PART 1

INTRODUCTION TO
INVESTMENT BANKING
CONTENT

1 What is IB?

2 Types of IB

3 Core activities at IB

4 IB Performance & Risk Management

From chapter 1 to chapter 4

After finishing this part, you should be
able to
• Highlight the evolution of IB
• Identify basic types of IB
• Understand the organizational structure of IB as well
as their core activities
• Examine IB performance and risk management
1. What is Investment Banking (IB)?

TOP 10 Investment Banks Globally

1. What is IB?
▫ An investment bank is typically a company that
provides various finance-related and other
services to individuals, corporations, and
governments such as raising financial capital
by underwriting or acting as the client's agent in
the issuance of securities. An investment bank
may also assist companies involved in mergers
and acquisitions (M&A) and provide ancillary
services such as market making, trading of
derivatives and equity securities, and FICC
services (fixed income instruments, currencies,
and commodities).
▫ Wikipedia
1. What is IB?
▫ An IB is a special type of financial institution that
caters to the financial needs of large institutions,
rather than retail consumers. IBs help companies
and governments issue securities, help investors
purchase securities, manage financial assets,
trade securities and provide financial advice
▫ Simply put, an IB acts as an intermediary between
those who need capital (the demand side) and
those who have excess capital (the supply side)
1. What is IB?
1. What is IB?

An investment bank can also be split into private

and public functions with a Chinese wall separating
the two to prevent information from crossing
▫ The private areas of the bank deal with private
insider information that may not be publicly
disclosed
▫ The public areas, such as stock analysis, deal
with public information
1. What is IB?

All investment banking activity is classed as either

"sell side" or "buy side“
▫ The “sell side" involves trading securities for cash
or for other securities (e.g. facilitating
transactions, market-making), or the promotion of
securities (e.g. underwriting, research, etc.)
▫ The “buy side” involves the provision of advice to
institutions that buy investment services. Private
equity funds, mutual funds, life insurance
companies, unit trusts, and hedge funds are the
most common types of buy-side entities
1. What is IB?

Global market share of revenue of

leading IBs as of July 2019
1. What is IB?

IB business
▫ IBs engage in public and private market transactions
for corporations, governments, and investors
▫ Traditionally, these transactions include M&A,
divestitures, the issuance of equity or debt securities
(capital raising), or a combination of both. IBs earn
M&A advisory fees, underwriting fees
▫ IBs today also include other securities business such
as trading, securitization, financial engineering,
merchant banking, investment management, and
securities services (prime brokerage, securities
lending and financing). IBs earn fees, commissions,
and gains from principal transactions
1. What is IB?

The history of IB
▫ Most of the oldest IBs started out as merchants trading
in commodities. The industry received a boost during
the Civil War when banks were syndicated to meet the
government’s need for money to fund its war efforts.
The 1800s also saw the birth of some of the most
famous IBs, such as JP Morgan and Goldman Sachs
▫ The term ‘IB’ gained popularity in the late 19th – early
20th century, largely in relation to the US. This period
marked a dramatic expansion for the IB industry which
benefited from the prosperous years following the 1st
World War, with the period sometimes referred to as a
golden age for investment banking
1. What is IB?

The history of IB
▫ The Great Depression – Excessive market
speculation, and unsustainable surges in stock prices
triggered the market crash of 1929 – was a difficult
time for IBs, some of which were forced to merge to
survive.
▫ The crash also triggered more stringent regulation for
the industry, including the famous Glass-Steagall Act
of 1933 which required the separation of commercial
banking from investment banking. JP Morgan for
instance was forced to spin off its securities
underwriting division to form Morgan Stanley & Co as
an independent investment bank.
1. What is IB?
The history of IB
▫ The 2nd golden age continued in the 1990s,
characterized by the dot-com boom and bubble. The
enactment of the Gramm-Leach-Bliley Act in
November 1999 effectively repealed the long-standing
prohibitions on the mixing of banking with securities or
insurance businesses under the Glass-Steagall Act
and thus permitted “broad banking”
▫ The financial crisis - the speculative bubble in housing
prices, overreliance on sub-prime mortgage lending
which damaged financial institutions globally. Among
the IB victims were Bear Stearns and Lehman
Brothers. The financial crisis triggered consolidation in
the industry, with JPMorgan & Chase acquiring Bear
Sterns, while Bank of America snapped up Merrill
Lynch
1. What is IB?

The history of IB
▫ The future of the industry is a highly debated topic.
 There is no question that the financial services
industry is going through something
pretty significant post-crisis.  Many banks had near-
death experiences in 2008 and 2009, and remain
hobbled
▫ IBs are facing an intensely competitive environment,
fostered by regulatory changes, by globalization, and
by technological advances. As a result, most IBs have
expanded to comprise all major capital market
activities
2. Types of IB
2. Types of IB

Two basic types of IB:

▫ Full-service IBs (typically categorized as Bulge
bracket or tier one and tier two IBs) – engage in
all kind of activities such as underwriting, M&A,
trading, merchant banking, investment
management, securities services, and research.
Some of the bulge bracket houses are part of a
larger financial holding companies
▫ Boutique IBs – focus on particular segments
2. Types of IB

Financial holding companies

▫ Large financial holding companies now include IB
in their menu of services
● Under the universal banking scheme, large banks in
EU, Japan have operated in commercial banking
and investment banking
● In US, since Gramm-Leach-Bliley Act of 1999 took
effect, investment banking has become an integral
part of financial holding companies’ businesses
▫ Example: HSBC, Deutsche Bank, UBS AG,
Citigroup, JPMorgan, Bank of America
2. Types of IB

Full service investment banks

▫ Goldman Sachs and Morgan Stanley are the two
US independent full-service investment banks.
They are not part of a financial holding company

Firms Goldman Sachs Morgan Stanley

Business Investment Banking Institutional Securities
Categories Investing and Lending Investment Management
Institutional Client Service Global Wealth
Investment Management Management
2. Types of IB

Boutique investment banks

▫ They do not offer a range of services and are not
part of a larger financial institution

▫Firms Sandler Greenhill Lazard

O’Neill
Specializations Financial Advisory Services Advisory Services
Institutions in M&As and in M&As
and Financial Asset
Insurance Restructuring Management
Companies Special
Committee
Advisory
3. Core activities at IB
3. Core activities at IB

Investment banking is split into front office, middle

office and back office activities
Front Office
▫ Corporate finance:  traditional aspect of
investment banks which involves helping
customers raise funds in capital markets and
giving advice on M&A
▫ Sales and trading: a large investment bank's
primary function is buying and selling products
▫ Research: The research division reviews
companies and writes reports about their
prospects, often with "buy", "hold" or "sell" ratings
3. Core activities at IB

Front office
▫ Corporate Finance – also labeled simply IB
Division
● Product Groups – focus on a specific deal type,
such as equity or debt issuances or acquisitions,
including
● Mergers and Acquisitions (M&A)
● Equity Capital Markets (ECM)
● Debt Capital Markets (DCM)
● Leveraged Finance (LF)
● Restructuring (RX)
3. Core activities at IB

Front office
▫ Corporate Finance – also labeled simply IB
Division
● Industry Groups – specialize in a specific industry
and often work with individual companies in that
industry
● Real estate, Media & telecom, Finance, Consumer
retail, Power & Utilities, Transportation, Healthcare,
Technology, F&B, Oil & gas…
3. Core activities at IB

Front office
● Raising Capital and Security Underwriting – IBs are
intermediaries between the issuers of securities and
the investing public. IBs determine the value and
riskiness of the business in order to price,
underwrite, and then sell the securities

● Sample Underwriting Scenario: Gillette wants to raise some money for a

new project. One option is to issue more stock (secondary stock offering). 
They’ll go to JPMorgan, which will price the new shares. JPMorgan will then
underwrite the offering, meaning it guarantees that Gillette receives proceeds
at $(share price*newly issued shares) less JPMorgan’s fees. Then, JPMorgan
will use its institutional salesforce to go out and get Fidelity and many other
institutional investors to buy chunks of shares from the offering. JPMorgan’s
traders will facilitate the buying and selling of these new shares by buying and
selling Gilette shares out of their own account, thereby making a market for
the Gillette offering
3. Core activities at IB
Front office
● M&A advisory and other corporate reorganizations –
an important source of fee income for IBs as the fee
margin structure is substantially higher than most
underwriting fees)
● IBs usually involve in various aspects of the
acquisition and sale of companies and assets such
as business valuation, negotiation, pricing and
structuring of transactions, as well as  procedure
and implementation
● When an IB takes on the role of an advisor to a
potential seller (target), this is called a sell-side
engagement.  Conversely, when an IB acts as an
advisor to the buyer (acquirer), this is called a buy-
side assignment
3. Core activities at IB

Front office
▫ Sales and Trading – helps institutional investor
clients (pension funds, endowments, insurance
firms, and wealthy individuals) to buy and sell
securities. The salespeople and traders must
divide up the large orders, match buyers and
sellers, and get desirable prices
● Equity trading – primarily companies’ stocks and
their derivatives, such as options
● Fixed income trading or FICC - “everything that
isn’t equities,” including rate, municipal bonds,
corporate bonds, CDS, FX, commodities, money
markets, and more
3. Core activities at IB

Middle Office
● Risk management: involves analyzing the market
and credit risk that an IB or its clients take onto their
balance sheet during transactions or trades
● Corporate treasury: responsible for an investment
bank's funding, capital structure management, and
liquidity risk monitoring
● Internal control: tracks and analyzes the capital
flows of the firm
● Internal corporate strategy: tackling firm
management and profit strategy
3. Core activities at IB

Back Office
● Handles things such as trade confirmation, ensuring
that the correct securities are bought, sold, and
settled for the correct amounts, the software and
technology platforms that allow traders to do their
job are state-of-the-art and functional, the creation of
new trading algorithms, and more
3. Core activities at IB

▫ So what does an investment bank actually do?

● Raising capital and Security underwriting. Banks are
middlemen between a company that wants to issue
new securities (such as IPO) and the buying public
● Mergers & Acquisitions (M&A). Banks advise buyers
and sellers on business valuation, negotiation,
pricing and structuring of transactions, as well as
 procedure and implementation
● Merchant banking. Providing capital to companies in
the form of share ownerships instead of loans, and
providing those businesses with advisory services.
However, bank typically services smaller clients and
makes direct equity investments in them
3. Core activities at IB

▫ So what does an investment bank actually do?

● Sales & Trading and Equity Research. Banks match
up buyers and sellers as well as buy and sell
securities out of their own account to facilitate the
trading of securities
● Prime brokerage. Providing bundled package of
services
● Asset management. Managing investments for a
wide range of investors including institutions and
individuals, across a wide range of investment styles
3. Core activities at IB

▫ Who are investment banks’ clients?

● Governments – work with governments to raise
money, trade securities, and buy or sell crown
corporations
● Corporations – work with private and public
companies / operating businesses (go public (IPO),
raise additional capital, growth business, make
acquisitions, sell business units, provide research
and corporate finance advice
3. Core activities at IB

▫ Who are investment banks’ clients?

● Institutions – work with institutional investors who
manage other people’s money to help them trade
securities and provide research
● Individuals – also deal with individual investors by
providing wealth management services and family
office support for ultra high net worth individuals
4. IB performance and risk management

▫ IB financial performance
● IB business is intensely competitive and volatile
● With the exception of boutiques, IBs offer a wide
range of services on a global basis. Diversification of
business lines is necessary and makes good
business sense. However, each house has focused
on a strategic framework that is its core competence
● For example, Goldman ranks high on financial advisory on M&As and
strategic issues. It also relies heavily on trading and merchant banking
4. IB performance and risk management

Global market share of revenue of

leading IBs as of July 2019
4. IB performance and risk management
▫ .
4. IB performance and risk management
▫ .
4. IB performance and risk management
▫ .
4. IB performance and risk management
▫ Risk management
● Major types of risks IBs face include market risk,
credit risk, operating risk, legal risk, and funding risk.
● The ability to properly and effectively identify,
assess, monitor, and manage each type of risk is
critical to an IB’s financial soundness and profitability
4. IB performance and risk management
▫ Market risk
● Refers to the risk of losses or a price decline for a
specified position or portfolio that the firm owns.
● Market risk factors include interest rate, foreign
exchange, equity prices, and commodity prices
● IBs manage these market risks by diversifying
exposures, controlling position sizes, and
establishing hedges in related securities or
derivatives
4. IB performance and risk management
▫ Credit risk
● The possible loss that occurs when a counterparty
or an issuer of securities or other instruments held
by the firm fails to meet its contractual obligation
● IBs need to establish limits for credit exposures.
Other safeguards include maintaining collateral and
continually assessing the creditworthiness of counter
parties and issuers
4. IB performance and risk management
▫ Operating and Reputation risk
● An operational failure may result in financial loss,
regulatory risk, or damage to a firm’s regulation
● Settlement errors or delays may cause losses due to
damages owed to counterparties or movements in
prices
● Most firms maintain backup facilities, use
technology, employ experienced personnel, and
maintain internal controls
4. IB performance and risk management
▫ Legal risk
● Includes the risk that a firm might fail to comply with
applicable legal and regulatory requirements and the
risk that the counterparty’s obligations may be
unenforceable
● IB need to establish procedures addressing
regulatory capital requirements, sales and trading
practices, new products, use and safekeeping of
customer securities, credit granting, collection
activities, money laundering, and record keeping
4. IB performance and risk management
▫ Funding risk
● Essential in IB business
● Maintain a cash position, borrow large sums in the
debt markets (if necessary), and secure access to
the repo and securities lending markets; in some
cases, IB may sell securities and other assets
Conclusion