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Master of Business Administration- MBA Semester 4 MF0017 Merchant Banking and Financial Services- 4 Credits (Book ID: B 1318) Assignment Set- 1 (60 Marks) Note: Answer all questions (with 300 to 400 words each) must be written within 6-8 pages. Each Question carries 10 marks 6 X 10=60
Q1. Identify the role of merchant banking as financial intermediaries. Answer: Merchant Banking: Merchant banking is an essential service provided by financial institutions that help in the growth of corporate sector, which eventually reflects in the overall growth and economic development of the country. Merchant banking in India: The need for merchant banking was felt with the rapid growth in number of issues made and initiated into Indian capital market. The National and Grindlays Bank (NGB) then got the license from RBI in 1967. Later in 1970, First National City Bank (FNCB) set up a merchant banking division. As a commercial activity, merchant banking took shape in India through the management of public issues of capital and loan syndication.It includes public sector, private sector and foreign players. Some of the registered merchant banks in India are Kotak Mahindra Capital, HDFC Bank, ICICI Bank, IDBI Bank, and so on. Merchant banking helps with the following: Channelise the financial surplus of the public into productive investment prospects. Coordinate the activities of intermediaries to the share issue such as bankers, registrars, underwriters, and brokers. Ensure the compliance with the rules and regulations governing the market. Functions as financial intermediaries: Financial intermediation is a process by which capital is mobilised from a large number of investors and is made available to all those who need them, mainly to corporate customers. Merchant banking is a financial intermediary which helps to transfer capital from one who owns it to those who require it. Merchant banks invest their capital in client companies and provide fee-based services for mergers and acquisitions. Many companies approach merchant banks to enhance their financial stability or to meet an essential capital requirement. Due to their knowledge in international finances, merchant banks specialise in dealing with multinational corporations. Merchant banks do not offer regular banking services to the public.
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Q2. Describe the issuance process of depository receipts. Answer: The Issuance Process of Depository Receipts A Depositary Receipt (DR) which is traded on a local stock exchange is a type of transferable financial security. It represents a security, usually in the form of equity that is issued by a foreign publicly listed company. The DR, which is a physical certificate, permits investors to hold shares in equity of other countries. Issue of Indian Depository Receipts (IDRs) As per the definition given in the Companies (Issue of IDRs) Rules, 2004, IDR is an instrument in the form of a depository receipt created by the Indian depository in India against the underlying equity shares of the issuing company. In an IDR, foreign companies would issue shares, to an Indian depository, which would in turn issue depository receipts to investors in India. The actual shares underlying the IDRs would be held by an overseas custodian, which shall authorise the Indian depository to issue the IDRs. The IDRs have the following features:
Capital requirement - The foreign company must have paid up capital and
free reserve of at least USD 100 million, in order to issue IDR. Sales turnover of companies - There must be an average turnover of USD 500 million for previous three years. Profits or dividend Company must have made profits in the previous five years and must have confirmed dividend of at least 10 percent for each of the previous year. Debt equity ratio The pre-issue debt equity ratio must not be more than 2:1. Level of issue The issue during a particular year must not go beyond 15 percent of the paid up capital plus free reserves and the size of issue must not be less than Rs. 500 million. Redemption The IDRs will not be redeemable into original equity shares before one year from the date of issue. Valuation The IDRs will be valued in Indian rupees, irrespective of the value of original shares. Profit In addition to other opportunities, IDR will be an extra investment opportunity to Indian investors for overseas investment.
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Q3. Explain the operational guidelines that need to be followed by a merchant banker. Answer: The following are the operational guidelines that need to be followed by a merchant banker: Submission of draft and final offer document First, the lead merchant banker files the offer documents of size up to Rs. 50 crores with the regional office of SEBI under the jurisdiction of the registered office of the issuer company. Then the lead merchant banker or stock exchange makes the draft offer document available to the public. The lead merchant banker makes ten copies of the draft offer document available to the Board, and 25 copies to the stock exchange(s), where the issue is proposed to be listed. Within three days of filing the offer document with registrar of companies or the stock exchange(s), the lead merchant bankers submits two copies of the final printed copy of the offer document to dealing offices of the Board and one final printed copy to the primary market department, SEBI, and head office. The lead merchant banker also submits a computer floppy containing the final prospectus or letter of offer to the primary market department, SEBI, and head office within three days of filing the final prospectus or letter of offer with the registrar of companies or concerned Stock Exchange. While offer documents are filed with any department or office of the Board, the details like registration number, date of registration or renewal of registration, details of any enquiry or investigation conducted by SEBI at any time, penalty imposed by stock exchange, and the date of expiry of registration will be given by the lead merchant banker in the forwarding letters. Instructions on post-issue obligations The merchant banker ensures compliance with the following post-issue obligations:
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days from the due dates either by registered post or delivers it at respective regional offices or head office. The lead merchant banker sends a copy of the report to the Boards head office, Mumbai stating the location where the regional office of the Board has dealt with the offer document. During the intervening period of the reports, the lead merchant banker informs the Board regarding important developments about the particular issues handled by them. Issue of No Objection Certificate (NOC):- The issuer companies deposit 1% of the amount of securities offered to the public and/or to the holders of the existing securities of the company with the regional stock exchange based on the listing agreement of the stock exchanges. The deposit amount can be released by the concerned stock exchange only after obtaining an NOC from the board. The issuer company to the board submits an application for NOC in the required format. Registration and renewal of registration of Merchant Bankers Merchant bankers make the application for renewal of certificate of registration as per Regulation 9 of SEBI. The renewal application for the certificate of registering as a merchant banker provides a statement that highlights the changes in the information submitted to the Board in an earlier registration. The earlier registration is accompanied by a declaration that there will not be any further changes in the statement. Registration with Association of Merchant Bankers of India (AMBI) The registered merchant bankers will inform the board of members of their registration with AMBI, accompanied by relevant details. Issue of penalty points The board can penalise the merchant banker if there is any violation regarding the provisions of operational guidelines. The merchant banker who is penalised by giving four or more penalty points cannot file any offer document or manage any issue for a certain periods of time.
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Q4. Explain the basic features of securities lending and borrowing scheme. Answer: The following are the basic features of securities lending and borrowing scheme: To provide necessary momentum to short sell, a scheme for Securities Lending and Borrowing (SLB) was introduced. With the introduction of short selling by institutional investors, a full-fledged security lending and borrowing scheme was introduced.
Eligibility Under the Securities Lending Scheme (SLS), 1997 the securities
transacted in F&O segment are authorised for lending and borrowing. The scheme is open for all market members in the Indian securities market. Operation The scheme is operated on an order-matching, screen based, automated platform, provided by the Approved Intermediaries (AIs). This platform is independent of other trading platforms. Participation The scheme permits participation by all sections of investor. This included retail, institutional and so on. The AIs sets up the platform for lending and borrowing which is accessed by the borrowers and lenders through the clearing members (CMs), banks and custodians who are authorised by the AIs. For the authorisation of AIs, the AIs, CMs and the clients enter into an agreement. This agreement specifies the rights, obligations and responsibilities of the parties to the agreement. Agreement The agreement consists of the basic conditions for lending and borrowing of securities that is recommended in the scheme. The AIs also include appropriate conditions in the agreement for proper execution, settlement of lending and borrowing transactions and risk management. The roles of the AIs, CMs and the clients are given in the agreement between the AIs, CMs and clients. The first part of the agreement is between the AIs and the CMs .The second part of the agreement is between the CMs and the clients. Identification The AIs allocates unique identification (ID) to each client which is mapped to the Permanent Account Number (PAN) of the clients. The AIs ensures that a client does not obtain multiple client IDs by placing systematic safeguards. Tenure The tenure of lending and borrowing is fixed as standardised contracts. Settlement The settlement of the lending and borrowing transactions is independent of normal market settlement. The settlement cycle for the scheme is based on T+1. The abbreviation T+1 denote the settlement date of security transaction date plus one day. The netting of transactions at any level is not permitted as settlement of the lending and borrowing transactions is done on a gross basis at the level of the clients. Risk management systems The AIs frame suitable risk management systems to provide guaranteed delivery of securities to the borrower and return of securities to the lender. The AIs conducts an auction for obtaining securities if the lender or borrower fails to return securities to the AI. Position limits AIs in consultation with SEBI decides the position limits at the level of market, CM and client.
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Q5. Discuss the difference between asset and fee based financial services. Answer: The difference between asset and fee based financial services:Asset or fund based Asset based financial services facilitate corporate and other business entities to mobilise resources at lower rates and open up investment opportunities with enhanced returns. These services enable the corporate institutions, in particular, to reject the traditional bank finance and opt for the more competitive financial market. The debt market enables a borrower to organise his borrowings and structure the repayments to match future cash flows. The investment options have widened significantly to enable the corporate entities to use their surplus cash in short-term maturities and increase the revenue. The agreement to asset based securities is facilitated by financial intermediaries through fee based services. The asset based financial service has emerged as an important supplementary source of finance in the industry. The following are some of the asset based financial services:
Fee based or advisory Fee based financial services are not used to create assets or liabilities. These financial services facilitate certain financial functions such as managing capital issues, making arrangements for the placement of capital and debt instruments, and arrangement of funds from financial institutions. They also undertake the responsibility of getting all government and other clearances. In addition, this sector
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does a large number of other services like rendering project advisory services, plan mergers and acquisitions, and guiding in capital restructuring to their clients. In fee based services, the intermediaries charge fees for their financial services, like merchant banking services, assisting in mergers, stock broking and so on. The following are some of the fee based financial services:
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Q6. Describe accounting and reporting for operating lease in detail. Answer: Operating lease Lessors present assets under operating leases in their balance sheets based on the nature of the asset. The depreciation policy for depreciable leased assets will be consistent with the lessors normal depreciation policy for related assets, and depreciation is calculated in accordance with International Accounting Standard (IAS 16 and IAS 38). Lease income from operating leases is identified in income on a straight-line basis over the lease term, unless another organised basis is more representative of the pattern in which user benefit derived from the leased asset is reduced. Accounting and reporting for operating lease Let us examine the operating lease in the financial statements of lessees. The entire payment is charged to the profit and loss account. IAS 17 requires the rental to be charged on a depreciation basis over the lease term, if the payments are not made on such a basis. If the term of the lease requires a heavy initial payment, a percentage of the payment can be treated as prepaid expense. Since the lessee will not consider the risk of ownership, the lease expenditure is treated as an operating expense in the income statement; the lease does not affect the balance sheet. The operating lease will not show up as part of the capital of the firm. A lease agreement allows the use of an asset, but does not convey rights similar to ownership of the asset. The accounting treatment for an operating lease is simple for both the lessor and the lessee. The lessee has acquired an operating expense, so the lease rental to be paid is written off in the profit and loss account. The lessee will have to disclose in the notes to the accounts the total amount charged in the year and the total amount of the payments to which the entity is committed at the year end. The lessor has made revenue from renting out the asset and consequently recognises the lease rental receivable as income in the profit and loss account.
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