investment banking vivek (1)

8/6/2019 Investment Banking Vivek (1)

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A Project on

INVESTMENTBANKING

Submitted to Prof. sangam


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INDEX Page no

INTRODUCTION 4

WHONEEDS ANINVESTMENT BANK? 5

WHATDOESITDO? (TOEARN) 6

COMMERCIAL BANKINGVS.INVESTMENT BANKING 8

THE BUY-SIDEV/STHESELL-SIDE 12

HEDGE FUNDS: An over view 12

ORGANIZATIONAL STRUCTUREOF ANINVESTMENT BANK 13

POSSIBLECONFLICTSOF INTEREST 17

Bibliography 18


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INTRODUCTION

An investment bank is a financial institution that raises capital, trades in

securities and manages corporate mergers and acquisitions. Investment banks profit

from companies and governments by raising money through issuing and selling

securities in the capital markets (both equity, bond) and insuring bonds, as well as

providing advice on transactions such as mergers and acquisitions. A majority of

investmentbanks offer strategic advisory services for mergers, acquisitions, divestiture

or other financial services for clients, such as the trading of derivatives,fixed income,

foreign exchange, commodity, and equity securities.

Trading securities for cash or securities (facilitating transactions,market-making),

or the promotion ofsecurities (underwriting, research, etc.) was referred to as the "sell

side".

Dealing with the pension funds, mutual funds, hedge funds, and the investing

public who consumed the products and services ofthe sell-side in order tomaximize

their return on investment constitutes the "buy side".Many firms have both buy and

sell side components.


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DEFINITION:-

An individual or institution, which acts as an underwriter or agent for

corporations and municipalities issuing securities. Most also maintain broker/dealer

operations, maintain markets for previously issued securities, and offer advisory

services toinvestors.Investmentbanks also have a large role in facilitating mergers and

acquisitions, private equity placements and corporate restructuring.Unlike traditional

banks,investmentbanks do not accept deposits from and provide loans toindividuals.

Also called investmentbanker.

To continue fromthe above words ofJohn F.Marshall and M.E.Eills, investment

banking is whatinvestmentbanks do.This definition can be explained in the contextof

how investment banks have evolved in their functionality and how history and

regulatory intervention have shaped such an evolution.Much ofinvestmentbanking in

its present form, thus owes its origins to the financial markets in USA, due o which,

American investment banks have banks have been leaders in the American and Euro

markets as well.Therefore,the term investmentbanking can arguably be said tobe of

American origin.Their counterparts in UK were termed as merchants banks since they

had confined themselves to capital market inter-mediation until the US investments

banks entered the UK and European markets and extended the scope of such

businesses.


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WHO NEEDS AN INVESTMENT BANK?

Any firm contemplating a significant transaction can benefit from the advice of

an investmentbank. Although large corporations often have sophisticated finance and

corporate development departments provide objectivity, a valuable contact network,

allows for efficient use of client personnel, and is vitally interested in seeing the

transaction close.

Most smalltomedium sized companies do not have a large in-house staff, and in

a financial transaction may be at a disadvantage versus larger competitors. A quality

investment banking firm can provide the services required to initiate and execute a

major transaction, thereby empowering small to medium sized companies with

financial and transaction experience without the addition of permanentoverhead, an

investment bank provides objectivity, a valuable contact network, allows for efficient

use ofclient personnel, and is vitally interested in seeing the transaction close.


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WHAT DOES IT DO? (TO EARN)

CORPORATE FINANCE

The bread and butter of a traditional investment bank, corporate finance generally

performs two differentfunctions:

1) Mergers and acquisitions advisory and2) Underwriting.

On the mergers and acquisitions (M&A) advising side of corporate finance, bankers

assistin negotiating and structuring a merger between two companies.If,for example,

a company wants tobuy another firm, then an investmentbank will help finalize the

purchase price, structure the deal, and generally ensure a smooth transaction. The

underwriting function within corporate finance involves shepherding the process of

raising capitalfor a company.In the investmentbanking world, capital can be raised by

selling either stocks or bonds toinvestors.

SALES

Sales is another core componentofany investmentbank.Salespeople take the formof:

1) the classic retailbroker2) The institutional salesperson,or 3)the private client service representative.

Brokers develop relationships with individualinvestors and sell stocks and stock advice

tothe average Joe.Institutional salespeople develop business relationships with large

institutional investors. Institutional investors are those who manage large groups of

assets, for example pension funds or mutual funds. Private Client Service (PCS)

representatives lie somewhere between retail brokers and institutional salespeople,


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providing brokerage and money management services for extremely wealthy

individuals. Salespeople make money through commissions on trades made through

their firms.

TRADING

Traders also provide a vital role for the investmentbank.Traders facilitate the buying

and selling ofstock,bonds,or other securities such as currencies, either by carrying an

inventory of securities for sale or by executing a given trade for a client.Traders deal

with transactions large and small and provide liquidity (the ability to buy and sell

securities)for the market. (This is often called making a market.)Traders make money

by purchasing securities and selling them at a slightly higher price. This price

differentialis called the "bid-ask spread."

RESEARCH

Research analysts follow stocks and bonds and make recommendations on whether to

buy, sell, or hold those securities. Stock analysts (known as equity analysts) typically

focus on one industry and will cover up to 20 companies' stocks at any given time.

Some research analysts work on the fixed income side and will cover a particular

segment, such as high yield bonds or U.S. Treasury bonds. Salespeople within the I-

bank utilize research published by analysts to convince their clients to buy or sell

securities through their firm.Corporate finance bankers rely on research analysts tobe

experts in the industry in which they are working. Reputable research analysts can

generate substantial corporate finance business as well as substantialtrading activity,

and thus are an integral partofany investmentbank.


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SYNDICATE

The hub of the investment banking wheel, syndicate provides a vital link between

salespeople and corporate finance.Syndicate exists tofacilitate the placing ofsecurities

in a public offering, a knock-down drag-out affair between and among buyers of

offerings and the investmentbanks managing the process.In a corporate or municipal

debt deal, syndicate also determines the allocation ofbonds.The breakdown ofthese

fundamental areas differs slightly fromfirmtofirm.


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COMMERCIAL BANKING VS. INVESTMENT BANKING

While regulation has changed the businesses in which commercial and

investmentbanks may now participate,the core aspects ofthese differentbusinesses

remain intact. In other words, the difference between how a typical investmentbank

and a typical commercialoperate bank is simple: A commercialbank takes deposits for

checking and savings accounts from consumers while an investment bank does not.

We'llbegin examining whatthis means by taking a look at what commercialbanks do.

COMMERCIAL BANKS

A commercial bank may legally take deposits for current and savings accounts

from consumers.The typical commercialbanking process is fairly straightforward.You

deposit money into your bank, and the bank loans that money to consumers and

companies in need of capital (cash). You borrow to buy a house, finance a car, or

finance an addition to your home. Companies borrow to finance the growth of their

company or meet immediate cash needs. Companies that borrow from commercial

banks can range in size from the dry cleaner on the corner to a multinational

conglomerate.

PRIVATECONTRACTS

Importantly, loans from commercial banks are structured as private legally

binding contracts between two parties - the bank and you (or the bank and a

company). Banks work with their clients to individually determine the terms of the

loans, including the time to maturity and the interest rate charged. Your individual


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credit history (or credit risk profile) determines the amount you can borrow and how

much interest you are charged. Perhaps you need to borrow Rs. 1,00,00,000 over 15

years tofinance the purchase of your home,or maybe you need Rs. 1,50,00,000 over

five years tofinance the purchase of a car.Maybe for the first loan, you and the bank

will agree that you pay an interest rate of 7.5 percent; perhaps for the car loan, the

interest rate willbe 11 percent.The same process applies toloans to companies as well

-the rates are determined through a negotiation between the bank and the company.

Let's take a minute tounderstand how a bank makes its money.On most loans,

commercialbanks earn interest anywhere from 5 to 14 percent. Ask yourselfhow much

your bank pays you on your deposits - the money that it uses to make loans. You

probably earn a paltry 1 percenton a current account, if anything, and maybe 2 to 3

percent on a savings account. Commercial banks thus make gobs of money, taking

advantage ofthe large spread between their costoffunds (1 percent,for example) and

their return on funds loaned (ranging from 5 to 14 percent).


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INVESTMENT BANKS

An investmentbank operates differently. An investmentbank does not have an

inventory of cash deposits to lend as a commercial bank does. In essence, an

investmentbank acts as an intermediary, and matches sellers ofstocks and bonds with

buyers ofstocks and bonds.

Note, however, that companies use investment banks toward the same end as

they use commercialbanks.Ifa company needs capital,itmay get a loan from a bank,

or it may ask an investment bank to sell equity or debt (stocks or bonds). Because

commercial banks already have funds available from their depositors and an

investmentbank does not, an I-bank must spend considerable time finding investors in

order toobtain capitalfor its client.

PUBLIC SECURITIES

Investment banks typically sell public securities (as opposed private loan

agreements). Technically, securities such as Microsoft stock or Ford AAA bonds,

represent government-approved stocks or bonds that are traded either on a public

exchange or through an approved dealer.The dealer is the investmentbank.

Private Debtvs. Bonds - An Example

Let's look at an example to illustrate the difference between private debt and

bonds. Suppose Acme Company needs capital, and estimates its need to be Rs. 200

million. Acme could obtain a commercial bank loan from Bank of New York for the

entire Rs. 200 million, and pay intereston that loan just like you would pay on a Rs.


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2,000 loan from Bank of New York. Alternately, it could sell bonds publicly using an

investment bank such as Morgan Stanley. The Rs. 200 million bond issue raised by

Morgan would be broken intomany bonds and then sold tothe public. (For example,

the issue could be broken into 200,000 bonds, each worth Rs. 1,000.) Once sold, the

company receives its Rs. 200 million and investors receive bonds worth a totalof the

same amount.

Over time,the investors in the bond offering receive the interest, and ultimately

the principal (the originalRs. 1,000) atthe end ofthe life ofthe loan, when Acme Corp

buys back the bonds (retires the bonds).Thus, we see thatin a bond offering, while the

money is stillloaned to Acme,itis actually loaned by numerous investors, rather than a

bank.

Because the investment bank involved in the offering does notown the bonds

but merely placed them with investors at the outset, it earns no interest - the

bondholders earn this interestin the formofregular coupon payments.The investment

bank makes money by charging the client (in this case, Acme) a small percentage ofthe

transaction upon its completion. Investment banks call this upfront fee the

"underwriting discount." In contrast, a commercialbank making a loan actually receives

the interest and simultaneously owns the debt.

Later, we will cover the steps involved in underwriting a public bond deal.

Legally, bonds must first be approved by the Securities and Exchange Commission

(SEC). (The SEC is a government entity that regulates the sale of all public securities.)

The investment bankers guide the company through the SEC approval process, and

then marketthe offering utilizing a written prospectus,its sales force and a road-show

tofind investors


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THE QUESTIONOF EQUITY (UNDERWRITING)

Investment banks underwrite stock offerings just as they do bond offerings. In

the stock offering process, companies sell a portion of the equity (or ownership) of

itselftothe investing public.The very firsttime a company chooses to sell equity,this

offering of equity is transacted through a process called an initial public offering of

stock (commonly known as an IPO). Through the IPO process, stock in a company is

created and sold tothe public. After the deal, stock sold are traded on a stock exchange

such as the NSEor the BSE.The equity underwriting process is another major way in

which investment banking differs from commercial banking. Commercialbanks (even

before Glass-Steagall repeal) were able to legally underwrite debt, and some of the

largest commercialbanks have developed substantial expertise in underwriting public

bond deals.So, notonly dothese banks make loans utilizing their deposits, they also

underwrite bonds through a corporate finance department. When it comes to

underwriting bond offerings, commercialbanks have long competed for this business

directly with investmentbanks. However,only the biggesttier ofcommercialbanks are

able to do so, mostly because the size of most public bond issues is large and

competition for such deals is quite fierce.


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THE BUY-SIDE V/S THE SELL-SIDE

The traditional investment banking world is considered the sell-side of the securities

industry.Investmentbanks create stocks and bonds, and sellthese toinvestors.Sellis

the key word, as I-banks continually selltheir firms' capabilities to generate corporate

finance business, and salespeople sell securities to generate commission revenue.

Who are the buyers of public stocks and bonds? They are individual investors

(you and me) and institutionalinvestors,firms like Fidelity and Vanguard.The universe

ofinstitutionalinvestors is appropriately called the buy-side ofthe securities industry.

Mutualfund companies represent a portion ofthe buy-side business.These are

mutualfund money managers.Insurance companies like ICICI Prudential, Birla Sunlife,

LIC also manage large blocks of assets and are another segmentof the buy-side. Yet

another class ofbuy-side firms manage pension fund assets -frequently, a company's

pension assets will be given to a specialty buy-side firm that can better manage the

funds and hopefully generate higher returns than the company itselfcould have.There

is substantial overlap among these money managers some manage both mutual

funds for individuals as well as pension fund assets oflarge corporations.


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HEDGE FUNDS: WHAT EXACTLY ARE THEY?

Hedge funds are one component of the buy side. Since the mid-1990s, hedge

funds popularity has grown tremendously. Hedge funds pool together money from

large investors (usually wealthy individuals) with the goal of making outsized gains.

Historically, hedge funds bought individual stocks, and shorted (or borrowed against)

the S&P 500 or another market index, as a hedge against the stock. (The funds bet

against the S&P in order to reduce their risk.) As long as the individual stocks

outperformed the S&P,the fund made money.

Nowadays, hedge funds have evolved into a myriad ofhigh-risk money managers

who essentially borrow money toinvestin a multitude ofstocks,bonds and derivative

instruments (these funds with borrowed money are said tobe leveraged).Essentially, a

hedge fund uses its equity base to borrow substantially more capital, and therefore

multiply its returns through this risky leveraging. Buying derivatives is a common way to

automatically leverage a portfolio.


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ORGANIZATIONAL STRUCTURE OF AN INVESTMENT BANK

Main activitiesand units

On behalfofthe bank and its clients,the primary function ofthe bank is buying

and selling products. Banks undertake risk through proprietary trading, done by a

special setoftraders who do notinterface with clients and through "principal risk", risk

undertaken by a trader after he buys or sells a productto a client and does not hedge

his total exposure. Banks seek tomaximize profitability for a given amountof risk on

their balance sheet. An investmentbank is split into the so-called frontoffice,middle

office, and back office.

Front office

Investmentbanking is the traditional aspectofthe investmentbanks which also

involves helping customers raise funds in the capital markets and advise on mergers

and acquisitions.These jobs pay well, so are often extremely competitive and difficult

toland.On a similar note,they are extremely stressful.Investmentbankers frequently

work 80 to 100 hours a week,often working well pastmidnight and during weekends.

Investment banking may involve subscribing investors to a security issuance,

coordinating with bidders, or negotiating with a merger target. Other terms for the

investment banking division include mergers and acquisitions (M&A) and corporate

finance. The investment banking division (IBD) is generally divided into industry

coverage and product coverage groups. Industry coverage groups focus on a specific

industry such as healthcare,industrials,or technology, and maintain relationships with

corporations within the industry to bring in business for a bank. Product coverage

groups focus on financial products, such as mergers and acquisitions, leveraged


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finance, equity, and high-grade debt and generally work and collaborate with industry

groups in the more intricate and specialized needs ofa client.

Investment management is the professional management of various securities

(shares, bonds, etc.) and other assets (e.g. real estate), to meet specified investmentgoals for the benefit of the investors. Investors may be institutions (insurance

companies, pension funds, corporations etc.) or private investors (both directly via

investment contracts and more commonly via collective investment schemes eg.

mutualfunds).The investmentmanagement division ofan investmentbank is generally

divided into separate groups,often known as Private Wealth Management and Private

Client Services. AssetManagementmarket making, traders will buy and sell financial

products with the goalofmaking an incremental amountofmoney on each trade.Sales

is the term for the investment banks sales force, whose primary job is to call on

institutional and high-net-worth investors to suggest trading ideas (on caveat emptor

basis) and take orders. Sales desks then communicate their clients' orders to the

appropriate trading desks that can price and execute trades,or structure new products

thatfit a specific need.

Structuring has been a relatively recent division as derivatives have come into

play, with highly technical and numerate employees working on creating complex

structured products which typically offer much greater margins and returns than

underlying cash securities. The necessity for numerical ability has created jobs for

physics and math Ph.D.s who act as quantitative analysts.

Merchantbanking is a private equity activity ofinvestmentbanks.[2] Current examples

include Goldman Sachs Capital Partners and JPMorgan's One Equity Partners.

(Originally, "merchantbank" was the British English termfor an investmentbank.)


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Research is the division which reviews companies and writes reports abouttheir

prospects,often with "buy" or "sell" ratings. While the research division generates no

revenue,its resources are used to assisttraders in trading,the sales force in suggesting

ideas to customers, and investment bankers by covering their clients. There is a

potential conflict of interest between the investment bank and its analysis in that

published analysis can affect the profits of the bank. Therefore in recent years the

relationship between investment banking and research has become highly regulated

requiring a Chinese wallbetween public and private functions.

Strategy is the division which advises external as well as internal clients on the

strategies that can be adopted in various markets.Ranging from derivatives to specific

industries, strategists place companies and industries in a quantitative framework with

full consideration ofthe macroeconomic scene.This strategy often affects the way the

firm will operate in the market, the direction it would like to take in terms of its

proprietary and flow positions, the suggestions salespersons give to clients, as well as

the way structurers create new products.

Middle office

Risk management involves analyzing the market and credit risk thattraders are

taking ontothe balance sheetin conducting their daily trades, and setting limits on the

amountof capitalthatthey are able totrade in order to prevent 'bad' trades having a

detrimental effect to a desk overall. Another key Middle Office role is to ensure that

the above mentioned economic risks are captured accurately (as per agreement of

commercial terms with the counterparty), correctly (as per standardized booking

models in the most appropriate systems) and on time (typically within 30 minutes of

trade execution).In recent years the risk of errors has become known as "operational


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risk" and the assurance Middle Offices provide now includes measures to address this

risk. When this assurance is not in place, market and credit risk analysis can be

unreliable and open to deliberate manipulation.

Finance areas are responsible for an investmentbank's capitalmanagement andrisk monitoring. By tracking and analyzing the capital flows of the firm, the Finance

division is the principal adviser to senior management on essential areas such as

controlling the firm's global risk exposure and the profitability and structure of the

firm's various businesses. In the United States and United Kingdom, a Financial

Controller is a senior position,often reporting tothe ChiefFinancialOfficer.

Compliance areas are responsible for an investment bank's daily operations'

compliance with government regulations and internal regulations. Often also

considered a back-office division.

Back office

Operations involves data-checking trades that have been conducted, ensuring

thatthey are not erroneous, and transacting the required transfers. While some[who?]

believe that operations provides the greatest job security and the bleakest career

prospects of any division within an investment bank, many banks have outsourced

operations.It is, however, a critical partofthe bank.Due to increased competition in

finance related careers, college degrees are now mandatory atmostTier 1 investment

banks.[citation needed] A finance degree has proved significant in understanding the

depth ofthe deals and transactions thatoccur across allthe divisions ofthe bank.

Technology refers to the information technology department. Every major

investment bank has considerable amounts of in-house software, created by the

technology team, who are also responsible for technical support. Technology has


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changed considerably in the last few years as more sales and trading desks are using

electronic trading. Some trades are initiated by complex algorithms for hedging

purposes.

Chinese wall

An investment bank can also be split into private and public functions with a

Chinese wall which separates the twoto preventinformation from crossing.The private

areas of the bank deal with private insider information that may not be publicly

disclosed, while the public areas such as stock analysis deal with public information.


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POSSIBLE CONFLICTS OF INTEREST

Potential conflicts of interest may arise between different parts of a bank,

creating the potential for financial movements that could be market manipulation.Authorities that regulate investmentbanking (the FSA in the United Kingdom and the

SEC in the United States) require that banks impose a Chinese wall which prohibits

communication between investment banking on one side and equity research and

trading on the other.

Some of the conflicts of interest that can be found in investment banking are listed

here:

Historically, equity research firms were founded and owned by investment

banks.One common practice is for equity analysts toinitiate coverage on a company in

order to develop relationships that lead to highly profitable investment banking

business.In the 1990s,many equity researchers allegedly traded positive stock ratings

directly for investmentbanking business.On the flip side ofthe coin: companies would

threaten to divert investmentbanking business to competitors unless their stock was

rated favorably. Politicians acted to pass laws to criminalize such acts. Increased

pressure from regulators and a series oflawsuits, settlements, and prosecutions curbed

this business to a large extent following the 2001 stock market tumble.[citation

needed]

Many investmentbanks alsoown retailbrokerages. Also during the 1990s, some

retailbrokerages sold consumers securities which did notmeettheir stated risk profile.

This behavior may have led to investment banking business or even sales of surplus

shares during a public offering to keep public perception ofthe stock favorable.


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Since investmentbanks engage heavily in trading for their own account,there is

always the temptation or possibility that they might engage in some form of front

running. Front running is the illegal practice of a stock broker executing orders on a

security for their own account before filling orders previously submitted by their

customers,thereby benefiting from any changes in prices induced by those orders.


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investment banking vivek (1)

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