Master of Business Administration Semester IV MA0041 Merchant Banking and Financial Services (Book Id: 1812)

Q 1. You want to apply for merchant banker. Find out the list of regulations that a merchant banker needs to follow in India? Ans: A merchant bank is a financial institution that provides capital to companies in the form of share ownership instead of loans. A merchant bank also provides advisory on corporate matters to the firms they lend to. In the United Kingdom, the term "merchant bank" refers to an investment bank. Hence, merchant bankers are financial institutions and their prime service is to offer various financial services and advice to corporate companies and needy individuals. a) The Role of Merchant Banking are as follows: Project counselling:- Project counselling includes preparation of project reports, deciding upon the financing pattern to finance the cost of the project and appraising the project report with the financial institutions or banks. This also includes filling up of application forms with relevant information for obtaining funds from financial institutions and obtaining government approval. Portfolio Management:- A merchant bank manages the portfolios (investments) of its clients. This makes investments safe, liquid and profitable for the client. It offers expert guidance to its clients for taking investment decisions. Offshore finance:-The merchant bankers help their clients in the following areas involving foreign currency: a) Long term foreign currency loans b) Joint venture abroad c) Financing exports and imports d) Foreign collaboration arrangements Corporate counselling:- Corporate counselling covers the entire field of merchant banking activities e.g. Project counselling, capital restructuring, public issue management, loan syndication, working capital, fixed deposits, lease financing acceptance credit, etc. Loan syndication:- Loan syndication refers to assistance rendered by merchant bankers to get mainly term loans for projects. Such loans may be obtained from a single development finance institution or a syndicate or consortium. Merchant bankers help corporate clients to raise syndicated loans from banks or financial institutions.

b) The Functions of merchant banking are as follows: Raising Finance for Clients:- Merchant Banking helps its clients to raise finance through issue of shares, debentures, bank loans, etc. It helps its clients to raise finance from the domestic and international market. This finance is used for starting a new business or project or for modernization or expansion of the business. Broker in Stock Exchange:- Merchant bankers act as brokers in the stock exchange. They buy and sell shares on behalf of their clients. They conduct research on equity shares. They also advise their clients about which shares to buy, when to buy, how much to buy and when to sell. Large brokers, Mutual Funds, Venture capital companies and Investment Banks offer merchant banking services. Project Management:- Merchant bankers help their clients in the many ways. For e.g. Advising about location of a project, preparing a project report, conducting feasibility studies, making a plan for financing the project, finding out sources of finance, advising about concessions and incentives from the government. Advice on Expansion and Modernization:- Merchant bankers give advice for expansion and modernization of the business units. They give expert advice on mergers and amalgamations, acquisition and takeovers, diversification of business, foreign collaborations and joint-ventures, technology up-gradation, etc. Managing Public Issue of Companies:- Merchant bank advice and manage the public issue of companies. They provide following services: a) Advise on the timing of the public issue. b) Advise on the size and price of the issue. c) Help in appointing underwriters and brokers to the issue. d) Listing of shares on the stock exchange, etc. Q 2. Is book building an efficient IPO pricing mechanism? Substantiate your reasons. Ans:- a) IPO Process:- An initial public offering (IPO) is the process by which a private company becomes publicly traded on a stock exchange. Once a company is public, it is owned by the shareholders who purchase the company's stock when it is put on the market. For many investors, the only real exposure they have to the IPO process occurs a few weeks prior to the IPO, when media sources inform the public. How a company gets valued at a particular share price is relatively unknown, except to the investment bankers involved and those serious investors who are willing to pour over registration documents for a glimpse at the company's financials. This article will look at what investors need to know about the IPO valuation process. A company goes through a three-part IPO transformation process: i. A Pre-IPO transformation phase:- The pre-IPO transformation phase can be considered to be a restructuring phase where a company starts the groundwork toward becoming a publicly-traded company. For example, since the main focus of public companies is to maximize shareholder value, the company should acquire management that has experience in doing so. Furthermore, companies should reexamine their organizational processes and policies and make necessary changes to enhance the company's corporate governance and transparency. Most importantly, the

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company needs to develop an effective growth and business strategy that can persuade potential investors the company is profitable and can become even more profitable. On average, this phase usually takes around two years to complete. An IPO transaction phase:- The IPO transaction phase usually takes place right before the shares are sold and involves achieving goals that would enhance the optimal initial valuation of the firm. The key issue with this step is to maximize investor confidence and credibility to ensure that the issue will be successful. For example, companies can choose to have reputable accounting and law firms handle the formal paperwork associated with the filing. The intent of these actions is to prove to potential investors that the company is willing to spend a little extra in order to have the IPO handled promptly and correctly. A Post-IPO transaction phase:- The post-IPO transaction phase involves the execution of the promises and business strategies the company committed to in the preceding stages. The companies should not strive to meet expectations, but rather, beat their expectations. Companies that frequently beat earnings estimates or guidance are usually financially rewarded for their efforts. This phase is typically a very long phase, because this is the point in time where companies have to go and prove to the market that they are a strong performer that will last.

b) Book building process:- Book building is the process through which the prices of securities being issued are (securities issued first time for public) obtained through the demand for market. In the process of book-building, the investors place their bids at the price which seem reasonable to them within a specified price range. Through the mechanism of book building, companies can raise capital from the general public by offering IPOs as well as by issuing Follow on Public Offers (FPOs). According to SEBI guidelines, an issuer company can follow the process of book building in two ways: i. ii. i. 75 per cent of net offer to the public through book building process. 100 per cent of net offer to the public through book building process. Book Building : 75 per cent:- A company is allowed 75 per cent book building of issue of capital to public by giving an offer in a prospectus if it follows the following: The company must be eligible to issue capital to public. The issuer company can reserve book building for firm allotment as an option. A minimum limit of 25 per cent must be mentioned for public issue in the prospectus of the company as net offer to public. There must be a provision of underwriting for the public issue. The book runner maintains the necessary records. The underwriter will maintain the record of public issue order. The underwriter shall intimate the book runner about the aggregrate amount of orders. The issue price will be same for public and placement offers.

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Book Building: 100 per cent:- A company can also make a 100 per cent of net offer to the public through book-building process if the issue size is 25 crore or above. The reservation of allotment is fixed as specified by SEBI guidelines. In this case also, an eligible merchant bankers is appointed as book runners which works as the lead banker and ensures all the functions to be performed by a lead banker. But in such a case, the company has to compulsorily issue 10 per cent of the share capital to the public through an offer made by prospectus.

Q 3. The banks are in a bind over the implementation of the new bancassurance proposal as announced in Budget 2013-14. Banks assuming the role of insurance brokers may also lead to conflict of interests where the bank is also the promoter of an insurance company. Discuss the opportunities and threats for the new proposal? Ans:- Bancassurance meaning:- Bancassurance means selling insurance product through banks. Banks and insurance company come up in a partnership wherein the bank sells the tied insurance company's insurance products to its clients. Bancassurance arrangement benefits both the firms. On the one hand, the bank earns fee amount (non-interest income) from the insurance company apart from the interest income whereas on the other hand, the insurance firm increases its market reach and customers. The bank acts as an intermediary, helping insurance firm reach its target customer in order to increase its market share. Bancassurance is the distribution of insurance products through a banks distribution channels. It is a service that can fulfill both banking and insurance needs at the same time. Bancassurance as a concept first began in India when the insurance industries opened up to private participation in December 1999. There are basically four models of bancassurance: Distribution alliance between the insurance company and the bank. Joint venture between the two companies. Mergers between a bank and insurer. Bank builds or buys own insurance products. Most of the bancassurance operations fall in the first model.

a) Bancassurance process:- The process of bancassurance are as follows:i. Every insurance company has a wants to grow quickly to reduce painful start-up expense overruns. Banks with their huge networks and large customer bases give insurers an opportunity to do this efficiently. It gives the companies an opportunity to tap the rural sectors. Selling insurance through traditional methods in these sectors falls very expensive. A tie up with a bank with an appropriate customer base can give an insurer a cheap access to these areas. Banassurance enables to have a huge pool of skilled professionals. The margins of the banks in their core lending business are declining sharply. Opportunities like banassurance augment their income. Banassurance enables to develop a sales culture within the bank. It helps to change the traditional mind set of banking companies.

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Though a relatively new concept, banassurance has been a phenomenal success in most of the cases. Currently banks are not just lending organizations but are emerging as more diverse financial institutions. The distribution of insurance products through banks has been beneficial to both insurance and banking companies as well as the customers.

b) Opportunities and threats:- Banks database is enormous even though the goodwill may not be the same as in case of their European counterparts. This database has to be dissected variously and various homogeneous groups are to be churned out in order to position the Bancassurance products. With a good IT infrastructure, this can really do wonders. Other developing economies like Malaysia, Thailand and Singapore have already taken a leap in this direction and they are not doing badly. There is already an atmosphere created in the country for liberalisation and there appears to be a political consensus also on the subject. Therefore, RBI or IRA should have no hesitation in allowing the marriage of the two to take place. This can take the form of merger or acquisition or setting up a joint venture or creating a subsidiary by either party or just the working collaboration between banks and insurance companies. Threats:- Success of a Bancassurance venture requires change in approach, thinking and work culture on the part of everybody involved. Our work force at every level are so well entrenched in their classical way of working that there is a definite threat of resistance to any change that Bancassurance may set in. Any relocation to a new company or subsidiary or change from one work to a different kind of work will be resented with vehemence. Another possible threat may come from non-response from the target customers. This happened in USA in 1980s after the enactment of Garn St Germaine Act. A rush of joint ventures took place between banks and insurance companies and all these failed due to the non-response from the target customers. US banks have now again (since late 1990s) turned their attention to insurance mainly life insurance. The investors in the capital may turn their face off in case the rate of return on capital falls short of the existing rate of return on capital. Since banks and insurance companies have major portion of their income coming from the investments, the return from Bancassurance must at least match those returns. Also if the unholy alliances are allowed to take place there will be fierce competition in the market resulting in lower prices and the Bancassurance venture may never break-even. Q 4. Global Finance magazine has named the SBI as the Best Trade Finance Bank 2013. SBI has a caption of Expertise delivered around the Globe! " Do you agree with this statement? Ans:- a) Explain Trade Finance:- Trade Finance is basically related to 'Domestic as well as International Trade Transaction'. The term "Trade Finance" means, finance for Trade. For a trade transaction there should be a Seller to sell the goods or services and a Buyer who will buy the goods or use the services. Various intermediaries such as (banks), (Financial Institutions) can facilitate this trade transaction by financing the trade. The financing of international trade. Trade finance includes such activities as lending, issuing letters of credit, factoring, export credit and insurance. Companies involved with trade finance include importers and exporters, banks and financiers, insurers and export credit agencies, as well as

other service providers. Trade finance is of vital importance to the global economy, with the World Trade Organization estimating that 80 to 90% of global trade is reliant on this method of financing. The following are the most famous products/services offered by various Banks and Financial Institutions in Trade Finance Segment. i. Letter of Credit:- It is an undertaking/promise given by a Bank/Financial Institute on behalf of the Buyer/Importer to the Seller/Exporter, that, if the Seller/Exporter presents the complying documents to the Buyer's designated Bank/Financial Institute as specified by the Buyer/Importer in the Purchase Agreement then the Buyer's Bank/Financial Institute will make payment to the Seller/Exporter. Bank Guarantee:- It is an undertaking/promise given by a Bank on behalf of the Applicant and in favour of the Beneficiary. Whereas, the Bank has agreed and undertakes that, if the Applicant failed to fulfill his obligations either Financial or Performance as per the Agreement made between the Applicant and the Beneficiary, then the Guarantor Bank on behalf of the Applicant will make payment of the guarantee amount to the Beneficiary upon receipt of a demand or claim from the Beneficiary. Collection and Discounting of Bills:- It is a major trade service offered by the Banks. The Seller's Bank collects the payment proceeds on behalf of the Seller, from the Buyer or Buyer's Bank, for the goods sold by the Seller to the Buyer as per the agreement made between the Seller and the Buyer.

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b) SBI position in Trade finance:- Global Finance magazine has named the Best Trade Finance Banks by region and country in an exclusive survey to be published in the February 2013 issue. Global Finance editors with input from industry analysts, corporate executives and technology experts selected the best trade finance banks in 83 countries or regions. In addition, for the first time, a poll of Global Finances corporate readership was conducted in order to increase the accuracy and reliability of the results. Criteria for choosing the winners included: transaction volume, scope of global coverage, customer service, competitive pricing and innovative technologies. i. IMPORT SERVICES: State Bank of India provides a gamut of global trade related services with our extensive, well equipped and expert/experienced personnel at our Domestic Branches and Foreign Offices. Their expertise lies in extending a complete range of import services. Their extensive and far reaching network helps us deliver products in a prompt and efficient manner and our expertise enables faster query resolution, quick responses to follow up action, improving lead time and early reimbursements. EXPORT SERVICES: State Bank of India gives you access to virtually all destinations in the world where you propose to sell your products. With us, you can be rest assured that you will have a greater control over your foreign receivables.

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 SBI also possess the ability to structure and customize solutions for your export related specific requirement. Our expertise in document checking helps you in all your export related transactions. Q 5. SKS Microfinance Limited, India's only listed micro-lender has concluded a securitisation transaction for Rs 321 crore with a major public sector bank. Describe the process of securitization? Ans:- a) Concept of securitization:- Securitization is a process by which long-term loans, whether backed by security or not, lease receivables, credit card balance, hire purchase debtors and trade debtors or any scheduled cash flows are converted into securities and are issued to investors. In other words, if some assets have predictable cash flows associated with them and a measurable default rate risk (credit rating), they are converted into tradable negotiable certificates and can be subscribed by investors. Thus, the securitization process converts long-term assets into cash/liquid assets and enables the originator funds for further business. The first reported securitization transaction was between Citibank and GIC Mutual Fund in 1990s. Features of Securitization:- Securitization has the following features which are as follows:i. Certain financial assets (loan assets, mortgages, lease receivables, credit card balance, etc.) are typically transferred to a Special Purpose Entity or Vehicle (SPE/SPV) which can be used as collateral for taking a loan. ii. After conversion of assets into SPE, these SPEs can be financed through issue of securities such as Pass-Through Certificate (PTCs) and debt securities to investors. These PTCs give certain rights to the buyer on the underlying asset such as right of interest payment and repayment pattern for principal amount. Additionally, the issuer cannot charge, cash-in or restructure the assets. iii. CRAs assign ratings to these securities which give investors comfort and assurance on timing of principal and interest payments. The credit rating is based on homegeniality (tenor, quality etc) of the underlying asset in case loans or expected future cash flows (in case of infrastructure financing). iv. Investors make payment to the SPV and assume ownership of the securities. The originator of the securities receives payment on the due date against the securities issued. v. Credit enhancement is the ultimate objective of securitization. Usually with securitization, the holder of security is protected against disparity in the repayment schedule through agreements like, provision of cash collateral, case of over collateralization, guarantee by third party and originator accepts recourse agreement of securitization through the issue of SPE. b) Process of Securitization:- The process of securitization are as follows: Selection of assets by the Originator. Packaging of pool of loans and advances (assets). Underwriting by underwriters. Assigning or selling to of assets to SPV in return for cash. Conversion of the assets into divisible securities. SPV sells them to investors through private stock market in return for cash. Investors receive income and return of capital from the assets over the life time of the securities.

 The risk on the securities owned by investors is minimized as the securities are collateralized by assets. The difference between the rate of the borrowers and the return promised to investors is the servicing fee for originator and the SPV. Assets to be securitized to be homogeneous in terms of underlying assets ,maturity period ,cash flow profile. First, long-term loans are converted to different packages of loans based on tenor, risk grading, underlying asset etc. These packages are then offered to the investors. Next, selected investors are issued PTCs. SPVs can also be issued to the investors. Final issue is made on the basis of pro rata basis as mentioned in the offer document. Q 6. Compare and contrast the various instruments of money and capital market that are available in India? Ans:- The money market in that part of a financial market which deals in the borrowing and lending of short term loans generally for a period of less than or equal to 365 days. It is a mechanism to clear short term monetary transactions in an economy. According to Crowther, "The money market is a name given to the various firms and institutions that deal in the various grades of near money." Market for short-term debt securities, such as banker's acceptances, commercial paper, repos, negotiable certificates of deposit, and Treasury Bills with a maturity of one year or less and often 30 days or less. Money market securities are generally very safe investments which return a relatively low interest rate that is most appropriate for temporary cash storage or short-term time horizons. a) Instruments in Money Market:- The various instruments available in the money market are as follows:i. Treasury Bills:- Treasury bills (T-bills) are issued under the Market Stabilization Scheme (MSS) of the Government of India. T-bills are short-term money market instruments used to raise funds for the government and their validity is generally less than one year. These bills are issued at discount and redeemed at par and the difference between the issue price and redemption value is the benefit enjoyed by the investor for investing in treasury bills. There is no default rate risk in T-bills. T-bills are sold by the RBI through auction. These bills are available with a minimum amount of `25,000 or in the denominations of `25,000. At present, three types of Tbills are issued by the government;91 day T-bills, 182 day T-bills, 364 day T-bills. ii. Clean bill or documentary bill:- In case of clean bills, documents are attached with the bill at the time of acceptance and delivered by the drawer and after that it is cleared. In case of documentary bills, documents are enclosed and delivered after the acceptance of payment by the drawer and these documents are kept by the bank till the date of repayment of loan. Inland bill and foreign bill:- In case of inland bills, the bill is drawn on a party in India and must be payable in India. The person on whom such a bill is drawn must be a resident of India. In case of foreign bills, the bill is drawn on a person outside India and it may be paid in India or it can be drawn on a person in India but payable outside India.

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Export bill and Import bill:- Export bills are drawn by exporters in India and by importers in any other country and the import bills are drawn on importers in India and by exporters in other countries. Bills discounting:- There are three parties involved in short-term financing through bills discounting. There is a bill financing seller who draws bills of exchange, and a buyer of bills financing who accepts it after which the seller of this bill gets it discounted from a bank. The buyer of the bill borrows the funds and the seller provides funds which get reimbursed by a bank providing bill discounting facility for which he is charged some fees. The buyer of the bills returns the money to the bank at the time of maturity.

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b) Instruments in Capital Market:- The capital market is the place where transactions take place for more than a year. Capital market instruments are equity shares, preference shares, convertible preference shares, non-convertible preference shares, etc. The capital market is classified as follows: Primary market:- The primary market is the part of the capital market that deals with issuing of new securities. Companies, governments or public sector institutions can obtain funds through the sale of a new stock or bond issues through primary market. This is typically done through an investment bank or finance syndicate of securities dealers. Secondary market:- Secondary market is the market wherein the trading of securities is done. Secondary market consists of both equity as well as debt markets. Securities issued by a company for the first time are offered to the public in the primary market. Once the IPO is done and the stock is listed, they are traded in the secondary market. The main difference between the two is that in the primary market, an investor gets securities directly from the company through IPOs, while in the secondary market, one purchases securities from other investors willing to sell the same. Derivative market:- The derivatives market is the financial market for derivatives, financial instruments like futures contracts or options, which are derived from other forms of assets. The market can be divided into two, that for exchange-traded derivatives and that for over-the-counter derivatives. The legal nature of these products is very different as well as the way they are traded, though many market participants are active in both. A derivative is a financial contract which derives its value from the performance of another entity such as an asset, index, or interest rate, called the "underlying". The capital market instruments are: i. Bonds:- A written and signed promise to pay a certain sum of money on a certain date, or on fulfilment of a specified condition. All documented contracts and loan agreements are bonds. A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities. Debentures:- It is a debt instrument but one that is not secured by any physical asset or collateral. Debentures are supported by the status and creditworthiness of the

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issuer. For example, corporations and governments frequently issue debentures to secure capital. Like other types of bonds, debentures are documented in an indenture. iii. Equities:- Equities represent another effective method of raising finances from investors who are prepared to take risks. Owners of equity shares represent part ownership of the company. They earn dividends in proportion to their equity holdings. Derivatives:- The term derivative indicates that it has no independent value, the value is entirely derived from the underlying value of an asset. Such asset can be commodities securities, currency, livestock, bullion, and so on. Derivatives means a forward, future, option or any other hybrid contract of pre-determined fixed duration, linked for the purpose of contract fulfilment to the value of a specified real or financial asset or to an index of securities. Preference share:- This instrument is issued by corporate bodies and the investors rank second (after bond holders) on the scale of preference when a company goes under. The instrument possesses the characteristics of equity in the sense that when the authorised share capital and paid up capital are being calculated, they are added to equity capital to arrive at the total. Preference shares can also be treated as a debt instrument as they do not confer voting rights on its holders and have a dividend payment that is structured like interest (coupon) paid for bonds issues. Preference shares may be: Irredeemable, convertible: in this case, upon maturity of the instrument, the principal sum being returned to the investor is converted to equities even though dividends (interest) had earlier been paid. Irredeemable, non-convertible: here, the holder can only sell his holding in the secondary market as the contract will always be rolled over upon maturity. The instrument will also not be converted to equities. Redeemable: here the principal sum is repaid at the end of a specified period. In this case it is treated strictly as a debt instrument.

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