Master of Business Administration - MBA Semester 4
MF0017 – Merchant Banking and Financial Services
Assignment Set- 1
Q.1 What do you understand by insider trading. What are the SEBI rules and
regulations to prevent insider trading.
Ans:- "Insider trading" is a term subject to many definitions and connotations and it
encompasses both legal and prohibited activity. Insider trading takes place legally every
day, when corporate insiders – officers, directors or employees – buy or sell stock in
their own companies within the confines of company policy and the regulations
governing this trading. It is the trading that takes place when those privileged with
confidential information about important events use the special advantage of that
knowledge to reap profits or avoid losses on the stock market, to the detriment of the
source of the information and to the typical investors who buy or sell their stock without
the advantage of "inside" information. Almost eight years ago, India's capital markets
watchdog – the Securities and Exchange Board of India organized an international
seminar on capital market regulations. Among others issues, it had invited senior
officials of the Securities and Exchange Commission to tell us how it tackled the
menace of insider trading.
SEBI rules and regulations to prevent insider trading.
SEBI had amended the Insider Trading Regulations 1992 vide a Notification dated
November 19, 2008 which I had discussed it here and here. SEBI has now released a
set of "Clarifications" on 24th July 2009 on certain issues arising out of the amendments
made. I had opined on some of these issues in my earlier posts referred to above and
hence me update on what are the clarifications so given.
Curiously, the "clarifications" have no formal standing or reference. It is neither a
circular, nor a notification, nor even a press release. It is neither signed nor dated. But it
seeks to "clarify" and giving meaning to the Regulations that have legal standing and
where such "meaning" is quite contrary - as we will see - to the plain reading of the text.
Having said that, the "clarifications" mostly relaxes the requirements and hence, being
gift horses, one should not examine them in the mouth too closely!
Let us see the clarifications given.
Recollect that specified persons were banned from carrying out opposite transactions
"(banned transactions") for six months of original buy/sale ("original transactions"). The
question was whether acquisition of shares under ESOPs scheme and sale of such
shares would be considered as transactions that trigger off such ban and whether these
themselves are banned.
It is clarified that exercise of ESOPs will neither be deemed to be "original transaction"
nor "banned transaction". Thus, by acquiring shares under ESOPs, you don't trigger a
ban and if you are banned for six months, you can still exercise ESOPs. The reasoning
given is that the ban is only on transactions in secondary market.(Incidentally, I had felt
that "However, taking all things into account, perhaps the intention is not to cover
shares acquired under ESOPs Schemes. ").
But sale of shares acquired through ESOPs is covered but it will only be deemed to be
a "original transaction" and not a "banned transaction". In other words, even if you are
under a ban, you can still sell shares acquired under ESOPs but once you sell such
shares, you have triggered a ban of six months. On this aspect, I do not understand the
basis of clarifying that the sale of shares acquired under ESOPs scheme will not be an
"original transaction" - the logic of covering secondary market transactions should apply
Then, it is clarified that every later transaction triggers a fresh six month ban. A
purchase on 1st February results in ban till 1st August. However, if there is a fresh
purchase on 15th March, there is a ban now till 15th September. Effectively, this means
that the ban period is from 2nd February till 15th September.
What about transactions before this amendment - will the amendment create ban in
respect of them too - this is an academic issue now at least as the six month period is
now complete. It is clarified though that the transactions before the amendment are not
to be considered. On a similar note, unwinding of positions in derivatives held on the
date of this amendment is possible.
A crucial clarification is that the ban on "sale" of shares for personal emergencies is
permissible by waiver by the Compliance Officer. This is not evident from a plain
reading of the provision and I had opined that "This bar on such transactions is total.
There are no circumstances – whether of urgent need or otherwise – under which the
bar can be lifted. There is also no provision under which even SEBI could grant
exemption.” But SEBI thinks it is so evident and hence let us accepts this gift without
creating legal niceties! Note that this clarification applies only to sales and there can be
no purchases within these six month ban period - obviously there cannot be any
personal emergency to purchase shares!
Q.2 What is the provision of green shoe option and how is it used by companies
to stabilize prices.
Ans:- Green Shoe Option (GSO) is an option where a company can retain a part of the
over-subscribed capital by issuing additional shares. Oversubscription is a situation
when a new stock issue has more buyers than shares to meet their orders. This excess
demand over supply increases the share price. There is another situation called under
subscription. In under subscription, a new stock issue has fewer buyers than the shares
available. An issuing company appoints a stabilizing agent, which is usually an
underwriter or a lead manager, to purchase shares from the open market using the
funds collected from the over-subscription of shares. The stabilizing agent stabilizes the
price for a period of 30 days from the date of listing as authorized by the SEBI. Green
shoe option agreement allows the underwriters to sell 15 percent more shares to the
investors than planned by the issuer in an underwriting. Some issuers do not include
green shoe options in their underwriting contracts under certain circumstances where
the issuer funds a particular project with a fixed amount of price and does not require
more funds than quoted earlier. The green shoe option is also known as over-allotment
option. The over-allotment refers to allocation of shares in excess of the size of the
public issue made by the stabilizing agent out of shares borrowed from the promoters in
pursuance of a GSO exercised by the issuing company.
The green shoe option is popular because it is the only SEC-permitted means for an
underwriter to stabilize the price of a new issue post-pricing. Issuers will sometimes not
permit a green shoe on a transaction when they have a specific objective for the offering
and do not want the possibility of raising more money than planned. The term comes
from the first company, Green Shoe Manufacturing now called Stride Rite Corporation,
to permit underwriters to use this practice in its offering.
The mechanism by which the green shoe option works to provide stability and liquidity
to a public offering is described in the following example:
A company intends to sell 1 million shares of its stock in a public offering through an
investment banking firm (or group of firms which are known as the syndicate) whom the
company has chosen to be the offering's underwriter(s). When the stock offering is the
first time the stock is available for public trading, it is called an IPO (initial public
offering). When there is already an established market and the company is simply
selling more of their non-publicly traded stock, it is called a follow-on offering.
The underwriters function as the broker of these shares and find buyers among their
clients. A price for the shares is determined by agreement between the company and
the buyers. One responsibility of the lead underwriter in a successful offering is to help
ensure that once the shares begin to publicly trade, they do not trade below the offering
When a public offering trades below its offering price, the offering is said to have "broke
issue" or "broke syndicate bid". This creates the perception of an unstable or
undesirable offering, which can lead to further selling and hesitant buying of the shares.
To manage this possible situation, the underwriter initially oversells ("shorts") to their
clients the offering by an additional 15% of the offering size. In this example the
underwriter would sell 1.15 million shares of stock to its clients. When the offering is
priced and those 1.15 million shares are "effective" (become eligible for public trading),
the underwriter is able to support and stabilize the offering price bid (which is also
known as the "syndicate bid") by buying back the extra 15% of shares (150,000 shares
in this example) in the market at or below the offer price. They can do this without the
market risk of being "long" this extra 15% of shares in their own account, as they are
simply "covering" (closing out) their 15% oversell short.
If the offering is successful and in strong demand such that the price of the stock
immediately goes up and stays above the offering price, then the underwriter has
oversold the offering by 15% and is now technically short those shares. If they were to
go into the open market to buy back that 15% of shares, the underwriter would be
buying back those shares at a higher price than it sold them at, and would incur a loss
on the transaction.
This is where the over-allotment (green shoe) option comes into play: the company
grants the underwriters the option to take from the company up to 15% more shares
than the original offering size at the offering price. If the underwriters were able to buy
back all of its oversold shares at the offering price in support of the deal, they would not
need to exercise any of the green shoe. But if they were only able to buy back some of
the shares before the stock went higher, then they would exercise a partial green shoe
for the rest of the shares. If they were not able to buy back any of the oversold 15% of
shares at the offering price ("syndicate bid") because the stock immediately went and
stayed up, then they would be able to completely cover their 15% short position by
exercising the full green shoe.
Q.3 Discuss the proportionate allotment procedure followed by the lead banker to
Ans:- The post-issue Lead Merchant Banker shall ensure that moneys received
pursuant to the issue and kept in a separate bank (i.e. Bankers to an Issue), as per the
provisions of section 73(3) of the Companies Act 1956, is released by the said bank
only after the listing permission under the said Section has been obtained from all the
stock exchanges where the securities were proposed to be listed as per the offer
Post-issue Advertisements -(Clause 7.5)
Post-issue Lead Merchant Banker shall ensure that in all issues, advertisement giving
details relating to over-subscription, basis of allotment, number, value and percentage
of applications received along with stock invest, number, value and percentage of
successful allottees who have applied through stock invest, date of completion of
dispatch of refund orders, date of dispatch of certificates and date of filing of listing
application is released within 10 days from the date of completion of the various
activities at least in an English National Daily with wide circulation, one Hindi National
Paper and a Regional language daily circulated at the place where registered office of
the issuer company is situated.
Post-issue Lead Merchant Banker shall ensure that issuer company / advisors / brokers
or any other agencies connected with the issue do not publish any advertisement
stating that issue has been over-subscribed or indicating investors' response to the
issue, during the period when the public issue is still open for subscription by the public.
Advertisement stating that "the subscription to the issue has been closed" may be
issued after the actual closure of the issue.
Basis of Allotment -(Clause 7.6)
In a public issue of securities, the Executive Director/Managing Director of the
Designated Stock Exchange along with the post issue Lead Merchant Banker and the
Registrars to the Issue shall be responsible to ensure that the basis of allotment is
finalized in a fair and proper manner in accordance with the following guidelines:.
Provided, in the book building portion of a book built public issue notwithstanding the
above clause, Clause 11.3.5 of Chapter XI of these Guidelines shall be applicable.
Proportionate Allotment Procedure
The allotment shall be subject to allotment in marketable lots, on a proportionate basis
as explained below:
Applicants shall be categorised according to the number of shares applied for.
The total number of shares to be allotted to each category as a whole shall be arrived at
on a proportionate basis i.e. the total number of shares applied for in that category
(number of applicants in the category x number of shares applied for) multiplied by the
inverse of the over-subscription ratio as illustrated below:
Total number of applicants in category of 100s - 1,500
Total number of shares applied for - 1,50,000
Number of times over-subscribed - 3
Proportionate allotment to category - 1, 50,000 x 1/3 = 50,000
Number of the shares to be allotted to the successful allottees shall be arrived at on a
proportionate basis i.e. total number of shares applied for by each applicant in that
category multiplied by the inverse of the over-subscription ratio. Schedule XVIII of basis
of allotment procedure may be referred to.
Number of shares applied for by – 100 each applicant
Number of times oversubscribed – 3
Proportionate allotment to each successful applicant - 100 x 1/3 = 33
(to be rounded off to 100)
All the applications where the proportionate allotment works out to less than 100 shares
per applicant, the allotment shall be made as follows:
Each successful applicant shall be allotted a minimum of 100 securities; and
The successful applicants out of the total applicants for that category shall be
determined by drawl of lots in such a manner that the total number of shares allotted in
that category is equal to the number of shares worked out as per (ii) above.
If the proportionate allotment to an applicant works out to a number that is more than
100 but is not a multiple of 100 (which is the marketable lot), the number in excess of
the multiple of 100 shall be rounded off to the higher multiple of 100 if that number is 50
If that number is lower than 50, it shall be rounded off to the lower multiple of 100. As an
illustration, if the proportionate allotment works out to 250, the applicant would be
allotted 300 shares.
If however the proportionate allotment works out to 240, the applicant shall be allotted
200 shares. All applicants in such categories shall be allotted shares arrived at after
such rounding off.
If the shares allocated on a proportionate basis to any category is more than the shares
allotted to the applicants in that category, the balance available shares for allotment
shall be first adjusted against any other category, where the allocated shares are not
sufficient for proportionate allotment to the successful applicants in that category.
The balance shares if any, remaining after such adjustment shall be added to the
category comprising applicants applying for minimum number of shares.
As the process of rounding off to the nearer multiple of 100 may result in the actual
allocation being higher than the shares offered, it may be necessary to allow a 10%
margin i.e. the final allotment may be higher by 10 % of the net offer to public.
Q.4What are the advantages of leasing to a company.
Ans: - Leasing has many advantages for the lessee as well as for the lessor. Lease
financing offers the following benefits to the lessee:
• One hundred percent finance without immediate down payment for huge investments,
except for his margin money investment.
• Facilitates the availability and use of equipments without the necessary blocking of
• Acts as a less costly financing alternative as compared to other source of finance.
• Offers restriction free financing without any unduly restrictive covenants.
• Enhances the working capital position.
• Provides finance without diluting the ownership or control of the lessor.
• Offers tax benefits which depend on the structure of the lease.
• Enables lessee to pay rentals from the funds generated from operations as lease
structure can be made flexible to suit the cash flow.
• When compared to term loan and institutional financing, lease finance can be arranged
fast and documentation is simple and without much formalities.
• The lessor being the owner of the asset bears the risk of obsolescence and the lessee
is free on this score. This gives the option to the lessee to replace the equipment with
The following are the benefits offered by lease financing to the lessor:
• The lessor’s ownership is fully secured as he is the owner and can always take
possession in case of default by the lessee.
• Tax benefits are provided on the depreciation value and there is a scope for him to avail
more depreciation benefits by tax planning.
• High profit is expected as the rate of return increases
• Return on equity is elevated by leveraging results in low equity base which enhance the
earnings per share.
• High growth potential is maintained even during periods of depression.
Q.5 Discuss Accounting standard 19 for lease based on operating lease.
Ans:- Accounting Standard (AS)-19, Leases, is issued by the Council of the Institute of
Chartered Accountants of India. This standard comes into force with respect of all
assets leased during accounting periods commencing on or after 1.4.2001 and is
mandatory in nature from that date. Accordingly, the ‘Guidance Note on Accounting for
Leases’ issued by the Institute in 1995, is not applicable in respect of such assets.
Earlier application of this Standard is, however, encouraged.
The right accounting policies and disclosures in relation to finance leases and operating
leases should be applied in accounting for all leases other than the following:
• Lease agreements to explore or to use natural resources, such as oil, gas , timber,
metals and other mineral rights; and
• Licensing agreements for items such as motion picture films, video recordings, plays,
manuscripts, patents and copyrights; and
• Lease agreements to use property such as lands.
The following terms are used in this statement:
• Lease – A lease is an agreement calling for the lessee (user) to pay the lessor (owner)
for use of an asset for an agreed period of time. A rental agreement is a lease in which
the asset is a substantial property.
• Finance lease – A lease which transfers all the risks and rewards incident to ownership
of an asset.
• Operating lease – A lease for which the lessee acquires the property for only a small
portion of its useful life.
• Non-cancellable lease – A non-cancellable lease is a lease that can be abandoned
• Inception of lease – The inception of lease is the former date of the lease agreement
and the commitment date by the parties to the principal provisions of the lease.
• Lease term – The lease term is the non cancellable period for which the lessee has
agreed to take on lease asset together with future periods.
• Minimum lease payments – It is the regular rental payments excluding executory costs
to be paid by the lessee to the lessor in a capital lease. The lessee informs that an
asset and liability at the discounted value of the future minimum lease payments.
• Fair value – The expected value of all assets and liabilities of a owned company used
to combine the financial statements of both companies.
• Economic life – The outstanding period of time for which real estate improvements are
expected to generate more income than operating expenses cost.
• Useful life – Useful life of a leased asset is either the period over which leased asset is
expected to be useful by the lessee or the number of production units expected to be
gained from the use of the asset by the lessee.
• Residual value – The value of a leased asset is the estimated fair value of the asset at
the end of the lease term.
• Guaranteed residual value – It is guaranteed by the lessee or by a party on behalf of
the lessee to pay the maximum amount of the guarantee; and in the case of the lessor,
the part of the residual value which is guaranteed by the lessee or on behalf of the
lessee, or an independent third party who is financially able of discharging the
obligations under the guarantee.
• Unguaranteed residual valued of a lease asset – It is the value of a leased asset that
is the total amount by which the residual value of the asset exceeds its guaranteed
• Gross investment in the lease – It is the sum of the minimum lease payments within a
finance lease from the lessors’ view and any unguaranteed residual value accumulating
to the lessor.
• Unearned finance income – Any income that comes from investments and other
sources unrelated to employment services.
• Net investment in the lease – Net investment in the lease is the gross investment in
the lease less unearned finance income.
• Implicit interest – An interest rate that is not explicitly stated, but the implicit rate can
be determined by use of present value factors.
• Contingent rent – It is the portion of the lease payments that is not permanent in
amount but is based on a factor other than just the passage of time. For example,
percentage of sales.
Classification of leases
The lease can be classified as either a finance lease or an operating lease based on
different accounting treatments as required for the different types of lease. This
classification is based on the extent to which risks and rewards of ownership of leased
asset are transferred to the lessee or remain with the lessor. Risks include loss from idle
capacity, technological obsolescence, and variations in return. Rewards include the
rights to sell the asset and gain from its capital value.
Leases are classified as a finance lease if it transfers considerably all the risks and
rewards of ownership to the lessee; else if it does not then it is an operating lease.
While classifying a lease, it is important to recognize the essence of the agreement and
not just its legal form. The commercial reality is always important. Conditions in the
lease may specify that an entity has only a limited disclosure to the risks and benefits of
the leased asset.
The following are some of the situations where an individual or in combination, would
usually direct to a lease being a finance lease:
• Transfer of ownership to the lessee by the end of the lease term.
• The lessee has the choice to purchase the asset at a cost that is expected to be lower
than its fair value and such that the option is likely to be exercised.
• The lease term is for a key part of the financial life of the asset, even if title to the asset
is not transferred.
• The current value of the least lease payments is equal to substantially all of the fair
value of the asset.
• The leased resources are of a specialized nature such that only the lessee can use
them without significant modification.
• Losses or gains from changes in the fair value of the residual value of the asset add to
• The lessee has the option to continue the lease for a secondary term at significantly
below market rent.
The following are some of the situations where an individual or in combination, would
usually direct to a lease being an operating lease:
• If the lessor experiences the risk associated with a movement in the market value of the
asset or the use of the asset.
• If there is an option to cancel, and the lessee is likely to exercise such an option.
• Leases of land, if title is not transferred.
• If the title to the land is not likely to pass to the lessee, then the rewards and risks of
ownership have not substantially passed.
The lowest lease payments need to be allocated between the land and the building
component in proportion to their relative fair values of the lease holding interests at the
beginning of the lease. If the allocation is not be made reliably, then both leases are
treated as finance leases or as operating leases.
Leases in the financial statements of lessees
Let us now discuss about leases in the financial statement of lessees.
In an operating lease, the lease payments are recognized as an expenditure on a
straight-line basis over the lease term, unless another organized basis is more
representative of the pattern of the user’s benefit. The incentives in operating leases will
be in the form of up-front payments and rent-free periods. These need to be properly
noticed over the lease term from its commencement.
At the initiation of the lease term, lessees identify finance leases as assets and liabilities
in their balance sheets on sum equal to the value of the leased asset or, if lower, on the
current value of the minimum lease payments. The discount rate in calculating the
current value of the minimum lease payments is the interest rate contained in the lease,
if this is possible to determine. Else, the lessee’s incremental borrowing rate can be
used. Any initial direct costs of the lessee are included to the amount identified as an
asset. After the initial recognition, the lease payments are assigned between the
repayment of the outstanding liability and the finance charge in order to reflect a
constant periodic rate of interest on the liability.
The asset needs to be depreciated over its expected useful life under IAS 16, using
rates for similar assets. If there is no reasonable certainty that ownership will transfer to
the lessee, then the shorter of the lease term and the useful life must be used.
Leases in the financial statements of lessor
This section analyses leases in the financial statement of lessor.
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 lessor’s 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 organized basis is more representative of
the pattern in which user benefit derived from the leased asset is reduced.
Lessors recognize assets held under a finance lease in their balance sheets and
present them as a receivable on an amount equal to the net investment in the lease.
The identification of finance income is based on a pattern showing a periodic rate of
return on the lessor’s net investment in the finance lease.
The dealer lessors recognise selling profit or loss in the period, based on the policy
followed by the entity for outright sales. If low rates of interest are quoted, selling profit
will be restricted which would apply if a market rate of interest were charged. Costs
incurred by manufacturer or dealer lessors associated with negotiating and arranging a
lease will be recognised as an expense when the selling profit is identified.
Q.6 Given the various types of mutual funds, take any two schemes and discuss
the performance of the schemes.
Ans:- Different types of mutual fund schemes
Schemes according to Maturity Period:
A mutual fund scheme can be classified into open-ended scheme or close-ended
scheme depending on its maturity period.
Open-ended Fund/ Scheme
An open-ended fund or scheme is one that is available for subscription and repurchase
on a continuous basis. These schemes do not have a fixed maturity period. Investors
can conveniently buy and sell units at Net Asset Value (NAV) related prices which are
declared on a daily basis. The key feature of open-end schemes is liquidity.
Close-ended Fund/ Scheme
A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years. The fund
is open for subscription only during a specified period at the time of launch of the
scheme. Investors can invest in the scheme at the time of the initial public issue and
thereafter they can buy or sell the units of the scheme on the stock exchanges where
the units are listed. In order to provide an exit route to the investors, some close-ended
funds give an option of selling back the units to the mutual fund through periodic
repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the
two exit routes is provided to the investor i.e. either repurchase facility or through listing
on stock exchanges. These mutual funds schemes disclose NAV generally on weekly
Schemes according to Investment Objective:
A scheme can also be classified as growth scheme, income scheme, or balanced
scheme considering its investment objective. Such schemes may be open-ended or
close-ended schemes as described earlier. Such schemes may be classified mainly as
Growth / Equity Oriented Scheme
The aim of growth funds is to provide capital appreciation over the medium to long-
term. Such schemes normally invest a major part of their corpus in equities. Such funds
have comparatively high risks. These schemes provide different options to the investors
like dividend option, capital appreciation, etc. and the investors may choose an option
depending on their preferences. The investors must indicate the option in the
application form. The mutual funds also allow the investors to change the options at a
later date. Growth schemes are good for investors having a long-term outlook seeking
appreciation over a period of time.
Income / Debt Oriented Scheme
The aim of income funds is to provide regular and steady income to investors. Such
schemes generally invest in fixed income securities such as bonds, corporate
debentures, Government securities and money market instruments. Such funds are less
risky compared to equity schemes. These funds are not affected because of fluctuations
in equity markets. However, opportunities of capital appreciation are also limited in such
funds. The NAVs of such funds are affected because of change in interest rates in the
country. If the interest rates fall, NAVs of such funds are likely to increase in the short
run and vice versa. However, long term investors may not bother about these
The aim of balanced funds is to provide both growth and regular income as such
schemes invest both in equities and fixed income securities in the proportion indicated
in their offer documents. These are appropriate for investors looking for moderate
growth. They generally invest 40-60% in equity and debt instruments. These funds are
also affected because of fluctuations in share prices in the stock markets. However,
NAVs of such funds are likely to be less volatile compared to pure equity funds.
Money Market or Liquid Fund
These funds are also income funds and their aim is to provide easy liquidity,
preservation of capital and moderate income. These schemes invest exclusively in safer
short-term instruments such as treasury bills, certificates of deposit, commercial paper
and inter-bank call money, government securities, etc. Returns on these schemes
fluctuate much less compared to other funds. These funds are appropriate for corporate
and individual investors as a means to park their surplus funds for short periods.
These funds invest exclusively in government securities. Government securities have
no default risk. NAVs of these schemes also fluctuate due to change in interest rates
and other economic factors as is the case with income or debt oriented schemes.
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive
index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the
same weightage comprising of an index. NAVs of such schemes would rise or fall in
accordance with the rise or fall in the index, though not exactly by the same percentage
due to some factors known as "tracking error" in technical terms. Necessary disclosures
in this regard are made in the offer document of the mutual fund scheme.
There are also exchange traded index funds launched by the mutual funds which are
traded on the stock exchanges.
How to know the performance of a mutual fund scheme?
The performance of a scheme is reflected in its net asset value (NAV) which is
disclosed on daily basis in case of open-ended schemes and on weekly basis in case of
close-ended schemes. The NAVs of mutual funds are required to be published in
newspapers. The NAVs are also available on the web sites of mutual funds. All mutual
funds are also required to put their NAVs on the web site of Association of Mutual
Funds in India (AMFI) www.amfiindia.com and thus the investors can access NAVs of
all mutual funds at one place
The mutual funds are also required to publish their performance in the form of half-
yearly results which also include their returns/yields over a period of time i.e. last six
months, 1 year, 3 years, 5 years and since inception of schemes. Investors can also
look into other details like percentage of expenses of total assets as these have an
affect on the yield and other useful information in the same half-yearly format.
The mutual funds are also required to send annual report or abridged annual report to
the unitholders at the end of the year.
Various studies on mutual fund schemes including yields of different schemes are being
published by the financial newspapers on a weekly basis. Apart from these, many
research agencies also publish research reports on performance of mutual funds
including the ranking of various schemes in terms of their performance. Investors should
study these reports and keep themselves informed about the performance of various
schemes of different mutual funds.
Investors can compare the performance of their schemes with those of other mutual
funds under the same category. They can also compare the performance of equity
oriented schemes with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc.
On the basis of performance of the mutual funds, the investors should decide when to
enter or exit from a mutual fund scheme.
Master of Business Administration - MBA Semester 4
MF0017 – Merchant Banking and Financial Services
Assignment Set- 2
Q.1 What are the provisions for prevention of fraudulent and unfair trade
practices by SEBI regulations.
Ans:- Prohibition of manipulative, fraudulent and unfair trade practice
(1) Without prejudice to the provisions of regulation 3, no person shall indulge in a
fraudulent or an unfair trade practice in securities.
(2) Dealing in securities shall be deemed to be a fraudulent or an unfair trade practice
if it involves fraud and may include all or any of the following, namely:-
a) indulging in an act which creates false or misleading appearance of trading in the
b) dealing in a security not intended to effect transfer of beneficial ownership but intended
to operate only as a device to inflate, depress or cause fluctuations in the price of such
security for wrongful gain or avoidance of loss;
c) advancing or agreeing to advance any money to any person thereby inducing any other
person to offer to buy any security in any issue only with the intention of securing the
minimum subscription to such issue;
d) paying, offering or agreeing to pay or offer, directly or indirectly, to any person any
money or money’s worth for inducing such person for dealing in any security with the
object of inflating, depressing, maintaining or causing fluctuation in the price of such
e) any act or omission amounting to manipulation of the price of a security;
f) publishing or causing to publish or reporting or causing to report by a person dealing in
securities any information which is not true or which he does not believe to be true prior
to or in the course of dealing in securities
g) entering into a transaction in securities without intention of performing it or without
intention of change of ownership of such security;
h) selling, dealing or pledging of stolen or counterfeit security whether in physical or
i) an intermediary promising a certain price in respect of buying or selling of a security to a
client and waiting till a discrepancy arises in the price of such security and retaining the
difference in prices as profit for himself;
j) an intermediary providing his clients with such information relating to a security as
cannot be verified by the clients before their dealing in such security
k) an advertisement that is misleading or that contains information in a distorted manner
and which may influence the decision of the investors
l) an intermediary reporting trading transactions to his clients entered into on their behalf
in an inflated manner in order to increase his commission and brokerage;
m) an intermediary not disclosing to his client transactions entered into on his behalf
including taking an option position;
n) circular transactions in respect of a security entered into between intermediaries in
order to increase commission to provide a false appearance of trading in such security
or to inflate, depress or cause fluctuations in the price of such security;
o) encouraging the clients by an intermediary to deal in securities solely with the object of
enhancing his brokerage or commission.
p) an intermediary predating or otherwise falsifying records such as contract notes.
q) an intermediary buying or selling securities in advance of a substantial client order or
whereby a futures or option position is taken about an impending transaction in the
same or related futures or options contract.
r) planting false or misleading news which may induce sale or purchase of securities.
Q.2 Discuss the method of price discovery using the book building process.
Ans:- A company that intends to issue capital through book-building has to follow the
book-building guidelines. The following are the guidelines for book-building:
• 75 percent book-building – The option for 75 percent book building is available in an
issue of securities to the public though prospectus. The option of book-building is
available to all the corporate that are eligible to make issue of capital to the public. In
the 75 percent book-building, the issue is classified into two parts:
• Placement part – The placement part of the issue is offered to the public through the
syndicate through the book building process. All investors can have a share in the
public portion which is done through the syndicate members.
• Public part – The public part is the offer to the public. It is responded by retail offering.
The price agreed in the book building process is applicable to the public offer.
The prospectus must specify the price band within which the securities are offered for
subscription. The SEBI permits partial book building with 75 percent of the total issue
allotted for the book built part. The remaining 25 percent is offloaded in the market at a
fixed price revealed during the book building process.
• 100 percent book-building – The SEBI has permitted the issuers to go for 100 percent
book-building without offloading any portion of the issue in the market. In 100 percent
book building, the entire issue is completed in a single stage without making a fixed
price offering. This type of book building can accelerate the public offering and allotment
process as it takes place entirely through the stock exchange network. The 100 percent
book building method provides an option to suspend the issue if the price is
The SEBI approved the process of book building in pricing new issues in November 1,
1995. According to the SEBI guidelines, the option of 100 percent book building is only
available to those issuer companies which made an issue capital of Rs.100 crore and
above. The guidelines were later modified in 1998 to 1999. The ceiling of issue size for
book building was reduced from Rs.100 crore to Rs.25 crore.
In April 2000, the SEBI modified the guidelines for the 100 percent book building
process. According to the guidelines, the maximum of 60 percent of the issue was
permitted to be allotted to institutional investors, 15 percent to non-institutional investors
who applied for 1000 shares and the remaining 25 percent were allotted to small
investors on a pro-rate basis. ICICI was the first to price its debt issue through book
Q.3 Discuss the role of a custodian of shares.
Ans:- The role of a custodian in such a case would be to:
• hold in safekeeping assets/securities such as stocks, bonds, commodities
such as precious metals and currency (cash), domestic and foreign
• arrange settlement of any purchases and sales and deliveries in/out of such
securities and currency
• collect information on and income from such assets (dividends in the case of
stocks/equities and coupons (interest payments) in the case of bonds) and administer
related tax withholding documents and foreign tax reclamation
• administer voluntary and involuntary corporate actions on securities held such
as stock dividends, splits, business combinations (mergers), tender offers, bond calls,
• provide information on the securities and their issuers such as annual general
meetings and related proxies
• maintain currency/cash bank accounts, effect deposits and withdrawals and
manage other cash transactions
• perform foreign exchange transactions
• often perform additional services for particular clients such as mutual funds;
examples include fund accounting, administration, legal, compliance and tax support
• provide regular and special reporting on any or all their activities to their
clients or authorized third parties such as MAIC Trust Account services for mergers &
Custodian banks are often referred to as global custodians if they safe keep assets for
their clients in multiple jurisdictions around the world, using their own local branches or
other local custodian banks with which they contract to be in their "global network" in
each market to hold accounts for their respective clients. Assets held in such a manner
are typically owned by larger institutional firms with a considerable amount of
investments such as MAIC Trust services & (QI) Qualified Intermediary services banks,
insurance companies, mutual funds, hedge funds and pension funds.
Q.4 A company wishes to take machinery on lease. Study the lease options
available to the company.
Ans:- A lease is in essence an extended rental agreement under which the owner of the
equipment allows the user to operate or otherwise make use of the equipment in
exchange for periodic lease payments. In leasing terminology, the owner is the lessor,
the user is the lessee. Equipment leasing is a popular option for companies of all sizes.
The Equipment Leasing Association of America estimates that 80 percent of all
companies lease at least some of their equipment, and the organization estimates that
firms leased $220 billion worth of goods in 2004, projected to reach $229 billion in 2005.
But equipment leasing is particularly favored by many small businesses, which often
have fewer options because of limited capital
The two primary types of leases are operating and long-term or "capital" leases.
Operating leases are characterized by short-term, cancelable terms; the lessor bears
the risk of obsolescence and enjoys such benefits as depreciation, including, if
applicable, accelerated depreciation. These leases are generally preferable when the
company needs the equipment for a short period of time. Under the usual terms of
operating leases, a lessee can usually cancel the lease, assuming prior notice, without
a major penalty. Long-term, "capital," non-cancelable leases, also known as full payout
or financial leases, are sources of financing for assets the lessee company wants to
acquire and use for longer periods of time. Most financial leases are "net" leases,
meaning that the lessee is responsible for maintaining and insuring the asset and
paying all property taxes, if applicable. Financial leases are often used by businesses
for expensive capital equipment.
In addition to these two basic leasing models, a considerable variety of other lease
arrangements are often used. These leases, each of which combine different financial
and tax advantages, are actually hybrids of financial and operating leases that reflect
the individual needs of lessor companies. For example, full-service leases are leases
wherein the lessor is responsible for insurance and maintenance (these are
commonplace with office equipment or vehicle leases). Net leases, on the other hand,
are leases wherein the lessee is responsible for maintenance and insurance. Leveraged
leases, meanwhile, are arrangements wherein the cost of the leased asset is financed
by issuing debt and equity claims against the asset and future lease payments
Q.5 Give examples of various venture capital funds that are present and examples
of some business ventures that have been successful with venture capital
Ans:- Venture capital is money put into an enterprise which may all be lost if the
enterprise fails. A businessman starting up a new business will invest venture capital of
his own, but he will probably need extra funding from a source other than his own
pocket. However, the term 'venture capital' is more specifically associated with putting
money, usually in return for an equity stake, into a new business, a management buy-
out or a major expansion scheme.
The institution that puts in the money recognizes the gamble inherent in the funding.
There is a serious risk of losing the entire investment, and it might take a long time
before any profits and returns materialize. But there is also the prospect of very high
profits and a substantial return on the investment. A venture capitalist will require a high
expected rate of return on investments, to compensate for the high risk.
A venture capital organization will not want to retain its investment in a business
indefinitely, and when it considers putting money into a business venture, it will also
consider its "exit", that is, how it will be able to pull out of the business eventually (after
five to seven years, say) and realize its profits.
Examples of venture capital organizations are: Merchant Bank of Central Africa Ltd
and Anglo American Corporation Services Ltd.
When a company's directors look for help from a venture capital institution, they must
• the institution will want an equity stake in the company
• it will need convincing that the company can be successful
• it may want to have a representative appointed to the company's board, to look after its
The directors of the company must then contact venture capital organizations, to try and
find one or more which would be willing to offer finance. A venture capital organization
will only give funds to a company that it believes can succeed, and before it will make
any definite offer, it will want from the company management:
a) a business plan
b) details of how much finance is needed and how it will be used
c) the most recent trading figures of the company, a balance sheet, a cash flow forecast
and a profit forecast
d) details of the management team, with evidence of a wide range of management skills
e) details of major shareholders
f) details of the company's current banking arrangements and any other sources of
g) Any sales literature or publicity material that the company has issued.
A high percentage of requests for venture capital are rejected on an initial screening,
and only a small percentage of all requests survive both this screening and further
investigation and result in actual investments.
Q.6 Mutual fund schemes can be identified by investment objective, List one
scheme within each category.
Ans:- Among the various investment routes available in the market currently, mutual
funds identifies more with the average investors, because of the ease, transparency,
cost of investment and wealth building capability in the long term. From a humble
beginning during the early nineties, the mutual fund industry in India has witnessed
phenomenal growth and has become a compelling investment avenue for the retail
investors. As of now, the average Assets Under Management (AUM) of all Mutual
Funds taken together is set to surpass Rs. 8,00,000 crores, while it was hovering
around Rs. 1,00,000 crore about a decade back. This explains the rising interest in
mutual fund investment. Mutual Funds in India are on the threshold of completing two
decades in business and the journey so far has been momentous. Initially from a regime
of guaranteed returns as an investment drawing measure, to the present situation
where returns are subject to the dynamics of stock markets, mutual fund houses have
seen it all. When the mutual fund industry was taking baby steps, it had to resort to
guaranteed return as a strategic move to attract customers to align with the investing
mindset in that particular period. The average person’s investing horizon could not
fathom anything beyond the safety net of Bank Fixed Deposits, Post Office and other
forms of guaranteed returns products. Therefore Mutual Funds could have never
afforded to swim against the tide and offer products declaring that these are subject to
market risk. They just took the opportune measure by offering guaranteed returns to get
a head start. Obviously, a lot of mutual fund schemes fared well in the initial years and
could generate assured return, but a majority of them suffered heavily due to the
infamous stock market scandal of 1992. This was a watershed year in the history of the
mutual fund industry which led to the culmination of the guaranteed return era. Proper
investor education and the increased penetration of equity cult among the masses led to
the transforming reality that investments in mutual funds are subject to market risks.
This risk taking ability has to be managed properly during the entire money life of an
individual to get higher return that will not only beat inflation, but help in reaching a lot of
financial milestones. For instance higher financial risk can be taken in the initial years of
one’s life to choose equity funds and thereafter switch to debt oriented funds in the later
years. This mindset transformation gave the required fillip and soon mutual funds
evolved as one of the most smart investment opportunity for the average person. The
results are striking example to justify that during the last decade, money invested in the
top ranked mutual fund have given substantial returns during the long term.
On the basis of investment objective, mutual fund can be grouped into
(i) Growth Scheme
(ii) Equity-Linked Savings Scheme (ELSS) and
(iii) Income Scheme
(i) Growth Schemes: Growth Scheme Mutual Fund is by far the largest in their
category and they invest in equity and equity-related capital market instruments,
generating capital appreciation over the medium to long-term. Equities normally have a
high-risk high-return characteristic, nevertheless if one is ready to invest over the long-
term, then equities can be very worthwhile and perfect for accumulation of wealth.
These are also follows: Diversified Equity Funds: These mutual fund places their
investments in companies spread over various sectors. These funds can be further
divided into large-cap funds, mid-cap funds and small cap funds. Large-cap funds are
those with a huge capital base like Reliance Group, Larsen Toubro etc whereas Mid-
cap companies are those with less capital compared to large-cap companies while
small-cap companies have comparatively less capital than mid-cap companies. Some of
the Diversified Large-Cap Mutual Fund schemes are Birla Sun Life Frontline Equity,
HDFC Equity, HDFC Top 200, DSP Black Rock Top 100 Equity, Fidelity Equity, ICICI
Prudential Dynamic, Kotak 30, Tata Pure Equity and UTI Dividend Yield Fund. Similarly
Diversified Mid-cap Funds are Birla Sun-Life Mid-cap, DSP Black Rock Equity, ICICI
Prudential Discovery, IDFC Premier Equity, Reliance Growth, Sundaram S.M.I.L.E. and
Sundaram Select Mid-Cap.
(ii) Equity-Linked Savings Scheme (ELSS): ELSS is nothing but diversified equity
funds embedded with a tax advantage feature. These funds have a lock-in period of
three year under which investors can avail tax benefits under Section 80C of the Income
Tax Rules. Some of the ELSS funds are SBI Magnum Tax Gain, Fidelity Tax
Advantage, ICICI Pru Tax Plan, Canara Robecco Equity Tax Saver, Franklin India Tax
Shield and Reliance Tax Saver.
(iii) Income Schemes: These schemes deliver steady income through investment in
fixed-income securities or debt instruments. Since these are invested in debt
instruments, the capital appreciation in case of such scheme will be limited but the
added advantage is that the downside risk will also be limited. It is important to note that
the risk-return profile in case of these funds is dependent on the average maturity i.e.
short, medium, long-term of the instrument that constitute these schemes. Some of the
better performing income schemes are Birla Sun Life MIP Savings 5, HDFC MIP and
Investment Mode: Investments in Mutual Fund can be made either in bulk amount or in
small amounts regularly known as Systematic Investment Plans (SIP). Investment
through SIP mode is considered better as it takes advantage of the stock market
volatility, thus buying more units when the NAV is low and lesser units when the NAV is
more. This aligns with the principle of Rupee Cost Averaging and hence helps in
accumulating wealth in the long-term.