investment banking sessions

CBSE Institute

2012 BSE Institute LimitedPGP Banking and Finance course - Investment Banking

Thank you all for this

opportunity

1

PGP Banking and Finance courseInvestment Banking

Sessions: 3 - 5Investment Banking Activities

Recapitulatethe

Last session

2012 BSE Institute LimitedPGP Banking and Finance course - Investment Banking 3

Key learning points Concepts Definitions

PS: to review by a brief summary, as at the end of a speech or discussion; summarize.

At the end of this session, you will be able to understand and comprehend the following:

Investment banking Activities

Private Equity

Equity Research

Asset Management

Private Wealth Management

Course Objective:



Mergers and Acquisitions

Corporate Finance

Corporate Advisory Services

Underwriting Activities

Structured Finance and Loan Syndication

Funded vs. Non Funded Activities

Organization structure of an Investment bank

4

Reference Books Available in Library:

An introduction to Investment Bank, Hedge Funds & Private Equity David P Stowell

Investment Banking Joshua Rosenbern /


Investment Banking Joshua Rosenbern / Joushua Pearl

Investment Banking Ca Tapan Jindal

Investment Banking Hand Book J Peter Williamson

5

Financial


Financial Instruments

6

Financial


Financial Instrume

nts

Shares

Equity Shares

Bonus Shares

Rights Shares

Preference

SharesWarrants

Debt

Money Market

Fixed Income

Securities

BondConverti

ble Bonds

7

Summary of Classification of Financial Markets

Classification by nature of claim.

Debt market; Equity market

Classification by maturity of claim.

Money market; Capital market

Classification by seasoning of claim.

Primary market; Secondary market


Primary market; Secondary market

Classification by immediate delivery or future delivery

Cash or spot market; Derivative market

Classification by organizational structure

Auction market; Over-the-counter market; Intermediated market

8

Financial Instruments and Markets

Primary Markets

Market for issuing a new security and distributing to saver-lenders.

Investment BanksInformation and marketing specialists for newly issued securities.


securities.

Secondary Markets

Market where existing securities can be exchanged

New York Stock Exchange

American Stock Exchange

Over-the-counter (OTC) markets9

Debt Instruments

Short Term

Medium Term

Money Market Instruments(T-Bills, Certificates of Deposit,

Commercial Paper)Less than a year

Fixed Income Securities 1 to 10 years

Tenor CategorizationTimeline


Medium Term

Long Term

Fixed Income Securities (T-note, Corporate)

1 to 10 years

Bonds(T-Bonds; Corporate Bonds)

10+ years(typically up to 30)

10

Bonds Represent Borrowing

Agreement by issuer to pay interest on specified dates and redeem the bond upon maturity.

Consol Bond with no maturity date, pay interest

forever Coupon Securities


Coupon Securities Make interest payments usually

semiannually. Zero-coupon Make no interest payments. Sold at price well below face value. Tax Exempt Interest earned is not taxed. 11

Stock Represents Ownership

Stockholders

Owns part of the corporation and receives dividends from the issuer.

Capital Gains


Capital Gains

Difference between price initially paid and amount received when stock is sold.

12

Types of Corporate Stock

Common Stock ( Equity Shares)

Ownership

Variable dividends, based on companys profits.

Preferred Stock

Fixed rate of Ddividend,


Fixed rate of Ddividend,

Priority over common stock in case of liquidation

Can be cumulative, non cumulative, callable, non callable etc

Convertible

Preferred stock that can be converted into common stock at a stated price

13

Measures of Trends in Common Stock Prices

Standard & Poors 500 Stock Index

Based on prices of 500 individual stocks

NASDAQ Composite Index

Based on all stocks listed in NASDAQ

Dow Jones Industrial Average


Dow Jones Industrial Average

Based on price of 30 blue-chip stocks

14

Both stocks and bonds represent a claim to a stream of payments in the future.

BondsInterest payment and face value at maturity


maturity

StocksDividends and sales price when sold

15

Mortgages

Debt incurred in order to buy land or building

Amortizedprincipal and interest is gradually repaid over the life of loan

Fixed RateRate of interest is fixed

Variable-RateRate of interest varies


Variable-RateRate of interest varies depending on financial environment

Cash flow for lender is uncertain

Interest payments may vary - variable rate mortgages

Home owner may prepay

Refinance a fixed mortgage if interest rates decline 16

The Money Market Exchange of short-term instrumentsless

than one year

Highly liquid, minimal risk

Use of a temporary surplus of funds by banks or businesses

Treasury billsshort-term debts of the government


Treasury billsshort-term debts of the government

Bank Certificates of DepositsLiabilities of issuing bank, interest bearing to corporations that hold them

Commercial papershort-term liabilities of prime business firms and finance companies

17

Mutual Funds

Stock or bond market related institutions

Pool funds from many people

Invest in wide variety of securitiesminimize


Invest in wide variety of securitiesminimize risk

18

Difference Between Equity Debt

Represents Ownership Loan

Rate of Return

Long Term Return

Variable

Growth / Loss

Fixed

Fixed

Returns Dividend ( Sharing of Profit), Bonus

Interest(Coupon)


of Profit), Bonus shares

(Coupon)

Safety Low High

Voting Rights Yes except where stated

No

Tenure Long Term NearlyPerpetual

Fixed

Position at Liquidity Last Prior to Equity

19

Investment Bank Activities


Investment Bank Activities

20

Investment Banking Activities

Private Equity

Equity Research

Asset Management




Mergers and Acquisitions

Corporate Finance



Structured Finance and Loan Syndication

21

Private Equity


Private Equity

22

Risk vs. Return by Investor Class


Multiple

What is Private Equity

An asset class consisting of securities invested in operating companies with a view to generating value

Investment typically lasts between 3-7 years


Investment typically lasts between 3-7 years depending on the investment focus of the company.

24

History and Development

Originated in the US in the 40s with the founding of two Venture Capital firms American Research and Development Corporation (ARDC) and J.H. Whitney & Company.

First Leveraged Buyout (LBO) in 1955. LBO


First Leveraged Buyout (LBO) in 1955. LBO boom in the 80s with the emergence of Kohlberg Kravis Roberts & Co (KKR).

Purchase of RJR Nabisco for $31.1 billion in 1989 standout LBO deal and subject of a book (Barbarians at the Gates)

25

Industry Structure

Institutional Investors

Fund of Funds

2012 BSE Institute LimitedPGP Banking and Finance course - Investment Banking Operating Companies

Direct Investment

PE Fund PE Fund PE Fund PE Fund

26

Industry Players

Fund of Funds (Limited Partners)

Pool funds together on behalf of institutional investors to invest in PE funds

Institutional Investors (Limited Partners)


Institutional Investors (Limited Partners)

Insurance companies, Pension Funds, Family Offices seeking portfolio diversification

General Partners

Private Equity Fund Managers

27

Forms of Private Equity

Leveraged Buyouts

Growth / Expansion Capital

Venture Capital


Venture Capital

Others

Distressed Investments

Management Buyouts

28

Leveraged Buyouts

Companies are acquired using Financial Leverage

Leverage can account for between 50% and 90% of total transaction cost

Target companies usually mature with strong


Target companies usually mature with strong cash flows

Cash flows generated by company used to pay down debt.

Value generated when debt portion is paid down

29

Growth/Expansion Capital

Company seeking expansion

Typically profitable and able to generate cash, but not enough to finance expansion


PE company approach is typically more hands on.

Value is generated via: Good entry price

Operational/Margin improvements

Growth due to expansion

30

Venture Capital

Funds buy partial stake in an early stage company

Early stage companies go through various rounds of funding Stage A, B, C, D, E, etc.

Funds typically exit their investment with IPO or buyout from subsequent funding rounds


or buyout from subsequent funding rounds

Funds usually go public after scaling

Riskier than typical PE investment due to business failure

High return potentials e.g. Google, Microsoft, Facebook

31

Others

Management Buyouts

PE fund supports existing management to take over company

Reliance on management to derive value

Inherent alignment of interest is invaluable


Distressed Investments

Investment in equity or debt securities of financially stressed companies.

Value is generated by turning around the business in addition to the typically undervalued entry price

PE funds typically have relevant industry experience32

Sources of Value Creation in PE

Financial Engineering

Cheap Debt

Earnings Enhancement

Change in

External Factors

Rising stock


Cheap Debt Varied sources of

funding

Change in management

Disposal of unprofitable businesses

Cost cutting New products

Rising stock markets

Mergers & Acquisitions

33

Exit Routes in PE

Sale via equity markets

Self liquidating instruments (redeemable preference shares, convertible debt)

Put option (Sale of shares to management)

Leveraged refinancing


Leveraged refinancing

Secondary sale (To other PE firms)

34

Fund Economics

Two major models General Partner/Limited Partnership Model

Bank Subsidiary Model

Limited Partnerships usually last for 10 years


Successful PE firms (with GP/LP model) stay in business by raising a fund every 3 to 5 years

Management Fees and Carried Interest are primary sources of revenue

35

The LBO Business

Turn around

Replacement Capital

Institutional Buy -In

Management Buy In

Management Buy out


Sources of Capital & Risk Profile

Seed Start-upExpansion

CapitalPre -

FloatationLBOs


* Temporary phenomenon

Private Investors Angels

Specialist VCsPublic Markets*

Generalist VCsPublic Markets*

Generalist VCsInvestment Banks

Fund Managers

Buy-out Firms

Investment Banks

37

Private Equity Pros / Cons

Pros:

Private equity out performs over the long term

It is a loosely-correlated asset

May be able to increase performance without


May be able to increase performance without materially increasing risk

Cons:

High Risk

Low Liquidity

38

How do you invest in Private Equity?

Direct

Private Equity Manager

Fund of Funds

Quoted Investment Trust


Quoted Investment Trust

39

PE - Investment Return

20.0%20%

25%Illustrative data

onlyIllustrative data

only

Portfolio construction

Harvesting

Value creation

Private equity investment return in a partnership typically follows a J-curve e.g. in the early years while investments are being made a Private Equity fund will show negative returns.


6.5%

15.5%

20.0%

-2.0%-1.0%

13.5%

14.5%

-5.0%

-10%

-5%

0%

5%

10%

15%

0 1 2 3 4 5 6 7 8 9 10 11 12 13

YearIRR

40

Difference between PE & Venture Capital:

Private equity is sometimes confused with venture capital because they both refer to firms that invest in companies and exit through selling their investments in equity financing, such as initial public offerings (IPOs).

Major differences in the way firms involved in the two types of funding do things. They buy different types and sizes of companies, they invest different amounts of money and they claim different percentages of equity in the companies in which they invest.


equity in the companies in which they invest.

Difference I:

Private equity firms mostly buy mature companies that are already established. The companies may be deteriorating or not making the profits they should be due to inefficiency. Private equity firms buy these companies and streamline operations to increase revenues.

Venture capital firms, on the other hand, mostly invest in start-ups with high growth potential.

41

Difference between PE & Venture Capital:Difference II

Private equity firms mostly buy 100% ownership of the companies in which they invest. As a result, the companies are in total control of the firm after the buyout.

Venture capital firms invest in 50% or less of the equity of the companies. Most venture capital firms prefer to spread out their risk and invest in many different companies. If one start-up fails, the entire fund in the venture capital firm is not affected substantially.


in the venture capital firm is not affected substantially.

Difference III:

Private equity firms invest $100 million and up in a single company. These firms prefer to concentrate all their effort in a single company, since they invest in already established and mature companies. The chances of absolute losses from such an investment are minimal.

Venture capitalists spend $10 million or less in each company, since they mostly deal with start-ups with unpredictable chances of failure or success. 42

Difference between PE & Venture Capital:

Difference IV:

Private equity firms can buy companies from any industry, while venture capital firms are limited to start-ups in technology, biotechnology and clean technology.

Difference V:


Difference V:

Private equity firms also use both cash and debt in their investment, but venture capital firms deal with equity only.

These observations are the common cases. However, there are exceptions to every rule; sometimes one firm type does things out of the norm for its kind.

43

What roles do Associates play within the Investment Cycle?

Fund Raising

Liaise with fundraising consultants Participate in road shows

Deal

Sourcing

Help define Investment Strategy Review submitted business plans Work on Pitch books for prospective deals

Work with Due Diligence Consultants (Financial, Legal,


Deal Execution

Work with Due Diligence Consultants (Financial, Legal, Commercial, Technical)

Work on Transaction Documents (Investment Proposal, Financial Model, Offer Letters, Term Sheets, Legal Agreements)

Make presentations to Investment Committee Manage disbursement process

Deal Monitoring

Review weekly/monthly/quarterly performance reports Work with management to redefine business and corporate

strategy

Act as consultant where necessary. E.g. 2 month on-site placement to help resolve working capital management issues

Work with investment bankers to handle IPOs/Trade Sales/Rights Issues etc

44

Venture Capital:

Early Stage (Seed to Start-up): Capital for businesses in the conceptual stage or where products are not developed and revenues and/or profits may not have been achieved

Expansion Late Stage (First stage to Mezzanine): Growth or expansion capital for mature businesses in need of product extension and/or market expansion. Sometimes referred to as development capital

Buy-out Capital: Equity capital for acquisition or refinancing of a larger

Appendices - Definition of Terms


Buy-out Capital: Equity capital for acquisition or refinancing of a larger company

Restructuring Capital: New equity capital for financially/operationally distressed companies

Mezzanine (/subordinated) debt:

Intermediate debt capital between equity and senior debt for acquisition or refinancing transactions

The debt holder participates in equity appreciation through conversation features such as rights, warrants or options

45

Carried Interest (carry): This represents the share of a private equity funds profit that will accrue to the general partners

Fund of funds: Private equity funds whose principal activity consists of investing in other private equity funds. Investors in fund of funds can thereby increase their level of diversification

General Partner (GP) /Sponsor: Managing partner of a Limited

Appendices - Definition of Terms


General Partner (GP) /Sponsor: Managing partner of a Limited Partnership, who is responsible for the operations of the partnership and, ultimately any debts taken on by the partnership

Hurdle Rate (or Preferred Return): A hurdle return allows investors to get preferential access to the profits of the partnership. In absence of reaching the hurdle return, the general partners will not receive a share of the profits

Limited Partnership: Most private equity firms structure their funds as limited partnerships. Investors are the limited partners and private equity managers the general partners 46

Equity Research


Equity Research

47

Equity Research

A professional term for the work performed by securities analysts, whose profit forecasts define "Street expectations" during an earnings season.

Analysts are often assigned a sector to cover, such as biotech, technology, retail or


such as biotech, technology, retail or commodities.

Equity research is conducted through studying a composite of financial records, news stories and interviews with company insiders.

Also called Securities research

48

Equity Research

Securities analysts seek to develop, and thereafter communicate to investors, insights regarding the value, risk, and volatility of a covered security, and thus assist investors to decide whether to buy, hold, sell, sell short, or simply avoid the security in question or


simply avoid the security in question or derivative securities

49

Equity Research

To gather the information required to do so, securities analysts review

Periodic financial disclosures of the issuer and

Other relevant companies

Participate or listen in on management conference


Participate or listen in on management conference calls

Read industry news

Use trading history

Industry information databases

Interview managers and customers of the issuer, and

Sometimes perform their own primary research.50

Research Analyst

Equity research is conducted by sell-side analysts at Investment banks and Independent equity research boutiques.

On the buy-side, investors also perform buy-side research; however, this is often not published and is inconsistent.


published and is inconsistent.

Sell-side research is offered as part of a broad set of financial services including broking and corporate finance.

It is typically purchased by institutional investors through Thomson Reuters subscription services or Bloomberg terminals.

51

Research Analyst

Independent equity research has largely sprung into existence as a result of scandals such as Enron, Lernout & Hauspie and Worldcom where investment banks wrote positive research despite deteriorating fundamentals or fraudulent management.


fundamentals or fraudulent management.

Credit rating agencies such as Moody's, Fitch, and S&P provide a similar service for bond securities.

Retail investor firms such as Morningstar, SEENSCO, Valueline, and Zacks Investment Research.

52

Research AnalystSell-side Research:

Cover 7 12 related companies within an industry

Understand industry/companies better than anyone else in the country

Speak to management, customers, suppliers, etc.

Provide written commentary and company/industry


Provide written commentary and company/industry opinions to the buy-side

Ideas and insights are passed on to Sales for mass distribution

Frequent interaction with buy-side clients via phone or office visits

53

How it works:


How it works:

54

How It All Works & How the Sell-side Makes Money

Sell-side Buy-side

Analyst Portfolio ManagerOr Analyst


Sales Desk

Research analyst has information on Q4 Infrastructure, which will be a boon toL&T and Punj Lloyd.Information is given to Sales desk during morning call. Sales Desk calls Buy-side Client with Analyst recommendation

55

Sell-side Buy-side




Sales Desk

Portfolio manager discusses idea with Sales Person. He is interested in getting exposure to the group; cant decide between L&T and Punj LloydPM calls Analyst to discuss L&T and Punj Lloyd. Analyst provides opinion on which is a better Buy right now

56

Sell-side Buy-side




Sales Desk

Buy-side trader

Based on Analyst feedback, PM decides to buy shares of L&T. Calls her firms trade desk, places order for 100,000 shares. Tells trader to buy stock through Sell-side firm

57

Sell-side Buy-side




Sales Desk

Buy-side traderTrade Desk

Buy-side trader calls sell-side trade desk and places order for 100,000 shares of L&T. Sell side trader works the order. Finds seller of 100,000 shares at Rs 1500, takes shares and sells to Buy-side desk for Rs1510.

58

Sell-side Buy-side




Sales Desk

Buy-side traderTrade Desk

Rs500,000

Commission of Rs 500,000 on L&T trade is split amongst the three areas that contributed to the trade (Research, Sales, Trading).

59

Equity Research- Skills set required:

Intelligence

Analytical Skills

Strong writing skills

Ability to work in teams

Strong interpersonal skills


Strong interpersonal skills

Passion and interest in the market

Be able to have an opinion, and back it up!

60

Asset


Asset Management

61

Asset Management: The management of a client's investments by a financial

services company, usually an investment bank.

The company will invest on behalf of its clients and give them access to a wide range of traditional and alternative product offerings that would not be to the average investor.


An account at a financial institution that includes checking services, credit cards, debit cards, margin loans, the automatic sweep of cash balances into a money market fund, as well as brokerage services.

Also known as an Asset management account" or a Central asset account"

62

Users:

High net-worth individuals,

Governments,

Corporations and

Financial intermediaries.

This includes such products as equity, fixed income, real estate, agriculture and international investments.

Asset Management:


estate, agriculture and international investments.

When individuals deposit money into the account, it is placed into a money market fund that offers a greater return that can be found in regular savings and checking accounts. The added benefit to individuals is that they can do all of their banking and investing at the same institution instead of having a bank and brokerage account at two different companies.

63




64

Investment are subject to market risk. Read the offer document carefully

Pass performance is not a guarantee for future performance

PWM:


for future performance

65

International Taxation

Behavioral Finance

Relationship Management


Wealth Management

Alternative Products

Real Estate & PMS

Equity Analysis

Investment management is the professional management of various securities (shares, bonds, etc.) and other assets (e.g., real estate), to meet specified investment goals for the benefit of investors

Investors may be institutions (Insurance companies, Pension funds, Corporations etc.) or

PWM:


companies, Pension funds, Corporations etc.) or Private investors (both directly via investment contracts and more commonly via collective investment schemes e.g., mutual funds)

The investment management division of an investment bank is generally divided into separate groups, often known as Private Wealth Management and Private Client Services

67

WM deals with creation, accumulation,preservation and enjoyment of wealth

WM involves active management in terms ofidentifying and taking advantage of opportunitiesto create and enjoy wealth and can even includesharing of wealth through philanthropy

Wealth Management Process:


sharing of wealth through philanthropy

WM, would be as a comprehensive or specific setof plans and strategies designed to manage a setof assets or one large category of assets (e.g. aninvestment portfolio, closely held business,commercial real estate, etc.) towards specificoutcomes

68

Wealth Management is more comprehensive &provides greater attention to detail.

Once an individual accumulates enough wealth,and this is a moving target for each person, theystart thinking about Wealth Preservations andWealth Transfer, now we are into Wealth

Wealth Management Process:


Wealth Transfer, now we are into WealthPlanning

At this wealth breakpoint, an individual startsto think differently.

They will entertain more advanced strategicideas to transfer wealth efficiently and minimizetaxation.

69

Investment options are available range from :

Equity

Bonds

Mutual Fund

Hedge Funds

PWM: Investment Options


Hedge Funds

Real Estate

Alternate Investments

Above instruments has been known to you

70

FORMULATE INVESTMENT POLICY

Understand Needs for Return, Liquidity

Client Objectives

Interest Rate Management

Establish Investment Policy Parameters

Yield Curve Management

Determine Positioning on Yield

Sector Allocation

Identify Relative Value Between

Benchmarking & Reporting

Select Appropriate Index / Benchmark

Security Selection

Identify and Capture Value Between

DEVISE A STRATEGY EXECUTE MONITOR

Strategic Options

PWM: Stages


for Return, Liquidity and Preservation of CapitalDefine Investment Goals, Acceptable Investments, Portfolio Limitations, Responsible Parties and Authorized Broker / Dealer / Bank

Identify and Schedule Anticipated Cash Outlays

Policy ParametersAdjust Portfolio Maturity Profile Based on Interest Rate Outlook

Positioning on Yield Curve

Forward Break-EvenAnalysis

Horizon Roll-Down Analysis

Spread Analysis

Value Between Sectors

Yield vs. StabilityTaxable vs. Tax-Exempt

Index / BenchmarkConduct Periodic Performance MonitoringProvide Full FASB Compliance ReportingProvide Monthly Reports Conforming to Month End

Value Between Alternative Investments

Security AnalysisExecution

Down market protection - the potential to lower volatility and help preserve capital through volatile markets

Diversification - into assets that have a low correlation to traditional asset classes

Absolute returns - the ability to produce returns regardless of market direction

Why Alternative Investments?

2012 BSE Institute LimitedPGP Banking and Finance course - Investment Banking72

market direction

Alternatives as a Diversifier

Alternatives can diversify a portfolio and be positioned as a risk reduction component or a return enhancer

The Endowment Model

Alternative Investments represent as much as 30-40% of some leading universities endowment funds

Economic Seasons

Special Situations Capital Structure Arbitrage Fundamentally Undervalued Securities

Distressed Securities

Alternative Investments Cycle:


Merger Arbitrage

Long/Short EquityMacro Relative Value

E

c

o

n

o

m

i

c

A

c

t

i

v

i

t

y

AIM - Diligent Process and Strategies

Current Market Dynamics

Regulatory Environment

Market Participants

Financial Health of Sponsor

Experience, Track Record

Organizational Alignment

Risk Disclosure

Legal, Compliance Issues

Investment Team

Investment Process

Track Record

Return Potential

Risk Profile

MARKET ANALYSIS SPONSOR ANALYSIS PRODUCT ANALYSIS


Whenever possible , analysis is supplemented by customized review, analysis and reports from specialized third party experts

Private Equity Hedge Fund Strategies Real Estate Structure Products

Global Buyout

Distressed RealEstate

Mezzanine

Event Driven

Equity LongShort

Absolute Return

Trend

Managed Futures

Multi-Strategy

Core

Opportunistic

Value-Added

Principal Protected

Return Enhanced

Bull/Bear

Risk Profile

Identification Diligence and Monitoring

Broad Access to Innovative

Alternative Investment Research

Focused on fund of funds, hedge funds, real estate, private equity, structured products and other non-traditional assets.

Implementation

Market Analysis Concepts for combining


High Quality - Well Researched Products

Broad Access to Innovative Products

Market Analysis

Product Analysis Risk / Return

Focus on Low Leverage fundamental research oriented products

Cross wealth products (Mutual funds to Bonds)

Sponsor Analysis Operational Processes and Stability

Product Analysis Legal / Disclosure

Concepts for combining Alternative with Traditional assets

Risk and Global based implementation strategies

Type of Fund Key Services

Defined Benefit Plans

Defined Contribution Plans

Asset / Liability Studies Asset Allocation Advice Traditional and Alternative Investment Manager Search Capabilities Performance Measurement Reports Trust and Custody Services

Bundled Platform Services Investment Consulting for Fund Lineup Lifestyle Funds and Automatic Enrollment Personalized Asset Allocation Advice for Plan Participants

Complete Package of Services


Foundations and Endowments

Investment and Spending Policy Statements Traditional and Alternative Investments Board Member Communications

Specialized services for high net worth families including all of the above and art advisory, private banking, aircraft leasing and other capabilities

Personalized Asset Allocation Advice for Plan Participants

Family Offices and Private Individuals

Merger &

Acquisition


Acquisition

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Merger:

A transaction where two firms agree to integrate their operations on a relatively co-equal basis because they have resources and capabilities that together may create a stronger competitive advantage.

The combining of two or more companies,


The combining of two or more companies, generally by offering the stockholders of one company securities in the acquiring company in exchange for the surrender of their stock

Example: Company A+ Company B= Company C.

78

Acquisition:

A transaction where one firms buys another firm with the intent of more effectively using a core competence by making the acquired firm a subsidiary within its portfolio of business

It also known as a takeover or a buyout


It is the buying of one company by another.

In acquisition two companies are combine together to form a new company altogether.

Example: Company A+ Company B= Company A.

79

Difference Between Merger & Acquisition:

i. Merging of two organization in to one.

ii. It is the mutual decision.

iii. Merger is expensive than acquisition(higher legal cost).

iv. Through merger shareholders

i. Buying one organization by another.

ii. It can be friendly takeover or hostile takeover.

iii. Acquisition is less expensive than merger.

MERGER ACQUISITION


iv. Through merger shareholders can increase their net worth.

v. It is time consuming and the company has to maintain so much legal issues.

vi. Dilution of ownership occurs in merger.

than merger.

iv. Buyers cannot raise enough capital.

v. It is faster and easier transaction.

vi. The acquirer does not experience the dilution of ownership.

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Merger: Why & Why not?

i. Increase Market Share.

ii. Economies of scale

iii. Profit for Research and development.

iv. Benefits on account of

i. Clash of corporate cultures

ii. Increased business complexity

iii. Employees may be

Why Is Important Problem With Merger


81

iv. Benefits on account of tax shields like carried forward losses or unclaimed depreciation.

v. Reduction of competition.

iii. Employees may be resistant to change

Acquisition: Why & Why not

i. Increased market share.

ii. Increased speed to market

iii. Lower risk comparing to develop new products.

i. Inadequate valuation of target.

ii. Inability to achieve synergy.

iii. Finance by taking huge

WHY IS IMPORTANT PROBLEM WITH ACQUISTION


82

develop new products.

iv. Increased diversification

v. Avoid excessive competition

iii. Finance by taking huge debt.

Corporate


Corporate

Finance

83

Forms of Business Organization

Three major forms:

Sole proprietorship

Partnership

Corporation


Sole Proprietorship

Advantages Easiest to start

Least regulated

Single owner keeps all the profits

Disadvantages Limited to life of owner

Equity capital limited to owners personal wealth


the profits

Taxed once as personal income

wealth

Unlimited liability

Difficult to sell ownership interest

Partnership

Advantages Two or more owners

More capital available

Relatively easy to start

Income taxed once as

Disadvantages Unlimited liability

General partnership

Limited partnership

Partnership dissolves


Income taxed once as personal income

Partnership dissolves when one partner dies or wishes to sell

Difficult to transfer ownership

The Capital Budgeting Decision

Current Assets

Current Liabilities

Long-Term


Assets

Fixed Assets

1 Tangible

2 IntangibleShareholders

Equity

Long-Term Debt

What long-term investments should the firm choose?

87

Main tasks of corporate finance

Capital budgeting: the process of planning and managing a firms long-term investments fixed assets.

Capital structure: the mixture of debt and equity maintained by the firm S-T and L-T


Capital structure: the mixture of debt and equity maintained by the firm S-T and L-T debt and equity.

Working capital management: a firms short-term assets and liabilities current assets and current liabilities.

88

Corporate Finance

is concerned with the efficient and effectivemanagement of the finances of an organization inorder to achieve the objectives of thatorganization.

This involves


This involves Planning & Controlling the provision of resources

(where funds are raised from)

Allocation of resources (where funds are deployed to)

Control of resources (whether funds are being usedeffectively or not)

89

Difference - CF & Financial A/c

Corporate Finance

is inherently forward-looking and based oncash flows.


Financial Accounting

is historic in nature and focuses on profit ratherthan cash.

90

Corporate Finance

is concerned with raising funds and providing a returnto investors.

Management Accounting

Difference - CF & Financial A/c


Management Accounting

is concerned with providing information to assistmanagers in making decisions within the company.

91

Key Concepts in Corporate Finance

The fundamental concepts in helping managers tovalue alternative choices are

Relationship between Risk and Return


Time Value of Money

92


This concept states that an investor or acompany takes on more risk only if higherreturn is offered in compensation.

Return refers to

Financial rewards gained as a result of making an


Financial rewards gained as a result of making aninvestment.

The nature of return depends on the form of theinvestment.

A company that invests in fixed assets & businessoperations expects return in the form of profit(measured on before-interest, before-tax & an after-tax basis)& in the form of increased cash flows. 93


Risk refers to

Possibility that actual return may be different from theexpected return.

When Actual Return > Expected Return

This is a Welcome Occurrence.

When Actual Return < Expected Return


When Actual Return < Expected Return

This is a Risky Investment.

Investors, Companies & Financial Managers are morelikely to be concerned with Possibility that Actual Return < Expected Return

Investors & Companies demand higher expected return Possibility of actual return being different from expected return

increases. 94

Time Value of Money

Time value of money is relevant to both

Companies

Investors

In wider context,


In wider context,

Anyone expecting to pay or receive money over a period of time.

Time value of money refers to the facts that

Value of money changes over time.

95

Time Value of Money

Imagine that your friend offers you either Rs.1000today or Rs.1000 in one years time.

Faced with this choice, you will (hopefully) prefer totake Rs.1000 today.


The question is to ask that why do you prefer

Rs.1000 today?

96

Time Value of Money

Solution: There are three major factors

Time: If you have the money now, you can spend it now.It is human nature to want things now rather than wait forthem. Alternatively, if you do not want to spend moneynow, you can invest it, so that in one years time you willhave Rs.1000 plus any investment income earned.


have Rs.1000 plus any investment income earned.

Inflation: Rs.1000 spent now will buy more goods &services that Rs.1000 spent in one years time becauseinflation undermines the purchasing power of your money.

Risk: If you take Rs.1000 now you definitely have themoney in your possession. The alternative of the promiseof Rs.1000 in a years time carries the risk that thepayment may be less that Rs.1000 or may not be paid atall. 97

Compounding

is the way to determine the future value of a sum ofmoney invested now.

FV = C0(1+i)n

Where: FV = Future Value

C0 = Sum deposited now

i = Interest Rate


i = Interest Rate

n = number of years until the cash flow occurs

Example: Rs. 20 deposited for five years at an annualinterest rate of 6% will have future value of:

FV = 20 x (1+.06)5 = Rs.26.76

Compounding takes us forward from current value of aninvestment to its future value.

98

Discounting

is the way to determine the present value of future cashflows.

PV = FV / (1+i)n

Where: FV = Future Value

PV = Present Value

i = Interest Rate


n = number of years until the cash flow occurs

Example: Investor choice between receiving Rs.1000 now& Rs.1200 in one years time. Annual Interest rate is 10%.

PV = 1200 / (1 + 0.1)1 = Rs.1091

Alternatively, PV of Rs.1000 into a FV

FV = 1000 x (1 + 0.1)1 = Rs.1110

Discounting takes us backward from future value of a cashflow to its present value. 99

Corporate Objectives

The objective should be to make decisions thatmaximise the value of the company for itsowners.

Financial Objective of Corporate Finance is statedas Maximisation of shareholder wealth.


Shareholder receive their wealth through increasein value of their shares, in the form of

Dividends

Capital Gains

Shareholder wealth will be maximised bymaximising the value of dividends and capitalgains that shareholders receive over time. 100

Corporate Structure

Sole Proprietorships

Partnerships

Unlimited LiabilityPersonal tax on profits


Corporations

Limited LiabilityCorporate tax on profits +Personal tax on dividends

101

The Finance Function

Chief Financial Officer


ComptrollerTreasurer

102

Financial managers

Frequently, financial managers try to address these tasks.

The top financial manager within a firm is usually the Chief Financial Officer (CFO).

Treasurer oversees cash management, credit management, capital expenditures and


Treasurer oversees cash management, credit management, capital expenditures and financial planning.

Controller oversees taxes, cost accounting, financial accounting and data processing.

103

Role of The Financial Manager

Financial

managerFirm's

operations

Financial

markets

(1)


(1) Cash raised from investors

104


Financial

managerFirm's

operations

Financial

markets

(1)(2)


(1) Cash raised from investors(2) Cash invested in firm

105


Financial

managerFirm's

operations

Financial

markets

(1)(2)



(3) Cash generated by operations

(3)

106


Financial

managerFirm's

operations

Financial

markets

(1)(2)

(4a)



(3) Cash generated by operations(4a) Cash reinvested

(3)

107


Financial

managerFirm's

operations

Financial

markets

(1)(2)

(4a)



(3) Cash generated by operations(4a) Cash reinvested(4b) Cash returned to investors

(3) (4b)

108

While accountancy plays an important role within corporate finance, the fundamental problem addressed by corporate finance is economic, i.e. how best to allocate the scarce resource of capital.

Aim of Financial Manager


Aim of Financial Manager is the optimal allocation of the scarce resources available to them.

109

Financial managers are responsible for making decisions about

Raising funds (the financing decision),



Allocating funds (the investment decision) and

How much to distribute to shareholders (the dividend decision).

110

The high level of interdependence existing between these decision areas should be appreciated by financial managers when making decisions



Can you think how these decisions may be inter-related?

111

Interrelationships - Investment, Financing & Dividend Decisions

Investment:Company decides to takeon a large number ofattractive newinvestment projects

Finance:Company will need toraise finance in order totake up projects

Dividends:If finance is not available fromexternal sources, dividends mayneed to be cut in order toincrease internal financing.

Dividends:Company decides to payhigher levels of dividend

Finance:Lower level of retainedearnings available for

Investment:If finance is not available fromexternal sources than company


higher levels of dividendto its shareholders

earnings available forinvestment meanscompany may have tofind finance from externalsources.

external sources than companymay have to postpone futureinvestment projects.

Finance:Company finances itselfusing more expensivesources, resulting in ahigher cost of capital.

Investment:Due to a higher cost ofcapital the number ofprojects attractive to thecompany decreases.

Dividends:The companys ability to paydividends in the future will beadversely affected.

112

Maximisation of a companys ordinary share price is used as a surrogate objective to that of maximisation of shareholder wealth.



Ownership vs. Management

Difference in Information

Stock prices and returns

Different Objectives

Managers vs. stockholders

Top mgmt vs.


returns

Issues of shares and other securities

Dividends

Financing

Top mgmt vs. operating mgmt

Stockholders vs. banks and lenders

114

Modern form of firms

Corporation: a business created as a distinct legal entity composed of one or more individuals or entities, e.g., IBM.

Separation of control (shareholders) and management (professionals).


management (professionals).

Ownership can be easily transferred.

Limited liability.

Double taxation.

Rather expensive to form.

Agency problems.

115

Goals of financial management

Survive

Beat the competition

Maximize sales

Maximize net income

Maximize market share


Maximize market share

Minimize costs

Maximize the value of (stock) shares

116

Appropriate Goal of Financial Management

Maximize the (fundamental or economic) value of (stock) shares is the right goal.

Why? Shareholders own shares. Managers, as agents, ought to act in a way to benefit shareholders; i.e., to enhance the value of


shareholders; i.e., to enhance the value of the shares.

A limitation of this goal is that value is not directly observable.

117

Value vs. Price

The value of shares are not observable. In contrast, the price of shares can be observable.

If one believes that share price is an accurate/good estimate of share value, the appropriate goal would be to maximize the price of shares.


of shares.

This belief/assumption is, however, questionable.

Study shows that Investors care about stock price, and that stock price performance is very important to the tenure of managers.

118

Corporate


Corporate

Advisory Services

119

Corporate Advisory Services:

Corporate advisory revolves around advising an organisation (such as a corporation, government or other institution) on activities like

Mergers and Acquisitions,


Mergers and Acquisitions, Corporate Division and restructuring and Other transactions that involve a change of

ownership. In the sphere of investment banking this service is typically referred to as M&A.

120

Various Services:

Various sorts of transactions are possible and include Mergers, Acquisitions, Defences, Disposals,


Disposals, Demergers, Spin-offs, Privatisations, Joint ventures and Leveraged buyouts, among others.

121


These sorts of transactions can affect both privately owned and public companies, the latter of which may involve substantial general market involvement or negotiations with only one or two major shareholders.


one or two major shareholders.

Any M&A activity there must be at least two parties involved, a buyer and a seller, referred to as the bidder and the target. In a straight-out sale the seller is referred to as a vendor.

122

Project Consulting :

Investment Appraisal of Companies.

Project Conceptualization and Related Services, including Guidance in relation to Selection of Projects, Preparation of Feasibility Studies, Detailed Project Report (DPR), Capital Structuring, Techno-Economic



Report (DPR), Capital Structuring, Techno-Economic Feasibility, Financial Engineering, Project Management Design etc.

Documentation of various project documents.

Syndication of debt on competitive terms.

Syndication of Equity.

Arranging Private Equity.

123

Mergers and Acquisition :

Buy / Sell Advisory

Identification of Potential Projects

Business Valuation

Due Diligence

Assisting in Negotiation Process



Assisting in Negotiation Process

Financial Structuring

Drafting and Execution of Transaction Documents

Deal Financing

Sell-Side Advisory including valuation, negations with potential client's evaluation of Bids etc.

124

Disinvestment/ Bid Process Management :

Preparation of Project Information Memorandum (PIM) and Confidential. Information. Memorandum (CIM), Request for Proposal (RFP) and Request for Quotation (RFQ).

Advertisement for inviting bids, Structuring of Bid Evaluation Criteria.



Evaluation Criteria.

Conducting Pre-bid meetings, Designing and execution of Non Disclosure Agreements, Technical and Financial Evaluation of Bids.

Fixation of Reserve Price/upset price, Selection of successful bidders and Execution of Memorandum of Understanding (MoUs) and Agreement.

125

Joint Venture / Public- Private Partnerships (PPP) Advisory :

Formulation of vision/strategy and preparation of Business Plan.

Partner Evaluation, Selection, Detailed Structure of Joint Venture and Due Diligence.



Joint Venture and Due Diligence.

Negotiation and Legal Documentation.

Business Integration, Planning and Implementation, Managing and Monitoring of the documentation, transaction and transition process.

126

Corporate Restructuring :

Financial & Legal Due-diligence.

Optimisation of Capital Structure & Asset Portfolio, Market Analysis, Cost-Benefit Analysis.

Operational Restructuring, Preparation of Business plan.



plan.

Funding Strategy, Preparation of relevant Agreements/ Legal Documents.

Bidding Advisory :

Consultancy to clients bidding for Power Projects, Ultra Mega Power Projects (UMPP), Gas Pipeline, City Gas Distribution (CGD) etc.

127




128

Underwriting:

As per regulations, in case of an IPO if 90% of the issue price is not received as subscriptions, the issue gets DEVOLVED.

Issuer has to return the money back to the investors.

Issuer has already spent time, effort and


Issuer has already spent time, effort and money (5 10%) for the IPO issue.

Hence, underwriter is appointed who assures issuer of a minimum subscription

129

Underwriting:

Underwriter will guarantee a certain price for a certain number of securities to the party that is issuing the security (in exchange for a fee).

Thus, the issuer is secure that they will raise a certain minimum from the issue, while the underwriter bears the risk of the issue.


underwriter bears the risk of the issue.

Underwriters make their income from the price difference (the "underwriting spread") between the price they pay the issuer and what they collect from investors or from broker-dealers who buy portions of the offering.

130

Underwriting:Risk and reward:

Underwriter bears the risk of being unable to sell the underlying securities, and the cost of holding them on its books until such time in the future that they may be favourably sold.

Securities issuer gets cash up front, access to the


Securities issuer gets cash up front, access to the contacts and sales channels of the underwriter, and is insulated from the market risk of being unable to sell the securities at a good price.

The underwriter gets a profit from the mark-up, plus possibly an exclusive sales agreement.

131

Best-Efforts underwriting

This is an agreement between the issuer and the underwriter (investment bank)

The underwriter agrees to sell as much of the offering as possible at the agreed upon price to investors


The investment bank is not responsible for any of the unsold offering but it can purchase the remaining shares/debt if it chooses to

Example: Ford offers a $10 million bond issue the investment bank sells 9.5 mill of the issue. The remaining .5 mill remains unsold or is purchased by the underwriter 132

Firm commitment underwriting

An agreement between the issuer and underwriter

The underwriter agrees to purchase the issue at the agreed upon price


The underwriter then tries to sell the issue to public investors at a higher price

The underwriter is responsible for the unsold portion

133

Structured Finance

&


&

Loan Syndication

134

Structured Finance:

Structured finance is a broad term used to describe a sector of finance that was created to help transfer risk using complex legal and corporate entities.

This transfer of risk, as applied to the securitization of various financial assets


securitization of various financial assets

Mortgages

Credit card receivables

Auto loans

has helped provide increased liquidity or funding sources to markets like housing and to transfer risk to buyers of structured products. 135

Structured Finance

It also permits financial institutions to remove certain assets from their balance sheets as well as provides a means for investors to gain access to diversified asset classes.

However, it arguably contributed to the


However, it arguably contributed to the degradation in underwriting standards for these financial assets, which helped give rise to both the inflationary credit bubble of the mid-2000s and the credit crash and financial crisis of 20079.

136

Structured Finance

Common examples of instruments created through securitization include

Collateralized debt obligations (CDOs) and

Asset-backed securities


Asset-backed securities

137

Collateralised Asset Process Flow


Loan Syndication


Loan Syndication

139

Syndicated Loan

JLR, which was acquired by Tata Motors from Ford Motor for $2.3 billion in March 2008

In Oct. 2009, it secured 500m of new finance, including a 175m loan with the State Bank of India. The company has also won a $90m (57m) export financing facility with


$90m (57m) export financing facility with ABC International Bank.

The remaining funding has been made with Standard Chartered, Bank of Baroda, and Burdale Financial Limited, a subsidiary of the Bank of Ireland

140

Syndicated Loan - Definition

A syndicated facility is a lending facility, defined by a single loan agreement, in which several or


agreement, in which several or many banks participate

141

Global Syndicated Loan Markets

Market & Centre

1. US Market - New York


2. European Market - London

3. Asian Market Hong Kong

142

A borrower wants to raise relatively large amount of money quickly and conveniently

The amount exceeds the exposure limits or appetite of any one lender

Syndicated Loan Why?


appetite of any one lender

Borrower does not want to deal with a large number of lenders

143

Syndicated Loan - Features

Two or more banks (the syndicate of Lenders) contract with a borrower to provide credit on common Terms and conditions governed by a common document.

Multi-bank transaction, each bank acting


Multi-bank transaction, each bank acting severally.

Although common documentation, a bank has ultimately, the individual right to take legal action against borrower

144

Syndicated Loan - Features

Interest usually accrues at a variable or floating rate and is reset periodically, at agreed intervals, usually at borrowers choice.

Usually of medium term maturity, 3-10 years. Banks participate on common terms and


Banks participate on common terms and conditions, but not necessarily in equal amounts

145

Lead Bank/Manager

Borrower

Under writer


Lead Bank/Manager

Bank CBank BBank A

146

Lead Manager

The bank that is awarded the mandate by the prospective borrower

It is responsible for placing the syndicated loan with other banks and


It ensures that the syndication is fully subscribed

Eligible for arrangement fee

147

Underwriting Bank

Bank that commits to supplying the funds to the borrower if necessary from its own resources if the loan is not fully subscribed

Risk factor


Loan may not be fully subscribed

Not all syndicated loans are underwritten

148

Participating Bank

The bank that participates in the syndication by lending a portion of the total amount required

Interest income and participation fees


Interest income and participation fees

149

Participating Bank

Risks

Credit risk of the borrower normal

Participating bank may be led to into passive approval and complacency (when many high


approval and complacency (when many high profile banks cannot be wrong?)

Funding risk: mismatch of inflows and outflows

150

Dealing with single bank - Single contact point & Single set of documents

Access to large amount of funds

Advantages to the Borrower


Sophisticated investor base

151

Relatively lower price & finer terms and highly flexible

Access to wide range of banks

Advantages to the Borrower


Greater speed & reasonable certainty of obtaining funds simpler than other ways of raising capital ( issuing of bonds or equity)

152

Advantages to the Lead Bank

Arrangement fees income without committing capital

Enhancing banks reputation


Enhancing the banks relationship with the client

153

Diversification of risks (exposure norms prescribed by Central Banking authority)

RBI guideline to Bank to reduce exposure to 25% of their Capital

Advantages to Participating Banks


Access to lending opportunities with low marketing cost

Opportunities to participate future syndications

154

In case of borrower runs into difficulties, participant banks have equal treatment no disadvantage of the size vis--vis dominant bigger banks

Recognition

Advantages to Participating Banks


Recognition

Return by way of Interest & Fees

Transferability

155

Term Loans

Revolving Credit

Standby Facility

Instruments:


Standby Facility

156

Stages:

The Prospective Borrower May Liaise With A Single Bank Or It May Invite Competitive Bids From A Number Of Banks.

The Lead Bank Needs To:Identify The Need Of The Borrower


Identify The Need Of The Borrower

Designing Appropriate Structure

Develop A Persuasive Proposal

On Approval Award Of Mandate157

Interest Spread Depends Upon:

Risk -Whether Sovereign Or Public / Joint Venture Or Private Sector

Industry Or Activity Of The Company Credit Rating Of The Country Credit Rating Of The Borrower/Group

Pricing:


Credit Rating Of The Borrower/Group Period / Average Life Of The Loan - 3-5-7

Years?

Repayment/ Structure - Whether Bullet Or Amortisation?

158

Reserve clause - increased cost revision of interest rate

Default clause right to recall Jurisdiction for settlement of disputes Availability of draw down subject to

availability of funds

Term Sheet:


availability of funds

Key documentation clauses Material adverse change clause - negative

lien

Expiry date

159

Preparation by Law Firm

Incorporation of Terms Specific / General role of each party clearly defined

Revision, Negotiation & Finalisation

Documentation:


Revision, Negotiation & Finalisation

LMA Recommended Form of Primary Documents (Loan Market Assn, London)

160

WHY:

Liquidity & Trading Profits

Exposure Management

Reduction & Diversification of Risks

Secondary Market Transfers:


Reduction & Diversification of Risks

Regulatory Constraints

Asset Building and Relationship

161

Secured / Unsecured


Secured / Unsecured

Funded Activities

163

Funding needs of corporates

Short-term FundingShort-term Funding Long-term FundingLong-term Funding

Meeting operational requirements Filling temporary cash-flow mismatches Generally, revolving in nature

Meeting operational requirements Filling temporary cash-flow mismatches Generally, revolving in nature

Meeting capital expenditure needs Financing specific projects Generally, non-revolving in nature

Meeting capital expenditure needs Financing specific projects Generally, non-revolving in nature


Fund-based credit facilitiesFund-based

credit facilitiesNon-fund based credit facilities

Non-fund based credit facilities

Fund-based credit facilitiesFund-based

credit facilitiesNon-fund based credit facilities

Non-fund based credit facilities

Working Capital Loans

Card Finance

Working Capital Loans

Card Finance

Letters of Credit Bank Guarantees Letters of Credit Bank Guarantees

Term Loans Project Finance Term Loans Project Finance

Letters of Credit Bank Guarantees Letters of Credit Bank Guarantees

Funded / Non funded Advances

Funded facilities:

Bank releases loan money / funds to the borrower

Non funded facilities:


Non funded facilities:

Bank does not release money when limit is sanctioned. But the bank (Issuer / Guarantor) gives a guarantee or promise or undertaking (Letter of Credit) on behalf of the customer (Applicant) in favour of third parties (Beneficiaries)

165

Funded / Non Funded Advances (contd)

The bank pays the beneficiaries if the customer fails to do pay or perform in terms of the guarantee / undertaking

At the time the bank makes such payments, the


At the time the bank makes such payments, the Non-funded credit facility becomes a funded facility i.e. a loan to the customer

166

Fund Based Non Fund Based

There is immediate out go of funds

No Immediate outgo of Fund but definite commitment

Money is paid to the Amount committed to

Form of Bank Lending


Money is paid to the Borrower

Amount committed tosomeone who he wants to become payable / funded

Appears on Bank Balance sheet

Appears as a foot note to Balance sheet

167

Front Office Middle Office

&


& Back Office

Why we need to segregate?

Segregation of roles and responsibilities to avoid frauds and ensure accountability


Better focus on each area

Employees having different skills set for carrying out various operations.

169

An investment bank is split into the so-called

Front Office

Middle Office and

Back Office.

Segregation of Bank


Back Office.

170

Front Office


Investment Banking is the traditional aspect ofinvestment banks which involves

Helping customers raise funds in the CapitalMarkets and

Advising on mergers and acquisitions.

Front Office:


Investment bankers prepare idea pitches thatthey bring to meetings with their clients, withthe expectation that their effort will be rewardedwith a mandate when the client is ready toundertake a transaction.

172

Front office is generally described as a revenue generatingrole.

There are two main areas within front office,

Investment Banking and

Markets.

Front Office:


Investment Banking involves advising the world's largestorganisations on mergers, acquisitions, as well as a widearray of fund raising strategies

Markets is divided into sales, trading, some research andalso structuring.

173

Once mandated, an investment bank is responsiblefor preparing all materials necessary for thetransaction as well as the execution of the deal,which may involve subscribing investors to asecurity issuance, coordinating with bidders, ornegotiating with a merger target.

Front Office:


Other terms for the Investment Banking Divisioninclude

Mergers & Acquisitions (M&A) and

Corporate Finance (often pronounced).

There are two main areas within front office, i.e.Investment Banking and Markets.

174

Investment Banking


Corporate finance is the traditional aspect of investmentbanks which also involves helping customers raise fundsin capital markets and giving advice on mergers andacquisitions (M&A).

This may involve subscribing investors to a securityissuance, coordinating with bidders, or negotiating witha merger target. Another term for the investment

Investment Management:


a merger target. Another term for the investmentbanking division is corporate finance, and its advisorygroup is often termed "mergers and acquisitions".

A pitch book of financial information is generated tomarket the bank to a potential M&A client; if the pitch issuccessful, the bank arranges the deal for the client.

176

Investment banking division (IBD) is generally divided intoindustry coverage and product coverage groups:

Industry coverage groups focus on a specific industryviz. Healthcare, Public finance (governments), FIG(financial institutions group), industrials, TMT(technology, media, and telecommunication)

Maintains relationships with corporations within the

Investment Management:


Maintains relationships with corporations within theindustry to bring in business for the bank.

Product coverage groups focus on financial products viz.M&A, leveraged finance, public finance, asset financeand leasing, structured finance, restructuring, equity,and high-grade debt

Generally work and collaborate with industry groups onthe more intricate and specialized needs of a client.

177

Markets

Sales and Trading


Sales and Trading

178

Sales and Trading

is often the most profitable area of aninvestment bank.

Responsible for the majority of revenue of


Responsible for the majority of revenue ofmost investment banks

In the process of market making, traders willbuy and sell financial products with the goal ofmaking an incremental amount of money oneach trade.

179

Sales is the term for the investment banks salesforce, whose primary job is to call oninstitutional and high-net-worth investors tosuggest trading ideas (on caveat emptor basis)and take orders.

Sales and Trading


Sales desks then communicate their clients'orders to the appropriate trading desks, who canprice and execute trades, or structure newproducts that fit a specific need.

180

Research


Research

is the division which reviews companies andwrites reports about their prospects, often with"buy" or "sell" ratings.

While the research division generates norevenue, its resources are used to assist tradersin trading, the sales force in suggesting ideas to


in trading, the sales force in suggesting ideas tocustomers, and investment bankers by coveringtheir clients.

In recent years the relationship betweeninvestment banking and research has becomehighly regulated, reducing its importance to theinvestment bank.

182

Structuring


Structuring

Structuring has been a relatively recentdivision as derivatives have come into play,with highly technical and numerate employeesworking on creating complex structuredproducts which typically offer much greater


products which typically offer much greatermargins and returns than underlying cashsecurities.

184

Middle Office


Middle Office

185

Risk Management involves analyzing themarket and credit risk that traders are takingonto the balance sheet in conducting their dailytrades, and setting limits on the amount of

Middle Office


trades, and setting limits on the amount ofcapital that they are able to trade in order toprevent 'bad' trades having a detrimental effectto a desk overall.

186

Another key Middle Office role is to ensure thatthe above mentioned economic risks are:

Captured accurately (as per agreement ofcommercial terms with the counterparty)

Middle Office


Correctly (as per standardized booking modelsin the most appropriate systems) and

On time (typically within 30 minutes of tradeexecution).

187

In recent