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Capital Markets

Question 1: Write a note on Indian Capital market?

Answer 1: Capital market is place for raising long-term funds and investments
in long tem instruments are available. It’s a market where borrowing and
lending of long term funds takes place. However the scope of capital market has
grown a lot in the recent years, now it includes all the financial instruments i.e.
Short term and Long term (like shares, debentures, bonds etc.), Commercial/
Industrial (Commercial Bills, Commercial Papers, Inter-corporate deposits etc)
and Government paper (T-bills, Central and State Government securities).
With the pace of economic reforms followed in India, the importance of Capital
markets has grown in the last ten years. Corporate’s both in public and private
sectors raise thousands of crores rupees through this market. The governments
through RBI (Reserve Bank of India) as well as FI’s (Financial Institutions) raise
a lot of money to pay off their Debts and to cope up with their Public
Following are the major operations being carried in Indian Capital Market:
1. The raising of new Capital. (Primary Market)
2. Trading in securities already issued by the companies. (Secondary Market)
The important constituents of Indian Capital Markets are:
1. Stock Exchange
2. Banks
3. Investment Trusts/ Companies
4. Development Banks / Specialized Financial Institutions
5. International financial Investors and Institutions
6. Non Banking Financial Institutions (NBFI)
7. Mutual funds
8. Post office Saving Banks
Functions of the Capital Market:
1. The organized and regulated capital market motivates individual to save and
invest funds. The availability of safe and profitable source of investment is an
essential criterion to create propensity to save and invest on the part of the
earning public.
2. It provides for the investors safe and productive channels for investment of
savings and secures the recurring benefit of return thereon, as long as the
savings are retained.
3. It provides liquidity to the savings of the investors, by developing a
secondary capital market, and thus makes even short term savings,
consistently available for long-term users
4. It thus mobilizes savings of large number of individuals, families and
associations and makes the same available for meeting the large capital
needs of organised industry, trade and business and for progress and
development of the country as a whole and its economy.
The Liberalization of Indian economy has opened doors for Foreign
Direct/Institutions investments to Indian Capital market. These institutions have
invested close to $14 billions in Indian Markets. As a result of which Indian

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market is considered as the part of emerging markets across the world. The
various liberal developments in the Indian Capital market includes opening of
mutual funds industry for banks and private players. This has helped a lot to
spread the equity culture. By investing in Mutual funds one can acquire the
shares of different companies, without actually buying them.

The recent developments in Indian Capital market include SCRIPLESS

trading; Over The Counter Exchange of India (OTCEI) and establishment of
SEBI (Stock and Exchange board of India) as a regulatory authority have
taken Indian markets to international standards. They provided improved
services to investors. The country's first ringless, scripless, electronic stock
exchange - OTCEI - was created in 1992 by country's premier financial
institutions - Unit Trust of India, Industrial Credit and Investment
Corporation of India, Industrial Development Bank of India, SBI Capital
Markets, Industrial Finance Corporation of India, General Insurance
Corporation and its subsidiaries and CanBank Financial Services.
Biggest achievement in Indian Stock market was establishment of NSE
(National Stock Exchange). It was a turning point by incorporating best
international practices of Capital market. NSE has several advantages over
the traditional trading exchanges. They are as follows:
• NSE brings an integrated stock market trading network across the nation.
• Investors can trade at the same price from anywhere in the country since
inter-market operations are streamlined coupled with the countrywide access
to the securities.
• Delays in communication, late payments and the malpractice’s prevailing in
the traditional trading mechanism can be done away with greater operational
efficiency and informational transparency in the stock market operations,
with the support of total computerized network.
Unless stock markets provide professionalised service, small investors and
foreign investors will not be interested in capital market operations. And capital
market being one of the major sources for long-term finance for industrial
projects, India cannot afford to damage the capital market path. In this regard
NSE gains vital importance in the Indian capital market system.
Due to vibrant market many Indian companies/projects have raised large sums
from these markets and investors in these activities have got good returns on
their investment. Also the GOI (Government of India) is slowly disinvesting from
the Public sector companies through these markets For e.g. Two public sector
companies viz. Maruti Udyog Ltd. and BPCL’s shares will be offered to public
through IPO (Initial public offers).
The secondary market in India is also very active and volumes on the 2 premier
stock exchanges National stock exchange and Bombay stock exchange have
shown marked/healthy growth. In the few years the markets have taken big
strides in the Derivatives instruments instead of Badla system. The Indian debt
markets has become more vibrant as the RBI has recently allowed participation
of individuals in the government securities markets, which was previously
dominated by Banks, FI’s and Mutual funds only. This has opened new avenues
for investment to individuals.

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Question 2: What are Mutual funds? What are the different types of
Mutual Funds?

Answer 2:
A Mutual Fund is a body corporate that pools the savings of a number of
investors and invests the same in a variety of different financial instruments, or

The income earned through these investments and the capital appreciations
realized by the scheme are shared by its unit holders in proportion to the
number of units owned by them. Mutual funds can thus be considered as
financial intermediaries in the investment business that collect funds from the
public and invest on behalf of the investors. The losses and gains accrue to the
investors only. The Investment objectives outlined by a Mutual Fund in its
prospectus are binding on the Mutual Fund scheme. The investment objectives
specify the class of securities a Mutual Fund can invest in. Mutual Funds invest in
various asset classes like equity, bonds, debentures, commercial paper and
government securities.

The various Technical terms commonly used in case of Mutual Funds:

Portfolio is a group of securities/assets that the fund manager plans to invest.

The Portfolio/fund manager invests the money in diverse assets with the aim of
maximizing return and minimizing the risk.

An Asset Management Company (AMC) is a highly regulated organization that

pools money from investors and invests the same in a portfolio. They charge a
small management fee, which is normally 1.5 per cent of the total funds

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.
NAV is calculated as follows:

M.V of investments+Receivables+Accr. Income– Liabilities-Accr. Expenses

Number of Outstanding units

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Different types of mutual funds:

of Mutual

On the basis of On the basis

Objective of Flexibility

(a) On the basis of Objective

Equity Funds/ Growth Funds

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. The returns in such funds are volatile since they are directly linked to
the stock markets. 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.

Index funds
These funds invest in the same pattern as popular market indices like S&P 500
and BSE Index. The value of the index fund varies in proportion to the
benchmark index.

Tax Saving funds

These funds offer tax benefits to investors under the Income Tax Act.
Opportunities provided under this scheme are in the form of tax rebates U/s 88
as well saving in Capital Gains U/s 54EA and 54EB. They are best suited for
investors seeking tax concessions.

Debt / Income Funds

These Funds invest predominantly in high-rated fixed-income-bearing
instruments like bonds, debentures, government securities, commercial paper
and other money market instruments. They are best suited for the medium to
long-term investors who are averse to risk and seek capital preservation. They
provide regular income and safety to the investor.

Hedge Funds
These funds adopt highly speculative trading strategies. They hedge risks in
order to increase the value of the portfolio.

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(b) On the basis of Flexibility

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. Investors are permitted to join or withdraw
from the fund after an initial lock-in period.

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 (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.

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Question 3: Explain the role of Merchant Bankers in the Initial Public


Answer 3: Merchant Bankers play a significant role in the Indian Capital

market, especially in placing equity in the primary market through the Public
offers route. Public money or savings constitute thousands of rupees every year,
which is raised through equity or debt from market. Merchant bankers help
corporates to raise capital from market. They ought to possess knowledge and
information about the various aspects of capital market, trends prevailing and
the psychology of the investors. The must have the ability to evaluate and
analyze various aspects concerning the formulation of Industrial project and
affecting the viability of the project.

Merchant Bankers helps corporate to raise money from capital market through
the issue of shares, debentures, bonds etc. They are designated as managers to
the issue. Their main business is to attract public money to capital issue. They
also help the companies to determine the capital structure. The pricing of the
issue esp. in the public issue is very important.
The pricing has to be such that:
Investors will be attracted to invest at that price and get suitable returns. And
the Company at the same time should get the premium they are looking for, as
larger the premium lesser is the requirement for borrowed funds.
All issues should be managed by at least one merchant banker functioning as
the lead merchant banker. Provided that, in an issue of offer of rights to the
existing members with or without the right of renunciation the amount of the
issue of the body corporate does not exceed rupees fifty lakhs, the appointment
of a lead merchant banker shall not be essential. No merchant banker, other
than a bank or a public financial institution, who has been granted a certificate
of registration under these regulations, shall after June 30th, 1998 carry on any
business other than that in the securities market.

The Merchant Bankers offers following services and activities during the
public issue:

Preparing the action plan and

Budget for the total expenses for the issue

Drafting of prospectus and application for SEBI.

Obtaining consent from SEBI.

Selection of the Underwriter, Brokers, Bankers to the issue,

Advertising agency, Printers etc.

Holding the road shows to sell the issue for the analyst,

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Brokers and institutional investors.

Deciding the pattern for advertising

Deciding the branches where application money should be


Fixing the Dates for opening and Closing the issue.

Obtaining the daily report of application money collected

In various branches.

Obtaining the subscription of the issue.

(Underwriting minimum 5% of the issue price)

After the closer of issue, Obtaining the consent of SEBI for

Deciding basis of allotment etc.

Companies are free to allot one or more agencies as managers to an issue. SEBI
guidelines insist that there should be at least one authorized Merchant Banker
for an issue less than Rs 100 crore and not more than two merchant bankers
should be associated as lead managers, advisors and consultants to public
issues over Rs 100 crore. This number could be up to max 4.

The prime responsibilities of the Merchant Bankers in the Management of public

issues are listed below:

1. The merchant bankers should satisfy themselves with the viability of the
projects (Technical, financial, managerial, market etc) before promoting it to
the invertors. Also this helps him to sell the issue with confidence. They
should associate themselves with good issues for maintaining high
professional standards and reputation in the market.

2. They should act as the custodians of the investor’s money and this puts a lot
of responsibility on them. To discharge this function they need to exercise
due diligence independently by verifying the content of prospectus and the
reasonableness of the views expressed there in. Though they don’t have to
sign the prospectus, but the have to give a certificate to that effect to SEBI.

3. They are responsible to get the securities listed on all the stock exchanges
mentioned in the prospectus. It can be especially true of companies who

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cannot list their shares on either NSE or BSE but promise listing in several
regional stock markets but actually they list the in one/two exchanges.

4. Non-receipt of the refund orders and allotment advice within the stipulated
period to the investors should be taken care. Introduction of DEMAT accounts
the allotment complaints have considerably reduced. But the timely refunds
and allotment of securities is the responsibility of lead/merchant bankers.

5. The Merchant bankers have to certify that the have verified everything and
they believe it to be true. This assures the investing public about the safety
of their investment. The precautions taken by merchant bankers would
ensure that the fake companies, whose intention is to defraud investors, do
not access market.

6. Every merchant banker shall keep and maintain the following books of
accounts, records and documents namely:
(a) A copy of balance sheet as at the end of each accounting period;
(b) A copy of profit and loss account for that period;
(c) A copy of the auditor's report on the accounts for that period; and
(d) A statement of financial position.

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Question 4: Write Notes on:

Answer 4:

a) Book Building:

Book building is the mechanism where in the price of issue is determined on

the basis of actual demand as evident from the offers give by the various
institutional investors and the underwriters.

As the companies generally raise the capital through public issues where they
need to decide the size of the issue and also the price at which the shares
are to be offered to the investors. However in this system the issuer is not
able to ascertain the price that the market may be willing to pay forth
shares, before launching the issue. This is where book building comes to their
aid. Book building is also termed as “Price Discovery Method”. In the usual
process investors are not involved in determining the issue/offer price where
as in book building pricing of the issue is determined on the basis of
investors’ feedback only which assures investor demand. Also the issue price
after the issue marketing is flexible in terms of issue size and the prices of
the shares.

The issue may have a placement portion and a public portion. The public
offer is retail marketing of the offer to the public, the placement portion can
be offered through the book building process. For e.g. Bharati Tele has
recently made issues in this way.

The Book Building process is described below:

• The issuer company appoints a LEAD Manager to the issue known as
“Book Runner”. The book runner forms a syndicate to procure
subscriptions to the issue.
• The syndicate members take steps for demand creation and for the
feedback. Orders are procured from the investors.
• Book runner builds the book based on the orders received from the
various bidders through the syndicate members. The BR determines the
Size and the Price of the issue.
• Book runner the closes the book in consultation with the Issuer and
finalizes the allocation to the syndicate members who in turn enter into
procurement agreement.
• Final prospectus is filed with the Registrar of companies along with
procurement agreements.
• The placement portion is to close one day before the opening of the public

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b) Depositories

A depository is an organization where the securities of a shareholder are held

in the electronic format at the request of the shareholder through the
medium of the depository participants. Basically a depository is a bank of
securities. The depository can legally transfer beneficial ownership, which a
custodian cannot. A Depository can be compared to a bank for shares. Just
as a Bank holds cash in your account and provides all services related to
transaction of cash, a depository holds securities in electronic form and
provides all services related to transaction of shares / debt instruments. A
depository interacts with clients through a Depository Participant (DP) with
whom the client has to maintain a DEMAT Account.

Depositories registered with SEBI are:

• NSDL – National Securities Depositories Limited is a Depository promoted
by UTI, IDBI, SBI & NSE who hold the securities in electronic form on
behalf of the beneficiary holder.
• CDSL – Central Depositories Securities Limited is a Depository promoted
by BSE.

The benefits of availing Depository services:

• Protection against loss, theft, forgery, mutilation etc.
• Safe and convenient way to hold securities.
• No stamp duty on transfer of securities as compared to the duty of 0.50%
in the physical segment while transferring ownership.
• Transfer of shares is done immediately i.e. Credit and debt of shares.
• Shorter settlement cycles
• Protection against bad deliveries
• Nomination facility
• No Odd lot problem even one share can be sold
• Minimum paperwork involved in transfer of securities
• Reduction in transaction costs
• Change in address recorded with DP gets registered with all the
companies in which the investor holds securities electronically eliminating
the need to correspond with each of them separately.
• Automatic credit into DEMAT account of shares, arising out-of
bonus/split/consolidation/merger etc.

c) Rolling statements

Rolling settlement is the one in which trades outstanding (Payments made for
the purchases or deliveries in case of sale of securities) at the end of the day
have to be settled at the end of the settlement period. For E.g. In a T+5
Rolling settlement, a transaction entered into Monday has to be settled on

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the fifth working day, which will be the subsequent Monday when either the
pay-in or pay-out transaction takes place.
Advantages of Rolling settlement:
The Rolling settlement payments are much quicker than weekly settlements.
Thus, investors benefit increases from the increased liquidity as in the Rolling
settlement system the investor would receive the payments on the fifth day
after the sales. Thus rolling settlement reduces delays.
Rolling settlement was introduced in India only after introduction of
depositories because the Rolling settlements necessarily require Electronic
transfer of funds and DEMAT facilities in place for trading of securities. This is
because of the fact that handling large volume of paper on a daily basis is
extremely difficult for the Clearinghouses of Stock exchanges. However, still
the transfer of funds in India takes two – three days, as all the Banks are not
yet connected electronically with all their branches, which delays the
clearance process.

d) Non-Voting Shares:

In equity market Shareholders enjoys basically two types of rights:

1. Dividend
2. Voting rights
In case of Non- voting shares one right gets excluded i.e. the shareholder
looses the right to vote, even though he is the member of the company and
may attend the general meeting of the company. They usually are not
entitled to rights or bonus issues of shares of the concerned company.

Non- voting shares therefore require being more attractive than the shares,
which carry Voting rights. This can be achieved in two ways:
1. By giving discount on the issue price
2. By giving higher dividend on Non- voting shares

Advantages of Non- voting shares:

To Companies/Issuer:
Most commonly the Non- voting shares will be quoted at a discounted price
with respect to normal share price. Due to the recent developments in the
economy the industries are growing at fast rate. Thus they require resources
for modernization, expansion, integration and for new projects. But raising
funds by the way of equity has an inherent danger of loosing control to
others. The ability to raise debts has its own limitations. Non- voting shares
provide a way out to companies to garner equity without dilution of the
promoter’s stake and control.

To Investors:
Some of the investors are always interested in gaining high returns from the
investment rather than the right to vote. This is quite evident from the fact
that very few investors/shareholders actually turn up in the annual general
body meetings of the companies and are really interested in the day-to-day

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activities of the company. Mostly the investors are not really interested in the
affairs of company or wish to participate in the affairs of the company.
Question 5: Write a note on Money Market. What is the Whole sale Debt
Market of NSE?

Answer 5: Money market is a place for trading in money and short-term

financial assets that are close substitutes for money. It provides an avenue for
equilibrating the short-term surplus funds of the lenders/investors with the
short-term requirements of borrowers. The number of players in the money
market and their objectives in participating in the market are different. The
volume and risk perception of each of these players are also different. To fulfill
such varied requirements, the money market needs a variety of instruments.

The objectives of Money Market are:

1. Providing equilibrating mechanism for ironing out short-term surpluses and
2. Provide liquidity and a realistic price.
3. Provide cash-rich corporations/institutions a means for parking their short-
term surpluses. (Provident Fund/ Income tax payments/ seasonal surpluses -
otherwise would be kept in current a/c)

Money Market Instruments: Money market is the most liquid market and very
short term in nature. Money market instruments are those with maturity less
than a year and highly liquid. Overnight inter bank call money market,
commercial paper market, certificate of deposit market and T-bills market come
under the purview of money market.

Money Market

Treasury Bills Money Market

Mutual funds

Certificates of Inter Corporate

Deposits (CDs) Deposits

Commercial Repos and

Paper (CPs) Reverse Repos

1. Commercial paper is a debt instrument issued by a corporate with a very

good credit rating to meet its working capital requirements. Corporates usually
take this route when the rates in the money market are lower than working
capital finance rates of the banks. It's a highly liquid market and these
instruments have a maximum maturity period of 1 year and it goes as low as 1

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month and it can be rolled over. The minimum denomination for issue of such
securities is Rs. 25 lakhs. The issuers are usually highly rated corporates. The
issuer has to be compulsorily by any of the credit rating agencies. CP was
introduced in India in 1990 by RBI to enable highly rated corporate borrowers
diversify their sources of short-term borrowings and also to provide an additional
instrument to investors. The biggest advantage is that by issuing CPs, a top-
rated corporate can raise funds at even below the prime lending rate of banks.

2. Certificate of deposit is a debt instrument issued by a Commercial Bank to

meet its short-term requirement of funds. These instruments have a maximum
maturity period of 1 year and in special cases, it can go up to 1 and a half years
with special permission of the RBI. The minimum denomination of CD is Rs. 5

3. T-bills are Promissory notes issued by the Government of India and

constitute a major portion of short-term borrowings by the government. T-Bills
are the most liquid paper after cash and call money. They are highly liquid and
virtually risk free as the Government of the respective country to tide over the
temporary imbalance between receipts and expenditures issues them. Usually,
there is a time lag between the receipts and expenditures of Government and
during that time; the Govt. issues the T-bills to make up this imbalance.
Presently, in India, we have 14 day T-bills, 91 day, 182 day and 364 day T-bills.
The RBI issues securities on behalf of the GOI and the yields are determined on
the basis of competitive bidding. The auction is conducted on the French auction
basis, i.e., all the bidders above the cutoff price will get the amount of securities
issued in their name for which they had bid for, while the bidders at the cutoff
price are issued securities on a pro rata basis.

4. Money Market mutual funds (MMMFs) enable the small investors to

participate in the money market. The collected funds are invested in Money
market instruments like T-bills, CPs, CDs, ICDs, Call/Notice money etc.

Wholesale debt market (WDM)

WDM is a market where pure debt instruments such as government
securities, treasury bills, public sector bonds, corporate debentures,
commercial paper, certificate of deposits etc are traded.

A debt instrument is an obligation undertaken by the issuer of the debt

instrument to repay principal with interest at a predetermined future date.
The concept of a debt instrument is based on a premise that when a person
borrows, he enters into an agreement with the lender that he will repay the
principal and interest at a future date. This arrangement can be converted
in the form of an instrument wherein the loans can be made tradable by
converting it into instruments of smaller units with a pro rate allocation of
principal and interest.

So the basic features of any debt instrument are as follows:

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• Face value of the instrument is the value that is written on the debt
• Issue price, is the value at which the security is issued. It might be at par or
at a premium or discount.
• Coupon, the interest rates payable on the instrument.
• Terms and conditions like repayment period, pattern and mode of repayment.

Various Characteristics of WDM:

• A WDM comprises of very large number of institutional investors and a very
high volume of trade dominate this segment.
• The wholesale debt market is not centrally located anywhere but it is an over
the counter market where buyers and sellers conduct business linked by
telephones, computers, faxes, telexes and other means of communications.
• Its participants include Banks, Financial Institutions, the RBI, Primary
Dealers, Insurance companies, Provident Funds, MFs, Corporates and FIIs.
• Gilt securities are immobilized with the RBI and they maintain a book entry
of holders.
• In this market, the player’s give two way quotes, i.e., both buy and sell
quotes to each other.
• Trades in this market are settled on the basis of trade for trade i.e. each
transaction is settled individually.
• Each trade has a settlement date specified upfront at the time of order entry
and is used a matching parameter. The actual settlement of funds and
securities are effected directly between participants.
• The recent development in this type of market is that RBI has allowed
individuals to buy and sell government securities.

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Question 7: What is meant by Buy back of shares? What are the legal
provisions for buy back in India?

Answer 7:
Buy back of shares is nothing but Buying back of the securities issued by the
company to the shareholders either from the market or directly from the

Objectives of Buy Back: Shares may be bought back by the company on

account of one or more of the following reasons:
1. To increase promoters holding
2. Increase earning per share
3. Rationalize the capital structure by writing off capital not represented by
available assets.
4. Support share value
5. To thwart takeover bid
6. To pay surplus cash not required by business
In fact the best strategy to maintain the share price in a bear run is to buy back
the shares from the open market at a premium over the prevailing market price.

Conditions of Buy Back

1. The buy-back is authorized by the Articles of association of the Company.
2. A special resolution has been passed in the general meeting of the company
authorizing the buy-back. In the case of a listed company, this approval is
required by means of a postal ballot. Also, the shares for buy back should be
free from lock in period/non transferability. The buy back can be made by a
Board resolution If the quantity of buyback is or less than ten percent of the
paid up capital and free reserves.
3. The buy-back is of less than twenty-five per cent of the total paid-up capital
and fee reserves of the company and that the buy-back of equity shares in
any financial year shall not exceed twenty-five per cent of its total paid-up
equity capital in that financial year.
4. The ratio of the debt owed by the company is not more than twice the capital
and its free reserves after such buy-back.
5. There has been no default in any of the following
(i) In repayment of deposit or interest payable thereon.
(ii) Redemption of debentures, or preference shares.
(iii) Payment of dividend, if declared, to all shareholders within the
stipulated time of 30 days from the date of declaration of dividend.
(iv) Repayment of any term loan or interest payable thereon to any
financial institution or bank.
6. There has been no default in complying with the provisions of filing of Annual
Return, Payment of Dividend, and form and contents of Annual Accounts.
7. All the shares or other specified securities for buy-back are fully paid-up.
8. The buy-back of the shares or other specified securities listed on any
recognized stock exchange shall be in accordance with the regulations made
by the Securities and Exchange Board of India in this behalf. and

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9. The buy-back in respect of shares or other specified securities of private and

closely held companies is in accordance with the guidelines as may be

Disclosures in the explanatory statement

The notice of the meeting at which special resolution is proposed to be passed
shall be accompanied by an explanatory statement stating –
1. A full and complete disclosure of all material facts.
2. The necessity for the buy-back.
3. The class of security intended to be purchased under the buy-back.
4. The amount to be invested under the buy-back. and
5. The time limit for completion of buy-back.

Filing of Declaration of solvency

After the passing of resolution but before making buy-back, file with the
Registrar and the Securities and Exchange Board of India a declaration of
solvency in form 4A. The declaration must be verified by an affidavit to the
effect that the Board has made a full inquiry into the affairs of the company as a
result of which they have formed an opinion that it is capable of meeting its
liabilities and will not be rendered insolvent within a period of one year of the
date of declaration adopted by the Board, and signed by at least two directors of
the company, one of whom shall be the managing director, if any:
No declaration of solvency shall be filed with the Securities and Exchange Board
of India by a company whose shares are not listed on any recognized stock

Register of securities bought back

After completion of buyback, a company shall maintain a register of the
securities/shares so bought and enter therein the following particulars
1. The consideration paid for the securities bought-back.
2. The date of cancellation of securities.
3. The date of extinguishing and physically destroying of securities and
4. Such other particulars as may be prescribed where a company buys-back its
own securities, it shall extinguish and physically destroy the securities so
bought-back within seven days of the last date of completion of buy-back.

Procedure for Buy back:

1. Where a company proposes to buy back its shares, it shall, after passing of
the special/Board resolution make a public announcement at least one
English National Daily, one Hindi National daily and Regional Language Daily
at the place where the registered office of the company is situated.
2. The public announcement shall specify a date, which shall be "specified date"
for the purpose of determining the names of shareholders to whom the letter
of offer has to be sent.
3. A public notice shall be given containing disclosures as specified in Schedule I
of the SEBI regulations.
4. A draft letter of offer shall be filed with SEBI through a merchant Banker. The
letter of offer shall then be dispatched to the members of the company.

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5. A copy of the Board resolution authorizing the buy back shall be filed with the
SEBI and stock exchanges.
6. The date of opening of the offer shall not be earlier than seven days or later
than 30 days after the specified date
7. The buy back offer shall remain open for a period of not less than 15 days
and not more than 30 days.
8. A company opting for buy-back through the public offer or tender offer shall
open an escrow Account.

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Question 8: Write a note on Portfolio management.

Answer 8:
Portfolio Management involves the allocation of assets for individuals and
institutions, keeping in mind their previous investment experience, their needs
and circumstances (such as liquidity needs, risk appetite, tax considerations),
and their investment objectives. Every portfolio is tailored to the individual
client's requirement, and the attempt is to provide personalized financial
Investment requirements are as unique as the individual. An individual's
investment needs would be driven by his current financial status, future
requirements, social and age profile. To comprehensively cover his needs, a
person would ideally require exposure to equities, debt, insurance, fixed
deposits, real estate, etc. Evaluation and investment in each requires a unique

Factors influencing the Portfolio decisions

• Investor’s Characteristics
• Liquidity needs
• Tax considerations
• Investment risk
• Interest rate risk
• Assurance of income
• Safety of principal
• Business and market risk

Types of Portfolio management

1. Discretionary Portfolio management services (DPMS): In this case the client
gives his money for investment to fund manager, who handles the paper
work, takes all investment decisions and gives a good return to the investors
and charges a fee for the service rendered.
2. Non-Discretionary Portfolio management services: The manager function acts
a counselor, but the investor is free to accept or reject the managers advice,
the managers handles the paper work and charges some service fees.
Manager makes a tailor made portfolio as per the risk taking ability of the

Steps in Portfolio management:

1. Specification and qualification of investor’s objectives, constraints and
preferences in the form of policy statement.
2. Determination and quantification of capital market expectations for the
economy, market sectors, industries and individual securities.
3. Allocation of assets and selection of individual securities (Elaborated in the
figure below).
4. Performance measurement and evaluation of portfolio to ensure investors
objectives are attained.

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5. Monitoring the performance and responding to changes in investors’ objective

constraints and capital market expectations.
6. Rebalancing the portfolio whenever necessary.

Benefits of Portfolio Management:

• It can be a complex, risky and time-consuming process for an individual to
handle in isolation. That's why it makes good sense to appoint a properly
qualified investment manager to invest in the stock market on ones behalf.
• As a client of Portfolio Management the investment manager will use his
market knowledge, experience and contacts to identify those investments,
which are likely to offer an appropriate combination of risk and return in
relation to ones objectives.
• Manage ones investments in a tax efficient manner, ensuring that the person
takes full advantage of the allowances and limits available to him.
• Assess your risk profile to identify the most suitable type of investments.
• Takes care of all the day-to-day administrative work ensuring that ones rights
in relation to his investments are protected,
• Keep the investor informed about changes in his portfolio and will regularly
review his financial objectives to ensure his investment portfolio continues to
be relevant to his financial goals.
• Regularly update him on the performance of his investments and stock
markets generally.

SEBI Regulation governing Portfolio Management activities:

1. The portfolio manager must register himself with the SEBI.
2. The applicant needs to have necessary infrastructure.
3. He must have in his employment at least 2 employees who are experienced
in the business of Portfolio Management.
4. The applicant must fulfill the capital adequacy norms laid down from time to
5. The applicant must not be involved in any litigation connected with the
securities market.
6. He must have a professional qualification from a recognized institution in
finance, law, and accountancy or business management.
7. The applicant must pay registration fees as are in force.
8. Portfolio manager must enter into an agreement clearly defining the inter
relationship and setting out their mutual rights, liabilities and obligation
relating to the management of portfolio of the client.
9. The funds of all the clients’ shall be placed by the portfolio manager in a
separate account to be maintained by him in a scheduled commercial bank.
10. The portfolio manager charges agreed fees from the client for rendering
portfolio management services.
11. The portfolio manager shall not accept money or securities form client for a
period of less than one year.
12. The portfolio manager shall sell and purchase securities separately from
each client.
13. Renewal of portfolio fund on maturity of the initial period shall be deemed as
a fresh placement and shall be for minimum period of one year.

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Question 9: Explain briefly the Derivative trading in stock exchanges.

Answer 9:
The Securities Contracts (Regulation) Act 1956 defines derivative as under:
1. A "Derivative” is a security derived from a debt instrument, share, and loan
whether secured or unsecured, risk instrument or contract for differences or
any other form of security;
2. A "Derivative" is a contract, which derives its value from the prices, or index
of prices of underlying securities

The above definition conveys:

• That derivatives are financial products
• Derivative is derived from another financial instrument/contract called the
underlying. In the case of Nifty futures, Nifty index is the underlying.
• A derivative derives its value from the underlying assets. The underlying
asset can be securities, commodities, bullion, currency, live stock or anything

In other words, Derivative means a forward, future, option or any other hybrid
contract of pre determined fixed duration, linked for the purpose of contract
fulfillment to the value of a specified real or financial asset or to an index of

Classification of Derivatives:

1. Forward Contracts (Currencies, Stocks etc):

A cash market transaction in which a seller agrees to deliver a specific cash
commodity to a buyer at some point in the future is called Forward Contracts.
Forward contract is different from a spot transaction, where payment of price
and delivery of commodity concurrently take place immediately the
transaction is settled. In a forward contract the sale/purchase transaction of
an asset is settled including the price payable, not for delivery/settlement at
spot, but at a specified future date. India has a strong dollar-rupee forward
market with contracts being traded for one, two,.. six month expiration. Daily
trading volume on this forward market is around $500 million a day. Indian
users of hedging services are also allowed to buy derivatives involving other
currencies on foreign markets.
Unlike futures contracts (which occur through a clearing firm), forward
contracts are privately negotiated and are not standardized. Further, the two
parties must bear each other's credit risk, which is not the case with a
futures contract. Also, since the contracts are not exchange traded, there is
no marking to market requirement, which allows a buyer to avoid almost all
capital outflows initially (though some counter parties might set collateral
requirements). Given the lack of standardization in these contracts, there is
very little scope for a secondary market in forwards. The price is specified in

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a forward contract for a specific commodity. The forward price makes the
forward contract have no value when the contract is written. However, if the
value of the underlying commodity changes, the value of the forward
contract becomes positive or negative, depending on the position held.
Forwards are priced in a manner similar to futures. Like in the case of a
futures contract, the first step in pricing a forward is to add the spot price to
the cost of carry (interest forgone, convenience yield, storage costs and
interest/dividend received on the underlying). Unlike a futures contract
though, the price may also include a premium for counter party credit risk,
and the fact that there is not daily marking to market process to minimize
default risk. If there is no allowance for these credit risks, then the forward
price will equal the futures price.

2. Futures Contract (Currencies, Stocks, Indexes, Commodities etc)

A future contract is an agreement between a buyer and a seller where the
seller agrees to deliver a specified quantity and grade of a particular asset at
a predetermined time in future at an agreed upon price through a designated
market (exchange) under stringent financial safeguards. A futures contract,
in other words, is a forward contract, which trades on an exchange. S&P CNX
Nifty futures are traded on National Stock Exchange. This provides them
transparency, liquidity, anonymity of trades, and also eliminates the counter
party risks due to the guarantee provided by National Securities Clearing
Corporation Limited.
3. Options (Currencies, Stocks, Indexes etc).
Options are the standardized financial contracts that allows the buyer
(holder) of the options, i.e. the right at the cost of option premium, not the
obligation, to buy (call options) or sell (put options) a specified asset at a set
price on or before a specified date through exchanges under stringent
financial security against default.
The underlying assets may be physical commodities like wheat/ rice/ cotton/
gold/ oil or financial instruments like equity stocks/ stock index/ bonds etc.

Various types of options:

• Call Option
• Put Option
• European Option & American Option

4. Swaps (Currency, Interest, Asset etc).

An agreement for an exchange of payments between two counter parties at
some point(s) in the future and according to a specified formula.

Types of swaps:
• An Interest Rate Swap (IRS) is a financial contract between two parties
exchanging or swapping a stream of interest payments for a 'notional
principal' amount on multiple occasions during a specified period. Such
contracts generally involve exchange of a 'fixed to floating' or 'floating to
floating' rates of interest. Accordingly, on each payment date - that occurs

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during the swap period - cash payments based on fixed/floating and

floating rates, are made by the parties to one another.
• A Currency Swap (CS) is a financial contract between two parties
exchanging or swapping a stream of payments for a 'notional principal'
amount on multiple occasions during a specified period. Such contracts
generally involve exchange of a 'fixed to floating' rate or ‘Cross currency'.
Accordingly, on each payment date -that occurs during the swap period -
the parties make cash payments based on fixed/floating and exchange
rates, to one another.

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Question 12: Write a note on Credit and Debit cards. Comment on the
future of plastic money in India.

Answer 12:

Credit Card
A credit card is a payment card issued to a person for purchasing goods and
services and obtaining cash against a line of credit established by the issuer.

It is a card (usually plastic) that assures a seller that the person using it has a
satisfactory credit rating and that the issuer will see to it that the seller receives
payment for the merchandise delivered. Some companies are now offering credit
cards for those with bad or no credit that do not require a security deposit. The
application fees, annual fees, and interest rates associated with these unsecured
cards are higher than standard cards. These cards should be used only to re-
establish a good credit history only, and not to run up a big balance.

Debit cards
A Debit card is a payment card (usually plastic) that enables the holder to
withdraw money or to have the cost of purchases charged directly to the
holder's bank account.

They are very similar to credit cards in that they can be used to withdraw cash
from ATMs and make purchases at millions of locations worldwide just as with a
regular Visa or MasterCard. The major difference is that amounts used for
purchases with your debit card are immediately deducted from your checking
account. Merchants prefer them to checks because they don't bounce and the
money is transferred quickly.

The biggest advantage of debit cards is convenience. Not only one needs to
carry cash, one doesn’t run up interest charges like in case of credit card. For
this reason, debit cards are a good option for those who have gotten into trouble
with credit cards in the past. They certainly will reign in uncontrolled spending,
since purchase amounts are immediately deduced from one's bank account, and
one can keep track of spending and expenses.

The major disadvantage of using debit cards is in terms of financial protection

that a credit card provides in regard of frauds. If ones credit card is stolen, he
will only be required to pay $50.00. However, if your debit card is stolen, a thief
can use it at many locations without being required to have access to a PIN
number. Money lost from your bank account in this manner is not refundable.
However, both Visa and MasterCard offer a $50 limit on liability on fraudulent
charges made with the debit cards they issue.

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Various Parties involved in the transaction

Card Issuers are mainly the banks. They are interested in this business
because of high margins i.e. they charge up to 3% fees from member
establishments, Charge annual fees from their customers, earn interest on the
credit made available to the users. The Banks also have to bear the costs
Like the cost of marketing the cards, the credit information cost, membership
fees paid to clearing agencies, admin fees and cost of bad debts.

Card Holders includes both the individuals and the business organization.

Member establishments (ME’s) are the establishments enlisted to the card

issuers, who accept payment through cards for goods sold or services rendered.
ME’s are enlisted after taking into account their reputation, integrity, standing,
popularity in market and the volume of business generated by them Based on
type of business, location turnover etc floor limit for ME’s is fixed.

Clearing agencies: The card issuer affiliates itself with MasterCard

International or Visa International –the two leading international card issuers
which act as clearing agencies. The advantage of this affiliation is that it enables
cardholder of one affiliate to use his/her card at the member of other affiliate

Future of plastic money in India

The prudish Indian psyche will have a tremendous bearing on the future of
plastic money. ``Among potential consumers, perception of likelihood of
spending beyond means and taking credit while using a credit card is considered
as the biggest obstacle,'' says a Finance market expert. ``Research shows that
consumers still felt threatened by a credit card. The primary reason being the
fear of overspending''. The credit card is ``looked upon more as a status symbol
and a sign of extravagance than a convenience tool or an alternative mode of

The debit card may still prove closer to the Indian heart, allowing conservative
spenders that ``perfect control on expenses.'' Yet the road ahead for the debit
card too is not entirely without its share of prickly gravel. ``The biggest
deterrent would be that very few merchant establishments in India are equipped
to accept debit cards and there is no grace period available.''

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Question 15: Explain the need and concept of Credit Rating?

Answer 15:

“Credit-rating” and "Credit-rating agency" are defined as under-

• "Rating" means an opinion regarding securities, expressed in the form of
standard symbols or in any other standardized manner, assigned by a credit
rating agency and used by the issuer of such securities, to comply with a
requirement specified by these regulations. Credit ratings are expressed as
letter grades such as A-, B, or C+. These ratings are based on various factors
such as a borrower's payment history, foreclosures, bankruptcies and charge-
offs. There is no exact science to rating a borrower's credit, and different
lenders may assign different grades to the same borrower.
• "Credit Rating Agency" is a commercial concern engaged in the business of
credit rating of any debt obligation or of any project or programme requiring
finance, whether in the form of debt or otherwise, and includes credit rating
of any financial obligation, instrument of security, which has the purpose of
providing a potential investor or any other person any information pertaining
to the relative safety of timely payment of interest or principal.

Credit rating is a measure of ones credit-worthiness: his/her reputation for

paying back money. A credit rating (or profile) is a picture of how you, as an
individual, pay back the companies you borrow money from. It is also an
accounting of how you meet your other financial obligations. A credit rating
usually requires information in five categories:
1. Identifying information (name, address, date of birth, etc.)
2. Employment information
3. Credit information
4. Public record information
5. Inquiries

Information on ones credit report comes from companies that have loaned
money. National credit reporting agencies, also known as credit bureaus,
organize the information and keep credit reports on file. Anyone who has ever
used credit to buy anything probably has a credit report.

To sum up what exactly Credit Rating is:

• It reflects the borrowers’ accountability, expected capability and inclination to
pay interest and principal in timely manner.
• It is an isolated function of a credit risk evaluation.
• It involves issue specific evaluation.

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• It is useful in differentiating credit quality.

What Credit rating is not:

• Rating is not a general-purpose evaluation of the issuer.
• It is not a recommendation to buy/sell/hold a security.
• It is not an extensive audit of the issuing company.
• Rating is not a one-time assessment of the credit worthiness valid over the
future life of the security.

The types of instruments rated:

Credit rating is used extensively for evaluating debt instruments. These include
long-term instruments like bonds and debentures as well as short-term
instruments like commercial paper. In addition to these fixed deposits,
Certificate of deposits (CDs), structured obligations including the non-convertible
portion of PCDs (Partially convertible Debentures) and preference shares are
rated. BUT the EUITY shares are not rated.

The need for credit rating is different for different parties depending on the
benefits it offers to the various parties utilizing these services viz. investors,
intermediaries, issuers and the regulatory authority.

• Benefits to Investors:
1. Credit Rating will supplement the investors’ credit evaluation process.
2. It facilitates comparison of relative value between competing securities.
3. It helps in recognizing the risk involved in the investment.

• Benefits to Financial Intermediaries:

1. The rating helps them in pricing the debt.
2. It shifts the burden of establishing the credit quality from intermediary to
a rating agency thereby easing the due diligence requirement.
3. With high credit rated instruments brokers find it easy to convince their
clients to select a particular investment proposal. This saves their time,
cost and manpower in the convincing activity.
• Benefits to Issuer:
1. A company with rating can approach a wider section of investors for
resource mobilization.
2. Smaller and not so well known companies can access the market.
3. A company with high credit rated instruments has the opportunity to
reduce the cost of borrowing by quoting less interest rates.
4. Encourages financial discipline as borrowers attempt to obtain ratings by
improving financial structures and reducing operating risks.
5. Rating encourages the companies to come out with more disclosures
about their accounting system, financial reporting and management
6. Company with rated instruments can use their rating as marketing tool to
create a better image in dealing with customers, lenders and the

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• Benefits to Regulatory Authorities:

1. By identifying risks, rating helps in channeling savings into more
productive investments.
2. Credit rating serves the objective of protecting Customer interest.

Semester III – Capital Markets