Investment banking

1. Priyanka Bhuwania
08BS0002372
Sec- F
Date: 24th Aug, 2009
Submitted to: Dr.K.M.Bhattacharya
Set - 2
Ques 1.Write short notes on-
a) Collateralized Borrowing and Lending Obligation (CBLO):
CBLO is explained as under:
• An obligation by the borrower to return the money borrowed, at a specified future date;
• An authority to the lender to receive money lent, at a specified future date with an option/
privilege to transfer the authority to another person for value received;
• An underlying charge on securities held in custody (with CCIL) for the amount
borrowed.
It is a money market instrument as approved by RBI, is a product developed by CCIL for the
benefit of the entities who have either been phased out from inter bank call money market or
have been given restricted participation in terms of ceiling on call borrowing and lending
transactions and who do not have access to the call money market. CBLO is a discounted
instrument available in electronic book entry form for the maturity period ranging from one day
to ninety Days (can be made available up to one year as per RBI guidelines). In order to enable
the market participants to borrow and lend funds, CCIL provides the Dealing System through:
- Indian Financial Network (INFINET), a closed user group to the Members of the Negotiated
Dealing System(NDS) who maintain current account with RBI.
- Internet gateway for other entities who do not maintain Current Account with RBI.
It is a variant of liquidity adjustment facility permitted by RBI. It is a mechanism to borrow and
lend funds against securities for maturities of 1 day to 1 year. It is a tripartite repo transaction
involving CCIL as 3rd party which functions as intermediary or common counter party to
borrower as well as lender.
Borrower will be able to repay back even before maturity, compared to payment on due date
under the existing Repo system. CBLO is expected to meet the needs of banks, FIs, PDs, MFs,
NBFCs and companies for deploying their surplus funds, which have been phased out of the call
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2. money market operations. CBLO is issued at a discount to face value. Under CBLO, securities of
borrower will be held in their constituent SGL account opened with CCIL and will not be
transferred to lender.
b) Capital Employed:
Capital employed is basically the long term funds employed in a business. Capital employed of a
business is from the ordinary shareholders and from long term liabilities. Hence, it is the
effective amount of money actually being used in a business, regardless of whether it is from the
owners or creditors or banks. The long term liabilities include the bank borrowings (at least more
than 12 months after balance sheet) or a debenture holder which is of fixed duration and
demands a fixed rate of interest. Capital Employed is also known as NET WORTH.
Formula = Owners’ Equity + Long Term Liabilities.
Since, Net Worth = Total Assets less current liabilities
So, Net Worth = Net Assets.
In general, it represents the capital investment necessary for a business to function. A slightly
different view of capital employed would take into consideration any current assets and current
liabilities. With this formula, both fixed assets as well as current assets are taken into
consideration. Current liabilities, including both short term and long term liabilities, would be
subtracted from the overall value of the assets.
Return on Capital Employed (ROCE) is used in finance as a measure of the returns that a
company is realizing from its capital employed. It is commonly used as a measure for comparing
the performance between businesses and for assessing whether a business generates enough
returns to pay for its cost of capital.
Formula = (EBIT/Capital Employed)* 100%
Here in the denominator we have net assets or capital employed. Capital employed is the value
of the assets that contribute to a company's ability to generate revenues, ie. their liquidity.
c) Qualified Institutional Buyer (QIB):
For additional capital, there are many routes available in the market: overseas issuances through
ADRs/GDRs/FCCBs, preferential issues, follow on public offerings and rights issues. The new
guidelines basically aim at offering an alternative to overseas issuances which have grown
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3. significantly in past days and thereby adversely impacting the activities in our domestic market.
In the last three fiscal years, Indian companies raised Rs.59, 567 crore from abroad.
QIB is a purchaser of securities under which a listed company don’t issue shares in public but
privately place securities with QIBs in the domestic market.
Following are few advantages of using QIB as route to raise finance:
• Serving as an alternative to overseas issuances and thereby protecting the domestic
market.
• Many companies prefer QIB route to ADRs etc because of the cost advantage – 2%
versus 5%.
• Further it gives an additional benefit of simplifying the offer process.
• Greater disclosures are sought for QIPs compared to those of preferential allotment.
• Another advantage is that such an issue can be made even to investors not registered with
SEBI as QIB.
Many banks are now resorting to this method like recently HDFC has displayed firm trend in an
otherwise weak market on back of its plans to raise Rs.4,000 crore from QIBs.
In terms of clause 2.2.2B (v) of DIP Guidelines, a ‘Qualified Institutional Buyer’ shall mean:
• Public financial institution as defined in section 4A of the Companies Act, 1956;
• Scheduled commercial banks
• Mutual funds
• Foreign institutional investor registered with SEBI
• Multilateral and bilateral development financial institutions
• Venture capital funds registered with SEBI
• Foreign Venture Capital investors registered with SEBI.
• State Industrial Development Corporations
• Insurance Companies registered with the Insurance Regulatory and Development
Authority (IRDA).
• Provident Funds with minimum corpus of Rs.25 crores
• Pension Funds with minimum corpus of Rs. 25 crores
d) Statutory Liquidity Ratio (SLR):
Monetary policy refers to the use of certain official instruments such as the bank rate or open
market operations or the reserve ratio for controlling the cost and volume of credit in the
economy and thereby supply of money. With the help of these techniques the Central Bank can
affect the credit creating capacity of banks in a nation. Besides, it will also protect the depositors
from bank getting liquidated. RBI exercises direct control over liquidity of the banks through the
use of two complementary methods, CRR and SLR.
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4. Under SLR, a bank is required to maintain a minimum fraction of its total demand and time
liabilities in the form of three types of liquid assets, namely:
• Excess Reserves,
• Unencumbered government and other securities,
• And Current account balances with other banks. In other words,
SLR = Liquid Assets
Total Demand and time liabilities
The RBI has used SLR:
• To control bank credit,
• To increase government securities in the investment portfolio of banks and
• To keep the banks solvent.
The increase in SLR has the effect of diverting funds from loans and advances to liquid assets.
The increase in SLR decreases the profitability of banks because the yield on government
securities is lower than the interest charged on loans and advances. The Narasimham Committee
(1991) recommended that the government should reduce SLR to release more funds with banks
for allocation to productive sectors of the economy. Accordingly the RBI has reduced SLR from
38.5% to 25% and now, 24% on incremental demand and time liabilities.
e) Special Purpose Vehicle (SPV):
According to Financial Dictionary “The SPV is usually a subsidiary company with an asset or
liability structure and legal status that makes its obligations secure even if the parent company
goes bankrupt.”
Special Purpose Vehicle (SPVs) or Special Purpose Entity (SPEs) is basically legally instrument
which companies use to accomplish certain goals in the field of corporate finance. Companies
use SPVs to isolate the firm from financial risk. These are created in many forms such as
subsidiaries, trusts etc. If an SPV is constituted as a charitable trust, the securities program is
structured in way that generates a profit that the SPV distributes as a dividend to the Trust so that
the trustees can use it for charitable activities. This form of SPV is not dependent of its sponsors
or promoters. A company transfers its assets to SPV for management purpose or to finance a
large project. Therefore, the basic purpose of its creation is to ease up companies to minimize
their monetary risks. No SPV can be formed for illegal or unlawful reasons or for reasons that
are against the provisions of Company’s law board or public policy.
Benefits from the creation of SPVs:
• Commonly used to securitize loans
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5. • To transfer a high risk project/ asset from the parent company to SPV
• Different countries have different tax rates for capital gains and gains from property
sales. SPVs created in different countries thereby help to have tax-gains.
• For regulatory reasons and
• For competitive reasons.
Ques. 2
(a) What is the yield, if the face value of 364 days T. Bill is Rs 100 and if the
purchase price is 90 for T. Bill?
Ans. The rupee income the buyer makes for 364 days investment is Rs.10 per bill and the return
on his investment works out to be:
- 1] *
=
= 11.14% per annum.
2. (b) Ever Grow Bank purchased commercial paper for Rs 19,40,000 with a
face value of Rs 20,00,000. Maturity Period 6 months. Calculate the yield for
the bank.
Ans. Yield for the bank =
=
= 0.06 or 6%.
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