Merchant Banking

Merchant bank is an institution which provides services to corporate such as flotation of new venture and companies, preparation, planning and execution of new project, consultancy and advice in technical, financial and managerial field, restructuring of business, mergers and acquisitions etc.

Issue Management
A major function of merchant bankers It involves following functions in respect of issue through prospectus.
Obtaining approval for the issue from SEBI Arranging underwriting Drafting prospectus and obtaining clearance from stock exchange, auditors, ROC etc Drafting other documents like application form, newspaper advt.etc

Functions of MB for issue through prospectus contd.

Selection of brokers, bankers to the issue and finalising terms and conditions Coordination with brokers, bankers, underwriters and stock exchange Receipt and processing of applications and preparation for the allotment Arranging for listing of securities

Other functions of MB
Pre investment studies
Feasibility study in a specific area Study for joint ventures by foreign companies in India Advice on Govt. regulatory factors

Project Finance
Estimating and deciding pattern of financing Arranging for the finance Legal assistance

Other functions contd.

Portfolio Management
Providing advice on selection of investment Undertaking investment in securities Safe custody of securities Collection of return on investment Carrying out critical evaluation of investment portfolio

Working capital finance

Assessment of working capital Arrangement for working capital

Other functions contd.

Merger and acquisition
Examining pros and cons of M & A Obtaining approval from stake holders Monitoring implementation of M & A Assisting in compliance of legal requirement

Foreign currency financing

Arranging for foreign currency loans Providing guidance for exchange risk mitigation

Other functions contd.

Loan syndication
Helps in procurement of term loan and working capital from banks / FIs Preparation of project report Identifying source of finance Submission of proposal for appraisal Obtaining sanction Documentation and creation of security Getting disbursement of loan to the client

Code of Conduct for MBs prescribed by SEBI

Integrity and fairness in dealing Quality service Best advice Secrecy Providing correct information to the client No unfair, unethical practice for manipulation in the market Compliance of rules and regulations

Need for MBs

Growing industrialisation Helps small and medium enterprises Growing complexity in rules and procedure Exploring possibility of joint ventures Promoting new issue market for saving mobilisation

Credit Rating
Rating is an opinion on the future ability of the issuer to make timely payment of principal and interest on a specific security It is process of assigning value to credit instrument by estimating the solvency to repay debt and expressing them through pre determined symbols

Features of CR
It is done by specialized institutions It can be for both equity and debt Whole organization is not graded It does reflect issuer's strength CR may be different for different instrument issued by the same company It is done on the request of the company issuing the instrument

Features contd.
It is done on the basis of the information provided by the organization CR agency also find out some information independently Factors like operating efficiency, market position, industry risk, track record, profitability, liquidity, assets quality etc are taken into account for rating

Features contd.
After rating is assigned it can be monitored by CR agency over entire life of the instrument and rating can be changed or suspended It is not a recommendation to buy or hold the security No guarantee for the accuracy of the information on which rating is based

Objectives of CR
To provide superior and low cost information to investor for investment decision It imposes discipline on the borrower It helps regulatory authority, merchant bankers, brokers etc It is a marketing tool for the issuer It encourage better information disclosure and accounting standard

Rating Methodology I. Business Analysis

Industry risk analysis
Demand supply position, future potentiality, Govt.policy

Market share of the firm

Marketing strength and weaknesses

Operating efficiency
Production process, cost structure

Legal position
Statutory process, filing of returns

Rating Methodology II. Financial Analysis

Accounting quality
Income recognition methods, inventory valuation, off balance sheet liabilities

Earning protection
Profitability ratio, projected earning

Financial Flexibility
Alternative financial plan

Adequacy of cash flow

Rating Methodology III. Fundamental Analysis

Liquidity management
Study of capital structure, matching of assets and liabilities

Assets quality
Credit management, composition of assets and risk analysis

Interest sensitivity
Exposure to interest rate change, hedging policy

Rating Methodology IV. Management evaluation

Management goals, philosophy, strategies, capacity to overcome adverse situation

Country / Sovereign Ratings

Entire country is rated Provides information to global investors to make decision about investment It is done by globally recognized authorities on assessing credit risk Largest rating agencies are
Moody Standard and Poor Fitch

What is sovereign credit rating?

The rating scale ranges from AAA to D AAA are the richest economies mainly located in North America / Europe Country like Japan, Singapore, Australia, New Zealand also included here D signifies default

Other ratings
Between AAA and D following ratings are found ( Moody and S&P )
Aaa / AAA Aa / AA A/A Baa / BBB Ba / BB B/B Caa / CCC Ca / CC C/C D

Other ratings contd.

Each letter grade is further subdivided into three divisions
For e.g. A1, Baa 2, Ba 3

Ratings of Baa 3 and above are considered to be of an investment grade

How rating are estimated?

Combine quantitative & qualitative factors
Political Risk Income and economic structure Economic growth prospects Fiscal Policy Debt Burden Monetary Policy External Liquidity Pub. / Pvt. Sector external debt burden

Political Risk
History of peaceful democratic development Transparency of political institutions Developed civil institutions

Income and Eco. Structure Eco. Growth prospects

Per capita GDP Average of other countries in the same category GDP projection rate

Fiscal Policy Debt Burden

Extent of fiscal deficit Average of other countries in the same category Debt / GDP ratio Average of other countries in the same category

Monetary Policy
Monetary management by Central Bank Inflation control Net foreign assets of banking sector

External Liquidity
Current account deficit Balance of Payment Position

Pub. & Pvt. Sector External debt burden

Ratio of external debt of public sector to GDP Ratio of external debt of private sector to GDP

Significance of country ratings

Encourage FDI and portfolio flows Support foreign trade Lowers borrowing cost of the Govt. Vote of confidence in stability and growth prospects of the country