1. MN50412 Investment Banking

2. General information
Lecturer: Dr Bruno Deschamps
Office: Wessex House 9.21
Class time: Wednesday pm
Office hours: Monday 11am-1pm

3. What is investment banking?

4. The banking function The banking function can be decomposed into:
Central banking:
Monetary policy (interest rates, money supply)
In the UK: Bank of England
Commercial banking:
Lending to the public (businesses, individuals, banks)
Receiving deposits from businesses and individuals
In the UK: HSBC, RBS, Barclays, HBOS
Investment banking

5. Investment banking activities
Investment banking activities include:
Mergers and acquisitions (+ divestitures)
Advise potential buyers on which companies to target
Help sellers screen potential buyers
Suggestions about what price to offer/accept
Negotiation support
Structuring the deal ( pay in cash vs. pay in stock)

6. Proprietary trading: Trading with the bank own money
Debt underwriting
IB help companies and governments raise money by issuing corporate or government bonds
Underwriting: IB act as intermediate between the issuer and investors (individuals, banks, mutual funds, hedge funds, sovereign funds etc.)
Act as primary dealers for the government
Have a certification role for companies that want to issue bonds
Proprietary trading: Trading with the bank own money

7. Equity underwriting Asset management - Determine the offering price
- Evaluate the issuer
- Determine the offering price
- Buy the shares from the issuer
- Find investors and sell the shares
- Initial public offering (IPOs)
Asset management
Managing short-term cash flows of corporate clients
Management of long-term bonds and equity portfolios of investors
Institutional investors: insurance companies, pensions funds etc.
Private investors

8. Asset securitization
Issuance of securities using a pool a similar assets as collateral
Mortgage-backed securities, asset-backed securities
Private equity: refers to shares in companies that are not publicly traded
- Venture capital
- LBOs: using borrowed money for a substantial portion of the purchase price of the buyout company
- IB can raise funds for private equity funds or manage these funds themselves

9. Investment banks
Investment banks are financial institutions that engage primarily in IB activities
Investment banks engage in public and private market
transactions with corporations, governments and institutional
investors.
Main differences with commercial banks:
- IB have a marginal role in deposits and loan activities.
- IB usually take short-term positions, i.e. few days (except in the non-core business of venture capital). Commercial banks take longer term positions.

10. Investment banks are intermediary between those needing funds and those having them:
Need funds: Corporations, government
Have funds: Corporations, investment vehicles such as mutual funds, pension funds etc.
How do they make money?
Fees (underwriting, M&A, asset management)
Trading revenues
Main IB up to early 2008: Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, Bear Stearns

11. Banks that combine commercial and investment banking
Commercial banks
Institutions whose current operations consist mostly in granting loans and receiving deposits from businesses and customers
Universal banks
Banks that combine commercial and investment banking
Example: UBS, Citibank, Bank of America 11

12. Content of the course

13. Content of the course Introduction Equity underwriting Why go public?
The IPO process
Syndicates in IPOs
Market shares in IPOs
Underwriting spread in IPOs
Underpricing of IPOs
Long-run performance of IPOs

14. Debt underwriting Derivatives products Pricing of bonds Yield curve
Corporate vs. government bonds
Callable bonds, convertible bonds
Derivatives products
Futures
Options
SWAPS, CDO, CDS

15. Mergers and acquisitions
M&A valuation
Determinants of market shares
Who gains from mergers?
Financing: cash vs. stock
Why use IB? Investment banks vs. commercial banks
Role of IB in the financial and economic crisis
Asset management:
- Active vs. passive management
- Performance measurement

16. Contribution of financial services to the UK economy16

17. Sectors' share in UK GDP 17

18. Financial services jobs in central London
City of London
Canary Wharf
City-type UK
Fin. servs
Total
2000
158
330 11 46
325
1069
2001
134
309 24 62
312
1089
2002
143 22 57
305
1113
2003
145
311 26 61
317
1105
2004
127
292 40 78
316
1075
2005
135
306 47 87
327
1063
2006
131
303 54 96
342
1048
2007
---
353
1045
2008
1029 18

19. UK sector trade balances19

20. Tax contribution of UK financial services
Corporation
Income
Total
Corporation(share)
Income (share)
2001
10.9
12.5
23.4
34.9
14.0
2002
7.3
12.2
19.6
25.8
13.3
2003
7.4
11.2
18.6
26.7
11.9
2004
7.7
25.7
11.7
2005
8.8
13.5
22.2
25.4
12.4
2006
11.4
14.8
26.2
27.0
13.0
2007
---
27.1 20

21. International financial markets in the UK21

22. IB revenues 22

23. Funds under management
2006
2007
Institutional
2,400
2,556
- Insurance
840
838
- Corporate pension funds
870
979
- Other (local authority, charity, etc)
690
737
Retail
650
769
- Hedge funds
150
180
- Property funds
202
174
- Private Equity funds 34 29
Private client funds
376
412
Total funds under management in the UK
3,812
4,118 23

24. Sovereign wealth funds under
management (global) 24

25. Global private equity 25

26. UK market shares % share UK US Japan France Germany
Cross-border bank lending (Mar 2008) 20 9 7 11
Foreign exchange turnover (Apr 2007) 34 17 6 3
Exchange-traded derivatives turnover 40 2 1 13
Over-the-counter derivatives turnover 43 24 4
International bonds - secondary market 70
...
Fund management (as a source of funds, end-2007) 48
Hedge funds assets (end-2007) 66 -
Private equity - investment value (2007) 71
IPOs (Jan-Sep 2008)5
Securitisation - issuance (2007) 76 26

27. Turnover of London based derivatives
exchanges
ICE Futures
Europe
Liffe
LME
EDX
Total
1997
14.7
209.3
57.4
4.4
285.8
1998
19.4
149.8
53.1
7.3
229.6
1999
23.0
117.8
61.5
10.4
212.7
2000
25.5
131.1
66.4
11.6
234.6
2001
26.4
619.1
59.4
15.9
720.8
2002
30.4
697
58.6
14.1
800.1
2003
33.3
695.1
72.3
14.8
815.5
2004
35.5
787.8
71.9
21.5
916.7
2005
42.1
759.3
78.6
20.3
900.3
2006
92.7
730.3
86.9
28.8
938.8
2007
138.5
949
92.9
43.1
1,223.50 27

28. UK vs. US ( ) 28

29. Investment banking in the US
The modern concept of “Investment Bank” was created by the Glass-Steagall act (Banking Act of 1933). Following the stock market crash, large banks went bankrupt.
Glass-Steagall separated commercial banks, investment banks, and insurance companies.
In 1999 the Glass-Steagall Act was waived (Graham-Leach-Bliley Act). 29

30. Investment banking in the UK
In the past, separation between:
Brokers: Rout the orders of customers to the stock exchange, give advices on investments. They cannot take positions in the stocks that act as brokers for.
Jobbers: Market makers that could trade only with the brokers, not with the general public.
Merchant banks: Commercial banks that offer corporate finance services (M&A advisory, underwriting etc.). Did not own the brokers.
In 1986: Big bang:
Abolition of fixed commission to increase competition
Dual capacity: Jobbers, brokers and merchant banks can integrate 30

31. 1990s: The failure of UK investment banks
Problems
The US had deregulated fees in 1975
Business became much more complex, more difficult to manage
Lack of managerial experience
Clash of cultures brokers/jobbers/merchant banks
Markets became volatile after the 1987 crash
Results became volatile and UK banks made substantial losses
1995 saw many UK banks fail amid losses 31

32. Reasons for US success since the 1990s
Large financial and management resources, meaning that they were less exposed
Huge profits in the US market allowed cross-subsidisation in Europe
Economies of scale for underwriting activities 32