1.1What is GNP? A 1.1 GNP stands for Gross National Product. This statistic measures the total money value of all the final goods and services produced by a country’s nationals in a year. The GNP of Top 10 countries in the year 2004 is shown in the below table: GNP Top Country 1 2 3 4 5 6 7 8 9 10 Table 1: GNP of top ten countries GNP is calculated as: GNP = (Gross Domestic Product (GDP) + income earned by residents from overseas investments) – (income earned within domestic economy by overseas residents) GDP on the other hand, is computed as: GDP = (Consumption + government purchases + investments + exports) - imports Q 1.2 What is Recession? A 1.2 A Recession is usually defined as a fall of a country's real Gross Domestic Product in two or more successive quarters of a year. A recession may also involve falling prices, which can lead to a depression; alternatively it may involve sharply rising prices (inflation), in which case this process is known as stagflation. Most recessions lead to falling inflation rates or what is called disinflation. Example 1.2: • • Asian financial crisis - 1997, caused by a collapse of the Thai currency Early 2000s recession - 2000 to 2003 due to the collapse of the Dot Com Bubble 10 (2004) (currency exchange rate) GNP ($ mill) United States $10,945,792 Japan $4,389,791 Germany $2,084,631 United Kingdom $1,680,300 France $1,523,025 China $1,417,301 Italy $1,242,978 Canada $756,770 Spain $698,208 Mexico $637,159
Q 1.3 What is Depression?
A 1.3 Depression means 6 quarters of declining GNP. A 1.2 The key symptoms of Depression are low production and sales and a high rate of falling businesses and high unemployment. Some key examples of depression are: US Long Depression 1870s – 1890s • • Great Depression in the 1930s Situation in Japan after “bubble burst” in the 1990s
Q 1.4 What is Business Cycle? A 1.4 The Business Cycle is a periodically repeated sequence of fluctuations in the aggregate economy of a nation, varying in duration, measured by the pattern of movement in real gross domestic product (GDP) and consisting of: a) expansion, including recovery and prosperity; b) cyclical peak; c) downturn, including recession; and d) cyclical trough. These cycles create price changes, which lead to changes in total spending in relation to the amount of goods and services being produced. The curve showing all the 4 phases in Business cycle is shown below.
Figure 1: Business cycle (Source: Q 1.5 What is Inflation? A 1.5 Inflation is an increase in the general price level of goods and services , which results in decrease of purchasing power. It is normally associated with economic expansion and a low unemployment figure. The Inflation rates of few countries from 1950-1994 is shown in the below curve: Pink = France, Green = Germany, Gray = Japan, Red = UK, Blue = US.
Q 1.6 What is Deflation? A 1.6 Deflation is a decline in prices, where production exceeds demand. Deflation normally occurs during recessions and leads to a rise in unemployment. Since 1930, it has been the norm in most developed countries for average prices to rise year after year. However, before 1930 deflation (falling prices) was as likely as inflation . Example 1.6 : On the eve of the First World War, prices in the UK, overall, were almost exactly the same as they had been at the time of the great fire of London in 1666. Did you know? Deflation is different from Disinflation. Q 1.7 What is CPI? A 1.7 CPI stands for Consumer Price Index. This is an indicator of the average change in prices of goods and services. Included in the index are food, transportation, medical care, entertainment and other items purchased by households and individuals.It is a tool used for measuring the rate of inflation. Table 2, given below contains the data on CPI for industrial workers: Table No. 2 GROUP-WISE ALL-INDIA AVERAGE CONSUMER PRICE INDEX NUMBERS FOR INDUSTRIAL WORKERS ON BASE: 1982=100 FOR THE PERIOD 1993 TO 2003 Year Calendar Year Average Pan, Supari, Tobacco andFuel & General Food Housing Intoxicants Light 1993 252 265 334 230 222 1994 278 296 361 241 234 1995 306 331 389 254 248 1996 334 359 422 286 276 1997 358 380 467 320 293 1998 405 437 505 348 366 1999 424 444 553 370 430 2000 441 452 587 435 456
Clothing, Bedding and Footwear 197 219 247 267 281 293 303 316
Misc. 246 267 289 314 346 377 410 436
Current Account A. U.8 BOP Data -.658 Net -375. and U.739 -14. to borrow money. A payment represents dollars flowing out of the country or any transaction that requires the conversion of dollars into some other currency.9 What is Prime Rate?
A 1. The three main components of the Balance of Payments are: The Current Account including Merchandise (Exports Imports).investment abroad. profits.136 -444.401 444.S.Investment Banking
2001 458 462 614 475 498 320 458 2002 477 474 629 524 549 331 483 2003 496 490 648 558 577 337 503 Table 2: GROUP-WISE ALL-INDIA AVERAGE CONSUMER PRICE INDEX NUMBERS FOR INDUSTRIAL WORKERS ON BASE: 1982=100 FOR THE PERIOD 1993 TO 2003 Source: Labour Bureau Government of India Q 1.667 1.667 Account 0
(Rents. other payments) Example 1.024. Transfers Current Account Balance II.678 352. A receipt represents any dollars flowing into the country or any transaction that require the exchange of foreign currency into dollars. Profits) C.417 -367. and The Balancing Account allowing for changes in official reserve assets (SDR's. usually well established companies. Interest.8 What is Balance of Payments? A 1. B. Capital Account A. Statistical Discrepancy Capital Account Balance III.952 1.866 Payments -1.2000 ($millions) Category I. Investment income (rents. Foreign Investment in the U. Gold.218 -580. Balancing (Official Reserve Transfers) Q 1.224. interest) The Capital Account measuring Foreign investment in the U. Investment Abroad C.S.9 Prime rate is the rate of interest banks charge their best customers.S. Merchandise (Exports/Imports) B.8 The Balance of Payments 'BOP' is an account of all transactions between one country and all other countries--transactions that are measured in terms of receipts and payments. Income Receipts Account Account 848.
S. Where as the Disintermediation is the process in which investors withdraw funds on deposit with banks and savings and loans. Q 1.in/ as on 15/12/2005 Did you know?Base rate is the British equivalent of the U. unit of accounts and store of value”. These "intermediaries" in turn to invest the funds in bonds or other securities with yields higher than the rates they are paying depositors. Coming together of Individuals is a MUST for formation of a company.co. There are different kinds of companies: Public Vs Private.11 Money is defined as: • • “Something acceptable and generally used as payment for goods and services” “Anything that functions as a means of payment (medium of exchange). which means “come together and share bread”. Q 1. Historically. prime rate Q 1. These merchants survived for two centuries in India.10 Intermediation is the process in which investors deposit funds in commercial banks and savings and loans. Companies can be created as proprietorship or partnership. the first company was registered in 1602 and it was Dutch East India Company. “com panis”.11 What is Money? A 1.12 The word company originated from the Latin word. thereby causing the first currency’s exchange rate to plummet. and invest directly in securities with higher rates of return.9 The Prime Lending Rate of HSBC bank is currently at 13% per annum* *Source http://www.hsbc. Limited Vs unlimited liability. It is often used to describe the money invested in currency markets by speculators.
Example 1. Did you know? Hot money is the money that is held in one currency but is liable to switch to another currency at a moment’s notice in search of the highest available returns .10 What is the difference between Intermediation and Disintermediation? A 1.12 What is a Company? A 1.
In financial markets.3 What is Market Risk?
.1 What is meant by Risk? A 2. to borrow money
Q 2. The different type of risks which are involved in a Economy are: • • • • • • • Market Risk. The chance of things not turning out as expected is called as Risk. an asset.1 Q 2.2 What are the different types of Risks involved in Economy? A 2. is a statistic measure of all goods and services produced in the country in a full year A Recession is usually defined as a fall of a country's real Gross Domestic Product in two or more successive quarters of a year.Investment Banking
Session 1 : Basic Economic Concepts: Summary • • • • • • GNP (Gross National Product). Business Risk Interest Rate Risk Purchasing Power Risk Liquidity Risk Economic Risk Tax Risk
Q 2. which results in decrease of purchasing power Balance of payments is a summary of money flowing in and out of the country Prime rate is the rate of interest banks charge their best customers. the most commonly used measure of risk is the volatility (or standard deviation) of the price of. Depression means 6 quarters of declining GNP Inflation is a gradual rise in prices.2.1. or more appropriately the total returns on. Example 2. usually well established companies. Risk is directly proportional to return and hence assets with low risk yield low returns.
This is the risk that the rate of increase in the value of an investment may be lower than the prevailing inflation rate.2. If a company's earnings rise due to inflation. Did you know? Market risk is also known as systematic risk. bond prices fall to bring their yields in line with the interest rate market.diversifiable because regardless of how diversified an Investor’s portfolio is a decline in the overall market could cause prices of all positions to fall. the effect of one company's decline in earnings is minimized. In this Risk the price of a security will decline despite the strength of the underlying company. Purchasing power risk has a more serious effect on bonds because bondholders receive a fixed return based on the coupon rate. An illiquid. long term bonds are more sensitive to interest rate fluctuations than those with shorter maturities. if an investor's portfolio is well diversified. Q 2. If interest rates fall. Q 2. leading to a decline in Purchasing power.3.5 What is Interest Rate Risk? A 2. Did you know? Idiosyncratic Risk is an unsystematic risk that is uncorrelated to the overall market risk. Bond investors therefore suffer a loss of earnings in terms of real dollars. this is the risk that a company may experience a decline in earnings.7 What is Liquidity Risk? A. Business Risk is also called as financial risk. bonds with the longest maturities are affected the most. Again. and is characterized by a large difference between bid and asked prices. bondholders do not benefit from the increase. Q 2.4 What is Business Risk? A 2. or being forced to sell at an unfavourable price due to lack of a liquid market. In other words. When interest rates rise.6. consisting of stock in several different companies. or "thin" market usually involves an over the counter security.4. Interest rate risk is the effect of rising interest rates on the value of investments.7 This is the risk of not being able to sell a security. Business risk is diversifiable. Q 2. Because of the effects of compounding.5. impairing its ability to pay dividends or interest causing the price of its securities to decline. the risk that is firm specific and can be diversified through holding a portfolio of stocks.Investment Banking
A 2.6 What is Purchasing Power Risk? A 2. bond prices rise. This is considered non .
Municipal bond prices would then fall. Municipals' investors are at risk if tax rates are lowered. are at risk if taxes are raised. Economic risk includes the effects of adverse international developments. Prices of corporate securities would then fall. • Risk
Risk is something inherent in any investment. These are differences in risk as between instruments.9 What is Economic Risk? A 2. while returns on corporate debt. This necessitates the need of a proper understanding as to what is risk and what is return. This risk may relate to loss or delay in the repayment of the principal capital or loss or non-payment of interest or variability of returns. namely risk and return. Lower taxes would increase the effective after-tax yield on corporate securities. There are two fundamental aspects to any investment made by or on behalf of some investor.9.10. particularly bonds. Did you know? Systemic Risk is the risk of damage being done to the health of the financial system as a whole. This is why regulators often organise a rescue when a bank gets into financial difficulties Q 2.
. others are more risky. Tax risk is the effect of rising tax rates on the value of investments Interest on municipal securities is tax exempt. A constant concern of bank regulators is that the collapse of a single bank could bring down the entire financial system.below. Investors in corporate securities. to bring their equivalent yields in line with those of corporate securities.10 What is the relationship between Risk and Return? A 2. Q 2.8. to bring yields in line with those of municipals.Investment Banking
Q 2. While some investments are almost risk less (like Government Securities) or bank deposits. changes in government policies or legislation and changes in consumer demand. Higher tax rates would decrease their effective after-tax yields. which can be represented as a spectrum of risk. as well as dividends on preferred and common stocks are fully taxable. as in Figure 1.8 What is Tax Risk? A 2.
Figure1. Risk Reward Spectrum • Return
Return or yield essentially differs from the nature of financial instruments, maturity period, and the creditor or debtor nature of the instrument and a host of other factors. What influences return more is the risk. Usually, the higher the risk, higher is the return. Therefore return is the income plus capital appreciation in the case of ownership instruments (like common stocks) and only yield is the case of debt instruments like debentures or bonds Q 2.11 What is the Risk/Return Trade-off? A 2.11. Risk is defined as the chance that an investment's actual return will be different than expected. Measured in statistics by standard deviation. It means you have the possibility of losing some or even all of your original investment. Low levels of uncertainty (low risk) are associated with low potential returns. High levels of uncertainty (high risk) are associated with high potential returns. The risk/return trade-off is the balance between the desires for the lowest possible risk against the highest possible return. On the lower end of the scale, the risk-free rate of return is represented by the return on U.S. Government Securities because their chance of default is next to nothing. If the riskfree rate is currently 5%, this means for virtually no risk we can earn 5% per year on our money. Question 2.11 Conti
Figure 2. Dynamics of Risk-Return trade off. Q 2.12 What is the role of Tax benefits in the risk and return relationship? A 2.12. An added dimension to this game of risk and return is taxation benefits or the absence of the same. Say, some instruments floated by the government and semi government bodies enjoy tax benefits and hence their return is higher. Thus in India, post office deposits, bank deposits and government securities are exempt from tax, either in part or in full. The other forms of tax benefits are the exemption or rebate with respect to wealth tax or capital gains. The investments made in specified instruments of government and semi government securities, NSS, PPF etc are fully exempt from income tax. Q 2.12 What is the role of Tax benefits in the risk and return relationship? A 2.12. An added dimension to this game of risk and return is taxation benefits or the absence of the same. Say, some instruments floated by the government and semi government bodies enjoy tax benefits and hence their return is higher. Thus in India, post office deposits, bank deposits and government securities are exempt from tax, either in part or in full. The other forms of tax benefits are the exemption or rebate with respect to wealth tax or capital gains. The investments made in specified instruments of government and semi government securities, NSS, PPF etc are fully exempt from income tax. Session 2 : Basic Risks in a Economy :
• • • Risk is defined as the chance that an investment's actual return will be different than expected. Market Risk is the price of a security will decline despite the strength of the underlying company. Business Risk the risk that a company may experience a decline in earnings, impairing its ability to pay dividends or interest causing the price of its securities to decline.
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• Interest rate risk is the effect of rising interest rates on the value of investments. Brief Explanation of the CPI The Consumer Price Index (CPI) is a measure of the average change in prices over time of goods and services purchased by households. The Bureau of Labour Statistics publishes CPIs for two population groups: (1) the CPI for Urban Wage Earners and Clerical Workers (CPI-W), which covers households of wage earners and clerical workers that comprise approximately 32 percent of the total population and (2) the CPI for All Urban Consumers (CPI-U) and the Chained CPI for All Urban Consumers (C-CPI-U), which cover approximately 87 percent of the total population and include in addition to wage earners and clerical worker households, groups such as professional, managerial, and technical workers, the self-employed, short-term workers, the unemployed, and retirees and others not in the labour force. The CPIs are based on prices of food, clothing, shelter, and fuels, transportation fares, charges for doctors' and dentists' services, drugs, and other goods and services that people buy for day-to-day living. Prices are collected in 87 urban areas across the country from about 50,000 housing units and approximately 23,000 retail establishments- department stores, supermarkets, hospitals, filling stations, and other types of stores and service establishments. All taxes directly associated with the purchase and use of items is included in the index. Prices of fuels and a few other items are obtained every month in all 87 locations. Prices of most other commodities and services are collected every month in the three largest geographic areas and every other month in other areas. Prices of most goods and services are obtained by personal visits or telephone calls of the Bureau's trained representatives. In calculating the index, price changes for the various items in each location are averaged together with weights, which represent their importance in the spending of the appropriate population group. Local data are then combined to obtain a U.S. city average. For the CPI-U and CPI-W separate indexes are also published by size of city, by region of the country, for cross-classifications of regions and population-size classes, and for 27 local areas. Area indexes do not measure differences in the level of prices among cities; they only measure the average change in prices for each area since the base period. For the C-CPIU data are issued only at the national level. It is important to note that the CPI-U and CPI-W are considered final when released, but the C-CPI-U is issued in preliminary form and subject to two annual revisions. The index measures price change from a designed reference date. For the CPI-U and the CPI-W the reference base is 1982-84 equals 100.0. The reference base for the C-CPI-U is December 1999 equals 100. An increase of 16.5 percent from the reference base, for example, is shown as 116.5. This change can also be expressed in dollars as follows: the price of a base period market basket of goods and services in the CPI has risen from $10 in 1982-84 to $11.65.
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Colorado. The Northeast--Connecticut.0 115. Missouri.7 111. North Carolina. Hawaii. Massachusetts.040 x 100 4.040 0. Maryland. These data indicate what the percent change would be if the current rate were maintained for a 12-month period. Indiana. Index Point Change CPI Less previous index Equals index point change Percent Change Index point difference Divided by the previous index Equals Results multiplied by one hundred Equals percent change Regions Defined: The states in the four regions shown in Tables 3 and 6 are listed below. Washington. Michigan. Ohio. Virginia.12 -
. Kansas. Iowa. and the District of Columbia. because index point changes are affected by the level of the index in relation to its base period while percent changes are not. Minnesota. A Note on Seasonally Adjusted and Unadjusted Data: Because different groups use price data for different purposes. Arizona. North Dakota. Utah. and Wisconsin. 4. New Jersey. Oregon. The example below illustrates the computation of index point and percent changes. South Dakota. Georgia. West Virginia. Arkansas. California. The South--Alabama. Texas. Louisiana.2 0. Rhode Island. New Hampshire. New York. Nevada. and Wyoming. South Carolina. The Midwest--Illinois.Investment Banking
Calculating Index Changes Movements of the indexes from one month to another are usually expressed as percent changes rather than changes in index points. Percent changes for 3-month and 6-month periods are expressed as annual rates and are computed according to the standard formula for compound growth rates. Nebraska. The West--Alaska. and Vermont. Mississippi. the Bureau of Labour Statistics publishes seasonally adjusted as well as unadjusted changes each month. New Mexico.5
. Florida. Oklahoma. Pennsylvania.5 111. Montana. Kentucky. Tennessee. Maine. Delaware. Idaho.2 4.
BLS advises against the use of these data in escalation agreements. Extreme values and/or sharp movements. are subject to revision for up to five years after their original release. not seasonally adjusted data will be used for the last 5 years. Beginning with the calculation of seasonal factors for 1996. For the fuel oil. model changeovers. Data from January 2000 through December 2004 were replaced in January 2005. the procedure was used to offset the effects of labour and supply problems for coffee. If any of the 73 components change their seasonal adjustment status from seasonally adjusted to not seasonally adjust. Combining the seasonal movement of 73 selected components derives the seasonal movement of all items and 54 other aggregations. including the all items index levels. dependently Seasonally adjusted series were revised for January 1987-December 2001 as a result of a change in the aggregation weights for dependently adjusted series. and sales. motor fuels. production cycles. which might distort the seasonal pattern. and educational books and supplies indexes. this procedure was used to offset the effects that extreme price volatility would otherwise have had on the estimates of seasonally adjusted data for those series. Each year. the Bureau of Labour Statistics has used an enhanced seasonal adjustment procedure called Intervention Analysis Seasonal Adjustment for some CPI series. changes in milk supply. The unadjusted data are of primary interest to consumers concerned about the prices they actually pay. and. For further information. Seasonally adjusted indexes and seasonal factors are computed annually. Seasonally adjusted data. For this reason. are estimated and removed from the data prior to calculation of seasonal factors. Intervention Analysis Seasonal Adjustment allows for better estimates of seasonally adjusted data. seasonally adjusted changes are usually preferred since they eliminate the effect of changes that normally occur at the same time and in about the same magnitude every year--such as price movements resulting from changing climatic conditions. Many collective bargaining contract agreements and pension plans. Note: 43 of the 73 components are seasonally adjusted for 2005. and large swings in soybean oil inventories affecting the Fats and oils series. holidays. Exceptions to the usual revision schedule were: the updated seasonal data at the end of 1977 replaced data from 1967 through 1977. X-12-ARIMA software was used for Intervention Analysis Seasonal Adjustment. utility (piped) gas. please see "Aggregation of Dependently Adjusted Seasonally Adjusted Series.
. Unadjusted data also are used extensively for escalation purposes. tie compensation changes to the Consumer Price Index unadjusted for seasonal variation. For Dairy products. in January 2002. Each year the seasonal status of every series is re-evaluated based upon certain statistical criteria.13 -
. For the Non-alcoholic beverages index. The procedure was used to account for unusual butter fat supply reductions. The X-12-ARIMA Seasonal Adjustment Method derives seasonal factors used in computing the seasonally adjusted indexes. it mitigated the effects of significant changes in milk. the last 5 years of seasonally adjusted data are revised.Investment Banking
For analysing general price trends in the economy. for example. Effective with the calculation of the seasonal factors for 1990. but the seasonally adjusted indexes will be used before that period." in the October 2001 issue of the CPI Detailed Report.
Barter-The direct trading of goods and services between people without the use of money Interdependence.The value of a good or service stated in money terms. also called workers.All natural. Services. Public Goods . and currencies.The ratio of output (goods and services) produced per unit of input (productive resources) over a period of time. For Electricity. Money. Price. Opportunity Cost -The next best alternative that must be given up when a choice is made. occurs as a result of specialization.Activities that can satisfy people’s wants. Goods-Objects that can be held or touched that can satisfy people’s wants. also called an economic choice.Goods and services that are provides by the government."Gifts of nature" that are present without human intervention (also called land). human and human-made aids to the production of goods and services. Also called productive resources.The condition of not being able to have all the goods and services that we want. Not all alternatives. it was used to offset an increase in demand due to warmer than expected weather.People who use resources to make goods and services. a good that can be used to buy other goods and services. resources. Consumers-People.What someone must make when faced with two or more alternative uses for a resource. the method was used to account for the effects of hurricane-related disruptions.bls. Specialization. Resources. Source: The CPI home page on the Internet at http://www. the procedure was used to offset the effects of a model changeover combined with financing incentives.gov/cpi/ Glossary of Economic Terms
. Human Resources-The quantity and quality of human effort directed toward producing goods and services (also called labour).The situation in which people produce a narrower range of goods and services than they consume. Choice. increased rates to conserve supplies. They often too expensive or not practical to be obtained by individuals.A medium of exchange. Division of Labour -The process whereby workers perform only a single task or very few steps of a major production task. For Fresh vegetable series. and declining natural gas inventories. whose wants are satisfied by using goods and services.Dependence on others for goods and services. as when working on an assembly line. Capital Resources-Goods made by people and used to produce other goods and services (also called intermediate goods).14 -
. services.Investment Banking
butter and cheese production levels. Production/Producers. just the next best choice. Natural Resources. Productivity . Markets-Any setting where buyers and sellers exchange goods. For new vehicle series.
Equilibrium Price . for which owners receive payment. entrepreneurial income.Giving up one thing to get some of another. and losses act as incentives for participants to take action in a market economy.15 -
. Surpluses -The situation resulting when the quantity supplied exceeds the quantity demanded of a good. Demand . usually because the price is for some reason above the equilibrium price in the market.All resources used in producing goods and services. or resource. consumption. or resource. profits. Buyers and sellers making exchanges in private markets determine prices.Resources used by businesses to produce goods and services. Trade-offs . Property Taxes Taxes paid by households and businesses on land and buildings.Taxes paid by households and business firms on the income they receive. Circular flow .Trading goods and services with people for other goods and services or for money. service. Income Taxes . Unemployment . Prices. Investment in Human Resources . When people exchange voluntarily.The situation in which people are willing and able to work at current wages but do not have jobs. and distribution of goods and services. Trade/Exchange . Competition . Entrepreneurship -The human resource that assumes the risk of organizing other productive resources to produce goods and services.The difference between the total revenue and total cost of a business. Sales Taxes .Investment Banking
Economic Systems -The way a society organizes the production. Supply .Activities that increase the skills and knowledge of workers. Costs of Production . they expect to be better off as a result. Shortages. Profit .Factors that motivate and influence the behaviour of households and businesses. Market Economy -An economic system where private households and businesses exchange most goods and services through private transactions. Taxes. service. Investment in Capital Resources Business purchases of new plant and equipment.The situation resulting when the quantity demanded exceeds the quantity supplied of a good.The market clearing price at which the quantity demanded by buyers equals the quantity supplied by sellers.Required payments of money made to governments by households and business firms. Incentives.A model of an economy showing the interactions between households and business firms as they exchange goods and services and resources in markets.A schedule of how much producers are willing and able to produce and sell at all possible prices during some time period. Factors of Production .Taxes paid on the goods and services people buy.A schedule of how much consumers are willing and able to buy at all possible prices during some time period.Techniques used by businesses to gain more customers and to earn higher profits.
by your motivation and your intent to learn. and it was the forceful statement of this disagreement by early economists such as Thomas Malthus and David Ricardo that Carlyle reacted to. is that of English economist W. People generally learn more when their study is being carried out with a particular intent.16 -
.1 What is economics ? One of the earliest and most famous definitions of economics was that of Thomas Carlyle. 1. wrote that economics was “the mechanics of utility and self interest. In the first half of this lesson you will read about various economic problems and ideas.” What Carlyle had noticed was the anti-utopian implications of economics. one which is perhaps more useful. You will probably find at least some of the problems and ideas to be interesting. you might wonder if this lesson is really important. Stanley Jevons who. There is more to man than self-interest. Another early definition. Many utopians. You may then study economics with an intent to acquire knowledge and reasoning abilities that will help you to understand these ideas and solve these problems. Economists have always disputed this. who in the early 19th century termed it the “dismal science. Since you will learn what economics is about as you progress through the course. The degree of success that you will experience in your study of economics will be determined. in the late 19th century. believe that good results come from good motives and good motives lead to good results.” One can think of economics as the social science that explores the results of people acting on the basis of self-interest.
. people who believe that a society of abundance without conflict is possible. to a large extent. the purpose of this lesson is to help you understand what economics is about and what you can hope to learn by undertaking a study of economics.Investment Banking
BUSINESS ECONOMICS-I LESSON 1: INTRODUCTION TO BUSINESS ECONOMICS As the title suggests.
and the other social sciences—such as psychology. As you read further into these pages. Alfred Marshall’s Principles of Economics was the most influential textbook in economics. it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing. you will see that the assumption of self-interest.” By now you must have got an idea that scarcity is central in
.” Definitions of this sort emphasize that the topics with which economics is most closely identified concern those processes involved in meeting man’s material needs. that a person tries to do the best for himself with what he has. Thus it is on one side a study of wealth. At the turn of the century. and on the other. Marshall defined economics as “a study of mankind in the ordinary business of life. Perhaps the earliest of these is by Lionell Robbins in 1935: “Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses.” Many other books of the period included in their definitions something about the “study of exchange and production. Though the exact wording differs from author to author.17 -
. though exchange remains at the heart of economics.” In other words “Economics is the science of choice — the science that explains the choices that we make and how those choices change as we cope with scarcity. underlies virtually all of economic theory. sociology. Economists do more than study exchange and production. Economists today do not use these definitions because the boundaries of economics have expanded since Marshall. the standard definition is something like this: “Economics is the social science which examines how people choose to use limited or scarce resources in attempting to satisfy their unlimited wants. a part of the study of man. and political science—attempt to tell us about those other dimensions of man. and more important side.” Virtually all textbooks have definitions that are derived from this definition. anthropology. Most contemporary definitions of economics involve the notions of choice and scarcity.
Now let’s examine scarcity. governments and multinational institutions. the cost of reading this text is the enjoyment you would have received playing the game. Scarcity limits us both as individuals and as a society. This includes financial markets. limited resources (such as manpower. securities exchanges. insurers. one can view the cost of choosing option A as the sacrifice involved in rejecting option B. As a society. central banks . Scarcity requires choice. For example. choose more of something. When there is scarcity and choice. 1. The basic functions of the financial system include mobilization of savings and promotion of investments. machinery. People must choose which of their desires they will satisfy and which they will leave unsatisfied.
Q 3. and then say that one chooses option A when the benefits of A outweigh the costs of choosing A (which are the benefits one loses when one rejects option B).1 The firms and institutions that together make it possible for money to make the world go round constitute the financial system. there are costs. banks . Most of economics is based on the simple idea that people make choices by comparing the benefits of option A with the benefits of option B (and all other options that are available) and choosing the one with the highest benefit. scarcity forces us to take less of something else. Economics is sometimes called the study of scarcity because economic activity would not exist if scarcity did not force people to make choices. An effective financial system facilitates flow of funds from less productive to
.1 What is a financial system? A 3. either as individuals or as a society. such as the IMF and W orld Bank . mutual funds. if you gave up the option of playing a computer game to read this text. pension funds. and natural resources) fix a maximum on the amount of goods and services that can be produced. As individuals.2 Scarcity and Choice Scarcity means that people want more than is available. limited income (and time and ability) keep us from doing and having all that we might like.Investment Banking
these definitions. When we. such as the Securities and Exchange Commission (SEC) in the United States. The cost of any choice is the option or options that a person gives up.18 -
. Alternatively. national regulators.
In hawala. While the Investors look for the highest return for a given level of risk (by purchasing the securities for the lowest price).
Q 3.3 A financial market consists of investors or buyers. Trust is the only capital that the dealers have. the users of funds endeavour to borrow at the lowest rate possible.
Q 3. Money and monetary assets are traded in the financial system and hence the other important activities of the financial system include provision of liquidity and trading in liquidity.3What is a financial market? A 3. Simply put. The financial system provides the required intermediation between investors and the major borrowers.2 Liquidity is defined as cash and in general “nearness to cash”. sellers.4Who are the key participants in the Financial System?
. so physical movement is minimised. Example: A currency like sterling pound has greater liquidity than a life insurance policy. and recipients are given only a code number or simple token. no money moves physically between locations.19 -
. dealers and brokers and does not refer to any physical location in particular. The value of financial assets change with the investors' earning expectations or interest rates. nowadays it is transferred by means of a telephone call or fax between dealers in different countries. No legal contracts are involved. the ease with which an asset or an investment can be converted into ‘cash’. fast and free of bureaucracy
Q 3. Over time. With it.Investment Banking
more productive activities by capitalizing on the difference in the rate of return.2 Define Liquidity: A 3. to prove that money is due.
Did you know? Hawala is an ancient system of moving money based on trust . transactions in opposite directions cancel each other out. the users of hawala have a worldwide moneytransmission service that is cheap. Financial markets trade in money and their price is the rate of return the buyer expects the financial asset to yield. such as a low-value banknote torn in half. The participants in the market are linked by formal trading rules and communication networks which are used for originating and trading financial securities.
4. The following are the important functions
.5. Financial system consists of variety of institutions.5What are Important Functions Of Financial Markets? A 3.20 -
They are related as shown below:
Q 3. markets and instruments. The key participants in the financial system are: • • • • Financial Institutions.Investment Banking
Session 3 : Introduction to Financial Markets: Question 3. Suppliers of funds Financial Markets Fund Demanders.
In the absence of such a medium. a company sells bonds to investors.6.
R educe The Cost Of Transacting. The two main products issued by capital markets specialists are shares and bonds. However. Financial markets are classified based on the following parameters: • Financial Claim: Debt market & Equity market
The debt market is the financial market for fixed claims (debt instruments) and the equity market is the financial market for residual claims (equity instruments). Information costs refer to those costs incurred in evaluating the investment merits of financial assets.
Financial markets provide a sophisticated medium to the Investors to sell their financial assets as and when required. Investors buy them and 'share' in the profits of the company through dividends. The company is assured of long-term availability of funds heedless of who owns the securities. The price of financial assets is established by the regular and continuous interaction among the plentiful buyers and sellers who throng the financial markets. As well as companies.
• Facilitate Price Discoveries . at some point in future. the company promises to pay the bondholders their money back. Search costs comprise those explicit costs such as the expenses incurred on advertising when one wants to buy or sell an asset and implicit costs such as the effort and time put in to locate a customer. if there are any. Well-organized financial markets ensure accurate pricing of the assets. bonds are a form of debt. governments also borrow money on the debt markets.6How are Financial Markets classified? A 3. • Provide Liquidity To Financial Assets . the negotiable and transferable feature of the securities make it possible for companies to raise long-term funds from investors with short-term and medium-term horizons. Unlike equities.21 -
. in order to raise money. Shares are also known as equities. Like equities.
Search costs and Information costs are the two major costs associated with transacting of financial assets. To know the true value of a financial asset it is advisable to simply look at its price in the financial market.
Q 3. Added to this. the motivation of investors to hold financial assets dwindles.
Fig 2: Classification of financial markets
. Generally the cut-off between short-term and long-term financial claims has been one year.22 -
• Maturity Of Claim: Money market & Capital market Money market is referred to as the market for short-term financial claims and Capital market is referred to the market for long-term financial claims. The capital market is the market for long-term debt instruments and equity instruments. The secondary market or stock exchange where existing securities are traded. is an auction market and may have a physical location such as the rotunda of the Bombay Stock Exchange. It does not have a physical location. • Timing Of Delivery: Cash market & Futures market
A cash or spot market is one where the delivery occurs immediately and a forward or futures market is one where the' delivery occurs at a pre-determined time in future Question 3. • Type Of Issue: Primary market & Secondary market
The primary market is one in which public issue of new securities is made through a prospectus in a retail market. The money market is the market for short-term debt instruments as short-term financial claims are mostly debt claims. the trading floor of Delhi stock exchange where members of the exchange meet to trade securities directly. The investors in the retail market are reached by direct mailing.
The capital market has undergone a sea change after the formation of SEBI.8How did the Indian Capital Market evolve? A 3. the BSE is engaged in the process of converting itself to a demutualised corporate entity. The following table illustrates the rapidity at which the capital market has grown after the liberalization
. The Bombay Stock Exchange. The structure of the market and the investment options were quite primitive. Every public offer required the central government’s approval and the pricing of shares was restricted.8
Q 3. most of the Indian companies depended on the development financial institutions like ICICI. The Landowners and municipal bodies issued debt securities while small business houses issued equities. The rapid growth of the Capital market can be attributed to the increase in capital mobilization from investors and also due to the decline of development banking activities of the financial institutions. This paved way for the growth of capital markets.23 -
. it later on spread to almost all the major trading centres in the country and stock exchanges were formed in these places. The capital market has its beginnings in medieval Europe before the Industrial revolution. The evolution was further helped by the transformation of family run businesses in to publicly held corporations. Though in the initial years.Investment Banking
Q 3. the Indian capital market was focused on Bombay and Gujarat. BSE.8.9.7. the growth of the corporate form of organizations with limited liability provided a wide spread of shareholding wherein shares were freely transferable and tradable. IDBI etc for their capital requirements. Question 3. Currently. In the Post-Industrial Era. The Indian capital market is one of the oldest markets in Asia having founded nearly 200 years ago. the Capital Issues (Control) Act was repealed and a new regulatory authority called the Securities and Exchange Board of India was established under the Securities and Exchange Board of India Act 1992. The first deals in shares and securities happened in Bombay in the 1830’s. In the post-independence the presence of Capital Issues (Control) Act. the native brokers assembled in the famous Dalal Street in South Bombay to transact in shares and securities.9Describe the post-independence and post-liberalisation scenario of the capital markets: A 3. Due to these restrictions. After the liberalization in 1991. Before its formation.7How did the Capital markets evolve? A 3. 1947 controlled each and every fresh capital issue. The BSE was formed as a voluntary non-profit association of brokers primarily to protect their interests in the business of trading securities. was established in 1875 as “The Native Share and Stock Brokers Association”.
Q 3. such as equities and bonds. underwriters.10Name the Capital Market Constituents: A 3. The intermediaries consist of brokers. • Infrastructure: This is an essential requirement for the efficient functioning of the capital market. the regulators and the necessary statutory framework. custodians. the depositories. capital markets bankers produce financial products. • • Investors: These can be either wholesale investors like institutional investors such as mutual funds etc or retail investors. 1956. • Instruments: These are floated in the market to raise capital both in debt and equity.10. There are five basic constituents of a Capital market. It includes stock exchanges. convertibles such as fully or partly convertible debentures and warrants. preference shares. Intermediaries: These provide help in mobilizing resources from the investors and provide other support services. market makers. depository participants. The Government can also raise finance from the capital market using the long-term debt route. for companies that want to raise money.
. While most factories turn out widgets and other physical goods. Shares do not carry any assured return whereas debt instruments carry fixed interest. registrars and share transfer agents. Equity instruments include equity shares. either privately owned or owned by the government. merchant bankers. They are: • Issuers of Securities: These are basically companies incorporated under the Companies Act. Debt instruments include non-convertible debentures and bonds. Capital markets divisions are the factory floors of investment banks.
the creation of the “euro” market in the fifties and sixties gave it a firm establishment
.1 What is an international financial market? A 4.Investment Banking
• • • • • • Trading in money and monetary assets constitute the activity in the financial markets and are referred to as the financial system A financial market consists of investors or buyers.1 In the International financial market. sellers. provide liquidity t o financial assets and r educe the cost of transacting Financial markets provide a sophisticated medium to the Investors to sell their financial assets as and when required The Indian capital market is one of the oldest markets in Asia having founded nearly 200 years ago Money market is referred to as the market for short-term financial claims and Capital market is referred to the market for long-term financial claims Q1) Liquidity is defined as
answer id answer id answer id answer id
Please check one answ er
Cash and “nearness to cash” Investments Fixed assets Money market instruments
Q 4. funds are raised from lenders or investors in a country by borrowers or issuers from another country. dealers and brokers and does not refer to any physical location in particular. This market is generally outside the purview of any single country and consists of the global bond and equity markets and a huge derivatives market. The Three important functions of financial markets are to facilitate Price discoveries.25 -
. While the international financial market had its development in Europe around the fifties. Transactions are conducted in currencies other than the domestic currencies of respective countries. It enables the flow of excesses in certain economies to the deficit and more needy economies.
. Equity market 3. Foreign bond market 3.2 What is a Euro market? A 4.2 The Euro Market is a market in which financial instruments – both short and long terms – that are denominated in a variety of currencies other than the domestic currency of the host currency are transacted.3 The three segments of the International Financial Market are 1.4 Describe the bond market in detail: A 4.
Q 4. The international bond market consists of the following sub-segments: 1. Debt market 2. Euro bond market Domestic Bonds: • • • • • Issued by domestic companies in a particular country mainly to domestic investors Participation of overseas investors depending on local regulations Denominated in the currency of the country of issuance Usually fixed-interest instruments with tenor ranging from 1-30 years Issued either through a public offer or through private placements
Foreign bonds: • • • • Issued within the domestic capital market by a foreign issuer for domestic investors Participation of overseas investors is not allowed Denominated in the currency of the host country Requires to be permitted by local regulations of the host country
.4 The debt market consists of a bond market that is very vibrant and much sought after by foreign issuers.Investment Banking
Q 4. Domestic Bond market 2.3 What are the different segments of the International Financial Market? A 4. Derivatives market Q 4.
Global Depository Receipts (GDRs) are issued to the investors across the globe. The following diagram illustrates the schematic representation of Depository Receipts
. In the US. Private placement of the ADRs need not be registered under the SEC whereas the public issue must be registered.5 A Depository receipt (DR) is a security that represents ownership in a foreign security.Investment Banking
• • • • • Issued and sold in a jurisdiction outside the country of denomination Are issued in a different currency Not entirely regulated by the local laws of that country Primary issues are governed by government and central bank guidelines of the various countries in which the bonds are issued Secondary market trades are self regulated by International Securities Market Association
Q 4. if the GDRs have to be issued through the public route they need to be ADRs that comply with the US securities law. DRs are eligible to be traded on all US stock exchanges as well as many other European stock exchanges. The mechanism of ‘depository receipts’ for shares underlying them has been in existence since 1927 in the capital market of USA and was designed originally to aid US investors to trade in securities that were not listed on the US exchanges. American Depository Receipts (ADRs) were issued in the US for the benefit of the investors in the US.27 -
.5 What is a Depository Receipt mechanism? A 4. The Securities and Exchange Commission (SEC) regulates the issue of ADRs.
Q 4..6 What is a global depository? A 4.5 Conti
The depository receipt mechanism is an indirect way of inviting the foreign investors by issuing the shares in a foreign jurisdiction with a surrogate listing mechanism. the South Korean major made the first GDR issue in December 1990. Did you know? Samsung Co. ltd. DRs are issued with the support of an agency that acts as a global depository.Investment Banking
Question 4.28 -
. The functions of a global depository are: • • • To administer the DRs for the individual investors Handling transfer of DRs arising out of secondary market trades Dividend distribution
. This is made possible by issue of intermediary securities called depository receipts (DRs) that actually represent the underlying shares against which they have been issued.6 A Company in one jurisdiction can issue depository receipts in other jurisdictions where such issues are permitted. The extent of representation would depend on the terms of the issue like how many shares are represented by each DR.
7 The following figure depicts the relationship between the two. usually by a branch or correspondent in the country of issue. and economic risks as Question 4. one share or a bundle of shares of a foreign corporation. These shares represent the issued capital of the company.7
Q 4. depository bank. The underlying shares are not allowed to be traded in the domestic market because the DRs representing
The depository mechanism creates two distinct pools of securities • • One being the issued shares The other being the DRs representing those shares.Investment Banking
• • Recovery of withholding tax Conversion of the DRs into shares etc. ADRs are subject to the same currency.29 -
. representing foreign shares held by the bank.
Did you know?ADRs are American Depository Receipts. They are Certificates issued by a U. One ADR may represent a portion of a foreign share.S.7 What is the relationship between depository receipts and the shares underlying them? A 4.. political. The Issuing Company issues the requisite shares underlying the DRs in its domestic jurisdiction to a domestic custodian against receipt of cash from the investors for the DRs.
The DRs are listed and then traded on the exchanges where they are listed.
. Under current regulations. Indian companies are not supposed to make an issue of its shares abroad to the foreign public and list these shares directly on global exchanges.Investment Banking
Q 4. To invest in depository receipts. which are more convenient for the foreign investors whereas settlement in shares have to be cleared in domestic clearinghouses in India. Shares are listed only on the domestic stock exchanges and not on international stock exchanges. A capital gain through investment in shares in India by foreign investors is subject to taxes whereas there is no tax for capital gains made on DRs. they have to register with SEBI. foreign investors need not register with SEBI whereas to invest in shares. 3. 5. 6. Settlement of transactions in DRs happens through international settlement systems. 2.
Q 4.9 What do you mean by Fungibility of Depository Receipts?
. Lastly. 4.8 The following are the answers to the above question: 1. compliance with Foreign Exchange Management Act and RBI approvals is not required for sale of depository receipts by foreign investors.8 Why should there be a complicated issue of DRs instead of issuing shares directly to investors? A 4.
whether it is GOLD bars.
Q 4. foreign companies incorporated outside India may take an issue of IDRs in the Indian Capital market to raise funds. beads or shells.11 What are Foreign Currency Convertible Bonds? A 4.31 -
. A domestic depository in India issues these IDRs against shares of the issuing company. which are held by an overseas custodian bank.10 What does Two-way Fungibility of Depository Receipts mean? A 4.11 A company can issue bonds that are convertible in to depository receipts at a later date.12 Describe Indian Depository Receipts (IDRs): A 4.Investment Banking
A 4. Question 4. Something is fungible when any one single specimen is indistinguishable from any other. When such bonds are issued in the euro market they are known as euro convertibles.9 Fungibility refers to the convertibility of depository receipts in to the shares underlying them. The IDRs would be listed and traded in India like any other domestic shares issued by Indian companies. The Indian government had initially prescribed two year lock-in-period for GDRs to become fungible. Somebody who is owed $1 does not care which particular dollar he gets. The ADRs became fungible in US market in 1990. This provides for a two-way exit route to the foreign investors.12
Q 4.12 Under the IDR mechanism. Similarly. Fungibility makes the prospects for the investor better since the price differential between the depository and the underlying shares can be exploited to make arbitrage gains. a domestic investor may convert shares into tradable DRs but they can be traded in markets wherein the DRs are listed. The IDR mechanism is exactly the inverse of ADR/GDR mechanism. This means that an overseas investor may convert DRs in to shares but they can be traded only in the domestic market. This restriction is now removed. Did you know the meaning of “Fungible”? You can't tell them apart. The issue of IDRs is subject to the guidelines issued by the Indian Government. These are known as Foreign Currency Convertible Bonds or FCCBs in India. They can exit either through the sale of DRs in the overseas market or through the sale of shares in the domestic market.10 Two-way Fungibility of DRs implies that DRs and the shares underlying them are convertible both ways but within their respective jurisdictions.
Q 4. Anything that people want to use as MONEY must be fungible. The reverse Fungibility process is being governed by RBI guidelines.
metals and other products like energy.14
Q 4. extensions of the existing products like interest rate.These contracts are futures and options on standard contracts of various commodities transacted in wholesale. For example: Tea.13 What is a Derivative? A 4. weather derivatives and insurance derivatives. futures and options on stock indices. Question 4. Also.32 -
. Financial Derivatives . Derivatives can be made of any variable (not necessarily financial assets) like price of sugar to the amount of snow falling at a certain location. there is now active trading in credit derivatives. With the developments happening in the derivatives market. options on stocks. They are traded in the over-the-counter market usually between two financial institutions or between a financial institution and its clients Forward Contracts on foreign exchange are very popular They can be used to hedge foreign currency risk Both the parties to a contract have a binding commitment in the contract
.Financial Derivative Contracts are interest futures. electricity derivatives. The main types of derivatives are: • • • Forwards Futures Option markets
Forward Contracts: • • • • • • They are simplest form of derivatives They are basically agreements to buy or sell an asset at a certain future time for a certain price. foreign exchange and equity derivative products have been created. currency futures. bandwidth etc.Investment Banking
Q 4. a stock option is a derivative whose value is dependent on the price of a stock. For example. Commodities Derivatives . oilseeds. etc.14 What are the types of derivatives? A 4.13 A Derivative can be defined as a financial instrument whose value is derived from the values of the underlying traded assets.14 Derivatives are either Financial Derivatives or Commodity Derivatives.
They are traded on exchanges unlike forward contracts They carry certain standardised features as per exchange specifications They carry a guarantee given by the exchange to both the parties that the contract will be honoured The underlying assets are a very wide range of commodities and financial assets
Options: • • • • • • • • • The right to buy or sell an asset is referred to as an Option Options are traded both on exchanges and in the over-the-counter market There are two basic types of options namely “call option” and “put option” Call option gives the holder the right to buy the underlying assets by a certain date for a certain price Put option gives the holder the right to sell the underlying asset by a certain date for a certain price The price in the contract is known as the “exercise price” or the “strike price” The date in the contract is known as the “expiration date” or “maturity” The holder of an option does not have to exercise his right whereas in forwards and futures. Derivatives exchanges have been in existence for a long time.33 -
. The Chicago
Q 4. are traded.Investment Banking
• • One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price The other party assumes a short position and agrees to sell the asset on the same date for the same price
Futures Contracts: • • • • • They are basically agreements between two parties to buy or sell an asset at a certain time in the future for a certain price.15 What is a Derivatives Exchange? A 4.15 A derivatives exchange is a market where standardized contracts. which have been defined by the exchange. the holder is obligated to buy or sell the underlying asset There is a cost to acquiring an option whereas it costs nothing to enter into forwards and futures.
People generally learn more when their study is being carried out with a particular intent. are traded 2 11.
Summary • The Euro Market is a market in which financial instruments – both short and long terms that are denominated in a variety of currencies other than the domestic currency of the host currency are transacted. • • • • • • • The debt market consists of a bond market that is very vibrant and much sought after by foreign issuers A Depository receipt (DR) is a security that represents ownership in a foreign security The depository receipt mechanism is an indirect way of inviting the foreign investors by issuing the shares in a foreign jurisdiction with a surrogate listing mechanism Fungibility refers to the convertibility of depository receipts in to the shares underlying them Under the Indian Depository Receipts (IDR) mechanism. foreign companies incorporated outside India may take an issue of IDRs in the Indian Capital market to raise funds A Derivative can be defined as a financial instrument whose value is derived from the values of the underlying traded assets A derivatives exchange is a market where standardized contracts. The degree of success that you will experience in your study of economics will be determined. 1848 and the Chicago Mercantile Exchange. you might wonder if this lesson is really important.34 -
. which have been defined by the exchange. by your motivation and your intent to learn. In the first half of this lesson you will read about various economic
Board of Trade.104 © Copy Right: Rai University BUSINESS ECONOMICS-I LESSON 1: INTRODUCTION TO BUSINESS ECONOMICS As the title suggests. to a large extent. 1919 are considered to be pioneer derivatives exchanges. the purpose of this lesson is to help you understand what economics is about and what you can hope to learn by undertaking a study of economics. The underlying assets include foreign currencies and futures contracts as well as stocks and stock indices. Since you will learn what economics is about as you progress through the course.
is that of English economist W.”
. Stanley Jevons who. you will see that the assumption of self-interest.1 What is economics ? One of the earliest and most famous definitions of economics was that of Thomas Carlyle. Alfred Marshall’s Principles of Economics was the most influential textbook in economics. Economists have always disputed this. Thus it is on one side a study of wealth. people who believe that a society of abundance without conflict is possible.” What Carlyle had noticed was the anti-utopian implications of economics. 1. wrote that economics was “the mechanics of utility and self interest. underlies virtually all of economic theory. As you read further into these pages. There is more to man than self-interest. a part of the study of man. and political science—attempt to tell us about those other dimensions of man. Marshall defined economics as “a study of mankind in the ordinary business of life. that a person tries to do the best for himself with what he has. and more important side. You will probably find at least some of the problems and ideas to be interesting. Another early definition. You may then study economics with an intent to acquire knowledge and reasoning abilities that will help you to understand these ideas and solve these problems.” One can think of economics as the social science that explores the results of people acting on the basis of self-interest. and the other social sciences—such as psychology. and it was the forceful statement of this disagreement by early economists such as Thomas Malthus and David Ricardo that Carlyle reacted to. and on the other. At the turn of the century. who in the early 19th century termed it the “dismal science. sociology. it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of wellbeing.35 -
.” Many other books of the period included in their definitions something about the “study of exchange and production.Investment Banking
problems and ideas. believe that good results come from good motives and good motives lead to good results. one which is perhaps more useful. Many utopians. anthropology. in the late 19th century.
” In other words “Economics is the science of choice — the science that explains the choices that we make and how those choices change as we cope with scarcity. either as individuals or as a society. choose more of something. Economics is sometimes called the study of scarcity because economic activity would not exist if scarcity did not force people to make choices. 1.Investment Banking
Definitions of this sort emphasize that the topics with which economics is most closely identified concern those processes involved in meeting man’s material needs. Now let’s examine scarcity. Most contemporary definitions of economics involve the notions of choice and scarcity. limited income (and time and ability) keep us from doing and having all that we might like. scarcity forces us to take less of something else.” Virtually all textbooks have definitions that are derived from this definition. When we.2 Scarcity and Choice Scarcity means that people want more than is available. People must choose which of their desires they will satisfy and which they will leave unsatisfied. Scarcity limits us both as individuals and as a society. and natural resources) fix a maximum on the amount of goods and services that can be produced. When there is scarcity and choice. Perhaps the earliest of these is by Lionell Robbins in 1935: “Economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses. machinery. As a society. there are costs. Though the exact wording differs from author to author. the standard definition is something like this: “Economics is the social science which examines how people choose to use limited or scarce resources in attempting to satisfy their unlimited wants. though exchange remains at the heart of economics.36 -
. The cost of
. As individuals. limited resources (such as manpower. Economists do more than study exchange and production. Scarcity requires choice.” By now you must have got an idea that scarcity is central in these definitions. Economists today do not use these definitions because the boundaries of economics have expanded since Marshall.
For example. and then say that one chooses option A when the benefits of A outweigh the costs of choosing A (which are the benefits one loses when one rejects option B). The significance of this subject is exemplified by focus on the securities markets at SIBOS this year (5-9 September). one can view the cost of choosing option A as the sacrifice involved in rejecting option B. the EU's internal market commissioner. the cost of reading this text is the enjoyment you would have received playing the game. According to McCreevy. an annual international banking conference and exhibition. such as a single pan-European central counterparty. if you gave up the option of playing a computer game to read this text.37 -
. Although the benefits of an integrated market are agreed.Investment Banking
any choice is the option or options that a person gives up. could help cut the high costs of cross-border trading. Last month. warned Europe's financial services industry that it was not moving fast enough in cutting the costs of cross-border trading in securities. president of JPMorgan Chase. cross-border clearing and settlement costs can be up to six times more than those of domestic settlements.
EU Moves Towards Integrating Capital Markets 18 Oct 2005 The high cost of cross-border trading in securities is driving debate on reform of Europe's capital markets and the creation of a pan-European capital market in order to cut costs. Alternatively. there is less consensus and lack of momentum on the method of integration. Charlie McCreevy. and therefore the creation of a panEuropean capital market. The session focused on issues
. He argues that the introduction of consolidated structures in the EU. which identified 15 barriers to efficient European clearing and settlement. as a "major issue for the capital markets" at a conference session on the Giovannini Group's report. Most of economics is based on the simple idea that people make choices by comparing the benefits of option A with the benefits of option B (and all other options that are available) and choosing the one with the highest benefit. The expense of crossborder security settlement was described by Andrew Crockett.
Alberto Giovannini. As mentioned. Mark Wellham. the UK has stamp duty while other countries will have no such practice. said the focus should be on "harmonisation of laws rather than infrastructure". whether to favour a consolidated competitive market structure. Internal Market Commissioner McCreevy claims the creation of consolidated structures in the EU will help cut the costs of cross-border trading in securities. laws. for instance. Although some respondents support the Commission's proposals to consider a directive on securities clearing and settlement. Aside from the question of whether to legislate. and how individual firms can be rewarded for making the investments necessary to achieve change. The EU Commission originally launched a consultation on objectives and actions to deliver efficient cross-border clearing and settlement in May 2002 and a second communication in April 2004 taking into account recommendations from the Giovannini Group's report. at a recent roundtable on cross-border clearing and settlement hosted by Rhyme Systems.38 -
. Euroclear believes the way forward for more efficient European clearing and settlement is through the harmonisation of market practices. senior relationship manager at Euroclear.Investment Banking
and challenges surrounding ongoing reform and harmonisation of Europe's capital markets. Ian Dalton explains how Euroclear. will comprise a different set of market practices than elsewhere and. product manager at Rhyme Systems. banks and exchanges. and consolidation of technology platforms and the interface used by clients to interact with Euroclear." At the SIBOS conference session. and how to ensure consistency between them. for example. One of the main obstacles in creating a pan-European capital market is the national dynamics of the clearing and settlement systems across Europe. In contrast. He agrees with the European Parliament's report that a rigorous regulatory impact assessment is needed before any legislation is proposed. CEO of Unifortune and chairman of the Giovannini Group. including many EU regulators. there is also lack of consensus on what to harmonise across Europe's capital markets. pointed out that though there was universal agreement on the challenges of creating an integrated capital market. Clearing and Settlement: Is Regulation Needed?. Crockett described how the securities industry still has a variety of issues to resolve including the relationship between European and global initiatives. explains: "If you look at custody and settlement. The settlement group is currently working on two programmes: harmonisation of market practices across the Euroclear group markets. post-trade operations in France. remains unconvinced that a directive focused on the activities of settlement systems will reduce cross-border settlement costs. opinion is divided. Charles Pugh. for instance. regulations and fiscal processes. or different versions of the same thing. and where necessary. momentum was a critical issue because participants were
. In his article.
Be it through harmonisation of laws and/or consolidation of platforms. there is consensus that an integrated European capital market will help reduce the costs of cross-border trading and also improve efficiencies within the European clearing and settlement infrastructure. Trevor Pitman. liberalised markets and initiatives to cut the costs of trading would be in favour of an integrated capital market. sadly been derailed by the pursuit of vested and perceived national interests. The European Commission is now deciding whether legislation. In his article. over time. Wigley argues that education and information dissemination is critical to "dispelling myths.39 -
. companies may have different systems for different markets but potentially [with an integrated European capital market] those companies could ultimately need only one where all their European trades are processed. This is mainly due to the different interests of market participants and European member states. "There are examples of domestic legislation and local infrastructure rules that are designed more with the protection of perceived national or local business interests in mind rather than the needs or interests of consumers. and to achieving the substantial benefits it would bring has. in turn. or other intervention." He believes that an integrated European capital market would be beneficial to corporate borrowers and. the lowest overall cost of trading and post-trading services combined with the greatest responsiveness to users' and consumers' needs. group managing director at Fitch Ratings. is necessary on European clearing and settlement. Rhyme System's Wellham agrees: "For players that deal largely in cross-border trades and in high volumes. a panelist at the conference session. cross-border charges will be reduced significantly through an integrated capital market. Euroclear's Dalton stresses the fact that the clearing settlement industry has a "moral obligation to contribute to the Commission's education". Bob Wigley." Both Euroclear and Merril Lynch advocate industry participation in moving forward development of efficient pan-European clearing and settlement. beneficial to the industry's rating agencies. said. comments: "Anyone in favour of free trade. in common with so many other well intentioned European initiatives. The next six months will be interesting and crucial for the securities industry as debate and consultation continues.Investment Banking
currently taking "a limited role". managing director and chairman EMEA at Merrill Lynch. In cross-border trade. Indeed." he added. counteracting protectionist strategies and creating greater awareness among the investment community that harmonisation will generate substantial benefits".
." He highlighted obstacles such as existing clearing and settlement structures that are not owned by organisations whose objectives are to achieve. "Progress towards the objective of pan-European infrastructure on clearing and settlement.
. It is a well-established truth that the Indian capital markets have taken significant strides in the last decade. but increased the attractiveness of the Indian capital markets to global investors.Investment Banking
Securities Market Infrastructure Trends in India Debopama Sen. It can be expected that the infrastructural measures recommended by the Committee would aim to build the same transparency and risk containment measures that exist in the equity markets today. In his 2005-06 Union Budget speech.9bn as of March 31. 2005. and the rapid growth of the derivatives market are testaments to the fundamental resilience and structural strength of the securities market.Originally published in Global Custody Review Continuous improvements in infrastructure and increased sophistication of available products are inevitable consequences of the rapid development of the Indian capital markets. Making India "a benchmark for the globe" is the mission statement of the Securities and Exchange Board of India (SEBI). The corporate debt market today in India is an over-thecounter market with bilateral settlement taking place directly between counterparties due to the absence of a central clearing house. regulatory. the Finance Minister of India announced that a committee of experts would look into the changes that are required to make the corporate bond market as vibrant as the equity capital markets. The fiscal year 2004-05 saw net investments from Foreign Institutional Investors (FIIs) reaching $10bn. Extending STP to the derivatives and debt markets
. the seamless implementation of T+2 settlement. and assesses their likely implications for foreign investors. Securities Country Manager India. with total net FII investment standing at $35. Continuous improvements in infrastructure and increased sophistication of available products are inevitable consequences of the rapid development of the Indian capital markets. The Committee will look into legal. and assess their likely implications for foreign investors. Citigroup . 2. We summarise below the major changes that are anticipated by the market in the coming months. The continuing inflow of foreign investment. summarises the major changes that are anticipated by the market in the coming months. tax and market design issues. The reforms undertaken by the Government over the last decade have not only refined and modernised the market infrastructure. 1.03 Oct 2005 . Citigroup Global Transaction Services. Debopama Sen. Enhancing the corporate bond market infrastructure SEBI had identified the need to build further transparency in India's corporate bond markets in its Strategic Action Plan for 2004-05.
.from confirmation to allotment and refunds . SMILE taskforce recommendations In April 2004.with the aim of reducing manual entry and avoidance of duplicate records. the FII share of open interest in the futures and options segment reached an all time high of 42 per cent. an indication of the significant interest shown by FIIs in the segment.Investment Banking
Straight through Processing (STP) was successfully introduced in the equity capital markets in 200203. In April 2005. 3.both paperbased and electronic. The clearing houses are voluntary bodies set up by the participating banks and post offices and they function in an autonomous manner. which has ensured STP for the equity capital markets. SEBI established the Securities Market Infrastructure Leveraging Expert (SMILE) taskforce to carry out a thorough "health check" of the securities market.
. The SMILE taskforce's recommendations for the primary market related to automating the primary market process in its entirety . SMILE published a report entitled "Infrastructure and Process Flows for the Primary Market" recommending increased automation in the entire process flow from confirmation to allotment to refunds. However. 4. The taskforce's suggestions to the mutual fund industry was to evaluate enhancing their reach by leveraging the existing depository infrastructure as an alternative to the existing collections centre model. Structural changes to payment and settlement infrastructure India's payment and settlement system currently involves a variety of payment instruments . Due to the multiplicity of operators. It is likely that the existing infrastructure for ensuring STP in the equity markets will be suitably enhanced so that it may operate in the derivatives and debt markets. SEBI mandated STP for all institutional transactions executed through the stock exchanges." The SMILE taskforce's recommendations are under review for implementation. In August 2004. The equity exchange traded derivatives segment in India has seen explosive growth since the commencement of trading on the exchanges in 2000 with average daily traded value being in excess of $3bn currently. the taskforce published "Infrastructure and Process Flows for Enhancing Distribution Reach in the Mutual Fund Industry. In January 2005. local practices vary from place to place. the process flow for debt and derivatives trading and settlement continues to be manual and paper-based. Settlement is characterised by the presence of multiple clearing houses (about 1050) handled by various legal entities. This also limits the scope of implementing innovations in the systems. In 2004. which may lead to a lack of coordination among organisations resulting in inconsistency of operations.
Vision 2005-08". The expansion of RTGS has been hampered by the relatively low penetration of technology in public sector banks. The developments.42 -
. Launch of derivatives trading. A reduction in operational costs will hasten the adoption of RTGS for securities settlements and reduce usage of paper-based instruments in the country.Investment Banking
In its vision document titled "Payment Systems .
. are the latest of a large number of initiatives. Launch of the Indonext Trading Platform on the BSE for Small and Medium
Sized Enterprises. Implementation of mandatory Straight Through Processing (STP) for
institutional equity trades. The Development of India's Market Infrastructure: Significant Milestones Since the establishment of the Securities and Exchange Board of India (SEBI) as the securities markets regulator in 1988. • • Introduction of the Market Participants and Investor (MAPIN) database. which are expected in the coming months. the Reserve Bank of India (RBI) has envisaged the Indian Retail Clearing function being entrusted to a separate single legal entity while the RBI remains the settlement institution for all clearing systems. Real Time Gross Settlement (RTGS) is expected to revolutionise the payments infrastructure in the country. which have been adopted so far. • Shortening of the settlement cycle from 30/14 days to a rolling T+2 settlement
cycle. • • • • Introduction of dematerialisation. operations and procedures will facilitate standardisation and efficiency in the processing of smaller value payments. Establishment of the Clearing Corporation of India Limited (CCIL) as the
clearing house for Government Securities and Forex. • • Introduction of Real Time Gross Settlement (RTGS). Implementation of risk management measures. The single entity having uniformity in structure. Citigroup India is a member of the National Payments Council constituted by the RBI. Significant milestones so far include the: • Replacement of open outcry trading with screen trading at the major stock
exchanges. much progress has been made in the modernisation of India's market infrastructure.
The reforms in the corporate debt market could herald in the era of anonymous order driven trading and a clearing house model of settlement . In the coming months. However.as opposed to cash . automation of broker back-offices in line with T+1 and the complications arising due to foreign investors and global custodians having operations and dealing rooms in multiple time zones. Further progress towards adoption of a T+1 rolling settlement cycle SEBI has envisaged a T+1 rolling settlement cycle for equity trades. In April 2005. This is likely to become more practical as RTGS becomes more widespread. Other key considerations include the presence of a banking sector infrastructure able to support T+1. The program may be extended to a wider base after a period of one year. the National Stock Exchange (NSE) announced the phased introduction of futures and options contracts for 70 additional individual securities as against 55-odd existing securities till then. gold or international instruments will be introduced in the future.settlement of derivative contracts will be possible before the second half of 2006. It remains to be seen whether the challenges of working with investors in multiple time zones hinders the introduction of a T+1 settlement cycle. however.Investment Banking
5. based on the exchange rate. The adoption of
. At this stage. Summary The Indian securities markets remain unique by virtue of its multiple exchanges and depositories. The basket of derivatives is expected to be expanded based on various instruments available internationally. The next three years would be crucial in the continuing development of the Indian capital markets as they will give direction and pace to the infrastructural and product reforms that are transforming the face of the securities market. Foreign Institutional Investors (FIIs) until now have had to deposit cash for collateral to satisfy margin requirements for derivatives trading.as distinct from the existing OTC trading and bilateral settlement that is in vogue today. Maturity of the derivative markets The rapid growth of the derivatives market in India has been remarkable. It is possible that new derivatives. securities lending and borrowing is expected to be introduced to handle settlement shortages by 1 June 2005. The widespread adoption of RTGS may build the necessary infrastructure for an efficient payments system. Index futures and options may be extended to other indices and stocks while stock futures and options could be extended to active securities. 7.43 -
. it seems unlikely that physical . SEBI and the exchanges are expected to publish guidelines that will enable FIIs to post securities as collateral. Implementation of securities lending and borrowing The absence of a widespread program of securities lending and borrowing has been a limiting factor to the introduction of the physical settlement of derivatives contracts. 6.
It also proffers the ability to earn mindboggling bonuses. which is nice.075 n = 1 FV = 50. What will the value of my investment be in 1 year's time? PV = £50. How we use this equation is important so it's worth going through the examples.075)1 FV = 4. I currently have £50. just for the avoidance of doubt. This is the essence of compound interest getting paid for something you've already received. 1. FV = PV(1+r)n eq. What is value of the extra interest? PV = £3. And here it is.000 x (1 + 0.25 Stewart Cowley. 1. simple equation.Investment Banking
automation in the primary market would address the existing gap between the secondary and the primary markets.075)1 FV = 53.750 So.750 at the end of one year.750 but what do I do then? Well.000 r = 7. I will receive £3.5% per annum for the next year. for my £50.750 of interest and you are forgoing your love of Italian suits to place on your money deposit for another year at 7.5% = 0.3.2.031.750 r = 7.a whole lifetime of employment rests upon the understanding and manipulation of a single.
Prices and Yields 1. At the end of one year I will receive the £3.5% = 0.075 n = 1 FV = 3.000 in a bank account which is less than generously offering 7.750 x (1 + 0.5%.44 -
. EXAMPLE OF COMPOUND INTEREST You have received £3. Newton Investment Management
. I could indulge my love of Italian suits and continue my deep desire to propel the UK trade deficit to new heights or being the sensible person that I am I could place it on deposit again and receive another year's interest plus interest on the interest that I have already earned.750 of interest.000 I will have £53.1. EXAMPLE OF INTEREST OVER ONE YEAR Due an excessively generous bonus system. if you know how to use it. CONFOUNDING COMPOUNDING Bond managers have it easy . 1 Contained in this equation is the ability to work out the Future Value (FV) of an investment whose Present Value (PV) is known and invested at a rate (r) for number of investment periods (n).
A company president can sell off his shares if news of an impending bankruptcy filing is announced in the Wall Street Journal. The efficiency of the market refers to the speed at which the disparate prices converge. The illegal form of insider trading involves information NOT readily available to the rest of the stockholders. Perhaps the biggest risk is the potential for rapid fluctuations in market prices. There are plenty of other instances where one can engage in the practice arbitrage. The presence of arbitrageurs typically causes the prices in different markets to converge: the prices in the more expensive market will tend to decline and the opposite will ensue for the cheaper market. Whenever an individual becomes a major stockholder or a senior officer in a company. The company president is considered an insider. They find tourists who need the convenience of a quick cash exchange. but his decision to sell his stock was based on information any other stockholder could have discovered. The difference between the two rates is the spread or profit. Tourists exchange cash for less than the market rate and then the money exchanger converts those foreign funds into the local currency at a higher rate. arbitrageurs can take advantage of varying liquidities between markets. Alternatively. Any stockholder is free to buy or sell their shares based on public information about the company's current or future financial outlook.
Insider Trading 'Insider trading' can refer to two separate financial transactions--one being perfectly legal and the other being subject to massive civil fines and possible prison time.45 -
. Foreign money exchangers operate their entire businesses on this principle. The term 'arbitrage' is usually reserved for money and other investments as opposed to imbalances in the price of goods. Engaging in arbitrage can be lucrative.Investment Banking
Did you know – Financial Markets Arbitrage Arbitrage is the activity of exploiting imbalances between two or more markets. the spread between two markets can fluctuate during the time required for the transactions themselves. would-be arbitrageurs can actually lose money. he or she must
. for example. The legal form of insider trading involves the sale of securities or stocks by officers of a company or stockholders who own more than 10% of the company. but it does not come without risk. one market does not know about or have access to the other market. In some cases. obviously. In cases where prices fluctuate rapidly. For example.
agree to keep certain events absolutely secret. LIBOR is calculated for periods as short as overnight and as long as one year. A department of the British Bankers Association averages the inter-bank interest rates being offered by its membership. especially for short durations. It is determined by rates that banks participating in the London money market offer each other for short-term deposits. The interest rate paid on Eurodollars
. The vice-president of that company and anyone he told about the FDA decision could be charged with insider trading. If. LIBOR applies not only to the Pound Sterling. he could not legally sell off his own shares or advise his friends and family to sell off their holdings. The most important financial derivatives related to LIBOR are Eurodollar futures. corporate executives everywhere could unfairly profit from their personal knowledge. for example. LIBOR is fixed for the 24 hour period. LIBOR is used in determining the price of many other financial derivatives. US depositors are not subject to Federal Reserve margin requirements. Insider trading is not a new white-collar crime. Regular stockholders without access to this information would not be able to sell off their stock in a failing company or reap the benefits of a company poised for success. allowing higher leverage of the funds. the use of privileged information for financial gain has been around since the inception of stock trading.46 -
. Generally. The decision to sell off stocks in a company that is about to receive devastating news would be based on privileged information. but also to major currencies such as the US Dollar. Swiss Franc. Due to London's importance as a global financial center. primarily in Europe. The Security and Exchange Commission (SEC) watches for signs of insider trading whenever companies experience huge losses or gains. a vice-president of a drug company learned that the Food and Drug Administration would not be approving his company's newest drug treatment for diabetes.
LIBOR LIBOR. However. By holding the deposits outside the country. even if these events could spell financial disaster for stockholders. Traded at the Chicago Mercantile Exchange (CME). including interest rate futures. Eurodollars are US dollars deposited at banks outside the United States. Without stiff penalties for insider trading. Japanese Yen and Canadian Dollar. swaps and Eurodollars. LIBOR is determined every morning at 11:00am London time. the London Interbank Offered Rate. the difference between the instantaneous rate and LIBOR is very small. While the rates banks offer each other vary continuously throughout the day. executives and major stockholders have an obligation to avoid the use of insider trading even if it means personal financial losses. is the most active interest rate market in the world. Most stockholders are free to make buying or selling decisions based on anything from a strong hunch to the latest pop culture trends.
It is commonly understood that "short" is used because the short seller is in a deficit position with his brokerage house. While LIBOR does have implications for transactions conducted in Euros. and Eurodollar futures provide a way of betting on or hedging against future interest rate changes. assume that shares in XYZ Company currently sell for $10 per share. hoping that it will decrease in value so that they can buy it back at a lower price and keep the difference. hoping that price will rise.
Short selling has been a target of ire since at least the 17th century when England banned it outright. If the price of XYZ shares later falls to $5 per share. while the other will have a variable rate. However. Conceptually similar to the LIBOR. the Euribor benchmark is defined and maintained by the European Banking Federation
In finance. short selling is selling something that one does not (yet) own. less than 5% of all shorts are done by public investors and traders.Investment Banking
is largely determined by LIBOR. and then immediately sell those shares for a total of $1000. Short sellers are widely regarded with suspicion because.47 -
. return the shares to their original owner. one party will have a fixed interest payment. are extremely important in providing a liquid secondary market for residential mortgages. two parties exchange sets of interest payments on a given amount of capital. A short seller would borrow (say) 100 shares of XYZ Company. they are profiting from the misfortune of others. to many people. The term "short" was in use from at least the mid-19th century. Most investors "go long" on an investment. and by extension LIBOR. Interest rate swaps are another significant financial derivative dependent on LIBOR. In a given year about 2% of stocks on the New York Stock Exchange are sold short.e. Short sellers borrow a security and sell it.
. which in turn allows lower interest rates on US mortgages. and make a $500 profit. the short seller would then buy 100 shares back for $500. Naked Short Selling). the advent of the Euro has brought with it the creation of the Euribor. Generally. The variable rate payment stream is often defined in terms of LIBOR. whereas at least 95% of short sales are done by broker-dealers and market makers who do not even always have to own shares to sell them (i. In an interest rate swap. For example. Interest rate swaps.
the broker usually in turn has borrowed the shares from some other investor who is holding his shares long. one may reasonably assume that interested parties have already established a short position in (i. You finally return them to the lender. The short seller takes a fundamentally negative. the broker itself seldom actually purchases the shares to loan to the short seller. anticipating that the price of the shorted stock will fall (not rise as in long buying). and it will be possible to buy at a lower price whatever was sold. Technically.Investment Banking
Short sellers were blamed (probably erroneously) for the Wall Street Crash of 1929. President Hoover condemned short sellers and even J. which are undervalued by buying those stocks. sold short) the stock being downgraded.
. you make a profit. Political fallout from the 1929 crash led Congress to enact a law banning short sellers from selling shares during a sharp downturn. Mechanism Short selling consists of the following: · · · · You borrow shares." to reverse the adage). Regulations governing short selling were implemented in 1929 and in 1940.
Short selling is the opposite of "going long". Legislation introduced in 1940 banned mutual funds from short selling (this law was lifted in 1997). You must "close" the position by buying back the shares (called covering) . as invariably the stock drops or even plummets when the "downgrade" hits the wire. Otherwise you make a loss. Therefore.e. thereby making a profit ("selling high and buying low. You sell them and the proceeds are credited to your account at the brokerage firm. Edgar Hoover said he would investigate short sellers for their role in prolonging the Depression. public investors are typically too late to short by the time the "downgrade" is heard on the news. which were sold short.48 -
. When Wall Street "downgrades" a stock. or "bearish" stance. The act of buying back the shares. just as traditional long investors attempt to profit on stocks. Day traders and hedge funds will often use short selling to allow them to profit on trading in stocks that they believe are overvalued. is called 'covering the short'. The short seller owes his broker and must repay the shortage when he covers his position.If the price drops.
pushing prices down is not as well tolerated as pushing prices up. If.2001. you can sell the stock now and buy it back at a lower price at a later date. say. This is referred to as a "locate". in order to sell stocks short. Of course. The bears. But. regulated broker-dealers not permit their customers to short securities without first obtaining a locate.S. bulls can likewise push up stocks. In these cases. This process of selling the stock without holding it is called short selling. Short selling is important for the overall functioning of the market. if the customer has fully paid for the long position. This is because such trading enables investors to take a bearish or a bullish view on the market. brokers come from loans made by the leading custody banks and fund management companies (see list below). you can short-sell only on a zero-plus tick. At the New York Stock Exchange. the seller must arrange for a broker-dealer to confirm that it is able to make delivery of the shorted securities. the broker cannot borrow the security without the express permission of the customer. for instance. however. If you want to bet on your hunch. the broker will not need to inform the customer that the long position is being used to effect delivery of another client's short sale. the customer borrowed money from the broker in order to finance the purchase of the security).S. In the U. Sometimes. That is one reason why even developed markets regulate short selling. In cases where the customer has not fully paid for the long position (meaning.50 and give the 100 shares back to the original owner keeping the profit.Venkatesh in Business Line’s Investment World on April 29.. Also read “Ban on short-selling” by B. Short selling can.Investment Banking
Example: Borrowing 100 shares from someone. for instance. Brokers have a variety of means to borrow stocks in order to facilitate locates and make good delivery of the shorted security. The vast majority of stocks borrowed by U. can deliberately push a stock down by short selling. and the broker must provide the customer with collateral and pay a fee to the customer.S. Infosys. brokers are able to borrow stocks from their customers who own "long" positions.when the stock drops. destabilise the market if not properly regulated. or shortsell the stock if you hold a bearish view. for instance.00 . THE Securities and Exchange Board of India (SEBI) recently banned short selling. the immediately preceding trades
. is overvalued at the current price and may fall sometime soon. selling them immediately at $1. you buy the stock if you are bullish. you buy them back for $0.49 -
. and it is a legal requirement that U. What is short selling and why did SEBI ban such trading? Suppose you hold a view that. given investor psychology.
why did SEBI ban short selling? Recall that the market was falling sharply in the last few weeks.1 Investment banks are essentially financial intermediaries. Once the securities are sold. Commercial banks were chartered exclusively to issue notes and make short-term business loans. In countries where
. They help interested parties in raising capital. In 1990. As put forth earlier. investment bankers make secondary markets for the securities as brokers and dealers. SEBI thought it fit to ban short selling. which will only push its price further down. where it is by legislation that they are separated. early investment banks were partnerships and were not subject to regulations that apply to corporations. and rightly so. Short selling typically precipitates the fall in such a trending market.2 Investment banks have often been thought to be as Commercial banks.
Q 6. both the terms have different connotations in United States.50 -
. corporate mergers and acquisitions. the zero-plus tick rule means that you can short-sell only at Rs 3. they could accept deposits as well as underwrite and trade in securities. While investment banks could not issue notes.Investment Banking
in Infosys are Rs 3. whether debt or equity in the primary market to finance capital expenditure. Now. Suppose Infosys is falling by.
Q 6. and securities trade.700 and Rs 3. Rs 3. which accepted deposits and made commercial loans. In USA such banks are the most important participants in the direct market by bringing financial claims for sale. Since falling equity values is bad news for investors and the economy. Investment banks were referred to as private banks and engaged in any business they liked and could locate their offices anywhere. say. About 100 firms are so large that they dominate the industry. traders will be tempted to profit from the trend by short-selling the stock. Rs 200 every day. This ensures that bears do not push prices down sharply by short selling.2 What is the difference between Investment Banks & Commercial Banks? A 6. In recent years some investment banking firms have diversified or merged with other financial institutions to become full service financial firms.700 and not at a lower price.700.1 What are Investment banks? A 6.710. Early investment banks in USA differed from commercial banks. there were 2500 investment banking firms in USA doing underwriting business. On the other hand. the distinction between commercial banks and investment banks is unique and is confined to the United States. who primarily help businesses and governments with raising capital. However.
acceptance of deposits is limited to commercial banks. valuing. make loans.3 In India commercial banks are restricted from buying and selling securities beyond five percent of their net incremental deposits of the previous year. Merchant banking in India is non-fund based except underwriting.3 How is the scenario for Investment Banking in India? A 6.both individual investors and larger entities such as hedge funds and mutual funds regarding shares and corporate and government bonds). Further. including mergers. banks provide investment-banking services as part of their normal range of banking activities. concerned with advising on the finances of corporations. Non-bank financial intermediaries accept deposits for fixed term are restricted to financing leasing/hire purchase.51 -
. For example. Such countries have what is known as universal banking system.
Q 6. underwrites securities. acquisitions and divestitures. Say for example. Only merchant bankers registered with the Securities and Exchange Board of India (SEBI) can undertake issue management and underwriting. For Investment banks management of the bank's own
Q 6.5 What are the Principal Functions Of Investment Banks? A 6. concerned with buying and selling shares both on behalf of the bank's clients and also for the bank itself. It envisages multiple business activities and can take number of forms ranging from the true universal bank represented by the German Model with few restrictions to the UK model providing a broad range of financial activities through separate affiliates of the bank and the US model with a holding company structure through separately capitalized subsidiaries.
Q 6. The following figure (figure 1). Corporate Finance.4 It refers to the combination of commercial banking and investment banking including securities business. investment and loan activities and housing finance.4 What is Universal Banking? A 6. each looking after one of the functions of investment banks. They can subscribe to securities in the primary market and trade in shares and debentures in the secondary market. They cannot act as issue managers or merchant banks. engage in brokerage activities and offer financial services. arrange mergers and offer portfolio services.Investment Banking
there is no legislated separation. which accepts deposits. and making recommendations to clients . Coming back to countries where investment banking and commercial banking are combined. concerned with investigating.5 Global investment banks typically have several business units. Research. and Sales and Trading. serves as an effective tool of rightly distinguishing between the above two banks. European Countries have universal banking system.
These brokerages assist in the purchase and sale of stocks.52 -
. with a view to make a profit for itself. In short the functions of Investment banks include: 1. Brokerage Services 3.Investment Banking
capital. is often one of the biggest sources of profit.8 Under Investment banking proprietary trading is what is generally used to describe a situation when a bank trades in stocks.
Q 6. commodities. This in turn also provides liquidity to the market.9
. Generally the highest profit margins come from advising on mergers and acquisitions. Question 6. they are not shy of making profit for itself by engaging in trading activities.7
Q 6. which assist other business in raising money in the capital markets (by selling stocks or bonds). bonds. Sales and Trading
Q 6.7 Brokerage Services.8Explain the “Proprietary Trading” Function: A 6.6 Explain the “Raising Capital” function: A 6. which involves helping customers raise funds in the Capital Market and advising on mergers and acquisitions. typically involves trading and order executions on behalf of the investors. Question 6. the banks may arbitrage stock on a large scale if they see a suitable profit opportunity or they may structure their books so that they profit from a fall in bond price or yields. For example. options.6 Corporate Finance is a traditional aspect of Investment banks. Though Investment Banks are usually defined as businesses. or other items with its own money as opposed to its customer’s money. Raising Capital 2.7Explain the “Brokerage Services” Function: A 6. bonds. Research Activities 5. Investment Bankers have had a palpable effect on the history of American business. as they often proactively meet with executives to encourage deals or expansion. or Proprietary Trading. Proprietary trading 4. and mutual funds.
. Sales is the term for the investment banks sales force. In the process of market making.9 Research.Investment Banking
Q 6. The primary reason for this is because the Investment Bank must take responsibility for the quality of the company that they are underwriting Vis a Vis the prices involved to the investor.10 Often referred to as the most profitable area of an investment bank. commodities. often with "buy" or "sell" ratings. Goldman Sachs etc). or other things the firm might have on its books. it is usually responsible for a much larger amount of revenue than the other divisions. Although in theory this activity would make the most sense at a stock brokerage where the advice could be given to the brokerage's customers. research has historically been performed by Investment Banks (JM Morgan Stanley.9Explain the “Research Activities” Function: A 6. investment banks will buy and sell stocks and bonds with the goal of making an incremental amount of money on each trade.11CORE BUSINESS PORTFOLIO 1. Another activity of the sales force is to call institutional investors to sell stocks. whose primary job is to call on institutional investors to buy the stocks and bonds.NON-FUND BASED Merchant Banking Services for • • • • Management of Public offers of equity and debt instruments Open offers under the Takeover Code Buy back offers De-listing offers
Advisory and Transaction service in • • Project Financing Syndicated Loans
Q 6. bonds. underwritten by the firm.
Q 6. is usually referred to as a division which reviews companies and writes reports about their prospects.11 What does the Business Portfolio of Investment Banks constitute? A 6.10 Explain the “Sales and Trading” Function: A 6.
Structured Finance Venture Capital Private Equity Preferential Issues Private Placements of equity and debt Business advisory and structuring Financial restructuring Corporate Reorganisations such as mergers and de-mergers. asset sales. FUND BASED • • • • • • • • • Underwriting Market Making Bought Out deals Investments in primary market Investment banks are essentially financial intermediaries. Acquisitions and takeovers Government disinvestments and privatisation Asset Recovery agency services (presently in take off stage) 2. Countries where investment banking and commercial banking are combined have universal banking system. Early investment banks in USA differed from commercial banks. Universal Banking refers to the combination of commercial banking and investment banking including securities business
. sell-off and exits. where it is by legislation that they are separated. corporate mergers and acquisitions.54 -
. strategic sale of equity. and securities trade. Distinction between commercial banks and investment banks is unique and is confined to the United States. hive-offs. which accepted deposits and made commercial loans. who primarily help businesses and governments with raising capital.
The SBI set up its merchant banking division in 1972 and the other banks followed suit.
Q 7. the Banking Commission report asserted the need for merchant banking activities in India and recommended a separate structure for merchant banks totally different from commercial banks’ structure.2 The advent of SEBI in 1988 was a major boost to the merchant banking activities in India and the activities were further propelled by the subsequent introduction of free pricing of primary market equity issues in 1992.Investment Banking
• Sales and Trading is often referred to as the most profitable area of an investment bank. ICICI was the first financial institution to set up its merchant banking division in 1973. SEBI started regulating the merchant banking activities in 1992 and a majority of the merchant bankers were registered with it. it is usually responsible for a much larger amount of revenue than the other divisions
Q 7.3 What were the major constraints in Indian Investment banking industry? A 7. Also not all the merchant bankers were able to transform themselves into full-fledged investment banks.1 How did Investment banking evolve in India? A 7.
Q 7. The erstwhile Grindlays Bank began its merchant banking operations in 1967 after obtaining the required license from RBI. The number of merchant bankers registered with SEBI began to dwindle after the mid nineties due to the inactivity in the primary market.1 For more than three decades. Currently bigger industry players who are in investment banking are dominating the industry. Both the banks focussed on syndication of loans and raising of equity apart from other advisory services.2 How did the formation of SEBI boost the Development of Investment banking in India? A 7. the investment banking activity was mainly confined to merchant banking services. Many merchant bankers succumbed to the downturn in the primary market because of the over-dependence on issue management activity in the initial years. Many of the merchant bankers were into issue management or associated activity such as underwriting or advisory.
. Post-1992. In 1972. Soon after Citibank followed through. there was lot of fluctuations in the issue market affecting the merchant banking industry.55 -
. The foreign banks were the forerunners of merchant banking in India. The merchant banks were meant to manage investments and provide advisory services.3 The major constraints were: • The Indian investment banks depended on issue management to a greater extent and so some of them had to perish due to the primary market downturn in the 90’s.
which would have otherwise paved way for other smaller players. • The lack of depth in the secondary market. the Indian financial services industry was characterised by debt services in the form of term lending by financial institutions and working capital financing by banks and non-banking financial companies. To prevent excessive exposure to business risk 2. NBFCs and financial institutions entered the merchant banking.4 Till the 1980s.Investment Banking
• The bigger industry players were the only ones to survive because of a general lack of institutional financing in a big way to fund capital market activity.5 What is the Structure of Indian Investment Banking Industry? A 7.5 The Indian investment banking industry has a heterogeneous structure for the following reasons: • The regulations do not permit all investment banking functions to be performed by a single entity for two reasons: 1.
Q 7. licensing and capital controls. Over the subsequent years. the merchant banking industry had faced a huge downturn due to recession in the capital markets.
The commercial banks are prohibited from getting exposed to stock market investments and lending against stocks beyond certain specified limits under the provisions of RBI and Banking Regulation Act.4 What are the Characteristics of Indian Investment Banking Industry? A 7. In the early nineties. merchant banking and asset management services flourished.56 -
Q 7. when the capital markets opened up. Many banks. Also. underwriting and advisory services driven by the boom in the primary market. To prescribe and monitor capital adequacy and risk mitigation mechanisms. Capital markets was still an unorganised industry and was mostly restricted to stock broking activity. the capital markets and investment banking activities came under lot of regulatory developments that required separate registration. especially in the corporate debt market could not supplement the primary market for any major development.
Merchant banking activities can be carried out only after obtaining a merchant-banking license from SEBI. This proved to be an impediment for the growth of the investment banking industry.
The Equity research activity has to be carried out independent of the merchant banking activity to avoid conflict of interest.7 Who are the major Players in the Indian Industry? A 7. ICICI.6
Q 7. Universal banks that function as investment banks are regulated by RBI under the RBI Act.
Q 7. 1992. Citibank and others offer almost all of the investment banking activities permitted in the country. SEBI governs the functional aspects of Investment banking under the Securities and Exchange Board of India Act. Ex: SBI. Certain banks like Canara bank and Punjab National bank have had successful merchant banking activities while some other subsidiaries have either closed their operations or sold off their business due to a couple of securities scam in the industry. SBI.
. Those investment banks that are incorporated under a separate statute are regulated by their respective statute. All Non-banking Finance Companies that function as investment banks are regulated by RBI under RBI Act. The middle level constitutes of some niche players and a few subsidiaries of the public sector banks. Kotak Mahindra.6 Explain in brief the regulatory framework for Investment banking: A 7. 1934. Stock broking business has to be separated into a different company
Question 7. 1934.57 -
.6 An overview of the regulatory framework is furnished below: • • • • • • All investment banks incorporated under the Companies Act. 1956 are governed by the provisions of that Act.Investment Banking
• • • Merchant bankers other than banks and financial institutions are not authorised to carry out any business other than merchant banking. The long-term financial institutions like ICICI and IDBI have converted themselves into full service commercial banks (called as Universal banks). 1999 with respect to foreign investment. The Indian investment banks have not gone global so far though some banks do have a presence in the overseas. Those investment banks that carry foreign direct investment either through joint ventures or as fully owned subsidiaries are governed by Foreign Exchange Management Act. IL&FS.7 Several big investment banks have set many group entities in which the core and non-core business segments are distributed. IDBI. IDBI.
10 How does the Future of Investment banking in India look like? A 7. Rabo India Finance ltd and so on.8 What are the Core Services of Indian Investment banks? A 7.10 The scope for investment banking in India is very big. and Price Water Coopers etc.9 They are • • • • Secondary Market Activities Asset Management Services Wealth Management Services (Private Banking) Institutional Investing
Q 7. Underwriting and Book Running Mergers and Acquisition Advisory Corporate Advisory
Q 7. Ernst & Young. Some of the pure advisory firms that operate in the Indian market are Lazard Capital. their markets are bound to broaden and their service deliveries poised to be more efficient. The technological and market developments influencing the capital market will also provide an additional impetus to the growth of the investment banks.
.9 What are the Support services and Businesses of Indian Investment banks? A 7. A lot of pure merchant banks and advisory firms have an opportunity to convert themselves in to full service investment banks. as much of it has not been exploited so far.Investment Banking
There are also merchant banks structures as NBFCs such as Alpic Finance.8 They are • • • Merchant Banking.
Q 7.58 -
. KPMG. With this. This proves to be a significant point for a bright future for the Indian investment banks.
• • The erstwhile Grindlays Bank began its merchant banking operations in 1967 after obtaining the required license from RBI The advent of SEBI in 1988 was a major boost to the merchant banking activities in India and the activities were further propelled by the subsequent introduction of free pricing of primary market equity issues in 1992 • Till the 1980s. 1996 Foreign Exchange Management Act.1 Which are the Acts that govern the Indian Statutory Framework for Capital markets? A 5. 1992 (SEBI Act) The Depositories Act. 1956 The Securities Contracts (Regulation) Act. the Indian financial services industry was characterised by debt services in the form of term lending by financial institutions and working capital financing by banks and nonbanking financial companies • • The Indian investment banking industry has a heterogeneous structure The commercial banks are prohibited from getting exposed to stock market investments and lending against stocks beyond certain specified limits under the provisions of RBI and Banking Regulation Act • The Indian investment banks have not gone global so far though some banks do have a presence in the overseas Question 5.1 The Indian capital market is regulated under the following broad statutory framework: • • • • • • The companies Act.
Q 5.59 -
.2 The following are the regulatory authorities for the capital market in India: 1. The Department of Company Affairs (DCA) 2. 1999 (certain provisions) (FEMA) The Income tax Act. 1956 (SCRA) The Securities and Exchange Board of India Act. The Department of Economic Affairs (DEA)
Q 5. 1961 (capital market securities) (IT Act)
The securities business is also affected by the provisions of the stamp law (both Central & State level laws) and relevant provisions of the Benami Transactions (Prohibition) Act 1988.2 Name the Regulatory Authorities of the Capital Markets in India and how do they control the capital market? A 5.
the SCRA and the Depositories Act were all administered by DEA.Investment Banking
3. The following are some of the areas that are regulated by SEBI: 1. 4. including the appointment of the chairman and members of the SEBI board. allotment and refunds.. They are Capital market division and the Stock exchange division. registration of charges. The SEBI Act. credit rating agencies etc. RBI and other agencies. holding of shareholder meetings etc. The Securities and Exchange board of India (SEBI) 4. Some of the focus areas are with respect to incorporation of companies. Prohibiting fraudulent and unfair trade practices relating to securities markets
. custodians of securities. It also deals with all the organizational matters related to SEBI.
and has regional offices in metros. who may be associated with the securities markets in any manner 3. participants. foreign institutional investors. Registering and regulating the work of depositories. The SEBI: The SEBI is the primary regulator of the working of the capital market in terms of the following: • • • • • New issues Listing agreements with stock exchanges Trading mechanisms Investor protection Corporate disclosure by listed companies etc. Registering and monitoring of the intermediaries like stock brokers etc.60 -
. The Reserve Bank of India (RBI) 6..
The Department of Economic Affairs (DEA): There are two divisions under the DEA. The functions and powers of SEBI are prescribed under sections 11 and 11A of the SEBI Act. annual reporting. The Central Listing Authority (CLA) 5. The Stock Exchanges The Department of Company Affairs (DCA): The Department of Company Affairs (DCA) is the main regulator for compliance under the Companies Act for prescribing rules and regulations for all capital market transactions to be made by companies. The business in stock exchanges and any other securities market 2. The DEA is responsible for the formulation of suitable policies for the development of the capital market in consultation with SEBI.
5. Promoting investor’ education and training of intermediaries 6. Prohibiting insider trading in securities 7. Regulating substantial acquisition of shares and take-over of companies Wide powers have been conferred on SEBI and it is the most important agency regulating the capital market in India. Its powers encompass the primary and secondary markets, the equity, debt and derivative segments and corporate disclosures and trading mechanisms of stock exchanges.
The CLA: It is a body constituted by SEBI for vetting of offers documents for public offerings in the primary market and for other related activities. The following are the functions of the CLA: • • • Receiving and processing of applications for letter precedent to listing from applicants Making recommendations to SEBI on issues pertaining to the protection of investors in securities Undertaking of any other activity delegated by SEBI.
The RBI: The Reserve Bank of India exerts an indirect influence on the Capital markets since it is more of a money market regulator. Some of the areas in which it exercises control are: • • Regulating the exposure of banks, FIs and other financial intermediaries in capital market instruments mostly related to equity & debt. Fixing the norms for regulating the flow of funds from the banking system to the securities market
Regulating the capital flows in the money market to regulate the liquidity in the financial system. RBI sucks out the excess liquidity in the system by the mechanism of repurchase options or Repos.
• • •
Carrying out the borrowing programmes of the Indian Government in the long-term debt market and the money market. Determination of bank rate, the benchmark for other interest rates in the economy including the rates at which capital market and money market instruments are traded. Regulating the flow of foreign funds in to the securities market.
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The Stock Exchange: The Stock market is a market body that wields some influence on the companies that are listed on it by virtue of the “Listing agreement” between itself and the company.
Stock markets can exert only contractual influence and not any legal influence on the companies. The following are the areas that are monitored by the Stock markets: • • • • • • Promotes discipline and adherence to corporate governance by listed companies Protects the interests of the investors Initiates action against defaulters as provided in the listing agreement In extreme cases enforces compulsory de-listing of companies Developing a fair and transparent trading mechanism Enforcing payments from market participants without any defaulters and bankruptcies
Q 5.3 What does Clearing Corporation do ? A 5.3 Clearing Corporation is an agency, which keeps track of buy and sell trades done by the members. For example: National Securities Clearing Corporation Limited (NSCCL), Clearing Corporation of India Ltd. (CCIL), etc. The clearing corporation calculates obligations for the member, for a given trading period. It can impose and collect margins on behalf of the exchange on outstanding positions of the members. The agency ensures settlement of the trades done on the stock exchange. Clearing Corporation acts as a clearing and settlement body for one or more stock exchanges like NSCCL in USA. Did you know? Clearing is the process of matching, guaranteeing and registering transactions and Automated clearinghouse - ACH is an electronic clearing and settlement system for exchanging electronic transactions among participating depository institutions; such electronic transactions are substitutes for paper checks and are typically used to make recurring payments such as payroll or loan payments. The Federal Reserve Banks operate an automated clearinghouse, as do some private-sector firms
Q 5.4 Who are the Capital Market Intermediaries? A 5.4 The following are the capital market intermediaries: 1. Stock brokers and Sub-brokers
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2. Depositories and Participants 3. Custodians 4. Share Transfer Agents 5. Debenture Trustees 6. Credit Rating Agencies 7. Portfolio Managers Question 5.5
Q 5.5 Who is a Stock Broker? A 5.5 Brokers are members of the stock exchange and trade on the stock exchange on behalf of the investors. Actual investors cannot directly trade on the stock exchange. Thus, the brokers establish a primary link between the securities market and the investors. The broker carries out trading activity for a brokerage fee. Even Corporate members can be brokers provided they meet the requirements of Securities Contracts (Regulation) Rules and SEBI. The books of stockbrokers are subject to audit by the stock exchange and inspection by SEBI.
Q 5.6 Who are Sub-brokers? A 5.6 Sub-brokers aid the brokers for the purpose of marketing securities or soliciting broking business. They function under the brokers and are not members of any stock exchange. The subbrokers have to compulsorily register with SEBI. All brokers have to maintain records of sub-brokers working under them.
Q 5.7 What is De-materialization? A 5.7 The method of converting physical securities into electronic form is known as dematerialization. For several decades the Indian market was trading in through the physical form. The physical form of securities led to lot of delays in trading and settlement and also there were lot of risks associated with it like loss in transit, damage to the security etc. So the conversion of physical form of securities into
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Q 5.11 A Custodian is a person or entity that deals with safekeeping of securities of a client and providing the following services: • • Maintaining accounts of securities of a client Collecting the benefits or rights accruing to the client in respect of securities
. without which de-materialization is not possible. Also unlike in the physical system.64 -
.8 What is Re-materialization? A 5.e. 1996. Depositories Act. governs depository system in India. the securities in the depository system become fungible.
Q 5. shares are grouped under share certificates with distinctive numbers for individual identification.
Q 5. In the physical system.9 A Depository is a central agency that maintains electronic records of securities.Investment Banking
electronic form and dealing with them through electronic transfers has eliminated several risks and delays.10 What is the Difference between Bank and Depository? A 5. Each DP is provided with a unique identification number by the depository and each investor who opens a demat account with a particular DP is also provided a unique investor number. National Securities Depository Limited (NSDL) 2. the securities do not have individual existence through distinctive numbers.
Q 5. Bank safeguards the money. Depository safeguards securities. i.10 Bank holds funds in the account and transfer funds between accounts without handling cash. In the depository system. the holding and trading of the securities is in scrip-less form (without physical certifications). The two depository institutions functioning currently in India are: 1.11 What is the role of a Custodian? A 5.8 The conversion of the electronic form of shares back in to its physical form is known as rematerialization.9 Who is a Depository? A 5. Depository on other hand holds securities in accounts and transfers securities between accounts without handling physical securities. Central Depository Services Limited (CDSL) Depository Participant (DP) acts on behalf of the Depository as an agent and becomes the interface between the investor and the Depository.
which provides for terms and conditions that govern the following: • • • • Issue of the debentures Creation of security Enforcement thereof in case of default Other provisions intended to protect the interests of debenture holders.Investment Banking
• • Keeping the client informed of the actions taken or to be taken by the issuer of securities. Credit rating is a recent development in India and was formally flagged off with the setting up of the Credit Rating Information Services of India Ltd (CRISIL) in 1988.
Q 5.13 What does a Debenture Trustee do? A 5.14 What role do Credit Rating Agencies have in the Capital Market? A 5. The other two
. Share Transfer Agents (STAs) are service providers who handle the process of maintaining ledger records of all the shareholders of a company and the day-to-day transactions of the shares of the company. The structure is framed through a debenture trust deed or a trusteeship agreement.65 -
.12 Who is a Share Transfer Agent? A 5.12 The shares of a listed company are traded on a daily basis on the stock exchange. SEBI regulates the STAs and make it necessary for them to register with it and impose minimum capital adequacy requirements etc. which is administered by the Debenture Trustee.
Q 5. The debenture holders are made the beneficiaries of the trust. The assets that are required to be secured for the debentures are secured in favour of the trust.
Q 5.14 Credit Rating is an assessment done on the issuer to find out the expected capacity and inclination of the issuer to service his obligations based on qualitative and quantitative factors. which entails frequent updating of records of shareholders and the register of members.13 The Debenture Trustees are appointed to address the interests of the debenture holders and safeguard their rights. having a bearing on the benefits or rights accruing to the client Maintaining and reconciling records of the services referred to above. The US based Standard & Poor and Moody’s are the largest credit rating agencies. The Credit rating is an assessment of the issue-specific default risk associated with an instrument to be subscribed by investors. This is being carried out by independent third party agencies on security issues by an issuer and conveyed to the investors.
undertakes on behalf of a client. which includes shares.
Portfolio managers are regulated by SEBI under the SEBI (Portfolio Manager) Rules 1993 and the SEBI (Portfolio Managers) Regulations 1993. A portfolio manager provides the following services: • • • • • Conducts in-depth research into the performances of companies with an investment angle Manages the investment of the clients’ funds in high income generating shares Monitors the portfolio and tracks corporate and market developments Manages to deal with lodging of physical securities if any Provides tax management services on investments. The SEBI is the primary regulator of the working of the capital market The CLA is a body constituted by SEBI for vetting of offers documents for public offerings in the primary market and for other related activities Brokers are members of the stock exchange and trade on the stock exchange on behalf of the investors A Depository is a central agency that maintains electronic records of securities. directs. bonds. They are Capital market division and the Stock exchange division. without which de-materialization is not possible
.15 A Portfolio is defined as the total holdings of assets (generally securities).). the management or administration of a portfolio of securities on a contract or arrangement basis.
Q 5. debentures or any other marketable securities. A Portfolio Manager is one who advises.66 -
. Credit Rating is regulated by SEBI under the SEBI (Credit Rating Agencies) Regulations 1999.15 What services do Portfolio Managers provide? A 5.
Summary • • The Indian capital market is regulated by six acts under a broad statutory framework The Department of Company Affairs (DCA) is the main regulator for compliance under the Companies Act for prescribing rules and regulations for all capital market transactions to be made by companies • • • • • There are two divisions under the DEA.) and Credit Analysis and Research Ltd (CARE Ltd. Also it is mandatory for all portfolio managers to register themselves with SEBI.Investment Banking
agencies are Credit Rating Agency of India Ltd (ICRA Ltd.
cross-border clearing and settlement costs can be up to six times more than those of domestic settlements. the EU's internal market commissioner. there is less consensus and lack of momentum on the method of integration. Although some respondents support the Commission's proposals to consider a directive on securities clearing and settlement. whether to favour a consolidated competitive market structure.67 -
. president of JPMorgan Chase.
EU Moves Towards Integrating Capital Markets 18 Oct 2005 The high cost of cross-border trading in securities is driving debate on reform of Europe's capital markets and the creation of a pan-European capital market in order to cut costs. The significance of this subject is exemplified by focus on the securities markets at SIBOS this year (5-9 September). warned Europe's financial services industry that it was not moving fast enough in cutting the costs of cross-border trading in securities. Crockett described how the securities industry still has a variety of issues to resolve including the relationship between European and global initiatives. Although the benefits of an integrated market are agreed. which identified 15 barriers to efficient European clearing and settlement. The session focused on issues and challenges surrounding ongoing reform and harmonisation of Europe's capital markets. Last month. According to McCreevy. and how individual firms can be rewarded for making the investments necessary to achieve change. and therefore the creation of a panEuropean capital market.Investment Banking
• Credit Rating is an assessment done on the issuer to find out the expected capacity and inclination of the issuer to service his obligations based on qualitative and quantitative factors. and how to ensure consistency between them. He argues that the introduction of consolidated structures in the EU. The EU Commission originally launched a consultation on objectives and actions to deliver efficient cross-border clearing and settlement in May 2002 and a second communication in April 2004 taking into account recommendations from the Giovannini Group's report. such as a single pan-European central counterparty. as a "major issue for the capital markets" at a conference session on the Giovannini Group's report. The expense of crossborder security settlement was described by Andrew Crockett. Charlie McCreevy. could help cut the high costs of cross-border trading. an annual international banking conference and exhibition.
regulations and fiscal processes. sadly been derailed by the pursuit of vested and perceived national interests. and consolidation of technology platforms and the interface used by clients to interact with Euroclear. the UK has stamp duty while other countries will have no such practice. The settlement group is currently working on two programmes: harmonisation of market practices across the Euroclear group markets. and where necessary. Clearing and Settlement: Is Regulation Needed?. senior relationship manager at Euroclear. said the focus should be on "harmonisation of laws rather than infrastructure". the lowest overall cost of trading and post-trading services combined with the greatest responsiveness to users' and consumers' needs. there is also lack of consensus on what to harmonise across Europe's capital markets. Charles Pugh. Aside from the question of whether to legislate." He highlighted obstacles such as existing clearing and settlement structures that are not owned by organisations whose objectives are to achieve. Mark Wellham. in common with so many other well intentioned European initiatives. managing director and chairman EMEA at Merrill Lynch. remains unconvinced that a directive focused on the activities of settlement systems will reduce cross-border settlement costs. Internal Market Commissioner McCreevy claims the creation of consolidated structures in the EU will help cut the costs of cross-border trading in securities. explains: "If you look at custody and settlement." At the SIBOS conference session.68 -
. CEO of Unifortune and chairman of the Giovannini Group. and to achieving the substantial benefits it would bring has. One of the main obstacles in creating a pan-European capital market is the national dynamics of the clearing and settlement systems across Europe. Euroclear believes the way forward for more efficient European clearing and settlement is through the harmonisation of market practices. This is mainly due to the different interests of market participants and European member states. will comprise a different set of market practices than elsewhere and. or different versions of the same thing. As mentioned. Alberto Giovannini. "There are examples of domestic legislation and local infrastructure rules
including many EU regulators. post-trade operations in France. for instance. Ian Dalton explains how Euroclear. momentum was a critical issue because participants were currently taking "a limited role". for instance. banks and exchanges. at a recent roundtable on cross-border clearing and settlement hosted by Rhyme Systems. said. over time. for example. In his article. In contrast. "Progress towards the objective of pan-European infrastructure on clearing and settlement. a panelist at the conference session. opinion is divided. laws. He agrees with the European Parliament's report that a rigorous regulatory impact assessment is needed before any legislation is proposed. pointed out that though there was universal agreement on the challenges of creating an integrated capital market. product manager at Rhyme Systems. Bob Wigley.
Euroclear's Dalton stresses the fact that the clearing settlement industry has a "moral obligation to contribute to the Commission's education". Wigley argues that education and information dissemination is critical to "dispelling myths. liberalised markets and initiatives to cut the costs of trading would be in favour of an integrated capital market. RITTER° University of Florida." He believes that an integrated European capital market would be beneficial to corporate borrowers and. is necessary on European clearing and settlement. Gainesville Contents Abstract 254 Keywords 254 1.Investment Banking
that are designed more with the protection of perceived national or local business interests in mind rather than the needs or interests of consumers. counteracting protectionist strategies and creating greater awareness among the investment community that harmonisation will generate substantial benefits". The European Commission is now deciding whether legislation. In cross-border trade. or other intervention. Trevor Pitman. in turn. In his article. The next six months will be interesting and crucial for the securities industry as debate and consultation continues.69 -
. comments: "Anyone in favour of free trade. Introduction 255
. Indeed. companies may have different systems for different markets but potentially [with an integrated European capital market] those companies could ultimately need only one where all their European trades are processed. there is consensus that an integrated European capital market will help reduce the costs of cross-border trading and also improve efficiencies within the European clearing and settlement infrastructure. group managing director at Fitch Ratings. Be it through harmonisation of laws and/or consolidation of platforms." Both Euroclear and Merril Lynch advocate industry participation in moving forward development of efficient pan-European clearing and settlement. Rhyme System's Wellham agrees: "For players that deal largely in cross-border trades and in high volumes." he added. beneficial to the industry's rating agencies. cross-border charges will be reduced significantly through an integrated capital market.
Business Ethics and Compliance in the Sarbanes-Oxley Era A Survey by Deloitte and Corporate Board Member Magazine Chapter 5 INVESTMENT BANKING AND SECURITIES ISSUANCE JAY R.
and securities trade.V. Seasoned equity offerings (SEOs) 261 2. Raghu Rau. Anand Vijh. Summary of explanations of new issues underpricing 289 ° This draft has benefited from comments from seminar participants at Emory University. They help interested parties in raising capital.3.3. Overview 277 4.1 Investment banks are essentially financial intermediaries. Initial public offerings (IPOs) 277 4. and City University of Hong Kong. Harris and R. Prospect theory 284 4.1. Overview 255 1. Short-run underpricing of IPOs 279 4.4. Lawsuit avoidance 288 4. Informational cascades 287 4. M. Kent Womack. Handbook of the Economics of Finance.2. Announcement effects 261 2. Reasons for underperformance 269 3.2.4. The comments of Tim Loughran are particularly appreciated. In USA such banks are the most important participants in the direct market by bringing financial claims for sale. Short-run and long-run reactions to corporate financing activities 272 4. All rights reserved
Q 6.4. who primarily help businesses and governments with raising capital.5. Hsuan-Chi Chen.4.1. Stulz © 2003 Elsevier Science B. the Hong Kong University of Science and Technology.2. Korea University.4. whether debt or equity in the primary market to finance capital expenditure.4. The information conveyed by investment and financing activities 259 2.7. Signalling 288 4. The IPO as a marketing event 288 4. Corruption 286 4. the University of California at Davis.1. Explanations of underpricing 284 4.4. A brief history of investment banking and securities regulation 257 1.Investment Banking
1.4.4. Alternative mechanisms for pricing and allocating securities 279 4.4.
.M.8.3. Chung-Ang University (Korea).1 What are Investment banks? A 6. Evidence on long-run performance 263 2. Edited by G. and from Alon Brav. The winner’s curse 286 4. Ren´e Stulz. as is research assistance from Donghang Zhang.3.6. Constantinides. Dynamic information acquisition 284 4.9.1. and Li-Anne Woo.70 -
.4.2. corporate mergers and acquisitions.
Investment banks were referred to as private banks and engaged in any business they liked and could locate their offices anywhere. They cannot act as issue managers or merchant banks. both the terms have different connotations in United States. investment and loan activities and housing finance. Non-bank financial intermediaries accept deposits for fixed term are restricted to financing leasing/hire purchase.71 -
. Say for example. engage in brokerage activities and offer financial services. there were 2500 investment banking firms in USA doing underwriting business. arrange mergers and offer portfolio services. which accepts deposits. banks provide investment-banking services as part of their normal range of banking activities. the distinction between commercial banks and investment banks is unique and is confined to the United States. However.3 How is the scenario for Investment Banking in India? A 6. Question 6. About 100 firms are so large that they dominate the industry. European Countries have universal banking system. Merchant banking in India is non-fund based except underwriting. Commercial banks were chartered exclusively to issue notes and make short-term business loans. acceptance of deposits is limited to commercial banks. and rightly so. While investment banks could not issue notes. they could accept deposits as well as underwrite and trade in securities. make loans. serves as an effective tool of rightly distinguishing between the above two banks.Investment Banking
Once the securities are sold. Early investment banks in USA differed from commercial banks. In countries where there is no legislated separation. In recent years some investment banking firms have diversified or merged with other financial institutions to become full service financial firms. Such countries have what is known as universal banking system.2 Investment banks have often been thought to be as Commercial banks. The following figure (figure 1). underwrites securities.2
Q 6. which accepted deposits and made commercial loans.
. In 1990.3 In India commercial banks are restricted from buying and selling securities beyond five percent of their net incremental deposits of the previous year.2 What is the difference between Investment Banks & Commercial Banks? A 6. investment bankers make secondary markets for the securities as brokers and dealers. early investment banks were partnerships and were not subject to regulations that apply to corporations. They can subscribe to securities in the primary market and trade in shares and debentures in the secondary market. Further. Coming back to countries where investment banking and commercial banking are combined. where it is by legislation that they are separated.
Q 6. As put forth earlier. Only merchant bankers registered with the Securities and Exchange Board of India (SEBI) can undertake issue management and underwriting. On the other hand.
Question 6. the banks may arbitrage stock on a large scale if they see a suitable profit opportunity or they may structure their books so that they profit from a fall in bond price or yields.5 What are the Principal Functions Of Investment Banks? A 6. Corporate Finance. acquisitions and divestitures. concerned with investigating. valuing. For example. or Proprietary Trading. Sales and Trading
Q 6. In short the functions of Investment banks include: 1. is often one of the biggest sources of profit.4 What is Universal Banking? A 6. Generally the highest profit margins come from advising on mergers and acquisitions.6 Corporate Finance is a traditional aspect of Investment banks. For example. which involves helping customers raise funds in the Capital Market and advising on mergers and acquisitions.4
Q 6. Research. Raising Capital 2. each looking after one of the functions of investment banks.6 Explain the “Raising Capital” function: A 6. It envisages multiple business activities and can take number of forms ranging from the true universal bank represented by the German Model with few restrictions to the UK model providing a broad range of financial activities through separate affiliates of the bank and the US model with a holding company structure through separately capitalized subsidiaries. concerned with advising on the finances of corporations. For Investment banks management of the bank's own capital.72 -
. concerned with buying and selling shares both on behalf of the bank's clients and also for the bank itself.
Q 6. and making recommendations to clients . and Sales and Trading. Investment Bankers have had
. Proprietary trading 4. Brokerage Services 3. Research Activities 5.4 It refers to the combination of commercial banking and investment banking including securities business.both individual investors and larger entities such as hedge funds and mutual funds regarding shares and corporate and government bonds). including mergers.5 Global investment banks typically have several business units.
7Explain the “Brokerage Services” Function: A 6. The primary reason for this is because the Investment Bank must take responsibility for the quality of the company that they are underwriting Vis a Vis the prices involved to the investor. options.9Explain the “Research Activities” Function: A 6.
Q 6. whose primary job is to call on institutional investors to buy the stocks and bonds.10
Q 6. Although in theory this activity would make the most sense at a stock brokerage where the advice could be given to the brokerage's customers.Investment Banking
a palpable effect on the history of American business.
Q 6.10 Often referred to as the most profitable area of an investment bank. Question 6. In the process of market making. commodities. These brokerages assist in the purchase and sale of stocks. typically involves trading and order executions on behalf of the investors. often with "buy" or "sell" ratings. bonds. This in turn also provides liquidity to the market. it is usually responsible for a much larger amount of revenue than the other divisions. Goldman Sachs etc). investment banks will buy and sell stocks and bonds with the goal of making an incremental amount of money on each trade. they are not shy of making profit for itself by engaging in trading activities.73 -
. is usually referred to as a division which reviews companies and writes reports about their prospects. Though Investment Banks are usually defined as businesses. Another activity of
Q 6. underwritten by the firm. bonds.8 Under Investment banking proprietary trading is what is generally used to describe a situation when a bank trades in stocks. and mutual funds. research has historically been performed by Investment Banks (JM Morgan Stanley. with a view to make a profit for itself.10 Explain the “Sales and Trading” Function: A 6. Sales is the term for the investment banks sales force. which assist other business in raising money in the capital markets (by selling stocks or bonds).7 Brokerage Services. as they often proactively meet with executives to encourage deals or expansion.8Explain the “Proprietary Trading” Function: A 6. Question 6. or other items with its own money as opposed to its customer’s money.
or other things the firm might have on its books. bonds. asset sales. strategic sale of equity.11 What does the Business Portfolio of Investment Banks constitute? A 6. sell-off and exits.
Q 6.NON-FUND BASED Merchant Banking Services for • • • • Management of Public offers of equity and debt instruments Open offers under the Takeover Code Buy back offers De-listing offers
Advisory and Transaction service in • • Project Financing Syndicated Loans
Structured Finance Venture Capital Private Equity Preferential Issues Private Placements of equity and debt Business advisory and structuring Financial restructuring Corporate Reorganisations such as mergers and de-mergers.11CORE BUSINESS PORTFOLIO 1.Investment Banking
the sales force is to call institutional investors to sell stocks.74 -
. commodities. Acquisitions and takeovers
and securities trade. FUND BASED • • • • Underwriting Market Making Bought Out deals Investments in primary market
12 What does the support activity portfolio of Investment banks constitute? A 6. who primarily help businesses and governments with raising capital. NON-FUND BASED Secondary Market services • • • Stock Broking Derivative products Portfolio management
Support services • • • • • • • • Sales and distribution Equity Research & Investment advisory Corporate research and information services Investment banks are essentially financial intermediaries. Early investment banks in USA differed from commercial banks. corporate mergers and acquisitions.75 -
Government disinvestments and privatisation Asset Recovery agency services (presently in take off stage) 2.12 SUPPORT ACTIVITY PORTFOLIO 1. Distinction between commercial banks and investment banks is unique and is confined to the United States. where it is by legislation that they are separated. Universal Banking refers to the combination of commercial banking and investment banking including securities business
. Countries where investment banking and commercial banking are combined have universal banking system. which accepted deposits and made commercial loans.
Q 9. named after their traditional meeting place. 1792. Two months later.2 In simplest terms. preferred stocks and derived securities. According to the securities contracts regulation act (1956).Investment Banking
• Sales and Trading is often referred to as the most profitable area of an investment bank.3 Describe the Securities Market: A 9. the auctioneers. these merchants signed a document named the Buttonwood Agreement.
Q 9. These instruments are called securities. Perfectly efficient markets present no arbitrage opportunities. to set trading fees. it is usually responsible for a much larger amount of revenue than the other divisions Question 9. Did you know? Arbitrage is the simultaneous buying and selling of a security at two different prices in two different markets. Perfectly efficient markets seldom exist. a Security represents the evidence of a property right. i.e. on May 17. The agreement called for the signers to trade securities only among themselves. but arbitrage opportunities are often precluded because of transactions costs
. There are four broad categories of securities: bonds.76 -
. it represents the claim on an asset and also any future cash flows that can arise from that asset. Stocks. Knowledge of securities market is essential if one has to know how securities are priced in these markets. securities include Shares. twenty-four of New York City's leading merchants met secretly at Corre's Hotel to discuss ways to bring order to the securities business and to wrest it from their competitors. Prices for financial assets will be set by these buyers and sellers.3 The market where securities are dealt with is called a securities market. bonds. resulting in profits without risk. and not to participate in other auctions of securities. It is mechanism for bringing together buyers and sellers of a particular type of security or a financial asset. 1792. a buttonwood tree. Securities are the source of funding to the corporate and non-corporate bodies by the method of borrowing or lending. common stocks. Scrips.1 In March.1How did the securities market evolve? A 9. debenture stock or any other marketable securities. These twenty-four men had founded what was to become the New York Stock Exchange.1
Q 9. Investing in capital markets can be done through various financial instruments..2 What are Securities? A 9. which in turn will finally influence the allocation of resources throughout the economy.
regardless of what the income of the firm may be during that period. the risk is correspondingly greater for the equity owners since they have the last claim to the firm’s income and assets. Lastly there is no legal requirement to pay dividends. Common stocks. If the company defaults on either interest or principal payments. the claims of bondholders are legally binding.4 Securities (or investment opportunities) are broadly categorized into the following • Bonds
Bonds have a fixed maturity that is the date when the firm has to pay all the liabilities it owes to the bondholder. are said to be perpetual. the bondholders are entitled to receive a stated amount (the principal). a samurai bond in Japan. On the other hand. This means that when the bonds mature. That is. Bondholders also have the right to receive their interest payment before any dividends are declared to the equity shareholders. The other facet to this that the equity owners can claim everything that remains after all other claims have been met. and so on. and this claim has priority over any of the claims of the equity owners. dividends are paid at the discretion of the company. Bondholders have a fixed claim on the income of the firm i.Investment Banking
Q 9. That is. there is no maturity for common stocks since the equity shares exist as long as the corporation exists. it can be forced into bankruptcy. Finally.77 -
. Thus. or in the event of the liquidation of the firm. Rather. bondholders have what is termed a fixed claim on the assets of the firm.
. holders of common stock have the last claim to the firm’s income.
Did you know?A bond issued by a foreign institution is known as a bulldog in the UK.e. • Common Stocks
Common stocks lie on the other end of the securities spectrum. In addition to that. a Yankee in the USA. the potential for gain is greater for holders of common stock than for bondholders whose gain is fixed. holders of common stock have what is termed a residual claim against the income and assets of the firm.4 What are the different types of Securities? A 9. as is evident. or the assets of the firm in the event of liquidation. This also goes on to say that that the bondholders are entitled to a fixed interest payment each year (or semi-annual period). or equity shares. Besides. a fixed interest every year irrespective of the firms’ earnings.
preferred stock dividends are treated as common stocks dividends for tax purposes. Also. • Derived Securities
Derived Securities are nothing but such financial assets as warrants. preferred dividends.78 -
. • Risk
Risk is something inherent in any investment. the decision to pay preferred stock dividends is at the discretion of the board of directors.5 There are two fundamental aspects to any investment made by or on behalf of some investor. higher is the return.5 What is the relationship between Risk and Return? A 9. What influences return more is the risk. Finally from the viewpoint of the firm. namely risk and return. like common dividends. the value of a call option is derived from the value of a common stock against which the call option is written. preferred stock is a perpetual liability of the firm. While some investments are almost risk less (like Government Securities) or bank deposits. On the other hand. It’s similar to the bonds. Therefore return is the income plus capital appreciation in the case of ownership instruments (like common stocks) and only yield is the case of debt instruments like debentures or bonds. options. whereas interest payments on bonds are a deductible expense. and futures. • Return
Return or yield essentially differs from the nature of financial instruments.
. For example. They are classified as derived from the value of another security. Usually.Investment Banking
• Preferred Stocks With characteristics of both the common stock and bonds. are not a tax-deductible expense.
Q 9. others are more risky. and the creditor or debtor nature of the instrument and a host of other factors. whereas interest payments are mandatory. This risk may relate to loss or delay in the repayment of the principal capital or loss or non-payment of interest or variability of returns. convertible bonds. these stocks are also called hybrid security since its characteristics lies somewhere between those of common stocks and bonds. like common stock. Finally. the higher the risk. like common stock. whereas the value of a commodity future is derived from the value of a commodity that must be delivered in the future. and also to do with fixed income. in a way that it enjoys claims on the assets of the firm in the event of liquidation. maturity period.
. Thus. speculations and asymmetric information.8 The primary market consists of the new issues market in which new securities are sold by • • • Public limited companies Government and semi government bodies Public sector undertakings. which is by default prone to rumours. The prices of stocks are determined by the intermingling of the demand for and supply of stocks. All the above are eligible to be listed on recognised stock exchanges for trading.8What is a Primary Market? A 9. be it positive or negative has a great effect on the final prices of the stocks listed. For the purpose of trading.7 What are the Types of Securities Market? A 9.
Q 9. it so happens that any favourable news increases the demand for the particular stock. while some may significantly bring down prices of individual stocks.Investment Banking
Q 9. there is bound to be many such situations where this information contradicts each other. • • Primary Market econdary Market
Q 9.79 -
.6 The characteristics are: • Securities markets are information sensitive
Funds can also be raised by mutual funds and FIs. thus raising prices and vice versa. the securities are to be transferable and marketable. In other words.6 Elucidate the Characteristics Of Securities Market: A 9. Some of this information does wonders to the company.7 There are two types of securities market namely. • Asymmetric information abounds
With the flow of information from all sides. a securities market is one place.
10 The secondary market is nothing but. 10 to 15 days in advance Opening.10 What is a Secondary Market? A 9. Public Sector undertakings and companies for borrowing funds and raising resources essentially issue these securities. Closing and earliest closing dates should be specified A minimum of 3 and a maximum of 10 days to be kept open for subscription.
. Securities as previously defined include any monetary claims and include stock. they are transferable by endorsement and are like movable property. shares.9Is there any time limit to public issues? A 9. So is the case with the shares of Companies.
2)Rights offer • • Offer should be kept open for a minimum of 30 days and a maximum of 60 days Specific dates for closing of renunciations. split forms are to be specified. They are tradable on the on the stock exchange. what we commonly refer to as the stock exchange.
Q 9. The Government. debentures.
Did you know?Rights issue or Rights offer is selling new shares to existing shareholders to raise capital.9 There are separate time limits for public offer and rights offer 1)Public offer • • • Should be advertised in papers. If these securities are marketable as in the case of Government Stock. bonds etc.
Q 9. semi-Government bodies.Investment Banking
New issues and further issues are made for • • • • New project of a new company Expansion and diversification of an existing company Cost overruns of projects Working capital purposes of the issuer company. which is again a place where securities are traded.80 -
Hand delivery deals for delivering shares within a period of 7 to 14 days from the date of the contract. Preferred Stocks and Derived Instruments. The above act has laid the ground rules as to the methods of trading in approved contracts through registered members. which is now reduced to 15 days.). Bangalore etc.m. Chennai.
Question 10. Primary and secondary markets form the two components of securities market. Special delivery deals for delivering of shares for specific longer periods as may be approved by the Governing Board of the Stock Exchange
SUMMARY • • • • • • • Security represents the evidence of a property right. Of these the major ones are in Mumbai. SEBI is the supervisory and regulatory authority for the stock and capital markets. A prudent investor should strike a right balance between risk and return. As per the rules trading is permitted in the normal trading is permitted in the normal trading hours (10 a. securities’ trading is regulated by the Central Government and such trading can take place only in Stock Exchanges recognized by the government under this Act. Delivery through a clearing for delivering shares within a period of 2 months from the date of contract. it represents the claim on an asset and also any future cash flows that can arise from that asset.e. Kolkata.Investment Banking
Under the Securities Contract Regulation Act of 1956. Hyderabad.10 Conti
The contracts approved for trading are as follows: • • • • Spot delivery deals are for delivery of shares on the same day or the next day as the payment is made. T Question 9.m.1 What are Money Markets?
. There are at present 23 stock exchanges in India. to 4 p. Investor has to make proper analysis before investment. The market where securities are dealt with is called a securities market. which involves both risk and return Securities are broadly categorized into Bonds. Delhi. i.81 -
. Common Stocks.1
• Focal Point
It acts as a focal point for central bank intervention for influencing liquidity in the economy.
A 10. traders.3 What are the Objectives behind the existence of money markets? A 10. speculators and even government institutions. The instruments are dealt within the money market are liquid and can be turned over quickly at low transaction cost and without loss. Concerned primarily with small business needs for working capital.2 Quote some definitions of money markets: A 10. it differs from the long-term or capital market which devotes its attention to dealings in bonds. and transfers of the short term credit instruments. These agencies create demand for money and also ensure supply of money for a short-term period. Hence. “Money market is the term designed to include the financial institutions which handle the purchase. The demand for money emanates from merchants. nonbanking financial concerns and the Central Bank of the country.
Q 10. It comprises individuals. manufacturers. The Reserve Bank of India defines it as. The money market includes the entire machinery for the channelizing of the short-term funds. sale. mainly of short term character. it meets the short term requirements of borrowers and provides liquidity or cash to the lenders.1 Money markets are best known as places where short-term funds are lent and borrowed.82 -
. In other words money markets are markets for short-term financial assets.3 Well-developed money markets serve the following objectives: • Equilibrium Mechanism
Money markets provide an equilibrium mechanism for ironing out short-term surplus and deficits. which are near substitutes for money. “the centre for dealings. it is not inappropriate to say that the money market represents the country’s pool of short-term investible funds to meet the shortterm requirements of the economy. It is the place where short term surplus investible funds at the disposal of financial and other institutions and individuals are bid by borrowers’ agents comprising institutions and individuals and also the government itself”. individual’s borrowing and government short term obligations. brokers. in money assets. insurance companies.2 According to the McGraw Hill Dictionary of Modern Economics. corporate stocks and mortgage credit”. Question 10.2
Q 10. The suppliers include commercial banks. institutions and the government.
speed.5 The following are the other essential requirements for a well-developed money market. financial assets being converted into money with ease. • • • • A large volume of international trade facilitating the emergence of a system of bills of exchange. • • Dealings may be conducted with or without the help of brokers The short-term financial assets that are dealt in are close substitutes for money. Political stability. Freedom of investment on equal basis for all individuals regardless of their residence.6 What are the different Segments/Sub-Markets in a Money market?
Q 10. etc. Rapid and massive industrial development resulting in the development of stock exchanges in the country. then the money markets at London and New York will be considered highly developed markets. the transactions being conducted even over the phone and therefore there is an essential need for the presence of well-developed communications system.
Q 10.4 The characteristics are: • • Short-term funds are borrowed and lent No fixed place for conduct of operations.83 -
• Users Access It provides access to users of short-term money to meet their requirements at a reasonable price. without loss and with minimum transaction cost.5 What are the essential requirements for a well-developed money market? A 10.4 What are the General Characteristics of money markets? A 10.5
Q 10. Question 10.
If we go by the above-mentioned requirements.
The collateral loans are given for a short period lasting for a few
. GIC etc participate only as lenders in this market. of which public sector banks account for 80% of borrowings and foreign banks/private sector banks account for the balance 20%.7 A market for call funds is called “Call Money Market”. 80% of the requirement of call money funds is met by the non-bank participants and 20% from the banking system. It deals in money market at call and short notice. This is an important segment of the money market. Funds are available for being borrowed and lent for extremely short periods ranging from a day. Needless to say the money invested by banks in the call money market provides high liquidity. In the event of non-repayment of the loan. LIC. Did You Know? The size of the market for these funds in India is between Rs.
Q 10. Bill Market 4. Call Money Market 2. Acceptance Market 5. The collateral is returned to the borrower after the repayment of the loan.8 What is a Collateral Loan Market? A 10. Loans are granted against the backing of securities. Following are the different type of such segments: 1. This is a specialized sector of the money market.6 A money market comprises of a variety of segments that specialize in a certain type of activity.Investment Banking
A 10.84 -
. the collateral becomes the property of the lender. bonds.8 A market for collateral loans is known as “Collateral Loan Market”.000 million to Rs 70.7 What is a Call Money Market? A 10. but comes at a price of low profitability. This market deals with extremely short loans.000 million. etc. Funds are demanded by brokers and dealers on stock exchanges and are advanced by commercial banks without any collateral securities. Non-banking financial institutions like IDBI. 60. Collateral funds refer to the money made available against the securities such as stock. Collateral Loan Market 3. Discount Market
Q 10. overnight or up to a maximum of 7 days.
10What is anAcceptance Market? A 10.9
Q 10. the treasury bills enthuse the confidence of greater number of investors. to pay on demand or at a fixed time in the future. requiring the buyer to whom it is addressed. The instrument. The borrowers in the collateral market are mostly brokers and dealers in stocks and shares. a definite sum of money to the order of seller or to the bearer is known as the Bill of exchange.85 -
. Collateral loans are mostly advanced by the commercial banks to private parties in the stock market.
Q 10. The bank has to make payment either to the order of a specified party or to the bearer. They are generally sold by auction to the highest bidder. Commercial Bills in turn are divided into two types of bills.
Treasury bill is a short-term government security having a maturity period ranging from a few days to few months. which are Bills of Exchange and Treasury Bills. Question 10. Banker’s acceptance arises out of commercial transactions both within the country as well as abroad. Being government papers.9 What is a Bill Market? A 10. A banker’s acceptance constitutes the draft issued by a bank (drawn by a business on a bank) and accepting/undertaking to make payment of the money specified on the draft on demand. sold by the central bank on behalf of the government does not guarantee any fixed rate of interest to the holder. the sum specified on the draft on demand.
An unconditional order in writing signed by the seller.9 Bill Markets are specialized segments of the money market that deals with the purchase and sale of various types of commercial bills.
.10 A market that deals with bankers’ acceptance is known as “Acceptance Market”.Investment Banking
. Since the bankers’ acceptance bears the signature of the bank. national saving certificate schemes. as investors simultaneously invest in various investment avenues such as savings bank. there is a substantial flow of funds between capital and money markets. fixed deposits. • Liquidity adjustments:
Non-banking financial institutions and special financial institutions approach money and capital markets to a limited degree in order to adjust their liquidity positions. it can be easily discounted with less charge. The bankers’ acceptance is different from a cheque as the formal is payable at a specified future date while the latter is payable on demand.
Q 10. bullion etc.11What is a Discount Market? A 10. • Preference for investors:
Preference is available for most of the suppliers of funds to operate in both the markets.12 The similarities are • Transfer of resources:
Transfer of resources takes place from surplus units to deficit units both in money market and capital market.
.11 The market where bankers’ acceptances are discounted is known as “Discount Market”.12 What are the similarities between Money Markets & Capital Markets? A 10. • Commercial banks:
Commercial banks provide both short-term and long-term finance and therefore an active part in the money market as well as capital market. borrowing and lending in both money and capital markets. real estates. Besides. As lenders and borrowers of funds have access to both capital and money market. life insurance. government and industrial securities. financial institutions operate on both sides of the market. units. This offers the advantage of temporary funds to traders.Investment Banking
A 10.87 -
. Dealings are conducted throughDealings are conducted through the mechanism of stockthe over-the-phone market.13 The following table brings out the differences between the two: S.no 1 2 3 5 6 7 8 Subject Capital market Money market Term of finance Provides long-term funds Provides short-term funds Nature of capital Capital used for fixed and workingCapital usually used for working Main function Link Underwriting Institutions Development assistance 9 Negotiation capital needs Mobilization and capital needs effectiveLending and borrowing to facilitate
utilization through lending liquidity adjustments Acts as a link between investorActs as a link between depositor and entrepreneurs and borrower It is a primary function Not a primary function Investment houses and mortgageCommercial banks and discount banks houses Provided to central and stateProvided to government by
Q 10. public and localdiscounting treasury bills.13Bring out the differences between capital market and money market. rise in interest rate in money market influences long-term interest rates also.no 13 14 15 16
securities Risk High credit and market risk Low credit and market risk Subject Capital market Money market Price fluctuations High Not much Liquidity Low High Price discovery Price discovery mechanism exists No price discovery mechanism Regulator Besides central bank. specialCentral bank regulatory authority like SEBI.Investment Banking
• Interest rates: There is an interdependency of short and long-term rates of interest. etc. Financial claims. etc. assets and exchanges Bonds and shares
11 12 S. Funds are lent after a prolongedDealings can take place with out negotiation between the lendingany financial institutions and personal contact and thenegotiations are not formal.
. This is because.
borrowing corporate entity. bodies.
Well-developed money markets serve objectives like equilibrium mechanism.88 -
. In some cases. They find tourists who need the convenience of a quick cash exchange. Alternatively. There are plenty of other instances where one can engage in the practice arbitrage. arbitrageurs can take advantage of varying liquidities between markets. Tourists exchange cash for less than the market rate and then the money exchanger converts those foreign funds into the local currency at a higher rate. focal point and Users Access. Foreign money exchangers operate their entire businesses on this principle. Non banking financial companiesCommercial banks and special financial institutions
SUMMARY • • • • • • Money markets are best known as places where short-term funds are lent and borrowed Money markets specialise in instruments that are liquid and can be turned over quickly at low transaction cost and without loss. collateral loan market. The various segments/sub-markets of money markets are call money market. acceptance market and discount market. Treasury bill is a short-term government security having a maturity period ranging from a few days to few months The money market represents the country’s pool of short-term investible funds to meet the short-term requirements of the economy. one market does not know about or have access to the other market. Did you know – Financial Markets Arbitrage Arbitrage is the activity of exploiting imbalances between two or more markets. bill market. The term 'arbitrage' is usually reserved for money and other investments as opposed to imbalances in the
. The difference between the two rates is the spread or profit.Investment Banking
18 Dominant institutions etc.
he could not legally sell off his own shares or advise his friends and family to sell off their holdings. The legal form of insider trading involves the sale of securities or stocks by officers of a company or stockholders who own more than 10% of the company. Any stockholder is free to buy or sell their shares based on public information about the company's current or future financial outlook. a vice-president of a drug company learned that the Food and Drug Administration would not be approving his company's newest drug treatment for diabetes. the use of privileged information for financial gain has been around since the inception of stock trading. The decision to sell off stocks in a company that is about to receive devastating news would be based on privileged information. even if these events could spell financial disaster for stockholders. Engaging in arbitrage can be lucrative. the spread between two markets can fluctuate during the time required for the transactions themselves. If. for example. In cases where prices fluctuate rapidly.
Insider Trading 'Insider trading' can refer to two separate financial transactions--one being perfectly legal and the other being subject to massive civil fines and possible prison time. The illegal form of insider trading involves information NOT readily available to the rest of the stockholders. The efficiency of the market refers to the speed at which the disparate prices converge. Perhaps the biggest risk is the potential for rapid fluctuations in market prices. A company president can sell off his shares if news of an impending bankruptcy filing is announced in the Wall Street Journal. For example. he or she must agree to keep certain events absolutely secret. The company president is considered an insider. would-be arbitrageurs can actually lose money. for example. The vice-president of that company and anyone he told about the FDA decision could be charged with insider trading. The presence of arbitrageurs typically causes the prices in different markets to converge: the prices in the more expensive market will tend to decline and the opposite will ensue for the cheaper market.89 -
. Most stockholders are free to make buying or selling decisions based on anything from a strong hunch to the latest pop culture trends. Whenever an individual becomes a major stockholder or a senior officer in a company.Investment Banking
price of goods. but his decision to sell his stock was based on information any other stockholder could have discovered. The Security and Exchange Commission (SEC) watches for signs of insider trading whenever companies experience huge losses or gains. However. executives and major stockholders have an obligation to avoid the use of insider trading even if it means personal financial
. obviously. but it does not come without risk. Insider trading is not a new white-collar crime.
and Eurodollar futures provide a way of betting on or hedging against future interest rate changes. the London Interbank Offered Rate. While the rates banks offer each other vary continuously throughout the day. but also to major currencies such as the US Dollar. Conceptually similar to the LIBOR. Traded at the Chicago Mercantile Exchange (CME).90 -
. and by extension LIBOR. one party will have a fixed interest payment. Interest rate swaps. By holding the deposits outside the country. Generally. The most important financial derivatives related to LIBOR are Eurodollar futures. In an interest rate swap. LIBOR is used in determining the price of many other financial derivatives. while the other will have a variable rate. LIBOR is calculated for periods as short as overnight and as long as one year. LIBOR applies not only to the Pound Sterling. Regular stockholders without access to this information would not be able to sell off their stock in a failing company or reap the benefits of a company poised for success. two parties exchange sets of interest payments on a given amount of capital. primarily in Europe. the difference between the instantaneous rate and LIBOR is very small. The variable rate payment stream is often defined in terms of LIBOR. Eurodollars are US dollars deposited at banks outside the United States. corporate executives everywhere could unfairly profit from their personal knowledge. Without stiff penalties for insider trading. especially for short durations.
LIBOR LIBOR. A department of the British Bankers Association averages the inter-bank interest rates being offered by its membership. US depositors are not subject to Federal Reserve margin requirements. allowing higher leverage of the funds. is the most active interest rate market in the world. which in turn allows lower interest rates on US mortgages. Swiss Franc. It is determined by rates that banks participating in the London money market offer each other for short-term deposits. are extremely important in providing a liquid secondary market for residential mortgages. The interest rate paid on Eurodollars is largely determined by LIBOR. Due to London's importance as a global financial center. the Euribor benchmark is defined and maintained by the European Banking Federation
. While LIBOR does have implications for transactions conducted in Euros. the advent of the Euro has brought with it the creation of the Euribor. LIBOR is fixed for the 24 hour period. including interest rate futures. Japanese Yen and Canadian Dollar. Interest rate swaps are another significant financial derivative dependent on LIBOR.Investment Banking
losses. Generally. swaps and Eurodollars. LIBOR is determined every morning at 11:00am London time.
the short seller would then buy 100 shares back for $500.91 -
Short selling has been a target of ire since at least the 17th century when England banned it outright. It is commonly understood that "short" is used because the short seller is in a deficit position with his brokerage house. as invariably the stock drops or even plummets when the "downgrade" hits the wire. return the shares to their original owner. short selling is selling something that one does not (yet) own. they are profiting from the misfortune of others. public investors are typically too late to short by the time the "downgrade" is heard on the news. whereas at least 95% of short sales are done by broker-dealers and market makers who do not even always have to own shares to sell them (i. Short sellers are widely regarded with suspicion because. Short sellers were blamed (probably erroneously) for the Wall Street Crash of 1929. hoping that price will rise. For example.Investment Banking
In finance. and then immediately sell those shares for a total of $1000. If the price of XYZ shares later falls to $5 per share. to many people. sold short) the stock being downgraded. one may reasonably assume that interested parties have already established a short position in (i. Regulations governing short selling were implemented in 1929 and in 1940. President Hoover condemned short sellers and even J. When Wall Street "downgrades" a stock. Legislation introduced in 1940 banned mutual funds from short selling (this law was lifted in 1997).e. Most investors "go long" on an investment.e. and make a $500 profit. However. Naked Short Selling). In a given year about 2% of stocks on the New York Stock Exchange are sold short. A short seller would borrow (say) 100 shares of XYZ Company. Edgar Hoover said he would investigate short sellers for their role in prolonging the Depression. Mechanism
. hoping that it will decrease in value so that they can buy it back at a lower price and keep the difference. Political fallout from the 1929 crash led Congress to enact a law banning short sellers from selling shares during a sharp downturn. The term "short" was in use from at least the mid-19th century. Short sellers borrow a security and sell it. Therefore. assume that shares in XYZ Company currently sell for $10 per share. less than 5% of all shorts are done by public investors and traders.
Short selling is the opposite of "going long". The vast majority of stocks borrowed by U. you make a profit.S. the broker itself seldom actually purchases the shares to loan to the short seller. is called 'covering the short'.S. the seller must arrange for a broker-dealer to confirm that it is able to make delivery of the shorted securities. which are undervalued by buying those stocks. You sell them and the proceeds are credited to your account at the brokerage firm. or "bearish" stance. This is referred to as a "locate". you buy them back for $0. Technically.If the price drops. Sometimes. Day traders and hedge funds will often use short selling to allow them to profit on trading in stocks that they believe are overvalued. Example: Borrowing 100 shares from someone.S. the broker usually in turn has borrowed the shares from some other investor who is holding his shares long. brokers are able to borrow stocks from their customers who own "long" positions. You must "close" the position by buying back the shares (called covering) . anticipating that the price of the shorted stock will fall (not rise as in long buying). brokers come from loans made by the leading custody banks and fund management companies (see list below).00 . In these cases. thereby making a profit ("selling high and buying low. and it will be possible to buy at a lower price whatever was sold.50 and give the 100 shares back to the original owner keeping the profit. if the customer has fully paid for the long position. the
.when the stock drops. Otherwise you make a loss. the customer borrowed money from the broker in order to finance the purchase of the security). The act of buying back the shares. and it is a legal requirement that U. In cases where the customer has not fully paid for the long position (meaning." to reverse the adage). which were sold short. In the U. regulated broker-dealers not permit their customers to short securities without first obtaining a locate. You finally return them to the lender. in order to sell stocks short. selling them immediately at $1. The short seller takes a fundamentally negative.. just as traditional long investors attempt to profit on stocks. The short seller owes his broker and must repay the shortage when he covers his position. and the broker must provide the customer with collateral and pay a fee to the customer. Brokers have a variety of means to borrow stocks in order to facilitate locates and make good delivery of the shorted security.Investment Banking
Short selling consists of the following: · · · · You borrow shares. the broker cannot borrow the security without the express permission of the customer.92 -
The bears. This ensures that bears do not push prices down sharply by short selling. for instance. say. bulls can likewise push up stocks. If. SEBI thought it fit to ban short selling. equity represents the owners’ investment in the firm. is overvalued at the current price and may fall sometime soon.700. This is because such trading enables investors to take a bearish or a bullish view on the market. Short selling can. Since falling equity values is bad news for investors and the economy. This process of selling the stock without holding it is called short selling. Of course.700 and Rs 3. say. pushing prices down is not as well tolerated as pushing prices up.Venkatesh in Business Line’s Investment World on April 29.700 and not at a lower price.
Q 12.1. That is one reason why even developed markets regulate short selling. you can sell the stock now and buy it back at a lower price at a later date. the zero-plus tick rule means that you can short-sell only at Rs 3. you can short-sell only on a zero-plus tick. That means
. given investor psychology. But. Rs 3. Unlike other types of financing.Investment Banking
broker will not need to inform the customer that the long position is being used to effect delivery of another client's short sale. you buy the stock if you are bullish. Now.1. for instance. Short selling typically precipitates the fall in such a trending market. the immediately preceding trades in Infosys are Rs 3. destabilise the market if not properly regulated. What do you mean by the term “Equity”? A 12. Short selling is important for the overall functioning of the market. What is short selling and why did SEBI ban such trading? Suppose you hold a view that. Rs 200 every day.2001. Suppose Infosys is falling by. At the New York Stock Exchange. If you want to bet on your hunch. or shortsell the stock if you hold a bearish view. Equity simply means “Ownership”.93 -
. Equity holders are also called the owners of residue. for instance. Infosys.710. Also read “Ban on short-selling” by B. why did SEBI ban short selling? Recall that the market was falling sharply in the last few weeks. traders will be tempted to profit from the trend by short-selling the stock. can deliberately push a stock down by short selling. THE Securities and Exchange Board of India (SEBI) recently banned short selling. which will only push its price further down. however.
Q 12.3. It is also another word for inventories of goods held by a firm to meet future demand.after payment of all obligations on the income and assets of the firm.
. Equity is a term whose meaning depends more on the context. What are the advantages of issuing stocks? A 12.2.94 -
.2. the other classifications of equities are • • • • Warrants Depository Receipts Exchange traded funds Closed end funds
Did you know? Market Capitalisation is the market value of a company’s shares : the quoted share price multiplied by the total number of shares that the company has issued.3. The advantages are • • • Company can raise more capital than it can borrow Need not have to make periodic interest payment to the creditors Need not have to make principal payments
Did you know? Ankle biter is the name of a stock issued with a market capitalization of less than $500 million. Discuss the classification of equities.
Q 12. In general. one can think equity as ownership in any asset after all debts associated with that are paid off. Did you know?Stock is a nother term for shares .Investment Banking
these securities provide claim on residue . In general there are 2 forms of equities: • • Preferred stock Common stock
Besides them. What are called ordinary shares in the UK is known as common stock in the United States.
7. Distinguish between Common stocks & Preferred stocks. Dividends Common Stock Preferred Stock Dividends vary depending onDividend is fixed the Voting rights company’s share performance Right to vote at shareholderNo right to vote
meetings Claims on company assets Low priority High Priority Market risk High Low Did you know? Cats and dogs refer to the speculative stocks with short histories of sales. Question 12. Investors’ interest must be given primary consideration in improving short-term earnings rather than pursuing strategies that show less immediate promise Did you know? Big uglies is the nickname for Unpopular stocks. The disadvantages are • • • Principal owners have to share their ownership with other shareholders Shareholders will have a say in the policies that effect the companies operations.
. Equity stock holders may get dividends and bonuses depending on the performance of the company.95 -
Q 12. Discuss briefly about Common stocks. Owning stock gives the opportunity to earn money on money. In addition to the ownership in the company.4.5. What are the disadvantages of issuing stocks? A 12. and dividend payments
Q 12.5. There is also a possibility that the company will grow and simultaneously the share price. earnings. Did you know? Bo Derek stock is the nickname for High quality stock. The differences are shown in the following table. State some of the benefits for investors from stock ownership.6.6. A 12.6
Q 12. they may be entitled to get a share in the profits of the company. A 12.
They are generally issued in proportion of shares already owned.8. State some of the types of common stock dividends.8. a 4 percent stock dividend will yield four extra shares.
Q 12. They are paid with assets owned by the issuing company. For example. Cash dividend is the most common payment method seen. Common stock dividends may be paid in cash. for every 100 shares of stock owned. Common stock pays dividends in three forms: cash. A 12. Did you know? Quarter stock refers to a stock with a par value of $25 per share
. stock or property. Few firms have more than one class of common stock. or shares of a subsidiary corporation. Property dividends Property dividends are generally paid in the form of products or services that the corporation produces.7. They benefit most from the improvement in the firms’ business prospects. Did you know? Orphan stock is a stock that is ignored by research analysts and as a result may be trading at low price earnings ratios. Common stock holders have a claim on the firm’s income and assets only after all creditors and preferred stock holders receive payment. in which case the stock of one class may be entitled to greater voting rights or to larger dividends than the stock of another class. will use securities of other companies owned by the issuer. stock and property. Often the corporation. Common stock is the most important form of equity.96 -
A 12. Cash dividends Cash dividends are those that are paid out in the form of cash. They are treated as investment income and are taxable in the year they are paid. when paying property dividends. An owner of common stock is part owner of the enterprise and is entitled to vote on important matters like selection of directors. Stock dividends Stock dividends are dividends paid out in the form of additional shares in the corporation.
Q 12.9. State some of the classification of stocks. A 12.9. Classification of stocks can be done according to their behaviour or performance in the market. The name of the stocks may come from the size of the company that issued it or by its investment objectives. These include • • • • • Growth stocks Income stocks Value socks Blue chip stocks Penny stocks
Growth stocks Growth stocks are those that strive for large capital gains. These stocks generally have investors’ expectations of above average future growth in earnings and valuations as a result of high P/E ratios. Investors expect these stocks to perform well in the future and will be willing to pay high multiples for this expected growth. Income Stocks Income stocks are those stocks that concentrate heavily on high interest and high dividend yielding securities. These stocks pay higher-than-average dividends over a sustained period. Income stocks are popular with investors who want steady income for a long time and who do not need much growth in their stock's value. In this sense, investors who choose income stocks have something in common with bondholders.
Value stocks Value stocks are those that feature cheap assets and strong balance sheets. A value stock is a stock that is currently selling at a low price. The stocks of the companies that have good earnings and growth potential but whose stock prices do not reflect the same are considered value stocks. Blue chip stocks Large established firms with a long and good record of profit growth, dividend payout and a reputation for quality management, products and services are referred to as Blue Chip companies. These firms are generally leaders in their industries and are considered likely candidates for long-term growth. Penny stocks
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Penny stocks are low-priced, speculative stocks that are very risky. Companies with a short or variable history of revenues and earnings issue them. They are the lowest of the low in price and many stock exchanges choose not to trade them. Penny stocks are also called as designated securities. Even though the odds are against it, if the company that issued them finds itself in the growth tracks, their share price can rise rapidly. These stocks are common among small speculators. Did you know?Bear is an investor who believes the market will fall.
Q 12.10. Discuss about Preferred stocks. A 12.10. Preference stock holders also called preference share holders have a greater claim to company’s assets and earnings in case of good times when the company has excess cash and decides to distribute money in form of dividends to its investors. In this case preference shareholders will get preference over common stock holders. Preference stock is the one, which has its characteristics some where between a bond and a common stock. Some investors favour preferred stock over bonds because the periodic payments are formally considered dividends rather than interest payments and may therefore offer tax advantages. Preference stock is also called as a hybrid security as it has features of common stock and a bond. Did you know? Bull is an investor who thinks the market or a specific security or industry will rise
Q 12.11. State some of the classifications of preference shares. A 12.11. In general there are eight different types of preferred stock. They are • • • • • • • • Cumulative Non-cumulative Redeemable Non Redeemable Convertible Non convertible Participating Non participating
Cumulative preferred stock
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In case of a cumulative preference share, if the amount of dividend payable remains due, in full or in part, in any of the years, such balance amount gets carried over to the next successive years, till the entire outstanding are cleared up to date.
Non-cumulative preferred stock Preferred stocks on which unpaid dividends do not accrue are called as non-cumulative preferred stocks. In case of a non-cumulative preference share, if the dividend payable remains due, in part or in full, the balance amount would not get automatically carried over. It would instead lapse that very year. Redeemable preferred stock In case of the redeemable preferred stock, the company buys them back at a specified future date as specified in the issue documents. Non-redeemable preferred stock Non-redeemable preference share are supposed to be perpetual in nature. They cannot be redeemed at any point in time till the existence of the company. These shares do not have any maturity period. In India, most of the preference shares are redeemable in nature. Convertible preferred stock Convertible preferred stocks are those where the shareholders have the right at their option to convert them in to equity shares after a certain period.
Non-convertible preferred stock Non-convertible preferred stock cannot be converted in to equity stock at any point of time. Participating preferred stock As well as providing a preferential fixed dividend, participating preference shares entitle the holders to additional payment when the dividends on ordinary shares exceed a defined percentage. Non-participating preferred stock
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They are the negotiable financial instruments issued by the U. Depository receipts are the negotiable financial instruments issued by a bank to represent a foreign company’s publicly traded securities.Investment Banking
Shareholders who have been issued non-participating preference shares are not entitled to any additional payment.13. Session 12 : Equities: Question 12. Tangible value = market price – strike price. Question 12. as the stock can be acquired more cheaply in the open market.S.S.S bank.100 -
.12. ADRs are denominated in U. the warrants have no value. What are Depository receipts? A 12. If the tangible value when the warrants are exercisable is zero or less. exchange. Warrants will offer the holder the opportunity to purchase a firms common stock during a specified time period in the future at a predetermined price. • American depository receipts
When the depository bank is in U.S dollars or Euros. buys them up to sell them immediately as they go on the market. What are Warrants? A 12. predicting a new issue of shares will increase in value. Question 12. dollars. These share trade as domestic shares but are offered globally through the various bank branches. The difference between the market price and the strike price is called as the tangible value. Did you know? Stag is an investor who.A then the instruments are known as American depository receipts.S. which represent a specified number of shares in a foreign stock that is traded on a U.12. GDRs are the bank certificates issued in more than one country for shares in a foreign company. The predetermined price is known as the exercise price or the strike price.12
Q 12. They cannot participate in the surplus profits or in the residual assets at the time of liquidation of the company.14
Q 12. • Global depository receipts
Global depository receipts are the financial instruments used by private markets to raise capital denominated in either U.
The price of the closed end funds is determined by the market and may be greater than or less than the shares net asset value (NAV).12. However the term fixed income may confuse us to think of it as an instrument. Exchange traded funds are some thing that trades like a stock on exchange. It has another dimension to it. depository receipts exchange traded funds and closed-end funds (the first two being the most important).101 -
Q 12. Fixed-income securities are nothing but an alternative investment opportunity to choose from. Common stockholders are the true owners of the company and are entitled to dividend if and when declared by the board of directors. It is to be noted that all the cash flows promised
. preferred stock.Investment Banking
Q 12. Equity holders are also called the owners of residue. which promises a minimum.1.1. Some closed end funds normally referred to as interval funds can be repurchased at specified intervals Summary
Summary • • • • Equity simply means “Ownership”. Types of equities include common stock. Closed end funds are generally not redeemable.14.14.e. What are closedend funds ? A. I. equity represents the owners’ investment in the firm. warrants. the misconception that returns are certain and the vast array of fixed income securities may finally confuse many investors. What are fixed income securities? A 13. it acts as a security that tracks an index and represents a basket of stocks like an index fund. it also experiences price changes through out the day as it is bought and sold. Therefore. Unlike other types of financing. But it may not be necessarily so. guaranteed payment.15.15 Closed ended funds are those that will be sold as a fixed number of shares at one time in the initial public offering after which shares will typically trade in the secondary market.
Q 13. What are Exchange traded funds? A 12. A preferred stock is one that enjoys preference over common stockholders in terms of payment of dividend and in terms of distribution of assets in case of liquidation of the firm. the realized returns may differ from the expected returns. Given its similarity to a stock. In other words “fixed income” suggests that though returns from these securities are certain.
Q 13. periods of increased uncertainty concerning inflation may substantially increase the risk associated with fixed income securities. Corporate bonds & notes
Q 13. While fixed income securities usually possess lower risks and returns than equities. highly marketable loans play a major role in the investment and borrowing activities of both financial and non-financial
. However for the sake of simplicity we have separated fixed income securities into two groups based on the maturity period. US Treasury bonds & notes. A 13.2. one year or less). and fixed income securities may dominate the composition of pension funds in the future. Commercial paper. Bankers acceptance. Certain types of short term (meaning arbitrarily.2. Euro dollars & Repurchase agreements. fixed income securities have become an integral part of most investors’ portfolios because of the growth of money market funds.4. Municipality bonds & notes.What are Money market securities? A 13. • Of late. The primary reasons are: • • The addition of fixed-income securities to universe of investment alternatives provides new diversification opportunities. A vast menu of fixed income securities exists in the market today.3. Question 13. where maturity period is defined as the time elapsed between the date of issue and the date when the issuer will pay for the principal. Certificate of deposits. Types Money Constituents marketUS Treasury bills. Discuss the classes of fixed income securities.
Q 13.4. What are the primary reasons to study Fixed Income Securities? A 13.102 -
might not be received because in many cases there is at least some risk that a promised payment will not be made in full and on time.
Discuss each of these constituents of money market. the Treasury accepts those competitive bids with the highest prices down to the point where the amount offered is reached.Investment Banking
corporations.6.5. A 13. The Treasury allocates usually 10% or less of the offering to non-competitive bids.
Q 13.6. Usually on every Monday.000 to $1 million sold by the federal government. The dollar amount of commercial paper outstanding exceeds for Treasury bills.6 Conti
Commercial Paper Commercial paper is an unsecured short-term promissory note. This method of computing yields is called the bank discount method and is also used to determine the yields of bankers’ acceptance and commercial paper. They are discussed as under: US Treasury Bills These are simply 91-360 day instruments with denominations of $10.5
Q 13. the US Treasury sells T-bills through a competitive or non-competitive bidding process. but most do so indirectly via money market accounts at financial institutions Question 13. The various constituents of money market securities are: • • • • • • US Treasury bills Commercial paper Certificate of deposits Bankers acceptance Euro dollars Repurchase agreements. Question 13. After all the bids are received. T-bills are sold at a discount. Individual investors with substantial funds may invest in such money market instruments directly.5. What are the various constituents of money market securities? A 13. with the majority being issued by the financial
. which means the return on a T-bill is the difference between the purchase price and the face value.103 -
Thus.000 or more having a specified maturity. all interest is paid along with the principal.000 -$20. Commercial paper is usually sold in denominations of $ 100. with the maturities of up to 270 days (this is the maximum allowed without requiring the registration of the Securities and Exchange Commission) to large institutional investors such as money market mutual funds. resulting in a very small secondary market. Bankers Acceptance An instrument called “bankers' acceptance” was invented to suit the needs of a party requiring temporary finance to facilitate the trading of specific goods. and are generally negotiable. the amount paid back by the borrower (called the nominal amount) would have to be more than the amount advanced by die lender.000. meaning that they can be sold by one investor to another. insurance and leasing.000 $980.000
A bank would normally bring the two parties together. The difference between the amount advanced and the amount paid back (the nominal amount) is known as the discount on the nominal amount. the name
. The Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration insures such certificates.6 Conti
Certificates of Deposit Certificates of deposit correspond to a type of interest-bearing deposit at savings or commercial banks and loan associations. Typically these investors hold onto the paper until maturity. making it highly likely that the loan will be paid off when it becomes due. More often than not. Such notes are often issued by large firms that have unused lines of credit at banks. Question 13. called the acceptance by the bank making the arrangement.000 or more. The redemption of the loan would have to be guaranteed by a bank.104 -
. The party needing finance would approach investors for this temporary finance. The interest rates on commercial paper reflect this small risk by being relatively low in comparison with the interest rates on other corporate fixed income securities. For this arrangement to be attractive to the lender. at the time of the maturity.
Example: Face value of Bankers Acceptance Minus 2% per annum commission Amount received $1. The investors or lenders would then lend a certain amount to the borrower in exchange for a document stating that the debt would be paid back on a certain date in the short-term future.Investment Banking
companies such as bank holding companies as well as companies involved in sales and personal finance. Both financial and non-financial companies usually issue instruments of this type. We also have large denominations (or jumbo) CDs which are issued in amounts of $100.
The Eurodollar market is relatively free of regulation.S. RPs provide lenders with extremely low risk . but Eurodollars can be held anywhere outside the United States.S. This market evolved in Europe (specifically London). Suppose that the treasurer of a large corporation calculates the firm’s cash position for the day and determines that the firm has funds that are not required immediately. A variation on the Eurodollar time deposit is the Eurodollar certificate of deposit. The Eurodollar market is obviously out of reach for all but the largest institutions. Bonds can be simply defined as an interest-bearing certificate of debt. and they are typically less liquid and so offer higher yields. and signed and
. arranges to purchase a government security from a commercial bank with an accompanying agreement that the bank will repurchase the security on the following day’. dollar-denominated deposits at banks outside of the United States. wishing to earn interest on these “excess” funds for a day. or a formal promise by the borrower to pay to the lender a certain sum of money at a fixed future day with or without security. A 13. The only way for individuals to invest in this market is indirectly through a money market fund. the Eurodollar market has expanded largely as a way of circumventing regulatory costs. Euro Dollars Eurodollars are U. although longer maturities are not uncommon. This shortterm maturity and government backing means. RPs frequently is made for one business day (overnight).
The average Eurodollar deposit is very large (in the millions) and has a maturity of less than 6 months.Investment Banking
"bankers' acceptance”. as the term is used in the financial markets. It can either be an obligation of the government (or business corporation). and so banks can operate on narrower margins than their counterparts in the United States. hence the name. The bank will then claim the nominal amount from the borrower. As a result. with a simultaneous agreement by the seller to repurchase them at a later date. bank. An illustration of a “typical” RP transaction is helpful in understanding this financial instrument.7.105 -
. The treasurer. at the redemption date approach the bank that will pay the nominal amount to the holder. Basically they are a secured means of borrowing and lending shortterm funds. The holder of the document may. but will likely be needed to meet expected expenditures in a day’ or two. A Eurodollar CD is basically the same as a domestic CD. is an acquisition of funds through the sale of securities. Re-Purchase Agreements A repurchase agreement (or Repos or RPs). except that it's the liability of a non-U.
sealed by the maker (borrower). It is usually a series of interest payments (usually semi-annually) and the principal, which is paid on the stated future date. Did you know? Bonds are often confused for what is known as promissory notes. The only way that a bond is distinguished from an ordinary promissory note is by the fact that it is issued as part of a series of like tenor and amount, and, in most cases, under a common security. By rule of common law the bond is also more formal in its execution. The note is a simple promise (in any form, as long as a definite promise for the payment of money appears upon its face), signed by the party bound, without any formality as to witnesses or seal.
Q 13.8. What are the various bond instruments available in the market? A 13.8. The various bond instruments are • • • US Treasury bonds & notes Municipality bonds & notes Corporate bonds & notes.
Q 13.9. Discuss the various bond instruments. A 13.9. They are discussed as under U.S. Treasury bonds and notes These are coupon issues with a broad appeal. Notes have maturities of 1 to 7 years while bonds maturities exceed 5 years. Both are available in bearer form where the interest is paid to whoever presents the coupon to the treasury on each coupon date, or in registered form where the owner of record (as recorded at the treasury) receives the coupon interest. The minimum purchase for most notes and bonds is $1000, but the denominations may be large as $1 million. The treasury generally offers new issues in exchange for maturing securities. This method of exchange refunding allows the investor to either exchange the maturing bonds for new bonds or receive the principal or final coupon payment. If the investor chooses to receive cash, he or she will sell the subscription rights for the new issue in the open market. If an investor buys or sells notes or bonds on dates other than the semi-annual coupon dates, the accrued interest is part of the sellers return. For example, an investor who sells the bond 1 month prior to the coupon date receives 5 months of accrued interest from the buyer. This way the seller
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receives interest for the number of months he or she actually held the security, whether or not the sale date falls on the coupon date. . Question 13.9 Conti
Municipal Bonds & Notes These are securities issued by state and local governments and whose interest payments are exempt from tax. While many US government and agency securities are exempt from state and local taxes, only municipal securities are state and local taxes. The rate of return on municipal securities reflects this tax treatment. This means for an investor in a 35% tax bracket, a tax free return of 9.61% on a municipal bond is equivalent to a 14.78% return on a fully taxable bond, such as corporate or US government bonds. There are several types of structures within municipal bonds. Below we give their description based on USA practice. In other countries some other types of municipal bonds can be used, but usually they are copying the US experience. There are basically two types of municipal securities in United States: 1. Tax-backed debt 2. Revenue bonds Question 13.9 Conti
Taxed-backed debt obligations are instruments that are secured by some form of tax revenue. Tax revenues do not secure revenue bonds. They are used for financing certain projects and are secured by revenues generated by the completed projects themselves. Also, both project revenues and municipality’s creditworthiness back some bonds, called Doublebarreled bonds. In USA many municipal bonds, especially revenue bonds, have an interesting additional feature: They may be insured by outside agencies ( insured bonds ). These insurers guarantee that they will pay the bondholder the interest and principal in case the bondholder defaults. Revenue bonds are issued for project financing, for example, construction of a new road, tunnel or bridge. These projects can generate their own cash flows that can be used for servicing debts. For example, a city may issue revenue bonds to pay for a new stadium. It will pay bondholders their interest and principal from the stadium's revenues. This type of bonds is obviously more risky than taxed-backed debt obligations. In some features municipal revenue bonds are close to corporate bonds because both require analyzing cash flows generated by project.
Corporate Bonds and Notes
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Corporate bonds (also called corporates) are bonds issued by private and public corporations. Within corporate bonds universe, the important characteristics of the debt is whether it is secured or not. By secured debt it is meant that there is some form of collateral, which is pledged to ensure repayments of the debt. Without this collateral the debt is unsecured. Recently the so-called mortgage-backed and asset-backed securities have emerged and grew in the importance. Underlying pools of assets backs these securities.
Q 13.1. State some of the risks associated with investing in bonds. A 13.1. Investors should be aware that even investments in fixed income securities also come with its share of risk. Some of the risks that apply to them are as follows, • Interest Rate Risk
If interest rate rise, bond price usually decline. If interest rates decline, bong prices usually rise . When rates are rising, market prices of existing debt securities will fall, as demand increases for newissue securities with the higher rates. As prices decline, yields are brought into line with the prevailing rates. When rates are falling, market prices will rise, because the higher rates on outstanding debt securities will be more valuable. • Credit Risk
The safety of a fixed-income investor’s principal depends on the issuer’s credit quality and ability to meet its financial obligations. Issuers with lower credit ratings usually have to offer investors higher yields to compensate for the additional credit risk. A change in either the issuer’s credit rating or the market’s perception of the issuer’s business prospects will affect the value of its outstanding securities. Question 13.10 Conti
Some classes of individual bonds, including mortgage-backed bonds, are subject to prepayment risk. It is when the issuer of a security will repay principal prior to the bonds maturity date, thereby changing the expected payment schedule of the bonds. • Price Risk
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Bonds can be simply defined as an interest-bearing certificate of debt. government bodies and commercial bodies such as financial institutions. • Reinvestment Risk
During periods of declining interest rates. Although investors in fixed-rate capital securities may take advantage of the exchange listing for retail offerings to sell their shares prior to maturity. since the existing investments are nearing maturity. and Bankers acceptances.1
Q 14. Eurodollars. What is a debt market? A 14. • Investments in fixed income securities also have some inherent risk. Question 14. banks.
.1 A market where fixed income securities of various types and features are issued and traded is known as a “debt market”. This becomes a potential risk to an investor in fixed income securities. These securities are structured in nature. they are securities issued by the central and state governments. which the investor should take. the investor may be forced to buy new bonds at lower interest rates. Certificates of Deposit. Summary
Summary • Money market instruments are nothing but highly marketable short-term instruments. municipal corporations. guard against. • • US Treasury bills are simply 91-360 day instruments with denominations of $10. which is paid on the stated future date. Just in case you can’t recall what is meant by fixed income securities. These instruments include Commercial paper.1. It is usually a series of interest payments (usually semi-annually) and the principal. public sector units etc. The table below gives a proper insight into India’s current standing in the Asian debt market. the price received may be more or less than the purchase price as a result of these dynamic risk factors.000 to $1 million sold by the federal government.Investment Banking
Investors who need access to their principal prior to maturity have to rely on the available market for the securities. Repurchase agreements etc.109 -
. accounting for approximately 30% of her GDP.Investment Banking
Session 14 : Debt Business: Question 14. the debt market can be expected to grow at an annual rate of approximately 15% in nominal rupee terms.3. Explain the rationale behind Debt Markets: A 14.2 India’s debt market has a substantial growth potential. Given the expected growth of India's GDP. If it is converted into per capita size. the market is not necessarily large at present.3
Q 14. What are the advantages to Investors in a debt market? A 14.110 -
. Further investors are assured of a dependable income. Question 14.3 The advantages that accrue to investors who invest in debt market are • Steady Income
Probably the biggest incentive of investing in fixed income securities is that they ensure steady and constant return by way of interest and repayment of principal at the maturity of the instrument.2
Fixed income securities are issued by eligible entities of standing against the moneys borrowed by them from the investors. What are the disadvantages/Risks to Investors in the debt market? A 14.111 -
. Assisting in the development of a reliable yield curve. What are the advantages to the Indian Financial System? A 14.5. • Interest Rate Risk
The risk emerging from an adverse change in the rate of interest prevalent in the market so as to affect the yield on the existing instrument is known as “interest rate risk”.
Q 14.5 In case the reader can recall some of the risks that had been previously mentioned for fixed income securities. Enhanced resource mobilization by unlocking illiquid retail investments like gold. Besides. Development of heterogeneity of market participants. The default on such securities is zero or near zero. there is a sovereign guarantee on those instruments. An investor may have to lose in a situation where there is a sudden upswing in the prevailing interest rate scenario where he has already invested his money.
Question 14. • Risk Free
Some of the fixed income securities such as government securities offer a risk free rate of return on the investor’s money.5
Q 14. understanding the below stated risks shouldn’t pose any problems.4 The benefits that accrue to the Indian financial system on account of the debt market are: • • • • Reduction in the borrowing costs thus facilitating mobilization of resources.
.4. This in turn guarantees safety of funds invested on these securities. • Default Risk
It is also known as credit risk and refers to the inability of the issuer to make prompt payment of the interest and the principal amount.
. The key terms that distinguish one debt instrument from another are as follows: • • • • • Issuer of the instrument Face value of the instrument Interest rate Repayment terms (and therefore maturity period/tenor) Security or collateral provided by the issuer
Question 14.6.6 Traditionally when a borrower takes a loan from a lender. This tradable form of the loan is termed as a debt instrument. due to an adverse movement in price is known as “price risk”. which the issuer would pay to the legal owner of the instrument.Investment Banking
• Investment Rate Risk The risk arising from the probability of a fall in the interest rate resulting in a lack of options to invest the interest received at regular intervals at higher rates or comparable rates in the market is known as “re-investment rate risk”. he enters into an agreement with the lender specifying when he would repay the loan and what return (interest) he would provide the lender for providing the loan. This entire structure can be converted into a form wherein the loan can be made tradable by converting it into smaller units with pro rata allocation of interest and principal. • Counter Party Risk
The risk arising from the failure or the inability of the opposite party to the contract to deliver either the promised security or the sale value at the time of settlement is known as “counter-party risk”. Therefore.6
Q 14. • Price Risk
The risk arising from the possibility of not being able to receive the expected market price of the debt instrument. debt instruments are basically obligations undertaken by the issuer of the instrument as regards certain future cash flows representing interest and principal. Question 14.112 -
. What are Debt Market Instruments? A 14.
GOISECs are issued by the Reserve Bank of India on behalf of the Government of India. most of the securities issued have been in the 5-10 year maturity bucket. Explain the various types of long-term debt instruments: A 14. with maturities ranging from 1 year to 30 years.
. those having maturity exceeding 20 years were in vogue in the seventies and the eighties while in the early nineties.7 Debt instruments are primarily traded in the market in the following types: 1. Government of India dated securities (GOISECs) Similar to treasury bills. Very long dated securities i. interest. any such instrument has a certain amount of accrued interest with it i. At any given point of time. • Long term debt instruments
Simply stating.7. Long term debt instruments • • • • • Government of India dated securities ( GOISECs) State government securities (state loans) Public Sector Undertaking Bonds (PSU Bonds) Bonds of Public Financial Institutions (PFIs) Corporate debentures
Question 14.e. And so we go ahead discussing the long-term debt instruments.8
Q 14. which has accrued (but is not due) calculated at the "coupon rate" from the date of the last coupon payment.e.Money Market Instruments • • • • Certificate of Deposits Treasury Bills Commercial Paper Bills of Exchange
2. They are issued in dematerialized form but can be issued in denominations as low as Rs.Investment Banking
Q 14.8. these are instruments having a maturity exceeding a year.8 The Money market instruments have already been covered as a separate module.113 -
.100 in physical certificate form. List down the different types of debt instruments: A 14.
. the coupon rates on state loans are marginally higher than those of GOISECs issued at the same time. investment bankers are roped in as arrangers for these issues. They issue bonds in 2 ways – through public issues targeted at retail investors and trusts and also through private placements to large institutional investors. Financial Institutions are also allowed to issue bonds. that too in much higher quantum. The planning commission in consultation with the respective state governments determines this limit.e.Investment Banking
State government securities (state loans) These are instruments issued by the respective state governments but the RBI coordinates the actual process of selling these securities. PSUs funded by and under the administrative control of the Government of India). What is the difference between Debenture and Bonds?
. The term usually denotes bonds issued by the central PSUs (i. While there is no central government guarantee on these loans. Long maturity debentures are rarely issued. On an incremental basis. as investors are not comfortable with such maturities. bonds of PFIs are second only to GOISECs in value of issuance. they have maturities ranging between 5-10 years and are issued in denominations (face value) of Rs1000 each.9. Often. Typically. they are deemed to be extremely safe.1000 and have maturities ranging between one and ten years. Public Sector Undertaking Bonds (PSU Bonds) These are long-term debt instruments issued by Public Sector Undertakings (PSUs). Generally. Each state is allowed to issue securities up to a certain limit each year. Most of these issues are made on a private placement basis at market determined interest rates. Generally.
Bonds of Public Financial Institutions (PFIs) Apart from public sector undertakings. Corporate Debentures These are long-term debt instruments issued by private sector companies and are issued in denominations as low as Rs. debentures are less liquid as compared to PSU bonds and the liquidity is inversely proportional to the residual maturity.
National Thermal Power Corporation (NTPC).e. There are two kinds of stamp duties levied on debentures via issuance and transfer. IFCI. various State Governments and some statutory bodies. issuance stamp duties have been coming down and are reasonably uniform. Issuers within this category include the Government of India. provident funds etc.115 -
. Who are the issuers of debt instruments? A 14. Over the years. Prominent DFI issuers include ICICI. (MTNL).10. IDBI. Stamp duty on transfer is paid to the state in which the registered office of the company is located.
. Issuance stamp duty is paid in the state where the principal mortgage deed is registered. • • • • Government of India and other sovereign bodies Banks and Development Financial Institutions PSUs Private sector companies
Government of India and other Sovereign bodies The largest volumes of instruments issued and traded in the debt market fall in this category. Indian Railway Finance Corporation (IRFC). Debenture stamp duty is a state subject and the quantum of incidence varies from state to state. The prominent PSU issuers include Mahanagar Telephone Nigam Ltd. These concessions are indirect i. these PSU bonds are approved securities for investment by various trusts. which enjoy special concessions. Transfer stamp duty remains high in many states and is probably the biggest deterrent for trading in debentures resulting in lack of liquidity
Banks and Development Financial Institutions Instruments issued by DFIs and banks carry the highest credit ratings amongst non-government issuers primarily because of their linkage with the Government. IRBI. and Konkan Railway Corporation (KRC) etc. ICICI and IDBI have been the most aggressive issuers. Public Sector Undertakings (PSUs) PSUs issue PSU bonds.Investment Banking
A 14. as well as some state level DFIs like SICOM.10 The issuers of debt instruments play a crucial in judging the functioning of the debt market and subsequently the debt business. GIIC etc.9 A key feature that distinguishes debentures from bonds is the stamp duty payment. Instruments issued by the central Government carry the highest credit rating because of its ability to repay its obligations.
• • • Some of the fixed income securities such as government securities offer a risk free rate of return on the investor’s money A key feature that distinguishes debentures from bonds is the stamp duty payment Similar to treasury bills. GOISECs are issued by the Reserve Bank of India on behalf of the Government of India Question 16. Hedge funds can be well defined based on their characteristics rather than on their hedging nature. Hedge funds are used as a tool to reduce the volatility and risk there by increasing the returns and preserving capital under any type of market conditions. Given the expected growth of India's GDP. Debt instruments are basically obligations undertaken by the issuer of the instrument as regards certain future cash flows representing interest and principal.
Q 16. The common characteristics of most of the hedge funds include • • • They are primarily private investment vehicles.2. Managing fund as a general partner. the debt market can be expected to grow at an annual rate of approximately 15% in nominal rupee terms.116 -
.1. There were large issues of debentures by private sector companies in the early and mid nineties. What are Hedge funds? A 16. Why are hedge funds in news?
Summary • • • A market where fixed income securities of various types and features are issued and traded is known as a “debt market”. The total value of outstanding debentures issued by private sector corporates is estimated at Rs500bn. which the issuer would pay to the legal owner of the instrument.1.Investment Banking
Private sector companies Private sector companies issue commercial papers (CPs) and short and long-term debentures. Performance based fee structure.
4.4. There are many different types of hedge fund strategies and styles depending on different degrees of risk and return. trade options or bonds and invest in almost any type of market where it can foresee reduced risk and higher returns. There are a huge variety of hedge fund investment styles that provides investors with a wide choice of hedge fund strategies to meet their investment objectives. These strategies can be classified into • Very high risk strategies
. State some of the most commonly used Hedge fund strategies. they are highly attractive for their high returns and the availability of various investment alternatives. buy and sell undervalued and over valued securities.117 -
. It would be quite helpful to know about different hedge fund strategies.Investment Banking
Q 16. as all hedge funds are not the same. Some specific advantages accrued are as follows: • • • • • • Many of the hedge fund strategies have the ability to generate positive returns in both rising and falling markets (equity and bond). Inclusion of hedge funds in a balanced portfolio reduces overall portfolio risk and volatility there by increasing returns.2. Even after having these disadvantages. volatility and risk vary enormously among the different hedge fund strategies. consistency of returns and capital preservation rather than on the magnitude of returns. The objective of most of the hedge funds is. Question 16. Hedge funds provide an ideal long-term investment solution by eliminating the need to correctly time entry and exit from markets.3. Hedge funds of late gained tremendous importance in the global financial market. State the advantages of hedge funds. The investment returns. they lack liquidity and are less transparent. A hedge fund can take both short and long positions. Hedge funds charge high fee. A 16.
Q 16. make use of arbitrage. Adding hedge funds to an investment portfolio provides diversification. A 16. which is not otherwise available in traditional investing.3. Generally hedge funds have higher returns and lower overall risk than traditional investment funds.
. The following are referred to as very high-risk strategies • Emerging markets:
Moderate risk strategies
o Special situations o Value o Funds of hedge funds • Low risk strategies
o Distressed securities o Income o Market neutral securities hedging o Market neutral arbitrage • Variable risk strategies.
o Opportunistic o Multi strategy Session 16: Hedge Funds: Question 16.5
Q 16.5. What are the Very high-risk strategies? A 16.Investment Banking
o Emerging markets o Short selling o Macro • High risk strategies
o Aggressive growth o Market timing Question 16.5.
This strategy includes investing in equity or debt of emerging markets where there is a huge scope for significant future growth. the manager borrows securities from a prime broker and sells them in the market immediately.
Macro: This strategy aims to profit from the changes in the global economies because of the change in government policies. He then repurchases the securities at a later date at a price lower than what he sold foe and returns the securities to the broker. The changes in the government policies in turn impact the interest rates.119 -
. Manager constructs the portfolio based on the global economic trends rather than on the individual securities. Short selling is done when the stock is overvalued at present. if the share price is expected to drop in the future as according to the fundamentals of the underlying company. This includes companies that have less or no dividends and smaller or micro capitalization of stocks. This means. The volatility of this strategy is mainly
. This strategy is based on the movement of the various markets and the predictions that can be made through the market movements. In order to short sell.e. • Short selling:
Short selling means selling shares with out owning them hoping to buy back at a future date with a lower price. stocks and bond markets. investing in less mature markets that tend to have high inflation and volatile growth. What are High-risk strategies? A 16.
Q 16. The following are referred to as high-risk strategies • Aggressive growth:
This strategy involves investing in equities that are expected to experience a strong growth in their EPS. • Market timing:
This strategy involves moving capital from one asset class to another there by capturing market gains and avoiding market losses.6. i. Many of the emerging markets do not allow short selling and therefore effective hedging is not available. these may also include sector specialist funds such as banking or technology. currency. Managers will consider the companies’ fundamentals before investing and they generally utilize short selling where earnings disappointment is expected.
This strategy requires patience and long term holding until the final or the expected value is recognized by market.
Q 16. • Value:
This strategy includes investing in securities that are supposed to be selling at a less or discounted price than its intrinsic value. What are the moderate risk strategies? A 16.7. What are the low risk strategies? A 16.7. reorganization or heading toward that
. The following are referred to as low-risk strategies • Distressed securities:
This strategy includes investing in the equity. mutual funds or individual hedge funds.8.Investment Banking
because of the unpredictability of market movements and to decide upon the entry and exit timings from the market. debt or trade claims that are issued at less or discounted prices of the companies that are facing bankruptcy. This strategy makes use of the mix of hedge funds and other pooled investments. Here the manager simultaneously purchases and sells the stock in the company being acquired and acquirer respectively there by getting profit from the spread between the current price and the purchase price of the company. return and volatility can be controlled by the underlying strategies and funds. • A fund of hedge funds is generally a diversified portfolio of uncorrelated hedge funds. An important consideration of this strategy is capital preservation and the volatility depends on the mix of the strategies employed. The risk. This mix of different strategies helps in providing a more stable long-term investment return than any of the stock portfolios. Managers take long and short positions in stocks that are believed as undervalued and overvalued respectively. This includes investing both long and short in stocks that are expected to change in price because of the underlying event. The following are referred to as moderate-risk strategies • Special situations:
This strategy makes use of the event driven situations like mergers and acquisitions or leveraged buyouts.120 -
This strategy involves making use of the inefficiencies of the market by offsetting long and short positions. The market risk can be greatly reduced by pairing individual long positions with related short positions
Q 16. The following are referred to as variable-risk strategies • Opportunistic:
Opportunistic strategy makes use of different events such as issuing IPOs. • Income:
The primary focus of this strategy is to invest in such a way to get yield or current income rather than on capital gains. • Multi strategy:
. The characteristics of the portfolio will vary from time to time. Managers can also make use of the combinations of different approaches at a given time. Managers can take short positions in companies whose position will worsen in the short term.securities hedging:
This strategy involves investing both long and short in the same sectors of the market.8 Conti
Market neutral. What are the Variable risk strategies? A 16. The logic in this strategy lies in picking up the stock and effective stock analysis to get better results. The logic behind this strategy is that the securities of companies in such situations often trade at a discount for a variety of reasons.9. or bids etc. sudden price changes because of low interim earnings. It may also make use of leverage to buy bonds or fixed income derivatives to profit from both interest income and principal appreciation. Long positions will be taken in securities that are expected to rise in value and short positions in securities that are expected to fall in their value. Question 16.9. The effect of bankruptcy will lead to under valuation of the shares. • Market neutral.Investment Banking
situation. This involves changing the investment idea from strategy to strategy according to the opportunities that arise rather than on selecting the securities with the same strategy.121 -
hedge funds are categorized in to different styles and strategies.10
. Question 16. Mutual funds are highly regulated. These include. Mutual funds are not able to effectively protectHedge funds are often able to protect portfolios from declining markets other than byportfolios from declining markets by going into cash making use of different hedging strategies. The future performance of the mutual fund isFuture performance of many hedge fund dependent on the direction of the equity markets. high risk. restricting theHedge funds are regulated to far less use of short selling and derivatives oversight and can make use of short management selling and derivatives Mutual funds generally remunerate managementHedge funds remunerate
based on the percentage of assets under thewith performance related incentives as management well as a fixed fee. A 16. direction of equity
Summary: • • Hedge funds are used as a tool to reduce the volatility and risk there by increasing the returns and preserving capital under any type of market conditions. very high risk. low risk and variable risk. strategies is highly predictable and is not dependent on the markets. This strategy is used to simultaneously realize both short term and long-term gains. make use of arbitrage.10.122 -
. moderate risk.Investment Banking
Multi strategy makes use of various strategies and can underweight or overweight different strategies to best capitalize on current investment opportunities. buy and sell undervalued and over valued securities.10. Mutual fund Hedge fund Mutual funds are measured on relative performance Hedge funds are expected to deliver absolute returns by making profits under all circumstances. Distinguish between mutual fund & hedge fund. A hedge fund can take both short and long positions. The weight of different strategies may vary over time. • Depending on different degrees of risk and return. trade options or bonds and invest in almost any type of market where it can foresee reduced risk and higher returns. There are 5 major differences between a hedge fund and a mutual fund.
remuneration. the bond is therefore sold at par. high yielding bonds. Full coupon bond is a bond with a coupon equal to the going market rate.Investment Banking
• The areas of difference between the hedge fund and mutual fund are regulatory over sight. Coupon is the interest payment on a bond. Baby bond a bond with a par value of less than $1000 Brady bonds are issued by emerging countries under a debt reduction plan Bulldog bond is a foreign bond issue made in London Citizen bonds are certificate less municipals that can be registered on stock exchanges and are listed in newspapers Cushion bonds are High-coupon bonds that sell at only at a moderate premium because they are callable at a price below that at which a comparable non-callable bond would sell.
. Samurai bond is a yen-denominated bond issued in Tokyo by a non-Japanese borrower. relative and absolute performance.123 -
. protection against declining markets and future performance. Related: Bulldog bond and Yankee bond. Cushion bonds offer considerable downside protection in a falling market Deep-discount bond A bond issued with a very low coupon or no coupon that sell at a price far below par value. Junk bonds are high risk. A bond that has no coupon is called a zero-coupon bond. Did you know – bonds? Z bond: A bond on which interest accrues but is not currently paid to the investor but rather is added to the principal balance of the Z bond and becoming payable upon satisfaction of all prior bond classes. Junk bonds are so called because they have a better than 50% chance of default. carrying a Standard & Poor's rating of CC or lower. Convertible Bond is a bond that can be converted into shares in a company.
banks and insurance companies. the market has seen hybrid issues worth €9bn (22 issues) in the insurance segment.
Pure discount bond is a bond that will make only one payment of principal and interest. Activity has therefore been concentrated in mid-sized corporates and frequently in situations to finance a restructuring exercise or an ambitious growth plan.Investment Banking
Payment-in-kind (PIK) bond is a bond that gives the issuer an option (during an initial period) either to make coupon payments in cash or in the form of additional bonds. This article discusses how hybrid securities can be a useful addition in the capital structure and shore up the credit profile of an issuer. In Europe. €24bn in banking (59 issues tier 1) and €6bn (10 issues) in corporate. fixed-income investors are looking for
better yield. These bonds are usually registered with the SEC. With the low-interest rate environment.
. This was in part driven by uncertainty over potential investors' perception of the instrument.S. Hybrid Securities Finally Hit Corporate Segment Karsten Frankfurth. issuers must compensate for such risks and therefore pay a higher coupon. By issuing hybrid instruments that qualify for regulatory capital. a bank can enhance its lending activities without having to issue straight equity. For a bank. Such as. This has changed. The sheer volume of hybrid issues clearly illustrates the dominance of this instrument within the financial institutions sector. the maximum amount of lending activity is limited by the amount of regulatory equity. dollars and issued in the United States by foreign banks and corporations. The dominance of hybrids in the financial institutions sector is caused by the fact that this instrument qualifies as 'regulatory' capital.e. Corporate issuers have been less than active in issuing hybrid securities in Europe. and highly rated issuers seem to have discovered corporate hybrids. During 2005 (until August). There are three principal motivations behind this: 1. As hybrids are similar to common equity. however. provided such securities meet certain structural criteria as set out by the relevant regulatory bodies. i. bonds issued by originators with roots in Japan are called Samurai bonds. Fitch Ratings .124 -
. hybrid securities have so far been largely a financing vehicle for financial institutions. Also called a zerocoupon bond or a single-payment bond Yankee bonds are foreign bonds denominated in U.18 Oct 2005 Hybrid securities have so far mainly been a financing vehicle for financial institutions in Europe but now corporate issues have become more active in issuing them.
300m hybrid with a maturity of 100 years.Investment Banking
. For example. Bayer's issue attracted so much interest that the volume was subsequently upsized. the capital structure profile of German pharmaceuticals/chemicals group Bayer was weakened following the acquisition of the OTC business of Roche in 2004. hybrid issues relieve pressures from investors and credit analysts on
companies to increase financial flexibility. Bayer used the majority of the proceeds to replace existing senior debt (by repurchasing outstanding bonds). further contributing to the strong investor interest in hybrids. corporate issuers are able to add an equity-like instrument to their capital structure at low cost. an instrument that includes strong equitylike features.
3. Bayer in 2005 issued a €1. the latter is taken into account by Fitch's assignment of a certain amount of equity credit in its rating
. To shore up its capital structure. Chart: Evolution of European Corporate Hybrid Issue Volumes
What are Corporate Hybrids? Corporate hybrids are financial instruments that combine certain elements of debt and equity.
Finally. Driven by the low interest-rate environment.
the more discretion the issuer has in making payments. Taken to the extreme.e.Investment Banking
assessment. those credit metrics that are primarily balance sheet based (total debt/total capital) and all 'dynamic leverage' ratios. A simple example illustrates the effect. a hybrid security will typically be considered more equity-like the more distant its maturity date. the higher the issuer's rating the more likely the hybrid security will perform like straight debt. The reason for this sliding scale is that. To avoid this.85 = 1788) (1520/0. Fitch will assign an amount of equity credit to an instrument accordingly. But what are the analytical implications of this? From the viewpoint of credit metrics. The high-grade company. Table 1: Comparison . Fitch limits the amount of hybrid securities eligible for equity credit within the equity-capital structure of any issuer. meaning that no capital provider ranks below it. i. Therefore.Equity Benefit from Issuing Hybrids (€m unless otherwise stated) Company Senior Unsecured Rating Common Equity + Reserves Soft Ceiling Hybrid Headroom Hybrids Issue Considered Assumed Equity Credit Given for the Instrument Equity Credit Amount Adjusted Equity High-Grade Company A1520 15 per cent 1788-1520 500 65 per cent 268 1788 = Sub-Investment Company BB+ 1520 35 per cent 2682338-1520 500 65 per cent 325 1845 = 818 Grade
(1520/0.65 = 2338)
The companies in the table both have equity of €1. and it is the most 'junior' form of capital. and therefore a stricter limit is adequate.126 -
. whereas it is 25 per cent for a BBB issuer and 35 per cent for the sub-investment grade territory (below BBB-). in Fitch's view. however. and the more junior the issue. only receives €268m in additional equity from
. Based on assumptions about the hybrid's structural features Fitch has given it 65 per cent equity credit. This means that a lower-rated issuer may stand to benefit more than a higher-rated issuer from issuing a hybrid security. an absence of fixed payment obligation. such as total or net debt/EBITDA.520m and are considering a hybrid issue of €500m each. For issuers in the single A-category. The Rating Perspective Depending on the structural features of a specific hybrid. the cap is at 15 per cent. this means that the issuer's capital structure ratios will improve. this would mean that the more hybrids a corporate issues the better its capital structure will become and consequently the better its rating should be. Equity is marked by the lack of a maturity date.
i. This is because only the US market provided a sufficient amount of publicly outstanding securities to derive any meaningful statistical results. However. cross-defaults and/or cross acceleration clauses have not performed as well. Also. Finally. a difficult period for the credit market. the incremental equity effect is stronger for the sub-investment grade company. it is found that a three-year coupon deferral feature is sufficient. Only the subinvestment grade issuer receives the full 65 per cent equity credit on the €500m. however. The total volume of securities included in the back-test was a substantial $48bn. the examination reveals some very interesting results. If the full €325m was assigned to this issuer. A further analytical consideration is whether the inclusion of a hybrid instrument improves coverage ratios. the interest cover based on EBITDA. and this would have to be factored into the senior unsecured rating.e. If skipping coupon payments were to be assumed at the outset. It is important to note. Fitch is of the opinion that the results would remain applicable to European hybrids. the Hybrid Securities Committee within Fitch undertook an extensive back-test on those instruments during 2000-2003. Fitch does not view it appropriate to exclude the interest expense on a hybrid security in its primary analysis as it bases its assessment on 'normal circumstances'. However. corresponding to €325m. First. By theory. it is assumed that they perform like regular debt instruments. This is the heart of the hybrid concept: hybrids need to unfold their equity like-features in a financial crisis as this is when they provide the most benefits. Under normal circumstances. Increased Issue Volume in Europe
. the hybrid instrument would correspond to more than 15 per cent of the total equity. Fitch runs scenario analysis to evaluate how much relief is provided by the deferral options of the instrument. but practice has shown that within three years companies either go into liquidation or manage to re-structure.127 -
. How do Hybrids Perform in a Financial Crisis? There is evidence that hybrids do perform in a financial crisis. this would imply a prospective substantial deterioration in credit metrics. the longer the deferral option the better.Investment Banking
the issue due to the stricter soft ceiling of 15 per cent. it would not be possible to place the instrument with investors if coupon deferrals would almost be certain. In 2004. Included in this test were 89 issuers and 209 securities. Secondly. documentations that are marked by 'excess complexity' do not provide sufficient equity-like characteristics in stress times. that the statistical population is entirely US-based. securities that include financial covenants. As a result. a maturity period in excess of 10 years is considered long and provides substantial cash-flow relief in stress times. While the overall criteria and features that lead Fitch to assign equity credit have not changed. Also.
100 or 1. In terms of tenor. Fitch also assesses the circumstances under which management may defer coupon payment. Table 2: Outstanding European Issues Issuer Vattenfall DONG Suedzucker Casino Bayer AG Thomson Volume €1bn €1.e. the more likely it is that the issue will be replaced. If this is excessively high. The step-up condition refers to the amount by which the coupon rises if the call is not exercised. Finally. which in turn requires qualitative analysis. The answer is that it depends namely on three factors: the senior unsecured rating of the issuer. These differentiations will have an impact on how Fitch allocates equity credit to each hybrid issue. This raises the analytical question whether a call date should be viewed as a de-facto maturity. which is a strong equity-like feature. what has also become a market feature is the call option on these instruments. the market standard has been either perpetuals or very long maturity dates. for example.3bn €500m
Fitch believes that the issues observed in Europe generally qualify for a high equity credit allocation. This is because investors probably expect the issuer to be obliged to replace the security if he aims to keep his access to this market open. the deferral is tied to certain provisions. Such hybrids can be called after a call date. then it must be assumed that the issuer will take all efforts to replace the security to avoid the rise in funding expenses after the call date.Investment Banking
Europe has recently seen substantial hybrid issue volumes. The higher the issuer's rating (senior unsecured rating).000 years. The issues have coupon deferral features that vary in their details. i. Strong replacement language reduces the likelihood of the call-date being viewed as a de-facto maturity. coupon payment cannot be deferred if a distribution to common equity has taken place.
. with bonds of considerable size. However. Some issues leave the payment of the coupon fully at the discretion of the issuer.1bn €700m €600m €1. usually 10 years after the issue date. In others. Some issues go even further by including a mandatory deferral on top of the optional deferral. the step-up conditions after the call date and the existence or lack of protective replacement language. the latter of which is a de-facto perpetual security. The table below outlines some of the currently outstanding European issues. Replacement language refers to a provision by which the issue can only be replaced by an issue that is of equal 'subordination'.128 -
. replacement language is considered.
1 Custodians in general refer to a bank / agent or any other organization responsible for safeguarding an individual’s or a firm's financial assets. and that the hybrids have yet to be tested during stress times. It is definetely one of the important functions being performed by the financial intermediaries nowadays. either using their own local branches or other local custodian banks in each market to hold accounts for their underlying clients.Investment Banking
Conclusion Hybrid securities can be a useful addition in the capital structure and shore up the credit profile of an issuer. Question 17.129 -
. Assets held in such a manner are typically owned by pension funds.1 Who are Custodians? A 17.2 The role of a custodian in such a case would be the following: • • • • • Hold in safekeeping assets such as equities and bonds Collect information on and income from such assets (dividends in the case of equities and interest in the case of bonds). an evaluation of the likelihood whether the instrument will be called at the call date.2
Q 17. Undertake foreign exchange transactions where required and provide regular reporting on all their activities to their clients.
. The current low interest-rate environment and ample liquidity make it fairly easy for issuers to place those instruments. Provide information on the underlying companies and their annual general meetings.2 What role do the custodians play? A 17. The majority of the issues observed so far fulfil conditions for high equity credit allocations. Detailed analysis is required including a qualitative analysis of the issuer and. Arrange settlement of any purchases and sales of such securities. besides being a great source of revenue. manage cash transactions Did you know? Custodian banks are also known as 'Global Custodians' if they hold assets for their clients in multiple jurisdictions around the world. Investors should be aware that they are investing in a strong credit environment. in particular.
the scrips are replaceable and the risk of the loss or damage of scrips while in the safe custody of the custodian should be borne by the custodian concerned. custodians are required to segregate their clients’ assets and cash from that of the custodians’ own assets and cash. However the actual insurance policies do vary from custodian to custodian.
Inspection of records: On an annual basis SEBI and RBI conduct external audits with respect to physical verification and reconciliation of records. like placing shares in pouches and storing them in fireproof cabinets with in vaults.4 Safe custody of shares encompasses the following activities Safe keeping methods: Custodians usually take safety measures. Protection of clients’ assets: As per SEBI. the procedures vary among custodians. Custodians are insured against risks arising from theft.3 Typical custodial services will include:
Q 17.3 What do the Custodial Services include? A 17.Investment Banking
Question 17. In addition. Question 17. The periodicity of verification and reconciliation of records is custodian specific and as per the internal checks are concerned.4 What do you mean by Safe Custody of Shares? A 17.5
. In case of any damage or mutilation of the scrips. SEBI wants to maintain separate cash and securities accounts for each of their clients.130 -
. Barcodes are then affixed to individual certificates that can be scanned for identification.3
Q 17. Some custodian banks have a better coverage than others.
It also goes to say that if the investor uses a particular custodial banks service anywhere else. safe custody fee is charged for the custodial services to the investors’ portfolio in safe custody. but the portfolio is valued on a monthly or a quarterly basis and the fee is payable accordingly. The fee is usually quoted at a certain percentage of the value of the portfolio on an annual basis. Financial / Business
. some custodians operating in India have their custodial service networks outside the country on a regional or global basis too.5 Custodial charges generally consists of the following: • • Transaction fee Safe Custody Fee
Q 17.7 Sources of corporate action information: According to listing guidelines.6 Explain in brief the above-mentioned custodial charges? A 17.
Q 17. Did you know? BSE circulates daily notices while NSE transmits it online.6 The details of each of the above mentioned expenses are • Transaction fee
For each transaction that the investor settles through the custodian the transaction fee is charged. The company informs the stock exchange where its shares are listed and the in turn the exchange informs the members and investors through various channels. he or she may have an additional bargaining edge in order to lower the fees. every company listed on the exchange has to notify the exchange of its corporate actions well in advance. The exchange sends circulars on listed companies corporate actions to its members from time to time.7 What do you mean by Corporate Actions? A 17.131 -
. • Safe custody fee
As is understood by the term.5 What does the Custodial Charge consist of? A 17. It may be a certain percentage of a transaction value or an amount per transaction. Say. One important thing to be noted is that each investors trading pattern significantly affect the economy of the custodial fees.Investment Banking
If it so happens that some shares are kept in street name instead of being registered.
Q 17. Meanwhile this situation may result in the occurrence of the possibility of having an ex-date fixed after the official record date or the book closure date. Thereafter. neither SEBI nor RBI has announced its official position in this matter. Proxy service to foreign investors: Providing proxy services to foreign investors like FIIs is a dreary area. the custodian will inform his or her FII clients of the same. some custodians have been offering such services in respect of those companies whose registered offices are located in metropolitan areas. both the trades done cum benefit and the trades settled after the official book closure date would still be entitled to corporate action benefit. Some brokers also maintain database on corporate actions and provide such information on a regular basis to their clients.8Explain the service of Dividend Payment and Sale Proceeds A 17. When such a situation takes place.
. It is a general understanding in the market that custodians do not provide proxy services to their foreign clients. Date for determining corporate entitlements: The book closure or the date record date will be used to analyse all corporate entitlements.8 Dividend payment: The amount of dividend to be declared is proposed to and approved by the company’s board of directors. Dividends are paid with in 42 days. the FII must make sure that his or her custodian has such a system so as to ensure that all stocks. At its annual general meeting the company declares payment of dividend. However. In spite of formal inquiries. The notice of dividend amount proposed that is to be declared is given to the stock exchange at least 42 days before the record date. on completion of which the custodian monitors his or her clients feed back in order to ensure that proper instructions are obtained from the clients.132 -
. However the responsibility of fixing the record date rests with the concerned company itself. This is more so because different stock exchanges will have different settlement cycles and the ex dates are announced by the exchanges themselves. the shareholders approve and declare the dividend payment the annual general meeting of. whether registered or in street name are monitored at the same time.
Notification to foreign investors: As the corporate benefit gets declared.Investment Banking
magazines and local newspapers are a reasonable source of such information.
RBI does not allow FIIs to enter into forward foreign exchange contracts with any locally registered foreign exchange dealer. All in all. some companies pay an interim dividend. Thereafter the repatriation of funds is allowed.
Q 17.9 FII does not require exchange control clearances for Dividend income repatriation. the custodian bank is responsible for ascertaining and with holding the proportion of tax amount payable. if any.133 -
Payment of dividends is usually done on an annual basis. the FII has to first obtain a certificate providing the computation of tax payable on capital gains from a chartered accountant.1. which requires the approval of its board of directors during the financial year.
Did you know? In case the FII intends to repatriate the cleared dividend proceeds.000) the same may be cleared on the same day.9 What is the scope of Foreign exchange control? A 17. In case of a high value cheque (a cheque more than Rs. Though not legally required. from the date of sale of securities assuming a normal settlement period. The FIIs custodian with holds the tax and then credits the net rupee sales proceeds to the FIIs non-resident foreign currency account and repatriate them to the FIIs account outside India. interim dividends are paid with in 42 days of the date of approval by the board of directors. while the cheques of smaller amount may take two days to be cleared. However in connection with the repatriation of dividends or sales proceed from FIIs equity investments.
. 00. usually drawn on banks located in big towns. before converting the funds into a foreign currency and crediting the foreign currency denominated funds to the FIIs foreign account. Payee banks designated in these demand drafts are obliged to pay the dividend cheque proceeds with in 48 hrs upon presentation of these drafts to the named payees.
Repatriation: • Sales proceeds
Once the securities have been sold. • Dividends
Dividend cheques are issued in the form of demand drafts. Indian rupee-denominated positions in Indian fixed income securities and yields on their investments in terms of a foreign currency like the US dollar can be covered by FIIs . Such a process should be completed with in 48 hours. it takes approximately three weeks to repatriate the net sales proceeds. However.
In India. For United States it is T+5 and for Japan it’s T+4. money managers and broker/dealers who rely on custodians and other market participants for the efficient handling of their worldwide securities portfolios
Summary • • • • • Custodian refers to a bank / agent or any other organization responsible for safeguarding an individual’s or a firm's financial assets. FII does not require exchange control clearances for Dividend income repatriation Dividend cheques are issued in the form of demand drafts. custodial charge and dividend and sale proceeds.134 -
. What are they? A 18. a batch of securities traded during a period of 7 calendar days settle all together through the clearing house on a predetermined day after the end of such period. usually drawn on banks located in big towns
Q 18.1 What are Settlement procedures? A 18. Corporate action. Custodian banks are often referred to as 'Global Custodians' if they hold assets for their clients in multiple jurisdictions around the world. Custodial Services can be classified as Safe custody of shares.2 The three key words are • Settlement period
. while a certain number of business days after the trade date.17.2It’s often said that the Indian Settlement system revolves around 3 keywords.10 Who uses Custody Services? A.
Q 18. trades commonly settle on a daily rolling basis. which is commonly expressed as T.10 Custodial services are used by Institutional investors.Investment Banking
Q 17.1 In the developed and Southeast Asian countries.
• • Ordinary settlement segment Rolling settlement segment. The transactions entered during a settlement period are to be settled on a set of ‘pay-in day’ and ‘pay-out day’. together with the transfer deeds for all sales made through them. because a transfer deed that has been duly stamped and executed will accompany a certificate of shares to register a transfer of ownership of shares. also known as ‘sunshine’ segment.3 From the point of view of settlement periods there are two segments of equity trades on the BSE. there is also a need to deliver security certificates. known as a ‘trading period’ on the NSE and a ‘settlement period’ on the BSE.
The day on which brokers receive the payments from the clearing house of the exchange for all sales made through them in the preceding settlement period and also to receive security certificates. In general there are 5 trading days during a settlement period. for all purchases made through them in the same settlement period.2 Conti
Payout day . Besides in the same settlement period. Did you know? The Bombay Stock Exchange (1875) is the oldest stock exchange in Asia. • Pay-in day
This is the day when brokers have to settle payments to the clearinghouse of the exchange for all purchases made by them in the preceding settlement period.135 -
.3 How are settlement periods defined for BSE listed stocks?
. together with transfer deeds. A transfer deed will be required on a physical delivery basis for the settlement of every trade in addition to a certificate of the traded shares.
There is also another segment called as the negotiated trade segment. Did you know?A transfer deed (also known as share transfer form) is basically an instrument of transfer.3 How are settlement periods defined for BSE listed stocks? A 18.
Q 18. much older than the Tokyo Stock Exchange (1878). Question 18.Investment Banking
In India Stock exchanges divide one-year periods into periods of 7 calendar days.
The selling broker subsequently delivers the securities directly to the buying broker in exchange for the funds on a DVP basis.4 Discuss in detail the constituents of the Ordinary settlement segment? A 18.Investment Banking
A 18. After that. whichever is higher. the cheque is returned to the selling broker or custodian. on Thursday evening or on Friday morning.4 In the ordinary settlement segment the trades executed are settled in two ways: Settlement through the clearinghouse Hand delivery
1.3 From the point of view of settlement periods there are two segments of equity trades on the BSE. If a make up delivery is made. on Friday. Settlement through clearinghouse: The settlement period starts on Monday. The settlement process completes unless there is any bad delivery. Hand delivery trades: The selling and buying member brokers mutually decide on the price at which a transaction is effected. Any bad delivered shares that are left unmatched after the auction are closed out at the highest price for the shares from the trade day or 20% above the closing price on the day of auction.
There is also another segment called as the negotiated trade segment. the buying broker or custodian examines the delivered securities for bad deliveries with in 48 hours of the delivery.136 -
. much older than the Tokyo Stock Exchange (1878). Did you know? The Bombay Stock Exchange (1875) is the oldest stock exchange in Asia. also known as ‘sunshine’ segment. the delivery and payment terms of the transaction. Securities and funds are paid-in on the first Thursday after the settlement period ends. • • Ordinary settlement segment Rolling settlement segment.
Q 18. The clearinghouse in turn obtains the members’ delivery obligations and generates settlement statements for its members.
2. It also checks for short delivery. The selling broker or custodian is required to makeup for the short delivery (if any) by 5:00 p. However as they
. The custodian or selling broker who commits short delivery gives the clearinghouse a notice of short delivery. and has to report a prima facie bad delivery to the BSE’s clearinghouse by the end of the following Tuesday. attached with a cheque for a value of the short delivered securities.m.
SEBI reportedly suggests that a single transaction should be more than 10. Book entry segment
Q 18. Conventionally this settlement cycle is termed as T+5. in which the NSE provides the settlement facilities for institutional investors. 00. but this excludes NBFCs for the purpose of sunshine segment.5 What constitutes the Sunshine segment? A 18. Normal market segment.Investment Banking
do not go through the clearinghouse. The sellers have to be institutional investors.6
Q 18.6 The NSE conforms to a 7-day period. convertible debentures. Institutions or individuals can be potential buyers. Question 18. These settlements facilitate substantial reduction of settlement risks for institutional investors by minimising paper movements. NSE comprises of two main markets: • • Wholesale debt market for trading of pure debt instruments Capital market for trading in equities. the National Securities Clearing Corporation Limited (NSCCL) called as ‘cleared deals’.5 This segment aims at wooing institutional investors back to the BSE.000 shares or Rs.7 What are the Special settlement facilities provided for institutional investors? A 18.6 How does the settlement system vary for NSE listed stocks? A 18. etc. Question 18. or through a delivery versus payment route without involving the NSCCL called as the ‘non cleared deals’.000 in order to be executed in this manner. In this segment.5
Q 18. 2. trades settle on a daily rolling basis on the fifth working day from their trade day. these trades are not protected by the facilities that the clearinghouse provides (like automatic buys-in. Securities listed on the NSE can be settled either through the clearinghouse of the NSE.25. Book entry segment:
1. BSE members can execute off-the-market transactions at negotiated execution prices and still settle them through the BSE’s clearinghouse. bad delivery cells).7 Institutional investors are provided with special facilities for their settlements. Did you know? In Negotiated trade segment.
8 Mention some of the important reports prepared in this field? A 18. The settlement in the book entry sub-segment is different from that in the normal-market-segment in two aspects • • The settlement for funds and securities takes place on the fifth working day from the trade day on a daily rolling basis There are no procedures to rectify bad deliveries or objections of transfer. A partial delivery is not an issue for trades that settle through the clearinghouse. Contract notes When the market closes down. because any short delivery is auctioned or closed out in the prescribed time frame.9 What is this phrase called Delivery Versus Payment? A 18. either mail or courier an account statement to their FII client on a fortnightly or a monthly basis as per its requirements. Upon execution of orders some brokers confirm them via faxing a transaction.
Question 18. Partial delivery: A short delivery gives rise to a partial delivery in the case of trades that settle on a DVP basis. the original contract notes for FIIs are forwarded to their custodians. Execution confirmation Local brokers who execute orders usually report all executed transactions to the FIIs by fax immediately after trading hours.8 The following are some of the important reports prepared in this field. In this section we will try to bring to lo light some related aspects.8
Q 18.Investment Banking
The settlement in the book entry sub-segment of the NSE is much simpler than that in the normal market segment.138 -
. because no bad delivery is expected in the book entry sub-segment.9 One term that finds extensive use under clearing and settlements is ‘delivery versus payment.
Q 18. fax or telex. [SWIFT (Society For Worldwide Inter bank Financial Telecommunication) is a cross border system in the world extensively used for exchanging banking specific electronic messages] Account settlement The broker and the custodian both. Delayed settlement:
. Settlement confirmation The custodian sends a settlement confirmation to his or her FII client and his or her broker via SWIFT.
while a certain number of business days after the trade date. or between the brokers. such as the absence of a brokers stamp from the transfer deed. have no specific time limit with in which these must be rectified. as share transfer form is basically an instrument of transfer. Institutional investors are provided with special facilities for their settlements
. In case the trade still fails. Short deliveries between the clearinghouse and the broker are taken care of by the ‘Buy-in’ procedures. Short deliveries between the custodian and broker.
Q 18. trades commonly settle on a daily rolling basis. which is commonly expressed as T. the delivery and payment terms of the transaction. Moreover the custodian follows up with the broker over the phone or through any other means prior to a settlement date to avoid the delayed settlements. The broker is supposed to settle trades with the custodian or investor on a settlement date right after the pay out.Investment Banking
As is generally seen a delayed settlement occurs in the case of a DVP settlement between the broker and the custodian (or investor).
Summary • Developed and Southeast Asian countries. Bad delivery: A bad delivery on the other hand is a delivery of share certificates and their accompanying transfer deed that have an obvious defect. The settlement period starts on Monday The selling and buying member brokers mutually decide on the price at which a transaction is effected. This should apparently disqualify the ownership of the share certificates from being transferred to the buyer of the share if these are submitted to the company’s transfer agent for registration of transfer. the custodian and the broker set up another settlement date.10 What are the most commonly faced Settlement troubles? A 18.10 Settlement troubles are generally of two types. • • Short deliveries. • • • • A transfer deed is also known. Bad deliveries.
Short delivery: When a custodian or the clearinghouse delivers fewer securities than what were contracted a short delivery takes place.139 -
500 companies in the country. As of January 2005. BSE is the oldest stock exchange in Asia..4.1.
Q 19. How many stock exchanges are there in India? A 19.2. which are listed and have a significant trading volume. The ISE provides a member/broker of any of these stock exchanges an access into the national market segment. National Stock Exchange (NSE).1 There are 24 stock exchanges in the country.
Q 19. in 1875. As of today. This banyan tree still stands in Horniman Circle Park. fair and open manner with access to investors across the country. The other three have been set up in the reforms era. As of 2005. ISE and majority of the stock exchanges have adopted the Screen Based Trading System (SBTS) to provide automated and modern facilities for trading in a trans parent.3. Mumbai. the second being the Tokyo Stock Exchange. which are the other stock-indices used by BSE?
Q 19. it is among the 5 biggest stock exchanges in the world in terms of number of transactions. with 21 of them being regional in nature.2 trillion.5. The BSE `Sensex' is a widely used market index for the BSE.2 The ISE has been promoted by 15 regional stock exchanges in the country and is based in Mumbai. A 19. established in 1878. there are around 3. the Over the Counter Exchange of India (OTCEI) and the Interconnected Stock Exchange of India Limited (ISE) have mandate to nation wide trading network.
Q 19.140 -
.4 An informal group of stockbrokers have been trading under a banyan tree opposite the Town Hall of Bombay from mid-1850s. was formally organized as the Bombay Stock Exchange (BSE). Which are the major exchanges to provide screen based trading system? A 19. viz. Discuss the genesis of the Bombay Stock Exchange.3 The NSE. the market capitalization of BSE is about Rs. This informal group of stockbrokers has organized themselves as “The Native Share and Stockbrokers Association” which. which would be in addition to the local trading segment available at present. How did the Interconnected Stock Exchange of India Limited (ISE) come to existence? A 19. Besides BSE Sensex.Investment Banking
Write a few lines on the management of BSE. consisting of 9 elected directors (1/3 rd of them retire every year by rotation). securities offered to the public for subscription have to be listed. A 19. 3 government nominees. Such criteria and disclosure requirements are virtually the conditions precedent to listing on the BSE. which regulates the exchange and decides its policies. 3 Government nominees.
Q 19. Following are the major requirements. the applicant company is required to make disclosure in accordance with the stipulated rules and regulations. as the Chief Executive officer.141 -
. viz.Investment Banking
A 19. a Reserve Bank of India nominee and 5 public representatives. Additionally. A President.5 The other stock-indices are • • • • • • BSE 100 BSE 500 BSEPSU BSEMIDCAP BSESMLCAP BSEBANKEX
Q 19.7.. The Executive Director. a RBI nominee. What are listing requirements for BSE? A 19. However. an Executive Director. Vice-President and Honorary Treasurer are annually elected from among the elected directors by the Governing board following the election of directors. Therefore an applicant company for listing on the BSE has to first satisfy the eligibility criteria for initial public offering (IPO). which need to be fulfilled by an unlisted company for being listed on BSE:
.6 It comprises of a governing board. as per SEBI orders issued in March 2001.6.7 Under current Indian Laws. is the Apex body. the elected directors have been restrained from acting as directors and the Governing body presently comprises of only 10 directors. is responsible for day-to-day administration of the Exchange. 5 public representatives and a Executive Director.
Issued Capital: The issued and subscribed equity capital of the applicant company. 00. Being aware of such distinctions will help an investor make a rational decision. Under such
. The NSE allows its members to trade odd lots outside the exchange • Realistic Approach: The BSE is an association of people and is run by people who are primarily brokers and who have years of experience in securities business.39 million) or more. What are the primary advantages of listing your stocks in BSE? A 19. the company has to have at least 10 shareholders for every Rs.8 There are some arguments in favour of trading in BSE.78 million approximately).Minimum Public Offer of Capital: At least 25% of each class of securities issued by a company has to be offered to the public for subscription. Net worth: Rs.100 million (US$ 2. ii. a company has to have at least 5 public shareholders for every Rs. the public shareholdings should not be reduced to less than 20% of the voting capital of the company). which has been already listed on another recognized stock exchange in India and seeks listing on BSE.100 million (approximately US$ 2.8. (However.000 of net capital offered to the public.50 million (approximately US$ 1. Did you know? A different set of listing criteria applies to an applicant company. • Odds lots trading: The BSE’s trading system facilitates trading odd lots of shares and such transactions settle through the exchange’s clearinghouse.000 of net capital offered to the public. The criteria are as follows: • • • Issued Capital: Rs.000 stocks are listed on the BSE while the NSE has approximately 1.500 listed or permitted stocks. shall not be less than Rs. and Market Capitalization: Rs. In the case of an offer for sale. BSE thus provides investors with a broader choice of Indian Companies to invest in.
. including that proposed to be issued before listing.150 million (approximately US$ 4. • Broader Market: Nearly 6. Public Shareholders: As a result of public issue. 00.1.78 million) or more.Investment Banking
i.1. The central government may relax this minimum public offer for government companies. “Public Shareholder” means a person who is neither a promoter nor a holder of more than 1% equity capital of the company.
Q 19.18 million) or more.
10 NSE also set up as index services firm known as India Index Services & Products Limited (IISL) and has launched several stock indices. accountancy. the exchange’s approach to problems tends to be more realistic and practical and does not upset the whole brokers community. Its two tier administrative set up involves a company board and a governing board of the exchange.9 The National Stock Exchange of India Limited was set up on the basis of the recommendations of the High Powered Study Group on Establishment of New Stock Exchanges. On its recognition as a stock exchange under the Securities Contracts (Regulations) Act. public
. Debenture and Government Securities with the entire necessary infrastructure and trading facilities. economics. including: • • • • • • S&P CNX Nifty CNX Nifty Junior CNX IT S&P CNX 500 S&P CNX Defty CNX MIDCAP 200
Q 19. eminent professionals in the fields of law.143 -
. finance. The Capital Market (Equities) segment commenced operations in November 1994 and operations in Derivatives segment. taxation. It is a professionally managed national market for shares. Discuss the genesis of the National Stock Exchange of India? A 19. PSU bonds.10. A 19.Investment Banking
management. where brokers own and mange the exchange. Write a few lines on the management of NSE.9. • More time for settlement: The BSE gives an investor’s broker or custodian more time to make payments and effect deliveries. Therefore.
Q 19.11. etc. NSE commenced operations in the Wholesale debt market (WDM) segment in June 1994. The NSE is not an exchange in the traditional sense of the term. professionals have been recruited to key administrative positions of the exchange.11 The Board of NSE comprises of senior executives from promoter institutions. 1956 in April 1933. Name some of the stock indices set up by NSE. A 19.
“Listing” means the admission of a stock to a stock exchange for trading on the exchange for trading on the exchange under a listing agreement between the exchange and the issuer of the stock. it is worthwhile to define the word “listing” here. What are the advantages of trading in NSE?
. If applicant company is not listed on another stock exchange in India for at least 3yrs. to distinguish listed stocks from permitted stocks. Minimum public offer of capital: At least 25% of each class of securities issued by a company must be issued to public for subscription.
Q 19. Issued capital or market capitalization: the issued and subscribed equity capital of the applicant company including that proposed to be issued before listing shall not be less than Rs.200 million. The central government may relax this minimum public offer of capital for government companies.12 Both Stocks and Bonds get listed on the NSE.500 million. ii. three nominees of SEBI and one full time executive of the exchange. or a scheduled commercial bank with a paid up capital exceeding Rs. What are listing requirements for NSE? A 19.12. the Board to an Executive Committee (EC) formed under the Articles of Association and Rules delegates’ decisions relating to market operations.Investment Banking
iii. The day-to-day management of the Exchange is delegated to the Managing Director who is supported by a team of professional staff. While the board deals with broad policy issues. • • • The aspirant company seeking listing The promoting company Another company of the same core promoters provided that the company is listed on another recognized stock exchange in India for at least 3 yrs.144 -
Q 19. Track record: One of the following three parties must have a track record of at least 3 yrs. iv. its project or activity plan must have been appraised by a financial institution under section 4A of companies act or a state financial corporation. A company applying for listing of its stock has to satisfy NSE’s listing guidelines listed below: i. We will however limit our discussions to stocks.
Q 19. • Public relations: NSE has established various programs for public relations. Professionalism: NSE is a body corporate run by professionals and has no representations of brokers on its board. This system allows all brokers in the network to know the terms being offered by all dealers in a given stock at any given time. Question 19.Investment Banking
.14. It is well prepared to disseminate information on the exchange’s rules and regulations and activities to the public through printed and Internet publications. The system as freed trades from persistent problems of the Indian securities markets such as paper work. NSE also has dedicated trained staff with the responsive attitude on the full time basis. What do you mean by the term “Over-the-Counter” market? A 19. The terms of trade are communicated through out the market system through the national association of security dealers automated quotations system. Retail prices are offered to individual investors who are usually executing orders through brokers. There are two levels of prices. wholesale and retail.14 One more dimension to the securities markets besides primary and secondary markets is Over-The-counter market. • Depository: NSE introduced the first depository system in India. • • Options and futures trading: The derivative trading added more liquidity and also a hedging tool to the current system. This market consists of a network of thousands of dealers in particular securities. Wholesale prices are offered to other dealers who wish to make changes in their inventory positions. Actual trades are subject to negotiation between brokers and dealers. They are • Unconditional counter party guarantee: the NSE’s clearinghouse guarantees the timely settlement of trades executed in their normal market segments against short and bad deliveries. Each dealer maintains inventories of one or more securities and has a bid price for which he or she is willing to buy the stock to add to inventory and an ask price for which he or she is willing to sell the stock from inventory. Question 19.13 There are some arguments in favour of the NSE. This enables NSE to quickly develop a stock exchange that is efficient and fair to investors. but the system report completed transactions. Securities that are not traded on organized exchanges are traded in the Over-The-Counter market. bad delivery and stamp duty.
NASDAQ uses a screen-based system that centralizes trading information to enable securities firm to compete with one another via the computer. The New York Stock Exchange (NYSE) celebrated its bicentennial in 1992. three exchanges – Tokyo.15 Some of the well-known Global stock markets are: New York Stock Exchange (NYSE).3 trillion. to 4:00 p.000 orders per day for 201 subscribers. It has an electronic rather than physical trading floor.6 trillion. Trades are executed at the prices displayed and size on NASDAQ terminals. NASDAQ began operations on February 8. NYSE is open for six and half hours every day from 9:30 a.S. 1971. A 19. Registered representatives on the trading floor who executes the order on behalf of the customer can convey orders.8 % of GDP in 1996. electronic stock market. The market value of NYSE stocks formed 95. More than 50 percent of the shares traded in USA are traded in the NASDAQ market.m. They reached an agreement on May 17.
Tokyo Stock Exchange: The Japanese stock market has a history of over 131 years beginning with the establishment of Tokyo Stock exchange in 1878.Investment Banking
NASDAQ (National Association of Securities Dealers Automated Quotations) NASDAQ stock exchange is the second largest stock exchange in the USA.15. Of the eight stock exchanges in Japan. Osaka and Nagoya are the largest. Since then it has grown to be the worlds largest stock exchange. The companies listed on NASDAQ exceed those on all exchanges combined. In 1992 Super Dot processed an average of 180. It is also highly automated with more than 60 percent of the orders executed automatically over the computers at the best prices available. It was the world's first electronic stock market and is now the largest U. Trading takes place over the telephone and through automated execution and trading systems. five days a week. The system completes the trading loop within seconds. The number of shares traded in 1996 was 104. The Tokyo Stock exchange in its present form was established in 1949 and accounts for about 80% of trades in both volume and value in Japan. Securities brokers took up trading under a buttonwood tree at 68 Wall Street. At the end of 1977 there
.25%. Discuss some of the well-known Global Stock Markets.146 -
.1992 to deal with each other and fixed the commission at 0. The shares of 2907 companies were listed in 1996 with capitalization of $7. It is a nation wide electronic screen based trading network blended with market maker competition. Orders can also be processes electronically through what is known as Super Dot 250 which is an electronic order routing system linking member firms all over USA directly to the trading floor of NYSE.
NSE and BSE together form the two most important stock exchanges in India. and it is the premier source of equity-market liquidity.1Define “Asset Management”? A 20.699 million yen. it is one of the largest stock exchanges in the world. even older than the Tokyo Old Exchange.147 -
. Founded in 1801. Some of the prominent stock exchanges in the world are the NYSE. The London Stock Exchange (abbreviated LSE) is one of the leading stock exchange markets of UK and the World. Some other notable definitions of the same. benchmark prices and market data in Europe. with many overseas listings as well as UK companies. the LSE aims to remove cost and regulatory barriers of capital markets worldwide
Summary • • • • The BSE is the oldest stock exchange in Asia. Question 20.” — The American Public Works Association Asset Management Task Force “…A comprehensive and structured approach to the long-term management of assets as tools for the efficient and effective delivery of community benefits.51. London Stock Exchange. which prevents any practise against public interest. NASDAQ.” Strategy for Improving Asset Management Practice. The 30 actively traded shares account for about 20 percent of the total turnover of $12. Both of the stock exchanges are governed by set of laws.216.Investment Banking
were 2387 companies quoted on the stock exchanges in Japan with a market capitalization of 2. The LSE is the most international of all stock exchanges with 350 companies from more than 50 countries. Linked by partnerships to international exchanges in Asia and Africa.750 million. “…A methodology needed by those who are responsible for efficiently allocating generally insufficient funds amongst valid and competing needs. given by premier world bodies are as follows.1 Asset management is a methodology to efficiently and equitably allocate resources amongst valid and competing goals and objectives. 1997
. Tokyo is the second most active stock exchange in the world after the NYSE.1
Q 20. AUSTROADS. Tokyo Stock Exchange and the London Stock Exchange.
Asset Management comprises of some fundamental guiding principles that make it a success.
The “who and how” drive the need for an effective practice of asset management. These fundamental principles are.148 -
.3 Detail your understanding on Asset Management and list out the guiding principles of the same. A 20. since it is a very dynamic and self-adjusting set of techniques. tools. while the “asset management enablers” are those components which make the functioning of asset management a success. and performance measures and shared understanding that glues the individual improvements or activities together.2 How do you describe the Asset Management Framework? A 20. it is the lubricant that keeps all the cogs from grinding against each other. Or rather.2 The Asset management is depicted by the following figure.Investment Banking
Q 20. • • • • • • Customer focused Mission driven System oriented Long-term in outlook Accessible and user friendly Flexible
Q 20.3 Asset Management is a set of processes.
6 What is the scope of operation for an Asset Manager? Stating differently. banks etc) are increasingly being privatised. an asset manger is the best person to have on the work premises. who can be entrusted with the job of taking care of the assets in use.5 List out the services offered by an Asset Manager. This can only be achieved by aiming to maximise the effectiveness of current assets and facilities.4 What makes Asset Managers so important? A 20. Question 20. In such a scenario. Asset management is about effectively managing physical assets and facilities to enable an organisation to maximize its corporate objectives or charter. airports. In such case an asset manger can effectively.
Q 20. • • • • Establish and identify the actual cost of owning and operating these assets and facilities Aligning the cost of assets and facilities with the organisation’s business or service direction Reducing the recurrent costs of asset and facilities ownership without impacting on the business or service level requirements.149 -
. Maximising the utilisation of current and future assets and facilities to avoid unnecessary capital expenditure.
Q 20.Investment Banking
Q 20. A 20. A 20. asset management is about effectively managing physical assets and facilities to enable an organisation to maximize its corporate objectives or charter.5 As pointed out in the last question. where does he actually fit in the scheme of things.6 The following diagram illustrates the role of an asset manager.4 It has been common phenomenon worldwide that some of the areas of work that had been previously supervised by the government (road constructions.
As is evident from the above diagram.7 Is an Asset Manager same as the facility manager or the service provider? If not what differentiates his scope of action? A 20. the role of an asset manager lies somewhere in between the business managers and the engineers and/or technical specialists.7 An Asset Manager is often confused with a Facility Manager (and is even substituted for Service Provider).150 -
. The following diagram has been provided to bring out the relevant differences between all the three roles.
Q 20.Investment Banking
. while the boxes on the left define the work responsibility each of the role are entrusted with. The boxes on the right-hand side extreme give us the competitive edge/distinctive features of each of the role.
Q 20. • Linking the activities. and minimise the inherent clashes between key performance indicators.
.8 The following steps ensure the same.9 Following are some of the asset management enablers. and some of them are naturally conflicting. A 20. and we would end up back where we started.Investment Banking
Q 20. The regime must ensure that all business objectives are considered. Question 20.8 How do you make Asset Management work? A 20. Underpinning all of the activities of Asset Management are some vital enablers – without which the individual activities grind together. processes & responsibilities
The overall map of Asset Management processes is very complex. There may be many interests to satisfy.151 -
. • Coordinated objectives
First and foremost in establishing Asset Management regime is involves making the objectives clear to everyone.9 State the Asset Management enablers.
Highlighting the economic importance of the concerned asset. Life Cycle Cost analysis).Investment Banking
• • Organisation alignment: agreed objectives.
. excellent leadership and communication.10 What are benefits that accrue to the organization with effective Asset Management? A 20. shared understanding. asset managers have gained tremendous importance. the successful implementation of which will result in following advantages/benefits to the organization. Successful implementation of Asset management can result in huge monetary benefits/savings to the organisation. asset managers have gained tremendous importance. • • • • Assets management is a methodology to efficiently and equitably allocate resources amongst valid and competing goals and objectives. based on the actual business (decision) needs for that information. Asset management is one such concept. available to those who need it in a timely and appropriate form.g. With more professionalism creeping into business operations. Long term-ism: taking account of long-term repercussions in short-term actions and decisions (e. An asset manager is a distinct designation and should not be confused with a Facility Manager or a Service Provider. 3. • • • • Assets management is a methodology to efficiently and equitably allocate resources amongst valid and competing goals and objectives. 2. • • Risk awareness and acceptance: building risk evaluation into normal decision-making.152 -
. information and knowledge management: the right data collected. Integrated data. An asset manager is a distinct designation and should not be confused with a Facility Manager or a Service Provider. With more professionalism creeping into business operations. to the appropriate quality/detail. 1.10 To summarize. Recognising the income (and costs) of infrastructure within a framework that is clearly understandable by all stakeholders.
Q 20. Control and perhaps even reduction of costs. Successful implementation of Asset management can result in huge monetary benefits/savings to the organisation.
It may look out for expansion opportunities. these services are spread over a vast spectrum of corporate activity. its advisory functions are beginning to find worldwide acceptance.1 With the growing importance of investment banking across the globe.g. which in turn will enable the company to get done with the job easily and effectively.2 “Corporate Advisory Services” is an umbrella term that encompasses specialised advices rendered to corporate houses by professional advisers such as accountants. Besides.3 What makes corporate advisory services important? A 21. Project advisory and Merger & Acquisition advisory.1 What led to the evolution of advisory services? A 21.
Q 21. law practitioners and host of similar service providers. with the rest finding place with specialist advisory firms. seek profitable mergers and acquisitions etc.3 The factors that necessitate the need for corporate advisory services are.
. • With the world growing at a rapid pace. However. business and legal angles. the company would not want to lose out on some vital opportunities.1
Q 21. • A company may have thousands of complex business processes to be handled and much of it can even be on a daily basis. the above activities will be better done with someone with the requisite experience and expertise. A majority of these transactions can have several implications e.2 What do you understand by corporate advisory services? A 21. Restructuring advisory.
Q 21. with increased confidence. It is here that corporate advisory services find a place. investment banks. go in for strategic alliances. People are looking at these advisory functions. Some of them are very well suited for investment banks.Investment Banking
Question 21. One of such functions is corporate advice. Such specialists enable a hassle free service. to improve upon its current standing. and so as to arrive at an effective structure that can further the interests of the company. The transactions and formalities involved in such a case need to be professionally handled and there tends to be a need for a specialist intermediary to the proposed transaction.153 -
. The essence of corporate advisory services for investment banking relates to Business advisory.
they also necessitate a multi-disciplinary approach. He may have to study the feasibility of the project. • Starting with professional firms such as company secretaries. chartered accounting firms.4 Given the dynamics of advisory functions. Now these firms can rope in accounting firms to provide for the necessary paper work like company valuation etc.154 -
. the environmental conditions. statutory compliance work.4 The functions that are covered by the corporate advisory services fall under a broad spectrum and address a wide range of corporate objectives.
Q 21. Similarly. 2. All this needs specialised handling and may not be done very efficiently by anyone and everyone and demand professionals with exposure in such areas of service. it might just be a financial compulsion. But no matter what the reason is. For example. Corporate advisers in such cases come in as very handy in meeting these considerations. • Often a company finds itself in the need of restructuring its operations or its financial statements. legal vetting. restructuring has to take place and need be looked at from business and financial (and legal) perspective. with a motto to revamp its current state of affairs or to bring about a much-needed change in the current state of affairs. sources of financing and many similar aspects. law firms etc.
There are sets of Investment banks and other financial institutions with merchant banking licenses. the political aspects. The services of these firms are mostly two fold: 1. Firms that provide a specialised service (which matches their core competency) in the form of complete solution. There are many professional bodies that provide such services. On the other hand. evaluating a business proposal etc. The important advisory services provided by these investment banks and merchant
. what is the scope of Corporate Advisory Services? A 21. two companies X and Y (who have their own investment banks for advise) have agreed on a merger. Some of these services can be taxation advice. These professional bodies can be classified under three broad categories. a law firm can also be roped in to look after the legal aspect connected with the merger. Suppose a person X plans to start a business.Investment Banking
• There may be several areas (which are of interest to the company) that may need specialised advice before initiating a business plan. There are other firms who provide complementary services wherein the investment banks provide the necessary transaction support. who provide corporate advisory services.
joint ventures and collaborations and cross-border investments.
Q 21. We have Mckinsey & Co. restructuring advisory. joint ventures. target market segment. Companies do appreciate the expertise. foreign exchange etc. formulation of business plan (which are primarily investment banking activities). strategic alliance etc. marketing. Let us consider an example of an Indian company planning to set shop in a foreign country. human resource.6 What are the services rendered by Investment Banks? A 21. The strategic recommendation required by the company can be a decision between establishing a wholly owned subsidiary vis-à-vis a joint venture with a local partner.7 This advice is required by a company when it plans to venture in to a new business either in a new line of business or existing line of business in a new market be it local or international..5 Business advisory services relate to considerations involved in corporate restructuring. • Lastly. This entails rendering of advisory services pertaining to a company’s present and future businesses from a strategic and financial perspective. risk management. The strategy can be in terms of corporate structure of a product and pricing strategy. These firms are specialists in some selected verticals. Likewise. project advisory etc. In some case these consulting firms also take up issues of providing advice on M&A.6 Investment banks render the following services: • • • • • Entry Strategy Plans Project Feasibility Plans Corporate Plans Business Alliances Cross Border Investments
. there may be firms specialising in technology.155 -
. we have a set of pure advisory firms that provide a wide range of corporate advisory services.Investment Banking
banks relate to numerous services like business advisory. which investment banks bring along with them in dealing with such issues.
Q 21. which specialise in strategy consulting and advise governments and corporates on strategy and policy issues.5 What are services that make up the Business Advisory Services? A 21.7 What do you mean by Entry Strategy Plans? A 21.
The formulation of corporate plans involve: • • • • • • • In-depth examination of the industry In-depth examination of the business Identification of growth drivers Market positioning Product policies Diversification strategies Corporate and group structure etc
Q 21.156 -
.10 This relates to joint ventures. Investments bankers carry out the following tasks in this regard: • • • Identification of partners with complementary strengths or synergies Due diligence and valuation aspects Negotiation and deal making
Question 21. Investment banks have the capability to conduct such feasibility studies from a business and financial perspective since they have in-depth information on each industry space.11
.8 What do you mean by Project Feasibility Plans? A 21.9 Companies need to formulate medium to long-term corporate plans in order to carry out their expansion and business strategy.
Q 21.10 What do you mean by Business Alliances? A 21.8 The viability of a proposed business has to be examined from a business. depend on investment banks for these services and those companies which have an inhouse corporate planning department.9 What do you mean by Corporate Plans? A 21. collaborations and other such strategic relationships between two corporate entities that are brought about due to business compulsions or to harness synergies and complementary strengths. technology and financial perspective before any fund raising activity is carried out by the corporate. Those companies which do not have in-house corporate planning department.Investment Banking
Q 21. believe in getting the same vetted by an investment bank.
collaborations and other such strategic relationships between two corporate entities. The term “Corporate advisory services” encompasses many a functions like accounting. Business advisory services relate to considerations involved in corporate restructuring.
. Besides equipping companies with its huge store of knowledge. The assets used for undertaking that project are used as collateral for financing that project.11 Strategic business investments are made in foreign entities owned or controlled by the investing corporate in the parent country or in other foreign entities.Investment Banking
Q 21.1 Project advisory services falls under one of the core branches of corporate advisory services. Corporate advisory services include highly specialised and complementary activities to further the business interests of the company. investment structure and taking necessary regulatory clearances. In other words Project financing deals with financing a project. legal advice. individuals are looking at advisory functions with renewed confidence.11 What do you mean by Cross-Border Investments? A 21. government bodies.1 What does project advisory services imply? A 22.157 -
. It deals with the decision of financing a project based on its strength of assuring the future cash inflows. corporate advisory services ensure multi-disciplinary approach. Investment banks carry out an indepth examination of the financial and regulatory issues that are necessary to arrive at the optimum size of the investment. corporates. which can in turn generate return for its stakeholders and help in repaying the interest and loan on the proposed project. taxation advice and a host of similar activities.
Q 22. valuation methodology. Summary
Summary • • • • • • With the increased acceptance of investment banking across the globe. joint ventures and collaborations and cross-border investments Business Alliances relate to joint ventures.
as the project has to be analyzed even before testing the market.
.4 What are the various components that aid the project financing process? A 22. the sponsors and other investing parties in the project and finally ends at the repayment of the long-term borrowings related to it. Where as if we talk about asset financing.Investment Banking
Q 22.3 What is the genesis of the Project financing process? A 22. the lenders look at the strength of the project to perform and generate sufficient returns to serve the interest and loan on that project.
Q 22.4 The following components take care of the financing process. The amount financed will be totally utilized in running the project and then the risk will totally be dependent on the profitability of the project. the risk involved is only up to financing risk. • In project financing. • The risk of financing a project is more.158 -
.5 Discuss Project Conceptualization. • • • • Project Conceptualization Project Structuring Project Consortium Key Project Contracts
Q 22.2 Differentiate between Project financing and other types of financing? A 22. Where as in asset financing. they may not be able to cover the entire loan through the sale of assets.3 The process of project financing starts from the very initial stage of analyzing the project and then moving on to the requirements of lenders.
Q 22. Hence the lenders mainly look about the profitability of the project. the statutory provisions. • The level of risk for the lender in financing a project can fall under both business risk and financing risk. the lenders are mainly interested in the value of the asset if sold. Business risk is the one that is associated with the business of the borrower and the financing risk is the risk of financing that particular borrower. Even if the assets are taken as collateral.2 The following constitute the differences between project financing and the other types.
technology identification. A 22. EPC (Equipment procurement and construction contractors) contract. product buy back or usage agreement.8 Discuss Key project contracts. A. The project should also satisfy the policy requirements of the government. Depending on the nature and size of the project.
Q 22.7 A strong project consortium helps in reducing the time required to achieve the financial closures of the project.6 Project structuring focuses on reducing the risks associated with the project in areas like location. contractors and various other investors. If the project uses a technology that is already in use and perceives profitability it becomes easier to convince the lenders. the business opportunity for it in the market and also the revenue model.8 These are the contracts that should be kept ready before the company enters in to any of the financial contracts.7 Discuss Project consortium.159 -
.6 Discuss Project structuring.9 The major options available are as follows • Project financing through long term debts
Q 22. operations and maintenance agreement.22.9 What are the major options available to the company to finance its projects? A 22. license agreement.Investment Banking
A 22. the lending institutions and the banks
Q 22. production and distribution. technology providers. Some of the key project contracts in infrastructure and other projects consist of shareholders agreement.5 The main requirement of financing depends on the concept of the project. suppliers. A 22. foreign collaboration and technology transfer agreement. marketing issues and the promoter resourcefulness. joint venture agreements etc. the consortium may consist of the combination of project sponsors. operational. Convincing the lenders for financing a project becomes comparatively easy if the project is not first of its kind.
12 List out the Project advisory and transaction services provided by investment banks.
.10 Project financing through long term debts takes three forms.10 Discuss Project financing through long-term debt? A 22.
Q 22. investors.11 The main source of equity for a project will be its promoters. A 22. • External commercial borrowings:
Loans raised for financing a project from outside India are called as external commercial borrowing. the project can be financed through debentures. JV partners. and institutional buyers.11 Discuss Project financing through equity? A 22.Investment Banking
• Project financing through equity
Q 22. Other sources include consortium partners. These borrowings are named so because they also add to the external debt of the country. They are • Domestic rupee term loans:
The project can be financed by short term or long-term loans from domestic financial institutions and commercial banks. bonds and other debt securities. • Debentures and other debt securities:
In some cases. These loans can be either fixed interest rate or floating interest rate pegged to some benchmark rate. collaborators. The projects can make use of private institutional investors or IPOs for getting the debentures and other debt securities
Q 22. They can finance the project through rupee loans or the foreign currency loans and guarantees.12 The different services offered by the investment banks in project advisory and transaction services are as follows • Investment banks can help in formation of the consortium and also in structuring the consortium agreements.
If one is changed. § Investment banks can help in achieving the financial closure in the optimal terms and time for the project.
Q 23.Investment Banking
• • • • • • • • Means of finance in project structuring. § Investment banks can help in private placements or public offers of equity and debt. Investment banks can advise in shareholders agreements.
Q 23.2Name the two components of financial restructuring. Investment banks can act as “arranger” in behalf of the client for representing and negotiating with lenders and investors. project consortium.2 The two components of financial restructuring are
. Incase the project is awarded to a particular consortium through bidding process. financing through long-term debt and equity financing • Investment banks also provide project advisory services and transaction services for running a project. equity shareholding pattern and subscription agreements. Helping in project report.
Summary: • • Project financing deals with the decision of financing a project based on its strength of assuring the future cash inflows. accordingly the other will be adjusted. Advising for entering in to other vital project contracts. project structuring. Financial restructuring can be done because of either compulsion or as part of the financial strategy of the company.1 Financial restructuring is the process of reshuffling or reorganizing the financial structure. investment bank can offer bid advisory services. The process of project financing covers different stages like project conceptualization. A 23. which primarily comprises of equity capital and debt capital. This financial restructuring can be either from the assets side or the liabilities side of the balance sheet. key project contracts.161 -
. linked documents and loan applications.1What do you understand by financial restructuring? A 23.
It involves reshuffling of the balance sheet items as it contains the debt obligations of the company. Debt restructuring is more commonly used as a financial tool than compared to equity restructuring. an insolvent company can go for restructuring in order to make it solvent and free it from the losses and make it viable in the future. 3. This is because a company's financial manager needs to always look at the options to minimize the cost of capital and improving the efficiency of the company as a whole which will in turn call for the continuous review of the debt part and recycling it to maximize efficiency. In short. A healthy company can go in for debt restructuring to change its debt part by making use of the market opportunities by substituting the current high cost debt with low cost borrowings. These can be broadly categorized in to 3 ways. 2.162 -
.3What does debt restructuring imply? A 23.
Q 23. can also go in for restructuring.4 Debt restructuring can be done based on different circumstances of the companies.3 Debt restructuring is the process of reorganizing the whole debt capital of the company. A company.Investment Banking
• • Debt Restructuring Equity Restructuring
Q 23. 1. which is not able to service the present financial obligations with the resources and assets available to it.5Mention the components of debt restructuring?
. A company that is facing liquidity problems or low debt servicing capacity problems can go in for debt restructuring so as to reduce the cost of borrowing and to increase the working capital position.4What are possible ways of making debt restructuring a possibility? A 23.
These are generally classified in to the following: • Restructuring of secured long-term borrowings
Restructuring of secured long-term borrowings will be done for the following reasons such as reducing the cost of capital for healthy companies. the terms of deposit can again be negotiated only if the scheme is approved by the right authority.163 -
.6 By and large. for improving liquidity and increasing the cash flows for a sick company and also for enabling rehabilitation for that sick company. • Restructuring of other short term borrowings
The borrowings that are very short in nature are generally not restructured. These can indeed be renegotiated with new terms. All these are secured by the charge on inventory and book debts and also on the charge on other assets. A 23. bill discounting and commercial paper fall under the working capital borrowings. clean bills and clean over drafts. These types of short-term borrowings include inter-corporate deposits. overdraft facilities. • Restructuring of secured working capital borrowings
Credit limits from commercial banks.5 The components of debt restructuring are as follows • • • • Restructuring of secured long-term borrowings Restructuring of unsecured long-term borrowings Restructuring of secured working capital borrowings Restructuring of other term borrowings
Q 23. • Restructuring of unsecured long-term borrowings
Restructuring of the long-term unsecured borrowings will be done depending on the type of borrowing. a company takes different types of borrowings each having different terms. demand loans. These borrowings can be public deposits.
. For public deposits.6Detail on the components of debt restructuring mentioned in the previous question. unsecured bonds or debentures.Investment Banking
A 23. private
loans (unsecured) and privately placed. The restructuring of the secured working capital borrowings is almost all the same as in case of term loans.
Q 23. • Repurchasing the shares from the shareholders for cash can do restructuring of share capital. 4.Investment Banking
Q 23. Formulating a viability plan for the company 2. Floating the debt restructured scheme 3. It includes reshuffling of the shareholders capital and the reserves that are appearing in the balance sheet.8 Equity restructuring is the process of reorganizing the equity capital.164 -
. The various steps involved in advising are: 1. it has to be ratified by the concerned approving authorities in each of the lenders organizations. Investment banks provide transaction services.7 What role does Investment banking play in debt restructuring? A 23.
Q 23. which are important for meeting the stated requirements. 5. Restructuring of equity and preference capital becomes a complex process involving a process of law and is a highly regulated area. After the debt-restructuring scheme is approved.8 What doe equity restructuring imply? A 23.9 The following are the some of the various methods of restructuring. 6. This helps in reducing the liability of the company to its shareholders resulting in a capital
. Equity restructuring mainly deals with the concept of capital reduction.7 Investment banks provide services for companies undergoing debt restructuring. Investment bankers work closely with other professionals for the legal work and the compliance required for debt restructuring services. Presenting the debt restructuring scheme to the lenders and representing the client in discussions and negotiations.9 What are various methods of giving effect to equity restructuring? A 23.
Q 23. Restructuring can also be done by consolidation of the share capital or by sub division of the shares. restructuring of secured working capital borrowings and other short term borrowings • Equity restructuring is the process of reorganizing the equity capital.165 -
. A 23.
. This will help in reducing the amount owed by the company to its shareholders without actually returning equity capital in cash.Investment Banking
reduction by returning the share capital. Reorganizing the capital for achieving better efficiency To wipe out accumulated losses To write off unrecognized expenditure To maintain debt-equity ratio For revaluation of the assets For raising fresh finance
Summary • • • Financial restructuring is the process of reshuffling or reorganizing the financial structure.10 The following are the reasons for which equity restructuring is done: • • • • • • • • • Correction of over capitalization Shoring up management stakes To provide respectable exit mechanism for shareholders in the time of depressed markets by providing them liquidity through buy back.10 State the reasons behind equity restructuring. The other method that falls in the same category is to change the equity capital in to redeemable preference shares or loans. The components of debt restructuring include restructuring of secured and unsecured longterm borrowings. which primarily comprises of equity capital and debt capital. It includes reshuffling of the shareholders capital and the reserves that are appearing in the balance sheet. • Restructuring of equity share capital can be done by writing down the share capital by certain appropriate accounting entries. • • Restructuring can also be done by reducing or waiving off the dues that the shareholders need to pay. Debt restructuring is the process of reorganizing the whole debt capital of the company.