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Case Studies

Case Studies

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An organization can raise money through public investors by issuing various financial
instruments. These can be in the form of equity shares, preference shares, debentures
and bonds and can be classified into two broad categories of equity and debt.

EQUITY

Equity refers to the raising of funds from the public by issuing shares from the equity
share capital of the company at face value or at a premium. Companies that have a

grade rating with a low probability of default. However, this rating was later withdrawn in

2001.

4

Business Standard Research Bureau, August 2002.

323

Reliance Petroleum’s Triple Option Convertible Debentures (A)

proven track record or new companies promoted by well-known existing companies
can issue shares at a premium. The price of the share issued in IPO is determined in
consultation with the lead manager5

for that issue. However, the price has to be

justified as per the Malegam Committee recommendations6

. Though equity is the
most common source of raising funds, it involves larger issue expenses including
underwriting7

costs, registration costs, listing fees, lead manager expenses etc.
Moreover, equity for an unproven venture may not be considered attractive by
investors resulting in lower than expected realizations from the issue.

Organizations can also raise equity capital through a rights issue. A rights issue allows

a company to give its current shareholders the opportunity, ahead of the general

public, to buy new shares in proportion to the number of shares they already own.

These additional shares are usually offered below the prevailing market price and

have to be exercised within a relatively short specified period. This method of raising

finance is similar to private placement8

, with the existing shareholders acting as

counter parties in the exchange. This method may reduce the cost of financing

substantially. The issue of rights shares in India is governed by Section 81 of the

Companies Act of 1956.

Preference shares are another form of shares that fall between pure equity and debt.

They do not carry any voting rights and can be issued only after the issue of equity

shares. The amount of dividend for these shares is fixed and paid in the event of a

profit ahead of equity shares. These shares can be subscribed either through a public

issue or can be allotted through a private placement. The claims of preference

shareholders are given higher priority than those of equity shareholders but lower than

those of debtholders.

A warrant is a certificate that gives its holder the right to purchase equity shares at a

specified price. A warrant is usually offered along with a bond. The warrant provides

its holder with a right and not an obligation to purchase equity shares.

DEBT

Debt instruments can be broadly classified into debentures and bonds. Debentures are

fixed interest debt instruments with varying periods of maturity. They can be listed on

the stock exchanges provided they have been rated by a credit rating agency.

Debentures can be classified as fully convertible, partially convertible and non

convertible. These together are classified as convertible securities or convertibles.

They are instruments with embedded options and give the holder a right to convert a

given security into a specified number of equity shares under stated conditions.

A bonds is a certificate of intention to pay the holder a specified sum, within a

specified date. The fundamental difference between debentures and bonds is that

debentures are normally secured against tangible assets of the company whereas

5

The Investment bank which is primary responsible for organizing a given issue. This bank

finds lending organizations and underwriters to create the syndicate, negotiate terms with the

issuer, and assess market conditions. It is also referred as the syndicate manager, managing

underwriter, lead underwriter.

6

The committee recommends price justification on the basis of i)Earnings Per Share (EPS) for

the last three years. ii) A comparison of pre-issue price to earnings (P/E) ratio and the P/E

ratio of the industry. iii) The minimum return on increased networth to maintain pre-issue

EPS.

7

Underwriting is a process, whereby, the Lead Manager or Underwriter ensures that the issue

will be subscribed fully. In case the issue is not fully subscribed, the underwriter is forced to

purchase the unsubscribed portion of the issue.

8

Issuing shares to a select group at a specified price.

324

Financial Management

bonds are not. Bonds can be of various types including income, infrastructure, and tax

savings or deep discount bonds. They can be fixed interest rate, floating rate or deep

discount bonds. Fixed rate bonds provide a fixed interest rate to investors which is

specified during the time of issue. In case of floating rate bonds, the interest is usually

linked to some benchmark index such as the bank rate. The interest is usually quoted

as a mark up of the bank rate and varies as that rate increases or decreases. Both these

bonds provide a regular income with the interest being paid at fixed intervals or a

cumulative income in which the interest is paid on redemption. However, deep

discount bonds are issued at a discount to the face value and an investor is paid the

face value on redemption.

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