Master of Business Administration - MBA Semester 4

MF0008 – Merchant Banking and Financial Services

Assignment Set- 1

Q.1 Differentiate between capital market and money market instruments.

Ans:- Capital Market Instruments

The capital market in India is being subject to various types of reforms following the
recommendations of various committees set-up by the Government from time to time including
the S. Chakravarty Committee on working of the Monetary System (1985), G.S.Patel Committee
on Organization and Management of Stock Exchanges (1986), M. Narasimham Committee on
the Financial Systems (December 1991), Shah Committee on Financial Companies (1992),
Nadkarni Committee on Trading in Public Sector Bonds and units of Mutual Funds, and report of
Jankiraman Committee set up on April 30, 1992 to investigate irregularities in funds
management by commercial banks and financial institutions and their dealings in government
securities, public sector bonds, UTI units and similar instruments.

The Government has adopted vigorously the policy of implementing the economic liberalization
and reforms since June, 1991 by effecting changes in its industrial policy, trade and exchange
rate policy, foreign investment policy, taxation, financial sector reforms, etc. which have been
carrying cumulative impact on the health of corporate sector and the capital market in general
and on the profession of the persons engaged in the services of capital market in particular
through reduction of bureaucratic control on the economic system, covering liberalization in
licensing system, foreign exchange controls, removal of MRTP hindrances etc. The Central
Government vide press release on July 3, 1993 has exhibited the outcome of various reforms.

Money Market Instruments

Money market is comprised of the following important instruments:

1) Call Money Market : In call money market, day to day surplus funds are traded in.
Loans are made in this market for short-term duration with maturity varying between one
day to a fortnight repayable on demand at the option of borrower or lender. It is highly
liquid. Participants in call money market are scheduled commercial banks, non-scheduled
commercial banks, foreign banks, state, district and urban co-operative banks, co-
operative banks, DFHI, ICICI, IFCI, IDBI, LIC, GIC, UTI, NABARD as allowed by RBI
as lenders and not the borrowers in call money market, in case these institutions are
having bulk lendable resources. Rs.20 cr. per transaction is minimum size for the
institutions to lend. The institutions have to operate through DFHI. There is no interest
ceiling at present. The market operates at the principal industrial and commercial centers
like Bombay, Calcutta, Madras and Delhi. There are two call rates at present viz. Inter –
bank call rate and DFHI rate in the money market.
2) Treasury Bills: There are three types of treasury bills at present in vogue in the money
market viz. 91 days treasury bills, 182 days treasury bills and 364 days treasury bills.
Treasury bills represent central government borrowings against a bill or a promissory
note. Treasury bills are highly liquid and risk- free instruments backed by RBI’s
purchase. There are two forms of treasury bills:

a) Ordinary – Issued to public and RBI by the Government to meet the short term
requirements of funds: and,

b) Ad hoc – Created in favor of RBI. Nearly 90% of the treasury bills are subscribed by
banks, financial institutions, RBI and DFHI. RBI rediscounts the treasury bills held by
banks, financial institutions and DFHL. However, DFHL does not deal in 91 days
treasury bills.

Treasury Bill Rate is the rate of discount at which treasury bills are solved by RBI.
Return on treasury bills is the discount at which they are sold and difference between the
selling price and their redemption value. Rate of interest on treasury bills is lowest. The
rate of interest is fixed by RBI from time to time.

Secondary markets in treasury bills require involvement of brokers and dealers and banks
have to seek RBI permission to avail of their services.

3) Commercial Bills: Bills of Exchange are an important financial instrument used for
financing the credit sales. It is a self-liquidating instrument. It carries low degree of risk.
It is also known as ‘banker’s acceptances’. Commercial bills may be demand bills and
usance bills. Demand bill is payable immediately at sight, or on presentation to the
drawee. Time may or may not be specified for maturity of bills. Usance bill or time bill is
payable at a specified later date as recognized by custom or usage for payment of bills.
Commercial bills may be clean or documentary bills. A Clean bill is the one when
documents are enclosed, deliverable against acceptance of drawee (D/A). After delivery
of documents it becomes clean bill. Documentary bill is document against payment (D/P)
bill, accepted by the drawee and documents of title are held by the bankers till the bill is
matured and paid. The bills could be inland bills, foreign bills, export bills import bills as
per circumstances. Commercial bills are used for financing the trade between countries.
Hundis are the indigenous form of commercial bills which are used by usage for
financing the movement for agricultural produce, inland trade by indigenous bankers.
Hundis are known by different regions viz.shahjog, namjog, dekharnoor jog, jokhmi jog,
dhani jog. Two types of Hundis, Darshni (sight or demand) or Muddati (usance) are in
use for 30 to 120 days. Commercial banks used to discount hundis but now RBI has
banned rediscounting of commercial bills.
 Size of bill market in India- Commercial bills help inter-corporate movement of funds for
financing the trade but RBI has put ban on the banks to rediscount the CBs. The usual
maturity period for bill is:

(a) Usance bills/Hundis- 30 to 120 days;

(b) Export bills- 90 days; and

(c) Import bills- 60 days.

4) Commercial Paper : Commercial papers are new instruments in the form of short
duration usance promissory notes with fixed maturity issued mostly by the leading,
creditworthy and highly credit rated companies. Commercial papers are unsecured
instruments negotiable by endorsement and delivery. Commercial papers have buy-back
facility from the issuer and are issued in a bearer form on discount to face value basis.
Commercial papers are usually in large denomination and are released in the market
through banks or merchant banks or dealers or brokers in the open market or are sold
through direct placement with lenders or investors. Issue of commercial paper may be
backed by a line of credit or a revolving underwriting facility from banks to ensure
continued availability of funds on each roll over of the paper. RBI issued guidelines on
January 1, 1990 introducing commercial papers in Indian money market. CP has gained
importance in the Indian money market. The outstanding amount of CP issued increased
sharply from Rs. 577.25 cr. as on March 31, 1993 to Rs. 3264.05 cr. as on March 31,
1994 and further Rs. 4210.55 as on July 31, 1994.
5) Certificate of Deposit: Certificate of deposits are also known as Negotiable Certificate
of Deposits (NCDs) and represent bank deposit accounts which are transferable from one
party to another. In other words, Certificate of deposits are documents of title to time
deposits with banks and they are marketable in bearer or registered form, bearing a
specified rate of interest for a specified period. Certificate of deposits are traded in the
secondary market and are highly liquid and risk-free for payment of interest and
repayment of principal. In India, Certificate of deposits was permitted by RBI through a
scheme launched in June, 1989 and modified subsequently in May, 1990. Certificate of
deposit can be issued to individuals, corporations, companies, trusts, funds, associations
and NRIs. The maturity period of Certificate of deposits vary between 3 months to 12
months. Rate of interest is market determined. The minimum amount of Certificate of
deposits is one crore of rupees or more in multiples of Rs.25 Lakh. Banks have to seek
authorization from RBI for issuing Certificate of deposits. DFHI has been helping in
creating the secondary market for Certificate of deposits. Apart from 46 scheduled
commercial banks, all India financial institutions viz. IDBI, ICICI, IFCI, IRBI, SIDBI,
EXIM, BANK, SCICI and CDs. As on 31-5-1994 Rs. 2249 cr. was outstanding against
CDs issued by them as against Rs. 6121 cr. by banks.
Q.2. Compare the marketing strategy of any financial services company with another.

Ans:- The role of financial services in stimulating and sustaining economic growth is well-
known. Financial services because of their intangible nature and the fact that services delivery is
variable have traditionally been considered more difficult to market than physical products.
However, the service organisations make an attempt to tangibalise their services with the help of
something. For e. g. LIC’s logo of two hands protecting the light of the lamp indicates the
protection assured by the company.

Services are ‘inseparable’ from the one who is providing it. Services cannot be sold like goods
wherever the customer wants it. Whenever a service like banking is given, the banker and the
customer must come together for an interaction. Though the technology is trying to make some
changes in this regard; separation of the service provider and the service receiver has not been
achieved completely.

Services are also perishable. Because of their intangibility, they cannot be stored. The
intangibility of the service also makes it ‘heterogeneous’ in nature. The service provided by one
stock broker will be completely different from the other one. The services provided by ICICI
Bank and those provided by Vijaya Bank differ completely. Because of the heterogeneity of the
service, it becomes very difficult to standardize them.

Because of all the above-mentioned features, providing a consistent level of service becomes a
major challenge to the marketer in today’s competitive environment.

Marketing Strategies for services

Marketing strategies refer to the plan of action that the organization will have to adopt as regards
its marketing mix elements are concerned. Marketing mix is defined as the elements an
organization controls that can be used to satisfy or communicate with customers. The traditional
marketing mix is composed of the four P’s: product, price, place (distribution) and promotion.
These elements appear as are decision variables in any marketing text or marketing plan. The
marketing mix philosophy implies that there is an optional mix of the four factors for a given
market segment at a given point of time.

The concept of four P’s is very essential to the successful marketing of services. However, the
strategies for the four P’s require some modifications when applied to services. In case of
marketing of products, the 4th P i.e., Promotion include advertising, sales promotion, publicity
No doubt, the promotion is important in services too, but as the employees are also involved in
the ‘real time marketing’ in addition to their regulars operational roles, the promotion includes
training the service delivery people, their dress, appearance etc. Moreover, in the absence of a
physical product, convincing the customer about the features of the service is more challenging.
At the same time, fixing the right price for the intangible $ service is a very difficult task.
Now let us try to understand the decisions that the marketer has to take regarding the Product,
Price, Place and Promotion. The following sections deal with the important decisions that the
manager has to take to satisfy the customer in a better way.

Q.3 Explain the mechanism of securitization and the benefits for a company.

Ans;- Mechanism of Securitisation

The concept of securitisation is best understood by considering a typical transaction.

In securitisation, the originator sells receivables to a Special Purpose Vehicle (SPV) established
to isolate the receivables and to perform other functions (e.g. restructuring of cash flows and
provision of credit enhancement and liquidity support). The SPV is usually structured as a
bankruptcy-remote trust or incorporated entity. The SPV finances the purchase of receivables by
issuing securities (usually notes, commercial paper, bills, bonds, or preferred stock) to investors.
Legal agreements delineate the rights and obligations of all parties to the transaction, including
the appointment of an administrator to manage the receivables where necessary.

One or more financial institutions are usually involved in structuring and marketing the securities
issued by the SPV. To facilitate investor demand, credit rating agencies assess the likelihood that
the SPV will default on its obligations and assign an appropriate credit rating. Credit
enhancement and liquidity support is usually obtained by the SPV to ensure a high rating for the
securities.

Features of Securitisation

A securitized instrument generally has the following features:

• Wide distribution: The basic purpose of securitization is to distribute the product. The
extent of distribution which the originator would like to achieve is based on a
 comparative analysis of the costs and the benefits that can be achieved. Wider
distribution leads to a cost-benefit in that the issuer is able to market the product with
lower return and hence, lower financial cost to him. In practice, securitization issues are
still difficult for retail investors to understand. Hence, most securitizations are privately
placed with professional investors. However, it is likely that in the future, retail investors
could be attracted into buying securitized products.
• Homogeneity: To serve as a marketable instrument, the instrument should be packaged
into homogenous lots. Most securitised instruments are broken into lots affordable to the
marginal investor, and hence, the minimum denomination becomes relative to the needs
of the small investor. The need to break the whole lot to be securitized into several
homogenous lots makes securitization an exercise of integration and differentiation;
integration of several assets into one lump and then differentiation into uniform
marketable lots.
• Marketability: The purpose of securitization is to ensure marketability to financial
claims. Liquidity is afforded to a securitised instrument either by introducing it into an
organized market or by one or more agencies acting as market makers i.e. agreeing to buy
and sell the instrument at their market determined prices. This is one of the most
important features of a securitised instrument, and the others that follow are mostly
imported only to ensure this one. The concept of marketability involves two postulates:
(a) the legal and systemic possibility of marketing the instrument; (b) the existence of a
market for the instrument.
• Merchantable quality: To be market-acceptable, a securitised product should be of
saleable quality. This concept, in case of physical goods, is something which is
acceptable in normal trade. When applied to financial products, it would mean that the
financial commitments embodied in the instruments are secured to the investor’s
satisfaction. In case of securitization of receivables, the concept of quality undergoes a
drastic change, making rating a universal requirement for securitizations. The quality of
the debtor’s claim assumes significance, which at times enables investors to rely purely
on the credit rating of the debtors and hence, make the instrument totally independent of
the originator’s own rating.
• Deconstruction: Securitisation is the process of deconstruction wherein, if one envisages
an entity’s assets as being composed of claims to various cash flows, the process of
securitization would split apart these cash flows into different buckets, classify them, and
sell these classified parts to different investors according to their needs. Thus
securitization breaks the entity into various sub-sets.
• Integration and differentiation: Securitisation is the process of integration and
differentiation where the entity that securitises its assets first pools them together into a
common pool. This is called the process of integration. Then, the pool itself is broken
into instruments of fixed denomination. This is the process of differentiation.
• Commoditisation: Securitisation is the process of commoditization, where the basic idea
is to take the outcome of this process into the capital market. Thus, the result of every
securitization process, whatever might be the area to which it is applied, is to create
certain instruments which can be placed in the market.
 Master of Business Administration - MBA Semester 4
MF0008 – Merchant Banking and Financial Services
Assignment Set- 2

Q.1 Discuss the importance of growth of merchant banking in India.

Ans;- The Growth of Merchant Banking in India

Formal merchant banking activity in India was originated in 1969 with the Merchant Banking
Division set up by the Grindlays Bank, the largest foreign bank in the country. The main service
offered at that time to the corporate enterprises by the merchant banks included the management
of public issues and some aspects of financial consultancy. Other foreign banks like Citi Bank,
Chartered Bank also started the Merchant Banking activity in India. State Bank of India started
merchant banking in 1973 followed by ICICI in 1974. Both these Indian merchant bankers
emerged as leaders in merchant banking having done significant business during the period of
1974-1985 in comparison with foreign banks. The early and mid-seventies witnessed a boom in
the growth of merchant banking organization in the country with various commercial banks,
financial institutions, brokers firms entering into the field of merchant banking.

The early growth of merchant banking in the country is assigned to the Foreign Exchange
Regulation Act, 1973 (FERA) under which a large number of foreign companies operating in
India were required to dilute their foreign holdings in order to continue business in the country.
This had caused two-pronged effect viz. firstly, in the form of spate in Foreign Exchange
Regulation Act Issues eliciting interest of the investors by creating massive awareness about
capital markets amongst the new class of investing public; secondly, merchant banking activity
became attractive to banks and the firms of consultants and share brokers who entered into this
field vigorously to reap the advantages of the expanding capital markets.

Importance and Need of Merchant Banking in India

Important reason for the growth of merchant banking have been the developmental activities
throughout country, exerting excess demand on the sources of funds forever, expanding industry
and trade and thus leaving a widening gap unbridged between the supply and demand of
investible funds. All India financial institutions had experienced resource constraint to meet the
ever-increasing demand for funds from the corporate sector enterprises. In the circumstances
corporate sector had the only alternative to avail of the capital market services for meeting their
long-term financial requirements through capital issues of equity and debentures. With the
growing demand for funds there was pressure of capital market that enthused the commercial
banks, share brokers and financial consultancy firms to enter into the field of merchant banking
and share the growing capital market. With the result, all the commercial banks in nationalized
and public sector as well as in private sector including the foreign banks in India have opened
their merchant banking windows and are competing in this field. There has been a mushroom
growth of financial consultancy firms and broker firms doing advisory functions as merchant
bankers as well as managing public issues in syndication with other merchant bankers.

Notwithstanding the above facts, the need of merchant banking institution is felt in the wake of
huge public savings lying still untapped. Merchant banks can play highly significant role in
mobilizing funds of savers into investible channels assuring promising return on investments and
thus can help in meeting the widening demand for investible funds economic activity. With the
growth of merchant banking profession, corporate enterprises in both public and private sectors
would be able to raise required amount of funds annually from the capital market to meet the
growing requirements for funds for establishing new enterprises, undertaking
expansion/modernization/ diversification of the existing enterprises. This reinforces the need for
a vigorous role to be played by merchant banks.

Merchant banks have been procuring impressive support from capital market for the corporate
sector for financing their projects. This is evidenced from the increasing amount raised from the
capital market by the corporate enterprises year after year.

In view of multitude of enactments, rules and regulations, guidelines and offshoot press release
instructions brought out by the Government from time to time, imposing statutory obligations
upon the corporate sector to comply with all those requirements prescribed therein, the need of
skilled agency existed which could provide counselling in these matters in a package form.
Merchant bankers, with their skills, updated information and knowledge, provide this service to
the corporate units and advise them on such requirements to be complied with for raising funds
from the capital market under different enactments viz. Companies Act, Income-tax Act, Foreign
Exchange Regulation Act, Securities Contracts (Regulations) Act, and various other corporate
laws and regulations.

Merchant bankers advise the investors of the investments available in the form of tax relief, other
statutory relaxations, good return on investment and capital appreciation in such investment to
motivate them to invest their savings in securities of the corporate sector. Thus, the merchant
bankers help industry and trade to raise funds, and the investors to invest their saved money in
sound and healthy concerns with confidence, safety and expectation for higher yields.

Q.2. Explain the book building process with an example of a recent issue.

Ans:- Book Building is essentially a process used by companies raising capital through Public
Offerings-both Initial Public Offers (IPOs) or Follow-on Public Offers ( FPOs) to aid price and
demand discovery. It is a mechanism where, during the period for which the book for the offer is
open, the bids are collected from investors at various prices, which are within the price band
specified by the issuer. The process is directed towards both the institutional as well as the retail
investors. The issue price is determined after the bid closure based on the demand generated in
the process.
The Process:

• The Issuer who is planning an offer nominates lead merchant banker(s) as 'book runners'.
• The Issuer specifies the number of securities to be issued and the price band for the bids.
• The Issuer also appoints syndicate members with whom orders are to be placed by the
investors.
• The syndicate members input the orders into an 'electronic book'. This process is called
'bidding' and is similar to open auction.
• The book normally remains open for a period of 5 days.
• Bids have to be entered within the specified price band.
• Bids can be revised by the bidders before the book closes.
• On the close of the book building period, the book runners evaluate the bids on the basis
of the demand at various price levels.
• The book runners and the Issuer decide the final price at which the securities shall be
issued.
• Generally, the numbers of shares are fixed; the issue size gets frozen based on the final
price per share.
• Allocation of securities is made to the successful bidders. The rest get refund orders

Two of the recent mega issues, one by Petronet LNG and the other by Biocon, were both
through the 100 per cent book-building route. Prospective bidders were advised to read the red
herring prospectus carefully. According to the Act, a red herring prospectus means a prospectus
that does not have complete particulars on the price of securities offered and the quantum of
securities offered. The Concise Oxford Dictionary gives the meaning of `red herring' as a
misleading clue or distraction, so named from the practice of using the scent of red herring (a
silvery fish) in training hounds.

The 2000 Amendment to the Act gave legal cloak to the book-building route by allowing
circulation of the information memorandum and the red herring prospectus. According to the
Act, information the memorandum denotes a process undertaken prior to the filing of a
prospectus by which a demand for the securities proposed to be issued by a company is elicited,
and the price and the terms of the issue of such securities are assessed by means of a notice,
circular, advertisement or document. Incidentally the working group on the comprehensive
Companies Bill, 1997 (since lapsed) had advocated introduction of book-building. It defined the
term as "an international practice that refers to collecting orders from investment bankers and
large investors based on an indicative price range. In capital markets, with sufficient width and
depth, such a pre-issue exercise often allows the issue to get a better idea of the demand and the
final offer price of an intended public offer.'
Q.3. Discuss the considerations of marketing products at different stages of the family life
cycle.

Ans:- In our society, family is a very influential factor that influences an individual’s buying
activities. Here we have to understand the influence of two types of families in an individual’s
life. They are-

a) Family of orientation – consisting of parents.

b) Family of procreation – consisting of one’s spouse and children.

The family of orientation influences an individual’s activities and thinking in the early part of his
life. Marketer should know the role and relative influence of husband, wife and children in the
decision-making activities.

Personal factors

Personal factors influencing the buying decision are

• Age and family cycle stages,

• Occupation
• Economic circumstances,
• life style
• Personality.

Age and life cycle stages- People buy different products in different stages of their life cycle.
The products that are purchased in the early part of the life may not be preferred in the later part
of their life.

The family life cycle concept was developed in the 1960s as a tool for segmenting the market for
goods and services. It was based an age, marital status, number and age of children and work
status-each of which affects the consumer’s needs, wants and ability to buy.

The following table presents the several stages in the family life cycle and the financial needs
that are most likely to be experienced at each stage.

Family life cycle and financial services

Stage Financial Situation Banking Needs

Young: Single Few financial burden, Low cost checking, auto
independent Recreation loan, credit cards
oriented
Full Nest: Youngest Home purchasing at peak Credit card; home loans,
Child Under six low liquid assets; Investments in shares,
planning about security, Insurance
Full Nest: with Good, stable financial Educational loan,
dependent children position more expenses
investment in real estates,
term deposits, other
investment services.
Empty Nest: Older Significantly reduced Retirement plans, saving
income, fewer expenses certificates, long term
couples with no deposits.
children

Occupation:- A person’s occupation affects the goods and services brought. Blue collar workers
tend to buy more work clothes; where as white collar workers buy more suits and ties. Marketers
try to identify the occupational groups that have an above overage interest in their products and
services.

Economic Circumstances:-A person’s economic situation will affect the product choice.
Because income changes over time, an individual’s ability to use financial services will also
change. Personal economic factors such as income, savings, net worth and ability to borrow
affect people’s power to buy all types of goods and services, but they are especially relevant to
the purchase of financial services.

Personality:- Personality can be defined as the aggregate of an individual’s trait or

characteristics that make him or her unique. Some are extroverts, some are sky some are
perfectionists other are casual minded. Some are risk takes: others are cautions. A study found
that ATM users were more soft, self- reliant, impulsive, innovative, curious, and active than non-
users. In short, they were considered to be on a faster track. A television act for such a product
should consist of fast paced cuts from one scene to another, showing individuals in various
situations that suggest spontaneity, independence and a high level of activity.

Life Style:- Life style refers to a person’s pattern of living. Marketers must find the relationship
between the product and life style. The measurement of life style is known as VALS (Values and
Life Style).

Based on the lifestyle, we can classify the people as below:

• Believers-conservatives, conventional and orthodox.

• Strivers- uncertain, try to follow successful people, have limited resources and exposure.
• Struggler- lower incomes, lowest renounces, brand loyal, buy on purpose.
• Makers- Practical, self -sufficient, family- oriented, buy on purpose.
• Achievers- successful, work- oriented, status- conscious.
 • Actualizes- Highest income, self- oriented, image-conscious, wide range of interests.
• Fulfilled- Mature, responsible, and well-educated professionals.
• Experiences- outgoing, young, risk- takers, and youthful customers.

Consumers living in the same geographic area do not necessarily buy for the same reasons.
Demographics are another easily understood and readily accessible characteristic of markets.
Demographic factors include consumers’ age, income, education, gender, religion and
nationality. Changing age distributions signaling an ageing population, for example, can have a
significant impact on the way an organization markets its products, e.g. Marketing to the baby
boomers in the US.

Demographic characteristics are a commonly used segmentation variable and secondary data is
widely available, e.g. The national census. For simple everyday products, demographic criteria
can work well in explaining differences in consumer behaviour, e.g. The Economic Times is
purchased more frequently by people in higher income brackets.

For more complex products, such as financial services, finer distinctions are required. The
demographic classification of ‘life stage’ or ‘life cycle’ can be a useful way to segment potential
markets. Differences in purchasing behaviors between two people of the same age and gender
can often be accounted for by the fact that they are at different life cycle stages.

Life stage classifications include:

• Bachelors (young singles living away from home)

• Newly married, no children
• Full nest I (youngest child under 6)
• Full nest II (youngest child 6 or over)
• Full nest III (older, dependent children still at home)
• Empty nest I (couple still earning, children left home)
• Empty nest II (couple retired, children left home)
• Solitary survivor (still earning)
• Solitary survivor (retired).

Individuals in different life stages will often have quite different financial positions and buying
behavior. Consider the list of the stage classifications in relation to decisions about saving,
spending, borrowing and investing.