Investment Banking

Introduction to Investment Banking
History of Investment Banking

1
• Investment banking emerged in the United States of America in the 19th century.
• The main activity of investment banks was security underwriting.
• The main clients that investment banks had during these days were government entities.
o Governments did not have expertise to sell bonds on their own
o They did not know how to price them
o They weren’t unbiased in the negotiation of proper terms
o Individual investors did not believe that their interests would be protected.
• Investment Bankers negotiated great terms with the government, which included buying fraction of the bonds
that government has to offer and sell the bonds to the investors.
2
salim.yolchiyev@kcl.ac.uk
• When government issues debt, there are two kinds of risk:
o Government can default and stop repaying its debt
o Government may attempt to renegotiate on its debt.
• In 1842, eight American States defaulted on their debt because their economy heavily relied on cotton
production and the price of cotton that year was low.
• These states refused pay their debt. Investment bankers, who underwrote these deals, rejected any attempts of
states raising new capital.
• James Rothschild was quoted as saying to the representatives of the federal government:
“you may tell your government that you have seen the man who is at the head of the financiers of Europe,
and that he has told you that they cannot borrow a dollar, not a dollar”.
3
• As a result, defaulting states agreed to restructuring plan, which satisfied the investors and repaid their
capital.
• This proves how important investment bankers were. Such episodes increased their credibility and
reputation, which allowed them to work with top investors, and top issuers of debt and equity.
• Conclusion: the investment banking, as a service, emerged because of the dynamics between project
owners and investors.
• Investment bankers brought to the table something very important – their reputation.
• The quality of the security was associated with the name of investment banker who sold it to the market.
These aligned the goals of investment bankers and investors.
4
Strategies of Investment Banks

5
• Global Investment Banks, Boutique Investment Banks, Wholesale Investment Banks and Investment Banks
offering Financial Markets Services
• These are two main approaches used by investment banks when formulating their strategies and interacting with
clients: Transaction Based Investment Banking vs. Relationship-Based Investment Banking
• The lesser degree of customization is not necessarily a bad thing for the bank or the clients. Client may prefer
TBB if they do not need the bank’s regular advice and would like to keep the fees at their minimum.
• TBB is more economic as bankers are result-driven and focus primarily on technical spectrum of the job. But
RBB banking is about establishing a contact with important corporate executives and supporting that
relationship in the years that follows.
• Link from Goldman Sachs MD: https://www.youtube.com/watch?v=z8kqCIxXTEw

6
Four Main Areas of IB

7
Initial Public Offering

8
Capital Markets
• Securities underwriting is the process by which investment banks raise investment capital from investors on
behalf of corporations and governments that are issuing securities (both equity and debt capital).
• When a company wants to raise equity, we talk about ECM (equity capital markets) and when company wants
to raise debt, we talk about DCM (debt capital markets).
• ECM: we will consider Initial Public Offerings (IPO) and Seasoned Equity Offerings (SEO)
• IPO – in an IPO, company’s shares are offered to public investors for the first time.
o The right time depends on company’s size, profitability, administrative capacity, growth potential and management.
o Investment Bankers provide guidance on IPOs.
• SEO (seasoned equity offerings) is a process where a publicly listed company issues additional shares as a source of
financing.
9
Capital Markets
• During a SEO, the role of investment bankers is much easier because
o Shares are already priced by the market
o The company is already compliant with requirements for listed firms
• During a SEO, the role of investment bankers is
o Create a list of investors that would buy the additional shares issued by the company
o Underwrite the stock once enough demand is established
• In DCM, investment bankers advise loan terms, prepare company presentations, find investors and price the loan.
• Pricing loans is easier than pricing equity because every company has a credit rating that is expressed by an
independent credit rating agency (i.e., S&P 500).
10
Why to go public?
• In an IPO, company’s shares are offered to public investors for the first time. The management wants to get the
highest price per share while investors want to invest in company with strong management and growth
potential.
• Why to go Public?
o To finance current growth by raising cash
o When listed on stock exchange it can acquire other companies by using its stock
o Listing on the stock exchange brings reputation and visibility in financial reporting and a vote of confidence by large
investors.
o A signal for strong market position (higher confidence of large investors).
o Acts as a tool for management compensation, including ESOPs, RSUs etc.
o IPO is considered as an exit opportunity for founders of company.

11
12
Investors in IPO
• The IPO investors can be grouped into three categories: retail investors, institutional investors and hedge funds.
• Retail investors are private individuals looking to invest their money to diversify their income to earn more
money.
• Institutional investors are entities like mutual and pension funds, and insurance companies.
• Some institutional investors have a very solid reputation, that is, attracting the interest of BlackRock and
Fidelity can be a very strong signal for the market.
• Hedge funds are investment vehicles who are mainly interested in trading with under-priced or overpriced
securities.
• These three types of investors differ from one another significantly in terms of investment horizon, return
expectations, risk profile and sophistication.
13
Coming up with a Share Price
• The typical IPO process lasts between 4 to 6 months.
• The price range which is set for an IPO depends on multiple factors. Its key goal is to provide a slight discount
to the actual trading value of the company to the institutional investors.
• DCF is the most common way to calculate the company’s value during an IPO. The basis for DCF is the
historical results and the business plan that has been prepared by the management team of the company.
• Another valuation technique is multiples valuation method. Analysts use the prices of these public companies
and calculate a ratio between their prices and operating results. This ratio can be multiplied by firm’s operating
results, thus, obtain a sense of company’s valuation.
• The shape of macroeconomic environment is critical too – nobody wants to conduct IPO when financial
markets are turbulent, and the value of shares are going down. Tens of IPOs were cancelled in 2008.
14
Coming up with a Share Price
• Book Building Process: book building is the process by which an underwriter attempts to determine the price at
which the IPO shares will be offered.
• An underwriter, normally an investment bank, builds a book by inviting institutional investors to submit bids for
the number of shares and the price(s) they would be willing to pay for them.
• Towards the end of IPO, investment banker’s idea of pricing improves significantly – after each meeting with
investors they receive feedback about investor’s willingness to buy shares at different prices.
• So, institutional investors are able to tell the banks how many of the “IPO” shares they are willing to buy at
different prices.
• Main aim: IPO pricing should achieve the company’s objectives, whilst ensuring a stable aftermarket.
15
IPO Timetable
16
Pricing Process
• Prior Roadshow consists of contacting institutional investors to learn more about their feelings towards the
equity of the company to be listed which allows the company to determine a suitable price range, which can be
10% - 20% wide.
• Once the suitable price range is established, the road-show presentation phase begins. Investment bankers
organize one-on-one and group meetings with investors interested in the IPO, which helps Investment Bankers
improve their idea about a possible price range.
• At the same time, when retail investors place an order, they can only indicate the maximum price at which they
are willing to buy the company’s shares and they can’t declare interest in buying different amounts of shares at
various price points
17
Allocating Shares
• When the investment bank and the firm have decided on the maximum price of IPO, the retail offering
(allocations) begins.
• Should company and investment bank choose the highest IPO price which allows the sales of targeted number
of shares?
o Firstly, it is important that investors are not left with a sour taste after the IPO. Therefore, company should offer its
shares at a slight discount allowing investors to profit in the first few hours of the trading.
o Secondly, a slight discount increases the number of investors willing to buy the company’s shares which provides some
extra liquidity in the market. Liquidity is helpful as it helps stabilize the stock in the period after listing (it facilitates
post-launch trading of shares).
o Finally, it is very important to allocate as many shares as possible to the investors that believe in the equity story and
are buying with a long-term perspective.
18
Stabilizing Share Price
• Stabilisation is a process of ensuring that the company’s price will remain stable in the immediate period after
the IPO.
• An IPO is a failure if the stock price is not stable after the listing.
• To keep the share price stable, investment bank responsible for the IPO makes a stabilisation effort which
consists of supporting the share price.
• Overallotment – Greenshoe Options.
• If the IPO is a success and the share price surges, the underwriters exercise the option, buy the extra stock from
the company at the predetermined price, and issue those shares, at a profit, to their clients.
• Conversely, if the price starts to fall, they buy shares from the market instead from company, supporting the
stock to stabilize its price.
19
Advisory – M&A
• Mergers and Acquisitions services became increasingly popular during the third M&A wave (between 1955 and
1970), where large conglomerates became to develop as a result of M&As.
• The buyer company can offer a compensation to the target company’s shareholders in several ways: 1) all cash,
all stock offer, 2) stock for stock offer, 3) combination of both.
• Reasons for M&A
o It is cheaper to acquire something that has been already created rather than generate it internally
o A buying company and a target company may be so complementary that their combination may unlock huge amounts
of savings, efficiencies and opportunities
• Investment bankers are ideally positioned to provide valuable M&A insights to their clients.
• Buy-side vs. Sell-side M&A

20
Mergers and Acquisitions

21
Historical M&A Waves
• The first wave of M&A took place between 1893 and 1904. At the time, horizontal M&As were prevalent.
• The second wave of M&A took place between 1919 and 1929. Companies expanded vertically.
• The third wave of M&A took place between 1955 to 1970. It involved the formation of conglomerates.
• The fourth M&A wave took place between 1974 and 1989. This is when hostile takeovers and leveraged
buyouts became popular among financial buyers
• The fifth wave of M&A occurred between 1993 and 2000. Companies expanded internationally.
• The sixth wave of M&A occurred between 2003 and 2008. A great deal of private equity and LBO transactions
were carried out during this period (movie recommendation: Big Short).
• The seventh wave of M&A occurred between 2011 – present. Many corporations in U.S. became attractive
targets to foreign investors due to suppressed valuations (movie recommendation: China Hustle)
22
The reasons for M&A
23
Deal Lifecycles
24
25
Valuation Methodologies
• Investment bankers at both buy-side and sell-side perform target’s valuations by calculating its intrinsic value
and the premium that should be paid before the negotiation process
• The main valuation methodologies used in an M&A are DCF, Public Comps., Precedent Transactions and
LBOs. Usually, investment bankers use the combination of two or more to triangulate their results.
• Investment bankers, when doing valuations, take the liabilities of the firm into consideration. Some liabilities
are necessary for firm’s operations, such as accounts payables, while others are form of financing, i.e., net debt.
• Equity Value is the value of firm’s shares and Enterprise Value is the value of firm’s shares plus Net Debt.
• It is important to consider both, because the valuation implied by enterprise value considers the capital structure
of firm, while equity value does not.
26
Negotiations
• When both sides do their valuations, they sit on negotiation table. Sometimes buyers and sellers can have
significant differences in valuing a target.
o If the difference between the price asked and price offered is higher than 5%, then it is considered to be a deal breaker
– transaction does not occur.
o If the difference is less than 5%, then it is considered earn-out mechanism.
• Earn-out
o Pros: seller keeps upside and remains involved in target’s integration with the buyer.
o Cons: difficult to measure (different EBITDA values from buyer and target). Also, can be subject to external events,
such as industry dynamics and macroeconomics cycles.
27
Payment Options
• Stock-for-stock offer: involves raising equity for M&A financing which does not involve additional borrowings
of debt or/and exploitation of cash in hand. All-cash-all-stock offer involves purchase of company’s
shareholders’ stocks at with cash only.
• The acquirer may prefer to use all cash all-stock offer if it is confident about future profitability from synergies
that would be enjoyed from acquired company. The acquirer may prefer all cash all-stock offer if it is concerned
about the future performance of the new company.
• In reality, the M&A is mostly financed through combination of cash in hand and stock offering.
• When deciding whether to finance an M&A majorly through cash or stock, the investment bankers should
analyse the cost of issuing debt and cost of issuing stock, respectively.
28
Trading and Brokerage

29
Trading and Brokerage
• Trading and brokerage is any securities transaction by using investment banks own money (proprietary trading)
or doing it on behalf of clients (brokerage).
• Trading and Brokerage accounts for 35% - 50% of revenue of pure investment banks, such as Morgan Stanley
and Goldman Sachs. Diluted for universal banks due to large amount of interest income that they register.
• Proprietary trading refers to a financial firm or commercial bank that invests for direct market gain rather than
earning commission through brokerage
• Traders may execute an assortment of market strategies that include index arbitrage, statistical arbitrage, merger
arbitrage, fundamental analysis, volatility arbitrage, technical analysis and/or global macro trading.
• Volcker Rule: prohibits banks in the U.S. from making certain speculative investments (including proprietary
trading) that do not benefit the customers.
30
31
32
Asset Management
33
Asset Management
• Asset Management is about managing client’s investments and providing them with strategies and expertise that
will allow them to achieve their financial goals.
• Asset managers are able to offer expertise across a wide spectrum of assets, such as stocks, bonds, commodities,
real estate, private equity and etc.
• Large investment banks have branches all over the world, hence, able to offer geographical expertise as well
• Asset managers study clients’ needs, create an actionable investment strategy, implement this strategy in
practice and oversee its development over time.
• Asset managers study the markets and their clients’ needs, hence, build investment portfolios across a broad
range of asset classes.
34
Types of investments are part of the equation that
determines how to allocate the client’s money.
The art of this profession is to maximize the
return without assuming excessive risk. 35
36
Non-technical Interview Questions

37
• Question 1: tell me about yourself.
o A lot of jobs require someone who can think on their feet or present ideas with crispness and clarity.
o This question provides employers with:
 An early preview of your core skills
 Your personality
 Your ability to respond to an unstructured question.
• Question 2: what is your greatest strength?
o Employers want to see if you can strike the right balance between confidence and humility.
o Hiring managers want to get a sense for how self-aware and honest you are and align your strengths to the role at hand.
38
• Question 3: what is your greatest weakness?
o The interviewer is assessing whether your weaknesses will get in the way of doing the job.
o Employers are looking for humility and whether you’re committed to learning and growing.
o This is a place you can showcase what you’re doing to improve.
• Question 4: tell us a time you managed conflicting priorities
o Employers want to see how you handle competing priorities, understand the implications of missing deadlines, and can
stay cool under pressure.
• Question 5: tell me about a time you were successful in a team
o If you can show that you’ve helped a team move through a challenge, you have strong communication and
interpersonal skills. Such “soft” skills are in high demand and make people successful in their jobs.
39
• Question 6: tell us a time you showed leadership
o Employers want to see if you can motivate and lead the team. If you can show that you’ve helped a team move through
a challenge, you have strong communication and interpersonal skills.
• Question 7: why investment banking?
o The main reason interviewers ask this question is because they want to know that you know the lifestyle and type of
work associated with the role. Many candidates don’t really know what an investment banking job entails. Get clear on
what an investment banker does.
• Question 8: why us?
o Employers want evidence that you have researched the firm and know what differentiates it from other banks. In some
cases, they also want to know if you’ve done some due diligence and tried to connect with others in the firm.
40
• Question 9: what does a banker do in an IPO or M&A transaction
o Interviewers ask this question because they want to confirm that you understand the difference between an IPO and an
M&A transaction.
o Because investment bankers are often involved in both types of transactions, they want to see that you have high
financial acumen and fully grasp your job function.
• Question 10: pitch me a stock
o This question helps interviewers understand your thought process. They want to see that you fully comprehend how to
evaluate an investment opportunity, and, while there may be no specific “right” stock to pitch, you need to make sure
your strategy is solid.
o We will come back to this question after doing Valuations I.
41
Brainteasers and Mental Math Questions

42
• Question 1: how many piano teachers are there in New York?
• Question 2: how many black cabs are there in London?
• Question 3: how many people pass through Heathrow Terminal 1 every day?
• Question 4: what is the weight of Empire State Building?
• Question 5: how many street lights are there in London?
• Question 6: what is the internal angle between the hour and the minutes hand at 6:20 pm?
• Question 7: how many pizzas are sold in London every day?
• Question 8: what is the price of Eiffel Tower?
• Question 9: how do you forecast revenues for Google?
• Question 10: how does Cafe Nero pay no taxes on multi million $s of revenue?
43
List of Technical Interview Questions

44
• Question 1: how do the three financial statements come together?
• Question 2: which financial statement is the most important?
• Question 3: what is NPV and how would you use it?
• Question 4: how do you value a company?
• Question 5: what is WACC?
• Question 6: what is the difference between fair value and book value?
• Question 7: walk me through DCF
• Question 8: walk me through an LBO process
• Question 9: explain the use of mezzanine debt in LBOs
• Question 10: explain the concept of IRR

45

Investment Banking

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Investment Banking

Uploaded by

Copyright:

Available Formats

Introduction to Investment Banking

History of Investment Banking

• The main activity of investment banks was security underwriting.

o Governments did not have expertise to sell bonds on their own

o They did not know how to price them

o They weren’t unbiased in the negotiation of proper terms

• When government issues debt, there are two kinds of risk:

o Government can default and stop repaying its debt

o Government may attempt to renegotiate on its debt.

Strategies of Investment Banks

• Link from Goldman Sachs MD: https://www.youtube.com/watch?v=z8kqCIxXTEw

Four Main Areas of IB

Initial Public Offering

o Investment Bankers provide guidance on IPOs.

• During a SEO, the role of investment bankers is much easier because

o Shares are already priced by the market

o The company is already compliant with requirements for listed firms

• During a SEO, the role of investment bankers is

o Underwrite the stock once enough demand is established

o A signal for strong market position (higher confidence of large investors).

o Acts as a tool for management compensation, including ESOPs, RSUs etc.

o IPO is considered as an exit opportunity for founders of company.

• The typical IPO process lasts between 4 to 6 months.

• Overallotment – Greenshoe Options.

• Reasons for M&A

• Buy-side vs. Sell-side M&A

Mergers and Acquisitions

o If the difference is less than 5%, then it is considered earn-out mechanism.

shareholders’ stocks at with cash only.

about the future performance of the new company.

Trading and Brokerage

Non-technical Interview Questions

• Question 1: tell me about yourself.

o This question provides employers with:

 An early preview of your core skills

 Your ability to respond to an unstructured question.

• Question 2: what is your greatest strength?

• Question 3: what is your greatest weakness?

o This is a place you can showcase what you’re doing to improve.

• Question 4: tell us a time you managed conflicting priorities

• Question 5: tell me about a time you were successful in a team

• Question 6: tell us a time you showed leadership

• Question 7: why investment banking?

• Question 8: why us?

• Question 9: what does a banker do in an IPO or M&A transaction

• Question 10: pitch me a stock

o We will come back to this question after doing Valuations I.

Brainteasers and Mental Math Questions

• Question 1: how many piano teachers are there in New York?

• Question 2: how many black cabs are there in London?

• Question 4: what is the weight of Empire State Building?

• Question 5: how many street lights are there in London?

• Question 7: how many pizzas are sold in London every day?

• Question 8: what is the price of Eiffel Tower?

• Question 9: how do you forecast revenues for Google?

List of Technical Interview Questions

• Question 1: how do the three financial statements come together?

• Question 2: which financial statement is the most important?

• Question 3: what is NPV and how would you use it?

• Question 4: how do you value a company?

• Question 5: what is WACC?

• Question 7: walk me through DCF

• Question 8: walk me through an LBO process