5.Indian Capital Markets Flashcards
Write a note about the functions of merchant banker.
Functions of Merchant Bankers: The basic function of merchant banker or investment
banker is marketing of corporate and other securities. In the process, he performs a number of
services concerning various aspects of marketing, viz., origination, underwriting, and
distribution, of securities. During the regime of erstwhile Controller of Capital Issues in India,
when new issues were priced at a significant discount to their market prices, the merchant
banker’s job was limited to ensuring press coverage and dispatching subscription forms to
every corner of the country. Now, merchant bankers are designing innovative instruments and
perform a number of other services both for the issuing companies as well as the investors the
activities or services performed by merchant bankers, in India, today include:
(a) Project promotion services.
(b) Project finance.
(c) Management and marketing of new issues.
(d) Underwriting of new issues.
(e) Syndication of credit.
(f) Leasing services.
(g) Corporate advisory services.
(h) Providing venture capital.
(i) Operating mutual funds and off shore funds.
(j) Investment management or portfolio management services.
(k) Bought out deals.
(l) Providing assistance for technical and financial collaborations and joint ventures.
(m) Management of and dealing in commercial paper.
(n) Investment services for non-resident Indians.
Write short note on Asset Securitisation.
Asset Securitisation: Securitisation is a process of transformation of illiquid asset into
security which may be traded later in the open market. It is the process of transformation of
the assets of a lending institution into negotiable instruments. The term ‘securitisation’ refers
to both switching away from bank intermediation to direct financing via capital market and/or
money market, and the transformation of a previously illiquid asset like automobile loans,
mortgage loans, trade receivables, etc. into marketable instruments.
This is a method of recycling of funds. It is beneficial to financial intermediaries, as it helps in
enhancing lending funds. Future receivables, EMIs and annuities are pooled together and
transferred to a special purpose vehicle (SPV). These receivables of the future are shifted to
mutual funds and bigger financial institutions. This process is similar to that of commercial
banks seeking refinance with NABARD, IDBI, etc.
Write a note on buy-back of shares by companies.
Buyback of shares: Till 1998, buyback of equity shares was not permitted in India. But now
they are permitted after suitably amending the Companies Act, 1956. However, the buyback of
shares in India are permitted under certain guidelines issued by the Government as well as by
the SEBI. Several companies have opted for such buyback including Reliance, Bajaj, and
Ashok Leyland to name a few. In India, the corporate sector generally chooses to buyback by
the tender method or the open market purchase method. The company, under the tender
method, offers to buy back shares at a specific price during a specified period which is usually
one month. Under the open market purchase method, a company buys shares from the
secondary market over a period of one year subject to a maximum price fixed by the
management. Companies seem to now have a distinct preference for the open market
purchase method as it gives them greater flexibility regarding time and price.
As impact of buyback, the P/E ratio may change as a consequence of buyback operation. The
P/E ratio may rise if investors view buyback positively or it may fall if the investors regard
buyback negatively.
Rationale of buyback: Range from various considerations. Some of them may be:
(i) For efficient allocation of resources.
(ii) For ensuring price stability in share prices.
(iii) For taking tax advantages.
(iv) For exercising control over the company.
(v) For saving from hostile takeover.
(vi) To provide capital appreciation to investors this may otherwise be not available.
This, however, has some disadvantages also like, manipulation of share prices by its
promoters, speculation, collusive trading etc.
Briefly explain ‘Buy Back of Securities’ and give the management objectives of buying
Back Securities.
Buy Back of Securities: Companies are allowed to buy back equity shares or any other
security specified by the Union Government. In India Companies are required to
extinguish shares bought back within seven days. In USA Companies are allowed to hold
bought back shares as treasury stock, which may be reissued. A company buying back
shares makes an offer to purchase shares at a specified price. Shareholders accept the
offer and surrender their shares.
The following are the management objectives of buying back securities:
(i) To return excess cash to shareholders, in absence of appropriate investment
opportunities.
(ii) To give a signal to the market that shares are undervalued.
(iii) To increase promoters holding, as a percentage of total outstanding shares, without
additional investment. Thus, buy back is often used as a defence mechanism
against potential takeover.
(iv) To change the capital structure.
Explain the term ‘Insider Trading’ and why Insider Trading is punishable.
Insider Trading: The insider is any person who accesses the price sensitive information
of a company before it is published to the general public. Insider includes corporate
officers, directors, owners of firm etc. who have substantial interest in the company.
Even, persons who have access to non-public information due to their relationship with
the company such as internal or statutory auditor, agent, advisor, analyst consultant etc.
who have knowledge of material, ‘inside’ information not available to general public.
Insider trading practice is the act of buying or selling or dealing in securities by as a person
having unpublished inside information with the intention of making abnormal profit’s and
avoiding losses. This inside information includes dividend declaration, issue or buy back of
securities, amalgamation, mergers or take over, major expansion plans etc.
The word insider has wide connotation. An outsider may be held to be an insider by
virtue of his engaging himself in this practice on the strength of inside information.
Insider trading practices are lawfully prohibited. The regulatory bodies in general are imposing different fines and penalties for those who indulge in such practices. Based on
the recommendation of Sachar Committee and Patel Committee, SEBI has framed
various regulations and implemented the same to prevent the insider trading practices.
Recently SEBI has made several changes to strengthen the existing insider Trading
Regulation, 1992 and new Regulation as SEBI (Prohibition of Insider Trading)
Regulations, 2002 has been introduced. Insider trading which is an unethical practice
resorted by those in power in corporates has manifested not only in India but elsewhere in
the world causing huge losses to common investors thus driving them away from capital
market. Therefore, it is punishable.
Write short note on Stock Lending Scheme.
Stock Lending: In ‘stock lending’, the legal title of a security is temporarily transferred from a
lender to a borrower. The lender retains all the benefits of ownership, other than the voting
rights. The borrower is entitled to utilize the securities as required but is liable to the lender for
all benefits.
A securities lending programme is used by the lenders to maximize yields on their portfolio.
Borrowers use the securities lending programme to avoid settlement failures.
Securities lending provide income opportunities for security-holders and creates liquidity to
facilitate trading strategies for borrowers It is particularly attractive for large institutional
shareholders as it is an easy way of generating income to offset custody fees and requires
little involvement of time. It facilitates timely settlement, increases the settlements, reduces
market volatility and improves liquidity.
The borrower deposits collateral securities with the approved, intermediary. In case the
borrower fails to return the securities, he will be declared a defaulter and the approved
intermediary will liquidate the collateral deposited with it. In the event of default, the approved
intermediary is liable for making good the loss caused to the lender. The borrower cannot
discharge his liabilities of returning the equivalent securities through payment in cash or kind.
Current Status in India: National Securities Clearing Corporation Ltd. launched its stock
lending operations (christened Automated Lending & Borrowing Mechanism – ALBM) on
February 10, 1999. This was the beginning of the first real stock lending operation in the
country. Stock Holding Corporation of India, Deutsche Bank and Reliance are the other three
stock lending intermediaries registered with SEBI.
Under NSCCL system only dematerialized stocks are eligible. The NSCCL’S stock lending
system is screen based, thus instantly opening up participation from across the country
wherever there is an NSE trading terminal. The transactions are guaranteed by NSCCL and
the participating members are the clearing members of NSCCL. The main features of NSCCL
system are:
(i) The session will be conducted every Wednesday on NSE screen where borrowers and
lenders enter their requirements either as a purchase order indicating an intention to
borrow or as sale, indicating intention to lend.
(ii) Previous day’s closing price of a security will be taken as the lending price of the
security.
(iii) The fee or interest that a lender gets will be market determined and will be the difference
between the lending price and the price arrived at the ALBM session.
(iv) Corresponding to a normal market segment, there will be an ALBM session.
(v) Funds towards each borrowing will have to be paid in on the securities lending day.
(vi) A participant will be required to pay-in-funds equal to the total value of the securities
borrowed.
(vii) The same amount of securities has to be returned at the end of the ALBM settlement on
the day of the pay-out of the ALBM settlement.
(viii) The previous day’s closing price is called the lending price and the rate at which the
lending takes place is called the lending fee. This lending fee alone is determined in the
course of ALBM session.
(ix) Fee adjustment shall be made for any lender not making full delivery of a security. The
lender’s account shall be debited for the quantity not delivered.
(x) The borrower account shall be debited to the extent of the securities not lend on account
of funds shortage.
Write a short note on ‘Book building’.
Book Building: Book building is a technique used for marketing a public offer of equity shares
of a company. It is a way of raising more funds from the market. After accepting the free
pricing mechanism by the SEBI, the book building process has acquired too much significance
and has opened a new lead in development of capital market.
A company can use the process of book building to fine tune its price of issue. When a
company employs book building mechanism, it does not pre-determine the issue price (in case
of equity shares) or interest rate (in case of debentures) and invite subscription to the issue.
Instead it starts with an indicative price band (or interest band) which is determined through
consultative process with its merchant banker and asks its merchant banker to invite bids from
prospective investors at different prices (or different rates). Those who bid are required to pay
the full amount. Based on the response received from investors the final price is selected. The
merchant banker (called in this case Book Runner) has to manage the entire book building
process. Investors who have bid a price equal to or more than the final price selected are given allotment at the final price selected. Those who have bid for a lower price will get their
money refunded.
In India, there are two options for book building process. One, 25 per cent of the issue has to
be sold at fixed price and 75 per cent is through book building. The other option is to split 25
per cent of offer to the public (small investors) into a fixed price portion of 10 per cent and a
reservation in the book built portion amounting to 15 per cent of the issue size. The rest of the
book-built portion is open to any investor.
The greatest advantage of the book building process is that this allows for price and demand
discovery. Secondly, the cost of issue is much less than the other traditional methods of
raising capital. In book building, the demand for shares is known before the issue closes. In
fact, if there is not much demand the issue may be deferred and can be rescheduled after
having realised the temper of the market.
Explain the term “Offer for Sale”.
Offer for sale is also known as bought out deal (BOD). It is a new method of offering equity
shares, debentures etc., to the public. In this method, instead of dealing directly with the
public, a company offers the shares/debentures through a sponsor. The sponsor may be a
commercial bank, merchant banker, an institution or an individual. It is a type of wholesale of
equities by a company. A company allots shares to a sponsor at an agreed price between the
company and sponsor. The sponsor then passes the consideration money to the company and
in turn gets the shares duly transferred to him. After a specified period as agreed between the
company and sponsor, the shares are issued to the public by the sponsor with a premium.
After the public offering, the sponsor gets the shares listed in one or more stock exchanges.
The holding cost of such shares by the sponsor may be reimbursed by the company or the
sponsor may get the profit by issue of shares to the public at premium.
Thus, it enables the company to raise the funds easily and immediately. As per SEBI
guidelines, no listed company can go for BOD. A privately held company or an unlisted
company can only go for BOD. A small or medium size company which needs money urgently
chooses to BOD. It is a low cost method of raising funds. The cost of public issue is around
8% in India. But this method lacks transparency. There will be scope for misuse also. Besides
this, it is expensive like the public issue method. One of the most serious short coming of this
method is that the securities are sold to the investing public usually at a premium. The margin
thus between the amount received by the company and the price paid by the public does not
become additional funds of the company, but it is pocketed by the issuing houses or the
existing shareholder.
What is the procedure for the book building process? Explain the recent changes made in the
allotment process.
The modern and more popular method of share pricing these days is the BOOK BUILDING
route. After appointing a merchant banker as a book runner, the company planning the IPO,
specifies the number of shares it wishes to sell and also mentions a price band. Investors
place their orders in Book Building process that is similar to bidding at an auction. The willing investors submit their bids above the floor price indicated by the company in the price band to
the book runner. Once the book building period ends, the book runner evaluates the bids on
the basis of the prices received, investor quality and timing of bids. Then the book runner and
the company conclude the final price at which the issuing company is willing to issue the stock
and allocate securities. Traditionally, the number of shares is fixed and the issue size gets
determined on the basis of price per share discovered through the book building process.
Public issues these days are targeted at various segments of the investing fraternity.
Companies now allot certain portions of the offering to different segments so that everyone
gets a chance to participate. The segments are traditionally three - qualified institutional
bidders (Q1Bs), high net worth individuals (HNIs) and retail investors (general public). Indian
companies now have to offer about 50% of the offer to Q1Bs, about 15% to high net worth
individuals and the remaining 35% to retail investors Earlier retail and high net worth
individuals had 25% each. Also the Q1Bs are allotted shares on a pro-rata basis as compared
to the earlier norm when it was at the discretion of the company management and the
investment bankers. These investors (Q1B) also have to pay 10% margin on application. This
is also a new requirement. Once the offer is completed, the company gets listed and investors
and shareholders can trade the shares of the company in the stock exchange.
Explain briefly the advantages of holding securities in ‘demat’ form rather than in physical
form.
Advantages of Holding Securities in ‘Demat’ Form: The Depositories Act, 1996 provides
the framework for the establishment and working of depositories enabling transactions in
securities in scripless (or demat) form. With the arrival of depositories on the scene, many of
the problems previously encountered in the market due to physical handling of securities have
been to a great extent minimized. In a broad sense, therefore, it can be said that ‘dematting’
has helped to broaden the market and make it smoother and more efficient.
From an individual investor point of view, the following are important advantages of holding
securities in demat form:
• It is speedier and avoids delay in transfer
• It avoids lot of paper work.
• It saves on stamp duty.
From the issuer-company point of view also, there are significant advantages due to
dematting, some of which are:
• Savings in printing certificates, postage expenses.
• Stamp duty waiver.
Easy monitoring of buying/selling patterns in securities, increasing ability to spot takeover
attempts and attempts at price rigging.
Write short notes on the Stock Lending Scheme – its meaning, advantages and risk involved.
Stock Lending Scheme: Stock lending means transfer of security. The legal title is
temporarily transferred from a lender to a borrower. The lender retains all the benefits of
ownership, except voting power/rights. The borrower is entitled to utilize the securities as
required but is liable to the lender for all benefits such as dividends, rights etc. The basic
purpose of stock borrower is to cover the short sales i.e. selling the shares without possessing
them. SEBI has introduced scheme for securities lending and borrowing in 1997.
Advantages:
(1) Lenders to get return (as lending charges) from it, instead of keeping it idle.
(2) Borrower uses it to avoid settlement failure and loss due to auction.
(3) From the view-point of market this facilitates timely settlement, increase in settlement,
reduce market volatility and improves liquidity.
(4) This prohibits fictitious Bull Run.
The borrower has to deposit the collateral securities, which could be cash, bank guarantees,
government securities or certificates of deposits or other securities, with the approved
intermediary. In case, the borrower fails to return the securities, he will be declared a defaulter
and the approved intermediary will liquidate the collateral deposited with it.
In the event of default, the approved intermediary is liable for making good the loss caused to
the lender.
The borrower cannot discharge his liabilities of returning the equivalent securities through
payment in cash or kind.
National Securities Clearing Corporation Ltd. (NSCCL), Stock Holding Corporation of India
(SHCIL), Deutsche Bank, and Reliance Capital etc. are the registered and approved
intermediaries for the purpose of stock lending scheme. NSCCL proposes to offer a number of
schemes, including the Automated Lending and Borrowing Mechanism (ALBM), automatic
borrowing for settlement failures and case by case borrowing.
How is a stock market index calculated? Indicate any two important stock market indices.
- A base year is set alongwith a basket of base shares.
- The changes in the market price of these shares is calculated on a daily basis.
- The shares included in the index are those shares which are traded regularly in high
volume. - In case the trading in any share stops or comes down then it gets excluded and another
company’s shares replace it. - Following steps are involved in calculation of index on a particular date:
Calculate market capitalization of each individual company comprising the index.
Calculate the total market capitalization by adding the individual market
capitalization of all companies in the index.
Computing index of next day requires the index value and the total market
capitalization of the previous day and is computed as follows:
Total tioncapitalisa of the dayprevious
marketTotal fortioncapitalisa daycurrent I Valuendex = onIndex Previous Day X
It should also be noted that Indices may also be calculated using the price weighted
method. Here the share prices of the constituent companies form the weights.
However, almost all equity indices world-wide are calculated using the market
capitalization weighted method.
Each stock exchange has a flagship index like in India Sensex of BSE and Nifty of NSE
and outside India is Dow Jones, FTSE etc.
What is a depository? Who are the major players of a depository system? What advantages
does the depository system offer to the clearing member?
(i) A depository is an organization where the securities of a shareholder are held in the form
of electronic accounts in the same way as a bank holds money. The depository holds
electronic custody of securities and also arranges for transfer of ownership of securities
on the settlement dates.
(ii) Players of the depository system are:
• Depository
• Issuers or Company
• Depository participants
• Clearing members
• Corporation
• Stock brokers
• Clearing Corporation
• Investors
• Banks
(iii) Advantages to Clearing Member
• Enhanced liquidity, safety, and turnover on stock market.
• Opportunity for development of retail brokerage business.
• Ability to arrange pledges without movement of physical scrip and further increase
of trading activity, liquidity and profits.
• Improved protection of shareholder’s rights resulting from more timely
communications from the issuer.
• Reduced transaction costs.
• Elimination of forgery and counterfeit instruments with attendant reduction in
settlement risk from bad deliveries.
• Provide automation to post-trading processing.
• Standardisation of procedures.
Write a short note on depository participant.
Under this system, the securities (shares, debentures, bonds, Government Securities, MF
units etc.) are held in electronic form just like cash in a bank account. To speed up the transfer
mechanism of securities from sale, purchase, transmission, SEBI introduced Depository
Services also known as Dematerialization of listed securities. It is the process by which
certificates held by investors in physical form are converted to an equivalent number of
securities in electronic form. The securities are credited to the investor’s account maintained
through an intermediary called Depository Participant (DP). Shares/Securities once
dematerialized lose their independent identities. Separate numbers are allotted for such
dematerialized securities. Organization holding securities of investors in electronic form and
which renders services related to transactions in securities is called a Depository. A depository
holds securities in an account, transfers securities from one account holder to another without
the investors having to handle these in their physical form. The depository is a safe keeper of
securities for and on behalf of the investors. All corporate benefits such as Dividends, Bonus,
Rights etc. are issued to security holders as were used to be issued in case of physical form.
Write short note on Advantages of a depository system.
Advantages of a Depository System
The different stake-holders have advantages flowing out of the depository system. They are:-
(I) For the Capital Market:
(i) It eliminates bad delivery;
(ii) It helps to eliminate voluminous paper work;
(iii) It helps in the quick settlement of dues and also reduces the settlement time;
(iv) It helps to eliminate the problems concerning odd lots;
(v) It facilitates stock-lending and thus deepens the market.
(II) For the Investor:
(i) It reduces the risks associated with the loss or theft of documents and securities
and eliminates forgery;
(ii) It ensures liquidity by speedy settlement of transactions;
(iii) It makes investors free from the physical holding of shares;
(iv) It reduces transaction costs; and
(v) It assists investors in securing loans against the securities.
(III) For the Corporate Sector or Issuers of Securities:
(i) It provides upto date information on shareholders’ names and addresses;
(ii) It enhances the image of the company;
(iii) It reduces the costs of the secretarial department;
(iv) It increases the efficiency of registrars and transfer agents; and
(v) It provides better facilities of communication with members.
