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CHAPTER 1

INTRODUCTION
At a very macro level, ‘Investment Banking’ as term suggests, is concerned with the primary function of
assisting the capital market in its function of capital intermediation, i.e., the movement of financial
resources from those who have them (the Investors), to those who need to make use of them for
generating GDP (the Issuers). Banking and financial institution on the one hand and the capital market
on the other are the two broad platforms of institutional that investment for capital flows in economy.
Therefore, it could be inferred that investment banks are those institutions that are counterparts of banks
in the capital markets in the function of intermediation in the resource allocation. Nevertheless, it would
be unfair to conclude so, as that would confine investment banking to very narrow sphere of its activities
in the modern world of high finance. Over the decades, backed by evolution and also fuelled by recent
technologies developments, an investment banking has transformed repeatedly to suit the needs of the
finance community and thus become one of the most vibrant and exciting segment of financial services.
Investment bankers have always enjoyed celebrity status, but at times, they have paid the price for the
price for excessive flamboyance as well.

To continue from the above words of John F. Marshall and M.E. Eills, ‘investment
banking is what investment banks do’. This definition can be explained in the context of how
investment banks have evolved in their functionality and how history and regulatory intervention have
shaped such an evolution. Much of investment banking in its present form, thus owes its origins to the
financial markets in USA, due o which, American investment banks have banks have been leaders in the
American and Euro markets as well. Therefore, the term ‘investment banking’ can arguably be said to be

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of American origin. Their counterparts in UK were termed as ‘investment banks’ since they had
confined themselves to capital market intermediation until the US investments banks entered the UK and
European markets and extended the scope of such businesses.

Investment banks help companies and governments and their agencies to raise money by issuing and
selling securities in the primary market. They assist public and private corporations in raising funds in
the capital markets (both equity and debt), as well as in providing strategic advisory services for
mergers, acquisitions and other types of financial transactions. Investment banks also act as
intermediaries in trading for clients. Investment banks differ from commercial banks, which take
deposits and make commercial and retail loans. In recent years however, the lines between the two types
of structures have blurred, especially as commercial banks have offered more investment banking
services. In the US, the Glass-Steagall Act, initially created in the wake of the Stock Market Crash of
1929,

prohibited

banks

from

both

accepting

deposits

and

underwriting securities; Glass-Steagall was repealed by the Gramm-Leach-Bliley Act in 1999.
Investment banks may also differ from brokerages, which in general assist in the purchase and
sale of stocks, bonds, and mutual funds. However some firms operate as both brokerages and investment
banks; this includes some of the best known financial services firms in the world.
More commonly used today to characterize what was traditionally termed” investment banking” is “sells
side." This is trading securities for cash or securities (i.e., facilitating transactions, market-making), or
the promotion of securities (i.e. underwriting, research, etc.).

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Definition
An individual or institution, which acts as an underwriter or agent for corporations and municipalities
issuing securities. Most also maintain broker/dealer operations, maintain markets for previously issued
securities, and offer advisory services 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.

1.1 Commercial banking vs. investment banking

While regulation has changed the businesses in which commercial and investment banks may now
participate, the core aspects of these different businesses remain intact. In other words, the difference
between how a typical investment bank and a typical commercial operate bank is simple. A commercial
bank takes deposits for checking and savings accounts from consumers while an investment bank does
not. We'll begin examining what this means by taking a look at what commercial banks do.

Commercial banks

A commercial bank may legally take deposits for checking and savings accounts from consumers. The
federal government provides insurance guarantees on these deposits through the Federal Deposit
Insurance Corporation (the FDIC), on amounts up to $100,000. To get FDIC guarantees, commercial
banks must follow a myriad of regulations. The typical commercial banking process is fairly
straightforward. You deposit money into your bank, and the bank loans that money to consumers and
companies in need of capital (cash). You borrow to buy a house,
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Finance a car, or finance an addition to your home. Companies borrow to finance the growth of their
company or meet immediate cash needs. Companies that borrow from commercial banks can range in
size from the dry cleaner on the corner to a multinational conglomerate.

Investment banks

An investment bank operates differently. An investment bank does not have an inventory of cash
deposits to lend as a commercial bank does. In essence, an investment bank acts as an intermediary, and
matches sellers of stocks and bonds with buyers of stocks and bonds.
Note, however, that companies use investment banks toward the same end as they use commercial
banks. If a company needs capital, it may get a loan from a bank, or it may ask an investment bank to
sell equity or debt (stocks or bonds). Because commercial banks already have funds available from their
depositors and an investment bank does not, an I-bank must spend considerable time finding investors in
order to obtain capital for its client.

1.2 History of Investment banking
Given its history, investment banking is often thought of as a European, and especially British, financial

Issue
r specialty, and British institutions continue to maintain a major presence in this area. Since the 1800s and

even earlier, however, U.S. firms (such as J.P. Morgan) also have been active in investment banking.
However, although both investment banks and commercial banks, as well as other types of businesses,
have been authorized to engage in private equity investment in the United States, financial institutions
have not been major providers of private equity.

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and wealthy investors. financial institutions-both commercial banks and investment banks-represent approximately 20 percent of total private equity capital. In the 1960s and 1970s. industrial corporations.) Through the late 1970s.Until the 1950s. (In the 1960s. investors in private equity were primarily wealthy individuals and families. Currently. changes in the Employee Retirement Income Security Act (ERISA) regulations. endowments and foundations. In recent years. funds raised through private equity have approximately equaled and sometimes exceeded funds raised through initial public offerings and public high-yield corporate bond issuance. increasing from approximately $4. commercial banks were the major providers of one kind of private equity investing. the private equity market is approximately one-quarter the size of the commercial and industrial bank-loan market and the commercial-paper market. venturecapital financing.S. constituted the bulk of private equity investors. and financial institutions. At $400 billion as of year-end 1999. in tax laws. In particular.S. corporations. and in securities laws brought new investors into private equity. In the late 1970s. The U. U. the major investors in private equity in the United States are pension funds. Department of the Treasury (Treasury) estimates that at year-end 1999. divided approximately equally between the two. The market also has grown dramatically in recent years. of the $400 billion total investment in the private equity market. the Department of Labor's revised interpretation of the "prudent man rule" spurred pension fund investment in private equity capital. for the most part investing directly in the issuing firms. corporations and financial institutions joined them in this type of investment. wealthy families. commercial banks accounted for approximately $35 billion to $40 billion and investment banks for approximately another $40 billion.7 billion in 1980 to its 1999 5 .

ANZ Grindlays bank set up separate Investment banking division to handle new capital issues. SBI ventured into this business by starting a investment business bureau in 1972. Several new players entered into the field. JM finance was set up in 1973.figure. The growth of industry during that period was very slow. In the early 20th century large business houses followed suit by establishing managing agencies which acted as issue house for securities. It was soon followed by CitiBnak. The capital market witnessed some buoyancy in the late eighties. In 1967. ICICI became the first financial institutions to offer investment banking. which was approximately $17 trillion at year-end 1999 1. both in public and private sector were found to be involved in various irregularities. But these entire roles were limited to small capital base. in its report in 1972. which started rendering Investment Banking services. 6 . In 1973. Despite this tremendous growth. the private equity market is extremely small compared with the public equity market.3 Evolution of investment banking in India The origin of investment banking in India can be traced back to the late 19th century when European investment banks set up their agency house in the country to assist in the setting up of new projects. 1992 was a major setback to the industry. The banking commission. took note if this with concern and recommended setting up of investment banking institutions by commercial banks and financial institutions. Several leading investment banker. The advent of economic reforms in 1991 resulted in a sudden spurt in both the primary and secondary market. promoters for new projects and also provided finance to green field ventures. The industry remained more or less stagnant in the eighties. The securities scam in may. The foreign banks monopolized investment banking services in the country.

Foreign Bankers b. depending on the sector to which they belong. National Financial Institutions. Some of tie ups player were  JM Finance. Private sector Investment Bankers a. 1. c. 2. Many foreign investment bankers stated entering in India in tie ups with Indian player. The registration norms with SEBI were quiet liberal. The current transition phase is witnessing a paradigm shift in the nature and composition of this industry. Commercials banks. State financial institutions. Public sector Investment bankers’ a. Financial and Investment companies.Goldman Sachs  SBI Capital Markets – Lehman Brothers In India investment banker can be segregated as follows. Indian private Banks c. The markets turned bullish again in the end of 1993 after the tainted shares problems were substantially resolved. Leasing Banks. d.some of the prominent public sector players involved in the scam were canbank financial services and champaklal investment and finances. b. The industry was hitherto 7 .Morgan Stanley  DSP Financial consultants.Merill lynch  Kotak Mahindra. The current of the investment banking industry is in state of flux.

and in a financial transaction may be at a disadvantage versus larger competitors. thereby empowering small to medium sized companies with financial and transaction experience without the addition of permanent overhead. 1. new techniques. and is vitally interested in seeing the transaction close. Life is very much at the mercy of the markets. Although large corporations often have sophisticated finance and corporate development departments provide objectivity. including high pressure. Investment bankers have stared diversifying into new function such M&A. long days and nights of hard work. allows for efficient use of client personnel. an investment bank provides objectivity. and the expectation—no. It requires substantial hardships. Bull 8 . the requirement— that all personal plans are subject to the demands of work. allows for efficient use of client personnel. Most small to medium sized companies do not have a large inhouse staff. A quality investment banking firm can provide the services required to initiate and execute a major transaction.synonymous with issue management and underwriting. and in a financial transaction may be at a disadvantage versus larger competitors. A quality investment-banking firm can provide the services.5 Type of Expertise Required Investment banking is one of the best ways a young person can learn about finance and make good money right out of school. new products. a valuable contact network. and is vitally interested in seeing the transaction close. a few difficult personalities. 1. a valuable contact network. Most small to medium sized companies do not have a large in-house staff.4 Who needs an Investment Bank Any firm contemplating a significant transaction can benefit from the advice of an investment bank.

taxations. Thirdly. etc. Listing requirements are to be observed and familiarity with the stock exchange rules and byelaws as well as the provisions of the Securities Contracts Regulations) Act would be essential. profit margins. The investment bank should have an organization large enough to deal with a number of applications at a time. warehouses. They have to keep ready all the information needed in the form of dossiers with respect to the affairs of the company generally enquired into by the investing public. Once these terms are settled the share certificates. They have to satisfy the Companies Act and other SS requirements of law. they may have to make an application to the appropriate stock exchange for quotation and satisfy the stock exchange authorities with respect to the terms of issue and prospectus. The type of staff required for a investment bank will depend upon its functions which are them selves flexible. accountants and others. Secondly. requires. a investment bank has to suggest an appropriate time of issue and provisional terms. the investment bank may have to get ready the application to the SEBI for the public issues. This requires familiarity with the regulations under the Companies Act and the SEBI guidelines and the procedures to be followed and the authorities to be approached. competitors. technical experts etc. prospectus and other documents are drafted by the investment bank with the assistance of lawyers. The provisions under the MRTP Act regulating monopoly practices and other activities of big industrial houses should also be looked into. They may have to advise on the desirability or otherwise of listing on the stock exchange as well 9 . lending financial institutions and the government. and other physical assets and if a company is making its first issue. Subsequently. industrial consultants. it might secure independent reports from Chartered Accountants. labor. management. plant. The issue house. The issue house which acts as the investment banker normally pays visits to the company's plant. which is a investment bank also.markets bring more work to do than is humanly possible.

the work of the investment bank relates to arranging for the allotment of shares in consultation with the company and the stock exchange authorities with the help of Registrars. a summary of the company’s business history. Once the issue made. etc. 10 . balance sheet. to which a reference was made earlier.as help the companies go through the process of getting their shares listed. Advertisements containing all the information legally required to be given in the prospectus must be published in all the leading proposed date of opening and closing.

to meet specified investment goals for the benefit of the 11 . done by a special set of traders who do not interface with clients and through Principal Risk. real estate). Investment bankers prepare idea pitches that they bring to meetings with their clients.g. Middle Office and Back Office. Banks seek to maximize profitability for a given amount of risk on their balance sheet An investment bank is split into the so-called Front Office. Banks undertake risk through proprietary trading. The individual activities are described below: Front Office  Investment Banking is the traditional aspect of investment banks which involves helping customers raise funds in the Capital Markets and advising on mergers and acquisitions. an investment bank is responsible for preparing all materials necessary for the transaction as well as the execution of the deal. or negotiating with a merger target. Once mandated. Other terms for the Investment Banking Division include Mergers & Acquisitions (M&A) and Corporate Finance (often pronounced "corpfin"). risk undertaken by a trader after he or she buys or sells a product to a client and does not hedge his or her total exposure. bonds etc) and other assets (e. which may involve subscribing investors to a security issuance.CHAPTER 2 THE MAIN ACTIVITIES AND UNITS The primary function of an investment bank is buying and selling products both on behalf of the bank's clients and also for the bank itself. coordinating with bidders. with the expectation that their effort will be rewarded with a mandate when the client is ready to undertake a transaction.  Investment management is the professional management of various securities (shares.

Another key Middle Office role is to ensure that the above mentioned economic risks are captured accurately (as per agreement of commercial terms with the counterparty) correctly (as per standardized booking models in the most appropriate systems) and on time (typically within 30 minutes of trade execution).investors. While it provides the greatest job security of the divisions within an investment bank. pension funds. In recent years the risk of errors has become known as "operational risk" and the assurance Middle Offices provide now include measures to address this risk. When this assurance is not in place. ensuring that they are not erroneous.) or private investors (both directly via investment contracts and more commonly via collective investment schemes e. corporations etc. Back Office  Operations involve data-checking trades that have been conducted. Investors may be institutions (insurance companies. and setting limits on the amount of capital that they are able to trade in order to prevent 'bad' trades having a detrimental effect to a desk overall. mutual funds) . and transacting the required transfers.g. market and credit risk analysis can be unreliable and open to deliberate manipulation. it is a critical part of the bank that involves managing 12 . Middle Office  Risk Management involves analyzing the market and credit risk that traders are taking onto the balance sheet in conducting their daily trades.

8. 9. takeovers. etc. Preparation of economic. Help in raising rupee resources from financial institutions and commercial banks. charitable trusts etc. pre-investment survey. Advice on setting up turnkey project s in foreign countries and locating foreign markets. 3. The staff in these areas are often highly qualified and need to understand in depth the deals and transactions that occur across all the divisions of the bank. 2. 5. amalgamation. Management of investment trust. 10. 6. Management aid and entrepreneurial aid (management audit providing designs of the 13 . Advice and liaison obtaining consent of the Central and Stat e Government. for the company. Help in financial management and in designing proper capital structure and debtequity ratio. technical and financial feasibility reports. and market studies. 4. 7. Assistance in raising foreign exchange resources so as to enable the industrial concerns to import machinery and technical know-how and secure foreign collaboration. 2. 11. if necessary. etc. to the new issues or syndication of loans. mergers. etc. Advice on restructuring of capital.1 Functions of the investment banking divisions 1. Initial project preparation. for the project if necessary.the financial information of the bank and ensures efficient capital markets through the financial reporting function. Underwriting and also for subscription.

operational research and management consultancy). etc. Recruitment (selection of technical and managerial personnel).complete system. and 12. 14 .

It has to assist its clients in raising fund from the market. 1.CHAPTER 3 SCOPE OF INVESTMENT BANKING The Investment banker plays a vital role in channelizing the financial surplus of the society into productive investment avenues. It may also be required to counsel them on various issues that affect their finances. Some of the major functions performed by investment banker are as follows. The investment banker has fiduciary role in relation to the investor. The role of the investment banker is dynamic and it has to be nimble footed to capitalize on available opportunities. The main area of its role includes:  Instrument Designing  Pricing the issue  Registration of the offer document  Underwriting the support  Marketing the issue  Allotment and refund  Listing on stock exchange  Listing on stock exchange 15 . Management of debt and equity offering – This is the traditional ‘bread and butter’ operations for most of the investment banker in India.

The investment proposal should be accompanied by high quality research reports of the Investment banker to justify the investment recommendation. Placement and distribution – The distribution network of Investment banker can be classified as institutional and retail. Thus a large base of captive investors is created and maintained. pension funds. bank. The basic requirement to create and service the institutional segment is the existence of good in-house research facilities. The distribution network can be used to distribute various financial products like:  Equity : retail and institutional investors  Debt Instruments : retail and institutional investors  Mutual Fund products : retail investors  Fixed deposits : retail investors  Insurance products : retail investors  Commercial paper : institutional investors 16 . etc. PE. The retail distribution reach depends upon the networking with the investors. The network of institutional investors consist of Mutual Funds. Many Investment banks have associate firms which are brokers on the stock exchange. These brokers appoint sub-brokers at various locations to service both the primary market and secondary market needs of the local investors.2. FIIs. the size of this network represent the wholesale reach of the Investment banker. domestic and multinational financial institutions.

investment bankers offers customized solutions to the financial problem of their clients. drawdown.investment bankers are associated with their clients from the early stage of their project. The company’s working capital practices are studied and alternative working capital policies are suggested.investment bankers arrange to tie up loans for their clients. The important loan parameters include amount. 5. tenure. The process includes determining the appropriate level of gearing and advising the company whether to leverage. They assist the companies in conceptualizing the project idea when it is at nebulous stage. The first step involves analyzing the client’s cash flow pattern so that terms of borrowing can be defined to suit the cash flow requirements. They play advisory role in securitization of receivables. deleverage or maintain its current debt-equity levels. Corporate advisory Services . The loan memorandum is then circulated to various banks and financial institutions and they are invited to participate in the syndicate. The asset turnover ratios may be analyzed to study whether the company is over trading or under trading. Project Advisory . Investment bankers provide inputs to their clients in preparation of the detailed project report. Loan syndication . Once the project is conceptualized. they carry out the initial feasibility studied to examine its viability. They also offer project appraisal services to clients. The investment banker may also explore the possibility of refinancing high cost funds with alternative cheaper funds.3. 17 . They also help their cash rich clients in deployment of their short-term surpluses. The investment bankers then prepare the detailed loan memorandum. One of the key areas for advisory role is financial structuring. moratorium and the amortization. 4. currency.

The banks indicate the amount of exposure of service they are willing to take and the interest rates thereon. The final allocation is done to the various members of the syndicate. The investment banker also helps the clients in loan documentation procedures.tuned to the satisfaction of both parties. The terms are further negotiated and fine. 18 .

but might upset Company X to the point that it drops Bank A and hires another firm to be its investment banker? Or should it recommend the purchase of Company X stock. which are based in part on the success of Bank A’s banking operations? In an effort to end the legal scrutiny of their operations. such as the sales and trading divisions. the research division has also played an important role in the underwriting process. And as the full service investment banks move to purchase independent research. and industry developments to provide proprietary investment advice to institutional clients and in-house groups. among its banking clients.6. 19 . which is facing financial difficulties. Indeed. Until recently. and JMP Securities) are benefiting in a big way from a settlement between the investment banking industry and regulators that requires investment banks to spend a total $432. which would benefit investors who subscribe to Bank A’s research. However. As a hypothetical example. individual company stocks.g. independent research houses (e. in many cases. Needham & Co. consider Bank A. investment banks are now attempting to reinforce the separation between their banking and research arms. both in wooing the client with its knowledge of the client’s industry and in providing a link to the institutions that own the client’s stock once it’s publicly traded. Research Services . Sidoti & Co. in recent times banks have faced public and regulatory outcries over conflicts of interest inherent in having bankers and researchers work hand in hand.. as they’re required to do by regulators..Nearly all banks have a staff of research analysts who study economic trends and news. Also. You can certainly count on research playing a lesser role in selling banking deals.. research analysts’ compensation was tied to investment banking revenues. certain research specialists—Standard & Poor’s and BNY Jay hawk (which actually aggregates research from more than 100 research organizations)—are looking like they’re going to make out handsomely.5 million over 5 years to give clients independent research. which would help Company X financially and keep the banking revenues from Company X rolling in—and pump up research analysts’ bonuses. which counts Company X. Should Bank A’s research team pan Company X’s stock.

the generic name of ‘venture capital’ was coined. In developed countries. mainly developed as a sideline activity of the rich in USA. Venture capital . To connote the risk & adventure & some element of investment. are called venture capital funds. which finance such risky. In the late 1960’s a new breed of professional investors called venture capitalists emerged whose specialty was to combine risk capital with entrepreneurial management & to use advance technology to launch new products and companies in the markets place. Undoubtedly. Venture capital is a post-war phenomenon in the business world. Some large companies with excess funds may provide this capital to achieve diversification. The funds. only the government or public financial institutions can provide the funds for venture capital. To connote the risk & adventure & some element of investment. 20 . mainly developed as a sideline activity of the rich in USA. it was ‘venture capitalists’ astute ability to assess and manage enormous risks & export from them tremendous returns that changed the face of America. the generic name of ‘venture capital’ was coined. which is used in risky enterprises either as equity or debt capital. market expansion & ‘window on technology’ or to share in this result of R&D of others. In the late 1960’s a new breed of professional investors called venture capitalists emerged whose specialty was to combine risk capital with entrepreneurial management & to use advance technology to launch new products and companies in the markets place.7. insurance companies & even large banks. this capital came from pension funds. Venture capital is a post-war phenomenon in the business world. as the majority of the above institutions are in the public sector. it was ‘venture capitalists’ astute ability to assess and manage enormous risks & export from them tremendous returns that changed the face of America. It may be in new sunshine industries or older risk enterprises. Undoubtedly. In India.Venture capital is risks money.

hi-tech ideas are necessarily risky. At the same time. The companies over a period of time became unwieldy conglomerates with suboptimal portfolio of assorted business. several companies had indulged in unrelated diversifications depending on the availability of the licenses. The mergers and acquisitions group provides advice to companies that are buying another company or are those selves being acquired. 21 . the work leading up to the headline-grabbing multibillion-dollar acquisition can involve a Herculean effort to crunch all the numbers.Innovative. Merger and acquisitions – M&A are becoming increasingly significant in term of services offered by the investment bankers in India. the M&A team will also work with a corporate finance industry group to arrange the appropriate financing for the transaction (usually a debt or equity offering). 8. Venture Capital provides long start up costs to high risks & returns project. The industry is passing through a transitory phase of restructuring. It is here that the concept of venture capital steps in. perform the necessary due diligence. M&A is often a subgroup within corporate finance. Typically. The policy of decontrol and liberalization coupled with globalization of the economy has exposed the corporate sector to serve domestic and global competition. “You have to really like spending time in front of your computer with Excel. M&A work can seem very glamorous and high profile. The companies thrived in spite of their inefficiencies because the total capacity in the industry was restricted due to licensing. it is a stand-alone department. all this may happen on a very tight timeline and under extreme secrecy. M&A can be one of the most demanding groups to work for. and work out the complicated structure of the deal. As one insider puts it. During the licensing era. but in some firms. In many cases.” Often. these projects have mortality rates and therefore are unattractive to risks-averse bankers & private sectors companies.

M&A benefits the following  Financial: I.  Con-generic merger/concentric mergers occur where two merging firms are in the same general industry. Diversification of risks. II. but they have no mutual buyer/customer or supplier relationship. IV. Increase in market share. Growth without increase in the capacity. combine. Benefits on account of tax shield. II. Elimination of competition. Classifications of mergers  Horizontal mergers take place where the two merging companies produce similar product in the same industry.  Vertical mergers occur when two firms. Profiting from leveraged buyouts.  Production I. Horizontal and vertical integration. III.  Marketing I. Acquisition of new technology. Restructuring and strengthening the balance sheet. IV. III. such as a 22 . II. each working at different stages in the production of the same good. Investment of surplus cash.

(b) Comparable companies’ method (c) Book value method 23 . no aggressive approach is used and active strategy i. Once the universe is determined.  Conglomerate mergers take place when the two firms operate in different industries. (iii) Valuation: .e.passive strategy i. Example: Prudential's acquisition of Bache & Company. M&Q requires following step (i) Acquisition search: . if the acquisition involves buying only part of the target company. industry specific journals. There are broadly two methods of approaching the targets.the first step is to determine the universe of potential target companies.valuation of the target company is the most critical task performed by the investment banker. segmental data may be difficult to obtain. information about private companies may not be readily available. database etc. (ii) Approaching the target: .merger between a bank and a leasing company. Information is gathered about these companies based on their published data. The commonly used valuation methods are (a) Discounted cash flow method. A conservative valuation can result in collapse of the deal while an aggressive valuation may create perpetual problems for the acquiring company. acquisition may be friendly or hostile.e.This is one of the most critical roles played by the investment bankers in the deal. targets may be short listed based on those parameters. Similarly.

other times. The investment banker plays a vital role in closing the financial side of the negotiation. Reasons for an IPO: - When a privately held corporation needs to raise additional capital. 9. it can either take on debt or sell partial ownership. the key elements of negotiations are the price and the form of consideration. Cash may be raise from the internal accruals.This is the process of formulating the structure of the deal. Sometimes IPOs are associated with huge first-day gains. Both the elements are interrelated and affect the attractiveness of the deal. It's often difficult for an individual investor to realize the huge gains.once the negotiation is over and the price is finalized. because this is the first opportunity to buy these stocks. since in most cases only institutional investors have access to the stock at the offering price. The investment banker must ensure that the final price paid should not exceed the perceived value of the targets to the acquirer. sale of assets. public issue or private placement of debt and equity. most of its first-day gains have already been made. the investment banker has to assist the acquirer in arranging the required finance. The consideration can be paid in the form of cash. If the corporation chooses to sell ownership to the public. they flop. From a financial standpoint. it engages in an IPO.(d) Market value method (iv) Negotiation: . By the time the general public can trade the stock. Corporations choose to "go public" instead of issuing debt securities for several 24 . a savvy and informed investor should still watch the IPO market. (v) Acquisition finance: . Initial Public Offerings: .Initial Public Offerings (IPO) is the first time a company sells its stock to the public. debt securities or equity of the acquiring company. when the market is cold. etc. It may also be refinanced by bank borrowing. However.

reasons. Corporations weigh the costs and benefits of an IPO carefully before performing an IPO. Appointment of investment banker and other intermediaries: The company first selects the Investment Banker(S) for handling the issue. The most common reason is that capital raised through an IPO does not have to be repaid. whereas debt securities such as bonds must be repaid with interest. Distribution network with institutional and individual investors iii. The investment banker should have a valid SEBI registration to be eligible for appointment. A large drawback to going public is that the current owners of the privately held corporation lose a part of their ownership. there are also many drawbacks to an IPO. Despite this apparent benefit. Past track record in successfully handling similar issues ii. Good rapport with other market intermediaries vi. Trained manpower and skills for instrument designing and pricing v. General reputation in the market iv. Value added services like providing bridge loans against public issue proceeds Issue in any of the capacities An investment banker can be associated with the issue in any of the following capacities:  Lead Manager to the issue  Co Manager to the issue  Underwriter to the issue  Advisor/Consultant to the issue 25 . The criteria normally used in selection of Investment Bankers are: i.

A investment banker underwrites the transaction. also known as net working capital. Along with fixed assets such as plant and equipment. with investors.Underwriting refers to the process that a large financial service provider (bank. This is a way of placing a newly issued security. and this trend is likely to continue.10. some of the larger banks are also involved in areas such as the arrangement of lease finance. Underwriting: . particularly for new ventures. India has become increasingly active in the international money markets. 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. and investment banks assist in this as well. the arrangement of various kinds of export credits from different countries is also required.Working capital. insurance.Of late. Foreign currency finance: . working capital is considered a part of operating capital. and others have been successfully tapped by investment bankers. In addition to this wide range of services. When a dealer bank purchases Treasury securities 26 . Finance for working capital. This ensures that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses 11. and assistance in acquisitions and mergers etc. For import of capital goods and services from overseas. is a financial metric which represents operating liquidity available to a business. For existing companies. such as stocks or bonds. investment house) uses to assess the eligibility of a customer to receive their products (equity capital. non/traditional sources such as through the issue of debentures for this purpose. insurer. they will have to hold some securities themselves. Should they not be able to find enough investors. Working capital: . often needs to be syndicated on behalf of the promoters. mortgage or credit). 12. which means they have taken on the risk of distributing the securities.

Treasury securities purchased by a primary dealer are held in a dealer bank's trading account assets portfolio. it acts as underwriter and distributor.is a structured finance process.It involves design. The main work of investment banks relates to underwriting of new issues and rising of new capital for the corporate sector. development and implementation of innovative financial instruments and processes and the formulation of creative solutions to the problem in finance. The SEBI has made underwriting Compulsory for all issues offered to Public first but later it was made optional. some part devolves on the underwriters. and the intrinsic worth of the project. The name "securitization" is derived from the fact that the forms of financial instruments used to obtain funds from the investors 27 . Of the amount underwritten. which varies depending on the state of the capital market. SEBI made it necessary for investment bank to undertake or make a firm commitment for 5% of issued amount to the public. Securitization:. 13. and they are often resold to other banks and to private investors. Financial Engineering by Investment Bankers: . A number of factors have accelerated the process of financial innovation.in a quarterly Treasury bond auction. which involves pooling and repackaging of cashflow-producing financial assets into securities that are then sold to investors. They include: – Interest rate volatility – Exchange rate volatility – Regulatory and tax changes – Globalization of the market – Increased competition among investment bankers 14.

if the buyers make their payments and pay off the loans. In exchange for taking that risk. in order to reduce the risk of bankruptcy and thereby obtain lower interest rates from potential lenders. They could sell those 10 loans to 10 investors. In doing this. which they will use to buy homes.one. A credit derivative is also generally used to change the credit quality of the underlying portfolio so that it will be acceptable to the final investors. From the perspective of XYZ.000 a piece. that one investor loses. Naturally. XYZ can do two things with those loans. Hence. XYZ has invested in the success and/or failure of those 10 home buyers. They give up some of the reward (profit) in exchange for not having the risk. securitization could also be defined as a financial process leading to an issue of an ABS. From this perspective. Or they could sell them to some other investor. XYZ Bank loans 10 people $100. the securities which are the outcome of securitization processes are termed asset-backed securities (ABS).are securities. those loans are 10 different assets. They have value. they would make less profit than if they held onto them long term. XYZ gets their money back along with the interest they charge. All assets can be securitized so long as they are associated with cash flow. So XYZ Bank decides they'd rather have the cash now. make a profit on their investment. A very basic example would be as follows. Two. the borrowers pay XYZ interest on the money they borrow. they would hope. Each investor would be taking a risk in buying those loans. Looking at it another way. and walk away. XYZ takes ownership of the house. if the loan succeeds. but they would benefit in that they make some profit while also getting their original investment back. investors would not be willing to pay very much for 28 . because if any loan defaults. XYZ makes a profit. alternatively known as a special purpose entity (SPE) or special purpose company (SPC). if the loan fails. XYZ has taken the risk that some borrowers won't repay the loan. They can hold them for 30 years and. Securitization often utilizes a special purpose vehicle (SPV).

advices or directs or undertakes on behalf of the clients the management or administration of a portfolio of securities or the funds of client.According to SEBI. However. 29 . knowing the risk involved. The term ‘portfolio’ means the total holdings of securities belonging to any person. as the case may be Discretionary Portfolio Manager:. every investor loses 10%. The result is that XYZ bank is able to sell their assets for more money. and then they split that one entity into 10 equal shares. 15. as the case may be. Each investor still pays the same $100. but instead of owning one loan.those loans. XYZ wants to sell those loans for the best price they can get.A list of all those services and facilities that are provided by a portfolio manager to its clients. under a contract relating to portfolio management. relating to the management and administration of portfolio of securities or the funds of clients.000. Investors incur some of the volatility and there is no inherent "insurance" against major loss. exercises any degree of discretion as to the investments or management of the portfolio of securities or the funds of the clients.According to SEBI. They combine the 10 loans into one entity. ‘discretionary portfolio manager’ means a portfolio manager who exercises or may. they will own 10% of all 10 loans. If one loan fails. is referred to as ‘portfolio management services’. and investors are insulated from the volatility of directly owning individual mortgages. if a majority of the mortgages in the asset pool act in the same way ( Correlation ) then the risk is similar to owning one mortgage. Portfolio management services:. Portfolio Manager: . so they decide to securitize those loans. ‘Portfolio Manager’ means any person who pursuant to contract or arrangements with a clients.

stocks. either by carrying an inventory of securities for sale or by executing a given trade for a client. Traders deal with transactions large and small and provide liquidity (the ability to buy and sell securities) for the market. individual investors and for the Banks themselves. futures. (This is often called making a market. or other securities such as currencies.Make trades in securities for the primary and secondary markets For currencies. This price differential is called the "bid-ask” spread. In trading traders also provide a vital role for the investment bank. bonds. Private Client Service (PCS) representatives lie somewhere between retail brokers and institutional salespeople.16. for example pension funds or mutual funds. bonds. or 3) The private client service representative. commodities. 30 . Sales & Trading: . asset-backed treasuries etc on Behalf of institutional clients (mutual and pension funds). Sales are another core component of any investment bank. providing brokerage and money management services for extremely wealthy individuals. Traders facilitate the buying and selling of stock. Salespeople take the form of: 1) The classic retail broker 2) The institutional salesperson.) Traders make money by purchasing securities and selling them at a slightly higher price. derivatives. Brokers develop relationships with individual investors and sell stocks and stock advice to the average Joe. Salespeople make money through commissions on trades made through their firms. Institutional investors are those who manage large groups of assets. Institutional salespeople develop business relationships with large institutional investors.

exposure risks. market risks (interest rate risk. risks relating to the country of origin of the entity to which a bank is exposed. investment banks are invariably faced with different types of risks that may have a potentially negative effect on their business. measurement and assessment. Investment banks are therefore required to form a special organizational unit in charge of risk management. Risk management in investment bank operations includes risk identification.  Liquidity risk . operational risk. as well as procedures for risk management.CHAPTER 4 RISK INVOLVED IN INVESTMENT BANKING In the course of their operations. investment risks. The risks to which a investment bank is particularly exposed in its operations are: liquidity risk. foreign exchange risk and risk from change in market price of securities. and its objective is to minimize negative effects risks can have on the financial result and capital of a bank.  Credit risk . financial derivatives and commodities). Also. measurement and assessment.is the risk of negative effects on the financial result and capital of the bank caused by the bank’s inability to meet all its due obligations. reputational risk and strategic risk. 31 . legal risk. credit risk. they are required to prescribe procedures for risk identification.is the risk of negative effects on the financial result and capital of the bank caused by borrower’s default on its obligations to the bank.

include risks of bank’s investments in entities that are not entities in the financial sector and in fixed assets.include risks of bank’s exposure to a single entity or a group of related entities.  Investment risks . Market risk- includes interest rate and foreign exchange risk. A special type of market risk is the risk of change in the market price of securities.is the risk of negative effects on the financial result and capital of the bank caused by changes in exchange rates. 32 . and risks of banks’ exposure to a single entity related with the bank. and transfer risk. financial derivatives or commodities traded or tradable in the market. 1. Interest rate risk is the risk of negative effects on the financial result and capital of the bank caused by changes in interest rates.is the risk of negative effects on the financial result and capital of the bank caused by omissions in the work of employees.  Exposure risks . 2. Foreign exchange risk . economic or social conditions in such entity’s country of origin.  Risks relating to the country of origin of the entity to which a bank is exposed -(country risk) is the risk of negative effects on the financial result and capital of the bank due to bank’s inability to collect claims from such entity for reasons arising from political. and unforeseeable external events. Country risk includes political and economic risk.  Operational risk . inadequate management of information and other systems. inadequate internal procedures and processes.

4. As risk taking is an integral Part of the investment banking business.  Strategic risk .is the risk of loss caused by a negative impact on the market positioning of the bank. and risk limits  Monitoring and reporting compliance with reliance with these limits  Delineating capital allocation and portfolio management  Developing guidelines for new products and including new exposures within the current frame work 33 . The only thing which has change is the complexity.is the risk of loss caused by a lack of a long-term development component in the bank’s managing team. and operational activities do not expose it losses that could threaten the viability of the firm. procedures. and penalties and sanctions pronounced by a regulatory body.1 Need for risk management The primary goal of risk management is to ensure that a financial institutions trading. Legal risk – it is the risk of loss caused by penalties or sanctions originating from court disputes due to breach of contractual and legal obligations. credit extension. position taking.  Reputational risk . It involves following steps  Identifying and assessing risks  Establishing policies. it is not surprising that investment bank have been risk management ever since they have been established.

Restrictions on transaction at off market rates and documentation procedures to justify any offmarket transactions. 7. Restriction on personal trading by the dealer. 5. Applying new measurements methods to the existing product Risk management practices in front office 1. Restrictions on after-hours trading and off-premises trading and documentation procedures to justify them when undertaken. Management should analyze the trading activity periodically. Adequate compensation policies should be formulated to protect dealers from losses in case of disputed traders. Risk management in the back office 34 . 6. Revaluation of position may be conducted by traders to monitor positions by the controllers to record periodic profit and loss. and by the risk mangers who seek to estimate risk under various market conditions. Taping of telephone lines of traders and dealers to resolve of disputes at a later date. confidentiality and proper language in telephone and electronic conversation. 2. 8. 3. Traders should maintain professionalism. 4.

4. trading authorities and permissible counterparties.1. 3. 3. It should have written documentation indicating the range of permissible products. 2. The top management has to identify those areas where the bank practices may not comply with the stated policies. The assessment of the counterparties based on simple balance sheet measures the traditional assessment of the financial condition may be adequate for many types of counterparties. The credit risk assessment policies should also properly define the type of analysis to be conducted on the counterparties based on the nature of their risk profile. The credit risk management function should verify that the limits are approved by the credit specialist. As with traditional banki9ng transactions. Credit guidelines should ensure that the limits are approved for only those counterparties that meet the appropriate credit criteria. In some instance stress testing may be needed when counterparty’s creditworthiness may be adversely affected by the short-term fluctuations in the financial markets. The management should explicitly state the procedure for the written authorization of the trades in excess of the laid down limits. 2. Other risk management practices 1. Necessary internal controls for ensuring that the practices confirm with that stated policies should be put in place. an independent credit function should conduct an internal credit review before engaging in transaction with the prospective counterparties. 35 . It should have limits for each type of contract or risk type. Adequate procedure for promptly resolving the failure to receive or deliver securities on the settlement dates must be established.

Goldman Sachs. market focus. as the name implies.CHAPTER 5 THE BIG PICTURE. These labels are still used (although the smaller firms scorn the boutique image). but as the rapid pace of mergers and acquisitions continues to alter the landscape. which consisted of the six largest firms: Merrill Lynch. Regional. At the top was the bulge bracket. firms could be neatly categorized by their size.MAJOR PLAYERS IN INVESTMENT BANKING Until the wave of consolidation and convergence that started in the 1990s in the financial services industry. Commercial banks and investment banks each had their roles. focus on financing and investment services in a particular geographic region. or both. Morgan Stanley. All firms beyond the bulge bracket were labeled boutiques or regional. These firms still dominate the securities underwriting and M&A markets. such as technology. and seldom did the two meet. and Lehman Brothers. the playing field had changed very little and was easy to understand. the traditional categories are becoming less and less meaningful. And within investment banking. Salomon Smith Barney. or financing vehicle. First Boston. Boutiques are niche firms that focus on a particular industry. Large commercial banks that have acquired investment banks are bringing large amounts of 36 . as defined by federal regulations. though there are few name changes in the past few years.

Credit Suisse First Boston is the result of the 1988 merger of the investment bank First Boston and Credit Suisse. Later. The company was created in 1998. Lufkin & Jenrette. CSFB ranked fifth among all banks in 2003 in terms of global debt. investment banking arm of Bank of America. 2.K. with business slackening in key areas (e. Some of the major players on investment banking are: 1. Credit Suisse first Boston LLC . and a leading underwriter of high-yield bonds with a golden reputation in research.. and research). trading. a European commercial bank.g. and equity-related issuance. e-commerce. Together with Bank of America’s U. when its parent bank acquired Montgomery Securities. In 2000. New York. one of the biggest commercial banks around. IPO underwriting) and regulatory trouble (the firm paid a $200 million fine in 2002 for research improprieties and another $100 million in 2002 to settle charges that it received kickbacks in the form of higher commissions 37 . Banc of America Securities Ltd. and asset management. the firm acquired Donaldson. and Charlotte. the global markets group (debt capital raising. it offers a full range of investment banking and brokerage services. Bank of America Securities LLC -Bank of America Securities is the U.S. A bulge-bracket bank. equity. and the combined entity took on the Bank of America name. It employs people in areas including corporate and investment banking. sales.capital to the playing field. investment banking subsidiary. CSFB has experienced trouble in recent years. Banc of America Securities’ main offices are in San Francisco.. along with a mix of financial services more varied than ever before. Bank of America was acquired by NationsBank. portfolio management. Banc of America Securities offers full-time and summer associate and analyst programs in the United States and in Europe. global treasury services.

The firm has also been losing key bankers in recent times. announced plans to leave the firm in the summer of 2004. with some key employees leaving the firm and the addition of a number of senior-level hires. the firm’s head in China announced plans to leave the firm. Observers report that layoffs could continue as the bank cuts back on research coverage. . Overall. In March 2004. reportedly due to the fact that his desire to merge Credit Suisse with another firm was not in line with the desires of the majority of the directors of Credit Suisse. epitomizing this trend. Deutsche announced it was laying-off 50 employees in the equity group. and telecom sectors. technology. The Goldman Sachs Group. which provides M&A. 4. including nine senior research analysts. It includes Deutsche Bank Alex. Deutsche Banc Securities Inc. . 3. a common trend on the Street.from clients to whom it allocated hot IPO shares—and in the process rock-star tech banker Frank Quattrone resigned and eventually was convicted of criminal charges). though. Inc. The bank has been undergoing some changes. and project finance advisory to clients in the health-care. the CEO of the investment bank. began a small enterprise to provide an alternative to expensive bank credit. acquisition finance. After that announcement. Goldman played a lead role in establishing the municipal 38 . and as this guide goes to press the firm must surely be worried that an exodus of the firm’s talent in Asia will ensue. In the 1950s. dropping coverage of 100 of the 731 companies it used to cover in the process. Deutsche Bank has been focused on building its presence in North America. John Mack.Goldman Sachs was founded in 1869 when Marcus Goldman. real estate.Deutsche Banc Securities is the full-service North American investment banking arm of German financial services giant Deutsche Bank AG. an immigrant from Europe. media. Brown.

fourth in global investment-grade corporate debt. Morgan Fleming Asset Management. Perhaps even more significant. (However. and J. Morgan.bond market. paid $33 billion to join with J. and trading. in U.P. a private-equity house. which serves wealthy private clients.) 5.P. and how a bank should do business. Today it continues to sit at or near the top in most areas of investment banking advisory. what an investment bank should be. Morgan Private Bank.S.P. In the first 6 months of 2004. J.P. fourth in underwriting. sales. Morgan H&Q. Morgan is a major player in terms of debt and equity issuance worldwide. J. and in the 1970s the firm formed the first official M&A and real estate departments on Wall Street. And now. one of the oldest and most prestigious commercial and investment banks in the world. second in global IPO underwriting.P. it’s getting even bigger.P.This firm was formed by a mega-merger when Chase Manhattan. in the first half of 2004. Morgan Partners. Goldman ranked second in global equity and equity-related business. and first in M&A advisory. with the 2004 acquisition of Bank One. J. J. which serves institutional investors. naturally).P. (A fact that’s a bit ironic given that Goldman has faced as much scrutiny as any other bank as the SEC and other regulators try to clean up Wall Street in the wake of the early-2000s banking scandals—and has had to pay a pretty penny to settle charges of misdeeds brought against it. an investment banking arm focused on areas like tech and health care. IPO 39 . it was third in the league tables in global equity underwriting.) J. one of the largest commercial banks around.P Morgan & Co. Subsidiaries include J. . it is probably considered by the majority of people in the industry as the gold standard in terms of the quality of its employees (a belief that’s especially true among Goldman employees. the acquisition probably won’t have a major effect on the way things are done in the investment bank. Morgan.

335 billion settlement with regulators for research misdeeds.S. and Merrill agreed to pay $80 million to settle. the company has worked to increase its presence in the global market place. winning his company the nickname “the firm that brought Wall Street to Main Street. retail brokerage firm. Inc. The firm’s strength lays in its vast retail brokerage network and large asset management business.. . the firm was one of a number of major banks paying between $80 million and $125 million as part of a $1. 40 . in terms of worldwide announced deals in the first half of 2004. the firm was charged by the SEC with helping Enron fraudulently pump up its profits in 1999. when Charles Merrill opened the first U. In 2003. Merill Lynch & Co. 6. It is also a player in M&A—fifth best in the business. as well as its position near the top of the global underwriting and advisory league tables. Poor performance has forced the firm to drop thousands of employees over the past several years. In recent years. and in overall debt underwriting.underwriting. In 2002.” He was joined a year later by his friend Edmund Lynch.Merrill was founded in 1914. the firm was forced to pay $100 million to New York State after evidence supporting allegations of fraudulent stock recommendations by Merrill research analysts came to light. All has not been rosy for Merrill of late. Also in 2002.

largely due to the late-1999 repeal of the Depression-era Glass-Steagall Act. such as mortgage-backed and municipal securities. As a result. investment banks have started laying-off. having hired new employees like gangbusters in the boom years of the 1990s.CHAPTER 6 THE EVOLVING INDUSTRY STRUCTURE As the global economic climate cooled down following the economic and financial meltdown. Lower interest rates drive business. which marked the deregulation of the financial services industry. At the same time. the big banks found them selves tremendously overstaffed. so did investment banking performance. now allows 41 . The repeal. Investment banking has witnessed a rash of cross-industry mergers and acquisitions in recent times.

Firms also came under fire for the methods by which they allocated stock offerings (specifically. 42 . investment banks. and protect their money all under one roof. almost all of the important investment banks have paid fines totaling in the billions of dollars to settle allegations against them. The Industry One of the biggest issues was the fact that banks overrated the investment potential of client companies’ stocks intentionally. as well as for possible manipulation of accounting rules in the course of presenting clients’ financial info to potential investors. By now. insurers. save.commercial banks. for whether they charged excessive commissions to clients who wanted to purchase hot offerings). These mergers have added a downward pressure on employment in the industry. And banks are paying millions to purchase independent research to provide to their customers. and the scrutiny of regulators remains sharp. as merged institutions make an effort to reduce redundancy. As I-banks add retail brokerage and lending to their offerings and commercial banks try to build up their investment banking services. the industry is undergoing some serious global consolidation. allowing clients to invest. and securities brokerages to offer one another’s services. deceiving investors in the pursuit of favorable relationships—and ongoing banking revenue opportunities—with those companies.

At present the industry is going through changes. Many non banking finance companies are focusing on becoming multi business entities so that they can remain commercially viable. corporate restructuring. And as the economy improves the need for these services will further intensify.CHAPTER 7 CONCLUSION For the past couple of years the investment banking industry has been shrinking and the current scenario calls for combined efforts by the regulators and the industry itself to take measures for improving the situation. This indicates good prospects for the investment banks proficient in 43 . The corporate sector has perennial needs for services such as investment advisory. distressed assets acquisition and equity and debt financing.

these areas of business. it is possible for bank to convert itself into a supermarket that offers all types of financial services to issuers and investors. investment banks have had to increase their international presence in order to retain existing clients and to generate new business. trust services etc. at both retail and wholesale level. The rapid technology changes have started affecting the industry. The industry has been witnessing consolidation across geographical functional-supermarket. insurance products. exchange rates. management. They have been achieving these offices abroad as well as by acquiring or merging with foreign investment banks. where all the financial need of all types of clients can be fulfilled. they need to stay big enough at all times 44 . As various commercial banking and investment banking activities have become digitalized. the established players are facing challenge on pricing front from all small new players. loans.. fund. In this scenario. It is time for the investment banks to focus on developing competitive advantages in the form of wider outreach and ability to mobilize national savings with greater efficiency. better quality services. During the downturn in the economy the demand for the industries services declines equally fast. credit cards. depository services. This is big forcing big banks to find means of turning the digitalization to their advantage and reducing cost. Today they are focusing more on lower cost. The earning in the industry are extremely volatile as they depend upon extremely volatile factors like interest rates. inflation etc. innovative products and new service channel so that can have deeper penetration in the market. Corporate advisory services. Similarly investment banks from other countries have been strengthening their ties with American investment banks. With the abolition of glass-Steagell act. The range of services offered may cover underwriting services.

45 . yet be flexible enough to be able to downsize quickly in a declining market.to be able to satisfy suddenly increasing demand.