2. Investment bank is an individual or institution which acts
as an underwriter or agent for corporation and
municipalities issuing securities.
Most also maintain brokerage/dealer operations, maintain
markets for previously issued securities, and offer advisory
services to investors. Investment banks also have a large
role in facilitating mergers and acquisitions, private equity
placements and corporate restructuring.
Unlike traditional banks, investment banks do not accept
deposits from and provide loans to individuals. Also called
investment bankers.
Investment BankingInvestment Banking
3. Investment banking is concerned with the allocation of
financial resources. It works as an intermediary which
deals with how and why money is moved from those who
have it (investors) to those who need it (issuers).
In traditional sense, the role of investment banking is one
of intermediation in resource allocation.
Now-a-days, investment banking is meant include primary
market making, secondary market making, trading,
corporate restructuring, financial engineering, advisory
services, merchant banking, investment management,
consulting, clearing, research, internal finance and
information services.
Investment BankingInvestment Banking
4. Although investments banking and merchant banking
often are used interchangeably in Bangladesh, in the
USA merchant banking is used to denote only a very
small segment of investment banking activities.
Originally, merchant banks were established in the UK
to provide special service to the merchants. Gradually,
its activities expanded quite significantly over time.
History of InvestmentHistory of Investment
BankingBanking
5. Glass-Steagall Act 1933
The modern concept of “Investment Bank” was
created in the Glass-Steagall act (Banking Act of
1933).
Carter Glass, Senator from Virginia, believed that
commercial banks securities operations had
contributed to the crash of 1929, that banks failed
because of their securities operations, and that
commercial banks used their knowledge as lenders to
do insider trading of securities.
Passed During the Great Depression
Glass Steagall Act separated commercial banking
from investment banking
History of InvestmentHistory of Investment
BankingBanking
6. Since then, investment banking had been narrowly
defined as those financial services associated with the
issuance or floatation of new (mainly corporate)
securities.
This definition confines its activities to primary market
making for securities.
At a little broader level, investment banking is also
understood to include secondary market making.
History of InvestmentHistory of Investment
BankingBanking
7. Controversy over Glass Steagall
Prof. George Benston showed that unregulated banks
have lower failure rate.
Other countries (Germany, Switzerland) have always
allowed universal banking
In 1990s, regulators nibbled away at Glass Steagall by
allowing commercial banks to engage in certain
securities operations
History of InvestmentHistory of Investment
BankingBanking
8. Graham-Leach Act 1999
President Clinton November 1999 signs Graham-
Leach Bill which rescinded the Glass-Steagall Act of
1933.
Consumer groups fought repeal of Glass-Steagall
saying it would reduce privacy. Graham-Leach calls for
a study of the issues of financial privacy
Permits Banking-Insurance-Securities Affiliations
History of InvestmentHistory of Investment
BankingBanking
9. Mergers among Commercial Banks, Investment
Banks & Insurance Companies
Travelers’ Group (insurance) and Citicorp (commercial
bank) 1998 to produce Citigroup, on anticipation that
Glass-Steagall would be rescinded. Brokerage Smith
Barney
Chase Manhattan Bank (commercial bank) acquires JP
Morgan (investment bank) (2000) for $34.5 billion
UBS Switzerland buys Paine Webber (brokerage) 2000
Credit Suisse buys Donaldson Lufkin Jenrette
(investment bank) 2000
History of InvestmentHistory of Investment
BankingBanking
10. Investment Bank
Revenue Generating Activities Support Activities
Primary Market Making
• Corporate Finance
• Municipal Finance
• Treasury & Agency Finance
Clearing
Research
Internal Finance
Information Service
Secondary Market Making
• Dealer Activity
• Brokerage Activity
Trading
• Speculation
• Arbitrage
Corporate Restructuring
• Expansion
• Contraction
• Ownership and Control
Financial Engineering
• Zero Coupon Securities
• Mortgage-backed Secu.
• Asset-backed securities
• Derivative Securities
Other Activities
• Advisory Services
• Investment Management
• Merchant Banking
• Venture Capital
• Consulting
Functions of IB
12. Types of InvestmentTypes of Investment
BankingBanking
Types by Size
• Bulge Bracket–(special bracket): Largest
investment banking firms with goodwill. Often their
names are printed larger and bolder on the public
offering announcements (called tombstones).
2. Major Bracket – They are the middle-sized firms
existing at the second tier.
3. Submajors and regionals – They are the small firms
existing at the third tier.
13. Types by Range of Service
1. Full Service Shops – provide full range of
investment banking services. Vary in their strengths.
Some are largely issuer-driven, some are largely
investor driven, some are essentially trading
organizations and some are primarily warehouses
(retail brokerage firms with large investor base).
2. Boutiques (also called specialty shops) – specialize
in just a few services.
Types of InvestmentTypes of Investment
BankingBanking
14. Investment Banking vs. Commercial BankingInvestment Banking vs. Commercial Banking
• In the USA, the Banking Act of 1933 (Glass-Steagall Act)
prohibited the commercial banks to perform investment-
banking activities. The main objective of this separation
was to restrain the commercial banks from undertaking
risky activities that may go against the interest of
depositors.
• However, because of the advancement of risk
management, the prohibitions on securities underwriting
had been relaxed. They were allowed to underwrite
municipal general obligation bonds, industrial bonds and
some corporate issues.
15. • Now-a-days, both investment banks and commercial
banks became players for the new range of services
(as the Act did not restrict commercial banks to perform
these functions).
• These services include swaps, structured solutions (to
solve financial problems), the Fed fund market,
repurchase agreements (repos) etc.
• In Bangladesh, commercial banks can perform the
functions of investment banks.
Investment Banking vs. Commercial BankingInvestment Banking vs. Commercial Banking
16. Investment Banking vs. Financial EngineeringInvestment Banking vs. Financial Engineering
• Financial engineering is the lifeblood of financial
innovation and a cornerstone of modern investment
banking.
• Finance has been transformed from descriptive discipline
to an analytical one.
• Financial Engineering can be defined as the
development and the creative application of financial
technology to solve financial problems, exploit financial
opportunities, and to otherwise add value.
18. Fixed-Income InvestmentsFixed-Income Investments
• Contractual payment schedule
• Recourse varies by instrument
• Bonds
– investors are lenders
– expect interest payment and return of principal
• Preferred stocks
– dividends require board of directors approval
19. Savings AccountsSavings Accounts
• Fixed earnings
• Convenient
• Liquid
• Low risk
• Low rates
• Certificates of Deposit (CDs)
- instruments that require minimum deposits for
specified terms, and pay higher rates of interest than
savings accounts. Penalty imposed for early
withdrawal
20. Money Market CertificatesMoney Market Certificates
• Compete against Treasury bills (T-bills)
• Minimum $10,000
• Minimum maturity of six months
• Redeemable only at bank of issue
• Penalty if withdrawn before maturity
21. Capital Market InstrumentsCapital Market Instruments
• Fixed income obligations that trade in secondary market
• U.S. Treasury securities
• U.S. Government agency securities
• Municipal bonds
• Corporate bonds
22. U.S. Treasury SecuritiesU.S. Treasury Securities
• Bills, notes, or bonds - depending on maturity
– Bills mature in less than 1 year
– Notes mature in 1 - 10 years
– Bonds mature in over 10 years
• Highly liquid
• Backed by the full faith and credit of the U.S.
Government
23. U.S. Government AgencyU.S. Government Agency
SecuritiesSecurities
• Sold by government agencies
– Federal National Mortgage Association (FNMA or
Fannie Mae)
– Federal Home Loan Bank (FHLB)
– Government National Mortgage Association
(GNMA or Ginnie Mae)
– Federal Housing Administration (FHA)
• Not direct obligations of the Treasury
– Still considered default-free and fairly liquid
24. Municipal BondsMunicipal Bonds
• Issued by state and local governments usually to
finance infrastructural projects.
• Exempt from taxation by the federal government and
by the state that issued the bond, provided the
investor is a resident of that state
• Two types:
– General obligation bonds (GOs)
– Revenue bonds
25. Corporate BondsCorporate Bonds
• Issued by a corporation
• Fixed income
• Credit quality measured by ratings
• Maturity
• Features
– Indenture
– Call provision
– Sinking fund
26. Corporate BondsCorporate Bonds
• Senior secured bonds
– most senior bonds in capital structure and have
the lowest risk of default
• Mortgage bonds
– secured by liens on specific assets
• Collateral trust bonds
– secured by financial assets
• Equipment trust certificates
– secured by transportation equipment
27. Corporate BondsCorporate Bonds
• Debentures
– Unsecured promises to pay interest and principal
– In case of default, debenture owner can force
bankruptcy and claim any unpledged assets to
pay off the bonds
• Subordinated bonds
– Unsecured like debentures, but holders of these
bonds may claim assets after senior secured
and debenture holders claims have been
satisfied
• Income bonds
– Interest payment contingent upon earning
sufficient income
28. Corporate BondsCorporate Bonds
• Convertible bonds
– Offer the upside potential of common stock and the
downside protection of a bond
– Usually have lower interest rates
• Warrants
– Allows bondholder to purchase the firm’s common
stock at a fixed price for a given time period
– Interest rates usually lower on bonds with warrants
attached
• Zero coupon bond
– Offered at a deep discount from the face value
– No interest during the life of the bond, only the
principal payment at maturity
29. Preferred StockPreferred Stock
Hybrid security
• Fixed dividends
• Dividend obligations are not legally binding, but
must be voted on by the board of directors to be
paid
• Most preferred stock is cumulative
• Credit implications of missing dividends
• Corporations may exclude 70% of dividend income
from taxable income
30. International BondInternational Bond
InvestingInvesting
Investors should be aware that there is a very
substantial fixed income market outside the United
States that offers additional opportunity for
diversification
• Bond identification characteristics
– Country of origin
– Location of primary trading market
– Home country of the major buyers
– Currency of the security denomination
• Eurobond
– An international bond denominated in a currency not
native to the country where it is issued
31. International BondInternational Bond
InvestingInvesting
• Yankee bonds
– Sold in the United States and denominated is U.S.
dollars, but issued by foreign corporations or
governments
– Eliminates exchange risk to U.S. investors
• International domestic bonds
– Sold by issuer within its own country in that
country’s currency
32. Equity InvestmentsEquity Investments
• Returns are not contractual and may be better or
worse than on a bond
Common Stock
– Represents ownership of a firm
– Investor’s return tied to performance of the
company and may result in loss or gain
33. Corporate Finance: UnderwritingCorporate Finance: Underwriting
And SyndicationAnd Syndication
• Primary market making is one of the basic functions of
investment banking.
• As primary market maker, the investment bank acts as an
intermediary between a business or government enterprise
that requires financing and persons or institutions that have
funds to invest.
35. Three Distinct Functions of InvestmentThree Distinct Functions of Investment
BankerBanker
1. Origination: It involves development and
registration of securities.
2. Underwriting: It involves purchase of securities
from the issuer by the underwriting syndicate for
subsequent sale to the public.
3. Distribution: It involves the final sale of the
securities to the public.
36. Factors affecting the Role ofFactors affecting the Role of
Investment BankInvestment Bank
The precise role of investment bank in origination,
underwriting and distribution depends on a number of
factors. These include:
i. The type of issuer – Corp., Treasury, Govt Agency,
Municipality
ii. Where issued – USA or International– registration/shelf-
registration
iii. The type of security– exemption from registration
(e.g.,com. paper)
37. Corporate FinanceCorporate Finance
• Corporations issue different types of securities:
- Equity Security – Common stock
- Hybrid Security – Preferred Stock
- Debt Security – Mortgage bond, debenture or notes,
commercial papers etc.
38. • Two fundamental ways to intermediate issuers and
investors.
- Public Offering, where securities that are issued are
offered for sale to the public investor.
- Private Placement, where the securities are placed,
through negotiations, in the hands of a small group of
sophisticated, usually institutional investors.
Ways to intermediate issuers and investorsWays to intermediate issuers and investors
39. • For making public offering, issuers must satisfy a
number of well-defined criteria and in Bangladesh, an
issuer has to get the prospectus approved from the
Securities and Exchange Commission (SEC).
• The public offering process involves a tedious,
sometimes complex and time-consuming undertaking
that can expose the corporate officers and directors to
financial and even criminal liabilities.
Ways to intermediate issuers and investorsWays to intermediate issuers and investors
40. • For this reason, issuers employ investment bankers
(a) to perform due diligence and
(b) to understand what information investors want and need to know
to make a reasonable investment decision.
This is the originating phase. Following this, the investment
banker works in the capacities of underwriter and
distributor.
Ways to intermediate issuers and investorsWays to intermediate issuers and investors
41. Investment Banker’s Role in the IPO Process
Origination Underwriting Distribution
Investment Banker’s Role in IPO ProcessInvestment Banker’s Role in IPO Process
42. The Public Offering ProcessThe Public Offering Process
1. At the first step, the investment bank negotiates a
mandate to “do the deal and prepares the issuance to
the satisfaction of the SEC. This part of the process is
called origination. The process involves an investigation
of the issuer, preparation and filing of required
documents, and organization of an underwriting
syndicate.
2. In the underwriting phase, the investment banker
negotiated, on behalf of an underwriting syndicate, with
the issuer for (1) an offering price for securities and (2)
the size of the issuance. They must also negotiate the
underwriting spread – the difference between the
offering price to the public and the proceeds to the
issuer. This is also known as the gross spread or
underwriting discount.
43. 3. In the distribution phase, an underwriting syndicate
and an affiliated selling group distribute the securities
to the public. Together, the underwriting syndicate and
the selling group constitute the distribution syndicate.
The Public Offering ProcessThe Public Offering Process
44. OriginationOrigination
• Investment banking, particularly primary market making, has
long been a very “relationship oriented” business. Corporations
used to get the service of the same investment bank.
• This has changed in recent years particularly due to the advent
of shelf registration. Now-a-days, the preparation of securities
for issuance and the subsequent underwriting and distribution
of those securities and not strongly linked.
• The separation of issuance preparation from underwriting and
distribution allows competition among underwriters. This had
reduced the floatation cost significantly.
• But preparation of issuance is still a very relationship-driven
business. Because it requires the investment banker to have
detailed knowledge of the firm and its management. This
knowledge takes time and considerable energy to develop.
45. Reasons for approaching investment bankersReasons for approaching investment bankers
(a) Assistance in issuing securities;
(b) Cashing our the shares of a privately held grown up firm;
(c) Acquiring capital to effect a transition of ownership and
control –as in the case of the sale of junk bonds to finance
an LBO.
(d) Altering the capital structure – the debt-equity ratio.
Firms leverage up when earning prospect is high and
leverage down when debt load is heavy compared to
earning prospect.
46. Steps for Issuance PreparationSteps for Issuance Preparation
1. First, the investment banker must perform a very
thorough investigation of the issuer. This is called due
diligence investigation.
2. Second, a primary filing with the SEC may be required.
3. Third, after addressing the concerns of the SEC, a
preliminary prospectus is prepared.
4. Then, a second and final filing with the SEC is made. At
this point, the origination phase is complete.
47. Due Diligence InvestigationDue Diligence Investigation
• A firm making public offering of securities should make a
reasonable effort to disclose to potential investors all material
information, otherwise the may be held liable for its absence.
• The responsibility for due diligence investigation, together with
financial liability, extends to the underwriter as well.
• Primary responsibility for the due diligence investigation
generally falls on the investment bank that will subsequently
manage the underwriting syndicate. This firm is referred to as
the lead underwriter, the lead manager, or the boo-running
manager.
• Often, on or more additional investment bank will share some
deal management responsibilities. They are referred to as co-
managers.
• The potential liability associated with the due diligence
investigation compels the investment bankers to dig deep and
ferret out all material information. The opinion of Chartered
Accountant is an integral part of the process.
48. • The disclosure of information required in this process may lead to
a conflict between investment banker and issuing firm. Because,
the firm had probably never had to disclose all material
information and they have to disclose a great deal of information
that they consider confidential and competitively sensitive.
Moreover, the investment banker will probably downplay all rosy
projections.
• The role of investment banker in this process is paradoxical. On
the one hand, investment banker represents the firm and is being
paid by the firm; it needs to present the firm favorably to preserve
the relationship with the firm. On the other hand, the bank is ever
conscious of its legal responsibilities and the potential liabilities
for misstatement and misrepresentations.
• Investment banks are required to perform a reasonable
investigation of the issuer. But the definition of the term
reasonable investigation is little cloudy.
Due Diligence InvestigationDue Diligence Investigation
49. The SEC Filing ProcessThe SEC Filing Process
In the USA, it consists of two parts:
1. Preliminary prospectus (or a red herring) – It is the
principal document used by investors in evaluating the
offering and is the only marketing document used by the
underwriters.
2. Exhibits including legal documents and a draft of the
underwriting agreement.
50. • Acceptance of the registration by the SEC does not
constitute an endorsement of the securities by the SEC.
• While the registration process is progressing,
a. An underwriting syndicate is formed.
b. Arrangements are to print the red herring in large
quantities for distribution.
c. Share certificates are printed.
d. Roadshows are arranged.
52. a. Firm commitment:
Underwriters guarantee that they will sell a specified
minimum quantity of issuance at the offer price. If they
fail to sell the quantity, they must take it themselves.
- An insurance against issue failure.
- The risk is transferred to the underwriter.
- The underwriting spread is generally higher.
- But the issuer may become biased to make
underpricing.
- This may create a natural friction between issuer and
underwriter.
- Most of the deals are on firm commitment basis.
UnderwritingUnderwriting
53. b. Best Efforts:
Underwriters do not make any guarantee. They
simply sell securities.
Unsold securities are returned to the issuer.
c. Standby Underwriting:
Standby underwriting is employed when the issuer
makes right offering and uses the underwriter only as
a backup for any securities not taken through the
right offering.
UnderwritingUnderwriting
54. DistributionDistribution
• New issues of securities are distributed through the
distribute syndicate. It includes both the underwriting
syndicate and the selling group.
• The primary purpose of the distribution syndicate is to
distribute the securities as quickly as possible.
• The speed is important, because between the time of
commitment to the offer price and the time of actual sale in
the market, the market price may decline. (But benefit
cannot be sought from a price rise.)
• Faster the distribution, better off the underwriters.
55. They often try to make the distribution syndicate large.
Because if each participant receives a small portion of
total issuance, they can participate in many issuances.
This makes them diversified across securities and
reduces the risk.
Distribution of securities:
For the purpose of allocating the revenues from the
underwriting and distribution, the syndicate is divided into
three groups:
a. The managers, who sell the majority of shares.
b. The preferred group of dealers, responsible for a bulk of
the distribution.
c. The non-preferred group dealers.
DistributionDistribution
56. • The lead underwriter is expected place a stabilization
bid in the market. (To offer same price for all at least
for a time).
• Sometimes over-allotment option is given to the
underwriter that puts the underwriter in the Green
Shoe.
- It allows the underwriter to issue additional shares up
to a stipulated amount (usually 5 to 15 percent) if the
issue is well received by the market.
DistributionDistribution
57. Division of RevenuesDivision of Revenues
a. Management Fee: It goes to the managers for their
role in preparing the offering. This fee is a partial
compensation for due diligence investigation.
b. Underwriting Fee: To cover the miscellaneous costs of
underwriting – advertising, legal expense, stabilization
expense, postage and others.
The remainder is distributed among the syndicate
members based on the their level of participation.
c. Selling Concession: To the syndicate based on the
number of shares they are responsible for selling.
58. Shelf RegistrationShelf Registration
In a shelf registration (or a shelf) the issuer prepares an
offering in the usual way, but the filing is good for two years.
This is in contrast to traditional registration in which filing is
good for a very short period of time.
• The firm may issue new securities with a 24 hours notice to
the SEC.
The major advantages are:
1. It allows the firm to get the costly and time-consuming part
of the issuance process over and done with in one shot.
2. It allows the firm to come into the market on a very short
notice in order meet the unexpected needs and to exploit
any windows of opportunities that might arise.
• In Bangladesh, there is no provision for shelf- registration.
59. Offshore Markets & Dual SyndicationOffshore Markets & Dual Syndication
The derivative markets allow a firm to raise money in almost any
country and currency by selling securities to investors and
swapping these liabilities into desired currency.
• For example, a US firm may sell dollar-denominated bonds in the
Eurobond market. If it is not sold in the USA, it does not require
an SEC registration in the USA. Later on, seasoned issues can
be offered in the USA.
• A dual syndication is one in which two separate syndicates are
employed – one for distribution in the USA and the other for
distribution outside the USA.
• Special terms:
Yankee bonds: Dollar denominated bonds issued in the USA by
any non-USA firm.
Samurais: Yen denominated bonds issued in Japan by non-
Japanese firms.
Bulldogs: Sterling denominated bonds issued in the UK by non-
British firms.
60. Syndication DepartmentSyndication Department
• The syndication department of an investment bank is
responsible for assembling the underwriting syndicate
and for helping to select the selling group in cooperation
of the issuing firm.
• It maintains close ties with many broker/dealer firms,
known collectively as the street.
• The syndication department plays an important role in
working gout problems and conflicts that occasionally
arise between members of syndicate.
61. Seasoned Public OfferingSeasoned Public Offering
• Seasoned public offering is a new offering of
securities to the public by a firm that has already
issued securities.
• Three distinct types of seasoned public offering:
a. Primary seasoned offering
b. Secondary public offering (secondary placement):
c. Combined offering
62. a. Primary seasoned offering:
An offering of a new issue by a firm that has already done
an IPO.
Its primary purpose is to raise new capital for the firm.
b. Secondary public offering:
A public offering of securities that are purchased by the
underwriters directly from the pre-public owners and not
from the firm.
Usually used by firm’s founders, other pre-public owners
and some post public holders of securities to cash out of
the firm.
Seasoned Public OfferingSeasoned Public Offering
63. c. Combined offering:
It is partly primary and partly secondary. It is used to both
raise new capital for the firm and to cash out some of the
pre-public owners.
- Often it is difficult to persuade the investors that the stock
is attractively priced when insiders are selling out.
Many underwriters do not handle a public offer that includes
the sale of securities by owners.
As an alternative, the owners could simply sell in the
secondary market through broker/dealer. But this may
send a negative signal to the market.
Seasoned Public OfferingSeasoned Public Offering
