Pranav Raythatha

IB 1st Module

(Q.1)What is Investment Banking? The Roles and Functions of Investment Banking.

Ans. Abstract Investment banking is the process of raising capital for businesses through public floatation and private placement of securities. The investment banking industry plays an important intermediation function in all market economies. Introduction A progression is usually a move in a forward or upward direction. In most spheres of life, this connotes a regression. The development of an economy is not an exception to this reasoning. Economic development is not achievable without an improved rate of capital formation. One important way of capital formation for developing economies is through improving their investment banking industries. Investment banking is the process of raising capital for businesses through public floatation and private placement of securities. Investment banks work with companies, governments, institutional investors and wealthy individuals to raise capital and provide investment advice. Originally, investment banking meant the underwriting and distribution of securities. Today investment bankers also invest a lot of effort into helping companies design deals and the securities to finance them, and then use their brokerage arms to sell the securities to the investing public, both retail and institutional. The investment banking industry is central to the market-based economy. By bringing together entities in search of new capital and investors, usually institutional investors, the investment banking industry play an important intermediation function in all market economies. However, if the experience of other counties is indicative of what is likely to happen, then it is likely that in the future, companies will increasingly migrate from bank finance to capital market financing for their long term capital needs. Financing of a companys investments is seen as part of its financial planning process. Financial planners need to evaluate every aspect of this decision process in order to come up with the best source and approach to raising long-term funds. An important consideration in taking this decision includes the selection of an Investment Banker to help the business in raising the needed funds. The decision variables in this direction will depend on established standards the company can rely on in order to identify the most qualified Investment Banker (Manaster and Carter, 1990). Meaning of Investment Banking: Investment Banking falls under two broad headings: 1. The provision of financial advice 2. Capital raising. Principal clients are companies, particularly publicly listed companies, and governments. For companies, these services are primarily directed towards raising shareholder value

(that is, ensuring that the share price fully reflects the value of the business); and the actions prescribed are corporate actions (taking over another company, selling a division, returning cash to shareholders by paying them a special dividend, etc). For governments, these services are usually directed at executing government policy, for example by selling off, or privatizing, government-held businesses or industries. 1.Provision of financial advice

As noted above, investment banking advice relates to corporate actions rather than product or organizational matters, such as product improvement, market analysis or management of organization. Nonetheless, an investment banker needs to have an understanding of all these things because they, too, will have an impact on shareholder value. Mergers and Acquisitions (or"M&A")

The majority of financial advice relates to M&A. The client company seeks to expand by acquiring another business. There are many possible commercial reasons for this, such as: increasing the range of products increasing the business' geographical footprint complementing existing products integrating vertically (i.e. acquire suppliers, further up the chain, or customers, further down the chain) protecting a position (for example by preventing a competitor from acquiring the business in question). In practice therefore, Investment Banking divisions tend to be divided into industry sector teams, who can then familiarize themselves with the principal players, economics and dynamics of the sector. There are also many possible financial reasons for making an acquisition, such as: raising profitability, and therefore the share price increasing in size followed and more widely invested in; again, likely to have a positive effect on the share price financing growth improving quality of profits - the market likes predictable profit streams, and will value these more highly shifting the business towards sectors more favourably viewed by the market. The Investment Bankers' roles in these transactions involve: using their knowledge of the industry sector, to help with the identification of potential targets which meet commercial criteria such as those referred to above using their knowledge of the investment market, to advise on valuation, form of consideration (should the sellers be paid in cash - which is likely to involve the buyer borrowing the money - or in the buyer's shares - so that the seller ends up with a stake in the buyer, or a blend of the two?), timing, tactics and structure coordinating the work of the other advisers involved in the transaction lawyers, who prepare the documentation for the acquisition and help with the "due diligence" to be performed on the business being acquired; accountants, who advise on the financial reporting aspects of the transaction, and tax consequences; brokers, who advise on shareholder aspects (how are the buyer's shareholders likely to view the acquisition?) and how the market as a whole is likely to receive the transaction; and public relations consultants, who ensure that the transaction has a favourable press. General financial advice

Investment Banking also involves providing general financial advice on a range of issues, such as funding structure (perhaps the company is too indebted, and should issue shares to raise more money; or does it have too much cash on its balance sheet, just sitting there not earning interest, so that it should consider paying a large dividend to its shareholders or buying back some of its own shares?). 2. Capital rising If a company is to grow, it has to invest and, often, that capital comes from external sources. This can be in the form of either "equity", when the company issues more shares to investors, who buy them for cash; or debt, either from banks or - more usually nowadays - directly from investors. Investors may be either institutional (pension funds and the like) or retail (individuals). Investment Banks advise on the raising of capital - in what form, how much, from whom, timing - and may also charge a fee for arranging the financing or for "underwriting" (guaranteeing to take up any securities that are unsold in the market, so that the issuer knows for sure how much cash it is going to raise and can plan accordingly). Ways of Raising Capital There are several ways of raising equity capital: These are discussed below: Rights Offerings Most company regulations or charters allow shareholders to have a pre-emptive right in additional stock issues. Thus, anytime the company wants to raise additional equity capital, it must make a formal offer to existing shareholders before it can seek the interest of potential outside investors. Where it sells additional stock issues to existing shareholders, it is called a rights offering. This offer may be renounceable or nonrenounceable. A renounceable rights offering gives the shareholder the option to exercise his right to purchase the new shares at the issue price. A non-renounceable rights offering obligates the shareholder to exercise his rights at the issue price. Public Offerings Where the corporate charter or regulations are silent on pre-emptive rights of existing shareholders, it may decide to sell new shares or stock through a rights offering or a public offering. Private Placements: This method of selling securities is generally used by companies who are interested in reducing their floatation costs and are interested in a specific group of investors. Under private placements, new stocks are sold to one or a few investors, generally institutional investors who invest in large blocks of shares. Employees Purchase Plans and Employee Share/Stock Ownership Plan

In most organizations, the regulations or charter allows employees to purchase the shares of the company usually at predetermined prices based on the financial performance of the entity. This usually affects managerial staff in order to reduce the prevalence of the principal-agency problem. Investment Banking also deals with The Initial Public Offering and the Regulatory Framework At this stage we will focus on the Initial Public Offering (IPO) process, the regulatory framework within which the activity is organized and the role of the investment banker. The IPO Process Many writers in corporate finance have given different descriptions of the initial public offering process. A combination of the approaches used will yield the best description of this process. Brigham et al (1999), divides the process into two distinct stages: Stage-one decisions are internal to the company while stage-two involves the company and an investment bank or investment banks. Some writers (Weston and Copeland, 1989; Brealey and Myers, 1994; Grinblatt and Titman, 2002) give a summary of the process by focusing on decisions concerning pre-registration statements to the trading of the securities on stock exchanges. This study describes the process under sections Phase-I and Phase-II IPO decisions. Phase-I IPO Decisions: At Phase-I, IPO decisions usually start with the company making decisions in the following areas: Amount to be raised: The decision variable here is the amount of new capital needed by the firm. Type of Securities to use: This stage of the process will consider the best security to use; the firm would have to choose from basic forms such as shares, bonds or other innovative types, which may include various combinations of securities usually called exotic securities. The choice of security and the method of selling will normally fall within the regulatory framework of the securities industry. Competitive bids versus a Negotiated deal: Should the company offer a block of securities for sale to the highest bidder? Or should it negotiate a deal with an investment banker? Competitive bids normally are used by large well-known firms whiles negotiated deals are used by small firms not known to the investment banking community. Selection of an Investment Banker: the firm must decide on the investment banker to use in raising the needed capital. This stage is very important to the firm, as it tends to have other implications on the success of the IPO process. The intensity of the problem faced by the issuing firm may stem from the fact that there is no model to rely on in selecting an investment banker to make the IPO successful (Manaster and Carter, 1990). Reputable investment banks target more established firms whiles other investment banks are good at speculative issues or new firms going public.

Phase-II IPO Decisions: At Phase-II, decisions include the input of the firms selected investment banker. Components of Phase-II decisions generally include the following: Re-evaluating the initial decisions: at this stage, the firm and its investment banker will have to re-evaluate regarding issues such as size of the issue and type of securities to use etc. These decision processes are organised under pre-underwriting conferences as espoused by Weston and Copeland (1989). The main aim of the re-evaluation processes is to fine-tune the internal decisions of the company under Phase-I. This is to ensure the success of the issue. Filing of Registration: The investment banker, after taking an inventory of all the relevant information, it has to file an application with the Securities and Exchange Commission (SEC) and the stock exchange if it wants the shares to be publicly traded. In Ghana, the securities industry laws (SIL) however allow applications to be filed with the GSE before it is filed with the SEC. Without the examination and approval by these regulatory bodies, public sale of the security can never begin. Pricing of the Security: Another important decision at this phase is the pricing of the security. This depends on a plethora of issues, usually resolved through the research or experience of the investment banker. The important issues considered here include, the risk profile of the issuer, the capacity of the market to accommodate the issue, the reputation of the investment banker etc. The pricing of the issue has been identified as one of the sources of controversy between the issuer and the investment banker (Weston and Copeland, 1989; Brigham et al, 1999; Grinblatt and Titman, 2002). Forming the Underwriting Syndicate: In underwriting of security issues, the managing/selected investment banker may or may not be in the position to underwrite the whole issue. Where it is unable to underwrite the issue, it may have to form an underwriting syndicate. This will ensure the diversification of underwriting risk to the managing investment banker and permits economy of selling effort and expense and encourages nationwide distribution. Forming of the Selling Group: The selling group is formed to facilitate the distribution of the issue for a commission. The managing investment bank through the selling group agreement, which usually covers the description of the issue, concession, handling of purchased securities and duration of the selling group, is able to control the selling group. Offering and Sale: The last important step in this process is the formal sale of the securities after the approval by the regulatory authorities. This is usually preceded by a series of publicity campaigns. The date on which the selling of the issue will begin is made public before or during the publicity campaign in order to avoid unfavourable events or circumstances.

The process in Ghana is very much the same as what pertains in other economies. Differences may be found in the regulatory framework within which it is organised. Important requirement in Ghana for a company going public is the appointment of an investment banker to guide it through the process. The Regulatory Framework for IPOs SEBI Guidelines must have to follows for raising capital through primary market in India by Companies. I. Procedure for IPOs of small companies II. Size of the Public Issue III. Promoter Contribution IV. Collection centres for receiving applications V. Regarding allotment of shares VI. Timeframes for the Issue and Post- Issue formalities VII. Despatch of Refund Orders VIII. Other regulations pertaining to IPO IX. Restrictions on other allotments X. Relaxations to public issues by infrastructure companies. Requirements with respect to the listing of securities on a recognised stock exchange The Role of the Investment Banker in the IPO Process is as under: It is clear from the above discussion that, the activities or roles of the investment banker in the IPO process cannot be discounted. The success of the IPO will to a large extent depend on the capabilities of the investment banker selected (Ellis, 1989). However, in the absence of a model to guide issuers of securities in selecting investment banks, how does a company come up with the right investment banker to manage its IPO? Despite the numerous efforts made by academics to investigate into issues concerning the market for IPOs, not much has been done on the capabilities of investment banks. However by examining critically the roles and responsibilities of investment banks in the IPO process, we can glean some qualities or capabilities an investment banker must possess in order to survive in its market. Weston and Copeland (1989) identified three main functions or roles investment banks play in the IPO process and these include: Underwriting, Distribution and, Advice and Counsel. Underwriting: This is the insurance function of bearing the risk of adverse price fluctuations during the period in which a new issue of securities is being distributed. There are two fundamental ways of doing this, and they are the firm commitment and best efforts underwriting agreements. The firm commitment agreement obligates the investment banker to assume all the risks inherent in the issue. On the other hand, the best efforts agreement absolves the investment banker from any risks in the issue. Under this underwriting agreement, the investment banker undertakes to help sell at least a minimum amount of the issue with any unsold amounts returned to the issuing firm.

Where the investment banker is not able to sell the minimum quantity agreed upon, the whole issue is cancelled and reissued when the market is ready to accommodate the issue. Distribution: Another related function to the one described above is the ability of the issuing firm to reach as many investors as possible with its security. According to Weston and Copeland (1989), investment banks play a very crucial role here, because of their expertise in doing this relative to the issuing firm assuming this responsibility when issuing securities. Advice and Counsel: This involves the investment banker making valuable inputs into decisions concerning its client ability to succeed in the capital market with an IPO. Its ability to make valuable inputs in this direction may largely depend on its experience in origination and selling of securities. In addition, Ellis (1989), identified two categories of factors critical to evaluating and choosing an investment bank. In his assessment, the most important factors include. 1.Understand our company 2.Earn credibility with our senior management 3.Make useful recommendations to our company The least important are: Expertise in Eurobond market Expertise in equity underwriting Ellis (1989), again identified six (6) reasons why investment banks gain importance with their corporate clients. These are: 1.Credibility with the client corporations senior management-earned over several years. 2.Understanding the client companys needs for service and its financial goals and policies. 3.Making useful recommendations to the company over a period of time. 4.Innovating with new financing techniques. 5.Having special expertise in a specific service. 6.Recommending a specific transaction. 1.Credibility with Senior Management His postulation on the role of an investment banker goes beyond the IPO process to include other activities or capabilities of the investment banker, which tends to impact on choice of an investment banker by senior management who are interested in strategic issues of the organisations they are responsible for. Thus if an investment bankers capabilities fit well with financial strategies of the organisation, it is made an integral part of implementing the financial strategy. 2.Understand Client Company

Another reason he finds important to corporate executives is the investment bankers knowledge of their companies and their operations. More conservative corporate executives rated this as a critical success factor in dealing with investment banks, especially when the investment banking industry in US has over the years survived, by maintaining a relationship with their clients. In his study, 3 of the 4 different industries he studied ranked this variable as the most important of all in dealing with an investment banker. 3.Making Useful Recommendations A more IPO related factor is the ability of the investment banker to make valuable recommendations to the issuing firm over time. This is because it reinforces the reliability and consistency of the investment banks capabilities to its corporate clients. In this light an investment banker that is able to consistently make valuable inputs into the financial decisions of a client strengthens the relationship between itself and its client. 4.Expertise in Equity Underwriting Another important IPO related capability is the ability of the investment banker to underwrite securities. In the absence of any model to determine the overall capabilities of an investment banker, this has been one of the criteria for ranking the performance of investment banks. 5.Having Expertise in a Specific Service The competitive wave sweeping the US investment banking industry has caused most investment banks to concentrate on their capabilities where they can gain a competitive advantage. The era where one investment banker was at the centre of a corporate entitys financial strategy is over. Corporate entities are shopping for specific capital market capabilities of investment banks. This has eventually changed the structure of the investment banking industry where size used to be a competitive factor. 6.Supplementing Capabilities Other capabilities such as Euro market capabilities, recommending specific transactions and innovating with new financing techniques are all additives to the more generic functions described above. These capabilities, though not really taken to be very important then are now making very important inputs into the choice of firms by corporate clients. Grinblatt and Titman (2002), point out that investment banks have been motivated in various ways to develop capabilities in these areas to expand their clientbase beyond their domestic financial markets.

Qualifications/Roles and Capabilities of an Ideal Investment Banker These capabilities can be identified in the services mostly offered by the investment banks. They include the following: 1.Investment Management/Fund Management

The ideal investment bank in Ghana should possess strong skills in investment management. This generates income for it as well as help in the distribution of new issues 2.In depth Knowledge of Corporate Finance Issues It must have a team of professionals who are well versed in the issues of corporate finance to enable it make valuable inputs into the financial decisions of their clients. It also gives it a competitive advantage when the investment banker is bidding for IPO projects. 3.Pricing of Services The ideal investment banker should be able to deliver its services at a lower cost in order to woo capable businesses interested in going public. One peculiar problem preventing SMEs in Ghana from going public is the cost involved in going public. 4.Pre-Financing of IPOs In Ghana, IPOs have been identified as very costly for the issuing firms. In order for an investment banker to woo clients, it should be capable of pre-financing the IPO in order to gain a competitive advantage in its market. This has been one of the strategies adopted by NTHC Ltd. over the years in order to gain dominance in the IPO market. 5.Performing Ancillary Services Other augmenting capabilities include the ability to support the trading of the securities floated. This primarily involves supporting transactions in the security on the secondary market. Registrar and Custodial services are key to the competitive strategies of an investment banker. Out of four active investment banks, only NTHC and MBL have built capabilities over the years to perform this function. An advantage of these supplementary services is the future cash streams in fees charged to the issuing firms. This is bundled together with other services when investment banks are pricing their fees. Thus it is cheaper for the issuing firm to outsource the registrar services to the investment banker rather than employ another investment banker to undertake this function. These activities, although may not seem necessary to the performance of the investment banking function, could create competitive advantage for the investment banker possessing them.

Conclusion Investment banking is the process of raising capital for businesses through public flotation and private placement of securities. Investment banking is thus critical to the existence of businesses intending to grow by employing external capital. Investment banks therefore play crucial role in the IPOs and capital raising process. IPOs generally involve the issue of equity securities by business for the first time and generally involve the use of investment banks in achieving this goal. In the absence of any model to guide businesses in choosing the capable investment banker (Manaster and Carter, 1990), it might fail in achieving this objective. Capabilities of investment banks, which are critical to the IPO process, have been found to lead to the development of competitive advantages for the investment banks. These capabilities include, competitive pricing of

services, knowledgebase developed by the investment banker, provision of ancillary services, experience of the investment banker in its area of business and the integrity of its stakeholders.

(Q.2) What is the difference between investment banks and merchant banks? Ans. merchant banks and investment banks, in their purest forms, are different kinds of financial institutions that perform different services. In practice, the fine lines that separate the functions of merchant banks and investment banks tend to blur. Traditional merchant banks often expand into the field of securities underwriting, while many investment banks participate in trade financing activities. In theory, investment banks and merchant banks perform different functions. Pure investment banks raise funds for businesses and some governments by registering and issuing debt or equity and selling it on a market. Traditionally, investment banks only participated in underwriting and selling securities in large blocks. Investment banks facilitate mergers and acquisitions through share sales and provide research and financial consulting to companies. Traditionally, investment banks did not deal with the general public. Traditional merchant banks primarily perform international financing activities such as foreign corporate investing, foreign real estate investment, trade finance and international transaction facilitation. Some of the activities that a pure merchant bank is involved in may include issuing letters of credit, transferring funds internationally, trade consulting and co-investment in projects involving trade of one form or another. The current offerings of investment banks and merchant banks varies by the institution offering the services, but there are a few characteristics that most companies that offer both investment and merchant banking share. As a general rule, investment banks focus on initial public offerings (IPOs) and large public and private share offerings. Merchant banks tend to operate on small-scale companies and offer creative equity financing, bridge financing, mezzanine financing and a number of corporate credit products. While investment banks tend to focus on larger companies, merchant banks offer their services to companies that are too big for venture capital firms to serve properly, but are still too small to make a compelling public share offering on a large exchange. In order to bridge the gap between venture capital and a public offering, larger merchant banks tend to privately place equity with other financial institutions, often taking on large portions of ownership in companies that are believed to have strong growth potential. Merchant banks still offer trade financing products to their clients. Investment banks rarely offer trade financing because most investment banking clients have already outgrown the need for trade financing and the various credit products linked to it.

An Investment Banker is total solutions provider as far as any corporate, desirous of mobilising capital, is concerned. The services range from investment research to investor service on the one side and from preparation of offer documents to legal compliances and post issue monitoring on the other. There exists a long lasting relationship between the Issuer Company and the Investment Banker. A "Merchant Banker" could be defined as "An organisation that acts as an intermediary between the issuers and the ultimate purchasers of securities in the primary security market" Merchant Banker has been defined under the Securities & Exchange Board of India (Merchant Bankers) Rules, 1992 as "any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory service in relation to such issue management".

(Q.3) Explain Investment Banking in India. Trend in Investment Banking in global and in India. Ans. List of Investment banking companies in India. J P Morgan USB Goldman Sach Morgan Staley Deutsche Bank HSBC Merchant Bank: Karvy In India, Investment bankers play an important role in the issue management process. Lead managers (category I merchant bankers) have to ensure correctness of the information furnished in the offer document. They have to ensure compliance with SEBI rules and regulations as also guidelines for disclosures and investor protection. To this effect, they are required to submit to SEBI a due diligence certificate conforming that the disclosures made in the draft prospectus or letter of offer are true, fair and adequate to enable the prospective investors to make a well informed investment decision. Merchant bankers primarily addressed the need to enhance the standard of disclosures. It was felt that a further strengthening of the criteria for registration of merchant bankers was necessary, primarily through an increase in the net worth requirements, so that the capital would be commensurate with the level of activities undertaken by them. With this in view, the net worth requirement or category I merchant bankers was raised in 1995-96 to Rs.5crore. In 1996-96, the SEBI (merchant bankers) regulations, 1992 were amended to require the payment of fees for each letter of offer or draft prospectus that is filed with SEBI. Underwriters are required to register with SEBI in terms of the EBI (Underwriters) Rules and Regulations, 1993. In addition to underwriters registered with SEBI in terms of these regulations, all registered merchant bankers in categories I, II and III and stock brokers and mutual funds registered with SEBI can function as underwriters Merrill Lynch Enam Securities SBI Capital Markets ICICI Securities

Important with the strengthening of the disclosure requirements and with the SEBI giving up the vetting up of prospectus. Global Trends for Investment Banking: The Revolutionary 1990s: An Incredible Decade $15 Trillion In Total Security Issuance $10 Trillion In Mergers & Acquisitions A Major New Currency Is Born Privatization & The Growth Of Stock Markets Capital Markets Vs Banks In Corporate Finance The Evolution Of A Truly Global Industry US Industry Practices Spreading Worldwide The Rise of Funded Pension Programs Three separate corporate finance models (or systems) have emerged in recent years: The capital-market-based system The financial-intermediary-based system The industrial group system Trends for Investment Banking in India: In India the roles plays by investment banking are as under.
Management of Capital Rising Management of Buybacks and Takeovers Private Placement of Debt and Equity Mergers and Amalgamations, Acquisitions of Company, its Shares and Takeover in corporate Loan Syndication Foreign Investment and Funds Management.

Financial services are an important component of financial system. The smooth functioning of financial system depends upon the range of financial services extended by the providers. Financial services in India have witnessed remarkable changes in the recent past after the implementation of Liberalization, privatization and globalization. Funds are tapped from the capital market to finance various mega industrial projects. In attracting public savings, Investment banks play a vital role as specialized agencies. The resources raising functions remains to be the primary business of a Investment banker.

The Investment banks have a social responsibility to in building an industrial structure in India. Investment Banking, branch of finance concerned with the underwriting, distribution, and maintenance of markets in securities issued by business firms and public agencies. Investment bankers are primarily merchants of securities; they perform three basic economic functions: (1) provide capital for corporations and local governments by underwriting and distributing new issues of securities; (2) maintain markets in securities by trading and executing orders in secondary market transactions; and (3) provide advice on the issuance, purchase, and sale of securities, and on other financial matters. In contrast to commercial banks, whose chief functions are to accept deposits and grant short-term loans to businesses and consumers, investment bankers engage primarily in long-term financing. (Q.4) Types of Investment Banking

Ans. Basically, investment banking involves the client purchasing assets from the investment bank. The client expects that the purchased asset capital will gain dividends and grow. In effect, the investor did not work on anything other than making the initial purchase. Generally, a bank is a financial institution. It is usually concerned with being the middle entity from which the client can transact business. The client places the money in the different forms of banking services and gains some interest out of this input. The bank, in turn, invests the client's money into business ventures or allows the clients to borrow money for interest in order to grow the initial cash investment. On the other hand, investment banking is a specific type of banking, which is transactions related and limited to the financial market. This type of banking is concerned with investments as a whole. Investment banks come in two types. 1.The basic investment bank issues stocks and bonds to the clients for a pre-specified amount. The bank then invests the money that the client used to purchase the stocks and bonds. These investments differ among banks. In countries where it is allowed to do so, investment banks have their networks of financial and lending institutions from which they profit. Others also invest in property development and construction. The client with the stocks and bonds would then receive payments from the profits made on his money on a specified period of time. It can be justified that both the client and the investment bank profited from the client's initial investment. Because these banks know the ins and outs of their trade, it is not unusual that small or large business ventures and corporations seek their help on matters regarding mergers, acquisitions, and other corporate activities. 2.The merchant bank. These banks are involved in trade financing and providing capital to business ventures not in terms of loans but of shares. Because these investment banks are based on security of the shares, they finance only those ventures that have made their mark in the business world. New merchant companies are usually not financed.

However, versatility is necessary in business. Therefore, a lot of banks have evolved to encompass all aspects of banking to cater to the needs of a wide range of customers. These banks offer savings deposits and loans services to regular customers and, at the same time, offer investments to the financially advanced ones.

(Q.5) What is Merchant Banking? What are the functions of merchant banking? Ans. Merchant banking is the financial intermediation that matches the entities that need capital and those that have capital. It is a function that facilitates the low of capital in the market. Ministry of Finance: Any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities as manager, consultant, advisor or rendering corporate advisory service in relation to such issue management

Services render by Merchant Banks in India: (Required a mandatory registration with SEBI under Companies Act.1956.) Organising finance for investment in projects Assistance in financial management Acceptance of house business Raising Eurodollar loans and issue of foreign currency bonds Financing export of capital goods, hydropower Financing of hire-purchase transaction, leasing Mergers, takeovers, valuation of assets In India, around 250 Merchant Bankers Abolished all categories and maintained Category-I Separate registration for underwriters and portfolio manager Segregation between fee based and Fund based activities Registration with SEBI is mandatory to carry out the business of merchant banking in India. An applicant should comply with the following norms: The applicant should be a body corporate The applicant should not carry on any business other than those connected with the securities market The applicant should have necessary infrastructure like office space, equipment, manpower etc. The applicant must have at least two employees with prior experience in merchant banking Any associate company, group company, subsidiary or interconnected company of the applicant should not have been a registered merchant banker

 The applicant should not have been involved in any securities scam or proved guilt for any offence The applicant should have a minimum net worth of Rs.5 crores FUNCTIONS OF MERCHANT BANK: Management of debt and equity offerings- This forms the main function of the merchant banker. He assists the companies in raising funds from the market. The main areas of work in this regard include: instrument designing, pricing the issue, registration of the offer document, underwriting support, marketing of the issue, allotment and refund, listing on stock exchanges. Placement and distribution- The merchant banker helps in distributing various securities like equity shares, debt instruments, mutual fund products, fixed deposits, insurance products, commercial paper to name a few. The distribution network of the merchant banker can be classified as institutional and retail in nature. The institutional network consists of mutual funds, foreign institutional investors, private equity funds, pension funds, financial institutions etc. The size of such a network represents the wholesale reach of the merchant banker. The retail network depends on networking with investors. Corporate advisory services- Merchant bankers offer customized solutions to their clients financial problems. The following are the main areas in which their advice is sought: Financial structuring includes determining the right debt-equity ratio and gearing ratio for the client, the appropriate capital structure theory is also framed. Merchant bankers also explore the refinancing alternatives of the client, and evaluate cheaper sources of funds. Another area of advice is rehabilitation and turnaround management. In case of sick units, merchant bankers may design a revival package in coordination with banks and financial institutions. Risk management is another area where advice from a merchant banker is sought. He advises the client on different hedging strategies and suggests the appropriate strategy. Project advisory services conceptualizing the project idea feasibility studies Preparing different documents like the detailed project report. Loan syndication Tie up loans for their clients Analyze the pattern of the clients cash flows Prepares a detailed loan memorandum This takes place in a series of steps. Firstly they, based on which the terms of borrowings can be defined. Then the merchant banker, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate. Corporate advisory services- Merchant bankers offer customized solutions to their clients financial problems. The following are the main areas in which their advice is sought:

 Financial structuring includes determining the right debt-equity ratio and gearing ratio for the client, the appropriate capital structure theory is also framed. Merchant bankers also explore the refinancing alternatives of the client, and evaluate cheaper sources of funds. Another area of advice is rehabilitation and turnaround management. In case of sick units, merchant bankers may design a revival package in coordination with banks and financial institutions. Risk management is another area where advice from a merchant banker is sought. He advises the client on different hedging strategies and suggests the appropriate strategy.

(Q.6) What is Underwriting? Ans. Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage, or credit Securities underwriting refers to the process by which investment banks raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt capital). This is a way of selling a newly issued security, such as stocks or bonds, to investors. A syndicate of banks (the lead managers) underwrite the transaction, which means they have taken on the risk of distributing the securities. Should they not be able to find enough investors, they will have to hold some securities themselves. Underwriters make their income from the price difference (the "underwriting spread") between the price they pay the issuer and what they collect from investors or from broker-dealers who buy portions of the offering. Once the underwriting agreement is struck, the underwriter bears the risk of being able to sell the underlying securities, and the cost of holding them on its books until such time in the future that they may be favorably sold. If the instrument is desirable, the underwriter and the securities issuer may choose to enter into an exclusivity agreement. In exchange for a higher price paid upfront to the issuer, or other favorable terms, the issuer may agree to make the underwriter the exclusive agent for the initial sale of the securities instrument. That is, even though thirdparty buyers might approach the issuer directly to buy, the issuer agrees to sell exclusively through the underwriter.

In summary, the securities issuer gets cash up front, access to the contacts and sales channels of the underwriter, and is insulated from the market risk of being unable to sell the securities at a good price. The underwriter gets a nice profit from the markup, plus possibly an exclusive sales agreement. (Q.7) Describe Underwriting Process for Issue management. Ans. The underwriting process begins with the decision of what type of offering the company needs. The company usually consults with an investment banker to determine how best to structure the offering and how it should be distributed. Securities are usually offered in either the new issue, or the additional issue market. Initial Public Offerings (IPO's) are issues from companies first going public, while additional issues are from companies that are already publicly traded. In addition to the IPO and additional issue offerings, offerings may be further classified as:

Primary Offerings - proceeds go to the issuing corporation. Secondary Offerings - proceeds go to a major stockholder who is selling all or part of his/her equity in the corporation. Split Offerings - a combination of primary and secondary offerings. Shelf Offering Under SEC Rule 415 - allows the issuer to sell securities over a two year period as the funds are needed.

The next step in the underwriting process is to form the syndicate (and selling group if needed). Because most new issues are too large for one underwriter to effectively manage, the investment banker, also known as the underwriting manager, invites other investment bankers to participate in a joint distribution of the offering. The group of investment bankers is known as the syndicate. Members of the syndicate usually make a firm commitment to distribute a certain percentage of the entire offering and are held financially responsible for any unsold portions. Selling groups of choosen brokerages, are often formed to assist the syndicate members meet their obligations to distribute the new securities. Members of the selling group usually act on a "best efforts" basis and are not financially responsable for any unsold portions. Under the most common type of underwriting, firm commitment, the managing underwriter makes a commitment to the issuing corporation to purchase all shares being offered. If part of the new issue goes unsold, any losses are distributed among the members of the syndicate. Whenever new shares are issued, there is a spread between what the underwriters buy the stock from the issing corporation for and the price at which the shares are offered to the public (Public Offering Price, POP). The price paid to the issuer is known as the underwriting proceeds. The spread between the POP and the underwriting proceeds is split into the following componenets:

Manager's Fee - goes to the managing underwriter for negotiating and managing the offering. Underwriting Fee - goes to the managing underwriter and syndicate members for assuming the risk of buying the securities from the issuing corporation. Selling Concession - goes to the managing underwriter, the syndicate members, and to selling group members for placing the securities with investors.

The underwriting fee us usually distributed to the three groups in the following percentages: Manager's Fee Underwriting Fee Selling Concession 10% - 20% of the spread 20% - 30% of the spread 50% - 60% of the spread

In most underwritings, the underwriting manager agrees to maintain a secondary market for the newly issued securities. In the case of "hot issues" there is already a demand in the secondary market and no stabilization of the stock price is needed. However many times the managing underwriter will need to stabilize the price to keep it from falling too far below the POP. SEC Rule 10b-7 outlines what steps are considered stabilization and what constitutes market manipulation. The managing underwriter may enter bids (offers to buy) at prices that bear little or no relationship to actual supply and demand, just so as the bid does not exceed the POP. In addition, the underwriter may not enter a stabilizing bid higher than the highest bid of an independent market maker, nor may the underwriter buy stock ahead of an independent market maker. Managing underwriters may also discourage selling through the use of a syndicate penalty bid. Although the customer is not penalized, both the broker and the brokerage firm are required to rebate the selling concession back to the syndicate. Many brokerages will further penalize the broker by also requiring that the commission from the sell be rebated back to the brokerage firm. (Q.8) What is Stock Exchange? Discuss its role in capital/fund rising for business.

Ans. A stock exchange is an entity that provides services for stock brokers and traders
to trade stocks, bonds, and other securities. Stock exchanges also provide facilities for issue and redemption of securities and other financial instruments, and capital events including the payment of income and dividends. Securities traded on a stock exchange include shares issued by companies, unit trusts, derivatives, pooled investment products and bonds. To be able to trade a security on a certain stock exchange, it must be listed there. Usually, there is a central location at least for record keeping, but trade is increasingly less linked

to such a physical place, as modern markets are electronic networks, which gives them advantages of increased speed and reduced cost of transactions. Trade on an exchange is by members only. The initial offering of stocks and bonds to investors is by definition done in the primary market and subsequent trading is done in the secondary market. A stock exchange is often the most important component of a stock market. Supply and demand in stock markets is driven by various factors that, as in all free markets, affect the price of stocks (see stock valuation).There is usually no compulsion to issue stock via the stock exchange itself, nor must stock be subsequently traded on the exchange. Such trading is said to be off exchange or over-the-counter. This is the usual way that derivatives and bonds are traded. Increasingly, stock exchanges are part of a global market for securities.

The role of stock exchange in economy:

Stock exchanges have multiple roles in the economy. This may include the following: Raising capital for businesses The Stock Exchange provide companies with the facility to raise capital for expansion through selling shares to the investing public.[4] Common forms of capital raising Besides the borrowing capacity provided to an individual or firm by the banking system, in the form of credit or a loan, there are four common forms of capital raising used by companies and entrepreneurs. All of these available options, might be achieved, directly or indirectly, involving a stock exchange. Going public Capital intensive companies, particularly high tech companies, always need to raise high volumes of capital in their early stages. By this reason, the public market provided by the stock exchanges, has been one of the most important funding sources for many capital intensive startups. After the 1990s and early-2000s hi-tech listed companies' boom and burst in the world's major stock exchanges, it has been much more demanding for the high-tech entrepreneur to take his/her company public, unless either the company already has products in the market and is generating sales and earnings, or the company has completed advanced promising clinical trials, earned potentially profitable patents or conducted market research which demonstrated very positive outcomes. This is quite different from the situation of the 1990s to early-2000s period, when a number of companies (particularly Internet boom and biotechnology companies) went public in the most prominent stock exchanges around the world, in the total absence of sales, earnings and any well-documented promising outcome. Anyway, every year a number of companies, including unknown highly speculative and financially unpredictable hi-tech startups, are listed for the first time in all the major stock exchanges - there are even specialized entry markets for this kind of companies or stock indexes tracking their

performance (examples include the Alternext, CAC Small, SDAX, TecDAX, or most of the third market companies). Limited partnerships A number of companies have also raised significant amounts of capital through R&D limited partnerships. Tax law changes that were enacted in 1987 in the United States changed the tax deductibility of investments in R&D limited partnerships. In order for a partnership to be of interest to investors today, the cash-on-cash return must be high enough to entice investors. As a result, R&D limited partnerships are not a viable means of raising money for most companies, specially hi-tech startups. Venture capital A third usual source of capital for startup companies has been venture capital. This source remains largely available today, but the maximum statistical amount that the venture company firms in aggregate will invest in any one company is not limitless. At those level, venture capital firms typically become tapped-out because the financial risk to any one partnership becomes too great. Corporate partners A fourth alternative source of cash for a private company is a corporate partner, usually an established multinational company, which provides capital for the smaller company in return for marketing rights, patent rights, or equity. Corporate partnerships have been used successfully in a large number of cases. Mobilizing savings for investment When people draw their savings and invest in shares (through a IPO or the issuance of new company shares of an already listed company), it usually leads to rational allocation of resources because funds, which could have been consumed, or kept in idle deposits with banks, are mobilized and redirected to help companies' management boards finance their organizations. This may promote business activity with benefits for several economic sectors such as agriculture, commerce and industry, resulting in stronger economic growth and higher productivity levels of firms. Sometimes it is very difficult for the stock investor to determine whether or not the allocation of those funds is in good faith and will be able to generate long-term company growth, without examination of a company's internal auditing. Facilitating company growth Companies view acquisitions as an opportunity to expand product lines, increase distribution channels, hedge against volatility, increase its market share, or acquire other necessary business assets. A takeover bid or a merger agreement through the stock

market is one of the simplest and most common ways for a company to grow by acquisition or fusion. Profit sharing Both casual and professional stock investors, as large as institutional investors or as small as an ordinary middle class family, through dividends and stock price increases that may result in capital gains, share in the wealth of profitable businesses. Unprofitable and troubled businesses may result in capital losses for shareholders. Corporate governance By having a wide and varied scope of owners, companies generally tend to improve management standards and efficiency to satisfy the demands of these shareholders, and the more stringent rules for public corporations imposed by public stock exchanges and the government. Consequently, it is alleged that public companies (companies that are owned by shareholders who are members of the general public and trade shares on public exchanges) tend to have better management records than privately held companies (those companies where shares are not publicly traded, often owned by the company founders and/or their families and heirs, or otherwise by a small group of investors).However, when poor financial, ethical or managerial records are known by the stock investors, the stock and the company tend to lose value. In the stock exchanges, shareholders of underperforming firms are often penalized by significant share price decline, and they tend as well to dismiss incompetent management teams. Creating investment opportunities for small investors As opposed to other businesses that require huge capital outlay, investing in shares is open to both the large and small stock investors because a person buys the number of shares they

can afford. Therefore the Stock Exchange provides the opportunity for small investors to own shares of the same companies as large investors. Government capital-raising for development projects Governments at various levels may decide to borrow money to finance infrastructure projects such as sewage and water treatment works or housing estates by selling another category of securities known as bonds. These bonds can be raised through the Stock Exchange whereby members of the public buy them, thus loaning money to the government. The issuance of such bonds can obviate the need, in the short term, to directly tax citizens to finance developmentthough by securing such bonds with the full faith and credit of the government instead of with collateral, the government must eventually tax citizens or otherwise raise additional funds to make any regular coupon payments and refund the principal when the bonds mature. Barometer of the economy At the stock exchange, share prices rise and fall depending, largely, on market forces. Share prices tend to rise or remain stable when companies and the economy in general show signs of stability and growth. An economic recession, depression, or financial crisis could eventually lead to a stock market crash. Therefore the movement of share prices and in general of the stock indexes can be an indicator of the general trend in the economy. Speculation The stock exchanges are also fashionable places for speculation. In a financial context, the terms "speculation" and "investment" are actually quite specific. For instance, although the word "investment" is typically used, in a general sense, to mean any act of placing money in a financial vehicle with the intent of producing returns over a period of time, most ventured moneyincluding funds placed in the world's stock marketsis actually not investment but speculation. (Q.9) what is the aim of capital raising?

Ans. Businesses raise capital to fund projects that they cannot fund internally or fund projects that they do not want to fund internally. The primary goal of a business is to make profit. That is it, no more, no less. Everything else comes in after that. What is a profit? Profit is money left after subtracting total costs of sales and operation from total revenues from sales of products and services of the company. To make revenues our company need to sell somethings. To sell somethings, either they be product or service, the company need to produce them. In order for company to produce both its products and services, it needs to buy equipments, build factories, and hire workers and employees to run the business operations. Well, all those things require money. Since we are in real world, the resources are limited. The management of the company must decided on which projects or investments they will take (i.e. make profit). When the company has insufficient money to fund those projects or they do not want to fund those projects entirely, they raise capital from external sources, usually via selling either equity and/or taking on debt. Those transactions are usually handled by investment banks.

(Q.10) Discuss Industrial financing system in India with reference to new issue market. Ans. In any country, the economic development is based on financial system to mobilize savings from investors to the industry and organization for commercial purpose to generate recourses for the consumer market. The industrial financing system in India consists of a network of basically two types of institutions: (1) Financial Intermediaries: Unit Trust of India, Commercial Banks, Investments Companies like LIC, Development banks etc. (2) Facilitating organizations: New Issue Market (IPO), Stock Exchanges.

New Issue Market: New issue market deals with new securities, i.e. securities which were not previously available and are offered to the investing public for the first time. The new issue market provides the issuing company with additional funds for starting a new enterprise or for either expansion or diversification of an existing one, and thus contribute to company financing is direct. Despite this difference, the new issue market and stock exchanges are inseparably connected: There are basically three methods that could be adopted for marketing shares/services.

(a) Private subscription (b) Right issues (c) Public issues Direct Financing/Private subscription envisages private sale of securities. The promoters subscribe to shares themselves or request their relations/friends to associate with them, i.e. there is an attempt to affect collection of saving-surplus units without the intermediation of financial institutions. This is known as direct financing. Right issues to raise capital can be employed by existing companies only. Whenever the capital of an existing company is to be increased, it should offer right issues to the existing shareholders, unless they themselves decide otherwise. Public issues is to be made when a company is new and has to raise huge funds which cannot be done by the previous two methods, it has to go in for public issue. Companies have also gone for public issue so as to get their shares listed in a stock exchange. The issue of capital to the public involves a number of steps, starting from obtaining consents from SEBI to opening/closing of subscription lists. Consequently, Managing the issue become a specialized job, for which a number of concerns like underwriters, brokers, issue-houses etc. have sprung up in the issue market rendering this type of financing to be an indirect one. The flow of savings from the savers is diverted through intermediary financial institutions to the entrepreneurs. Functions of the New Issue Market: The main function of the new issue market is to facilitate the transfer of resources from savers to users. However, the new issue market should not be conceived as a platform only for the purpose of raising finance for new capital expenditure. In fact, the facilities of the market are also utilized selling existing shares to the public as going concerns through conversion of existing proprietary enterprises or private companies into public companies. Classification of New Issues (a) New Companies- initial issues (b) Old companies-further issues The main function of the New Issues Market is the channeling of investible funds, can be divided, from the operational stand-point, into a triple-series function: (a) Origination: the work of investigation, analysis and processing of new proposals. This in turn may be: a preliminary investigation undertaken by the sponsors (Specialized agencies) of the issue. This involves a careful study of the technical, economic, financial and legal aspects of the issuing companies to ensure that it warrants the backing of issue house.

(b) Underwriting: to overcome the uncertainties prevailing in the capital market as a result of which the success of the issue becomes unpredictable. If the issue remains unsubscribed, the directors cannot proceed to allot the shares, and have to return money to the applicant if the subscription is below a minimum amount fixed under companies Act. Consequently, the issue and hence the project will fail. Underwriting entails an agreement whereby a person/organization agrees to take a specified number of shares or debentures or a specified amount stock offered to the public in the event of the public not subscribing to it, in consideration of a commission- the underwriting commission. If the issue is fully subscribed by the public, there is no liability attaching to the underwriters; else they have to come forth to meet the shortfall to the extent of the undersubscription. Two types of underwriters are classified (1) Institutional Underwriters (2) NonInstitutional Underwriters. Institutional Underwriters: Public financial institutions namely IDBI, IFCI, ICICI, LIC and UTI (c) Distribution: The sale of securities to the ultimate investors is referred to as distribution; it is another specialized job, which can be performed by brokers and dealers in securities who maintain regular and direct contact with the ultimate investors.