BUS 394 Final

What are league tables and why are league tables important in investment banking?

"League tables" is the way that the investment banking industry keeps track of underwriting participations by all banks and this becomes a basis for comparing banks' underwriting capabilities- there is one for every different type of security and geographic region.

What is a key consideration in determining the cost and other parameters of a corporate debt offering and why is it important?

*** The issuer's credit will determine if they are an investment grade or a non-investment grade issuer.

What are two key considerations for bankers in the debt capital markets division when working with an issuer on an offering?

**** Of critical importance is the determination of the likely impact that a new debt offering will have on the company's credit ratings. This can affect its future cost of capital. Additionally, Debt Capital Market Bankers gauge investor reaction to a potential offering, decide timing, maturity, size, covenants, call features, and other aspects of debt financing.

Class notes pre/post 2008

- Pre 2008, compensation kept going up and up -before bankers would pay equity researchers bonuses if they could go on trips with them... now they can't communicate - dodd frank said companies must bring down leverage and not do as much investing as PE/hedgefunds (this brought ROE and compensation down)

corporate capital structure (raise cash through)

- debt issuance (public or private bonds, loans or securitization) - equity-related issuance (public or private share issuance, convertibles, or preferred shares) - selling assets (M&A) - decrease capital expenditure - cut dividends or eliminate share repurchase

Collaterlized Debt Obligations (CDOs) (from class notes)

- government backed - CDO designed to bring money to people so they could buy homes - in 2008, housing market crashed and people couldn't pay mortgages - CDO like a bond. Rated AAA or whatever. - explanation: bankers didn't ask about employment (they didn't care because they passed risk onto IBs)

Capital Markets Financing

- long-term funding obtained through the issuance of a security in a regulated market or through a private placement - can be debt, equity, or a hybrid - underwritten by investment banks (the banks take on risk when purchasing securities from an issuer and then reselling those securities to investors) or distributed by banks as a private placement on an agency or principal basis - In the US, a securities offering must either be registered with the Securities and Exchange Commission (SEC) through a registration statement ( a portion of which is called a "prospectus") or sold as a private placement pursuant to an exemption from this registration requirement

corporate capital structure (reduce cash through)

- share repurchases (open market, auctions, or derivatives) - asset acquisitions (M&A) - retire debt, convertibles, or preferred shares - increase capital expenditure - dividend payments (quarterly small payments or one time large special dividend)

IPO Pricing

-An investment bank determines the expected value of the company based on comparisons with publicly traded comparable companies or values derived through other methods (including DCF analyses) -This is an imperfect process that requires analysis of both historical operating earnings and revenues and forecasts of future earnings and revenues -In order to encourage investor interest in an IPO company that does not have a track record as a public company, typically, bankers will set an IPO price at a discount to the determined value

financing considerations

-Bankers focus on liquidity (cash balances, marketable securities, and available lines of credit), cash flow multiples, cost of capital and rating agency considerations before recommending whether a client should raise financing and, if so, whether it should be in the form of debt, equity or a hybrid security like convertibles -Bankers also analyze liquidity as a percentage of market capitalization, total debt, annual interest payment obligations and other balance sheet and income statement metrics

What is a shelf registration statement and what securities can be included in it?

A shelf registration allows a company to file one registration statement that covers multiple issues of different types of securities. Once accepted by the SEC, the company can have multiple offerings of several types of securities over a three-year period, as long as the company updates the registration with quarterly financial statements. Securities of any public capital markets financings, such as equity offerings, debt, and convertible securities can be included after a shelf registration statement is made.

Why was Lehman Brothers allowed to collapse while Bear Stearns was not?

After Bear's bailout, people became angry over taxpayers' assumption of $29 billion in potential Bear losses. The FED, therefore, could not justify another bailout without political repercussions and refused to back Lehman's liabilities. Without the FED's backing, other financial institutions doubted Lehman could make good on their trades and obligations, so they dropped out of any potential deal to acquire the company.

Principal Businesses of IBs (asset management)

Asset Management Business- -offers equity, fixed income, alternative investments, and money market investment products and services to individual investing clients -for alternative investment products, the firm coinvests with clients in hedge funds, private equity, and real estate funds

Equity Capital Markets (ECM)

Equity Capital Markets (ECM) refers to a broad network of financial institutions, channels, and markets that together assist companies to raise capital. Equity capital is raised by issuing shares in the company, publicly or privately, and is used to fund the expansion of the business.

A goal of many parts of U.S. regulatory legislation has been to eliminate/minimize conflicts of interest between issuers, investment banks, and investors. Provide examples of conflicts of interest in the U.S. investment banking industry and the corresponding regulations that attempted to resolve those issues.

Example 1: Investment banking divisions and equity research groups within the same bank, resolved by the Global Research Settlement in 2003. Example 2: Fraudulent information about sale of securities between investment banks and issuers and investors, Securities Act of 1933 required information be released about securities Example 3: Banks incentive to be involved in bankruptcy proceedings. Suspicion that banks were using bankruptcy accesses to make excessive profits: resolved by the Chandler Act in 1938.

Trading Division (FICC)

Fixed Income, Currencies and Commodities (FICC) business: -Interest Rate Products: foreign exchange, government bond trading, and interest rate derivatives - Credit Products: corporate bonds (investment grade, high yield and distressed debt securities), mortgage-backed securities, asset-backed securities (credit card receivables, automobile loans, computer leases, trade receivables, etc), structured credit and credit derivatives -Commodities products: contracts on commodities are traded in the energy (electricity, natural gas, and oil) and metals (precious metals and base metals) - Research

Describe the function of the equity capital markets group, including the two major divisions they directly work with and the two types of clients they indirectly work with.

Function: Equity Capital Markets Groups help private companies determine if an IPO of stock is a logical decision based on an analysis of benefits and disadvantages. Then, determine if there is sufficient investor demand to purchase new equity securities offered by the company. Then, the investment bank determines the expected value of the company based on comparisons with publicly traded comparable companies or values derived through other methods. Major divisions (directly): Groups work directly with companies prepping for primary market transactions. Major divisions (indirectly): They indirectly work with institutional clients as well as the issuing companies themselves.

Leverage during 2008

GS - 26x; Lehman - 31x; Merrill - 32x; MS - 33x; Bear- 34x

The Five Pure Play Banks

GS, MS, Merrill Lynch, Lehman brothers, Bear Stearn

Describe the unique process utilized by Google in its IPO, intended advantages and potential disadvantages.

Google was determined to IPO using a Dutch Auction, in which potential investors weigh in with bids, listing the number of shares they want and how much they are willing to pay for those shares. Bids are then ranked with the highest price at the top. And then, going from the highest price down, the market price is established in which all the shares that can be sold will be sold at the lowest price offered. Advantages: It guarantees the greatest distribution to retail investors. Disadvantages: It removes the opportunity to receive a large allocation directed by the book-runner. The commissions received in the underwriting would also be considerably less for investment bankers.

Before an SEC registration statement is declared effective, companies (or their underwriters) that sell stock or are deemed to be promoting the sale of stock have a securities law problem. What is this problem called and what are its consequences?

Gun Jumping: May result in an SEC imposed "cooling off" period, rescission rights to purchasers in the public offering, and class action or other litigations

gun jumping

Gun-jumping flouts the rule that investors should make decisions based on the full disclosure available to the public in the prospectus, not on information disseminated by the company that has not been approved by the SEC. If a company is found guilty of jumping the gun, its IPO will be delayed.

Principal Businesses of IBs (IB)

IB business- Arranges financings for corporations and governments: debt, equity, convertibles...advises on M&A transactions

Key problems in 2008

IBs were over-reliant on short-term financing (repos and CPs) IBs were overleveraged IBs suffered large mortgage securities related losses in their proprietary trading, underwriting and asset management areas

Equity Offerings

IPO -When a company sells stock to the public for the first time in an SEC-registered offering, this is an Initial Public Offering (IPO) Follow on Offerings -Subsequent sales of stock to the public by the company are called "follow-on" offerings Secondary Offerings -Selling shareholders can sell shares using the company's registration statement, which is called a "selling shareholders" or "secondary" offering, with proceeds received by the shareholder and not the company -The difference between the purchase and sale price of a securities offering is called the "gross spread" and represents compensation for the bank for undertaking a distribution effort and certain legal risks

LTCM and Bear

In 1998, LTCM took on two much leverage and blew up. FED was worried because other IB banks connected would struggle and have a financial crisis. So, banks saved LTCM by bailing them out. Bear didn't help- (they typically didn't have cohesion with other banks because they recruited scrappy people). In 2008, Bear had a lot of CDOs. When they needed help no one wanted to buy them. Finally JP was asked and they worked out an arrangment with the FED to give them a $30 billion safety net.

Describe the forms of risk that an investment bank must consider in relation to acquisition and underwriting transactions. Describe what it means for a firm to set aside capital when it completes underwriting transactions.

In relation to acquisition and underwriting transactions, the bank takes on capital and reputation risk. Capital risk is the potential of financial losses a bank can incur from providing loans to the merged companies. Reputation risk is the damage that can be done if a consummated deal has a poor outcome. This may hinder a bank's ability to garner future revenues from future investment banking deals. Banks set aside capital in a risk-free security proportionate to the risk they take in a specific deal.

Could any one of the investment banks have remained competitive without following theindustry trend of taking on increasing amounts of leverage to boost returns on investment? Ifso, how?

In the short term, it would have been difficult for Investment banks to remain competitive without taking on increasing amounts of leverage to boost returns and achieve the high ROE's posted by other banks. They would not have looked as profitable as others who were taking on more risk. It was possible, however, for some banks to sacrifice short term results and excess risk by focusing on advisory businesses that didn't require as much capital or leverage. This would have proven to be a better long term strategy as they wouldn't have incurred the same level of losses that other banks incurred.

Global Research Settlement (2003)

Investment banks were required to comply with significant restrictions relating to interaction between the Investment Banking Division and the equity research department (part of the Trading Division) -No influence on research opinions or coverage -No payment of compensation or influence on promotion -Restriction on communications The practice of "spinning" hot IPOs is restricted

Describe the role of equity research at JPMorgan in the transaction. How has the role ofequity research changed since 2003?

Investment ideas originate from a bank's equity research analysts. Institutional salespeople are tasked with informing the bank on investment opportunities. In this case, JPMorgan's analyst team was barred from providing investment opinions on FCX. This was a change made since 2003. In 2003, the SEC mandated the separation of research and investment banking and also prohibited compensation to equity analysts from investment banking deals. Prior to 2003, these mandates were not in place.

M&A products (buy side assignment)

Involves the purchase of a company; lower priority since lower probability of completion

M&A products (sell side assignment)

Involves the sale, merger, or disposition of a company; highest priority since higher probability of completion

What are the "Risk Factors" in a prospectus? Why are they important to the issuer and to the investor?

It is a section that highlights the specific risks an investor faces. They're important for the investor to understand the risks they might be facing in investing in the security and the company. The issuers use the section to specify risks and provide transparency to potential investors. This covers the bases of the issuers. (risk related to a borrower's default and to compliance and regulatory requirements) (potential problems including possible losses, unpredictable revenue, capacity constraints, reliance on suppliers, technological change, competition, litigation regulation, customer mix, etc)

Could Morgan Stanley and Goldman Sachs have survived without becoming bank holding companies? What were the benefits and disadvantages of becoming bank holding companies? What does designation as bank holding companies mean for the way Morgan and Goldman operate going forward?

It would have been difficult for Morgan Stanley and Goldman to survive had they not become bank holding companies. Becoming a bank holding company allowed them to gain easier access to credit by borrowing from the FED against all forms of collateral. Because they are now subject to great regulation and capital requirements, leverage ratios will remain lower as will returns on equity. That was the price they paid for being given a safety net to survive the financial crisis.

Why do you think JPMorgan and Merrill Lynch were selected to underwrite and book-run all$23.3 billion in financings (all debt, common stock, and convertible), instead of sharing theunderwriting with additional firms?

JPMorgan and Merrill Lynch were involved every step of the way. Typically banks run a "bake-off" to determine which banks to work with but because of the amount of risk JPMorgan and Merill Lynch took in the deal and the established ties FDX had to them, FCX decided to grant JPMorgan and Merrill Lynch all buisness from the deal. Additionally, both companies placed very high in league table rankings for US convertibles and common stock underwriting, and most importantly, for this deal, the leveraged loan business. Both banks were able to deliver soup to notes financing, distribution, and capital raising ability. There was no need to turn elsewhere.

List the three types of bank participants in an underwriting syndicate and their core responsibilities, in order of compensation received, from high to low.

Lead bookrunners - they have the responsibility for determining the marketing method and the pricing for the transaction and, therefore, receive the highest underwriting allocation and a proportionately higher percentage of the gross spread. Co-managers -they take on smaller underwriting allocations and provide minor input to the bookrunners on marketing a pricing issues, and have less risk and less work to, and so receive lower compensation Selling group - these banks don't take any financial risk and receive even lower compensation

Both Bear and Lehman bailed out their proprietary hedge funds. Did they have any otheroption? What would have happened had they not done so?

Lehman and Bear bailed out their proprietary funds, so the lenders to the funds wouldn't seize the assets of the fund. Had they not done so, a negative perception of the banks would have ensued. When investors lose confidence in a bank's ability to remain solvent, a run on the bank can occur.

New landscape

Leverage ratio dropped 30x to 11x Return on Equity dropped >25% to <12% Short term borrowing from repos and CPs were reduced risk based capital increased proprietary trading reduced more regulations access to discount window and FDIC guarantees

What happened to MS, GS, Merilll, JP, etc after 2008

MS/GS --> conversion to bank holding companies JP --> acquired Bear Sterns Lehman --> filed for bankruptcy (sold US operations to Barclays and asia business to Nomura) Merrill Lynch --> sale to Bofa

What does the Dodd-Frank Act of 2010 mainly focus on?

Mainly focused on protecting consumers. Ending TBTF bailouts. Improving coordination between various regulatory agencies. Identifying systemic risk early. Creating greater transparency for executive compensation.

Pure Play Investment Bank

Only focused on banking, trading, and asset management note: if you aren't taking deposits you aren't regulated by FED so the SEC was only regulator of pure play banks

What type of securities offerings do not need to be registered with the SEC?

Private Placements- these securities are not offered or sold in a public offering.

What type of U.S. securities offerings do not need to be registered with the SEC?

Private offerings to a limited number of persons or institutions Offerings of limited size Intrastate offerings Securities of municipal, state, and federal governments

What conflicts might exist as a result of having both an Asset Management business and a Private Wealth Management business?

Private wealth management clients may be encouraged to invest in funds managed by their own banks's Asset Management. The bank can also co-invest in the funds that are managed by the Asset management.

M&A products (Hostile Defense)

Raid defense: defense against a specific take-over proposal Anti-raid preparation: work to deter future unsolicited take over activity Advice to hostile bidders: strategic and tactical advice on initiating an unsolicited takeover

Why might an investment bank place higher priority on sell-side M&A engagements over buy-side engagements?

Sell-side M&A engagements have a higher probability of completion. As fees are typically paid to M&A bankers only upon successful completion of a transaction, there is greater incentive alignment with sell-side engagements compared to the buy-side.

What is the significance of the Gramm-Leach-Bliley Act of 1999 in relation to the securities industry?

The Act overturned the mandatory separation of commercial banks and investment banks required by Glass-Steagall. It's also referred to as the Financial Services Modernization Act. The argument behind the act was that it would create a more stable business model, regardless of the economic environment. (had to operate under a holding company structure)

Investment Company Act of 1940

The Act's purpose is "to mitigate and... eliminate the conditions... which adversely affect the national public interest and the interest of investors" -Specifically, the Act regulates conflicts of interest in investment companies and securities exchanges -It protects the public primarily by requiring disclosure of material details about the investment company and also places some restrictions on mutual fund activities such as short selling shares -However, the Act does not include provisions for the SEC to make specific judgments about or even supervise an investment company's actual investment decisions -The Act requires investment companies to publicly disclose information about their own financial health

Compare the regulatory bodies of the four countries covered in this chapter.

The Financial Supervisory Agency in Japan, the Financial Services Authority in the UK, and the China Securities regulatory commission are the sole financial regulators in those countries (centralized). In the US, the two main regulators are the Fed and the SEC (US is more fragmented). In addition, entities such as the Commodity Futures Trading Commission and the FDIC also have regulatory powers (US even more fragmented).

Who are the clients of the institutional sales team at JPMorgan? What is meant by a "limit order," and what is its impact on the sales function? Describe the role of an Equity Capital Markets Syndicate group.

The clients of the institutional sales team include portfolio managers of large asset managers such as hedge funds, pension funds, mutual funds, and insurance companies. The limit order is the highest price an investor would be willing to pay for a stock. While the bank wants to price the stock as high as possible, they do not want to ignore large investors, so the sales function is impacted by a combination of all investors' limit orders. They are essentially looking for the clearing price for where buyers and the seller are satisfied with the price. In banking deals, the Syndicate group monitors the price of an issue taking into consideration the price buyers are willing to pay versus what the company is willing to sell at.

Describe the role and importance of credit rating agencies in the Freeport-McMoRan transaction. Which group within an investment bank has the primary responsibility to work with companies regarding rating agency considerations?

The debt capital market group has the responsibility of working with companies regarding rating agency considerations. In the Freeport McMcRon case, in order to syndicate the bridge loan to raise capital to complete the transaction, the debt market group worked with credit rating agencies to attain the highest rating for the bond offering. The better the rating, the lower the interest rate would be on the financial loans. Over time, the credit ratings for FCX bonds improved due to better than expected cash flow and a $5 billion equity raise, which significantly improved the balance sheet and capital structure.

Benefits of CP and repo funding (during normal markets)

cheap, liquid, flexible and, substantial earnings power in upward sloping yield environment when use to purchase long term assets

Trading Division (equities business)

common stock, convertible securities

roadshow

for the company to discuss the prospective offering with investors and an internal presentation to sales professionals to get them ready to sell the offering

Risks of CP and repo funding

refinancing risk and asset/management liability mismatch, resulting in potential bankruptcy threat if need to sell unfunded assets because can't replace short-term funding

private placements

a sale of stocks, bonds, or securities directly to a private investor, rather than as part of a public offering. (ex: if dad buys potbelly stock directly from them without doing it over public exchange)

Financial Crisis Regulatory Reform

---Enhancing Risk Assessment and Measurement -Regulators are correcting faulty risk-measurement methods, including analysis of stressed asset valuations -Default and migration risk of counterparties in trading businesses will be better recognized -Derivative positions require longer margin periods and higher risk weights if not cleared with central counterparties ---Strengthening the Capital Base -Regulators scrutinizing core equity to make sure it is fully available to creditors in case of default - More narrowly defining Tier 1 to be principally common shares and retained earnings - Hybrid capital instruments will no longer be eligible for Tier 1 status unless satisfy strict criteria - Tier 1 capital will be reduced by unrealized gains and losses, net deferred taxes, defined benefit deficits, minority interests and goodwill ---Imposing a Maximum Leverage Ratio ---Setting a Global Standard for Minimum Liquidity ---Accounting for Systemic Risks ---In addition to the general initiatives that are common to most countries, certain regulatory regimes are also focusing on the following: -Realignment of bank business models, restricting size and activities of individual banks -Separation of deposit taking banks and investment banks Forced divestitures of hedge fund and private equity investment businesses -Prohibition of proprietary trading activity

Convertible Bond Example

-A company issues a $100 million convertible with a seven-year maturity and a 3% annual coupon. Investors are given the right to receive either $100 million repayment at maturity or, at their option, give up receipt of this cash amount in exchange for receiving a predetermined number of shares of the issuer's common stock -On the date of convertible issuance, the company's stock price is trading at $25, and the company agrees to a "conversion price" for the convertible of $31.25, which is 25% above $25. This percentage is called the "conversion premium," because the conversion price is set at a premium (in this case, a 25% premium) to the company's share price on the date of convertible issuance -The conversion price determines the number of shares that the investor has the right to convert into. This determination is made by dividing the total proceeds of the offering by the conversion price• The result, in this example, is $100 million / $31.25 = 3.2 million shares -Convertible investors, therefore, have a choice to make: either take $100 million in cash at maturity or give up the cash right in exchange for receiving 3.2 million shares anytime at or before maturity -If, for example, the issuer's share price increases to $45 at maturity in seven years, convertible investors might elect to give up the right to receive $100 million in cash in exchange for 3.2 million shares because the value of these shares would be 3.2 million x $45 = $144 million -In practice, most investors wait until maturity to make the conversion decision due to the value of the options embedded in the convertible, but they have the right to convert earlier.

Convertibles

-A convertible security is a type of equity offering, even though most convertibles are originally issued in the form of a bond or preferred shares -Most convertible bonds or convertible preferred shares are convertible anytime (after a three month period following issuance), at the option of the investor, into a predetermined number of common shares of the issuer -This is called an "optionally converting convertible" -The other type of a convertible is a "mandatorily converting convertible", where the investor must receive a variable number of common shares (based on a floating conversion price) at maturity (a mandatory receipt rather than an option to receive -The issuer's preference regarding equity content of the convertible determines whether the convertible will be issued as an optionally converting convertible or a mandatorily converting convertible -From the perspective of a credit rating agency, an optionally converting bond is considered to have bond-type characteristics since there is no assurance that the bond will convert into common shares and there is a fixed coupon payment obligation -As a result, when originally issued, an optionally converting bond weakens a company's balance sheet in almost the same way that a straight bond of the same size and maturity would (although the company's balance sheet will subsequently be strengthened if the convertible bond eventually converts into common shares) -By contrast, mandatorily converting convertibles (mandatory convertible), from a credit rating agency perspective, are considered to have equity-type characteristics -This is because there is certainty regarding conversion into common stock (and therefore no cash repayment obligation at maturity in the event of non-conversion) -Therefore, mandatory convertibles strengthen a company's balance sheet in almost the same way that a common share offering of the same size would

Underwriting

-A group, or "syndicate" of investment banks underwrites a securities offering -the issuer must decide which banks in the syndicate will act as the "lead book runners" of the transaction -These banks determine the marketing method and pricing for the transaction and, therefore, receive the highest underwriting allocation and a proportionately higher percentage of the gross spread

Green Shoe Option

-Allows an investment bank to sell short securities that are equal to 15% of the securities sold in a public offering (happens about 10 days after IPO) -For example, bank sells 100 shares for a company @ $100/share = $10,000 -Bank simultaneously sells short 15 company shares @ $100/share = $1,500 -If company's share price increases after the offering, the bank buys 15 shares from the company @ $100/share and delivers these shares to the short buyers -The company therefore sells 115 shares and receives proceeds of $11,500 -If company's share price decreases after the offering, the bank buys 15 shares from the market at, say, $99/share and delivers these share to the short buyers -These market purchases mitigate further downside price movement in the stock -If share price increases, the bank earns $11,500 x 2% gross spread = $230 -If share price decreases, the bank earns $10,000 x 2% gross spread = $200 plus trading profits of $100-$99 = $1 for each share sold short, so earnings of $215

Determining the type of financing

-An equity offering generally has a higher cost of capital than a debt financing and will likely cause a drop in earnings per share (EPS) for the issuer, which may negatively impact the company's share price -equity will strengthen the company's balance sheet and may lead to a higher credit rating, resulting in lower future debt financing costs and potentially higher long-term value -A debt offering usually has a lower cost of capital, but may weaken the company's balance sheet and reduce financial flexibility -Before issuing new debt, one must consider both the impact of debt on cash flow multiples (to determine if additional interest charges can be adequately covered by cash flow) and the likely impact on credit ratings -Risk-adjusted cost of capital, credit ratings, peer comparisons, equity and debt analyst views, and management comfort with the resultant balance sheet are all important considerations when determining whether to raise financing from debt, equity or convertible markets

Rational for issuing a convertible

-If a company wants to issue debt, they might consider a convertible bond rather than a straight bond in order to reduce the coupon associated with debt issuance -For example, if a company could issue a $100 million bond with a seven-year maturity and a coupon of 6%, that same company might be able to issue a convertible bond for the same amount and maturity, but with a coupon of 3% -The reason convertible bond investors might accept a coupon that is 3% lower than a straight bond coupon is because the convertible bond gives them the option to receive a predetermined number of common shares of the issuer's stock in lieu of receiving cash repayment -If the value of the common shares that convertible bond investors have the right to receive does not exceed $100 million during the life of the convertible, they will generally not elect to convert the bond into shares and will therefore receive $100 million in cash at maturity in seven years -If the value of the shares exceeds $100 million on or anytime before maturity, investors may elect to convert the bond and receive shares

What are some securities regulations in place in the U.K., Japan and China that mirror U.S. regulations?

-Japan: Similar to the U.S. Glass-Steagall Act, Japanese regulators distinguished banks based on their business activities. Commercial banks were restricted from underwriting securities until 1999. In 2006, the financial instruments and exchange law which provides for registration and regulation of broker-dealers, disclosure obligations and internal controls in public companies. -UK: Securities Investment Board (SIB) is similar to the SEC, financial firms have to register with the SIB. -China: The Securities Law of 1998, there was a separation of banks engaging in deposit taking and securities activities. Also, China instituted anti-fraud and insider trading rules in 2005 similar to those in the US.

Following the 1929 Stock market crash, Congress passed a series of Acts to regulate the securities industries. Name four of these Acts and briefly describe their purpose.

-Securities Act of 1933: Require that investors receive financial information concerning securities being offered for public sale to prohibit deceit, misrepresentation, and other fraud in the sale of securities -Glass-Steagall Act of 1933: Separated commercial and investment banks and created the FDIC which insured depositors' assets in the event of a bank's default -Securities Exchange Act of 1934: Dealt with the supervision of new securities offerings, ongoing reporting requirements for these offers, and the conduct of exchanges. Created the SEC. -Investment company Act of 1940: Describe what constitutes an investment company and separates the functions of investment banks and investment companies.

Capital Markets Group

-The capital markets group is responsible for originating and executing capital markets transactions -They coordinate with client coverage bankers to target likely issuers and, with the syndicate desk and sales professionals from the Trading Division, determine appropriate potential pricing -Most capital markets financings shift price risk during the sales process to the issuer under a "best efforts" or "fully marketed" offering -Competitive pressures sometimes compel investment banks to undertake considerable risks, such as agreeing to a "bought deal" (also called "block trade"), where the banks take complete price risk in reselling the purchased security -Another risk that investment banks sometimes assume involves providing a large loan to a client as a "bridge" financing (to support an M&A transaction) prior to a subsequent "take-out" financing underwritten by the bank in the capital markets

proprietary trading

-The firm invests its own money in order to make a profit for itself. -Non-client related traders -Can compete with clients of the firm -Covered by sales professionals within same firm or competing firm

Disclosure of information to investors is another recurring theme in U.S. regulation of the securities industry. Provide examples of disclosure required by U.S. regulations.

-The investor Prospectuses: Description of company's properties and business Information about the management of the company Financial statements certified by independent accountants Securities cannot be distributed until after the issue had been resisted with the SEC -The Registration Statement: Before a security can be sold, certain info regarding the issuer and the security must be provided to regulators and prospective investors through a filing with the SEC

Glass-Steagall Act (1933)

-This Act separated commercial and investment banks and limited the underwriting capabilities of commercial banks -Officials of firms associated with security investments were restricted from serving as directors or officers of commercial banks -The Federal Deposit Insurance Corporation (FDIC) was founded by this Act to insure bank deposits

Securities Act of 1933

-Two main objectives: to require that investors receive financial and other significant information concerning securities being offered for public sale; and to prohibit deceit, misrepresentations and other fraud in the sale of securities -In general, securities sold in the U.S. must be registered with the Securities and Exchange Commission (SEC) (unless qualified for certain exemptions) and must provide a minimum required amount of information regarding the security -After a registration statement is filed with the SEC, an investment prospectus must be provided to investors

What are some major differences between the regulatory frameworks of the four countries covered in this chapter?

-US: One main difference is the US has somewhat fragmented and decentralized securities regulatory bodies, whereas in the other three countries, securities regulation is centralized. -UK: Self-regulation prevailed until 1986, until the Securities and Investment Board (SIB) was created to be a comprehensive government regulator. Financial firms have to register with the SIB unless they are SRO's. The SRO's were given enforcement powers (fines, censures, bans). SIB became the FSA in 1997 and combined the powers of all 9 regulatory bodies into a single regulator for the industry, removing the influence of SROs. Like the SEC, FSA rules are binding without any parliamentary Action. The UK is also subject to the EU banking and securities legislation as a member of the EU. -China: Originally had two commissions in 1992, the State Council Securities Commission and the China Securities Regulatory Commission. The SCSC deals with centralized market regulation whereas the CSRC is the enforcer of the regulations. These two entities merged in 1998 and became a direct entity of the state council, the head council of the Central People's Government of China. -Japan: Regulation differs in distinction of bank types and ownership structure of business.

What is a "Red Herring"?

A prospectus which, during the quiet period, oral or written offers can be made

Repurchase Agreements

A repo provides financing when a bank sells securities and agrees to repurchasing them the next day or week at a higher price

SEC Registration Process

-When a company files a registration statement with the SEC, this starts a "quiet period", which ends when the SEC declares the registration "effective", meaning that all required information is provided (which could take several days to several months, depending on the company) -The securities are priced and sold immediately following effectiveness -During the quiet period, the lead bank may conduct a roadshow -The company and bank are only allowed to discuss information provided in the prospectus with prospective investors in order to avoid the discussion being deemed an "offer to sell" securities, which is a "gun jumping" violation -For Well-Known Seasoned Issuers (WKIS filers), a registration statement may become immediately effective and usable for offerings, without SEC review, allowing the issuer, through the bank, to immediately make offers to sell after filing, which avoids the potential gun jumping problem

Dodd-Frank Act

-a law enacted in the aftermath of the financial crisis of 2008-2009 that strengthened government oversight of financial markets and placed limitations on risky financial strategies such as heavy reliance on leverage -16 titles, with regulators to interpret meaning over time -Title 1-Financial Stability: creates the Financial Stability Oversight Council and the Office of Financial Research (both attached to the Treasury Department) to identify threats to financial stability, promote market discipline and respond to financial risk -Title 2-Orderly Liquidation Authority granted to FDIC, Fed and SEC: provides authority to liquidate banks, depositary institutions and securities firms -Title 3-Transer of Powers to Comptroller, FDIC and Fed: streamlines banking regulation and reduces competition and overlap between regulators -Title 4-Regulation of Advisors to Hedge Funds and similar private fund investment advisers: increases reporting requirements and limits ability to exclude information reporting -Title 6-Improvements to Regulation of Proprietary Trading: incorporates the "Volker Rule" which limits bank proprietary trading activity (except with clients) and ownership of or investment in a hedge fund or private equity fund -Title 7-Wall Street Transparency and Accountability: regulates over the counter swaps, including credit default swaps, and encourages derivatives characterized as swaps to be traded through exchanges or clearinghouses -Title 9-Investor Protections and Improvements to the Regulation of Securities: revises the powers and structure of the SEC, credit rating organizations and the relationships between customers and broker-dealers -Title 10-Bureau of Consumer Financial Protection: creates the Bureau of Consumer Financial Protection -Title 11-Fed System Provisions: allows the Fed to establish standards for risk-based capital requirements, leverage, liquidity, credit exposure and concentration limits and to determine overall risk management

How do companies choose between bonds and loans?

-prepayable vs non-prepayable debt (loans are generally prepayable at anytime at pay, bonds are non-callable for some period of time, usually 4 to 5 years) - bonds usually have no covenants/agreements (incurrence covenants vs. maintenance covenants, usually less restrictive on incurring more debt) - loans require amortization -bond investors generally accept more risk and therefore receive higher returns -bonds have longer maturities -bonds are generally more expensive

Bank Holding Company

A bank holding company is a corporation that owns a controlling interest in one or more banks but does not itself offer banking services.

Why might a younger high-tech company select equity over debt when raising capital?

A high-tech company, that has a less certain future cash flow, will prefer an equity offering since there are no regular payments required in raising equity capital; it may not be able to generate the necessary cash to make regular coupon payments on debt capital. A young company that does not have the same credit reputation as older will have to pay more for debt financing- interest rates are higher and so raising debt capital will be more expensive.

EBIDTA

Earnings Before Interest, Depreciation, Taxes, and Amortization - companies with a lot of debt will then have interest to pay for this debt so it will be different

Why were proponents of deregulation so successful in the late 1990s? How much can we blame deregulation for the meltdown in the investment banking industry, and how could the government have foreseen and/or stopped the domino effect before the crisis of 2008?

Because of globalization trends, most US banks and their lobbyists successfully convinced lawmakers and regulators to ease many of the banking rules that came from the Glass Steagall Act. Permitting banks to offer both commercial and investment banking products allowed banks to be more competitive with its international competitors. This set the stage for banks to have the ability to be more flexible and diversify their business, including proprietary trading of riskier assets. Deregulation does not necessarily guarantee banks will make foolish decisions with regard to their capital- but it certainly allowed them to take on undue risk and increased leverage chasing profits This notion of taking more leverage to stay competitive was created by deregulation and played a large role in the meltdown in the investment banking industry. The government should have required that banks be more conscious of the risk they were taking and insist banks have higher capital ratios. By doing so, this would have minimized the risk banks were putting on their balance sheets.

Benefits and disadvantage of IPO

Benefits include -access to public market funding, enhanced profile and marketing benefits, creation of an acquisition currency and compensation vehicle and liquidity for shareholders Disadvantages include -SEC reporting requirements, costs associated with on-going reporting (including Sarbanes-Oxley), disclosure of sensitive information and short term focus by management to meet investor expectations in quarterly reports

type of bond underwritings

Best Efforts -the underwriters do not agree to purchase all of the securities from the issuer. Underwriters agree to use their best efforts to sell the securities and act only as an agent of the issuer in marketing the securities to investors. - comprises a majority of transactions - issuer of bond bears price risk - least expensive - market deal Bought deal - investment banks buy the bond at a certain rate -generally seen in competitive markets -investment bank bears the price risk (eliminates risk for issuer company) -the underwriter commits to buying the entire offering from the issuer company before a preliminary prospectus is filed Backstop commitments - rate is "backstopped" or committed to, but issuer will get the lower rate if it clears the market - investment bank commits to a worst case price

bridge financing

Bridge financing, often in the form of a bridge loan, is an interim financing option used by companies and other entities to solidify their short-term position until a long-term financing option can be arranged.

Commercial Paper (CP)

CP is unsecured financing that has a maturity of up to 270 (most CP matures in 90 days)

Investment bank clients can be categorized into two broad groups of issuers and investors. These two groups often have competing objectives (issue equity at highest possible price vs. acquire stock in companies at lowest possible price). Who within the investment bank is responsible for balancing these competing interests?

Capital Market Group

Assume the following fees were paid: M&A fee of 0.5 percent of the transaction value; debt fees of 0.75 percent on all debt and loan financing; equity fees of 3 percent on all equity and convertible financing. Calculate the estimated total fees for both JPMorgan and Merrill Lynch.Indicate whether you think these fees were justified and support your views. (17.5 bil in debt financing) (FCX purchased Phelps for 25.9 cash and stock) (5.8 bil in stock)

Debt Fee= (0.0075*17.5 billion)= $131,250,000 M&A Fee=(0.005*25.9 billion)= $129,500,000 Equity Fee= (0.03*5.8 billion)=$174,000,000 Total= $434,750,000 billion While the total fee is very high, the amount reflects the risk JPMorgan and Merrill Lynch took to finance this acquisition. They completed the acquisition successfully and FCX could not have done it without their assistance of financing (which was difficult). Given the successful completion of the transaction, I think the fees were justified.

Debt Capital Markets (DCM)

Debt capital markets (DCM) is a division of investment banking and a concept in corporate finance. As a concept, a debt capital market is a space for companies and governments to buy and sell debt as a way to raise capital or make a profit.

A BBB-/Baa3 rated company is looking at acquiring a smaller (but sizeable) competitor. Discuss considerations the company should take into account when deciding whether to fund the acquisition with new debt, equity, or convertible securities.

Debt- This company is barely investment grade rating, and so must seriously take into consideration the debt structure of the company that it is looking at acquiring. The company, when considering funding the acquisition with debt, will need to determine how much debt it can take on, since an increase in the debt may cause the debt offering rating to go below BBB-/Baa3 and thus become non-investment grade. Equity- If the company is considering an equity funding, then it must consider the dilutive effects of the equity offering, and thus the loss in shareholder value for each shareholder Convertibles- If the company would like to fund the acquisition with convertible securities, it must determine whether it would be better to issue optionally converting convertibles or mandatorily converting convertibles. This consideration is importance since, from a credit agency point of view, the optional convertible will exhibit bond-type characteristics (and may reduce the credit rating), whereas the mandatory convertible will exhibit equity-type characteristics

What is the role of states in the U.S. in regulating investment banks?

During the Great Depression, states were involved in the regulating issuance of new securities. By 1996, the National Securities markets Improvement Act effectively removed states from securities regulation of investment banks, expect for anti fraud matters

How much of the industry-wide crisis stemmed from the investment banks' financials and the current economic climate as opposed to investor panic and speculation?

The industry-wide crisis was caused predominantly by the banks foray into the subprime mortgage business and by bloating their balance sheets with risky assets. When the housing bubble burst, the banks were left with having to raise capital or receive bailouts to replace the write-offs on their balance sheets. With the meltdown underway, investors lost confidence in the market, looked to sell homes, equities, etc and withdrew capital from the system. This exacerbated an already leveraged environment. Financial environment vulnerable to investor panic and speculation. Rumors that investors were no longer honoring Lehman's trades contributed to Lehman's downfall. Lehman's reliance on repos dangerous as they require renewal and parties would not renew them due to distrust in Lehman's stability.

What was the role of the leveraged finance group at JPMorgan and why was its involvementimportant to the acquisition?

The leveraged finance group is in charge of all analysis behind the bridge loan. In this case, the bridge loan was important because it showed a strong commitment and more importantly, the ability of FCX to be able to follow through with the takeout of a larger player.

M&A products (mergers of equals (MOE))

The merger of two companies with equal assets that have comparable market value

What conflicts might exist between a proprietary trading business and the rest of the investment bank?

They can use internal information to make trades, though this is prohibited. Internalization of trade orders also can occur. Banks can also exploit inherent conflicts of interest in their trades. So, there are strict compliance guidelines that wall off proprietary traders from certain information that is available to the client-related service areas of the firm. Some firms even go further and completely wall off proprietary traders from any interactions with client-related sales and trading people within the firm.

Securities Exchange Act of 1934

This Act deals primarily with the supervision of new security offerings, ongoing reporting requirements for these offerings and the conduct of exchanges -Companies with >$10 million in assets and >500 owners must file annual and other periodic reports -Proxy solicitations and the acquisition of >5% ownership stakes in registered companies are subject to filing requirements -This Act created the SEC -Insider trading is prohibited by this Act

Gramm-Leach-Bliley Act (1999)

This Act overturned the mandatory separation of commercial and investment banks, as originally required by the Glass-Steagall Act -Following passage of this Act, large commercial banks significantly expanded their investment banking business -JP Morgan, Citigroup and Bank of America created the largest investment banking franchises among US commercial banks

What were the two main arguments for rejoining investment banks and retail deposit-taking banks that led to the passing of the Gramm-Leach-Bliley Act?

To provide for a more stable and countercyclical business model for these banks and to allow US banks to better compete with international competitors (i.e: UBS, Credit Suisse, and Deutsche Bank) that were less restricted by the Glass-Steagall Act.

Principal Businesses of IBs (trading)

Trading Businesses- -sells and trades securities and other financial assets as an intermediary on behalf of institutional investing clients, operates in two business units: fixed income, currency, and commodities (FICC) -provides research to investing clients - Make markets and clear on exchanges -Responsible for a limited amount of principal investments for the firm's own account and limited proprietary trading -Trade derivatives as well as underlying (cash) securities

M&A products (Joint Venture)

Two companies contribute assets and form a new entity to undertake economic activity together

Why might a universal bank be better able to compete against a pure-play investment bank for M&A and other investment banking engagements?

Universal banks also have commercial loan divisions making them more capable of providing more resources and products to their clients than a pure investment bank.

Did the compensation structure of the investment banking industry encourage banking executives and employees to take on excessive risk to boost short-term profits? Why or why not?

Yes. The compensation structure rewarded bankers and employees for taking on excessive risk to boost short-term profits of the business. As all the risk fell on the institutions themselves, individuals were in a position to reap the rewards without taking on any financial individual risk themselves.