What is Investment Banking?

An investment bank is a financial institution that raises capital, trades securities and manages corporate mergers and acquisitions.

In brief:

• Investment Banking tries to match people who havemoney to those that need money

• Acts as a middleman by facilitating the flow of savings from those economic units that want to invest to those units that want to raise funds.

• Corporations• Governments• Municipalities

Providers of Capital

Investment Banking

Chinese Wall

Sales & Trading

Research

Capital Need

Investment Banking

Sell sideBuy side

“Buy" side / “Sell" side

Examples “Buy side”

Suppose an investor wants to purchase 100 shares of company X. They can solicit the services of an investment bank, where a

stock broker can place an order and deliver these shares.

INVESTMENT BANKER

Examples “Sell side”

Suppose company X plans to raise capital by issuing new shares of stock in an initial public offering (IPO) , X can solicit an

investment bank to underwrite the shares, market and sell them to their clients.

Activities under Investment Banking

What Does An Investment Banker Do?

STARTS

Idea Generation & Problem Solving

• Strategic Alternatives

• Raising Capital

• Capital Structure Optimization

• Risk Management, Dividend Policy

Client Relationship Management

• Ongoing dialogue on financial markets, industry developments, new products

• Long-term relationship as advisor to Senior Management and Boards

Opportunities Assessment

ACTIONS

Financial Analysis

Communication

• Management, Board of Directors

• Internal Committees

Potential Investors Identification

Negotiation / Structuring Transactions

Due Diligence

Documentation

Top IB Players in US and Europe

Overview of the IB Industry US (2013)

Market Share

- J.P. Morgan Chase & Co. - 12.4%

- Bank of America Corporation – 9.6%

Annual Growth 13-18

3.2%

Revenue

$149.5bn

Annual Growth 08-13

2.8%

Market Share

- The Goldman Sachs Grp - 9.4%

- Morgan Stanley – 7.2%

- Citigroup Inc. – 5.9%

Wages

$33.9bn

Profit

$22.3bn

Businesses

9,049

Top IB Players in US

54%

20%

16%

10%

Products & Services Segmentation

Trading & Related Services

Corporate Finance Services

Underwriting Securities ( Equity and Debt )

Financial Advisory Services

Structure of an Investment Bank

Research department

enables the bank as well as its clients to take informed

decisions

Capital markets trading and investment

responsible for all investments into the securities markets

Corporate finance department

caters to the funding requirements of a company

FRONT OFFICE- Raise Capital- Sales & Trading- Research

MIDDLE OFFICE- Risk Management- Financial Control- Corporate Treasury. Strategy and Compliance

BACK OFFICE- Operations- Technology

Revenue sources of the Investment Banks

• Charged for advice, providing finance, keeping money available for clients, trading services, investment services, and research

Fees

• Income from investments made in sharesDividends

• Income from loans madeInterest

• Profits from investments madeInvestments

• Profit made from buying and selling securitiesTrading

780

639

971

750

562

401

459

450

81

291

919

693

824

779

609

540

535

443

239

435

2,247

1,948

1,239

1,106

1,335

1,428

1,254

1,199

1,032

584

0 500 1000 1500 2000 2500 3000 3500 4000 4500

JPMorgan

Bank of America Merrill Lynch

Goldman Sachs

Morgan Stanley

Citi

Deutsche Bank

Credit Suisse

Barclays

RBC Capital Markets

UBS

Revenue in million U.S. dollars

Revenue of the world's largest investment banks, by product group(in million U.S. dollars; as of August 27, 2013)

Mergers & Acquisitions Equity Capital Markets Debt Capital Markets & Loans

Revenue figures of Top IB Firms

SERVICES PROVIDED BY INVESTMENT BANKS

Mergers & Acquisitions

Company

X

Company

Y

Company

Z

Company

A

Company

B

Company

A

Copyright © 2013 CFA Institute 17

Merger with Consolidation Acquisition

Types of Mergers & Acquisitions

M&A

Acquisition

Share purchase Asset purchase

Merger ConsolidationLeveraged

buyoutHolding Divestitures

Why Do Mergers And Acquisitions Occur?

Creating Value

• Increasing market power

• Synergy

• Growth

• Acquiring unique capabilities or resources

• Unlocking hidden value

Cross-Border Mergers

• Overcoming adverse government policy

• Exploiting market imperfections

• Product differentiation

• Technology transfer

• Following clients

Dubious Motives

• Tax considerations

• Diversification

• Bootstrapping earnings

• Managers’ personal incentives

Example Of A Merger: AMR And U.S. Airways

• U.S. Airways proposes merger to bankrupt AMR.

April 2012

• AMR creditors encourage AMR to merge with another airline, instead of emerging from bankruptcy alone.

July 2012

• AMR and U.S. Airways begin merger discussions.

September 2012

• U.S. Airways proposes merger, with its shareholders owning 30% of the new company.

November 2012

• Details of the merger are worked out.

• Merger filed with the FTC under Hart-Scott-Rodino Act.

February 2013

M&A: Synergy

Synergy occurs when the whole is greater than sum of its parts. For example, in terms of math it could be represented as

“2+2=3” or as “2+2=5”.

In the context of mergers, there can be two types of synergy:

The first type of synergy results in economies of scale, which refers to decreased costs ( Cost synergy)

Another type of synergy results in increased revenues such as cross-selling (Revenue Synergy)

Example: Bootstrapping earnings

Company One Company TwoCompany One

Post-Acquisition

Earnings $100 million $50 million $150 million

Number of shares 100 million 50 million 125 million

Earnings per share $1 $1 $1.20

P/E 20 10 20

Price per share $20 $10 $24

Market value of stock $2,000 million $500 million $3,000 million

22

Assumptions:• Exchange ratio: One share of Company One for two shares of Company Two• Market applies pre-merger P/E of Company One to post-merger earnings

Bootstrapping earnings is the increase in earnings per share as a result of a merger, combined with the market’s use of the

pre-merger P/E to value post-merger EPS.

ADVISORY SERVICES

Advisory Services

Business Planning

These include sharpening value proposition, definition of markets/ industry/ customer, financial projections, milestones and risk planning and creating a business plan document.

Intellectual Property & Technology Commercialization

These include preliminary patentability analysis, IP landscapes, IP portfolio analytics & planning, basic IP knowhow & infringement issues, etc.

Nuts-and-Bolts of Company Creation and Management

These include company incorporation, financial & accounting setup, HR processes, import/export basics, regulatory requirements, etc.

Science & Technology

These include technology road-maps, strategy creation & due diligence; with an emphasis on chemical, materials and biological sciences; instrumentation, scientific software, informatics, and scientific services.

Fund Raising

These include planning & matching start-up capital requirements with appropriate sources of funding; ranging from governmental agencies (e.g.. DST, MoMSME) to HNIs/angels and professional investors such as venture capital firms.

Market and Industry Insights

In specific domains, Venture Center can provide insights into specific markets or industry segments in India.

Broad Services under this :

RAISING CAPITAL AND SECURITY UNDERWRITING

Primary Market/Secondary Market

Primary Market

(Newly Issued Securities)

Raise New Capital for the corporate

IB’s create a public market for their client’s

securities

Secondary Market

(Previously Issued Securities)

Market makers facilitate trading of old securities

Trades through agency : e.g. broker operating through an

exchange like NYSE

Trades through principal transactions

Raise Capital

There are several ways in which firm can raise capital in the public market:

• Private corporate issues public traded shares for the first time

Initial Public Offering

• Existing public firm issues new shares again in the market

Seasoned Equity Offering

• Corporate issues shares in a subsidiary to the public

Carve Out

• Corporate issues all subsidiary shares to their current shareholders

Spin Off

• Debt Issuances : Coporate Bonds

Fixed Income

• Share offered directly to public shareholders

Direct Public Offering

Raise Capital

Firms can skip going public by going to private market:

Going to Large Investors :

Insurance Companies

Wealthy Individuals

Mutual Funds

Other Corporate, etc.

Private Placement can be below the Market Price

Easier to renegotiate than public issues

Underwriting

Definition of 'Underwriting‘

The process by which investment bankers raise investment capital from investors on behalf of corporations and governments that are issuing securities (both equity and debt).

The process of guaranteeing the placement of new debt or equity with public financial markets

Securities Underwriting : The IPO Process

Firm Selects an Underwriter ( Investment Bank) and agree on the offering method

Valuing the Offer

- SEC Filing

- Syndication

- Road-show

- Offer

- Quiet Period

Fees of IB

Example of Securities Underwriting

Gillette wants to raise some money for a new project through issue of new stock

JPMorgan will then underwrite the offering. It will use its institutional sales force to go out and get Fidelity and many other institutional investors to buy chunks of shares from the offering.

JPMorgan’s traders will facilitate the buying & selling of these new shares by buying and selling Gillette shares out of their own account, thereby making a market.

JPMorgan will pay Gillette proceeds at $(share price * newly issued shares) less JPMorgan’s fees.

LeverageDefinition of 'Leverage‘

The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment

The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged

Leverage is most commonly used in real

estate transactions through the use of

mortgages to purchase a home.

Example Explaining Leverage

Particulars Company One Company Two

Equity Share Capital ($100/share)

$100 million $50 million

5% Debentures - $50 million

CALCULATION OF EPS/SHARE:

Particulars Company One Company Two

EBIT $10 million $10 million

Less: Interest - $2.5 million

PBT $10 million $7.5 million

Less: Taxes (50%) $5 million $3.75 million

PAT $5 million $3.75 million

No. of Shares 1 million 0.5 million

EPS/Share $5 $7.5

CAPITAL STRUCTURE:

TRADING AND ACTIVITIES

Bonds

Definition of 'Bond'

A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate

Bonds are used by companies, municipalities, states and U.S. foreign governments to finance a variety of projects and activities

Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents

Types of Bond

1. US Government Bonds (Treasuries)

2. Agency Bonds (Agencies)

3. Municipal Bonds (Munis)

4. Corporate Bonds (Corporates)

Broad classification of Bonds on the basis of Interest:

Fixed rate bonds

• Pays a fixed rate of interest (the coupon rate) for the life of the bond

Floating rate bonds

• Interest payments that are tied to some measure of current interest rates. A common measure is the 90 day bank bill swap rate or BBSW

Indexed bonds

• Interest is usually paid at a fixed rate on the adjusted face value. They are generally medium to long-term bonds

Bond Market Domestic Bond Market: Bonds issued locally by domestic

borrower usually in domestic currency

Example: General Motors issues a bond in the U.S. for placement in the U.S. domestic market, that is, to investors residing in the

U.S.

Foreign Bond Market: Bonds issued in local market by foreign borrowers, usually issued in local currency

Example: Korea electric, a foreign corporation, issues bonds in the US for placement in US alone.

The issue is denominated in the currency of the intended investors, US$.

Euro Bonds: Bond denominated in a currency not native to the issuer’s home country. Eurobonds are commonly issued by governments, corporations, and international organizations.

Example: Company XYZ is headquartered in the United States. Company XYZ decides to go to Australia to issue

bonds denominated in Canadian dollars.

Bond Market

Future of Investment Banking FirmsInvestment banking has always been a cyclical business. The ‘old

ways’ of doing business need to change. Here are just a few of the trends affecting the industry:

Find new ways to connect with customers

Improve their abilities to effectively manage and leverage data, including their analytics

and predictive modelling capabilities

Industrialize their internal processes

Future of Investment Banking Firms

Step up use of cloud and other emerging technology

Re-examine merger and acquisition opportunities

Rebuild their reputations