Tag: Risk management

Management Notes

Distinction between Memorandum of Association and Articles of Association

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Memorandum of Association

Memorandum of Association (MoA) is the charter document of a company that defines its constitution and scope of activities. It lays down the fundamental conditions upon which the company is formed. MoA includes essential clauses such as the Name Clause, Registered Office Clause, Object Clause, Liability Clause, Capital Clause, and Subscription Clause. It specifies the company’s relationship with the external world, guiding stakeholders on its permitted range of operations. As per Section 4 of the Companies Act, 2013, a company cannot undertake activities beyond what is specified in its MoA. Any act outside its scope is termed ultra vires and is invalid. Hence, the MoA serves as the foundation of a company’s legal identity and powers.

Articles of Association

The Articles of Association (AoA) are the internal rules and regulations that govern the day-to-day management and administration of a company. It operates as a contract between the company and its members, outlining provisions related to share capital, director appointments, board meetings, dividend declarations, and voting rights. Under Section 5 of the Companies Act, 2013, a company may adopt model articles or create its own. While MoA sets out the company’s external objectives, the AoA focuses on how those objectives will be achieved internally. The AoA must not contradict the MoA, and any provision conflicting with the MoA is void. It ensures smooth functioning by providing clear procedural guidelines for corporate operations.

Here is a detailed explanation of the Distinction between Memorandum of Association (MoA) and Articles of Association (AoA)

  • Nature of Document

The Memorandum of Association (MoA) is the charter of the company. It defines the company’s fundamental conditions of existence such as its name, registered office, objectives, and scope of activities. It sets the external boundaries of what a company can or cannot do. In contrast, the Articles of Association (AoA) are the internal rules that govern how a company operates and manages its affairs. It outlines provisions for meetings, share transfers, director duties, and more. While the MoA is essential for incorporation, AoA are adopted to help regulate the internal functioning of the company.

  • Legal Position

The MoA has a superior legal position as it overrides the AoA in case of any conflict between the two. It is a public document filed with the Registrar of Companies and binds both the company and the outsiders. The AoA is subordinate to the MoA and must not contain anything contrary to it. The Articles operate like a contract between the company and its members, and among the members themselves. Any clause in AoA that conflicts with the MoA will be considered invalid under the Companies Act.

  • Scope and Content

The MoA defines the scope of a company’s operations and contains clauses like Name Clause, Registered Office Clause, Object Clause, Liability Clause, Capital Clause, and Association Clause. These are fixed parameters and are not easily alterable. The AoA governs the internal operations, such as share allotment, transfer, dividend policies, board meetings, and director appointments. The MoA answers “What a company can do”, whereas the AoA answers “How a company does it”. Together, they ensure legal identity and smooth administration of the company.

  • Binding Nature

The MoA binds the company with the outside world, such as investors, creditors, and government authorities. It sets out what the company is permitted to do and acts as a declaration to the public. The AoA is binding only on the company and its members. It does not govern relationships with external parties unless specifically mentioned. While the MoA forms the foundation for legal existence, the AoA helps in enforcing contractual duties and internal governance between the members and management.

  • Requirement and Filing

Filing the MoA is compulsory at the time of incorporation, without which a company cannot be registered. It must be drafted and submitted in a specific format prescribed under the Companies Act, 2013. AoA, though not mandatory for all types of companies, is essential for private companies and can be adopted or modified from Table F in Schedule I. Both documents must be filed with the Registrar of Companies (RoC), but MoA is foundational, whereas AoA is functional.

  • Alteration Process

The MoA is difficult to alter and requires a special resolution and, in some cases, approval from the Central Government or Tribunal (especially for changes in registered office state or object clause). In contrast, the AoA can be easily altered by passing a special resolution at a general meeting. This flexibility allows companies to update their internal procedures as needed, while the MoA retains the company’s fundamental legal identity and objectives with more regulatory oversight.

  • Hierarchical Position

In the hierarchy of company documents, the MoA holds a higher status than the AoA. It sets the outer framework within which the company must function. The AoA is subordinate to the MoA and is governed by it. If any provision in the AoA goes beyond or contradicts the MoA, it is considered ultra vires and void. This hierarchical relationship ensures that companies cannot extend their powers or breach their foundational terms by merely modifying internal regulations.

  • Ultra Vires Doctrine

The Doctrine of Ultra Vires applies strictly to the MoA. If the company undertakes any activity beyond the powers conferred in the MoA, it is considered void and unenforceable. This doctrine protects shareholders and creditors. However, the AoA does not fall under this doctrine to the same extent. Actions inconsistent with AoA can be ratified by the shareholders unless they are also ultra vires to the MoA or the Companies Act. Thus, MoA protects external parties, whereas AoA ensures internal discipline.

  • Regulatory Focus

Regulatory authorities like the Registrar of Companies (RoC), NCLT, and MCA focus heavily on the MoA since it defines the company’s purpose and limits of operation. Alteration to MoA may involve governmental approval. The AoA is more of a corporate governance document, drawing attention mostly during legal disputes, shareholding conflicts, or when internal procedures need enforcement. MoA acts as a tool for compliance and regulatory oversight, while AoA is a tool for company management and administration.

Use in Legal Proceedings

In legal matters, courts and tribunals give greater weight to the MoA in determining the company’s scope, liability, and acts. If an act is outside the MoA’s object clause, it is void ab initio, and no ratification is possible. The AoA is used to determine whether the company and its officers followed the correct procedure in conducting internal affairs, such as appointments, dividends, or share issues. Thus, MoA defines legal existence, while AoA governs legal operation.

  • Applicability to Stakeholders

The MoA is primarily relevant to outsiders—investors, creditors, regulatory bodies—who need to understand the company’s scope and credibility before engaging with it. It provides assurance about the company’s limits. On the other hand, AoA is relevant to internal stakeholders, such as members, directors, and auditors, who use it to guide daily decision-making and responsibilities. MoA communicates the company’s purpose, while AoA communicates the procedures by which that purpose will be achieved internally.

  • Control over Business Activities

The MoA controls the company’s business activities by specifying what kind of ventures the company can engage in. It is restrictive and can only be altered with shareholder approval and often regulatory permission. In contrast, the AoA controls how the business is conducted, such as how decisions are made, how profits are distributed, or how directors operate. This internal control is more flexible and subject to regular changes, ensuring adaptability in corporate functioning while MoA ensures consistency in purpose.

  • Adoption and Use in Court

At the time of incorporation, the MoA must be signed by all subscribers and submitted to the RoC. It becomes a legal and public document. The AoA can be adopted as per Table F or customized and submitted accordingly. In legal proceedings, courts interpret both documents to understand whether an action was within legal authority. However, preference is always given to the MoA in case of contradictions. It represents the outer legal shell, while AoA forms the operational core.

key differences between Memorandum of Association (MoA) and Articles of Association (AoA)

Aspect Memorandum of Association (MoA) Articles of Association (AoA)
Nature Charter Document Internal Rules
Scope External Affairs Internal Management
Legal Position Supreme Document Subordinate Document
Objective Company Purpose Management Procedure
Contents Six Clauses Rules & Regulations
Alteration Restrictive Flexible
Binding Effect Company & Outsiders Company & Members
Regulation Statutory Requirement Company’s Choice
Ultra Vires Not Permitted Sometimes Permitted
Registration Mandatory Optional for Public Co.
Priority Higher Authority Lower Authority
Approval Needed Tribunal/Government (in some cases) Shareholders
Legal Enforceability Public Document Private Contract
Management Notes

Private Company and Public Company, Meaning, Features and Differences

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Private Company

Private Company is defined under Section 2(68) of the Companies Act, 2013 as a company having a minimum paid-up share capital as may be prescribed, and which by its articles of association:

  • Restricts the right to transfer its shares,
  • Limits the number of its members to 200, excluding current and former employee-members.
  • Prohibits any invitation to the public to subscribe to any of its securities.

Private company is typically closely held, meaning its shares are not traded publicly and are held by a small group of investors, promoters, or family members. It enjoys certain exemptions and privileges under the Act to reduce the burden of compliance, making it a popular form of incorporation for startups, small businesses, and family-owned enterprises.

The company must have a minimum of two members and two directors, but it cannot raise capital from the general public through a stock exchange. Private companies are also exempted from appointing independent directors or constituting audit and nomination committees, unlike public companies.

While offering limited liability protection and perpetual succession, a private company combines the benefits of a corporate entity with the flexibility of a partnership. This makes it a suitable structure for small to medium-sized enterprises seeking legal recognition with minimal public exposure and regulatory obligations.

Examples include Flipkart India Pvt. Ltd., Infosys BPM Pvt. Ltd., and other unlisted business entities operating under the private company model.

Features of a Private Company:

  • Restriction on Share Transferability

One of the primary features of a private company is the restriction on the transfer of shares. The Articles of Association must explicitly limit the right of shareholders to transfer their shares to outsiders. This restriction ensures that ownership remains within a close group, protecting the company from hostile takeovers and maintaining the confidence and trust among existing shareholders. Although shares can be transferred with approval, it ensures that only desired individuals become part of the ownership structure, maintaining control within a limited circle.

  • Limited Number of Members

Private company can have a maximum of 200 members, as per the Companies Act, 2013. This excludes current employees and former employees who were members during their employment. The limited membership ensures more manageable and controlled decision-making, especially in small and medium enterprises. Unlike public companies, which can have unlimited shareholders, private companies remain closely held entities, often involving family, friends, or close business associates. This limited membership requirement makes private companies ideal for those wanting flexibility without extensive regulatory exposure.

  • Minimum Capital Requirement

Earlier, a minimum paid-up capital of ₹1 lakh was required to form a private company. However, the Companies (Amendment) Act, 2015 removed this mandatory requirement, and now, a private company can be formed with any amount of paid-up capital. This relaxation encourages small entrepreneurs and startups to incorporate businesses easily. Although there is no specific capital requirement, a company must have enough capital to meet its operational and regulatory obligations, ensuring that it functions effectively and responsibly without unnecessary financial barriers at the start.

  • Separate Legal Entity

Private company is considered a separate legal entity distinct from its owners (shareholders). This means the company has its own legal identity and can own property, enter into contracts, sue or be sued in its own name. This separation ensures that the company’s liabilities are its own and not personally attributable to its members. It helps in building credibility and trust in the business and allows continuity of operations even if the ownership or management changes, making it a preferred structure for long-term business stability and legal protection.

  • Limited Liability of Members

The liability of members in a private company is limited to the extent of their shareholding. This means that in the event of financial losses or debts, shareholders are not personally responsible for the company’s obligations beyond the unpaid amount of their shares. Personal assets of shareholders are protected, which is a major advantage over sole proprietorships or partnerships. This limited liability feature provides a sense of security and encourages individuals to invest in or start companies without the risk of personal financial ruin.

  • No Invitation to Public for Securities

Private companies are prohibited from inviting the public to subscribe to their shares, debentures, or other securities. This feature distinguishes them from public companies, which can raise capital through public offerings. The restriction ensures that private companies remain privately funded, often through internal sources or private equity investors. This makes regulatory compliance simpler and avoids the complexities involved with public disclosures and SEBI regulations. It also ensures that control remains within a close group of investors, aiding quick decision-making and confidentiality.

  • Fewer Compliance Requirements

Compared to public companies, private companies enjoy several exemptions and relaxed compliance norms under the Companies Act, 2013. They are not required to appoint independent directors, hold elaborate general meetings, or form mandatory committees like the Audit or Nomination Committee. This reduces the administrative burden and operational costs, allowing entrepreneurs to focus on business growth rather than being overburdened with legal formalities. However, basic compliance such as annual filings, statutory audits, and board meetings still need to be conducted in accordance with the Act.

  • Perpetual Succession

Private company enjoys perpetual succession, meaning its existence is not affected by the death, insolvency, or incapacity of any of its members or directors. It continues to exist as a legal entity until it is formally dissolved according to the provisions of the Companies Act. This ensures continuity in operations and builds long-term trust with stakeholders such as employees, suppliers, customers, and lenders. The company can sign contracts, own property, and maintain operations independently of changes in ownership or management.

  • Minimum Two Directors and Members

To incorporate a private company, at least two directors and two members are required. These can be the same individuals or different people. One of the directors must be an Indian resident. This requirement makes it easy for small businesses or families to incorporate private companies with minimal personnel. The flexibility to have the same person as both a shareholder and director adds to the convenience of managing operations efficiently without involving too many external parties in decision-making.

  • Use of “Private Limited” in Name

Every private company is required to add the words “Private Limited” at the end of its name. This distinguishes it legally from public companies and informs the public and stakeholders about its structure. The suffix reflects its private nature, restricted shareholding, and limited liability status. It also signals that the company is registered and governed by the Companies Act, 2013, helping establish trust and credibility in commercial and contractual dealings.

Public Company

Public Company is defined under Section 2(71) of the Companies Act, 2013 as a company which is not a private company and has a minimum paid-up share capital as prescribed under law. Unlike private companies, public companies can invite the general public to subscribe to their shares or debentures and may be listed on recognized stock exchanges.

A public company must comply with the following key requirements:

  • Minimum of seven members with no limit on the maximum number of shareholders.

  • At least three directors are required to manage the company.

  • Shares are freely transferable, enabling public participation and liquidity.

  • It may raise funds through Initial Public Offerings (IPO), Follow-on Public Offers (FPO), and other means allowed under SEBI regulations.

Public companies are subject to stricter disclosure, audit, and corporate governance norms. They are required to file regular financial reports, conduct annual general meetings (AGMs), appoint independent directors, and establish committees such as the Audit Committee and Nomination & Remuneration Committee.

These companies play a major role in the economic development of the country by mobilizing public savings for investment and growth. They offer opportunities for the general public to invest and share in profits through dividends and capital gains.

Examples of public companies in India include Tata Motors Ltd, State Bank of India, and Infosys Ltd. Public companies promote transparency, broader ownership, and accountability in the corporate sector.

Features of Public Company:

  • Unlimited Membership

A key feature of a public company is that it can have an unlimited number of members or shareholders. The minimum requirement is seven members, but there is no maximum limit. This allows the company to raise large amounts of capital from the public by issuing shares. The wider ownership base also spreads the financial risk. Having more shareholders promotes better transparency and accountability in governance, and such companies often have to follow stricter rules to protect the interests of this diverse and dispersed ownership.

  • Free Transferability of Shares

In a public company, shares can be freely transferred by shareholders without the consent of other members. This feature enhances the liquidity of shares, making them attractive to investors. It also allows shareholders to exit or enter the company without procedural complexity. The ease of transferring shares facilitates trading in the stock market, which is crucial for companies listed on recognized stock exchanges. Free transferability ensures that ownership can be restructured efficiently and that the company can attract public investment.

  • Invitation to Public for Subscription

A public company is legally permitted to invite the public to subscribe to its shares, debentures, and other securities. This is typically done through Initial Public Offerings (IPOs), Follow-on Public Offers (FPOs), or other market instruments. By doing so, the company can raise significant capital for expansion, development, or debt repayment. This is a major feature that distinguishes public companies from private companies, which are prohibited from seeking funds from the public. Public invitation also necessitates regulatory compliance and transparency.

  • Listing on Stock Exchange

Many public companies choose to list their securities on recognized stock exchanges such as BSE or NSE. Listing provides the company access to a wide investor base and helps in raising capital efficiently. Listed companies are subject to the rules and regulations of the Securities and Exchange Board of India (SEBI) and must comply with disclosure norms, corporate governance standards, and investor protection measures. Being listed also boosts credibility, visibility, and trust among investors and stakeholders.

  • Stringent Regulatory Compliance

Public companies must follow strict legal and regulatory compliances as per the Companies Act, 2013, and SEBI regulations. These include maintaining proper books of accounts, appointing statutory auditors, conducting Annual General Meetings (AGMs), filing annual returns, and disclosing financial results. They are also required to maintain transparency through regular disclosures to shareholders and the public. Non-compliance can result in penalties and loss of investor confidence. These rules aim to protect the interests of public shareholders and promote good governance practices.

  • Separate Legal Entity

Public company, like all registered companies, is a separate legal entity distinct from its members. It can own property, enter into contracts, sue or be sued in its own name. This legal separation ensures that the company’s obligations and liabilities do not affect the personal assets of its shareholders. The corporate entity status continues even if the ownership changes, offering operational stability and legal protection. This principle is foundational to corporate law and underpins the rights and responsibilities of public companies.

  • Limited Liability of Shareholders

In a public company, the liability of shareholders is limited to the unpaid amount on their shares. If the shares are fully paid, the shareholders have no further financial liability toward the company’s debts or obligations. This feature protects individual investors from financial risk beyond their investment. It encourages public participation in company ownership and investment, as individuals are assured that their personal assets are not at stake if the company fails or incurs losses.

  • Perpetual Succession

Public companies enjoy perpetual succession, meaning their existence is unaffected by changes in membership such as death, insolvency, or retirement of any shareholder or director. The company continues to exist and operate until it is legally dissolved through a winding-up process. This continuity is essential for long-term projects and investor confidence. The stability offered by perpetual succession ensures that the company can enter into long-term contracts, maintain business operations, and build sustainable relationships with stakeholders.

  • Minimum Number of Directors and Members

Public company must have a minimum of seven members and at least three directors to be incorporated under the Companies Act, 2013. There is no upper limit on members, allowing mass public ownership. The requirement for multiple directors helps bring diverse perspectives and professional management to the company. It also promotes democratic decision-making and accountability in corporate governance. The Board of Directors is responsible for managing the company’s affairs and ensuring statutory compliance.

  • Use of “Limited” in Name

Public company must end its name with the word “Limited” to indicate its legal status and limited liability structure. For example, “Reliance Industries Limited” or “Tata Steel Limited.” This naming convention informs stakeholders, including customers, vendors, and investors, that the company is governed by corporate laws and that the liability of shareholders is limited. It also distinguishes public companies from private limited companies, where the word “Private” is used in the name to reflect their different legal and operational characteristics.

Key Differences between Private Company and Public Company

Aspect Private Company Public Company
Minimum Members 2 7
Maximum Members 200 Unlimited
Name Suffix Pvt. Ltd. Ltd.
Share Transferability Restricted Freely Transferable
Public Invitation Not Allowed Allowed
Stock Exchange Listing Not Listed Listed
Minimum Directors 2 3
Annual General Meeting Not Mandatory Mandatory
Regulatory Compliance Less More
Capital Raising Private Sources Public Offerings
Disclosure Norms Minimal Extensive
Independent Directors Not Required Required
Governance Norms Relaxed Strict
Bangalore City University BBA Notes

Strategic Management Bangalore City University BBA SEP 2024-25 6th Semester Notes

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Bangalore City University BBA Notes

Advanced Financial Management Bangalore City University BBA SEP 2024-25 5th Semester Notes

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Unit 1
Cost of Capital Meaning and Definition, Significance of Cost of Capital VIEW
Types of Capital VIEW
Computation of Cost of Capital VIEW
Specific Cost VIEW
Cost of Debt VIEW
Cost of Preference Share Capital VIEW
Cost of Equity Share Capital VIEW
Weighted Average Cost of Capital VIEW
Unit 2
Meaning and Definition Capital Structure VIEW
Capital Structure Theories:
The Net Income Approach VIEW
Net Operating Income Approach VIEW
Traditional Approach VIEW
MM Hypothesis VIEW
Unit 3
Risk Analysis, Types of Risks in Capital Budgeting VIEW
Risk and Uncertainty VIEW
Techniques of Measuring Risks VIEW
Risk adjusted Discount Rate Approach VIEW
Certainty Equivalent Approach VIEW
Probability Approach VIEW
Standard Deviation Method VIEW
Co-efficient of Variation Method VIEW
Sensitivity Analysis VIEW
Decision Tree Analysis VIEW
Unit 4
Introduction, Significance of Current Assets VIEW
Meaning of Cash and Cash Management, Objectives, Motives of Holding Cash VIEW
Meaning and Definition of Receivables VIEW
Cost of Maintaining Receivables VIEW
Objectives, Factors influencing the Size of Receivables VIEW
Problems:
Debtors Turnover Ratio VIEW
Average Collection Period VIEW
Creditors Turnover Ratio VIEW
Average Payment Period VIEW
Inventory Management, Meaning and Definition of Inventory VIEW
Elements of Inventory VIEW
Motives of holding the Inventory VIEW
Costs associated with Inventory VIEW
Techniques of Inventory Management VIEW
Unit 5
Dividend Decisions: Meaning, Types of Dividends VIEW
Types of Dividends Polices VIEW
Significance of Stable Dividend Policy VIEW
Determinants of Dividend Policy VIEW
Dividend Theories VIEW
Theories of Relevance, Walter’s Model and Gordon’s Model VIEW
Theory of Irrelevance: The Miller-Modigliani (MM) Hypothesis VIEW
Bangalore City University BBA Notes

Entrepreneurship and Start-up Eco System Bangalore City University BBA SEP 2024-25 3rd Semester Notes

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Unit 1 [Book]
Introduction, Meaning of Entrepreneurship, Factors influencing Entrepreneurship VIEW
Entrepreneur and Enterprise VIEW
Functions of Entrepreneur VIEW
Pros and Cons of being an Entrepreneur VIEW
Qualities of an Entrepreneur VIEW
Types of Entrepreneurs VIEW
Role of Entrepreneurs in Economic Development VIEW
Unit 2 [Book]
Ventures, Meaning and Definition, Objectives, Characteristics, Types, Stages in Venture Planning VIEW
Methods to initiate Ventures, Advantages of an ongoing Venture and examination of key issues VIEW
Developing a Market plan: Customer analysis, Sales analysis, and Competition analysis VIEW
Unit 3 [Book]
Introduction, Meaning, Importance, Format of Business Plan VIEW
Preparation of Business Plan VIEW
Financial aspects, Marketing aspects, Human Resource aspects, Technical aspects and Social aspects of the Business Plan VIEW
Common Pitfalls to be avoided in Preparation of a Business Plan VIEW
Unit 4 [Book]
Startups, Introduction, Meaning & Definition, Characteristics, Types: Fintech, Edutech, Appareltech, Greentech and Cleantech VIEW
Objectives, Scope, Functions, Eligibility Criteria for Startups VIEW
Pradhan Mantri MUDRA Yojana VIEW
Venture Capital Scheme VIEW
Support for International Patent Protection in Electronics and Information Technology (SIP-EIT) VIEW
Stand up India VIEW
Single Point Registration Scheme (SPRS) VIEW
High Risk-High Reward Research VIEW
Atal Innovation Mission (AIM) VIEW
Unit 5 [Book]
Introduction, Overview of Indian Startup Ecosystem VIEW
Government Initiatives: Handholding, Funding/Incentives, Accelerators and Incubation Centers VIEW
Credit Guarantee Scheme for Startups VIEW
Tax Exemptions and Legal support by the Government to Startup VIEW
Benefits to Startups by the Indian Government VIEW
Challenges for Startups in India VIEW
Bangalore City University B.Com Notes

Financial Management Bangalore City University B.Com SEP 2024-25 5th Semester Notes

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Unit 1
Introduction, Meaning of Finance VIEW
Finance Function, Objectives of Finance function VIEW
Organization of Finance Function VIEW
Financial Management, Meaning and definition of Financial Management VIEW
Goals of Financial Management VIEW
Scope of Financial Management VIEW
Functions of Financial Management VIEW
Role of Finance Manager in India VIEW
Financial Planning: Meaning, Need, Importance VIEW
Steps in financial Planning VIEW
Principles of a Sound Financial Plan VIEW
Factors affecting Financial Plan VIEW
Unit 2  
Meaning of Time Value of Money VIEW
Time Preference of Money VIEW
Techniques of Time Value of Money VIEW
Compounding Technique, Discounting Technique VIEW
Future Value of Single Cash Flow, Multiple, Annuity VIEW
Perpetuity VIEW
Present Value of Single Cash Flow, Multiple, Annuity VIEW
Unit 3  
Meaning and Definition of Capital Structure VIEW
Factors determining the Capital Structure VIEW
Concept of Optimum Capital Structure VIEW
EBIT-EPS Analysis VIEW
Leverages, Meaning and Definition VIEW
Types of Leverages:  
Operating Leverage VIEW
Financial Leverage VIEW
Combined Leverages VIEW
Unit 4
Investment Decisions VIEW
Introduction, Meaning and Definition of Capital Budgeting, Features, Significance VIEW
Steps in Capital Budgeting Process VIEW
Techniques of Capital budgeting: VIEW
Traditional Methods:
Payback Period VIEW
Accounting Rate of Return VIEW
Discounted Cash Flow (DCF) Methods VIEW
Net Present Value VIEW
Internal Rate of Return VIEW
Internal Rate of Return under Trail and Error Method using Interpolation and Extrapolation VIEW
Profitability Index VIEW
Unit 5
Meaning and Definition, Types of Working Capital VIEW
Operating Cycle VIEW
Determinants of Working Capital Needs VIEW
Sources of Working Capital VIEW
Merits of Adequate Working Capital VIEW
Dangers of Excess and Inadequate Working Capital VIEW
Bangalore City University B.Com Notes

Corporate Administration Bangalore City University B.Com SEP 2024-25 2nd Semester Notes

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Unit 1 [Book]
Company Act, Introduction, Features Highlights of Companies Act 2013 VIEW
Kinds of Companies, One Person Company, Company limited by Guarantee, Company limited by Shares, Holding Company, Subsidiary Company, Government Company-Associate Company, Small Company Foreign Company, Global Company, Body Corporate, Listed Company VIEW
Private Company and Public Company, Meaning, Features and Differences VIEW
Unit 2 [Book]
Meaning of Promoter, Position of Promoter & Functions of Promoter VIEW
Meaning and Contents of Memorandum of Association VIEW
Meaning and Contents of Articles of Association VIEW
Distinction between Memorandum of Association and Articles of Association VIEW
Certificate of Incorporation VIEW
Subscription Stage VIEW
Meaning and Contents of Prospectus, Statement in lieu of Prospects and Book Building VIEW
Commencement Stage Document to be filled, e- filling VIEW
Certificate of Commencement of Business VIEW
Unit 3 [Book]
Director, Meaning, Positions, Rights VIEW
Board of Directors VIEW
Appointment of Directors VIEW
Protem and Full Time Directors VIEW
Managing Director, Appointment Powers Duties & Responsibilities VIEW
Company Secretary-Meaning, Types, Qualification, Appointment, Position, Rights, Duties, Liabilities & Removal, or dismissal VIEW
Auditors, Meaning, Types, Appointment, Powers, Duties & Responsibilities, Qualities VIEW
Unit 4 [Book]
Corporate Meetings, Importance and Types VIEW
Shareholder’s meeting (SGM, AGM and EGM and essentials of valid Meetings) VIEW
Director’s Meetings (Board Meetings and Committee Meetings) VIEW
Resolutions, Meaning and Types, Registration of resolutions VIEW
Role of a Company Secretary in convening and conducting the Company Meetings VIEW
Unit 5 [Book]
Winding up Companies, Meaning, Modes VIEW
Consequence of Winding up VIEW
Official liquidator, Roles & Responsibilities of Liquidator VIEW
Management Notes

SPAN Margin, Features, Components, Challenges

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SPAN Margin is a risk-based margining system developed by the Chicago Mercantile Exchange (CME) and widely adopted by exchanges like NSE in India. It evaluates the total risk of a derivatives portfolio by analyzing various possible market scenarios. Instead of calculating margin separately for each position, SPAN assesses the overall portfolio risk, considering hedges, offsetting positions, and volatility. It determines the maximum potential loss a portfolio could incur in a day and sets margin requirements accordingly. SPAN Margin ensures efficient risk coverage and better capital utilization, promoting safety and reducing systemic risk in the derivatives market.

Features of SPAN Margin:

  • Portfolio-Based Risk Analysis

SPAN Margin uses a portfolio-based approach to calculate margins by assessing the total risk of all positions held, rather than each position in isolation. It accounts for hedging positions, cross-margining, and offsetting trades. This allows for a more efficient margin requirement, reducing excess capital blockage. By simulating various market conditions (price changes, volatility shifts, etc.), SPAN identifies the worst-case loss for a portfolio and sets the margin accordingly. This integrated evaluation helps clearing corporations and exchanges in managing systemic risk and ensuring smoother operations of the derivatives market.

  • Scenario-Based Calculation

SPAN Margin uses pre-defined scenarios to evaluate potential losses under different market conditions. These scenarios are based on hypothetical changes in price and volatility, covering both upside and downside risks. For each scenario, SPAN computes the net loss or gain, and the maximum potential loss among all scenarios determines the required margin. This method ensures that margin requirements are dynamic and responsive to market conditions, helping protect the market infrastructure. It also prevents under-margining, which can lead to defaults, or over-margining, which can restrict market liquidity.

  • Margin Offsetting and Spreads

One of the key advantages of SPAN is that it recognizes offsetting positions and spreads, reducing the overall margin requirement. If a trader holds positions in different contracts that naturally hedge each other, SPAN allows margin offsets. For example, long and short positions in related futures contracts may carry lower risk when combined, and SPAN adjusts margins to reflect this. This feature makes SPAN cost-effective and capital-efficient, allowing traders and institutions to take positions without excessive margin pressure. It encourages hedging behavior, which contributes to market stability.

  • Initial and Maintenance Margins

SPAN Margin system helps determine both initial and maintenance margins. The initial margin is the amount required to open a position, based on worst-case scenario losses. The maintenance margin is the minimum balance that must be maintained to keep the position open. If the account balance falls below this level, a margin call is triggered. SPAN keeps these margins aligned with the actual risk exposure of a portfolio. This feature ensures that clearing members maintain adequate capital buffers while allowing traders to optimize capital usage based on portfolio dynamics.

  • Daily Recalculation and Updates

SPAN Margin requirements are recalculated daily to reflect market fluctuations, contract volatility, and any changes in portfolio positions. Exchanges and clearing corporations use SPAN files, which contain the latest risk parameters, to ensure accuracy. These daily updates make margin calls more timely and precise, preventing build-up of risk due to outdated margin levels. This real-time adaptability is crucial in volatile markets where prices and volatility change rapidly. The dynamic nature of SPAN promotes market integrity and protects both participants and the broader financial ecosystem.

  • Globally Accepted Risk Model

SPAN is a globally recognized and widely adopted risk-based margining system used by leading exchanges such as NSE, BSE, CME, LME, and more. Its standardized methodology allows for transparency and consistency in margin calculation across different markets and asset classes. This global acceptance makes SPAN suitable for multinational institutions and traders operating across exchanges. Moreover, its robust risk management framework contributes to financial market resilience, supporting fair pricing, contract performance, and reducing counterparty risk. As regulatory bodies increasingly emphasize risk containment, SPAN plays a vital role in aligning with international best practices.

Components of SPAN Margin:

  • Scanning Risk

Scanning Risk is the core component of SPAN margin. It evaluates the maximum potential loss a portfolio may suffer under a variety of hypothetical market conditions. These include scenarios involving shifts in prices and implied volatility. The SPAN system calculates potential profit and loss across 16 standard scenarios and considers the largest loss as the scanning risk. This margin ensures the trader has sufficient capital to withstand extreme yet plausible market movements, thereby maintaining system-wide stability and preventing cascading defaults during volatility spikes.

  • Short Option Minimum (SOM)

Short Option Minimum is a margin floor imposed on traders who write (sell) options. Sometimes, SPAN’s scanning risk may calculate a low margin for short options in low-volatility periods. However, since writing options comes with theoretically unlimited risk, SOM ensures a minimum required margin regardless of scanning results. This protects the clearinghouse and other market participants from sudden market reversals that could create significant liabilities for uncovered option writers. It adds a safety layer to cover possible losses that exceed calculated risks in unusual market situations.

  • Inter-Commodity Spread Credit (ICSC)

The Inter-Commodity Spread Credit offers a margin reduction when traders hold offsetting positions in related commodity contracts. If two contracts are positively correlated, like crude oil and natural gas, SPAN considers the reduced risk due to the hedge and applies a discount on the margin. This encourages strategic hedging and reduces capital burden while still maintaining systemic risk coverage. This benefit is calculated using historical correlation and volatility data and is dynamic, adjusting as the relationship between commodities strengthens or weakens over time.

  • Premium Margin

Premium Margin is specifically applied to options sellers (writers). It represents the amount by which the option premium is added to or deducted from the margin requirement. Since option buyers pay a premium upfront, their risk is capped, but option writers face open-ended losses. Therefore, the premium margin ensures that the seller has sufficient funds to meet obligations in case of adverse price movements. It protects the system by ensuring premiums received do not get used elsewhere, thereby securing liquidity for settlement.

  • Assignment Margin

Assignment Margin is levied when an option writer is assigned—meaning the option buyer exercises their right and the contract must be settled. In such cases, the seller is exposed to the full delivery obligation or cash settlement. The SPAN system calculates this margin in addition to the regular scanning risk and ensures funds are available to meet the full financial implications of assignment. This mechanism maintains integrity in the options clearing system by minimizing credit risk post-assignment.

  • Exposure Margin

Exposure Margin, also known as Extreme Loss Margin (ELM), is an additional safety buffer over and above the scanning risk. It is designed to cover the risk of extreme adverse market movements that fall outside typical risk scenarios. Exposure margin is especially important during volatile market phases or unexpected geopolitical/economic events. It ensures a cushion beyond modeled risk, keeping the market resilient and preventing systemic breakdowns. It is mandated by SEBI and varies depending on the instrument and market conditions.

Challenges of SPAN Margin:

  • Complexity of Calculations

SPAN Margin uses complex algorithms involving multiple risk scenarios, option greeks, volatility shifts, and correlation matrices. These intricacies make it difficult for average retail investors or small traders to understand how margins are calculated. It demands specialized software or brokers that provide SPAN analysis tools. The lack of transparency and interpretability in the SPAN model can create confusion and reduce trust among less-informed participants. This complexity may also result in errors or misinterpretation, affecting trading decisions and capital efficiency.

  • Inadequate During Black Swan Events

Although SPAN Margin covers a wide range of hypothetical scenarios, it may not fully account for black swan events—extreme, unpredictable market crashes or price spikes. These outlier events often exceed the predefined risk parameters used in SPAN simulations. As a result, even participants with full margin coverage could face margin calls or losses during sudden crashes. This highlights the system’s limited ability to anticipate systemic risk during events such as pandemics, geopolitical wars, or flash crashes.

  • Limited Real-Time Adjustability

SPAN Margin calculations are typically based on end-of-day data or fixed intervals. In fast-moving markets, where prices can fluctuate significantly within minutes, this lag in margin adjustment can expose clearing members and brokers to risk. It becomes particularly concerning during highly volatile trading sessions when real-time margin recalculations would be more appropriate. This delay might also lead to discrepancies in required margins and available balances, impacting trading continuity and settlement accuracy.

  • Dependence on Historical Volatility

SPAN’s margin model relies heavily on historical price volatility to simulate risk scenarios. However, past volatility is not always an accurate predictor of future risk. In emerging or highly speculative markets, where volatility patterns shift rapidly, SPAN may either underestimate or overestimate the margin requirements. This could lead to excessive capital blockage during calm markets or under-protection during unstable periods, distorting risk perception and affecting market liquidity.

  • Technology Infrastructure Requirement

Effective implementation of SPAN Margin requires advanced technology infrastructure on the part of brokers, clearing members, and exchanges. High-speed computing, data storage, risk engines, and real-time integration are essential to calculate and manage margins accurately. For smaller brokers or participants from developing markets, investing in such technology could be costly and resource-intensive. Without proper tech support, there’s a higher chance of margin errors, compliance lapses, or failed trades, increasing operational risk.

  • Capital Efficiency Concerns

While SPAN aims to cover risk comprehensively, its conservative approach may tie up more capital than necessary, especially during low volatility phases. Excessive margin requirements can restrict a trader’s ability to take new positions or diversify portfolios. This reduces capital efficiency and trading volumes. Moreover, when hedged positions are not fully recognized by the SPAN model, the margin savings through netting are lost, making the entire system more capital-intensive than economically justified.

  • Inter-Exchange Inconsistencies

Different exchanges might implement slight variations of the SPAN methodology or use different parameters for risk assessment. This inconsistency leads to confusion among traders operating across multiple platforms. It also complicates the process of calculating unified margins for arbitrage or hedge trades involving multiple contracts across different exchanges. Such variation undermines standardization, introduces operational friction, and creates barriers for participants seeking seamless, multi-market strategies.

Management Notes

Types of Margins in Derivatives Market

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Margins in the Derivatives Market refer to the collateral or security deposit that traders must maintain with the exchange to cover potential losses. These margins ensure financial integrity and reduce counterparty risk. There are different types of margins, such as initial margin (required upfront), maintenance margin (minimum balance to be maintained), and variation margin (adjusted daily based on market movements). Margins act as a risk management tool and promote discipline among market participants. They help ensure that parties involved in derivative contracts fulfill their obligations, especially in volatile markets where prices can change rapidly.

Types of Margins in Derivatives Market:

  • Initial Margin

Initial Margin is the minimum amount that a trader must deposit to open a derivatives position. It serves as a performance bond to cover potential future losses. The exchange calculates this based on the volatility and risk of the asset. Higher risk assets require higher initial margins. This amount is collected upfront and held until the position is closed. It ensures that the trader has enough financial backing to fulfill the contract obligations and prevents excessive speculation or default in highly volatile markets.

  • Maintenance Margin

Maintenance Margin is the minimum account balance that must be maintained after the trade is initiated. If the margin account falls below this level due to adverse price movements, a margin call is issued, requiring the trader to deposit additional funds. This margin acts as a safety net to ensure the position remains adequately funded. Failure to meet the margin call may result in the broker closing the position. Maintenance margin is usually lower than the initial margin and helps manage the ongoing risk exposure of open derivative positions.

  • Variation Margin

Variation Margin is the daily adjustment made to a trader’s margin account based on the market value of the open derivatives position. As prices fluctuate, the margin account is credited or debited to reflect unrealized gains or losses. These daily settlements are part of the mark-to-market process and ensure that the margin account accurately reflects current exposure. Variation margins help minimize counterparty risk and enforce daily discipline, ensuring traders respond quickly to adverse market moves and maintain sufficient capital to cover potential losses.

  • Exposure Margin

Exposure Margin, also known as additional or ad hoc margin, is collected over and above the initial margin to cover unexpected volatility or market risk. Regulatory authorities or exchanges may impose exposure margins during high-risk periods or for specific instruments with greater potential for sharp price movements. This margin protects the system against extreme market conditions and unexpected losses. It is particularly common in commodity and currency derivatives. Exposure margin reinforces market stability and strengthens the overall risk management framework.

Management Notes

Types of Risk in Derivatives Market

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Risk in Derivatives Market refers to the potential for financial losses due to various uncertainties affecting derivative contracts. These risks stem from market volatility, counterparty default, legal ambiguities, operational failures, and pricing model errors. Since derivatives derive value from underlying assets, even small fluctuations can result in significant gains or losses. Effective risk management, including hedging, margin requirements, and regulatory oversight, is essential to mitigate such risks in derivative trading.

Types of Risk in Derivatives Market:

  • Market Risk

Market risk refers to the possibility of financial loss due to unfavorable changes in market variables such as interest rates, commodity prices, or stock prices. Since derivatives derive value from underlying assets, any volatility in those assets directly impacts derivative prices. Traders exposed to market risk may face losses if the market moves against their position. Market risk is categorized into directional risk (due to price movement) and volatility risk (due to fluctuation in asset volatility). Effective risk management strategies like hedging and stop-loss orders are commonly used to mitigate market risk.

  • Credit Risk (Counterparty Risk)

Credit risk arises when one party in a derivative contract fails to meet its financial obligations, potentially leading to default. This is especially relevant in over-the-counter (OTC) derivatives, where contracts are bilateral and not standardized. If a counterparty defaults, the other party may incur losses or legal complications. To mitigate this risk, exchanges use clearinghouses, which act as intermediaries and ensure contract performance. In OTC markets, participants use credit limits, collateral, and margin agreements to manage counterparty exposure effectively.

  • Liquidity Risk

Liquidity risk occurs when a derivative position cannot be easily entered, exited, or unwound without a significant price impact. This is common in derivatives with low trading volumes or those tied to illiquid underlying assets. A lack of buyers or sellers may prevent timely execution, forcing traders to accept less favorable prices. It can also arise during times of market stress. To manage liquidity risk, traders prefer exchange-traded derivatives with high volume and open interest, and institutions often monitor liquidity ratios regularly.

  • Operational Risk

Operational risk stems from failures in internal processes, systems, human error, or external events that disrupt trading, clearing, or settlement of derivatives. Examples include system outages, trade entry errors, or compliance breaches. It is not related to market movements but can cause financial loss or reputational damage. Effective internal controls, robust IT infrastructure, employee training, and compliance monitoring are essential for minimizing operational risk. Regulatory bodies also mandate specific protocols to ensure operational stability in derivative markets.

  • Legal and Regulatory Risk

Legal and regulatory risk refers to the possibility of loss due to changes in laws, regulations, or legal disputes affecting derivative contracts. This may include regulatory restrictions, invalid contracts, or issues in contract enforceability. Unclear legal frameworks, especially in international or OTC markets, increase this risk. Sudden regulatory changes can also impact pricing and trading strategies. Traders and institutions must stay updated on legal developments and ensure contracts comply with current regulations to reduce exposure.

  • Model Risk

Model risk arises when pricing or risk management models used for derivatives are incorrect, inaccurate, or based on faulty assumptions. If the model fails to capture real-world complexities or sudden market changes, it can lead to wrong valuations and poor decisions. This is critical in structured or exotic derivatives where pricing models are complex. Regular model validation, stress testing, and use of alternative valuation approaches help manage model risk and improve accuracy in derivative trading.

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