CHAPTER-4

CAPITAL MARKET AND MONEY

MARKET INSTRUMENTS
 72

CHAPTER-4

CAPITAL MARKET AND MONEY MARKET INSTRUMENTS

Shares
Share is a fractional part of the capital and forms the basis of ownership in
a company. The persons who contribute money through shares are called
shareholders. A share is not a sum of money but is an interest measured by a
sum of money. Share is a bundle of rights and obligations contained in the
contract (ie Articles of Association).
Under the existing provisions of sec 86 of the Companies Act, now only
two kinds of shares may be issued viz Preference shares and Equity shares.
Share Capital includes equity shares and preference shares with a period
of redemption of 12 years or more. A share is a form of transferable right
representing the interest of the owner in the company, either of equity or
preference capital. For a new company some minimum equity base is necessary
to prove the stake of promoters and the willingness of risk taking. The extent of
minimum would depend upon the project cost, the state of capital market,
national importance of such a project, the financial institutions, interest in it and
the general level of interest rates, the background of company, the cost of capital
for the company from various sources etc.

Preference share

According to Sec 85, a preference share is one which carries the following
two rights.
(a) A right to receive dividend at a stipulated rate or of a fixed amount before
any dividend is paid on equity shares.
(b) A right to receive payment of capital on winding up of the company, before
the capital of equity shareholders is returned.

In addition to the aforesaid two preferential rights, a preference share may

carry some other rights. On the basis of additional rights, preferences shares can
be clarified as under.
1) Cumulative preference share is the share on which arrears of dividend
accumulate.
2) Non cumulative preference share is that on which arrears of dividend do
not accumulate as pr the express provision in the Articles of Association.
3) Participating Preference share is that share which, in addition to two basic
preferential rights, also carries one or more of the following rights as per
Articles.
(i) A right to participate in the surplus profits left after paying dividend to
equity shareholder.
 73

(ii) A right to participate in the surplus assets left after the repayment of
capital to equity shareholders on the winding up of the company.
4) Non participating Preference share is that share which is not a
participating share. Unless otherwise stated, a preference share is always
deemed to be a non participating Preference share.
5) Convertible Preference share is that share which confers on its holders a
right of conversion into equity share.
6) Non convertible preference share is that share which does not confer on
its shareholder a right of conversion into equity share, unless otherwise
stated, a preference share is always deemed to be a non convertible one.
7) Redeemable preference share is that share which is redeemable in
accordance with the provisions of sec 80 and sec80A of The Companies
Act 1956. After the commencement of the Companies Amendment Act
1988, no company limited by shares can issue any preference share
which is irredeemable.

Preference shares are a category of shares having preferential right in

respect of payment of dividend and repayment of principal. The Companies Act
authorizes the issue of preference shares and the fact that various companies
have issued preference shares indicates that they have a role to play in the
capital structure of the companies. Preference share are of various categories.
Redeemable preference shares are to be redeemable out of profits or capital
specially raised for the purpose. Under the Companies Act as recently amended,
redemption of the preference shares is now compulsory after 9-12 years. No
such shares will be redeemed except when they are fully paid up and provision
ids made for a special reserve fund called Capital Redemption account created
for the redemption.
Cumulative preference shares have a right to be paid dividends in arrears in a
cumulative manner, once the company makes profits. In 1985 the government
had introduced a new instrument of Cumulative Convertible Preference Share
(CCP) issued at 10% fixed dividend. These are convertible into equity after 3 to 5
years. Non cumulative shares have no right of accumulation of arrears.
Participating Preference shares have a right to participate in residual profits after
all the claims of creditors and owners are met alongwith equity holders.
Preference shares stand in between debenture holders and equity holders in
the matters of rights. While a debenture holder is a creditor who is to be paid
irrespective of the profits made, the equity share holders gets the residual as
owner of the company. Preference share are a hybrid category standing in
between these- neither a complete creditor, nor owner of the company.
Preference shareholders have priority of repayment of principal over equity
shareholders in the vent of winding up of the company. They have also the right
to participate in the leftover assets or capital after equity holders are paid in full.
Voting rights of the preference shareholders are exercised in the event of
arrears of dividends for more than two years and in matters relating to the
interests of the preference shareholders. In practice, these voting rights are
highly circumscribed by the overwhelming power of the equity holders who are a
 74

majority. In almost all the companies, preference shareholding constitutes

roughly one third or less of the total equity holdings. A norm of preference to
equity ratio of 1:3 is generally insisted by the government.
So long as the company is doing well, the preference shareholders have
nothing to grumble and they are paid their due dividends. They are treated as
good as creditors in such circumstances but in times of adverse conditions,
profits are not adequate to any dividends to the preference shareholders and
they are not treated as creditors but as owners, though their interests may not be
identical with the equity holders. They are, however, bound by the decisions of
the majority equity holders. The creditors of the company viz financial institutions,
banks etc have a greater say so far as their dues are concerned from that of a
preference share holder. If the institutions are preference shareholders
themselves, then the situation is somewhat better as they can bargain for better
terms. Whatever is the category of holders, these shareholders would suffer from
capital depreciation once the shares are quoted and trade on the exchanges, due
to a rise in interest rates in the market.
Preference shareholders are generally at the mercy of the equity holders
particularly in adverse years. They would neither be able to get away from the
company nor improve the lot of the company by management changes and
active interference. It is in this sense that preference shareholders are in
perpetual bondage to the company.
Preference shares are in demand despite such disadvantages, particularly
with the financial institutions. The investors preference for these can be
explained by the following features of Preference shares
i) Less risk.
ii) Fixed income.
iii) Special attractions like cumulative dividends or redeemable
shares.

From the point of view of the company, Preference shares are chosen for the
following reasons.
(i) It would be cheaper to issue Preference shares than equity although
costlier than the issue of debentures.
(ii) Equity shareholders gain by the gearing ratio provided by the
Preference capital in the capital structure of the company as it is a
fixed interest security.
(iii) The companies can cater to the needs of investment trusts, UTI, LIC
etc who require fixed interest securities in their portfolio and
Preference shares capital neither dilutes the equity nor interferes with
the management by equityholders.
From the point of view of the company, it is costlier to issue preference
shares than debentures as the company would have to earn more to maintain a
given return on preference capital than that of debentures. For the purpose of
taxation, the interest paid in debt or debentures is treated as part of the expenses
and commitment on gross profits whereas the dividend paid on preference
shares is taxable. The grossed up rate is the rate at which the company has to
 75

earn in order to pay a dividend to the preference share holders and would
depend upon the rate of taxation on the company and the coupon rate on the
preference share. The higher the tax rate, the higher should be gross profits of
the company in order to maintain a given rate of distribution to preference share
holder.

Equity Shares

Payment and repayment of dividend of Equity Share is made after the

payment of preference share capital . the rate of equity dividend may wary from
year to year depending upon the decision of directors and members. This is in
contrast to preference shares where rate of dividend is fixed. In case of an equity
share, arrears of dividend cannot accumulate in any case. Equity share is non
convertible and not redeemable during the lifetime of the company. It can not
carry a right to receive premium or redemption. However equity shareholders
enjoy voting rights.
A company can issue shares in two ways
(a) For cash
(b) For considerations other than cash.
These shares are issued at par or at a pr4emium or at a discount. Such issue
price may be payable either in lumpsum alongwith application or in installments
at different stages.

Bonus shares

There are certain regulations regarding the issue of Bonus Share enforced
by the government. The companies act however takes no notice of Bonus Share
except for a passing reference that share premium may be applied by a company
for issuing fully paid Bonus Shares to the members. The issue of Bonus Shares
is a normal practice adopted by the companies to bring the paid up capital in line
with the market value of shares. Companies are not required to get the consent
of the Government under the latest guidelines. Bonus issue are permitted subject
to the following conditions.

1) They are made out of free reserves (free and unencumbered from any
commitments or charges).
2) They may be issued out of general reserves or capital profits or reserves
not including reserves out of revaluation of assets and not based upon
cash accruals, or out of development rebate reserves or development
allowance reserve and share premium received in cash.
3) Total amount permitted to be capitalized for bonus share issue should not
exceed the total paid up equity of the company (except in certain cases
such as dilution of foreign companies).
4) Residual reserves after issue of bonus shares should be at least 40% of
the increased paid up capital.
 76

5) After the declaration of Bonus Shares, one third of the pre tax profits of the
company should be able to meet the requirements of at least 10%
dividend on the increased capital of the economy.
6) Bonus Shares are permitted only if all the existing shares are fully paid up
and are not in lieu of a dividend.
7) The time lag between two such Bonus issues should be at least 12
months.
8) A resolution for the proposed capitalization should be applied by the
General body of the shareholders provided the memorandum and Articles
of Association permits such an issue of Bonus Shares. After the issue of
the Bonus Shares, the paid up capital should not exceed the authorized
capital of the company.

The issue of Bonus Share does not require any Government Clearance under
the latest guidelines.
Bonus share is permitted before conversion of a private limited company into
a public limited company provided the interests of the participating public are
protected to the extent of the equity interest of the existing shareholders. The
issue of preference shares as Bonus Share is generally not favoured except
when the proposed preference shares are redeemable and the ratio between the
equity and preference capital does not exceed 3:1.
Free reserves out of which Bonus Shares are to be issued are accumulated
retained earnings, capital and current reserves and general reserves not
specifically earmarked for any purpose and sinking fund reserve for debentures,
development rebate reserve or allowance reserve, capital redemption reserve
and share premium account received in cash.

Debentures

Debenture is a written instrument acknowledging a debt and containing

provisions as regards the repayment of principal and the payment of interest at a
fixed rate. Debenture repr5esents a debt and the reward for debenture is the
payment of interest. The rate of interest is fixed. Payment of interest is a charge
against profits and is to be made even if there is no profit. Payment of interest
gets priority over the payment of dividend. Payment of debentures is made
before the payment of share capital. Debentures are usually secured by a
charge. No restriction is imposed on the issue of Debentures at discount. No
restriction is imposed on the purchase of Debentures by the company. Debenture
holders do not have any voting rights (except at their class meetings). Debenture
are to be redeemed during the lifetime of the company and can be convertible.
Debenture Trust Deed is required to be executed.
The issue of Debentures by public limited companies is regulated by The
Companies Act 1956 and the guidelines issued by SEBI on June 11, 1992. The
Debenture is a document which either creates a debt or acknowledges it. Any
document which fulfills either of these conditions is a debenture. Debentures are
issued through a prospectus by a company. It is usually in the form of a
 77

certificate which acknowledges indebtedness under the company's seal.

Debentures are one of a series issued to a number of lenders with specified
dates of repayment. A company can however issue perpetual or irredeemable
debentures. Generally they are issued against a charge on the assets of the
company but at times may be issued without any such change. Debentures can
be issued at a discount, the particulars of which are to be filed with the Registrar
of Companies.

Features of Debentures

Debentures may be distinguished according to negotiability, security,

duration, convertibility and ranking for discharge.

Negotiability

1. Bearer Debentures are registered and payable to its bearer. They are
negotiable instruments and transferable by delivery.
2. Registered Debentures are payable to the registered holder whose name
appears both on the debenture and in the register of Debenture holders
maintained by the company. Registered Debentures can be transferred
but will have to be registered again. They are not negotiable instruments
and contain a commitment to pay the principal sum, interest, description of
the charge and a statement that is issued subject to the conditions
endorsed therein.

Security

Secured Debentures are those which create a charge on the assets of the
company which may be fixed or floating.
Unsecured or naked Debentures are those which are issued without any
charge on assets. The holders are like unsecured creditors and may sue the
company for the recovery of debt.

Duration

Redeemable Debentures are normally issued on the condition that they

shall be redeemed after a certain period. They can, however be reissued after
redemption under section 121 of The Companies Act 1956.

Convertibility

Non convertible Debentures are duly paid as and when they mature.
Convertible debentures are those for which an option to convert them into equity
shares is given at the stated rate of exchange after a specified period. In our
country, convertible Debentures are very popular. On conversion, the holders
cease to be lenders and become owners.
 78

Ranking for Discharge

Debentures are usually issued in a series with a pari passu (at the same rate)
clause which entitles them to be discharged rateably, though issued at different
times. New series of debentures can not rank pari passu with old series unless
the old series provides so. If there is no pari passu clause, they are payable
according to the date of issue.

Kinds of Debentures

New debt instruments issued by the public limited companies are

1. Participating debentures.
2. Convertible debentures with options.
3. Third party convertible debentures.
4. Convertible debentures redeemable at premium.
5. Debt equity swaps.
6. Zero coupon convertible notes.
7. Secured premium notes (SNP) with detachable warrants.
8. Non convertible Debentures with detachable equity warrants.
9. Zero interest fully convertible debentures.
10. Secured zero interest partly convertible Debentures with detachable and
separately tradeable warrants.
11 . Fully convertible Debentures with interest (optional).
Recent issues by DFls are as below-

Participating Debentures are unsecured corporate debt securities which

participate in the profits of a company. They might find investors if they are
issued by existing dividend paying companies.

Convertible debentures with options are a derivative of convertible

Debentures with an embedded option, providing flexibility to the issuer, as well as
the investor, to exit from the terms of the issue. The coupon rate is specified at
the time of issue.

Third party convertible Debentures are debts with a warrant allowing the
investor to subscribe to the equity of a third firm at a preferential price vis a vis
the market price. The interest rate on the third party convertible Debentures is
lower than pure debt on account of the conversion option.

Convertible Debentures redeemable at a Premium are issued at face

value with a put option entitling investors to sell the bond to the issuer at a
premium later on. They are basically similar to convertible Debentures but less
risk.
 79

Debt equity swaps are offers from an issuer of debt to swap it for equity.
The instrument is quite risky for the investor because the anticipated capital
appreciation may not materialize.

Zero coupon convertible note can be converted into shares. If the choice
is exercised, investors forgo all accrued and unpaid interest. The zero coupon
convertible notes are quite sensitive to changes in the interest rates.

Secured Premium Notes with detachable warrants which are issued

alongwith a detachable warrant, are redeemable after a notified period, of, say 4
to 7 years. The warrants attached to it assure the holder the right to apply and
get equity shares allotted, provided the Secured Premium Note is fully paid.
There is a lock in period for Secured Premium Note during which no interest will
be paid for the investment amount. The Secured Premium Note holder has an
option to sell back the Secured Premium Note to the company at par value after
the lock in period. If the holder exercises this option, no interest/ premium will be
paid on redemption. In case he/ she holds it further, on redemption, the holder
will be repaid the principal plus the additional interest/ premium amount in
instalments decided by the company. The conversion of detachable warrant into
equity shares will have to be done within the time limit notified by the company.

Non Convertible Debentures with detachable Equity Warrants

The holders of Non Convertible Debentures with detachable Equity

Warrants is given an option to buy a specific number of shares from the company
at a predetermined price within a definite time frame.
The warrants attached to Non Convertible Debentures will be issued
subject to full payment of NCD's value. After the specific lock in period, the
holders have to exercise their option to apply for equities. If the option is not
exercised, the company is at liberty to dispose off the unapplied portion of
shares.

Zero Interest Fully Convertible Debentures

The investors in zero interest fully convertible debentures will not be paid
any interest. However there is a notified period after which fully paid FCDs will be
automatically and compulsorily be converted into shares.
No interest will be paid during the lockin period. Conversion is allowed
only for fully paid FCDs. In the event of company going in for rights issue prior to
the allotment of equity (resulting from the conversion of equity shares into FCDs),
it shall only do so after the FCD holders are offered securities.
 80

Secured Zero interest Partly Convertible Debentures (PCDs) with

detachable and separately Tradeable Warrants.

It has two parts. Part A is convertible into equity shares at a fixed amount
on the date of allotment and Part B, non convertible, to be redeemed at par at the
end of a specific period from the date of allotment. Part B will carry a detachable
and separately tradeable warrant which will provide the warrant holder with an
option to receive equity shares for every warrant held, at a price worked out by
the company.

Fully Convertible Debentures (FCDs) with Interest (Optional)

It will not yield any interest for a short period say 6 months. After this
period, the holder is given an option to apply for equities, at premium for which
no additional; amount is needed to be paid. This option should be indicated in the
application form itself. However the interest on FCDs is payable at a determined
rate from the date of first conversion to the date of second/ final conversion and
in lieu, equity shares will be issued.

Deep discount Bonds

These are relatively new Instruments of the capital market and are debt
instruments issued by various financial institutions to raise capital. They are sold
at a discount today to secure a face value of Rs 100/- or Rs 1000/- after five or
30 years. This discount rate depends on the amount of discount and the number
of years to maturity.
IDBI had issued a deep discount bond in 1992. In 1996, it again issued a
deep discount bond alongwith other bonds. The IDBI deep discount bond was
issued at a price of Rs 5300/- with a maturity value of Rs 2,00,000 payable 25
years from the date of allotment.
Under IDBls first deep discount series issued in January 1992, bonds
were issued at Rs 2,700/- with a maturity value of Rs 1,00,000 for the same time
period. IDBI had received Rs 488 crores against an announced issue size of Rs
300 crores. IDBI has offered a call and put option on the bonds.
IFCI also issued deep discount bonds in 1996 by the name of Lakhpati
bonds. The maturity period of these bonds vary from 5 to 10 years after which
the investor gets Rs 1 lakh.
Other financial Institutions like ICICI have also issued deep discount
bonds.

Zero Interest Bonds

Zero interest bonds are sold at discount and no interest is paid. Issuers
prefer them because periodic interest payment is avoided. Investors would find it
attractive if interest is exempted from tax. The issue has not been settled. One
 81

view is that on maturity, the difference between original investment (or issue
price) and the repayment amount would be liable to tax as interest. The other
view is that each year

UTI Units

Unit Trust Of India was setup under an Act of Parliament in 1964 known
as Unit Trust of India Act. It was a closed end Mutual Fund to mobilize the
resources/ savings of small investors. The Unit Linked scheme was the first of its
kind in the Indian Financial market and it registered considerable success.
Unit Trust Of India is a unique organization, combining the elements of a
unit trust as well as a financial institution. It is recognized as a financial institution
under Section 4 of the Companies Act and has been able due create enormous
synergy because of the combination of these two functions. The mutual fund
operations of the UTI are subject to the guidelines of SEBI.

Obiectives of UTI

According to the preamble of the UTI Act, the trust was established with a
view to encouraging savings and investment and participation in the income,
profits and gains accruing to the Corporation from the acquisition, holding,
management and disposal of securities. The trust announces the NAV of the
listed schemes every week. Even for equity oriented schemes which are not
listed, NAVs are announced every week after one year of operation. The major
schemes of UTI in operation are as follows.

Unit Scheme 1964

This is the first scheme introduced by the trust. Introduced on 1st July
1964, the primary aim of this scheme is to provide to the unit holders a regular
and growing income, easy encashability and a reasonable capital appreciation.
Units under this scheme have a face value of Rs 10 and they are sold in
multiples of fifty units subject to a minimum of 50 units. However in case of
application from a Trust, minimum number of units should be 1,000.
This scheme is a tax concession scheme and its objective is to give tax
benefits to the investors and not the higher returns. 60% of the holding of this
scheme is with the corporate sector.

Mutual Fund (Subsidiary) Unit Scheme 1986 ( Master Share)

The Mutual Fund Scheme 1986 was launched on 19th September 1986.
the Scheme provides for long term capital appreciation in addition to modest
dividend to small investors. The scheme offered 5 crore Mastershares of Rs 10
for 1 month ie from 19th Sep 1986 to 18th Oct 1986. the mastershares were
offered in lots of 100 for Rs 10 each at par with a minimum of 100 Mastershares.
There was no upper limit. Mastershare is a growth fund. The Mastershares have
 82

been listed and are being traded at all the stock exchanges of the country and
are therefore easily marketable and transferable. Under the scheme dividend
declared for the year 1991-92 was 18%. There is a provision for redemption after
""" 7 years.

Unit Growth Scheme 2000 (UGS 2000)

The sale of units was open from 1st Sep 1990 to 31 st Oct 1990. The face
value of units is Rs 10. the minimum investment has to be 50 units and thereafter
in multiples of 50 units. The maximum investment can be of 200 units. The period
of holding is 10 years. There is no dividend for the first two years thereafter the
trust may or may not declare dividend.

Master Equity Pan- 1991

In this there is no maximum limit but the minimum limit and the face value
is the same as in the UGS 2000 scheme. It is open to adult citizens of India,
HUF, parents on behalf of minors. Being a growth oriented scheme, the
emphasis is on building up of capital appreciation. The trust may declare
dividend depending upon income realization.

Capital Growth Unit Scheme 1991 (Master Gain)

The sale of units was open from 15th April to 30th June 1991 . the face
value of units is Rs 100. the minimum investment has to be 50 units and
thereafter in multiples of 10 units. There is no maximum limit. The period of
holding is 7 years and 15 days. The object of this scheme is to give benefit to
investors by way of long term capital gain. The trust may declare no dividend or
modest dividend in the first three years of lock in period.

Unit scheme 1992

This scheme was open for sale from 2nd Nov to 23rd Nov 1992. the face
value of units is Rs 10 and the minimum investment has to be 500 units and
thereafter in multiples of 100 units. The year of maturity has not been specified.
The object of this scheme is to give benefit to the investors by way of long term
capital appreciation, the emphasis would be on sharing of growth through rights
and bonuses. The trust may consider declaring a reasonable dividend after initial
lockin period of 3 years. It will be listed on major recognized stock exchanges of
the country after initial lock in period of 3 years.

Master Equity Plan 1993

It has similar characteristics as MEP-91 exception being that it will be

listed on major stock exchanges after initial lockin period of 3 years.
 83

Master Growth 1993

It was open for sale from 18th Jan to 16th Feb 1993. The face value is Rs
10. the minimum investment has to be 100 units and thereafter in multiples of
100 units. There is no maximum limit. The period of holding is 7 years. 50 % of
the funds mobilized will be invested in Public Sector undertaking shares.

Grand Master 1993

It has the same characteristics as Mastergain 1992.

Master Equity Plan 1995

The scheme aims at providing to the members the twin benefits of income
tax rebate on amount of investment as well as reasonable growth of the said
amount over a period of time. It is a 10 year plan. Repurchase is allowed after a
lockin period of 3 years from the date of allotment. There is not tax deduction at
source on dividend. The application shall be made for a minimum of 50 units and
thereafter in multiples of 50 units. The face value of units is Rs 10.

There were a total of 37 mutual funds, (excluding UTI) operating in India

as on March 31 , 2000. Though UTI is not registered with SEBI, there is an
arrangement of voluntary compliance of regulations with the UTI. The details of
mutual funds registered with SEBI are given in Table 5.

Table-5* Mutual Funds Registered with SEBI

Sector As on 31-03-1999 As on 31-03-2000

Public Sector 9 9
Private Sector 31 28
Total 40 37

Table 6 * : Amount Mobilised by Commercial Banks & MFs ( Rs. Crore)

Year Mutual Funds Bank

Public Pvt. UTI Total Deposits
1996-97 151 346 9,600 10,097 71 ,780
1997-98 332 1,974 9,100 11,406 99,811
1998-99 335 1,453 -2,738 -950 1,08,615
1999-00 -701 14,669 4,548 18,516 91 ,075

• Table 5 and 6 - Source- Sebi Annual Report 1999-00

 84

Number of schemes and net assets

During 1999-2000, 330 schemes were in operation, out of which 188 schemes
~ were open-ended schemes. In terms of investment objective, the details of these
330 schemes are as follows:-

lncome (Debt oriented)Schemes - 122

(including 13 gilt schemes)

Growth (Equity oriented}Scheme - 173

(including 64 ELSS Schemes}

Balanced (Equity and Debt} Schemes - 35

The combined outstanding net assets of all domestic schemes of mutual funds
stood at Rs.1,07,946.10 crore as on March 31 , 2000. The details of which are
given in Table 7

Table 7 • : Outstanding Position of Mutual Funds Assets at end-March (Rs.

Crore)

Category of Amount Percentage Share

Mutual Funds 1999-00 1998-99
UTI 72,333.43 67.00 77.90
Public Sector 10,444.78 9.68 12.09
Private Sector 25,1 67.89 23.32 9.97
Total 100

• Source- Sebi Annual Report 1999-00

 85

Graph- 2 * : Resources (Gross) Mobilised by the Mutual Funds during 1999-

2000

43725.66
49XO o Mobiliza1on of Funds

4CID) □ Repurchase/ Redemp1on .Amount

□ Net hi Ou11ow oftmds

39XO
28559.18
::nm
29XO

2IIll) 15166.48
13698.44
19XO

1CllXJ

9lD

0 ..!.--~ ==~====~:.....--~~==~~~--===========~
-9XO+--------..---------r----------r
Priv~tc Sector MFt;- p.,blic S e cto r M01t11;,I Fund" UTI

Assured return schemes of mutual funds

The SEBI pursuing its objective to protect the interest of the investors has been
directing, sponsors/AMCs of mutual funds to honour their commitment of assured
returns. Several investors have received income from their investment due to
efforts of SEBI. According to data available, 7 mutual funds have so far
contributed Rs.1,979.35 crore to meet the shortfalls in 19 assured return scheme.
The details of these contributions are below in the table 8

During the year1999-2000, SEBI directed Indian Bank and Indian Bank Mutual
Fund u/s 11 B of the SEBI Act, 1992 to meet the shortfall in the returns committed
in the offer documents of Ind Prakash and Ind Jyothi schemes. It may be
mentioned that earlier lndbank Mutual Fund had paid assured return to the
unitholders of Ind Jyothi scheme as directed by the SEBI. However, some of the
investors who had opted for redemption before the SEBls' directive could not get
assured returns. They preferred an appeal before the appellate authority. The
appellate authority upheld the stand taken by the SEBI and directed Indian Bank
and lndbank Mutual Fund to pay the returns to the investors as committed in the
offer document. Subsequently, an appeal against the decision of the appellate

• Source- Sebi Annual Report 1999-00

 86

authority has been filed with the Delhi High Court.

It may be recalled that Canbank Mutual Fund had been directed to honour its
commitments in case of Canstar scheme. Though most of the investors opted for
redemption in the year 1997 some of the investors could do so in the subsequent
years. As a result, the amount contributed by Canara Bank has increased to Rs.
1,237 Crore. In case of Cantriple scheme, the matter pertaining to assured
returns is sub-judice.

In case of Magnum Triple Scheme of SBI Mutual Fund, SEBI insisted that the
investors of the schemes must be paid three times the face value of units as
indicated in the offer document. Accordingly, SBI Mutual Fund paid Rs.300 to the
investors at the time of redemption and the shortfall was met by the sponsors i.e
State Bank of India, who contributed Rs. 125.97 Crores (Table 8).

Table - 8 • : Assured Return Schemes: Contributions Made to Honour the

Commitments (Rs. Crore).

Name of the Fund Name of the Scheme Contribution Made by

Sponsor/ AMC
BOI Mutual Fund Double square plus 31 .58
Festival Bonanza Growth 1.38
Scheme*
RMI 3.69
Canbank Mutual Fund Canstar 1,237.83
GIC Mutual Fund GIC Big Value 46.88
GIC Rise II 170.00
PNB Mutual Fund Premium Plus 91 26.15
RisinQ Income Plus 90 3.92
Indian Bank Mutual Fund Ind Jyothi 43.59
Swarnapushpa 0.42
SBI Mutual Fund Magnum Bond Fund 12.29
MMIS 91 42.27
Magnum Triple Plus 125.97
Scheme
MMIS 97 4.55
MMIS 89 18.67
UC Mutual Fund Dhanvarsha (3) 12.40
Dhanvarsha (4) 136.92
Dhanvarsha (5) 53.34
Dhanshree 89 7.50
Total 19,79.35

• Source- Sebi Annual Report 1999-00

 87

Certificate of Deposits

Certificate of deposits are being used in India since 1989. only banks can
issue Certificate of deposits. It is a document of title to a time deposit. It is a
bearer certificate and is negotiable in the market. The minimum Certificate of
deposit should be for Rs 1 crore, later lowered to Rs 50 lakhs and in multiples of
Rs 25 lakhs, later lowered to 10 lakhs and additional amount in multiples of Rs 5
lakhs each.
It is issued by banks against deposits kept by individuals, companies and
institutions and is marketable after 45 days. It can have a tenure of 91 days to 1
year. Banks are to observe CRR and SCR rules. These are permitted upto 1% of
average aggregate deposits. They are issued on discounting basis. No loans and
no buy backs are permitted and no duplicates are to be issued by the banks.
Banks cannot discount them or negotiate them. CDs are interest bearing,
maturity dated obligations of banks and are technically a part of bank deposits.
CDs are in bearer form and can be traded in the secondary market. Since they
are not homogeneous in terms of issues, maturity, internal rate and other
features, secondary market has not developed.
The demand for CDs from financial institutions was stable in 1996-97. the
outstanding amount of CDs issued by Fis was Rs 4299 crores (76.4 percent of
limits) by the end of May 1997. An umbrella limit for mobilization of resources by
way of term money borrowings, CDs, term deposits and intercorporate deposits
was prescribed for IDBI, ICICI and IFCI. The overall ceiling of umbrella limit
would be equal to the net owned funds of the financial institution and the
minimum amount of CD, Rs 10 lakhs. The discount rates on CDs were in the
range of 13.00 -18.03 percent in March 1997.
Certificate of deposits are permitted to be issued during 1991-92 by the All
India Financial Institutions like IDBI, ICICI, IFCI etc. the maturity period for them
may range from 1 year to 3 years and the RBI may fix and aggregate limits for
them. There is no ceiling interest rate on them.

COMMERCIAL PAPER- AN INTRODUCTION

A commercial paper is a usance promissory note issued by a company,

negotiable by endorsement and delivery, issued at such discount on face value
as may be determined by the issuing company. Each CP will bear a certificate
from the banker verifying the signatures of the executants.

CP is a short term negotiable money market instrument comprising of

usance promissory notes with a fixed maturity evidencing short term obligations
of an issuer. CP is generally issued by the companies as a means of raising
short term debt and by a process of debt securitisation, by-passing. CP is
typically issued at a discount to face-value basis but it can also be issued in
 88

interest-bearing form. The issuer promises to pay the buyer some fixed amount
on some future date but pledges no assets, only his liquidity and the established
earning power, to guarantee that promise. In other words CP is not tied to any
specific self- liquidating transaction unlike commercial bill which arises out of a
specific trade or commercial transaction. CP can be issued directly by a company
to the investors or through banks/merchant banks (called dealers). It is generally
backed by a revolving underwriting facility from the banks to ensure continuous
availability of funds on each roll-over of the paper.

Highlights of Commercial Paper

An important feature of the March 1989, credit policy of the RBI was the
decision to allow the issue of the Commercial Paper (CP) by a highly rated
commercial borrowers who have initially been cleared by CRISIL (Credit Rating
Information Services of India Limited).

The highlights of this new instrument were as follows:

(a) It would be a new source of short term funds.

(b) It would be transferable.
(c) The rate of interest would be market determined and in fact
this whole instrument is based on the market conditions.
(d) By doing away with the financial intermediary, the spread
that the bank charged on commercial loans would be
eliminated, thereby reducing the cost of funds for the
commercial borrowers.

Commercial Paper Market in other Countries

United States

The CP market in the US dates back to the early nineteenth

century but it developed in the early 1920's.
The CP issues in the US are exempt from the Security Exchange
Commission registration and from the requirement of the issue of
the prospects so long as the proceeds are used to finance the
current transactions and the papers maturity period is less than 270
days.
Rating by one of the U.S. rating agency is obligatory.
Major investors in such papers are corporations, money market
funds.
A major notable feature of the U.S. CP market is that the secondary
market has not been active due to the enormities and the short
duration of the maturities and the preference of the investor to hold
the paper till the time of maturity. CP dealers may however , buy-
back the paper sold through them from an investor in case of need
 89

of funds. CP's are therefore considered less liquid instrument than

Treasury Bills, Certificate of deposit , acceptances, etc.

Europe

Most of the CP markets in the Europe are modelled on the lines of

the US market.
In the UK the sterling CP market was launched in May 1986.
Unlike the U.S. in U.K., the borrowers must be listed on the stock
exchange and they must have net assets of at least 50 million
pounds. However, the rating of the credit agencies is not required.
The maturities of the CP must be between 7 and 364 days.
In France, the CP was introduced in December 1985.
CP can be issued only by non-bank French companies and the
subsidiaries of the foreign companies.
The papers are in bearer form and can be issued by the dealers or
placed directly.
Maturity range from one to seven years.
Rating by the credit rating agencies is essential.
To protect the investors, law contains fairly extensive disclosure
requirements and requires publication by issuers of regular financial
statements.
The issuer must have a line of credit equal to at least 75 per cent of
the outstanding CP.

ELIGIBILITY CRITERIA

The eligibility criteria for a company to issue a commercial paper,

according to the latest RBI guidelines, are as given under:

(i) Tangible Net Worth

Tangible net worth of the company, as per the latest audited balance sheet,
should not be less than Rs. 5 crores.

The tangible net worth will comprise of:

Paid -up-capital
Plus: free reserves

Less: accumulated balance of losses, balance of deferred revenue expenditure

and also and also other intangible assets.
 90

( Free reserves including balances in share premium account, capital and

debentures redemption reserves but excluding the reserves created for any
future liability, or for depreciation of assets, or for the bad debts, or for a
revaluation reserve).
(ii) Working Capital (fund based) Limit

This limit for the company should not be less than Rs. 5 crores.

(iii) Listing Requirement

(a) For public sector companies there is no listing requirement.

(b) For companies other than in the public sector, the same should be
listed on one or more stock exchanges.
(c) Closely held companies whose shares are not listed on any of the
stock exchanges will also be eligible to borrow under the commercial
paper scheme, provided they meet all the other requirements.

(iv) Credit Rating:

(a) Credit rating , as obtained from CRISIL ( Credit Rating Information
Services of India Ltd.) should not be less than P2.
(b) Credit rating, as obtained from ICRA should not be less than A2..

The issuer should ensure that the credit rating at the time of applying to
the RBI should not be more than two months old.

(v) Health Code

Health code assigned to the boreal account of the issuing company should
not be less than No.1.

(vi) Current Ratio:

Current Ratio as per the latest audited balance sheet should not be less
than 1.33.1.

For the purpose of computing the current ratio, the current assets and
current liabilities are classified as per the RBI guidelines issued from time to time.

CURRENT SCENARIO

Commercial Paper made a rather quiet entry into India's financial market.
Stiff entry barriers meant that only the cream of the corporate sector was able to
utilize these conditions to their advantage.
 91

Even then, a significant amount of the paper has been floated so far a
worth approximately RS. 500 crores. Still India has to go a far way as far as
financing the working capital through the CP is concerned. In the West cash
credit is exception rather than the rule.

Moreover, of the amount floated so far only an insignificant amount has

found its way into the Secondary market. Few CP's have changed hands, and in
most cases , the banks, which initially bought the paper, have been forced to
hang on to it. Only in very few cases have they been able to off load it.

However, things are set to change now , the RBI obviously is carrying on
with its liberalization drive, which it has initiated. And as with other money market
instruments, constraints on the use of CP's too have been eased considerably.

And both the bankers and companies are now bullish about its prospects.
And if some of the reliable projections are any pointer then it is estimated that in
the next three years at least fifty per cent of the business shall be accounted for
by the CP and it is believed that it will replace the CC over the long haul.

At present the various CP issues are not marked by a wide range of

discount rates for various companies. But as the market progress, this difference
is bound to become very noticeable.

The companies are thrilled, is thus understandable. They can now finance
a larger proportion of their working capital requirements at a lower cost. Even
one per cent reduction in the interest rate is a tremendous saving. Currently top
ranking companies are able to float CP's at around 18 per cent , which includes
the stamp duty and various other expenses, while the cash credit rates are now
approximately 21 per cent.
What companies are thankful for is that the procedure is simple enough.
Though getting the paper stamped sometimes takes time.

Another surprising development of this whole CP affair is that the banks,

which were the prime losers on account of the free market system, that is
gradually emerging, do not seem to be unduly worried. That their blue-chip
accounts may be slipping has not made them insomniacs. On the contrary , they
seem to have accepted that the CP is going to be in vogue from now on and are
even learning to use the situation to their advantage.

With the funds becoming scare and costly, the banks can no longer lend
on incremental scales at which they were lending in the past. The credit-deposit
ratio has been brought down to between 48 and 52 per cent and profits
increased. The alternative through which the banks can improve its profitability
by retaining its good customers is obviously CP.
 92

With the deposit growth being sluggish, funds are not easy to come by
and so money will have to be directed towards good customers. Thus, if the
corporate sector decides to borrow through CP, banks will have to lend in a
similar fashion. What's more, the loss in terms of lending at a lower rate does'nt
seem to bother the bankers. In terms of spreads, some bankers say, there isn't
going to be much difference. In fact the benefits far outweigh the marginal loss, if
any. In a free market situation the spreads are expected to stabilize at a
competitive level between the banks.

The Discount and Finance House of India (DFHI) already offers a one-way
quote of the CP's but there have not been many takers. One reason being that
most bankers/investors have been hanging on to their papers. This hopefully will
all change as more and more participants come into the market.

Money market is under going very fast changes. One of such changes is
the introduction of many new money market instruments- Certificate of deposit,
Commercial Paper , 82 day Treasury bills, 364 days treasury bills.

All these instruments were introduced to increase the flexibility of the

money market in India.

Commercial Paper was introduced for the blue-chip companies to raise

money from the money market for short term (from three to six months). It failed
to catch on initially because of very stiff entry barriers. RBI did not want to take
many chances with the new instrument. But the market behaved in a disciplined
manner and the number of CP's issued increased rapidly. Seeing it, RBI,
loosened the control in terms of the eligibility criteria laid down by for a company
to issue a CP.

Mandatory credit rating is a feature of the RBI guidelines. The norms for
credit rating has been relaxed from p1 +p1 to p2 at present. If this trend
continues, it is hoped that a more broad range of credit rating will be permitted
and this credit rating will allow the investors to fix their discount rates accordingly.

Though CP is an unsecured promissory note there has been no case of

default as yet. The reason for this are two fold. Firstly, the issuing company's
rating provides a picture for the investor about the credit- worthiness. Secondly,
companies which can issue CP are blue-chip companies, these cannot afford to
take the risk of defaulting because once they do that nobody in the money
market will deal with them and even if someone does, the interest rate charged
will be exorbitant.

CP issue is subject to working capital limits. To give CP a chance as a

viable resource option, it is suggested that the CP issue should be made
separate from the working capital limits of the company. The company should be
 93

given the freedom to decide, at the beginning of the year, the proportion between
the cash-credit and the CP and the decision will be binding on it for the entire
year. This means that if a company wants to use the amount under CP limit, it
will be forced to issue a CP.

Another problem which CP is facing is that for each roll-over all the issue
expense have to be incurred once again. This is a daunting factor. One solution
to this can be that the maturity period of CP is increased from six months to
twelve months.

Stamp duty is another issue plaguing CP. Stamp duty is exorbitant

and is to be paid by the issuer. Stamp duty has been waived in case of
commercial bills and factoring services, which are the competitors of CP.

Cash credit is the main competitor of CP. Currently cash credit

interest rate are about twenty one per cent. Whereas top ranking companies,
currently, are able to float CP's at about eighteen per cent.

Banks, who were thought to be the major losers after the

introduction of CP have turned to be investors in CP. With the Money Market
Mutual Funds opening up, the potential of CP has increased tremendously.
Though CP is said to be highly liquid because of its transferability , the reality is
some what different. In the absence of secondary market its liquidity is greatly
reduced.

CP has immense scope in India. It is expected that within three

years, if the suggested corrections are made. CP shall takeover more than fifty
per cent of the cash credit business.

Electronic Trade Monitoring System

As trading in the Indian securities markets has become on-line, a

sophisticated on-line surveillance system was called for to have effective market
surveillance in line with international standards. Development of the Stock Watch
System at the exchange level was initiated by the SEBI with this objective. All
major exchanges have put in place the basic structure of the stock watch system.
The system is fully functional in NSE.
This system was introduced on 1/9/97. the stockwatch system is a
computer system designed and programmed to monitor market activity and
identify aberrations from historical patterns.
The algorithm for the NSE system is somewhat similar to the one
prevalent at NASDAQ in the US. The trading system at NASDAQ has been
adopted to NSE's trading conditions. The system will enable NSE to
electronically monitor the trading patterns which would lead to more effective
surveillance. Currently NSE Officials have manually screen the trading patterns
 94

to ascertain any strange price fluctuations. The electronic track monitoring

system will automatically kick off alerts. It will make the task of surveillance
easier and more effective. There is a great need to enhance information flow and
this will go hand in hand with better monitoring of trading patterns to reduce
cases of price manipulation. SEBI will define the kind of information Stock
Exchanges need to furnish so as to make their enforcement job more effective.
This will include setting up of an issuer database, as it has been felt that in
several cases, it is the issuer who is responsible for price manipulations and not
necessarily the brokers.
In BSE, the system was formally inaugurated in July 1999, and is
operational. However, BSE and some other exchanges are now in the process of
prioritisation and benchmarking of the alerts generated by the system. Further
refinements of the stock watch system will be taken up after the basic system
becomes fully functional in all major stock exchanges.