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Securities Laws and Regulation of Financial

Markets (Guideline Answers)
INTERMEDIATE EXAMINATION

DECEMBER 2002

Time allowed: 3 hours Maximum marks: 100

NOTE: Answer SIX questions including Question No. 1 which is COMPULSORY.

Question 1

Write short notes on any four of the following:

i. Sweat equity shares

ii. Global depository receipts
iii. Money market mutual funds
iv. Securities appellate tribunal
v. Takeover of a listed company. (5 marks each)

Answer 1(i)

Sweat Equity Shares

Sweat Equity shares are shares allotted to employees of companies, as rewards, free of
cost or at a price which is considerably below the ruling market price. It is given as a
reward for performance to further encourage them to put in their best in the
organisation. Under the Companies Act, 1956, sweat equity shares means equity
shares issued by a company to its employees or directors at a discount or for
consideration other than cash for providing know how or making available rights in
the nature of intellectual property rights.

Sweat equity shares are used as a tool for retaining experienced personnel at senior
level. The increase in competition has increased the fear of losing personnel to a
competitor. The concept of sweat equity shares is gaining popularity these days in
information technology, telecom and knowledge based economic sectors.

Answer 1(ii)

Global Depository Receipts

It is a form of depository receipt or certificate created by the Overseas Depository

Bank outside India denominated in dollar and issued to non-resident investors against
the issue of ordinary shares or foreign currency convertible bonds of issuing company.
In simple words, it is basically a negotiable instrument denominated in US dollars. It
is traded in Europe or the US or both. GDR is traded like any other dollar denominated
security in the foreign markets, GDR issue also possesses merits like less issue
formalities, less administrative works as regards dividend payment, information
dissemination, annual general meeting etc. as the issuer deal only with a single

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shareholder, the depository; easy availability of foreign exchange and no foreign

exchange risk. Besides issuing companies, foreign investors especially FIIs also get
advantage of investing in the Indian companies. In fact, GDR holder enjoy all
economic benefits of the underlying shares but has none of the corporate rights like
right to vote.

Answer 1(iii)

Money Market Mutual Fund

In India, the decision to promote MMMFs was announced by RBI while unveiling its
credit policy in April, 1991. These funds invest in short-term debt securities in the
money market like certificates of deposits, commercial paper, Government trading
bills etc. Owing to their large size, the funds normally get a higher yield on such short
term investments than an individual investor. Money Market Mutual Funds used to be
regulated by the Reserve Bank of India and money market schemes of other mutual
funds were regulated by SEBI. However, On 7th March, 2000 the RBI withdrew these
guidelines and it was notified by SEBI later on that the MMMF schemes like any other
mutual fund schemes, would exclusively be governed by SEBI (Mutual Funds)
Regulations, 1996.

Answer 1(iv)

Securities Appellate Tribunal (SAT)

The Central Government by any notification may establish an appellate tribunal

known as Securities Appellate Tribunal (SAT) to exercise the jurisdiction, powers and
authority conferred on such tribunal, under the SEBI Act, 1992. SAT shall consist of
one person known as presiding officer to be appointed by Central Government. The
Central Government shall appoint such staff, as it may deem fit, in the SAT. Any
aggrieved person may refer an appeal to a Securities Appellate Tribunal having
jurisdiction in the matter. On receipt of an appeal the SAT may after giving the parties
opportunities to be heard may pass such order, as it thinks fit.

The SAT is not bound by the Code of Civil Procedure, 1908 but is guided by the
principle of natural justice and has the powers to regulate its own proceedings.

The Central government has, by notification dated 18.2.2000 has established a

Securities Appellate Tribunal.

Answer 1(v)

Takeover of a listed company

Takeover has been defined as a business transaction whereby an individual or a group

of individuals or a company acquires control over the assets of a company, either
directly or becoming owner of those assets or indirectly by obtaining control of the
management of the company. Normally, the company which wants to takeover the
other company acquires the shares of the target company either in a single transaction
or a series of transactions. In case of amalgamation under Sections 391-394 of the
Companies Act, 1956 the amalgamating as well as amalgamated company have to
apply to the High Court(s) for making order of amalgamation. The takeover of a listed
company is regulated by Clauses 40A and 40B of the Listing Agreement. These

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clauses in the Listing Agreement seek to regulate takeover activities independently

and impose certain requirements of disclosure and transparency. The takeover of a
company is also subject to SEBI (Substantial Acquisition of Shares and Takeovers)
Regulations, 1997 issued on 20.2.1997 and further amended from time to time.

Question 2

“Mutual funds are essential vehicles for collective investments, which provide to
the small investors, benefits in stock market, risk diversification and expert
management advice of the fund managers”. In the light of this statement and in
accordance with the provisions of the Securities and Exchange Board of India
(Mutual Funds) Regulations, 1999, answer the following questions:

a. What are the organs of a mutual fund? (2 marks)

b. What are the benefits of mutual funds? (2 marks)
c. What are the general obligations of mutual funds? (3 marks)
d. What are the eligibility criteria for setting up a mutual fund? (3 marks)
e. What are the various schemes of mutual funds? (6 marks)

Answer 2(a)

The following are the main organs of a mutual fund:

a. Asset management company - company who manages the assets of the mutual
fund.
b. Custodians - agency providing custodial services to the fund.
c. Trustees - board of trustees or the trustee company who hold the property of
mutual fund in trust as per the benefit of unit holders.
d. Sponsors - any person who alone, or in combination with another body
corporate, establishes a mutual fund.

Answer 2(b)

There are a number of benefits for small investors which arise as a result of their
parking funds with mutual funds -

1. Security and reduced risk.

2. Availability of expert advice of professional management.
3. Diversification of portfolio for best returns.
4. Automatic reinvestment of returns.
5. Best selection and timing of investments through professional approach.
6. Liquidity of investment.
7. Adequate transparency and periodic disclosures.
8. Economies of scale operate and maximize return and minimize costs.

Note: Students are expected to provide list of 4-5 benefits.

Answer 2(c)

General Obligations of the Mutual funds

i. To maintain proper books of accounts, records, etc.

ii. Clear identification and appropriation of expenses to individual schemes.

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iii. Timely dispatch of warrants and proceeds.

iv. Preparation of annual report and annual statement of accounts of the scheme for
each financial year which should be duly audited and its publication thereof.
v. Periodic and continual disclosures to SEBI and investors.

Answer 2(d)

Eligibility criteria for setting up a mutual fund

i. The sponsor should have a sound track record and general reputation of fairness
and integrity in all his business transactions.
ii. In the case of an existing mutual fund such fund is in the form of a trust and the
trust deed has been approved by the Board.
iii. The sponsor has contributed or contributes at least 40% to the net worth of the
asset management company
iv. The sponsor or any of its directors or the principal officer to be employed by the
mutual fund should not have been guilty of fraud or has not been convicted of
an offence involving moral turpitude or has not been found guilty of any
economic offence.
v. Appointment of trustees to act as trustees for the mutual fund in accordance with
the provisions of the regulations.
vi. Appointment of asset management company to manage the mutual fund and
operate the scheme of such funds in accordance with the provisions of these
regulations.
vii. Appointment of a custodian in order to keep custody of the securities and carry
out the custodian activities as may be authorized by the trustees.

Answer 2(e)

The MFs in India offer a wide array of schemes that cater to different needs suitable to
any age, financial position, risk tolerance and return expectations. These include:

l - open-ended schemes, which provide easy liquidity;

l - close-ended schemes with a stipulated maturity period;
l - growth schemes, which provide capital appreciation over medium to long
term;
l - income schemes, which provide regular and steady income to investors;
l - balanced schemes, which provide both growth and income by periodically
distributing a part of income and capital gains they earn;
l - money market schemes; which provide easy liquidity, preservation of capital
and moderate income; and
l - tax saving schemes, which offer tax rebates to investors under tax laws as
prescribed from time to time.

Question 3

a. Define ‘credit rating’. State the benefits of credit rating to the companies
and investors. Name any two credit rating agencies of India. (5 marks)
b. Briefly explain the regulatory framework for non-banking financial
companies (NBFCs) in India. (5 marks)
c. What do you mean by ‘investor protection? “Investor protection is the
major responsibility of the Securities Exchange Board of India.” Explain.
(6 marks)

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Answer 3(a)

Definition

Credit Rating is an opinion of the relative ability and willingness of an issuer to make
timely payments on specific debt or relate obligations over the life of the instrument.
Credit rating thus provides a relative ranking of the credit quality of debt instruments.

Benefits to Companies and Investors

For companies/issuers: The market places immense faith in opinion of credit rating
agencies. Hence the issuers also depend on their information which enables the issuers
of highly rated instruments to access the market even during adverse market
conditions.

For investors: The main purpose of credit rating is to communicate to the investors the
relative ranking of the default loss probability for a given fixed income investment in
comparison with other rated instruments. In a way, it is essentially an information
service. Credit rating by skilled, competent and credible professionals eliminates or at
least minimizes the role of name recognition and replaces it with a well-researched
and properly analyzed opinions. This method provides a low cost supplement to
investors. Large investors use information provided by rating agencies such as
upgrades and downgrades and alter their portfolio mix by operating in the secondary
market.

Names of Credit Rating Agencies

The main Credit Rating Agencies, presently operating in India are:

a. Investment Information & Credit Rating Agency of India Ltd. (ICRA)

b. Credit Rating and Information Services (India) Ltd. (CRISIL)
c. Credit Analysis & Research Ltd. (CARE)
d. Fitch India Pvt. Ltd., and
e. Onida Individual Credit Rating Agency of India Ltd.(ONICRA)

Note: Students are expected to give any two names out of the above.

Answer 3(b)

Reserve Bank of India (RBI) regulates the functioning of Non Banking Finance
Companies (NBFCs) in India through various provisions of Reserve Bank of India
Act, 1934. It provides for compulsory registration by all NBFCs with RBI. NBFCs
cannot commence business without obtaining a certificate of registration from RBI.

The RBI has a strong supervisory framework for ensuring compliance with the
provisions of the RBI Act and Regulatory directives. This includes subjecting the
NBFCs to the rigors of scrutiny of applications to determine their eligibility as per the
criteria enunciated in the RBI Act for issue of certificate of registration, detailed on-
site inspection for ascertaining the level and quality of adherence by the entities to the
regulatory norms relating to deposits, quality of assets, capital adequacy etc.,
technology driven offsite surveillance and a sensitive market intelligent system to
capture the early warning signals.

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Answer 3(c)

Investor Protection is to protect the investors from being deceived or being put to loss
by the companies.

No doubt, investor protection is the major responsibility of SEBI. SEBI has been in
fact constituted for the purpose of investor protection and welfare only. According to
the preamble of the SEBI Act, the objective of setting-up SEBI is to protect the
interest of investors in securities and to promote the development and to regulate the
security market. During the last eight years, SEBI has sought to balance the two
objectives by constantly reviewing and re-appraising its existing policies and
programmes, formulating new policies and regulations, to foster developments in
these areas and implementing them to ensure growth of the market with efficiency,
integrity and protection of interests of investors. All throughout, enforcement and
surveillance has been a major priority for SEBI. It introduced several reforms in
primary market and acted as a catalyst for modernization of market infrastructure. It
streamlined and simplified the issue procedure, gave flexibility to the issue process
and strengthened the criteria for accessing the securities market. In secondary market,
it improved market efficiency, integrity and transparency. Trading infrastructure was
modernized in most of the traditional stock exchanges, clearing and settlement
systems were improved and depositories were established. Mutual funds were
reformed drastically so as to provide greater operational flexibility to the fund
manager and increase their accountability and supervision. Substantial acquisition of
takeover of shares was regulated and regulations for foreign institutional investors
were liberalized. SEBI action has resulted in number of complaints coming down.
SEBI launched prosecution against companies apart from serving show cause notices,
inspections and investigations.

Question 4

a. You are company secretary of Gates & Locks India Ltd. Your company,
which presently has a paid-up share capital of Rs.5 crore held by the
promoters’ group, now intends to make an initial public offer of Rs.20
crore to finance its ambitious expansion plan. Your managing director
desires you to prepare a note setting out the following: (3 marks)

i. Advantages of listing to the company and its shareholders; and

ii. Statutory provisions related to listing of initial public offer. 5 marks)

b. Discuss the functions of a registrar to the issue and share transfer agent. (8
marks)

Answer 4(a)(i)

Advantages of Listing to company and shareholders

1. Improves public image of the Company.

2. Provides liquidity to the securities of the company.
3. Wide distribution of shares is possible which help in mobilization
of resources in future by way of further issues, rights issues and
deposits.
4. Forced disclosure of important information is beneficial for
investors and society at large.

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5. Bankers or financial institutions extend loan facilities to the

company easily to listed companies.

Answer 4(a)(ii)

Section 73(1) provides that every company issuing shares to the public by issue of
prospectus, shall before such issue, make an application to one or more recognized
stock exchanges for permission for enlistment of its shares.

Sub-section 73(1) makes the listing of all public issues with recognized stock
exchange compulsory.

Section 73(1A) provides that where a prospectus states that application has been made
for permission for the shares offered thereby to be dealt in one or recognized stock
exchanges, then the allotment shall be void. If the permission has not been granted by
the stock exchange or each such stock exchange, as the case may be, before the expiry
of ten weeks from the date of the closing of the subscription lists. However, where a
stock exchange refuses to grant an application or fails to dispose off within 10 weeks,
the company may, under Section 22 of the Securities Contracts (Regulation) Act, 1956
appeal to the Central Government against the refusal.

Answer 4(b)

Registrars are the public face of the primary capital market, the intermediary that
comes into greatest contract with investors in new issues. Their services can be
grouped under two heads:

1. Registrars to issue
2. Securities transfer agents

The functions of a Registrar to the issue can be listed as follows:

A. Pre-issue Work of Registrars

1. Finalisation of bankers to issue, list of branches, controlling and

collecting branches.
2. Design of application form, bank schedule, pre-printed stationery.
3. Preparing and issuing details instructions on procedures to be
followed by collecting and controlling branches.
4. Arranging dispatch of application schedule for listing of
applications to collecting and controlling branches.
5. Placing of orders for and procuring pre-printed stationery.

B. Issue Work of Registrars

1. Collection of daily figure from bankers to the issue.

2. Expediting dispatch of applications, final certificate to the
controlling branches.
3. Informing stock Exchange/SEBI and providing necessary certificate
to lead Manager on closure of issue.
4. Preparing ‘Obligation of Underwriters statement’ in the event of
under subscription and seeking extension from stock exchange for
processing.

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5. Scrutiny of application received from bankers to issue.

6. Transcribing information from documents to magnetic media for
computer processing.
7. Reconciliation of number of applications, securities applied for and
money received with final certificate received from bank.
8. Identify and reject applications having technical faults.
9. Prepare statement for deciding basis of allotment by the company in
consolation with the Stock Exchange.
10. Finalizing basis of allotment after approval of the stock exchange.
11. Allotment of shares on the formula derived by stock exchange.
12. Obtaining certificate from auditors that the allotment has been made
as per the basis of allotment.
13. Preparation of reverse list, list of allottees and non-allottees as per
the basis of allotment approved by stock exchange.
14. Preparing of allotment register cum return statement, register of
member, index register.
15. Preparation of list of brokers to whom brokerage is to be paid.
16. Printing postal journal for dispatching share certificates, for
refunding application money/stock invest, printing of allotment
letter cum refund order.
17. Printing postal journal for dispatching share certificate or allotment
letters and refund orders by registered post.
18. Printing distribution schedule for submission to stock exchange.
19. Preparing register of members and specimen signature cards.
20. Work relating to printing, issue of share certificates and refund
orders and stock invest.
21. Redressal of investor grievances and furnishing prescribed
information to SEBI.

A share transfer agent provides services relating to -

1. Transfer of shares
2. Transmission
3. Nomination
4. Issue of duplicate certificates
5. Split, Consolidation of Certificate
6. Dispatch of interest/dividend warrant, etc.

Question 5

a. Explain the concept of ‘book building’. (3 marks)

b. Discuss the role of a merchant banker in a public issue. (3
marks)
c. While managing a public issue as a lead manager, what are the
pre-issue and post-issue obligations of a merchant banker. (6
marks)
d. What is the scope and objective of ‘due diligence’ by the lead
manager to an issue, as prescribed by the Securities Exchange
Board of India? (4 marks)

Answer 5(a)

Book Building is a method of floating a public offer that allows the issuer
to price its offer of securities based on the market demand. Traditionally,

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when an issuer makes a public offer, its pricing is a one-sided process,

decided privately by the issuer and the lead manager. The success or
failure of the offer depends on whether the market is willing to subscribe
at the price fixed by the issuer.

In a book-building offer, the issuer determines only the offer size or the
number of securities he would like to offer for subscription. He then
invites bids from prospective investors for the offer. Then the offer is
priced based on the inherent demand and the price discovered through the
process of bidding.

Answer 5(b)

Merchant banker is responsible for managing the public issue of a company. His role
primarily includes the following:

i. Verification of the contents of a prospectus or letter of offer in respect of an

issue and reasonableness of the views expressed therein.
ii. Carrying out of Due Diligence.
iii. Submission of timely reports etc. to SEBI.
iv. Ensuring compliance with SEBI Guidelines.
v. Enquiring that adequate steps are taken for fair allotment of securities and
refund of application money without delay.
vi. Complaints from investors are adequately dealt with.

Answer 5(c)

Pre-Issue obligations of Lead Manager

i. Execution of memorandum of understanding

ii. Inter-se allocation of responsibilities
iii. Drafting of draft prospectus.(iv) Underwriting of obligations.
iv. Due diligence certification.
v. Project appraisal.
vi. Deciding upon capital structure and size of issue.
vii. Pricing of the issue.
viii. Reservations etc.
ix. Timing of issue.
x. Appointment of other intermediaries.
xi. Updating the prospectus and filing it.
xii. Issue of advertisement
xiii. Compliance with Company Law, SEBI and Stock Exchange requirements.
xiv. Printing of application forms and distribution of stationery.
xv. Opening of issue and receipt of subscriptions.

Post issue responsibilities of lead Manager

i. Collecting information on subscriptions received.

ii. Compliance as to requirement of Minimum subscription.
iii. Closing of subscription list.
iv. Periodic return to SEBI.
v. Approval of basis of allotment.
vi. Ensuring allotment/dispatch of certificates and refund orders.

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vii. Listing of securities

viii. Post issue monitoring and reports to SEBI.

Answer 5(d)

Scope

The lead manager in the due diligence certificate confirms that the draft
prospectus/letter of offer forwarded to SEBI is in conformity with the documents,
materials and papers relevant to the issue, that all the legal requirements connected
with the said issue have been duly complied with and that the disclosure made in draft
prospectus/letter of offer are true, fair and adequate to enable the investors to make a
well informed decision as to the investments in the proposed issue.

Merchant Banker shall also examine various documents including those relating to
litigation like commercial disputes, patents disputes, disputes with collaborators, etc.
and also discuss with the company, its directors, other officers and other agencies on
matters including objects of the issue, projected profitability, price justification, etc.
before giving the due diligence certificate. A merchant banker shall also include in the
due diligence certificate, list of important documents.

Objective

Lead manager is required to submit due diligence certificate to SEBI. This is done
with an objective of giving an attestation by the merchant banker that due diligence in
terms of SEBI guidelines has been carried out by him in respect of the proposed issue
of securities.

Question 6

“Financial markets, financial services and financial instruments are integral parts of
the financial system”. Critically examine. (16 marks)

Answer 6

Financial Markets, Financial Institutions and Intermediaries and Financial Instruments

are the three components of organisational structure of Indian financial system.

Financial Markets

Financial market provide channels for allocation of savings to investment and provide
a variety of assets to savers as well as various forms in which the investors can raise
funds. Indian Financial markets have two major components - money market and
capital market. Money market refers to the market where borrowers and lenders
exchange short term funds to solve their liquidity needs. Indian Capital market, on the
other hand, is a market for financial investments that are direct or indirect claims to
capital. It is wider than securities market and embraces all forms of lending and
borrowing, whether or not evidenced by the creation of a negotiable financial
instruments. The securities market has two interdependent and inseparable segments -
new issuer market and secondary market. The primary market provides the channels
for sale of new securities, while the secondary market deals in securities previously
issued.

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Financial Institutions and Intermediaries

The second constituent of the financial system comprises of the financial

institutions/intermediaries. In contrast to financial markets, these are institutional
source of finance to industry. A brief explanation of these are given hereunder:

1. Development Finance Institutions - Development Banking Institutions cater to

the needs of the growing industrial sector as well as factor the growth of the
capital market. In recent years, these institutions are gearing up to play the
traditional role to supplement and not supplant the capital market. In addition to
the financing of industry by these institutions in the traditional form of
rupee/foreign currency term loans for project finance, underwriting, direct
subscription, lease financing and provide core working capital to the company.
The present structure consist of national/all India Institutions IDBI, IFCI, ICICI,
SIDBI, IIBI and regional level institutions namely SFCs, SIDCs, SIIs and
TCOs.
2. Commercial Banks - As a result of planned economic development and the
consequent nationalisation, a geographical wide and functionally diverse
banking system has emerged in India. There has been a phenomenal branch
expansion, especially in the rural and semi-urban areas and the share of the
priority sector in the total bank credit. These banks has emerged as commercial
viable, organisationally dynamic, vibrant and functionally tuned to the emerging
economic scenario. At present, there are three groups of banks - public sector,
private sector and foreign banks.
3. Non-Banking Financial Companies - Reflecting the imperative of the evolution
of a vibrant, competitive and dynamic financial system, NBFCs have marked
significant growth in terms of number, deposits etc. NBFCs provide wide range
of financial services. These are partly fund based and partly fee based. The
important activities of NBFCs are equipment leasing, hire purchase finance, bill
discounting, loans/investments, venture capital, housing finance, factoring issue
management, portfolio management, corporate counselling, mergers and
acquisitions etc.
4. Insurance Organisations - Life Insurance Corporation of India (LIC) and
General Life Insurance Corporation of India (GIC) are public sector institutions.
Nationalisation of insurance business in the country resulted in the
establishment of LIC in 1956 as a wholly owned corporation of Government of
India. LIC operates a variety of schemes and has made significant progress in
extending social security to weaker sections of the society through its Group
Insurance Scheme (GIC) alongwith its four subsidiaries viz. National Insurance
Co. Ltd., The New India Assurance Company Ltd., Oriental Insurance Company
Ltd. operates a number of insurance schemes to meet various needs of different
sectors of society.

Financial Products

The third constituent of financial system is financial product. The Indian

financial system witnessed a significant growth in new financial
instruments. The attraction of the instrument for both the corporate sector
and the investor lies in that on one hand investor gets a reasonable return
and issuer gets credit on reasonable terms.

Question 7

a. Who are the intermediaries in the capital market requiring registration

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with the SEBI? (5 marks)

b. Explain briefly the guidelines for the ‘external commercial
borrowings’ (ECBs). (5 marks)
c. Distinguish between any two of the following:
i. ‘Securities market’ and ‘money market’.
ii. ‘Depository’ and ‘custodian’.
iii. ' Public issue’ and ‘rights issue’. (3 marks each)

Answer 7(a)

The intermediaries in the capital market requiring registration with the SEBI are:

l - Merchant banker
l - Banker to issue
l - Registrar to issue
l - Debenture Trustees
l - Portfolio Managers
l - Underwriters and Brokers
l - Stock Brokers
l - Custodians
l - Mutual funds
l - Depositories
l - Credit Rating Agencies

Answer 7(b)

Guidelines for External Commercial Borrowings

1. ECB’s include - commercial bank loans; buyers’ credit; suppliers’ credit;

securitised payments such as floating rate notes and fixed rate bonds; credit
from official export credit agencies; and commercial borrowings from
multinational financial institutions such as IFC, ADB, AFIC, CDC, etc.
2. Greater priority is accorded to infrastructure and core sectors
3. ECB’s upto US$ 5 million may be utilized for general corporate objectives
without any end use restrictions, excluding investments in stock markets or real
estate.
4. ECB’s upto US$ 5 million may be used in one or more branches subject to a
maximum of US$ 5 million outstanding.
5. The minimum average maturity of ECB is a minimum of 3 years for ECB’s upto
US$ 20 million and 5 years for ECB’s above $ 20 million for all sectors except
100% EOUs.
6. Effective 14th June, 2000, ECB approvals up to US$ 50 million and all
refinancing of existing ECBs have been placed under the automatic route.
7. Monitoring of end-use of ECB will be done by RBI.
8. Prepayment facility would be permitted if they are met out of inflow of foreign
equity or where the source of funds is from EEFC account(s).
9. Refinancing of outstanding amounts under existing loans by raising fresh loans
at lower costs may also be permitted on a case to case basis.

Answer 7(c)(i)

Securities market and Money market

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Securities market is a market place where securities are dealt in i.e., purchase and sale
of all types of securities such as shares, preference shares, debentures, bonds, etc.
Securities market comprises of stock exchange, stock brokers, investors and regulatory
authority, SEBI. Securities market is an important segment of financial system.

Money market on the other hand, is a place for trading money and short term financial
assets that are as liquid as money. It provides a platform for short term surplus of
lenders or investors and short term requirement of borrowers. The instruments can be
traded at low cost and are highly liquid. Instead of stock exchanges, institutions like
Discount and Finance House of India and Securities Trading Corporation of India
provide liquidity through primary dealers. The instrument in money market include
treasury bills, certificate of deposits, commercial paper, call money, etc.

Answer 7(c)(ii)

Depository and Custodian

Depository is an agency for keeping securities on deposit in electronic (paperless)

form and makes scripless trading possible. The physical form of securities could be
held in electronic form by way of immobilization and dematerialisation. While
custodians immobilize the physical securities by custodial function, depositories
interface with the investors only through depository participants who are registered
with depositories as well as SEBI. On the other hand, custodial services are required to
handle huge paper work or volumes and thus facilitate trading. Its main aim is to
simplify and expedite the transactions involving transfer of securities. Custodians
provide services such as safe keeping of securities, documents of title on behalf of
client under a proper system of control including physical custody or maintenance of
accounts in depositories manually or in machine readable form, etc. Custodial services
generally provide clearing services, registration and transfer processing, safe custody,
corporate actions and management information services.

Answer 7(c)(iii)

Public Issue and Right Issue

Issue of securities in capital market could be done directly or through an issue of

public as a general offer or as a right issue. Public issue of securities imply issue of
securities by the company (issuer) to the public by general invitation through offer
document called prospectus. Public issue is offered to public subject to guidelines
issued by SEBI in which public can subscribe and get allotment. Once the securities
are issued, they are listed on stock exchanges.

In rights issue, in case of existing companies having share capital, companies are
under obligation to offer any further issue of capital to the existing shareholders on a
right basis which is known as right issue. The shareholders are offered new shares in
the ratio of existing holdings. In case the shareholders do not subscribe, such shares
can be offered to others as decided by the company. What prospectus is to the public
issue, letter of offer is to the right issue. Letter of offer is not a public document and is
not filed with Registrar of Companies. While public issue is open for 3-4 days
(maximum 10 days) right issue remains open for 30 days (maximum 60 days). Once
issued, all securities issued, whether through public or right issue, rank pari-passu.

Question 8

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a. What is meant by ‘derivatives’? Explain ‘option’ and ‘future’. (5 marks)

b. What is ‘venture capital’? How does it operate? (5 marks)
c. Explain the concepts of rolling settlement, road show and green shoe option. (6 marks)

Answer 8(a)

Derivatives

According to Securities Contracts (Regulations) Act, 1956, derivative include -

a. A security derived from a debt instrument, shares, loans, whether secured or

unsecured, risk instrument or contract for differences or any other form of
security.
b. A contract which derives its value from the prices or index of prices, of
underlying securities.

Derivatives is meant essentially to facilitate temporarily hedging of price risk of

inventory holding or a financial/commercial transaction over a certain period. Every
derivative contract has a fixed expiration date. Financial derivatives are financial
contract whose value is based upon the value of other underlying financial assets such
as shares, stocks, bonds and foreign exchanges. With the change in price of such
assets, the value of derivatives will also change.

Options and Futures

Options - A contract which gives the holder the right to purchase (call) or sell (put)
the underlying futures contract or security at a specified price within a specified period
of time. Options may be Put or Call options.

Futures - A contract obliging one signatory to buy and another to sell a standard
quality of a financial instrument on a pre-determined price. Futures may be
commodity futures or security features.

Answer 8(b)

Venture Capital

Venture Capital may be defined as a form of equity financing which is specially

designed for funding high risk and high reward projects. It is direct investment in
securities of new and unseasoned enterprises by way of private placement. It plays an
important role not only in financing high technology projects but also helps to turn
research and development into commercial production. Venture capital is also
involved in fostering growth and development.

Operation of Venture Capital

In India, venture capital scheme is of recent origin. In recent years, the moves to
deregulate both industries and financial markets, coupled with the country’s defective
infrastructure and strong domestic market have made this country ideal for formation
of venture capital industry as a provider of development and risk capital prior of
listing.

Venture capital is operated by different banks in their own manner. Investments are

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generally made in equity instruments with possibility of high capital appreciation.

Investments are made in high technology enterprises to produce new products.
Investors are directly involved in the management of the enterprise. Venture capitalists
have a long term stake in the business unlike the stock market investment which may
be for short term considerations.

Answer 8(c)

Rolling Settlement

Rolling settlement involved shrinking the netting period to one day. It requires that all
transactions on a particular day to be compulsorily settled after a specified number of
days. The length of the netting period has gone from an undisciplined fortnight to a
disciplined week and with rolling period it goes to a day.

Roadshow

Roadshow represent meetings of issuers, analysts and potential investors. Details

about the company are presented in the roadshows and such details usually include
information about the company making the issue. Thus at roadshows, series of
information presentations are organized in selected cities around the world with
analysts and potential institutional investors. It is, in fact, a conference by the issuer
with the prospective investors.

Green shoe option

A right granted by a securities issuer to its underwriter giving the underwriter an over-
call on 10-15% of the stated size of the issue to meet heavy investor demand. This
provision of many underwriting agreements is named after the Green Shoe Company
which first granted such an option to the underwriter.

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