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STUDY MATERIAL ON

FINANCIAL MARKETS AND SERVICES

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)

Monopoly power to R.B.I for issuing coins and currency notes


In India the R.B.I has been vested with the monopoly power of issuing coins
and currency notes commercial banks can also create cash (deposit) in the
form of credit creation and other financial institutions also deal in monetary
assets.
RBI is the leader of the financial system and hence it has to control the
money supply and creation of credit by banks and regulate all the financial
institutions in the country. RBI develops sound financial system.
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It has to develop a sound financial system by strengthening the institutional


structure and by promoting savings and investment in the country.
2.Mobilisation of savings
Another important activity of the financial system is to mobilizesavings and
channelize them into productive activities.[For example Banks mobilize
savings and from customers and provide loans to industries for carry out
production]. Attractive incentives to be given to mobilize savings. Financial
system should offer appropriate incentives to attract savings and make them
available for productive venture.The financial system facilitates the
transformation of saving into investment and consumption.
Features of financial system
1. Financial system provides an ideal linkage between depositors and investors,
thus encouraging both savings and investment.
2. Financial system facilitates expansion of financial markets over space and
time.
3. Promotes efficient allocation of financial resources for socially desirable and
economically productive purposes.
4. Financial system influences both the quality and the pace of economic
development

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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4.Financial Rates of Return


5.Financial Instruments.
1. Financial Assets:
In each financial transaction there should be a creation or transfer of financial
asset. Hence the basic product of any financial system is the financial asset.
A financial asset is a tangible asset whose value is derived from a contractual
claim such as bank deposits bonds and stocks.
A Financial asset is one which is used for production or consumption or for
further creation of assets. [Financial assets are usually more liquid than other
tangible assets such as commodities or real estate.]
For instance, A buys equity shares and these shares are financial assets since
they earn income in future.
The capital amount (is raised) gathered by way of issuing shares will be
utilized for production work.
Distinction between the financial assets and physical assets .
Financial asset is one which is used for production or consumption or for
further creation of asset or income physical assets are not useful for further
production of goods or for earning income.For example, X purchases land
and building or gold and silver.These are physical assets since they cannot be
used for further production.
Many physical assets are useful for consumption only.
It is interesting to note that the objective of investment decides the nature of
the assets.For instance if a building is bought for residence purpose, it becomes
a physical asset.If the same is bought for hiring it becomes a financial asset.
Classification of Financial Assets.
Financial assets can be classified differently under different circumstances one
such classification is

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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There are two types of stock namely


1. Equity
2. Preference
1. Equity- Equity shareholders are the real owners of the business and they
enjoy the fruits of ownership and at the same time bears the risks as well.
2. Preference Share holders- Preference share holders gets a fixed rate of
dividend ( as in the case of debt assets) and at the same time they retain some
characteristics of equity.

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.

Capital Market Intermediaries:

These intermediaries provide long term

funds to individuals and corporate customers they consist of term landing


institutions like financial corporations and investing institutions like
development Banks, Insurance, UTI, Companies [LIC and GIC], Agriculture
financing institutions, Government P.F, NSC, IRBI, Exim Bank, NBI
Company.

Money Market Intermediaries :Money market intermediaries supply only


short term funds to individuals and corporate customers they consist of
commercial banks, co-operative banks etc.

Example RBI, Commercial

Banks, Co-Op Banks, P.O savings, Government Treasury Bills.


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Unit-I
Financial Markets in India

There is no specific place or location to indicate a financial market whenever


a financial transaction takes place it is deemed to have taken place in the
financial market.
For instance issue of equity shares, granting of loan by term lending
institutions, deposit of money in to a bank, purchase of debenture sale of
shares and so on .
Financial Markets
Financial markets can be referred to as those centers and arrangements which
facilitate buying and selling of financial assets, claims and services. We find
the existence of a specific place or location for a financial market as in the
case of stock exchange.
Classification of Financial Markets
The classification of financial markets in India are classified as follows :

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.

2). Organised Markets


In the organized markets there are standardized rules and regulations
governing their financial dealings. There is also a high degree of
institutionalization and Instrumentalisation. These markets are subject to
strict supervision and control by the RBI or other regulatory bodies.
These organized markets can be further classified into two
1. Capital Market
2. Money Market
1.Capital Market The capital market is a market for financial assets which
have a long maturity generally it deals with long term securities which have a
maturity period of above one year.
Capital Market may be further divided in to three namely
(1) Industrial Securities Market
(2) Government Securities Market
(3) Long Term Loans Market

I . Industrial Securities Market


It is market for industrial securities namely (i) Equity shares or ordinary shares
(ii) Preference shares (iii) Debentures or bonds.
It is a market where industrial concerns raise their capital or debt by issuing
appropriate instruments .It can be further divided in to two they are.
1.Primary market
2. Secondary market

1. Primary Market : Primary market is a market for new issues or new


financial claims. Hence it is called new issue market. The primary market
deals with those securities which are to the public for the first time. There are
three way by which a company may raise capital in a primary market
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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.

2.Secondary Market - Secondary market is a market for secondary sale of


securities. Securities which have already passed through the new issue market
are traded in this market. Generally such securities are quoted in the stock
exchange and it provides a continuous and regular market for buying and
selling of securities. This market consists of all stock exchange recognized by
the government of India.

II) Government Securities Market:


It is otherwise called Gilt- Edged Securities[High grade bonds issued by
Government for firm]. It is a market where Government securities are traded.
In India there are many kinds of GovernmentSecurities short term and long
term.Long term securities are traded in this market while short term securities
are traded in the money market.
Securities issued by the central Government, State Government., SemiGovernment authorities like City Corporations, Port trusts etc.
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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.

III) Long Term Loans Market:


Development banks and commercial banks play a significant role in this
market by supplying long term loans to corporate customers.
Long term loans market may further be classified into
1. Term Loans Market
2. Mortgage Market
3. Financial Guarantees Market

1. Term Loans Market


Many industrial financing institutions have been created by the Government.
both at the national level and regional levels to supply long term and
medium term loans to corporate customers. Industrial financing is done by
developmentbanks. Institutions like IDBI, IFCI, ICICI and other state
financial corporations come under this category. These institutions meet the
growing and varied long term financial requirement of industries by
supplying long term loans.They also help in identifying investment
opportunities, encourage new entrepreneurs and support modernization
efforts.

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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].

Two Types of Treasury Bills :


1.Ordinary or Regular-Ordinary treasury bills are used to the public bank
and other financial institutions with a view of raising resources for the
Central Government to meet its short term financial needs.

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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 -

It is an instrument in writing of containing

and unconditioned orders signed by the maker directing a certain person/bank


to pay sum of money to a third party mentioned in the bill at a future date.
Finance Bills - These bills are payableimmediately after the expiry of time
period mentioned in the bill.
Commercial Papers(CPs)
Short term promissory notes with a fixed maturity. It is issued by corporates
belonging to Financial or non-finance organization.

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Certificate of Deposits (CDs)


CDS or short term deposits by way of issuance promissory notes payable on
fixed data and having short term maturity not less than 3 months and not more
than 1 year .
Capital Market Instruments
Capital market is a place where long term funds required by business
enterprises are provided. Various types of securities are dealt with in the
capital market.The commonly traded securities of the capital market.
Ordinary shares or equity shares
Preferable Shares
No Par Stock
Debentures.

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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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2. Funds Deployment - In array of financial services are available in financial


markets which help the players to ensure an effective deployment of the
funds raised.Financial services assist in the decision making regarding the
financial mix. Services such as bill discounting of factoring of debtors,
parking of short term funds in the money market, credit rating e-commerce
and securitization of debts are provided by financial services firms in order to
ensure efficient management of funds.
3. Specialized Services - The financial services sectors provides specialized
services such as credit rating, venture capital financial lease of financing.
factoring, mutual funds, merchants banking, stock lending, depository, credit
cards, housing finance, book building, etc.. besides banking and insurance.
Institutions and Agencies such as stock exchanges, specialized and general
financial institutions, non-banking finance companies, subsidiaries of financial
institutions, banks and insurance.
4. Regulation -There are agencies that are involved in the regulation of the
financial service activities. In India, agencies such as the Securities and
Exchange Board of India (SEBI), Reserve Bank of India (RBI) and the
department of banking and Insurance of the Government of India through
many legislations regulate the functions of the financial services institutions. E
5. Economic growth - Financial services contributing to spending of up the
process of economic growth and development this takes place through the
mobilization of the savings of a cross section of the people for the purpose of
channeling them in to productive investments.

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It is to be noted that a number of developed and developing countries which


have a highly efficient financial market, have witnessed a greater rate of
savings and investments.
1. Leasing Companies
Companies that undertake leasing is known as lease financing
2. Mutual funds
Mutual funds are trusts that pool the savings of innumerable small investors
for the purpose of making investment in various financial instruments
capital market and money marketto provide reasonable return
3. Merchant Bankers
A set of financial institutions that are engaged in providing specialist
services which generally include the acceptance of bill of exchange,
corporate finance, portfolio MG--- and other banking services are known as
Merchant Bankers.
4.Port Folio Management.
Making decisions relating investments of the cash resources of a
corporate enterprise in marketable securities by deciding the quantum
timing and type of security to be bought is known as portfolio management.

FINANCIAL SERVICES - CHARACTERISITCS


Financial Services are characterized by the following :
1. Intangibility - The basic characteristics of financial services are tangible in
nature .for financial services to be successfully created and marketed the
institutions providing them must gain good and confidence of its clients.
Quality and innovativeness of services are the focal points for building
credibility and gaining the trusts of the clients.

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2. Customer Orientation - The institutions proving the financial services


study the needs of the customers in detail based on the results of the study they
come out with innovative financial strategies that give due regard to costs,
liquidity and maturity considerations for various financial products this way
financial services are customer orientated.
3. Inseparability - The functions of producing and supplying financial
services have to be carried out simultaneously their calls for a perfect
understanding between the financial services firms and their clients.
4. Perishability - Financial services have to be created and delivered to target
clients they cannot be stored. They have to be supplied according to the
requirements of customers.
Hence it is imperative that the providers of financial services ensure a match
between demand and supply.
5.Dynamism - The financial services must be dynamic they have to be
constantly redefined and refined on the basis of socio-economic changes
occurring in the economic such as disposable income, standard living level of
education are
Financial services institutions must be proactive in nature, and evolve new
services by visualizing the expectations of the market.
Various Financial Services
The financial services may be classified in to two groups
Fund or Asset - based financial services
Fee- based financial services

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1. Fund or Asset based financial services


Lease Financing
Hire Purchase Finance and consumer credit
Factoring and forfaiting
Bills discounting
housing finance
Insurance services
Venture capital financing
2. Fee based Advisory Services
The emerging financial services sector in India also provide fee-based
advisor services to corporate enterprises.
These services include the mgt. either by making arrangement regarding
selling, buying or subscribing to securities and they render corporate
advisory services in relation to such issue mgt.
The institutions or persons engaged in such activities are merchant bankers,
stock brokers, credit rating agencies etc.

Constituents of the Financial Services Sector


The financial services sector constitutes the following elements.
1. Government The Central Government is the most important constituent
of the financial services sector. It has wide powers under various acts to
regulate the sector.
2. Regulatory Agencies- In India, SEBI and Reserve Bank of India act as the
regulatory agencies in the sector.
3.Financial Institutions- Various financial institutions also play an important
role in the sector.
4. Other Constituents- The financial services sector has the following three
major elements:
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(a) Instruments- These include public issue of shares, debentures, fixed


deposit certificates etc.
(b) Market Players- Banks, financial institutions, mutual funds, stock
exchanges, merchant bankers, portfolio managers, stock brokers, non-banking
financial institutions, financial consultants etc..are included.
(c) Specialized financial institutions
1.These institutions include the Credit Rating Information Services of India
Ltd (CRISIL). It was promoted jointly by ICICI other shareholders such as
Asian development and UTI in 1987 LIC, SBI, HDFC and GIC.
2.The Information and Investment Credit Rating Association (IICR).
Promoted by IFCI Ltd, which capital and other shareholders holds 26% of
the shares SBI, UTI, PNB, LIC, GIC, Exim Bank are important credit
Rating agencies.
3.

The Discount and Finance House of India Ltd (DFHIL). Recent

Development of money market for widening and deepening of the market


where banks and financial institutions are participants.
4. The stock Holding Corporation of India Ltd (SHCIL). It helps investors
to buy and sell securities in the secondary market. Over the counter market
is a place where the buyers seek out sellers and sellers seek out buyers and
they arrange term.
5. The Over-the-Counter Exchange of India (OTCEI) is a recognized stock
exchange under Securities contracts (Regulation Act).

Activities of the Financial Services Sector


The financial services sector is involved in two types of activities.
Fund based activities
Non-Fund based activities

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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.

Non-Fund based Activities


A part from the provision of finance, the customers, both individual and
corporation expect more from financial services sector so it has come forward
to render a large variety of services such as management capital issues, making
arrangements for the placement of capital and debt instruments and
arrangements of funds from financial institutions etc.It also undertakes the
responsibility of getting all government and other clearness.

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.

Essentials of an Ideal Financial Services Industry:

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.

REGULARTORY FRAME WORKS


Regulation of Financial services
The Indian financial services sector is regulated by
1. Government
2. The Reserve Bank of India
3. The Securities and Exchange Board of India (SEBI).
1. Government -The Central Government has extensive power to regulate the
financial services sector.It Exercises control by various acts, rules, directives,
guidelines, notifications etc.The issue of capital is regulated by :
The companies Act 1956
The capital Issues (Control) Act 1947
The capital Issues (Exemption) order 1969.
The capital Issue (Application for consent) Rules 1966.
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The stock exchanges are regulated by the securities contracts


(Regulation) Act 1956.
The Securities contracts (Regulation) Rules 1957
The notification of stock exchange.
2. Reserve Bank of India
The Reserve Bank of India (RBI) is the apex institution in the Indian Financial
system. It has wide powers to control the money and capital markets. It
ensures the efficient functioning of the financial system by keeping a watch on
the development and disturbances in.

It influences the operations of the

financial system through regulation on the banking system.


3. Securities and Exchange Board of India (SEBI)
The Securities and Exchange Board of India (SEBI) was set up in 1988 as a
non-statutory body. In January 1992, it was made a statutory body.

The

objectives of SEBI are to


1. Protect the interests of the investors in securities.
2. Promote the development of the Securities market.
3. Regulate the securities market.

SEBI is authorized to regulate all merchant banks on issues activities and to


regulate mutual funds by issuing guidelines and supervising.SEBI in
consultation with the Government has taken a number of steps to introduce
improved practices and greater transparency in the capital markets in the
interests of the investing public and the healthy development of the capital
market.

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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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What is a credit Card?


A credit card is a card made of plastic material, carrying a specimen of the
holders signature and have certain information embossed on it so that when it is
pressed the information on it are recorded on an invoice or other documents.

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.

Specimen of a Credit Card


1. The front side of the card bears the following details :
a) 16 digit card number
b) Period of validity of the card.
c) Embossed name of the card holder
d) Visa / Master Card logo and 3D hologram for card security and to
identify the associated franchise.
e) The photograph (in case of photo care only)
f) The signature in case of photo card.

2. The banks side of the card contains the following details


a) Usage validity of the card.
b) A magnetic strip containing coded information for the security of the
card.
c) The signature panel

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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.

Salient Features of a Credit Card

1. Use of the Card


a) The card is the property of the bank and must be surrendered to the
designated office of the bank on demand.
b) Use of the card to facilitate the purchase of goods or services will be
limited by the individual credit limit.
If the card limit is exceeded the card member shall immediately reduce
the over limit debit balance.
c) The card should be kept in a safe place.
d) The card should not be allowed to use by any other individual.
e) The card member should sign the card immediately upon receipt.
f) The issue and use of card will be subject to RBIs Regulations in force

2. Charges on the Card


1. Voluntary charges
a) The cost of any purchase of goods.
b) The amount of any cash advance provided
c) Any amount chargeable to the card account by virtue of a transaction
instruction.
2. Involuntary charges
a) Any fees charged by the bank as entrance, annual replacement renewal,
handling, late payment and other fees.
b) The banks finance charges
c) Commission on specific types of transactions
28

d) Any other payment of a charge paid by the bank.

3. Procedure for Billing and Payment


The billing and payment procedure involve three stages.
Making the purchases
Reimbursements to the establishment
Reimbursement to the bank.
(i) At the Time of Purchases- Present the Card
When a person intends to make a purchase form a establishment using the
credit card, he has to present the card to the establishment.
Check the Validity - After that the establishment scrutinizes it and makes
sure that its validity period has not expired.
Compare the signature with card holder - Then the merchant will
compare the signature of the cardholder with the specimen signature.
Takes impression of the Card - The merchant takes the impression of the
card with the help of the imprinter and prepares a charge slip in triplicate.He
retains one copy for records, another copy is given to the customer and the
third copy to the bank for obtaining payment.
(ii) For Getting Reimbursements to the Establishment
On receipt of the copy of the charge slip and the summation sheet, the bank
reimburses the amount after deducting its commission.
(iii) For Getting Reimbursement to the Bank
The bank prepares a statement every month reflecting the transactions on
the card. The Cardholder has the following two option for settling the
amount due to the bank as per the statement prepared by the bank.

29

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.

4. Privileges of the Credit Cardholders


1. Global acceptance- As the credit cards are most widely accepted for
making purchase anywhere in the world at any establishment.
2. Cash Advance- The credit cardholder is allowed to withdraw cash
from designated ATMs using the credit card. But the charges are levied
for this facility for transaction.
Global ATM Access- Within India, the card holders can have any time
cash with draw from the banks ATM in all major cities.
When travelling abroad the cardholder can access cash from any of the
ATM bearing logo VISA/Master Card.

Different types of Credit Cards/ Classification of Credit Cards


The credit card system can provide a wide range of products and services to
the user.Depending on the money of the customer and trade competition
banks issue different types of cards is given below :

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Based on Mode of Credit Recovery


1. Revolving Credit Card
A limit is set on the amount of money one can spend on the card for a
particular period. The card holder has to pay a minimus. Percentage of
outstanding credit at the end of a particular period with interest varying from
30 to 36 percent per annum is charged on the outstanding amount.
2. Charge Card
A charge card is not a credit instrument. It is a convenient mode of making
payment. This facility gives a consolidated bill for a specific period an bills
are payable in full on presentation. There is no liability and no limit.

Based on Status of Credit Card

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.

Some banks issue

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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Based on Geographical Validity


1. Domestic Card- Cards that are valid only in India and Nepal are called
domestic cards. All transactions will be in rupees. These cards are issued by
most of the banks in India.
2. International Card- Credit Cards that have international validity are
called international cards. They are issued to people who travel abroad
frequently. These cards are honored in every part of the world except India
and Nepal.The cardholder can make purchases in foreign currencies subject
to RBI. Sanction and FEMA rules and regulations.
Based on franchise or tie-up
1. Proprietary cards- Cards that are issued by the bank themselves, without
any tie up are called proprietary cards.A bank issues such cards under its
own brand. Examples include SBI card, can card of Canara bank etc.
2. Master Card- This type of credit card issued under the umbrella of
Master Card International. The issuing bank has to obtain a franchise from
the master card corporation of U.S.A.The franchised cards will be honored in
the Master Card Network.
3. VISA Card- This is a type of credit card, which can be issued by a bank
having tie-up with VISA International USA. The banks that issue VISA
cards are said to have a franchise of VISA International.
4. Domestic Tie-Up Card- These are cards issued by a bank having a tie up
with domestic credit card brands such as Cancard and Indcard. For example,
Indian overseas bank has a tie up with Cancard.These banks issue cards to
users through the original banks. However they can have their bank name
engrave on the card.Credit is available on similar lines to the original card.

32

Based on the Issuer Category:


1.Individual cards- These are the non-corporate cards that are issued to
individuals. Generally all brands to credit cards issue individual cards.
2.Corporate Cards- These are credit cards issued to corporate and business
firms. The executives and top officials of the firm use these cards. The card
bears the name of the firm and the bill are paid by the firm.
Innovative Cards
Credit cards have evolved into a variety of innovative cards such as the
following.
ATM Cards
An ATM cards allows customers to access their accounts at anytime 24
hours a day, every day of the year through automated teller machines
customers can withdraw cash, transfer funds, find out their account balance
and perform other banking and financial transactions with the help of ATMs.
Debit Card
A debit card like an ATM card directly accesses a customers accounts. The
card directly debits a designated savings Bank Account.
The debit card details are fed through a terminal at the merchant establishment
and the card holder is asked to key in a pin code allotted by the card issuer.
On completion of the transaction the amount is immediately debited in the
cardholders account and transferred to the account of merchant establishment.
Prepaid Cards
Prepaid cards are known as stored value cards, are cards with stored value paid
in advance by the holder. The card issuer and service provider are identical.
33

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

essentially in prepaid card.


Two Types of Smart Cards
1.Memory Card
2.Micro Processor Card
1.Memory Cards- Memory cards are static they store information and value
and are not programmable it is not reloadable phone cards and other prepaid
cards are example.

34

2. Micro Processor Cards- Micro Processor Cards have internal memory,


have high storage capabilities and the data stored in the chip is dynamic and
reloadable.
Smart cards hold a promising future because they offer multiple advantages to
merchants consumers and banks.
Chip Card- A chip card is a plastic card with an embedded integrated circuit
or a micro chip as opposed to magnetic strips on conventional card. The chip
can be used on existing debit and credit cards as well as on emerging products
like store valued cards, inserting the card is what is called a pin pad effects the
transaction and the value on it reduces accordingly. These cards are reloadable
and disposable. The idea is to do away with the trouble of carrying cash.
Co-branded card- The times card a cobranded card is the first of its kind form
a publishing house in the Asian subcontinent. There is a co-branded credit
card of Times of India Group and Citibank Master Card. The co-branding
concept has caught in the credit card industry the world over during the last
five year.

Credit card operating cycle


1. Credit PurchaseCard -Holder purchases goods/ services and gives the
credit card.
2. Credit card processing-

Merchant establishment delivers goods after

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.

Bank card Associations


Two international card Associations
1. Master Card International
2. Visa Card International
Are the associations actively involved in the grouping Indian Credit Card
Industry. The two associations are owned by member banks and governed by
separate board of directors.Most banks are members of both the organizations
and therefore issue both types of cards.

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.

Validity and Renewal


The cardholder can use the card within the validity period only. A new card is
sent once in every 2 to 3 years before the expiry of the old card.The fees and
eligibility criteria for credit cards vary from bank to bank.The cost of obtaining
credit card is cheaper among the Indian Banks as compared to foreign banks.

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Benefits of Credit Cards


Credit cards offer enormous benefits to users and bankers
Benefits to cardholders
1. Shopping Convenience- Credit cards are convenient to use. They dispense
with the need to carry large amount of cash or issue cheques shopping is made
more comfortable and joyous as purchasing poses no difficulty. Since cards
have wide acceptance.
2. Credit Facility- Credit cards offer a convenient mode of credit to customers.
The credit card enables the cardholder to avail the credit facility sanctioned by
the card issuing company. The customer can either pay the amount of credit in
full or can opt. for repaying it in flexible monthly installments.
3. Safety- Credit cards allow for a safe means of conducting transaction.
Credit card holders need not carry large amount of cash, avoiding the risk of
theft.
4. Meticulous Record - Credit Card facilitate meticulous and easy record
keeping. The transactions are printed on a monthly statement that can be
reconciled with the sales receipt issued by merchants. Thus the accumulated
interactions are easily accounted for every month.
5. Acceptability- Merchant establishments widely accept VISA and Master
Card. This makes it very convenient for holding a credit card.

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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3. No Risk As there is no direct contact of the merchant establishment with


collection of payments on credit cards, there is no risk to the merchant in
accepting credit facility.

Benefits to issuer Banks


1. Source of Income- Credit cards provide an easy way to extend credit to
customers.
2. Market Expansion- Credit cards can be used by banks to increase their
market presence. Example ATM which can be established in a place like
supermarket, is accessible to the consumer directly for financial transactions.
3. Cross-Selling- Credit cards provide ample opportunity to banks for
additional revenue. This is possible by cross-selling other bank products and
services to its existing and potential cardholder.

38

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.

Steps involved in usage of the debit Card


1. Customer presents the card for making payment.
2. Shopkeeper swipes the card on the terminal and keys in the purchase amount.
3. Customer types in the confidential PIN (personal Identification Number) after
verifying the amount typed on the terminal.
4. Terminal processes and prints the transaction slip.
5. Customer verifies the amount and signs on the transaction receipt.
6. Customer obtains a copy of the transaction receipt and the card after
completion of the transaction.

39

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
40

help prevent the increasing number of frauds found in the traditional financial
cards.

Types of Smart Cards


The term Smart Cards is often used in a broad sense to include cards with a
large memory an processing power and which are capable of being packaged in
the ISO format.There are three types of smart cards as described below.
1. Contact Smart Cards- Contact smart cards have microelectronic chips
embedded in the card. These chips have connections to metallic contact pads on
the surface of the card. The contact pads are used for reading and writing card.
2. Contactless card- A contactless card does not require the use of external
contacts and is used for transferring data between a smart card and a read write
device. The card is able to operate at a distance from the read / write unit.
3. Super Smart Card- the super smart card incorporates a keyboard and a
liquid crystal display (LCD). It functions more like a stand alone terminal and
does not need a separate read/write unit.

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 :

a) Physical and Manufacturing Security


The physical and manufacturing security features include deterrents to
reproducing the cards without the approved facilities equipment and expertise.
For instance, Chips for Smart Cards are not publicly available.

41

b) Personal Identification Security


Personal identification security links the card to its rightful owner. The most
commonly used method for identifying the rightful owner is the PIN (Personal
Identification Number). However various other methods are as follows.
1. Voice Recognition systems- A computer is used to recognize different
voice in pull by comparing them with the recorded original voice available in
its databanks.
2. Hand Geometry- This system is based on the unique hand structure of
individuals. Features such as finger length, skin web opacity and radius of
curvature of fingertips are scanned with photoelectric devices and used by the
system for identification.
3. Retinal pattern verification- In this method, the unique pattern of blood
vessels on the retina of the human eye is used for the purpose of personal
identification. A persons identical is ascertained by scanning the retina using a
low intensity infrared beam.
4. Vein Recognition- This method like previous one uses the unique vein
structure of the human body to identify individuals.
The vein check system uses a simple infrared scanning and encoding
techniques to locate the number, position and size of subcutaneous vessels.
5. Visual Recognition-It is possible to digitize the picture of a person and
stored it in the memory of smart cards.
The picture is usually obtained by a scanning video camera, digitized and then
compressed and stored in the smart card.

c) Communication strategy
The third category of security features offered by the smart card related to
communication.

42

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.

43

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.

44

5. ISO laid Standards:


The International standards covering various aspects of the cards including
dimensions, embossing and location of the magnetic stripe.
6. VISA and MASTERCARDSecurity Features:
Both VISA and MASTER CARD incorporated various other security features
such as holograms, fine background printing and signature panels to counter the
threat of card-related crimes.
Computers and magnetic stripe cards gradually joined hands as computers
began to be increasingly used for card transactions.
7. Conventional plastic card:
In 1944 Roland Moreno, a French journalist patented his idea of putting a chip
inside a conventional plastic card.
8. Granting patent for smart cards:
Dr. KunitakaArimura of Japan was granted a patent for smart cards and today
all smart cards made in Japan have to be licensed by the Arimura Institute.
9. Other Companies:
Various other companies like smart card International, Philips Honey well bull
and GEC started using Intel chips in smart cards.
10. Concept of Super Smart Card:
In Japan and the USA, the smart card was taken a stage further with the design
concept of a small card having a display and keyboard. This concept came to be
known as the super smart card.
11. Standards for smart Cards:
In 1989, the ISO set up a working group to set standard for smart cards. The
standards cover items such as the contact position interface protocol information
content and control.

45

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.

46

Key Aspects of Investing


1. Return on Investment- Return on investment is the basic driving force
behind investing and the most importance aspect. The purpose of investing is to
earn the best possible returns.
2. Time- Time is another key aspect all investments, whether bonds, fixed
deposits, fixed-income instruments or stocks, require a certain period of time to
generate returns.
3. Risks- Investors must be prepared for the risks. An investment involves
sacrifice in the present which is certain.
The benefits are expected to be received in the future which is uncertain.
This involves risk which is very high in certain investments such as stocks,
equity based mutual funds and so on.
4. Liquidity- Yet another aspect is liquidity. If you cannot get your money
back easily when you need it most, it will defeat the very purpose of savings
and investment.
The fundamentals are:
Maximizing Returns
Minimizing Risk
Ensuring a degree of liquidity

Features of any Investment product


1. Rate of Return
2. Risk involved
3. Liquidity
4. Convenience
5. Tax concessions are the most important features of any investment products.
It has to evaluated.

47

Various Options available for Investment or Various Investment


Alternatives:
All the modes of investment differ from each other in one or more of these
features.These features can also be used to evaluate whether a particular
investment product is suitable for you or fulfills your financial needs.
A critical evolution of various investment alternatives based on these features is
given below.
1. Bank Deposits
These are high on liquidity and convenience. The risk involve is negligible, the
return is also moderate only a few tax concessions are available.
2. Equity shares
The potential for high returns is more because of capital appreciation. Equity
shares rank high on risk, liquidity and convenience. Returns however are
uncertain and subject to market forces.
3. Mutual Funds
High on liquidity and convenience. Good tax concessions available which
differ from scheme to scheme. Returns and risk may vary according to the
scheme.
4. Life Insurance Policies
Tax benefits are high, life insurance policies rank high on convenience, but the
returns are modest. Liquidity and risk are low.
5. Company Deposits
These provide higher returns but are also high on risk. No tax concessions are
available Liquidity and convenience are also low.
6. Bonds and corporate Debentures
Returns and risk are both high with no tax concessions available these are low
on liquidity and convention.

48

7. Post office Deposit Schemes:


Returns are moderate but risk is low. Various tax concessions are available but
liquidity is low.
8. Gold, Silver, Other Precious Metals:
Potential exists for high returns with good quality. With only a few tax
concessions available, the risk is moderate to high convenience is medico.
9. Real Estate:
High on returns with high risk, but liquidity is low. Tax concessions are
available for self occupies houses convenience is low.

49

UNIT II
SECURITIES

Financing or investment instruments bought and sold in financial markets such


as bonds debentures, notes shares (Stocks) and warrants.
Security- A financing or investment instrument issued by a company or
government agency that denotes an ownership interest and provides evidence
of a debt, a right to share in the earnings of the issuer or a right in the
distribution of a property.
Financial instruments can be also be called financial securities.
Classification of Financial Securities
Financial securities can be classified into:
1. Primary Securities or Direct Securities
These are securities directly issued by the companies Ex. Shares and
debentures issued directly to the public.
2. Secondary Securities
These ate securities or indirect securities issued by some intermediaries to the
ultimate savers. Ex. Unit Trust of India and Mutual Funds.
Issue of Securities- Issue of Securities of Legal entities such as body corporate
and others to the general public for their subscription is known as public Issue
of 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.
50

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.

2. Follow on public offering [FPO]:


Follow on public offering is a kind of public issue of securities, where an
already listed company makes an already listed company makes either a
fresh issue of securities to the public or an offer for sale to the public
through an offer document.

2. Rights Issue (RI) :


Rights Issue is a kind of public issue of securities where a listed company,
proposes to issue fresh securities to its existing shareholders. The rights are
normally offered in a particular rating to the number of securities held prior
51

to the issue.This route is best suited for companies who would like to raise
capital without diluting stake of its existing shareholder.

3. Preferential Issue (PI):


Preferential issue is an issue of share or of convertible securities by listed
companies to select group of persons under section 81 of the companies Act
1956 that is neither a rights issue not a public issue. This is a faster way for a
company to raise equity capital.The issuer company has to comply with the
companies Act and the requirement contained in the chapter pertaining
allotment in SEBI (DIP) guidelines.

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.

52

Unit-II
SECURITIES MARKET

Stock market or securities market is a market where securities issued by


companies in the form of shares, bonds and debentures can be bought and sold
freely.
The components of stock market are:
1. Primary Market
2. Secondary Market
1. Primary Market
Primary market is a channel for the sale of new securities.
2. Secondary Market
Secondary market provides a platform for sale of the already issued and listed
securities.
Features of primary market
The features are as follows
1. It is a market for a long term capital where the securities are sold for the first
time. Hence it is also called new issue market (NIM).
2. Funds are collected and securities are issued directly by the company to the
investors.
3.Primary issues are carried out by the companies for the purpose of inception
and functioning of business.
Benefits of Primary Market.
The benefits are as follows
1.Company need not repay the money raised from the market.
53

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.

55

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
56

Insurance companies registered with the insurance regulatory and


development Authority (IRDA)
Provident fund with a minimum carpus of Rs.25 crores.
Non-Institutional Investors
Residential Indian individuals HUF companies, corporate bodies,
NRIssocieties and trusts whose application size in terms of value is more than
Rs1 Lakh also come under this category. At least 15 percent of the total issue
has to be reserved for non- institution investors.
Retail Investors- They are defined in terms of the value of the primary issue
applied by them. The value of the applied shares should not exceed Rs.1 lakh.
According to the new guidelines, the inclusion of PAN in application forms for
public/rights issuer has been also made mandatory, irrespective of the value of
application.
Thirty five percent of the issue has to be reserved for them.
Under this category only individuals both resident and NRIs along with HUFs
are allowed to bid.
Companies making public issues can offer a discounted price to retail individual
investor provided that the discount is not more than 10 percent.

Intermediaries in primary market


Intermediaries- The companies take the assistance of many agencies for
accessing the primary market because of the complicated rules and regulations
of the company and the dynamic nature of the capital market.
The intermediaries have to be registered with SEBI and must have a valid
certificate from SEBI to act as intermediaries.
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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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The rate and amount of commission or brokerage chargeable by the


underwriter.

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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5. Share Transfer Agents- They maintain the records of the holders of


securities of the company for and on behalf of the company. They also handle
all matters related to transfer and redemption of securities of the company.

6. Stock-Brokers and Sub-Brokers - Appointing a broker is not compulsory


but approval of the stock exchange is mandatory. The names and address of the
brokers to the issue should be given in the prospectus. The brokers enhance the
sale of issue.The issuing company pays brokerage according to the provisions in
the company Act and guidelines prescribed by the SEBI.

7. Depositories - They are the intermediaries who hold the securities in


dematerialized form on behalf of the shareholders.They enable transactions of
securities by book entry.The depository system links the issuers, depository
participants, NSDL and clearing corporation houses of the stock exchanges.
Transfers are affected by means of account transfer.

ROLE OF SEBI IN PRIMARY MARKET


1. To file Draft offer document:
A company making a public issue, or a value of more than Rs.50 lakhs is
required to file a draft offer document with SEBI for its observation.The
company can proceed observations from SEBI.
The validity period of SEBIs observation letter is three months only. i.e. the
company has to open its issue within three months period.

2. SEBI does not recommend any Issue:


SEBI does not recommend any issue nor does it take any responsibility either
for the financial soundness of any scheme or the project for which the issue is

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proposed to be made or for the correctness of the statements made or opinion


expressed in the offer document.

3. Submission of offer document not deemed to be approved:


Submission of offer document to SEBI cannot in any way be deemed or
construed that the same has been cleared or approved by SEBI.

4. Lead Manager to certify:


The lead manager certifies that the disclosures made in the offer document
are generally adequate and are in conformity with SEBI guidelines for
disclosures and investor protection in force for the time being. This
requirement is to facilitate investors to take an informed decision for making
investment in proposed issue.

5. SEBI does not associate itself with any issue/issuer


SEBI does not associate itself with any issue/issuer and should in no way be
construed as a guarantee for the funds that the investor proposes to invest
through the issue.

6.SEBI guides investors to take action by themselves.


The investors are expected to make an informed decision purely by
themselves based on the contents disclosed in the offer documents.

7. Investors to study all material facts.


Investors are generally advised to study all the material fact pertaining to the
issue including the risk factors before considering any investment they are
strongly warned against any tips or news through unofficial means.

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DIP Guidelines (Disclosure and Investor Protection)

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.

3.SEBI issued Securities and Exchange Board of India (Disclosure and


Investorprotection) Guidelines 2000 which is a compilation of all circles
organized in chapter forms.

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.

5. The DIP provides a comprehensive frame work for issuance by the


companies.

Due Diligence - (Examination by head managers)


1. Due Diligence is the act of lead managers to examine various documents
including those relating to litigation like commercial disputes, patent disputes
,disputes with collaborates and other materials in connection with the
finalization of the offer document pertaining to the said issue.

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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3.It also forms an independent verification of the statements concerning the


objects of the issue projected profitability price justification etc

4.The objective of conducting due diligence is to ensure that they are in


compliance with SEBI, the Government and any other competent authority on
this behalf.

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.

Central Listing Authority (CLA)

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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3.To make recommendations to the Board on issues pertaining to the protection


of the interest of the investors in securities and development and regulation of
the securities market including the listing of agreements, listing of conditions
and disclosures to be made in offer documents.
4.To undertake any other functions as may be delegated to it by the Board from
time to time.
5.SEBI as the regulator of the securities market, examines all the policy matters
pertaining to issues and will continue to do so even during the existence of the
CLA.

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.

2) Draft Offer Document


It is the offer document in the draft stage. The draft offer documents are
filed with SEBI, at least 21 days prior to filing of the offer document with
ROC/Stock Exchanges.

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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The requirements are detailed in Chapter IV of DIP guidelines depositors &


investors.

Structure of offer Document


The offer Document contains several sections wherein loads of information is
planted by the issuer as part of mandatory compliance.
Following are the features of the structure of the offer document :
1. Cover Page
The cover page of the offer document covers full contact details of the
Issuer Company, least managers and registrar the nature, number price and
amount of instrument (securities) offered and issue size and the particulars
regarding listing.Other details such as credit rating, risks in relation to the first
issue etc. are disclosed if applicable.
2. Risk Factors
The issuers management gives its view on the internal and external risks faced
by the company. The company also makes a note on the forward looking
statement.This information is disclosed in the initial pages of the document and
it is also clearly disclosed in the abridged prospectus.
It is generally advised that the investors should go through all the risk factors of
the company before making an investment decision.
3. Introduction
The introduction covers a summary of the industry and business of the issuer
company the offering details in brief. Summary of consolidated financials
operating and other data.

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General information about the company the merchant bankers / syndicate


members to the issue, credit rating, debenture trustees (in case of debt issue)
monitoring agency, book building process in brief and details of under writing
agreements are given here.
4. Important details of capital structure
Objectsof the offering, funds requirement funding plan, schedule of
implementation funds deployed and of funds already deployed and of the
balance fund requirement, interim use of funds, basic terms of issue, basis for
issue price, tax benefits etc. are covered.
5. About us
This section presents a review of the details of the business of the company
business strategy, competitive insurance, industry regulation (if applicable)
history and corporate structure, main objects subsidiary details, management
and board of directors, compensation, corporate governance exchange rates,
currency of presentation, dividend policy, management discussion and analysis
of financial condition and results of operations.
6. Financial statements
Financial statement changes in accounting policies in the last three years and
difference between the accounting policies and the Indian Accounting Policies.
7. Legal and Other Information
Outstanding litigations and material developments, litigations involving the
company and its subsidiaries, promoters and group of companies are disclosed.
8. Mandatory disclosures
Under this heading the following information are covered. authority for the
issue prohibition by SEBI, eligibility of the company to enter the capital market,
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disclaimer, clause of the stock exchange listing, impersonation, minimum


subscription letters of allotment or refund orders, consents expert opinion,
changes in the auditors in the last three years, expenses of the issue, fees pay at
to the lead managers, few payable to the issue mgt. team, fees payable to the
registrars, underwriting commission, brokerage and selling commission etc.
9. Offer Information
Under this heading, the following information is covered. terms of issue ,
ranking of equity shares, mode of payment of dividend, face value and issue
price, rights of equity shareholder, market lot, nomination facility to investor,
issue procedure, bid form, bidding process escrow mechanism, announcement
of statutory advertisement issuance of confirmation of allocation note (CAN)
payment instruction etc.
10. Other information
This covers description of equity shares and terms of the Articles of
Association, material contracts and documents for inspection declaration
definition and abbreviations.

Procedure for buying shares through IPO issue process


The process of public issue of securities is described below.
1. Obtaining issue information: The information pertaining to primary issues
of securities such as name of the issuer, total issue size the intermediaries etc
can be had from the SEBIs monthly bulletin.A digital version of the same is
available on the SEBI website.
2.Obtaining Application form:The form for applying / bidding of shares is
available with all collection centers, the brokers to the issue and the bankers to
the issue.
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3.Collecting offer information:The document is prepared by an independent


specialized agency called merchant Bankers, which is registered with SEBI.
They are required to offer due diligence while preparing an offer document.The
draft offer document submitted to SEBI is put on the website for public
comment.
4. Demat Account - As per the requirement all the public issues of size in
excess of Rs.10 crores are to be made compulsorily in the demat mode.Thus if
an investor choose to apply for an issue that is being made in a compulsory
demat mode, he has to have a demat account and has the responsibility to put
the correct ID in the bid application forms.
5. Bidding/Applying - The investors are generally advised to study all the
material facts pertaining to the issue including the risk factors, before
considering any investment they are strongly warned against any tips or relying
on news obtained through official means.
6. Qualified Institutional Buyers (QIB) - Qualified Institutional buyers
constitute an important segment of investors who bid in a new issue of
securities.
QIBs are those institutional investors who are generally perceived to possess
expertise and financial muscle to evaluate and invest in the capital markets.
QIBs means and includes:
1. Public financial institutions as defined in Sec 4 A of the companies Act
1956.
2. Scheduled commercial banks
3. Mutual funds
4. Foreign institutional investor registered with SEBI.
69

5. Multilateral and bilateral development financial institutions.


6. Venture capital funds registered with SEBI.
7. Foreign venture capital investors registered with SEBI.
8. State Industrial Development Corporation
Any entities falling under the categories specified above are considered as
QIBs for the purpose of participating in primary issuance process.
7. Issue open
Subscription list for public issues is kept open for atleast three working days
and not more than ten working days. in case of book-built issues, the minimum
and maximum period for which bidding will be open is three to seven working
days extended by three days in case of a revision in the price band.
8. Bid Revision
It is possible for the investor to change or revise the quantity or price in the bid,
using the form for changing/ revising the bid that is available along with the
application form However, the entire process of changing of revising the bids
shall be completed within the date of closure of the issue.
The syndicate member returns the counter foil with the signature, date
and stamp of the syndicate member. The investor can retain this as a sufficient
proof that the bids have been taken into account.Syndicate members are mainly
appointed to collect the entire old forms in a book built issue.
9. Allotment
An investor would get confirmatory allotment note (CAN) / Refund order
within 30 days of the closure of the issue.

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In case of book-built issues, the basis of allotment is finalized by the book


running lead managers within two weeks from the date of closure of the issue.
The registrar then ensures that the demat credit or refund as applicable is
completed within 15 days of the closure of the issue.
The listing on the stock exchanges is done within seven days from the
finalization of the issue.
10.Book-building
Book-building is a process by which corporate determine the demand and the
price of a proposed issuer of securities through public bidding.
11. Listing
The listing on the stock exchanges is done within seven days from the
finalization of the issue. Ideally, it would be around three weeks after the
closure of the book built issue. In case of fixed price issue, it would be around
37 days after the closure of the issue.
12. Issue complaints
Most of the issue complaints pertain to non receipt of refund or allotment or
delay in receipt of fund or allotment and payment of interest thereon. These
complaints shall be made to the post- issue lead manager, who in turn will face
up the matter with the registrar to redress the complains.
In case the investor does not receive any reply within a reasonable time,
investor may complain to SEBI, office of investors assistance.
Safety Net - It refers to a scheme of buy-back arrangement of the shares
proposed in any public issue with the objective of protecting the investors in the
event of share prices going down after the issue is made.

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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.

IPO Grading [Initial public offering]


The securities and exchange Board of India has made IPO grading mandatory
and the new norm has been effective from 1 May 2007.
Grading of IPO is the assessment of the fundamentals of the issuer concerned
on a Relative Grading Scale. [ IPOInitial Public offering- If the company is a
new entrant to the capital market the issuers made by such a company is called
Initial Public Offering]
The IPO grade assigned is the outcome of a detailed evaluation of qualitative
and quantitative factors of the concerned company.It is a comment on the
fundamentals of the company concerned and its growth prospects from a longterm perspective.
Generally, grades are assigned on a five point scale,

where IPO grade 5

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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The Grading Process


It involves several steps, these are given below.
1. The issuer company sends a formal request to the grading agency.
2. The agency seeks information on the companys existing operations as well
as proposed projects through a questionnaire.
3. Site visits and discussions with the key operating personnel of the company
concerned are conducted by the rating agency.
4. Apart from the officials of the company the agency also meets its bankers,
auditors, merchant bankers and appraising authority (if any). If needed the
opinion of independent expert agencies on critical issues like technology
proposed to be used is also obtained.
5. Analysts of the agency present a detailed grading report to the rating
committee which then assigns the grade. Usually the assignment of grade takes
three to four weeks after all the necessary information has been provided to
ICRA.
6. The issuer comp. is required to disclose the assigned grade and also publish
it in the red herring prospectus, which is filed with SEBI and other statutory
authorities.
Grading Methodology
The Grading methodology consists of analyzing the
1) Industry prospectus
2) Competitive position
3) Risks and prospectus
4) Financial performance
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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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SEBI (Disclosure and Investor Protection) guidelines 2000 introduced a new


method of raising funds from the market by companies in the form of QIP. It
is a form of private placement.
It is an attempt by SEBI to encourage Indian companies to raise money
domestically rather than going outside for foreign currency convertible bonds
(FCCBs) and American Depository receipts (ADRs)

75

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.

Features of a secondary market


1. Trading of securities in the secondary market does not provide any funds to
the company.
2. The investors as well as the speculators trade in securities.
3. Securities of listed public limited companies are traded on a recognized
stock-exchange.
4. Secondary market provides liquidity to the investors.
5. The market prices in the secondary market reflect the investors perceptions of
a company performance.

Market Segments
The secondary market has the following three segments.
1. Capital Market Segment (CM)
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2. Whole sale Debt Market (WDM)


3. Futures and options (F and O)
[ Speculation buying shares in the hope of being able to sell them again at
higher price and make profit ]
1. Capital Market Segments - Where equity share preference shares and
warrants are traded.
2. Wholesale Debt Market- Where state and central Government. securities, Tbills, PSU-bonds (public security undertakings), corporate debentures,
commercial papers, certificate of deposits, mutual funds etc. are traded.
3. Future and options (F and O) - Segment where derivatives based on equity
and indices are traded. Index option, index futures stock options and stock
futures are bought and sold in this segment.

Participants of secondary market


Index is a system by which changes in the value of something and rate at which
it changes can be recorded or interpreted. Participants of the secondary market
mainly consist of
I. Investors
II. Market Intermediaries
III. Regulatory Bodies

I. Investors
The investors can be broadly classified into
1. Retail Investors
2. Institutional Investors
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3. Foreign Institutional Investors


1. Retail Investors
They are individual investors with a limited access to funds they invest their
surplus funds in securities to earn returns.
Equity investment is considered to be high risk high return proposal as
compared to other investment instruments like fixed deposits and post office
savings scheme.
High net worth individual [HNI] is used to refer to individuals and families who
are affluent in their wealth holding and consequently have a higher risk profile.
2. Foreign Institutional Investors [FIIs]
They are venture capital funds, pension funds, hedge funds, mutual funds and
other institutions registered outside the country of the financial market in which
they take an investment exposure.
They are allowed to invest in the primary and secondary capital markets in India
through the portfolio investment scheme (PIS).
Under this scheme, FIIs can acquire shares/ debentures of Indian companies
through the stock exchange in India. The ceiling for the overall investment for
FIIs is 24 percent of the paid up capital of the Indian comp.
The number of FIIs registered with the securities and exchange Board of India
has doubled.The Indian capital market has attracted many global majors like
HSBC, Citigroup, crown capital, Fidelity, UBS, ABN Amro, Morgan Stanley.

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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.

II. Market Intermediaries


Intermediaries such as
1. Stock brokers
2. Depository participants
3. Banks facilitate the payment of money in share transactions.
Main Market Intermediaries are:
1. Stock Exchange Members/Brokers
2. Depositories
3. Depository participants
1) Stock Exchange Members/Brokers
A stock broker is a member of the stock exchange and he is permitted to trade
on the screen- based trading system of the stock exchange.The brokers have to
register with SEBI and should keep a registration certificate.
A Sub-broker is a person who is affiliated to a member of a recognized stock
exchange. He also has to register himself with SEBI.

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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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2. Penalties arising on a specific default


3. Service as stipulated
4. Securities Transaction Tax (STT) as prescribed and paid to stock exchanges.
The maximum brokerage charge is fixed at 2.5 percent of the contract price
inclusive of the amount charged by the sub-broker, it excludes turnover fees,
service and stampduty. The sub-broker should not exceed 1.5 percent of the
contract price.STT rates are prescribed by the Central Government from time to
time.
2) Depository
A depository is an organization which maintains investors securities in
electronic form. In simple terms a depository is a bank for securities.
National Securities Depository Limited (NSDL)
Central Depository Services (India) Limited (CDSL)
are functioning as depositories in India.NSDL was first set up by NSE with
UTT and IDBI.CSDL is a depository managed by professional and it was
promoted by the Bombay Stock Exchange (BSE) Limited along with a cross
section of several leading Indian and foreign banks.
Function of Depository
The principal function of a depository is to dematerialize the securities and
enable their transactions in book entry form.
Dematerialization of securities occurs when securities issued in physical form
are destroyed and an equivalent number of securities are credited into the
beneficiary owners account.

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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

intermediaries below the depository and the investors.The relationship between


the DPs and the depository is governed by an agreement made between the two
under the Depositories Act.
In a strictly legal sense, a DP is an entity who is registered with SEBI under the
provisions of the SEBI Act. As per the provisions of this Act, a DP can offer
depositors related services only after obtaining a certificate of registration from
SEBI.SEBI (D and P) regulations 1996 prescribe a minimum net worth of Rs.
50 lakh for stock brokers, registrars, transfer agent and non-banking finance
companies (NBFCs) for granting them a certificate of registration to act as
DPs.
Benefits of Depository Services
1. The risk of bad deliveries and loss of certificates in transit are removed.
2. There is saving in stamp duty.
3. The cost of courier, notarization and the need for further follow up is
eliminated.

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4. The liquidity of securities due to immediate transfer and registration is


increased.
5. The brokerage charge for trading in dematerialized share is low.
6. Bonuses and rights are directly credited into the depository account.
7. Interest charges are lower for loans taken against demat shares as compared
to physical shares.
8. The limit of loans availed against demat shares is higher than the loans
borrowed against physical shares.It is Rs.20 lakhs per borrower against the
demat shares as collateral, but it is Rs.10 lakh per borrower against physical
shares.
9. The margin is 25 percent for loans against demat shares. However it is 50
percent for loans against physical shares.
Depository Account Opening
Opening a depository account is just like opening a bank account.
1. The investors can select any depository participant with whom he is
comfortable.
2. The investor has to get the account opening form from the DP and fill it up.
3. He has to sign a DP client agreement.
4. The agreement specifies the rights and duties of the DP and the demat
account holder.
5. Client identity proof along with the DP identity proof is given to the account
holder.

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6. To dematerialize the shares, the investors has to obtain the dematerialization


request form [DRI].
7. The investor has to submit the filled up form along with the share certificate
to Depository Participant.
8. The Dematerialized shares are credited in the demat account with fifteen
days.In the case of directly purchasing dematerialized shares from the broker,
once the order is executed, the DP receives Securities from the brokers clearing
account.

Bank and Depository - Comparison


Feature

Bank

Depository

Account

Hold funds in an account

Hold Securities in an
account

Transfer

Transfers funds between

Transfers securities

accounts on the instruction

between accounts of the

of the account holder.

instruction of the account


holder.

Handling

Safe Keeping

Facilitates transfers without

Facilitates transfer without

having to handle money

having to handle securities

Facilitates safe keeping of

Facilities safekeeping of

money

securities

Customer contract Direct contact

Contact through depository


participate

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Demat Services: Financial services relating to DP holding, maintaining and


dealing in securities in electronic form by a financial intermediary known as
depository participant or demat services.

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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14. No scope for theft/forgery/damage of share certificates.


15. Minimum handing of paper.
16. Low transaction cost for purchases and sale of securities compared to
physical mode.
17. Reduction in paper work.
Need for Demat Services
SEBI has made compulsory trading of shares of all the companies listed in stock
Exchanges in demat form w.e.f 2nd January 2002. Hence if an investor wants to
trade in respect of the companies which have connectivity with NSDL and
CSDL, it would require a demat (beneficiary account) opened with the DP of
choice to hold shares in dematerialized (demat) form and to undertakeScriplus
trading.
Services / Functions
Important services of a depository participant are transferring securities as per
the investors instruction without actually handling securities through electronic
mode, maintaining the account balance of securities bought and sold by the
investor from time to time, furnishing the investor a statement of holding
similar to a pas book etc.
Depository in financial services industry provides the following services:
Account Opening For Clients
An investor needs a satisfactory introduction and identification to open a
DEMAT account. An investor has to fill up an agreement with the DP for
opening a Demat account.

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The investors (investors are called Beneficial owners in Depository system)


intending to hold securities in electronic form in the Depository system open an
account with a DP of NSDL.
The investor opens account opening form and signs an agreement with DP. The
investor can also open multiple accounts with same DP as also with different
DPs.
The DP will provide the investor a statement of holdings and transactions. In
case the shares are held in joint names then the account is to be opened in the
same order of names.Similarly separate accounts to be opened for each
combination of names.
Materialization
Holding of securities in physical form is known as materialization requires
securities that are held in paper form whereby buying and selling transactions in
securities can take place only in paper mode.
In materialization securities are heal by the owner itself and the depository can
of course help hold securities in electronic form.
Dematerialization
The process of transforming paper form of holding securities into electronic
form is known as dematerialization of securities.
A process by which the physical certificates of an investor are takes back by the
company registrar and actually destroyed and an equivalent number of securities
are credited in the depository account of that investor.
For this purpose the investor just files in Dematerialization request form
available with DP and submits the share certificates along with the above form

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legend like(surrendered for Dematerialization should be written on the face of


each certificates before its submission for Dematerialization).
The beneficial owners account will be credited within 15 days and he will be
informed by the DP.
If one wishes to convert the electronic shares back to physical shares at a later
stage it can be done by making an application for rematerialization through a
rematerialization request form (RRF) available with his DP.
Rematerialization
The reverse of dematerialization is rematerialization. The process of converting
securities from electronic form to physical form is known as rematerialization of
securities.The investor must fill up a Remat Request Form (RRF) and give it to
the DP. The DP will forward the request to Depository after verifying that the
shareholder has the necessary balances.Depository inturn will intimate the RTA
companies. The RTA companies will print the certificate and dispatch the same
to the investor.
Electronic Trading
Selling of shares held in electronic form is very similar to selling of the paper
form of shares.Instead of signing the transfer deed as seller and delivering it
with share certificates to a broken one gives to the Depository participant debit
instructions for delivering the shares form the clients account to the chosen
brokers account.
The debit instruction is verified for signature and correctness and then acted
upon by the DP broker in the same manner as is received now. For buying
shares in the depository system the client must inform the broker, the
Depository account number (Client ID) along with the Depository Participant
ID (DPID) so that the shares bought by the client are credited into that account.
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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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4. Recording Details- Depository records the details of the Electronic Request


in the system and forward the request to Registrar and Transfer Agent (RTA) or
issuer (i.e., the company whose shares are sought to be dematerialized).
5. Verification- RTA/Company on receiving the physical documents are in
order, dematerialization of the concerned securities is electronically confirmed
to the depository.
6. Account crediting - Depository credits the dematerialized securities to the
beneficiary account of the investor and intimates the DP electronically. The DP
issues a statement of transaction to the client.
7. Company Identification -Once the company is admitted in the depository
system ISI No ( i.e., International securities Identification number)
8. Dematerialization of shares sent for transfer- Shares sent for transfer can
be dematerialized if the comp is providing simultaneous transfer cumDematerialization scheme.
Simultaneous Transfer -Cum- Dematerialization Scheme
On completion of the process of registration of securities sent for transfer, the
RTA / company will send an option letter to the investor, providing an option to
dematerialize such securities.
The investor may exercise this option by submitting demat request form
together with the option letter to the DP. Then the company or its RTA would
confirm the demat request in the usual manner.
SEBI has made it mandatory for all companies whose shares are traded
compulsorily in demat form in the stock exchanges to offer this facility and has
prescribed the procedure thereof.

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Certificate Number for Dematerialized shares


The dematerialized shares are fungible and they do not have any certificate
number or distinctive numbers.
Fungible-Fungible means the dematerialized securities do not have any
distinctive or certificate numbers. It is represented only by the number of
securities. This is called fungible.
Process Time- Dematerialization will normally take about 30 days.
Holding in Both Demat Form and Physical Form
The investor can dematerialize part of his holdings and hold the balance in
physical mode for the same security.
Distinguishing partly paid-up and fully paid-up shares
Partly paid up shares and fully paid up shares are identified by separate ISINs
(International Securities Identification Number).

These are also traded

separately at the stock exchanges.


The company issues call notices to the beneficial holders of partly paid up
securities in the electronic form. The details of such beneficial holders will be
provided to the RTA/ Comp by the Depositories.
After the call money realization RTA/ company will electronically convert the
partly paid up shares to fully paid up shares.
Electronic Settlement of Trade-Procedure
I) For selling Dematerialized securities
The Procedure for selling dematerialized securities in stock exchanges is
similar to the procedure for selling physical securities. Instead of delivering
physical securities to the broker, the investor must instruct his / her DP to debit
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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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Regulatory Authorities of Secondary Market


The capital market is regulated by the:
1) Ministry of Finance
2) The Securities and Exchange Board of India (SEBI).

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.

Ministry of Finance administers legislation such as securities and Exchange


Board of India Act 1992 (SEBI Act 1992). Securities contracts (Regulation).
Act 1956 and the Depositories Act 1996.

THE SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)

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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Regulates business in stock exchanges


Supervises the working of stock brokers share transfer agents, merchant
bankers, underwriters, etc.
Prohibits unfair trade practices in the Securities market.
Administers mostly the Acts, rules and regulations related to the
securities market.
The following departments of the SEBI regulate the secondary market :
1. Market Intermediaries Registration and Supervision Department
(MIRSD)
This department takes care of the registration of all market intermediaries
related to all segments of the market namely the equity and derivative
segments. It also supervises monitors and inspects all the intermediaries.
2. Market Regulation Department(MRD)
The main function of this department is to formulate new policies except
relating to derivatives for stock exchanges, their subsidiaries and market
institutions such as clearing and settlement organizations and Depositories.
It also supervises their functioning and operations
3. Derivatives and New Products Departments (DNPD):
The function of this department is mainly related to the supervision of
derivatives segments of the stock exchanges and introduction of new
products to be traded. It also takes care of the consequent policy changes.

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).

Section 2 (j) of the Securities contracts (Regulation)Act 1956 defines a stock


exchange as: Anybody of individuals whether incorporated or not constituted for
the purpose of assisting regulating (or) controlling the business of buying, selling
or dealing in securities.

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.

Functions of stock Exchange


The Stock exchanges perform a number of functions useful t both the investors
and the corporations. They carry out the following functions.
1. Central Trading Place- They provide a central place, where the brokers
and dealers regularly meet and transact business.
2. Settlement of Transaction- They provide convenient arrangements for the
settlement of transactions.
3. Continuous market- These are the market for the existing securities.
These are places for the holders of securities to buy and sell their securities
and for those who want to invest their savings. The stock exchange thus
provides liquidity to their investment.
4. Supply of Long Term Funds- Since the securities can be negotiated and
transfer through stock exchanges, it becomes possible for the companies to
raise long term funds from investors.In the stock exchange, one investor is

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substituted by another when a security is transacted.

Therefore the

company is assured of long-term availability of funds.


5. Setting up of Rules and Regulations - Stock exchanges set up rules and
regulations governing the conduct and finance of their members. It ensures
that a reasonable measure of safety is provided to investors and the
transactions take place under competitive conditions.
6. Evaluation of Securities- Stock exchanges help to evaluate the securities
as they publish the prices of securities regularly in newspapers. They also
enable the holders of securities to know the worth of their holdings at any
time.
7. Control over Company Management- A Company which wants to get its
shares listed in a stock exchange has to follow the rules framed by the stock
exchange. Through these rules and requirements, the stock exchanges
exercise some control on the mgt. of the company.
8. Helps capital Formation - Stock Exchange helps capital formation. The
publicity given by the stock exchanges about the different types of
securities and their prices encourage even the disinterested persons to save
and invest in securities.
9. Facilities Speculation- Stock Exchange provides facilities for speculation
and enables shrewd business man to speculate in the market and make
substantial profits.
10.Directs the flow of savings - A stock exchange directs the flow of savings
of the community between different types of competitive investments. It
also helps to meet the investment needs of entrepreneur.

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Stock Exchanges in India


Origin
Bombay stock Exchange (BSE) is the oldest stock exchange in India. It is
more than 100 years old. It was first organized as an informal association of
brokers in 1875 and later in 1887 it was formally established in Bombay as a
society known as native share and stock brokers Association.During the period
between the two world wars there was a great boom in the share market and a
number of stock exchanges were established. But they could not survive long
as they were not recognized under the Bombay securities contracts
(control)Act. By 1950s the control on securities trading became a central
subject under the Indian constitution.

The Securities contracts (Regulation)Act was passed in 1956 to control the


security trading in India.There are at present 23 recognized stock exchanges in
India including the over-the-counter Exchange of India(OTCET) and National
stock Exchange (NSE).Some of them are voluntary non- profit marking
organizations while others are companies limited by guarantee.Among the
recognized stock exchanges in India, Bombay, Calcutta, Madras, Delhi and
Ahmedabad are the prominent ones.24 stock exchanges are there in India.

The Stock Exchanges


Originally, the area of operation of each stock exchange was specified at the
time of its recognition. However, at present they are permitted to set up a
terminal anywhere in India. OTCEI, NSE and ICSE were permitted to set up a
terminal anywhere in revolution in the information technology has led to easy
nationwide access. The names of the recognized stock exchanges of SEBI are
given below.

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The recognized Stock Exchanges

Ahmedabad Stock Exchange Ltd.

Ludhiana Stock Exchange Ltd.

Bangalore Stock Exchange Ltd.

Madhya Pradesh Stock Exchange Ltd.

Bombay Stock Exchange Ltd.

Madras Stock Exchange Ltd.

Bhubaneswar Stock Exchange Ltd.

MCX Stock Exchange Ltd.

Calcutta Stock Exchange Association National Stock Exchange of India Ltd.


Ltd.
Cochin Stock Exchange Ltd.

OTC Exchange of India

Delhi Stock Exchange Ltd.

Pune Stock Exchange Ltd.

Guwahati Stock Exchange Ltd.

Utter

Pradesh

Stock

Exchange

Interconnected Stock Exchange of Association Ltd.


India Ltd.

Vadodara Stock Exchange Ltd.

Jaipur Stock Exchange Ltd.

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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Organisation and management


The organization, management, membership and functioning of stock
exchanges in India are governed by the provisions of the securities contracts
(Regulation) Act 1956.
This act permits only recognised stock exchanges which have to function
under the rules, by laws and regulations approved by the central Government.
At present the stock exchanges in India have one of the following
organizational format.
Voluntary non-profit making association
Public limited company
Company limited by guarantee.
A stock exchange is managed by a governing body consisting of
1. A President
2. A Vice President
3. An Executive Director
4. The elected directors
5. The public representatives
6. The nominees of the Government
Major stock exchanges are managed by Executive Directors. He is a full
time employee of the exchange with substantial powers smaller stock
exchanges are managed by secretaries.

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.

The eligibility criteria for

membership of a stock exchange are given under Rule 8 of the securities


Contracts (Regulation) Rules 1957.

Trading in Stock Exchange


Online Trading
Online trading means purchase and sale of stocks on the Internet E-trading
facility is offered by all the stock exchanges. Formerly trades took place in the
trading hall. Orders were placed with the stock broker either verbally
(personally or telephonically)or in a written form (fax).
In online trading, the investor accesses a stock brokers website through internet
enabled personal computer and places orders through the brokers Internet
based order routing and trading engine. These orders are first routed to the stock
exchange without manual interference.All the players in the securities market
via stock brokers, stock exchanges, clearing corporation depositories, DPs,
clearing banks, etc. are electronically linked.The order routing to the exchange
takes place in a matter of seconds.Many securities trading agencies provide
online trading facilities to their clients honor.
This provides a higher degree of transparency in transactions. The investor
knows exactly when and at what rate his order was processing.

Procedure for Online Trading


The investor has to register with the online trading portals listed on the
site.

100

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.

Classification of Stock Exchange Operators


Operators in a stock exchange may be classified in several defined groups on a
functional basis, they include :
1. Brokers
2. Jobbers
3. Authorised clerks
4. Taravaniwalas
5. The odd lot dealers
6. The Badliwalas
7. Arbitrageurs

1. Commission brokers- A large number of members devote themselves to


the execution of orders received from the non-member customers. They
buy and sell securities for earning commission. They act as agents for their
customers and earn commission for their services.
2. Jobbers- A jobber is an independent dealer in securities. He buys and
sells securities in his own name. This means that a jobber can deal either
103

with a broker or with another jobber. He does not work on commission


basis, but for a profit called turn.

Distinction between Broker and Jobber


Brokers

Jobbers

Buy and sell securities on behalf of Jobbers buy and sell securities in
their clients only as agents.

their own name.

Deal with non- members

Can deal only with brokers or with


other jobbers
Work for a profit known as turn.

Work for a commission

Only a link between the general Dealer in their own right.


public and the jobber.
Negotiate terms and conditions of Quote two prices one to buy and
purchase or sale to safeguard their another to sell
clients interest.
Their commission is fixed by the Their profit is fixed by competition.
exchange

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.

104

4. Remisers - Remisers are agents who secure business from non-members in


return for a commission. They are also called half commission me. They
are sub- brokers. They are only procurers of business and are not allowed
to transact business on the floor of the stock exchange their remuneration.
5. Taravaniwalas -Taravaniwalas are members of the stock exchange who
transact business on their own behalf. They resemble the jobbers. They
trade in and out of the market for small difference in price thereby
providing the necessary liquidity and continuity of market in securities.
They often act as brokers for the public when they do not have any
business as jobber. This helps them to sell their own securities at higher
prices.
6. Budliwalas -The Budliwalas are the financiers operating on the securities
market. They advance money by taking delivery of securities on the due
date at the end of the clearing, for those who wish to carry over their
purchases. They also sell securities to the market when it is short of them,
by giving delivery on the due date at the end of the clearing for those who
wishes to carry over their sales.
7. Authorized clerks- The authorized clerks or assistants are persons
authorized to transact business on behalf of their member- employers.
They cannot make any bargain in their own name. They can sign on behalf
of their employers only when they carry a power of attorney for them.
Various stock exchanges permit their members to employ a certain number
of clerks or assistants to help them in their work. In the madras stock
Exchange, the clerks are called member assistants
8. Arbitrageur - An Arbitrageur is a specialist in dealing with securities in
different stock exchange centers at the same time. He makes profit from
the differences in prices between the two markets. The success of an
arbitrageur depends on the number of securities simultaneously listed on

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different stock exchanges and the availability of fast means of


communication system.
9. Security Dealers - Security dealers are specialists in buying and selling
gilt-edged securities i.e. securities issued by the central and state
Government and by statutory public bodies such as municipal corporation
improvement trusts and electricity boards. They act as mainly as jobbers
and are prepared to take risks inherent in the ready purchase and sale of
securities to meet current requirements. The gilt edged market is over- thecounter market.
10.Odd-Lot Dealers: the standard trading unit for listed stocks is designated
as a round lot which is usually a 100 shares. The odd lot dealers are
members specializing in the execution of orders for blocks of shares less
than 100. They buy odd lots which other members wish to sell to their
customers and sell odd lots which other wish to buy. The prices of the
odd-lot transaction are being determined by the round lot transactions. The
odd lot dealer earns his profit on the difference between the price at which
he buys and sells the securities.

Speculation- Speculation may be defined as buying things in the hope of


selling them late at a higher price, or selling things which the speculator does
not possess, hoping to buy them at a lower price.Speculative operations are in
the nature of futures or forward trading.
Speculation in securities
Stock exchange is the place where the listed securities are marketed. The
people whobuy and sell securities will have different motives namely
investment motive and speculative motive.

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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.

Difference between Investor and Speculator


Investor

Speculator

An investor cares more for the

A speculator is interested more in the

safety of investment and security

appreciation of his capital and quick

of income.

profits by buying or selling securities.

He

seeks

income

from

his

He seeks profit from the purchase and

investment.

sale of securities

He takes actual delivery of

He usually does not take delivery of

securities when he buys securities

the securities sold by him.

by paying for them

investor simply receives or pays the

The

difference between the purchase price


and sale price as the case may be.

Types of Speculators
In stock exchanges the speculator are identified as some 200 logical characters
such as bulls, bears, stags and lame ducks.

1. Bull - He is a speculator on the stock exchange who anticipate arise in


prices and enters into a contract tp buy the shares at current prices with
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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.

3. Lame Duck: A lame duck is a bear speculator. He finds it difficult to


meet his commitments and struggles like a lame duck. This happens
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because of the non availability of securities in the market which he has


agreed to sell and at the same time the other party is not willing to
postpone the transaction.

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.

Constituents of Secondary Markets


1. National Stock Exchange (NSE)
2. Over the Counter Exchange of India (OTCEI)
3. Stock Holding Corporation of India (SHCIL)

1). National Stock Exchange(NSE):


National stock Exchange was established by the IDBI and other all- India
financial institutions in Bombay in Nov 1992 with a paid up equity
capital of Rs.25 crore.
NSE was recognized by the Government in 1993 and its started its
operation in whole sale debt and equity market.
It has become a national market for shares, public sector undertaking
bonds, UTI units, debentures, treasury bills, government securities and
call money. It has no trading floor as in other stock exchanges NSE has a
country wide screen based, online trading system.

Membership The National stock exchange has two types of members

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Participating Trading members who are allowed to trade only on


their own behalf.
Intermediary Trading members who deal on behalf of their
members.

Settlement System - National stock Exchange is the only in India


which has set up a clearing corporation which act as the central counter
party guaranteeing all settlements.

2) .Over the counter Exchange of India (OTCEI):


Over the counter Exchange of India (OTCEI) is the first unlisted security
market in India.

It has been incorporated as a company under the

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.

The OTCEI is recognized as a stock exchange under section 4 of


the securities contracts (Regulation) Act, 1956.The OTCEI was set up to
meet specific needs of the investors and countries.
Features of OTCEI
1. OTCEI has no trade rights. It has a network of counters linked by
electronic communication system.
2. OTCEI operations are fully computerized and there are four components
in a transaction via offer, Acceptance, Settlement and Documentation.
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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

The objectives of the OTCEI are :


1. Create a stock exchange to help companies to raise finance from the
capital market in cost effective manner.
2. To provide an efficient channel of capital market investment to strengthen
the investor community.
3. To provide opportunity for small companies to acquire public funds at
low cost.

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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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ratings or security )which would be available in small denominations to suit


everyones purse.
Reason for preferring Securitized Financial Instrument
1.Helping small investor Financial claims often involves sizeable sum of
money, clearly outside the reach of the small investor. The initial response to
this was the development of financial intermediation, where by an intermediary
such as bank would pool together the resources of the small investors and use
the same for a larger investment need of the user.
2.Facilitating Liquidity Small investors are typically not in the business of
investments and hence liquidity of investments is most critical for them.
Marketable instruments provides the liquidity of investments.
3.Utility of Instruments- Generally instruments are easily understood than
financial transaction. An instrument is a homogenous, usually made in a
standard form and generally containing standard issuer obligations. Besides an
important part of investor information is the quality and price of the instrument
and both are easier in case of the instruments than in case of financial
transactions.
Special Purpose Vehicle (SPV)
The entity that intermediate between the originator of the receivables and endinvestor is known Special purpose vehicle.
Since securitization involves a transfer of receivables from the originator it
would be inconvenient to transfer such receivables to the investors could keep
changing and security is a marketable security. Therefore it is necessary to bring
is an intermediary that would hold the receivable on the behalf of the end
investor. This entity created solely for the purpose of the transaction is called
Special purpose vehicle(SPV) or Special purpose entity(SPE).
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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.
----------------------------

119

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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It refers to a situation of issue of securities being underwritten by two or more


underwriting intermediaries jointly.
4.Syndicate underwriting
Syndicate of underwriters by means of an agreement, underwrites the issue of
securities collectively, it is called syndicate underwriting.
Functions of Underwriting
Adequate funds
Underwriting being a kind of a guarantee for subscription of a guarantee for
subscription of a public issue of securities enables a company to raise the
necessary capital funds. By undertaking to take up the whole issue of the
remaining shares not subscribed by the public, it helps a company to undertake
project investments with the assurance of adequate capital funds.
Expert advice
Underwriters of repute often help the company by providing advice on matters
pertaining to the soundness of the proposed plan etc thus enabling the
companyavoid certain pitfalls. It is therefore possible for an issuing company to
obtain the benefit of expert advice through underwriting before entering into an
agreement.
Enhanced Goodwill
The fact that the issues of securities of a firm are underwritten would help the
firm achieve a successful subscription of securities by the public.This is because
intermediaries of financial integrity and established reputation usually do the
underwriting.Such an activity therefore helps to enhance the goodwill of the
issuing company.

121

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.

122

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

assistance.Among the assistance underwriting constitutes an important


segment.These institutions include LIC,IFCI,ICICI,IDBI,UTI,SFCs.
Underwriter
The financial services intermediary who arranges for the subscription of issue
not being taken by the public or who firmly guarantees a capital issue is called
the underwriter.National financial institutions ,commercial banks,merchant
bankers and members of stock exchanges function as underwriters.

123

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.

125

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.

130

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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entrepreneur to provide the feasibility of a project and qualify for start up


capital.
This stage involves serious risk as there is no guarantee for the success of the
concept,idea,and process pertaining to high technology or innovation. This stage
requires constant infusion of funds in order to sustain the research and
development work and establish the process to successful adaptation going into
the commencement of commercial production and marketing. Venture financing
constitutes financing of ideas developed by research and development wings of
companies or at university centers.Chances of success in hi-tech projects are
meager.
Start up financing
The European venture capital association defines start up capital as capital
needed to finance the product development, initial marketing and the
establishment of product facilities.This too falls under the category of early
stage financing.The start up refers tothe stage where a new activity is
launched. The activity may be one emanating from the R&D stage,or arising
from transfer of technology from overseas-based business.Venture capital
finance is provided to projects which have been selected for commercial
production.
Early stage Financing
The European Venture capital association defines early stage finance as finance
provided to companies that have completed development stage and require
further funds to initiate commercial manufacturing and sales.They will not yet
be generating profit. This is the kind of financing required for completed the
project.It is required immediately after the start up stage of a project.The
enterprises may need further investment before completion of the project.
Follow on Financing
The European Venture capital association defines follow on financing or second
round finance as the provision of capital to a firm which has previously been in
receipt of external capital but whose financial needs have subsequently
expanded.Later stage in a project implies that the projects has passed the test of
acceptability and has proved to be successful. Since project at this stage
promises to be attractive in terms of earning potential,it is considered to be the
most attractive stage for venture capital financing.
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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

however do not recommend or indicate the rating levels of instruments upto


which one should or should not invest.
Continuous Monitoring
Credit rating agencies keep a constant surveillance during the life of the
instrument for any developments until it is fully serviced by the company.In the
absence of any specific development,such reviews are taken up periodically
either quarterly,orannually.In addition a formal and extensive written review is
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taken up immediately.The grading is altered on the basis of the changing debt


servicing capability of the issuer.
Grade surveillance
Where any major deviation from the expected trends of the issuers business
occurs or where any event has taken place which may have an impact on the
debt servicing capability of the issuer, which could warrant a change in the
rating,

the

rating

agency

put

such

ratings

under

grade

surveillance.Gradesurveillance listing may also specify positive or negative


outlooks.
Rating ceiling
While rating an issue outside the issuers country of domicile,international credit
rating agencies impose a ceiling which is equal to the sovereign rating assigned
to the country of domicile.Accordingly rating of an instrument of any issuer
domiciled in that country would be placed above the sovereign rating of the
country of domicile.
Evaluation of Line
Evaluation of bank line policy is an essential component of rating a commercial
paper.However it is not apart of the rating criteria and the rating decision itself
decision itself is not predicted on the strength of the amount of bank lines.
Ownership Considerations
It invariably happens that ownership by a strong enterprises enhances the credit
rating of an entity,unless there exists a barrier separating the activities of the
parent and subsidiary.The important issues that are involved in deciding the
relationship are mutual dependence,legalrelationship,the entitys ability to
influence the business of other.
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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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3.Payment is made through a number of instalments.


4.No possibility of the article sold being returned to the seller since sale is
complete immediately after the execution of the agreement.
5.Seller has no right to recover possession of the goods even if the buyer
commits a default in the payment of outstanding instalments and there is no
question of forfeiture of paid instalments against default. He is entitled to
recover his dues with the help of the court.

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150

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

158

diversification, economies of scale on transaction cost and professional finance


management.
7. Investment Protection
Mutual funds in India are largely by guidelines and legislative provisions put in
place by regulatory agencies such as the SEBI.The Securities Exchange
Commission (SEC) in the USA allows for the provision of safety of
investments. In order to protect the investor interest, it is incumbent on the part
of mutual funds to broadly follow the provisions laid down in this regard.
8. Switching Facility
Mutual funds provide investors with flexible investment opportunities, whereby
it is possible to switch from one scheme to another. This enables investors to
shift from income scheme to growth scheme or vice versa or from a close
ended scheme to an open ended scheme, all at will.
9. Tax-Benefits
An attractive benefit of mutual funds is that the various schemes offered by
them provide tax shelter to the investor. This benefit is available under the
provisions of the Income Tax Act.
10. Low Transactions Cost
The cost of purchase and sale of mutual funds units is relatively lower. This is
due in the large volume ofmoney being handled by mutual funds in the capital
market. The fees payable such as brokerage fee or trading commission etc. are
lower. This obviously enhances the quantum of distributable income available
for investors.

159

11. Economic Development


Mutual funds make contribution to the development of a countrys economy.
For instance, the efficient functioning of mutual funds contributes ton efficient
financial system. This in turn paves the way for efficient allocation of the
financial resources of the country, thus contributing to the economic
development. This is made possible through the mobilization of more savings
and channelizing them to the productive sectors of the economy.
12. Convenience
Mutual Fund units can be traded easily and with little or no transaction costs.
No brokerage is incurred.
13. Other Benefits
In addition to the above mentioned advantages, mutual funds also offer the
following benefits as compared to a personal portfolio:
a. Adoption to reinvest dividends
b. Strong possibility of capital appreciation
c. Regular returns
PRODUCTS/SCHEMES
Investors have an option of choosing from a wide variety of schemes in a
mutual fund, depending upon their requirements.Following section presents a
detailed classification of mutual funds.
Operational Classification
1.Open-ended scheme When a fund is accepted and liquidated on a
continuous basis by a mutual fund manager, it is called open-ended scheme. The
fund manager buys and sells units constantly on demand by the investors.
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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.

165

SEBIs Regulations to Registration of Mutual Fund


1.Every mutual fund shall be registered with SEBI through an application to be
made by the sponsor in the prescribed proforma,accompanied by a non
refundable application fee of Rs.25,000.
2.Every mutual fund shall pay Rs.25 lakh towards registration fee and
Rs.2,50,000 p.a.as service fees.
3.Regisration will be granted by the Board on fulfillment of conditions such as
thesponsor having a sound track record of five years and a general reputation of
integrity in all business transactions, the net worth of the immediately
preceeding year being more than the capital contribution of thesponsor in Asset
management company and the sponsor showing profits after providing for
depreciation,interest and tax for three out of the immediately preceding five
years.
SEBI Regulations for Constitution and Management of Mutual Fund
I Regulations as to the trust
1.Constitution Amutual fund shall be constituted in the form of a trust under
the provision of Indian Registration Act,1908(u/s 16 of 1908)and the trust deed
containing the provisions laid down by SEBI.
2.Code of conduct-A trustee should be a person of ability ,integrity and
standing and should not have been found guilty of moral turpitude or been
convicted of any economic offense or violation of any securities law.
3.IndependenceAtleast 50 percent of the trustees shall be independent trustees
(who are not associated with an associate,subsidiary or sponsor in any manner).
4.Agreement-The trustees and the AMC with SEBI s prior approval shall enter
into an investment management agreement.
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5.Requirement-The trustees shall ensure before the launch of a scheme that


theAMC has its back office,dealing and accounting system in place, and that
key personnel,auditors and registrars are appointed. They also have to ensure
that the compliance manual has been prepared,an internal control mechanism
has been designed and norms have been specified for the empanelment of
brokers and marketing agents.
6.Monitoring- The trustees shall ensure that the AMC has been diligent in
monitoring securities transactions with brokers, and in avoiding undue
concentration of business with any single broker.
7.Managing-The trustees shall ensure that the AMC has been managing the
schemes independently of other activities.They should also take remedial steps
by informing SEBI if the conduct of business of a mutual fund is not in
accordance with SEBI regulations.
8.Consent-In the interests of unit holders the trustees shall obtain the consent of
the unit holders or if a majority of trustees decide to wind up or prematurely
redeem the units or in the event of any change in the fundamental attributes of
any scheme , trustee, fees, expenses payable or any other change in the
fundamental attributes of any scheme, trustees, fees, expenses payable or any
other change which would modify the scheme or affect the interest of unit
holders.
9.Details The trustee shall call for the details of transactions in securities from
the key personnel of the AMC.
II SEBI s Regulations as to Asset Management Company
1.For grant of approval of the AMC it should have a sound track record,general
reputation and fairness in transaction.

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.

168

5.Redemption-Units of a close ended scheme can be opened for sale or


redemption at apredetermined fixed interval.
6.Subscription open- No scheme other than unit linked scheme can be opened
for subscription for more than 45 days. The AMC shall specify in theoffer
documents the minimum subscription amount it seeks to raise under the scheme
and in case of oversubscription, the extent of subscription it may retain.In such
a case all applicants applying for upto 5000 units shall be given full allotment.
7.Repurchase of close end scheme-The asset management company may at its
option,repurchase or reissue therepurchased units of a close ended scheme .The
units of close ended schemes mentioned above may be open for sale or
redemption at fixed predetermined intervals without listing, if the maximum and
minimum amount of sale or redemption of the units and theperiodicity of such
sale/redemption have been disclosed in theoffer document.
8.Conversion into open- ended schemes The units of close ended schemes
may be converted into open ended scheme, if the offer document of such a
scheme discloses the option and the4period of conversion. Upto January
12,1998, approval by the majority of the unit holders for such a conversion was
required. But now, those unit holders who do not express written consent to
the above shall be allowed to redeem their holdings in fullat NAV based prices.
9.Roll over- A close ended scheme shall be fully redeemed at the end of the
maturity period unless a majority of the unit holders decide for its roll over by
passing a resolution. But the unit holders who do not opt for roll-over shall be
allowed to redeem their holdings in the scheme at NAV based prices.
10.Offering period- Any scheme of a mutual fund shall be open for
subscri0ption for not more than 45 days.

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

170

astrusts to perform thefunctions of mutual funds by amending the Banking


Regulation Act.
SBI set up the first mutual fund which was followed by Canara Bank.Later
many large financial institutions under government control also came out with
mutual funds subsidiaries.
The government introduced a number of regulatory a number of regulatory
measures through various agencies such as the SEBI, for the purpose of
allowing the growth of the mutual funds industry inan orderly fashion for the
benefit of the investors, especially the small investors.
Managing Mutual Funds in India
The four tier system for managing mutual funds in India is as designed by the
SEBI
The Sponsor
Any corporate body which initiates the launching of a mutual fund is referred to
as the sponsor.The agency which is expected to have a sound track record and
experience in the relevant field of financial services for a minimum period of 5
years, ensures complying with the various formalities required in establishing a
mutual fund.
According to SEBI norms the sponsor should have professional competence,
financial soundness and a general reputation for fairness and integrity in
business transactions. There must be a minimum contribution by the sponsor to
the tune of 40 percent of the net worth of the Asset Management Company. The
sponsor appoints trustees, as asset management company and custodians in
compliance with the regulations.

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

funds,management of insurance funds, financial consultancy and exchange of


research on commercial basis can be undertaken by the AMC.With the
permission of SEBI it can alsooperate as an underwriter.
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Unit Trust of India


The unit trust of India(UTI) was the first government sponsored mutual fund in
the country with social content and government commitment.The Trust was
established in 1964 by a special Act of parliament passed in the year 1963.It
was constituted as afinancial intermediary to mobilize savings through the sale
of units and invest these funds,primarily in corporate securities.UTI followed
the British pattern in which the function of management and trustees is
combined in one body.The special attraction of theschemes that were launched
by the trust was the tax concessions that were launched by the Trust was the tax
concessions that were made available to the unit holders.
Management
The management of the Trust is vested in the Board of Trustees comprising of
eleven trustees headed by a Chairman appointed by the Government.The Board
is responsible for the supervision,direction, and management of UTI, and has all
the necessary powers to carry out its responsibilities.The chairman heads a
senior management team and the executive trustees.It is responsible for the
daily management and administration of Unit Trust of India.
Investment Committee
The day to day management of the investment portfolio is done by an
investment Committee which is assisted by a Research and Analysis
Department. The Investment Committee actively monitors trends and policies
affecting the economy as awhole and the Indian securities market.Details of the
financial results critical ratios and yield of nearly 300 corporations are
maintained online on Unit Trust of India s computer system and some specific
corporations or industries are subject to detailed study from time to time.

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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.

177

3.Nolending-The mutual funds should not undertake direct or indirect lending,


portfolio

fund

management,underwriting,billsdiscounting,money

market

operations etc which are essentially banking /merchant banking functions.


4.Inter-scheme- Mutual funds may invest in schemes in other money market
instruments,rediscounting of bills or bank deposits for periods not exceeding six
months.The mutual funds also invest their temporary surplus funds in similar
instruments upto not more than 25 percent of their total investable funds.
5.Prohibited avenues- Mutual funds shall not make short sale /purchase of
securities to carry over the transactions from one settlement period tk the next
settlement period.Similiarly no investment shall be made in any other unit trust,
mutual fund or similar collective investment schemes.The funds should also not
invest in shares etc of investment companies.
Prudential Exposure ceiling limits-Mutual funds shall nothold under any one
scheme ,more than 5 percent of issued share capital or debenture stock of any
company.In case more than one scheme is operated by a fund, such holdings in
respect of all its schemes put together,should not exceed 15 percent of the paid
up capital or debenture stock of a company.
Pricing The maximum spread between purchase and selling prices of
units/shares of any scheme should not be more than 5 percent.
Income Distrtibution
1.Cost- The total cost of managing any scheme under a fund inclusing
management fees and other administrative costs should be kept3 within 5
percent of the total income of thescheme.
2.Income

Distribution-Income

distribution

by

way

of

dividend

or

capitalization of gains should not be made on the basis of revaluation of the


stock holdings or unrealised capital appreciation.
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Statement of accounts and disclosures


1.separate accounts- Mutual funds shall maintain separate accounts of each
scheme launched by it segregating the assets under each scheme.
2.Annual Statement- The Board of Trustees of mutual funds shall prepare an
annual statements of accounts for each of theschemes furnishing details such as
statements of assets and liabilities , income and expenditure accounts duly
audited by qualified auditors.
UTI Guidelines
Constitution and Management
1.Trust- The mutual fund shall be constituted as a trust,with the investor as the
beneficiary.The basic structure should consist of 3 elements,viz the trustees the
fund manager and the beneficiary.The trustee could be the sponsor bank.The
mutual fund should qualify to engage in the business of investment and
management of securities.
2.Board of Trustees The management of the mutual fund shall vest in the
Board of Trustees.The board of trustees shall have not less than members and
not more than 10 members.Day to day management shall be the responsibility
of the Board of trustees.
3.Sponsor shall contribute Rs.5crores to thecorpus fund as non
transeferablecapital.The corpus may be used to commence investment in
schemes to be floated by the mutual fund.
4.Approval- UTI should obtain approval for its mutual fund schemes from the
Ministry of finance.

Investment Objectives and Policies


179

1.Areas of Investment-The mutual fund can engage itself in activities such as


holding or disposing of

securities, collecting and discounting ofbills of

exchange,purchasing and selling of participation certificates in relation to any


loan or advances granted by any public financial institution or scheduled
bank,make deposits with companies,formulate schemes inassociations with
LICorGIC.
2.Granting advance Mutual funds can grant advances to corporations or
cooperative societies engaged in industrial activities. under this head shall not
exceed 20 percent of the funds in any scheme.
Investment Limits
Scheme limit- No schemes of a mutual fund should invest more than 5 percent
of its assets on the equity of the company.Investment in a company should not
exceed 15 percent of the securities issued by the company.
Pricing and Income Distribution1.Each mutual fund should clearly provide in the offer document,investment
objectives of the scheme and the manner of publication of NAV.
2.Where it is not possible to announce a general policy for the distribution of
income,the mutual fund should give due weightage to theprincipal objectives
and the investment objectives of the scheme.
Account Statement and Disclosures
1.The mutual fund should maintain separate account for each scheme.
2.Books of account should be balanced and closed atleast once each year.
3.Valuation of each scheme should be done atleast once in a year.
4.Accounts should be audited every year.
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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

181

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.
182

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.

183

Factoring and Off- Balance Sheet Financing


Under factoring arrangements and while making credit sales the invoice is made
in the name of the factor.The clients debts are purchased by the factor.Hence the
finance provided by the factor goes off the balance sheet and the items appear in
the balance sheet only as acontingent liability in the case of recourse
factoring.In case of non-recourse factoring it does not appear in financial
statements of the borrower.
Types of Factoring
1. Domestic factoring
Factoring that arises from transactions relating to domestic sales is known as
Domestic Factoring. Domestic factoring may be of three types as described
below.
1. Disclosed Factoring
In case of disclosed factoring the name of the proposed factor is mentioned on
the face if the invoice made out by the seller of goods. In this type of factoring
the payment has to be made by the buyer directly to the factor named in the
invoice. The arrangement for factoring may take the form of recourse whereby
the supplier may continue to bear the risk of non-payment by the buyer without
passing it in the factor. In case of non-recourse factoring, factor assumes the risk
of bad debt from non-payment.
2. Undisclosed Factoring
Under undisclosed factoring the name of the proposed factor finds no mention
on the invoice made out by the seller of goods. Although the content of all
monies remains with the factor, the entire re4alization of the sales transaction is
done in the name of the seller. This type of factoring is quite popular in the U.K.
184

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
185

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
186

*The factor makes an advance payment in the range of 70 to 80 percent of the


receivables factored ans approved from the client the balance amount being
payable after collecting from customers.
*The factor collects interest on the advance payment from the client.
*The factor considers such conditions as the prevailing short term rate, the
financial standing of their client and the volume of turnover while determining
the rate of interest.
8.Bank participating Factoring
IT is variation of advance and maturity factoring. Under this type of factoring
the factor arranges a part of the advance to the clients through the banker. The
net factor advance will be calculated as follows:
(Factor Advance Percent x Bank Advance percent )
9.Collection/Maturity Factoring
Under this type of factoring, the factor makes no advancement of finance to the
client. The factor makes payment either on the guaranteed payment date or the
date of collection, the guaranteed payment date being fixed after taking into
account the previous ledger experience of the client and the date of collection
being reckoned after the due date of the invoice.

Legal Aspects of Factoring


Factoring Contract Terms and Conditions
The contract entered into between the seller of goods and the factor is called
factoring contract. Such a contract is similar to any of the sale purchase
agreement regulated under the law of contract. All the relevant terms and
187

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

as an innovative financial service commands the following

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.

188

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.

189

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.

190

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.
191

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

Group under the chairmanship of Shri

C.S.Kalyansundaram in January,1988.The study group aimed at examining the


feasibility and mechnism of organizing factoring business in India. The group
submitted its report in January 1989.Various functional formalities, implications
and the importance promoting factoring in the country, with the participation of
banking and non-banking financial intermediaries like merchant banks etc were
examined by the group.
RBI has come out with guidelines designed to regulate the functioning of the
factors in India. Accordingly factoring can be started as an associate business of
a banking company with prior permission from RBI.

192

Development in India factoring scenario started taking place with the


recommendations of the Kalyansundaram committee on factoring. At present
factoring is undertaken by a limited number of banks on a smallscale. Banks
such as SBI and Canara Bank in addition to certain institution in the private
sector, such as Foremost Factors Limited and Fairgrowth Factors Limited are
involved in the factoring business.
Forfaiting
Definition
A form of financing of receivables arising from international trade is known as
Forfaiting. Within this arrangement a bank /financial institution undertakes the
purchase of trade bills/promissory notes without recourse to the seller. Purchase
is through discounting of the documents covering the entire risk of non-payment
at the time of collection. All the risk becomes the full responsibility of the
purchaser (forfeiter). Forfaiter pays cash to the seller after discounting the
bills/notes.
Characteristics of Forfaiting
1. Forfaiting essentially involves non-recourse bill discounting in a modified
way.
2. It aims at protecting the exporter from any default risk.
3.Under this arrangement ,the bills of exchange or promissory notes accepted by
the importer and co-accepted by a bank in favour of the forfaiting agency are
exchanged for the discounted cash proceeds, without recourse by the exporter.
4. The discount rates are charged as a percentage above the euro market interest
rates.

193

5.Forfaiting to be successful it is imperative that there exists a successful


secondary market. A forfaiting may not be interested in holding the discounted
bills or notes upto maturity because of liquidity considerations.
6. In the secondary market forfeiters can buy or sell these bills like any other
security. The reputation of the forfaiting agency and the credit period are
important in deciding the cost of forfaiting .
Steps in involved in Forfaiting
1.Commercial contract
Exporter and importer enter into a commercial contract. The contract provides
th basic terms of the arrangement, such as cost of forfaiting, margin to cover
risk, commitment charges, days of grace, fee to compensate the forfeiter for the
loss of interest due to transfer and payment delays ,period of forfeiting contract,
repayment instalment (usually by annually),rate of interest and so on. The
factoring charge depends on such factors as the terms of the note/bill, the
currency in which it is denominated, the credit rating of the availing bank, the
country, risk of the importer etc.
2. Transaction
The exporter sells and delivers the goods to the importer on a deferred payment
basis.
3. Notes Acceptance
The importer accepts a series of promissory notes on favour of the exporter for
payments including interest charges. Such notes are then sent to the exporter.
Bank guarantee in respect of promissory notes /bills is also obtained.

194

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.

195

DISTINCTION BETWEEN FACTORING AND FORFAITING


S.NO CHARACTERISTICS FACTORING

Suitability

Recourse

Risk

Cost

Coverage

Extent of financing

FORFAITING

For transactions with For transactions with


short term maturity

medium term maturity

period.

period

Can be either with or Can be either without


without recourse

recourse only

Risk can be

All risks are assumed by

transferred to seller

the forfeiter

Cost of factoring is

Cost of forfeiting is

usually borne by the

borne by the overseas

seller

buyer (importer)

Covers a whole set

Structuring and costing

of jobs at a pre-

is done on a case to case

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

the financial standing of

standing of the

the availing bank

exporter
8

Services

Besides financing, a

It is a pure financing

factor also provides

arrangement

other services such


as ledger
196

administration etc.,
9

Exchange fluctuations No security against

A forfeiter guards

exchange rate

against exchange rate

fluctuations

fluctuations for a
premium charge

10

Contract

Between seller and

Between exporter and

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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8.Working Capital Finance


9.Acceptance credit and Bill Discounting
10.Mergers,Amalgamations and Takeovers
11.Venture Capital
12.Lease Financing
13.Foreign Currency Finance
14.Fixed Deposit Broking
15.Mutual Funds
16.Relief to Sick Industries
17.Project Appraisal
A brief description of these functions is presented below:
Corporate Counselling
Corporate counselling refers to a set of activities that is undertaken to ensure
efficient running of a corporate enterprise at its maximum potential through
effective management of finance. It aims at rejuvenating old line companies and
ailing units, and guiding existing units in locating areas/activities of growth and
diversification. A merchant banker, as a managerial economist, guides the
client, on aspects of organizational goals, locational factors, organization size
and operational scale ,choice of product and market survey, forecasting for a
product, cost reduction, cost analysis, allocation of resources, investment
decisions, capital management and expenditure control, pricing methods and
marketing strategy.
Project counselling
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Project counsellingis a part of corporate counselling and relates to project


finance. It broadly covers the study of the project, offering advisory assistance
on the viability and procedural steps for its implementation.
Pre-investment studies
Activities that are connected with making a detailed feasibility exploration to
evaluate alternative avenues of capital investment in terms of growth and profit
prospects are called pre-investment studies.
Capital Restructuring Services
Activities that are carried out to assist projects in achieving their maximum
potential through effective capital structuring and to suggest various strategies
to widen and restructure the capital base, diversify operations and
implementation schemes for amalgamation, merger or changes in business
status are collectively known as Capital Restructuring services.
Credit Syndication
Activities connected with credit procurement and project financing aimed at
raising Indian and foreign currency loans from banks and financial institutions,
are collectively known as credit syndication.
Issue Management and Underwriting
Issue management and underwriting connotes activities that are concerned with
the management of the public issues of corporate securities, viz equity shares,
preference shares, and debentures or bonds and aimed at mobilization of money
from the capital market.
Portfolio Management
Making decisions relating to the investment of the cash resources of a corporate
enterprise in marketable securities by deciding the quantum ,timing and the type
200

of security to be bought, is known as portfolio Management. It involves making


the right choice of investment, aimed at obtaining an optimum investment mix,
taking into account factors such as the objectives of the investment, tax bracket
of the investor, need for maximizing yield and capital appreciation etc.
Acceptance Credit and Bill Discounting
Activities relating to the acceptance and the discounting of bills of exchange,
besides the advancement of loans to business concerns on the strength of such
instruments are collectively known as Acceptance Credit and Bill discounting.
Bill accepting and discounting are an integral part of a developed money
market.
Merger and Acquisition
This is a specialized service provided by the merchant banker who arranges for
negotiating acquisitions and mergers by offering expert valuation regarding the
quantum and the nature of consideration and other related matters. Merchant
bankers provide advice on acquisition proposition after careful examination of
all aspects viz. Financial statements , articles of associations, provisions of
companies act, rules and guidance of trade chambers, the issuing house
associations.
Venture Financing
A specially designed capital as a form of equity financing for funding high risk
and high reward projects is known as Venture Capital. Several private
enterprises undertook the financing of high risk and high reward projects. In
India venture capital companies have largely contributed to the technological
and industrial revolution.
A large number of Indian and international companies are engaged a in venture
capital funding for high technology and high risk projects. A number of leading
201

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.

202

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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Listing guidelines of stock exchanges


Securities Contracts (Regulation) Act,1956.
The merchant banks play an important role in the development of the
Indian capital market. Apart from merchant banking divisions of
commercial banks and financial institutions, a number of private sector
merchant banking companies have entered the field. Until the passing of the
Act, wide powers have been conferred on SEBI and accordingly it issued
various guidelines and rules to regulate the merchant banks from time to
time. The merchant banking activities especially those covering issue and
underwriting of shares and debentures are regulated by the SEBI (Merchant
Bankers) Regulations, 1992.
As per notification of the Ministry of Finance and SEBI the merchant bankers
have to be organized as body corporate. They are to be compulsorily registered
with SEBI to carry out their activities.
SEBI Regulations
The SEBI regulations stipulate that any person or body proposing to engage in
the business of merchant banking would need to comply with the following
terms of authorization by the board:
1. The merchant banks must have a minimum net worth of Rs.5crores (with
effect from 7February, 1995)
2. Theauthorization is valid for an initial period of three years.
3. An initial authorisationfee, an annual fee and a renewal fee are collected by
SEBI.
4. All issues should be managed by at least one authorized merchant banker
functioning as the sole manager or lead manager. The number of lead
managers is restricted to two for the issues up to Rs.5crore.For issues
204

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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