Bonus shares: A tax saving scheme?

Bonus shares: A tax saving scheme?
Lots of Indian companies offer "bonus" shares: a 1:1 bonus means that for every share you own, you get one "free" share. Now given that the company's fundamentals don't change, the number of outstanding shares doubles but the net profit remains the same. Meaning, to retain the same P/E, the share price must come down by half.

Only profitable companies can give a bonus, out of their profits. Technically, a bonus is nothing but moving a liability (profit or reserve) over to capital. So it doesn't affect the balance sheet at all on the assets side, only minor moves on the liabilities side.

But we notice that stock prices of companies that have offered bonus shares suddenly ZOOM ahead in the market. Why? There's no reason to do so, is there?

There is. And it's a legal way to avoid paying tax.

Avoiding tax through bonuses

Let's say you're a stock trader with Rs. 15 lakh in short term capital gains. This, in general, would need you to pay 10.2% short term capital gains tax, which is an outflow of about Rs. 1.5 lakhs, which you can only offset if you have a short term capital loss. How do you have such a loss without really losing money?

The answer: Bonus shares.

Let's say a company's stock is at Rs. 300, and offers a 1:1 bonus. You buy 10,000 shares for Rs. 30 lakhs (okay, you're a rich trader) before the bonus record date (usually a date much after the bonus announcement).

Now after the record date the price comes down to Rs. 150 and you now have 20,000 shares. Sell 10,000 shares. The tax department expects you to price shares based on "First In First Out", and for pricing purposes the cost of bonus shares is ZERO; so you have:

10,000 shares at Rs. 300
10,000 shares at Rs. 0

If you sell 10,000 shares at Rs. 150, the first lot is sold - so you incur a Short term LOSS of Rs. 150 per share, a total loss of Rs. 15 lakhs. This completely offsets your gain you had made earlier so you now have to pay no tax.

What about the remaining shares, you say? Well, hold them for a year, and since long term capital gains tax has been removed, you can safely take home the money. Other capital gains saving avenues need you to hold for at least 3 years, and this is a one year holding only!

That's why the share price of companies goes up when they make bonus announcements. So many traders buy to make their short term capital gains lesser!

IPO Tips

I have been getting a lot of enquiries from retail investors who apply in IPO’s for the purpose of listing gains. A lot of them have been making listing losses by applying in the wrong IPO and/or by following wrong strategies. Hence, I thought I should share some tips which I have been following to make “investing in IPO’s” profitable for retail investors.

The truth is, investing in IPO is an easy, low-risk way to make an average of 2-3% in 20 days. A 2 -3% return can seem very low on a nominal basis, but when you calculate the annualised return it becomes very attractive. You can make an annualised return of about 30%, ona an average, easily by investing in quality IPO’s by following the guidelines mentioned below. Infact I have made an annualised return of over 125% in a few IPO’s like the Sun TV IPO, Parsavnath IPO, Infoedge IPO (naukri.com IPO) and a few others. Now tell me which other investment class with similar risk reward structure will give you as much returns.

Here are eight guidelines that should be followed by retail investors to select the IPO’s to invest in and make sure the risk involved is minimum and at the same time ensuring chances of allotment are very high.

These tips are applicable only to those investing in IPO’s for listing gains

Tip - 1 : How do you select which IPO’s to invest in? Do research and a detailed fundamental analysis of the company? Read third party research reports? Listen to rumours, tips and gossip? Well, If you have been doing this in the past, I would suggest that you stop doing this immediately. Trust me on this - Its of no use. As a small investor, you will never get access to all the information you need to do your own analysis of the IPO. Don’t read third party research reports either because most of them would have a conflict of interest. Investment banks and brokerage firms through their reports might try to push the IPO’s of their clients and ensure that they retain getting that company’s business in the future. Magazines and newspaper reports can be biased and vested interests can be involved.

You would by now be wondering how else you could select IPO’s. Here is a simple secret. Blindly invest in a particular IPO, if the institutional category is oversubscribed by over 5 times. Institutional investors have access to information that retail investor will never have access to. This sometimes involves even insider information. So, just leverage on their analysis.

Tip - 2 : Always invest at cut-off price. The “cut off ” feature is an excellent facility that is offered only to retail investors. Make sure you make use of this facility.

Tip - 3 : Make sure you apply for the maximum shares possible that a retail investor is eligible to applyfor (Rs. 1 lakh limit). If you apply for the minimum shares its like throwing darts on a dart board. Most probably you will not get allotment and you would just end up locking your money for 20 days.

Tip - 4 : If you find 3 or 4 IPO’s which are good but have only 1 lakh of capital to invest, select the best IPO among the 3 and invest in it. Don’t split your money. You might end up not getting allotment in any of the IPO. Diversifying doesn’t work in IPO’s

Note - The next tip might seem unethical. So all of you out there who are very particular about ethics, kindly do not read the fifth tip. Further, It is just my personal opinion and I don’t endorse or recommend the following tip. It has worked for me in the past, but it might not work in future. I would take no legal liability / responsibility if you choose to follow the next tip and you get into trouble.

Tip - 5 : Many people would think this is not ethical but I do. I always apply for an IPO through a cheque. Once the final subscription figures are released and if I find that either the institutional investor category has been subscribed less than 5 times or if I find that the retail investor category has received much higher response than the institutional investor category (increases the chances of a bad listing, since most retail investors would sell on listing and there would be a huge selling pressure on the day of listing) or if I find to my dismay that the IPO has been oversubscribed by more than 50 times or so, then I would go ahead and give a stop payment.

As mentioned already, I’m not endorsing or recommending the previous tip. Its just my personal strategy / opinion.

Tip - 6 : If you want to invest more than 1 lakh in a particular IPO, invest in more than 1 application. Never invest more than 1 lakh per application. You can invest in your spouse’s name or your mom/dad’s name

Tip - 7 : Update your ECS details and make sure you write the following in bold and very clearly in the IPO application form.
1) Your name
2) Your DP details

If your name or DP number is incorrect or unclear, then you will face unnecessary delays in getting the shares alloted and you wouldn’t be able to sell on listing. Also make sure you opt for ECS refund. Cheques can be lost or delayed and lazybones like me would take over 1 month to deposit a cheque in the bank. ECS is hassle free and safe.

Tip - 8 : Sell of the shares alloted to you on the day of listing. Sell 50% between 9.55 and 10 AM and the rest in the afternoon. The shares of that particular IPO might do well in day 2 and day 3 and in subsequent weeks too, but I have seen an equivalent number of IPO’s which have witnessed a huge fall in the second and third day after listing. You have invested in the IPO for listing gains, so make sure you sell it off as soon as the company lists on the stock exchange. This way you will be exposed to the least amount of risk.

IPO terms

Coming across a lot of new terms? What do they mean?

Green-shoe Option: A Green Shoe option means an option of allocating shares in excess of the shares included in the public issue and operating a post-listing price stabilizing mechanism for a period not exceeding 30 days through a Stabilising Agent. This is an arrangement wherein the issue would be over allotted to the extent of a maximum of 15 per cent of the issue size. From an investor's perspective, an issue with green-shoe option provides more probability of getting shares and also that post-listing price may show relatively more stability as compared to market.

e-IPO: A company proposing to issue capital to public through the on-line system of the stock exchange for offer of securities can do so if it complies with the specified requirements. The appointment of various intermediaries by the issuer includes a prerequisite that such members/registrars have the required facilities to accommodate such an online issue process.

Safety Net: Any safety net scheme or buy-back arrangements of the shares proposed in any public issue shall be finalised by an issuer company with the lead merchant banker in advance and disclosed in the prospectus. Such buy-back or safety net arrangements shall be made available only to all original resident individual allottees up to a maximum of 1,000 shares per allottee and the offer is kept open for a period of 6 months from the last date of dispatch of securities.

Syndicate Member: The Book Runner(s) may appoint those intermediaries who are registered with the Board and who are permitted to carry on activity as an `Underwriter' as syndicate members. The syndicate members are mainly appointed to collect and entire the bid forms in a book built issue.

Open book/closed book: At present, in issues made through book building, Issuers and merchant bankers are required to ensure online display of the demand and bids during the bidding period. This is the Open book system of book building.

Here, the investor can be guided by the movements of the bids during the period in which the bid is kept open.

Under closed book building, the book is not made public and the bidders will have to take a call on the price at which they intend to make a bid without having any information on the bids submitted by other bidders.

Cut-Off Price: In Book building issue, the issuer is required to indicate either the price band or a floor price in the red herring prospectus. The actual discovered issue price can be any price in the price band or any price above the floor price. This issue price is called "Cut off price". This is decided by the issuer and Lead Manager after considering the book and investors' appetite for the stock. Only retail individual investors to have an option of applying at cut off price.

Differential pricing: Pricing of an issue where one category is offered shares at a price different from the other category is called differential pricing. Differential pricing is allowed only if the securities to applicants in the firm allotment category is at a price higher than the price at which the net offer to the public is made. The net offer to the public means the offer made to the Indian public and does not include firm allotments or reservations or promoters' contributions.

Source: www.sebi.gov.in

Investment yields as of Apr 2007

Liquid Funds
Used as an alternative option to savings bank. Invest in money market instruments and have a lock-in period of a maximum of three days and offer redemption proceeds within 24 hours.
YIELD: 6.88 per cent*

Floating Rate Funds
These invest in floating rate instruments and fixed rate corporate bonds. For investors who want to reduce risk due to interest rate fluctuations.
YIELD: 6.90 per cent*

Fixed Maturity Plans
These, typically, are plans for a fixed tenure ranging mostly from 15 days to three years. They mostly invest in fixed income instruments (bonds, government securities, etc.) and money market instruments such that the fund matures in the same period. Over one-year FMPs are best because they can take advantage of indexation.
YIELD: 6.61 per cent*

Bond Funds
Targeted towards investors with a low appetite for risk and for whom safety and returns are paramount. These pay income regularly and their NAVs typically fluctuate less than those of an equity fund. They invest in corporate papers, GoI papers, money market instruments and call papers.
YIELD: 5.24 per cent*

Gilt Funds
They invest exclusively in government securities, including state government securities and treasury bills. They are safe and yield better returns than direct investments in these securities.
YIELD: 4.83 per cent*

Public Provident Fund (PPF)
It is a savings-cum-tax saving instrument. Also serves as a retirement planning tool due to its 15-year tenure. Maximum annual deposit limit of Rs 70,000, but interest is tax-free. Early withdrawals are possible after the end of five years, and it makes a good tax-saver scheme.
Rate of return: 8 per cent

National Savings Certificate (NSC)
These are issued by the post offices in denominations of Rs 100, Rs 1,000, Rs 5,000 and Rs 10,000 issued for a maturity period of six years. Early encashment is not permissible.
Rate of return: 8 per cent

Kisan Vikas Patra (KVP)
Doubles your money in eight years, seven months (returns exempt from TDS) and comes in denominations of Rs 100, Rs 500, Rs 1,000, Rs 10,000 and Rs. 50,000. Early encashment is not permissible.
Rate of return: 8 per cent

Post Office Monthly Income Scheme
Offers a return of 8 per cent, payable in monthly installments. Good for investors looking for a safe monthly income. However, the upper limit for investment is Rs 6 lakh, but there are no loan facilities.
Rate of return: 8 per cent

Government of India Bonds (Taxable)
These have a five-year tenure and are offered by the Government of India, which carry a sovereign guarantee.
Rate of return: 8 per cent

Bank Fixed Deposits (FDs)
Rising interest rates have ensured that banks are once again offering double-digit interest rates (10-10.25 per cent) mostly on short-term deposits ranging from a few days to a little over a year. Short-term bank deposits have once again become a viable option for people willing to park their funds safely for short durations.
Rate of return: 10.25 per cent

*Average annual yield (last four quarters)
These figures do not factor in actual return to an individual investor as taxation with or without indexation and/or capital gains are not considered

Mutual funds, at what `expense'?

If you thought that the entry and exit loads that you pay on the purchase or sale of units are the only fees charged by a mutual fund for their market-beating performance, think again. There are other costs associated with your mutual fund investments. The costs charged by a mutual fund to operate and manage the portfolio is captured by a measure called the expense ratio. The net asset value, which determines the value of your holdings, is usually arrived at after adjusting the portfolio return for expenses incurred on marketing, administration and management fees.

Expense ratio


Expense ratio is usually expressed as a percentage of assets managed by a fund. Expense ratios can be found in the half-yearly portfolio statements of funds and represent the amount charged to investors by the asset management company for recurring expenditure. In the Indian context, the expense ratio that can be charged by a fund house is capped by law. According to the Securities and Exchange Board of India (SEBI) rules, the expense ratio is capped at 2.5 per cent for an equity fund and 2.25 per cent for a debt fund. As a fund grows in asset size, the cap on expenses as a percentage of assets declines. This is one of the reasons why you find that funds with a larger asset base such as Franklin India Bluechip, HDFC Equity or Fidelity Equity have lower expense ratios.

Do expenses matter?


After a four-year rally when top-performing equity funds have delivered annualised returns of more than 40 per cent, you may believe that a 2.5 per cent charge on your NAV would have little impact on returns. But the same cannot be said of debt funds, which have struggled to deliver a return of 6-7 per cent.

In a debt fund, a 2.5 per cent expense ratio would shave off 25-30 per cent off your returns! Expenses are, thus, crucial in determining the performance of debt funds and should be a factor to consider when buying a fund. Typically, institutional options within debt funds deliver better returns because of the lower expenses required to services bigger customers.

Though they have not mattered much until now, expenses could assume greater importance for equity funds as well. In the developed markets, equity funds, which find it difficult to outperform the market by more than a per cent or two, are often evaluated on the basis of their expense ratios.

A low expense ratio is also a reason why investors in developed markets are advocated to buy passively managed index funds and exchange traded funds. These funds save on the steep management fee involved in active fund management.

In India, the strong outperformance of active equity funds have more than compensated for the higher expense ratio vis-à-vis index funds. But if the degree of outperformance begins to diminish, passive funds might begin to look more attractive as a low-cost, convenient alternative.

Comparing expenses


While it pays to monitor a fund's expenses, recent performance by equity funds reveal sharply divergent returns. This means that fund manager skills still play a big role in determining equity fund returns in the Indian context. Track record and investment strategy should therefore take precedence over expenses. Investors should check if expenses justify performances.

A fund with a low expense ratio may not necessarily be the best performer and vice-versa. Strangely, index funds too reveal differences in returns not only due to expenses but also because of tracking errors. Hence, focusing on expense ratios as a sole factor in choosing between equity funds is certainly not advisable.

Expense ratios can be useful in choosing between funds of comparable track record, size and investment strategy. The savings in expenses could compound into a sizeable difference in returns over a long holding period of five to ten years.

Choosing debt funds is a more difficult proposition, given the number of options available in the debt space, from deposits to small-savings to funds, and expense ratios may help you narrow down your choices. With heavier competition in this segment, funds do keep a tighter leash on expenses. Among debt funds, passive funds such as fixed maturity plans might be more attractive because of the lower expenses involved.

Mutual Fund Basics

When you invest, you can look at the investment from two perspectives: to generate a regular periodic return or to invest for a long term, without bothering about the intermediate returns. Mutual funds are a great avenue for achieving either end.

You can either choose to invest in the 'dividend' option or a 'growth' option to achieve your objectives.

When a mutual fund invests money on your behalf and makes gains on the same, it can either return the gains to you or keep the gains in the fund on your behalf. You can use either of these options based on your requirements. However, be careful that you know the tax treatment!

Dividend option:

If you are someone who requires money on a periodic basis from your investments, then you should choose the dividend option. This means that the fund will periodically (quarterly or mostly, annually) return some of its gains to you. Note that the fund is under no obligation to declare a certain rate of dividend.

The amount of dividend that it pays out depends on the gains that it has made, and here too, the fund manager/the asset management company can decide to return only part of the gains. A fund cannot dip into its corpus to pay dividend.

For example, assume the fund collects Rs 10 from you and at the end of one year, the fund value has risen to Rs 11. The fund can declare a dividend of any amount up to Re 1. It cannot go beyond Re 1 because then it will have to dip into its original corpus, which it is not allowed to do.

Assume that your fund declares a dividend of Re 0.8. When a non-equity oriented mutual fund declares dividend, it pays a tax of 15% (+10% surcharge and 3% cess, totalling to 15%*1.1*1.03=16.995%) on the dividend amount. Hence, in this example, the fund will need to pay Rs 0.14 (Rs. 0.8*16.995%) as dividend distribution tax.

However, once this tax is paid, the dividend received is tax free in the hands of the investor. Recently, this dividend distribution tax has been increased to 25% in case of liquid funds: the calculations remain similar.

The value of the fund (and your investment) will fall from Rs 11 to Rs 10.06 (i.e. Rs 11 � Rs 0.8 � Rs 0.14). This is an important point because many people do not realize that dividends reduce the value of the investment and also because dividend is considered as tax free. Clearly, your money is refunded to you and also the same goes from your investment to pay the dividend distribution tax.

However, if an equity fund were to declare a dividend, there is no dividend distribution tax. Hence, when a mutual fund declares Rs 0.8 as dividend, you receive Rs 0.8 and the NAV falls to Rs 10.2.

Note that in this option, you face 'reinvestment risk' -- you need to plan where you will invest the dividend amount.

Growth option:

If you do not want the investment back on a regular basis but would rather wait till the end of your planning horizon for the investment, then you should choose the 'growth option.' This option means that the gains that the fund makes are retained in the fund and are invested on your behalf.

Taking the earlier example, the fund will reflect as Rs 11 as your balance in the fund at the end of the year. However, you will receive nothing from the mutual fund as current income. Note that because nothing is paid to you, you do not need to pay anything to the government as taxes.

If you sell a mutual fund with 'growth' option, you will have to pay the government capital gains taxes. If you hold the fund for less than a year, you will pay short term capital gains tax at the marginal rate of taxation (30%+10% surcharge+3% cess).

However, if you hold the mutual fund for more than a year, you pay the concessional long-term capital gains tax. If you are holding an equity mutual fund (any fund that invests greater than 65% of its corpus in equities), then the capital gains tax is nil. In case of debt funds, you need to pay 10% or 20% indexed gains.

Dividend reinvestment option:

There exists a provision in many mutual fund forms which asks you whether you want your dividend reinvested. This was a good provision when there was no tax on dividends and the long term capital gains tax was not zero.

Then, it was better for you to have shown the income as dividend and reinvest it: that way you avoided paying long term capital gains tax.

However, now the situation is reversed -- we have zero long-term capital gains tax and there is tax on dividends received. Hence, this option does not make sense under any circumstance -- though some fund houses still carry it as a legacy option.

Conclusion

If you have a horizon of greater than a year, then the growth option makes sense for you. Similarly, if you do not have a need for a periodic flow of income, growth option is better for you.

Remember two things from this article: a) dividend is your own money back to you and it may not be tax-free, and b) never choose the dividend reinvestment option.


Tax liability on your mutual fund
by
Akhilesh Tilotia
article from rediff.com

Advt - Sell Time Share , online trading , share trading , online investment , stock trading , online stock trading, BSE , NSE , buy time share , stock market , live market , mutual fund ,  - Advt

6 IPO terms you must know! - Rediff article

The IPO mania is on.

Everyone is talking about it even if they don't know what it means.

Before you decide to hop on to the bandwagon and apply for the next IPO, get some facts right.
6 ways not to get duped by an IPO!

What is an IPO?

If a brand new company or a company already in existence, but with no shares listed on the stock exchange, decides to invite the public to buy its shares, it is called an Initial Public Offering or an IPO.

Since it is the first time the company is approaching the public for money, it is also referred to as 'going public'.

If a company that is already listed (its shares are available for buying and selling on the stock exchange) is coming out with a fresh lot of shares, it is called the new issue.

Here are six terms commonly associated with an IPO that you, as an investor, must be aware of.
How to invest in an IPO

i. Book building

Book building is the process of price discovery. That means there is no fixed price for the shares.

Instead, the company issuing the shares comes up with a price band. The lowest price is referred to as the floor and the highest, the cap.

Bids are then invited for the shares. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band).

The actual price is then discovered based on these bids. To understand the entire book building process, read Want to bid for shares?

ii. Allotment

This is the process whereby those who apply are given shares.

According to the book building process, three classes of investors can bid for the shares:
Qualified Institutional Buyers: QIBs include mutual funds and Foreign Institutional Investors. At least 50% of the shares are reserved for this category.
Retail investors: Anyone who bids for shares under Rs 50,000 is a retail investor. At least 25% is reserved for this category.
The balance bids are offered to high net worth individuals and employees of the company.

The bids are first allotted to the different categories and the over-subscription (more shares applied for than shares available) in each category is determined.

Retail investors and high net worth individuals get allotments on a proportional basis.

Assuming you are a retail investor and have applied for 200 shares in the issue, and the issue is over-subscribed five times in the retail category, you qualify to get 40 shares (200 shares/5).

Sometimes, the over-subscription is huge or the issue is priced so high that you can't really bid for too many shares before the Rs 50,000 limit is reached.

In such cases, allotments are made on the basis of a lottery.

Say, a retail investor has applied for five shares in an issue, and the retail category has been over-subscribed 10 times. The investor is entitled to half a share.

Since that isn't possible, it may then be decided that every 1 in 2 retail investors will get allotment. The investors are then selected by lottery and the issue allotted on a proportional basis.

That is why there is no way you can be sure of getting an allotment.

To understand the entire allotment process, read Want to bid for shares?
iii. Draft Offer Document

Any company making a public issue is required to file its prospectus with the Securities and Exchange Board of India, the market regulator.

A prospectus is the document that contains all the information you need about the company. It will tell you why the company is coming is out with a public issue, its financials and how the issue will be priced.

This is called a Draft Offer Document.

This is first filed with SEBI which may specify changes, if any, to be made.

Once the changes are made, it is filed with the Registrar of Companies or the Stock Exchange.

It must be filed with SEBI at least 21 days before the company files it with the RoC/ Stock Exchange.

During this period, you can check it out on the SEBI web site.

iv. Red Herring Prospectus

This is a prospectus that will have all the information as a draft offer document, except details of the price or number of shares being offered or the amount of issue.

That is because it is used in book building issues only, where the details of the final price are known only after bidding is concluded.

So a Red Herring prospectus is an offer document used only in book building issues. All issues these days are through the book building route.

v. Underwriters

An underwriter to the issue could be a banker, broker, merchant banker (see below) or a financial institution. They give a commitment to underwrite the issue.

Underwriting means they will subscribe to the balance shares if all the shares offered at the IPO are not picked up.

Suppose there is an issue is for Rs 100 crore (Rs 1 billion) and subscriptions are received only for Rs 80 crore (Rs 800 million). It is then left to the underwriters to pick up the balance Rs 20 crore (Rs 200 million).

If underwriters don't pay up, SEBI will cancel their licenses.

vi. Lead Manager

Just because the prospectus has been filed with SEBI, it doesn't mean it recommends the issue or guarantees its contents.

That responsibility rests with the lead managers to the issue, who are supposed to do due diligence on the issue. In plain language that means certifying the issue is in accordance with the regulations, proper disclosures have been made and the facts in the prospectus are correct.

They are also called merchant bankers or investment bankers and are in charge of the issue process. Their functions are:
To act as intermediaries between the company seeking to raise money and the investors. They must possess a valid registration from SEBI enabling them to do this job.
They are responsible for complying with the formalities of an issue, like drawing up the prospectus and marketing the issue.
If it is a book building process, the lead manager is also in charge of it. In such a case, they are also called Book Running Lead Managers.
Post issue activities, like intimation of allotments and refunds, are their responsibility as well.

The actual work of drawing up the list of allottees, crediting the shares to their demat accounts and ensuring refunds is done by the Registrars to the Issue. These are financial institutions appointed to keep a record of the issue and ownership of company shares.

In the case of complaints like non-receipts of shares or refunds, investors must complain to the lead managers, who take up the matter with the registrars.

The names of all the lead managers and the registrar to the issue, with their addresses, phone numbers and e-mail addresses, are displayed prominently on the cover of every prospectus.

On a closing note

Don't forget there are no guarantees in subscribing to IPOs.

The lead manager may have certified the facts as disclosed in the prospectus are right. Prominent financial institutions may agree to underwrite the issue. The issue may end up being oversubscribed.

But the responsibility for investing in an issue rests fairly and squarely on you, the investor.

So make sure you have studied the company and the issue thoroughly before you make the decision to invest.

IPO - Rediff article

Few things frustate an investor more than applying for shares and not getting them, especially when talk of booming share prices leaves them with stars in their eyes.

A number of my friends have been similarly disappointed.

They simply did not get an allotment after they applied for an Initial Public Offering.

An IPO refers to the first time a company offers its shares to the public. After the shares are alloted through the IPO, the stock will be listed on the stock exchange so that the shares can be bought and sold.

A number of IPOs are in the limelight at the moment.

Since many people apply for an IPO, very few end up with the shares.

Let me explain why this happens and how the IPO game works.

The company will 'discover' its price

Earlier, the company determined a fixed price for the stock issue. The issue was marketed to the general public through advertisements and a media campaign.

Today, companies prefer a book building process. Book building is the process of price discovery. That means there is no fixed price for the share.

Instead, the company issuing the shares comes up with a price band. The lowest price is referred to as the floor and the highest, the cap.

Bids are then invited for the shares. Each investor states how many shares s/he wants and what s/he is willing to pay for those shares (depending on the price band).

The actual price is then discovered based on these bids.

Who can play the game?

Three classes of investors can bid for the shares:
Qualified Institutional Buyers: QIBs include mutual funds and Foreign Institutional Investors. At least 50% of the shares are reserved for this category.
Retail investors: Anyone who bids for shares under Rs 50,000 is a retail investor. At least 25% is reserved for this category.
The balance bids are offered to high networth individuals and employees of the company.

How the game is played

Individuals who apply for the IPO put in their bids.

The process is transparent. You can check on the issue subscription at the BSE and NSE Web sites.

After evaluating the bid prices, the company will accept the lowest price that will allow it to dispose the entire block of shares. That is called the cut-off price.

Let's take an example.

Number of shares issued by the company = 100.

Price band = Rs 30 - Rs 40.

Now let's check what individuals have bid for.

BidNo.
Number of shares
Price per share

1. 20 shares @ Rs 40

2. 10 shares @ Rs 38

3. 20 shares @ Rs 37

4. 30 shares @ Rs 36

5. 20 shares @ Rs 35

6. 20 shares @ Rs 33

7. 20 shares @ Rs 30


The shares will be sold at the Bid 5 price of 20 shares for Rs 35.

Why?
Because Bidders 1 to 5 are willing to pay at least Rs 35 per share.
The total bids from Bidders 1 to 5 ensure all 100 shares will be sold (20 + 10 + 20 + 30 + 20).

The cut-off price is therefore Bid 5's price = Rs 35.

Bidders 1 to 5 get allotments at that price. Bidders 6 and 7 don't get an allotment because their bids are below the cut-off price.
How to make bidding work for you

Go for the higher price band.

As a retail investor, you don't have to specify an exact price.

Make out a cheque for the number of shares you are applying for at the highest end of the price band. If you are applying for 10 shares, the amount wll be Rs 400 (10 x Rs 40 -- the higher end of the price band).

On allotment, the extra amount paid will be refunded to you. Since the cut-off price is Rs 35, the 10 shares will cost you Rs 350 (10 x Rs 35). The balance Rs 50 will be refunded to you.

How the allotment is done

The bids are first allotted to the different categories and the over-subscription (more shares applied for than the shares available) in each category is determined.

Retail investors and high networth individuals get allotments on a proportional basis.

Assuming you are a retail investor and have applied for 200 shares in the issue, and the issue is over-subscribed five times in the retail category, you qualify to get 40 shares (200 shares/5).

Sometimes, the over-subscription is huge or the issue is priced so high that you can't really bid for too many shares before the Rs 50,000 limit is reached.

In such cases, allotments are made on the basis of a lottery.

Say a retail investor has applied for 5 shares in an issue, and the retail category has been over-subscribed 10 times, the investor is entitled to half a share.

Since that isn't possible, it may then be decided that every 1 in 2 retail investors will get allotment. The investors are then selected by lottery and the issue allotted on a proportional basis among.

That is why there is no way you can be sure of getting an allotment.

How to make an allotment work for you

Put in bids in the names of your family members. The problem is, you will need to open demat accounts for them first.

Most regular IPO investors try to calculate how much the issue will be over-subscribed and then put in their bids accordingly.

For instance, if you want 10 shares and feel the retail portion of the issue will be over-subscribed three times, you should bid for 30 shares.

You could also apply separately in the high networth category if you have the money.