Master of Business Administration- MBA Semester 4

MF0017-Merchant Banking and Financial Services

Q1 Explain the concept of book building and methods or guidelines of book building
with 75 and 100% of book building.

Ans.CONCEPT OF BOOK BUILDING:
Book building is the process through which the prices of IPOs (securities issued first time
for public) are obtained through the demand of market. Through the mechanism of book
building, companies can raise capital from the general public by offering Initial Public
Offers (IPOs) as well as by issuing Follow-on Public Offers (FPOs). In the process of book
building, the investors send their bids at the price which seems reasonable within a price
range.
GUIDELINES BY SEBI
On the recommendations of Malegam committee, the concept of Book Building
assumed significance in India as SEBI approved, with effect from November 1, 1995, the
use of the process in pricing new issues.
SEBI issued the guidelines under which the option of 100%book-building was
available to only those issuer companies which are to make an issue of capital of and above
Rs. 100crore.
These guidelines were modified in 1998-99.The ceiling of issue size was reduced to
Rs. 25crore.
SEBI modified book-building norms for public issues in 1999
and allowed the issuer to choose either the existing or the
modified mode of book building.

Modified Guidelines:-
Compulsory display of demand at the terminals was made optional.
The reservation of 15% of the issue size for individual investors could be
clubbed with fixed price offer.
The issuer was allowed to disclose either the issue size or the number of
securities being offered.
The allotment of the book built portion was required to be made in Demat mode
only.

Types of Book-Building:
The Companies are bound to adhere to the SEBIs guidelines for book building offers in the
following manner:
75% book building
100% book building
75 per cent Book-Building Process:
Under this process 25 per cent of the issue is to be sold at a fixed price and the balance of
75 per cent through the Book Building process.

2. Offer to Public through Book Building Process:
The process specifies that an issuer company may make an issue of securities to the public
through prospectus in the following manner:
A. 100 per cent of the net offer to the public through book building process, or
B. 75 per cent of the net offer to the public through book building process and 25 per cent
of the net offer to the public at a price determined through book building process.
100% book building


BOOK BUILDING
METHOD
FIXED PRICE
METHOD
75% OF THE PUBLIC ISSUE CAN
BE OFFERED TO INSTITUTIONAL
INVESTORS WHO HAVE
PARTICIPATED IN THE BIDDING
PROESS.
25% OF THE PUBLIC ISSUE CAN
BE OFFERED THROUGH
PROSPECTUS AND SHALL BE
RESERVED FOR ALLOCATION TO
INDIVIDUAL INVESTORS WHO
HAVE NOT PARTICIPATED IN
THE BIDDING PROCESS.
TOTAL PUBLIC ISSUE
(i.e. net offer to the public)
CHART 1

75% OF THE NET OFFER THROUGH BOOK BUILDING PROCESS



Q2. Issue management is one of the important functions of merchant bankers and lead
bankers. Explain the two types of activities pre issue obligation and post issue obligation.
Also write on the concept of Application Supported by Blocked Amount (ASBA).

Ans. Management of issues involves marketing of corporate securities equity shares,
preference shares and debentures by offering them to public.
Pre-issue activities:
They prepare copies of and send it to SEBI and then file them to Registrar of Companies
They conduct meetings with company representatives and advertising agencies to decide
upon the date of opening issue, closing issue, launching publicity campaign etc..
They help the companies in fixing up the prices for their issues
Documents to be submitted along with Offer Document by the Lead Manager
MOU
Inter-se Allocation of Responsibilities
Due-Diligence Certificate
Certificates signed by Company Secretary or Chartered Accountant
List of Promoters Group & other details
Promoter individual shareholding.
Stock exchanges on which securities proposed to be listed, Permanent A/c No.,
Bank A/c No. & passport No. of promoters.
Undertaking to SEBI
by promoter, promoter group & relatives of promoters
B/w date of filling offer documents & date of closure of issue.

Appointment of Intermediaries
Merchant Banker not lead manage issue:
If he is a promoter or a director of issuer company.
Can manage if securities listed/proposed to be listed on OTCEI.
Merchant Banker lead manage issue:
Associate of Issuer Company.
Involved in marketing of issue.
Underwriting
The lead merchant banker shall satisfy themselves about the ability of the
underwriters to discharge their underwriting obligations. The lead merchant banker
shall:

Post-issue activities:
It includes collection of application forms, screening of applications, deciding allotment
procedure, mailing of allotment letters, share certificates and refund orders

Post issue monitoring reports
The post issue lead merchant banker shall ensure the submission of the post issue
monitoring reports
Due diligence certificate to be submitted with the final post issue monitoring report. The
post issue lead merchant banker shall file a due diligence certificate in the format specified
along with the final post issue monitoring report. Redressal of the investor grievances. The
post-issue lead merchant banker shall actively associate himself with post-issue activities
namely allotment, refund and dispatch and shall regularly monitor redressal of investor.

Applications Supported by Blocked Amount (ASBA):
SEBI vide its circular no. SEBI/CFD/DIL/DIP/31/2008/30/7 July 30, 2008 introduced a
supplementary process of applying in public issues, viz., and the Applications Supported
by Blocked Amount (ASBA) process. The ASBA process shall be available in all public
issues made through the book building route.
The main features of ASBA process are as follows:
Meaning of ASBA: ASBA is an application for subscribing to an issue,
containing an authorization to block the application money in a bank account.
2. Self-Certified Syndicate Bank (SCSB): SCSB is a bank which offers the
facility of applying through the ASBA process.

Q3. Write short notes on:
a) Foreign Direct Investment (FDI) and its role
b) Foreign Currency Convertible Bonds (FCCB)

Ans. a) Foreign Direct Investment (FDI):
Foreign direct investment (FDI) in its classic form is defined as a company from one
country making a physical investment into building a factory in another country.
Include investments made to acquire lasting interest in enterprises operating outside of
the economy of the investor.
Generally speaking FDI refers to capital inflows from abroad that invest in the production
capacity of the economy and are:
Usually preferred over other forms of external finance because they are
Non-debt creating, non-volatile and their returns depend on the performance of the
projects financed by the investors.
FDI also facilitates international trade and transfer of knowledge, skills and
technology.

The FDI relationship consists of a parent enterprise and a foreign affiliate which together
form a multinational corporation (MNC).
In order to qualify as FDI the investment must afford the parent enterprise control over its
foreign affiliate.
The IMF defines control in this case as owning 10% or more of the ordinary shares or
voting power of an incorporated firm or its equivalent for an unincorporated firm.
Foreign Direct Investment (FDI) is permitted as under the following forms of investments-
Through financial collaborations.
Through joint ventures and technical collaborations.
Through capital markets via Euro issues.
Through private placements or preferential allotments.

b) Foreign Currency Convertible Bond (FCCB):
A Foreign Currency Convertible Bond (FCCB) is a type of convertible bond issued in a
currency different than the issuer's domestic currency.
In other words, the money being raised by the issuing company is in the form of a foreign
Currency. It gives two options. One is, to get the regular interest and principal and the other
is to convert the bond into equities. It is a hybrid between bond and stock.
Benefits to companies
Some companies, banks, governments, and other sovereign entities may decide to issue
bonds in foreign currencies because:

gives issuers the ability to access investment capital available in foreign markets.

coupon
and principal payments, but these bonds also give the bondholder the option to convert the
bond into stock.
-50 percent
lower than the market rate because of its equity component.

Q4 Depository helps in the transfer of securities from one investor to another in an
electronic form. Write the differences between Bank and Depository. Explain the
functions performed by Depository.
Ans. Bank vs. Depository:
A depository functions like a bank. As banks deal with the funds of the clients and depository
deals with the holding of the security accounts. Both maintain their respective accounts in
obedience with the prevailing rules and by-laws.

DIFFERENCE BETWEEN BANK AND DEPOSITORY
BANK DEPOSITORY
Allocates account number.
Holds funds in accounts
Minimum balance required.
Functions through branches.

Issues account statement &
pass book.

Charges commission/ service
charges.





Provides interest to the
account holders.
Allocates client ID number.
Holds securities in accounts.
Normally no minimum balance
required.
Functions through depository
participants.
Issues account statement i.e.
statement of holding and statement
of transactions.
Depository Participant charges:
o Account opening and closing
fee
o Demat and Remat fee
o Transaction fee (buy, sell,
off market)
o Custody charges
In future, through stock lending, it
will be possible to earn income on
Depository Account.

Functions of Depository:
Dematerialization: One of the primary functions of depository is to eliminate or minimize the
movement of physical securities in the market. This is achieved through dematerialization of
securities. Dematerialization is the process of converting securities held in physical form into
holdings in book entry form.
Account Transfer: The depository gives effects to all transfers resulting from the settlement
of trades and other transactions between various beneficial owners by recording entries in the
accounts of such beneficial owners.
Transfer and Registration: A transfer is the legal change of ownership of a security in the
records of the issuer. For affecting a transfer, certain legal steps have to be taken like
endorsement, execution of a transfer instrument and payment of stamp duty. The depository
accelerates the transfer process by registering the ownership of shares in the name of the
depository.
Corporate Actions: A depository may handle corporate actions in two ways. In the first case,
it merely provides information to the issuer about the persons entitled to receive corporate
benefits. In the other case, depository itself takes the responsibility of distribution of corporate
benefits.
Pledge and Hypothecation: The securities held with NSDL may be used as collateral to
secure loans and other credits by the clients. In a manual environment, borrowers are required
to deliver pledged securities in physical form to the lender or its custodian. These securities
are verified for authenticity and often need to be transferred in the name of lender. This has a
time and money cost by way of transfer fees or stamp duty.

Q5. Every investor has his own risk perceptions and objectives of investment. Write
about Mutual funds also write down about the benefits and disadvantages of Mutual
funds which is very essential for all the investors to know.

Ans. Mutual Funds:
A mutual fund is an investment company which pools together the funds of investors
having a common objective. The funds collected under one common objective are invested
in various investment avenues (equity, bond, preference shares, real estate, gold, off shore
funds etc.) and managed by professional fund managers. The whole investment in a mutual
fund is divided into various units and each investor is known as a unit holder.
Advantages of Investing Mutual Funds:
1. Professional Management - The basic advantage of funds is that, they are professional
managed, by well qualified professional. Investors purchase funds because they do not
have the time or the expertise to manage their own portfolio.
2. Diversification - Purchasing units in a mutual fund instead of buying individual stocks
or bonds, the investors risk is spread out and minimized up to certain extent. The idea
behind diversification is to invest in a large number of assets so that a loss in any
particular investment is minimized by gains in others.
3. Economies of Scale - Mutual fund buy and sell large amounts of securities at a time,
thus help to reducing transaction costs, and help to bring down the average cost of the
unit for their investors.
4. Liquidity - Just like an individual stock, mutual fund also allows investors to liquidate
their holdings as and when they want.
Disadvantages of Investing Mutual Funds:
1. Professional Management- Some funds doesnt perform in neither the market, as their
management is not dynamic enough to explore the available opportunity in the market,
thus many investors debate over whether or not the so-called professionals are any better
than mutual fund or investor himself, for picking up stocks.
2. Costs The biggest source of AMC income is generally from the entry & exit load
which they charge from investors, at the time of purchase. The mutual fund industries
are thus charging extra cost under layers of jargon.
3. Dilution - Because funds have small holdings across different companies, high returns
from a few investments often don't make much difference on the overall return. Dilution
is also the result of a successful fund getting too big.
4. Taxes - when making decisions about your money, fund managers don't consider your
personal tax situation. For example, when a fund manager sells a security, a capital-gain
tax is triggered, which affects how profitable the individual is from the sale.

Q6 Rating methodology is used by the major Indian credit rating agencies. Explain on
the main factors that are analyzed in credit rating agencies and also on the limitations
on the limitations of credit rating.

Ans. Factors analyzed in credit rating agencies:
A Credit Rating issued by a credit rating agency is an assessment of the credit
worthiness of individual financial securities (For example, a bond) and debt issued by
corporations, government issued securities or even a countrys ability to repay debt.
Credit Ratings are assigned by rating agencies to companies and debt instruments, are
designed to gauge the likelihood that a company will default on its obligations to creditors.
Thus, they give investors a rough idea of the risk associated with loaning money to the
entity being rated.
Credit ratings are forward-looking opinions about credit risk. It expresses the agencys
opinion about the ability and willingness of an issuer, such as a corporation or state or city
government, to meet its financial obligations in full and on time.
Credit ratings provide individual and institutional investors with information that
assists them in determining whether issuers of debt obligations and fixed-income
securities will be able to meet their obligations with respect to those securities.
Credit rating agencies provide investors with objective analyses and independent
assessments of companies and countries that issue such securities. Globalization in the
investment market, coupled with diversification in the types and quantities of securities
issued, presents a challenge to institutional and individual investors who must analyze risks



DISADVANTAGES OF CREDIT RATING:

1. Biased rating and misrepresentations: It is very important that credit rating agencies
function independently and are objective in their assessment of companys financial position
and its ability to meet its obligations on time.
2. Static study: Rating is done on the basis of present and past historical data of the
company and this is only a static study.
3. Concealment of material information: The issuer company might conceal vital
information from the investigation team of the agency.
4. No guarantee for soundness of company: Independent views should be formed by the
user public in general of the rating symbol.
5. Human bias: Human bias may adversely affect the credit rating.
6. Subsequent downgrading: credit rating agencies would review the grade and downgrade
the rating resulting into impairing the image of the company.
7. Reflection of temporary adverse conditions: it might get low rating which might
adversely affect companys interest.
8. Difference in rating of two agencies: Rating done by two different credit rating for the
same instrument of the same issuer company in many cases can be different.