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  2. 2. Q1 Identify the role of merchant banking as financial Intermediaries.Ans: Merchant banking in IndiaThe need for merchant banking was felt with the rapid growth in number of issues made andinitiated into Indian capital market. The National and Grindlays Bank (NGB) then got thelicense from RBI in 1967. Later in 1970, First National City Bank (FNCB) set up a merchantbanking division. As a commercial activity, merchant banking took shape in India through themanagement of public issues of capital and loan syndication. During that time the mainservices offered by the merchant banks to the corporate enterprises involved managementof public issues and financial consultancy. State Bank of India was the first Indian bank to setup its Merchant Banking Division in 1972. There was a boom for merchant bankingorganisations in the country in mid-seventies as various financial institutions and commercialbanks entered into the field of merchant banking. From 1992, reform measures wereintroduced in the capital market. The reform measures included conferring of statutorypowers on the Securities and Exchange Board of India (SEBI) and the repeal of CapitalIssues Control Act. These measures brought about major improvement in the regulatory andfunctional efficiency of the market. The measures also enabled the merchant bankers to takelegal and moral responsibility towards the investing public. It includes public sector, privatesector and foreign players. Some of the registered merchant banks in India are KotakMahindra 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.As per the SEBI guidelines, a Category I merchant banker must be a corporate body with anet worth of Rs.5 Crores and has to compulsorily register with the SEBI in the interest of theinvestors. In order to get the registration with SEBI the merchant banker must meet followingrequirements:· Capital adequacy – The merchant banker has to fulfil the minimum prescribed capitaladequacy norms in terms of net worth.
  3. 3. · Infrastructure – The merchant banker needs to have adequate infrastructure.· Expertise – The merchant banker must be professionally competent to undertakemerchant banking business.· Responsibility – The merchant banker has to make payment of the prescribed fee toSEBI and also needs to adhere to the obligations, responsibilities and to the code of conductprescribed by SEBI.
  4. 4. Functions as financial intermediariesFinancial intermediation is a process by which capital is mobilised from a large number ofinvestors 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 whoowns it to those who require it.Merchant banks invest their capital in client companies and provide fee-based services formergers and acquisitions. Many companies approach merchant banks to enhance theirfinancial stability or to meet an essential capital requirement. Due to their knowledge ininternational finances, merchant banks specialise in dealing with multinational corporations.Merchant banks do not offer regular banking services to the public.
  5. 5. Q 2. Describe the issuance process of depository receipts.Ans Issuance Process of Depository ReceiptsA Depositary Receipt (DR) which is traded on a local stock exchange is a type oftransferable financial security. It represents a security, usually in the form of equity that isissued by a foreign publicly listed company. The DR, which is a physical certificate, permitsinvestors 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 aninstrument in the form of a depository receipt created by the Indian depository in Indiaagainst the underlying equity shares of the issuing company. In an IDR, foreign companieswould issue shares, to an Indian depository, which would in turn issue depository receipts toinvestors in India. The actual shares underlying the IDRs would be held by an overseascustodian, which shall authorise the Indian depository to issue the IDRs. The IDRs have thefollowing features:· Abroad custodian - Foreign banks that have branches in India require an approval fromMinistry of Finance to act as a custodian. They also require a registration of Indiandepository with the SEBI.· Consents for issue of IDRs - The IDR issue requires consent from SEBI before the issueopening date.· Listing - IDRs will be listed on stock exchanges and will be freely transferable In India.EligibilityThe following are the eligibilities which the company must fulfil to issue an IDR:· Capital requirement - The foreign company must have paid up capital and free reserveof at least USD 100 million, in order to issue IDR.· Sales turnover of companies - There must be an average turnover of USD 500 millionfor previous three years.· Profits or dividend – Company must have made profits in the previous five years andmust 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.
  6. 6. · Level of issue – The issue during a particular year must not go beyond 15 percent of thepaid 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 oneyear from the date of issue.· Valuation – The IDRs will be valued in Indian rupees, irrespective of the value of originalshares.· Profit – In addition to other opportunities, IDR will be an extra investment opportunity toIndian investors for overseas investment.
  7. 7. Q3. Explain the operational guidelines that need to be followed bya merchant banker.Operational GuidelinesLet us now understand the operational guidelines issued by the SEBI for thestandard disclosure of the offer document.Submission of draft and final offer documentFirst, the lead merchant banker files the offer documents of size up toRs. 50 crores with the regional office of SEBI under the jurisdiction of the registeredoffice of the issuer company. Then the lead merchant banker or stock exchangemakes the draft offer document available to the public.The lead merchant banker makes ten copies of the draft offer document available tothe Board, and 25 copies to the stock exchange(s), where the issue is proposed tobe listed. Within three days of filing the offer document with registrar of companies orthe stock exchange(s), the lead merchant bankers submits two copies of the finalprinted copy of the offer document to dealing offices of the Board and one finalprinted copy to the primary market department, SEBI, and head office.The lead merchant banker also submits a computer floppy containing the finalprospectus or letter of offer to the primary market department, SEBI, and head officewithin three days of filing the final prospectus or letter of offer with the registrar ofcompanies or concerned Stock Exchange.While offer documents are filed with any department or office of the Board, thedetails like registration number, date of registration or renewal of registration, detailsof any enquiry or investigation conducted by SEBI at any time, penalty imposed bystock exchange, and the date of expiry of registration will be given by the leadmerchant banker in the forwarding letters.Instructions on post-issue obligationsThe merchant banker ensures compliance with the following post-issue obligations:
  8. 8. Association of resource personnelA public representative nominated by the Board will be associated with the processof finalising the basis of allotment in case of over-subscription in public issues. Thelead merchant banker informs the nominated person about the date, time, venue andother details with regard to the process of finalisation of basis of allotment.The expenses of the public representatives associated in the allotment process ofoversubscribed issues will be borne by the lead merchant bankers and recoveredfrom the issuers.
  9. 9. Redressal of investor grievancesThe merchant bankers assign high priority to investor grievances and take allmeasures to minimise the number of complaints. The lead merchant banker sets upproper grievance monitoring and redressal system in co-ordination with the issuersand the registrars to an issue, and takes all steps to resolve the grievances as soonas possible. The merchant banker has to actively associate with the post-issuerefund and allotment activities and regularly monitor investor grievances emergingthere from.Submission of post issue monitoring reportsThe lead merchant banker submits the post issue monitoring reports in duplicatewithin three working days from the due dates either by registered post or delivers itat respective regional offices or head office.The lead merchant banker sends a copy of the report to the Board’s head office,Mumbai stating the location where the regional office of the Board has dealt with theoffer document.During the intervening period of the reports, the lead merchant banker informs theBoard regarding important developments about the particular issues handled bythem.Issue of No Objection Certificate (NOC)The issuer companies deposit 1% of the amount of securities offered to the publicand/or to the holders of the existing securities of the company with the regional stockexchange based on the listing agreement of the stock exchanges. The depositamount can be released by the concerned stock exchange only after obtaining anNOC from the board. The issuer company to the board submits an application forNOC in the required format.Registration and renewal of registration of Merchant BankersMerchant bankers make the application for renewal of certificate of registration asper Regulation 9 of SEBI.
  10. 10. The renewal application for the certificate of registering as a merchant bankerprovides a statement that highlights the changes in the information submitted to theBoard in an earlier registration. The earlier registration is accompanied by adeclaration 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 theirregistration with AMBI, accompanied by relevant details.
  11. 11. Q 4 Explain the basic features of securities lending and borrowingscheme.Ans: Securities lending and borrowingTo provide necessary momentum to short sell, a scheme for Securities Lending andBorrowing (SLB) was introduced. With the introduction of short selling by institutionalinvestors, a full-fledged security lending and borrowing scheme was introduced.The following are the characteristics of the scheme of securities lending andborrowing:· Eligibility – Under the Securities Lending Scheme (SLS), 1997 the securitiestransacted in F&O segment are authorised for lending and borrowing. The scheme isopen 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 isindependent of other trading platforms.· Participation – The scheme permits participation by all sections of investor. Thisincluded retail, institutional and so on. The AIs sets up the platform for lending andborrowing which is accessed by the borrowers and lenders through the clearingmembers (CMs), banks and custodians who are authorised by the AIs. For theauthorisation of AIs, the AIs, CMs and the clients enter into an agreement. Thisagreement specifies the rights, obligations and responsibilities of the parties to theagreement.· Agreement – The agreement consists of the basic conditions for lending andborrowing of securities that is recommended in the scheme. The AIs also includeappropriate conditions in the agreement for proper execution, settlement of lendingand borrowing transactions and risk management. The roles of the AIs, CMs and theclients are given in the agreement between the AIs, CMs and clients. The first part ofthe agreement is between the AIs and the CMs .The second part of the agreement isbetween the CMs and the clients.
  12. 12. · Identification – The AIs allocates unique identification (ID) to each client which ismapped to the Permanent Account Number (PAN) of the clients. The AIs ensuresthat 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 isindependent of normal market settlement. The settlement cycle for the scheme isbased on T+1. The abbreviation T+1 denote the settlement date of securitytransaction date plus one day. The netting of transactions at any level is notpermitted as settlement of the lending and borrowing transactions is done on a grossbasis at the level of the clients.· Risk management systems – The AIs frame suitable risk management systemsto provide guaranteed delivery of securities to the borrower and return of securitiesto the lender. The AIs conducts an auction for obtaining securities if the lender orborrower fails to return securities to the AI.· Position limits – AIs in consultation with SEBI decides the position limits at thelevel of market, CM and client.
  13. 13. Q 5. Discuss the difference between asset and fee based financialservices.Ans: Financial ServicesFinancial services are a very important part of the financial system. Financial services enablemobility and allocation of savings through the transformation of savings into investments. Awell functioning financial system provides better financial services which empowersindividuals, integrates with the economy, contributes to development, and providesprotection against economic shocks. Financial services are offered by specialised institutionswhich help the client to raise funds, manage funds, and transform savings into investments.Financial services are classified into two categories based on the asset creation function ofthese services· Fund based or asset based category and.· Fee based or advisory based category.We will study these financial services in the following sections of this unit.Asset or fund basedAsset based financial services facilitate corporate and other business entities to mobiliseresources at lower rates and open up investment opportunities with enhanced returns. Theseservices enable the corporate institutions, in particular, to reject the traditional bank financeand opt for the more competitive financial market. The debt market enables a borrower toorganise his borrowings and structure the repayments to match future cash flows. Theinvestment options have widened significantly to enable the corporate entities to use theirsurplus cash in short-term maturities and increase the revenue. The agreement to assetbased securities is facilitated by financial intermediaries through fee based services.The asset based financial service has emerged as an important supplementary source offinance in the industry. The following are some of the asset based financial services:· Leasing – Leasing is a contractual arrangement or transaction in which a party owning anasset provides the asset for use to another party over a certain period of time in return forrent.
  14. 14. · Hire-purchase – It is a mode of financing the price of the goods to be sold on a futuredate. The goods are let on hire with an option to the hirer to purchase them· Customer credit – Consumer credit includes all asset-based financing plans offered toindividuals for acquiring durable consumer goods. The main suppliers of consumer credit aremultinational banks, commercial banks and non banking finance companies.· Factoring – Factoring is a fund-based financial service that provides resources to financereceivables as well as facilitates the collection of receivables.· Forfaiting – Forfaiting is financing of receivables arising from international trade.· Bill discounting - Bill discounting is encashing or trading of bills at less than its par valueand before its maturity date.In the next section, we will discuss the various types of fee based corporate financialservices offered by the financial intermediariesFee based or advisoryFee based financial services are not used to create assets or liabilities. These financialservices facilitate certain financial functions such as managing capital issues, makingarrangements for the placement of capital and debt instruments, and arrangement of fundsfrom financial institutions. They also undertake the responsibility of getting all governmentand other clearances. In addition, this sector does a large number of other services likerendering project advisory services, plan mergers and acquisitions, and guiding in capitalrestructuring to their clients.In fee based services, the intermediaries charge fees for their financial services, likemerchant banking services, assisting in mergers, stock broking and so on. The following aresome of the fee based financial services:· Issuing of Letters of Credit (LC) – LCs successfully complete their purpose to facilitate tradeby substituting the credit of the bank for the credit of the customer. There are mainly twotypes of letters of credit - commercial and standby. The commercial letter of credit is theprimary payment mechanism for a transaction, whereas the standby letter of credit is asecondary payment mechanism.· Issuing Letters of Guarantee (LGs) – LGs can be with or without collateral security deposit.While there are different forms of LGs in the context of business usually, Letters of guaranteeare concerned with providing safeguards to buyers that suppliers will meet their obligations
  15. 15. and are issued by the customers bank depending on which party seeks the guarantee. Thebank essentially becomes a co-signer for the buyer. It pays the seller only if the buyer cannotpay and so the initial buyer-seller agreement depends on the sellers credit.· Other services – The other important fee based financial services generally offered bybanks and non banking financial companies include cash management services, foreignexchange services, merchant banking services, registrar, underwriting, custodial services,and credit rating services.For these financial services the bank will charge fees. However, they are associated withrisk. For example, in the event of invocation of guarantee or letters of credit, the paymentliability immediately falls on the banks and then becomes a fund based. It will of course haverecourse against the defaulter in whose favour the bank has issued the LC or LG
  16. 16. Q 6. Describe accounting and reporting for operating lease in detail.Ans: Accounting and reporting for operating leaseLet 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 therental to be charged on a depreciation basis over the lease term, if the payments arenot made on such a basis. If the term of the lease requires a heavy initial payment, apercentage of the payment can be treated as prepaid expense. Since the lessee willnot consider the risk of ownership, the lease expenditure is treated as an operatingexpense in the income statement; the lease does not affect the balance sheet. Theoperating 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 toownership of the asset. The accounting treatment for an operating lease is simple forboth the lessor and the lessee. The lessee has acquired an operating expense, sothe lease rental to be paid is written off in the profit and loss account. The lessee willhave to disclose in the notes to the accounts the total amount charged in the yearand the total amount of the payments to which the entity is committed at the yearend. The lessor has made revenue from renting out the asset and consequentlyrecognises the lease rental receivable as income in the profit and loss account.