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1.Q: Explain the functions of Merchant Banking.
Functions
Merchant banking is a service oriented industry. Merchant banks all over
the world carry out the same set of services. Merchant banks in Indiacarry out the following functions and services specifically.
1. Corporate Counseling
2. Project counseling
3. Pre-investment Studies
4. Capital restructuring
5. Credit Syndication
6. Issue Management and underwriting
7. Portfolio Management
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
Each of these functions is detailed briefly below.
Corporate Counseling
The set of activities that is undertaken to ensure the efficient running of a
corporate enterprise is known as corporate counseling. It may include the
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rejuvenating of old line companies and ailing units, and guiding the
existing units in identifying the areas or activities for growth and
diversification. The merchant banker guides the clients on various
aspects like Locational factors, organizational size, operational scale,
choice of product, market survey, cost analysis, cost reduction, allocation
of resources, investment decision, capital management and expenditure
contro, pricing, etc.
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Following are the activities which form part of corporate counseling:
1. Providing guidance in areas of diversification based on the
Governments economic and licensing policies.
2. Undertaking appraisal of product lines, analyzing their growth and
profitability and forecasting future trends.
3. Rejuvenating old-line companies and ailing sick and units by appraising
their technology and process assessing their requirements and
restructuring their capital based.
4. Commissioning of diagnostic studies.
5. Assessment of the revival prospects and planning for rehabilitationthrough modernization and diversification and revamping of the
financial and organizational structure.
6. Arranging for the approval of the financial institutions/banks for
schemes of rehabilitation involves financial relief, etc.
7. Providing assistance in getting soft loans from financial institutions for
capital expenditure, and the requisite credit facilities from the bank.
8. Monitoring of rehabilitation schemes.
9. Exploring possibilities for takeover of sick units and providing
assistance in making consequential arrangements and negotiations
with financial institutions/banks and other interests/authorities
involved.
Project counseling
Project counseling relates to project counseling and is part of corporate
counseling. The study and analysis of the project viability and the steps
required for its effective and efficient implementation are broadly the subject
matter of project counseling.
Following are the activities forming part of the Project counseling:
1. Undertaking the general review of the project ideas/project profile.
2. Providing advice on procedural aspects of project implementation.
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3. Conducting review of technical feasibility of the project on the basis of
the report prepared by own exerts or by outside consultants.
4. Assisting in the selection of a Technical consultancy Organization
(TCO) for preparing project reports and market surveys, or review of
the project report or market survey reports prepared by TCO.
5. Assisting in the preparation of project report from a financial angle,
and advising and acting on various procedural steps including
obtaining government consents for implementation of the project.
6. Assisting in obtaining approvals/licenses/permissions/grants, etc from
government agencies in the form of letter of intent, industrial license,
DGTD registration, and government approval for foreign collaboration.
7. Providing guidance to Indian entrepreneurs for making investment in
Indian project in India and in Indian joint ventures overseas.
8. Identification of potential investment avenues.
9. Carrying out precise capital structuring and shaping the pattern of
financing.
10. Arranging and negotiating foreign collaborations,
amalgamations, mergers, and takeovers.
Pre-Investment Studies
Pre-investment studies relate to the activities that are concerned with
making a detailed feasibility exploration to evaluate alternative avenues of
capital investment in terms of growth and profit prospects. Some of these
activities are as follows:
1. Carrying out an in-depth investigation of environment and regulator
factors, location of raw material supplies, demand projections and
financial requirements in order to assess the financial and economicviability of a given project.
2. Helping the client in identifying and short-listing those projects which
are built upon the clients inherent strength with a view to accentuate
corporate profitability and growth in the long run.
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Capital Restructuring Services
Merchant bankers assist the corporate enterprise in structuring their capital
in such a way that it would minize the cost of capital and maximize its return
on capital invested.
Following are the services covered:
1. Examining the capital structure of the client company to determine the
extent of capitalization required.
2. Preparing a comprehensive memorandum for the controller of Capital
issues, and securing consent where the capitalization takes place
through issue of bonus shares.
3. Suggesting an alternative capital structure conforming to legal
requirements, viz., extent of capitalization on reserve and quantum ofdisinvestments by offer for sale and/or fresh issues of corporate
securities such as equity share, and preference share in the case of
FERA/FEMA companies.
4. Preparing a memorandum covering valuation of shares and justifying
the level of premium applied for.
Credit Syndication
Credit syndication relates to 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.
Activities covered under credit syndication are as follows:
1. Estimating the total cost of the project to be undertaken.
2. Drawing up a financing plan for the total project cost which conforms
to the requirements of the promoters and their collaborators, financial
institutions and banks, government agencies and underwriters.
3. Preparing loan application for financial assistance from term
lenders/financial institutions/banks, and monitoring their progress,
including pre-sanction negotiations.
4. Selecting institutions and banks for participation for financing.
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Credit syndication services overlap with the act ivies of project counseling
and project finance. But the loan syndication also incluses the preparation of
applications for financial assistance from financial institutions/banks.
Issue Management and Underwriting
Issue management and underwriting concerns with the activities relating to
the management of the public issues of corporate securities, viz. equity
shares, preference shares, and debentures of bonds, and are aimed at
mobilization of money from the capital market.
Following are some of the popular services provided by merchant bankers in
this regard:
1. Preparation of an action plant.
2. Preparation of budget for the local expenses for the issues.
3. Preparation of CCI application and assisting in obtaining
consent/acknowledgement.
4. Drafting of prospectus
5. Selection of institutional and broker underwriters for
syndicating/underwriting arrangements.
6. Selection of issues Houses and advertising agencies for undertaking
pre and post-issue publicity.
7. Obtaining the approval of institutional underwriters and stock
exchanges for publication of the prospectus.
Portfolio management is making decisions for the investment of cash
resources of a corporate enterprise in marketable securities by deciding the
quantum, timing and the type of security to be bough.
The services covered are as follows:
1. Undertaking investment in securities.
2. Undertaking investment for non-resident Indians, on both repatriation
and non-repatriation basis.
3. Undertaking review of Provident fund investment, Trust investment,
etc.
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4. Safe custody of securities in India and overseas.
5. Providing advice on selection of investments.
6. Carrying out a critical evaluation of investment portfolio.
7. Collecting and remitting interest and dividend on investment.
Working Capital Finance
The finance required for meeting the day-to-day expenses of an enterprise is
known as Working Capital finance.
1. Assessment of working capital requirements.
2. Preparing the necessary application to negotiations for the sanction of
appropriate credit facilities.
3. Assisting, co-coordinating and expediting documentation and other
formalities for disbursement.
4. Advising on the issue of debentures for augmenting long-term
requirements of working capital.
Acceptance Credit and Bill discounting
Acceptance credit and bill discounting connotes the activities relating to the
acceptance and the discounting of bills of exchange, besides the
advancement loans to business concerns on the strength of such
instruments, are collectively known as Acceptance Credit and Bill of
discounting.
In order that the bill accepting and discounting takes place on sound lines, it
is imperative that the firm involved command a good reputation and
financial standing.
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Merger and Acquisition
This is a specialized service provided by the merchant banker who arranges
for negotiating acquisitions and mergers by offering expert valuationregarding the quantum and the nature of considerations, and other related
matters.
The various functions that form part of this activity are as follows:
1. Undertaking management audit to identify areas of corporate strength
and weakness in order to help formulate guidelines and directions for
future growth.
2. Conducting exploratory studies on a global basis to locate overseas
markets, foreign collaborations and prospective joint ventureassociates.
3. Obtaining approvals from shareholders, depositors, creditors,
government, and other authorities.
4. Monitoring the implementation of merger and amalgamation schemes.
5. Identifying organizations with matching characteristics.
Merchant bankers provide advice on acquisition propositions 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, etc.
There are many reasons for the recent trend towards mergers and
amalgamations, such as:
Existence of excess unused manufacturing capacity of the purchasing
company, which can be utilized efficiently by taking over other units.
Lack of manufacturing space with the purchase company. The best
solution may be to buy the controlling interest in another company
having excessive manufacturing space or capacity.
Venture Financing
Venture capital is the equity financing for high-risk and high-reward projects.
The concept of venture capital originated in the USA in the 1950s, when
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business magnates like Rockefeller financed new technology companies.
The concept became more popular during the sixties and seventies, when
several private enterprises undertook the financing of high-risk and high
reward projects.
Lease Financing
Leasing is an important alternative source of financing a capital outlay. It
involves letting out assets on lease for use by the lessee for a particular
period of time.
Following are the important services provided in regard to leasing:
1. Providing advice on the viability of leasing as an alternative source for
financing capital investment projects.
2. Providing advice on the choice of a favorable rental structure.
In India, leasing is a non-banking financial activity. Commercial banks like
State Bank of India and Canara Bank also provide lease financing by forming
subsidiaries under the amended Banking Regulations Act of 1949.
Foreign Currency Financing
Foreign currency finance is the fund provided for foreign trade transactions.
It may take the form of export-import trade finance, euro currency loans.
Indian joint venture abroad or foreign collaborations. The main areas that
are covered in this type of merchant activity are as follows:
1. Providing assistance for carrying out the study of turnkey and
construction contract projects.
2. Providing assistance in applications to working groups, liaison with RBI,
ECGD and other institutions.
3. Providing assistance in opening and operating banks accounts abroad.
4. Providing assistance in obtaining export credit facilities from the EXIM
bank for export of capital goods, and arranging for the necessary
government approvals and clearance.
5. Providing guidance on forward cover for exchange risk.
6. Assisting in arranging foreign currency guarantees and performance
bonds for exporters.
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Forms of Foreign Currency Loans
The various types of foreign currency loans are:
a) Euro-currency Loans
b) Financing Indian Joint Ventures abroad through:
1. Advice on the nature of clients investment.
2. Financial structuring of the project
3. Syndication of Euro loans
4. Bank guarantees
5. Procuring euro-currency facilities in the form of management and
syndication of Euro-currency loans, bonds, floating Rate Notes (FRNs),floating Rate Certificates of Deposits (FRCDs), US commercial papers,
with the assistance of International Treasury Management Limited
(ITM).
6. Providing advice on currency swaps and interest rate swaps.
7. Arranging deferred term export finance to Indian entrepreneurs by
maintaining a quick liaison with the export countrys Export Credit
Agencies who offer fixed rate finance at concessionary interest rates,
in particular export credit agencies in the UK (ECGD), USA (EXIM Bank),Japan, Italy, Norway, East Germany (HERMES), and who enjoy lines of
credit from France (COFACE), Korea, Spain, Austria, Canada, Denmark,
and India.
c) Providing assistance in foreign collaborations through:
1. Helping locate foreign collaboration and joint venture partners
abroad.
2. Providing advice on local laws, product risk, government regulations
regarding shareholdings, exchange restrictions, taxation, dividends,
incentives and subsidies, etc.
Brokering Fixed Deposits
Following are the services rendered by merchant bankers in this regard:
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1. Computation of the amount that could be raised by a company in the
form of deposits from the public and loans from shareholders.
2. Drafting of advertisement for inviting deposits.
3. Filing a copy of advertisement with the Registrar of Companies forregistration.
4. Making arrangement for payment of interest amounts.
5. Providing advice to the company on the terms and conditions of fixed
deposits, and deciding on the appropriate rate of interest, keeping in
view the prevailing capital and money market conditions.
6. Helping the company of observe all the rules and regulation in the
connection.
Mutual Funds
Mutual funds are institutions that mobilize the savings of innumerable
investors for the purpose of channeling them into productive investments in
a wide variety of corporate and other securities.
Some of the services rendered by mutual funds are as follows:
1. Mopping up public savings.
2. Investing the funds in a diversified portfolio of shares and debentures
belonging to well managed and growing companies.
3. Earning investors a steady return on investments with an assurance of
capital appreciation.
Relief to Sick Industries
Merchant bankers extend the following services as part of providing relief to
sick industries:
1. Rejuvenating old-lines and ailing units by appraising their technology
and process, assessing their requirements and restructuring their
capital base.
2. Evolving rehabilitation packages which are acceptable to financial
institutions and banks.
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3. Exploring the possibilities of mergers/amalgamations, wherever called
for.
Project Appraisal
The evaluation of industrial projects in terms of alternative variants intechnology, raw materials, production capacity and location of plant is known
as Project Appraisal.
Financial appraisal
Financial appraisal involves assessing the feasibility of a new proposal for
setting up a new project or the expansion of existing production facilities.
Financial appraisal is undertaken through an analysis which takes into
account the financial features of a project, including sources of financing.Financial analysis helps trace the smooth operation of the project over its
entire life cycle.
Technical Appraisal
Technical appraisal is primarily concerned with the project concept in terms
of technology, design, scope and content of the plant, as well as inputs are
infrastructure facilities envisaged for the project, Basically, the project
should be able to deliver a marketable product fro the resources deployed, a
t a cost which would leave a margin that would be adequate to service theinvestment, and also plough back a reasonable amount into the project to
enable the enterprise to consolidate its positions.
Economic Appraisal
Economic appraisal of a project deals with the impact of the project on
economic aggregates. These may be classified under two broad categories.
The first deals with the effect of the project on employment and foreign
exchange, and the second deals with the impact of the project on net social
benefits or welfare. *************
2.Q:Briefly explain the regulator framework on merchant banking
Introduction
According to the SEBI, merchant banker means any person who is engaged
in the business of issue management either by making arrangements
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regarding selling, buying or subscribing to securities as manager, consultant
adviser or rendering corporate advisory service in relation to such issue
management.
The SEBI has brought about a number of regulative measures for the
purpose of disciplining the functioning of the merchant bankers in India. Theobjective is to usher in an era of regulated financial markets and thereby
pave way for the development of the capital market in India. The measures
were introduced by the SEBI in the year 1992 . The measures were revised
by SEBI in 1997. The salient features of the regulative framework of
merchant banking in India are described below:
SEBI Regulations
1. Registration of Merchant Bankers
The relevant guidelines with regard to the registration of merchant
bankers are as follows:
Application for Grant of Certificate
An application by a person for grant of a certificate shall be made to the
Board in Form A. The application shall be made for anyone of the
following categories of the merchant banker namely:
1. Category I, to carry on any activity of the issue management, whichwill inter-alia consist of prepared of prospectus and other information
relating to the issue, determining financial structure, tie-up of
financiers and final allotment and refund of the subscription; and to act
as adviser, consultant, manage underwriter, portfolio manager.
2. Category II, to act as adviser, consultant, co-manager, underwriter,
portfolio manager.
3. Category III, to act as underwriter, adviser, consultant to an issue.
4. Category Iv, to act only as adviser or consultant to an issue.
With effect from 9th December, 1997, an application can be made only for
carrying on the activities mentioned in category I. An applicant can carry on
the activity as underwriter only if he obtains separate certificate of
registration under the provisions of Securities and Exchange Board of India
(Underwriting Regulations, 1993), and as portfolio manager only if he obtains
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separate certificate of registration under the provisions of Securities and
Exchange Board of India (portfolio Manager) Regulations, 1993.
Conformance to Requirements
Subject to the provisions of the regulations, any application, which is notcomplete in all respects and does not conform to the instructions specified in
the form, shall be rejected.
Furnishing of Information
The Board may require the applicant to furnish further information or
clarification regarding matters relevant to the activity of a merchant banker
for the purpose of disposal of the application.
Consideration of Application
The Board shall take into account for considering the grant of a certificate, all
maters, which are relevant to the activities relating to merchant banker and
in particular whether the applicant complied with the following requirement.
1. That the applicant shall be a body corporate other than a non-banking
financial company as defined under clause (f) of section 45-I of the
Reserve Bank of India Act, (2 of 1934) as amended from time to time;
2. That the merchant banker who has been granted registration by the
Reserve Bank of India to act as a primary or Satellite Dealer may carry
on such activity subject to the condition that it shall not accept or hold
public deposit;
3. That the applicant has the necessary infrastructure like adequate office
space, equipments, and manpower to effectively discharge his
activities;
4. That the applicant has in his employment minimum of two persons who
have the experience to conduct the business of the merchant banker;
5. That the applicant fulfils the capital adequacy requirement as specified
in the relevant;
6. That the applicant is a fit and proper person; and
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7. That the grant of certificate to the applicant is in the interest of
investors.
Capital Adequacy Requirement
According to the regulations, the capital adequacy requirement shall not beless than the net worth of the person making the application for grant of
registration.
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Procedure for Registration
The Board on being satisfied that the applicant is eligible shall grant a
certificate in Form B. On the grant of certificate the applicant shall be liableto pay the fees in accordance with Schedule II.
Renewal of Certificate
Three months before expiry of the period of certificate, the merchant banker,
may if he so desires, make an application for renewal in form A. The
application for renewal shall be dealt with in the same manner as if it were a
fresh application for grant of a certificate. On the grant of a certificate the
applicant shall be liable to pay the fees in accordance with Schedule II.
Procedure where registration is not granted
Where an application for grant of a certificate under regulation 3 or of
renewal under regulation 9, does not satisfy the criteria set out in regulation
6, the Board may reject the application after giving an opportunity being
heard. The refusal to grant registration shall be communicated by the Board
within thirty days of such refusal to the applicant stating therein the grounds
on which the application has been rejected.
************
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3.Q:Explain the activities involved in Public Issue Management
Activities involved in Public Issue Management
There are several activities that have to be performed by the issue manager
in order to raise money from the capital market. Adequate planning needs
to be done while chalking out an appropriate marketing strategy. The
various activities involved in raising funds from the capital markets are
described below:
Pre-issue Activities
1. Signing of Memorandum of Understanding (MOU): Signing of
MOU between the client company and the merchant banker-issuemanagement activities, marks the award of the contract. The role and
responsibility of the merchant banker as against the issuing company
are clearly spelt out in the MOU.
2. Obtaining appraisal note: An appraisal note containing the details
of the proposed capital outlay of the project and the sources of
funding is either prepared in-house or is obtained from external
appraising agencies, viz, financial institutions/banks, etc.
3. Optimum capital structure: The level of capital that would maximizethe shareholders vale and minimize the overall cost of capital has to
be determined.
4. Convening Meeting: A meeting of the Board of Directors of the
issuing company is convened. This is followed by an EGM of its
members.
5. Appointment of financial intermediary: Financial intermediaries
such as Underwriters, registrars, etc have to be appointed. Necessary
contracts need to be made with the underwriter to ensure duesubscription to the offer. Similar contracts, when entered into with
the Registrars to an issued, will help in share allotment related work.
6. Preparing documents: As part of the issue management procedure,
the documents to be prepared are initial listing application for
submission to those stock exchanges where the issuing company
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intends to get its securities listed, MoU with the registrar, with bankers
to the issue, with advisors to the issue and co-managers to the issue,
agreement for purchase or properties, etc.
7. Due diligence certificate: The lead manager issues a due diligence
certificate which certifies that the company has scrupulouslyfollowing all legal requirements, has exercised utmost care while
preparing the offer document and has made a true, fair and adequate
disclosure in the draft offer document.
8. Submission of offer document: The draft offer document along
with the due diligence certificate is filed with SEBI. The SEBI, in turn,
makes necessary corrections in the offer document and returns the
same with relevant observations, if any, within 21 days from the
receipt of the offer document.
9. Finalization of collection centers: In order to collect the issue
application forms from the prospective investors, the lead manager
finalizes the collection centers.
10.Filing with RoC: The offer document, completed in all respects after
incorporating SEBI observations, is filed with Registrar of Companies
(RoC) to obtain acknowledgement.
11.Launching the issue: The process of marketing the issue starts
once the legal formalities are completed and statutory permission forissue of capital is obtained. The lead manager has to arrange for the
distribution of public issue stationery to various collecting banks,
brokers, investors, etc. the issue is opened for public immediately
after obtaining the observation letter from SEBI, which is valid for a
period of 365 days from the date of issue.
12.Promoters contribution: a certificate to the effect that the
required contribution of the promoters has been raised before opening
of the issue, has to be obtained from a Chartered Accountant, and
duly filed with SEBI.
13.Issue closure: An announcement regarding the closure of the issue
should be made in the newspapers.
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***************
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4Q:Explain the different methods of marketing securities
Methods of Marketing Securities
Following are the various methods being adopted by corporate entities for
marketing the securities in the New Issue Market:
1. Pure Prospectus Method
2. Offer for Sale Method
3. Private Placement Method
4. Initial public Offers (IPOs) Method
5. Rights Issue Method
6. Bonus Issue Method
7. Book-building Method
8. Stock Option Method and
9. Bought-out Deals Method
Pure prospectus Method
Meaning
The method whereby a corporate enterprise mops up capital funds from the
general public by means of an issue of a prospectus, is called Pure
Prospectus Method. It is the most popular method of making public issue of
securities by corporate enterprises.
Features
Exclusive subscription: Under this method, the new issues of a company
are offered for exclusive subscription of the general public.
Issue Price: Direct officer is made by the issuing company to the general
public to subscribe to the securities as a stated price.
Underwriting: Public issue through the pure prospectus method is usually
underwritten. This is to safeguard the interest of the issuer in the event of
an unsatisfactory response from the public.
Prospectus: A document that contains information relating to the various
aspects of the issuing company, besides other details of the issue is called a
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Prospectus. The document is circulated to the public. The general details
include the companys name and address of its registered office, the names
and addresses of the companys promoters, manager, managing director,
directors, company secretary, legal adviser, auditors, bankers, brokers, etc.
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Advantages
The pure prospectus method offers the following advantages to the issuer
and the investors alike:
Benefits to investors: The pure prospectus method of marketing the
securities serves as an excellent mode of disclosure of all the information
pertaining to the issue. Besides, it also facilitates satisfactory compliance
with the legal requirements of transparency, etc.
Benefits to issuers: The pure prospectus method is the most popular
method among the larger issuers. In addition, it provides for wide diffusion
of ownership of securities contributing to reduction in the concentration of
economic and social power.
Drawbacks
The raising of capital through the pure prospectus method is fraught with a
number of drawbacks as specified below:
High issue costs: A major drawback of this method is that it is an
expensive mode of raising funds from the capital market. Costs of various
hues are incurred in mobilizing capital.
Time Consuming: The issue of securities through prospectus takes more
time, as its requires the due compliance with various formalities before an
issue could take place.
Offer for Sale Method
Meaning
Where the marketing of securities takes place through intermediaries, such
as issue houses, stockholders and others, it is a case of Offer for sale
Method.
Features
Under this method, the sale of securities takes place in two stages.
Accordingly, in the first stage, the issuer company makes an en-block sale of
securities to intermediaries such as the issue houses and share brokers of an
agreed price. Under the second stage, the securities are re-sold to ultimate
investors at a market-related price.
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The issue is also underwritten to ensure total subscription of the issue. The
biggest advantage of this method is that it saves the issuing company the
hassles involved in selling the shares to the public directly through
prospectus.
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Private Placement Method
Meaning
A method of marketing of securities whereby the issuer makes the offer of
sale of individuals and institutions privately without the issue of a prospectus
is known as Private Placement Method.
Features
Under this method, securities are offered directly to large buyers with the
help of share brokers. This method works in a manner similar to the Offer
for Sale Method whereby securities are first sold to intermediaries such as
issues houses, etc.
Advantages
Private placement of securities offers the following advantages:
1. Less expensive as various types of costs associated with the issue are
borne by the issue houses and other intermediaries.
2. Placement of securities suits the requirements of small companies.
3. The method is also resorted to when the stock market is dull and the
public response to the issue is doubtful.
Disadvantages
The major weaknesses of the private placement of securities are as follows:
1. Concentration of securities in a few hands.
2. Creating artificial scarcity for the securities thus jacking up the prices
temporarily and misleading general public.
3. Depriving the common investors of an opportunity to subscribe to the
issue, thus affecting their confidence levels.
Initial Public Offer (IPO) Method
The public issue made by a corporate entity for the first time in its life is
called Initial public Offer (IPO), Under this method of marketing, securities
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are issue to successful applicants on the basis of the orders placed by them,
through their brokers.
When a company whose stock is not publicly traded wants to offer that stock
to the general public, it takes the form of Initial public offer. The job of
selling the stock is entrusted to a popular intermediary, the underwriter. Theunderwriters charge a fee for their services.
Stocks are issued to the underwriter after the issue of prospectus which
provides details of financial and business information as regards the issuer.
The issuer and the underwriting syndicate jointly determine the price of a
new issue. IPO stock at the release price is usually not available to most of
the public. Good relationship between, the broker and the investor is a pre-
requisite for the stock being acquired.
Full disclosure of all material information in connection with the offering of
new securities must be made as part of the new offerings. A statement and
preliminary prospectus (also known as a red herring) containing the following
information is to be filled with the Registrar of Companies:
1. A description of the issuers business.
2. The names and addresses of the Key company officers, with salary and
a 5 year business history on each.
3. The amount of ownership of the key officers
4. Any legal proceedings that the company is involved in
The essential steps involved in this method of marketing of securities are as
follows:
1. Order: Broker receives order from the client and places orders on
behalf of the client with the issuer.
2. Share Allocation: The issuer finalizes share allocation and informs
the broker regarding the same.
3. The Client: The broker advises the successful clients of the share
allocation. Clients then submit the application forms for shares and
make payment to the issuer through the broker.
4. Primary issue account: The issuer opens a separate escrow account
(primary issue account) for the primary market issue. The clearing
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house of the exchange debits the primary issue account of the broker
and credits the issuers account.
5. Certificates: Certificates are then delivered to investors. Otherwise
depository account may be credited.
Rights issue Method
Where the shares of an existing company are offered to its existing
shareholders. It takes the form of rights issue. Under this method, the
existing company issues shares to its existing shareholder sin proportion in
the number of shares already held by them.
The relevant guidelines issued by the SEBI in this regard are as follows:
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1. Shall be issued only by listed companies.
2. Announcement regarding rights issue once made, shall not be
withdrawn and where withdrawn, no security shall be eligible for listing
upto 12 months.
3. Underwriting as to rights issue is optional and appointment of Registrar
is compulsory.
4. Appointment of category I Merchant Bankers holding a certificate of
registration issued by SEBI shall be compulsory.
5. Rights share shall be issued only in respect of fully paid share.
6. Letter of Offer shall contain disclosures as per SEBI requirements.
7. Issue shall be kept open for a minimum period of 30 days and for a
maximum period of 60 days.
8. A No complaints Certificate is to be filed by the Legal Merchant
Banker with the SEBI after 21 days from the date of issue of the
document.
9. Obligatory for a company where increase in subscribed capital isnecessary after two years of its formation of after one year of its first
issue of shares, whichever is earlier (this requirement may be
dispensed with by a special resolution).
Advantages
Rights issue offers the following advantages
1. Economy: Rights issue constitutes the most economical method ofraising fresh capital, as it involves no underwriting and brokerage
costs.
2. Easy: The issue management procedures connected with the rights
issue are easier as only a limited number of applications are to be
handled.
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3. Advantage to shareholders: Issue of rights shares does not involve
any dilution of ownership of existing shareholders.
Drawbacks
The method suffers from the following limitations:
1. Restrictive: The facility of rights issue is available only to existing
companies and not to new companies.
2. Against society: the issue of rights shares runs counter to the overall
societal consideration of diffusion of share ownership for promoting
dispersal of wealth and economic power.
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Bonus Issues Method
Where the accumulated reserves and surplus of profits of a company are
converted into paid up capital, it takes the form of issue of bonus shares. Itmerely implied capitalization of existing reserves and surplus of a company.
Issue under Section 205 (3) of the companies Act, such shares is governed
by the guidelines issued by the SEBI (applicable of listed companies only) as
follows:
SEBI Guidelines
Following are the guidelines pertaining to the issue of bonus shares by a
listed corporate enterprise:
1. Reservation: In respect of FCDs and PCDs, bonus shares must be
reserved in proportion to such convertible part of FCDs and PCDs. The
shares so reserved may be issued at the time of conversion(s) of such
debentures on the same terms on which the bonus issues were made.
2. Reserves: the bonus issue shall be made out of free reserves built
out of the genuine profits or share premium collected in cash only.
3. Dividend mode: the declaration of bonus issue, in lieu of dividend, is
not made.
4. Fully paid: The bonus issue is not made unless the partly paid
shares, if any are made fully paid-up.
5. No default: The Company has not defaulted in payment of interest or
principal in respect of fixed deposits and interest on existing
debentures or principal on redemption thereof and has sufficient
reason to believe that it has not defaulted in respect of the payment of
statutory dues of the employees such as contribution to provident
fund, gratuity, bonus, etc.
6. Implementation: A company that announces its bonus issue after
the approval of the Board of Directors must implement the proposal
within a period of 6 months from the date of such approval and shall
not have the option of changing the decision.
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7. The articles: The articles of Association of the company shall contain
a provision for capitalization of reserves, etc. if there is no such
provision in the articles, the company shall pass a resolution at is
general body meeting making provision in the Articles of Association
for capitalization.
8. Resolution: consequent to the issue of bonus shares if the subscribed
and paid-up capital exceeds the authorized share capital, the company
at its general body meeting for increasing the authorized capital shall
pass a resolution.
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Book-building Method
A method of marketing the shares of a company whereby the quantum and
the price of the securities to be issued will be decided on the basis of thebids received from the prospective shareholders by the lead merchant
bankers is known as book-building method.
The option of book-building is available to all body corporate, which are
otherwise eligible to make an issue of capital of the public. The initial
minimum size of issue through book-building route was fixed at Rs.100
crores.
The book-building process involves the following steps:
1. Appointment of book-runners: the first step in the book-building isthe appointment by the issuer company, of the book-runner, chosen
from one of the lead merchant bankers. The book-runner in the forms
a syndicate for the book building. A syndicate member should be a
member of National Stock Exchange (NSE) or Over-the-Counter
Exchange of India (OTCEI). Offers of bids are to be made by
investors to the syndicate members, who register the demands of
investors.
2. Drafting prospectus: The draft prospectus containing all the
information except the information regarding the price at which thesecurities are offered is to be filed with SEBI as per the prevailing SEBI
guidelines. The offer of securities through this process must
separately be disclosed in the prospectus, under the caption
placement portion category.
3. Circulating draft prospectus: A copy of the draft prospectus filed
with SEBI is to be circulated by the book-runner to the prospective
institutional buyers who are eligible for firm allotment and also to the
intermediaries who are eligible to act as underwriters.
4. Maintain offer records: The book-runner maintain a record to the
offers received. Details such as the name and the number of
securities ordered together with the price at which each institutional
buyer or underwriter is willing to subscribed to securities under the
placement portion must find place in the record. SEBI has the right to
inspect such records.
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5. Intimation about aggregate orders: The underwriters and the
institutional investors shall give intimation on the aggregate of the
offers received to the book-runner.
6. Bid analysis: The bid analysis is carried out by the book-runner
immediately after the closure of the bid offer date. An appropriatefinal price is arrived at after a careful evaluation of demands at
various prices and the quantity.
7. Mandatory underwriting: Where it has been decided to make offers
of shares to public under the category of Net offer of the Public, it is
incumbent that the entire portion offered to the public is fully
underwritten.
8. Filling with ROC: A copy of the prospectus as certified by the SEBI
shall be filed with the Registrar of Companies within two days of thereceipt of the acknowledgement card from the SEBI.
9. Bank accounts: The issuer company has to open two separate
accounts for collection of application money, one for the private
placement portion and the other for the public subscription.
10.Collection of completed applications: The book-runner collects
from the institutional buyers and the underwriters the application
forms along with the application money to the extent of the securities
proposed to be allotted to them or subscribed by them.
11.Allotment of securities: Allotment for the private placement
portion may be made on the second day from the closure of the issue.
The issuer company, however, has the option to choose one date for
both the placement portion and the public portion.
12.Payment schedule and listing: The book-runner may require the
underwriters to the net offer to the public to pay in advance all
moneys required to be paid in respect of their underwriting
commitment by the eleventh day of the closure of the issue.
13.Under-subscription: In the case of under-subscription in the net
offer to the public category, any spillover to the extent of under
subscription is to be permitted from the placement portion category
subject to the condition that preference is given to the individual
investors.
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Advantages of book-building
Book building process is of immense use in the following ways:
1. Reduction in the duration between allotment and listing
2. Reliable allotment procedure
3. Quick listing in stock exchanges possible
4. No price manipulation as the price is determined on the basis of the
bids received.
Stock Option or employees Stock Option Scheme (ESOP)
A method of marketing the securities of a company whereby its employees
are encouraged to take up shares and subscribe to it is know as stock
option. It is a voluntary scheme on the part of the company to encourage
employees participation in the company. The scheme also offers an
incentive to the employees to stay in the company.
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SEBI Guidelines
Company whose securities are listed on any stock exchange can introduce
the scheme of employees stock option. The offer can be made subject to theconditions specified below:
1. Issue at discount: Issue of stock options at a discount to the market
price would be regarded as another form of employee compensation
and would be treated as such in the financial statements of the
company regardless the quantum of discount on the exercise price of
the option.
2. Approval: The issue of ESOPs is subject to the approval by the
shareholders through a special resolution.
3. Maximum limit: There would be no restriction on the maximum
number of shares to be issued to a single employee.
4. Minimum period: A minimum period of one year between grant of
options and its vesting has been prescribed. After one year, the
company would determine the period during which the option can be
exercised.
5. Superintendence: The operation of the ESOP Scheme would have to
be under the superintendence and direction of a CompensationCommittee of the Board of Directors in which there would be a majority
of independent directors.
6. Eligibility: ESOP scheme is open to all permanent employees and to
the directors of the company but not to promoters and large
shareholders.
7. Directors report: The Directors report shall make a disclosure of
the following:
a. Total number of shares as approved the shareholders
b. The pricing formula adopted
c. Details as to options grated, options vested, options exercised and
options forfeited, extinguishments or modification of options, money
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realized by exercise of options, total number of options in force,
employee-wise details of options granted to senior managerial
personnel and to any other employee who received a grant in
anyone year of options amounting to 5 percent or more of options
granted during that year.
d. Fully diluted EPS computed in accordance with the IAS
8. IPO: SEBIs stipulations prohibiting initial public offerings by
companies having outstanding options should not apply to ESOP.
Stock Option Norms for Software Companies
The relevant guidelines issued by the SEBI as regards employees stock
option for software companies are as follows:
1. Minimum issue: A minimum issue of 10 percent of its paid-up capitalcan be made by a software company which has already floated
American Depository Receipts (ADRs) and Global Depository Receipts
(GDRs) or a company which is proposing to float these is entitled to
issue ADR/GDR linked stock options to its employees.
2. Mode of Issue: Listed stock options can be issued in foreign currency
convertible bonds and ordinary shares (through depository receipt
mechanism) to the employees of subsidiaries of Info Tech Companies.
3. Permanent employees: Indian IT companies can issue ADR/GDRlinked stock options to permanent employees, including Indian and
overseas directors, of their subsidiary companies incorporated in India
or outside.
4. Pricing: The pricing provisions of SEBIs preferential allotment
guidelines would not cover the scheme. The purpose is to be enable
the companies to issue stock options to its employees at a discount to
the market price which serves as another form of compensation.
5. Approval: Shareholders approval through a special resolution is
necessary for issuing the ESOPs. A minimum period of one year
between grant of option and its vesting has been prescribed. After one
year, the company would determine the period in which option can be
exercised.
Bought-out Deals
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Meaning
A method for marketing of securities of a body corporate whereby the
promoters of an unlisted company make an outright sale of a chunk of equity
shares to a single sponsor or the lead sponsor is known as bought-out
deals.
Features
1. Parties: There are three parties involved in the bought-out deals.
They are promoters of the company sponsors and co-sponsors who are
generally merchant bankers and investors.
2. Outright Sale: Under this arrangement, there is an outright sale of a
chunk of equity shares to a single sponsor or the lead sponsor.
3. Syndicate: Sponsor forms a syndicate with other merchant bankersfor meeting the resource requirements and for distributing the risk.
4. Sale price: The sale price is finalized through negotiations between
the issuing company and the purchaser, the sale being influenced by
such factors as project evaluation, promoters image and reputation,
current market sentiments, prospects of off-loading these shares at a
future date, etc.
5. Listing: The investor-sponsor make a profit, when at a future date,
the shares get listed and higher prices prevail. Listing generally takesplace at a time when the company is performing well in terms of higher
profits and larger cash generations from projects.
6. OTCEI: Sale of these share at Over-the-Counter Exchange of India
(OTCEI) or at a recognized stock exchanges, the time of listing these
securities and off-loading them simultaneously are being generally
decided in advance.
***********
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5.Q:Explain briefly the mechanism of underwriting
Benefits/Functions
The financial service of underwriting is found advantageous for the issuers
and the public alike. The function and the role of underwriting firms is givenbelow:
Adequate Funds
Underwriting being a kind 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, or the remaining shares not
subscribed by the public, it helps a company to undertake project
investments with the assurance of adequate capital funds. Underwriting
agreement assures the company of the required funds within a reasonable or
agreed time.
Expert Advice
Underwriters of repute often help the company by providing advice on
matter pertaining to the soundness of the proposed plan etc. thus enabling
the company in avoid certain pitfalls. It is therefore, possible for an issuing
company to obtain the benefit of expert advice through underwriting before
entering into a n 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 they. Such an activity, therefore, helps enhance the goodwill of
the issuing company.
Assurance to investors
Under writers, before underwriting the issue, satisfy themselves with the
financial integrity of the Issuer Company and viability of the plan. Theunderwriting firms assure this way, the soundness of the company the
investors are, therefore, assured of having low risk when they buy shares or
debentures which have been underwritten by them. There firm commitment
towards fulfilling their underwriting obligations helps creates confidence in
the minds of the investing public about the company.
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Better Marketing
Underwriters ensure efficient and successful marketing of the securities of
the firm through their network arrangements with other underwriters andbrokers at national and global level.
Benefits to Buyers
Underwriters are very useful to the buyers of securities due to their ability to
give expert regarding the safety of the investment and the soundness of
companies. The information and the expert opinion published by them in
various newspapers and journals 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.
Indian Scenario
Underwriting, as an important type of financial service, became popular in
the Indian capital market only recently. It made its beginning in 1912 when
M/s. Batliwala and Karni underwrote the shares of the Central India Spinning
and Weaving Co. Ltd. Underwriting, on a substantial scale, started in the
Indian Capital market only after World War I. The Tatas started the first
underwriting business in India in 1937, with the setting up of the Investment
Corporation of India ltd.
Underwriting gained momentum and popularity after January 1955, with the
setting up of he Industrial Credit and Investment Corporation of India (ICICI).
Later, other development financial institutions such as Life Insurance
Corporation of India, Industrial Development Bank of India (IDBI) and Unit
Trust of India (UTI) started taking an active part in the underwriting of new
issues, with IDBI being one of the largest.
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6.Q:Explain the different types of capital market instruments
Introduction
Indian capital market has been experiencing metamorphic changes in the
last decade, thanks to a host of measures of liberalization, globalization, and
privatization that have been initiated by the Government. Pronounced
changes have occurred in the realm of industrial policy, licensing policy,
financial services industry, interest rates, etc. As a result of these changes,
the financial services industry has come to introduce a number of
instruments with a view to facilitate borrowing and lending of money of
money in the capital market by the participants.
Types
Financial instruments that are used for raising capital resources in the capital
market are know as Capital Market Instruments,
The various capital market instruments used by corporate entities for raising
resources are as follows:
1. Preference shares
2. Equity shares
3. Non-voting equity shares
4. Cumulative convertible preference shares
5. Company fixed deposits
6. Warrants
7. Debentures and Bonds
Preference Shares
Meaning
Shares that carry preferential rights in comparison with ordinary shares are
called Preference Shares. The preferential rights are the rights regarding
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payment of dividend and the distribution of the assets of he company in the
event of its winding up, in preference to equity shares.
Types
1. Cumulative preference share where the arrears of dividends in times ofno and/or lean profits can accumulated and paid in the year in which
the company earns good profits.
2. Non cumulative preference shares Shares where the carry forward of
the arrears of dividends is not possible.
3. Participating preference shares Shares that enjoy the right to
participate in surplus profits or surplus assets on the liquidation of a
company or in the both, if the Articles of Association provides for its.
4. Redeemable preference shares Shares that are to be repaid at the endof the term of issue. The maximum period of a redemption being 20
years with effect from 1.3.1997 under the Companies Amendment Act,
1996.
5. Preference shares with warrants attached The attached warrants
entitle the holder to apply for equity shares for cash, at a premium, at
any time, in one or more stages between the third and fifth year from
the date of allotment.
Equity Shares
Meaning
Equity shares, also known as ordinary shares are the shares held by the
owners of a corporate entity.
Features
Since equity shareholders face greater risks and have no specific preferential
rights, they are given larger share in profits through higher dividends than
those given to preference shareholders, provided the company performanceis excellent.
A strikingly noteworthy feature of equity shares is that holders of these
shares enjoy substantial rights in the corporate democracy, namely the
rights to approve the companys annual accounts, declaration of dividend
enhancement of managerial remuneration in excess of specified limits and
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fixing the terms of appointment and election of directors, appointment of
auditors and fixing of their remuneration.
Equity shares in the hands of shareholders are mainly reckoned for
determining the managements control over the company. Where
shareholders are widely disbursed, it is possible for the management toretain the control, as it is not possible for all the shareholders to attend the
companys meeting in full strength.
Equity shareholders represent proportionate ownership in a company. They
have residual claims on the assets and profits of the company. They have
unlimited potential for dividend payments and price appreciation in
comparison to the owners of debentures and preference shares who enjoy
just a fixed assured return in the form of interest and dividend.
Voting rights are granted under the Companies Act (Sections 87 to 89)wherein each shareholder is eligible for votes proportionate to the number of
shares held or the amount of stock owned.
Capital
Equity shares are of different types. The maximum values of shares as
specified in the Memorandum of Association of the company is called the
authorized or registered or nominal capital. Issued capital is the nominal
value of shares offered for public subscription.
Par Value and Book Value
The face value of a share is called its Par value. Although shares can be sold
below the par value, it is possible that shares can be issued below the par
value. The financial institutions that convert their unpaid principal and
interest into equity in sick companies are compelled to do it at a minimum of
Rs.10 because of the par value concept even though the market price might
be much less than Rs.10.
Par value is of use to the regulatory agency and the stock exchange. It can
be used to control the number of shares that can be issued by the company.The par value of Rs.10 per shares serves as a floor price for issue of shares.
Cash Dividends
These are dividends paid in cash; a stable payment of cash dividend is the
hallmark of stability of shares prices.
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Stock dividends
These are the dividends distributed as shares and issued by capitalizing
shares reserves. While net worth remains the same in the balance sheet, its
distribution between shares and surplus is altered.
Non Voting Equity Shares
Consequent to the recommendations of the Abid Hussain Committee and
subsequent to the amendment to the Companies Act, corporate
managements are permitted to mobilize additional capital without diluting
the interest of existing shareholders with the help of a new instrument called
non-voting equity shares. Such shares will be entitled to all the benefits
except the right to vote in general meetings. Such non-voting equity share
is being considered as a possible addition to the two classes of share capital
currently in vogue. This class of shares has been included to an amendmentto the Companies Act as a third category of shares Corporate will be
permitted to issue such shares upto a certain percentage of the total Non-
voting equity shares will be entitled to rights and bonus issued and
preferential offer of shares on the same lines as that of ordinary shares.
Convertible Cumulative Preference Shares (CCPS)
These are the shares that have the twin advantage of accumulation of
arrears of dividends and the conversion into equity shares. Such shares
would have to be of the face value of Rs.100 each. The shares have to be
listed on one or more stock exchanges in the country. The object of the
issue of CCP shares is to allow for the setting up of new projects, expansion
or diversification of existing projects, normal capital expenditure for
modernization and of meeting working capital requirements.
Following are some of the terms and conditions of the issue of CCP shares:
1. Debt-equity ratio: For the purpose of calculation of debt-equity ratio
as may be applicable CCPS are be deemed to be an equity issue.
2. Compulsory conversion: The conversion into equity shares must befor the entire of issue of CCP shares and shall be done between the
period at the end of three years and five years as may be decide by
the company.
3. Fresh Issue: The conversion of CCP shares into equity would be
deemed as being one resulting from the process of redemption of the
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preference shares out of the proceeds of a fresh issue of shares made
for the purposes of redemption.
4. Preference dividend: The rate of preference dividend payable on
CCP shares would be 10 percent.
5. Guideline ratio: The guidelines ratio of 1:3 as between preference
shares and equity shares would not be applicable to these shares.
6. Arrears of dividend: The right to receive arrears of dividend up to
the date of conversion, if any, shall devolve on the holder of the equity
shares on such conversion.
7. Voting right: CCPS would have voting rights as applicable to
preference shares under the companies Act, 1956.
8. Quantum: The amount of the issue of CCP shares would be to theextent the company would be offering equity shares to the public for
subscription.
Company Fixed Deposits
Fixed deposits are the attractive source of short-term both for the companies
and investors as well. Corporates favor fixed deposits as n ideal form of
working capital mobilization without going through the process of
mortgaging assets and the associated rigmaroles of documentation, etc.
investors find fixed deposits a simple avenue for investment in popularcompanies at attractively reasonable and safe intrest rates.
Regulations
Since these instruments are unsecured, there is a lot of uncertainty about
the repayment of deposits and regular payment of interest. The issue of
fixed deposits is subject to the provisions of the Companies Act and he
companies (Acceptance of Deposits) Rules introduced in February 1975,
some of the important regulations in this regard as follows:
1. Advertisement: Issue of an advertisement (with the prescribedinformation) as approved by the Board of Directors in dailies circulating
in the state of incorporation.
2. Liquid assets: Maintenance of liquid assets equal to 15 percent
(substituted for 10% by Amendment Rules, 1992) of deposits
(maturing during the year ending March 31) in the form of bank
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deposits, unencumbered securities of State and Central Governments
or unencumbered approved securities.
3. Disclosure: Disclosure in the newspaper advertisement the quantum
of deposits remaining unpaid after maturity. This would help highlight
the defaults, if any, by the company and caution the depositors.
4. Deemed public Company: Private company would become a
deemed public company where such a private company, after inviting
public deposits through a statutory advertisement, accepts or renews
deposits from the public other than the members, directors or their
relatives.
5. Default: Penalty under the law for default by companies in repaying
deposits as and when they mature for payment where deposits were
accepted in accordance with the Reserve Bank directions.
6. CLB: Empowerment to the Company Law Board to direct companies
to repay deposits, which have not been repaid as per the terms and
conditions governing such deposits, with a time frame and according to
the terms and conditions of the order.
Warrants
An option issued by a company whereby the buyer is granted the right to
purchase a number of shares (usually one) of its equity share capital at a
given exercise price during a given period is called a warrant. Althoughtrading in warrants are in vogue in the U.S.Stock markets for more than 6 to
7 decades, they are being issued to meet a range of financial requirements
by the Indian corporate.
Both warrants and rights entitle a buyer to acquire equity shares of the
issuing company. However, they are different in the sense that warrants
have a life span of three of five years whereas, rights have a life span of only
four to twelve weeks (duration between the opening and closing date of
subscription list). Moreover rights are normally issued to effect current
financing, and warrants are sold to facilitate future financing. Similarly, the
share, is usually above the market price of the share so as to encourage
existing shareholders to purchase it. On the other hand, one warrant buys
one equity share generally, whereas more than one rights may be needed to
buy one share. The detachable warrant attached to each share provides a
right to the warrant holder to apply for additional equity share against each
warrant.
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Debentures and Bonds
A document that either creates a debt or acknowledges it is known as a
debenture. Accordingly, any document that fulfills either of these conditions
is a debenture, issued under the common seal of a company, usually takes
the form of a certificate that acknowledges indebtedness of the company.
Features
Following are the features of a debenture:
1. Issue: In India, debentures of various kinds are issued by the
corporate bodies, Government, and others as per the provision of e
Companies Act, 1956 and under the regulations of the SEBI. Section
117 of the Companies Act prohibits issue of debentures with voting
rights. Generally, they are issued against a charge or the assets of he
company but at times may be issued without any such charge also.
Debentures can be issued at a discount in which case, the relevant
particulars are to be filed with the Registrar of Companies.
2. Negotiability: In the case of bearer debentures the terminal value is
payable to its bearer. Such instruments are negotiable and are
transferable by delivery. Registered debentures are payable to the
registered holders whose name appears both on the debenture and in
the register of debenture holders maintained by the company.
Further, transfer of such debentures should be registered. They are
not negotiable instruments and contain a commitment to pay the
principal and interest.
3. Security: Secured debentures create a charge on the assets of the
company. Such a charge may be either fixed or floating. Debentures
that are issued without any charge on assets of the company are called
unsecured or naked debentures.
4. Duration: Debentures, which could be redeemed after a certain
period of time are called Redeemable Debentures. There are
debentures that are not to be returned except at the time of winding
up of the company. Such debentures are called Irredeemable
Debentures.
5. Convertibility: Where the debenture issue gives the option of
conversion into equity shares after the expiry of a certain period of
time, such debentures are called Convertible Debentures.
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6. Return: Debenture have a great advantage in them, in that they
carry a regular and reasonable income for the holders. There is a legal
obligation for the company to make payment of interest on debentures
whether or not any profits are earned by it.
7. Claims: Debentures holders command a preferential treatment in the
matters of distribution of he final proceeds of he company at the time
of its winding up . There claim of preference and equity shareholders.
Kinds
Innovative debt instruments that are issued by the public limited companies
in India are described below:
1. Participating debentures
2. Convertible debentures
3. Debut-Equity swaps
4. Zero-coupon convertible notes
5. Secured Premium Notes (SPN) with detachable warrants
6. Non-Convertible Debenture (NCDs) with detachable equity warrants
7. Zero-interest Fully Convertible Debentures (FCDs)
8. Secured Zero-interest Partly Convertible Debentures (PCDs) with
detachable and separately tradable warrants.
9. Fully Convertible Debentures (FCDs) with interest (optional).
10. Floating Rate Bonds (FRB)
1. Participating debentures: Debentures that are issued by a bodycorporate which entitle the holders to participate in its profits are
called Participating Debentures. These are the unsecured corporate
debt securities. They are popular among existing dividend paying
corporate.
2. Convertible debentures
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a) Convertible debentures with options. Are a derivative of convertible
debentures that give an option to both the issuer, as well as
investor, to exist from the terms of the issue.
b)Third party convertible debentures are debts with a warrant that
allow the investor to subscribe to the equity of a third firm at apreferential price viz-a-vis market price, the interest rate on the
third party convertible debentures being lower than pure debt on
account of the conversion option.
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3. Debt-equity swaps: They are offered from a n issuer of debt to swap
it for equity. The instrument is quite risky for the investor because the
anticipated capital appreciation may not materialize.
4. Zero-coupon convertible note: These are debentures that can be
converted into shares and on its conversion the investor forgoes all
accrued and unpaid interest. The Zero-coupon convertible notes are
quite sensitive to changes in the interest rates.
5. SPN with detachable warrants: These are the Secured Premium
Notes (SPN) with detachable warrants. These are the redeemable
debentures that are issued along with a detachable warrant. The
warrant entitles the holder to apply and get equity shares allotted,
provided the SPN is fully paid. The warrants attached it assured theholder such a right. No interest will be paid during the lock-in period
for SPN.
6. NCDs with detachable equity warrants: These are Non-
Convertible Debentures (NCDs) with detachable equity warrants.
These entitle the holder to buy a specific number of shares from the
company at a predetermined price within a definite time frame.
7. Zero interest FCDs: These are Zero-interest Fully Convertible
Debentures on which no interest will be paid by the issuer during the
lock-in-period. However, there is a notified period after which fully
paid FDCs will be automatically and compulsorily converted into
shares.
8. Secured Zero interest PDCs with detachable and separately tradable
warrants. These are Secured Zero interest Partly Convertible
Debentures with detachable and separately tradable warrants.
9. Fully convertible debentures (FCDs) with interest (Optional):
These are the debentures that will not yield any interest for an initial
short period after which the holder is given an option to apply for
equities at a premium.
10.Floating Rate Bonds (FRBs):These are the bonds where the yield is
linked to a benchmark interest rate like the prime rate in USA or LIBOR
in the Euro currency market. For instance, the State Bank of Indias
floating rate bond, issue was lined to the maximum interest on term
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deposits that was 10 percent at the time. The floating rate is quoted in
terms of a margin above or below the benchmark rate. Interest rates
linked to the benchmark ensure that neither the borrower nor the
lender suffer from the change sin interest rates. Where interest rates
are fixed, they are likely to be inequitable to the borrower when
interest rates fall and inequitable to he lender when interest rates rise
subsequently.
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SET 2
1. Explain the different types of merger.
Merger Types
Mergers are of different types as discussed below:
1. Horizontal merger: Where two or more companies that complete in
the same industry amalgamate, it is a case of horizontal merger. The
objective of horizontal merger is to expand the firms operations in the
same industry through the substantial economies of scale and through
the elimination of competition. The merger of Tata oil Mills Ltd. With
the Hindustan Level ltd. Is an example of a horizontal merger. Under
horizontal merger combination of two or more firms that are engaged
in similar type of production, distribution or area of business takes
place. For instance where two or more cement manufacturing
companies are combined, it makes the form of horizontal merger.
2. Vertical merger: A company is said to be adopting a vertical
integration strategy where it seeks to participate in other links in the
value chain by remaining in the same industry by acquiring suppliers
or production technology, or acquiring sales or distribution capacity.
Where two or more companies that operate in the same industry but at
different stages of production or distribution system amalgamate, it is
a case of vertical merger. Vertical merger happens by means of
combination of two or more firms that are engaged in different stages
of operation, production or distribution. For instance, where a
company that manufactures laptops combines with a company that
markets laptops, it is a case of a vertical merger.
Vertical merger may take the form of either a forward merger or a
backward merger. A backward merger happens where a
manufacturing company joins with a company that supplier raw
material. On the other hand, a forward merger happens where a
company that supplies raw material joints hands with a company themanufacturers.
3. Diagonal Merger: A company is said to be adopting a diagonal
integration strategy where it pursues an acquisition that involves both
horizontal and vertical elements. Under this merger strategy, content
and intellectual property ownership is combined with distribution
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technology and infrastructure, resulting in so entirely new media
industry.
4. Forward merger: In a forward merger, the shareholders of the target
company exchange their shares for the shares of the acquiring
company and all of the assets and liabilities of the target company areautomatically transferred to the acquire.
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5. Reverse merger: In a reverse merger, the shareholders of the
acquiring company exchange their shares for shares of the targetcompany. It is a case of the acquiring company merging into the
target company. Where a prosperous and profit making company
acquires a loss-making sick company with substantial erosion in its net
worth, it is a case of reverse merger.
6. Forward triangular merger: In a forward triangular merger, a
subsidiary company is formed by the parent company for the purpose
of engaging in the merger deal. A parent company funds a subsidiary
formed for this purpose. The stock of the parent company is
transferred to the target company by the subsidiary.
7. Reverse triangular merger: In a reverse triangular merger, the
parent company funds a subsidiary company with stock of the parent.
The shareholders of the target company exchange their stock for the
stock of the parent company, which is held by the subsidiary company.
8. Conglomerate merger: A company is said to be adopting a
conglomerate merger strategy where it makes acquisitions across
different industries. Where several firms engaged in unrelated lines of
business activity combine together to for a new company, it takes the
form of conglomerate merger.
A conglomerate takeover or merger involves the coming together of
two companies in different industries i.e. the businesses of the two
companies are into related to each other horizontally (in the sense of
producing the same or competing products), or vertically (in the sense
of standing towards each other in the relationship of supplier and
buyer, or potential supplier and buyer).
A co generic merger is said to take place where the companies that are
getting merged are engaged in complementary activities and not in
direct competitive activities, amalgamate to form a new company. The
coming together of a car manufacturer with a scooter manufacturer is
an example of a co generic merger.
Conglomerate takeovers or mergers may in turn be classified
according to the purpose of the dominant party. The dominant party
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may itself be a fully-fledged conglomerate company, i.e. a holding
company staffed by professional managers exercising management
control over a substantial number of subsidiaries in a wide range of
industries.
To dominant party may be a financial conglomerate, i.e. the groupmay have been put together largely on the basis of financial
engineering by the holding company, usually be exchanging its highly
priced quoted securities (frequently in the form of convertible
securities) for shares of companies in a wide range of industries.
9. Negotiated merger: Where merger of two or more companies takes
place after protracted negotiations, it is a case of negotiated merger.
Under this type of merger, the acquiring firm negotiates directly with
the management of the target firm. The merging companies willingly
reach an agreement for the merger proposal. Accordingly, of theparties to the agreement fall to reach an agreement, the merger
proposal will be terminated and dropped out. The merger of ITC
Classic Ltd., with ICICI Ltd., is an example of a negotiated merger.
10.Arranged merger: Where merger of a financially sick company takes
place with another sound company as part of package of financial
rehabilitation under the initiative of a financial body, it is a case of an
arranged merger. Merger schemes are crafted in consultation with
the lead bank, the target firm and the acquiring firm. These are
motivated mergers and the led bank takes the initiative and decides
the terms and conditions of merger.
11.Agreed merger: Where the directors of target firm agree to the
takeover or merger, accept the offer in respect of their own
shareholdings (which might range from nil or negligible to controlling
shareholdings) and recommend other shareholders to accept the offer,
it is a case of agreed takeover or merger. The directors may agree
right from the start or after early negotiations or even after public
opposition to the bid (which may or may not have resulted in an
improvement in the terms of the proposed offer).
12.Unopposed merger: Where the directors of the target firm, while
making a deal with the acquiring firm, do not oppose the offer or
recommend rejection, it is a case of unopposed merger.
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13.Defended merger: Where the directors of a target firm decide to
oppose the bid, recommending shareholders to reject the offer and
perhaps taking further defensive action, it takes the form of a
defending merger. The decision to defend may be with the intention
of stopping the take over (which in turn may be prompted either by the
genuine belief of the directors that it is in the interests of the company
to remain independent or by a desire of the directors to protect their
own personal positions) or persuading the bidder to improve its terms.
14.Competitive merger: Where a second bidder (and perhaps even a
third bidder) comes into the scene with a rival bid, it is a case of a
competitive merger. This may be an independent action on the part
of the rival bidder or it may be at the invitation of the directors of the
target firm, who deciding that a takeover is inevitable, feel that the
company comes under the control of a bidder selected by them rather
than the original bidder.
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15.Tender offer: Where a bid is made by an acquiring firm to acquire
controlling interest in a target firm by purchasing the shares of thetarget firm at a fixed price. It is a case of tender offer. Under this
type of merger, the acquiring firm directly approaches the
shareholders of the target firm and makes them sell their
shareholdings at a fixed price. The offer prices is generally fixed at a
level higher than the current market price in order to induce the
shareholders to divest their holding in favor of the acquiring firm.
16.Diversification: Diversification is a case of conglomerate merger.
Diversification consists of a company, deriving all or the greater part of
its revenue from the particular industry, acquiring subsidiariesoperating in other industries for one or more of the following reasons.
17. To obtain greater stability of earnings through spreading
activities in different industries with different business cycles or to
diversify out of a static or dying industry.
18. To employ spare resources, whether or capital or management
19. To obtain benefit of economies of scale, particularly in regard to
staff functions (such as personnel, advertising, accounting and
financial) where there are some common factors.
20. To make the company too large to be likely to be the object of a
takeover or perhaps to make it a less attractive object in the case of
defensive diversification.
21. To provide an outlet for the ambitions of management, here
antimonopoly laws make further acquisitions (or perhaps even growth)
in the companys own field impracticable.
Conglomerate takeovers and mergers do not usually raise anti-monopoly
questions, but may do so where it is feared that the firm may abuse its
market power, such as by exerting pressure on firms from which some
companies in the group purchase supplies to place business