IB FINAL EXAM
Q4. How have recent modernizations by the NYSE helped eliminate the problem of front running?
The NYSE has moved to eliminate a specific system of specialists and replaced them with designated market makers (DMM's) which eliminated the issue of front running because DMM's do not get a first look at the electronic orders and thus cannot trade knowing that a big order is going to be placed
Which of the following companies would make a better LBO target, and why? (a) a diversified manufacturer of consumer snack products or (b) a manufacturer of factory automation equipment for car makers, agricultural equipment and other heavy machinery.
● (a) would be a better LBo target because selling snack products have a steadier cash flow and the diversified products can be easily divested in the event that more cash needs to be raised to pay off debt more quickly. Lower capex too.
Q8. An investor lends 10,000 shares of ABC for two months when the stock is at $50 and requires 102% cash collateral. The market interest on cash collateral is 4.0%. The rebate rate on ABC shares is 2.5%. Calculate the combined profit for the stock lender and investment bank.
● 10,000 shares * $50 = $500,000. 102% cash collateral = $500,000 * 1.02 = $510,000 ○ (510,000 * 0.04)/6 = $3400 ○ (510,000 * 0.025)/6 = $2125 ○ Combined profits = 3400 - 2125 = 1275
Q3. Why are revenue synergies typically given less weight than cost synergies when evaluating the combination benefits of a transaction?
● Revenue synergies should be discounted from management's projections since they are very difficult to capture, though cost-synergies are generally easier to forecast since cost-structures typically do not regularly and drastically change.
Q3. How are the different functions of the sell-side versus the buy-side manifested through their fee structures?
- Sell-side collects fees through an indirect approach as a part of the commission for selling a security to a client, which is then relocated to the research department - Buy-side was initially against a direct fee for research as it would lower their investment return. However, the model changed in 2006 coming to terms with many investment banks that allowed a separate fee while simultaneously reducing fees. Research receives revenue from investing clients through an indirect mechanism: part of commissions paid by investors to sales professionals when they buy securities is redirected to the research department This "soft dollar" compensation is key because investors are reluctant to pay direct fees for the use of research.
Q1. 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?
1. To provide for a more stable and countercyclical business model for these banks 2. To allow US banks to better compete with international counterparts like UBS, Credit Suisse, and Deutsche Bank
Q4. If company A and B are identical in every respect except B has higher stock price volatility, which company would likely achieve better convertible pricing? Assuming convertibles issued by A and B have the same terms except for conversion price, would the company you selected above have a higher or lower conversion price?
A. B will have better convertible pricing because it has higher stock price volatility. And convertible arbitrageurs are willing to accept higher conversion price for B
Q2. Why are most corporate Eurobond issuers large, multinational corporations?
A. Because these bonds are not issued with any regulator, interest income from these bonds is exempted from withholding tax and is in a market that is self-regulated. All attributes that a large multinational corporation would be looking for to issue bonds.
Q7. A U.S.-based BBB-rated company is looking to make a large acquisition. Management believes synergies from the acquisition will create new market opportunities. Unfortunately, these new opportunities will take a few years to realize and until then, benefits will not be fully reflected in the company's stock price. If the company has rating agency concerns and wants tax deductions from interest payments, what type of security is this company likely to issue in support of its acquisition and why?
A. Unit-structure mandatory convertibles: a) Tax deduction on interest payments b) 50%-70% equity credit - address rating agency concerns, strengthen balance sheets
Q10. Assume a company's ADTV is 240,000 shares. How many days would it take to complete a 10.8 million share repurchase program? The company has 120 million shares outstanding and its estimated EPS for the current fiscal year is $3.40. Assuming the company meets its earnings estimate, what would year-end EPS be under an ASR program for the full 10.8 million shares, assuming it is executed 20 business days before the company's fiscal year end? Under an open market repurchase program?
A. 10,800,000 / (240,000*0.25) = 180 days (3.4*120M) / (120M - 10.8M) = $3.74 (3.4*120M) / (120M - 240,000 *0.25*20) = $3.43
Q9. What is ASR an abbreviation for? Describe this transaction and the principal benefit for a client? What additional benefit did IBM achieve in their ASR?
A. ASR stands for Accelerated Share Repurchase program. This is accomplished by a contract under which a company purchases a large block of its shares from an IB at the closing market price on the date of the purchase, with a cash adjustment to follow at the end of the contract. IB borrows the shares it sells to the company from existing shareholders, creating a short position, which it covers through daily open market purchases that are limited to 25% of the company's ADTV. Once IB purchases enough shares to cover its short position, the total cost for the purchases of shares over this period is determined. B. The principal benefit for a client is an immediate realization of EPS benefit of a repurchase program. IBM achieved an additional repatriation-related tax benefit in an ASR program.
Q3. Assume Hedge Fund A purchases a portion of Company B's convertible and will execute a delta hedge strategy. Describe the steps Hedge Fund A will take in the event the price of Company B's shares fall and explain the reasoning behind each action
A. As an example, assume a company's share price is $10 at the time of its convertible issuance. A hedge fund purchases a portion of the convertible, which gives the right to convert into 100 common shares of the issuer B. If the hedge ratio is 65%, the hedge fund may sell short 65 shares of the issuer's stock on the same date as the convertible purchase C. During the life span of the convertible, the hedge fund investor may sell more shares short or buy shares, based on the changing hedge ratio D. To illustrate, if one month after purchasing the convertible (and establishing a 65-share short position) the issuer's share price decreases to $9, the hedge ratio may drop from 65% to 60% E. To align the hedge ratio with the shares sold short as a percent of shares the investor has the right to convert the security into, the hedge fund investor will need to buy five shares in the open market from other shareholders and deliver those shares to the parties who had lent the shares originally F. "Covering" five shares of their short position leave the hedge fund with a new short position of 60 shares
Q6.Suppose you are a wealth advisor and a client has asked for your recommendation on which of the BRIC countries poses the least risk and most opportunity for investment growth. Briefly compare the perceived risks and benefits of each of the countries and provide support for your selection.
A. Brazil -Brazil's credit was upgraded in 2008 to Investment Grade status (BB-) enabling foreign pension funds to investment in Brazil for first time -IPO's are usually used for already established family-run companies -Foreign investors accounted for over half of IPO sales leaving the local IPO market susceptible to changes in conditions outside of its control B. Russia -Most large companies doing IPOs list in both Moscow and London, giving the company higher international exposure to investors -Russian regulations seem ambiguous and repel some investors -IPO market concentrated in few sectors: finance, real estate and energy leaving the market subject relatively undiversified and subject to the volatility of those few sectors -In 2007, one company accounted for nearly half of the IPO market C. India -Mumbai and National stock exchanges became 20% owned by foreign exchanges such as NYSE and Deutsche Boerse in 2007, thus benefiting from their management and regulatory practices -India has large pool of savings to provide future IPO capital -Average deal size of $83 million is much smaller than Brazilian or Russian markets -Foreign investors account for ¾ of IPO capital leaving market susceptible to changes in foreign conditions -Indian companies required to list in India, but most dual list in US or London D. China -Largest market for IPOs in 2007 (including Hong Kong) -Average deal size of about $250 million includes a high number of mid-sized IPOs rather than just mega-deals -Many restrictions on foreign and domestic investors- Chinese citizens can't by shares in Hong Kong
Q8. Why was the Nikkei Put Warrant program so profitable for Goldman Sachs?
A. By purchasing Nikkei Put Warrants at a below theoretical market cost from the Nikkei-linked bond issuer and delta hedging this risk position, Goldman created the opportunity for significant trading profits (buying when stock prices dropped and selling when they increased) that exceeded the Nikkei put warrant purchase cost. Goldman was able to succeed in this strategy because it had accurately estimated that the future volatility of the Nikkei 225 index would be higher during the delta hedging period than the implied volatility of the Japanese stock market at the time of the purchase of the Nikkei put warrants.
Q2. True or false (and explain your answer): Convertible arbitrage hedge funds invest in convertible bonds because the fund managers have a bullish view on the company's stock.
A. False. Convertible securities are generally sold at par, undervalued compared to their theoretical value, which is usually 102%-107%. So by delta hedging their investment, HFs should be able to make trading profits at least equal to the difference between the theoretical value and par. Convertible arbitrageurs invest in convertible bonds to monetize the volatility of the underlying stock, so they don't necessarily have a bullish view on it. B. Convertible arbitrageurs would profit from short positions if stock price goes down, and value of conv. shares won't decrease the much due to its fixed income nature. Value of conv. shares would also increase if stock price goes up.
Q5. WheelCo is raising $200 million via a mandatory convertible bond issuance. Assuming the company's share price on the date of issuance is $20 and the convertible bond carries a 25% conversion premium, what is the number of shares WheelCo has to deliver to investors if its share price at maturity is (a) $19; (b) $22, (c) $26, and (d) $30?
A. Floating conversion price for mandatory convertibles： B. a) $200M/$20 = 10M shares C. b) $200M/$22 = 9.09M shares D. c) $200M/$25 = 8M shares E. d) $200M/$25 = 8M shares
Q3. How has recent legislation accelerated the development of the Japanese M&A market?
A. In 2003, a new law passed that permitted non-Japanese companies to use their own stock to acquire Japanese companies that were under Japanese bankruptcy court protection B. Then again in 2007 they extended the ability even more of foreign companies to use their stock to acquire Japanese companies, as well as other laws that lowered the threshold shareholder approval requirement for an acquisition
Q5. In a comparable transactions analysis, what additional considerations might an investment banker factor in when valuing an emerging market company?
A. Incremental risks associated with investment banking businesses in these countries include, currency, political, liquidity, accounting, tax and volatility risk.
Q1. What are the benefits of issuing Eurobonds? Investing in Eurobonds?
A. Interest income from Eurobonds is exempt from withholding tax and the bonds are generally not registered with any regulatory body. Ex: US corporation domestic bonds are subject to the SEC oversight; its Eurobonds are not. B. Eurobonds can be issued in many forms, including fixed-rate coupon bonds, convertible bonds, zero-coupon bonds, and floating rate notes. C. The market is self-regulated and settled is completed through two global electronic depository systems. D. Eurobonds can also be issued in many different currencies. (U.S. Dollar, Yen, pound, etc.)
Q4. How has the Chinese government's relaxation of its foreign exchange controls helped facilitate growth in the Chinese economy?
A. It has allowed the renminbi (RMB) to become convertible into other currencies B. It helped create the Qualified Financial Institutional Investor program (QFII), which allowed qualifying foreign investors to participate in the Chinese equity market via domestic A-shares and in the Chinese debt market.
Q6. Suppose you are a current shareholder in a company that is contemplating capital raising alternatives. Assuming the transaction would have no negative credit repercussions and you want minimal EPS dilution, rank the following types of convertibles from least potential for dilution to most potential for dilution: coupon-paying convertible, mandatory convertible, zero coupon convertible.
A. Least to most potential for EPS dilution: zero coupon convertible < coupon-paying convertible < mandatory convertible i. ZCC: no coupon payment + tax deductions in relation to annual accretion = positive cash-flow bond financing; lower probability of conversion (higher principal at maturity) ii. Coupon-paying convertibles: tax deductions, optional convertible iii. Mandatory convertible: extent of dilution depended on share price at maturity
Q1. After an initial hedge is in place, what do hedge fund investors in convertible bonds do with shares of the underlying stock when the stock price increases or decreases?
A.When stock price increases, hedge fund (=HF) investors in convertible bonds short more shares of the underlying security (increase their hedge ratio). When stock price decreases, HFs buy shares to reduce current short position (decrease their hedge ratio).
Q1. What is the difference between asset management and wealth management?
Asset Management: Refers to the professional management of investment funds for individuals, families, and institutions Wealth Management: Refers to advisors who provide investment advice to selected individuals, families, and institutional investing clients Wealth management professionals create investment advisory relationships with investors and are NOT directly involved in the management of asset classes (that is the role of Asset Managers)
Q2. What is the difference between business risk and financial risk?
Business Risk - an analysis of the competitive position within the industry, diversity of product lines, and profitability compared to peers; inherent risks to the business Financial Risk - Includes accounting and cash flow financial flexibility as well as capital restructuring considerations; inherent risks to the finances of the business
Q2. Describe what a "Chinese Wall" is, which U.S. regulator would be concerned with issues involving the wall and what is meant by being brought "over-the-wall".
Chinese Wall is a legal and metaphorical separation of between traders and investment bankers within a firm. With the investment banking division having access to private, non-public information if a trader were to catch wind of that information, it would be insider trading. The SEC is concerned to ensure that no illegal insider trading taking place. If someone is brought "over the wall" they are given access to nonpublic information and they are not allowed to trade on it. The Chinese Wall is the dividing point of information.
Q1. Compare the different roles provided to the investor community by credit rating analysts and sell-side research analysts.
Credit analyst: Assign ratings to a company's debt, ratings are used by investors, banks and governments as an input into their decisions. Leads to increased market efficiency. Lower cost for borrowers, investors and lenders. Expands the total supply of capital. The issuer, not the investor must pay for the rating. Sell Side Research analysts: Provide research to investing clients of the firm, sell side research consists of building models to forecast a company's future earnings based on factors like company guidance, economic conditions, historical trends etc. Uses multiples based on revenue, EBITDA,book value cash flow to asses future share price. Research to attract clients to invest in securities. The role of a credit rating agency is to communicate unbiased opinions on creditworthiness of companies and their debt instruments to the investment community. Credit ratings reflect the issuer's creditworthiness (or the ability to repay a debt), which affect the interest rate applied to the security being rated. These ratings are used by investors, banks, and governments as an input into their investment, loan and regulatory decisions
Q2. Describe the three principal businesses of an investment bank.
Investment Banking Business: · Managed by Investment Banking Division · Focuses on capital raising and M&A transactions for corporate clients and capital raising for government clients o Arranges financing for corporations and government o Debt, equity, convertibles o Advises M&A Transactions Trading Business: · Managed by the Trading Division · Provides investing, intermediating, and risk management services to institutional investor clients, research, and participates in selected direct investing and lending activities o Sells and trades securities and other financial assets as an intermediary on behalf of institutional investing clients o Operates in two business units § Equity and Fixed Income, Currency, and Commodities (FICC) o Provides research to investing clients Asset Management Business: · Managed by the Asset Managment Division · Responsible for individual and institutional investing clients o Offers equity, fixed income, alternative investments, and money market investment products and services principally to individual investing clients o For alternative investment products, the firm co-invests with clients in hedge funds, private equity, and real estate funds
Q4. What drove the need to separate research and investment banking?
Investment Banking Division puts pressure on research analysts to modify negative views on a company when bankers were soliciting a financing or M&A transaction from a company. Negative equity or fixed income research can upset company management, making it problematic for bankers to obtain mandates. Positive research might motivate a company to award a financing or M&A mandate to the bank. Some bankers asked research departments to prioritize their research activities based on the IB Division's underwriting and M&A efforts, rather than on the firm's investing clients' priorities for objective research. Essentially causes a conflict of interest.
Q6. What are the objectives of Regulation FD? What are the concerns about this U.S.-based regulation?
Objectives: Prohibits a company's executives from selectively disclosing material information that could impact a company's share price. Prior to discussing any potential "stock moving" information with research analysts, the company must disclose the information through an SEC filing. This levels the playing field, enabling all investors to receive the same information at the same time. Concerns: Less information is distributed in a less-timely manner because companies must now be more careful about what they say to analysts and investors. The information is usually filtered through lawyers, which causes a dilution in the quality of information. Some investors feel that, as a result of Regulation FD, no one in the investment community has the same quality or depth of information they used to receive.
The NYSE has moved to eliminate a specific system of specialists and replaced them with designated market makers (DMM's) which eliminated the issue of front running because DMM's do not get a first look at the electronic orders and thus cannot trade knowing that a big order is going to be placed
Over the Counter (OTC) derivatives are securities and derivatives that are traded directly between two parties without an intermediary exchange. These trades are not made known to the public and typically remain confidential. These OTC's derivatives could be riskier in that they are done in private without the regulatory assurance of the public market. Due as well to exceptional growth the potential systemic risk posed by this market.
Q1. 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.
The Securities Act of 1933: · Meant to bring stability to capital markets and stop manipulative and deceptive practices in the sale or distribution of financial securities . The 1933 Glass-Steagall Act: · Separated commercial and investment banks and created the Federal Deposit Insurance Corporation (FDIC), which insured depositors' assets for up to $2,500 (now up to $250,000). · It required the industry to alter its operations and the structure of its firms, changed the process for distribution and underwriting of securities, and cut off a key source of capital for new security underwriting The 1934 Securities Exchange Act: · A supplement to the Securities Act of 1933 · Dealt with the supervision of new security offerings, on-going reporting requirements for these offerings, and the conduct of exchanges · Significantly changed the secondary market for securities by requiring minimal reporting standards and codifying rules for transactions · It required that exchanges be governed by self-regulatory organizations (SROs) · Created the SEC o Took over responsibility of supervising the capital markets, including supervision of investment banks ● Investment Company Act of 1940 ○ Determined what constitutes an investment company (best known as mutual funds) and separates the functions of investment banks and investment companies. Sets out restrictions on the number of investment bankers who can serve as directors of an investment company and restricts business transactions between investment banks and investment companies. ● The Sarbanes Oxley Act ○ Restoring confidence in the accounting profession, improving tone at the top, improving disclosure and financial reporting, improving performance of gatekeepers and enhancing enforcement tools.
Q5. How have the U.S. enforcement actions against sell-side research in 2003 heightened the issue of declining research revenues?
The U.S. enforcement required firms to comply with significant requirements, including eliminating any influence by the IB Division over the Research Department, increasing supervision, and making independent research available to investors. By eliminating the influence of the IB Division, the research department was cut off from fees that they would get from IB Division related activity.
Q1. What are core differences between Investment Banking and Sales & Trading career paths?
The entry points, career paths and compensation are generally the same in both divisions (Analyst, Associate, VP, MD) but bankers typically work much longer hours than the traders. Bankers can be on a number of deals at a time and often work over 100 hours a week, no to mention all-nighters and weekends. Traders may work 50-60 hours a week, but need to be on the trading floor early in the morning and their work is intense a Chinese Wall is a legal and metaphorical separation of between traders and investment bankers within a firm. With the investment banking division having access to private, non-public information if a trader were to catch wind of that information, it would be insider trading. The SEC is concerned to ensure that no illegal insider trading taking place. If someone is brought "over the wall" they are given access to nonpublic information and they are not allowed to trade on it. The Chinese Wall is the dividing point of information. nd loud which requires a lot of big decisions to be made before lunch.
Q3. What are the major criticisms directed at Moody's, Standard & Poor's and Fitch?
They have been heavily criticized for working with investment banks to create mortgage-backed securities that had higher ratings than they deserved and for not downgrading these securities earlier. Other complaints have risen from their relationship with corporations that issue straight bonds and other non-asset backed securities. It is suggested that agencies are susceptible to undue influence from corporations or are vulnerable to being mislead.
Q7. What steps have U.S. regulators taken to reduce the systemic risk associated with OTC derivatives?
US regulators promoted increased Federal regulations on the previously unregulated OTC market. New regulatory reforms attempt to increase transparency and promote market discipline by requiring many standard OTC derivative contracts to be cleared through regulated central counterparties. New reporting requirements were put in place to bring a higher level of disclosure across all major players in the derivatives market.
Q6. How is derivatives settlement different from securities settlement?
Unlike securities clearing in three days, derivatives often remain outstanding for much longer. A derivative represents an obligation or option to buy or sell a financial instrument or asset at a future date, which could be weeks, month or years in the future. Securities on the other hand are delivered and paid for simultaneously. Derivatives have substantially more complex risk to them than securities due to this lapse of time in proposal and settlement.
Q2. Why would a wealth manager choose to allocate some of a client's asset to another bank?
Wealth management advisors must exercise good judgement in allocating funds to achieve high investment returns and appropriate diversification relative to client risk objectives. Wealth management advisors have a duty to help clients achieve the best possible returns, even if it means directing a client to a competing bank. This is a potential conflict of interest because incentive systems are designed to keep all client investments within the bank, rather than see funds go to a competing firm.
Calculate the investment bank's fees and profit for a 5 million share equity offering at $40/share, with a 15% green shoe option (fully exercised) assuming a 2% gross spread, assuming the issuer's share price decreases to $38/share after the offering.
● 5 million shares $40/share= $200 million ● 2% underwriting fee = $4 million ○ total bank underwriting fee ● (5 million*15% greenshoe option)*$40=$30 million sold short ● (5 million*15%)*$38 = $28.5 ○ million how much what they sold short is now worth now that the share price has decreased to $38/share ● $30 million - $28.5 million = $1.5 million ○ profit bank makes on share price decreasing ● =$1.5 million + $4 million = $5.5 million
Q8. Why might a board want to include a "go-shop" provision in the merger/purchase agreement?
● A "go-shop" provision would allow a target company to "shop" its current deal with other prospective buyers, whereas a "no-shop" provisions will disallow this. A board will opt for a go-shop provision because it will encourage other potential buys, who may be competitors of the acquiring company, to be willing to pay more for the target company after seeing the viability of the company and the deal.
Q9. When is a break-up fee paid? What is the normal fee as a percent of equity value?
● A break-up fee is paid if a transaction is not completed because a target company walks away from the transaction after a Merger Agreement or Stock Purchase Agreement is signed. A reverse breakup fee is paid if the acquiring company walks away from a transaction after signing the agreement. These fees usually set at 2-4% of the target company's equity value, but is subject of considerable negotiation during the documentation process.
Q16. Explain what a "green shoe" is.
● A green shoe option gives an investment bank the right to sell short 15% of the shares the bank is underwriting. This creates a "naked" short position. Shares need to be bought following the initial offering
Q3. What are league tables and why are league tables important in investment banking?
● A league table keeps track of underwriting participation of all banks, and is a basis for comparing different banks underwriting capabilities. League tables are important in investment banking as it is how their clients can compare them. League table leaders are more attractive when seeking a bank as an advisor.
Q6. What is a shelf registration statement and what securities can be included in it?
● A shelf registration statement allows a company to file a single registration statement that covers multiple issues of different types of securities. Equity offerings, debt, and convertible securities can all be included in a shelf registration statement. It is filed at least annually.
Q7. Why might a high short interest ratio be potentially misleading with respect to the opinions of market participants regarding a particular stock?
● A short interest ratio can often outline market sentiment towards a particular stock, however, in situations like a short squeeze, short interest ratios should be interpreted with a grain of salt. This is because short sellers are covering their position by purchasing shares, which drives stock price up. This lowers the short interest ratio and raises the stock price, but does not necessarily mean that the market participants are any more bullish than before.
Q1. Provide definitions for strategic buyers and financial buyers in a prospective M&A transaction.
● A strategic buyer is a company whose business is currently in line with that of the company to be purchased. The strategic buyer would gain synergies from purchasing a company similar to itself because of similar operations and business. (Adidas acquired reebok)
Q3. Why might a universal bank be better able to compete against a pure-play investment bank for M&A and other investment banking engagements?
● A universal banks are more stable ● have counter cyclical business cycles ● Better to compete internationally ● Their larger balance sheet can also allow it to take on more risk in transaction
Q12. Provide seven reasons that an investment bank might give to support their advice that a private company should "go public".
● Access to the public market ● Enhanced profile and marketing benefits ● Creation of an acquisition currency and compensation vehicle ● Liquidity for shareholders ● IDK OTHER 3???
Q7. Assume an investment bank has provided a fairness opinion on a proposed M&A transaction. Does this mean the board should go ahead and approve the transaction?
● After a fairness opinion is provided, the board should not go ahead and approve the transaction since the fairness opinion is not an evaluation of the business rationale for the transaction, a legal opinion, or a recommendation to the board to approve the transaction.It is only a statement that shows the fairness of the transaction from a financial point of view from a summary of the valuation analysis conducted by the investment bank.
Q1. When might an investment bank decline participation in an underwriting and why?
● An investment bank may decline to participate in underwriting when the commitments committee assigned to determine the risk decide the firm will lose money or expose itself to significant risk for the underwriting
Q7. What are two key considerations for bankers in the debt capital markets division when working with an issuer on an offering?
● Bankers in DCM work closely with client coverage bankers to determine suitable corporate and government issuer objectives and help clients decide timing, maturity, size, covenants, call features, and other aspects of a debt financing. Of critical importance is determination of the likely impact that a new debt offering will have on the issuer's credit ratings and investor reaction to a potential offering.
Q10. Under what circumstances would an investment bank hold a public auction in an attempt to help sell a company?
● Believe business is unlikely to be damaged by public process ● Have difficulty identifying potential buyers
Q14. How does a negotiated (best efforts) transaction differ from a "bought deal"?
● Best efforts transactions is where the bank buys the entire issue at a discount, and then tries to resell at a higher price. The gross spread represents the compensation for the bank taking on the risk. ● A bought deal is when the bank buys the whole transactions at a specified price, and again, tries to sell at a higher price to other investors. ● The difference between these two transaction is who bears the risk. In a best efforts transactions, the issuer bears the risk, and in a bought deal, the bank bears the risk.
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.
● Capital Market groups originate and execute capital market transactions. They work directly with client coverage bankers and the syndicate desk. They work indirectly with issuers and investors. The capital markets group basically runs between the issues and the buyers of securities
Q12. Of the major valuation methods which one(s) are based on relative values? ...on intrinsic values? ...on ability to pay?
● Comparable company analysis and comparable transactions analysis are multiples-based methods for determining value in relation to a peer group of public companies and so are methods based on relative values. ● A DCF is a cash flow-based method of valuation which attempts to determine the intrinsic value of a company based on future cash flow projections. ● An LBO analysis attempts to determine an internal rate of return based on future cash flow projections and so is a valuation method based on the company's ability to pay
Q10. How many shares will be issued by a convertible issuer if conversion occurs for a $200 million convertible with a conversion premium of 20%, which is issued when the issuer's stock price is $25? (show your calculation).
● Current price*(1+Premium)=Conversion Price ○ Proceeds/Conversion Price=# of Shares ● 25*1.2=30 ○ 200mm/30=6.67mm
Q7. Why might a younger high-tech company select equity over debt when raising capital?
● Equity strengthens the balance sheet. A stronger balance sheet will lead to higher ratings, and permit further funding to be available in the future using cheaper debt. A young company may want to initially strengthen their balance sheet before issuing bonds.
FICC is one of the main Divisions in an Investment Bank. What does FICC stand for? Other than during 2007 and 2008, how does this division typically rank from a profitability point of view, compared to other Divisions? What happened during these two years and which part of the FICC Division was most responsible for this outcome?
● FICC stands for fixed income, currency and commodities. It historically had been the most profitable division in most investment banks. Since the FICC division handles collateralized bond obligations (CBO) and collateralized loan obligations (CLO), it suffered massive losses during the 2007 credit crisis. The risk in many CDOs in Mortgage-backed securities was underestimated and the result was heavy losses when the real estate bubble popped. These were part of the structured credit business.
Q5. Describe the unique process utilized by Google in its IPO, intended advantages and potential disadvantages.
● Google wanted their IPO to be done in a Dutch Auction fashion. This was designed to allow for a greater distribution to retail investors, by issuing stocks to the highest bidders. This process would also avoid some of the excess seen in an IPO. Investment bankers were concerned that this strategy would alienate the biggest clients, as they would hold no large advantage in claiming a large allocation of the IPO.
Q11. A domestic airline based in the U.S. has placed a large $10 billion order for new airplanes with French aircraft manufacturer Airbus. Delivery is scheduled in four years. Payments are staggered based on a percentage of completion rate. The U.S. airline believes the Euro will appreciate against the Dollar during this time frame. How can the U.S. airline hedge currency risk related to this purchase with an investment bank?
● Hedge 10 billion worth of puts on the dollar calls on the Euro against 10 billion. It is paying the French aircraft manufacture
Q6. What is a potential risk of trying to complete a stock-based acquisition during periods of high market volatility?
● In a stock-based acquisition, if a fixed exchange ratio, the number of acquiring company shares to be exchanged for each target company shares, is used, then high market volatility would greatly change the economic value of acquiring stock.
Q5. Why would a prospective issuer prefer to hire as underwriter an investment bank that has traders already active in its security?
● Issuers prefer traders active in its security because this can lead to more accurate pricing and higher trading-based revenue.
Q13. What does the Dodd-Frank Act of 2010 mainly focus on?
● It primarily focuses on placing the regulation of the financial industry in the hands of the government. It creates financial regulatory processes to limit risk by enforcing transparency and accountability
Q10. What are some securities regulations in place in the U.K., Japan and China that mirror U.S. regulations?
● Japan and China: Originally separated the functions of commercial and investment banks (these changes happened within a much shorter time frame for china). Later, like the U.S., those restrictions were eliminated. Also, various japanese laws requiring disclosure and internal controls in public companies were similar to those in the U.S. China instituted anti-fraud and insider trading rules in 2005 similar to those in the U.S. ● The U.K.: Also has an SRO system like the U.S.
. 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 Bookrunner: determine the marketing method and pricing for the transaction, highest underwriting allocation. ● Co-Managers: Provide minor input on marketing and pricing marketing and pricing, do small underwriting allocations. There are 1-7 co-managers ● Selling group: does not take on any financial risk, just sell
Q4. Explain traders' market-making function.
● Market making is the client-focused trading activities of large investment banks. It means that the bank will quote a client a bid price or an offer price on securities or derivatives at any time. Market making traders desire to capture bid-ask spread, difference between bid price and offer price in those transactions.
Q10. How were senior tranches of a CDO able to obtain investment grade credit ratings when some of the underlying assets were non-investment grade?
● Models used by rating agencies ● Failed to consider the possibility of a significant decline in housing prices across the countries ● Credit rating agency have investment grade rating to certain tranches
Q1. What type of securities offerings do not need to be registered with the SEC?
● Most bonds and convertible transactions are completed without registration with the SEC based on a Rule 144A exemption
Q4. In the U.S., if an M&A transaction is relatively large within its industry, what is the name of the regulatory filing that is probably necessary before the transaction can be consummated? Which agency is it filed with? How long is the waiting period after a filling is made? What is the name of the European regulator that may be relevant in an M&A transaction?
● Most large M&A transactions require a Hart-Scott Rodino (HSR) filing before the transaction can be consummated. I ● It is usually filed with the Federal Trade Commission 9 (FTC) and the Department of Justice (DOJ) ● The waiting period after a filling last for 30 days in which the FTC and DOJ may request further information. ● The European Commission is the European regulator that may require further filings in an M&A transaction.
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.
● Must disclose, summary informations, risk factors and ratio of earnings to fixed charges, use of proceeds, dilutions, selling security holders, plan of distributions, description of securities to be registered, interests of names experts and counsel... A description of the company's properties and business, a description of the security to be offered for sale, information about management of the company and financial statements certified by independent accountants
What is a key consideration in determining the cost and other parameters of a corporate debt offering and why is it important?
● 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.
Q11. What are some major differences between the regulatory frameworks of the four countries covered in this chapter?
● One main difference is the U.S. has somewhat fragmented and decentralized securities regulatory bodies, whereas in the other three counties, securities regulation is centralized.
Q4. What is the role of states in the U.S. in regulating investment banks?
● Only Anti-fraud matters
Q11.List the four principal alternative methods for establishing value in an M&A transaction.
● Preemptive ○ Where bankers will screen and identify the single most likely buyer and contact that buyer only ● Targeted Solicitation ○ Where bankers identify and contact the two to five most likely buyers ● Controlled/Limited Auction: ○ Where bankers approach a subset of buyers (6-20 potential buyers) who have been prescreened to be the most logical buyers ● Public Auction ○ Where the company publicly announces the sales process and invites all interested parties to participate
. Describe what Prime Brokerage is, including four principal products in this area and the generic name of the financial institutions that are targeted for this business.
● Prime Brokerage business is housed in the Trading Division and focuses principally on hedge funds and other clients who borrow securities and cash to support their investment business. ● In addition to lending, Prime Brokerage provide trade clearing, custody and settlement, real estate and computer assistance, performance measurements and performance reporting.
Q6. What is a "Red Herring"?
● Prior to reforms promulgated during 2008, oral and written offers by an issuer were prohibited during the waiting period. During the waiting period, oral or written offered, but not sales, could be made and any offers made in writing could only be made by means of prospectus that conformed to the requirements of the 1933 Act. The prospectus is typically called a red herring prospectus because of the legend on the first page that reminds investors that the information contained in the prospectus is preliminary.
Q5. 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, offering of limited size, intrastate offerings and securities of municipal, state and federal governments.
Q9. Suppose a company issues a $180 million convertible bond when its stock is trading at $30. Assuming it is convertible into 5 million shares, what is the conversion premium of the convertible?
● Proceeds/# of shares=Conversion Price ○ (Conversion Price-Current Price)/Current Price=Conversion Premium ● 180mm/5mm=36mm ● (36-30)/30=.2 ○ 20% Conversion Premium
Q8. Define proprietary trading.
● Proprietary Trading: making short-term, non-client related investments in securities, commodities, and derivatives for their own account ● · Proprietary investing activities used to compete directly with hedge funds for investing and hedging opportunities worldwide
Q9. What conflicts might exist between a proprietary trading business and the rest of the investment bank?
● Proprietary traders must be dealt with on an arm's length basis by internal sales people, and confidentiality is paramount. Because proprietary trading happens with the firm's money, they could benefit greatly from having inside information on the companies that the investment bank deals with as clients. Therefore, there are strict compliance guidelines that wall off proprietary traders from certain information that is available to the client-related areas of the firm. Some firms go even further and completely wall off proprietary traders from any interaction with client-related sales and trading.
Suppose you are the sell-side advisor for a multinational household and personal products manufacturer and marketer that sells primarily to the mass consumer markets. The analyst on your deal team prepares the following comparable companies analysis. Which, if any, of the companies in the list would you potentially remove from the analysis?
● Remove Beiersdorf AG (only skincare), Henkel (has personal care, but large on adhesives business, not the focus here), McBride (not so necessary to remove since its around Europe, but just seems to be nowhere else)
Q2. How do professionals in sales, trading and research work together?
● Research helps traders gain knowledge and analysis of securities they are trading. Sales professionals bring investing or hedging ideas as well as pricing to clients. Salespeople help both clients and traders create profits.
Q8. What are the "Risk Factors" in a prospectus? Why are they important to the issuer and to the investor?
● Risk Factors are disclosures about potential problems the company may encounter, including possible losses, unpredictable revenue, capacity constraints, reliance on suppliers, technological change, competition, litigation regulation, customer mix, etc. ● Issuer: The issuer must list every reasonable risk in order to meet full disclosure requirements of securities laws and to therefore have a defense in case they are sued by shareholders if the company's share price drops. ● Investors: Investors should read these disclosures to ensure that they understand all relevant risks before making decisions regarding purchase of securities
Q2. 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.
● Sell-side research vs. banking division: global research settlement; spinning: insider trading; '34 Act; independence of outside auditors: Sarbanes-Oxley; Commercial banks vs. investment banks: Glass-Steagall; Bankers' involvement in bankruptcies: Chandler Act; investment bank/mutual fund cross holdings/mgmt: ICA 1940
Q17. When a company has agreed to a green shoe, who does the underwriter buy shares from if the share price drops? Who do they buy shares from if the share price increases?
● Share price drops - market ● Share price increases - issuer ● This feature is intended to stabilize the price of an equity following its initial placement in the market
Q2. Why have strategic buyers traditionally been able to out bid financial buyers in auctions?
● Strategic buyers are more inclined to outbid financial buyers because of synergies
Q13. List six characteristics of companies that are good targets for an equity issuance.
● Strong stock performance or supportive equity research ● Large insider holding or small float/illiquid trading ● Overly leveraged capital structure ● Strategic event; finance acquisition or large capital expenditure ● Sum of the parts analysis indicates hidden value ● Investor focus
Compare the regulatory bodies of the four countries covered in this chapter.
● The Financial Supervisory Agency in Japan, the Financial Services Authority in U.K., and the China Securities Regulatory Commission are the sole financial regulators in those countries (centralized). In the U.S., the two main regulators are the Fed and the SEC (US more fragmented). In addition, entities such as the Commodity Futures Trading Commission and the FDIC also have regulatory powers (US even more fragmented)
Q14. Which valuation method tends to show the lowest valuation range? Why?
● The LBO analysis valuation method tends to show the lowest valuation range because it provides a "floor value" for a company since it represents the price that a financial buyer would be willing to pay, based on achievement of their required IRR. Strategic buyers will generally use the other valuation methods because they are able to pay more than the financial buyers since they can take advantages of synergies with their own company.
Q10. What conflicts might exist as a result of having both an Asset Management business and a Private Wealth Management business
● The Private Wealth Management Division advise investors on where they can invest their resources. The problem lies in the fact that the PW and AM Divisions are under one division head, and PW could have the incentive to direct investors into investments managed by AM, which may not best meet the risk and return objectives of the investors.
Q11. Why did the SEC delay declaring Google's IPO registration effective?
● The SEC did not elaborate on the delay in declaring Google's IPO. Assumptions have been made that the delay in declaring Google's IPO registration effective was likely due to there being an issue or error in the paperwork
Q5. Assume an acquiring company's P/E is 15x and the target company's P/E is 11x. Is the acquirer more or less likely to use stock as the acquisition currency? Why?
● The acquirer is more likely to use stock as the acquisition currency because the acquirer has to pay less for each dollar of earnings than the market values its own earnings. Hence, the acquirer will issue proportionally less shares in the transaction. Mechanically, pro forma earnings, which equals the acquirer's earnings plus the target's earnings (the numerator in EPS) will increase more than the pro forma share count (the denominator), causing EPS to increase
Q9. What risks do investors take on when buying on margin?
● The biggest risk from buying on margin is that you can lose much more money than you initially invested. In addition, the equity in your account has to maintain a certain value, called the maintenance margin. If an account loses too much money due to underperforming investments, the broker will issue a margin call, demanding that you deposit more funds or sell off some or all of the holding in your account to pay down the margin loan.
Q8. 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.
● The company would want to consider ○ 1) the cost of capital that comes with stock issuance ○ 2) The current state of their balance sheet (leveraged) ○ 3) the impact on future cash flows ○ 4) the EPS impact of issuing new stock and/or a convertible bond.
Q4. 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?
● The equity capital markets bankers intermediate between the investment banking divisions issuing clients and the trading divisions investing clients. This poses a challenge to balance competing interest and structure an optimal equity related security.
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?
● The problem is called 'gun-jumping' and is done so by speaking to select investors in the pre-filing period and the subsequent delay might cause for an SEC-imposed 'cooling-off' period where the offer is put on hold
Q6. Why might an investment bank place higher priority on sell-side M&A engagements over buy-side engagements?
● The sell-side of the M&A group is often given the highest priority since it has a higher probability of completion, which results in accompanying fees. The buy-side has a lower probability of completion. However, in the case of buy-side transactions, a nominal retainer fee may be charged during the period of the engagement
Q19. What is the tradeoff for having a stabilizing green shoe option in a common equity offering?
● There is a potential risk for negative EPS, as there is a chance that more share will have to be issued. Because earnings are split among shares, so the > # of shares the < EPS
Q9. What is the significance of the Gramm-Leach-Bliley Act of 1999 in relation to the securities industry?
● This act overturned the mandatory separation of commercial and investment banks as originally required by the Glass-Steagall Act
Q15. What are some methods used by investment banks to help equity issuers mitigate price risk during the marketing process?
● To mitigate price risk during the marketing process by filing a registration statement. The prospectus portion of this filing notes a share price range. During the marketing process, a red herring prospectus is shown during the marketing period to display pricing during this process.
Q12. What does VaR stand for? What is its definition and why is it important to investment banks? What are some of the criticisms of VaR?
● VaR stands for value at risk. It represents the potential loss in value of a trading position due to adverse market movements over a defined time horizon based on specific statistical confidence level. Criticisms of VaR include that it gives a false sense of security and creates risk to take excessive risk for positions.
