BA 958 MERCHANT BANKING AND FINANCIAL SERVICES

PRESENTED BY S.EUGINE SELVA SABITHA

UNIT I
MERCHANT BANKING

Merchant Banking
An activity that includes corporate finance activities, such as advice on complex financings, merger and acquisition advice (international or domestic), and at times direct equity investments in corporations by the banks.

MERCHANT BANKING HISTORY

In late 17th and early 18th century Europe, the largest companies of the world were merchant adventurers. Supported by wealthy groups of people and a network of overseas trading posts, the collected large amounts of money to finance trade across parts of the world. For example, The East India Trading Company secured a Royal Warrant from England, providing the firm with official rights to lucrative trading activities in India. This company was the forerunner in developing the crown jewel of the English Empire. The English colony was started by what we would today call merchant 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 now Indonesia; the French and Portuguese acted similarly in their respective colonies. The American colonies also represent the product of merchant banking, as evidenced by the activities of the famous Hudson Bay Company. One does not typically look at these countries' economic development 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 BANK

Merchant Banking, as the term has evolved in Europe from the 18th century to today, pertained to an individual or a banking house whose primary function was to facilitate the business process between a product and the financial requirements for its development. Merchant banking services span from the earliest negotiations from a transaction to its actual consummation between buyer and seller. In particular, the merchant banker acted as a capital sources whose primary activity was directed towards a commodity trader/cargo owner who was involved in the buying, selling, and shipping of goods. The role of the merchant banker, who had the expertise to understand a particular transaction, was to arrange the necessary capital and ensure that the transaction would ultimately produce "collectable" profits. Often, the merchant banker also became involved in the actual negotiations between a buyer and seller in a transaction.

THE MODERN MERCHANT BANK

During the 20th century, however, European merchant banks expanded their services. They became increasingly involved in the actual running of the business for whom the transaction was conducted. Today, merchant banks actually 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 a composite of modern day skills. These skills include those inherent in an entrepreneur, a management advisor, a commercial and/or investment banker plus that of a transaction broker. Today a merchant banker is who has the ability to merchandise -- that is, create or expand a need -- and fulfill capital requirements. The modern European merchant bank, in many ways, reflects the early activities and breadth of services of the colonial trading companies.

Functions of Merchant Bank

1. 2. 3. 4. 5. 6. 7. 8. 9. Corporate Counseling Project counseling Pre investment studies Capital restructuring Credit syndication and project finance Issue management and underwriting Portfolio management Working capital finance Acceptance credit and bill discounting

10. Mergers, amalgamations and takeovers 11. Venture capital 12. Lease financing 13. Mutual fund 14. Project appraisal

Post issue Activities

Activities that are undertaken immediately after the closure of the issue are known as post issue activities. Major Activities are Finalization of basis of allotment Despatch of share certificates Advertisement

Prospectus
A document through which public are solicited to subscribe to the share capital of a corporate entity is called as prospectus.

Content of the prospectus

Part I 1. General information 2. Capital structure 3. Terns of issue 4. Particulars of the issue 5. Company management and project 6. Perception of risk factors

Part II 1. General information 2. Financial information 3. Statutory and other information

Capital structure
The term capital structure refers to the proportionate claims of debt and equity in the total 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 market value of shares of a firm is known as optimal capital structure,

 An optimal capital structure should possess the following characteristics.  Simplicity  Low cost  Maximum return and minimum risks  Maximum control

Pricing of issues
While fixing an appropriate price, the relevant guidelines for capital issues given by SEBI from time to time must be considered. Companies themselves in consultation with the merchant bankers, do the pricing of issues.

Factors to be considered
While fixing a price for the security issue, the following factors should be considered. Qualitative factors: which include the prospects of the industry, track record of the promoters, the competitive advantage the company has in making the best use of the business opportunities, and growth of the company as compared to the industry, etc.

Quantitative factors: which include the earnings per share, book value, the average market price for 2 or 3 years, dividend payment record, the profit margins, the composite industry price earnings ratio and the future prospects of the company, etc

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

The Process of book building:

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

Guidelines for Book Building Rules governing Book building are covered in Chapter XI of the Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines 2000. BSE's Book Building System BSE offers a book building platform through the Book Building software that runs on the BSE Private network. This system is one of the largest electronic book building networks in the world, spanning over 350 Indian cities through over 7000 Trader Work Stations via leased lines, VSATs and Campus LANS. The software is operated by book-runners of the issue and by the syndicate members , for electronically placing the bids on line real-time for the entire bidding period. In order to provide transparency, the system provides visual graphs displaying price v/s quantity on the BSE website as well as all BSE terminals.

Underwriters and Brokers

BROKER: A person who buys and sells things for other people is called 'Broker'. UNDERWRITER: A person or organization underwrites insurance policies, especially for ships is called 'Underwriter'

Green shoe option

A provision contained in an underwriting agreement that gives the underwriter the right to sell investors more shares than originally planned by the issuer. This would normally be done if the demand for a security issue proves higher than expected. Legally referred to as an over-allotment option. A green shoe option can provide additional price stability to a security issue because the underwriter has the ability to increase supply and smooth out price fluctuations if demand surges.

UNIT III
OTHER FEE BASED SERVICES

Mergers and Acquisitions

Mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling, dividing and combining of different companies and similar entities that can aid, finance, or help an enterprise grow rapidly in its sector or location of origin or a new field or new location without creating a subsidiary, other child entity or using a joint venture. The distinction between a "merger" and an "acquisition" has become increasingly blurred in various respects (particularly in terms of the ultimate economic outcome), although it has not completely disappeared in all situations.

Financing M&A
Mergers are generally differentiated from acquisitions partly by 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 acquisitions rather than mergers because the shareholders of the target company are removed from the picture and the target comes under the (indirect) control of the bidder's shareholders. Stock Payment in the acquiring company's stock, issued to the shareholders of the acquired company at a given ratio proportional to the valuation of the latter.

Portfolio Management Services

Portfolio management is all about strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other tradeoffs encountered in the attempt to maximize return at a given appetite for risk.

Functions of portfolio management

Risk diversification Efficient portfolio Asset allocation Beta estimation Rebalancing portfolios

credit syndication services

A project financing service offered by merchant bankers whereby financial facilities tare organized and procured from financial institutions, banks, or other lending agencies is known as credit syndication 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 the lender Credit ratings are calculated from financial history and current assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the subject being able to pay back a loan. However, in recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit.

Personal credit ratings

An individual's credit score, along with his credit report, affects his or her ability to borrow money through financial institutions such as banks. The factors that may influence a person's credit rating are ability to pay a loan interest amount of credit used

Mutual fund
A mutual fund is a professionally managed type of collective investment that pools money from many investors to buy stocks, bonds, short-term money market instruments, and/or other securities

Advantages of mutual funds

Mutual funds have advantages compared to direct investing in individual securities. These include:
Increased diversification, Daily liquidity Professional investment management Service and convenience Government oversight Ease of comparison

Disadvantages of mutual funds

Mutual funds have disadvantages as well, which include:  Fees  Less control timing of recognition of gains  Less predictable income  No opportunity to customize

Types of mutual funds

There are three basic types of registered investment companies defined in the Investment Company Act of 1940: open-end funds, unit investment trusts (UITs); and closed-end funds. exchange-traded funds(ETFs)are open-end funds or unit investment trusts that trade on an exchange. Open-end funds Open-end mutual funds must be willing to buy back their shares from their investors at the end of every business day at the net asset value computed that day. Most open-end funds also sell shares to the public every business day; these shares are also priced at net asset value

Closed-end funds Closed-end funds generally issue shares to the public only once, when they are created through an initial public offering. Their shares are then listed for trading on a stock exchange.

Business valuation
Business valuation is a process and a set of procedures used to estimate the economic value of an owners interest in a business. Valuation is used by financial market participants to determine the price they are willing to pay or receive to consummate a sale of a business

UNIT IV
FUND BASED FINANCIAL SERVICES

Leasing
Leasing is a process by which a firm can obtain 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 companies that continually update or replace equipment and want to use equipment without ownership, but also want to return equipment at lease-end and avoid technological obsolescence. 2. Finance lease A finance lease is a full-payout, non cancelable agreement, in which the lessee is responsible for maintenance, taxes and insurance.

Hire purchase
Hire purchase is the legal term for a contract, in this persons usually agree to pay for goods in parts or a percentage at a time.

Financial evaluation
Financial evaluation of a project is analysis of a project for checking whether project is profitable or not before taking project in hand. We also review the project by investigating its cost, risk and return. If we have lots of alternatives projects, then we select best project on the basis of financial evaluation. In simple words, we uses following tools for financial evaluating of a project. 1. Evaluate the Cost of Project: First thing which we see before take the any project from financial point 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 which affects the decisions of financial evaluation of any capital investment because we check the profitability of project according to time. Today earned one rupee from any project is better than one rupee earned after one year because we can get interest one rupee which has earned today. 3. NPV: NPV is also good tool of financial evaluation. If we have two project and we have to choose any one best project, then we will check NPV of each project. We will accept that project whose NPV will higher. NPV means net present value. It is excess of present value of cash inflows over present value of cash outflow.

4. IRR IRR is internal rate of return. It is that rate where the total present value of cash inflow is equal to the present value of cash outflow. So, if any project gives use this earning rate, 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 total time 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 be liquidity, solvency or interest or any other. After this, we see whether we have ability to manage these risks, if not, then, we leave that project for projecting our business.

UNIT V
OTHER FUND BASED FINANCIAL SERVICES

Consumer credit
Consumer credit is basically the amount of credit used by consumers to purchase non-investment goods or services that are consumed and whose value depreciates quickly

Credit card
A credit card is a small plastic card issued to users as a system of payment. It allows its holder to buy goods and services based on the holder's promise to pay for these goods and services

Benefits of Credit Card

1) Free Credit Period : Firstly the Credit Card offers you a free credit period (of 50-55 days) from the date of the billing cycle which helps you to purchase on credit without any hassle of carrying cash, thus making your shopping much easier. 2) Online Shopping : The Credit Card helps you to buy products/services online or over the phone thus helping you to purchase anywhere 24x7

3) Advantage of various Branding offers : Most importantly credit cards offer various discounts & schemes which are associated with entertainment, travel, shopping etc. Issuing Credit Card Banks tie up with the reputed brands to sell products/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 can accumulate 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 & uses it. 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 the acquiring 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 transactions such as Visa or Master Card.

Credit Card Process

The process starts with the swiping of your card on the merchants card swiping machine which has been provided by the acquiring bank to him. As soon as the card is swiped; the transaction is checked & verified by the card issuing 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 charge slip which is forwarded to the acquiring bank and closes the transactions with the merchant; further the acquiring bank settles the transactions with the issuing bank. Banks earn in two ways, firstly by the fee paid by the merchants for enrolling the services (machine etc.). Secondly from the card holders who default by not 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 balance within the grace period; otherwise the card holder has to pay interest charges & late fee if the payment is made after the due date. In nutshell buying through credit cards really benefit till the time you pay your card bills on time, or else it will turn out be very expensive.

Real Estate Finance

Real Estate Finance can be defined as a branch of finance, which deals with investing money or wealth in real estate. Real estate finance deals with the allocation, generation and use of monetary resources over time, which is invested in the real estate business. Like any other aspect of finance, real estate finance also has risks associated with it and the effective management of assets, which will maintain or increase in value over time, i.e. the investment yield of the project.

Bill Discounting
Bill Discounting is a process where the financial institution gets the Bill of Exchange (Cheque / PO /DD etc.) before its maturity date and below its par value. Hence the amount or cash realized may vary depending upon the number of days until maturity and the risk involved. Discounting the bill of exchange is practiced to get the same immediately enchased before the maturity date. The liability in case of dishonor of the bill remains with the person in whose favor the bill is generated.

Commercial bill discount

A commercial bill discount is an act by which the legal holder of a commercial bill (including banker's acceptance draft and commercial acceptance draft) transfers it to bank to acquire cash before its maturity date

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 since it ensures the cash availability in the business.

FACTORING AND FORFAITING

Factoring is the process of purchasing invoices from a business at a certain discount. Factors provide financing service to small an mediumsized companies who need cash. Forfiting is the purchase of a series of credit instruments such as drafts, bills of exchange, other freely negotiable instruments on a non recourse basis. Nonrecourse means that if the importer does not pay, the forfeiter cannot recover payment from the exporter.

Venture capital
Venture capital is financial capital provided to early-stage, high-potential, high risk, growth startup companies. The venture capital fund makes money by owning equity in the companies it invests in, which usually have a novel technology or business model in high technology industries, such as biotechnology, IT, software, etc.

Types of Venture Capital Funds

Generally there are three types of organized or institutional venture capital 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 capital subsidiaries are established by major corporations, commercial bank holding companies and other financial institutions. Venture funds in India can be classified on the basis of the type of promoters. 1 . VCFs promoted by the Central govt. controlled development financial institutions such as TDICI, by ICICI, Risk capital and Technology Finance Corporation Limited (RCTFC) by the Industrial Finance Corporation of India (IFCI) and Risk Capital Fund by IDBI.

2. VCFs promoted by the state government-controlled development finance institutions such as Andhra Pradesh Venture Capital Limited (APVCL) by Andhra Pradesh State Finance Corporation (APSFC) and Gujarat Venture Finance Company Limited (GVCFL) by Gujarat Industrial Investment Corporation (GIIC) 3. VCFs promoted by Public Sector banks such as Canfina by Canara Bank and SBI-Cap by State Bank of India. 4. VCFs 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 Development Fund.

The Venture Capital Investment Process:

The venture capital activity is a sequential process involving the following six steps. 1. Deal origination 2. Screening 3. Due diligence Evaluation) 4. Deal structuring 5. Post-investment activity 6. Exist

Venture Capital Investment Process

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. referral system, active search system, and intermediaries. Referral system is an important source of deals. Deals may be referred to VCFs by their parent organizations, trade partners, industry associations, friends etc. 2. Screening: VCFs, before going for an in-depth analysis, carry out initial screening of all projects on the basis of some broad criteria. For 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 could also be used as the broad screening criteria.

3. Due Diligence: Due diligence is the industry jargon for all the activities that are associated with evaluating an investment proposal. The venture capitalists evaluate the quality of entrepreneur before appraising the characteristics of the product, market or technology. Most venture capitalists ask for a business plan to make 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 negotiate the 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 venture capitalist generally assumes the role of a partner and collaborator. He also gets involved in shaping of the direction of the venture. The degree of the venture 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, the venture 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 years after the initial investment. They play a positive role in directing the company towards particular exit routes. A venture may exit in one of the following ways: 1. Initial Public Offerings (IPOs) 2. Acquisition by another company 3. 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 Financing

Venture capital is typically available in three forms in India, they are: Equity : All VCFs in India provide equity but generally their contribution does not exceed 49 percent of the total equity capital. Thus, the effective control and majority ownership of the firm remains with the entrepreneur. Conditional Loan: It is repayable in the form of a royalty after the venture is able to generate sales. No interest is paid on such loans. In India, VCFs charge royalty ranging between 2 to 15 percent; actual rate depends on other factors of the venture such as gestation period, cost-flow patterns, riskiness and other factors of the enterprise. Income Note : It is a hybrid security which combines the features of both conventional loan and conditional loan. The entrepreneur has to pay both interest and royalty on sales, but at substantially low rates. Other Financing 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.