UNIT-3

MERCHANT BANKING
INTRODUCTION:
Merchant banking in India is of recent origin. It has its beginning in India in 1967,
when Grindlays Bank established a division, followed by Citibank in 1970 (it has now ceased
to provide merchant banking services) and State Bank of India in 1972. Later on, the ICICI
set up its merchant banking division followed by a few other banks like Syndicate Bank,
Bank of India, Bank of Baroda, Chartered Bank, Mercantile Bank etc. Some leading brokers
have also entered the field.
The merchant banks, as they have developed in our country, could be broadly
classified into three categories. The first category comprises the divisions of commercial
banks. The second category consists of national and state level financial corporations like
ICICI and SICOM. 'The third category includes leading broker firms who have extended their
activities into merchant banking like H. L. Consultancy & Management Services,
Champaklal Investments and Financial Consultancy Company (CIFCO), J.M. Financial and
Investment Consultancy Services, DSP Financial Consultancy etc. A closer look at the work
of these merchant banks indicates that the whole gamut of merchant banking activities is
hardly covered by any of these agencies. They operate more like issue houses than fullfledged merchant banks. For many of these merchant banking firms, there was an extension
of broking services rendered earlier.
MEANING AND DEFINITION OF MERCHANT BANKING
Merchant banks are issue houses. They render many services to industrial projects or
corporate units such as floatation of new ventures and new companies, preparation, planning
and execution of new projects, consultancy and advice in technical, financial, managerial and
organisational fields. They also perform a number of other functions such as restructuring,
revaluation of assets, mergers, takeovers, acquisitions etc.
Merchant bankers play a significant role as a catalyst to convert the project ideas into
industrial ventures. They help in the promotion of the enterprise by undertaking various
activities like market surveys, choice of suitable location and its size, preparation of
documents and obtaining consent from various authorities. They also help in taking important
decisions regarding financing mix, management of public issues, credit syndication etc. 'The
success of the merchant bankers depends on the quality of service and soundness of advice to
clients.
DEFINITION
Merchant bank may be defined as "a kind of financial institution that provide a variety
of services, including investment, banking, management of customer's securities, portfolios,
insurance, acceptance of bills, etc".
As per the Securities and Exchange Board of India (Merchant Bankers) Rules, 1992,
"Merchant Bankers" means "any person who is engaged in the business of issue management
either by making arrangements regarding selling, buying or subscribing to securities as

manager, consultant, adviser or rendering corporate advisory services in relation to such issue
management".
To sum up, merchant bankers may be referred to an "intermediary who provides
various financial services, other than lending money, such as managing public issues,
underwriting new issues, arranging loan syndications and giving advice on portfolio
management, financial restructuring, mergers and acquisitions.

According to SEBI, a merchant banker is one who is engaged in the business of issue
management either by making arrangements regarding selling, buying or subscribing
to the securities as manager, advisor or rendering corporate advisory services in
relation to such issue management.
Investment Banking Vs Merchant Banking

The term merchant banking and investment banking are often used interchangeable
in the financial literature. However, we can make out a subtle distinction between
these two. The term Investment Banking has the US origin whereas the term
merchant banking is in vogue in countries such as the UK and India.
The following list shows the selected investment banks, both domestic and global:
Domestic

Global

ICICI Securities
Kotak Mahindra Capital Company
Enam Financials
Karvy Investor Services
SBI Capital Markets
DSP Merill Lynch
Keynore Corporate Services
ABN Amro

Goldman Sachs
Morgan Stanley
JP Morgan Chase
Rothschild
HSBC
Credit Suisse
Blackstone
UBS
Deutsche Bank
City Group
Barclays

INSTITUTIONAL STRUCTURE

In tracing the history of the merchant banking in India, the structure of merchant
bankers appeared as follows at one point of time:
1. Merchant banking divisions of commercial banks, both Indian and Foreign.
2. Merchant banking divisions of financial institutions (e.g. IDBI, IFCI, etc.)
3. Merchant banking companies promoted by stock broking firms. (e.g. JM
Financial, DSP)
4. Merchant banking services of NBFCs
However, the above structure has undergone a transformation now. The merchant
banking divisions of the commercial banks exist now as independent subsidiary
companies of the parent firms. For example, the SBI Capital Markets Ltd is the
subsidiary of SBI. The merchant banking activities of the NBFCs almost cease to
exist.

SERVICES OF MERCHANT BANKS

Merchant banks generally offer the following services:
1. Conduct Pre-investment Studies: Merchant banks conduct pre-investment studies for
the purpose of investors. These are in the nature of financial feasibility explorations in
selected areas of interest of the client.
2. Working out Package for Project Funding: They assist in working out a comprehensive
package for tale project funding and pattern of financing is available from the merchant
banks. They work in close liaison with the client, his technical consultants, and the funding
institutions. They prepare and submit complete financial dossiers, and arrange for the
various sources of finance. They also assist

in

legal documentation for the finance arranged.

3. Financial Structuring and Syndication: They render advice on the financial

'structuring of these projects as well as assist in syndication of the finance itself.
4. Arrangement of Lease Financing etc.: Some of the larger banks are also involved in
areas such as the arrangement of lease finance, and assistance in acquisitions and mergers
etc.
5. Provide Counselling Services: Merchant banks provide counsel on capital and capital
structure, the form of capital to be raised, preparing the terms and conditions of issue,
underwriting, preparation of the prospectus etc. They provide the services of financial and
non-financial nature, and a host of related services.
6. Management of Issue: The public visibility of merchant banking has been largely
confined to management of issue of corporate securities by newly floated companies,
existing companies, and foreign companies for complying with the provisions of FEMA. The
types of services under this head include obtaining consent/acknowledgement from SERI
for issue of capital, preparation of prospectus, tying up arrangement of underwriting,
appointment of brokers and bankers to the issues, press publicity, compliance of stock
exchange listing requirements etc.
7. Prepare Project Files etc.: Merchant banks undertake preparation of project files, loan
application for financial assistance on behalf of promoters from various financial
institutions for term loan, working capital finance from commercial banks for new projects
etc. Merchant bankers also arrange finance for the projects abroad.
8. Guide Promoters: Merchant banks guide promoters in the matter of rules, regulations,
capital goods clearance, import clearance etc.
9. Help in Raising Public Finance: The companies are also helped by merchant banks to
raise finance by way of public finance. In this connection, they provide not only the required
guidance but also act as brokers for the mobilisation of public deposits. Management of new
accounts of deposits is also undertaken.
10. Advise on Investment in Government Securities: It includes advising on investment
in Government securities to trusts, charitable institutions, and companies regarding their
investment in compliance with the provisions of various Acts. Merchant banks have
undertaken purchase and sale of securities and management of individual investment
portfolio of investors.

11. Cost Audit: Merchant banks provide corporate counselling and advisory services on
mergers, acquisition and reorganisation. Some of them also help in taking up cost audit and
recruitment of executives.
12. Issue Management: Management of the public issue of shares/ debentures including
even an offer for sales has been the traditional service rendered by merchant bankers in
India. Under this head, they decide on the size and timing of a publ ic issue in the light of
the market condition. They prepare the base, of successful issue marketing from the initial
documentation, liaison with the Controller of Capital Issues for clearances o1c. to the
preparation of the actual launch of the proposed issue. They perform underwriting services;
appoint bankers and brokers as well as issue houses; manages the issues. They act as an
intermediary with share market functionaries like brokers, portfolio managers and financial
press for pre-selling and media coverage. Prepare draft prospectus and other documents.
Provide coverage throughout the country for collection of applications. Prepare advertising
and promotional material.
13. Provision of Working Capital: Merchant banking is a part of the banking system. So
the client has to be assisted in arranging for' working capital finance especially for the new
ventures. If the requirement of the client is substantially large, then it is desirable to
arrange for the syndication on behalf of the promoters. There has been recent change in
arrangement for the working capital finance by issue of debentures on Rights basis.
Merchant bankers play a great role in helping the clients in the preparation of the
necessary forms for the financial institutions such as LIC, GIC, UTI who are the major
supporters for such issue. He arranges for the trustees for the debentures and also ensures
that the balance portion is tied up with the other bankers.
14. Foreign Currency Loans: The merchant banker also arranges for export credit for
various countries. He also arranges for foreign currency loan like Eurodollar, IFCI loans etc.

15. Portfolio Management for Non-residents: The merchant banker assists in this area by
identifying suitable arrangements of investment suitable to each Non-Resident Indian. Under
this head, a merchant banker performs various functions, which are as follows:
Guides on buying and selling of securities.
Handles the transactions relating to the purchase and sale of securities
Advices on market conditions.
Keeps the documents safely.
Collects of earning such as dividend, interest etc.
Serves as a link between non-residents and Reserve Bank of India for obtaining
necessary permission.
16. Marketing: It is also a very important function, which the merchant banker has to take
into account since he has to create the business for himself. He also has to have a close
association with his own clients, understand their future expansion/modernization programs
and advise them the way in which these programs are to be carried out. His imagination and
expertise play a great role in this area.

Corporate Counseling: Corporate counseling is the beginning of the merchant banking

services. Every industrial unit either new or existing needs it. The scope of corporate
counseling is very vast. It covers a wide range of merchant banking activities and
includes the services such as project counseling, project management, loan
syndication, working capital management, capital re-structuring, public issue
management, fixed deposit, lease financing, etc.
Project Counseling: Project counseling has originated from corporate counseling. It

relates to project finance and includes preparation of project reports, cost of the
project and also arranging the financing pattern. The projects are appraised on the
basis of the location, marketing and technical and financial viability of the project.
QUALITIES OF A SUCCESSFUL MERCHANT BANKER
The qualities, which a successful merchant banker should possess, are given below:
1. Analysing Ability: Merchant banker should have the ability to analyse various aspects
such as technical, financial and economic aspects concerning the formation of an industrial
project.

2. Knowledge about Various Aspects: Knowledge about the various aspects of capital
markets, trends in stock exchange, psychology of investing public, change in the economic,
political and technological environment in the country is another quality which a merchant
banker

3. Ability to build up Relationship: Ability to build up the bank client relationship and live
up to the clients expectations with total involvement in the project assigned to them is another
quality that a merchant banker is expected to possess.
4. Innovative Approach: Innovative approach in developing capital market instruments to
satisfy the ever changing needs of investing public is another requisite for a successful
merchant banker.
5. Integrity and High Professional Standards: Integrity and maintenance of high
professional standards are the essential requisites for the success of merchant bankers present
scenario?
SIGNIFICANCE OF MERCHANT BANKING.
The following are the objective of merchant banking:
The merchant banker performs an objective of translating project ideas I to industrial
venture.
Merchant banker helps particularly the small entrepreneurs in overcoming the
complex problems of promotion of an enterprise.
The merchant banking as specialized institutions, they are capable of reducing the
time taken for organizing new issues as well cost of raising capital.

 Cost of floating of equity and preference capital is higher for new companies when
compared to existing companies, the banks help in saving the cost of new companies
and small companies.
The merchant banker renders, professional guidance regarding capital mix,
management of public issue, credit syndication, investment counseling.
Merchant banker also plays an important role in rehabilitation when he guides the
management at the time of acquisition, merger, take over or amalgamation.
It also advice and give guidance in regarding foreign trade financing and guides nonresident Indians looking for investment opportunities in India.

OBJECTIVES OF MERCHANT BANKERS:

The following are the objective of merchant banking:
i. Corporate Counseling:
Merchant Bankers provide counseling services to companies with regard to their
timing of issues of shares. Capital structure and other promotional aspect with regard to the
company.
ii. Project Counseling:
Here, the new entrepreneur is helped in the conception of idea, identifying various
projects, preparation of projects, feasibility reports, location of factory, obtaining funds,
sanctions approvals from state and central Government departments.
iii. Capital Structure:
Here, the amount of capital Required rising of the capital, debt-Equity Ratio, issue of
shares and debentures, working capital, fixed capital requirements etc., are worked out.
iv. Portfolio Management:
In portfolio management, the merchant banker helps the investor in matters pertaining
to investment decisions; taxation and inflation are taken into account while advising on
investment in different securities. The merchant banker also undertakes the function of
buying and selling of securities on behalf of their client companies.
v. Issue Management:
Obtaining clearances, drafting of prospectus underwriting, liaising with brokers and
bankers and keeping constant communications with investors.
vi. Credit indication:
When the funds required are more, different financial institutions are combined for
contributing working capital and fixed capital requirements. The credit worthiness of the
borrower is more represented by the merchant banker to the various members of the credit
syndication. It is also called consortium finance.
vii. Working capital:
Concerns are given working capital finance depending upon their earning capacity in
relation to the interest rate prevailing in the market.
viii. Venture Capital:

Venture capital is a kind of finance wherein a new venture proposed by an

entrepreneur is financed. Venture capital carries more risks and hence very few financial
institutions come forward to finance. As the risk involved is more, the technical competency
of the entrepreneur is an important condition for the venture capital finance.
ix. Lease Finance:
The leasing companies are provided finance for procuring on different assets which
are required by different companies. It is a form of finance employed to acquire use of asset.
x. Fixed Deposit:
Merchant banks will enable companies to raise finance by way of fixed deposits from
the public. The companies will have to fulfill credit rating requirements which the merchant
banker helps the borrowing company to fulfill the required conditions.
LEGAL AND REGULATORY FRAMEWORK

An application should be submitted to SEBI in Form A of the SEBI (Merchant

Bankers) Regulations, 1992. SEBI shall consider the application and on being
satisfied issue a certificate of registration in Form B of the SEBI (Merchant Bankers)
Regulations, 1992.
The registration fee payable to SEBI is Rs.5 lakhs which should be paid within 15
days of date of receipt of intimation regarding grant of certificate. The validity period
of certificate of registration is Three years from the date of issue.
Renewal, three months before the expiry period, an application should be submitted to
SEBI in Form A of the SEBI (Merchant Bankers) Regulations, 1992. SEBI shall
consider the application and on being satisfied renew certificate of registration for a
further period of 3 years. The renewal fee payable to SEBI is Rs.2.5 lakhs which
should be paid within 15 days of date of receipt of intimation regarding renewal of
certificate. The person whose registration is not current shall not carry on the activity
as merchant banker from the date of expiry of validity period.
Categories of Merchant Bankers

Originally, as per SEBI regulations, merchant bankers were required to get

authorization to act as an issue manager, underwriter or advisor. This authorization
was granted by SEBI based on the net worth limits, professional competence,
experience in the business, general reputation and the past performance record.
The categories for which registration may be granted are given below:
Category I To carry on the activity of issue management and to act as
adviser, consultant, manager, underwriter, portfolio manager.
Category II To act as adviser, consultant, co-manager, underwriter,
portfolio manager.
Category III To act as underwriter, adviser or consultant to an issue
Category IV To act only as adviser or consultant to an issue
Accordingly, four categories of merchant bankers should full fill the capital
requirement as under:
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Category I
Category II
Category III
Category IV

Capital adequacy of Rs.5 crores

Capital adequacy of Rs.50 lakhs
Capital adequacy of Rs.20 lakhs
No capital adequacy requirement

The functions rendered by these four categories were also stipulated by SEBI.
Category I merchant banker could act as an issue manager, underwriter, advisor,
consultant and portfolio manager. Although the advisory or consultancy function
could be performed by all the four categories, it will not possible for Categories III
and IV merchant bankers to act as an issue manager or portfolio manager.
SEBI GUIDELINES
The SEBI Act, 1992 established SEBI as market regulator with all statutory powers.

SEBI was established with the objective of protecting the interest of investors and for
regulation and development of securities market in India. It has the powers to
regulate all the market intermediaries. The SEBI grants registration to the market
intermediaries and has powers to inspect, monitor and take penal actions on them in
case of violations of any provisions of the Act or rules, Issues of securities, stock
exchanges and other market intermediaries are subject to regulatory power of SEBI.
Merchant banking in India is governed by SEBI (Merchant Bankers) Regulations
1992. It provides for registration of merchant bankers, general obligations and
responsibilities of merchant bankers, procedures for inspection and procedures for
action in case of defaults. Besides these, the code of conduct for merchant bankers is
also specified. To become a merchant banker the following are the pre-requisites:
The applicant must be corporate body.
The applicant should not carry on a business other than the securities market
business.
He should have the necessary infrastructure in terms of office space and
experienced man-power.
The associate company or the group company should not have been a
registered merchant banker.
The applicant should not have been involved in security scams.
The minimum net worth of the applicant firm should be Rs.50million
Obligations and Responsibilities of Merchant Bankers

In the conduct of his business, a merchant banker is supposed to observe certain codes
of conduct. SEBI has issued some guidelines for regulating the merchant banking
activities and the code of conduct for the merchant banks is specified in the Schedule
III of the SEBI (Merchant Bankers) Regulations 1992.

1. High standards:
2. Due diligence:
3. Dealing with competing merchant bankers:

4.
5.
6.
7.
8.
9.

No tall claims:
Cost-effective service:
Confidentially:
Disclosure of information:
Avoid market manipulative practices:
Restrain on advisory role:

All public issues shall be managed by a merchant banker who acts as the lead
merchant banker or the lead manager to the issue. The number of such lead managers
is linked to the size of the public issue as given below. The regulations of SEBI
specify certain responsibilities of the lead merchant banker. In a public issue, the
responsibilities relate to the disclosure of information in the offer documents,
allotment of securities and refund of application money.
Size of Public Issue and Number of Lead Managers
Issue Size
No.of Lead Managers
Less than Rs.50 crores
2
Rs.50 100 crores
3
Rs.100 200 crores
4
Rs.200 400 crores
5
Above 400 crores
5 or more
SEBI has pronounced the following guidelines for Merchant Bankers:

1. Submission of Offer Document:

2. Dispatch of issue material
3. Underwriting:
4. Compliance Obligations:
5) Redressed of investor grievances:
6) The concerned lead merchant banker
7) Issue of No objection Certificate (NOC):
8) Registration of Merchant Bankers:
9) Renewal of Registration:
10) Impositions of Penalty Points:
ROLE OF MERCHANT BANKING IN APPRAISAL OF PROJECTS

Merchant Banking, as a commercial activity, took shape in India through the

management of Public Issues of capital and Loan Syndication. It was originated in
1969 with the setting up of the Merchant Banking Division by ANZ Grind lays Bank.
The main service offered at that time to the corporate enterprises by the merchant
banks included the management of public issues and some aspects of financial
consultancy.
The early and mid-seventies witnessed a boom in the growth of merchant banking
organizations in the country with various commercial banks, financial institutions, and
brokers firms entering into the field of merchant banking. Reform measures were
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initiated in the capital market from 1992, starting with the conferring of statutory
powers on the Securities and Exchange Board of India (SEBI) and the repeal of
Capital Issues Control Act and the abolition of the office of the Controller of Capital
Issues.
Merchant Bankers and Capital Issues Management

Merchant Banker has been defined under the Securities & Exchange Board of India
(Merchant Bankers) Rules, 1992 as any person who is engaged in the business of issue
management either by making arrangements regarding selling, buying or subscribing
to securities as manager, consultant, advisor or rendering corporate advisory service in
relation to such issue management.
The capital issue management comprises of the effective management of market
related factors. They are:
Transition to rolling settlement on the equity market
Impact on different classes of market users
Obtaining a liquid bond market
Impact of reforms of 1990s
Law and taxation
Taxation of capital
Legal reforms
Political economy of financial sector reforms
Market design, market inefficiencies, and trading profits
Issue Management

The management of issues for raising funds through various types of instruments by
companies is known as issue management. The function of capital issues management
in India is carried out by merchant bankers. The Merchant Bankers have the requisite
skill and competence to carry out capital issues management. The funds are raised by
companies to finance new projects, expansion / modernization/ diversification of
existing units etc.
The definition of merchant banker as contained in SEBI (Merchant Banker) Rules and
Regulations, 1992 clearly brings out the significance of Issue Management as, Any
person who is engaged in the business of issue management either by making
arrangement regarding selling, buying or subscribing to securities as manager,
consultant, advisor or rendering corporate advisory services in relation to such issue
management.
Merchants of Public Issue Management

Classification of Securities Issue

Public Issue
Right Issue
Private Placement
Merchant Bankers Functions

The different functions of merchant bankers towards the capital issues management

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are as follows:
1) Designing Capital Structure
2) Capital Market Instruments
3) Issue Pricing
4) Book Building
5) Preparation of Prospectus
6) Selection of Bankers
7) Advertising Consultants
8) Role of Registrar
9) Bankers to the Issue
10)Underwriters to the Issue
11)Brokers to the Issue
DESIGNING CAPITAL STRUCTURE

The term capital structure refers to the proportionate claims of debt and equity in the
total long-term capitalization of a company.
According to Weston and Brigham, Capital structure is the permanent financing of
the firm, represented primarily by long-term-debt, preferred stock and common equity,
but excluding all short-term credit. Common equity includes common stock, capital
surplus and accumulated retained earnings.
Decisions on Capital Structure: The decisions regarding the use of different types of
capital funds in the overall long term capitalization of a firm are known as capital
structure decisions. Any decisions on Capital Structure are based on different
principles.
a) Cost Principle
b) Control Principle
c) Return Principle
d) Flexibility Principle
e) Timing Principle
Factors affecting Capital Structure Decisions: The major developments taking place in

the economy affect the capital structure of firms. In order words, the way the economy
of a country is managed determines the way the capital structure of a firm will be
determined. Factors that are active in the economy are:
1. Business Activity:
2. Stock Market:
3. Taxation:
4. Regulations:
5. Credit Policy:
6. Financial Institutions:
CAPITAL MARKET INSTRUMENTS

11

Financial instruments that are used for raising capital resources in the capital market
are known as Capital Market Instruments. The changes that are sweeping across the
Indian capital market especially in the recent past are something phenomenal. It has
been experiencing metamorphic in the last decade, thanks to a host of measures of
liberalization, globalization, and privatization that have been initiated by the
Government. Pronounced changes have occurred in the realm of industrial policy such
as Licensing policy, Financial services, Interest rates, etc. The competition has become
very intense and real in both industrial sector and financial services industry. As a
result of these changes, the financial services industry has come to introduce a number
of instruments with a view to facilitate borrowing and lending of money in the capital
market by the participants.
Types of Capital Market Instruments: The various capital market instruments used by

corporate entities for raising resources are as follows:

1. Equity Shares
2. Non-voting Equity shares
3. Preference Shares
4. Cumulative Convertible Preference Shares
5. Company Fixed Deposits
6. Warrants
7. Debentures and Bonds
Equity Shares: Equity shares, also known as ordinary shares are the shares held by the
owners of a corporate entity. Since equity shareholders face greater risks and have no
specified preferential rights, they are given larger share in profits through higher
dividends than those given to preference shareholders, provided the companys
performance is excellent.
Non-voting Equity Shares: Consequent to the recommendations of the Abid Hussain

Committee and subsequent to the amendment to the Companies Act, corporate

managements are permitted to mobilize additional capital without diluting the interest
of existing shareholders with the help of a new instrument called non-voting equity
shares. Such shares will be entitled to all the benefits except the right to vote in
general meetings.
Preference Shares: Shares that carry preferential rights in comparison with ordinary

shares are called Preference Shares. The preferential rights are the rights regarding
payment of dividend and the distribution of the assets of the company in the event of
its winding up, in preference to equity shares.
Types of Preference Shares

o
o
o
o
o
o

Cumulative preference shares:

Non-cumulative preference shares:
Participating preference shares:
Redeemable preference shares:
Fully convertible cumulative preference shares:
Preference shares with warrants attached:
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Company Fixed Deposits: Fixed deposits are the attractive source of short-term capital

both for the companies and investors as well. Corporate favour fixed deposits as an
ideal form of working capital mobilization without going through the process of
mortgaging assets. Investors find fixed deposits a simple avenue for investment in
popular companies at attractively reasonable and safe interest rates.
Warrants: An option issued by a company whereby the buyer is granted the right to

purchase a number of shares of its equity share capital at a given exercise price during
a given period is called a warrant. Although trading in warrants are in vogue in the
U.S. Stock markets for more than 6 to 7 decades, they are being issued to meet a range
of financial requirements by the Indian corporate.
Debentures and Bonds: A document that either creates a debt or acknowledges it is

known as a debenture. Accordingly, any document that fulfills either of these

conditions is a debenture. A debenture, issued under the common seal of the company,
usually takes the form of a certificate that acknowledges indebtedness of the company.
A document that shows on the face of it that a company has borrowed a sum of money
from the holder thereof upon certain terms and conditions is called a debenture.
Kinds of Debentures: Innovative debt instruments that are issued by the public limited
companies are described below:
1. Participating Debentures
2. Convertible Debentures
3. Debt-equity Swaps
4. Zero-coupon Convertible Notes
5. Secured Premium Notes (SPN) with detachable Warrants
6. Non-Convertible Debentures (NCDs) with detachable Equity Warrant
7. Zero-interest Fully Convertible Debentures (FCDs)
8. Secured Zero-interest Partly Convertible Debentures (PCDs) with detachable
and separately tradable warrants
9. Fully Convertible Debentures (FCDs) with interest (optional)
10. Floating Rate Bonds (FRB)

ISSUE PRICING

A listed company can freely price equity shares/convertible securities through public/
rights issues. An unlisted company eligible to make a public issue and desirous of
getting its securities listed on a recognized stock exchange can also freely price shares
and convertible securities. The free pricing of equity shares by an infrastructure
company 8is subject to the compliance with disclosure norms as specified by the SEBI
from time to time. While freely pricing their initial public issue of share/convertibles,
all banks require approval by the Reserve Bank of India (RBI).
Differential Pricing: Listed/unlisted companies may issue shares/convertible securities
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to applicants in the firm allotment category (i.e. Allotment on a firm basis made to
Indian and multilateral development finance institutions, Indian mutual funds, foreign
institutional investors including non-resident Indians/overseas corporate bodies and
permanent/regular employees of the issuing company) at a price different from the
price at which the net offer to the public (i.e. the Indian public, excluding firm
allotments/reservations/ promoters contribution) is made, provided the price at which
the security is offered to the applicants in firm allotment category is higher than the
price at which securities are offered to the public.
Price Band: The issuer/issuing companies can mention a price band of 20 percent (cap

in the price band should not exceed 20 percent of the floor price) in the offer
document filed with the SEBI and the actual price can be determined at a later date
before filing it with the ROCs (Registrar of Companies). If the Board of Directors
(BOD) of the issuing company has been authorized to determine the offer price within
a specified price band, a resolution would have to be passed by them to determine
such a price.
Payments of Discounts/Commissions: Any direct/indirect payment in the nature of

discount/commission/allowance or otherwise cannot be made by the issuer

company/promoters to any firm allotted in a public issue.
Denomination of Shares: Public/rights issue of equity shares can be made in any
denomination in accordance with Section 13(4) of the Companies Act and in
compliance with norms specified by the SEBI from time to time. The companies that
have already issued shares in the denominations of Rs.10 or Rs.100 may change their
standard denomination by splitting/consolidating them.
BOOK BUILDING

A method of marketing the shares of a company whereby the quantum and the price of
the securities to be issued will be decided on the basis of the bids received from the
prospective shareholders by the lead merchant bankers is known as Book-Building
method.
Under the book-building method, share prices are determined on the basis of real
demand for the shares at various price levels in the market. For discovering the price
at which issue should be made, bids are invited from prospective investors from which
the demand at various price levels is noted. The merchant bankers undertake full
responsibility for the same.
The option of book-building is available to all body corporate, which are otherwise
eligible to make an issue of capital to the public. The initial minimum size of issue
through book-building route was fixed at Rs.100 Crores. However, beginning from
December 9, 1996 issues of any size will be allowed through the book-building route.
Book-building facility is available as an alternative to firm allotment.
Accordingly, a company can opt for book-building route for the sale of shares to the
extent of the percentage of the issue that can be reserved for firm allotment as per the
prevailing SEBI guidelines. It is therefore possible either to reserve securities for firm
allotment or issue them through the book-building process.
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The book-building process involves the following steps:

1) Appointment of Book-Runners
2) Drafting Prospectus
3) Circulating Draft Prospectus
4) Maintaining Offer Records
5) Intimation about Aggregate Orders
6) Bid Analysis
7) Mandatory Underwriting
8) Filling with ROC
9) Bank Accounts
10)
Collection of Completed Applications
11)Allotment of Securities
12)
Payment Schedule and Listing
13)
Under-subscription
Advantages of Book Building: Book-building process is of immense use in the
following ways:
a. Reduction in the duration between allotment and listing
b. Reliable allotment procedure
c. Quick listing in stock exchanges possible
d. No price manipulation as the price is determined on the basis of the bids
received
UNDERWRITERS
Another important intermediary in the new issue/primary market is the underwriters to
issues of capital who agree to take up securities which are not fully subscribed. They
make a commitment to get the issue subscribed either by others or by themselves.
Though underwriting is not mandatory after April 1995, its organization is an
important element of the primary market. Underwriters are appointed by the issuing
companies in consultation with the lead managers/merchant bankers to the issues. A
statement to the effect that in the opinion of the lead manager, the underwriters assets
are adequate to meet their obligation should be incorporated in the prospectus.
Registration: To act as underwriter, a certificate of registration must be obtained from

the SEBI. In granting the certificate of registration, the SEBI considers all matters
relevant/relating to the underwriting and in particular.
Fee: Underwriters, had to, for grant or renewal of registration, pay a fee to the SEBI

from the date of initial grant of certificate, Rs. 2 lakhs for the first and second years
and Rs.1 lakh for the third year. A fee of Rs.20,000 was payable every year to keep the
certificate in force or for its renewal. Since 1999, the registration fee has been raised
to Rs.5 lakhs. To keep the registration in force, renewal fee of Rs.2 lakhs every three
years from the fourth year from the date of initial registration is payable. Failure to
pay the fee would result in the suspension of the certificate of registration.
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Agreement with Clients: Every underwriter has to enter into an agreement with the

issuing company. The agreement, among others, provides for the period during which
the agreement is in force, the amount of underwriting obligations, the period within
which the underwriter has to be subscribe to the issue after being intimated by/on
behalf of the issuer, the amount of commission/brokerage, and details of
arrangements, if any, made by the underwriter for fulfilling the underwriting
obligations.
Inspection and Disciplinary Proceedings: The framework of the SEBIs right to

undertake the inspection of the books of accounts, other records and documents of the
underwriters, the procedure for inspection and obligations of the underwriters is
broadly on the same pattern as applicable to the lead managers.
SEBIs General Obligations and Responsibilities Code of Conduct for Underwriters:

1) Make all efforts to protect the interests of its clients.

2) Maintain high standards of integrity, dignity and fairness in the conduct of its
business.
3) Ensure that it and its personnel will act in an ethical manner in all its dealings
with a body corporate making an issue of securities (i.e. the issuer).
4) Endeavour to ensure all professional dealings are effected in a prompt, efficient
and effective manner.
5) At all times render high standards of service, exercise due diligence, ensure
proper care and exercise independent professional judgment.
6) Not make any statement, either oral or written, which would misrepresent (a)
the services that the underwriter is capable of performing for its client, or has
rendered to any other issuer company; (b) his underwriting commitment.
7) Avoid conflict of interest and make adequate disclosure of his interest.
8) Put in place a mechanism to resolve any conflict of interest situation that may
arise in the conduct of its business or where any conflict of interest arises,
should take reasonable steps to resolve the same in any equitable manner.
9) Make appropriate disclosure to the client of its possible source or potential in
areas of conflict of duties and interest while acting as underwriter.
10) Not discriminate amongst its clients, save and except on ethical and
commercial considerations.
Action in Case of Default: The liability for action in case of default arising out of

i.
ii.

non-compliance with any conditions subject to which registration was granted.

contravention of any provision of the SEBI Act/rules/regulations, by an
underwriter involves the suspension/cancellation of registration, the effect of
suspension/ cancellation are on the lines followed by the SEBI in case of lead
managers.
PORTFOLIO MANAGEMENT SERVICES

Preserving and growing capital is as hard as earning it. Knowing what one want is as
important as achieving those goals. Assessing ones risk profile and aligning potential
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returns for the risk assumed from various investment options is the crucial task. In
todays fluid environment, that has become a hard task to achieve. As the investors
net worth increases, financial complexity expands exponentially and the investment
needs and options multiply. And equities offer one of the best options for investments.
Mutual funds as an investment vehicle are structured to reduce risks as far as possible,
as they cater to thousands of investors.
Portfolio and Management Services: A list of all those services and facilities that are

provided by a portfolio manager to its clients, relating to the management and

administration of portfolio of securities or the funds of the client, is referred to as
portfolio management services. The term portfolio means the total holdings of
securities belonging to any person.
Portfolio Manager: According to SEBI, Portfolio Manager means any person who

pursuant to a contract or arrangement with a client, advises or directs or undertakes on

behalf of the client (whether as a discretionary portfolio manager or otherwise) the
management or administration of a portfolio of securities or the funds of the client, as
the case may be.
Discretionary Portfolio Manager: According to SEBI, discretionary portfolio manager

means a portfolio manager who exercises or may, under a contract relating to portfolio
management, exercises any degree of discretion as to the investments or management
of the portfolio of securities or the funds of the client, as the case may be.
Objectives of Portfolio Management

Provide long term capital appreciation with lower volatility, compared to the
broad equity markets.
Takes long positions in the cash market and short positions in the index futures
markets.
Invests in the model portfolios thus downside the risk by selling index futures
in the derivatives market.
Functions of Portfolio and Management: The objective of portfolio management is to
develop a portfolio that has a maximum return at whatever level of risk the investor deems
appropriate.
Risk Diversification An essential function of portfolio management is spread risk akin to
investment of assets. Diversification could take place across different securities and across
different industries. Is an effective way of diversifying the risk in an investment. Simple
diversification reduces risk within categories of stocks that all have the same quality rating.
Asset Allocation An important function of portfolio management is asset allocation. It deals
with attaining the operational proportions of investments from asset categories. Portfolio
managers basically aim of stock-bond mix. For this purpose, equally weighted categories of
assets are used.
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Bets Estimation Another important function of a portfolio manager is to make an estimate of

best coefficient. It measurers and ranks the systematic risk of different assets. Best coefficient
is an index of the systematic risk. This is useful in making ultimate selection of securities for
investment by investment by a portfolio manager.
E-Balancing Portfolios Rebalancing of portfolios involves the process of periodically
adjusting the portfolios to maintain the original conditions of the portfolio. The adjustment
may be made either by way of Constant proportion portfolio or by way of Constant best
portfolio. In
Constant proportion portfolio, adjustments are made in such a way as to maintain the relative
weighing in portfolio components according to the change in prices. Under the constant beta
portfolio, adjustments are made to accommodate the values of component betas in the
portfolio.
Strategies A portfolio manager may adopt any of the following strategies an part of an
efficient portfolio management.
Buy and Hold Strategy Under the buy and hold strategy, the portfolio manager builds a
portfolio of stock which is not disturbed at all for a long period of time. This practice is
common in the case of perpetual securities such as common stock.
Indexing Another strategy employed by portfolio managers is indexing. Indexing involves
an attempt to replicate the investment characteristics of a popular measure of the bond
market. Securities that are held in best-known bond indexes are basically high grade issues.
Laddered Portfolio Under the laddered portfolio, bonds are selected in such a way as that
their maturities are spread uniformly over a long period of time. This way a portfolio
manager aims at distributing the funds throughout the yield curve.
Barbell Portfolio Under the laddered portfolio, bonds are selected in such a way as that their
maturities are spread uniformly over a long period of time. This way a portfolio manager
aims at distributing the funds throughout the yield curve can also benefit from lower
transaction costs because of better liquidity.
1SEBI Guidelines
Following are the guidelines pertaining to the issue of bonus shares by a listed
corporate enterprise:
Reservation In respect of FCDs and PCDs, bonus shares must be reserved in
proportion to such convertible part of FCDs and PCDs. The shares so reserved may be issued

18

at the time of conversion(s) of such debentures on the same terms on which the bonus issues
were made.
Reserves The bonus issue shall be made out of free reserves built out of the genuine
profits or share premium collected in cash only. Reserves created by revaluation of fixed
assets are not capitalized.
Dividend mode The declaration of bonus issue, in lieu of dividend, is not made
Fully paid The bonus issue is not made unless the partly paid shares, if any are made
fully paid-up.
1 No default The Company has not defaulted in payment of interest or principal in
respect of fixed deposits and interest on existing debentures or principal on redemption
thereof and has sufficient reason to believe that it has not defaulted in respect of the payment
of statutory dues of the employees such as contribution to provident fund, gratuity, bonus etc.
2 Implementation A company that announces its bonus issue after the approval of
the Board of Directors must implement the proposal within a period of 6 months from the
date of such approval and shall not have the option of changing the decision.
3 The articles The articles of Association of the company shall contain a provision
for capitalization of reserves, etc. If there is no such provision in the Articles, the company
shall pass a resolution at its general body meeting making provisions in the Articles of
Associations for capitalization.
4 Resolution Consequent to the issue of bonus shares if the subscribed and paid-up
capital exceeds the authorized share capital, the company at its general body meeting for
increasing the authorized capital shall pass a resolution.
PRICING OF THE ISSUE Preferential Issue of Shares:
The issue of shares on a preferential basis can be made at a price not less than the higher
of the following:
a. The average of the weekly high and low of the closing prices of the related shares quoted
on the stock exchange during the six months preceding the relevant date (thirty days prior to
the date on which the meeting of general body of shareholders is held in terms of Section
81(1A) of the Companies Act, 1956 to consider the proposed issue) (or)
b. The average of the weekly high and low of the closing prices of the related shares quoted
on a stock exchange (any of the recognized stock exchanges in which the shares are listed and
in which the highest trading volume in respect of the shares of the company has been

19

recorded during the preceding 6 months prior to the relevant date) during the two weeks
preceding the relevant date.
Pricing of Shares arising out of warrants, etc
Where warrants are issued on a preferential basis with an option to apply for and be
allotted shares, the issuer company shall determine the price of the resultant shares. The
relevant date for the above purpose may, at the option of the issuer be either the one referred
to above or a date 30 days prior to the date on which the holder of the warrants becomes
entitled to apply for the said shares. The resolution to be passed in terms of section 81(1A)
shall clearly specify the relevant date on the basis of which price of the resultant shares shall
be calculated. An amount equivalent to at least ten percent of the price fixed in terms of the
above shall become payable for the warrants on the date of their allotment. The amount
referred to above shall be adjusted against the price payable subsequently for acquiring the
shares by exercising an option for the purpose. The amount so referred to above shall be
forfeited if the option to acquire shares is not exercised.
Pricing of shares on conversion:
Where PCDs/FCDs/other convertible instruments, are issued on a preferential basis,
providing for the issuer to allot shares at a future date, the issuer shall determine the price at
which the shares could be allotted in the same manner as specified for pricing of shares
allotted in lieu of warrants as indicated above.
RAISING INTER CORPORATE LOANS AND FIXED DEPOSITS:
Loan syndication - the sources of funds
Loan syndication in the case of domestic borrowings is undertaken with the institutional
lenders and the banks. Amongst institutional lenders , the following institutions are the main
suppliers of long and medium term funds with which the merchant bankers contact liaison
and arrange loans , working for and on behalf of the clients.
A. Some of the All India Financial Institutions include:
i)

Industrial Finance Corporation of India (IFCI)

ii)

Industrial Development Bank of India (IDBI)

iii)

Industrial Credit and Investment Corp. of India (ICICI)

iv)

Industrial Reconstruction Bank of India (IRBI)

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B. State financial institutions like :

i)

state financial Corporations(SFCs)

ii)

State industrial development corporations(SIDCs)

iii)

State Industrial and Investment Corp. (SIICs)

are also approached by the merchant bankers

C. All India level investment institutions also help in the process . They include ;
i)

Life Insurance Corp. of India

ii)

Unit Trust of India

iii)

General Insurance Corp. of India an its subsidiaries.

D. Commercial Banks
Commercial banks join consortium financing with All India financial institutions to provide
medium term loans to industrial projects , otherwise they cater to the needs of working capital
requirements .
Loan Syndication - the instruments
There are several main groups of instruments on offer in the syndicated loan market :
Term loan : This type of loan is fully drawn and is either repaid in full at maturity (bullet
payment) or repayments may start before the final maturity (staged repayment). The borrower
has a right to call all or part of the loan at any time without paying penalty, but it cannot
redraw any part it has canceled.
Revolving credit facility : A revolving credit facility gives the borrower more flexibility
about how much principal can be outstanding during the loans life.
Evergreen facility : A loan that can be extended after pre-set periods. For example, a five
year evergreen loan could be extendible every year for another five years.
Back-stop facility : A back-stop facility protects a company against liquidity crunch; it is a
loan designed to be drawn only as the last resort. Many borrowers regard back-stop as an
insurance policy in case they suffer temporary shortfalls in funds or a failure of one of their
normal funding sources. Most back-stops also include a swingline facility, which gives the
borrowers the "same day money".

21

Loan syndication - the advantages

Cost of funds :
This mode of financing is cheaper than their average cost of funds raised through a series of
bilateral loans. The cost saved increases as the amount required increases.
Maturity Profile :
These facilities have a wide maturity range starting from an year to 20 years.
Diversity of credit risk :
Banks are also prepared to lend to non-investment grade companies, to borrowers not rated
and to borrowers who are starting operations. Another advantage is that the banks will
consider and price a range of credit enhancements, such as security over assets, off-balance
sheet structures, security over property and using offshore vehicles to channel cash flows;
which reduces funding costs for non-investment grade borrowers.
Confidentiality :
Confidentiality of the process can be ensured.
Size :
Funds larger than $1 billion have been raised by syndicated loan market. A case in point is
the Hanbo Steel Company of S.Korea which raised close to $5.8 billion through syndicated
loans to finance its expansion and modernisation.
Speed and certainty :
Once a borrower has mandated a group of banks to underwrite a loan it can be certain that it
will have the funds it requires and on the terms it needs.
Flexibility :
Unlike highly standardised debt markets, banks are willing to price a wide range of
transactions incorporating non-standard cash flow. A borrower can incorporate a variety of
instruments like multi-currency options, risk management techniques and pre-payment of the
loan in advance without paying a fee.
Currency :
Most bank lenders, provide freely convertible currencies while international bank markets
change their positions regularly and are generally reluctant to buy bonds in a currency that is
weakening.
Renegotiation :
Renegotiation may be possible under certain situations.
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LOAN SYNDICATION FOR DOMESTIC BORROWINGS - THE CURRENT SCENARIO

The Reserve Bank of India announced, in April 1997, a series of measures to free
banks from the shackles of norms and other restrictive rules large advances. One of the
measures was to remove the requirement of consortium lending and, as further gratuitous, it
said, ``as an alternative to sole/multiple banking/consortium, banks are free to adopt the
syndication route irrespective of quantum of credit involved, if the arrangement suits the
borrower and financing banks''.
Syndicated lending for working capital, as advised by RBI, has not yet made its debut
in India, although 15 months have elapsed since it made the suggestion. Some of the reasons
for this are as follows.
Dispute over Interest Rate setting :
The vast majority of such loans the world- over carry a uniform interest rate, viz., the
borrower pays the same interest to all the banks participating in a syndicated loan. Under
Indian conditions, this could prove to be a major stumbling block. Different banks have
different prime lending rates (PLR) and prime term lending rates (PTLR), with big public
sector banks having the lowest PLR/PTLR and private sector/foreign banks having the
highest PLR/PTLR. . If a blue chip borrower were to seek a syndicated loan at the PLR of a
big public sector bank, all the smaller private/foreign banks would be shut out of the loan;
they cannot obviously lend below their PLR, which would be higher than the rate paid by the
borrower. The one possibility is to treat such loans as being outside the purview of PLR. But
then, the very sanctity of PLR would be lost.
Dispute over Overall Responsibility :
Secondly, the syndicated form of lending pre-supposes that the main bank or the
leader bank assumes the overall responsibility for the appraisal and supervision of the loan.
Currently, in multiple or consortium lending, all member banks individually appraise the loan
and are also supposed to monitor the end-use, value of security, the general health of the
borrower etc., periodically. In syndicated lending, it is unlikely that the Government and RBI
officers sitting on the boards of various public sector banks would permit the officers of the
member banks in a syndicated loan to rely solely or even primarily on the leader bank for
regular appraisal and monitoring of the loan. They would expect these officers to do a
complete due diligence exercise for the loan, as if it is solely granted by the member bank.
This would defeat the purpose behind syndication.
Lack of Marketing Skills :
Last of the peripheral reasons is that syndicated lending calls for active, if not
aggressive marketing by the leader bank. Indian banks, primarily in the public sector, do not
possess this skill or if they did possess the skill, it has been kept under wraps for so long as to
be ineffective.
The main reason, of course, is that nowhere in the world has anybody attempted
syndicated lending for working capital (short- term) advances.

23

Two of the prerequisites for a syndicated loan are that the period of the loan is for a
few years and the security is a fixed charge on the assets of the borrower, unless it is on an
unsecured basis.
Both these are not met in a short-term working capital advance. The
period of such an advance is contractually short, not exceeding one year. The security for
working capital loans is invariably a floating charge on assets created with the loan, i.e.,
current assets on hypothecation basis. The value the security comprising current assets will be
constantly changing and this kind of security is totally unsuited for a syndicated loan.
Therefore, syndicated loans are not for short-term working capital advances, for which RBI
had recommended that system to all banks.
Examples
1 . Crompton Greaves Ltd. raises Rs.45 cr
CROMPTON Greaves Ltd (CGL) has raised Rs. 45 crores from the domestic market by way
of loan syndication. The transaction, which is the first of its kind in the country, was
arranged by ANZ Investment Bank. Typically, in a offshore term-loan syndication, an
arranger bank places the specified amount with a number of other non-consortium banks. The
transaction is structured on a uniform pricing basis, with fee sharing indicated upfront and
with common loan and security documentation.
In CGL's case, the total facility of Rs. 45 crores was placed with three banks - Vijaya Bank
(Rs. 20 crores), Indian Overseas Bank (Rs. 15 crores) and State Bank of Saurashtra (Rs. 10
crores).
The syndicated term-loan, linked to the respective bank prime lending rates (PLRs), has been
priced uniformly at 13.5 per cent per annum payable quarterly. The four-year loan, repayable
in equal installments at the end of second, third and fourth years, is secured by pari passu first
charge on the assets of the company. The loan and security documentation for all three
participating banks is common.
CGL plans to utilise the amount for modernisation of its plant and machinery and other
capital expenditure programmes. This fund-raising is a part of the company's overall
borrowing programme of Rs. 200 crores for the financial year 1998-99.

QUESTION BANK
TWO MARKS
1) What do you mean by merchant bank?
2) Define merchant banker.
3) What is portfolio management?
FIVE MARKS
1. What are the objectives of merchant bankers?
2. What are the functions of merchant bankers?
3. What are the guidelines given to merchant bankers?
24

TEN MARKS
1. What are the regulations issued to merchant bankers from SEBI?
2. Describe about the process of merchant banking.
3. Explain about the services provided by merchant bankers.

25