By: 1. Kenneth A. Kim John R. Nofsinger And 2. A. C. Fernando

Lesson 12

 Last Lecture Review ◦ What is Investment Bank? ◦ Examples of Investment banks ◦ What does Investment Bank actually do? ◦ What is “Security”? ◦ Who are analysts in Investment Banks? ◦ Duties and responsibilities of “Analysts”. ◦ Methods of issuing stocks and bonds  Underwriting method  Best effort method ◦ What is “IPO”?

 Lecture Outline ◦ Criticisms of Investment Banks  IPO Problems  Structured Deals ◦ Two categories of securities analysts  Buy-side Analysts (Institutional Investors)  Sell-side Analysts (Investment Bank) ◦ What is “Institutional Investors” ◦ Our focus is toward the sell-side analysts. ◦ Functions of sell-side analysts

 Quality of Analysts Recommendations ◦ Conservative predictions ◦ Under promise and over delivery is the name of this game  Potential conflicts of interests ◦ Analysts and the firm they analyse ◦ Analysts dual responsibility toward its employer (i.e. Investment Bank), the firm and the investors.

Criticism of Investment Banks 1. IPO Problems  The business models of many firms would not be more effectively as large national firms. Or the small business owners may not be capable of running a large business.  Only a small fraction of firms succeeded.

2. Structured Deals  In bankruptcy, the equity of the firms is taken from the stockholders, who gain nothing, and given to some of the creditors.  Therefore, investors are not likely to buy additional shares from financially troubled firms.  Structured deal using SPEs i.e. Making debts as company’s revenue.

Securities Analysts  Analysts fall into two categories ◦ Buy side (Institutional Investors) ◦ Sell side (Investment Banks)  Institutional Investors ◦ Institutional investors are organizations which pool large sums of money and invest those sums in securities, real property and other investment assets.

 Institutional investors, such as mutual funds and pension funds hires buy-side analysts to help to decide which stocks the fund should buy.  The recommendations of these analysts are not public and can be seen only by the institutional investors.

 Similarly, investment banks also hire sell-side analysts to generate enough interest in a security that their firm will generate trading commission or underwriting business.  Our focus will be on sell-side analysts.  Sell-side analysts look at the firm’s; ◦ Operating and financial conditions ◦ Immediate and long-term future prospects ◦ Effectiveness of its management team ◦ And the general outlook of the industry in which the firm belongs.

 They usually try to predict the quarterly earnings per share (EPS).  Analysts make trading recommendations to investors. ◦ Buy or hold or sell  Analysts recommendations are timely.

Quality of Analysts’ Recommendation  Analysts are slightly conservative with regard to predicting earnings.  These conservative predictions are for two reasons; ◦ To meet or beat earnings expectations ◦ They need information

 If the analysts have full access to the firms, such as personal meetings with the CEO, then their task become easier.  CEO will not be 100% cooperative with an analysts.  Analysts’ conservation is what the management also wants and the CEO will be happy.

 The company will either make or beat the estimate and it will be considered a good company.  “under promise, over delivery” is the name of this game.  The ability of analysts to predict earnings accurately may suffer in the future.

Potential Conflicts of Interest 1. Analysts and the Firm they analyse  conflict of interest with the management. ◦ Try to get more and more information  Friendships with the manager can’t bring the desired goals

2. Analysts Working at Investment Banks  Analysts can work for an independent research firm, for a brokerage firms, or for the brokerage operations of an investment bank.  These analysts charge huge fee for their services.

 Will these analysts feel free to make public honest assessments if it would jeopardize those banking fees?  What if the analysts came out with the statement that his colleagues at the bank had under writing earlier?  However, analysts that work at investment banks may feel the need to compromise their integrity for the good of their employer.

 Analysts must be “Independent” rather than working as a salesperson or promoters for the investment bank.  He/she must be the objective analyzers of financial performances.

 Summary ◦ Criticisms of Investment Banks  IPO Problems  Structured Deals ◦ Two categories of securities analysts  Buy-side Analysts (Institutional Investors)  Sell-side Analysts (Investment Bank) ◦ What is “Institutional Investors” ◦ Our focus is toward the sell-side analysts. ◦ Functions of sell-side analysts

 Quality of Analysts Recommendations ◦ Conservative predictions ◦ Under promise and over delivery is the name of this game  Potential conflicts of interests ◦ Analysts and the firm they analyse ◦ Analysts dual responsibility toward its employer (i.e. Investment Bank), the firm and the investors. The End