Paper 11
Capital Market Analysis & Corporate Laws
Test Paper – III/11/CMC/2008/T-2
GROUP A
Ans. To Q. 1(A)
A Capital Market can be defined as the market in which financial assets are created or transferred. The capital market is designed to finance the long-term investments. The transactions taking place in this market will be for periods over a year. The Capital Market is broadly classified as Primary market and Secondary Market. The Primary market is the segment in which new issues are made whereas secondary market is the segment in which outstanding securities are traded. It is for this reason that the Primary Market is also called New issues Market or IPO/FPO market and the Secondary market is
called Stock Market.
Stock Market in India
From scattered and small beginnings in the 19th Century, India’s stock market has risen to great
heights. In 1990, we had 19 stock exchanges in the country. There were around 6,000 listed
companies and the invested population stood around 15 million. You might be interested in
knowing more about the growth of stock market in India. What functions does it perform?
What is the form of organization of stock exchange in India? How are they administered? What
is the trading system followed on these exchanges? We shall discuss these and other questions
in the following sections
The history of stock exchanges shows that the development of joint stock enterprise would never have reached its present stage but for the facilities which the stock exchanges provide for dealing with the securities. Stock exchanges have a very important function to fulfill in the country’s economy. The stock exchange is really an essential pillar of the private sector corporate economy. It discharges essential functions in the process of capital formation and in raising resources for the corporate sector
NEED FOR STOCK MARKET
1. It helps in the capital formation in the economy of the country
2. It facilitates and maintains active trading.
3. It provides liquidity to financial assets.
4. It also helps in price discovery process
Functions of Stock Market :
a) To provides a market place for purchase and sale of securities:- It ensures the free transferability of securities which is the essential basis for the stock enterprise system. The private sector economy cannot function without the assurance provided by the exchange to the owners of shares and bonds that they can be sold in the market at any time. At the same time, those who invest their surplus funds in securities for long-term capital appreciation or for speculative purpose can also buy scripts of their choice in the market.
b) To provides the linkage between the savings in the household sector and investment in corporate economy:- It mobilizes savings, and channelize them in the form ofsecurities into those enterprises which are favored by the investors on the basis of such criteria as future growth prospects, good returns and appreciation of capital.
c) To providing a market quotation of the prices of shares and bonds:- a sort of collective
judgement simultaneously reached by many buyers and sellers in the market-the stock exchange serves the role of barometer, not only of the state of health of individual companies, but also of the nation’s economy. The changes in share prices are brought about by a complex set of factors, all operating in the market simultaneously. Share values as a whole are subject to secular trends set by the economic programme of the nation, and governed by factors like general economic situation, financial and monetary policies, tax changes, political environment, international - economic and financial development, etc.
Ans. To Q. No.1 (b)
σp = 0.52 X 0.62 + 2 X .5 X .05 X .6 X .4 X 25 + 52 X .42
= 0.09 + 0.03 + 0.04
= 0.16
= 0.4
Ans. To Q. No. 2 (a)
Depository Participant (DP):- DP is an agent of the depository and is authorised to offer depository services to investors. According to SEBI guidelines, financial institutions, banks, custodians, stockbrokers, etc. can become Depository Participants in a depository. You can open your securities account through a DP and start dematerialising your securities into your account and / or start trading in the electronic mode. The balances in your account are maintained with the depository and are available through the DP. Your DP will intimate you the status of your holdings or transactions from time to time.
Benefits of DP:- As an investor you will enjoy many benefits if you buy and sell in the depository mode. Some of the benefits are –
• No bad deliveries
• Reduced paper work
• No risk of loss, mutilation or theft of share certificates.
• Faster settlement
• No stamp duty for transfer of shares
• Low transaction cost for buying and selling in the dematerialised segment
• Low interest rates on loans granted against pledge of dematerialised securities by banks
• Low margin on securities pledged with banks
• Pay-In and pay-out of securities on the same day
• Increase in the liquidity of your securities because of faster transfer and registration of securities in your account.
• Instant disbursement of non-cash corporate action benefits like bonus and rights into your account. Regular account status updates available from the DP at any point of time
Ans. To Q. No. 2 (b)
Working notes
(1) The number of days to expiration must be converted into years by dividing by 365
Thus t = 120/365 = 0.329
(2) The simple annual interest must be converted to the Black - Scholes continuously compounded
equivalent using the relationship that 1+R = er, making r = In (1+R).
Now r = In (1.06) = 0.0583
Now we can find the values of d1and d2 as follows
d2 = In(80 / 85) (0.0583 0.5x0.3 )X0.329 = -0.327
(0.3)(0.329 )
The next step is to look up the N(d1) and N(d2) values in a table of such Values. Note that N(d1) =
N (-0.155) and N(d2) = (-0.327) represent areas under a standard normal distribution function.
From Table given at the end of the book, we see that the value of d{ = 0.155 implies the area under
the normal curve to the left of -0.155, which is approximately (interpolating from the table) .438.
The value of N(d2) is found in a similar fashion to be approximately 0.372.
Now, we can insert the above values in Black - Scholes formula, to obtain the value of the stock
option. = 80X.438Xe(-00583x329)X .372 = Rs. 4.03
Ans. To Q. No. 4 (a)
Stock invest:- In case of oversubscription of issue, there have been inordinate delay in refund of excess application money and large amounts of investors’ funds remain locked up in companies for long periods affecting the liquidity of the investing public. To overcome the said problem a new instrument called ‘stock invest’ is introduced. The Stock invest is a non-negotiable bank instrument issued by the bank in different denominations. The investor who has a savings or current account with the bank will obtain the stock invest in required denominations and will have to enclose it with the share/debenture application. On the face of the instrument provides for space for the investor to indicate the name of the issues, the number and amount of shares/ debentures applied for and the signature of the investor. The stock invests issued by the bank will be signed by it and the date of issue will also be indicated on the instruments. Simultaneously with the issue of stock invest, the bank will mark a lien for the amounts of stock invest issued in the deposit account of the investor. On full or partial allotment of shares to the investor, the Registrar to issue will fill the columns of stock invest indicating the entitlement for allotment of shares/debentures, in terms of number, amount and application number and send it for clearing.
The investor’s bank account would get debited only after the shares/debentures allotted. In respect of unsuccessful applicants, the funds continue to remain in their account and earn interest if the account is a savings or a term deposit. The excess application money of partly successful applicants also, will remain in their accounts. There will be lien on the funds for a maximum of four months period. The stock invest is intended to be utilised only by the account holders and the stock invest should not be handed over to any third party for use. In case the cancelled/partly utilised stock invest is not received by an investor from the registrar, lien will be lifted by the issuing branch on expiry of four months from the date of issue against an indemnity bond from the investor.
Ans. To Q. No. 4 (b)
Green Shoe Option:- Green shoe option denotes “ an option of allocating shares in excess of the shares included in the public issue. It is an option that allows the underwriting of an IPO to sale additional shares if the demand is high. It can be understood as an option that allows the underwriter for a new issue to buy and resell additional shares up to a certain pre-determined quantity. Looking to the exceptional interest of investors in terms of over subscription of the issue certain provisions are made to issue additional shares or bonds. In common parlance, it is retention of over subscription to a certain extent. It is a special feature of EURO issues. In the Indian context, Green-Shoe issue is limited connotation. SEBI guidelines governing public issues certain appropriate provisions for accepting over subscription subject to ceiling, say 15% of the offer made to public. In certain cases, the Green Shoe option can be even more than 15%. The Green Shoe option facility would bring in price stability of initial public offerings.
Ans. To Q. No. 4 (d)
Fringe Market :- The fringe market is a disorganised money market, deemed to include everything that is outside the scope of the money market (i.e., the institutional money market). The fringe market includes activities like the Inter-Corporate Deposit (ICD) market, small scale trade financing, financing of investments in the stock market, discounting and lending against lOUs or promissory notes, etc. The ICDs market is the most visible feature of the fringe market. As its name indicates it essentially involves short-term borrowing and lending of funds amongst the corporations. Generally the fringe market exist, wherever the main borrowers and lenders of the funds are based, i.e., at the location of the industrial, corporate and trading establishments. The interest rates at which the funds can be lent in the fringe market are generally higher than those operating in the money market. The risk level of the fringe market is higher too - the people who borrow at exorbitant rates are the ones who are most likely to default.
Ans. To Q. No. 4 (e)
Intraday Price Bands:- Daily price bands are applicable on securities as below:
• Daily price bands of 2% (either way) on securities as specified by the Exchange.
• Daily price bands of 5% (either way) on securities as specified by the Exchange.
• Daily price bands of 10% (either way) on securities as specified by the Exchange.
• Price bands of 20% (either way) on all remaining scrips (including debentures, warrants, preference shares etc).
• No price bands are applicable on: scrips on which derivative products are available or scrips included in indices on which derivative products are available..
Ans. To Q. No. 4 (c)
CHAOS THEORY :- At recent finance conferences, a few researchers have presented papers on chaos theory and its application to the stock market. In physics, chaos theory is growing field of study examining instances in which apparently random behaviour is, in fact, quite systematic or even deterministic. Scientists apply this theory to weather prediction, population growth estimates, and
fisheries biology.
As an example of the latter application, a given volume of ocean water, left free from human interference, will not necessarily reach an equilibrium population of the various species that inhibit it. As fish grow, they consume the smaller fry (of their own or a different species ) in increasing numbers. Fewer younger fishes are left to mature ; this, coupled with the natural death of the older fish, eventually results in a sudden drastic reduction in fish population, causing dismay to fishermen and excitement in the local media. At the same time, it results in reduced predation and food competition by the surviving fry, so the population begins to grow dramatically, and the cycle continues. Interactions between species add complexity to the process.
Investment analysts have sought a pattern in stock market behavior since the origin of the exchanges. Much remains unknown about how security prices are determined, and chaos theory may eventually provide some potential answers. If the apparent randomness of security price changes, can be shown to be nonrandom, much of the theory of finance
would need revision
GROUP –B
Ans. to Q. No.6 (d)
According to section 2 (13) of the Companies Act 1956, a director includes any person occupying the position of a director, by whatever name called. Thus it is clear that merely the designation as a director does not mean that the person is indeed a director. What really matters is the functions discharged by him. If a person is discharging the duties and functions of a director, he will be called as a director even though his designation may be different. Thus a person who has control over the direction, conduct and management of the business of the company is the director of the company. The Companies Act also provides that only individuals can be directors. A body corporate, association of persons or firm cannot function as director of a company. A company is an artificial person created by law. There is
no physical existence to a company. It doesn’t have a body or soul and hence cannot act on its own. Hence SBC ltd. cannot be appointed as a Director of Telco Ltd.
Ans. to Q. No. 8
(a) “consumer” means any person who—
(i) buys any goods for a consideration which has been paid or promised or partly paid and partly promised, or under any system of deferred payment and includes any user of such goods other than the person who buys such goods for consideration paid or promised or partly paid or partly promised, or under any system of deferred payment when such use is made with the approval of such person, whether such purchase of goods is for resale or for any commercial purpose or for personal use;
(ii) hires or avails of any services for a consideration which has been paid or promised or partly paid and partly promised, or under any system of deferred payment and includes any beneficiary of such services other than the person who hires or avails of the services for consideration paid or promised, or partly paid and partly promised, or under any system of deferred payment, when such services are availed of with the approval of the first-mentioned person whether such hiring or availing of services is for any commercial purpose or for personal use;
“person” includes—
(i) an individual;
(ii) a Hindu undivided family;
(iii) a company;
(iv) a firm;
(v) an association of persons or a body of individuals, whether incorporated or not, in India or outside India;
(vi) any corporation established by or under any Central, State or Provincial Act or a Government company as defined in section 617 of the Companies Act, 1956 (1 of 1956);
(vii) any body corporate incorporated by or under the laws of a country outside India;
(viii) a co-operative society registered under any law relating to cooperative societies;
(ix) a local authority;
(x) every artificial juridical person, not falling within any of the preceding sub-clauses;
(b) Appointment by Central Government :- As per section 408, the Central Government can appoint such number of directors on the Board of the company as the Tribunal may order in writing, to safeguard the interests of the company or its shareholders. The appointment shall be for not more three years on any one occasion. The purpose of this appointment is to prevent the affairs of the company from being conducted either in the manner
a) Which is oppressive to any members of the company, or
b) Which is prejudicial to the interests of the company or to public interest
The Tribunal may pass the above order on a reference made to it by the Central Government or on the application of,
a) Not less than 100 members of the company or
b) Members of the company holding not less than 1/10th of the total voting power therein.
Any director appointed by the Central Government shall not be required to hold any qualification shares nor shall his period of office be liable to termination by retirement of directors by rotation. Any such director may be removed by the Central Government from his office and another person may be appointed in his place.
Ans. to Q.No.9
(a) DEMERGER:- Demerger is the converse of a merger or acquisition. It describes a form of restructure in which shareholders or unit holders in the parent company gain direct ownership in a subsidiary (the ‘demerged entity’). Underlying ownership of the companies and/or trusts that formed part of the group does not change. The company or trust that ceases to own the entity is known as the ‘demerging entity’. If the parent company holds a majority stake in the demerged entity , the resulting company is referred to as the subsidiary. In a market of falling prices, mergers and IPOs are less popular, and the merchant banks who earn their fees from corporate activity will start to look at demerger possibilities for their clients.
(b) Sweat Equity Shares: A company may issue Sweat Equity Shares as per the provisions of Section 79 A of the Companies [Amendment] Act 1999. The relevant provisions are as follows.
i. A company may issue Sweat Equity Shares of a class of shares already issued if the following conditions are fulfilled, namely -
The issue of these shares is authorized by a special resolution passed by the company in the general meeting.
The resolution shall specify the number of shares, current market price, consideration if any and the class or classes of directors or employees to whom such equity shares are to be issued.
Not less than one year has, at the date of the issue elapsed since the date on which the company was entitled to commence the business.
The sweat equity shares of a company whose equity shares are listed on a recognized stock exchange are issued in accordance with the regulations made by the Securities Exchange Board of India in this behalf. However in the case of a company whose equity shares are not listed on any recognized stock exchange, the sweat equity shares are issued in accordance with the guidelines as may be prescribed.
(c) Independent Director:- An independent director of a company is a non-executive director who :
1. Apart from receiving director’s remuneration, does not have any material pecuniary relationships or transactions with the company, its promoters, its senior management or its holding company, its subsidiaries and associated companies
2. Is not related to promoters or management at the board level, or one level below the board (spouse and dependent, parents, children or siblings)
3. Has not been an executive of the company in the last three years.
4. Is not a partner or an executive of the statutory auditing firm, the internal audit firms that are associated with the company, and has not been a partner or an executive of any such firm for the last three years. This will also apply to legal firm and consulting firm that have a material association with the entity.
5. Is not a significant supplier, vendor or customer of the company.
6. Is not a substantial shareholder of the company, i.e. owning 2 percent or more of the block of voting shares;
7. Has not been a director, independent or otherwise of the company for more than three terms of the three years each (not exceeding nine years in any case);
An employee, executive director or nominee of any bank, financial institution, corporations or trustees of debenture and bond holders, who is normally called a ‘nominee director’ will be excluded from the pool of directors in the determination of the number of independent directors. In other words, such a director will not feature either in the numerator or the denominator.
Moreover, if an executive in, say, Company X becomes an non-executive director in another Company Y, while another executive of Company Y becomes a non-executive director in Company X, then neither will be treated as an independent director.
The committee recommends that the above criteria be made applicable for all listed companies, as well as unlisted public limited companies with a paid up share capital and free reserves of Rs.10 crore and above or turnover of Rs.50 crore and above with effect from the financial year beginning 2003.
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