MERCHANT BANKING

Origin:
The origin of merchant banking can be traced back to the thirteenth
century when a few family owned and managed firms engaged in
sale and purchase of commodities were also found to be engaged in
banking activity.

Meaning and Concept:

Merchant banking can be seen as a non-banking financial activity
resembling banking, originated, grown and sustained in Europe, got
enriched under American influence and now being performed all
over the world by both banking and non banking institutions.

In India,merchant banking services were started only in1967 by

National Grindlays bank followed by City Bank in1970.The S.B.I
was the first Indian commercial bank to set up a separate merchant
banking division in1972.

Difference between Merchant Banks and Commercial Bank:

Commercial Banks Merchant Banks

1. Basically deals in debt and
debt related finance.
2. Asset oriented. Generally
avoids risks.
3. Are merely financiers.
1. Basically deals in equity and
equity related finance.
2. Management oriented. Willing
to accept risks.
3. Main activity is to render
financial services.

Functions of merchant bankers (Services/Scope):

1. Corporate Counseling:
Counseling is provided in the form of opinion, suggestion
and detailed analysis of corporate laws as applicable to the
business units.
2. Project Counseling:
Project counseling broadly covers the study of the project
and providing advisory services on the project viability and
procedural steps to be followed for its implementation.
3. Capital restructuring services like examination of the
capital structure, guiding the bonus issue, guidance
regarding FEMA regulations, suggestions of appropriate
capital structure to sick units, help in merger and
acquisition etc.
4. Portfolio Management:
They advise their clients, mostly institutional investors,
regarding investment decisions as to the questions of
amount of security and the type of security in which to
invest.

5. Issue management like preparation of prospectus,

preparation of expenditure budgets, selection of under
writers, appointment of registrars, brokers and bankers,
advertising , bonus issue, right issue etc.
6. Loan/ Credit Syndication:
They provide specialized services in preparation of projects,
loan application for raising short term as well as long term
credits.
7. Arranging working capital finance:
Finance for working capital is provided usually for new
ventures or for existing companies through issue of
debentures.
8. Lease financing:
Leasing is an arrangement that provides a firm with the use
and control over assets without buying or owning them.
Merchant bankers assist their clients by providing finance
for the acquisition of assets taken on lease.
9. Bill discounting:
10. Venture capital:
It is a form of equity financing especially designed for
financing high risk and high yield projects.
11. Public deposits : Help companies in raising finance by
way of public deposits
12. Specialized services: Merchant bankers also provide
corporate advisory services on issues like M&A, takeovers,
tax matters, recruitment, cost and management audit etc.

Importance (Role) of merchant bankers:

He is the most critical link between a company raising funds

and investors. He plays the role of promoter, advisor and an
agent or intermediary for corporate enterprises. He acts as a
corporate advisor. As a financial and management expert, a
merchant banker has to guide the corporate clients in areas
covering financial reporting, project management, working
capital management, evaluating financial alternatives etc. He
acts as a manager to the issue. He acts as a rehabilitator at
the time of M&A, takeover, amalgamation etc. He acts as
transfer agent and paying agent for interest and dividend etc.

For an industry which is just 3 decades old, the merchant

bankers have indeed come a long way. They are masters in all
trading activities.

Management of public Issues (Fund raising):

The management of issues of various securities for raising

funds by corporate is known as issue management. The
functions of issue management in India is carried out by
merchant bankers They possess skill and expertise in issue
management.

Categories of security issue:

Private placement, right issue, public issue (initial public
issue, offer for sales, ie. not directly to public but offer through
intermediaries)
New issue procedure:
Equity offerings by companies are in two forms- fixed price
offer and book building method.

Steps involved in issue of shares under fixed price

method:

1. Selection of merchant banker 2. Issue of prospectus 3.

Application for shares 4. Allotment of shares 5. Issue of
share certificate

Book building method:

Under this method, the company does not price the securities
in advance. Instead, it offers the investors an opportunity to
bid collectively. It then uses the bid to arrive at a consensus
price.

Issue manager (Lead manager):

Issue management is an important activity of merchant

bankers. Registration with SEBI is required for conducting
issue management.

Role of merchant bankers in managing public issues:

1. Easy fund raising. 2. Financial consultant 3. Underwriting

4. Comply with SEBI guidelines 5. Co-ordination with
number of institutions and agencies while managing an
issue 6. Liaison with SEBI--should file a number of reports
to SEBI.

Merchant banking in India

Earlier managing agents and share broking firms acted as
merchant bankers. Grindlays bank opened its merchant
banking division in 1967, followed by City Bank in 1970. SBI
entered the field in 1972. Other nationalized banks also
followed suit.

CREDIT RATING:

Meaning and Definition:

Credit rating is the opinion of the rating agency on the relative
ability and willingness of the issuer of a debt instrument to
meet the debt service obligations as and when they arise.
.Rating is usually expressed in alphabetical or alphanumeric
symbols.

credit rating is a symbolic expression by an independent

agency about the credit worthiness of a company.

Features of credit rating

1. Credit rating is specific to an instrument 2. The rating
symbolically expresses the debt servicing ability. 3.The
ratings are expressed in code numbers.4.It is only a guidance
to investors.5. It is based on internal and external
information 6.It is an ongoing appraisal of a security.

Need/importance of credit rating

Credit ratings establish a link between risk and return. It
provides a yardstick against which to measure the risk
inherent in any instrument. Credit rating is a professional
opinion

Functions of Credit Rating

1. Provides unbiased information 2 .Provides quality and

dependable information 3 .Provides information at low
cost 4 .Provides easy to understand information 5.
Provide basis for information
Rating Methodology

The following are analyzed in detail while assessing an

instrument:

1. Business risk analysis (industry risk, market position of

the company, size of business)
2. Financial analysis (accounting, profitability, cash flow
analysis)
3.Management evaluation: Evaluation of management
strength and weakness.
4. Geographical analysis: Undertaken to determine the
locational advantages of the company.
5. Regulatory and competitive environment.
6. Fundamental analysis (analysis of liquidity, profitability
and financial position, interest, tax rates etc.)

Credit rating agencies in India:

In India, there are three major credit rating agencies-

CRISIL, ICRA and CARE.

CRISIL (Credit Rating Information Services of India

Limited):

CRISIL was promoted by ICICI along with UTI as a public

limited company with its head quarters in Mumbai. Its
objective is to accord credit rating to public limited companies
which desire to float share capital, debentures and public
deposits.

Services of CRISIL:

a. Credit rating services,

b. Information services
CRISIL card provides corporate data for analysis. CRISIL 500
equity index is based on 500 companies representing 74% of
market capitalization of Mumbai stock exchange.

c. Advisory services to financial institutions

ICRA (Investment Information of Credit Rating Agency of

India Limited):
It is promoted by IFCI with head quarters at New Delhi.
ICRA currently provides three types of services namely

a. Rating Services: It is concerned with rating of long

term instruments such as loans, debentures and
medium term instruments such as fixed deposits
and short term instruments such as certificates
of deposits, commercial papers etc.
b. Information Services
c. Advisory services
CARE (Credit Analysis and Research Equity):
It was promoted by IDBI. Services include credit rating,
information services, equity research etc.
DUFF and PHELPS Credit rating India (DCR):
It is a joint venture between the international credit
rating agency DUFF and Phelps and JM financial and Alliance
group.
ONICRA (Onida Individual Credit Rating Agency):
ONICRA is the first individual credit rating agency of
India promoted by famous ONIDA.

Rating Symbols: Different agencies use different symbols.

Important symbols used by CRISL are noted below.

Instruments Rating Meaning/

Judgment
1. Debentures(Long AAA
term) AA Highest safety
A High safety
 BBB Adequate safety
D Moderate safety
In Default
FAAA
2. Fixed FAA Highest safety
Deposits(Medium FA High safety
Term) FD Adequate safety
In Default
P1
P2 Very strong safety
3. Short term P3
Instruments P4
P5
In Default
BLR-1
Strong likely hood
BLR- 6 of repayment
4. Bank loan High loss likely
hood

CRISIL and ICRA both are engaged in rating

banks based on the following six parameters also
called CAMELS
C- Capital Adequacy A-Asset Quality M-
Management Evaluation E-Earnings L-Liquidity
Position S-Systems and Control

Advantages of credit rating:

A. To investors:
1. Safety of investments 2. Recognition of risk and
return 3. Freedom of investment decision 4.
Wider choice of investments 5. Easy
understandings of investment proposals. 6. Relief
from botheration to know the company 7.
Advantages of continuous monitoring 8. Low cost
information
 B. Benefits to the company:
1. Easy to raise resources 2. Reduced cost of
borrowing 3. Reduced cost of public issue. 4
Rating builds up image 5. Rating facilitates
growth 6. Recognition to unknown companies 7.
Warning signal to low rated companies 8. Helps
in foreign collaboration 9. Acts as an index of
faith.
C. Advantages to intermediaries:

It helps the brokers and other financial

intermediaries to save time , energy and man power
in convincing their clients

Limitations of credit rating:

1. No disclosure of significant information
2. Static Study- Rating is a static study of present and
past historic data of the company at a particular point
of time only
3. Rating is no certificate of soundness- users should
form an independent view of the rating symbol
4. Rating may be biased.
5. Rating under unfavorable conditions-a company might
be given low grade because it was passing through
unfavourable condition
6. Rating by different agencies may confuse investors due
to difference in rating grades.
 ROLE OF MERCHANT BANKERS IN PROJECT
APPRAISAL

Before investing funds in projects, it is necessary to

ensure whether it is worthwhile to invest funds in the
project or not. This process is known as project
appraisal. Project appraisal is one of the important
functions of merchant bankers. The role of merchant
banker in project appraisal may be understood from
the following points:-
1. Financial appraisal: The merchant banker has to
conduct a cost benefit analysis for determining the
profitability and financial viability of the project.
2. Technical appraisal: The merchant banker will have
to make a detailed estimate of the inputs and
infrastructural facilities required for the projects.
3. Economic appraisal: While evaluating the economic
viability of the project, a merchant banker should
consider the factors such as capital cost, working
capital, operating cost, operating revenues, market
trends, the effect of the project on employment and
net social welfare etc.
4. Commercial appraisal: the merchant banker has to
study the proposed arrangements for purchase of raw
materials and sale of finished goods.
LEASE FINANCING

Lease Financing is an arrangement that provides a firm with

the use and control over assets without buying and owning the
assets. It is a form of renting assets. Leasing separates ownership
and use as two economic activities and facilitates asset use without
ownership . Lease financing is a device of financing/ money lending.
It is a tool of financing the cost of an asset. Leasing is an
alternative to purchase of an asset. In a word ,Leasing is, in effect, a
contract of lending money.
 Essential elements of lease financing

1.Parties to the contract—Lessor(owner) and Lessee(user) 2. Asset

3. Consideration 4. Lease period 5. Use vs. ownership:
ownership of the asset remains with the lessor whereas the
possession of the asset lies with the lessee 6.Termination of
contract:—renewed or buy, or reverts to lessor 7. The lessee
agrees to insure 8 The lessee agrees not to make any changes in
the asset.

Need for lease financing:

1. Need for more investible funds 2.Desire to capture market share
3. Availing new opportunities opened by technology 4. For
modernizing plant and machinery
5. For expansion and diversification

Forms of Lease Financing:

1. Operating or Service lease 2. Financial lease

Operating or service lease

1. It is a short term lease on a period to period basis 2. Usually

cancelled at short term notice by the lessee 3. It does not
necessarily amortize the original cost of the asset 4.The lessee
has the option of renewing the lease 5.It implies higher risk to
the lessor (period short) but higher lease rentals to the lessee

IBM is a pioneer in the field of operating lease

Financial lease

Financial lease is usually for a longer period and not cancellable

Features:- 1.Within the lease period, the lessor recovers his

investment in the asset along with an acceptable rate of return 2. It
is for a longer period 3.It is non- cancellable 4. The lessee is
generally responsible for maintenance, insurance and service of the
asset .If the lessor has to maintain and service the asset , it is
known as Maintenance or Gross lease

Forms of Financial lease

1. Sale and Leaseback:- It involves the sale of an asset already

owned by a firm (vendor) and leasing of the asset back to the vendor
from the buyer

2. Leverage Lease:-It is an arrangement under which the lessor

borrows funds for purchasing the asset from a third party called
lender(bank or finance company).The loan is usually secured by
mortgage of the asset and the lease rentals to be recovered from the
lessee. The loan is paid back out of the lease rentals.

Difference between Finance and Operating Lease

Financial Lease Operating Lease

For specific use of the lessee May be commonly used by a
number of users

The lessor is simply legal owner Lessee simply uses the asset
Lessee bears the risk of Lessor bears the risk of
obsolescence obsolescence
Cannot be cancelled Can be cancelled
Period is generally longer Period is generally shorter
Cost of repairs borne by the Cost of repairs borne by the
lessee lessor

Advantages of lease financing

1) Avoidance of initial capital out lay 2)Minimum delay in

the use of an asset 3) Easy source of finance 4)Shifting the
risk of obsolescence to the lessor 5) Facilitates the use of
working capital for other purposes 6)It is cheaper than loan
7)It helps the lessee to enjoy cent percent tax rebate on the
 entire amount of lease rentals(revenue expenditure) .Hence,
he can reduce the profit before tax and save the tax 8) Lease
arrangements are highly flexible 9) Leasing gives more
freedom to the finance manager 10) No disposal problem
Disadvantages of lease finance:
1. Ownership remains with the lessor
2. Long term lease is more expensive to the lessee because
miscellaneous expenses have to be borne by him.
3. The lessee never becomes the owner; so he does not get
the residual value.
4. Lessor may take back possession if lessee defaults
payment
5. It may impose certain restrictions on the use of the
equipment or require compulsory insurance and so on.

Scope of merchant banking in India:

There is much scope for merchant

banking in India because of the following factors:-
1. Growth of new issue markets
2. Entry of foreign investors in India
3. Development of debt market
4. Innovative financial instruments
5. Corporate restructuring(M&A)
6. Disinvestment in public sector units.
7. Changing policy of financial institutions.

DEPOSITORY SERVICES:

Depository is an institution which transfer the ownership of

securities in electronic mode on behalf of customers. It is a place
where securities are stored and recorded in the books on behalf of
the investors. This system would eliminate paper work. It facilitates
electronic book entry of the transfer of securities. It facilitates
automatic and transparent trading in scrips. It is also known as
scripless trading system. Anybody to be eligible to provide
depository services must register with SEBI.

A Depository Participant is an agent of the depository through

which it interfaces with the investor. A depository can be compared
to a bank. The investor is required to open an account called demat
account with the depository. It is opened through a depository
participant.

Characteristics of Depository System:

1. Immobilization and dematerialization: Immobilization means

stopping the physical movement of securities.
Dematerialization means converting securities held in physical
form into electronic form.
2. Separate identity: Each and every security has a separate and
distinctive identifiable number.
3. Free option: The owners will be given the free option of
keeping their scrips either under a depository or under the
custody of the issuing company.

Difference between depository and bank:

BANK DEPOSITORY
Holds fund in an account Holds securities in an account
Transfer of funds according Transfer of securities
to instructions of the according to instructions of
account holder the account holder
Direct contact with Contact through depository
customers participant
Facilitates transfer without Facilitates transfer without
having to handle money having to handle securities

Benefits of depository services:

A. Benefits to the investors:
1. Quick transfer and settlement 2. Elimination of
financial loss that may arise due to physical loss of scrip
 3. Reduction of paperwork 4. Faster disbursement of
corporate profits 5. Increased liquidity 6. Reduction in
transaction cost
B. Benefits to the issuer (Companies or development banks):
1. Up-to-date knowledge of shareholders’ names and
addresses
2. Savings in cost of new issues
3. Better facilities for communication with shareholders
4. Increased ability to attract international investors
C. Benefits to intermediaries:
1. Less risky settlement
2. Greater profits from increased trading
3. Improved cash flow
4. Reduced transaction cost

National Securities Depository Limited (NSDL) was

registered by SEBI in 1996 as India’s first depository. It
was promoted by IDBI, UTI and NSE.

CUSTODIAL SERVICES:

The owner of securities can keep his securities to some

others for safety. These services are called custodial
services. The services provide by a custodian are called
custodial services.

Custodian is an institution or a person who is handed

over the securities by the owners for safe custody.
Custodian is a caretaker of a public property or
securities. The remuneration of the custodian is called
custodial charges. Thus custodial service is the service of
keeping the securities safe for and on behalf of somebody
else for a remuneration called custodial charges.

Duties and responsibilities of custodian:

(as laid down by the SEBI)

1. Exercise due care in safe keeping
2. Separate custody account in the name of each client
3. A separate deposit account in the name of each client
4. Assets should be recorded
5. Securities must be registered
6. Adequate insurance
7. Physical verification and control mechanism
8. Annual audit should be made
9. Fees charged should be specified in the agreement.
 SREE NARAYANA COLLEGE, VATAKARA

B.B.A.3.3-FINANCIAL SERVICES, TAX AND AUDIT

Model Question (1)

Time: 3 Hours PART A Max: 80 Marks

Answer All Questions

Each Question Carries 4 Marks

1. What are the characteristics of investments ?

2. Write the need for insurance
3. What are the functions of regional rural banks ?
4. What are the objectives of auditing ?
5. How would you determine the Gross Annual Value of a
residential house property owned by an assessee ?
(5*4=20)
PART B

Answer any three of the following

Each question carries 10 marks

6.Explain the procedure of Audit.
7.What are the various types of mutual funds? Explain them.
8.What are the functions of insurance intermediaries ?

9. What is Merchant Banking? Explain the functions of a

Merchant Banker.
10. An assessee commences his business on:
1) 1st July,2009; (2) 1st October,2009; and(3) 1st January 2010.
In each case, what will be his assessment year and what
period will be treated as his previous year for the concerned
assessment year?
 (3*10=30 marks)

PART C
Answer any two questions
Each question carries 15 marks

11.Explain the functions of Reserve Bank of India.

12.Explain fundamental analysis and technical analysis.

13.Explain the fundamental principles of insurance.

14.From the following information compute the total income of

an individual for the assessment year 2010-2011:

(a)Salary after deduction of provident fund contribution and

income tax Rs. 1,77,000.

(b)Income tax deducted a on basic salary Rs.3000.

©His contribution to recognized provident fund Rs.20,000.

(d) Employer’s contribution to provident fund Rs.20,000

(e) Interest credited to provident fund Rs. 6,200 @ 9.5%.

(f)Net dividends received from domestic company Rs. 8950.

(g)Life insurance premium paid Rs.2000.

(2*15=30 marks)
From

Chandran. M

Retired Principal,

Govt. College Madappally

(Father of Prasoon.C, Old student of

M.C om.1st.Sem. 2010-2011 Batch).

To

The Principal,

St.Joseph’s College ,Devagiri.

Respected Sir,

Sub: NAAC accreditation-reg :-

I am infinitely happy to hear that your college has won the

prestigious NAAC ‘ A’ level accreditation for the second time. And
that too by securing the highest ever marks in the history of NAAC
accreditation in Kerala.

Sir, an institution is the lengthened shadow

of one man. It is your keen insight and inspiration that brought
laurels to your institution. It is your dedication that brought glory
to your institution. It is your leadership acumen that brought
honours to your institution.

The college would remember you with pride

and gratitude for ever.

I request you to kindly convey my sincere

best wishes and words of appreciation to all the students , staff
and the management.
Yours faithfully,

Chandran. M

N.B.

A college of St.Joseph’s college, Devagiri has the potential to

publish a research journal of international standard. I request you
to take necessary steps to publish ‘Devagiri Times’ as a quarterly
research journal.