Unformatted text preview:

FIN3244 Extremely Extensive but Comprehensive Exam 2 Study Guide J Chapter 5 Investment Banks Mutual Funds Hedge Funds and the Shadow Banking System 5 1 Investment Banking o During the financial crisis it became clear that commercial banks no longer played the dominant role in routing funds from savers to borrowers Instead a variety of non bank financial institutions were acquiring funds that had previously been deposited in banks and they were using these funds to provide credit that banks had previously provided These nonbanks were using newly developed financial securities that even long time veterans of Wall Street often did not fully understand o Paul McCauley managing director of PIMCO at a conference of the Federal Reserve Bank of Kansas City in 2007 coined the phrase shadow banking system A term to describe the new role of nonbank financial firms Geithner was president of the Federal Reserve Bank of NY and used the term at an Economic Club of New York He later became the secretary of the Treasury in the Obama administration o Problems with nonbanks made dealing with the crisis more difficult because the policymaking and regulatory structures were based on the assumption that commercial banks were the most important financial firms Interesting fact The Federal Reserve System had been set up in 1913 to stabilize and regulate the commercial banking system A key issue for policymakers was what role the Fed should play and what role it could play in dealing with a financial crisis that involved many nonbank financial firms o Commercial Bank Taking in deposits and making loans o Investment Bank Is mainly concerned with the following activities the first three are central to investment banking the other three have recently emerged Providing advice on new security issues Underwriting new security issues Providing advice and financing for mergers and acquisitions Financial engineering including risk management Research Proprietary trading o Definition of investment banking Financial activities that involve underwriting new security issues and providing advice on mergers and acquisitions o 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 Investment banks have information about the current willingness of investors to buy different types of securities and on the prices investors are likely to require This information would be difficult to gather for themselves but it is essential if they are to raise funds at a low cost Underwriting New Security Issues o Underwriting is an activity in which an investment bank guarantees to the issuing corporation the price of a new security and then resells the security for a profit o Initial Public Offering IPO is the first time a firm sells stock to the public o Syndicate is a group of investment banks that jointly underwrite a security issue o One way in which investment bankers earn income is by underwriting firms sales of new stocks or bonds to the public o In underwriting investment banks typically guarantee a price to the issuing firm sell the issue in financial markets or directly to investors at a higher price and keep the difference the spread Typically investment banks earn between 6 and 8 of the total dollar amount raised in the IPO An investment bank typically earns between 2 and 4 of the dollar amount raised in a secondary offering or seasoned offering which represents security sales by a firm that has sold securities previously In return for the spread the investment bank takes on the risk that it cannot profitably resell the securities being underwritten In other words if the investment bank misjudges the state of the market it may have to sell securities for a lower price than it had guaranteed to the issuing firm Syndicates underwrite large issues In a syndicated sale the lead investment bank acts as a manager and keeps part of the spread and the remainder for the spread is divided among the syndicate members and brokerage firms that sell the issue to the public Once a firm has chosen the investment bank that will underwrite its securities the bank carries out a due diligence process during which it researches the firm s value Next a prospectus is prepared The SEC requires every firm to do this before allowing it to sell securities to the public The prospectus should include all information about the firm that a potential investor would find relevant to making a decision to buy the firm s stock or bonds including a firm s profitability and net worth as well as risks faced by the firm such as pending lawsuits Next a road show is conducted This involves visiting institutional investors such as mutual funds and pension funds that might be interested in buying the security issue Finally the investment bank sets a price for the stock that it estimates will equate the quantity of securities being sold with the quantity that investors will demand Underwriting can lower information costs between lenders and borrowers because investment banks put their reputation behind the firms they underwrite Investors typically have confidence that the underwriting investor has collected enough quality information This confidence was shaken in 2007 2009 when investment banks underwrote mortgage backed securities that turned out to be very poor investments o Providing Advice and Financing for Mergers and Acquisitions Larger firms often expand by acquiring or merging with other firms A small firm might feel the best way to expand is to be acquired by a larger firm Investment banks are very active in mergers and acquisitions M A advising both the buyers buy side mandate and sellers sell side mandate 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 try to find a firm willing to pay much more than the book value firms assets minus liabilities Investment banks can estimate the value of firms lead negotiations and prepare acquisition bids Likewise they are responsible for setting up financing M A is particularly profitable for investment banks because unlike the underwriting and most other investment banking activities an investment bank does not have to invest its own capital It s only significant costs are the salaries of the bankers involved in the deal o Financial Engineering Including Risk Management Investment banks have


View Full Document

FSU FIN 3244 - Chapter 5: Investment Banks

Documents in this Course
Margin

Margin

9 pages

TEST 3

TEST 3

10 pages

EXAM 3

EXAM 3

8 pages

Chapter 8

Chapter 8

32 pages

Chapter 1

Chapter 1

14 pages

CHAPTER 1

CHAPTER 1

10 pages

EXAM 4

EXAM 4

15 pages

EXAM 3

EXAM 3

14 pages

Chapter 1

Chapter 1

15 pages

Chapter 1

Chapter 1

15 pages

Exam 1

Exam 1

11 pages

EXAM 1

EXAM 1

15 pages

Exam 1

Exam 1

6 pages

CHAPTER 8

CHAPTER 8

20 pages

Test 3

Test 3

27 pages

Chapter 5

Chapter 5

23 pages

Chapter 9

Chapter 9

58 pages

Test 2

Test 2

12 pages

Test 2

Test 2

24 pages

Finance

Finance

24 pages

Test 2

Test 2

19 pages

Exam 3

Exam 3

15 pages

Test 4

Test 4

18 pages

Test 3

Test 3

15 pages

Test 1

Test 1

18 pages

Exam 1

Exam 1

8 pages

Exam 1

Exam 1

13 pages

Chapter 9

Chapter 9

18 pages

Chapter 8

Chapter 8

14 pages

Chapter 5

Chapter 5

14 pages

Chapter 5

Chapter 5

14 pages

Notes

Notes

21 pages

Chapter 1

Chapter 1

54 pages

Chapter 1

Chapter 1

40 pages

CHAPTER 1

CHAPTER 1

10 pages

Notes

Notes

1 pages

EXAM 4

EXAM 4

21 pages

Exam 1

Exam 1

9 pages

Test 1

Test 1

6 pages

Test 4

Test 4

40 pages

Load more
Download Chapter 5: Investment Banks
Our administrator received your request to download this document. We will send you the file to your email shortly.
Loading Unlocking...
Login

Join to view Chapter 5: Investment Banks and access 3M+ class-specific study document.

or
We will never post anything without your permission.
Don't have an account?
Sign Up

Join to view Chapter 5: Investment Banks 2 2 and access 3M+ class-specific study document.

or

By creating an account you agree to our Privacy Policy and Terms Of Use

Already a member?