Ba 958 Merchant Banking

8/6/2019 Ba 958 Merchant Banking

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BA 958 MERCHANT BANKING AND FINANCIAL SERVICES

PRESENTED BY

S.EUGINE SELVA SABITHA



UNIT I

MERCHANT BANKING



Merchant Banking

An activity that includes corporate financeactivities, such as advice on complex

financings, merger and acquisition advice(international or domestic), and at timesdirect equity investments in corporationsby the banks.



MERCHANT BANKING HISTORY

In late 17th and early 18th century Europe, the largest companies of theworld were merchant adventurers. Supported by wealthy groups of peopleand a network of overseas trading posts, the collected large amounts of money to finance trade across parts of the world. For example, The EastIndia Trading Company secured a Royal Warrant from England, providing

the firm with official rights to lucrative trading activities in India. Thiscompany was the forerunner in developing the crown jewel of the EnglishEmpire. The English colony was started by what we would today callmerchant bankers, because of the firm's involvement in financing,negotiating, and implementing trade transactions.The colonies of other European countries were started in the same manner.For example, the Dutch merchant adventurers were active in what is nowIndonesia; the French and Portuguese acted similarly in their respectivecolonies. The American colonies also represent the product of merchantbanking, as evidenced by the activities of the famous Hudson BayCompany. One does not typically look at these countries' economicdevelopment as having been fueled by merchant bank adventurers.However, the colonies and their progress stem from the business of merchant banks, according to today's accepted sense of the word.



THE HISTORICAL MERCHANT

BANKMerchant Banking, as the term has evolved in Europe from the 18thcentury to today, pertained to an individual or a banking housewhose primary function was to facilitate the business processbetween a product and the financial requirements for itsdevelopment. Merchant banking services span from the earliest

negotiations from a transaction to its actual consummation betweenbuyer and seller.In particular, the merchant banker acted as a capital sources whoseprimary activity was directed towards a commodity trader/cargoowner who was involved in the buying, selling, and shipping of goods. The role of the merchant banker, who had the expertise tounderstand a particular transaction, was to arrange the necessary

capital and ensure that the transaction would ultimately produce"collectable" profits. Often, the merchant banker also becameinvolved in the actual negotiations between a buyer and seller in atransaction.



THE MODERN MERCHANT BANKDuring the 20th century, however, European merchantbanks expanded their services. They became increasinglyinvolved in the actual running of the business for whomthe transaction was conducted. Today, merchant banksactually own and run businesses for their own account,and that of others.

Since the 18th century, the term merchant banker has,therefore, been considerably broadened to include acomposite of modern day skills. These skills include thoseinherent in an entrepreneur, a management advisor, acommercial and/or investment banker plus that of atransaction broker. Today a merchant banker is who hasthe ability to merchandise -- that is, create or expand aneed -- and fulfill capital requirements. The modernEuropean merchant bank, in many ways, reflects the earlyactivities and breadth of services of the colonial tradingcompanies.



Functions of Merchant Bank

1. Corporate Counseling2. Project counseling3. Pre investment studies4. Capital restructuring5. Credit syndication and project finance6. Issue management and underwriting

7. Portfolio management8. Working capital finance9. Acceptance credit and bill discounting



10. Mergers, amalgamations and takeovers11. Venture capital

12. Lease financing13. Mutual fund14. Project appraisal



Post issue Activities

Activities that are undertaken immediatelyafter the closure of the issue are known aspost issue activities. Major Activities areFinalization of basis of allotmentDespatch of share certificates

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Prospectus

A document through which public aresolicited to subscribe to the share capitalof a corporate entity is called asprospectus.



Content of the prospectus

Part I1. General information

2. Capital structure3. Terns of issue4. Particulars of the issue

5. Company management and project6. Perception of risk factors



Part II1. General information

2. Financial information3. Statutory and other information



Capital structure

The term capital structure refers to theproportionate claims of debt and equity in thetotal long term capitalization of a company.

Optimal capital structure: An ideal mix of various sources of long term funds

that aims at minimizing the overall cost of

capital of the firm and maximizes the marketvalue of shares of a firm is known as optimalcapital structure,



Pricing of issues

While fixing an appropriate price, therelevant guidelines for capital issues givenby SEBI from time to time must beconsidered. Companies themselves inconsultation with the merchant bankers,do the pricing of issues.



Factors to be considered

While fixing a price for the security issue, thefollowing factors should be considered.

Qualitative factors: which include theprospects of the industry, track record of the promoters, the competitive advantagethe company has in making the best use

of the business opportunities, and growthof the company as compared to theindustry, etc.



Quantitative factors: which include theearnings per share, book value, theaverage market price for 2 or 3 years,dividend payment record, the profitmargins, the composite industry priceearnings ratio and the future prospects of

the company, etc



The Process of book building:

The Issuer who is planning an offer nominates lead merchant banker's) as 'bookrunners'.The Issuer specifies the number of securities to be issued and the price band for thebids.The Issuer also appoints syndicate members with whom orders are to be placed bythe investors.

The syndicate members input the orders into an 'electronic book'. This process iscalled 'bidding' and is similar to open auction.The book normally remains open for a period of 5 days.Bids have to be entered within the specified price band.Bids can be revised by the bidders before the book closes.On the close of the book building period, the book runners evaluate the bids on thebasis of the demand at various price levels.The book runners and the Issuer decide the final price at which the securities shall beissued.Generally, the number of shares are fixed, the issue size gets frozen based on thefinal price per share.

Allocation of securities is made to the successful bidders. The rest get refund orders.



Guidelines for Book BuildingRules governing Book building are covered in Chapter XI of the Securitiesand Exchange Board of India (Disclosure and Investor Protection)Guidelines 2000.

BSE's Book Building SystemBSE offers a book building platform through the Book Building software thatruns on the BSE Private network.This system is one of the largest electronic book building networks in theworld, spanning over 350 Indian cities through over 7000 Trader WorkStations via leased lines, VSATs and Campus LANS.The software is operated by book-runners of the issue and by the syndicatemembers , for electronically placing the bids on line real-time for the entirebidding period.In order to provide transparency, the system provides visual graphsdisplaying price v/s quantity on the BSE website as well as all BSEterminals.



Underwriters and Brokers

BROKER: A person who buys and sells things for other people is called 'Broker'.

UNDERWRITER: A person or organization underwritesinsurance policies, especially for ships is

called 'Underwriter'



Green shoe option A provision contained in an underwriting agreement thatgives the underwriter the right to sell investors moreshares than originally planned by the issuer. Thiswould normally be done if the demand for a security

issue proves higher than expected. Legally referred to asan over-allotment option.

A green shoe option can provide additional price stabilityto a security issue because the underwriter has the

ability to increase supply and smooth out pricefluctuations if demand surges.



UNIT III

OTHER FEE BASED SERVICES



Mergers and AcquisitionsMergers and acquisitions (abbreviated M&A) refers tothe aspect of corporate strategy, corporate finance andmanagement dealing with the buying, selling, dividingand combining of different companies and similar entities

that can aid, finance, or help an enterprise grow rapidlyin its sector or location of origin or a new field or newlocation without creating a subsidiary, other child entityor using a joint venture. The distinction between a"merger" and an "acquisition" has become increasingly

blurred in various respects (particularly in terms of theultimate economic outcome), although it has notcompletely disappeared in all situations.



F inancing M&A

Mergers are generally differentiated from acquisitions partlyby the way in which they are financed and partly by the relative size of the companies. Various methods of financing an M&A deal exist:Cash:

Payment by cash. Such transactions are usually termed acquisitionsrather than mergers because the shareholders of the targetcompany are removed from the picture and the target comes under the (indirect) control of the bidder's shareholders.

StockPayment in the acquiring company's stock, issued to theshareholders of the acquired company at a given ratio proportionalto the valuation of the latter.



Portfolio Management Services

Portfolio management is all aboutstrengths, weaknesses, opportunities andthreats in the choice of debt vs. equity,domestic vs. international, growth vs.safety, and many other tradeoffsencountered in the attempt to maximize

return at a given appetite for risk.



credit syndication services

A project financing service offered bymerchant bankers whereby financialfacilities tare organized and procured fromfinancial institutions, banks, or other lending agencies is known as creditsyndication service.



Credit rating A credit rating is also known as an evaluation of a potential borrower's ability to repay debt,prepared by a credit bureau at the request of thelender Credit ratings are calculated fromfinancial history and current assets andliabilities. Typically, a credit rating tells a lender or investor the probability of the subject beingable to pay back a loan. However, in recentyears, credit ratings have also been used toadjust insurance premiums, determineemployment eligibility, and establish the amountof a utility or leasing deposit.



Mutual fund

A mutual fund is a professionallymanaged type of collective investment thatpools money from many investors to buystocks, bonds, short-term money marketinstruments, and/or other securities



Advantages of mutual fundsMutual funds have advantages compared to direct investing in

individual securities. These include:

Increased diversification, Daily liquidityProfessional investment managementService and convenience

Government oversightEase of comparison



Disadvantages of mutual funds

Mutual funds have disadvantages as well,which include:

FeesLess control timing of recognition of gainsLess predictable income

No opportunity to customize



Types of mutual funds

There are three basic types of registered investmentcompanies defined in the Investment Company Act of 1940: open-end funds, unit investment trusts (UITs); and

closed-end funds. exchange-traded funds(ETFs)areopen-end funds or unit investment trusts that trade on anexchange.

Open-end fundsOpen-end mutual funds must be willing to buy back their shares from their investors at the end of every businessday at the net asset value computed that day. Mostopen-end funds also sell shares to the public everybusiness day; these shares are also priced at net assetvalue



Closed-end fundsClosed-end funds generally issue shares

to the public only once, when they arecreated through an initial public offering.Their shares are then listed for trading ona stock exchange.



Business valuation

Business valuation is a process and a setof procedures used to estimate theeconomic value of an owner¶s interest in abusiness. Valuation is used by financialmarket participants to determine the pricethey are willing to pay or receive to

consummate a sale of a business



Leasing

Leasing is a process by which a firm canobtain the use of a certain fixed assets for which it must pay a series of contractual,periodic, tax deductible payments.



Common Lease Types

1. Operating lease: An operating lease is particularly attractive to companiesthat continually update or replace equipment and want to

use equipment without ownership, but also want toreturn equipment at lease-end and avoid technologicalobsolescence.

2. Finance lease A finance lease is a full-payout, non cancelableagreement, in which the lessee is responsible for maintenance, taxes and insurance.



Hire purchase

Hire purchase is the legal term for acontract, in this persons usually agree topay for goods in parts or a percentage at atime.



F inancial evaluationF inancial evaluation of a project is analysis of a project for checking whether project is profitable or not before taking project inhand. We also review the project by investigating its cost, risk andreturn. If we have lots of alternatives projects, then we select bestproject on the basis of financial evaluation. In simple words, we usesfollowing tools for financial evaluating of a project.

1. Evaluate the Cost of Project:

First thing which we see before take the any project from financialpoint of view is to evaluate the cost of project. Whether cost of project is good according to its quality or not?



2 . Time Value of Investment in Money:

Time value of investment in money is the importance factor whichaffects the decisions of financial evaluation of any capital investmentbecause we check the profitability of project according to time.Today earned one rupee from any project is better than one rupeeearned after one year because we can get interest one rupee whichhas earned today.

3. NPV:

NPV is also good tool of financial evaluation. If we have two projectand we have to choose any one best project, then we will check

NPV of each project. We will accept that project whose NPV willhigher. NPV means net present value. It is excess of present valueof cash inflows over present value of cash outflow.



4 . IRR

IRR is internal rate of return. It is that rate where the totalpresent value of cash inflow is equal to the present value

of cash outflow. So, if any project gives use this earningrate, we will accept that project.

5. Pay back period

Pay back period is not non-discounting technique of financial evaluation. In payback period, we find the totaltime in which our project will give use profit equal to our initial cost.



6 . Risk evaluating:

We also analyze different risks relating to

financial evaluation of any project. Risk may beliquidity, solvency or interest or any other. After this, we see whether we have ability to managethese risks, if not, then, we leave that project for

projecting our business.



UNIT V

OTHER FUND BASED FINANCIALSERVICES



Consumer credit

Consumer credit is basically the amount of credit used by consumers to purchasenon-investment goods or services that areconsumed and whose value depreciatesquickly



Credit card

A credit card is a small plastic card issuedto users as a system of payment. It allowsits holder to buy goods and services basedon the holder's promise to pay for thesegoods and services



Benefits of Credit Card

1) F ree Credit Period : Firstly the Credit Cardoffers you a free credit period (of 50-55 days)from the date of the billing cycle which helps youto purchase on credit without any hassle of carrying cash, thus making your shopping mucheasier.

2) Online Shopping : The Credit Card helps youto buy products/services online or over thephone thus helping you to purchase anywhere24x7



3) Advantage of various Branding offers :Most importantly credit cards offer various discounts & schemeswhich are associated with entertainment, travel, shopping etc.Issuing Credit Card Banks tie up with the reputed brands to sellproducts/services at attractive rates which you can buy through your credit cards. To check offers running on your credit card.

4) Borrowing cash through credit cards :You can also withdraw cash through ATMs at any time.

5) Credit Cards also offer reward points on purchases which you canaccumulate and redeem later with cash backs & attractive gifts etc



Players involved in the credit card business:

Players involved in the credit card business:

Credit Card Holder : The person who is issued a credit card, who actually holds & usesit. He purchases various things through the card & pays the borrowed money later within a scheduled time to the bank or the company.

Merchant/Shop-keeper : The person who accepts the payments from the card holder through the swiping of the credit card in return of the transaction.

Card Issuing Bank : It is the bank which has actually issued the credit card to customers& offers credit to them on transactions made by the card holder.

Acquiring Bank: All the transactions made using the credit card is done through theacquiring bank. The merchant pays a fee to the acquiring bank for the signing of machine & other services.

Credit Card Network : This is that network which helps facilitate the card transactionssuch as Visa or Master Card.



Credit Card Process

The process starts with the swiping of your card on the merchant¶s cardswiping machine which has been provided by the acquiring bank to him. Assoon as the card is swiped; the transaction is checked & verified by the cardissuing bank whether the credit card is eligible for the requested amount of credit. Once the card holder is verified for the credit, he signs the chargeslip which is forwarded to the acquiring bank and closes the transactionswith the merchant; further the acquiring bank settles the transactions withthe issuing bank.

Banks earn in two ways, firstly by the fee paid by the merchants for enrollingthe services (machine etc.). Secondly from the card holders who default bynot paying the entire outstanding balance before the due date.

Credit Cards help in day-to-day transactions of goods & services offering a

free credit period provided the card holder pays the outstanding balancewithin the grace period; otherwise the card holder has to pay interestcharges & late fee if the payment is made after the due date.

In nutshell buying through credit cards really benefit till the time you payyour card bills on time, or else it will turn out be very expensive.



Real Estate Finance

Real Estate Finance can be defined as a branchof finance, which deals with investing money or wealth in real estate. Real estate finance dealswith the allocation, generation and use of monetary resources over time, which is investedin the real estate business. Like any other aspect of finance, real estate finance also hasrisks associated with it and the effectivemanagement of assets, which will maintain or increase in value over time, i.e. the investmentyield of the project.



Bill DiscountingBill Discounting is a process where thefinancial institution gets the Bill of Exchange(Cheque / PO /DD etc.) before its maturitydate and below its par value. Hence theamount or cash realized may vary dependingupon the number of days until maturity andthe risk involved.Discounting the bill of exchange is practicedto get the same immediately enchased beforethe maturity date. The liability in case of dishonor of the bill remains with the personin whose favor the bill is generated.



Bill Discounting Benefits

1) Provides ready cash for the business.2) Improve liquidity and accelerates the

production cycle.3) Customers get adequate period for payments.4) Enables the business to go for credit sales thus

improves the sales and ultimately the profit for the business.

5) Facilitates the critical business decisions sinceit ensures the cash availability in the business.



F ACTORING ANDF OR F AITING

Factoring is the process of purchasing invoicesfrom a business at a certain discount. Factorsprovide financing service to small an medium-

sized companies who need cash.

Forfiting is the purchase of a series of creditinstruments such as drafts, bills of exchange,other freely negotiable instruments on a nonrecourse basis. Nonrecourse means that if theimporter does not pay, the forfeiter cannotrecover payment from the exporter.



Types of Venture Capital F unds

Generally there are three types of organized or institutional venturecapital funds: venture capital funds set up by angel investors, that is,high net worth individual investors; venture capital subsidiaries of corporations and private venture capital firms/ funds. Venture capitalsubsidiaries are established by major corporations, commercialbank holding companies and other financial institutions. Venturefunds in India can be classified on the basis of the type of promoters.

1 . VC F s promoted by the Central govt. controlled developmentfinancial institutions such as TDICI, by ICICI, Risk capital andTechnology Finance Corporation Limited (RCTFC) by the Industrial

Finance Corporation of India (IFCI) and Risk Capital Fund by IDBI.



2. VCF s promoted by the state government-controlleddevelopment finance institutions such as Andhra PradeshVenture Capital Limited (APVCL) by Andhra Pradesh State FinanceCorporation (APSFC) and Gujarat Venture Finance CompanyLimited (GVCFL) by Gujarat Industrial Investment Corporation(GIIC)

3. VCF s promoted by Public Sector banks such as Canfina byCanara Bank and SBI-Cap by State Bank of India.

4. VCF s promoted by the foreign banks or private sector companies and financial institutions such as Indus Venture Fund,

Credit Capital Venture Fund and Grindlay's India DevelopmentFund.



The Venture Capital InvestmentProcess:

The venture capital activity is a sequentialprocess involving the following six steps.

1. Deal origination2. Screening3. Due diligence Evaluation)4. Deal structuring5. Post-investment activity6. Exist



Venture Capital InvestmentProcess



1. Deal origination:In generating a deal flow, the VC investor creates a pipeline of deals or investment opportunities that he would consider for investing in. Deal may originate in various ways. referralsystem, active search system, and intermediaries. Referralsystem is an important source of deals. Deals may be referredto VC F s by their parent organizations, trade partners, industryassociations, friends etc.

2 . Screening:VCF s, before going for an in-depth analysis, carry out initialscreening of all projects on the basis of some broad criteria.F or example, the screening process may limit projects to areas

in which the venture capitalist is familiar in terms of technology, or product, or market scope. The size of investment, geographical location and stage of financing couldalso be used as the broad screening criteria.



3. Due Diligence:Due diligence is the industry jargon for all the activities that are associatedwith evaluating an investment proposal. The venture capitalists evaluate thequality of entrepreneur before appraising the characteristics of the product,market or technology. Most venture capitalists ask for a business plan tomake an assessment of the possible risk and return on the venture.

Business plan contains detailed information about the proposed venture.The evaluation of ventures by VCFs in India includes;Preliminary evaluation: The applicant required to provide a brief profile of the

proposed venture to establish prima facie eligibility.Detailed evaluation: Once the preliminary evaluation is over, the proposal is

evaluated in greater detail.4 . Deal Structuring:

In this process, the venture capitalist and the venture company negotiatethe terms of the deals, that is, the amount, form and price of the investment.This process is termed as deal structuring.



5. Post Investment Activities:Once the deal has been structured and agreement finalized, the venturecapitalist generally assumes the role of a partner and collaborator. He alsogets involved in shaping of the direction of the venture. The degree of theventure capitalist's involvement depends on his policy. It may not, however,be desirable for a venture capitalist to get involved in the day-to-day

operation of the venture. If a financial or managerial crisis occurs, theventure capitalist may intervene, and even install a new management team.6 . Exit:

Venture capitalists generally want to cash-out their gains in five to ten yearsafter the initial investment. They play a positive role in directing thecompany towards particular exit routes. A venture may exit in one of thefollowing ways:

1. Initial Public Offerings (IPOs)2. Acquisition by another company3. Purchase of the venture capitalist's shares by the promoter, or 4. Purchase of the venture capitalist's share by an outsider.



Methods of Venture F inancing

Venture capital is typically available in three forms in India, they are:Equity : All VCFs in India provide equity but generally their contribution does notexceed 49 percent of the total equity capital. Thus, the effective control and majorityownership of the firm remains with the entrepreneur.

Conditional Loan: It is repayable in the form of a royalty after the venture is able togenerate sales. No interest is paid on such loans. In India, VCFs charge royaltyranging between 2 to 15 percent; actual rate depends on other factors of the venturesuch as gestation period, cost-flow patterns, riskiness and other factors of theenterprise.

Income Note : It is a hybrid security which combines the features of bothconventional loan and conditional loan. The entrepreneur has to pay both interest androyalty on sales, but at substantially low rates.

Other F inancing Methods: A few venture capitalists, particularly in the private sector,have started introducing innovative financial securities like participating debentures,introduced by TCFC is an example.

Ba 958 Merchant Banking

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