Book Notes - VAULT CAREER GUIDE TO INVESTMENT BANKING

VAULT CAREER GUIDE TO INVESTMENT BANKING

Chapter 1

1. What is investment banking? Is it banking? Is it investing? Really, it is neither. Investment banking, or I-banking, as it is often called, is the term used to describe the business of raising capital for companies and advising them on financing and merger alternatives.

2. Generally, the breakdown of an investment bank includes the following areas;
a) Corporate Finance (equity)
b) Corporate Finance (debt)
c) Mergers & Acquisitions (M&A)
d) Equity Sales
e) Fixed Income Sales
f) Syndicate (equity)
g) Syndicate (debt)
h) Equity Trading
i) Fixed Income Trading
j) Equity Research
h) Fixed Income Research

3. The bread and butter of a traditional investment bank, corporate finance generally performs two different functions: 1) Mergers and acquisitions advisory and 2) Underwriting.
On the M&A advising side of corporate finance, bankers assist in negotiating and structuring a merger between two companies. The underwriting function within corporate finance involves shepherding the process of raising capital for a company. In the investment banking world, capital can be raised by selling either stocks or bonds (as well as some more exotic securities) to investors.

4. Sales is another core component of any investment bank. Salespeople take the form of:
a) the classic retail broker
b) the institutional salesperson, or
c) the private client service representative

5. A trader plays two distinct roles for an investment bank:
a) Providing liquidity
b) Proprietary trading

6. Research analysts follow stocks and bonds and make recommendations on whether to buy, sell, or hold those securities.They also forecast companies’ future earnings.

7. Syndicate - the hub of the investment banking wheel, the  syndicate group provides a vital link.

between salespeople and corporate finance.
Syndicate exists to facilitate the placing of securities in a public offering, a knock-down drag out affair between and among buyers of offerings and the investment banks managing the process.

Chapter 2

1. Commercial Banking vs. Investment Banking - A commercial bank takes deposits checking and savings accounts from consumers while an investment bank does not.  

2. A commercial bank may legally take deposits for checking and savings accounts from consumers. The federal government provides insurance guarantees on these deposits through the FDIC.

3. Commercial banks make money by taking advantage of the large spread between their cost of funds and their return on funds loaned.

4. An investment bank does not have an inventory of cash deposits to lend as a commercial bank does. In essence, an investment bank acts as an intermediary, and matches sellers of stocks and bonds with buyers of stocks and bonds. Note, however, that companies use investment banks toward the same end as they use commercial banks. If a company needs capital, it may get a loan from a bank, or it may ask an investment bank to sell equity or debt (stocks or bonds). Because commercial banks already have funds available from their depositors and an investment bank typically does not, an I-bank must spend considerable time finding investors in order to obtain capital for its client.

5. Private Debt vs Bonds - ...in a bond offering, while the money is still loaned...it is actually loaned by numerous investors, rather than from a single bank. Because the investment bank involved in the offering does not own the bonds but merely placed them with investors at the outset, it earns no interest - the bondholders earn this interest in the form of regular coupon payments. The investment bank makes money by charging the client a small percentage of the transaction upon its completion. Investment banks call this upfront fee the ‘underwriting discount.’ In contrast, a commercial bank making a loan actually receives the interest and simultaneously owns the debt.

6. Legally, most bonds must first be approved by the Securities and Exchange Commission (SEC). The investment bankers guide the company throughout the SEC approval process, and then market the offering utilizing a written prospectus, its sales force and a roadshow to find investors.

7. Investment banks underwrite stock offerings just as they do bond offerings. In the stock offering process, a company sells a portion of the equity (or ownership) of itself to the investing public. The very first time a company chooses to sell equity, this offering of equity is transacted through a process called an IPO of stock. Through the IPO process, stock in a company is created and sold to the public.

8. Glass-Steagall Reform - The famous Glass-Steagall Act, enacted in 1934, erected barriers between commercial banking and the securities industry. A piece of Depression-Era  legislation, Glass-Steagall was created in the aftermath of the stock market crash of 1929 and the subsequent collapse of many commercial banks. At the time, many blamed the securities activities of commercial banks for their instability.

9. The framers of Glass-Steagall argued that a conflict of interest existed between commercial and investment banks. The conflict of interest argument ran something like this: a) A bank that made a bad loan to a corporation might try to reduce its risk of the company defaulting by underwriting a public offering and selling off the bad loan.

Chapter 3

1. Almost everyone loves a bull market.

2. A bull market occurs when stock prices move up. A bear market occurs when stocks fall. More specifically, a bear markets generally occur when the market has fallen by greater than 20 percent from its highs, and a correction occurs when the market has fallen by more than 10 percent but less than 20 percent.

3. The most widely publicized, most widely traded, and most widely tracked stock index in the world is the DOW JONES INDUSTRIAL AVERAGE. The Dow was created in 1896 as a yardstick to measure the performance of the US stock market in general. Today the Dow is made up of 30 large companies in a variety of industries and is measured in the thousands of points.


Chapter 6


  1. An IPO is the process by which a private company transforms itself into a public company. The company offers, for the first time, shares of its equity (ownership) to the investing public.
  2. The primary reason for going through the rigors of an IPO is to raise cash to fund the growth of a company and to increase the company’s ability to make acquisitions using stock.
  3. From an investment banking perspective, the IPO process consists of these three major phases: hiring the managers, due diligence, and marketing.
    1. Hiring the managers
                                                              i.      The first step for a company wishing to go public is to hire managers for its offering. This choosing of an investment bank is often referred to as a ‘beauty contest’. The primary manager is known as the ‘lead manager’, while additional banks are known as ‘co-managers’.
    1. Due diligence and drafting
    2. Marketing
                                                              i.      Investment banks earn fees by taking a percentage commission (called the ‘underwriting discount’, usually around 8% for an IPO) on the proceeds of the offering.
  1. A company that is already publicly traded will sometimes sell stock to the public again. This type of offering is called a ‘follow-on offering’, or a secondary offering. Another reason that a company would issue a follow-on offering is similar to the cashing out scenario in the IPO.
  2. When a company requires capital, it sometimes chooses to issue ‘public debt’ instead of equity. Almost always, however, a firm undergoing a public bond deal will already have stock trading in the market. (It is relatively rare for a private company to issue bonds before its IPO.)

Chapter 8

GOING PUBLIC
  1. Phase 1 – Hiring the Managers
    1. Pitching / Beauty Contests
    2. Selecting the Managers in the Deal
  2. Phase 2 – Due Diligence & Drafting
    1. Organizational Meeting with All Parties
    2. Due Diligence
    3. Drafting the Prospectus
    4. Meeting at the Printer and Filing the Prospectus
  3. Phase 3 – Marketing
    1. Designing the Roadshow – Slides & Presentation
    2. Amend the Prospectus – Per Comments from the SEC
    3. Managers Set Up Roadshow Meetings
    4. Roadshow Begins
    5. Roadshow Ends & Stock is Priced
    6. Stock Begins Trading the Next Day
  4. COMMONLY USED RATIOS
    1. SOLVENCY RATIOS
      Quick Ratio = Cash + Accts Rec / Total Current LiabilitiesShows the dollars of liquid assets (convertible into cash within 30 days) available to cover each dollar of current debt.
      Current Ratio = Total Current Assets / Total Current LiabilitiesMeasures the margins of safety present to cover any possible reduction of current assets
      Current Liabilities to Net Worth = Total Current Liabilities / Net WorthContrasts the amounts due creditors within a year with the funds permanently invested by owners. The smaller the net worth and the larger the liabilities, the greater the risk.
      Current Liabilities to Inventory = Total Liabilities / Net WorthCompares the company’s total indebtedness to the venture capital invested by the owners. High debt levels can indicate greater risk.
      Fixed Assets to Net Worth = Fixed Assets / Net WorthReflects the portion of net worth that consists of fixed assets. Generally a smaller ratio is desired.
      EFFICIENCY RATIOS
      Collection Period = Accounts Receivable X 365 / SalesReflects the average number of days it takes to collect receivables
      Inventory Turnover = Sales / InventoryDetermine the rate at which merchandise is being moved and the effect of the flow of funds into a business
      Assets to Sales = Total Assets / SalesThis rate ties in sales and the total investment in assets that is used to generate those sales
      Sales to Net Working Capital = Sales / Net Working CapitalMeasures the efficiency of management to use its short-term assets and liabilities to generate revenues
      Net Working Capital = Current Assets – Current Liabilities
      Accounts Payable to Sales = Accounts Payable / SalesMeasure the extent to which the supplier’s money is being used to generate sales. When this ratio is multiplied by 365 days, it reflects the average number of days it takes the company to repay its suppliers.
      PROBABILITY RATIOS
      Return on Sales (Profit Margin) = Net Profit After Taxes / SalesReveals profits earned per dollar of sales and measures the efficiency of the operations.
      Return on Assets = Net Profit After Taxes / Total AssetsThis is the key indicator of probability for a firm. It matches net profits with the assets available to earn a return
      Return on Net Worth (Return on Equity) = Net Profit after Taxes / Net WorthAnalyzes the ability of the firm’s management to realize an adequate return on the capital invested by the owners of the firm.



      Glossary

      Consumer Price Index (CPI) – The CPI measures the percentage increases in a standard basket of goods and services. The CPI is a measure of inflation for consumers.

      Convertible bonds – Bonds that can be converted into a specified number of shares of stock.

      Derivatives – An asset whose value is derived from the price of another asset. Examples include call options, put options, futures and interest rate swaps.

      Dividend – A payment by a company to shareholders of its stock, usually as a way to distribute profits.

      Equity – In short, stock. Equity means ownership in a company that is usually represented by stock.

      Leveraged buyout (LBO) – The buyout of a company with borrowed money, often using that company’s own assets as collateral.

      Mutual Fund – An investment vehicle that collects funds from investors (both individual and institutional) and invests in a variety of securities, including stocks and bonds. MFs make money by charging a percentage of assets in the fund. 


Notes: These are my notes from the book that have been shared. This is not a book review.

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