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PREFACE
Since 1991 the Indian economy saw a gradual metamorphosis. It has left the
backwaters and entered the sea of globalization. The book encompasses new
developments in the system and discusses various components such as financial
markets, institutions, instruments, agencies and regulations in an analytical and
critical manner. It is designed so that students have a better insight of the financial
systems of a country right from constitution to methods of raising funds from
domestic and foreign markets, different kinds of financial markets and their
instruments, modern techniques of financing etc. The book is lucid and interactive
in expression and full of cases for better understanding of the text. I express my
heartfelt gratitude to all those who were directly or indirectly associated with the
development of this course material.
Pallavi Kudal
COURSE OBJECTIVES
The objective of this course is to provide an in depth insight and conceptual
understanding to the students of the structure, organization and working of financial
systems.
Course Contents:
Module I:
Introduction to financial systems, importance of financial institutions, role of
financial intermediaries, constituents of financial systems. Financial System and
economic development
Module II :
Financial instruments:
Capital market instruments : Equity, debentures, preference shares, sweat equity
shares, non voting shares.
Money market instruments: Commercial bills, Treasury Bills, Certificate of
deposit, Commercial paper.
Other instruments: FCCB, ADR , GDR
Module III:
Primary market: Meaning , significance and scope, developments of primary
market, various agencies and institutions involved, role of intermediaries,
merchant bankers, registrars, underwriters , bankers to the issue and regulatory
agencies.
Secondary Market : Meaning , significance and scope, secondary market
intermediaries, brokers, sub brokers, functions and operations of secondary
market .
Debt Market: An overview of government securities market, Credit rating
agencies.
Module IV:
Mutual funds
Module V:
Module VI:
Contents:
The financial system is possibly the most important institutional and functional
vehicle for economic transformation. Finance is a bridge between the present and
the future and whether it be the mobilisation of savings or their efficient, effective
and equitable allocation for investment, it is the success with which the financial
system performs its functions that sets the pace for the achievement of broader
national objectives.
Van Horne defined the financial system as the purpose of financial markets to
allocate savings efficiently in an economy to ultimate users either for investment
in real assets or for consumption. Christy has opined that the objective of the
financial system is to "supply funds to various sectors and activities of the
economy in ways that promote the fullest possible utilization of resources without
the destabilizing consequence of price level changes or unnecessary interference
with individual desires."
According to Robinson, the primary function of the system is "to provide a link
between savings and investment for the creation of new wealth and to permit
portfolio adjustment in the composition of the existing wealth."
From the above definitions, it may be said that the primary function of the
financial system is the mobilisation of savings, their distribution for industrial
investment and stimulating capital formation to accelerate the process of economic
growth.
Financial assets with attractive yield, liquidity and risk characteristics encourage
saving in financial form. By evaluating alternative investments and monitoring the
activities of borrowers, financial intermediaries increase the efficiency of resource
use. Access to a variety of financial instruments enables an economic agent to
pool, price and exchange risks in the markets. Trade, the efficient use of resources,
saving and risk taking are the cornerstones of a growing economy. In fact, the
country could make this feasible with the active support of the financial system.
The financial system has been identified as the most catalyzing agent for growth
of the economy, making it one of the key inputs of development.
The Indian financial system is broadly classified into two broad groups:
"The financial system is also divided into users of financial services and providers.
1. Banking system
2. Cooperative system
3. Development Banking system
(i) Public sector
(ii) Private sector
4. Money markets and
5. Financial companies/institutions.
Over the years, the structure of financial institutions in India has developed and
become broad based. The system has developed in three areas - state, cooperative
and private. Rural and urban areas are well served by the cooperative sector as
well as by corporate bodies with national status. There are more than 4,58,782
institutions channellising credit into the various areas of the economy.
On the other hand, the unorganised financial system comprises of relatively less
9controlled moneylenders, indigenous bankers, lending pawn brokers, landlords,
traders etc. This part of the financial system is not directly amenable to control by
the Reserve Bank of India (RBI). There are a host of financial companies,
investment companies and chit funds etc., which are also not regulated by the RBI
or the government in a systematic manner.
However, they are also governed by rules and regulations and are, therefore within
the orbit of the monetary authorities.
The formal financial system consists of four segments or components. These are:
Financial Institutions, Financial markets, financial instruments and financial
services.
Financial markets are also classified as primary, market and secondary market.
While the primary market deals in new issues, the secondary market deals for
trading in outstanding or existing securities. There are two components of the
secondary market, OTC (over the counter) market and Exchange traded market.
The government securities market is an OTC market, spot trades are negotiated or
traded for immediate delivery and payment while in the exchange traded market,
trading takes place over a trading cycle in stock exchanges. Derivatives markets
are OTC in some countries and exchange traded in some other countries.
Before investors lend money, they need to be reassured that it is safe to exchange
securities for funds. This reassurance is provided by the financial regulator who
regulates the conduct of the market, and intermediaries to protect the investors
interests. The Reserve Bank on India regulates the money market and Securities
and Exchange Board of India (SEBI) regulates capital market.
These four sub-systems do not function in isolation. They are interdependent and
interact continuously with each other. Their interaction leads to the development
of a smoothly functioning financial system.
Financial intermediaries have close links with the financial markets in the
economy. Financial institutions acquire, hold, and trade financial securities which
not only help in the credit-allocation process but also make the financial markets
larger, more liquid, stable and diversified. Financial intermediaries rely on
financial markets to raise funds whenever they are in need of some. This increases
One of the important functions of a financial system is to link the savers and
investors and thereby help in mobilizing and allocating the savings efficiently and
effectively. By acting as an efficient conduit for allocation of resources, it permits
continuous upgradation of technologies for promoting growth on a sustained basis.
A financial system not only helps in selecting projects to be funded but also
inspires the operators to monitor the performance of the investment. It provides a
payment mechanism for the exchange of goods and services and transfers
economic resources through time and across geographic regions and industries.
A financial system helps in the creation of a financial structure that lowers the cost
of transactions. This has a beneficial influence on the rate of return to savers. It
also reduces the cost of borrowing. Thus, the system generates an impulse among
the people to save more.
Two prominent polar designs can be identified among the varieties that exist. At
one extreme is the bank-dominated system, such as in Germany, where a few large
banks play a dominant role and the stock market is not important. At the other
extreme is the market-dominated financial system, as in the US, where financial
markets play an important role while the banking industry is much less
concentrated.
The other major industrial countries fall in between these two extremes. In India,
banks have traditionally been the dominant entities of financial intermediation.
The nationalization of banks, an administered interest rate regime, and the
government policy of favouring banks led to the predominance of a bank-based
financial system in India.
Capital market: A capital market is a market for long-term securities (equity and
debt). The purpose of capital market is to
A capital market can be further classified into primary and secondary markets.
The primary market is meant for new issues and the secondary market is a
market where outstanding issues are traded. In other words, the primary market
creates long-term instruments for borrowings, whereas the secondary market
provides liquidity through the marketability of these instruments. The
secondary market is also known as the stock market.
There is strong link between the money market and the capital market:
i. Often, financial institutions actively involved in the capital market are also
involved in the money market.
ii. Funds raised in the money market are used to provide liquidity for longer-
term investment and redemption of funds raised in the capital market.
The cost of acquiring information and making transactions creates incentives for
the emergence of financial markets and institutions. Different types and
combinations of information and transaction costs motivate distinct financial
contracts, instruments, and institutions.
A variety of services is provided by financial markets as they can alter the rate
of economic growth by altering the quality of these services.
The role of financial system in economic development has been a much discussed
topic among economists. Is it possible to influence the level of national income,
employment, standard of living, and social welfare through variations in the
supply of finance?
One view holds that finance is not important at all. The opposite view regards it to
be very important. The third school takes a cautionary view. It may be pointed out
that there is a considerable weight of thinking and evidence in favour of the third
view also. Let us briefly explain these viewpoints one by one.
In his model of economic growth, Solow has argued that growth results
predominantly from technical progress, which is exogenous, and not from the
increase in labor and capital. Therefore, money and finance and the policies about
them cannot contribute to the growth process.
It has been argued that men, materials, and money are crucial inputs in production
activities. The human capital and physical capital can be bought and developed
with money. In a sense, therefore, money, credit, and finance are the lifeblood of
the economic system. Given the real resources and suitable attitudes, a well--
developed financial system can contribute significantly to the acceleration of
We can conclude from the above that in order to understand the importance of the
financial system in economic development, we need to know its impact on the
saving and investment processes. The following theories have analyzed this
impact:
(a) The Classical Prior Saving Theory,
(b) Credit Creation or Forced Saving or Inflationary Financing Theory,
(c) Financial Repression Theory,
(d) Financial Liberalisation Theory.
The second strand of thought propounded by Keynes and Tobin argues that
investment, and not saving, is the constraint on growth, and that investment
determines saving and not the other way round. The monetary expansion and the
repressive policies result in a number of saving and growth promoting forces:
(a) If resources are unemployed, they increase aggregate demand,
output, and saving;
(b) If resources are fully employed, they generate inflation which lowers
the real rate of return on financial investments. This in turn, induces
portfolio shifts in such a manner that wealth holders now invest
more in real, physical capital, thereby increasing output and saving;
The extent of contribution of the financial sector to saving, investment, and growth
is said to depend upon its being free or repressed (regulated). One school of
thought argues that financial repression and the low/ negative real interest rates
which go along with it encourage people
(i) To hold their saving in unproductive real assets,
(ii) To be rent -seekers because of non-market allocation of investible
funds
(iii) To be indulgent which lowers the rate of saving,
(iv) To misallocate resources and attain inefficient investment profile, and
(v) To promote capital intensive industrial structure inconsistent with the
factor-endowment of developing countries. Financial liberalisation or
deregulation corrects these ill effects and leads to financial as well as
economic development. However, as indicated earlier, some economists
believe that financial repression is beneficial.
Q5. Which of these is true for money market & capital market:
a) Linked with each other
b) Not linked with each other
c) Money market does not provide liquidity to capital market
d) All are true
FINANCIAL MARKETS
Contents:
A Financial Market can be defined as the market in which financial assets are
created or transferred. As against a real transaction that involves exchange of
money for real goods or services, a financial transaction involves creation or
transfer of a financial asset. Financial Assets or Financial Instruments represents a
claim to the payment of a sum of money sometime in the future and /or periodic
payment in the form of interest or dividend.
Money Market- The money market is a wholesale debt market for low-risk,
highly-liquid, short-term instrument. Funds are available in this market for
periods ranging from a single day up to a year. This market is dominated mostly
by government, banks and financial institutions.
Forex Market - The Forex market deals with the multicurrency requirements,
which are met by the exchange of currencies. Depending on the exchange rate that
is applicable, the transfer of funds takes place in this market. This is one of the
most developed and integrated market across the globe.
Having designed the instrument, the issuer should then ensure that these financial
assets reach the ultimate investor in order to garner the requisite amount. When he
borrower of funds approaches the financial market to raise funds, mere issue of
securities will not suffice. Adequate information of the issue, issuer and the
security should be passed on to take place. There should be a proper channel
within the financial system to ensure such transfer. To serve this purpose,
Financial intermediaries came into existence. Financial intermediation in the
organized sector is conducted by a wide range of institutions functioning under the
overall surveillance of the Reserve Bank of India. In the initial stages, the role of
the intermediary was mostly related to ensure transfer of funds from the lender to
the borrower. This service was offered by banks, FIs, brokers, and dealers.
However, as the financial system widened along with the developments taking
place in the financial markets, the scope of its operations also widened. Some of
the important intermediaries operating ink the financial markets include;
investment bankers, underwriters, stock exchanges, registrars, depositories,
custodians, portfolio managers, mutual funds, financial advertisers financial
consultants, primary dealers, satellite dealers, self regulatory organizations, etc.
Though the markets are different, there may be a few intermediaries offering their
services in move than one market e.g. underwriter. However, the services offered
by them vary from one market to another.
Features:
The money Market is a whole sale market. The volumes are very large and
generally transactions are settled on daily basis. Trading in the money market is
conducted over the telephone followed by written confirmation from both the
borrowers and lenders. There are large numbers of participants in the money
market: commercial banks, mutual funds, investment institutions, financial
institutions, and finally the central bank of a country. The banks operations ensure
that the liquidity and short term interest rates are maintained at the levels
consistent with the objective of maintaining price and exchange rate stability. The
central bank occupies a strategic position in the money market. The money market
can obtain funds from central bank either by borrowing or through sale of
securities. The bank influences liquidity and interest rates by open market
operations, REPO transactions, changes in Bank Rate , cash Reserve
Requirements and by regulating access to its accommodation. A well developed
money market contributes to an effective implementation of the monetary policy.
Some of the important money market instruments are briefly discussed below;
1. Call/Notice Money
2. Treasury Bills
3. Term Money
4. Certificate of Deposit
5. Commercial Papers
Call/Notice money is the money borrowed or lent on demand for a very short
period. When money is borrowed or lent for a day, it is known as Call (Overnight)
Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus
money, borrowed on a day and repaid on the next working day, (irrespective of the
number of intervening holidays) is "Call Money". When money is borrowed or
lent for more than a day and up to 14 days, it is "Notice Money". No collateral
security is required to cover these transactions.
3. Treasury Bills
Treasury Bills are short term (up to one year) borrowing instruments of the union
government. It is an IOU of the Government. It is a promise by the Government to
pay a stated sum after expiry of the stated period from the date of issue
(14/91/182/364 days i.e. less than one year). They are issued at a discount to the
face value, and on maturity the face value is paid to the holder. The rate of
discount and the corresponding issue price are determined at each auction.
4. Certificate of Deposits
Usance: Commercial paper should be issued for a minimum period of 30 days and
a maximum of one year. No grace period is allowed for payment and if the
maturity period falls on a holiday it should be paid on the previous working day.
Every issue of commercial paper is treated as a fresh issue.
Investor: Commercial paper can be issued to any person, banks, companies and
other registered corporate bodies and unincorporated bodies. Issue to NRIs can
only be on a non-repatriable basis and is non transferable. The paper issued to the
NRI should state that it is non-repatriable and non-endorsable
Procedure of Issue: Commercial paper is issued only through the bankers who
have sanctioned working capital limits to the company. It is counted as a part of
working capital. Unlike public deposits, commercial paper really cannot augment
working capital resources. There is no increase in the overall short term borrowing
facilities.
The capital market generally consists of the following long term period i.e., more
than one year period, financial instruments; in the equity segment Equity shares,
preference shares, convertible preference shares, non-convertible preference shares
Hybrid Instruments
Hybrid instruments have both the features of equity and debenture. This kind of
instruments is called as hybrid instruments. Examples are convertible debentures,
warrants etc.
SHARES
Capital refers to the amount invested in the company so that it can carry on its
activities. In a company capital refers to "share capital". The capital clause in
Memorandum of Association must state the amount of capital with which
company is registered giving details of number of shares and the type of shares of
the company. A company cannot issue share capital in excess of the limit specified
in the Capital clause without altering the capital clause of the MA.
The following different terms are used to denote different aspects of share capital:-
2. Issued capital means that part of the authorised capital which has been offered
for subscription to members and includes shares allotted to members for
consideration in kind also.
3. Subscribed capital means that part of the issued capital at nominal or face value
which has been subscribed or taken up by purchaser of shares in the company and
which has been allotted.
4. Called-up capital means the total amount of called up capital on the shares
issued and subscribed by the shareholders on capital account. I.e if the face value
of a share is Rs. 10/- but the company requires only Rs. 2/- at present, it may call
only Rs. 2/- now and the balance Rs.8/- at a later date. Rs. 2/- is the called up share
capital and Rs. 8/- is the uncalled share capital.
5. Paid-up capital means the total amount of called up share capital which is
actually paid to the company by the members.
Types of shares: Shares in the company may be similar i.e they may carry the
same rights and liabilities and confer on their holders the same rights, liabilities
and duties. There are two types of shares under Indian Company Law :-
1. Equity shares means that part of the share capital of the company which are not
preference shares.
2. The shares will be only redeemable if they are fully paid up.
3. The shares may be redeemed out of profits of the company which otherwise
would be available for dividends or out of proceeds of new issue of shares
made for the purpose of redeem shares.
5. When shares are redeemed out of profits a sum equal to nominal amount of
shares redeemed is to be transferred out of profits to the capital redemption
reserve account. This amount should then be utilised for the purpose of
redemption of redeemable preference shares. This reserve can be used to
issue of fully paid bonus shares to the members of the company.
Sweat Equity Shares mean equity shares issued by the company to its directors
and / or employees at a discount or for consideration other than cash for providing
ii. The resolution specifies the number of shares, the current market price,
consideration, if any, and the class of employees to whom the shares are to
be issued
iii. At least 1 year has passed since the date on which the company became
eligible to commence business.
iv. In case of issue of such shares by a listed company, the Sweat Equity
Shares are listed on a recognized stock exchange in accordance with SEBI
regulations and where the company is not listed on any stock exchange, the
the prescribed rules are complied with.
DEBENTURES
The advantage of debentures to the issuer is they leave specific assets burden free,
and thereby leave them open for subsequent financing. Debentures are generally
From the issuer's perspective, the key benefit of raising money by selling
convertible bonds is a reduced cash interest payment. However, in exchange for
the benefit of reduced interest payments, the value of shareholder's equity is
reduced due to the stock dilution expected when bondholders convert their bonds
into new shares.
The convertible bond markets in the United States and Japan are of primary global
importance. These two domestic markets are the largest in terms of market
capitalization. Other domestic convertible bond markets are often illiquid, and
pricing is frequently non-standardised.
Asia (ex Japan): The Asia region provides a wide range of choice for an
investor. The maturity of Asian convertible bond markets varies widely.
Non Convertible Debentures are those that cannot be converted into equity shares
of the issuing company, as opposed to Convertible debentures, which can be. Non-
convertible debentures normally earn a higher interest rate than convertible
debentures do.
Bonds
In finance, a bond is a debt security, in which the authorized issuer owes the
holders a debt and is obliged to repay the principal and interest (the coupon) at a
later date, termed maturity.
A bond is simply a loan in the form of a security with different terminology: The
issuer is equivalent to the borrower, the bond holder to the lender, and the coupon
to the interest. Bonds enable the issuer to finance long-term investments with
external funds. Note that certificates of deposit (CDs) or commercial paper are
considered to be money market instruments and not bonds.
Bonds and stocks are both securities, but the major difference between the two is
that stock-holders are the owners of the company (i.e., they have an equity stake),
whereas bond-holders are lenders to the issuing company. Another difference is
that bonds usually have a defined term, or maturity, after which the bond is
redeemed, whereas stocks may be outstanding indefinitely.
Issuing bonds
Features of bonds
Maturity datethe date on which the issuer has to repay the nominal
amount. As long as all payments have been made, the issuer has no more
obligations to the bond holders after the maturity date. The length of time
until the maturity date is often referred to as the term or tenure or maturity
of a bond. The maturity can be any length of time, although debt securities
with a term of less than one year are generally designated money market
instruments rather than bonds. Most bonds have a term of up to thirty years.
Some bonds have been issued with maturities of up to one hundred years,
and some even do not mature at all. In early 2005, a market developed in
Euros for bonds with a maturity of fifty years. In the market for U.S.
Treasury securities, there are three groups of bond maturities:
Couponthe interest rate that the issuer pays to the bond holders. Usually
this rate is fixed throughout the life of the bond. It can also vary with a
money market index, such as LIBOR, or it can be even more exotic. The
name coupon originates from the fact that in the past, physical bonds were
issued which had coupons attached to them. On coupon dates the bond
holder would give the coupon to a bank in exchange for the interest
payment.
Coupon datesthe dates on which the issuer pays the coupon to the bond
holders. In the U.S., most bonds are semi-annual, which means that they
pay a coupon every six months. In Europe, most bonds are annual and pay
only one coupon a year.
Debentures and bonds are similar, but bonds are more secure than debentures. In
the case of both, the company pays you a guaranteed interest that does not change
in value irrespective of the fortunes of the company. However, bonds are more
secure than debentures, and carry a lower interest rate. In the case of bonds, the
company provides collateral for the loan. Moreover, in case of liquidation,
bondholders will be paid off before debenture holders.
In other words, the money being raised by the issuing company is in the
form of a foreign currency.
The investors receive the safety of guaranteed payments on the bond and
are also able to take advantage of any large price appreciation in the
company's stock. (Bondholders take advantage of this appreciation by
means warrants attached to the bonds, which are activated when the price of
the stock reaches a certain point.)
Due to the equity side of the bond, which adds value, the
coupon payments on the bond are lower for the
company, thereby reducing its debt-financing costs.
The FCCB holder opts to convert the FCCB, in case the market price
exceeds the option price or if there is an intention to make a strategic
investment by the lender irrespective of the stock price in market.
In many cases, the FCCB issuer may also look forward for conversion so
that there is no fund outflow on redemption. Instead, the issuers reserves
are inflated by receipt of premium.
If however, the FCCB holders do not opt for conversion, the Issuer has
either to reissue the bonds to same holder or redeem.
Among the Indian Companies, Reliance Industries Ltd. was the first company to
raise funds through a GDR issue.
Currently, there are over 1600 Depository Receipt programmes for companies
from over 60 countries. Companies have round that the establishment of a
depository receipt programme offers numerous advantages. The primary reasons
Benefits to an Investor
An owner of an ADR has the right to obtain the foreign stock it represents,
but US investors usually find it more convenient simply to own the ADR.
The price of an ADR is often close to the price of the foreign stock in its
home market, adjusted for the ratio of ADRs to foreign company shares.
The first ADR was introduced by JP Morgan in 1927, for the British
retailer Selfridges Co.
Indian bidders allowed raising funds through ADRs, GDRs and external
commercial borrowings (ECBs) for acquiring shares of PSEs in the first
stage and buying shares from the market during the open offer in the second
stage.
Companies have been allowed to invest 100 per cent of the proceeds of
ADR/GDR issues (as against the earlier ceiling of 50%) for acquisitions of
foreign companies and direct investments in joint ventures and wholly
owned subsidiaries overseas.
Any Indian company which has issued ADRs/GDRs may acquire shares of
foreign companies engaged in the same area of core activity upto $100
million or an amount equivalent to ten times of their exports in a year,
whichever is higher. Earlier, this facility was available only to Indian
companies in certain sectors.
Characteristics of ECBs
ECB can be raised from any internationally recognized source like banks,
export credit agencies, suppliers of equipment, foreign collaborations,
foreign equity - holders, international capital markets etc.
They are a source of finance for Indian corporates for expansion of existing
capacity as well as for fresh investment.
The guiding principles of the policy are to keep borrowing maturities long,
costs low, and encourage infrastructure and export sector financing, which
are crucial for the overall growth of the economy.
Capital issue management is concerned with the management of issues for raising funds
through various types of instruments by the companies. Management of capital issues in India
is a professional service rendered by merchant bankers. In fact, a major function of merchant
bankers is issue management. This can be attributed to the tremendous growth of public listed
companies in number and size and the complexity arising due it the ever-increasing SEBI
guidelines and requirements. The issue can be a public issue through prospectus, a rights (offer
of sale) issue or private placement and so on. Issue management involves the following
function in respect of issues through prospectus:
3. Drafting and finalizing of the prospectus and obtaining its clearance from the
various agencies concerned.
7. Coordinating printing, publicity and other work so as to get every thing ready at
the time of the public issue.
8. Complying with the SEBI guidelines after the issue is over (both in case of over
subscription or devolvement), by sending the various reports as required by the
authorities.
The procedure and steps for managing public issues fall under two phases: (1) pre-issue
management commencing with structuring of issues and up to the opening of subscription list;
(2) post issue management up to listing of securities on the stock exchange. The management
of capital issues in both the phases is regulated and monitored by the SEBI through regulations,
guidelines and so on. The present article dwells on the merchant banking activities relating to
capital issues in the form of public and rights issues.
Q6. Financial securities are assets for the __________ and liabilities for the
_________.
(a) issuer, buyer.
(b) buyer, issuer.
(c) grantor, grantee.
(d) brokerage house, client.
Contents:
Introduction
The capital market is the market for long term funds. Capital markets discharge
the important function of transfer of savings , specially of household sector to
companies, governments and public sector bodies. Individuals or households with
surplus money invest their savings in exchange for shares, debentures and
securities of such companies and governments. The market for such long term
sources of finance (equity and debt ) is primary market. In the primary market,
new issues of equity and debentures are arranged in the form of new floatation,
either publicly or privately in form of a rights offer, to existing share holders.
Companies raise new cash in exchange for financial;; claims. The financial claims
may take the form of shares or debentures. Public sector undertakings also issue
share securities. The transactions in primary market result in capital formation.
The primary market consists of new issue market in which new securities are sold
by public limited companies through public issue of debt or equity and financing
through venture capitalists.
The venture capital firm (a new financial intermediary which emerged in the early
eighties) provides substantial amounts of capital mostly through equity purchases
and occasionally through debt offerings to help growth oriented firms to develop
and succeed.
The Securities Market is divided into two segmentsthe Primary Market and the
Secondary Market. The main difference between these two lies in the facts that
while the former deals with the securities, which the issuer issues for the first time,
the latter deals in the existing securities.
Thus, the primary market facilitates the transfer of investible funds of the savers to
the corporates, which need them for - productive purposes. In the Secondary
Market, no new securities come into existence, rather the existing securities
change hands-one set of persons invest in them, while the other group disinvests.
The Primary Market, also called the New Issue Market, is of vital importance in
the economv of a country, as it leads to better utilisation of otherwise inactive
dormant monetary resources in the economy, These two markets are not isolated
from each other, rather they are very much inter-dependent. Activities in the new
issues market and the response of the investors to the near issues of securities
depend upon the prevailing conditions in the Secondary Market. If the secondary
There are three ways in which a company may raise capital in the primary market.
i) Public Issue
ii) Rights Issue
iii) Private Placement
No allotment can be made unless, the amount stated in the prospectus as the
minimum subscription has been subscribed, and the company has received sum
payable on application. Minimum subscription refers to the number of shares,
which should be subscribed. As per the SEBI guidelines, minimum subscription
has been fixed at 90% of entire public issue. Generally, the amount is mobilized in
two installments application money and allotment money. If the full amount is not
asked for at the time of allotment itself, the balance is called up in one or two calls
thereafter known as call money. The letter of allotment sent by the company is
exchangeable far share certificates. If the allottee fails to pay the calls, his shares
are liable to be forfeited. In that case, allottee is not eligible for any refund. The
public issue may also be underwritten by an underwriter.
Rights Issue
A rights issue involves selling securities in the primary market by issuing rights to
the existing shareholders. In this method the company gives the privilege to its
existing shareholders for the subscription of the new shares on prorata basis. A
company making a rights issue sends a letter of offer along with a composite
application form consisting of four parts A, B, C, and D. Part A is meant for
acceptance of the offer. Part B is used if the shareholder wants to renounce his
rights in favour of someone else. Part C is filled by the person in whose favour the
renunciation has been made. Part D is used to request the split of the shares.
The composite application form must be mailed to the company within a stipulated
period, which is usually 30 days. The shares that remain unsubscribed will be
offered to the public for subscription. Sometimes an existing company, can come
out with a simultaneous 'Right cum Public Issue'.
Private Placement
A Public Issue is a costly affair involving Press advertisements, brokers, fees and
Press conference, etc. Therefore, some of the companies find it easy and cheaper
to raise funds through private placement of bonds and shares.
In this method, the securities are issued to some selected investors like banks or
financial institutions. The private placement agreement is undertaken when the
issue size is not very big and the issuer does not want to spend much on floating
In May 1992, the above Act was repealed and instead the Securities and Exchange
Board of India (SEBI, Regulatory authority for stock market operations in India)
was empowered to exercise control over the new issues market as well. The SEBI
subsequently permitted the companies to determine the premium themselves.
However, SEBI issued guidelines in this regard, which divided the companies into
three categories, and within each category, companies which fulfilled conditions of
SEBI has brought about several reforms in the new issues market during recent
years. Important reforms are as detailed below:
In modern times, importance of merchant banker is very much, because it the key
intermediary between the company and issue of capital. Main activities of the
merchant bankers are Determining the composition of the capital structure,
drafting of prospectus and application forms, compliance with procedural
formalities, appointment of registrars to deal with the share application and
transfer, listing of securities, arrangement of underwriting / sub-underwriting,
placing of issues, selection of brokers, bankers to the issue, publicity and
advertising agents, printers and so on. Due to overwhelming importance of
merchant banker, it is now mandatory that merchant banker(s) functioning as lead
manager(s) should manage all public issues. In case of rights issue not exceeding
Rs.50 lakh, such appointments may not be necessary. The salient features of the
SEBI framework, related to merchant bankers are discussed as under.
Fee: A merchant banker has to pay a registration fee of Rs. 5 lakh and renewal
fees of Rs. 2.5 lakh every three years from the fourth year from the date of
registration.
Code of Conduct: Every merchant banker has to abide by the code of conduct, so
as to maintain highest standards of integrity and fairness, quality of services, due
diligence and professional judgment in all his dealings with the clients and other
people. A merchant banker has always to endeavor to (a) render the best possible
advice to the clients regarding clients needs and requirements, and his own
professional skill and (b) ensure that all professional dealings are effected in a
prompt, efficient and cost effective manner.
Due diligence certificate: The lead manager is responsible for the verification of
the contents of a prospectus / letter of offer in respect of an issue and the
reasonableness of the views expressed in them. He has to submit to the SEBI at
least two weeks before the opening of the issue for subscription a due diligence
certificate.
Action in case of Default: A merchant banker who fails to comply with any
conditions subject to which the certificate of registration has been granted by SEBI
and / or contravenes any of the provisions of the SEBI Act, rules or regulations, is
liable to any of the two penalties (a) Suspension of registration or (b) Cancellation
of registration.
Underwriters
Fee: Underwriters had to pay Rs. 5 lakhs as registration fee and Rs. 2 lakhs as
renewal fee every three years from the fourth year from the date of initial
registration. Failure to pay renewal fee leads to cancellation of certificate of
registration.
Code of conduct: Every underwriter has at all times to abide by the code of
conduct; he has to maintain a high standard of integrity, dignity and fairness in all
his dealings. He must not make any written or oral statement to misrepresent (a)
the services that he is capable of performing for the issuer or has rendered to other
issues or (b) his underwriting commitment.
Agreement with clients: Every underwriter has to enter into an agreement with the
issuing company. The agreement, among others, provides for the period during
which the agreement is in force, the amount of underwriting obligations, the
period within which the underwriter has to subscribe to the issue after being
Bankers to an Issue
Brokers are persons mainly concerned with the procurement of subscription to the
issue from the prospective investors. The appointment of brokers is not
compulsory and the companies are free to appoint any number of brokers. The
managers to the issue and the official brokers organize the preliminary distribution
of securities and procure direct subscription from as large or as wide a circle of
investors as possible. A copy of the consent letter from all the brokers to the issue,
should be filed with the prospectus to the ROC. The brokerage applicable to all
types of public issue of industrial securities is fixed at 1.5%, whether the issue is
underwritten or not. The listed companies are allowed to pay a brokerage on
private placement of capital at a maximum rate of 0.5%.
Code of Conduct: The registrars to an issue and the share transfer agents have to
maintain high standards of integrity and fairness in all dealings with their clients
and other registrars to the issue and share transfer agents in the conduct of the
business. They should endeavor to ensure that (a) enquiries from investors are
adequately dealt with, and (b) adequate steps are taken for proper allotment of
securities and refund of application money without delay and as per law. Also,
they should not generally and particularly in respect of any dealings in securities
to be a party to (a) creation of false market, (b) price rigging or manipulation (c)
passing of unpublished price sensitive information to brokers, members of stock
exchanges and other intermediaries in the securities market or take any other
action which is not in the interest of the investors and (d) no registrar to an issue,
share transfer agent or any of its directors, partners or managers managing all the
affairs of the business is either on their respective accounts, or though their
respective accounts, or through their associates or family members, relatives or
friends indulges in any insider trading.
Debenture Trustees A debenture trustee is a trustee for a trust deed needed for
securing any issue of debentures by a company. To act as a debenture trustee a
certificate from the SEBI is necessary. Only scheduled commercial banks, PFIs,
Insurance companies and companies are entitled to act as a debenture trustees. The
certificate of registration is granted to suitable applicants with adequate
infrastructure, qualified manpower and requisite funds. Registration fee is Rs. 5
lakhs and renewal fee is Rs. 2.5 lakhs every three years.
Portfolio Managers
The first type of portfolio management permits the exercise of discretion in regard
to investment / management of the portfolio of the securities / funds. In order to
carry on portfolio services, a certificate of registration from SEBI is mandatory.
The certificate of registration for portfolio management services is granted to
eligible applicants on payment of Rs.5 lakhs as registration fee. Renewal may be
granted by SEBI on payment of Rs. 2.5 lakhs as renewal fee (every three years).
Investment of Clients money: The portfolio manager should not accept money or
securities from his clients for less than one year. Any renewal of portfolio fund on
the maturity of the initial period is deemed as a fresh placement for a minimum
period of one year. The portfolio funds and is withdrawn or taken back by the
portfolio clients at his risk before the maturity date of the contract under the
following circumstances:
a. Voluntary or compulsory termination of portfolio management services by the
portfolio manager.
b. Suspension or termination of registration of portfolio manager by the SEBI.
c. Bankruptcy or liquidation in case the portfolio manager is a body corporate.
d. Permanent disability, lunacy or insolvency in case the portfolio manager is an
individual.
The portfolio manager can invest funds of his clients in money market instruments
or as specified in the contract, but not in bill discounting, badla financing or for
the purpose of lending
a. Time Frame
The circular of 5th December 2002, which was distributed to all Licensed Dealing
Members, the Stock Exchange, Investment Advisers, and Listed Companies,
refers. You are reminded that the circular requires draft prospectuses or
documents to be submitted to the Commission at least 6 weeks before the
proposed date for the opening of an offer.
The review process itself, is to establish that the prospectus has been prepared in
accordance with the Securities and Exchange Regulations, 2003 (L.I. 1728) and
contains adequate disclosure.
1. Schedule meetings with sponsor (and/or issuer) to discuss issues that need to be
discussed.
2. Advise amendments to the timetable as may be necessary in view of issues that
arise.
The sponsor/issuer will be required to cooperate fully with the Commission during
the process. Any new material information regarding the issue/issuer that becomes
available during the period (from the submission of the application to the SEC
until the Offer closes) must be communicated to the SEC and incorporated in the
offer document. The Commission will treat any such information that is not
disclosed as material withheld. Appropriate sanctions will apply in the event of
such conduct.
The issuer may proceed on a publicity campaign during this period with the sole
intention of generating interest of the investing public and to solicit commitments
in the offer.
The offer can be launched and declared open only after the Commissions
approval of the prospectus or offer document has been given in writing. It is only
then that the timetable for the offer can be fixed and presented to the Commission
for approval. The prospectus should then be made available to the public and
investors can formally apply for the shares. Where the issuer intends to use mini
prospectuses, the Commission needs to be informed about this. It should be stated
on the front cover that the Mini Prospectus should be read in conjunction with the
full prospectus. Full Prospectuses should be made available for inspection and for
applicants who wish to have them.
During the offer period the issuer can continue to advertise or promote the issue
to ensure success, but cannot introduce any new information that is not already
disclosed in the prospectus or offer document without prior permission from the
Commission. Both Manager and Issuer however, have an obligation to report to
the Commission on any new information that is material to the offer, and to do so
in a timely manner. Such new material information will be disclosed to the public
in the form of an addendum or by way of a publication or any other mode of
dissemination as the SEC may direct. The Commission has the power to invalidate
the offer should the circumstances so warrant.
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V. USE OF THE ESCROW ACCOUNT
The Commission requires the use of an escrow account for the lodgement of all
subscription monies for any public issue of securities. A template for a typical
escrow agreement is available at the SEC for guidance. The following procedures
are to be followed in the use of an escrow account.
1. Open an Escrow account at a bank and submit the Agreement to the SEC.
2. Escrow accounts shall be non-interest bearing.
3. All subscription monies shall be paid directly into the escrow account.
4. The escrow account shall not be debited except as a result of returned cheques,
refund of over subscription monies, or the payment of the offer amount to the
issuer.
5. All refunds shall be paid out of the escrow account that received the monies.
6. Refunds shall be in the form of printed cheques (like dividend warrants) payable
to subscribers and may be opened for cash on request.
7. A statement of account of the escrow account shall be submitted to the
Commission within 14 days after the close of the offer.
8. A bank issuing shares to the public may not hold its own escrow account.
During the period of refunding money to subscribers the Commission shall be
furnished with periodic (fortnightly) reports on the status of the refund process.
Sponsors of the offer may apply to the Commission for an extension of the offer
period. The following points should guide such requests.
1. Problems that may affect the success of the offer must be brought to the notice
of the Commission before the offer closes.
2. The Commission will consider applications for extension on a case-by-case
basis, especially in situations where market dynamics may have created a
situation that might have affected the overall response to an offer.
3. The sponsor/issuer is required to monitor the progress of the offer and the
market as a whole during the offer period, and this must be demonstrated to the
Commission. An application for extension therefore should be made at least
one week before the close of the offer(and not after the Offer has closed),
stating tangible reasons for the request. The Commission has the discretion to
approve or decline the request.
4. The Commission will respond to an extension request within 2 days of receipt
of the request in writing.
Regulation 33 (5) of the L.I. 1728 requires a person performing the functions of an
issuing house or a manager of a public issue of securities to submit to the
Commission, a report on the offer. This report should be submitted within 14 days
(two weeks) after the close of the offer, and shall include among others
information on the Offer such as:
Anyone who contravenes the provision of this regulation is liable for the payment
of a penalty of 1m for each day that the default subsists.
The fee for the examination and approval of a prospectus or offer document shall
be based on the amount realized for the shares issued. This fee should accompany
the report. The fees as set out in Schedule 2 of L.I. 1728 are as follows:
a) 1 million for any offer where the value is less than or equal to 1 billion
b) 0.05% of the offer where the value of the offer is greater than 1 billion
In the event that the minimum subscription is not attained, monies must be
returned to applicants immediately after the offer closes. The refund shall be made
in accordance with section 284 (4) of the Companies Code.
IX. ALLOTMENT
Under the Plan of Distribution in schedule five of the L.I. 1728, the offer
document shall provide information on the allotment policy, which will be adopted
if applications exceed the securities on offer.
In the light of recent developments with the floatation of IPOs, the Commission
reminds managers that they must ensure that they keep to the timetable set out in
offer documents and the Commission will enforce same.
In the event that the shares on offer are over-subscribed, monies should be
returned to applicants within ten (10) days after the allotment of shares. Any
refunds that are returned after the deadline shall attract interest at the Bank of
Ghana Prime Rate.
The Commission hereby emphasises that proceeds from the offer shall be held in
the escrow account, and refunds shall be made out of this account directly to
subscribers.
2. If the refund is being affected through receiving brokers, then dispatch shall be
considered concluded when the following are all in place,
If refunds occur later than the date indicated in the prospectus, then the SEC shall
consider the process complete only when the Manager has notified subscribers of
the refund.
Until the refund process is complete the Commission will require periodic
(weekly) reports on the refund of excess subscription monies.
All share certificates must be dispatched at least one week before trading can
commence.
1. Mode of dispatch of Certificates shall be according to the provisions of the
prospectus.
2. If dispatch of certificates and or excess monies occurs later than the date
indicated in the prospectus, the manager for the floatation has an obligation to
inform applicants/subscribers of a new timetable via a medium that is
acceptable by the SEC.
The following guidelines are provided to aid the process of issuing securities to
the public.
A. PUBLIC OFFERS
In the light of increased issues of securities to the public and recent developments
with the flotation of IPOs, it has become necessary for the Commission to provide
a guide to the market to streamline the process.
In furtherance of the above, the attached guidelines have been developed by SEC.
The guidelines are based on the provisions of the Securities and Exchange
Regulations 2003, LI 1728 and do not replace the Law and Regulations. The
Commission in addition to the provisions set out in Regulation 51 and Schedule 5
Part II A of LI 1728, issues the following notices to guide market participants.
Issuers shall require the approval of the Issuers registered shareholders granted at
an Annual General Meeting or Extraordinary General Meeting before funds raised
by the offer are used for any other purpose other than those disclosed in the offer
document.
A resolution to this effect when taken shall be communicated to the Commission.
The involvement and / or decisions of shareholders in the above-mentioned action
at the AGM or EGM is necessary as the law requires that the shareholders receive
full disclosure of all information that will enable them to make an informed
decision.
C. FLOTATION EXPENSES
The Securities and Exchange Commission acknowledges that some expenses must
necessarily be incurred in any Initial Public Offer or Rights Issue. The
Commission has however noted with disquiet that the flotation expenses incurred
in some IPOs / Rights Issues amount to as much as 10% of the proceeds raised.
The Commission is concerned that such expenditure prejudices the purpose for
which the money was ostensibly raised, i.e. the proposed expansion of the Issuers
business. As the underlying purpose of the flotation is the increased value of the
shareholders investment, the Issuer should endeavour to increase or maximize the
net proceeds of the flotation for the expansion of the business. The Commission
therefore directs that total flotation costs should not exceed 5% of the total amount
to be raised.
This service which the SEC has hitherto been providing gratis takes a heavy toll
on the SECs human resources and detracts from its other statutory duties.
The Commission is of the view that it is proper Issuers pay for this crucial and
invaluable service it provides as in other emerging markets. The Commission has
therefore proposed the following scale of processing fees for the review of
prospectuses with effect from 1st July 2006 (proposed starting date):
1. 20,000,000.00. for first submission
2. 10,000,000.00. for all re-submission due to material omissions or
discrepancies identified by the Commission after initial review at the first
submission.
Except for Johannesburg, turnover on all markets is less than 15 per cent of market
capitalization. There was no trading on the Maputo exchange in 2004. Low
turnover is reflected in, and feeds back onto, a lack of liquidity as illustrated by
large gaps between buy and sell orders, and high price volatility. This lack of
transactions is also somewhat reinforcing, as the transaction volume does not
justify investment in technology either by the exchange itself or member brokers.
Limited trading discourages listing and raising money on the exchanges. Even
linking different centers electronically (as for example in the BRVM, or with the
Master of Finance & Control Copyright Amity university India Page 71
case of Namibia whose stock exchange is now electronically linked to the JSE)
cannot guarantee much more trading and liquidity.
The small size and illiquidity of Africas stock exchanges partly reflects low levels
of economic activity, making it hard to reach a minimum efficient size or critical
mass, and partly also the state of company accounts and their reliability. Several of
the exchanges established in the late 1980s and 1990s were set up mainly in order
to facilitate privatization, and in the hope of attracting inward investment with the
modernization and technology transfer that that could convey (Moss, 2003). For
example, the stock exchange in Maputo was established in the process of
privatizing Mozambiques national brewery, which is still the only listed company
and which has to bear the operating costs of the stock exchange. To the extent that
their establishment was driven by outside influencesrather than emerging from a
realistic need felt in the market, whether by investors or issuersit is perhaps
unsurprising that many have so far struggled to reach an effective scale and
activity level. Pricing on all of the markets appears to build in a sizable risk
premium to judge for example from the low price-earnings ratios that have been
prevalent (Moss, 2003; Senbet and Otchere, 2005). The widespread limitations on
foreign holdings of listed shares, although diminishing in recent years, have also
contributed to low prices.24 High risk perceptions affect all countries, even those
with stable macroeconomic environment; indeed, most countries lack sovereign
credit ratings. The perceived risk is reflected also in the very small amount of
The market for long term securities like bonds, Equity, stocks and preferred stocks
is divided into primary market and secondary market. The primary market deals
with the new issues of securities. Outstanding securities are traded in the
secondary market, which is commonly known as stock market or stock exchange.
In the secondary market, the investors can sell buy securities. Stock market
predominantly deals in the equity shares. Debt instruments like bonds and
debentures are also traded in the stock market. Well regulated and active stock
market promotes capital formation. Growth of the primary market depends on the
secondary market. The health of the economy is reflected by the growth of the
stock market.
Fair dealing: The exchange assures that no investor will have an undue
advantage over other market participants
Efficient Market: This means that orders are executed and transactions are
settled in the fastest possible way
Transparency: Investor make informed and intelligent decision about the
particular stock based on information. Listed companies must disclose
information in timely, complete and accurate manner to the Exchange and
the public on a regular basis Required information include stock price,
corporate conditions and developments dividend, mergers and joint
ventures, and management changes etc
Doing Business: People who buy or sell stock on an exchange do so
through a broker The broker takes your order to the floor of the exchange
and looks for a broker representing someone wanting to buy or sell. If a
mutually agreeable price is found the trade is made
Maintains active Trading: A continuous trading on exchange increases the
liquidity or marketability of the shares traded on the stock exchange.
Fixation of prices: Price is determined by the transactions that flow from
investors demand and suppliers preferences. Usually the traded process is
made known to the public. This helps investors to make better decisions.
Ensure safe and fair dealing: The rules regulations and by laws of the stock
exchanges provide a measure of safety to the investors.
Regulatory Framework:
primary dealers
Market intermediaries
Monetary Policy
Collective investment
Settlement systems
Secondary market
Central bank of a country: Central bank of a country through its operations keeps
a check on the operations of the stock market. It regulates the business of stock
exchange, other security market and even the mutual funds. Registration and
regulation of other market intermediaries are also carried out by Central bank.
For example: The primary Mission of the Ghana Securities and Exchange
Commission (SEC) is to protect investors and maintain the integrity of the
securities market. As more and more first-time investors begin to look upon the
securities market as an alternative investment opportunity and as a means of
securing their futures, paying for homes, and educating children, these goals are
more compelling than ever. The SEC has a governing board as per the law. The
governing board has the responsibility to maintain an orderly and well regulated
market.
Commissioners of SEC
The Securities Industry Law, 1993 (PNDCL 333) as amended by the Securities
Industry (Amendment) Act 2000 (Act 590) provides that Commissioners of the
SEC shall be composed of a maximum of Eleven (11) members.
Act 590 provides that the Commission's membership be made up of the following:
1. A Chairman
2. The Director-General
11. Four other persons including either a judge of the Superior Court or a
lawyer qualified to be appointed a judge of the Superior Court.
The Commissioners of the SEC, who shall hold office for a period of 3 years, are
appointed by the President of the Republic acting in consultation with the Council of
State.
The Commissioners are eligible for re-appointment at the end of their three-year term.
The Administrative Hearings Committee, which has a composition of five (5) members
(who are all Commissioners), is chaired by the chairman of the Commission.
Act 590 also provides that any complaint, dispute or violation arising from Act 590,
PNDCL 333 or Regulations made thereunder shall, before redress is sought in the
courts be addressed by the Administrative Hearings Committee.
The Present Commissioners of the SEC were appointed by His Excellency, the
President of Ghana in consultation with the members of the Council of State as
required by Law on the 17th of January, 2002 and they were sworn into office on the
17th of March, 2002.
(Source: http://www.secghana.org/aboutus/commissioners.asp)
Types of Orders
Buy and Sell orders re placed with the members of the stock exchange by the
investors. The orders are of different types:
Limit Orders: Orders are limited by a fixed price Buy Reliance Petroleum
at Rs.50.Here, the order has clearly indicated the price at which it has
bought and the investor is not willing to give more than Rs50.
Best rate Order: Here, the buyer or seller gives the freedom to the broker to
execute the order at the best possible rate quoted on that particular date for
buying. It may be the lowest rate for buying and the highest rate for selling.
Discretionary order: The investor gives the range of price for purchase and
sale. The broker can use his discretion to buy within the specified limit.
Generally the approximate price is fixed. The order stands as this : Buy
BRC 100 shares around Rs 40.
Stop Loss Order: The order is given to the limit the loss due to unfavorable
price movements in the market. A particular limit is given for waiting. If the
price falls below the limit, the broker is authorized to sell the shares to
prevent further losses. Ex: Sell BRC at Rs 25 , stop loss at Rs 22
Growth Stocks:
In the investment world we come across terms such as Growth stocks, Value
stocks etc. Companies, whose potential for growth in sales and earnings are
excellent, are growing faster than other companies in the market or other stocks in
the same industry are called the Growth Stocks. These companies usually pay little
or no dividends and instead prefer to reinvest their profits in their business for
further expansions.
Value Stocks:
The task here is to look for stocks that have been overlooked by other investors
and which may have a hidden value. These companies may have been beaten
down in price because of some bad event, or may be in an industry that's not
fancied by most investors. However, even a company that has seen its stock price
decline still has assets to its name - buildings, real estate, inventories, subsidiaries,
and so on. Many of these assets still have value, yet that value may not be
reflected in the stock's price. Value 38 investors look to buy stocks that are
undervalued, and then hold those stocks until the rest of the market realizes the
real value of the company's assets. The value investors tend to purchase a
company's stock usually based on relationships between the current market price
of the company and certain business fundamentals. They like P/E ratio being
below a certain absolute limit; dividend yields above a certain absolute limit; Total
sales at a certain level relative to the company's market capitalization, or market
value etc.
The Bid is the buyers price. It is this price that you need to know when you have
to sell a stock. Bid is the rate/price at which there is a ready buyer for the stock,
which you intend to sell.
The Ask (or offer) is what you need to know when you're buying i.e. this is the
rate/ price at which there is seller ready to sell his stock. The seller will sell his
stock if he gets the quoted Ask price. If an investor looks at a computer screen
for a quote on the stock of say XYZ Ltd, it might look something like this:
PORTFOLIO
Introduction
Debt instrument represents a contract whereby one party lends money to another
on pre-determined terms with regards to rate and periodicity of interest, repayment
of principal amount by the borrower to the lender. In Indian securities markets, the
term bond is used for debt instruments issued by the Central and State
governments and public sector organizations and the term debenture is used for
instruments issued by private corporate sector.
Each debt instrument has three features: Maturity, coupon and principal.
Maturity: Maturity of a bond refers to the date, on which the bond matures, which
is the date on which the borrower has agreed to repay the principal. Term-to-
Master of Finance & Control Copyright Amity university India Page 81
Maturity refers to the number of years remaining for the bond to mature. The
Term-to-Maturity changes everyday, from date of issue of the bond until its
maturity. The term to maturity of a bond can be calculated on any date, as the
distance between such a date and the date of maturity. It is also called the term or
the tenure of the bond.
Coupon: Coupon refers to the periodic interest payments that are made by the
borrower (who is also the issuer of the bond) to the lender (the subscriber of the
bond). Coupon rate is the rate at which interest is paid, and is usually represented
as a percentage of the par value of a bond.
Principal: Principal is the amount that has been borrowed, and is also called the
par value or face value of the bond. The coupon is the product of the principal and
the coupon rate.
The name of the bond itself conveys the key features of a bond. For example, a GS
CG2008 11.40% bond refers to a Central Government bond maturing in the year
2008 and paying a coupon of 11.40%. Since Central Government bonds have a
face value of Rs.100 and normally pay coupon semi-annually, this bond will pay
Rs. 5.70 as six- monthly coupon, until maturity.
Interest is the amount paid by the borrower (the company) to the lender (the
debenture-holder) for borrowing the amount for a specific period of time. The
interest may be paid annual, semi-annually, quarterly or monthly and is paid
usually on the face value (the value printed on the bond certificate) of the bond.
There are three main segments in the debt markets in India, viz., (1) Government
Securities, (2) Public Sector Units (PSU) bonds, and (3) Corporate securities.
The market for Government Securities comprises the Centre, State and State-
sponsored securities. In the recent past, local bodies such as municipalities have
also begun to tap the debt markets for funds. Some of the PSU bonds are tax free,
while most bonds including government securities are not tax-free. Corporate
bond markets comprise of commercial paper and bonds. These bonds typically are
structured to suit the requirements of investors and the issuing corporate, and
include a variety of tailor- made features with respect to interest payments and
redemption.
Given the large size of the trades, Debt market is predominantly a wholesale
market, with dominant institutional investor participation. The investors in the
debt markets are mainly banks, financial institutions, mutual funds, provident
funds, insurance companies and corporates.
Most Bond/Debenture issues are rated by specialised credit rating agencies. Credit
rating agencies in India are CRISIL, CARE, ICRA and Fitch. The yield on a bond
varies inversely with its credit (safety) rating. The safer the instrument, the lower
is the rate of interest offered.
A credit rating agency (CRA) is a company that assigns credit ratings for issuers
of certain types of debt obligations as well as the debt instruments themselves. In
some cases, the services of the underlying debt are also given ratings. In most
cases, the issuers of securities are companies, special purpose entities, state and
local governments, non-profit organizations, or national governments issuing debt-
like securities (i.e., bonds) that can be traded on a secondary market. A credit
rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its
ability to pay back a loan), and affects the interest rate applied to the particular
security being issued.
CAREAAA Debt service payments protected by stable Cash flows with good
margin
CARE AA High quality but rated lower because of Somewhat lower margin
of protection
In order of increasing risk, the ratings for short-term instruments are PR-1,PR-2,
PR-3 and PR-5 and CARE -1, CARE -2, CARE -3, CARE 4, and CARE 5 for
credit analysis of companies.
Q1. If you buy stock from a corporation newly-formed by your sibling when
the firm makes its initial public offering (IPO), you would be engaged in:
(a) direct primary financing.
(b) long-term debt financing.
(c) Part-mutual financing.
(d) short term equity financing.
(e) mutual funding.
Q3. The markets in which the general public is least likely to learn about
activities are:
(a) primary markets.
(b) secondary markets.
(c) money market markets.
(d) residential real estate markets.
Q4. A corporation acquires new funds only when its securities are sold in the:
(a) secondary market by an investment bank.
(b) primary market by an investment bank.
(c) international money market by a stock exchange broker.
(d) secondary market by a commercial bank.
Q5. Security transactions that do not yield flows of funds to the issuers of the
financial instruments traded are financial investments involving:
(a) brokerage services by investment bankers.
(b) initial public offerings [IPOs].
(c) secondary markets.
(d) new issues of seasoned instruments.
(e) insider trading by corporate executives.
MUTUAL FUNDS
Contents:
Mutual funds are financial intermediaries which collect the savings of investors
and invest them in a large and well diversified portfolio of securities such as
money market instruments, corporate and Government bonds and equity shares of
joint stock companies. A mutual fund is a pool of commingle funds invested by
different investors, who have not contract with each other. Mutual funds are
conceived as institutions for providing small investors with avenues of
investments in the capital market.. Since small investors generally do not have
adequate time, knowledge, experience and resources for directly accessing the
capital market, they have to rely on an intermediary which undertakes informed
investment decisions and provides the consequential benefits of professional
expertise. The raison deter of mutual funds is their ability to bring down
transaction costs. The advantages for the investors are reduction in risk, export
professional management ,diversified portfolios, liquidity of investment and tax
benefits . By pooling their assets through mutual funds, investors achieve
economies of scale. The interests of the investors are protected by the SEBI which
acts as a watch dog. Mutual funds are governed by the SEBI (Mutual Funds)
Regulations,1993.
MUTUAL FUNDS IN INDIA:
The first mutual fund to be set up was the Unit Trust of India in 1964 under an
act of Parliament . During the years 1987-1992,even new mutual funds were
established in the public sector. In 1993, the government changed the policy to
allow the entry of private corporations and foreign institutional investors in to
the mutual fund segment. By the end of march 2000, apart from UTI there were 36 mutual
funds, 9 in the public sector and 27 in the private sector.
The UTI dominated the mutual fund sector till 1994-95, accounting for 76.5% of the total
mobilization. But there were large repurchases by UTI in 1995-97, which resulted in
reverse flow funds. Meanwhile the number of mutual funds especially in the private sector
have grown along the number of schemes matching the preferences of the investors. The
year 1999-2000 was a watershed year in which mutual funds emerged as an important
investment conduit for investors at large. Net resource mobilization by all mutual funds
amounted to 21,972 crores. Growth was led mainly by private sector mutual funds, which
witnessed an inflow of the order of Rs. 17,171.0 crores. Fiscal incentives provided in the
union funds 1999-2000 exempted all income received by the investors from UTI and other
mutual funds from income-tax. All open-ended equity oriented schemes along with the US
64 scheme were exempted from dividend tax for 3 years. Buoyant stock markets were also
a
contributory factor. The outstanding net assets of all domestic schemes of mutual funds
stood at Rs 1,07,946 crores at the end of March 2000. The share of UTI in the outstanding
assets was 67%, public sector funds 10%, and private sector mutual funds 23%.
Small investments: Mutual funds help you to reap the benefit of returns by a
portfolio spread across a wide spectrum of companies with small investments.
Spreading Risk: An investor with limited funds might be able to invest in only
one or two stocks/bonds, thus increasing his or her risk. However, a mutual fund
will spread its risk by investing a number of sound stocks or bonds. A fund
normally invests in companies across a wide range of industries, so the risk is
diversified.
Choice: The large amount of Mutual Funds offer the investor a wide variety to
choose from. An investor can pick up a scheme depending upon his risk/ return
profile.
Regulations: All the mutual funds are registered with SEBI and they function
within the provisions of strict regulation designed to protect the interests of the
investor.
NAV or Net Asset Value of the fund is the cumulative market value of the assets of
the fund net of its liabilities. NAV per unit is simply the net value of assets divided
by the number of units outstanding. Buying and selling into funds is done on the
basis of NAV-related prices. The NAV of a mutual fund are required to be
published in newspapers. The NAV of an open end scheme should be disclosed on
a daily basis and the NAV of a close end scheme should be disclosed at least on a
weekly basis
A Load is a charge, which the mutual fund may collect on entry and/or exit from a
fund. A load is levied to cover the up-front cost incurred by the mutual fund for
selling the fund. It also covers one time processing costs. Some funds do not
charge any entry or exit load. These funds are referred to as No Load Fund.
Funds usually charge an entry load ranging between 1.00% and 2.00%. Exit loads
vary between 0.25% and 2.00%.
For e.g. Let us assume an investor invests Rs. 10,000/- and the current NAV is
Rs.13/-. If the entry load levied is 1.00%, the price at which the investor invests is
Rs.13.13 per unit. The investor receives 10000/13.13 = 761.6146 units. (Note that
units are allotted to an investor based on the amount invested and not on the basis
of no. of units purchased).
Let us now assume that the same investor decides to redeem his 761.6146 units.
Let us also assume that the NAV is Rs 15/- and the exit load is 0.50%. Therefore
the redemption price per unit works out to Rs. 14.925. The investor therefore
receives 761.6146 x 14.925 = Rs.11367.10.
Mutual Funds do not provide assured returns. Their returns are linked to their
performance. They invest in shares, debentures, bonds etc. All these investments
involve an element of risk. The unit value may vary depending upon the
performance of the company and if a company defaults in payment of
interest/principal on their debentures/bonds the performance of the fund may get
affected. Besides incase there is a sudden downturn in an industry or the
government comes up with new a regulation which affects a particular industry or
company the fund can again be adversely affected. All these factors influence the
performance of Mutual Funds.
Some of the Risk to which h Mutual Funds are exposed to is given below:
Market risk
If the overall stock or bond markets fall on account of overall economic factors,
the value of stock or bond holdings in the fund's portfolio can drop, thereby
impacting the fund performance.
Bad news about an individual company can pull down its stock price, which can
negatively affect fund holdings. This risk can be reduced by having a diversified
portfolio that consists of a wide variety of stocks drawn from different industries.
Bond prices and interest rates move in opposite directions. When interest rates
rise, bond prices fall and this decline in underlying securities affects the fund
negatively.
Credit risk
Bonds are debt obligations. So when the funds invest in corporate bonds, they run
the risk of the corporate defaulting on their interest and principal payment
obligations and when that risk crystallizes, it leads to a fall in the value of the bond
causing the NAV of the fund to take a beating.
Funds that invest in equity shares are called equity funds. They carry the principal
objective of capital appreciation of the investment over the medium to long-term.
They are best suited for investors who are seeking capital appreciation. There are
different types of equity funds such as Diversified funds, Sector specific funds and
Index based funds.
Diversified funds
These funds invest in companies spread across sectors. These funds are generally
meant for risk-averse investors who want a diversified portfolio across sectors.
Sector funds
These funds invest in the same pattern as popular market indices like S&P CNX
Nifty or CNX Midcap 200. The money collected from the investors is invested
only in the stocks, which represent the index. For e.g. a Nifty index fund will
invest only in the Nifty 50 stocks. The objective of such funds is not to beat the
market but to give a return equivalent to the market returns.
These funds offer tax benefits to investors under the Income Tax Act.
Opportunities provided under this scheme are in the form of tax rebates under the
Income Tax act.
Debt/Income Funds
These funds invest in highly liquid money market instruments. The period of
investment could be as short as a day. They provide easy liquidity. They have
emerged as an alternative for savings and short-term fixed deposit accounts with
comparatively higher returns. These funds are ideal for corporates, institutional
investors and business houses that invest their funds for very short periods.
Gilt Funds
These funds invest in Central and State Government securities. Since they are
Government backed bonds they give a secured return and also ensure safety of the
principal amount. They are best suited for the medium to long-term investors who
are averse to risk.
Balanced Funds
Open-ended Funds
These funds do not have a fixed date of redemption. Generally they are open for
subscription and redemption throughout the year. Their prices are linked to the
daily net asset value (NAV). From the investors' perspective, they are much more
liquid than closed-ended funds.
Close-ended Funds
These funds are open initially for entry during the Initial Public Offering (IPO)
and thereafter closed for entry as well as exit. These funds have a fixed date of
redemption. One of the characteristics of the close-ended schemes is that they are
generally traded at a discount to NAV; but the discount narrows as maturity nears.
These funds are open for subscription only once and can be redeemed only on the
fixed date of redemption. The units of these funds are listed on stock exchanges
(with certain exceptions), are tradable and the subscribers to the fund would be
able to exit from the fund at any time through the secondary market.
The term investment plans generally refers to the services that the funds provide
to investors offering different ways to invest or reinvest. The different investment
plans are an important consideration in the investment decision, because they
determine the flexibility available to the investor. Some of the investment plans
offered by mutual funds in India are:
A growth plan is a plan under a scheme wherein the returns from investments are
reinvested and very few income distributions, if any, are made. The investor thus
only realizes capital appreciation on the investment. Under the dividend plan,
income is distributed from time to time. This plan is ideal to those investors
requiring regular income.
Return form mutual funds: Investors on mutual funds can obtain the following
returns . They are:
1. Dividends.
2. Capital gains.
3. Increase or decrease in NAV
Although mutual funds do not earn high rates of return, they are able to reduce risk
to the systematic level of market fluctuations. Most mutual funds earn in long run,
an average rate of return that exceeds the return on bank tern deposits.
The Sponsor of a fund is the entity that sets up the mutual fund. The fund is
governed either by a Board of Trustees, or The Directors Of A Trustees
Company. The sponsor selects them. The Board of Trustee is responsible for
protecting the investors interests. The sponsor or the trustee if so authorized by
the Trust Deed appoints the Asset Management Company (AMC) for the
investment and administrative functions. The AMC does the research, and
manages the corpus of the fund. It launches the various schemes of the fund,
manages them, and then liquidates them at the end of their term. It also takes care
of the other administrative work of the fund. It receives annual management fees
from the fund from its services. The Custodians are appointed by the sponsor for
looking after the transfer and storage of the securities and co-ordinate with the
brokers.
The Trustee
A mutual fund in India is constituted in the form of a Public Trust created under
the Indian Trusts Act 1882. The Fund Sponsor acts as the Settler of the Trust,
contributing to its initial capital and appoints a trustee to hold the assets for the
benefit of the unit-holders, who are the beneficiaries of the trust. The fund then
invites investors to contribute their money in the common pool, by subscribing to
units issued by various schemes established by the trust, units being the evidence
of their beneficial interest in the fund.
The trust the mutual fund- may be managed by a Board of Trustees- a body of
individuals, or a trust company- a corporate body. The Board of Trustees manages
most of the funds in India. While the Provisions of the Indian Trusts Act, govern
the Board of Trustees where the Trustee is a corporate body, it would also be
required to comply with the provisions of the companies Act, 1956. The Board or
the trustee company, as an independent body, acts as protector of the unit-holders
interest the trustees do not directly manage the portfolio of securities.
For this specialist function, they appoint an Asset Management Company. They
ensure that the fund is managed by the AMC as per the defined objectives and in
accordance with the Trust Deed and SEBI Regulations.
The trustees being the primary guardians of the unit holders funds and assets, a
trustee has to be a person of high repute and integrity. He acts as a watchdog over
the AMC so that the investors money is safe and secure.
Fund Management
When investment decisions of the fund are at the discretion of a fund manager(s)
and he or she decides which company, instrument or class of assets the fund
should invest in based on research, analysis, market news etc. such a fund is called
as an actively managed fund. The fund buys and sells securities actively based on
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changed perceptions of investment from time to time. Based on the classifications
of shares with different characteristics, active investment managers construct
different portfolio.
Two basic investment styles prevalent among the mutual funds are Growth
Investing and Value Investing:
A Value Manager looks to buy companies that they believe are currently
undervalued in the market, but whose worth they estimate will be recognized in
the market valuations eventually.
When an investor invests in an actively managed mutual fund, he or she leaves the
decision of investing to the fund manager. The fund manager is the decision-
maker as to which company or instrument to invest in. Sometimes such decisions
may be right, rewarding the investor handsomely. However, chances are that the
decisions might go wrong or may not be right all the time which can lead to
substantial losses for the investor. There are mutual funds that offer Index funds
whose objective is to equal the return given by a select market index. Such funds
follow a passive investment style. They do not analyse companies, markets,
economic factors and then narrow down on stocks to invest in. Instead they prefer
to invest in a portfolio of stocks that reflect a market index, such as the Nifty
index. The returns generated by the index are the returns given by the fund. No
attempt is made to try and beat the index. Research has shown that most fund
managers are unable to constantly beat the market index year after year. Also it is
not possible to identify which fund will beat the market index.
Therefore, there is an element of going wrong in selecting a fund to invest in. This
has lead to a huge interest in passively managed funds such as Index Funds where
the choice of investments is not left to the discretion of the fund manager. Index
Funds hold a diversified basket of securities which represents the index while at
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the same time since there is not much active turnover of the portfolio the cost of
managing the fund also remains low.
This gives a dual advantage to the investor of having a diversified portfolio while
at the same time having low expenses in fund. There are various passively
managed funds in India today some of them are:
Principal Index Fund, an index fund scheme on S&P CNX Nifty launched by
Principal Mutual Fund in July 1999.
UTI Nifty Fund launched by Unit Trust of India in March 2000.
Franklin India Index Fund launched by Franklin Templeton Mutual
Fund in June 2000.
Franklin India Index Tax Fund launched by Franklin Templeton
Mutual Fund in February 2001.
Magnum Index Fund launched by SBI Mutual Fund in December 2001.
IL&FS Index Fund launched by IL&FS Mutual Fund in February 2002.
Prudential ICICI Index Fund launched by Prudential ICICI Mutual Fund in
February 2002.
HDFC Index Fund-Nifty Plan launched by HDFC Mutual Fund in July 2002.
Birla Index Fund launched by Birla Sun Life Mutual Fund in September 2002.
LIC Index Fund-Nifty Plan launched by LIC Mutual Fund in November 2002.
Tata Index Fund launched by Tata TD Waterhouse Mutual Fund in February 2003.
ING Vysya Nifty Plus Fund launched by ING Vysya Mutual Fund in January
2004.
Canindex Fund launched by Canbank Mutual Fund in September 2004
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UTI was set up as a trust without ownership capital and with an independent Board
of Trustees. The Board of Trustees manages the affairs and business of UTI. The
Board performs its functions, keeping in view the interest of the unit-holders under
various schemes. UTI has a wide distribution network of 54 branch offices, 266
chief representatives and about 67,000 agents. These Chief representatives supervise
agents. UTI manages 72 schemes and has an investors base of 20.02 million
investors. UTI has set up 183 collection centres to serve to serve investors. It has 57
franchisee offices which accept applications and distribute certificates to unit-
holders.
UTIs mission statement is to meet the investors diverse income and liquidity needs
by creation of appropriate schemes, to offer best possible returns on his investment,
and render him prompt and efficient service, baying normal customer expectations.
UTI was the first mutual fund to launch India Fund, an offshore mutual fund in
1986. The India Fund was launched as a close-ended fund but became a multi-class ,
open ended fund in 1994. Thereafter, UTI floated the India
Growth Fund in 1988, the Columbus India Fund in 1994, and the India Access Fund
in 1996. The India Growth Fund is listed on the New York Stock Exchange. The
India Access Fund is an Indian Index Fund, tracking the NSE 50 index.
UTIs Associates:
UTI has set up associate companies in the field of banking, securities trading ,
investor servicing, investment advice and training, towards creating a diversified
financial conglomerate and meeting investors varying needs under a common
umbrella.
UTI BANK Limited: UTI Bank was the first private sector bank to be set up in
1994. The Bank has a network of 121 fully computerized branches spread across the
country. The Bank offers a wide range of retail, corporate and forex services.
UTI Securities Exchange Limited: UTI Securities Exchange Limited was the first
institutionally sponsored corporate stock broking firm incorporated on June28,1994,
with a paid-up capital of Rs.300 million. It is wholly owned by UTI and promoted
to provide secondary market trading facilities, investment banking, and other related
services. It has acquired membership of NSE,BSE,OTCEI and Ahmedabad Stock
Exchange (ASE) UTI Investors Services Limited: UTI Investor Services Limited
was the first Institutionally sponsored Registrar and Transfer agency set up in 1993.
It helps UTI in rendering prompt and efficient services to the investors.
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UTI Institute of Capital Markets: UTI Institute of Capital Market was set up in
1989 as a non-profit educational society to promote professional development of
capital market participants. It provides specialized professional development
programmes for the varied constituents of the capital market and is engaged in
research and consultancy services. It also serve as a forum to discuss ideas and issues
relevant to the capital market.
UTI has extended its support to the development of unit trusts in Sri Lanka and Egypt.
It has participated in the equity capital of the Unit Trust Management Company of Sri
Lanka.
Promotion of Institutions:
The Unit Trust of India has helped in promoting/co-promoting many institutions for
the healthy development of financial sector. These institutions are:
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Review Questions
Q2. All else equal, the more diversified an investors portfolio is,
a) The less risky that portfolio will be.
b) The less liquid that portfolio will be.
c) The lower that portfolios yield will be.
d) None of the above.
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Q6. Which of the following is not an advantage of mutual funds:-
a) Expertise in selection and timing of investment
b) Economics of scale
c) Dividends are tax free
d) Limited investment opportunities and hence no need for the investor to
have knowledge of investment management
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CHAPTER 5
Contents:
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Foreign Direct Investment is viewed as a major stimulus to economic growth in
developing countries. Its perceived ability to deal with major obstacles such
shortages of financial resources, technology, and skills. This has made it the center
of attention for policy makers in developing countries such as Africa. FDI refers to
investment made to acquire a lasting management interest (usually at least 10 % of
voting stock) and acquiring at least 10% of equity share in an enterprise operating
in a country other than the home country of the investor. FDI can take the form of
either greenfield investment (also called "mortar and brick" investment) or
merger and acquisition (M&A), depending on whether the investment involves
mainly newly created assets or just a transfer from local to foreign firms.
5.1 Foreign direct investment (FDI) in its classic form is defined as a company
from one country making a physical investment into building a factory in another
country. It is the establishment of an enterprise by a foreigner. Its definition can be
extended to include investments made to acquire lasting interest in enterprises
operating outside of the economy of the investor.The FDI relationship consists of a
parent enterprise and a foreign affiliate which together form a multinational
corporation (MNC). In order to qualify as FDI the investment must afford the
parent enterprise control over its foreign affiliate. The IMF (International
Monetary Fund) defines control in this case as owning 10% or more of the
ordinary shares or voting power of an incorporated firm or its equivalent for an
unincorporated firm; lower ownership shares are known as portfolio investment
Types of FDI
I. By Direction
1.
Inward
Tax breaks, subsidies, low interest loans, grants, lifting of certain restrictions. The
thought is that the long term gain is worth short term loss of income.
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Inward FDI is restricted by:
2. Outward
II. By Target
1. Greenfield investment
Greenfield investments results in the loss of market share for competing domestic
firms.
The Profits are perceived to bypass local economies, and instead flow back
entirely to the multinational's home economy.
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2. Mergers and Acquisitions
Transfers of existing assets from local firms to foreign firms takes place; the
primary type of FDI. Cross-border mergers occur when the assets and operation of
firms from different countries are combined to establish a new legal entity.
3.Horizontal FDI
a) Vertical FDI
III. By Motive
FDI can also be categorized based on the motive behind the investment from the
perspective of the investing firm:
1. Resource-Seeking
Investments which seek to acquire factors of production that are more efficient
than those obtainable in the home economy of the firm. In some cases, these
resources may not be available in the home economy at all (e.g. cheap labor and
natural resources)..
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2. Market-Seeking
The businesses are more likely to be pushed towards this type of investment out of
fear of losing a market rather than discovering a new one.
3. Efficiency-Seeking
Investments which firms hope will increase their efficiency by exploiting the
benefits of economies of scale and scope, and also those of common ownership. It
is suggested that this type of FDI comes after either resource or market seeking
investments have been realized, with the expectation that it further increases the
profitability of the firm.
4. Strategic-Asset-Seeking
A tactical investment to prevent the loss of resource to a competitor. For E.g., the
oil producers, whom may not need the oil at present, but look to prevent their
competitors from having it.
ForbiddenTerritories:
FDI is not permitted in the following industrial sectors:
2. Atomic Energy.
3. Railway Transport.
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4. Coal and lignite.
The term is used most commonly in India to refer to outside companies investing
in the financial markets of India. International institutional investors must register
with the Securities and Exchange Board of India to participate in the market. One
of the major market regulations pertaining to FIIs involves placing limits on
FII ownership in Indian companies.
One who propose to invest their proprietary funds or on behalf of "broad based"
funds or of foreign corporates and individuals and belong to any of the following
categories can be registered for FII.
Pension Funds
Mutual Funds
Investment Trust
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Endowment Funds
University Funds
Nominee Companies
Trustees
Bank
Foreign Direct Investment (FDI) are usually preferred over other forms of external
finance because they are non-debt creative, non-volatile and their returns depend
on the performance of projects financed by the investors. FDI benefits domestic
industry as well as Indian consumer by providing opportunities for technological
upgradation, access to global managerial skills and practices, optimal utilisation of
natural and human resources, making Indian industry internationally competitive,
opening up export markets, providing backward and forward linkages and access
to international quality goods and services. In a world of increased of competition
and rapid technological change, their complimentary and their catalytic role can be
very valuable.
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Here is an example of one of the state governments of India ( Tamil Nadu
government) which has followed certain strategies to attract FDIs
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WHY FDI IS SEEN AS IMPORTANT FOR AFRICA
The Economic Report on Africa by the United Nations Economic Commission for
Africa advocates that FDI is the key to solving Africas economic problems. Bodies
such as the IMF and the World Bank have suggested that attracting large inflows of
FDI would result in economic development. SubSaharan African governments are
very eager to attract FDI. They have changed from being generators of employment
and spillovers for the local economy to governors of states that promote competition
and search for foreign capital to fill the resource gap. This change is attributed to
changes that are caused through structural adjustment programmes and the
internalization of neo-liberal assumptions promoted by the World Bank and IMF.
All African countries are keen on attracting FDI. Their reasons would differ but may
be summarised as: trying to overcome scarcities of resources such as capital,
entrepreneurship; access to foreign markets; efficient managerial techniques;
technological transfer and innovation; and employment creation. In their attempts to
attract FDI, African countries design and implement policies; build institutions; and
sign investment agreements. These benefits of FDI to African countries are difficult
to assess but will differ from sector to sector depending on the capabilities of
workers, firm size, and the level of competitiveness of domestic industries.
In Southern Africa, the main five reasons governments want to attract FDI are:
FDI is seen as an important source of capital formation particularly when the
capital base is low. Capital inflow is seen as a way of creating a surplus in the
capital account of the balance of payments or to make up for the deficit on the
current account. Consumer Unity and Trust Society (CUTS) points out that there
has been cases where FDI have not led to capital formation but rather crowded
out domestic investment ( Chatterjee, undated),
Transfer of technologies is expected because foreign companies will use
technology from their home country. From a developmental perspective, it is
more important that technology is diffused with spill- over into the local production
process, and that technology be adopted and adapted by local enterprises. For
an economy to improve on quality, technological upgrading is crucial. Technical
inefficiency, in developing countries, can severely hinder the quality of products
produced and the ability to cope with new demands. At the moment, no studies have
shown that FDI had this diffusion-effect in Southern Africa. On the contrary,
foreign investment results in competition that tends to stifles local technology
development and diverts resources from technology development to attracting
FDI.
It is argued that FDI will lead to employment creation. International experience
shows that foreign direct investment is not always accompanied by substantial
employment creation and in most cases lead to job losses when public
companies are privatised. In a special ECONEWS report on Foreign Investment
in SADC, it was pointed out that FDI is not a good way to create jobs. While a
quarter expands employment, a third will contract employment. For example, in
Namibia, most FDI investments went into the mining industry that reduced its
workforce from 14000 to 5000 during the past 12 years.
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Transfer of management skills, to local managers, takes place when investors set
up new plants, acquire companies or outsource to local subcontractors.. .
Increased export competitiveness is anticipated. This was an important argument
when South Africa introduced its Growth, Employment, and Redistribution
(GEAR) strategy. It emphasized the importance of attracting investment in
clusters of industries to develop local companies.
A closer analysis of the main reasons for attracting FDI, employment creation and
capital formation, dont really have the desired effect.
Employment creation: International experiences have shown that FDI is hardly
accompanied by substantial employment creation, and in some cases may even
lead to job losses. Another problem with employment through FDI is the kind of
employment it creates. In Namibian, for example, the government claimed that
the Export Processing Zone (EPZ) programme created jobs and thus reduced the
unemployment rate. However, the jobs that were created are mostly
characterized by poor working conditions and very low salaries. Most of the
employees do not have job security and little prospects of improving their
standards of living. It is thus important to examine the quantity and quality of jobs
created.
Capital Formation: Yash Tandon argues that any reasonable accounting of
capital flows must take into account what flows in and out of the country (Tandon,
2002). In the Investment Position Paper by COSATU, it was pointed out that FDI
flowing out of South Africa had increased rapidly, and since 1994, it has
exceeded direct capital flows. COSATU has indicated that between 1994 and
2000, FDI into the country came to R45 billion, while outflows of direct investment
came to R54 billion (COSATU, 2001).
2.1. Initiatives taken by African countries to attract FDI
African countries, like most other developing countries have taken various initiatives
to attract FDI. These initiatives include incentives, signing of investment treaties and
investment promotion activities.
2.1.1 Incentives
Incentives can be described as policies used to attract internationally mobile
investors. Through the EPZ programme, African countries offer incentives to attract
foreign investment in the form of tax holidays, exemptions on export and import
duties, subsidized infrastructures, and limits on workers rights. According to Jauch
and Endresen (2000), opinions about the importance of incentives vary significantly.
Governments consider them as a mean to obtain FDI whereas transnational corporations
perceive EPZs as providers of favourable investment sites. The case of
Namibia is instructive in this regard.
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In 1995, Namibia passed its EPZ Act. Four years later, LaRRI carried a study to
assess the socio-economic impact of Namibias EPZ programme. This study
revealed that Namibia had come short of the expectation in terms of the EPZ
programme. The government anticipated creating 25 000 jobs by the end of 1999.
The actual number of jobs created at the time of the study was 400. The study
carried out by LaRRi unraveled poor labour conditions that could lead to future
conflicts (LaRRI, 2000). This prediction was confirmed in 2002-2003 when
RAMATEX, a Chinese owned textile company producing for the US market from
Namibia had two strikes within months of each other. The reasons were poor
working conditions and poor salaries, typical conditions that prevail in EPZs.
African countries have improved their regulatory frameworks for FDI by opening their
economies, permitting profit repatriation and providing tax and other incentives to
attract investment. Improvements in the regulatory framework for FDI have been
stressed in many countries through the conclusion of international agreements on
FDI. Most African countries have concluded bilateral investment treaties with
countries whose main aim is the protection and promotion of FDI. They also clarify
the terms under which FDI can enter the host country (UNCTAD; 1999;P.6).
Since the 1980s, all SADC governments have relaxed regulations for foreign
investors:
By granting investors easier entry,
By relaxing the ability to borrow locally although it implies a constraint on a
countrys foreign currency reserves,
Relaxation of land and mining concession ownership,
By forming new kinds of partnerships with the private sector (public private
partnerships) in areas which were previously the responsibility of the government
e.g. water distribution.
The incentives offered by governments can be grouped into three categories such as
fiscal, financial and rule or regulatory-based:
Fiscal Incentives
Reduced tax rates
Tax holidays,
Subsidies,
Exemptions from import duties
Accelerated depreciation allowances
Investment and reinvestment allowances
Specific deductions from gross earnings for national income tax purposes
Deductions from social security contributions
Financial Incentives
Grants
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Loan and loan guarantees
Rules-based incentives
Modifying rules on workers rights
Modifying environmental standards
Greater protection for intellectual property rights (CUTS, 2001)
2.1.2 Investment treaties
Incentives are only a part of what governments offer to attract foreign investors to their
countries for investment. Increasingly countries have entered into investment treaties, both
bilateral investment treaties and multilateral ones.
Bilateral investment treaties The bilateral treaties contribute to the establishment of
favourable investment climate between two countries by providing assurance and guarantees
to investors. In the SADC region, only South Africa did not have a law that specifically dealt
with FDI by the late 1990s. More and more bilateral treaties are being signed by African
countries
to safeguard the rights of the investors. Bilateral investment treaties are perceived as
contributing to the establishment of favourable investment climate because they include the
following:
Fair and equitable treatment for foreign investors in terms of applications for
investment approval and setting up their businesses,
Specific provisions on expropriation and non-commercial losses and
compensation for the same, and
Dispute or conflict settlement mechanism (CUTS, 2001).
2.1.3 Investment Promotion
More and more countries are engaging in pro-active policies to attract FDI. Most countries
have established investment promotion agencies (IPA) whose main purpose is to attract FDI
and to look after foreign firms once they have set operations. Many countries, particularly in
Africa, still suffer from a negative image. This makes the marketing role of IPAs extremely
important. Investment promotion agencies usually fulfill a dual role:
By acting as a one stop for investors to deal with regulatory and administrative
requirements, and
By changing or modifying investor perception of the country by attending and organizing
investor fairs and by distributing materials.
Investment promotion covers a range of activities, including investment generation,
investment facilitation, aftercare services, and policy advocacy to enhance the
competitiveness of a location.
According to the World Investment Report (2002) the majority of countries have moved from
the first generation of investment to the second generation of investment. First generation
investments mainly involve the opening up of an economy to FDI whereas second generation
investment actively involves a government in marketing its location by setting up investment
promotion agencies.
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In order to increase the efficiency of investment generation and enhance the
chances of attracting export-oriented FDI, some IPAs go further and utilize part of their FDI
promotion resources for investor targeting. Third generation promotion can be an efficiency
policy tool, but it is not an easy task and involves certain risks, such as, the process of
investor targeting does not integrate with the overall development strategy of a country. |
Other risks involve utilising resources which may be focused on seeking investments that do
not materialize; attracting the wrong types of firms; and assuming the governments ability
to foresee which types of FDI are likely to have the greatest ability to integrate and link with
local investment (WIR, 2002).Such risks necessitates that investment promotion agencies
work closely with other parts of government to identify and create comparative advantages
that are sustainable and that developmental policies do not offset each other.. Targeting
needs to be a continuous process and should not be taken as a once off initiative.
2.2 A targeted approach to FDI
According to the WIR (2002) targeting can be defined in different ways. In principle, it
involves the focusing of promotional resources to attract a defined sub-set of FDI flows,
rather than FDI in general. Some countries i.e. Singapore, Ireland and The Netherlands, have
practiced targeting export-oriented FDI for some time, with success. However, it is only
recently that targeting has become a more widely accepted tool among IPAs. The WIR
(2002) identifies some reasons as to why some countries have adapted the targeting
approach to attract export-oriented FDI:
First and foremost, a targeted approach can help countries achieve strategic objectives
related to such aspects as employment, technology transfer, exports and cluster development
which are in line with their overall development strategies. Effective targeting involves a
comprehensive approach to attracting investment that can contribute to development and
enhance the competitiveness of a location. It also requires the adoption of government
policies that underpin the specific marketing activities and coordination of the relevant
government agencies, including IPA, in order to define investment priorities and the package
of advantages offered in the framework of an overall development strategy,
A second reason for engaging in investor targeting, that attracts export-oriented FDI, is the
increased competition for this kind of investment. Due to the fact that some countries are
better known to foreign investors in their capabilities to offer substantial domestic markets,
the smaller less well-known economies have to work twice as hard in their targeting efforts,
and
A third reason relates to cost-effectiveness. A focused approach to attract export oriented
investment is likely to be less costly than the one in which an IPA tries to attract new
investments in all sectors at the same time.
Once an IPA has decided to use targeting as part of its strategy to attract export oriented FDI,
the next challenge is to determine what industries; activities; countries; companies and
individual managers should be targeted. The starting point of the selection process is careful
assessment of the strengths of a location as a base for export production
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The recent trend amongst countries to liberalize investment policies in all respects may not
allow them to reap the full benefits from investment. In countries like Taiwan and Korea,
targeted investment policies placed requirements on investments to ensure the transfer of
skill and technology. Similarly other successful newly industrialized countries also
controlled the amount of investment in particular sectors, time periods and the balance
between direct investment and portfolio investment.
During the period of 1982-1999, most FDI flows to developing countries were directed
towards the South, East and South-Eastern Asia followed by Latin America. The SADC
region on the other hand experienced a decline from 0.9% to 0.3% between 1995 and 2000.
According to the WIR (2001) FDI inflows to Africa declined from $10.5 billion in 1999 to
$9.1 billion in 2000. African share of FDI in the world fell below 1 percent in 2000. The
inflow to its top recipients, namely, Angola; Morocco; and South Africa have fallen by half.
The main sources of FDI to Africa were France, the United Kingdom, and the United States,
and to a lesser extent, Germany and Japan (WIR, 1999). On average FDI flows to North
Africa remained more or less the same as in the previous year, $2.6 billion. Flows declined
into Morocco and Algeria but increased to Sudan (concentrated in petroleum exploration)
from $370 million to $392 million.
Egypt has remained the most important recipient of FDI flows in North Africa.
In sub-Saharan Africa, there has been a decrease in FDI from $8 billion in 1999 to
$6.5 billion by the year 2000. A sharp drop of inflows into two countries caused the
overall drop of inflows into Sub-Saharan Africa: Angola and South Africa. In South
Africa, the reduced inflow of M&As in the country played a role in the downturn. The
decline of inflows in Angola resulted in FDI flows to the least developed countries to
drop from $4.8 billion in 1999 to $3.9 billion in 2000.
More recently, a group of African countries including Botswana, Equatorial Guinea,
Ghana, Mozambique, Namibia, Tunisia and Uganda have attracted rapidly increasing
FDI inflows. The reasons I differ from country to country. In the case of Equatorial
Guinea it was mostly rich reserves of oil and gas. Natural resource reserves also
played a role in the case of Botswana, Ghana, Mozambique and Namibia.
Privatization has been pointed out as a factor which is attributed to attracting FDI to
countries like Mozambique, Ghana and Uganda.
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Angola has attracted most FDI in Africa, compared to its GDP, particularly in
offshore exploration of gas and petroleum. The Angolan case proves that it is
insufficient to base an analysis of FDI trends only on what business determines as
attractive for FDI. Angola attracted resource-seeking FDI despite being the site of
a longstanding war. After Angola, South Africa is attracting most FDI in the
Southern African region, mostly from the US and the UK. Even though South
Africa is supposed to be one of the recipients of FDI, the figures given by
UNCTAD do indicate that South Africa is also a massive exporter of capital. South
Africa is seen as the most attractive country for FDI by business (SOMO and
LaRRI, 2001). Flows by region: SADC
The Southern African Development Community (SADC) was established in 1992
out of the South African Development Coordination Conference. SADC
committed itself to develop protocol that should take into account the
heterogeneity of the region and interests of the different stakeholders
(International Investment Treaties in S.A). The SADC trade protocol was signed in
1996 by all member states and it provides for the creation of a free trade zone
among the member states. The main aim of the protocol is to contribute towards
the improvement of the climate for domestic, cross-border and foreign investment.
Due to the drop of FDI flows into Angola and South Africa, the overall SADC
region experienced a fall in flows from $5.3 billion in 1999 to $3.9 billion in 2000.
However, countries like Mauritius and Lesotho experience strong increases in FDI
whereas others, for example, Zimbabwe experienced a significant drop from $444
million in 1998 to $59 million in 1999 and only $30 million in 2000 (WIR, 2001).
The latest figures of FDI into SADC by UNCTAD (2001) reveal that the highest
amount of FDI inflow in absolute terms was recorded by Angola (US$ 1,8 billion),
followed by South Africa with an inflow of US$ 877 million. The rest of the
region accounted for FDI inflows of less than US$300 million in the year 2000.
Flows by sectors
Social Observatory Pilot Project Final Draft Report FDI
A large proportion of FDI is directed towards the primary sector, especially oil and
gas. Between 1996 and 1999, most investments in the SADC region went into the
metal industry and the mining sector and thereafter into the food, beverages and
tobacco sectors. Other sectors like tourism accounted for a small amount of FDI.
Sectors attracting FDI in the SADC region in order of priority are: the mining and
quarrying; financial services; food; beverages and tobacco; agriculture, forestry
and fishing; hotel; leisure and gaming; other manufacturing; energy and oil;
telecom and IT; retail and wholesale; and; construction (Hansohm et al, 2002).
(Source: http://www.sarpn.org.za/documents/d0000883/P994-
African_Social_Observatory_PilotProject_FDI.pdf)
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5.3 THE COSTS AND BENEFITS OF FDI
Foreign Direct Investment as a development tool has its benefits and risks, and
will only lead to economic growth in the host country under certain conditions. It
is the responsibility of governments to make sure that certain conditions are in
place so that FDI can contribute to development goals rather than just generating
profits for the foreign investor. These conditions cover broad features of the
political and macroeconomic environment. The impact of FDI in a country would
depend on a number of factors such as:
The mode of entry (greenfield or merger and acquisition),
The activities undertaken, and whether these are already undertaken in the host
country,
Sources of finance for FDI (reinvested earnings, intra-company loans or the
equity capital from parent companies), and
The impact on the activities of domestic companies (CUTS, 2001).
Impact on the balance of payments. The trade deficit can be a real constraint for
developing countries. If investors import more that they export, FDI can end up
worsening the trade situation of the country.
Instability. Volatility is associated more with portfolio capital flows. Although
investment in physical assets is fixed, profits from investment are as mobile as
portfolio flows and can be reinvested outside the country at short notice. Profits
may surpass the initial investment value and FDI may thus contribute to capital
export.
Transfer pricing. This refers to the pricing of intra-firm transactions which does
not reflect the true value of products entering and leaving the country. This could
lead to a drain of national resources. Countries may lose out on tax revenue from
corporations, as they are able to juggle their accounts in such a manner as to avoid
their tax liabilities.
The impact of development, when FDI occur through TNCs is uneven. In many
situations TNC activities reinforce dualistic economic structures and acerbate
income inequalities. They tend to promote the interests of a small number of local
factory managers and relatively well paid modern-sector workers against the
interests of the rest of the population by widening wage differentials. They tend to
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worsen the imbalance between rural and urban economic opportunities by locating
primarily in urban export enclaves and contributing to the flow of rural-urban
migration.
TNCs use their economic power to influence government policies in directions
that usually do not favor development. They are able to extract sizable economic
and political concessions from competing governments in the form of excessive
protection, tax rebates, investment allowances and the cheap provisions of factory
sites and services. As a result, the profits of TNCs may exceed social benefits.
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Review Questions
Q1. FDI is
a) Method of raising finances in domestic market
b) Method of investment in foreign market
c) Method of investment in both foreign and domestic market
d) None of the above
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c) Economy is self sufficient
d) All of the above
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Chapter 6
Contents:
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6.1 NON BANKING FINANCIAL COMPANIES (Indian Perspective)
Definitions
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A non-banking non-financial company is an industrial concern as defined in
Industrial Development Bank of India Act or a company whose principal activities
are agricultural operations or trading in goods and services or real estate and
which is not classified as financial or miscellaneous or residuary non-banking
company.
6.2 NBFCs can be classified into different segments depending on the type of
activities they undertake:
The above mentioned entities are either partially or wholly regulated by the RBI.
Before we proceed forward lets understand few terms as these are important for
further learning.
Deposits : Definition of the deposit is in its broadest sense to include any receipt
of money by way of deposit or loan or in any other form. The term excludes
following receipts :
i. Amount received from bank.
ii Amount received from development/ State financial
corporation or any other financial institution,
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iii. Amount received in the ordinary course of business by way of security deposit,
dealership deposit, earnest money, advance against order for goods/properties and
services.
iv. Amount received by way of subscription in respect of a chit and
v. Loan from Mutual Funds.
Financial Institutions : These mean any non-banking Institution / financial
companies engaged in any of the following activities :
vi. Financing by way of loans, advances and so on any activity except of its own.
vii. Acquisition of shares/ stocks/ bonds/ debentures/securities.
viii. Hire purchase.
ix. Any class of insurance, stock-broking etc.
x. Chit-funds and
xi. Collection of money by way of subscription/ sale or units or other
instruments/any other manner and their disbursement.
Mutual Benefit Finance Company (MBFC) : MBFC (also called Nidhis) are
NBFCs notified under section 620A of the Companies Act, 1956, and primarily
regulated by Department of Company Affairs (DCA) under the directions/
guidelines issued by them under section 637A of the Companies Act, 1956. These
companies are exempt from the core provision of the RBI Act and NBFC
directions relating to acceptance of public deposits. However, RBI is empowered
to issue direction in matters relating to deposit acceptance activities and directions
relating to ceiling on interest rate. They are also required maintain register of
deposits, furnish receipt to depositors and submit returns to the RBI.
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Regulatory Non-Banking Companies (RNBC) : RNBCs are a class of NBFCs
that cannot be classified as equipment leasing company, hire purchase, loan,
investment, nidhi or chit fund companies, but which tap public savings by
operating various deposit schemes, akin to recurring deposit schemes of Banks.
6.3Regulatory Measures
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the period of 8 years specified in that section might not have been completed in
respect of all the assets) be counted as a free reserve and
(ii)In the case of industrial concerns as defined in the directives which (a) have
paid dividends on their equity shares at, six per cent or more per annum in the five
years or in five out of six years immediately preceding 1 January 1967, or (b) have
unencumbered fixed assets of a book value in excess of twice the amount of
deposits and the unsecured loans, the time limit of two years, for the adjustment of
the deposits already received in excess of 25 per cent of the paid-up capital and
free reserves including the development rebate reserve, will increase to five years,
i. e., upto the end of December 1971.
During 1973, the Reserve Bank issued a new set of directions known as the
Miscellaneous Non-Banking Companies (Reserve Bank) Direc-tions, 1973 which
sought to regulate the acceptance of deposits by com-panies conducting prize
chits, lucky draws, savings schemes, etc. These directions which came into effect
from 1 September, 1973, had clarified that the amounts received by such
companies by way of contributions or subscriptions or by sale of units, certificates,
etc., or other instruments or any other manner or as membership fees or service
charges to or in respect of any savings, or mutual benefit, thrift or any other
scheme or arrangement also constitute deposits. It was further clarified that the
usual ceiling on deposits (25 per cent of paid-up capital plus free reserves less
accumulated balance of loss), would also apply to such deposits. Any amount in
excess of the ceiling existing on 1 September 1973 would have to be adjusted
before October 1976. All other requirements applicable to other non-banking
companies such as these relating to the issue of advertisements, acceptance of
deposits on the basis of application forms, maintenance of registers of deposits and
furnishing of receipts to depositors, would also apply to these companies.
However, companys coming within the purview of these directions would be
required to submit their returns to the Reserve Bank twice a year.
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The two principal notifications containing the directions issued in October 1966,
respectively to non-banking companies were further amended during 1973. The
principal features of the amendments were: (i) any loan secured by the creation of
a mortgage or pledge of the assets of the company or any part thereof would be
exempt from the ceiling restrictions relating to deposits only if there is a margin of
only at least 25 per cent of the market value of the assets charged as security for
the loan, the mortgage or pledge, as the case may be, is created in favour, of a
trustee which should either be a scheduled commercial bank or an executor and
trustee company which is a subsidiary of such scheduled commercial bank and the
company has to execute a trust deed in favour of the scheduled commercial bank
or its subsidiary. If the Reserve Bank is satisfied that the mortgage or pledge
created by a company is not in the public interest, it may declare that the deposits
sought to be secured by such mortgage of pledge shall not be entitled to the benefit
of the aforesaid provision. Companies accepting such secured deposits will,
however, have to comply with all other provisions contained in the directions as
applicable to ordinary deposits or unsecured loans. (ii) Loans obtained from a
registered moneylender would henceforth be treated as deposits for the purposes
of the directions. After an examination of the recommendations of the Banking
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(f) Provide for enhanced penalties for contravention of the provisions of the Act
and the directions issued by the Bank.
The ceiling of 25 per cent of the paid-up capital and free reserves less the balance
of accumulated loss, if any, imposed by the Reserve Bank with effect from January
1972, in respect of deposits accepted by non-banking companies in the form of
unsecured loans guaranteed by the directors, deposits raised from shareholders
(excluding those received by private companies from their shareholders subject to
certain stipulations) etc., was lowered by the Bank to 15 per cent with effect from
the 27th January 1975, by issue of three notifications amending the directions in
force. Non-banking financial and non-financial companies having deposits in
excess of the reduced ceiling were given time till 31st December 1975, to wipe out
the excess. Miscellaneous non-banking companies viz., those conducting prize
chits/lucky draws/savings schemes etc., which had been allowed time up to the
end of September 1976, to wipe out the excess over the ceiling of 25 per cent fixed
earlier were allowed further time up to the 31st December 1976, to bring down
their outstanding in respect of the unsecured loans, etc., within the reduced ceiling
of 15 per cent.
The Companies (Amendment Act), 1974 which came into force from the 1st
February 1975, has inserted anew Section 58 A in the Companies Act, 1955
regulating acceptance of deposits by non-banking companies. Under the powers
vested by the aforesaid Section, the Central Government has in consultation with
the Reserve Bank, framed rules governing acceptance of deposits by non-financial
companies. The rules came into force with effect from the 3rd February 1975.
Consequently, the directions issued by the Reserve Bank to non-financial
companies have since been withdrawn.
The Study Group headed by Shri James S. Raj referred to above submitted its
Report to the Reserve Bank on 14th July 1975.
With regard to non-financial companies, the Study Group observed that the
acceptance of deposits by such companies may not be prohibited altogether but the
measures should be so designed as to ensure the efficacy of monetary policy and
to avoid disruption of the productive process consistent with need to safeguard the
depositors interests. At the same time the ultimate objective should be to
discourage further growth of these deposits and to roll them back gradually so that
they would cease to be a significant source of finance for industry and trade.
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In the case of non-banking financial companies, the Study Group recommended
effective regulation of their activities considering the large number of depositors
involved as well as the incidence of malpractices in these companies. The Study
Group suggested that such companies should be subjected, by and large, to the
same type of controls as banks under the Banking Regulation Act, 1949. As the
operations of loan companies are analogous to those of banks, the Study Group
recommended a ceiling of ten times the net owned funds. In the opinion of Study
Group, avail-ability of funds to that extent would give them a reasonable chance of
profitable working and enable them to become, viable units. While in regard to
hire-purchase finance companies, which are at present exempt from ceiling
restriction, a ceiling (not exceeding ten times their net owned funds) as in the case
loan companies has been proposed, housing finance companies, however, will
continue to be exempted from the ceiling restrictions. Since such special
considerations will not be relevant in respect of investment companies, the
existing composite ceiling of 40 per cent of the net owned funds is proposed to be
reduced to 25 per cent in two stages. Apart from the restrictions on the quantum of
deposits that may be accepted by the companies, the Group has recommended
minimum capital requirements for starting new financial companies and also in
respect of existing companies other than nidhis. Some of the other
recommendations made by it relate to the creation of reserve funds, maintenance
of liquid assets, prohibition of grant of loans and advances to the directors and
firms and companies in which they are interested and enactment of the Provisions
on the lines of certain sections of the Banking Regulation Act, 1949. In view of the
substantive nature of the recommendations made by it for the purpose of
tightening the control over the deposit acceptance activities of the financial
companies as also the operational aspects relating to their working, it has been
decided to enact a separate comprehensive legislation in place of Chapter III B of
the Reserve Bank of India Act, 1934. The drafting of the legislation is in progress
and in the meantime, steps are also being taken to implement such of the
recommendations as could be given effect to by invoking the power vested in the
Reserve Bank under the existing provisions of Chapter III B of the said Act by
suitable amendments to the directions now force. The amendments to the
directions have been finalized.
As regards companies conducting prize chits benefit savings schemes, etc., the
Group had come to the conclusion that such schemes benefited primarily the
promoters and did not serve any social purpose. Such schemes were prejudicial to
public interest and also adversely affected the efficacy of fiscal and monetary
policy, It had, therefore, suggested that the conduct of such schemes should be
totally banned in the larger interests of the public and suitable legislative measures
should be taken for the purpose, the provisions of the existing enactment were
considered inadequate.
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REVIEW QUESTIONS
Q1. NBFC is a :
a) Is a trust
b) Is a company
c) Bank
d) Firm
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Q8. Regulated deposit is one which:-
a) Deposits with minimum investment
b) Includes unsecured debentures
c) Does not have any
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BIBLIOGRAPHY
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KEY TO QUESTIONS
CHAPTER ONE:
Q1. (a), Q2. (a), Q3. (b), Q4. (b), Q5. (a)
Q6. (b), Q7. (b), Q8. (d), Q9. (b), Q10. (c)
CHAPTER TWO:
Q1. (b), Q2. (a), Q3. (c), Q4. (a), Q5. (b),
Q6. (b), Q7. (d), Q8. (c), Q9. (d), Q10. (a)
CHAPTER THREE:
Q1. (a), Q2. (e), Q3. (a), Q4. (b), Q5. (c),
Q6. (d), Q7. (a), Q8. (b), Q9. (b), Q10. (d)
CHAPTER FOUR:
Q1. (d), Q2. (a), Q3. (d), Q4. (e), Q5. (e),
Q6. (d), Q7. (b), Q8. (b), Q9. (c), Q10. (b)
CHAPTER FIVE:
Q1. (b), Q2. (a), Q3. (d), Q4. ( a), Q5. (b),
Q6. (c), Q7. (a), Q8. (c), Q9. (a), Q10. (b)
CHAPTER SIX:
Q1. (b), Q2. (a), Q3. (c), Q4. (b), Q5. (b),
Q6. (d), Q7. (c), Q8. (b), Q9. (b), Q10. (a)
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CASE STUDY
The Federal Reserve System (also known as the Federal Reserve, and
informally as The Fed) is the central banking system of the United States. It
was created in 1913 when the Federal Reserve Act was signed by Woodrow
Wilson. According to official Federal Reserve documentation, "It was
founded by Congress in 1913 to provide the nation with a safer, more
flexible, and more stable monetary and financial system. Over the years, its
role in banking and the economy has expanded."
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system and containing systemic risk that may arise in financial markets; and
(4) providing financial services to depository institutions, the U.S.
government, and foreign official institutions, including playing a major role
in operating the nation's payments system.
Within the Federal Reserve, the Federal Open Market Committee (FOMC) is
primarily responsible for the formulation of monetary policy. Seven of the
twelve members of the board are appointed by the President, and are called
the "Board of Governors." The remaining five are regional Reserve Bank
presidents. Since February 2006, Ben Bernanke has served as the Chairman
of the Board of Governors of the Federal Reserve System. Donald Kohn is
the current Vice Chairman (Term: June 2006June 2010).
In early 1781 the Articles of Confederation & Perpetual Union were ratified
so that Congress had the power to emit bills of credit. It passed later that
year an ordinance to incorporate a privately subscribed national bank
following in the footsteps of the Bank of England. However, it was thwarted
in fulfilling its intended role as a nationwide central bank due to objections
of "alarming foreign influence and fictitious credit," favoritism to foreigners
and unfair competition against less corrupt state banks issuing their own
notes, such that Pennsylvania's legislature repealed its charter to operate
within the Commonwealth in 1785.
Four years after the U.S. constitution was ratified, the government adopted
another central bank, the First Bank of the United States, but it would
ultimately be shut down by President Madison. The Second Bank of the
United States, i.e. the second central bank, met a similar fate when its charter
expired under President Jackson. Both banks were, again, based upon the
Bank of England, but the increased Federal power, due to the constitution,
gave them more control over currency. Political opposition to central
banking was the primary reason for shutting down the banks, but there was
also a considerable amount of corruption in the second central bank.
Ultimately, the third national bank was established in 1913 and still exists to
this day. The time line of central banking in the United States is as follows:
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17911811
18111816
No central bank
18161836
18371862
1846-1921
18631913
National Banks
1913Present
The first U.S. institution with central banking responsibilities was the First
Bank of the United States, chartered by Congress and signed into law by
President George Washington on February 25, 1791 at the urging of
Alexander Hamilton. This was despite strong opposition from Thomas
Jefferson and James Madison, among numerous others. The charter was for
twenty years and expired in 1811 under President James Madison.
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In 1816, however, Madison revived it in the form of the Second Bank of the
United States. Early renewal of the bank's charter became the primary issue
in the reelection of President Andrew Jackson. After Jackson, who was
opposed to the central bank, was reelected, he pulled the government's funds
out of the bank. Nicholas Biddle, President of the Second Bank of the
United States, responded by contracting the money supply to pressure
Jackson to renew the bank's charter forcing the country into a recession,
which the bank blamed on Jackson's policies. The bank's charter was not
renewed in 1836. From 1837 to 1862, in the Free Banking Era there was no
formal central bank. From 1862 to 1913, a system of national banks was
instituted by the 1863 National Banking Act. A series of bank panics, in
1873, 1893, and 1907, provided strong demand for the creation of a
centralized banking system.
Purpose
The primary motivation for creating the Federal Reserve System was to
address banking panics. Other purposes are stated in the Federal Reserve
Act, such as "to furnish an elastic currency, to afford means of rediscounting
commercial paper, to establish a more effective supervision of banking in the
United States, and for other purposes." Before the founding of the Federal
Reserve, the United States underwent several financial crises. A particularly
severe crisis in 1907 led Congress to enact the Federal Reserve Act in 1913.
Today the Fed has broader responsibilities than only ensuring the stability of
the financial system.
Central bank
In its role as the central bank of the United States, the Fed serves as a
banker's bank and as the government's bank. As the banker's bank, it
helps to assure the safety and efficiency of the payments system. As the
government's bank, or fiscal agent, the Fed processes a variety of financial
transactions involving trillions of dollars. Just as an individual might keep an
account at a bank, the U.S. Treasury keeps a checking account with the
Federal Reserve through which incoming federal tax deposits and outgoing
government payments are handled. As part of this service relationship, the
Fed sells and redeems U.S. government securities such as savings bonds and
Treasury bills, notes and bonds. It also issues the nation's coin and paper
currency.
Federal funds
Federal funds are the reserve balances that private banks keep at their local
Federal Reserve Bank. These balances are the namesake reserves of the
Federal Reserve System. The purpose of keeping funds at a Federal Reserve
Bank is to have a mechanism through which private banks can lend funds to
one another. This market for funds plays an important role in the Federal
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Reserve System as it is what inspired the name of the system and it is what
is used as the basis for monetary policy. Monetary policy works by
influencing how much money the private banks charge each other for the
lending of these funds.
In the current system, private banks are for-profit businesses but government
regulation places restrictions on what they can do. The Federal Reserve
System is a part of government that regulates the private banks. The balance
between privatization and government involvement is also seen in the
structure of the system. Private banks elect members of the board of
directors at their regional Federal Reserve Bank while the members of the
Board of Governors are selected by the President of the United States and
confirmed by the Senate. The private banks give input to the government
officials about their economic situation and these government officials use
this input in Federal Reserve policy decisions. In the end, private banking
businesses are able to run a profitable business while the U.S. government,
through the Federal Reserve System, oversees and regulates the activities of
the private banks.
Some regulations issued by the Board apply to the entire banking industry,
whereas others apply only to member banks, that is, state banks that have
chosen to join the Federal Reserve System and national banks, which by law
must be members of the System. The Board also issues regulations to carry
out major federal laws governing consumer credit protection, such as the
Truth in Lending, Equal Credit Opportunity, and Home Mortgage Disclosure
Acts. Many of these consumer protection regulations apply to various
lenders outside the banking industry as well as to banks.
The Board has regular contact with members of the Presidents Council of
Economic Advisers and other key economic officials. The Chairman also
meets from time to time with the President of the United States and has
regular meetings with the Secretary of the Treasury. The Chairman has
formal responsibilities in the international arena as well.
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Whole
Board of Governors
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Decisions seek to foster economic growth with price stability by
influencing the flow of money and credit
Member banks
Private banks
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ASSIGNMENT INSTRUCTION PAGE
AMITY Center for E-Learning
F-2, Block, II Floor,
Amity University, Uttar Pradesh
Sector-125 Campus, Noida (UP)
India 201301
ASSIGNMENTS
INSTRUCTIONS:-
a) Students are required to submit three assignments
Assignment Details Marks
Assignment A Five Subjective Questions 15
Assignment B Three Subjective Questions + Case 15
Study
Assignment C 40 Objective Questions 10
b) Total Weight age given to these assignment is 40%
c) All assignments are to be completed in your own hand writing / typed.
d) All questions are required to be attempted.
e) All the three assignments are to be completed by due dates (specified from time to
time) and mailed / given by hand for evaluation at the ACeL office Noida / your
Study Centre.
f) The evaluated assignments can be collected from the study centre/ACeL office
after six weeks. Thereafter, these will be destroyed at the end of each semester.
g) The students have to attach a scan signature in the form.
Signature : ________________________
Date : _________________________
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ASSIGNMENT- A
Attempt these five analytical questions
Q1. What do you understand by financial system of a country? Explain its definition,
significance and structure?
Q2. Financial Markets are an important component of the financial system, what are
different types of financial markets ? Explain
Q5. What are bonds? Explain their features. How are they different from debentures?
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Assignment B
Q1. How are primary market and secondary market different from each other? Explain
Q2. What are mutual funds? Explain the benefit and risks involved in investing in
Mutual Funds.
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CASE STUDY
The US-64 Controversy
They have cheated us. I am telling everyone to sell. If they are stupid and offering Rs
14.25 for paper worth Rs 9, why should I let go of the opportunity?
CAN OF WORMS
In 1998, investors of Unit Trust of India's (UTI) Unit Scheme-1964 (US-64) were shaken
by media reports claiming that things were seriously wrong with the mutual fund major.
For the first time in its 32 years of existence, US-64 faced depleting funds and
redemptions exceeding the sales. Between July 1995 and March 1996, funds declined by
Rs 3,104 crore. Analysts remarked that the depleting corpus coupled with the
redemptions could soon result in a liquidity crisis.
Soon, reports regarding the lack of proper fund management and internal control
systems at UTI added to the growing investor frenzy. By October 1998, US-64's equity
component's market value had come down to Rs 4200 crore from its acquisition price
of Rs 8200 crore. The net asset value (NAV) of US-64 also declined significantly
during 1993-1996 due to turbulent stock market conditions. A Business Today survey
cited US-64's NAV at Rs 9.68. The US-64 units, which were sold at Rs 14.55 and
repurchased at Rs 14.25 in October 1998, thus were around 50% and 47%, above their
estimated NAV.
Amidst growing concerns over the fate of US-64 investors, it became necessary for UTI
to take immediate steps to put rest to the controversy.
CREATING TRUST
UTI was established through a Parliament Act in 1964, to channelise the nation's savings
via mutual fund schemes. This was done as in the earlier days, raising the capital from
markets was very difficult for the companies due to the public being very conservative
and risk averse. By February 2001, UTI was managing funds worth Rs 64,250 crore
through over 92 saving schemes such as US-64, Unit Linked Insurance Plan, Monthly
Income Plan etc. UTI's distribution network was well spread out with 54 branch offices,
295 district representatives and about 75,000 agents across the country.
The first scheme introduced by UTI was the Unit Scheme-1964, popularly known as US-
64. The fund's initial capital of Rs 5 crore was contributed by Reserve Bank of India
(RBI), Financial Institutions, Life Insurance Corporation (LIC), State Bank of India (SBI)
and other scheduled banks including few foreign banks. It was an open-ended scheme ,
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promising an attractive income, ready liquidity and tax benefits. In the first year of its
launch, US-64 mobilized Rs 19 crore and offered a 6.1% dividend as compared to the
prevailing bank deposit interest rates of 3.75 - 6%. This impressed the average Indian
investor who until then considered bank deposits to be the safest and best investment
opportunity. By October 2000, US-64 increased its capital base to Rs 15993 crore, spread
over 2 crore unit holders all over the world.
However by the late 1990s, US-64 had emerged as an example for portfolio
mismanagement. In 1998, UTI chairman P.S.Subramanyam revealed that the reserves of
US-64 had turned negative by Rs 1098 crore. Immediately after the announcement, the
Sensex fell by 224 points. A few days later, the Sensex went down further by 40 points,
reaching a 22-month low under selling pressure by Foreign Institutional Investors (FIIs).
This was widely believed to have reflected the adverse market sentiments about US-64.
Nervous investors soon redeemed US-64 units worth Rs 580 crore. There was widespread
panic across the country with intensive media coverage adding fuel to the controversy.
DISTRUST IN TRUST
Unlike the usual practice for mutual funds, UTI never declared the NAV of US-64 - only
the purchase and sale prices for the units were announced. Analysts remarked that the
practise of not declaring US-64's NAV in the initial years was justified as the scheme was
formulated to attract the small investors into capital markets. The declaration of NAV at
that time would not have been advisable, as heavy stock market fluctuations resulting in
low NAV figures would have discouraged the investors. This seemed to have led to a
mistaken feeling that the UTI and US-64 were somehow immune to the volatility of the
Sensex.
Following the heavy redemption wave, it soon became public knowledge that the erosion
of US-64's reserves was gradual. Internal audit reports of SEBI regarding US-64
established that there were serious flaws in the management of funds.
Till the 1980s, the equity component of US-64 never went beyond 30%. UTI acquired
public sector unit (PSU) stocks under the 1992-97 disinvestment program of the union
government. Around Rs 6000-7000 crore was invested in scripts such as MTNL, ONGC,
IOC, HPCL & SAIL.
A former UTI executive said, Every chairman of the UTI wanted to prove himself by
collecting increasingly larger amounts of money to US-64, and declaring high dividends.
This seemed to have resulted in US-64 forgetting its identity as an income scheme,
supposed to provide fixed, regular returns by primarily investing in debt instruments.
Even a typical balanced fund (equal debt and equity) usually did not put more than 30%
of its corpus into equity. A Business Today report claimed that eager to capitalise on the
1994 stock market boom, US-64 had recklessly increased its equity holdings. By the late
1990s the fund's portfolio comprised around 70% equity.
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While the equity investments increased by 40%, UTI seemed to have ignored the risk
factor involved with it. Most of the above investments fared very badly on the bourses,
causing huge losses to US-64. The management failed to offload the equities when the
market started declining. While the book value of US-64's equity portfolio went up from
Rs 7,943 crore (June 1994) to Rs 13,627 (June 1998), the market value had actually
declined in the same period from Rs 18,334 crore to Rs 10,029 crore. Analysts remarked
that UTI had been pumping money into scrips whose market value kept falling. Raising
further questions about the fund management practices was the fact that there were hardly
any growth scrips'from the IT and pharma sectors in the equity portfolio.
In spite of all this, UTI was able to declare dividends as it was paying them out of its
yearly income, its reserves and by selling the stocks that had appreciated. This kept the
problem under wraps till the reserves turned negative and UTI could no longer afford to
keep the sale and purchase prices artificially inflated.
Following the public outrage against the whole issue, UTI in collaboration with the
government of India began the task of controlling the damage to US-64's image.
UTI realised that it had become compulsory to restructure US-64's portfolio and review
its asset allocation policy. In October 1998, UTI constituted a committee under the
chairmanship of Deepak Parekh, chairman, HDFC bank, to review the working of
scheme and to recommend measures for bringing in more transparency and
accountability in working of the scheme.
US-64's portfolio restructuring however was not as easy as market watchers deemed it to
be. UTI could not freely offload the poor performing PSU stocks bought under the GoI
disinvestment program, due to the fear of massive price erosions after such offloading.
After much deliberation, a new scheme called SUS-99 was launched.
The scheme was formulated to help US-64 improve its NAV by an amount, which was
the difference between the book value and the market value of those PSU holdings. The
government bought the units of SUS-99 at a face value of Rs 4810 crore. For the other
PSU stocks held prior to the disinvestment acquisitions, UTI decided to sell them through
negotiations to the highest bidder. UTI also began working on the committee's
recommendation to strengthen the capital base of the scheme by infusing fresh funds of
Rs 500 crore. This was to be on a proportionate basis linked to the promoter's holding
pattern in the fund.
The inclusion of the growth stocks in the portfolio was another step towards restoring
US-64's image. Sen, Executive Director, UTI said, The US-64 equity portfolio has been
revamped since June. During the last nine months the new ones that have come to occupy
a place among the Top 20 stocks from the (Satyam Computers, NIIT and Infosys) and
FMCG (HLL, SmithKline Beecham and Reckitt & Colman) sectors. US-64 has reduced
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its weightage in the commodity stocks (Indian Rayon, GSFC, Tisco, ACC and
Hindalco.)
To control the redemptions and to attract further investments, the income distributed
under US-64 was made tax-free for three years from 1999. To strengthen the focus on
small investors and to reduce the tilt towards corporate investors, UTI decided that retail
investors should be concentrated upon and their number should be increased in the
scheme.
UTI also decided to have five additional trustees on its board. To enable trustees to
assume higher degree of responsibility and exercise greater authority UTI decided to give
emphasis on a proper system of performance evaluation of all schemes, marked-to-
market valuation[5] of assets and evaluation of performance benchmarked to a market
index. The management of US-64 was entrusted to an independent fund management
group headed by an Executive Director. UTI made plans to ensure that full responsibility
and accountability was achieved with support of a strong research team. Two independent
sub-groups were formed to manage the equity and debt portion of US-64. An independent
equity research cell was formed to provide market analysis and research reports.
TABLE I
HOW THINGS WERE SET RIGHT
PSU shares were transferred to a special unit scheme (SUS'99) subscribed
by the government in 1998-99.
Core promoters such as the Industrial Development Bank of India added
around Rs 450 crore to the unit capital, thus helping to bridge the reserves
deficit of Rs 2,800 crore in 1998-99.
Portfolios were recast in the current quarter to capitalise on the stock
surge as the BSE Sensex rose by 15%. Greater weightage was given to
stocks such as HLL, Infosys, Ranbaxy, M&M and NIIT.
In US-64's case exposure to IT, FMCG and Pharma stocks rose from
20.45% to 22.09%. This was replicated across funds. Between June 1999 -
September 1999, 21 out of UTI's 28 schemes have outperformed the
Sensex.
UTI has become more proactive in fund management. For instance, it
bought into Crest at between
Rs 200 and Rs 210 in October 1999. The stock was trading at Rs 340 in
November 1999.
Stocks like Visual Software, Mastek and Gujarat Ambuja have entered the
top 50 equity holding list. Scrips like Thermax, Thomas Cook and Carrier
Aircon are out.
Complete exit from illiquid stocks such as Esab Industries. The divesture
of around 83 stocks released estimated Rs 300-500 crore of extra investible
cash.
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UTI constituted an ad-hoc Asset Management Committee with 7 members comprising 5
outside professionals and 2 senior UTI officials. The committee's role was clearly defined
and its scope covered the following areas:
To ensure that US-64 complied with the regulations and guidelines and the prudential
investment norms laid down by the UTI board of trustees from time to time.
To review the scheme's performance regularly and guide fund managers on the future
course of action to be adopted.
To oversee the key issues such as product designing, marketing and investor servicing
along with the recommendations to Board of Trustees.
One of the most important steps taken was the initiative to make US-64 scheme NAV
driven by February 2002 and to increase gradually the spread between sale and
repurchase price. The gap between sale and repurchase price of US-64 was to be
maintained within a SEBI specified range. UTI announced that dividend policy of US-64
would be made more realistic and it would reflect the performance of the fund in the
market. US-64 was to be fully SEBI regulated scheme with appropriate amendment to the
UTI Act.
The real estate investments made by UTI for the US-64 portfolio were also a part of the
controversy as they were against the SEBI guidelines for mutual funds. UTI had Rs 386
crore worth investments in real estate. UTI claimed that since its investments were made
in real estate, it was safe and it could sell the assets whenever required. However, the
value of the real estate in US-64's portfolio had gone down considerably over the years.
The real estate investments were hence revalued and later transferred to the Development
Reserve Fund of the trust according to the recommendations of the Deepak Parekh
committee.
By December 1999, the investible funds of US-64 had increased by 60% to Rs 19,923
crore from Rs 12,433 crore in December 1998. The NAV had recovered from Rs 9.57 to
Rs 16 by February 2000 after the committee recommendations were implemented
Though UTI started announcing the dividends according to the market conditions, this
was not received well by the investors. They felt that though the dividend was tax-free, it
was not appealing as most of the investors were senior citizens and they did not come
under the tax bracket.
The statement in media by UTI chairman that trust would try to attract the corporate
investors into the scheme was against the recommendation by the committee, which had
adviced the trust to attract the retail investors into the scheme. This led to doubts about
UTI's commitment towards the revival of the scheme.
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2000, US-64 was again termed as one of the best investment avenues by analysts and
market researchers. UTI had become more proactive in fund management with its scrips
rising in value, restoring the confidence of the small investor in the scheme. The National
Council of Applied Economic Research (NCAER) and SEBI surveys mentioned that US-
64 was once again perceived as a safe investment by the middle class income groups.
However, the euphoria seemed to be short lived as in 2001, US-64 was involved in yet
another scam due to its investments in the K-10 stocks . Talks of a drastically low NAV,
inflated prices, increasing redemption and GoI bailouts appeared once again in the media.
An Economic Times report claimed that there was a difference of over Rs 6000 crore
between the NAV and the sale prices. Doubts were raised as to US-64 being an inherently
weak scheme, which coupled with its mismanagement, had led to its downfall once again.
Source:www.icmrindia.org
1. Explain in detail the reasons behind the problems faced by US-64 in the mid
1990s. Were these problems the sole responsibility of UTI? Give reasons to
support your answer.
2. Analyse the steps taken by UTI to restore investor confidence in US-64.
Comment briefly on the efficacy of these steps.
3. As a market analyst, would you term US-64 a safe mode of investment? Justify
your stand with reasons.
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ASSIGNMENT C
Q1. Equity shareholders rights are listed below. One of the rights is incorrect.
(a) rights to have first claim in the case of winding of the company
(b) right to vote at the general body meeting of the company
(c) right to share profits in the form of dividends
(d) right to receive a copy of the statutory report
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(a) Best rate order
(b) Limit order
(c) Discretionary order
(d) Stop Loss Order
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(a) multi currency
(b) only domestic currency
(c) none of the above
Q18. When money is borrowed or lent for more than a day and up to 14 days it is
called
(a) Call money
(b) Quick money
(c) Notice money
(d) Term money
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Q22. Private placement has following advantage:
(a) Flexibility and high cost
(b) Accessibility and speed
(c) High cost and speed
(d) Speed and complexity
Q26. Total amount of called up share capital which is actually paid to the company
by the members is called
(a) Subscribed capital
(b) Called up capital
(c) Paid up share capital
(d) None of the above
Q27. A shares par value is Rs 10 but it is issued at Rs 20 , then extra amount over
par value is called
(a) Coupon
(b) Interest
(c) Premium
(d) None of the above
Q28. Bad news about a company can pull down its stock prices. This is called
(a) Market risk
(b) Non market risk
(c) Interest risk
(d) Callable risk
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(a) Tax saving schemes
(b) Money Market Instruments
(c) High Rate fixed income bearing instruments
(d) Both debt and equity
Q32. Sweat Equity are the Equity Shares issued by company to its directors or
employees.
(a) As salary
(b) As consideration
(c) Both of the above
(d) None of the above
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(a) Active trading and insider information
(b) Active trading and transparency
Q40. Preference shares means which fulfill the following two conditions
a) It carries preferential rights in respect of dividend at fixed amount and fixed rate
b) It does not carry preferential rights in regard to payment of capital on winding up .
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KEY TO ASSIGNMENT C QUESTIONS
Questio Answe Questio Answe
n rs n rs
1 a 21 c
2 d 22 b
3 c 23 a
4 b 24 a
5 b 25 b
6 c 26 c
7 b 27 c
8 d 28 b
9 a 29 c
10 d 30 d
11 d 31 b
12 b 32 b
13 d 33 a
14 a 34 a
15 c 35 a
16 b 36 c
17 c 37 a
18 c 38 b
19 a 39 a
20 b 40 b