BOOK BUILDING PROCESS

1) Book-building is a process of price discovery used in public offers 2) The issuer sets a base price and a band within which the investor is allowed to bid for shares. Take the recent, Yes Bank [ Get Quote ] IPO, the floor price was Rs 38 and the band was from Rs 38 to Rs 45. 3) The investor had to bid for a quantity of shares he wished to subscribe to within this band. The upper price of the band can be a maximum of 1.2 times the floor price. 4) Every public offer through the book-building process has a book running lead manager (BRLM), a merchant banker, who manages the issue 5) Further, an order book, in which the investors can state the quantity of the stock they are willing to buy, at a price within the band, is built. Thus the term 'bookbuilding 6) An issue through the book-building route remains open for a period of 3 to 7 days and can be extended by another three days if the issuer decides to revise the floor price and the band 7) Once the issue period is over and the book has been built, the BRLM along with the issuer arrives at a cut-off price. The cut-off price is the price discovered by the market. It is the price at which the shares are issued to the investors. 8) The cut-off price is arrived at by the method of Dutch auction. In a Dutch auction the price of an item is lowered, until it gets its first bid and then the item is sold at that price. Let's say a company wants to issue one million shares. The floor price for one share of face value, Rs 10, is Rs 48 and the band is between Rs 48 and Rs 55. At Rs 55, on the basis of the bids received, the investors are ready to buy 200,000 shares. So the cut-off price cannot be set at Rs 55 as only 200,000 shares will be sold. So as a next step, the price is lowered to Rs 54. At Rs 54, investors are ready to buy 400,000 shares. So if the cut-off price is set at Rs 54, 600,000 shares will be sold. This still leaves 400,000 shares to be sold. The price is now lowered to Rs 53. At Rs53, investors are ready to buy 400,000 shares. Now if the cut-off price is set at Rs 53, all one million shares will be sold. Investors who had applied for shares at Rs 55 and Rs 54 will also be issued shares at Rs 53. The extra money paid by these investors while applying will be returned to them. 9) There are three kinds of investors in a book-building issue. The retail individual investor (RII), the non-institutional investor (NII) and the Qualified Institutional Buyers (QIBs). RII is an investor who applies for stocks for a value of not more than Rs 100,000. Any bid exceeding this amount is considered in the NII category. NIIs are commonly referred to as high net-worth individuals. On the other hand QIBs are institutional investors who posses the expertise and the financial muscle to invest in the securities market

10) As per SEBI guidelines, an issuer company can issue securities to the public though prospectus in the following manner: 100% of the net offer to the public through book building process 75% of the net offer to the public through book building process and 25% at the price determined through book building. The Fixed Price portion is conducted like a normal public issue after the Book Built portion, during which the issue price is determined.
Price at which the securities are offered and would be allotted is made known in advance to the investors A 20 % price band is offered by the issuer within which investors are allowed to bid and the final price is determined by the issuer only after closure of the bidding. 50 % of the shares offered are reserved for applications below Rs. 1 lakh and the balance for higher amount applications. 50 % of shares offered are reserved for QIBS, 35 % for small investors and the balance for all other investors.

Fixed Price Issues

Demand for the securities offered is known only after the closure of the issue Demand for the securities offered , and at various prices, is available on a real time basis on the BSE website during the bidding period..

100 % advance payment is required to be made by the investors at the time of application.

BookBuildingIssues

10 % advance payment is required to be made by the QIBs along with the application, while other categories of investors have to pay 100 % advance along with the application.

ADR-GDR
Every publicly traded company issues shares and these shares are listed and traded on various stock exchanges. Thus, companies in India issue shares which are traded on Indian stock exchanges like BSE (The Stock Exchange, Mumbai), NSE (National Stock Exchange), etc. These shares are sometimes also listed and traded on foreign stock exchanges like NYSE (New York Stock Exchange) or NASDAQ (National Association of Securities Dealers Automated Quotation). But to list on a foreign stock exchange, the company has to comply with the policies of those stock exchanges. Many times, the policies of these exchanges in US or Europe are much more stringent than the policies of the exchanges in India. This deters these companies from listing on foreign stock exchangesdirectly. But many good companies get listed on these stock exchangesindirectly using ADRs and GDRs. This is what happens: The company deposits a large number of its shares with a bank located in the country where it wants to list indirectly. The bank issues receipts against these shares, each receipt having a fixed number of shares as an underlying (Usually 2 or 4). These receipts are then sold to the people of this foreign country (and anyone who is allowed to buy shares in that country). These receipts are listed on the stock exchanges.

They behave exactly like regular stocks their prices fluctuate depending on their demand and supply, and depending on the fundamentals of the underlying company. These receipts, which are traded like ordinary stocks, are calledDepository Receipts. Each receipt amounts to a claim on the predefined number of shares of that company. The issuing bank acts as a depository for these shares that is, it stores the shares on behalf of the receipt holders. Both ADR and GDR are depository receipts, and represent a claim on the underlying shares. The only difference is the location where they are traded. If the depository receipt is traded in the United States of America (USA), it is called an American Depository Receipt, or an ADR. If the depository receipt is traded in a country other than USA, it is called a Global Depository Receipt, or a GDR.

There are many advantages of ADRs. For individuals, ADRs are an easy and cost effective way to buy shares of a foreign company. The individuals are able to save considerable money and energy by trading in ADRs, as it reduces administrative costs and avoids foreign taxes on each transaction. Foreign entities prefer ADRs, because they get more U.S. exposure and it allows them to tap the American equity markets.

The shares represented by ADRs are without voting rights.

FCCB
A Foreign Currency Convertible Bond (FCCB) is a type of convertible bond issued in a currency different than the issuers domestic currency. In other words, the money being raised by the issuing company is in the form of a foreign currency. It gives two options. One is, to get the regular interest and principal and the other is to convert the bond in to equities. It is a hybrid between bond and stock. How does it help companies? Some companies, banks, governments, and other sovereign entities may decide to issue bonds in foreign currencies because: It may appear to be more stable and predictable than their domestic currency Gives issuers the ability to access investment capital available in foreign markets Companies can use the process to break into foreign markets The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component Conversion of bonds into stocks takes place at a premium price to market price. Conversion price is fixed when the bond is issued. So, lower dilution of the company stocks

How does it benefit an investor? Its not just companies who are benefited with FCCB. Investors too enjoy its benefits. Here are some: Safety of guaranteed payments on the bond Can take advantage of any large price appreciation in the companys stock Redeemable at maturity if not converted Easily marketable as investors enjoys option of conversion in to equity if resulting to capital appreciation Are there any disadvantages to the investors and companies? Yes. Like any financial instruments, FCCBs also have there disadvantages. Some of these are: Exchange risk is more in FCCBs as interest on bond would be payable in foreign currency. Thus companies with low debt equity ratios, large forex earnings potential only opted for FCCBs FCCBs means creation of more debt and a FOREX outgo in terms of interest which is in foreign exchange In case of convertible bond the interest rate is low (around 3 to 4%) but there is exchange risk on interest as well as principal if the bonds are not converted in to equity If the stock price plummets, investors will not go for conversion but redemption. So, companies have to refinance to fulfil the redemption promise which can hit earnings It will remain as debt in the balance sheet until conversion

ETF

Exchange-Traded Fund (ETF)

What It Is: Exchange-traded funds (ETFs) are securities that closely resemble index funds, but can be bought and sold during the day just like common stocks. These investment vehicles allow investors a convenient way to purchase a broad basket of securities in a single transaction. Essentially, ETFs offerthe convenience of a stock along with the diversification of a mutual fund. How It Works/Example: Exchange-traded funds are some of the most popular and innovative new securities to hit the marketsince the introduction of the mutual fund. The first ETF was the Standard and Poor's Deposit Receipt (SPDR, or "Spider"), which was first launched in 1993. Purchasing Spiders gave investors a way to mimic the performance of the S&P 500 without having to purchase an index fund. Furthermore, because they traded like a stock, SPDRs could be bought and sold throughout the day, purchased onmargin, or even sold short. Whenever an investor purchases an ETF, he or she is basically investing in the performance of an underlying bundle of securities -- usually those representing a particular index or sector. UnitInvestment Trusts (UITs) are often organized in the same manner. However, the unusual legal structure of an ETF makes the product somewhat unique.

Exchange-traded funds don't sell shares directly to investors. Instead, each ETF's sponsor issues large blocks (often of 50,000 shares or more) that are known as creation units. These units are then bought by an "authorized participant" -- typically a market maker, specialist or institutional investor -- which obtains shares of the underlying securities and places them in a trust. The authorized participant then splits up these creation units into ETF shares -- each of which represents a legal claim to a tiny fraction of the assets in the creation unit -- and then sells them on a secondary market. Just as closed-end funds don't always trade at a price that precisely reflects the value of the underlying assets in each share of the portfolio, it is also possible for an ETF to trade at a premium or a discount to its actual worth. To liquidate their holdings, most investors simply sell their ETF shares to other investors on the open market. However, it is possible to amass enough ETF shares to redeem them for one creation unit and then redeem the creation unit for the underlying securities. Because of the large number of shares involved, individual investors seldom use this option. Why It Matters: Exchange-traded funds have grown increasingly popular in recent years, and the number of offerings has swelled. Today, these securities compete with mutual funds and offer a number of advantages over their predecessors, including: Low Cost -- Unlike traditional mutual and index funds, ETFs have no front- or back-end loads. In addition, because they are not actively managed, most ETFs have minimal expense ratios, making them much more affordable than most other diversified investment vehicles. Most mutual funds also have minimum investment requirements, making them impractical for some smaller investors. By contrast, investors can purchase as little as one share of the ETF of their choice. Liquidity -- Whereas traditional mutual funds are only priced at the end of the day, ETFs can be bought and sold at any time throughout the trading day. Many have average daily trading volumes in the hundreds of thousands (and in some cases millions) of shares per day, making them extremely liquid. Tax-Advantages -- In a traditional mutual fund, managers are typically forced to sell off portfolio assets in order to meet redemptions. Often, this act triggers capital gains taxes, to which all shareholders are exposed. By contrast, the buying and selling of shares on the open market has no impact on an ETF'stax liability, and those that choose to redeem their ETFs are paid in shares of stock rather than in cash. This minimizes an ETF's tax burden because it does not have to sell shares (and therefore potentially realize taxable capital gains) to obtain cash to return to investors. Furthermore, those who redeem theirETFs are paid with the lowest-cost-basis shares in the fund, which increases the cost basis for the remaining holdings, thereby minimizing the ETF's capital gains exposure. Although exchange-traded funds offer several advantages over traditional mutual funds, they also have two distinct disadvantages. To begin, the securities that an ETF tracks are largely fixed, so investors that prefer active management will probably find ETFs wholly unsuitable. Furthermore, because they trade as stocks, each ETF purchase will be charged a brokerage commission. For those that make regular periodic investments -- such as a monthly dollar-cost averaging investment plan -- these recurring commissions might quickly become costprohibitive.

As with any security, the pros and cons should be weighed carefully, and investors should first do their homework to determine whether exchange-traded funds are the appropriate vehicle to meet their individual goals and objectives

SWAPTIONS

1) 2)

A swaption provides the holder with the right, but not the obligation, to enter into a specific swap deal on a future date (or set of dates). One way to eliminate this uncertainty is to purchase an appropriately structured swaption. Lets say that company A could enter into a swaption agreement that gives them the right to receive LIBOR and pay a fixed rate of 7.5% starting in six months time. If the swap rate in six months time turns out to be greater than 7.5%, then company A would be best suited by exercising their option to enter into a swap where they are only required to pay 7.5%. Conversely, if the market swap rate turns out to be lower than 7.5%, then company A should allow the swaption to expire and simply enter into a swap at the lower fixed rate. Either way, the fixed rate of the desired swap is guaranteed to be no higher than 7.5% and company A are therefore assured that the net funding cost of the proposed loan will not exceed 7.5%.

3) One thing that makes a swap very different from a simple option is that there is nostrike price. however, the fixed rate specified for the swaption plays a role very similar to that of a strike price. The holder of the swaption will decide whether or not to exercise based on whether swap rates rise above or fall below that fixed rate. For this reason, the fixed rate is often called the strike rate.

4) A swaption can therefore be defined by: the terms of the underlying swap, the expiry date, the type of option e.g. European or American

5)

we also need to distinguish between the two broad types of interest rate swaptions. An option that gives the right to pay fixed and receive floating is called a payer swaption, while those that give the right to receive fixed and pay floating are described

as receiver swaptions. In general option pricing terms, the former swaption type can be thought of as a call option, and the receiver swaption treated as a put option.

CREDIT DERIVATIVES
In the most basic of terms, a credit derivative is a financial tool used to shift risk from one party to another. They are a relatively new addition to the financial toolbox of investment bankers, having popped up in the 1990s. By allowing the mitigation of risk by spreading it out over a number of investors, companies and banks are able to see increased profits since they are no longer alone when it comes to facing the risk of a credit event (e.g. bankruptcy, insolvency) or a loan. For example, a bank that sells a loan to an automotive plant is worried that the plant may not be able to pay all of its debts. The bank can sell the risk associated with the debt to investors, but still keep the loan to the automotive plant on its books. The value of the derivative is derived from the value of the bond held by the bank. The credit derivative allows these investors to invest in the risks of a firm (the bank) without actually having to purchase that firms bonds or loans. The higher the risk of a credit event occurring, the higher the price of the credit derivative. There are several types of derivatives. Three basic forms are:

Credit Default Swaps

A credit default swap is a swap wherein the counterparty receives a premium at predetermined periods in consideration for assurance to make a specific payment if a negative credit event occurs. Credit events are described as bankruptcies, debt restructurings, obligation defaults or failures to pay. Consequently, the swap is annulled once the credit event takes place. Usually, the amount of the payment is associated with the reduction of the market value of the asset after the credit event. Credit default swaps are customized to diversify or hedge credit portfolios.

Total Return Swaps

With a total return swap, two parties enter into an agreement in which one party agrees to receive the total returns (interest payments and capital gains or losses) of an asset, while the other party receives interest on a notional amount. The asset referenced in the swap deal can be any asset, index or a basket of assets. Total return swaps are utilized to transfer credit risks between two parties.

Credit Linked Note

The value of a credit linked note depends on the occurrence of a credit event, such as a bankruptcy. They are an embedded credit default swap in which investors accept exposure to a

particular credit event in return for a higher yield on the note. As opposed to credit default swaps, credit linked notes are logged on a balance sheet as an asset. The most fundamental credit linked note includes a bond, issued by a high-rated borrower, along with a credit default swap on a less creditworthy risk. Credit-linked notes are normally issued by dealers or by special-purpose companies (or special-purpose vehicles, SPVs) residing in an offshore location and are collateralized with securities having the highest credit rating of AAA. SPVs are set up by dealers to issue various credit linked notes. The coupon or price of the note is linked to the performance of an asset. If there is no default, the credit default swap expires, the collateral redeems at maturity, and the collateral redemption proceeds are paid back to the investor. However, if a credit event occurs, the collateral is sold and its proceeds are used to pay the dealer the par amount. The dealer either pays the investor the recovery amount, in the case of a cash settlement, or delivers obligations to the investor in case of physical settlement

Collateralized debt obligation (CDO)

A Collateralized Debt Obligation, or CDO, is a synthetic investment created by bundling a pool of similar loans into a single investment that can be bought or sold. An investor that buys a CDO owns a right to a part of this pool's interest income and principal. For example, a bank might pool together 5,000 different mortgages into a CDO. An investor who purchases the CDO would be paid the interest owed by the 5,000 borrowers whose mortgages made up the CDO, but runs the risk that some borrowers don't pay back their loans. The interest rate is a function of the expected likelihood that the borrowers whose loans make up the CDO will default on their payments - determined by the credit rating of the borrowers and the seniority of their loans. CDOs are created and sold by most major banks (e.g. Goldman Sachs, Bank of America) over the counter, i.e. they are not traded on an exchange but have to be bought directly from the bank. Securities Industry and [1] Financial Markets Association estimates that US$ 503 billion worth of CDOs were issued in 2007. CDOs played a prominent role in the U.S. subprime crisis, where critics say CDOs hid the underlying risk in mortgage investments because the ratings on CDO debt were based on misleading or incorrect information about the creditworthiness of the borrowers.

How CDOs Work

Bundling debt into a CDO changes the riskiness of investing in debt in two ways:

Reduction of Statistical Outliers

First, CDOs reduce the effect of statistical outliers. Lending someone money to buy a house is risky, because that person either defaults or they don't - even if there's only a one in 5,000 chance of someone defaulting on their mortgage, if you happened to be the lender for the person who defaults, you're out of luck. CDOs turn individual loans into a portfolio in which a default by any single lender is unlikely to have an enormous impact on the portfolio as a whole. By aggregating many different mortgages together into a CDO, investors can own a small percentage of many different mortgages, and therefore the CDO's losses as a result of borrowers defaulting on their obligations usually represent the statistical averages in the market as a whole

Tranches
Second, CDOs are created in tranches - portions of the underlying debt that vary in their riskiness, despite being backed by a generic pool of bonds or loans. Typically, a pool of debt is divided into three tranches, each of which is a separate CDO. Each tranche will have differentmaturity, interest rates and default risk. This allows the CDO creator to sell to multiple investors with different degrees ofrisk preference. The bottom tranche will pay the highest interest rate, but will be the first to lose money if some of the loans in the pool aren't repaid. The top tranche will have the lowest interest rate, but will always be the first to be repaid - the bottom two tranches have to be wiped out before the top tranche is affected. This allows bankers to create investments with risk / reward profiles that are very different from the underlying debt in the pool. So, one pool of mortgages can be divided into three CDOs, one with an "AAA" debt rating that pays low interest, one with an intermediate debt rating with moderate interest, and one with a low debt rating with high interest. This is important because some asset manager is only allowed to invest in "AAA"-rated debt - dividing a pool of debt that is not AAA rated into three different CDO tranches means at least some portion of that debt is now AAA-rated and can be purchased by institutions that can only invest in AAA debt. For example, assume a bond pool of $100 million divided into three tranches and expected to earn 15% or $15 million in interest pa. The three tranches are A ($25 million), B ($50 million) and C ($25 million); and, A is senior to B and B is senior to C. A, B and C tranches provide 10%, 15% and 20% interest rates, respectively. If none of the bonds defaults, A receives $2.5 million, B $7.5 million, and C $5 million. But, say there is a default and the interest income shrinks to $11 million. As A and B are senior to C, they will be settled first. So, tranche A and B receive full interest of $2.5 million and $7.5 million, whereas tranche C receives $1 million only