Cash Reserve Ratio (CRR): Mandatory reserves held by banks with the RBI, adjusted to
control liquidity.
 Statutory Liquidity Ratio (SLR): Reserves banks must maintain internally; lowering it
injects liquidity into the economy.
 Liquidity Adjustment Facility (LAF): Repo and reverse repo agreements to regulate short-
term liquidity.
 Marginal Standing Facility (MSF): Emergency borrowing mechanism for banks at penal
rates.
 Market Stabilization Scheme (MSS): Government-issued securities to absorb excess
market liquidity.
 Open Market Operations (OMO): RBI's buying or selling of securities to manage liquidity.

2. Federal Reserve (Fed) Policy

The Federal Reserve is the U.S. central bank, aiming to stabilize the economy and financial system
through monetary policies.

2.1 Functions:

 Promotes maximum employment, stable prices, and moderate interest rates.

 Monitors and mitigates systemic financial risks.
 Ensures safety and soundness of financial institutions.
 Facilitates efficient payment systems.
 Protects consumers and promotes community development.

2.2 Policy Tools:

 Open Market Operations: Buying/selling securities to control liquidity.

 Discount Rate: Interest charged on loans to banks.
 Reserve Requirements: Minimum reserves banks must hold.
 Interest on Reserves: Fed pays interest on excess and required reserves.
 Reverse Repo Facility: Short-term liquidity adjustments.
 Term Deposit Facility: Drains excess reserves by locking funds.

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2.3 Impact of Fed Funds Rate:

 Influences global capital flows. High U.S. interest rates can attract global funds, impacting
emerging markets like India.
 Affects borrowing costs and investment decisions worldwide.

2.4 Quantitative Easing (QE):

 Central banks buy financial assets to inject money into the economy, lower long-term
interest rates, and stimulate demand.
 Benefits: Economic growth, liquidity enhancement, and confidence building.
 Drawbacks: Inflation risk, potential asset bubbles, and income inequality.

3. Cost Inflation Index (CII)

Used to adjust the acquisition cost of assets for inflation in capital gains tax computation.

 Formula:
Indexed Cost of Acquisition=CII of Sale Year/CII of Purchase Year×Purchase Price
 Impact: Reduces taxable gains by accounting for inflation, thereby lowering tax liability.

4. Consumer Price Index (CPI)

Measures retail price changes of a fixed basket of goods and services, reflecting the cost of living.

4.1 Purpose:

 Tracks inflation and serves as a deflator in national accounts.

 Helps the government and RBI in inflation targeting and policy decisions.

4.2 Issues:

 CPI's relevance is questioned as it doesn't fully capture household expenses.

 Sharp price fluctuations in essential items create disconnects between CPI trends and real-
world perceptions.

5. Wholesale Price Index (WPI)

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Tracks price changes at the wholesale level, focusing on bulk transactions.

5.1 Key Features:

 Covers primary articles, fuel, and manufactured products.

 Measures price changes earlier in the supply chain compared to CPI.

5.2 Differences from CPI:

 WPI excludes services and focuses on bulk prices, while CPI includes retail prices and
services.
 CPI reflects the end consumer's cost, while WPI captures intermediate costs.

Takeaways

The chapter demonstrates the intricate interplay between central banks' policies and economic
stability. While tools like interest rate adjustments, reserve ratios, and market operations provide
control over liquidity and inflation, their global implications highlight the interconnectedness of
financial markets. Understanding these dynamics is crucial for policymaking and economic
analysis.

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CHAPTER 3 CAPITAL MARKET – PRIMARY

Basics of Capital Markets

Definition:

 A capital market is a financial marketplace where long-term securities, such as stocks and
bonds, are traded.
 It provides a platform for governments, corporates, and banks to raise long-term funds
while offering investment opportunities to individuals and institutions.

Role:

 Mobilizes savings and allocates them to productive investments, fueling economic growth.
 Acts as an indicator of the country’s economic health by reflecting investor sentiment and
economic performance.

Evolution:

 Pre-1990s:
o The market was highly regulated, and corporate funding largely came from
Development Financial Institutions (DFIs) like IDBI and ICICI.
o Securities were traded on a limited number of stock exchanges, such as the
Bombay Stock Exchange (BSE), using an open outcry system.
 Post-1990s:
o Liberalization and the establishment of SEBI transformed the market.
o Pricing became market-driven, and the National Stock Exchange (NSE) introduced
modern trading mechanisms.

Functions:

1. Resource Mobilization: Helps channel funds from surplus sectors to deficit sectors.
2. Liquidity: Allows investors to buy and sell securities.
3. Price Discovery: Establishes fair pricing for securities based on demand and supply.
4. Regulation & Transparency: SEBI ensures compliance with rules to protect investors and
maintain market integrity.

2. Segments of the Capital Market

Primary Market:

 Purpose: Facilitates the issuance of new securities by companies to raise capital.

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  Types of Issues:
o Initial Public Offerings (IPOs): When companies issue shares to the public for the
first time.
o Follow-on Public Offerings (FPOs): Subsequent public offerings by already listed
companies.
o Rights Issues: Offered to existing shareholders.
o Bonus Issues: Shares issued without payment from reserves.
 Key Players: Merchant bankers, brokers, registrars, and SEBI.

Secondary Market:

 Purpose: Facilitates the trading of previously issued securities.

 Importance: Provides liquidity and ensures continuous price discovery.

Differences Between Primary and Secondary Markets:

 Primary Market: Direct involvement of the company, new securities issued, and funds are
raised for the first time.
 Secondary Market: Involves only investors, trading existing securities, and does not raise
new funds.

3. Capital Market Instruments

Capital market instruments are financial securities traded in the capital market to raise funds for
long-term purposes. These include shares, bonds, depository receipts, and derivatives.

A. Shares

1. Definition:
o Shares signify ownership in a corporation and represent a claim on a portion of its
assets and earnings.
o Shareholders have the potential to earn dividends and benefit from capital
appreciation.
2. Types of Shares:
o Equity Shares:
 Represent ownership in the company.
 Offer voting rights to shareholders.
 High-risk, high-reward instruments; returns depend on dividends and
market value appreciation.
 No guaranteed returns, as payouts depend on the company's performance.
o Preference Shares:
 Priority in receiving dividends and repayment in case of liquidation.

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  Do not typically offer voting rights.
 Less risky compared to equity shares.
3. Key Features of Shares:
o Limited Liability: Shareholders are not personally liable for company debts.
o Perpetual Nature: Equity shares remain valid indefinitely unless redeemed.
o Market Value: The trading price depends on market demand and supply.

B. Debentures/Bonds

1. Definition:
o Debt instruments where the buyer lends money to the issuer in exchange for fixed
returns over time.
o Bonds typically have a fixed maturity period, often exceeding one year.
2. Features:
o Interest Payments: Coupon rates determine the fixed interest paid periodically.
o Maturity Period: Can be short-term (up to 5 years) or long-term (20–40 years).
o Callable Bonds: Allow issuers to repay bonds before maturity to reduce borrowing
costs.
3. Yields:
o Calculated using the Yield to Maturity (YTM) formula, which expresses total return
if the bond is held until maturity.

Yield to Maturity (YTM):

C. Depository Receipts

1. American Depository Receipts (ADRs):

o Negotiable instruments issued in U.S. markets representing shares of non-U.S.
companies.
o Allow U.S. investors to trade foreign shares in U.S. dollars.

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 o Benefits: Dividends paid in dollars, easy transferability, and no stamp duty.
2. Global Depository Receipts (GDRs):
o Similar to ADRs but listed on international exchanges like London or Luxembourg.
o Allow companies to raise funds globally.
o May include warrants, giving holders the option to convert them into equity shares.

D. Derivatives

1. Definition:
o Financial contracts that derive their value from an underlying asset (stocks,
commodities, currencies).
2. Types:
o Futures:
 Obligate the buyer and seller to trade the asset at a predetermined price on
a specific date.
o Options:
 Give the buyer the right (but not the obligation) to buy/sell an asset at a
specific price.
3. Advantages:
o Provide leverage (require lower upfront capital).
o Allow hedging against risks.
o Enable speculation for profit opportunities.

2. Aspects of the Primary Market

The primary market is where new securities are issued for the first time to raise funds from the
public or select investors. It plays a critical role in capital formation.

A. Types of Issues

1. Public Issue:
o Initial Public Offering (IPO):
 First-time issuance of securities to the public.
 Companies get listed on stock exchanges for trading post-IPO.
o Further Public Offering (FPO):
 Additional issuance by an already listed company to raise more funds.
2. Rights Issue:
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 o Shares offered to existing shareholders in proportion to their current holdings.
o Enables companies to raise additional capital while maintaining shareholder
structure.
3. Bonus Issue:
o Free shares issued to existing shareholders out of the company’s reserves.
o No new funds are raised; it increases the total number of shares.
4. Private Placement:
o Issuance of securities to select investors, not exceeding 200 in number.
o Includes:
 Preferential Allotment: Offered to select individuals or entities under SEBI
regulations.
 Qualified Institutional Placement (QIP): Offered only to Qualified
Institutional Buyers (QIBs).

B. Offer Documents

1. Draft Offer Document: Filed with SEBI for review and public comments before the final
issue.
2. Red Herring Prospectus: Used in book-building issues; price and quantity of shares are not
disclosed initially.
3. Prospectus: Final offer document containing complete details, including price and the
number of shares.
4. Shelf Prospectus: Enables multiple issues over a year without refiling.

Key Disclosures in Offer Documents:

 Company’s financial position and risks.

 Promoters’ background and contribution.
 Utilization plan for funds raised.
 Underwriting and pricing details.

C. Steps in the Public Issue Process

1. Board Resolution: Approval for fundraising.

2. Appointment of Intermediaries: Merchant bankers, brokers, and registrars are hired.
3. Filing and Approvals: Submission of offer documents to SEBI and stock exchanges.
4. Subscription Period: Public subscription opens (3–10 days).

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 5. Allotment and Refunds: Shares allotted based on demand; excess application money
refunded.
6. Listing: Shares are listed on stock exchanges for trading.

D. Pricing Mechanisms

1. Fixed Price Issue:

o Pre-determined price disclosed in the prospectus.
o Investors pay the full amount upfront.
2. Book-Building:
o Price discovered through investor bids within a range (price band).
o Final price is set at the "cut-off" price to ensure full subscription.

E. SEBI Regulations

1. Entry Norms:
o Companies must meet specific criteria, such as net worth, profitability, and
operating history, to access the primary market.
2. Promoter Contribution:
o Promoters must contribute at least 20% of the post-issue capital, subject to a lock-
in period.
3. Compliance:
o SEBI ensures proper disclosures, fair pricing, and adherence to listing norms.

1. Issue Requirements

Issue requirements set the eligibility criteria and procedural rules for companies raising funds
through public offerings.

Eligibility Criteria for IPOs (Unlisted Companies):

1. Entry Norm I (Profitability Route):

o Net Tangible Assets: At least ₹3 crores in each of the last 3 years.
o Operating Profit: Minimum of ₹15 crores as an average during the preceding 3
years.
o Net Worth: At least ₹1 crore in each of the last 3 years.

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 If the company has changed its name within the last year, at least 50% revenue
o
must align with the new name.
2. Entry Norm II (QIB Route):
o At least 75% of the net offer must be allocated to Qualified Institutional Buyers
(QIBs).
o Refund the subscription money if the minimum QIB subscription is not achieved.

FPO Requirements (Listed Companies):

 No significant name change within the past year unless 50% revenue aligns with the new
name.
 Compliance with SEBI guidelines for pricing and allotment.

2. Special Purpose Acquisition Companies (SPACs)

Definition:

SPACs are shell companies formed to raise capital through an IPO for acquiring private companies,
offering them a route to go public.

Key Features:

1. No Commercial Activities: SPACs do not operate businesses; they exist solely to merge
with or acquire private entities.
2. Funds Held in Trust: IPO proceeds are kept in a trust until a target is identified.
3. Two-Year Limit: SPACs must complete a merger within two years; otherwise, funds are
returned to investors.

Advantages:

 Faster and simpler process for private companies to go public.

 Backed by experienced sponsors or celebrities who attract investors.

Controversies:

 Seen as bypassing rigorous regulatory scrutiny of traditional IPOs.

 Sponsor shares acquired at significant discounts dilute returns for retail investors.

3. ASBA (Application Supported by Blocked Amount)

Definition:
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A mechanism to apply for IPOs where the application money is blocked in the applicant’s bank
account until allotment.

Features:

1. No Money Transfer: Funds remain in the account and earn interest until required.
2. Investor Protection: Ensures that the amount is only debited upon allotment.
3. Bank as an Intermediary: ASBA applications are processed through designated banks.

Benefits:

 Eliminates refund delays.

 Reduces chances of fraud as funds remain in the investor’s account.

4. Green Shoe Option

Definition:

A provision in IPOs allowing issuers to allocate up to 15% more shares than the original issue size
to stabilize the stock price post-listing.

Mechanism:

 If the stock price falls below the issue price, the over-allotted shares are bought back by
the underwriter, creating demand and stabilizing the price.

Benefits:

 Protects investors from excessive volatility.

 Helps maintain price stability in the post-listing period.

5. Anchor Investors

Definition:

Large institutional investors who subscribe to shares in an IPO before it opens to the public,
providing a measure of demand stability.

Features:

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 1. Pre-IPO Participation: Anchor investors are allotted shares 1-2 days before the issue
opens.
2. Lock-In Period: Shares allotted to them are subject to a 30-day lock-in.

Benefits:

 Increases confidence among retail and institutional investors.

 Indicates strong demand for the IPO.

6. Disinvestment

Definition:

The process by which the government sells its stake in public sector enterprises to private
investors.

Types:

1. Minority Disinvestment: Government retains a majority stake.

2. Majority Disinvestment: Control is transferred to private players.
3. Strategic Disinvestment: Sale of a substantial portion, including management control.

Objective:

 Reduce fiscal burden and improve efficiency of public enterprises.

7. Rights Issue

Definition:

An offering where existing shareholders are given the right to buy additional shares at a
discounted price, proportional to their current holdings.

Features:

1. Non-Dilutive: Helps companies raise funds while maintaining ownership structure.

2. Renounceable Rights: Shareholders can sell their rights to others.

Benefits:

 Cost-effective method for companies to raise capital.

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  Offers shareholders an opportunity to increase their stake.

8. Exit Offers

Exit offers are mechanisms to provide an option for existing shareholders to sell their holdings
during significant corporate changes.

Types:

1. Delisting Offers:
o Provided when a company decides to delist from stock exchanges.
o Shareholders are offered an exit price based on regulations.
2. Strategic Exit:
o Given during mergers, acquisitions, or buybacks where shareholders can exit the
company.

Benefits:

 Protects shareholder interests during corporate restructuring.

 Ensures fair pricing for minority shareholders.

9. Capital Market Intermediaries

Intermediaries facilitate the smooth functioning of the capital market and include banks, brokers,
and other entities.

Key Intermediaries:

1. Merchant Bankers/Lead Managers:

o Manage IPOs and FPOs.
o Conduct due diligence and advise on pricing and regulatory compliance.
2. Underwriters:
o Ensure subscription by purchasing unsubscribed shares.
o Reduce risk for issuers.
3. Registrars to Issue:
o Handle applications, allotments, and refunds.
4. Brokers:
o Facilitate buying and selling of securities for investors.
5. Debenture Trustees:

23
 Represent interests of debenture holders, ensuring compliance with terms of the
o
issue.
6. Depository Participants:
o Provide dematerialization services and manage securities electronically.

10. IPO Grading

Definition:

A grading assigned to an IPO by SEBI-registered credit rating agencies based on the company’s
fundamentals.

Features:

1. Five-Point Scale:
o Grade 1: Poor fundamentals.
o Grade 5: Strong fundamentals.
2. Mandatory Disclosure: Companies must disclose IPO grades in the prospectus.

Purpose:

 Provides additional information to investors about the quality of the IPO.

 Helps investors make informed decisions.

Limitations:

 IPO grading does not consider the price at which shares are offered, leaving it to investors
to evaluate valuation.

4.1 Different Kinds of Issue of Securities

Classification of Issues:

1. Public Issue:
o When securities are issued to the public.
o Sub-categories:
 Initial Public Offer (IPO): The first-time issuance of shares or convertible
securities to the public. It sets the stage for listing and trading on stock
exchanges.

24
  Further Public Offer (FPO): When an already listed company makes a fresh
issue of securities or offers for sale to the public.
2. Rights Issue (RI):
o Issued to existing shareholders in proportion to their holdings as on a specific
record date.
o Rights are offered in a particular ratio to shares held.
3. Composite Issue:
o A combination of public and rights issues where allotment in both categories is
done simultaneously.
4. Bonus Issue:
o Shares issued free of cost to existing shareholders, based on the number of shares
already held.
o Funded from the company’s free reserves or premium accounts.
5. Private Placement:
o Issuance of securities to a select group of investors, typically fewer than 200.
o Sub-types:
 Preferential Allotment: Issuance to a select group of individuals in
compliance with SEBI’s regulations, including pricing, disclosure, and lock-
in requirements.
 Qualified Institutional Placement (QIP): Issuance to Qualified Institutional
Buyers (QIBs) under specific SEBI guidelines.

4.2 Types of Offer Documents

Offer documents contain vital information about the issuer, its projects, financial details, and
terms of the issue. The main types include:

1. Draft Offer Document:

o Submitted to SEBI for review and public comments before filing with the Registrar
of Companies (RoC).
2. Red Herring Prospectus (RHP):
o Used in book-built public issues.
o Contains all information except price or the number of securities being offered.
o Filed with the RoC before the issue opens.
3. Prospectus:
o Detailed offer document for public issues.
o Includes pricing and number of securities offered. Filed with RoC before the issue
(fixed price issues) or after the issue closes (book-built issues).
4. Letter of Offer:
o Used for rights issues. Filed with stock exchanges before the issue opens.

25
 5. Abridged Prospectus:
o Summarized version of the prospectus provided along with application forms for
public issues.
6. Abridged Letter of Offer:
o A shortened version of the Letter of Offer sent to shareholders during rights issues.
7. Shelf Prospectus:
o Enables issuers like public sector banks and financial institutions to make multiple
issuances within a year without filing fresh prospectuses.
8. Placement Document:
o Used for QIPs, containing all relevant disclosures.

4.3 Issue Requirements

SEBI has established entry norms for public issues to protect investors and ensure fair practices.

1. Entry Norm I (Profitability Route):

o Issuer must meet the following:
 Net Tangible Assets: At least ₹3 crores for the preceding three years, with
no more than 50% in monetary assets.
 Operating Profit: Minimum ₹15 crores average over the past three years.
 Net Worth: At least ₹1 crore for the past three years.
 If the company has changed its name in the past year, 50% of revenue
should reflect the new name's activity.
2. Entry Norm II (QIB Route):
o Allows issuers who don't meet profitability norms to raise funds through book-
building with at least 75% of the net offer allocated to QIBs. Refunds are issued if
this minimum subscription is not met.
3. General Conditions for Issuers:
o Must list securities on a recognized stock exchange.
o Existing partly paid-up equity shares must be fully paid or forfeited.
o Firm arrangements for financing 75% of the stated means (excluding the public
issue) must be in place.

4.4 Minimum Promoter Contribution and Lock-In

1. Promoter Contribution:
o Minimum of 20% of the proposed issue size or post-issue capital.
o For composite issues, 20% of the post-issue capital excluding the rights issue
component.

26
 2. Lock-In Requirements:
o Minimum contribution by promoters must remain locked for 18 months.
o Additional contribution beyond the minimum remains locked for 6 months.
o For capital-intensive projects, the lock-in period extends to three years.

4.5 IPO Grading

 Purpose: Provides an assessment of the fundamental strengths of the IPO by SEBI-

registered credit rating agencies.
 Rating Scale:
o Grade 1: Poor fundamentals.
o Grade 5: Strong fundamentals.
 Optionality: Since February 4, 2014, IPO grading has been optional.
 Key Considerations: Industry prospects, competitive positioning, financial health,
management quality, and corporate governance.

4.6 Pricing of Issues

1. Fixed Price Issue:

o Pre-determined price disclosed in the prospectus.
o Investors pay the full amount upfront.
2. Book-Building Process:
o Price is determined based on investor demand within a price band.
o Allows real-time tracking of demand and a more dynamic pricing mechanism.

4.7 Intermediaries to the Capital Market

Key intermediaries involved in public issues include:

1. Merchant Bankers/Lead Managers: Oversee the issue and provide advisory services.
2. Underwriters: Ensure subscription by purchasing unsold shares.
3. Bankers to an Issue: Manage application money and refunds.
4. Brokers to an Issue: Execute buy/sell orders for investors.
5. Debenture Trustees: Protect the interests of debenture holders.
6. Registrars: Manage applications, maintain records, and facilitate allotment.

27
4.8 Steps Involved in Public Issue

1. Board Resolution: Approval for raising funds.

2. General Meeting: Shareholder approval if required by Articles of Association.
3. Appointment of Intermediaries: Merchant bankers, brokers, underwriters, etc.
4. Draft Prospectus: Preparation and approval.
5. Filing with SEBI and RoC: Submission for compliance checks.
6. Stock Exchange Approval: Listing permissions.
7. Subscription Period: Typically 3–10 working days.
8. Allotment: Shares distributed, and refunds processed.
9. Compliance Report: Submitted to SEBI within 45 days of issue closure.

4.9 Public Issue of Shares – Book Building Route

 Definition: A price discovery method based on bids received during the subscription
period.
 Process:
o Price band is disclosed in the Red Herring Prospectus.
o Investors bid within the price band.
o Final price (cut-off price) is determined based on demand.

Difference Between Fixed Price and Book-Building:

 Fixed Price: Pre-set price known to investors.

 Book-Building: Price discovered based on investor demand.

4.10 Special Purpose Acquisition Companies (SPACs)

 Definition: Shell entities raising funds through IPOs to acquire private companies.
 Features:
o Funds are held in trust until acquisition.
o Return of funds if acquisition fails within two years.
 Criticism: Seen as bypassing traditional IPO regulations.

ANCHOR INVESTORS

An anchor investor is a Qualified Institutional Buyer (QIB) who subscribes to a substantial portion
of shares in an Initial Public Offering (IPO) one day before it opens to the public. Introduced by the
Securities and Exchange Board of India (SEBI) in June 2009, the concept aims to enhance the
credibility and attractiveness of public issues.
28
Importance of Anchor Investors:

 Price Discovery: By committing to a significant portion of the IPO at a predetermined price,

anchor investors assist in establishing a fair valuation for the offering.
 Market Confidence: Their participation signals strong institutional interest, instilling
confidence among retail and other investors.
 Guidance for Complex Companies: In cases where companies have intricate structures or
are not yet profitable, the involvement of anchor investors can provide valuable insights
and reassurance to potential investors.

SEBI Guidelines for Anchor Investors:

1. Minimum Investment: An anchor investor must apply for shares worth at least ₹10 crores
in a public issue.
2. Allocation Limit: Up to 60% of the shares reserved for QIBs can be allotted to anchor
investors.
3. Reservation for Mutual Funds: One-third of the anchor investor portion is reserved for
domestic mutual funds.
4. Bidding Timeline: The bidding process for anchor investors opens one day before the
public issue.
5. Payment: Anchor investors are required to pay the entire application amount upon
bidding, with payment due within two days of the issue's closure.
6. Allocation Completion: Shares must be allocated to anchor investors on the same day as
their bidding.
7. Price Adjustments: If the final issue price is higher than the anchor allocation price, anchor
investors must pay the difference. If it is lower, no refunds are provided; they receive
shares at the original allocation price.
8. Lock-In Period: Anchor investors are subject to a lock-in period to ensure market stability:
o Initially, they cannot sell their allotted shares for 30 days from the date of
allotment.
o Subsequently, they can sell only 50% of their holdings after 30 days, with the
remaining 50% eligible for sale after 90 days.
9. Eligibility Restrictions: Merchant bankers, individuals related to the promoter or promoter
group, and their associates are prohibited from applying as anchor investors in the
concerned public issue.

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CHAPTER 4: CAPITAL MARKET SECONDARY

1. Introduction to Secondary Market

Definition and Scope

 The secondary market, also known as the stock market, is where securities (e.g., shares,
bonds) issued in the primary market are traded.
 Operates under rules and guidelines approved by regulatory authorities like SEBI.
 Securities traded include those issued by companies, government entities, and public
bodies.

Key Characteristics

1. Investor Transactions:
o Investors buy securities from others who are willing to sell, unlike the primary
market where securities are bought directly from issuers.
2. Safety:
o Transactions are executed electronically, ensuring security and reducing fraud
risks.

Functions

 Economic Indicator: Reflects economic stability or instability based on market trends.

 Valuation of Securities: Market forces of demand and supply determine security prices.
 Economic Growth: Facilitates fund reallocation to productive sectors, contributing to
capital formation.
 Encouraging Investments: Transparency motivates individuals to invest in equity markets.
 Performance Monitoring: Companies strive to improve performance as stock prices reflect
their market reputation.

2. Development of the Stock Market in India

Historical Evolution

 18th Century: Emergence of negotiable instruments.

 1860: Companies Act introduced limited liability.
 1875: Establishment of the Bombay Stock Exchange (BSE), India's oldest stock exchange.

Growth Trends

 1961: CSE (Calcutta Stock Exchange) was the largest.

 BSE gained prominence during the late 1960s.

Challenges Pre-1990s

30
  Uncertain execution prices.
 Lack of transparency.
 Systemic risks and broker bias.

Post-1991 Reforms

 Introduction of NSE in 1994: Modernized trading practices.

 OTCEI (1992): Supported small and medium enterprises.
 Adoption of advanced technologies like dematerialization and electronic trading.

3. Stock Market Organization in India

Key Components

1. Stock Broking:
o Brokers facilitate transactions and must register with SEBI.
o Examples: ICICI Direct, Angel Broking, HDFC Securities.
o Compliance Officers ensure adherence to SEBI rules.
2. Custodial Services:
o Safekeeping and management of securities for clients.
o Responsibilities include maintaining records, collecting benefits, and reconciling
accounts.
3. Depository System:
o Eliminated physical certificates.
o NSDL and CDSL hold securities in dematerialized form.
o Advantages: Reduced fraud, faster transactions, and increased market
participation.

4. Demutualization of Stock Exchanges

Concept

 Transformation of broker-owned exchanges into publicly owned corporate entities.

 Example: BSE underwent demutualization post-2004 SEBI mandate.

Advantages

1. Improved governance through separation of ownership and management.

2. Increased transparency and investor confidence.
3. Access to funds for modernization and expansion.

5. Share Trading in Secondary Market

Retail Trading Process

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 1. Open Accounts:
o Bank account: For funds.
o Demat account: For holding securities.
o Trading account: For executing trades.
2. Trading Mechanism:
o Orders are placed through brokers or online platforms.
o Matching is automated via electronic systems.

Algorithmic Trading

 Definition: Automated execution of trades using predefined criteria (e.g., moving

averages).
 Benefits:
o Speed, accuracy, and reduced emotional bias.
o Example: Buy 50 shares when the 50-day moving average exceeds the 200-day
moving average.

Stock Market Organization in India

The Indian stock market is organized with multiple intermediaries and infrastructure institutions
that ensure smooth and efficient trading, clearing, and settlement. It operates under the
regulatory framework of the Securities and Exchange Board of India (SEBI), ensuring compliance,
transparency, and fairness.

Diagram Overview

The organizational structure, as depicted in the PDF, highlights:

1. Stock Broking (including brokers and sub-brokers).

2. Custodial Services.
3. Depository System (including depositories and participants).
4. Trading and Clearing Members.
5. Banks and Financial Institutions (acting as intermediaries).

1. Stock Broking

Role and Function

 Brokers are members of the stock exchange and act as intermediaries between buyers and
sellers of securities.
 They conduct transactions on behalf of clients or for their proprietary trading purposes.

Registration and Regulation

32
  Brokers must register with SEBI before starting operations.
 Compliance with SEBI regulations and a prescribed code of conduct is mandatory.

Types of Brokers

 Traditionally, brokers operated as proprietary or partnership firms.

 Now, most top brokers are incorporated as companies (e.g., Sharekhan, ICICI Direct, HDFC
Securities).

Compliance and Monitoring

 Brokers must appoint a Compliance Officer to ensure adherence to SEBI rules and redress
investor grievances.
 SEBI conducts periodic inspections and audits of brokers' accounts, records, and
operations.
 Non-compliance leads to penalties or suspension.

Brokerage

 Brokerage charges vary but are capped at 2.5% of the transaction value.

Sub-Brokers

 Brokers can only deal with SEBI-registered sub-brokers.

 Sub-brokers facilitate trades on behalf of brokers and must adhere to the same regulatory
framework.

2. Custodial Services

Definition

 Custodians are entities that provide safekeeping for securities and ensure proper
maintenance of clients’ accounts.

Key Responsibilities

1. Maintaining accounts of clients’ securities.

2. Collecting benefits/rights (e.g., dividends, interest, bonuses) for clients.
3. Informing clients about corporate actions like rights issues or stock splits.
4. Reconciling client accounts and records regularly.

Regulation

 Governed by the SEBI Custodian of Securities Regulations, 1996.

 SEBI can request information, conduct inspections, and investigate complaints.

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3. Depository System

The depository system revolutionized Indian stock markets by eliminating physical share
certificates and introducing dematerialized (demat) securities.

Key Depositories in India

 NSDL (National Securities Depository Limited).

 CDSL (Central Depository Services Limited).

Depository Features

 Investors can hold securities in electronic form, akin to money in a bank account.
 Enables faster, safer, and more efficient transactions.

Processes

1. Dematerialization:
o Investors convert physical certificates into electronic format by submitting them to
a depository participant (DP).
2. Rematerialization:
o Investors can reconvert demat securities into physical certificates if desired.
3. Pledging/Hypothecation:
o Securities held in demat form can be pledged for loans.

Regulations and Grievances

 Depositories are obligated to address investor grievances promptly.

 SEBI has the authority to intervene and impose penalties for non-compliance.

4. Trading and Clearing Members

Trading Members

 Authorized individuals/entities that facilitate buying and selling of securities on stock

exchanges.
 They access the trading platform of stock exchanges to place buy/sell orders.

Clearing Members

 Ensure that all trades are cleared and settled efficiently.

 Coordinate with clearing corporations and custodians for fund and security transfers.

34
5. Foreign Brokers

Foreign brokers primarily deal with foreign portfolio investors (FPIs) and offer specialized services:

 Currency conversions.
 Compliance with FPI regulations.
 Execution of trades on behalf of foreign clients.

6. Banks and Financial Institutions

Clearing Banks

 Clearing banks act as intermediaries for fund transfers between clearing members and the
clearing corporation.
 They play a critical role in the pay-in and pay-out processes during settlement.

Depository Participants (DPs)

 Banks often act as DPs, providing clients access to depositories for holding securities in
demat form.

7. Stock Exchange Structure

Board of Directors

 Stock exchanges are governed by a Board, which includes:

o Government Nominees: Represent ministries like finance to safeguard public
interest.
o Public Representatives: Protect investor interests.
o Executive Director (ED): Operational head responsible for day-to-day activities.

Recognition

 Stock exchanges must be recognized by the Central Government under the Securities
Contract (Regulation) Act, 1956.

Functions

1. Facilitate liquidity and marketability of securities.

2. Ensure transparent pricing through demand-supply forces.
3. Provide a platform for capital formation by channelizing surplus funds into productive
sectors.

35
8. Safeguards and Regulations

Risk Management

 Stock exchanges impose trading limits and monitor exposures to prevent over-leveraging.
 Brokers are required to maintain margins to manage settlement risks.

Inspections

 Regular inspections ensure compliance with trading, clearing, and settlement guidelines.

Investor Protection

 SEBI and exchanges actively work to safeguard investor interests through rules, penalties,
and awareness programs.

Additional Insights

Technological Integration

 Electronic trading platforms ensure transparency and minimize errors.

 Trading systems provide real-time data and automated matching of buy/sell orders.

Evolution

 Transition from physical to electronic systems significantly reduced fraud, increased

efficiency, and enhanced investor participation.

Examples of Large Brokers

 ICICI Direct, Angel Broking, HDFC Securities, Sharekhan, and Motilal Oswal serve millions
of retail and institutional clients across India.

4. Stock Market Intermediaries

o The following intermediaries are registered with SEBI to support stock market
operations:
 Brokers and sub-brokers.
 Depository participants (DPs).
 Clearing members and custodians.
 Merchant bankers, credit rating agencies, and portfolio managers.

5. Clearing and Settlement

36
 o Clearing Corporation:
 Facilitates trade clearance and guarantees settlement.
o Custodians:
 Act on behalf of institutional investors to confirm and settle trades.
o Depositories:
 Maintain electronic records of securities and handle transfer instructions
during settlements.

6. Other Key Participants

o Foreign Brokers:
 These brokers specialize in providing services related to foreign institutional
investments in Indian markets.
o Banks and Financial Institutions:
 Play roles as clearing banks and depository participants.

Summary of Responsibilities

The stock market organization in India is designed to:

 Ensure transparency and fairness: Through regulated brokers and trading practices.
 Secure investor assets: Via custodial and depository systems.
 Facilitate seamless trading: By leveraging technology for dematerialized and electronic
trading.
 Mitigate risks: Through proper clearing and settlement mechanisms.

Detailed Explanation of Risk Management in the Secondary Market

The secondary market has established a robust risk management system to ensure a secure and
efficient trading environment. The various aspects of this structure are outlined below:

Key Components of Risk Management

1. Trading Rules and Regulations

o Purpose: These rules prevent unfair practices such as insider trading and excessive
speculation.
o Margins: Stock exchanges impose various margins on brokers for individual stocks,
based on their exposure. These include:
 Margins based on ownership.
 Margins for clients of brokers.
o Objective: To limit market positions to the buying capacity of brokers and ensure
settlement even during financial shortfalls.
37
 o Monitoring: Real-time monitoring of intra-day trading limits and gross exposure
limits is enforced.
o Actions on Breach: Automatic deactivation of trading terminals occurs if exposure
limits are violated.
o Restrictions:
 Brokers and sub-brokers cannot engage in proprietary trading with brokers
of the same exchange.
 Proprietary trading with brokers from another exchange is permitted.

2. Circuit Breakers to Control Volatility

o Definition: A temporary halt or suspension of trading in a stock or index due to
excessive volatility.
o Types:
 Partial suspension for a few hours.
 Full-day suspension of trading.
o Advantages:
 Allows participants to gather new information and reassess.
 Prevents panic among investors.
 Enables rational decision-making during volatile times.
o Disadvantages:
 Hinders price discovery during suspension.
 May delay required market corrections.

3. Trade and Settlement Guarantee Fund

o Purpose: Ensures timely settlement even if a broker or member defaults on
security delivery or payment.
o Operation: The fund acts as a financial safeguard, maintaining trust in the market's
functionality.

4. Clearing Corporations
o Role: Reduces credit risk by guaranteeing the financial settlement of all trades.
o Functions:
 Processes trading information.
 Ensures net obligations are settled accurately.
o Significance: Provides counterparty assurance, thereby enhancing the credibility
and efficiency of settlements.

Mechanisms Enhancing Risk Management

38
 1. Securities Lending and Borrowing
o Concept: Facilitates the borrowing and lending of securities for short selling or
liquidity management.
o Benefits:
 Adds liquidity to the market.
 Helps maintain price stability.
2. Straight Through Processing (STP)
o Definition: An automated system for seamless trade processing, eliminating
manual intervention.
o Advantages:
 Reduces errors and delays.
 Lowers transaction costs.
 Enhances efficiency in settlement.
3. Margin Trading
o Definition: Allows investors to purchase securities by partially funding the trade
and borrowing the rest from brokers.
o Risk Management:
 Margins act as collateral to cover potential losses.
 Brokers can issue margin calls for additional funds if the trade moves
unfavorably.
4. Short Selling
o Definition: Selling borrowed shares with the intent to buy them back at a lower
price.
o Risk: Unlimited potential loss if prices rise instead of falling.
o Benefits:
 Increases market liquidity.
 Helps correct overvaluations.
5. National Securities Clearing Corporation Limited (NSCCL)
o Role: Provides a settlement guarantee for trades executed on exchanges.
o Functionality: Acts as an intermediary between trading parties, ensuring timely
fund and security transfers.

This comprehensive structure ensures that risks such as volatility, credit defaults, and settlement
inefficiencies are mitigated, maintaining a stable and secure trading environment in India's
secondary market.

39
Detailed Notes on the Indian Debt Market

The Indian Debt Market is a crucial segment of the financial system, often larger than equity
markets in developed economies. Below is a comprehensive summary of the key aspects of the
Indian Debt Market:

Definition and Function

 A financial marketplace where the buying and selling of debt securities occur.
 Facilitates the allocation of mobilized resources efficiently.
 Primarily used by the government to finance developmental activities and address fiscal
deficits.

Classification of the Indian Debt Market

1. Government Securities Market (G-Sec Market):

o Comprises securities issued by the central and state governments.
o Represents loans taken by these governments.
o Most dominant category in the Indian Debt Market.
o Serves as instruments for internal debt management, monetary management, and
liquidity management.
2. Bond Market:
o Includes:
 Financial institution bonds
 Corporate bonds and debentures
 Public Sector Unit (PSU) bonds
o Issued to meet financial requirements at fixed costs, reducing cost uncertainties.
o Key for infrastructure investments and addressing financial constraints in banking.

Structure and Trends

 The debt market is heavily skewed towards government securities, with the corporate
bond market catering primarily to top-rated financial and public-sector issuers.
 Growth in the corporate bond market is driven by:
o Regulatory reforms.
o Mounting pressure on banks from non-performing assets (NPAs).
o Increased channeling of financial savings into the capital market.
 Projected Growth:
o Corporate bond outstanding is expected to more than double by FY 2023, reaching
₹55-60 lakh crore from ₹27 lakh crore in FY 2018.

40
Types of Debt Markets

1. Wholesale Debt Market:

o Involves institutional investors like banks, financial institutions, RBI, mutual funds,
and corporates.
2. Retail Debt Market:
o Caters to individuals, pension funds, private trusts, and other entities.

Benefits of the Debt Market

1. Government Funding:
o Supports developmental projects and reduces reliance on institutional financing.
2. Resource Mobilization:
o Unlocks illiquid assets like gold for productive investments.
3. Cost Efficiency:
o Reduces borrowing costs for the government and ensures reasonable resource
mobilization.
4. Market Development:
o Encourages diverse participation, from institutional investors to retail players.
o Assists in creating a reliable yield curve and term structure of interest rates.

Participant Dynamics

 Major Participants: Mutual funds, banks, insurance companies, primary dealers, and
foreign portfolio investors (FPIs).
 Trading Shares:
o Mutual funds lead with 49.5% share (2022-23).
o Other notable contributors include banks, insurance companies, and corporates.

Risks in Debt Securities

1. Default Risk:
o Risk of issuer defaulting on interest or principal payments.
2. Interest Rate Risk:
o Adverse changes in interest rates affecting yields.
3. Reinvestment Rate Risk:
o Difficulty in reinvesting at comparable rates due to falling interest rates.
4. Counterparty Risk:
o Failure of the opposite party in fulfilling settlement obligations.

41
 5. Price Risk:
o Inability to sell at expected prices due to adverse price movements.

The Indian Debt Market remains essential for financial stability and economic development,
playing a pivotal role in mobilizing resources and managing public and private sector funding.

42
CHAPTER 5: MONEY MARKET

Detailed Explanation of Money Market Participants

The Indian Money Market consists of participants from both organized and unorganized sectors..

Organized Segment

The organized money market comprises institutions regulated by the Reserve Bank of India (RBI).

1. Reserve Bank of India (RBI)

o The RBI is the most significant participant, implementing monetary policy and
maintaining liquidity in the economy.
o Functions:
 Regulates interest rates, reserve requirements, and sectoral credit
allocation.
 Provides liquidity by lending to banks during deficits or absorbing excess
liquidity when necessary.
o Role in Instruments:
 Issues Treasury Bills (T-bills).
 Manages liquidity through repo and reverse repo operations.
2. Scheduled Commercial Banks (SCBs)
o Central to the money market as both borrowers and lenders of short-term funds.
o Functions:
 Mobilize public savings via deposits.
 Invest in government securities and corporate bonds.
 Provide working capital loans to businesses.
o Participate actively in Call Money Markets and Notice Money Markets.
3. Co-operative Banks
o Serve similar roles as SCBs but focus on rural and semi-urban areas.
o Provide credit to agriculture and small-scale industries.
4. Financial and Investment Institutions
o Include entities like LIC, UTI, GIC, and Development Banks.
o Primarily act as lenders in the money market.
o Participate in instruments such as Call Money and Treasury Bills.
5. Corporates
o Issue Commercial Papers (CPs) to raise short-term funds.
o Engage in inter-corporate deposits and investments.
6. Mutual Funds
o Invest in money market instruments to manage short-term surplus funds.
o Examples include Money Market Mutual Funds (MMMFs) specifically designed for
this purpose.
7. Discount and Finance House of India (DFHI)
o Established by RBI, public sector banks, and financial institutions to promote short-
term money market instruments.
43
 o Functions as both borrower and lender in Call Money Markets.
o Rediscounts Treasury Bills, Commercial Bills, and other short-term instruments.

Unorganized Segment

This segment comprises entities outside the regulatory ambit of RBI.

 Participants:
1. Money Lenders: Provide credit to individuals and small businesses.
2. Indigenous Bankers: Operate like informal banks, especially in rural areas.
3. Nidhis (Mutual Loan Associations): Provide loans to members in a cooperative
structure.
4. Chit Funds: A form of rotating savings and credit association.
 Characteristics:
o Flexible terms and informal procedures.
o Attractive deposit rates but higher borrowing costs.
o Mostly serve those excluded from the organized money market.

Comparative Characteristics

Feature Organized Segment Unorganized Segment

Regulation Regulated by RBI. Informal and self-regulated.
Participants Banks, Financial Institutions, Money Lenders, Indigenous
Corporates. Bankers.
Procedures Formal and systematic. Informal and flexible.
Interest Rates Controlled and market-driven. Higher and less standardized.

Significance of Participants

1. Enhance Liquidity: Facilitate short-term borrowing and lending.

2. Implement Policies: Allow RBI to execute monetary policies effectively.
3. Promote Financial Inclusion: Serve diverse economic sectors, including rural areas.
4. Support Development: Fund critical needs such as working capital and government
deficits.

This comprehensive structure ensures efficient functioning of the Indian money market by
connecting borrowers and lenders across various economic strata.

Section 1: Money Market

Definition and Features

44
  The money market is a segment of the financial market where short-term instruments
(with maturities of one year or less) are traded.
 It provides liquidity to businesses, governments, and financial institutions.
 Key characteristics:
o High liquidity.
o Low-risk instruments.
o Facilitates short-term borrowing and lending.

Functions

1. Facilitates Liquidity Management: Provides a platform for managing short-term funds for
financial institutions and businesses.
2. Monetary Policy Implementation: Central banks (e.g., RBI) use money markets to
implement monetary policies.
3. Efficient Allocation of Resources: Ensures funds flow to sectors requiring short-term
financing.
4. Provides Investment Avenues: Offers low-risk, short-term instruments for investors.

Instruments of the Money Market

1. Treasury Bills (T-Bills)

o Short-term securities issued by the government to meet its short-term borrowing
needs.
o Features:
 Issued at a discount and redeemed at face value.
 Maturities: 91 days, 182 days, and 364 days.
o Formula for Yield: Yield=(Face Value−Issue Price)/ Issue Price ×364/Maturity Days

o Commercial Bill Formula:

2. Commercial Papers (CPs)

o Unsecured promissory notes issued by corporations for short-term funding.
o Maturity: 7 days to 1 year.
o Higher risk than T-bills but offers higher returns.
3. Certificates of Deposit (CDs)
o Issued by banks and financial institutions to mobilize funds.
o Negotiable and tradable in secondary markets.
o Maturity: 7 days to 1 year.
4. Call Money and Notice Money
o Call Money: Loans repayable on demand, used for interbank borrowing.
o Notice Money: Borrowing for periods exceeding one day but less than 14 days.

45
 5. Repurchase Agreements (Repo)
o Instruments used by financial institutions to borrow funds by selling securities with
an agreement to repurchase them.
o Formula for Repo Rate:
o Repo Rate=(Repurchase Price− Sale Price)×365Days/n

Participants in the Money Market

 RBI: Regulates the money market, sets repo and reverse repo rates.
 Banks: Active participants for liquidity management.
 Corporations: Issue CPs and CDs for short-term funding.
 Mutual Funds: Invest in short-term instruments for safe returns.
 Government: Issues T-bills to manage short-term deficits.

Role of the RBI in the Money Market

1. Liquidity Adjustment Facility (LAF): Manages liquidity through repo and reverse repo
operations.
46
 2. CRR and SLR Requirements: Maintains monetary stability by mandating banks to hold
reserves.
o CRR (Cash Reserve Ratio): Percentage of total deposits to be maintained as cash
with the RBI.
o SLR (Statutory Liquidity Ratio): Percentage of net demand and time liabilities to be
held in specified assets.

Importance of the Money Market

1. Ensures financial stability by meeting short-term funding needs.

2. Supports the government in implementing fiscal and monetary policies.
3. Acts as a benchmark for interest rate determination (e.g., MIBOR).

Detailed Notes on CRR and SLR

Cash Reserve Ratio (CRR)

1. Definition
o CRR is the proportion of a bank’s total deposits that must be kept as a reserve with
the Reserve Bank of India (RBI).
o This reserve is maintained in the form of cash or deposits with the central bank.
2. Current Rate
o The prevailing CRR rate is 4. 5%, though it may vary as per RBI’s discretion.
3. Purpose
o To ensure liquidity in the banking system.
o Acts as a contingency fund to avoid any payment crises.
o CRR is an essential monetary policy tool used to control money supply and inflation.
4. Mechanism
o For example, if a depositor deposits ₹10,000 in a bank and the CRR is 3%, the bank
must hold ₹300 as a reserve with RBI.
5. Impact on Banks
o Reduces the lendable amount for banks.
o Helps RBI regulate inflation by increasing or decreasing CRR rates.

Statutory Liquidity Ratio (SLR)

1. Definition
o SLR is the portion of a bank’s net demand and time liabilities (NDTL) that must be
kept in the form of liquid assets like cash, gold, or approved government securities.
2. Current Rate
o The present SLR rate is 18%, but it can also be adjusted as per RBI’s discretion.
3. Purpose
o Ensures that banks maintain adequate liquidity to meet depositor demands.

47
 o Promotes investments in government securities.
4. Mechanism
o Banks must maintain their SLR reserves and report compliance to the RBI every
alternate Friday (referred to as “reporting Friday”).
o Non-compliance results in penalties.
5. Examples
o The government issues tax-free bonds worth ₹5,000 crore. If the State Bank of India
subscribes to ₹500 crore of these bonds, this amount qualifies as SLR.

Differences Between CRR and SLR

Aspect CRR SLR

Reserve Type Maintained with RBI Maintained with the bank itself
Form Cash or deposits Liquid assets like cash, gold,
securities
Purpose Manage liquidity and control Ensure solvency and liquidity
inflation
Impact on Direct impact on bank lending Limits liquidity indirectly
Lending

Significance in Monetary Policy

1. Control Inflation
o Increasing CRR or SLR reduces liquidity in the economy, helping to curb inflation.
2. Encourage Investments
o SLR requirements encourage banks to invest in government bonds, ensuring a
steady demand for government securities.
3. Stabilize Banking System
o Acts as a safety net against sudden cash outflows or crises.

Detailed Notes on Interest Rate Determination: MIBOR and LIBOR

Mumbai Interbank Offer Rate (MIBOR)

1. Definition
o MIBOR stands for Mumbai Interbank Offer Rate, the overnight lending rate for
Indian commercial banks.
o Modeled after the London Interbank Offer Rate (LIBOR), MIBOR was established in
1998.
2. Calculation
o Computed as a weighted average of lending rates from a panel of 30 banks and
primary dealers.

48
 o It represents the rate at which banks lend to other banks in India for maintaining
liquidity and meeting reserve requirements.
3. Publication and Usage
o Published daily by the National Stock Exchange of India (NSE) and Thomson
Reuters.
o Used in determining interest rates for various short-term financial instruments,
such as call money loans and repo agreements.
4. Applications
o Benchmark for floating-rate loans and debt securities in India.
o Acts as a reference rate for financial contracts such as Overnight Index Swaps (OIS).
5. Example
o If Bank A lends ₹10 crore to Bank B at a 7% MIBOR rate, the interest for one day
would be: Interest=Principal×Rate×Actual Time/365
o Interest=10,00,00,000×7×1/365=₹19,178

London Interbank Offer Rate (LIBOR)

1. Definition
o LIBOR, now referred to as ICE LIBOR, is a globally recognized benchmark rate for
short-term loans among the world's leading banks.
o It represents the average interest rate at which banks borrow unsecured funds
from each other in the London interbank market.
2. Currencies and Maturities
o LIBOR rates are provided for five major currencies:
 US Dollar (USD)
 Euro (EUR)
 Pound Sterling (GBP)
 Japanese Yen (JPY)
 Swiss Franc (CHF)
o Maturities range from overnight to 12 months.
3. Calculation and Administration
o Administered by the ICE Benchmark Administration (IBA).
o Determined based on submissions from a panel of 11–18 banks.
4. Applications
o Used as a benchmark for various financial products, including:
 Bonds and loans.
 Mortgages, student loans, and credit cards.
 Derivatives like currency and interest rate swaps.
5. Example
o A floating-rate note (FRN) offers a coupon rate of LIBOR + 35 basis points.
o If the one-year LIBOR rate is 4%, the total coupon rate would be:
Coupon Rate=4%+0.35%=4.35%

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Comparison: MIBOR vs. LIBOR

Aspect MIBOR LIBOR

Region India Global
Currency Indian Rupee (INR) USD, EUR, GBP, JPY, CHF
Publication NSE and Thomson Reuters ICE Benchmark Administration
Use Cases Indian financial instruments Global loans, derivatives, bonds

Recent Developments: LIBOR Transition to SOFR

 Due to manipulation scandals and reliability issues, LIBOR was replaced with Secured
Overnight Financing Rate (SOFR) for USD-based contracts in 2021.
 Key differences:
o LIBOR included a credit risk premium, while SOFR is collateralized and reflects
actual transactions.
o SOFR is based on overnight Treasury repo rates, making it more robust and
transparent.

Detailed Notes on the Government Securities Market

The government securities (G-Sec) market is a crucial segment of the Indian debt market,
facilitating the issuance and trading of government debt instruments.

Definition and Types of Government Securities

Government securities are debt instruments issued by the central or state governments to finance
their fiscal deficits. They are considered low-risk investments because they are backed by the
sovereign.

Types of Government Securities:

1. Dated Securities:
o Medium to long-term securities issued at par value.
o Fixed maturity and interest payments (coupons).
o Redeemed at face value on maturity.
2. Treasury Bills (T-Bills):
o Short-term instruments with maturities of 91, 182, and 364 days.
o Issued at a discount and redeemed at face value.
o No interest payments; the difference between face value and issue price
constitutes the return.
3. Zero-Coupon Bonds:
o Issued at a discount without periodic interest payments.
o The return is realized as the difference between the issue price and redemption
value.
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 4. Floating Rate Bonds:
o Interest rates fluctuate based on a benchmark like MIBOR or INBMK (Indian
Benchmark Swaps).
o Periodic resets ensure alignment with market conditions.
5. Capital-Indexed Bonds:
o Principal is indexed to an inflation measure like CPI or WPI.
o Protects investors from inflation risk.

Features of G-Secs

1. Safety: Guaranteed by the government, making them risk-free.

2. Liquidity: Highly liquid, traded in both primary and secondary markets.
3. SLR Eligibility: G-Secs qualify as Statutory Liquidity Ratio (SLR) securities.
4. Market Participation: Accessible to retail and institutional investors, including banks,
mutual funds, and foreign investors.

Key Components of the G-Sec Market

1. Primary Market:
o New securities are issued via auctions conducted by the Reserve Bank of India (RBI).
o Competitive and non-competitive bidding is allowed.
2. Secondary Market:
o Facilitates the trading of previously issued G-Secs.
o Ensures liquidity and price discovery.

Role of the RBI

1. Issuer: Issues G-Secs on behalf of the government.

2. Debt Manager: Implements public debt policies.
3. Monetary Policy Tool: Uses G-Secs to manage liquidity and interest rates in the economy.

Yield and Pricing of G-Secs

1. Yield Formula for Treasury Bills:

Yield=(Face Value−Issue Price)/IP×364/Maturity Period×100

2. Zero-Coupon Bonds:
Pricing depends on the present value of the face amount, discounted at the yield rate.
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Advantages of G-Secs

1. Risk-Free Returns: Minimal default risk.

2. Portfolio Diversification: Diversifies investment risk.
3. Income Certainty: Predictable returns through fixed coupon payments.

Recent Developments: RBI Retail Direct Scheme

 Objective: Simplify access to G-Secs for retail investors.

 Features:
o Retail investors can open a “Retail Direct Gilt (RDG)” account with RBI.
o Enables direct investment in primary auctions and secondary markets.
o Facilitates transparency and ease of investment.

The G-Sec market is vital for financial stability and serves as a benchmark for pricing other fixed-
income instruments.

Detailed Notes on Recent Developments in Money Market: Debt Securitization and MMMFs

1. Debt Securitization

Definition
Debt securitization refers to converting illiquid retail loans into marketable securities. The loans
are pooled, repackaged, and sold to investors in the secondary market. This process helps to
mobilize resources and improve liquidity.

Example

 A bank lends ₹10 lakhs each to 300 borrowers, amounting to a total debt of ₹30 crores.
 Through securitization, the bank can break this ₹30 crores portfolio into smaller, tradable
securities (e.g., ₹300 each) and market them to investors

Philosophy Behind Securitization

 Individual lenders cannot provide large, long-term loans continuously.

 By converting the debt into small, transferable units, it becomes easier to fund projects
with long gestation periods.

Notable Experiments in India

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  HDFC Initiative: Sold part of its housing loan portfolio to Infrastructure Leasing and
Financial Services (ILFS).
 ICICI and Private Companies: Similar deals for lease rentals and financing promoter
contributions for projects.

Benefits of Debt Securitization

1. Enhances liquidity for financial institutions.

2. Attracts a wider investor base.
3. Mobilizes additional resources for development projects.
4. Creates an active market for long-term assets like mortgages.

Process

 Pooling retail loans into a single portfolio.

 Creating securities backed by the portfolio.
 Selling these securities to investors.

2. Money Market Mutual Funds (MMMFs)

Definition
Money Market Mutual Funds are schemes established by banks and public financial institutions
to mobilize short-term funds for investment in money market instruments.

Regulatory Framework

 Guidelines issued by the Reserve Bank of India (RBI).

 Eligibility: Banks and public financial institutions can set up MMMFs

Key Features

1. Limits
o Cannot exceed 2% of the sponsoring bank’s fortnightly average aggregate deposits.
o For public financial institutions, the limit is 2% of long-term domestic borrowings.
2. Eligibility for Investors
o Primarily targets individual investors, including NRIs, on a non-repatriable basis.
o MMMFs can set minimum investment sizes at their discretion.
3. Returns
o No guaranteed minimum rate of return.
4. Lock-in Period
o Minimum lock-in period is 46 days.
5. Capital Deployment

53
 o Funds must be invested exclusively in money market instruments like T-bills, CPs,
CDs, and repo agreements.

Advantages of MMMFs

1. Higher Liquidity: Invest in short-term, high-quality instruments.

2. Risk Management: Fund managers adjust lending durations to control risk.
3. Better Returns: Often outperform bank fixed deposits of similar durations.
4. Ideal Investment Horizon: Best suited for 3–6 months.

Practical Benefits

 For short-term goals, MMMFs provide relatively stable returns while maintaining liquidity.
 Useful for corporates, retail investors, and institutions seeking safer, short-term avenues.

These recent developments—debt securitization and MMMFs—have significantly contributed to

making India’s money market more dynamic, efficient, and resourceful.

Detailed Notes on Repurchase Options (Repo), Reverse Repo, and Ready Forward Contracts

Repurchase Agreements (Repo)

1. Definition
o A repurchase agreement (Repo) is a money market instrument where a participant
raises funds by selling securities and simultaneously agreeing to repurchase them
at a future date and predetermined price, which includes interest.
o Often referred to as a Ready Forward Contract, it involves the sale of securities on
a spot basis and repurchase on a forward basis.
2. Key Characteristics of Repos
o Short-term Maturity: Typically overnight or for a few days. The minimum period
for repos in India is one day.
o Hybrid Nature: Combines features of secured loans and outright purchase/sale
transactions.
o Repo Rate: The interest earned by the lender is the difference between the
repurchase price and the initial sale price. This rate is determined independently of
the securities' coupon rate and influenced by market conditions.
o Interest Earned=Funds Invested×Repo Rate×Number of Days/365
o Example:
 Funds Invested = ₹1 crore
 Repo Rate = 5%
 Number of Days = 3

Interest Earned=1,00,00,000×0.05×3365=₹4110

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 3. Purpose
o Provides liquidity to financial institutions.
o Used as a tool for monetary policy by the Reserve Bank of India (RBI).
4. Participants
o Commercial banks, financial institutions, brokers, and specialized entities like the
Securities Trading Corporation of India (STCI) and Discount and Finance House of
India (DFHI)

Reverse Repurchase Agreements (Reverse Repo)

1. Definition
o A Reverse Repo is the reverse of a Repo transaction, where a lender provides funds
to a borrower (usually the RBI) in exchange for securities, agreeing to sell them
back at a future date and price.
2. Purpose
o Used by the RBI to absorb excess liquidity from the banking system.
3. Key Differences Between Repo and Reverse Repo
o Rate: Repo rate is higher than the reverse repo rate.
o Function: Repo fulfills the shortfall of funds, while reverse repo manages excess
liquidity.
o Perspective: Viewed from the seller's side, it's a Repo; from the buyer's side, it's a
Reverse Repo.
o Economic Impact: Repo rate aims to curb inflation, while reverse repo rate controls
the money supply

Ready Forward (RF) Contracts

1. Definition
o RF contracts are another name for Repo transactions, emphasizing the sale of
securities on a spot (ready) basis and their repurchase on a forward basis
2. Role of RBI in RF Contracts
o The RBI uses repos and reverse repos to influence liquidity and short-term interest
rates.
o Transactions are often conducted through its subsidiaries, STCI and DFHI, which act
as market makers in government securities.

Conclusion

Repos, reverse repos, and ready forward contracts are essential tools for liquidity management
and monetary policy implementation in the money market. Their structured nature ensures
flexibility, security, and efficiency in short-term borrowing and lending transactions.
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Detailed Notes on Day Count Convention

Definition

The Day Count Convention refers to the method used to calculate the number of days in a period
for interest calculation purposes. This methodology is critical for determining the accrued interest
on financial instruments like bonds, treasury bills, and other debt securities.

Types of Day Count Conventions

1. 30/360 Convention
o Assumes 30 days in a month and 360 days in a year, irrespective of actual days.
o Commonly used in the Indian Bond Market and for mortgage-backed securities.
2. Actual/365 Convention
o Uses the actual number of days in a month while assuming 365 days in a year.
o Applied to Indian Money Market instruments, such as treasury bonds and
government securities.
3. Actual/Actual Convention
o Considers the actual number of days in a month and the actual number of days in
a year (365 or 366 for leap years).
o Commonly used for Indian corporate bonds.
4. Actual/360 Convention
o Counts the actual number of days in a month but assumes 360 days in a year.
o Predominantly used for commercial paper, treasury bills, and other short-term
debt instruments.

Illustrative Example

The following table illustrates how accrued interest is calculated under different conventions:

Field 30/360 Actual/360 Actual/365 Actual/Actual

Starting Date 01-May-18 01-May-18 01-May-18 01-May-18
Settlement Date 01-Aug-18 01-Aug-18 01-Aug-18 01-Aug-18
Coupon Rate (%) 10% 10% 10% 10%
Face Value ₹100 ₹100 ₹100 ₹100
Number of Days 90 92 92 92
Accrued Interest ₹2.5000 ₹2.5556 ₹2.52055 ₹2.52055

Note: For 2018 (not a leap year), 365 days are considered for Actual/Actual interest calculation.

56
Clarifications by SEBI

1. Holiday Adjustments
o If an interest payment date falls on a holiday, the payment may be deferred to the
next working day. Future coupon schedules, however, remain unaffected.
o Example:
 Bond issued: 01-Jul-2016
 Maturity: 30-Jun-2018
 Coupon Dates: 01-Jan and 01-Jul semi-annually
 If 01-Jan-2017 is a Sunday, payment will occur on 02-Jan-2017, but
calculation will consider up to 31-Dec-2016.
2. Leap Year Consideration
o In a leap year, February 29 is included, making the year 366 days. This applies
uniformly across annual, semi-annual, quarterly, or monthly payments.
o Example: For a bond issued on 01-Jan-2016 with semi-annual payments, both the
periods (01-Jan to 01-Jul and 01-Jul to 01-Jan) use 366 days as the denominator for
interest calculations.

Importance of Day Count Convention

1. Ensures accurate calculation of interest accrued on financial instruments.

2. Provides consistency in settlement and valuation of debt securities.
3. Allows clear communication and standardization across global financial markets.

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CHAPTER 6: BOND MARKET

1. Introduction to Bond Markets

 What is a Bond Market?

o A bond market is where debt securities (bonds) are issued and traded. It is also
called the fixed-income market because bondholders receive fixed interest
payments.
o Governments use bonds to finance infrastructure and pay off debts. Corporations
issue bonds to fund expansion or operational costs.

58
Example:

 A government may issue bonds to fund the construction of highways. Investors buy these
bonds, and the government pays them interest annually until the bond matures.
 Historical Context:
o Debt instruments date back to 2400 B.C., with grain-based loans in Mesopotamia.
o Governments have used bonds for war financing, such as Liberty Bonds in World
War I in the U.S.
 Indian Context:
o Introduced during the East India Company era for funding military campaigns.
o Bonds in India are legally recognized as securities under the Securities Contract
(Regulation) Act, 1956.

2. What is a Bond?

 A bond is a loan made by investors to an issuer (government or corporation). The issuer

promises:
o Principal repayment (face value or par value) at maturity.
o Interest payments (coupon) during the bond’s tenure.

Key Concepts

1. Face Value:
o Amount paid back at maturity.
o Bonds may trade above (premium) or below (discount) face value in the secondary
market.

Example:

o A ₹1,000 face value bond trading at ₹950 is at a discount; trading at ₹1,050 is at a

premium.
2. Coupon Rate:
o The fixed annual interest rate on the face value.
o If a bond has a ₹1,000 face value and an 8% coupon rate, the issuer pays ₹80
annually.
3. Yield:
o The return an investor earns, expressed as a percentage.
o Current Yield Formula: Current Yield

59
 4. Maturity:
o The tenure after which the principal is repaid.
o Bonds can have maturity periods ranging from days to decades.
5. Price-Yield Relationship:
o Bond prices and yields have an inverse relationship.
o As bond prices increase, yields decrease, and vice versa.

Practical Example:

 A ₹1,000 face value bond has a coupon rate of 10% (₹100 annual interest). If the bond
trades for ₹1,200:
o Current Yield = 100/1200×100=8.33%

3. Factors Affecting Bond Prices

1. Interest Rates:
o Rising rates lower bond prices because new bonds offer better returns.
o Falling rates increase bond prices as older bonds with higher rates become more
attractive.
2. Credit Quality:
o Lower creditworthiness of the issuer reduces bond prices due to higher risk.
3. Maturity Period:
o Longer maturity bonds are more sensitive to interest rate changes (duration
effect).

Illustration of Price-Yield Dynamics:

 Assume a 5-year bond with a 6% coupon. If market rates rise to 8%, the bond’s value
decreases to make its yield comparable to new bonds.

4. Types of Bonds

 Secured vs. Unsecured:

o Secured bonds are backed by assets (e.g., real estate).
o Unsecured bonds depend on the issuer’s creditworthiness.
 Convertible vs. Non-Convertible:
o Convertible bonds can be exchanged for equity.
o Non-convertible bonds offer higher fixed returns but no equity option.
 Zero-Coupon Bonds:
o No periodic interest payments.
60
 o Issued at a discount and redeemed at face value.

Example:

o A ₹1,000 zero-coupon bond issued at ₹800 provides a ₹200 gain at maturity.

 Callable Bonds:
o Issuers can redeem before maturity, usually during falling interest rate periods.
 Junk Bonds:
o High-risk, high-yield bonds rated below investment grade.

5. Risks in Bonds

1. Inflation Risk:
o Reduces the real purchasing power of returns.
2. Interest Rate Risk:
o Higher rates make existing bonds with lower rates unattractive, reducing their
price.
3. Reinvestment Risk:
o Occurs when coupon payments must be reinvested at lower rates.
4. Credit Risk:
o Issuer’s inability to meet payment obligations.
5. Liquidity Risk:
o Difficulty in selling bonds in thinly traded markets.
6. Exchange Rate Risk:
o For bonds in foreign currencies, depreciation affects returns negatively.

6. Relation Between Bond Prices and Interest Rates

 Inverse Relationship:
o When interest rates rise, bond prices drop because new bonds offer better returns.
o Formula for Yield to Maturity (YTM):

7. Primary Market vs. Secondary Market

 Primary Market:
o Bonds are issued directly by the issuer to raise funds.

61
 o Example: A government issues treasury bonds for ₹1,000 each.
 Secondary Market:
o Investors trade existing bonds.
o Example: Investor A sells a corporate bond to Investor B on a stock exchange.

8. Types of Bond Markets

1. Corporate Bonds:
o Issued by companies, with varying risk profiles.
2. Government Bonds (G-Secs):
o Issued by central or state governments, considered risk-free.
3. Municipal Bonds:
o Issued by local governments for infrastructure projects.
4. Emerging Market Bonds:
o Issued by developing nations, offering higher risks and returns.

9. Bond Market Strategies

 Active Strategy:
o Actively trade bonds to capitalize on market fluctuations.
 Passive Strategy:
o Hold bonds to maturity for stable income.
 Hybrid Strategy:
o Combines active and passive elements.

10. Bond Market Index

 Tracks performance in the bond market.

 Used as benchmarks for fund performance.
 Examples: Nifty Bharat Bond Index, Nifty G-Sec Index.

11. Bond Market vs. Stock Market

Feature Bond Market Stock Market
Nature Debt (loan) Equity (ownership)
Risk Lower Higher
Returns Fixed (interest) Variable (dividends)
Sensitivity Interest Rates Company Performance

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12. Bond Ratings

 Ratings assess issuer creditworthiness.

 Provided by agencies like S&P, Moody’s, Fitch.
 Categories: Investment Grade (low risk) and Non-Investment Grade (high risk).

5. Risks in Bonds

Bonds, while generally considered safer than stocks, carry various types of risks that investors
should carefully evaluate before investing. These risks influence the bond’s value, returns, and
attractiveness. The primary risks include:

1. Inflation Risk (Purchasing Power Risk)

 Definition: Inflation risk refers to the erosion of purchasing power due to rising prices.
When inflation increases, the real value of a bond's interest payments and principal
repayment decreases.
 Impact: The same nominal income buys fewer goods and services over time, reducing the
bondholder’s real return.
 Example:
o Suppose a bond pays ₹1,000 annually in interest. If inflation is 5%, the real value of
this payment will be 1,000×(1−0.05)=₹950

2. Interest Rate Risk

 Definition: Interest rate risk arises when changes in market interest rates affect bond
prices inversely.
o Rising Interest Rates: Bond prices decrease because newer bonds offer higher
yields.
o Falling Interest Rates: Bond prices increase because existing bonds have higher
coupon rates.
 Impact:
o Long-term bonds are more sensitive to interest rate changes than short-term
bonds.
 Example:

63
 o A bond with a face value of ₹1,000 and a 6% coupon rate (₹60 annual interest) will
lose value if new bonds are issued at an 8% rate. Investors will prefer the new
bonds, decreasing the older bond's price to compensate for its lower yield.

3. Reinvestment Risk

 Definition: The risk of earning a lower return on reinvested interest or principal payments
due to declining market interest rates.
 Impact:
o Affects bonds with higher coupon rates and callable bonds, where early
redemption forces reinvestment at lower yields.
 Example:
o A ₹10,000 bond with an 8% coupon rate earns ₹800 annually. If the market rate
drops to 4%, the reinvested ₹800 will only generate ₹32 (₹800 × 4%).

4. Credit Risk (Default Risk)

 Definition: The risk that the issuer may fail to make interest payments or repay the
principal amount at maturity.
 Factors Influencing Credit Risk:
o Issuer's financial health, credit history, and economic conditions.
 Impact:
o Higher credit risk leads to higher yields to attract investors but lowers the bond’s
price.
 Example:
o If a bond issuer defaults, investors may recover only a portion of their investment,
depending on the company’s liquidation value.

5. Liquidity Risk

 Definition: Liquidity risk occurs when a bond cannot be sold quickly at its fair market value
due to a lack of buyers in the market.
 Impact:
o Common in bonds from smaller issuers or those with limited trading volumes.
 Example:

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 o A municipal bond from a small town may have fewer buyers, making it difficult for
investors to sell without significant price discounts.

6. Market Risk (Systematic Risk)

 Definition: The risk of loss due to overall market factors, such as economic slowdowns,
regulatory changes, or geopolitical events.
 Impact:
o Affects all investments in the market, including high-quality bonds.
 Example:
o During an economic recession, even AAA-rated bonds may lose value as investors
anticipate a higher risk of default or reduced economic activity.

7. Default Risk

 Definition: A specific type of credit risk where the issuer is unable to meet its financial
obligations.
 Impact:
o If an issuer defaults, bondholders may lose part or all of their investment.
 Example:
o If a corporate bond issuer declares bankruptcy, bondholders may only recover a
portion of their principal after secured creditors are paid.

8. Rating Risk

 Definition: The risk that a bond's credit rating will be downgraded, decreasing its value
and demand in the market.
 Impact:
o Downgraded bonds are considered riskier, requiring higher yields to attract
investors.
 Example:
o If a bond is downgraded from AA to BBB, its price will drop as investors demand
higher returns for the increased risk.

9. Repricing Risk
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  Definition: The risk that arises from the relationship between bond prices and their coupon
rates.
 Factors:
o Maturity: Bonds with longer maturities exhibit higher price sensitivity to interest
rate changes.
o Coupon Rate: Lower-coupon bonds are more sensitive to rate changes.
 Example:
o A 10-year bond with a 2% coupon rate will experience larger price fluctuations than
a similar bond with an 8% coupon rate.

10. Exchange Rate Risk

 Definition: The risk that changes in currency exchange rates will reduce the returns of
bonds denominated in a foreign currency.
 Impact:
o Investors receive interest and principal payments in a foreign currency, which may
lose value when converted to their home currency.
 Example:
o A U.S. investor holds a ₹1,000 Indian bond. If the rupee weakens against the dollar,
the investor receives fewer dollars when converting the payment.

Detailed Illustration:

 A U.S. investor buys a bond denominated in ₹100,000. At the time of purchase, the
exchange rate is ₹75 = $1. The investor expects to receive $1,333.33.
 If the exchange rate shifts to ₹80 = $1, the investor’s return decreases to $1,250, resulting
in a loss.

Managing Bond Risks

To mitigate these risks, investors can adopt strategies such as:

1. Diversification:
o Invest in a mix of bonds with varying maturities, issuers, and credit qualities.
2. Laddering:
o Stagger bond maturities to reduce reinvestment and interest rate risks.
3. Monitoring Credit Ratings:
o Regularly check for changes in bond ratings to avoid exposure to downgrades.
4. Staying Informed:
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 o Keep an eye on market trends, economic indicators, and regulatory changes.

Example of Diversification:

 A portfolio could include:

o 30% Government Bonds (low risk),
o 40% Corporate Bonds (moderate risk), and
o 30% High-Yield Bonds (high risk, high return).

Summary Table of Risks in Bonds

Risk Cause Impact Mitigation
Inflation Risk Rising prices reduce real Decreases purchasing Invest in inflation-
returns. power. protected securities.
Interest Rate Rate changes affect Price volatility. Opt for short-term
Risk bond prices. bonds.
Reinvestment Declining rates affect Reduced future Ladder bond
Risk reinvested income. returns. investments.
Credit Risk Issuer’s inability to pay. Loss of Choose high-rated
principal/interest. bonds.
Liquidity Risk Difficulty in selling Forced to sell at a Invest in liquid markets.
bonds. discount.
Market Risk Economic changes affect Reduced bond value. Diversify across asset
value. classes.
Default Risk Issuer fails to meet Loss of Assess issuer’s
obligations. principal/interest. creditworthiness.
Rating Risk Downgrades reduce Decreased price and Monitor ratings
bond value. demand. regularly.
Repricing Risk Price sensitivity due to Price volatility. Choose bonds with
coupon/maturity. higher coupon rates.
Exchange Rate Foreign currency Reduced returns. Hedge using currency
Risk devaluation. derivatives.

Here’s an even more detailed note on Types of Bonds and Bond Ratings,

Types of Bonds

1. Secured and Unsecured Bonds

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  Secured Bonds:
o Backed by a specific asset or revenue stream (e.g., real estate, equipment, or
mortgage payments).
o Investors have a claim on the issuer's assets if the issuer defaults.
o Example: Mortgage-Backed Securities (MBS) are backed by mortgage payments.
o Risk: If the value of the asset decreases or the claim on it is contested, investors
may not recover the full investment.
 Unsecured Bonds:
o Not backed by any specific asset but rely on the issuer's creditworthiness and "full
faith and credit."
o These are riskier than secured bonds but may still be issued by reputable entities.
o Example: Debentures issued by corporations.

2. Convertible and Non-Convertible Bonds

 Convertible Bonds:
o Can be converted into equity shares of the issuing company.
o Attractive due to the possibility of capital appreciation if the company performs
well.
o Types:
 Fully Convertible: Entire principal can be converted into equity.
 Partially Convertible: Only a portion of the bond is convertible, and the
remainder is redeemed as debt.
o Example: A convertible bond with a face value of ₹1,000 can be converted into 10
shares at ₹100 each.
 Non-Convertible Bonds:
o Cannot be converted into equity.
o Offer higher fixed returns to compensate for lack of conversion flexibility.
o Example: Corporate bonds issued for long-term funding with fixed periodic interest
payments.

3. Zero-Coupon Bonds

 No periodic interest payments.

 Issued at a discount and redeemed at face value at maturity.
 Key Features:
o Entire return is realized as the difference between purchase price and face value.
o Suitable for investors seeking a lump sum at maturity.
 Example:
o A ₹1,000 zero-coupon bond issued for ₹800 provides a ₹200 gain at maturity.
 Alternate Names: Pure discount bonds, deep discount bonds.

4. Callable and Puttable Bonds

 Callable Bonds:
o Issuers have the right (but not the obligation) to redeem the bond before its
maturity date.
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 o Issuers benefit when interest rates decline, allowing them to refinance debt at
lower rates.
o Risk for Investors: Loss of future interest payments if the bond is called.
o Example: A bond callable after 5 years with a 10-year maturity.
 Puttable Bonds:
o Bondholders have the option to sell the bond back to the issuer before maturity.
o Protects investors if interest rates rise, as they can reinvest at higher rates.
o Example: A 10-year bond with a put option after 3 years.

5. Junk Bonds

 High-risk bonds with ratings below investment grade (e.g., BB or lower by S&P).
 Offer higher yields to compensate for increased default risk.
 Issued by companies with uncertain financial stability.
 Example: A startup with a speculative credit rating issuing bonds at a 15% yield.

6. Foreign Currency Bonds

 Foreign Currency Exchangeable Bonds (FCEB):

o Issued by an Indian company but exchangeable into equity shares of another
(offered) company.
o Principal and interest are payable in foreign currency.
o Example: Parent company issues FCEBs backed by its subsidiary’s equity.
 Foreign Currency Convertible Bonds (FCCB):
o Issued by a company, allowing bondholders to convert them into shares of the
same company.
o Key Difference from FCEB: FCCBs involve only one company.

Bond Ratings

Bond ratings indicate the creditworthiness of issuers and provide insight into the risk of default
on principal or interest payments. These ratings are assigned by independent agencies.

1. Importance of Bond Ratings

 Help investors assess the risk-return profile of a bond.

 Categorize bonds into Investment Grade and Non-Investment Grade (Junk).
 Influence bond prices and interest rates:
o Higher-rated bonds offer lower yields (safer).
o Lower-rated bonds offer higher yields (riskier).

2. Major Credit Rating Agencies

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  S&P Global Ratings:
o Focus: Default probability.
o Ratings: From AAA (highest credit quality) to D (in default).
o Example:
 AAA: Extremely safe, low-risk bonds.
 BBB: Medium credit quality, still investment-grade.
 BB or below: Speculative (junk bonds).
 Moody’s Investors Service:
o Focus: Expected losses in case of default.
o Ratings: From Aaa (highest) to C (default).
o Subdivisions: Uses numeric modifiers (1, 2, 3) to further specify ranking within
categories.
 Example: A bond rated Aa1 is higher than Aa2 but below Aaa.
 Fitch Ratings:
o Focus: Probability of default.
o Uses a rating scale similar to S&P (e.g., AAA, BBB, etc.).
o Specialized in corporate, sovereign, and financial institution ratings.

3. Categories of Bond Ratings

 Investment Grade:
o Bonds rated BBB-/Baa3 or above.
o Low default risk, suitable for conservative investors.
o Examples: Government bonds, high-quality corporate bonds.
 Non-Investment Grade (Junk):
o Bonds rated BB+/Ba1 or below.
o Higher risk, higher yield.
o Examples: Bonds issued by financially unstable corporations.

4. Factors Influencing Ratings

 Issuer's Financial Health:

o Profitability, debt levels, and liquidity.
 Economic Environment:
o Impact of inflation, interest rates, and market trends.
 Industry Trends:
o Stability and growth prospects of the issuer’s sector.

5. Bond Rating Implications

 Higher Ratings:
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 o Lower yields due to lower risk.
o Attract risk-averse investors.
 Lower Ratings:
o Higher yields to compensate for increased risk.
o Suitable for risk-tolerant investors seeking higher returns.

6. Example of Rating Applications

1. Investment Grade Example:

o A government issues AAA-rated bonds at a 5% coupon rate. These bonds are safe
and ideal for long-term, risk-averse investors.
2. Junk Bond Example:
o A startup issues BB-rated bonds with a 12% coupon rate. These bonds carry higher
risk but attract investors seeking high yields.

Critical Analysis of Bond Ratings

 Bond ratings offer valuable guidance but have limitations:

o Conflict of Interest: Rating agencies may be influenced by issuers, as seen during
the 2008 financial crisis.
o Lag in Downgrades: Agencies may react slowly to deteriorating credit conditions.

Best Practice for Investors:

 Use bond ratings as a starting point.

 Perform additional due diligence, including financial statement analysis and industry
trends.

Yield Curve: Relationship between yield and maturity

Types of Yield Curve:

1. Normal Yield Curve: Represents mkt situation where the int. rate on LTB
are higher than STB.
2. Inverted Yield Curve: Represents mkt situation where the int. rate on LTB
are lower than STB.
3. Steep yield curve: Represents temporary scene in economic expansion,
where the LT yields increase quicker than ST yields.
4. Flat yield curve: Mkt situation where yields from all maturities become
similar.
5. Humped yield curve: Medium term yields are higher than short term yields.

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 CHAPTER 7: DERIVATIVE MARKET

1. Introduction to Derivatives

 Definition:
A derivative is a financial instrument whose value is derived from the performance of an
underlying asset, such as stocks, commodities, indices, interest rates, or currencies.
 Key Features:
1. Underlying Asset: The asset from which the derivative derives its value.

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 2. Leverage: A small change in the underlying can result in significant changes in the
derivative's value.
3. Hedging Instrument: Used to reduce risks associated with unfavorable price
movements.
4. Speculative Nature: Enables traders to profit from price changes without owning
the underlying.
5. Price Discovery: Provides an indication of what the market expects future spot
prices to be.

2. Characteristics of Derivatives

 Value Dependency: Relies on the underlying asset’s price movement.

 Settlement at Future Date: Agreements are settled on a predefined expiry date.
 Mechanisms for Risk Transfer:
o Hedging
o Speculation
o Arbitrage
 High Leverage: Amplifies potential rewards and risks.

Example:
A stock currently trading at ₹500 might have a call option priced at ₹50 with a strike price of ₹550.
If the stock rises to ₹600, the call option buyer profits significantly.

3. Key Elements of a Derivative Contract

1. Legally Binding Contract: Enforceable by law.

2. Two Parties: Buyer (long position) and seller (short position).
3. Underlying Asset: Asset whose value impacts the derivative.
4. Predefined Price and Date:
o Futures Price: Agreed price.
o Expiry Date: Date of settlement.
5. Risk Transfer: One party assumes the risk of the underlying asset.

Example:
If you agree today to buy gold at ₹50,000 per 10g three months from now, you have entered a
derivative contract.

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4. Benefits of Derivatives

 Risk Management: Mitigates price fluctuations.

 Leverage: Enables large exposure with smaller capital.
 Price Discovery: Provides insights into future price expectations.
 Market Efficiency: Arbitrage activities correct price discrepancies.

5. Risks in Derivatives

1. Credit Risk:

 Counterparty may default on obligations.

Example: In an OTC forward contract, if one party fails to honor the agreement, the
other incurs losses.

2. Market Risk:

 Adverse price movements can result in losses.

Example: A trader holding a long position in futures suffers if the underlying asset’s price
falls.

3. Operational Risk:

 Failures in processes, fraud, or errors.

Example: Incorrect execution of a trade order may result in unintended exposure.

4. Liquidity Risk:

 Inability to exit a position due to lack of market participants.

Example: Exotic derivatives may have limited buyers or sellers.

5. Legal/Regulatory Risk:

 Legal complexities or changing regulations.

Example: Government-imposed restrictions on certain derivative instruments.

6. Uses of Derivatives

1. Hedging:

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  Reduces exposure to adverse price movements.
Example:
A farmer expecting a drop in wheat prices can sell wheat futures to lock in a price.

2. Speculation:

 Profiting from expected price changes.

Example:
An investor expects crude oil prices to rise and buys oil futures.

3. Arbitrage:

 Exploiting price differences in different markets.

Example:
If gold trades at ₹50,000 in Delhi and ₹50,100 in Mumbai, a trader buys in Delhi and sells
in Mumbai to lock in a ₹100 profit per unit.

7. Important Terms in Derivatives

1. Basis:

 The difference between spot price and futures price.

o Premium: Futures Price > Spot Price.
o Discount: Futures Price < Spot Price.

2. Cost of Carry:

 Measures storage cost + interest paid - income earned on the asset.

Formula: Futures Price

3. Initial Margin:

 Security deposit required to enter a futures contract.

4. Mark-to-Market (MTM):

 Daily adjustment of margin accounts to reflect gains or losses.

5. Expiry Date:

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  The last trading date of a derivative contract.

8. Types of Derivatives

1. Forwards:

 Definition: OTC contracts to buy/sell at a predetermined price on a future date.

 Features:
o Customizable terms.
o High counterparty risk.
o Illiquid due to lack of exchange trading.
 Example:
Booking USD at ₹82 for payment due in 3 months.

2. Futures:

 Definition: Standardized contracts traded on exchanges.

 Features:
o Daily MTM settlement.
o Counterparty risk minimized by clearing houses.
 Example:
Nifty futures with a lot size of 50 expire on the last Thursday of the month.

3. Options:

 Definition: Right, but not obligation, to buy/sell.

 Types:
o Call Option: Right to buy.
o Put Option: Right to sell.
 Key Terms:
o Strike Price: Agreed price.
o Intrinsic Value: Realizable profit if exercised.
o Time Value: Premium – Intrinsic Value.

4. Swaps:

 Definition: Exchange of cash flows between parties.

 Types:
o Interest Rate Swaps: Fixed-for-floating interest exchange.
o Currency Swaps: Exchange of principal and interest in different currencies.

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9. Option Strategies

1. Call Buying:

 Expect price rise.

 Breakeven: Strike Price + Premium.

2. Put Buying:

 Expect price fall.

 Breakeven: Strike Price – Premium.

3. Writing (Selling) Options:

 Earn premium but bear unlimited risk (for calls).

10. Key Differences

Forward vs. Futures:

Feature Forwards Futures

Trading Mechanism OTC Exchange-traded
Counterparty Risk High Low
Standardization Non-standardized Standardized

Equity vs. Futures:

Feature Equity Futures

Ownership Provides ownership No ownership
Margin Requirement Full payment upfront Requires margin

11. Advanced Concepts

Contango and Backwardation:

 Contango: Futures price > Spot price.

 Backwardation: Futures price < Spot price.

Intrinsic and Time Value:

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12. Swaps in Detail

Use Cases:

 Hedging against interest rate or currency risk.

 Speculative positioning.

Example of Interest Rate Swap:

 Company A (fixed-rate loan) and Company B (floating-rate loan) exchange interest

payment obligations.

CHAPTER 8: INSTITUTIONS AND INTERMEDIARIES

1. Depository

A depository is an organization that holds securities in electronic form and facilitates their transfer
and settlement. It functions similarly to a bank for securities.
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Key Points:

 Definition (Depositories Act, 1996): A company registered under the Companies Act,
2013, granted a certificate by SEBI.
 Dematerialization: Conversion of physical shares into electronic form.
 Participants: Customers, Depository Participants (DPs), the depository, and the issuer
company.

Benefits of Depository System:

1. To Investors:
o Eliminates risks like theft, forgery, and damage.
o Faster settlement cycle (T+2 days).
o Reduced transaction costs (no stamp duty).
o Simplifies corporate actions like dividends and bonus issues.
2. To Companies:
o Maintains an updated shareholding pattern.
o Reduces costs of issuing securities.
o Enhances speed and transparency.
3. To Capital Markets:
o Enhances transparency and efficiency.
o Boosts investor confidence and attracts foreign investors.

2. Stock and Commodity Exchanges

2.1 Stock Exchanges (Indian and Global):

Stock exchanges facilitate the buying and selling of securities. Their main objective is to mobilize
resources while protecting investor interests.

Leading Stock Exchanges in India:

1. Bombay Stock Exchange (BSE):

o Oldest stock exchange in Asia (established 1875).
o Known for the SENSEX index.
o Provides trading in equity, debt, and derivatives.
2. National Stock Exchange (NSE):
o Launched in 1994 with electronic trading systems.
o Known for NIFTY 50 index.
o Offers a fully integrated business model including trading, clearing, and financial
education.

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Major Global Stock Exchanges:

1. New York Stock Exchange (NYSE):

o Established in 1792.
o World’s largest securities marketplace.
o Operates on open outcry and electronic platforms.
2. Nasdaq:
o Fully electronic trading platform (established 1971).
o Attracts tech companies with stringent listing requirements.
3. London Stock Exchange (LSE):
o Known for stability and historical significance (founded 1773).
o Offers trading services and data analytics.

2.2 Commodity Exchanges:

Commodity exchanges facilitate trading in raw materials and agricultural products.

Indian Commodity Exchanges:

1. National Commodity & Derivatives Exchange (NCDEX):

o Focus on agricultural products.
o Promoted by ICICI, NABARD, and others.
2. Multi Commodity Exchange (MCX):
o Specializes in energy, metals, and agricultural futures.
o Provides nationwide online trading infrastructure.
3. Indian Commodity Exchange (ICEX):
o Offers benchmark future products like bullions and energy.
o Focuses on warehousing and delivery facilities.
4. National Multi-Commodity Exchange (NMCE):
o First electronic multi-commodity exchange in India.
o Zero-debt company with strong delivery mechanisms.

Global Commodity Exchanges:

1. Chicago Mercantile Exchange (CME): Focus on agriculture, equity, and interest rate
futures.
2. London Metal Exchange (LME): Trades in metals like aluminum and copper.
3. New York Mercantile Exchange (NYMEX): Largest physical commodity futures exchange.

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3. Intermediaries in Capital Markets

Capital market intermediaries facilitate trading and ensure compliance with regulations.

Key Intermediaries:

1. Merchant Bankers:
o Manage public and rights issues.
o Coordinate with underwriters, brokers, and registrars.
o Prohibited from accepting deposits or leasing.
2. Registrars and Share Transfer Agents:
o Maintain records of investors and securities.
o Facilitate the allotment process.
3. Underwriters:
o Guarantee subscription for public issues.
o Essential to meet SEBI’s 90% subscription requirement.
4. Bankers to an Issue:
o Handle application money, allotment, and refunds.
o Facilitate smooth fund transfers to escrow accounts.
5. Debenture Trustees:
o Protect the interests of debenture holders.
o Ensure proper security for loans and repayment schedules.
6. Portfolio Managers:
o Manage client investments based on contracts.
o Provide regular performance reports.
7. Stockbrokers and Sub-brokers:
o Facilitate buying and selling on exchanges.
o Governed by SEBI regulations.

4. Institutional Investors

Institutional investors are large entities that invest on behalf of others.

Types:

1. Commercial Banks: Provide working capital and long-term loans.

2. Insurance Companies: Offer safety, promote savings, and generate funds.
3. Mutual Funds: Pool resources to invest in diversified portfolios.
4. Pension Funds: Accumulate contributions to provide retirement benefits.
5. Hedge Funds: Use strategies like arbitrage to maximize returns.
6. Endowment Funds: Used by non-profits for long-term sustainability.
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5. Foreign Portfolio Investors (FPIs)

 FPIs invest in Indian capital markets either in equity or debt.

 Categories:
o Category I: Government entities, pension funds, etc.
o Category II: Corporate bodies, family offices, etc.
 FPIs are sensitive to global interest rate changes, impacting Indian markets.

6. Custodians

Custodians safeguard client securities and provide services like:

 Maintaining security accounts.

 Collecting benefits like dividends.
 Monitoring issuer actions.

7. Clearing Houses

Clearing houses ensure financial integrity and risk management in trades.

Functions:

1. Act as counterparty to all trades.

2. Monitor margins and guarantee settlements.
3. Use initial, maintenance, and variation margins to manage risk.

Trading Procedure:

 Trades are reported to the clearing house.

 Margins are deposited based on the transaction.

Formulas & Practical Applications

 Futures Price: Futures Price=Spot Price+Cost of CarrY

 Margin Requirements: Initial margin + Maintenance margin ensure trade stability.

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CHAPTER 9: COMMODITY MARKET

1. Introduction to Commodity Markets

What Are Commodities?

 Commodities are physical goods that are either:

o Agricultural: Wheat, soybeans, rice, pulses.

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 o Energy Products: Crude oil, natural gas.
o Metals: Gold, silver, aluminum.

Modern Commodity Markets

 Evolved from simple barter trade to sophisticated, regulated systems with global
participation.
 Price Discovery Example:
o A steel manufacturer tracks iron ore futures to estimate input costs, ensuring
competitiveness in pricing final products.

2. Role of Commodity Markets

Key Functions:

1. Platform for Trade:

o Links producers (e.g., farmers) with consumers (e.g., manufacturers).
2. Price Discovery:
o Markets determine prices by matching demand and supply in real time.
3. Risk Hedging:
o Futures and options allow participants to mitigate risks associated with price
volatility.

Influence on Prices

 Commodity markets impact pricing at multiple levels:

o Producers make planting decisions based on expected prices.
o Manufacturers hedge against rising input costs to maintain profitability.

3. Commodity Markets in India

Major Commodity Exchanges

1. Multi Commodity Exchange (MCX):

o Specializes in metals, energy products, and bullion.
o Examples of traded products: Crude oil, natural gas, gold.
2. National Commodity & Derivatives Exchange (NCDEX):
o Focused on agricultural commodities like wheat, soybeans, and spices.
o Launched Agridex, an agricultural futures index.
3. National Multi-Commodity Exchange (NMCE):

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 o Offers contracts in spices, metals, and grains.
o Pioneered electronic trading in India.

Challenges in Indian Commodity Markets

1. Low Farmer Participation:

o Farmers struggle with access due to a lack of market awareness.
2. Speculative Practices:
o Excessive speculation disrupts price stability.
3. Political Interventions:
o Commodities like sugar are removed from futures trading during price-sensitive
periods.

Way Forward:

 Educate farmers on the benefits of futures trading.

 Reduce the influence of intermediaries.
 Promote digital platforms for seamless trading.

4. Applications of Derivatives in Commodities

Differences Between Commodity and Financial Derivatives

Aspect Commodity Derivatives Financial Derivatives

Storage Costs Significant (e.g., warehousing) Negligible
Delivery Physical delivery required Cash settlement common
Transaction Costs High due to logistics Relatively low
Complexity Quality variation possible Standardized instruments

Trading and Settlement Process

1. Order Matching:
o Trades are matched electronically.
o Example: A trader places a buy order for 1 MT of wheat at ₹25,000/MT, matched
with a seller’s offer.
2. Clearing Mechanism:
o Clearing houses act as intermediaries ensuring smooth settlement.
3. Delivery Process:
o Buyers request delivery via Depository Participants (DPs).
o Warehouses verify and release commodities to buyers.

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Hedging Example in Commodities

 A farmer growing soybeans hedges against price drops by selling soybean futures at
₹4,000/quintal.
Outcome:
o If prices drop to ₹3,500, the farmer avoids losses on physical sales by gaining in
futures contracts.

5. Important Terms in Commodity Markets

1. Margin:
A percentage of the contract value deposited to enter trades, typically 5–15%.
2. Open Interest:
Number of active contracts in the market.
3. LTP (Last Traded Price):
The most recent transaction price in a session.

Types of Participants

1. Hedgers:
o Seek to reduce risks associated with price volatility.
o Example: Airlines hedging against rising jet fuel prices.
2. Speculators:
o Aim to profit from short-term price changes.
o Example: Traders buying crude oil futures anticipating geopolitical tensions.
3. Arbitrageurs:
o Exploit price differences between markets.
o Example: Buying gold on one exchange and selling at a higher price on another.

6. Global Commodity Exchanges

6.1 London Metal Exchange (LME)

 Focuses on ferrous and non-ferrous metals like aluminum, zinc, and copper.
 Key Features:
o Trading through open outcry, electronic platforms, and inter-office systems.
o Standardized 3-month futures contracts.

6.2 Eurex Exchange

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  Europe’s largest platform for futures and options trading.
 Innovations:
o Introduced factor-based indices for risk diversification.

6.3 Chicago Mercantile Exchange (CME)

 Largest US-based commodity exchange.

 Offerings:
o Contracts on agricultural products (e.g., wheat, milk).
o Weather derivatives and real-estate indices.
 Developed SPAN software for margin calculation, a global standard.

7. Practical Example: Crude Oil Futures on MCX

Feature Details
Symbol CRUDEOIL
Trading Unit 100 barrels
Tick Size ₹1 per barrel
Daily Price Limit 4–9%, adjustable
Settlement Cash
Margins Initial: 10%, Extreme Loss: 1%

Settlement Formula:

DDR=NYMEX Price×RBI Reference Rate

Example:
If the NYMEX crude oil price is $50/barrel and the RBI reference rate is ₹75/USD, the DDR (Due
Date Rate) will be ₹3,750/barrel.

8. Advanced Hedging Example

Hedge Ratio Formula:

H=ρ×σSσFH

Where:

 HH: Hedge Ratio

 ρ\rho: Correlation coefficient
 σS,σF\sigma_S, \sigma_F: Standard deviation of spot and futures prices.
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Example:

 A trader holds 10 MT copper spot at ₹474/kg.

 Spot price volatility (σS\sigma_S) = 4%, Futures volatility (σF\sigma_F) = 6%, Correlation
(ρ\rho) = 0.75.

Calculation:

H=0.75×0.040.06=0.5

Futures Contracts to Sell:

Contracts=H×Spot Quantity=0.5×10=5

Conclusion

The commodity market is a crucial financial system component, offering risk mitigation, price
discovery, and investment opportunities. However, challenges like low farmer participation and
speculative activities require focused regulatory and operational reforms for greater efficiency
and inclusivity.

CHAPTER 10: MUTUAL FUNDS

1. Basics of Mutual Funds

Concept & Example:

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A mutual fund aggregates money from investors with similar objectives. This pooled money is
invested in securities like stocks, bonds, and money market instruments.

 Example: If 1,000 investors each contribute ₹10,000 to a mutual fund, the total fund size
becomes ₹1 crore. This amount is then invested in various securities.

Advantages:

 Diversification: Spreads risk by investing in multiple securities.

 Professional Management: Experts analyze and adjust the portfolio.
 Affordability: Small investments grant access to high-value portfolios.

2. Evolution of Mutual Funds

Indian Mutual Fund History:

1. First Phase (1964-1987): Dominated by UTI with schemes like "Unit Scheme 1964."
2. Second Phase (1987-1993): Public sector mutual funds by SBI, LIC, and others were
introduced.
3. Third Phase (1993-2003): Private players entered, and SEBI regulations were
strengthened.
4. Fourth Phase (Post-2003): Modernization with bifurcation of UTI and private sector
consolidation.

 Example: SBI Mutual Fund, one of India’s largest, was established in 1987.

3. Types of Mutual Funds

Based on Structure

1. Open-Ended Funds:
o Can be purchased or redeemed at any time.
o Example: HDFC Equity Fund.
2. Close-Ended Funds:
o Invested for a fixed term; less liquid.
o Example: ICICI Prudential Fixed Maturity Plan.

Based on Portfolio Management

1. Active Funds:
o Fund managers aim to outperform benchmarks by selecting high-performing
assets.
o Example: Mirae Asset Emerging Bluechip Fund.
2. Passive Funds:
o Replicate the performance of an index (e.g., Nifty 50).
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 o Example: Nippon India ETF Nifty BeES.

Investment Objective:

1. Capital Growth:
o High-risk funds aiming for long-term wealth creation.
o Example: Small-Cap Funds.
2. Regular Income:
o Focus on consistent returns via interest/dividends.
o Example: Debt Funds.

4. Performance Measurement

Metrics and Formulas:

1. Net Asset Value (NAV):

o Formula: NAV=Market Value of Investments + Current Assets – Liabilities /
Number of Outstanding Units
o Example:
 Investments: ₹10,00,000
 Current Assets: ₹2,00,000
 Liabilities: ₹50,000
 Units: 10,000
 NAV = (10,00,000+2,00,000−50,000)/10,000=₹115(10,00,000 + 2,00,000 -
50,000) / 10,000 = ₹115
2. Sharpe Ratio:
o Formula: Sharpe Ratio=Portfolio Return−Risk Free Rate / Standard Deviation of Portfolio Returns
o Example:
 Portfolio Return: 12%, Risk-Free Rate: 6%, Std Dev: 4%
 Sharpe Ratio = (12−6)/4=1.5(12 - 6) / 4 = 1.5
3. Treynor Ratio:
o Formula: Treynor Ratio=Portfolio Return−Risk-Free RatePortfolio Beta
o Example:
 Portfolio Return: 14%, Risk-Free Rate: 7%, Beta: 1.2
 Treynor Ratio = (14−7)/1.2=5.83(14 - 7) / 1.2 = 5.83
4. Jensen’s Alpha:
o Formula: Alpha=Portfolio Return−[Risk-Free Rate+β(Market Return−Risk-
Free Rate)]
o Example:
 Portfolio Return: 15%, Risk-Free Rate: 6%, Market Return: 12%, Beta: 1.1
 Alpha = 15−[6+1.1(12−6)]=15−12.6=2.415 - [6 + 1.1(12 - 6)] = 15 - 12.6 = 2.4
5. Expense Ratio:
o Formula:
Expense Ratio=Expenses of the Fund/Average Assets Under Management (AUM)
o Example:
 Expenses: ₹20,000; AUM: ₹5,00,000
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  Expense Ratio = (20,000/5,00,000)×100=4%

Rolling Returns:

Used to evaluate consistency over time, smoothing out short-term fluctuations.

 Example:
o Calculate 2-year CAGR from Jan 2013 (NAV = ₹100) to Jan 2015 (NAV = ₹150):

5. Regulatory and Operational Features

Direct vs. Regular Plans:

 Direct Plan: Lower costs, better returns, suitable for knowledgeable investors.
 Regular Plan: Includes distributor commission, suitable for beginners.

6. Advanced Topics

1. Exchange-Traded Funds (ETFs):

o Traded like stocks; combines mutual fund benefits with liquidity.
o Example: Nifty 50 ETF.
2. Side Pocketing:
o Segregating distressed assets from liquid portfolios to protect investors.
o Example: Debt funds with exposure to stressed corporate bonds.
3. REITs and InvITs:
o Investments in real estate and infrastructure projects.
o Example: Embassy Office Parks REIT.

7. Advantages and Disadvantages

Advantages:

1. Access to professional management.

2. Liquidity and diversification.
3. Cost efficiency.

Disadvantages:

1. Market risks.
2. Costs (management fees, expense ratio).
3. Less control for investors.
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8. Factors Influencing Fund Selection

 Example Considerations:
o Historical Performance: Compare rolling returns and risk-adjusted metrics.
o Expense Ratio: Lower is better for long-term growth.
o Fund Manager: Experienced managers often provide more consistent returns.

1. Basics of Mutual Funds

 Definition: A mutual fund is a financial instrument pooling money from multiple investors
to invest in securities like stocks, bonds, or other assets. This pooling allows individual
investors to benefit from professional management and diversification, which they may
not achieve independently.
 Advantages:
o Diversification: Spreads investment risks by holding a portfolio of various assets.
o Professional Management: Experienced fund managers oversee investments.
o Economies of Scale: Reduces costs due to bulk transactions.
o Convenience: Eliminates the need for individual stock/bond selection.
 Illustration: If 1,000 investors each contribute ₹1,000, the pooled ₹10,00,000 is used to
purchase securities. Each investor owns a proportionate share in the total portfolio.

2. Evolution of Mutual Funds

Global Context:

 Originated in the 18th century in the Netherlands.

 Gained prominence in the USA in the 20th century, with laws like the Securities Act (1933)
and the Investment Company Act (1940) providing structure and safeguards.

Indian Context:

1. First Phase (1964-87):

o Formation of Unit Trust of India (UTI), which dominated the market.
o Example: Unit Scheme 1964.
o Assets under management (AUM): ₹6,700 crore by 1988.
2. Second Phase (1987-1993):
o Entry of public sector funds like SBI and LIC.
o Increased competition in the industry.
o AUM grew to ₹47,004 crore by 1993.
3. Third Phase (1993-2003):
o Private sector entry under SEBI's new regulations (1993).
o Notable fund: Kothari Pioneer (now Franklin Templeton).

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 4. Fourth Phase (Post-2003):
o UTI split into Specified Undertaking of UTI and UTI Mutual Fund.
o Increased foreign fund participation and mergers.

3. Types of Mutual Funds

Classification by Structure:

 Open-Ended Funds:
o No fixed maturity; continuous subscription and redemption.
o Example: Liquid Funds.
o Suitable for investors seeking liquidity.
 Close-Ended Funds:
o Fixed duration; listed on stock exchanges for liquidity.
o Example: Fixed Maturity Plans (FMPs).
o Appeals to long-term investors.

Portfolio Management:

 Active Funds:
o Fund managers actively select securities to outperform benchmarks.
o Higher expense ratios due to research and active trading.
 Passive Funds:
o Mimics market indices like Nifty 50.
o Lower costs and consistent performance with benchmarks.

Investment Objectives:

 Growth Funds: Focus on capital appreciation (e.g., Equity Funds).

 Income Funds: Target steady income through bonds.
 Balanced Funds: Combine equity and debt for moderate risk/return.

Portfolio Type:

 Equity Funds: Investments in stocks; high risk, high return.

 Debt Funds: Fixed-income instruments; stable and lower risk.
 Hybrid Funds: Diversified across asset classes for balance.

4. Performance Measurement

Key Metrics:

1. Net Asset Value (NAV): Reflects per-unit market value of a mutual fund after deducting
liabilities.
2. Sharpe Ratio: Evaluates return per unit of total risk.
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 -adjusted return by comparing excess returns to volatility.

1. Treynor Ratio: Measures return relative to systematic risk.

2. Jensen’s Alpha: Indicates a fund’s performance over a benchmark.

Indicates a fund manager's skill in outperforming the market for a given risk level.

Cost Analysis:

 Expense Ratio: Percentage of fund assets used for operational expenses.

o Example: A fund with an AUM of ₹100 crore and expenses of ₹2 crore has an
expense ratio of 2%.

Rolling Returns:

 Provides a smoothened performance view over various intervals.

 Helps identify consistency in fund performance.

5. Regulatory Features

 Direct vs. Regular Plans:

o Direct Plans: Lower costs but require self-management.
o Regular Plans: Include distributor fees for guidance.
 Key Documents:
o Scheme Information Document (SID): Comprehensive scheme details.
o Key Information Memorandum (KIM): Simplified version of SID.
o Statement of Additional Information (SAI): Includes fund constitution.

6. Advanced Topics

Money Market Mutual Funds (MMMFs):

 Short-term investments in instruments like Treasury bills.

 Provide liquidity and safety for investors.

Exchange-Traded Funds (ETFs):

 Traded on stock exchanges.

 Example: Gold ETFs track gold prices.

Side Pocketing:

 Used for segregating bad assets to protect other investors.

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REITs and InvITs:

 REITs: Investments in income-generating real estate.

 InvITs: Infrastructure projects like toll roads and power plants.

7. Advantages and Disadvantages

Advantages:

 Professional management.
 Access to a diversified portfolio.
 Flexibility and liquidity.

Disadvantages:

 Market risks.
 Management fees.
 Lack of control over individual investments.

8. Fund Selection Criteria

 Performance History: Assess past performance and consistency.

 Fund Manager Expertise: Track record and management style.
 Costs: Lower expense ratios preferred.
 Risk Alignment: Choose funds based on risk tolerance.

Types of Mutual Funds Based on Investment Portfolio

This classification categorizes mutual funds based on the composition of their underlying assets.
Below is a deep dive into each portfolio type.

1. Equity Schemes

Overview:

 Equity schemes invest primarily in stocks and aim for capital appreciation.
 Suitable for investors with a high-risk appetite and a long-term investment horizon.

Categories of Equity Schemes:

1. Multi-Cap Funds:

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 o Characteristics: Invest in stocks across large-cap, mid-cap, and small-cap
companies.
o Minimum Allocation: 65% of assets in equity instruments.
o Objective: Balanced risk and return profile by diversifying across market
capitalizations.
o Example: A fund investing 40% in large caps, 35% in mid-caps, and 25% in small
caps.
2. Large-Cap Funds:
o Characteristics: Focus on the top 100 companies by market capitalization.
o Minimum Allocation: 80% of assets in large-cap stocks.
o Objective: Stable returns with relatively lower risk.
3. Mid-Cap Funds:
o Characteristics: Invest in mid-cap companies ranked 101-250 in market
capitalization.
o Minimum Allocation: 65% of assets in mid-cap stocks.
o Objective: Higher growth potential but with increased volatility.
4. Small-Cap Funds:
o Characteristics: Target small-cap companies (251st onward in market cap
rankings).
o Minimum Allocation: 65% in small-cap stocks.
o Objective: High-risk, high-reward opportunities.
5. Sectoral/Thematic Funds:
o Characteristics: Focus on a specific sector (e.g., IT, Pharma) or theme (e.g., ESG,
Infrastructure).
o Minimum Allocation: 80% in the chosen sector/theme.
o Objective: Benefit from sector-specific growth trends.
o Risk: Limited diversification increases risk if the sector underperforms.
6. Dividend Yield Funds:
o Characteristics: Invest in stocks offering high dividend yields.
o Minimum Allocation: 65% in equity.
o Objective: Generate income with moderate growth.
7. Value and Contra Funds:
o Value Funds: Follow a value investment strategy, targeting undervalued stocks
with potential for growth.
o Contra Funds: Employ a contrarian strategy, investing in stocks that are
temporarily out of favor.
o Minimum Allocation: 65% in equity.
8. Focused Funds:
o Characteristics: Invest in a limited number of stocks (maximum 30).
o Objective: Concentrated investment strategy for higher returns.
9. ELSS (Equity Linked Savings Scheme):
o Characteristics: Tax-saving fund with a statutory lock-in of 3 years under Section
80C of the Income Tax Act.
o Minimum Allocation: 80% in equity.
o Objective: Provide tax benefits and wealth creation.

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2. Debt Schemes

Overview:

 Invest in fixed-income instruments like bonds and government securities.

 Suitable for risk-averse investors seeking stability and regular income.

Categories of Debt Schemes:

1. Overnight Funds:
o Investments: Overnight securities maturing in 1 day.
o Objective: Safety of principal with minimal returns.
2. Liquid Funds:
o Investments: Debt/money market securities with a maturity of up to 91 days.
o Objective: High liquidity and low risk, suitable for short-term parking of surplus
funds.
3. Ultra-Short Duration Funds:
o Investments: Debt instruments with a Macaulay duration of 3-6 months.
o Objective: Slightly higher returns than liquid funds with minimal interest rate risk.
4. Short, Medium, and Long Duration Funds:
o Differentiated by the portfolio's Macaulay duration:
 Short Duration: 1-3 years.
 Medium Duration: 3-4 years.
 Long Duration: Greater than 7 years.
o Objective: Varying risk-return profiles based on interest rate sensitivity.
5. Credit Risk Funds:
o Investments: At least 65% in lower-rated corporate bonds (below AAA).
o Objective: Generate high returns by taking credit risk.
6. Gilt Funds:
o Investments: Minimum 80% in government securities (G-Secs).
o Objective: Safety and steady returns.
o Variants: Include Gilt Funds with a 10-year constant duration.
7. Corporate Bond Funds:
o Investments: Minimum 80% in highest-rated corporate bonds (AAA).
o Objective: Secure income with low credit risk.
8. Dynamic Bond Funds:
o Investments: Across durations depending on interest rate cycles.
o Objective: Maximize returns by adapting to market conditions.

3. Hybrid Schemes

Overview:

 Combine equity and debt investments to balance risk and return.

 Ideal for moderate-risk investors.

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Categories of Hybrid Schemes:

1. Conservative Hybrid Fund:

o Allocation: 10%-25% in equity, 75%-90% in debt.
o Objective: Focus on stable income with minimal risk.
2. Balanced Hybrid Fund:
o Allocation: 40%-60% each in equity and debt.
o Objective: Balance between growth and income.
3. Aggressive Hybrid Fund:
o Allocation: 65%-80% in equity, 20%-35% in debt.
o Objective: Emphasize growth with moderate risk.
4. Arbitrage Fund:
o Strategy: Exploits price differences between cash and derivatives markets.
o Objective: Risk-free returns in volatile markets.
5. Dynamic Asset Allocation:
o Strategy: Adjusts equity and debt allocation dynamically based on market
conditions.

4. Solution-Oriented & Other Funds

Solution-Oriented Funds:

1. Retirement Funds:
o Lock-in of at least 5 years or until retirement age.
o Objective: Long-term wealth accumulation for retirement.
2. Children’s Funds:
o Lock-in of at least 5 years or until the child reaches adulthood.
o Objective: Funding educational or other future expenses.

Other Funds:

1. Index Funds/ETFs:
o Invest in a specific index, replicating its performance.
o Suitable for passive investors seeking low-cost exposure to benchmarks.
2. Fund of Funds (FoF):
o Invest in other mutual funds rather than securities.
o Can be domestic or overseas.

5. Multi-Asset Funds

Overview:

 Invest in multiple asset classes (e.g., equity, debt, commodities).

 Minimum 10% allocation in at least three asset classes.

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Objective:

 Diversification to reduce risk and optimize returns during market volatility.

6. Arbitrage Funds

Overview:

 Execute simultaneous buy and sell of securities in different markets to lock in price
differentials.
 Risk-free returns with no exposure to directional market risks.
 Example: Buy a stock in the cash market and sell it in the futures market.

Signals Highlighting the Exit of the Investor from Mutual Fund Schemes

Exiting a mutual fund can be a strategic decision influenced by various signals. Key indicators
include:

1. Underperformance Against Benchmark:

 Explanation: If the mutual fund consistently underperforms its benchmark index or peer
funds over a prolonged period, it may indicate inefficiency in fund management.
 Action: Compare the fund’s returns with its benchmark (e.g., Nifty 50, Sensex) over various
timeframes (1 year, 3 years, etc.).

2. Change in Fund Manager or Strategy:

 Explanation: A new fund manager may bring a different investment philosophy, which
could impact performance.
 Action: Monitor changes in strategy or asset allocation post management changes.

3. Persistent High Expense Ratios:

 Explanation: Excessively high costs reduce returns. Funds with high expense ratios
compared to peers should be reconsidered.
 Action: Evaluate the Total Expense Ratio (TER) periodically.

4. Style Drift:

 Explanation: When a fund deviates from its stated objectives or investment strategy, it
increases risk and misaligns with investor goals.
 Action: Check whether the portfolio aligns with the fund’s stated investment mandate.

5. Changes in Personal Financial Goals:

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  Explanation: A change in life circumstances (e.g., nearing retirement, large expenses) may
require reallocating funds to better-suited investments.
 Action: Align investments with updated financial goals.

6. Excessive Portfolio Overlap:

 Explanation: If multiple mutual funds in a portfolio hold similar securities, diversification

benefits are reduced.
 Action: Regularly review the portfolio for redundancy.

7. Significant Changes in Market Conditions:

 Explanation: Market downturns or interest rate hikes may affect specific fund categories
(e.g., debt funds during rate hikes).
 Action: Consider rebalancing or shifting to safer options during turbulent times.

Money Market Mutual Funds (MMMFs)

Overview:

 MMMFs invest in short-term debt instruments like Treasury bills, commercial papers, and
certificates of deposit.
 Ideal for investors seeking liquidity, low risk, and moderate returns.

Characteristics:

1. Short-Term Maturity:
o Investment instruments typically have maturities less than a year.
o Examples: T-bills (91 days), commercial papers (6 months).
2. Liquidity:
o Highly liquid, allowing investors to access their funds quickly.
3. Low Risk:
o Investments in high-credit-quality instruments minimize risk.
4. Returns:
o Relatively lower compared to long-term funds but stable.

Suitability:

 Temporary parking of funds.

 Emergency reserves.

Separation of Distribution and Advisory Functions in the Mutual Fund Industry

Background:

 SEBI introduced norms to separate advisory services from distribution to prevent conflicts
of interest.

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  Distributors previously earned commissions from recommending funds, leading to biased
advice.

Key Features:

1. Fee-Based Advisory:
o Registered investment advisors (RIAs) offer advice for a fee without receiving
commissions.
2. No Dual Role:
o An entity cannot simultaneously act as an advisor and distributor.
3. Transparency:
o Clear demarcation between advice and product sale ensures unbiased
recommendations.
4. Investor Benefits:
o Improved trust and clarity in mutual fund investments.
o Enhanced focus on client needs rather than commissions.

Exchange-Traded Funds (ETFs)

Overview:

 ETFs are mutual funds traded on stock exchanges like stocks.

 They combine the features of mutual funds (diversification) and stocks (real-time trading).

Characteristics:

1. Passive Management:
o Most ETFs track an index, such as Nifty 50 or gold prices.
2. Low Expense Ratio:
o Cheaper than actively managed funds.
3. Liquidity:
o Traded throughout the day on exchanges.

Types of ETFs:

 Equity ETFs: Track equity indices.

 Debt ETFs: Invest in bonds and fixed-income securities.
 Commodity ETFs: Track commodities like gold or silver.

Suitability:

 Ideal for investors seeking low-cost, diversified exposure to markets.

Side Pocketing

Definition:

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  Side pocketing involves segregating distressed or illiquid assets from the main portfolio to
protect investors.

Purpose:

 To ensure that new investors or existing ones do not bear losses from bad assets.

Mechanism:

1. Segregation:
o Illiquid assets are separated into a side pocket, creating a distinct unit.
2. Redemption Restriction:
o Investors cannot redeem units from the side pocket until the assets regain liquidity
or value.

Example:

 If a bond defaults or becomes illiquid, its value is segregated, and only healthy assets
remain in the main portfolio.

Benefits:

 Protects existing investors.

 Offers transparency.

Tracking Error

Definition:

 Tracking error measures the deviation between a fund’s performance and its benchmark
index.

Formula:

Tracking Error=

Where:

 RfR_f: Fund return.

 RbR_b: Benchmark return.
 n: Number of observations.

Low vs. High Tracking Error:

 Low Tracking Error: Indicates better benchmark replication (common in ETFs).

 High Tracking Error: Implies poor alignment with the benchmark.

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Causes:

1. Cash holdings.
2. Fees and expenses.
3. Market timing strategies.

Real Estate Investment Trusts (REITs) & Infrastructure Investment Trusts (InvITs)

REITs:

 Invest in income-generating real estate like commercial properties and warehouses.

 Offer dividends from rental income and potential capital appreciation.

InvITs:

 Focus on infrastructure projects like roads, power plants, and telecommunications.

 Generate returns from tolls, tariffs, or leases.

Characteristics:

1. Structure:
o Both operate like mutual funds, pooling money from investors.
2. Liquidity:
o Listed on stock exchanges, providing liquidity.

Benefits:

 Regular income via dividends.

 Diversification beyond traditional asset classes.

Example:

 REITs: Embassy Office Parks REIT (India).

 InvITs: India Grid Trust.

CHAPTER 11: PRIVATE EQUITY

Chapter Overview

The chapter focuses on Private Equity (PE), its meaning, classifications, cost structure, exit
routes, valuation processes, and fund structures. It also delves into specific terminologies and
concepts that define private equity investments and strategies.

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1. Meaning and Classification of Private Equity

Definition:

 Private Equity refers to investments made by PE firms into enterprises in the form of equity
capital. These investments are typically in startups, emerging businesses, or established firms
needing strategic funding.

Characteristics:

 PE focuses on high-risk, high-reward investments.

 PE firms often act as strategic mentors for the companies they invest in.
 The goal is to amplify returns through valuation increases, often employing leverage (debt
funding).

2. Classifications

2.1 Venture Capital (VC)

 Purpose: Funding early-stage startups or innovative businesses.

 Who Benefits:
o Startups
o Innovative and niche enterprises
o High-risk, high-reward sectors
 Examples: WhatsApp, Facebook, Spotify.

Stages of VC Funding:

1. Seed Capital: Initial funds to acquire assets or set up operations.

2. Crowdfunding: Raising funds from multiple small investors through platforms.
3. Early-Stage Funding: Series A funding for full-scale setup and working capital.
4. Interim Funding:
o Bridge Financing: Short-term funding to meet immediate financial needs.
o Mezzanine Financing: Hybrid of debt and equity financing.
5. Expansion Funding: Long-term funding to scale up operations.

2.2 Buyouts

1. Leveraged Buyouts (LBOs):

o Use significant debt to acquire a company and restructure it for value creation.
o Examples: Tata Steel's acquisition of Corus.
2. Management Buyouts (MBOs):
o Acquisition by the company’s own management team.
o Often supported by PE firms.

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3. Hurdle Rate

 Definition: The minimum return required by investors before profit-sharing begins.

 Application: Ensures Limited Partners (LPs) get a guaranteed minimum return before General
Partners (GPs) share profits.

4. Paid-In Capital

 Represents the funds raised by issuing equity shares, recorded in the equity section of the
balance sheet.

5. Term Sheet

 A document outlining terms and conditions of the PE investment.

 Critical Terms:
o Fee Structure: Includes a "2 and 20" model (2% management fee, 20% carried interest).
o Harvest Year: Planned exit timeline.
o Down Round: When successive funding values the company lower than earlier rounds.
o Anti-Dilution Rights: Protects earlier investors against ownership dilution.
o Exclusivity Agreement: Restricts the company from negotiating with other investors.

6. Cost of Investing in Private Equity

 Includes fund management fees, commissions, and other associated costs. Weighted Average
Cost of Capital (WACC) is often used to assess the investment cost.

7. Exit Routes for Private Equity

1. Initial Public Offering (IPO):

o Allows the PE firm to sell shares to the public.
o Offers high returns but involves market risks and regulatory requirements.
2. Strategic Acquisition:
o The company is acquired by a larger entity, e.g., Instagram’s acquisition by Facebook.
3. Secondary Sale:
o PE firm sells its stake to another PE firm.
4. Management Buyout (MBO):
o Founders or management repurchase the PE firm’s stake.
5. Liquidation:
o The least preferred route, involving the sale of assets at a loss.

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8. Valuation of Private Equity Transactions

Key Concepts:

1. Pre-Money and Post-Money Valuation:

o Pre-Money: Value before investment.
o Post-Money: Value after investment.
2. Ownership Dilution:
o Additional investments dilute existing ownership stakes.
3. Liquidation Preference:
o PE investors receive proceeds before common stockholders during liquidation.
4. Series A & B Funding:
o Series A: Initial round.
o Series B: Follow-up funding.
5. ROI: Rate of return expected by investors.
6. Tranches: Funds released in stages based on milestones.
7. Terminal Value: The projected value at the end of the investment horizon.

9. Private Equity Funds

 Structure:
o General Partner (GP): Manages the fund and makes investment decisions.
o Limited Partners (LP): Contribute capital but have limited management roles.
 Returns:
o Distributed after deducting fund expenses and meeting hurdle rates.
 Tranches and Calls:
o Funds are raised in stages ("calls") as required by the GP.

10. Key Takeaways

 Private equity fills a critical funding gap for innovative and high-growth businesses.
 PE and VC investments have distinct strategies and timelines but share common goals of wealth
creation and strategic growth.
 PE and VC in India are evolving, with increasing regulations under SEBI.

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Answer is a) 70,000/-

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CHAPTER 12: INVESTMENT BANKING

1. Concept of Investment Banking

 Definition:
o Investment banking involves financial intermediaries that help companies raise capital by
underwriting shares or bonds or managing securities issuance.
o In India, SEBI defines a merchant banker as a person involved in issue management,
underwriting, consultancy, or corporate advisory services.
 Global and Indian Players:
o Global: Goldman Sachs, Morgan Stanley, JP Morgan, Deutsche Bank.
o Indian: Bank of America, Barclays Capital, Citi, and JP Morgan.
 Key Areas:
o Corporate Finance:
 Mergers & Acquisitions (M&A): Negotiation, valuation, and deal structuring.
 Underwriting: Purchasing unsold shares or bonds during issuance.
o Sales and Trading:
 Sales: Recommendations and transaction execution for clients.
 Trading: Executing trades on behalf of clients and proprietary trading (using the
bank’s own money for investments).
o Research:
 Analysts recommend buy, hold, or sell based on stock/bond performance.
o Syndicate:
 Facilitates securities placement during public offerings.
 Comparison with Commercial Banking:
o Investment banks act as intermediaries, while commercial banks accept deposits and
lend money directly.
o Investment banks earn fees (underwriting discounts), while commercial banks earn
interest.

2. Functions of Investment Banks

2.1 Initial Public Offering (IPO)

 Investment banks assist companies in:

o Compliance with SEBI regulations.
o Underwriting shares.
o Connecting with institutional and retail investors.
 Key steps:
o Hiring merchant bankers as lead or book-running managers (BRLM).
o Conducting due diligence and preparing a prospectus.

2.2 Follow-On Public Offer (FPO)

 Issuance of additional shares by already-listed companies.

 Often used to raise funds for growth.

2.3 Debt Issuance

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  Companies issue bonds instead of equity when:
o Stock prices are low.
o Existing shareholding dilution is undesirable.
 Importance of credit ratings (e.g., CRISIL, ICRA) in attracting investors.

2.4 Mergers and Acquisitions (M&A)

 M&A is divided into:

o Buy-Side Advisory: Short-listing acquisition targets, preparing term sheets, conducting
due diligence, and finalizing deals.
o Sell-Side Advisory: Identifying buyers, preparing information documents, and negotiating
terms.

2.5 Private Placements

 Selling shares or bonds to private investors instead of the public.

 Often precedes IPOs to gather sufficient funds.

2.6 Financial Restructuring

 Involves renegotiating debt obligations or issuing convertible securities.

 Investment banks guide distressed companies through bankruptcy or restructuring processes.

3. Challenges in Investment Banking

 Pricing:
o Accurate valuation of shares and deals is critical to satisfy all stakeholders.
 Compliance:
o Meeting legal and regulatory requirements during issue management.
 Retention of Talent:
o Competition from startups and fintech for skilled professionals.
 Ethical Concerns:
o Avoiding bias in credit ratings and maintaining market reputation.

4. Developments in Investment Banking

 Post-2008 Financial Crisis:

o Lehman Brothers’ collapse highlighted risks in the sector.
o Banks like Goldman Sachs transitioned to commercial banking models for stability.
 Indian Scenario:
o Slow but resilient economic growth.
o Emerging opportunities in global mergers and acquisitions.
o Focus on ethical practices and relationship-building with clients.

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5. Merchant Banking and Issue Management

5.1 Role of Merchant Bankers:

 SEBI defines merchant bankers as facilitators of issue management and corporate advisory
services.
 Merchant bankers:
o Coordinate with underwriters, registrars, and banks.
o Ensure compliance with SEBI regulations.
 Prohibited Activities:
o Cannot accept deposits, lease assets, or engage in proprietary trading.

5.2 SEBI Responsibilities for Merchant Bankers:

1. Communication:
o Approve all public communications and advertisements.
2. Compliance:
o Submit certificates on news reports and ensure accurate offer document disclosures.
3. Investor Grievances:
o Handle allotments, refunds, and grievances promptly.
4. Due Diligence:
o Verify the accuracy of disclosures and audited financial statements.

5.3 Pre-Issue Management:

 Merchant bankers:
o Draft offer documents.
o Ensure promoter contributions meet regulations.
o Appoint intermediaries (e.g., underwriters, syndicate members).

5.4 Post-Issue Management:

 Focuses on:
o Timely allotment and refunds.
o Advertising subscription details and resolving complaints.
o Coordination with intermediaries to ensure compliance and investor satisfaction.

Key Takeaways

1. Investment banks play a pivotal role in capital raising, M&A, and financial restructuring.
2. Merchant bankers ensure smooth execution of public and private issues by adhering to
regulatory frameworks.
3. Challenges like pricing accuracy, compliance, and ethical standards remain critical to the
industry’s reputation and success.

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Buy-Side Advisory

Buy-side advisory services are provided by investment banks to clients who are interested in
acquiring another company. These services involve identifying suitable targets, negotiating the
deal, and facilitating the transaction. The process is typically divided into the following steps:

1. Short-Listing of Companies to Be Acquired

 Objective: Identify companies that align with the client’s acquisition goals, such as entering new
markets, achieving synergies, or acquiring innovative technology.
 Methodology:
o Leverage the investment bank's network with companies, private equity funds, and
intermediaries to identify suitable acquisition targets.
o Analyze the financial and strategic fit of potential targets.

2. Preparing and Executing a Term Sheet

 Term Sheet: A document outlining the terms and conditions of the proposed acquisition,
including price, payment structure, and other key details.
 Role of Investment Banker:
o Facilitate negotiations with the target company.
o Draft and finalize the term sheet to ensure alignment between parties.

3. Due Diligence

 Objective: Assess the target company’s legal, financial, and operational health.
 Scope:
o Verify assets and liabilities.
o Identify potential risks and liabilities.
o Evaluate cash flows, contracts, and compliance issues.
 Outcome: Provide the client with a clear picture of the target company’s value and risks.

4. Transaction Closure

 Final Steps:
o Negotiate the final agreement with the target company.
o Arrange financing for the deal, if necessary.
o Ensure all regulatory and legal requirements are met.
 Objective: Complete the acquisition in a smooth and timely manner.

Sell-Side Advisory

Sell-side advisory services focus on helping a client (the seller) find suitable buyers for their
business or a part of it. The investment bank works to secure the best possible deal for the seller.
The process involves the following steps:

1. Preparation of Information

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  Objective: Create a comprehensive business profile to present the client company effectively to
potential buyers.
 Role of Investment Banker:
o Prepare a detailed information memorandum covering the client’s business model,
financial performance, growth prospects, and strategic value.

2. Target Short-Listing

 Objective: Identify potential buyers who align with the seller's goals (e.g., strategic fit, financial
capacity).
 Methodology:
o Utilize the investment bank’s network of relationships with private companies, public
companies, private equity funds, and hedge funds.
o Evaluate potential buyers based on their ability to close the deal.

3. Preparing and Executing a Term Sheet

 Role of Investment Banker:

o Help the client negotiate terms with potential buyers.
o Ensure that the term sheet reflects the seller's interests and outlines key aspects like
price, payment terms, and conditions.

4. Due Diligence and Deal Closure

 Due Diligence:
o Assist the buyer in verifying the seller’s financial, legal, and operational information.
o Address any issues raised during due diligence to prevent deal breakdowns.
 Transaction Closure:
o Finalize agreements and oversee the signing of contracts.
o Ensure the deal is closed smoothly, meeting all regulatory and legal requirements.

Key Differences Between Buy-Side and Sell-Side Advisory

Aspect Buy-Side Advisory Sell-Side Advisory
Client The buyer (acquiring company) The seller (company looking to divest)
Objective Find and acquire a suitable company Identify and negotiate with potential
buyers
Primary Focus Evaluating targets and structuring the Presenting the seller attractively to
deal buyers
Role of Investment Conduct due diligence, valuation, and Marketing the seller and facilitating
Bank financing negotiations
End Goal Complete acquisition Successful sale or divestment

Practical Applications

1. Buy-Side Example:
o A tech company looking to acquire a startup with innovative AI capabilities hires an
investment bank to shortlist potential targets, conduct valuation, and facilitate the
acquisition process.
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2. Sell-Side Example:
o A family-owned manufacturing business seeking to sell its operations engages an
investment bank to identify strategic buyers, prepare an information memorandum, and
negotiate terms.

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CHAPTER 13: CREDIT RATING

1. Introduction to Credit Rating

 Credit rating represents an agency's opinion on the likelihood of default on principal and interest
payments of an instrument issued by a company.
 Key Features:
o Not an insurance against default.
o Doesn't judge market value or overall performance.
o Primarily used for debt instruments (not equity).
o Dynamic and subject to change with new information.

2. Rating Services and Types

 Credit rating agencies (CRAs) provide various services:

1. Corporate Sector Ratings: Evaluates business, management, and financial risks.
2. Financial Sector Ratings: Uses the CRAMEL framework to assess banks, NBFCs, and
housing finance companies.
3. Structured Finance: Ratings for complex financial instruments like collateralized debt
obligations.
4. Credit Quality Ratings: Assesses credit quality of debt fund securities.
5. Recovery Risk Ratings: Indicates variability in recovery post-default.
6. Expected Loss (EL) Ratings: Predicts loss over an instrument's life.
7. Insurance Hybrids: Evaluates subordinated debts and hybrid instruments.
8. Independent Credit Evaluation: Reviews residual debt for restructuring plans.
9. REITs and INVITs Ratings: Focuses on real estate and infrastructure investment trusts.

3. Objectives of Credit Rating

 Evaluating debt obligations.

 Guiding investors on risk.
 Enhancing investor confidence.
 Encouraging quality consciousness among issuers.

4. Uses of Credit Rating

 For Investors: Aids in decision-making, time-saving, and comparison of financial instruments.

 For Issuers: Helps meet regulatory requirements, reduces borrowing costs, and enhances
goodwill.

5. Credit Rating Process

1. Request and initial analysis.

2. Rating committee's internal evaluation.
3. Communication and potential appeals by the issuer.
4. Public announcement of rating.
5. Continuous monitoring of assigned ratings.
6. Periodic reviews and updates.

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6. Credit Rating Methodology

 Analyzing risks and business dynamics:

1. Business Risk: Includes strategic, compliance, operational, and reputational risks.
2. Financial Risk: Covers counterparty, political, interest rate, currency, and accounting
risks.
3. Management Evaluation: Analyzing management discussions and reports.
4. Business Environment Analysis: Examines macroeconomic factors and industry-specific
trends.

7. CAMELS Model in Credit Rating

 Focuses on six aspects:

o Capital Adequacy.
o Asset Quality.
o Management.
o Earnings.
o Liquidity.
o Sensitivity to market risks.

8. Rating Revisions

 Ratings are dynamic and reviewed continuously to reflect changes in circumstances.

 Mandated by SEBI to monitor securities throughout their lifecycle.

9. Credit Rating Agencies in India

 Key Agencies:
o CRISIL.
o ICRA.
o CARE.
o Fitch Ratings India.
o ONICRA.
 All are regulated by SEBI.

10. Global Credit Rating Agencies

 Standard & Poor’s (S&P): Operates in 28 countries and provides ratings for various sectors.
 Fitch Ratings: Offers alphabetic scale ratings globally.
 Moody’s Ratings: Focuses on global transparency and integrated financial markets.

11. Credit Rating Agencies and the US Sub-Prime Crisis

 Agencies faced criticism for underestimating risks in mortgage-backed securities, contributing to

the 2008 financial crisis.

12. Limitations of Credit Rating

 Ratings may change over time.

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  Focus on macro factors can overshadow company-specific performance.
 Conflict of interest exists as agencies are paid by entities they rate.
 Lack of accountability and transparency in the rating process.

13. Contemporary Aspects

 SEBI Initiatives:
o Mandated disclosure of default probabilities for issuers.
o Monitoring of bond spreads to enhance transparency.
 RBI Guidelines:
o Emphasis on using AI and social media to improve rating accuracy.
o Encouraging proactive signal detection to preempt defaults.

1. Introduction to Credit Rating

Definition and Purpose:

 Credit rating provides an opinion on the creditworthiness of an entity or instrument. It

assesses the likelihood of timely repayment of interest and principal amounts.
 Credit ratings play a crucial role in the financial ecosystem, helping investors make
informed decisions while enabling issuers to access capital.

Key Characteristics:

 Not an Insurance Against Default: Ratings do not provide a guarantee; they represent an
informed opinion based on available data.
 Non-Judgmental: Credit ratings are not indicative of a company’s operational or financial
performance.
 Debt Instrument Focus: Ratings are primarily assigned to bonds, debentures, and other
fixed-income instruments rather than equity.
 Dynamic Nature: Ratings evolve as new data, risks, or developments emerge.
 Contextual Scales: Different rating scales are used for long-term and short-term
instruments.

2. Rating Services and Types

Overview:

Rating agencies offer specialized services tailored to various financial instruments and industries.
The scope of services ensures that issuers and investors have a clear understanding of risks and
returns.

Types of Rating Services:

1. Corporate Sector Ratings:

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 o Used by companies issuing bonds or debt instruments.
o Evaluates three dimensions:
 Business Risk: Revenue stability, market positioning, and competition.
 Management Risk: Leadership quality, governance, and transparency.
 Financial Risk: Debt levels, cash flows, and liquidity.
2. Financial Sector Ratings:
o Targets banks, NBFCs, housing finance companies, etc.
o Uses the CRAMEL framework for evaluation, emphasizing financial stability, asset
quality, and management practices.
3. Structured Finance:
o Rates complex instruments like collateralized debt obligations (CDOs) and
syndicated loans.
o Focuses on asset class risks and transaction structure.
4. Credit Quality Ratings:
o Reflects the creditworthiness of funds invested in debt securities.
5. Recovery Risk Ratings:
o Assesses potential losses post-default, factoring in collateral value and recovery
mechanisms.
6. Expected Loss (EL) Ratings:
o Introduced for operational infrastructure projects.
o Ratings account for both default probability and recovery expectations.
7. Insurance Hybrids:
o Ratings for non-equity capital instruments like subordinated debt.
o Analyzes risks arising from regulatory restrictions.
8. Independent Credit Evaluation (ICE):
o Mandatory for stressed debt accounts.
o Ensures transparency in debt restructuring plans.
9. REITs and InvITs Ratings:
o Evaluates Real Estate Investment Trusts and Infrastructure Investment Trusts.
o Focuses on portfolio quality, cash flow stability, and leverage.

3. Objectives of Credit Rating

Core Goals:

 Debt Risk Evaluation: Provides clarity on repayment risks.

 Investor Guidance: Helps investors understand risks associated with financial instruments.
 Awareness Building: Educates stakeholders on the significance of credit rating.
 Investor Confidence: Promotes trust in debt markets by enhancing transparency.
 Quality Consciousness: Encourages issuers to maintain high standards.

4. Uses of Credit Rating

For Investors:

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  Time-Saving: Eliminates the need for exhaustive research.
 Risk Benchmarking: Helps compare instruments and issuers.
 Input for Analysis: Mutual funds and institutions rely on ratings for internal evaluations.

For Issuers:

 Regulatory Compliance: SEBI mandates credit ratings for many instruments.

 Cost Efficiency: High ratings translate to lower interest rates and improved funding terms.
 Reputation Building: Enhances goodwill and investor trust.

5. Credit Rating Process

Step-by-Step Overview:

1. Issuer Request:
o The process begins with a formal application by the issuer, providing financial and
operational data.
2. Analysis by Agency:
o Analysts assess:
 Historical performance.
 Risk profiles (strategic, financial, operational).
 Market position and business strategies.
3. Rating Committee Review:
o An independent committee evaluates the analysis to finalize the rating. The issuer
cannot influence this decision.
4. Communication and Appeal:
o The issuer is informed of the rating and can appeal with additional information.
5. Public Disclosure:
o Accepted ratings are publicly announced.
6. Monitoring and Updates:
o Ratings are continuously reviewed, ensuring they reflect current conditions.
7. Rating Watch:
o Instruments may be placed under “Rating Watch” during periods of uncertainty or
change.

6. Credit Rating Methodology

Key Evaluation Parameters:

1. Business Risk:
o Strategic Risk: Challenges arising from outdated business strategies or
technological disruptions.
o Compliance Risk: Penalties due to non-adherence to regulations.
o Operational Risk: Losses caused by internal errors or inefficiencies.
o Reputational Risk: Negative public perception impacting investor confidence.
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 2. Financial Risk:
o Counterparty Risk: Non-fulfillment of contractual obligations.
o Political Risk: Adverse government actions affecting foreign investments.
o Interest Rate Risk: Sensitivity to fluctuating borrowing/lending rates.
o Currency Risk: Exposure to exchange rate volatility.
o Accounting Risk: Poor adherence to financial reporting standards.
3. Management Evaluation:
o Involves analyzing the quality of leadership, strategic vision, and crisis management
capabilities.
4. Business Environment Analysis:
o Examines macroeconomic factors (e.g., inflation, recession) and industry-specific
dynamics.

7. CAMELS Model in Credit Rating

 A holistic framework used to evaluate financial institutions.

 Capital Adequacy: Financial strength and risk absorption capacity.
 Asset Quality: Loan performance and recoverability.
 Management: Leadership and governance efficiency.
 Earnings: Profitability and growth potential.
 Liquidity: Cash flow management and debt servicing capability.
 Sensitivity: Vulnerability to market risks.

8. Rating Revisions

 Ratings are updated periodically to reflect new data or events.

 SEBI mandates ongoing monitoring throughout an instrument’s life.
 Agencies disclose revisions publicly to ensure transparency.

9. Credit Rating Agencies in India

1. CRISIL: Dominates the Indian market with a 60% share.

2. ICRA: Affiliated with Moody’s Investor Services.
3. CARE: Focuses on a wide range of instruments.
4. Fitch Ratings India: A subsidiary of the Fitch Group.
5. ONICRA: Specializes in individual credit ratings.

10. Credit Rating Agencies Abroad

 Standard & Poor’s (S&P): Operates in 28 countries with a focus on sovereign and corporate
ratings.
 Fitch Ratings: Known for its alphabetic scale and global presence.
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  Moody’s: Key contributor to global financial transparency.

11. Credit Rating Agencies and the US Sub-Prime Crisis

 Agencies were criticized for:

o Overrating risky mortgage-backed securities (MBS).
o Failing to anticipate the housing market crash.
o Contributing to the 2008 financial crisis.

12. Limitations of Credit Rating

1. Ratings may not reflect real-time changes.

2. Dependence on issuer-provided information risks inaccuracies.
3. Conflict of interest due to fee-based models.
4. Limited focus on company-specific factors.

13. Contemporary Aspects

1. SEBI Initiatives:
o Probability of default disclosures.
o Enhanced transparency through bond spread tracking.
2. RBI Guidelines:
o Encourages AI and social media integration for proactive monitoring.
o Advocates for early detection of stress signals.

CHAPTER 14: LEASING

1. Introduction to Leasing

Definition:
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Leasing involves granting the right to use an asset (equipment or capital goods) by its owner
(lessor) to another party (lessee) in exchange for periodic payments. It is essentially an alternative
financing mechanism for acquiring expensive assets without requiring upfront capital.

 Example: A construction company leases a crane instead of purchasing it outright. The

company pays monthly rentals while the crane ownership remains with the lessor.

Parties in a Lease Agreement:

1. Lessor:
o Owns the asset.
o Grants usage rights in return for lease rentals.
o Example: A leasing company or financial institution.
2. Lessee:
o Gains usage rights for the asset.
o Pays lease rentals for the agreed period.
o Example: A manufacturing company using leased machinery.

Lease vs. Hire Purchase:

Aspect Lease Hire Purchase

Ownership Stays with the lessor throughout the Transfers to the buyer after the
lease term. final payment.
Balance Sheet Asset is often recorded on the lessor’s Asset is recorded on the buyer’s
Impact balance sheet (depends on lease type). balance sheet from inception.
Depreciation Claimed by the lessor (unless explicitly Claimed by the buyer.
Claims stated otherwise).
Example Leasing office furniture for 3 years. Buying a car through hire
purchase over 5 years.

2. Types of Leasing

2.1. Operating Lease:

 A short-term lease where the ownership rights remain with the lessor.
 The lease term is less than the economic life of the asset.
 Suitable for assets prone to obsolescence or temporary use.
 Examples:
o Leasing computers or printers for an office.
o Renting a vehicle for a month-long project.
 Key Features:
o Lessor bears maintenance and insurance costs.
o Agreements include early termination options.
o No significant risks or rewards are transferred to the lessee.

2.2. Financial Lease:

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  A long-term lease where the lessee assumes ownership-like responsibilities, except legal
ownership.
 Covers most of the asset’s economic life.
 Examples:
o Leasing factory equipment for 10 years.
o Renting a fleet of trucks with no early termination clause.
 Key Features:
o Irrevocable during the primary lease period.
o Lessee handles maintenance and insurance.
o Lessee may purchase the asset at the end of the lease term.

Variants of Financial Lease:

1. Lease with Purchase Option:

o Lessee can buy the asset at a pre-agreed price after the lease term.
2. Leveraged Lease:
o A lessor funds the asset purchase through equity and external borrowing.

2.3. Sales and Leaseback:

 Process:
o The lessee sells an existing asset to a lessor and immediately leases it back.
 Purpose:
o Generates cash flow while retaining asset usage.
 Example:
o A company sells its office building to a lessor and leases it back for continued
operations.

2.4. Sales-Aid-Lease:

 Involves collaboration between a leasing company and a manufacturer.

 Purpose:
o Promotes sales of the manufacturer’s products through leasing.
 Example:
o A tractor manufacturer collaborates with a leasing firm to offer tractors on lease to
farmers.

3. Advantages of Leasing

Lessee Benefits:

1. Flexibility:
o Leasing companies customize terms based on the lessee’s requirements.
o Example: Adjusting lease tenure for seasonal businesses.
2. 100% Financing:
o Lessees can acquire assets without initial down payments.
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 o Example: A start-up leases machinery without tying up limited capital.
3. Risk Mitigation:
o Lessees avoid risks of obsolescence, especially for technological assets.
o Example: Leasing smartphones for employees ensures they are upgraded
frequently.
4. Tax Benefits:
o Lease rentals may qualify as tax-deductible expenses.
5. Liquidity:
o Sale and leaseback agreements provide immediate cash for urgent needs.
o Example: A retail store raises funds for inventory by leasing back its owned
premises.

4. Disadvantages of Leasing

1. Higher Long-Term Costs:

o Lease rentals can be more expensive than buying over time.
o Example: Leasing a vehicle for 5 years might cost more than buying it outright.
2. Lack of Ownership:
o Lessees don’t own the asset, which could limit control.
o Example: A lessee cannot customize a leased property without approval.
3. Immediate Payments:
o Unlike loans with moratoriums, lease rentals start immediately.
o Example: A new project incurs lease costs even before generating revenue.
4. Bank Default Risks:
o If the lessor defaults on their bank obligations, the asset might be repossessed.
o Example: A manufacturing company loses its leased machinery due to lessor
bankruptcy.

5. Evaluation of Lease Proposals

Lessee’s Perspective:

1. Present Value Analysis (Net Advantage of Leasing, NAL):

o Compares the cost of owning vs leasing.
o Formula:
NAL=PV of Owning Costs−PV of Leasing Costs
o Example:
o Machine Cost: ₹5,00,000.
o Lease Payments: ₹73,976/year for 10 years.
o Borrowing Interest: 16%.
o NAL = ₹3,32,205 (owning) - ₹2,87,915 (leasing) = ₹44,290.
Leasing is preferred since NAL > 0.
2. Internal Rate of Return (IRR):
o Calculates the effective cost of leasing.

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 o Compares it to the cost of borrowing or other funding sources.
3. Bower-Herringer-Williamson Method:
o Separates financial and tax aspects.
o Prefers leasing if financial benefits outweigh tax disadvantages.

Lessor’s Perspective:

 Leasing is treated as a capital budgeting decision:

1. Net Present Value (NPV): Accept leasing if NPV ≥ 0.
2. Internal Rate of Return (IRR): Accept if IRR > WACC.
 Example:
o Asset Cost: ₹1,50,00,000.
o Salvage Value: ₹10,00,000.
o Depreciation Tax Benefit: ₹27,34,184.
o BELR (minimum rental): ₹49,59,100/year (pre-tax).

6. Cross-Border Leasing

Definition:

Leasing agreements between parties in different countries.

 Examples:
o Leasing aircraft for international operations.
o Telecommunications equipment leased for global projects.

Key Features:

1. Tax Arbitrage:
o Exploits differences in depreciation and ownership rules across countries.
o Example: Double-dip leases for tax benefits in both jurisdictions.
2. Benefits:
o 100% financing for high-cost infrastructure.
o Easier repossession in case of default.

7. Regulatory Aspects

 Leasing companies are categorized as Non-Banking Financial Companies (NBFCs).

 Must register with the Reserve Bank of India (RBI).
 Requirements:
o Minimum net owned funds of ₹25 lakh.
o Compliance with NBFC public deposit guidelines.

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CHAPTER 16: SEBI REGULATIONS – COMPLIANCES IN CAPITAL MARKET

SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR)

The SEBI ICDR Regulations, 2018, provide a comprehensive framework governing the issuance of
securities in the Indian capital market. Its purpose is to ensure transparency, protect investor
interests, and facilitate smooth capital raising by companies.

1. Introduction

The Securities and Exchange Board of India (SEBI) serves as the apex regulator of the Indian
securities market. The ICDR regulations are specifically designed to:

 Govern the process of raising capital.

 Ensure full disclosure of relevant information to investors.
 Foster trust and transparency in the capital markets.

Key Purpose

 Investor Protection: Prevents fraudulent activities by ensuring accurate and adequate

disclosures.
 Market Integrity: Promotes fairness and transparency in capital issuance.
 Facilitating Fundraising: Provides guidelines for companies raising funds via IPOs, rights
issues, or other methods.

2. Key Objectives

The ICDR regulations are built around three primary goals:

1. Ensuring Investor Protection:

o By establishing strict norms for disclosures, the regulations prevent manipulation
or withholding of critical information.
o Investors receive all material facts to make informed decisions.
2. Promoting Market Integrity:
o Establishes standards for capital issuance to ensure fairness in pricing and
allotment.
o Discourages unfair practices like price rigging.
3. Facilitating Capital Raising:
o Provides a structured framework for companies to issue securities such as Initial
Public Offerings (IPOs), Rights Issues, and Preferential Allotments.

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3. Major Compliances under ICDR

3.1 Appointment of Lead Managers, Intermediaries, and Compliance Officer

 Lead Managers:
o Companies issuing securities must appoint SEBI-registered merchant bankers as
lead managers.
o If multiple lead managers are involved, their roles must be predefined and
disclosed in the offer documents.
 Other Intermediaries:
o Includes registrars, syndicate members, and self-certified syndicate banks (for
ASBA process).
o Lead managers assess their capabilities before appointment.
 Compliance Officer:
o Responsible for ensuring adherence to regulations and resolving investor
grievances.

3.2 Disclosures in and Filing of Offer Documents

 Material Disclosures:
o Offer documents must include material information such as financial data, risk
factors, and business objectives.
o Disclosures must be true, adequate, and enable investors to make informed
decisions.
 Filing Requirements:
o Draft offer documents must be filed with SEBI and the stock exchanges.
o SEBI reviews and provides observations within 30 days. Companies must
incorporate SEBI’s suggestions before finalizing the document.
 Public Comments:
o Draft offer documents are made public for at least 21 days, allowing stakeholders
to provide feedback.

3.3 Issuance Conditions and Procedures

 Minimum Public Offer:

o Specifies the minimum percentage of securities that must be offered to the
public.
 Prohibition on Incentives:
o Prevents companies from offering incentives (cash, gifts, etc.) to encourage
subscriptions.
 Security Deposit:
o Issuers must deposit 1% of the issue size with the designated stock exchange as a
safeguard.
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3.4 Monitoring and Utilization of Funds

 Companies raising funds above ₹100 crore must appoint a monitoring agency to oversee
fund utilization.
 The monitoring agency submits quarterly reports to the issuer’s board, ensuring that
funds are used only for stated objectives.
 These reports must also be publicly disseminated, increasing transparency.

3.5 Advertisement Norms

 Pre-Issue Advertisements:
o Companies must publish advertisements in national and regional newspapers
announcing the filing of offer documents.
 Post-Issue Advertisements:
o Details like subscription levels, allotments, and refund timelines must be
published within 10 days of the issue's closure.
 Prohibitions:
o Advertisements cannot mislead or suggest the issue's success (e.g., stating it is
fully subscribed before closure).

3.6 Post-Issue Responsibilities

 Role of Lead Managers:

o Ensure timely allotment of securities or refunds.
o Handle investor grievances until all securities are listed and funds are refunded.
 Monitoring Syndicate Members:
o Lead managers coordinate with syndicate members and registrars to ensure
smooth processing of applications and allotments.

4. Key Features of SEBI ICDR

4.1 Framework for Initial Public Offerings (IPOs)

 Companies must meet eligibility criteria, such as:

o Net tangible assets of at least ₹3 crores for the preceding three years.
o Positive cash flows from operating activities in at least two out of the last three
years.
 Book-Building Process:
o A pricing mechanism where investors bid for shares within a price band.
o Ensures that share prices reflect market demand.
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  Fixed Price Issue:
o The price is predetermined and disclosed in the offer document.

4.2 Preferential Allotment

 Allotment of shares to specific investors (e.g., private equity firms) on a preferential

basis.
 Pricing must be based on SEBI-mandated formulas, considering past trading data.

4.3 Rights Issue

 Allows existing shareholders to purchase additional shares at a discounted price.

 Offer documents must disclose the issue's purpose and the rationale for the price
discount.

5. Impact of SEBI ICDR Regulations

 Investor Trust:
o Accurate disclosures reduce the risk of fraud, increasing investor confidence in
the securities market.
 Market Efficiency:
o Standardized processes streamline capital raising, benefiting issuers and investors
alike.
 Global Competitiveness:
o Aligns Indian capital market practices with international standards, attracting
foreign investment.

SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR)

1. Introduction

The SEBI (LODR) Regulations, 2015, provide a comprehensive framework for listed entities to
meet disclosure obligations and governance standards. They aim to:

 Ensure transparency in financial reporting and material event disclosures.

 Strengthen corporate governance by requiring adherence to global best practices.
 Foster trust and confidence among investors by mandating proactive grievance redressal
mechanisms.

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2. Key Objectives

1. Disclosure Norms:
o Detailed guidelines ensure timely disclosure of material events such as:
 Financial results.
 Mergers and acquisitions.
 Changes in key management personnel.
 Cybersecurity breaches or data loss incidents.
2. Corporate Governance:
o Promotes board independence, ethical practices, and committee-based decision-
making.
3. Protection of Shareholder Interests:
o Related party transactions and significant changes require shareholder approval
to maintain fairness.
4. Simplification:
o Consolidates various listing agreements into a single, unified regulation.

3. Detailed Explanation of Major Compliances

3.1 Compliance Officer and Obligations (Regulation 6)

 Appointment:
o A qualified Company Secretary is mandatory to act as the Compliance Officer.
o The role is critical in ensuring that the listed entity adheres to SEBI norms.
 Responsibilities:
o Regulatory Conformity: Ensuring compliance with SEBI regulations in letter and
spirit.
o Liaison: Acting as a point of contact between the company, stock exchanges, SEBI,
and investors.
o Filing Accuracy: Guaranteeing the correctness, authenticity, and timeliness of
reports, filings, and disclosures.
o Monitoring Grievance Redressal: Ensuring that investor complaints are
addressed through the entity's grievance redressal system.

3.2 Share Transfer Agent (Regulation 7)

 Obligations:
o Appoint a share transfer agent if security holders exceed 1,00,000.
o Alternatively, entities may manage share transfer facilities in-house.
 Compliance Certification:
o Submit an annual compliance certificate signed by:
 The Compliance Officer.
 The Authorized Representative of the share transfer agent.

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 o The certification ensures that share transfers are conducted efficiently and
transparently.

3.3 Preservation of Documents (Regulation 9)

 Documents must be categorized into:

1. Permanent Records:
 Examples: Board minutes, certificates of incorporation, and charters.
 Essential for audits, legal scrutiny, and corporate history.
2. Time-Limited Records:
 Examples: Financial statements (minimum eight years).
 Useful for compliance and regulatory reporting.
 Electronic Storage:
o Permitted for both categories, ensuring easy access and security against physical
loss.

3.4 Grievance Redressal Mechanism (Regulation 13)

 Key Requirements:
o Entities must resolve investor complaints within 21 calendar days.
o Mandatory registration on the SCORES platform enables electronic complaint
handling.
 Quarterly Reporting:
o A statement must be filed with stock exchanges detailing:
 Number of complaints at the start and end of the quarter.
 New complaints received and resolved.
o This report ensures accountability and allows SEBI to monitor redressal timelines.

3.5 Audit Committee (Regulation 18)

 Composition:
o Minimum three directors.
o Two-thirds must be independent directors.
o Members must be financially literate, with at least one having financial expertise.
 Responsibilities:
o Review financial statements, internal audit reports, and risk management
systems.
o Investigate irregularities and escalate significant issues to the board.
 Meeting Frequency:
o Minimum four meetings per year, ensuring regular oversight.

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3.6 Nomination and Remuneration Committee (Regulation 19)

 Composition:
o At least three directors, all non-executive, with two-thirds independent.
o Chaired by an independent director.
 Role:
o Formulate policies for director appointments.
o Recommend executive compensation aligned with company performance.

3.7 Stakeholders Relationship Committee (Regulation 20)

 Composition:
o Minimum three directors, including one independent director.
o Chaired by a non-executive director.
 Responsibilities:
o Address grievances related to securities, dividends, and debenture issues.
o Resolve disputes between security holders and the company.

3.8 Risk Management Committee (Regulation 21)

 Applicability:
o Compulsory for the top 1,000 listed entities by market capitalization.
 Composition:
o At least three members, with a majority being board members.
o One member must be an independent director.
 Role:
o Oversee enterprise risks, including financial, operational, and cybersecurity risks.
 Meeting Requirements:
o At least two meetings per year, with no more than 180 days between them.

3.9 Vigil Mechanism (Regulation 22)

 Entities must establish a whistleblower policy that:

o Encourages directors and employees to report unethical practices.
o Provides safeguards against victimization.
o Allows direct access to the Chairperson of the Audit Committee for critical issues.

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3.10 Secretarial Audit and Compliance Report (Regulation 24A)

 Secretarial Audit:
o Conducted by a practicing Company Secretary to evaluate compliance with
corporate laws and SEBI regulations.
 Compliance Report:
o Must be submitted to stock exchanges within 60 days of the financial year-end.
o Highlights compliance status and gaps.

3.11 Corporate Governance Compliance (Regulation 27)

 Entities must file a quarterly corporate governance report to stock exchanges.

 Key Details:
o Composition of the board and committees.
o Updates on material related-party transactions.
o Cybersecurity incidents, if any.

3.12 Prior Intimations to Stock Exchanges (Regulation 29)

 Listed entities must provide prior notice for:

o Board meetings related to buybacks, delisting, and fundraising activities (two
working days).
o Financial result disclosures (five working days).

4. Key Features and Significance

1. Transparency:
o Timely disclosures ensure that investors are well-informed about corporate
activities.
2. Accountability:
o Board-level oversight, committee structures, and compliance reports hold
companies accountable for their actions.
3. Investor Protection:
o Grievance redressal mechanisms and related-party transaction norms safeguard
shareholder interests.

6. Non-Compliance Penalties

SEBI imposes strict penalties for non-compliance with LODR regulations, such as:

 Monetary Fines: Up to ₹25 crores or three times the profit made due to non-compliance.
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  Suspension of Trading: SEBI may suspend trading of securities for prolonged violations.
 Prosecution: Serious breaches can lead to legal action against directors.

SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR)

2. Key Objectives

1. Disclosure Norms:
o Mandates timely and accurate disclosures of financial results, material events,
and other crucial information.
2. Corporate Governance:
o Strengthens governance practices through the formation of mandatory
committees, such as Audit Committees and Nomination Committees.
3. Fairness in Related Party Transactions:
o Ensures transparency and shareholder approval for material related-party
transactions to avoid conflicts of interest.
4. Adherence to a Code of Conduct:
o Listed entities must adopt and adhere to a code of conduct for ethical business
practices.
5. Simplification:
o Consolidated multiple listing agreements into one regulation for clarity and ease
of compliance.

3. Major Compliances under LODR

The regulations detail specific obligations for listed entities, categorized by their scope and
impact.

3.1 Compliance Officer and Obligations (Regulation 6)

 Appointment:
o A qualified Company Secretary must be appointed as the Compliance Officer.
 Responsibilities:
o Ensuring compliance with applicable regulatory provisions in both letter and
spirit.
o Coordinating with the Board, stock exchanges, and depositories for compliance
matters.
o Ensuring the authenticity and comprehensiveness of submitted statements,
reports, and filings.
o Monitoring the grievance redressal system for investors.

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3.2 Share Transfer Agent (Regulation 7)

 Listed entities must:

o Appoint a share transfer agent or manage share transfer facilities in-house.
o If the number of security holders exceeds 1,00,000, entities must either:
 Register with SEBI as a Category II Share Transfer Agent.
 Appoint a Registrar to an Issue and Share Transfer Agent (RTA) registered
with SEBI.
 Compliance Certification:
o Submit a compliance certificate to stock exchanges annually, jointly signed by the
Compliance Officer and RTA.

3.3 Preservation of Documents (Regulation 9)

 The company must categorize documents into:

1. Permanent Preservation:
 Examples: Minutes of board meetings, Memorandum of Association
(MOA), Articles of Association (AOA).
2. Preservation for a Minimum of Eight Years:
 Examples: Annual returns, audit reports.
 Documents can be preserved in physical or electronic form.

3.4 Grievance Redressal Mechanism (Regulation 13)

 Investor grievances must be resolved within 21 calendar days from receipt.

 Entities must be registered on SEBI’s SCORES platform to handle complaints
electronically.
 Quarterly Filing Requirements:
o File a report with stock exchanges on:
 Pending investor complaints at the start of the quarter.
 Complaints received, resolved, and pending at the end of the quarter.
o Reports must also be placed before the company’s Board of Directors.

3.5 Audit Committee (Regulation 18)

 Composition:
o Minimum three members, with two-thirds being independent directors.
o All members must be financially literate, and at least one must have financial or
accounting expertise.
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 o Chaired by an independent director who must attend the Annual General
Meeting (AGM).
 Meetings:
o At least four meetings per year, with no more than 120 days between two
consecutive meetings.
 Quorum:
o Two members or one-third of the committee, whichever is higher, with at least
two independent directors.
 Role and Powers:
o Review financial reporting and internal audit reports.
o Investigate issues within the committee’s scope and seek external advice if
needed.

3.6 Nomination and Remuneration Committee (Regulation 19)

 Composition:
o At least three directors, all non-executive, with two-thirds being independent.
o Chaired by an independent director.
 Responsibilities:
o Identify individuals qualified to become directors or senior management.
o Recommend the board-level appointment or reappointment of directors.
o Determine remuneration policies for directors and executives.

3.7 Stakeholders Relationship Committee (Regulation 20)

 Composition:
o Minimum three members, including at least one independent director.
o Chaired by a non-executive director.
 Responsibilities:
o Address grievances of shareholders, debenture holders, and other security
holders.

3.8 Risk Management Committee (Regulation 21)

 Applicability:
o Mandatory for the top 1,000 listed entities by market capitalization.
 Composition:
o At least three members, with a majority being board members and one
independent director.
 Meetings:
o At least two meetings per year, with no more than 180 days between them.

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  Role:
o Define, monitor, and review the company’s risk management plan.
o Cybersecurity must be specifically addressed.

3.9 Vigil Mechanism (Regulation 22)

 Entities must establish a whistleblower policy for directors and employees to report
genuine concerns.
 Adequate safeguards must be in place to protect whistleblowers from victimization.
 Whistleblowers must have direct access to the Chairperson of the Audit Committee.

3.10 Secretarial Audit and Compliance Report (Regulation 24A)

 Listed entities must:

o Conduct a secretarial audit for compliance with SEBI and Companies Act norms.
o Submit a Secretarial Compliance Report to stock exchanges within 60 days of the
end of the financial year.

3.11 Corporate Governance Compliance (Regulation 27)

 Entities must file a quarterly compliance report with stock exchanges within 21 days of
each quarter’s end.
 The report should include:
o Details of material related party transactions.
o Cybersecurity incidents or breaches.

3.12 Prior Intimations to Stock Exchanges (Regulation 29)

 Listed entities must notify stock exchanges at least two working days before board
meetings to consider:
o Buybacks or delisting proposals.
o Fundraising plans (e.g., through FPOs, rights issues, or QIPs).
o Dividend declarations or bonus securities.
o Financial results (intimation required five working days in advance).

4. Key Features of LODR Regulations

1. Harmonization with Global Standards:

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 o Brings Indian governance practices in line with international benchmarks.
2. Focus on Stakeholders:
o Protects the interests of shareholders, debenture holders, and investors.
3. Proactive Grievance Redressal:
o Encourages companies to resolve issues promptly, ensuring investor trust.

SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (SAST)

SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (SAST)

The SAST Regulations govern the acquisition of shares, voting rights, or control of a listed
company. They aim to ensure transparency, fairness, and the protection of investor rights during
takeover activities.

1. Introduction

 Enacted to regulate takeovers and acquisitions of substantial stakes in listed companies.

 Ensures shareholders receive fair treatment during such transactions.
 Promotes market integrity by standardizing acquisition procedures.

2. Key Objectives

1. Protection of Shareholder Interests:

o Shareholders are informed about significant transactions and have an opportunity
to exit.
2. Market Integrity:
o Prevents unfair practices by ensuring takeovers are conducted transparently.
3. Equal Opportunity:
o All shareholders, including minority shareholders, are given equal treatment in
decision-making during takeovers.

3. Applicability

 Applies to direct and indirect acquisitions of shares or voting rights in a listed company.
 Also applicable to acquisitions resulting in a change of control.

Exemptions:

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  Companies listed on the Innovators Growth Platform (IGP) without raising capital via
public issues are exempt from these regulations.

4. Important Definitions

1. Acquirer:
o A person or entity acquiring shares, voting rights, or control of a target company.
2. Acquisition:
o Direct or indirect acquisition of shares or voting rights in a target company.
3. Control:
o Includes the right to appoint a majority of directors or influence key management
or policy decisions.
4. Frequently Traded Shares:
o Shares traded on a stock exchange, with a turnover exceeding 10% of total shares
during the preceding 12 months.
5. Persons Acting in Concert (PAC):
o Two or more persons working together to acquire shares or voting rights, formal
or informal.

5. Key Provisions

5.1 Types of Offers

1. Mandatory Open Offer (Regulation 3):

o Triggered when an acquirer crosses 25% ownership of shares or voting rights in a
target company.
o Acquirer must make a public announcement to acquire at least an additional 26%
shares.
o Further acquisition exceeding 5% in a financial year (between 25% and 75%
ownership) also triggers this obligation.
2. Voluntary Open Offer (Regulation 6):
o Allows acquirers holding 25%-75% to make a public announcement to acquire
more shares.
o Post-acquisition, the total shareholding must not exceed the maximum
permissible limit for non-public shareholders (75% in most cases).
3. Conditional Offer (Regulation 19):
o The acquirer may set a minimum acceptance level for the offer to be valid.
o For instance, an acquirer may specify that the offer is valid only if 50% of shares
are tendered by shareholders.
4. Competing Offer (Regulation 20):
o A third-party acquirer can make a competing offer within 15 working days of the
first public announcement.
o All competing offers are evaluated, and shareholders choose the best deal.

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5.2 Open Offer Process

1. Appointment of Manager:
o Acquirers must appoint a SEBI-registered Merchant Banker as the Manager to the
Offer.
o Ensures compliance with regulations and fair treatment of shareholders.
2. Public Announcement:
o A short public announcement must be made on the same date as the transaction
triggering the offer.
o A detailed public statement must follow within 5 working days.
3. Offer Price Determination:
o The offer price must be the highest of:
 Negotiated price for the acquisition.
 Volume-weighted average price of shares during the last 60 trading days.
 Highest price paid by the acquirer in the past 52 weeks.
4. Escrow Account:
o Acquirers must deposit a portion of the total offer consideration in an escrow
account before making a public announcement.
o Minimum amounts:
 25% of the first ₹500 crore.
 10% of the remaining consideration.
5. Filing of Letter of Offer:
o Acquirer files a draft Letter of Offer with SEBI within 5 working days of the
detailed public statement.
o SEBI reviews and provides comments within 15 working days.
6. Tendering Period:
o Shareholders have a 10-working-day window to tender their shares after the offer
opens.
7. Completion of Acquisition:
o Acquirer must complete the acquisition within 26 weeks of the offer period's end.

5.3 Disclosure Obligations (Regulation 29 and Regulation 31)

1. Disclosure on Acquisition/Disposal:
o Any acquisition or disposal of shares/voting rights reaching 5% or more must be
disclosed within 2 working days.
o Any subsequent change of 2% or more must also be disclosed.
2. Disclosure of Encumbered Shares:
o Promoters must disclose details of shares pledged, invoked, or released within 7
working days.
3. Annual Declaration:
o Promoters must declare yearly that no encumbrances exist other than those
disclosed.
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6. Types of Acquisitions Covered

1. Direct Acquisitions:
o Buying shares directly from the stock exchange or through agreements with
shareholders.
2. Indirect Acquisitions:
o Acquisitions resulting in control over a company through an intermediary (e.g.,
acquiring a holding company).
3. Control Acquisitions:
o Includes gaining management control or acquiring voting rights without
increasing shareholding.

7. Penalties for Non-Compliance

1. SEBI imposes strict penalties for failing to make timely disclosures or public
announcements:
o Monetary fines up to ₹25 crores.
o Suspension of trading in shares.
o Prosecution for fraudulent transactions.

9. Key Takeaways

1. Ensures shareholder protection by mandating transparency during acquisitions.

2. Encourages fair practices with clear guidelines for price determination and competing
offers.
3. Aligns Indian takeover rules with global standards, attracting foreign investment.

Here is a further expanded and detailed explanation of the SEBI (Substantial Acquisition of
Shares and Takeover) Regulations, 2011 (SAST), as requested. This section will dive deeper into
the provisions, their significance, real-world implications, and practical applications.

SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (SAST).

1. Introduction

The regulations lay down:

 Rules for Takeovers: Ensures fair treatment for all shareholders, especially minority
shareholders, during control changes in listed companies.
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  Market Discipline: Prevents abusive practices such as creeping acquisitions or unfair
prices.
 Public Transparency: Mandates public announcements for material acquisitions, allowing
investors to make informed decisions.

2. Key Objectives

1. Shareholder Protection:
o Provides shareholders the right to exit the company when there is a significant
acquisition or change in control.
2. Transparency:
o Ensures that all stakeholders, including the public, are informed about substantial
acquisitions.
3. Fair Play:
o Prevents acquirers from gaining an unfair advantage and ensures equality among
shareholders.
4. Market Integrity:
o Reduces market manipulation by regulating acquisitions and related disclosures.

3. Detailed Definitions and Applicability

3.1 Important Definitions

1. Acquirer:
o Any person/entity acquiring or intending to acquire shares or control over a listed
company.
o Can act individually or with Persons Acting in Concert (PAC).
2. Persons Acting in Concert (PAC):
o Entities working with a common objective of acquiring shares/control.
o Includes:
 Parent companies, subsidiaries, or related parties.
 Promoters and members of the promoter group.
 Investment funds and their managers.
3. Control:
o Defined as the ability to influence the management, policy decisions, or appoint a
majority of directors.
4. Target Company:
o A listed entity whose shares are being acquired or whose control is being sought.

3.2 Applicability

 Direct Acquisitions:
o Acquirer buys shares directly from shareholders or through stock exchanges.
 Indirect Acquisitions:

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 o Acquirer gains control over a company indirectly, such as by acquiring a holding
company that owns shares in the target company.
 Control Acquisitions:
o Acquisition of management control or key voting rights.

3.3 Exemptions

 Companies listed on the Innovators Growth Platform (IGP) that have not raised public
funds are exempt from SAST regulations.
 Other Exemptions:
o Acquisitions through court-approved schemes like mergers or corporate
restructuring.

4. Detailed Analysis of Key Provisions

4.1 Types of Offers

1. Mandatory Open Offer (Regulation 3)

Triggered under the following circumstances:

 When an acquirer, alone or with PACs, holds 25% or more of voting rights in a company.
 Any subsequent acquisition of 5% or more voting rights in a financial year (if the acquirer
already owns 25%-75% of the company).

Key Features:

 Acquirer must make an open offer to acquire an additional 26% of the company’s shares
from public shareholders.
 Shareholders are given the opportunity to exit the company at a fair price determined by
SEBI norms.

Example:

 If an investor owns 30% of a company and acquires an additional 10%, they must make
an open offer for at least 26% of the remaining shares.

2. Voluntary Open Offer (Regulation 6)

 Acquirers holding 25%-75% of shares can voluntarily acquire additional shares.

 Post-acquisition, the acquirer’s holding must not exceed 75% of the company’s shares
(the maximum limit for public companies in most cases).
 Acquirer must maintain a six-month cooling-off period after completing the offer.

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3. Conditional Offer (Regulation 19)

 Acquirers can specify a minimum level of acceptance for their offer.

 Example: The acquirer may state that the offer is valid only if 50% of shareholders tender
their shares.

4. Competing Offer (Regulation 20)

 Any other acquirer can make a competing offer within 15 working days of the initial
public announcement.
 Shareholders evaluate all competing offers and choose the most favorable.

4.2 Offer Price Determination

The offer price must be the highest of the following:

1. Negotiated price for the acquisition.

2. The volume-weighted average price (VWAP) paid by the acquirer in the last 52 weeks.
3. Highest price paid by the acquirer during the last 26 weeks.
4. VWAP for the last 60 trading days (if shares are frequently traded).

For infrequently traded shares, SEBI requires valuation by independent experts.

4.3 Process and Timeline of Open Offers

1. Public Announcement:
o Must be made immediately upon triggering the open offer.
o Includes details about the acquirer, offer size, and price.
2. Detailed Public Statement:
o Must follow within 5 working days of the public announcement.
3. Draft Letter of Offer:
o Filed with SEBI within 5 working days of the detailed statement.
o SEBI provides comments within 15 working days.
4. Tendering Period:
o Shareholders can tender shares during a 10-working-day window.
5. Completion:
o Acquirer must complete the process within 26 weeks of the end of the tendering
period.

4.4 Escrow Requirements

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  Escrow Account:
o Acquirers must deposit a portion of the offer consideration as security before
making a public announcement.
o Escrow Amount:
 25% for the first ₹500 crore.
 10% for the remaining offer size.

Significance:

 Protects shareholders by ensuring the acquirer’s financial commitment to the offer.

4.5 Disclosure Obligations

1. Regulation 29:
o Any acquisition or disposal of 5% or more voting rights must be disclosed within 2
working days.
o Subsequent changes of 2% or more must also be disclosed.
2. Regulation 31:
o Promoters must disclose encumbrances (pledges, liens, etc.) on shares within 7
working days.
o An annual declaration of all encumbrances is mandatory.

5. Key Features and Safeguards

1. Transparency:
o Disclosures keep the public and minority shareholders informed about major
acquisitions.
2. Fair Valuation:
o The offer price reflects market trends and historical acquisitions, ensuring
fairness.
3. Shareholder Rights:
o Shareholders can exit the company during major acquisitions or control changes.
4. Accountability:
o Managers and acquirers are held responsible for adhering to SEBI regulations.

The SEBI (Buyback of Securities) Regulations, 2018

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1. Introduction

 The SEBI (Buyback of Securities) Regulations, 2018 replaced the earlier regulations of
1998, with improved provisions aligning with contemporary market practices.
 What is a Buyback?
o A corporate action where a company repurchases its shares or specified securities
from existing shareholders.
o Key purpose:
 Enhance shareholder value by reducing the number of outstanding shares.
 Improve financial metrics such as earnings per share (EPS) and return on
equity (ROE).
 Optimize capital structure by efficiently using surplus funds.

2. Key Objectives

1. Enhancing Shareholder Value:

o Buybacks signal management’s confidence in the company’s financial stability.
2. Improving Market Dynamics:
o Helps stabilize stock prices during periods of volatility.
3. Preventing Fund Misuse:
o Buybacks are restricted to legitimate sources like free reserves, ensuring financial
prudence.
4. Ensuring Transparency:
o Regulations mandate comprehensive disclosures and equitable participation for
all shareholders.

3. Applicability
Applicability Scope

1. Listed companies that intend to repurchase their:

o Equity shares.
o Specified securities, such as convertible debentures.
2. Buybacks under Section 68 of the Companies Act, 2013.

Exclusions

 Companies not listed on recognized stock exchanges.

 Buybacks intended for delisting purposes (explicitly prohibited under these regulations).

4. Methods of Buyback

4.1 Tender Offer

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 1. Mechanism:
o Shareholders tender their shares for repurchase at a fixed price determined by
the company.
2. Proportional Allotment:
o Shares are bought back proportionally from all eligible shareholders, ensuring
fairness.
3. Advantages:
o Transparent and equitable process.
o Ensures direct participation by shareholders.

4.2 Open Market Purchase

1. Mechanism:
o Companies repurchase shares directly from the stock exchange at prevailing
market prices.
2. Types:
o Stock Exchange Mechanism: Buyback conducted over the trading platform.
o Book-Building Process: A price range is specified, and shareholders submit bids.
3. Advantages:
o Greater flexibility for companies in terms of pricing and execution.
4. Disclosures:
o Quarterly progress reports are mandatory.

4.3 Other Methods

 Includes buybacks under court-approved schemes like mergers or amalgamations.

5. Pre-Requisites for Buyback

5.1 Approval Requirements

1. Articles of Association (AOA):

o The AOA must explicitly authorize buybacks.
2. Board Approval:
o Buybacks up to 10% of paid-up capital and free reserves can be approved by the
board of directors.
3. Shareholder Approval:
o For buybacks exceeding 10% but within the limit of 25%, a special resolution
must be passed in a general meeting.

5.2 Financial Limits

 Maximum buyback size:

o 25% of the aggregate of paid-up capital and free reserves.
 Applicable to both:
o Standalone financials.
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 o Consolidated financials (in cases of group companies).

5.3 Debt-Equity Ratio

 Post-buyback, the ratio of secured and unsecured debt to free reserves and paid-up
capital must not exceed 2:1.
 Rationale:
o Prevents over-leveraging, ensuring financial health.

5.4 Time Restrictions

 Companies are barred from announcing another buyback within 12 months of

completing a previous one.
 The buyback process must conclude within 6 months from the date of passing the
resolution.

5.5 Fully Paid-Up Securities Only

 Only fully paid-up equity shares or specified securities are eligible for buyback, ensuring
clear ownership records.

6. Prohibited Buybacks

6.1 Prohibited Uses

1. Buybacks cannot be undertaken to:

o Delist securities from the stock exchange.
o Engage in negotiated or spot transactions.
2. Buybacks using proceeds from:
o New issuances of securities.
o Borrowed funds.

6.2 Ineligible Companies

 Companies with unresolved defaults in:

o Repayment of deposits or debentures.
o Redemption of preference shares.
o Dividend payments or statutory dues.
 Defaults must be rectified, and three years must pass after clearance before undertaking
a buyback.

7. Funding Sources for Buyback

Companies can finance buybacks from:

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 1. Free Reserves:
o Unutilized earnings retained from past profits.
2. Securities Premium Account:
o Represents the premium collected over the nominal value of shares.
3. Exclusions:
o Companies cannot use funds raised from the issuance of the same class of
securities being bought back.

8. Detailed Buyback Process

8.1 Filing and SEBI Review

1. Draft Letter of Offer:

o Filed with SEBI within 5 working days of the board/shareholder resolution.
o SEBI provides observations within 7 working days.
2. Disclosures:
o Shareholding pattern before and after the buyback.
o Source of funds and the impact on financial statements.
o Price and rationale for the buyback.

8.2 Public Announcement

 Companies must publish a public announcement in:

o One English national daily.
o One Hindi national daily.
o One regional newspaper where the company’s registered office is located.
 Announcement must detail:
o Buyback price, size, and eligibility criteria.
o Expected timeline and key dates.

8.3 Letter of Offer

 Sent to eligible shareholders within 5 working days of SEBI’s approval.

8.4 Tendering Period

 A 10-working-day window is provided for shareholders to tender their shares.

8.5 Completion and Extinguishment

 Shares accepted for buyback must be extinguished within 7 days.

 Final report on buyback completion must be filed with SEBI and stock exchanges.

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9. Post-Buyback Restrictions

1. Lock-in Period:
o Companies cannot issue the same class of securities for 6 months post-buyback,
except for:
 Bonus shares.
 Stock splits.
 Conversions of debentures or warrants.
2. Dividend Restrictions:
o SEBI discourages large dividend payouts immediately post-buyback to prevent
cash depletion.

10. Reporting and Compliance

1. Progress Reports:
o Quarterly updates for open-market buybacks.
2. Post-Buyback Filings:
o Final compliance report submitted to SEBI within 7 days of buyback completion.
3. Audit Oversight:
o Merchant bankers appointed to oversee adherence to the regulations.

11. Penalties for Non-Compliance

1. Monetary Penalties:
o Fines up to ₹25 crore for violations of disclosure or procedural requirements.
2. Suspension or Delisting:
o Severe violations may result in trading suspension or delisting.
3. Legal Consequences:
o SEBI may initiate legal action against directors or promoters for fraudulent
activities.

Detailed Notes on General Compliance and Filing Requirements under SEBI (Buyback of
Securities) Regulations, 2018

2. Key General Compliance Requirements

2.1 Approval Requirements

1. Board Resolution:
o Companies must pass a board resolution approving the buyback if the amount is
up to 10% of the paid-up capital and free reserves.
2. Shareholder Approval:

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 o If the buyback amount exceeds 10% but is within the statutory limit of 25% of
paid-up capital and free reserves, a special resolution must be passed in a
general meeting.

2.2 Appointment of Intermediaries

1. Merchant Banker:
o The company must appoint a SEBI-registered merchant banker to manage the
buyback.
o The merchant banker oversees compliance, prepares necessary filings, and
submits due diligence reports to SEBI.
2. Registrar and Transfer Agent (RTA):
o Responsible for verifying shareholder records, ensuring accurate communication,
and processing share tenders during the buyback.

3. Filing Requirements under SEBI Regulations

3.1 Public Announcement

 Companies must make a public announcement within two working days of passing the
board or shareholder resolution approving the buyback.
 The announcement must include:
1. Buyback size (amount and percentage of paid-up capital/free reserves).
2. Buyback price.
3. Method of buyback (tender offer or open market).
4. Eligibility criteria for participation.
5. Timelines for the buyback process.

3.2 Filing of Draft Letter of Offer

1. Timeline:
o The company must file a draft Letter of Offer (DLOF) with SEBI within five
working days of the public announcement.
2. Details Included:
o Financial impact of the buyback on the company.
o Source of funds for the buyback (free reserves, securities premium, or other
permissible sources).
o Shareholding pattern before and after the buyback.
o Management discussion and analysis (MD&A) of the company’s future plans post-
buyback.
3. SEBI Observations:
o SEBI reviews the DLOF and provides its observations or comments within seven
working days of receiving the filing.
o The company must incorporate SEBI’s comments before finalizing the Letter of
Offer.

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3.3 Submission of Final Letter of Offer

1. Purpose:
o The Final Letter of Offer is a detailed document sent to all eligible shareholders.
2. Timeline:
o The company must dispatch the Letter of Offer to shareholders within five
working days of receiving SEBI's observations.
3. Contents:
o Detailed instructions on how shareholders can tender their shares.
o Proportionate entitlement and allocation method for shares accepted under the
buyback.
o Key dates, including the tendering window and payment schedule.

3.4 Filing of Post-Buyback Reports

1. Interim Report:
o Companies must submit an interim report to SEBI within 15 days of the tendering
period closing.
o Report includes:
 Total shares tendered and accepted.
 Payment details for accepted shares.
2. Final Report:
o A final compliance report must be filed within seven working days of completing
the buyback.
o The final report includes:
 Final number of shares bought back.
 Total funds utilized.
 Extinguishment details of repurchased shares.

3.5 Quarterly Filings (For Open Market Buybacks)

 Companies undertaking open-market buybacks must file quarterly progress reports with
SEBI.
 These filings track:
o Number of shares repurchased during the quarter.
o Average purchase price.
o Remaining buyback budget and outstanding shares.

3.6 Extinguishment of Securities

1. Timeline for Extinguishment:

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 oCompanies must extinguish all repurchased shares within seven days of
completing the buyback.
2. Mandatory Filing:
o A certificate of extinguishment must be submitted to SEBI and stock exchanges,
confirming that the shares have been canceled.

3.7 Stock Exchange Intimations

1. Prior Intimation:
o Companies must notify stock exchanges at least two working days before
convening board or shareholder meetings for buyback approval.
2. Outcome Disclosure:
o Results of the board or shareholder meeting must be communicated to stock
exchanges within 30 minutes of the meeting's conclusion.
3. Buyback Updates:
o Companies must regularly update stock exchanges about the progress of the
buyback process.

4. Compliance with Advertisement Norms

1. Pre-Buyback Advertisements:
o Advertisements announcing the buyback must be published in:
 One English national daily.
 One Hindi national daily.
 One regional daily where the company’s registered office is located.
o These advertisements must clearly disclose the buyback method, price, eligibility
criteria, and timelines.
2. Post-Buyback Advertisements:
o Post-buyback completion, companies must issue an advertisement summarizing:
 Total shares tendered and accepted.
 Amount paid to shareholders.
 Total funds utilized.

5. Monitoring and Oversight

1. Role of SEBI:
o SEBI monitors compliance through the review of filings and progress reports.
o It can impose penalties for non-compliance or procedural delays.
2. Merchant Banker’s Oversight:
o The merchant banker acts as a compliance guardian, ensuring:
 Adherence to buyback regulations.
 Timely and accurate filings with SEBI and stock exchanges.
3. Audit Mechanisms:
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 o Internal and external audits ensure transparency and accountability in the
buyback process.

Various Compliances under Buyback through Tender Offer as per SEBI (Buyback of Securities)
Regulations, 2018
1. Introduction

 Tender Offer Definition: In a tender offer, a company invites its shareholders to sell their
shares back to the company at a pre-determined price.
 Purpose of Tender Offer:
o Provide an equitable opportunity for all shareholders to participate.
o Offer a premium price as a benefit to shareholders.
 Regulated under SEBI (Buyback of Securities) Regulations, 2018, in conjunction with the
Companies Act, 2013.

2. Key Compliances for Buyback through Tender Offer

2.1 Board Approval

1. Initial Approval:
o The buyback must be approved by the company’s board of directors.
o For buybacks not exceeding 10% of the total paid-up capital and free reserves,
only board approval is needed.
2. Resolution Details:
o The board resolution must include:
 Maximum buyback size.
 Maximum price for the buyback.
 Method of buyback (tender offer).
 Funding sources.

2.2 Shareholder Approval

1. Special Resolution:
o If the buyback exceeds 10% of paid-up capital and free reserves but remains
within the statutory limit of 25%, a special resolution is required.
o Approval must be sought in a general meeting.
2. Voting Requirements:
o The resolution must be passed with at least 75% votes in favor of the total
shareholders present and voting.
3. Disclosures in Notice:
o The notice for the general meeting must provide:
 Justification for the buyback.
 Impact of the buyback on financial ratios.
 Post-buyback shareholding pattern.
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2.3 Public Announcement

1. Mandatory Announcement:
o A public announcement must be made within 2 working days of board or
shareholder approval.
2. Key Details in the Announcement:
o Total buyback size (value and number of shares).
o Buyback price per share.
o Record date to determine eligibility.
o Process for shareholders to participate.
3. Publication:
o The public announcement must be published in:
 One English national daily.
 One Hindi national daily.
 One regional daily where the company’s registered office is located.

2.4 Appointment of Merchant Banker

1. Role of Merchant Banker:

o The company must appoint a SEBI-registered merchant banker to:
 Manage the buyback process.
 Ensure compliance with SEBI regulations.
 Conduct due diligence on the company’s financials and disclosures.
 Provide a report confirming compliance with SEBI norms.

2.5 Filing of Draft Letter of Offer (DLOF)

1. Timeline:
o The company must file the Draft Letter of Offer (DLOF) with SEBI within 5
working days of the public announcement.
2. Details to be Included:
o Objectives of the buyback.
o Details of funds to be utilized.
o Shareholding pattern pre- and post-buyback.
o Expected financial impact, including changes in earnings per share (EPS), return
on equity (ROE), and book value per share.
o Declaration by the board that the company is compliant with debt-equity limits.
3. SEBI Review:
o SEBI reviews the DLOF and provides comments within 7 working days.
o The company must address SEBI’s observations before dispatching the final Letter
of Offer.

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2.6 Final Letter of Offer

1. Dispatch to Shareholders:
o The Final Letter of Offer must be sent to all eligible shareholders within 5
working days of receiving SEBI's observations.
2. Contents:
o Steps for tendering shares.
o Proportionate entitlement of shareholders.
o Key dates, including:
 Opening and closing of the tendering period.
 Settlement timeline.

2.7 Tendering Period

1. Duration:
o The tendering window must remain open for a minimum of 10 working days.
2. Shareholder Participation:
o Shareholders can tender their shares through their respective brokers.
o Shares are credited to a demat escrow account for processing.
3. Proportionate Allocation:
o If shares tendered exceed the buyback limit, the company accepts shares
proportionately based on shareholders’ entitlements.

2.8 Payment to Shareholders

1. Timeline for Payment:

o Payment for accepted shares must be completed within 7 working days of the
tendering period closure.
2. Mode of Payment:
o Payment is made electronically or via cheques/demand drafts, depending on
shareholder preferences.
3. Refund of Unaccepted Shares:
o Shares not accepted under the buyback must be returned to shareholders' demat
accounts promptly.

2.9 Extinguishment of Shares

1. Mandatory Extinguishment:
o All repurchased shares must be extinguished within 7 days of buyback
completion.
2. Certification:
o A compliance certificate, signed by the company’s statutory auditor and merchant
banker, must be filed with SEBI, confirming the extinguishment.
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3. Disclosures and Reporting
3.1 Post-Buyback Advertisement

1. Publication:
o A post-buyback advertisement summarizing the results must be published within
2 working days of buyback completion.
2. Contents:
o Total shares tendered and accepted.
o Amount paid to shareholders.
o Total funds utilized.
o Change in the shareholding pattern post-buyback.

3.2 Filing of Compliance Report

1. Interim Report:
o An interim report must be filed with SEBI within 15 days of the tender period
closure.
o Includes details of shares tendered, accepted, and rejected.
2. Final Report:
o A final compliance report must be filed within 7 working days of buyback
completion, providing:
 Total shares repurchased and extinguished.
 Final financial impact on the company.
 Statement of compliance with SEBI regulations.

4. Restrictions Post-Buyback

1. Reissuance of Shares:
o Companies cannot issue new shares or specified securities for 6 months post-
buyback.
o Exceptions:
 Issue of bonus shares.
 Stock splits or conversions.
2. Dividend Restrictions:
o SEBI discourages large dividend payouts immediately after a buyback to prevent
cash depletion.

VARIOUS COMPLIANCES UNDER BUYBACK FROM OPEN MARKET

1. Methods for Buyback from the Open Market:

o Buybacks can be executed through:
 (a) Stock exchanges.
 (b) Book-building process.

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 2. Utilization of Funds:
o At least 75% of the amount earmarked for the buyback must be utilized, as
specified in the board resolution or special resolution.
o A minimum of 40% of the earmarked amount must be utilized within the first
half of the specified duration of the buyback period

SEBI (Prohibition of Insider Trading) Regulations, 2015

1. Overview of SEBI PIT Regulations

The SEBI (Prohibition of Insider Trading) Regulations, 2015, are designed to curb insider trading
in listed companies and ensure a level playing field for all investors by regulating access to, and
dissemination of, Unpublished Price Sensitive Information (UPSI). It applies to all listed
companies, their employees, connected persons, intermediaries, and any entity dealing with
securities.

2. Important Definitions

2.1 Insider

An insider is not limited to the employees or directors of the company but includes any person
who has access to UPSI. This encompasses:

 Connected persons:
o Directors, key managerial personnel, employees, or consultants associated with
the company.
o Legal and auditing firms, banks, or consultants hired by the company.
 Deemed insiders:
o Immediate relatives or associates of connected persons who may gain access to
UPSI.
o Anyone receiving UPSI from insiders directly or indirectly (e.g., tipper-tippee
relationships).

2.2 Unpublished Price Sensitive Information (UPSI)

UPSI refers to specific, non-public information that can significantly affect the price of a
company’s securities if made public. Examples include:

1. Financial results (e.g., quarterly/annual earnings).

2. Dividends (interim or final).
3. Mergers, demergers, acquisitions, or takeovers.
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 4. Change in capital structure, such as share issuance, buybacks, or stock splits.
5. Significant changes in policies, agreements, or contracts.
6. Material events such as lawsuits, regulatory actions, or key managerial changes.

Key Highlight:

 UPSI becomes public information only after it is disclosed to stock exchanges or made
widely available (e.g., through press releases or the company’s website).

2.3 Legitimate Purposes

Sharing UPSI is allowed if it is necessary for legal or business purposes, such as:

 Discussions with bankers, legal advisors, or consultants.

 Statutory filings or compliance requirements.
 Due diligence for mergers, acquisitions, or investments.

3. Key Provisions in Detail

3.1 Trading Restrictions

Insiders are strictly prohibited from:

1. Dealing in securities of a listed company while in possession of UPSI.

2. Inducing others to trade based on UPSI (tipping or passing insider information).

Exception: If an insider can demonstrate that the trading decision was made without being
influenced by the UPSI, they may not face penalties (e.g., trades under a pre-approved trading
plan).

3.2 Communication and Handling of UPSI

1. Prohibition on Communication:
o Insiders cannot share UPSI unless required for legitimate purposes or statutory
obligations.
2. Structured Digital Database:
o Companies must maintain a structured digital database of all individuals or
entities with whom UPSI is shared.
o The database must record:
 The nature of UPSI shared.
 Identity of persons accessing UPSI.
 Audit trails of sharing.

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3.3 Disclosure Requirements

Initial Disclosure:

1. Promoters, directors, and key managerial personnel (KMPs) must disclose their holding
of securities at the time of appointment or when the regulations come into effect.
2. Designated employees (as defined by the company’s Code of Conduct) must report their
holdings if specified.

Continual Disclosure:

1. Changes in securities holdings exceeding ₹10 lakhs in value or any thresholds prescribed
by the company must be disclosed.
2. The company is required to notify stock exchanges of such disclosures within 2 trading
days of receipt.

3.4 Trading Window Mechanism

To prevent insider trading during sensitive periods, companies implement a trading window
system:

1. Closure of Trading Window:

o The window is closed for all insiders during key periods such as:
 Finalization of financial results.
 Announcements related to dividends, mergers, or acquisitions.
o This ensures no trading activity occurs when UPSI is available to insiders but not
to the public.
2. Opening of Trading Window:
o The trading window is reopened 48 hours after UPSI is made public.

3.5 Pre-Clearance of Trades

1. Pre-Approval:
o Insiders (employees, directors, and KMPs) must obtain pre-clearance from the
compliance officer for trades exceeding specified thresholds.
2. Execution Deadline:
o Approved trades must be executed within 7 trading days.
o If not executed, the insider must reapply for pre-clearance.

3.6 Trading Plans

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Insiders can adopt pre-approved trading plans to mitigate accusations of insider trading. These
plans must:

1. Be disclosed to SEBI and the stock exchanges.

2. Specify the trades and timelines in advance.
3. Lock the insider into trading commitments, ensuring they cannot alter trades after the
plan is approved.

4. Code of Conduct for Listed Companies

Each listed company must:

1. Establish a Code of Conduct to regulate trading activities of its insiders and employees.
2. Appoint a Compliance Officer to enforce and monitor compliance with the regulations.
3. Define processes for:
o Identification of designated persons.
o Periodic disclosures of holdings.
o Maintenance of structured digital databases.

5. Fair Disclosure Obligations

Companies must ensure equitable access to information:

1. Disclose all UPSI to stock exchanges before sharing with outsiders (e.g., analysts or
media).
2. Publish price-sensitive announcements promptly on their websites.
3. Appoint a senior officer to oversee disclosure policies and ensure adherence to fair
disclosure principles.

6. Institutional Mechanisms

The regulations emphasize the role of intermediaries (stockbrokers, depositories, etc.) and
fiduciaries (auditors, law firms, etc.) in preventing insider trading by:

1. Adopting internal controls to monitor access to UPSI.

2. Regular training for employees to understand the regulations.
3. Reporting any violations or suspicious activity to SEBI.

7. Penalties for Violations

SEBI has the authority to:

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 1. Impose penalties under the SEBI Act, 1992:
o Monetary fines up to ₹25 crore or 3 times the profit made, whichever is higher.
o Imprisonment of up to 10 years.
2. Initiate civil or criminal proceedings.
3. Debar individuals or entities from accessing the market.

8. Recent Updates

1. Enhanced Disclosure Requirements:

o Companies must disclose more granular information in structured databases.
2. Role of Fiduciaries:
o Greater accountability for intermediaries handling UPSI (e.g., law firms, auditors).
3. Whistleblower Policies:
o Companies must establish frameworks for anonymous reporting of insider trading
activities.

CHAPTER 15: FACTORING

1. Average Receivables Formula

Average Receivables = Annual Credit Sales / Number of Days in a Year ×
Average Collection Period

 Purpose: To estimate the amount tied up in receivables over a given period.

 Example in the PDF:
For annual credit sales of ₹219 lakh and an average collection period of 50 days:
Average Receivables=219/365×50=₹30 lakh

2. Factoring Commission Formula

Factoring Commission=Average Receivables×Commission Rate (%)

 Purpose: To calculate the fee charged by the factor for services.

 Example in the PDF: Factoring Commission=₹30 lakh×2%=₹0.6 lakh

3. Interest on Advances
Interest=Advance Amount×(Annual Interest Rate/365)×Credit Period (in Days)

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Purpose: To determine the cost of borrowing from the factor.

 Example in the PDF:

For an advance of ₹23.4 lakh at 15% annual interest for 50 days:
Interest=₹23.4 lakh×(15/365)×50=₹0.48 lakh

4. Net Cost of Factoring

Net Factoring Cost=Factoring Cost (Commission + Interest)−Savings from Bad Debts and Admin
istration
Purpose: To calculate the overall cost or savings from adopting factoring.

 Example in the PDF:

For factoring costs of ₹7.884 lakh and savings of ₹6.38 lakh:
Net Factoring Cost=₹7.884 lakh−₹6.38 lakh=₹1.504 lakh

5. Effective Rate of Interest

Effective Rate (%)=(Net Factoring Cost/Advance Amount)×100

Purpose: To express the factoring cost as a percentage of the funds advanced.

 Example in the PDF:

For a net factoring cost of ₹1.504 lakh and an advance of ₹22.92 lakh:
Effective Rate (%)=(1.504/22.92)×100=6.56%

6. Weighted Average Credit Period

Weighted Credit Period = Standard Credit Period + (Weight Factor × Additional Delay)

 Purpose: To calculate the average delay in receivables across different periods.

 Example in the PDF:
For an FMCG company with a 30-day standard credit period, 5 days' delay in 40% of the
year, and 10 days' delay in 60%: Weighted Credit Period=30+(0.4×5+0.6×10)=38 days

7. All-in-One Quote Formula (For Factoring Companies)

All-in-One Quote (%) =
(Total Cost of Factoring (including Markup)/Average Receivables Outstanding)×100

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  Purpose: To compute the rate to be quoted to clients.
 Example in the PDF:
For a total factoring cost of ₹16.03288 crore and average receivables of ₹104.1096 crore:
All-in-One Quote (%)=(16.03288104.1096)×100=15.4%

1. Introduction to Factoring

 Purpose and Need:

Small and medium-sized enterprises (SMEs), especially in the small-scale sector, often
face financial strain due to delays in realizing payments from larger units. Factoring
services help businesses overcome these difficulties by providing immediate liquidity
against receivables.
 Impact:
Factoring eliminates the need for businesses to focus on collecting dues, allowing them
to concentrate on product development and marketing.

2. Definition and Mechanism of Factoring

 Definition:
Factoring is a financial service where businesses sell their accounts receivables to a third
party (factor) at a discount. This generates immediate funds for the seller to meet
working capital needs.
o Distinction from Bill Discounting:
While bill discounting only involves discounting invoices, factoring is broader,
encompassing receivables management, financing, and credit protection.
 Mechanism:
1. Customer Order: The customer places an order for goods or services on credit.
2. Invoice Issuance: The client delivers the goods/services and issues an invoice to
the customer.
3. Assignment to Factor: The client assigns the invoice to the factor, transferring the
rights of collection.
4. Advance Payment: The factor provides an upfront payment of 70–80% of the
invoice value.
5. Receivables Management: The factor manages the accounts receivables and
follows up with the customer for payment.
6. Balance Settlement: Once the customer pays, the factor releases the remaining
amount to the client after deducting its commission and interest.
 Charges:
o Finance Charges: Calculated on the prepayment amount, typically charged
monthly.
o Service Fees: Cover the costs of services like collections, reporting, and
administrative overhead.

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3. Types/Forms of Factoring

1. Recourse Factoring:
o The factor can reclaim funds from the client if the customer fails to pay.
o Risk of bad debts remains with the client.
2. Non-Recourse Factoring:
o The factor assumes the risk of non-payment, charging a higher commission for
bearing the credit risk.
3. Advance Factoring:
o The factor pays a portion of the invoice value upfront, with the balance released
after collection.
4. Post-Facto Factoring:
o The factor collects the invoice amount from the customer before the original
credit period ends and releases payment to the client.
5. Full Factoring:
o A comprehensive service combining features of credit risk management,
financing, and receivables management.
6. Disclosed Factoring:
o The factor’s involvement is disclosed in the invoice, and customers pay directly to
the factor.
7. Undisclosed Factoring:
o The factor operates behind the scenes, with customers unaware of their
involvement.
8. Domestic and Export Factoring:
o Domestic: All parties (client, customer, factor) are in the same country.
o Export: Involves cross-border transactions with additional parties like export and
import factors.

4. Functions of a Factor

The factor provides the following services:

1. Ledger Maintenance:
o Manages the client’s sales ledger and issues periodic statements.
o Helps the client focus on core operations by reducing administrative burdens.
2. Receivables Collection:
o Handles the collection of receivables, saving the client time, effort, and resources.
o Ensures timely payments, reducing bad debts.
3. Financing Trade Debts:
o Offers upfront funding against receivables, improving liquidity.
4. Credit Risk Protection:
o In non-recourse factoring, the factor assumes the credit risk, protecting the client
from customer defaults.
5. Advisory Services:
o Provides insights into customer creditworthiness, market trends, and operational
improvements.
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5. Benefits of Factoring

 Liquidity Improvement:
Immediate funds improve the client’s cash flow.
 Time Efficiency:
Outsourcing receivables management allows the client to focus on business growth.
 Credit Risk Mitigation:
Non-recourse factoring eliminates the risk of bad debts.
 Better Working Capital Management:
Reduces the operating cycle by accelerating cash inflows.

6. Challenges in the Growth of Factoring in India

 Key Challenges:
1. Lack of credit appraisal systems and reliable client databases.
2. High stamp duties on invoices, increasing costs.
3. Limited awareness among businesses about factoring benefits.
 Proposed Solutions:
1. Reduce or eliminate stamp duties.
2. Establish credit appraisal companies for better risk assessment.
3. Expand factoring services to smaller towns and regions.
4. Increase awareness through workshops and seminars.

7. Forfaiting

 Definition:
Forfaiting is a financial arrangement where receivables from international trade are sold
without recourse to the seller.
 Differences from Factoring:
o Forfaiting is long-term (3–5 years) compared to the short-term nature of
factoring.
o Forfaiting provides 100% financing, while factoring typically covers 75–80%.
o Forfaiting focuses only on financial aspects, whereas factoring includes
receivables management.

8. Regulatory Aspects

1. Factoring Regulation Act, 2011:

o Registration with the RBI is mandatory for factors.
o Factors must dedicate at least 50% of their total assets and income to factoring.
2. NBFC-Factor Directions, 2012:
o Factors must have a minimum net owned fund (NOF) of ₹5 crores.
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o They must commence operations within six months of receiving the Certificate of
Registration.

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