AssignmentMaster of Business Administration – MBA Semester 4MF 0017 - Merchant Banking and Financial Services

Name : Rakesh KumarSMU Roll No. 581117457Centre Code: 2805

Question 1- Identify the role of merchant banking as financial intermediaries.Answer:

Merchant bankingMerchant banking is an essential service provided by financial institutions that help in the growth of corporate sector, which eventually reflects in the overall growth and economic development of the country.

Functions of merchant banking:The following are the main functions of merchant banking:

1. Issue management – A major function of merchant banking is issue management. The issue can be through offer of sale or private placements, prospectus, and so on.

2. Pre-investment studies of investors – The merchant bankers undertake the practicality surveys in selected areas of client’s interest. It also includes the studies for foreign organisations which are planning for joint ventures in India. The survey covers the advice on the nature of participation and Government regulations.

3. Corporate counselling – Corporate counselling refers to the activities undertaken to ensure effective running of a corporate enterprise through efficient management of finance. A merchant banker guides the clients on organisational goals, choice of product and market survey, forecasting a product, cost analysis, investment decisions, pricing methods, capital management and expenditure control, market strategy and so on.

4. Loan syndication – A merchant banker helps the clients to get loan for the project. They also help in conducting appraisal and designing capital structure.

5. Project finance – A merchant banker who undertakes a project scheme also assists in arranging a comprehensive package for the project funding. The process involves the study of the pattern of financing available from merchant banks and financial institutions.

6. Working capital – Merchant bankers assist in arranging finance for working capital particularly for new ventures. For existing firms, the merchant bankers arrange the funds from non-traditional sources such as through issue of debentures, and so on.

Role of Merchant banking as financial intermediaries:Financial intermediation is a process by which capital is mobilised from a large number of investors and is made available to all those who need them, mainly to corporate customers. Merchant

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banking is a financial intermediary which helps to transfer capital from one who owns it to those who require it.

Merchant banks invest their capital in client companies and provide fee-based services for mergers and acquisitions. Many companies approach merchant banks to enhance their financial stability or to meet an essential capital requirement. Due to their knowledge in international finances, merchant banks specialise in dealing with multinational corporations. Merchant banks do not offer regular banking services to the public.

Question 2- Describe the issuance process of depository receipts.Answer:

Issuance Process of Depository ReceiptsA Depositary Receipt (DR) which is traded on a local stock exchange is a type of transferable financial security. It represents a security, usually in the form of equity that is issued by a foreign publicly listed company. The DR, which is a physical certificate, permits investors to hold shares in equity of other countries.

The DR is created when a foreign company wishes to list its already publicly traded shares or debt securities on a foreign stock exchange. Before it can be listed to a particular stock exchange, the company in question will first have to meet certain requirements put forth by the exchange. Initial public offerings, however, can also issue a DR. DRs can be traded publicly or over-the-counter. Let us look at an example of how an ADR is created and traded:

Example:Say a gas company in Russia has fulfilled the requirements for DR listing and now wants to list its publicly traded shares on the NYSE in the form of an ADR. Before the gas company's shares are traded freely on the exchange, a U.S. broker, through an international office or a local brokerage house in Russia, would purchase the domestic shares from the Russian market and then have them delivered to the local (Russian) custodian bank of the depository bank. The depository bank is the American institution that issues the ADRs in America. In this example, the depository bank is the Bank of New York. Once the Bank of New York's local custodian bank in Russia receives the shares, this custodian bank verifies the delivery of the shares by informing the Bank of New York that the shares can now be issued in the United States. The Bank of New York then delivers the ADRs to the broker who initially purchased them.

Based on a determined ADR ratio, each ADR may be issued as representing one or more of the Russian local shares, and the price of each ADR would be issued in U.S. dollars converted from the equivalent Russian price of the shares being held by the depository bank. The ADRs now represent the local Russian shares held by the depository, and can now be freely traded equity on the NYSE. After the process whereby the new ADR of the Russian gas company is issued, the ADR can be traded freely among investors and transferred from the buyer to the seller on the NYSE, through a procedure known as intra-market trading. All ADR transactions of the Russian gas company will now take place in U.S. dollars and are settled like any other U.S. transaction on the NYSE. The ADR investor holds privileges like those granted to shareholders of ordinary shares, such as voting rights and cash dividends. The rights of the ADR holder are stated on the ADR certificate.

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Question 3- Explain the operational guidelines that need to be followed by a merchant banker.

Answer:Operational GuidelinesThe operational guidelines issued by the SEBI for the standard disclosure of the offer document.

Submission of draft and final offer document:First, the lead merchant banker files the offer documents of size up to Rs. 50 crores with the regional office of SEBI under the jurisdiction of the registered office of the issuer company. Then the lead merchant banker or stock exchange makes the draft offer document available to the public.

The lead merchant banker makes ten copies of the draft offer document available to the Board, and 25 copies to the stock exchange(s), where the issue is proposed to be listed. Within three days of filing the offer document with registrar of companies or the stock exchange(s), the lead merchant bankers submits two copies of the final printed copy of the offer document to dealing offices of the Board and one final printed copy to the primary market department, SEBI, and head office.

The lead merchant banker also submits a computer floppy containing the final prospectus or letter of offer to the primary market department, SEBI, and head office within three days of filing the final prospectus or letter of offer with the registrar of companies or concerned Stock Exchange.

While offer documents are filed with any department or office of the Board, the details like registration number, date of registration or renewal of registration, details of any enquiry or investigation conducted by SEBI at any time, penalty imposed by stock exchange, and the date of expiry of registration will be given by the lead merchant banker in the forwarding letters.

Question 4- Explain the basic features of securities lending and borrowing scheme.

Answer:To provide necessary momentum to short sell, a scheme for Securities Lending and Borrowing (SLB) was introduced. With the introduction of short selling by institutional investors, a full-fledged security lending and borrowing scheme was introduced.

The following are the characteristics of the scheme of securities lending and borrowing:1. Eligibility – Under the Securities Lending Scheme (SLS), 1997 the securities transacted in F&O segment are authorised for lending and borrowing. The scheme is open for all market members in the Indian securities market.

2. Operation – The scheme is operated on an order-matching, screen based, automated platform, provided by the Approved Intermediaries (AIs). This platform is independent of other trading platforms.

3. Participation – The scheme permits participation by all sections of investor. This included retail, institutional and so on. The AIs sets up the platform for lending and borrowing which is accessed by

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the borrowers and lenders through the clearing members (CMs), banks and custodians who are authorised by the AIs.

4. Agreement – The agreement consists of the basic conditions for lending and borrowing of securities that is recommended in the scheme. The AIs also include appropriate conditions in the agreement for proper execution, settlement of lending and borrowing transactions and risk management. The roles of the AIs, CMs and the clients are given in the agreement between the AIs, CMs and clients. The first part of the agreement is between the AIs and the CMs .The second part of the agreement is between the CMs and the clients.

5. Identification – The AIs allocates unique identification (ID) to each client which is mapped to the Permanent Account Number (PAN) of the clients. The AIs ensures that a client does not obtain multiple client IDs by placing systematic safeguards.

6. Tenure – The tenure of lending and borrowing is fixed as standardised contracts.

7. Settlement – The settlement of the lending and borrowing transactions is independent of normal market settlement. The settlement cycle for the scheme is based on T+1. The abbreviation T+1 denote the settlement date of security transaction date plus one day. The netting of transactions at any level is not permitted as settlement of the lending and borrowing transactions is done on a gross basis at the level of the clients.

8. Risk management systems – The AIs frame suitable risk management systems to provide guaranteed delivery of securities to the borrower and return of securities to the lender. The AIs conducts an auction for obtaining securities if the lender or borrower fails to return securities to the AI.

Question 5- Discuss the difference between assets and fee based financial services.

Answer:Financial Services: Financial services are a very important part of the financial system. Financial services enable mobility and allocation of savings through the transformation of savings into investments. A well functioning financial system provides better financial services which empowers individuals, integrates with the economy, contributes to development, and provides protection against economic shocks. Financial services are offered by specialised institutions which help the client to raise funds, manage funds, and transform savings into investments.Financial services are classified into two categories based on the asset creation function of these services

Fund based or Asset based financial services: Asset based financial services facilitate corporate and other business entities to mobilise resources at lower rates and open up investment opportunities with enhanced returns. These services enable the corporate institutions, in particular, to reject the traditional bank finance and opt for the more competitive financial market. The debt market enables a borrower to organise his borrowings and structure the repayments to match future cash flows. The agreement to asset based securities is facilitated by financial intermediaries through fee based services.

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Some of fee based financial services are as follow:a) Leasing and Hire Purchaseb) Housing Financec) Credit Cardsd) Venture Capitale) Factoringf) Forfeitingg) Bill Discountingh) Insurance

Advisory based or Fee based financial services: Fee based financial services are not used to create assets or liabilities. These financial services facilitate certain financial functions such as managing capital issues, making arrangements for the placement of capital and debt instruments, and arrangement of funds from financial institutions. They also undertake the responsibility of getting all government and other clearances. In addition, this sector does a large number of other services like rendering project advisory services, plan mergers and acquisitions, and guiding in capital restructuring to their clients.

The major fee based financial services are as follow:a) Issue Managementb) Corporate Advisory Servicesc) Credit Ratingd) Mutual Fundse) Asset Securitizationf) Stock Broking Services

Question 6- Describe accounting and reporting for operating lease in detail.Answer:

Lease payments under an operating lease shall be recognised as an expense on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit.

For operating leases, lease payments (excluding costs for services such as insurance and maintenance) are recognised as an expense on a straight-line basis unless another systematic basis is representative of the time pattern of the user’s benefit, even if the payments are not on that basis.

Accounting and reporting for operating leaseThe entire payment is charged to the profit and loss account. IAS 17 requires the rental to be charged on a depreciation basis over the lease term, if the payments are not made on such a basis. If the term of the lease requires a heavy initial payment, a percentage of the payment can be treated as prepaid expense. Since the lessee will not consider the risk of ownership, the lease expenditure is treated as an operating expense in the income statement; the lease does not affect the balance sheet. The operating lease will not show up as part of the capital of the firm.

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A lease agreement allows the use of an asset, but does not convey rights similar to ownership of the asset. The accounting treatment for an operating lease is simple for both the lessor and the lessee. The lessee has acquired an operating expense, so the lease rental to be paid is written off in the profit and loss account. The lessee will have to disclose in the notes to the accounts the total amount charged in the year and the total amount of the payments to which the entity is committed at the year end. The lessor has made revenue from renting out the asset and consequently recognises the lease rental receivable as income in the profit and loss account.

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