Unit - I
THE FINANCIAL SYSTEM IN INDIA
Financial system
Financial system is one system which supplies the necessary financial inputs
for the production of goods and services which in turn promote the wellbeing
and standard of living of the people of a country.
Functions of the financial system
1. Provision of Liquidity
The major function of the financial system is the provision of money and
monetary assets for the production of goods and services. There should not
be any shortage of money for productive ventures.
(i)
Liquidity
In financial language the money and monetary assets are referred to as
liquidity.
The term liquidity refers to cash or money and other assets which can be
converted into cash readily without loss.
Hence all activities in a financial system are related to liquidity-either
provision of liquidity or trading in liquidity.
(ii)
Financial concepts
An understanding of the financial system requires and understanding of the
following concepts.
1.Financial Assets
2.Financial Intermediaries
3.Financial Market
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1. Marketable Assets
2. Non- Marketable Assets.
1. Marketable Assets Marketable Assets are those which can be easily
transferred from one person to another without much hindrance Examples
shares issued by companies, Government Security bonds of public sector
undertaking etc.
2. Non Marketable Assets - On the other hand if the assets cannot be
transferred easily, they come under this category.Examples-Bank Deposits,
Provident Funds Pension fund, National savings certificate Insurance policy etc.
Another Classification of Financial Assets.
1. Money or cash assets
2. Debt Assets
3. Stock Assets
1. Money or cash assets- In India all coins and currency notes are issued by the
R.B.I and the Ministry of Finance Government of India [Cash assets include
anything you own such as savings, shares, stocks, loan to other].Commercial
banks can also create money by means of creating credit. When loans are
sanctioned liquid cash is not granted Instead of that an account is opened in the
borrowers name and a deposit is created .It is also a kind of money asset.
2.Debt Asset. Debt asset is issued by a variety of organizations for the purpose
of raising their debt capital.Debt capital is a fixed repayment schedule with
regard to interest and principal.Different ways of raising debt capital is as
follows issue of debentures, raising of term loans, working capital advance etc..
3.Stock Assets.- Stock is issued by business organizations for the purpose of
raising their fixed capital.
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Financial Intermediaries
The term intermediaries includes all kinds of organizations which intermediate
and facilitate financial transactions of both individuals and corporate
customers.It refers to all kinds of financial institutions and investing institution
which facilitate financial transactions in financial markets.
They may be classified into two:
1. Capital Markets Intermediaries
2. Money Market Intermediaries.
Unit-I
Financial Markets in India
1. Unorganized Markets
In these unorganized markets there are a number of money lenders,
indigenous bankers, traders (who lend and collect deposits from the public)
private finance companies (Indigenous bankers are private firms or
individuals who operate as banks and receive deposits and give loans), Chit
funds etc whose activities are not controlled by the RBI.
The RBI has already taken some steps to bring private finance companies and
chit funds under its strict control by issuing Non banking financial companies
Reserve Bank Direction 1998.
1. Public Issue
2. Right Issue
3. Private Placement.
(i) Public Issue - The most common method of raising capital by new
companies is trough sale of securities to the public it is called public issue.
(ii) Rights Issue - When an existing company wants to raise additional capital,
securities are first offered to the existing of share holders on a pre-emptive
basis [Relating to the purchase of goods or shares by one person or party
before the opportunity is offered to others].It is called rights issue.
(iii) Private Placement - Private placement is a way of selling securities
privately to a small groups of investors.
State
Electricity Boards, all India and State level institutions and public sector
enterprises are dealt in this market.
The role of brokers in marketing these securities is practically limited and the
major participant in this market is commercial banks.
The secondary market for these securities is very narrow since most of the
investors tend to retain these securities until maturity. Example -stock
certificates, promissory notes, Bearer bond.
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2. Mortgages market:
The mortgages market refers to those centers which supply mortgage loan
mainly to individual customers. A mortgage loan is a loan against the security
of immovable property.LIC & HUDC [Housing and urban development
corporation] play a dominant role in financing residential projects.
3. Financial Guarantees market:
A guarantee market is a centre where finance is provided against the guarantee
of a reputed person in the financial circle.Guarantee is a contract to discharge
the liability of a third party in case of his default. If the borrower fails to repay
the loan, the liability falls on the shoulders of the guarantor. The guarantor
must be known to both the borrower and the lender.
MONEY MARKET
Money market is a market for dealing with financial assets and securities
which have a maturity period of up to one year.It is a market for purely short
term funds.
The money market may be out divided into four. They are:
1. Call Money Market
2. Commercial Bills Market
3. Treasury bills Market
4. Short term loan Market
1)Call Money Market- The call money market is a market extremely short
period loans say one day to fourteen days, so it is highly liquid. Call money
market is for inter-bank lending and borrowing. The loans are repayable on
demand at the option of either the lender or the borrower.
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In India call money markets are associated with the presence of stock
exchange and hence they are located in major industrial towns.The Special
feature of this market is that the interest rate varies from day today and even
from hour to hour and centre to centre.[Bill of exchange or trade bill is an
instrument containing an unconditional order signed by the maker, directing a
certain person to pay a sum of money to the bearer of the instrument]. It is
very sensitive to changes in demand and supply of call loans.
2) Commercial Bills Market - It is a market for bill of Exchange arising out
of genuine trade transactions. In case of credit sale the seller may draw a bill
of exchange on the buyer. The buyer accepts such a bill promising to pay at a
later date specified in the bill. The seller need not wait until the due date of the
bill. Instead he can get immediate payment by discounting the bill.The
commercial banks play a significant role in this market.
3) Treasury Bills Market - It is a market for treasury bills which have short
term maturity. A treasury bill is a promissory note or a finance bill issued by
the government. [They were issued for 91 days but now they there are issuance
for 182 and 364days]. It is highly liquid because its repayment is guaranteed
by the Government.[These treasury bills are floated through auction and
conducted by RBI]. It is an important instrument for short term borrowing of
the Government [RBI as the leader and controller of money market buys and
sells treasury bills].
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2. Adhoc Treasury Bills - Adhoc treasury bills are issued in favour of the
RBI only. Adhocs are not marketable in India but holders of these bills can
sell them back to RBI.
4) Short-Term Loan Market- It is a market where short loans are given to
corporate customers for meeting their working capital requirements.
Commercial banks play a significance roll in this market.
Commercial banks provide short term loans in form of cash credit and
overdraft over graft facility is mainly given to business people whereas cash
credit is given to industrialists. Over draft is given in the current account itself.
Cash credit is for a period of one year and it is sanctioned in a separate
account.
Foreign Exchange Market-The term foreign exchange refers to the process of
converting home currencies into foreign currencies. According to Paul
Einzing, Foreign exchange is the system or process of converting one national
currency into another and of transferring money from one country to another.
The market where foreign exchange transactions take place called a foreign
exchange market. It consists of number of dealers and banks and brokers
engaged in the business of buying and selling foreign exchange.
The foreign exchange business are controlled by the foreign exchange
regulation act (FERA).
Financial Rates of Return :
Investments in financial assets like equities in capital market fetches more
return than investments in Gold(physical). The return on government securities
and bonds are comparatively less than on the corporate securities due to lower
risk. The Government and RBI determines the interest rates on Government
securities.
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The interests rates are administered and controlled. The interest rate structure
for bank deposits and bank credit is determined by the RBI.
Financial Instruments Financial instruments refers to those documents
which represents financial claims on assets.
Financial assets refers to a claim at repayment of a certain sum of money at the
end of a period together within interest or dividend.
Financial instruments may be categorized into :
1.Money Market Instruments.
2. Capital Market Instruments.
1. Money Market Instruments.
Money market instruments which deals in the money market are of short term
nature .Their maturity period varies between 14 and 364 days.
Examples are Treasury or short term financial bills - Issued by the Government
they are highly liquid and risk free as they are guaranteed by the Government.
Bills ofexchange or trade bills -
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Unit - I
Financial Services
Introduction
Financial services constitute an important component of the
financial system. Financial services through the network of elements such as
financial institutions,financial markets such as markets and financial
instruments serves the need of individuals, institutions and corporate.Through
these elements that the functioning of the financial systems is facilitated
.financial services are regarded as the fourth element of the financial system.
Financial Services Concept
Services that are offered by financial companies denotes
financial services. Financial companies include both asset management
companies and liabilities of management companies.
Asset management companies include leasing companies, mutual funds,
merchant bankers and issue/portfolio managers. Liability management
companies comprise of the bill discounting and acceptance houses.
Financial Services- Objectives/Functions
Following are the objectives of financial services that are
generally offered to financial companies.
1. Fund Raising - Financial Services help to raise the required funds from a
host of investors, individuals, institutions and corporate for this purpose,
various instruments of finance are used.
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Fund-Based Activities
These include underwriting of or investment in shares, debentures or bonds of
new issues, dealing in secondary market, participating in money market,
equipment leasing, hire purchase venture capital. It also participates in foreign
exchange activities.
In addition to the above activities this sector does a large number of other
services to their clients. For example, rendering project advisory services, plan
mergers and acquisitions and guiding in capital restructuring.
1. The customers should have easy access to organized capital or money markets
and financial services industry.
2. The customers should be able to transact a reasonable qty. of securities at a
shout notice.
3. The people should be able to invest in a wide range of securities which fit their
return expectations.
4. There should be access to people for sound financial counseling and fiduciary
services at a competitive price.
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5. Capital borrowers and investors should have easy and timely access to capital
markets.
6. Corporations should have flexibility in their financial decisions.
7. Report and findings of credit agency should be made available to corporations
and investors.
8. There should be efficient allocation of capital whereby the surplus capital gets
allocated to the most desirable investment opportunities to meet the
requirements of public policy.
9. The Government should be able to implement efficiently the monetary and
fiscal policy initiatives wing the capital markets.
10.The participants in the financial service industry should have the ability to
enter and exit with minimal costs and offer products and services and offer
products and services that the market may need.
The
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Unit - I
CREDIT CARD
Now banks have begun to render many innovative services to their customers
for the sake of providing better convenience to them.
The innovation of credit card is one among the many services provided by the
modern banker.
Origin of credit Card
The forerunner of todays payment card was the shoppers plate which
was introduced in USA in the 1920s. It was an early version of the modern
store card. It could be used in the shops which issued it and offered shoppers a
basic form of credit-buy now pay latter.
In India, the central Bank of India was the first bank to introduce
credit card known as central card in the middle of 1981.The Grindlays Bank
was the first foreign bank in India to make a credit card available to its
customers. It has over 280 million card holders across the globe and 28,000
establishments through India and Nepal that accept the Visa cards.
The Citibank the world largest bank card company with over 30 million card
holders has added another 65,000 members to its Network in India, by taking
over the countrys oldest credit card franchise the Diners club, with the
approval of the Reserve Bank of India.The Bank of India, Bank of Baroda,
Dena Bank, Andhra Bank, Canara Bank, Vijaya Bank and Union Bank of
India also have launched new credit card facility. The State Bank of India
introduced a different type of card known as State Bank Card in 1987.
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Credit cards are designed to avoid the use of either cash or cheque and also to
give some measure of credit to the card holders. They can be used only in those
establishments which have agreed to accept them. They may be used instead of
making payment for cash for goods and services.
The credit card organizer makes the payment to the establishments concerned
and once a month sends a statement to the credit card holder for all his
purchases in the previous month.A credit card is referred to as plastic money.
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d) Cirrus / plug logo can be used at any ATM which carries logo as that on
the back of the card.
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Charge :
If the total amount due as per the latest statement is paid in fullon or before
the payment due date, no finance charges are levied on the account.If the
cardholder maintains a savings current account with the bank he could pay
his credit card through the account. The cardholder can authorize the bank
to directly debit his account.If the cardholder maintains a savings current
account with the bank he could pay his credit card through the account the
cardholder can authorize the bank to directly debit his account.
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1. Standard Card- Credit card that are regularly issued by all card issuing
banks are called Standard Cards.It is possible for a card holder to make
purchase without having to pay cash immediately.
standard cards under the brand name classic cards. These cards are generally
issued to salaried people.
2. Business Card- Business cards also known as Executive cards are issued
to small partnership firms, solicitors firms of chartered accountants, tax
consultants and others, for use by executive on their business trips.
This card enjoys higher credit limits and more privileges than the standard
cards.These cards are issued in the names of the executives of the firms.
Elite- most powerful, rich or talented people within a society.
3. Gold Card- The gold card offers high value credit for the elite. It offers
many additional benefits and facilities such as higher credit limits more cash
advance limits, etc that are not available with standard or executive cards.
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They are also limited purpose prepaid cards which can be used for a limited
number of well defined purpose.
Private Label Cards
These cards are uniquely fixed to the retailer issuing the card and can be used
in that retailer stores & bank on the basis of a contract agreement with the
retailer extends credit under this type of card.
Affinity Group Cards
These are credit cards designed for use by a collection of individuals with
some form of common interest or relationship such as professional
alumni,retired persons organizations etc
Smart Cards
A smart card is a credit card sized plastic card with an embedded computers
chip. The chip allows the card to carry a much greater amount of information
than a magnetic card.The telecom industry was perhaps the pioneer in smart
cards, the most prominent being subscriber Identity Module (SIM) cards in the
GSM digital calculator network using special terminals designed to interact
with
the embedded chip the card can perform special functions this is
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taking an authenticated credit card and noting the number and taking
signatures on certain forms.
3. Bill Raising- Merchant establishment raises the bill for the purchase and
sends it to the credit card issuing bank for payment.
4. Payment- Issuing bank pays the amount to the merchant establishment.
5. Bill to card holder- Issuing bank raises bill on the credit cardholder and
sends it for payment.
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6. Card Payment- Credit cardholder makes the payment to the issuing bank.
Functions of Associations
These associations perform several key functions such as
1. processing of card holder
2. Merchant transactions
3. Licensing
4. Setting operations regulations
5. Conducting research and analysis
6. Development products and promotion of various types of cards.
Latest information indicates the Master Card International has 23,000 and Visa
Card International has 21,000 member financial institutions around the globe.
American Express is another major play in the global marker.
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Benefits to Merchants
1. Enhanced Sales- The credit card mechanism makes the buying process
convenient and easy. This in turn helps boost up the sales of business concerns
as it increase purchase power.
2. Easy Validation- The electronic system which is the back bone of credit
card operation, allows for easy verification greatly facilitates sale transactions
by merchants.
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Unit-I
DEBIT CARD
Debit Card
It is a plastic card similar to the credit where the expenditure amount is
automatically debited to the corresponding bank account. This amount will
appear in due course on the monthly statement of account.
It is a variant of an ATM card, which helps the customer to make payments
instantaneously for goods and services purchased.
Mechanism
While using a debit card at retail outlets the customer punches in a personal
identification number and the money is immediately debited to the concerned
bank account electronically.Unlike ATM cards, where the facility of cash
withdrawal can be availed only at specified locations in person, the debit card
allows the customer to use the card with case at any location and the money is
deducted directly from a customers bank account electronically.
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Unit - I
SMART CARDS
Smart Card is a plastic card different from a magnetic Stripecard, that is
embedded with a computer microchip and designed with a far greater memory
capacity.
It commands as powerful a computing power as the personal computer.
It has manifold applications, is affordable and is small enough to be carried
around at all times-truly like a computer in ones pocket.
Features
Like other computers, the smart card can be programmed to carry out any task
within its processing power and memory capacity.Following are the features
and practical applications of smart cards.
1. Data Carrier- Smart cards can be used as a convenient, portable and secure
means of storing information such as medical record equipment maintenance
records, driving license data, and Car maintenance records as an electronic
notepad etc.
2. Personal Identification- Smart cards serves as a safe medium of
identification of the holder.Important applications in the areas of identification
are protection of computer software, corporate cash management, Gaining
physical access to sports stadium, holiday complexes or hotel facilities. Satellite
television is another emerging opportunity for smart cards.The direct-to-home
service would be a pay television service and the smart card can be programmed
to unlock the television signal.
3. Financial usage- Smart cards can be used in such transactions replacements
for other instruments of payment etc.Some of the areas of applications are
paying for TV, Telephone/ electricity road tolls, ATM cash vending etc.
It is expected that financial credit cards and debit cards are likely to gradually
get converted to the more useful smart cards in the near future. Smart cards will
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help prevent the increasing number of frauds found in the traditional financial
cards.
Security Features
A Specialty of smart cards is that they contain a number of security features
which help prevent card-related crimes. Some of the security features of smart
cards are as follows :
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c) Communication strategy
The third category of security features offered by the smart card related to
communication.
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Visual Identification
1. All cards used with visual identification while communicate with another
device.
2. Provides integrity and validity of messages. The smart card with its
processing ability, provides integrity of messages and also validates messages.
3. Privacy is ensured through encryption.
4. Dynamic signature verification truces the way in which a signature is
written and the dynamic signature tablet automatically verifies the authencity
of the signature.
5. Finger print verification is used to identify the user by electronically
scanning finger print ridges.
Financial Application
Smart cards have potentially wide applications in banking insurance, wholesale
and retail business some of the principal uses of smart cards in these areas are as
follows :
1. Debit and Credit Cards
Smart cards have their wide usage in debit and credit cards. This is account of
the security features built into smart cards. They can ideally be used as a debit
or a credit card because of the protection they extend against fraud.
2. Electronic Cheque
Smart cards can be used during Electronic Funds Transfer at the point of sale
(EFTPOS). At a retailers checkout the card is placed in the reader, where it
automatically goes through the authentication sequences.
Payment authorization with the customer PIN is easily done. The card holder
bank account is automatically debited the retailer account credited and record of
the transactions stored in the card.
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3. Electronic Cash
Smart card facilitate loading of funds into a card for use as cash. This electronic
cash can then be used for making purchases without the need for authorization
of a PIN. In such a case, the retailer presents this information to the bank for
his account to be credited.
4. Electronic Token
Smart cards allow the storing of prepaid electronic units of time or electronic
tickets,etc for a specific service or item Magnetic stripe cards are often used
with public telephone parking meters and vending machines.
5. Cash Management services
Smart cards are used by banks for providing corporate cash management
services to major clients. The cards can act as secure keys to the banks
mainframe computers allowing major account holders to view and
automatically transact their accounts.
Evolution
1. Attributed to development of two products:
The evolution of the smart card is attributed to the development of two
products, the micro computer chip and magnetic stripe card.
2. Contains both processing and Data Storage:
The micro computer chip contains both processing and data storage capacity.
3. Revolutionizing the smart cards:
The advent of embossed metallic and plastic cards introduced by international
card companies such as diners club, etc in 1950s was also responsible for
revolutionizing the smart cards.
4. World Wide Use:
In 1969 magnetic stripes were first added to the embossed cards to ensure that
the cards could be used worldwide.
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Unit II
Investment
Meaning
Investment means sacrificing your current resources in return for certain
benefits you expect to receive in the future.
For instance when you purchase the shares of a company, you spend money
today because you expect the shares toappreciate in value and to pay out a
dividend.
Need for Investment:
The most common financial needs that require regular investing are:
Purchasing or construction of a house providing the margin needed to
obtain a housing loan from a bank.
Higher education of children
Marriage of children
Post-retirement regular income
Creating a contingency fund for medical and other emergencies.
All of these needs may arise during the lifetime of any person.
Creating a fund for meeting this needs is essential for living a stress free
life.The quality of your life will improve when you have the confidence
that the money required to meet any major expenditure will be available
when the need arises.
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UNIT II
SECURITIES
Kinds of Issues
Classification of Issue of Securities:
1. Public Issues
2. Rights Issues
3. Preferential Issue/ Private issue
Public and rights issues involve a detailed procedure.
Private and placements or preferential issues are relatively simple in its
procedure.
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1. Public Issues:
Public issuers can be further classified into initial public offerings and
further public offerings. In Public offering, the issuer makes a offer for new
investors to enter its shareholding family.The issuer company makes
detailed disclosures as per the DIP [Disclosures and Investor protection]
guidelines in its offer document and offers it for subscription.
Types of public issue of securities
Initial public offering (IPO)
Follow on public offering (FPO)
1. Initial public offering (IPO)
Initial public offering is a kind of public issue of securities, where an
unlisted company makes either a fresh issue of securities or an offer for
sale of its existing securities or both for the first time to the public.
This paves way for listing and trading of the issuer securities.
e-IPO :
A company proposing to issue capital to public through the online system
of the stock exchange for offer of securities can do so by complying with
the requirements under IIA of DIP guidelines. It is known as e-IPO.
to the issue.This route is best suited for companies who would like to raise
capital without diluting stake of its existing shareholder.
Unlisted Company
A Company with that is not traded on a stock exchanges very often unlisted
companies are very small and do not trade on a stock exchange because they
do not meet capitalization requirements.
Listed Company
A Listed company means a company which is listed on stock exchange for
public trading. This is also called as quoted company.
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Unit-II
SECURITIES MARKET
2.Money has to be repaid only in the case of winding up or buy back of shares.
3.There is no financial burden because it does not involve interest payment if
the company earns profit dividend may be paid.
4.Better performance of the company enhances the value for the shareholders.
5. It enables trading and listing of securities at stock exchanges.
6.There is greater transparency in the corporate governance.
7.If the company performs well the image of the company brightens.
Issuers The listed and unlisted issue securities both of these have to fulfill
conditions laid down by the SEBI to issue equity shares.
Issue by Unlisted Company :
According to SEBI Disclosure and investor protection guideline (DIP), an
unlisted company may make an initial public offering only if meets the
following conditions specified by SEBI.
The company has net tangible assets of at least Rs.3 crore in each of the
preceding three full years (of twelve month each) of which not more than 50
percent is held in monetary of assets.
* If more than 50 percent of the net of the net tangible assets are held in
monetary assets,the company has to make firm commitments to deploy such
assets monetary assets in its business projects.
* The company has track record of distributable profits in terms of section 205
of the Companies Act 1956 for at least three out of immediately preceding of
five years.
*In case the company has changed its name within the last one year at least 50
percent of the revenue for the preceding of one full year is earned by the
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company from the activity suggested by the new name and the aggregate of the
proposed and all the previous issues made in the same financial year in forms of
size ( offer through offer document + firm allotment + promoters contribution
through the offer document ,does not exceed five times its pre-issue net worth
as per the credited balance sheet of the last financial year.
Issue by Listed Company
A listed company is eligible to make a public issue of equity shares or
other security which may be converted into or exchanged with equity shares at a
later date at a later date if it satisfies the following conditions :
The aggregate of the proposed issue and all the previous issues made in
the same financial year in terms of size (offer through offer document +
firm allotment + promoters contribution through the offer document), the
revenue accounted for by the activity suggested by the new name is not
less than 50 percent of the total revenue in the preceding one full year
period.
Exemption from Eligibility Norms Exemption are provided to the following companies subject to certain
conditions :
Banking Companies
Infrastructure Companies
Listed Companies
Investor
Primary marketsattract a wide spectrum of investors, Different
categoriesof investors buys shares in the primary market.
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Reservations
There may be reservations for retail investors, Non institutional Investors,
Qualified institutional builders (QIBs) employees of the issuing company,
existing shareholders of the issuing company etc.,
Classification of investors :
Investors are broadly categorized as :
Qualified Institutional Buyers
Non-Institutional Investors
Retail Investors
Qualified Institutional Buyers (QIB) Mutual funds banks financial institutions like LIC and foreign investors, fall
under the category of QIB. Earlier QIB were not required to submit any
money along with their bids and this had led to some manipulative practices.
However SEBI has recently changed the provisions and now QIBs have to
pay margin not the full amount at the time of bidding in the book building of
an issue.
The following are specified as QIBs by the SEBI public financial
institutions defined in the section 4 of the companies Act.
Scheduled Commercial banks
Mutual Funds
Foreign Institutional investors registered wit SEBI
Multilateral and bilateral development financial institutions
Venture capital fund registered with SEBI
Foreign Venture capital investors registered with SEBI
State industrial development corporations
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Following are the intermediaries who are involved in the new issue market /
primary market:
Bankers to the Issue
Underwriters
Stock brokers and sub-brokers
Depositories
1. Lead Managers- Merchant bankers are appointed to manage the issue and
are called lead managers to the issue. Depending on the size of the issue a
company may appoint more than one merchant Banker. The Pre-issue and post
issue responsibilities of the merchant bankers are properly structured. The lead
managers assist the company right from the preparation of prospectus, to the
listing of securities on stock exchanges.
2. Under writers- Under writing is an agreement with or without conditions to
subscribe to the securities of a body corporate in the event of non-subscription
by the public.If there is under-subscription(the amount received is less than the
issue size) the underwriter subscribe to the un-subscribed portion. The person
who assures the sum is called an underwriting commission.
A certificate of registration from SEBI has to be obtained by the agencies
that wish to carry out underwriting activities.After the selection of the
underwriter the issuing company enters into an agreement with the underwriter.
The agreements contains the following
The period during which the agreement will remain in force.
The amount of the underwriting obligation.
The maximum period within which the underwriter will have to
subscribe to the offer the companys intimation.
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3. Bankers to the Issue - Banks which accept application forms and money on
behalf of the public are called bankers to the issue. The collected money is
transferred to the escrow accounts as per the provision of the companies Act.
[An escrow account is a designated account in which the funds can be utilized
only for a specified purpose]
The bankers to the issue have to keep the funds in the escrow account on
behalf of the holders.These funds are not available to the company till the issue
is completed and allocation is made commission is paid to the bankers to the
issue.
4. Registrar to the Issue- The Company appoints the registrars to the issue in
consultation with the lead manager some merchant bankers carry on the
activities of the registrars to an issue as well as of the share transfer agents.
Some carry on the activities of a registrar to an issue or those of a share
transfer agent.Quotations containing the details of the various functions that
they would perform along with the expected charges for the functions are called
for selection. Suitable ones are selected from the applications received.
If the number of applications in a public issue is expected to be large, the
issuer company in consultation with the lead merchant banker can appoint one
or more registrars for the purpose of collecting the application forms at different
centers and forwarding the same to the designated registrar to the issue, as
mentioned in the offer document. The designated registrar is responsible for all
the activities related to issue.
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1.The primary issues are governed by SEBI in terms of SEBI (Disclosure and
Investor Protection) Guidelines.
2. SEBI framed its DIP guidelines in 1992. Many amendments have been
carried out in the same in line with the market dynamics and requirements.
4. These guidelines and amendments there on are issued by SEBI India under
Section 11 of the Securities and Exchange Board of India Act 1992.
2. Due diligence forms the basis of any such examination and the discussions
which the dead manager has with the company its directors and other officers
and other agencies.
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5. The merchant bankers are the specialized intermediaries who are required to
do due diligence and ensure that all the requirements of DIP are compiled with
while submitting the draft offer document to SEBI.
6.Any non-compliances on their part attract penal action from SEBI in terms of
SEBI (Merchant Bankers) Regulations.
7.The draft offer document filed by Merchant Bankers is also placed on the web
sites for public comments.
8.Officials of SEBI at various levels examine the compliance with DIP Guide
Lines and ensure that all necessary material information is disclosed in the draft
offer documents.
1. The Central Listing Authority (CLA) functions have been detected under
regulations of SEBI, The central Listing Authority Regulations 2008, (CLA
regulations) issued on Aug 21st, 2003.
2.CLA covers processing applications for the letter precedent to listing of from
applicants.
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Documents of issue
Public issue of securities requires certain documents to be drafted and filed with
the SEBI and registrar of companies These documents include prospectus,
abridged prospectus etc..
1) Offer Document
Offer document means prospectus in case of a public issue or offer for
sale and letter of offer in case of a rights issue, which is filed with Registrar of
Companies (ROC) and Stock Exchange.
An offer document covers all the relevant information to help an investor to
make his/her investment decision.SEBI issues press releases every were
regarding the draft offer documents received and observations issued during the
period.The draft offer document are put upon the website under reports.
Document Section
The final offer documents that are filed with SEBI/ROC are also put up
for information under the same section.The hard copy may be obtained from the
office of SEBI located at Mumbai on payment of Rs.100.The final offer
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documents that are filed with SEBI/ROC can be down loaded from the same
section of the website.
3) Red-Herring Prospectus
It is a prospectus which does not have details of either price or number of
shares being offered or the amount of issue. This means that incase price is not
disclosed, the number of shares and the upper and lower price bands are
disclosed.
A Red-Herring prospectus for a Follow-On Public offering can be filed with
the ROC without the price band and the issuer, in such a case will notify the floor
price or a price band by way of advertisement one day prior to the opening of the
issue.
4) Abridged prospectus
Abridged prospectus means the memorandum as prescribed in Form 2A
under sub-section (3) of section 56 of the Companies Act 1956. It contains all the
salient features of prospectus. It accompanies the application form of public
issues.
Lock-in Shares
The term Lock-in indicates a freeze on the shares SEBI (DIP) guidelines have
promoters mainly to ensure that the promoters or main persons who are
controlling the comp shall continue to hold some minimum percentage in the
company after the public issue.
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Any safety net scheme or buy back arrangement of the shares proposed in any
public issue shall be finalized by an issue company with the lead merchant
banker in advance and disclosed in the prospectus.
Such buy-back or safety net arrangements shall be made available only to all
original individual allottees limited up to a maximum of 1000 shares per allottee
and offer is kept open for a period of six months from the last date of dispatch
of securities.
indicated the highest grading and IPO Grade 1 indicated the lowest grading i.e.,
a higher score indicate stronger fundamentals.IPO grading represents an
independent opinion form an agency that is not connected with the placement of
the issue.IPO grading is a one-time exercise not subject to subsequent
surveillance.
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5) Management quality
Placement of issues in primary market
The placement of the issues may be through
1. Prospectus
2. Offer of sale
3. Private placement
4. Book building
5. Qualified Institutions placement.
1. Prospectus
In the offer through prospectus subscription from the public is invited through
issue of the prospectus.
2. Offer of Sale
It means outright sale of shares to intermediaries such as issuing houses or
share brokers instead of offering shares to the public.
3. Private placement
A private placement is a direct private offering of securities to limited number
of investors.
4. Book-Building
Is a process adopted in initial public offering for efficient price discovery. The
investors bids the offer wither above or equal to the floor price.
5. Qualified Institutions Placement
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Unit - II
SECONDARY MARKET
Stock market has two components
1. Primary market- It is a channel for the sale of new securities.
2. Secondary market- It provides a platform for sale of the already issued and
listed securities.
It has been defined as a body of individuals whether incorporated or not,
constituted for the purpose of assisting, regulating and controlling of business of
buying, selling and dealing in securities.
Both markets are interdependent and inseparable.
Market Segments
The secondary market has the following three segments.
1. Capital Market Segment (CM)
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I. Investors
The investors can be broadly classified into
1. Retail Investors
2. Institutional Investors
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3. Institutional Investors
Mutual funds, unit Trust, Insurance Companies, banks and other large
institutions which invest their members money in shares and bonds are known
as Institutional Investors.
They have professional analyst and advisors who usually analyse the stock
market trends much better than individual investors.They trade in large volumes
and play a major role in the stock market.
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The trading can be carried out only through the members. the investors can
enter into trade only through a brokers account.
The brokers enters into trade either on his own account or on behalf of his
clients in the stock exchanges.
The members can be :
Individuals
Firms
Corporate entities
IDBI, LIC, GIC, UTI, ICICI and subsidiaries of any of the corporations are
members in stock exchanges.
Experience - To become a member, he should have a minimum of two years
experience in any activity related to dealing in securities.
Capital Requirement: The stock exchanges shall have theBase minimum
capital [BMC].
According to the present requirement atleast 50 percent of the base minimum
capital should be in cash or in cash with an approved bank. The remaining 50
percent can be held by way of approved securities.
Fees: A stock broker has to pay a registration fee of Rs. 5000 for every financial
year. After the expiry of five years from the date of initial registration as
broker, he has to pay Rs. 5000 for a block of five financial years.
The stock exchange also collects transaction charges from its trading members.
Brokerage charges
The trading member can charge the following:
1. Brokerage charge
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A depository established under the depositaries act can provide any service
connected with recording of allotment of securities or transfer of ownership of
securities in the recon of a depository.
A depository cannot directly open accounts and provide services to clients. Any
person who is willing to avail the services of the depository can do so by
entering into an agreement with the depository through any of its depository
participants.
3) Depository participants
Agents to depository are called depository participants(DP).
They are
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Bank
Depository
Account
Hold Securities in an
account
Transfer
Transfers securities
Handling
Safe Keeping
Facilities safekeeping of
money
securities
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Benefits of Investors:
1. Faster Investors - Transactions takes place much faster in electronic trading
compared to a 30-60 days settlement cycle that usually takes place in the case of
physical transfer of securities, transfer of shares is effected within a few days
after payment is made.
2. Elimination of bad deliveries and all risks associated with physical certificate
such as loss, theft, mutilation (deliberately damaged or spoiled, forgery etc.,).
3. Easy and enhanced liquidity.
4. No stamp duty on transfer
5. No postage / courier charges
6. Faster disbursement of corporate benefits like rights, bonus etc
7. No delay in transfer of securities
8. No follow up with the comp. regarding the status of the dispatched
certification
9. Facility for creating charge on dematerialized shares for granting loans and
advances against shares.
10. Lower interest on loans against demat shares.
11. Nomination facility at the time of account opening.
12. No loss of share certificate in postal transit.
13. Much faster payment on sale of shares.
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The payment for the shares in the depository system can be made in the same
way as one pays for the purchase of any physical shares.
Market Trade and Off Market Trade
Trade done and settled through a stock exchange and clearing corporation is
called Market Trade.Trade done in private without the involvement of stock
broker or stock exchange is called Off Market Trade. However DP helps in
delivering the shares against a sell transaction or receiving the shares for a buy
transaction.
Dematerialization
Dematerialization is the process of conversion of shares or other securities held
in physical form into electronic form.The investor must approaching DP for
dematerialization. The investor can demat the shares of any company that has
established connectivity with NSDL or CSDL.
Steps in Dematerialization
1. Demat Request Form - Investor must submit Demat Request Form (DRF)
and share certificate to DP
2. Checking Securities - DP will check whether securities are available for
Demat Investor must deface the share certificate by stamping surrendered for
dematerialization and DP will punch two holes on the name of the comp and
will draw two parallel lines across the face of the certificate.
3. Entry of Request - DP enters the demat request in their system to be sent to
Depository. DP dispatches the physical certificates along with the DRF to
Registrar and Transfer Agents (RTA)/ company.
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his/her demat account with the number of securities sold by him and credit
brokers clearing account procedure for selling securities is as follows.
1. Investors sells securities in any of the stock exchanges linked to
depository through a broker.
2. Investor gives instruction to DP to debit his account and credit the
brokers account (Clearing member poof).
3. Before the pay in day, investors broker transfer the securities to clearing
corporation.
4. The broker receives payment from the stock exchange (clearing
corporation).
5. The investor receives payment from the broker for the sale in the same
manner as that is received for a sale in the physical mode.
II) For Buying Dematerialized Securities
The procedure for buying dematerialized securities form stock exchanges is
similar to the procedure for buying physical securities. Investor may give a
one-time standing instruction to receive credits into his /her account or may give
separate instruction each time in the prescribed format.
The transactions relating to purchase of Securities are as follows.
1. Investor purchases securities in any of the stock exchanges connected to
Depository through a broker.
2. Broker receives payment from Investors.
3. Broker arranges payment to the clearing corporation.
4. Broker receives credit of securities in clearing account and credit clients
account.
5. Investor receives shares in his account.
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MINISTRY OF FINANCE
In the ministry of Finance, the capital market is regulated by the capital markets
division of the department of economic affairs.
This division is responsible for formulating and development of the securities
markets i.e. share, debt, derivatives as well as protecting of the interests of the
investors. In particular it is responsible for
Institutional reforms in the securities market
Building regulatory and market institution.
Strengthening investor protection mechanism
Providing efficient legislative framework for securities markets.
The SEBI was established under the SEBI Act 1992, as a regulatory authority of
Securities market with the objective to protect the interest of the investors in the
securities market and promote the development of the capital market.
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Stock Exchanges
Stock exchanges are the most important segment of the secondary market where
securities are traded.Securities markets are places where securities, stocks, shares
and bonds of all types are bought and sold.
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Definition - Stock exchange are organized market places in which stock, shares
and other securities are traded by members of the exchange, acting as both agents
(brokers and principals dealers or traders).
Stock exchanges have a physical location where brokers and dealers meet to
execute orders from institutional and individual investors to buy and sell
securities. Here only members are allowed to buy or sell securities. It is a market
for existing not for new issues.
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Therefore the
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Utter
Pradesh
Stock
Exchange
As per SEBI report, Mangalore stock Exchange was derecognized in 2006 and
Hyderabad Stock Exchange Ltd., Magadh Stock Exchange Ltd., and SaurashtraKutch Stock Exchange were derecognized in 2007. Coimbatore Stock Exchange
Ltd., has not filed application for renewal of recognition which expired on 17
September 2006 due to a pending litigation in the Court.
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Recognition
The stock exchanges are to be registered by the Government. For getting
recognition an application under the sec 3 of the securities contracts
(Regulation) Act has to be submitted to the Government.
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Membership
The members and their authorized clerks alone can enter the trading floor and
conduct buying and selling of securities.
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He has to open a bank account with one of the Internet trading portals
banking and depository services partners.
He must be registered I connect user
On placing an order for buying / selling of securities through the listed
online trading portal. He has to click on pay through bank listed on the
online portal which will directed to a log in screen of the investors
account.
Once the details of the login ID and password are entered the investor has
to verify the transaction details and confirm the transactions be entering
his transaction ID and password.
Once his order is executed, an email confirmation regarding the status of
his transaction follows.
Investors account status is updated on a real time basis.
Securities status can be viewed online after the day of settlement.
Types of Orders
1. Limit order- In the limit order, buy or sell order is placed with a price
limit. For Example if the investors place a buy order of Ranbaxy shares
with the limit price of Rs.450, he puts a cap on purchase price.
In case the current price is higher than the limit price, the order will be
kept pending. It will be executed only when the price hits Rs.450 (or)
below. If the actual price in the market is Rs.447 the order will be
immediately executed.
2. Market Order- In the market order, the buy and sell orders are executed
at the best price offered in the exchange. For Example, the last quote of
Infosys was Rs.1494 (15 Jan 2008) and the buyer placed a market buy
order. Then the execution was at the best offer price on the exchange
which could be above or below Rs.1494.
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3. Stop Loss Order- These orders are given to limit the loss due to
unfavorable price movement in the market. A particular limit is given for
waiting. If the price falls below the limit, the broker is authorized to sell
the shares to prevent loss. The limit price is also known as trigger price.
Day Trading - It means not holding any stock overnight. This is really the
safest way to do day trading because the trader is not exposed to the potential
losses that can occur overnight when the stock market is close due to news that
can affect the prices of the particular stock.
Any news regarding a particular comp or any macro economic factor received
after the closure of the stock exchange may affect the opening price of the stock
on the next day.
Types of Day Trading
The various types of day trading are as follows.
1. Scalpers
This type of day trading involves rapid and repeated buying and selling of
a large volume of stocks within seconds or minutes. The objective is to
earn a small percentage of profit per share on each transaction while
minimizing the risk.
2. Momentum Traders
This type of day trading involves identifying the moving patterns of the
stock during the day. It is an attempt to buy such stocks at bottoms and
sell at tops within a day.
Advantages of Day Trading
1. No Overnight Risk- Since positions are closed prior to the end of the
trading day, news and events that affect the opening prices of the next
trading day do not affect the traders portfolio.
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2. Leverage- (Using borrowed money in order to buy it or pay for it) Day
traders have a greater leverage on their trading capital because of low
margin requirement as their trades are closed in the same market day.
This increased leverage can increase the profits.
3. Gains from market Movement- Day trading often utilizes short- selling
to take advantages of declining stock prices. The ability to lock in profits
even as markers fall throughout the trading day is extremely useful during
the bear market conditions.
4. Margin Trading- Trading with borrowed funds or securities scatted
margin trading. It helps the investors to trade over and above.
Jobbers
Buy and sell securities on behalf of Jobbers buy and sell securities in
their clients only as agents.
3. Floor Broker- Floor Broker is a person who buys and sells shares for
other brokers on the floor of the exchange. He is an individual member
who owns his own seat and receives commission on the orders executed by
him. He helps other brokers when they are busy and get a portion of the
brokerage charged by the commission agent to his customer as
compensation. Such brokers are not found in the Indian stock exchanges.
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Investors
There are some persons who buy securities with a view to investing their
money for the purpose of getting an income or selling them for getting ready
cash. Such persons are called genuine Investors.
Speculators: There are some people who buy securities with ahope of selling
them in future at a profit (or) in the expectation of being able to buy them at a
profit in future such dealers in the stock exchange are called speculators.
Speculator
of income.
He
seeks
income
from
his
investment.
sale of securities
The
Types of Speculators
In stock exchanges the speculator are identified as some 200 logical characters
such as bulls, bears, stags and lame ducks.
the hope of selling them at the future date when the price rise as per his
expectation. If the prices rises, he sells and makes a speculative profit.
The bull is to buy security without taking actual delivery to sell it in the
future when there is a rise in prices. The bull raises the prices in the stock
market of those securities in which he deals.
If the price continues to fall he pays the difference at loss or he may
either close his deal or carry forward the deal to the next settlement day
by paying the contango charge.
Example of bull transaction- if a person asks his broker to buy 1000
shares at Rs.10 per share for which no immediate payment will be made
and if the price of those shares increases to Rs.16 per share, he will
instruct his broker to sell the shares on this behalf. The transaction may
not be real. The profit made in this transaction is calculated as follows.
Sale price of 1000 shares @ Rs.16 per share
= 16,000
Purchase price pf 1000 shares @ Rs.10 per share
= 10,000
Profit
6000
This profit of Rs.6,000 only will be paid on the date of settlement and
there will be no delivery of shares.
2. Bear A bear is an operator who anticipates a fall in prices and enters
into a contract to sell the shares at current prices. With the hope of
buying themback at a future date when the prices fall. If the price falls as
per his expectation the bear will buy back the shares and thus make a
profit.
4. Stag: A stag is a premium hunter. He does not buy and sell securities in
the market. He applies for shares in the new issue market just like a
genuine investor. He expects that the price of shares will soon increase
and shares can be hold for premium stag expects a rise in price.
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companies Act 1956. It has been promoted by UTI, ICICI, IDBI, IFCI,
LIC, GIC, SBI capital markets Ltd and can bank financial services Ltd.
The OTCEI is a different kind of stock exchange OTC stands for Over
the Counter. Investor can buy and sell securities over the counters of heir
local banks. The OTC markets refers to a way of trading securities
through a network of broker dealers spread over different locations linked
with telephone, Tele-Fax, Faxes and comfort.
3. OATCEI has an exclusive list on the OTCEI are not permitted to list on
other exchanges and vice versa
4. OTCEI methods of pricing securities differ from the other pricing.
OTCEI Market
OTCEI is not lending institution. It does not provide promoter contribution.
The securities of companies are traded on the OTCEI the investors deal
through OTCEI counters.
The OTCEI has two classes such as members and dealers undertake
booking, trading and voluntary market and listed companies may choose one
among them. It has in house control over the transfer of securities.
It intends to offer the investors the option of opening an account with an
affiliated bank. It ensures speedy transactions. The major constituents of the
OTCEI are companies, investors, members and licensed dealers. The OTCEI
is a ring less electronically traded, automated national market. Trading is
being done electronically.The OTCEI will be nonprofit making and free of
income tax liability.
Objectives of OTCEI
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Guideline of OTCEI:
The minimum issued equity share capital of a company for eligible for listing
on the OTCEI is Rs.30 Lakhs. Subject to a minimum of public offer of
equity shares worth of Rs.20 Lakh in face value.
3). Stock Holding Corporation of India LTD (SHCIL):
The stock holding corporation of India Ltd (SHCIL) has been promoted by
IDBI, ICICI, IFCI, UTI, LIC and GIC and its subsidiaries. It is the first
organization to register as a depository participant both with National
Securities Depository Ltd (NSDL) and central Depository services Ltd
(CSDL).
The SHCIL is the largest depository participant in the country with more than
7 lakh account. It has the network of many offices across the country. It
formulates new products that give benefits to investors, corporate houses and
brokers.
The SHCIL provides complete solutions to its institutional clients. Its core
services such as market operations, safe keeping, custody mgt. corporation
action, stock lending, reporting and market updates, etc. support services like
fund transfer and data bank information needs. The SHCIL is accredited by
the RBI for providing services to investments in Government securities in
dematerialized form.
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UNIT-II
SECURITIZATION
The Indian financial services is witnessing a tremendous growth due to the
economic liberalization measures adopted by the Government of India. The new
developments taking place in the realm has led to the innovation of financial
techniques and new financial instruments.
One such important innovation is Asset securitization.
Definition of Securitization
Asset securitization is the process of separating certain assets from the balance
sheet and using them as collateral for the issuance of securities.
Securities may then be rated and sold based upon the economic quality of the
assets.
A technique where by assets are converted into securities, which are in turn
converted into cash on an ongoing basis, with a view to allow for increasing
turnover of business and profit is known as asset securitisation.
Securitisation may be defined as a method of funding any kind of receivables
(mortgage debts, leased, loans, credit card balances etc).
Illustration Explaining the Securitization
1.Simple Financing In a typical case of simple financing a loan is obtained to
buy a car. This creates a loan obligation and ownership of the car.
2.Asset Securitization The car financed by a financial institution generates a
series of claims in the form of interest and principal value over a period of time
to the lender.
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Securitization involves selling this series of cash flow that emanates from
the above dealing by creating pools of securities and selling them for a certain
maturity period.
Meaning of security
Securitization is a process by which the financial relations are converted into
transferable securities.
The word security here means a financial claim which is generally in the
form of a document its essential feature being marketability .To endure
marketability the instrument must have general acceptability as a store of value.
Hence it is generally either rated by credit agencies or secured by charge over
substantial assets.
Further to ensure liquidity the instrument is generally made in
homogenous lots.
Need for Securitization
Financial markets developed in responsible to the need to involve a large
number of investors in the market place.
As the number of investors keeps on increasing the average size of each
investment keeps on diminishing which is a simple rule of the market place
because growing size means involvement of a wider base of investors.
The small investor is not a professional investor and is not in the business
of investments. Hence an instrument is needed which is easy to understand and
is liquid.
The above said needs set the stage for the evolution of financial
instruments which would convert financial claims into liquid,easy to understand
and homogenous products at times carrying certified quality labels(credit
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Therefore the originator transfers the assets to SPV which holds the assets on
behalf of investors and issues to the investors its own securities.For this purpose
the SPVis also called the issuer.
Asset Securitisation- Mechanism
Asset securitization works through a special purpose vehicle. The SPV act as a
crucial link in the securitization chain intermediating between the primary
market for the underlying asset and the secondary market for the asset backed
security.
Process of Securitisation
Following are the steps involved in the securitisation process.
Origination
Assets are originated by a company and funded on that companys balance
sheet.This company is normally referred to as the originator.
Asset Identification and pooling
The asset to be securitized by the institution is identified, which comprises of
the loans advanced by the institution.The identification of the assets is done in
such a manner as to ensure an optimum mix of homogenous assets having
almost the same maturity.
Security Creation
Securities of uniform maturity are created out of the assets that are identified.
These are then passed on to another institution called Special purpose
vehicle.The SPV is a trust,which like an investment banker,manage the issue of
securities to investors.These securities are known as pay or pass through
certificates.The SPV becomes liable to the investor for principal repayments and
interest recovery.
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SPVs Task
The SPV engages itself in the task of enhancing its credibility in order to make
the issue attractive.For this purpose the SPV obtains an insurance policy to
cover the credit losses or arranges a credit facility from a third party lender to
cover delayed payments.
Security Issue
The SPV issues tradable securities to fund the purchase of assets. The
performance of these securities is directly linked to the performance of the
assets and there is no recourse (other than in the event of breach of contract)
back to the originator.
Security purchase
Investor purchase the securities because they are satisfied (normally by relying
upon a rating)that the securities will be paid in full and on time ,from the cash
flows available in the asset pool. A considerable amount of time is spent
considering the different likely performance of the asset pool and the
implications of default by borrowers. The proceeds from the sale of the
securities are used to pay the originator.
Receipt of Benefits
The SPV agrees to pay any surplus which arises during its funding of the assets
back to the originator.This means that the originator, for all practical purposes
retains its existing relationship with the borrowers and all the economics of
funding the assets(i.e.the originator continues to administer the portfolio and
continues to receive the economic benefits (profits)of owning the assets)
Rating and Trading
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The SSPV gets the securities rated by some reputed credit rating agencies so as
to enhance the marketability of the securitized assets. In addition,credit rating
increases the trading potential of the certificate in a secondary market, thus
augmenting its liquidity potential.
Redemption
On maturity of the security the investors get a redemption amount from the
issuer along with interest due on the amount.
Securitization Benefits
Benefits to originator
1.Off-balance sheet financing
Securitization offers the advantage of off-balance sheet funding by allowing for
the conversion of an otherwise non-liquid- asset into ready liquidity. This
allows for better balance sheet management.This also enables faster recovery of
funds leading to higher business turnover and profitability.
2.Creditenhancement
Credit enhancement helps make the transaction attractive by means of an
investment credit rating for the instrument.Since a variety of factors are taken
into consideration for rating, it would give a boost to investor confidence in the
newly created market of instruments which have qualitative differences but
have been built upon underlying debts.
3.Low costs
Securitization helps reduce the funding cost substantially as compared to
conventional fund rising instruments like bonds, debentures,and commercial
papers.
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4..Access to market
Asset securitization enables the originators to access the securities market at
debt ratings higher than their own overall corporate ratings through the novel
technique of credit enhancement and diversification of risk. For instance the
National Stock Exchange has announced that it will allow listing of securitized
assets.This will definitely help to develop an active secondary market and
improve liquidity.
Benefits to investors
a.Multiple new investment instruments for investors to meet their preferences.
b. Enabling the end investor to look past the issuing entity to the collateral pool
that the issue represents.
c. Reduction in uncertainty for the investor by minimizing the risk element
through transparency.
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Unit -II
UNDERWRITING OF SECURITIES
A kind of guarantee given by a financial intermediary to take up whole or part
of the issue of securities not subscribed by the public is termed as underwriting.
An institution or an agency that provides this sort of a guarantee for sale of
certain quantum of securities to an issuer is called the Underwriter.
Different Types of Underwriting
1. Firm underwriting
Firm underwriting takes place when the underwriter agrees to take up a certain
specified number of securities,irrespective of the securities being offered to the
public.
2.Sub-underwriting
Sub-underwriting takes place when the underwriting of securities is contracted
out by the main underwriter to other underwriting intermediaries.
3.Joint underwriting
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Assurance to investors
Underwriters before underwriting the issue satisfy themselves with the financial
integrity of the company and viability of the plan.The underwriting firms assure
this way the soundness of the company.Theinvestors are therefore assured of
having low risk when they buy sharesof debentures which have been
underwritten by them.
Better Marketing
Underwriters ensure efficient and successful marketing of the securities of a
firm through their networks arrangements with other underwriters and brokers
at national and global level.This promotes a wide geographical dispersion of
securities and facilities tapping of financial resources for the company.
Benefits to Buyers
Underwriters are very useful to the buyers of securities due to their ability to
give expert advice regarding the safety of the investment and the soundness of
companies. The information and the expert opinion published by them in
various newspapers and journal are also helpful.
Price Stability
Underwriters provide stability to the price of securities by purchasing and
selling various securities.This ultimately benefits the stock market.
Underwriting Agencies
The Indian capital market is dominated by several underwriting agencies such
as private firms,banks,financial institutions etc.
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Private Agencies
Some of the important private firms that are involved in underwriting business
are M/s.Dalaland Co., M/s.Kothari and Co and M/s.Wright and Co.
Investment Companies
In addition to private agencies a number of investment companies and trusts are
also engaged in the ;underwriting business.These include Industrial Investment
Trusts of Bombay, Birds Investment Ltd., Calcutta, Devakaran Nanji
Investment Co., and Investment Trust of India Ltd.
Commercial Banks
After the nationalization of commercial banks and with the initiation of reform
measures if the beginning of the nineties, banks started taking a active part in
the underwriting business.
Development Finance Institutions
A number of development finance institutions were established allover to spur
development and growth in the industrial,export and agricultural sectors.These
institutions provide direct and indirect financial and other type
of
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Unit - II
BOOK BUILDING
Book Building is a process by which Corporates determine the demand and
price of a proposed issue of securities through public bidding.
Characteristics of Book Building
1. Tendering process
Book Building involves inviting subscriptions to a public offer of
securities, essentially through a tendering process. Eligible investors are
required to place their bids for their number of shares to be issued and the
price at which they are willing to invest, with the lead manager running
the book. At the end of the cut-off period, the lead manager determines
the response to the issue in terms of the quantum of shares and the highest
price at which the demand is sufficient to match the size of the issue.
2. Floor Price
Floor price is the minimum price set by the lead manager in consultation
with the issuer. This is the price at which the issue is open for
subscription. Investors are free to place a bid at any price higher than the
floor price.
3. Price Band
The range of price (The Highest and the lowest price) at which offer for
the subscription of securities is made is known as price band. Investors
are free to bid any price within the Price band.
4. Bid
The Investor can place a bid with the authorized lead manager- merchant
banker. In case of equity shares usually several brokers in the stock
exchange are also authorized by the lead manager. The investor fills up a
bid-cum-application form, which gives a choice to bid upto three optional
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prices. The price and demand options submitted by the bidder are treated
as optional demands and are not cumulated.
5. Allotment
The lead manager in consultation with the issuer, decides the price at
which the issue will be subscribed and proceeds to allot shares to the
investors who have bid at or above the fixed price. All investors are
allotted shares at the same fixed price. For any allottee, therefore, the
price will be equal to or less than the price bid.
6. Participants
Generally, all investors including, eligible to invest in a particular issue of
securities can participate in the book building process. However, if the
issue is restricted to qualified institutional investors, as in the case of
government securities, then only those eligible can participate.
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Unit II
STOCK INVEST
Meaning
Stock invest is a non negotiable instrument used for subscribing to capital
issues in the primary market.Under this arrangement the money invested in a
public issue,along with the instrument,continues to remain in the account of the
investor and it earns interest till the investor successfully obtains the
allotment.Stock-invest serves as an additional mode of payment by an
investor.Funds of the investor are not locked up when applying for an
issue.Funds are released from the stock-invest account by the bank only in the
event of successful allotment of securities to the subscriber-customer.
To avail the benefit of stock invest the prospective subscriber has to open an
account with a banker,who operates the stock-invest scheme.Banks issue the
facility of stock-invest to the prospective subscriber in the deposit account of
the investor. The issue is made with the banks lien for the amount of stockinvest issued.The collecting banker gives credit to the account of the company
only on successful allotment of securities.
The scheme of stock-invest serves as a convenient and a safe mode of
making payment while applying for the public issue.Stock-invests are however
,not advantageous to the issuer are no float funds available to them.
Features of Stock-invest
Following are the salient features of stock-invest as operated by banks
Additional Mode
Stock-invest serves as an additional mode of payment of application money
besides the traditional modes such as cash, cheque or draft.
No Locking up of funds
By this mechanism ,making payment for the public issue of securities does not
involve any locking up of the investor funds.This way,the scheme ensures
effective utilization of investor funds.
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Denominations
The instrument was issued in five denominations, with ceiling for drawing upto
Rs.250,Rs.500,Rs.2,500,Rs.5,000 and Rs.10,000.Later on stock-invests came to
be issued with the RBI directives upto a maximum it Rs.50,000.
Interest income
The scheme provided for the benefit of earning interest income for the investors
by allowing the money to remain with bank,which is highly advantageous.
Participation
All investor and banks may take part in the scheme and be benefited by its
merits
Release of funds
Funds are released from the stock-invest account by the bank only in the event
of successful allotment of securities to the subscriber customer.
Nature
Stock-invest combines the characteristics of a guaranteed cheque and a letter of
authority and is therefore considered as good as cash.
Validity
The instrument of stock invest has a validity of 4months from the date of issue
by the bank concerned
Bank Charges
Banks levy a charge to the extent of utilization of the money in the stock invest
account. This is to the tune of Rs.5 for every Rs.1,000.
Modus Operandi
The working mechanism of the stock-invest is outlined below:
Account
The prospective subscriber opens an account with a banker ,who operates the
stock- invest scheme. The account may be a savings bank account, , current
account ,or FD account.
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Request
An application requesting the banker to issue the facility of stock-invest for a
certain amount is made out in the prescribed form by the prospective applicant.
Issue
Banks issue the facility of stock-invest for a certain amount is made out in the
prescribed form by the prospective applicant.
Enclosure
The prospective investor encloses the stock-invest form with the application
made for securities to companies and deposits the same with the collecting
banker.The investor fills in particulars such as companys name,number and the
value of shares applied for ,etc in stock-invest form.
Collecting Banker
The collecting banker receives the share application forms along with the
stock-invest form.The amount is not credited to the account of the company
making the public issue. The banker gives credit to the account of the company
only on successful allotment of securities.
Entitlement
The company and the Registrar to the issue present to the bank,the entitlement
of the investor in the stock-invest.The banker credits the account of the issuing
company upon the presentation of stock-invest.
Intimation
The issuing bank intimates the unsuccessful applicants about the non-allotment
of shares . The bank then lifts the lien on the account or males due payment
from the account.This way the stock-invest account is closed.
Benefits
Following benefits accrue from the scheme of stock-invest to both investors and
issuers alike:
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Convenient Mode
Stock-invest offers a convenient mode of making payment for securities
allotted to the investor.The allows the money to go into the companys account
only in the event of allotment.
Safe Mode
Stock-invest offers a safe mode of making payment on successful applicants.
No misuse of funds
The scheme allows for the use of funds of the prospective allottee only on the
successful allotment of securities.There is no locking up of funds and this
prevents possible misuse by the issuer.
Satisfied investor
The scheme of stock-invest works to the total satisfaction of the investor to earn
too,for the period between application for shares and the allotment/refund.
Sources of Funds
The funds that are available in stock-invest are used by the issuing bank as an
ideal source of short-term financing. In fact stock -invest serves as an additional
source of attracting funds needed for business.
Bank Lien
Stock-invest provides the facility of lien on the deposits of the investor.The
instrument provides full protection in respect of the guarantee given by the
bank.
Benefit to issuers and Registrars
The mechanism of stock-invest precludes the necessity of printing of refund
orders as, eligible funds will be credited to their account based only on the
allotment and not otherwise.
Boon to investors
The scheme of stock invest is bound to be highly beneficial to the investors as
it does away with many of the ills afflicting mode of making payment in respect
of securities being subscribes and allotted.
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Unit - II
VENTURE CAPITAL
A form of equity financing designed specially for funding high risk and high
reward projects is known as Venture Capital.Venture capital plays an important
role in financing hi-tech projects,besides helping research and development
projects to turn into commercial production.
Venture capital fund activities generally include financing new and rapidly
growing companies that are specially knowledge based,sustainable,up-scalable
companies, purchase of equity securities assisting in the development of new
products or services,adding value to the company through active participation of
higher rewards and having a long term orientation.
A venture capital fund strives to provide entrepreneurs with the support they
need to create up-scalable business with sustainable growth,while providing
their contributions with outstanding returns on investment for high risks they
assume.
Features of venture capital
New ventures
Ventures capital investment is generally made in new enterprises that use new
technology to produce new products in expectations of high gains or sometimes,
spectacular returns.
Continuous Involvement
Venture capitalists continuously involve themselves with the clients investments
either by providing loans or managerial skills of any support.
Mode of Investment
Venture capital is basically a equity financing methods the investment being
made in relatively new companies when it is too early to go to the capital
market to raise funds.In addition financing also takes the form of loan
finance/convertible debt to ensure a running yield on the portfolio of the venture
capitalists.
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Objective
The basic objective of a venture capitalists is to make a capital gain on equity
investment at the time if exit and regular return on debt financing.It is a long
term investment growth oriented small/medium firms.It is a long term capital
that is injected to enable the business to grow at a rapid pace mostly from the
start up stage.
Hands on Approach
Venture capital institutions take active part in providing value added services
such as providing business skills to investee firms.They do not interfere in the
management of the firms nor do they acquire a majority controlling interest in
the investee firms. The rationale for the extension of hands on management is
that venture capital investments tend to be highly non liquid.
High Risk return ventures
Venture capitalists finance high risk return ventures.Some of the ventures yield
very high return in order to compensate for the heavy risks related to the
ventures.ventures capitalists usually make huge capital gains at the time of exit.
Nature of Firms
Venture capitalists usually finance small and medium sized firms during the
early stages of their development until they are established and are able to raise
finance from the conventional industrial finance market.Many of these firms are
new high technology oriented companies.
Liquidity
Liquidity of venture capital investment depends on the success or otherwise of
the new venture of product. Accordingly there will be higher liquidity where the
new ventures are highly successful.
STAGES OF VENTURE CAPITAL FINANCING
Seed capital
This is an early stage financing.This stage involves primarily R&D
financing.The European Venture capital Association defines seed capital as the
financing of the initial product development or the capital provided to an
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Expansion Financing
The European Venture Capital Association defines expansion capital or
financing as the finance provided to fund the expansion or growth of a
company which of breaking even or trading at a small profit.Expansion or
development capital will be used to finance increased production
capacity,market or product development and or to provide additional working
capital.This is one of the later stage financing methods whereby finance is
provided by the venture capitalists for adding productioncapacity,once it has
successfully gained a market share and faces increased demand for adding
production capacity,once it has successfully gained a market share and faces
increased demand for the product.
Replacement Financing
A later-stage financing methods also known as money-out deal where by
venture capitalists extend financing for the purchase of the existing shares from
an entrepreneur or their associates in order to reduce their holdings in the
unlisted company is known as replacement financing.
Turnaround Financing
This is the type of financing provided by the venture capitalists in the event of
an enterprises becoming unprofitable after launch of commercial
production.This is provided in the form of a relief package from the existing
venture capital investors and the enterprises is provided with specialists skills to
recover.
Management Buy- outs
The European Venture Capital association of a company defines management
buy outs as the acquisition of a company (or the shares in that company) from
the owners by a team of existing management/ employees.The vending
shareholder may or may not have been actively involved in the day to day
running of the company,the acquiring group are presumed to be actively
involved in the day to day running of the company.Deals pertaining to the
purchase of management holding of an enterprises is called Buy-out deals.
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Management Buy In
A management buy in involves bringing in a management team comprising of
outsiders who are strangers to the company as opposed to a buy out where they
are part of the existing team.The European Venture Capital association defines
management buy in as funds provided to enable a manager or group of
managers from outside the company to buy in the company with the support of
venture capital investors.
Mezzanine Finance
The last stage of equity related funding is known mezzanine financing.It is often
the last type of financing supplied to a private company in the final run upto a
trade sale or a public floatation.
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UNIT-III
CREDIT RATING
Meaning
The process of assigning a symbol with specific reference to the instrument
being rated that acts as an indicator of the current opinion on relative capability
on the issuer to service its obligation in a timely fashion is known as credit
rating.
Rating are usually expressed with alphabetical or alphanumeric symbols.They
are simple and easily understood which enables the investor to differentiate
between debt instruments on the basis of their underlying credit quality.
The main focus lies in communicating to the investors the relative ranking of
the default loss probability for a given fixed income investment in comparison
with other rated instruments.
According to the Moodys, a rating is an opinion on the future ability and legal
obligation of the issuer to make timely payments of principal and interest on
aspecific fixed income security.The rating measures the probability that the
issuer will default on the security over its which depending on the instrument
may be a matter of days to 30 years or more.
FeaturesofCreditRating
Following are the characteristics features of credit rating
Specificity
The rating is specific to a debt instrument.It is intended as a grade and an
analysis of the credit risk associated with that particular instrument. Rating is
neither a general purpose evaluation of the issuer,nor an overall assessment of
the credit risk likely to be involved in all the debts contracted by such an entity.
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Relativity
The rating is based on the relative capability and willingness of the issuer of the
instrument toservice debt obligations(both principal and interest) in accordance
with the terms of the contract.
Guidance
The rating primarily aims at furnishing guidance to investors/creditors in
determining a credit risk associated with a debt instrument /credit obligation.
Not a Recommendation
The rating does not provide any sort of recommendation to buy,hold or sell an
instrument since it does not take into consideration, factors such market prices,
personal risk preferences and other considerations which may influence an
investment decision.
BroadParameters
The rating process is based on certain broad parameters of information supplied
by the issuer and also collected from various other sources including personal
interactions with various entities.
NoGuarantee
The rating furnished by the agency does not provide any guarantee for the
completeness or accuracy of the information on which the rating is based.
QuantitativeandQualitative
While determining the rating grade both quantitative as wellas qualitative
factors are employed. The judgement is qualitative in nature and the role of
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quantitative analysis is limited toassist in the making of the best possible overall
judgement.
Advantages
Credit rating offers the following advantages
ToInvestors
1.Information service
The credit system allows for the recognition of risk perception by the common
investor debt instruments and makes the investor familiar with risk profile of
debt instruments.
2.Systematic Risk Evaluation
For the efficient allocation of resources a systematic risk evaluation is an
essential requirement.Rating helps the issuer of a debt instrument to offer every
prospective investor the opportunity to undertake a detailed risk evaluation.
3.Professional competency
A credit rating agency equipped with the required skills ,competence and
credibility,provides a professional service,making it possible to use wellresearch and scientifically analyzed opinions regarding the relative ranking of
different debt instruments according to their credit quality.
4.Easy to Understand
Credit ratings are symbolic and are therefore easy to understand.The rating
seeks to establish a link between risk and return.Investors use the rating to
assess the risk level of theinstrument by making a comparison of the offered
rate of return for the particular level of risk with a view to optimizing the riskreturn preference.
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5.Low Cost
The rating as provided by a professional credit rating agency is of significance
not just for the individual/small investor but also for an organized institutional
investor. It provides a low cost supplement to their own in house appraisal.
6.Efficient Portfolio Management
Large investors may use the credit rating for portfolio diversification by
information provided by rating agencies, by carefully watching upgrades and
downgrades and altering their portfolio mix by operating agencies by carefully
watching upgrades and downgrades and altering their portfolio mix by operating
in the secondary market.
7.Other benefits
The investor community in general also benefits from the other services offered
by credit rating agencies namely,research in the form of industry reports,
corporate reports, seminars, and open access to the analysis of the agencies.
To Issuers
1.Index of faith
Credit rating acts as an ideal index of faith placed by the market on the
issuers.This eventually also acts as aguide for investment decision.
2.Wider Investor Base
Credit rating offers the advantage of a wider investor base as compared to
unrated securities.Rating arms a large section of investors with specific skills to
analyze every investment opportunity and helps them make a very considered
decision about their investment.
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3.Bench Mark
The opinion of a rating agency enjoys a wider investor confidence.This could
enable the issuers of highly rated instruments to access the market even in
adverse market condition.Moreover a credit rating provides a basis for
determining the additional return which is required by investors as a
compensation for the additional risk borned by them.
Credit Rating Agencies
International credit rating agencies
International agencies are Moodys Investor Services, S&P,Duff and Phelps
credit rating company, Japan credit rating agency etc.
Domestic credit rating agencies
Some of the domestic rating agencies include CRISIL,CARE,ICRA etc.
MajorIssues
Investment Vs Speculative Grades
Investment and Speculative grades are two terms popularized by regulators.For
instance securities that are rated below BBB (S&P) or Baa (Moodys) are called
non-investment grade, or speculative grade or junk bonds.Rating
agencies
the
rating
agency
put
such
ratings
under
grade
Grading Process
The process of Equity Grading is mandate from the issuer and involves the
following steps.
Mandate from the issuer
The agency initiates the job of equity analysis and grading on the basis of
instructions received from the issuer.
Assigning Team of Analysis
After obtaining the mandate from the issuer, the agency then proceeds to assign
technical teams to the issuing company in order to begin the analysis process.
Data Analysis
The data collected by the team of analysis is analyzed for inferences. The results
are then benchmarked against general business and financial parameters.
Discussions
Detailed and personal discussions are held with various managerial personnel.
In addition interactions are also held with bankers and auditors of the company.
Credit Report
On the basis of the discussions and meetings that are held and based on the data
analyzed, a report on the company is prepared. The report is then presented to
the Grading Committee, which in turn assigns the relevant grade.
Grade Communication
The grade assigned by the grading committee is then communicated to the
company.The option of acceptance or non-acceptance rests with the
company.The grade is made public only if the company accepts it. In the event
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of non-acceptance the company is given one chance to appeal and the analysts
are provided with fresh inputs and clarifications.
UNIT -III
CONSUMER FINANCE
Meaning
The term consumer finance refers to the activities involved in granting credit to
consumers to enable them possess own goods meant for everyday use.
1.According to Seligman, an authority on consumer finance, the term
consumer credit refers to a transfer of wealth, the payment of which is deferred
on whole or in part to future and is liquidated piecemeal or in successive
fractions under a plan agreed upon at the time of the transfer.
2.Reavis Cox, an authority on economics of consumer credit defines consumer
credit as Business procedure through which the consumers purchase semidurables and durables other than real estate in order to obtain from them a series
of payments extending over a period of three months to five years, and obtain
possession of them when only a fraction of the total price has been paid.
Types of consumer Finance
There are several types of credit facility available to consumers.They are briefly
discussed below
Revolving Credit
An ongoing credit arrangement similar to a bank overdraft where by the
financier of a revolving basis, grants credit is called Revolving Credit. The
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consumer is entitled to avail credit to the extent sanctioned as the credit limit.
An ideal example of revolving credit is credit cards.
Fixed credit
It is like a term loan whereby the financier provides loan for a fixed period of
time.The credit has to be squared off within a stipulated period. Examples of
fixed credit include monthly instalment loan, hire purchase,etc.
Cash Loan
Under this type of credit banks and financial institutions provide money with
which the consumers buy articles for personal consumption. Here the lender and
the seller are different. The lender does not have the responsibilities of a seller.
Secured Finance
When the credit granted by a financial institutions is secured by a collateral, it
takes the form of secured finance. The collateral is taken by the creditor in order
to satisfy the debt in the event of default by the borrower. The collateral may be
in the form of personal property, real property or liquid assets.
Unsecured Finance
When there is no security offered by the consumer against which money is
granted by financial institution it takes the form of unsecured finance.
Sources of Consumer Finance
The various sources of consumer finance available to people are discussed
below :
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Traders
The predominant agencies that are involved in the provision of consumer
finance are traders. They include sales finance companies, hire-purchase and
other such financial( non-bank ) institutions.
Commercial Banks
Commercial banks take keen interest in providing, directly or indirectly ,the
finance for consumer durables. Banks lend large sums of money at wholesale
rates to commercial or sales finance companies. Hire purchase concerns and
other such financial intermediaries. Recently banks have also started directly
financing consumers through personal loans, which are meant for purchasing
consumer durable goods. Personal loans are granted without a security.
Credit Card Institutions
Credit card institutions arrange for credit purchase of consumer articles through
the respective banks which issue the credit cards.The credit card system enables
a person to buy goods and services on credit.
NBFCs
Non banking finance companied constitute another important source of
consumer finance. Consumer finance companies also known as small loan
companies, personal finance companies or licensed lenders, are non-savings
institutions whose prime assets constitute sale finance receivables, personal
cash loans to consumers, short and intermediate term business receivables etc.
These finance companies charge substantially higher rate of interest than the
market rates.
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Credit Unions
A credit union is an association of people who agree to save their money
together and in turn provide loans to each other relatively lower rates of interest.
These are called cooperative credit societies in India. The first credit union was
started in Germany in the year 1848.These are non-profit, deposit-taking and
low-cost credit institutions.
Middlemen
Middlemen such as dealers of consumer articles also grant credit to consumers
as part of their promotion campaign. In many cases dealers work in union with
banks and finance companies and direct the consumers to the friendly finance
companies. This type of arrangement helps dealers maintain a close and loyal
relationship with customers.
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Unit-III
Hire Purchase System
Definition
Themodeof acquiring ownership of consumer durables by individuals and
productive assets by manufacturers where by the payment for the product is
conveniently spread over a period of two or three years, is known as Hire
purchase system. Hire purchase serves as a convenient tool of credit in
situations where it is difficult to save in advance to make the purchase of
expensive articles but find it easier to make regular payment, weekly or monthly
after they receive the article.
Characteristics of Hire Purchase System
Following are the characteristics features of hire purchase system
1.Popular Method
Hire purchase is the most popular method used for the sale of expensive and
durable goods on credit.
2.Retention of Right
In a hire purchase the seller sells on credit to buyers the security being the
sellers right to retain property rights on the goods sold.
3.Instalments
The Hire purchase is paid in instalments spread over a fixed period.
4.Ownership
The property rights in goods sold remains with the seller and the buyer gets
legal ownership of the article only after the payment of the last instalment.
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5.Agreement
The hire purchase transaction takes place through a formal written agreement
signed by the seller and the buyer. The agreement provides for the payment of
the price in the form of fixed equitable instalments spread over a specified
period of time, the instalments being in the nature of rental payables on fixed
dates.
6.Possession
The buyer is given possession of the goods on payment of the first rental
amount in cash known as the down payment.
7.Default
When the buyer defaults i.e fails to either pay the specified instalments or insure
the article in accordance with the terms of the contract, the seller has the right to
terminate the hire purchase agreement and take re-possession of the article. If
the agreement is terminated because of default, the hirer or buyer will have no
claim to the amount already paid since that amount is already paid, since that
amount is already treated as rental charges.
8.No Breach of Trust
Under the hire purchase agreement the buyer simply hires the article. The buyer
cannot commit any criminal breach of trust. If the buyer does so and managers
to sell the article the seller can recover the article from the sub-buyer, since
there is no transfer of ownership.
Hire Purchase Agreement
The hire purchase agreement serves as the basis of hire purchase financing.
Following are some of the features of the agreement.
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1.Formal agreement
It is a formal agreement between a seller and a buyer under which the seller
agrees to transfer possession of an article to the buyer.
2.Document
It is a document that sets out the terms and conditions on the basis of which
goods are sold on credit. It also sets out the payment schedule spread over a
fixed future period.
3.Property
The property ownership right for the goods passes from the seller to the buyer
only when the last instalment is paid and only where the buyer fulfills all the
terms of the agreement.
4.Owner
The seller is the owner of the goods right up to the payment of the last
instalments. Therefore the seller can take possession of the article sold in the
event of failure to pay the instalments.
Advantages of Hire purchase System
1.No immediate cash
Hire purchase finance helps asset creation without having to immediately part
with the cash.
2.Easy possession
The hire purchase financing system helps individuals of limited means to realize
their dreams by facilitating the possession of the article.
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3.Economic growth
Hire purchase finance helps the growth of the economy by enhancing,
investment and sales. In addition the mass sale of expensive and durable goods
also contributes to employment generation. It helps mass production and
accelerates industrial development and economic growth.
4.Thrift
Hire purchase inculcates /forces the saving habit on the buyer so that it becomes
possible to pay instalments without default.
5.Relief to Buyer
It relieves the buyer of arranging for loans and advances which eventually
involves a financial burden to pay for the asset. It is considered to be
advantageous especially for the small sector farmers and industrialists.
Instalment Credit System
Definition
A system of consumer financing where by the payment of the purchase price is
deferred to be paid in reasonable instalments is known as Instalment credit
system.
Features of Instalment System
The instalment system which is a modified hire purchase sale has the following
features.
1.An ordinary sale of goods with easy payment system.
2.The buyer obtains ownership and possession on payment of the first
instalment.
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Unit - III
LEASING
Meaning
According to Meaning of Leasing the Institute of Chartered Accountants of
India, a lease is an agreement whereby the lessor conveys to the lessee, in return
for rent the right to use an asset in consideration of a payment of periodical
rental, under a lease agreement. Lessee is a person who obtains from the lessor,
the right to use the asset for a periodical rental payment for an agreed period of
time.
A financing arrangement that provides a firm with the advantage of using an
asset without owning it, may be termed as Leasing.
Characteristics of Lease
1.The Parties
There are two parties to a lease agreement.They are the lessor and the
lessee.Lessor is a person who conveys to another person (lessee) the right to use
an asset in consideration of a periodical rental payment, under a lease
agreement.Lessee is a person who obtains the right to use from the lessor for a
periodical rental payment for an agreed period of time.
2.The Asset
Leasing is used for financing the use of fixed assets of high value.The asset is
the property to be leased out.It may include an automobile,an aircraft ,plant and
machinery, a building etc.However the ownership of the asset is separated from
the use of the asset.During the period of the lease, the ownership of the asset
rests with the lessor while the use is transferred to the lessee.
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3.Term
The term of the lease is called the lease period.It is the period for which the
lease agreement is in operation.It is illegal to have a lease without a specified
term. However in India, perpetual lease is in operation where the lease period is
for an indefinite period of time. On expiry of the lease period, the asset reverts
to the lessor mentioned in the operating lease.In the case of a financial lease
period is in consonance with the economic life of the asset so that the lessee is
given the advantage of exclusive use throughout its useful period.
Sometimes the lease period may be broken into primary lease period and
secondary lease period.A primary lease period is a period during which the
lessor wants to get back the investment together with interest. As secondary
period comprises the latter part of the lease period where only nominal rentals
are charged in order to keep the lease agreement operational.
4.The Lease Rentals
Lease rentals constitute the consideration payable by the lessee as specified in
the lease transaction. Rentals are determined to cover such costs as interest on
the lessors investment, cost of any repairs and maintenance that are part of the
lease package, depreciation on the asset and any other service charges in
connection with lease.
Types of Lease
Lease is of different types.They are discussed below:
1.FinancialLease A financial lease is a noncancelable in nature.The lease
generally provides for the renewal of the lease on expiry of the lease contract.
Variants of financial lease include full payout lease and true lease.
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(i).Full Payout Lease-In this type of lease,the lessor recovers the full value of
the leased asset within the period of the lease rentals and the residual value.
(ii)True Lease- In this type of lease, the typical tax-related benefits such as
investment tax credit,depreciation tax shields etc. are offered to the lessor.
2.Operating Lease An operating lease is any other type of lease whereby the
asset is not fully amortized during the non-cancelable period of the lease and
where the lessor does not rely on the lease rentals for profits.It is a short-term
lease on a period to period basis,the period of lease being less than the useful
life of the asset.
The lease is cancellable at short notice by the lessee.The lessee has the option of
renewing the lease after the expiry of the lease period.It is the responsibility of
the lessor to ensure maintenance,insurance, etc. of the asset which is chargeable
by the lessor. It is a high-risk lease to the lessor since it could be cancelled at
any time.
3.Net Lease- A variant of operating lease is not lease.A type of lease where the
lessor is not concerned with the repairs and maintenance of the leased asset is
known as Net Lease.The only function of thelessor is to provide financial
service.
4.Conveyance-typeLease-Itisa very long tenure lease applicable to immovable
properties.The intention of the lease is toconvey title in property.Such leases are
entered into for periods which may be as long as 99 years or 999 years.
5.Leveraged Lease- When a part or whole of the financial requirement
involved in a lease are arranged with the help of a financier, it takes the form of
leveraged lease.This type of lease is resorted to in cases where the value of the
leased asset is very high.In this type of lease the lessor who is also a financier
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involves one more financier who may hold a charge over the leased asset over
and above a part of the lease rentals.
4.Sale and LeaseBack-Under this type of lease the owner of an asset sells it to
the lessor and gets the asset back under theleaseagreement.The ownership of the
asset changes hands from the original owner to thelessor who in turn leases out
the asset,back to the original owner.This paper exchange of title has the effect of
providing immediate free finance to the selling company, the lessee.The
transaction also helps the release of fundstied up in that particular asset.
5.Partial Pay-outLease- It is a type of lease whereby the lessor obtains full
payment of the lease in several leases.This broadly falls under the category of
operating lease.
6.Consumer Leasing-Leasing of consumer durables such as televisions,
refrigerators etc is called consumer leasing.
7.Balloon Lease-A type of lease which has zero residual value at the end of the
lease period is called Balloon Lease.It also means a kind of a lease where
thelease rentals are low at the inception, high during the mid years and low
again during the end of the lease.
8.Close-End Leasing-A leasing arrangement whereby the asset leased out is
reverted to the lessor is known as close-end leasing.It is also called walk-way
lease.
9.Open-end Leasing- A term commonly used in automobile leasing in the
USA,it means a lease agreement where lessee guarantees that lessor will realize
a minimum value from the sale of the asset at the end of the lease period.
Under this arrangement if the assets residual value fetches less price than
agreed,the lessee pays the difference to the lessor. In the same manner where
the assets residual value fetches more than the value agreed the lessor pays the
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excess to the lessee.It is so called because the lessee does not know the actual
cost of the asset until it is sold at the end of the lease.
10.Swap Leasing-In swap leasing the lessee is allowed to exchange equipment
leased out whenever the original asset has to be sent to the lessor for repair or
maintenance.
11.Import Leasing-The leasing of imported capital goods is known as import
leasing.It is beneficial to the lessee because arranging any other source
offunding may take a long time, during which the prices of the importable item
as also the rates of exchange may change. Moreover lenders dont usually
finance the import duty which forms a sizable part of theacquisition of such
items.
12.Cross Border Leasing-A type of lease where the lessor in one country
leases out assets to another country is known as cross-border leasing.
13.Double Dip- According to the concept of double dip,it is possible to have
advantage of depreciation tax benefits twice,depending on the prevelance of
differing tax laws in two different countries.
14.Triple Dip-Where the benefit of depreciation tax allownces is available in
three different jurisdiction for a single asset leased out,it is a case ofTriple
dip.Accordingly benefits are available for hire purchases ,true lease and capital
lease.
15.International Leasing- When a leasing company operates in different
countries through its branches it is a case of international leasing.
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Unit IV
Mutual Funds
Meaning
A trust that pools the savings of investor who share a common financial goal is
known as a Mutual Fund.The money thus collected is then invested in financial
market instruments such as shares,debentures and other securities like
government paper.The income earned through these investments and the capital
appreciation realized,are shared by its unit holders in proportion to the number
of units owned by them.Investments in securities are spread over a wide cross
section of industries and sectors,thus allowing risk reduction to take place.
A special type of institution that acts as an investment conduct is called a
Mutual Fund. It is essentially a mechanism of pooling together the savings of
a larger number of investors for collective investments with the objective of
attractive yields and appreciation in their value.Mutual funds are an important
segment of the financial system. It is a non depository financial intermediary.
Mutual are mobilizers of savings,particularly of the small and house hold
sectors, for investment in the stock and money market.
To state in simple words, a mutual funds collects the savings from small
investors, invest them in Government and other corporate securities and earn
income through interest and dividends.
A mutual fund is nothing but a form of collective investment. It is formed by
the number of investors who transfer their surplus funds to a professionally
qualified organization to manage it.To get the surplus funds from investors, the
fund adopts a simple technique.Each fund is divided into a small fraction called
unitsof equal value.Each investor is allocated units in proportion to the size of
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his investment.Thus every investor whether big or small will have a stake in the
fund and enjoy the wide portfolio of the investment held by the fund.
Features /Role/Benefits
1.Mobilizing Small Savings
Mutual funds mobilize funds by; selling their own shares,Known as units.To an
investor, a unit in mutual funds means ownership of a proportional share of
securities in the portfolio of a mutual fund.This gives the benefit of convenience
and the satisfaction of owning shares in many industries.Thus, mutual funds are
primarily investment intermediaries to acquire individual investments and pass
on the returns to small fund investors.
2.Investment Avenue
One of the basic characteristics of a mutual fund is that it provides an ideal
avenue for investment forpersons of small means and enables them to earn a
reasonable return with the advantages of relatively better liquidity.It offers
investors a proportionate claim on the portfolio of assets that fluctuate in value
in comparison to the value of the assets that comprise the portfolio.
3.Professional Management
It is possible for the small investors to have the benefit of professional and
expert management of their funds.Mutual funds employ professional experts
who manage the investment portfolios efficiently and profitability.
Investors are relieved of the emotional stress involved in buying or selling
securities since mutual funds take care of this function.With their professional
knowledge and experience, they act scientifically with the right timing to buy
and sell for their clients. Moreover, automatic reinvestment of dividends and
capital gains provides relief to the members of mutual funds.
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Expertise in stock selection and timing is made available to investors so that the
invested funds generate returns.
4.Diversified Invesments
Mutual funds have the advantage of diversified investment of funds in various
industry segments across the country.This is advantageous to small investors
who cannot afford having the shares of highly established corporates because of
high market price.Thus mutual funds allow millions of investors to have
investment ina variety of securities of many different companies.Small investors
therefore share the benefits of an efficiently managed portfolio managed
portfolio and are free of the problem of keeping track of share certificates etc of
various companies tax,rules etc.
5.Better Liquidity
Mutual funds have the distinct advantage of offering to its investors the benefit
of better liquidity of investment.There is always a ready market available for the
mutual funds units. In addition there is also an obligation imposed by SEBI
guidelines.Further a high level of liquidity is possible for the fund holders
because of more liquid securities in the mutual fund portfolio.The securities
could be converted into cash at anytime.Moreover mutual fund schemes provide
the advantage of an active secondary market by allowing the units to be listed
and traded thus offering a secondary market for the units
6. Reduced Risk
There is only a minimum risk attached to the principal amount and return for the
investments made in mutual fund schemes. This is usually made possible by
expert supervision, diversification, and liquidity of units. Mutual funds provide
small investors the access to reduced investment risk resulting from
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159
Under this scheme the capitalization of the fund will constantly change,since it
is always open for the investors to sell or buy their share units.The scheme
provides an excellent liquidity facility to investors,although the units of such
scheme are not listed.
2.Close-Ended Scheme- When units of a scheme are liquidated (repurchased)
only after the expiry of a specified period it is known as a close-ended
scheme.Under this scheme funds have fixed capitalization and remain as a
corpus with the mutual fund manager.Units of close-ended scheme are to be
quoted and therefore traded in the floors of a stock exchange in the secondary
market.The price is determined on the basis of demand and supply.Therefore
there will be two prices,one is market determined and the other which is NAVbased.The market price may be either above or below NAV.
3.Interval Scheme-It is a kind of close-ended scheme with a peculiar feature that
it remains open during a particular part of the year for the benefit of
investors,either to off-load their holdings or to undertake purchase of units at
the NAV.Under SEBI (MF) Regulations every mutual fund is free to launch any
or both types of schemes including interval scheme.
3.Return Based Classification
Under this classification fall those mutual fund schemes that are designed to
meet the diverse needs of investors and to earn a good return.Returns expected
are in the form of regular dividends or capital appreciation or a combination of
these two.
1.Income Fund Scheme
This scheme that is tailored to suit the needs of investors who areparticular
about regular returns is known as income fund scheme.The scheme offers the
maximum current income,where by the income earned by units is distributed
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periodically .such funds are offered in two forms.Such funds are offered in two
forms.The first scheme earns a target constant income at relatively low
risk,while the second scheme offers the maximum possible income.This
obviously implies that the higher expected return comes with a higher potential
risk of the investment.
2.Growth Fund Scheme
It is a mutual fund scheme that offers the advantage of capital appreciation of
the underlying investment.For such funds investment is made in growthoriented securities that are capable ofappreciating in the long run.Growth funds
are also known as nest eggs or long investments.In proportion to such capital
appreciation the amount of risks to be assumed would be far great
3.Conservative Fund Scheme
A scheme that aims at providing a reasonable rate of return,protecting the value
of the investment and achieving capital appreciation,may be designed as
conservative fund scheme.These are also known as middle of-the- road
funds,since such funds offer a blend of allthesefeatures.Further such funds
divide their portfolio in common stocks and bonds in such a way as to achieve
the desired objectives.
Investment-Based Classification
1.Equity Fund Scheme
A kind of mutual fund whose strength is derived from equity based
investments is called equity fund scheme.They carry a high degree of risk.Such
funds do well in periods of favourable capital market trends.A variation of the
equity fund scheme is the Index Fund or Never beat market fund which are
involved in transacting only those scrips which are included in any specific
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index E.g the scrips which constitute the BSE-30 or 100 shares National
index.Thesefunds involve low transactions costs.
2.Bond Fund Scheme
It is a type of mutual fund whose strength is derived from bond based
investments. The portfolio of such funds comprises bonds,debenturesetc.This
type of fund carries the advantage of secure and steady income. However, such
funds have little or no chance of capital appreciation and carry low risk. A
variant of this type of fund is called Liquid funds which specializes in investing
in short term money market instruments. This focus on liquidity delivers the
twin features of lower risks and lower returns.
3.Balanced Fund Scheme
A scheme of mutual fund that has a mix of debt and equity in the portfolio of
investments may be referred to as a balanced fund scheme.The portfolio of such
funds will be often shifted between debt and equity,depending upon the
prevailing market trends.
4.Sectoral Fund Scheme
When the managers of mutual funds invest the amount collected from a wide
variety of small investors directly in various specific sectors of the
economy,such funds are called sectoral mutual funds.The specialized sectors
may include gold and silver,realestate,specific industry such as oil and gas
companies,offshore investments.
5.Funds-of-funds scheme
There can also be funds of funds where funds of one mutual fund are invested
in the units of other mutual funds.There are a number of funds that direct
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investment into a specified sector of the economy. This makes diversified and
yet intensive investment of funds possible.
6.Leverage-fund scheme
The funds that are created out of investments with not only the amount
mobilized from small savers but also the fund managers who borrow money
from the capital market are known as leverage-fund scheme.This way fund
managers pass on the benefit of leverage to the mutual fund investors.
7.Gilt Funds
These funds seek to generate through investment ingilts.Under this scheme
funds are invested only in central and state Government securities and
repos/reverse repos in such securities, and not in equity or corporate debt
securities.A portion of corpus may be invested in the call money market or RBI
to meet liquidity requirement. This may provide alternative investment for the
call money market.Government securities carry zero credit risk or default risk.
8.Index-Funds
These are also known as growth funds,but they are linked to a specific index if
share prices.It means that funds mobilized under such scheme are invested
principally in the securities of companies whose securities are included in
theindex concerned and in the same weightage. Thus the funds performance is
linked to the growth in the concerned index.
9.Tax Saving Scheme
Certain mutual fund schemes offer tax rebate on investments made in equity
shares, under section 88 of the Income Tax Act 1961.Income may also be
periodically distributed,depending upon surplus.Subscriptions made upto
Rs.10,000 in an assessment year are eligible for tax rebate under Section 88.
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10.Other Funds
a.LoadFunds
Where mutual fund managers charge a fee over and above the NAV from the
purchaser.
b. No Load Funds
Where no load-fee is charged because very little effort is made to promote the
sale of the funds unit except through direct advertising.
c.MMMF which is designed to offer tax options
d.Offshore Mutual Funds
also known as regional or country funds where the funds are mobilized from
abroad for deployment in the Indian market.
e.Other funds such as property funds, art funds,commodity funds,energy funds
etc.
SEBI ( Mutual Funds) Regulations,1996
The regulations governing the functioning of the mutual funds in India were
introduced by SEBI in December 9,1996.The objectives of these regulations
was to impose regulatory norms for the formation, operation and management
of mutual funds in India.The regulations also lay down the broad guidelines on
investment valuations,investment restrictions,advertisement code and code of
conduct for mutual funds and asset management companies.The salient features
of these regulations are as follows.
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167
2.The sponsor or trustees (if authorized by the trust deed)shall appoint an AMC
with SEBI s approval.
3.The appointment of AMC can be determined by a majority of the trustees or
by 75 percent to the unit holders of the scheme.
4.The directors of the AMC should have adequate professional experience I
finance and related with the sponsor or its subsidiaries or the trustees.
5.Atleast 50 percent if the directors of the Board of Management of the AMC
should not be associated with the sponsor or its subsidiaries or the trustees.
6.The Chairman of the AMC should not be atrustees of any other mutual fund.
7.No AMC shall act as an AMC for any other mutual fund.
SEBIs Regulations to Schemes of Mutual Funds
1.Approval- All the schemes to be launched by the AMC need to be approved
by the trustees,and copies of offer documents of such schemes are to be filed
with SEBI.
2.Disclosure The offer documents shall contain adequate disclosures so asto
enable the investors to make informed decisions.
3.AdvertisementsAdvertisement of schemes should be in confirmity with the
SEBI- prescribed advertisement code.
4.Listing-The listing of close ended schemes is mandatory and every close
ended scheme should be listed in arecognized stock exchange within 6 months
from the closure to susbscription. Listing however is not mandatory in case the
scheme provides for periodic repurchase facilities to all unit holders and the if
the scheme provides for monthly income or caters to special classes of persons
like senior citizens.
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169
11.Refund- The mutual fund and asset management company shall be liable
torefund the application money to the applicants if the minimum subscriptions
referred to above is not received and incase of over subscription. The same shall
be refunded within 6 weeks from the date of closure of subscription list or 15 %
p.a shall be payable.
12.Transfer of Units Unless otherwise restricted or prohibited under the
scheme a unit certificate shall be freely transferable by act of parties or by
operation of law.
13.Guaranteed returns- Aunit scheme may provide for guaranteed return only
if such returns are fully guaranteed by the sponsor or the Asset Management
Company a statement indicating the name of the persons who will guarantee
thereturn is made in the offer document and the manner in which theguarantee is
to be meant has been stated in the offer document.
Mutual Funds in India
The mutual fund industry in India made its debut with the setting up of the
largest public sector mutual fund in the world namely the Unit Trust of India
(UTI).It was set up in the year 1964 by a special Act of Parliament. The first
unit scheme offered was the US-64.A host of other fund schemes were
subsequently introduced by the UTI.
The basic objective behind the setting up of the Trust was to mobilize small
savings and to allow channelizing of those savings into productive sectors of the
economy so as to accelerate the industrial and economic development of the
country.
The monopoly of the UTI ended in the year 1987 when the Government of India
permitted commercial banks in the public sector to set up subsidiaries operating
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171
The Trustees
Persons who hold the property of the mutual fund in trust for thebenefit of the
unit holders are called trustees. Trustees look after the mutual fund which is
constituted as a trust under theprovisions of the Indian Trust Act. For this
purpose a company or appointed as a trustee to manage with prior approval
from SEBI. A minimum of 75 percent of the trustees must be independent of the
sponsors so as to ensure fair dealings. The important functions of the Trustees:
1.Keep under its custody allthe property of the mutual fund schemes
administered by the mutual fund.
2.Furnish information to unit holders as well asto about the mutual fund
schemes.
3.Appoint an asset management company (AMC) for the purpose of floating the
mutual funds schemes.
4.Evolve an investment management agreement to be entered into with AMC.
5.Observe and ensuring that AMC of managing schemes in accordance with the
trust deed.
6.Dismiss the AMC appointed by the Trustees.
7.Supervise the collection of any income due to be paid to the scheme.
8.Are paid compensation for their services in the form of trusteeship fee as
specified in the provisions of the trust deed. Trustees are to present an annual
report to the investors.
The Custodians
An agency that keeps custody of the securities that are bought by the mutual
fund managers under the various schemes is called the custodians. They ensure
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safe custody and ready availability of scrips. According to SEBI norms, the
custodian who is so appointed should in no way be associated with the AMC
and cannot act as sponsor or trustee to any mutual fund. A custodian is
supposed to act for a single mutual fund unless otherwise approved by SEBI.
Some of the important functions of thecustodians are:
1.Safe keeping of the securities.
2.Participation in any clearing system on behalf of the client to effect deliveries
of the securities.
3.Collecting income /dividends on the securities depending on the terms of
agreement.
4.Ensuring delivery of scrips only on receipt of payment and payment only
upon receipt of scrips.
5.Carrying out regular reconciliation of assets with accounting records.
Ensuring timely resolution of discrepancies and failures
6.Arranging for proper registration or recording of securities.
Asset Management Company (AMC)
The investment manager of a mutual fund is technically known as the Asset
Management Company and is appointed by thesponsor or the trustees.TheAMC
manages the affairs of the mutual fund.It is responsible for operating all the
schemes of the fund and can act as the AMC of only one mutual fund.Only
activities which are in the nature of management and advisory services to
offshore
funds,
pension
funds,
provident
funds,
venture
capital
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Investment Restrictions
The Unit Trust of India is prohibited
1.Investing insecurities having unlimited liability.
2.Investing more than 10 percent of the total assets of the Unit trust of India
scheme in unlisted equities.
3.Investing in securities issued by a unit trust,mutual fund, investment
corporations or other similar investment vehicle.
4.Borrowing unless it is required for clearance transactions.
5.Dealing short or in options.
6.Investing more trust holding more than 5 percent of the total assets of the
scheme of the Trust in the obligations of single equity, provided that such
percentage may be increased upto 10 percent on the condition that the aggregate
of all such obligations on excess of 5 percent does not exceed 20 percent of the
total assets of the scheme of the Trust.
7.Acquiring any security if it amounts to the trust holding more than 10 percent
of any class of securities of an issuer.
8.Buying or selling commodities,futures or futures contracts, real estate or
interests in real estate and the securities of corporations which invest or deal in
real estate.
9.Making any loan(other than by theway of call deposits and bills discounted
by, banks,short term borrowings by corporations and variable rate debentures)or
giving any guarantee or granting any security.
10.Making investments for the purpose of exercising legal or management
control.
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Reorganization of UTI
Parliament has approved the bifurcation of the unit trust of India into two
companies viz UTII and UTI-II.Under the new arrangement,UTI-Iwould not
be floating any new scheme and the government would meet all existing
commitments. The UTI-IIwould be started as a SEBI regulated asset managed
and market competing scheme.
Government would remain committed to Part-I for UTI social content,it would
allow thesecond part ofUTI to act as mutual fund in competition with private
players under SEBI regulation.
Regulatory Structure of Mutual Funds
The regulatory structure for mutual funds as operating in India is as follows:
1.RBI Guidelines.
2.UTIs Own Guidelines.
3.SEBI(Mutual Fund) Regulations.
A brief description of the provisions and regulatory norms of the above
authorities is given below
RBI Guidelines
Constitution and Management Guidelines
1.Trustees Every mutual fund shall constitute a trust under theIndian Trust
Act and thesponsoring bank should appoint a Board of Trustees to manage
it.The board of trustees should have atleast two outside trustees i.e those who
are not connected with the sponsoring bank are person of ability and integrity
and have proven capacity to deal with problems relating to investment and
investor protection.
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The day to day management of the schemes under the fund as may be delegated
by the Board of Trustees should be looked after by a fulltime executive trustee
who not be concurrently discharging any other responsibility in the concerned
bank.
2.Sponsor- The sponsor bank fund contribution to the corpus of the fund should
be a minimum of Rs.2 crores or such higher amount as may be specified by the
RBI.The corpus may be converted at a later date into a subscription to any of
the schemes of the fund with theapproval of the Board of Trustees of the
fund.The sponsor bank should make no additional contribution to the corpus
without the approval of RBI.The sponsor bank should contribute and maintain
its stake in each of the funds scheme equivalent to the amount outstanding.
3.Mutual Fund banks-Banks should obtain RBI s prior approval before
announcing any scheme of a mutual fund,irrespective of whether it is identical
or not to any of the earlier schemes approved by RBI.
Investment Objectives and policies
1.Trust Deed The investment objectives and policies of the mutual fund
should be laid down in the Trust Deed andevery scheme to be launched by the
fund must be in accordance with these broad objectives and policies,rules, and
regulations,framed in connection therewith. While inviting subscription from
the public,the mutual fund should make a clear statement of investment
objectives of the fund and its investment policies besides the term and
conditions of the scheme.
2.Funds Deployment-The subscription amounts collected by mutual funds are
primarily intended to be channeled into capital market instruments like
Government and other Trustees securities,share,debentures of public limited
companies ,bonds of public sector undertakings.
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fund
management,underwriting,billsdiscounting,money
market
Distribution-Income
distribution
by
way
of
dividend
or
Unit-V
Factoring and Forfaiting
Factoring Meaning
The word factor is derived from the Latin word facere which means to make or
do or to get things done. Factoring originated in countries like USA
,UK,France,etc where specialized financial institutions were established to
assist firms in meeting their working capital requirements by purchasing their
receivables.
Definition
A financial service whereby an institution called the Factor,undertakes the task
of realizing accounts receivables such as book debts,bills receivables, and
managing sundry debts and sales registers of commercial and trading firms in
the capacity of an agent for a commission is known as Factoring.
Factoring is a fund based financial service,providers resources to finace
factoring receivables besides facilitating the collection of receivables.
C.S.Kalyanasundaram,in his report(1988)submitted to the RBI defines
factoring as a continuing arrangement under which a financing institution
assumes the credit and collection functions for its client,purchase receivables as
they arise ,maintains the sales ledger, attends to other book-keeping duties
relating to such accounts and performs other auxilary functions.
Factoring can also bebroadly defined as an agreement in which receivables
arising out of a sale of goods/services are sold by a firm (client) to the factor (a
financial intermediary),as a result of which the title to the goods/services
represented by the said receivables passes on to the factor.Hence forth the factor
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becomes responsible for all credit control,sales accounting and debt collection
from the credit customers.
Mechanism
Under the factoring arrangement the seller does not maintains a credit or
collection department.The job is handed overto a specialized agency called the
Factor.After each sale a copy of the invoice and delivery challan,the agreement
and other related papers are handed over to the factor.The factor in turn receives
payment from the buyer on the due date as agreed, whereby the buyer is
reminded of the due date payment account for collection.The factor remits the
money collected to the seller after deducting and adjusting its own service
charges at the agreed rate.Thereafter the seller closes all transactions with the
factor.The seller passes on the papers to the factor for recovery of the amount.
Characteristics of Factoring
1.The Nature
The nature of the factoring contract is similar to that of abailment
contract.Factoring is a specialized activity where by a firm converts its
receivables into cash by selling them to a factoring organization.The factor
assumes the risk associated with the collection of receivables and in the event of
non-payment by the customers/debtors,bears the risk of a bad debt loss.
2.The Form
Factoring takes the form of a typical invoice factoring since it covers only those
receivables which are not supported by negotiable instruments such as bills of
exchange etc.This is because the firm resorts to the practice of bill discounting
with its bankers in the event of receivables being backed by bills.Factoring of
receivables helps the client do away with the credit department and the debtors
of the firm become the debtors of the factor.
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3.The Assignment
Under factoring there is an assignment of debt in favour of the factor.This is the
basic requirement for theworking of a factoring service.
4.Fiduciary Position
The position of the factor is fiduciary in nature since it arises from the
relationship with the client firm.The factor is mainly responsible for better
credit management.
5.Credit Realizations
Factor assist in realization of credit sales.They help in avoiding the risk of bad
debtsloss,which might arise otherwise.
6.Less Dependence
Factors help in reducing the dependence on bank finance towards working
capital.This greatly relieves the firm of the burden of finding financial facility.
7.Recourse Factoring
Factoring may be non-recourse in which case the factor will have no recourse to
the supplier on non-payment from the customer.Factoring may also be with
recourse in which case the factor will have recourse to the seller in the event of
non-payment by the buyers.
8.Compensation
A factor works in return for a service charge calculated on the turnover.Factor
pays the net amount after deducting the necessary charges some of which may
be special terms to handle the accounts of certain customers.
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3. Discount Factoring
Discount factoring is a process where the factor discounts the invoices to the
seller at a pre agreed credit limit with the institutions providing finance. Book
debts
and
receivables
serves
as
securities
for
obtaining
financial
accommodation.
2. Export Factoring
When the claims of an exporter are assigned to a banker or any financial
institution and financial assistance is obtained of the strength of export
documents and guaranteed payments it is called export factoring. An important
feature of this type of factoring is that6 the factor bank is located in the country
of the exporter. If the importer does not honour claims, exporter has to make
payment to the factor. The factor bank admits a usual advance of 50 to 75
percent of the export claims as advance.
3.Cross Border Factoring
Cross Border Factoring involves the claims of an exporter which are assigned to
a banker or any financial institution the importers country and financial
assistance is obtained on the strength to the export documents and guaranteed
payments. They handle exporters overseas sales on credit terms. Complete
protection is provided to the clients (exporters) against bad debt loss on credit
approved sales. The factors take requisite assistance and avail the facilities
provided for export promotion by the exporting country. When once
documentation of complete and goods have been shipped the factor becomes the
sole debtor to the exporter.
4.Full service Factoring
Full- service factoring also known as old line factoring is a type of factoring
whereby the factor has no recourse to the seller in the event of the failure of the
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buyers to make prompt payment to their dues to the factor,which might result
from financial inability/ insolvency/bankruptcy of the buyer. It is a
comprehensive form of factoring that combines the features of almost all
factoring services specially those of non-recourse and advance factoring
services, specially those of non-recourse and advance factoring.
5.With Recourse Factoring
The salient features of this type of factoring arrangement are as follows
The factor has recourse to the client firm in the event of the book debts
purchased becoming irrecoverable.
The factor assumes no credit risks associated with the receivables.
If the customer defaults in payment the resulting bad debt loss shall be met
by the firm.
The factor becomes entitled to recover dues from the amount paid in
advance.
6. Without Recourse Factoring
The salient features of this type of factoring are as follows
*No right with the factor to have recourse to the client.
*The factor bears the loss arising out of irrecoverable receivables.
*The factor charges higher commission called Del credere commission as a
compensation for the said loss.
*The factor actively involves in the process of grant of credit and the extension
of line of credit to the customers of the client.
7. Advance and Maturity Factoring
The essential features of this type of factoring are as follows
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conditions on which factor agrees to purchase the debts from seller are specified
in the contract.
Legal Implications of Factoring
The following are the legal implications of the contract entered into between the
factor and the firm(client)
a. The factor is to carry out the verification of the genuiness of trade
transactions when receivables are presented for financing the genuiness being
verified by checking the invoice and other evidence of delivery.
b. The factor is to confirm that there is no double financing from any other
source as bank etc.
c. The factor is to ensure that all payment in respect of factored receivables are
made only to the factor.
d. Protection under section 130 of the Transfer of Property Act regarding
assignment of book debts of clients.
Advantages of Factoring
Factoring
advantages
Cost savings
Factoring allows for the elimination of trade discounts .Besides it also helps in
reduction of administrative cost and burden, facilitating cost savings. There is
also overall savings in cost, expenses and efforts as there is no need for the
client to maintain a special administrative set up to look after credit control.
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Leverage
Another advantage of factoring is that it helps improve the scope of operating
leverage.
Enhanced Return
Factoring is considered attractive to users as it helps enhance return.
Liquidity
Factoring enhances liquidity of the firm by ensuring efficient working capital
management. For instance it helps avoid increased debts in the case of without
recourse factoring. Similarly efficient management of current assets leads to
reduced working capital requirements, besides helping to minimize bad debt
losses.
Credit Discipline
Factoring brings about better credit discipline amongst customers due to regular
realization of dues. This is achieved through effective control of the sales
journal, reduced credit risk, better working capital management, etc. Factoring
indirectly guides the client (seller) to sell only to customers with good credit
standing, thus bringing about credit discipline. Further factoring allows for
investigation of market reputation, financial standing, business prospects etc of
the parties concerned.
Cash Flows
Accelerated cash flows helps the client meet liabilities promptly as and when
they arise.
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Credit Certification
The factor acceptance of the clients receivables is amount to credit certification
by the factoring agency.
Prompt Payment
Factoring facilitates prompt payments and credits by providing insurance
against bad debts.
Information Flow
Factoring ensures constant flow of critical information for the purpose of
decision making and follow up. It therefore helps eliminate delays and wastage
of man hours.
Infrastructure
Factoring acts as a stimulant to go in for sophisticated infrastructure towards
high level specialization in credit control and sales ledger administration.
Better Linkages
Factoring allows for the promotion to linkages between bankers and factors.
Such arrangement helps better dealings, debt protection, collection of sales
ledgers etc.
Boon to SSI sector
Factoring arrangements work as a boon to the SSI sector which invariably faces
the problem of inadequate working capital. Thus the client can concentrate on
functional areas of the business such as planning, purchase, production,
marketing and finance.
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Reduced Risk
Factoring allows for reduction in the uncertainty and risk associated with the
collection cycle,since funds from a factor are an additional source of finance for
the client outside the purview of MPBF.
Export Promotion
Factoring facilities are designed to help exporters avail of financial assistance
on attractive terms, which in turn allows for promotion of export
Limitations of Factoring
Despite the fact that factoring offers an excellent sort of financial services, in
that helps sellers of goods on credit basis to avoid bad debts and at the same
time ensure prompt collection from buyers, it is fraught with the following
drawbacks:
1. Engaging a factor may be reflective of the inefficiency of the management of
the firms receivables.
2. Factoring may be redundant if a firm maintains a nation wide network of
branches.
3. Difficulties arising from the financial evaluation of clients.
4. A competitive cost of factoring has to be determined before taking a decision
about engaging a Factor.
Factoring Players
Factoring starts with credit sales made by the seller and is mainly concerned
with the realization of credit sales. Factoring starts where credit sales ends. Thus
the factor works between the seller and the buyer and sometimes together with
sellers banks too.
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The people who take part in factoring services include the following:
1. Buyer of the goods who has to pay for them on credit terms.
2. Seller of goods who has to realize credit sales from buyer.
3. Factor who acts as agent in realizing credit sales from buyer and passes on
the realized sum to the seller after deducting a commission.
Functions of a Factor
The various functions that are performed by a factor are described below:
Maintenance/ administration of sales ledger.
Collecting facility of accounts receivable
Financing facility trade debts.
Assumption of credit risk /credit control and credit protection.
Provision of advisory services.
Factoring Indian Scenario
An important development in the Indian factoring services took place with the
RBI setting up a Study
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193
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4. Factoring contract
The exporter and the forfaiting agent enter into a forfeiting contract, with the
forfaiter usually being a reputed bank, including the exporters banks.
5. Sale of notes
The exporter sells the notes/bills to the bank (forfaiter) at a discount without
recourse.
6. Payment
The exporter makes payment to the forfeiter for the face value of the bill/note,
less discount. The forfeiter either holds these notes/bills till maturity for
payment by the importers bank or securitizes them in order to sell them as short
term high yielding unsecured paper in the secondary market.
ADVANTAGES OF FORFAITING
1) Facilitating a broad range of instruments in use, such as promissory notes,
bills of exchange, acceptance, letter of guarantee, documented receivable
in Balance sheet as pending, and can use own credit lines.
2) Averting export risk for non-settlement of claims etc., as it provides for a
non-recourse facility.
3) No risk on account of foreign exchange fluctuations to the exporter for the
period between the insurance and the maturity of the paper.
4) Exporters need not have to bother or face credit administration and
collection problems.
5) Provision of finance for counter trade etc.
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Suitability
Recourse
Risk
Cost
Coverage
Extent of financing
FORFAITING
period.
period
recourse only
Risk can be
transferred to seller
the forfeiter
Cost of factoring is
Cost of forfeiting is
seller
buyer (importer)
of jobs at a pre-
determined price.
basis
Only a certain
Hundred percent
percent of
financed is available
receivables factored
is advanced
7
Basis of financing
Financing depends
Financing depends on
on the credit
standing of the
exporter
8
Services
Besides financing, a
It is a pure financing
arrangement
administration etc.,
9
A forfeiter guards
exchange rate
fluctuations
fluctuations for a
premium charge
10
Contract
factor
forfaiter
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Unit -V
Merchant Banking
Meaning of Merchant Bankers
A set of financial institution that are engaged in providing specialist services
which generally include the bills of exchange, corporate finance, portfolio
management and other banking services are known as merchant bankers. It is
not necessary for a merchant banker to carry out all the above mentioned
activities. A merchant banker may specialize in one activity and take up other
activities, which may be complementary of supportive to the specialized
activity.
Functions of Merchant Bankers
Merchant banking being a service oriented industry renders the same services in
India as merchant banks in UK and other European countries. In the U.S,
investment bankers cater to the needs of business enterprises carrying out
merchant banking functions Merchant banks in India carry out the following
functions and services.
1.Corporate Counselling
2.Project Counselling
3.Pre-investment studies
4.Capital Restructuring
5.Credit Syndication and project Finance
6.Issue Management and Underwriting
7.Portfolio Management
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national development financial institutions such as IFCI, IDBI, and ICICI are
engaged in venture capital financing and have developed a number of special
schemes for this purpose.
Lease Financing
A merchant banking activity where by financial facilities are provided to
companies that undertakes leasing is known as Lease Financing. Leasing
involves letting out assets on lease for a particular time period for use by the
lessee. Leasing provides an important alternative source of financing capital
outlay. Lease financing benefits both lessor and the lessee.
Foreign Currency Financing
The finance provided to fund foreign trade transactions is called Foreign
Currency Finance. The provisions of foreign currency finance takes the form of
export import trade finance, euro currency loans, Indian joint ventures abroad
and foreign collaborations.
Brokering Fixed Deposits
The services rendered by the merchant bankers in this regard are, computation
of the amount that could be raised by a company in the form of deposits from
public and loans from shareholders, Drafting of advertisement for inviting
deposits, Filing a copy of advertisement with the Registrar of Companies for
registration, Drafting and printing of application forms, Making arrangements
for the collection of deposits at the bank branches. Submission of periodical
statements to companies concerned. Making arrangements for payment of
interest amounts. Proper advice to the company on the terms and conditions of
fixed deposits and deciding on the appropriate rate of interest.
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Mutual Funds
Institutions and agencies that are engaged in the mobilization of the savings of
innumerable investors for the purpose of channeling them into productive
investments of a wide variety of corporate and other securities are called Mutual
Funds.UTI is the first and the largest mutual fund in the country. The mutual
funds industry has a large number of players both in the public as well as the
private sector Commercial banks are also making rapid strides in the realm of
mutual funds business.
Relief to Sick Industries
Merchant bankers extend the following services as part of providing relief to
sick industries:
*Rejuvenating old lines and ailing units by appraising their technology and
process, assessing their requirements and restructuring their capital base.
*Evolving rehabilitation packages which are acceptable to financial institutions
and banks
*Exploring the possibilities of mergers/amalgamations.
Project Appraisal
The evaluation of industrial projects in terms of alternative variants in
technology, raw materials, productive capacity and location of plant is known as
Project Appraisal.
Regulation of Merchant Banks
At present the merchant banking activities are regulated by the:
Guide lines of SEBI and the Ministry of Finance
Companies Act ,1956
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exceeding Rs.400 crore, the number could go up to five. Lead merchant banker
is not necessary where the issue does not exceed Rs.50 lakh.
5. The specific responsibilities of each lead manager must be submitted to
SEBI prior to the issue.
6. The merchant bankers are expected to exercise due diligence independently.
They should verify the contents of the prospectus and the reasonable of the
views expressed there in and it should be reported to SEBI.
7. Whateverinformation, documents, returns and reports as may be prescribed
and called for have to be submitted to SEBI.
8. The merchant bankers have to adhere to SEBI s code of conduct.
9. The authorisation may be suspended or cancelled for suitable duration in
case of violation of the guidelines.
Inspection by SEBI
SEBI may inspect the books of account, records and documents of merchant
bankers
(i) to ensure that the books of account are maintained in the required manner;
(ii) to verify that the provisions of the act,rules and regulations are compiled
with and;
(iii)to investigate complaints against the merchant bankers.
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