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Designed and Developed by: Finance Learning and Development Team (FLAD)
Table of Contents
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Investment Banking
Underwriting
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Securities Underwriting In securities underwriting the investment banker raise capital for corporations through the structuring and sale of securities such as bonds and stocks. Municipal finance is securities underwriting (strictly bonds) on behalf of government entities such as states, counties, municipalities and public authorities. This is a way of selling a newly issued security, such as stocks or bonds, to investors. A syndicate of banks (the lead-managers) underwrites the transaction, which means they have taken on the risk of distributing the securities. Should they not be able to find enough investors, they will have to hold some securities themselves.
Merger and Acquisitions Mergers A merger refers to a combination of two or more companies, usually of not greatly disparate size, into one company. Horizontal merger - Two companies that are in direct competition and share the same product lines and markets. Vertical merger - A customer and company or a supplier and company. Think of a cone supplier merging with an ice cream maker. Market - extension merger - Two companies that sell the same products in different markets. Product - extension merger - Two companies selling different but related products in the same market. Conglomeration - Two companies that have no common business areas.
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Acquisitions An action in which a company buys most, if not all, of the target company's ownership stakes in order to assume control of the target firm. Acquisitions are often paid in cash, the acquiring company's stock or a combination of both. Acquisition can be: Congenial Hostile Reverse Take Over (RTO) Private Company becomes public without IPO.
Difference between Merger and Acquisition Though the two words mergers and acquisitions are often spoken in the same breath and are also used in such a way as if they are synonymous, however, there are certain differences between mergers and acquisitions Merger Acquisition
The case when two companies (often of same The case when one company takes size) decide to move forward as a single new over another and establishes itself as company instead of operating business separately. the new owner of the business. The buyer company swallows the The stocks of both the companies are surrendered, business of the target company, which while new stocks are issued afresh. ceases to exist. For example, Glaxo Wellcome and SmithKline Dr. Reddy's Labs acquired Betapharm Beehcam ceased to exist and merged to become a through an agreement amounting $597 new company, known as Glaxo SmithKline. million.
Role of Investment Banks in Merger and Acquisitions Identify potential investors for the client Gain attention of these investors Pitch Book. Reviews financial statements of the target companies/industries
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Securitized Products
Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling said debt as bonds, pass-through securities, or Collateralized mortgage obligation (CMOs), to various investors. The principal and interest on the debt, underlying the security, is paid back to the various investors regularly. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS). The granularity of pools of securitized assets is a mitigant to the credit risk of individual borrowers. Unlike general corporate debt, the credit quality of securitised debt is nonstationary due to changes in volatility that are time- and structure-dependent. If the transaction is properly structured and the pool performs as expected, the credit risk of all tranches of structured debt improves; if improperly structured, the affected tranches may experience dramatic credit deterioration and loss.
Securities
Custody and Clearance Investment bank provides timely, consistent and accurate information of trades to the participants for efficient clearing It can support custody of a variety of assetsincluding equity, fixed-income and foreign exchange products, as well as options, swaps, warrants, futures and other derivatives
It integrates the entire trade cycle, preventing the inconsistencies arising due to dealing with different market practices, accounting standards and time zones
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Lending and Financing It is a service provided by investment banks to large investors who can allow the investment bank to lend out their shares to other people. This is often done to investors of all sizes who have pledged their shares to borrow money to buy more shares, but large investors like pension funds often choose to do this to their unpledged shares because they will receive interest income. In these types of agreements, the investor still receives any dividends as normal, the only thing they cannot generally do is to vote their shares.
Hedge Funds
Research
Conducting research of different industries by looking at economy, interest rates and company data Providing analysis and rating of securities such as hold, add and reduce to various clients
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Principal Transaction
A transaction in which the counterparty acts as a principal, i.e., carries some or all of the risk associated with the change in the instrument value Example: Client : I want to buy 1,000,000 shares of Reliance at the price of X Principal : Agrees to the price with client Client : Receives share at the price Principal : May transfer his / her own shares to the client, or buy them in the market, therefore carrying the risk executing the transaction at a price different from X
Agency Transaction
A transaction in which the executing brokerage firm acts as an agent and usually charges a commission for its services Example: Client : Buy 100 shares of Reliance at the current market price Agent : Executes trade in the market Client : Does not know exact price he will receive (depends on timing) Agent : Receives commission (~ 0.25 - 0.5 % of the total value of the purchase)
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Key Products
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Stock Market
A stock market or equity market is a public entity (a loose network of economic transactions, not a physical facility or discrete entity) for the trading of company stock (shares) and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. The stocks are listed and traded on stock exchanges which are entities of a corporation or mutual organization specialized in the business of bringing buyers and sellers of the organizations to a listing of stocks and securities together.
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Bond Market
The bond market (also known as the credit, or fixed income market) is a financial market where participants buy and sell debt securities, usually in the form of bonds. Bond market takes place between broker-dealers and large institutions in a decentralized, over-the-counter (OTC) market. However, a small number of bonds, primarily corporate, are listed on exchanges.
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Market Participants
1. 2. 3. 4. 5. Investors: Issuers Custodians Security Trading Organizations Regulators
Individuals who invest in securities for their personal gain, their focus being capital growth through an increase in the market value of their investment or regular income through the receipt of dividends on shares Individual Investors visit the marketplace via agents through whom the buying & selling of securities is effected To buy or sell securities, an individual usually places a request with an agent commonly known as an order
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An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets Mutual funds are operated by money / fund managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus Examples of Money Managers : Fidelity, Reliance MF, HDFC MF
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Institutional Investors Hedge Funds An aggressively managed portfolio of investments that uses advanced investment strategies in both domestic and international markets with the goal of generating high returns (either in an absolute sense or over a specified market benchmark) Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year Examples : Julius Baer, Marble Bar Asset Management Institutional Investors Pension Funds
A pension fund is a pool of assets forming an independent legal entity that are bought with the contributions to a pension plan for the exclusive purpose of financing pension plan benefits Example : AMP, State Pension Funds
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Type of Issuer Corporations Sovereign Entities Local Governments Government Agencies Supranational Organisations
Example Vodafone (UK) Kingdom of Denmark City of London Federal National Mortgage Association International Bank for Reconstruction & Development (World Bank IBRD)
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Region Europe
Country UK
Asia Pacific
Singapore
Singapore
America
Stock Exchange London Stock Exchange (LSE) London International Financial Futures & Option Exchange (LIFFE) Deutsche Bourse Bolsa de Madrid Stock Exchange of Hong Kong Hong Kong Futures Exchange Shenzhen Stock Exchange Shanghai Stock Exchange Tokyo Stock Exchange Tokyo International Financial Futures Exchange (TIFFE) Stock Exchange of Singapore Singapore International Monetary Exchange (SIMEX) Australian Stock Exchange (ASX) Bombay Stock Exchange New York Stock Exchange (NYSE) Chicago Stock Exchange
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Introduction
A derivative instrument is a contract between two parties that specifies conditionsin particular, dates and the resulting values of the underlying variablesunder which payments, or payoffs, are to be made between the parties. Derivatives can be used for speculating purposes ("bets") or to hedge ("insurance").
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Derivative Spread
FORWARDS
SWAPTIONS
FUTURES
Derivatives
WARRANTS
OPTIONS
SWAPS
Forwards
Customised contract between two entities Settlement takes place at a future date
Futures
Its an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price Its exchange traded contract
Options
Call and Put are the two types of Options Call gives the buyer the right but not the obligation to buy Put gives the buyer the right but not the obligation to sell
Warrants
Longer dated options are called Warrants Generally traded Over the Counter
Swaps
Its a private agreement between two parties to exchange cash flows in the future according to pre arranged formula Two commonly known Swaps are Interest Rate Swaps and Currency Swaps
Swaptions
Swaptions are options to Buy or Sell a Swap The Swaptions market has receiver swaptions and payer swaptions
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NSEs index options market, contracts at different strikes having one-month, two month, three-month expiry cycles o o Each with minimum seven price available for trading Hence at a given point of time there are minimum 42(3*7*2) options product available
TOPIX Options market contracts at different strikes having three-month, four month, five month expiry cycle The strike prices depends on the contract cycle-13(more than four months trading period),19 (with four months trading period)
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Settlement Basis: Mark to market and final settlement will be cash settled on T+1 basis. Settlement Price: Daily settlement price will be the closing price of the futures contracts for the trading day and the final settlement price shall be the closing value of the underlying index on the last trading day.
Trading Mechanism
The futures and options trading system of the respective exchange Generally provides fully automated screenbased trading for equity futures & options Online monitoring and surveillance mechanism Support order- driven market , provides complete transparency of trading operations, operate on strict price-time priority basis
Forward Contracts
Salient features of Forward Contracts: They are bilateral contracts and hence exposed to counter party risk Each contract is custom designed and hence is unique in terms of Contract size, expiry date and asset type and quality The contract price is generally not available in public domain On expiry, contract has to be settled by delivery of the asset If the party wishes to reverse the contract it has to be compulsorily go to the same counterparty, which often results in high prices being charged
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Futures
Its an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Its an exchange traded contract. The standardized items in a future contract are: Quantity of the underlying Quality of underlying The date and the month of delivery The unit of price quotation and minimum price change Location of settlement
Options
Options are derivative instruments where one party has a right to buy/sell the underlying while the other party has an obligation to buy/sell The person with the right is called the buyer of the option. The person with the obligation is called the writer of the option
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Payoff of Options
Non-linear payoffs Losses for the buyer are limited and profits are unlimited For the writer the payoff is exactly opposite Pricing of Options Price of option is called premium Theoretical value of premium can be calculated by option calculator on our site Market price, however, will be dependent on demand supply scenario Payoff for buyer of call option
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Applications of F&O
Applications of Futures
Hedging: Long security , Sell futures Speculation: Bullish security , Buy futures Speculation: Bearish security , Sell futures Arbitrage: Overpriced futures : Buy spot , Sell futures Arbitrage: Underpriced futures : Buy futures, Sell spot
Application of Options
Hedging: Buying stock - Buy Put Speculation: Bullish security - Buy Call or Sell Put Speculation: Bearish security - Sell call or Buy Put
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*****************************************Thank You***************************************************
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