SMU BBA5 BB0022- Capital and money Market solved assignment

Bachelor of Business Administration-BBA Semester 5

BB0022 Capital and Money Market - 4 Credits

(Book ID: B0101)

Assignment (60 Marks)

1.      Explain the securities market and discuss the methods of underwriting the securities.

Ans. Securities Market: The bulk of the financial needs (long term financial requirements) of a company are met by rising through the securities like equity shares, preference shares, debentures and bonds. The term securities market is a comprehensive one and refers to the buyers and sellers of securities and also the structure comprising all those agencies and institutions which help in the sale and resale of company securities. There are different types of business organizations in India namely partnership firm, cooperative societies, private & public limited companies and joint sector organizations etc. The more frequently organized method is the company registered under the Indian companies Act, 1956. Under this act, there are three types of companies:

a) Companies Limited by guarantee.

b) Companies which are private limited companies – limited by shares paid up.

c) Companies which are public limited companies – limited by shares paid up.

Under this act, the private limited companies can have 50 members and their shares are not transferable freely. These companies reserve the right to refuse any transfer of shares and as such trading in them is restricted. Due to these inhibitive features, private limited companies do not have any access to the securities market.

Methods of Underwriting An underwriting agreement may take any of the following forms.

i) Standing behind the Issue: Under this method, the underwriter guarantees the sale of a specified number of shares within a specified period. If the public does not take up the whole of the specified amount of the issue, the underwriters standing behind the issue come forward to purchase the balance.

ii) Outright Purchase: Underwriters purchase the issue outright and resell the securities to the investors. The purchase price is negotiated between the issuers and the underwriters or may be determined by competitive bidding.

iii) T he Consortium Method: Underwriting is jointly done by a group of underwriters who form a syndicate for the purpose. This method is adapted for large issues. This method enables the spread of risk among the members of the syndicate. No single underwriter bears the entire risk.

2. List out the primary stock exchanges operating in India and the causes of price fluctuations of shares.

Ans. There are 23 stock exchanges functioning in India. Stock exchanges are organized as voluntary associations or public limited companies or as guarantee companies. These two are primary stock exchanges operating in India.

Bombay Stock Exchange (BSE) The Bombay Stock Exchange (BSE) established in 1875 is the first stock exchange in India.

National Stock Exchange of India (NSEI) NSEI was established in 1994 by the financial institutions and banks with IDBI as a nodal agency.

CAUSES OF PRICE FLUCTUATIONS The prices of variable yield securities, say equity shares, in the stock exchange fluctuate frequently and sometimes widely. Many factors combine together to cause such changes, but quite a few are only remotely related to the process of the valuation of shares. In general, the fluctuations in the prices of scrip’s may be ascribed to the following factors:

Demand and Supply: The law of demand and supply operates rigidly in the stock exchange. The demand and supply depends on a variety of factors, all of which are related either to the actual yield from them or the general expectation about the yield. If the actual yield is below the general expectations, there may be more sellers than buyers of the shares as such the market value of the shares will fall. On the other hand the market value of the shares may rise when actual yield is better than general expectations.

Bank Rate: The bank rate is the rate percent at which the central bank of a country discounts approved bills of exchange. This rate governs the rate of interest charged by commercial banks from their clients on loans and overdrafts procured by them. When the bank rate is low, the commercial banks provide credit at lower rate of interest, which in turn induces people to borrow money from banks to speculate in securities. Because the possible gains due to price changes are greater than interest paid to the bank. With more money, more people buy more stocks and shares, the price of securities will tend to rise.

Speculative Pressure: The activities of bulls and bears are both the cause and result of fluctuations in security prices. The Bull Run results in upward movement of prices and the bear pressure will lower the security prices. When the bulls liquidate or unload their holdings, they lower the prices. Large scale buying by the bears to meet their short sales will force the security prices upwards.

Actions of underwriters and other Financial Institutions: Large scale buying of a particular security by the institutional investors will have the effect of raising the expectations of the general public about the prospects of the company. The prices of such shares will rise when general public also rush forth to invest their savings in these shares.

Changes In Company’s Board of Directors: The soundness and financial stability of the company is doubted by the investors when an influential and well known director resigns from the Board of Directors. Large scale selling caused by this brings down the prices.

Financial position of the Company: Good dividend, attractive and healthy balance sheet, good prospects etc. obviously raise the prices.

Trade Cycles: The boom period is generally marked by an artificially high level of prices. Securities are quoted at lower rates during the period of depression.

Political factors: The stock exchange is very quick to react to political changes. The political disturbances at the national and international level may bring an immediate reaction on security prices. The changes in finance ministry, the policy decisions, change in Government, general elections etc. have bearing on the fluctuations in security prices.

3. Explain the meaning, requirements, criteria, advantages and limitations of Listing.

Ans. MEANING OF LISTING A stock exchange deals in listed securities only. Any company desirous of mobilizing resources from capital market through a prospectus has to get its shares listed on at least one stock exchange, nearest to its registered office, known as regional stock exchange. A security is said to be “listed” when it is added to the “authorized trading list” of securities in which trading on a particular exchange is permitted. A security may list on more than one stock exchange.

LISTING REQUIREMENTS A company seeking listing of securities is required to make an application in the prescribed form supported by the following documents:

i) Copies of Memorandum, Articles, Prospectus, Director’s Report, and Balance Sheet for the last 10 years.

ii) Copies of agreements with promoters, vendors, managing directors, underwriters etc.

iii) Specimen copies of share certificate, debenture certificate, letter of allotment etc.

iv) Particulars of capital structure.

v) A statement of distribution of shares.

vi) Particulars of dividends and cash bonus paid during the last 10 years.

vii) Particulars of securities for which listing is being sought.

viii) A brief history of company’s activities since its incorporation.

CRITERIA FOR LISTING The stock exchange scrutinizes the application to ensure that following conditions are satisfied:

– Use of common share transfer form.

– Fully paid shares shall be free from all liens.

– Calls paid in advance may carry interest but shall not confer a right to dividend or to participate in profits.

– Unclaimed dividends shall not be forfeited before the claim becomes time barred.

– The company must offer for public subscription through a prospectus at least the prescribed minimum percentage of its issued capital.

If the stock exchange feels satisfied with the above conditions, it calls upon the company to execute a listing agreement which embodies covenants of performance by the company.  

ADVANTAGES AND LIMITATIONS OF LISTING: Listing is advantageous both to the company and the investors:

– Listing enhances the marketability and liquidity of security.

– It adds to the goodwill and standing of the company and contributes to its growth by making future financing easier.

– Listed securities command higher collateral value. Banks prefer listed securities while making advances.

– Listing lends prestige to the security and widens its market. – It facilitates easy and quick evaluation of real worth of securities.

– Listed securities enjoy more public confidence as the stock exchange compels the issuer company to comply with high standards.

Limitations There are certain limitations of listing. They are:

i) Speculative activities in the listed securities cause wide fluctuations in the prices. The frequent changes in the value of securities may affect the investors as well as the company.

ii) With the inside knowledge of operations of the company, management of the company may carry on trading on such securities to their personal gain at the cost of uniformed shareholders.

iii) The free negotiability of such securities may induce certain groups of persons to own substantial shares of company with a view to capture management of company in their hands.  

4. Discuss the shortcomings of Indian money markets.

Ans. There are some inherent shortcomings confronted by Indian Money Market which are as follows:

Absence of Co-ordination and Co-operation between the Organized and Unorganized Sector: There is no co-ordination and co-operation between the organized and the unorganized sectors of the money market. At times, there is even severe competition between the two sectors, especially between the commercial banks and the indigenous bankers. Such a competition is extremely harmful to the economic progress of the country.

Competition among the members in the individual Sector: There is competition not only between the organized sector and the unorganized sector, but also among the members of the individual sectors. For instance, in the organized sector, the foreign exchange banks and the commercial banks consider themselves as rivals. Similarly, in the unorganized sector, there is severe competition among the indigenous bankers. This harmful competition is not in the interests of the banking system of the country.

No all India Money Market: there is any all India money market as such. The Indian Money Market is split into local markets. The money markets in big cities like Bombay, Calcutta, Madras, etc. have no contact with the money market in the smaller towns.

Lack of Uniformity in the Interest Rates: One of the serious defects of the Indian Money Market is the existence of a wide diversity in the interest rates. For instance, the interest rates prevailing in the organized sector differ widely from those prevailing in the unorganized sector on account of lack of co-ordination between the two. Similarly, the interest rates current in the different sub-markets differs from one another on account of the absence of integration between them. Again, the interest rates differ from place to place. The interest rates that prevail in the big commercial centers differ widely from those prevailing in the smaller towns, as funds do in interest rates. In certain seasons of the year, the interest rates go up, while in other seasons, they fall down. Above all, the various money market rates are not related to the bank rate, and so, they do not change in response to changes in the bank rate.

Seasonal Financial Stringency: Another important drawback of the Indian money market is the stringency of funds during the busy agricultural season extending from November to June. During this season, there is an increase in the demand for loans from traders and businessmen for financing the movement of agricultural produce from the producing areas to the commercial centers, but the supply of funds during this season by providing re-discounting facilities to the commercial banks and by purchasing securities in the securities market. Yet, it has not been able to eliminate completely the stringency of funds during the busy season.

Lack of Adequate Banking Facilities: Banking facilities available in the country are not adequate. No doubt, the State Bank of India, the nationalized banks and the private sector banks have expanded banking facilities even in semi-urban and rural areas through their branch expansion programs. Yet, the banking facilities available in the country, especially in the rural areas are not sufficient for the country.

5. What do you mean by “Bullish and Bearish”? Explain the attitudes of buyers and sellers of call and put options.

Ans. Bullish market: A financial market of a certain group of securities in which prices are rising or are expected to rise. The term "bull market" is most often used in respect to the stock market, but really can be applied to anything that is traded, such as bonds, currencies, commodities, etc. 

Bear Market: A market condition in which the prices of securities are falling or are expected to fall. Although figures can vary, a downturn of 15-20% or more in multiple indexes (Dow or S&P 500) is considered an entry into a bear market.

A call option, often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option.^[1] The buyer of the call option has the right, but not the obligation to buy an agreed quantity of a particular commodity or financial instrument (the underlying) from the seller of the option at a certain time (the expiration date) for a certain price (the strike price). The seller (or "writer") is obligated to sell the commodity or financial instrument should the buyer so decide. The buyer pays a fee (called a premium) for this right.

The buyer of a call option purchases it in the hope that the price of the underlying instrument will rise in the future. The seller of the option either expects that it will not, or is willing to give up some of the upside (profit) from a price rise in return for the premium (paid immediately) and retaining the opportunity to make a gain up to the strike price (see below for examples).

6. Explain the importance of credit rating agencies. List out the credit rating agencies operating in India and describe the rating system. 

Ans. Credit Rating Agencies: A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings.

Importance of Credit Rating agencies: Credit rating agencies provide investors and debtors with important information regarding the creditworthiness of an individual, corporation, agency or even a sovereign government. The credit rating agencies help measure the quantitative and qualitative risks of these entities and allow investors to make wiser decisions by benefiting from the skills of professional risk assessment carried out by these agencies. The quantitative risk analysis carried out by credit rating agencies include comparison of certain financial ratios with chosen benchmarks and the qualitative analysis focuses on the management character, legal, political and economic environment in a jurisdiction.

CREDIT RATING AGENCIES IN INDIA

CRISIL (Credit Rating & Information Services of India Ltd.): The CRISIL was set-up in 1988 jointly by the ICICI, UTI, LIC, GIC, SBI and ADB along with a number of other financial institutions. The objective of this institution is to rate the debt obligations of Indian companies on a voluntary basis with a view to provide investors a guide as to the risk of timely payment of interest and principal by the company. The rating is at present confined only to FDs, debentures, preference shares and short term instruments like commercial paper. The SEBI guidelines now insist that all the companies should get the ratings and publicize them compulsorily, if they are borrowing through the issue of debentures. Many companies accepting FDs are also using CRISIL ratings. The RBI made it compulsory for all NBFCs (Non-Banking financial companies) registered with it to get them rated, before they borrow from public in any form.

ICRA: (The Investment Information and Credit Rating Agency of India Ltd.): ICRA was set-up and registered in1991, sponsored by the IFCI and a number of other financial institutions. ICRA has started rating equity also.

CARE (Credit Analysis and Research Ltd.): CARE was set-up in April, 1993 in the private sector.

DPCR (Duff Phelps Credit Rating India Pvt. Ltd.)  This is a private sector credit rating agency with foreign collaboration set-up in 1996. It has made rating exercises to many companies and provided a competitive environment for rating agencies.

The Rating System: All investments are risky and debt instruments carry a risk less than that of equity. The risk on debt instruments can be known to the investors before investing in these instruments. The agency rating has no fixed formula and it has to encounter a number of subjective elements like management quality, asset quality, auditor’s quality, accounting accuracy etc. Despite the highly competent and experienced staff, the credit rating agency can give only an indication and can not claim any foolproof and 100% reliability of its assessment.