Wealth Managment 1
Content
Semester III
WEALTHMANAGEMENT Prof. D. C. Pai
STOCKS
FINANCIAL STATEMENTS MEANING Financial statement consists of Balance Sheet, Profit and Loss Account, Sources and Uses of Funds Statements, Auditors·point Notesoftotime. the financial The Balance sheet shows the financial position of the firm atand a particular The profitstatements. and loss account (Income Statement) shows the financial performance of the firm over a period of time. The sources and uses of funds statements reflect the flow of funds through the business during a given period of time.
TYPES OF FINANCIAL F INANCIAL STATEMENTS Balance Sheet The balance sheet of a company, according to the Companies Act, should be either in account form or the report form.
Balance Sheet: Account Form
Liabilities
Assets
Share Capital
Fixed Assets
Reserves and Surplus
Investments
Secured loans
Current Assets, loans and Advances
Unsecured loans
Miscellaneous Miscellaneous expenditure
Current liabilities and provisions pr ovisions
Liabilities: y
Share Capital: Share capital has been divided into equity capital and preference capital. The share capital represents the contribution of owners of the company. Equity capital does not have fixed rate of dividend. The preference capital represents contribution of preference shareholders and has fixed rate of dividend.
y
Reserves and Surplus: The reserves and surpluses are the profits retained in the company. The reserves can be divided into revenue reserves and capital reserves. Revenue reserves represent accumulated retained earnings from the profits of business operations. Capital reserves are those gained which are not related to business operations. The premium on issue of shares and gain on revaluation of assets are examples of the capital reserves.
y
Secured and Unsecured Loans: Secured loans are the borrowings against the security. They are in the form of debentures, loans from financial institutions and loans from commercial banks. The unsecured loans are the borrowings without a specific security. They are fixed deposits, loans and advances from promoters, inter-corporate borrowings, and unsecured loans from the t he banks.
y
Current Liabilities and Provisions: They are amounts due to the suppliers of goods and services brought on credit, advances payments received, accrued expenses, unclaimed dividend, provisions for taxes, dividends, gratuity, pensions, etc.
Assets:
y
Fixed Assets: These assets are acquired for long-terms and are used for business operation, but not meant for resale. The land and buildings, plant, machinery, patents, and copyrights are the fixed assets.
y
Investments: The investments are the financial securities either for long-term or short-term. The incomes and gains from the investments are not from the business operations.
y
Current Assets, Loans, and Advances: This consists of cash and other resources which can be converted into cash during the business operation. Current assets are held for a short-term period. The current assets are cash, debtors, inventories, loans and advances, and pre-paid expenses.
y
Miscellaneous Expenditures and Losses: The miscellaneous expenditures represent certain outlays such as preliminary expenses and pre-operative expenses not written off. Though loss indicates a decrease in the owners· equity, the share capital can not be reduced with loss. Instead, Share capital and losses are shown separately on the liabilities side and assets side of the t he balance sheet.
Balance Sheet: Report Form
I. Sources of Funds
1. Shareholders· Funds
(a) Share Capital (b) Reserves & surplus 2. Loan Funds (a) Secured loans (b) Unsecured loans II. Application of Funds
(i) Fixed Assets (ii) Investments (iii) Current Assets, loans and advances Less: Current liabilities and provisions Net current assets (iv) Miscellaneous expenditure and losses
Profit and Loss Account Profit and Loss account is the second major statement of financial information. It indicates the revenues and expenses during particular period of time. The period of time is an accounting period/year, April-March. The profit and loss account can be presented broadly into two forms: (i) usual account form and (ii) step form. The accounting report summarizes the revenue items, the expense items, and the difference between them (net income) for an accounting period.
Mere statistics/data presented in the different financial statements do not reveal the true picture of a financial position of a firm. Properly analyzed and interpreted financial statements can provide valuable insights into a firm·s performance. To extract the information from the financial statements, a number of tools are used to analyse analyse such statements. The popular tools are: 1. Comparative Financial Statements, 2. Common Sized Statements, and 3. Ratio Analysis. Comparative Financial Statements
This involves putting statements for two periods/organizations in a comparative form and indicating differences between them in terms of rupees and percentages.
Example 12: Financial statement of XYZ Ltd. for the years 2005 and 2006 are compared as under: __________________________________________________________________________ Particulars Amount (in Rs. Lakh) Increase/Decrease
Equity Share Capital Debentures
2005
2006
15.00
15.00
-
9.00
6.00
(-) 3.00
Current Liabilities Liabilities Land and Building Investments Current Assets
10.00
Amount_(%)______
10.50
(-) 33.33 (+) 0.50
(+) 5.00
13.00
13.00
-
-
8.00
10.00
(+) 2.00
(+) 25.00
13.00
8.50
(-) 4.50
(-) 34.62
__________________________________________________________________________ Common Size Statements This involves putting statements for two years/organizations in a comparative form, where the items appear in percentage to total, rather than in absolute rupee form. This indicates relative importance of each item in the total and significant changes in the composition of the items.
Example 13: Common size statement of ABC Ltd. for the years 2005 and 2006 is as under: __________________________________________________________________________ Particulars
Equity Share Capital Debentures
Amount (in Rs. Lakh) 2005
2006
2005
2006_____
15.00
15.00
44.11
47.62
9.00
6.00
26.47
19.05
Current Liabilities Liabilities Land and Building Investments
Percentage
10.00
10.50
29.42
33.33
13.00
13.00
38.23
41.27
8.00
10.00
23.53
31.75
Current Assets
13.00
8.50
38.24
26.98
__________________________________________________________________________
Ratio Analysis Financial ratio is a quantitative relationship between two items/variables. Financial ratios can be broadly classified into three groups: (I) Liquidity ratios, (II) Leverage/Capital structure ratio, and (III) Profitability ratios.
(I) Liquidity ratios
Liquidity refers to the ability of a firm to meet its financial obligations in the short-term which is less than a year. Certain ratios which indicate the liquidity of a firm are: (i) Current Ratio, (ii) Acid Test Ratio, (iii) Turnover Ratios. It is based upon the relationship between current ass assets ets and current liabilities. (i) Current ratio =
Current . Assets Current . Liabilitie s
The current ratio measures the ability of the firm to meet its current c urrent liabilities liabilities from the current assets. asset s. Higher the current ratio, greater the short-term solvency (i.e. larger is the amount of rupees available per rupee of liability).
Quick . ssets ¢
(ii) Acid-test Ratio
=
urrent . iabilitie s
¡
Quick assets are defined as current assets excluding inventories and prepaid expenses. The acid-test ratio is a measurement of firm·s ability to convert its current assets quickly into cash in order to meet its current liabilities. Generally Generally speaking 1:1 ratio is considered to be sat satisfactory. isfactory.
(iii) Turnover Ratios:
Turnover ratios measure how quickly certain current assets are converted into cash or how efficiently the assets are employed by a firm. The important turnover ratios are: -Inventory Turnover Ratio, -Debtors Turnover Ratio, -Average Collection Period, -Fixed Assets Turnover and -Total Assets Turnover
Cost of Goods Sold
Inventory Turnover Ratio =
Average I nventoty nventoty
Where, the cost of goods sold means sales minus gross profit. ¶Average Inventory· refers to simple average of opening and closing inventory. The inventory turnover ratio tells the efficiency of inventory management. Higher the ratio, more the efficient of inventory management.
Debtors· Turnover Ratio =
Net reditS ales ¤
verage ccounts Re ceivable( Debtors )
£
£
The ratio shows how many times accounts receivable (debtors) turns over during the year. If the figure for net credit sales is not available, then net sales figure is to be used. Higher the debtors turnover, the greater the efficiency of credit management.
¦
Average Collection Period =
¦
ver a ge Debtors
verage Daily reditSales
¥
Average Collection Period represents the number of days· worth credit sales that is locked in debtors (accounts receivable).
Please note that the Average Collection Period and the Accounts Receivable (Debtors) Turnover are related as follows: Average Collection Period =
365 Da ys DebtorsTur nover
Fixed Assets turnover ratio measures sales per rupee of investment in fixed assets. In other words, how efficiently fixed assets are employed. Higher ratio is preferred. It is calculated as follows: Fixed Assets turnover ratio = =
Net .S ales NetFixed s sets §
Total Assets turnover ratio measures how efficiently all types of assets are employed.
Total Assets turnover ratio =
Net .S ales ¨
ver a geTot al ssets ¨
(II) Leverage/Capital structure ratios
Long term financial strength or soundness of a firm is measured in terms of its ability to pay interest regularly or repay principal on due dates or at the time of maturity. Such long term solvency of a firm can be judged by using leverage or capital structure ratios. Broadly there are two sets of ratios: First, the ratios based on the relationship between borrowed funds and owner·s capital which are computed from the balance sheet. Some such ratios are: Debt to Equity and Debt to Asset ratios. The second set of ratios which are calculated from Profit and Loss Account is: The interest coverage ratio and debt service coverage ratio are coverage ratio for leverage risk. (i) Debt-Equity ratio reflects relative contributions of creditors and owners to finance the business.
Debt-Equity ratio
=
Debt
Equity
The desirable/ ideal proportion of the two components (high or low ratio) varies from industry to industry.
(ii) Debt-Asset Ratio: Total debt comprises of long term debt plus current liabilities. The total assets comprise of permanent capital plus current liabil liabilities. ities.
Debt-Asset Ratio
=
Tot al Debt Tot al A ssets
The second set or the coverage ratios measure the relationship between proceeds from the operations of the firm and the claims of outsiders.
E arnings Before I nterest nterest and T a xes = I nterest nterest
(iii) Interest Coverage ratio
Higher the interest coverage ratio better is the firm·s ability to meet its interest burden. The lenders use this ratio to assess debt servicing ser vicing capacity of a firm. (iv)Debt Service Coverage Ratio (DSCR) is a more comprehensive and apt to compute debt service capacity of a firm. Financial institutions calculate the average DSCR for the period during which the term loan for the project is repayable. The Debt Service Coverage Ratio is defined as follows:
Pr ofit .a fter .t a x Depreciati on Other onca shExpendit ure I nterest nterest .on.term.loan ©
I nterest nterest on term
loan R e pa yment of term loan
(III) Profitability ratios
Profitability and operating/management efficiency of a firm is judged mainly by the following profitability ratios:
(i) Gross Profit Ratio =
(ii) Net Profit Ratio =
ross Pr ofit Net S ales
Net Pr ofit Net S ales
Some of the profitability ratios related to investments are:
(iii) Return on Total Assets =
et I ncome ncome
Average otal Assets
et Pr ofit apital E mployed mployed
(iv)Return on Capital Employed =
(Here, Capital Employed = Fixed Assets + Current Assets - Current Liabilities) Liabilities) nco e A fter T a x Net I nco
Return on Shareholders· Equity =
Aver a ge Tot al Shareholde rs ' Equity
or NetWorth
(Net worth includes Shareholders· equity capital plus reserves and surplus) A common (equity) shareholder has only a residual claim on profits and assets of a firm, i.e., only after claims of creditors and preference shareholders are fully met, the equity shareholders receive a distribution of profits or assets on liquidation. A measure of his well being is reflected by return on equity. There are several other measures to calculate return on shareholders· equity:
(i) Earnings Per Share (EPS): EPS measures the profit available to the equity shareholders per share, that is, the amount that they can get on every share held. It is calculated by dividing the profits available to the shareholders by number of outstanding shares. The profits available to the ordinary shareholders are arrived at by net profits after aft er taxes and preference dividend.
It indicates the value of equity in the market. market .
EPS =
Net Pr ofit Nu ber of r d ing diin nary Shares uts tand ing
(ii) Price-earnings ratios = P/E Ratio =
Market Pr ice per Share EPS
(iii) Cash Earnings per share (CPS/CEPS):
CPS/CEPS =
Net Pr ofit Pr eference Divid en end Depreciati on Nu ber of Equity Shares
Illustration:
Balance Sheet of ABC Co. Ltd. as on March 31, 2006
(Amount in Rs. Crores) Liabilities
Amount
Assets
Amount
Share Capital
16.00
Fixed Assets (net)
60.00
Reserves & Surplus
22.00
Current Assets:
23.40
Secured Loans
21.00
Cash & Bank
0.20
Unsecured Loans
25.00
Debtors
11.80
Current Liabilities Liabilities & Provisions
16.00
Inventories
10.60
(1,00,00,000 equity shares of Rs.10 each)
Pre-paid expenses
Total
100
0.80
Investments
16.60
Total
100
Profit & Loss Account of ABC Co. Ltd. for the year ending on March 31, 2006:
Particulars
Amount
Particulars
Amount
Opening Stock
13.00
Sales (net)
105.00
Purchases
69.00
Closing Stock
15.00
Wages and Salaries
12.00
Other Mfg. Expenses
10.00
Gross Profit
16.00
Total
120.00
Total
120.00
Administrative and Personnel Expenses
1.50
Gross Profit
16.00
Selling and Distribution Expenses
2.00
Depreciation
2.50
Interest
1.00
Net Profit
9.00
Total
16.00
Total
16.00
Income Tax
4.00
Net Profit
9.00
Equity Dividend
3.00
Retained Earning
2.00
Total
9.00
Total
9.00
Market price per equity share - Rs. 20.00
Current Ratio = Current Assets / Current Liabilities = 23.40/16.00 = 1.46
Quick Ratio = Quick Assets / Current Liabilities =Current Assets-(inventory + prepaid expenses)/Current Liabilities = [23.40-(10.60+0.8)]/16.00 = 12.00/16.00 = 0.75
Inventory Turnover Ratio = Cost of goods sold/Average Inventory
= (Net Sales-Gross Profit)/ [(opening stock + closing stock)/2] = (105-16)/ [(15+13)/2] = 89/14 = 6.36
Debtors Turnover Ratio= Net Sales/Average account receivables (Debtors) =105/11.80 =8.8983
Average Collection period = 365 days / Debtors turnover = 365 days/8.8983 = 41 days
Fixed Assets Turnover ratio = Net Sales / Net Fixed Assets = 105/60 = 1.75
Debt to Equity Ratio = Debt/ Equity Equ ity = (21.00+25.00)/(16.00+22.00) = 46/38 = 1.21 Gross Profit Ratio = Gross Profit/Net Sales = 16.00/105.00 = 0.15238 or 15.24%
Net Profit Ratio = Net Profit / Net Sales = 9/105.00 = 0.0857 or 8.57 %
Return on Shareholders· Equity = Net Profit after tax/Net worth = 5.00/(16.00+22.00) =0.13157 or 13.16
SECURITIES MARKET IN INDIA The securities market in India is an important component of Indian Financial system.
FUNCTIONS OF SECURITIES MARKET: Securities Markets is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures etc. Further, it performs an important role of enabling corporates, entrepreneurs to raise resources for their companies and business ventures through public issues. Transfer of resources from those having idle resources (investors) to others who have a need for them (corporates) is most efficiently achieved through the securities market. Stated formally, securities markets provide channels for reallocation of savings to investments and entrepreneurship.
Mobilization of savings and acceleration of capital formation In developing countries like India, plagued by the paucity of resources and increasing demand for investments by industrial organizations and governments, the importance of the capital market is self evident. In this market, various types of securities help mobilize savings from various sections of the population. The twin features of reasonable return and liquidity in the stock exchange are definite incentives to the people to invest in securities. This accelerates the capital ca pital formation in the country.
Promotion of industrial growth The capital market is a central market through which resources are transferred to the industrial sector of the economy. The existence of such an institution encourages encourages the people to t o invest in productive channels rather than in the unproductive sectors like real estate, bullion etc. Thus, it stimulates industrial growth and economic development of the country by mobilizing funds for investment in the corporate sector.
Raising long-term capital The existence of a stock exchange enables companies to raise permanent capital. The investors cannot commit their funds for a permanent period but companies require funds permanently. The stock exchange resolves this clash of interests by offering an opportunity to investors to buy or sell their securities while permanent capital with the company remains unaffected. unaffect ed.
Ready and continuous market
The stock exchange provides a central convenient place where buyers and sellers can easily purchase and sell securities. The element of easy marketability mar ketability makes investment in securities more liquid as compared to other assets.
Proper channelization of funds An efficient capital market not only creates liquidity through its pricing mechanism but also functions to allocate resources to the most efficient industries. The prevailing market price of a security and relative yield are the guiding factors for the people to channelise their funds in a particular company. This ensures effective utilization of funds in the public interest.
Provision of a variety of services The financial institutions functioning in the securities market provide a variety of services, the more important ones being the following : (i) (ii) (iii)
grant of long-term and medium-term loans to entrepreneurs to enable them t hem to establish, expand or modernize business units; provision of underwriting facilities; f acilities; assistance in the promotion of companies (this function is done by the developing banks like
(iv) (v)
IDBI); participation in equity capital expert advice on management of investment in industrial securities.
MARKET SEGMENTS IN SECURITIES MARKET The securities market has two interdependent and inseparable segments, the new issues (primary) market and the stock (secondary) market.
PRIMARY MARKET The primary market provides the t he channel for creation and sale of new securities, while the secondary market deals in securities previously issued. The securities issued in the primary market are issued by public limited companies or by government agencies. The resources in this kind of market are mobilized either through the public or through privateisplacement route.toIt ais selected a public group issue ifofanybody can subscribe for it,issue whereas if the issue made available persons and it iseverybody termed as private placement. There are two major types of issuers of securities, the corporate entities who issue mainly debt and equity instruments and the government (central as well as state) who issue debt securities (dated securities and treasury bills).
Secondary Market The secondary market enables participants who hold securities to adjust their holdings in response to changes in their assessment of risks and returns. Once the new securities are issued in the primary market they are traded in the stock (secondary) market. The secondary market operates through two mediums, namely, the over-the-counter (OTC) market and the exchange-traded market. OTC markets are informal markets where trades are negotiated. Most of the trades in the government securities are in the OTC market. All the spot trades where securities are traded for immediate delivery and payment take place in the OTC market. The other option is to trade using the infrastructure infrastr ucture provided by the stock exchanges. The secondary market is a market in which existing securities are resold or traded. This market is also
known as the stock market. In India, the secondary market consists of recognised stock exchanges operating under rules, bye laws and regulations of regulators. According to Securities Contracts (Regulation) Act 1956, a stock exchange is defined as any body of individuals, whether incorporated or not, constituted before corporatisation and demutualization or a body corporate incorporated under the Companies Act 1956 whether under a scheme of corporatisation and demutualization or otherwise for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities. The exchanges in India follow a systematic settlement period. All the trades taking place over a trading cycle (day=T) are settled together after a certain time (T+2 day). The trades executed on exchanges are cleared and settled by a clearing corporation. The clearing corporation acts as a counterparty and guarantees settlement. A variant of the secondary market is the forward market, where securities are traded for future delivery and payment. A variant of the forward market is Futures and Options market. Presently only two exchanges viz., National Stock Exchange of India Ltd. (NSE) and Bombay Stock Exchange (BSE) provide trading in the Futures & Options.
HISTORY OF SECURITIES MARKET The securities market in India dates back to the 18th century when the securities of the East India Company were traded in Mumbai and Kolkata. The brokers used to gather under a Banyan tree in Mumbai and under a neem tree in Kolkata for the purpose. However the real beginning came in the 1850·s with the introduction of joint stock companies with limited liability. The 1860·s witnessed feverish fever ish dealings in securities and reckless speculation. This brought brokers in Bombay together in July 1875 to form f orm the first formally organised stock exchange in the country viz. The Stock Exchange, Mumbai. Ahmedabad Stock Exchange in 1894, Calcutta in 1908 and Madras in 1937 and 22 others followed this in the 20th century. In order to promote the orderly development of the stock market, the central government introduced a comprehensive legislation called the Securities Contract (Regulation) Act, 1956.
The Calcutta Stock Exchange (CSE) was the largest stock exchange in India till the 1960·s. However, during the later half of the 1960s the relative importance of the CSE declined while that of the BSE increased sharply.
Till the early 1990s, the Indian secondary market comprising of various regional stock exchanges was plagued with the many problems like uncertainty of execution price, uncertain delivery and settlement periods, lack of transparency, absence of risk management, herd mentality of brokers etc.
Emergence of NSE
The National Stock Exchange of India Limited (NSE) ( NSE) was conceptualized at a time when the industry suffered from extreme infirmities of opacity, inefficiency of processes and poor infrastructure. It was the time when a section of powerful brokerage firms mostly located in metropolitan cities dominated the securities industry.
NSE wrote for itself the mandate to create a world-class exchange and use it as an instrument of change for the industry as a whole through competitive pressure. NSE incorporated in 1992 was given recognition as a stock exchange in April 1993 and started operation in June 1994 with the following f ollowing objectives (a) establish a nationwide trading facility for all types of securities, (b)ensure equal access to all investors all over the country through an appropriate communication network, (c) provide for a fair, f air, efficient and transparent securities market using electronic trading system, (d) enable shorter settlement cycles and book entry settlements, s ettlements, and (e) meet the t he international benchmarks and standards. Within a short span of time, t ime, the above objectives have been realized and the exchange has played a leading role as a change agent in transforming the Indian Capital Markets to its present form.
The process of reforms has led to a pace of growth almost unparalleled in the history of any country. Securities market in India has grown exponentially as measured in terms of amount raised from the market, number of stock exchanges and other intermediaries, the number of listed stocks, market capitalisation, trading volumes and turnover on stock exchanges, investor population and price indices. Along with this, the profiles of the investors, issuers and intermediaries have changed significantly. The market has witnessed fundamental institutional changes resulting in drastic reduction in transaction costs and significant improvements in efficiency, transparency and safety. Indian market is now comparable to many developed markets in terms of a number of parameters, as may be seen from the table below.
Table: International Comparison: Comparison: end December 2007
Ger-
Hong
pore
Kong
China
Particulars
USA
UK
Japan
No. of listed Companies
5,130
2,588
3,844
658
472
1,029
1,530
4,887
Market Capitalisation (US $ Bn.)
19,947
3,859
4,453
2,106
353
1,163
6,226
1,819
Market Capitalisation Ratio (%)
149
157.1
90.25
69.43
274.41
583.89
237.6
200.1
42,613
10,324
6,497
3,363
384
917
7,792
1,108
Turnover ( US $
many
Singa-
India
Bn.) Turnover Ratio (%)
216.5
270.1
141.6
179.7
122
89.1
180.1
84
Note: Market Capitalisation Ratio is computed as a percentage of GNI 2006
There are very few countries that have higher turnover ratio than India. Market Capitalisation Capitalisation as a percentage of GNP compares favorably even with advanced countries and much better than emerging markets. In terms of number of companies listed on stock exchanges, India is second.
MARKET PARTICIPANTS IN SECURITIES MARKET In every economic system, some units, individuals or institutions, are surplus-generating, who are called savers, while others are deficit- generating, called spenders. Households are surplus-generating and corporates and Government are deficit generators. Through the platform of securities markets, the savings units place their surplus funds in financial claims or securities at the disposal of the spending community and in turn get benefits like interest, dividend, capital appreciation, bonus etc. These investors and issuers of financial securities constitute two important elements of the securities markets. The third critical element of markets is the intermediaries who act as conduits between the investors and issuers. Regulatory bodies, which regulate the functioning of the securities markets, constitute another significant element of securities markets. The process of mobilisation of resources is carried out under the supervision and overview of the regulators. The regulators develop fair market practices and regulate the conduct of issuers of securities and the intermediaries. They are also in charge of protecting the interests of the investors. The regulator ensures a high service standard from the intermediaries and supply of quality securities and nonmanipulated demand for them in the market. Thus, the four important participants of securities markets are the investors, the issuers, the intermediaries and regulators.
Market Participants
Investors
Issuers
Intermediaries
Regulators
Investors An investor is the backbone of the capital markets of any economy as he is the one lending his surplus resources for funding the setting up of or expansion of companies, c ompanies, in return for financial gain. Investors in Stock Markets can broadly be classified into Retail Investors and Institutional Investors.
Retail Investors are individual investors who buy and sell securities for their personal account, and not for another company or organization. This category also includes High Networth Individuals (HNI) which comprise of people with large personal financial holdings.
Institutional Investors comprise of domestic Financial Institutions, Banks, Insurance Companies, Mutual Funds and FIIs (Foreign Institutional investor is an entity established or incorporated outside India that proposes to make investments in India).
Issuers Both PSUs and private companies tap the securities market to finance capital expansion activity and growth plans. Even banks, financial institutions raise resources from securities market. Other important issuers are mutual funds which are important investment intermediaries which mobilize the savings of the small investors. Funds can rise in the primary market from the domestic market as well as from international markets. After the reforms initiated in 1991, one of the major policy change was allowing Indian companies to raise resources by way of equity issues in in the international markets. Indian companies have raised resources from international capital markets through Global Depository Receipts (GDRs)/American Depository Receipts (ADRs), Foreign Currency Convertible bonds (FCCBs) and External Commercial Borrowings (ECBs). (ECBs). GDRs are are essentially equity equity instruments issued abroad by authorized overseas overseas corporate bodies theinstruments, shares/bondsdenominated of Indian companies nominated domestic custodian banks. ADRs are against negotiable in dollars held and with issued by the US Depository Bank. FCCBs are bonds issued by Indian companies and subscribed to by a non-resident in foreign currency. They carry a fixed interest or coupon rate and are convertible into a certain number of ordinary shares at a preferred price. ECBs are commercial loans (in the form of bank loans, buyers, credit, suppliers credit, securitised instruments (floating rate notes and fixed rate bonds) availed ava iled from any internationally recognised source such as bank, export credit agencies, suppliers of equipment, foreign collaborators, foreign equity holders and international capital market. ECBs supplement domestically available resources for expansion of existing capacity as well as for fresh investment. Indian companies have preferred this route to raise funds as the cost of borrowing is low in the international markets.
Intermediaries
The term market intermediary usuallydealing used toin refer to those who are in the managing individual portfolios, executingisorders, or distributing securities and business providingofinformation relevant to the trading of securities. The market mediators play an important role on the stock exchange market; they put together the demands of the buyers with the offers of the security sellers. A large variety and number of intermediaries provide intermediation services in the Indian securities markets.
Stock Exchanges: The stock exchanges provide a trading platform whereby the buyers and sellers can meet to transact in securities. The Securities Contract (Regulation) Act, 1956 [SCRA] defines ¶Stock Exchange· as any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling selling or dealing in securities. se curities. Stock exchange could be a regional stock exchange whose area of operation/jurisdiction is specified at the time of its recognition or national exchanges, which are permitted to have nationwide trading since inception. Currently, there are 20 stock exchanges in India.
Stock Exchanges in India Ahmedabad Stock Exchange Ltd.
MCX Stock Exchange Ltd
Bangalore Stock Exchange Ltd.
National Stock Exchange of India Ltd.
Bhubaneswar Stock Exchange Ltd.
OTC Exchange of India
Bombay Stock Exchange Ltd.
Pune Stock Exchange Ltd.
Calcutta Stock Exchange Association Ltd.,
Uttar Pradesh Stock Exchange Association Ltd.
Cochin Stock Exchange Ltd. Delhi Stock Exchange Ltd. Gauhati Stock Exchange Ltd. Interconnected Stock Exchange of India Ltd. Jaipur Stock Exchange Ltd. Ludhiana Stock Exchange Ltd. Madhya Pradesh Stock Exchange Ltd Madras Stock Exchange Ltd.
Clearing Corporation: A Clearing Corporation is a part of an exchange or a separate entity and performs three functions, namely, it clears and settles all transactions, i.e. completes the process of receiving and delivering shares/funds to the buyers and sellers in the market, it provides financial guarantee for all transactions executed on the exchange and provides risk management functions. National Securities Clearing Corporation a 100% subsidiary of NSE, performs the role of a Clearing Corporation for transactions executed(NSCCL), on the NSE.
Stock Brokers and Sub²brokers: Sub²brokers: Stock Broker means a member of of a Stock Exchange and Sub-broker means any person not being a member of Stock Exchange who acts on behalf of a Stock broker as an agent or otherwise for assisting the investors in buying, selling or dealing in securities through such stock brokers.
Depository : A bank or company which holds funds or securities deposited by others, and where exchanges of these securities take place.
Depository Participant (DP): The Depository provides its services to investors through its agents called depository participants (DPs). These agents are appointed by the depository with the approval of SEBI. According to SEBI regulations, amongst others, three categories of entities, i.e. Banks, Financial Institutions and SEBI registered trading members can become DPs. Custodian: A Custodian is basically an organisation, whi which ch helps register and safeguard the securities of its clients. Besides safeguarding securities, a custodian custodian also keeps track of corporate ac actions tions on behalf of its clients:
Maintaining a client·s securities account Collecting the benefits or rights accruing to the client in respect of securities Keeping the client informed of the actions taken or to be taken by the issue of securities, having a bearing on the benefits or rights accruing to the client.
Merchant Bankers: Merchant bankers means any person who is engaged in the business of issue management either by making arrangements regarding regarding sellin selling, g, buying or subscribing to securities or acting as a manager, consultant , adviser or rendering corporate advisory services in relation to such issue management. Merchant Bankers. Merchant banks are also called investment banks and are most significant institutions in the financial markets. The merchant banking activity in India is governed by SEBI (Merchant Bankers) Regulations 1992. Each merchant banker is required to have capital adequacy with prescribed net worth.
Foreign Institutional Investors: Foreign Institutional Investors means an institution established or incorporated outside India which proposes to make investment in India in securities. Currently, entities eligible to invest under the FII route are as follows:
a) As FII: (i) an institution established or incorporated outside India as a pension fund, mutual fund, investment trust, insurance company or reinsurance company; (ii) an International or Multilateral Organization or an agency thereof or a Foreign Governmental Agency, Sovereign Wealth Fund or a Foreign Central Bank; (iii) an asset management company, investment manager or advisor, bank or institutional portfolio manager, established or incorporated outside India and proposing to make investments in India on behalf of broad based funds and its proprietary funds, if any; (iv) a Trustee of a trust established outside India, and proposing to make investments in India on behalf of broad based funds and its proprietary funds, if any
(iv) university fund, endowments, foundations or charitable trusts or charitable societies ¶broad based fundµ means a fund established or incorporated outside India, which has at least twenty investor with no single individual investor holding holding more hat fort-nine f ort-nine percent of the shares or units of the fund
(b) As Sub-accounts: Sub-accounts means any person resident outside India, on whose behalf investments are proposed to be made in India by a FII and who is registered as a Sub-account under SEBI (FII) Regulations, 1995.
Mutual Funds: A mutual fund is a company that pools money from many investors and invests the money in stocks, bonds, short-term money-market instruments, other securities or assets, or some combination of these investments. Mutual Funds are essentially investment vehicles where people with similar investment objective come together to pool their money and then invest accordingly. SEBI defines mutual funds as ¶A fund established in the form of a trust to raise money through the sale of units to the public or a section of the public under one or more schemes for investing in securities, including money market instruments or gold or gold related instruments or real estate assets.
Collective Investment Scheme (CIS): A Collective Investment Scheme (CIS) is any scheme or arrangement made or offered by any company, which pools the contributions, or payments made by the investors, and deploys the same.
Venture Capital Funds: Venture Capital Fund (VCF) is a fund established in the form of a trust or a company including a body corporate having a dedicated pool of capital, raised in the specified manner and invested in Venture Capital Undertakings (VCUs). VCU is a domestic company whose shares is not listed on a stock exchange and is engaged in a business for providing services, production, or manufacture of article. A company or body corporate to carry on activities as a VCF has to obtain a certificate from SEBI and comply with the regulations prescribed in the SEBI (Venture ( Venture Capital Regulations) 1996.
Credit Rating Agency: Credit Rating Agency means a body corporate which is engaged in or proposes to be engaged in the business of rating of securities offered by way of public or rights issues.
Debenture Trustee: Debenture Trustee means a trustee of a Trust deed for securing any issue of debentures of a body corporate. The table below presents an overview of market participants in the Indian securities market. Market Participants
As on March 31 As on
2007
March 31, 2009
2008
Securities Appellate Tribunal (SAT)
1
1
1
Regulators*
4
4
4
Depositories Stock Exchanges
2
2
2
22
19
20
With Debt Market Segment
2
2
2
With Derivative Trading
2
2
2
With Currency Derivatives
-
-
3
9,443
9487
9628
27,541 996
44,074 1319
60,947 1626
158
205
232
Custodians
15
15
16
Registrars to an issue & Share Transfer Agents
82
76
71
Primary Dealers
17
16
16
152
155
134
Bankers to an Issue
47
50
51
Debenture Trustees
30
28
30
Underwriters
45
35
19
Venture Capital Funds
90
106
132
Foreign Venture Capital Investors
78
97
129
Mutual Funds
40
40
44
4
5
5
With Equities Trading
Stock Brokers Sub-brokers FIIs Portfolio Managers
Merchant Bankers
Credit Rating Agencies
Collective Investment Schemes
0
0
0
* DCA, DEA, RBI & SEBI. Source: SEBI Bulletin.
The market intermediary has a close relationship with the investor with whose protection the Regulator is primarily tasked. As a consequence a large portion port ion of the regulation of a securities industry is directed at the market intermediary. Regulations address entry criteria, capital and prudential requirements, ongoing supervision and discipline discipline of entrants, and the consequences c onsequences of default and failure. One of the issue concerning brokers is the need to encourage then to corporatize. Presently, 44% of the brokers are corporates. Corporatisation of their business would help them compete with global players in capital markets at home and abroad. Corporatisation brings better standards of governance and better transparency hence increasing the confidence level of customers.
Regulators The absence of conditions of perfect competition in the securities market makes the role of regulator extremely important. The regulator ensures that the market participants behave in a desired manner so that securities market continues to be a major source of finance for corporate aand nd government and the interest of investors are protected. The responsibility for regulating the securities market is shared by Department of Economic Affairs (DEA), Ministry of Company Affairs (MCA), Reserve Bank of India (RBI) and SEBI. The activities of these agencies are coordinated by a High Level Committee on Capital Markets. The orders of SEBI under the securities laws are appellable before a Securities Appellate Tribunal. Most of the powers under the SCRA are exercisable by DEA while a few others by SEBI. The powers of the DEA under the SCRA are also con-currently exercised by SEBI. The powers in respect of the contracts for sale and purchase of securities, gold related securities, money market securities and securities derived from these securities and ready forward contracts in debt securities are exercised concurrently by RBI. The SEBI Act and the Depositories Act are mostly administered by SEBI. The rules under the securities laws are framed by government and regulations by SEBI. All these are administered by SEBI. The powers under the Companies Act relating to issue and transfer of securities and non-payment of dividend are administered by SEBI in case of listed public companies and public companies proposing to get their securities listed. The SROs ensure compliance with their own rules as well as with the rules relevant for them under the securities laws.
COMPONENTS OF SECURITIES MARKET Securities Market is classified into following markets and different types of instruments are traded in these markets.
Cash/Equity Markets & Its Products The equity segment of the stock exchange allows trading in shares, debentures, warrants, mutual funds and ETFs. These products are explained ex plained in detail below.
Shares:
Equity Shares: An equity share, commonly referred to as ordinary share, represents the form of fractional ownership in a business venture.Equity Equity shareholders collectively enjoy the rewards of ownership. Equi ty shares are a re further classifiedown into:the company. They bear the risk and y
y
y
y
y
y
Blue chip shares: Shares of large, well established and financially strong companies with an impressive record of earnings and dividends Growth shares: Shares of companies that have a fairly entrenched position in a growing market and which enjoy an above average rate of growth gr owth as well as profitabili profitability ty Income shares: Shares of companies that have fairly stable operations, relatively limited growth opportunities and high dividend payout ratios. Cyclical Shares: Shares of companies that have a pronounced cyclicality to their operations. Speculative Shares: Shares that tend to fluctuate widely because there is lot speculative trading in them. Defensive Shares: Shares of companies that are relatively unaffected by the ups and downs in general business conditions.
Rights Issue/ Rights Shares: The issue of new securities to existing shareholders at a ratio to those already held, at a price. For e.g. a 2:3 2: 3 rights issue at Rs. 125, would entitle a shareholder to receive 2 shares for every 3 shares held at a price of Rs. 125 per share.
Bonus Shares: Shares issued by the companies to their shareholders free of cost based on the number of shares the shareholder owns.
Preference shares: Owners of these kinds of shares are entitled to a fixed dividend or dividend calculated at a fixed rate to be paid regularly before dividend can be paid in respect of equity share. They also enjoy priority over the equity shareholders in payment of surplus. But in the event of liquidation, their claims rank below the claims of the company·s creditors, bondholders/debenture holders.
Cumulative Preference Shares: A type of preference shares on which dividend accumul accumulates ates if remained unpaid. All arrears of preference dividend have to be paid out before paying dividend on equity shares.
Cumulative Convertible Preference Shares: A type of preference shares where the dividend payable on the same accumulates, if not paid. After a specified date, these shares will be converted into equity capital of the company. Difference between Equity shareholders and Preferential shareholders:
Equity Shareholders are supposed to be the owners of the company, who therefore, have right to get dividend, as declared, and a right to vote in the Annual General Meeting for passing any resolution.
The act defines a preference share as that part of share capital of the Company which enjoys preferential right as to: (a) payment of dividend at a fixed rate during the life time of the Company; and (b) the return of capital on winding up of the Company.
But Preference shares cannot be traded, unlike equity shares, and are redeemed after a pre-decided period. Also, Preferential Shareholders do not have voting rights.
Debentures: An instrument for raising long term debt. Debentures in India are typically secured by tangible assets.
Convertible debentures can be converted at the option of the holder into ordinary shares of the same company under specified terms and conditions. Thus it has features of both debenture as well as equity.
Non Convertible debentures are pure debentures without a feature of conversion They are repayable on maturity. These debentures are issued at a highly discounted issue price.
Partly Convertible debentures have features f eatures of convertible and non-convertible debentures.
Warrants: A company may issue equity shares or debentures attached with warrants. Warrants entitle an investor to buy equity shares after a specified time period at a given price.
PRIMARY MARKET The primary market is a market for new issues i.e. a market for fresh capital. The primary market provides the channel for sale of new securities. Primary market provides opportunity to issuers of securities; government as well as corporates, to raise resources to meet their requirements of investment and/or discharge some obligation. They may issue the securities at face value, or at a discount/premium discount/premium and these securities may take a variety of forms such as equity, debt etc. They may issue the securities in domestic market and/or international market. The primary market issuance is done either through public issues or private placement. A public issue does not limit any entity in investing while in private placement, the issuance is done to select people. In terms of the Companies Act, 1956, an issue becomes public if it results in allotment to more than 50 persons. This means an issue resulting in allotment to less than 50 persons is private placement. There are two major types of issuers who issue securities. The corporate entities issue mainly debt and equity instruments (shares, debentures, etc.), while the governments (central and state governments) issue debt securities (dated securities, treasury bills). The price signals, which subsume all information about the issuer and his business including associated risk, generated in the secondary market, help the primary market in allocation of funds. The issuers may issue securities secur ities in domestic market and international market through ADR / GDR route.
DIFFERENT KINDS OF ISSUES Most companies are usually started privately by their promoter(s). However, the promoters· capital and the borrowings from banks and financial institutions may not be sufficient for setting sett ing up or running the business over a long term. So companies invite the public to contribute towards the equity and issue shares to individual investors. The way to invite share capital from the public is through a ¶Public Issue·. Simply stated, a public issue is an offer to the public to subscribe to the share capital of a company. Once this is done, the company allots shares to the applicants as per the prescribed rules and regulations laid down by SEBI. Issues can be classified as a Public, Rights or preferential issues (also known as private placements). While public and rights issues involve a detailed procedure, private placements or preferential issues are relatively simpler. The classification of issues is illustrated illustrat ed below:
Issues
Public Issue
IPO
Fresh Issue
Rights Issue
FPO
Fresh Issue
Bonus Issue
Private Placement
Preferential Issue
Qualified Inst. Buyers
PUBLIC ISSUE When an issue / offer of securities is made to new investors for becoming part of shareholders· family of the issue3 it is called a public issue. Public issue can be further classified into Initial public offer (IPO) and Further public offer (FPO). The significant features of each type of public issue are illustrated below:
IPO Initial Public Offering (IPO) is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer·s securities in the Stock Exchanges. An IPO can either be a fresh issue or an offer for sale i.e. offering of securities by existing shareholders of the company to the public.
FPO A Further public offering (FPO) is when an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, through an offer document. An offer for sale in such scenario is allowed only if it is made m ade to satisfy listing or continuous listing obligations.
RIGHTS ISSUE When an issue of securities is made by an issuer to its shareholders existing as on a particular date fixed by the issuer (i.e. record date), it is called a rights issue. The rights are offered in a particular ratio to the number of securities held as on the record date.
BONUS ISSUE When an issuer makes an issue of securities to its existing shareholders as on a record date, without any consideration from them, it is called a bonus issue. The shares are issued out of the Company·s free reserve or share premium account in a particular ratio to the number of securities held on a record recor d date.
PRIVATE PLACEMENT When an issuer makes an issue of securities to a select group of persons not exceeding 49, and which is neither a rights issue nor a public issue, it is called a private placement. Private placement of shares or convertible securities by listed issuer can be of two types:
Preferential allotment When a listed issuer issues shares or convertible securities, to a select group of persons in terms of provisions of Chapter XIII of SEBI (DIP) guidelines, guidelines, it is called a preferential allotment. The issuer is required to comply with various provisions which inter alia include pricing, disclosures in the notice, lock in etc, in addition to the requirements specified in the Companies Act.
Qualified institutions placement (QIP) When a listed issuer issues equity shares or securities convertible in to equity shares to Qualified Institutions Buyers only in terms of provisions of Chapter XIIIA of SEBI (DIP) guidelines, it is called cal led a QIP.
Usually, the term private placement is used for unlisted companies and the term preferential issue is used for listed companies. QIP is also for listed companies.
Funds mobilized in Primary Market 2008-09 Particulars
2007-08
Amount
Amount
No. of issues
No. of issues (Rs. Cr.)
(Rs. Cr.)
a) Public Issues
21
2082.35
92
54511
(I) IPOs
21
2082.35
85
42101.8
(ii) FPOs
0
0
7
11915.8
25
12637.16
32
32518
2
188.82
36
25525
b) Rights Issues c) QIP
TOTAL
48
14908.33
160
112554
* excluding preferential allotments
OFFER DOCUMENTS Offer document is a document which contains all the relevant information about the company, promoters, projects, financial details, objects of raising the money, terms of the issue etc and is used for inviting subscription to the issue being made by the issuer.
Offer Document is called Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue.
The terms used for offer documents are defined def ined below.
Draft offer document Draft offer document is an offer document filed with SEBI for specifying changes, if any, in it, before it is filed with the Registrar of companies (ROCs). Draft offer document is made available in public domain including SEBI website, for enabling enabling public to give comments, if any, on the draft offer document.
RED HERRING PROSPECTUS Red herring prospectus is an offer document used in case of a book built public issue. It contains all the relevant details except that of price or number of shares being offered. It is filed with RoC before the issue opens.
PROSPECTUS Prospectus is an offer document in case of a public issue, which has all relevant details including price and number of shares being offered. This document is registered with RoC before the issue opens in case of a fixed price issue and after the closure of the issue in case of a book built issue.
LETTER OF OFFER Letter of offer is an offer off er document in case of a Rights issue and is filed with Stock exchanges before the issue opens.
Abridged prospectus is an abridged version of offer document in public issue and is issued along with the application form of a public issue. It contains all the salient features of a prospectus.
Abridged letter of offer with the application form.is an abridged version of the letter of offer. It is sent to all the shareholders along
Shelf prospectus is a prospectus which enables an issuer to make a series of issues within a period of 1 year without the need of filing a fresh prospectus every time. This facility is available to public sector banks /Public Financial Institutions.
PLACEMENT DOCUMENT Placement document is an offer document for the purpose of Qualified Institutional Placement and contains all the relevant and material mat erial disclosures.
UNDERSTANDING THE OFFER DOCUMENT Cover Page Under this head full contact details of the Issuer Company, lead managers and registrars, the nature, number, price and amount of instruments offered and issue size, and the particulars regarding listing. Other details such as Credit Rating, IPO Grading, risks in relation to the first issue, etc are also disclosed if applicable.
Risk Factors Under this head the management of the issuer company gives its view on the Internal and external risks envisaged by the company and the proposals, if any, to address such risks. The company also makes a note on the forward looking statements. This information is disclosed in the initial pages of the document and also in the abridged prospectus. It is generally advised that the investors should go through all the risk factors of the t he company before making an investment decision.
Introduction Under this head a summary of the industry in which the issuer company c ompany operates, the business of the Issuer Company, offering details brief, summary consolidated financial and other data to general information aboutinthe company, theofmerchant bankers and statements their responsibilities, the relating details of
brokers/syndicate members to the Issue, credit rating (in case of debt issue), debenture trustees (in case of debt issue), monitoring agency, book building process in brief, IPO Grading in case of First Issue of Equity capital and details of underwriting Agreements are given. Important details of capital structure, objects of the offering, funds requirement, funding plan, schedule of implementation, funds deployed, sources of financing of funds already deployed, sources of financing for the balance fund requirement, interim use of funds, basic terms of issue, basis for issue price, tax benefits are a re also covered.
About us Under this head a review of the details of business of the company, business strategy, competitive strengths, insurance, industry]regulation (if applicable), history and corporate structure, main objects, subsidiary details, management and board of directors, compensation, corporate governance, related party transactions, exchange rates, currency of presentation and dividend policy are given.
Financial Statements Under this head financial statement and restatement as per the requirement of the Guidelines and differences between any other accounting policies and the Indian Accounting Policies (if the Company has presented its Financial Statements also as per either US GAAP/IFRS) GAAP/IFRS) are presented.
Legal and other information Under this head outstanding litigations and material developments, litigations involving the company, the promoters of the company, its subsidiaries, and group companies are disclosed. Also material developments since the last balance sheet date, government approvals/licensing arrangements, investment approvals (FIPB/RBI (FIPB/RBI etc.), technical approvals, and indebtedness, etc. are disclosed.
Other regulatory and statutory disclosures Under this head, authority for the Issue, prohibition by SEBI, eligibility of the company to enter the capital market, disclaimer statement by the issuer and the lead manager, disclaimer in respect of jurisdiction, distribution of information to investors, disclaimer clause of the stock exchanges, listing, impersonation, minimum subscription, letters of allotment or refund orders, consents, expert opinion, changes in the auditors in the last 3 years, expenses of the issue, fees payable to the intermediaries involved in the issue process, details of all the previous issues, all outstanding instruments, commission and brokerage on, previous issues, capitalization of reserves or profits, option to subscribe in the issue, purchase of property, revaluation of assets, classes of shares, stock market data for equity shares of the company, promise vis-àvis performance in the past issues and mechanism for redressal of investor grievances is disclosed.
Offering information
Under this head, terms of the Issue, ranking of equity shares, mode of payment of dividend, face value and issue price, rights of the equity shareholder, market lot, nomination facility to investor, issue procedure, book building procedure in details along with the process of making an application, signing of underwriting agreement and filing of prospectus with SEBI/ROC, announcement of statutory advertisement, issuance of confirmation of allocation note("can") and allotment in the issue, designated date, general instructions, instructions for completing the bid form, payment instructions, submission of bid form, other instructions, disposal of application applicationallotment, moneys, ,dispatch interest on of excess bid amount, basis of allotment or allocation, method ofand proportionate of refund rrefund efund orders, communications, undertaking by the company, utilization of issue proceeds, restrictions on foreign ownership of Indian securities, are disclosed.
Other Information This covers description of equity shares and terms of the Articles of Association, material contracts and documents for inspection, declaration, definitions and abbreviations, etc.
REGULATION FOR DIFFERENT KINDS OF ISSUES SEBI DIP GUIDELINES
SEBI (Disclosure & Investor Protection) Guidelines, 2000 are applicable to all public issues by listed and unlisted companies, all offers for sale and rights issues by listed companies whose equity share capital is listed, except in case of rights issues where the aggregate value of securities offered does not exceed Rs.50 lakhs in case of the rights issue where the aggregate value of the securities offered is less than Rs.50 lakhs, the company is required to prepare the letter of offer in accordance with the disclosure requirements specified in the DIP guidelines and file the same with SEBI for its information. Unless otherwise stated, all provisions in these guidelines are also applicable to public issues by unlisted companies shall also apply to offers for sale to the t he public by unlisted companies.
SEBIs role in an Issue Any company making a public issue or a rights issue of securities of value more than Rs 50 lakhs is required to file a draft offer document with SEBI for its observations. The validity period of SEBIs observation letter is twelve months only i.e. the company has to open its issue within the period of twelve months starting from the date of issuing the observation letter.
There is no requirement of filing any offer document / notice to SEBI in case of preferential allotment and Qualified Institution Placement (QIP). In QIP, Merchant Banker handling the issue has to file the placement document with Stock Exchanges for making the t he same available on their websites.
(a) Till the early nineties, Controller of Capital Issues used to decide about entry of company in the market and also about the price at which securities should be offered to public. However, following the introduction of disclosure based regime under the aegis of SEBI, companies can now determine issue price of securities freely without any regulatory interference, with the flexibility to take advantage of market forces.
(b) The primary issuances are governed by SEBI in terms of SEBI (Disclosures and Investor protection) guidelines. SEBI framed its DIP guidelines in 1992. The SEBI DIP Guidelines over the years have gone through many amendments in keeping pace with the dynamic market scenario. It provides a comprehensive framework for issuing of securities by the companies.
(c) Before a company approaches the primary market to raise money by the fresh issuance of securities it has to make sure that it is in compliance with all the requirements of SEBI (DIP) Guidelines, 2000. The Merchant Banker are those specialised intermediaries registered with SEBI, who perform the due diligence and ensures compliance with DIP Guidelines before the document is filed with SEBI.
(d) Officials of SEBI at various levels examine the compliance with DIP guidelines and ensure that all necessary material information is disclosed in the draft offer documents.
SEBI does not recommend any issue nor does it take any responsibility either for tthe he financial soundness of any scheme or the project for which the issue is proposed to be made. The submission of offer document to SEBI does not imply that the same has been cleared or approved by SEBI. The Lead manager certifies that the disclosures made in the offer document are generally adequate and are in conformity with SEBI guidelines for disclosures and investor protection in force for the time t ime being. This requirement is to facilitate investors to take an informed decision for making investment in on the the proposed issue. The investors are required take an informed decision purely by themselves based contents disclosed in the offer documents. SEBI is not associated with any issue/issuer. Investors are advised to study all the material facts pertaining to the issue including the risk factors before considering any investment.
ISSUE REQUIREMENTS SEBI has laid down eligibility norms for entities accessing the primary market through public issues. There is no eligibility norm for a listed company making a rights issue as it is an offer made to the existing shareholders who are expected to know their company. There are no eligibility norms for a listed company making a preferential issue.
A) Entry Norms SEBI has laid down entry norms for entities making a public issue/ offer. Entry norms are different routes r outes available to an issuer for accessing the capital market.
(i ) ) An un listed listed issuer makin g a public issue i.e. (makin g an IPO ) is required to satisfy the followin g provisions :
y kno wn as Pro fi Entry Norm I (common l y fit abili ability Ro ut e )
The Iss u ueer Com p paany has to m ee eet t he he f o olll lo wi win g r equi equir em ents : (a ) Net Tan gible gible Ass ets o f at least Rs . 3 Cror es in each o f f t he he pr ecedi ecedin g t hr ee ee full y eeaars . y pr ecedi (b ) Distr ibu ibut able able pro fi fits in at llea east t hr ee ee o f f t he he imm edia ediat el el y ecedin g five y eeaars . (c ) Net wort h o f at least Rs . 1 cror e in each o f f t he he pr ecedi ecedin g t hr ee ee full y eeaars .
(d ) If t he he com p paany has chan ged ged its n am e wit hi hin t he he last on e y eeaar , at llea east 50% r eve even ue ue f o or r t he he pr ecedi ecedin g 1 y ea ear s ho uld uld be f rom rom t he he act ivi ivity s ugge uggest ed ed b y t h hee n ew ew n am ee..
(e ) The iss u uee s ize ize do es not exceed 5 t im es t he he pr e] iss ue ue n et wort h as per t he he audit ed ed balan ccee s hee heet o ff t h hee last fin an cial cial y ea ear .
To pro vide vide s ufficie ufficient flexibility an d also to ens ur e t ha hat gen u uiin e com p paan iiees do not s uffe uffer on acco unt o ff r igidi igidity o f f t he he Par am et ers , SEBI has pro vided vided t wo ot he her alt ern at iive ve ro ut es to t h hee com p paan iiees not s at is ff y in g any o f f t he he abo ve ve con di dit ions , f o or r
access in g t he he pr im ary Mar ke ket , as un de der :
Entry Norm II (Common l y y kno wn as ´QIB Ro ut eeµµ ) (a ) Iss u uee s ho uld uld be t hro ugh ugh boo k buildin g ro ut e, e, wit h at least 50% to be m an d daatory allott eed d to t he he Qualified Inst it ut ion al al Bu y ers (QIBs) . (b ) The m in im um post -i -iss ue ue face value capit al al s hall hall be Rs . 10 Cror es or t h heer e s hall hall be a com pul pulsory m ar kkeet m aki or r at least 2 y ea akin g f o ears .
Entry Norm III (commonly known as Appraisal Route) (a) The ´projectµ is appraised and participated to the extent of 15% by Financial Institutions / Scheduled Commercial Banks of which which at least 10% comes from the appraiser(s).
(b) The minimum post issue face value capital shall be Rs. 10 Crores or there should be a compulsory market-making for at least 2 years.
In addition to satisfying the aforesaid entry norms, the Issuer Company should also satisfy the criteria of having at least 1000 prospective allotees in its issue.
(ii) A listed issuer making a public issue (FPO) is required to satisfy the t he following requirements: requirements: (a) If the company has changed its name within the last one year, atleast 50% revenue for the preceding 1 year should be from the activity suggested by the new name. (b) The issue size does not exceed 5 times the pre] issue net worth as per the audited balance sheet of the last financial year. Any listed company not fulfilling these conditions shall be eligible to make a public issue by complying with QIB Route or Appraisal Route as specified spec ified for IPOs.
(iii) Certain category of entities which are exempted from the aforesaid entry norms, are as under: (a) Private Sector Banks (b) Public sector banks (c) An infrastructure company whose project has been appraised by a Public Financial Institution or IDFC or IL&FS or a bank which was earlier a PFI and not less than 5% of the project cost is financed by any of these institutions.
Mandatory Norms An issuer making a public issue is required to inter alia comply with the following provisions mentioned in the guidelines:
Minimum Promoter·s contribution and lock-in: In a public issue by an unlisted issuer, the promoters are required to contribute not less than 20% of the post issue capital which should be locked in for a period of 3 years. ´Lock inµ indicates a freeze on the shares. The remaining pre issue capital should also be locked in
for a period of 1 year from the date of listing. In case of public issue by a listed issuer [i.e. FPO], the promoters are required to contribute not less than 20% of the post issue capital or 20% of the issue size. This provision ensures that promoters of the company have some minimum stake in the company for a minimum period after the issue or after the project for which funds have been raised from the public is commenced.
IPO Grading: Grading: IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to the initial public offering (IPO) of equity shares or other convertible securities. The grade represents a relative assessment of the fundamentals of the IPO in relation to the other listed equity securities. Disclosure of ´IPO Gradesµ, so obtained is mandatory for companies coming out with an IPO.
No unlisted company can make an IPO of equity shares or any other security which may be converted into or exchanged with equity shares at a later date, unless the following conditions are satisfied as on the date of filing of Prospectus (in case of fixed price issue) or Red Herring Prospectus (in case of book built issue) with ROC:
y y
y
the unlisted company has obtained grading for the IPO from at least one credit rating r ating agency; disclosures of all the grades obtained, along with the rationale/ description furnished by the credit rating agency(ies) for each of the grades obtained, have been made in the Prospectus (in case of fixed price issue) or Red Herring Prospectus (in case of book built issue) the expenses incurred for grading IPO have been borne by the unlisted company obtaining grading for IPO.)
Other Conditions are:
y
y
y
No unlisted company can make a public issue of equity share or any security convertible at later date into equity share, if there are any outstanding financial instruments or any other right which would entitle the existing promoters or shareholders any option to receive equity share capital after the initial public offering. No company can make a public or rights issue of equity share or any security convertible at later date into equity share, unless all the existing partly paid-up shares have been fully paid or forfeited in a manner specified in clause No company shall make a public or rights issue of securities unless firm arrangements of finance through verifiable means towards 75% of the stated means of finance, excluding the amount to be raised through proposed Public/ Rights issue, have been made.)
Credit Rating of Debt Instruments: No issuer company should make a public issue or rights issue of convertible debt instruments, unless the following conditions are satisfied, as on date of filing of draft offer
document with SEBI and also on the date of filing a final offer document with ROC/ Designated Stock Exchange:
(i) credit rating is obtained from at least one credit rating agency registered with SEBI and should be disclosed in the offer document; (ii) The company should not be in the list of willful defaulters of RBI; (iii) The company should not have defaulted in payment of interest or repayment of principal in respect of debentures issued to the public, if any, for a period of more than t han 6 months.
If the credit ratings are obtained from more than one credit rating agencies, all the ratings, including the unaccepted ratings, should be disclosed in the offer document. All the credit ratings obtained during the three (3) years preceding the pubic or rights issue of debt instrument (including convertible instruments) for any listed security of the issuer company should be disclosed in the offer document.
FAST TRACK ISSUES (FTI) SEBI introduced FTI in order to enable well established and compliant listed companies satisfying certain specific entry norms/conditions to access Indian Primary Market in a time effective manner. Such companies can proceed with FPOs / Right Issues by filing a copy of RHP / Prospectus with the RoC or tthe he Letter of Offer with designated SE, SEBI and Stock Exchanges. Such companies are not required to file Draft Offer Document for SEBI comments and to Stock Exchanges. Entry Norms for companies seeking to access Primary Market through FTI·s in case aggregate value of securities including premium exceeds Rs. 50 lakhs:
(i) The shares of the company have been listed on any stock exchange having nationwide terminals for a period of at least three years ye ars immediately preceding the date of filing of offer document with RoC/ SE.
(ii) The ´average market capitalisation of public shareholdingµ of the company is at least Rs. 10,000 Crores for a period of one year up to the end of the quarter proceeding the month in which the proposed issue is approved by the Board of Directors / shareholders of the issuer.
(iii) The annualized trading turnover of the shares of the company during six calendar months immediately preceding the month of the reference date has been at least two percent of the weighted average number of shares listed during the said six months period.
(iv) The company has redressed at least 95% of the total shareholder / investor grievances or complaints received till the end of the quarter immediately proceeding the month of the date of filing of offer document with RoC/ SE.
(v) The company has complied with the listing agreement for a period of at least three years immediately preceding the reference date.
(vi) The impact of auditors· qualifications, if any, on the audited accounts of the company in respect of the financial years for which such accounts are disclosed in the offer document does not exceed 5% of the net profit/ loss after tax of the company for the respective years.
(vii) No prosecution proceedings or show cause notices issued by the Board are pending against the company or its promoters or whole time directors as on the reference date.
(viii) The entire shareholding of the promoter group is held in dematerialised form as on the reference ref erence date.
PRICING BY COMPANIES ISSUING SECURITIES Public/Rights Issue by Listed Companies A listed company whose equity shares are listed on a stock exchange, can freely price its equity shares and any security convertible into equity at a later date offered through a public or rights issue.
Public Issue by Unlisted Companies An unlisted company eligible to make a public issue and desirous of getting its securities listed on a recognised stock exchange pursuant to a public issue, may freely price its equity shares or any securities convertible at a later date into equity shares.
Initial Public Issue by Banks The banks (whether public sector or private sector) may freely price their issue of equity shares or any securities convertible at a later date into equity share subject to the approval by the Reserve Bank of India.
Differential Pricing
Any unlisted company or a listed company making a public issue of equity shares or securities convertible at a later date into equity shares, may issue such securities to applicants in the firm allotment category at a price different from the price at which the net offer to the public is made, provided that the price at which the security is being offered to the applicants in firm allotment category is higher than the price at which securities are offered to public. The net offer to the public means the offer made to the Indian public and does not include firm allotments or reservations or promoters· contributions.
An unlisted company or a listed company making a public issue of equity shares or securities convertible at a later date into equity shares may issue such securities to retail individual investors and/or retail individual shareholders at a price lower than the price at which net offer is made to other categories of public. However, the difference between the price at which the securities are issued to retail individual investors and/or retail individual shareholders and the price at which the net offer is made to other categories of public, is not more than 10% of the price at which securities are offered to other categories of public.)
Price Band Issuer company can mention a price band of 20% (cap in the price band should not be more than 20% of the floor price) in the offer documents filed with SEBI and actual price can be determined at a later date before filing of the offer document with ROCs. If the Board of Directors have been authorised to determine the offer price within a specified price band such price shall be determined by a Resolution to be passed by the t he Board of Directors. The Lead Merchant Bankers should ensure that in case of the listed companies, a 48 hours notice of the meeting of the Board of Directors for passing resolution for determination of price is given to the Designated Stock Exchange.
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In case of public issue by listed issuer company, issue price or price band may not be disclosed in the draft prospectus filed with SEBI. In case of a rights issue, issue price or price band may not be disclosed in the draft letter of offer filed with SEBI. The issue price may be determined anytime before fixation of the record date, in consultation with the Designated Stock Exchange.)
The final offer document should contain only one price and one set of financial projections, if applicable. No payment, direct or indirect in the nature of a discount, commission, allowance or otherwise shall be made either by the issuer company or the promoters in any public issue, to the persons who have received firm allotment in such public issue.
Determining Denomination of Shares for Public/Rights Issues An eligible company is free to make public or rights issue of equity shares in any denomination determined by it in accordance ac cordance with Sub-section (4) of Section 13 of the Companies Act, 1956 and in compliance with the following followin g and other norms as may be specified by SEBI from time to time.
In case of Initial public offer by an unlisted company:
a. If the issue price is Rs. 500/- or more, the issuer company has a discretion to fix the face value below Rs. 10/- per share subject to the condition that the face value however it shou should ld not be less than Rs. 1 per share. However, this does not apply to initial public offer made by any government company, statutory authority or corporation or any special purpose vehicle set up by any of them, t hem, which is engaged in infrastructure sector.
b. If issue price is less than Rs. 500 per share, share , the face value should be Rs. 10/- per share;
Indian primary market ushered in an era of free pricing in 1992. Following this, the guidelines have provided that the issuer in consultation with Merchant Banker shall decide the price. There is no price formula stipulated by SEBI. SEBI does not play any role in price fixation. The company and merchant banker are however required to give full disclosures of the parameters which they had considered while deciding the issue price. There are two types of issues one where company and Lead Merchant banker fix a price (called fixed price) and other, where the company and Lead Manager (LM) stipulate a floor price or a price band and leave it to market forces to t o determine the final price (price discovery through book building process).
PRICING OF AN ISSUE On the basis of Pricing, an issue can be further furt her classified into Fixed Price issue or Book Built issue.
Fixed Price Issue: When the issuer at the outset decides the issue price and mentions it in the Offer Document, it is commonly known as Fixed price issue.
Book built Issue: When the price of an issue is discovered on the basis of demand received from the prospective investors at various price levels, it is called Book Built issue·.
BOOK BUILDING Book building is a process of price discovery. The issuer discloses a price band or floor price before opening of the issue of the securities offered. On the basis of the demands received at various price levels within the price band specified by the t he issuer, Book Running Lead Manager (BRLM) in close consultation with the issuer arrives at a price at which the security offered by the issuer, can be issued.
P rice rice Band
The price band i s a band of price wi th thin whic h in ve sto stor s can bid . The spread be tw tween the floor and the ca p of the price band should n ot ot be more than 20%. The price band can be re vi sed . If re vi sed , the biddin g peri od sha llll be e xt xtended for a fur th ther peri od of three da ys, ys, subjec t to the tota l biddin g peri od n o ott e xceedin g thir teen da ys. ys.
P r ro ce ss ss
of Book Bui ldin g
Book bui ldin g i s a pr oce ss ss of price di sc ov over y. y. A floor price or price band wi tth hin whic h th e bid s can move i s di sc llos osed a t lea st st two workin g da ys ys be fo fore openin g of the i ssu ssue in ca se of an IP O and a ttllea st st one da y be ffo ore openin g of the i ssu ssue in ca se of an FP O. O. The a ppl pplican ts ts bid for the share s quotin g th e price and the quan ti ttyy tha t the y would like to bid a t. t. After the biddin g pr oce ss ss i s c ompl omple te , the ¶c ut ut off· price i s arri ved a t b a sed on the de mand of sec uri tie s. s. The ba si s of Allotmen t i s then f ina ina li zed and a llotm llotmen tt//re ffu und i s under taken . The f ina ina l pr osp ospec tus tus wi th th a llll the de tai ls ls inc lu ludin g th e f ina ina l i ssu ssue price and the i ssu ssue si ze i s f i il ed wi th th ROC, thus c ompl omple tin g the i ssu ssue pr oce ss. ss. On ly ly the re tai l in ve sto stor s ha ve the opti on of biddin g a t ¶c utoff·. utoff·.
Cut off opti on i s a vai la bl ble for on ly ly re tai l indi vid ua l in ve sto stor s i .e . in ve sto stor s who are a pply pplyin g for sec uri tie s wor th th up to Rs 1,00,000/ on ly. ly. Suc h in ve sto stor s are re qu quired to tick the c ut ut off opti on whic h indica te s their wi llllin gne ss ss to subscri be to share s a t an y price di sc ov overed wi tth hin the price band . Un like price bid s (where a c price i s indica ted ) whic h can be in va lid , i f price indica ted by a ppl speci f f iic pplican t i s lower than the price di sc o ovvered , the c ut ut off bid s a lw lwa ys ys re main va lid for the pur pos pose of a llotm llotmen t
One can c han ge or re vi se the quan ti ty ty or price in the bid usin g th e for m for c han gin g g//re vi sin g th e bid tha t i s a vai la b blle a lo lon g wi th th the a ppl pplica ti on for m. m. Howe ver , the en tire pr oce ss ss of c han gin g or re vi sin g the bid s i s re qu quired to be c ompl omple ted wi th thin the da te of c losu losure of the i ssu ssue . One can a lso lso cance l the bid an yytti me be ffo ore the f ina ina li za ti on of the ba si s of a llotm llotmen t by a pp ppr oac hin g/ g/ wri tin g/ g/ makin g an a ppl pplica ti on to the re gi ssttrar to the i ssu ssue .
TYP ES ES OF INVESTORS & ALLOTMENTS MADE TO THEM eren t ca te go Allotmen t of i ssu ssue s i s made to di fff f eren gorie s of In ve sto stor s. s. Le t us under ssttand the type s of in ve sto stor s for a llotm llotmen t pur pos pose .
Re tai l indi vid ua l In ve sto stor (RIIs)
Retail individual Investor Investor (RIIs) means an investor who applies or bids for securities sec urities for a value of not more than Rs. 1,00,000.
Qualified Institutional Bu y er er Qualified Institutional Bu y er er means: a) a public financial institution as defined in section 4A of the Companies Act, 1956; b) a scheduled commercial bank; c) a mutual fund registered with the Board; d) a foreign institutional investor and sub]account registered with SEBI, other than a sub account a ccount which is a foreign corporate or foreign individual; e) a multilateral and bilateral development financial f inancial institution; f) a venture capital fund registered with SEBI; g) a foreign venture capital investor registered with SEBI; h) a state industrial development corporation; y i) an insurance compan y registered with the Insurance Regulator
and Development Authorit y y (IRDA); j) a provident fund with minimum corpus of Rs. 25 Crores; k) a pension fund with minimum corpus of Rs. 25 Crores); l) National Investment Fund
Non Institutional Investors (NIIs) Non Institutional Investors are those who do not fall under the categories of Retail Individual Investor and Qualified Institutional Investor.
ALLOTMENT TO VARIOUS KINDS OF INVESTORS In case of Book Built issue 1. In case an issuer compan y makes an issue of 100% of the net offer to public through 100% book building process³
(a) Not less than 35% of the net offer to the public shall be available for allocation to retail individual investors; (b) Not less than 15% of the net offer to the public shall be available for allocation to Non institutional investors i.e. investors other than retail individual investors and Qualified Institutional Buyers; (c) Not more than 50% of the net offer to the public shall be available for allocation to Qualified Institutional Buyers:
2. In case of compulsory Book Built Issues at least 50% of net offer to public being allotted to the Qualified Institutional Buyers (QIBs), failing which the full subscription money will be refunded.
3. In case the book built issues are made pursuant to the requirement of mandatory allocation of 60% to QIBs in terms of Rule 19(2)(b) of Securities Contract (Regulation (Regulation)) Rules, 1957, the respective ffigures igures are 30% for RIIs and 10% for NIIs.
In case of fixed price issue The proportionate allotment of securities to the different investor categories in a fixed price issue is as described below: 1. A minimum 50% of the net offer of securities to the public shall initially be made available for allotment to retail individual investors, as the case may be. 2. The balance net offer of securities secur ities to the public shall be made available for allotment to:
a. Individual applicants other than retail ret ail individual investors, and
b. Other investors including corporate bodies/ institutions irrespective of the number of securities applied for.
FIRM ALLOTMENT INVESTOR CATEGORIES SEBI (DIP) (DIP) guidelines provide that an issuer making an issue to public can allot shares on firm basis to some categories as specified below:
(i) Indian and Multilateral Development Financial Institutions, (ii) Indian Mutual Funds, (iii) Foreign Institutional Investors including including Non]Resident Indians and Overseas Corporate Bodies and (iv) Permanent/regular employees of the issuer company. (v) Scheduled Banks
OCBs are prohibited by RBI to make investment. investment .
Reservation on Competitive Basis is when allotment allotment of shares is made in proportion to the shares applied for by the concerned reserved categories. Reservation on competitive basis can be made in a public issue to the following categories:
(i) Employees of the company. (ii) Shareholders of the promoting companies in the case of a new company and shareholders of group companies in the case of an existing company. (iii) Indian Mutual Funds. (iv) Foreign Institutional Investors (including non resident Indians and overseas corporate bodies). (v) Indian and Multilateral development Institutions. (vi) Scheduled Banks.
In a public issue by a listed company, the reservation on competitive basis can be made for retail individual shareholders and in such cases the allotment to such shareholders shall be on proportionate basis
There is no discretion in the allotment process. All allotees are allotted shares on a proportionate basis within their respective investor categories.
INTERMEDIARIES INVOLVED IN THE ISSUE ISS UE PROCESS
Intermediaries areinregistered withbuilt SEBIpublic are Merchant Bankers toto thetheissue (known as Book Lead Managerswhich (BRLM) case of book issues), Registrars issue, Bankers to theRunning issue &
Underwriters to the issue who are associated with the issue for different activities. Their addresses, telephone/fax numbers, registration number, and contact person and email addresses are disclosed in the offer documents.
Merchant Bank eer r Merchant bank eerr does the due diligence to prepare the offer document which contains all the details about the company. They are also responsible for ensuring compliance with the legal formalities in the entire issue process and for mar k keting e ting of the issue.
Registrars to the Issue They are involved in finalizing the basis of allotment in an issue and for sending refunds, allotment etc.
Bank ers ers to the Issue The Bank ers ers to the Issue enable the movement of funds in the issue process and therefore enable the registrars to finalize the basis of allotment by mak ing ing clear funds status available to the Registrars.
Underwriters Underwriters are intermediaries who undertak e to subscribe to the securities offered by the company in case these are not fully subscribed by the public, in case of an underwritten issue.
ASBA To mak e the existing public issue process more efficient, SEBI introduced a supplementary process of applying in public issues, viz, the ¶Applications Supported by Block ed ed Amount (ASBA) in July 2008. ASBA is an application containing an authorization to block the application money in the bank account, for subscribing to an issue. If an investor is applying through ASBA, his application money is debited from the bank account only if his/her application is selected for allotment after the basis of allotment is finalized, or the issue is withdrawn/failed .In case of rights issue his application money is debited from the bank account after the receipt of instruction from the registrars. The ASBA process is available in all public issues made through the book building route. In September 2008, the ASBA facility was extended ext ended to Rights Issue.
Meaning ASBA stands for ¶Application Supported by Block ed ed amount·. ASBA is an application containing an authorization to block the application money in the bank account, for subscribing to an issue. If an investor is applying through ASBA, his application money will be debited from the bank account only if his/her application is selected for allotment after the basis of allotment is finalized, or the issue is withdrawn/failed
.In case of rights issue his application money shall be debited from the bank account after the receipt of instruction from the registrars.
ASBA Investor ASBA Investor means an Investor who intends to apply through ASBA process and is a Resident Retail
Individual Investor, is bidding at cut-off, with single option as to the number of shares bid for; is applying through blocking of funds in a bank account with the S CSB ; has agreed not to revise his/her bid; is not bidding under any of the reserved categories.
An investor can apply through ASBA process in a public issue through book building route provided he/
she: a. is a ´Resident Retail Individual Investorµ i.e. applying for f or shares/ securities up. b. is bidding at cut off, with single option as to the number of shares bid for. c. is applying through blocking of funds in a bank account with the S CSB ; d. has agreed not to revise his/her bid; e. is not bidding under any of the reserved reser ved categories.
S EB I has permitted ASBA process in rights issue on pilot basis. All shareholders of the company as on record date are permitted to use ASBA for making applications in rights issue provided he /she:
a. is holding shares in dematerialised form and has applied for entitlements or additional shares in the issue in dematerialised form;
b. has not renounced its entitlements in full or in part;
c. is not a renouncee to the t he Issue;
d. applies through a bank account a ccount maintained with S CSB s. s.
Advantages of ASBA
(i) The investor need not pay the application money by cheque rather the investor submits ASBA which accompanies an authorization to block the bank account to the extent of the application money.
(ii) The investor does not have to bother about refunds, as in ASBA only that much money which is required for allotment of securities, secur ities, is taken from the bank account only when his application is selected for allotment after the basis of allotment is finalized.
(iii) The investor continues to earn interest on the application money as the same remains in the bank account.
(iv) The application form is simpler.
(v) The investor deals with the known intermediary i.e its own bank.
Self certified Syndicate Bank (SCSB) SCSB is a bank which is recognized as a bank capable of providing ASBA services to investors. Names of such banks would appear in the list available in website of SEBI.
In case of an issue, an investor can apply either through ASBA or through existing system of payment through cheque. If an applicant applies through both ASBA as well as non ASBA then the both the applications having the same PAN, will be treated as multiple application and hence rejected.
CONCEPT CLARIFIERS FOR PRIMARY MARKET Face Value of a share/debenture
The nominal or stated amount (in Rs.) assigned to a security by the issuer. For shares, it is the original cost of the stock shown on the certificate; for bonds, it is the amount paid to the holder at maturity. It is also known as par value or simply par. For an equity share, the face value is usually a very small amount (Rs. 5, Rs. 10) and does not have much bearing on the price of the share, which may quote higher in the market, at Rs. 100 or Rs. 1000 or any other price. For a debt security, face value is the amount repaid to the investor when the bond matures (usually, Government securities and corporate bonds have a face value of Rs. 100). The price at which the security trades depends on the fluctuations f luctuations in the interest rates in the economy.
Premium and Discount Securities are generally issued in denominations of 5, 10 or 100. This is known as the Face Value or Par Value of the security as discussed earlier. When a security is sold above its face value, it is said to be issued at a Premium and if it is sold at less than t han its face value, then it is said to be issued at a Discount. Cut-Off Price In a Book building issue, the issuer is required to indicate either the price band or a floor price in the prospectus. The actual discovered issue price can be any price in the price band or any price above the floor price. This issue price is called ´Cut-Off Priceµ. The issuer and lead manager decides this after considering the book and the investors· appetite for the stock.
Collection Centre means a place where the application for subscribing to the public or rights issue is collected by the Banker to an Issue on behalf of the issuer company;
Composite Issues means an issue of securities by a listed company on a public cum rights basis offered through a to single offer simultaneously; document wherein the allotment for both public and rights components of the issue is proposed be made
Convertible Debt Instrument means an instrument or security which creates or acknowledges indebtedness and is convertible into equity shares at a later date, at or without the option of the holder of tthe he instrument or the security of a body corporate, whether constituting a charge on the assets as sets of the body corporate or not.
Credit Rating Agency means a body corporate registered under Securities and Exchange Board of India (Credit Rating Agencies) Regulations, 1999;
Lock-in indicates a freeze on the sale of shares for a certain period of time. SEBI guidelines have stipulated lock-in requirements on shares of promoters mainly to ensure that the promoters or main persons, who are controlling the company, shall continue to hold some minimum percentage in the company after the public issue.
Listing of securities means admission of securities of an issuer to trading privileges (dealings) on a stock exchange through a formal agreement. The prime objective of admission to dealings on the exchange is to provide liquidity and marketability to securities, as also to provide a mechanism for effective control and supervision of trading.
Listing Agreement: At the time of listing securities of a company on a stock exchange, the company is required to enter into a listing agreement with the exchange. The listing agreement specifies the terms and conditions of listing and the disclosures that shall be made by a company on a continuous basis to the exchange.
Delisting of securities means permanent removal of securities of a listed company from a stock exchange. As a consequence of delisting, the securities of that company would no longer be traded at that stock exchange.
Green shoe Option is a price stabilizing mechanism in which shares are issued in excess of the issue size, by a maximum of 15%. From an investor·s perspective, an issue with green shoe option provides more probability of getting shares and also that post listing price may show relatively more stability as compared to market volatility. Issue price means the price at which a company's shares are offered initially in the primary market is called as the Issue price. When they begin to be traded, tr aded, the market price may be above or below the issue price. Market Capitalisation means the market value of a quoted company, which is calculated by multiplying its current share price (market price) by the number of shares in issue is called as market capitalization. E.g. Company A has 120 million shares in issue. The current market price is Rs. 100. The market mar ket capitalisation of company A is Rs. 12000 million
In a safety net scheme or a buy back arrangement the issuer company in consultation with the lead merchant banker discloses in the RHP that if the price of the shares of the company post listing goes below a certain level the issuer will purchase back a limited number of shares at a pre specified price from each allottee.
Open book/closed book: In an open book building system the merchant banker along with the issuer ensures that the demand for the securities is displayed online on the website of the Stock Exchanges. Here, the investor can be guided by the movements of the bids during the period in which the bid is kept open. Indian Book building process provides for an open book system. In the closed book building system, the book is not made public and the bidders will have to take a call on the price at which they intend to make a bid without having any information on the bids submitted by other bidders.
Hard underwriting is when an underwriter agrees to buy his commitment before the issue opens. The underwriter guarantees a fixed amount to the issuer from the issue. Thus, in case the shares are not subscribed by investors, the issue is devolved on underwriters and they have to bring in the amount by subscribing to the shares. The underwriter bears a risk which is much higher than soft underwriting.
Soft underwriting is when an underwriter agrees to buy the shares at stage after the issue the issue is closed. The risk faced by the underwriter as such is reduced to t o a small window of time.
Differential pricing: When one category of investors is offered shares at a price different from the other category it is called differential pricing. An issuer company can allot the shares to retail individual investors at a discount of maximum 10% to the price pr ice at which the shares are offered to ot other her categories of public.
Basis of Allocation/Basis of Allotment: After the closure of the issue, for example, a book built public issue, the bids received are aggregated under different categories i.e., firm allotment, Qualified Institutional Buyers (QIBs), Non Institutional Buyers (NIBs), Retail, etc. The oversubscription ratios are then calculated for each of the categories as against the shares reserved for each of the categories in the offer document. Within each of these categories, the bids are then segregated into different buckets based on the number of shares applied for. The oversubscription ratio is then applied to the number of shares applied for and the t he number of shares to be allotted for applicants in each of the buckets is determined. Then, the number of successful allotees is determined. This process is followed in case of proportionate allotment. Thus allotment to each investor is done based on proportionate basis in both book built and fixed price public issue.
Firm Allotment means allotment on a firm basis in public issues by an issuing company made to Indian and Multilateral Development Financial Institutions, Indian Mutual Funds, Foreign Institutional Investors including non-resident Indians and overseas corporate bodies and permanent/ regular employees of the issuer company.
Networth means aggregate of value of the paid up equity capital and free reserves (excluding reserves created out of revaluation) reduced by the aggregate value of accumulated losses and deferred expenditure not written off (including miscellaneous miscellaneous expenses not written off) as per the audited balance sheet.)
Offer Document means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue.
Offer for Sale means offer of securities by existing shareholder(s) of a company to the public for subscription, through an offer document.
Preferential Allotment means an issue of capital made by a body corporate in pursuance of a resolution passed under Sub-section (1A) of Section 81 of the Companies Act, 1956.
Public Issue means an invitation by a company to public to subscribe to the securities offered through a prospectus;
Underwriting means an agreement with or without conditions to subscribe to the securities of a body corporate when the existing shareholders of such body corporate or the public do not subscribe to the securities offered to them.
Unlisted Company means a company which is not a listed company.
Mutual Funds
Mu t t u u a al l Fu nds nds
A mu t t u u a al l f u un nd d is a compan y t hat pools mon ey ey from man y in vveest o or r s s and in vveests t he he mon ey ey in st ock ocks , bonds , s hor hor t t- t erm erm mon ey-m ey-ma rke rket inst r r u um me ents , ot her her s ec ecu ri rit ie ies or ass ets , or s ome ome combinat iio on of t h hees e in vveest m meents . Mu t t u ua al l Fu nds nds a re re ess ent iall y in ve vest m meent vehicl es where peopl e wit h s iimi mila r in vveest m meent object ive ive come t oge oget her her t o pool t heir heir mon ey ey and t he hen in ve vest a ccor ccor d di n gl y. y.
SEBI d efi efin es mu tt u u a al l f u unds n ds as ¶A f u un nd d esta bl is he hed in t he he form of a t rr u u st st t o r a ai s e mon eeyy t hro hrou gh gh t h hee sal e of u n n i ts t o t he he pu bl ic ic or a s ec ect io ion of t he he pu bl ic ic u n nd d er er on e or more s cheme chemes for in vveest in g in s eeccu rriit iiees , in cl u ud d in g mon ey ey ma rke rket inst r r u um me ents or gold or gold relat ed inst r ru u m me ents or real estat e ass ets ··..
A Mu t t u u a al l Fu n nd d will ha ve ve a f u u n nd d mana ger ger who is res po pons ib ibl e for in vveest in g t he he pool ed mon eeyy int o s pecific pecific s ec ecu ri rit ie ies (u s su u aall ll y st ock ocks and bonds ). ). When you in ve vest in a MF , you a re re bu yyiin g s ha rrees (or por t t iio ons ) of t h hee MF and become a s ha reho rehold er er of t he he f u un nd d . Mu t t u ual a l Fu nds nds (MF s s ) a re re cons id ere ered a good rou t t e t o in vveest and ea rr n n ret u ur r n ns s wit h reas ona bl e sa fe fet y. y.
u al a l Fu n nd d is a ¶pool in g· ua al l Fu n nd d is an in vveest m The bas is of a Mu t t u g· con cep cept . A Mu t t u meent vehicl e t hat pools t h hee sa vi s who s ha re s coll eecct ed is t h vin gs of s ever ever aal l in ve vest o or r s re a common finan ci cial goal . The mon eeyy t hu s heen in vveest ed u ents s u uch ure res and ot her ne d t hro in ca p piital ma rke rket inst r ru m me c h as s ha re res , d ebe ebent u her s eeccu rriit iiees . The in come come ea rr n hrou gh gh t h ni t hold eer s in propor t t iio hees e in ve vest m meents and t he he ca pi pital a ppreci ppreciat io ion real is ed a rree s ha rreed by its u n r s on t o t h hee n u u mber ber of u n n i ts own ed by t hem. m hem.
Advantages of Mu tt u l Fu nds nds ua al y
Number of available options: equity funds, debt funds, gilt funds and many others are available that cater to the different needs of an investor.
y
Diversification: Mutual funds diversify the risk of the investor by investing in a basket of various stocks.
y
Managed by Skilled Professionals: Investors who lacks time, the inclination or the skills to actively mange their investment risk in individual securities can delegate this role to the mutual funds which are managed by a team of professional fund managers who manages them with in-depth research inputs from investment analysts.
y
Liquidity: When in need of liquidity, the money can be withdrawn or redeemed at the Net Asset Value related prices anytime, without much reduction in yield (unlike penalty on premature fixed deposit withdrawal). Some mutual funds however, charge exit loads for withdrawal within a specified period.
y
Well Regulated: All investments have to be accounted for & decisions judiciously taken. SEBI acts as a true watchdog through regulations, designed to protect the investors· interests and impose penalties on the AMCs at fault.
y
Transparency: Being under a regulatory framework, mutual funds have to disclose their holdings, investment pattern and all the information relating to the investment strategy, outlooks of the market and scheme related details to all investors frequently to ensure that transparency exists in the system. Flexible, Affordable and a Low Cost affair: Mutual Funds provide the benefit of cheap access to expensive stocks.
y
y
Tax benefits: Mutual Funds (MFs) are undoubtedly an important product innovation in the financial field, as an instrument of raising capital from the wider public for corporate enterprise growth. Historically MFs originally called unit trusts in the United Kingdom were invented for the mass of relatively small investors. Investors are issued ¶units·, thus for an investor, investments in MF imply buying shares (or portions) of the MF and becoming the shareholders of the fund.
tructure of Mutual Funds: S tructure A typical MF in India has the following constituents:
Fund Sponsor - A ¶sponsor· is a person who, acting alone or in combination with another corporate body, establishes a MF. The sponsor should have a sound financial track record of over five years, have a positive net worth in all the immediately preceding five years and integrity in all his business transactions.
In case of an existing MF, such fund which is in the form of a trust and the trust deed has been approved by the Board; the sponsor should contribute at least 40% of the net worth of the AMC (provided that any person who holds 40 % or more of the net worth of an asset management company should be deemed to be a sponsor and would be required to fulfill f ulfill the eligibility criteria specified in the SEBI regulations).
Trustees - The MF can either be managed by the Board of Trustees, which is a body of individuals, or by a Trust Company, which is a corporate body. Most of the funds in India are managed by a Board of Trustees. The trustees are appointed with the approval of SEBI. Two thirds of trustees are independent persons and are not associated with sponsors or be associated with them in any manner whatsoever. The trustees, being the primary guardians of the unit holders· funds and assets, have to be persons of high repute and integrity. The Trustees, however, do not directly manage the portfolio of MF. It is managed by the AMC as per the defined objectives, in accordance with trust deed and SEBI (MF) Regulations.
Asset Management Company - The AMC, appointed by the sponsor or the Trustees and approved by SEBI, acts like the investment manager of the Trust. The AMC should have at least a net worth of Rs. 10 crore. It functions under the supervision of its Board of Directors, Trustees and the SEBI. In the name of the Trust, AMC fl oats and manages different investment ¶schemes· as per the SEBI Regulations and the Investment Management agreement signed with the Trustees. The regulations require non-interfering relationship between the fund sponsors, trustees, t rustees, custodians and AMC.
Custodians - A custodian is appointed for safe keeping the securities or gold or gold related instruments or other assets and participating in the clearing system through approved depository. Custodian also records information on stock splits and other corporate actions. No custodian in which the sponsor or its associate holds 50 % or more of the voting rights of the share capital of the custodian or where 50 % or more of the directors of the custodian represent the interest of the sponsor or its associates should act as custodian for a mutual fund constituted by the same sponsor or any of its associate or subsidiary company.
Registrar and Transfer agent - Registrar and transfer agent maintains record of the unit holders· account. A fund may choose to hire an independent party registered with SEBI to provide such services or carryout these activities in-house. If the work relating to the transfer of units is processed in-house, the charges at competitive market rates may be debited to the scheme. The registrar and transfer agent forms the most vital interface between the unit holder and mutual fund. Most of the communication between these two parties takes place through registrar and transfer agent.
Distributors/ Agents - To send their products across the length and breadth of the country, mutual funds take the services of distributors/agents. Distributors comprise of banks, non-banking financial companies and other distribution companies.
TYPE S S OF MF ss//S CH CHEME S S A wide variety of MF s/ s/S cchemes hemes caters to different preferences of the investors based on their financial position, risk tolerance and return expectations.
F unds unds by S tructure/Tenor tructure/Tenor
Open ended S cheme cheme
An open-ended fund provides the investors with an easy entry e ntry and exit option at NAV, which which is declared on a daily basis.
Close ended S cheme cheme
In close-ended funds, the investors have to wait till maturity to redeem their units, however, an entry and exit is provided through mandatory listing of units on a stock exchange. The listing is to be done within six months of the close of the subscription.
Assured return schemes
Assures a specific return to the unit holders irrespective of performance of the scheme, which are fully guaranteed either by the sponsor or AM C. C.
Interval F und und
This kind of fund combines the features of open-ended and closed-ended schemes, making the fund open for sale or redemption during pre-determined intervals.
Open Ended Scheme
Close Ended Scheme
1) An Open Ended Scheme accepts funds from 1) The subscription to a closed ended scheme is investors by offering its units or shares on a kept open only for a limited period (usually one continuing basis. month to three months) 2) It permits permits investors to withdraw funds on a 2) It does not allow investors to withdraw funds continuing basis under a re-purchase as and when they like. arrangement. 3) Open Ended scheme has no maturity period.
3) A close ended scheme has a fixed maturity period (usually five to fifteen years).
4) The open ended schemes are ordinarily not 4) The close ended schemes are listed on the listed.
secondary market.
5) They offer greater liquidity and relatively lower 5) They offer lesser liquidity and higher returns returns. compared to Open Ended Scheme.
Regulation of M utual utual F unds unds The MF s are regulated under the SEBI (MF ) Regulations, 1996. All the MF s have to be registered with SEBI. The regulations have laid down a detailed procedure for launching of schemes, disclosures in the offer document, advertisements, listing and repurchase of close-ended schemes, offer period, transfer of units, investments, among others.
In addition, RBI also supervises the operations of bank-owned MF s. s. While SEBI regulates all market related and investor related activities of the bank/F F I-owned I-owned funds, any issues concerning the ownership of the AM Cs Cs by banks fall under the regulatory ambit of the t he RBI.
F urther, urther,
as the MF s, s, AM Cs Cs and corporate trustees are registered as companies under the Companies Act 1956, they have to comply with the provisions of the Companies Act.M any any close-ended schemes of the MF s are listed on one or more stock exchanges. Such schemes are, therefore, subject to the regulations of the concerned stock exchange(s) through the listing agreement between the fund and the stock exchange.MF ss,, being Public Trusts are governed by the Indian Trust Act, 1882, are accountable to the office of the Public
Trustee, which in turn reports to the Charity Commissioner, that enforces provisions of the Indian Trusts Act.
Constitution of a Mutual Fund, Asset Management Company
A mutual fund is constituted in the form of a trust and the instrument of trust should be in the form of a deed, duly registered under the provisions of the Indian Registration Act, 908 (16 of 1908), executed by the sponsor in favour of the trustees named in such an instrument. A trust is appointed with the approval of the Board. The sponsor or, if so authorised by the trust deed, the trustee, would appoint an asset management company, which has been approved by the Board.
The trustees and the asset management company should with prior approval SEBI enter into an investment management agreement which should contain clauses necessary for the purpose of making investments. (Clauses are in the forth f orth schedule chapter III SEBI Mutual Fund Regulation 1996).
Index Funds Index funds are those funds which track the performance of an index. This is usually carried out by either investing in the shares comprising the index or by buying a sample of shares making up the index or a derivative based on the likely performance of the index. The value of the fund is linked to the chosen index so that if the index raises so will the value of the fund. Conversely, if the index falls so will the value of the fund. In the Indian context, the index funds attempt to copy the performance of the two main indices in the market viz., Nifty 50 or Sensex. This is done by investing in all the stocks that comprise the index in proportions equal to the weightage given to those stocks in the index. Unlike a typical MF, index funds do not actively trade stocks throughout the year. They may at times hold their stocks for the full year even if there are changes in the composition of index; this reduces transaction costs. Index funds are considered, particularly, appropriate for conservative long term investors looking at moderate risk, moderate return arising out of a well-diversified portfolio. Since index funds are passively managed, the bias of the fund managers in stock selection is reduced, yet providing returns at par with the index. As of March 2009, there were 35 Index Funds available.
Index Funds as of March 2009
S.No.
Scheme Name
1 JM Nifty Plus Fund - Dividend
Benchmark Index S&P Nifty
Index Funds as of March 2009 2 JM Nifty Plus Fund - Growth
S&P Nifty
3 ICICI Prudential Index Fund - IP - Dividend
S&P Nifty
4 Canara Robeco Nifty Index - Dividend
S&P Nifty
5 Canara Robeco Nifty Index - Growth
S&P Nifty
6 Franklin India Index Fund - NSE Nifty Plan - Growth
S&P Nifty
7 ING Nifty Plus Fund - Dividend
S&P Nifty
8 ING Nifty Plus Fund - Growth
S&P Nifty
9 Tata Index Fund - Nifty Plan - Option A
S&P Nifty
10 LIC MF Index Fund - Nifty Plan - Dividend
S&P Nifty
11 LIC MF Index Fund - Nifty Plan - Growth
S&P Nifty
12 Birla Sun Life Index Fund - Dividend
S&P Nifty
13 Birla Sun Life Index Fund - Growth
S&P Nifty
14 HDFC Index Fund - Nifty Plan
S&P Nifty
15 ICICI Prudential Index Fund
S&P Nifty
16 SBI Magnum Index Fund - Dividend
S&P Nifty
17 SBI Magnum Index Fund - Growth
S&P Nifty
18 Franklin India Index Fund - NSE Nifty Plan - Dividend
S&P Nifty
19 UTI Nifty Fund ² Dividend
S&P Nifty
20 UTI Nifty Fund ² Growth
S&P Nifty
21 PRINCIPAL PRINCIPAL Index Fund - Dividend
S&P Nifty
22 PRINCIPAL PRINCIPAL Index Fund - Growth
S&P Nifty
23 Benchmark S&P CNX 500 Fund - Dividend
CNX500
24 Benchmark S&P CNX 500 Fund - Growth
CNX500
Franklin India Index Fund - BSE Sensex Plan 25 Dividend
BSE Sensex
Index Funds as of March 2009 Franklin India Index Fund - BSE Sensex Plan 26 Growth
BSE Sensex
27 Tata Index Fund - Sensex Plan - Option A
BSE Sensex
28 LIC MF Index Fund - Sensex Advantage Plan - Div
BSE Sensex
LIC MF Index Fund - Sensex Advantage Plan 29 Growth
BSE Sensex
30 LIC MF Index Fund - Sensex Plan - Dividend
BSE Sensex
31 LIC MF Index Fund - Sensex Plan - Growth
BSE Sensex
32 HDFC Index Fund - Sensex Plan
BSE Sensex
33 HDFC Index Fund - Sensex Plus Plan
BSE Sensex
34 UTI Master Index Fund - Dividend
BSE Sensex
35 UTI Master Index Fund - Growth
BSE Sensex
Exchange Traded Funds An Exchange Traded Fund (ETF) is a type of Investment Company whose investment objective is to achieve similar returns as in case of a particular market index. An ETF is similar to an index fund, but the ETFs can invest in either all of the securities or a representative sample of securities included in the index. Importantly, the ETFs offer a one-stop exposure to a diversified basket of securities that can be traded t raded in real time like an individual stock. ETFs first came into existence in USA in 1993. Some of the popular ETFs are: SPDRs (Spiders) based on the S&P 500 Index, QQQs (Cubes) based on the Nasdaq-100 Index, iSHARES based on MSCI Indices, TRAHK TRAHK (Tracks) based on the Hang Seng Index and DIAMONDs DIAMONDs based on Dow Jones Industrial Average (DJIA).
Like index funds, ETFs are also passively managed funds wherein subscription/redemption of units implies exchange with underlying securities. These being exchange traded, units can be bought and sold directly on the exchange, hence, cost of distribution is much lower and the reach is wider. These savings are passed on to the investors in the form of lower costs. The structure of ETFs is such that it protects long-term investors from inflows and outflows of short-term investor. ETFs are highly flexible and can be used as a tool for gaining instant exposure to the equity markets.
The first ETFs in India, based on Nifty 50, were the Nifty Benchmark Exchange Traded Scheme (Nifty BeES). This was launched by Benchmark Mutual Fund in December 2001. It is bought and sold like any other stock on NSE. Over the years more and more ETFS have been introduced. As on October 2008 there were 15 Exchange trade funds in India, out of which 5 are gold exchange traded funds. The various ETFs are detailed below. As on March 2009 there were 12 ETFs in India.
List of Exchange traded tr aded Funds in India: Exchange Traded Funds (ETFs) 1
BANKBE ES BANKBEES
Benchmark Asset Management Company Pvt. Ltd.
2
JUNIORBEES JUNIORBEE S
Benchmark Mutual Fund-Nifty Junior Benchmark ETF
3
UTISUNDER
UTI Mutual Fund
4 LIQUIDBEES LI QUIDBEES
Benchmark Asset Management Company Private Limited
5
NIFTYBEES
Benchmark Mutual Fund
6
KOTAKPSUBK
Kotak Mahindra Mutual Fund
PSUBNKBEES PSUBNKB EES
Benchmark Mutual Fund - PSU Bank Benchmark Exchange Traded Scheme.
8
RELBANK
Reliance Reli ance Mutual Fund -Banking Exchange Traded Fund (ETF)
9
QNIFTY
Quantum Index Fund -Exchange Traded Fund (ETF)
SHARIABEES SHARIABEE S
Benchmark Mutual Fund - Shariah Benchmark Exchange Traded Scheme (ETF)
11
ICICI SPICE
ICICI SENSEX Exchange Traded Fund
12
Kotak Sensex ETF
Kotak SENSEX Exchange Traded Fund
7
10
Gold Exchange Traded Fund A gold exchange traded fund unit is like mutual fund units whose underlying asset is Gold and is held in demat form. It is typically an Exchange traded Mutual Fund unit which is listed and traded on a stock exchange. Every gold ETF unit is representative of a definite quantum of pure gold and the traded price of the gold unit moves in tandem with the price of the actual gold metal. The GETF aims at providing returns which closely correspond to the returns provided by Gold. In India gold ETFs came about in the year 2007, the first being Gold Bees. This Gold fund was introduced in India by Benchmark Asset Management Company. It offers investors an innovative, cost-efficient and secure way to access the gold market. As on March 2009 there were 5 Gold ETFs in India.
GOLD ETFs on NSE
1 GOLDBEES
Benchmark Mutual Fund - Gold Benchmark Exchange Traded Scheme
2 GOLDSHARE GOLDSHARE UTI Mutual Fund - UTI Gold Exchange Traded Fund 3 KOTAKGOLD KOTAKGOLD Kotak Mutual Fund - Gold Exchange Traded Fund 4 RELGOLD RELGOLD
Reliance Mutual Fund - Gold Exchange Traded Fund
5 QGOLDHALF QGOLDHALF
Quantum Gold Fund -Exchange Traded Fund (ETF)
BONDS
Debt Market The debt market is one of the most critical components of the financial system of any economy and acts as the fulcrum of a modern financial system. Debt market consists of Bond markets, w which hich provide financing through the issuance of Bonds, and enable the subsequent trading thereof. Instruments like bonds/debentures are traded in this market. These instruments can be traded in OTC or Exchange traded markets. The debt market in most developed economies is many times bigger than other financial markets including equity market. In India, the debt market is broadly divided into two parts- G-Sec or government securities market /gilt edged market and Corporate Bond Market.
The debt market plays a key role in the efficient mobilisation and allocation of resources in the economy, financing the development activities of the government, facilitating liquidity management, framing monetary policy and pricing of non-government securities in financial markets. Debt market can provide returns commensurate to the risk. G-Sec Market: The government needs enormous amount of money to perform various functions such as maintaining law and order, justice, national defense, central banking, creation of physical infrastructure. The government generates revenue in the form of taxes and income from ownership of assets. Besides, it borrows extensively from banks financial institutions and public to finance its expenditure. One of the important sources of borrowing funds is the government securities market. The government raises short term and long term funds by issuing securities. These securities do not carry risk as the government guarantees the payment of interest and the repayment of principal. They are therefore referred to as gilt edged securities. Government securities are issued by the central government, state government and semi government authorities. The major investors in this market are banks, insurance companies, provident funds, state governments, FIIs. Government securities are of two types- treasury bills and government dated securities. One of the important Dated Govt. Govt. securities consists consists of zero credit risk (sovereign), (sovereign), Coupon bearing and non coupon (zero) bearing bonds Longer maturity government debt products are the Government of India Treasury Bonds (ranging from greater than a year up to 30 years). Treasury bonds issued have face value of all treasury products, both bonds and bills, is Rs.100 and the maturity of bonds issued goes from over a year, all the way out to 30 years. All GOI bonds are coupon bearing bonds, with coupons being paid semiannually. semiannually. The maturity and the coupon of each bond are defined at the date. Corporate Bond Market: Corporate bonds are bonds issued by firms and are issue to meet needs for expansion, modernization, restructuring operations, mergers and acquisitions. The corporate debt market is a market wherein debt securities of corporates are issued and traded therein. The investors in this market are banks, financial institutions, insurance companies, mutual funds, FIIs etc. Corporates adopt either the public offering route or the private placement route for issuing debentures/bonds.
Other instruments available for trading in the debt segment are T-Bills, T-Bills, Commercial Papers and Certificate of Deposits.
Regulation of Debt Market: The RBI regulates the government securities market and money market while the corporate debt market comes under the purview of the SEBI.
Participants in the Debt Market The participants in the debt market are a small number of large players which has resulted in the debt market. Central & State Govt. Primary Dealers
FIIs
Corporates
PSUs
Players In Debt Market
Banks
HNIs
Mutual
Provident
Funds
Funds
PARTICIPANTS IN DEBT MARKET Primary and Secondary Segments of Debt Market In the primary market, new debt issues are floated either through public prospectus, rights issue or private placement.
Collective Investment Vehicles A collective investment vehicle is any entity that allows investors to pool their money and invest the pooled funds, rather than buying securities se curities directly as individuals. The most common types of collective investment vehicles are mutual funds, exchange traded funds, collective investment schemes and venture capital funds. The Collective Investment Scheme is well established in many jurisdictions and now serves as an investment vehicle for a wide range ra nge of investment opportunities opportunities around the world.
In India, there are three distinct categories of collective investment vehicles in operation namely, Mutual Funds (MFs), Exchange Traded Funds and Index Funds.
BOND FUNDAMENTALS Bonds
A company needs funds to expand into new markets, while governments need money for every everything, thing, from creating infrastructure to executing social programs. Large organizations need bigger sums of money than one institution can provide. Hence, they raise money by issuing bonds (or other debt instruments) to the public. Thousands of investors then each lend a portion of the capital needed. A bond represents a defined unit of the loan and each investor holds certain number of bonds. The organisation that sells a bond is known as the issuer. The bond is a promise to pay principal and interest given by a borrower (the issuer) to a lender (the investor). The issuer of a bond must pay the investor something extra for the privilege of using his or her money. This comes in the form of interest payments, which are made at a predetermined rate and schedule. The interest rate is referred to as the coupon rate. The date on which the issuer has to repay the amount borrowed (known as face value value)) is called the maturity date. Bonds are often known as fixed-income securities because the exact amount of cash that will be repaid is known in advance if the security is held until maturity. This is particularly true for fixed coupon bonds. In floating coupon bonds, the coupon rate is linked to some benchmark as the benchmark changes, so does the coupon rate on the bond. If an investor buys a bond with a face value of INR I NR 1000, a coupon of 8%, and a maturity of ten years, he will receive a total of INR 80 (INR 1000*8%) of interest per year for the next ten years. Actually, because most bonds pay interest semi-annually, he will receive two payments of INR 40 a year for ten years. When the bond matures after a decade, he will get his original investment back. Bonds are Different from equity Bonds are debt, whereas stocks are equity. This is an i mportant distinction between the two securities. By purchasing equity (stock), an investor becomes a part owner in the company, with voting rights and the right to share in any future profits. By purchasing pur chasing debt (bonds) an investor becomes a creditor to the company (or government). The primary advantage of being a creditor is a bigger claim on assets than shareholders. That means that in bankruptcy, a bondholder will get paid before the shareholder. Shareholders only have a residual claim on the assets of the company. The bondholders, however, do not share in the profits if a company does wellhe or she is entitled only to the principal plus interest. There is generally less risk in owning bonds compared to stocks, but this comes at the cost of lower returns. Face Value/Par Value The face value (also known as the par value or principal) is the amount of money a holder will receive once a bond matures. This is also the value which is printed on the face of the bond certificate. cer tificate. A newly issued bond usually sells at the par value.
Price
After issue of the bond, its price need not no t be equal to its face value. A bonds price fluctuates in response to a number of variables. When a bonds price trades above the face value, it is said to be selling at a premium, and when sold below face value, it is said to be selling at a discount. Coupon (The Interest Rate)
The coupon is the amount the bondholder will receive as interest payments. It is called a coupon because sometimes there are physical coupons that are issued towards interest. This was common in the past, but at present records is more likely to be kept electronically. Funds are also now transferred electronically. As previously mentioned, most bonds pay interest every six months, but it is possible to be paid monthly, quarterly, or annually. However, higher frequency increases the cost of the bond. The coupon is expressed as a percentage of the par value. A rate that stays as a fixed percentage of the par value is a fixed-rate bond. Another possibility is an adjustable interest payment, known as a floating-rate bond. In this case the interest rate is i s tied to market rates throug through h an index, such as the rate on Treasury bills. Maturity The maturity date is the day on which the investors i nvestors principal will be repaid. Maturities can range from one day to 30 years (though bonds of a term of 100 years have also been issued) A bond that matures in one year is more predictable and thus less risky than a bond that matures in 20 years. In general, the longer the time to maturity, the higher the interest rate. Also, generally, the price of a longer-term bond will fluctuate more than that of a shorter-term bond. Measuring Return with Yield/current yield Yield is a measure of the return on a bond. The simplest version of yield (called current yield) is calculated by the following formula:
If the bond trades at par, yield yie ld is equal to the coupon interest rate. W When hen the price changes, so does the yield. Let us consider an example. If I f one buys a bond at its par value of INR 1000 with a 10% coupon, the yi yield eld is 10% (100/1 000). But if the price goes down to INR 800, then the yield goes up to 12.5%. This happens because the guaranteed INR 100 return is earned on an asset that is worth INR 800 (INR 100/INR 800). Conversely, if the bond goes up to INR1200 the yield shrinks to 8.33%(INR 100/INR 1200)
Yield To Maturity (YTM)
Often, when bond investors refer to yield, they mean yield to maturity (YTM). YTM is a more advanced calculation that shows the total return one will receive if one holds the bond to maturity. YTM thus equates the present value of all future cash flows in the form of coupon receipts and redemption redem ption amount with the current price. It equals all the interest payments the investor will receive r eceive (and assumes that the investor will reinvest rei nvest the interest payment at the same rate as the YTM on the bond) plus the amount due on maturity (including premium, if any) with the prevailing price through a time adjustment process. Bond Valuation There are different approaches to the valuation val uation of a bond. The most common is the net present value approach. Under this approach various cash inflows that are committed to the bond are determined along with their timings. tim ings. The cash inflows include coupon payments and redemption re demption amounts. The market value of a bond is thus the net present value of all the future cash flows. This can be stated as follows.
where, P= Price of the bond including accrued interest C = Coupon payment at time t
= Principal repayment at time t (often this would be only at time t with one bullet rrepayment) epayment) t = Number of periods to each payment T= Total time to final maturity, i.e. when whe n the entire principal is repaid. Y= the yield to maturity of the bond It may be noted that instead of the price pri ce of the bond, yie yield ld to maturity itself is used to compare its market value. The yields relationship with price can be summarized as: when price goes up, yield goes down and vice versa. Technically, it can be said that the bonds prices and its yield are inversely related. Price in the Market: Role of Prevailing Interest Rates So far, weve discussed the factors of face fa ce value, coupon, maturity; the issuer and yield. All these characteristics play a role in a bonds price. However Howev er the factor that influences a bond most is the level of prevailing interest rates. When interest rates rise, the prices of bonds fall, thereby raising the yield of the older bonds and bringing them in line with the newer bonds being issued with a higher coupon.
When interest rates fall, the prices of bonds rise, lowering the yield of the older bonds and bringing them in line with the newer bonds being issued with a lower coupon. E.g. a government issues bonds bearing a coupon of 12% in 1994 maturing in the year 2014. Let us vi visualize sualize the scenario in 2004, when the bond is only ten years to maturity. Assume the interest rates have been falling since 2000. If the government now issues 10-year bonds in 2004 with interest rates of 6%, an investor has a choice. He can invest in either of the bonds, and obviously his choice would be in favour of a bond bo nd that gives a coupon of 12%. However, every investor who wishes to enhance his return would do that. The result would be a great demand for the 12% bond and no takers for the 6% bond. This demand will come to a halt when the price of the 12% bond gets ge ts adjusted so that it starts yielding 6% for the remaining ten ye years ars of its life. Thus the price of this bond has gone up with the falling interest rate scenario. The reverse would happen when the interest rates rise, i.e. the price of the bond would fall. From a time value perspective, if the prevailing interest rates fall, the present pre sent value of all the future cash flows would go up, thus resulting in a higher present value than what was prevailing before. Thus, the price would go up. Issuer The issuer is extremely important in assessing the credibility of a debt investment. The financial strength and stability of the company provide the main assurance of being repaid. For example, the US Government is far more creditworthy than any corporation. corpor ation. Their default risk (the chance of the debt not being paid back) is extremely small, so small that US Government securities are known as risk- free securities. The reason for this is that a government will always be able to bring in future revenue through taxation, can print money and has mechanisms to back it. A company on the other hand must continue to make profits, which is not guaranteed. This means the corporations must offer a higher yield in order to entice investors this is called the risk/ re return turn tradeoff.
The bond rating system helps investors distinguish a companys credit risk. Blue chip firms, have a high rating while risky companies have a low rating. The chart below illustrates the different bond rating scales from the major rating agencies in the United States: Moodys, Standard and Poors, and Fitch Ratings:
Table 1: Bond rating scale
oo od M o
y¶s
Bond Rating /Fitch
Grade
S&
Risk
Aaa Aa A Baa Ba, B Caa/C aa/Ca/C a/C C
AAA AA A BBB BB BB,, B CCC/CC CCC/ CC//C D
IInv nves estm tmeent Inves nvestm tmeent Inves nvestm tmeent Inves Inv estm tmeent Ju Junk nk Ju Junk nk Ju Junk nk
High estt Qu Highes Qual aliity ty High Qual Qualiity ty Stron rong Med ediu ium m Gr ade de Sp Spec ecu ulat latiive Highly High ly Sp Spec ecu ulat latiive In Def ault lt
Note that if the company falls below a certain credit cre dit rating, its grade changes from investment quality to junk status. Junk bonds are aptly .named: they are the debt of companies in some sort of financial difficulty. Because they are so risky, they have to offer far higher yields than any other debt instrument. Fixed income market could be classified into various categories categ ories based on the issuers of the debt instruments: y
Government or Sovereign bonds: Issued by central or federal governments.
y
Government guaranteed bonds: Issued by an agency of the government or guaranteed by the government
y
State government bonds: issued by state government
y
Municipal bonds: issued by municipal bodies or counties countie s
y
Bonds issued by financial institutions including banks, insurance companies, etc.
y
Corporate Bonds: Issued by manufacturing companies and utilities
Government bonds In general, government securities are classified, particularly in the US context, according to the length of time before maturity. These are the three categories: Treasury Bills debt securities maturing in less than one year Notesdebt securities maturing in one to ten years Bondsdebt securities maturing in more than ten years Marketable securities from the US Governmentknown collectively as Treasuriesfollow this guideline and are issued as Treasury bonds, Treasury notes, and Treasury bills (T-bills). All debt issued by the US Government is regarded as extremely safe, as is the debt of any stable country. The debts of many developing countries, however, do carry substantial risk. Just like companies, countries can default on payments. Government guaranteed bonds This category includes bonds that have been issued by government gover nment agencies or those guaranteed by the federal government to ensure availability of finance and funding for causes that are supported by public policy.
Although most agency securities do not carry the governments g overnments full-faith-and-credit guarantee, their credit quality is enhanced by their governmentsponsored status. Investors in agency securities are primarily institutional and include state and local governments, mutual funds, pension funds, investment trusts and foreign investors.
State government and municipal bonds More than 50,000 state and local governments in the US and their agencies borrow m money oney by issuing bonds to build, repair or improve schools, streets, hospitals, water and sewer systems, ports, and other public works. Projects funded by municipal bonds have a positive impact on the surrounding communities by creating jobs, strengthening the infrastructure and improving the quality of life. Municipal issuers repay their debts in two ways: Community Projects related debt is repaid out of tax revenues. Specific User Group Projects are funded by revenue bonds which are often repaid with fees collected from people who use the services or facilities. The federal income tax law in the US exempts interest on municipal bonds from federal taxation. As a result, state and local governments can borrow at interest rates that are, on an average, 25 30% lower than otherwise possible. The municipal securities market has a record of safety second only to that of the US Treasury securities market. marke t. Individuals directly or through funds hold over 70% of the municipal debt outstanding. Bonds issued by financial institutions Banks have finance as their basic raw material. Ensuring the availability of funds of desirable maturity is an essential aspect of Asset Liability Management. Banks are therefore major issuers of bonds. Similarly, insurance companies as well as issuers of Asset Backed Securities also issue bonds. Corporate bonds A company can issue bonds just like stock. Large corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear. Generally a short term corporate bond is less than five years; intermediate is five to 12 years, and long-term is over 12 years. Corporate bonds are characterized by higher yields because there is a higher risk of a company defaulting than a government. The advantage is that they can also be more rewarding re warding investments. The companys credit quality is very important: the higher the quality, the lower the interest rate the investor receives. Variations of this are convertible bonds, which the holder can convert into stock, and callable bonds, which allow the company to redeem an issue prior to maturity. There are different types of instruments. The most common types are: 1. Fixed coupon bond: These bonds pay a fixed rate of interest and the principal is typically repaid on maturity. It may also be repaid in i n a couple of installments towards the end of the period.
2. Zero coupon bonds: This is a type of bond that makes no coupon payments but instead is issued at a discount to par value. For example, a zero coupon cou pon bond with a INR 1000 par value and ten years ye ars to maturity might be trading at INR 600. The difference between the two indicates the interest that would be earned and compounded over this period. 3. Annuities: This involves a fixed amount being repaid to the investor over a period per iod of time, which includes interests as well as repayment of a part of the principal. 4. Perpetual bonds: These bonds do not have a set redemption or maturity date. Their value is derived from interest earnings only. They are also called Consols. 5. Floating rate bonds: In these bonds, the rate of interest is not fixed. IItt varies in accordance with the performance of a benchmark, like London Inter-bank Offered Rate. Rate . 6. Structured notes: In case of these bonds, the pattern of coupon payment is tailored to the requirements of the investor class.
Bonds could also have added option features. When these features are added, the bond types that emerge are: 1. Callable bonds: These are the bonds which can be called back by the issuer on a specified date at a specified price against repayment of the principal. This option is likely to be exercised, for example, in a fixed rate bond, where after the issuance of the bonds, the interest rates have come down significantly. 2. Puttable bonds: This option rests with the investor to sell the bonds back to the issuer at a predetermined date and price before its natural maturity. The option is likely to be exercised if the interest rate offered on the bond is much lower than the marke markett interest rate. The investor may sell this bond back to the issuer to invest in a better bet ter yielding instrument. 3. Convertible bonds: This bond offers an option to the investor to convert the bond into equity stock at a predetermined price on a specified date.
