Investment Bank

Investment Banking is branch of banking that deals with high net worth
transactions that helps companies in managing their long term financing
requirement and help them to manage their capital structure that ensures
maximum value.

Investment Bank is a financial Institution dealing in:

•Trading Securities (Both Debts & Equity)

•Manages Corporate Mergers & Acquisitions

•Providing Advisory
 Functioning of Investment
Front Office
Bank
–Investment Banking
–Sales & Trading
–Research
–Custody & Brokerage
–Investment Management

Middle Office
–Risk Management
–Corporate Treasury
–Financial Control
–Corporate Strategy
–Compliance

Back Office
–Ops (Operations)
–Technology
–Facility Management
 Overview of Investment
Banking & Security Analysis
 Variability
• The essentially feature of stock prices is
unpredictable variability
• Even when averaged into an index this variability
is apparent
• Portfolio management is about coping with the
variability
• Investment analysis is about underlying longer-
term trends
• The same principles apply to both
Variability
Variability
Variability
Variability
Variability
 Investment
• Investment is defined as a sacrifice made now to
obtain a return later
– It is current consumption that is sacrificed
• Two forms of investment can be defined
– Real investment is the purchase of land, machinery,
etc
– Financial investment is the purchase of a "paper"
contract
 Investments
• Real investments and financial investments are
linked
– The share issue of a firm finances the purchase of
capital
– The commitment to a mortgage finances the
purchase of property
• Financial investment can provide finance for real
investment decisions
• Financial investment can guide real investment
decisions
 Financial Investment
• There are numerous components to financial
investment
• Markets: where assets are bought and sold, and
the forms of trade
• Securities: the kinds of securities available, their
returns and risks
• Investment process: the decision about which
securities, and how much of each
• Financial theory: the factors that determine the
rewards from investment (and the risks)
 Markets
• A market is any organized system for
connecting buyers and sellers
• There are many security markets
• Markets may have a physical location
– The Karachi Stock Exchange
• May exist only as computer networks
– The London Stock Exchange
• Markets vary in the securities that are
traded and in the way securities are traded
 Characteristics of Markets
• There are a number of ways to classify markets
• Primary/Secondary
– Primary markets are security markets where new
issues of securities are traded
– A secondary market is a market where securities are
resold
• The London Stock Exchange is a secondary
market
• Most activity on stock exchanges is in the
secondary market
 Characteristics of Markets
• Trades on the primary market raise capital for
firms
• Trades on the secondary market do not raise
additional capital for firms
• The secondary market is still important
– It gives liquidity to primary issues. New securities
would have a lower value if they could not be
subsequently traded
– It signifies value. Trading in assets reveals
information and provides a valuation of the assets.
This helps to guide investment decisions
 Characteristics of Markets
• A second way to classify markets is the times of
trading
• Call/continuous
– In a call market trading takes place at a specified time
intervals
– Some call markets have a provision that limits
movement from the prior price. This is to prevent a
temporary order imbalance from dramatically moving
the price
– In a continuous market there is trading at all times the
market is open
 Characteristics of Markets
• Markets can also be characterized by the
lifespan of the assets traded
• Money/Capital
– Money market: the market for assets with a life of less
than 1 year
– Capital market: the market for assets with a life
greater than 1 year
• Some assets, such as most bonds, have a fixed
lifespan
• Common stock have an indefinite lifespan
 Brokers
• A broker is a representative appointed by an
individual investor
• Brokers have two conflicting roles
– An advisor: a broker can offer investment advice and
information
– A sales person: brokers are rewarded through
commission and have an incentive to encourage trade
• A full-service broker is a brokerage house that
can offer a full range of services including
investment advice and portfolio management
 Brokers
– A discount broker offers a restricted range of
services at a lower price
– To complete a trade additional brokers are
needed
– A floor broker is located on the floor of the
exchange and does the actual buying and
selling
– A specialist ensures trade happens by holding
an inventory of stock and posting prices
 Securities
• The standard definition of
a security is:
"A legal contract
representing the right to
receive future benefits
under a stated set of
conditions"
• The piece of paper
defining the property
rights held by the owner
is the security
 Securities
• Money market securities
– Short-term debt instruments sold by governments,
financial institutions and corporations
– They have maturities when issued of one year or less
– The minimum size of transactions is typically large,
usually exceeding PKR 10,000,000
• 1. Treasury Bills
– GOP Treasury Bills are the least risky and the most
marketable of all money markets instruments
– They represent a short-term IOU of the Government
of Pakistan
– Similar bills are issued by many other governments
 Securities
– New 91- and 182- day T-bills are issued weekly, by
auction whereas 52-week T-bills are issued monthly.
– An active secondary market with very low
transactions costs exists for trading T-bills
– T-bills are sold at a discount from face value and pay
no explicit interest payments.
• T-bills are considered to have no risk of default,
have very short-term maturities, and have a
known return
• T-bills are the closest approximations that exist
to a risk-free investment
 Securities
• Capital market securities
– Instruments having maturities greater than one year
and those having no designated maturity at all
• 1. Fixed income securities
– Fixed income securities have a specified payment
schedule
– Bonds promise to pay specific amounts at specific
times
– Failure to meet any specific payment puts the bond
into default with all remaining payments. The creditor
can put the defaulter into bankruptcy
 Securities
– Fixed income securities differ from each other
in promised return for several reasons
• The maturity of the bonds
• The creditworthiness of the issuer
• The taxable status of the bond
– Income and capital gains are taxed differently
in many countries
– Bonds are designed to exploit these
differences
 Securities
• 1.1 Treasury notes and bonds
– The government issues fixed income securities over a
broad range of the maturity spectrum
– Both notes and bonds pay interest twice a year and
repay principal on the maturity date
• 1.2 Corporate bonds
– These promise to pay interest at periodic intervals
and to return principal at a fixed date
– These bonds are issued by business entities and thus
have a risk of default
 Securities
• 2. Common stock (shares, equity)
– Common stock represents an ownership claim on the
earnings and assets of a corporation
– After holders of debt claims are paid, the
management of the company can either pay out the
remaining earnings to stockholdings in the form of
dividends or reinvest part or all of the earnings
– The holder of a common stock has limited liability –
the most they can lose is the value of the shares
 Securities
• 3. Derivative instruments
– Derivative instruments are securities whose value
derives from the value of an underlying security or
basket of securities
– The instruments are also known as contingent claims,
since their values are contingent on the performance
of underlying assets
– The most common contingent claims are options and
futures
– 3.1 An option on a security gives the holder the right
to either buy (a call option) or sell (a put option) a
particular asset at a future date or during a particular
period of time for a specified price
 Securities
– 3.2 A future is the obligation to buy or sell a particular
security or bundle of securities at a particular time for
a stated price
– A future is simply a delayed purchase or sale of a
security
– 3.3 The corporation can issue contingent claims.
– Corporate-issued contingent claims include rights and
warrants, which allow the holder to purchase common
stocks from the corporation at a set price for a
particular period of time
 Securities
• 5. Indirect investing
– The purchase of a shares of an investment portfolio
– A mutual fund holds a portfolio of securities, usually in
line with a stated policy objective.
– Unit trusts invest depositors' funds in bonds or
equities. Size is determined by inflow of funds.
– Investment trusts Issue a certain fixed sum of stock
to raise capital. This fixed capital is then managed by
the trust. The initial investors purchase shares, which
are then traded on the stock market
– Hedge funds actively manage deposits in large sum
of money. Trade in all financial markets, including
derivatives.
 Return
end - of - period wealth -- beginning - of - period wealth
Return 
beginning - of - period wealth

V0 Initial value of investment

V1 Final value of investment

V V
Return is r 1 0
V0
V1  V0
Or as a percentage r  100
V0
 Return
• Example 1
– An initial investment is made of 10,000. One year
later, the value of the investment has risen to 12,500.
The return on the investment is
12500  10000
r 100  25%
• Example 2 10000
– An investment initially costs 5,000. Three months
later, the investment is sold for 6,000. The return on
the investment per three months is
6000  5000
r  100  20%
5000
 Return and Risk
• The risk inherent in holding a security is the
variability, or the uncertainty, of its return
• Factors that affect risk are
– 1. Maturity
• Underlying factors have more chance to change
over a longer horizon
• Maturity value of the security may be eroded by
inflation or currency fluctuations
• Increased chance of the issuer defaulting the
longer is the time horizon
 Return and Risk
– 2. Creditworthiness
• The government of Pakistan and other countries
are all judged as safe since they have no history of
default in the payment of their liabilities
• Some other countries have defaulted in the recent
past
• Corporations vary even more in their
creditworthiness. Some are so lacking in
creditworthiness that an active ''junk bond'' market
exists for high return, high risk corporate bonds
that are judged very likely to default
 Return and Risk
– 3. Priority
• Bond holders have the first claim on the assets of
a liquidated firm
• Bond holders are also able to put the corporation
into bankruptcy if it defaults on payment
– 4. Liquidity
• Liquidity relates to how easy it is to sell an asset
• The existence of a highly developed and active
secondary market raises liquidity
• A security's risk is raised if it is lacking liquidity
 Risk and Return
– 5. Underlying Activities
• The economic activities of the issuer of the security
can affect how risky it is
• Stock in small firms and in firms operating in high-
technology sectors are on average more risky than
those of large firms in traditional sectors
 Return and Risk
• The greater the risk of a security, the higher is
expected return
• Return is the compensation that has to be paid
to induce investors to accept risk
• Success in investing is about balancing risk and
return to achieve an optimal combination
• The risk always remains because of
unpredictable variability in the returns on assets
 The Investment Process
• A description of the process is:
– 1. Set investment policy
• Objectives
• Amount
• Choice of assets
– 2. Conduct security analysis
• Examine securities (identify those which are mispriced?)
Use
• a. Technical analysis – the examination of past prices for
trends
• b. Fundamental analysis – true value based on future
expected returns
 The Investment Process
– 3. Portfolio Construction
• Identify assets
• Choose extent of diversification
– 4. Portfolio Evaluation
• Assess the performance of portfolio
– 5. Portfolio Revision
• Repeat previous three steps