2018 – Solved Question Paper | Financial Service | Final Year – Masters of Commerce (M.Com) | Dibrugarh University

2018 – Solved Question Paper | Financial Service | Final Year – Masters of Commerce (M.Com) | Dibrugarh University



Paper: 205

(Financial Services)

Full Marks: 80

Time: Three Hours

The figures in the margin indicate full marks for the questions.

1. (a) Discuss the role and responsibility of merchant bankers in pre-Issue and post Issue management of New Issue Market. (18)

-> Merchant bankers regulations, 1992 defines ‘merchant banker’ as any person who is engaged in the business of issue management either by making arrangements regarding selling, buying, or subscribing to securities or acting as manager, consultant, adviser, or rendering corporate advisory service in relation to such issue management. A merchant banker provides various services such as Promotional activities, Credit syndication, Project counseling, and Portfolio management, etc. However, one of the primary functions of the merchant banker is issue management, be it IPO, FPO, or right issue. The purpose of this article is to practically analyze the role of a merchant banker in IPO management right from due diligence aspect to allotment/refund of the securities while also discussing applicable provision of SEBI (ICDR) Regulations, 2018 and relevant notifications or circulars by SEBI.

The Roles and obligation of the merchant banker can be classified into three groups-

  • Pre-issue role
  • Post issue role

· Operational guidelines prescribed by SEBI

Pre-issue role of Merchant Banker in IPO Management

The pre-issue stage is the stage before issuing the securities to the subs. The pre-issue role and obligation of the merchant banker generally involve activities such as due diligence, requisite fee, submission of documents, the appointment of intermediaries, underwriting, etc. Some of the major activities done by the merchant banker in relation to IPO management at this stage are-

Due Diligence of the issuer–

Regulation 24 of SEBI (ICDR) Regulation, 2018 mandate that lead manager shall exercise due diligence and satisfy themselves about all aspects of the issue including the veracity and adequacy of disclosure in the draft offer document and the offer document which means merchant banker shall ensure that the framework provided by the SEBI shall be complied with and implemented in draft offer documents. A checklist that may be useful for conducting pre-issue due diligence is-

· Check whether the issuer fulfills the eligibility criteria relating to a minimum tangible asset, Net worth, and average operating profit limited mentioned in regulation 6 of ICDR Regulations

· Check whether the issuer is not ineligible to make an IPO under regulation 5 of ICDR Regulations.

· Check whether the issuer satisfies the general conditions for IPO mentioned in Regulation 7 of ICDR regulation

· Check whether the issuer has made all the material disclosure in draft offer documents and verifying the content of offer documents

· Check whether the minimum promoter contribution requirement mentioned in Regulation 14 is fulfilled

Merchant banker is obligated to submit a due diligence certificate along with a Draft offer document to SEBI.

Appointment of intermediaries-

Regulation 23 of the ICDR Regulation imposes the duty to appoint merchant bankers and other intermediaries with merchant banker consultation on the issuer. However, practically it is the merchant who gets the issuer in touch with other intermediaries. This regulation also imposes an obligation on the merchant banker to assess the capability and independence of the intermediaries. As per ICDR Regulation, some of the intermediaries involved in an IPO are-

  • Merchant banker
  • Underwriters
  • Banker to the issue
  • Registrar to the issue
  • Compliance officer
  • Depositories

· Monitoring agency if issue size exceeds 100 crore

Filling draft offer document with requisite document

In accordance with Regulation 25 of the ICDR Regulation and other applicable guidelines, the lead manager along with a draft offer letter shall file the following documents with SEBI-

· Due diligence certificate as per schedule V

· Memorandum of Understanding entered between the issuer and the merchant banker

· In case a public or rights issue is managed by more than one merchant banker the rights, obligations, and responsibilities of each merchant banker shall be demarcated as specified in Schedule II.

· Details of Promoter of the issuer and list of the promoter group

· an undertaking to the Board by the issuer to the effect that transactions in securities by the `promoter’ the ‘promoter group’ and the immediate relatives of the `promoters during the period between the date of filing the offer documents with the Registrar of Companies or Stock Exchange as the case may be and the date of closure of the issue shall be reported to the Stock exchanges concerned within 24 hours of the transaction(s).

Making public the offer document and advertisement of the issue

As per regulation 26 of ICDR merchant banker should ensure that draft offer letter is available for the public on SEBI and stock exchange website for at least 21 days from the date of filling. A public announcement is also needed to be made within 2 days of the filling of the offer document in an English and Hindi national newspaper inviting the public to give their comments to the SEBI. A pre-issue advertisement is also required to be made as per regulation 43 after registering the prospectus with ROC containing the disclosure specified in part A of Schedule X. After 21 days of filing the draft offer document, the merchant banker shall file a statement showing the complaints received by the public and highlights of the proposed amendments to SEBI.

Setting up mandatory collection center and authorized collection agents

As per regulation 23 read with schedule XII, a merchant banker needs to ensure that the issuer designates a collection center in Mumbai,Kolkata, Delhi,Chennai, and at such place where the recognized stock exchange is located. The issuer company can also appoint authorized collection agents in consultation with the Lead Merchant Banker subject to necessary disclosures including the names and addresses of such agents made in the offer document.

Calculating requisite fee and ensuring legal compliances

It is the duty of the merchant banker to calculate the required fee needed to be paid with the draft offer document mentioned in Schedule III and ensure that the issue complies with all the relevant legal compliance

Post-issue role of Merchant Banker in IPO Management

The post-issue obligation is the stage after the securities are issued to the subscribers. The major post-issue obligations relate to association with allotment procedure, post-issue monitoring reports, redressal of investor grievances and coordination with intermediaries, etc. This includes-

Allotment procedure and basis of allotment

Merchant banker along with MD of the recognized stock exchange and registrar of the issue is responsible to ensure that the basis of allotment is finalized in a fair and proper manner in accordance with Regulation 49 of ICDR Regulations. The allotment of such shares should be in such a way that the minimum allotment would be equal to the minimum application size as determined and disclosed in the offer document.

Post issue monitoring report

The merchant banker in case of IPO shall submit a post-issue monitoring report on the 3rd day from the date of closure of the subscription of the issue.

Post-issue advertisement

Regulation 51 of ICDR regulation impose a duty on merchant banker to ensure that a post-issue advertisement giving details relating to subscription, the basis of allotment, value, and percentage of all applicants, date of filing of listing application, etc is released within ten days from the date of various activities in at least one nationwide English and Hindi newspaper.

Redressal of investor’s grievance

The Post -issue Lead Merchant Banker shall actively associate himself with post-issue activities namely, allotment, refund and dispatch and shall regularly monitor redressal of investor grievances arising therefrom.

Coordination with intermediaries

It includes coordinating with various agencies connected with the post-issue activity such as registrar to issue, bankers to the issue, bankers to the issue, self-certified banks, and underwriter.

Certificate regarding the realization of stock investors and other requirement

The Post-Issue Lead Merchant Banker shall submit within two weeks from the date of allotment, a Certificate to the Board certifying that the stock invests on the basis of which allotment was finalized, has been realized

Operational guidelines prescribed by SEBI

The compliance requirements of merchant banker(s) in relation to operational guidelines cover submission of the draft and final offer documents, instruction on post-obligations, issue of penalty points, and so on. These guidelines can be accessed on the website of SEBI.

Case study related to Role of Merchant Banker in IPO Management

The recent hit public issue of Burger king India limited is a classic example of how a well-managed issue can benefit all the stakeholders. Burger King is India’s fastest growing quick-service restaurant chain which opened up its issue from 2nd December to 4th December 2020. Due to the uncertainties in the market and COVID-19, the role of the merchant became more important than ever. Activities in the secondary market picked up pace after the benchmarks rebounded on the optimism stemming from the fiscal and monetary stimulus announced by the government and central bank, a faster-than-expected pickup in economic activities after lockdown curbs were eased, robust foreign flows, and a potential Covid-19 vaccine. This issue was managed by 4 merchant bankers being Kotak Mahindra Capital limited, CLSA India private limited, Edelweiss Financial services limited, and JM Financial limited. The IPO was getting delayed due to regulatory requirements and then COVID which created uncertainties in the mind of the investors. The company came up with 810 crores rs issue and the issue got fully subscribed within 2 hours and was 156 times oversubscribed. One of the major challenges before the merchant banker to gain the trust of the investors as the risk involved was higher. The key risks were-

· The outbreak of the Covid-19 pandemic

· Real and perceived health concerns arising from food-borne illnesses, health epidemics, food quality, allergic reactions or other negative food-related incidents

· The termination of master franchise and development agreement

· Demand for products may decrease due to changes in consumer preferences and food habits

· Business depends in part on the continued international success and reputation of the Burger King brand globally, and any negative impact on the brand may have an adverse impact

· Deterioration in the performance of, or its relationships with, third-party delivery aggregators

· Inability to identify suitable locations and successfully develop and roll out new restaurants, and expand into new regions.

Even besides all the issues the merchant bankers involved did their pre and post-issue duties diligently. The offer letter of the IPO got accepted by SEBI and the public issue was a hit. This showed how important the role of the merchant banker is and how proper due diligence can be beneficial for everyone.

(b) Write short notes on the following: (6×3=18)

1) Portfolio Management Procedure.

-> Portfolio management’s meaning can be explained as the process of managing individuals’ investments so that they maximize their earnings within a given time horizon. Furthermore, such practices ensure that the capital invested by individuals is not exposed to too much market risk.

The entire process is based on the ability to make sound decisions. Typically, such a decision relates to – achieving a profitable investment mix, allocating assets as per risk and financial goals and diversifying resources to combat capital erosion.

Primarily, portfolio management serves as a SWOT analysis of different investment avenues with investors’ goals against their risk appetite. In turn, it helps to generate substantial earnings and protect such earnings against risks.

Objectives of Portfolio Management

The fundamental objective of portfolio management is to help select best investment options as per one’s income, age, and time horizon and risk appetite.

Some of the core objectives of portfolio management are as follows –

  • Capital appreciation
  • Maximizing returns on investment

· To improve the overall proficiency of the portfolio

  • Risk optimization
  • Allocating resources optimally
  • Ensuring flexibility of portfolio

· Protecting earnings against market risks

Nonetheless, to make the most of portfolio management, investors should opt for a management type that suits their investment pattern.

Types of Portfolio Management

In a broader sense, portfolio management can be classified under 4 major types, namely –

  • Active portfolio management

In this type of management, the portfolio manager is mostly concerned with generating maximum returns. Resultantly, they put a significant share of resources in the trading of securities. Typically, they purchase stocks when they are undervalued and sell them off when their value increases.

  • Passive portfolio management

This particular type of portfolio management is concerned with a fixed profile that aligns perfectly with the current market trends. The managers are more likely to invest in index funds with slow but steady returns which may seem profitable in the long run.

  • Discretionary portfolio management

In this particular management type, the portfolio managers are entrusted with the authority to invest as per their discretion on investors’ behalf. Based on investors’ goals and risk appetite, the manager may choose whichever investment strategy they deem suitable.

  • Non-discretionary management

Under this management, the managers provide advice on investment choices. It is up to investors whether to accept the advice or reject it. Financial experts often recommended investors to weigh in the merit of professional portfolio managers’ advice before disregarding them entirely.

There are few things more important and more daunting than creating a long-term investment strategy that can enable an individual to invest with confidence and with clarity about his or her future. Constructing an investment portfolio requires a deliberate and precise portfolio-planning process that follows five essential steps.

Step 1: Assess the Current Situation

Planning for the future requires having a clear understanding of an investor’s current situation in relation to where they want to be. That requires a thorough assessment of current assets, liabilities, cash flow, and investments in light of the investor’s most important goals. Goals need to be clearly defined and quantified so that the assessment can identify any gaps between the current investment strategy and the stated goals. This step needs to include a frank discussion about the investor’s values, beliefs, and priorities, all of which set the course for developing an investment strategy.

Step 2: Establish Investment Objectives

Establishing investment objectives centers on identifying the investor’s risk-return profile. Determining how much risk an investor is willing and able to assume, and how much volatility the investor can withstand, is key to formulating a portfolio strategy that can deliver the required returns with an acceptable level of risk. Once an acceptable risk-return profile is developed, benchmarks can be established for tracking the portfolio’s performance. Tracking the portfolio’s performance against benchmarks allows smaller adjustments to be made along the way.

Step 3: Determine Asset Allocation

Using the risk-return profile, an investor can develop an asset allocation strategy . Selecting from various asset classes and investment options, the investor can allocate assets in a way that achieves optimum diversification while targeting the expected returns. The investor can also assign percentages to various asset classes, including stocks, bonds, cash, and alternative investments, based on an acceptable range of volatility for the portfolio. The asset allocation strategy is based on a snapshot of the investor’s current situation and goals and is usually adjusted as life changes occur.

Step 4: Select Investment Options

Individual investments are selected based on the parameters of the asset allocation strategy. The specific investment type selected depends in large part on the investor’s preference for active or passive management . An actively managed portfolio might include individual stocks and bonds if there are sufficient assets to achieve optimum diversification, which is typically over $1 million in assets. Smaller portfolios can achieve the proper diversification through professionally managed funds, such as mutual funds or exchange-traded funds. An investor might construct a passively managed portfolio with index funds selected from the various asset classes and economic sectors.

Step 5: Monitor, Measure and Rebalance

After implementing a portfolio plan, the management process begins. This includes monitoring the investments and measuring the portfolio’s performance relative to the benchmarks. It is necessary to report investment performance at regular intervals, typically quarterly, and to review the portfolio plan annually. Once a year, the investor’s situation and goals get a review to determine if there have been any significant changes. The portfolio review then determines if the allocation is still on target to track the investor’s risk-reward profile. If it is not, then the portfolio can be rebalanced , selling investments that have reached their targets, and buying investments that offer greater upside potential.

When investing for lifelong goals, the portfolio planning process never stops. As investors move through their life stages, changes may occur, such as job changes, births, divorce, deaths, or shrinking time horizons, which may require adjustments to their goals, risk-reward profiles or asset allocations. As changes occur, or as market or economic conditions dictate, the portfolio planning process begins anew, following each of the five steps to ensure that the right investment strategy is in place.

2) Preparation and Issue of Prospectus.

3) Registration of Merchant Bankers in Indian Capital Market.

-> A merchant banker underwrites corporate securities and provides guidelines to clients on issues like corporate mergers. The merchant banker may be in the form of a bank, a firm, company or even a proprietary concern. It is basically service banking which provides non-financial services such as arranging for funds rather than providing them.

The merchant banker understands the requirements of the business concerns and arranges finance with the help of financial institutions, banks, stock exchanges, and money market.

Registrations of Merchant banking:-

1. The applicant shall be a body corporate

2. The applicant shall have necessary infrastructure like perform adequate office space, equipment, and manpower to carry on the business activities and to discharge his activities and services effectively

3. The applicant shall employ at least two persons having experience in the field of merchant banking activities

4. The applicant shall fulfill the minimum capital adequacy requirement i.e. the applicant must have a net worth of at least Rupees Five Crores

5. The applicant, his partner, director, or his principal officer shall not at any time been:

(i) involved in any litigation connected with the securities market which has an adverse bearing on the business of the applicant

(ii) convicted for any offence involving moral turpitude or has been found guilty of any economic offence.

Regulations by SEBI on Merchant Banking

Reforms for the merchant bankers

SEBI has made the following reforms for the merchant banker

1. Multiple categories of merchant banker will be abolished and there will be only one equity merchant banker.

2. The merchant banker is allowed to perform underwriting activity. For performing portfolio manager, the merchant banker has to seek separate registration from SEBI.

3. A merchant banker cannot undertake the function of a non banking financial company, such as accepting deposits, financing others’ business, etc.

4. A merchant banker has to confine himself only to capital market activities.

2. Write explanatory notes on the following: (any two) (5×2=10)

1) Equity linked Mutual Fund.

-> Equity mutual funds try generating high returns by investing in the stocks of companies across all market capitalizations. Equity mutual funds are the riskiest class of mutual funds, and hence, they have the potential to provide higher returns than debt and hybrid funds. The performance of the company plays a significant role in deciding the investors’ returns.

Equity mutual funds invest at least 60% of their assets in equity shares of numerous companies in suitable proportions. The asset allocation will be in line with the investment objective. The asset allocation can be made purely in stocks of large-cap, mid-cap, or small-cap companies, depending on the market conditions. The investing style may be value-oriented or growth-oriented. After allocating a significant portion towards the equity segment, the remaining amount may go into debt and money market instruments. This is to take care of sudden redemption requests as well as bring down the risk level to some extent. The fund manager makes buying or selling decisions to take advantage of the changing market movements and reap maximum returns.

Features of Equity Funds

Cost of investment

The frequent buying and selling of equity shares often impact the expense ratio of equity funds. The Securities and Exchange Board of India (SEBI) has capped the expense ratio at 2.5% for equity funds. A lower expense ratio will translate into higher returns for investors.

Holding period

Investors earn capital gains on the redemption of their fund units. The capital gains are taxable in the hands of investors. The rate of taxation depends on how long one stays invested and this period is called the holding period. Equity holdings of less than one year are termed short-term, and short-term capital gains are taxed at 15%. Equity holding of more than a year is termed long-term, and the long-term capital gains are taxed at the rate of 10% if the gains exceed Rs 1 lakh a year.

Cost-efficiency & diversification

By investing in equity funds, you get exposure to several stocks, and you get this benefit by investing a nominal amount. However, your portfolio will face the risk of concentration.

Types of Equity Funds

You can categories equity funds based on the investment mandate and the kind of stocks and sectors they invest in.

Based on Sector and Themes

Equity funds that focus investments on a particular sector or theme fall under this category. Sector funds invest in a specific industry such as FMCG, pharma, or technology. Thematic funds follow one specific subject, such as emerging consumer companies or international stocks. As sector funds and thematic funds focus on a particular sector or theme, they tend to be riskier. This is because of their performance face sectoral as well as market risks. However, industry and thematic funds can be diversified in terms of market capitalization.

Based on Market Capitalization

Large-cap equity funds: Large-cap companies are well-established, and hence, large-cap funds are capable of offering stable returns.

Mid-cap equity funds: These funds invest in medium-sized companies. Mid-cap equity funds are not as stable as large-cap funds.

Mid-and-small-cap funds: These funds invest in both mid-cap and small-cap funds and have the potential to offer high returns.

Small-cap funds: These funds invest in shares of small-cap funds. Investors should be aware of the fact that small-cap funds are more prone to market volatility and risk.

Multi-cap funds: Multi-cap funds invest in stocks across all market capitalizations. The fund manager decides to invest predominantly in a particular capitalization depending on the market condition.

Based on Investment Style

All the funds discussed above follow active investing style, wherein the fund manager decides the portfolio composition. However, there are funds whose portfolio composition imitates a specific index. Equity funds that follow a particular index, such as Sensex, are called index funds. These are passively-managed funds that invest in the same companies, in the equal proportions, making up the index the fund follows.

For example, a Sensex index fund will invest in all Sensex companies in the same proportion in which the companies form part of the index. Index funds are low-cost funds as they don’t require the active management of a fund manager. Example, a Sensex index fund will have investments in all 30 Sensex companies in the same proportion in which the companies form part of the index. Index funds are low-cost funds as they don’t require the active management of a fund manager.

Performance of Equity Funds in India

Among all categories of mutual funds, equity funds generally deliver the highest returns. On average, equity funds have generated returns in the range of 10% to 12%. The returns fluctuate depending on the market movement and overall economic conditions. To earn returns in line with your expectations, you need to choose your equity funds carefully. For that, you have to strictly follow the stock markets and possess knowledge of the quantitative and qualitative factors. ClearTax assists by handpicking the top-performing investment portfolios for you, which suits your financial goals.

Benefits of Investing in Equity Funds

The benefits of investing in mutual funds are many:

  • Expert money management
  • Low Cost
  • Convenience
  • Diversification
  • Systematic investments
  • Flexibility
  • Liquidity

The primary benefit of investing in equity funds is that you don’t need to worry about choosing stocks and sectors to invest. Successful equity investing requires a lot of research and knowledge. You need to understand and analyze the performance of a company before you decide to invest. You also need to have an understanding of how a particular sector is expected to perform in the future. Of course, all of this requires a lot of time and effort, which most individuals don’t have. Hence, the solution is to leave the stock-picking to an expert fund manager by investing in an equity mutual fund.

Taxation of Equity Funds

As mentioned earlier, short-term capital gains (STCG) are taxable at the rate of 15%. The Union Budget 2018-19 brought back the long-term capital gains (LTCG) tax on equity holdings. It is applicable at the rate of 10% if the gains exceed Rs 1 lakh a year.


Lump sum investments are apt for those individuals who have a considerable sum to invest. However, not many investors invest via the lump sum route.

Systematic Investment Plan (SIP)

A SIP allows you to invest a fixed sum on a period basis. The frequency of SIP can be weekly, monthly, and quarterly. You give a mandate to the fund company to deduct the investment from your bank account. SIPs give you the benefit of rupee cost averaging. This means that when the markets are high, you will be allotted fewer units. And when the markets are low, you will get more units for the same amount. This way, you invest at different levels of the market. SIPs also inculcate financial discipline and make mutual funds affordable for all. Click here to start a SIP in equity mutual funds .

2) Index Fund.

-> An index fund is a mutual fund that imitates the portfolio of an index. These funds are also known as index-tied or index-tracked mutual funds. Let us explore index funds in detail through the following topics.

Many investors are aware of the benefits of diversifying their portfolio across sectors. Index funds often catch investors’ attention as they intend to replicate the performance of their underlying index– like the Sensex or the Nifty. All the stocks in these indices will find some representation in their investment portfolio. This theoretically ensures a performance identical to that of the index, which is being tracked. The low expense ratio is its main USP.

Index funds are not actively managed funds, thus incurs low expenses. They do not aim at outperforming the market, but instead to track an index. They help an investor manage or balance the risks in their investment portfolio.

How do Index Funds Work

When an index fund tracks a benchmark like the Nifty, its portfolio will have the 50 stocks that comprise Nifty, in the same proportions. An index is a group of securities defining a market segment. These securities can be bond market instruments or equity-oriented instruments like stocks. Some of the most popular indices in India are BSE Sensex and NSE Nifty. Since index funds track a particular index, they fall under passive fund management. The fund manager decides which stocks have to be bought and sold according to the composition of the underlying benchmark. Unlike actively managed funds, there isn’t a standalone team of research analysts to identify opportunities and select stocks as index funds track an index.

While an actively managed fund strives to beat its benchmark, an index fund’s role is to match its performance to that of its index. Index funds typically deliver returns more or less equal to the benchmark. However, there can be a small difference between fund performance and the index. This is referred to as the tracking error. The fund manager must work towards bringing down the tracking error as much as possible.

Index Funds is invested by-

The investment decision in a mutual fund solely depends upon your risk preferences and investment goals. Index funds are ideal for investors who are risk-averse and expect predictable returns. These funds do not require extensive tracking. For example, if you wish to participate in equities but don’t wish to take risks associated with actively managed equity funds, you can choose a Sensex or Nifty index fund. These funds will give you returns matching the upside that the particular index sees. However, if you wish to earn market-beating returns, then you can opt for actively managed funds.

The returns of index funds may match the returns of actively managed funds in the short run. However, the actively managed fund tends to perform better in the long term. Investing in these funds is suitable for long-term investors who have an investment horizon of at least 7 years. These funds do carry market and volatility risks and hence suits only those willing to take some risk.

Things to Consider as an Investor

  • Risk tolerance
    Since index funds map an index, they are less prone to equity-related volatility and risks. Investing in index funds is an excellent option if you wish to generate high returns amid a rallying market. However, you will have to switch to actively managed funds during a market slump. Index funds tend to lose their value during a market downturn. Hence, it is advised to have a mix of actively managed funds and index funds in your portfolio.
  • Return factor
    Unlike actively managed funds, index funds track the performance of the underlying benchmark passively. These funds do not aim to beat the benchmark but just to replicate the performance of the index. However, the returns generated may not be at par with that of the index due to tracking errors. There can be deviations from actual index returns.
    Hence, it is advised to shortlist funds with minimum tracking error before investing in an index fund. The lower the errors, the better the performance of the fund.
  • Cost of investment
    Index funds usually have an expense ratio much lower than actively managed funds. The portfolio of the index funds is generally passively managed, and the fund manager is not required to formulate any investment strategy. Hence, the difference in the expense ratio.
    If two index funds are tracking the Nifty, both will generate similar returns. The only difference will be the expense ratio. The fund, which has a lower expense ratio, will generate comparatively higher returns on investment.
  • Investment horizon
    Index funds, generally, suits individuals with a long-term investment horizon. Usually, the fund experiences many fluctuations during the short run, which averages out in the long run, say, more than seven years to generate returns in the range of 10%-12%. Those who choose index funds must be patient enough to stick around for at least that long. Only then can the fund perform at its full potential.
  • Financial goals
    Equity funds can be ideal for achieving long-term financial goals like wealth creation or retirement planning. Being a high risk-high return haven, these funds are capable of generating enough wealth, which may help you retire early and pursue your passion in life.

Taxation of Index Funds

As index funds are a class of equity funds, they are essentially taxed like any other equity fund plan. The dividends offered by an index fund is added to your overall income and taxed at your income tax slab rate. This is referred to as the classical method of taxing dividends in the hands of investors. The rate of taxation of index funds depends on the holding period. Short-term capital gains are realised on redeeming your units within a holding period of one year. These gains are taxed at a flat rate of 15%. Long-term capital gains are those gains that are realised on selling your fund units after a holding period of one year. These gains of up to Rs 1 lakh a year are made tax-exempt. Any gains above this limit attract a tax at the rate of 10%, and indexation is not allowed.

3) Open-ended Fund.

-> Open-ended Mutual Fund is an investment scheme where the shares can be issued and redeemed at any time.

A mutual fund is an investment option. It involves pooling in money from investors for investment in a variety of underlying securities. A mutual fund house issues unit of mutual funds to investors in proportion to their investment money.

The objectives of the mutual fund are disclosed in the offer document. The profits or losses are shared by investors in proportion to their investments.

A mutual fund must be registered with the Securities and Exchange Board of India (SEBI) before it can collect funds from the public.

On the basis of structures, mutual funds can be classified into two categories: open-ended mutual funds and close-ended mutual fund. Open-ended schemes are available for subscription and repurchase on a continuous basis. There is no fixed maturity period. Investors have the option to buy and sell units at NAV which is declared on a daily basis. The past performance of these assets can be tracked which allows the investor to make a well-informed decision. If the investor is looking for liquidity alone, these funds are a great option.

A mutual fund is floated in the market through a new fund offer. In case of open-ended funds, an investor can purchase or sell units of an open-ended mutual fund at any time after the closure of NFO. The NFO is usually open for a maximum period of 30 days. Investment in these funds can be made through systematic investment plans (SIPs) and systematic withdrawal plans (SWPs).

In open-ended mutual funds, units are purchased and sold on demand at the net asset value of the fund. The NAV fluctuates every day based on the prices of the stocks and bonds in the market. There is no limitation on the number of units of the mutual fund that can be issued. There is no set maturity period for these funds. Once an investor redeems the units of an open-ended fund, the units are taken off the market. However, an investor has to pay exit loads for units that are sold within 1 year.

The fund is professionally managed by the fund manager. This scheme is a great option for investors who do not want to actively monitor their investments but are looking at optimal returns.

Advantages of investing in an open-ended fund:-

Here are the key advantages of investing in these funds

– Access to liquidity: There are no restrictions on the investor to redeem the units of an open-ended fund. This provides access to liquidity to the investors at any time they want. Moreover, the investors can redeem the funds as per the net asset value as on the day of redemption.

– Past performance: Investors of these funds can track the performance of the funds. The historical data available helps the investor take the best investment decision.

– Various systematic options available: These funds allow investors to make use of systematic plans for making investments and withdrawal. The investor can choose from SIPs, SWPs and systematic transfer plans.

– Professionally managed plans: There is an experienced fund manager who manages the fund. These managers have the expertise, experience, and resources to make the right investment decision for the investors.

Diversified portfolios: Open-ended funds invest a range of assets. The stocks belong to a variety of industries and companies. A diversified portfolio helps to reduce the risks associated with investments.

– Higher returns: These funds provide better returns in the long run compared to other schemes. For an investor with a short-term investment horizon, open-ended funds offer the perfect solution.

4) Mid-Cap Fund.

-> Mid cap funds are a type of equity mutual funds that invests in the stock of mid-sized companies. According to the norms, companies that are ranked from 101 onwards till 250 based on their market capitalization are categorized as mid cap companies.

Every mutual fund, be it debt or equity, has an underlying asset that generates returns for them. In the case of mid cap funds, the underlying asset is the stocks of mid-sized companies. This means that the money invested by investors in mid cap funds is used by fund managers to buy stocks of mid-sized companies, which have a potential to generate good returns in the long haul.

These companies are categorized as mid cap on the basis of their market capitalization or market value of the company. SEBI has specified that companies ranked between 101-250 based on their market capitalization will be put under the head of mid cap companies.

Mid Cap companies, as the name suggests, lies between large cap and small cap companies. They have evolved from small cap companies and are striving to become large cap companies. During the growth phase of the economy, mid-sized companies tend to grow at a faster rate than large cap or blue chip companies. On the other hand, during a slowdown, they get affected more.

It is important to note that when we talk about mid companies, we are not talking about small or unknown companies. Mid-sized companies are also pretty well known companies like Voltas, Sundaram Finance, Godrej Industries Ltd, etc.

Advantages of Investing in Mid Cap Funds-

· Higher Returns than Large Cap Funds:

In comparison to large cap funds, mid cap funds have given higher returns in the past over a long run. Reason being, as large cap funds invest in companies that are already mature and well known in the market, they grow at a stable but relatively lower pace.On the other hand, mid cap companies are future large caps and are where today’s large caps were a few years back. During this journey to become big, they can deliver outstanding returns

· Less Risky than Small Cap Funds:

As compared to small cap funds, mid cap funds are less risky. This is because stocks of small cap companies are relatively more volatile. That’s because while mid cap companies are not as financially strong as large companies, in most cases, they have a stronger balance sheet than small caps and therefore also have a better ability to navigate tough market conditions.

Mid Cap Mutual Funds is invested by-

· Investors with a Long Term Investment Horizon:

As we all know, big companies do not get built overnight. Since the underlying asset of mid cap mutual funds are companies that are yet to become big, investors need to be patient with their investments. Also, since these companies are not as financially strong as big companies, during a slowdown they might falter and take time to recover. So, to truly reap the benefits of investing these funds, one should invest in it for 7 to years.

· Investors willing to take higher risk for a chance to earn higher returns:

Mid cap funds carry higher risk than large cap funds but also give investors the opportunity to earn market beating returns. So only those investors who have the appetite to take should pick this fund category

· Investors willing to take higher risk for a chance to earn higher returns:

Mid cap funds can be volatile in short to medium term. You might even see a sharp drop in your portfolio’s value and that too suddenly. So only those who are willing to fathom this kind of volatility should invest in them.

Things to Consider Before Investing in Mid Cap Funds

  • Investment Goals: While investing in an equity mutual fund, normally it takes at least 5 years for the investment to give good returns. This period extends even more in the case of mid cap mutual funds. That’s because in the event of an economic downturn they get affected more than large cap companies, and might take some years to recover. So one should have a long term investment goal in mind like early retirement, child’s education, etc. while planning to invest in mid cap funds.
  • Returns: Mid Cap Funds generally tend to deliver market-beating returns over a long term. However, in a short to medium period, they might underperform. So investors need to be prepared to stay invested if they want to benefit from this fund category.
  • Risk: Not all mid cap companies grow to become large caps. In a tough market, there have been instances of mid caps going bankrupt. And while that is an extreme scenario, even if the company is not able to deliver on its return potential for whatever reason, the mutual fund holding that company or companies might not deliver the returns
  • Expense Ratio: There are expenses that eat into your returns. In order to manage the mid cap fund, the Asset Management Company (AMC) charges a fee from you on an annual basis called Expense Ratio, which reduces your real returns. So you should always try and pick a fund that has the least expense ratio coupled with a good track record.

Taxation on Mid Cap Funds

It’s the post tax returns that matter. So always check what is the return you’ll get after the tax is deducted because that is what counts. In order to determine that, you should be familiar with how mid cap funds are taxed. The capital gains made as a result of selling your mid cap fund are taxed depending on how long the investment was held by you.

  • Short Term Capital Gain Tax (STCG): If you sell your investments within 1 year, the gains are classified as Short Term Capital Gain (STCG) and you need to pay 15% tax on them.
  • Long Term Capital Gain Tax (LTCG): Whereas, any mid cap investment held for more than one year, the gains are classified as taxed Term Capital Gain (LTCG). Gains of up to 1 lakh in a financial year are tax free. Beyond 1 lakh, the gains are taxed at a rate of 10%.

3. (a) Discuss the importance of venture capital finance to small and micro enterprises. (10)

-> The importance of venture capital finance to small and micro enterprises:-

1. Promotes Entrepreneurs: Just as a scientist brings out his laboratory findings to reality and makes it commercially successful, similarly, an entrepreneur converts his technical know-how to a commercially viable project with the assistance of venture capital institutions.

2. Promotes products: New products with modern technology become commercially feasible mainly due to the financial assistance of venture capital institutions.

3. Encourages customers: The financial institutions provide venture capital to their customers not as a mere financial assistance but more as a package deal which includes assistance in management, marketing, technical and others.

Example: Hot mail dot com. It was a project invented by a young Indian graduate from Bangalore, by name Sabir Bhatia. This project was developed by him due to the financial assistance provided by the venture capital firms in Silicon Valley, U.S.A. His project was later on purchased by Microsoft Company, U.S.A. The Chairman of the company, Mr. Bill Gates offered 400 Million US Dollars in hot cash.

4. Brings out latent talent: While funding entrepreneurs, the venture capital institutions give more thrust to potential talent of the borrower which helps in the growth of the borrowing concern.

5. Promotes exports: The Venture capital institution encourages export oriented units because of which there is more foreign exchange earnings of the country.

6. As Catalyst: A venture capital institution acts as more as a catalyst in improving the financial and managerial talents of the borrowing concern. The borrowing concerns will be keener to become self dependent and will take necessary measures to repay the loan.

7. Creates more employment opportunities: By promoting entrepreneurship, venture capital institutions are encouraging self employment and this will motivate more educated unemployed to take up new ventures which have not been attempted so far.

8. Brings financial viability: Through their assistance, the venture capital institutions not only improve the borrowing concern but create a situation whereby they can raise their own capital through the capital market. In the process they strengthen the capital market also.

9. Helps technological growth: Modern technology will be put to use in the country when financial institutions encourage business ventures with new technology.

10. Helps sick companies: Many sick companies are able to turn around after getting proper nursing from the venture capital institutions.

11. Helps development of backward areas: By promoting industries in backward areas, venture capital institutions are responsible for the development of the backward regions and human resources.

12. Helps growth of economy: By promoting new entrepreneurs and by reviving sick units, a fillip is given to the economic growth. There will be increase in the production of consumer goods which improves the standard of living of the people.

(b) What are the factors that are analyzed by venture capitalists while deciding on investments? (10)

-> For entrepreneurs looking to raise capital for their start-up businesses, early-stage investors such as angel and venture capitalist investors can be awfully hard to find, and when you do find them, it’s even tougher to get investment dollars out of them.

But angels and venture capitalists (VCs) are taking on serious risk. New ventures frequently have little to no sales; the founders may have only the faintest real-life management experience, and the business plan may be based on nothing more than a concept or a simple prototype. There are plenty of good reasons why VCs are tight with their investment dollars.

Still, despite facing enormous risks, VCs do fork-out millions of dollars to tiny, untested ventures with the hope that they will eventually transform into the next big thing. So, what things prompt VCs to pull out their checkbooks?

With mature companies, the process of establishing value and investability is fairly straightforward. Established companies produce sales, profits and cash flow that can be used to arrive at a fairly reliable measure of value. For early-stage ventures, however, VCs have to put much more effort into getting inside the business and the opportunity.

Here are some key considerations for a VC when evaluating a potential investment:

Solid Management

Quite simply, management is by far the most important factor that smart investors take into consideration. VCs invest in a management team and its ability to execute on the business plan, first and foremost. They are not looking for “green” managers; they are looking ideally for executives who have successfully built businesses that have generated high returns for the investors.

Businesses looking for venture capital investment should be able to provide a list of experienced, qualified people who will play central roles in the company’s development. Businesses that lack talented managers should be willing to hire them from outside. There is an old saying that holds true for many VCs – they would prefer to invest in a bad idea led by accomplished management rather than a great business plan supported by a team of inexperienced managers.

Size of the Market

Demonstrating that the business will target a large, addressable market opportunity is important for grabbing VC investors’ attention. For VCs, “large” typically means a market that can generate $1 billion or more in revenues. In order to receive the large returns that they expect from investments, VCs generally want to ensure that their portfolio companies have a chance of growing sales worth hundreds of millions of dollars.

The bigger the market size, the greater the likelihood of a trade sale, making the business even more exciting for VCs looking for potential ways to exit their investment. Ideally, the business will grow fast enough for them to take first or second place in the market.

Venture capitalists expect business plans to include detailed market size analysis. Market sizing should be presented from the “top down” and from the “bottom up.” That means providing third-party estimates found in market research reports , but also feedback from potential customers, showing their willingness to buy and pay for the business’s product.

Great Product with Competitive Edge

Investors want to invest in great products and services with a competitive edge that is long lasting. They look for a solution to a real, burning problem that hasn’t been solved before by other companies in the marketplace. They look for products and services that customers can’t do without – because it’s so much better or because it’s so much cheaper than anything else in the market.

VCs look for a competitive advantage in the market. They want their portfolio companies to be able to generate sales and profits before competitors enter the market and reduce profitability. The fewer direct competitors operating in the space, the better.

Assessment of Risks

A VC’s job is to take on risk. So, naturally, they want to know what they are getting into when they take a stake in an early stage company. As they speak to the business’s founders or read the business plan, VCs will want to be absolutely clear about what the business has accomplished and what still needs to be accomplished.

  • Could regulatory or legal issues pop up?
  • Is this the right product for today or 10 years from today?
  • Is there enough money in the fund to fully meet the opportunity?

· Is there an eventual exit from the investment and a chance to see a return?

The ways that VCs measure, evaluate and try to minimize risk can vary depending on the type of fund and the individuals who are making the investment decisions. But at the end of the day, VCs are trying to mitigate risk while producing big returns from their investments.

4. (a) Trace the factors that have facilitated the growth of the leasing industry in India. (10)

-> The major reasons for the growing popularity of lease financing in India include but are not confined to the following only:

Ever since the First Leasing Company of India Limited (FLC) in 1973, lease financing has increased with a compound rate of 24% over the period (Sharmita;2009).

(i) Easy Entry:

Entry into leasing business is easy free from any barriers. Anyone could float a leasing entity, and even an existing company not in leasing business can write a lease purely for tax shelters.

(ii) Growing Capital Expenditure by Companies:

The post-liberalization era saw a spate of new ventures and fresh investments by existing ventures. Though primarily funded by the capital markets, these ventures initially relied mainly upon leasing as a source of additional or stand-by funding.

(iii) Ever Growing Car Market:

There are facts and figures readily available to believe that the growth in car leasing volume has been the highest over these years. The reason is not difficult to seek. The spurt in car sales with the entry of several new models was funded largely by leasing plans.

(iv) Tax Motivations:

India continues to have unclear distinction between a lease that will qualify for tax purposes, and one which would not. In retrospect, this is being realized as an unfortunate legislative mistake, but the absence of any clear rules to distinguish between true leases and financing transactions, and no bars placed on deduction of lease tax breaks against non-leasing income, propelled tax-motivated lease transactions.

(v) Optimistic Capital Markets:

Data would establish a clear connection between bullish stock markets and the growth in both number of leasing entities and lease volumes. Year 1994-1995 saw the peak of primary market activity where a company, even if a new entrant in business, could price itself on unexplainable premium and walk out with pride.

(vi) Easy Access to Public Deposits:

Most leasing companies in India have relied, some heavily, on retail public funds in the form of deposits. Most of these deposits were raised for 1 year tenure, and on promise of high rates of interest, at times even more than the regulated rate.

(vii) A Conducive Business Environment:

At the backdrop of all this was a general euphoria created by liberalization and the economic policies of Dr. Manmohan Singh making the business environment quite conducive for leasing business in India. For example, the withdrawal of investment allowance w.e.f. April 1, 1990 has made it more rational and economical to get a plant and equipment on lease than to purchase it.

5. (a) What is credit rating? Discuss the role of credit rating in industrial development of a country. (6+10=16)

(b) Briefly explain the methodology adopted by credit rating agencies in India. Give your comment regarding its credibility to the capital market. (10+6=16)

-> Credit rating is a codified rating assigned to an issue by authorized credit rating agencies . These agencies have been promoted by well-established financial Institutions and reputed banks/finance companies. Credit rating is a relative ranking arrived at by a systematic analysis of the strengths and weaknesses of a company and debt instrument issued by the company, based on financial statements , project analysis, creditworthiness factors and future prospectus of the project and the company appraised at a point of time.

Objectives of Credit Rating

Credit rating aims to:

· Provide superior information to the investors at a low cost;

· Subject borrowers to a healthy discipline, and

· Assist in the framing of public policy guidelines on institutional investment.

Thus, credit rating in financial services represents an exercise in faith building for the development of a healthy financial system .

Approaches to Credit Rating

As a technique for independent examination of the investment worth of financial securities as an input to investment decision-making , the process of credit rating usually involves use of one or more of (i) implicit judgmental approach and (ii) explicit judgmental approaches and (iii) statistical approach. While implicit judgmental follows beauty-contest approach wherein a broad range of factors concerning promoter, project, environment and instrument characteristics are considered ‘generally’. Explicit judgmental approach involves identification and measurement of the factors critical to an objective assessment of the credit/investment worthier of an instrument with a view to arriving at a numerical credit score or index. Finally, statistical approach involves assignment of weights to each of the factors and obtaining the overall credit rating score with a view to doing away with personal bias inherent in both-explicit and implicit judgment.

Methodology of Credit Rating

The process of credit rating begins with the prospective issuer approaching the rating agency for evaluation. The experts in analyzing banks should be given a free hand and they will collect data and informant and will investigate the business strength and weaknesses in detail. The entire process of rating stands on the for of confidentiality and hence even the most confidential business strategies , marketing plans , future outlook etc., are revealed to the steam of analysis.

The rating is based on the investigation analysis, study and interpretation of various factors. The world of investment is exposed to the continuous onslaught of political, economic, social and other forces which does not permit any one to understand sufficiently certainty. Hence a logical approach to systematic evaluation is compulsory and within the framework of certain common features the agencies employ different methodologies. The key factors generally considered are listed below:

1. Business Analysis or Company Analysis

This includes an analysis of industry risk, market position of the company, operating efficiency of the company and legal position of the company.

  • Industry risk: Nature and basis of competition , key success factors; demand supply position; structure of industry; government policies, etc.
  • Market position of the company within the Industry: Market share; competitive advantages , selling and distribution arrangements; product and customer diversity etc.
  • Operating efficiency of the company: Vocational advantages ; labor relationships ; cost structure and manufacturing as compared to those of competition.
  • Legal Position: Terms of prospectus; trustees and then responsibilities; system for timely payment and for protection against forgery/fraud, etc.

2. Economic Analysis

In order to evaluate an instrument an analyst must spend a considerable time in investigating the various economic activities and also analyze the characteristics peculiar to the industry, whose issue the analyst is concerned with. It will be an error to ignore these factors as the individual companies are always exposed to changing environment and the economic activates affect corporate profits, attitudes and expectation of investors and the price of the instrument. Hence the relevance of the economic variables such as growth rate, national income and expenditure cannot be ignored. The analysis, while doing the economic forecasting use surveys, various economic indicators and indices.

3. Financial Analysis

This includes an analysis of accounting, quality, earnings, protection adequacy of cash flows and financial flexibility.

4. Management Evaluation

· Evaluation of capacity to overcome adverse situations

5. Geographical Analysis

  • Location advantages and disadvantages

· Backward area benefit to the company/division/unit

6. Fundamental Analysis

Fundamental analysis is essential for the assessment of finance companies. This includes an analysis of liquidity management, profitability and financial position and interest and tax sensitivity of the company.

  • Liquidity Management: Capital structure ; term matching of assets and liabilities policy and liquid assets in relation to financing commitments and maturing deposits.
  • Asset Quality: Quality of the company’s credit-risk management; system for monitoring credit; sector risk; exposure to individual borrower; management of problem credits etc.
  • Profitability and financial position: Historic profits, spread on fund deployment revenue on non-fund based services accretion to reserves etc.
  • Interest and Tax sensitivity: Exposure to interest rate changes, hedge against interest rate and tax law changes, etc.

6. Write explanatory notes on any two of the following: (8×2=16)

a) Foreign Direct Investment.

-> Foreign direct investment (FDI) is an investment from a party in one country into a business or corporation in another country with the intention of establishing a lasting interest. Lasting interest differentiates FDI from foreign portfolio investments, where investors passively hold securities from a foreign country. A foreign direct investment can be made by obtaining a lasting interest or by expanding one’s business into a foreign country.

Methods of Foreign Direct Investment

As mentioned above, an investor can make a foreign direct investment by expanding their business in a foreign country. Amazon opening a new headquarters in Vancouver, Canada would be an example of this.

Reinvesting profits from overseas operations, as well as intra-company loans to overseas subsidiaries , are also considered foreign direct investments.

Finally, there are multiple methods for a domestic investor to acquire voting power in a foreign company. Below are some examples:

· Starting a subsidiary of a domestic firm in a foreign country

Benefits of Foreign Direct Investment

Foreign direct investment offers advantages to both the investor and the foreign host country. These incentives encourage both parties to engage in and allow FDI.

Below are some of the benefits for businesses:

  • Market diversification
  • Tax incentives
  • Lower labor costs
  • Preferential tariffs
  • Subsidies

The following are some of the benefits for the host country:

· Access to management expertise, skills, and technology

For businesses, most of these benefits are based on cost-cutting and lowering risk. For host countries, the benefits are mainly economic.

Disadvantages of Foreign Direct Investment

Despite many benefits, there are still two main disadvantages to FDI, such as:

  • Displacement of local businesses
  • Profit repatriation

The entry of large firms, such as Walmart, may displace local businesses. Walmart is often criticized for driving out local businesses that cannot compete with its lower prices.

In the case of profit repatriation, the primary concern is that firms will not reinvest profits back into the host country. This leads to large capital outflows from the host country.

As a result, many countries have regulations limiting foreign direct investment.

Types and Examples of Foreign Direct Investment

Typically, there are two main types of FDI: horizontal and vertical FDI.

Horizontal: a business expands its domestic operations to a foreign country. In this case, the business conducts the same activities but in a foreign country. For example, McDonald’s opening restaurants in Japan would be considered horizontal FDI.

Vertical: a business expands into a foreign country by moving to a different level of the supply chain . In other words, a firm conducts different activities abroad but these activities are still related to the main business. Using the same example, McDonald’s could purchase a large-scale farm in Canada to produce meat for their restaurants.

However, two other forms of FDI have also been observed: conglomerate and platform FDI.

Conglomerate: a business acquires an unrelated business in a foreign country. This is uncommon, as it requires overcoming two barriers to entry: entering a foreign country and entering a new industry or market. An example of this would be if Virgin Group, which is based in the United Kingdom, acquired a clothing line in France.

Platform: a business expands into a foreign country but the output from the foreign operations is exported to a third country. This is also referred to as export-platform FDI. Platform FDI commonly happens in low-cost locations inside free-trade areas. For example, if Ford purchased manufacturing plants in Ireland with the primary purpose of exporting cars to other countries in the EU.

b) Foreign Institutional Investors.

-> Foreign Institutional Investors is an institutional, individual or group entity seeking to invest in the economy of a country other than where the entity is headquartered. FIIs are important to emerging economies because they bring funds and capital to businesses in developing countries.

  • These investors usually include hedge funds, mutual funds, insurance companies and investment banks among others. FIIs generallyhold equity positions in foreign financial markets. Due to this, the companies invested in by FIIs generally have improved capital structures due to healthy inflow of funds. Thus, FIIs facilitate financial innovation and growth in capital markets.

· The entry of an FII can cause a drastic swing in domestic financial markets. It increases demand for local currency and directs inflation. Therefore, there are restrictions put by the managing authority of a country on how much stake FIIs can hold in the domestic company. This ensures that the FII’s influence on the company is limited, so as to avoid exploitation.

Factors to Consider

· Foreign Direct Investments (FDI) are a part of the investment made by Foreign Institutional Investors. However, not every FII will make an FDI in the country it is investing in.

  • FIIs directly impact the stock/securities market of the country, its exchange rate and inflation.

· FIIs can invest in listed, unlisted, and to-be-listed companies on the stock markets, in both the primary and secondary markets.

· FDIs are more intentional, while FIIs are more concerned with transfer of funds and looking for capital gains in a prospective company.

· In India, FIIs tend to invest via Portfolio Investment Scheme (PIS) after registering with Securities and Exchange Board of India (SEBI).

· Foreign Institutional Investors choose to invest in developing countries because they provide greater growth potential, due to the emerging economies.

· Sometimes, FIIs invest in the securities for a short period of time. This is helpful for liquidity in the market, but they also cause instability in flow of money.

c) International Finance Instruments.

-> The following points highlight the top four international capital market instruments. They are: 1. Global Depository Receipts 2. Foreign Currency Convertible Bonds 3. American Depository Receipts 4. External Commercial Borrowing.

Instrument # 1. Global Depository Receipts:

Global Depository Receipt (GDR) is an instrument which allows Indian Corporate, Banks, Non- banking Financial Companies etc. to raise funds through equity issues abroad to augment their resources for domestic operations.

As per the recent guidelines on issue of GDR, a corporate entity can issue any number of GDR issues in a year and the corporate involved in infrastructure projects need not have a past track record of financial performance.

A GDR is a dollar denominated instrument of a company, traded in stock exchanges outside the country of origin i.e., in European and South Asian Markets. It represents a certain number of underlying equity shares.

Though the GDR is quoted and traded in dollar terms, the underlying equity shares are denominated in rupees only. Instead of issuing in the names of individual shareholders, the shares are issued by the company to an intermediary called the ‘depository’, usually in Overseas Depository Bank, in whose name the shares are registered.

It is the depository, which subsequently issues the GDR to the subscribing public. The physical possession of the equity shares will be with another intermediary called the ‘custodian’, who is an agent of the depository. Though the GDR represents the company’s shares, it has a distinct identity and does not figure in the books of the company.

Instrument # 2. Foreign Currency Convertible Bonds:

Foreign Currency Convertible Bonds (FCCBs) are issued in accordance with the scheme and subscribed by a non-resident in foreign currency and convertible into ordinary share of the issuing company in any manner, either in whole or in part on the basis of only equity related warrants attached to debt instrument. The FCCB is almost like the convertible debentures issued in India.

The Bond has a fixed interest or coupon rate and is convertible into certain number of shares at a prefixed price. The bonds are listed and traded on one or more stock exchanges abroad. Till conversion the company has to pay interest on FCCBs in dollars (or in some other foreign currency) and if the conversion option is not exercised, the redemption also has to be done in foreign currency. The bonds are generally unsecured.

Instrument # 3. American Depository Receipts:

A foreign company might make issue in U.S. by issuing securities through appointment of Bank as depository. By keeping the securities issued by the foreign company, the U.S. Bank will issue receipts called American Depository Receipts (ADRs) to the investors.

It is a negotiable instrument recognizing a claim on foreign security. The holder of the ADRs can transfer the instrument as in the case of domestic instrument and also entitled for dividends as and when declared.

The ADR holder can ask the bank for the original foreign security by exchanging the ADR. The Bank will act as a custodian for the investors. An ADR can be described as a negotiable instrument denominated in US dollars, representing a non-US Company’s local currency equity shares or known as depository receipts.

These are created when the local currency shares of an Indian Company are delivered to an overseas depository bank’s domestic custodian bank, against which depository receipts in US dollars are issued. Each depository receipt may represent one or more underlying shares. These depository receipts can be listed and traded as any other dollar denominated security.

The disclosures as required under the Securities Exchange Commission’s (SEC) regulations are stringent and onerous. In order to protect the investor, the SEC places the onus on the issuer company, its officers and directors to ensure that the prospectus does not contain any misstatement or omissions which are material in nature.


To Indian Company:

(a) Better corporate image both in India and abroad which is useful for strengthening the business operations in the overseas market.

(b) Exposure to international markets and hence stock prices in line with international trends.

(c) Means of raising capital abroad in foreign exchange.

(d) Use of the foreign exchange proceeds for activities like overseas acquisitions, setting up offices abroad and other capital expenditure.

(e) Increased recognition internationally by bankers, customers, suppliers etc.

(f) No risk of foreign exchange fluctuations as the company will be paying the interest and dividends in Indian rupees to the domestic depository bank.

To Overseas Investors:

(a) Assured liquidity due to presence of market makers.

(b) Convenience to investors as ADRs are quoted and pay dividends in U.S. dollars, and they trade exactly like other U.S. securities.

(c) Cost-effectiveness due to elimination of the need to customize underlying securities in India.

(d) Overseas investors will not be taxed in India in respect of capital gains on transfer of ADRs to another non-resident outside India.

Instrument # 4. External Commercial Borrowing:

External Commercial Borrowings (ECBs) is a borrowing of over 180 days. ECB is the borrowing by corporate and financial institutions from international markets. ECBs include commercial bank loans, buyers credit, suppliers credit, security instruments such as floating rate notes and fixed rate bonds, credit from export-credit agencies, borrowings from international financial institutions such as IFC etc.

The incentive available for such loans is the relative lower financing cost. ECB’s can be taken in any major currency and for various maturities. ECBs are being permitted by the Government for providing an additional source of funds to Indian corporate and PSU’s for financing expansion of existing capacity as well as for fresh investment to augment the resources available domestically.

ECBs are approved with an overall annual ceiling. Consistent with prudent debt-management keeping in view the balance of payments position and level of foreign exchange reserves.

d) Limitations of foreign capital.

-> Limitations of Foreign Capital:-

1. Distort of the Pattern of Development of the Economy:

It is not suitable for countries who have adopted a scheme of planned development, While deciding about the investment projects the foreign capitalists will be guided by the maximization of profit criteria and not the plan priorities of the country. In other words, it always invests in low priorities of the economy.

2. Adverse Effect on Domestic Savings:

This sort of investment should be expected to have an income effect which will lead to a higher level of domestic savings. But at the same moment if private foreign investment reduces profits in domestic industries, it will adversely affect the income of profit earning and further will tend to reduce domestic savings.

3. Adverse Effect on Balance of Payments of the Recipient Country:

Foreign investors may earn huge profits which are to be repatriated in due course of time. The repatriation of these profits may turn into serious imbalances in the balance of payments of the recipient nation.

4. Not Useful on Political Grounds:

Private foreign investment in under developed countries is feared not only for economic reasons but also on political grounds. There is a great fear that it may lead to loss of independence of the recipient country. In the opinion of Prof. Lewis, “The loss of independence may be partial or complete; partial if the capitalists confine themselves to bribing politicians or backing one political group against another or complete if the debtor country is reduced to colonial status”.

These fears are quite widespread. They are mainly responsible for the reluctance on the part of developing countries to accept private foreign capital. In this connection Prof. WA. Lewis holds the view that, “These fears are one of the strongest reasons as to why the less developed countries are anxious that the United Nations should create adequate institutions for transferring capital so that they should not become dependent upon receiving capital from any one of the great powers”.

5. Limited Coverage:

Private capital usually restricts itself to certain limited spheres of economic life. For example, it chooses those industries where it can make large and quick profits, irrespective of the fact whether the development of those industries is in the development interest. Such industries are largely consumer goods industries or those industries in which the gestation period is not too long. It is for these reasons that in India before Independence, foreign capital mostly British, was directed to such industries as plantations, etc.

6. More Dependence:

The use of private capital often increases dependence on foreign sources. This happens at least on two counts. One is that the use of foreign technology appropriate to the resource-endowments of advanced countries does not permit the development of indigenous technology appropriate to the conditions of the recipient country.

On the contrary, it positively discourages the development of such a technology in competition with itself. This means the country in question will continue to depend upon the import of foreign technology. Two, the foreign technology used requires import of goods for replacement and maintenance, thereby creating balance of payments difficulties.

We have taken so much from the foreign technical know-how that we have not yet developed what may be described, as an appropriate technology suited to our resources and needs. Further, imports of replacement and maintenance goods are costing us a lot.

7. Restrictive Conditions:

In many cases foreign collaboration agreements contain restrictive clauses in respect of such things as exports. For example, foreign collaborators make investments to exploit the Indian market because they find it difficult to approach this market from outside.

But these collaborators do not want the Indian concern to export its goods to other countries which are already being supplied by the foreign collaborators from their concerns operating in other countries. Obviously, such agreements are of limited value for the country.

8. Remittance of Large Amounts:

Remittance of profits of course is a normal facility which the foreign investor expects. But often the profits earned in the early stages are high, involving big remittances. In many collaboration agreements, for example, the initial foreign capital is confined to the foreign exchange component of the project.

The rest of the resources are made available through internal sources. Since the rate of return on initial investment is usually very high, it makes it possible for the foreign collaborator to recover his amount in a relatively short time. Yet the payment on account of such things as technical services, royalty payments, etc., continues.

From the above cited discussion, it can easily be concluded that private foreign capital is not very safe for less developed countries, it does not fit into their planned development. Again it does not provide hope for their rapid industrialization and economic growth.

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