FINANCIAL SYSTEM

The economic development of any country depends on the existence of a well organized Financial System (F.S). It is the F.S which supplies the necessary financial inputs for the production of goods and services, which in turn promote the well being and standard of living of the people of the country. Thus, the F.S is a broader term which brings under its fold the financial markets and the financial institutions which supports the system The F.S comprises a variety of intermediary, markets and instruments that are shown in above diagram. It provides the main means by which savings are transformed into investments. Given its role in the allocation of resources, the efficient functioning of F.S is critical to a modern economy. The economic development of a nation is reflected with the progress of various economic units, broadly classified into corporate sector, Govt. and Household sector. While the corporate has the surplus arising from the retained earnings, they need funds for investment in new projects, for expansion/Diversification/modernization, etc. On the other hand, a Govt. which always faces a deficit budget needs funds for public expenditure to finance its developmental projects and other Public Sector Undertakings (PSUs), etc. along with these two economic units, the household sector requires funds for varied purposes. Example, for acquiring assets. How ever the surplus funds of the household is normally more than the other units. While an understanding of the financial system is useful to all informed citizen, it is particularly relevant to the financial manager. He negotiates loans from financial intermediaries, raises resources from the financial markets and invests surplus funds in financial instruments. In a very significant way he manages the interface between the firm and its financial environment. An overview of Financial Service (F.Sr)
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Financial services constitute an important component of the F.S. F.Sr through the network of elements such as financial institutions, financial markets and financial instruments serve the need of individuals, institutions and corporates.

It is through these elements that the functioning of the F.Sr is facilitated. In fact, an orderly functioning of the F.S depends to a great deal on the range and the quality of the F.Sr extended by the host of providers. Concept of Financial Services In general, services that are offered by the financial service companies are said to F.Services. The term Financial services in a broad sense means mobilizing and allocating savings. Thus, it includes all activities involved in the transformation of saving into investment. Financial Service companies include both Asset Management Companies (AMC) and Liability Management Companies (LMC). AMC include leasing companies, Mutual Funds, Merchant Bankers and Issue/Portfolio managers. LMC comprise of the Bill Discounting and Acceptance Houses. Objectives of Financial Services 1. Fund Raising Financial Services help to raise required fund from a host of investors, individuals, institutes and corporate. 2. Funds Deployment An array (variety/types/collection/group) of financial services are available in the market which helps the players to ensure an effective deployment of the funds raised. Services such as Bills Discounting, Factoring of debtors, parking of short term funds in the money market, credit rating, etc. are provided by financial services firms in order top ensure efficient management of funds. 3. Specialized services The financial services sector provides specialized services such as credit rating, venture capital financial, lease financing, factoring, mutual funds, merchant banking, credit cards, housing finance, etc. besides banking and insurance. 4. Regulation In India, Agencies such as Securities and Exchange Board of India (SEBI), RBI and the Dept. of Banking and Insurance of the Govt. of India, through a number of legislations regulate the functioning of the financial services institutions. 5. Economic Growth Financial services help in speeding up the process of economics growth and development. This takes place through the mobilization of the savings of a cross section of peoples, for the purpose of channeling then in the productive investments. FINANCIAL ENGINEERING
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Financial Engineering (F.E) is the development and application of financial technology to solve financial problems and the creation of value by the identification and exploitation of financial opportunities. The term F.E means different things to different people. F.E involves the design, the development and the implementation of innovative financial instruments and processes, and the formulation of the creative solutions to the problems in finance. In corporate finance, the financial engineers are often called upon to develop new instruments to secure the funds necessary for the operation of large scale businesses. Financial Innovation Miller describes financial innovations as unanticipated improvements in the array of financial products and instruments that are stimulated by unexpected tax or regulatory impulses. Silber considers financial innovation as devices used by companies to reduce the financial constraints faced by them A financial innovation makes the market more efficient if it reduces transaction costs, diminishes losses, etc, Van Horne Financial Innovation in India
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Till the mid 1980s, the Indian financial system did not see much innovation. In the last 18 years, financial innovation in India has picked up and it is expected to grow in the years to come, as a more liberalized environment affords greater scope for financial innovation. The important financial innovation that have taken place in India are listed below along with the principal factor which motivated it or fuelled its growth. New financial products and services are as follows Innovation Principle motivation factor 1. Debt oriented schemes of MF Tax Benefits 2. Partially convertible debentures and fully Pricing and interest rate regulation obtaining

convertible debentures 3. Deep discount/zero coupon bonds 4. Puttable and callable bonds 5. Stock index futures 6. Badla Transaction 7. Ready forwards 8. Havala transactions 9. Interest rate Caps/floors/Collars 10. Interest rate swaps 11. Currency swaps 12. Forward rate agreements 13. Automated teller machine 14. Screen based trading 15. Floating rate bonds 16. Electronic funds transfer 17. Money market mutual funds 18. Specialized Mutual Funds 19. Exchange traded options 20. Project finance

under the capital issues control act Tax benefits Perceived volatility of interest rates Volatility of equity prices Restriction on forward trading Restrictions under the portfolio management scheme RBI restrictions Volatility of interest rates Volatility of interest rates Volatility of foreign exchange rates Volatility of interest rates Technology Technology Volatility of interest rates Technology Volatility of interest rates Investor preferences Volatility of Stock prices Risk Sharing

LEASING
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Concept of Leasing Definition Leasing as a source of finance Essential elements of leasing Modes of terminating lease Advantage of leasing Disadvantage of leasing Types of leasing Legal aspects of leasing Income tax provisions relating to leasing Accounting treatment of lease

CONCEPT OF LEASING Leasing, as a financing concept, is an arrangement between two parties, the leasing company or lessor and the user or lessee, whereby the former arranges to buy capital equipment for the use of latter for an agreed period of time in return for the payment of rent. The rentals are pre-determined and payable at fixed intervals of time, according to the mutual convenience of both the parties. By resorting to leasing, the lessee Co. is able to use the economic value of the equipment by using it as he owned it without having to pay for its capital cost. DEFINITION Lease is a form of contract transferring use or occupancy of land, space, structure or equipment, in consideration of a payment, usually in the form of a rent. Lease is a contract whereby the owner of an asset (lessor) grants to another party (lessee) the exclusive right to use the asset usually for an agreed period of time in return for the payment of rent LEASING AS A SOURCE OF FINANCE 1. Modernisation of business 2. Balancing equiment 3. Cars, scooters, and other vehicles and durables 4. Assets which are not being financed by banks/ institutions. ESSENTIAL ELEMENTS OF LEASING 1. Parties to the contract 2. Asset 3. Ownership separated from user 4. Term of lease 5. Lease Rentals

MODES OF TERMINATING LEASE 1. The lease is terminated at the end of the lease period and various courses are possible, namely 2. The lease is renewed on a perpetual basis or a definite period, or 3. The asset reverts to the lessor, or 4. The asset reverts to the lessor and the lessor sells it to a third party, or 5. The lessor sells the asset to the lessee 6. The parties may mutually agree to, and choose any of the foresaid alternatives at the beginning of the lease term. ADVANTAGE OF LEASE 1. Permits alternative use of funds 2. Facilitates additional borrowings 3. Protection against obsolescence 4. 5. Hundred percent financing Boon to small firms

DISADVANTAGE OF LEASE 1. Lease is not suitable mode of project finance. 2. Tax benefits/ incentives such as subsidy may not be available on leased equipment 3. The value of asset might increase during lease period 4. Cost of financing is higher than debt financing 5. Default in rentals TYPES OF LEASE 1. Financial Lease It is also known as capital lease, long term lease, net lease and close lease.

In financial lease, the lessee selects the equipment, settles the price and terms of sale and arranges with a leasing company to but it. He enters into non-cancellable contractual agreement with the leasing company. The lessee uses the equipment exclusively, maintains it, insures and avails the after sales-services and warranty backing it. This lease could also be with purchase option, where at the end of the predetermined period, the lessee has the option to buy the equipment at a pre-determined value or at a nominal value or at fair market price. In a large number of cases, the financial leases are used as financing-cometax planning tool. The Financial lease is very popular in India as in other countries such as USA, UK, and Japan. In India, at present, around a lease worth Rs.75 to 100 crores is transacted as a tax planning device. The high cost equipments such as office equipment, diesel generators, machine tools, textile machinery, containers, ships, aircrafts, etc are leased under financial lease. In short, in a Financial lease, the lessor transfers to the lessee, substantially all risks and reward incidental to ownership of the asset whether or not the title is eventually transferred. OPERATING LEASE 2. Operating Lease It is also known as service lease, short term lease or true lease. In this lease, the contractual period between lessor and lessee is less than the full economic life of equipment.

This means the lease may be for a limited period such as a month, six months or a year or few years. The risk of obsolescence is enforced on the lessor who will also bear the cost of maintenance and other relevant expenditure. This lease is suitable for computers, copy machines, vehicles, material handling equipment, etc which are sensitive to obsolescence, and where the lessee is interested in tiding over temporary problem. LEGAL ASPECTS OF LEASING As there is no separate statute for equipment leasing in India, the provisions relating to BAILMENT in the Indian Contract Act govern equipment leasing agreements. Provisions of Se.148, 150 and 168 have to be fulfilled INCOME TAX PROVISIONS RELATING TO LEASING The lessee can claim lease rentals as tax-deductible expenses The lease rentals received by the lessor are taxable under the head of Profits and Gains of Business and Profession. The lessor can claim investment allowance and depreciation on the investment made in leased assets. ACCOUNTING TREATMENT OF LEASE The leased asset is shown on the balance sheet of the lessor Depreciation and other tax shields associated with the leased asset are claimed by the lessor The entire lease rental is treated as income in the books of the lessor and as expense in the books of the lessee.

Hire Purchase It is a method of selling goods. In Hire Purchase (H.P) transaction the goods are let out on hire by a finance company. The buyer is required to pay an agreed amount in periodical installments during a given

period. The ownership of the property remains with creditor and passes on to hirer on the payment of last installment HISTORY OF H.P

The growth and development of H.P system can be traced back to the advent of industrial

development in the U.K Henry Moore, a piano maker introduced H.P system in 1846 in the U.K Cowperwait & Sons, a furniture dealer introduced H.P system in U.S.A in 1807. Earlier all H.P transactions were financed by manufacturers or dealers themselves. Later,

independent finance house came into existence In India , H.P finance started only after World War I. The concept of H.P was not quite popular in the pre-independence period. With the increase in economic activity, many NBFCs entered the market in the 50s & 60s Wide variety of consumer articles, automobiles and industrial machinery were offered on H.P Apart from consumer vehicles, purchase of consumer articles such as household appliance, air

conditioners, refrigerators, office furniture and equipment is financed presently through hire purchase. The Indian H.P market is registering a staggering growth rate of around 20 percent per annum.

H.P. INSTITUTIONS The Institutions engaged in the H.P business in organised sector include

Commercial Banks Co-operative Banks State Financial Corporations National Small Industries Corporations In the unorganised sector the comprise a large number of partnership firms and individuals.

FEATURES OF HIRE PURCHASE Buyer takes possession of goods immediately and agrees to pay total price in installments. Each installment is treated as hire charges The ownership of goods passes from the seller to the buyer on the payment of the

installment.

If buyer makes default in the payment of any installment, the seller has right to repossess the

goods from the buyer and forfeit the amount already received treating it as hire charged The hirer has right to terminate the agreement any time before the property passes.

LEGAL POSITION The Hire Purchase Act,1972 defines a Hire Purchase as an agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of agreement as under 1. Payment is to be made in installments over a specified period. 2. The possession is delivered to the purchaser at the time of entering into a contract 3. The property in the goods passes to the purchaser on payment of the last installment. 4. Each installment is treated as hire charge so that if default is made in payment of anyone installment, the seller is entitled to take away the goods. 5. The hirer/purchaser is free to return the goods without being required to pay further installments falling due after the return HIRE PURCHASE AGREEMENT

The description of goods in a manner sufficient to identity them The H.P price of the goods The date of commencement of the agreement The number of installments in which H.P price is to be paid, the amount, and due date

H.P & CREDIT SALE Hire purchase is different from Credit Sale In credit sale, the ownership and possession is transferred to the purchaser simultaneously. In H.P, the ownership remains with the seller until last installment is paid H.P & INSTALLMENT SALE H.P transaction is different from Installment System (I.S). In case of I.S the possession and ownership is transferred to the buyer immediately. When the buyer stops payment of dues (installments), the seller has no right to re-possess the goods. He has the only right to sue the buyer for the non-payment by returning the goods. HP Vs. LEASING CHARACTERISTICS LEASING HIRE PURCHASE

Ownership

It rests with lessor Lessor, not the lessee is entitled to claim Lease rent is tax deductible It can be claimed by the lessor & not the lessee Not required Shown in foot note only

It is transferred on payment of last installment The hirer is entitled to claim Interest of H.P installment is tax deductible It can be claimed by the hirer as he is the owner It is required to the extent of 20 to 25% of margin. In Balance sheet as asset

Depreciation Tax Benefits Salvage Value

Down Payment Reporting

FACTORING
The word Factor has been derived from the Latin word Facere which means to make or to do. Factoring, basically involves transfer of the collection of receivables and the related book-keeping functions from the firm to a financial intermediary called the factor. Factoring provides the firm with a source of financing its receivables and facilitates the process of collecting the receivables. FUNCTIONS OF A FACTOR 1. 2. 3. 4. 5. Purchase and collection of debts Sales ledger management Credit investigation and undertaking of credit risk Provision of finance against debts Rendering consultancy services

FORMS OF FACTORING 1. Recourse and Non-recourse factoring 2. Advance and Maturity factoring 3. Full Factoring

4. Disclosed and Undisclosed factoring 5. Domestic and International factoring

COST OF FACTORING Finance Charge It is computed on the payment outstanding in the clients account at monthly intervals. Finance charges are only for financing that has been availed. These charges are similar to the interest levied on the cash credit facilities in a bank. Service Fee It is a nominal charge levied at monthly intervals to cover the cost of services such as collection, sales ledger management, and periodical MIS reports. Service fee is determined on thee basis of criteria such as the gross sales value, the number of customers, the number of invoice and credit notes, and the degree of credit risk represented by the customer or the transactions. ADVANTAGES OF FACTORING 1. Cost Savings reduction in administrative cost 2. Liquidity Promotes efficient WC mgt 3. Credit Discipline 4. Cash Flows 5. Prompt payment 6. Boon to SSI sector helps in financing WC

7. 8. 9.

Efficient Production Reduced Risk Export Promotion

FACTORING IN INDIA Factoring is of recent origin in the Indian context and is still in a nascent stage. According to the recommendation of the Kalyanasundaram Committee,1988, RBI amended the Banking Regulation Act and permitted subsidiaries of banks to start factoring companies FACTORING OBSTACLES IN INDIA

Factoring deals in India encounter serious obstacles which stand in the way of growth of such services 1. 2. 3. 4. Lack of specialised credit information agency Legal hassles Funding Limitations Limited coverage

PRIVATE EQUITY VENTURE CAPITAL

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Introduction to Private Equity (P.E) Types of P.E Market Segment for Privately Placed Equity Private Investment in Public Equity (PIPE) Introduction to Venture Capital (V.C) Definition of V.C History of V.C Worldwide and India Companies Financed Through Venture Capital Stages in Financing What Venture Capitalist Looks Exit Mechanism

Exit Methods Valuation of Portfolio Important V.C Funds in India

PRIVATE EQUITY

INTRODUCTION It has not been specifically defined in financial literature as a distinct financial activity probably since it has evolved over the years as a key source for corporate capital and is therefore referred to more in terms of a Private Placement. The term Private Equity is commonly associated with the institutional investors that cater to the requirement of equity capital by companies otherwise than through public offers. In finance, private equity is an asset class consisting of equity investments in companies that are not traded on a public stock exchange. The spectrum of private equity capital ranges from early stage financing to later stage financing. Early stage financing entails risk and is therefore identified separately as Venture Capital

TYPES OF P.E Venture capital: An investment to create a new company, or expand a smaller company that has undeveloped or developing revenues; Buy-out: Acquisition of a significant portion or a majority control in a more mature company. The acquisition normally entails a change of ownership; Special situation: Investments in a distressed company, or a company where value can be unlocked as a result of a one-time opportunity (Changing industry trends, government regulations etc.) Merchant banking: Negotiated private equity investment by financial institutions in the unregistered securities of either privately or publicly held companies

MARKET SEGMENT FOR PRIVATELY PLACED EQUITY PRIVATE INVESTMENT IN PUBLIC EQUITY (PIPE)

According to Bloomberg, Private Investment in Public Equity (PIPE) occurs when private investors take a sizable investment in publicly traded corporations. This usually occurs when equity valuations have fallen and the company is looking for new sources of capital. PIPEs were initiated as a corporate financing instrument in the late 1990s in Wall Street and initially associated with the kind of last resort capital that companies with poor fundamentals were forced to seek. VENTURE CAPITAL

INTRODUCTION A form of equity financing designed specially for funding high risk and high reward projects is known as Venture Capital. Venture Capital (V.C) plays an important role in financing hi-tech projects, besides helping research and development projects to turn into commercial production.

In a narrow sense, it refers to, investment in new and tried enterprises that lack a stable record of growth

It is long term risk capital to finance high technology projects which involve risk but at same time has strong potential for growth.

Venture capitalists pool their resources including managerial abilities to assist new entrepreneurs in the early years of the project. Once the project reaches the stage of profitability, they sell their equity holdings and rewards of the enterprise.

DEFINITION

1. Steven James Lee defines it as an actual or potential equity investments in companies through the purchase of stock, warrants options or convertible securities.

2. Jane Koloski Morris, editor of the well known publication Venture Economics, defines V.C as providing seed, start-up and first stage financing and also funding the expansion of companies that have already demonstrated their business potential but do not yet have access to the public securities market or to credit oriented institutional funding sources..

3. International Finance Corporation, Washington defines V.C as an equity featured capital seeking investment in new ideas, new companies, new products, new processes or new services, that offer the potential of high returns on investment.

4. According to M.Y.Khan, V.C is an equity/equity related investment in a growth-oriented small/medium business to enable investee to accomplish corporate objectives, in return for minority shareholding in the business or the irrevocable right to acquire it. 5. According to a very widely accepted definitions V.C is described as a separate asset class, often labelled private equity.

6. According to the Bank of England (Quarterly bulletin of 1984), V.C investment is defined as an activity by which investors support entrepreneurial talent with finance and business skills to exploit market opportunities and thus obtain long-term capital gains. HISTORY OF V.C o Venture capital as a new phenomenon originated in the USA and developed spectacularly

worldwide since the mid 70s. o American Research and Development Corporation, founded by Gen. Doriot soon after the

Second World War, is believed to have started the institutionalisation of venture capital in the USA . o Since then the industry has developed in many other countries in Europe, North America and Asia .

The real development of V.C took place in 1958, when the Business Administration Act was

passed by the US congress. o In USA alone there are 800 venture capital firms managing around $40 billion of capital with annual accretion of between $1b & 5b. o The U.K occupies a second place after the U.S in terms of investment in V.C. o The Bank of England established its V.C company in late 40s. o The concept became popular in late 60s in U.K o The U.K witnesses a massive growth of industry during 70s and 80s. o During 1988 there were 1,000 V.C companies in the U.K, which provided Rs.3,700 crores to over 1,500 firms. o The success of V.C in these countries prompted other counties to design and implement measures to promote V.C, and their total commitment have been rising V.C HISTORY INDIA Indian tradition of V.C for industry goes back more than 150 years when many of the managing agency houses acted as venture capitalists providing finance and management skill to risky projects.

It was managing agency system through which Tata Iron and Steel, and Empress Mills were able to raise equity capital from the investing public.

In 1973, R.S. Bhatt Committee recommended formation of Rs.100 crore venture capital fund The seventh five year plan emphasised the need for developing a system of funding venture capital. The Research and Development Cess Act was enacted in May 1986 which introduced a cess of 5% on all payments made for purchase of technology from abroad. The levy provides the source for the venture capital fund.

START-UP COMPANIES FINANCED THROUGH VENTURE CAPITAL 1. Global Companies

Microsoft Xerox

Netscape Communications Apple Computer Cisco Systems Network General Yahoo e-Bay, etc.

2. Indian Companies

Biocon i-Flex Solutions Avesthagen Sasken Geometric Software Mastek Global, etc. STAGES IN FINANCING

1. Development of an Idea Seed Finance 2. Implementation Stage Start-up Finance 3. Fledging Stage Additional Finance 4. Establishment Stage Establishment Finance 5. Turnaround Stage

1. Seed Finance Translating an idea into a business proposition. This is an early-stage financing. This stage involves primarily R&D financing. 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

2. Start-up Finance According to European Venture Capital Association (EVCA) Start-up Finance is Capital needed to finance the product development, initial marketing and the establishment of product facilities. The term start-up refers where a new activity is launched. The venture capitalist will consider the following factors before making investments.

Managerial Capability of the entrepreneur, Capacity, Experience of the entrepreneur, Competence of the business, etc. The entrepreneur should furnish the following information in their proposals to the venture capitalist. Brief history of business or project The career history and skills of entrepreneur and key managers Description of product/service to be manufactured Description of market for the product/service with existing/future state of competition, growth prospects in the market share, etc Description of technical process involved, and technology to be followed in the manufacturing process. Degree of technological obsolescence in technical process Financial history and forward projections of turnover, profits, cash flows and borrowings over at least a two-year period. Proposed deal structure for the funding being sought

3. Additional Finance The product has already been launched in the market but the business has not yet become profitable enough for public offering to attract new investors. The promoter has invested his own funds but further infusion of funds by V.C institutes is necessary. 4. Establishment Finance The firm is well established in the market and needs further financing for expansion and diversification. Establishment finance will be used to finance increased production capacity, market or product development and to provide additional working capital. 5. Turnaround Finance It is provided by the venture capitalists in the event of an enterprise becoming unprofitable after the launch of commercial production. This is provided in the form of a relief package from the existing venture capital investors, and the enterprise is provided with specialist skills to recover.

WHAT VENTURE CAPITALIST LOOKS FOR

Before deciding to invest, the venture capitalist normally looks for the following type of attributes in a business plan. 1. An industry or space that is currently a sunrise sector 2. An exciting concept that has the potential for growth 3. A concept that significantly improves existing processes or applications and therefore find a vast replacement market. 4. The start-up business that has potential to become an attractive proposition for strategic acquisition in future by a market leader. 5. A firm that has the calibre to become an industry leader in due course with the right inputs. 6. A business technology that has a first mover advantage which can be harnessed adequately before competition catches up. 7. A firm that offers possibilities for multiple exit options EXIT MECHANISM Every V.C investment is usually liquidated after accomplishment of the purpose of the venture investment. Capital gains are usually made by the venture capitalist since they are in a position to sell their units at a fabulous price in the capital market. The time of exit is decided in advance, sometimes even at the time of financing the venture companies. METHODS OF EXIT

1. IPO method 2. Sale of shares method 3. Puts and calls methods Put option is the right to sell Call option is the right of entrepreneurs to buy.

Book value Method, P/E ratio, Agreed price, etc

4. Trade sales Entire investee company is sold through management buy-in or buy-out.

5. Liquidation Failure of unit due to stiff competition, technology failure, poor management, etc. VALUATION OF V.C PORTFOLIO The V.C portfolio has to be valued from time to time to monitor and evaluate the performance of the V.C investment, i.e. whether there has been on appreciation in the value of the investment or otherwise.The portfolio valuation approaches depend on the type of investments, namely equity and debt instruments. These, in turn, depend on the stage of investment: Seed, Start-up, early and later stages of the venture.
FOR MATERIAL ON VALUATION OF V.C, REFER TEXT BOOK FINANCIALSERVICES BY M.Y KHAN

IMPORTANT V.C FUNDS IN INDIA

1. ICICI Venture In association with the UTI, the ICIC founded Technology Development and Information Company of India Ltd. (TDICI) as a leading V.C company. TDICI was renamed in 1998 as ICICI Venture Funds Management Co. Ltd. 2. SBI VCFs 3. IDBI VCFs 4. Gujarat VCF 5. Indus Venture Management Ltd. (IVML) 6. Credit Capital Venture Fund Ltd. (CCVFL) 7. Andhra Pradesh Industrial Development Corporations Venture Capital Ltd. (APIDC VCL)

MERCHANT BANKING
The word Merchant Banking originated among the Dutch and the Scottish traders, and was later on developed and professionalised in Britain.

Though Merchant banking is a non banking financial activity, it resembles banking function. DEFINITION According to Random House Dictionary, Merchant bank is an organisation that underwrites securities for corporations, advises such clients on mergers and is involved in the ownership of commercial ventures. These organisations are some banks which are not merchants and sometimes merchants who are not banks and sometimes houses which are neither merchants not banks. MERCHANT BANKERS A set of financial institutions that are engaged in providing specialist services, which generally include the acceptance of bills of exchange, corporate finance, portfolio management and other banking services, are known as Merchant bankers. FUNCTIONS OF M.B 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. Corporate Counselling Project Counselling Pre-investment studies Capital Restructuring Credit Syndication and Project Finance Issue management and Underwriting Portfolio management Working capital finance Bill discounting Mergers, amalgamations and takeovers Venture Capital Lease Financing Foreign Currency Finance Fixed Deposit Broking

15. Mutual Funds 16. Relief to Sick Industries 17. Project Appraisals

REGULATORY FRAMEWORK The SEBI has the responsibility to protect the interest of the investors in securities, to promote the development of the securities market and to regulate it. To carry out its functions, the SEBI is empowered to make regulations with the prior approval of the Government. The SEBI has now full powers to regulate the new issue/primary market. It is also empowered to impose penalties for default on securities market intermediaries.

The SEBI has laid down the legal framework for the operations of the intermediaries in the primary market as well as the operating instructions and guidelines. The major intermediaries for whom the framework is firmly in place are lead managers, underwriters, bankers to issue, registrars and share transfer agents, debenture trustees, brokers to issue and portfolio managers. The main elements of their operations framework are Compulsory registration, capital adequacy requirement and fee payable; Obligation and responsibilities, code of conduct, number of lead managers, and their responsibilities, due diligence certificate, submission of documents; and Procedure for inspection, action in default, suspension and cancellation of registration.

COMPULSORY REGISTRATION Category I: To carry on any activity of the issue management and to act as adviser, consultant, manager, underwriter, portfolio manger. Category II: To act as adviser, consultant, co-manger, underwriter, portfolio manager Category III: To act as underwriter, adviser, consultant to an issue Category IV: To act only as adviser or consultant to an issue CAPITAL ADEQUACY REQUIREMENT Category Category I Category II Category III Category IV Minimum Amount Rs. 5,00,00,000 (5 Crore) Rs. 50,00,000 (0.5 Crore) Rs. 20,00,000 (0.2 Crore) Nil

FEES Registration Fee Renewal Fee

OBLIGATIONS & RESPONSIBILITIES CODE OF CONDUCT FOR MB A Merchant Banker should Make efforts to protect interest of investors Maintain high standard of integrity, dignity and fairness in the conduct of its business Fulfill its obligations in a prompt, ethical manner Always exercise due diligence Satisfy the Investors Adequate disclosures are made

 Not discriminate amongst its client Make no misrepresentation Always render best possible advice to the client Not indulge in any unfair competition Ensure good corporate policies and corporate governance are in place

NEW ISSUE VS. SECONDARY MARKETS OR PRIMARY MARKETS VS. SECONDARY MARKETS MECHANICS OF PUBLIC ISSUE MANAGEMENT Decision to Raise Capital Funds Obtaining SEBI approval Arranging Underwriting Preparing and Finalization of Prospectus Selection of Registrars, Brokers, Bankers ,etc Arranging Press and Investor Conference Printing and Publicity of Public Issue Documents SEBI Compliance

CATEGORIES OF SECURITIES ISSUE Public Issue Right Issue Private Placement MARKETING OF NEW ISSUES METHODS OF MARKETING SECURITIES Pure Prospectus Method Offer for Sale Method Issue House, stock brokers Private Placement Method Private Individual & inst Initial Public Offer (IPOs) Method Rights Issue Method Bonus Issue Method Accumulated R&S converted

Book-Building Method (Next Slide) Stock-Option Method Bought-out Deals Method Promoter make outright sale of equity share to sponsor. BOOK-BUILDING METHOD The B-b process involves the following steps 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Appointment of book-runners Drafting Prospectus Circulating draft Maintaining offer records Intimation about aggregate orders Bid analysis Mandatory underwriting Filing with ROC Bank accounts Collection of completed application Allotment of securities Payment schedule and listing Under-subscription

ELIGIBILITY NORMS OF PUBLIC ISSUE 1. Public Issue by Unlisted companies It has net tangible assets of at least Rs.3 crore in each of the preceding 3 full years of which more than 50 % should be in monetary assets It has a track record of distributed profits in terms of Sec.205 of the Companies Act for at least 3 out of the immediately 5 years It has net worth as per the audited balance sheet of at least Rs.1 crore in each of preceding 3 full years (of 12 months each) The aggregate of the proposed issue and all previous issues made in the same financial year in terms of size does not exceed 5 times its

pre-issue networth as per the audited balance sheet of the last financial year. 2. Public Issue by Listed Companies All listed companies are eligible to make public issue of equity shares/securities convertible into, or exchangeable with equity shares at a later date on the condition that the issue size in terms of the aggregate of the proposed issue and all previous issues made in the same financial year does not exceed 5 times its pre-issue networth as per the audited balance sheet of the last year. PRE-ISSUE OBLIGATIONS 1. Due diligence 2. Requisite fee 3. Submission of documents 4. Appointment of intermediaries 5. Underwriting 6. Making public the offer document 7. Dispatch of issue material 8. No-compliant certificate 9. Mandatory collection centres 10. Authorized collection agents 11. Advertisement for rights post-issues, appointment of compliance officer POST-ISSUE OBLIGATIONS 1. 2. 3. 4. 5. 6. 7. To associate with allotment procedure Post issue monitoring reports 3-day post issue monitoring report Final post issue monitoring report (78 days) Redressal of investors grievances Coordination with intermediaries Post-issue advertisements

8. 9.

Basis of allotment in over-subscribed issues Other responsibilities

CREDIT RATING
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. INTRODUCTION TO CREDIT RATING (C.R) DEFINITION OF C.R HISTORY OF C.R REASONS FOR GROWTH OF C.R SYSTEM GROWTH OF C.R AGENCIES WORLDWIDE FUNCTIONS OF C.R ESSENTIALS OF RATING SERVICE BENEFITS OF C.R BENEFITS TO RATED COMPANIES CREDIT RATING IN INDIA RATING PROCESS RATING METHODOLOGY RATING SYMBOLS

INTRODUCTION As the number of companies borrowing directly from the capital market increases, and as the industrial environment becomes more and more competitive and demanding, investors find that borrowers net worth or name are no longer sufficient to ensure successful raising of funds from the market. In such a scenario, to enable the investors to take informed decisions, Credit Rating has emerged as one of the most important financial services. A Credit rating is not a general evaluation of the issuing organisation. It essentially reflects the probability of timely repayment of principal and interest by a borrower company. DEFINITION

According to Moodys Investor Service (USA) Rating is designed exclusively for the purpose of grading bonds according to their investment qualities. According to Credit Rating Information Services of India Ltd. (CRISIL) Credit rating is an unbiased, objective and independent opinion as to issuers capacity to meet its financial obligations. It does not constitute a recommendation to buy/sell or hold a particular Security HISTORY The concept of credit rating dates back to 1840s Mercantile Credit Agency (MCA) was set up in New York after the financial crisis of 1837. The agency (MCA) rated the ability of merchants to pay their financial obligations. The first rating guide was published in 1859. In 1909, John Moody founded Moodys Investors Agency, which gave a new direction to the concept of credit rating. In 1970, Penn Central, the then largest Railroad company in the world went bankrupt with just under $100 million in outstanding commercial paper. This forced the investors to ask for rating for commercial papers Today, almost 100% of the commercial paper and 99% of the corporate bond are rated in the U.S.A REASONS FOR GROWTH OF C.R SYSTEM 1. The increasing role of capital and money markets 2. Increase in corporate borrowing and lending 3. The continuing growth of Information Technology 4. The growth of confidence in the efficiency of the market functioning GROWTH OF CREDIT RATING AGENCIES WORLDWIDE Missing info

FUNCTIONS OF CREDIT RATINGS 1. Superior Information 2. Low Cost Information 3. Proper risk-return trade off 4. Healthy discipline on Corporate Borrowers 5. Formulation of public policy guidelines on institutional investment ESSENTIALS OF RATING SERVICE Critical investment decisions may be taken based on the ratings offered by the credit rating agency. In order to ensure that ratings lead to good investment decisions it is essential that the rating service has the following two important factors 1. The quality of rating should be such that it wins the confidence and trust of the users of such ratings 2. Rating agencies should be unbiased to both the investors and the corporate. BENEFITS OF CREDIT RATING 1. 2. 3. 4. Low cost information Quick investment decision Independent investment decision Investors protection

BENEFITS TO RATED COMPANIES 1. 2. 3. 4. 5. 6. 7. 8. 9. Sources of additional certification Increase the investors population Fore-warns risks Encourages financial discipline Merchant bankers job made easy Foreign collaboration made easy Benefits the industry as a whole Low cost of borrowing Rating as a marketing tool

CREDIT RATING IN INDIA The stupendous growth of Indian Capital Market necessitated setting up of Credit rating agencies in India. As the average size of debenture issued by the company, the number of companies issuing debentures and the number of investors were growing substantially, the need for establishment of independent credit rating agency was felt in the country This growth led the establishment of 1. Credit Rating Information Services of India Limited (CRISIL) in 1987. 2. Investment Information and Credit Rating Agency of India (ICRA) in 1991 3. Credit Analysis and Research Limited (CARE) in 1993. All the three credit rating agencies have been approved by the Reserve Bank of India. CRISIL It is the first credit agency started on January 1,1988 It was started jointly by ICICI and UTI with an Equity Capital of Rs.4 crores It is the most important rating agency in the country. Its major objective is to rate the debt obligations of Indian Companies Apart from rating debentures, commercial papers, LPG/Kerosene dealers, its rating services also extend to preference shares, real estate developers/builders, banks, etc. Its rating guides investors about the risk of timely payment of interest and principal on particular debt instrument.

 It has used its information base and expertise in credit rating to provide counselling to governments, banks, financial institutions on aspects such as privatization of PSUs, credit evaluation and so on. ICRA It was set up by IFCI on 16 Jan1991 It focuses on rating of instruments for which credit rating is mandatory, suhc as debentures/bonds, commercial papers, Kerosene/LPG dealers. It also rates banks It also provides credit assessment and general assessment services During 1994-95, ICRA rates 212 debt instruments covering a debt volume of Rs.5,343 crores. The cumulative number of instruments rated since its inception till March 1995 has been 485 covering a total debt volume of Rs.17,638 crores.
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CARE It is credit rating and information services company promoted by IDBI jointly with investment institutions, banks, and fianance companies. It commenced its credit rating operation in October1993. CARE is offering a wide range of products & services in the fields of credit information and equity research. CARE confines to normal rating business only and has not diversified its operations the instruments credit-rated by CARE are debentures, Fixed deposits, Commercial papers, etc CARE also undertakes general credit analysis of companies for the use of bankers, other lenders and business counterparties CAREs rating methodology and rating process are much similar to CRISIL Since its inception till the end of March 1995, CARE has rated249 instruments covering a total debt volume of Rs.9,729 crores.

RATING PROCESS The credit rating process adopted by leading credit rating agencies in India and the world over is depicted below 1. Contract between Rater and Client 2. Sending expert team to clients Place 3. Data collection 4. Data analysis 5. Discussion 6. Credit report preparation 7. Submission to grading committee 8. Grade communication to client RATING METHODOLOGY In India, the rating exercise starts at the request of the company the process of obtaining a rating is quite lengthy and time consuming. Ratings are assigned after an in-depth study of various factors related to Business, Financial Management, and so on. The analytical framework for rating consists of the following four broad areas. 1. 2. 3. 4. Business Analysis Financial Analysis Management Evaluation Fundamental Analysis

1. Business Analysis Industry Risk Market Position Operating Efficiency Legal Position 2. Financial Analysis Accounting Quality Earnings Protection Cash Flow Adequacy

Financial Flexibility

3. Management Evaluation Study of the track record Managements capacity to overcome adverse or negative situations Goals Philosophy, and Strategies 4. Fundamental Analysis Liquid management Asset management Profitability and interest Tax sensitivity RATING SYMBOLS Since the rating of the agencies will be used by lay investors, the outcome of the rating should be delivered in an understandable manner. To facilitate the rating, symbols are provided These rating symbols can be easily understood by investors and enable them to take decisions on investments. The investor will not have to wholly depend on the brokers advice as the rating symbols gives a clue to the credibility of the issuer. CRISIL Fixed Deposit Rating Symbols