1. Investment Banking Process and Profit Measurement-Return on Assets (ROA): An indicator of how profitable a company is relative to its total assets. Givesan idea as to how efficient management is at using its assets to generate earning. Calculated by dividing a company’s net income by total assets.-Return on Equity (ROE): The amount of net income returned as a percentage of shareholders equity. Measures a corporation’s profitability by revealing how much profit a company generates with the money shareholders have invested. ROE=Net Income/Shareholders Equity2. Investment Banking Organization and Types of Investment Banking Trading-Investment banking is concerned with the following activities1. Providing advice on new security issues- Firms usually turn to investment banks for advice on how to raise funds by issuing stock or bonds or by taking out loans.2. Underwriting new security issues-In underwriting investment banks typically guarantee a price to the issuing firm, sell the issue in financial markets or directly to investors at a higherprice, and keep the difference, known as the spread. When groups of investments banks called syndicated underwrite large issues there is a syndicate sale. The lead investment bankacts as a manager and keeps part of the spread, and the remainder of the spread is divided among the syndicates members and brokerage firms that sell the issue to the public. Once a firm has chosen the investment bank it will underwrite its securities, the bank carries out a due diligence process during which it researches the firm’s value. Then prepares a prospectus, which is all the information a potential investor may find relevant. Then the investment bank goes on a road show, involving visits to institutional investors, such as mutual funds and pension funds that might be interested in buying securities. 3. Providing advice and financing for mergers and acquisitions- Investment banks advise both the buyers and sellers. Typically investment banks take the initiative in contacting firms about potential purchases, sales, or mergers. When advising a firm seeking to be acquired, investment banks attempt to find a buyer willing to pay significantly more than thebook value of the firm. M&A is particularly profitable because an investment bank does not have to invest its own capital. The only significant costs are the salaries of the bankers involved.4. Financial engineering, including risk management-Financial engineering typically involvesdeveloping new financial securities or investment strategies using sophisticated mathematical models. Investment banks use these financial engineering strategies, such as derivatives, to hedge risk by creating risk management strategies. 5. Research- Investment banks uses some of the research material compiled to identify merger or acquisition targets for clients and it makes some of the research material public through the financial media as “research notes”. The opinions of senior analysts at large investment bans can have a significant impact on the market. Some analyst specialize in offering opinions on the current state of the financial markets, sometimes minute by minutesduring the hours the market is open. This information can be useful for investment bank trading desks. 6. Proprietary Trading- In 1990, proprietary trading, or buying and selling securities for the bank’s own account rather than for clients, became a major part of the operations and an important source of profits for many investment banks.7. Repo Financing- Investment banks borrowed to finance their investments in securities and their direct loans to firms. Financing investments by borrowing rather than by using capital increases a bank’s leverage. Using leverage in investing is a double-edged sword: Profits from the investment are increased, but so are losses. 3. Various Types of Securities Risks and their emergence as an effect on markets and securities -Proprietary trading exposes banks to both interest-rate risk and credit risk.1. Interest-rate risk: If investment banks hold long-term securities, such as U.S. Treasury bonds or many mortgage-backed securities, the banks are exposed to the risk of an increase in market interest rates that will cause the prices of their long-term securities to decline.2. Credit risk: Is the risk that borrowers might default on their loans.-Many of the large investment banks were highly leveraged, so when the financial market crashed many investment banks lost a lot of money. They were forced to reduce leverage in a process know as deleveraging.-Another way investment banks were vulnerable during the financial crisis was because of the ways in which they financed their investments. They borrowed primarily by either issuing commercial paper or by using repurchase agreements. Repurchase agreements are short-term loans backed by collateral. Both are short-term loans. If the funds raised are used to invest in mortgage backed securities or to make long-term loans, investment banks face a maturity mismatch because the maturity of their liabilities is shorter than the maturity of their short-term assets. Maturity mismatch leaves investment banks vulnerable to bank runs. -Counterparty risk, or the risk that the party on the other side of a financial transaction will not fulfill its obligations, played in important role in the financial crisis.4. Major Legislative and major components/impacts of those legislation-Glass-Steagall Act of 1933: Legally separated investment banking from commercial banking. Also contained a provision for a system of federal deposit insurance. If the federal government was going to insure deposits, it should not allow banks to use the deposits to engage in what it saw as risky investments banking activities. -Graham-Leach-Bliley Act of 1999: Repealed the Glass-Steagall Act. It allowed commercial banks to participate in securities, insurance, and real estate activities.-Troubled Asset Relief Program (TARP): Allowed Goldman Sachs & Morgan Stanley to become financial holding companies, which are regulated by the Federal Reserve and eligible for discount loans through their bank subsidiaries. -Commodity Futures Trading Commission (CFTC): Regulates the futures markets-Federal Deposit Insurance Corporation (FDIC): By reassuring depositors that they would receive their money back even if their bank failed, deposit insurance effectively ended the era of bank panics in the United States.-On September
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