Term
Looking at the leverage ratios of former pure-play investment banks GS and MS in Exhibit 1.4,
why were these banks able to operate at higher leverage ratios as investment banks, compared
to as bank holding companies? |
|
Definition
Bank holding companies must follow regulations which restrict the amount of debt that they can
incur. This drastically changed the way investment banks worked because they were no longer
allowed to make large bets with borrowed money while keeping little capital on hand. |
|
|
Term
U.S. companies currently report their financials based on US GAAP rules. Many companies in
Europe report according to IFRS rules. There has been a movement for all companies to shift to
an IFRS basis globally. When this occurs, what may happen to the leverage ratios of U.S. banks? |
|
Definition
U.S. banks will see an increase in their leverage ratio because IFRS shows gross exposure of
derivatives, non derivative trading assets and reverse repos/borrowed securities. US GAAP
shows these values on a net basis. |
|
|
Term
Why might a universal bank be better able to compete against a pure-play investment bank for
M&A and other investment banking engagements? |
|
Definition
The universal banks have lending capabilities that they use to entice companies to do everything
with them as a one stop shop. In addition, these banks are able to use their balance sheet to
make M&A transactions easier on their clients. Being able to lend also leads to a more stable
business environment because when revenue from M&A transactions drops, typically revenue
from deposits rises and vice versa. |
|
|
Term
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? |
|
Definition
The capital markets group is responsible for balancing these competing interests. This is true
because they determine pricing, timing, size and other aspects in conjunction with other
professionals. |
|
|
Term
What is a key consideration in determining the cost and other parameters of a corporate debt
offering, and why is it important? |
|
Definition
Debt capital market professionals work with their client’s coverage bankers to determine timing,
maturity, size, covenants, call features and other aspects of debt financing. This is important
because whatever is decided will have an impact on the company’s credit rating. |
|
|
Term
Why might an investment bank place higher priority on sell-side M&A engagements over buy-
side engagements? |
|
Definition
Sell side engagements receive a higher priority because they have a higher probability of
completion. |
|
|
Term
Many investment banks have a principal investment group that invests directly in public and
private companies. What conflicts of interest might arise from operating this type of business? |
|
Definition
There are potential conflicts of interest because the firms do research on companies and offer
buy, sell, hold recommendations to their clients. If a firm holds an interest in a particular
company, it may be more likely to give a buy recommendation even if it is not in the best
interests of its clients. |
|
|
Term
What conflicts might exist between the proprietary trading division and the rest of the
investment bank? |
|
Definition
The investment bank is supposed to primarily focus on their clients. Salespeople must be
careful when dealing with proprietary traders. Many banks have instituted a Chinese wall
meaning that proprietary traders and the rest of the bank must be separate. However, some
clients have questioned the effectiveness of this wall and claim that the best investment ideas
could end up staying within the firm rather than being shared with the firms paying clients. |
|
|
Term
What conflicts might exist as a result of having both an Asset Management business and a
Private Wealth Management business? |
|
Definition
Private wealth managers have a fiduciary responsibility to select the best investment funds to
meet their clients risk and return objectives. However many banks run their own funds and
wealth managers may be encouraged to invest in the firms fund rather than find the best one
for their clients. |
|
|
Term
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. |
|
Definition
The Securities Act of 1933: intended to bring stability to capital markets and stop manipulative and deceptive practices in the sale or distribution of financial securities. Banks must now disclose a significant amount of relevant and important details regarding securities and the firms they represented.
The Glass-Steagall Act was a large piece of regulation that separated commercial and investment banks and created the Federal Deposit Insurance Corporation which insures deposits up to $250,000. This act required the industry to alter its operation and structure of firms and cut off a key source of capital for new security underwriting.
The Securities Exchange Act of 1934 was a supplement to the Securities Act of 1933. The new law dealt primarily with the supervision of new security offerings, ongoing reporting
requirements for these offerings and the conduct of exchanges. The law also required minimum reporting standards in the secondary securities markets and codified rules for transactions. It also required that exchanges be governed by self-regulating organizations.
The Public Utility Holding Company Act allowed the SEC to supervise the relationship between utility holding companies and investment banks. It restricted investment banks from owning these utility companies based on the belief that the banks would limit competition and engage in monopolistic behavior. |
|
|
Term
A goal of many parts of U.S. regulatory legislation has been to eliminate or 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. |
|
Definition
There are several possible conflicts of interest between investment banks and their clients. For
example, the Securities Exchange Act of 1934 gave the SEC broad powers to enact and enforce
new regulation on exchanges, investment banks, broker/dealers, and traders. They are able
to prohibit manipulative practices like wash sales and matched orders and also can set strict
standards for short selling and stop-loss orders. In addition, investment banks aren’t allowed to
own any public utilities because it could potentially decrease competition. |
|
|
Term
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. |
|
Definition
The Securities Act of 1933 mandates that investment banks must conduct an investigation
“reasonably calculated to reveal all those facts that would be of interest to a reasonably prudent
investor.” Investment banks can be held liable if material facts are omitted from the registration
statement and investors suffer a loss that is attributable to that omission. |
|
|
Term
| What is the role of US states in regulating investment banks? |
|
Definition
Investment banks were almost wholly regulated by the states until Federal laws were enacted
that duplicated and/or superseded state law. These laws were called Blue Sky Laws and
among other things they required that no security issued in the state could be offered without
previously obtaining a permit from the state’s Bank Commissioner. |
|
|
Term
| What types of US securities offerings do not need to be registered with the SEC? |
|
Definition
| private placements, offerings of limited size, intrastate offerings, securities of municipal, state, or fed gov. |
|
|
Term
|
Definition
A red herring is a preliminary prospectus that allows offers to be made on securities during a
waiting period. It is called a red herring because of the red legend on the first page that reminds
investors that the information contained in the prospectus is preliminary. |
|
|
Term
Widgets Inc. is a publicly traded company with approximately $300 million in market
capitalization. The company filed a registration statement for a follow-on offering in May of this
year, but began selectively speaking to investors about the issue in March. Its offering is now
being delayed by the SEC. What is the likely reason for the delay? |
|
Definition
The likely reason is called “gun jumping.” This occurs when companies attempt to attract
investors to certain securities prior to the statement being declared effective by the SEC. The
SEC can institute a cooling off period when this occurs in addition to taking other action. |
|
|
Term
What is the significance of the Gramm-Leach-Bliley Act of 1999 in relation to the securities
industry? |
|
Definition
The Gramm-Leach-Bliley Act overturned Glass-Steagall. In other words it made it possible for
commercial banks and investment banks to become one enterprise once again. The reasoning
behind this was to allow American banks to better compete with deposit taking firms outside
the U.S. that weren’t subject to Glass-Steagall. However, the Act failed to give the SEC or any
other agency direct authority to regulate large investment bank holding companies. |
|
|
Term
What are some securities regulations in place in the United Kingdom, Japan, and China that
mirror U.S. regulations? |
|
Definition
Japan: The United States led the rebuilding effort in Japan after World War 2 so their laws look
very much like American laws when it comes to financial securities. For example, Japan has
laws almost exactly like the 1933 Securities Act, the 1934 Securities Exchange Act and the Glass-
Steagall Act of 1933.
United Kingdom: The Financial Services Act of 1986 created a comprehensive government
regulator very much like the SEC in the United States.
China: China also has agencies to deal with regulating securities. They were just recently able
to trade derivatives in China as well. |
|
|
Term
What are some major differences between the regulatory frameworks of the four countries
covered in this chapter? |
|
Definition
China: China was closed to investment banking prior to 1992. There is a separation of banks
engaging in deposit taking and securities activity. China was recently opened up to derivatives
trading.
United Kingdom: The UK is a member of the EU and is therefore subject to follow EU banking
and securities legislation. Bank of England no longer regulates banks.
Japan: Japan has two regulatory agencies, the Securities Exchange and Surveillance Commission
and the Financial Supervisory Agency which is now the current regulator of Japan’s security
industry.
United States: The SEC is the government agency that regulates the financial markets and
ensures a level playing field. The central bank determines monetary policy while the President
and Congress determine fiscal policy. |
|
|
Term
| Compare the regulatory bodies of the four countries covered in this chapter. |
|
Definition
United States: The SEC is the sole regulator of the U.S. financial markets and has the ability to
levy fines or prosecute institutions that don’t follow the laws of the United States or engage in
unfair practices.
Japan: Japans regulatory bodies are very similar to those of the United States. The Securities
Exchange Surveillance Commission is the primary regulator. Commercial banks can own
brokerage firms to underwrite securities.
United Kingdom: The main regulator in the United Kingdom is the Financial Services Authority.
The FSA consolidated the powers of nine regulatory agencies into a single regulator. The FSA
regulates banks.
China: The main regulator in China is the China Securities Regulatory Commission and the State
Council Securities Commission. The SCSC deals with centralized market regulation where as the
CSRC is the enforcement arm of the SCSC and supervises the securities markets. |
|
|
Term
| What type of securities offerings do not need to be registered with the SEC? |
|
Definition
Private placements, i.e. most bond and convertible transactions (other than mandatory
convertibles) are completed without registration with the SEC based on a Rule 144A exemption.
Primary offering is the only securities offering that must be registered with the SEC. |
|
|
Term
List the three types of bank participants in an underwriting syndicate and their core
responsibilities, in order of compensation received, from high to low. |
|
Definition
Lead bookrunners: have the responsibility for determining the marketing method
and pricing for the transaction. Receive the highest underwriting allocation and a
proportionately higher percentage of the gross spread.
- Co-managers: provide minor input to the bookrunner(s) on marketing and pricing issues,
but do not control this process and have less risk and less work to do. Receive less
compensation than bookrunner.
- Selling group: do not take on any financial risk and receive lowest amount of compensation. |
|
|
Term
| What are league tables, and why are league tables important in the investment banking? |
|
Definition
League table: a record the investment banking industry makes to keep track of underwriting
participations by all banks. Important because they are used as a basis for comparing banks’
underwriting capabilities. Every different type of security and geographic region had its own
league table. |
|
|
Term
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. |
|
Definition
Equity capital markets group helps private companies determine if an IPO of stock is a logical
decision based on an analysis of benefits ad disadvantages. If there is sufficient interest, the
bank determines the expected value of the company based on comparable publically traded
companies or other valuation methods (ie DCF). Act as an intermediary between Investment banking divisions issuing clients, and trading division investing clients |
|
|
Term
Describe the unique process utilized by Google in its IPO, including its intended advantages and
potential disadvantages. |
|
Definition
Google wanted to hold a modified Dutch auction instead of the traditional “book-building”
based on a road show that enables bankers to obtain pricing input from large institutional
investors. Dutch auction system – investors weigh in with bids, listing the number of shares
they want and how much they’re willing to pay for them. Bids are stacked with the highest price
on top. A final market price at which all shares can be sold is established by starting at the top of
the stack and working down. All bidders get the selected lowest price offered.
- Disadvantages: Dutch auction would alienate large institutional investors by disfranchising
their pricing input; removes the opportunity to receive a large allocation directed by the
bookrunner.
- Advantages: avoid excesses that occur in large IPOs, including the large first day pop in their
stock’s price. |
|
|
Term
| What is a shelf registration statement, and what securities can be included in it? |
|
Definition
- A shelf registration enables a company to file one registration statement (S-3 filing) that
covers multiple issues of different types of securities. The company still has to do the same
accounting, disclosure, and descriptive information as an IPO filing. Allows the company to use
the registration opportunistically without having to file separately for each financing and wait
for SEC clearance.
- Securities include equity offerings, debt, and convertible securities. |
|
|
Term
| Why might a younger high-tech company select equity over debt when raising capital? |
|
Definition
Typically a tech company is very capital intensive up front and so instead of having debt that
they have an interest payment on they prefer equity. |
|
|
Term
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. |
|
Definition
Companies should consider risk-adjusted cost of capital, credit ratings, comparisons with
peer companies, equity and debt analyst views, chance of bankruptcy, financial flexibility, tax
implications, and management comfort with the resultant balance sheet. |
|
|
Term
Provide reasons an investment bank might give to support their advice that a private company
should “go public.” |
|
Definition
Access to public market funding
- Enhanced profile and marketing benefits
- Creation of an acquisition currency and compensation vehicle
- Liquidity for shareholders |
|
|
Term
| List six characteristics of companies that are good targets for an equity issuance. |
|
Definition
- Strong stock performance or supportive equity research
- Large insider holdings 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 (carve-out, spin-off, tracking stock)
- Investor focus
o Road show focuses investors on misunderstood value
o Brings additional equity research |
|
|
Term
How does a negotiated (best efforts) transaction differ from a “bought deal”?
|
|
Definition
Main difference – best efforts the issuer bears the risk and bought deal the investment bank
bears the risk.
- Best efforts
o Issuer of bonds bears price risk
o Least expensive
o Market deal
o Comprises a majority of transactions
- Bought deal
o Investment bank buys the bonds at a certain rate
o Generally seen in competitive market
o Investment bank bears the price risk. |
|
|
Term
What are some methods used by investment banks to help equity issuers mitigate price risk
during the marketing process? |
|
Definition
- By completing an accelerated offering with a shorter road show period of 1 or 2 days or by
carrying out a block trade (investment bank buys the securities without a road show and bears
full price risk) |
|
|
Term
| Explain what a green shoe is. |
|
Definition
A green shoe option is an over-allotment option that allows an investment bank to sell short
securities that are equal to 15% of the securities sold in an IPO by a company at the time of the
offering. It is used to mitigate downside share price risk in an SEC registered securities offering
and to meet potential investor demand for more securities. |
|
|
Term
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? |
|
Definition
Drop in share price – buy shares from the market
Increase in share price – buy shares from the company. |
|
|
Term
| What is the tradeoff for having a stabilized green shoe option in a common equity offering? |
|
Definition
The tradeoff for having a stabilized green shoe option is that the company must get board
approval for issuing a range of shares (accepting the negative earnings per share consequences
of issuing more shares), and the earnings per share risk the company faces if the their share
price decreases after the offering. |
|
|
Term
| Provide definitions for strategic buyers and financial buyers in a prospective M&A transaction. |
|
Definition
- Creating value: is the M&A beneficial to shareholders?
- Strategic Rational: includes the desire to achieve cost savings through economies of scale
- Synergies: expected reduced costs or increased revenues.
- Control premium: the price that an acquiring company is willing to pay to purchase control
over a target company’s decision-making and CF
- Credit Rating
- Acquisition currency: using cash or stocks as payment |
|
|
Term
| Why have strategic buyers traditionally been able to out-bid financial buyers in auctions? |
|
Definition
- Because strategic buyers are usually willing to pay more. Strategic buyers are often a much
larger company or have larger financing capacity compared to that of financial buyers. Strategic
buyers may offer an all cash consideration whereas financial buyers use debt financing. |
|
|
Term
Why are revenue synergies typically given less weight than cost synergies when evaluating the
combination benefits of a transaction? |
|
Definition
| - Revenue synergies are much more difficult to calculate. |
|
|
Term
In the US, 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? What is the name of the European regulator that may be relevant in an
M&A transaction? |
|
Definition
- A HSR (Hart-Scott-Rodino) filing is required with the FTC and DOJ. If there are international
operations, then the EC (European Commission) is involved. |
|
|
Term
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? |
|
Definition
-More likely to use stock as acquisition currency because it can mitigate credit rating concerns
and be more tax-effective for selling shareholders. |
|
|
Term
What is a potential risk of trying to complete a stock based acquisition during periods of high
market volatility? |
|
Definition
| - Risk of significant share price movement and a potential change in economic value. |
|
|
Term
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? |
|
Definition
- No it does not because it does not guarantee that a deal is fair or even good. Simply used as a
data reference for the board to base their opinion off of. |
|
|
Term
| Why might a board want to include a go-shop provision in the merger/purchase agreement? |
|
Definition
- Because it allows the board to shop around and view competing offers from other potential
buyers and ensure they are getting the best offer for the shareholders. |
|
|
Term
| When is a break-up fee paid? What is the typical fee charged as a percent of equity value? |
|
Definition
- Paid if the transaction is not completed because target company walks away after a Merger
Agreement or a Stock Purchase Agreement is signed. Usually 2-4% of the target company’s
equity value. |
|
|
Term
Of the various methods by which a corporate subsidiary can be separated from the parent
company in the public markets (IPO, carve-out, spin-off, split-off, and tracking stock) which ones
offer the subsidiary the most and least independence? |
|
Definition
- Carve-out leaves the parent company with an ongoing ownership and the least
independence for the subsidiary.
- Spin-off is a full separation and offers the subsidiary the most independence. |
|
|
Term
| List the four principal alternative methods for establishing value in an M&A transaction. |
|
Definition
- Comparable companies analysis: Public Market Valuation
- Comparable transaction analysis: Private market valuation
- Discounted CF analysis: Intrinsic value of business
- LBO analysis: value to a financial buyer |
|
|
Term
Of the major valuation methods, which one(s) are based on relative values? On intrinsic values?
On ability to pay? |
|
Definition
- Relative values: Publically Traded Comparable Companies Analysis and Comparable
Transaction Analysis
- Intrinsic values: DCF Analysis
- Ability to pay: LBO analysis |
|
|
Term
| Which valuation method tends to show the lowest valuation range? Why? |
|
Definition
- Comparable company range is normally lower than a comparable transaction range because a
control premium is included in the comparable transaction analysis. |
|
|
Term
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. |
|
Definition
| - company (b) because it is a mature industry with stable CF |
|
|
Term
| When might an investment bank decline participation in an underwriting and why? |
|
Definition
There is a lot of liability and some potential risk associated with underwriitng. Sometimes
banks have "over the wall" inormation about security risk within a potential IPO and they don't
want the liability or bad name associated with underwriting a deal that doesn't turn out great. |
|
|
Term
How do professionals in sales, trading, and research work together?
|
|
Definition
Researchers analyze the proposed stock recommendations to and for the sales force. sales
people add value for the potential client. Sales traders contact bank sales traders with the
order. The institutional trader than executes the order. They work in a close knit team in this
operation. There are a lot of moving parts. |
|
|
Term
| Describe what Prime Brokerage is including the four principal products in this area and the generic name of the financial institutions that are targeted for this business |
|
Definition
Prime brokerage: housed withing the trading Division and focuses on hedge funds and other
clients that borrow securities and cash to support their investment business. Four products
offered: trade clearing, real estate, performance management, and computer assistance. |
|
|
Term
| Explain traders' market making function |
|
Definition
Market making is something that a bank does to make a market of anything that is requested
by a client. If the client wants to buy a security, the bank finds a way to sell it, and if a client
wants to sell a certain sercurity, a bank finds a way to sell it. |
|
|
Term
| What does FICC stand for? How does this division typically rank from a profitability point of view? What happened during 07 08 and which part of FICC was most responsible for this outcome? |
|
Definition
FICC Fixed Income Currencies and Commodities. Other than in 2007 - 2008 it is the most
profitable. they became subject to large write downs in 2007-2008. The structured credit
buisness was the cause of it. |
|
|
Term
| Which stock would likely have a lower rebate and why: a stock whose issuer has a large amount of convertibles outstanding, or a stock whose issuer has no convertibles and has no significant share moving news in the near term? |
|
Definition
The group that has a lot of outstanding shares will receive lower rebate because the demand
is low. (Rebate = interest paid by lender to share borrowers.) |
|
|
Term
| How were senior tranches of a CDO able to obtain investment grade credit ratings when some of the underlying assets were non investment grade? |
|
Definition
They would package the CDO's together and spread the rish over large unrisky portfolios to
mitigate risk from the individual risky CDO's. This helped the rating. |
|
|
Term
| 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? |
|
Definition
VaR stands for value at Risk. VaR represents the potential loss in value of trading positions
due to adverse market movements based on statistical confidence levels. It may not predict the
accurate future market risk. VaR over a one day time period excludes market risk for things not
liquidated over a one day period. |
|
|
Term
What is the difference between asset management and wealth management?
|
|
Definition
Asset Management - Professional management of investment funds for individuals. They
actually manage the money and investments for the client.
Wealth Management - refers to advisors who give investment advise. They don't actually
manage the asset classed for the client. |
|
|
Term
| Why would a wealth manager choose to allocate some of a clients assets to another bank? |
|
Definition
They send to other banks, because they may not offer a specific investment tool or product.
They also might be a low performing institution in certain classes and help their clients find
better returns else where. |
|
|
Term
| How are the different functions of the sell side versus the buy side manifested through their fee structure? |
|
Definition
The sellside research gets a small part of the investor commissio which is charged in the price
premium that helps the sell side research fund their operations. Buy side commissions are paid
as fees outside of the transaction. |
|
|
Term
| What drove the need to separate research and investment banking? |
|
Definition
Conflicts of interest in fradulent research was beig pushed instead of investing for the benefit
of the client. Many fines were required of by the SEC in 2003 for this behavior. |
|
|
Term
| How have the US enforcement actions against sell side research in 2003 heightened the issue of declining research revenues? |
|
Definition
They have created even less revenue and profits doing sell side research. There is no push for
the research side because the costs outwiegh the revenues. |
|
|
Term
| What are the objectives of regulation FD? What are the concerns about this US based regulation? |
|
Definition
Reg FD makes companies file with the SEC before releasing info that will impact the stock
price. Because of this, info travels slower and is more dilute by lawyers weakening the company
info. Quality of info has declined. |
|
|
Term
Compare the different roles provided to the investor community by credit rating analysts and
sell-side research analysts. |
|
Definition
Credit rating analysts assign credit ratings to debt and fininancial securities backed by various
types of collateral so investors can make educated decisions about corporation’s ability to repay
debt. Sell-side research analysts gather information and provide that information to investing
clinets with hopes of selling a product. |
|
|
Term
| What is the difference between business risk and financial risk? |
|
Definition
Business risk includes the competetive position within the industry, diversity of product lines
and profitability compared to peers; financial risk includes accounting, cash flow financial
flexibility and capital structure considerations. |
|
|
Term
| What precipitated the decline in CDO values during the 2007-2008 credit crisis? |
|
Definition
After a few mortgage backed securities defaulted, the big three credit rating agencies, Moody’s,
Standard & Poor’s, and Fitch, felt compelled to downgrade all mortgage backed securities
exacerbating their decline in value. |
|
|
Term
| What are the major criticisms directed at Moody’s, Standard & Poor’s, and Fitch? |
|
Definition
The major criticicms of the credit rating agencies are that they worked with investment banks
to create mortgage backed securities that had higher ratings than they deserved, and that they
should have been downgraded a lot sooner. Also, these agencies are susceptible to undeue
influence from corporations (investor’s use their services but corporations pay for them). |
|
|
Term
| Why might OTC derivatives be considered more risky than exchange-traded derivities? |
|
Definition
Unlike listed trades, OTC traders are not in the public domains and unless reported by the
parties to the trade, remain confidential. |
|
|
Term
| How is derivatives settlement different form securities settlement? |
|
Definition
Instead of clearing and settling within 3 days, derivatives often remain outstanding for a much
longer time. Unlike securities, where the security is delivered and simultaneously paid for in
full, derivatives represent an obligation or an option to buy or sell a financial instrument or
asset at a future date, which can be weeks , months or years in the future. Derivatives require
substantially more complex risk management system than are required for securities. |
|
|
Term
| What are the benefits of issuing and investing in Eurobonds? |
|
Definition
They are issued and traded outside the country whose currency the Eurobond is denominated
in, and outside the regulations of a single country. Interest income from these bonds is exempt
from withholding tax and the bonds are generally not registered with any regulatory body. |
|
|
Term
| Why are most corporate Eurobond issuer’s large, multinational corporations? |
|
Definition
The market is self-regulated through the International capital Markets Association. Eurobonds
are generally issued by multinational corporations or sovereign entities of high credit quality.
Eurobonds are issued and traded outside the country whose currency the Eurobond is
denominated in, and outside the regulations of a single country. It needs high credit quality for
investors to ensure the quality of the bonds. |
|
|
Term
A put option gives the holder the right, but not the obligation, to sell an underlying asset at an
agreed –upon price. Discuss why the Japanese government’s guarantee to Ripplewood as part
of its buyout of Long Term Credit Bank is similar to granting Ripple wood a put option on the
bank’s assets. |
|
Definition
Put option is to have the option to sell something when certain thing happens. Japanese
government agreed to purchase any LTCB assets that fell by 20% or more post following the
acquisition is the same that LTCB has the option to sell any assets that fell by 20% or more post
following the acuqition. |
|
|
Term
| Why did Chine institute an A-share/B-share system? How has regulatory easing benefited QFIIS? |
|
Definition
A-shares are limited to purchase by only Chinese resident and QFIIS and are denominated in
renminbi. B-shares can be purchased by foreign investors and Chinese residents. |
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Term
In a comparable transactions analysis, what additional considerations might an investment
banker factor in when valuing an emerging market company? |
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Definition
It should add the analysis of political risk, liquidity risk, accounting risk, tax risk, volatility risk and
legal regulation change risk. |
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Term
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? |
|
Definition
When share price increases hedge fund investors sell short. When share price decreases
hedge fund investors buy stock. Delta Hedging |
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Term
True or false: Convertible arbitrage hedge funds invest in convertible bonds because the fund
managers have a bullish view on the company’s stock. Explain your answer. |
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Definition
False. Investors can generate profits throughout the life of the convertible by delta
hedging. Thus, whether the stock price increases or decreases the investor can profit by
purchasing the stock or selling short the stock. |
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Term
Discuss whether you feel the SEC’s temporary ban on short-selling financial stocks in 2008
during the financial crisis unfairly punished convertible arbitrage funds. |
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Definition
The reason for the ban was to prevent the high volume of short selling on firms that
investors saw as bearish. Convertible arbitrage funds do not invest in a convertible
security because a stock may seem bullish; after the initial short sell the investors are
just as likely to purchase shares as they are to short sell the same shares. Therefore, by
banning short selling in 2008 it unfairly punished convertible arbitrage funds. |
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Term
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. |
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Definition
| Least dilution to most dilution: ZCC -> coupon paying -> mandatory convertible |
|
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Term
If a company has rating agency concerns and wants tax deductions from interest payments,
what type of security is the company likely to issue in support of an acquisition and why? |
|
Definition
A Unit Structure mandatory convertible because the company will receive tax
deductions, which arise from the 30-year debt issuance. Also, since the stock price will
not reflect the cost synergies for a couple years, the 3-year stock purchase agreement
should allow enough time for the cost synergies to be reflected in the stock price. |
|
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Term
| Why was the Nikkei Put Warrant program so profitable for GS? |
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Definition
They were able to purchase the Nikkei put warrants below theoretical market cost and
delta hedge the risk associated with this position |
|
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Term
What is ASR an abbreviation for? Describe this transaction and the principal benefit fort a client.
What additional benefit did IBM achieve in the ASR program described in this chapter? |
|
Definition
Accelerated Share Repurchase program. A company announces that it will repurchase
x amount of shares, and investment bank borrows this amount from current
shareholders, gives the shares to the company and the company gives the investment
bank the money. The investment bank purchases shares daily until it reaches the
amount of the initial agreement. At the end of the period the investment bank and
company settle depending on the final costs
IBM received tax benefits by using its foreign units |
|
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Term
What are the core differences between Investment Banking (IB) and Sales and Trading career
paths? |
|
Definition
a. Trading could have accelerated promotions based on exceptional performance
b. IB typically has 80-100 hr. workweeks while Sales and Trading are closer to 50-60.
c. More associates are promoted opposed to IB |
|
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Term
Describe what a Chinese Wall is and which US regulator would be concerned with issues
involving the wall. |
|
Definition
| The wall between proprietary traders and investment bankers. the SEC |
|
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Term
| What advancement in the mortgage market set the foundation for the subprime crisis and why? |
|
Definition
Mortgage securitization
It allowed lenders to take the mortgages the issued off their balance sheet, thus getting
rid of the risk associated with said mortgages. This led to a more lax system of lending
and a growth of sub-prime mortgages |
|
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Term
Describe a Credit Default Swap (CDS). What are regulators trying to do to mitigate risk in the
CDS market? |
|
Definition
a. Derivative contracts designed to spread risk and reduce exposure to credit events such
as default or bankruptcy. On party buys protection from another party, in with the
buyer can receive capital in the event of a default.
b. New regulations are requiring sellers to disclose the nature and terms of the credit
derivative, the reason it was entered into, the current status of its payment and
performance risk, the amount of future payments it might be required to make, the fair
value of the derivative, and whether there are provisions that would allow the seller to
recover money or assets from third parties |
|
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Term
| Under what scenarios will the SIV market arbitrage model fail? |
|
Definition
| When liquidity shrinks and credit risk increases |
|
|
Term
Why were US investment banks allowed to operate at higher leverage ratios compared to
commercial banks? |
|
Definition
| Because they don’t need to protect customer deposits |
|
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Term
| Who does the phrase “perception is reality” apply to Bear Stearns? |
|
Definition
The perception of Bear Stearns contributed to the demise of the firm. Therefore,
because people perceived the firm as a failing firm it soon became a reality |
|
|
Term
| Discuss how CDS can be used for hedging and speculative purposes. |
|
Definition
An investor can use a CDS to hedge his long position in a bond, receiving an insurance
payment if the bond defaults. An investor can also purchase a CDS without owning
the corresponding bond in speculation that there will be a default. Once the default
becomes more apparent the value of the CDS will increase and the speculative investor
will profit from the hedging investors purchase of the CDS. |
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