A Project on

INVESTMEN
T BANKING
Submitted to Prof. Jalpa

Team mates

Dhaval Shah 49

Saad Kazi 43

Mohammad Zaveri 52

Abdul 48

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Kshitij Pandeya 46

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INDEX PAGE NO

INTRODUCTION 4

WHO NEEDS AN INVESTMENT BANK? 5

WHAT DOES IT DO? (TO EARN) 6

COMMERCIAL BANKING VS. INVESTMENT BANKING 8

THE BUY-SIDE V/S THE SELL-SIDE 12

HEDGE FUNDS: An over view 12

ORGANIZATIONAL STRUCTURE OF AN INVESTMENT BANK 13

POSSIBLE CONFLICTS OF INTEREST 17

Bibliography 18

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 INTRODUCTION

An investment bank is a financial institution that raises capital, trades in securities and
manages corporate mergers and acquisitions. Investment banks profit from companies and
governments by raising money through issuing and selling securities in the capital markets (both
equity, bond) and insuring bonds, as well as providing advice on transactions such as mergers and
acquisitions. A majority of investment banks offer strategic advisory services for mergers, acquisitions,
divestiture or other financial services for clients, such as the trading of derivatives, fixed income,
foreign exchange, commodity, and equity securities.

Trading securities for cash or securities (facilitating transactions, market-making), or the

promotion of securities (underwriting, research, etc.) was referred to as the "sell side".

Dealing with the pension funds, mutual funds, hedge funds, and the investing public who
consumed the products and services of the sell-side in order to maximize their return on investment
constitutes the "buy side". Many firms have both buy and sell side components.

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. Also called investment banker.

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

WHO NEEDS AN INVESTMENT BANK?

Any firm contemplating a significant transaction can benefit from the advice of an investment
bank. Although large corporations often have sophisticated finance and corporate development
departments provide objectivity, a valuable contact network, allows for efficient use of client
personnel, and is vitally interested in seeing the transaction close.

Most small to medium sized companies do not have a large in-house staff, and in a financial
transaction may be at a disadvantage versus larger competitors. A quality investment banking firm can
provide the services required to initiate and execute a major transaction, thereby empowering small
to medium sized companies with financial and transaction experience without the addition of
permanent overhead, an investment bank provides objectivity, a valuable contact network, allows for
efficient use of client personnel, and is vitally interested in seeing the transaction close.

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 WHAT DOES IT DO? (TO EARN)

CORPORATE FINANCE
The bread and butter of a traditional investment bank, corporate finance generally performs two
different functions:

1) Mergers and acquisitions advisory and

2) Underwriting.

On the mergers and acquisitions (M&A) advising side of corporate finance, bankers assist in
negotiating and structuring a merger between two companies. If, for example, a company wants to
buy another firm, then an investment bank will help finalize the purchase price, structure the deal,
and generally ensure a smooth transaction. The underwriting function within corporate finance
involves shepherding the process of raising capital for a company. In the investment banking world,
capital can be raised by selling either stocks or bonds to investors.

SALES
Sales is another core component of any investment bank. Salespeople take the form of:

1) the classic retail broker

2) The institutional salesperson, or 3) the private client service representative.

Brokers develop relationships with individual investors and sell stocks and stock advice to the average
Joe. Institutional salespeople develop business relationships with large institutional investors.
Institutional investors are those who manage large groups of assets, for example pension funds or
mutual funds. Private Client Service (PCS) representatives lie somewhere between retail brokers and
institutional salespeople, providing brokerage and money management services for extremely

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wealthy individuals. Salespeople make money through commissions on trades made through their
firms.

TRADING
Traders also provide a vital role for the investment bank. Traders facilitate the buying and selling of
stock, bonds, or other securities such as currencies, 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. (This is often called making a
market.) Traders make money by purchasing securities and selling them at a slightly higher price. This
price differential is called the "bid-ask spread."

RESEARCH
Research analysts follow stocks and bonds and make recommendations on whether to buy, sell, or
hold those securities. Stock analysts (known as equity analysts) typically focus on one industry and will
cover up to 20 companies' stocks at any given time. Some research analysts work on the fixed income
side and will cover a particular segment, such as high yield bonds or U.S. Treasury bonds. Salespeople
within the I-bank utilize research published by analysts to convince their clients to buy or sell
securities through their firm. Corporate finance bankers rely on research analysts to be experts in the
industry in which they are working. Reputable research analysts can generate substantial corporate
finance business as well as substantial trading activity, and thus are an integral part of any investment
bank.

SYNDICATE

The hub of the investment banking wheel, syndicate provides a vital link between salespeople and
corporate finance. Syndicate exists to facilitate the placing of securities in a public offering, a knock-
down drag-out affair between and among buyers of offerings and the investment banks managing the

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process. In a corporate or municipal debt deal, syndicate also determines the allocation of bonds. The
breakdown of these fundamental areas differs slightly from firm to firm.

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 current and savings accounts from
consumers. 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, 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.

PRIVATE CONTRACTS
Importantly, loans from commercial banks are structured as private legally binding contracts
between two parties - the bank and you (or the bank and a company). Banks work with their clients to
individually determine the terms of the loans, including the time to maturity and the interest rate

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charged. Your individual credit history (or credit risk profile) determines the amount you can borrow
and how much interest you are charged. Perhaps you need to borrow Rs. 1,00,00,000 over 15 years to
finance the purchase of your home, or maybe you need Rs. 1,50,00,000 over five years to finance the
purchase of a car. Maybe for the first loan, you and the bank will agree that you pay an interest rate of
7.5 percent; perhaps for the car loan, the interest rate will be 11 percent. The same process applies to
loans to companies as well - the rates are determined through a negotiation between the bank and
the company.

Let's take a minute to understand how a bank makes its money. On most loans, commercial
banks earn interest anywhere from 5 to 14 percent. Ask yourself how much your bank pays you on
your deposits - the money that it uses to make loans. You probably earn a paltry 1 percent on a
current account, if anything, and maybe 2 to 3 percent on a savings account. Commercial banks thus
make gobs of money, taking advantage of the large spread between their cost of funds (1 percent, for
example) and their return on funds loaned (ranging from 5 to 14 percent).

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.

PUBLIC SECURITIES
Investment banks typically sell public securities (as opposed private loan agreements).
Technically, securities such as Microsoft stock or Ford AAA bonds, represent government-approved

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stocks or bonds that are traded either on a public exchange or through an approved dealer. The
dealer is the investment bank.

Private Debt vs. Bonds - An Example

Let's look at an example to illustrate the difference between private debt and bonds. Suppose
Acme Company needs capital, and estimates its need to be Rs. 200 million. Acme could obtain a
commercial bank loan from Bank of New York for the entire Rs. 200 million, and pay interest on that
loan just like you would pay on a Rs. 2,000 loan from Bank of New York. Alternately, it could sell bonds
publicly using an investment bank such as Morgan Stanley. The Rs. 200 million bond issue raised by
Morgan would be broken into many bonds and then sold to the public. (For example, the issue could
be broken into 200,000 bonds, each worth Rs. 1,000.) Once sold, the company receives its Rs. 200
million and investors receive bonds worth a total of the same amount.

Over time, the investors in the bond offering receive the interest, and ultimately the principal
(the original Rs. 1,000) at the end of the life of the loan, when Acme Corp buys back the bonds (retires
the bonds). Thus, we see that in a bond offering, while the money is still loaned to Acme, it is actually
loaned by numerous investors, rather than a bank.

Because the investment bank involved in the offering does not own the bonds but merely
placed them with investors at the outset, it earns no interest - the bondholders earn this interest in
the form of regular coupon payments. The investment bank makes money by charging the client (in
this case, Acme) a small percentage of the transaction upon its completion. Investment banks call this
upfront fee the "underwriting discount." In contrast, a commercial bank making a loan actually
receives the interest and simultaneously owns the debt.

Later, we will cover the steps involved in underwriting a public bond deal. Legally, bonds must
first be approved by the Securities and Exchange Commission (SEC). (The SEC is a government entity
that regulates the sale of all public securities.) The investment bankers guide the company through
the SEC approval process, and then market the offering utilizing a written prospectus, its sales force
and a road-show to find investors.

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THE QUESTION OF EQUITY (UNDERWRITING)

Investment banks underwrite stock offerings just as they do bond offerings. In the stock
offering process, companies sell a portion of the equity (or ownership) of itself to the investing public.
The very first time a company chooses to sell equity, this offering of equity is transacted through a
process called an initial public offering of stock (commonly known as an IPO). Through the IPO
process, stock in a company is created and sold to the public. After the deal, stock sold are traded on a
stock exchange such as the NSE or the BSE. The equity underwriting process is another major way in
which investment banking differs from commercial banking. Commercial banks (even before Glass-
Steagall repeal) were able to legally underwrite debt, and some of the largest commercial banks have
developed substantial expertise in underwriting public bond deals. So, not only do these banks make
loans utilizing their deposits, they also underwrite bonds through a corporate finance department.
When it comes to underwriting bond offerings, commercial banks have long competed for this
business directly with investment banks. However, only the biggest tier of commercial banks are able
to do so, mostly because the size of most public bond issues is large and competition for such deals is
quite fierce.

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 THE BUY-SIDE V/S THE SELL-SIDE
The traditional investment banking world is considered the sell-side of the securities industry.
Investment banks create stocks and bonds, and sell these to investors. Sell is the key word, as I-banks
continually sell their firms' capabilities to generate corporate finance business, and salespeople sell
securities to generate commission revenue.

Who are the buyers of public stocks and bonds? They are individual investors (you and me)
and institutional investors, firms like Fidelity and Vanguard. The universe of institutional investors is
appropriately called the buy-side of the securities industry.

Mutual fund companies represent a portion of the buy-side business. These are mutual fund
money managers. Insurance companies like ICICI Prudential, Birla Sunlife, LIC also manage large blocks
of assets and are another segment of the buy-side. Yet another class of buy-side firms manage
pension fund assets - frequently, a company's pension assets will be given to a specialty buy-side firm
that can better manage the funds and hopefully generate higher returns than the company itself could
have. There is substantial overlap among these money managers – some manage both mutual funds
for individuals as well as pension fund assets of large corporations.

HEDGE FUNDS: WHAT EXACTLY ARE THEY?

Hedge funds are one component of the buy side. Since the mid-1990s, hedge funds popularity
has grown tremendously. Hedge funds pool together money from large investors (usually wealthy
individuals) with the goal of making outsized gains. Historically, hedge funds bought individual stocks,
and shorted (or borrowed against) the S&P 500 or another market index, as a hedge against the stock.
(The funds bet against the S&P in order to reduce their risk.) As long as the individual stocks
outperformed the S&P, the fund made money.

Nowadays, hedge funds have evolved into a myriad of high-risk money managers who
essentially borrow money to invest in a multitude of stocks, bonds and derivative instruments (these
funds with borrowed money are said to be leveraged). Essentially, a hedge fund uses its equity base to

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borrow substantially more capital, and therefore multiply its returns through this risky leveraging.
Buying derivatives is a common way to automatically leverage a portfolio.

ORGANIZATIONAL STRUCTURE OF AN INVESTMENT BANK

Main activities and units

On behalf of the bank and its clients, the primary function of the bank is buying and selling
products. Banks undertake risk through proprietary trading, done by a special set of traders who do
not interface with clients and through "principal risk", risk undertaken by a trader after he buys or
sells a product to a client and does not hedge his total exposure. 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, middle office, and back office.

Front office

Investment banking is the traditional aspect of the investment banks which also involves
helping customers raise funds in the capital markets and advise on mergers and acquisitions. These
jobs pay well, so are often extremely competitive and difficult to land. On a similar note, they are
extremely stressful. Investment bankers frequently work 80 to 100 hours a week, often working well
past midnight and during weekends. Investment banking may involve subscribing investors to a
security issuance, coordinating with bidders, or negotiating with a merger target. Other terms for the
investment banking division include mergers and acquisitions (M&A) and corporate finance. The
investment banking division (IBD) is generally divided into industry coverage and product coverage
groups. Industry coverage groups focus on a specific industry such as healthcare, industrials, or
technology, and maintain relationships with corporations within the industry to bring in business for a
bank. Product coverage groups focus on financial products, such as mergers and acquisitions,
leveraged finance, equity, and high-grade debt and generally work and collaborate with industry
groups in the more intricate and specialized needs of a client.

Investment management is the professional management of various securities (shares, bonds,

etc.) and other assets (e.g. real estate), to meet specified investment goals for the benefit of the

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investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or
private investors (both directly via investment contracts and more commonly via collective
investment schemes eg. mutual funds). The investment management division of an investment bank
is generally divided into separate groups, often known as Private Wealth Management and Private
Client Services. Asset Management market making, traders will buy and sell financial products with
the goal of making an incremental amount of money on each trade. Sales is the term for the
investment banks sales force, whose primary job is to call on institutional and high-net-worth
investors to suggest trading ideas (on caveat emptor basis) and take orders. Sales desks then
communicate their clients' orders to the appropriate trading desks that can price and execute trades,
or structure new products that fit a specific need.

Structuring has been a relatively recent division as derivatives have come into play, with highly
technical and numerate employees working on creating complex structured products which typically
offer much greater margins and returns than underlying cash securities. The necessity for numerical
ability has created jobs for physics and math Ph.D.s who act as quantitative analysts.

Merchant banking is a private equity activity of investment banks.[2] Current examples include
Goldman Sachs Capital Partners and JPMorgan's One Equity Partners. (Originally, "merchant bank"
was the British English term for an investment bank.)

Research is the division which reviews companies and writes reports about their prospects,
often with "buy" or "sell" ratings. While the research division generates no revenue, its resources are
used to assist traders in trading, the sales force in suggesting ideas to customers, and investment
bankers by covering their clients. There is a potential conflict of interest between the investment bank
and its analysis in that published analysis can affect the profits of the bank. Therefore in recent years
the relationship between investment banking and research has become highly regulated requiring a
Chinese wall between public and private functions.

Strategy is the division which advises external as well as internal clients on the strategies that
can be adopted in various markets. Ranging from derivatives to specific industries, strategists place
companies and industries in a quantitative framework with full consideration of the macroeconomic
scene. This strategy often affects the way the firm will operate in the market, the direction it would

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like to take in terms of its proprietary and flow positions, the suggestions salespersons give to clients,
as well as the way structurers create new products.

Middle office

Risk management involves analyzing the market and credit risk that traders are taking onto the
balance sheet in conducting their daily trades, 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. 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).
In recent years the risk of errors has become known as "operational risk" and the assurance Middle
Offices provide now includes measures to address this risk. When this assurance is not in place,
market and credit risk analysis can be unreliable and open to deliberate manipulation.

Finance areas are responsible for an investment bank's capital management and risk
monitoring. By tracking and analyzing the capital flows of the firm, the Finance division is the principal
adviser to senior management on essential areas such as controlling the firm's global risk exposure
and the profitability and structure of the firm's various businesses. In the United States and United
Kingdom, a Financial Controller is a senior position, often reporting to the Chief Financial Officer.

Compliance areas are responsible for an investment bank's daily operations' compliance with
government regulations and internal regulations. Often also considered a back-office division.

Back office

Operations involves data-checking trades that have been conducted, ensuring that they are
not erroneous, and transacting the required transfers. While some[who?] believe that operations
provides the greatest job security and the bleakest career prospects of any division within an
investment bank, many banks have outsourced operations. It is, however, a critical part of the bank.
Due to increased competition in finance related careers, college degrees are now mandatory at most
Tier 1 investment banks.[citation needed] A finance degree has proved significant in understanding
the depth of the deals and transactions that occur across all the divisions of the bank.

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 Technology refers to the information technology department. Every major investment bank
has considerable amounts of in-house software, created by the technology team, who are also
responsible for technical support. Technology has changed considerably in the last few years as more
sales and trading desks are using electronic trading. Some trades are initiated by complex algorithms
for hedging purposes.

Chinese wall

An investment bank can also be split into private and public functions with a Chinese wall
which separates the two to prevent information from crossing. The private areas of the bank deal with
private insider information that may not be publicly disclosed, while the public areas such as stock
analysis deal with public information.

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 POSSIBLE CONFLICTS OF INTEREST

Potential conflicts of interest may arise between different parts of a bank, creating the
potential for financial movements that could be market manipulation. Authorities that regulate
investment banking (the FSA in the United Kingdom and the SEC in the United States) require that
banks impose a Chinese wall which prohibits communication between investment banking on one
side and equity research and trading on the other.

Some of the conflicts of interest that can be found in investment banking are listed here:

Historically, equity research firms were founded and owned by investment banks. One
common practice is for equity analysts to initiate coverage on a company in order to develop
relationships that lead to highly profitable investment banking business. In the 1990s, many equity
researchers allegedly traded positive stock ratings directly for investment banking business. On the
flip side of the coin: companies would threaten to divert investment banking business to competitors
unless their stock was rated favorably. Politicians acted to pass laws to criminalize such acts. Increased
pressure from regulators and a series of lawsuits, settlements, and prosecutions curbed this business
to a large extent following the 2001 stock market tumble.[citation needed]

Many investment banks also own retail brokerages. Also during the 1990s, some retail
brokerages sold consumers securities which did not meet their stated risk profile. This behavior may
have led to investment banking business or even sales of surplus shares during a public offering to
keep public perception of the stock favorable.

Since investment banks engage heavily in trading for their own account, there is always the
temptation or possibility that they might engage in some form of front running. Front running is the
illegal practice of a stock broker executing orders on a security for their own account before filling
orders previously submitted by their customers, thereby benefiting from any changes in prices
induced by those orders.

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Searched From:

www.google.com

www.wikipedia.com

www.scribd.com

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