Investment banking.pdf

8/20/2019 Investment banking.pdf

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INTRODUCTION

At a very macro level, ‗Investment Banking‘ as term suggests, is concerned with

the primary function of assisting the capital market in its function of capital

intermediation, i.e., the movement of financial resources from those who have

them (the Investors), to those who need to make use of them for generating GDP

(the Issuers). Banking and financial institution on the one hand and the capital

market on the other are the two broad platforms of institutional that investment for

capital flows in economy. Therefore, it could be inferred that investment banks are

those institutions that are counterparts of banks in the capital markets in the

function of intermediation in the resource allocation. Nevertheless, it would beunfair to conclude so, as that would confine investment banking to very narrow

sphere of its activities in the modern world of high finance. Over the decades,

backed by evolution and also fuelled by recent technologies developments, an

investment banking has transformed repeatedly to suit the needs of the finance

community and thus become one of the most vibrant and exciting segment of

financial services. Investment bankers have always enjoyed celebrity status, but

at times, they have paid the price for the price for excessive flamboyance as well.

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.


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Investment banks help companies and governments and their agencies to raise

money by issuing and selling securities in the primary market. They assist public

and private corporations in raising funds in the capital markets (both equity and

debt), as well as in providing strategic advisory services for mergers, acquisitions

and other types of financial transactions. Investment banks also act as

intermediaries in trading for clients. Investment banks differ from commercial

banks, which take deposits and make commercial and retail loans. In recent years

however, the lines between the two types of structures have blurred, especially as

commercial banks have offered more investment banking services.

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.

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History of Investment banking

Given its history, merchant banking is often thought of as a European, and

especially British, financial specialty, and British institutions continue to maintain amajor presence in this area. Since the 1800s and even earlier, however, U.S.

firms (such as J.P. Morgan) also have been active in merchant banking. However,

although both investment banks and commercial banks, as well as other types of

businesses, have been authorized to engage in private equity investment in the

United States, financial institutions have not been major providers of private

equity.

Until the 1950s, U.S. investors in private equity were primarily wealthy individuals

and families. In the 1960s and 1970s, corporations and financial institutions joined

them in this type of investment. (In the 1960s, commercial banks were the major

providers of one kind of private equity investing, venture-capital financing.)

Through the late 1970s, wealthy families, industrial corporations, and financial

institutions, for the most part investing directly in the issuing firms, constituted the

bulk of private equity investors.

In the late 1970s, changes in the Employee Retirement Income Security

AcTERISA) regulations, in tax laws, and in securities laws brought new investors

into private equity. In particular, the Department of Labor's revised interpretation

of the "prudent man rule" spurred pension fund investment in private equity

capital. Currently, the major investors in private equity in the United States arepension funds, endowments and foundations, corporations, and wealthy

investors; financial institutions-both commercial banks and investment banks-


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represent approximately 20 percent of total private equity capital, divided

approximately equally between the two.

The market also has grown dramatically in recent years, increasing from

approximately $4.7 billion in 1980 to its 1999 figure. Despite this tremendous

growth, the private equity market is extremely small compared with the public

equity market, which was approximately $17 trillion at year-end 1999

Evolution of investment banking in India

The origin of investment banking in India can be traced back to the late 19th

century when European merchant banks set up their agency house in the country

to assist in the setting up of new projects. In the early 20th century large business

houses followed suit by establishing managing agencies which acted as issue

house for securities, promoters for new projects and also provided finance to

green field ventures. But these entire roles were limited to small capital base.

In 1967, ANZ Grindlays bank set up separate Merchant banking division to handle

new capital issues. It was soon followed by Citibank, which started rendering

Merchant Banking services. The foreign banks monopolized merchant banking

services in the country. The banking commission, in its report in 1972, took note if

this with concern and recommended setting up of merchant banking institutions

by commercial banks and financial institutions. SBI ventured into this business by

starting a merchant business bureau in 1972. In 1973, ICICI


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became the first financial institutions to offer merchant banking. JM finance was

set up in 1973. The growth of industry during that period was very slow. The

industry remained more or less stagnant in the eighties.

Some of tie ups player were

JM Finance- Morgan Stanley

DSP Financial consultants- Merill lynch

Kotak Mahindra- Goldman Sachs

SBI Capital Markets – Lehman Brothers

The main activities and units

The primary function of an investment bank is buying and selling products both on

behalf of the bank's clients and also for the bank itself. 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 or she

buys or sells a product to a client and does not hedge his or her 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. The individual activities are described below:

Front Office

Investment Banking is 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

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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. Other terms for the InvestmentBanking Division include Mergers & Acquisitions (M&A) and Corporate Finance

(often pronounced "corp. fin").

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 investors. Investors may be

institutions (insurance companies, pension funds, corporations etc.) or privateinvestors (both directly via investment contracts and more commonly via collective

investment schemes e.g. mutual funds) .

Financial Markets is split into four key divisions: Sales, Trading, Research

and Structuring.

Sales and Trading is often the most profitable area of an investment bank ,

responsible for the majority of revenue of most investment banks 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, which can price and execute trades, or structure new products that fit a

specific need.

Research is the division which reviews companies and writes reports about their

prospects, often with "buy" or "sell" ratings. While the research division

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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. In recent years the relationship between investment banking and

research has become highly regulated, reducing its importance to the investmentbank.

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.

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 arecaptured 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 include 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.

Back Office

Operations involve data-checking trades that have been conducted,

ensuring that they are not erroneous, and transacting the required transfers.

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While it provides the greatest job security of the divisions within an investment

bank, it 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 tounderstand in depth the deals and transactions that occur across all the divisions

of the bank.

Investment Bankers work with the different ―product‖ groups

within the broader Investment Bank to service our clients ‘

needs

Services Provided b y an Inv estment Bank

Equity

Debt - Bonds

Debt - Loans

M&A, Restructuring,Divestiture

Equity Capital

Markets (ECM)

Debt Capital

Markets (DCM)

Corporate Bankers

M&A Group

Investment Bankers Client

Transaction Product Group

Scope of investment Banking The Investment banker plays a vital role in

channel zing the financial surplus of the society into productive investment

avenues. The merchant banker has fiduciary role in relation to the investor.

Some of the major functions performed by investment banker are as follows


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.1. Management of debt and equity offering – This is the traditional ‗bread and

butter‘ operations for most of the investment banker in India. The role of the

investment banker is dynamic and it has to be nimble footed to capitalize on

available opportunities. It has to assist its clients in raising fund from the market.It may also be required to counsel them on various issues that affect their

finances.

The main area of its role includes:

Instrument Designing

Pricing the issue

Registration of the offer document

Underwriting the support

Marketing the issue

Allotment and refund

Listing on stock exchange

Listing on stock exchange


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2. Placement and distribution – The distribution network of Investment banker

can be classified as institutional and retail. The network of institutional investors

consist of Mutual Funds, FIIs, bank, domestic and multinational financial

institutions, PE, pension funds, etc. the size of this network represent thewholesale reach of the Investment banker. The basic requirement to create and

service the institutional segment is the existence of good in-house research

facilities. The investment proposal should be accompanied by high quality

research reports of the Investment banker to justify the investment

recommendation. The retail distribution reach depends upon the networking with

the investors. Many Investment banks have associate firms which are brokers on

the stock exchange. These brokers appoint sub-brokers at various locations to

service both the primary market and secondary market needs of the local

investors. Thus a large base of captive investors is created and maintained.

The distribution network can be used to distribute various financial products like:

Equity : retail and institutional investors

Debt Instruments : retail and institutional investors

Mutual Fund products : retail investors

Fixed deposits : retail investors

Insurance products : retail investors


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3. Corporate advisory Services - investment bankers offers customized

solutions to the financial problem of their clients. One of the key areas for

advisory role is financial structuring. The process includes determining the

appropriate level of gearing and advising the company whether to leverage, de-leverage or maintain its current debt-equity levels. The asset turnover ratios may

be analyzed to study whether the company is over trading or under trading. The

company‘s working capital practices are studied and alternative working capital

policies are suggested. The investment banker may also explore the possibility of

refinancing high cost funds with alternative cheaper funds. They play advisory

role in securitization of receivables. They also help their cash rich clients in

deployment of their short-term surpluses.

4. Project Advisory - investment bankers are associated with their clients from

the early stage of their project. They assist the companies in conceptualizing the

project idea when it is at nebulous stage. Once the project is conceptualized,

they carry out the initial feasibility studied to examine its viability. Investment

bankers provide inputs to their clients in preparation of the detailed project report.

They also offer project appraisal services to clients.

4. Loan syndication - investment bankers arrange to tie up loans for their

clients. The first step involves analyzing the client‘s cash flow pattern so that

terms of borrowing can be defined to suit the cash flow requirements. The

important loan parameters include amount, currency, tenure, drawdown,

moratorium and the amortization. The investment bankers then prepare thedetailed loan memorandum. The loan memorandum is then circulated to various

banks and financial institutions and they are invited to participate in the

syndicate.


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The banks indicate the amount of exposure of service they are willing to take and

the interest rates thereon. The terms are further negotiated and fine- tuned to the

satisfaction of both parties. The final allocation is done to the various members of

the syndicate. The investment banker also helps the clients in loandocumentation procedures.

5. Research Services - Nearly all banks have a staff of research analysts who

study economic trends and news, individual company stocks, and industry

developments to provide proprietary investment advice to institutional clients and

in-house groups, such as the sales and trading divisions. Until recently, the

research division has also played an important role in the underwriting process,

both in wooing the client with its knowledge of the client‘s industry and in

providing a link to the institutions that own the client‘s stock once it‘s publicly

traded. Indeed, in many cases, research analysts‘ compensation was tied to

investment banking revenues. However, in recent times banks have faced public

and regulatory outcries over conflicts of interest inherent in having bankers and

researchers work hand in hand.

6. Venture capital - Venture capital is risks money, which is used in risky

enterprises either as equity or debt capital. It may be in new sunshine industries

or older risk enterprises. The funds, which finance such risky, are called venture

capital funds. Venture capital is a post-war phenomenon in the business world,

mainly developed as a sideline activity of the rich in USA. To connote the risk &

adventure & some element of investment, the generic name of ‗venture capital‘

was coined. In the late 1960‘s a new breed of professional investors called

venture capitalists emerged whose specialty was to combine risk capital with

entrepreneurial management & to use advance technology to launch new

products and companies in the markets place. Undoubtedly, it was ‗venture


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capitalists‘ astute ability to assess and manage enormous risks & export from

them tremendous returns that changed the face of America.

In India, as the majority of the above institutions are in the public sector, only

the government or public financial institutions can provide the funds for venture

capital. Venture capital is a post-war phenomenon in the business world, mainly

developed as a sideline activity of the rich in USA. To connote the risk &

adventure & some element of investment, the generic name of ‗venture capital‘

was coined. In the late 1960‘s a new breed of professional investors called

venture capitalists emerged whose specialty was to combine risk capital with

entrepreneurial management & to use advance technology to launch new

products and companies in the markets place. Undoubtedly, it was ‗venturecapitalists‘ astute ability to assess and manage enormous risks & export from

them tremendous returns that changed the face of America.

Venture Projects

Proposals come to the venture capitalists in the form of business plans. He

appraises the same, giving due regard to the credentials of the founders, the

nature of the product or services to be developed, the market to be saved & the

financing required. If satisfied, he will invest his own money in the equity shares

of the new company, known as the assisted company. In addition to money,

managerial & marketing assistance may also be provided that is, the venture

capitalist not only provides funds but also on line operational advice.

Indian Position in venture capital

In India, most project financing schemes require at least 25 per cent of

the project cost to be contributed by the promoters, while the latter can raise

barely 5-10 percent. For long, there were a few agencies such as IFCI‘s


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subsidiary company, Risks Capital And Technology Foundation of India, which

provides finance to bridge the shortfall in the promoter‘ contribution, but they

could fulfill the requirements of a great many budding entrepreneurs. As results

of promoters not being able to bring in those vital initial inputs of money, many of

their good projects were hanging fire. Venture capital could remedy this situation

as well.

A beginning was made in this direction by the setting up of venture capital

divisions under the aegis of ICICI, IDBI & IFCI. Encouraged by the response to

technology financing, ICICI floated a separate company ---Technology

Development and Information Company of India (TDICI) includes, apart from

venture capital financing, technology, consultancy as well as entrepreneur escortservices such as marketing, business management, vendor development etc.

The successful operation of this fund will hopefully spark off some interest from

the private sector, which will then consider entering this line of activity. Ultimately,

it is only when venture capital financing becomes more broad-based and

widespread that it will truly taking root in economy. In tune with its tradition of

pioneering new ideas, ICICI deviated from the beaten path to usher in an unusual

type of financial support. Addition to equity participation (up to maximum of 49

percent) undertaken by typical venture capital companies, TDICI offer the

conditional loans. The entrepreneur neither pays interest on it nor does he have

to repay the principal amount. If the venture capital succeeds, TDICI recoups its

investment in the form of royalty on sales which ranges between two and eight

percent. On the other hand, if the venture fails to take off even after five years

TDICI will consider writing off the loan.

Difficulties in India

Fundamentally, there are no private pools of the capital of finance risk ventures

in India. The financial institutions perforce occupy a dominant position in the


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provision of long-term capital to Indian industry. They and the State development

agencies do provide limited amount of equity finance to assist the development

of new business but there is no private, professionally managed investment

capital sources. There are no private sector insurance companies or the pension

funds gathering regular premium income and virtually no private banks willing to

devote a small portion of their resources to the venture capital niche. It is unlikely

that such enterprises will be created in the foreseeable future to mobilize private

saving for investments. As an answer the situation, mutual funds and investment

trusts are permitted to set up and to commit the part of their resources to the

venture capital area. As a part of the broader equity investment fund, given

suitable standards of the valuation for unquoted investments, it should bepossible for the fund managers to commit the portion of there portfolios to

venture capital situations. The participation of the private sector in venture capital

funding, as it has come to be defined in the narrow Indian context, is not possible

in isolation from the opportunity to develop a broadly spread investment

business.

Tax Treatment for venture capital

The tax treatment of the venture capital funds in India is ungenerous and falls

well short of what is required. Whereas the Mutual Funds established by the

government controlled financial institutions and nationalized commercial bank

suffer no tax on either income or capital gains, a venture capital fund would

suffer at 20 per cent on dividend income and a similar rate on long-term capital

gains. Given an adequate investment spread and tax incentives, mutual funds

step into the early stage financing arena, professionally assess and the monitor

investments assist the launch of new medium size businesses. SBI Mutual Fund

is really undertaking investment work with its ‗brought deals‘. The creation of


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more funds to participate in this area of the market is now clearly seen. Early

stage financings could then be syndicated between number of professionally

managed funds and sound, competitive situation between them might also be

created.

The Government has since 1995-96 been treating the venture funds like

Mutual funds for tax benefits and brought them under Regulation of SEBI. The

SEBI has set out the guidelines for their registration and control by itself a code

of conduct for them to operate as in the case of capital market mutual funds and

for their investment and operations on the fund. In the Central Budget for 2000-

01 the income of the Venture Capital Fund is taxed at the rate of 20%, although

the dividends declared in the hands of the investors are tax-free.

8. Initial Public Offerings: - Initial Public Offerings (IPO) is the first time a

company sells its stock to the public. Sometimes IPOs are associated with huge

first-day gains; other times, when the market is cold, they flop. It's often difficult

for an individual investor to realize the huge gains, since in most cases only

institutional investors have access to the stock at the offering price. By the time

the general public can trade the stock, most of its first-day gains have already

been made. However, a savvy and informed investor should still watch the IPO

market, because this is the first opportunity to buy these stocks.

Reasons for an IPO: - When a privately held corporation needs to raise

additional capital, it can either take on debt or sell partial ownership. If the

corporation chooses to sell ownership to the public, it engages in an IPO.

Corporations choose to "go public" instead of issuing debt securities for several

reasons. The most common reason is that capital raised through an IPO does

not have to be repaid, whereas debt securities such as bonds must be repaid


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with interest. Despite this apparent benefit, there are also many drawbacks to an

IPO. A large drawback to going public is that the current owners of the privately

held corporation lose a part of their ownership. Corporations weigh the costs and

benefits of an IPO carefully before performing an IPO.

Going Public

If a corporation decides that it is going to perform an IPO, it will first

hire an investment bank to facilitate the sale of its shares to the public. This

process is commonly called "underwriting"; the bank's role as the underwriter

varies according to the method of underwriting agreed upon, but its primary

function remains the same.In accordance with the SEBI act, the corporation will file a registration statement

with the Securities Exchange Board of India (SEBI).The registration statement

must fully disclose all material information to the SEBI including a description of

the corporation, detailed financial statements, biographical information on

insiders, and the number of shares owned by each insider. After filing, the

corporation must wait for the SEBI to investigate the registration statement and

approve of the full disclosure.

During this period while the SEBI investigates the corporation's filings, the

underwriter will try to increase demand for the corporation's stock. Many

investment banks will print "tombstone" advertisements that offer "bare-bones"

information to prospective investors. The underwriter will also issue a preliminary

prospectus, or "red herring", to potential investors. These red herrings include

much of the information contained in the registration statement, but are

incomplete and subject to change. An official summary of the corporation, or

prospectus, must be issued either before or along with the actual stock offering.

After the SEBI approves of the corporation's full disclosure, the corporation and


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the underwriter decide on the price and date of the IPO; the IPO is then

conducted on the determined date. IPO‘s are sometimes postponed or even

withdrawn in poor market conditions.

Performance

The aftermarket performance of an IPO is how the stock price behaves after the

day of its offering on the secondary market (such as the BSE or the NSE).

Investors can use this information to judge the likelihood that an IPO in a specific

industry or from a specific lead underwriter will perform well in the days (or

months) following its offering. The first-day gains of some IPO‘s have made

investors all too aware of the money to be had in IPO investing. Unfortunately, for

the small individual investor, realizing those much-publicized gains is nearlyimpossible. The crux of the problem is that individual investors are just too small

to get in on the IPO market before the jump. Those large first-day returns are

made over the offering price of the stock, at which only large, institutional

investors can buy in. The system is one of reciprocal back scratching, in which

the underwriters offer the shares first to the clients who have brought them the

most business recently. By the time the average investor gets his hands on a hot

IPO, it's on the secondary market, and the stock's price has already shot up.

Appointment of Investment Bankers and Other Intermediaries

The company first selects the Investment Banker(S) for handling the issue.

The investment banker should have a valid SEBI registration to be eligible for

appointment.

The criteria normally used in selection of Investment Bankers are:

i. Past track record in successfully handling similar issues


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ii. Distribution network with institutional and individual investors

iii. General reputation in the market

iv. Trained manpower and skills for instrument designing and pricing

v. Good rapport with other market intermediaries

vi. Value added services like providing bridge loans against public issue

proceeds

Issue in any of the capacities

An investment banker can be associated with the issue in any of the following

capacities:

Lead Manager to the issue Co Manager to the issue

Underwriter to the issue

Advisor/Consultant to the issue

SEBI has set certain limits on the maximum no of intermediaries associated with

the issue

Size of the issue No of lead managers

Less than Rs 50cr 2

Rs 50cr to Rs 100cr 3



Above Rs 400cr 5 or more as agreed by the board

The no of co managers cannot exceed no of lead managers appointed for that

issue.

There can be only one advisor or consultant to the issue. There is no limit on the

no of underwriters to the issue. An associate company of the issuer company

cannot be appointed either as lead manager or Co manager to the issue. However


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they can be appointed as Underwriter or Advisor/Consultant to the issue. The lead

investment banker enters into a MOU with the issuer company. The no of co

managers cannot exceed no of lead managers appointed for that issue. There is

no limit on the no of underwriters to the issue. An associate company of the issuer

company cannot be appointed either as lead manager or Co manager to the issue.

However they can be appointed as Underwriter or Advisor/Consultant to the issue.

The lead investment banker enters into a MOU with the issuer company. MOU

specifies the mutual rights, obligations and liabilities relating to the issue. The lead

investment banker has to ensure that copy of MOU is submitted to the board along

with the draft offer document. In case of more than one lead manager is appointed,

all lead managers have a meeting and the entire issue related work is distributedamong them. This agreement is called as ‗Inter -se Allocation of Responsibilities‘.

Once the lead manager(s) is/are appointed, the other intermediaries are appointed

in consultation with them. The selection of the intermediary is based on their past

records, ranking, previous relationship with the issuer company, fees charged etc

The other intermediaries appointed are:

a. Registrar to the issue

b. Bankers to the issue

c. Underwriters to the issue

d. Debenture trustees (if applicable)

e. Brokers to the issue

f. Advertising agencies

g. Printers of issue stationery

h. Auditor

i. Legal advisor to the issue


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9. Working capital: - Working capital, also known as net working capital, is a

financial metric which represents operating liquidity available to a business. Along

with fixed assets such as plant and equipment, working capital is considered a part

of operating capital. Finance for working capital, particularly for new ventures,

often needs to be syndicated on behalf of the promoters, and merchant banks

assist in this as well. For existing companies, non/traditional sources such as

through the issue of debentures for this purpose, and others have been

successfully tapped by merchant bankers. This ensures that the firm is able to

continue its operations and that it has sufficient cash flow to satisfy both maturing

short-term debt and upcoming operational expenses

10. Foreign currency finance: - Of late, India has become increasingly active in

the international money markets, and this trend is likely to continue. For import of

capital goods and services from overseas, the arrangement of various kinds of

export credits from different countries is also required.

In addition to this wide range of services, some of the larger banks are also

involved in areas such as the arrangement of lease finance, and assistance in

acquisitions and mergers etc.

11. Underwriting: - Underwriting refers to the process that a large financial

service provider (bank, insurer, investment house) uses to assess the eligibility of

a customer to receive their products (equity capital, insurance, mortgage or credit).

This is a way of placing a newly issued security, such as stocks or bonds, with

investors. A merchant banker underwrites the transaction, which means they havetaken on the risk of distributing the securities. Should they not be able to find

enough investors, they will have to hold some securities themselves. Underwriters

make their income from the price difference (the "underwriting spread") between

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the price they pay the issuer and what they collect from investors or from broker-

dealers who buy portions of the offering. When a dealer bank purchases Treasury

securities in a quarterly Treasury bond auction, it acts as underwriter and

distributor. Treasury securities purchased by a primary dealer are held in a dealer

bank's trading account assets portfolio, and they are often resold to other banks

and to private investors. The main work of merchant banks relates to underwriting

of new issues and rising of new capital for the corporate sector. Of the amount

underwritten, some part devolves on the underwriters, which varies depending on

the state of the capital market, and the intrinsic worth of the project. The SEBI has

made underwriting Compulsory for all issues offered to Public first but later it was

made optional. SEBI made it necessary for merchant bank to undertake or make

a firm commitment for 5% of issued amount to the public.

Structure of Securitization

Pooling and transfer

The originator initially owns the assets engaged in the deal. This is

typically a company looking to raise capital, restructure debt or otherwise adjust its

finances. Under traditional corporate finance concepts, such a company would

have three options to raise new capital: a loan, bond issue, or issuance of stock.

However, stock offerings dilute the ownership and control of the company, while

loan or bond financing is often prohibitively expensive due to the credit rating of

the company and the associated rise in interest rates.

A suitably large portfolio of assets is "pooled" and sold to a "special purpose

vehicle" or "SPV" (the issuer), a tax-exempt company or trust formed for thespecific purpose of funding the assets. Once the assets are transferred to the

issuer, there is normally no recourse to the originator. The issuer is "bankruptcy

remote," meaning that if the originator goes into bankruptcy, the assets of the

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Issuer will not be distributed to the creditors of the originator. In order to achieve

this, the governing documents of the issuer restrict its activities to only those

necessary to complete the issuance of securities. Since the structural issues is

very complex, an investment bank facilitate (the arranger) the originator in setting

up the structure of the transaction.

Issuance

To be able to buy the assets from the originator, the issuer SPV issues tradable

securities to fund the purchase. Investors purchase the securities, either through a

private offering (targeting institutional investors) or on the open market. The

performance of the securities is then directly linked to the performance of the

assets. Credit rating agencies rate the securities which are issued in order toprovide an external perspective on the liabilities being created and help the

investor make a more informed decision.

In transactions with static assets, a depositor will assemble the underlying

collateral, help structure the securities and work with the financial markets in order

to sell the securities to investors. The depositor typically owns 100% of the

beneficial interest in the issuing entity and is usually the parent or a wholly owned

subsidiary of the parent which initiates the transaction. In transactions with

managed (traded) assets, asset managers assemble the underlying collateral, help

structure the securities and work with the financial markets in order to sell the

securities to investors. Some deals may include a third-party guarantor which

provides guarantees or partial guarantees for the assets, the principal and the

interest payments, for a fee.

The securities can be issued with either a fixed interest rate or a floating rate.

Fixed rate set the ―coupon‖ (rate) at the time of issuance, in a fashion similar to

corporate bonds. Floating rate securities may be backed by both amortizing and

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non amortizing assets. In contrast to fixed rate securities, the rates on ―floaters‖

will periodically adjust up or down according to a designated index such as a U.S.

Treasury rate, or, more typically, the London Interbank Offered Rate (LIBOR). The

floating rate usually reflects the movement in the index plus an additional fixed

margin to cover the added risk.

Credit enhancement and tranching

Unlike conventional corporate bonds which are unsecured, securities generated in

a securitization deal are "credit enhanced," meaning their credit quality is

increased above that of the originator's unsecured debt or underlying asset pool.

This increases the likelihood that the investors will receive cash flows to which

they are entitled, and thus causes the securities to have a higher credit rating thanthe originator. Some securitizations use external credit enhancement provided by

third parties, such as surety bonds and parental guarantees (although this may

introduce a conflict of interest). Individual securities are often split into tranches, or

categorized into varying degrees of subordination. Each tranches has a different

level of credit protection or risk exposure than

another: there is generally a senior (―A‖) class of securities and one or more junior

subordinated (―B,‖ ―C,‖ etc.) classes that function as protective layers for the ―A‖

class. The senior classes

have first claim on the cash that the SPV receives, and the more junior classes

only start receiving repayment after the more senior classes have repaid. Because

of the cascading effect between classes, this arrangement is often referred to as a

cash flow waterfall. In the event that the underlying asset pool becomes insufficient

to make payments on the securities (e.g. when loans default within a portfolio of

loan claims), the loss is absorbed first by the subordinated tranches, and the

upper-level tranches remain unaffected until the losses exceed the entire amount

of the subordinated tranches. The senior securities are typically AAA rated,

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signifying a lower risk, while the lower-credit quality subordinated classes receive a

lower credit rating, signifying a higher risk.

The most junior class (often called the equity class) is the most exposed to

payment risk. In some cases, this is a special type of instrument which is retained

by the originator as a potential profit flow. In some cases the equity class receivesno coupon (either fixed or floating), but only the residual cash flow (if any) after all

the other classes have been paid.

Credit enhancements affect credit risk by providing more or less protection to

promised cash flows for a security. Additional protection can help a security

achieve a higher rating, lower protection can help create new securities with

differently desired risks, and these differential protections can help place a securityon more attractive terms.

In addition to subordination, credit may be enhanced through

A reserve or spread account, in which funds remaining after expenses such

as principal and interest payments, charge-offs and other fees have been paid-off

are accumulated, and can be used when SPE expenses are greater than itsincome.

Third-party insurance, or guarantees of principal and interest payments on

the securities.

Over-collateralization, usually by using finance income to pay off principal

on some securities before principal on the corresponding share of collateral is

collected.

Cash funding or a cash collateral account, generally consisting of short-

term, highly rated investments purchased either from the seller's own funds, or

from funds borrowed from third parties that can be used to make up shortfalls in

promised cash flows.

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A third-party letter of credit or corporate guarantee.

A back-up servicer for the loans.

Discounted receivables for the pool.

Servicing

A servicer collects payments and monitors the assets that are the crux of the

structured financial deal. The servicer can often be the originator, because the

servicer needs very similar expertise to the originator and would want to ensure

that loan repayments are paid to the Special Purpose Vehicle. The servicer can

significantly affect the cash flows to the investors because it controls the collection

policy, which influences the proceeds collected, the charge-offs and the recoveries

on the loans. Any income remaining after payments and expenses is usuallyaccumulated to some extent in a reserve or spread account, and any further

excess is returned to the seller. Bond rating agencies publish ratings of asset-

backed securities based on the performance of the collateral pool, the credit

enhancements and the probability of default.

When the issuer is structured as a trust, the trustee is a vital part of

the deal as the gate-keeper of the assets that are being held in the issuer. Even

though the trustee is part of the SPV, which is typically wholly owned by the

Originator, the trustee has a fiduciary duty to protect the assets and those who

own the assets, typically the investors.

Repayment structures

Unlike corporate bonds, most securitizations are amortized, meaning that the

principal amount borrowed is paid back gradually over the specified term of the

loan, rather than in one lump sum at the maturity of the loan. Fully amortizing

securitizations are generally collateralized by fully amortizing assets such as home

equity loans, auto loans, and student loans. Prepayment uncertainty is a important

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concern with full amortization. The possible rate of prepayment varies widely with

the type of underlying asset pool; so many prepayment models have been

developed in an attempt to define common prepayment activity.

A controlled amortization structure is a method of providing investors with a more

predictable repayment schedule, even though the underlying assets may be non-amortizing. After a predetermined ―revolving‖ period, during which only interest

payments are made, these securitizations attempt to return principal to investors in

a series of defined periodic payments, usually within a year. An early amortization

event is the risk of the debt being retired early.

On the other hand, bullet or slug structures return the principal to investors in a

single payment. The most common bullet structure is called the soft bullet,meaning that the final bullet payment is not guaranteed on the expected maturity

date; however, the majority of these securitizations are paid on time. The second

type of bullet structure is the hard bullet, which guarantees that the principal will be

paid on the expected maturity date. Hard bullet structures are less common for

two reasons: investors are comfortable with soft bullet structures, and they are

reluctant to accept the lower yields of hard bullet securities in exchange for a

guarantee.

Securitizations are often structured as a sequential pay bond, paid off in a

sequential manner based on maturity. This means that the first tranche, which may

have a one-year average life, will receive all principal payments until it is retired;

then the second tranche begins to receive principal, and so forth. Pro rata bond

structures pay each tranche a proportionate share of principal throughout the life ofthe security.

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Structural Risks and Mis-incentive

Originators (e.g. of mortgages) have less incentive towards credit quality and

greater incentive towards loan volume since they do not bear the long-term risk of

the assets they have created and may simply profit by the fees associated with

origination and securitization.

14. Portfolio management services:- A list of all those services and facilities that

are provided by a portfolio manager to its clients, relating to the management and

administration of portfolio of securities or the funds of clients, is referred to as

‗portfolio management services‘. The term ‗portfolio‘ means the total holdings of

securities belonging to any person.

Portfolio Manager: - According to SEBI, ‗Portfolio Manager‘ means any person

who pursuant to contract or arrangements with a clients, advices or directs or

undertakes on behalf of the clients the management or administration of a portfolio

of securities or the funds of client, as the case may be

Discretionary Portfolio Manager:- According to SEBI, ‗discretionary portfolio

manager‘ means a portfolio manager who exercises or may, under a contractrelating to portfolio management, exercises any degree of discretion as to the

investments or management of the portfolio of securities or the funds of the clients,

as the case may be.

FUNCTIONS

The objective of portfolio management is to develop a portfolio that has maximum

return at whatever level of risk the investor deems appropriate.

Risk Diversification - An essential function of portfolio management is

spread risk akin to investment of assets. Diversification could take place


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across different securities and across different industries. Diversification

achieved in different industries is an effective way of diversifying the risk

in an investment. Simple diversification reduces risk within categories of

stocks that all have the same quality rating. whereby portfolio risk are

sought to be reduced through combining assets, which are less than

perfectly positively correlated.

(B) Efficient Portfolio:- A portfolio manager aims at building ‗dominant investment‘

called ‗efficient portfolio‘. An efficient portfolio consists of combination of assets

that maximizes return and maximizes the risk level of expected return. The

objective of portfolio management is to analyze different individual assets and

delineate efficient portfolios. A group of portfolio of efficient portfolios is called

‗efficient set of portfolios‘. The efficient set of portfolio comprises efficient frontier.

(C) Asset allocation: - An important function of portfolio management is asset

allocation. It deals with attaining proportion of investments from categories.

Portfolio managers basically aim at stock-bond mix. For this purpose equally

weighted categories of assets are used.

(D) Beta Estimation: - Another important function of a portfolio manger is to make

an estimate of beta coefficient. It measures and ranks the systematic risk of

different assets. Beta coefficient is an index of the systematic risk. This is useful in

making ultimate selection of securities for investment by portfolio manager.

(E) Rebalancing Portfolios: - Rebalancing of portfolio involves the process of

periodically adjusting the portfolios to maintain the original conditions of portfolio.

The adjustments may be made either by way of ‗constant proportion portfolio‘ or by

way of ‗constant beta portfolio‘. In constant proportion portfolio, adjustments are

made in such a way as to maintain the relative weighting in portfolio components


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according to the change in prices. Under the constant beta portfolio, adjustments

are made to accommodate the values of component betas in the portfolio.

STRATEGIES

A Portfolio manager may adopt any of the following strategies as part of an

efficient management:

(A) Buy and Hold Strategy: - Under the ‗buy and hold‘ strategy, the portfolio

manager builds a portfolio of stock, which is not disturbed at all for a long period

of time. This practice is common in case of perpetual securities such as common

stock.

(B) Indexing: - Another strategy employed by portfolio managers is ‗indexing‘.

Indexing involves an attempt to replicate the investment characteristics of a

popular measure of the bond market. Securities that are held in best-known bond

indexes are basically high-grade issues.

(C) Laddered Portfolio: - Under the laddered portfolio, bonds are selected in such

a way that their maturities are spread uniformly over a long period of time. This

way a portfolio manager aims at distributing the funds throughout the yield curve.

(D) Barbell Portfolio: - under this portfolio strategy, less investment of funds is

made in middle maturities.

15. Sales & Trading: - Make trades in securities for the primary and secondary

markets For currencies, stocks, bonds, derivatives, futures, commodities, asset-

backed treasuries etc on Behalf of institutional clients (mutual and pension funds),

individual investors and for the Banks themselves. Sales are another core

component of any investment bank. Salespeople take the form of:

1) The classic retail broker


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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) representative‘s lies somewhere between retail brokers and

institutional salespeople, providing brokerage and money management services

for extremely wealthy individuals. Salespeople make money through commissions

on trades made through their firms.

In trading traders also provide a vital role for the investment bank. Traders

facilitate the buying and selling of stock, bonds, or other securities such ascurrencies, 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.

SEBI Guidelines

The Government has setup Securities Exchange Board of India

(SEBI) in April 1988. For more then three years, it had no statutory powers.

Its interim functions during the period were:

i. To collect information and advise the Government on matters relating toStock and Capital Markets.

ii. Licensing and regulatory and Merchant Banks, Mutual Fund, etc.Iii To prepare the legal drafts for regulatory and developmental role of SEBI and

iv.To perform any other functions as may be entrusted to it by Government.

The need for setting up independent Government agency to regulate and develop


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the Stock and Capital Market in India as in many developed countries was

recognized since the Seventh Five Year was launched (1985) when some major

industrial policy changes like opening up of the economy to out side the world and

greater role to the Private Sector were initiated. The rampant malpractices noticed

in the Stock and Capital Markets stood in the way of infusing confidence of

investors, which is necessary for mobilization of large quantity of funds from the

public, and help the growth of the industry. The malpractices were noticed in the

case of companies, Merchant Bankers and Brokers who are all operating in

Capital Markets. The security industry in India has to develop on the right lines for

which a competent Government agency as in UK (SIB) or in USA (SEC) is

needed.

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI) MERCHANT

BANKING -ROLE & FUNCTIONS

(a) Authorization

Any person or body proposing to engage in the business of Merchant Banking

would need authorization by SEBI in the prescribed format. This will apply to

those presently engaged in the Merchant Banking activity, including as Manager,

Consultants or Advisers to issues.

(b) Authorized Activity

(i) Issue Management

(ii) Corporate Advisory services relating to the issue

(iii) Underwriting

(iv) Portfolio Management Services (PMS)

(v) Managers, Consultants or Advisers to the issue

(c) Authorization Criteria


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All Merchant Bankers are expected to perform with high standards of integrity

and fairness in all their dealings. A code of conduct for the Merchant Bankers is

prescribed by SEBI which will take into account the following:

(i) Professional Competence

(ii) Personnel, their adequacy and quality and other infrastructure

(iii) Capital Adequacy

(iv) Past track record, experience, general reputation and fairness in all their

transactions.

(d) Terms of Authorization

(i) All Merchant bankers shall have a minimum net worth of Rs.5crore.

(ii) The Authorization will be for an initial period of 3 years.

(iii) All issues should be managed by at least one authorized to Merchantbanker functioning as the Lead Manager or sole Manager.

(iv) The Merchant Bankers shall exercise due diligences independently verifying

the contents of the prospectus. The Merchant Bankers of the issues shall certify to

this effect to SEBI.

(v) In respect of issues managed by the Merchant Bankers, they would be

required to a minimum 5% underwriting obligation for issue subject to a ceiling of

Rs.25lakh.

(vi) The merchant banker‘s involvement will continue till the complete on of

essential to follow-up steps including listing of the shares and dispatch of

certificates.

(vii) The Merchant Banker shall make available to SEBI such information, returns

and reports as may be called for.

(viii) Merchant Bankers shall adhere to the code of conduct which shall prepared

by SEBI.

(ix) Merchant Bankers to ensure that Publicity / Advertisement material


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accompanying the application form to the issue meets the requirement of

GOI/SEBI.

(x) SEBI shall be informed well before the opening of the issue the Inter allocation

of activities/sub-activities, among lead managers to the issue.

(xi) Merchant Bankers performing or planning to perform portfolio management

services shall furnish the details in the prescribed format.

(f) Grading of Prospectus

Grading of Prospectus will be done by SEBI using the following parameters:-

(i) Objective description of the project, its status and implementation.

(ii) Track record of the promoters and their competence.

(iii) Disclosure about Demand - Supply position, Market and Marketing

arrangements, Raw materials availability and infrastructural facility.(iv) Objective assessment of Business prospects and profitability.

(g) Penalty Point System

SEBI has introduced penalty point system for Merchant Bankers who fail to

comply with the various provisions. The areas of non-compliance/defaults have

been categorized into following four categories. The activities are classified within

these four categories:

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


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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 checking and savings accounts

from consumers. The federal government provides insurance guarantees on these

deposits through the Federal Deposit Insurance Corporation (the FDIC), on

amounts up to $100,000. To get FDIC guarantees, commercial banks must follow

a myriad of regulations. 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.

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).


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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.

Risk involved in investment banking

In the course of their operations, investment banks are invariably faced with

different types of risks that may have a potentially negative effect on their

business. Risk management in investment bank operations includes risk

identification, measurement and assessment, and its objective is to minimize

negative effects risks can have on the financial result and capital of a bank.

Investment banks are therefore required to form a special organizational unit in

charge of risk management. Also, they are required to prescribe procedures for

risk identification, measurement and assessment, as well as procedures for risk

management.

The risks to which a investment bank is particularly exposed in its operations are:

liquidity risk, credit risk, market risks (interest rate risk, foreign exchange risk and

risk from change in market price of securities, financial derivatives and

commodities), exposure risks, investment risks, risks relating to the country of

origin of the entity to which a bank is exposed, operational risk, legal risk,

reputational risk and strategic risk.

Liquidity risk - is the risk of negative effects on the financial result and

capital of the bank caused by the bank‘s inability to meet all its due obligations.

Credit risk - is the risk of negative effects on the financial result and capitalof the bank caused by borrower‘s default on its obligations to the bank.

Market risk - includes interest rate and foreign exchange risk.

1. Interest rate risk - is the risk of negative effects on the financial result and capita


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of the bank caused by changes in interest rates.

Foreign exchange risk - is the risk of negative effects on the financial result

and capital of the bank caused by changes in exchange rates.

A special type of market risk is the risk of change in the market price of securities,

financial derivatives or commodities traded or tradable in the market.

Exposure risks - include risks of bank‘s exposure to a single entity or a group

of related entities, and risks of banks‘ exposure to a single entity related with the

bank.

Investment risks - include risks of bank‘s investments in entities that are not

entities in the financial sector and in fixed assets.

Risks relating to the country of origin of the entity to which a bank is

exposed -(country risk) is the risk of negative effects on the financial result and

capital of the bank due to bank‘s inability to collect claims from such entity for

reasons arising from political, economic or social conditions in such entity‘s

country of origin. Country risk includes political and economic risk, and transfer

risk.

Operational risk - is the risk of negative effects on the financial result and

capital of the bank caused by omissions in the work of employees, inadequate

internal procedures and processes, inadequate management of information and

other systems, and unforeseeable external events.

Legal risk – it is the risk of loss caused by penalties or sanctions originating

from court disputes due to breach of contractual and legal obligations, and

penalties and sanctions pronounced by a regulatory body.

Reputational risk - is the risk of loss caused by a negative impact on the

market positioning of the bank.


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Strategic risk - is the risk of loss caused by a lack of a long-term development

component in the bank‘s managing team.

Need for risk management

The primary goal of risk management is to ensure that a financial institutions

trading, position taking, credit extension, and operational activities do not expose it

losses that could threaten the viability of the firm. As risk taking is an integral Part

of the investment banking business, it is not surprising that investment bank have

been risk management ever since they have been established. The only thing

which has change is the complexity.

It involves following steps

Identifying and assessing risks

Establishing policies, procedures, and risk limits

Monitoring and reporting compliance with reliance with these limits

Delineating capital allocation and portfolio management

Developing guidelines for new products and including new exposures

within the current frame work

Applying new measurements methods to the existing product

Risk management practices in front office

1. Taping of telephone lines of traders and dealers to resolve of disputes at

a later date.

2. Restriction on personal trading by the dealer.3. Restrictions on transaction at off market rates and documentation

procedures to justify any off-market transactions.


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4. Restrictions on after-hours trading and off-premises trading and documentation

procedures to justify them when undertaken.

5. Adequate compensation policies should be formulated to protect dealers from

losses in case of disputed traders.

6. Revaluation of position may be conducted by traders to monitor positions by the

controllers to record periodic profit and loss, and by the risk mangers who seek to

estimate risk under various market conditions.

7. Traders should maintain professionalism, confidentiality and proper language in

telephone and electronic conversation.

8.Management should analyze the trading activity periodically.

Risk management in the back office

1. It should have written documentation indicating the range of permissible

products, trading authorities and permissible counterparties.

2. It should have limits for each type of contract or risk type.3. The management should explicitly state the procedure for the written

authorization of the trades in excess of the laid down limits.

4. Adequate procedure for promptly resolving the failure to receive or deliver

securities on the settlement dates must be established.

Other risk management practices

1. As with traditional banki9ng transactions, an independent credit function

should conduct an internal credit review before engaging in transaction with the

prospective counterparties. Credit guidelines should ensure that the limits are

approved for only those counterparties that meet the appropriate credit criteria.


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2. The credit risk management function should verify that the limits are approved

by the credit specialist.

3. The assessment of the counterparties based on simple balance sheet

measures the traditional assessment of the financial condition may be adequatefor many types of counterparties. The credit risk assessment policies should also

properly define the type of analysis to be conducted on the counterparties based

on the nature of their risk profile. In some instance stress testing may be needed

when counterparty‘s creditworthiness may be adversely affected by the short -

term fluctuations in the financial markets.

4. The top management has to identify those areas where the bank practices

may not comply with the stated policies. Necessary internal controls for ensuring

that the practices confirm with that stated policies should be put in place.

Possible conflicts of interest

It is crucial to note whether an investment bank has provided corporate finance

services to the company under coverage. Usually at the end of a research piece,

a footnote will indicate whether this is the case. If so, investors should be careful

to understand the inherent conflict of interest and bias that the research report

contains. Often covering a company's stock (and covering it with optimistic

ratings) will ensure corporate finance business, such as a manager role in equity

offerings, M&A advisory services, and so on. Potential conflicts of interest may

arise between different parts of a bank, creating the potential for financialmovements 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 research and equities on the other.

http://en.wikipedia.org/wiki/Financial_Services_Authorityhttp://en.wikipedia.org/wiki/United_Kingdomhttp://en.wikipedia.org/wiki/United_States_Securities_and_Exchange_Commissionhttp://en.wikipedia.org/wiki/United_Stateshttp://en.wikipedia.org/wiki/United_Stateshttp://en.wikipedia.org/wiki/Chinese_wall_%28financial%29http://en.wikipedia.org/wiki/Chinese_wall_%28financial%29http://en.wikipedia.org/wiki/United_Stateshttp://en.wikipedia.org/wiki/United_Stateshttp://en.wikipedia.org/wiki/United_States_Securities_and_Exchange_Commissionhttp://en.wikipedia.org/wiki/United_Kingdomhttp://en.wikipedia.org/wiki/Financial_Services_Authority


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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 fromregulators and a series of lawsuits, settlements, and prosecutions curbed this

business to a large extent following the 2001 stock market tumble

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.


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The Big Picture- Major Players in investment banking

Until the wave of consolidation and convergence that started in the 1990s in the

financial services industry, the playing field had changed very little and was easy

to understand. Commercial banks and investment banks each had their roles, as

defined by federal regulations, and seldom did the two meet. And within

investment banking, firms could be neatly categorized by their size, market focus,

or both. At the top was the bulge bracket, which consisted of the six largest firms:

Merrill Lynch, Goldman Sachs, Morgan Stanley, Salomon Smith Barney, First

Boston, and Lehman Brothers.

1. Bank of America Securities LLC -Bank of America Securities is the U.S.

investment banking arm of Bank of America, one of the biggest commercial banks

around. Together with Bank of America‘s U.K. investment banking subsidiary,

Banc of America Securities Ltd., it offers a full range of investment banking and

brokerage services. The company was created in 1998, when its parent bank

acquired Montgomery Securities. Later, Bank of America was acquired byNationsBank, and the combined entity took on the Bank of America name. Banc

of America Securities‘ main offices are in San Francisco, New York, and

Charlotte. It employs people in areas including corporate and investment banking,

the global markets group (debt capital raising, sales, trading, and research),

portfolio management, e-commerce, global treasury services, and asset

management. Banc of America Securities offers full-time and summer associate

and analyst programs in the United States and in Europe.

2. Credit Suisse first Boston LLC - Credit Suisse First Boston is the result

of the 1988 merger of the investment bank First Boston and Credit Suisse, a

European commercial bank. In 2000, the firm acquired Donaldson, Lufkin &


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Jenrette, and a leading underwriter of high-yield bonds with a golden reputation

in research. A bulge-bracket bank, CSFB ranked fifth among all banks in 2003 in

terms of global debt, equity, and equity-related

issuance. CSFB has experienced trouble in recent years, with business

slackening in key areas (e.g., IPO underwriting) and regulatory trouble (the firmpaid a $200 million fine in 2002 for research improprieties and another $100

million in 2002 to settle charges that it received kickbacks in the form of higher

commissions from clients to whom it allocated hot IPO shares—and in the

process rock-star tech banker Frank Quattrone resigned and

eventually was convicted of criminal charges). The firm has also been losing key

bankers in recent times; epitomizing this trend, the CEO of the investment bank,

John Mack, announced plans to leave the firm in the summer of 2004, reportedly

due to the fact that his desire to merge Credit Suisse with another firm was not in

line with the desires of the majority of the directors of Credit Suisse. After that

announcement, the firm‘s head in China announced plans to leave the firm, and

as this guide goes to press the firm must surely be worried that an exodus of the

firm‘s talent in Asia will ensue.

3. Deutsche Banc Securities Inc. - Deutsche Banc Securities is the full-

service North American investment banking arm of German financial services

giant Deutsche Bank AG. It includes Deutsche Bank Alex. Brown, which provides

M&A, acquisition finance, and project finance advisory to clients in the health-

care, media, real estate, technology, and telecom sectors. The bank has been

undergoing some changes, with some key employees leaving the firm and the

additio

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