1) Book-building is a process of price discovery used in public offers 2) The issuer sets a base price and a band within which the investor is allowed to bid for shares. Take the recent, Yes Bank [ Get Quote ] IPO, the floor price was Rs 38 and the band was from Rs 38 to Rs 45. 3) The investor had to bid for a quantity of shares he wished to subscribe to within this band. The upper price of the band can be a maximum of 1.2 times the floor price. 4) Every public offer through the book-building process has a book running lead manager (BRLM), a merchant banker, who manages the issue 5) Further, an order book, in which the investors can state the quantity of the stock they are willing to buy, at a price within the band, is built. Thus the term 'bookbuilding 6) An issue through the book-building route remains open for a period of 3 to 7 days and can be extended by another three days if the issuer decides to revise the floor price and the band 7) Once the issue period is over and the book has been built, the BRLM along with the issuer arrives at a cut-off price. The cut-off price is the price discovered by the market. It is the price at which the shares are issued to the investors. 8) The cut-off price is arrived at by the method of Dutch auction. In a Dutch auction the price of an item is lowered, until it gets its first bid and then the item is sold at that price. Let's say a company wants to issue one million shares. The floor price for one share of face value, Rs 10, is Rs 48 and the band is between Rs 48 and Rs 55. At Rs 55, on the basis of the bids received, the investors are ready to buy 200,000 shares. So the cut-off price cannot be set at Rs 55 as only 200,000 shares will be sold. So as a next step, the price is lowered to Rs 54. At Rs 54, investors are ready to buy 400,000 shares. So if the cut-off price is set at Rs 54, 600,000 shares will be sold. This still leaves 400,000 shares to be sold. The price is now lowered to Rs 53. At Rs53, investors are ready to buy 400,000 shares. Now if the cut-off price is set at Rs 53, all one million shares will be sold. Investors who had applied for shares at Rs 55 and Rs 54 will also be issued shares at Rs 53. The extra money paid by these investors while applying will be returned to them. 9) There are three kinds of investors in a book-building issue. The retail individual investor (RII), the non-institutional investor (NII) and the Qualified Institutional Buyers (QIBs). RII is an investor who applies for stocks for a value of not more than Rs 100,000. Any bid exceeding this amount is considered in the NII category. NIIs are commonly referred to as high net-worth individuals. On the other hand QIBs are institutional investors who posses the expertise and the financial muscle to invest in the securities market

NSE (National Stock Exchange). Thus. Mumbai). This is what happens: The company deposits a large number of its shares with a bank located in the country where it wants to list indirectly. But many good companies get listed on these stock exchangesindirectly – using ADRs and GDRs. Many times. The bank issues receipts against these shares. and at various prices. during which the issue price is determined. . These shares are sometimes also listed and traded on foreign stock exchanges like NYSE (New York Stock Exchange) or NASDAQ (National Association of Securities Dealers Automated Quotation). BookBuildingIssues 10 % advance payment is required to be made by the QIBs along with the application. These receipts are listed on the stock exchanges. 1 lakh and the balance for higher amount applications. while other categories of investors have to pay 100 % advance along with the application. 100 % advance payment is required to be made by the investors at the time of application. etc. The Fixed Price portion is conducted like a normal public issue after the Book Built portion. is available on a real time basis on the BSE website during the bidding period. These receipts are then sold to the people of this foreign country (and anyone who is allowed to buy shares in that country). ADR-GDR Every publicly traded company issues shares – and these shares are listed and traded on various stock exchanges. 50 % of shares offered are reserved for QIBS. companies in India issue shares which are traded on Indian stock exchanges like BSE (The Stock Exchange. each receipt having a fixed number of shares as an underlying (Usually 2 or 4). the company has to comply with the policies of those stock exchanges.  10) As per SEBI guidelines.. the policies of these exchanges in US or Europe are much more stringent than the policies of the exchanges in India. 50 % of the shares offered are reserved for applications below Rs. This deters these companies from listing on foreign stock exchangesdirectly. an issuer company can issue securities to the public though prospectus in the following manner: 100% of the net offer to the public through book building process 75% of the net offer to the public through book building process and 25% at the price determined through book building. Price at which the securities are offered and would be allotted is made known in advance to the investors A 20 % price band is offered by the issuer within which investors are allowed to bid and the final price is determined by the issuer only after closure of the bidding. 35 % for small investors and the balance for all other investors. Fixed Price Issues Demand for the securities offered is known only after the closure of the issue Demand for the securities offered . But to list on a foreign stock exchange.

In other words. So. to get the regular interest and principal and the other is to convert the bond in to equities. The only difference is the location where they are traded. as it reduces administrative costs and avoids foreign taxes on each transaction.They behave exactly like regular stocks – their prices fluctuate depending on their demand and supply. the money being raised by the issuing company is in the form of a foreign currency. or an ADR. It gives two options. If the depository receipt is traded in a country other than USA. Each receipt amounts to a claim on the predefined number of shares of that company. but these bonds also give the bondholder the option to convert the bond into stock It is a low cost debt as the interest rates given to FCC Bonds are normally 30-50 percent lower than the market rate because of its equity component Conversion of bonds into stocks takes place at a premium price to market price. Like bonds it makes regular coupon and principal payments. exposure and it allows them to tap the American equity markets. How does it help companies? Some companies. and represent a claim on the underlying shares. FCCB A Foreign Currency Convertible Bond (FCCB) is a type of convertible bond issued in a currency different than the issuer’s domestic currency. or a GDR. It is a hybrid between bond and stock. lower dilution of the company stocks   . Conversion price is fixed when the bond is issued. Both ADR and GDR are depository receipts. Foreign entities prefer ADRs. banks. and depending on the fundamentals of the underlying company. The individuals are able to save considerable money and energy by trading in ADRs. These receipts. it is called an American Depository Receipt. governments. because they get more U. There are many advantages of ADRs. are calledDepository Receipts.S. The shares represented by ADRs are without voting rights. which are traded like ordinary stocks. For individuals. One is. it is called a Global Depository Receipt. If the depository receipt is traded in the United States of America (USA). The issuing bank acts as a depository for these shares – that is. it stores the shares on behalf of the receipt holders. ADRs are an easy and cost effective way to buy shares of a foreign company. and other sovereign entities may decide to issue bonds in foreign currencies because:     It may appear to be more stable and predictable than their domestic currency Gives issuers the ability to access investment capital available in foreign markets Companies can use the process to break into foreign markets The bond acts like both a debt and equity instrument.

Purchasing Spiders gave investors a way to mimic the performance of the S&P 500 without having to purchase an index fund. which was first launched in 1993. . Furthermore. companies have to refinance to fulfil the redemption promise which can hit earnings It will remain as debt in the balance sheet until conversion ETF Exchange-Traded Fund (ETF) What It Is: Exchange-traded funds (ETFs) are securities that closely resemble index funds. Investors too enjoy its benefits. Essentially. investors will not go for conversion but redemption. SPDRs could be bought and sold throughout the day. UnitInvestment Trusts (UITs) are often organized in the same manner. he or she is basically investing in the performance of an underlying bundle of securities -. large forex earnings potential only opted for FCCBs FCCBs means creation of more debt and a FOREX outgo in terms of interest which is in foreign exchange In case of convertible bond the interest rate is low (around 3 to 4%) but there is exchange risk on interest as well as principal if the bonds are not converted in to equity If the stock price plummets. or even sold short. Like any financial instruments. purchased onmargin. Some of these are:      Exchange risk is more in FCCBs as interest on bond would be payable in foreign currency. Whenever an investor purchases an ETF.usually those representing a particular index or sector.How does it benefit an investor? It’s not just companies who are benefited with FCCB. These investment vehicles allow investors a convenient way to purchase a broad basket of securities in a single transaction. or "Spider"). So. but can be bought and sold during the day just like common stocks. How It Works/Example: Exchange-traded funds are some of the most popular and innovative new securities to hit the marketsince the introduction of the mutual fund. Here are some:     Safety of guaranteed payments on the bond Can take advantage of any large price appreciation in the company’s stock Redeemable at maturity if not converted Easily marketable as investors enjoys option of conversion in to equity if resulting to capital appreciation Are there any disadvantages to the investors and companies? Yes. the unusual legal structure of an ETF makes the product somewhat unique. ETFs offerthe convenience of a stock along with the diversification of a mutual fund. However. Thus companies with low debt equity ratios. because they traded like a stock. The first ETF was the Standard and Poor's Deposit Receipt (SPDR. FCCBs also have there disadvantages.

thereby minimizing the ETF's capital gains exposure. Because of the large number of shares involved. Tax-Advantages -. and those that choose to redeem their ETFs are paid in shares of stock rather than in cash. Instead. To liquidate their holdings. individual investors seldom use this option.Exchange-traded funds don't sell shares directly to investors.000 shares or more) that are known as creation units. each ETF purchase will be charged a brokerage commission.each of which represents a legal claim to a tiny fraction of the assets in the creation unit -. .Whereas traditional mutual funds are only priced at the end of the day. Many have average daily trading volumes in the hundreds of thousands (and in some cases millions) of shares per day. because they trade as stocks. most investors simply sell their ETF shares to other investors on the open market. the buying and selling of shares on the open market has no impact on an ETF'stax liability. so investors that prefer active management will probably find ETFs wholly unsuitable. In addition. For those that make regular periodic investments -.these recurring commissions might quickly become costprohibitive. which increases the cost basis for the remaining holdings. and the number of offerings has swelled. it is possible to amass enough ETF shares to redeem them for one creation unit and then redeem the creation unit for the underlying securities.In a traditional mutual fund. those who redeem theirETFs are paid with the lowest-cost-basis shares in the fund.Unlike traditional mutual and index funds.typically a market maker. making them much more affordable than most other diversified investment vehicles. to which all shareholders are exposed. To begin. Most mutual funds also have minimum investment requirements.or back-end loads.which obtains shares of the underlying securities and places them in a trust. specialist or institutional investor -. ETFs can be bought and sold at any time throughout the trading day. because they are not actively managed. they also have two distinct disadvantages. By contrast. Just as closed-end funds don't always trade at a price that precisely reflects the value of the underlying assets in each share of the portfolio. it is also possible for an ETF to trade at a premium or a discount to its actual worth. most ETFs have minimal expense ratios. Although exchange-traded funds offer several advantages over traditional mutual funds. Often. Furthermore. these securities compete with mutual funds and offer a number of advantages over their predecessors. making them impractical for some smaller investors. By contrast. making them extremely liquid. However. managers are typically forced to sell off portfolio assets in order to meet redemptions. the securities that an ETF tracks are largely fixed. including: Low Cost -. Why It Matters: Exchange-traded funds have grown increasingly popular in recent years. ETFs have no front.and then sells them on a secondary market. each ETF's sponsor issues large blocks (often of 50. These units are then bought by an "authorized participant" -.such as a monthly dollar-cost averaging investment plan -. Furthermore. this act triggers capital gains taxes. Today. investors can purchase as little as one share of the ETF of their choice. This minimizes an ETF's tax burden because it does not have to sell shares (and therefore potentially realize taxable capital gains) to obtain cash to return to investors. The authorized participant then splits up these creation units into ETF shares -. Liquidity -.

the expiry date. the pros and cons should be weighed carefully. the fixed rate of the desired swap is guaranteed to be no higher than 7. The holder of the swaption will decide whether or not to exercise based on whether swap rates rise above or fall below that fixed rate.As with any security.5% and company A are therefore assured that the net funding cost of the proposed loan will not exceed 7.5%. Lets say that company A could enter into a swaption agreement that gives them the right to receive LIBOR and pay a fixed rate of 7. however.5%.5%. If the swap rate in six months time turns out to be greater than 7. to enter into a specific swap deal on a future date (or set of dates). and investors should first do their homework to determine whether exchange-traded funds are the appropriate vehicle to meet their individual goals and objectives SWAPTIONS 1) 2) A swaption provides the holder with the right. 3) One thing that makes a swap very different from a simple option is that there is nostrike price. For this reason. the type of option — e. the fixed rate is often called the strike rate. then company A should allow the swaption to expire and simply enter into a swap at the lower fixed rate.g. An option that gives the right to pay fixed and receive floating is called a payer swaption. if the market swap rate turns out to be lower than 7. but not the obligation. the fixed rate specified for the swaption plays a role very similar to that of a strike price.5% starting in six months time. One way to eliminate this uncertainty is to purchase an appropriately structured swaption. Either way.5%. 4) A swaption can therefore be defined by: the terms of the underlying swap. while those that give the right to receive fixed and pay floating are described . Conversely. then company A would be best suited by exercising their option to enter into a swap where they are only required to pay 7. European or American 5) we also need to distinguish between the two broad types of interest rate swaptions.

The credit derivative allows these investors to invest in the risks of a firm (the bank) without actually having to purchase that firm’s bonds or loans. insolvency) or a loan. For example. CREDIT DERIVATIVES In the most basic of terms. companies and banks are able to see increased profits since they are no longer alone when it comes to facing the risk of a credit event (e. and the receiver swaption treated as a put option. the former swaption type can be thought of as a call option. They are a relatively new addition to the financial toolbox of investment bankers. a bank that sells a loan to an automotive plant is worried that the plant may not be able to pay all of its receiver swaptions. debt restructurings. while the other party receives interest on a notional amount. such as a bankruptcy. the amount of the payment is associated with the reduction of the market value of the asset after the credit event. but still keep the loan to the automotive plant on its books. obligation defaults or failures to pay. having popped up in the 1990s. Total return swaps are utilized to transfer credit risks between two parties. There are several types of derivatives. Consequently. Credit Linked Note The value of a credit linked note depends on the occurrence of a credit event. The higher the risk of a credit event occurring. The bank can sell the risk associated with the debt to investors. a credit derivative is a financial tool used to shift risk from one party to another. the higher the price of the credit derivative. Credit default swaps are customized to diversify or hedge credit portfolios. Credit events are described as bankruptcies. bankruptcy.g. the swap is annulled once the credit event takes place. The asset referenced in the swap deal can be any asset. In general option pricing terms. They are an embedded credit default swap in which investors accept exposure to a . Total Return Swaps With a total return swap. two parties enter into an agreement in which one party agrees to receive the total returns (interest payments and capital gains or losses) of an asset. Usually. By allowing the mitigation of risk by spreading it out over a number of investors. The value of the derivative is “derived” from the value of the bond held by the bank. index or a basket of assets. Three basic forms are: Credit Default Swaps A credit default swap is a swap wherein the counterparty receives a premium at predetermined periods in consideration for assurance to make a specific payment if a negative credit event occurs.

The interest rate is a function of the expected likelihood that the borrowers whose loans make up the CDO will default on their payments . but runs the risk that some borrowers don't pay back their loans. SPVs are set up by dealers to issue various credit linked notes. Bank of America) over the counter. The dealer either pays the investor the recovery amount. is a synthetic investment created by bundling a pool of similar loans into a single investment that can be bought or sold. SPVs) residing in an offshore location and are collateralized with securities having the highest credit rating of AAA. If there is no default. issued by a high-rated borrower. Lending someone money to buy a house is risky.particular credit event in return for a higher yield on the note. As opposed to credit default swaps.000 borrowers whose mortgages made up the CDO.g. they are not traded on an exchange but have to be bought directly from the bank. The most fundamental credit linked note includes a bond.000 chance of someone defaulting on their mortgage. An investor that buys a CDO owns a right to a part of this pool's interest income and principal. CDOs turn individual loans into a portfolio in which a default by any single lender is unlikely to have an enormous impact on the portfolio as a whole. where critics say CDOs hid the underlying risk in mortgage investments because the ratings on CDO debt were based on misleading or incorrect information about the creditworthiness of the borrowers. and therefore the CDO's losses as a result of borrowers defaulting on their obligations usually represent the statistical averages in the market as a whole . Securities Industry and [1] Financial Markets Association estimates that US$ 503 billion worth of CDOs were issued in 2007. the credit default swap expires. For example. CDOs are created and sold by most major banks (e. or delivers obligations to the investor in case of physical settlement Collateralized debt obligation (CDO) A Collateralized Debt Obligation. the collateral redeems at maturity. if a credit event occurs. credit linked notes are logged on a balance sheet as an asset.S. An investor who purchases the CDO would be paid the interest owed by the 5. The coupon or price of the note is linked to the performance of an asset. Goldman Sachs. you're out of luck. or CDO. subprime crisis. However. i. investors can own a small percentage of many different mortgages. if you happened to be the lender for the person who defaults. CDOs played a prominent role in the U. a bank might pool together 5. in the case of a cash settlement. Credit-linked notes are normally issued by dealers or by special-purpose companies (or special-purpose vehicles. the collateral is sold and its proceeds are used to pay the dealer the par amount.even if there's only a one in 5.determined by the credit rating of the borrowers and the seniority of their loans.000 different mortgages into a CDO.e. How CDOs Work Bundling debt into a CDO changes the riskiness of investing in debt in two ways: Reduction of Statistical Outliers First. because that person either defaults or they don't . CDOs reduce the effect of statistical outliers. along with a credit default swap on a less creditworthy risk. By aggregating many different mortgages together into a CDO. and the collateral redemption proceeds are paid back to the investor.

Typically.5 million. but will be the first to lose money if some of the loans in the pool aren't repaid. each of which is a separate CDO. So.5 million and $7. A receives $2.Tranches Second. and one with a low debt rating with high interest. whereas tranche C receives $1 million only . 15% and 20% interest rates. but will always be the first to be repaid .5 million. If none of the bonds defaults. The top tranche will have the lowest interest rate.portions of the underlying debt that vary in their riskiness. The bottom tranche will pay the highest interest rate. and C $5 million. This allows the CDO creator to sell to multiple investors with different degrees ofrisk preference. As A and B are senior to C. a pool of debt is divided into three tranches. they will be settled first. despite being backed by a generic pool of bonds or loans. This allows bankers to create investments with risk / reward profiles that are very different from the underlying debt in the pool. respectively. tranche A and B receive full interest of $2. A is senior to B and B is senior to C.dividing a pool of debt that is not AAA rated into three different CDO tranches means at least some portion of that debt is now AAA-rated and can be purchased by institutions that can only invest in AAA debt. and. B ($50 million) and C ($25 million). For example. assume a bond pool of $100 million divided into three tranches and expected to earn 15% or $15 million in interest pa.the bottom two tranches have to be wiped out before the top tranche is affected. one with an intermediate debt rating with moderate interest. But. Each tranche will have differentmaturity. one pool of mortgages can be divided into three CDOs. A. one with an "AAA" debt rating that pays low interest. interest rates and default risk.5 million. B and C tranches provide 10%. say there is a default and the interest income shrinks to $11 million. CDOs are created in tranches . This is important because some asset manager is only allowed to invest in "AAA"-rated debt . The three tranches are A ($25 million). So. B $7.

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