Question Paper Investment Banking & Financial Services–II (262): January 2006

Section D : Case Study (50 Marks)
This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study Read the case carefully and answer the following questions:
1. Appraise the various alternatives available to Discovery Engineering Systems. (20 marks) < Answer > 2. Represent your appraisal in the form of a decision tree with explanatory notes. (6 marks) < Answer >

3.
4.

Discuss the various lease related risks that HP Financial Services would need to bear.
(8 marks) < Answer > How mature is IT leasing in India and what are the emerging trends in IT leasing in India? (8 marks) < Answer >

5.

What competition does IT leasing companies face from banks that also offer leasing options?

(8 marks) < Answer > Discovery Engineering Systems (P) Limited is a Noida based venture capital funded manufacturing company in the Small and Medium Enterprise (SME) sector. The company is having a very good track record for the past 3 years • • • • • • With an outstanding growth rate Having its own sprawly premises in Nodia Having enough working capital and provisions for contingency.

Discovery Engineering has quality management, aggressive in nature. The management team comprises of professionals having extensive knowledge and related experience both in India and abroad. Goal of the company is to work on untested projects and develop new products and hence get the pioneering advantage of earning higher than normal returns. For achieving its goal the management is also planning to develop strong marketing, sales and distribution network in India and abroad. For achieving its goals and increasing its productivity, Discovery Engineering wants to use some high cost Computer Numerical Control (CNC) machines costing Rs.200 lakhs for complete automation of all its services. This automation would help the company to achieve 100% capacity utilization from the current 80% level. Given the uncertainties associated with the CNC machine market, the Vice President (Technical) believes that the useful life of the CNC machines is a stochastic (random) variable with the following probability distribution: Useful Life (in years) Probability 3.0 0.4 4.0 0.2 5.0 0.2 6.0 0.2

After reviewing the above probability distribution, the Vice President (Finance) is not very keen on purchasing the equipment. He believes that taking the equipment on lease, preferably under a flexible arrangement will

make more commercial sense. HP Financial Services is leasing company with offerings ranging from leasing of CNC machines to various automation equipments. Under this segment the company has provided CNC machines and automation equipment to approximately 750 customers. HP has also started IT equipment leasing, which includes hardware, software and other services for HP customers. Their financial service portfolio includes operating and finance leases, variety of acquisition strategies for multi-vendor/ multi-technology solutions, utility structures and lifecycle asset management. There is also a range of re-marketing services to maximize value of older equipment, add-ons and upgrades for corporate accounts and financing for printing and imaging services. In India they have approximately 100 customers. HP Financial Services leverage their relationship to reach the different verticals that their customers target, which includes telecom companies, banking, finance, manufacturing and the government sector. Their offerings can cut across any vertical. The financial and telecom segments are emerging in nature and have a very huge growth potential, therefore HP has included these in its portfolio to increase the volume of business. HP Financial Services have come up with two lease proposals for Discovery Engineering Systems. Proposal I : A finance lease under which the lessee will have to pay a rental of Rs.350/Rs.1000 a year for a non-cancelable period of five years. After 5 years, the lease can be renewed for another three years on a yearly basis at a rental of Rs.15/Rs.1000 per year. The lease rentals are payable annually in arrears. Proposal II: This involves a Back-to Back Short-Term Lease arrangement. Under this arrangement two short term leases, each for a duration of three years will be structured. The lease rentals payable annually in arrears for the first short-term lease will be as follows: Year 1 2 3 Lease Rental (Rs. in lakhs) 45 45 45

On expiry of the lease period, the lease can be renewed for another three years on the basis of the prevailing lease rate for the equipment of that vintage. The following information is provided by the VP Finance of Discovery Engineering Systems: • • • • • • • • • • The capital costs of similar high technology CNC machines have been escalating at the rate of 15% over the last 3 years • 3 years • • The ratio of cost of used CNC machine to cost of new CNC machine is expected to be 0.20 after The net realizable value of the CNC machines by the end of year 4 will be negligible The lease rentals for the second lease term should be projected assuming a pre-tax return of 25%

The cash flow projections reveal that the investment in the new CNC machines will result in an • incremental EBDIT of Rs.75 lakh in year 1, Rs.90 lakh in year 2 and Rs.105 p.a. in years 3 to 6 • • • • The tax relevant rate of depreciation is 25% Marginal rate of tax (including surcharge) is 35% Post tax required rate of return is 13% p.a. Incremental cost of debt is 16% p.a.

END OF SECTION D

Section E : Caselets (50 Marks)
This section consists of questions with serial number 6 - 11. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 6. In recent times Individual Credit Rating is taking pace. Explain how the lenders are benefited through Individual Credit Rating and also state the disadvantages associated with it. (9 marks) < Answer > 7. What kind of credit information does the credit information bureau store and what happens lender provides the incorrect information to the bureau? when the

(8 marks) < Answer > As the number of companies borrowing directly from the capital market increases, and as the industrial environment becomes more and more competitive and demanding, investors find that the borrower’s net worth or the name are no longer sufficient to ensure successful raising of funds from the market. In such a scenario to enable the investor to take informed decision, credit rating has emerged as one of the most critical factor in choosing. Offering this service is a Credit Rating Agency, which provides an impartial and objective opinion on the credit quality of debt obligations of different companies and assists investors, individuals and institutions in making investment decision. This was the discussion requirement of credit rating for companies but now a days credit rating of the individual is also taking pace. With liberalization in full swing, loans for cars and white goods are freely available at the right price for India’s 200 million strong middle class. Today there is no stigma attached to the loan for acquisition of goods for status. The consumer finance market is on boom and with it, the need to rate or assess an individual in order to avoid the risk of default, is all the more necessary. The presence of so many consumer finance companies like Country Wide, is an indication of growing need for consumer finance and with it the individual rating. In developed financial markets, there are specialized financial institutions that maintain records of credit histories of individuals and business entities. Lenders — mostly banks and credit card companies, usually setup these institutions, called credit information bureaus. Whenever an individual seeks a loan from a bank or finance company, the lender before extending the loan checks his credit profile with the bureau to find out whether the borrower has defaulted with any other lender and whether he is capable of settling the loan. The question which arises in every ones mind is that why there was no credit information bureau in India until now. Until now, if any borrower failed to repay his loan to the bank in time, the bank could not share his loan details with anyone else. Laws relating to banking secrecy prevented a lender from sharing information pertaining to their customer with any third party. The only time information of a default would come in public domain was when the bank filed a suit for recovery of the loan. The bureau largely provides information on retail borrowers. This information is available to banks that contribute information in respect of their own borrowers. Lenders are provided a credit information report based on which they can take an informed decision on whether to lend or not.

Caselet 2
Read the caselet carefully and answer the following questions: 8. What according to you are the possible costs the SSI units are expected to bear, if they don’t opt for factoring? (8 marks) < Answer > Explain the difference between credit insurance and factoring. (8 marks) < Answer >

9.

There are many ways to generate cash flow. However, not all may be right for you. If your

business is smaller one or you are new, you may not qualify for a traditional working capital loan. Or you may need cash flow support above and beyond such a loan. In such circumstance one attractive alternative you have is to hire a factor. A factor is a company that purchases receivables, giving your business an advance payment up front. It is a mode of financing that can help free businesses from the cash-flow squeeze caused by slow-paying customers. Companies in the services industry are particularly well-suited to factoring as a financing tool. Smaller companies requires cash frequently while a large client or customer takes long time to pay the dues. These imbalances the financial position of the company. In such situation factoring comes to rescue the companies. Similar problems are faced by the SSI units. They have been facing constrains in their operations on account of inadequacy caused by delays in receiving payments for their supplies. A large number of SSI units are managed by their promoters and/or persons with technical orientation who are unable to pay continuous attention to the areas of debt collection, accounting and working capital management. By and large, such units do not have an organizational set up for recovery of dues from the buyers. The potential demand for factoring services from SSI sector is estimated to be sizable; it would take some time before this demand could crystallize. In this connection, it is considered that the question of reservation of a specific percentage of total business of factoring organizations’ for SSI sector, to give an initial boost to factoring for this sector. In its view this may not be desirable, especially in the initial stages as it could endanger the factoring organizations’ commercial viability. Moreover, as factoring develops, such reservation may not be necessary at all. Some experts are of the view that factoring for SSI units could prove to be mutually beneficial to both factors and SSI units and factor should make every effort to orient their strategy to crystallize the potential demand from this sector. Caselet 3 Read the caselet carefully and answer the following questions:
10. What does Clause 49 of listing agreement state with respect to appointment of independent directors? Explain the rationale of SEBI behind appointment of independent directors in the company. (9 marks) < Answer > 11. Clause 49 may be a headache to the listed companies but it is a big opportunity for headhunter to make money. Explain. (8 marks) < Answer >

Clause 49 is comparable to Sarbanes-Oxley Act in US and the EU-VIII in Europe. It alters the qualification of the independent directors (IDs) in the board, besides making the CEOs and CFOs fully accountable for the financial statements that they certify. The new clause has brought in the much-needed clarity and has done away with ambiguity. In its present form, Clause 49 puts in black and white as to who qualifies for the role of an independent director and who does not. Some of the important qualifiers are Any person holding more than 2% stake in the company has been debarred from • • acting as an independent director. Supplier, service provider, customers cannot act as an independent director. • •

• Independent directors should not be related to promoters or management at the board level or at one level below the board. He should not have been an employee of the firm in the immediately preceding • • three financial years. He has not been, for the last three years, and should not be, a partner of the • • current legal and consulting firms, which is associated with the firm. India has over 6,500 listed firms, which are required to fulfill the Clause 49. SEBI has set a deadline of December 31 this year for listed companies to implement this clause. This has created a good opportunities for the recruiting agencies. In the given time available companies should identify and appoint required number of IDs. With the stringent policies in place searching for a right candidate is definitely a difficult task. The CEOs and CFOs should be properly geared up so that the pressure of certifying the statements do not hamper their day to day functioning. Proper policies and guidelines will have to be framed in accordance with Clause 49, so that there is no confusion regarding functionality, authority and accountability of different offices within the firm. This new requirement of Clause 49, will thrust more responsibility on the CEOs and CFOs of the company. This step taken by SEBI is in the right direction. This clause will make it necessary for the CEOs/CFOs to disclose proper information in the financial system. This will definitely bring some relief to the investors. This clause also increases the frequency of audit committee meetings to a minimum of four times a year with a maximum gap of four months between any two meetings, form the original three meetings a year with a maximum gap of six months between two meetings. According to experts increased frequency of meetings will lead to better governance.
• END OF SECTION E END OF QUESTION PAPER

Suggested Answers Investment Banking & Financial Services–II (262): January 2006
Section D : Case Study 1. We have to evaluate the NPVs of the following three alternatives: – Purchase – Finance Lease – Back to Back Short-term Lease We shall define N as the random variable presenting the useful life of the asset. Alternative (A): Purchase the Equipment The net present value of this option will be as follows: NPV (P) = P.V. [EBDIT (1-T)] + P.V. (Tax Shield on Depreciation) + P.V. (Salvage Value) – Initial Investment. The present value of EBDIT (1-T) depends upon the value of N. For N = 3, P.V. [EBDIT (1-T)] @ K=13% = [75(1-0.35)*0.8550] + [90(1-0.35)*0.7831] + [105(1– 0.35)*0.6930] = Rs. 134.78 Lakh For N = 4, P.V. [EBDIT (1-T)] @ K=13% = Rs. 176.64 Lakh For N = 5, P.V. [EBDIT (1-T)] @ K=13% = Rs. 213.68 Lakh For N = 6, P.V. [EBDIT (1-T)] @ K=13% = Rs. 246.46 Lakh P.V. Tax Shield on Depreciation @ K=13% and N=3 is equal to [(50*0.8850) + (37.50*0.7831) + (28.13*0.6930)] * 0.35 = Rs. 32.59Lakh Since the salvage value of the equipment is insignificant beyond the third year, we will assume that it will be retained and the full Depreciation Tax shelter available under the Income Tax act will be claimed. Salvage value of the equipment after three years = 200(1.15) 3 * 0.2 = Rs. 60.84 Lakh P.V. of the salvage value realizable after three years = (60.84*0.6930) = Rs. 42.16 Lakh Net salvage value at the end of years four, five and six is taken to be insignificant. For different values of N, the values of NPV (P) will be as follows:

Initial Investment NPV (P) N P.V. [EBDIT P.V. Tax Shield P.V. (1-T)] (Net salvage value) on Dep. 3 134.78 32.59 42.16 200 9.53 4 176.64 37.12 0 200 13.76 5 213.68 40.13 0 200 53.81 6 246.46 42.13 0 200 88.59 Expected NPV (P) = (9.53*0.4) + (13.76*0.2) + (53.81*0.2) + (88.59*0.2) = Rs.35.04 lakh. Alternative (B): Finance Lease NPV (FL) = P.V. [EBDIT (1-T)] - P.V. (Lease Rental) + P.V. (Tax Shield on Lease Rental) - P.V. (Tax Shield on Depreciation) - P.V. (Interest tax shield on displaced debt) P.V. of lease rentals during the primary period at K=16% = (200*0.350) PVIFA (16,5) = Rs.229.20 Lakh P.V. of lease rentals during the secondary period = (200*0.015) PVIF (16,6) = Rs.1.23 Lakh P.V. of Tax Shield on Lease Rental during the primary period = (200*0.350*0.35) * PVIFA (13,5) = Rs.85.99 Lakh P.V. of Tax Shield on Lease Rental during the secondary period = (200*0.015*0.35) * PVIF (13,6) = Rs.0.50 Lakh P.V. of Interest tax shield on displaced debt = [(36.67*0.8850) + (31.34*0.7831) + (25.15*0.6930) + (17.98*0.6133) +(9.65*0.5428)]* 0.35 = 123.14 * 0.35 = Rs.43.09 Lakh P.V. Tax Shield on Depreciation @ K=13% and N=3 is equal to [(50*0.8850) + (37.50*0.7831) + (28.13*0.6930)] * 0.35 = Rs. 32.59 Lakh Since the salvage value of the equipment is insignificant beyond the third year, we will assume that it will be retained and the full Depreciation Tax shelter available under the Income Tax act will be claimed. Amortization Schedule for Debt Displaced Year Amount o/s Rate of Interest Capital Debt Service at the beginning Interest Content Component Charge 1 229.20 0.16 36.67 33.33 70

2 3 4 5

195.87 157.21 112.36 60.34

0.16 0.16 0.16 0.16

31.34 25.15 17.98 9.65

38.66 44.85 52.02 60.34

70 70 70 69.99

For different values of N, the values of NPV (FL) will be as follows: N P.V. [EBDIT P.V. P.V. (Tax P.V. P.V. NPV (Lease Shield on (Interest tax (Depreciation (FL) (1-T)] Rental) Lease shield on Tax Shield Rental) displaced forgone) debt) 3 134.78 229.20 80.22 43.09 32.59 -89.88 4 176.64 229.20 80.22 43.09 37.12 -73.19 5 213.68 229.20 80.22 43.09 40.13 -39.16 6 246.46 230.43 80.65 43.09 42.13 11.46 Expected NPV (FL) = (-89.88*0.4) + (-73.19*0.2) + (-39.16*0.2) + (11.46*0.2) = Rs. -53.13 lakh. Alternative (C): Back-to-Back Short-term Lease (BBSTL) NPV (BBSTL) = P.V. [EBDIT (1-T) - P.V. (Lease Rentals)] + P.V. (Tax Shield on Lease Rental) We have not considered the interest tax shield and depreciation tax shields on the displaced debt in the computation of NPV (BBSTL). This is because of the fact that the back-to-back short-term lease is not a finance lease. We have treated the lease rentals payable over the lease term like any other operating cash outflow and valued this out flow at the marginal cost of capital. P.V. (Lease Rentals payable during the initial lease period) = 45 * PVIFA (13,3) = 106.25 P.V. (Tax Shield on Lease Rentals payable during the initial lease period) = 106.25 * 0.35 = 54.99 The equated annual lease rental (L2) payable during the second lease term can be obtained from the equation: L2 * PVIFA (25,3) = 60.84 1.952* L2 = 60.84 therefore, L2 = Rs.31.16 lakh (approx) The discount rate of 25% represents the rate of return required by the lessor. The value of Rs.31.16 lakh is the estimated market price of the used equipment after three years and has been derived from the assumption made by the finance manager. P.V. (Lease Rental payable during the second lease period)

N 3 4 5 6

= 31.16 * PVIFA(13,3) * PVIF(13,3) = Rs.51 lakh P.V. (Tax Shield on Lease Rental payable during the second lease period) = 51 * 0.35 = Rs.17.85 lakh For different values of N, the values of NPV (BBSTL) will be as follows: P.V. [EBDIT (1P.V. (Lease P.V. (Tax Shield on Lease NPV T)] Rental) Rental) (BBSTL) 134.78 106.25 37.18 65.71 176.64 157.25 55.03 74.42 213.68 157.25 55.03 111.46 246.46 157.25 55.03 144.24 Expected NPV (BBSTL) = (65.71*0.4) + (74.42*0.2) + (111.46*0.2) + (144.24*0.2) = Rs. 92.30 lakh The expected net present values of the three alternatives are as follows: Alternatives Expected NPV (Rs. in lakh) Purchase +35.04 Finance Lease –53.13 Back-to-Back Short-Term lease + 92.30 The NPV of the Back-to-Back Short-Term lease is substantially higher than the NPVs of the Purchase and Finance Lease. Therefore, the company is advised to go for Back-toBack Short-Term lease plan. < TOP >

2.
Pay offs EL = 3 p = 0.4 Purchase EL = 4 p = 0.2 C1 + 35.04 EL = 5 p = 0.2 EL = 6 p = 0.2 EL = 3 p = 0.4 EL = 4 p = 0.2 D1 Opt. for FL C2 - 53.13 EL = 5 p = 0.2 EL = 6 p = 0.2 EL = 3 p = 0.4 EL = 4 p = 0.2 Opt. for BBSTL C3 +92.30 EL = 5 p = 0.2 EL = 6 p = 0.2 9.53 13.76 53.81 88.59 -89.88 - 73.19 - 39.16 11.46 65.71 74.42 111.46 144.24

Explanatory Notes:

1. 2. 3. 4. 5.

D1 denotes the first decision node. C1, C2 and C3 denote the chance forks. EL stands for Economics Life in years. p stands for the probability associated with a given economic life. The pay offs are denominated in lakh of rupees. < TOP >

3.

The total risk of a lease portfolio consists of the following types of risks: Default risk: The risk of not receiving the lease rentals on schedule. The default risk can arise on account of certain economy wide factors like unanticipated cost push inflation which affects the financial performance of almost all lessees or on account of industry/company specific factors which affect only a few lease accounts in the portfolio3. Residual value risk: The possibility of a decline in the estimated residual value of the equipment. This risk is particularly relevant in operating leases of hi-tech equipments and is caused by factors like technological obsolescence and uncertainty with regard to the product market life of the equipment. Interest rate risk: The interest rate risk refers to the changes in the market rate of interest, which adversely affects the cost of funds to the lessor. Purchasing power risk: This refers to the reduction in the value of lease rentals in real terms caused by unanticipated inflation. This risk is particularly relevant for real estate leases or leases with a long duration. Political risk: The political risk refers to the changes in the governmental policies in general, and the fiscal policy in particular, which have significant implications for the economic viability of lease investments. An example is the withdrawal of the investment allowance scheme, which as we noted earlier has a favorable implication for the economies of leasing. Currency and Crossborder risk: These risks are relevant only for cross-border lease transactions. The currency risk refers to the fluctuations in the exchange rate of the rupee vis-à-vis the currency in which the lease payments are structured. The cross-border risk refers to the unfavorable changes in the political and economic environment of the country where the lessee is located. < TOP > The total leasing industry itself is very large, of which IT leasing forms a part. The IT industry slowdown has positively impacted IT leasing, as companies generally tend to go for leasing and financing options now. Though leasing has been three for a long time, the market in India is not that mature for leasing IT equipment. This is because of tax law amendment that have been affected over a period of time and also the way a typical company looks at IT as different kind of capital investment as compared to investments in an aircraft or a truck. Today banks in India are looking at extending IT solutions to all their branches and there is also a lot of activity happening on the government front. These facts assisted by mindset change are

4.

leading to a shift from buying to leasing of IT assets. In fact, India has been outlined as a high focus and growth engine for the company in the future. Utility services and pay-per-use is an emerging trend in IT leasing. The offering allows customers to buy computing power on a pay-per-use basis. Metered billing capability allows paying for actual usage. The service provider tracks usage, bills customers and collects the billing. < TOP > 5. IT leasing companies face tough competition from banks in this regard because they have the ability to access funds at lower rates. They can also finance everything without restricting themselves to IT, which gives them the ability to handle different kinds of portfolios. So, they might be able to take more risks in certain cases than we would ever do. But the advantage It leasing companies bring is that we are dedicated only towards IT leasing and they understand the IT business better than anyone else. IT leasing companies understand when technology is to be refreshed (replacing older equipment) and offer end-of-term solutions, under which they take responsibility for replacing and the customer is not paying for it. The IT leasing companies offer residual value, which banks are not providing. They take up residual value of risk involved, typically ranging from 10 to 25 percent of total contract. This gives the IT leasing companies a definite edge over banks. There are also other value adds like an asset management offering, which allows for Web-enable tracking and management, helping the customer understand where the equipment is, details of the equipment, how much is paid for it and other such information.
< TOP >

Section E: Caselets Caselet 1 6. Advantages of Individual Credit Rating 1. One of the main problems associated with consumer finance is that of bad debts. More than 20 percent of the sales become bad debts due to customer default. Unlike automobile finance, the recoveries for consumer durables are possible only after prolonged civil suits. Besides, dealers are unwilling to take any financial risk on the clients they recommend. In such a situation, the credit rating of individuals provides scope to minimize risk of default. This can, in turn, provide buoyancy to consumer finance companies. 2. Determining the willingness and ability of the borrower to pay can be assessed properly. 3. Getting durables or any other products on loans/ installments becomes easy to borrowers, especially the middle class families. 4. Rating of individuals by an outside agency, like ONICRA would be less expensive than employing a team of personnel by banks to get each credit appraisal. Today, a finance company is engaged in a variety of activities and one of them is consumer finance. By utilizing the services of independent and specialized credit rating

agencies, finance firms can concentrate on other areas of business activities and maximize their returns. Disadvantages of Individual Credit Rating 1. It is not clear how the entire process will evolve. Unlike corporate ratings, which are directly sought by a corporate before a public issue of debt, individuals cannot approach ONICRA directly to obtain a rating. Also, it is relatively easy to rate corporates owing to the availability of audited balance sheets, market data about suppliers and customers, the industry scenario and the quality of management. Individual credit rating requires a different approach. 2. The crucial issue in India is how much information individuals will voluntarily disclose. The Indian laws do not allow access to information needed for accurate rating. Obtaining information even from government authorities such as the tax department will be difficult. < TOP > 7. The credit information bureau has information on loans advanced by member banking companies, financial institutions, non-banking financial companies, housing finance companies and credit card companies. In India there is no provision for a borrower to acquire his own credit information from the bureau. In some countries it is possible for a borrower to obtain his own credit report to ascertain whether a borrower has fed the bureau with incorrect information. The only way that a borrower can correct inaccuracies in his own credit report are by approaching the lender who had fed the information in the first place. < TOP > Caselet 2 8. The high cost associated if the firm does not go for factoring are as follows:
• • • • • • • • • •

• • • • • • • • •

Devaluation of your money due to inflation while waiting for payment. Inability to take advantage of net and volume discounts and other purchasing opportunities. Worsened customer relations due to collection efforts and phone calls. Inability to expand. Cash flow planning and control skewed due to uncertainty of payment dates. Inability to increase inventory. Bad debt losses. Continuous cost of ongoing credit and collection efforts. Continuous cost of accounts receivable maintenance. Inability to implement marketing and sales plans. Lowered financial statement and bank balances. Loss of working capital. Restrictions on action due to credit line and other borrowing limits.

• • • • • • •

Cost of executive and staff time fixed on non-income producing activities. < TOP >

9.

In countries where credit insurance is in popular in use, a firm can insure its receivables against credit risk. While the insurance company does not help in the collection of receivables, it settles the claims arising on account of insured accounts which have turned delinquent.( An account is considered to be delinquent not only if the customer actually becomes insolvent, but also if an account has reached a particular in being overdue.). Thereafter it takes over the delinquent account and makes vigorous efforts to collect. To ensure the insured does not throw caution to the winds by adopting liberal credit standard, the insurance company specifies the maximum amount it will cover for account with a particular credit rating. Where as the factor is a financial intermediary which pays for the debts as and when they are collected. Usually factors makes part payment immediately after the debts are purchased thereby provides immediate liquidity to the client. For rendering the services for collection and maintenance of sales ledger, the factor charges commission. < TOP > Caselet 3

10. Clause 49 of the listing agreement states that all listed entities with executive chairman to have at least 50 per cent of independent directors in the board. SEBI has set a deadline of December 31 this year for listed companies to increase the number of independent directors as per the revised clause 59 of the listing agreement, which also says that companies with non-executive chairman can have at least one-third of the board as independent directors. The companies require the independent directors to have the basic knowledge of the duties to be performed in the public company. The firms should also cooperate with the independent directors so that they can discharge their duties properly. The motive of SEBI behind this clause is very clear. Independent directors are one of the most important pillars of good board governance, and by extension it will lead to good corporate governance. Having the director who does not have the linear relations management, company, etc., is not the end reason. What is desirable is that he strives through his actions for the maximization of shareholder’s wealth, bringing corporate democracy and ensuring maximum transparency and disclosures by corporate houses. This reaffirms the shareholders faith, trust and confidence in accepting him as an independent director of the company. < TOP > 11. Clause 49 may be a pain to the listed companies but it is a big opportunity for headhunter to make money. The new guidelines by the market regulator have opened a huge new market for the headhunters. India has over 6,500 listed firms and on an average each should have a minimum of 3-4 independent directors. Under the new guidelines, past practices of appointing the company lawyer or the auditor on the board are not allowed any more. This has again narrowed the choice for the companies.

Leading search firms are use to charge very high for an independent director depending on the size of the company and its expectations from the prospective director. Lesser known agencies however charge one-third of the first-year remuneration of the director for recruiting them. Since the time SEBI made it mandatory for listed companies to fill half the board with independent directors (Clause 49 of the listing agreement) with strict deadlines, headhunters are setting up new teams to search around for potential independent directors (IDs). The new practice is expected to be a cash machine for headhunters < TOP > < TOP OF THE DOCUMENT >

Question Paper Investment Banking & Financial Services - II (262) : April 2006
Section D : Case Study (50 Marks)
This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study Read the case carefully and answer the following questions:
1. Delineate the risk factors inherent in the issue; clearly distinguishing between internal and external factors. (10 marks) < Answer > 2. As an Investment Banker, before doing the valuation of Bartronics India Limited, perform a SWOT analysis of the company. (12 marks) < Answer > A leading investment banking firm has decided to use price/earning multiple approach to value the stock of Bartronics India Limited (BIL) in view of the difficulties in applying other methods. As no comparable stock is available in India, it has decided to use international average P/E multiple of 21.7. The earnings of the company are expected to grow at the sustainable rate. The new equity is expected to earn a return of 10% p.a. The investment banking firm is contemplating to appraise the issue price of the share based on the earning per share of BIL as on 31st March 2006. You are required to find the intrinsic worth of the share using the above method assuming that the company comes with an IPO on 30th December 2005. Based on the same give your advice to an investor if, the price range of the issue is Rs.70-Rs.75. (10 marks) < Answer > It was often said that Fixed Price IPO suffered from wrong valuation and price was forced upon the investors in the Indian primary equity market. Book Building came as a ready solution and is regarded as a vehicle for price discovery. Does Book Building give 100% true price discovery in Indian equity market when compared to US market? What is the rationale of giving a floor price or a price band in IPO? (10 marks) < Answer > Some of the widely used terms we come across in context of IPO are Offer Document, Red Herring Prospectus, Abridged Prospectus, Draft Offer Document etc. What is the difference between an offer document, RHP, a prospectus and an abridged prospectus? What does it mean when someone says “Draft Offer Document”?

3.

4.

5.

(8 marks) < Answer > Bartronics India Limited (BIL) Public issue of 65,00,000 equity shares of face value of Rs. 10/- each per share at a price of Rs. [•] for cash at a premium aggregating Rs.[•]lakh (hereinafter referred to as “the issue”) including Promoters’ reservation of 5,00,000 equity shares of face value or Rs. 10/- each per share at a price of Rs. [•] for cash aggregating Rs. [•] and net issue to the public of 54,00,000 equity shares of face value or Rs. 10/- each per share at a price of Rs. [•] for cash aggregating Rs. [•] (herein after referred to as the “net issue”) and the net issue would constitute 37.07% of the fully diluted post issue paid-up capital of the company. The Issue is being made under clause 2.2.1 of SEBI (DIP) GUIDELINES, 2000 through a 100% Book Building Process wherein up to 50% of the net issue will be allocated on a proportionate basis to Qualified Institutional Buyers (“QIBs”). Further, not less than 15% of the net offer will be available for allocation on a proportionate basis to Non-Institutional Bidders and not less than 35% of the net offer will be available for allocation on a

proportionate basis to Retail Individual Bidders, subject to valid bids being received at or above the Offer Price. Authority for the Issue The Issue has been authorized pursuant to a resolution of the Board of Directors of the company adopted at its meeting held on April 25, 2005 and by a special resolution adopted pursuant to Section 81(1A) of the Companies Act, 1956, at the Extra Ordinary General Meeting of the company held on May 2, 2005 Listing The Equity Shares are proposed to be listed on Bombay Stock Exchange Limited (BSE) (the Designated Stock Exchange) and The National Stock Exchange of India Limited (NSE). The in-principle approvals of the Stock Exchanges for listing Equity Shares have been received pursuant to their letters dated [_] and [_] respectively.Capital Structure of the Company Share capital as on the date of filing of Draft Red Herring Prospectus with SEBI is set forth below: Particulars A. AUTHORISED CAPITAL 1,70,00,000 Equity shares of Rs.10/- each. B. C. ISSUED SUBSCRIBED AND PAID-UP CAPITAL 80,68,950 Equity Shares of Rs. 10/- each. PRESENT ISSUE THROUGH THIS DRAFT RED HERRING PROSPECTUS 65,00,000 Equity shares of Rs.10/- each at a price of [•] Out of which 5,00,000 Equity shares of Rs. 10/- each are reserved for promoters, their friends, relatives and associates at a price of [•]. 6,00,000 Equity Shares of Rs. 10/- each reserved for Employees at a price of Rs. [•] NET OFFER TO PUBLIC 54,00,000 Equity shares of Rs.10/- each at a price of Rs. [•] EQUITY CAPITAL AFTER THE ISSUE 1,45,68,950 Equity Shares of Rs.10 Each SHARE PREMIUM ACCOUNT Before the Issue After the Issue Nominal Value 1700.00 806.89 Aggregate Value

650.00

[•]

50.00

[•] [•]

0.00

D.

540.00

[•]

E. F.

1456.89 705.91 [•]

[•] [•]

[•] THE FIGURES WILL BE FINALIZED AFTER THE BOOK BUILDING PROCESS Ranking of Equity Shares The Equity Shares being offered shall be subject to the provisions of Memorandum and Articles and shall rank pari passu in all respects with the other existing Equity Shares of the company including rights in respect of dividend. The Allottees will be entitled to dividend or any other corporate benefits (including dividend), if any, declared by the company after the date of allotment. Face Value and Issue Price The Equity Shares with a face value of Rs.10 each are being offered in terms of this Draft Red Herring Prospectus at a price band of Rs. [•] Rs. [•] per Equity Share. At any given point of time, there shall be only one denomination for the Equity Shares of the company, subject to applicable laws. History of the company:

The company has been incorporated on 10.09.1990 as Super Bartronics Private Limited; it became a Public Limited Company in 1995. The company got its current name “Bartronics India Limited” on 1st January 1996. The company started its business in the field of Bar Coding and Smart Card Technology. Subsequent to that, the company started experimenting with new Automatic Identification & Data Capture (AIDC) solutions and today the company is in a strong position to capture the new opportunities in AIDC market The company is involved mainly with the manufacturing sector and has implemented a number of projects across companies in their manufacturing set-ups. The projects primarily involved inventory & logistics management, time & attendance and asset tracking systems. AIDC is seen as an enhancing technology as it automates the data collection for the main systems. Presently the company offers diverse range of AIDC technologies – Barcode, Biometrics, Radio Frequency Identification (RFID), Radio Frequency Data Communications (RFDC) and Electronic Article Surveillance (EAS). Management The company is currently managed by the Board of Directors comprising 6 directors. The day-to-day affairs of the company are being managed by Mr. Sudhir Rao, Managing Director. Mr. Sudhir Rao- to function as CEO and to be responsible for the operational activities such as product design and development, marketing and positioning of the brand in all its channels, human resources management, financial and treasury operations, sales and marketing, import and export related activities and general administration and ultimately for optimizing shareholders value by ensuring legal and fiscal compliance. Main and Other Objects of the Company The main and other objects of the company as stated in the Memorandum of Association are: 1) 2) To manufacture, sell, deal in all types of Bar Code Equipments, Systems Accessories, Attachments, Label Materials, Label Printers, Label Verifiers and Allied Products. To enter into Technical and/or Financial collaborations with foreign companies to manufacture Bar Code Equipments, Systems. Accessories, Attachments, Label Materials, Label Printers, Label Verifiers and Allied Products. To carry on business of other automatic identifications, Equipments, Systems. Accessories, Attachments and Allied Products. To establish and run data processing / computer centers and to offer consultancy and data processing and other computer related services that are normally offered by data processing/computer centers to industrial, business and other type of customers and to impart training on electronic data processing and others and to provide IT enabled solutions in India and abroad to implement internet technologies with web based applications for e-commerce, e-business, e-trade, multimedia, call center services and networking worldwide. To acquire and take over all or any part of business, property, plant and machinery and any other assets and liabilities of any person, firm or company carrying on any business which this Company is authorized to carry on or possessed of any property suitable for the purposes of this company. To expand the company’s activities by opening branches and /or in appointing agents in India and in any foreign country. The main objects and objects incidental to the main objects permit the company to undertake the present and proposed activities.

3) 4)

5)

6)

Subsidiaries of the Company The company does not have any subsidiary. Objects of the Issue The net proceeds from the issue after deducting underwriting commission and management fees, brokerage; fees to various advisors and all other Issue related expenses are estimated at Rs [•] lakh. The proceeds from the issue of shares are intended to be deployed for:

• Setting up of R&D Technology Center, • Establishing branches in India and abroad • Meeting the issue expenses

Repaying the loan Making acquisitions Meeting the working capital requirements Meeting marketing expenses The main objects clause and objects incidental or ancillary to the main objects clause of the Memorandum of Association of the company enables the company to undertake the existing activities and the activities for which the company, through the issue, is raising the funds. The Industry Bartronics is in the Automatic Identification and Data Capture (A.I.D.C) business. A.I.D.C. is the industry term used to describe the identification, and/or direct collection of data into a microprocessor controlled device such as a computer system or a programmable logic controller (PLC), without the use of a keyboard. The technology supports two fundamental requirements v.i.z. eliminating errors associated with identification and/or data collection and accelerating the throughput process. The key application of the technologies is in tracking and traciablity of products/articles, product and item identification and sortation, information and data processing, security and access control and inventory management. The A.I.D.C. technology covers six distinct groups of technologies and services. They are: Card Technologies, Data Communications Technologies, Bar Code Technologies, Radio Frequency Identification Technologies, Emerging Technologies, and the support and supplies which serve the industry. This technology can be applied to virtually every sector of industry, commerce and services where data is handled and needs to track and trace individuals, materials & equipment. The A.I.D.C. Boom: In some quarters it is being talked of as the next’ Killer Application’, which will drive the future of Supply Chain Management. The fact that it can leverage past IT investments better through automated data collection and input, has made it receive unprecedented attention. The RFID market is expected to jump from $1.4 billion annually this year to as much as $6.1 billion in 2010, according to a study by research firm Data Monitor. The U.S. Government’s growing reliance on R.F.I.D., the acceptance and use of technology by retailers like WalMart proves its success. The Indian Scenario: The Indian market is estimated to be about Rs 100 crore in FY 2005. The market has been growing at an estimated CAGR of over 50% over the past few years and is poised to grow rapidly due to the retail and manufacturing growth in the country. Additionally a majority of the larger companies have already invested in ERP and SCM software that need to be leveraged further. The use of barcode has been made mandatory in several areas of manufacture, retail and exports. For example, the Canteen Stores Department of the Ministry of Defense has embarked upon an ambitious program of automating its depots and retail outlets across the country to monitor and control stocks and sales of an estimated 4,000 different products it supplies and an inventory of over 200,000 items to the Indian armed forces. The International Scenario: Countries like Bangladesh, Sri Lanka, Dubai, Mauritius etc have a thriving Industrial sector, which contributes a significant portion to the G.D.P of their respective countries. With a good number of large, medium and midsize Industries in both the public and private sector these countries are important vendor bases that export a wide variety of goods and services to many developed nations. The AIDC potential is expected to develop strongly in the emerging markets as mentioned above. (Source: AMR Research, A Boston Based Technology Research Company and www.aidcindia.org) 1. Industry Review Automatic Identification and Data Capture (AIDC) is the industry term, which describes the identification, and/or direct collection of data into a microprocessor controlled device such as a computer system or a programmable logic controller (PLC), without the use of a keyboard. At their core, all AIDC technologies support two common goals: • To eliminate errors associated with identification and/or data collection • To accelerate the through-put process ( the through-put process is the input to output process ) As an industry composite, AIDC covers six distinct groups of technologies and services. They are: Card

• • • •

Technologies, Data Communications Technologies, Bar Code Technologies, Radio Frequency Identification Technologies, Emerging Technologies, and the support and supplies which serve the industry. AIDC is now being seen as a radical and revolutionary data carrier and identifier discipline with principles and practices that can be applied virtually to every sector of industry, commerce and services where data is handled and needs to track and trace individuals, materials and equipment. The majority of applications are based on a few generic foundations, as listed below : • Tracking and traceability • Escort Information • Product and item • Transaction and services support • Access control • Sortation • Automation support Booming AIDC Industry Following the successes of the ERP, CRM and SCM industries over the past few years, AIDC is receiving a good amount of attention as it can leverage past IT investments better through automated data collection and input. In fact a recent AMR research study concluded that “Dwarfing Y2K and the Internet in the scope and scale of changes it will ring in, RFID is the killer application driving the next ten years of supply chain investment.” While smart card and bar code technologies continue to find applications, the AIDC industry is moving rapidly towards the use of RFID in a number of high-value and high-volume market segments. The RFID market is expected to jump from $1.4 billion annually this year to as much as $6.1 billion in 2010, according to a recent study by research firm Data Monitor. It is still in a nascent stage but there are several factors, in addition to dropping chip prices, which are driving the growth of RFID as an enabling technology. These include (but are not limited to):

The US Government’s use of RFID to track military shipments (to and from the Persian Gulf, for example) & Wal-Mart’s mandate that has asked 138 of its retail suppliers to be RFID enabled at the case- and pallet- level by January 2005 • The development of standards and standards bodies such as EPC (Electronic Product Code), ISO (International Standards Organization) and ongoing work by the Auto ID Center (www.autoidcenter.org) a joint collaboration between the Uniform Code Council and EAN International) • Dramatic benefits being achieved by leading consumer packaged goods, retail, manufacturing, logistics, and transportation and healthcare companies • Improvements in RFID technology Indian Scenario The Indian market as specifically catered to by Bartronics, estimated at about Rs 100 crore in FY 2005, largely comprises of smart card and bar code solutions. This segment is expected to grow at 20-30% per annum. RFID and biometric solutions are making their presence felt in the current year. The market has been growing at an estimated CAGR of over 50% over the past few years and is poised to grow rapidly due to the retail and manufacturing growth in the country. Additionally a majority of the larger companies have already invested in ERP and SCM software that need to be leveraged further. Barcode Segment, the AIDC Technologies Association of India (www.aidcindia.org) has done a lot of work in the field of bar code technology, which is the precursor to RFID solutions. India is already a signatory to the EAN UCC System that enables automatic capture of vital data across the supply chain from raw material to warehousing to distribution to final retailing. The industry expects that the Walmart mandate combined with a number of other chains (Metro, Tesco, etc) will force Indian suppliers to set up confirming systems. In India, the use of barcode has been mandatory in several areas of manufacture, retail and exports. For example, the Canteen Stores Department of the Ministry of Defence has embarked upon an ambitious program of automating its depots and retail outlets across the country to monitor and control stocks and sales of an estimated 4,000 different products it supplies and an inventory of over 200,000 items to the

Indian armed forces. Source:www.aidcindia.org Smart Card segment Over the last few years, the awareness of smart cards and its applications have gradually increased among the potential users in India. Significant growth has taken place in wireless cellular applications, retail loyalty applications, healthcare applications and vehicle registration applications. Several pilot projects have also been implemented for multi-application campus cards, banking, ID, automatic fare collection, toll, healthcare, etc. Though the SIM card market has driven the growth in the last 5 years, the rate of growth in banking and retail sector is expected to be larger in the coming years. The usage in transport and health care sectors is also expected to increase. However, the industry is looking at the government usage and the much-touted national ID project for a spiraling growth in the next few years. Biometrics As both the private and Government sector organizations search for more secure authentication methods, they have increasingly become aware of biometrics as the killer technology for near foolproof security. It may not be long before all password and card based systems currently in vogue get replaced with biometric devices. While there is a growing demand for both physiological and behavioral biometrics devices, fingerprint recognition is the current hot favorite. However, lack of infrastructure and standardization in the industry, high costs and duties are the impediments in the growth of the industry. Most of the biometrics hardware is being imported from USA, Germany, Israel and in recent times from China. Indian manufacturers are also getting into the act with some fingerprint scanners now being made available in the market. Competitive Landscape The competitive landscape for Bartronics’ solutions is largely marked by players who are either trading in Hardware or software system integrators. Large players in the industry include Essae Technology, Great Eastern Impex, Intellicon and Stallion. Bartronics’ differentiates itself by being a total solution provider and hence has a list of impressive clientele in the Indian Market. This is the reason why every major company in India like ITC, HLL, TISCO, TELCO, ISPAT etc. has been served by Bartronics during the past few years. The second differentiating factor is the nation-wide sales and service network. The branches and sales offices of the company ensure that the Bartronics’ engineers are always “on-hand” to provide solutions in case there are problems at customer locations. Probably the most important differentiating factor in favour of Bartronics’ is its skilled service engineers. Apart from being technically qualified, the company has ensured through a structured training program that its engineers are continuously updated on the latest developments in the relevant technologies. Many of the engineers are specially trained by the company’s principals. In fact, Intermec Corporation, USA awarded Bartronics’ with a Gold Medallion Program Certificate which certifies Bartronics’ engineers to service and repair any product supplied by Intermec Corporation. Apart from this recognition, Bartronics’ After Sales Service Function has been certified for ISO 9002 which in turn means that the company’s processes have been standardized and are capable of delivering quality results consistently. Awards and Recognitions

• The company has received ISO accreditation in 2002 from Det Norske Veritas (DNV). • Intermec Technologies Corp., USA awarded the company with Intermec Global Medallion Partner
Award in the year 2003, appreciating the efforts of the company in the embedded hardware component with Bar Code Technology. Statements of Profits & Losses (Rs. in Lakhs) Period ended on Income Sales: Of Products manufactured by the Company Of products traded by the Company 2000-01 Apr-Mar 0 841.51 2001-02 Apr-Mar 0 820.48 2002-03 Apr-Mar 0 831.29 2003-04 Apr-Mar 0 1257.64 2004-05 Apr-Mar 0 1805.52

Other Income Increase (decrease) in inventory Total Income Period ended on Expenditure Raw materials & goods consumed Staff Costs Other Admn. expenses Selling & distribution expenses Interest Depreciation Miscellaneous expenditure written off Total expenditure Net profit before tax and extraordinary items Provision for taxation Net profit after tax & before extraordinary items Extraordinary items (net of tax) Net profit after extraordinary items Earlier year adjustments Appropriations Transfer to general reserve Proposed dividend Tax on proposed dividend Balance carried to Balance sheet

2.92 844.43 2000-01 583.50 82.15 79.60 28.00 13.63 22.73 16.69 826.30 18.13 1.65 16.48 0.00 16.48

4.15 824.63 2001-02 540.90 74.51 115.36 38.00 10.85 32.7 6.14 818.46 6.17 0.50 5.67 0.00 5.67

0.29 0 831.58 2002-03 539.94 83.81 46.08 45.00 45.68 35.65 9.29 805.45 26.13 12.54 13.59 0.00 13.59

0.54 0 1258.18 2003-04 735.05 88.71 64.10 45.00 86.51 25.14 0.19 1044.70 213.48 78.29 135.19 0.00 135.19

11.66 0 1817.18 2004-05 1117.65 115.43 71.19 45.00 107.92 83.88 0.89 1541.96 275.22 35.50 239.72 0.00 239.72

0.00 0.00 0.00 16.48

0.00 0.00 0.00 5.67

0.00 0.00 0.00 13.59

0.00 0.00 0.00 135.19

0.00 0.00 0.00 239.72

(Rs. in Lacs) A. As at Assets Fixed Assets- gross block Less: Depreciation Net Block Less: Revaluation Reserve Net Block after adjustment for Revaluation Reserve Investments/CWIP Current assets, loans and advances Inventories Receivables Cash and bank balances Other current assets Loans and advances Total assets Liabilities and provisions Loan funds Secured loans Unsecured loans Current liabilities and provisions Sundry liability 2000-01 128.88 48.68 80.20 0 80.20 361.11 63.5 258.71 87.88 0 19.57 870.97 2001-02 232.39 81.37 151.02 0 151.02 536.93 74.55 285.82 0.79 44.33 1,093.44 2002-03 802.01 117.02 684.99 0 684.99 0.00 60.98 418.72 0.82 0 54.27 1,219.78 2003-04 817.35 142.16 675.19 0 675.19 0.00 2004-05 983.57 226.04 757.53 0 757.53 0.00

B. C.

170.15 303.22 706.56 976.95 0.70 0.50 0 0 29.02 68.77 1,581.62 2,106.97

D.

262.83 10.32 100.84

478.39 10.32 91.43

536.12 10.32 128.44

604.55 0.00 178.68

740.08 0.00 310.39

E.

Provisions Total Liabilities Net worth Represented by: Shareholders funds Share capital Reserves and surplus Less: Revaluation Reserve Reserves (Net of Revaluation Reserve) Less: miscellaneous expenditure not written off Total

10.00 383.99 486.98

15.00 595.14 498.30

15.00 689.88 529.90

15.00 798.23 783.39

15.00 1,065.47 1,041.50

432.51 70.26 0 70.26 15.79 486.98

407.93 100.52 0 100.52 10.15 498.30

407.93 122.82 0 122.82 0.86 529.90

437.93 346.12 0 346.12 0.67 783.39

437.93 606.84 0 606.84 3.28 1,041.50

END OF SECTION D

Section E : Caselets (50 Marks)
This section consists of questions with serial number 6 - 12. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 6. To be a developed country by 2010, India requires a jump start in each sector and needs to emphasize on the development of rural areas. The retail sector is linked to the rural sector and it needs focused attention. Discuss the keys and constraints for the growth of the retail sector in India. (6 marks) < Answer > 7. What is the need of FDI in the development of retail sector in India? Discus the benefits associated with the entry of FDI in the retail sector of India. (9 marks) < Answer > 8. Explain the causes of concern of allowing FDI in the retail sector.

(5 marks) < Answer > In the early part of the 17 century the East India Company, a group of British merchants, arrived in India to seek permission to establish their business in India. They stayed back in India and ruled India for almost 150 years. Though every trader is not a comparison for the traders of the East India Company, our parliamentarians and officials are of the notion that India would be a colony again if they allowed FDI in its retail sector. Globalization brings the entire world onto a single stage. The world’s largest retail enterprises seek globalization in the retail industry and are continuously striving to make their presence global. FDI, as in other sectors, brings advanced marketing models, management skill and technical know-how along with the capital to the host country to promote their operating efficiency and business modernization. Hence, globalization of retail sector is necessary for the development of that sector. Many countries including China, Brazil, Thailand and Singapore have opened their retail sector to foreign players and are reaping of it. This sector accounts for 10% of GDP in most countries. The global retail game is changing fast. Big international players are focusing on rebalancing their position, and they are knocking at the door of India. Being the second largest populated country in the world with 110 crore people coupled with a highly developed IT sector, the Indian retail sector is hailed as one of the sunrise sectors of the economy. According to a survey conducted by A. T. Kearney management consulting firm, India is the second most attractive retail destination among 30 emerging markets after China. Indian retail sector is contributing 14% of GDP and employing more than 7% of the total workforce. Therefore, the retail sector in India is one of the strong pillars in the growth of employment and GDP. Presently, the total size of the Indian retail industry is around $200 bn and could touch $300 bn by 2010. The growth of modern retailing and economic development will go hand in hand and India cannot afford to lag behind. The Indian retail sector can be broadly divided into two categories: Organized and unorganized. The organized sector refers to business employing more than ten persons, which includes hypermarkets and retail chains like Big Bazaar. This organized sector is only about 2% of the total retail sector and employs just 5 lakh persons. The remaining 98% of the total retail trade is in the unorganized sector. They are in the traditional form; low-cost building, kirana shops run by family members, pan-beedi shops and roadside vendors. Over 4 crore people are engaged in these unorganized retail sector. About 12 million outlets are operating in India, out of which only 4% are having an area of more than 500 sq.ft. The sector is basically labor-intensive. In 2002-03, according to the government estimation figure the retail trade in India amounted to Rs. 3,82,000 cr, whereas, A. T. Kearney estimate says that it was around Rs. 400,000 cr. On the other hand, the total size of the corporate-owned retail business was around Rs. 15,000 cr in 1999 and in 2005 it grew up to Rs. 35,000 cr at a rate of 40% per annum in the last three years. It is estimated that by 2010, the organized retail trade may touch Rs. 70,000 cr. From employment point of view, four to five crore people are engaged by the retail sector directly or indirectly.
th

Caselet 2
Read the caselet carefully and answer the following questions: 9. Farmers are provided credit cards to support their credit needs. Discuss how it will be beneficial to the farmers and to the issuing banks. (6 marks) < Answer > Explain the features of the Kisan Credit Card (KCC) scheme.

10.

(6 marks) < Answer > The emphasis in agricultural credit has continued to be on progressive institutionalization for providing timely and adequate credit support to farmers with particular focus on small and marginal farmers and weaker sections of society to enable them to adopt modern technology and improved agricultural practices

for increasing agricultural production and productivity. The policy essentially lays emphasis on augmenting credit flow at the ground level through credit planning, adoption of region-specific strategies and rationalization of lending policies and procedures. Agricultural credit is disbursed through a multiagency network consisting of Commercial Banks (CBs), Regional Rural Banks (RRBs) and Cooperatives. With their vast network covering almost all the villages in the country, wider coverage and outreach extending to the remotest part of the country, the cooperative credit institutions have remained the primary institutional agency for dispensation of agricultural credit. The significant contribution made by the Cooperatives can be gauged from the fact that its share in total agricultural credit flow and total rural deposits is around 43 percent and 31 percent respectively and the small farmers constitute 44 percent of their total membership. For several reasons, the Cooperative Credit Structure is facing severe problems which have restricted its ability to function viably and perform effectively the task of reaching out to all segments of the farming community and meet in full their requirements of credit. The cooperative structure is facing many structural deficiencies viz. operationally small in size (especially PACS/PCARDBs) to be economical and viable, dependent mostly on the finance provided by the higher tiers, lack of diversification in business portfolio, high transaction costs, a large percentage of non-borrowing members, involvement in non-credit function like PDS work giving negative net margin to the PACS, poor recovery and limited growth rate in issue of fresh loans. The other problems faced by the cooperatives are: Overall weak financial health, duality of control, lack of autonomy, close identification with the ‘State’, absence of professional management, inadequate internal controls/supervision, arrears in audit, and existence of imbalances. Though a number of measures have been initiated to improve the viability and functioning of Cooperatives, yet these institutions remain in moribund state requiring urgent initiation of steps for their rehabilitation. Some of the policy initiatives are namely (i) Revamping of Cooperative Credit Structure: Pursuant to the announcement made in the Union Budget for the year 2004-05, Ministry of Finance has constituted a Task Force under the Chairmanship of Prof. A. Vaidyanathan for suggesting measures required for improving the efficiency and viability of Rural Cooperative Credit Institutions and to suggest an appropriate regulatory framework. The Task Force is expected to submit its recommendations very soon. (ii) Kisan Credit Card Scheme: Kisan Credit Card (KCC) Scheme which aims at providing adequate and timely credit support from the banking system to farmers for their cultivation needs in a flexible, hassle free and cost effective manner has been operationalised. The farmers may use the cards for the purchase of agricultural inputs such as seeds, fertilizers, pesticides etc. and also draw cash for their production needs. Credit limits is fixed on the basis of operational land holding, cropping pattern, scale of finance etc. and the entire credit needs for full year plus ancillary activities related to crop production such as the maintenance of agricultural machinery/implements, electricity charges etc. is reckoned for the purpose of fixing the credit limit under KCC.

Caselet 3
Read the caselet carefully and answer the following questions:

11. With respect to the caselet explain the working mechanism of reverse mortgage and also state when it comes to an end? (9 marks) < Answer > 12. With reverse mortgage one can turn the value of home in to cash without having to move out of the home. Discuss the advantages and disadvantage associated with this mechanism. (9 marks) < Answer > The prime concern of the elderly people is whether their savings are sufficient to meet the unexpected future financial crisis. This worry is often faced by the middle-class, especially when retirement knocks on their door. This concern is bound to creep-in, unless their children give them financial support either fully or partially. No one plans to go broke while nearing retirement. Many senior citizens fill up their retirement gas tank and get ready to cruise. But with today’s longer lifespan, the elders often need more cash to help

them lead a comfortable life post-retirement. No one can predict the financial roadblocks that may arise, such as the need for expensive prescription or medical procedures. Just one major setback can drain out a major portion of the hard-earned retirement money that one has saved. Retired people may want to consider the reverse mortgage as a way of generating cash flow. But the reverse mortgage is not for everyone. It may be a good option for those who have already retired or are looking for the same. A self-occupied house in a prime location is actually not of much worth for the elderly without adequate means of support in the case of absence of old-age security. Until recently, there were two main ways to get cash against your home—either you could sell your house or you could mortgage your house. But selling the house and moving elsewhere are options that generally are not very appealing to most elderly people. Again in case of borrowing against your home, you borrow money and make payments to build equity in a house. As you make payments, your equity (the home value minus mortgage debt) increases and your debt (loan balance) shrinks. If you fail to make regular payments, you could lose the ownership of your house. Now reverse mortgage gives you a third way of getting money against your home. With a reverse mortgage, you can turn the value of your home into cash without having to move out or repay the loan each month. The reverse mortgage is aptly named so because the payment stream is ‘reversed’. This financial instrument was first introduced in the late 1980s in the US and Canada to help the homeowners who were ‘house-rich-but-cash-poor’ remain in their house and still meet their financial obligations. In the US and Canada some guidelines have been laid down for the eligibility of reverse mortgage. All senior homeowners aged 62 years or above can apply for reverse mortgage. Owners must occupy the home as principal residents. Single family, one unit dwelling is eligible property for all reverse mortgages. Some programs also accept 2-4 units owner occupied dwelling along with some condominiums, planned unit developments and manufactured homes. Almost all of the eligible people asked one common question, “How much money can I get for my home?” The shortest answer to this question is “It depends”. In general, to the amount one can receive depends on six different aspects like the mortgage program and the program option one select, the age of the youngest borrower when he takes the loan, the appraised value of the house, current interest rate, the amount of equity in the home and the location of the home. END OF SECTION E END OF QUESTION PAPER

Suggested Answers Investment Banking and Financial Services-II (262): April 2006
Section D : Case Study
1. RISK FACTORS An investment in Equity Shares involves a high degree of risk. You should carefully consider all of the information in this Draft Red Herring Prospectus, including the risks and uncertainties described below, before making an investment in the Equity Shares of the Company. If any of the following risks actually occur, the business, results of operations and financial condition could suffer, the trading price of the Equity Shares of the Company could decline, and the investor may lose all or part of his investment. Materiality The Risk factors have been determined on the basis of their materiality. The following factors have been considered for determining the materiality: a) Some events may not be material individually but may be found material collectively. b) Some events may have material impact qualitatively instead of quantitatively. c) Some events may not be material at present but may be having material impacts in future. The risk factors are as envisaged by the management along with the proposals to address the risk if any. Wherever possible, the financial impact of the risk factors has been quantified.
A. INTERNAL TO THE COMPANY

1.

2.

4.

5.

6.

The Company is promoted by first generation entrepreneurs and the investments will be subjected to all consequential risk associated with such ventures. The company was promoted by first generation entrepreneurs 15 years back. The company’s business was the brain-child of these entrepreneurs and the sourcing of solutions provided by the company was the result of their efforts and understanding. Consequently, the relationships that the company has established with various stakeholders are a product of the efforts of the erstwhile promoters and carry inherent consequential risk. Currently, a team consisting of qualified professionals is managing the company on a day-to-day basis. Dependence on key management Team The company has a team of professionals who are responsible for the day-to-day operations. The company may lose the key management team to the competitors. If one or more members of the management team are unable or unwilling to continue with the company, Bartronics may find it difficult to replace such people and the business may be adversely affected. The proposed expansion project is mainly funded by the Public Issue. Any delay in raising the funds from IPO may have an adverse impact on the future performance of the Company. Delays in raising funds are likely to have an impact in the growth plans of the company in the short run due to delayed deployment of funds. Due to delays, it is likely that the company may have to renegotiate with some of the suppliers and in some cases even settle for alternate suppliers for key equipment. Such processes can delay the project thereby affecting the future performance of the company. The performance projections are prepared based on timely rising of funds and hence the delay in IPO can affect future performance of the company. The promoters and the promoter’s group are expected to hold 36.94 % of the post-issue paid up capital of the company. The promoters and their group will hold relatively less equity in the company postissue. To this extent, the control of the company’s operations shall rest on its board of directors appointed from time to time. Due to broad-based shareholding pattern, the company shall be subjected to the risk of being run by an independent professional team. The Company has not made any definitive arrangements for the procurement of some of the equipment/machinery/fixed assets for the project, which may cause delay in implementation of the project. The process of issuing confirmation to the suppliers for the supply of equipments have been held up due to the company not having released any advances to the suppliers. Because of delay in payment of advances to suppliers, the delivery of the equipment/materials may get delayed in turn causing further delay in project implementation. By not finalizing terms with some of the vendors, the

company may also be faced with situation of seeking new vendors/suppliers where negotiations and discussions need to be started afresh. As a result, the project implementation may be significantly effected in terms of delays. 7. 8. 9. 10. 11. If the Company is unable to implement its growth strategies in a timely manner, its business and results of operations could be adversely affected. Expanding Company’s market outside of India could increase costs and may decrease profits. The Company is dependent on external suppliers for key materials and components. The Company’s geographically diverse business operations and its rapid growth have placed constraints on the Company’s ability to generate financial information in a timely manner. The Company may, in the future, enter into strategic alliances, investments, partnerships and acquisitions. These may harm the Company’s business, dilute your ownership interest and cause the Company to incur debt. The Company has significant planned capital expenditures; its capital expenditure plans may not yield the benefits intended. The capital expenditure mentioned in the Objects of the Issue has not been appraised by any bank or financial institution. The Company has not entered into any definitive agreements to utilize the proceeds of the Issue. Further, the management of the Company will have significant flexibility in applying the proceeds of the Issue. Technology Risk Automated Identification and Data Collection (AIDC) systems can be extremely difficult to specify, quantify, or justify. There are performance and security issues to address in wireless networking. Privacy Concerns of Individuals It is apprehended that the technology carries the potential for serious privacy and security violations - particularly when used on individual consumer items. Key security issues include protecting the confidentiality, integrity and availability of the data and information systems. The privacy issues include notifying consumers; tracking an individual's movements; profiling an individual's habits, tastes and predilections; and allowing for secondary uses of information. High costs become a major inhibitor to the uptake of the RFID technology. All the hardware for RFID is imported which means that costs are high. RFID tags cost between 5 and 20 US cents each at bulk rates. Given such high price levels, the tags may not be used for low value items or perishable goods. Inadequate assessment of market need The market in India is at a very nascent stage. The market potential is tremendously high considering the wide array of applications the technology would enable. However, Bartronics has not based its projections on valid research of demand. The projections have been considered using past trend and pertinent industry growth. Inadequate confirmed orders Bartronics has planned the capital outlay considering the perceived growth in demand for AIDC technologies. However, no confirmed orders of substantial amount have been placed on the Company as of date.
EXTERNAL RISK FACTORS

12.

13.

14.

15.

16.

17.

18.

B.

1.

2.

3.

Competition from unorganized Sector. The company may face competition from unorganized sector, other established companies and new entrants into the industry; which may affect the profitability of the company. Changes in Laws Changes if any in the Government policies, Laws, governing business policies in general taxation laws, etc., may affect the profitability of the Company. Business with SAARC countries The Company is entering into the business in SAARC countries as well. It has been a general

2.

perception that business in SAARC countries except India is not secured with lot of risk involved in it. Economic downturn may affect operating performance In case of an economic downturn caused by political instability, acts of violence, terrorist attack or any other reason whatsoever, the company may not be in a position to attract maximum value for the content provided by it and hence this may affect the operating performance. 5. High Rate of Obsolescence Rate of obsolescence of the technology and equipments used in the Barcoding Industry is very high. 6. The prices of Equity Shares may fluctuate after this issue The prices of the Equity Shares may fluctuate after the issue as a result of several factors, including volatility in the Indian and Global securities market; the Company’s results of operations and performance; performance of the Company’s competitors, performance of the Barcoding Industry as a whole and the perception in the market about investments in the Barcoding Industry ; adverse media reports on the Company or the Barcoding Industry; changes in the estimates of the Company’s performance or recommendations by financial analysts; significant developments in India’s economic liberalization and deregulation policies. There can be no assurance that an active trading market for the Equity Shares will develop or be sustained after this issue, or that the prices at which the Equity Shares are initially traded will correspond to the prices at which the Equity Shares will trade in the market subsequent to this issue. < TOP > SWOT Analysis Strengths 4.

The company has established a Brand Value amongst its clients over a period of 16 years. The company has a reputed clientele, which include corporate houses of India like TISCO, TELCO, HLL, ITC, Ashok Leyland, TVS, CMC, Ranbaxy, Compaq, VST, Whirlpool, ITW, Dr.Reddys, and Nagarjuna etc. The company also offers services to the Devotees of Lord Balaji (Tirupati) by managing the Inflow Logistics of the Pilgrims. To promote the use of barcodes in India, the national IT task force laid down a clause, making the use of barcodes mandatory for all products within a time frame of five years. This gives a boost to the business prospects of the company. Barcode technology helps in effective inventory management and back tracking of the goods. These benefits are encouraging the business and trade houses to adopt this technology thereby enhancing the business opportunities for the company.

• • •

The Government of India is favoring Foreign Direct Investment (FDI) into the retail sector. Barcode technology plays a very important role in this sector. The hardware and software tools of this technology have become essential for retailing. The company with its experience is at an advantageous position to meet the demands of the retail sector. Weaknesses

• • • •

Bar coding made its foray in the Indian business sector in the 80’s and only now it is gaining momentum, because of this the company has to satisfy itself with low level of operations and subsequently a low growth rate. The adoption of man made procedures with ease and comfort and human tendency of resistance for change can be counted as the hindrances in the growth path of the company as they continue to be the de-marketing features. Companies hesitate to adopt this technology because of its service related issues. Access for trouble shooting mechanism and operational aspects act as hindrances for the growth of the industry as a whole and the company in particular.

Huge infrastructure costs associated at the implementation stage; particularly with RFID technology is an impediment, which would influence the buyer’s decision. Opportunities Bar coded cargo gets faster clearance worldwide by Customs, freight forwarders etc., thereby

enhancing the prospects for the bar coding technology.

• • •

The company can enjoy enhanced product / exporter’s image by virtue of compliance with International standards The benefits of using the technology in the retail sector and the availability of service providers across the country makes it easy for the client to adopt and implement the bar coding technology.

Biometric technologies will be used for verifying or recognizing the identity of a living person based on a physiological characteristic through fingerprint identification, voice identification, facial feature identification, etc. This could open up new avenues wherein the technology can be applied. Threats

• •
3.

Technology obsolescence perceived as a threat to the industry as well as to the company. Entry of global players into the Indian market is also perceived as a threat to the company. < TOP >

g = ROE * b ROE = Net Profit / Net Worth 239.72/1041.50 g = 23% Net Profit as on 31st March 2005 = Rs.239.72 lakh. Net Profit as on 31st March 2006 = 239.72 * 1.23 = Rs.294.86 lakh. Let ‘x’ be the allotment price for the shares of BIL. Return from new capital = 65 * x * 0.1* 0.25 = Rs.1.625x lakh, Therefore, the total profit on 31st March, 2006 = 294.86 + 1.625x. The EPS as on 31st march, 2006 is (294.86 + 1.625x)/145.68950. Average P/E ratio is 21.7 Now, the price as on 31st December, 2005
x = 21.7 * 294.86 + 1.625x

4.

145.68950 145.68950x = 6398.46 + 35.2625x 110.427x = 6398.46 x = 57.94 i.e Rs.58 (approximately) The offer price of shares of BIL is higher than the value of the shares calculated above. Therefore an investor is advised to avoid investing in this company as per the valuations made above. < TOP > In a typical fixed price offer, the price of the issue is fixed by the issuer in consultation with the Investment Banker taking into consideration the company’s historical performance and also the future projections. The Investment Banker does lot of qualitative and quantitative analysis and performs the valuation exercise. But here one thing, which is not considered at all, is the market perception. All the greatest of valuations become irrelevant when market does not accept. Because ultimately market is the decision maker. With the advent of the book building method in Indian IPO, market forces came into play. The onus does not lie on the issuer and the Investment Banker but it lies on the market. Who comprises of market? The only one answer is “Investors”. This is their investment and they have all right to decide how much they want to pay for it. What value the different set and class of investors perceive as the true value of the company’s equity, they bid at that rate. Hence we can say that here price is not forced but discovered by the market. A very plausible question follows. Is Indian IPO by book building method is giving rise to 100% true price discovery like US market? The answer is not so simple. The answer can be YES or NO. Let us explain why it is yes and why it is no. Why it yes in spite of having a Floor Price or a Band. The issuer is definitely having some rationale in fixing this floor or band. Let us first focus on the rationale of fixing a floor price.

Indian investors are still not so rational and their maturity level is no where when compared with those of their US counterparts. Moreover in US the market is totally dominated by the Institutional investors. Small investors are virtually non existent. Due to this immaturity of the small investors, the issuers feel that given a free hand the investors lowest bid rate can be any thing. So they are hedging the risk of not achieving a minimum price. This minimum floor price is determined by the most savvy Investment Bankers after exercising all the valuation models. Hence the floor price here is nothing but a risk hedging mechanism. Now the main question comes they why a cap? Is not “More the Merrier”. But here also there lies a risk. Taking into consideration of the maturity level of the investors in a book building issue the investors can bid at a very high rate to ensure an allotment. A very high issue price once again will create a tremendous pressure to the issuer to maintain that price. Stock price is nothing but an indicator of the company’s performance. So here the pressure lies on the high performance and that may be beyond the capacity of the company. Hence they prefer a price cap also to hedge this risk. If we assume that due to this diligent band given by the issuer the bids would not go haywire. In the US market, as the market is dominated by the institutional investors, the big boys are not irrational in their bids. Hence here this band is nothing but a risk management tool in the hand of the investors. So we can say that in spite of this floor price or price band, price discovery is achieved to quite an extent. But once again, the irrationality of the Indian market comes here in book building where there is a band. Most of the investors always try to bid at the cut off rate to ensure allotment and hence true price discovery is never achieved. And then, once again there are some reservations. Hence we can only say that in book building only a price discovery is tried and it is definitely much better than a fixed price offer but we have to go a long way in achieving true price discovery. < TOP > 5. “Offer document” means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue which is filed Registrar of Companies (ROC) and Stock Exchanges. An offer document covers all the relevant information to help an investor to make his/her investment decision. “Draft Offer document” means the offer document in draft stage. The draft offer documents are filed with SEBI, at least 21 days prior to the filing of the Offer Document with ROC/ SEs. SEBI may specifies changes, if any, in the draft Offer Document and the issuer or the Lead Merchant banker shall carry out such changes in the draft offer document before filing the Offer Document with ROC/ SEs. The Draft Offer document is available on the SEBI website for public comments for a period of 21 days from the filing of the Draft Offer Document with SEBI. “Red Herring Prospectus” is a prospectus which does not have details of either price or number of shares being offered or the amount of issue. This means that in case price is not disclosed, the number of shares and the upper and lower price bands are disclosed. On the other hand, an issuer can state the issue size and the number of shares are determined later. An RHP for and FPO can be filed with the ROC without the price band and the issuer, in such a case will notify the floor price or a price band by way of an advertisement one day prior to the opening of the issue. In the case of book-built issues, it is a process of price discovery and the price cannot be determined until the bidding process is completed. Hence, such details are not shown in the Red Herring prospectus filed with ROC in terms of the provisions of the Companies Act. Only on completion of the bidding process, the details of the final price are included in the offer document. The offer document filed thereafter with ROC is called a prospectus. “Abridged Prospectus” means the memorandum as prescribed in Form 2A under sub-section (3) of section 56 of the Companies Act, 1956. It contains all the salient features of a prospectus. It accompanies the application form of public issues. < TOP >

Section E: Caselets Caselet 1
6. The Key to the Growth of the Organized Retail Sectors in India

• •

Increase per capita disposable income and increase of consumption Changing taste and fashions

Expansion of urban areas and availability of easy loan to the entrepreneurs. The Constraints for the Growth of Retail Sector

• • • • • • • •

Easy availability of consumer credit with low interest rate Infrastructure development and availability of retail space

Neglecting the required policy Complex government regulations Inefficiency in supply chain Lack of expert management and trained staff Ban on FDI in the sector. < TOP >

7.

Though Indian retail sector is emerging as one of the most dynamic and fast growing industries with several domestic players taking interest in the retail market, the sector could not develop more because of the lack of infrastructure and complex government rules as it would develop with proper infrastructure. The sector needs heavy initial investment, having a long gestation period. Present data says that most of the popular brands, which were established in previous years have yet to taste success. So there is always a fear of losing capital. Domestic corporates without modern retail technical know-how do not want to take risk. Allowing FDI in the sector would definitely help in this regard. It would bring a huge amount of capital, for which India needs to develop its infrastructure and create additional jobs. This should be the prime concern of Indian policy makers. India can expect a lot of benefits out of the FDI in Indian retail bandwagon. Categorically, retail sector can generate huge employment opportunities. In developed countries like the US, this sector employs 12% of its total workforce; whereas, the Indian retail sector employees only 6 to 7% of its workforce. This is because of the lack of organized retail sector. The market share of organized retail sector in India is only 2%; whereas, in the US it is 80%, in Thailand it is 40% and in China it is 20%. A modern organized retail sector can create more than 2 million jobs directly in India within the next five to six years. According to an estimate of Cygnus Research Center, the retail industry requires more than 115,000 skilled workers to support its growth in years to come. Even the Planning Commission also hinted that the retail sector is a potential sector for employment generation. Table 2 shows a slow growth rate of Employment in wholesale and retail sector. India can expect a sudden growth in the agricultural sector as the retail sector will create more demand for the agricultural products like fresh and processed fruits. Farmers and dairy farms will benefit the most with this development. The retail giants can bring better managerial skills and IT-friendly services, would be facilitated to cut cost and minimize the wastages. They can develop food processing industries and cold storage, which require huge amount of capital. Organized players focus on efficient supply chain and target complete saturation of the market where they are established. Market intermediaries may be omitted. There may be a direct contact between the farmer or the producer and the market. Farmers will get a good return on their product and the consumer will also get a better quality with affordable price. FDI could see an improvement in the lifestyle of the people, particularly the middle class, and the longterm impact of such a move will be seen in the growth of a number of small and medium-size entrepreneurs as in the real estate sector. The tax revenue for the government could also increase with this development. < TOP > The following are the causes of concern of allowing FDI in the retail sector. 1. 2. 3. MNCs usually do not bring funds from outside sources. Government and other financial institutions are ready to lend them with low interest rate as they are multinationals and more efficient. In the name of technology, they may replace the age-old calculations. A street shopkeeper used to calculate huge numbers within a few minutes which they will calculate with machines. Big retailers can be useful in case of capital abandoned country. India is a labor surplus country so this

8.

practice may be harmful and can create more unemployment. < TOP >

Caselet 2
9. Advantages to farmers Access to adequate and timely credit to farmers Full year's credit requirement of the borrower taken care of. Minimum paper work and simplification of documentation for drawal of funds from the bank. Flexibility to draw cash and buy inputs. Assured availability of credit at any time enabling reduced interest burden for the farmer. Sanction of the facility for 3 years subject to annual review and satisfactory operations and provision for enhancement. Flexibility of drawals from a branch other than the issuing branch at the discretion of the bank. Benefits of the Scheme to the Banks Reduction in work load for branch staff by avoidance of repeat appraisal and processing of loan papers under Kisan Credit Card Scheme. Minimum paper work and simplification of documentation for drawal of funds from the bank. Improvement in recycling of funds and better recovery of loans. Reduction in transaction cost to the banks. Better Banker - Client relationships. < TOP > 10. Salient features of the Kisan Credit Card (KCC) Scheme Eligible farmers to be provided with a Kisan Credit Card and a pass book or card-cum-pass book. Revolving cash credit facility involving any number of drawals and repayments within the limit. Limit to be fixed on the basis of operational land holding, cropping pattern and scale of finance. Entire production credit needs for full year plus ancillary activities related to crop production to be considered while fixing limit. Sub-limits may be fixed at the discretion of banks. Card valid for 3 years subject to annual review. As incentive for good performance, credit limits could be enhanced to take care of increase in costs, change in cropping pattern, etc. Each drawal to be repaid within a maximum period of 12 months. Conversion/reschedulement of loans also permissible in case of damage to crops due to natural calamities. Security, margin, rate of interest, etc. as per RBI norms. Operations may be through issuing branch (and also PACS in the case of Cooperative Banks) through other designated branches at the discretion of bank. Withdrawals through slips/cheques accompanied by card and passbook. < TOP >

Caselet 3
11. Typically, this loan ends when the last surviving co-borrower dies, moves away or does not live in the house for 12-consecutive months. If the borrower dies and the loan is due, the amount due will always be lesser of his loan balance or the market value of his home. Even if the amount he borrowed eventually exceeds the value of his home, he or his heir will never owe more than the value of the home. All proceeds in excess to what he owes belong to his estate, which means the remaining equity on the home can be passed on to his heir. Thus it is also called a non-recourse loan. If the loan is for a fixed period (term), when that time runs out it becomes due. The amount the borrower owes at the end of the loan (his loan balance) consists of the entire money borrowed including the part used to pay to loan closing cost and the accrued interest on that money and any financed fees up to the loan’s non-recourse limit, the fair market value of

your home. There are three ways to pay-off the loan, i.e. the borrower or his heir can sell the house. Either the sale will cover the loan or it will fetch more than the loan. Any proceeds of the sale beyond what is required to pay off the mortgage belong to him and his heirs. The lender can never get more than the fair market sales price of the home. The second way to pay off the loan is to sell the other assets or the heirs’ assets. As the lender gets the money he/she or his/her heirs get to keep the house. The third and last way is, if there is enough equity left, or his/her heir can refinance the home and pay off the loan that way. A borrower should discuss the reverse mortgage loan option with his family or other heirs before choosing the loan. His heir needs to be prepared to pay off the loan balance if they would like to keep the home. Open communication along with strong monthly financial planning is necessary to keep family affairs run smoothly. If he plans to leave his/her home to the children to inherit, he/she has to think twice before taking a reverse mortgage. < TOP > 12. Reverse mortgage has some great advantages. First of all, the borrower does not have to pay anything (principal or interest) until the loan ends or the house is sold. Secondly, it allows him/her to stay in their home and keep title of the property. Thirdly, it will help the borrower to maintain his financial independence and improve the quality of life. Fourthly, since there are no payments till the loan ends, the borrower’s income is not a consideration for the financial company. As it is a non-recourse loan, which means the bank or financial institutions will never go to any borrower for repayment of loan. Finally, there is no upper age limit for getting the benefit of reverse mortgage facility. On the contrary, for the elder one it would be the easiest to get the loan. Although there are some great advantages of reverse mortgage still there are some limitations of it. As each and every real estate is unique in nature, the contract of reverse mortgage is not well understood. The reverse mortgage is even more complicated than conventional mortgage. And as the borrower’s home equity is reducing, so it could cause a potential negative impact for the heirs. < TOP > < TOP OF THE DOCUMENT >

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Question Paper Investment Banking and Financial Services-II (262): July 2006
Section D : Case Study (50 Marks)
· · · · This section consists of questions with serial number 1 - 4. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study Read the case carefully and answer the following questions:
1. The Bharat Cement wants to come out with the issue of 8.5% bonds worth of 50 crore with a maturity of 8 years. You are required to rate the bond issue based on qualitative and quantitative factors of the bank. And also comment whether the bond is under investment grade or speculative grade. (25 marks) < Answer > Bharat Cement Ltd. has recently come up with 8.5% Rs.100 (face value) bond issue. The Bond Index at the time of issue was 988.64. Mr. Prashant, invested Rs.5,00,000 in the bond issue. He is planning to sell the bond after one year. The following are the probabilities associated with different economic scenarios after one year. The price of 91 day T-Bills and Bond Index values under different economic scenarios are also given below. It is assumed that the credit rating to be assigned to the bond after one year is dependent on economic scenario prevailing at that time. Economic Scenario Probability of Economic Scenario 0.3 Credit Rating Beta values Probability of T-bill prices and bond index values 0.2 0.3 0.3 0.2 0.25 0.3 0.3 0.15 0.1 0.1 0.4 0.4 0.1 0.1 0.3 0.5 T-Bill Prices Bond Index values

2.

Super Normal Growth

AAA

0.97

98.5 98.4 98.4 98.5 98.5 98.6 98.6 98.7 98.6 98.7 98.7 98.7 98.7 98.7 98.7 98.8

1089.48 1087.5 1086.5 1085.53 1087.11 1083.35 1082.17 1080.78 1085.3 1079.89 1078.61 1077.22 1079 1078.21 1077.02 1075.15

Normal Growth

0.3

AA

0.99

Declining

0.2

A

1.05

Recession

0.2

BB

1.07

You are required to compute the expected return on the bond, if Mr. Prashant sells it after one year from purchase. (Apply CAPM approach to calculate the cost of bond.) (9 marks) < Answer > 3. Is credit rating necessary at all? Does credit rating constitute an advice to the investors to buy? (8 marks) < Answer >

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4.

How reliable and consistent is the rating process? How do rating agencies eliminate the subjective element in rating?

(8 marks) < Answer > CARE's rating process for manufacturing companies begins with a review of the Economy/Industry in which the company operates along with an assessment of the business risk factors specific to the company. This is followed by an assessment of the financial risk factors and quality of management of the company. The degree of financial risk exposure of the company within the overall context of the business risk together with the evaluation of the company management forms the basis for arriving at the rating level. 1. Economy and Industry risk analysis CARE's analysis of industry risk focuses on the prospects of the industry and the competitive factors affecting the industry. The Economic/Industry environment is assessed to determine the degree of operating risk faced by the company in a given business. Investment plans of the major players in the industry demand supply factors, price trends, changes in technology, international/domestic competitive factors in the industry, entry barriers, capital intensity, business cycles etc. are key ingredients of industry risk. CARE also takes into account economy wide factors which have a bearing on the industry under consideration. The strategic nature of the industry in the prevailing policy environment, regulatory oversight governing industries etc, are also analyzed. This factor consists of maximum of 25 points for the purpose of rating. 2. Business risk analysis Against the backdrop of economy and industry risk, CARE assesses the company's position within the industry. Some of the key parameters used to assess business risk are: Diversification For companies that operate in several industries, each major business segment is analysed separately. The contribution of each business segment to the company's overall profitability is assessed. While diversification results in better sustainability in cash flows, CARE also analyses the suitability and adequacy of management structure in such scenarios and forward and backward linkages present. This factor consists of maximum of 10 points for the purpose of rating. Seasonality and Cyclicality Some industries are cyclical in nature with their performance varying through the economic cycle. Moreover, certain industries are seen to exhibit seasonality. CARE's ratings aim to be stable across seasons and economic cycles and are arrived at after deliberating on the long term fundamentals. This factor consists of maximum of 10 points for the purpose of rating. Size Small size presents a significant hurdle in getting higher ratings commensurate with a company's financials. Presence in selected market segments, limited access to funds leading to lack of financial flexibility etc., result in lower protection of margins when faced with adverse developments in business areas. Large firms, on the other hand, have higher susteinance power, even during troubled times. This factor consists of maximum of 10 points for the purpose of rating. Cost structure The cost factors and efficiency parameters of existing operations are assessed with respect to expenditure levels required to maintain its existing operating efficiencies as well as to improve its efficiency parameters in a competitive scenario. Nature of technology may also influence the cost structure. This factor consists of maximum of 10 points for the purpose of rating. Market share A company's current market share and the trends in market share in the past are important indicators of the competitive strengths of the company. A sustained leadership position leads to ability to generate cash over the long term. A market leader generally has financial resources to meet competitive pricing challenges. This factor consists of maximum of 10 points for the purpose of rating. Marketing and distribution arrangements Depending on the nature of the product, CARE analyses the depth and importance of the marketing and distribution of the company. For example, companies in FMCG sector require an extensive marketing

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and distribution network and CARE attaches high importance to the same when analyzing companies in those industries. This factor consists of maximum of 10 points for the purpose of rating. 3. Financial risk analysis Financial risk analysis involves evaluation of past and expected future financial performance with emphasis on assessment of adequacy of cash flows towards debt servicing. CARE's analysis is mainly based on audited accounts of the company although unaudited accounts are noted. A review of accounting quality and adherence to prudential accounting norms are examined for measuring the company's performance. Accounting policies relating to depreciation, inventory valuation, income recognition, valuation of investments, provisioning/write off etc. are given special attention. Prudent disclosures of material events affecting the company are reviewed. Impact of the auditor's qualifications and comments are quantified and analytical adjustments are made to the accounts, if they are material. The rating team meets the auditor to understand his comfort level with the accounting records, systems and policies of the company and his assessment of the management of the company. In the process, the rating group also forms an opinion on the quality of the auditor and his firms' reputation in the market. Off-balance sheet items are factored into the financial analysis and adjustments made to the accounts, wherever necessary. Change of accounting policy in a particular year which results in improved reported performance is analyzed more closely. Financial ratios Financial ratios are used to make a holistic assessment of financial performance of the company, as also to see the company's performance w.r.t its peers within the industry. Growth Ratios Trends in the growth rates of a company vis-a-vis the industry reflect the company's ability to sustain its market share, profitability and operating efficiency. In this regard, focus is drawn to growth in income, PBILDT, PAT and assets. This factor consists of maximum of 10 points for the purpose of rating. Profitability Ratios Capacity of a company to earn profits determines the protection available to the company. Profitability reflects the final result of business operations. Important measures of profitability are Operating and PAT margins, RONW both reported and adjusted. Profitability ratios are not regarded in isolation but are seen in comparison with those of the competitors and the industry segments in which the company operates. This factor consists of maximum of 25 points for the purpose of rating. Leverage and Coverage Ratios Financial leverage refers to the use of debt finance. While leverage ratios help in assessing the risk arising from the use of debt capital, coverage ratios show the relationship between debt servicing commitments and the cash flow sources available for meeting these obligations. CARE uses ratios like Debt / Equity Ratio, owner’s fund as a percentage of total fund, Interest Coverage are used vis-a-vis level of coverage available with the company. This factor consists of maximum of 15 points for the purpose of rating. Turnover Ratios Turnover ratios, also referred to as activity ratios or asset management ratios, measure how efficiently the assets are employed by the firm. These ratios are based on the relationship between the level of activity, represented by sales or cost of goods sold, and level of various assets, including inventories, fixed assets and total assets. This factor consists of maximum of 15 points for the purpose of rating. Liquidity Ratios Liquidity ratios such as current ratio, quick ratio etc. are broad indicators of liquidity level and are important ratios for rating short term instruments. Cash flow statements are also important for liquidity analysis. This factor consists of maximum of 15 points for the purpose of rating. Cash flows Interest and principal obligations are required to be met by cash and hence only a thorough analysis of cash flow statements would reveal the level of debt servicing capability of a company. Cash flow analysis forms an important part of credit rating decisions. Availability of internally generated cash for servicing debt is the most comforting factor for rating decisions as compared to dependence on external

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sources of cash to cover temporary shortfalls. Cash flow adequacy is viewed by the capability of a company to finance normal capital expenditure, as well as its ability to manage capital expenditure programmes as per envisaged plans apart from meeting debt servicing requirements. This factor consists of maximum of 10 points for the purpose of rating. Financial flexibility Financial flexibility refers to alternative sources of liquidity available to the company as and when required. Company's contingency plans under various stress scenarios are considered and examined. Ability to access capital markets and other sources of funds whenever a company faces financial crunch is reviewed. Existence of liquid investments, access to lines of credits from strong group concerns to tide over stress situations, ability to sell assets quickly, defer capex etc. are favourably considered. This factor consists of maximum of 10 points for the purpose of rating. 4. Management Evaluation Management evaluation is one of the most important factors supporting a company's credit standing. An assessment of the management's plan in comparison to those of their industry peers can provide important insights into the company's ability to sustain its business. Capability of the management to perform under stress provides an added level of comfort. Meetings with the top management of the company are an essential part of CARE's rating process. Track record The track record of the management team is a good indicator for evaluating the performance of the management. Management's response to key issues/events in the past like liquidity problems, competitive pressures, new project implementation, expansions and diversifications, etc. are assessed. This factor consists of maximum of 10 points for the purpose of rating. This factor consists of maximum of 10 points for the purpose of rating. Corporate Strategy The company's business plans, mission, policies and future strategies in relation to the general industry scenario are assessed. An important factor in management evaluation is assessment of the management's ability to look into the future and its strategies and policies to tackle emerging challenges. This factor consists of maximum of 15 points for the purpose of rating. Performance of group companies Interests and capabilities of the group companies belonging to the same management give important insights into the management's capabilities and performance in general. This factor consists of maximum of 10 points for the purpose of rating. Organizational structure Assessment of the organizational structure would indicate the adequacy of the same in relation to the size of the company and also give an insight on the levels of authority and extent of its delegation to lower levels in the organization. The extent to which the current organizational structure is attuned to management strategy is assessed carefully. This factor consists of maximum of 10 points for the purpose of rating. Control systems Adequacy of the internal control systems to the size of business is closely examined. Existence of proper accounting records and control systems adds credence to the accounting numbers. Management information systems commensurate with the size and nature of business enables the management to stay tuned to the current business environment and take judicious decisions. This factor consists of maximum of 10 points for the purpose of rating. Personnel policies Personnel policies laid down by the company would critically determine its ability to attract and retain human resources. Incidence of labour strikes/unrest, attrition rates etc., are seen in perspective of nature of business and relative importance of human capital. This factor consists of maximum of 10 points for the purpose of rating. The rating process is ultimately an assessment of the fundamentals and the probabilities of change in the fundamentals. Rating determination is a matter of experienced and holistic judgment, based on the relevant quantitative and qualitative factors affecting the credit quality of the issuer.

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Based on the individual scores for all the areas, an overall rating of the bank will be given in the following manner:

Total Score in % 90 – 100

Rating AAA

Significance Best quality as basically sound in all respects, carrying negligible investment risk. Debt service payments are protected by stable cash flows with good margin. Instruments carrying this rating are judged to be of high quality by all standards. They are also classified as high investment grade. They are rated lower than AAA securities because of somewhat lower margins of protection. Instruments with this rating are considered upper medium grade instruments and have many favorable investment attributes. Safety for principal and interest are considered adequate. Such instruments are considered to be of investment grade. They indicate sufficient safety for payment of interest and principal, at the time of rating. However, adverse changes in assumptions are more likely to weaken the debt servicing capability compared to the higher rated instruments. Such instruments are considered to be speculative, with inadequate protection for interest and principal payments. Instruments with such rating are generally classified susceptible to default. While interest and principal payments are being met, adverse changes in business conditions are likely to lead to default. Such instruments carry high investment risk with likelihood of default in the payment of interest and principal. Such instruments are of the lowest category. They are either in default or are likely to be in default soon.

80 – 89

AA

70 – 79

A

60 – 69

BBB

50 – 59 40 – 49

BB B

30 – 39 1 – 29

C D

Any score above 59% is considered as investment grade instrument and any score below the same is considered as speculative instrument. The rating agency has selected seven best performing companies of the same industry and their average performance is given below: 2006 Operating Margin (%) Net Profit Margin (%) Adjusted Return On Net Worth (%) Reported Return On Net Worth (%) Return On long Term Funds (%) Total Debt/Equity Owners fund as % of total Source Financial charges coverage ratio Inventory Turnover Ratio Fixed Asset Turnover Ratio Total Assets Turnover Ratio 15.54 8.13 2.03 2.09 1.09 5.01 24.54 1.75 5.36 1.55 1.08 2005 14.25 5.24 1.89 2.01 1.11 5.23 24.56 1.54 5.12 1.49 1.06 2004 10.89 2.13 0.79 1.55 0.97 5.28 24.53 1.27 4.78 1.47 1.02

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Current Ratio Quick Ratio Indian Cement Industry

2.54 2.07

2.81 2.09

2.52 2.17

The cement industry in India has come a long way since 1914, when the first cement plant was commissioned with a production level of 1000 tons/ annum. Today India is the second largest cement producer in the world with a production level of about 99 million tones (about 5% of world production ~ 2000 million tonnes). The installed capacity is about 119 million tonnes and at an expected 10 % growth rate the production is likely to grow to about 158.5 million tones at the end of 2006-2007. However, cement consumption per capita in our country at about 99-kg/ capita is one of the lowest. The world average is about 267 kg/capita. While that of China is 450 kg/capita. Similarly in Japan it is 631 kg/capita while in France it is 447 kg/capita. Over the years, the growth of the industry has been uneven. With traditionally cement deficit regions covering the most of the major growth centers of the country. Cement plants in our country have mostly changed from the wet process to the energy efficient dry process. Out of 157 kilns, 117 are dry process based, 32 are based on wet process and 8 on semi dry. Though the best of our industry matches quite well with world standards in terms of energy (thermal energy Kcal/kg of clinker – India 665 against 690 of Japan) and pollution norms (SPM of 40 in India against 20 of Japan) but the average performance of the Indian industry is lagging behind. In the coming years, in order to survive and grow in the globalize market, rapid modernization and adoption of cost effective energy efficient and environment friendly technologies will be the prime mover for the viability of the industry in the global canvas. The industry should increasingly look for other cheaper fuel options like sludge from paper plants, sugar cane trash, bagasse, jute dust, textile dust, biogas refinery waste like pet coke etc. The industry should be known in future as savior of the country for sustainable development by consuming most of the industrial wastes. Outlook The major players in the cement industry have posted encouraging numbers for Q'3 FY'06, riding on the buoyant demand for cement consumption due to resurgence of the construction activities across the country post monsoon period. Robust volume growth as well as appreciation of the cement prices in almost all parts of the country helped the industry to record a strong performance. Despite, prolonged monsoons in many parts of the country, the industry maintained a strong growth momentum and recorded 11% and 12 % YoY growth in production and consumption, respectively, during Apr-Feb 2005-06 period.

Domestic demand-supply Period ended Production Consumption Apr-Feb 2004-05 115.3 109.4 Apr-Feb 2005-06 127.7 122.0

(mn. Tonnes) PoP growth 11% 12% Source: CMIE

Buoyant performance for the quarter ended December 2005: Buoyant cement consumption demand boosted topline for the quarter ended December'05. The largest cement manufacturer, ACC, led by robust growth in despatches during the quarter, reported 12% of YoY growth in its topline. Gujarat Ambuja Cement (GACL) benefited from the firm prices and strong demand prevailing in the western region. GACL has posted 24% YoY growth in earnings during Q'3FY'06. Numbers for Q'3FY'O6 Net Sales Company Grasim (Cement) Q3FV06 894.86 Q3FV05 688.52 YoY growth 30% Operating Profit Q3FY06 133.91 Q3FY05 69.5 YoY growth 93% (Rs. Mn.) Net Profits Q3FY06 – YoY growth –

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ACC Ultratech Gujarat Ambuja Madras Cement

10,721 7,829 7731.5 2426.5

9553.3 6877.3 6198.3 1607.6

12% 14% 24% 51%

1919 945.8 1944.6 429.4

1526.5 323.4 1768.1 253.5

26% 192% 10% 69%

941 238.6 879 95.9

76%

-2% 244%

Source: CARE Research Improved realizations boosted profitability of the companies. The major players posted strong bottom-line growth on account of higher price realizations. Southern players earned handsome profits backed by robust topline growth. On the operating cost front the prices of furnace oil, naphtha and other petroleum products escalated during Q'3FY06 leading to increase in power and fuel costs. However, the industry received a reprieve from softening of the prices of imported coal. Power and fuel constitute to about 55-65% of the total costs and going forward, Power and fuel along with freight charges are going to be the concerns for the industry. Further, the apex court has banned overloading of trucks carrying cement, which will push up the freight costs. With the continued buoyancy in the housing construction, continued emphasis on infrastructure along with the new industrial projects expected to materialize, CARE believes that the industry is braced with better times ahead. Indian cement industry is also witnessing a steady rise in exports, thanks to the construction boom in the Middle East. Cement and clinker exports account for about 6-8 per cent of the total cement demand. The construction activity in the Middle East is expected to remain strong leading to stable demand for exports in the near term. With cement demand expected to grow at 8-10 per cent in the medium term, the dynamics of Indian cement industry are undergoing a gradual shift. While demand for cement has picked up steadily, additions to capacity have risen at a lower pace, leading to an improvement in the demand-supply dynamics. From an oversupply situation not so long ago, we are now moving towards a scenario where demand growth is expected to outstrip the supply. In the past, southern region was a major concern due to the unfavorable demand-supply equation; the region had large capacities and weak demand. In 2004-05, the region had a capacity of 46 million tonnes while the demand was merely over 30 million tonnes, and the players in the region depended on selling their production into other regions, mainly the West. However, fiscal 2005-06 brought a sudden transformation and the region saw 25% rise in demand in the first eleven months of FY'06. Cement demand in South Region South Apr-Feb 2004-05 28.46 Apr-Feb 2005-06 35.51 (Mn. Tonnes) PoP growth 25%

Source: CMIE This sharp jump in cement consumption in south is driven by both housing construction and infrastructure projects. Going forward, the cement demand in the southern markets is expected to continue growing at a faster pace. Cement consumption has a strong correlation with the GDP growth and with 7-8% GDP growth forecast and thrust on infrastructure development; cement demand is expected to be robust. The true long term potential is clearly visible from the comparative analysis of per capita consumption of 250 kg for world average and 110 kg for India. And if one compares with our most talked about neighbor China's 660 Kg, India has a long way to go. The cement consumption projections by National Council of Applied Economic Research (NCAER), on a conservative basis, have placed the cement demand of 225 million tonnes by the year 2010-11. And if the government goes ahead with infrastructure projects in a big way as planned, the consumption is pegged to be at much higher levels of 291 million tonnes. With current production capacity at just 156 million tonnes, the cement industry, undoubtedly, is in for good times. Cement Prices to remain firm: With favorable demand supply equation, cement prices are expected to firm up with a pick up in construction activity across the country. Cement prices have been on a steady uptrend since January 2004 and have risen to historical highs in the early part of 2005-06. During June-September when large parts of India experience monsoons, cement prices fall. However, this time, in 2005-06, cement prices have remained stable, a sign of the improved demand-supply position. In the month of March'06, again cement prices in the western and northern markets saw an unprecedented rise with average cement prices in Delhi and Mumbai markets rising by 20% and 16% respectively, over the previous month. However, during the same

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period cement prices remained more or less flat in Chennai and Hyderabad region, despite the robust demand. The price rise was mainly fueled by the rising demand as well as the rise in freight costs on account of Supreme Court decree against overloading of the trucks. With a general optimism in the economy, improving demand supply dynamics and rising costs of the inputs, the cement prices are expected to remain firm in the coming months. However, high energy costs and freight costs remain a cause of concern for the industry. Consolidations Over the past couple of years, the structure of the industry has undergone a sea change on account of consolidation; the top four manufacturers control over 50% -60% of the market share while the remaining is shared by large number of smaller players. Grasim acquired L&T's cement division; Holcim took a stake in ACC in the year 2005 and has recently announced an acquisition of 14.8% in Guj. Ambuja Cement Ltd. (GACL), Jaypee Associates has acquired the assets of UP cement through a hotly contested bid. All these indicate that the consolidation of capacities through mergers and acquisitions is going to be the name of the game for the players to grow and consolidate their share since green field projects involve a considerable gestation period. Further, the fragmented nature of the industry, offers ample opportunity for quickly acquiring the capacities and size. This trend is also in line with the global trend, where only 2 or 3 cement producers dominate the entire market in their respective countries. Holsim's acquisition of GACL is considered to be the most expensive deals in the global cement industry with a price of USD 206 per tonne of cement - more than double the amount, USD100 per tonne it had paid to acquire 34% equity in ACC, India's No 2 cement producer. This also, indicates that the Indian cement industry has truly arrived in MNC's business radar and they are ready to accord handsome valuations to have a pie of the growth story. The Bharat cements Ltd. The Bharat cements Ltd was established in 1946 and the first plant was setup at Sankarnagar in Tamilnadu in 1949. Since then it has grown in stature to seven plants spread over Tamilnadu and Andhra Pradesh. The capacities as on March 2002 have increased multifold to 9 million tons per annum. Management The Bharat cements Ltd. is a professionally managed company headed by its chairman Mr. Narayan Sankar. The day-today affairs of the company are managed by Mr. M. Srinivas, the Vice Chairman and Managing Director assisted by the Executive Director Mr. P. Ram and other key personnel in each functional area. The Board of Directors are ultimately responsible for the management of the affairs of the company. The personnel policies of the company are also very transparent. It has never faced any strike in it from its inception. Company Highlights

· · ·

The Company is the largest producer of cement in South India. The Company's plants are well spread with three in Tamilnadu and four in Andhra Pradesh which cater to all major markets in South India and Maharashtra. The Company is the market leader with a market share of 28% in the South. It aims to achieve a 35% market share in the near future. The Company has access to huge limestone resources and plans to expand capacity by de-bottlenecking and optimization of existing plants as well as by acquisitions. The Company has a strong distribution network with over 10,000 stockists of whom 25% are dedicated. The Company has well established brands- Sankar Super Power, Coromandel Super Power and Raasi Super Power. Regional offices in all southern states and Maharasthra offices/representative in every district.

· · · · ·

Recent Milestone 2004 The Unique Waste Heat Recovery System for generation of power from waste gas at Vishnupuram Cement Plant was commissioned during November 2004, for a capacity of 7.7 MW of power 2004 The company through its Special Purpose vehicle M/s Coromandel Electric Co Ltd. has commissioned a (gas based) captive power plant at Ramanathapuram for a capacity of 17.4 MW and the same has started supplying power from the month of November 2004. 2005 The Company has successfully completed an equity issue in the international market during October 2005 by issuing 25,613,796 Global Depositary Shares (GDSs) at USD 4.3226 per GDS, (each GDS representing 2 underlying equity shares of Rs 10 each) and raised an amount of Rs 497 crores including a premium of Rs 446 crores.

·

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Accounting policies: The company follows both US GAAP and Indian GAAP for accounting. Products of the company Coromandel King-Sankar Sakthi- Raasi Gold (53 Grade Cement) Coromandel King, Sankar Sakthi and Raasi Gold are high strength cements to meet the needs of the consumer for high strength concrete. As per BIS requirements the minimum 28 days compressive strength of 53 Grade OPC should not be less than 53 Mpa. For certain specialised works such as prestressed concrete and certain items of precast concrete requiring consistently high strength concrete, the use of 53 Grade OPC is found very useful. 53 Grade OPC produces higher-Grade concrete at very economical cement content. In concrete mix design, for concrete M-20 and above Grades a saving of 8 to 10% of cement may be achieved with the use of above mentioned 53 Grade OPC. Coromandel-Sankar-Raasi (43 Grade Cement) Coromandel, Sankar and Raasi are the 43 grade OPCs most popular general-purpose cement in the market today. The production of 43 grade OPC is nearly 50% of the total production of cement in the country The compressive strength of cement at 28 days when tested as per IS code shall be minimum 43 Mpa. Characteristic strength requirements of this cement are given in the chart BLENDED CEMENT Coromandel Super Power, Sankar Super Power and Raasi Super Power are the premium blended cements from THE BHARAT CEMENTS LIMITED. It is produced by intergrinding of OPC clinker alongwith gypsum and mineral admixtures. Dedicated to the end user after passing through stringent tests at our R&D laboratory, it ensures durable structures that lasts for generations. Salient features:

· · · · · · ·

Strength increases as time passes. High durability concrete - protects from corrosion, coastal attack and extreme temperature. Ideal cement for resisting aggressive environments like chemical, chloride and sulphate attack. Best suited for high performance concrete. High fineness - suited for plastering and finishing works. Low heat of hydration - Ideal for mass concrete pours and machine foundations Equivalent to 53 grade cement.

Sulphate Resisting Portland Cement (SRPC) Sankar SRC can be used for structural concrete wherever OPC or PPC or Slag Cement is usable under normal conditions. Sankar SRC is particularly beneficial in such conditions where the concrete is exposed to the risk of deterioration due to sulphate attack. For example, in contact with soils and ground waters containing excessive amounts of sulphates as well as for concrete in sea water or exposed directly to sea coast. The IS 456 1978 (revised draft code) has made elaborate provisions for use of particular type of cement against different percentages of soluble sulphate salts

Name of the associate /subsidiary companies Industrial Chemicals & Monomers Ltd. BCL Securities Ltd. BCL Financial Services Ltd. BCL International Ltd. Coromandel Electric Company Ltd. BCL Shipping Ltd. BCL Sugars Ltd. Bharat cements Capital & Finance Ltd. Jubilee Cements Ltd. Raasi Cement Ltd. Subsidiary Company Subsidiary Company Subsidiary Company Subsidiary Company Associate Company Associate Company Associate Company Associate Company Associate Company Associate Company

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Soudambika Finance & Investments Private Ltd. Sivasunder Finance & Investments Private Ltd. Trishul Investments Private Ltd. Visaka Cement Industry Ltd.

Associate Company Associate Company Associate Company Associate Company

Performance Indicators Key Performance Statistics THE BHARAT CEMENTS LIMITED (Figures in millions) 2001 Production (tonnes) Turnover (Rs.) Net Profit-Before (Rs.) Cash Generated (Rs.) Tax 6.0 14196.6 473.1 1212.0 2002 6.0 14513.7 511.5 1341.6 2003 4.85 13132.5 (75.7) 799.4 2004 4.95 10330 (3072.3) (2258.2) 2005 5.41 12368.8 (1127.3) (312.2) 2006 5.49 13853.9 45.8 833.5

Overall Capacity Position Plant Sankar Nagar Sankari Durg Chilamkur Dalavoi Yerraguntla Vishnupuram Visaka Cement Industry Limited Total Capacity on March 2005 1.55 0.72 1.30 1.30 0.52 2.30 1.12 8.81

Income Statement
Rs. Crore Mar '06 Income : Operating Income Expenses Material Consumed Manufacturing Expenses Personnel Expenses Selling Expenses Administrative Expenses Cost Of Sales Operating Profit Other Recurring Income Adjusted PBDIT Financial Expenses 153.87 449.01 80.24 298.23 38.50 1,019.85 142.29 12.52 154.81 133.50 138.92 374.99 85.52 260.77 36.98 897.19 119.71 3.92 123.63 161.68 147.06 324.87 84.35 218.12 37.32 811.72 39.85 5.93 45.78 258.54 128.50 320.60 79.82 282.20 34.16 845.27 173.84 5.73 179.57 205.86 131.06 369.42 77.08 317.87 33.78 929.22 327.72 9.29 337.01 190.20 1,162.14 1,016.90 851.58 1,019.11 1,256.95 Mar '05 Mar '04 Mar '03 Mar '02

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Depreciation Other Write offs Adjusted PBT Tax Charges Adjusted PAT Non Recurring Items Other Non Cash adjustments Reported Net Profit Earnings Before Appropriation Equity Dividend Preference Dividend Retained Earnings Net Cash Activity Flow-Operating

78.77 5.68 -63.14 0.00 -63.14 67.72 0.00 4.58 -307.84 0.00 0.00 -307.84 214.18

81.51 13.24 -132.80 -16.80 -116.00 20.07 0.00 -95.93 -312.42 0.00 0.00 -312.42 91.03

81.39 13.01 -307.17 -114.06 -193.11 -0.04 -8.22 -193.17 -176.49 0.00 0.00 -176.49 127.42

87.47 12.71 -126.47 -6.75 -119.71 117.13 -0.04 -0.81 24.88 0.00 2.88 22.00 103.87

83.00 12.71 51.11 3.00 48.11 0.05 -0.01 51.15 61.72 27.47 3.52 30.72 208.12

Balance Sheet Bharat cements Ltd. Rs. Crore Mar ' 05 Mar ' 04

Mar ' 06 SOURCES OF FUNDS Owner's Fund Equity Share Capital Share Application Money Preference Share Capital Reserves & Surplus Loan Funds Secured Loans Unsecured Loans Total USES OF FUNDS Fixed Assets Gross Block Less : Revaluation Reserve Less Accumulated Depreciation Net Block : 2,985.28 912.29 783.43 138.59 13.91 25.00 199.42

Mar ' 03

Mar ' 02

138.59 0.00 25.00 221.26

138.59 0.00 25.00 255.15

138.59 0.00 25.00 453.64

138.48 0.00 25.00 642.89

1,845.28 141.96 2,364.16

1,932.91 159.73 2,477.49

1,586.15 192.28 2,197.17

1,569.90 223.20 2,410.33

1,513.19 295.51 2,615.07

2,889.77 975.90 654.69

1,714.60 0.00 580.85

1,701.89 0.00 499.77

1,673.42 0.00 412.86

1,289.56 2.99

1,259.18 98.80

1,133.75 210.84

1,202.12 223.50

1,260.55 230.54

Capital Work-in-progress

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Investments Net Current Assets Current Assets, Loans & Advances Less : Current Liabilities & Provisions Total Net Current Assets Miscellaneous expenses not written Total Note : Book Value of Unquoted Investments Market Value of Quoted Investments Contingent liabilities Number of Equity shares outstanding Inventory

34.84

34.69

34.74

34.62

36.88

1,556.02

1,518.41

1,509.49

1,413.41

1,406.15

541.14

454.04

708.85

492.06

359.44

1,014.88 21.89

1,064.37 20.45

800.64 17.20

921.35 28.74

1,046.72 40.37

2,364.16

2,477.49

2,197.17

2,410.33

2,615.06

29.47

29.34

29.34

29.19

16.75

6.21

5.40

5.43

5.62

74.30

438.77

395.68

313.13

176.54

176.00

139,545,504.00 387.15

139,545,504.00 369.69

139,545,504.00 346.98

139,545,504.00

139,545,504.00

Expected performance for the next three quarters: Dec ' 06 411.87 3.65 46.78 29.57 20.86 19.69 0.60 7.22 6.65 190.77 11.35 5.02 1.73 Sep ' 06 466.52 0.91 67.96 42.71 26.16 19.72 0.59 5.85 0.00 139.54 14.56 5.59 1.25

Rs. Crore Jun ' 06 452.09 0.89 69.85 45.21 25.53 19.75 0.57 5.21 0.00 138.59 15.45 5.63 1.15

Sales Other Income Operating Profit Interest Gross Profit Depreciation Taxation Net Profit / Loss Extra Ordinary Item Equity Capital OPM(%) GPM(%) NPM(%)

END OF SECTION D

Section E : Caselets (50 Marks)

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· · · ·

This section consists of questions with serial number 5 - 11. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 5. This caselet says that the multiple demat account have become a weapon for some investors to benefit from the IPOs. What according to you can be the reasons for having multiple demat accounts? Explain with an example. (8 marks) < Answer > 6. Opening multiple bank and demat accounts is not an offense, but to protect the interest of the small investors in the IPOs suggest some measures that should be taken by our regulator.

(7 marks) < Answer > The Indian capital market is booming like never before. The secondary market is on an upsurge and is reaching new highs every next week. The primary market is also active with lots of initial and follow-on public issues. In such a scenario, investors have to be more specific in their choice of investment. We saw the instances of circular trading and the issues of penny stocks in the secondary market a few months ago. The regulatory body, the Securities and Exchange Board of India (SEBI), unearthed this issue and made the retail investor cautious and more vigilant in picking up the right stocks. Once again, SEBI has done well to detect the violation of regulations in the primary market relating to demat accounts and public offerings. This throws some light on the functioning of banks, depository and registrar. SEBI's stance on this issue will further decide the strength of Indian capital market. This issue of multiple demat accounts has definitely created panic among investors, but it has also prompted them to make cautionary moves in the forthcoming public offers. From 2004-05, the primary market has witnessed increased activity by Foreign Institutional Investors (FIIs) and others. The sensex moved up by leaps and bounds. Earlier, the great primary market rally was witnessed during the Harshad Mehta Scam in 1992 and later in 1996 when technology stocks were on the rise. In the year 2005, many public offerings came and most of them are now trading higher than their listing price. They opened with a considerable premium at the time of listing. These huge profits in a very short span of time had lured some investors to explore IPO investments. They started applying for the public offerings with more than one demat account. Some unscrupulous people started taking advantage of this situation by opening a number of benami/fictitious demat accounts with the help of bankers and depository participants. They successfully had hidden their identity till they were exposed. After the Yes Bank scam, SEBI unveiled another scam that of the IDFC IPO. SEBI's investigation revealed that about 8.29% of the retail portion of the IDFC IPO was received by fictitious applicants who operated multiple demat accounts. Roopalben Panchal received 39,43,184 shares from 14,807 demat accounts and Purushottam Ghanshyam Budhwani received 2,98,412 shares from 1,122 demat accounts. It was also found that Budhwani had adopted a similar process in other IPOs such as Suzlon Energy, SPL Industries, Shoppers' Stop, Provogue India, Nectar Lifesciences, IL&FS Investmart, Gokuldas Exports, Gateway Distriparks, etc. Roopalben Panchal and her associates were also said to be involved in the IPOs of Sasken Communication and Jet Airways. All these demat account holders had their bank account with Bharat Overseas Bank and demat account with Karvy-DP. Other issues, which are under scanner, are Jaiprakash Hydro-Power, Punj Lloyd, FCS Software, PVR Cinema and Sringar Cinema.

Caselet 2
Read the caselet carefully and answer the following questions: 7. With respect to the caselet discuss the steps that should be taken for the development of Indian venture capital industry. (7 marks) < Answer > According to you which sectors appear to be promising for venture capitalists in India? (7 marks) < Answer > 9. India and China are becoming hub for the venture capital investment. Compare China with India as a destination of venture capital. (7 marks) < Answer >

8.

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The Indian venture capital (VC) sector has again started picking up momentum. Global venture capitalists are now looking at both India and China as the next big destinations for cross-border investments. India is the third largest economy in Asia (behind Japan and China), and also the second fastest growing country in Asia, next only to China. At an annual growth rate of 7% to 8%, it is surely ahead of many developing economies. Till 1998 India had no organized industry for venture capital. Till that time financial institutions and individuals were used to play the role of venture capitalists in India. In 1973 the committee was developed to enhance the venture capital as a source of funding new entrepreneurs and technology. After that some public sector funds were set up but the activity of the venture capital did not speed up as the concentration was on the high technology projects. After that the World Bank examined the possibility of developing venture capital in the private sector based on this the Government of India took a policy initiative and announced guidelines for venture capital fund in India. Some of the major VCF in India are ICICI Venture Funds Management Company Limited, IFCI Venture Capital Funds Ltd. (IVCF), SIDBI Venture Capital Limited (SVCL) and IL & FS Group Businesses. Foreign players are also taking part in the India as the venture capital funds. Although there is a lot of inflow of venture capital in the form of private equity to India, there remains a scarcity of venture capitalists willing to make investments in start-ups. The risks and the need for hand holding associated with early start-ups are much higher than those in private equity. But, definitely the VC industry will see resurgence in the early-stage funding due to a number of reasons, most important of them being the arrival of a number of US VC firms which would handpick companies with new, innovative or speculative enterprises. Secondly, although lots of VCs are on a lookout for ‘well-run’ companies, they haven’t been able to find many companies in areas like biotechnology and BPO which are still in a nascent stage in India.

Caselet 3
Read the caselet carefully and answer the following questions: 10. Now a days outsourcing of financial services is becoming a trend. But outsourcing has some risk attached with it. Before outsourcing the banks are required to consider these risks. Discuss these risks. (8 marks) < Answer > 11. Banks can outsource the financial services but still there are some activities the bank can not outsource. Discuss these activities.

(6 marks) < Answer > The world over, banks are increasingly using outsourcing, as a means of both reducing cost and accessing specialist expertise, not available internally and achieving strategic aims. 'Outsourcing' may be defined as a bank's use of a third party (either an affiliated entity within a corporate group or an entity that is external to the corporate group) to perform activities on a continuing basis that would normally be undertaken by the bank itself, now or in the future. Typically outsourced financial services include applications processing (loan origination, credit card), document processing, investment management, marketing and research, supervision of loans, data processing and back office related activities etc. This draft guideline given by RBI on Outsourcing is intended to provide direction and guidance to banks to adopt sound and responsive risk management practices for effective oversight, due diligence and management of risks arising from such outsourcing activities. This draft guideline is applicable to outsourcing arrangements entered into by a bank with a service provider located in India or elsewhere. The service provider may either be a member of the group/conglomerate to which the bank belongs, or an unrelated party. The underlying principles behind these guidelines are that the regulated entity should ensure that outsourcing arrangements neither diminish its ability to fulfill its obligations to customers and RBI nor impede effective supervision by RBI. Banks, therefore, have to take steps to ensure that the service provider employs the same high standard of care in performing the services as would be employed by the banks if the activities were conducted within the banks and not outsourced. Accordingly banks should not engage in outsourcing that would result in their internal control, business conduct or reputation being compromised or weakened. Outsourcing arrangements should not affect the rights of a customer against the bank, including the ability of the customer to obtain redress as applicable under relevant laws. Since the customers are required to deal with the service providers in the process of dealing with the bank, banks should reveal to their customers in the product brochures/agreements etc., the role of the service provider and their obligation towards the customers.

END OF SECTION E

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END OF QUESTION PAPER

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Suggested Answers Investment Banking and Financial Services-II (262): July 2006
Section D : Case Study
1. Economy and Industry risk analysis: As per the Economic analysis we can say that India is the third largest economy in Asia (behind Japan and China), and also the second fastest growing country in Asia, next only to China. At an annual growth rate of 7% to 8%, it is surely ahead of many developing economies. So India has the better prospects. And cement industry has also entered in the growth phase. We can observe that India is the second largest cement producer in the world with a production level of about 99 million tones (about 5% of world production ~ 2000 million tonnes). The installed capacity is about 119 million tonnes and at an expected 10 % growth rate the production is likely to grow to about 158.5 million tones at the end of 2006-2007. However, cement consumption per capita in our country at about 99-kg/ capita is one of the lowest. The world average is about 267 kg/capita. While that of China is 450 kg/capita. Similarly in Japan it is 631 kg/capita while in France it is 447 kg/capita. Infrastructure development is also taking pace in India. So it seems to be attractive. We can rate 20 out of 25 points on a conservative basis. 2. Business risk analysis a. Diversification: The Company is well diversified. Its cash flows are closely related to the sales of cement. It has four subsidiaries and ten associate companies. The company is achieving the advantage of diversification. Therefore we can assign 8 out of 10 to this parameter. b. Seasonality and Cyclicality: The cement industry has lot to do with the economic cycle. When economy is in growth phase cement industry also gains but when the economy passes through recession it faces the declines in the revenue. Therefore we can assign 5 out of 10 to this parameter. c. Size: Bharat cement is not among major players across India but it has large market in the south Indian market. The Company is the largest producer of cement in South India. The company is also having various products for various requirements. The Company’s plants are well spread with three in Tamilnadu and four in Andhra Pradesh which cater to all major markets in South India and Maharashtra. Therefore we will assign 8 out of 10 for this parameter on a conservative basis. d. Cost Structure: When we consider the cost associated with the company, it comes very high. The operating margin of the company is low i.e. around 12.24% and the industry average is 15.54%. The company can be benefited with the economies of scale. And the increase in the demand is more likely considering the economic scenario and size of the company we can assign 8 out of 10 for this parameter. e. Market Share: The Company is the market leader with a market share of 28% in the South. It aims to achieve a 35% market share in the near future. The Company has access to huge limestone resources and plans to expand capacity by de-bottlenecking and optimization of existing plants as well as by acquisitions. Therefore we will assign 10 out of 10 for this parameter. f. Marketing and Distribution Arrangement: The Company has a strong distribution network with over 10,000 stockists of whom 25% are dedicated. Therefore we can assign 10 out of 10 for this parameter. Financial Ratios: Growth Ratios: From March 2004 the operating income of the company is increasing but if we consider the PAT of the company, it’s negative. But the loss of the company is reducing. But looking at the market share and the growth potential we can assign 5 out of 10 to this parameter. Profitability ratios: Operating Margin (%) Net Profit Margin (%) Adjusted Return On Net Worth (%) 2006 12.24 -5.43 -17.94 2005 11.77 -11.41 -32.23 2004 4.68 -22.68 -49.05

3.

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Reported Return On Net Worth (%) Return On long Term Funds (%) Industry Averages Operating Margin (%) Net Profit Margin (%) Adjusted Return On Net Worth (%) Reported Return On Net Worth (%) Return On long Term Funds (%)

1.30 0.19 2006 15.54 8.13 2.03 2.09 1.09

-26.6 -3.87 2005 14.25 5.24 1.89 2.01 1.11

-49.06 -8.79 2004 10.89 2.13 0.79 1.55 0.97

Form the above comparison we can observe that the performance of the company was always behind the industry. But we can observe that the operating profit of the company has increased significantly in last two years. There is a correction in the net profit margins for the company. The return on long term funds was much below the industry average in the year 2004 but now it is coming in line with the industry. The expected performance of the company is also positive. It will achieve the operating margin of 13.79% on average and net profit margin of 1.38% on average. Which is significantly higher than the current levels. Considering the growth of the company we can assign 10 points out of 25 for this parameter. Leverage and Coverage Ratios Total Debt/Equity Owners fund as % of total Source Industry Averages Total Debt/Equity Owners fund as % of total Source 2006 5.01 24.54 2005 5.23 24.56 2004 5.28 24.53 2006 5.65 14.88 2005 5.81 14.52 2004 4.51 17.92

Debt to equity ratio of the company is almost in line with the industry average. But the difference can be observed in case of owner’s funds as % of total source.

2006
Financial charges coverage ratio Industry Averages 0.57

2005
0.26

2004
-0.14

2006
Financial charges coverage ratio 1.75

2005
1.54

2004
1.27

The financial charges coverage ratio of the company has improved during last two years. It has improved from -0.14 to 0.57 but still the company’s current earnings are not more than the interest commitment. Therefore for leverage and coverage we can assign 10 points out of 15 for this parameter. Turnover Ratios

2006
Inventory Turnover Ratio Fixed Asset Turnover Ratio Total Assets Turnover Ratio Industry Averages Inventory Turnover Ratio Fixed Asset Turnover Ratio Total Assets Turnover Ratio 2006 5.36 1.55 1.08 3.00 0.90 0.40

2005
2.75 0.81 0.35 2005 5.12 1.49 1.06

2004
2.46 0.75 0.29 2004 4.78 1.47 1.02

The company’s performance on this parameter as compared to the industry is not convincing. The company’s fixed asset turnover ratio is constantly below 1 which states the company’s sales are below its assets. Same with total asset turnover ratio. But we can also observe that these ratios are improving year by year. Therefore we can assign 10 points out 15 for this parameter. Liquidity Ratios 2006 2005 2004

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Current Ratio Quick Ratio Industry Averages

2.88 2.16

3.34 2.53

2.12 1.64

2006
Current Ratio Quick Ratio
2.54 2.07

2005
2.81 2.09

2004
2.52 2.17

4.

As far as the liquidity is concerned, the company is having very comfortable position as compared the industry. Therefore we can assign 15 out of 15 for this parameter. Cash flows Cash flows of the company is showing a volatile picture. But from the last year it has increased significantly. The expected performance of the company is also positive which will further improve the cash flows for the company. Therefore we can assign 10 out of 10 for this parameter. Financial flexibility The company is having superior financial flexibility. The company is having the access of various sources of finance. In 2005 it came out with GDS issue and raised amount of Rs 497 crore. The company is cement company which is highly capital intensive. And it is also difficult to liquidate the assets quickly. Therefore we can assign 8 points out of 10 for this parameter. Management Evaluation Track record The Bharat Cements Ltd was established in 1946 and the first plant was setup at Sankarnagar in Tamilnadu in 1949. After that the company has grown steadily. The company is having professional management.The cement industry itself is a cyclical industry because of that the performance of the company is not stable. But the vision of the management is very firm. And now the company has become the market leader in south. As well as they have diversified the business of the company having four subsidiaries and ten associate companies. That shows that the management of the company efficient and we can assign 10 out of 10 for this parameter. Corporate Strategy The corporate strategy of the company is also very sound. Company has undergone acquisitions too. Which shows that the company is trying to achieve growth. The company has also commissioned the power plants too. It has more than 10,000 stockiest. The company has also become the market leader in south. Considering all this we can assign 15 points out of 15 for this parameter. Performance of group companies: No adequate data is provided for the performance of the group companies. Therefore on a conservative basis we will assign 8 out of 10 for this parameter. Organizational structure Not much information is provided for the organizational structure. Considering the track record of the company and the corporate strategy we can assign 10 out of 10 for this parameter. Control systems The company has way back adopted the MIS. The company has adopted the Indian as well as the US standards for its accounting. We assign 10 out of 10 for this parameter. Personnel policies The company is also having fair personnel policies. It is given that the company has never faced any incidence of labour strike. Here we can assign 10 out of 10 for this parameter. Maximum Points 25 10 10 10 10 10 10 10 25 Points Awarded 20 8 5 8 8 10 10 5 15

Economy and Industry risk analysis Diversification Seasonality and Cyclicality Size Cost Structure Market Share Marketing and Distribution Arrangement Growth Ratios Profitability ratios

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Leverage and Coverage Ratios Turnover Ratios Liquidity Ratios Cash flows Financial flexibility Track record Corporate Strategy Performance of group companies Organizational structure Control systems Personnel policies

15 15 15 10 10 10 15 10 10 10 10 250 %

12 10 15 10 8 10 15 8 10 10 10 200 80.00

Therefore we can rate the bond under the AA grade. And we can say that that the bond is under investment grade. < TOP > 2. Probability Super Normal Normal Declining Recession 0.3 0.3 0.2 0.2 Credit Rating AAA AA A BB Beta 0.97 0.99 1.05 1.07 Expected Yield Super Normal Growth 0.3 0.3 0.3 0.3 Probability 0.2 0.3 0.3 0.2 Price 98.5 98.4 98.4 98.5 Yield 6.11 6.52 6.52 6.11 Value 1089.48 1087.5 1086.5 1085.53 Yield 10.20 10.00 9.90 9.80 T-Bill Bond Index 2.04 3.00 2.97 1.96 9.97 9.86 1.22 1.96 1.96 1.22 6.36 Expected cost

Expected Yield Normal Growth 0.3 0.3 0.3 0.3 Probability 0.25 0.3 0.3 0.15 Price 98.5 98.6 98.6 98.7 Yield 6.11 5.70 5.70 5.28 Value 1087.11 1083.35 1082.17 1080.78 Yield 9.96 9.58 9.46 9.32 T-Bill Bond Index 1.53 2.49 1.71 2.87 1.71 2.84 0.79 1.40 5.74 9.60 Expected cost Expected Yield T-Bill Bond Index 0.57 0.98 0.53 0.92 2.11 3.64 2.11 3.58 5.32 9.12 Expected cost

9.56

Declining 0.2 0.2 0.2 0.2

Probability 0.1 0.1 0.4 0.4

Price 98.6 98.7 98.7 98.7

Yield 5.70 5.28 5.28 5.28

Value 1085.3 1079.89 1078.61 1077.22

Yield 9.78 9.23 9.10 8.96

9.31

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Recession 0.2 0.2 0.2 0.2

Probability 0.1 0.1 0.3 0.5

Price 98.7 98.7 98.7 98.8

Yield 5.28 5.28 5.28 4.87

Value 1079 1078.21 1077.02 1075.15

Yield 9.14 9.06 8.94 8.75

Expected Yield T-Bill Bond Index 0.53 0.91 0.53 0.91 1.58 2.68 2.44 4.38 5.08 8.88 Expected cost

9.14

Now the expected cost of the bond considering all the scenarios will be 0.3 0.3 0.2 0.2 Expected cost Now the expected price after one year = 8.5PVIFA(9.52,7) + 100PVIF(9.52,7) = 42.04 + 52.92 = Rs.94.96 Expected one year return to Mr. Prashant 9.86 9.56 9.31 9.14 2.96 2.87 1.86 1.83 9.52

= = 3.46%. < TOP > Credit rating is an opinion expressed by an independent professional organization, after making a detailed study of all relevant factors. Such an opinion will be of great assistance to investors in making investment decisions. It also helps the issuers of debt instruments to price their issues correctly and to reach out to new investors. Regulators like Reserve Bank of India (RBI) and Securities & Exchange Board of India (SEBI) often use credit rating to determine eligibility criteria for some instruments. For example, the RBI has stipulated a minimum credit rating by an approved agency for issue of Commerce Paper. In general, credit rating is expected to improve quality consciousness in the market and establish, over a period of time, a more meaningful relationship between the quality of debt and the yield from it. Credit Rating is also a valuable input in establishing business relationships of various types. It does not. The reason is that some factors, which are of significance to an investor in arriving at an investment decision, are not taken into account by rating agencies. These include reasonableness of the issue price or the coupon rate, secondary market liquidity and pre-payment risk. Further, different investors have different views regarding the level of risk to be taken and rating agencies can only express their views on the relative risk. < TOP > It is neither possible nor even desirable, to totally eliminate the subjective element. Rating does not come out of a pre-determined mathematical formula, which fixes the relevant variables as well as the weights attached to each one of them. Rating agencies do a great amount of number crunching, but the final outcome also takes into account factors like quality of management, corporate strategy, economic outlook and international environment. To ensure consistency and reliability, a number of qualified professionals are involved in the rating process. The Rating Committee, which assigns the final rating, consists of professionals with impeccable credentials. Rating agencies also ensure that the rating process is insulated from any possible conflicts of interest. < TOP >

3.

4.

Section E: Caselets Caselet 1
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5.

Various reasons can be sited for resorting to multiple demat accounts. Firstly, using more than one demat account for application in a retail investor category of a public offer will significantly swell up the possibility of getting the allotment. Secondly, banks cannot lend more than Rs. 10 lakhs to a single investor for a public issue. This prompts the investors to open multiple and benami accounts. Thirdly, as per the banking norms and the government guidelines any investment or deposit beyond Rs. 50,000 has to be through a cheque or cash by indicating the Permanent Account Number (PAN). So, by opening many demat accounts and paying less than 50,000 one can escape mentioning the PAN. It has also been revealed that the benami account holders created duplicate PAN. And finally, the modus operandi encouraged money laundering. Through benami accounts one can refine one's unaccounted money. This can be explained by the following example. Mr. X had applied for 5000 shares in a public offer with a price of Rs. 10. He was able to make a contract with Mr. Y, who agreed to buy those shares at Rs. 12 on the date of listing. If on the listing date the share price opened with a 30% premium, then Mr. Y would earn Re. 1. At the same time, Mr. X also a fixed a profit of Rs. 2. In this situation, Mr. X would get a cheque of Rs. 65,000 on the sale of 5000 shares at Rs. 13 each. He would give Rs. 5,000 in cash from his unaccounted money. So, Mr. X was able to convert his unaccounted Rs. 5,000 to account it. < TOP > For compliance of the KYC norms, a robust and powerful identification system needs to be put in place. Many countries have their own identification mechanism. In the US, a Social Security Number (SSN) is commonly used as the identification mechanism. Those persons who are not qualified for SSN are issued an Individual Taxpayer Identification Number (ITIN). This number is given to foreign nationals and others who have tax reporting or filing requirement and do not qualify for SSN. The UK is in the process of having a national identity card system. Germany has an identity card system which is compulsory for all its citizens. Some other countries also have similar arrangements for identifying their citizens. In India we have various identification mechanisms like the birth certificate, school leaving certificate, driving license, phone bill, electricity bill, passport, voter's identity card, PAN and Market Participants' and Investors' Identification Numbers (MAPIN). MAPIN was introduced to create a unique non-duplicable ID for all investors in order to establish an audit trail. Sebi had initiated MAPIN, but later halted it; with a view that there will be a multiple unique ID. However, instead of making a new identity base, the government should make PAN compulsory for all capital market actions. On the basis of the PAN card, a new identity based on the biometric system should be introduced. Thus, PAN will become the sole identity for all financial transactions. All customer identification should be based on the PAN card. This unique number will enable Sebi and the government to cover different segments of the markets, check fraud and manipulation and assist in building other government databases. There is also a crucial need to continuously observe securities flow in demat accounts. Both NSDL and CDSL [Central Depository Services (India) Ltd.] should move toward better surveillance mechanism and should take up greater responsibility in the interest of the investors. < TOP >

6.

Caselet 2
7. Venture funds can evolve in an atmosphere of structural flexibility, fiscal neutrality and operational adaptability that can be attained mostly through relative flexibility in investment and exit norms. Infrastructure in the form of incubators and R&D needs to be promoted using government support and private management as has successfully been done by other countries. This is necessary for faster conversion of R&D and technological innovation into commercial products. Also, the present pool of funds available for venture capital is very limited and is predominantly contributed by foreign funds. The list of sophisticated institutional investors permitted to invest in venture capital funds needs to be increased. Active and buoyant stock market and ample of liquidity is also an important factor to attract the foreign investors because it leads to easy exits. < TOP > 8. Technology is the lead focus of the VCs. This is expected to remain relatively steady over the next five years. Apart from technology, communications and biotechnology are also areas which have generated strong interest. There are many niche areas where significant value can be created such as nano-technology, material science, environment and alternative source of energy. Entertainment and digital media are also emerging areas. Investments in companies operating in the energy/environment sector over the next five years are

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likely to be increased. This trend will be reflected in India too. < TOP > 9. Venture capitalists today view India and China as regions ripe for investment, due to an abundance of skilled labour at a low cost, high level of IT knowledge and a strong sense of work ethic. The large indigenous populations mean that products made in each country could have domestic, as well as foreign markets, showcasing both country’s ability to become the ‘factory to the world.’ Also, China has always been open to international trade, which has always been leery of foreign direct investment. But China, for instance, does not offer much legal protection for intellectual property rights. Also, the state-owned banking system is inefficient and supports state-owned enterprises, rather than the private sector. Even the stock market there is largely reserved for state-backed entrepreneurs. An ideal situation for a venture capitalist would be to invest in a company that develops products and services in India and has a manufacturing team in China. In China there is no market for block deals and stock markets are also not liquid and transparent as India. < TOP >

Caselet 3
10. The key risks in outsourcing that need to be looked into by the banks are: -

· · · · ·

Strategic Risk – The service provider may conduct business on its own behalf, which is inconsistent with the overall strategic goals of the bank Reputation Risk – Poor service from the service provider, its customer interaction not being consistent with the overall standards of the bank Compliance Risk – Privacy, consumer and prudential laws not adequately complied with Operational Risk – Arising due to technology failure, fraud, error, inadequate financial capacity to fulfill obligations and/or provide remedies Exit Strategy Risk – This could arise from over–reliance on one firm, the loss of relevant skills in the bank itself preventing it from bringing the activity back in-house and contracts entered into wherein speedy exits would be prohibitively expensive Counterparty Risk – Due to inappropriate underwriting or credit assessments Country Risk – Due to the political, social or legal climate creating added risk

Contractual risk – arising from whether or not the bank has the ability to enforce the contract Concentration and Systemic Risk – Due to lack of control of individual banks over a service provider, more so when overall banking industry has considerable exposure to one service provider. < TOP > 11. Banks cannot outsource core management functions like corporate planning, organization, management and control and decision-making functions like determining compliance with KYC norms for opening deposit accounts, according sanction for loans and management of investment portfolio. < TOP >

· · ·

< TOP OF THE DOCUMENT >

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Question Paper
Investment Banking & Financial Services - II (262) : October 2006
Section D : Case Study (50 Marks)
• • • • This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study Read the case carefully and answer the following questions:
1. Delineate the risk factors inherent in the issue; clearly distinguishing between internal and external factors. (10 marks)< Answer > 2. Discuss the qualitative factors both internal and external to the company that are to be considered for determining the basis for the issue price. (8 marks) < Answer > After the closure of the issue Rs.60 is the cut-off price decided. Being the registrar to the issue you are required to allot the shares to the Retail Investors and Non-Institutional Investors. (12 marks) < Answer > SEBI has been taking a pioneering role in investor protection by increasing disclosure levels by entities seeking to access equity markets for funding. However, these disclosures demand fairly high levels of analytical sophistication of the reader in order to effectively achieve the goal of information dissemination. In this context, a. Discuss how IPO grading differs from the investment recommendation. b. Elucidate how RPL can get its IPO graded. (5 + 5 = 10 marks) < Answer > In the prospectus of the company one generally comes across the following terms: a. Green-shoe Option b. Open book/closed book c. Hard underwriting d. Soft underwriting e. Differential pricing As an investment banker discuss these terms.

3.

4.

5.

(2 + 2 + 2 + 2 + 2 = 10 marks) < Answer > ISSUE OF 1,800,000,000 EQUITY SHARES OF RS.10 EACH FOR CASH AT A PRICE OF RS. [●] PER EQUITY SHARE (INCLUDING SHARE PREMIUM OF RS. [●] PER SHARE) AGGREGATING TO RS. [●] MILLION INCLUDING PROMOTER’S CONTRIBUTION OF 900,000,000 EQUITY SHARES OF RS. 10 EACH FOR CASH AT A PRICE OF RS. [ ●] PER EQUITY SHARE (“PROMOTERS CONTRIBUTION”) AND NET ISSUE TO PUBLIC OF 900,000,000 EQUITY SHARES OF RS. 10 EACH (“NET ISSUE”). THE NET ISSUE WILL CONSTITUTE 20% OF THE FULLY DILUTED POST-ISSUE PAID-UP CAPITAL OF RELIANCE PETROLEUM LIMITED (“COMPANY” OR “ISSUER”). The Issue was made through the 100% Book Building Process where at least 60% of the Net Issue was to be allocated on proportionate basis to Qualified Institutional Buyers ("QIBs") (including 5% of the QIB portion that was to specifically be allotted to mutual funds on proportionate basis). Further, not less than 10% of the Net Issue was available for allocation on proportionate basis to Non-Institutional Bidders and not less than 30% of the Net Issue was available for allocation on proportionate basis to Retail Bidders, subject to valid bids being

received at or above the Issue Price. On 12th April, 2006 the Company and Reliance Industries Limited (“RIL”), entered into an Equity Investment Agreement with Chevron India Holdings Pte. Ltd, (“Chevron India”) a wholly owned subsidiary of Chevron Corporation, (“Chevron”). Under the terms of the agreement, Chevron India agreed to purchase initially 225 million of the Company’s Equity Shares (out of the minimum promoters’ contribution of 20% subscribed as per Clause 4.1.1 of the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines, 2000, as amended (the “SEBI DIP Guidelines”), representing 5% of the post-Issue Equity Share capital of the Company, at a price of Rs. 60 per Equity Share for an aggregate consideration of Rs. 13.5 billion (approximately US$300 million). On April 20, 2006, Chevron India has agreed to be one of the Promoters of the Company. Pursuant to this agreement RIL transferred 225,000,000 Equity Shares to Chevron India on April 27, 2006. Upon the acquisition of the 5%, Chevron India may choose a nominee to serve as a director of the Company for as long as Chevron retains ownership of all of the 5% of the Equity Share capital. No such director has been appointed by Chevron as of the date of this Prospectus. Upon completion of the offering, RIL would hold 75% of the Company’s Equity Share capital and Chevron India will hold 5% of the Company’s Equity Share capital. THE ISSUE Issue of Equity Shares : 1,800,000,000 Equity Shares (1,800 million Equity Shares) Of which, Promoter's : 900,000,000 Equity Shares (900 million Equity Shares) Contribution : 900,000,000 Equity Shares (900 million Equity Shares) Net Issue to Public Of which the QIB Portion : At least [•] Equity Shares (allocation on proportionate basis) Of which Available for : [•] Equity Shares (allocation on proportionate basis) Allocation to Mutual Funds Non-Institutional Portion1 : Minimum of [•] Equity Shares (allocation on proportionate basis). Retail Portion1 : Minimum of [•] Equity Shares (allocation on proportionate basis). Equity Shares outstanding prior : 2,700,000,000 Equity Shares to the Issue Equity Shares outstanding after : 4,500,000,000 Equity Shares the Issue 1. Under-subscription, if any, in any category except in the QIB category would be met with spill-over from other categories at RPL’s sole discretion, in consultation with the BRLMs. If a minimum allotment of 60% of the Issue is not made to the QIBs, the entire subscription money shall be refunded. OBJECTS OF THE ISSUE The objects of the Issue are to achieve benefits of listing and raising capital for financing RPL’s proposed greenfield Project as discussed below. RPL intend to utilize the proceeds of the Issue, after deducting underwriting and management fees, selling commissions and other expenses associated with the Issue (“Net Proceeds”), to partially finance the equity portion of the Project. RPL’s fund requirements are based on management estimates only at this stage. The main object clause of RPL’s Memorandum of Association and objects incidental to the main objects enable us to undertake RPL’s existing and proposed activities. Description of the Project: RPL is proposing to set up a refinery that will have a capacity to process 580 kilo barrels of crude oil per stream day (KBPSD) and also a 0.9 million tonnes per annum (TPA) polypropylene plant. The plant is proposed to be set up in a Special Economic Zone at Jamnagar being set up by RFL, a subsidiary of RIL. The SEZ is yet to be notified. Upon completion, RPL’s refinery will be the sixth largest refinery in the world based on current capacities. (Source: Oil and Gas Journal, December 2005). While being one of the largest globally, the proposed refinery would also be a highly complex refinery with significant secondary processing facilities designed to maximize the quantity of value added products such as Alkylates, Diesel, ATF, Polypropylene, etc.

INDUSTRY Global Oil Markets

Oil is one of the world’s most significant sources of commercial energy. It met 37% of the global energy needs of 10,224 million tonnes of oil equivalent (“MTOE”) in 2004 while its nearest rivals, coal and natural gas, met 27% and 24% respectively, as shown in the chart below.
Total -10,224 MTOE
Natural Gas, 24.00% Coal, 27.00%

Nuclear, 5.00% Hydro Electricity, 6.00%

Oil, 37.00% Natural Gas Nuclear Hydro Electricity Oil Coal

According to the BP Statistical Review of World Energy, June 2005, the Middle East dominates proven reserves of oil, with about two-thirds of the estimated 1,189 billion barrels of the world’s proven reserves. Saudi Arabia (263 billion barrels), Iran (133 billion barrels) and Iraq (115 billion barrels) are the three largest holders of proven oil reserves in the world. The three largest producers of oil, including natural gas condensates, in the world are: Saudi Arabia (10.6 million barrels per day), Russia (9.3 million barrels per day) and the United States (7.2 million barrels per day). Global Oil Refining Industry Introduction The oil refining industry is a global business because crude oils, other feedstocks and refined petroleum products can be transported at a relatively low cost by sea and by pipeline and there is worldwide demand for such products. The principal factors affecting refining margins are the demand for and prices of refined petroleum products relative to the supply and cost of crude oils and other feedstocks and the configuration, capacity and utilization rates of refineries. The range and quality of refined petroleum products produced by any given refinery depends on the types of crude oil used as feedstock and the configuration of the refinery. Light and sweet crude oils are more expensive and generate greater yields of higher value refined petroleum products, such as gasoline, aviation fuels and diesel. Heavier and sourer crude oils are less expensive and generate greater yields of lower value petroleum products, such as fuel oils. The configuration of certain refineries, particularly in North America, is typically oriented towards the production of gasoline whereas the configuration of refineries in most of the other regions is typically oriented towards the production of middle distillates, such as diesel and aviation fuels. In addition, there are refineries which are configured towards certain other specialty products, such as base oils, naphthenics and bitumen. Oil refineries can generally be divided into two principal categories: simple hydroskimming refineries and complex refineries. Simple hydroskimming refineries primarily carry out the distillation process while complex refineries carry out two additional functions, conversion of hydrocarbon fractions produced in the crude distillation process to other products and the treatment of intermediate products to create higher valueadded products. Consequently, simple refineries produce lower value petroleum products than complex refineries for any given mix of crude oil feedstocks. Refined Petroleum Products Below is a brief description of petroleum products and their applications: LPGs: Liquefied petroleum gases, consisting primarily of propane and butane, are produced for use as a

premium fuel and as an intermediate material in the manufacturing of petrochemicals. Naphtha: Principally used as a feedstock by the petrochemicals industry for producing basic building blocks such as ethylene, propylene, butadiene, benzene, toluene and xylenes, which in turn are used for the production of plastics, synthetic fibres, synthetic rubbers and other products. Gasoline: Various gasoline blendstocks are blended to achieve specifications for regular and premium grades in both summer and winter gasoline formulations, wherever applicable. Additives are often used to enhance performance and provide protection against oxidation and corrosion. Middle distillates: Middle distillates are kerosene, aviation fuel, diesel fuel and heating oil. Fuel oils: Many marine vessels, power plants, commercial buildings and industrial facilities use fuel oils or combinations of fuel oils and distillate fuels for heating and processing. Petcoke: Petroleum coke is a solid residual byproduct of delayed coking process. Over 75% of petcoke produced is fuel grade and has about 15-25% higher heating value than coal. Bitumen: Residual product of crude oil vacuum distillation, which is used primarily for asphalt coating of roads and roofing materials. Niche, high value-added refined petroleum products: Various refined petroleum products produced in relatively small quantities such as base oils, MTBE, ETBE, TAME, Alkylate, Iso Octane and other refined petroleum products. These products are commonly used as blending components for transportation fuels or for lubricants. RPL’S BUSINESS Overview RPL is a start-up company, formed to set up a greenfield petroleum refinery and polypropylene plant (the “Project”) to be located in a Special Economic Zone in Jamnagar in the state of Gujarat in western India. RPL’s proposed refinery and polypropylene plant will be located adjacent to the existing refinery and petrochemicals complex of RPL’s Promoter, Reliance Industries Limited (“RIL”), the largest private sector company by market capitalization in India with assets of over Rs.806 billion (approximately US$ 18 billion) as of March 31, 2005. RIL is the only private sector company from India to feature in the Fortune Global 500. RPL will be 80% owned subsidiary of RIL after the Issue. RPL have not yet commenced business operations. RPL have developed plans to construct a refinery with a complexity of 14.0, as measured using the Nelson Complexity Index. The refinery will have a total atmospheric distillation capacity of approximately 580 kilo barrels per stream day (“KBPSD”). The polypropylene plant will have a capacity to produce 0.9 million metric tonnes per annum (“MMTPA”). The Project was initially contemplated to be set up by RIL which subsequently decided to implement the Project through RPL. The capital cost of the Project is estimated at Rs.270 billion (approximately US$ 6 billion). RPL propose to fund the Project through debt of Rs.157.5 billion (approximately US$ 3.5 billion) and equity of Rs.112.5 billion (approximately US$ 2.5 billion), including proceeds from the Issue. Any additional equity raised in excess of Rs.112.5 billion will be used as additional contingency for the Project. RPL have agreed to a preliminary term sheet with certain banks and financial institutions to provide a syndicated term loan facility for approximately Rs.67.5 billion (US$ 1.5 billion).RPL intend to seek additional financing through export credit agencies for approximately Rs.45 billion to Rs.67.5 billion (US$ 1 billion to US$ 1.5 billion). RPL anticipate raising further debt funding of approximately Rs.22.5 billion to Rs.33.75 billion ( US$ 500 million to US$ 750 million) in accordance with the funding requirements for the Project, as they arise. RPL’s intention is to complete construction and commission the refinery and the polypropylene plant in, or around, December 2008. RPL have entered into agreements with Bechtel France S.A.S (“Bechtel”) to license the technology for the major process units of the refinery and polypropylene plant. Bechtel will also provide engineering, project management and other construction services for the Project. RIL has proven expertise in building and operating a large refinery and petrochemicals complex. Its existing refinery, currently the third largest refinery in the world by atmospheric distillation capacity, was built in 36 months and commenced commercial production during 2000. This refinery has operated at near 100% utilization during its five years of operations, consistently outperforming the average utilization rate of refineries

in the Asia Pacific region, the European Union and North America as reported by PEL Market Services, Biannual Refining Report, July 2005. With a Nelson Complexity Index of 11.3, the existing refinery has achieved Gross Refining Margins (“GRMs”) that are consistently higher by US$ 2 to US$ 3.2 per barrel than the benchmark Singapore Dubai Crack Margins as reported by Reuters (“Singapore Margins”) during this period. In 2005, RIL was named the “International Refiner of the Year” by the Hart Energy Publishing LP. It was ranked number one in “Energy Performance” amongst large complex refineries in the Asia Pacific Region in the Solomon Benchmarking Survey, by Solomon Associates of USA in 2003. RPL’s proposed refinery and polypropylene plant will be located in a Special Economic Zone (the “SEZ”) and will receive certain tax benefits and concessions under SEZ regulations, subject to certain conditions. Product Slate The proposed refinery process configuration is designed to maximize production of gasoline, alkylate, jet fuel and diesel as well as premium products such as 10 ppm sulphur gasoline and 10 ppm sulphur diesel and to minimize the production of lower value-added products such as fuel oil. Importantly, the refinery’s configuration is intended to achieve the product slate, outlined in the table below, by using lower cost heavy/sour crude grades, which RPL believe will help it to maximize the refining margins. RPL have designed the refinery process to enable it to shift production within specified ranges to meet product demand. The table below shows the range of volumes that may be produced/ processed for the principal products from RPL’s proposed refinery. The mix of volumes may change depending on market dynamics. Product Diesel Gasoline Jet / Kerosene Petcoke Alkylates Polypropylene Sulphur RPL’s Key Competitive Strengths RPL believe that its proposal to construct and operate a refinery and polypropylene plant benefits from the following competitive strengths: • • • • • RIL’s (RPL’s Promoter’s) superior project execution skills in constructing a complex refinery. Large and complex refinery capable of using heavier and sourer, low cost crude to produce high quality, premium petroleum products Benefits of low capital costs Strategic location with proximity to crude oil sources and target export markets Fiscal incentives by virtue of being located in a Special Economic Zone Production Range (in MMTPA) 12.0-13.0 8.0-10.0 1.0-2.0 2.0 -3.0 2.0-3.0 0.85-0.90 0.45-0.6

RPL’s Strategy RPL’s strategy for the refinery operations is three pronged: • • • Capitalise on forecast demand-supply imbalances in global petroleum products Retain flexibility in the refinery design to provide us with the ability to optimise crude oil input, product slate and product quality Incorporate best practices of RIL’s existing refinery to establish efficient and profitable operations and exploit synergies with RIL’s existing refinery.

Operational support services by RIL’s Affiliates

RPL’s arrangements with RIL will be supplemented by infrastructural and support agreements that RPL intend to enter into, pursuant to term sheets that have been agreed, with RIL’s Affiliates, including RFL, RUPL, RPTL and REAL. These services include: • Land and associated infrastructure in SEZ: RPL require approximately 1,700 acres of land for RPL’s proposed refinery and polypropylene plant in the SEZ. Reliance Infrastructure Limited (“RFL”), a wholly owned subsidiary of RIL and the developer of the SEZ, will acquire and lease the required land to us and provide basic infrastructure in the SEZ including roads, storm water drains and township facilities for the employees of the proposed refinery. RFL will also provide the desalinated water, sea water and potable water facilities required by us. RFL has already acquired 1,100 acres of land and is in the process of acquiring the remaining land for the Project. The above land is yet to be notified as an SEZ by the relevant authorities. • Power and Steam: Steam and power required for RPL’s refinery and polypropylene plant will be supplied by Reliance Utilities and Power Limited (“RUPL”), a proposed co-developer of the SEZ that currently supplies steam and power to RIL’s existing refinery and petrochemicals complex at Jamnagar. As per the proposed configuration for the Project, the estimated ongoing power and steam requirement for RPL’s refinery and polypropylene plant are expected to be approximately 450 MW and 1600 tonnes per hour, respectively. • Port and Terminal Facilities: Reliance Ports and Terminals Limited (“RPTL”), a proposed co-developer of the SEZ, is to provide the port and terminal facilities required for the proposed refinery’s import of feedstock and export of petroleum products. RPTL at present provides these types of facilities for RIL’s existing refinery and polypropylene plant at Jamnagar. For RPL’s proposed refinery, RPTL is to put in place additional infrastructural facilities to meet RPL’s requirements. The projected costs for these new facilities will be financed by RPTL from its own resources and through borrowings from third parties. • Construction Services: Reliance Engineering Associates Private Limited (“REAL”) is to provide civil construction services during the construction of RPL’s proposed refinery. REAL has significant experience in providing these services and was involved in the construction of RIL’s existing refinery at Jamnagar. REAL has over 2,000 employees and is in the process of augmenting its workforce in preparation for providing its services for our proposed refinery. Comparison with Domestic Peers Book Value EPS (Rs.)1 Reliance Petroleum Limited# Indian Oil Corporation Limited Hindustan Petroleum Corporation Limited Bharat Petroleum Corporation Limited Mangalore Refinery and Petrochemicals Limited Reliance Industries Limited Kochi Refineries Limited Bongaigaon Refinery and Petrochemicals Limited Chennai Petroleum Corporation Limited 1. 2. 3. 15.8 4.1 63.3 32.2 9.8 P/E2 33.4 10.6 11.3 5.6 7.0 RONW (%)3 20.0 15.8 15.8 48.5 21.8 38.6 73.0 33.0 (R ) 9.99 222.5 248.8 212.9 12.3 270.4 184.8 38.0 134.4

44.8 5.3 # Not applicable as it has not commenced commercial operations. EPS is for trailing twelve months period ended January 31, 2005

Price per share has been taken as the closing price on February 14, 2006 for calculating P/E RONW has been calculated as per latest fiscal year ended March 31, 2005

Source: EPS and BV have been used from Capital Market dated February 13-26, 2006 Vol. XX/25 Source of RONW is from Capital Market dated January 30-February 12, 2006 Vol. XX/24 Promoter Group Companies 1. Indian Petrochemicals Corporation Limited

2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22.

Reliance Industrial Infrastructure Limited Reliance Industrial Investments and Holdings Limited Reliance Ventures Limited Reliance Strategic Investments Limited. Reliance LNG Limited Reliance Do Brasil Industria E Commercia De Portudos Texteis, Quimicos, Petroquimicos E Derivados Ltda (Reliance Brazil L.L.C.) Reliance Industries (Middle East) DMCC Reliance Infrastructure Limited Reliance Power Ventures Limited Reliance Gas Pipelines Limited Reliance Technologies LLC Reliance Europe Limited Reliance Petroinvestments Limited Reliance Nutraceuticals Private Limited Reliance Pharmaceuticals Private Limited Reliance Retail Private Limited Reliance Netherlands B.V. Petronet India Limited Petronet VK Limited Petronet CI Limited Trevira Holding GmbH CAPITAL STRUCTURE OF RPL

RPL’s share capital as at the date of filing this Draft Red Herring Prospectus with SEBI (before and after the Issue) is set forth below. (Rs. million, except share data) Aggregate Nominal Aggregate Value Value at Issue Price A. Authorised Share Capital 10,000,000,000 5,000,000,000 B. Issued, Subscribed and Paid-Up Share Capital 2,700,000,000 Equity Shares of Rs.10 each fully C. Issue in terms of this Draft Red Herring 1,800,000,000 Equity Shares of Rs.10 each fully D. Promoter's Contribution 900,000,000 900,000,000 Of which QIB Portion of at least [•] Equity Shares Non-Institutional Portion of at least [•] Equity Shares Retail Portion of at least [•] Equity Shares [•] [•] [•] [•] [•] [•] Equity Shares of Rs.10 each as Equity Shares of Rs.10 each 27,000 18,000 [•] Equity Shares of Rs.10 each Preference Shares of Rs.10 each 100,000 50,000

9,000 9,000 [•]

[•]

E. Net Issue to Public

F. Equity Share Capital after the Issue 4,500,000,000 Equity Shares of Rs.10 each fully G. Share Premium Account Before the Issue After the Issue Notes: a. b. 45,000 0 [•] [•]

RPL’s authorised share capital at the time of incorporation was Rs.100 million divided into 100 million Equity Shares of Re.1 each. At the Extraordinary General Meeting held on January 30, 2006, the authorised share capital was modified by consolidating the existing authorised share capital of Rs.100 million divided into 100 million Equity Shares of Re. 1 each into 10 million Equity Shares of Rs.10 each. At the same meeting, the authorised share capital was increased to Rs.150,000 million divided into 10,000 million Equity Shares of Rs.10 each and 5,000 million Preference Shares of Rs.10 each. The Company is exploring possibilities of placing Equity Shares with certain investors. The Company has sought approval from SEBI for such placement of Equity Shares prior to filing of Red Herring Prospectus with the ROC. In such a case, the size of the Net Issue to Public would stand reduced to the extent of such placement.

c. d.

Book Building Process Book Building Process refers to the process of collection of Bids, on the basis of the Draft Red Herring Prospectus within the Price Band. The Issue Price is fixed after the Bid Closing Date. The principal parties involved in the Book Building Process are: 1. 2. 3. 4. 5. The Company; The Book Running Lead Managers, in this case being JM Morgan Stanley Private Limited and DSP Merrill Lynch Limited; The Syndicate Members who are intermediaries registered with SEBI or registered as brokers with BSE/NSE and eligible to act as Underwriters; and The Registrar to the Issue, in this case being Karvy Computershare Private Limited; Escrow collection banks.

IPO Grading RPL have not opted for the grading of this issue from credit rating agency. Credit Rating As the Issue is of equity shares, credit rating is not required. Trustees As the Issue is of equity shares, the appointment of Trustees is not required. Payment Methods The Payment Methods available to the investors for applying in this Issue are as follows: Amount Payable Payment Method-I Retail Individual Bidders Face Value (per share) On Application [•] [•] [•] 10 [•] [•] Premium Total Payment Method-II Any Category** Face Value Premium Total

By Due Date for [•] [•] [•] payment of Balance Amount Payable * Total 10 [•] [•] 10 [•] [•] * Retail Individual Investors shall be required to make the payment of the Balance Amount Payable by the Due Date for payment of Balance Amount Payable. They shall be notified of the Balance Amount Payable simultaneously with the approval of the Basis of Allotment by the Stock Exchanges. ** Bidders in the QIB category will be required to make payment of 10% of the Bid Amount, with the balance being payable on allocation, but before allotment.

Key Features of the Payment Methods 1 Payment Method - I (“Payment Method – I”) a. b. c. d. Only Retail Individual Investors are eligible for this method. (Investors may note that the total bid amount will be used to determine if a bid is in the retail category or not, and not just the amount payable on application). While bidding, the Bidder shall make a payment of Rs. [●] per Equity Share, irrespective of the Bid Price. Out of the amount of Rs. [●] paid while bidding, Rs. [●] would be adjusted towards face value of the Equity Shares and Rs. [●] shall be towards share premium. At the time of allotment i. If the amount paid by the Bidder is equal to or higher than the total amount payable (being the Issue Price multiplied by the number of shares allotted) by the Bidder on the Equity Shares allotted to the Bidder, RPL reserve the right to adjust the excess amount towards the Balance Amount Payable and issue fully paid Equity Shares only. The excess amount, if any, after adjusting the Balance Amount Payable shall be refunded to the Bidder (i.e., Refund equals total amount paid on bidding minus the total amount payable on the shares allotted). ii. If the amount paid by the Bidder is less than the total amount payable by the Bidder (being the Issue Price multiplied by the number of shares allotted) on the Equity Shares allotted to the Bidder, RPL reserve the right to adjust any excess of the amount received from the Bidder over the Amount Payable on Application towards the Balance Amount Payable.

e.

Equity Shares in respect of which the Balance Amount Payable remains unpaid may be forfeited, at any time after the Due Date for payment of Balance Amount Payable.

Payment Method II (“Payment Method II”) a. Bidders under any category can choose this method. b. While bidding, the Bidder shall have to make the full payment (Bid Amount multiplied by number of Equity Shares bid) for the shares bid. However, Bidders in the QIB category will be required to make payment of 10% of the Bid Amount multiplied by the number of Equity Shares bid, with the balance being payable on allocation but before allotment. The Issue received 2,108,279 applications for 23,049,733,824 Equity Shares resulting in 51.22 times subscription. The details of the applications received in the Issue from Qualified Institutional Buyers, NonInstitutional and Retail Individual Investors categories are as under (Before Technical Rejection): Category No. of Applications No. of Shares Retail Bidders 2094659 2011656932 Non Institutional Bidders 13209 2622131892 Qualified Institutional Bidders 411 18415945000 Final Demand The final demand at different bid prices is as under: Bid Price No. of Shares % to Total Cumulative Cumulative

57 58 59 60 61 62 & Cut Off

3493900 1031800 107000 34334100 2020200 23046289300 23087276300

0.02 0.00 0.00 0.15 0.01 99.82 100.00

Total 23087276300 23083782400 23082750600 23082643600 23048309500 23046289300

% to total 100.00 99.98 99.98 99.98 99.83 99.82

Retail Investors The total number of shares to be allotted in this category is 135,000,000 Equity Shares and following is the relevant information Category 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1500 1600 Non Institutional Investors The total number of shares to be allotted in this category is 45,000,000 Equity Shares and following is the relevant information Category 1700 1800 10000 50000 100000 120000 150000 200000 500000 1000000 1500000 2000000 4000000 5000000 11300000 32258000 93540000 111290000 No. of Applns. 299 71 416 137 177 7 48 50 48 15 6 6 6 1 1 2 1 1 No. of Applications 74871 100887 67209 64367 189368 45310 34686 562408 5022 115074 8673 10712 3446 3440 32200 621601 % to total 3.86 5.20 3.47 3.32 9.76 2.34 1.79 29.00 0.26 5.93 0.45 0.55 0.18 0.18 1.66 32.05

Method of proportionate basis of allocation In the event the Issue is over-subscribed, the basis of allotment shall be finalized by the Company in consultation with the Designated Stock Exchange. The Executive Director or Managing Director (or any other senior official nominated by them) of the Designated Stock Exchange along with the BRLMs and the Registrar to the Issue shall be responsible for ensuring that basis of allotment is finalized in a fair and proper manner. Allotment to Bidders shall be as per the basis of allocation as set out in this Prospectus under “Issue Structure”. a. Bidders will be categorized according to the number of Equity Shares applied for by them. The total number of Equity Shares to be allotted to each portion as a whole shall be arrived at on a proportionate basis, being the total number of Equity Shares applied for in that portion (number of Bidders in the portion multiplied by the number of Equity Shares applied for) multiplied by the inverse of the oversubscription ratio. b. Number of Equity Shares to be allotted to the successful Bidders will be arrived at on a proportionate basis, being the total number of Equity Shares applied for by each Bidder in that portion multiplied by the inverse of the over-subscription ratio. c. If the proportionate allotment to a Bidder is a number that is more than [●] but is not a multiple of one (which is the market lot), the decimal would be rounded off to the higher whole number if that decimal is 0.5 or higher. If that number is lower than 0.5, it would be rounded off to the lower whole number. Allotment to all Bidders in such categories would be arrived at after such rounding off. d. In all Bids where the proportionate allotment is less than [●] Equity Shares per Bidder, the Allotment shall be made as follows: • • Each successful Bidder shall be allotted a minimum of [●] Equity Shares; and The successful Bidders out of the total Bidders for a portion shall be determined by draw of lots in a manner such that the total number of Equity Shares allotted in that portion is equal to the number of Equity Shares calculated in accordance with (b) above;

e.

If the Equity Shares allocated on a proportionate basis to any portion are more than the Equity Shares allotted to the Bidders in that portion, the remaining Equity Shares available for allotment shall be first adjusted against any other portion, where the Equity Shares are not sufficient for proportionate allotment to the successful Bidders in that portion. The balance Equity Shares, if any, remaining after such adjustment will be added to the portion comprising Bidders applying for minimum number of Equity Shares. END OF SECTION D

Section E : Caselets (50 Marks)
• • • • This section consists of questions with serial number 6 - 12. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 6. The reason why so many organizations are going through so much trouble to securitize their portfolio is the benefits accruing from its merits. With respect to this statement discuss the economic logic of securitization. (7 marks) < Answer > 7. In India, two sectors are the principal beneficiaries of securitization – banking and infrastructure sector. Explain the benefits to each sector. (8 marks) < Answer >

8.

In spite of the remarkable benefits of the securitization, there are certain factors which hinder the growth of securitization in India. Discuss these factors.

(5 marks) < Answer > One of the recent phenomena that underscore the steady sophistication of the Indian financial services sector is the increased volumes of securitization transactions and the varied nature of such transactions. In 2004, India trailed just behind Japan, South Korea and Taiwan amongst Asian countries in securitization volumes. Both the volumes and the variety of transactions in India are expected to grow exponentially due to the significance of securitization in two vital sectors— banking and infrastructure development. So, what then is securitization and what the hype is all about? Securitization is a process wherein homogenous illiquid financial assets are grouped and repackaged into smaller, marketable financial instruments for subsequent sale to investors. Simply put, securitization is the process of converting illiquid or non marketable assets into smaller, marketable assets by selling the expected cash flow to be generated from these assets. When existing assets (identifiable cash flows), such as auto loan portfolios, are securitized, the process is called Asset Backed Securitization (ABS). The same process is also called Mortgage Backed Securities (MBS) when the banks use their home loan portfolios to create new securities. Similarly, the securitization of future cash flows like credit card payments etc., is called Future Flows Securitization. As highlighted earlier, India was amongst the pioneers within Asian nations in leveraging securitization — Citibank was the first to securitize part of its Auto Loans portfolio way back in 1991. As of 2004, India was one of the leading securitization issuance nations in the Asian region. In the fiscal year 2005, the structured finance market grew by 120% in terms of value to Rs. 308 bn, primarily driven by increased Asset Backed Securitization (ABS) deals, which contributed over 70% of the volumes. The growing issuance volumes indicate a widening of the investor pool and also the stable performance of previously issued PTCs in the current relatively benign credit environment. FY 2005, has also witnessed the securitization of new assets, namely Used Vehicle Loan (cars or motorcycles) and Two Wheeler Loan portfolios, in addition to increased activity on the traditional asset classes. Other emerging trend is securitizing pools of mixed assets—such as Personal Loans with Auto Loans, by smaller financiers and NBFCs, whose individual asset portfolios may not be large enough for a securitization issue. Worldwide securitization issuance volumes in 2004, was pegged at over USD3,300 bn which has been growing steadily. The US has the lion’s share of the same at 80% at USD2,668 bn while Europe contributes 9% at USD303 bn. Other major issuers include Australia at USD74 bn and Japan at USD51 bn. There is significant depth in these markets and thus, a larger number of market participants (investors). Issuers from the US, Australia and certain Asian markets also tap the European markets. For instance, over 50% of Australian volumes were issued in Europe. Within Asia, India, Japan and South Korea are the major players, with South Korea and India being the first movers among the rest of Asia. Recent developments and legislations have seen Taiwan, Hong Kong, and Singapore also unlock value from securitization. But the world is waiting and watching China—which has a huge pool of banking assets, estimated at USD445 bn (and very high NPAs between 20-30%) readying itself for securitization in a big way. In terms of the type of securitization, worldwide, Mortgage Backed Securitization (MBS) dominates the total securitization volumes (owning to larger portfolio sizes, better security etc). Asia is no different; MBS contributes to over 90% of volumes.

Caselet 2
Read the caselet carefully and answer the following questions: 9. With respect to the caselet explain what is mortgage insurance? Also discuss how mortgage insurance is different from other types of home insurance? (8 marks) < Answer > 10. Discuss the advantages associated with the mortgage insurance.

(8 marks) < Answer > If you've never heard of mortgage insurance, you're in for a pleasant surprise. Mortgage insurance not only can make a big difference in how quickly your mortgage loan is approved, it can help you buy your home with a lower down payment than you expected. In a market where rising property prices and high home loan interest rates are enveloping the customer, a mortgage insurance product may be the solution. The benefits of this product are phenomenal in that they are advantageous to the home loan borrower, lender and the market. A mortgage insurance product is now being launched for the first time in India, with the US-based Genworth Financial Inc introducing residential mortgage guarantee products. The company has received permission from the Foreign Investment Promotion Board (FIPB) to introduce these products with an investment of $50 million. Of this, $7.5 million would be brought upfront and the remaining within the next 24 months. Earlier, the National Housing Bank tied up with four international corporations to form the India Mortgage Guarantee Company (IMGC) to bring in such a product in the market. However, the RBI has still to come up with the regulatory framework for such a mortgage insurance company to operate. The five partners in IMGC are the United Guaranty Company (UG), the Asian Development Bank (ADB), the Canada Mortgage and Housing Corporation (CMHC), the International Finance Corporation (IFC), and the National Housing Bank (NHB). The company's primary product would be a mortgage guarantee, providing coverage to India's mortgage lenders in the event of a borrower default. The guarantee product will be a three-way contract between the borrowers, lenders and the mortgage guarantor (IMGC). Indirectly, the credit enhancement aspects of the guarantee will allow lenders to access lower cost funds. According to financial analyst Ravi Kumar, there is a huge need for such products in the Indian scenario, and they will be a huge success once launched. These products are purchased by the lenders and paid for by the borrowers. A typical borrower who finds it difficult to raise the down payment required for purchase of his property would find this product to his advantage. It would also serve to cater to segments which have hitherto been unserved or underserved. Such products help the housing finance institutions to serve segments which are perceived to be high risk, but which in reality may not be so. These include self-employed professionals, traders and other segments who do not have a predictable repayment pattern. It would also help borrowers who have less collateral guarantee and personal guarantee to get loans.

Caselet 3
Read the caselet carefully and answer the following questions: 11. What according to you is the rationale behind increasing the repo rate in the credit policy announced in January' 06? (6 marks) < Answer > 12. What according to you would be the probable impact of increase in repo rate on the housing loan rate? Discuss with reasons. (8 marks) < Answer > The Reserve Bank of India has done it again. In the Credit Policy review done in January' 06, the RBI has hiked the repo rate - the rate at which RBI lends to banks - from 6.25 percent to 6.50 percent. It has also hiked the reverse repo rate - a short-term benchmark rate in the money market - by 25 basis points, from 5.25 percent to 5.50 percent. Repo is a money market instrument, which enables collateralized short term borrowing and lending through sale/purchase operations in debt instruments. Under a repo transaction, a holder of securities sells them to an investor with an agreement to repurchase at a predetermined date and rate. In the case of a repo, the forward clean price of the bonds is set in advance at a level, which is different from the spot clean price by adjusting the difference between repo interest and coupon earned on the security. The terms of the transaction are structured to compensate for the funds lent and the cost of the transaction is the repo rate. The inflow of cash from the transaction can be used to meet temporary liquidity requirement in the short-term money market at comparable cost. Repo rate is nothing but the annualized interest rate for the funds transferred by the lender to the borrower.

Generally, the rate at which it is possible to borrow through a repo is lower than the same offered on unsecured interbank loan for the reason that it is a collateralized transaction and the credit worthiness of the issuer of the security is often higher than the seller. Other factors affecting the repo rate include the credit worthiness of the borrower, liquidity of the collateral and comparable rates of other money market instruments. For the debt markets, the robust GDP growth that has exceeded expectations and the healthy flow of liquidity are the positives. On the other hand, the concerns include the weakening of the rupee, the widening deficit and the rising prices of oil that would impact inflation. International developments including the strengthening of the dollar and the rising interest rates in the US are certainly factors that could impact most countries, including India. With yesterday's monetary policy having given clues in terms of how policy plans to respond to these signals, the factors to watch out for now would include liquidity, oil prices and US yields.

END OF SECTION E END OF QUESTION PAPER

Suggested Answers
Investment Banking & Financial Services - II (262): October 2006
Section D : Case Study
1. An investment in the Equity Shares involves a degree of risk. You should carefully consider all information in the Prospectus, including the risks and uncertainties described below, before making an investment in the Equity Shares. If any of the following risks occur, RPL’s business, results of operations and financial condition could suffer, the price of the Equity Shares could decline and you may lose all or part of your investment in the Equity Shares. Unless specified or quantified in the relevant risk factors below, RPL are not in a position to quantify financial implications of any of the risks mentioned below. Risks Relating to RPL’s Business The construction and commencement of commercial operations of the refinery and polypropylene plant (the “Project”) involve many uncertainties and risks that may have a material adverse effect on RPL’s business, results of operations and financial condition. A key part of RPL’s strategy is dependent upon the timely completion of the Project in, or around, December 2008. The Project involves engineering, construction and other commercial risks, including: • The availability of financing on acceptable terms; • The acquisition of additional land to construct the Project; • Reliance on third parties to construct and complete, among other things, the Project, power and port facilities, pipelines and storage tanks; • Construction and development delays or defects; • Engineering design and technological changes; • Mobilizing the required resources, including housing and training a large workforce; • Failure to obtain necessary governmental and other approvals; • Changes in management’s views of the desirability of RPL’s current plans; • Changes in market conditions; • Actions of RPL’s competitors;

• Accidents, natural disasters and weather-related delays; • Time and cost overruns and unanticipated expenses; and • Regulatory changes. Risks Related to RPL’s Industry Changes in refining margins in the refining industry may have a material adverse effect on RPL’s business, results of operations and financial condition. Upon the commencement of RPL’s refinery operations, RPL’s financial results will be affected by the price differential, or margin, between the cost of crude oil and other feedstocks and the sales prices for refined petroleum products. The crude oil and feedstock costs and the price at which RPL can ultimately sell RPL’s refined petroleum products will depend upon a variety of factors beyond RPL’s control. Historically, refining margins have been volatile and are likely to continue to be volatile in the future. Future volatility in refining margins could have a material adverse effect on RPL’s business, results of operations and financial condition. Factors that may affect RPL’s refining margins in the future include: • Aggregate demand and supply for crude oil, other feedstocks and refined petroleum products; • Changes in demand and supply for specific crude oils and other feedstocks as well as specific refined petroleum products such as gasoline and diesel; • Fluctuations in the cost for crude oil, changes in differentials between light and heavy crude oil prices and differentials between crude oil prices and prices for refined petroleum products; • Aggregate refining capacity in the global and regional refining industry to convert crude oil into refined petroleum products and, in particular, the value added products refined by RPL • Pricing and other actions taken by suppliers and competitors that impact the market; • Continuation of exemptions from Indian taxes/levies on purchase and sales arising from RPL’s location in an SEZ; • Price differentials for refined petroleum products between different geographical markets; • Changes in the cost and availability of shipping and other logistics services for feedstocks and for refined petroleum products; • • • 2. Changes by governmental authorities in the mandatory petroleum product specifications for refined petroleum products; Governmental actions that restrict exports or fix prices of petroleum products; and General political and economic conditions. < TOP > Qualitative Factors Factors Internal to the Company RPL is promoted by Reliance Industries Limited (“RIL”), which is the largest private sector company, in terms of market capitalization, in India [Source: Bloomberg]. RIL is the only private sector company from India to feature in the Fortune Global 500. RPL will utilize RIL’s resources and project execution skills to establish efficient and profitable operations. RPL will benefit from economies of scale arising out of RPL’s size. RPL’s proposed refinery, having a capacity of 580 KBPSD, will be the sixth largest refinery globally based on current capacities. (Source: Oil and Gas Journal, December 2005). RPL would derive significant advantages owing to higher complexity of RPL’s refinery. RPL’s refinery has been designed to have a Nelson Complexity Index of 14.0, which would make it amongst the most complex refineries in Asia. The higher complexity levels will enable it to process lower cost, heavier and sourer crude oils and yet achieve superior yields of higher value products such as gasoline, aviation fuel and diesel. This significant flexibility would enable us to take advantage of price differential between the lighter and sweeter crude oils and heavier and sourer crude oils, which have widened considerably in recent years. Close proximity to the Middle Eastern crude oil sources would help it in reducing turn-around time and crude freight costs. RPL will enjoy several fiscal incentives by virtue of being set-up in a Special Economic Zone (“SEZ”). Key fiscal incentives include tax holidays, simplified import and export procedures, exemption from customs

and excise duties imposed by the central government as well as other central and state government taxes. RIL’s expertise will be available for crude and other feedstock procurement, marketing of products, operation and maintenance of the refinery as well as risk management. Factors External to the Company The world economy is expected to grow at a CAGR of 3.9% per annum in terms of GDP on a purchasing power parity basis between 2002 and 2025, according to EIA International Energy Outlook 2005. RPL is likely to benefit from this expected growth in world economy as there is a close co-relation between demand for petroleum products and economic activity. RPL are likely to benefit from the significant imbalances between demand and supply of different refined petroleum products that have developed in certain regions like the shortage of gasoline production capacity in the United States and the shortage of diesel fuel production capacity in Western Europe. These increasing regional product imbalances have created attractive opportunities for those complex oil refiners capable of supplying lighter products like gasoline and diesel fuel. Highly complex refineries like that of RPL capable of meeting increasingly stringent product specifications globally would enjoy higher margins. < TOP > 3. No. of Applns. 74871 100887 67209 64367 189368 45310 34686 562408 5022 115074 8673 10712 3446 3440 32200 621601 Total No. of Shares applied Total no. of shares alloted through oversubscription rate 542150.62 1461071.69 1460007.24 1864359.16 6856191.17 1968573.50 1758160.75 32579753.80 327284.58 8332657.49 690825.49 930803.77 324388.12 348732.80 3497465.60 72017494.57 No.of successful applicants No. of shares alloted Total allocated shares

Category 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1500 1600

7487100 5422 100 542200 20177400 14611 100 1461100 20162700 14600 100 1460000 25746800 18644 100 1864400 94684000 68562 100 6856200 27186000 19686 100 1968600 24280200 17582 100 1758200 449926400 325798 100 32579800 4519800 3273 100 327300 115074000 83327 100 8332700 9540300 6908 100 690800 12854400 9308 100 930800 4479800 3244 100 324400 4816000 34401 101 347440 48300000 32200 109 3509800 994561600 621601 116 72105716 1863796500 1248206 1350594562 Oversubscription ratio is 13.81. Allotment to retail investors 1 If we divide the No. of shares applied here by oversubscription rate, we will get 3487 in the 1400 shares category of applicants, which is higher than the no. of applicants in that category i.e. 3440. So, firm allotment will be there in the last three category of allocation. 2 As the process of rounding off to the nearest multiple of 100 may result in the actual allocation being higher than the shares offered, it is sometime necessary to allow a 10% margin i.e. the final allotment may be higher by 10% of the net offer to public. Allotment to Non Institutional Investors Category No. of Total No. Total No. of Ratio for No. of Total no. of Applications of successful allotment shares to allotted Shares shares applicants be shares Applied allotted allotted

1700 1800 10000 50000 100000 120000 150000 200000 500000 1000000 1500000 2000000 4000000 5000000 11300000 32258000 93540000 111290000

299 71 416 137 177 7 48 50 48 15 6 6 6 1 1 2 1 1

508300 127800 4160000 6850000 17700000 840000 7200000 10000000 24000000 15000000 9000000 12000000 24000000 5000000 11300000 64516000 93540000 111290000 417032100

through over subscription rate 54832.794 13786.408 448759.44 738942.83 1909385.1 90614.887 776699.03 1078748.7 2588996.8 1618123 970873.79 1294498.4 2588996.8 539374.33 1218986 6959654.8 10090615 12005394

548 138 4488 7389 19094 906 7767 10787 25890 16181 9709 12945 25890 5394 12190 69597 100906 120054

FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM FIRM

183 194 1078 5393 10787 12944 16181 21574 53937 107874 161812 215749 431499 539374 1218985 3479827 10090614 12005393

54717 13774 448448 738841 1909299 90608 776688 1078700 2588976 1618110 970872 1294494 2588994 552833 1218985 6959654 10090614 12005393 45000000

Oversubscription ratio is 9.27. 4. a. < TOP > IPO grading (initial public offering grading) is a service aimed at facilitating the assessment of equity issues offered to public. The grade assigned to any individual issue represents a relative assessment of the ‘fundamentals’ of that issue in relation to the universe of other listed equity securities in India. Such grading is assigned on a five-point point scale with a higher score indicating stronger fundamentals. Investment recommendations are expressed as ‘buy’, ‘hold’ or ‘sell’ and are based on a security specific comparison of its assessed ‘fundamentals factors’ (business prospects, financial position etc.) and ‘market factors’ (liquidity, demand supply etc.) to its price. On the other hand, IPO grading is expressed on a five-point scale and is a relative comparison of the assessed fundamentals of the graded issue to other listed equity securities in India. As the IPO grading does not take cognizance of the price of the security, it is not an investment recommendation. Rather, it is one of the inputs to the investor to aiding in the decision making process. All other things remaining equal, a security with stronger fundamentals would command a higher market price. The company needs to first contact one of the grading agencies and mandate it for the grading exercise. The agency would then follow the process outlined below. • • • • • Seek information required for the grading from the company. On receipt of required information, have discussions with the company’s management and visit the company’s operating locations, if required. Prepare an analytical assessment report Present the analysis to a committee comprising senior executives of the concerned grading agency. This committee would discuss all relevant issues and assign a grade

b.

Communicate the grade to the company along with an assessment report outlining the rationale for the grade assigned. Though this process will ideally require 2-3 weeks for completion, it may be a good idea for

companies to initiate the grading process about 6-8 weeks before the targeted IPO date to provide sufficient time for any contingencies. < TOP > 5. A Green Shoe option means an option of allocating shares in excess of the shares included in the public issue and operating a post-listing price stabilizing mechanism for a period not exceeding 30 days in accordance with the provisions of Chapter VIIIA of DIP Guidelines, which is granted to a company to be exercised through a Stabilizing Agent. This is an arrangement wherein the issue would be over allotted to the extent of a maximum of 15% of the issue size. From an investor’s perspective, an issue with green shoe option provides more probability of getting shares and also that post listing price may show relatively more stability as compared to market. Presently, in issues made through book building, Issuers and merchant bankers are required to ensure online display of the demand and bids during the bidding period. This is the Open book system of book building. Here, the investor can be guided by the movements of the bids during the period in which the bid is kept open. Under closed book building, the book is not made public and the bidders will have to take a call on the price at which they intend to make a bid without having any information on the bids submitted by other bidders. Hard underwriting is when an underwriter agrees to buy his commitment at its earliest stage. The underwriter guarantees a fixed amount to the issuer from the issue. Thus, in case the shares are not subscribed by investors, the issue is devolved on underwriters and they have to bring in the amount by subscribing to the shares. The underwriter bears a risk which is much higher in soft underwriting. Soft underwriting is when an underwriter agrees to buy the shares at later stages as soon as the pricing process is complete. He then, immediately places those shares with institutional players. The risk faced by the underwriter as such is reduced to a small window of time. Also, the soft underwriter has the option to invoke a force Majeure (acts of God) clause in case there are certain factors beyond the control that can affect the underwriter’s ability to place the shares with the buyers. Pricing of an issue where one category is offered shares at a price different from the other category is called differential pricing. In DIP Guidelines differential pricing is allowed only if the securities to applicants in the firm allotment category is at a price higher than the price at which the net offer to the public is made. The net offer to the public means the offer made to the Indian public and does not include firm allotments or reservations or promoters’ contributions. < TOP >

Section E: Caselets Caselet 1
6. The Economic Logic of Securitization Capital Relief Financial Institutions (Originators) have to maintain mandatory Capital Adequacy Ratios (capital to risk weighted assets). As asset portfolios grow, the CAR requirements force FIs to increase capital via either additional equity infusion (which may dilute share price, limit future investments etc.) or additional debt (worsens leverage, increases cost etc.), both of which may often be undesirable. Securitization often offers the ideal alternative by removing the assets from the FI’s balance sheet, and reducing capital requirement. Cheap, Off Balance Sheet Financing Upon securitization, organizations unlock the value of the transferred portfolio in the form of the upfront payment from the SPV, which they can invest profitably, often by issuing fresh loans/investing further in asset creating activities. Further, the rating of the PTCs can often be superior to that of the originator (rating is for a selected asset portfolio and not the entire business and also, key risks like prepayment or concentration risks get reallocated) which permits it to raise funds from investors via securitization at lower rates than from corporate debt. Balance Sheet Management Depending upon corporate capital structure strategy, securitization leads to improved financial ratios (like

debt equity) and also smaller, leaner and better managed balance sheets. NPA Management Securitization deals can also be used by banks to transfer their Non Performing Assets (NPAs) to specialized Asset Reconstruction Companies (ARCs) who either manage these portfolios using specialized expertise or aggregate and restructure these loans to sell them to other buyers as PTCs, freeing up the balance sheets of banks and allowing them to focus on core banking activities. < TOP > 7. In India, two sectors are the principal beneficiaries of securitization – banking and the infrastructure sector. Let us evaluate the benefits to each sector. The Banking Sector Three factors underscore the importance of securitization for the banking sector. 1. Bank credit growing faster than deposits: Indians have been shedding their traditional aversion to borrowing and banks have aggressively driven a retail credit revolution of sorts—with record disbursements in Mortgages, Auto Loans, Personal Loans and Credit Card outstanding. As per RBI, rate of growth in deposits is lagging the rate of growth of Credit5, a trend that is expected to continue. Thus, banks are expected to struggle to fund the aggressive retail credit expansion from their own means (deposits) in the near future. To remedy the same, banks may either opt to attract more deposits by offering higher interest rates on the same, but this would lead to lower margins and lower earnings. The alternative banks are expected to opt for—is to securitize their existing portfolios, free their balance sheets, and use proceeds from it to disburse more loans. 2. Banks are capital starved: A majority of Indian banks (especially public sector banks) are starved of capital and are expected to require Rs.600 bn over the next few years, as per Finance Minister P Chidambaram. To a certain extent, the per bank burden of their capital enhancement requirements can be met by securitization. 3. Basel II compliance by 2007: Indian banks would move to Basel II norms by 2007, and with it, more stringent norms on Capital Adequacy would apply. Banks must sell off their portfolio of bad loans to Asset Reconstruction Companies (ARCs) to free up their balance sheets and focus on their core banking activities. Recent developments like the Government of India’s decision to permit 49% FDI in ARCs would widen the market and appetite for such loans. Infrastructure Sector India’s infrastructure investment needs are huge but financing the same raises several issues such as huge initial outlays, multiple project risks, unconventional assets (bridges, roads etc.), long gestation period etc. Additionally, many state-owned service providers like State Electricity Boards (SEBs) etc., are saddled with huge NPAs—limiting their ability to invest from internal accruals. Securitization may just be the answer to the issues above as it makes available financing from a larger pool of investors; enables players specialized in various different aspects of the project to participate, redistribute risks etc. For instance, SEBs could securitize their NPAs and generate additional funds available for investments or road sector projects could be funded via Future Flow Securitization of toll collections etc. < TOP > 8. Small Investor Base Currently, the market for securitization is rather shallow and shackled by a small investor base. This is especially true for the market for stressed assets. Currently, banks sell their NPAs to the ARC on the business side and the same banks end up buying the PTCs on the treasury side. Thus, the risk transfer from the bank’s balance sheet is often artificial. Greater participation, especially from foreign specialists, is required. According to Rajendra Kakkar, CEO of ARCIL, India’s first and only ARC, “We have got a buyer, we have got a seller, it so happens that the seller is the loan side of the same institutions and buyer is the treasury side.” Double Taxation

There are instances of double taxation in the securitization process, which escalate the cost of the structure and may lend a shade of uncertainty to the process. Other issues include issues with certain legal provisions, ambiguity regarding the accounting (e.g., in case of over-collateralization) and inherent poor quality of assets of some banks. < TOP >

Caselet 2
9. Simply insurance that protects the lender if in any case the homebuyer does not make their respective mortgage payments is called as mortgage insurance. It can be defined as a financial guarantee that protects the lenders against the loss. In any case if the borrower is found to be defaulted and the lender takes the title of the property then the mortgage insurer reduces the loss to the lender. More over in case of mortgage insurance, the insurer has some risk by lending money. One is probably familiar with homeowner's insurance, which protects homeowners against theft or damage to their house and contents. Similarly, hazard insurance is designed to compensate a homeowner for any losses that occur due to specified hazards, such as fire or flooding. Mortgage life insurance provides financial protection in case of the homeowner's death. But mortgage insurance pays a lender for part of their financial losses when a borrower fails to repay the loan. Mortgage insurance makes it possible to buy a home with a low down payment or, in some cases, no down payment. < TOP > 10. Mortgage insurance is temporary insurance; you may be able to cancel it after you have acquired 20 percent equity in your home. Mortgage insurance is having following advantages: Mortgage insurance is a win-win solution. While it is a great benefit to consumers, lenders and mortgage investors also rely on mortgage insurance to protect themselves from financial losses in case a loan is not repaid. Because lenders have this protection, they are willing to offer loans with very low down payments as little as 3 to 5 percent of the loan amount or, in some cases, with no money down at all. Under most circumstances, lenders require a down payment of 20 percent of the purchase price before they approve a loan without mortgage insurance. That's a lot of money, especially in today's housing market of fast-rising prices. And while you're saving, the price of your dream home may rise faster than you can save. Mortgage insurance allows you to start enjoying the benefits of homeownership sooner rather than later. < TOP >

Caselet 3
11. The Reserve Bank of India has come out with a flexible policy that seeks to do justice to its objective of encouraging growth, maintaining price stability, managing exchange rate and ensuring a smooth passage of the government borrowing program. The focus of the monetary policy is clearly on prompt and calibrated action to maintain equilibrium among all these conflicting factors. While the present emphasis seems to be on inflation management and price stability, the hike in repo and reverse repo rates seem to suggest that RBI is watching inflation carefully. < TOP > 12. The increase in repo rate may lead to a hardening in interest rates across the board. Repo rate increase may lead to increase in interest rates - both lending as well as deposit rates. The banks' funding costs would increase as higher repo rates would trigger an increase in inter-bank borrowing rates and retail deposit rates. However this process takes time. There may be other mitigating factors to watch out before the increase in repo rates does translate into higher cost of borrowings. Due to competition, in the short term the banks may try to attract customers with low floating rate loans. A lot will depend on the inflation rates and petroleum prices. If these stay under control, then the increase in interest rates may not happen altogether. Many banks are of the view that they would not rush to increase their lending rates. No doubt the increase would enhance their borrowing costs, however most banks would

prefer to wait and watch before taking a decision. Each bank would review rates to see the impact of increasing or not increasing the interest rates. Macro economic indicators still stay strong, which may also help to keep interest rates under control. Also it is to be noted that even if the banks are compelled to increase the rates, it may only be a marginal increase and not a drastic increase. < TOP > < TOP OF THE DOCUMENT >

Question Paper
Investment Banking & Financial Services - II (262) : January 2007
Section D : Case Study (50 Marks)
• • • • This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study Read the case carefully and answer the following questions:
1. What is delisting of securities? Enumerate the situations under which a company goes for delisting. (8 marks) < Answer > 2. How delisting is different from share buy back? Explain the difference between voluntary delisting and compulsory delisting. a. (7 marks) < Answer > Compute the floor price of the offer and the final offer price, clearly mentioning the basis of computing them. Also mention the number of shares acquired if the acquirer accepts the final offer price. If the final offer price is not accepted by the acquirer, what he will have to do? What is the amount that acquirer will have to keep in the escrow account for this acquisition? What are the provisions as per SEBI Guidelines if the offer for delisting results in acceptance of a fewer number of shares than the offer made? (8 + 3 + 3 + 3 = 17 marks) < Answer > 4. Mr. Prashant, an investor holding shares of FIL wants to know whether the final price and floor price arrived at in Q-3(a) are justifiable or not. For this, he approached an analyst of Angle Analysts Ltd. The analyst suggested him two approaches for valuing the share. (I) Dividend Discount Model and (II) Relative Valuation Model. Based on the information provided in the case, advice Mr. Prashant whether he will be benefited from the given offer or not. (10 marks) < Answer > 5. Explain the reverse book building process as per the Securities and Exchange Board of India (delisting of securities) guidelines – 2003.

3.

b. c. d.

(8 marks) < Answer > Offer for Acquisition of Equity Shares from Shareholders of Fortune Infotech Limited (“FIL” or “Target”) Enam Financial Consultants Pvt. Ltd. (“Enam”), the Manager to the Offer, on behalf of Covansys (India) Private Limited (hereinafter referred to as the “Acquirer”/“Covansys”) pursuant to regulations 10 and 12 in compliance with the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 and subsequent amendments thereto (the “Regulations”). The Acquirer is making an offer to the shareholders (other than “Sellers I” and “Sellers II”) of FIL to acquire 10,81,020 fully paid up equity shares of Rs. 10/- each representing 20% of the outstanding voting equity share capital of FIL. Covansys (India) Private Limited, The Acquirer Covansys (India) Private Limited is a private limited company constituted under the Companies Act, 1956 originally incorporated under the name Total Business Solutions (India) Private Limited on July 18, 1991. It changed its name to Complete Business Solutions (India) Private Limited on October 04, 1994. Consequent to

the name change of its parent company, the company again changed its name to Covansys (India) Limited on February 22, 2001 and to Covansys (India) Private Limited on May 24, 2001. The authorized equity share capital of Covansys is Rs. 25,00,00,000 divided into 5,00,00,000 equity shares of Rs. 5/- each. It's issued and paid-up capital is Rs. 20,00,00,000 divided into 4,00,00,000 equity shares of Rs. 5/each. Shareholding pattern of Covansys is as follows: Name of shareholder Covansys (Mauritius) Limited Mr. Raj B Vattikuti, Nominee of Covansys (Mauritius) Limited No. of Equity Shares 39,999,980 20 % Shareholding 100.00 0.00

Covansys (Mauritius) Limited, in turn, is a 100 % subsidiary of Covansys Corporation, USA. Covansys is engaged in the business of software development services and has development centres in Chennai, Bangalore and Mumbai. Covansys offers a range of services which include advisory services to clients on strategic business & technology plans, development, implementation and maintenance services. Its service capabilities include: • • • Strategic Outsourcing Integration services Industry Specific Solutions

Covansys has a pool of close to 4000 skilled employees. 84% of Covansys revenue is generated from the US region, 3% from Europe, and the rest from Asia Pacific region. The audited financial highlights of Covansys are as follows: (Rs. in lakh) Particulars (Year ended December 31) Equity Share Capital Reserves and surplus Total Income Profit after Tax Earnings per share (EPS) Rs. Net Asset Value per share (NAV) Return on Networth (RONW) 2005 2000 21167.15 34290.45 3873.34 9.68 Rs. 57.92 16.72% 2004 2000 17293.81 22155.10 1855.95 4.64 48.23 9.62% 2003 2000 15259.74 20832.05 3660.33 9.15 43.15 21.21%

Fortune Infotech Limited, The Target Fortune Infotech Limited was incorporated on February 03, 1998 as a private limited company under the name, Chimanlal Maniklal Fortune Fiscal Limited, under the Companies Act 1956. Subsequently the name was changed to Fortune Infotech Limited on December 15, 1998. Fortune Infotech is an international software development company based in Asia (Mumbai, India). Having strong base and tie-ups in Europe and America. The company has expertise in onshore software development, offshore software development, IT Support, Sub-Contracting and Web design services. The company has domain expertise as mentioned under but not limited to it. It continuously strive to reach for new domains and skills: Engineering (Automotive, Heavy Engineering and Trading) Education (Higher Education & R & D) Insurance (Life and Non Life, Claims Settlement) Healthcare (Hospital and Laboratory Management) Finance (Advisory, Stocks, M & F)

Legal (Advisory) IT (BPO, Marketing, E-Learning, New Product Development) Safety (Crime Prevention and Traffic Safety) Business Models The company follows the below mentioned business models with its clients for overall development flexibility. Fixed Time/Fixed Price Projects: With fixed time, fixed price model it offer the customers, a minimum risk option and this model can be applied when the scope and specifications of the project are reasonably clear. This model guarantees on-time, on-budget delivery of projects. In addition the deliverables, costs, and timelines are clearly defined in the Fixed Time/Fixed Price model. Time and Materials Projects: In this model, the company forms project team with the required Project Managers, Developers, Equipment and infrastructure based on project requirements. Customers pay a monthly charge based on the size and composition of the team. The company is highly competitive in Man-month & hourly rates. Dedicated Offshore or Onshore team: The company helps to organize a dedicated offshore or onshore team. The team is fully at the disposal of the organization. The company charges as per the Man-Month basis on these kinds of projects. But the infrastructure and equipments are from the clients end. Technical Capabilities The company has good industry experience and it can handle projects in following technologies. Further it is well equipped to gear up easily to implement new technologies or solutions as per the client or the project needs. The company has dedicated professionals in its R & D team which it has setup recently. Operating System : Windows, Macintosh, Linux, UNIX, Free BSD, Symbian. G.U.I : VC++, VB, VF, Delphi, Visual Interdev, Java, Carbon, Cocoa. Case Tools : Rational Rose, Power Designer. Databases : MSSQL, Oracle, MS-Access, MySQL, Filemaker Pro(Macintosh). Tools : Codewarrior, Visual Studio, Project Builder, Interface Builder, Xcode, IFS, DDK, Rapidweaver. Technologies : .NET, Carbon, Cocoa, IRDA, WDM Drivers, USB, Applescript, Firewire, IO KIT. Internet : ASP.NET (VC# and VB.NET), J2EE, ASP, XML, PERL, CGI, PHP. Wireless Platforms : WinCE on PocketPC's and Smart phones. Bug Tracking : Mantis, Bugzilla. Connectivity : ODBC, JDBC. Servers : MS Exchange server, MS BizTalk server, Lotus Domino Server. Web Graphics : Adobe Photoshop, Corel Draw, Illustrator, Fireworks, Flash, Image ready, PageMaker, Director, 3D StudioMax CS. Out-of-Box Software’s : Code warrior (Cross Platform development tool using C++ for Windows and Macintosh), Web crossing community board for iitiim.com (webcrossing.com), buildacommunity.com software’s for community building, VXMail (Voice Email Service), Credit cards (payment gateway on cybersmartinvestor.com), Shop site (E-commerce storefront building software), IMail (Ipswitch.com mailing service for NT Server.), WorldPay (payment gateway for crimeonline.info). Services • • • The company provides development and technical services as under: Client Server Software Development. Device Driver Development (Linux, Macintosh and Window)

• • • • • • •

Plugin Development (Macintosh and Window) Interactive Portals Designing & Development and Hosted Applications. Multi-Platform Application Development. (Linux, Macintosh and Windows). Wireless Applications - for Mobile Phones and Handheld Devices High Resolution Multimedia and Graphical Presentations. Embedded Software Development for Telecom Industry Anti-Virus, Anti Spam, Anti-Phising Development.

Products • The company provides support for following products which it has developed inhouse: • Hospital Management and Information System (HMIS). • Customizable Audio Player development (Macintosh / Windows). • Spare Parts Management System cum Customer Relationship Management System. • Practice Management Software for High/Supreme Court Attorney. • GPS Tracking Software for Satellites and Educational Kits. • Wireless Software for Stocks and Mutual Funds. • Disaster & Greviances Management System. • Crime Prevention and Property Management System. • Community Awareness & Messaging Service. • Parallel Port Software for Windows. • Motor, Fire and Marine Insurance Calculators. • Pharmacy & Laboratory Management System. Clientele The company provides development and technical services to clients from various Industry domains. • Engineering (Automotive, Heavy Engineering and Trading) • Insurance (Life and Non Life, Claims Settlement) • Healthcare (Hospital and Laboratory Management) • Finance (Advisory, Stocks, M & F) • IT (BPO, Marketing, E-Learning, New Product Development) • Safety (Crime Prevention and Traffic Safety) • Electronic Industry (Embedded Development, Device Driver Development) The present subscribed and paid up Equity Share Capital of FIL, as on the date is Rs. 5,40,51,000 sub-divided into 54,05,100 fully paid-up equity shares of Rs. 10/- each. There are no partly paid up equity shares. The financial highlights of FIL are as follows: (All figures in Rs. Lakh except per share figures) Particulars (Year ended March 31) Equity Share Capital Reserves and Surplus (excluding revaluation reserve) Total Income Profit After Tax Net Asset Value Per Share (Rs.) 2006 (limited reviewed) 540.51 1,069.41 1,052.44 151.51 29.79 2005 (Audited) 540.51 1,029.61 1,231.03 402.84 29.05 2004 (Audited) 540.51 735.13 1,411.45 642.58 23.60 2003 (Audited) 540.51 200.88 426.17 142.39 13.72

The company has the policy of transfering the profit after distributing dividend to reserves and surplus. Future expectations From last two years the company is facing the cut throat competition in the industry. The operating cost has also increased substantially. Therefore to cope up with the market conditions the company is proposing to introduce

innovative products and services and implement the cost reduction measures. Since the benefits of these proposals are expected to be realised only after one year, it is expected that the current growth rate of dividend per share of the company will decline by 0.50% for next year. However after that it will increase by 2.00% p.a. for the period of subsequent six years and is expected to stabilize at 15% thereafter. The cost of the equity of the company is 20% and is expected to remain the same in the future. The relevant information for the peer companies is as follows: Name of the company Infocom Ltd. BPO Ltd. India Outsourcing Ltd. Soft solution Ltd. Envest sol Ltd. Reason for Acquisition and Offer Price to sales ratio 2.22 2.36 3.19 2.66 2.54 Price to book value ratio 3.25 2.22 1.61 1.69 1.19 Price to Earning ratio 22.15 27.89 14.79 21.32 11.44

The acquirer, an IT service company, is acquiring FIL to expand its BPO service capabilities. FIL is anticipated to be a key BPO delivery center for Covansys, and the acquirer's plan is to offer such BPO services to its existing and new clients globally. Covansys USA and FIL have signed a 'Teaming Agreement' on May 01, 2005 for jointly providing BPO services to various clients. To the extent required and to optimize the value to all shareholders, the acquirer may, subject to applicable shareholders' consent, enter into any compromise or arrangement, reconstruction, restructuring, merger, rationalizing and/or streamlining of various operations, assets, liabilities, investments, businesses or otherwise of FIL. The Board of Directors of FIL will take appropriate decisions in these matters. The acquirer does not have any plan to dispose off or otherwise encumber any asset of FIL in the next two years except in the ordinary course of business of FIL and except to the extent mentioned above. However, the acquirer undertakes that it shall not sell, dispose off or otherwise encumber any substantial assets of FIL except with the prior approval of the shareholders of FIL. Pre bid details of FIL Price Movement of the FIL Stock in the past 40 weeks at NSE is as follows: Week 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Price (Rs.) 39.20 37.00 39.25 41.95 39.75 38.25 37.10 35.00 34.50 34.25 33.85 31.95 30.50 29.85 29.25 28.65 28.00 27.55 28.45 28.00 Week 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 Price (Rs.) 27.75 27.45 28.65 29.55 28.25 31.10 30.25 29.30 29.15 29.00 28.55 27.00 27.25 26.95 26.35 26.05 25.10 25.85 26.00 25.50

Post bid details of FIL The details of the bids are as follows: Offer Price (Rs.) 32.00 32.50 32.75 33.00 33.50 34.00 34.25 34.50 34.75 35.00 Offer Quantity 15,895 2,50,548 1,10,344 1,75,431 2,15,682 4,45,247 3,45,121 1,25,963 1,65,487 1,12,549

END OF SECTION D

Section E : Caselets (50 Marks)
• • • • This section consists of questions with serial number 6 - 12. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 6. Technology ventures can go through several stages of maturation, each one with a different type of financing requirement. Elucidate. (6 marks) < Answer > 7. Discuss the positive features of the environment in India that suggests that if properly structured, the risk capital industry ought to be a flourishing engine for early-stage growth of technology ventures. (7 marks) < Answer > 8. With respect to the caselet discuss the steps to be taken by SEBI and the RBI to encourage the investment in technology ventures.

(7 marks) < Answer > Venture capital plays a significant role in bringing together technology innovation and entrepreneurship. This successful interaction has been the growth engine for success stories in the Silicon Valley. Recently, the Planning Commission-appointed ‘Committee on technology innovation and venture capital’ gave its report. It was set up to suggest policy changes to facilitate the flow of venture capital (VC) for new ventures, especially from incubation centres of excellence. The report broadly says that the crucial need now is to strengthen the research-finance entrepreneurship network, raise the supply of risk capital for early stage activities, and finetune the fiscal and regulatory system. The recommendation aimed at mobilizing risk finance will help indigenous venture capital firms. The upsurge in the capital markets and alternate investment instruments has created a shortage of risk capital. In 2005, only 7% of the total risk capital investment here was diverted to early stage funding. Fund raising is becoming difficult for early stage funding though funds are readily available for late stage funding. Technology start-ups are often small to start with and involve new products, processes and business models. The class of enterprises is quite wide as the definition of technology includes not only what comes out of the

institutes of technology but also those involved in healthcare, life sciences and related services, new products and new processes, new forms of distribution or retailing and consumer related products. The new business models or products and services may be such with which the capital market is not familiar. India has a vast pool of scientific and technical research carried out in research laboratories, defense laboratories as well as in universities and technical institutes. A conducive environment including incubation facilities can help a great deal in identifying and actualizing some of this research into commercial production. Venture capital for technology innovation is a special type of financing arrangement. It is different from other institutional capital because its provision is customized to the needs of the receiver and the skills of the provider and requires close, ongoing, face-to-face interaction, i.e., it is not an arms-length transaction with standardized templates for contracts and lender-borrower relationships. Development of a proper venture capital industry particularly in the Indian context is important for bringing to market high quality public offerings (IPOs). In the present situation, an individual investor becomes a venture capitalist of a sort by financing new enterprises and undertaking unknown risk. Investors also get enticed into public offerings of unproven and at times dubious quality. This situation can be corrected by venture capital backed successful enterprises accessing the capital market. This will also protect smaller investors. A study of US markets during the period 1972 through 1992 showed that venture-backed IPOs earned 44.6% over a typical five year holding period after listing compared with 22.5% for non-venture backed IPOs. The success of venture capital is partly reflected by these numbers since 80% of firms that receive venture capital are sold to acquiring companies rather than coming out with IPOs, in which the return multiple vis-à-vis non-venture funded companies is much higher. This potential can also be seen in sales growth figures for the U.S. where, from 1992 to 1998, venture capital funded companies sales have grown by 66.5% per annum on average versus 5% for Fortune 500 firms. The export growth by venture funded companies was 165%. All the top 10 sectors measured by asset and sales growth in USA were technology related.

Caselet 2
Read the caselet carefully and answer the following questions: 9. With respect to the caselet explain what pension mortgage is. How does it work? Also discuss the advantages and disadvantages associated with the pension mortgage. (8 marks) < Answer > 10. In endowment mortgage the money that would have been used to repay the capital is instead invested in an endowment policy. Being a financial analyst how would you select the endowment policy for endowment mortgage? (7 marks) < Answer > Housing sector is growing rapidly in India. Real estate has become a very popular choice for every investor. Income level of the individuals is also increasing and simultaneously their disposable income is also increasing, which is inspiring them for betterment of their life. The demand for the houses is increasing steadily. Considering the demand the housing finance companies are also coming up with various financing schemes to attract more and more amount of customers and serving them the best. A few of these schemes are: • • • Repayment mortgage Endowment mortgage Pension mortgages

A repayment mortgage is the traditional method of paying back a mortgage. In this method each month, one pays a sum of money to the lender, this consists partly of repayment of the outstanding debt, plus interest on the mortgage amount that one owes, hence, a repayment mortgage. This type of loan is safe. If one makes all the payments throughout the repayment mortgage term, the loan is guaranteed to be repaid. In order to keep the mortgage repayments down in the early years (when a lot is owed to the lender) only a small bit of capital is repaid in the early years of the loan. As the amount of the loan decreases, the amount of interest payable decreases, and a larger percentage of the repayment becomes available to repay the capital. This means that if the borrowers move house again in two or three years time they may find that little of their

original loan has been paid off. On moving, you have to cash in your loan and start again from scratch. If they move house on a regular basis they might still be paying off a mortgage at an age when they wish to retire. Endowment mortgage policies were sold by the bucketful in the 1980s and 1990s as an alternative option to a repayment mortgage. An endowment mortgage is a life insurance savings policy which is designed to grow over a certain time scale (often 25 years) to pay off the amount borrowed to purchase a property. So in this respect the homeowner pays the interest on his/her mortgage and a monthly premium into the endowment mortgage savings plan. The phrase endowment mortgage is used mainly in the United Kingdom by lenders and consumers. In this scheme the money that would have been used to repay the capital is instead invested in an endowment policy. This money is used to buy stocks and shares. And at the end of the tenure the lump sum is used to repay the mortgage obligation. There a basically two types of endowment mortgage policy. A "full" endowment mortgage policy is where there is an underlying guarantee, that all of the mortgage amount will be paid off. In paying for this guarantee the monthly premiums are expensive which explains why the second type of endowment mortgage, the "low cost" endowment mortgage has been by far the most popular plan sold to millions of UK householders over the last 20 years. Both "full" and "low cost" endowment mortgage policies are linked to the stock-market. Nowadays people understand the importance of ensuring that their retirement will be comfortable and worryfree. This is often achieved through a secure and suitable pension plan. However, a pension plan can also be used as a Tax-efficient means of investing in property. Pension mortgage is an interest only mortgage with an additional investment plan in the form of a personal pension. A personal pension is a stock market based investment that benefits from tax relief and tax free growth.

Caselet 3
Read the caselet carefully and answer the following questions:

11. Being a financial analyst explain the factors to be considered before choosing a credit card? (8 marks) < Answer > 12. Being a credit card user, how would you protect yourself from the frauds associated with the credit cards? (7 marks) < Answer > The credit card was the successor of a variety of merchant credit schemes. It was first used in the 1920s, in the United States, specifically to sell fuel to a growing number of automobile owners. In 1938 several companies started to accept each other's cards. The concept of using a card for purchases was invented in 1887 by Edward Bellamy and described in his utopian novel Looking Backward. Bellamy uses the explicit term "Credit Card" eleven times in his novel (Chapters 9, 10, 11, 13, 25 and 26) and 3 times (Chapters 4, 8 and 19) in its sequel, Equality. Bank of America created the BankAmericard in 1958, a product which eventually evolved into the Visa system ("Chargex" also became Visa). MasterCard came to being in 1966 when a group of credit-issuing banks established MasterCharge. The fractured nature of the US banking system meant that credit cards became an effective way for those who were traveling around the country to, in effect, move their credit to places where they could not directly use their banking facilities. In 1966 Barclaycard in the UK launched the first credit card outside of the US. There are now countless variations on the basic concept of revolving credit for individuals (as issued by banks and honored by a network of financial institutions), including organization-branded credit cards, corporate-user credit cards, store cards and so on. Credit card no doubt is a great innovation but simultaneously the other side of the innovation is the frauds associated with it. Where a card is stolen, or an unauthorized duplicate made, most card issuers will refund some or all of the charges that the customer has received for things they did not buy. These refunds will in some cases be at the expense of the merchant, especially in mail order cases where the merchant cannot claim sight of the card, but in other cases, these costs must be borne by the card issuer. In several countries merchants will lose the money if no ID card was asked for, therefore merchants usually require ID card in these countries. The cost of

fraud is high; in the UK in 2004 it was over £500 million. Credit card companies generally guarantee that the merchant will be paid on legitimate transactions regardless of whether the consumer pays their credit card bill or not. There is some controversy about credit card usage in recent years. Credit card debt has soared, particularly among young people. Since the late 1990s, lawmakers, consumer advocacy groups, college officials and other higher education affiliates, have become increasingly concerned about the rising use of credit cards among college students. The major credit card companies have been accused of targeting a younger audience, in particular college students, many of whom are already in debt with college tuition fees and college loans, and who typically are less experienced at managing their own finances. A recent study by United College Marketing Services has shown that student credit lines have increased to over $6,000. Credit card usage has tripled since 2001 amongst teenagers as well. Since eighteen year-olds in many countries and most U.S. states are eligible for a card without parental consent or employment, the likelihood of increased balances, unwise use of credit and damaged credit scores increases.

END OF SECTION E END OF QUESTION PAPER

Suggested Answers
Investment Banking & Financial Services - II (262) : January 2007
Section D : Case Study
1. The term "delisting" of securities means permanent removal of securities of a listed company from a stock exchange. As a consequence of delisting, the securities of that company would no longer be traded at that stock exchange. There are several reasons for seeking de-listing of securities from the stock exchanges. These can be highlighted as follows: a. When market conditions are so depressed, the acquirer or promoter of a company can exploit the opportune moment for acquisition of the remaining securities from the shareholders through delisting; b. In the liberalized economy, the regulatory framework relating to FDI norms permits foreign companies to hold 100 per cent equity in many key sectors; c. As per the regulatory framework of FDI norms foreign companies are allowed to take an opportunity to control entire holdings which give complete flexibility in operational decisions, and preference of retaining listing only in one place, preferably in the home country; d. Besides the flexibility in operational decisions, on account of de-listing boards of companies enjoy the sole decision making powers, greater independence in investment decisions, freedom from the regulatory environment, possibility of easier repatriation of profits and tax rebates in the country of their origin. These factors however do not lead to good corporate governance. < TOP > As a consequence of de-listing, the securities of that company would no longer be traded at that stock exchange subject to certain condition as per SEBI (De-listing of Securities) Guidelines 2003. De-listing is also different from “buy back” of securities in which the securities of a company are extinguished with consequent reduction of capital of the company. In the case of de-listing there is no reduction of capital. It is needless to mention that in the case of buy back securities, the company itself is the acquirer and hence provides the funds for buy back. In the case of de-listing, the securities are acquired by a person other than the company and who could be the promoter, majority shareholder or a person in control of the management and the funds have to be provided by that acquirer. As the two processes are fundamentally different, the concerns and safeguards for the shareholders should also be necessarily different. Compulsory delisting refers to permanent removal of securities of a listed company from a stock exchange as a penalizing measure at the behest of the stock exchange for not making submissions/comply with various requirements set out in the Listing agreement within the time frames prescribed. In voluntary delisting, a listed company decides on its own to permanently remove its securities from a stock exchange. < TOP > Week 1 2 3 4 5 6 7 8 9 10 11 Price 39.2 37 39.25 41.95 39.75 38.25 37.1 35 34.5 34.25 33.85

2.

3.

12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 Total

31.95 30.5 29.85 29.25 28.65 28 27.55 28.45 28 27.75 27.45 28.65 29.55 28.25 31.1 845.05

b.

Therefore the average is 32.50 which is the floor price. The final offer price shall be determined as the price at which the maximum number of shares has been offered. In this case at the offer price of Rs.34 the maximum number of shares were offered i.e. 4,45,247. Hence Rs.34 is the final offer price. The acquirer shall have the choice to accept the price. If the price is accepted then the acquirer shall be required to accept all offers up to and including the final price but any offer below the floor price is not acceptable. Hence the number of shares acquired =2,50,548+1,10,344+1,75,431+2,15,682+4,45,247 =11,97,252 Where the acquirer decides not to accept the offer price so determined: • • He shall not make an application to the exchange for delisting of the securities; and

4.

He shall ensure that the public shareholding is brought up to the minimum limits specified under the listing conditions within a period of 6 months from the date of such decision. c. The acquirer is required to keep 100% of the estimated amount of consideration calculated on the basis of the floor price indicated and the number of securities required to be acquired. Therefore in this case the acquirer will have to keep 32.50*10, 81,020 = Rs.3,51,33,150 in the escrow account. d. Where the offer for delisting results in acceptance of a fewer number of shares than the total shares outstanding and as a consequence the public shareholding does not fall below the minimum limit specified by the listing conditions or the listing agreement, the offer shall be considered to have failed and no securities shall be acquired pursuant to such offer. < TOP > Approach – I (DDM) Calculation for growth rate: Year 2004 2005 2006 Change in reserves (I) 735.13–200.88 = 534.25 1029.61–735.13 = 294.48 1069.41–1029.61 = 39.80 Profit after tax (II) 642.58 402.84 151.51 Dividend (II–I) 108.33 108.36 111.71 DPS 2.00 2.00 2.07

Now, 2.00(1+g)2 = 2.07 g= 1.73

Year 0 1 2 3 4 5 6 7 8 Applicable 1.73 1.23 3.23 5.23 7.23 9.23 11.23 13.23 15.00 growth rate DPS 2.07 2.10 2.17 2.28 2.44 2.67 2.96 3.35 3.85 TV – – – – – – – 77.00 – PV @20% – 1.75 1.51 1.32 1.18 1.07 0.99 22.42 – Hence as per DDM the price of the security should be Rs.30.24 which is lower than the floor price provided for the security. Approach-II (Relative Valuation) Name of the company

Price to Price to book Price earning sales ratio value ratio ratio Infocom Ltd. 2.22 3.25 22.15 BPO Ltd. 2.36 2.22 27.89 India Outsourcing Ltd. 3.19 1.61 14.79 Soft solution Ltd. 2.66 1.69 21.32 Envest sol Ltd. 2.54 1.19 11.44 Average 2.594 1.992 19.518 Now sales per share for FIL is =1,052.44/54.051 = Rs.19.47 Hence price of the share as per this ratio should be 19.47 * 2.594 = Rs.50.51 Book value per share is Rs. 29.79 Hence price of the share as per this ratio should be 29.79 * 1.992= Rs.59.34 Earning per share of the company is Rs.2.80 Hence price of the share as per this ratio should be 2.80 * 19.518 = Rs.54.65 From the above analysis we can conclude that the share holder will be willing to offer his shares at the floor or the final price because as per the analyst the price of the security comes to Rs.30.24 using DDM model while floor price is Rs32.50 and the final price is Rs.34. While as per the Relative Valuation model the price of the security should be more than Rs.50 as per the three ratios provided. This is substantially higher than the final price of Rs34. < TOP > 5. THE BOOK BUILDING PROCESS 1. The book building process shall be made through an electronically linked transparent facility. 2. The number of bidding centres shall not be less than thirty, including all stock exchange centres and there shall be at least one electronically linked computer terminal at all bidding centres. 3. The promoter shall deposit in an escrow account, 100 per cent of the estimated amount of consideration calculated on the basis of the floor price indicated and the number of securities required to be acquired. The provisions of clause 10 of the Securities and Exchange Board of India (Buyback of Securities) Regulations,1998 shall be applicable mutatis mutandis to such escrow account. 4. The offer to buy shall remain open to the security holders for a minimum period of three days. The security holders shall have a right to revise their bids before the closing of the bidding. 5. The promoter or acquirer shall appoint ‘trading members’ for placing bids on the online electronic system. 6. Investors may approach trading members for placing offers on the on-line electronic system. The format of the offer form and the details that it must contain shall be specified. 7. The security holders desirous of availing the exit opportunity shall deposit the shares offered with the trading members prior to placement of orders. Alternately they may mark a pledge for the same to the trading member. The trading members in turn may place these securities as margin with the exchanges/clearing corporations. 8. The offers placed in the system shall have an audit trail in the form of confirmations which gives broker ID details with time stamp and unique order number 9. The final offer price shall be determined as the price at which the maximum number of shares has been offered. The acquirer shall have the choice to accept the price. If the price is accepted then the

acquirer shall be required to accept all offers up to and including the final price but may not have to accept higher priced offers, subject to clause 15. 10. At the end of the book build period the merchant banker to the book building exercise shall announce in the press and to the concerned exchanges the final price and the acceptance (or not) of the price by the acquirer. 11. The acquirer shall make the requisite funds available with the exchange/clearing corporation on the final settlement day (which shall be three days from the end of the book build period). The trading members shall correspondingly make the shares available. On the settlement day the funds and securities shall be paid out in a process akin to secondary market settlements. 12. The entire exercise shall only be available for demat shares. For holders of physical certificates the acquirer shall keep the offer open for a period of 15 days from the final settlement day for the shareholders to lodge the certificates with custodian(s) specified by the merchant banker. < TOP >

Section E: Caselets Caselet 1
6. Seed financing: to the technologist/entrepreneur to prove a concept Start-up financing: for product development and initial marketing to a few customers. First stage financing: to initiate commercial production and marketing. Second stage financing: for expansion to scale. Later stage financing: for expansion of an enterprise that is already profitable. Bridge/Mezzanine financing: as a preparation for going public or for buyout/takeover. The very early stage financing is seldom provided by venture funds and often comes from angel investors, a category that can, in principle include official agencies that provide low cost seed capital. The effectiveness of a venture funding system depends on this entire range of options for capital finance. Thus without an adequate system of funding at the very early seed stage the deal flow for venture capital may be sparse. At the same time the availability of early stage venture funding will depend on the exit options made possible by strong private equity funds and a healthy stock market. < TOP > 7. The success of the software and services industry, which has created a cadre of engineers and other domain experts with marketing and product development skills. • • • • • • • • 8. Well-developed managerial skills among managers of large firms. A cadre of returnees with advanced technical and business development skills. The rising number of graduates in various fields. Entrepreneurial opportunities arising from rapidly changing global dynamics, e.g., in textiles, auto components industry and healthcare. The growth of domestic markets in fast-growing sectors such as telecommunications, finance and retail. Presence of risk finance providers even in centres outside the main commercial centre, Mumbai, and closer to the locations of small and medium enterprises. Globally connected and flourishing private equity industry with independent management structure and experience of dealing with large, global institutional funds. Expanding pool of multinational firms providing access to the latest technologies in a range of sectors. < TOP > Steps to be taken by SEBI • Current SEBI guidelines restrict investment in preferential offering through pure equity investment;

SEBI should consider including optionally convertible instruments as these are hybrid & hence classified as non-debt • • • • • • • • • • Amend SEBI VCF Regulations to clarify that placing of surplus funds by VCFs temporarily in bank deposits and other non-VCU investments is permissible to avail of tax benefits Standstill agreements to be permitted during due-diligence of VCUs Clarify the foreign component of Corpus permitted in DVCFs Permit investment in projects/SPVs Reduce the time for registration of VCFs from the current 6-8 weeks; define minimum guidelines required for registration, and for funds which meet these guidelines, permit retrospective registration SEBI (Substantial Acquisition and Takeover Code) Regulation, 1997: Private equity & Venture investors not to be deemed as ‘Promoters’ & hence not to be qualified as persons acting in concert (PAC), Modify definition of control to appropriately reflect PE investment features Exempt PE investors from open offer requirements of 20% additional offer for sale Permit use of bank guarantee instead of using cash in escrow account for open offers

Steps to be taken by the RBI • To avoid delays, RBI should come out with a general permission, as in the case of FIIs, so that once an FVCI is approved and registered with SEBI, it will be eligible under FEMA regulations to make investments in India in accordance with Schedule VI; similarly Schedule VI of FEMA needs to be made consistent with SEBI VCF Regulations w.r.t. investments in listed entities and purchase of secondary shares. Allow banks to value VCF investments on a cost-basis for the first three years (or upto ‘investment period’ of VCF) and marked-to-market thereafter (current regulations require marked-to-market throughout) Clarify eligibility and limits of VCFs and PE firms to take stakes in banks Clarify ability of FVCIs to invest in real estate and applicability of FDI limits Clarify inconsistencies in references to VCFs and FVCIs in different sections of FEMA Exclude an SPV formed by a VCF from definition of NBFC as defined under Section 451(f) of the RBI Act and permit a bank to fund acquisition of shares, debentures etc by the SPV to enable leveraged buyouts Clarify applicability of ECB guidelines for debt investments by FVCIs Overarching guidelines to state that Venture capital RBI guidelines for Venture capital investments to be harmonized with and governed by SEBI guidelines. < TOP >

• • • •

• •

Caselet 2
9. Pension mortgage is an interest only mortgage with an additional investment plan in the form of a personal pension. A personal pension is a stock market based investment that benefits from tax relief and tax free growth. A pension pays a tax free lump sum and a monthly taxed income on retirement. The lump sum is normally used to pay off the mortgage. By repaying just the interest to the lender, instead of repaying any of the capital, the outstanding balance of the loan stays constant. However, alongside the loan, the pension policy grows as more payments are made. Because some of the pension fund may be subject to tax in retirement, most Institutions require the pension fund to build up to twice the loan amount. This ensures that the fund should be more than enough to repay the mortgage at the end of the term. The end of the term must coincide with the borrower being 60 or more, as most people cannot access their pension fund until this time.

The Advantages of a Pension Mortgage • • Tax Relief on contributions Tax free growth on the fund

• Tax free lump sum. Disadvantages • • • Mortgage debt remains constant throughout the mortgage period. There is no guarantee that one will have sufficient funds to pay off the mortgage at the end of the repayment period, as the pension fund could perform below expectations. The lump sum cannot be used for other purposes. One therefore needed to ensure that the level of pension contributions is sufficient enough to maintain his required standard of living during retirement. The mortgage period may be longer than 25 years, depending on one’s age. He will still need to meet interest rate payments throughout this period. < TOP > 10. Risk-to-Reward Ratio of Endowment Policy The most conservative form of endowment policies are those with low risk and low reward, for example, a with-profits endowment policy. • Monthly premiums are pooled with the funds of all the other investors. At the end of each year, the life company will allocate bonuses to all the investors (depending on the investment performance). Once awarded, these annual bonuses can't be taken away.

At the end of the term (when the endowment mortgage is to be repaid) the life company will pay a one-off terminal bonus. The terminal bonus may represent a large proportion of your final payout but it isn't guaranteed. Unit-linked endowment policies are higher risk but are projected to earn a higher return. • • One’s premiums buy specific units in stock market linked investments. The value of these units (like the stock market) can go up or down on a daily basis.

Unit-linked funds have the potential for greater and faster growth than with-profits policies (possibly leaving you with a tax-free lump sum, or maybe the chance to pay off your mortgage early). However, there is also a risk that the unit-linked endowment policy may not produce such a good return as a with-profits policy. The highest risk endowment policy is that which invests in areas such as small companies or emerging markets. In a good year performance can be spectacular but in a bad year losses could be huge or even total. < TOP >

Caselet 3
11. Factors to be considered before choosing a credit card Credit Card Terms A credit card is a form of borrowing that often involves charges. Credit terms and conditions affect your overall cost. So it's wise to compare terms and fees before you agree to open a credit or charge card account. The following are some important terms to consider that generally must be disclosed in credit card applications or in solicitations that require no application. You also may want to ask about these terms when you're shopping for a card. Annual Percentage Rate The APR is a measure of the cost of credit, expressed as a yearly rate. It also must be disclosed before you become obligated on the account and on your account statements. The card issuer also must disclose the "periodic rate" - the rate applied to your outstanding balance to figure the finance charge for each billing period. Some credit card plans allow the issuer to change the APR when interest rates or other economic indicators

-called indexes - change. Because the rate change is linked to the index's performance, these plans are called "variable rate" programs. Rate changes raise or lower the finance charge on your account. If you're considering a variable rate card, the issuer must also provide various information that discloses to you: • • that the rate may change; and how the rate is determined - which index is used and what additional amount, the "margin," is added to determine your new rate. Free Period Also called a "grace period," a free period lets you avoid finance charges by paying your balance in full before the due date. Knowing whether a card gives you a free period is especially important if you plan to pay your account in full each month. Without a free period, the card issuer may impose a finance charge from the date you use your card or from the date each transaction is posted to your account. If your card includes a free period, the issuer must mail your bill at least 14 days before the due date so you'll have enough time to pay. Annual Fees Most issuers charge annual membership or participation fees. This fees is also to be considered before choosing the credit card. Transaction Fees and Other Charges A card may include other costs. Some issuers charge a fee if you use the card to get a cash advance, make a late payment, or exceed your credit limit. Some charge a monthly fee whether or not you use the card. < TOP > 12. Credit and charge card fraud costs cardholders and issuers hundreds of millions of dollars each year. While theft is the most obvious form of fraud, it can occur in other ways. For example, someone may use your card number without your knowledge. It's not always possible to prevent credit or charge card fraud from happening. But there are a few steps one can take to make it more difficult for a crook to capture his card or card numbers and minimize the possibility. Guarding Against Fraud Here are some tips to help protect yourself from credit and charge card fraud. Do: • • • • • • • • • Sign your cards as soon as they arrive. Carry your cards separately from your wallet, in a zippered compartment, a business card holder, or another small pouch. Keep a record of your account numbers, their expiration dates, and the phone number and address of each company in a secure place. Keep an eye on your card during the transaction, and get it back as quickly as possible. Void incorrect receipts. Destroy carbons. Save receipts to compare with billing statements. Open bills promptly and reconcile accounts monthly, just as you would your checking account. Report any questionable charges promptly and in writing to the card issuer.

• Notify card companies in advance of a change in address. Don't: • • • • • Lend your card(s) to anyone. Leave cards or receipts lying around. Sign a blank receipt. When you sign a receipt, draw a line through any blank spaces above the total. Write your account number on a postcard or the outside of an envelope. Give out your account number over the phone unless you're making the call to a company you know is

reputable. If you have questions about a company, check it out with your local consumer protection office or Better Business Bureau. < TOP > < TOP OF THE DOCUMENT >

Question Paper
Investment Banking & Financial Services - II (262): April 2007
Section D : Case Study (50 Marks)
• • • • This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study
Read the case carefully and answer the following questions: 1. Cinemax India Limited. is an emerging family entertainment centre focused primarily on exhibition and gaming business. Discuss the growth drivers and growth potential of multiplexes in India. Also explain the advantages of the multiplexes. (9 marks) The Issue Price of Rs.155 has been determined by the company in consultation with the BRLMs on the basis of assessment of market demand for the offered Equity Shares by the Book Building Process. Delineate the basis for issue price to be furnished in the final offer document. (10 marks) After the closure of the issue Rs.155 is the cut-off price decided. Being the registrar to the issue you are required to allot the shares to the Retail Investors, the Non-Institutional Investors and the Employees. (15 marks) After the closure of the issue the successful investors are allotted the shares, while for other investors the amount paid is refunded. Discuss the various modes through which the refund can be made. (8 marks) Discuss various technical grounds on which the application of the bidder is rejected for this issue. (8 marks) CINEMAX INDIA LIMITED (CIL)
< Answer >

2.

< Answer >

3.

< Answer >

4.

< Answer >

5.

< Answer >

PUBLIC ISSUE OF 8,920,000 EQUITY SHARES OF Rs.10 EACH (“EQUITY SHARES”) FOR CASH AT A PRICE OF Rs. [●] PER EQUITY SHARE AGGREGATING Rs. [●] MILLION, COMPRISING OF A FRESH ISSUE OF 7,000,000 EQUITY SHARES BY CINEMAX INDIA LIMITED (“CIL”, “COMPANY” OR “ISSUER”) AND AN OFFER FOR SALE OF 1,920,000 EQUITY SHARES BY THE SELLING SHAREHOLDERS. THE FRESH ISSUE AND THE OFFER FOR SALE ARE JOINTLY REFERRED TO AS THE “ISSUE”. 60,000 EQUITY SHARES OF Rs.10 EACH WILL BE RESERVED IN THE ISSUE FOR SUBSCRIPTION BY EMPLOYEES (AS DEFINED HEREIN), (THE “EMPLOYEE RESERVATION PORTION”). THE OFFER OF EQUITY SHARES OTHER THAN THE EMPLOYEE RESERVATION PORTION SHALL BE CALLED THE “NET ISSUE”. THE ISSUE WILL CONSTITUTE 31.86% OF THE FULLY DILUTED EQUITY SHARE CAPITAL OF OUR COMPANY. THE NET ISSUE WILL CONSTITUTE 31.64% OF THE FULLY DILUTED EQUITY SHARE CAPITAL OF OUR COMPANY. PRICE BAND: Rs.135 TO Rs.155 PER EQUITY SHARE OF FACE VALUE Rs.10. THE FACE VALUE OF EQUITY SHARE IS Rs. 10 AND THE FLOOR PRICE IS 13.5 TIMES OF THE FACE VALUE AND THE CAP PRICE IS 15.5 TIMES OF THE FACE VALUE. The SEBI Guidelines have permitted an issue of securities to the public through the 100% Book Building Process, wherein not less than 50% of the Net Issue shall be allocated on proportionate basis to QIBs. Further, upto 15% of the Net Issue shall be available for Allotment on a proportionate basis to Non-Institutional Bidders and upto 35% of the Net Issue shall be available for Allotment on a proportionate basis to Retail Individual Bidders, subject to valid Bids being received at or above the Issue Price. We will comply with the SEBI Guidelines for this Issue. In this regard, the Company and the Selling Shareholder have appointed the BRLMs and the Co-BRLMs to manage the Issue and to procure subscriptions to the Issue. Listing

The Equity Shares offered through this Red Herring Prospectus are proposed to be listed on the BSE and the NSE. CIL has received in-principle approval from the BSE and the NSE for the listing of our Equity Shares pursuant to letters dated November 16, 2006 and October 23, 2006, respectively. The National Stock Exchange of India Limited shall be the Designated Stock Exchange. Objects of the Issue The net proceeds of the present fresh issue after deducting lead managers’ fees, underwriting commission and selling fees is estimated to be Rs. [●] million. We will receive no proceeds from the Offer for Sale of the Equity Shares by the Selling Shareholders. We intend to deploy the net proceeds of the fresh issue for financing of our expansion plans of setting up new Theatres across the country and general corporate expenses including acquisitions and capital expenditure. We believe that listing of our Equity Shares on Stock Exchanges will also enhance our visibility and our brand name. In the event of a shortfall in raising the requisite capital from the proceeds of the present Fresh Issue, towards meeting the objects of the fresh issue, the extent of the shortfall will be met by internal accruals and/or from fresh debt. In case of any surplus of amount received in relation to the Present Fresh Issue, our Board of Directors in accordance with our internal policies will take necessary steps to determine the application of such amount for general corporate purposes, which may include acquisitions and capital expenditures. Indian Entertainment Industry The Indian Entertainment Industry is currently estimated at Rs.234 billion (US$5.2 billion). Films contribute a significant proportion (28%) to India’s entertainment industry (Source: The Indian Entertainment and Media Industry (“FICCI – PWC Report, 2006”)). The entertainment industry is expected to grow annually at almost 21 percent to reach around Rs.617 billion (US$13.77 billion) by 2010. The Indian Film industry is expected to reach Rs.153 billion in 2010, contributing 25% to India’s entertainment industry. Growth of the Indian Entertainment Industry (INR Bn)

2004

2005

2006E

2007E

2008E

2009E

2010E

(Source: FICCI - PWC Report, 2006) Indian Film Industry The Indian film industry is the largest film industry in the world in terms of the number of films produced and admissions each year. (Source: Indian Entertainment Industry Focus 2010: Dreams to Reality, Confederation of Indian Industry - KPMG, 2005) The film industry comprises three segments:

• • •

Film production: which involves the making of movies Film distribution: which involves the distribution of movies to cinemas, television, video stores etc. Film exhibition: which involves the exhibition of movies.

Inadequate Number of Screens In India, the number of screens per million of population is just 12 whereas the average in western countries is approximately

40. The table below shows the number of cinema screens per million people in selected countries.

Screen per million population

(Source: CII-KPMG Report, 2005) Business Overview of CIL In this section, unless otherwise stated, any reference to “we”, “us”, “our” or “the Company” refers to Cinemax India Limited. along with its existing subsidiaries and erstwhile subsidiary companies which have been amalgamated. We are an emerging family entertainment centre focussed primarily on Exhibition and Gaming business with limited interests in mall development. We are one of the largest Exhibition theatre chains in India operating 10 properties with 33 screens and 9,220 seats. We believe we are one of the dominant players in Mumbai operating 30 screens with seating capacity of 8218 at 9 locations in and around Mumbai, which is home to the Hindi Film industry ('Bollywood'). We believe we are also one of the largest owners of multiplex properties in India with 21 screens spread over approximately 146,000 sq ft area. Our brand 'Cinemax' is one of the most recognizable film exhibition brands in the areas where we operate. Across our various theatres we had 2.73 million patrons in H1FY07 and 3.67 million patrons in FY06. We are part of the Kanakia Group which has a track record of over 20 years in real estate development. The group has developed over 5 million sq. ft. area of Residential and Commercial estate. As a result of a recent corporate restructuring, we presently own/control all the movie exhibition businesses of the Kanakia group. Our promoters experience in real estate helps us in identifying strategic locations at economical rates, and rapid and timely execution of projects with tight control on costs and quality. Exhibition Our exhibition chain is a combination of high-end multiplexes and budget retrofit single-screens. We believe in providing customer satisfaction through process enhancements and constant innovation in our services and facilities such as high comfort recliner seating arrangements in ‘The Red LoungeTM’, massage chairs, etc. Having established ourselves in Mumbai, Thane and Nashik with 9,220 seats housed in 33 screens across 10 properties, we plan to expand our operations in India across 42 locations in 11 states by the end of FY 2009. With our proposed expansion plan we intend to enhance our capacity aggregating to over 25,700 seats housed in 102 screens across 28 properties by the end of FY 2009. Gaming Our Gaming business is currently operational under the brand name – ‘Giggles - The Gaming ZoneTM’, at Eternity Mall, Thane. It is spread over 13,000 sq ft area and offers around 50 state-of-the-art games. We plan to expand our gaming business by opening seven Giggles gaming zones at some of our future multiplexes in different locations.

Mall Development We have already developed over 200,000 sq. ft. of mall area and projected around 30,000 sq. ft. area for Eternity Mall at Thane where part of the space is occupied by our exhibition business and our gaming business Giggles. Tenants include Globus, Proline, Planet M, Metro Shoes, Bon Bon Shoes, My Dollar Stores and Archies Gallery. Our mall development business is limited to the development of Nagpur mall and development of the balance FSI available at Eternity Mall phase 2, Thane. We are currently, developing a mall at Nagpur with over 100,000 sq. ft. area and which are expected to be operational by FY07 and FY08 respectively. Except the above mentioned projects, currently we do not have any proposed mall development plans. CIL standalone income is Rs. 438.6 million for FY06 and Rs. 347.32 million for H1 FY07. Our standalone adjusted profit after tax was Rs. 75.05 million for FY06 and Rs. 21.39 million for H1 FY07. Currently, CIL have three wholly owned subsidiaries namely Vista Entertainment Private Limited. Growel Entertainment Private Limited. and Nikmo Finance Private Limited. a wholly owned subsidiary of Growel Entertainment Private Limited. Vista Entertainment Private Limited. and Nikmo Finance Private Limited. operate our Multiplexes at Versova and at Kandivali (East) pursuant to business conducting agreements. Presently, our Company along with our subsidiaries is today one of India's largest exhibition chains operating 10 properties with 33 screens and 9,220 seats with dominant presence in Mumbai and Thane. Competitive strengths

• • • • • • • • • • • • •

Kanakia Group - Strong Developer Background Exhibition outlets catering to diverse customer base Exhibition Chain for the value-conscious Indians Strong presence in the Mumbai and Thane market One of the largest owners of theatre properties in India Established Brand and track record of innovation Strong relationship with film fraternity Enhancing revenues through optimal utilization of large available area Strong project execution capabilities Ability to identify strategic locations and to acquire properties at competitive prices Offering a wide variety of games Easy Availability of locations/customers Games across age groups at competitive rates Business Model

Regulatory Environment In India, regulation is one of the key drivers for the success of this business. There are essentially two types of regulations involved, fiscal regulations and building and operating regulations. Film exhibition is subject to a number of taxes at the

Central, State and Local level. The incidence of tax on this industry is probably the highest. Entertainment tax, the key levy on this industry, varies from state to state and ranges from 16% to 34% of gross ticket price. Prohibitively high level of taxes has been the key detrimental factor in hindering the progress of the film exhibition industry in India. Recently however, the Government of India and some State Governments have taken steps to encourage investments in the film exhibition sector and have introduced an Entertainment Tax holiday to newly constructed multiplexes. Many States are also reducing entertainment tax rates for all cinemas, to encourage the industry. Most States, also prescribe building and operating regulations, through the respective State Cinema Rules. These regulations have an impact on how multiplexes are built, and operated.

CAPITAL STRUCTURE OF CINEMAX INDIA LIMITED Our Share Capital as on the date of filing of this Red Herring Prospectus is as follows: (Rs. in Million) Aggregate nominal value A. Authorised Capital The Authorised Share Capital of the Company is Rs.402,500,000 divided as follows: i) 40,000,000 Equity Shares of Rs.10 each ii) 250,000 Redeemable Non-Convertible Preference Shares of Rs.10 each Issued, Subscribed and Paid up capital prior to the issue: i) 21,000,000 Equity Shares of Rs.10 each ii) 170,160 Preference Shares of Rs.10 each Present issue to the Public in terms of the Red Herring Prospectus Fresh Issue of Equity Shares 7,000,000 Equity Shares of Rs.10 each Offer for Sale 1,920,000 Equity Shares of Rs.10 each Out of which 60,000 Equity Shares for Employee Reservation Portion 8,860,000 Equity Shares for Net Issue Issued, Subscribed and Paid up Capital post the issue Share Premium Account Prior to the issue Post the issue Aggregate value at issue Price

400 2.50

[•] [•]

B.

C.

210 1.70 89.20 70 19.20

[•] [•] [•] [•] [•]

D. E.

0.60 88.60 280 Nil [•]

[•] [•] [•] [•]

The authorised share capital of the Company was increased from Rs.500,000 divided into 50,000 shares of Rs.10 each to Rs.60,000,000 divided into 6,000,000 shares of Rs.10 each through a resolution of the shareholders of the Company dated November 24, 2003. The authorised share capital of the Company was further increased from Rs.60,000,000 to Rs.62,500,000 by addition of 250,000 redeemable non-convertible preference shares of Rs.10 each by resolution of the shareholders of the Company dated March 29, 2006. The authorised share capital of our Company was increased from Rs.62,500,000 divided into 6,000,000 equity shares of Rs.10 each and 250,000 redeemable non-convertible preference shares of Rs.10 each to Rs.402,500,000 divided into 40,000,000 equity shares of Rs.10 each and 250,000 redeemable non-convertible preference shares of Rs.10 each by a resolution of the shareholders of the Company dated June 12, 2006. Cinemax India Limited Summary of Assets and Liabilities (Rs. in million)

Particulars

For the year ended March 31, 2004 173.55 2.31 171.24 60.45 6.80 AND 0.21 0.30 2.72 7.60 10.83 249.32 61.38 73.63 49.50 2.20 186.71 62.61 60.00 2.97

For the year ended March 31, 2005 230.73 11.08 219.65 34.05 16.90 68.87 152.55 80.72 302.14 572.74 224.37 77.54 143.16 8.49 7.41 460.97 111.77 60.00 52.14

For the year ended March 31, 2006 203.87 20.50 183.37 125.54 60.08 157.11 31.76 21.05 271.40 481.32 850.31 425.43 6.69 190.87 31.08 9.23 663.30 187.01 60.00 127.19 0.18 187.01

For the six months ended September 30, 2006 664.41 98.61 565.80 34.34 17.18 18.23 154.09 34.67 17.68 371.73 578.17 1213.72 590.15 120.31 157.81 46.74 35.99 951.00 262.72 211.70 56.06 5.04 262.72

FIXED ASSETS Gross Block Less: Depreciation Net Block Capital Work In Progress GOODWILL ON AMALGAMATION INVESTMENTS CURRENT ASSETS, LOANS ADVANCES Inventory Sundry Debtors Cash and Bank Balances Loans and Advances Total (A) LIABILITIES AND PROVISIONS Secured Loans Unsecured Loans Current Liabilities Provisions Deferred Tax Liability (Net) Total (B) NET WORTH (A) - (B) REPRESENTED BY Share Capital Reserves & Surplus General Reserves Profit & Loss Account Less: Miscellaneous Expenditure Debit Balance in Profit & Loss Account NET WORTH

0.36 0.37 62.61 111.77 Cinemax India Limited Summary of Profit and Loss Account

(Rs. in Million) For the year ended March 31, 2004 For the year ended March 31, 2005 For the year ended March 31, 2006 For the six months ended September 30, 2006

Particulars

INCOME Operating Income Ticket Sales Sale of Foods and Beverages Advertisement Income Project Income Giggles & Game Income

21.56 4.44 0.49 -

123.32 25.41 2.80 0.29

137.75 25.30 7.68 252.58 0.31

206.27 43.44 13.06 71.72 4.31

Other Income TOTAL EXPENDITURE Operating Expenses Distributor's Share Entertainment Tax Power & Fuel Cost of Foods and Beverages Cost of Projects Other Expenses Employees Remuneration and Benefit Administrative and Selling Expenses Preliminary Expenses Written Off Financial Charges Depreciation Depreciation Written Back Amortization of Goodwill TOTAL PROFIT BEFORE PRIOR PERIOD ADJUSTMENTS, EXTRAORDINARY ITEMS AND TAX Add/(Less): Taxes related to earlier years Less: Prior period items Less: Extraordinary Items PROFIT BEFORE TAX Provision for Income Tax (Include Wealth Tax) Deferred Tax Provision for Fringe Benefit Tax PROFIT AFTER TAX ADJUSTMENTS Impact of material adjustment for restatement in corresponding years Adjusted Net Profit after tax Balance brought forward from Previous year Profit available for appropriation Less: Proposed Preference Dividend & Tax thereon

1.28 27.77

2.86 154.68

14.98 438.60

8.52 347.32

5.99 5.08 1.37 1.48 0.32 1.14 3.72 0.09 1.10 8.45 28.74 (0.97)

34.52 4.93 7.88 8.00 0.85 5.34 17.89 0.09 3.53 24.67 107.70 46.98

39.10 0.19 9.17 7.44 209.40 0.63 9.93 29.61 24.49 9.42 (22.04) 317.34 121.26

61.07 32.44 16.40 15.32 66.83 4.12 25.98 47.91 0.30 20.73 17.36 1.91 310.37 36.95 0.69 5.08 31.18 5.50 3.65 0.64 21.39

(0.97)

46.98 8.49

121.26 22.21 9.23 0.14 89.68 (14.63) 75.05 52.14 127.19

(0.97) 3.95 2.98 (0.01) 2.97

38.49 10.68 49.17 2.97 52.14

21.39 127.19 148.58 0.03

Less: Amount capitalized for bonus share issued BALANCE CARRIED OVER TO BALANCE SHEET

92.49

2.97 Industry peers

52.14

127.19

56.06

Adlabs Films Inox Leisure PVR Shringar Cinemas

EPS (Rs) P/E 5.60 35.4 2.90 50.1 2.4 62.6 286.1 Industry P/E Highest Lowest

RONW% 10.40 15.90 8.7 -

NAV (Rs.) 85.10 36.00 75.40 16.90

720.0 9.8 NA

Average Method of Proportionate basis of allocation in the Issue

In the event of the Issue being oversubscribed, the Company shall finalize the basis of allotment in consultation with the Designated Stock Exchange. The Executive Director (or any other Senior official nominated by them) of the Designated Stock Exchange along with the BRLMs and the Registrar to the Issue shall be responsible for ensuring that basis of allotment is finalized in a fair and proper manner. The allotment shall be in marketable lots, on a proportionate basis as explained below. a. b. Bidders will be categorized according to the number of Equity Shares applied for by them. The total number of Equity Shares to be allotted to each category, as a whole shall be arrived at on a proportionate basis, which is the total number of Equity Shares applied for in that category (number of Bidders in the category multiplied by the number of Equity Shares applied for) multiplied by the inverse of the over-subscription ratio. Number of Equity Shares to be allotted to the successful Bidders will be arrived at on a proportionate basis, which is total number of Equity Shares applied for by each Bidder in that category multiplied by the inverse of the oversubscription ratio. Each successful Bidder shall be allotted a minimum of 45 Equity Shares; and The successful Bidders out of the total Bidders for a category shall be determined by draw of lots in a manner such that the total number of Equity Shares allotted in that category is equal to the number of Equity Shares calculated in accordance with (b) above.

c.

In all Bids where the proportionate allotment is less than 45 Equity Shares per Bidder, the allotment shall be made as follows: • •

If the proportionate allotment to a Bidder is a number that is more than 45 but is not a multiple of one (which is the market lot), the decimal would be rounded off to the higher whole number if that decimal is 0.5 or higher. If that number is lower than 0.5, it would be rounded off to the lower whole number. All Bidders in such categories would be allotted Equity Shares arrived at after such rounding off. If the Equity Shares allocated on a proportionate basis to any category are more than the Equity Shares allotted to the Bidders in that category, the remaining Equity Shares available for allotment shall be first adjusted against any other category, where the allotted Equity Shares are not sufficient for proportionate allotment to the successful Bidders in that category. The balance Equity Shares, if any, remaining after such adjustment will be added to the category comprising Bidders applying for minimum number of Equity Shares. The basis of allocation on a proportionate basis shall be finalised in consultation with the Designated Stock Exchange. Allocation to Retail Individual Bidders: The total number of shares to be allotted in this category is 3101040 Equity Shares. The category wise details of the Basis of

Allocation in this category are as under: Category 45 90 135 180 225 270 315 360 405 450 495 540 585 630 No. of applications 19314 15826 9845 9791 5001 4240 29048 2623 878 1653 680 756 726 43152

Allocation to Non Institutional Bidders: The total number of shares to be allotted in this category is 1328960 Equity Shares. The category wise details of the Basis of Allocation in this category are as under: Category 675 720 765 810 900 990 1035 1260 1305 1350 48330 101250 577440 1028700 8859960 8865000 8910000 9000000 9045000 No. of applications 22 4 3 2 8 13 2 3 5 2 1 6 1 2 1 2 1 1 1

Allocation to Eligible Employees: The total number of shares to be allotted in this category is 60000 Equity Shares. The category wise details of the Basis of Allocation in this category are as under: Category 45 1125 2115 2925 3915 4680 No. of applications 23 5 4 3 2 2

6525 7920 8550

1 1 1

END OF SECTION D

Section E : Caselets (50 Marks)
• • • • This section consists of questions with serial number 6 - 11. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 6.
< Answer > The plans discussed in the caselet provides for the possible appreciation in the value of the aged person's house. Reverse SAM is one of the plans which are suitable for this purpose. Along with a suitable example, discuss how the reverse SAM works out. (8 marks)

7.

With respect to the caselet discuss the shortcomings associated with the SAM.

< Answer >

(7 marks) The Shared Appreciation Loan Program is designed to make funds available to moderate and very low income households to help them in purchase of a home. The Shared Appreciation Mortgage (SAM) was introduced in the early 80’s because interest rates were so high that it made it too difficult to qualify for a conventional mortgage. The loan was created to provide borrowers a lower interest rate in return for a share of the equity that would hopefully accrue with the property’s appreciation. The share of the appreciated value is known as the “conditional interest”. This is calculated and due when the property is sold or the mortgage ends or is terminated. Under SAM the interest rate varies depending on how much of the property's appreciation you bargain away. For example: Standard 30 Year Fixed Rate Mortgage: SAM w/20% Appreciation given to investor: SAM w/30% Appreciation given to investor: SAM w/40% Appreciation given to investor: SAM w/50% Appreciation given to investor: 8.00% 7.50% 7.00% 6.50% 6.00%

Obviously with a SAM, there are tradeoffs. A shared appreciation mortgage can offer certain opportunities to the borrowers that traditional mortgage arrangements cannot. However, you may be sacrificing thousands of dollars in appreciation on the back end. The lender is taking a risk by participating in the appreciation of the property. A lot depends on the home, its location, and the conditions of the housing market. Under a SAM the principal of the loan is an unconditional obligation. In other words, if the property’s value decreases, the borrower will still owe the outstanding principal. If the property is sold for a loss, the “conditional interest” would be zero. Now further home equity conversion plans can broadly be divided into loan plans and split equity plans. In the loan plans, the aged homeowner accumulates a debt to be paid off at some future time. In the split equity plans, the aged person sell off the house and the equity is split into ownership rights that belong to the buyer-investor and occupancy rights that are maintained by the aged person for life. Loan plans can be divided into those that guarantee lifetime tenure and those that do not. The former involve a non-repayable debt-that is, the debt does not have to be repaid until the aged person dies or sell off the house. The latter involves a repayable debt which is repaid over a given term. Both loan and split equity plans may use public subsidies. Each plan is described and evaluated according to the income it provides to the aged person and what the aged person has to

give up in return. All plans have advantages and disadvantages that need to be understood and carefully weighed before a decision can be made as to which is preferable in one's individual situation.

Caselet 2
Read the caselet carefully and answer the following questions: 8. Essentially, the draft regulations for delisting seek to punish investors for corporate lapses and mis- < Answer > management. Do you agree with this? Justify your answer with suitable explanation. (10 marks) The company gets delisted from the stock exchange when its shares become illiquid; it looses the < Answer > profitability etc. Instead of getting the company delisted certain corrective measures can help the investors and the company to recover from such situation. According to you what should be such measures. (9 marks)

9.

The ongoing boom in stock markets reveals a regulatory paradox and one has to see whether it would be full blown or would it stabilize. As one force brings more and more retail investors in the market, another force seeks to drive them out. Succinctly, it appears that the sheer market demand of shares of listed companies is sowing the seeds of its own destruction. This trend is being observed not just in India but the world over. Ironically, steps by the Securities and Exchange Board of India seeking to ensure good governance and transparent delisting are only remedy to aggravate this. The phenomenal demand for shares of companies has resulted in more and more investors chasing the existing limited stock. The prices have thus gone higher and higher. Many retail investors have exited by profiting from sale or have generally avoided further purchase. Thus, the number of retail investors has reduced as one part of this trend. The other is the entry of wholesale investors who seek to buy in bulk, and preferably from the company itself or, at times, from the promoters. Important amongst these are private equity investors whose size in billions of dollars has only increased. The result is a sheer paradox. The stock markets are mainly intended for small and large investors to freely trade in and if the shareholders finally are just a few in numbers, with significant shareholding, the purpose of listing is probably lost. One may recollect that SEBI had once sought to enforce a requirement that companies should have a certain minimum number of shareholders related to the size of its share capital. The requirement was dropped but the principle still remains. The recently announced draft norms for delisting companies from stock exchanges stipulate, inter alia, that the securities of a company may be delisted if they have remained ‘infrequently traded’ during the preceding three years or the shareholding held by the public has fallen below the minimum level applicable under the listing agreement. The draft rules also say that stock exchanges can compulsorily delist companies that make losses for three consecutive years or if the management fails to inform the exchange about a change of address. In 2005-06, out of 7,311 securities listed on the BSE, only 3,049 were traded, of which 87 were traded for 31 to 60 days, while 243 were traded for 30 days or less. Apart from the 4,262 securities not traded, it can be reasonably deduced that 330 securities were ‘infrequently traded’. Over a time horizon of three years, the number of ‘infrequently traded’ securities may be less. Delisting over 4,500 securities, amounting to more than 60% of the listed securities, will be a blow to the investors. There are, at any point of time, those who want to sell or want to buy are at a price. Absence of market makers after the automation of trade is responsible for this dismal state of affairs. The answer to illiquidity is not delisting, but to categorize securities under different heads such as liquid securities-securities traded for more than 90% of trading days; thinly-traded securities-for at least 25% of trading days; marginally-traded securities-for at least 10% of trading days; and illiquid shares, which are hardly traded.

Caselet 3
Read the caselet carefully and answer the following questions: 10. With respect to the following article discuss the advantages and disadvantages of the private equity investment. (9 marks) 11 Explain how private equity investment differs from venture capital investment. (7 marks)
< Answer > < Answer >

Indian companies raised more funds from Private Equity and Venture Capital firms in 2006 than they did via IPOs. That PE financing (even after accounting for investments in already publicly-listed companies) overtook fund raising via IPOs is indeed significant — especially when it happens during a year when the booming public markets have welcomed new companies with open arms. So, why do companies, including those that can tap the public markets, opt to raise PE financing? “PE is a creative mode of financing,” avers Ajit Kamath, CMD of Arch Pharmalabs, which was featured as a case study in Venture Intelligence’s recently released Private Equity Impact report. “For example, in 2004, ICICI Venture was willing to back us to acquire a sick company. This was at a time when there was no asset reconstruction company in India and the financial landscape was very different,” Kamath adds. In November 2006, Arch raised another round of funding from ICICI Ventures - at a time when it had the option of going to the public markets. Akhil Gupta, Joint Managing Director & CFO of Bharti Airtel points out how availability of funds at the right time has been crucial to the company’s growth and success. Beyond providing the capital to support its rapid growth, PE investors also helped the company’s management with important strategic inputs and mentoring. “While we could have raised funding from other sources, ‘Warburg Pincus’ involvement helped us in scaling up significantly,” Gupta adds. When they eventually end up going public, PE-backed companies seem to be quite well. For instance, the PE Impact study found sales at publicly-listed PE-backed companies growing at 22.9% over the five year period between 2000 and 2005, compared to 10% at non PE-backed listed firms and 15.8% at Nifty Index companies. Private Equity is also patient capital. Bharti Airtel’s Akhil Gupta recalls how their PE investors did not lose their calm when, post the company’s January 2002 IPO, the stock price went lower than the IPO price (of Rs. 45 per share). “Their repeated advice to us was to forget about the share price and just focus on the good work that we were doing,” Gupta says. All this seems to hold for smaller companies too. The first-ever qualitative survey of founders of privately held PE/VC-backed companies in India, conducted as part of the PE Impact study, revealed that about 96% of top executives at PE/VC-backed firms believe that without PE/VC financing, their companies would not have existed or would have developed slower. Going by the positive impact that this form of financing has had on Indian companies and the overall economy, it is clear that Indian entrepreneurs will continue to strike more and more innovative partnerships with PE and VC firms in the years ahead. END OF SECTION E END OF QUESTION PAPER

Suggested Answers
Investment Banking & Financial Services - II (262): April 2007
Section D : Case Study
< 1. Multiplex Growth Drivers and Growth Potential: TO The key growth drivers responsible for the expected increase in the number of Multiplex Cinemas P> are: An increase in disposable income in the hands of an ever expanding Indian middle class: Higher propensity to spend on entertainment and quality cinema viewing experience in multiplexes has helped grow the film exhibition business through multiplexes significantly. Multiplex Cinemas generally cater to middle and high income households. The emergence of the Indian middle class with greater earning power and a higher disposable income is one of the key factors that will drive the growth of the Multiplex Cinema segment. Favorable demographic changes India is likely to see a significant demographic shift that will be favourable for the film exhibition sector. The urban population between the ages of 15-34 years is expected to increase from 107 million in 2001 to 138 million in 2011, an increase of 30%, and the urban population between the ages of 15-44 years is expected to increase from 146 million to 186 million during the same period, an increase of 27%. (Source: Yes Bank Report - Bollywood - Emerging Business Trends & Growth Drivers). These expected increases are likely to cause a rise in the demand for movies, especially in the 15-34 years age group as this age group represents the most frequent movie goers across the

global markets. Development of organized retail In the last 5-7 years organized retail in India has witnessed significant growth. Retailing in India is currently estimated to be a USD 200 billion industry, of which organised retailing makes up 3 percent or USD 6.4 billion. Entertainment tax benefits for Multiplex Cinemas Entertainment tax rate/ exemptions are given to the multiplixes that is again a growth driver but it varies state to state. Increased corporatisation in the film industry Over the last few years, there has been some change in the operating style of the industry. Film financing from organised sources is on the rise: around 100 films availed of organised funding of INR 7 billion in 2004, compared to virtually nil a few years ago (Source: CII - KPMG Report, 2005.) Increasing corporatisation of the film production sector should result in an increase in the number of high quality films produced, which should increase demand for movies. In an increasingly corporate environment, unviable movies with weak scripts should find it difficult to garner funding. Consequently, although the average number of films produced annually in India is expected to fall from over 900 in 2004 to around 600 by 2010, the quality of the movies produced is expected to increase. Increase in number of high grade films An increase in the average quantity of high grade Hindi films released per week should increase the total demand for movies, as these movies tend to be more popular. From 2001 until 2004, there was an increase of 48% in the number of releases per week for high grade Hindi films. Advantages of Multiplexes Multiplex Cinemas offer significant economic advantages over similar size single-screen theaters. The key economic advantages are as follows:

Better occupancy ratios: Multiplex Cinemas have multiple screens with different seating capacities. The Multiplex Cinema operator can choose to show a movie in a larger or a smaller theater based on its expected potential. This enables the Multiplex Cinema operator to maintain higher capacity utilization compared with a single-screen cinema. Greater number of shows: Each movie has a different screening duration. A Multiplex Cinema operator has the flexibility to decide on the screening schedule so as to maximize the number of shows in the Multiplexes, thus enabling it to generate a higher number of patrons. Better cost management: A Multiplex Cinema benefits from a set of shared facilities, such as the box office, toilets, food and beverage facilities and common manpower, resulting in a lower cost of overhead per screen. Tax Rebates: The government has accorded various tax rebates for multiplexes. Dynamic Pricing: States like Maharashtra and Delhi have incorporated dynamic ticket pricing, allowing them to charge ticket prices according to demand and supply.

• • • •

< 2. BASIS FOR ISSUE PRICE TO Qualitative Factors P> Competitive strengths Kanakia Group - Strong Developer Background The company is a part of the Kanakia Group, which has been associated with the real estate development for more than two decades and has developed over 5 million square feet of residential & commercial space. The wide experience in real estate development has enabled us to reduce cost and time overrun in developing projects without compromising on quality and ambience. It has already developed 6 multiplexes having 24 screens. The group has established good relationships with various suppliers, which enable it to get preferred services and negotiate for competitive commercial terms.

Exhibition outlets catering to diverse customer base We provide a wide range of offerings catering to a wide spectrum of cinema goers from high quality multiplexes to budget retrofitted/single screens. We believe in optimising revenue and have adopted a price differentiation model, offering our patrons a superior cinema-going experience at each price point. Currently our ticket prices range from Rs. 40 to Rs. 110 for our retrofitted/single screens and Rs.100 to Rs. 450 for our multiplexes across various properties. Our theatres are strategically located in high-catchment residential areas providing convenient access to our target customers. Our diversified offering enables us to cater to various sections of the urban population viz. upmarket households through multiplex theatres and middle-income households through retrofitted/single screens. Exhibition Chain for the value-conscious Indians We endeavour to offer a superior movie experience to our patrons at each price point by focusing on quality, customer service and providing a host of value added services. We are able to develop highquality infrastructure at low cost points and provide services to our patrons at reasonable prices. Strong presence in the Mumbai and Thane market Mumbai, is the hub for Indian cinema and is a large market for exhibition business. We have a strong presence in and around Mumbai market with 9 theatres, 30 screens and a seating capacity of 8314. Our theatres in Mumbai are strategically located in high catchment areas - Sion, Andheri, Versova, Goregaon, Kandivali, Mira Road and Thane. This allows us flexibility in rotating prints between our theatres, and thereby maximize returns. One of the largest owners of theatre properties in India We believe we are one of the largest owners of theatere properties in India with 8 properties with 21 screens spread over approximately 146,000 sq. ft. under ownership. In Mumbai and Thane itself, we own 7 properties spread over 120,000 sq ft of area. This gives us lifetime access to properties with no rentals to be paid. This also provides us the flexibility of remodelling our screen formats within the owned premises with newer technology / concepts / exhibition formats. Established Brand and track record of innovation Our brand 'Cinemax' is one of the most recognisable movie exhibition brands in the areas where we operate. We have a track record of innovation in the exhibition industry. We were amongst the first few players to anticipate the need for modern multiplexes in India. We were one of the first to introduce the concept of high comfort recliner seating arrangements with 'The Red Lounge'. We constantly focus on providing service enhancements and innovative value additions to our patrons. In line with this, we have introduced massage chairs, karaoke facilities. We have also introduced a gaming zone in our multiplex at Thane and also intend to further expand it by opening seven new gaming zones at different locations where are Multiplexes are present in India by fiscal 2009, to provide complete family entertainment and enhance the overall experience. However, we have filed application for registration of our brand "Cinemax" and the application is still pending with the relevant authorities. Strong relationship with film fraternity We believe that our position as one of the leading exhibition players in Mumbai have helped us to build strong relationships with both Indian and foreign film distributors. We believe this gives us an edge in accessing content - both in terms of quality of content as well as terms of agreement due to better negotiating leverage. This enables us to host premieres which generate a lot of footfalls and have a ripple effect on future screenings, brand visibility and brand recognition. We hosted 17 film premieres in FY06 including blockbuster films such as Salaam Namaste, Rang de Basanti, Chronicles of Narnia, Hanuman and Shaadi No. 1. Enhancing revenues through optimal utilization of large available area We normally plan our area in theatres based on certain predefined parameters of area per seat which enables our patrons to have a free movement within the theatre premises having large foyer area. The excess available area per patron is put to productive use through concessionaires (rented kiosks or speciality food vendors) or advertising hoardings and props which generate significant revenue for us at no extra costs.

Strong project execution capabilities We have an in-house specialized team for design and development of our properties. Our strong developer background, regulatory management skill sets and relationship with various suppliers help us in timely execution of projects and in maintaining tight control on costs and quality. Ability to identify strategic locations and to acquire properties at competitive prices One of the key factors for the success of any multiplex is the location. Our promoter's background and expertise in real estate development enables us to identify strategic locations and acquire properties at competitive prices. In addition, we have a professional team with many years of experience to assess the potential of a location after evaluating its demographic trends in terms of catchment areas, purchasing power, competing alternatives, etc. Our ability to evaluate such trends enables us to identify locations which are relatively untapped and gain the first mover advantage. FOR GAMING Offering wide variety of games We offer a wide variety of games including LAN based games, designed specially to engage every age group. We believe that this provides greater choice to our patrons and enhances the overall gaming experience. Games across age groups at competitive rates The pricing of the games has also been kept very competitive and there are incentives for those who achieve set parameters in each game. Quantitative Factors Adjusted Earning per Equity Share (EPS) of face value Rs.10 Rupees Weight Particulars Year ended March 31, 2004 0.50 1 Year ended March 31, 2005 8.20 2 Year ended March 31, 2006 12.51 3 Sixth month period ended September 30, 2006 1.01* Weighted average 9.07 The EPS for six months ended September 30, 2006 is Rs.1.01. (ii) P/E pre-issue in relation to Issue Price of Rs.155. a. For the year ended March 31, 2006, EPS is Rs.12.51. b. P/E based on profits after taxes, as restated, for the year ended March 31, 2006 is 12.39. c. Industry P/E i) Highest : 720.0 ii) Lowest : 9.8 iii) Average : NA (iii) Average Return on Net Worth in the last three years. RONW % Weight Particulars 4.76 1 Year ended March 31, 2004 43.99 2 Year ended March 31, 2005 40.13 3 Year ended March 31, 2006 35.52 Weighted Average The Average Return on Net Worth for the six months ended September 30, 2006 is 8.14%. (iv) Minimum Return on Increased Net Worth required to maintain pre-issue EPS at Rs. 12.51 is Required EPS Number of shares after the issue Required PAT Increased Net Worth Required RONW = Rs.12.51 = 28,000,000 = 12.51 ×28,000,000 = Rs.350,280,000 = 7,000,000× 155 +187,010,000 = Rs.1,272,010,000 =350,280,000 /1,272,010,000= 27.54%

(v) Net Asset Value per Equity Share. Net Asset Value per Equity Share for the year ended March 31, 2006 is Rs.31.17. Net Asset Value per Equity Share for the six months ended September 30, 2006 is Rs. 12.41. Post issue Net Asset Value per Equity Share on September 30, 2006 is Rs.57.72 (vi) Comparison with industry peers Cinemax Adlabs Films Inox Leisure PVR Shringar Cinemas EPS (Rs) 12.51 5.60 2.90 2.4 P/E 12.39 35.4 50.1 62.6 286.1 RONW% NAV (Rs.) 40.13 31.17 10.40 85.10 15.90 36.00 8.7 75.40 16.90

The BRLMs believe that the Issue Price of Rs. 155 is justified in view of the above qualitative and quantitative parameters. 3. Allotment to Retail Investors: Category 45 90 135 180 225 270 315 360 405 450 495 540 585 630 No. of applications 19314 15826 9845 9791 5001 4240 29048 2623 878 1653 680 756 726 43152 Total number of shares applied Total no. of shares to be allotted O/S ratio Total number of shares applied 869130 1424340 1329075 1762380 1125225 1144800 9150120 944280 355590 743850 336600 408240 424710 27185760 47204100 3101040 15.22 Total number of shares applied 1035 5625 8460 8775 7830 9360 6525 No. of Successfu l applicant s 22 5 4 3 2 2 1 Proportionate allocation 57104.46781 93583.44284 87324.24442 115793.6925 73930.68331 75216.81997 601190.5388 62042.04993 23363.33771 48873.19317 22115.63732 26822.60184 27904.73062 1786186.597 No. of successful applicants 1269 2080 1941 2573 1643 1671 13360 1379 519 1086 491 596 620 39693 No. of shares allotted 45 45 45 45 45 45 45 45 45 45 45 45 45 45
< TO To>al t P

allocated shares 57105 93600 87345 115785 73935 75195 601200 62055 23355 48870 22095 26820 27900 1786185 3101445

Allotment to Employees: Categor y 45 1125 2115 2925 3915 4680 6525 No. of application s 23 5 4 3 2 2 1 Proportionat e allocation 969.10112 5266.8539 7921.3483 8216.2921 7331.4606 8764.0449 6109.5505 No. of Shares allotte d 45 1053 1980 2739 3666 4382 6110 Total Allocate d shares 990 5265 7920 8217 7332 8764 6110

7920 8550 O/S ratio

1 1

7920 8550 64080 1.068

7415.7303 8005.6179

1 1

7416 8006

7416 8006 60018

Allotment to Non-Institutional Investors: Total No. of No. of Total No. of Proportionate number of Category successful shares allocated shares applications allocation applicants allotted shares applied 675 22 14850 346.8815697 8 45 360 720 4 2880 67.2740014 1 45 45 765 3 2295 53.60896987 1 45 45 810 2 1620 37.84162579 1 75 75 900 8 7200 168.1850035 4 45 180 990 13 12870 300.6306938 7 45 315 1035 2 2070 48.35318851 1 45 45 1260 3 3780 88.29712684 2 45 90 1305 5 6525 152.4176594 3 45 135 1350 2 2700 63.06937631 1 45 45 48330 1 48330 1128.941836 1 1129 1129 101250 6 607500 14190.60967 6 2365 14191 577440 1 577440 13488.43728 1 13488 13488 1028700 2 2057400 48058.86475 2 24029 48059 8859960 1 8859960 206960.0561 1 206960 206960 8865000 2 17730000 414155.5711 2 207078 414156 8910000 1 8,910,000 208128.9418 1 208129 208129 9000000 1 9000000 210231.2544 1 210231 210231 9045000 1 9,045,000 211282.4107 1 211282 211282 56892420 1328960 O/S ratio 42.810 < 4. Mode of making refunds: TO The payment of refund, if any, would be done through various modes in the following order of P> preference: • ECS - Payment of refund would be done through ECS for applicants having an account at any of the following fifteen centres: Ahmedabad, Bangalore, Bhubaneshwar, Kolkata, Chandigarh, Chennai, Guwahati, Hyderabad, Jaipur, Kanpur, Mumbai, Nagpur, New Delhi, Patna and Thiruvananthapuram. This mode of payment of refunds would be subject to availability of complete bank account details including the MICR code as appearing on a cheque leaf, from the Depositories. The payment of refunds is mandatory for applicants having a bank account at any of the above mentioned fifteen centres, except where the applicant, being eligible, opts to receive refund through NEFT, direct credit or RTGS. • NEFT (National Electronic Fund Transfer) - Payment of refund shall be undertaken through NEFT wherever the applicants' bank has been assigned the Indian Financial System Code (IFSC), which can be linked to a Magnetic Ink Character Recognition (MICR), if any, available to that particular bank branch. IFSC Code will be obtained from the website of RBI as on a date immediately prior to the date of payment of refund, duly mapped with MICR numbers. Wherever the applicants have registered their nine digit MICR number and their bank account number while opening and operating the demat account, the same will be duly mapped with the IFSC Code of that particular bank branch and the payment of refund will be made to the applicants through this method. • Direct Credit - Applicants having bank accounts with the Refund Banker(s), in this case being HDFC Bank shall be eligible to receive refunds through direct credit. Charges, if any, levied by

the Refund Bank(s) for the same would be borne by the Company. RTGS - Applicants having a bank account at any of the abovementioned fifteen centres and whose refund amount exceeds Rs. 5 million, have the option to receive refund through RTGS. Such eligible applicants who indicate their preference to receive refund through RTGS are required to provide the IFSC code in the Bid-cum-Application Form. In the event the same is not provided, refund shall be made through ECS. Charges, if any, levied by the Refund Bank(s) for the same would be borne by the Company. Charges, if any, levied by the applicant's bank receiving the credit would be borne by the applicant. For all other applicants, including those who have not updated their bank particulars with the MICR code, the refund orders will be dispatched under certificate of posting for value up to Rs. 1,500 and through Speed Post/ Registered Post for refund orders of Rs.1,500 and above. Such refunds will be made by cheques, pay orders or demand drafts drawn on the Escrow Collection Banks and payable at par at places where Bids are received. Bank charges, if any, for cashing such cheques, pay orders or demand drafts at other centres will be payable by the Bidders. < 5. GROUNDS FOR TECHNICAL REJECTIONS TO Bidders are advised to note that Bids are liable to be rejected on, among other things, the following P> technical grounds: • • • • • • • • • • • • • • • • • • • • Amount paid does not tally with the amount payable for the highest value of Equity Shares bid for; Age of first Bidder not given; In case of partnership firms, Equity Shares may be registered in the names of the individual partners and no such partnership firm, shall be entitled to apply; Bids by Non-Residents; if not in compliance with the appropriate foreign and Indian laws; Bids by persons not competent to contract under the Indian Contract Act, 1872, including minors and insane persons; PAN not stated if Bid is for Rs.50,000 or more or copy of PAN, Form 60 or Form 61, as applicable, or GIR number furnished instead of PAN. Bids for lower number of Equity Shares than specified for that category of investors; Bids at a price less than lower end of the Price Band; Bids at a price more than the higher end of the Price Band; Bids at Cut-off Price by Non-Institutional Bidders and QIB Bidders and by bidders in the Employee Reservation Portion in excess of Rs.1,00,000 Bids for number of Equity Shares, which are not in multiples of 45; Category not ticked; Multiple Bids as defined in this Red Herring Prospectus; In case of Bid under power of attorney or by limited companies, corporate, trust etc., relevant documents are not submitted; Bids accompanied by stockinvest/money order/postal order/cash; Signature of sole and/or joint Bidders missing; Bid cum Application Form does not have the stamp of the BRLMs or the Syndicate Member; Bid cum Application Form does not have the Bidder's depository account details; Bid cum Application Form is not delivered by the Bidder within the time prescribed as per the Bid cum Application Form and this Red Herring Prospectus and as per the instructions in this Red Herring Prospectus and the Bid cum Application Form; In case no corresponding record is available with the Depositories that matches three parameters namely, names of the Bidders (including the order of names of joint holders), the depositary participant's identity (DP ID) and the beneficiary account number; Bids for amounts greater than the maximum permissible amounts prescribed by the regulations

Bids by OCBs;

Section E: Caselets Caselet 1
6. Under this plan the aged homeowner receives monthly loan installments at below-market rates in < exchange for giving the investor a share of the appreciation. The investor's share of equity could be TO 50 percent or more even 100 percent. A greater share provides a greater annuity. The payment P > continues for life, or until the homeowner wishes to sell. At sale or death, the loan balance, including interest plus the share of the appreciation, is due. Annuity income is related to life expectancy as well as to initial home value. In the past, open-ended Reverse Annuity Mortgages (RAM) were not possible even on a small scale because some persons would live longer than expected and their debt could easily exceed home equity at death. With mortality risk-sharing and appreciation sharing, these rising debt loans are now feasible. A model of the reverse SAM was presented in a recent study, which discussed offering adequate profits to attract investors. For a woman aged 72 (with life expectancy of about 12 years), a reverse SAM will provide an annuity of $34.20 per $1,000 of initial property value, or $200 per month on a $70,000 house. The model assumes a 12.4-percent mortgage interest rate and 100 percent appreciation sharing. In comparison, a term reverse annuity mortgage for a period of 12 years with a higher market interest rate of, say, 14 percent, would yield an annuity of $35.67 per $1,000 of home value, an amount similar to the payment provided by the reverse SAM. Since the reverse SAM provides guaranteed payments for life--not just for life expectancy--the reverse SAM's total payments could be higher. Of course, the trade-off for higher payments is appreciation sharing. Another example: Consider a woman aged 85 with a life expectancy of 5 years. With a reverse SAM, she could receive a yearly annuity of $70.50 per $1,000 of initial home value. Although this is much more than what the woman aged 72 could receive, it is relatively low. With a term RAM for 5 years at 14 percent she would receive $151.28 per $1,000. True, the reverse SAM provides a lifetime guarantee of occupancy and payments, but a woman aged 85 could take out a term RAM at 14 percent for 8 years--3 years more than life expectancy--and still receive at this interest rate $75.57 per $1,000 of initial home value, which is more than the reverse SAM would provide. 7. Tough the SAM at first glance seems vary attractive and advantageous, it has some serious < disadvantages associated with it. Penalties: It might be tempting to take a SAM for a while and then refinance to avoid sharing the appreciation, but SAMs have a sort of prepayment penalty to keep you from doing so. Typically, if one prepays more than 20% of the outstanding balance during the first 3 years of the loan, he'll be penalized the lesser of a) 2% of the amount of my prepayment which is greater than the 20% level or b) six months stated interest which would be charged on amount of my prepayment which is greater than the 20% level or c) the maximum allowable penalty by law. Appreciation: Since appreciation is at the heart of this mortgage, it's important to know how the term is defined. Virtually all improvements or upgrades one makes to the home will count as appreciation; so will the appreciation which results from market conditions. At maturity: If one is not selling the home when the SAM ends, he will have to come up with the money, whether from savings or a home equity loan. The contract states that what one owes is due and payable, with no extensions.

Urgency: If one is at urgency and want to sell off the house say for example one is suffering from some dieses and requires money immediately and he is not able to sell his home at the market prices then also as per SAM his appreciation will be calculated as per the market price and not as per the actual selling price. Cost: If the property prices rise significantly in long term one may end up paying the higher as compared to other means of financing.

Caselet 2
8. Essentially, the draft regulations seek to punish investors for corporate lapses and mis-management < by throwing out companies and shutting exit opportunities. The draft rules say that stock exchanges can compulsorily delist companies that make losses for three consecutive years, if the management fails to inform the exchange about a change of address or even when they mop up shares and cause public holding to fall below the minimum prescription for listing. In most of these situations, the rules ought to hold the management accountable and help investors effect a change in management; instead, the government seems set to create conditions for companies to raise public money, siphon it off to their private coffers and get a smooth and automatic exit after three years of losses. The irony is that everybody agrees with the need for a few thousand companies to be dropped from the Bombay Stock exchange’s (BSE) list and sympathises with its burden of surveillance and ensuring compliance with listing regulations for 7,500 companies. Many of these were historically listed with tiny capital requirement and low public shareholding of which barely 2,500 are traded regularly. The draft rules only underline the need for policy making through proper discussion and a clear purpose. Funnily enough, at the inauguration of Sebi Bhavan in Mumbai, Finance Minister P. Chidambaram asked the regulator to “come out with measures to draw small investors to the capital market and ensure they felt safe about their investments”. But these new regulations are likely to frighten investors because the absence of IPO ratings are allowing mutual funds and institutional investors to continue investing in a host of dubious and over priced issues. As we noted last week, when a company gets a poor rating, those in charge of institutional investors would be forced to explain their investment in poorly rated issues. That is exactly how an issue that got a rating of 2 out of 5 failed to get any institutional subscription and was withdrawn. What better check could there be on dubious issuers? Yet, companies and market intermediaries are powerful enough to ensure that the demand of investor associations is consistently ignored and mandatory IPO rating is not being introduced. So, companies can now take advantage of a 3-year bull run to pick up public funds through an overpriced and much hyped public offering and walk away with it in three years, so long as they meet one of these conditions: their shares are suspended for more than six months (this can be ensured by not paying listing fees, or not fulfilling corporate governance requirements or not complying with mandatory corporate filings) or infrequently traded in a three year period. Failure to furnish the correct address, unauthorised change of address, if the public shareholding sinks below the minimum listing requirement (usually because management mops up the shares) or violation of the SCRA which warrant a Rupees one crore penalty or three month imprisonment could also trigger delisting. But the most contentious regulation is that three consecutive years of losses are reason enough for companies to delist. Apparently, the government has forgotten the entire saga of India’s steel majors which made losses for several years until global commodity prices turned bullish and India’s economic growth boosted turnover and profitability. It may be recalled that institutional investors such as ICICI Bank made a lot of money by forcing companies to convert their debt to equity and then selling the shares when prices rallied substantially. Some companies involved with Ketan Parekh have also made a sharp recovery after floundering for several years in the aftermath of the scam.

A quick search shows that even companies like IFCI, Whirlpool and Tata Tele Maharashtra are among those reporting losses for the last three years. But are their shareholders desperate to get rid of these shares? Under the delisting regulations drafted by the SCRA, all of these companies would have been thrown out from the market. 9. Illiquid securities may be delisted after giving proper notice to the companies to increase liquidity by < increasing the paid-up capital and public shareholding, if companies fail to generate at least some modicum of liquidity. For the thinly- and marginally-traded securities, liquidity must be generated with steps like compulsory appointment of market makers by companies, a call auction system, etc. Proper facilities by way of supply of stock and borrowing of funds on reasonable terms, fiscal incentives to market makers and weekly contracts are needed. Norms for spreads of market makers have to be liberal. In fact, jobbers on the BSE not subject to any norms used to generate liquidity in most of the listed shares, albeit with wide spreads. Delisting may be considered only for companies that fail to comply with the above. The problem is investors loaded with illiquid shares have no exit route. They can’t write off the losses, as under the I-T Act, it is possible only if there is a transfer. One possible answer is that asset reconstruction companies (ARCs) buy these shares at a nominal value of say one paise a share so investors can book losses while the ARCs can hope for a sunny day. Alternatively, the I-T Act can be amended to let shareholders of the delisted securities to claim the losses treating the value of such securities as zero. The losses could be set off against taxable long-term gains, if any. With regard to the norm for delisting securities of a company where the shareholding held by the public has fallen below the specified minimum, the answer is not to delist, but to direct the companies to raise the level of public shareholding to the prescribed level within a reasonable period, say a year. If a company still fails to manage this level, penal action should be taken against its promoters and directors. The quantum of fines may be related to extent of the slide below the minimum level. If the company fails to achieve the level within the deadline, it may be given a grace period on payment of a higher fine. If it still fails to raise the level of public shareholding to the minimum level, delisting needs to be considered. Even the norms for delisting of securities of a company which has incurred losses in the preceding three years and its net-worth has declined to less than its paid-up capital needs reconsideration. Quite a few companies in this category have the potential to turn into profit-making ones. As long as these comply with listing requirements and as long as the public shareholding in these companies comply with the minimum level, there is no need to delist their securities.

Caselet 3
10 Advantages of private equity: Companies backed by private equity funds are developed or made more efficient with the active participation of the private equity manager’s team working alongside management, to preagreed plans and targets. One member of the private equity team will usually have a nonexecutive seat on the company’s Board. • Private equity-backed companies have a limited number of highly-incentivised shareholders, including management, all working to achieve the same objectives. • Companies backed by private equity can grow, or be restructured, out of the public eye – and that of competitors – without the constraint and distraction of performance being honed for quarterly or six monthly reporting. • The private equity manager has control over the timing of a sale of the business. • Private equity firms have access to high caliber management from around the world for portfolio companies. Disadvantages of private equity: • • Difficult to access: private equity Limited Partnership funds may only be marketed to institutions and very wealthy individuals; in addition the minimum investment accepted is usually very high. Relative illiquidity: private companies may not be saleable, either because they are not •
<

performing to plan or because market conditions are not conducive to a sale or floatation or obtaining debt facilities. Shares in public companies can almost always be sold if cash is required, albeit prices will vary widely depending on market conditions. • A long term investment perspective is necessary to achieve gains for a private equity investment program (although individual companies may produce very good returns over quite short periods). • As discussed above it is an expensive source • Leads to significant dilution of existing share holders • Governance - investor will typically want a board seat • Transaction timings are high, it generally takes 4 to 6 months to close a transaction Investors will desire a 3 to 5 year strategy 11 Considering the growth stage of companies and their financing reasons, the financial partnership < investments can be made at different stages, like seed financing, start-up financing, early stage financing, expansion financing, mezzanine financing, LBO and MBO. These stages sometimes mark the distinction between venture capital and private equity investments. Although the differences between venture capital and private equity investments are not apparent in many cases, seed, start-up or early stage companies with a business or product development plan are generally financed by venture capital funds whereas private equity funds prefer investments to ongoing businesses at later stages of growth via mezzanine or expansion financing. Private equity funds seek companies, which have reached a certain size, enjoy high operating profit, realize rapid growth, hold considerable market share, and create significant entry barriers in their sectors.
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Question Paper
Investment Banking and Financial Services - II (MSF2K2) : July 2007
Section D : Case Study (50 Marks)
• • • • This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study
Read the case carefully and answer the following questions: 1. Discuss the various factors which can affect financial condition and operating results of ICRA Ltd. (9 marks) 2. The Issue Price of Rs.330 has been determined by the company in consultation with the BRLMs on the basis of assessment of market demand for the offered Equity Shares by the Book Building Process. Delineate the basis for issue price to be furnished in the final offer document. (Furnish quantitative factors considering both pre and post Preferential Allotment i.e. allotment to Moody's India and ESOS Welfare Trust). (15 marks) 3. From the capital structure given in the red herring prospectus, frame the capital structure of the company to be furnished in the final offer document. (6 marks) 4. The instruments rated by the rating industry can be broadly classified into four major sectors namely Corporate Sector, Financial Sector, Structured Finance Ratings and Public Finance. Explain the various instruments rated under each sector also discuss the growth potential of rating under each sector. (10 marks) 5. With respect to the IPO of ICRA answer the following questions with suitable explanation: a. Does SEBI tag make the investors’ money safe? b. What is a price band? c. Who decides the price band? d. Is there any preference while doing the allotment? e. What is the amount of faith that the investor can lay on the contents of the documents? And whom should the investor approach if there are any lacunae? (2 + 2 + 2 + 2 + 2 = 10 marks) EXTRACTS FROM THE RED HERRING PROSPECTUS OF ICRA LIMITED PUBLIC OFFER OF 2,581,100 EQUITY SHARES OF RS.10 EACH (“EQUITY SHARES”) OF ICRA LIMITED (“ICRA” OR “COMPANY”) THROUGH AN OFFER FOR SALE BY IFCI LIMITED, ADMINISTRATOR OF THE SPECIFIED UNDERTAKING OF THE UNIT TRUST OF INDIA AND STATE BANK OF INDIA, (“SELLING SHAREHOLDERS”) FOR CASH AT A PRICE OF RS. [q] PER EQUITY SHARE AGGREGATING RS. [q] MILLION (“OFFER”). THE OFFER SHALL CONSTITUTE 25.81% OF THE FULLY DILUTED POST-OFFER CAPITAL OF OUR COMPANY. PRICE BAND: RS.275 TO RS.330 PER EQUITY SHARE OF FACE VALUE RS.10. THE FACE VALUE OF THE EQUITY SHARES IS RS. 10 EACH AND THE OFFER PRICE IS 27.5 TIMES THE FACE VALUE AT THE LOWER END OF THE PRICE BAND AND 33.0 TIMES THE FACE VALUE AT THE HIGHER END OF THE PRICE BAND. The Equity Shares are proposed to be listed on the NSE and the BSE. We have received in-principle approvals from the NSE and the BSE for the listing of our Equity Shares pursuant to letters dated August 24, 2006 and August 21, 2006, respectively. NSE by its letter dated March 1, 2007 has extended its in-principle approval until May 26, 2007. BSE shall be the Designated Stock Exchange. Objects of the Offer The objects of the Offer are to achieve the benefits of listing on the Stock Exchanges and to carry out the sale of up to 2,581,100
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Equity Shares by our Selling Shareholders. We believe that listing will enhance our brand name and provide liquidity to our existing shareholders and our employees who would be allotted Equity Shares under our ESOP Scheme. Listing will also provide a public market for our Equity Shares in India. Our Company will not receive any proceeds from the Offer. Global Credit Rating Industry The credit rating business can trace its origins to the mercantile credit agencies in the United States of America. Their function was to rate merchants’ ability to honor their financial obligations. The first such agency was established in New York in 1841 by Louis Tappan. Robert Dun subsequently acquired the agency and published its first ratings guide in 1859. A similar mercantile rating agency was formed by John Bradstreet in 1849. The expansion of the ratings business for securities began in 1909 when John Moody started to rate US railroad bonds, and subsequently utility and industrial bonds. Poor’s Publishing Company issued its first ratings in 1916, Standard Statistics Company in 1922, and the Fitch Publishing Company in 1924. The Moody’s Group and Standard & Poor are the leaders in the global credit rating industry. The international coverage of the major rating groups differs to some degree, with both of them having substantial coverage in the US and Europe. Other international rating agencies include Fitch, Japan Credit Rating Agency Ltd. (JCRA) and A.M. Best, amongst others. The Moody’s Group, Standard & Poor and the Fitch group have pursued a strategy of globalization, in part to reflect the growing international integration of fixed-income markets among the OECD countries and in part to pick up new business in local markets, especially in developing countries. Their contribution in creating both global consistency and setting local standards for credit analysis is significant. With the rapid development of bond markets in Asia, these agencies have entered the market through their regional offices in Singapore, Hong Kong and Japan and through strategic tie-ups with local credit rating agencies. Indian Credit Rating Industry In India, the first credit rating agency, CRISIL (Credit Rating and Information Services of India Limited.) was set up in 1987. A second rating agency, ICRA (then known as, Investment Information and Credit Rating Agency of India Limited.) was established in 1991 and a third agency CARE began operations in 1993. Fitch India, a wholly owned subsidiary of the Fitch group started operations in 1997. In the initial stages, the rating agencies faced several challenges as corporate debt market in India was at an embryonic stage. In 1992, credit rating became mandatory for the issuance of debt instruments with maturity/convertibility of 18 months and above. Subsequently, the RBI guidelines made rating mandatory for issuance of commercial paper. RBI also made rating of public deposit schemes mandatory for NBFCs. Since then credit rating has made rapid strides in terms of the number and value of instruments which have been rated. Further, in 2003, SEBI along with stock exchanges made ratings mandatory for debt instruments placed under private placement basis and having a maturity of one year or more, which are proposed to be listed. Similarly, non-government provident funds, superannuation funds, gratuity funds can invest in bonds issued by public financial institutions, public sector companies/banks and private sector companies only when they are dual rated. Further, such provident funds, superannuation funds, gratuity funds can invest in shares of companies which have investment grade debt rating from at least two credit rating agencies. Investment by mutual funds and insurance companies in unrated paper/non investment grade paper is also restricted. Also, demand for rating services is derived from the overall resource mobilization in the economy particularly from the growth of debt markets viz. corporate bonds and commercial paper (or other market linked short term instruments) issuance. Economic growth fuels both investment and operational related funding demand. In a competitive business environment many industries are also increasingly witnessing trends like consolidation, leading to demand for funding mergers and acquisitions. All these factors result in an increase in funding requirements for Indian corporate entities, which can be met through debt placement in the capital market, bank credit, cross border financing such as external commercial borrowing, foreign currency convertible bonds or equity placement. In last few years bank credit has been a major source of funding for the corporates. Banks in India enjoy relative advantage of extending loans as different from investing in debt papers, which are not required to be ’marked to market’. This provides them with an advantage in the rising interest rate scenario. Banks in India also enjoy the benefit of lower cost of funding as the interest on savings deposits is regulated. This growth in bank credit has led to growth in issuance by banks. The banks have raised considerable amounts of debt from market to meet growing capital requirements either by issuing Tier-II bonds or by issuing hybrid bonds. Internationally, the debt markets have also benefited with the increased penetration by pension funds and insurance companies, as these investors have an appetite for longer term investments. They are expected to drive the debt market activity levels in longer term buckets, which was hitherto slack. In last few years, India has seen emergence of private insurance companies who have grown rapidly. Apart from these, the government has expressed its commitment to develop the domestic debt markets. It has also appointed high level committees to recommend measures to improve the buoyancy in both primary and secondary debt markets. Development of corporate debt market
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India’s corporate bond market is relatively small at 5.3% of GDP vis-à-vis the other markets. The market size of debt securities as a percentage of GDP in other countries is given below: Country China Thailand Malaysia Korea Brazil Mexico Penetration of ratings in the domestic bond market Ratings over the years have achieved market penetration across various industries and companies. Ratings for the nonregulated debt issuances stems from demands made by the investor community, comprising banks, mutual funds, and pension funds, which have restrictions on investment in unrated and unlisted bonds. In 2004-05, of the total debt with tenor or put/call option of one year or above of Rs.55,384 crore that was placed privately, Rs53,749 crore was credit rated. That is a credit rating penetration level of 97%. For 2005-06 the total privately placed debt was Rs.794,458.25 million, the rated amount was Rs.764,633.25 million, leading to a penetration level of 96.25%. % of GDP 10.1% 17.8% 51.9% 58.4% 12.5% 3.5%

Market Size The rating industry in India has registered a growth in the last three years. The average outstanding rated commercial paper increased from Rs.77,390 million in FY 2004 to Rs. 116,520 million in 2005 to Rs.171,700 million in FY 2006. Similarly issuance of rated corporate bonds has increased from Rs.503,484.59 million in FY 2004 to Rs.578,691.55 million in FY 2005 to Rs.764,633.25 million in FY2006. Also the number of cumulative outstanding published issuers has also increased from 1,199 in FY05 to 1,237 in FY06. On November 30, 2006 the number of cumulative outstanding published issuers had gone up to 1,382.

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Our Business We are one amongst the four credit rating agencies in India providing a wide range of products and services. We were established in 1991 as a credit rating agency by a consortium of financial/ investment institutions, commercial banks and financial services companies. We operate as a professionally managed commercial entity with the objective of maximizing shareholder value. Our Company is primarily engaged in the business of providing rating services. In addition, we, along with our Subsidiaries, provide (i) consulting services, (ii) information technology based services, (iii) information services, and (iv) outsourcing services. Moody’s India, which is part of the Moody’s Group, is our Promoter. In addition, Moody’s Investors Service, which is an international rating agency, has entered into the Technical Services Agreement with us pursuant to which it has been providing technical services to us. Our business has grown consistently since we began operations in 1991. We had initially commenced our business as a credit rating agency in 1991. We have since expanded our portfolio of products and services. Besides the growth in our rating business, diversification of our products and services portfolio has resulted in increased revenues. Our total revenue has increased from Rs.333.67 million in fiscal 2003 to Rs.559.09 million in fiscal 2006, at a CAGR of 18.77%. During the same period, our profit after tax has increased from Rs.97.05 million to Rs.142.08 million, at a CAGR of 13.55%. In the nine months ended December 31, 2006 we received revenues of 512.50 million and our profit after tax was 135.87 million. Our Group Our Company has three subsidiaries, namely, IMaCS, ICTEAS and ICRA Online. Our Company is engaged in the business of providing rating and grading services, research based information services and outsourcing services. IMaCS provides management consulting services to clients based in India and abroad. ICTEAS is engaged in the business of providing business solutions and computer aided engineering services. ICRA Online provides mutual fund based information services and outsourcing services. ICRA Online, to complement its information services business, also provides technology solutions targeted at distributors of third party financial products, insurance brokers and stock broking houses. Competitive Strengths We believe that the following are our primary strengths: One of the few credit rating agencies in India We are one amongst the four credit rating agencies in India. In fiscal 2006, volume of debt rated by us was Rs.1389.49 billion and the number of published issuers rated by us outstanding as on March 31, 2006 were 398. For the nine months period ended December 31, 2006, the volume of debt rated by us was Rs.988.64 billion and the number of published issuers rated by us outstanding as on December 31, 2006 was 399. In particular, we believe that we enjoy strong market position for credit ratings in the financial sector and structured finance. Rich database and research support for our products and services portfolio Our in-depth industry knowledge in several sectors supplemented by knowledge management systems has enabled us to develop a comprehensive range of products in order to address the varied requirements of different sectors. Our diverse portfolio of products and services enable us to obtain additional business from existing clients as well as address a larger base of potential clients. Product and service innovation We believe that part of our success lies in our ability to successfully introduce new products and services. In the last five years, we have introduced various rating and grading products such as corporate governance ratings, project finance ratings, issuer ratings, mutual fund ratings and grading of maritime training institutes, healthcare institutions and real estate developers and projects. In addition, we have acquired Online India Capital.Com Private Limited. (subsequently name changed to ICRA Online), which, in 1999, had launched MutualFundsIndia.com, a dedicated portal on mutual funds in India.

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Demonstrated track record of our ratings We believe that for ratings to be used as reliable indicators of credit risk, it is critical that a rating agency be able to demonstrate, over a period of time, strong correlation between the actual performance of the ratings it assigns and what the ratings themselves convey. Since 2001, we have been publishing our rating transition studies. We believe that the ratings assigned by us show that higher category ratings demonstrate a relatively lower likelihood of default and a higher degree of stability with greater resilience to change. Experienced and strong management team and pool of high quality employee talent The members of our management team and other professionals come from a diverse set of backgrounds including leading commercial banks and lending institutions, finance companies and other rating agencies and hold formal qualifications in varied disciplines, including engineering, academics, business management, law and accountancy. The diversity of experience helps us adapt a creative and cross-functional approach. Our managers and professional staff also have domain expertise of and experience in the various sectors we serve, which contributes to our understanding of the sector-specific aspects of our business. In addition, many of our key managerial personnel have continued with us for several years. We have a close association with the Moody’s Group Moody’s India, which is part of the Moody’s Group, is our Promoter. In addition, Moody’s Investors Service, which is an international rating agency, has entered into the Technical Services Agreement with us pursuant to which it has been providing technical services to us. Further, we provide certain outsourcing services to Moody’s Investors Service. Our Operations Rating Services The primary users of credit ratings are investors. Credit rating is a symbolic indicator of the current opinion on the relative capability of the concerned entity to service debts and obligations in a timely manner, with reference to the instrument or issuer rated. Credit ratings purport to highlight the relative credit risk, which may be factored in by investors in their investment decisions. We rate rupee-denominated debt instruments issued by entities including corporates, NBFCs, financial institutions, public sector undertakings and municipalities, among others. The financial instruments we rate include bonds and debentures, fixed deposit schemes, commercial papers, certificates of deposit and preference shares. Rating Services Domains Our rating services can also be classified based on the rating services domains, namely, (i) corporate and infrastructure; (ii) financial sector including mutual funds and insurance; (iii) structured finance and (iv) public finance. Consulting Services IMaCS, our wholly owned subsidiary, provides management consulting services to clients based in India and abroad. IMaCS was incorporated on December 21, 2004, as a wholly owned subsidiary of our Company. The consulting services were provided by a division of our Company till fiscal 2005, when the consulting division was demerged into IMaCS. As a division of our Company, the consulting division adopted the brand name “IMaCS” on December 1, 2004, earlier to which it operated under the name ‘ICRA Advisory Services’. IMaCS (along with the erstwhile consulting division of our Company) has executed over 600 consulting assignments since till date. IMaCS’ clients include banks, financial institutions, non-banking financial companies, manufacturing and services organizations, governments, government-owned organizations, debt and equity investors, regulators, and multilateral agencies. Multilateral agencies include the World Bank, International Finance Corporation, Commonwealth Development Corporation (CDC), United Nations Development Programme (UNDP), United States Agency for International Development (USAID), African Development Bank (AfDB), and Asian Development Bank (ADB). Information Technology Based Services Business Solutions We, through ICTEAS, provide information technology solutions in the realm of business applications and processes. The verticals addressed by ICTEAS in the realm of providing business solutions include sales and distribution management, franchisee service management, financial management and business analytics. The portfolio of business solutions division of ICTEAS can be categorized into two broad heads, namely, standard products and customized solutions. Standard Products: The standard products can be further divided into two categories: (i) Turf View Distribution: This is a solution to aid large organization to manage sales through a network of distributors. The solution aims to ensure implementation of a uniform sales and distribution policy across the channel partners. (ii) Turf View Customer Care: This solution is aimed to manage service franchisee operations for consumer durables. For this product, ICTEAS targets large organization which uses a network of service franchisee to service customers to use this solution to bring about uniform service practices across their service franchisee network.

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Customized Solutions: This service essentially covers development of tailor-made software solutions for business applications. Such solutions may be web-based or client server solutions. The clients of our business solutions services business included BP Lubricants and Judge Technical Staffing. Computer Aided Engineering Services ICTEAS, with its team of engineers, offers computer aided engineering and design services. ICTEAS either deploys skilled resources to work on customer projects under the supervision of the customer at customer locations or design work is outsourced by the client and engineering team of ICTEAS works as a back office for the customer. Online software To complement its information services business, ICRA Online also provides technology solutions, both in the form of products and services, targeted at distributors of third party financial products, insurance brokers and stock broking houses. The revenues from our information technology based services business accounted for 15.84% and 14.00% for nine months ended December 31, 2006 and fiscal 2006, respectively. There was no corresponding revenue in earlier fiscals, since ICTEAS and ICRA Online, which provide such services, became subsidiaries of our Company in fiscal 2006. Outsourcing Services ICRA Online provides outsourcing services in the area of knowledge process outsourcing, research, data aggregation and technical services to financial services entities. ICRA Online’s focus has been on high-end data or knowledge processing services where the existing research and analyses capabilities of its client may be supplemented by providing similar service at attractive costs. Information Services Grading services offered by us employ pioneering concepts and methodologies designed for some of the key sectors of an economy, such as infrastructure, healthcare and education. Our gradings are independent opinions on the relative performance capability of the entities concerned and are designed to serve as tools for identifying and managing risks associated with these entities. Our grading services include gradings in relation to construction companies/entities, real estate developers and specific projects, healthcare and maritime institutions, equity shares and grading of small scale enterprises. Competition We face competition in all our businesses, including those conducted through our Subsidiaries. For our rating services, we face competition from CRISIL, Fitch India and CARE and for our grading services, depending on the sector, we face competition from other rating agencies and certain specialised accreditation agencies. In consulting services sector, IMaCS competes with various players including investment banks and consulting organizations. In mutual funds based services, ICRA Online faces competition from CRISIL, Value Research India Private Limited. Capital Market Publishers India Private Limited and Centre for Monitoring Indian Economy, among others. ICRA Online and ICTEAS face intense competition in the outsourcing services and software development and computer aided engineering activities. Out of this peer group, only CRISIL is listed and hence provides the basis for industry comparison including ratios. EPS CRISIL Capital Structure Our share capital as at the date of this Red Herring Prospectus is set forth below: (Rs. in million) Aggregate Value at Offer Price 31.7 P/E 43.8 RONW 19.5%

Particulars Authorised Capital 15, 000, 000 Equity Shares of Rs.10 each B. Issued, subscribed and paid-up equity share capital prior to the Offer and the Preferential Allotment: 8,805,100 Equity Shares of Rs.10 each C. Equity Shares outstanding post Preferential Allotment* but prior to the Transfer under the Offer 10,000,000 Equity Shares of Rs.10 each. D. Offer in terms of this Red Herring Prospectus Offer for Sale of 2,581,100 Equity Shares of which: A.

Aggregate nominal value 150.00

88.05

100.00 25.81 [•]

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QIB Portion of not more than 1,290,550 of which: Reservation for Mutual Funds is 64,527 Equity Shares Other QIBs is 1,226,023 Equity Shares Non Institutional Investors Portion of not less than 387,165 Equity Shares Retail Investors Portion of not less than 903,385 Equity Shares E. Issued, Subscribed and Paid-Up Capital post the Offer: 10,000,000 Equity Shares* F. Share Premium Account Prior to the Offer Post the Offer and Preferential Allotment

12.90 0.64 12.26 3.87 9.03 100.00 268.76 [•]

[•] [•] [•] [•] [•] [•]

* Though the Offer does not include any fresh issuance of Equity Shares by our Company, our Company shall issue 288,900 Equity Shares to Moody's India and 906,000 Equity Shares to ESOS Welfare Trust at the Offer Price ("Preferential Allotment"). Since the Preferential Allotment shall be done at the Offer Price, the same shall be carried out after determination of the Offer Price, in terms of this Red Herring Prospectus. However, the Preferential Allotment shall be concluded prior to the date of Transfer of Equity Shares under the Offer. For the purpose of the Preferential Allotment, Moody's India and ESOS Welfare Trust have undertaken that they shall subscribe to 288,900 Equity Shares and 906,000 Equity Shares, respectively, at the Offer Price. In this regard, at least one day prior to the Bid/ Offer Opening Date, Moody's India and ESOS Welfare Trust shall deposit with us an advance against the subscription. The advance against the subscription shall be an amount equivalent to number of Equity Shares proposed to be allotted to each of them multiplied by the Cap Price. We shall retain this amount in a no-lien account until the Offer Price is determined, after which the amount shall be adjusted towards consideration for the Preferential Allotment. In case the Price Band is upwardly revised, Moody's India and ESOS Welfare Trust shall pay an additional amount equivalent to the deficit.

STATEMENT OF PROFIT AND LOSS (Rs. in million) Particulars Income Rating Services Fees Information Services Fees Outsourcing Services Fees Consulting Services Fees Total Operating Income Other income Total Income Expenditure Personnel Expenses Administrative Expenses Other Expenses Depreciation Miscellaneous expenditure written off Total Expenditure Net Profit before tax and extraordinary items Extraordinary items (net) Provision for taxation Profit after tax Appropriations Transfer to general reserve Proposed dividend Tax on proposed dividend Deferred Tax liability created Transitional Incremental Provision for Employees' Benefits
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Nine months ended 31/12/2006 285.18 4.18 3.58 0.00 292.94 26.23 319.17 100.70 33.54 31.76 11.54 0.11 177.65 141.52 22.80 (46.88) 117.44 114.17 0.00 0.00 0.00 3.27

Year ended 31/03/2006 312.94 6.74 12.45 0.00 332.13 19.86 351.99 121.22 37.93 37.83 15.23 0.15 212.36 139.63 34.02 (47.39) 126.26 86.10 35.22 4.94 0.00 0.00

Year ended 31/03/2005 256.16 14.43 5.86 95.07 371.52 11.15 382.67 169.42 54.25 57.58 14.25 0.14 295.64 87.03 25.62 (31.70) 80.95 45.81 30.82 4.32 0.00 0.00

Year ended 31/03/2004 244.88 10.47 1.59 71.75 328.69 20.79 349.48 132.43 45.80 53.16 13.74 0.15 245.28 104.20 43.84 (37.46) 110.58 60.92 44.02 5.64 0.00 0.00

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Balance carried to Balance sheet Notes to Adjustments carried out in restated Financial Statements

0.00

0.00

0.00

0.00

STATEMENT OF ASSETS AND LIABILITIES (Rs. in million) Particulars A. Assets Fixed Assets-gross block Less: Depreciation Net Block Investments Current assets, loans and advances Receivables Cash & bank balances Other current assets Loans and advances Total Current assets, loans and advances Total Assets Liabilities & Provisions Current liabilities & provisions Sundry liabilities Provisions Deferred Tax Total Liabilities & Provisions Net worth Net worth represented by: Shareholders funds Share Capital Reserves & surplus Less: miscellaneous expenditure not written off Total As at 31/12/2006 As at 31/03/2006 285.48 (101.34) 184.14 749.53 93.41 60.99 1.91 75.60 231.91 1,165.58 282.18 (109.77) 172.41 684.17 49.25 39.16 2.49 138.10 229.00 1,085.58 As at 31/03/2005 288.26 (102.20) 186.06 596.65 98.05 37.69 2.32 58.07 196.13 978.84 As at 31/03/2004 228.44 (90.56) 137.88 643.90 70.51 32.50 5.32 59.41 167.74 949.52

B. C.

D.

59.25 62.02 6.30 127.57 1,038.01

59.69 95.33 6.83 161.85 923.73

56.80 80.70 3.86 141.36 837.48

52.03 102.36 3.60 157.99 791.53

E.

88.05 950.14 (0.18) 1,038.01

88.05 835.97 (0.29) 923.73

88.05 749.87 (0.44) 837.48

88.05 704.06 (0.58) 791.53

END OF SECTION D

Section E : Caselets (50 Marks)
• • • • This section consists of questions with serial number 6 - 11. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 6.While everything carries a degree of risk, shopping online should be relatively safe provided the owner of the card ensures certain things. Enumerate. (8 marks) 7.If the purchaser opts for NetSafe type of card, explain the level of safety and advantages the purchaser will have for his online purchases. (7 marks)
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Shopping online has become increasingly popular in recent years to the point that it is now part of everyday life competing head on with traditional stores for everything from DVD’s and groceries through to travel. In spite of this increasing popularity there is one fear that has kept many wary of online shopping. This fear is credit card fraud. How do you know that when you enter your credit card details online your personal information and card details are not going to fall into the wrong hands? When you go to an online store and submit an order form with a credit card number, the information is transmitted from your computer via local telephone lines to your Internet Service Provider (ISP) and then over the Internet. The order may go to an intermediary or directly to the merchant's server. Companies vary as to when they process your credit card details. Some do immediately, while others wait until the product has been shipped. If you plan to shop on the Internet with a credit card, a secure ordering system is a must. Both Netscape Navigator and Microsoft Internet Explorer use Secure Sockets Layer (SSL) to encrypt your data before sending it over the Net. SSL scrambles your personal data - look for an unbroken key or lock to appear in the bottom of your browser window. This technology provides a secure connection that keeps data private during transmission over the Internet. However, this technology does not authenticate the parties at either end of the transaction. Visa International and MasterCard International, with support from many of the world's top financial institutions, are presently working to develop a more advanced encryption process called Secure Electronic Transaction (SET). SET involves a system of digital certificates provided by card issuers, and encryption. SET enables the identity of both merchant and cardholder to be authenticated and also ensures that neither the merchant or cardholder's bank sees the purchaser's credit card number. Credit card fraud is not limited to the online world. It’s existed for as long as credit cards have been around, and it’ll exist for as long as credit cards do, in their current form. So, question should be—Is it more dangerous to use a credit card online? There’s no reason for not using credit cards online, provided the owner takes a few steps to ensure the security of the transaction. All that’s needed online is the credit card number and date of birth. The online vendor needs neither your signature nor physical access to the card. Your date of birth could generally be known. So, you need to be more careful to ensure that your credit card number doesn’t fall into the hands of unscrupulous elements. Credit card details could potentially be stolen from you, your computer, or from vendors with whom you’ve used the credit card. Let’s take these one by one. Don’t let your credit card lie around so that someone can pick up the number. Also, don’t give the number out to anyone other than a vendor. While entering your credit card number at an online store, ensure that you do so only on a secure page. If you’re asking for clarifications or help from the sites, you don’t have to give them your credit card number. If they ask for it, there’s something fishy. Stop all transactions at the site immediately and inform the Webmaster. Don’t enter your credit card number or date of birth as part of the information you give while registering at any site. Online, the third instance—of the numbers being stolen from the vendor— could happen if someone hacks into an ecommerce server. Frankly speaking, you have no control over this, except hoping that the vendor takes enough care to ensure that his servers are not open to hackers. While everything carries a degree of risk, shopping online should be relatively safe provided the owner of the card ensures certain things. To safe guard the shopper and to curb all these threats NetSafe is a unique online secure payment solution provided by HDFC Bank in India. The NetSafe offering involves generation of a virtual card number that you set up using your existing physical credit card or debit card. You can then use this virtual card number to shop online at any merchant website. Generally the validity of virtual card is maximum 48 hours.

Caselet 2
Read the caselet carefully and answer the following questions: 8. “There is little chance that there will be any significant decline in growth rates”. What have been the key factors in triggering this high growth period? (8 marks) 9. With respect to the caselet explain the working mechanism of pledged asset mortgage with suitable example. Explain the disadvantages associated with the same. (10 marks)
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Housing is the one of the basic needs for every human being, with Food, Clothing and Education being the other three. Housing is an important component and a measure of socio–economic status of the people. It is regarded as a critical sector in terms of policy initiatives and interventions. The relevance of housing as a social need has been long recognized, and this has influenced the innovations and inventions made by mankind, since the Stone Age. Housing being one of the essential needs of mankind, the demand for shelter grows in line with the increase in population and the standard of living, hence the need of financing the purchasing of a house came up. The importance of the housing sector can be judged by the fact that we consider house as the best investment and want to invest our hard earned money or saving in a house. The need for Finance to purchase a house brought out specialized Housing Finance Institutions. The Housing Finance Companies (HFCs) as they are called today, have stepped up their lending over the years contributing to the growth of the housing sector. The market for home loans has been sizzling in India. The spurt in growth in recent years and the prospects of continued buoyancy in demand have attracted many players to the industry, which till a few years back had two major players - HDFC and LIC Housing Finance. The result - cut throat competition, which has benefited the loan seeker by the way of innovations in the housing finance schemes. The home loan market has grown at a compounded rate of over 40% over the last four years. What industry experts believe, there is little chance that there will be any significant decline in growth rates going forward. A pledged asset mortgage is one of the various types of the housing finance options available to the borrower. A pledged asset mortgage is generally not a viable option for those of limited means. They work best for people who have excellent credit, higher-thanaverage income and net worth, adequate liquidity and many years of investment experience. There's an old saying that those who don't need to borrow usually get the best terms. Pledged asset mortgages usually make the most sense for wealthy people who are in high tax brackets and inclined to buy more expensive homes. However, high net worth isn't necessarily a prerequisite. A pledged asset mortgage could also make sense for someone who needs a bridge loan while waiting on the sale of another asset, such as other real estate or a small business. Other candidates might be parents or grandparents who want to help their children, grandchildren or other relatives buy a home. If they have sufficient investments, they could help family members qualify for better lending terms without making a potentially taxable gift, and without disrupting their investment plan. In pledged asset mortgage borrowers set aside a portion of their investment portfolio, say, 40% of the home's value, into a separate "pledge" account that acts as collateral for a 100% mortgage. Most account actions like trading on securities must receive the lender's approval.

Caselet 3
Read the caselet carefully and answer the following questions: 10.The caselet says that venture capital has become an important source of finance for innovative ideas that are risky and have a potential for high returns over a long-term. With respect to this discuss the objectives and vision for venture capital in India. (7 marks) 11.Describe the stages in the venture capital investment process. Also explain the various stages of venture capital financing along with the various types of funding requirement at each stage.
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(10 marks) It is popularly believed that venture capitalists fund only established players and proven products. There is a lot of cynicism amongst many about all the hype that private equity and venture capital is getting in India of late. However, the truth is that, in recent times in India, the VCs have actually provided capital to relatively new, start-up companies that have a reasonable, though not certain, prospects to develop into highly profitable ventures. Travelguru.com is a case in point, funded by Sequoia Capital and Battery Ventures. The advent of firms like Helion Ventures with a $140 million corpus is helping the VC scenario to improve in the country. The three key people behind Helion Ventures, Ashish Gupta, Sanjeev Aggarwal and Kanwaljit Singh, all carry with them a successful track record across various companies in the international arena. What is interesting is that for first time in India, venture capital will be backed by successful entrepreneurs who themselves have a hands-on experience in handling and developing businesses.

The National Venture Capital Association defines venture capital as: "Money provided by professionals who invest alongside management in young, rapidly growing companies that have the potential to develop into significant economic contributors." Innovation is the key driver of competitiveness within organisations as well as within countries. It has been well said: "Nothing is more powerful than an idea whose time has come." However, innovative ideas need more than research and knowledge to succeed. Not only financial, but also, managerial (technical, marketing and HR), support is required to achieve success. This support is lent in many forms by private funding and incubation organisations such as venture capitalists. Akhil Gupta, JMD & CFO of Bharti Airtel, once remarked, "While we could have raised funding from other sources, Warburg Pincus' involvement helped us in scaling up significantly." Almost identical has been the findings of a research conducted recently by Venture Intelligence (founded by Arun Natarajan, a leading provider of information and networking services to the private equity and venture

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capital ecosystem in India) with the guidance of Prof. Amit Bubna of Indian School of Business, Hyderabad, to study the economic impact of PE and VCs on the Indian businesses. The following are some of the interesting observations of this study: The study shows that the PE and VC backed companies grew faster compared to the non-PE backed peers and even better • than the benchmark indices like the NSE Nifty. They found that the sales of listed PE-backed companies grew at 22.9% as compared to 10% for non-PE-backed listed firms. PE backed firms added more jobs to the economy and even the wages at listed PE financed firms grew at around 32% as • compared to 6% for non-PE-backed firms. An astonishing finding was that almost 96% of the top executives felt that without the support and the backing of private • equity these companies would not have existed or would have grown at a slower rate, while only about 4% felt that they would have developed the same way even without PE funding. The study also shows that the biggest support of the PE investors were provided in the area of strategic direction followed by • the financial advice and then recruitment and the marketing activities. Thus venture capital has become an important source of finance for innovative ideas that are risky and have a potential for high returns over a long-term horizon. Venture capitalist investment is driven by the expectation that the start-ups invested in could give them a higher rate of return than other firms. In the process venture capitalists have created some of the best known companies in the world. Without VCs we might not have seen companies such as Apple, Compaq, Sun Microsystems, and Intel to name a few. END OF SECTION E END OF QUESTION PAPER

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Investment Banking and Financial Services - II (MSF2K2) : July 2007
Section D : Case Study
1.Volume of debt securities issued in domestic capital markets Company’s revenues are largely linked to financial services that we render in the Indian market. A significant portion of company’s revenues i.e. 55.97% in fiscal 2006 was on account of company’s rating services, which is primarily linked to the issuance of debt securities in the Indian capital markets. In the last three years, the Indian economy has experienced an average real GDP growth of 8.10%. A substantial part of company’s business is dependent on volume and number of debt securities issuance in the capital markets in India. Changes in the interest rates and volatility in the financial markets Company’s revenues and financial condition are primarily linked to its ability to render services in the domestic financial market. Company’s services such as credit ratings, consulting services, mutual funds based information services and outsourcing services are dependent on the condition of the financial markets in India and abroad. Any variation in interest rates and credit spreads, volatility in corporate bonds market or interest rate environment, foreign exchange fluctuations, defaults of significant issuers and other market and economic factors both domestically and globally may negatively impact the issuance of credit sensitive products and other financial services. Competition The credit rating and financial services markets are constantly evolving. We face competition in all company’s businesses, including those conducted through its Subsidiaries, and it has been facing increased pricing pressures from company’s competitors. In addition for the consulting services business, IMaCS competes with various players including investment banks and consulting organizations. Acquisitions and consolidation During fiscal 2006, we acquired majority of equity shares of ICTEAS and ICRA Online, pursuant to which these companies became subsidiaries of the Company. In addition, in fiscal 2006, the consulting division of the Company was demerged into IMaCS. Moreover, IMaCS had commenced its operations in fiscal 2006 and had not prepared the statement of profit and loss till then. Further, in fiscal 2007, we have acquired the remaining equity shares of ICRA Online, consequent to which it has become the wholly owned subsidiary. The acquisition and consolidation has substantially affected the results of company’s operations in fiscal 2006.
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Cyclical nature of consulting business The consulting market is large and diversified across several industries/sectors, and the market is fragmented across several consulting firms. However, the demand for consulting services tends to fluctuate and skilled resources are expensive and difficult to source. Fluctuations in interest and dividend and market value of the investments As an investing/treasury function, we make substantial investments in mutual funds, bonds, debentures and other marketable securities. Company’s income from such investments and the market value of its securities portfolio may be affected by changes in the interest rates and volatility in the financial markets. Offering of new services and products The Company had been set up to undertake credit rating business. The company has since expanded its portfolio of products and services, both organically and through acquisitions. Diversification of company’s products and services portfolio has resulted in increased revenues. The company intends to continue expanding its range of products and services. Employee Stock Option Plan The company has adopted the ESOP Scheme, under which eligible employees of Company and Subsidiaries can participate, subject to such approvals as may be necessary. As per the ESOP Scheme, we are permitted to grant options up to a maximum of 906,000 Equity Shares, constituting 9.06% of company’s post-Offer (including Preferential Allotment to Moody’s India and ESOS Welfare Trust) paid-up equity capital. We propose to grant stock options at an exercise price, which shall be the same as the Offer Price. Under Indian GAAP, the grant of these stock options may result in a charge to company’s profit and loss account due to amortisation of expenses, if any, relating to the grant of stock options over the vesting period of the stock options. 2.BASIS FOR OFFER PRICE The Offer Price will be determined by our Company in consultation with the BRLMs on the basis of assessment of market demand for the Equity Shares offered by way of Book Building Process. Qualitative Factors • We are one amongst the four credit rating agencies in India. We were the second player to enter the credit rating agency business in India and have been in existence since 1991. We are recognised amongst investors, issuers and intermediaries. The reliability enjoyed by ratings is crucial for our business and growth. There are certain entry barriers for ratings business, which may render it difficult for new players to • enter the sector. Such entry barriers are created by knowledge intensive nature of the business and need for proven track record and reputation of the players. Our Company focuses on product and service innovation, and has introduced innovative products in • the market. Moody's India, which is part of the Moody's Group, is our Promoter. In addition, Moody's Investors • Service, which is an international rating agency, has entered into the Technical Services Agreement with us pursuant to which it has been providing technical services to us. • We are expanding global capabilities for our consulting and outsourcing services. Quantitative Factors 1. A. Earning Per Share (EPS) before Preferential Allotment (i.e. allotment to Moody's India and ESOS Welfare Trust) Year March 31, 2004 March 31, 2005 March 31, 2006 Weighted Average EPS (Rs.) 12.56 9.19 14.34 12.33 Weight 1 2 3
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B. Earning Per Share (EPS) after Preferential Allotment (i.e. allotment to Moody's India and ESOS Welfare Trust) Year March 31, 2004 March 31, 2005 March 31, 2006 EPS (Rs.) 12.56 9.19 12.63* Weight 1 2 3

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Weighted Average

11.47

Note: The earnings per Equity Share has been computed on the basis of adjusted profits/(losses) for the respective years/periods after considering the impact of accounting changes and prior period adjustments / regroupings pertaining to the earlier years. *The denominator considered for the purpose of calculating earning per share is the average number of Equity Shares outstanding during the period plus the Preferential Allotment to Moody's India and ESOS Welfare Trust (i.e. 8,805,100 Equity Shares plus issue of 288,900 Equity Shares to Moody's India + issue of 906,000 Equity Shares to ESOS Welfare Trust). Thus, number of Equity Shares considered for denominator is 10,000,000 Equity Shares. 2. Price/Earning Ratio (P/E) in relation to Offer Price of Rs. 330 a.. Based on the yearly results of FY 2006 adjusted EPS of Rs. 14.34 (before allotment to Moody's India and ESOS Welfare Trust) on Equity Share of face value of Rs. 10 each-23.01 b. Based on the yearly results of FY 2006, EPS of Rs. 12.63 (after allotment to Moody's India and ESOS Welfare Trust) on Equity Share of face value of Rs. 10 each-26.13 c. Industry P/E - 43.8. Return on Net worth (RONW) Year March 31, 2004 March 31, 2005 March 31, 2006 Weighted Average RONW Weight 13.97% 1 9.67% 2 13.67% 3 12.39%

3.

Note: The average return on net worth has been computed on the basis of the adjusted profits and losses of the respective years drawn after considering the impact of accounting policy changes and material adjustments/ regroupings pertaining to earlier years. Return on Net worth (%) = Adjusted Profit after tax / Net worth 4. a) Minimum Return on Increased Net Worth to maintain pre-issue EPS (before Preferential Allotment) of 14.34 is Required EPS Number of shares after the issue Required PAT Increased Net Worth Required RONW = Rs.14.34 = 8,805,100 = 14.34 ×8,805,100 = Rs.126,265,134 = (2,581,100× 320) +88,051,000 = Rs.914,003,000 =126,265,134 /914,003,000 = 13.81%

b) Minimum Return on Increased Net Worth to maintain pre-issue EPS (after Preferential Allotment) of 12.63 is Required EPS Number of shares after the issue Required PAT Increased Net Worth Required RONW 5. = Rs.12.63 = 10,000,000 = 12.63×10,000,000= Rs.126,300,000 = (1,194,900× 330) + (2,581,100× 320) + 88,051,000 = Rs.1,308,320,000 =126,300,000 /1,308,320,000 = 9.65%

Net Asset Value (NAV) per share Before Preferential allotment (i.e. allotment to Moody's India and ESOS Welfare Trust) Rs. as on March 31, 2004 as on March 31, 2005 as on March 31, 2006 Offer Price NAV after the Issue 89.89 95.11 104.91 330 104.91*

*Since this is the offer for sale Our Company will not receive any proceeds from the Offer.
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Note: Net Asset Value per Share = Net worth/No. of Equity Shares After Preferential allotment (i.e. allotment to Moody's India and ESOS Welfare Trust) Rs. As on March 31, 2004 As on March 31, 2005 As on March 31, 2006 Offer Price NAV after the Issue *Net Asset Value Per share = Net worth/No. of Equity Shares (outstanding at the year + preferential allotment to Moody's India and ESOS Welfare Trust i.e. 8,805,100 equity shares + issue of 288,900 equity shares to Moody's India + issue of 906,000 equity shares to ESOS Welfare Trust. Thus, number of shares considered for denominator is 10,000,000 equity shares). 6. Comparison with Peer Group Our Company is in the business of credit rating and providing other investment information. Our competitors are CRISIL, CARE and Fitch Ratings India Private Limited. Out of this peer group, only CRISIL is listed and hence provides the basis for industry comparison including ratios. CRISIL 7. EPS 31.7 P/E 43.8 RONW 19.5% 89.89 95.11 92.37* 330 131.8

The face value of Equity Shares of ICRA is Rs. 10 and the offer price is 33 times of the face value. The Offer Price has been determined by the Company in consultation with the BRLMs, on the basis of assessment of market demand for the Equity Shares by way of Book Building, and on the basis of the above factors. CAPITAL STRUCTURE (Rs. in million) Aggregate nominal value A. Authorised Capital 15, 000, 000 Equity Shares of Rs. 10 each 150.00 Aggregate Value at Offer Price
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3.

B. Issued, subscribed and paid-up equity share capital prior to the Offer* 10,000,000 Equity Shares of Rs. 10 each. C. Offer in terms of this Prospectus Offer for Sale of 2,581,100 Equity Shares of which

100.00

25.81 12.90 0.64 12.26 3.87 9.03

851.76 425.88 21.29 404.59 127.76 298.12

QIB Portion of not more than 1,290,550 of which: Reservation for Mutual Funds is 64,527 Equity Shares Other QIBs is 1,226,023 Equity Shares Non Institutional Investors Portion of not less than 387,165 Equity Shares Retail Investors Portion of not less than 903,385 Equity Shares D. Issued, Subscribed and Paid-Up Capital post the Offer: 10,000,000 Equity Shares

100.00

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E.

Share Premium Account 268.76 651.13

Prior to the Offer Post the Offer and Preferential Allotment

* Though the Offer does not include any fresh issuance of Equity Shares by our Company, our Company has

issued 288,900 Equity Shares to Moody's India and 906,000 Equity Shares to ESOS Welfare Trust on March 24, 2007 at the Offer Price on the Pricing Date ("Preferential Allotment"). 4.Corporate Sector Rating agencies provide ratings of debt instruments such as bonds, debentures, preference capital, commercial paper and other short-term debt to Indian companies. They also assign issuer rating and line of credit ratings to companies. The demand for funds from the corporate sector has witnessed an increase due to increase in capital investment, capacity creation and business growth leading to working capital requirements. The corporates can raise funds either by taking loans from banks, issuing bonds or commercial paper or by resorting to external commercial borrowing/ foreign currency convertible bonds. It is only when corporates raise funds through bonds or commercial papers that a demand for a credit rating is created. The demand for ratings is influenced by choice of sources of funding which in turn depends on liquidity condition in the banking system, prevailing interest rate and changes in currency expectations, etc. Financial Sector Financial sector ratings cover the credit ratings of banks, financial institutions and NBFCs (including asset financiers, capital market related entities and housing finance companies). The debt instruments for the banks are Tier II bonds, hybrid debt capital, certificate of deposits and fixed deposits programmes. For the NBFCs and financial institutions, the debt instruments are primarily long/short term debentures, commercial paper and certificate of deposits. The growth prospects for the financial sector ratings are driven by the economic fundamentals. This in turn leads to increase in demand for funds by banks, financial institutions and NBFCs, for maintaining prescribed capital adequacy as well as financing growing disbursements. Structured Finance Ratings The structured finance segment comprises the asset backed securitization (ABS), mortgage backed securitization (MBS), collateralized debt obligations (CDO), partial guaranteed (PG) structures, future flow transactions (FFT) and loan sell offs (LSO). The increased issuances in the domestic structured finance market in the last few years has been supported by these reasons, particularly, for leveraging on the available capital as some large private sector banks have grown rapidly. However, the investors in structured finance deals have so far been investing in highly rated pools, the markets for lower rated pools are yet to develop. RBI has recently issued guidelines disallowing upfront profit booking and reduction in originators’ capital to the extent of subordination. This has adversely affected the securitization market and there has been a decrease in the number of privately placed securitized instrument. However, direct assignment or bilateral deals including on-tap securitization have increased. Securitization is being increasingly used to finance growth of retail assets which have shown a healthy growth in recent years. It also helps financiers to manage capital adequacy, balance sheet exposure and liquidity and ALM related risks besides providing an alternate source of funding. Public Finance Public finance rating revenues have largely been through ratings/assessments of local body borrowings (either standalone, credit enhanced by own resource structures, or pooled financing), state level entity borrowings (excluding power which is covered under infrastructure) and state guaranteed borrowings. While the local body sector has seen some issuances, a large portion of debt issuance in the past has been from state supported borrowings. However, downgrade of some of these bonds coupled with a steady decline in bond ratings by state supported entities has affected issuance of fresh bonds by them. Twelfth Finance Commission has allowed state governments to tap the markets directly through rated bonds. These borrowings may replace of central government loans, which were of the order of Rs.100-150 billion annually over the last few years. Also, it has been recommended that states undertake credit risk assessment of their guarantee portfolio. However, most states and local bodies in the country currently have relatively weak standalone credit quality, which limits fresh issuance of debt instruments to a few better credit quality states.
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5.

a. The investors should make an informed decision purely by themselves based on the contents disclosed < TOP > in the offer documents. SEBI does not associate itself with any issue/issuer and should in no way be construed as a guarantee for the funds that the investor proposes to invest through the issue. However, the investors are generally advised to study all the material facts pertaining to the issue including the risk factors before considering any investment. They are strongly warned against any ‘tips’ or news through unofficial means. b. The red herring prospectus may contain either the floor price for the securities or a price band within which the investors can bid. The spread between the floor and the cap of the price band shall not be more than 20%. In other words, it means that the cap should not be more than 120% of the floor price. The price band can have a revision and such a revision in the price band shall be widely disseminated by informing the stock exchanges, by issuing press release and also indicating the change on the relevant website and the terminals of the syndicate members. In case the price band is revised, the bidding period shall be extended for a further period of three days, subject to the total bidding period not exceeding thirteen days. c. It may be understood that the regulatory mechanism does not play a role in setting the price for issues. It is up to the company to decide on the price or the price band, in consultation with Merchant Bankers. The basis of issue price is disclosed in the offer document. The issuer is required to disclose in detail about the qualitative and quantitative factors justifying the issue price. d. The allotment to the Qualified Institutional Buyers (QIBs) is on a discretionary basis. The discretion is left to the Merchant Bankers who first disclose the parameters of judgment in the Red Herring Prospectus. There are no objective conditions stipulated as per the DIP Guidelines. The Merchant Bankers are free to set their criteria and mention the same in the Red Herring Prospectus. e. The document is prepared by an independent specialized agency called Merchant Banker, which is registered with SEBI. They are required to do through due diligence while preparing an offer document. The draft offer document submitted to SEBI is put on website for public comments. In case, the investor has any information about the issuer or its directors or any other aspect of the issue, which in his view is not factually reflected, he may send his complaint to Lead Manager to the issue or to SEBI, Division of Issues and Listing.

Section E: Caselets Caselet 1
6.Shop online from Well-Known companies The Internet has matured to the point that many online companies such as Amazon.com in the US have become household names. Also, many big brands from the real world have moved online. Well known names are likely to use the latest online security measures and handle a large number of transactions. Check company reputation with First Time Purchases There will always be times when you want to purchase something online from a website you've not purchased from before. This is especially true in Australia where many big name chain stores have been slow to move online and many online retailers are small operators. If it's your first time shopping on a particular site then check out the company before making purchases to be sure they have a good reputation. As well as word of mouth from friends and family you can also search consumer review websites where companies and products are rated and discussed. Check for Contact Details: Make sure the company you plan to buy from provides contact details other than just an email address or online form. If anything was to go wrong then you will need to contact them. Look for a postal address and landline phone number. Only use Secure Websites Once you are happy with the company you are purchasing from you need to make sure your credit card details are being processed using a secure connection. The most common form of secure encryption is known as Secure Sockets Layer or SSL for short. SSL encrypts data by breaking it up into small pieces so that the information can not be read by anyone attempting to intercept it. To ensure your purchase is processed using SSL or secure technology there are a few things to look for in your Internet browser. Depending on your browser settings you may receive a message stating that you are about to enter a secure area. The secure area normally begins on the first page of the site where you enter personal details. You can also look for a padlock symbol in the lower right corner of your browser symbolising the page is secure. Most often the website address in your browser address bar will also change from starting with http to https. Never send your credit card details through non-secure online methods such as via email. Such methods will offer little protection. Security Code
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An ever growing number of online stores now require a CVV or card verification number when making a purchase. The CVV code is the small code located on the back of your card on the signature bar. Generally the last 3 digits of the code are required. This is to prevent fraudulent purchases from someone who has managed to get your name; card number and expiration date from being able to make purchases using your card. Further Security Another security feature that credit card companies are using is to create another level of security by adding an additional password. An example of this is Verified by Visa or Mastercard Secure Code. These are optional security features so only offer support with selected websites or payment processing systems. If you activate the code and shop on sites that carry the Verified by Visa or Mastercard Secure Code logos, the check out process will require the password you set up in order to authorise your purchase. Phishing Emails - Don't Get Reeled In Be aware of email scams designed to gain access to your credit card information. Email scams that are designed to gather personal information such as passwords and credit card details are known as phishing emails. The idea is that thousands or hundreds of thousands are sent out in the hope of reeling in unsuspecting victims and getting them to part with confidential information. The emails often appear to be from well known companies and can look quite convincing. However, legitimate companies including all banks will never send you an email with a link requesting your login, password or credit card details. If in doubt, type the web address of the company it relates to directly into the browser rather than following the email link. Use a Credit Card with Online Fraud Protection Just in case all else fails it helps to know the policy for online fraud protection offered by your credit card company. Many credit card companies offer protection against purchases made without your consent and have special clauses to include online purchases. Credit cards tend to offer greater protection than debit cards as they don't directly remove funds from your own back account. If a transaction goes under investigation or proves to be fraudulent your credit card provider may credit back any fraudulent transactions meaning you don't end up out of pocket if they offer fraud protection. 7.Safety • NetSafe Card is created online in real time for an amount decided by the owner and valid for maximum 48 hrs. The NetSafe Card is an online, single transaction card. Therefore it cannot be used more than • once, nor can it be used on a swiping machine. • • On use of the Card the card expires, and can never be used again. The owner will be the first and the only person to use the card.
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Advantages • The actual credit/debit card number is never used in the online transactions. Therefore, there is no risk of the actual card number getting exposed during the online transaction or on the merchant website. • • For credit cards, the NetSafe Card amount can be upto the available card limit The NetSafe Card will be valid for maximum 48 hours.

The NetSafe Card can be used at any online merchant site that accepts cards, thereby providing • secure online payment. After the end of the validity period of the NetSafe Card, such unutilised amount will be credited • back to the owner’s credit/debit card account.

Caselet 2

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8.On the demand side • Faster rise in disposable incomes because of globalization. Availability of ready to occupy property as well as the faster liquidation due to improved information • flow. Availability of customized finance schemes as per the requirement of the borrowers. • Tax benefits, which further reduced the effective cost of borrowing (both on interest and capital) • On the supply side • More competition in the housing finance sector resulted in the reduction of the spread charged by the lender which has led to cheaper availability of the loans. The fee for getting a home loan has reduced dramatically over the few years, from over 2% of the • loan amount to as low as 0.25% (some companies are known to waive off the fee entirely!) Housing finance companies have introduced several new products to meet the needs of a wide • variety of customers. One such scheme, the step up loan, where the EMIs increase as the income of the individual increases has been a big hit with individuals just starting off with their careers. One other factor is the increasing collaboration between housing finance companies and builders. • Such partnerships minimize service and funding related issues significantly, thus making it easier to buy property. 9.A pledged asset mortgage allows homebuyers to pledge financial assets to a mortgage lender instead of making a down payment. Depending upon the lender, you can pledge almost any type of financial asset, including stocks, bonds, mutual funds and certificates of deposit (CDs), while maintaining ownership. With a pledged asset mortgage, you can enjoy the benefits of making a large down payment—more attractive interest rates, no private mortgage insurance (PMI), and so on—without actually having to come up with the cash. Instead of making a down payment on a home, you pledge investments, which are transferred to an account maintained by the lender. You're still free to manage the account and make trades (within certain limitations), but you can't make any withdrawals or transfers without the lender's permission. The lender will usually allow you to withdraw amounts in excess of the initial pledge requirement, but don't count on your pledged assets for short-term liquidity. Ideally, the pledged asset account should be broadly diversified and consist of high-quality securities. Don't let the pledging of assets divert you from your long-range investment goals. True, your pledged assets aren't readily accessible, but they still belong to you and you should manage them as part of your overall investment plan. In a typical arrangement, you might be required initially to pledge investments worth 130% of the pledged asset portion of the loan (this works out to 39% of the total loan—see the example below). If the value of the pledged asset account later drops below 110% of the pledged asset portion of the loan, you may be required to add more assets to the account to meet the 110% maintenance threshold (similar to a margin call). The lender generally reserves the right to increase these levels depending on the securities you pledge. A hypothetical example Banta and Santa want to purchase a Rs.10 lakh home. With their high income and excellent credit rating, they qualify for 100% financing. But they could get a much better interest rate on the mortgage if they make a cash down payment. Unfortunately, they don't have that kind of cash sitting around. However, they do have a diversified investment portfolio with a market value of Rs.8,00,000. Given current market conditions (and factoring in the after-tax cost of mortgage debt), Banta and Santa believe their investments have more potential for appreciation than the home they're looking to buy—in other words, they believe they would suffer an opportunity cost if they cash out some of their investments to make a down payment. They would also like to stay diversified and avoid the capital gains taxes and transaction costs that would result from selling investments. Disadvantages • Pledged asset mortgages generally work best when stocks are going up and home values are rising or relatively stable. A bear market in stocks combined with falling home prices is obviously not favorable for this type of loan. If you default on the mortgage, the lender can tap both your pledged assets and your house to • cover the loan. You may be required to pledge additional assets if the value of your pledged asset account falls • below minimum maintenance levels. The lender is allowed to unilaterally liquidate your pledged assets if you fail to meet a • maintenance call.

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If you finance 100% of the cost of your new home with a pledged asset mortgage, your overall interest payments will be larger than if you cash out investments and use the money for a down payment. Consult your tax professional about the relative, total, after-tax cost of debt. You should also consider the potential appreciation/depreciation of your pledged assets and your home.

Caselet 3
10.Venture capitalists finance innovation and ideas which have potential for high growth but with inherent uncertainties. This makes it a high-risk, high return investment. Apart from finance, venture capitalists provide networking, management and marketing support as well. In the broadest sense, therefore, venture capital connotes financial as well as human capital. In the global venture capital industry, investors and investee firms work together closely in an enabling environment that allows entrepreneurs to focus on value creating ideas and allows venture capitalists to drive the industry through ownership of the levers of control, in return for the provision of capital, skills, information and complementary resources. This very blend of risk financing and hand holding of entrepreneurs by venture capitalists creates an environment particularly suitable for knowledge and technology based enterprises. Scientific, technology and knowledge based ideas properly supported by venture capital can be propelled into a powerful engine of economic growth and wealth creation in a sustainable manner. In various developed and developing economies venture capital has played a significant developmental role. India, along with Israel, Taiwan and the United States, is recognized for its globally competitive high technology and human capital. India has the second largest English speaking scientific and technical manpower in the world. The Indian software sector crossed the Rs 100 billion mark turnover during 1998. The sector grew 58% on a year to year basis and exports accounted for Rs 65.3 billion while the domestic market accounted for Rs 35.1 billion. Exports grew by 67% in rupee terms and 55% in US dollar terms. The strength of software professionals grew by 14% in 1997 and has crossed 1,60000. The global software sector is expected to grow at 12% to 15% per annum for the next 5 to 7 years. Recently, there has also been greater visibility of Indian companies in the US. Given such vast potential not only in IT and software but also in the field of service industries, biotechnology, telecommunications, media and entertainment, medical and health services and other technology based manufacturing and product development, venture capital industry can play a catalytic role to put India on the world map as a success story. It is now time for India to move to a higher level in the value chain. A conducive venture capital environment, including incubation facilities, can help a great deal in identifying and actualizing some of this research into commercial production. Development of a proper venture capital industry particularly in the Indian context is important for bringing to market high quality public offerings (IPOs). Thus, venture capital is valuable not just because it makes risk capital available at the early stages of a project but also because of the expertise of venture capitalist that leads to superior product development. 11.Stages in the Venture Capital Investment Process Deal Origination in which potential investments come to the attention of venture capitalists. Screening is a step in which the venture capitalist reaches an initial decision to investigate further the investment (or not). The initial screen is a cursory glance at the business plan to determine whether or not the proposal fits within the investor's areas of expertise. If warranted, the investor reads the plan more thoroughly as part of the generic screen to assess potential of the product or idea to obtain first impressions of management. Evaluation, during which the venture capitalist conducts detailed analysis of the venture. Criteria that venture capitalist apply are: • • • assessment of concept; assessment of the principals; and assessment of returns.
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Due Dilligence, if warranted, is the second phase of the evaluation step. This step may include formal market suite studies, reference checks, consultation with third parties. The investor outlines basic contract terms and discusses pricing. Negotiation is a step in which the investor and the principals iron out the framework for a deal. The deal closes once the parameters are acceptable to both parties. Post-investment activity relates to how the venture capitalist monitors the firm and takes part in major decisions. This phase largely involves monitoring, control, and intervention only as needed.

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Stages of Financing These are the typical funding stages that a startup moves through over the course of its life. Post IPO (i.e., Initial Public Offering) financings are not covered here as the focus is on the privately-held phase of the company's life. Seed or Concept stage financing: The venture is still in the idea formation stage and its product or service is not fully developed. The usually lone founder/inventor is given a small amount of capital to come up with a working prototype. Monies may also be spent on marketing research, patent application, incorporation, and legal structuring for investors. It's rare for a venture capital firm to fund this stage. In most cases, the money must come from the founder's own pocket, from the "3 Fs" (Family, Friends, and Fools), and occasionally from angel investors. Startup financing: The venture at this point has at least one principal working full time. The search is on for the other key management team members and work is being done on testing and finalizing the prototype for production or launch of version. Early stage venture capitalists-who are as rare as hen's teeth-may fund this stage. But more likely, it will be sophisticated angel investors. First -stage financing: The venture has finally launched and achieved initial traction. Sales are trending upwards. A management team is in place along with employees. The funding from this stage is used to fuel sales, reach the breakeven point., increase productivity, cut unit costs, as well as build the corporate infrastructure and distribution system. At this point the company is two to three years old. It's at this stage that venture capitalists prefer to get involved. Second -stage financing: Sales at this point are starting to snowball. The company is also rapidly accumulating accounts receivable and inventory. Capital from this stage is used for funding expansion in all its forms from meeting increasing marketing expenses to entering new markets to financing rapidly increasing accounts receivable. Venture capital firms specializing in later stage funding enter the picture at this point. Third stage financing: At this stage the future is so bright the founders "gotta wear shades" to borrow a phrase from the old pop tune. Everything looks good. Sales are climbing. Customers are happy. The second level of managers is in place. Money from this financing is used for increasing plant capacity (or other capacity depending on the nature of the business), marketing, working capital, and product improvement or expansion. Mezzanine or Bridge financing: At this point the company is a proven winner and investment bankers have agreed to take it public within 6 months. Mezzanine or bridge financing is a short term form of financing used to prepare a company for its IPO. This includes cleaning up the balance sheet to remove debt that may have accumulated, buy out early investors and founders deemed not strong enough to run a public company, and pay for various other costs stemming from going public. The funding may come from a venture capital firm or bridge financing specialist. They are usually paid back from the proceeds of the IPO. Initial Public Offering (IPO): The company finally achieves liquidity by being allowed to have its stock bought and sold by the public. Founders sell off stock and often go back to square one with another startup.
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Question Paper Investment Banking and Financial Services - II (MSF2K2) : October 2007
Section D : Case Study (50 Marks)
• • • • This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study
Read the case carefully and answer the following questions: 1. Delineate the risk factors inherent in the issue; clearly distinguishing between internal and external factors. (8 marks) 2. Delineate the basis for issue price to be furnished in the final offer document considering both rights issue and public issue. (12 marks) 3. Describe the procedure for proportionate allotment to be furnished in the offer document for the public issue. (8 marks) 4. The public issue of DFTL is open for subscription. People funds, a partnership firm established under partnership act is planning to subscribe to the issue. State whether it is eligible to subscribe to the issue or not. And also mention the various individuals/entities that are eligible and not eligible to apply for the public issue. (8 marks) 5. With respect to the issues of DFTL discuss the following question: a. Mr. Prashant, Mr. Souvick , Mrs. Lakshmi and Mr. Tarun are the existing shareholders of the company holding 72, 56, 46 and 6 shares respectively. None of these share holders has applied for the additional shares. All existing share holders have subscribed to the issue. Determine how many shares will be allotted to each of them in rights issue? b. Incase application of any applicant towards rights issue is rejected what would happen to the application money paid by the applicant? c. What are the rights of equity shareholders of DFTL? d. Can DFTL withdraw its public issue? e. How much minimum subscription DFTL should receive for both the issues? If the minimum subscription is not received, when the company will refund the money of the investors? (4 + 3 + 2 + 2 + 3 = 14 marks) DAGGER FORST TOOLS LIMITED.
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COMPOSITE ISSUE OF 73,31,104 EQUITY SHARES OF RS.10/- EACH AGGREGATING TO RS. 2,900.00 LACS COMPRISING OF: 1. RIGHTS ISSUE OF 33,24,954 EQUITY SHARES OF RS. 10/- EACH FOR CASH AT A PREMIUM OF RS.23 PER SHARE (i.e. AT A PRICE OF RS. 33 PER SHARE) AGGREGATING TO RS. 1,097.23 LACS TO THE EXISTING EQUITY SHAREHOLDERS OF THE COMPANY IN THE RATIO OF 5 EQUITY SHARES FOR EVERY 7 EQUITY SHARES HELD AS ON JULY 06, 2007 (RECORD DATE) 2. PUBLIC ISSUE OF 40,06,150 EQUITY SHARES OF RS. 10/- EACH FOR CASH AT A PRICE OF RS.45 INCLUSIVE OF PREMIUM AGGREGATING TO RS.1,802.77 LACS INCLUDING PROMOTERS CONTRIBUTION OF 4,00,000 EQUITY SHARES FOR CASH AT A PRICE OF RS. 45 INCLUSIVE OF PREMIUM AGGREGATING TO RS. 180.00 LACS. THUS NET OFFER TO PUBLIC IS 36,06,150 EQUITY SHARES FOR CASH AT A PRICE OF RS. 45 INCLUSIVE OF PREMIUM AGGREGATING TO RS. 1622.77 LACS THE FACE VALUE OF THE EQUITY SHARE IS RS. 10/- PER EQUITY SHARE AND THE RIGHTS ISSUE PRICE OF RS.33 IS 3.3 TIMES OF THE FACE VALUE AND THE PUBLIC ISSUE PRICE OF RS.45 IS 4.5 TIMES OF THE FACE

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VALUE. THE NET PUBIC ISSUE WOULD CONSTITUTE 30.09 % OF THE POST ISSUE PAID UP CAPITAL OF THE COMPANY. The existing equity shares of the company are listed on The Bombay Stock Exchange Limited, the Designated Stock Exchange. The Equity Shares to be issued through this issue will also be listed on the Bombay Stock Exchange Limited. The Company has received in-principle approval from the Stock Exchange for listings of the equity shares issued pursuant to the Rights Issue vide their letter no. DCS/PREF/SM/IP-RT/316/07-08 dated May 11, 2007. The company has received an in principle approval for listing of the equity shares issued pursuant to the Public Issue from the Stock Exchange vide their letter no. DCS/IPO/SC/IPO-IP/0236/2006-07 dated May 11, 2007 INDUSTRY OVERVIEW Broaches & Gear Cutting tool Industry in India This industry largely caters to the demand of Engineering and Automobile industry. Players in the engineering and automobile industry are the major users of Broaches and Gear cutting tools. Demand for these tools moves in line with the world industrial production in the engineering and automobile industry. Due to upgradation of manufacturing facilities in most auto/auto component industries, users focus on local suppliers with better product and quick technical services. A handful of organized players service 80 to 85% market and balance need is met by small-unorganized sector & imports. Due to growth in Auto sector and major growth in Export of Auto Components, demand for these tools is expected to grow at 10% p.a. for next 5 years. These products are used primarily for manufacture of: • • • • • Auto components used in cars, trucks, motorcycles, tractors (Automobile Industry).

Other industries where these tools are used include Aerospace (manufacture of turbines & other components). Power generation (manufacture of turbines). Defense (manufacture of various components for their vehicles and other defense equipment). Industrial products, such as gearboxes, pumps & other industrial products.

Broaches & Gear Cutting Tools Market in India (Rs. in Lac) Year /Product Broaches Hobs Shaper Cutters Shaving Cutters Total 2003- 04 (Actual) 1700.00 2100.00 500.00 600.00 4900.00 2004-05 (Actual) 2000.00 2100.00 600.00 700.00 5400.00 2005-06 (Actual) 2300.00 2500.00 700.00 800.00 6300.00 2006-07 (Estimated) 2007-08 (Projection) 2500.00 2800.00 700.00 900.00 6900.00 2900.00 3200.00 800.00 1100.00 8000.00

Industry Trend in Automobile Industry Automobile industry has shown a positive trend in the recent past, particularly in the two wheelers, commercial vehicles and car sectors. India has the second largest small car production base. With rising disposable incomes, improved standards of living and easy vehicle financing schemes, the trend of positive growth is likely to continue in the automobile industry in the near future. The roaring success of some of the two-wheelers, such as Victor (TVS-Suzuki), Caliber (Bajaj Auto) and Splendour (Hero Honda), has substantially increased the market growth for motorbikes, resulting in substantial tooling orders for the broach and gear cutting tool industry. The 2-wheeler segment is anticipated to grow to over 13 million units a year with the turnover likely to increase four times to Rs 340 billion by 2010, implying a CAGR of 12%. Automobile Production in India (Nos) Type of Vehicle Passenger Cars Utility Commercial Vehicles Two Wheelers
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April – March (2003- April – March (20042004) 2005) 7,82,562 2,06,998 2,75,040 56,22,741 9,60,487 2,49,389 3,53,703 65,29,829

Growth Rate % 22.73 20.48 28.60 16.13

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Three Wheelers Future Trends in the Automobile Industry

3,56,223

3,74,445

5.12

Growth in the automobile industry is expected to continue due to increase in capacities by automobile manufacturers in India. Maruti Suzuki has planned to set up manufacturing facilities, which would result in initial investment of Rs.2500 Crore. This could result in an investment of up to Rs 7,500 Crore (Rs 75 billion) by the components industry. Hyundai has already initiated its plans to invest Rs.850 Cr in its Indian operations. Ford is also planning to double capacity in it’s plant near Chennai. Tata Motors, too has plans to expand it’s car production capacity by almost 50%.. All this expansion needs to be backed by a downstream investment in auto components thus increasing the market for broach and gear cutting tools. Expected Growth in Domestic Auto Components Industry Since domestic demand for automobiles is expected to increase, this will translate into a direct increase in sales of the Auto Component Industry. OEM’s account for majority of sales for the Auto Component Industry - almost 65%. Most Indian OEM’s nowa-days source 70-80% of their requirements from vendors, compared with 50-60% in mid–nineties, this has also led to an increase in demand. An export of Auto Component Industry is also expected to increase due to cost competitiveness.

Main Objects of the Company The main objects of the Company as stated in the Memorandum are as under: To buy and/or sell and/or manufacture and/or produce and/or otherwise engage generally in the manufacture or production of • broaches and broaching and other machines and machine tools and small tools, cutting tools, precision tools, precision instruments, etc. and to do all acts and things necessary or required for the purpose. • Without prejudice to the generality of the other powers of the Company, a. To mine, quarry, smelt, refine, manufacture, process, fabricate, purchase or otherwise acquire, sell or otherwise dispose of or deal in ores, metals and compounds, metal goods wares and products of all kinds chemicals, chemical compounds and metals, minerals or other materials of every kind needed for or resulting from the mining, production or processing of iron and steel or other ferrous or non-ferrous metals and metal products of every kind. b. To make or cause to be made studies, reports and tests to determine the desirability and the feasibility of establishing and integrated metal processing and fabrication business in the Union of India or to determine the desirability and feasibility of establishing plants, factories and other facilities at various locations to serve such a metal fabrication business. • To buy, sell, refine, manufacture and deal in minerals and metals of all kinds.

To buy, sell, manufacture and/or deal in machinery, plant, implements, rolling stock, hardware, and other articles and things • which may be of use in connection with the business of the Company including metallurgical or other operations which may be required by those employed in or about the business of the Company. To construct, purchase, take on lease, hold, manage, operate, develop, grant licenses or easements over or sell, exchange, • lease repurchase, mortgage, let-out on hire or lease of movable and immovable properties including sale and purchase of land and other things, rights, benefits, licenses and easements connected therewith and advantages of any kind whatsoever and the same to resell, mortgage, let on lease or otherwise deal with.

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BUSINESS OVERVIEW Dagger Forst Tools Limited (DFTL), a part of Yashovardhan Birla Group, is engaged in the manufacture of high precision Cutting Tools viz. Broaches, Hobs, Shaper Cutters & Shaving Cutters (Gear Cutting Tools). Broaching is one of the most economical methods of machining, an integral process in the Engineering and Automobile Industry. It is, in most cases, the only process by which complex internal and external shapes can be achieved with high accuracy and surface finish. The first broach manufacturing plant was set up by the Company in 1965 at Thane in Maharashtra in collaboration with Oswald Forst GmbH of Germany and a decade later i.e. in 1975, another plant was setup at Aurangabad, Maharashtra, to cater to the increased market demand for broaches. As part of its diversification plans, DFTL put up yet another manufacturing plant in Aurangabad in 1977. This manufacturing unit, in collaboration with W. Forst, England, was set up to manufacture gauges within the same industrial area. In 1984, the Company purchased a plant at Aurangabad where gear cutting tools and built up Hobs are manufactured in technical collaboration with Klingelnberg Sohne of Germany. The Company also began manufacturing slitting saws since 1977. Aurangabad was also the venue for the gear cutting tools and builtup hobs manufacturing units in collaboration with Klingelnberg Sohne of Germany and the expertise for the manufacture or Shaving Cutters came from Mis. Samputensili SpA of Italy in 1999. All the collaborations mentioned above i.e. with Oswald Forst GmbH, W. Forst, Klingelnberg Sohne and M/s. Samputensili SpA have expired. For brief details of collaborations, please refer the heading “Collaborations” on page 48 of this Offer Document. All these manufacturing units have obtained ISO certification and satisfy all the norms related to environmental clearances. Consumers Profile The hobs & broaches produced are generally used for engineering purpose hence customers are predominantly industrial units. Some prominent customers of DFTL, in various sectors, include: Sector Automobile Industry Defense/Government Vehicle Railways Export Customers Countries Major Customers Domestic Customers Maruti Udyog, Mahindra & Mahindra, Tata Motors, Hyundai Motors, Toyota, Honda, Bajaj Auto, Hero Honda, L&T John Deere, Etc. Factory, Jabalpur; MTPF, Ambernath; Nuclear Power Corporation; Heavy Vehicle Factory, Undertakings Avadi; Ordinance Factory, BHEL, etc. DCW, DLW Germany, U.K., Italy, South Korea, Taiwan, Australia, etc. General Electric, Graziono, Forst Tech, Forst Cardinal, Hyundai, TRW.

Broaches Broaching is the most economical method of machining, an integral process in the engineering and automobile industry. This is, in most cases, the only process by which complex internal and external shapes can be achieved with greater accuracy and superb surface finish. Dagger Forst broaches makes it possible to achieve high rates of productivity with almost nil rejections. Gear Shaving Cutters Gear Shaving Cutters are high precision tools, primarily used in automobile and auto ancillary industries. It is absolutely essential for manufacture of highly accurate gears.
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Spline Gauges Spline Gauges, an import substitute manufactured by DFTL, are the inspection tools to check external and internal splines. They are a necessity for any engineering or auto industry to achieve ISO 9000 standards. Dagger Forst is an established manufacturer of spline gauges with the requisite close accuracy. Hobs & Shaper Cutters Hobs and Shaper Cutters are required for various Gears/Profiles for Automobile Industry. Dagger-Forst introduced ‘Built-Up Hobs’ first time in India. Slitting Saws Slitting Saws are made of finest imported High Speed Steel and used for cutting metals. They have high degree of hardness, wear resistance and concentricity, apart from dished side relief resulting in prevention of abrasion and burn marks. Broach Sharpening Machine The machine is used for sharpening & resharpening broaches, as well as nicking operations of circular and flat broaches. Its rigid bed, well-balanced and vibration-free grinding spindle enable the machine to perform with high precision. Major events in the History of the Company: 1983 The technical collaboration with W. Forst Engineers Ltd. got expired.

1985 Company came out with first public issue and also acquired Aurangabad unit of Indian tool manufactures a division of Zenith Steel Pipes & Industries Ltd manufacturing Gear Cutting Tools as a going concern. 1986 New facilities set up at Aurangabad for manufacture of built-in hobs for the first time in India with German technology and shaper cutters with Italian technology. 1992 1993 1996 1997 2000 2003 Company implemented modernisation and renovation programme. The technical collaboration with Oswald Forst GmbH, Germany got expired. Implemented expansion and modernisation of existing plants. New facilities set up at Aurangabad for manufacture of shaving cutters in collaboration with Samputensili, Italy. ISO 9001:1994 Certificate awarded for Thane as well as Aurangabad Units. ISO 9001:2000 Certificate awarded for Thane as well as Aurangabad Units.

2005 The Company has set up new Unit No. VI at Gandhidham for manufacture of existing products viz. Broaches, Gear Hobs, Shaving Cutters etc. 2006 The technical and commercial collaboration with Samputensili SpA got expired.

The following group companies have negative networth for the last three years: (Rs. in Lakhs) Particulars Birla Transasia Carpets Limited Birla Electricals Limited Birla Perucchini Limited OBJECTS OF THE OFFERING The Company proposes to raise equity through this composite issue to meet the following objectives: • Setting up a new plant for providing machining facility of castings at Aurangabad. To repay the unsecured loan raised by the Company for setting up the Gandhidham unit from Nirved Traders Private • Limited, Promoter Company. • • To meet the margin money for working capital requirement for Aurangabad Project. To meet the expenses of the issue. FY 2006 -2423.19 -1012.37 -1702.52 FY 2005 -2164.70 -198.12 -1675.57 FY 2004 -1901.53 -188.98 -1612.78

The main objects clause and objects incidental or ancillary to the main objects clause of the Memorandum of Association enables the Company to undertake the existing activities and the activities for which the funds are being raised by the Company, through this Issue. Funds Requirement The Company has estimated funds requirement as under: (Rs. in lacs)

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Particulars Setting up a new plant for providing machining facility of castings at Aurangabad. Repay the unsecured loan raised by the Company for setting up the Gandhidham Project from Nirved Traders Private Limited, Promoter Company. Margin Money for Working Capital requirement for Aurangabad Project To meet Expenses of Issue Total Note: Out of the total cost 62.58% will be utilized to create the tangible assets. Funding Plans (Means of Finance) The funding plans proposed by the company are as under: (Rs. In Lacs) Particulars Rights Issue of Equity Shares Public Issue of Equity Shares Promoter Contribution in the Public Issue Total Amount 1,097.23 1,622.77 180.00 2,900.00

Amount 2,079.86 470.14 50.00 300.00 2,900.00

1. 2. 3.

Any shortfall in the funding plans will be met through the Company’s internal accruals. Competitors of the company: Company Kennametal India – 30th June 2006 Kulkarni Power – 31st March 2007 Batliboi Ltd. – 31st March 2007 Latest market price of the share of the company is Rs.67.15 Terms to the right issue: Fractional entitlement If the shareholding of any of the Equity Shareholders is less than 7 or not in multiple of 7, then the fractional entitlement of such holders arrived at after multiplying such number of shares by 0.71 shall be ignored (since 5 shares are being offered for every 7 shares held, the entitlement would be 0.71 shares for every one share held). Shareholders holding less than 7 equity shares, whose fractional entitlement is being ignored as above, will be offered one new equity share out of those new equity shares not subscribed by the existing Equity Shareholders or available after consolidation of the fractional entitlements. Shareholders whose fractional entitlements are being ignored would be given preferential allotment of one additional share each if they apply for additional shares. The Equity Shares needed for such shares shall be adjusted from the Promoter’s entitlement. EPS (Rs.) 14.60 14.70 9.80 P/E Ratio 31.90 7.60 15.30 RONW (%) 25.80 22.50 31.30 NAV (Rs.) 70.30 62.20 29.90

SUMMARY STATEMENT OF PROFIT AND LOSSES, AS RESTATED (Rupees in Lacs) Year Ended 31st March 2002 INCOME Sales: Of products manufactured by the Company (net of Excise duty) Of products traded in by the Company Sub-total Other Income Increase/Decrease in Stock Total EXPENDITURE Period Period Ended Period Year Ended Year Ended Ended 30th 30th June Ended 31st 31st March 31st March June 2004 15 2005 12 March 2006 2003 2007 months months 9 months

1,459.60 121.70 1,581.30 70.38 42.71 1,694.39

1,866.49 1,866.49 116.95 34.54 2,017.98

2,808.20 2,808.20 75.24 84.89 2,968.33

2,735.82 2,735.82 41.22 44.13 2,821.17

2,274.17 2,274.17 16.26 29.24 2,319.67

3,569.18 3,569.18 144.43 117.32 3,830.93

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Purchase of goods traded Raw materials Consumed Staff Costs Other Manufacturing expenses Administration expenses Selling & Distribution expenses (Write back)/Provision for diminution in value of investments Provision for Doubtful advances (net) Interest Total operating expenses Profit before depreciation, doubtful advances & extraordinary items Gross Depreciation Less: Transfer from Revaluation reserve Net Depreciation Net adjusted profit/ (loss) before extraordinary items Add: Extraordinary items Net adjusted profit/ (loss) after extraordinary items Less: Provision for current tax (including Wealth tax ) Less: Provision for deferred tax (net) Less : Provision for Fringe Benefit tax Less: Tax Provision for earlier years Effect of adjustments on tax Net profit/ (-)loss after taxation & adjustments

187.16 194.54 999.84 247.84 366.11 68.52 407.86 193.96 265.57 2,931.40

259.74 777.93 256.03 327.34 55.05 -1.46 23.27 247.98 1,945.88

421.92 1,193.11 359.20 352.27 55.10

470.38 1,096.34 308.24 330.08 44.92

486.20 823.85 244.70 272.98 29.40

757.69 1,335.25 500.89 418.57 60.97

257.11 2,638.71

155.67 2,405.63

142.23 1,999.36

300.92 3,374.29

-1,237.01 179.89 1.04 178.85 -1,415.86 92.00 -1,323.86 24.71 20.42 -1,368.99

72.10 141.94 0.74 141.20 -69.09 70.46 1.37 2.29 -127.91 -2.00 128.99

329.62 371.58 371.58 -41.95 -41.95 6.00 -130.24 -5.50 87.79

415.54 303.70 303.70 111.84 111.84 17.51 60.38 3.00 15.61 15.34

320.31 139.70 139.70 180.60 180.60 24.77 30.74 12.00 7.08 106.01

456.64 264.90 264.90 191.75 191.75 35.00 32.94 14.00 -4.78 114.59

SUMMARY STATEMENT OF ASSETS AND LIABILITIES, AS RESTATED (Rupees in Lacs) Year Ended 31st March 2002 A FIXED ASSETS: (i) Gross Block Less: Accumulated Depreciation Net Block Less: Revaluation Reserve (i) Capital work in Progress Net Block after adjustment B Investments C Current Assets , Loans & Advances: Inventories Sundry Debtors Cash & Bank Balances Loans & Advances A+B+C D Less :Liabilities & Provisions: Secured Loans Year Ended 31st March 2003 Period Period Ended Period Year Ended Ended 30th 30th June Ended 31st 31st March June 2004 2005 March 2006 2007 15 months 12 months 9 months 6,228.17 3,028.62 3,199.55 3,199.55 55.68 3,255.23 44.35 6,370.85 3,325.63 3,045.22 3,045.22 184.83 3,230.05 44.35 8,325.04 3,434.48 4,890.56 4,890.56 179.19 5,069.75 44.35 8,804.07 3,689.41 5,114.66 5,114.66 83.45 5,198.11 44.35

3,873.30 2,566.30 1,307.00 4.65 1,302.35 48.72 1,351.07 46.65

6,189.55 2,665.23 3,524.32 2,370.38 1,153.94 48.72 1,202.66 48.11

451.68 783.08 56.95 294.72 1,586.43 2,984.15 1,167.30

448.12 758.78 93.51 353.65 1,654.06 2,904.83 1,138.45

521.94 512.65 123.45 275.87 1,433.91 4,733.49 1,061.30

652.57 543.57 157.26 268.74 1,622.14 4,896.54 988.22

717.56 596.88 170.84 366.53 1,851 6,965.91 2,102.36

981.50 904.79 189.59 395.52 2,471.40 7,713.86 2,617.15

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Unsecured Loans Net Deferred Tax liabilities Current Liabilities Provisions Networth (A + B + C - D) Represented By: (i) Share Capital Reserves & Surplus Less: Revaluation Reserve (ii) Reserves (net of Revaluation Reserve) (iii) Less: Misc. Expenditure (to the extent not writtenoff/ adjusted) Networth (i + ii - iii)

724.85 318.26 648.10 236.88 3,095.39 -111.24 465.49 -378.40 4.65 -383.05

662.59 190.35 649.48 203.04 2,843.91 60.92 465.49 2,116.33 2,370.38 -254.05

515.41 60.11 586.91 242.12 2,465.85 2,267.64 465.49 1,802.15 1,802.15

674.48 120.49 492.61 337.78 2,613.58 2,282.96 465.49 1,817.47 1,817.47

1,223.00 151.24 700.65 442.17 4,619.42 2,346.49 465.49 1,881.00 1,881.00

1,323.91 184.17 703.85 495.63 5,324.71 2,389.15 465.49 1,943.86 1,943.86

193.68 -111.24

150.52 60.92

2,267.64

2,282.96

2,346.49

20.20 2,389.15

END OF SECTION D

Section E : Caselets (50 Marks)
• • • • This section consists of questions with serial number 6 - 11. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 6. Budget 2007 amongst other things has given a green signal to the launch of Reverse Mortgage (RM) - a widely used instrument in the developed world by the elderly to derive cash flows from their owned house. With this regard perform SWOT analysis of RM in Indian context. (10 marks) 7. With respect to the caselet discuss the deficiencies associated with RMs.
< Answer > < Answer >

(7 marks) Mr. Patil has retired after what can be called a very fulfilling career with a leading engineering company. His only daughter is married and well settled in Bangalore. He owns a large house in Thane - worth about Rs.80 lakh (Rs.8 million), but he has limited savings (including PPF and EPF) of Rs.10 lakh (Rs.1 million) to generate any major income. He is not expecting any pension either. His worry now is to pay for his modest monthly expenses of Rs.20,000. His financial assets can at best generate Rs.10,000 per month for him and the income thus generated will not keep pace with inflation - meaning that after five years, when he will require Rs.30,000 per month, while his financial assets will still generate only Rs.10,000 per month. The only option he had earlier was to rent his house and move to a smaller house himself or to sell his house altogether and invest the proceeds to earn a higher monthly income. Either way, in his old age, he will be forced to look around for accommodation and keep on worrying about the rising rents - not a very happy prospect. This is where reverse mortgage can be of great value. Budget 2007 amongst other things has given a green signal to the launch of Reverse Mortgage - a widely used instrument in the developed world by the elderly to derive cashflows from their owned house. The popularity of the instrument lies in that it converts an illiquid asset - the house - into liquid cash flows for the owner, typically a senior citizen. A more attractive feature is that senior citizens can continue to live in that house even after drawing cash-flows from it. Here is how it works. Reverse mortgage as its name indicates operates in a manner opposite to that of the typical mortgage such as a home loan. In a typical mortgage, you borrow money in lump-sum right at the beginning and then pay it back over a period of time. In your payback - the EMI - a portion goes towards paying the interest and the remaining goes towards paying back principal. All along, you pledge the asset - namely the home you have bought with the loan - to the bank. This asset is the security against which the bank is lending to you. In reverse mortgage, you pledge a property you already own (with no existing loan outstanding against it). The bank in turn gives you a series of cash-flows for a fixed tenure. These can be thought of as reverse EMIs. There are various forms of reverse mortgage available in the developed countries. The specific format National Housing Board (the facilitator

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for housing finance in India) is promoting is one in which the tenure is 15 years and the owner of the house and his/her spouse continue to live in the house till their death - which can occur later than the tenure of the reverse mortgage. Simply put, in case of Mr and Mrs Patil, if they were to opt for reverse mortgage for tenure of 15 years, they will get annuity (the reverse EMI) from bank for 15 years. After that, the annuity payments stop. However, they continue to live in the house. Assume that Mr Patil dies after 17 years. Mrs Patil can still live in the house till she is alive. After her death, the bank will give their heirs two options - settle the overall outstanding loan and retain the house or the bank will sell the house, use the proceeds to settle the outstanding loan and give the rest to the heirs. The bank bears the risk that the outstanding will exceed the market value of property then and will not ask for the difference from the heirs. The key question is - how much of an annuity income can my house generate using reverse mortgage? The banks have so far not indicated which interest rates they will use to determine the EMI - however, we can safely assume that it will not exceed the interest rates used for loan against property - which is currently in the region of 12-14%. Second important variable is the loan to value ratio. Most loans against property work at 60% loan to value ratio - i.e. by pledging a Rs.1 crore (Rs.10 million) property, you can get a Rs.60 lakh (Rs.6 million) loan. Some banks are however designing reverse mortgage products with a higher loan to value ratio - as much as 90% in some cases. The specific annuity paid out also depends on the age of the home owner. Higher the age, higher the annuity everything else being constant. For simplicity consider a 60-year-old home owner taking reverse mortgage with loan to value ratio of 80% and an interest rate of 12%. The annuity from reverse mortgage works out to be roughly Rs.160 per lakh of property value. Hence for Mr. Patil, with a property valued at Rs.80 lakh, the annuity he can expect will be in the range of Rs.12,800 per month. Coupled with his income from financial assets, he can continue to live comfortably with no cutback on lifestyle. END OF CASELET 1

Caselet 2
Read the caselet carefully and answer the following questions: 8. IPO grading may be especially useful to retail investors who are seeking to invest in companies that are unknown in the equity markets. With respect to this discuss the following: a. Drawback of IPO grading. b. IPO grading vs. credit rating. c. Usefulness of IPO grading in the absence of an opinion on valuation. (3 + 4 + 5 = 12 marks) 9. With respect to the CRISIL IPO grading discuss the following: a. Basis for CRISIL IPO Grading. b. How it helps in safeguarding investors money.
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(4 + 3 = 7 marks) In keeping with its pioneering work in the field of rating and grading services, CRISIL has launched its IPO grading service. IPO grading is a globally unique concept introduced into the Indian market under the aegis of the Securities and Exchange Board of India (SEBI). The CRISIL IPO Grading is designed to provide investors an independent, reliable and consistent assessment of the fundamentals of new public issues. This offering may be especially useful to retail investors who are seeking to invest in companies that are unknown in the equity markets. CRISIL has played a central role in the conceptualization and development of the idea of IPO grading and believes that a grading provided by an independent entity would be a significant addition to the presently available tools for assessing the investment attractiveness of IPO offerings. The CRISIL IPO Grading includes an assessment of business and financial prospects, management quality and corporate governance; and reflects CRISIL's unique understanding of these issues, particularly corporate governance. CRISIL IPO Gradings are assigned by CRISIL Research, the research business of CRISIL. It deploys industry experts to assign the CRISIL IPO Grading. CRISIL Research pioneered the concept of industry research in India and its 16-year track record has enabled it to develop significant sector knowledge and expertise. CRISIL Research works independently from CRISIL Ratings. These two divisions in CRISIL do not share any confidential information provided to them by their respective clients. IPO Grading is value adding to the investment process of institutional investors due to the independent and focused information on relative fundamentals that is contained in the IPO Grading rationale. Moreover, the expression of the independent opinion on relative fundamentals as a single unambiguous symbol creates the possibility of discovering meaningful relationships between fundamentals and pricing. It may be noted that institutional investors extensively use credit ratings in the market for privately placed bonds where credit ratings are not mandatory. The grading of IPO, according to SEBI, will be expressed on a five-point scale and is a relative comparison of the assessed fundamentals of the graded issue to other listed equity securities in the country. CRISIL IPO Grading – Scale CRISIL IPO Grade Assessment

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5/5 4/5 3/5 2/5 1/5

Strong fundamentals Above average fundamentals Average fundamentals Below average fundamentals Poor fundamentals

The third leading rating agency Fitch India is "not rushing in" to offer the IPO grading service and prefers a wait-and-watch policy, according to Mr R. Jayakumar, Chief Operating Officer of Fitch India. Meanwhile, industry officials said grading of IPOs might be a "tricky" affair as it could give a false sense of security to the public. "Grading of IPOs is not done internationally by global rating agencies such as Standard & Poor's and Moody's. The grading of IPOs may shift the responsibility of merchant bankers (in bringing out good IPOs) to the rating agencies," said a merchant banker. Global rating majors Standard & Poor's is the majority stakeholder in CRISIL Ltd, while Moody's is the single biggest stakeholder in ICRA Ltd. Similarly, the third global player Fitch IBCA (which acquired another rating agency Dun & Bradstreet in 2000), also does not provide grading of IPOs internationally. END OF CASELET 2

Caselet 3
Read the caselet carefully and answer the following questions: 10. Knowledge Process Outsourcing (KPO) can be done for so many services including financial services. Discuss the challenges faced by Indian companies in the financial services KPO Business. (8 marks) 11. Discuss the reasons why India is the ideal KPO destination. (6 marks) The evolution and maturity of the Indian BPO sector has given birth to yet another wave in the global outsourcing scene: KPO or Knowledge Process Outsourcing. The success in outsourcing business process operations to India has encouraged many firms to start outsourcing their high-end knowledge work as well. Cost savings, operational efficiencies, access to a highly talented workforce and improved quality are all underlying expectations in offshoring high-end processes to India. This talent is soon being discovered and tapped by leading businesses across the globe resulting in the outsourcing of high-end processes to low-wage destinations. Hence Knowledge Process Outsourcing involves offshoring of knowledge intensive business processes that require specialized domain expertise. KPO is significantly higher on the value chain and involves processes that demand advanced information search, analytical, interpretation and technical skills as well as some judgment and decision making. For example, Financial Services KPO usually deals with areas such as insurance underwriting, fund management, risk assessment and actuarial analytics, debt collection and recovery, equity research, financial data mining, corporate & market research. Cost savings, operational efficiencies, access to a highly talented workforce and improved quality are the major drivers behind knowledge process outsourcing to India. The term KPO is often misleading. Unlike a BPO which deals with low end, predefined processes, knowledge creation and codification cannot be turned into a process and subsequently outsourced. In the case of knowledge, there is never a pre-defined process or a structured, rules-based manner to reach a conclusion or solve a problem. Instead the term KPO can be interpreted to mean outsourcing of knowledge intensive business processes that require specialized domain expertise. A few of the prominent Indian players in the financial services KPO domain are OfficeTiger, Smart Analyst, The Smart Cube. In addition to these, a number of MNC, KPOs such as EvalueServe, GE Capital as well as captive arms of global firms such as JP Morgan, HSBC, Reuters, Fidelity, Morgan Stanley and Citigroup also operate in India. According to a report by GlobalSourcingNow, the Global Knowledge Process Outsourcing industry (KPO) is expected to reach USD 17 billion by 2010, of which USD 12 billion would be outsourced to India. In addition, the Indian KPO sector is also expected to employ more than 250,000 KPO professionals by 2010, compared with the current figure of 25,000 employees. A report by Evalueserve predicts that India will capture more than 70 percent of the KPO sector by 2010. Apart from India, countries such as Russia, China, the Czech Republic, Ireland, and Israel are also expected to join the KPO industry. END OF CASELET 3
< Answer > < Answer >

END OF SECTION E END OF QUESTION PAPER

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Suggested Answers Investment Banking and Financial Services - II (MSF2K2) : October 2007
Section D : Case Study
1.Internal risk factors: • The issuer company is yet to place orders for machinery required and is yet to enter into contract for civil work for implementation of the project • Possible delay in project implementation will lead to cost overrun Part of the funds raised through composite issue will be utilised for repayment of unsecured loan raised from the • one of the promoter, nirved trader private ltd. Some of the group companies of DFTL namely birla transasia carpets ltd., birla electricals ltd., birla perucchini • ltd., have negative networth The materialisation of any of the contingent liabilities of the company may adversely affect the financial condition • of the company • • The financial data is not comparable due to frequent change in financial period Any labour unrest could significantly affect the working of the company
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Dependence on limited number of suppliers and no long term contracts for supply of raw materials might lead to • delay or shortage in supply One of the promoter companies, birla international private limited, has transferred its shareholding in dagger forst • tools limited at a price less than the proposed public issue price • Exchange rate fluctuation risk for the machinery to be imported Risk Factors External to the Company: • The company’s performance is linked to the performance of the Indian economy and passenger car industry in India • • • • • • • Increase in the cost of raw material Globally competitive environment Performance linked to stability of policies & political situation in India Terrorist attacks, drought, floods etc. May adversely affect the financial markets in India Changes in the domestic tax laws: Post-issue volatility in prices of the script No standard valuation methodology

< TOP > 2.BASIS FOR ISSUE PRICE The trading price of the Equity Shares of the Company could decline due to following risks and the investor may lose all or part of his investment.

Qualitative Factors • Leadership in terms of sales turnover in the tools industry Established sales & technical services network all over India at all key locations mainly Delhi, Chennai, • Bangalore, Pune, Jamshedpur, and Chandigarh etc. Competitive cost of production and low break even at Gandhidham unit due to exemption in payment of excise • duty leads to sell the products at competitive price to its customers. • Multi-location production facilities i.e. in Thane & Aurangabad in Maharashtra and Gandhidham in Gujarat. Major Customers – Automobile OEMs such as Suzuki, Hyundai, Honda, TVS, Tata etc. and other auto component • manufacturers and Defence/Government Undertakings. Top management has on an average 35 years of experience in the Forging Industry. Hence there has been an • expertise in manufacturing and providing customer service.

Quantitative Factors
1. Adjusted earning per share (EPS) weighted Year EPS Weightage 12 Months Ended 30th June 2005 9 Months Ended 31st March 2006 0.33 2.28 1 2

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12 Months Ended 31st March 2007 Weighted average

2.46 2.05

3

2. Price Earning ratio (P/E ratio) in relation to the Issue Price of Rs.33 per share in case of Rights Issue and Rs.45 in case of Public Issue Particulars A. Rights Issue Price of Rs. 33 per share (a) Based on EPS of Year Ended 31st March 2007 i.e. Rs. 2.46 (b) Based on weighted average (EPS) of Rs. 2.05 B. Public Issue Price of Rs. 45 per share (a) Based on EPS of Year Ended 31st March 2007 i.e. Rs. 2.46 (b) Based on weighted average (EPS) of Rs. 2.05 C. PE Multiple Engineering Industry Highest Lowest Average P/E 13.41 16.10 18.29 21.95 174.40 6.10 27.60

The Company is in Cutting Tool business. The accounting ratios of companies in the Industry Group (Engineering) are as follows: Company Dagger Forst 12 Months Ended 31st March 2007 Kennametal India – 30th June 2006 Kulkarni Power – 31st March 2007 Batliboi Ltd. – 31st March 2007 EPS (Rs.) 2.46 14.60 14.70 9.80 P/E Ratio 27.30 31.90 7.60 15.30 RONW (%) 4.80 25.80 22.50 31.30 NAV (Rs.) 51.33 70.30 62.20 29.90

Please note the company is in the business of cutting tools. The companies mentioned above are not the exact comparables for the Company. None of the companies who are in the same business as that of DFTL are listed. 3. Return on Net worth Year RONW (%) Weightage 12 Months Ended 30th June 2005 9 Months Ended 31st March 2006 12 Months Ended 31st March 2007 Weighted Average Required EPS Number of shares after the issue Required PAT Increased Net Worth Required RONW 4. Net Asset Value (NAV) per share (Rs.) a. b. c. d. e. As on March 31st 2006 As on March 31st 2007 After Public Issue* Rights Issue Price Public Issue Price 50.41 51.33 44.12 33 45 0.67 4.52 4.80 4.02 1 2 3

Minimum Return on Increased Net Worth required to maintain pre-issue EPS at Rs.2.46 is = Rs.2.46 = 119.86 = 2.46 ×119.86 = Rs.294.856 lakh = 2389.15+(33.250×33) + (40.062×45)= Rs.5289.19 =294.856 /5289.15= 5.57%

* Calculation of NAV after Public Issue also includes the Rights Issue Component. The face value of shares is Rs.10/- and the Issue price of rights component is 3.3 times of the face value and the issue price of public issue component is 4.5 times of the face value. The Lead Manager believes that the issue Price of Rs.33 for the rights component and Rs.45 of the public issue component is justified in view of the above qualitative and quantitative parameters.

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3.Proportionate Allotment Procedure Allotment will be made in consultation with Bombay Stock Exchange. Further the allotment for both public and rights components of the issue is proposed to be made simultaneously. The allotment will be done on proportionate basis within the specified categories, rounded off to the nearest integer subject to a minimum allotment being equal to the minimum application size of 150 shares subject to market lots as explained below: a. Applicants will be categorized according to the number of Shares applied for b. The total number of Shares to be allotted to each category as a whole shall be arrived at on a proportionate basis i.e. the total number of Shares applied for in that category multiplied by the inverse of the oversubscription ratio (number of applicants in the category x number of Shares applied for). c. The number of Shares to be allotted to the successful allottees will be arrived at on a proportionate basis (i.e. Total number of Shares applied for into the inverse of the oversubscription ratio). d. For applications where the proportionate allotment works out to less than 150 Shares the allotment will be made as follows: Each successful applicant shall be allotted 150 Shares; and ii. The successful applicants out of the total applicants for that category shall be determined by the drawing of lots in such a manner that the total number of Shares allotted in that category is equal to the number of Shares worked out as per (b) above. e. If the proportionate allotment to an applicant works out to a number that is not a multiple of 1, the applicant would be allotted Shares by rounding off to the nearest multiple of 1. f. If the Shares allocated on a proportionate basis to any category is more than the Shares allotted to the applicants in that category, the balance available Shares for allotment shall be first adjusted against any category, where the allocated Shares are not sufficient for proportionate allotment to the successful applicants in that category. The balance Shares, if any, remaining after such adjustment will be added to the category comprising of applicants applying for the minimum number of Shares g. If the process of rounding off to the nearest multiple of one results in the actual allotment being higher than the shares offered, the final allotment may be higher at the sole discretion of the Board of Directors, upto 110% of the size of the offering offer specified under point 23 of the Notes to the Capital Structure mentioned in the Offer Document. h. The above proportionate allotment of shares in an issue that is oversubscribed shall be subject to the reservation for small individual applicants as described below: i. A minimum of 50% of the net offer of shares to the Public shall initially be made available for allotment to retail individual investors as the case may be. ii. The balance net offer of shares to the public shall be made available for allotment to a) individual applicants other than retails individual investors and b) other investors, including Corporate Bodies/ Institutions irrespective of number of shares applied for value more than Rs. 100,000. iii. The unsubscribed portion of the net offer to any one of the categories specified in (i) or (ii) shall/may be made available for allotment to applicants in the other category, if so required. ‘Retail individual investor’ means an investor who applies for shares of value of not more than Rs. 100,000/Investors may note that in case of over – subscription; allotment shall be on proportionate basis and will be finalized in consultation with BSE. The drawing of lots (where required) to finalize the basis of allotment shall be done in the presence of a public representative on the governing board of the BSE. 4.No partnership firm or their nominees can apply for the issue. Hence People funds can not apply for the issue.
ISSUE MAY BE SUBSCRIBED BY:

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i.

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• Indian Nationals, who are resident in India and are Adult Individuals and are not lunatic, in single name or joint names (not more than three), • Hindu Undivided Families through the Karta of the Hindu Undivided Family Companies, Bodies Corporate and Societies registered under the applicable laws in India and authorized to invest • in the Shares • • Indian Mutual Funds registered with SEBI Indian Financial Institutions & Banks

Indian Venture Capital Funds / Foreign Venture Capital Funds registered with SEBI subject to the applicable RBI • Guidelines and Approvals, if any. • • • • • State Industrial Development Corporations Insurance Companies registered with Insurance Regulatory and Development Authority Provident Funds with minimum corpus of Rs.2500 Lac Pension Funds with minimum corpus of Rs.2500 Lac Trusts or Societies registered under the Societies Registration Act, 1860 or any other applicable Trust Law and are

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authorized under its constitution to hold and invest in Equity Shares of a Company Commercial Banks and Regional Rural Banks. Co-operative Banks may also apply subject to permission from • Reserve Bank of India • • • • • • • • • • • • 5. Permanent and Regular employees of the Company Non-Resident Indians (NRIs) on repatriation / non-repatriation basis Foreign Institutional Investors (FIIs) on repatriation / non-repatriation basis Scientific or industrial research organization, which are authorized to invest in shares Multilateral & Bilateral Development Financial Institution Minors Partnership firms or their nominees Foreign Nationals (except NRIs) Overseas Corporate Bodies (OCBs) Trusts (except as stated above) HUFs (except as stated above) NRIs (except as stated above) a. As per the terms of the issue, for every 7 shares held, 5 new shares will be issued and any fractional entitlement < TOP > will be ignored. However, if Prashant: For 70 shares held, 50 shares will be allotted. For the remaining 2 shares, fractional entitlement of 1.42857 (2×5/7) will be ignored. Souvick: For 56 shares held, 40 shares will be allotted. In this case, there is no issue of fractional entitlement. Lakshmi: For 42 shares held, 30 shares will be allotted. And for the remaining 4 shares, fractional entitlement of 2.8571 (4×5/7) will be ignored. Tarun: For 6 shares, fractional entitlement is 4.2857 (6×5/7) which will be ignored. b. In case an application is rejected in full, the whole of the application money received will be refunded. Wherever an application is rejected in part, the balance of application money, if any, after adjusting any money due on Equity Shares allotted, will be refunded to the applicant within six weeks from the close of the Offer. If there is delay in refund of application money by more than 8 days after the Company becomes liable to pay (i.e. 42 days after the closure of the Issue), the company will pay interest for the delayed period at the rate prescribed under subsection (2) and (2A) of section 73 of the Act. following are the rights of the equity shareholders: • • • • • • Right to receive dividend, if declared; Right to attend general meetings and exercise voting powers, unless prohibited by law; Right to vote on a poll either in person or by proxy; Right to receive offers for rights shares and to be allotted bonus shares, if announced; Right to receive surplus on liquidation; Right of free transferability; and

ISSUE NOT TO BE SUBSCRIBED BY:

c.

Such other rights, as may be available to a shareholder of a listed public company under the Companies • Act 1956 and Memorandum and Articles of Association of the Company. d. Company in consultation with the Lead Managers reserves the right not to proceed with any issue, any time after the issue opening date but before allotment without assigning any reason thereof. In case the Company decides so, it shall issue a public notice within two days of the closure of issue, indicating the reasons for withdrawal of Issue in the newspapers in which the issue advertisement appeared earlier. The Company shall also inform the Stock Exchanges on which the shares are proposed to be listed. e. Rights Issue: If the Company does not receive application money for atleast 90% of the issued amount, the entire subscription will be refunded to the applicants within forty-two days from the date of closure of the issue. If there is a delay in the refund of application money by more than 8 days after the Company becomes liable to pay the amount (i.e. forty two days after the closure of the issue), the company will pay interest for the delayed period, at prescribed rates in subsection (2) and (2A) of Section 73 of the Companies Act, 1956. Public Issue: If the company does not receive the minimum subscription of 90% of the issued amount on the date of closure of the issue, or if the subscription level falls below 90% after the closure of issue on account of cheques having been

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returned unpaid or withdrawal of applications, the company shall forthwith refund the entire subscription amount received. If there is a delay beyond 8 days after the company becomes liable to pay the amount, the company shall pay interest as per Section 73 of the Companies Act.

Section E: Caselets Caselet 1
6. Strengths • The senior citizens are entitled to regular cash flows at their choice - monthly, quarterly, half yearly and annually. • • • • • • The loan is given without any income criteria at an age where normal loans are not available. No loan servicing or repayment required during the lifetime of borrower and spouse. If the borrower dies during the period, the spouse will continue to get the loan amount for 15 years. Tax treatment of a RML will be as loan, not income, so no tax will be payable on the regular cash flows. The borrower and their spouse can continue to stay in the house till both die. Heirs of the borrower will be entitled to get the surplus of sale value of the property.
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Borrower/heir can get mortgage released by paying loan with interest without having to sell property at • any time. Prepayment of loan is allowed. NHB to guarantee obligation of banks/housing finance companies to pay the committed loan amount as • regular sums over a period of time. • Reassessment of property value will be done periodically or at least once every 5 years. Borrower can cancel the mortgage within three days of approval/disbursement, subject to return of loan • amount. Weaknesses • This loan product has a maximum tenure of only 15 years. If the borrower outlives this period, the regular cash flows will stop. • • • • • Basis of property valuation is not clear. Requirement of clear title to property in the name of the borrower to get the loan. Three days period to cancel loan is too less. Should be at least 15 days to go through the fine print. Various fees to be added to borrower’s liability, which can be quite substantial. Partial substitute for a social security scheme for senior citizens.

Opportunities Longevity increasing with nuclear families. However, medical expenses and cost of living going up, • increasing the need for additional income in old age. Most Indians have strong preference for own home. Therefore many eligible citizens may opt for the • scheme. • Threats • Property valuations are ambiguous. There is a non-recourse guarantee, which means that loan plus interest should never exceed realizable • value of property. In case of fall in property value or loan with interest exceeding assessed property value, banks may resort to strong-arm tactics to force the borrowers to move out, if they live too long after the loan period is over. Rate of interest is at the discretion of lender. Any increase in the rate, if floating, will increase the burden • of the borrower. Lender has discretion to raise loan amount on revaluation. However, if it does not do so, borrower doesn't • get loan according to proper value of property. Lender has right to foreclose loan by forcing sale of property if borrower doesn't pay for insurance, • property taxes or maintain and repair house. Can lead to further harassment. This product seems very good in theory and can be of great help to senior citizens who can live in their • own houses and yet avail of a loan against it. However, the norms need to be fine-tuned and made watertight so that these borrowers are not harassed or short-changed in their old age. Quantum of loan can increase favorably for borrower on revaluation of property.

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7. Following are the deficiencies associated with the RMs: RMs are rising-debt loans. This means that the interest is added to the principal loan balance each month, • because it is not paid on a current basis. Therefore, the total amount of interest increases significantly with time as the interest compounds. • RMs use up some or all of the equity in a home, leaving your loved one with fewer assets for the future. Your loved one may be able to request a loan advance at closing that is substantially larger than the rest of • his or her payments. Your loved one’s legal obligation to pay back the loan is limited by the value of his or her home at the • time the loan is repaid. This could include increases in the value (appreciation) of the home after the loan begins. RM loan advances are nontaxable. Further, they do not affect Social Security or Medicare benefits. If • your loved one receives Supplemental Security Income, RM advances won’t affect his or her benefits as long as he or she spends the advances within the month they are received. This is also true in most states for Medicaid benefits. For more information, check with a benefits specialist at your loved one’s local Area Agency on Aging. Some plans provide for fixed-rate interest. Others involve adjustable rates that change over the loan term • based upon market conditions. Interest on RMs is not deductible for income tax purposes until your loved one pays off all or part of his • or her total RM debt.

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Caselet 2
8. a. • It does not provide valuation of the equity offering It does not comment on the issue price of the shares being offered, likely listing price or likely • movement of price post listing • • • It does not assess of the market risk associated with equity investments It does not give an audit of the issuer It does not recommend to invest in the graded instrument
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It does not give forensic exercise that can detect fraud • Though the basic elements of the analysis that goes into credit rating and IPO grading are the same b. business prospects, financial prospects, management quality and corporate governance - the orientation of the analysis and therefore outcomes are very different as the assessment is done for very distinct objectives. A credit rating assesses these factors from a debt-holders' perspective, which is very distinct and sometimes opposite to an equity-holders' perspective. For instance, some companies that raise far more equity than they need in an IPO and hence suffer a depressed ROE are likely to be assessed unfavorably in the IPO grading exercise. However, they are likely to be assessed more favorably in a credit rating exercise, as equity cushions debt repayment. This distinction of objectives also means that the relative emphasis on the elements is very different in IPO grading and credit rating. For instance, the assessment of corporate governance while evaluating an IPO grading would tend to assume a much more pervasive character than credit rating where the emphasis of assessment is on estimating cash protection available to pay debt. IPO grading seeks to introduce a new paradigm with respect to research availability in the equity c. market. Until now, research has been available to equity investors only in the form of investment advice ('buy/ sell/hold' recommendations). IPO grading, which is an assessment of fundamentals, seeks to singly and comprehensively assess one of the key components that goes into any investment decision as illustrated here:

The approach to IPO grading is very similar to the research architecture that is available to bond markets in the form of credit ratings. A credit rating is a relative assessment of the fundamentals of the bond security. Likewise, IPO grading is a relative assessment of the fundamentals of the equity security. CRISIL believes that, over time, IPO grading will emerge to be a useful valuation tool for equity shares just as credit ratings are used for the valuation of 'buy/sell/hold' recommendations of bonds. It is important to note that as a AAA rated bond at a zero coupon might be a bad investment, a 5/5 graded IPO at a very high valuation too would not be an attractive investment opportunity.
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9.

a. CRISIL IPO Grading is based on the assessed future performance. The assessed future performance is based on the business plan of the company's management as understood by CRISIL. CRISIL will subject the business plan to extensive reality checks based on its understanding of industry and market dynamics, future management capability and the management's track record of translating intentions into action. b. Equity investment does not guarantee safety of the money investment as the likelihood of gains is accompanied by the likelihood of losses. CRISIL IPO Grading is a tool to enable you to make your investment decision with the benefit of an informed opinion on fundamentals in a relative framework. You must use this opinion on fundamentals in conjunction with the other elements outlined in the chart under question 5 to make your investment decision.

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Caselet 3
10. Following are the challenges faced by Indian companies in the financial services KPO Business: INTERNAL CHALLENGE Recruiting and Retaining the Right Talent KPO services in India are set to touch the $17 billion mark by 2010 (CII). To grab a sizable market share in the KPO sector, Indian companies will need to recruit a significant number of highly qualified employees with very strong academic backgrounds. Unlike a BPO where fluency in English is all you need to get in, the work in financial services KPO requires expertise in specific domains such as financial analysis and equity research. Access to a large, high-quality skill pool is a precondition for successful KPO operations. But the requisite skill pool is not easy to get. Reasons being: • • • • High competition for access to a limited superior - quality pool Successful players attract better people High attrition rates Lack of domain expertise
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Incorrect perception of the KPO profession as low grade • CUSTOMER CHALLENGES Demand for Quality KPOs require keen understanding of how a client works and what his exact needs are for each assignment. No predefined process can be created and replicated each time there is an assignment since every project is unique. As a result of this, defining an ideal metrics to measure the quality of work can be quite a difficult task. For example, an analyst may target twenty factors of importance for a market research study whereas another analyst may shortlist just five. The client may be pleased with the preciseness of the latter though the number of factors seem inadequate compared to the former. Thus, the difficulty lies in accurately determining whether you met client expectations or not. Ultimately, the client in a KPO will not look at dollar figures but will be mainly concerned with quality of services. That is where Indian companies may fail. Concern over Data Security and Client Confidentiality The data and information a KPO business works with is extremely sensitive. Clients such as banks, insurance companies and corporations trust KPO providers with company financial data, treasury and cash management functions and investment portfolio decisions. Thus, KPOs are privy to information not otherwise public knowledge. Thus, clients often hesitate to offshore research and processing of sensitive financial data and information involving strategic decisions. Compliance and Corporate Governance Outsourcing might lead to a loss of control, which might in turn lead to a weakening of corporate governance and subsequent breaches of compliance with regulatory requirements. COMPETITOR CHALLENGES Competition from Global KPO Units Operating in India Thus far, MNCs like GE and Evalueserve, with their huge resources and large scale have been doing well in India. Many of the financial number crunching for firms like Fidelity, Reuters and are also done by captive units in India. These firms take advantage of the low cost Indian knowledge worker, simultaneously leveraging their specific domain expertise, huge scales of operation and higher employee remuneration. INDUSTRY CHALLENGES Infrastructure The government has been continuously improving infrastructure with better roads, setting up technology parks, opening up telecom for enhanced connectivity, providing uninterrupted power to augment growth. But it may not grow at the faster speed as required.

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11. The reasons why India is becoming popular for KPO are: • • • • • • • • The Indian Education System The English Advantage Government Policies that will aid KPO Infrastructure Improvements Employee Scrutiny policy Standards in Quality Quality Initiatives Reverse Brain Drain.

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Question Paper Investment Banking & Financial Services - II (MSF2K2) : January 2008 Section D : Case Study (50 Marks)
• • • • This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study*
Read the case carefully and answer the following questions:
1. 2. With respect to the issue of shares of Koutons Ltd., delineate the risk factors associated with the issue? It is assumed that Issue Price of Rs.415 has been determined by the company in consultation with the BRLMs on the basis of assessment of market demand for the offered Equity Shares by the Book Building Process. Delineate the basis for issue price to be furnished in the final offer document. Discuss the important norms regarding listing of shares of a company that Bombay Stock Exchange has recently issued. Display with proper justification to prove whether Koutons satisfies clause 2.2.1 of SEBI guidelines regarding Eligibility to the issue? With respect to the public offer made by Koutons, construct a discussion on the “Forward Looking Statements” that are mentioned in the red herring prospectus on behalf of the company. ( 10 marks) <Answer>

( 15 marks) <Answer> ( 8 marks) <Answer> ( 10 marks) <Answer> ( 7 marks) <Answer>

3.

4.

5.

PUBLIC ISSUE OF 3,524,439 EQUITY SHARES OF RS. 10 EACH (“EQUITY SHARES”) OF KOUTONS RETAIL INDIA LIMITED (THE “COMPANY” OR THE “ISSUER”) FOR CASH AT A PRICE OF RS. [_] PER EQUITY SHARE (INCLUDING A SHARE PREMIUM OF RS. [_] PER EQUITY SHARE), CONSISTING OF A FRESH ISSUE OF 2,607,897 EQUITY SHARES (“FRESH ISSUE”) AND AN OFFER FOR SALE OF 916,542 EQUITY SHARES BY MR. DPS KOHLI, MR. BS SAWHNEY AND MR. GS SAWHNEY (THE “SELLING SHAREHOLDERS”), AGGREGATING RS. [_] MILLION (THE“ISSUE”). UPTO 50,000 EQUITY SHARES WILL BE RESERVED IN THE ISSUE FOR SUBSCRIPTION BY ELIGIBLE EMPLOYEES (THE “EMPLOYEE RESERVATION PORTION”). THE ISSUE LESS THE EMPLOYEE RESERVATION PORTION IS REFERRED TO AS THE “NET ISSUE”. THE ISSUE WILL CONSTITUTE APPROXIMATELY 11.54% OF OUR POST-ISSUE CAPITAL. THE NET ISSUE WILL CONSTITUTE APPROXIMATELY 11.37% OF OUR POST-ISSUE CAPITAL. PRICE BAND: RS. 370 TO RS. 415 PER EQUITY SHARE OF FACE VALUE RS. 10 EACH THE FACE VALUE OF THE EQUITY SHARES IS RS. 10 AND THE FLOOR PRICE IS 37.0 TIMES OF THE FACE VALUE AND THE CAP PRICE IS 41.5 TIMES OF THE FACE VALUE. Objects of the Issue The Issue comprises a Fresh Issue of 2,607,897 Equity Shares by the Company and an Offer for Sale of 916,542 Equity Shares by the Selling Shareholders. The Company will not receive any proceeds of the Offer for Sale by the Selling Shareholders. We intend to utilise the proceeds of the Fresh Issue, after proportionate deduction of underwriting and management fees, selling commissions and other expenses associated with the Issue (the “Net Proceeds”) for the following purposes: A. Setting up of the exclusive brand outlets of the Company; B. Establishment of a new integrated manufacturing facility; C. Purchase of plant and machinery to increase the finishing and manufacturing capacity of the Company; D. Improvement of our information technology network; and E. General corporate purposes.

Industry Overview Indian Retail Sector The Indian retail sector is at an inflexion point, with many enabling conditions coming into existence e.g. economy which is growing at 7-8%, favourable demographics, rising consumer incomes, real estate developments like emergence of new shopping malls and changing lifestyles that bring the Indian consumer closer to the consumers in more developed markets. All these changes
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are driving growth of organized retailing. Organized Retail Retailing in India is currently estimated to be a USD 270 billion industry. Organized retail has grown by leaps and bounds from USD 6.2 billion in 2004 to USD 8 billion in 2005 to USD 12.4 billion, a CAGR of 30%. (Source: India Retail Report by Images F&R Research 2007). In India, top 6 cities account for 66% of the total organized retailing. (Source: FICCI KPMG Report 2005). The organized retail market size at current prices is Rs 55,000 crores. In the organized retail pie, the lion’s share is 39% held by clothing and accessories sector, followed by food and grocery at 11%. Organized retail is on a high growth trajectory due to several favourable factors like strong economic growth, favourable demographics, easy availability of credit, supply of real estate, shift of lifestyle patterns etc. Apparel Manufacturing - Shifting towards Asia India’s textile industry has opened up significantly with the dismantling of quotas; hence apparel manufacturing is gradually shifting from Western countries to Asian countries on account of cost competitiveness. The elimination of these quotas has led retailers to source their requirements from the most competitive vendor. India also has an added advantage of low labour cost, along with other countries like Bangladesh, Indonesia and China, which has added to their rapid growth. Growth Drivers Rising Income Levels A larger number of households are getting added to the consuming class with growth in income levels. There has been a 100% growth in the addition of households, from 40 million in 1995 to 80 million households in 2005. This has resulted in significant increase in high income group from 5.5 million household in 1995 to 18 million households in 2005 for the high income group and from 18 million households in 1995 to 31 million in 2005 for the mass affluent. Consumer Spend Growth in income at all the levels, supported by the changing demographics has resulted in higher aspirational values, which is the key driver for the consumption spends. The AC Nielsen Online Omnibus Survey of 2005 rates India in the highest category of Aspiration Index in Asia along with China, Indonesia and Thailand. Urbanization Currently organized retail is focused on metros then moving down to the tier 1 and 2 cities. In the next 10 years the growth in the organized retail is going to come from the metros thus the target audience for organized retail is going to be the urban population. Organized retail has been more successful in cities more so in the South and West of India. Retail Space Quality retail space has always been one of the key hurdles for the development of Organized Retail. Currently there are 95 operational shopping centres with approximately 22 million sq.ft space growing to over 375 shopping centres/malls covering 90 million sq.ft space quality retail space by 2007. (Source: Images Yearbook Volume III, 2005). There is additional retail space to add Rs. 300 billion of business to organized retail. Mall Culture The emergence of mall culture and rapid development of malls is expected to act as a catalyst in this retail growth story. Approximately 68 million sq ft of mall space is expected to come up by the end of 2007. Retail Formats preferred in India The KPMG retail survey in India states that the specialty and supermarket format have the most potential for growth followed by hypermarkets. With the increase in the percentage of working women and dual income families, customers often visit shops with intention to purchase a specific product, thus confirming the emerging trend of focused malls. OUR BUSINESS Overview We are an integrated apparel manufacturing and retail company in India. We are in the business of designing, manufacturing and retailing apparel under the “Koutons” and “Charlie Outlaw” brands through a network of 999 exclusive brand outlets (as of August 20, 2007) across India. We started our business with the formation of a partnership firm “M/s. Charlie Creations”. We established a manufacturing unit (having a capacity to manufacture approximately 20,000 pieces of apparel per annum) in Delhi in 1993. In 1994, our Promoters with the vision of broadening operations incorporated our Company, as a private limited company i.e. “Charlie Creations Private Limited”. Our Company started its operations by taking over the business of the Erstwhile partnership firm. As of August 20, 2007 we had 18 in-house manufacturing/finishing units and 14 warehouses which are spread across various locations in and around Gurgaon and Haryana. We have increased our annual finishing and manufacturing capacity from 3,000,000 and 600,000 pieces of apparel, respectively as of March 31, 2005 to 22,920,000 and 12,360,000 pieces of apparel, respectively as of March 31, 2007. We have also entered into fabricating agreements with various manufacturing units to which we outsource
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stitching of certain apparel. Our brand “Koutons” has contributed to the success of our business. Sales from our brand “Koutons” has increased from Rs. 516.32 million in fiscal 2005 to Rs. 3,726.91 million in fiscal 2007 and has contributed 99.11% and 92.34% of our total income in fiscal 2006 and 2007, respectively. We have positioned the “Koutons” brand in the middle to high fashion segment, offering a complete range of a man’s wardrobe (in the age group of 22 to 45 years) ranging from formal to casual and party wear. We have recently reinvented and re-launched our old premier brand “Charlie” as “Charlie Outlaw”. Our Strategy Principal elements of our strategy are the following: Increase geographic penetration by spreading our network of exclusive brand outlets. We will focus on maintaining and reinforcing the image of our existing exclusive brand outlets and also introduce our apparel to new geographic areas and consumer sectors that are presently less familiar with our apparel. For the “Koutons” brand, we have an established network in north/north western India and are expanding our network in western and eastern India. Enhancing manufacturing capacities. We are focused on establishing and increasing our in-house manufacturing facilities as this allows us to exercise due control over both the manufacturing costs and the quality of the apparel being manufactured. Target the growing segments. We are focused on providing a complete menswear range in the middle to high fashion segment at affordable prices. This business strategy and brand positioning is in line with our target market, which is India focused. Strengthen the competitive position and recognition of our brands. We intend to continue to enhance the recognition of our brands by aggressively marketing our brands to both consumers and franchisees. We have made a strategic decision to focus on branded apparel and to market the same through exclusive brand outlets. Further improving our cost structure. We believe in providing quality apparel at affordable prices. We have improved our operating margins and cost structure by consolidating our manufacturing and distribution operations, reducing our selling, general and administrative costs, and by actively seeking efficient sources of production, whether through internal sources of supply or through outsourcing. Capital Structure The share capital as at the date of filing this Red Herring Prospectus with the RoC (before and after the Issue) is set forth in the table below: (Rs. except for share details) Particulars A. Authorised Capital 36,300,00 Equity Shares B. Issued, Subscribed and Paid-up Capital prior to the Issue: 27,943,500 Equity Shares C. Present Issue to the public in terms of this Red Herring Prospectus* 3,524,439 Equity Shares Fresh Issue 2,607,897 Equity Shares Offer for Sale 916,542 Equity Shares of which Employee reservation 50,000 Equity Shares D. Net Issue to the Public 3,474,439 Equity Shares Of Which: QIB Portion of at least 2,084,663 Equity Shares Non-Institutional Portion of up to 347,444 Equity Shares Retail Portion of up to 1,042,332 Equity Shares E. Issued, Subscribed and Paid-up Capital after the Issue: 30,551,397 Equity Shares F. Share Premium Account Prior to the Issue Post the Issue Aggregate value at face value 363,000,000 279,435,000 35,244,390 2,607,897 9,165,420 500,000 34,744,390 20,846,630 3,474,440 10,423,320 305,513,970 1,252,612,838 [•] [•] [•] [•] [•] [•] Aggregate value at Issue Price

The authorised share capital of the Company was increased from Rs. 1,000,000 divided into 100,000 Equity Shares to Rs. 5,000,000 divided into 500,000 Equity Shares through a resolution of the shareholders of the Company dated October 5, 1996. The authorised share capital of the Company was increased from Rs. 5,000,000 divided into 500,000 Equity Shares to Rs. 10,000,000 divided into 1,000,000 Equity Shares through a resolution of the shareholders of the Company dated March 30, 2000.

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The authorised share capital of the Company was increased from Rs. 10,000,000 divided into 1,000,000 Equity Shares to Rs. 50,000,000 divided into 5,000,000 Equity Shares through a resolution of the shareholders of the Company dated December 15, 2004. The authorised share capital of the Company was increased from Rs. 50,000,000 divided into 5,000,000 Equity Shares to Rs. 120,000,000 divided into 12,000,000 Equity Shares through a resolution of the shareholders of the Company dated April 17, 2006. The authorised share capital of the Company was increased from Rs. 120,000,000 divided into 12,000,000 Equity Shares to Rs. 363,000,000 divided into 12,000,000 Equity Shares and 243,000 Preference Shares through a resolution of the shareholders of the Company dated June 20, 2006. The authorised share capital of the Company was changed from Rs. 363,000,000 divided into 12,000,000 Equity Shares and 243,000 Preference Shares to Rs. 363,000,000 divided into 36,300,000 Equity Shares through a resolution of the shareholders of the Company dated January 30, 2007. Offer for Sale by Selling Shareholders: The Issue comprises an offer for sale of 916,542 Equity Shares by Mr. DPS Kohli, Mr. BS Sawhney and Mr. GS Sawhney in the following proportion: Name of Selling Shareholder Mr. DPS Kohli Mr. BS Sawhney Mr. GS Sawhney No. of Equity Shares 305,514 305,514 305,514

Statement of Restated Assets and Liabilities For the year ended A Assets Fixed Assets-Gross Block Less: Depreciation Net Block Less Revaluation Reserve Net Block after adjustment for Revaluation Reserve Investments C Current Assets, Loans and Advances Inventories Sundry Debtors Cash & Bank balances Other Current Assets Loans & Advances Total of C D Current Liabilities and Provisions Sundry liabilities Provisions Total of D Net Current Assets (C–D) Total Assets (A+B+E) G Liabilities and Provisions Loan Funds Working Capital Loans Secured Loans Unsecured Loans Total of G Deferred Tax Liability Net worth (F–G–H) Net worth Represented by: Shareholders Funds Share Capital Share Application Money (Pending Allotment) Share Premium Account Reserves and Surplus Less: Revaluation Reserve Reserves (Net of Revaluation Reserve) Less: Miscellaneous expenditure (not written off) Total 31.03.2003 31.80 13.70 18.10 – 18.10 – 105.16 50.29 4.63 9.16 169.24 75.40 5.60 81.00 88.24 106.34 50.28 6.49 16.26 73.03 0.13 33.18 31.03.2004 36.60 16.31 20.29 – 20.29 – 146.99 43.17 4.97 17.89 213.02 62.61 11.97 74.58 138.45 158.74 86.31 7.76 22.40 116.47 0.12 42.15 31.03.2005 51.88 20.33 31.55 – 31.55 – 191.67 51.97 28.09 74.87 346.60 118.21 18.22 136.43 210.17 241.72 110.83 22.16 41.82 174.81 0.24 66.67 31.03.2006 137.08 30.69 106.39 – 106.39 – 977.32 81.58 21.42 172.95 1,253.27 582.00 62.66 644.66 608.61 715.00 282.41 43.39 186.78 512.58 2.14 200.28 31.03.2007 505.98 70.36 435.62 – 435.62 – 3,738.40 203.92 172.57 509.85 4,624.74 1,114.69 205.41 1,320.10 3,304.64 3,740.26 1,522.82 101.52 469.96 2,094.30 19.42 1,626.54

B

E F

H

9.89 3.55 – 19.87 – 19.87 0.13 33.18

9.89 3.55 – 28.82 – 28.82 0.11 42.15

47.39 1.05 – 18.55 – 18.55 0.32 66.67

49.90 – – 150.77 – 150.77 0.39 200.28

273.44 – 1,070.94 288.40 – 288.40 6.24 1,626.54

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Statement of Restated Profit and Loss Account (Rupees in million) A For the year ended Income Sales: Of products traded by the Company Of Products manufactured by the Company Other Income Total Income Expenditure Materials consumed, manufacturing expenses & cost of goods sold Payment to & Provision for Employees Administrative & General expenses Selling expenses Interest & Financial charges Miscellaneous expenditure written off Total expenditure Net Profit Before Tax, Depreciation and Prior Period Items (A-B) Depreciation Net Profit before tax and Prior Period Item (C-D) Income tax Provision Tax Paid/Provisions Written bank for the previous years Deferred Tax Liabilities FBT Provision Prior Period expenses Profit After Tax Profit Brought Forward from Previous year Add: Deferred tax liability for earlier year written back Less: Bonus Shares Issued during the year Profit Carried Forward to Balance Sheet 31.03.2003 – 210.49 12.69 223.18 160.52 6.99 7.13 32.89 7.42 0.02 214.97 8.21 2.66 5.55 1.09 0.01 0.13 4.32 15.55 19.87 31.03.2004 31.03.2005 31.03.2006 31.03.2007

27.96 282.71 6.86 317.53 207.55 10.55 12.04 58.21 13.83 0.02 302.20 15.33 3.72 11.61 2.67 0.12 8.82 19.87 0.13 28.82 2005 22.73 17.82

46.36 533.09 2.01 581.46 375.66 22.64 18.15 114.71 15.52 0.04 546.72 34.74 4.24 30.50 10.97 0.24 19.29 28.82 0.12 29.68 18.55 2006 22.12 21.70

174.18 1,409.26 0.41 1,583.85 922.43 31.86 41.34 332.01 34.37 0.05 1,362.06 221.79 10.36 211.43 75.17 0.57 2.14 1.57 131.98 18.55 0.24 150.77 2007 24.25 24.25

603.60 3,420.37 12.20 4,036.17 2,163.14 76.20 86.23 993.91 149.06 1.84 3,470.38 565.79 39.67 526.12 161.95 17.27 2.03 344.87 150.77 207.24 288.40

B

C D E

Year Weighted average outstanding shares for diluted EPS Weighted average outstanding shares for basic EPS Industry P/E* i. Highest: 432.9 ii. Lowest: 4.2 iii. Industry Composite: 35.3.

Information Regarding Peer Group EPS (Rs.) P/E (times) RoNW (%) Pantaloon Retail (India) Limited Provogue (India) Limited Kewal Kiran Clothing Limited Vishal Retail Limited Zodiac Clothing Company Limited Industry Average 4.4 10.3 14.7 5.6 16.9 10.6 110.4 57.1 15.8 115.7 18.9 35.3 17.2 15.7 22.9 24.3 9.9 16.7

NAV (Rs.) 55.9 137.5 102.2 96.9 121.6 75.5

END OF SECTION D

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Section E : Caselets (50 Marks)
This section consists of questions with serial number 6 - 11. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions:
6. The increase in interest rates resulted in default made by the home loan borrowers. Explain the role of home owners in the subprime meltdown. ( 9 marks) 7. The effects of the meltdown spread beyond housing and disrupted global financial market. Explain how this meltdown lead to global 'credit crunch'. ( 9 marks) Subprime lending is a general term that refers to the practice of making loans to borrowers who do not qualify for market interest rates because of problems with their credit history or the ability to prove that they have enough income to support the monthly payment on the loan for which they are applying. Subprime loans or mortgages are risky for both creditors and debtors because of the combination of high interest rates, bad credit history, and murky financial situations often associated with subprime applicants. A subprime loan is one that is offered at a rate higher than A-paper loans due to the increased risk. In the 20th century, collateralized debt obligations became popular investment vehicles, in use worldwide. Traditionally, when payments on a mortgage were late, the personal relationship between debtor and creditor allowed some leeway when paying off a mortgage. But when subprime mortgage-backed securities were collateralized, the traditional links between lenders and their creditors were severed. This created a vicious circle when subprime loan payers defaulted on their obligation, leaving foreclosure of their mortgages as the only perceived recourse for investors in the loan. The subprime mortgage financial crisis was the sharp rise in foreclosures in the subprime mortgage market that began in the United States in 2006 and became a global financial crisis in July 2007. Rising interest rates increased the monthly payments on newly-popular adjustable rate mortgages and property values suffered declines from the demise of the US housing bubble, leaving home owners unable to meet financial commitments and lenders without a means to recoup their losses. The sharp rise in foreclosures after the housing bubble caused several major subprime mortgage lenders, such as New Century Financial Corporation, to shut down or file for bankruptcy, with some accused of actively encouraging fraudulent income inflation on loan applications, leading to the collapse of stock prices for many in the subprime mortgage industry, and drops in stock prices of some large lenders like Countrywide Financial. This has been associated with declines in stock markets worldwide, several hedge funds becoming worthless, coordinated national bank interventions, contractions of retail profits, and bankruptcy of several mortgage lenders. There was an economic bubble in many parts of the U.S. housing market from 2001 to 2005, especially in populous areas such as California, Florida, New York, the Bos Wash megalopolis, and the Southwest markets. The real estate bubble in these and other parts of the U.S. was caused by historically low interest rates (meant to soften the blow of the massive collapse of the dot-com bubble), poor lending standards, and a mania for purchasing houses. This bubble is related to the stock market or dot-com bubble of the 1990s. <Answer> <Answer>

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A housing bubble is characterized by rapid increases in the valuations of real property such as housing until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability. This in turn is followed by decreases in home prices that can result in many owners holding negative equity, a mortgage debt higher than the value of the property. The effects of the meltdown spread beyond housing and disrupted global financial markets as investors, largely deregulated foreign and domestic hedge funds, were forced to re-evaluate the risks they were taking and consumers lost the ability to finance further consumer spending, causing increased volatility in the fixed income, equity, and derivative markets. END OF CASELET 1

Caselet 2
Read the caselet carefully and answer the following questions:
8. Beyond benefits to the corporate sector and large institutions, does private equity benefit the broader economy and society? Discuss. ( 9. How does private equity firms change the short-term mindset and enhance growth? Explain. ( Private equity (PE) firms are making a killing in India. Most of their investments in listed companies over the past two years have turned out to be money spinners. Some of the PE favourites like NIIT, Lakshmi Overseas, Centurion Bank of Punjab, Diamond Cables, KS Oils, Sical Logistics and Himadri Chemicals & Industries have outpaced the Sensex in returns to investors during the period, although a few like GMR Industries, Spentex Industries and SpiceJet are yet to see positive returns on investments According to data compiled by research outfit Thomson Financial, the highest rise in share prices following the announcement of PE funding has been for Delhi-based infotech training firm NIIT, mustard oil manufacturer KS Oils and cables & conductors maker Diamond Cables. The share price of NIIT has shot up 518% since May 12, 2005, the day it was announced that Intel Capital would invest $10 million in the firm. In comparison, the Sensex during the same period has risen by 140%. Baroda-based Diamond Cables’ scrip has gone up 396% from June, 2006, when PE funding in the company was announced. Sensex in the same period went up by 56%. KS Oils has seen a 230% increase in the scrip price, against a mere 15% jump for the Sensex from November 15, 2006, the day Citigroup Venture Capital’s investment in the firm was announced. Auto component maker Amtek Auto, pharma company Jubilant Organosys, Patel Engineering and JBF Industries are the four companies where returns on the investments made by PE funds are positive, though a little less than the gains made by the Sensex during the same period. 8 marks) 8 marks) <Answer> <Answer>

“Clearly, PE funds are making money in India and have been successful in beating the market. Most investments in the listed space for PE funds have been successful,” said CVC managing director Ajay Relan. Unlike the West, in India, private equity funds have primarily followed a strategy of acquiring minority stakes in listed companies. “In India, there is little difference between mutual funds and private equity funds as both take small stakes in large public companies. This is largely due to the risks involved with investments in unlisted companies,” explains Sri Rajan, Bain & Co partner and head of the firm's private equity practice in India. Adds 3i India director (growth capital) Mahesh Chhabria: “With companies looking at both organic and inorganic growth, PE funding will continue to pour in to India, but most deals will continue to be in the PIPE (private investment in public enterprises) space.” Considerations for investing in private equity funds relative to other forms of investment include: Substantial entry costs, with most private equity funds requiring significant initial investment plus further investment for the first few years of the fund called a 'drawdown'. Investments in limited partnership interests (which is the dominant legal form of private equity investments) are referred to as "illiquid" investments which should earn a premium over traditional

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securities, such as stocks and bonds. Once invested, it is very difficult to gain access to your money as it is locked-up in long-term investments which can last for as long as twelve years. Distributions are made only as investments are converted to cash; limited partners typically have no right to demand that sales be made. For the above mentioned reasons, private equity fund investment is for those who can afford to have their capital locked in for long periods of time and who are able to risk losing significant amounts of money. This is balanced by the potential benefits of annual returns which range up to 30% for successful funds. In the past two years, there has been a huge inflow of private equity funding in India, almost touching record levels. Analyst reports suggest that this year, the amount of PE investments made in India is equal to PE investments in Hong Kong and Singapore put together. According to Thomson Financial’s data, in January-July 2007, $2.49 billion worth of PE investments were made in India, as against $1.05 billion in Hong Kong, $1.47 billion in Singapore and $752.2 million in China.

END OF CASELET 2

Caselet 3
Read the caselet carefully and answer the following questions:
10. There are lot many restrictions on the investment in corporate debts. Suggest a strategy to form a synthetic corporate bond explaining how it works. <Answer> ( 9 marks)

<Answer> 11. There are other risks in addition to credit risks which should be taken into account when investing in corporate debts. On the above grounds explain call risk and event risk associated with corporate bonds.( 7 marks) From the perspective of developing countries, a liquid corporate bond market can play a critical role in supporting economic development. First, it supplements the banking system to meet the requirements of the corporate sector for long-term capital investment and asset creation. Second, it provides a stable source of finance when the equity market is volatile. Third, a well developed liquid corporate debt market has become even more crucial as an alternative source of finance since the decline in the role of Development Financial Institutions (DFIs). For most developing countries, where dependence on bank loans is substantial, corporate bond markets are small, marginal and heterogeneous in comparison with corporate bond markets in developed countries. India has had a bank-dominated financial system. As a source of funds for the corporate sector, the share of the domestic capital market (debt plus equity) was 10.4% in FY3 200405 (April-March) while that of domestic borrowings from banks and financial institutions was 34.7%. In addition, corporations can have recourse to the overseas markets for raising equity, debt or loans. In recent times, the share of loans raised abroad has been significant - 23.3% in 2004-05. The dominance of the banking system can be gauged from the fact that the proportion of bank loans to GDP is approximately 36%, while that of corporate debt to GDP is only 4% or so. By the same measure, the government securities market is nine to ten times as large as the corporate debt market. The corporate debt market in India has been in existence since Independence. Public limited companies have been raising capital by issuing debt securities in small amounts. State-owned Public Sector Undertakings (PSUs) that started issuing bonds in FY 1985-86 account for nearly 80% of the primary market. Due to falling interest rates and adequate availability of funds, corporate issuance has shown a noticeable rise in recent years. The reduction in the share of debt in total resource mobilisation in the last two years can be attributed to buoyant equity markets. Indian corporate bond issues could face a lukewarm response from investors abroad as there has been a large number of issuances in the recent past, a top debt market expert observed here on Thursday. There have been a lot of issues very quickly and it is not necessary that the investors will have the ability and appetite for it. There could be a danger of saturation, ‘Barclays’ Capital FIG Debt Capital Markets Director Richard Grainger said on the sidelines of a FICCI conference here. He however, maintained that there was no need to panic and that there was some room for further issuance. ‘It does not mean Indian banks would struggle to raise funds abroad...India is likely to overtake Korea as the largest bond issuer from Asia,’ he added. In 2007 to date, India has raised six billion dollars abroad - 20 per cent of the total Asian issuance compared to two billion dollars last year and a mere 200 million dollars in 2005, he said. The issuances this year make India second only to Korea in the Asian region.

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The Securities Exchange Board of India (SEBI) and the RBI have taken steps, especially for improving transparency through appropriate regulations, viz. compulsory holding of securities in dematerialized form, limiting investment in unlisted paper, prescribing disclosure requirements for private placements by listed companies, mandating use of the order matching system of stock exchanges, etc. However, for further development of the market, some more issues need to be tackled in a concerted manner. Following the budget proposals for 2005-06, the Finance Minister has appointed a High-Level Expert Committee on Corporate Bonds and Securitisation to look into the legal, regulatory, tax and market design issues in the development of the corporate bond and securitisation market. The Committee is expected to submit its report shortly.

END OF CASELET 3

END OF SECTION E END OF QUESTION PAPER

Suggested Answers Investment Banking & Financial Services-II (MSF2K2): January 2008
Section D: Case Study
1. a. Investors will not be able to sell immediately any of the Equity Shares they subscribe to in this Issue on the stock exchanges: The Equity Shares will be listed on the BSE and NSE. Pursuant to Indian regulations certain actions must be completed before the Equity Shares can be listed and trading may commence. Investors’ book entry, or “demat” accounts with Depositary Participants in India are expected to be credited within two Business Days of the date on which the Issue and Allotment is approved by the Board. Thereafter, upon receipt of final approval of the Stock Exchanges, trading in the Equity Shares is expected to commence. There can be no assurance that the Equity Shares allocated earlier to investors will be credited to their demat accounts, or that trading will commence, within six days of the Issue and Allotment being approved by the Board. Additionally the company is liable to pay interest at 15% per annum if Allotment is not made, refund orders are not dispatched or demat credits are not made to investors within 15 days from the Bid/Issue Closing Date. b. There is no existing market for the Equity Shares, and the price of the Equity Shares may be volatile and fluctuate significantly in response to various factors: An active market for the Equity Shares may not develop or be sustained after the Issue. The market price of our Equity Shares may vary from the Issue Price after the Issue. The market price of our Equity Shares may fluctuate significantly due to factors beyond our control, including, but not limited to: volatility in the Indian and global securities markets; external factors affecting our operating results, including the risks outlined in this section; investor perceptions of the company’s future performance; announcements or others of significant contracts, acquisitions, strategic partnerships, joint ventures, or capital commitments; political developments or other governmental action or regulation in India or other countries; and additions or departures of key personnel. In addition, the shares listed on the BSE and/or the NSE may experience significant price and volume fluctuations, which may have a material adverse effect on the market price of the Equity Shares. There is a risk that you will not be able to sell your Equity Shares at a price at or above the Issue Price. c. Future sales of Equity Shares by shareholders or any future equity offerings by the company may adversely affect the market price of the Equity Shares: If the company do not have sufficient internal resources to fund the working capital or capital expenditure needs in the future, we may need to raise funds through further equity offerings. As a purchaser of the Equity Shares, you may experience dilution to your shareholding to the extent that we conduct future equity or convertible equity offerings. Such dilutions can adversely affect the market price of the Equity Shares. In addition, any perception by investors that such issuances or sales might occur could also affect the trading price of the Equity Shares. d. The company in the past has not distributed it’s profits by way of dividends and their ability to pay dividends in the future will depend upon their future earnings, financial condition, cash flows, working capital requirements, capital expenditures and other factors:
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The company has in the past not distributed profits by way of dividends. The amount of future dividend payments, if any, will depend upon future earnings, financial condition, cash flows, working capital requirements, capital expenditures and other factors. There can be no assurance that the company may have distributable funds. e. The company has in the last 12 months issued Equity Shares at a price which may be lower than the Issue Price. 2.1. Basic and Diluted Earnings per Share (EPS) Period ended 2007 2006 2005 Weighted Average Basic EPS (Rs.) 14.22 6.08 1.08 9.32 Diluted EPS (Rs.) 14.22 5.97 0.95 9.26 Weight 3 2 1
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2. Price Earning Ratio (P/E) in relation to the upper band price of Rs[415] per equity share of Rs10 each. a. P/E based on the diluted EPS for the year ended March 31,2007: 29.18 b. P/E based on the weighted average diluted EPS: 44.82 c. Industry P/E* i. Highest : ii. iii. 3. 432.9

Lowest 4.2 Industry composite: 35.3

Average Return on Networth (RoNW) Period ended 2007 2006 2005 Weighted Average RoNW(%) 21.20 65.90 28.93 37.39 Weight 3 2 1

4.

Minimum required return on net worth after the issue to maintain pre issue EPSNumber of outstanding shares pre issue- 27943500 Number of outstanding shares post issue- 30551397 Required post issue profit after tax- 30551397*14.22=434440865.34 Post issue net worth- 1626540000 + (415* 2607897) = 2708817255 Required return on net worth = (434440865.34/2708817255) *100 = 16.04% Net Asset Value (NAV) a. Issue price per equity share is Rs: 415 b. c. NAV per Equity Share after the issue is Rs : 2708817255/30551397 = 88.66 NAV per Equity Share as March 1,2007, 2006 and 2005 is as follows: Weight 3 2 1

5.

Period

NAV per Equity Share (Rs) 2007 59.49 2006 40.14 2005 14.07 Weighted Average 45.47 6.

Comparision with other listed companies Particulars EPS (Rs) P/E (times) RONW(%) NAV (Rs.) 14.22 44.82 21.20 59.49 4.4 14.7 5.6 16.9 10.6 110.4 15.8 115.7 18.9 35.3 17.2 22.9 24.3 9.9 16.7 55.9 102.2 96.9 121.6 75.5

Koutons Retail1 Comparision with other listed companies Pantaloon Retail (India) Limited Provogue (India) Limited Vishal Retail Limited Zodiac Clothing Company Limited Industry Average

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3.The Bombay Stock Exchange, BSE has decided to tighten the norms for listing shares of initial public offering, IPO and follow-on public issue, FPO to check fly-by-night operators entering the capital market reports. An important requirement under new norms, which will come into effect from August 1, is that due diligence for IPOs and FPOs for less than Rs 10 cr (Rs 100 million) has to be done by merchant bankers and chartered accountants appointed by the BSE. This requirement will be waived off if a financial institution or a scheduled commercial bank has appraised the project in the preceding 12 months, according to the revised listing norms issued here on Tuesday. The minimum number of public shareholders after the issue shall be 1,000 for smallcap companies. Small cap companies are those companies that have a market capitalization of less than Rs 25 crore (Rs 250 million) or companies that tap the IPO market with an issue size of less than Rs 10 crore. Under the new norms, BSE said minimum post-issue paid-up capital and minimum issue size for a small cap companies should be Rs 3 crore (Rs 30 million) respectively. Again, for small cap companies tapping the IPO/ FPO market, the minimum market capitalization is stipulated at Rs 5 crore (Rs 50 million) and the minimum turnover of the company should be Rs 3 crore in each of the preceding 12 months period, the BSE said. For large cap companies, the minimum post-issue paid-up capital of the applicant company should be Rs 3 crore and the minimum issue size is stipulated at Rs 10 crore. Under the existing norms, new companies can be listed on the BSE, if their issued and subscribed equity capital after the public issue is Rs 10 crore. In addition to this, the issuer company should have a post issue net worth (equity capital + free reserves excluding revaluation reserve) of Rs 20 crore (Rs 200 million). BSE said the new norms would be in addition to the conditions prescribed under SEBI (Disclosure and Investor Protection) Guidelines, 2000. 4.Clause 2.2.1 of the SEBI guidelines stipulate that a company would be eligible to make an initial public offer of its equity shares only if it meets all the conditions as specified in such clause. The Company has net tangible assets of at least Rs. 30 million in each of the preceding three full • years of which not more than 50% is held in monetary assets and is therefore compliant with clause 2.2.1 (a) of the SEBI Guidelines; The Company has a track record of distributable profits in accordance with Section 205 of the • Companies Act, for at least three years of the immediately preceding five years and is compliant with clause 2.2.1(b) of the SEBI Guidelines. The Company has a net worth of at least Rs. 10 million in each of the three preceding full years and • is compliant with clause 2.2.1(c) of the SEBI Guidelines. The Company has not changed its name in the last one year and is compliant with clause 2.2.1(d) of • the SEBI Guidelines. The net worth of the Company was Rs. 1,626.54 million as of March 31, 2007 as per our restated • financial statements included in this Red Herring Prospectus. Therefore, as required under clause 2.2.1 (e) of the SEBI Guidelines, the aggregate of the proposed issue and all previous issues made in the same financial year in terms of size (that is offer through offer document + firm allotment + promoters’ contribution through the offer document) does not exceed five (5) times its pre-issue net worth as per the audited balance sheet of the last financial year. (Rs. in million) Net Tangible Assets Monetary Assets 2 Distributable Profits3 Net worth, as restated 4
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Fiscal 2003 Fiscal 2004 Fiscal 2005 Fiscal 2006 Fiscal 2007 106.34 158.74 241.72 715.00 3,740.26 4.63 4.32 33.18 4.97 8.95 42.15 28.09 19.41 66.67 21.42 132.22 200.28 172.57 344.87 1,626.54
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5.This Red Herring Prospectus includes certain forward looking statements with respect to our financial condition, results of operations and business. These forward-looking statements can generally be identified by the fact that they do not relate to any historical or current facts. Forward-looking statements often use words such as “anticipate”, “expect”, “estimate”, “intend”, “plan”, “believe”, “will”, “may”, “should”, “would”, “could” or other words with similar meaning. Similarly, statements that describe our objectives, strategies, plans or goals are also forward looking statements. By their nature, forward looking statements are subject to risk and uncertainty and there are a number of factors that could cause actual results and developments to differ materially from those expressed in or implied by, such forward-looking statements. Actual results may differ materially from those suggested by the forward-looking statements due to risks or uncertainties associated with our expectations with respect to, but not limited to, regulatory changes pertaining to the industries in India in which we have businesses and our ability to respond to them, our ability to successfully implement strategy, growth and expansion of our business, technological changes, exposure to market risks, general economic and political conditions in India which have an impact on our business activities or investments, the monetary and fiscal policies of India, inflation, deflation, unanticipated turbulence in interest rates, foreign exchange rates, equity prices or other rates or prices, the performance of
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the financial markets in India and globally, changes in domestic laws, regulations and taxes and changes in competition in the industry. Neither we, nor the Selling Shareholders, nor the BRLM, the Co-BRLM, nor the other Underwriters, nor any of their respective affiliates have any obligation to update or otherwise revise any statements reflecting circumstances arising after the date hereof or to reflect the occurrence of underlying events, even if the underlying assumptions do not come to fruition. In accordance with the SEBI requirements, the Company, the Selling Shareholders, the BRLM and the Co-BRLM will ensure that investors in India are informed of material developments until such time as the grant of listing and trading permission by the Stock Exchanges are received in relation to the Equity Shares.

Section E: Caselets Caselet 1
6.Subprime loans or mortgages are risky for both creditors and debtors because of the combination of high interest rates, bad credit history, and murky financial situations often associated with subprime applicants. In this residential mortgage business in the US, a homeowner selects a mortgage lender who gives the loan after checking the borrower’s creditworthiness and the property that serves as collateral for the loan. Homeowners had been using the increased property value experienced in the housing bubble to refinance their homes with lower interest rates and take out second mortgages against the added value to use the funds for consumer spending. Many borrowers bought a home they could not afford but hoped that prices would continue rising and that they could re-sell their homes for a profit. Un-fortunately, prices went in the wrong direction. Many borrowers, in the sub-prime sector, lied about their income, their assets or their jobs in their greed to make money from the housing boom. After the loan is disbursed, most mortgage lenders resell these loans to investors or Wall Street firms, often through multiple intermediaries. But when other homeowners with mortgages also attempt to meet their financial obligations, some of them put their homes up for sale, which drags down the price of other houses in their neighborhood, not merely those houses with subprime mortgages, this compounded the problem. In the early 2000s recession that began in early 2001 and was exacerbated by the September 11, 2001 terrorist attacks, Americans were asked to spend their way out of economic decline with "consumerism... cast as the new patriotism". The call linking patriotism to shopping was bipartisan with former President Bill Clinton urging his countrymen to "get out and shop"[12], and corporations like General Motors producing commercials with the same theme. The housing bubble was largely fed by the lowering of interest rates to record low levels to diminish the blow of the massive collapse of the dot-com bubble. The collapse of the housing bubble, and resultant decline in property values, and increase in defaults has left lenders unable to recover losses. 7.Global markets have been overcome by concerns over financial institutions' exposure to bad credit in the US sub prime mortgage market. Sub prime mortgage lenders offer loans to consumers with a poor credit history. In the past five years, very low interest rates in the US have led financial institutions to lend substantial sums of money to such individuals without making checks on the suitability of the loans. Some 21% of mortgage applications in the US between 2004-2006 were sub prime compared to 9% between 1994 –2004. Recently, the number of defaults has risen as a result of rising interest rates. This in turn has raised concerns that the wobble in the housing market could spread to the rest other parts of the economy and then other nations. Repossessions have risen in line with interest rates and the US housing market is seriously struggling so the banks are finding themselves burdened with much more bad debt. The defaults on sub-prime mortgages were much more than expected, with approximately 17 percent of loans defaulting so far. Over two million American homes are expected to enter foreclosure with losses amounting to more than $200 billion. It is the worst housing market scene in the US since the Great Depression of the 1930s. To compound the situation, securities backed by sub-prime mortgages started showing up in unexpected portfolios leading to staggering losses. So for, losses have been reported from France, Germany, China, Australia, Japan and England in addition to the US. And this is just the tip of the iceberg. There are likely to be many more casualties over the next two years. Given this uncertainty, banks decided to stop lending – not just housing loans but other forms of debt as well. If banks make losses, it damages profitability and makes them far less willing to fund the takeovers and buyouts, such as the private equity deals that have been a staple in the stock markets' recent success. In addition it could make it far more difficult for banks and consumers to get loans. Many observers believe this has resulted in a severe credit crunch, threatening the solvency of a number of marginal private banks and other financial institutions, which in turn hit the markets worldwide.
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Caselet 2

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8.Superior returns from private equity investments strengthen pension funds that provide benefits for millions of workers. According to Private Equity Intelligence, private equity firms worldwide delivered net returns of $430 billion to their limited partner investors in the period from 1991 to 2006. A corollary benefit from these exceptional returns is that dozens of states were able to avoid budget cuts or tax increases that would have been required to meet their legally mandated pension obligations to retirees who have devoted their careers to public service. More broadly, research shows that private equity investment results in long-term employment growth and enhances the economic viability of a business to the benefit of all stakeholders. Research by A.T. Kearney found that PE firms have created jobs across the world, and that PE-financed firms generate employment, on average, at a much faster pace than comparable, traditionally financed firms. A study by the British Venture Capital Association found that over the last five years businesses backed by private equity increased employment an average of nine percent per year compared with one to two percent for public companies. BVCA also reported that PE companies grew sales faster than public firms as well and that their investment and R&D outlays grew at an average annual rate of 21 percent. A separate study by the European Venture Capital Association found that between 2000 and 2004, employment in private equity-backed companies rose by 5.4 percent, almost eight times higher than the European Union average of 0.7 percent. Finally, The Financial Times studied the 30 largest European private equity transactions in 2003-04 and reported that “Overall, jobs were more likely to have been gained than lost as a result of private equity backed buys.” A recent study by the Munich Technical University for the European Private Equity and Venture Capital Association (EVCA) found that between 2000 and 2004, European businesses acquired in buyout deals recorded a net increase of 420,000 jobs. 9.As a backdrop, it is important to understand one important truth about private equity: the entire investment hinges on improving the business and increasing its value. If the private equity firm fails to do that, it loses money, its investors lose money, and its ability to raise future funds is undermined. The essence of private equity is the alignment of the interests and incentives of management with that of the owners. In a public company, the owners – shareholders - are largely separate from the management of a company. Private equity eliminates this disconnect. The owners often include the management (PE firms usually requirement management to invest their own money into the company so they have a vested interest in its success) his provides a sharper focus on how capital is allocated across the business – without the constant pressure of delivering quarterly results to public shareholders. Everyone has a single objective: grow the company’s value. Thus, they can make business decisions solely focused on that goal, rather than satisfying external constituencies, such as analysts, traders, stock brokers, and the media.

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Caselet 3
10. We can think of one interesting set of moves, to produce a low volatility cashflow: 1. Setup a SPV in a tax haven. 2. Buy $100 million of zero debt company’s shares in India. These generate a stream of dividends in the future. 3. Issue a senior claim on the assets - which is "an zero debt company’s bond". The residual (subordinated / junior) claim is then a "leveraged company’s equity". Just to fix ideas, the senior claim promises to pay cash of Rs.10 per year for five years and in the end, pay Rs.100. So it looks like a five-year maturity, 10% coupon, corporate bond issued by zero debt company. Every year, the SPV takes stock of the cash and shares available with it. The SPV first pays Rs.10 to the senior investors. If there is no cash in hand (i.e. the company’s dividend dropped to 0), it sells shares to obtain Rs.10. If there is any cash in hand at the end of these steps, this is sent to the subordinated investors. At the end of five years, the position is liquidated. The first Rs.100 obtained are paid out to the senior investors. After that, if there is residual cash, it is paid out to the subordinated investors. The senior claim is akin to a "fixed income" instrument issued by company. A Japanese insurance company or pension fund, that likes to buy corporate bonds, might like to buy these "corporate bonds". The subordinated claims will be bought by the usual risk-loving characters such as the hedge funds. The senior claims are not corporate bonds in one key respect: the treatment of bankruptcy. When a corporate bond fails to pay a coupon, this is a default event, and the bondholder gets the company. In contrast, the senior investors of the SPV don't have recourse to a bankruptcy process where they takeover the zero debt company in the event of bankruptcy. While we respect this difference, we still feel that the senior claim does have risk/ return characteristics that are a lot like a corporate bond, particularly since India doesn't have much by way of a bankruptcy process. Another fly in this ointment is that the structure works best as long as company preserves their zero-leverage
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structure of liabilities. If (say) next year, the company chooses to issue debt, then that muddies the waters. The investors in the senior claim on the SPV would be unhappy because now there is some other debt which is more senior than them, at the mother source. There could be a provision in the contracting - a "debt covenant"? - that the entire structure will unwind, at prices driven by formulas agreed-upon as of today, in the event that in the future, the company issues debt. In other words, if the company issues debt in the future, then the senior and the subordinated paper are both put back to the originator where they are extinguished, and the originator sells off his initial zero debt company shareholding in India. 11.Investors should be aware of some other risk factors affecting corporate bonds. Two of the most important ones are call risk and event risk. If a corporate bond is callable, then the issuing company has the right to purchase (or pay off) the bond after some minimum time period. If you hold a high-yielding bond and prevailing interest rates decline, a company with a call option will want to call the bond in order to issue new bonds at lower interest rates (in effect, to refinance its debt). Not all bonds are callable, but if you buy one that is, it is important to note the terms of the bond. It is important that you be compensated for the call provision with a higher yield. Event risk is the risk that a corporate transaction, natural disaster or regulatory change will cause an abrupt downgrade in a corporate bond. Event risk tends to vary by industry sector. For example, if the telecom industry happens to be consolidating, then event risk may run high for all bonds in this sector. The risk is that the bondholder's company may purchase another telecom company and possibly increase its debt burden (financial leverage) in the process.
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* The above case is prepared only for the purpose of examination. The case contains real information adapted and combined with other information to generate discussion or analysis on the desired topics.

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Question Paper Investment Banking and Financial Services - II (MSF2K2) : April 2008
Section D : Case Study (50 Marks)
• • • • This section consists of questions with serial number 1 - 5. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study
1. Reliance power was the largest IPO in the history of the Indian capital market. The 22.85 crore share mega issue, looking to raise roughly Rs 11,000 crore, was fully subscribed under a minute of the start of bidding, making it wonder if there were any early-bid prizes on offer. However, against the expectation of all investors, the shares of Reliance power got listed at the price of Rs.530 and closed at 17% below the issue price on its first day of trading. Analyse the possible reasons for this panic situation. ( 8 marks) 2. As mentioned in the case study, the retail individual category was over subscribed by 13.57234 times. Based on this, show how the share allotment to retail individual investor can be carried out. ( 11marks) 3. In most of the cases, it is experienced that IPO through Book Building method in India turns out to be overpriced or underpriced after listing and ultimately the small investor becomes a net looser. In this context, explain how Green Shoe Option can be helpful to stabilize the price. ( 10marks) 4. Some of the widely used terms we come across in context of IPO are Offer Document, Red Herring Prospectus, Abridged Prospectus, Draft Offer Document etc. In this context, define these terms. ( 9 marks) 5. a. There are different methods available for a company to make an IPO – Fixed price method, Book building method and Open auction method. Explain these methods. ( 6 marks) b. The IPO made in the United States by Google through an open auction method has raised concerns as to the feasibility of this model in the Indian capital market. In this context, explain how open auction method is better than other options available in the market and also comment on the feasibility of this model in the Indian capital market. ( 6 marks) PUBLIC ISSUE OF 260,000,000 EQUITY SHARES OF RS. 10 EACH OF RELIANCE POWER LIMITED (“RELIANCE POWER” OR THE “COMPANY” OR THE “ISSUER”) FOR CASH AT A PRICE OF RS. 450# PER EQUITY SHARE (INCLUDING A SHARE PREMIUM OF RS. 440# PER EQUITY SHARE) AGGREGATING TO RS. 115,632 MILLION (NET OF RETAIL DISCOUNT) (THE “ISSUE”). THE ISSUE COMPRISES A NET ISSUE TO THE PUBLIC OF 228,000,000 EQUITY SHARES AGGREGATING TO RS. 101,232 MILLION (NET OF RETAIL DISCOUNT) ("THE NET ISSUE") AND A PROMOTERS’ CONTRIBUTION OF 32,000,000 EQUITY SHARES AGGREGATING RS. 14,400 MILLION. THE ISSUE WILL CONSTITUTE 11.5% OF THE POST ISSUE PAID-UP CAPITAL OF THE COMPANY AND THE NET ISSUE WILL CONSTITUTE 10.1% OF THE POST ISSUE PAID-UP CAPITAL OF THE COMPANY. ISSUE PRICE: RS. 450 PER EQUITY SHARE OF FACE VALUE RS. 10 EACH# THE ISSUE PRICE IS 45 TIMES THE FACE VALUE # A discount of Rs. 20 to the Issue Price determined pursuant to completion of Book Building Process has been offered to Retail Individual Bidders (“Retail Discount”). <Answer> <Answer> <Answer> <Answer> <Answer>

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The Issue made through the 100% Book Building Process wherein at least 60% of the Net Issue was to be allocated on a proportionate basis to Qualified Institutional Buyers (“QIBS”) (including 5% of the QIB portion that was to be allocated specifically to mutual funds). Further, at least 10% of the Issue was to be allocated on a proportionate basis to Non-Institutional Bidders and at least 30% of the Net Issue was to be allocated on a proportionate basis to Retail Bidders, subject to valid bids, being received at or above the Issue Price. OBJECTS OF THE ISSUE It is intended to utilise the Issue Proceeds, after deducting the underwriting and issue management fees, selling commissions and other expenses associated with the Issue (the “Net Proceeds”) for the following objects: a. Funding Subsidiaries to part-finance the construction and development costs of certain projects (identified below); The company is pursuing the development of 13 power generation projects which are currently under various stages of development. Out of these projects, one is being executed by the company and 11 projects are being developed by nine subsidiaries which have been set up to develop these projects. One project is expected to be executed through a subsidiary that remains to be transferred to the company. It is intended to use a portion of the Net Proceeds to partially fund five subsidiaries which are developing the following six projects, collectively referred to as “Identified Projects”: S. No. 1. 2. 3. 4. 5. 6. b. Name of Subsidiary RPSCL RPSCL VIPL SPL MEGL USHPPL The percentage shareholding of the company in the subsidiary 100% 100% 100% 100% 100% 80%

Identified Projects 600 MW Rosa Phase I 600 MW Rosa Phase II 300 MW Butibori 3,960 MW Sasan 1,200 MW Shahapur Coal 400 MW Urthing Sobla

Location Uttar Pradesh Uttar Pradesh Maharashtra Madhya Pradesh Maharashtra Uttarakhand

General corporate purposes; and c. Achieve benefits from listing of the equity shares. The main objects clause of company’s Memorandum of Association and the objects incidental and ancillary to the main objects enable the company to undertake the activities for which the funds are being raised by it in the Issue. Further, the activities the company has been carrying out until now are in accordance with the objects clause of its Memorandum of Association. INDUSTRY OVERVIEW Overview

India has emerged as one of the fastest growing economies in the world. Its current economic performance reflects a healthy trend based on increased consumption, investment and exports. Over the next five years, this growth is expected to continue. A key risk to the continued growth of the Indian economy is inadequate infrastructure. Infrastructure investment in India is on the rise, but growth may be constrained without further improvements. The Government of India has identified the power sector as a key sector of focus to promote sustained industrial growth. It has embarked on an aggressive mission -”Power for All by 2012”- and has undertaken multiple reforms to make the power sector more attractive to private sector investment. Indian power Sector Demand Supply Scenario The power industry in India has historically been characterized by energy shortages which have been increasing over the years. The gap between demand and supply has been increasing, leading to increased power shortages. The following table highlights the peak deficit over the years: Fiscal Year 2001-02 2002-03 2003-04 Peak Deficit (MW) 10,293 9,945 9,508

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2004-05 10,254 2005-06 11,463 2006-07 13,897 April-September 2007 12,409 Source: CEA, Power Scenario at a Glance, October 2007 The peak deficit for the period between April - September 2007 was 12,409 MW. The peak deficit varies across India, ranging from 5.8% of peak demand requirements in the Southern Region to 26.5% of peak demand requirements in the Western Region. The following table depicts the peak deficit scenario for the period between April - September 2007 across different regions in India. Region Peak Demand DeDemand 32,308 36,371 25,682 11,284 1,589 102,428 Peak Supply Figures in Net MW Deficit Deficit (%)

North West South East North-East All India

29,495 26,732 24,194 10,562 1,347 90,019

2,813 9,639 1,488 722 242 12,409

8.7 26.5 5.8 6.4 15.2 12.1

# Lakshadweep and Andaman & Nicobar Islands are standalone systems, power supply position of these, do not form part of regional requirements and availability Source: CEA, “Power Scenario at a Glance”, October 2007 Installed Generation Capacity by Sector Public entities such as the National Thermal Power Corporation and state generation companies have been prominent players in capacity addition in the power sector. The participation of private sector, however, has increased over time owing to power sector reform. As of September 30, 2007, the state government sector led installed capacity levels with 70,947 MW, or 52.3% of the total installed capacity in India, followed by the central sector at 46,166 MW, or 34.0% of the total installed capacity in India, and by the private sector at 18,669 MW, or 13.7% of total installed capacity in India. (Source: Ministry of Power) Future Outlook The Ministry of Power has set a goal—Mission 2012: Power for All. Based on the 17th EPS, the total energy requirement in India will increase to 968,659 GWh by fiscal year 2012, 1,392,066 GWh by fiscal year 2017 and to 1,914,508 GWh by fiscal year 2022. This would lead to an annual electric peak load of 152,746 MW in fiscal year 2012, 218,209 MW in fiscal year 2017 and 298,253 MW in fiscal year 2022. The northern region is expected to contribute 30.1% and the western region is expected to contribute 28.4% of the overall annual electric peak load in fiscal year 2022. The Government has estimated the total investment potential of the sector at Rs. 9,000 billion for a specified period up to fiscal year 2011. This represents a significant opportunity for capacity expansion and growth for power generation companies, both in the public and the private sector Reliance Power Limited Overview Reliance power limited is part of the Reliance ADA group and was established to develop, construct and operate power projects domestically and internationally. The prevailing and expected electricity demand and supply imbalance in India presents significant opportunities in the power generation sector. The Government of India's vision of “Power for All” by 2012 will require aggressive growth and increased private sector participation. To capitalize on this opportunity, RPL is currently developing 13 medium and large sized power projects with a combined planned installed capacity of 28,200 MW, one of the largest portfolios of power generation assets under development in India. The company’s 13 power projects are planned to be diverse in geographic location, fuel type, fuel source and off-take, and each project is planned to be strategically located near an available fuel supply or load center. The identified project sites are located in western India (12,220 MW), northern India (9,080 MW) northeastern India (2,900 MW) and southern India (4,000 MW). They include seven coalfired projects (14,620 MW) to be fueled by reserves from captive mines and supplies from India and abroad, two gas-fired projects (10,280 MW) to be fueled primarily by reserves from the Krishna Godavari Basin (the “KG Basin”) off the east coast of India, and four hydroelectric projects (3,300 MW), three of them in Arunachal Pradesh and one in Uttarakhand. The company intends to sell the power generated by these projects under a combination of long-term and short-term PPAs to statehttp://206.223.65.215/suggested/MSF2K2-0408.htm (3 of 16) [06/Apr/08 6:57:56 PM]

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owned and private distribution companies and industrial consumers. Its projects include:
• Rosa Phase I, a 600 MW coal-fired project in Uttar Pradesh which is currently under construction and scheduled to be commissioned in March 2010. Rosa Phase II, a 600 MW expansion of Rosa Phase I which is scheduled to be commissioned in • September 2010. Butibori, a 300 MW coal-fired project which will supply power to a group of industrial consumers in • Maharashtra and is scheduled to be commissioned in June 2010. Sasan, one of the first UMPPs promoted and awarded by the Government of India. This 3,960 MW • supercritical coal-fired power project is expected to be the largest pithead coal-fired power project at a single location in India and is scheduled to be commissioned in April 2016 as stated in the PPA. The company will endeavour to commission the project ahead of the specified schedule, as permitted under the PPA. Shahapur, a 4,000 MW coal-fired (1,200 MW) and combined cycle gas-fired (2,800 MW) project in • Shahapur, Maharashtra, which the company intends to develop in two phases: Shahapur Coal, a supercritical coal- fired project, is scheduled to be commissioned in December 2011, and Shahapur Gas, a combined cycle gas-fired project, is scheduled to be commissioned in March 2011. Urthing Sobla, a 400 MW, run-of-the-river hydroelectric project, will be located on the Daulinganga • River in Uttarakhand and is scheduled to be commissioned in March 2014.

Six other projects—the gas-fired Dadri (7,480 MW), the coal-fired MP Power (3,960 MW) and Krishnapatnam (4,000 MW) projects and three run-of-the-river hydroelectric projects, Siyom (1,000 MW), Tato II (700 MW) and Kalai II (1,200 MW)—are in various stages of development. Dadri, a 7,480 MW project to be located in Uttar Pradesh, is expected to be the largest gas-fired power project at a single location in the world. Krishnapatnam, a 4,000 MW coal-fired power project, will be located in Andhra Pradesh and is the most recently awarded UMPP. According to projections made in the National Electricity Plan, demand for power is expected to grow at an average annual rate of 9% during the 11th Plan period (2007-12) and at an average annual rate of 7% during the 12th Plan period (2012-17). In addition to the 28,200 MW of power projects that the company is currently developing, it intends to develop additional power projects to help meet this demand. The company is considering the development of coal-bed methane (“CBM”) power generation projects based on fuel from CBM blocks being explored by a consortium that includes its affiliates. It also intends to invest in overseas opportunities that are a strategic fit with it business. The company intends to explore the possibility of registering certain of its projects with the Clean Development Mechanism executive board for the issuance of carbon emission reduction certificates that it may sell. Reliance Power and the Reliance Anil Dhirubhai Ambani group It is a part of the Reliance ADA group, one of India's largest business houses by market capitalization (approximately Rs. 2,825 billion as of December 20, 2007 as per NSE website). The Reliance ADA group comprises companies in the telecommunications, financial services, media and entertainment, infrastructure, energy and other sectors. The Reliance ADA group includes RCOM, one of the largest wireless carriers in India in terms of coverage and capacity, RCL, one of the largest private sector financial services companies in India with over Rs. 777,650 million in assets under management as of November 30, 2007, and Adlabs Films Limited, one of the leading movie and entertainment companies in India. Its energy sector companies include REL, RNRL, Reliance Energy Transmission and Reliance Energy Trading. The Reliance ADA group intends Reliance Power to be its primary vehicle for investments in the power generation sector in the future. However, there is no non-compete agreement in place between REL and the company. The company had entered and intends to enter into various arrangements with companies of the Reliance ADA group, including REL, RNRL and Reliance Energy Transmission, so that it may draw upon the considerable expertise and resources these affiliates have in the Indian energy sector. It expects they will provide, among other services, EPC services, fuel sourcing and transmission services for certain of its projects. The company also expects to enter into off-take arrangements with certain of its affiliates, including REL and Reliance Energy Trading. REL is now one of the largest private sector power distributors and power generation companies in India. It has power generation projects in Andhra Pradesh, Karnataka, Maharashtra and Goa with a combined installed capacity of 941 MW. One of these projects, the 500 MW Dahanu project in Maharashtra, was the best performing Indian power project in terms of PLF for the fiscal year ending March 31, 2007 (Source: Operation Performance Monitoring Division Report, CEA). During the fiscal year ending March 31, 2007, REL distributed over 7.5 billion units of electricity to over 2.6 million
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customers in Maharashtra. REL is also one of the leading participants in the Engineering, EPC segment of the Indian power sector and had an order book of Rs. 55,247.5 million as of March 31, 2007. REL's EPC division has been associated with the development of 44 power sector projects in the last ten years. In the power generation sector, it has significant experience in EPC contracting (including turnkey EPC and Balance of Plant projects) and is associated with the development of 25 power generation projects of various sizes that have been completed or are in progress. REL is also involved in the transmission and trading of power through its affiliates, Reliance Energy Transmission and Reliance Energy Trading, respectively. Reliance Energy Trading traded over one billion units of power during the fiscal year ended March 31, 2007. RNRL recently commenced the business of sourcing, supply and transporting gas, coal and liquid fuels and has represented to the company that it has rights to 28 mmscmd of gas in the KG Basin plus additional option volume as described below under “Description of Projects Under Development—8. Dadri—7,480 MW Gas-Fired Power Project, Uttar Pradesh—Fuel Supply.” RNRL also leads a consortium (including REL) that owns the rights to four blocks over a 3,251 km2 area for the exploration and production of CBM, making it the second largest CBM exploration company in India in terms of acreage as of September 13, 2007. During the fiscal year ended March 31, 2007, RNRL supplied over 500,000 metric tonnes of imported coal to REL's Dahanu power station. Competitive Strengths of Reliance Power Limited It is well positioned to tap the growth opportunity in the Indian power sector and become one of the leading IPPs in India because it has:
• One of the Largest Portfolios of Power Generation Projects Under Development in India. The 13 projects that it is developing have a combined planned installed capacity of 28,200 MW and comprise one of the largest power generation portfolios under development in India. Its portfolio includes some of the most significant power projects in the industry. Sasan, a 3,960 MW coal-fired UMPP to be located in Madhya Pradesh, is expected to be the largest pithead coal-fired power project at a single location in India. Dadri, a 7,480 MW gas-fired project to be located in Uttar Pradesh, is expected to be the largest gas-fired power project at a single location in the world. Krishnapatnam, a 4,000 MW coal-fired project, is the third and most recently awarded UMPP. Given the size of the portfolio and these projects, it expects to benefit from economies of scale in its dealings, including in sourcing fuel and equipment supplies. A Diversified Portfolio of Power Projects. The company has planned projects that are diverse in • geographic location, fuel type, fuel source and off-take. The identified project sites are located in western India, northern India, north-eastern India and southern India. They include seven coal-fired projects (14,620 MW) employing supercritical (13,120 MW) and subcritical (1,500 MW) PCC technology, two gas-fired projects (10,280 MW) employing CCGT technology and four run-of the-river hydroelectric projects (3,300 MW). It plans to source coal from captive mines and supplies from India and abroad, and it plans to source gas from the KG Basin through RNRL and from other sources. Its hydroelectric projects will be run-of-the- river projects, three of them to be located in Arunachal Pradesh and one to be located in Uttarakhand. The company intends to maintain a judicious mix of off-take arrangements, including long-term PPAs to provide a level of committed revenues and short-term PPAs to maximize revenues. It plans to sell its power to state-owned and private distribution companies and industrial consumers. It also intends to invest in overseas opportunities that are a strategic fit with its business. Strategically Located Power Projects. It has located the majority of its projects in the northern, • western and north-eastern regions of India to cater to the significant unmet demand in the northern and western regions of India. According to the CEA, the peak deficit was 9,639 MW in western India and 2,813 MW in northern India for the period between April and September 2007. As the peak demand for the fiscal year ended March 31, 2007 was 104,867 MW and CEA expects it to grow to 152,746 MW and 218,209 MW by the fiscal years ending March 31, 2012 and March 31, 2017, respectively, the company believes that its projects are well positioned to serve expected demand. In addition, it has planned for each project to be situated either close to its fuel source or load center. For example, fuel for its 3,960 MW coal-fired power project in Sasan will be supplied by captive pithead coalmines, approximately 25 km from the project site. In the case of Rosa Phase I, the entire 600 MW of power will be sold to UPPCL and transmitted to a UPPCL substation approximately 20 km from the project site. Reliance ADA group's Experience and Position in the Indian Power Sector. REL and its affiliates • have expertise in the development and operation of power projects and the distribution, transmission and trading of power in India. RNRL is a company in the business of sourcing, supply and transportation of gas, coal and liquid fuels and has represented to the company that it has rights to significant stimated gas reserves in the KG Basin (28 mmscmd). The company expects to draw on the expertise of REL in providing EPC services and to benefit from the rights that RNRL has to these fuel reserves. It believes that their involvement in the development of its projects will help the company improve its project execution capabilities, achieve economies of scale and exploit new power generation opportunities. The company has entered into an MOU with REL under which it may approach REL to negotiate a contract for its EPC services on a project-by-project basis in the future. It

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has entered into MOUs with RNRL to negotiate a definitive GSTA to supply 28 mmscmd plus additional option volume as described below under “—Description of Project Under Development— Dadri—7,480 MW Gas-Fired Power Project, Uttar Pradesh—Fuel Supply” and to negotiate a definitive Coal Supply Agreement for the supply of imported coal. In addition, it has entered into an MOU with Reliance Energy Transmission under which it may approach Reliance Energy Transmission to negotiate a contract for transmission services on a project-by-project basis in the future. The company also expects to enter into off-take arrangements with REL and Reliance Energy Trading. For example, it has entered into an MOU with Reliance Energy Trading under which it has agreed to negotiate a PPA for the supply of 300 MW of power from Rosa Phase II for a price and on terms to be agreed. It also expects to enter into other arrangements with its affiliates for the provision of key power related management and support services. These MOUs are subject to the negotiation of binding definitive agreements between the company’s affiliates and the company. The Reliance ADA group Brand. The Reliance ADA group is a diversified business group with a • strong reputation in India and the Indian power sector > The Reliance ADA group includes five listed companies in India in the telecommunications, financial services, media and entertainment, energy, infrastructure and other industries. These companies had a combined market capitalization of Rs.2,825 billion as of December 20, 2007, over 7.03 million registered shareholders as of December 20, 2007, and more than 23,000 employees as of March 31, 2007. > Mr. Anil Dhirubhai Ambani heads the Reliance ADA group and its group companies REL, RNRL and Reliance Power. In 2006, Mr. Anil Dhirubhai Ambani was voted 'Businessman of the Year' in a poll conducted by The Times of India and in 2004 he was named 'CEO of the Year' in Platts Global Energy Awards. > REL has received a number of certifications and awards for performance, corporate governance, management training, quality control, environmental excellence and safety. For example, REL's Dahanu power project was ranked by Platts Power Magazine as one of the top twelve power projects in the world in 2004. The Dahanu project was also awarded the Srishti Good Green Governance (G- Cube) Award and the Silver Shield for Meritorious Performance by CEA for its excellent performance amongst the Indian thermal power plants in the year 2005-06.

Strategy of Reliance Power Limited The company will endeavour to become a world-class IPP by:
• Capitalizing on the Growth of the Indian Power Generation Sector. The power sector in India has historically been characterized by power shortages that have consistently increased over time. According to CEA, the total peak shortage was 13,897 MW as of March 31, 2007. In the 11th Plan (2007-2012), the Government of India recommended a capacity addition of 78,577 MW, assuming a 9.5% growth in the demand for power, and the 11th Plan Working Group recommended a capacity addition in the range of 82,200 MW to 94,300 MW for the 12th Plan (2012-2017), assuming a 9% GDP growth rate. It believes that its power projects will play a significant role in the growth of the Indian power sector and help achieve the Government of India's vision of “Power for All.” In addition to the 28,200 MW of power projects that the company is currently developing, it intends to develop or acquire additional power projects in the future. For example, it has submitted bids for four hydroelectric projects in the state of Himachal Pradesh. • Securing Fuel Supplies. Securing adequate supplies of fuel is critical to the success of a power project. It intends to secure fuel for its projects by seeking captive fuel sources, procuring long-term contracts with domestic and foreign suppliers and entering into supply arrangements with its affiliates, including RNRL. For example, it will source the coal needed for its 3,960 MW Sasan project from three captive mines in the Singrauli coalfields. It intends to seek supplies of coal for its supercritical coal-fired projects, Shahapur Coal (1,200 MW) and Krishnapatnam (4,000 MW), through RNRL or third parties. In addition, it is planning to seek supplies of natural gas from Reliance Natural Resources for its gasfired projects at Shahapur (2,800 MW) and Dadri (7,480 MW), primarily from its rights to KG Basin gas reserves. It is also considering opportunities for securing fuel for other power generation projects with the supplies expected to be available from CBM exploration activities led by RNRL. • Realizing the Opportunities Presented by Power Sector Reforms. In 1991, the Indian power sector began a process of deregulation that is continuing today. The Electricity Act of 2003 and subsequent reforms have generated significant opportunities in the power sector. These changes include the following: > Power generation has been made a non-licensed activity and techno-economic clearance from CEA has been waived for thermal power projects, which expedites the thermal power project development process. > Distribution licensees can now procure power through a process of international competitive bidding; projects are no longer awarded on a cost-plus basis. It believes that competitive bidding presents attractive opportunities for efficient power generation companies. > Power generation companies can now sell power to any distribution licensees, or where allowed by the state regulatory commissions, directly to consumers, which expands the market. > The market has evolved for short-term PPAs, which allows for the supply of peak power at

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premium rates. > Power generation companies have open access to transmission lines, which will facilitate the direct sale of power to distribution and trading licensees. > The Government of India is promoting the development of large power projects, including UMPPs. Certain UMPPs allow it to obtain rights to large captive fuel supplies such as the mines for pithead coal based UMPPs. UMPP project companies are transferred to the successful bidder with certain key approvals in place which helps expedite the implementation process. > Improved payment security mechanisms, which the company believe will improve sector stability and enhance its ability to obtain financing for its projects. Future power sector reforms may present additional opportunities for the company and it intends to capitalize upon these opportunities as they arise. Optimizing Operational Efficiency. Achieving optimal project operating efficiency is the key to • maximizing profitability in its business. The company plans to invest in supercritical technology (beginning with its Sasan UMPP) to reduce the amount of required coal supplies for its coal-fired projects and combined cycle gas turbine (“CCGT”) technology to increase output for its gas-fired projects. It expects its relationship with REL will permit the company to operate efficiently at its projects. It intends to adopt those procedures and practices currently employed at REL's Dahanu project at its own projects. Focusing on Best Practices. It plans to incorporate the best practices of the Reliance ADA group • with respect to performance, corporate governance, management and employee training, quality control, environmental excellence and safety. Its vision is to generate clean, green, environment friendly and affordable power -for a better tomorrow.

CAPITAL STRUCTURE The company’s share capital as of the date of this Prospectus is set forth below: (Rs. in million, except share data) Aggregate Nominal Aggregate Value at Value Issue Price A) AUTHORISED SHARE CAPITAL 11,000,000,000 Equity Shares of Rs. 10 each 5,000,000,000 Preference Shares of Rs. 10 each Total ISSUED, SUBSCRIBED AND PAID UP SHARE CAPITAL BEFORE THE ISSUE 2,000,000,000 Equity Shares of Rs. 10 each PRESENT ISSUE IN TERMS OF THIS PROSPECTUS Issue of 260,000,000 Equity Shares of Rs. 10 each Of which: PROMOTER'S CONTRIBUTION Issue of 32,000,000 Equity Shares of Rs. 10 each as Promoter's Contribution in the Issue Therefore: NET ISSUE TO THE PUBLIC Issue of 228,000,000 Equity Shares of Rs. 10 each 110,000.0 50,000.0 160,000.0

B)

20,000.0

C)

2,600.0

115,632.0#

i)

320.0

14,400.0

ii)

2,280.0

101,232.0#

EQUITY CAPITAL AFTER THE ISSUE 2,260,000,000 Equity Shares of Rs. 10 each 22,600.0 E) SHARE PREMIUM ACCOUNT Before the Issue After the Issue # (net of Retail Discount) Payment Methods The Payment Methods available to investors to apply in this Net Issue are as follows: 1)

D)

1,015,632.0# 113,032.0#

Payment Method - 1 a. Only Retail Individual Bidders and Non-Institutional Bidders are eligible for this method. QIBs cannot submit a Bid under this Payment Method.

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b. While bidding, the Bidder shall make a payment of Rs. 115.0 per Equity Share, irrespective of the Bid Price. Investors should note that the total Bid Amount will be used to determine whether a Bid is in the Retail Individual category, Non-Institutional category or not, and not the amount payable on submission of Bid-Cum-Application Form. c. Under Payment Method-1, of the Rs. 115.0 paid while bidding, Rs. 2.5 would be adjusted towards face value of the Equity Shares and Rs. 112.5 shall be towards share premium of the Equity Shares applied for. d. At the time of allotment: 1. If the amount paid by the Bidder is equal to or higher than the total amount payable (being the Issue Price multiplied by the number of shares allotted, net of Retail Discount) by the Bidder on the Equity Shares allotted to the Bidder, company reserve the right to adjust the excess amount towards the Balance Amount Payable and issue fully paid Equity Shares only. The excess amount, if any, after adjusting the Balance Amount Payable shall be refunded to the Bidder (i.e., Refund = Total amount paid on bidding minus the total amount payable on the shares allotted). 2. If the amount paid by the Bidder is less than the total amount payable by the Bidder (being the Issue Price multiplied by the number of shares allotted, net of Retail Discount) on the Equity Shares allotted to the Bidder, company reserve the right to adjust the excess of the amount received from the Bidder over the Amount Payable on Submission of Bid-cum-Application Form towards the Balance Amount Payable and issue a Call Notice for the balance. 3. The notice of the Balance Amount Payable will also be published in two widely circulated newspapers (one each in English and Hindi) and a regional newspaper along with the statutory advertisement for the Basis for Allotment. Equity Shares in respect of which the Balance Amount Payable remains unpaid may be forfeited, at any time after the Due Date for Balance Amount Payable. 2) Payment Method - 2 a) Bidders under any category can choose this method. b) While bidding, the Bidder shall have to make the full payment (Bid Amount multiplied by number of Equity Shares bid, net of Retail Discount) for the equity shares bid. Bidders in QIB category will be required to make payment of 10% of the Bid Amount multiplied by the number of Equity Shares bid, with the balance being payable on allocation but before allotment. The Issue received 48,02,930 applications for 1599,71,29,272 equity shares resulting in 61.52 times subscription. The details of the applications received in the Issue from Qualified Institutional Buyers, Non-Institutional and Retail Individual Investor categories are as under: (Before technical rejections) No. of Category No. of Shares Subscription Applications Qualified Institutional Buyers 446 11299720185 82.60 Non Institutional Investors 21592 3706983112 162.59 Retail Individual Investors 4780891 958425975 14.01 Final Demand A sample of the final demand at different bid prices is as under Bid Price Rs.405 Rs.430 Rs.450 & Cut Off Price No. of Shares 6763590 9282000 16629590805 16645636395 % to Total Cumulative Total 0.04 16645636395 0.06 16638872805 99.90 16629590805 100.00 Cumulative % to total 100.00 99.96 99.90

The Basis of Allocation was finalized in consultation with the Bombay Stock Exchange Limited (“BSE”) on February 1st, 2008. Allocation to Retail Individual Investors (After Technical Rejections) The Basis of Allocation to the Retail Individual Investors, who have bid at cut-off or at the Issue Price of Rs.450 per Equity Share, was finalized in consultation with BSE. The category was over subscribed 13.572340 times. The total number of shares allotted in this category is 6,84,00,000 Equity Shares. The category-wise details of the applications are as under:

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Category 15 30 45 60 75 90 105 120 135 150 165 180 195 210 225

No. of Applns. 60176 82844 67812 112793 40359 70934 151763 66497 19057 57122 14203 30708 19752 172499 3656564

END OF SECTION D

Section E : Caselets (50 Marks)
This section consists of questions with serial number 6 - 11. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1
Read the caselet carefully and answer the following questions: 6. As mentioned in the caselet, it is observed that QIP route has become more viable for the small and mid-cap companies who do not have brand name in the market. In this context, analyse how QIP route can substitute the other routes such as GDRs/ADRs and FPOs. According to caselet, several reputed companies with good corporate governance practices have failed to achieve their funding objectives via the QIP route because of the floor price. In this context, analyse how the floor price becomes the issue of concern for the entities opting for the QIP route especially in bearish market conditions. The Securities and Exchange Board of India (SEBI) on 8 May, 2006 allowed listed companies to raise funds from the domestic markets by making private placement of Securities with Qualified Institutional Buyers (QIBs) with no pre-issue filings with the regulator. The process will be called Qualified Institutional Placement (QIP). The securities which can be issued through QIP are equity shares or any securities other than warrants, which are convertible into or exchangeable with equity shares. SEBI, in its release introducing the QIPs, has stated that it wanted Indian companies to use the QIP route to raise capital rather than raising funds through the American Depository Receipt (“ADR”) or the Global Depository Receipt (“GDR”) or the Foreign Currency Convertible Bond (“FCCB”) routes. In the current market scenario, so many Indian companies are raising funds through the issuances of ADRs, GDRs or FCCBs. As per the guidelines of regulatory authority, a minimum of 10% of the securities in each placement shall be allotted to Mutual Funds. For each placement, there shall be at least two allottees for an issue of size up to Rs.250 crores and at least five allottees for an issue size in excess of Rs.250 crores. Further, no single allottee shall be allotted in excess of 50 per cent of the issue size. Total amount raised through this route should be within five times the net worth of the issuing company as at the end of the previous financial year. There is no lock in period for the investors. Pursuant to the QIP Scheme, the Securities may be issued by the issuer at a price that shall be no lower than the higher of the average of the weekly high and low of the closing prices of the related
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shares quoted on the stock exchange (i) during the preceding six months; or (ii) the preceding two weeks. These guidelines are intended to make Indian Market more competitive and efficient. But now since the market has been in a bearish mode for the past few weeks, several reputed Companies with good corporate governance practices have failed to achieve their funding objectives via the QIP route because of the floor price. While the Markets were bullish, few complained, but when markets fall, this problem has come into focus. As there is major change in fund rising plans of companies with various avenues opening in last couple of years, among them QIPs is turning out to be major attraction especially for the small and mid-cap companies who do not have brand name in the market. Delhi based Spentex Industries was the first company to raise fund through QIP of Rs.46.59 crore. As per the data compiled by SEBI, 21 National Stock Exchange (NSE)-listed companies had cumulatively raised Rs 4,530 crore through QIPs in 2006-07. In 2005-06, Indian companies mobilised $3.6 billion through ADRs/GDRs. However, the next year saw the resource mobilisation level through the route coming down to $896 million. Fuelled by mega-QIP (Qualified Institutional Placement) issues such as GMR Infrastructure and Suzlon Energy, India Inc. are estimated to have raised over Rs. 21,700 crore through QIPs in 2007. During the year in reference, Indian companies through 36 QIPs, raised about Rs.21,700.34 crore. Recently some of the banks also opted for the QIP route due to cost consideration. Bank of India has the first public sector bank, which has successfully raised Rs 1,360 crore through QIP issue. Syndicate bank also has decided to raise its additional capital through QIP route rather than going for the FPO which was planned early this year. END OF CASELET 1

Caselet 2
Read the caselet carefully and answer the following questions: 8.

<Answer> As per the caselet, it is observed that sub prime lending in US market led to Subprime Crisis which caused significant losses to various people ranging from the mortgage lender to the investor in mortgage backed securities. In light of this, explain what subprime lending is and also describe how it led to Subprime Crisis. ( 10 marks) <Answer> According to the caselet, the various risks arising from the securitization of subprime lending caused several major corporations and hedge funds to shut down or file for bankruptcy. With respect to this, elucidate the various types of risks arising from the securitization of subprime lending. ( 8 marks)
The crisis began with the bursting of the housing bubble in the U.S. and high default rates on “subprime”, adjustable rate, “Alt-A”, and other mortgage loans made to higher-risk borrowers with lower income or lesser credit history than “prime” borrowers. The share of subprime mortgages to total originations increased from 9% in 1996, to 20% in 2006 and decline in subprime markup from 2.8% in 2001 to 1.3% in 2007. Further, loan incentives including “interest only” repayment terms and low initial teaser rates (which later reset to higher, floating rates) encouraged borrowers to assume mortgages believing they would be able to refinance at more favorable terms later. While U.S. housing prices continued to increase during the 1996-2006 period, refinancing was available. However, once housing prices started to drop moderately in 2006-2007, in many parts of the U.S., refinancing became more difficult. Defaults and foreclosure activity increased dramatically. By October 2007, 16% of subprime loans with adjustable rate mortgages (ARM) were 90 days delinquent or in foreclosure proceedings, roughly triple the rate of 2005. By January of 2008, this number increased to 21%. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up by 79% from that of 2006. As of December 22, 2007, a leading business periodical estimated subprime defaults would reach a level between U.S. $200-300 billion. The mortgage lenders that retained credit risk (the risk of payment default) were the first to be affected, as borrowers became unable or unwilling to make payments. Major banks and other financial institutions have reported losses of approximately U.S. $130 billion as of January 25, 2008. Due to a form of financial engineering called securitization, many mortgage lenders had passed the rights to the mortgage payments and related credit/default risk to third-party investors via mortgagebacked securities (MBS). Individual and institutional investors holding MBS faced significant losses, as the value of the underlying mortgage assets and payment streams declined and became difficult to predict. In addition, certain legal entities designed to isolate this risk from the originating lenders, called collateralized debt obligations (CDO) and structured investment vehicles (SIV), held substantial amounts of MBS. As the value of payments into these entities declined, their value also declined, forcing the sale of MBS at fire-sale prices in some instances. The widespread dispersion of credit risk and the unclear impact on large banks, MBS, CDO, and SIV caused banks to reduce their loans to each other or make them at higher interest rates. Similarly, the ability of corporations to obtain funds through the issuance of commercial paper was impacted. This

9.

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aspect of the crisis is consistent with a credit crunch. The liquidity concerns drove central banks around the world to take action to provide funds to member banks to encourage the lending of funds to worthy borrowers and to re-invigorate the commercial paper markets. The combination of impacts due to credit risk and liquidity risk caused several major corporations and hedge funds to shut down or file for bankruptcy. Stock market declines among both depository and non-depository financial corporations were dramatic. Many hedge funds and other institutional investors holding MBS also incurred significant losses. END OF CASELET 2

Caselet 3
Read the caselet carefully and answer the following questions:

<Answer> 10. As mentioned in the caselet, with the advent of retail-cum-financial marts, customers will have access to different consumer products as well as finance at the outlet itself. In light of this, explain retailcum-financial mart and also analyse its future potential in India. ( 8 marks) <Answer> 11. Despite the fact that, easy availability of credit to the consumers will further boost the top-line of the players of this new business model, there are certain issues and challenges to be addressed by them. Explain. ( 8 marks) Liberalization has transformed India into a consumption-led economy. One of the major reasons for this transformation is the easier availability of credit. Private banks set up in the post-liberalization era have been able to attract and sell new financial products like credit cards, various consumer loans, personal loans and mutual funds. Prospective customers are approached by banks themselves offering various loans and financial products. They are offered loans on phone and are not required to submit various documents that were previously demanded by public sector banks. They are not required to wait for months to get approval for a personal loan. Apart from this, the advent of BPOs has created numerous employment opportunities, thus increasing disposable income levels. All this has transformed the conservative Indian customer. The products that were once considered comforts have become necessities and those that were once considered luxurious have become comforts. Indian customers are now more prone to spending as they have wider choice of products and services. Also, they are now not averse to trying new products and services. Taking advantage of this new mindset of Indian customer, certain retailers have come up with the retail-cum-financial mart or the money bazaars concept. With the advent of retail-cumfinancial marts, customers will have access to different consumer products as well as finance at the outlet itself. The initiative has been taken by the Future Group through its financial services division, Future Capital under the banner Future Money. The first Future Money outlet has been set up at Noida. Many more such outlets are being planned. The Future Group is well-known for its Pantaloon retail outlets like Big Bazaar and Central. These outlets have been a huge success. The retail-cum-financial marts or financial supermarkets have worked successfully in the US and the UK. The possibilities are immense as more and more business houses are entering retail trade like Reliance, Aditya Birla group, Tatas, ITC and Bharti. These players are capable of making large investments. Aditya Birla has announced a $2 bn investment plan for a nationwide retail chain. On the positive front, it will revolutionize consumer finance in India and the Indian customer will have more access to credit along with wider choice. It will encourage impulsive buying and free retailers from paying service charges to banks for swiping credit cards as they will issue their own credit cards. It will also encourage banks to promote doorstep banking. The RBI has recently given clearance to doorstep banking. Easy availability of credit will further boost consumerism and create more job opportunities and more disposable income. All these factors will affect the growth of the economy in a positive way. But, on the other hand, the economy will face new challenges. In their urge to become a one-stop destination for financial products as well as stock they may be in danger of losing focus on their core business as it happened in the case of Sears, the US retailer. Excess availability of credit may lead to rise in inflation, as demand may be more than supply. The RBI is already striving hard to keep inflation under check. Secondly, it may negatively affect the banks as the retailers may provide funds at cheaper cost to customers. Further, banks require licenses to set up new branches from the RBI while NBFCs have no such restrictions. From a non-monetary viewpoint, these companies may resort to telemarketing that may further irritate customers who are already bombarded with promotional calls and offers by banks. Initially, only a few players may enter the fray. But gradually, the competition will pick up. Apart from major business houses and MNCs, local and medium-sized retailers will enter the scene. These players are well aware of the purchasing patterns and preferences of the customers in a particular area or locality. To counter this, the big players may acquire popular small-or medium-sized outlets. Further, banks may also come forward to tie up with retail-cum-financial marts to offer co-branded

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financial products, as practiced by certain banks currently. Indian customer is no longer the king, he has become the emperor. The Indian customer will expect the best service and that too at a cheaper cost. He will bargain hard as he will have a wide range of choices. He is no longer patient with delays and will demand prompt service. Companies will have to constantly innovate and come up with new offers and schemes. Companies can keep a track of the changing customer needs by identifying their purchase pattern. One of the significant aspects will be educating the customer about the various financial products on offer and the utility of the same for various purposes. This will be crucial as there will be immense competition and players who are able to provide proper guidance to customer will be able to retain them longer. END OF CASELET 3 END OF SECTION E END OF QUESTION PAPER

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Investment Banking and Financial Services-II (MSF2K2): April 2008
Section D : Case Study
1.Reliance power was the largest IPO in the history of the Indian capital market, and heavily subscribed and gathered a record number of applications. It is further evident from the fact that all the major indices were down over 2%, as if every investor was liquidating a part of his profitable trades to deploy the proceeds in the Reliance Power issue. Investors expected handsome return on their investment with the general optimism that share would list at a heavy premium to the issue price but the story changed dramatically after that Global markets went into a nosedive on fears of a recession in the US. Even continuous interest rate cuts by the US Federal Reserve could not hold the market sentiments. Indian stocks too, got a hammering the Sensex has lost 18 per cent in 2008. Reasons for the panic situation can be: • • It is due to uncertainties with regard to the long gestation period of the power project. Downgrading the rating of Reliance Energy by Morgan Stanley due to over valuation of Reliance power.
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Reliance power shares are valued at 81 times its estimated earning per share for 2011-12, which may be considered • as expensive. • IPO pricing was more aggressive, when compared with existing segment leaders like NTPC and Tata power. Some of the investors who have borrowed money from the market to investing this IPO wants to get out of the • market due to overall downtrend in the market due to global cues. 2. Category (a) No. of Applns. (b) Total No. of Shares applied (c) = a*b Total no. of shares Alloted through oversubscrip- tion rate (d) = 66505.85 No. of shares allotted (f) No.of successful applicants (g) = d/f Total allocated shares (h)=f*g
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(e) =

15

60176

902640

1.1

15

4434

66510

30

82844

2485320

183116.5

2.2

15

12208

183120

45

67812

3051540

224835.2

3.3

15

14989

224835

60

112793

6767580

498630.3

4.4

15

33242

498630

75

40359

3026925

223021.6

5.5

15

14868

223020

90

70934

6384060

470372.8

6.6

15

31358

470370

105

151763

15935115

1174088

7.7

15

78273

1174095

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120

66497

7979640

587934

8.8

15

39197

587955

135

19057

2572695

189554.3

10.0

15

12637

189555

150

57122

8568300

631306

11.1

15

42087

631305

165

14203

2343495

172667

12.2

15

11511

172665

180

30708

5527440

407257.7

13.3

15

27151

407265

195

19752

3851640

283786

14.4

15

18919

283785

210

172499

36224790

2669016

15.5

16

166814

2669000

225 Total

3656564

822726900 928348080

60617911

16.6

17

3565759 4073447

60617890 68400000
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3.If the IPO is overpriced it creates a bad feeling in investor’s mind as initial returns to them may be negative at that point of time. On the other side, if the prices in the open market fall below the issue price, small investors may start selling their securities to minimize losses. Therefore, there was a vital need of a market stabilizer to smoothen the swings in the open market price of a newly listed share, after an initial public offering. Market stabilization is the mechanism by which stabilizing agent acts on behalf of the issuer company, buys a newly issued security for the limited purpose of preventing a declining in the new security’s open market price in order to facilitate its distribution to the public. It can prevent the IPO from huge price fluctuations and save investors from potential loss. Such mechanism is known as Green Shoe Option (GSO) which is an internationally recognized option for market stabilization. So, GSO can rectify the demand and supply imbalances and can stabilize the price of the stock. In case an initial public offer of equity shares is made by an issuer company through the book building mechanism, the Green Shoe option (GSO) can be used by such company for stabilizing the post listing price of its shares, subject to the guidelines prescribed by SEBI. The company shall appoint one of the lead book runners, amongst the issue management team, as the “stabilizing agent” (SA), who will be responsible for the price stabilization process, if required. The SA shall enter into an agreement with the issuer company, prior to filing of offer document with SEBI, for this purpose. The SA shall also enter into an agreement with the promoter(s) who will lend their shares, specifying the maximum number of shares that may be borrowed from the promoters, which shall not be in excess of 15% of the total issue size. 4.“Offer document” means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue which is filed with Registrar of Companies (ROC) and Stock Exchanges. An offer document covers all the relevant information to help an investor make his/her investment decision. “Draft Offer document” means the offer document in draft stage. The draft offer documents are filed with SEBI, at least 21 days prior to the filing of the Offer Document with ROC/ SEs. SEBI may specify changes, if any, in the draft Offer Document and the issuer or the Lead Merchant banker shall carry out such changes in the draft offer document before filing the Offer Document with ROC/ SEs. The Draft Offer document is available on the SEBI website for public comments for a period of 21 days from the filing of the Draft Offer Document with SEBI. “Red Herring Prospectus” is a prospectus which does not have details of either price or number of shares being offered or the amount of issue. This means that in case price is not disclosed, the number of shares and the upper and lower price bands are disclosed. On the other hand, an issuer can state the issue size and the number of shares are determined later. An RHP for and FPO can be filed with the ROC without the price band and the issuer, in such a case will notify the floor price or a price band by way of an advertisement one day prior to the opening of the issue. In the case of book-built issues, it is a process of price discovery and the price cannot be determined until the bidding process is completed. Hence, such details are not shown in the Red Herring prospectus filed with ROC in terms of the provisions of the Companies Act. Only on completion of the bidding process, the details of the final price are included in the offer document. The offer document filed thereafter with ROC is called a prospectus. “Abridged Prospectus” means the memorandum as prescribed in Form 2A under sub-section (3) of section 56 of the Companies Act, 1956. It contains all the salient features of a prospectus. It accompanies the application form of public issues.

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5.

a. Fixed price method is the traditional method of doing IPOs. Here, the issuer and the merchant banker agree on an "issue price". In fixed price offering the price at which the securities are offered/allotted is known in advance to the investor but demand for the securities offered is known only after the closure of the issue. Investor can file an application form at this price and subscribed to the issue. Book building is a process introduced in India in 1999, which enables the company to discover the price and demand of its securities. The Issuer, who is planning an IPO, nominates a lead merchant banker as a 'book runner'. The issuer company then decides the number of securities to be issued and the price band is fixed and is mentioned in the redherring prospectus. There is an electronic book which remains open for a minimum of 5 days. During these days bidding takes place, i.e. interested persons make an offer at a price within the price band. The Book Runner and the issuer, after the book building is closed, evaluate the offers and then fix a particular price. The offers below the fixed price are not accepted. Allocation of securities is made to the successful bidders. An IPO may be through a 100% book building process or a 75% book building process. In the latter, the remaining issue is made through a fixed price method. In this method, the issuer company mentions the fixed issue price of its shares in the prospectus. Here, no bidding takes place. In an open auction method, the auctioneer sells the shares of the company to the interested investors by calling out a high price. He then lowers the price till an investor/s agrees to buy shares at that price. He further lowers the price till more investors agree to buy shares and in this manner he keeps lowering the price till all the shares are claimed for. Now, the investors will get the number of shares they have bid for but at a price the last investor has bid, i.e. the lowest price. In case of oversubscription, allocation is done on a pro-rata basis. This method allows the market to determine the price and not the issuer company. b. Comparing the fixed price method to the open auction method, it can be said that the fixed price method is more expensive and also leads to short term gains to the investors but not long term. This is so because the company will hire an agent to estimate how much investors will pay for the shares. Then the company agrees to sell its shares at a fixed price which is below this estimate. Generally, the first in line to buy IPO shares can gain profit by immediately selling it for a higher price in the market in the coming few days. While open auction ensures future gains too. The drawback of the Book Building Process is that it does not leave it to the market to determine the real price, the investors only have an illusion that they have discovered the price whereas in reality it is the merchant banker who has fixed the price band. As opposed to this, in a Dutch auction method there is no constraint of a book building range. It is entirely on the potential investor to indicate the price of the shares and the quantity he is willing to subscribe for. The open auction method increases the ability of small investors to participate in the IPO process though it might be difficult for them to price the shares due to lack of information. This information gap could arise since the small investors lack access to the sources that institutional investors have and also because the issuer companies are not required to provide detailed information in this process. An open auction leads to a higher risk since neither the issuer company nor the potential investor knows exactly how many investors will participate and what price the auction will lead to. There can be a negative effect in case of both the extremes, i.e. if there are too few bidders then the entire auction will lose its meaning and too many bidders may erode the potential profits. However, the major question for SEBI to answer is whether the Indian investor is matured enough to know what is the best price for him? A good solution for that would be to leave it on each company to decide which method to adopt. The company depending on its area of business, its current net worth, and its current investors can decide whether it wants to rely on the merchant banker or its investors.

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Section E: Caselets Caselet 1
6.QIP route has become more viable for the small and mid-cap companies who does not have brand name in the < TOP> market. In case of ADRs and GDRs, companies are required to have consistent track record of good performance (financial or otherwise) for a period of at least 3 years, fulfillment of US GAAP, discloser norm etc,; QIPs are also the most cost-efficient route to raise money. QIPs could replace GDRs/ADRs offerings because in case of GDRs/ADRs issue costs are higher for, mainly due to legal cost with international counsel and depository fees. Further, in case of overseas issues, corporates have to satisfy the rules and requirements of overseas stock exchanges on which proposed issue will be listed. The main reason issuer preferred overseas markets earlier was the tedious and time consuming process involved with secondary issues in India. Further Public Offering (FPOs) and rights issue can take as much as four months because almost all the procedure including documentation and regulatory approvals are similar to an initial public offering (IPOs). But QIPs take about 4-6 weeks less than a GDR and ADR, on account of the time saved at the regulatory end. Even there is no pre-issue filling of the placement document with SEBI. Because of these, QIPs are considered much faster and simpler way to raise funds in domestic market. QIPs also gives the better price discovery than FPOs and right issue because in case of FPOs and right issue to attract retail investors issue would have to be at a discount to the prevailing market price, or else retail investors
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wouldn’t participate in the issue; they would rather buy from the market. 7.Recently, several reputed Companies with good corporate governance practices have failed to achieve their funding objectives via the QIP route because of the floor price. While the Markets were bullish, few complained, but now when markets fall, this problem has come into focus. Whenever the market has been in a bearish mode, the floor price stipulation (being the higher of the six-month weekly average or 15-day weekly average of the quoted prices) in the QIP guidelines have begun to adversely affect the issues. The floor prices based on the SEBI formula are now higher than their current market prices. The floor price is again applicable from the date of the enabling resolution by the board. Recently, prospective issuers are finding their floor prices higher than their current prices. While SEBI doesn’t allow the QIP issuer the flexibility to revise the price downwards, investors wouldn’t be willing to come in at a price higher than the prevailing market price.
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Caselet 2
8.Subprime lending is a general term that refers to the practice of making loans to borrowers who do not qualify for market interest rates because of problems with their credit history or the inability to prove that they have enough income to support the monthly payment on the loan for which they are applying. The word Subprime refers to the credit-worthiness of the borrower (being less than ideal) and does not refer to the interest rate of the loan. The subprime mortgage financial crisis refers to the sharp rise in foreclosures in the subprime mortgage market that started in the US in 2006 and became a global financial crisis in July 2007. The subprime lending storm did not break out overnight. The clouds had been gathering strength for the past few years. And to understand this sub prime crisis let take one example, an American who seeks a home loan, but does not have a very good credit rating. That essentially means that banks may not extend him a home loan. Enter, another American with stellar credit rating and the willingness to take on some risk. This individual the divides the loan into small lots and gives them out as home loans to lots of Americans, who do not have very good credit rating and cannot get a home loan from any bank. He gives out the home loan at a rate of interest higher than it is paying to the bank it borrowed money from. This higher rate is referred to as the subprime rate and this home loan market is referred to as the subprime home loan market. But the individual giving out loans in the subprime market does not stop here. He goes ahead and securitizes these loans. Securitization involves converting these home loans into financial securities, which promise to pay a certain rate of interest. These financial securities are then sold to big institutional investors. The interest and the principal that is repaid by the subprime borrowers through equated monthly installments is passed onto these institutional investors. The individual giving out the subprime loans, takes the money that he gets from selling the financial securities and passes it on to the bank, he had taken the loan from, thereby repaying the loan. A neat plan. But then things went horribly wrong. The subprime home loans were given out as floating rate home loans. So as interest rates increased, the rates on floating home loans too went up, and so did the monthly installments needed to service these loans. These high installments hit the subprime borrowers with the terrible force. Many, given their poor credit rating to begin with, defaulted. Once, more and more subprime borrowers started defaulting, payments to the institutional investors who had bought the financial securities stopped, leading to huge losses. 9.The reasons for this crisis are varied and complex. Understanding and managing the ripple effect through the world-wide economy poses a critical challenge for governments, businesses, and investors. Due to innovations in securitization, the risks related to the inability of homeowners to meet mortgage payments have been distributed broadly, with a series of consequential impacts. The crisis can be attributed to a number of factors, such as the inability of homeowners to make their mortgage payments; poor judgment by either the borrower or the lender; inappropriate mortgage incentives, and rising adjustable mortgage rates. Further, declining home prices have made re-financing more difficult. There are three primary risk categories involved: Credit risk: Traditionally, the risk of default (called credit risk) would be assumed by the bank • originating the loan. However, due to innovations in securitization, credit risk is now shared more broadly with investors, because the rights to these mortgage payments have been repackaged into a variety of complex investment vehicles, generally categorized as mortgage-backed securities (MBS) or collateralized debt obligations (CDO). Asset price risk: CDO valuation is complex and related "fair value" accounting for such assets is subject • to wide interpretation. This valuation fundamentally derives from the collectibility of subprime mortgage payments, which is difficult to predict due to lack of precedent and rising delinquency rates. Banks and institutional investors have recognized substantial losses as they revalue their CDO assets downward. Most CDOs require that a number of tests be satisfied on a periodic basis, such as tests of interest cash flows, collateral ratings, or market values. For deals with market value tests, if the valuation falls below certain levels, the CDO may be required by its terms to sell collateral in a short period of time. Liquidity risk: A related risk involves the commercial paper market, a key source of funds (i.e., • liquidity) for many companies. Companies and SPE called structured investment vehicles (SIV) often obtain short-term loans by issuing commercial paper, pledging mortgage assets or CDO as collateral. Investors provide cash in exchange for the commercial paper, receiving money-market interest rates. However, because of concerns regarding the value of the mortgage asset collateral linked to subprime and Alt-A loans,
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the ability of many companies to issue such paper has been significantly affected.

Caselet 3
10.A retail-cum-financial mart is one-stop destination for a wide range of financial services at the place of purchase or store. The customer can simultaneously purchase goods at the outlet as well as procure finance for the same. These financial bazaars offer a wide range of financial products like credit cards, consumer loans, home loans and insurance. As of now, customers depend on banks and finance companies for financing their purchases. With the advent of retail-cum-financial marts, customers will have access to different consumer products as well as finance at the outlet itself. In other words, big retail outlets like supermarkets will come up with a separate division at their outlets which will issue various financial products and their own credit cards which can be used at different outlets. The financial products may be offered through a separate financial services firm of the retail group or by tying up with an existing financial services firm. Potential of retail-cum-financial mart in India: India is currently witnessing an enormous growth of consumerism. It only promises to increase as the income levels of a large chunk of population have increased. The young generation has more disposable income. Hence, there will be a huge scope for innovations like retail-cum-financial marts. Customers will welcome any change that increases their convenience and facilitates easy availability of credit. As already said, the mindset of Indian customer has undergone tremendous change. A few years back, there were no takers for credit cards. Now, we find many customers holding credit cards of numerous banks. Further, this change is witnessed across all income groups. It would be fascinating for customers to have access to purchase and finance goods under one roof. One need not approach a bank to finance one's purchase. The possibilities are immense as more and more business houses are entering retail trade like Reliance, Aditya Birla group, Tatas, ITC and Bharti. These players are capable of making large investments. Many more multinational companies are waiting to enter the Indian market. They have entered into agreements with Indian firms and are meanwhile studying the Indian market as well as the behavior of the Indian customer. Entry of more foreign players will further intensify the retail boom in India. In order to retain and attract more customers, these companies may also offer various types of consumer loans and financial products by forming Non-banking Financial Companies (NBFCs). Thus, the field is wide open for retail-cum-financial marts. Furthermore, sooner or later the government may allow foreign direct investment in retail sector. 11. • Initially, the retail-cum-financial marts may find it difficult to manage the credit. The recovery of loans will be a major challenge. The proper allocation of funds to different financial products depending upon their popularity should be the strategy. Bad debts can be limited if the customers are offered proper financial advisory services and informed about different financial products on offer. These players have to decide a fee structure which on the one hand will cover the costs and on the other • hand ensure liquidity while allowing them to be competitive. The choice of location along with cost of infrastructure will also assume significance with the rise in • competition. But again the choice will be limited as all business houses will target areas with people having more disposable incomes. Therefore, the challenge will be to retain customer loyalty. Product differentiation will hold the key. The companies will have to come up with different or customized products depending upon the needs of the people in areas where they operate. Although the financial products on offer may remain the same, the offers on these products can be customized to suit the local requirements. Privacy of customer information as provided by customers in their application for loans and other • financial products has to be maintained, unless and until it is required by law to be disclosed. Failure to maintain privacy may lead to litigation and tarnish the image of the company involved, which may also affect the company's core business negatively.
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Question paper Investment Banking and Financial Services - II (MSF2K2): July 2008 Section D : Case Study (50 Marks)
• • • • This section consists of questions with serial number 1 - 4. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.

Case Study*
<Answer>

1.

CRISIL’s IPO Grading is based on the assessment of a company’s fundamentals by mainly taking into account five parameters i.e., Business Prospects, Project Related Risk, Financial Performance, Management Quality and Corporate Governance. You are required to grade the IPO of KNR Construction Limited based on the detail evaluation of each of the factors listed above and also justify your grading. ( 20 marks)
<Answer>

2.

Mr.Bimal, a CFA working in KK Consultancy, an Investment Advisory Consultancy firm, is involved in the job of advising his clients in their investment decisions and hence he decided to judge the issue price of stock of KNR Construction Limited. To conduct the valuation of stock of KNR Construction Limited, he proposed to use Price/ Earning Multiple approach and also decided to apply average P/E multiple of industry peers and EPS of the company for the year 2008-09. He forecasted that the company can maintain its performance in generating restated profits in the second half of financial year 2007-08 as it did during the first half of the year. He also estimated that the growth rate in the earnings of the company on the existing capital depends on the retention policy of the company during the year 2006-07, as the company is expected to maintain the same retention policy even in future. Furthermore, he also forecasted that the funds realized from the proposed IPO will be operative since April 2008 and will generate return of 15% during the year 2008-09. Based on the above information, compute the value of the share and also observe whether issue is over priced or under priced. ( 10 marks)
<Answer>

3.

The allotment price of Rs.170 has been determined by the company in consultation with the BRLMs on the basis of assessment of market demand for the offered Equity Shares by the Book Building Process. Delineate and justify the basis for issue price furnished in the final offer document based on Qualitative and Quantitative factors. ( 10 marks)

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4.

SEBI has been taking a pioneering role in investor protection by increasing disclosure levels by entities seeking to access equity markets for funding. Initiating a new step towards tightening Initial Public Offering (IPO) norms, SEBI has made the IPO grading mandatory. In this context, a. b. Explain how IPO grading can help the investors. Discuss how IPO grading differs from investment recommendation. ( 5 ( 5 marks) marks)

<Answer>

The IPO grading is a relative assessment of the fundamentals of the equity security. Investment decisions for IPOs are at present based on voluminous and complex disclosure documents, which pose a challenge to investors to arrive at informed decisions. The focus, in these documents is meeting regulatory guidelines on disclosures. Though seemingly there is a lot of information available on IPOs through free research on websites, media and other sources, investors often look for structured, consistent and unbiased analysis to aid their investment decisions. Moreover, information available on new companies varies with the size of the issue, the market conditions and the industry that the issuing company belongs to. IPO grading aims to bridge this gap and facilitate more informed investment decisions. CRISIL IPO Grading Methodology The emphasis of the IPO Grading exercise is on evaluating the prospects of the industry in which the company operates, the company’s competitive strengths that would allow it to address the risks inherent in the business(es) and effectively capitalize on the opportunities available as well as the company’s financial position. In case, the IPO proceeds are planned to be used to set up projects, either greenfield or brownfield, CRISIL evaluates the risks inherent in such projects, the capacity of the company’s management to execute the same, and the likely benefits accruing from the successful completion of the projects in terms of profitability and returns to shareholders. Due weightage is given to the issuer company’s management strengths and weaknesses and issues, if any, from the corporate governance perspective. Accordingly, CRISIL’s IPO Grading methodology examines the following key variables:

Business prospects: Industry and company

− Industry prospects: Typical factors which are assessed here include the growth prospects of the industry, the extent of cyclicality, competitive intensity, vulnerability to technological changes and regulatory risks inherent in the business. − Company prospects: The alignment between industry opportunities, the company’s strategy and its capabilities. A company’s market position is indicated by its ability to increase/protect market share, command differential pricing and maintain margins at par with, or superior to its peers. •
Project related factors Key issues evaluated here are the company’s ability to successfully execute the project that is being undertaken and the potential upside to the shareholders on completion and commissioning of the project.

Financial performance Ability to generate sustained shareholders’ value as reflected by trends in profitability margin, EPS growth, Return on Capital Employed (RoCE) and Return on Net Worth (RoNW) and other key financial indicators relevant for an equity investor are evaluated by CRISIL.

Management Quality

The assessment of the ability of the management to handle uncertainty in terms of capitalizing on future business opportunity and mitigating the impact of contingencies.

Corporate Governance practices While IPO grading is not intended to be a detailed evaluation of a company’s corporate governance practices, broad issues like

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quality of accounting policies and type of transactions with subsidiaries and associates are looked into. The IPO Grade assigned is the outcome of a detailed evaluation of each of the factors listed, and is a comment on the fundamentals of the company concerned and its growth prospects from a long-term perspective. The assessment involves combination of both quantitative factors as reflected in financial numbers, market shares etc as well as qualitative factors like risks associated with new projects, or the management’s ability to deliver on the promises made. CRISIL IPO Grade does not comment on the valuation or pricing of the issue that has been graded, nor does it seek to indicate the likely returns to shareholders from subscribing to the IPO. CRISIL’s IPO Grading Scale CRISIL’s five-point IPO Grading scale is as follows: • • • • • CRISIL IPO Grade 5: Strong fundamentals CRISIL IPO Grade 4: Above-average fundamentals CRISIL IPO Grade 3: Average fundamentals CRISIL IPO Grade 2: Below-average fundamentals CRISIL IPO Grade 1: Poor fundamentals KNR CONSTRUCTION LIMITED (KNRCL) PUBLIC ISSUE OF 7,874,570 EQUITY SHARES OF RS.10/- EACH FOR CASH AT A PRICE OF RS. [•] PER EQUITY SHARE AGGREGATING RS. [•] MILLION (THE “ISSUE”), INCLUDING A RESERVATION FOR ELIGIBLE EMPLOYEES OF 140,000 EQUITY SHARES (THE “EMPLOYEE RESERVATION PORTION”) AND A NET ISSUE TO THE PUBLIC OF 7,734,570 EQUITY SHARES (THE “NET ISSUE”) BY KNR CONSTRUCTIONS LIMITED (“COMPANY”/”ISSUER”). THE ISSUE WOULD CONSTITUTE 28.00% OF THE FULLY DILUTED POST ISSUE PAID UP CAPITAL OF OUR COMPANY. THE NET ISSUE WOULD CONSTITUTE 27.50% OF THE FULLY DILUTED POST ISSUE PAID-UP EQUITY CAPITAL OF OUR COMPANY. PRICE BAND: RS. 170/- TO RS. 180/- PER EQUITY SHARE OF FACE VALUE RS. 10/THE ISSUE PRICE IS 17 TIMES OF THE FACE VALUE AT THE LOWER END OF THE PRICE BAND AND 18 TIMES OF THE FACE VALUE AT THE HIGHER END OF THE PRICE BAND. The Issue is being made through the 100% Book Building Process wherein up to 50% of the Net Issue shall be allocated on a proportionate basis to Qualified Institutional Buyers (QIB Bidders), of which 5% shall be available for Allocation on a proportionate basis to Mutual Funds only. Further, not less than 35% of the Net Issue shall be available for allocation on a proportionate basis to Retail Individual Bidders and not less than 15% of the Net Issue shall be available for allocation on a proportionate basis to NonInstitutional Bidders, subject to valid Bids being received at or above the Issue Price. Further, 140,000 Equity Shares shall be available for allocation on a proportionate basis to Eligible Employees, subject to valid Bids being received at or above the Issue Price. Listing The Equity Shares offered through the Prospectus are proposed to be listed on the Bombay Stock Exchange Limited (“BSE”) and the National Stock Exchange of India Limited (“NSE”). Company has received in-principle approval from BSE and NSE for the listing of its Equity Shares pursuant to letters dated October 22, 2007 and November 21, 2007 respectively. BSE shall be the Designated Stock Exchange. Objects of the Issue The company intends to deploy the net proceeds from the Issue of Rs.1250.41 million after meeting Issue expenses of Rs.90.09 million for the following:
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1. 2. 3. 4.

Further Equity investment in BOT (Built, Operate and Transfer) projects, Contribution towards the unsecured loan portion in the BOT Project (namely AP-07), Purchase of capital equipment, and Meeting working capital requirement.

The fund requirement and deployment is based on internal management estimates and has not been appraised by any bank or financial institution. In addition, company’s capital expenditure plans are subject to a number of variables, including possible cost overruns, construction delays or defects and changes in the management's views of the desirability of current plans, among others. Requirement of Funds and Schedule of Implementation The objects and the estimated cost of the objects as envisaged by the company management and the proposed deployment of funds over the two fiscals are as follows: (Rs. In Millions) S.No 1 2 Particulars Investment in Capital equipment Investment in BOT Projects: a. Further Equity investment in Patel - KNR Infrastructures Pvt. Ltd. b. Further Equity investment in Patel - KNR Heavy Infrastructures Pvt. Ltd. c. Contribution towards Unsecured loan in PatelKNR Heavy Infrastructures Pvt. Ltd. Augmenting working capital requirements Issue Expenses Total FY2007-08 214.87 303.50 119.96 160.00 252.08 90.09 1140.50 FY2008-09 200.00 200.00 Total 214.87 303.50 119.96 360.00 252.08 90.09 1340.50

3. 4.

In the event of a shortfall in raising the requisite capital from the proceeds of the Present Issue, towards meeting the objects of the Issue, the extent of the shortfall will be met by internal accruals and/or from fresh debt. In case of any surplus of monies received in relation to the Present Issue, the company may use such surplus towards further expansion and general corporate purposes including repayment of debt, if any. Means of Finance The entire fund requirement towards the aforesaid objects of the issue is proposed to be funded through the net proceeds from the issue. In the event of a shortfall in raising the requisite capital from the proceeds of the issue towards meeting the objects of the issue, the extent of the shortfall will be met by internal accruals and/or from fresh debt. As per the last audited restated consolidated financial statements, as on September 30, 2007, its free reserves stand at Rs.496.73 millions. As per the restated consolidated audited statements for the half year ended September 30, 2007, its operating cash inflow net of direct taxes paid stands at Rs.477.09 million. Indian Infrastructure Industry Industry Overview General Economy and Role of Infrastructure1 India has witnessed an economic growth of 9.2 per cent in the period 2006–07. It is aiming at sustainable growth trajectory with a rate of approximately 10 per cent by the end of the next plan period (2007-2012). The higher growth rate expectations are based on the likely
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better performance from the manufacturing and service sectors and strong consumer demand. In order to achieve and sustain the anticipated growth levels, large investments in infrastructure segments are required. As outlined in Approach Paper to 11th Plan, investment in infrastructure defined as road, rail, air and water transport, power generation, transmission and distribution, telecommunication, water supply, irrigation and storage will need to increase from 4.6% to around 8% of GDP in the 11th Plan period. In other words, of the increase of 6 percentage points in average gross domestic investment rate from 29.1% to 35.1% of GDP needed to accelerate GDP growth rate from 7% to 9%, about half should be in infrastructure. This will place a heavy burden on the government finances, which will have to invest more in this area. Since government resources are scarce, an aggressive effort at
1(Source:

Approach Paper to 11th plan) Promoting public private partnership in infrastructure development will be needed. A number of initiatives have been taken in the last two years of the 10thPlan by both the Central government and the state governments to promote infrastructure development through public private partnership. Composition of Expected Infrastructure Investments: Rs.3.213 billion

Rs.6.129 billion

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(Source: Crisil Research, Annual Review - Construction, May 2007) Over the next 5 years, roads are slated to be the key driver of construction investments among infrastructure sectors. Road development programmes such as the National Highway Development Programme (NHDP) and Pradhan Mantri Gram Sadak Yojana (PMGSY) together with state-level projects will provide a fillip to the construction industry. ROADS2 For a country of India’s size, an efficient road network is necessary both for national integration as well as for socio-economic development. As part of infrastructure growth, it has become essential for the transport sector to flourish efficiently and effectively to ensure better connectivity between various industrial towns, Special Economic Zones, airports, ports etc and for that a wide and well-developed network of roads is required. However, the focus on the road modernisation program in India has regained ever since the conceptualization of the Golden Quadrilateral (GQ) project. National Highways Development program (NHDP) has been promoted to develop and upgrade the long-neglected Indian national highways. Besides NHDP, the road sector in India will also witness a greater level of development activity through road programmes like Pradhan Mantri Grameen Sadak Yojana (PMGSY) and Special Accelerated Road Development program (SARDP-NE) and also on account of the increased focus of state governments on development of road sector. The ongoing NHDP involves a total of seven phases entailing development and upgradation of around 52,960 km of roads. In this regard, Cabinet approval has been received for Phase I, Phase II and Phase III A, involving development and upgradation of around 18,287 km, while the remaining phases i.e. Phase III B to Phase VII, have received an in-principle approval from the government. Out of the remaining phases, Phase IIIB and V are expected to be launched in the next few years.
2(Source:

Crisil Research, Roads & Highways – Annual Review, September 2006.)

Opportunity After roads, urban infrastructure and power sectors, irrigation is expected to be the biggest contributor to total infrastructure investments expected to materialize over the next 5 years. To achieve the target of creation of 10 million hectare of irrigation potential as envisaged in the 10th plan, the pace of potential creation will have to increase from 1.42 million hectares per year in recent years to 2.5 million hectares per year. Out of the new potential envisaged under Bharat Nirman, about half is planned for 2007-08 and 2008-09 that is first 2 years of the 11th Plan. Assuming the same rate continues thereafter, a total of about 11 million hectares of new potential can be expected in the 11th Plan consisting of 5.5 million hectares in major & medium irrigation, 3.5 million hectares through minor irrigation and about 2.0 million hectares through ground water development. In addition, another 3-4 million hectares of land is to be restored through modernization of major, medium, and minor projects and restoration of tanks. Business Overview of KNRCL It is an infrastructure project development company providing engineering, procurement and construction services across various fast growing sectors namely roads & highways, irrigation and urban water infrastructure management. Its project execution strength primarily is in road transportation engineering projects namely construction and maintenance of roads, highways, flyovers and bridges wherever integral to the projects undertaken. Its strong project management skills help it in timely and successful completion of projects. The company was incorporated in 1995 by professionals having experience in the field of infrastructure development. In 1997, it acquired the assets and liabilities of M/s K. Narasimha Reddy & Co. (“partnership firm”), which was engaged in the business of undertaking civil and mechanical contracts work since 1979. It has over a period of time gained expertise in construction of roads on EPC basis and further diversified into other infrastructure segments like irrigation, water supply and urban water infrastructure management. It has in the past executed infrastructure projects independently as well as through joint ventures. Currently, most of the road projects under execution are with its joint venture partner, Patel Engineering Limited with whom it has business association for the past 7 years. As on June 30, 2007, it has 25 projects on hand across various states in India covering Uttar Pradesh, Madhya Pradesh, Assam, Andhra
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Pradesh, Karnataka, and Tamil Nadu. The Company has the ability to bid, execute and implement medium and large size projects across various infrastructure segments. The estimated unexecuted order book position as at November 30, 2007 was Rs. 17,338.25 million, which is approximately 5.4 times the operational income of FY 2006-07 on consolidated basis. Also, one of the group companies, KNR infrastructure Projects Private Ltd, which has been floated as a shell company to enable formation of SPVs, has objectives similar to that of KNRCL. Vision It intends to become a world-class construction company having presence across all segments of infrastructure development. It is committed to create wealth out of nation’s available resources by using latest technologies and precision engineering. Strengths 1. Significant experience and strong track record in timely and successful execution of projects 2. It has earned significant reputation and goodwill in road construction sector, as demonstrated by the repeat orders received by it on continuous basis 3. Good clientele base 4. Qualified and experienced employees led by a proven management team 5. Expertise in sourcing and maintaining supply chain for raw material 6. Strong order book position: Its unexecuted order book position of Rs. 17,338.24 million as on November 30, 2007, is approx 5.4 times of its operational income for FY 2007. Business Strategy It intends to achieve its growth objectives by adopting the following strategies: 1. Maintain performance and competitiveness of existing business to capitalize on huge investments expected to be made in infrastructure development especially in segments where it presently operates 2. Focus on BOT based projects in the infrastructure sector 3. Focus on Irrigation and Water Supply projects 4. Focus on urban water infrastructure management projects 5. Focus on projects involving higher degree of engineering skills 6. Leverage its business growth by identifying and forming strategic joint venture relationships for mutual benefit through sharing of resources and business skills. Business Operations It is an infrastructure project development company. Its execution strength lies in road transportation engineering projects and has further diversified into other related segments like irrigation, water supply and urban water infrastructure management. Presently, it is executing 25 contracts spread across various states in the country. Execution of all its projects is systematically planned in terms of material, manpower, machinery and finance. Its top management is actively involved and closely monitors all the projects on a regular basis thereby ensuring quick decisions and timely availability of all resources. Composition of its order book as of November 30, 2007 is as follows: Sectors Balance Order Book as at November 30, 2007 Rs. in million %

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Road transportation engineering projects Irrigation and Water Supply Urban Water Infrastructure Management Total

15,490.28 1,456.46 391.51 17,338.25

89.34 8.40 2.26 100.00

Board of Directors The Company is currently managed by a Board of Directors comprising of 8 (eight) Directors. As per its Articles of Association, its Board shall consist of not less than 3 (three) Directors and not more than 12 (twelve) Directors. The day to day affairs of the Company is looked after by its Managing Director, Mr. K Narasimha Reddy and its Executive Directors namely Mr. K Jalandhar Reddy, Mr. J V Panindra Reddy & Mr. M Rajesh Reddy under the overall supervision and control of its Board of Directors. Its Board of Directors are directly involved in bidding and monitoring of the projects on site. Although Mr. K Jalandhar Reddy is the most likely successor to Mr. K N Reddy, there is no clear plan of succession in place. Risk Factors Risks Related to the Company

• •

Its operations are substantially dependent on government agencies/state government public works departments. Risks associated with such dependence include risk of delayed payments and risk of uncertainty as to procurement of business since contracts are on a tender basis. Projects included in its balance order book may be delayed which could have a material adverse effect on its cash flow position, revenues and earnings. Its order book does not necessarily indicate future earnings. Balance order book merely indicates the values of signed contracts or contracts where letters of acceptance have been received and represents only business that is considered firm, although cancellations or modifications may occur.

It does not have any definitive agreements to utilize the net proceeds of the Issue. Further, the Objects of the Issue have not been appraised by any bank or financial institution. It has not entered into any definitive agreements for utilisation of the net proceeds of the Issue for investment in capital equipment or for investments in any special purpose vehicles on terms anticipated by it. It depends very heavily on road transportation engineering projects. Presently it is engaged in the business of providing engineering, procurement and construction services in the transportation sector, namely road & highways, irrigation and urban water infrastructure management segment. As on March 31, 2007 and September 30, 2007 revenues from road transportation-engineering segment has contributed to approximately 95% of its respective income from operations. Its revenues may be adversely affected, if it is unable to execute major portion of its road transportation engineering projects or it is not able to bid for and procure additional business in other segments of its business. It may not qualify for bidding for larger projects independently. Its operations primarily include construction of roads under the NHDP awarded by NHAI. It can bid for projects only if it meets the pre-qualification bidding criteria set for each project. This necessitates a need for entering into joint venture with bigger construction companies. It cannot assure that it will be able to secure projects independently in the future or of being able to secure the projects on its terms which may adversely impact its results of operations and financial condition. Majority of its projects currently under execution and those bidded for are with its joint venture partner Patel Engineering Limited (“PEL”). Any material price escalation in the costs of and/or scarcity in availability of key equipments, basic materials may adversely affect its operations. Materials costs such as steel, bitumen etc. and fuel costs such cost of furnace oil constitute a major portion of its operating expenses. It faces competition in its business from other engineering construction companies. It mainly competes with domestic players in the

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road construction and irrigation segments. While service quality, technical capability, past performance record, experience, safety records and availability of skilled personnel are key factors influencing client decisions, price often is the deciding factor when it comes to awarding contracts. There are a number of competitors having better financials and other resources who have achieved greater market penetration than it has in the markets in which it competes. It may have to accept contracts with lower margins and values if it is unable to compete with other bigger players in the large and high margin contracts. This may affect its relative market share and profit.

The company has articulated its vision of having only 50 per cent of its total revenues from roads in 2010 by diversifying into EPC of power plants and real estate. Uncertainties associated with company’s plans to diversify into power generation and real estate sectors.

Its business operations are sensitive to weather conditions, which may affect its revenues. Implementation of its projects may get affected due to adverse weather conditions, such as heavy rains and floods. Though it makes adequate provisions for non-execution during certain seasons like monsoon, any unforeseen vagaries of nature and season may result in failure of its meeting the contractual obligations and affect its business. It records revenues on the percentage of completion method determined on the basis of applicable accounting standards issued by ICAI.

Loss of key managerial personnel could have a material adverse effect its business. Its business substantially depends on the continued service of its key managerial personnel including its whole-time directors. The loss of the services of its key managerial personnel could have a material and adverse effect on its operations. Its future success will also depend on its ability to attract and retain experienced and skilled personnel.

It may have to raise capital or debt to fund its growth, which may further dilute the rights/interests of the existing equity shareholders and/or increase its overall interest cost. Construction industry as such and particularly BOT based projects are capital intensive in nature. Going forward to meet its capital requirements or pre-qualification criteria for bidding, it may have to access the capital markets and/or raise debt to fund its growth. This in turn, could further dilute the rights or interests of its existing equity shareholders and/or increase its overall interest cost.

• •

It has made applications for registration of trademarks, which are yet to be registered. It has made trademark applications for registration of its corporate logo and trade name, which is pending registration. It may not be able to sustain effective implementation of its business and growth strategy. The success of its business will depend mainly on its ability to effectively implement its business and growth strategy. While it has successfully executed its business strategy in the past, there can be no assurance that it will be able to execute its strategy in future also and within the estimated budget.

− Its past history of dividend declaration/payment does not assure that the Company will pay dividends to its shareholders in the near future. It has declared/paid dividends in the last three fiscal years. However, there can be no assurance that dividend will be paid in the future. −
It is involved in various legal proceedings, which if decided against it, could impact its income and financial condition. Total number of pending cases/ show cause notices/summons 5 3 1 1 1 Remarks and amount involved(to the extent quantifiable) (Rs. in million) 4.33 3.43 9.64 Not quantifiable 0.5 Cases filed against the Company: Type of legal proceeding Income Tax Labour cases Civil Commercial Tax Dispute Motor Accident

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External Risk Factors • A slowdown in economic growth in India could cause its business to suffer. Its performance is linked to the stability of policies and the political situation in India. The rate of economic liberalization could • change and specific laws and policies affecting companies in the infrastructure sector, foreign investment, currency exchange rates and other matters affecting investment in its securities could change as well thereby affecting its business. Force majeure events, terrorist attacks and other acts of violence or war involving India, or other countries could adversely affect • the financial markets, result in a loss of customer confidence and adversely affect its business, results of operations, financial conditions and cash flows. • • Natural calamities could have a negative impact on the Indian economy and cause its business to suffer. Active trading market for its Equity Shares may not develop or prices of Equity Shares may be volatile post listing.

Siginificant accounting policies: KNR Constructions Ltd. (KNRCL) has prepared consolidated financial statements to provide the financial information of its activities along with its Associates & Joint Ventures as a single entity. They are collectively referred to as “Group” herein. Principles of Consolidation: i. The consolidated financial statements include the accounts of KNR Constructions Ltd., and its associates and financially controlled Integrated Joint Ventures. The consolidated Financial Statements of KNR Constructions Ltd., and its Associates and Joint Ventures are prepared as per the accounting principles generally accepted in India. ii. The financial statements of financially controlled integrated Joint Ventures (i.e sharing profit) are consolidated to the extent of KNRCL’s share in Joint Venture. Method of Accounting The financial statements are prepared under the historical cost convention on accrual basis and are in accordance with the requirements of Companies Act, 1956 and comply with the Accounting Standards referred to in Subsection (3C) of Section 211 of the said Act. Fixed Assets and Depreciation Fixed Assets of KNRCL are stated at cost of acquisition, or construction including any attributable cost of bringing the assets to its working condition for its intended use less accumulated depreciation. Depreciation is provided on Written Down value method at the rates prescribed in Schedule XIV to the Companies Act, 1956. Fixed Assets of Joint Ventures are depreciated using straight-line method based on useful lives as estimated by the management. Borrowing Costs Borrowing Costs directly attributable to acquisition or construction of a qualifying asset are capitalized till the date such assets are ready to be put to use. All other borrowing costs are recognized as an expense of the period in which they are incurred. Investments Long-term investments are stated at cost. Current investments are stated at lower of cost and fair value. Inventories Work in progress is valued at cost where as in the case of joint ventures the same is valued at contract rates. Raw Materials and Stores & Spares of KNRCL are valued on weighted average cost method, where as in the case of Joint Ventures, the same are valued at cost. Preliminary Expenses Preliminary expenses are amortised over a period of 10 years.
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Foreign Currency Transactions Transactions in foreign currency including acquisition of fixed assets are recorded at the prevailing exchange rates on the date of the transaction. All monetary assets and monetary liabilities in foreign currencies are translated at the relevant rates of exchange prevailing at the year end. Revenue Recognition Contract revenue is recognized using the percentage completion method. Percentage of completion is determined as a proportion of cost incurred to date to the total estimated/revised contract cost. Full provision is made for any loss in the year in which it is foreseen. Work done but not yet billed in the case of Joint ventures which has been consolidated proportionately is accounted as work-in-progress. Taxes on Income Provision for current tax is made based on the liability computed in accordance with the relevant tax rates and tax laws applicable. Provision for deferred tax is made for timing differences arising between taxable incomes and accounting income using the tax laws and tax rates enacted or subsequently enacted as of the balance sheet date. Deferred Tax Assets are recognized only if there is virtual certainty that there will be sufficient taxable income in future. Provision for tax is made after considering deduction u/s 80IA of the Income Tax Act, 1961 for which the Joint Venture is eligible. Summary of consolidated financial data Summary of Profit and Loss account - As Restated The Profit and Loss statement of the company for five financial years ended March 31, 2003 to 2007 and also as at the half year ended 30th September, 2007 are set out below: (Rs. In Millions) Half Year ended 30, Fiscal Fiscal Fiscal Fiscal Fiscal Particulars September 2007 2006 2005 2004 2003 2007 Income Work Contract Receipts 2294.83 3,212.03 1,455.66 1,218.00 2,136.83 1,820.66 Other Operating Income 20.98 32.13 44.29 75.26 1.04 2.36 Other Income 6.82 82.22 104.43 14.33 11.22 10.85 Increase / (Decrease) in Work in 92.26 (7.99) 106.30 (191.60) 51.89 42.66 Progress Total income 2414.89 3,318.39 1,710.68 1,115.99 2,200.98 1,876.53 Expenditure Material Consumed 389.48 532.35 168.02 239.60 948.39 645.60 Work Contract Expenses 1549.65 2,117.55 1,214.16 664.47 992.14 1,014.91 Staff Cost 48.98 60.37 31.95 32.75 63.34 25.75 Administration & Other Expenses 55.04 82.66 58.58 66.11 44.35 32.66 Preliminary Expenses Written Off 0.04 0.04 0.04 0.04 0.04 Total Expenditure 2043.15 2,792.97 1,472.75 1,002.97 2,048.26 1,718.96 Profit Before Interest, Depreciation and 371.74 525.42 237.93 113.02 152.72 157.57 Taxation Interest & Finance Charges 72.21 119.79 17.18 13.46 32.25 38.39 Depreciation 97.59 136.42 53.98 33.77 35.33 31.51
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Net Profit before tax Provision for Taxation - Current tax - Fringe benefit tax - Wealth Tax - Deferred tax Net Profit after tax Add/(Less) : Prior Period Items Net Profit After Tax before Extra ordinary items Extra Ordinary Items Net Profit After Tax as per Audited Financial Statements Impact of adjustments for restatement in corresponding years Restated Profits Balance in Profit and Loss account brought forward Profit available for Appropriation Proposed Dividend & Dividend Tax Less: Appropriation towards Bonus Shares Balance Carried to Balance Sheet Summary Of Assets & Liabilities - As Restated

201.94 64.23 0.69 0.11 1.36 135.55 (7.40) 128.15

269.21 69.43 0.90 0.09 (5.22) 204.01 (5.23) 198.78

166.77 38.83 0.80 42.82 84.32 (10.71) 73.61

65.79 18.98 1.77 45.04 0.09 45.13

85.14 13.12 0.90 71.12 (1.76) 69.36

87.67 13.66 21.75 52.26 1.45 53.71

128.15 7.40 135.55 372.67 508.22

198.78 6.62 205.40 190.96 396.36 23.69

73.61 7.11 80.72 268.32 349.04 23.09 134.99 190.96

45.13 (3.94) 41.19 234.83 276.02 7.70

69.36 (1.60) 67.76 167.07 234.83

53.71 (8.59) 45.12 121.95 167.07

508.22

372.67

268.32

234.83

167.07

Assets & Liabilities of the Company as at the end of each five financial years and also at the half year ended 30th September, 2007 are set out below. (Rs. in Millions) Particulars Half Year ended September 30, 2007 March 31, 2007 March 31, 2006 March 31, 2005 March 31, 2004 March 31, 2003

A.

Fixed Assets: Gross Block Less : Depreciation Net Block Capital Work in Progress Total Fixed Assets B. Investments

1852.45 318.50 1533.95 302.89 1836.84 0.53

1,504.87 221.35 1,283.52 15.04 1,298.56 0.02

767.71 86.25 681.46 18.79 700.25 0.01

441.38 143.69 297.69 297.69 0.14

370.07 143.92 226.15 226.15 0.03

344.92 119.67 225.25 225.25 2.58

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C. Current Assets, Loans & Advances Inventories Sundry Debtors Cash and Bank Balances Other Current Assets Loans and Advances Total Current Assets D. Total Assets (A+B+C) E. Liabilities & Provisions Secured Loans Unsecured Loans Current Liabilities and Provisions Deferred Tax Liability Total Liabilities & Provisions F. Networth (D-E) Represented by Shareholder's Fund : G. Share Capital H. Reserves and Surplus Less: Miscellaneous Expenditure(to the extent not written off) Issue Expenses I. Net Worth (G+H)

435.37 403.51 252.82 383.51 729.58 2204.79 4042.16 1877.06 9.73 1390.01 63.38 3340.18 701.98

286.85 476.69 143.02 395.18 530.77 1,832.51 3,131.09 1,326.39 16.86 1,151.88 62.00 2,557.13 573.96

328.84 286.71 135.59 203.71 271.23 1,226.08 1,926.34 843.13 3.91 618.03 67.86 1,532.93 393.41

188.06 153.02 130.37 85.53 122.81 679.79 977.62 224.82 2.84 389.13 25.08 641.87 335.75

385.25 93.84 77.29 28.30 101.69 686.37 912.55 108.08 12.00 462.70 22.65 605.43 307.12

261.87 104.95 49.61 84.72 164.13 665.28 893.11 230.53 137.45 268.95 21.75 658.68 234.43

202.49 508.22 3.24

202.49 372.67 1.20

202.49 190.96 0.04

67.50 268.32 0.07

72.39* 234.83 0.10

67.50 167.07 0.14

5.49 499.49 701.98

371.47 573.96 Capital Structure

190.92 393.41

268.25 335.75

234.73 307.12

166.93 234.43

*- Inclusive of share application money of Rs. 4.89 mn
(Rs. in million, except share data) Number of Equity Share Aggregate Nominal Value Authorized Share Capital 35,000,000 Equity Shares of Rs. 10 each Issued, Subscribed And Paid-Up Capital Prior To The Issue 20,248,890 Equity Shares of Rs. 10 each Issue In Terms Of The Prospectus Issue of 7,874,570 Equity Shares of Rs. 10 each Aggregate Value at Issue Price 350.00 202.49 -

A. B. C.

78.75

1338.68

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Of which: i. 140,000 Equity Shares of Rs. 10/- each are reserved for Eligible Employees ii. 7,734,570 Equity Shares of Rs. 10/- each as Net Issue D. Issued, Subscribed And Paid-Up Capital Post Issue 28,123,460 Equity Shares of Rs. 10 each outstanding after the Issue E. Securities Premium Account Before the Issue After the Issue Details of increase in Authorised Capital

1.40 77.35 281.23

23.80 1314.88

NIL 1259.93

The Company has not issued any Equity Shares for consideration other than cash except for: (a) Allotment of 3,183,000 shares pursuant to acquisition of assets and liabilities of partnership firm namely M/s K. Narasimha Reddy & Co with effect from April 1, 1997. (b) Bonus issue of 13,499,260 shares on March 20, 2006. Industry peers J Kumar Infraproject Ltd. Kaushaly Infrastrcture Development Corporation Ltd. Supreme Infrastructure India Ltd. MSK Project India Ltd EPS (Rs) 6.41 3.44 12.27 6.00 P/E 11 8 5 12 RONW% 37.47 17.65 32.21 8.10 NAV (Rs.) 17.10 21.43 38.07 19.70

END OF SECTION D

Section E : Caselets (50 Marks)
This section consists of questions with serial number 5 - 10. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.

Caselet 1 Read the caselet carefully and answer the following questions:

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5.

With the advent of P2P lending, a hassle-free way of transacting money, it's indeed getting quite easier for people to lend and borrow money on the Internet. However, there can be even drawbacks of such lending. In this context, explain the Pros and Cons of peer-to-peer lending. ( 10 marks) P2P lending has given birth to a new concept where anyone can be a money lender or a borrower. Identification and assessment of the borrower by the lender is an important area of concern in such lending. In this context, explain how various tools discussed in the caselet help lender in identifying and assessing the borrower. ( 6 In the wake of the subprime mortgage debacle and the subsequent global credit squeeze, traditional lending channels such as banks across the globe have resorted to tightening of liquidity. Despite this, borrowers could still find ways to mobilize the required funds, thanks to an emerging Internet-based financing tool, peer-to-peer (P2P) or social lending. P2P lending is emerging as the eBay of consumer loans, as it brings together individual borrowers and lenders in the same way as eBay links buyers and sellers. More importantly, it has come as a boon to those who cannot access formal credit. Peer-to-peer lending enables borrowers and lenders to transact business online and thus avoids traditional intermediaries such as banks. This form of people-helping-people model has been gaining traction in many parts of the world. Those who are in need of money post their requirements in a creative and emotional way. This kind of emotional and more humane way of making money distinguishes P2P lending from other forms. The idea behind the concept is that while the borrowers can find cheaper rates than those of traditional banks, the lenders can earn higher returns than from, say, a savings account. P2P lending is more efficient as it doesn't incur massive overheads like banks do. (Banks normally take larger margins to fund their overheads such as employee payments and branch maintenance, etc.) In the P2P model, both the lenders and borrowers are treated as members. Typically, all the members involved in online lending have to go through the following process. It is a fairly simple model that allows the borrowers and lenders to aggregate on an Internet enabled network. The aggregator, who acts as an intermediary, develops machinery which ranks members based on their creditworthiness. Thereafter, borrowers can post their requirements on the sites. Lenders have the option of selecting the person to whom they wish to lend and reveal their expected rate of return. The aggregator is accountable for the transactions—from crediting the borrowers' account with the loan amount to debiting the appropriate monthly installment from their account. The lender's decision to lend money to a particular borrower is usually based on the borrower's credit score and existing debt. However, unlike a bank or a credit card loan, the decision relies sometimes on social factors too. Typically, loan amounts range from $8,000 to $20,000. To diversify the risks, lenders can choose to invest their money on different borrowers. It may also happen that multiple lenders may fund a single loan, each offering to lend $25 to $200 to a borrower. With the advent of peer-topeer lending, a hassle-free way of transacting money, it's indeed getting quite easier for people to lend and borrow money on the Internet. The concept of P2P lending has been pioneered by P2P lending hub, Zopa, which commenced operations in the UK in 2005 and followed it up with operations in Italy and the US. A slew of other players, such as Prosper, GlobalFunder, Circlelending, Lending Club, Smava, Boober and Virgin Money, have commenced P2P lending operations subsequently in Europe and North America. These sites, which provide a platform to lenders and borrowers, typically profit from the fees they charge their members to make and service loans and not from a loan's interest rate. They also check the borrowers' credit, and contract with third parties to collect bad loans. This form of lending has gained momentum in many European and North American countries and also in India. In India, there are three tools that can help evaluate the opportunities and significance of P2P lending: the introduction of Social Security Number (SSN), credit score by CIBIL, and payment bills. P2P lending has given birth to a new concept where anyone can be a money lender or a borrower. Nevertheless, people have to browse through the Internet to access loan. marks)

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END OF CASELET 1

Caselet 2 Read the caselet carefully and answer the following questions:
7. As discussed in the caselet, dominating role of CRAs in the subprime crisis and the resultant credit crunch, questioned the vision of CRAs to judiciously assess the economic resources and their inability to convey the information to investors in an unbiased manner. In this context, critically analyze the role of CRAs in assigning credit ratings. ( 8 8. As mentioned in the caselet, CRAs argue that they cannot be blamed even if some financial crisis or fraud takes place since their ratings are mere opinions and are based on certain caveats. In this context, explain the various caveats on the basis of which credit rating is done. ( 9 Some of the most valued and respected Credit Rating Agencies (CRAs) like Moody's, Fitch, and Standard & Poor's are under regulatory scrutiny for their failure to send off adequate signals about the impending subprime crisis and downturn of related products. In fact, this is not the first time their reputation has been at stake. Many investors have lost significant amounts of money, thanks to the great faith investors have reposed in these rating agencies. On the other hand, rating agencies derive their revenues mostly from the companies they rate, and this leads to a certain amount of conflict of interest. Concerns about their integrity have been gathering momentum in the world of finance for a long time now. The international financial community has started questioning the disproportionately dominating role of CRAs in the subprime crisis and the resultant credit crunch. They are supposed to assign grades to financial products based on the perceived risk of default. CRAs like Standard & Poor's, Moody's and Fitch Ratings gave gold-plated AAA credit ratings to complex structured products like Collateralized Debt Obligations (CDOs) and Residential Mortgage-Backed Securities (RMBS), indicating that they were as secure as government bonds. Investors were led to believe they had trustworthy portfolios; later only did they realize that they were actually sitting on massive losses. CRAs are facing intense opposition. In the past, they were also blamed for playing a key role in the bankruptcy of Californiabased Orange County. Another big failure was in maintaining a superior investment grade to Enron in 2001. Likewise, in the case of the Asian currency meltdown in 1997, the CRAs had received flak for further escalating the impact of crisis and allowing the contagion effect to spread to other countries. They were accused of being reactive in rating the South East Asian countries rather than being proactive. CRAs argue that they cannot be blamed if some financial crisis or fraud takes place since their ratings are mere opinions. Further, they support their claim by mentioning that they do not recommend anyone to buy or sell any security and that their ratings are only evaluation of the creditworthiness of a security at a particular point of time and will not carry any predictive information. Nevertheless, CRAs are well aware that whatever steps they take are not sufficient enough to take on all the public criticism. Hence, the agencies have warned asset managers to alter the way they use these ratings. There is a need to increase the accountability of CRAs by modifying Nationally Recognized Statistical Rating Organizations (NRSRO) legislation to improve competitiveness in the industry and minimize the conflicts of interest. At present, credit ratings are considered as mere opinions, and this provision doesn't make CRAs liable to investors. END OF CASELET 2
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Caselet 3 Read the caselet carefully and answer the following questions:
9. 10. Initially, at the time of inception, PNs made up only a small portion of the total ownership by foreigners, but later on reached alarmingly high levels. In this context, explain how PNs became the preferred choice for international investors. As mentioned in the caselet, the case against PNs is not only to control the quantity of inflows but also to improve the quality of the same. In this context, analyze how the restriction by SEBI on PNs helps in achieving this objective. In the current globalization regime, everyone is looking for opportunities worldwide. The capital market is the most happening place for making money in short-term. Investors, issuers and brokers are the most dominating characters in the capital market. Once it recall Foreign Institutional Investors (FIIs), the most influencing nature in Indian capital market, automatically Participatory Notes (PNs) come into picture. PNs have always been known for the controversies they create. Every now and then, the Securities and Exchange Board of India (SEBI) and Reserve Bank of India (RBI) have been making regulations and putting restrictions on PNs. PNs have been associated with Indian capital market for a long time but they are unable to gain the confidence of investors. A Participatory Note is a financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. A Participatory Note is an Offshore Derivative Instrument (ODI). The invention of this product was necessitated as many fund managers did not want to register with SEBI as FIIs, but still wanted to play the stock market. The mechanism is simple, contact a foreign broking house registered also as an institutional investor in India and ask it to buy shares in the local market and issue a synthetic share by way of a PN. Any dividends or capital gains collected from the underlying securities go back to the investors. There are about 1,000 FIIs registered with SEBI. Of these, only about 34 are both stock brokers and institutional investors. These are the ones that buy Indian stocks for their own clients as well as on behalf of those who do not wish to be registered in India, mainly hedge funds. These 34 brokers have issued offshore derivatives to the tune of about $100 billion, or almost 10 per cent of the country’s GDP. Now it gets a very clear picture of how it has developed a completely new market that is outside the purview of Indian regulators. When it started, PN made up only a small portion of the total ownership by foreigners, but this has now reached alarmingly high levels. Until March 2004, it was just 20 per cent of the total FII participation. By August 2007 it was over 50 per cent and by October it was likely to touch 60 per cent, amounting to around $100 billion. In the six weeks from September, the RBI has had to grapple with the problem of buying the huge influx of dollars on account of PN purchases. The case against PN is not only quantitative but also qualitative - that is, quality of investors participating in the Indian market. Market regulator SEBI announced new rules to regulate foreign investments through instruments like Participatory Notes. The rules, to be effective from October 26, 2007, include no fresh issuance of PNs in derivatives as also winding up existing positions in 18 months, besides curbs on such instruments in the spot market. In spot market, FIIs will not be allowed to issue PNs more than 40 per cent of their assets under custody. The reference date for calculating such assets will be September 30, 2007 SEBI said. Those FIIs who have issued PNs of more than 40 per cent of their assets, could issue such instruments only if they cancel, redeem, or close their existing PNs. Those FIIs who have issued PNs less than 40 per cent of their assets under custody can issue additional instruments at the rate of five per cent of their assets. According to SEBI, PNs affect the transparency of inflows. It wants foreign portfolio investors to register so that it knows the source of funds coming into the country. The finance minister has said “India is also trying to moderate inflows to avoid a stock market bubble.” India, the world's fastest-growing major economy after China, has battled a surge of foreign capital, which has
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pushed the rupee to its strongest against the dollar since 1998 and helped power the stock market to a series of record highs. SEBI wants FIIs to wind up existing PNs on underlying derivatives over 18 months and restrict the issuance of new PNs on cash positions. SEBI curbs on PNs have gone a long way in helping the Union Government cope with copious inflows. Also, FII participation in the derivatives market has fallen to 7% since the ban on participatory notes with derivatives as underlying. The number of FIIs registered has increased to 1,133, from 1,125 on 26 October, the day the PN curbs became effective. The number of sub-accounts, on the other hand, has gone up from 3,454 to 3,478. END OF CASELET 3 END OF SECTION E END OF QUESTION PAPER

Suggested Answers Investment Banking and Financial Services - II (MSF2K2): July 2008
Section D: Case Study
1. Business prospects: Industry and company Industry Prospects:
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For a country of India’s size, an efficient road network is necessary both for national integration as well as for socio-economic development. As part of infrastructure growth it has become essential for the transport sector to flourish efficiently and effectively to ensure better connectivity between various industrial towns, Special Economic Zones, airports, ports etc and for that a wide and well-developed network of roads is required. Since government resources are scarce, an aggressive effort at promoting public private partnership in infrastructure development will be needed. A number of initiatives have been taken in the last two years of the 10th Plan by both the Central government and the state governments to promote infrastructure development through public private partnership. The National Highways Authority of India (NHAI) is responsible for the development, maintenance and management of National Highways entrusted to it and for matters connected or incidental thereto. NHAI is mandated to implement National Highways Development Project (NHDP), which is: – India 's largest highways project till date – Aims to provide world-class roads with smooth traffic flow.
With a favourable policy framework in place and specific measures taken by the Government to augment finance, the road and highway sector offers attractive business and investment opportunities. These projects are being typically executed under the Build, Operate and Transfer (BOT) model where the contractor invests in building the road and maintaining it for upto 30 years and then transfer it back to the NHAI at zero cost. Company Prospects:
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KNRCL is involved in the transportation sector, namely, roads and highways, irrigation and urban water infrastructure management by providing engineering, procurement and construction services. Roads and highways is the key business of operation, forming 89 per cent of the company’s order book as on September 30, 2007. The company has been awarded various projects by both NHAI and state governments. The company has executed many projects as part of the NHAI’s NHDP program and has had a 7-year relationship with Patel Engineering as a joint venture partner. The KNR-Patel has a good track record in obtaining road construction projects in general and as well as projects from NHAI under NHDP in specific. The various proposed projects under NHDP provide good opportunity to the company. Project related factors Sound record in timely and quality execution KNRCL is backed by the strong operational skills of the promoters, who have been involved in road construction for almost a decade. The promoters themselves are project directors and pay close attention to project management. The company has a good reputation with NHAI for quality and timely execution and has not been fined for delays as yet. Long standing relationship with Patel Engineering KNRCL has been working along with Patel Engineering since 2000 for road construction. The joint venture will continue to provide KNRCL with support on the net worth criterion and aid the bidding process for larger projects. Good prospects for revenue growth in the roads sector The NHAI has planned huge investment for the development of roads and highways through its NHDP programme. This will provide a large opportunity to road developers, which augurs well for the company. However, most of the future awards will be in the form of BOTs, to which KNRCL will gain exposure only over the next 2 years. Focus on BOT based projects in the infrastructure sector Central and State Governments are pursuing the BOT strategy to encourage development of the infrastructure facilities in India. Toll based BOT projects offer the possibility of higher revenues to the contractor by virtue of better than anticipated use of the asset. Company’s joint venture Patel-KNR (JV) has been awarded two road projects under the annuity model by NHAI. Further, going forward KNRCL also intend to simultaneously focus on toll-based projects by leveraging its technical and financial credentials, which they believe will further improve after the proposed issue. A stronger balance sheet should enable them to bid for more projects, including BOT projects on their own or in alliance with other construction companies. No clear strategy in place for diversification The company has a vision of diversifying into different areas by 2010. It has plans of obtaining only half of the revenue from road and the rest from power generation and real estate. However, the diversification strategy is not yet clear. Financial performance Ratio Analysis Particulars Ratio September 30, 2007 6.69* 19.31% 34.67 March 2007 10.14 35.79% 28.35 For the Year ended March March 2006 2005 3.99 20.52% 19.43 2.03 12.27% 16.58 March 2004 3.35 22.06% 15.17 March 2003 2.23 19.25% 11.58

Earning Per Share (Rs.) Return on net worth (%) Net Asset Value per share (Rs.)
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Face Value per share (Rs.) No. of Equity Shares (Basic and adjusted) * Not Annualised Notes:

10.00 20,248,890

10.00 20,248,890

10.00 20,248,890

10.00 6,749,630

10.00 6,749,630

10.00 6,749,630

1. Earnings per share (Rs.) = Profit available to equity shareholders / Weighted average no. of equity shares. 2. Return on Net Worth (%) = Restated profit after Tax / Net Worth at the end of the year / relevant period* 100 3. Net Asset value / Book value per share (Rs.) = Net Worth / No. of equity shares. 4. Profit & Loss as restated has been considered for the purpose of computing the above ratios. 5. EPS and Net Asset Value per share are computed after taking into account the bonus shares issuance in the F.Y 2005-06 in the ratio of 2:1 for earlier financial years.
Management Quality The company’s operations are headed by the promoters. Mr K N Reddy is the managing director. Mr K Jalandhar Reddy and Mr. JV Panindra Reddy have played an active role in the growth of KNRCL. The execution of projects is closely monitored by the promoters on site. The estimation skills within KNRCL, while bidding for projects, are concentrated and the involvement of promoters is high in execution. This poses a potential problem with regard to bandwidth. As the company expands, the promoters will find it increasingly difficult to personally oversee each site. Though the company has a strong middle level management for execution, most senior level management, other than the promoters, has joined recently. Though the directors are from diverse backgrounds, the contribution of some directors to the board functioning is significantly less than others. The KNR infrastructure Projects Private Ltd, a shell company floated by KNRCL has similar objective to that of KNRCL and may lead to potential conflict of interest. The succession plan of company is not clear and may lead to confusion/conflict in future and in turn may dampen the confidence of the people and the quality of management. Corporate Governance practices Though the joint ventures have adopted different accounting policies as compared with respective accounting policies adopted by the issuer company, they are however within the frame work of applicable accounting standards for treatment of different items of income, expenditure, assets and liabilities and these accounting policies have been applied consistently by joint ventures for preparation of financial statements for all financial years. Therefore, the true and fair view and the comparability of the respective financial statements are not affected. There are also various cases filed against the company pertaining to Income Tax, Labour cases, Civil, Commercial tax dispute and Motor Accident indicating the associated risk with the company. After a thorough analysis of the above factors, the rate that can be assigned to IPO is 3/5. This grade indicates that the fundamentals of the issue are average. The grading reflects KNRCL’s strong track record of project execution in both roads construction and operations and maintenance (O&M). It also indicates the companys ability in executing many projects in the past and its long term relationship with Patel Engineering. The rating also substantiates its ability in obtaining the various projects under NHDP by NHAI. However, the grading is constrained by the relatively underdeveloped state of the company’s operating system, which in turn could constrain its ability to expand the size of its operations. The grading also reflects the uncertainties associated with company’s plans to diversify into the power generation and real estate sectors and conflicting management successor.

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2.

Dividend pay out ratio (2006-07) =23.69/205.40=11.53% Retention ratio (b)=1–0.1153 =0.8847 Net Profit as on 31st March 2008 = Rs.271.10 Million (135.55×2) Retained profit carried forward to balance sheet = Rs.271.10 Million × 0.8847 = Rs.239.84 Million Net worth as on 31st March 2008 = Rs.573.96 + Rs.239.84 = Rs.813.80 Million ROE = Net Profit / Net Worth = 271.10/813.80 ROE = 33.31% g = ROE × b g = 33.31 × 0.8847 g = 29.47% Net Profit as on 31st March 2009 = 271.10 × 1.2947 = Rs.350.99 Million. Let ‘x’ be the allotment price for the shares of KNRCL. Return from new capital = 7.87457 × x × 0.15 = Rs.1.1812x Million, Therefore, the total profit on 31st March, 2009 = 350.99 + 1.1812x. Total number of equity share = 20.24889+7.87457 = 28.12346 Million The EPS as on 31st march, 2009 is (350.99 + 1.1812x)/28.12346. Average industry P/E ratio is Now, the price as on 31st March, 2009 x = 9 × (12.48 + 0.042x) x = 112.32 + 0.378x x = Rs.180.58 The price obtained is near to the upper band. Therefore an investor may invest in this company as per the valuations made above.

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3.

Qualitative Factors • KNRCL is an infrastructure project development company providing engineering, procurement and construction services across various fast growing sectors namely roads & highways, irrigation and urban water infrastructure management. KNRCL’s project execution strength primarily is in road transportation engineering projects namely construction and maintenance • of roads, highways, flyovers and bridges wherever integral to the projects undertaken. KNRCL’s strong project management skills help them in timely and successful completion of projects. • KNRCL has over a period of time gained expertise in construction of roads on EPC basis and further diversified into other • infrastructure segments like irrigation, water supply and urban water infrastructure management. As on November 30, 2007, it has 25 projects on hand across various states in India covering Uttar Pradesh, Madhya Pradesh, • Assam, Andhra Pradesh, Karnataka, and Tamil Nadu. The estimated unexecuted order book position as at November 30, 2007 was Rs. 17,338.25 million, which is approximately 5.4 times the • operational income of FY 2006-07 on a consolidated basis.

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• Good clientele base, comprising of governmental agencies like the NHAI, and public works department under the State Governments of Andhra Pradesh, Madhya Pradesh, Karnataka, Tamil Nadu and Uttar Pradesh which it believes has the ability to adequately fund the projects. Qualified and experienced employees led by a proven management team • Quantitative Factors Adjusted Earning per Equity Share (EPS) of face value Rs.10 Particulars Year ended March 31, 2005 Year ended March 31, 2006 Year ended March 31, 2007 Weighted average i. ii. Price/Earning Ratio (P/E) in relation to Issue Price of Rs. 170 a. Based on Fiscal 2007 EPS of Rs. 10.14 - 16.77(x) iii. b. Based on weighted average EPS of Rs. 6.74 - 25.22(x) Average Return on Net Worth in the last three years. Particulars Year ended March 31, 2005 Year ended March 31, 2006 Year ended March 31, 2007 Weighted Average iv. Required EPS Number of shares after the issue Required PAT Increased Net Worth Required RONW v. RONW % 12.27 20.52 35.79 26.78 Weight 1 2 3 Rupees 2.03 3.99 10.14 6.74 Weight 1 2 3

The weighted average EPS for Equity Share considered with face value of Rs. 10 is Rs. 6.74

Minimum Return on Increased Net Worth required to maintain pre-issue EPS at Rs. 10.14 is = Rs.10.14 = 28.12346 Million = 10.14 ×28.12346 = Rs.285.17188 Million = 7.87457× 170 +573.96 = Rs.1912.6369 Million =285.17188 /1912.6369= 14.91%

vi.

Net Asset Value per Equity Share. Net Asset Value per Equity Share for the year ended March 31, 2007 is Rs.28.35. Post issue Net Asset Value per Equity Share is Rs.68.01 Comparison with industry peers EPS (Rs) 10.14 6.41 P/E 16.77 11 RONW% NAV (Rs.) 35.71 28.35 37.47 17.10

KNR Construction Limited J Kumar Infraproject Ltd.
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Kaushaly Infrastrcture Development Corporation Ltd. Supreme Infrastructure India Ltd. MSK Project India Ltd

3.44 12.27 6.00

8 5 12

17.65 32.21 8.10

21.43 38.07 19.70
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The issue Price of Rs. 170 can be justified in view of the above qualitative and quantitative parameters. 4. a. The objectives that have been made public are to help the aam aadmi make a rational investment decision, and for ‘investor protection’. However, the equity markets are unlike the debt markets. In the debt markets, the probability of default is a major determinant of the rating over the life of the debt instrument, which in turn is finite. Further, debt has limited upside risk, whereas, equity has unlimited upside risk. Hence, grading, or rating debt, and equity will have to be done quite differently. Further, the present form of IPO grading will not address the pricing of the issue. The rating will be on the issuer’s ‘fundamentals’ usually to carry on various parameters, viz, business prospects of the company and industry, financial risks, management competence, governance, and accounting quality. However, for an existing firm the assessment will have to be made on the overarching assumption that the past would continue to hold in future especially in respect of the last three parameters, and for a new firm it would be difficult to judge on all parameters except, probably, the business prospects parameter. Further, the parameters are likely to be different for different rating agencies. The grading is, therefore, not likely to reflect the behavior of the market in future, which is the real determinant of how much the investor would gain. The main idea behind introducing the rating mechanism is the prospectus of the company which are too complex for the lay investor to understand and in this situation of crisis, the rating agency comes into rescue in the form of providing guidance for choosing the right company, at right time, in the right manner. This rating is a service aimed at facilitating the assessment of equity issues offered to the public. The grade assigned to any individual issue represents a relative assessment of the ‘fundamentals’ of that issue in relation to the universe of other listed equity securities in India. All these measures help the investor in choosing the good company and avoiding the bad company and indeed help in making good investment decisions. b. IPO grading (initial public offering grading) is a service aimed at facilitating the assessment of equity issues offered to public. The grade assigned to any individual issue represents a relative assessment of the ‘fundamentals’ of that issue in relation to the universe of other listed equity securities in India. Such grading is assigned on a five-point point scale with a higher score indicating stronger fundamentals. Investment recommendations are expressed as ‘buy’, ‘hold’ or ‘sell’ and are based on a security specific comparison of its assessed ‘fundamentals factors’ (business prospects, financial position etc.) and ‘market factors’ (liquidity, demand supply etc.) to its price. As the IPO grading does not take cognizance of the price of the security, it is not an investment recommendation. Rather, it is one of the inputs to the investor to aiding in the decision making process. All other things remaining equal, a security with stronger fundamentals would command a higher market price.

Section E: Caselets Caselet 1

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5. Pros: • P2P lending is beneficial to those who may not otherwise qualify for any loan amount under the traditional system of lending. In the P2P model, both the lenders and borrowers are treated as members, and hence the borrowers can easily get the loan without having to prove their credentials. Borrowers, in this form of lending, get cheaper interest rates, when compared to other types of loans. As they are members of one group, the borrowers can standardize the procedure for contracts and get better rates each time they take loans. On the other hand, lenders also get a better rate for their money than what they would get by depositing them in any other savings scheme. Thus, social lending provides lower rates of interests on borrowings and higher returns on savings. P2P lending offers transparency to both the borrowers and the lenders. Traditionally, banks have been following a very • complex and lengthy procedure to provide loans, which lacks clarity and transparency in the system. As a result, banks stand to benefit when there are changes in rates and make huge profits. In this system, borrowers get to know the rate at which loans are provided and from whom they are taking the loan. On the other hand, lenders will be able to know where the money is going and who is paying them. P2P lending eliminates intermediaries involved in the financial transactions. No agencies and regulatory authorities are • involved in assessing the creditworthiness of the members in the group. People are free to join as members and get loans based on the goodwill of the lending members. The advantage over the traditional system is that, as the borrowers and lenders know each other, there are less chances of money being in risk or the borrower turning out to be an insolvent. In order to avoid unforeseen cases of insolvency, some online vendors provide loans only to families and friends. They • don't encourage transactions between strangers. This makes it easier for the lenders to transact online. Other ways of transactions include linking those with similar interests or belonging to the same community like the same office, city, etc. Cons: • Although P2P lending has many benefits, it also has certain drawbacks. As P2P lending does not require underwritings and guarantees and is completely based on goodwill, it involves higher risk than the traditional systems. Lenders may be tempted to earn more returns without considering the risks associated. The aggregator who provides the platform for the members cannot be held responsible in case of defaults. They just charge • the fees from both the parties and do not possess any liability for the transactions. Although the credit is generally provided only after thorough documentation and review of credit history, yet there is scope for fraud and misinterpretation by the group, because the basic information provided by the borrower may be misleading. In order to avoid such cases, there should be an external reviewer to look into the credentials of the borrower. But, having • an external reviewer may further delay the process. The concept is based on social relationships, i.e., among family members and friends. However, lending to close relatives may lead to bitterness and mar the relationships. In fact, when people are willing to lend only to their friends and relatives, then there is no need for any online company • providing them the platform. They can interact and transact among themselves without even a single intermediary. As the social lending system completely depends on personal bias and judgments, the lenders cannot be questioned as to • why they are not ready to lend to a particular borrower; whereas in the case of banks, they can be questioned regarding the rejection of a loan. The banks should have proper reasons to reject a loan application.

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6. In India, there are three factors that can help us evaluate the opportunities and significance of P2P lending: the introduction of Social Security Number (SSN), credit score by CIBIL, and payment bills. The SSN is a number allotted for provident fund holders. It is a unique identification number allotted along with PAN. This gives a specific identity to people to transact in various ways. CIBIL (Credit Information Bureau of India) and TransUnion initiated the process of providing credit scores for the first time in India in November 2007. It evaluates the past repayment history and gives their credit scores. It helps the banks and financial institutions in India to evaluate the creditworthiness of their customers. It can be used in the credit card and personal loan industries, and so on. The third factor is introduction of payment bills. In addition to these, the growing reach of the Internet is contributing to the spread of this concept in India.

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Caselet 2
7. CRAs have also been widely criticized for their practice of giving voluntary ratings, in which they rate an organization or issuer in the name of public interest and then upgrade the rating after being rewarded by the organization. Some lawmakers say that CRAs sometimes guide organizations on how to maintain better ratings, and compare them with accounting firms which audited and advised companies, such as Enron, that later collapsed because of accounting irregularities. Furthermore, as the rating agencies do not come under the purview of Regulation Fair Disclosure, the possibility of rating agencies leaking selective corporate information to selective investors cannot be ruled out, and this is attracting a fair amount of criticism. It is not just the competence of the CRAs which has come under scanner. Some of their other abusive practices also appear to be unethical and damaging to the interests of the entities they rated. One such practice is to offer higher ratings to issuers that adopted investment decisions, policies and financial restructuring requested by the CRAs. Critics claim that higher ratings assigned to mortgage-related securities were the result of the close relationships that the CRAs maintained with debt issuers. The US government has initiated official investigations to find out whether the CRAs gave artificially overstated ratings to low quality debt in order to win the favor of financial institutions which paid for the ratings. Regulators have labeled the revenue structure of the CRAs conflict of interest and called on to revert to their earlier business model instead of taking payment from financial institutions to keep away from potential conflicts of interest. 8. Certain caveats • A rating is specific to a debt instrument and is an analysis of the credit risk associated with the particular instrument. It is neither a general-purpose evaluation of the issuer, nor an overall assessment of the credit risk likely to be involved in all the debts contracted or to be contracted by such entity. The primary objective of rating is to provide guidance to investors/creditors in determining a credit risk associated with a • debt instrument/credit obligation. It does not amount to a recommendation to buy, hold or sell an instrument, as it does not take into consideration factors such as market prices, personal risks preferences and other considerations, which may influence an investment decision. The rating process is based on certain ‘givens’. The agency, for instance, does not perform an audit. Instead, it is required to • rely on information provided by the issuer and collected by analysts from different sources, including interactions in -person with various entities. Consequently, the agency does not guarantee the completeness or accuracy of the information on which the rating is based. A credit rating is a considered opinion of the agency as regards repayment of interest and principal by borrower. It is based • upon the situation at that point of time and investors will have to watch for downgrades in rating, if any, from time to time. A credit rating does not constitute a guarantee for repayment of debt or interest. •
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Caselet 3
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9. PNs became the preferred choice for international investors because They could avoid registration procedures. • They had flexibility in investment. • They found it an easy route at minimum cost. • They could decide the holding period and withdraw investment at any time of their choice. • They were guaranteed fixed returns. • The FIIs issuing PNs are almost running a parallel Indian derivative exchange. PN holders in derivative markets also enjoy high leveraging opportunities in the same securities in which the investor takes position in the cash market. PN derivatives became the preferred route because it allowed FIIs to invest in individual stocks in excess of that permitted by the Indian law. PNs are freely transferable instruments. 10. PNs with underlying derivatives have to be withdrawn in 18 months, it is likely that there may be some choppy sessions ahead but the volatility should pan out very soon. The volatility should reduce because derivative-based PNs are highly leveraged — something that contributes to volatility. It should also mean that the hedge funds, which have been fairly responsible for this steep rise in the market, might exit the market because SEBI will never let them register as FIIs. SEBI knows that PNs are held by hedge funds and SEBI will not register hedge funds even if they wanted to register. Quality of the inflow will come as SEBI told FII to register with it so that the source of the fund can be known. This will bring more transparency in the capital market. The RBI can then heave a sigh of relief because the appreciation pressure on the rupee will slacken to a large extent. The Finance Ministry too will heave a sigh of relief because the danger of a full-scale bubble bursting has reduced to a good extent, if not fully.
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* The above case is prepared only for the purpose of examination and not to illustrate either effective or ineffective performance of the fund. The case contains real information adapted and combined with other information to generate discussion or analysis on the desired topics.

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