Module

I
Meaning
Investment can be defined in different aspects. These are:

Generally, investment is the application of money for earning more money.

Investment also means savings or savings made through delayed consumption.

In Finance, the purchase of a financial product or other item of value with an

expectation of favorable future returns. the practice of investment refers to the
buying of a financial product or any valued item with an anticipation that
positive returns will be received in the future.

In Business, the purchase by a producer of a physical good, such as durable

equipment or inventory, in the hope of improving future business.
 According to economics, investment is the utilization of resources in order
to increase income or production output in the future. An amount deposited
into a bank or machinery that is purchased in anticipation of earning
income in the long run are both examples of investments.
What is Investing?
 Purchase of assets with the goal of increasing future income

 Focuses on wealth accumulation

 Appropriate for long-term goals

 Investment and Speculation
Basis Investment Speculation
Time Horizon Plans for the longer Plans for very short term
time Horizon horizon
Risk Assumes Moderate Willing to undertake high
risk risk
Return Expecting Moderate High return because of high
return risk
Decision Considers Consider the inside
fundamental factors of information and market
the Company or the behavior
Investment avenue
Funds Use his own funds and Use borrowed funds to
avoids borrowed funds supplement his personal
records
Gambling
 Game of Chances / Skills
 The results are determined by the roll of dice or the
turn of a card

 Games of Chance
 Arcades, Rolling Dice, Lotteries, Bingo,
 Scratch & Win, Flipping Cards, Raffles
 Sweepstakes, Sporting Events
 Games of Skill
 Poker, Pool, Darts
 Video Games, Race Track, Marbles
 Sports
Investment and Gambling
Basis Investment Gambling
Time Horizon Plans for the longer time Time Horizon for
Horizon gambling is shorter
than Speculation and
Investment
Risk Assumes Moderate Creation of artificial
commercial risk risk
Return Expecting Moderate return High return because
of high risk
Decision Considers fundamental As a means of
factors of the Company or the entertain themselves
Investment avenue
Funds Use his own funds and avoids Use borrowed funds
borrowed funds along with owned to
supplement his
personal records
Investment Objectives

 Return
 Risk
 Liquidity
 Hedge against Inflation
 Safety
Return
 The total income the investor receiving from their Holding
period
 Rate of return is stated semi annually or annually

 Return = Capital Appreciation & Dividend *100

Purchase Price

Risk
• Risk is the probability of actual return becoming less than
the expected return
• if the rate of return varies from time to time then the risk is
higher
Liquidity
 Marketability of the investment provides liquidity
 If a portion of the investment is easy to convert into cash
then the investor can meet emergencies.
 A stock is liquid when it gas return, dividends and capital
appreciation
Hedge against inflation
 The rate should ensure a cover against inflation
 Otherwise the investor will loose
 Growth stock would appreciate in their values over time
and provides protection against inflation
Safety
 The selected investment avenue should be under the legal and
regulatory framework
 From the safety point of view the investment avenues can be
ranked in the following ways.

 Bank deposit
 Government bonds
 UTI units
 Non convertible debentures
 Convertible debentures
 Equity shares
 Deposits with NBFCs
1. Investment Policy
 Investment policy provides the raw material for the
Investment management. In this stage various
investment assets are identified and their features are
connected.
 The goal of investment policy is to decide which
stock to be held in an investment portfolio. The
formulation of investment policy requires
 Determination of amount invested.
 Determination of investment objectives.
 Identification of potential investment assets.
 Consideration of attributes of various investment assets.
 Allocation of investible funds to various investment
categories.
Investment policy can be well explained with following criteria.
 Investible Funds
 Fund is the basic factor
 Source : Borrowed fund or own fund
 The return from the borrowed fund should overcome the
cost incurred for the fund.
• Objectives
 Required rate of return, need for regularity of income risk
perception and the need of liquidity
• Knowledge
 Knowledge about the investment alternatives and market
 Stock market structure and the brokers
Security Analysis
 Market Analysis
The trend of the market is analyze

 Industry analysis
The economic si9gnificance and growth potential of the
industry have to be analyzed

 Company Analysis
The company's earnings, profitability, operating efficiency,
capital structure and management have to be screened
Valuation
 The intrinsic value of share
Which means the actual value of the share not the market
value

 Future value
Trend analysis can be used for predicting future value
Construction of Portfolio
 A portfolio is a combination of securities
 To meet the investors goals and objectives
 Diversification
Debt and Equity Diversification
Industry Diversification
Company Diversification
 Selection & Allocation
Evaluation
 Appraisal
Risk and return
The variability measured and compared

 Revision
The low yielding securities with high risk are replaced with
high yielding securities with low risk
Investment Avenues

Investment
Avenues

Real Financial
Assets Assets
Real Assets
 Gold
 Silver
 Arts
 Property
 Antiques
Financial Assets

Financial
Assets

Non
Negotiable
Negotiable
Negotiable Securities
 Equity Shares (Variable Income Securities)
 Equity shares with Detachable Warrants
 Shares with Differential Voting Rights
 Shares with no voting rights
 Blue Chip Shares
 SWEAT Equity Shares
Preference Shares
 Redeemable
 Irredeemable
 Convertible
 Non Convertible
 Participative
 Preference shares with warrants
Debentures
 Secured Premium notes with Detachable warrant
 Secured Debentures
 Unsecured or Naked Debenture
 Bearer Debenture
 Registered Debenture
 Redeemable Debenture
 Convertible Debenture
 Non Convertible Debenture
Bonds
 Interest rate / coupon rate
 Regular payment known as coupon payment
 In India, debentures are issued by Corporate where Bonds are
issued by Government/ Semi Govt. Bodies. But now it is also
issue by Corporates.
Bonds
 Government Bonds
 Corporate Bonds
 Zero Coupon Bonds
 Mortgage Bonds
 Convertible Bonds
 Step-up- bonds
 Callable and non callable
 Option bonds
 Bonds with warrants
 Floating rate bonds
Derivatives
 Derivatives are a broad set of instruments whose values
depend upon some underlying basic assets and variables.
 they are contracts that have no intrinsic value, but are based
on the value of an underlying commodity, currency or stocks.
 In a strict sense, when we say Derivatives as Financial
Derivatives
 Thus a financial derivative is a financial instrument, whose
value is linked in some way to the value of another
instrument, underlying the transaction.
Types of Financial Derivatives
 Forwards
 Futures
 Options
 Swaps
Types of Investors
 Automatic Investor
 Daily Down Watcher
 Active Trader
 Conscientious Investor
 Property Investor
 Bargain Investor
 Company Loyalist
 Portfolio Tweaker
Factors affecting Investment Decision
 Longer life expectancy or planning for retirement
 Increasing rate of taxation
 High Interest rate
 High rate of inflation
 Larger incomes
 Availability of complex number of investment outlets
 Legal safeguards
 Stable currency
 Existence of savings institutions
 Form of business organization
Risk Analysis and Management
Meaning of Risk
Risk is possibility of suffering an injury or loss. It present in
every field or situation. In the context of financial world ,it
represents the uncertainty associated with an investment. In
other words , risk is the possibility that the actual return on
an investment carrying a higher risk has potential of a
higher yield
Causes of Risk
 Wrong decision
 Wrong timing
 Nature of instruments
 Creditworthiness of issuer
 Length of investment
 Amount of investment
 Method of investment
 Terms of lending
Types of Risk
1. Systematic Risk
 Market Risk
 Interest Rate Risk
 Purchasing Power Risk
2. Unsystematic Risk
 Business Risk
 Financial Risk
 Systematic Risk
 It’s a uncontrollable risk and un-diversifiable risk
 It affects the entire market and not one specific stock or
industry
 It cannot be mitigated through diversification, but can be
managed only through the right asset allocation strategy.
Components Of Systematic Risk
1. Market Risk
 Market risk is the possibility of an investor experiencing losses
due to factors that affect the overall performance of the financial
markets in which he or she is involved. cannot be eliminated
through diversification, though it can be hedged against.
 Sources of market risk include recessions, political turmoil,
changes in interest rates, natural disasters and terrorist attacks.
2. Interest Rate Risk
It’s the possibility of an unexpected change in interest rates
prevailing in the market, which affects the value of an investment
adversely
Systematic risk
conti . . .
3. Purchasing power risk
Purchasing power risk is the possible reduction in the purchasing power of the
expected returns. Due to high rate off inflation, there is erosion in the purchasing
power of money , which results in decrease in the returns
 UNSYSTEMATIC RISK

 Also known as “ Diversifiable Risk”.

 Can be managed

 Can be controlled

 May be specific to an industry or company.

 CAUSES OF UNSYSTEMATIC RISK
 Lack of managerial ability.

 Technological advancement in the process of

production.

 Procurement of raw material .

 Lack of human resources

 Change in consumer preferences .

Factors leading to Unsystematic Risk may
relate to
• Financial Leverage

• Source of fund and repayment of the loans

• Sometimes product become obsolete

COMPONENTS OF UNSYSTEMATIC RISK

Unsystematic
Risk

Business Financial
Risk Risk

Internal External
Risk Risk
1. Business Risk

 Comes from operational activities of the business.

Business risk is due to internal and external causes

• Internal Business Risk

• External Risk
Internal Business Risk

 Internal business risk is related to the operational

effectiveness of a company
Operational effectiveness of the company is influenced
by,

• Sales Variation
• Research and Development
• Personnel Management
• Fixed Cost
• Single Product
External Business Risk

This business risk is caused by the external

circumstances
The company have no control over these factors . Which
are,

• Social and regulatory factors

• Monetary policy of the Central Bank of the country
• Fiscal policy of the Government
• Business Cycle
• General economic conditions
2.Financial Risk

 Closely related to manner in which the funds have

been raised to design capital structure of the
company.

 High level of debt component indicates the presence

of a low cost of capital, Which provides financial
leverage for shareholders
 Low cost of capital is due to

I. Earnings of the company remain higher than the

cost of capital
II. EPS shows an increasing trend

• High debt financing in a company may lead to

increase in financial risk
 Difference between systematic and un
systematic risk
Basis of Systematic Risk Unsystematic
comparison Risk
Meaning Systematic risk refers to Unsystematic
the hazard which is Unsystematic risk
associated with the refers to risk associated
market or market with a particular
segment as a whole security ,company or
industry .
Nature Uncontrollable Controllable
Factors External Factors Internal Factors
Affects Large number of Only particular company
securities in the market

Protection Asset allocation Portfolio diversification

 COMPUTATION OF RISK

 Statisticaltechniques are applied to measure the

approximate level of risk.

1. Range

2. Variance and Standard Deviation

3. Coefficient of variation
What is Money Market?
As per RBI definitions “ A market for short terms
financial assets that are close substitute for money,
facilitates the exchange of money in primary and
secondary market”.

 The money market is a mechanism that deals with

the lending and borrowing of short term funds (less
than one year).

 A segment of the financial market in which financial

instruments with high liquidity and very short
maturities are traded.
Continued…….
 It doesn’t actually deal in cash or money but deals with
substitute of cash like trade bills, promissory notes &
govt papers which can converted into cash without any
loss at low transaction cost.

 It includes all individual, institution and

intermediaries.
Features of Money Market?

 It is a market purely for short-terms funds or

financial assets called near money.

 It deals with financial assets having a maturity

period less than one year only.

 In Money Market transaction can not take place

formal like stock exchange, only through oral
communication, relevant document and written
communication transaction can be done.
Continued……..
 Transaction have to be conducted without the help
of brokers.

 It is not a single homogeneous market, it

comprises of several submarket like call money
market, acceptance & bill market.

 The component of Money Market are the

commercial banks, acceptance houses & NBFC
(Non-banking financial companies).
Objective of Money Market?

 To provide a parking place to employ short term

surplus funds.

 To provide room for overcoming short term deficits.

 To enable the central bank to influence and

regulate liquidity in the economy through its
intervention in this market.

 To provide a reasonable access to users of short-

term funds to meet their requirement quickly,
adequately at reasonable cost.
Importance of Money Market?

o Development of trade & industry.

o Development of capital market.
o Smooth functioning of commercial banks.
o Effective central bank control.
o Formulation of suitable monetary policy.
o Non inflationary source of finance to
government.
Composition of Money Market?

Money Market consists of a number of sub-markets

which collectively constitute the money market. They
are,
Call Money Market
Commercial bills market or discount market
Acceptance market
Treasury bill market
Functions of Money Market
 To maintain monetary balance between demand and supply of
short term monetary transactions.
 Money market plays a very important role of making funds
available to many units or entities engaged in diversified field of
activities be it agriculture, industry, trade, commerce or any other
business.
 By providing funds to developing sectors it helps in growth of
economy also.
 Another important feature that money market provides is
discounting of bills of exchange which facilitates growth of
trade.
 No doubt it provides a base for the implementation of
monetary policy also.
 The money market provides opportunity for short term
investments, which provide for short term savings, which in turn
help formation of capital base also.
Money Market Instruments
 Commercial Papers (CPs)
 Certificate of Deposits (CDs)
 Treasury Bills (T-Bills)
 Inter Bank Participation certificate (IBPCs)
 Commercial Bills (CBs)
 Call Money
 Repurchase Agreement(REPOs)
 Inter corporate Deposits (ICDs)
 Collateralized Borrowing and Lending Obligations (CBLO)
 I. Commercial Papers
 Unsecured Promissory notes issued with a fixed maturity by
a company and approved by RBI.
 Introduced in India in 1990
 The period of maturity may range from 7 days to 1 year.
 The instrument is negotiable by endorsement and delivery
 It is issued at a discount on face value
 It is a debt instrument issued by large credit worthy
companies as a means of short term finance (Working
Capital Needs)
 The total limit of CP issue should not exceed the working
capital limits sanctioned by banks or financial institutions
 Manufacturing Companies, Leasing and Finance Companies,
Mutual Funds and financial Institutions are the major issuers
of CP
 The minimum size of issue shall be 5lakhs and multiples
there of.
 The Net worth of the issuing company shall be Rs.4 cores or
more
 CPs can be issued to Individuals, Banks, Corporate, non-
Corporate, NRIs FIIs. However scheduled commercial banks
are the major investors of CPs.

Advantages
 T he issue and transactions of CPs is Simple and document free
 It is a flexible instrument. The maturity can be tailored as to
the cash flow of the company.
 Corporates get direct and quick access to institutional
investors. Hence it is also called Direct Paper
 Low Cost and high returns to investors
 2. Certificate of Deposits (CDs)
 Certificate of Deposits is a negotiable money market
instrument issued in dematerialized form instead of
Promissory Notes, for funds deposited at a bank or with other
eligible financial institutions for a specified time period
 They are short term time deposits instruments issued by
banks and financial institutions to raise large sum of money.
 It is a debt instrument and bearer certificate which is
negotiable in the market.
 It is issued by banks / financial institutions against deposits
kept by banks/ individual, companies and institutions.
 They are almost like bank fixed deposits and often are
Negotiable Certificate of Deposits (NCDs)
 Indian market RBI introduced in 1989
 A CD pays the depositor a specific amount of interest during
the term of the certificate plus the purchase price of the CD
at maturity.
 The original purchaser need not hold the CD to maturity.
However, banks cannot discount them or negotiate them.
 CDs are issued by scheduled commercial banks (excluding
RRBs and local Area Banks) and selected all India Financial
institutions permitted by RBI
 Banks can offer CDs which have a maturity between 7 days
and 1v year.
 CDs are available in the denominations of Rs.1 lakhs and in
multiples thereafter.
 With effect from 2002, Banks and FI can issue CDs in
Dematerialized form only
3. Inter-Bank Participation Certificates
(IBPCs)
 IBPCs are introduced in the market following the
recommendation of working committee known s Vaghul
Committee.
 it is an inter bank participation to fund their short term
needs.
 The participation certificates are issued by banks for periods
of 91 days and 180 days.
 The objective is to provide some degree of flexibility in the
credit portfolio of banks and smoothen consortium
arrangements.
 This system was introduced in 1988
 Scheduled commercial banks can participate in this
arrangement
 The procedural complexities are less
 4. Treasury Bills (T-bills)
 They are the short term promissory notes issued by RBI on
behalf of the central government to bridge the deficit
between the revenue and expenditure in the budget.
 It is usually issued at a discount for a specific period namely
91 days , 182 days and 364 days.
 The government promises to pay the specified amount
mentioned therein to the bearer of the instrument on due
date.
 It doesn't carry regular interest payments as it is issued at a
discount ,the difference between the purchase price and face
is the income.
 It is a finance bill as it does not arises out of any trade
transactions.
 They are issued in Dematerialized form
Features
 They are the zero risk instruments
 Treasury bills are available for a minimum amount of 25000
and multiples there of.

Types
 Ordinary treasury bills
 Adhoc treasury bills (1994)
5. Commercial Bills
 Commercial bills arises out of trade transactions when goods
are sold on credit the seller draws a bill on the buyer for the
due amount. The buyer accepts its agreeing to pay the
amount after specific period to the person mentioned in the
bill or to the bearer of the bill
 It is drawn for a short period ranging between three months
to six months.
 These bills are transferable by endorsement and delivery and
can be discounted or rediscounted.
 In a bill market the bill of exchanges are brought and sold
 Commercial bills are negotiable instruments drawn by the
seller on the buyer which are, in turn accepted and
discounted by commercial banks.
 commercial banks, cooperative banks financial institutions
mutual funds etc can participate in bill market.
 There are many types of bills such as demand and usance
bills, clean bills and documentary bills, inland and foreign
bills, export bills and import bills, accommodation bills and
supply bills, indigenous bills or hundis.
6. Call/ Notice Money
 It means a loan for very short period i.e, 1 day to 14 days. The
loans are repayable on demand at the option of either the
lender or the borrower.
 Call Money is otherwise known as Monet at Call
 Call money market is a market where short term surplus
funds of commercial banks, and other financial institutions
are traded
 The call money market is the highly liquid market and
accounts for a major share of the total turnover of the money
market
 In call money market, if money is lent for a day it is called
call money (money at a call) or overnight money, if it is for a
period of more than one day and less than 14 days , it is called
notice money or money at short period
 This market is governed by the RBI which issues guidelines
for the various participants in the call/notice money market
 Participants in call/notice money market currently include
banks, both scheduled commercial banks (excluding RRBs)
and co-operative banks other than Land Development Banks,
both as borrowers and lenders
 Major industrial and commercial centers like Mumbai, Delhi,
Chennai, Ahmadabad, etc are important call market centers
 The dealers are conducted both on telephone as well as on
the NDS Call system , which is an electronic screen based
system set up by RBI for negotiating money market deals
between entities permitted to operate in the money market
 Deals in the call/notice money market can be done up to
5.00pm on weekdays and 2.30pm on Saturdays or as specified
by RBI from time to time
 The deal specifies the amount of loan and the interest rate
(call rate )
 7. Repurchase Agreements (REPOS )
 A repurchase agreement, also know as Repo is the sale of
securities together with an agreement by the seller to buy
back the securities at the later date. The repurchase price will
be greater than the original sale price, the difference
effectively representing interest, known as repo rate.
 The party who sells a security under a repurchase agreement
is borrower and the party who buys the security is the lender.
 Only RBI approved securities can be traded in this way.
 They include Central and state government bonds, treasury
bills, corporate bonds, bonds of public sector units, financial
institutions etc. banks, NBFCs, State Owned Financial
Institutions, Mutual Funds, Housing Financing Companies
and Insurance Companies or any other entity allowed by RBI
only can undertake REPO deals
 A repo is combination of a secured cash loan and a forward
contract. As it is a means of funding by selling a security held
on a spot basis and repurchasing the same on a foreword
basis, it is also called ready forward deal.
 Two types of REPOs are there Inter-bank repo and RBI Repo
 Inter-bank repo is an agreement between Banks themselves
and with DFHI and STCI (STCI Finance Ltd (formerly
Securities Trading Corporation of India Limited), is a
Systemically Important Non-Deposit taking NBFC registered
with Reserve Bank of India (RBI). Presently STCI Finance Ltd
is classified as a loan NBFC.)
 RBI repo (RBI and Scheduled commercial banks)
Repos again be classified into
 Oovernight Repos – last only one day
 Term Repos – if the period is fixed and agreed in advance
 Open Repos – there is no such fixed maturity period
 Flexible Repos – there is flexibility for borrower to raise funds
Advantages of REPO
 Repos enable collateralized short term borrowings backed by
securities
 Opportunity to invest cash for a customized period of time
 Central banks can use repo as an integral part of their open
market operations
 Repo transaction facilitate banks to invest surplus cash for
adjusting CRR positions and also for adjusting SLR positions
 8. Collateralized Borrowing and
Lending Obligation (CBLO)
 CBLO is a RBI approved money market instrument which
can be issued for a maximum tenure of one year. It is
launched by Clearing Corporation of India Ltd. (CCIL) in
2003, to provide liquidity to non bank entities, which had
only access regulated access to call/notice money market
 CBLO as name indicated is a fully collateralized and secured
instrument for borrowing / lending money
 It is backed by GILTS (G-secs) as collaterals(central govt
securities and t bills )
 CBLO are discounted instruments issued in an electronic
book entry from and has a maturity period ranging from 1
day to 1 year
 Creates an obligation on the borrower to repay the money
borrower to repay the money borrowed along with interest
on a predetermined future date
 Gives a right and authority to the lender to receive money
lent along with interest on a predetermined future date
 Creates a charge on the collaterals deposited by the borrower
with CCIL for the purpose
 CBLO dealing system is a screen based, order driven,
anonymous order matching system that facilitates borrowing
and lending by members
 The entity type eligible for CBLO membership are
Nationalized Banks, Private Banks, Foreign Banks, Co-
operative banks, Financial Institutions, Insurance
Companies, Mutual Funds, NBFCs Corporate , Provident/
Pension Funds
 Two types of market are available to CBLO dealing system
members, viz., CBLO Normal Market and the CBLO Auction
Market
 CBLO normal market facilitates borrowing and lending by
members on an online basis
 CBLO Auction market facilitates borrowing and lending by
members through submission of bids.
 The minimum and multiple lot size for CBLO normal market
is Rs.5 lakhs. The minimum lot size for CBLO auction market
is Rs.50lakhs and multiple lot size is Rs.5 lakhs
 9. Inter- Corporate Deposits (ICD)
 An ICD is an unsecured loan extended by one corporate to
another
 It allows fund-surplus corporate to lend other corporate
facing shortage
 This lending is uncollateralized basis and hence a higher arte
of interest is charged by the lender
 The tenure of ICD may range from 1 day to 1 year, but the
most common tenure of borrowing is for 90 days.
 ICDs are unsecured, and hence the risk inherent in high
 The market participants are cash rich corporates, NBFCs
PSUs and FIs.
 Brokers play an important role in procuring and placing
orders
 The market is not well organized
Reference Rate
 A reference rate is an interest rate benchmark used to set
other interest rates.
 Various types of transactions use different reference rate
benchmarks, but the most common are the LIBOR, the
prime rate, and benchmark U.S. Treasury securities.
 Reference rates are useful in homeowner mortgages and
sophisticated interest rate swap transactions made by
institutions.
 Let's say a homebuyer needs to borrow Rs.40,000 to help
finance the purchase of a new home. The bank offers
a variable interest rate loan at prime plus 1%. That
means the interest rate for the loan equals the prime
rate plus 1%. Therefore, if the prime rate is 4%, then your
mortgage carries an interest rate of 5% (4%+1%).

In this case, the prime rate is the reference rate.

LIBID and LIBOR
 Both LIBID and LIBOR are reference rates set by banks
in the London interbank market.
 The London interbank market is a wholesale money
market in London where banks exchange currencies
either directly or through electronic trading platforms.
LIBOR - London Interbank Bid Rate.

LIBOR (officially ICE LIBOR –stands for London InterBank

Offered Rate.
LIBOR is the interest rate at which banks can borrow money
(unsecured funds) from other banks in the London interbank
market for a specified period of time in a specified currency.
The benchmark rate is calculated for seven maturities for five
currencies: the Swiss franc, the euro, the pound sterling, the U.S.
dollar and the Japanese yen. There are actually 35 rates that are
released to the market every day.
LIBOR is the interest rate at which the London banks are willing to offer
funds in the inter-bank market. It is the average of rates which five major
London banks are willing to lend £10 million for a period of three or six
months, and is the benchmark rate for setting interest rates for adjustable-
rate loans and financial instruments.

ie. the London banks are LENDING to each other, which affects the rate
at which the banks will lend to other parties eg. local authorities
LIBID stands for London Interbank Bid Rate.
The acronym LIBID stands for London Interbank Bid Rate.
 It is the bid rate that banks are willing to pay for eurocurrency
deposits and other banks' unsecured funds in the London
interbank market.
 Eurocurrency deposits refer to money in the form of bank
deposits of a currency outside that currency's issuing country.
They may be of any currency in any country.
 The most common currency deposited as eurocurrency is
the U.S. dollar. For example, if U.S. dollars are deposited in
any bank outside the U.S – Europe, the U.K., anywhere – then
the deposit is referred to as a eurocurrency.
LIBID is the interest rate at which London banks are willing to
borrow from one another in the inter-bank market. It is the
average of rates which five major London banks willing to bid
for a £10 million deposit for a period of three or six months.
ie. the London banks are BORROWING from each other, which
affects the rates at which they will borrow from other parties
MIBID and MIBOR
 Mumbai Inter-Bank Offer Rate (MIBOR) and Mumbai
Inter-Bank Bid Rate (MIBID) are the benchmark rates at
which Indian banks lend and borrow money to each other.
 The bid is the price at which the market would buy and
the offer (or ask) is the price at which the market
would sell.
 These rates reflect the short term funding costs of major
banks.
 The MIBID/MIBOR rate is also used as a bench mark rate
for majority of deals struck for Interest Rate
Swaps (IRS), Forward Rat Agreements (FRA), Floating Rate
Debentures and Term Deposits.
 MIBOR reflects the price at which short term funds are
made available to participating banks.
 MIBID is the rate at which banks would like to borrow
from other banks and MIBOR is the rate at which banks
are willing to lend to other banks. Contrary to general
perception, MIBID is not the rate at which banks attract
deposits from other banks.
 Tools for Managing Liquidity in the
Money Market
 Reserve Requirement
 Interest Rate/Bank Rate
 Refinance from the Reserve Bank
 Liquidity Adjustment Facility
 REPOs
 1. Reserve Requirements
The Reserve Requirements are of two Types
 Cash Reserve Ratio
 Statutory Liquid Ratio

Cash reserve Ratio (CRR)

 CRR is the amount of funds that the banks have to keep with the
RBI.
 If the central bank decides to increase the CRR, the available
amount with the banks comes down.
 The RBI uses the CRR to drain out excessive money from the
system.
 Commercial banks are required to maintain with the RBI an
average cash balance.
Current CRR : 4 %
 Statutory Liquidity Ratio (SLR)

 Apart from Cash Reserve Ratio (CRR), banks have to

maintain a stipulated proportion of their net demand
and time liabilities in the form of liquid assets like cash,
gold and unencumbered securities.
 Treasury bills, dated securities issued
under market borrowing programme and market
stabilization schemes (MSS) etc also form part of the SLR.

Current SLR : 20.50%

 2. Interest Rate/ Bank Rate

 A prime rate or prime lending rate is an interest rate

used by banks, usually the interest rate at which banks lend
to favoured customers
 Bank rate is the rate of interest which a central bank
charges on the loans and advances to a commercial bank.
 3. Refinance from the Reserve Bank
 Refinance is the method to replace or adjust the terms of
existing debt obligation like loan, mortgage or credit note.
 While taking a credit, you take the loan or mortgage at a
certain rate of interest.
 Through refinance, you can renegotiate the terms of your
debt obligations like interest rates of your borrowed
amount, length of agreement, amount of loan etc.

There are various types of refinance offered by RBI.

1. Export Credit Refinance Facility
2.Special Refinance Facility (SRF)
1. Export Credit Refinance Facility

 RBI offers export credit refinance facility to the scheduled

banks under Section 17(3A) of RBI Act 1934.
 Presently, credit refinance is offered up to 15% of the
outstanding export credit.
 The monthly payable interest is calculated on
daily balances and maximum duration for repayment is
180 days.
Special Refinance Facility (SRF)
 Special refinance facility was introduced under
Section17(3B) of RBI Act, 1934. It allows scheduled
commercial banks(except Regional Rural Banks) to
refinance up to 1% of Net Demand and Time Liabilities
(NDTL) of each bank.
4.Liquidity Adjustment Facility
 LAF is used to aid banks in adjusting the day to day
mismatches in liquidity. LAF helps banks to quickly borrow
money in case of any emergency or for adjusting in
their SLR/CRR requirements

LAF consists of repo and reverse repo operations

 Repo or repurchase option is a collaterised lending i.e.

banks borrow money from Reserve bank of India to meet short
term needs by selling securities to RBI with an agreement to
repurchase the same at predetermined rate and date
 Reverse Repo operation is when RBI borrows money
from banks by lending securities. The interest rate paid by RBI
in this case is called the reverse repo rate
 5. REPOs
 Repo Rate
Repo rate is the rate at which RBI lends to its clients generally
against government securities. Reduction in Repo rate helps
the commercial banks to get money at a cheaper rate and
increase in Repo rate discourages the commercial banks to
get money as the rate increases and becomes expensive.

 Reverse Repo Rate

Reverse Repo rate is the rate at which RBI borrows money from
the commercial banks. The increase in the Repo rate will
increase the cost of borrowing and lending of the banks
which will discourage the public to borrow money and will
encourage them to deposit.
Money Markets in India
 The average turn over of the money market in India is over
Rs 40000 daily
 This is more than 3 percent let out to the system.
 This implies that 2 percent of the annual GDP of India gets
traded in the money market in just one day
 The Indian money market is divided into formal (organized)
and informal (un organized) segments.
 Several steps were taken in the 1980’s and 1990’s to reform
and develop the money market.
Steps to Developing Money Market in
India
In the 1980’s
 A committee to review the working of the monetary system
under the chairmanship of Sukhamoy Chakravorthy was set
up in 1985. it underlined the need to develop money market.
 As a follow up, the RBI set up a working group on the
monetary market under the chairmanship of N. Vaghul
which submitted report on 1987.
 This committee laid the blue print for the institutions of
money market. Based on its recommendations, the RBI
initiated a number of measures.
 The DFHI was setup in 1988 as a subsidiary to RBI to perform
the duties of RBI on Money Market.
 Money market instruments such as the 182 day treasury bill,
certificate of deposits and IBPCs were introduced in 1988-89.
 To enable price discovery, the interest rate ceiling on call
money was freed in stages from October 1988. interest rate
ceiling on inter bank term money (10.5 % to 11.5 %),
rediscounting of commercial bills (12.5 %), inter bank
participation without risk (12.5%) were withdrawn effectively
may 1989.
 There has been a gradual shift from a regime of administered
interest rate to market based interest rate
1990’s
 The Government set up a high level committee in August
1991 under the chairmanship of M. Narasimham (the
Narasimbham Committee) to examine all aspects relating
structure, organization, functions and procedures of the
financial system.
 Commercial paper was introduced in 1990 s
 The STC of Indian was set up in June 1994 to provide active
secondary market
 Barriers to entry were gradually eased by Setting up of
Primary Dealer System in 1995
 Relaxing issuance restrictions and subscriptions norms in
respect of money market instruments
 Allowing the determination of yield based on the demand
and Supply of such paper
 Enabling market evaluation of associated risk by
withdrawing regulatory restrictions eg : bank guarantee
 increasing the number of participants by the entry of FIIs
NBFCS and Mutual Funds
 Treasury bills and RBI repos introduced 1990s
 Development of a market for short term market from banks
to borrowers
 Ad-hoc and on tap 91 day treasury bills were discontinue
 Indirect monetary control instruments (bank rate) re
activated in April 1997
 LAF in June 5, 2000
 Money Minimum Lock in Period brought down to 15 days
 Foreword Rate Agreements and Interest Rate Swaps
introduced in 1999
 Negotiated Dealing System February 2002
 CCIL April 2002
 RTGs April 2004
 CBLO January 20, 2003
 Call/Notice Money market is transformed in to pure inter
bank market
 The NDS and CCIL have improved the functioning of Money
Market
Bond Basics
 a bond is a contract that requires the borrower to pay the
interest income to the lender.
 It resembles the promissory note and issued by the
government and corporate
 The par value of the bond indicates the face value of the
bond i.e the value stated on the bond paper.
 Generally, the face value of the bonds are Rs. 1000,2000,5000
and alike.
 Most of the bonds make fixed interest payment till the
maturity period.
 This specific rate of interest is known as coupon rate.
 Coupons are paid quarterly, semi-annually and annually.
 At the end of the period, the value is repaid
Types of Bonds
 Fixed Rate Bonds
In Fixed Rate Bonds, the interest remains fixed through out the
tenure of the bond. Owing to a constant interest rate, fixed rate
bonds are resistant to changes and fluctuations in the market.
 Floating Rate Bonds
Floating rate bonds have a fluctuating interest rate (coupons) as
per the current market reference rate.
 Zero Interest Rate Bonds
Zero Interest Rate Bonds do not pay any regular interest to the
investors. In such types of bonds, issuers only pay the principal
amount to the bond holders.
 Inflation Linked Bonds
Bonds linked to inflation are called inflation linked bonds. The
interest rate of Inflation linked bonds is generally lower than fixed
rate bonds.
 Perpetual Bonds
Bonds with no maturity dates are called perpetual bonds. Holders
of perpetual bonds enjoy interest throughout.
 Subordinated Bonds
Bonds which are given less priority as compared to other bonds of
the company in cases of a close down are called subordinated
bonds. In cases of liquidation, subordinated bonds are given less
importance as compared to senior bonds which are paid first.
 Bearer Bonds
Bearer Bonds do not carry the name of the bond holder and
anyone who possesses the bond certificate can claim the amount.
If the bond certificate gets stolen or misplaced by the bond holder,
anyone else with the paper can claim the bond amount.
 War Bonds
War Bonds are issued by any government to raise funds in cases of
war.
 Serial Bonds
Bonds maturing over a period of time in installments are called
serial bonds.
 Climate Bonds
Climate Bonds are issued by any government to raise funds when
the country concerned faces any adverse changes in climatic
conditions.
Bond Risk
 Generally stocks are considered to be risky but bonds are not
 This is not fully correct. Bonds do have risk but the nature
and types of risks may be different. The risks are interest rate,
default, marketability, and callability risks

Bond Risks

Interest rate Marketability Callability

Default Risks
Risks Risks Risks
1. Interest rate risk
 Variability in the return from the debt instruments to investors is
caused by the changes in the market interest rate. This is known
as interest rate risk.
 Changes that occur in the interest rate affect the bonds more
directly than the equity
 There is a relationship between the coupon rate and the market
interest rate
 If the market interest rate moves up, the price of the bond
declines and vice-versa
For Example

If one holds a 14.50 per cent bond and the market interest rate falls,
from 14 percent to 13 per cent, the bond value would be higher . In
contrast, if the market interest rate goes up to 15 per cent, the price
would decline to offer the buyer a yield that is proximate to the
market inertest rate.
2. Default Risk
 The failure pay the agreed value of the debt by the issuer in
full, on time or both are the default risk.
 Treasury bills and bonds issued by the Central Government
are avoid of this risk.
 The same cannot be assured of bonds/debentures issued by
any other corporate bodies.
 The default risk occurs because of macro economic factors
or film specific factors. The macro economic factors affect
the overall system.
1. Interest Rate Risk and Bond Prices
 Interest rates and bond prices have an inverse relationship as
interest rates fall, the price of bonds trading in the marketplace
generally rises. Conversely, when interest rates rise, the price of
bonds tends to fall.
 This happens because when interest rates are on the decline,
investors try to capture or lock in the highest rates they can for as
long as they can. To do this, they will scoop up existing bonds
that pay a higher interest rate than the prevailing market rate.
This increase in demand translates into an increase in bond
price.
 On the flip side, if the prevailing interest rate were on the rise,
investors would naturally jettison bonds that pay lower interest
rates. This would force bond prices down.
Let's look at an example:
Example - Interest Rates and Bond Price
An investor owns a bond that trades at par value and carries a
4% yield. Suppose the prevailing market interest rate surges to
5%. What will happen? Investors will want to sell the 4% bonds
in favor of bonds that return 5%, which in turn forces the 4%
bonds' price below par.
2. Reinvestment Risk and Callable Bonds
 Another danger that bond investors face is reinvestment risk
which is the risk of having to reinvest proceeds at a lower rate
than the funds were previously earning. One of the main ways
this risk presents itself is when interest rates fall over time
and callable bonds are exercised by the issuers.
 The callable feature allows the issuer to redeem the bond prior to
maturity. As a result, the bondholder receives the principal
payment, which is often at a slight premium to the par value.
 However, the downside to a bond call is that the investor is then
left with a pile of cash that he or she may not be able to reinvest
at a comparable rate. This reinvestment risk can have a major
adverse impact on an individual's investment returns over time.
 To compensate for this risk, investors receive a higher yield on
the bond than they would on a similar bond that isn't callable.
Active bond investors can attempt to mitigate reinvestment risk
in their portfolios by staggering the potential call dates of their
differing bonds. This limits the chance that many bonds will be
called at once
3. Inflation Risk and Bond Duration

 When an investor buys a bond, he or she essentially

commits to receiving a rate of return, either fixed or
variable, for the duration of the bond or at least as long as it
is held.
 But what happens if the cost of living and inflation increase
dramatically, and at a faster rate than income investment?
When that happens, investors will see their purchasing
power erode and may actually achieve a negative rate of
return (again factoring in inflation).
 Put another way, suppose that an investor earns a rate of
return of 3% on a bond. If inflation grows to 4% after the
bond purchase, the investor's true rate of return (because of
the decrease in purchasing power) is -1%.
4. Credit/Default Risk of Bonds
 When an investor purchases a bond, he or she is actually
purchasing a certificate of debt. Simply put, this is borrowed
money that must be repaid by the company over time with
interest. Many investors don't realize that corporate bonds aren't
guaranteed by the full faith and credit of the U.S. government,
but instead depend on the corporation's ability to repay that
debt.
 Investors must consider the possibility of default and factor this
risk into their investment decision. As one means of analyzing
the possibility of default, some analysts and investors will
determine a company's coverage ratio before initiating an
investment.
 They will analyze the corporation's income and cash flow
statements, determine its operating income and cash flow, and
then weigh that against its debt service expense. The theory is
the greater the coverage (or operating income and cash flow) in
proportion to the debt service expenses, the safer the investment.
5. Rating Downgrades of Bonds
 A company's ability to operate and repay its debt (and
individual debt) issues is frequently evaluated by major
ratings institutions such as Standard & Poor's or Moody's.
 Ratings range from 'AAA' for high credit
quality investments to 'D' for bonds in default. The
decisions made and judgments passed by these agencies
carry a lot of weight with investors.
 If a company's credit rating is low or its ability to operate
and repay is questioned, banks and lending institutions will
take notice and may charge the company a higher interest
rate for future loans.
 This can have an adverse impact on the company's ability to
satisfy its debts with current bondholders and will hurt
existing bondholders who might have been looking to
unload their positions.
6. Liquidity Risk of Bonds

 While there is almost always a ready market for government

bonds, corporate bonds are sometimes entirely different
animals.
 There is a risk that an investor might not be able to sell his
or her corporate bonds quickly due to a thin market with
few buyers and sellers for the bond.
 Low buying interest in a particular bond issue can lead to
substantial price volatility and possibly have an adverse
impact on a bondholder's total return (upon sale).
 Much like stocks that trade in a thin market, you may be
forced to take a much lower price than expected to sell your
position in the bond.
Bond Returns
 Holding Period Return
An investor buys a bond and sells it after holding for a period.
The rate of return in that holding period is :

Holding Period Return =

Price gain/loss during the period + Coupon interest rate, if any

Price at the beginning of the holding period

The holding period rate of return is also called the one period
rate of return. The holding period rate of return can be
calculated daily or monthly or annually. If the fall in the bond
price is greater than the coupon payment the holding period
return will turn to be negative.
Example
 A) an investor A Purchased a bond at a price of Rs.900 with
Rs.100 as coupon payment and sold it at Rs. 1000. What is his
holding period return ?
 If the bond is sold for Rs.750 after receiving Rs.100 as coupon
payment, then what is the holding period return ?
Solution
Price Gain + Coupon Payment
Holding Period Return =
Purchase Price
100+100
900
 For the casual observer, bond investing would appear to be as
simple as buying the bond with the highest yield.
 While this works well when shopping for a certificate of
deposit (CD) at the local bank, it's not that simple in the real world.
 There are multiple options available when it comes to structuring a
bond portfolio, and each strategy comes with its own risk and
reward tradeoffs.
 The four principal strategies used to manage bond portfolios are:

1. Passive, or "buy and hold“

2. Quasi – Passive Strategy
 Ladders
 Bullets
 Barbells
3. Semi- active Strategy or Immunization
4. Active Strategy
 Valuation
 Bond Swap Strategy
1. Passive Bond Management Strategy
 The passive buy-and-hold investor is typically looking to
maximize the income-generating properties of bonds.
 The premise of this strategy is that bonds are assumed to
be safe, predictable sources of income. Buy and hold
involves purchasing individual bonds and holding them
to maturity.
 Cash flow from the bonds can be used to fund external
income needs or can be reinvested in the portfolio into
other bonds or other asset classes.
 In a passive strategy, there are no assumptions made as to
the direction of future interest rates and any changes in
the current value of the bond due to shifts in the yield are
not important.
 The bond may be originally purchased at a premium or a
discount, while assuming that full par will be received
upon maturity. The only variation in total return from the
actual coupon yield is the reinvestment of the coupons as
they occur.
 On the surface, this may appear to be a lazy style of
investing, but in reality passive bond portfolios provide
stable anchors in rough financial storms.
 They minimize or eliminate transaction costs, and if
originally implemented during a period of relatively high
interest rates, they have a decent chance of
outperforming active strategies
 One of the main reasons for their stability is the fact that
passive strategies work best with very high-quality, non-
callable bonds like government or investment
grade corporate or municipal bonds.
 These types of bonds are well suited for a buy-and hold
strategy as they minimize the risk associated with changes
in the income stream due to embedded options, which are
written into the bond's covenants at issue and stay with
the bond for life.
 Like the stated coupon, call and put features embedded in
a bond allow the issue to act on those options under
specified market conditions.
2. Quasi Passive Bond Management Strategy
 LADDERS
 Ladders are one of the most common forms of Quasi
passive bond investing.
 This is where the portfolio is divided into equal parts and
invested in laddered style maturities over the
investor's time horizon.
 An investor gains more flexibility by spreading out
investment capital over a number of different bonds at
different times and at different interest rates.
 This prevents a single lump sum of money being stuck in a
bond over a long period, thereby limiting potential
income and not allowing an investor to take advantage of
potential rises in interest rates.
Barbells
 The barbell strategy is used to take advantage of the best
aspects of short-term and long-term bonds. In this strategy
only very short-term and extremely long-term bonds are
purchased. Longer dated bonds typically offer higher interest
yields, while short-term bonds provide more flexibility.
 The short-term bonds give an investor the liquidity to adjust
potential investments every few months or years. If interest
rates start to rise, the shorter maturities allow an investor to
reinvest principal in bonds that will realize higher returns than
if that money was tied up in a long-term bond.
 The long-term bonds give an investor a steady flow of higher-
yield income over the term of the bond. However, by not
having all of your capital in long-term bonds, this limits the
downside effects if interest rates were to rise in that bond
period.
Bullets
 If an investor knows that he or she will need a certain amount of
capital at a given point in time in the future, then a bullet
investment strategy might be the best way to go.
 This strategy suggests that an investor stagger purchase dates on
bonds that all mature at the same time.
 By staggering the purchase of bonds, investors can more
efficiently seek out securities that have more attractive interest
rates. And since all of the bonds have the same maturity date,
investors are able to receive a potentially more attractive inflow.
 However, because the investor is staggering the purchase of the
bonds, it can lead to a risk that interest rates will fall over the
bond purchasing period.
 Keeping a close eye on the interest rate environment is key to
successfully following this strategy.
 3. Immunization Bond Strategy
 This strategy has the characteristics of both active and passive
strategies. By definition, pure immunization implies that a portfolio
is invested for a defined return for a specific period of time
regardless of any outside influences, such as changes in interest
rates.
 Similar to indexing, the opportunity cost of using the immunization
strategy is potentially giving up the upside potential of an active
strategy for the assurance that the portfolio will achieve the
intended desired return. As in the buy-and-hold strategy, by design
the instruments best suited for this strategy are high-grade bonds
with remote possibilities of default.
 In fact, the purest form of immunization would be to invest in
a zero-coupon bond and match the maturity of the bond to the date
on which the cash flow is expected to be needed. This eliminates
any variability of return, positive or negative, associated with the
reinvestment of cash flows.
 Duration, or the average life of a bond, is commonly used
in immunization. It is a much more accurate predictive
measure of a bond's volatility than maturity. This strategy
is commonly used in the institutional investment
environment by insurance companies, pension funds and
banks to match the time horizon of their future liabilities
with structured cash flows. It is one of the soundest
strategies and can be used successfully by individuals.

For example, just like a pension fund would use an

immunization to plan for cash flows upon an individual's
retirement, that same individual could build a dedicated
portfolio for their own retirement plan.
4. Active Bond Strategy
 The goal of active management is maximizing total
return.
 Along with the enhanced opportunity for returns
obviously comes increased risk.
 Some examples of active styles include interest rate
anticipation, timing, valuation and spread
exploitation, and multiple interest rate scenarios.
 The basic premise of all active strategies is that the
investor is willing to make bets on the future rather
than settle with the potentially lower returns a
passive strategy can offer.
Valuation Strategy
 The benefit of a valuation strategy depends on the bond
portfolio managers ability to identify and purchase the
undervalued bonds and avoid the overvalued ones. It
requires a through knowledge about the bond market
valuation process.
Bond Swap Strategy
• A bond swap is the exchange of a set of bond other bond
having similar risk and maturity.
5.1 Interest rate anticipation
 This is the riskiest strategy because the investor must act on
uncertain forecasts of future interest rates
 When interest rate rise bond price drop & when interest rate
drop bond price rise
 Increase the investment in long duration bonds when
interest rates are expected to decline & vice versa
 The risk of misestimating interest rate movement
 5.2 Valuation analysis
 Select the bond on the basis of their intrinsic values
 What are the factors which affect the bonds intrinsic
values
 Bonds rating, call feature, interest rate etc.
 Buy the undervalued bond & sell the overvalued bonds
 If bond rating is higher then interest is low and as result
income is low
5.4 Yield spread analysis
 Yield spread means difference between the return of
two bonds
 Factor affecting yield spread:- – Business cycle –
Volatility in the market interest rate
6. Matched-funding techniques
 Mixture of passive buy & hold strategy and active
management strategy
 Objective is to get higher return at minimum risk
 Require constant monitoring
 Could give more return than buy & hold but not higher
than active management strategy
Capital Market
Capital Market
 Capital market is a market for long term capital / fund
 It is a comprehensive term consisting of all the
facilities and institutional arrangements for borrowing
and lending of long term capital .
 The government as well as business organization raise
finance from this market to meet their long term
needs
 The market where investment instruments like bonds,
equities and mortgages are traded is known as the
capital market.
 The primal role of this market is to make investment
from investors who have surplus funds to the ones who
are running a deficit.
 Primary Market and Secondary Market are the two
wings of this market
Nature or Functions of Capital Market

The nature of capital market is brought out by the

following facts:

 Two Segmented Operation

 It deals in Long-Term Securities
 It creates dispersion in Business Ownership
 It helps in Capital Formation
 It helps in Creating Liquidity
 Mobilizes the savings of the people for investment
Primary Market
 Primary market or new issue market is the market
where the companies issue their shares for the first time
and public can subscribe to it.
 It is not a specific space place but extends to all places
where the shares or debentures or other securities of a
company can be subscribed for the first time.
 This market is one major segment of capital market and
includes all institutions dealing in new issue
 The underwriters, merchant banks, brokers and
investors are the participants
Three main services/functions of
the primary market
1. Origination
This is the primary investigation undertaken by the
sponsors of the issue of new shares, Usually merchant
bankers may take up this work
2. Under writing
Underwriting is an agreement whereby the underwriter
agrees to subscribe a specific number of securities if
the public do not subscribe to it
3. Distribution
Sale of securities to the investors is the distribution.
Merchant bankers, brokers, agents and other
intermediaries perform this function for the company.
Methods of floating new issue
 Public Issue
(a)Initial public offering (IPO) Offer through Prospectus
Offer of Sale
(b)Further public offering (FPO)

 Private Placement
(a)Preferential Issue
(b)Qualified Institutional Placement

 Rights Issue

 Bonus Issue
INITIAL PUBLIC OFFERING (IPO)
 Corporates may raise capital in the primary market by way
of an initial public offer, rights issue or private placement.
An Initial Public Offer (IPO) is the selling of securities to
the public in the primary market. This Initial Public
Offering can be made through the fixed price method,
book building method or a combination of both.
 In case the issuer chooses to issue securities through the
book building route then as per SEBI guidelines, an issuer
company can issue securities in the following manner:
 100% of the net offer to the public through the book
building route.
 75% of the net offer to the public through the book
building process and 25% through the fixed price portion.
Entry Norms For IPO & FPO

Entry Norms:

 Net Tangible Assets of at least Rs. 3 crores for 3 full

years.
 Distributable profits in atleast three years.
 Net worth of at least Rs. 1 crore in three years.
 If change in name, atleast 50% revenue for preceding 1
year should be from the new activity.
 The issue size does not exceed 5 times the pre- issue
net worth
BASIC CONCEPTS:
 Bid
- A bid is the demand for a security that can be entered by the
syndicate/sub-syndicate members in the system. The two main
features of a bid are the price and the quantity.
 Bidder
- The person who has placed a bid in the Book Building process.
 Book Running Lead Manager: (BRLM)
- A Lead Merchant Banker who has been appointed by the Issuer
Company as the Book Runner Lead Manager. The name of the Book
Runner Lead Manager is mentioned in the offer document of the Issuer
Company.
 Floor Price and Cap Price (PRICE BAND)
- The minimum offer price below which bids cannot be entered. The
Issuer Company in consultation with the Book Running Lead Manager
fixes the floor price while the maximum offer price is known as Cap
Price in Price Band.
BASIC CONCEPTS: CONT…

 Merchant Banker
- An entity registered under the Securities and Exchange Board of India
(Merchant Bankers) Regulations, 1999.

 Order Book
- It is an 'electronic book' that shows the demand for the shares of the
company at various prices.
BASIC CONCEPTS: CONT…
 Offer Document:
“Offer document” means Prospectus in case of a public issue or
offer for sale and Letter of Offer in case of a rights issue, which is
filed with Registrar of Companies (ROC) and Stock Exchanges.
An offer document covers all the relevant information to help an
investor to make his/her investment decision.

 Red Herring Prospectus:

Red Herring Prospectus is a prospectus, which does not have
details of EITHER PRICE OR NUMBER OF SHARES being
offered, or THE AMOUNT OF ISSUE. This means that in case
price is not disclosed, the number of shares and the upper and
lower price bands are disclosed. On the other hand, an issuer can
state the issue size and the number of shares are determined
later.
BASIC CONCEPTS: CONT…
 Abridged Prospectus:
Abridged Prospectus means the memorandum as prescribed
in Form 2A of section 56 of the Companies Act, 1956.
It contains all the salient features of a prospectus. It also
combines the application form of public issues.

 Lock-in:
Lock-in indicates a freeze on the shares. SEBI (DIP)
Guidelines have stipulated lock-in requirements on shares
of promoters mainly to ensure that the promoters or main
persons who are controlling the company, shall continue to
hold some minimum percentage in the company after the
public issue.
BASIC CONCEPTS: CONT…
Who decides the price of an issue?
 There is no price formula stipulated by SEBI. SEBI does not
play any role in price fixation.
 There are two types of issues,
 First Case: where company and LM fix a price (called fixed
price) and
 Second Case: where the company and LM stipulate a floor
price or a price band and leave it to market forces to
determine the final price (price discovery through book
building process).
BASIC CONCEPTS: CONT…
 What is firm allotment?
 A company making an issue to public can reserve some
shares on “ALLOTMENT ON FIRM BASIS” for some
categories as specified in DIP guidelines.
 Allotment on firm basis indicates that allotment to the
investor is on firm (definite) basis. DIP guidelines provide
for maximum % of shares, which can be reserved on firm
basis.
 The shares to be allotted on “firm allotment category” can
be issued at a price different (GENERALLY HIGHER) from
the price at which the net offer to the public is made.

Rameshwar Patel 150

BASIC CONCEPTS: CONT…
 How many days is the issue open?
 Subscription list for public issues shall be kept open for at
least 3 working days and not more than 10 working days.
 In case of Book built issues, the minimum and maximum
period for which bidding will be open is 3–7 working days
extendable by 3 days in case of a revision in the price band.

 Listing Time After Closure of an Issue:

 The listing on the stock exchanges is done within 7 days
from the finalization of the issue. Ideally, it would be around
3 weeks after the closure of the book built issue.
 In case of fixed price issue, it would be around 37 days after
closure of the issue.
BASIC CONCEPTS: CONT…

The INTERMEDIARIES in an issue:

 Merchant Bankers to the issue or Book Running Lead
Managers (BRLM)
 Syndicate Members
 Registrars to the Issue
 Bankers to the Issue
 Auditors of the Company
 Underwriters to the Issue
 Solicitors

Rameshwar Patel 152

BASIC CONCEPTS: CONT…
 Green-shoe Option:
 Green Shoe option means an option of allocating shares in excess
of the shares included in the public issue and operating a post-
listing price stabilizing mechanism for a period not exceeding 30
days in accordance with the provisions of Chapter VIIIA of DIP
Guidelines, which is granted to a company to be exercised
through a Stabilizing Agent.
 This is an arrangement wherein the issue would be over allotted
to the extent of a maximum of 15% of the issue size.
 From an investor’s perspective, an issue with green shoe option
provides more probability of getting shares and also that post
listing price may show relatively more stability as compared to
market.
 Mainly practiced in US and European Markets
BASIC CONCEPTS: CONT…
 What is Safety Net?
 Any safety net scheme or buy-back arrangements of the
shares proposed in any public issue shall be finalized by an
issuer company with the lead merchant banker in advance
and disclosed in the prospectus.
 Such buy back or safety net arrangements shall be made
available only to all original resident individual allottees
limited up to a maximum of 1000 shares per allottee and
the offer is kept open for a period of 6 months from the last
date of dispatch of securities.
BASIC CONCEPTS: CONT…
 Who is a Syndicate Member?
 The Book Runner(s) may appoint those intermediaries who
are registered with the Board and who are permitted to
carry on activity as an ‘Underwriter’/ Syndicate Members.
 The syndicate members are mainly appointed to collect
and enter the bid forms in a Electronic Book in case of
book built issue.
 Differential pricing:
 When one category of investors is offered shares at a price
different from the other category it is called differential
pricing. An issuer company can allot the shares to retail
individual investors at a discount of maximum 10% to the
price at which the shares are offered to other categories.
BASIC CONCEPTS: CONT…

 What is HARD Underwriting?

 Hard underwriting is when an underwriter agrees to buy
his commitment at its earliest stage. The underwriter
guarantees a fixed amount to the issuer from the issue.
Additional shares are also purchased at later stage, if any.

 What is SOFT Underwriting?

 Soft underwriting is when an underwriter agrees to buy the
shares at later stages as soon as the allocation process is
complete.

Rameshwar Patel 156

SALIENT FEATURES OF
OFFER DOCUMENT (PROSPECTUS):
 GENERAL INFORMATION:
 NAME AND ADDRESS OF THE COMPANY
 OPENING AND CLOSING DATES OF THE ISSUE
 NAME OF STOCK EX. WHERE THE PRICE IS TO BE
LISTED
 NAME AND ADDRESS OF THE LEAD MANAGERS
 CREDIT RATING OF AN ISSUE, IF ANY.
 CAPITAL STRUCTURTE OF THE COMPANY:
 ISSUED, SUBSCRIBED AND PAID UP CAPITAL
 SIZE OF THE PRESENT ISSUE
 DETAILS OF PROMOTER’S HOLDINGS AND LOCK-IN
 TERMS OF PRESENT ISSUE:
 HOW TO APPLY, AVAILABILITY OF FORMS AND MODE OF
PAYMENT
SALIENT FEATURES OF
OFFER DOCUMENT (PROSPECTUS): CONT…..

 PARTICULARS OF THE ISSUE:

 OBJECTIVES OF THE ISSUE
 PROJECT COST AND MEANS OF FINANCING
 COMPANY MANAGEMENT AND PROJECT:
 HISTORY OF THE COMPANY
 BACKGROUND OF PROMOTERS AND DIRECTORS
 DETAILS OF PLANT, MACHINERY AND TECHNOLOGY
 DETAILS OF COLLABORATIONS AND PARTNERSHIP, IF ANY
 PRODUCT DETAILS
 INSTALLED AND UTILISED CAPACITY
 FUTURE PROSPECTS AND PLANS
SALIENT FEATURES OF
OFFER DOCUMENT (PROSPECTUS): CONT…
 FINANCIAL STATEMENTS AND PERFORMANCE:
 P & L A/c AND BALANCE SHEET
 PAST PROFIT AND LOSS DATA
 ANY CHANGE IN ACCOUNTING POLICIES IN LAST 3
YEARS AND ITS EFFECTS ON PROFIT
 FINANCIAL PERFORMANCE OF SUBSIDIARY COMPANY,
IF ANY
 RISK FACTORS OF THE COMPANY, IF ANY
Private Placement Market
• It refers to the direct sale of newly issued securities to a
small number of investors through merchant bankers.
• These investors are selected clients;
• Financial institutions
• Corporate Bodies
• Banks
• High net worth individuals

 BENEFITS:
• Less time and cost of issue
• Greater flexibility
• Simplified procedure
 PREFERENTIAL ISSUE:
 A preferential issue is an issue of shares or of convertible
securities by listed companies to a select group of persons
under Section 81 of the Companies Act, 1956 which is neither
a rights issue nor a public issue.
 Shares are issued to Promoter’s Family/Friends/Relatives.
 This is a faster way for a company to raise equity capital. The
issuer company has to comply with the Companies Act and
the requirements contained in Chapter pertaining to
preferential allotment in SEBI (DIP)
 ADVANTAGES;
 To enhance promoters holding
 To issue shares by way of employees stock option plans
(ESOPs)

Rameshwar Patel 161

Qualified Institutional Placement (QIP)
 QIP is a capital raising tool, primarily used in India, whereby a
listed company can issue equity shares, fully and partly
convertible debentures, or any securities which are convertible to
equity shares to a Qualified Institutional Buyer (QIB).
 Apart from preferential allotment, this is the only other speedy
method of private placement whereby a listed company can issue
shares or convertible securities to a select group of persons.
 QIP is highly preferable over other methods because the issuing
firm does not have to undergo complicated procedural
requirements to raise this capital.
 Why was it introduced?
 The (SEBI) introduced the QIP process to prevent listed
companies in India from developing an excessive dependence on
foreign capital.
Rameshwar Patel 162
Who can participate in the issue?
 The specified securities can be issued only to QIBs,
who shall not be promoters or related to promoters of
the issuer.
 The issue is managed by a SEBI-registered merchant
banker. There is NO Pre-issue Filing of the placement
document with SEBI.
 The placement document is placed on the websites of
the stock exchanges and the issuer, with appropriate
disclaimer to the effect that the placement is meant
only for QIBs on private placement basis and is not an
offer to the public.

Rameshwar Patel 163

 “Book building is basically a method of PRICE DISCOVERY. “
• In this method, the company doesn't fix up a particular price for the
shares, but instead gives a price range (PRICE BAND), e.g. Rs 80-
100.
• When bidding for the shares, investors have to decide at which price
they would like to bid for the shares, for e.g. Rs 80, Rs 90 or Rs 100.
They can bid for the shares at any price within this range.
• Based on the demand and supply of the shares, the final price is
fixed. The lowest price (Rs 80) is known as the FLOOR PRICE and
the highest price (Rs 100) is known as CAP PRICE.
• The price at which the shares are allotted is known as -
“CUT OFF PRICE”. The entire process begins with the selection of
the lead manager, an investment banker whose job is to bring the
issue to the public.
Book Building Process:
 The Issuer who is planning to offer appoints 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‘.
• The book normally remains open for a period of 5 days
(means Issue time duration).
• Bids have to be entered within the specified price
band.
165
Book Building Process: Cont..

 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 number 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.
Rameshwar Patel 166
TYPES OF INVESTORS:

• The Retail Individual Investor (RII), the Non-institutional

Investor (NII) and the Qualified Institutional Buyers (QIBs).
• RII is an investor who applies for stocks for a value of not more than
Rs 100,000. Any bid exceeding this amount is considered in the NII
category.
• NIIs are commonly referred to as High Net-worth Individuals.
• Each of these categories is allocated a certain percentage of the total
issue.
RII Category - 35 % of Total Issue
NII Category - 15 % of Total Issue
QIB Category - 50 % of Total Issue

• Allotment to RIIs and NIIs is made through a proportionate

allotment system. The allotment to the QIBs is at the discretion
(sometimes Firm Allotment) of the BRLM.
BOOK BUILDING V/s FIXED PRICE
FEATURE BOOK BUILDING FIXED PRICE PROCESS
S
PRICING Price at which securities will Price at which the securities
be are
offered/ allotted is not offered/ allotted is known
known in in
advance to the investor. Only advance to the investor.
an
indicative price range is
known.
DEMAND Demand for the securities Demand for the securities
offered can be known offered is known only after
everyday the
Qualified Institutional Buyers (QIBs)

• ‘Qualified Institutional Buyer’ shall includes:

• Public financial institution

• Scheduled commercial banks;
• Mutual Funds;
• Foreign institutional investor registered with SEBI;
• Venture Capital funds registered with SEBI.
• Foreign Venture Capital investors registered with SEBI.
• State Industrial Development Corporations.
• Insurance Companies
• Provident /Pension Funds with minimum corpus
(fund) of Rs.25 crores
Reverse Book Building

 It is a price discovery mechanism for the

companies who want to delist their shares or buy
back shares from the shareholders.
The Intermediaries / Players in the primary market are

 Merchant Bankers to the issue or Book Running Lead

Managers (BRLM)
 Underwriters to the Issue
i. Standing behind the issue
ii. Outright purchase
iii. Consortium method
iv. Partial Underwriting
v. Joint Underwriting
 Registrars to the Issue
 Bankers to the Issue
 Syndicate Members
 Printers and Advertising Agents