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Investment Banking, Credit Rating & Broking

What is investment banking?

Investment banking is a field of banking that aids companies in acquiring funds. In addition to the acquisition of new funds, investment banking also offers advice for a wide range of transactions a company might engage in.

How Investment Banking operations differ from Commercial Banking?

Investment banks instead make their money

primarily By advising corporate clients on the creation of stocks, bonds and other securities By underwriting securities By facilitating mergers and acquisitions, along with any due diligence and securities exchanges that may go along with them. And by brokering (or selling) securities to investors.

Structure of an Investment Bank

Core functions of Investment Banking

An intermediary between the capital markets (investors) and corporations (borrowers) Offers strategic advice and financial analysis on Mergers & Acquisitions, Divestitures, and Capital Structure Offers Equity and Fixed Income Underwriting (e.g.. IPOs, High Yield Offerings) Provides Sales and Trading of Equity (Stocks), Fixed Income Securities (Bonds), Derivatives (Options). Provides asset management advice to high net worth individuals and institutions Offers research and advice on publicly listed stocks and bonds to institutional and individual investors

Underwriting Stocks and Bonds

The process of underwriting a stock or a bond issue requires that the investment banker purchase the entire offering at a predetermined price and then resell the offering (securities) in the market. The services provided during this process include:
Giving Advice
Filing Documents Underwriting, Best Efforts, or Private Placement

Underwriting Stocks and Bonds(2)

Giving advice
Explaining current market conditions in to help determine what type of security (equity, debt, etc.) to offer Assisting in determining when to issue, how many, at what price (more important with IPOs than SEOs)

Underwriting Stocks and Bonds(3)

Filing Documents
SEC registration (filing) is required for issues greater than $1.5 million and with a maturity greater than 270 days. A portion of the registration statement known as the prospectus is made available to the public. Debt issues require several additional steps, including acquiring a credit rating, hire a bond counsel, etc. For equity issues, the investment banker may also arrange for the securities to appear on one of the exchanges

Underwriting Stocks and Bonds(4)

Underwriting (firm commitment)
The investment banker purchases the entire offering at a fixed price and then resells the offering to the market. An underwriter may form an underwriting syndicate to diffuse part of the underwriting risk.

Underwriting Stocks and Bonds(5)

The goal of underwriting is for all of the shares in an offering to be spoken for. However, this may not occur.
Fully subscribed: all shares are spoken for Undersubscribed: underwriting syndicate unable to generate interest in all of the available shares Oversubscribed: interest in more shares than are available (may lead to rationing).

Underwriting Stocks and Bonds(6)

Best Efforts: An alternative to a firm commitment, the underwriter does not buy the issue, but rather makes its best effort to sell the entire issue.

Private Placements: The entire issue is sold to a small, select group of investors. This is rarely done with equity issues.

Facebook e.g.
Book runner- initially expected was Goldman Sachs but eventually won by Morgan Stanley. Co-managers 12 other prestigious banks. Fees -1.1% which is about $176 million. Usually other banks earn about 7% fee.

Investment Banks serve as intermediaries between providers and users of capital

Chinese Wall

Strategic advisory Securities underwriting

Users of capital

Corporations Governments Municipalities

Investment Banking

Sales & Trading Research

Providers of Capital
Individuals Pension Funds Insurance Companies Asset Managers Corporate Treasuries Sovereign Wealth Funds

Private side

Public side

Overview of Investment Banking

Capital Markets
Equity capital-raising o Initial public offerings (IPOs) o Follow-on offerings o Equity-linked (convertible) Debt capital-raising o High-grade or investment grade o High-yield o Syndicated loans o Tax-exempt

Mergers & Acquisitions o Buyside o Sellside o Spin-offs / Splitoffs / Carveouts o Hostile defense o Hostile takeovers / proxy fights o Joint Ventures Restructuring Ratings


Investment bankers may assist both acquiring firms and

potential targets (although not both in the same deal)

Deal may be a hostile takeover, where the target does not

wish to be acquired

Investment bankers will assist in all areas, including deal

specifics, lining up financing, legal issues, etc.



Securities firms with brokerage services offer several types of services:
Brokerage Service

Other services
Full-Service Brokers v/s Discount Brokers

A demerger (the opposite of merger) involves divestitures. It is the splitting up of a corporate body into two or more separate and independent bodies.

Some of the reasons for divestitures/demerger could be: i. A subsidiary/associate/investment is not adding value or eroding value. The buyer may be the management of the subsidiary, i.e., management buyout; ii. A subsidiaries/associate/investment does not or longer fits in with the groups strategic plan;

iii. Subsidiaries/associates/investment with high risk could be sold to reduce the business risk of the group as a whole iv. To profit from the sale of the subsidiaries/associate/investment

In Malaysia, divestitures are more commonly known as disposals.Disposals by a corporation may be in the form of fixed assets such as plant and equipment, land and properties,etc When a company decides to divert part of its operations, it will try to get the highest value by selling off the business unit, or selling individual assets

Investment Banking (Mergers & Acquisitions (M&A) and Corporate Finance ).

The traditional aspect of investment banks which involves helping customers raise funds in the Capital Markets and advising on mergers and acquisitions. Investment bankers prepare idea pitches that they bring to meetings with their clients With the expectation that their effort will be rewarded with a mandate when the client is ready to undertake a transaction. Once mandated, an investment bank is responsible for preparing all materials necessary for the transaction as well as the execution of the deal, which may involve subscribing investors to a security issuance, coordinating with bidders, or negotiating with a merger target.



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 investors. Investors may be institutions (insurance companies, pension funds, corporations etc.) or
investors (both directly via investment contracts and more commonly via collective investment schemes, mutual funds)


Is often the most profitable area of an investment bank. responsible for the majority of revenue of most investment


In the process of 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, who can price and execute trades, or structure new products that fit a specific need.

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



sales force in suggesting ideas to customers, and investment bankers by covering their clients. In recent years the relationship between investment banking and research has become highly regulated, reducing its importance to the investment bank.

Carried out at 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).



involves data-checking trades that have been conducted, ensuring that they are not erroneous, and transacting the required transfers. While it provides the greatest job security of the divisions within an investment bank


is a critical part of the bank that involves managing the financial information of the bank and ensures efficient capital markets through the financial reporting function. 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.

Investment Banking Competitive Landscape

Bulge bracket

Middle Market

Boutiqu e




Credit Rating

Evaluation of the timely repayment ability of an individual, firm, of debt security (such as a bond).

Credit rating is built up on the basis of the

1. credit history, 2. present financial position, and 3. The likely future income.

Credit Rating Process

The process/procedure followed by all the major credit rating agencies comprises of the following steps.
1. 2. 3. 4. 5. 6. 7. 8. 9. Receipt of the request Assignment to analytical team Obtaining information Plant visits and meeting with management Presentation of findings Rating committee meeting Communication of decision Dissemination to the public Monitoring for possible change

Rating Methodology
The main factors that are analysed into detail by the credit rating agencies. 1. Business Risk Analysis 2. Financial Analysis 3. Management Evaluation 4. Geographical Analysis 5. Regulatory and Competitive Environment 6. Fundamental Analysis

Business Risk Analysis

a. Industry risk: Strength, demand & supply position, structure, pattern of business cycle etc. b. Market position: Percentage of market share ,Diversity of products ,Customer base ,R&D projects undertaken etc. c. Operating efficiency: Cost structure, availability of rawmaterial, compliance to pollution, capital employed etc. d. Legal position: Assessed by letter of offer containing terms of issue ,mode of payment of interest +principal in time, provision for protection against fraud etc. e. Size of business: The size of the business operations.

Financial Analysis
This includes an analysis of 4 important factors namely: a. Accounting quality b. Earnings potential/profitability c. Cash flows analysis d. Financial flexibility

Management Evaluation

Management goals, plans and strategies, Capacity to overcome unfavourable conditions, Staffs own experience and skills, Planning and control system etc.

Geographical Analysis
To determine the locational advantages enjoyed by the issuer company Benefits of diversification Benefit of lower cost of operation

Regulatory and Competitive Environment

Evaluates structure and regulatory framework of the financial system

CRAs evaluate the impact of regulation/deregulation on the issuer company.

Fundamental Analysis
1. Liquidity management :study of capital structure, availability of liquid assets , matching of assets and liabilities. 2. Asset quality :credit risk management, exposure to individual borrowers and management of problem credits etc. 3. Profitability and financial position :past profits, funds deployment, revenues on non-fund based activities 4. Interest and tax sensitivity :sensitivity of company due to the changes in interest rates and changes in tax law.

Objectives of credit rating

(i) provide superior information to the investors at a low cost (ii) provide a sound basis for proper risk return structure (iii) subject borrowers to a healthy discipline (iv) assist in the framing of public policy guidelines on institutional investment

Factors Involved in Credit Rating

Overall fundamentals and earnings capacity Overall macro economic and business environment Liquidity position of the company Financial flexibility of the company Guarantee/support from

financially strong external bodies Level of existing leverage (borrowings) & Financial risk

Uses of Credit Rating

Building Portfolios


Credit Ratings Contracts Trading

Regulatory Requirements

Credit ratings are critical to the activities of securities markets, as they are dependent on to create and manage investment portfolios, the pricing of new securities, trading of securities, financial contracts (and loans) and for some financial institutions to meet regulatory requirements.

Advantages of Credit Rating

Benefits to Investors
Safety of investments Recognition of risk and returns Freedom of investment decisions Wider choice of investments Dependable credibility of issuer Easy understanding of investment proposals

Benefits to Company
Easier to raise funding Reduced cost of borrowing Reduce cost of public issues Ratings can build up image Ratings facilitates growth Recognition to unknown companies

Benefits to Intermediaries
For brokers ratings make it easier to persuade clients to select an investment proposal of investment in highly rated instruments.

Disadvantages of Credit Rating

Non-disclosure of significant information Static study Rating is no certificate of soundness Rating may be biased Rating under unfavorable conditions Difference in rating grades Improper Disclosure May Happen Impact of Changing Environment Problems for New Companies Downgrading by Rating Agency

Credit Rating does not serve

Not an overall evaluation of the
organisation Not a recommendation for purchasing, selling or holding of a security No comprehensive audit of the operations of the issuing organisation. Rating not valid for the entire life of the security. No legal relationship between the agency and the user

Rating Agencies in India

CRISIL - The oldest rating agency was originally promoted by ICICI.
Standard & Poor, the global leader in ratings, has recently taken a small 10% stake in CRISIL.

ICRA - Promoted by IFCI. Moodys, the other global rating major, has
recently taken a small 11% stake in ICRA.

CARE - Promoted by IDBI. Duff and Phelps(Fitch) - Co-promoted by Duff and Phelps, the worlds
4th largest rating agency.

CRISIL is believed to have about 42% market share followed by ICRA with about 36%, CARE with 18% and Fitch with 4%

Credit Rating Case



Experienced promoter group and management Approval of the natural gas pricing formula by the Oil Ministry Dominant leadership position in the petrochemical segment Strong financial risk profile characterized by robust capital structure and liquidity profile

Lower than envisaged utilization of recently commenced manufacturing facilities in India and China Stressed liquidity with continued reliance on short term unsecured borrowings

Services offered by people / firms for buying and selling securities


Oldest stock exchange in the Asian region Traced back to 1830s A group of Traders trading in banking and cotton holdings Initially known as the Native Share and Stock Brokers Association Moved to Dalal Street between 1874 to 1875

An individual / organization who are specially given license to participate in the securities market on behalf of clients Role of an agent Governed by SEBI Act, 1992, Securities Contracts (Regulation) Act, 1956

Role of a Broker in Financial Markets

Primary Task
Buying and Selling of securities

Other Tasks
Providing advisory services Offering limited banking services Brokering other securities

Charges Levied
Brokerage commissions Margin interest charges Service charges

Leading Stock Brokers in India

Motilal Oswal ICICIdirect Share khan India bulls Geojit Securities HDFC Reliance Money Religare Angel Broking

Types of Broking Firms in India

Full service brokers
Provide the best information on the different profitable stocks. Charge very high

Direct access brokers Dual advantage for traders direct access to the market Transactions carried out

Other Types of Broking Firms

Captive Brokers
Owns part of the mutual fund company Inclined to sell only their own

Independent Brokers Not connected to any mutual fund company nor are they part of a chain brokerage Discount Service Brokerage Firm Deals with the trading aspect of managing investments for their customers

Deep Discount Brokerage Firms

Deal with specific aspects of investing, specializing in one area of trading

Online Discount Brokerage Firms Immediate trading Good investment services offered

Types of Brokers

Stock Broker Mortgage Broker Insurance Broker Commodity Broker Options Broker Real Estate Broker

Types of Services
Advisory Services Expensive Have to maintain good relationship and contact Provides financial consultant and financial advisory services Range of products to buy E.g. Bonds, MF, ETF, CD etc. Discretionary Management Expensive Have to maintain good relationship and contact Takes complete control over the investment Takes investment decision on behalf of customers and provides
only periodic statements to the customers.

Common Broker Services Offered

Online Trading Platform Different types of platforms Charting Packages Charting Costs Example of Charting Services : Charting services can be found
at TradeStation, Esignal, and FXCM

Paper Trading Perfect for beginners Other Services

Types of Brokerage Accounts

Custodial Account: brokerage account for a minor that requires parent or guardian to handle transactions

Cash Account: brokerage account that can only make cash transactions
Margin Account: brokerage account in which the brokerage firms extends borrowing privileges Wrap Account: account that shifts investment decisions to a professional money manager and charges a flat annual fee

Basic Types of Orders

Odd-lot Orders

Round-lot Orders

Market Orders Limit Orders Fill-or-Kill Orders Day Orders Good-til-Cancelled (GTC) Orders Stop-Loss (Stop) Orders Stop-Limit Orders

Banks give brokers tough time in third party products sale Bigger broker networks can compete with the big banks The non bank lending sector will disappear when the exit fee is banned

Key Trends in Broking

Trading in other platforms Advent of foreign and new Indian players Hard selling of Demat Account Stock Brokers foray into real estate broking MFs pose less risk when invested for a long term Lifetime offers by brokerage houses to lure customers Tie-ups between big and small brokers